9911796707
TMI Blog2011 (7) TMI 583X X X X Extracts X X X X X X X X Extracts X X X X ..... ted 21-12-2006, passed under section 92CA(3) of the Act, while adopting Transactional Net Margin Method ('TNMM' in short) as the most appropriate method, has determined the ALP of the transactions in respect of IT Enabled Services (BPO Segment) at Rs. 25,66,92,632 as against Rs. 20,96,64,974 shown by the assessee, thereby suggesting for adjustment of Rs. 4,70,27,658 on that account. Further, he determined the ALP of the transactions relating to Software Development Services at Rs. 33,40,15,302 as against Rs. 31,61,40,091 shown by the assessee thereby suggesting for adjustment of Rs. 1,78,75,211 under that head. Later, on basis of such order of the TPO, the Assessing Officer has made additions of Rs. 6,49,02,869 and after allowing deduction of Rs. 4,65,50,115 under section 10A of the Act, completed the assessment under section 143(3) of the Act determining total income at Rs. 6,68,13,850. Being aggrieved by the order of the Assessing Officer, the assessee went in appeal before the CIT(A). On appeal, the CIT(A) after elaborately discussing the grounds raised by the assessee before him held that the TPO was justified in directing the assessee to conduct a fresh search of comparables d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sion of interest received on bank deposits which has already been offered by the assessee for taxation as income under the head other source from the figure of total turnover for the purpose of determining the deduction under section 10A of the Act. Aggrieved by the findings of the CIT(A), both the assessee as well as the Revenue is in appeal before us. 5. The learned counsel for the assessee, Shri. A.V. Sonde, submitted that, during the previous year relevant to assessment year 2004-05, the assessee had the following international transactions (a) Back office services-Rs. 20,96,64,974 and (b) SAP project work-Rs. 31,61,40,091 with associate enterprise (AE). The assessee company is a captive contract service provider rendering Business Process Outsourcing ("BPO") services to D.C. Outsourcing BPO LP and Software Development Services to D.C. Outsourcing ITO LP based on the instructions received from its AEs. The assessee company provides software development services to its AE in the areas of SAP implementation and back office support services in the nature of routine follow-up calls with insurance companies regarding claims status, documenting the call minutes and communicating the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was within the 5% price range of the average cost plus markup of comparable companies, it was concluded that the transactions for sale of software development services by DCIPL to its associate enterprises were at arm's length. The TPO issued notice dated July 4, 2006 instructing the assessee company to undertake a fresh search of independent comparable companies taking the sales criteria of Rs. 10 crores to 30 crores, in respect of back office services and sales criteria of Rs. 15 crores to 45 crores in respect of ERP project work (software development services) and providing details of the net sales, total cost, operating profit, and operating profit margin on sales and on total cost, of such comparable companies. The assessee company provided the requisite details on 27th September, 2006. In case of software development services, the assessee company provided 9 comparable companies with an average operating margin of 4.72% and in case of back office services, it provided 10 comparable companies with an average operating margin of 4.93%. The TPO issued a show cause notice on 16th Oct., 2006 stating that, in respect of back office, he has rejected 5 companies out of 6 companies i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t those comparables, the TPO has rejected the comparables. In case of show cause notice issued in for back office services, the TPO has undertaken a fresh search and selected the comparable companies; the search process was not been shared with the assessee company. However, for software services, the TPO not undertake a fresh search process and accepted the search process undertaken by the assessee company which consisted of 13 comparables of which he rejected 8 comparable companies and accepted 5 as final set of comparables. (b) The TPO issued notice dated July 4, 2006 instructing the assessee company to undertake a fresh search of independent comparable companies, which are in the similar line of business, taking the sales criteria of Rs. 10 crores to 30 crores, in respect of back office services and sales criteria of Rs. 15 crores to 45 crores in respect of software development services. However, the TPO did not follow such criteria while carrying out a fresh search in case of back office services and accepted the search process of the assessee company for software services. (c) Rule 10D(4) clearly specifies ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ppeal before us. 13. The learned counsel for the assessee submitted that the assessee company is a captive service provider and does not incur any research and development expenses whereas the Visualsoft incurred around 4% of the revenue towards these expenses. The assessee company undertakes SAP projects which is the software development service segment for its associated enterprise outside India. For such services, the assessee-company is remunerated at cost plus 7% by its associated enterprise. These facts have been accepted by the learned TPO in para 6.1.2 on page No. 10 of his order and have not been objected by the CIT (A). Accordingly, the comparable, i.e. Visualsoft Technologies Ltd. ought to be rejected by the TPO as the said company cannot be treated as comparable to the assessee company. For this proposition he relied on the decision of Kolkata Bench of the Tribunal in the case Development Consultants (P.) Ltd. v. Dy. CIT [2008] 115 TTJ 577/23 SOT 455 and the decision of the Bangalore Tribunal in the case of Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 119 TTJ 721/26 SOT 226. He also relied on the decision of the Delhi Bench of the Tribunal in the case of Ment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... earing financial risk. Integrated service providers operate on a fundamentally different business model than a captive service provider. Hence, it is incorrect to consider large integrated service providers as comparables. The assessee being a captive service provider its personnel/employee cost comprises a major component of cost of the assessee. The assessee company has wages to total operating revenue ratio of 52.12 per cent whereas in the case of Vishal Information Ltd. the wages to total operating revenue ratio is only 1.38 per cent. For this proposition, he relied on the decision of Delhi Bench in the case of Avaya India [IT Appeal No. 5150/Delhi/2010]. Without prejudice to the fact that Vishal Information Ltd. owns valuable intangibles and it has a very low wages to sales ratio of 1.38 per cent as compared to that of the assessee company which is 52.12 per cent. Hence, in view of the above, it cannot be considered as a comparable and accordingly should be excluded from the final list of comparable companies. 16. It is submitted that TPO has selected Wipro BPO Solutions Ltd. as a comparable company without appreciating the fact that the comparable company has a huge variatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... learly evident that there are no controlled transactions between Ace Software Exports Ltd. and Apex Data Services Inc. Secondly, the TPO has concluded that Ace Software Exports Ltd. and Apex Data Services Inc. are deemed associate enterprises under section 92A(2)(i) of the Act and the prices and other conditions must have been influenced by the other entity section 92A(2)(i) has two limbs. The first limb provides that the section is applicable only to goods or articles manufactured or processed by one enterprise and sold to the other enterprise. It is important to note that the section does not specify regarding rendering of services by one enterprise to the other enterprise. The second limb provides that in order for the two entities to be deemed as an AE, the prices and other conditions must have been influenced by the other entity. In the present case, the TPO has wrongly concluded that Ace Software Exports Ltd. and Apex Data Services Inc. are deemed AE merely on the ground that Ace Software Exports Ltd. sources business exclusively from Apex Data Services Inc. As the first limb of section 92(A)(2)(i) is applicable only to goods or articles manufactured and not to services the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssential to consider the activity/functions performed by the company (functional comparability), the specific characteristics of the services provided, the contractual terms and the conditions prevailing in the markets in which the respective parties to the transaction operate, for which, the learned counsel for the assessee relied on Rule 10A(a) wherein "uncontrolled transaction" has been defined to mean a transaction between any two enterprises so long as they are not related. Nowhere does the provision mention that such transaction should be between resident and non-resident. More so, the provision specifically mentions that such transactions could be between enterprises whether 'resident or non-resident'. In other words an uncontrolled transaction can be between a resident and a non-resident or a resident and a resident. If the intention of the Legislature was to restrict the choice of uncontrolled transaction to between a resident and a non-resident, the provision should have mentioned that any transaction between two unrelated parties would be considered to be an uncontrolled transaction provided it is between a resident and a non-resident. Contrary to that, the provisions in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iteria of different market conditions as discussed. The assessee company is a captive contract service provider rendering services to its AE in USA. For instance, if we consider one of the conditions being geographical location and size, the TPO has not demonstrated that the comparable companies selected by him make their exports only to USA as in the case of the assessee. There is no mention in the entire TP order of the market condition in which the comparable companies selected by the TPO have carried out their operations. On verifying the annual reports of the comparable companies selected by the TPO, the assessee observed that the comparable companies have exported their services to varied geographies like USA, UK, Canada and Ireland etc., However, while rejecting the comparable companies selected by the assessee, the TPO without applying any basis concluded that companies with no foreign exchange revenue should be rejected as the ultimate customer of these companies is located in India. The TPO has adopted a contradictory approach, wherein he expects the assessee to demonstrate the market conditions in which the comparable companies selected by the assessee operate whereas in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompetitive times of today, no entity can operate in a risk-free environment even if it is a captive service provider. The claim of the assessee for an adjustment on account of differences in risk profile is also supported by the decision of the Delhi Bench in the case of Mentor Graphics (Noida) (P.) Ltd. (supra) and also decision of Pune Bench in the case of E-Gain Communications (P.) Ltd. v. ITO [2008] 118 TTJ 354/23 SOT 385. The other case laws relied on him for this propositions are at Delhi Bench in the case of Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448 and jurisdictional Bench in the case of Cordys [IT Appeal No. 212/Hyd./2006]. Thus, the assessee submits that there is enough in the law which provides and recognizes the need to perform adjustments while determining the ALP with respect to the risks assumed by the comparable companies vis-à-vis the taxpayer. The assessee works out 5.13% towards entrepreneurial risk to adjust the average cost plus mark ups for final comparables. 22. On the issue of 5% deduction before computing the ALP, it is submitted that the proviso to section 92C(2) of the Act, prior to the amendment by the Finance (No. 2) Act, 2009 with effe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l be deemed to be the arm's length price. The learned counsel for the assessee submitted that present case is relating to the assessment year 2004-05. Therefore, the amended proviso as explained above is not applicable to the present case in hand. Further, the learned CIT(A) erred in not allowing the benefit of +/-5% variation in light of the fact that the said amended proviso is applicable from October 1, 2009 onwards and not in case where the appellate proceedings are ongoing as erroneously interpreted by the learned CIT(A). The CBDT in its Circular No. 5 of 2010, dated June 3, 2010 [324 ITR (St.) 293 2010] has clarified on determination of arm's length price in case of international transactions. Later, a Corrigendum [No. 142/13/2010-SO(TPL)] in partial modification of the original Circular No. 5/2010 was issued by CBDT wherein it was clarified that the amendment shall apply in relation to all cases in which proceedings which are pending before the Transfer Pricing Officer (TPO) on or after 1st October, 2009. As evident from the above circular cited, these new provisos are effective from April 1, 2009 onwards. In fact these provisos have been brought into the Act by the Finance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T 319 (Pune). l Schefenacker Motherson Ltd's. case (supra). l Asstt. CIT v. MSS India (P.) Ltd. [2009] 32 SOT 132 (Pune). l Cummins India Ltd. [IT Appeal Nos. 277 & 1412/PN/2007]. 24. Relying on the above decisions, it is submitted that it is well settled from the aforesaid decisions of the Tribunal that "at the option of the assessee" the benefit of 5% standard deduction is available irrespective of the fact that the arm's length price determined by the TPO exceeds by 5% or more from the transfer price. Thus the assessee is eligible for the said deduction while computing the adjustment to the transfer price as determined by the assessee in its TP study. The learned counsel for the assessee concluded that its claim for adjustments relating to risk, difference in depreciation policy adopted by the assessee vis-à-vis the comparable companies and the benefit of +/-5% variation, the transactions of the assessee company with its associated enterprises in case of software development and back office services satisfy the arm's length test, and that the order of the TPO is bad in law and on facts. 25. On the other hand, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gin of error, within which an adjustment will not be made. Once this band is breached the entire adjustment is to be made. The case law relied upon by the assessee does not provide an adequate basis for deciding the matter because these cases have not had the benefit of considering the important issue of intended retrospectively laid down by the Supreme Court in the case of CIT v. Gold Coin Health Foods (P.) Ltd. [2008] 304 ITR 308/172 Taxman 386 which is relevant in the facts of the case. Reference had been made to the decision of the ITAT, Bangalore Bench in the case of SAP Labs India (P.) Ltd. (supra). In paragraphs 57-60 of its order dated 30-8-2010, it was held that after the amendment in 2009 the provision does not operate to confer a standard deduction. Since the amendment apparently came into force from 1-4-2009, it was felt that the amended proviso had no application to an earlier assessment year. The decision thus turned on the date of coming into effect of the amended proviso. Moreover, this date of coming into effect noticed by the Bench turned out to be a typographic mistake in the circular, which was corrected by a corrigendum subsequently issued on 30-9-2010, c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... catena of decisions, such as Mentor Graphics Noida (P.) Ltd's. case (supra), Aztec Software & Technology Services Ltd. v. Asstt. CIT [2007] 107 ITD 141 (Bang.) (Customer Services India (P.) Ltd. v. Asstt. CIT [I.T. Appeal Nos. 3942 and 4001 (Delhi) of 2007], besides the recent decision of the Delhi Bench of the Tribunal in the case of ST Microelectronics (P.) Ltd. (supra) for assessment years 2003-04 and 2004-05). 28. As regards the issue of selection of comparables it is submitted by the learned Departmental Representative that with the exception of Northgate BPO Services (P.) Ltd., the CIT(A) upheld the TPO's rejection of assessee's comparables and confirmed the TPO's selection of comparables. The TPO's argument rests on application of filters relating to forex earnings, export transactions, related party transactions, functional differences, data incompatibility, and persistent losses and which is found to be correct. In response to the learned counsel's arguments, on certain specific comparables retained by the CIT(A), he invited our attention to the recent decision of the Delhi Bench of this Tribunal in the case of ST Microelectronics (P.) Ltd. (supra). It is further submitte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted by the companies. With reference to the department's appeal against the order of CIT(A) against directing removal of Northgate as a comparable, it is submitted that the case of Northgate, proposed by the assessee, was found by the TPO to be unrealiable because it had two segments-Software Services and BPO, but segmental results were not available to TPO and CIT(A) took cognizance of some figures furnished before him, without affording any opportunity for the TPO to be heard in the matter and the conclusion of the CIT(A) to this extent is vitiated by lack of opportunity. It is further submitted that the adjustment of margins proposed by the TPO deserves to be considered for acceptance. 29. In the rejoinder, the learned counsel submitted that it would be appreciated that similarly, Wipro BPO Solutions Ltd. is another giant in the industry of providing IYeS services, assuming all the risks and thus leading to higher profits. Based on the above, the assessee submits that Wipro BPO Solutions Ltd. ought to be excluded from the list of the comparable companies. In connection with the comparables discussed in the case of SAP Labs India (P.) Ltd. (supra) with the alleged comparables pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rroneous and his application that present case be decided having regard to this MAP ruling is illegal and unwarranted, bad in law, void and inadmissible and without prejudice, the learned counsel for the assessee submits that the Departmental Representative has not set out the facts and the background of the company in respect of which the MAP ruling was administered. In view of the foregoing, the reliance placed by the Departmental Representative on MAP ruling in case of another taxpayer is erroneous. It is further submitted that Ace Software Exports Ltd. was one of the comparable accepted by the assessee during the methodical search process conducted by it to select potentially comparable companies in the ITES segment of the purpose of its TP study. The Departmental Representative has made an argument that the assessee is objecting to the selection of Vishal Information Ltd. as a comparable as it has a low wages to cost ratio of 1.38 per cent. Applying similar principle Ace Software Exports Ltd. should also be rejected as a comparable as against an operating revenue of Rs. 4,41,40,306 it has a salary cost of Rs. 41,14,989 which constitutes only 9.32 per cent of operating revenue. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ailability of current year data in respect of the comparables at the time of filing the return of income is concerned, we find force in the finding of the CIT(A) in confirming the action of the TPO in directing the assessee company to conduct fresh search of the comparables during the transfer pricing proceedings as the Rule 10B(4) of the IT Rules require use of current year data for the purpose of comparability analysis. In view of the above, the ground raised by the assessee on this issue is rejected. 31. Next we deal with the issue with regard to the allowance of 5% deduction before computing the ALP. It is contention of the learned counsel for the assessee that the arithmetical mean of the comparable price should be reduced by 5% for determining the ALP. We have gone through the submissions and also the case law relied upon by him. He pointed out that the amendment made under section 92C of the Act would be applicable prospectively and not retrospectively. Whereas the learned Departmental Representative objected to the above proposition and submitted that under the proviso, no standard deduction has been provided to the assessee company. In our considered view, the tolerance b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O. Under these circumstances, the ground raised by the assessee company before us is not entertainable and the same is rejected. 34. Now we deal with the issue relating to the action of the TPO/CIT(A) in considering the Visualsoft Technologies Ltd. as comparable (Software Development Services Segment) even though the said company has incurred research and development expenses in excess of 3% of its sales. We find that the assessee has not raised any objection vide its letter dated 28-11-2006 in considering the said company as comparable being unrelated party having similar functions and risks as that of the assessee company, by the TPO. Before the TPO, the assessee company has agreed that it is an unrelated party and can be comparable with that of the assessee company. We do not see any merit in the contentions of the learned counsel for the assessee that even though the assessee company earlier accepted Visualsoft as comparable company in the assessee's TP study, it is not estopped from pointing out any facts before us, which have material bearing in the case under consideration, even though such facts are as a result of the evidence adduced by the taxpayer. We find that the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rs that the VITL has outsourced the manpower and the cost of outsourcing appears to have been included in the other heads of the expenditure instead of wages-employee cost. Moreover, the intangibles will not materially affect the price or profit earning. By outsourcing the manpower, the VITL would have incurred more cost compared to the assessee company, thus resulting in lesser operating profit. But, having considering the findings of the TPO, we find that the intangibles or outsourcing the manpower will not materially affect the price or profit margin. In our considered opinion, no two comparable companies can be replicas of each other. The application of rule 10B should be carried out and judged not with technical rigor, but on a broader prospective. In this view of the matter, we find no infirmity in the order of the CIT(A) in confirming the action of the TPO by selecting the VITL as comparable company. The case-law relied on by the learned counsel for the assessee is distinguishable on facts. Hence, the ground raised by the assessee on this issue is rejected. 37. Now, we deal with the issue whether the TPO was correct in selecting Wipro BPO having turnover of 20 times more th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (i) C.S. Software Enterprise Ltd. (ii) Ideaspace Solutions Ltd. (iii) MCS Ltd. (iv) Tata Share Registry Ltd. (v) Vakrangee Softwares Ltd. We find that the domestic BPO is much smaller business segment than the export BPO. The productivity and return in domestic segment is also much less than the export segment. The TPO clearly demonstrated in his order at page-9 that the earnings per seat in domestic segment is 0.45 lakhs as against 2.37 lakhs in the export segment which works out to 5.27 times more than the domestic segment. In the export segment, the earnings will be more due to the fact that they have advantage of time zone and higher productivity etc. It appears that the assessee company agreed that one criterion for selection/rejection of the comparables is FAR analysis. The aforesaid companies do not have any export business for the year under consideration whereas the assessee company has full-fledged export business. The functions, risks and assets are entirely different. Hence, the aforesaid company cannot be considered as a comparable company for determining the ALP. It is the contention of the learned counsel for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ubmissions made before us were all in the background of showing the assessee company as low end performer. We do not find force in the contention of the learned counsel for the assessee that the assessee is a risk-ree service provider and sufficient adjustment needs to be allowed to compare with the other comparable companies. The learned counsel for the assessee placed reliance on several decisions in support of his case that there should be some adjustment for risk to be given. However, we find that the first appellate authority after going through the agreement, entered by the assessee company with the AE, observed that the assessee company is an independent contracting entity and shall be solely responsible for determining the manner, means and methods by which it performs its obligation under the said contract as per Article-5, the assessee company has undertaken the warranty that all its work and documentation to be delivered to the associate enterprise shall be free of error. In a nutshell, the assessee company was carrying several risks while undertaking various works/services for its associate enterprise. In view of this matter, after considering the detailed reasoning giv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is squarely covered in favour of the assessee by the decision of Chennai Special Bench in the case of ITO v. Sak Soft Ltd. [2009] 30 SOT 55 and accordingly we held that the telecommunication charges incurred by the assessee company, which has been excluded by the Assessing Officer from export turnover, has to be excluded from the total turnover also, if such amount stands included therein, while computing the admissible deduction under section 10A of the Act. We direct according. Hence, the grounds raised by the Revenue on these issues are rejected. 45. The ground Nos. 5 and 6 raised by the revenue are with regard to the inclusion of Northgate Technologies Ltd. ('NTL' in short), as comparable company in the BPO segment. We find that the TPO in his order accepted the contention of the assessee company that NTL is in the business of providing high end back office services and also observed that this company is a comparable company with that of assessee company having similar functions. The 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, we do not find any obs ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
