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TMI Blog2013 (5) TMI 49X X X X Extracts X X X X X X X X Extracts X X X X ..... first proviso to section 92C(2) of the Income-tax Act, 1961, the Tribunal was correct in holding that if one profit level indicator of a comparable, out of a set of comparables, is lower than the profit level indicator of the taxpayer, then the transactions reported by the taxpayer is at an arm's length price as contemplated in sections 92, 92C and other related provisions of the said Act?" 3. This question has specifically arisen because of the observation of the Tribunal in paragraph 46.2 of the impugned order which reads as under:- "46.2 While holding so, we have not adopted mean profit of several comparable found by respective parties because in spite of our repeated requests, the parties before us, were unable to show us any rule or decision under which average or mean margin (OP/TC) of different companies is to be taken. Tax administration and parties can work different Arm's length price i.e. a range by the application of different methods. In such a situation, mean of Arm's Length Price as provided in proviso to Section 92C(2) of the Act can be taken. But above Arm's length range is not the same thing as average operating profits of different entities with different FAR ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to adjust the conditions of the controlled transaction taking into account the arm's length rante. It could be argued that any point in the range nevertheless satisfies the arm's length principle." 4. Insofar as the above observations are concerned, we may straightway refer to the relevant provisions of the Income-tax Act, 1961 (hereinafter referred to as 'the said Act'). Chapter X deals with special provisions relating to avoidance of tax. Section 92, which is the first section in that chapter, stipulates that any income arising from an international transaction is to be computed having regard to the arm's length price. "Arm's length price" is defined in section 92F to mean a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions. It may be pointed out at this juncture that the respondent/assessee is an Indian company which was incorporated in 1998. It is a wholly owned subsidiary of IKOS System Inc., a company incorporated in USA and engaged in the business of software development and also in rendering marketing systems services to the parent company. The present case, as pointed out above ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Board. (2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed:- Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices: xxx xxx xxx xxx (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that- (a) the price charged or paid in an international transaction [or specified domestic transaction] has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction [or specified domestic transaction] have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm's length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ployment of the most appropriate method. That observation of the Tribunal, we may say straightway, is incorrect. When more prices than one are thrown up by the most appropriate method, the statute requires that the arm's length price shall be taken to be the arithmetical mean of such prices. This is the plain and simple meaning of the proviso to section 92C(2) of the said Act. 8. Having said so, we may now notice the provisions of sub-section (3) of section 92C which we have already extracted above. A reading of the said provision makes it clear that if the assessing officer in the course of any proceeding of assessment, on the basis of material or information or documents in his possession, is of the opinion that any of the 4 conditions (a) to (d) stipulated in sub-section (3) are satisfied then, the assessing officer may proceed to determine the arm's length price in relation to the international transaction in accordance with the provisions of sub-section (1) and sub-section (2) of section 92C on the basis of such material or information or documents available with him. Provided, of course, that an opportunity is given by the assessing officer to the assessee to show cause as t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rm an opinion that any of the four conditions (a) to (d) set out in sub-section (3) of section 92C existed and then he could proceed to determine the arm's length price in relation to the international transactions in question in accordance with sub-sections (1) and (2) of section 92C on the basis of such material or informaction or document available with him. After the Transfer Pricing Officer determines the arm's length price, it is incumbent upon him to send a copy of the order to the assessing officer and to the assessee. In the present case what has happened is that the Transfer Pricing Officer has generally rejected the comparables submitted by the respondent/assessee in his transfer pricing report and has rejected the suggested arm's length price based on a profit level indicator of 6.99% as determined by the respondent/assessee and, in place thereof, the Transfer Pricing Officer adopted a profit level indicator of 24.53% and determined the arm's length price of the international transactions at Rs. 10,34,40,177/- as against Rs. 8,88,66,320/- returned by the respondent/assessee. This resulted in an adjustment of Rs. 1,45,73,857/- in the income of the assessee being the diff ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se comparables which were finally selected should not have been there since none of them is into development of chip design software, which is the main business of the assessee. Companies having high ratio of trading, activity were not excluded." 12. It may be clarified that while six companies have been specifically mentioned in the Transfer Pricing Officer's order, there is no such specific elimination in respect of the other ten comparables. Insofar as the aforesaid six comparable companies are concerned, the observations of the Transfer Pricing Officer were as under:- "7.5 On 20.01.2005 the assessee was again asked to explain as to why the companies having substantially low turnover as compared to that of the assessee, companies engaged primarily in manufacturing activity and companies with low employee cost (as software development companies typically have high wages/salaries to total sales ratio), may not be eliminated. The list of such companies is as under :- Name of the company Reason for elimination Kushagra Software Ltd. Manufacturing concern lntergrated Hitech Ltd. Low turnover Fare C Software Ltd. Low employee cost Luminaire technologies Ltd. Low turnover ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns Ltd. 20.69% Integrate Hitech Ltd. 3.16% NIIT Gis Ltd. 28.80% Quintegra Solutions Ltd. 37.89% Sark Systems India Ltd. 27.91% Teledata Informatics Ltd. 32.99% Average OP/TC 26.94%" 16. The respondent/assessee submitted that all the companies other than Quintegra Solutions Ltd and Sark Systems India Ltd had either a foreign parent or subsidiary company and therefore might be involved in related party transactions and therefore could not be considered to be comparables. The respondent/assessee also submitted that insofar as Quintegra Solutions Ltd was concerned it ought to be eliminated because it had a different product profile. The Transfer Pricing Officer accepted the contentions of the respondent/assessee with regard to Blue Star Infotech Ltd. and NIIT Gis Ltd. and excluded those companies from the list of comparables. However, the Transfer Pricing Officer rejected the objections of the respondent/assessee with regard to the other suggested comparables. As a result, the Transfer Pricing Officer finalised his list of comparable companies as under:- "7.8 In view of the above discussions, the following list of comparable companies are finally chosen for analysis. Na ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sions of rule 10B(4) of the said Rules. Secondly, the Transfer Pricing Officer did not do any functional asset risk (FAR) analysis and was of the view that insofar as the TNMM method was concerned it was more tolerant to functional differences and was less effected by transactional differences and for this, the Transfer Pricing Officer relied on para 7.2 of the OECD guidelines referred to above. According to the Tribunal this was contrary to the provisions of rule 10B(2)(3) as well as rule 10B(1)(e). The Tribunal also found that the range of turnovers which was employed by the Transfer Pricing Officer for filtering in comparables was far too wide inasmuch as the Transfer Pricing Officer had considered the range of Rs.50 lakhs to Rs.100 crores whereas the turnover of the respondent/assessee was only Rs.8.8 crores. It may be pointed out that the respondent/assessee, while selecting its comparables in its Transfer Pricing Report, had taken the range of Rs.47 lakhs to Rs.25.71 crores. Thirdly, the Tribunal returned the finding that the Transfer Pricing Officer should not have rejected the comparables selected by the respondent/assessee. Apart from this, the Tribunal also held that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y, the Transfer Pricing Officer had not specifically rejected any of the comparables of the respondent/assessee. The Tribunal was of the view that the comparables of the respondent/assesse ought to have been accepted and, had that been the case, there would have been no need for the Transfer Pricing Officer to search for comparables. Of course, in passing the order, the Tribunal made certain general observations that unless and until the comparables drawn by the tax payer were rejected, a fresh search by the Transfer Pricing Officer could not be conducted. However, this has to be tempered with the relevant statutory provisions which are clearly set out in sub-section (3) of section 92C of the said Act which stipulates four situations whereunder the assessing officer/ Transfer Pricing Officer may proceed to determine the arm's length price in relation to an international transaction. If any one of those four conditions are satisfied, it would be open to the assessing officer/Transfer Pricing Officer to proceed to determine the arm's length price. This clarification of the observation of the Tribunal was necessary and that is why we have done so. 22. We also note that the Tribunal h ..... X X X X Extracts X X X X X X X X Extracts X X X X
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