9911796707
TMI Blog2011 (6) TMI 682X X X X Extracts X X X X X X X X Extracts X X X X ..... common ground in all the three years, relates to addition made on account of adjustment recommended by the TPO in the arms length price of the international transactions entered by the assessee with its associate enterprises. The facts and circumstances on this issue are common. Therefore, we deem it appropriate to dispose of all these appeals by this common order. 2. The basic facts are common in all the asstt. years. For the facility of reference, we are taking up the facts from the asstt. year 2003-04. However, if we find some variation in the facts which have any bearing in adjudicating the controversy, we would refer those facts at the appropriate stage of this order. 3. The dispute in brief is that assessee has disclosed international transaction with its associate enterprises in all these three asstt. years. In its transfer pricing report submitted in form No. 3CEB, it has provided the appropriate method as transactional net margin method (TMM) and computed the PLI by dividing operating profits with operating cost. In this procedure, assessee has shown profit level indicator at 9.87%. The Ld. TPO on the basis of comparables, recommended the adjustment by working out avera ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee along with form No. 3CEB, made a reference u/s 92CA(1) of the Act to the transfer pricing officer. Ld. TPO in order to verify whether assessee has disclosed the value of its international transaction according to the arms length price or not examined the transfer pricing report submitted by the assessee and thereafter pointed out the defects in preparation of such report. After hearing the assessee, he carried out a fresh search and then selected suitable comparables and then recommended the adjustment in the value of internal transaction disclosed by the assessee. In this exercise, Ld. TPO first noticed the business profile of the assessee. Thereafter, he noticed operating model etc. The object of analysing the report is that such report will throw light on the function performed by undertaking, what type of assets were employed and how much risk was assumed by the assessee. Keeping in view these factors it is to be seen how much return is disclosed by the assessee in the shape of profit whether it is consumerate with the function performed, assets used and risk assumed. The business profile and operating model noticed by the Ld. CIT(A) read as under :- "A. Business ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rms the long-term strategic management and planning function for overseas operations * The product conceptualisation, core design, research and development, marketing, distribution, sales and post-sales client support are all performed by ST Group * All major decisions relating to software development (in terms of extent, timing, sequence, etc.) are taken by ST Group. * ST Group follows a waterfall model of chip design/software development life cycle. * ST Group is engaged in core technology development, complex manufacturing, global sales and marketing, etc. * STML develops Integrated Circuit Designs, CAD Tools, Computer Software etc, for ST Group and undertakes these activities in accordance with the guidelines. * STML acts as a back office contract service provider to ST Group and does not need to perform software development for any external customers. * STML only performs the routine service function in the life cycle provided by the ST Group, within the framework of budgets decided between ST India and ST Group, which shows that all high value functions are performed by ST Group. * STML undertakes all the common functions such as finance and accounting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esearch and development on its own account, and accordingly, it is not exposed to this risk. * STML is protected from credit risk as it is compensated by ST Group irrespective or collections by the latter from the ultimate customer. * STML bears foreign currency risk during the period between involving and recovery. * STML is exposed to manpower risk. * As ST India bills ST Group on a cost plus basis, it does not bear the idle capacity risk. * STML has low exposure to price risk because it renders software development services exclusively for ST Group under a long term development arrangement. 6. Ld. TPO after analysing the TP report submitted by the assessee observed that assessee has identified a set of 14 comparable companies from prowess data base by adopting a formula based search strategy, thereafter it applied various quantitative and qualitative filters to the set of potential comparables. He also found that assessee has relied multiple year data and had focused on the operating results of comparable over the three Financial years i.e. Finance year 2000-2001 to 2002-03. The arithmetic mean of the 14 comparables identified by the assessee was worked out at 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wer of an advanced worldwide communications network and the discipline of a global service oriented corporate culture with the skill and enthusiasm of the Indian Scientific engineering community. (iii) STML has established a Design Centre at Noida, which serves the group as one of the most important centre for IP creation. It develops libraries of reusable IPs based upon UNICAD and the CAD platform, especially in advanced System-on-Chip (SoC) solutions for digital consumers, computer, telecom and automotive applications. (iv) Among the custom chip designs that have been implemented at Noida are telephone ICs and a variety of high profile hard disk and computer peripherals. (v) The range of design activities carried out by STML reflects the multifunctional nature and its ability to create leading edge technologies. (vi) STML specializes in developing high value VLSI intellectual Property (IP's), System on Chip (SOC's), embedded software for end applications and IT infrastructure. (vii) STML was also a major contributor to the development of the latest Nomadik chip family which will enable portable terminals to play music, take pictures, record video, and host two-way ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erformed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions (iii) Contractual terms whether or not such terms are formal or in writing, of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (iv) Conditions prevailing in the markets in which the respective parties to the transactions operate, including geographical locations and size of the markets, the laws and Government orders in force, costs of labor and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail (v) A high degree of similarity is required in a number of aspects of the associated enterprise and the independent enterprise involved in the transactions in order for the controlled transactions to be comparable (vi) Various factors other than products and functions that can significantly influence net margins. (vii) Net margins may be directly affected by such forces operating in the industry as follows * Threat of new entrants * Competitive ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business as high end service provider. According to the assessee, there is no material on the record which suggest that assessee is a high end service provider. For buttressing his contention, assessee has drew the attention of Ld. First Appellate Authority about its operating model as well as business profile extracted supra. It also submitted that Ld. TPO has erred in rejecting the search methodology used by the assessee for selecting the comparables. According to the assessee, the TPO has erred in applying fresh search method without pointing out specific defects in the assessee's method. The assessee also contended that TPO has erred in not granting the benefit of + - 5% variation from arithmetic mean provided in the proviso to section 92C(2). The assessee further contended that the TPO ought to have not relied upon the current year data alone. He should have appreciated the TP report submitted by the assessee on the basis of multiple year data. 11. The Ld. CIT(A) has considered the submissions of the assessee in detail. With regard to its first objection that reference made by the AO to the TPO is bad in law. Ld. CIT(A) , on the strength of special bench order of the ITAT in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with related party as filter, is an arbitrary step and, therefore, any enterprise who has related party transaction that has to be excluded from the comparable. 13. The next filter applied by the Ld. TPO is employee cost to the total cost. In asstt. year 2003-04, he was of the opinion that employees cost to total cost of the assessee was 53.69%. The TPO has used a filter of 10% for selecting the comparables. Ld. CIT(A) was of the opinion that there is a huge margin between 10% and 53.69%. In his opinion, the companies who have employees cost ratio over total cost exceeding 25% can be considered as a comparable. After applying these two additional filters, Ld. CIT(A) has identified 4 companies which can be termed as a comparable. An arithmetic mean of NCP in respect of these four companies comes out to 16.16%. He upheld the adjustment by applying this ALP. Ld. TPO has recommended an adjustment of Rs. 10,35,72,191/- with the ratio worked out by the Ld. CIT(A), it comes out to Rs. 8,30,01,779/-. The Ld. CIT(A) in this way deleted the adjustment to the extent of Rs. 2,05,70,412/-. The revenue is impugning this deletion whereas assessee is impugning the confirmation of addition at Rs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gin (TNMM), using net profit margin based on cost as PLI. In these three years this method was not disputed by the Ld. TPO. We can say that both sides are in agreement on the method. The next dispute is use of current year data or multiple area data 19. After resolving the appropriate method for determining the ALP, the next step is to find out the data required to be used for selecting comparables. The assessee has used multiple area data whereas the TPO is of the opinion that current year data is to be used. The view of the Ld. TPO has been accepted by the Ld. CIT(A) in asstt. year 2003-04 and 2004-05 and Ld. DRP in asstt. Year 2006-07. Arguments of the assessee 20. The assessee has contended before the Ld. TPO that section 92C and section 92D read with rule 10D clearly indicate that documentation (including the bench marking / analysis) is required to be maintained by the assessee to establish and support the arms length nature of its international transaction. The assessee is required to maintain TP documentation contemporaneously . Such documentation should exist latest by 31st October of the relevant financial year. This make it clear that legislature prefers the determ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t an exception that the data relating to the period of being more than two year prior to such financial year may also be considered, if such data reveals facts which could have an influence on the determination of transfer price in relation to transaction of comparison. Thus the main section used the expression "shall" which make it mandatory to first use the current year data. If certain other circumstances reveals an influence on the determination of transfer pricing in relation to the transaction being compared than other datas for period not more than two years prior to such financial year may be used. Thus Ld. CIT(A) as well as Ld. DRP has rightly upheld the view point of TPO for using current year data. 23. The next step for determination of A.L.P. of the international transactions entered by the assessee with its associate enterprises is to find out the comparable assessees who have uncontrolled international transactions of similar nature. Before finding out the comparable, it is necessary to find out the status of assessee i.e. what it manufactures and with whom it can be compared. This dispute arises because the Assessing Officer termed the assessee as high end performer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es research and development activities related to the product. The high design cost is incurred in France and Italy and are mainly on account of their focused activities on centralized development of technology platform. The role of the assessee is negligible in performance of this stage. He admitted that no doubt in India, certain designs works are also carried out but they are only a partial execution of the design and developments carried out by the ST Group. The assessee works only on the specification given to it by the ST Group. The next stage is product testing and verification. The product design is followed by the product testing and verification stage. According to the assessee, it is critical stage which requires high infusion of capital in order to test the designed product. There is no contribution of ST India in performance of this stage. Stage No.5: At this stage, manufacturing and fabrication taken place. According to the assessee, it also involves high capital and it is highly complex process. There is no role of ST India in carrying out this activity. Stage No. 6: In this stage, sales marketing and customers support are performed. On the strength of this flow ch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ithin India may be not be at par with the activities carried out by it's A.E. but that cannot be a test to determine the nature of activity performed by the assessee. The work performed by the assessee within India has to be compared with other assessees who are performing such type of activities and where they stand in a value chain of software development. The crucial issue is to find out whether the activity performed by the assessee can generate the profit equivalent to the one shown by the assessee only or there is some hidden embedded advantage being siphoned off by the assessee to its A.E. He also referred to the article of learned professor relied upon by the Learned CIT(Appeals) as well as the circumstance pointed out by the Learned TPO (extracted supra). In assessment year 2006-07, Learned DRs have pointed out that there is no disparity on facts. They have submitted that ST India is on of the largest design centres of ST group outside Europe. ST India has established a design centre at NOIDA and a Branch Office at Bangalore. The design centre employees around 1600 people. It develops Libraries of re- usable IP's based upon UNICAD and the CAD platform, specially advanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... formed by ST group. The crucial issue which ought to be explained by the assessee is what is the importance of this 2% role vis-à-vis the role performed by similarly situated companies in an uncontrolled business environments. On an analysis of the learned TPO's order in different three years, including the TP report submitted by the assessee, we find that assessee has tried to give a uniform PLI, certain comparables which were found acceptable by the assessee in financial year 2004-05 all of a sudden become incomparable in financial year 2005-06. It suggests that efforts of the financial analysist was to prepared the documentation in such a fashion which would give the result near to the result disclosed by the assessee. Learned TPO in all the three assessment years and the Learned CIT(Appeals) in assessment years 2003-04 and 2004- 05 has considered this aspect elaborately. The objections pointed out by the learned counsel for the assessee during the course of assessment proceedings are peripheral objections, a suitable adjustment can be made while selecting the comparables which can take care of their objections. After considering the detailed findings of Learned CIT(Appea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 crores and eliminated companies having sales more than Rs.2500 cores. On the strength of ITAT's order in the case of Mento Graphic, it was submitted that learned TPO could have carried out fresh search only if the comparable drawn by the tax payers was insufficient or had other deficiencies. The learned counsel for the assessee also submitted that in the case of Philips Software, ITAT has held that learned TPO was supposed to satisfy and communicate to the taxpayers, about carrying out fresh search and not accepting the comparables selected by the assessee. Learned DR on the other hand relied upon the orders of the Revenue Authorities Below. 31. We have duly considered the rival contentions and gone through the record carefully. In assessment year 2003-04, learned TPO while pointing out the defects in the TP report has observed that assessee is engaged in a specialized area of development of embedded technology under the overall guidance from the parent group companies. No doubt assumption of risk and development of intangible assets is limited but still assessee did not make any attempt to take note of this characteristic of the service provided in the selection of comparables. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of ITAT in the case of Sony India reported in 114 ITD 448 and in the case of Philips Software reported in 26 SOT 226. To some extent, we concur with the proposition raised by the learned counsel for the assessee but in our opinion such circumstances are to be decided by the learned TPO on a touchstone basis. He is not supposed to record specific finding before proceeding to select fresh comparables. The idea is to arrive at a reasonable conclusion for identification of comparables which can goad any authority to determine the ALP of any international transaction entered with an associate enterprises by an assessee. Every effort should be made within the ambit of procedure provided in the Act as well as Rule 10B of the Income-tax Rules. The approach of the Learned TPO ought to be judicious. The comparability between a controlled transaction and uncontrolled transaction is a comparison of condition which is broader than a mere comparison of price or margin. Where it is found that the conditions were imposed which differ from those which would be made between independent enterprises, transfer pricing adjustment are to be made. Thus, the learned TPO while evaluating the TP study made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rned TPO has pointed out other aspects also. As observed earlier, he has to appreciate the TP study submitted by the assessee on reasonable basis as well as prima facie. Therefore, we do not see any error in the procedure adopted by the learned TPO for carrying out the fresh search in identifying the new comparables. We have seen TP report submitted by the assessee for these three years and the order of the PTO in assessment year 2007-08 also, we find that in every year by adjusting the financial calculation depending on different aspects effecting any business organization, assessee is submitting a TP report which is consumerate to the result declared by it. It used to select different filters for selecting or eliminating the comparables in each assessment year in such a way that would give only uniform result. Therefore, this issue is decided against the assessee in all the assessment years. 33. The next area of dispute between the parties is selection of comparable companies for the benchmarking analysis of ALP relating to international transaction. In assessment year 2003-04, learned TPO has selected 23 comparables which have been reproduced by the Learned CIT(Appeals) on page ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... td 16.52 2 Lanco Global Systems Ltd. 5.88 3 Exensys software solutions Ltd. 26.18 4 Sankhya Infotech Ltd. 25.27 5 Visualsoft Technologies Ltd. 13.05 6 Sasken Communications Tech. Ltd. 2.59 7 L & T Infotech Ltd. 12.42 8 Infosys 41.99 9 Flextronics Ltd. 28.55 10 Tata Elxsi Limited (seg) 20.61 11 Akshay Software Technologies Ltd. 7.4 12 VJIL 6.07 Average OP/TC% 18.30 36. In assessment years 2003-04 and 2004-05, Learned DR has submitted that assessee has eliminated certain comparables on the ground that such companies have related party transaction because more than 26% shareholding of subsidiary were held by the company abroad. He pointed out that meaning of associate enterprises has been provided in section 92A(2)(a) of the Act. According to this clause, there should be holding of more than 26% shares, directly or indirectly by one enterprises in the other enterprises only then they will be related party. The TPO was of the view that there may be transactions with associate enterprises but the transactions should not be more than 30%. Learned CIT(Appeals) did not accept this filter and held that there should not be any transaction with rel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Act. The expression "in accordance" means "inconformity" or "as provided". If the assessee has determined ALP of international transaction according to this mandate then Assessing Officer cannot determine the price according to the method which is appropriate according to him, unless the method selected by the assessee cannot reasonably be applied to the facts and the circumstances of the case. Learned TPO has provided two set of comparables and some of the companies were common in both the sets whereas some of the companies appearing in first set were missing in the second set. It indicates that learned TPO had worked with a pre-determined mind set of recommending some adjustments. The second set was issued within eight days of the issuance of the first set. Learned TPO has excluded certain companies which are comparable to the assessee but indicating the loss. The companies cannot be excluded merely for the reasons that they were showing loss. For buttressing his contentions, he relied upon the decision of the ITAT in the case of M/s. SONY India (P) Ltd. Vs. DCIT reported in 114 ITD 448 (Delhi). He pointed out that if Assessing Officer was excluding the companies who are consis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic development and level of competition and whether the markets are wholesale or retail". 40. A bare perusal of this rule indicates that various aspects of the international transaction vis-à-vis uncontrolled transactions are to be kept in mind while deciding ALP of international transaction. Thereafter, Rule 10B(3)(ii) provides that reasonably accurate adjustment can be made to eliminate the material effects of such differences. If we have overall look on the TP regulations then it would reveal that ALP of an international transaction cannot be determined accurately in accordance with a scientific formula. It is quite difficult to arrive at any firm conclusion with mathematic precision. The simple reason is that concept of business which gives rise to all national and international transactions in itself has a wide import and it means an activity carried on continuously and systematically by a person by the application of his labour and skill with a view to earn an income. There are large number of factors which effects the business such as functions performed, assets employed and risk assumed. The concept of risk in itself provides various type of risk for example market ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was conscious of the fact that in a quantitative filter, this concern deserves to be excluded but then he observed that in this year assessee in its TP study report included certain concerns who has a huge turnover of 14740 crores. Similarly, assessee has also accepted comparables like Lanco & Aksha Software which have sales turnover of less than Rs.10 crores. Thus, it reveals that assessee did not adhere to quantitative filter in this assessment year. Infosys no doubt gives a better profit result but again in the 12 comparables selected by the learned TPO, there are certain comparables whose profit margin is quite low then the assessee and an arithmetical mean of 18.30 has been worked out. 41. As far as the arguments of Learned DR in assessment years 2003-04 and 2004-05 are concerned, we find that in the case of Sony India, ITAT has accepted the comparables who has related party transaction in between 10 to 15%. Such a company can be compared. Learned TPO selected the comparables to the extent of 25% related party transactions whereas Learned CIT(Appeals) eliminated all those comparables. At the time of hearing, he was unable to point out the specific company which was selected b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... C(2) with retrospective effect from 1.4.2002. It provides a tolerance band. It also suggests that there will be no TP adjustment in cases of marginal variation up to +/- 5% but substantial variation would result in appropriate TP adjustment. Learned CIT(Appeals) has explained the meaning of tolerance band which read as under: * "Whether there is an international transaction involving sale of a product or export of services, there would be a credit entry in the profit & loss account. By allowing a margin of (-) 5% for such a transaction, a taxpayer is permitted to have a credit entry which is not below 95% of the ALP so that profit from the transaction is not understated beyond the tolerance level of (-) 5%. * Whenever there is an international transaction involving purchase of a product or import of services, there would be a debit entry in the profit and loss account. By allowing a margin of (+) 5% under such a transaction, a taxpayer is permitted to have a debit entry which is not above 105% of the ALP so that profit from the transaction is not understated beyond the tolerance level of (+) 5%. 11.18.3 The decision rule contained in the proviso to the sec. 92C(2) of the Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the PLI of the assessee. If that arithmetic mean falls within the range of alleged tolerance band then there may not be any adjustment but if it exceeds then ultimate adjustment is not required to be computed after reducing the arithmetic mean by 5%. The actual working is to be taken. Learned First Appellate Authority has considered this aspect elaborately in assessment year 2003-04 and after going through his order, we do not see any merit in the ground of appeal raised by the assessee in all these three assessment years. 47. In assessment year 2006-07, the next grievance of the assessee is that the Assessing Officer has erred in treating the software expenses as capital in nature. Learned DRP has erred in upholding the conclusion of the Assessing Officer. The brief facts of the case are that the assessee has debited an amount of Rs.4,88,63,330 on account of computer software. It has capitalized a sum of Rs.1,31,41,004 in the computation of income. The assessee had claimed a sum of Rs.2,81,60,384 as revenue expenses. Contention of the assessee is that this expenditure was incurred for acquiring the license to use of software for a period of one year or less than two years. Assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th the parties for these two years along with the present appeal. We also do not find any such dispute in those years. It suggests that learned DRP has considered this issue without making proper analysis. On perusal of the assessment order, we find that the Assessing Officer while considering the ratios laid down by the Special Bench of the ITAT has observed that Special Bench was not correct in interpreting the law. In our opinion, it is not for the Assessing Officer to comment upon the orders of the higher authorities rather she is bound to follow them. If revenue has any grievance with the proposition laid down by the Special Bench then there are remedies in the Act, to redress those grievances. The understanding of the Assessing Officer with regard to the ratios laid down by the Special Bench, is not appreciable. The assessee has not acquired any ownership in the alleged license and the license's self life is less than two years. The nature of assessee's business is such that which required computer software. Therefore, the expenses incurred by the assessee for obtaining the license to use the software is to be treated as revenue expenditure. Respectfully following the order o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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