TaxTMI 
TaxTMI 
2008 (4) TMI 340
X X X X Extracts X X X X
X X X X Extracts X X X X
.... contribution Rs. 65,75,780/- b) Employees contribution Rs. 63,37,510/- Aggregating to Rs. 1,29,13,290 together with arithmetical mistake in disallowance to the extent of Rs. 4,08,181 and thereby total disallowance sustained was Rs. 1,33,21,471/-(Rs. 1,29,13,290 + 4,08,181). 2. For that on the fact and circumstances the ld. CIT(A) wrongly and arbitrarily disallowed payment of Rs. 67,77.210/- to the approved gratuity fund. 3. (a) That on the facts and in the circumstances of the case, the ld. CIT(A) erred in confirming the adjustments of Rs. 8,44,78,673/- to the international transactions of the appellant with its Associated Enterprises (AE), namely Development Consultant International Ltd. (Bahamas). The Kulijan Corporation (USA) and Datacore Systems Inc. (USA), without considering the written submissions and the financial of the Associated Enterprises explaining the facts of the case preferred before the ld. CIT(A). (b) That on the facts and in the circumstances of the case, the ld. CIT(A) erred in holding in principle that 'No matter which method is adopted, if the facts are in order, we should arrive at the same amount of adjus....
X X X X Extracts X X X X
X X X X Extracts X X X X
..... Without prejudice to ground (2) above, in the event Your Honours are of the view that ld. CIT(A) was right in confirming the adjustment, even assuming but not admitting the ld. CTT(A) erred in not considering the fact that the maximum amount of adjustment to the price of international transaction of the appellant would be limited to the gross profit earned by Development Consultant International Ltd., Bahamas and accordingly should have restricted the amount of adjustment in the international transaction of the appellant with Development Consultant International Ltd., Bahamas to USD 1,74,086 i.e. INR 78,33,870/-. 4. (a) That on the facts and in circumstances of the case, the ld. CIT(A) erred in specifying the reason for confirming the adjustment to the price of international transaction between Kulijan Corporation USA and the appellant by way of a speaking order. (b) Without prejudice to ground (2) above, in the event Your Honours are of the view that ld. CIT(A) was right in confirming the adjustment, even assuming but not admitting, the ld. CIT(A) erred in not considering the fact that the maximum amount of adjustment to the price (if international transaction ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....hed by the assessee, which stood at Rs.67,77,210/- is not to be allowed and has directed the AO to add back the same. 10. In appeal before us, the ld. counsel for the assessee has disputed such addition and has admitted that this is a continuous practice of assessee and has claimed the gratuity payment on the basis of calculation and following the consistency of making provision and claiming the same in its return of income and, therefore, the action of ld. CIT(A) in enhancing the disallowance is most arbitrary and liable to be deleted. 11. The ld. Departmental Representative for the Revenue has relied heavily on the order of the ld. CIT(A). 12. We after hearing both the parties are of the opinion that the claim of the assessee that the claim of gratuity has been made strictly following the consistency in the earlier years needs verification and, therefore, we restore the matter back to the file of A.O. to decide the same afresh and affording reasonable opportunity to the assessee of being heard. We hold accordingly and allow the ground for statistical purpose. 13. We now take up grounds no. 3, 4 & 5 for the appeal relating to the assessment year 2003-04 and grounds no.....
X X X X Extracts X X X X
X X X X Extracts X X X X
....0A to 10B of the I T. Rules, constitute a specific code or legislation on account of transfer pricing. 15. As per the provisions of Section 92E of the IT. Act read with Section 92D of the IT Act any assessee entering into any cross border transaction with an AE is required to furnish a certificate in the form accountant report along with the return of income and also maintain necessary documents, which must be filed with the Revenue Officer at the time of transfer pricing assessment, as and when called for. It is found that the assessee had failed to furnish the accountant report under Section 92E of the IT Act alongwith its return of income for the assessment year 2003-04. Further, then required by the TPO, during the course of the transfer pricing assessment for the assessment year 2003-04 to substantiate the transactions with the AEs having regard to the ALP through filing of necessary documentation, the assessee had not furnished any details/explanation with the TPO. As a result of such non-compliance on the part of the assessee, the TPO virtually framed a best judgement assessment so far as transfer pricing is concerned for the assessment year 2003-04 and computed a transfe....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ggested to retain the initial additions made by them at the time of the regular assessments. Shri Mitra therefore submitted, that the Commissioner (Appeals) had duly considered the merits of the case and decided the issues against the assessee for both the assessment years, not on the ground of non-compliance but on the ground of not being satisfied with respect to the arguments of the assessee justifying that the transactions entered into with the AEs were at arm's length. We have carefully considered the said submissions made by the learned AR and find the same to be correct, inasmuch as, the Commissioner (Appeals) did not uphold the additions on the ground of non-compliance by the assessee or furnishing of inadequate information/explanation by the assessee at the stage of the appellate proceedings, but the additions were sustained purely on merits. We also find that adequate opportunity was also given to the Revenue Officers at the time of the remand proceedings to verify the documents and other evidences filed by the assessee before the Commissioner (Appeals) and therefore it is nobody's case that while the appeals are subjudice before the Tribunal, the additions can be....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nto the following types of transactions (a) Engineering drawing and design services, (b) Deputation of employees, (c) Reimbursement of traveling costs and (d) Rendering data entry services through its group entity Datacore India. Hence, the ALP of each of the international transactions should be determined separately as the nature of transactions entered by the assessee with its AEs was different. Hence, the ALP would be determined based on the nature of services provided by the assessee for each class of transaction taking into consideration the functions performed, assets employed and the risks assumed, by the respective parties to the transactions. 4. The learned DR could not controvert the above arguments placed by Shri Rahul Mitra regarding determining the ALP of each international transaction separately by giving any strong argument. We are also of the same view that the ALP should be determined on a transaction-by-transaction basis and not on an aggregate basis as done by there TPO and sustained by the Commissioner (Appeals). 5. Before proceeding to discuss the determination of ALP on transaction by transaction basis, Shri Mitra submitted that as per Sectio....
X X X X Extracts X X X X
X X X X Extracts X X X X
....We agree with the view that in order to determine the most appropriate method for determining the arm's length price, it is first necessary to select the 'tested party' and the tested party will be the least complex of the controlled taxpayer and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables. 7. Based on the above discussion on 'tested party', Shri Rahul Mitra proceeded to argue the merits of the case for the international transactions entered by the assessee with each of its AE separately. 8. First in case of transactions entered by the assessee with its AE, DCIL in Bahamas, the learned AR stated that DCIL, is a wholly owned subsidiary company of the assessee in Bahamas. It is engaged in providing engineering services to its clients who are engaged in turnkey, projects at various industrial sites. The assessee has discussed and stated in the transfer pricing documentation report that DCIT is an entrepreneur company and since its inception it has created significant marketing intangibles. It utilizes these intangibles in order to generate work and enters into contract with....
X X X X Extracts X X X X
X X X X Extracts X X X X
....n assets, operating income to sales, and possibly other measures of net profit) are less affected by transactional differences than is the case with price, as used in the Comparable Uncontrolled Price (UCP) Method or in Resale Price Method (RPM). This has also been discussed in detail in the Transfer Pricing guidelines issued by the OECD. Para 3.27 of these guidelines stated that, "One strength of the transactional net margin method is that net margins (e.g. return on assets, operating income to sales, and possibly other measures of net profit are less affected by transaction differences than is the case with price, as used in the CUP Method. The net margins also may be more tolerant to some functional differences between the controlled and uncontrolled transactions than gross profit margins. Differences in the functions performed between enterprises are often reflected in variations in operating expenses...." Shri Rahul Mitra also submitted that without prejudice to the above, since DCIL had incurred losses at the net level and comparing margins at the net level would involve the process of determining the veracity of operating expenses incurred by DCIL, and also since the TPO int....
X X X X Extracts X X X X
X X X X Extracts X X X X
....atabase on the basis of the above-mentioned SIC codes and the region selected - this search resulted in 337 companies: Out of the above, all companies having no financial data were excluded. This resulted in the exclusion of 40 companies and we were left with a set of 320 companies. As mentioned earlier, the search is for distributors, whose functions performed, risks assumed and assets utilised are similar to that of DCIL i.e. a distributor of services. Hence, in order to arrive at a set of distributors whose assets employed are more akin to that of DCIL we have applied the following quantitative filters: - Net Sales: The companies for which no sales data was available were rejected; - Sales, General & Administrative (SG&A) Expenses: Companies having nil SG&A expenses were not considered as comparable companies to the tested party; - Research & Development Expenses/Sales 0%: We have rejected companies who have incurred any research and development expenses since DCIL as a distributor would not undertake any research and developmental activity; -SG&A Expenses/Sales falling outside Inter-Quatile Range: SG&A expenses/Sales ratio o....
X X X X Extracts X X X X
X X X X Extracts X X X X
....anies and we were left with a set of 295 companies. As mentioned earlier, the search is for distributors; whose functions performed, risks assumed and assets are similar to that of DCIL i.e. a distributor of services. Hence, in order to arrive at a set of distributors whose assets employed are more akin to that of DCIL we have applied the following quantitative filters: - Net sales 0: The companies for which no sales data was available were rejected; - Sales, General & Administrative (SG&A) Expenses 0: Companies having nil SG&A expenses were not considered as comparable companies to the tested party; - Research & Development Expenses/Sales 0%: We have rejected companies who have incurred any research and development expenses since DCIL as a distributor would not undertake any research and developmental activity: - SG&A Expenses/Sales falling outside Inter-Quartile Range: SG&A expenses/Sales ratio of a distributor represents the intensity of functions performed in order to generate sales. Hence, in order to select our appropriate set of comparables we have rejected companies which were lying outside the inter-quartile range of SG&A expens....
X X X X Extracts X X X X
X X X X Extracts X X X X
....different matter altogether that the Revenue Officers suggested to retain the initial additions made by them at the time of the regular assessment. 22. The learned AR Submitted that in case of AY 2003-04, the arm's length GP/Sales of the comparable companies is 28.22% which is lower than the GP/Sales of DCIL for the year ended 31 March 2003 of 61.10% indicating that DCIL has retained more than the arm's length margin at the gross level. He stated that transfer pricing legislation as provided in the IT Act allows a taxpayer to have an option to compute the ALP which may vary from the IT Act which states that "where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices or at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean". The assessee computed the arm's length price considering the 5% tolerance range. The results of such computation are given below: Sl. No. Particulars Reference Amount (in USD 1 Actual sales 940,822 2 Actual Cost of Sales ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e no paper company would be having such substantial business operations and having excellent customer relationship with its bankers and no nationalised banks would give such substantial credit limits to a paper company. 25. We have examined all the facts and record and after the due consideration of arguments placed by both the sides, we can see that DCIL has long standing banking relationship with banks like, Bank of India and Indian Overseas Bank. Further, it enjoys substantial credit limits provided by these banks for the purpose of its business operations. No paper company would be having such substantial business operations and have excellent customer relationship with its bankers and no nationalized banks would give such credit limits to a paper company. DCIL has been established after proper permission obtained from the Reserve Bank of India. Hence, based on the facts and our findings we can conclude that DCIL is a company of substance and is performing full-fledged distribution activities. It is not a paper company established to evade taxes as argued by the Commissioner (Appeals) in his order. Hence, we do not find any justification in the arguments of the Commissioner ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....y all the international transactions of the assessee as documented in the said report were aggregated and combined gross profit margin over direct & indirect costs for such international transactions was computed and compared with the gross margins earned by the assessee for transactions with third parties. Based on such global approach, the TPO made an adjustment in ALP of the assessee and accordingly made an upward adjustment of Rs. 8,48,82,472/-in the ALP of the assessee. 3. The ld. AR submitted that, TKC is one of the subsidiaries of Am DC Inc, New York USA, which in turn is a subsidiary of DCIL. TKC is a multi-disciplinary Engineering/Architech firm. It is in consulting engineering business for last 50 years. The range of services provided by TKC includes, feasibility study, master planning, preliminary design, design development, detailed engineering, preparation of construction specs & construction drawings, bid document preparation and bid evaluation, vendors' drawings review, inspection/quality control, project management, TKC has strength of 105 technical personnel in its Philadelphia office and another 68 in its Saudi Arabia, Jordan, Egypt and other offices.....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... order to the status to TKC and did not controvert the analysis done by the assessee. Shri Rahul Mitral submitted that the TPO and accordingly the Assessing Officer had duly considered all the said documents and evidences and furnished remand reports before the Commissioner(Appeals), copies of which were filed with the paper book, however, the Revenue Officers had refused to accept the explanations given by the assessee and suggested to retain the initial additions made by them at the time of the regular assessments. Based on the above facts and our findings, we agree with the arguments of Shri Rahul Mitra that in case of transactions of the assessee with TKC, the transfer pricing analysis should be from the Indian side considering the assessee as the tested party. 6. Shri Rahul Mitra submitted that in case of A.Y 2003-04, the analysis from the Indian side showed that the arm's length GP/DICOP of comparable uncontrolled transactions entered by the assessee with third parties is 334.17% whereas the assessee has earned profitability at the gross level of 1092.45% on its international transactions with TKC. In case of AY 2004-05, the analysis should that the arm's len....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Selection of time period This analysis has generally focused to operating results of service providers over the two-year period 2001 through 200. Basic Search Strategy The cut-off date of Prowess is on February 15, 2003. Basic Search Criteria The first set in our search process was to identify a large set of potentially comparable companies based on "Company Main Activity" as identified by Prowess. To ensure that we capture all the "potential comparables vis-a-vis companies proving service activity, the ratio of other operating income/Sales was taken to be more than 50% for both the years. The completeness of our selection was verified by checking by checking that well-known Indian services companies were included. We also cross-checked the selected companies against those listed in the ERC database for similar industries. Quantitative Screening Quantitative screening is a process under which comparability is assessed by comparing economically significant financial data or rations. To insure comparability, companies with the following characteristics were eliminated. (i) had a ratio of research and development (R and D....
X X X X Extracts X X X X
X X X X Extracts X X X X
....turing (Toll Manufacturing) - Photographic films, contract Manufacturing (Toll Manufacturing) - Type and rubber products, Contract Manufacturing (Toll Manufacturing) - tolls, Cellular Mobile services, Consultancy services. Software Development services - Client server and internet software solutions, Software development services - Design and engineering software (CAD/CAE), engineering software etc.) Software development services - Embedded systems and communication software. Software development services - General, Engineering and construction services (Dams, bridge-railway, etc), Education services, Entertainment & media services, Facilities management services, Hotel & restaurant services, Investment and financial services, industrial turnkey project execution services, internet service provider and e-commerce, Logistics support services, Media and publishing services, Medical and health care services Oil and commercial construction services, Road transport, services, Shipping and cargo services, Software products and services, Sales and support services, Travel related services, Warehousing and storage services. Out of the above 41 service categories the following cate....
X X X X Extracts X X X X
X X X X Extracts X X X X
....m these we extracted companies, which had Sales in at least two out of the three financial years during the period April 1, 2001 and February 16, 2004. This left us with 3,560 companies. The next step in our search process was to identify a large set of potentially comparable companies in the services domain from prowess. As the analysis pertain to capturing potential comparables within the service industry, the ratio of [oth op inc (other operating income)/sales-internal transfer-exp sales tax)] 50% was used as a cut-off criterion for all the years. The Other operating income definition as per Prowess captures all income generated by a company apart from its manufacturing and trading revenues. This left us with 582 companies within the services industry. We also used the Capitaline Plus database to extract companies within the services industry. Here, we started with a universe of 10,954 companies available in Capitaline Plus updated as of February 16,2004. From these were extracted companies, which had Sales 0 in at least two out of the three financial years ending during the period April 1, 2001 and February 16, 2004. This left as with 3,989 companies. As, we already ha....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ction (Companies involved in manufacturing, trading or any other activities not akin to consultancy services were rejected) 7 3 1. This criterion cannot be used in Capitaline Plus because of database constraints. 2. NSEIT Ltd god eliminated, as prowess did not provide information on the ownership structure. We have selected companies with functions similar to that of DCPL from the service category "Consultancy Services". Hence, we have chosen CNS -Consultancy Service as service category. Based on the above performed search process, a comparable set of 10 companies were finally selected. The same comprised of 7 from Prowess and 3 from Capitalline Plus. Subsequently all loss making companies were rejected. This led to the exclusion of 3 companies leaving us with a final set of comparables of 7 companies. This set of 7 companies represented the final set of comparable companies for DCPL. The final result are tabulated below: ALP ALP (Mean) DCPL's margin with DCPL's margin PLI DCIL Kuljian Operating Profit/TC (No of comparable companies = 7) 19.74% 173.19% 121.09% The re....
X X X X Extracts X X X X
X X X X Extracts X X X X
....India') - a 100% subsidiary of the assessee. The transaction is in nature of reimbursements from the assessee's perspective and it acts merely as a pass through entity. The assessee in this case assumes no risk whatsoever and is merely a pass through entity. Datacore India, the entity providing the services to Datacore USA assumes normal risks of the business as service liability risk, manpower risk, and capacity utilization risk whereas Datacore USA. the entrepreneurial company assumes greater risks. With respect to reimbursement received from Data Core USA the assessee is just a pass through entity in this case (as such no profits arise in books of the assessee) and it is Datacore India which is providing the back office services in respect of work downloaded by Datacore USA. Hence, in the books of the assessee there is no shifting of profits out of India and hence transaction has been undertaken satisfying the arm's length criteria. Hence. Shri Rahul Mitra submitted that there is no issue from transfer pricing perspective for the transaction entered by the assessee with Datacore US, it is the question of profits between two Indian entities, the assessee DCPL and Data....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ed below: For assessment year 2003-04. The entire Search procedure is the same as discussed above except for the comparable service category selected for Data-Core India. As discussed to the Functional Analysis section Data-Core India performs functions which are purely related to back end data entry involving no technical expertise as such. Hence we have chosen BOS - Back Office Services as service category. Please refer to Appendix E for the computation of the profit level Indicator (PLI) of Data-Core India. This resulted in the selection of six companies. Subsequently all loss making companies were rejected. This led to the exclusion of two companies leaving us with a final set of comparable of four companies. This set of four companies represented the final set of comparable companies for Data-Core India. Adjustment to Marketing and selling expenses A captive service provider is not required to market its services as the group companies download work to it. A third party service provider on the other hand, markets its services thereby incurring substantial expenses on account of such marketing and sales promotional activities. These third party service provide....
X X X X Extracts X X X X
X X X X Extracts X X X X
....bulated below PLI AL (Mean) -after application of the +/- 5% range Data-core India's margin Operating Profit/TC (No. of comparable companies = 4) 24.08% 26.61% The results of the economic analysis show that line arm's length OP/TC of the comparable companies is 24.08% alter application of the +/-5% range whereas the results of Data-core India for the year ended 31st March 2003 indicate that the company has earned a profitability of 26.61% on it international transactions when measured by the OP/TC criteria, This clearly establishes that the International transaction of Data-Core Indians with its associate is at arms length. For assessment year 2004-05 Selection of time period This analysis has generally focused to operating results of service providers over the two year period 2002 through 2003. Basic Search Strategy The cut-off date of Prowess is on February 16, 2004 We started with a universe of 7,957 companies which had sales. 0 in at least two out of the three financial years during the period April 1, 2001 and February 16, 2004. This left us with 3,560 companies. The next step in our search process was to identify a large set of p....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ompanies with low levels of sales can be significantly reduced because the same persons are often both major shareholders and key employees, diminishing the economic distinction between profits and salaries. (viii) Qualitative selection was done on the set of companies passing the above quantitative filters, The review was based on the selecting companies providing software development services. Table: Selection Process Criteria No of Cos. Passing the criterion Prowess Capitaline Plus Sales 0 (In at least 2 yrs within 2001-2004) 3560 1228 [othopinc/(sales - internal transfer-exp sales tax)] 50% 582 NA 3 Ownership group 581 4 NA 1 Excel Quantitative filters - (r and d current + r and d capital)/sales 3% 570 1227 NFA/Sales 200% 458 1060 Start-ups (Sales Rs. 1 cr. 397 774 Qualitative Selection (Companies involved in manufacturing, trading or any other activities not akin to consultancy services were rejected) 7 3 This resulted in the selection of 12 companies. Subsequently all loss making companies were rejected. This led to the exclusion of 5 companies leaving us with a final set....
X X X X Extracts X X X X
X X X X Extracts X X X X
....atacore India to Datacore US forms only a segment of the entire business operations of Datacore India. Datacore India is not a captive unit of Datacore US; it also has dealings with third party customers. To substantiate this contention, Shri Rahul Mitra referred to the segmental results of Datacore India for the A.Yrs. 2003-04 and 2003-04) and 2004-05, which have been filed in the written submission, as below: Assessment Year 2003-04 Particulars Segmental results in relation to transactions with Datacore USA (Rs.) Others (Rs.) Total (Rs.) INCOME 19,491,284 51,181,920 70,673,205 EXPENDITURE Salary & Benefits 9,877,570 22,057,677 31,935,248 Other Welfare 622,015 1,443,288 2,065,304 Purchase 666,000 666,000 Rates & Taxes 1,250 212,181 213,431, Travelling & Conveyance 411,509 2,757,242 3,168,751 Other expenses 4,123,659 17,516,688 21,640,348 Depreciation 346,616 827,547 1,174,163 Bank charges 12,116 104,690 116,806 Misc. Exp. Written off 1,528 1,528 Spec. Software Dev. Costwritten off 1,249,080 1,249,080 Int....