TaxTMI 
TaxTMI 
2017 (3) TMI 1963
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....("AO") pursuant thereto are not in accordance with law and are therefore, bad in law. 2. On the facts and circumstances of the case and in law, the Transfer Pricing order/ Assessment order/ directions passed by the TPO/ AO/ DRP are invalid and bad in law as the said order/ directions violate judicial discipline. GROUNDS ON TRANSFER PRICING ISSUES 3. The impugned order passed by ignoring the directions issued by the DRP is contrary to provisions of section 144C of the Act. 4. The TPO/ DRP and consequently the AO have erred, in law and on facts and circumstances of the case, by not accepting the economic analysis undertaken by the appellant in accordance with the provisions of the Act read with the Rules. 5. Without prejudice to above, the TPO has committed certain arithmetical inaccuracies while computing the net margins of comparable companies and the DRP has failed to adjudicate on the objection raised by the Appellant in this regard. 6. The TPO/ DRP and consequently the AO have erred in law and on facts and circumstances of the case, by rejecting the quantitative / qualitative filters applied by the appellant and substituting ....
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..... That the action of DRP in upholding denial of deduction under section 10AA and consequently the impugned order are contrary to law as the same is contrary to law including provisions of Special Economic Zones Act, 2005 which have an overriding effect. 17. That the AO has erred in incorrectly computing the tax demand payable by the Appellant under the impugned order. 18. That on the facts and circumstances of the case and in law, the AO erred in holding that the Appellant has furnished inaccurate particulars of income in respect of each item of disallowance/ additions and in initiating penalty proceedings under section 274 read with section 271 of the Act." 2. Out of above grounds, the assessee has not pressed ground No. 1 & 2 , ground No. 17 is consequential and ground No. 18 is premature. Grounds in Department's Appeal: "1. Whether on the facts and in circumstances of the case, the Hon'ble Dispute Resolution Panel (DRP) has erred in directing the Assessing Officer/Transfer Pricing Officer (AO/TPO) to exclude M/s Infosys Technologies Ltd from the list of comparables for the purpose of benchmarking the international Transaction and comput....
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....ttributable to oversight, the delay in filing the appeal is liable to be condoned, if the limitation period is reckoned from the date of original final order dated 19.09.2014 and if it is reckoned from the date of order u/s. 154 dated 09.12.2014, the appeal has to be treated as filed within the period of limitation. We observe that the reasons assigned by the revenue for filing the appeal with a short delay, are genuine, as nothing contrary is laid on record by the assessee. Accordingly, the delay is condoned. 4. The first major issue raised by the assessee in his appeal is against the addition of Rs.6,23,15,808/- made by the AO on account of transfer pricing adjustment, which was reduced to Rs.5,57,09,134/- vide rectification order u/s. 154 dated 09.12.2014. 5. Briefly stated, the facts of the case are that the assessee is an Indian branch office of Sony Mobile Communications International AB (hereinafter referred to as `SMCI') (formerly called Sony Ericsson Mobile Communications International AB), a company incorporated under the laws of Sweden. The assessee's Head office is a wholly owned subsidiary of Sony Ericson Mobile Communications AB (hereinafter referred to as `SEMC....
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....in the functional analysis, SEMCI can be characterized as a contract software development service provider providing routine software development services to its AEs. SEMCI does not own any intangibles vis-a-vis the products and does not have any other additional rights to use or exploit the intangibles owned by AEs. AEs, on the other hand, are complex entities that are engaged in fullfledged manufacturing and marketing / product development / product selling etc. covering a wide range of activities and other commercial or marketing intangibles (brand names, trademarks etc.) AEs are the developers, owners and licensors of virtually all valuable intellectual property rights including proprietary products and processes. They bear all significant business and entrepreneurial risks, including product development, performance in the market, financial risks etc. All returns / risks attributable to the intangibles should accrue / vest in the entity that owns the intangibles (i.e. AEs). SEMCI has undertaken the below mentioned international transactions with its AEs during FY 2009-10 (Please refer to Appendix D for details): a) Rendering of services; b) Purchase ....
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....o priority of methods. Rather, the selection of the pricing method to be used to test the arm's length character of a controlled transaction must be made under the 'Most Appropriate Method Rule'. The 'Most Appropriate Method' is that method which, under the facts and circumstances of the transaction under review, provides the most reliable measure of an arm's length result. In determining the reliability of a method, the two most important factors to be taken into account are (i) the degree of comparability between the controlled and uncontrolled transactions and (ii) the coverage and reliability of the available data. As per the Indian Regulations24, other factors such as nature and class of international transactions, conditions prevailing in the markets, extent and reliability of adjustments that can be made, and extent and reliability of assumptions that may be required in applying the method, shall also be taken into account. Because the selection of the "Most Appropriate Method" involves a test of relative merit, a method that may not be perfect is not rejected unless some other method can be shown to be more reliable or provide a bet....
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....India. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for software development services. External CUPs *The arm's length per unit prices to uncontrolled enterprises is substantially dependent upon factors such as volume, contractual terms, locational differences etc. *It may not be possible to estimate, with reasonable reliability and accuracy, the combined effect of such factors on per unit prices. *Abstract factors such as the use of intangibles make it difficult to use the CUP method for benchmarking purposes. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for software development services. Recharges received from AEs Internal CUPs In case of transactions in the nature of reimbursement of expenses like Recharges received from AEs from Group Companies to SEMCI, the third party cost reimbursed is a CUP for the reimbursement. Accordingly, keeping in view the nature of transaction and the degree of comparabi....
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....lit Method In general, the Profit Split Method ("PSM") evaluates whether the allocation of the combined profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contribution to that combined profit or loss. The profit split methods typically are applied where each party to the transaction under evaluation has significant intangible assets and/or the operations of the parties to the transaction are highly integrated and cannot be evaluated on a separate basis. Although the Indian transfer pricing rules list only one PSM, they provide guidance that the PSM can be applied by i) relying entirely on a contribution analysis; or ii) splitting the profits based on a residual analysis. Under the contribution analysis, the total profit earned by the parties to a controlled transaction is divided, based upon the relative contributions of the parties. The residual analysis allocates the combined operating profit or loss from the relevant business activity between the parties to the controlled transaction in two steps. First, a market return is provided to each party's routin....
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....t no comparable data at such a transactional level is likely to exist. Further, in case the transactions are closely interlinked, the same can be aggregated under the TNMM. Further, the CUP method has been applied to test the arm's length nature of the international transactions in the nature of cost reimbursements received from group companies. 5.2.5. Search for uncontrolled comparables and determination of Arm's Length Price. We searched the two widely recognised corporate databases to identify potential uncontrolled comparables for SEMCI's transaction. We primarily relied on Prowess and extracted additional companies from Capitaline Plus, i.e., companies for which data was not available in Prowess. For details about these databases and their limitations please refer Appendix E. To comply with the requirements of contemporaneous documentation to exist by the due date of filing the return of income as per the Indian Regulations, the Branch has conducted a benchmarking analysis using information in databases updated till February 19, 2010 focusing on the financial results of companies having financial years ended during the period Apr....
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..... FCS Software Solutions Ltd. P 38.97% 4. Goldstone Technologies Ltd. P 12.49% 5. LGS Global Ltd. P 22.57% 6. Larsen and Toubro Infotech Ltd. P 21.57% 7. Mindtree Ltd. P 21.52% 8. PSI Data Systems Ltd. P 4.70% 9. Polaris Software Lab Ltd. P 10.81% 10. Reliance Infosolutions Pvt. Ltd. P 0.97% 11. Sasken Communication Technologies Ltd. P 13.45% 12. Synetairos Technologies Ltd. P 21.33% 13. Thinksoft Global Services Ltd. P 17.72% 14. Zensar Obt. Technologies Ltd. P 18.97% 15. Crazy Infotech Ltd. P-Seg 1.35% 16. Teledata Marin Solutions Ltd. C-Seg 2.86% Mean 13.18% Median 12.97% Upper Quartile 21.38% Lower Quartile 4.24% The details of search for uncontrolled comparables and determination of arm's length price has been given in Appendix G. Our analysis shows that the arithmetic mean OP/TC of comparable companies is 13.18%. Hence, prices of international transactions of SEMCI that achieve an OP/TC of 13.18% or more would meet the arm's length standard required under....
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....ing profit margin was calculated in TP study report as under : Particulars Amount in Rs. Service Fee 574,714,335 Salaries and benefits 144,095,864 Admin and other expenses 243,260,899 Depreciation 102,026,461 Total Operating cost 489,383,224 Operating Profit 85,331,111 OP/TC (%) 17.44% 9. On the basis of above table, the tested party operating profit margin on cost is 17.44% in the international transactions which is held to be at Arm's length in the T.P. documentation. The observations of the TPO on the filters used by the assessee in the TP study report for arriving at the ALP of the international transactions, are as under : "8. In view of the functional profile of the assessee, the following set of filters have been found to be appropriate. The justification to apply them is discussed as follows: i. Use of current year data: The transfer pricing provisions lay down that primarily current year data should be use. The proviso to Rule 10D(4) allows the use of multiple year data only if the assessee is able to demonstrate through relevant data that certain factors of earlier years has affected the transfer prices ....
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....e when it will start affecting the price paid/received. The rationale given for the use of the limit of 25% is sound and this threshold limit has been approved explicitly an implicitly in quite a few judicial pronouncements. vii Companies that have employee cost that is less than 25% of total cost: The rationale for this filter is that companies that are engaged in providing services similar to yours will require a minimum level of expenditure as personnel expense. Employees cost constitutes the major component of cost in any service sector. Very low employee cost, viz., less than 25% of total cost, indicates that company is either engaged in some other business or it has outsourced the service/functions to a third party, i.e., it is not rendering services on its own. Such companies cannot be treated as functionally comparable to the assessee. viii Companies that are affected by some peculiar economic circumstances: Companies that are affected by factors like persistent losses, declining sales, extraordinary income or expense, mergers and acquisitions or other such factors which affect the operations of the company substantially should not be used as comparables a....
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....at this company is in the field of both IT services and e-learning and is presently engaged mainly in the business of education segment It cannot be taken as a comparable. iii. Goldstone Technologies Ltd. As per P-8/AR:- "Goldstone Technologies Limited (GTL) is presently engaged in the business of IT Enabled Services. GTL offers highly complex and mission critical solutions such as software support, software maintenance, business process outsourcing etc. Goldstone has a strong presence in the US and European markets for its highly specialized consulting services and Forte to Java Migration projects. Goldstone has strong initiatives to capture the new markets in the field of IT and IT Enabled Services." It is clear from the above description that this company is in the field of both IT and IT enabled services and is presently engaged mainly in the business of IT enabled services. It cannot be taken as a comparable. iv. PSI Data Systems Ltd As per the Prowess data base, the company has been merged and now is called Aditya Birla Minacs IT Services Ltd. The company does not qualify net worth filter as its net worth is (3.86) which is less than zero. It cannot be....
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.... Infinite Data Systems Pvt. Ltd. [Merged] 88.25 vi. Infosys Ltd. 45.08 vii. Larsen & Toubro Infotech Ltd, 20.48 viii LGS Global Ltd 12.79 ix. MindtreeLtd. 16.62 x. Persistent Systems Pvt Ltd. 30.50 xi. *Persistent Systems and Solutions Ltd. 15.38 xii. RS Software (fadiajitd. 10.29 xiii Sasken Communication Tech, Ltd. 17.54 xiv Tata Elxsi Ltd. 19.82 xv. Thinksoft Global Services Ltd. 17.35 xvi Thirdware Solutions 41.63 Average 27.82% *This company does not find place in the final set of comparables taken by TPO as narrated above. 15. Accordingly, the ld. TPO calculated the ALP of the international transactions with its AE as under : Particulars Amount Operating Cost 489,383,224 Arm's length margin (%) 27.82% Arm's length margin (Rs.) 136,146,413 Arm's length Price 6255,29,637 Price charged by the assessee 574,714,335 105% of Price charged in international transaction 603,450,052 Difference for which adjustment is proposed to be made 50,815,302 16. The ld. TPO has made point wise discu....
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....ccordingly, the ld. DRP directed the AO to exclude this company and confirmed the rest of the order of TPO. The AO, accordingly, passed final order on 10.09.2014, but he did not exclude Infosys as per directions of the DRP. Thereafter, the assessee filed 154 application, which was accepted by the AO vide order dated 09.12.2014 and excluding the company, Infosys Ltd. as per directions of the DRP, the AO reduced the addition of Rs.6,23,15,808/- to Rs. 5,57,09,134/- vide order u/s. 154 dated 09.12.2014. The Revenue has challenged the assessment order passed in compliance to DRP directing the exclusion of Infosys Technologies Ltd. and the assessee has also challenged the order of the AO by way of these cross appeals. 19. Grounds Nos. 3 to 8 are decided together. 20. We have heard the rival submissions and perused the relevant material on record. There is no dispute on the determination of ALP of any transaction other than that of `Rendering of services' with the declared value at Rs 574714335/-. Further, there is no dispute on the application of the TNMM as the most appropriate method with PLI of OP/TC. The assessee is aggrieved only against inclusion of four new companies in the....
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....ating from any information or material including intangibles supplied by it to the assessee. It has further been agreed that the assessee will not acquire any ownership or economic interest in the intangibles. We have gone through certain invoices raised by the assessee on SEMC, copies of which are available on page No. 138 onwards of the paper book No.2. For example, invoice dated 06.05.2009 has been raised on SEMC by giving total expenses incurred during the month of April, 2009 to which a markup of 15% has been added. Similar is the position about 15% markup on the costs incurred by the assessee in providing these software services to its AE in other months. However, as per agreement, the assessee has not furnished every year evaluation chart of compensation level for consideration of Arm's length compensation over the multiple years. Keeping the above background in mind about the functional profile of the assessee, we will now try to ascertain as to whether or not the above referred six companies are comparables. i) E-Infochips Banglore Ltd. 22. It has been submitted by the ld. AR that this comparable was selected by ld. TPO (Page No. 32-34 ) of the TPO's order even....
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.... what is being compared is not pure transaction of software development services but a mixture of SWD services and ITes services. 24. Having considered the rival submissions, we find that the co-ordinate Bench of ITAT, in the identical facts and circumstances has considered this company as excludable from the final set of comparables in the case of Sunlife India Services Centre Pvt. Ltd. vs. DCIT (ITA No. 750/Del./2015- order dated 27.06.2016) on the basis of functional disparity observing as under : "10.3.After considering the rival contentions and perusing the annual reports placed on record, we are of the opinion that this company cannot be selected as comparable for TP analysis, because it is engaged in both software development as well as ITes. Assessee being characterized as a routine service provider, the above company cannot be considered as comparable on functional basis. 10.4. As this company is functionally different from assessee and in absence of segmental information we direct the AO/TPO to exclude this company from the final list of comparables." 25. Respectfully following the decision of coordinate Bench, we direct the AO/TPO to exclude this ....
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....comparable from the list of comparables selected by the TPO. (iii). Persistent Systems Limited: 30. This company has been selected by the TPO (page No. 208-210). The TPO has discussed the functional profile of this company. According to TPO, the company is predominantly engaged in SWD services and concluded that it is fit to be considered as comparable. The assessee objected this company to be taken as comparable on the premise that the company is functionally dissimilar, as it is engaged in product development and product design services and that the complete segmental information are not available. He relied on the following decisions: (i). Cash Edge (ITA 64/Del./2015 - A.Y. 2010-11 - ITAT) affirmed by Hon'ble Delhi High Court in ITA No 279 of 2016. (ii). Equant Solutions India Pvt. Ltd.(ITA No. 1202/Del./2015-ITAT) (iii). Pyramid IT Consulting (ITA No. 5401/Del./2012 - ITAT) 31. After hearing the submissions of both the sides and perusing the material available on record and we find that this comparable company has been considered by ITAT in the case of Cash Edge (supra) wherein it has not considered as a comparable company in the identi....
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....dia Pvt. Ltd. Since both these companies are also engaged in the business of providing software development services to its AEs, similar to the activity done by the assessee, respectfully following the precedents, we order for the exclusion of this company from the list of comparables." Similarly, in the case of assessee's group company, viz., Fiserv India Pvt. Ltd. for AY 2010-11, which company is also in the business of software development services, a co-ordinate Bench of the Delhi Tribunal in ITA No.6737/Del/2014 deleted Persistent from the list of comparables. 17. Further a perusal of page 484 (PB-2) Annual Report of Persistent reveals that it is not only engaged in the business of software development services but also manufacture and sale of software products and owns significant intangibles and that segmental data for services and products is not available and the ld DR, could not controvert this fact, so we concur with the order of co-ordinate bench of the Tribunal, and we direct exclusion of Persistent Systems Ltd. from the list of comparables." 32. The Hon'ble jurisdictional High Court has affirmed the above decision of Tribunal in ITA No. 279 of 201....
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.... from the list of comparables." In view of the above decision, this company is directed to be excluded from the final set of comparables. (v). PSI Data Systems : 35. This company was included by the assessee as comparable, but excluded by the TPO (page 170 & 194 of TPO's order) for the reason that this company fails in the filter of net worth and stands merged with Aditya Birla Minacs IT Services Ltd. on 12.08.2009. The assessee submitted that the company has a positive net worth and it satisfied all the filters of comparability test. 36. The learned DR, on the other hand, submitted that this company has different functional profile, as it is a products company and earns income from license fees. It is also trading in products and as such does not qualify RPT filter. 37. After hearing both the sides, we find that the above company had been merged w.e.f. 12.08.2009 with Aditya Birla Minacs IT Services Ltd. and as such, said company had no locus standi for the whole year. Therefore, the TPO has rightly excluded this company from the list of comparables. (vi). Crazy Infotech Ltd.: 38. This comparable was selected by the assessee, but was rejected by TP....
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....nue primarily from providing SWD services and as such functionally comparable; that its 95% of total revenue is on account of SWD Services and only 4.38% of total revenue earns from software product; and that brand building and marketing expenses is only 0.34% of total revenue and R & D expenses constitutes only 2.07% of the Revenue and R &D spending does not necessarily create IPR. The assessee raised certain objections before the DRP against the inclusion of this company, and the ld. DRP accepted the objections of the assessee and following the decision of jurisdictional High Court in the case of Agnity India Technologies, 262 CTR 291 (Del.) excluded this company from the final set of comparables, which has been agitated by the Revenue in its appeal. 42. The ld. DR relying on the reasons given by the ld. TPO, submitted that the ld. DRP was not justified in excluding this company, as this comparable satisfies all the filters of comparability test, as given by the ld. TPO. 43. On the other hand, the ld. AR of the assessee submitted that this company has diversified business operations, viz., technical consultancy, designing development, system integration, package integration....
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....ny is, therefore, directed to be excluded from the list of comparables." 45. Respectfully following the decision of co-ordinate Bench, we find no good reason to interfere with the directions of ld. DRP with regard to exclusion of this company from the final set of comparables. Therefore, the appeal of the Revenue is liable to fail. 46. The assessee has raised issue regarding arithmetical errors while computing the net margin of comparable companies and the DRP has failed to adjudicate on the objections raised by the assessee on this issue. The assessee has relied on the decision of ITAT Delhi Bench in Rolls Royce India Pvt. Ltd. vs. DCIT (ITA No. 1310/Del./2015 - para 55). However, the assessee did not specify as to what arithmetical inaccuracies have been committed by the TPO. Therefore, the assessee is directed to demonstrate before the TPO the errors whatsoever. 47. In respect of ground No.9 for the use of multiple year data and determining the Arm's Length Margin, the ld. TPO has rightly dealt with this issue and the decision of ld. DRP upholding the order of the TPO is correct. Rule 10B(4) of the Income-tax Rules clearly stipulates that normally current year data shou....
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....purposes. 49. By means of Ground No. 11, the assessee has agitated the action of AO in upholding the decision of TPO for not making suitable adjustment to account for differences in the risk profile of the assessee, vis a vis, the comparable companies. 50. This issue has been elaborately discussed by the ld. TPO in his order (para 33). We are disinclined to interfere with the findings reached by the ld. TPO. Therefore, this ground is dismissed. 51. To sum up, we set aside the impugned order on the issue of addition towards transfer pricing adjustment and remit the matter to the file of AO/TPO for fresh determination of the ALP of the international transaction of rendering of software services in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings. 52. The only other issue, raised vide grounds Nos. 12 to 16 which survives for our consideration is the disallowance of deduction u/s 10AA of the Act amounting to Rs.10,01,05,706/-. 53. The facts apropos this issue are that the assessee claimed this deduction u/s 10AA. The AO refused it giving three major reasons as recorded on....
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....mined on cost plus basis, for development of computer software and not the sale proceeds of software sold by the assessee. (c) From the discussion made above, it is clear that the assessee cannot claim benefit of deduction u/s 10AA of the Act from transfer of its software to its Holding Company. The profit of the assessee from its Indian operation will only be determined once the software supplied by it is sold to third party. The assessee could have claimed deduction u/s 10AA of the Act on such profit subject to fulfillment of other conditions laid down in the said section. The assessee has not fulfilled all the conditions laid down in Section 10AA of the Act. For example, it has not remitted back the entire profit arising to it out of its supplies of software outside India. Hence, the deduction is not allowable to the assessee." The assessee is aggrieved against the denial of benefit of deduction u/s 10AA of the Act. 54. This issue is covered by the decision of ITAT, Delhi Bench in ITA No. 769/Del./2014 in the case of assessee itself for A.Y. 2009-10, wherein the Coordinate Bench of Tribunal held as under : "13. We have heard the rival submission and perus....