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TMI Blog2013 (9) TMI 195X X X X Extracts X X X X X X X X Extracts X X X X ..... lar nature of transaction, therefore, its margin is at ALP; secondly, 12% of the contract price retained by AE has resulted into loss to AE and' therefore, assessee's profit margin should be taken at arm's length; thirdly, based on segmental details of AE and non-AE Internal transaction Net Margin Method (TNMM) should have been accepted, as operating margin of total cost earned by the assessee for its AE transactions is more than operating margin earned on all contracts with similar transaction with third party; fourthly, while applying external TNMM, the search process/filters criteria applied by the TPO are improper and has also objected to the various comparables taken by the TPO' The other independent ground taken in ground No.18 is on account of allowing set off of brought forward business loss and unabsorbed depreciation against business income and any income from other sources earned during the previous year. 3. At the time of hearing, ld counsel for assessee did not press Ground Nos. 17 & 19 and, therefore, same are dismissed as not pressed. 4. The relevant facts, apropos the issue of transfer pricing adjustment, are that assessee is in the business of Information Technol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO observed that assessee has not used the cost of the product for bench marking the transactions, hence, CPM is not the appropriate method for bench marking the arm's length price in this case. To substantiate its claim that price charged by the assessee is at arm's length, assessee submitted the invoices of it's transactions with third party and that with its AE and contended that its margin with AE was better. The TPO was however not very much clear as to what was the cost of the work done by the assessee, hence, he issued a show cause notice to explain its operating margin. In reply, it was submitted by assessee as under: "without prejudice of the above, it is also submitted that even if the assessee's operating margin is compared at entity and net level as per preceding assessment year i.e. A Y 2007-08, the operating margin of CSSL on software services at entity level (OPTC) comes to 27.48% after making certain economic adjustments to the operating cost (certain expenses, such as, payroll cost, communication expenses, security expenses, training expenses, loss on sale of assets, exchange loss and loss on sale of investment have been considered as no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent of Rs.2,44,94,134 was proposed by him. 9. Before the DRP, assessee has raised several objections and one of such objection was that in case CPM fails for benchmarking the international transaction for software development services, then internal comparable uncontrolled price (CUP) method should be followed. The segmental details filed before the TPO was also referred to. The DRP rejected the said contention on the ground that neither CPM method nor internal CUP method would be applicable because in the case of CPM direct and indirect cost of production incurred by the AEs in respect of property transferred or services provided to an AE has to be considered and then normal gross profit mark-up to such cost can be considered, which in this case is not ascertainable. Secondly, the internal CUP would not be applicable because it requires stricter comparability and assessee has not demonstrated the terms and conditions of the contract with the third party which are comparable to the transactions with AE. Assessee further objected that in case both CUP and CPM methods are not applicable then internal TNMM should be followed for bench marking the transaction, which too has been rejec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansaction and go beyond to determine the arm's length price by adopting any of the prescribed method. His main arguments in short was that on facts of assessee's case, the international transaction entered into with its AE were at arm's length price because it was directly comparable to similar transaction with non AE. To justify that assessee's margin with its AE was at arm's length price, he submitted that the AE at USA which was retaining 12% of the invoice amount was in fact incurring huge losses and in support of the same, he referred to the relevant documents in the paper book 11. The other limb of his arguments was that before the Transfer Pricing Officer, assessee has submitted the segmental details of profit and loss account, disclosing the margin earned by the assessee on international transaction with its AE and that with Corliant lnc i.e. non-AE. The TPO despite recording the said details in para 15 has failed to consider the margins of the AE and non-AE. He pointed out that this specific submission of internal TNMM was made before TPO which is evident from submissions made before him, given at pages 108 and 221 of PB and annexure thereto, wherein, segmental details we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ength price should be accepted as such, cannot be accepted because we are not bench marking the arrangement but bench marking the margins for which only one of the prescribed method has to be followed. Regarding ld counsel's submission that the AE has been incurring losses on the margin retained by it i.e. 12% of the contract price, he submitted that, what we are looking into, is the ALP of the international transaction undertaken by the assessee and not the margin earned by AE. We have no details about the AE and its margin and expenses is not tested here, so as to determine the ALP of the assessee. Assessee's controlled transaction has to be seen from the conditions of uncontrolled transaction. Thus, such a plea cannot be sustained. Lastly, with regard to internal comparable, he submitted that none of the authorities have carried out any comparability analysis as the segmental details have not been properly examined. Moreover, there is huge difference between the turnover undertaken with the AE and non-AE, therefore, these could not be said to be comparable. Regarding external comparables, he also gave his detailed rebuttal and submissions about the adoption of the criteria taken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee. 15. Now coming to the first contention of the ld. counsel that ALP should be accepted as such in the case of the assessee, looking to the nature of the transaction. Section 92 of the Act provides that any income arising from an international transaction shall be computed "having regard to arm's length price". The phrase "having regard to" has to be understood for considering all the relevant factors including those which are relevant to compute arm's length price. The terms 'arm's length price' has been defined in section 92F(ii) to mean that "the price which is applied or proposed to be applied in a transaction between persons other than AEs, in uncontrolled conditions." The arm's length price operates on a hypothesis that AEs are independent of each other in their commercial and financial relation and the transactions between them are to be free from any condition which should be imposed because of such relationship. The profits from transaction, if they are dictated, have to be worked out by reference to the conditions which would have obtained between the independent enterprise in comparable transaction and comparable circumstances. The comparison of the conditions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thods. Sub-section (1) of section 92C starts with: "The arm's length price in relation to an international transaction shall be determined by any of the following methods, being most appropriate method .....". In our considered opinion, the contention of the ld. DR laying emphasis on the word 'any' for propelling his point of view that the method for determining the ALP can also be a combination of the prescribed methods, is devoid of force. There is no doubt that the word "any" has been used u/s 92C(1) which would have ordinarily implied that any specific or non-specific method or even a combination of one or more prescribed methods is sufficient. However it is relevant to note that the scope of the word "any" is circumscribed by the succeeding words of the following methods being the most appropriate method". The ambit of the word "any" in sub-section (1) has been restricted by the 'following' five specific methods given in the later part of the provision. Rule 10B also provides in the same manner that ".... the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method .....". Here also th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e within any of the existing procedures prescribed as per these methods. No one is authorized to add one or more new steps in the prescribed procedure or to substitute any other mechanism with the one prescribed under the rule. It is neither possible to invent a new method nor to substitute a new methodology in place of the one prescribed in the rule. Thus, we are unable to persuade ourselves to the first contention raised by ld counsel. 16. Section 92C prescribes for following methods for determining ALP. (i) Comparable uncontrolled price method (CUP); (ii) Resale price method; (iii) Cost plus method; (iv) Profit split method; (v) Transactional net margin method and (vi) any such method, as may be prescribed by the Board. These above methods can be broadly classified into following categories: (i) the method which focuses directly on the price of products sold or transferred requiring both financial and product comparability. Under this method, CUP is applied. (ii) the second type of method operates at gross profit margin level requiring financial rather than product comparability. In this category, Resale price Method (RPM) and Cost Plus Method (CPM) is applied. (iii) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are chosen having functional comparability and these comparables may be internal comparables or external comparables. This point in issue has been dealt by the Third Member decision of ITAT Mumbai Bench in the case of Tecnimont ICB (P.) Ltd. (supra), wherein, the Hon'ble Third Member had an occasion to deal with the similar question. This was answered in the following manner: "10. Clause (i) of Rule 10B(e) stipulates that net profit margin from an international transaction with an AE is computed in relation to cost incurred or sales effected or assets employed etc. clause (ii) is material for the present purpose. It provides that the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions computed having regard to the same base. The 'base' of this provision takes one back to clause (i) which refers to cost incurred or sales effected or assets employed or to be employed. On splitting clause (ii) into two parts, it divulges that the reference is made to internal and external comparables. one part of clause (ii) refers to 'the net profit margin realised by the enter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... number of adjustments. In the case of the assessee, it is not in dispute that assessee is providing software development services to its AE and also similar services to non-AE. In both cases, the nature of contract and the nature of product and services transferred are the same. Therefore, comparing the operating margin of an internal comparable qua the margins on transaction with the AE is quite preferable as there is dismal chance of adjustment. The assessee before the TPO has made detail submission for considering Carliant Inc, non-AE as internal comparable and also provided segmental details of profit and loss account. This is evident from the following submissions made before the TPO. "Without prejudice to the above, we further submit the segmental profit and loss account disclosing the profitability earned by the company on international transactions with respect to software development services to CSSI of INR 12,45,57,517 and Corliant Inc. in Annexure-I. This segment is drawn up by only considering the operating income and costs with reference to the business arrangement where the ultimate customer pays to CSSI and corliant Inc. which is passed on ..... X X X X Extracts X X X X X X X X Extracts X X X X
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