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TMI Blog2011 (6) TMI 385X X X X Extracts X X X X X X X X Extracts X X X X ..... gth Price (hereinafter for short "ALP") in relation to international transaction. The TPO, vide order dated 29-10-2009, arrived at a Transfer Pricing adjustment of Rs. 1,94,44,068. The assessee made submissions before the Assessing Officer against the proposed adjustment. The Assessing Officer rejected the same and issued a draft assessment order. The assessee filed objections against the proposed variation to the income before the Dispute Resolution Panel-1, Mumbai on 22-12-2009. The panel, vide its order dated 6-8-2010, has issued certain direction under section 144C(4) of the Act. The Assessing Officer passed the order under section 143(3) read with section 144C(13) of the Act on 20-9-2010. Aggrieved the assessee is in appeal before us. 3. The facts, as far as the company and the issues are concerned, have been brought out in the order dated 29-10-2009, passed by the Transfer Pricing Officer (hereinafter for short "TPO") under section 92CA(3) of the Act, which is extracted for ready reference :- "3. The assessee is a company of the Exxon Mobil Corp. Group of US and is responsible for information dissemination, maintaining customer relationship and market development for its AE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... All these activities are to be carried out at the Bangalore Research and Development Technology Centre (BRDTC), which has been set up for this purpose. For the services rendered the AE undertakes to reimburse the entire costs for running BRDTC. This includes the direct cost represented by compensation for employees for materials and supplies and other costs including travel, bonus etc., of employees. The indirect costs comprising of utilities, rentals, supervisory and administrative costs plus general overheads including apportionment of the supporting departments etc. The AE also compensates direct expenses of application technical developments managers and expenses on seminars and conferences etc. However, the assessee does not get any compensation in respect of the services rendered to the AEs. (ii) The second agreement is called Technical Representation Agreement entered into by the assessee with Exxon Mobil Research & Engg. Company. Under this agreement the assessee has to assist its AE in promotion of its various petroleum processes and other technologies listed out in para 3 of the agreement. In consideration of the services rendered the assessee is paid $ 400 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... earch & Development Technology Centre (BRDTC), division of EMCIPL (the assessee) is one of the Exxon Mobil Chemical US research centres, others being in US and in Belgium. This centre offers technical services to its associated enterprises and it concentrates primarily on developing new customer centric applications for the Butyl Polymers and Ethylene Elastomers line of products. 3.2 .......... 3.3 .......... 3.4 The centre of Bangalore is being run pursuant to an agreement between Exxon Mobil Co. India (P.) Ltd. and Exxon Mobil Asia Pacific (P.) Ltd. A perusal of the agreement, dated 17-5-2004 shows that as per Article 2 the assessee (BRDTC) shall provide the following services : 2.1 Application technical development services to Butyl and Ethylene Elastomers customers of EMCAP in Asia Pacific and other regions. 2.2 Develop product applications and undertake new applications development. 2.3 Such other technical services as and when required by EMCAP BRDTC will undertake the above projects as per requests received from EMCAP or its nominees and provide a report of its findings/analysis. 3.5 Further in consideration of these services the assessee receives only a reimbursement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d entity. Just because they provided some assistance in marketing (if any), cannot lead to allocation of their cost for marketing. They were full time employees of BRTDC and any such activity would have been possible only in their spare time. This cannot result in allocation of their costs between the marketing & the application research segments. Further there is no evidence to substantiate claim the assessee, nor have you maintained any log book or carried out any time and motion study to explain the percentage of 1, 10 and 25 per cent. Moreover as a matter of fact out of total study 36 persons employed only 9 persons are stated to be employed in application research and they were stationed at Bangalore. Just because they happened to be with the marketing team for some clarifications cannot be any basis of allocated their cost towards marketing. It is also a fact that the assessee while claiming the reimbursements has claimed the entire establishment cost. 3.7.3 The allocation of expenses therefore, cannot be accepted as a proper allocation of cost in segmental analysis. 3.7.4 As already stated the assessee has not charged any price for the services being rendered by it to its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ATD and R&D lab would be 10 per cent and 1 per cent respectively. Similarly, there is another letter from Pradeep Patki, who has enumerated the activities which he has undertaken. 8.3 I have gone through the various correspondences which are addressed to the Taxation Department. The e-mail correspondence which has initiated from the head office itself mentions the percentage of allocation carried out and seeks instances of work being done for justifying this allocation. None of the executives have any basis to justify the percentages of 1, 10 and 25 as mentioned above. The correspondences are self-serving documents without any supporting log books or time and motion studies. Such self-serving documents do not carry any evidential value. The total staff strength of the employees is only about 36 persons as stated by the assessee. Out of these 9 persons are in the application research and technical team stationed at Bangalore. There are 14 persons under the marketing segments and 13 another in back office services. These also include the persons in the head office administrating the overall affairs. The Technical agreement with Exxon Mobil Chemical Asia Pacific clearly shows that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e compensation for BRTDC is being worked out as under. 8.6 Selection of comparables and their operating margins : The assessee had undertaken a detailed search in its transfer pricing report and selected following 7 comparable companies for working out arithmetic mean of 18.47 per cent: Sr. No. Name of the company Average adjusted OP/TC 1. Alphageo (India) Ltd. 24.74% 2. Dolphin Medical Services Ltd. 11.46% 3. N.G. Industries Ltd. 29.60% 4. Vimta Labs Ltd. 69.49% 5. Neeman Medical International (Asia) Ltd. -0.89% 6. ADS Diagnostic Ltd. - seg. -9.20% 7. Pfizer Ltd. - service seg. 4.07% Arithmetic mean 18.47% As discussed above, on his own segmental analysis it has worked out its PLI of 13.13 per cent and considered its pricing to be at arm's length. A perusal of the comparable shown that the assessee had adopted multiple year data for working out the PLI of the comparables and further some of the companies so selected could not be considered as comparable companies. Accordingly, the assessee was issued a show-cause notice dated 17th July, 2009 confronting the above facts and a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of the Company Return on total costs 1. Alphageo (India) Ltd. 47.79 2. Dolphin Medical Services Ltd. 14.52 3. N.G. Industries Ltd. 31.26 4. Vimta Labs Ltd. 57.68 5. Choksi Laboratory Ltd. 32.22 6. Transgene Biotech Lt. - segmental 8.16 7. Medinova Diagnostics Services Ltd. 7.26 Arithmetic mean 28.41% The assessee has further sought working capital adjustments of 0.47 per cent in respect of the working capital being employed by the comparables and the assessee. The assessee has further sought risk adjustments by following the capital asset pricing model. The issue of risk adjustments and the short comings of CAPM model adopted by the assessee are discussed in detail later in the order and therefore, I do not allow any risk adjustments in this case. The assessee will, therefore, suffer an adjustment in respect of services rendered from BRDTC to its AE viz., Exxon Mobil Chemical Asia Pacific as under :- Cost of services rendered Rs. 4,98,14,572 Mark up as per the comparables (28.41 - 0.47) = 27.94 per cent = Rs. 1,39,18,191 9. Back office support services : As already mentioned abo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4.4 The essence remains that you have agreed for the being remunerated at only 10 per cent markup to cost. You have requested to show cause why the segmental results not to rejected and your total receipts on account of BPO be bench marked at the comparable PLI considering your PLI to be 10 per cent instead of 21.3 per cent as shown by you in your TP Report. 9.1 In his explanation the assessee has stated that the billings are made on budgeted costs while the books of account show the actual cost incurred and there is likely to be variation. Further, the accounts of the AEs are maintained on calendar year basis while the accounts of the assessee are on financial year basis. This generally results in variations. The assessee has again failed to provide his budgetary figures. It has filed certain reconciliations. In its working it has shown that the budgeted cost was USD 437,000 (Rs. 1,93,18,000) after adjusting the differences in respect of Jan., to Mar., 2005 (USD 115,000) and Jan., 06 to March, 2006 (USD 115,000). Since the actual cost (Rs. 1,58,27,000) was lower than the billed costs, they could achieve a higher mark up. The explanation of the assessee does not seem to be accep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gregated various technical services rendered into one category (total amount of Rs. 6,28,71,633). He observed that the assessee mentioned that a mark up of 10 per cent has been charged on ATD activities of Rs. 1,13,04,961 and in relation to technical representation Rs. 17,52,400, the mark-up is around 80 per cent. He also observed that the assessee has not denied the fact that, it has not been separately compensated for services rendered at Bangalore Research and Development Technology Centre (for short "BRDTC") (Rs. 4,98,14,572). The assessee allocated a part of cost of the application and research technical segment, towards marketing services as follows :- (a) 1 per cent R&D testing Rs. 4,45,507; (b) 10 per cent Butile ATD India cost on Rs. 8,47,107; (c) 25 per cent EEB ATD costs Rs. 9,93,833. 5. The allocation has been justified on the ground that the personnel involved in scientific research and ATD managers, do assist marketing team in marketing the product. On the cost incurred under the market head, which is to be allotted to technical service, the assessee furnished correspondence from its employees wherein some employees have estimated tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... % Arithmetic mean 18.47% As discussed above, on his own segmental analysis it has worked out its PLI of 13.13 per cent and considered its pricing to be at arm's length. A perusal of the comparable shown that the assessee had adopted multiple year data for working out the PLI of the comparables and further some of the companies so selected could not be considered as comparable companies. Accordingly, the assessee was issued a show cause notice dated 17th July, 2009 confronting the above facts and also the reasons for rejection of a few office comparable companies. The correct operating margin was also worked out." 6. Thereafter, the TPO observed that the assessee had undertaking research in its transfer pricing report and selected seven comparable companies for working out the arithmetic means of 18.47 per cent. He also observed that the Profit Level Indicator (PLI) of 13.13 per cent was worked out by the assessee on its own segment analysis and this was taken by the assessee to be the ALP. The assessee adopted multiple data for working out the PLI of comparables. The TPO, on the ground that certain comparables selected by the assessee have to be rejected, issued ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... endent Company and a separate profit centre. None would like to provide a higher expenditure than warranted. The AEs have allowed a mark up of 10 per cent only and if they were finding that the AE is actually making profit of 21 per cent they would have reduced their mark up in the first quarters of 2006 so as to make an overall mark up of 10 per cent for the year. The assessee is not an independent company which can be fool the various group companies by charging a mark up of 21.3 per cent against agreed margins of 10 per cent. In fact, the assessee has reported that in the next years the mark up has been increased for 10 to 15 per cent. If the assessee was actually making a margin of 21.3 per cent no AEs would have increased the margin from 10 to 15 per cent. While filing the explanation the assessee has not been able to explain the head-wise variation and the specific reasons on account of which those variations have arisen. It therefore appears that the allocation of expense by the assessee is not as per the actual budget exercise but only with a basis to work out better margins for the lower priced segments. The explanation/the segmental allocation of the assessee therefore, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparables in the IT industry. The search strategy and the comparables are reproduced below. This was confronted to the assessee vide questionnaire dated 17th July, 2009. The search for suitable comparables is conducted based on the data available in Prowess and capital databases. These two databases were searched and the filters are applied on these data. The information on related party transactions is taken from these databases and Annual Reports. In some of the cases, either the Annual Reports or the information in respect of export turnover, related party transactions, etc., are not available. Such information is asked from the companies under the express provisions of section 92CA(7) read with section 133(6) of the Act. Based on the information received as on date, the search process and results thereon are given below :- 9.3.2 Prowess Database Key Word Search The search process in Prowess Database was carried under the head "Company Classifications" and under the sub-heading "Non-financial Services" - "Services (Other than Financial) - "Information Technology" - ITES. Thus, the search for suitable comparables is based on the key word "ITES". The search was carried on 29-1- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies with export revenue more than 25 per cent of the revenues 4 8 8. Reliability of data (Satyam Computer Services Eliminated) 3 1 Balance 3 9.3.5 Capitaline Plus Database Key Word Search The search process in Capitaline Plus Database was carried under the head "Industry" based on the key word "IT Enabled Services/Business Process Outsourcing". The search was carried on 3-2-2009. It has thrown up 73 companies. The search process is elaborated as under :- Step Description No. of Companies Resulted No. of Companies eliminated 1. Number of companies resulted by the key word "IT enabled Services/Business Process Outsourcing" 73 2. The companies for which the data is available for the F.Y. 2005-06 26 47 3. Companies exclusively in Capitaline (and not in Prowess) 14 12 4. The companies whose turnover is more than Rs. 1 cr 12 2 5. The companies whose export revenues are more than 25% of the revenues 10 2 6. Related party transactions < 25% of the revenues (based on the data available in the databases) 8 2 Balance companies for further examination ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sp; Software & Processing charges 4. Software activities 5. Software Development 6. Software Development & Related 7. Software Development & Sal 8. Software Development & Ser 9. Software Development & Ser 10. Software Development India 11. Software Division 12. Software Maintenance 13. Software Production 14. Software Products & Services 15. Software Services 16. Software Solutions & Services 17. Software Training & Develop As a result of above search, the probable comparables were also examined to see whether those companies are into IT enabled services based on their annual reports and/or information submitted in response to section 133(6) notices. These companies are discussed as under :- S. No. Name of Company Reason for acceptance/rejection 1. Apex Knowledge Solutions Ltd. In response to notice under section 133(6), the company cat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as it has very high margin by any standard. Thus, it is not considered as a comparable. 9. Sitel India Ltd. The company is an IT enabled service provider. But, based on the information and the annual report submitted by the company in response to section 133(6) notice, almost 100 per cent of its revenue are generated from its AEs for the F.Y. 2005-06. Thus, it fails RPT filter and is not considered as a comparable. 10. Autoline Dimensions Software (P.) Ltd. As per the information submitted by the company, in response to notice under section 133(6), the ITES segment of the company fails 25 per cent export earning filter. Its ITES segment has only 19.55 per cent of its revenues as exports. Thus the company is not considered as a comparable. 11. Flextronics Software Systems Ltd. (Seg.) Based on the segmental information submitted by the company in response to notice under section 133(6), the company has an ITES segment and this segment qualifies all the filters applied by the TPO 12. Ace Software Exports Ltd. As the company is into IT enabled services and qualifies all the filters applied by the TPO, the same is considered as a comparables ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adjustment should be Rs. 1,94,44,068. The draft of the proposed assessment order was forwarded to the assessee on 26-11-2009. The assessee carried the matter before the Disputes Resolution Panel (DRP). Before the DRP, the assessee is recorded as having raised two main objections i.e., with respect to transfer pricing adjustment of Rs. 1,39,18,191, on account of technical service and (ii) adjustment of Rs. 55,25,877, on account of back office support service. The DRP rejected the objections of the assessee on exclusion of three loss making companies on the ground that they are not comparable companies. As regards elimination of Pfizer Ltd., from the list of comparables the DRP directed the Assessing Officer to include Pfizer Ltd. On the issue of back office support service, it observed that the assessee has argued that the actual profit shown by it is 21 per cent as against 24 per cent margin worked out by the Assessing Officer. It held that this falls within +/- 5 per cent range. It observed that the Assessing Officer cannot ignore the actual mark-up earned by the assessee while comparing the average mean worked out by him with the mean shown in the agreement. It held that the Asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... carried out by appellant. 2.5 not correctly granting the benefit of working capital adjustment in relation to technical services; and 2.6 denying the benefit of (+/-) 5 per cent range mentioned in proviso to section 92C(2) of the Act while computing the ALP. The appellant prays that the book value of the international transactions of technical services and back office support services, should be held to be the arm's length price of the said transactions as per the appellant's Transfer Pricing documentation, and the Assessing Officer be directed to delete the addition made keeping the aforesaid grounds in perspective. Without prejudice to the above, the Assessing Officer erred in not following the directions of the DRP, in relation to back office services, whereby the DRP directed to delete the adjustments in relation to back office services, if the appellant's margin is within +/- 5 per cent of the margin proposed by the TPO and your appellant's margin is within the said 5 per cent range. The above grounds are without prejudice to each other. 3. The Assessing Officer erred in facts and in law in disallowing a sum of Rs. 2,61,761 being 25 per cent of the total entertainment e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ; Aztec Software & Technology Services Ltd. v. Asstt. CIT [2007] 107 ITD 141 (Bang.)(SB); u E-gain Communication (P.) Ltd. v. ITO [2008] 118 TTJ 354/118 ITD 243 (Pune); u Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448 (Delhi); and u SAP LABS India (P.) Ltd. v. Asstt. CIT [2011] 44 SOT 156/[2010] 8 taxmann.com 207 (Bang.) 26. On the issue of adjustment for working capital and adjustment for risk, the learned Counsel submits that he is not pressing for the same. Thus, these issues are dismissed as "not pressed". 27. Coming to the order of the Dispute Resolution Panel (for short "DRP"), the learned Counsel submits that detailed submissions were made and detailed objections were raised but the DRP, without considering any of the submissions or the material, has disposed of the case unjustly in a summary manner. He contends that no discussion was made on the 5 per cent margin. 28. Coming to the second issue of back office services, he submits that the services include customers' support service, customer satisfaction advisory services and product stewardship advisory services. He submits that under the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... epresentative relied on section 144C(11) and submits that the act requires the DRP to give an opportunity to the Assessing Officer, if the direction is prejudicial to the interests of revenue. Thus, he argues that once opportunity has not been given to the Assessing Officer, the directions issued by the DRP would not be binding on the Assessing Officer. He submits that sub-section (11) is mandatory and non-observance of the same by DRP vitiates the proceedings. 32. In reply, learned Counsel submits that all the issues were before the Assessing Officer and TPO and that the learned Departmental Representative cannot raise an objection at this stage on the direction of the DRP. He vehemently contended that the Assessing Officer has not been given a statutory right to appeal against the order of the DRP and, hence, what he cannot do directly, cannot also be done indirectly. He submits that the learned Departmental Representative is challenging the DRP through a back door and this should not be permitted. He further submits that it is never the case of the Assessing Officer that he has not been heard. 33. Rival contentions were heard. On a careful consideration of the facts and circum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... one year has to be taken or multiple year data has to be taken. Rule 10B(4) of the I.T. Rules, 1962, reads as follows:- "4. The data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared." (vi) A plain reading of this rule makes it clear that the data relating to the financial year only has to be taken. As an exception, the rule also provides that the data of two years prior to the financial year may be taken, only if, such data reveals the facts which could have influenced the determination of transfer pricing. When the assessee wants to consider previous year's data, then the burden is on the assessee to demonstrate that the previous year's data contained certain facts which would influence the determination of transfer pricing. In the case on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Over all income increased by Rs. 23,25,000. The loss after depreciation, during the year under review, has decreased from Rs. 21,76,000 to Rs. 14,32,000. Thus, the income from scanning business has decreased, income from trading has increased and income from services has increased. Fundamentally, in this case, the comparison itself is flawed for the reason that enterprise level profits are taken for comparison. The actual margin of servicing segment has not been identified. The main income is from scanning. The function of the assessee is not akin to scanning. Being a diagnostic laboratory it is common knowledge that one of the main expenditures is in the form of referral fees to doctors. The assets base and the machinery required for diagnostic laboratory is different from the requirements of the assessee company, whose main function is related to EMCC products. The assessee is a captive unit and has no risk in the form of stiff competition. If ADS Diagnostic Laboratory Ltd. has made a loss due to stiff competition not only from existing units, but also from new diagnostic centers that were coming up in and around Delhi, then, the loss made by such a unit cannot be taken into acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a loss making unit. Similarly, a higher profit making unit cannot also be automatically eliminated just because the comparable company earned higher profits than the average. The reason for rejecting the two loss making units is not just because they were loss making units but for the reasons which are already stated in the preceding paragraphs. If similar reasons existed in the higher profit making unit, then, it is for the assessee to bring out those reasons and seek exclusion of the same. A general argument that, you have to exclude units which have high profit range, in case you exclude units which have made loss is a general submission which cannot be accepted. In other words, as a general principle, both loss making unit and high profit making unit cannot be eliminated from the comparables unless, there are specific reasons for eliminating the same which is other than the general reason that a comparable has incurred loss or has made abnormal profits. Thus, this ground is dismissed. (xii) The other issue is grant of adjustments i.e., working capital adjustment and risk adjustment while arriving at ALP. In this case, the assessee in his transfer pricing study, has not made a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... companies which resulted into average margin of 24 per cent and the Assessing Officer made TP adjustment by holding that the assessee has charged only 10 per cent mark while it should be 24 per cent mark. At the first instance, the assessee argued that actual profit shown by the assessee is 21 per cent and in case it is compared with the 24 per cent margin worked out by the Assessing Officer then it falls within the plus minus range of 5 per cent adjustment, and ultimately no TP adjustment is called for. The DRP has carefully considered the matter and is of the view that the Assessing Officer cannot ignore the actual mark up earned by the assessee while comparing the average mean worked out by him with the mean shown in the agreement. Therefore, the Assessing Officer's action cannot be sustained. Accordingly, the Assessing Officer is directed to compare the average mean worked out by him with the 21 per cent actual profit shown by the assessee and then apply the range of plus minus 5 per cent and in case of adjustment falls within the range, then he should not make any adjustment." (xv) The argument of the learned Departmental Representative that the Assessing Officer has n ..... X X X X Extracts X X X X X X X X Extracts X X X X
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