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TMI Blog2011 (7) TMI 583X X X X Extracts X X X X X X X X Extracts X X X X ..... Tolerance band provided in the aforesaid provision is not to be taken as a standard deduction. If the arithmetic mean falls within the tolerance band, then there should not be any ALP adjustment. If it exceeds the said tolerance band, then ALP adjustment is not required to be computed after allowing the deduction at 5%. That means, actual working is to be taken for determining the ALP without giving deduction of 5%. Difference in accounting policies followed by the assessee company and the alleged comparable companies selected by TPO - Held that:- Assessee company has not raised any ground on this issue before the first appellate authority. Further, no such plea has been made during the transfer pricing proceedings before the TPO. Under these circumstances, the ground raised by the assessee company before us is not entertainable. Selection of comparables - Held that:- As the assessee company not adduced any cogent reason as to why it had selected Visualsoft as comparable in its TP study erroneously. Moreover, the assessee company agreed before the TPO that the Visualsoft is an unrelated party and can be comparable with that of the assessee company. Since the TPO included the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... charges in its international transactions at the time of framing the transfer pricing assessment - Held that:- Transfer pricing rules shall apply when one of the parties to the transaction is a non-resident, even if the transaction takes place within India and there is no requirement to demonstrate the motive of the assessee company to shift the profits outside India by manipulating the prices. Telecommunication charges incurred by the assessee company, which has been excluded by the Assessing Officer from export turnover, should be excluded from the total turnover also, if such amount stands included therein, while computing the admissible deduction under section 10A of the Act. Inclusion of Northgate Technologies Ltd. as comparable company in the BPO segment - Held that:- TPO simply rejected the aforesaid company on the ground that segmental results are neither available in the public data base nor provided by the assessee company. Moreover, no observation of the TPO in his order that NTL has failed to fulfil the RPT filter conditions. Thus no infirmity in the findings of the CIT(A) in holding that the aforesaid company should be considered as comparable. - 1082 & 1084 (HY ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal income of an assessee in conformity with the ALP as determined by the TPO. 3. While adjudicating the issue, the CIT(A) confirmed the action of the TPO in not considering the following companies as comparable, in respect of back office segment, for the purpose of determining the ALP. (a) ACE Software Export Ltd. (b) C.S. Software Export Ltd. (c) Max Health Scribe Ltd. (d) Online Media Solutions Ltd. (e) Apollo Health Street Ltd. (f) Idea-space Solutions Ltd. (g) Netvista Information Technology Ltd. (h) Saffron Global Ltd. (i) Vakrangee Software Ltd. (j) MCS Ltd. (k) Tata Share Registry Ltd. and (l) BNK Solutions (P.) Ltd. However, the CIT(A) considered the following companies as comparable, for the purpose of determining the ALP. (a) North Gate BPO/North Gate Technologies Ltd. (b) Spanco Tele-systems Solutions Ltd. (c) Vishal Information Technologies Ltd. (d) Fortune Infotech Ltd. (d) Tricom India Ltd. and (e) Wipro Ltd. He also held that the assessee is not entitled to any adjustment for the alleged entrepreneurial risk borne by various comparables. The CIT(A) rejected the claim for allowing an adjustment for the difference in depreciation policy followed by the comparables ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... above purpose, 'cost' has been defined as total direct costs and expenses incurred in connection with the performance of such services. 6. In its transfer pricing study undertaken in compliance with the provisions of section 92D of the Act read with rule 10D of the Income-tax Rules, 1962, the assessee company selected Transactional Net Margin Method ('TNMM') as the most appropriate method for back office services and software development services. Once having selected TNMM as the most appropriate method, the Appellant conducted a methodical search process to select potentially comparable companies on the following publicly available databases- Prowess and Capitaline Plus. With regard to the software development services, the assessee company applied various quantitative and qualitative filters and arrived at a final set of 13 comparable companies. The search process was conducted by the assessee company during October, 2004, wherein the database as updated on October 22, 2004 was used. Accordingly, the data used for computing the profit margins of the comparable companies was the latest data which was available as on October 22, 2004. The due date for filing the income-tax retur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rables from the public database and arrived net profit margin of the 7 comparables at 35.60% and concluded that the ALP was different from that of computed by the assessee company. Similarly, out of 13 companies selected as comparable by the assessee company in its TP study, the TPO rejected 9 companies and accepted only 4 companies as comparable. The TPO computed a net profit margin of the 4 comparable companies at 16.78% and concluded that the ALP was different from that of computed by the assessee company. The assessee company rebutted to the comparables proposed by the TPO by making a detailed submissions which are placed at pages 174 to 215 of the paper book filed by the assessee company. 8. The TPO passed his order on December 21, 2006. The findings of the TPO are summarized below: Findings of TPO Particulars Software development services Back office services Mark-up proposed in the Show Cause Notice 16.78% 35.60% Mark-up as per TP Order 15.05% 33.00% Less: Working Capital Adjustment as per TP order 2.00% 2.00% Proposed Adjustment 13.05% 31.00% 9. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied date, i.e. the date of filing of the return. However, in case of back office services, the TPO conducted a fresh comparability analysis during October 2006, using the data which was available after the specified date. (d) The assessee company does not bear significant business and operational risks and is only a captive contract back office services and software development service provider rendering services to its AEs. The profile of the assessee company clearly distinguishes it from full-fledged entrepreneurial companies. The TPO did not grant the assessee company, an adjustment on account of risk as computed by the assessee company as per Capital Asset Pricing Model ('CAPM') method at 5.13 per cent. (e) The proviso to section 92C(2) of the Act prior to the amendment by the Finance (No. 2) Act, 2009 with effect from October 1, 2009, provided that while arriving at the Arm's Length Price ('ALP'), at the option of the assessee, a price which may vary from the arithmetical mean by 5%, can be considered as the arm's length price. In the instant case, the TPO/CIT(A) have not applied the second proviso to section 92C(2) prior to its amendment in October 2009 i.e. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the TPO was erroneously considered as a comparable. The assessee further places reliance on the recent judgment given by Delhi Tribunal in case of Sapient Corpn. (P.) Ltd. [I.T. Appeal No. 5263/Delhi/2010] wherein it was held that the fact that the comparable selected initially by the assessee himself cannot act as estoppel in rejecting the company. Hence, it is submitted that though Visualsoft Technologies Ltd. was earlier accepted as a comparable company in the assessee's TP study, it is not estopped, from pointing out any facts which have a material bearing on the case on hand even though such facts are as a result of the evidence adduced by the taxpayer. 14. With regard to Back office segment, it is submitted that the TPO had accepted the International call centre segment of Spanco Telesystems Solutions Ltd. as an independent comparable company. While conducting the comparability analysis, the TPO rejected companies having substantial related party transactions. The TPO in his remand report to the CIT(A) has commented that the criteria to be used to exclude companies having related party transactions should be 25 per cent over its sales but whereas Spanco has got its rela ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is evident from the fact that its turnover is Rs. 4,30,30,70,635 which is 20 times that of the assessee's turnover of back office service segment of Rs. 20,96,64,974. Similarly, the learned counsel for the assessee compared the capital base of the Wipro with the assessee company. It is submitted that Delhi Tribunal in the case of Agnity India Technologies (P.) Ltd. [IT Appeal No. 3856/2010] has observed that where there is a huge variance in the turnover of comparable companies vis-a-vis the taxpayer it should not be considered as a comparable company. 17. It is submitted that Ace Software Exports Ltd. was selected by the assessee during the methodical search process conducted by it to select potentially comparable companies in the back office services segment for the purpose of its TP Study in compliance with the provisions of section 92D of the Act. However, the TPO/CIT(A) has rejected the said comparable company stating that Ace Software Exports Ltd. is catering only to a single customer, Apex Data Services Inc., USA and that the company sources its business exclusively from Apex Data Services Inc., USA. On account of this reasoning, the TPO/CIT(A) has concluded that the trans ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ced, as it is clearly evident that there are no materially significant related party transactions between Ace Software Exports Ltd. and Apex Data Services Inc. Hence, it is a mere assumption of the TPO that the prices and other conditions between Ace Data have been influenced by Apex Data Services Inc. Further, it is clear that if the intention of the Legislature was to include services it would have clearly specified services in the provisions of section 92(A)(2)(i) of the Act. There is a clear distinction between 'articles/goods' and 'provision of services' section 92A(2)(i) clearly deals with manufacturing of the goods/articles and not with provision of services. Thus, the TPO has erroneously considered Apex Data Services Inc. to be associated to Ace Software Exports Ltd. by applying the provisions of section 92A(2)(i) of the Act. 18. The assessee company in its TP study, based on a methodical search process on the publicly available data sources has arrived at a final set of functionally comparable companies for both the software development services back office services segment. However, during the course of hearing, the TPO had asked the assessee to conduct fresh search a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een two residents, it would still be considered as an uncontrolled transaction. Therefore, the action of the TPO of rejecting comparable companies on account of no foreign exchange revenue is not sustainable within the provisions of the law. Further he relied on rule 10B(2)(d) and submitted that the market conditions are important in the comparability analysis. For instance, one is to evaluate one of the market conditions mentioned in rule 10B(2)(d), being geographical, location and size it means that uncontrolled comparables ordinarily derive from the geographic market in which the control taxpayer operates, because there may be significant differences in the economic conditions in different markets. Further to illustrate, if the controlled taxpayer is operating in India and has controlled transactions with its AE in Poland. It would be appropriate to evaluate the geographical locations and the size of the market in India and not Poland. Similarly, in case of other market conditions specified in rule 10B(2)(d) like regulatory laws and Government orders, cost of labour and capital etc. it would be appropriate to evaluate the Government laws, the labour cost where the controlled tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee and the comparable companies, it is submitted that the assessee follows a depreciation policy, whereby, the rates at which it charges depreciation on its assets is much higher than the rates at which the comparable companies charge depreciation. Accordingly, due to the difference in the rates of depreciation, the profit margins of the comparable companies are much higher than that of the assessee. In order to conduct a fair and equitable comparison of the profit margins in terms with rule 10B(1)(e)(iii), the assessee made adjustments to the depreciation rates charged by the comparable companies placed at page 511 of paper book filed by the assessee. The CIT(A) has observed that neither such ground relating to depreciation adjustment was raised by the assessee in the appeal memo before him nor any such plea was placed before the TPO and hence, the said adjustment was not allowed. The CIT(A) has not expressly rejected the need for making depreciation adjustment in the instant case. The learned counsel for the assessee relied on the decision of Chandigarh Bench in the case Dy. CIT v. Quark Systems (P.) Ltd. [2010] 38 SOT 307 (SB) in support of his view that the taxpayer is n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Finance Bill, 2002. The Circular No.12-2001 dated 23-8-2001 issued by CBDT is not relevant in the context of the issue raised as the said circular does not address the treatment in a case where the arm's length price determined varies by more than 5% and the Circular was issued in August 2001 whereas the proviso to section 92C of the Act was amended in 2002. The TPO did not allow any benefit to the assessee, as in his view the above provision was not applicable in this case. As per the TPO, the margin earned by the assessee falls substantially short of the margin earned by comparable companies or the arm's length margin. As the assessee was not falling in the 5 per cent range, it was not entitled to any benefit. Aggrieved by the stand taken by the TPO, raised this ground before the CIT(A). The assessee submitted that upward adjustments, if any made should be only after giving effect to the option available for the assessee as provided in the proviso to section 92C (2). During the course of the appellate proceedings, the CIT(A) remanded the matter to the TPO. After considering the remand report and submissions of the assessee, the CIT(A) found no force in the submissions advanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave thus ignored a specific and mandatory provision of law. The CIT(A) did not have the benefit of the said circular which clearly states that the amended proviso is applicable from October 1, 2009 onwards and not a continuation of the assessment as concluded by the CIT(A) as he has passed the order on May 31, 2010 which is prior to the issuance of Circular and Corrigendum cited above. He relied on the decision of Delhi Bench in the UE Trade Corpn. [IT Appeal No. 4405/Delhi/2009] wherein it has been categorically held that the proviso to section 92C(2) was substituted with effect from October 1, 2009 and not retrospectively. Therefore it comes in to operation from assessment year 2009-10 and applies to subsequent years. Similar view was taken by the Bangalore Bench in the case of SAP Labs India (P.) Ltd. [IT Appeal No. 418/Bang/2008]. He also relied on the judgment of the Bombay High Court in the case of Tata Sons Steel Co. Ltd. v. N.C. Vpadhyaya [1974] 96 ITR 1 for the proposition that a circular which places a burden on an assessee cannot be relied on by an Assessing Officer. 23. It is also submitted that, as per the decision of Delhi Bench in the case of I Policy Network [IT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on also. For this proposition, he relied on the decision of the Bangalore Bench of the Tribunal in the case of SAP LABS India (P.) Ltd. (supra). It is submitted that under the Mutual Agreement Procedure (MAP), the competent authorities of US and India have agreed for a mark-up for software services at 19% for the financial year under consideration whereas the mark-up of the assessee company is only 7%. It is submitted that ACE Software Exports was one of the comparables accepted by the assessee company during the methodical search process conducted by it to select potentially comparable companies in the ITES Segment for the purpose of its transfer pricing study. If the objection, having low wages to the cost ratio, of the learned counsel for the assessee in selecting Vishal Information as comparable is to be accepted, then applying the same principle ACE Software should also be rejected as comparable since the said company's salary cost constitutes only 9.32% of the operating revenue. It is also submitted that the assessee cannot object to the exclusion of Vishal Information Ltd. from the final list of comparable companies before this Tribunal, since no such objections were raised ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [2009] 318 ITR (AT) 156. It is further contended that the successive changes in the proviso to section 92C(2) of the Act, and the intention of the lawmakers as exemplified by the various instructions/circulars issued from time to time, seen in the light of the above decisions of the Supreme Court, should offer guidance in the matter of deciding the issue. Further he relied on the Circulars of the CBDT and key operational words. In view of the Instruction Nos. 12 and 14/2001, 8/2002 and 5/2010, the intention of the lawmakers and the stand of the department would be apparent from the above that the 5% margin is not, and never was a standard deduction. For similar reasons, minus reliance on case law cited herein above, the ITAT Delhi Bench in the case of ST Microelectronics (P.) Ltd. [IT Appeal Nos. 1806 1807/Delhi/2008, dated 3-6-2011] in a decision dated 3rd June, 2011 ruled that the assessee was not entitled to such an interpretation of then proviso to section 92C(2) of the Act as is being claimed in the present case. It is important to note that Transfer Pricing legislation cannot be seen as incentive provisions admitting of liberal construfction. It seeks to protect a nation's ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ze any classification based on size of turnover. Reference was also made to a study of M/s Infosys carried out by the TPO from which it is seen that over a ten year period margins fluctuated within a narrow band of around 5% in spite of the fact that turnover went steadily up 150 times. It is an established fact that in the software development services sector the principal element of cost being personnel cost is variable in proportion to the turnover. The gross margins therefore tend to be constant, unlike say, the manufacturing industry with significant fixed costs that result in margins responding differently to turnover. Secondly, the figures in Wipro's financials supplied by the assessee's counsel during the hearing by itself bears out this point. In the category of services income though the turnover increases from Rs. 194.23 cr. to Rs. 430.3 cr. from financial year 31-3-2003 to 31-3-2004, Profit before tax, as a percentage of turnovers, moved from 23.68% to 23.91%, which is as good as static. It is further contended that the assessee has nowhere shown that Wipro is charging more from its clients than the present assessee, for any given service. Besides, it is important to no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s it came to 6% to 40%. It would be appreciated that the TPO had arrived at the arithmetic mean of 22.24% before allowing working capital adjustment. Further, the said decision was pertaining to assessment year 2003-04 which cannot be considered for the purpose of comparability of operating margins of comparables proposed by the assessee as final set of comparable companies. It is submitted that the MAP does not deprive the taxpayer from taking recourse to ordinary legal remedies available i.e. domestic appeal process and MAP are mutually exclusive. It has been held by the A.P. High Court in the case of CIT v. Vishakhapatnam Port Trust [1983] 144 ITR 146/15 Taxman 72 that MAP is available in addition to and not in substitution to the domestic remedies. Findings under MAP are not even binding on the assessee itself and it cannot therefore be binding on any other taxpayer as well. Further, the taxpayer has to accept the MAP ruling for resolution to be reached. A settlement, if accepted, is only binding for the financial year under dispute and would not apply for either past or future years. It is evident from the above that an assessee has an option to take recourse to the appeal pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an accurate comparison the software sourcing charges should be included for the purpose of calculation of employee cost of Ace Software. Thus, Ace Software should be accepted as a comparable and there the assessee in the course of proceedings before the Tribunal had requested for the rejection of Vishal Information Ltd. having wages to total operating revenue ratio at 1.38 per cent which was selected as a comparable by the TPO. As the Departmental Representative has argued for rejection of Ace Software Exports Ltd. by comp raring it to Vishal Information Ltd. it will be appropriate to go through the wages to operating income ratio of Vishal Information Ltd. 30. We have considered the rival submissions and perused the material available on record. First we will take up the appeal of the assessee. Firstly, we deal with the issue with regard to the objection of the assessee company in not allowing the use of multiple years' data for the purpose of a determining the ALP. We find that, for the purpose of determining the ALP, the transactions entered into the Associate Enterprises are to be compared with uncontrolled transactions carried on by an entity during the same period as that o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cent decision of the Delhi Bench of the Tribunal in the case of ST Microelectronics (P.) Ltd. (supra). We also find that the issue is covered in favour of the revenue by the decision of Co-ordinate Bench in the case of ADP (P.) Ltd. v. Dy. CIT [I.T. Appeal Nos. 106 155/Hyd./2009, dated 25-2-2011], to which one of us was a party of that order and the same is binding on us. Since the decision of Co-ordinate Bench is binding on us, we are not inclined to follow the decisions rendered by other Benches of this Tribunal which are relied on by the learned counsel for the assessee. We are also in agreement with the elaborate findings of the first appellate authority in dealing with this issue and accordingly we do not see any infirmity in his order. Hence, the grounds raised by the assessee on this issue are rejected. 32. Next we deal with the issue relating to the assessee's contention that the TPO had violated the rules of natural justice by not providing/sharing the complete details of the Bench marking analysis carried out by him. At the time of hearing, the learned counsel for the assessee did not press this ground. Accordingly, the ground raised by the assessee is dismissed as no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the TPO should have excluded the Visualsoft from the list of comparable companies. Hence, the ground raised by the assessee on this issue is rejected. 35. Now, we turn to the issue relating to the selection of Spanco Tele-system as comparable company in the back office services segment by the TPO. We find that the TPO has applied the criteria of excluding the companies having related party transaction of more than 25% of the turnover from the list of comparable companies. Having done so, the TPO should have excluded the Spanco Tele-system from the list of comparable companies as it is evident from the paper book filed by the assessee company that the percentage of related party transaction in the case of Spanco Tele-system is 28.73% and it fails to satisfy the TPO's own criteria. In view of this matter, we find force in the arguments of the learned counsel for the assessee that Spanco Tele-system should be excluded from the final list of comparable companies. We direct accordingly. 36. Now, we deal with the issue relating to inclusion of Vishal Information Technology Ltd. ('VITL' in short) in the final list of comparable companies by the TPO. It is contention of the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reasoning being that the latter is a giant company having 20 times more turnover than the assessee company. In view of this, based on the facts and the circumstances of the case, and following the decision of Delhi Bench of ITAT in the aforesaid case, we are of the view that Wipro BPO should be excluded from the list of comparable companies. Hence, the ground raised by the assessee on this issue is allowed. 38. The next issue is with regard to the rejection of Ace Software Ltd. ('ASL' in short) as comparable company in back office services segment on the basis that the company sources its exclusively from Apex Data Services Inc., USA and thus, has related party transactions. We find that ASL does not render any services to Apex Data but only sources business from them. Therefore, ASL renders services directly to the third parties and not to the Apex Data. The learned counsel for the assessee clearly demonstrated that ASL had only transaction with Apex Data in purchasing of fixed assets. Relevant papers are placed at page No. 250 of the paper book filed by the assessee. In view of this matter, we find no controlled transaction between the ASL and Apex Data. Thus, no materially si ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rules, is related to the residential status and not related to the domestic or export. Moreover, the Delhi Bench of the Tribunal in the case of Mentor graphics (Noida) (P.) Ltd. (supra) held that the ALP should be determined by taking results of a comparable transaction in comparable circumstances. Rule 10B(2)(d) also emphasizes that the comparability of the transaction should be international transaction. We do not find any merit in the argument of the learned counsel for the assessee that the companies rejected by the TPO operate in similar market condition as that of assessee company due to the fact that the aforesaid companies do not have any international transaction. In view of the above, the reasoning given by the CIT(A) in confirming the action of the TPO in rejecting the aforesaid company as not comparable is justified. In view of the above, five companies listed above shall not be included in the final list of comparable companies. 40. The next ground is with regard to the issue that the TPO/CIT(A) not allowing any adjustment towards valuable intangibles owned by and in respect of entrepreneurial risk borne by the comparables. We find that there are several factors suc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rate the motive of the assessee company to shift profits outside of India by manipulating the prices charges in its international transactions at the time of framing the transfer pricing assessment. We find that transfer pricing rules shall apply when one of the parties to the transaction is a non-resident, even if the transaction takes place within India. There is no need to find out the legislative intent behind the transfer pricing provision when the provisions themselves were unambiguous. Therefore, existence of actual cross border transactions or motive to shift profits outside India or to evade taxes is not free conditions for transfer pricing provisions to apply. In view of this, the lower authorities, during transfer pricing assessment, are not required to demonstrate the motive of the assessee company to shift the profits outside India by manipulating the prices. 42. The next ground is with regard to charging of interest under sections234B and 234C of the Act. We find that charging of interest under sections 234B and 234C are mandatory and merely consequential in nature to the assessed income. Hence, the grounds raised by the assessee on these issues are rejected as such ..... X X X X Extracts X X X X X X X X Extracts X X X X
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