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TMI Blog2013 (9) TMI 120X X X X Extracts X X X X X X X X Extracts X X X X ..... ra India also enters into direct contracts with end customers. 3. The Transfer Pricing Officer at Page 2 brought out the portfolio of the assessee in the following words:- "Interra IT India has significant expertise in developing distributed enterprises software. It delivers high-quality, robust and scalable software services and solutions using multi-tiered client-server architecture. The software solutions can be distributed between IBM Mainframes, Unix Platforms and Microsoft Windows 2000 and XP. In many projects, the engineers in Interra have successfully applied their ingenuity in marrying legacy applications on the IMB Mainframe to today's web-based client-server techniques to provide cost-effective solutions to complex problems. The entire effort is backed by considerable experience in the state-of-the-art technologies like Microsoft DNA (Distributed Internet Architecture). Universal Data Access (UDA), MTS, IIS, COM/DCOM/COM+, OLAP AND COMTI. The team uses a host of development tools like Visual C++, Visual Basic and Visual InterDev, SQL server 7.0, Essbase. Interra India has recently started developing intranets and Microsoft Exchange based work flows. Interra KIT India ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tracts with Voxiva Inc. and also with domestic customers. It had used TNMM as a method and for this purpose took the operative profits divided by total cost as the profit level indicator. The assessee relied upon the internal comparables by using TNMM analysis and found that PLI 7.63% of "internal uncontrolled transaction" was lesser than the PLI of the "international controlled transaction" entered by the assessee with Interra India, which was found to be 8.98%. 6. Alternatively, the assessee benchmarked the international transactions entered into with its associated enterprise (AE), using TNMM method, with external comparable companies. 7. 52 external comparable companies were identified by the assessee and PLI was found at (-) .33% and it was concluded that the assessee's controlled transactions with it's AE, which was 8.98% PLI, was higher and hence at arm's length. The assessee used multiple year data. 8. The Transfer Pricing Officer rejected the use of multiple year data by the assessee. He relied on the Special Bench decision in the case of Aztec Software & Technology Services Ltd., 294 ITR (AT) 32 and other decisions and only data for the year 2006, which would be the cu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re on personnel was Rs. 12.87 crores, which amounts to 61% and such percentage is comparable to the results of the NASSCOM-CRISIL survey on the matter. The assessee's fresh search which threw up nine comparables and which were sought to be included as additional evidence was rejected on the ground that the fresh search was embarked upon to achieve biased results. 16. The assessee's argument on res judicata was rejected by relying on the decision of the Tribunal in the case of M/s. Carraro India Ltd. Vs. DCIT (2008-TIOL-519-ITAT-DEL). 17. The argument for grant of adjustment for risk at 5%, on the ground that the assessee is a captive service provider is rejected on the ground that, the assessee is exposed to all kinds of risks like, technological risk, government policies risk, environmental risks, security risks etc. The Transfer Pricing Officer also held that, being a captive service provider is itself a big risk as the assessee is dependent on only the AE. He also referred to other risks like human capital risk, intangible etc. Further the TPO held that reasonable accurate adjustment for risk cannot be done. He analyzed various risks and came to a conclusion that no risk analy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and not on financial results. 2.5 That the assessing officer / TPO erred in applying the abovementioned additional filters without raising any objection to the search process as adopted by the appellant in the Transfer Pricing Documentation. 2.6 That the assessing officer / TPO erred on facts and in law in applying inconsistent approach by eliminating loss making companies or companies with declining profit without eliminating the companies having significantly high margins. 2.7 That the assessing officer / TPO erred on facts and in law in applying the filter of wages to sales of 45-65% after relying on Nasscom-CRISIL survey, without appreciating the fact the wages constitute 52.78% of appellant's total turnover. 2.8 That the assessing officer / TPO erred on facts in rejecting the claim of the assessee that the companies having wages to sales ratio within the band of 42%-62%, (i.e. +/- 10%) should be selected so as to benchmark the international transactions undertaken by the appellant. 2.9 That the assessing officer / TPO erred in rejecting Genesys International Corp. Ltd., Compulink Systems Ltd. as comparables allegedly holding that there has been decline in the sales wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... could not be any motive for the transfer of profits outside India. 2.20 That the assessing officer / TPO erred on facts and in law in not following the transfer pricing order passed in the immediately preceding assessment year even when there is no change in the facts of the appellant's case. 2.21 That the assessing officer / TPO erred on facts and in law in applying operating results for the relevant previous year as opposed to the contemporaneous data available at the time of making Transfer Pricing documentation which is in complete disregard of the contentions of the assessee. 2.22 Without prejudice, that the assessing officer / TPO erred in law in not allowing variation to the extent of (+/-)5%, while determining the arm's length price of the 'international transactions' 3. That the assessing officer erred on facts and in law in denying deduction amounting Rs.I,93,30,9451- under section 10A of the Income-tax Act, 1961 ('the Act') in respect of profits of Noida Unit, i.e. the undertaking set up in Noida Export Processing Zone ('NEPZ'). 3.1 That the assessing officer erred on facts and in law in holding that the appellant is not entitled to c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TD 448. (v) Philips Software, 26 SOT 226 (vi) Quark Systems Pvt. Ltd. Vs. DCIT (ITA Nos. 100 & 115/CHD/2009). 25. The TPO has selected the companies with very high operative profit margin and ignored or rejected other companies having low margin or loss. It was argued that selection of only high profit margin company and rejecting the loss making/low profit companies as comparable companies has distorted the results. 26. On application of filter of wages/sales ratio, he submitted that the survey referred to by the TPO was not available in the public domain and that the range of 42% to 62% may be considered as it would be (+)/(-) 10% range. He further submitted that without prejudice the assessee company was essentially a software development company and not an ITES/BPO company and hence, this filter cannot be applied. 27. On excluding comparable companies with negative ROG-Sales i.e. (a) Genesys International Corpn. Ltd. (OP/OC - 3.49%); & (b) Compulink Systems Ltd. (OP/OC (-) 4.65%), he referred to the objections filed before the DRP which is at pages 47 and 29 of the Paper Book and argued that there has been increase in sales of all the aforesaid companies in the subsequent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tware companies. He vehemently contended that the assessee cannot be expected to earn more profit than what has been earned from the combined operations of the two entities i.e. the assessee and its AE while dealing with unrelated parties. 31. That the assessee has low capacity utilization and sought adjustment for the same by relying on Rule 10B(3) as well certain decisions of the Tribunal which under certain circumstances have accepted such claims for adjustment. 32. One of the main contentions of Mr. Ajay Vohra is that the T.P. adjustment cannot exceed the amount of margin retained by the AE. He furnished a chart which gives the total revenues of the A.E., cost incurred and profit declared and it was argued that the adjustments if any, cannot exceed the profits combinedly derived, for the reason that notional income cannot be brought to tax. 33. He relied on the following case laws:- (i) Sony India P. Ltd. Vs. CBDT, 288 ITR 52 (Delhi). (ii) Philip Software Centre Pvt. Ltd. Vs. ACIT (ITA No.218 (Bang.)/2008). (iii) Kyungshin Industrial Motherson Ltd. (ITA No.1396/Del/2009). (iv) DCIT vs. Global Ventedge P. Ltd. (v) Li & Fun (India) Pvt. Ltd. Vs. DCIT (ITA No.5156/Del/2010 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t be a comparison as the transaction with the third party is economically insignificant. He further submits that if such comparables are allowed, it would give scope for tax avoidance and evasion by assessees, by indulging in small sample sales to third party, so as to demonstrate that the transactions with the AE are at arm's length. He pleaded that insignificant transaction cannot be taken into account. 40. He relied on Rule 10B(2)(d) for the proposition that size of market is to be considered. He relied on the decision of ITAT, Pune Bench `A' in ITA No.1296/PN/10 in the case of Brinton Carpets Asia Pvt. Ltd. vs. DCIT, for the proposition that small value transactions cannot be taken as comparables. Significant volume difference between the two segments has to be considered as a factor for selection of comparables. He argued that domestic transactions cannot be compared with export transactions and hence benchmarking should not be done of PLI of export transactions with the PLI of domestic transactions. He further relied on the following case laws:- (i) Sony India Pvt. Ltd., 315 ITR 150; (ii) Sony India Pvt. Ltd. 114 ITD 448 (Del)(Trib.) 41. He further pointed out that the na ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Bench as to why range of 50% to 55% should not taken when the assessee has shown wages to sales ratio of 52%, both the parties did not respond with a cohesive answer. 46. In the case of Genesys International Corpn. Ltd., being a comparable, he submitted that the data of subsequent years cannot be relied upon and only current year data has to be taken for which proposition he relied on the decision of Delhi Bench in the case of Mentor Graphics, 109 ITD 101 (Del). He also relied on the decision of Pune Bench in the case of Honeywell Automation (India) Ltd. vs. DCIT, (ITA No.18/PN/2011). 47. On Soft Pro Systems he relied on the findings of the AO and argued that the same should be taken as a comparable. On fresh comparables he submitted that the AO has rightly not allowed the same for the reason that the assessee is picking up comparables with the objective to achieve such results which would lead to a conclusion that the transaction in question is at arm's length. Such biased selection cannot be allowed at a latter stage. He submitted that the assessee has not given any reason as to why these comparables were not taken at an earlier point of time and what is the reason for admitt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... learned DR distinguished the case laws relied upon by the assessee by submitting that what was stated was that the adjustment cannot exceed the combined turnover of the assessee as well as the A.E. and that no reference was made to the combined profits. On the issue of taxing notional profit, he submitted that such an eventuality would not arise if the assessee uses to determine ALP and discloses proper profits. 55. The learned counsel for the assessee in reply submitted that internal comparables are the most preferred comparables for benchmarking the international transactions. He argued that each software service assignment is not of significant value, whether it relates to the AE or to the unrelated party and hence are comparable transactions. Similar software services were rendered to domestic customers and could be taken as a comparable. Referring to the Rules he submitted that size of the market does not refer to volume or value of transaction but is refers to nature or characteristics of the market in which the transaction are undertaken. He argued that there is no inconsistency with Rule 10B(2)(d) and Rule 10B(1)(e). He submitted that internal comparable cannot be disregar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... companies cannot be rejected merely on the basis that it has incurred loss. On Sap Labs (India) Pvt. Ltd. and Quark Systems Ltd., he submitted that the Tribunal held that extreme cases cannot be considered. On reliance placed on the decision of Mentor Graphics (supra) it was submitted that the Tribunal objected to the use of future data only because the TPO was drawing inferences merely on the basis of assumptions and surmises. In the case of ADP Pvt. Ltd. (supra) he submitted that the case is distinguishable for the reason that the assessee is using data of subsequent years only for the purpose of analyzing the trend of turnover and profitability of the comparable companies just to demonstrate that such companies are not suffering from any extra-ordinary circumstances. On Honeywell (supra) the provisions for future loss made, was held as that which cannot be considered for the purpose of computing the operating margin. On Intellinet Technologies India Pvt. Ltd. Vs. ITO (ITA No.1267/Bang/2010) the Tribunal held that single customer risk is a hypothetical risk and the risk faced by the comparable companies is actual risk and therefore, adjustment to account for differences in risk i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... OP to Total Cost % Reasons for rejection Ref. Pg. no 1. Avani Cimcon Technologies Ltd. 50.29 * Earning extraordinary profits. 2. Celestial Labs Ltd 58.35 * Employee cost only 23.36% of sales. Does not satisfy the filters applied by the TPO. * Rejected by the DRP in assessment year 2008-09 in the case of Interra Infotech, a sister concern of the appellant and engaged in provision of identical services. * Functionally not comparable, engaged in IT & ITES, Biotechnology andmanufacturing business. Segmental results of IT division are not available. * Even within the software domain, the company is primarily a software product company. It owns proprietary products such as Cell vision, CLL TOX etc. * Super normal profit. Pg 244, 248, 251 250 3. Flextronics Software Systems Ltd. (Seg.) 25.31 * very high turnover of Rs. 665 cr. Which is 33 times the turnover of the assessee. * also deals in software products. Pg 253 & 265 4. Infosys Technologies Ltd. 40.30 * Very high turnover of Rs. 13,655 Cr which is 680 times the revenue of the appellant. * also deals in software products. Pg 289 5. KALS Information Systems Ltd. (Seg.) 30.55 * deals in software products ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpany is 54% which demonstrates the fact that it is performing significant functions in-house through it's own employees. Pg 453 2. Vision Computech Integrators Limited Related party transaction is in excess of 25% - However, actual RPT is 23.15% Pg 461 & 474 In view of the aforesaid, it was submitted that VMF Softech and Vision Computech satisfies all the filters of TPO and should be considered as comparable for the purpose of benchmarking the international transactions of the assessee. In respect of cases of Celestial Labs Ltd. and Megasoft Ltd. It was contended that these companies are making super normal profits and hence, cannot be taken as comparables for the purpose of benchmarking. The assessee also disputed rejection of comparables by the TPO on the basis that they rendered on sight service which is inappropriate. 61. The learned DR on the other hand, controverted these submissions by arguing that in the case of internal comparables the submissions made for the assessment year 2006-07 have to be considered. He submits that though the volumes are not as miniscule as in the previous year, the fact remains that the nature of transactions is not the same. He aga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are not legal principles, in the sense that it does not involve interpretation of law. Picking up samples or comparables, stating that in a given situation a particular methodology should be adopted for benchmarking a transaction or coming to a conclusion that particular method is most appropriate method etc. are not legal interpretations but only solution found by the Bench, in its own wisdom, given a certain fact situation. It is difficult to have a case where the functions, assets and risk of an assessee, are same as the case decided subsequently. Seldom two business models are the same. Quoting these case laws and relying upon them as if they have laid down binding legal precedence without reference to the facts, to our mind is not only wrong but even misleading. Even in following a binding legal precedence, the Courts have cautioned that what has to be seen is whether the facts and circumstances are same. Though it is well settled, for sake of ready reference we quote following case laws:- (i) GVK Gautami Power Ltd. vs. ACIT, 336 ITR 451 (A.P.) for the proposition that observations of Court are neither to be read as Euclid's theorems nor as provisions of a statute and that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e in decision making process; a point never considered in a decision shall not be an authority therefor. (viii) Gujarat Co-operative Bank Ltd. vs. CIT, 250 ITR 229 (Guj.) for the proposition that for SC's decision to be law has to be declared or stated vocally to support conclusion, not mere conclusion by which case is disposed of. (ix) CIT vs. Sun Engineering Works P. Ltd., 198 ITR 297 for the proposition that it is neither desirable nor permissible to pick out a word or a sentence from the judgment of this court, divorced from the context of the question under consideration and treat it to be the complete "law" declared by this court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this court. A decision of this court takes its colour from the question involved in the case in which it is rendered and, while applying the decision to a later case, the courts must carefully try to ascertain the true principle laid down by the decision of this court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this court to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansfer pricing adjustment at best cannot exceed the amount of margins retained by the assessee, as well as the A.E. In other words, he states that the transfer pricing adjustment cannot exceed the total profits earned by the group, as it would result in taxation of notional income. Reliance was placed on the judgment of the Delhi High Court in the case of Sony India Pvt. Ltd. and other case laws. He urged the Bench to lay down this proposition with as many caveats or conditionalities as the Bench may deem proper. 68. In our considered view no such proposition can be laid down, as it would be against law. Neither the Act nor the Rules provide for such capping of an adjustment. Such an exercise is not permissible under the Transfer Pricing provisions but also, it is not practical as the profits of the entire group are not subject to scrutiny of the Indian authorities. Multinationals have innumerous types of business and have multiple locations with multiple AEs and to lay down such a proposition would make the transfer pricing provisions unworkable. Under the Indian law, the T.P.O. is given a mechanism to determine ALP and make an adjustment. Such power is not subject to the acts of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e group entity. When Transfer Pricing Study is done with appropriate comparables by adopting the most appropriate method, the question of Transfer Pricing adjustment being more than gross receipts from a transaction simply does not arise. The assessee as well as the Revenue authorities are bound to determined the ALP by applying the law and rules laid down and cannot be guided by extraneous parameters. 74. If the proposition of the assessee is accepted, then it would result in a situation where, when an Indian authority decides on the Transfer Pricing adjustment by fixing the arm's length price and because the Revenue authorities of the other country in which the A.E. is situated decide to tax that entity on a particular ALP, then the arm's length price arrived at by the Indian authorities by applying the law would require to be disturbed, which in our opinion is not correct as it is not permitted by the law. For all these reasons, this plea of the assessee is dismissed as devoid of merit. 75. The other contention of the assessee that the Transfer Pricing adjustment should not be made for the reason that the income of the assessee company is exempt under sec. 10A of the Act and h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ear. The material available with the TPO in the current year is vastly different to the material available with the TPO in the earlier year. In such circumstances, the principle of consistency does not hold water. No doubt it is desirable that the Revenue Authorities be consistent but in cases where the subsequent officer is able to gather further material, which would require him to decide in a way different from the decision taken by the AO in the earlier year, who did not have the benefit of such material, and when the analysis of the material is different, then in our view he is permitted to do so. There is no res judicata in the Income-tax Proceedings. The principle of consistency also has its limitations and cannot be applied across the board. The fact situation has to be seen. The ld. Counsel for the assessee has not demonstrated as to which particular conclusion of the previous TPO or AO was viewed in an opposite manner by the current T.P.O. It is a case of non application of mind by the previous T.P.O. on some issues. Hence this argument is rejected. 78. Coming to the argument that the service is a low end software maintenance service and combined profitability is low and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... given as a sample. 81. In our considered opinion the requirement of transaction margins being compared at a transaction level or at the level of a class of similar transactions, does not warrant comparing miniscule transactions with large transaction for the purpose of benchmarking. Benchmarking of transactions at the transaction level does not warrant ignoring the principle or concept of materiality. The facts and circumstances of each case has to be seen. At the same time reliance placed by the learned DR on Rule 10B(2)(d) is not correct as the same does not apply to the factual situation. This Rule refers to external conditions and not to the miniscule nature of the comparable uncontrolled transactions. Rule 10B(1)(e) relied upon by the assessee also does not come to its rescue as the Rule does not lay down as to which transaction can be taken as a comparable uncontrolled transaction for the purpose of benchmarking the net profit margin with the controlled transaction. Thus the reasoning of both the parties on the issue does not fit into the facts of this case and has to be rejected. 82. Having said so we find in the assessment year 2007-08, the assessee has uncontrolled comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AO/TPO. Our view is guided by our decision taken for the subsequent year. 85. In view of our decision, we do not consider it necessary to adjudicate the numerous other arguments raised by both parties as it would be an academic exercise. 86. Thus, we set aside these additions for both the assessment years under consideration to the AO/TPO for fresh adjudication in accordance with law. As we have upheld the contention of the assessee on the issue of internal comparables being taken for the purpose of benchmarking, as clearly stated we do not adjudicate the issue of selection of External comparables as this would be an academic exercise. Therefore, these grounds are allowed for statistical purposes. 87. Ground No.3 is against the disallowance of deduction under sec. 10A of the Act. The assessee had set up the Noida Unit/undertaking and had started its commercial operations in the previous year relevant to the assessment year 1997-98. In that year the Noida unit/undertaking of the assessee had suffered losses of Rs. 37,34,740/- and no exemption was claimed in that year. In the previous year relevant to the assessment year 1998-99 (i.e. 2nd year of operation) the appellant claimed d ..... X X X X Extracts X X X X X X X X Extracts X X X X
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