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TMI Blog2012 (10) TMI 779X X X X Extracts X X X X X X X X Extracts X X X X ..... ,71,89,793/- proposed by the Ld. TPO by holding that its international transactions do not satisfy the arm's length principle envisaged under the Act. In doing so, the Ld. DRP and the Ld. AO has grossly erred in agreeing with and upholding the Ld. TPO's action of: 2.1 not appreciating that none of the conditions set out in section 92C(3) of the Act are satisfied in the present case. 2.2 disregarding the ALP, as determined by the appellant in the TP documentation maintained by it in terms of section 92D of the Act read with Rule 10D of the Rules; 2.3 disregarding multiple year/prior years' data as used by the appellant in the TP documentation and holding that current year (i.e FY 2005-06) data for comparable companies should be used despite the fact that the same was not necessarily available to the appellant at the time of preparing its TP documentation, and in doing so have grossly erred in; 2.3.1 interpreting the requirement of 'contemporaneous' data in the Rules to necessarily imply current/single year (i.e FY 2005-06) date; and 2.3.2 holding that at the time of creating/maintaining the TP documentation, the appellant could have procured current/single year data (i.e FY 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eficiencies in the appellant's claim for a risk adjustment and thereby denying the appellant a reasonable opportunity to study/examine the same and provide its comments/objections thereto; 2.13 denying the benefit of (+/-) 5 percent [as per proviso to section 92C(2) of the Act] available to the appellant; 2.14 disregarding judicial pronouncements in India in undertaking the TP adjustment. 3. the Ld. AO has while passing the final assessment order has grossly erred in not granting the relief of Rs. 71,47,803/- directed by the Ld. DRP vide its directions/order dated December 14, 2011 in the computation of the ALP of the appellant (by directing exclusion of one of the comparable namely, Necleus Netsoft and GIS (India) Limited from the comparable set). 4. the Ld. A O erred on facts and in law in charging interest under sections 234A, 234B and 234D of the Act. 5. the Ld. A O erred on facts and in law in charging interest under section 220 of the Act; 6. the Ld. A O has grossly erred in initiating penalty under section 271(1)(c) of the Act mechanically and without recording any satisfaction for its initiation. Grounds in assessment year 2007-08: 1. The assessment order passed by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the information/reply received by the TPO/Assessing Officer u/s 133(6). 2.5 rejecting comparability analysis in the appellant's fresh search and in conducting a fresh comparability analysis based on application of the following additional/revised filters in determining the comparable companies: 2.5.1 exclusion of companies having different financial year ending (i.e. not March 31, 2007); 2.5.2 exclusion of companies with export sales that are less than 25% of their total revenue; 2.5.3 exclusion of companies with diminishing revenues/persistent losses for last three years upto and including FY 2006-07; 2.5.4 retaining companies with related party transaction up to 25% of their sales; and rejecting, in particular, the following filters applied by the appellant in its fresh search; 2.5.5 companies having other operating income (i.e income other than manufacturing and trading income) to sales greater than 50% were accepted; 2.5.6 companies with net worth less than zero were rejected; 2.5.7 companies having research & development costs to sales less than 3% were accepted; and 2.5.8 companies having advertising, marketing and distribution costs to sales less than 3% were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... depreciation amounting to Rs. 2,28,821/- on 45% of the opening written down value of the block of computers without any basis and without appreciation that the depreciation claim of the appellant on computers has been duly accepted and allowed by his predecessors in earlier years; 6. The Ld. DRP and the Ld. AO (following the directions of the Ld. DRP) erred in law in confirming the disallowance of Rs. 31,42,720/- on account of club entrance fees; 7. The Ld. DRP erred in disregarding the detailed arguments/submissions put forth by the appellant during the course of the DRP/assessment proceedings while passing its direction under section 144C of the Act; 8. That the Ld. A O erred on facts and in law in charging interest under sections 234B and 234D of the Act; 9. The Ld. A O has grossly erred in initiating penalty under section 271(1)(c) of the Act mechanically and without recording any satisfaction for its initiation. 2. There are certain issues and facts which are common in both the years, therefore, before taking up the main dispute involved in the appeals, we would deem it appropriate to take the common issues first. 3. The brief facts of the case are that the assessee Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee. He passed the order under sec. 92CA(3) of the Income-tax Act, 1961 on 14th September, 2009 and 26th October 2010 in assessment years 2006-07 and 2007-08 respectively. Learned TPO has recommended an adjustment of Rs.371,89,793 in assessment year 2006-07 and Rs.755,53,984 in assessment year 2007-08. The adjustments recommended by the learned TPO were proposed to be added in the income of the assessee by the learned Assessing Officer in the draft assessment orders. The assessee has filed objections before the learned DRP but failed to convince the learned DRP hence the draft assessment orders were confirmed by the learned DRP, Assessing Officer has passed the assessment order and accordingly an adjustment of Rs.371,89,793 has been made in the income of the assessee in assessment year 2006-07. Dissatisfied with the order of the Assessing Officer, assessee filed an appeal before the ITAT. The ITAT has set aside the assessment order observing that learned DRP has not disposed of the objections of the assessee by passing a speaking order. Therefore, the ITAT has set aside the assessment order vide its order dated 7.1.2011 and remitted the issues back to the file of the lea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ea. 7. The next area of dispute between the parties could be in respect of selection of single year data or multiple year data. The assessee in assessment year 2006-07 has reported that it has used TNMM as the most appropriate method with OP/TC as PLI (Profit level indicator). It has shown net profit margin at 10.10% on account of its consultancy and advisory services. The assessee has selected 11 comparables in its transfer pricing study report by using Prowess Capital Lines and Nasscom Data Base. It has used multiple year data of 2004, 2005 and 2006. It has applied following filters for eliminating the incomparable: * Companies having financial data available only up to financial year ended March 2004 have been rejected. * Companies having sales less than Rs.1 crore have been rejected. * Companies having a ratio of income from trading activities equal to or more than 25% of total sales have been rejected. * Companies having a ratio of income from manufacturing activities equal to or more than 25% of total sales have been rejected. * Companies which are functionally dissimilar have been rejected. 8. On the basis of above exercise,assessee has selected eleven comparables who ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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." 11. A bare perusal of this rule would reveal that expression "shall" has been employed in this rule which make it abundantly clear that current year data of an uncontrolled transaction is to be used for the purpose of comparability, while examining the international transactions with associate enterprises. The proviso appended to the section carves out 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 ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s earned a net margin of 10.10% which has been worked out by OP/TC. The working has been noticed by the learned TPO as under: Particulars Amount Service Income 281,643,203 Miscellaneous income 431,810 Total 282,075,013 Expenditure Operating and other expenses 256,193,649 Total 256,193,649 Operating Profit 25,881,364 OP/TC 10.10% 14. The assessee has undertaken transfer pricing study and selected 11 comparables whose average profit margin of the years 2004, 2005 and 2006- 07 is 11.45%, therefore, according to the assessee its value of international transaction is at arm's length. The assessee has selected following comparables: S.No. Name of the Company Database 2004 2005 2006 Weighted average 1. Ask me info hubs ltd. Prowess 10.00 -13.98 4.67 -1.10 2. MCS Ltd. Prowess 15.43 3.41 -5.81 6.00 3. CMC Ltd. Segmental Prowess 13.67 1.44 2.33 6.37 4. CS Software Enterprise Ltd. Prowess 13.73 9.76 10.53 11.15 5. Ace Software Exports Ltd. Prowess -0.45 20.15 14.47 11.93 6. Mphasis BFL Ltd. Consol Seg NASSCOM 12.52 13.71 10.53 12.36 7. Tata Share Registry Ltd. Segmental. Prowess 10.74 15.38 NA 13.02 8. HCL Tec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see then the mean profit of the comparable would be 20.62%. Pointing out the importance of working capital, he submitted that an uncontrolled entity will expect to earn a market rate of return on that capital, independent of its operation. Thus, if an uncontrolled entity did not require the use of capital from its own source then such capital can be put to use for earning some other income, different from its operation. The assessee has not put to use the capital of its own resources because all its costs are being born by associate enterprises, therefore, the non-utilization of the essential capital for its day to day working, its profit margin is to be adjusted by giving benefit of the working capital cost. He drew our attention towards the working capital adjustment made for financial years 2004-05 and 2005-06 in his synopsis and submitted that had this benefit is given then the average profit margin of the comparable would be 20.62%. Learned DR submitted that before the learned TPO, assessee did not take working capital adjustment as a filter. Similarly, he drew our attention towards internal page 18 of the TPO's order and pointed out that learned TPO has observed that no compu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... file fresh working. 19. In the next fold of submissions, learned counsel for the assessee submitted that out of these seven comparables, the two comparables deserve to be excluded, namely, Allsec Technology Ltd. and Maple E-Solution. He did not raise dispute with regard to other comparables. For excluding these two comparables, he pointed out that the companies who had incurred high marketing and advertising expenditure, they are supposed to earn higher income. They are functionally different. Therefore, the result cannot be compared with the result of the assessee. He submitted that the assessee did not incur any kind of advertisement and marketing expenses, whereas Allsec Technology Ltd. incurred 6% of sales towards advertisement and marketing. In order to demonstrate how this issue can impact the profitability of any organization, learned counsel for the assessee placed on record a graph indicating that higher the amount incurred on advertisement and marketing then higher will be the profit. According to the learned counsel, the companies who have incurred 3% of its sales on advertisement and marketing, they reported profits in between 23% to 27.18%. More than 3% and up to 5% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... also accepted that though it is a captive service provider and not exposed with various risks, but, it is not a totally risk free enterprises. The nature of risk in the case of assessee are different. We have made a analysis of the assessee's TP study report as well as the findings recorded by the learned TPO and the DRP. We have extracted the filters applied by the assessee for eliminating the non-comparable companies or adjusting their profit margin, the assessee has not applied the filter i.e. the companies who have incurred expenses of more than 5% of its sales on advertisement and marketing which required to be excluded. At this stage, in the absence of any finding, at the level of the TPO or of the learned DRP, it is difficult to verify the version put forth by the learned counsel for the assessee. Apart from this, at the cost of repetition, we would like to observe that profit margin of any company is dependent upon many factors. By taking into consideration the one aspect, if we kept on excluding the comparables then not a single comparable would be identified. The simple reason is whenever any adjudicating authority would try to carry out a study of the result of any comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e losses or the profit. Therefore, such comparable deserves to be excluded. Maple e Solution has shown 100% loss in financial year 2002-03 but all of a sudden shown profit at 37.38% in financial year 2004-05. In financial year 2008-09, it again shown losses and its profit margin is -65.23%. Considering this aspect, we are of the view that this comparable deserves to be excluded from the list of comparables. With the above observations, we set aside the issue to the file of the Assessing Officer for readjudication. Learned Assessing Officer shall give working capital adjustments to the assessee in assessment year 2006-07. He shall work out the average profit margin of the comparables after excluding Maple e Solution. The appeal for assessment year 2006-07 is accordingly allowed for statistical purposes. 23. Now, we take the remaining issues in assessment year 2007-08. In this assessment year, we have already noticed the basic facts as well as the filters applied by the assessee in its TP Study report in order to identify the comparable companies for justifying its arm's length price in respect of the transaction entered with the A.E. In this year, the assessee has shown value of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... panies which have incurred expenses more than 3% but less than 5% of the sales in the area of marketing and advertisement, their profit ratio is 45.52%. Similarly, the companies which have incurred expenses on advertisement and marketing at 5% to 7% of the sales, the profit ratio is between 67.46%. The learned counsel for the assessee in this way emphasized that out of the total comparables identified by the TPO following comparables deserve tobe excluded. S.No. Name of the Companies % of marketing expenses to sales - F.Y. 2006-07 1. Accentia Technologies Ltd. (Seg) 28.36% 2. Allsec Technologies Ltd. 5.22% 3. Asit C Mehta Financial Services Ltd. 5.42% 4. Datamatics Financial Services Ltd. (Seg) 4.45% 5. Eclerx Services Ltd. 9.72% 6. Informed Technologies India Ltd. 14.95% 7. Infosys BPO Ltd. 6.39% 8 Mold-Tek Technologies Ltd. (Seg.) 7.46% 25. On the other hand, Learned DR contended that the learned TPO has considered this aspect in the impugned order and pointed out that assessee did not give the basis on which it concluded that such companies have created marketing intangibles. There is no specific co-relation between the incurrence of expenses vis-&agr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity. Learned TPO rejected the contention of the assessee on the ground that 95% of the revenue of Infosys is from repeat business. The marketing intangible did not help Infosys to get any better business according to the learned TPO. On an analysis of the learned TPO's order coupled with the contentions of the assessee, we are of the view that learned TPO has rightly observed that in the case of manufacturing or distribution companies marketing expenses over a period of time may create marketing intangible which will helpful to them for getting better business but it may not be applicable with equal force on service industries like I.T. Enabled Services. The instances of Infosys referred by the assessee has been specifically dealt with by the learned TPO, he has reproduced relevant portion of the annual report of Infosys on page 25. For buttressing this plea, learned counsel for the assessee mainly gave two explanation. In his first reasoning he pointed out that profit ratio of the companies who have incurred expenses less than 3% of the sales is 22.26%. The companies who have incurred expense more than 3% but less than 5% of the sales on AMP, their profit is 45.52%. Similarly, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1189/Del/05 & Ors., ITAT has held that an entity can be taken as uncontrolled, if its related party transaction do not exist 10 to 15% of the total revenue. Thus, according to the learned counsel for the assessee, the comparables who have transactions more than 15% with its related party then they deserve to be excluded from the list of comparables. On the other hand, Learned DR opposed the contentions of assessee. He pointed out that in the case of S.T. Micro Electronics Pvt. Ltd. vs. CIT(A) rendered in ITA No. 1806 & 1807/Del/08, the ITAT has upheld the RTP Filter up to 25%. In this case, the ITAT has only excluded those concerns who have related party transactions to sales more than 30%. In rebuttal, learned counsel for the assessee submitted that in the case of S.T. Micro Electronics, this was not the direct issue before the ITAT. In that case, learned TPO selected comparables to the extent up 25% for related party transaction. Learned first appellate authority has eliminated all those comparables. ITAT has observed that Learned DR was unable to point out specific companies which were selected by the learned TPO as comparables and who has transactions less than 15% with related ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are rejected. 30. In the next fold of submissions, learned counsel for the assessee submitted that the learned TPO has erred in including certain companies which are having extra-ordinary high turnover as compared to the appellant. The learned counsel for the assessee pointed out following companies; Sr. No. Name of the comparable company Turnover (In crores) 1 HCL Comnet Systems & Services Ltd. (Seg.) 260.19 2 Infosys BPO Limited 649.56 3 Wipro Limited (Seg) 939.78 Who have huge turnover in comparison to the operations of the assessee. The total value of assessee's international transaction is Rs.35.42 crores, whereas these companies have multifold turnover then the turnover of the assessee. According to the learned counsel for the assessee, these companies are not comparable with that of the assessee. In support of his contentions, he relied upon the order of the ITAT in the case of Genisys Integrated System India Pvt. Ltd. ITA No. 1231/Bang/2010, Centillium India Pvt. Ltd. vs. DCIT, ITA No. 1354/Bang/2010. The copies of these orders have been placed on the record. In these cases, the turnover filter in between 1 to 200 crores was considered as a comparable. On th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... excluded. If the result of a company over a period shows fluctuation and such result is disproportionate to other concern then that would be an indication that profit or loss may not be resulting from the operation of the company alone, rather there may be some extra reasons for such losses or profit. Therefore, Vishal Information Technology is consistent in its result and it cannot be excluded from the comparables. In assessment year 2006-07, we have excluded Maple E Solution. This year also, it will be excluded. As far as I Service India Pvt. Ltd. is concerned, there is no information with regard to the earlier years and financial year 2006-07 is the first year. Therefore, it cannot be said that this company has shown vast fluctuation. In view of the above discussion, we partly accept the contentions of the learned counsel for the assessee in this fold of arguments and only exclude Maple E Solution from the comparable. 34. In the next fold of submissions, learned counsel for the assessee has submitted that learned TPO has included functionally different companies in the comparables. The first objection raised by him relates to inclusion of Mould-Tech Technology Ltd. He pointed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the appellant. Learned DR on the other hand relied upon the order of the learned TPO and drew our attention towards page Nos. 81 and 82 of the order. On due consideration of the facts and circumstances, we find that assessee has reiterated its contentions as were raised before the learned TPO. Learned TPO rejected the contentions on the ground that neither the assessee nor he went in to functional line horizontal test within I.T. Enables Services, meaning thereby, the comparables were selected who were in the I.T. Enabled Services, Qualitative Filter specifically was not applied in the selection of the comparables. The duty of the Learned TPO is to find out just and reasonable comparables. It is quite difficult to get accurate comparables. The assessee wants that I.T. Enabled Services be further dissected, but in that way, there will not be any end and it is a very subjective exercise. Learned TPO has considered these aspects and also the contentions of the assessee. His order is quite speaking one. After looking into the findings recorded by him, we do not find any merit in the contentions of the learned counsel for the assessee. 36. The learned counsel for the assessee fur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o submitted that this concern has shown high margin and, therefore, it deserves to be excluded. On the other hand, Learned DR submitted that complete details of this concern were called for by the learned Assessing Officer by exercising his powers under sec. 133(6) of the Act. As per the reply received from the company, it revealed that it is into I.T. Enabled Services. On due consideration of the objections of the learned counsel for the assessee, we are of the view that information collected by the learned TPO were duly confronted to the assessee. The assessee raised objections which have duly been noticed on page 92 of the order. Learned TPO thereafter rejected the objections of the assessee. We also do not find any substantial merit in the objections of the assessee. The plea raised by the assessee is that no information is available regarding the functional profile of the company in the annual report. Whatever learned TPO got from this company, those were communicated to the assessee and after providing due opportunity, learned TPO found it as a comparables and only thereafter included it. We do not find any force in the contentions of the learned counsel for the assessee for ..... X X X X Extracts X X X X X X X X Extracts X X X X
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