9911796707
TMI Blog2013 (10) TMI 747X X X X Extracts X X X X X X X X Extracts X X X X ..... ed upon by the CIT(A) in this regard are incorrect. 3. The learned CIT(A) has erred in commenting adversely about the "onsite income/Revenue" filter applied by the TPO and thereby rejected some of the comparables selected by the TPO. The arguments and the facts relied upon by the CIT(A) in this regard are incorrect. 4. The learned CIT(A) has erred in allowing the benefit of deduction of 5% under proviso to sec. 92C(2) of the Act. The arguments and the facts relied upon by the CIT(A) in this are devoid of merit. 5. The learned CIT(A) has erred in allowing the additional benefit of risk adjustment of 1% to the tax payer, the arguments and the facts relied upon by the CIT(A) in this regard are devoid of merit." In ground Nos. 1, 2 and 3, the department has challenged the rejection by the CIT(A) of certain comparables selected by the TPO applying different filters. 3. Briefly the facts of the issue are, the assessee is a wholly owned subsidiary of Hellosoft Inc, USA its associated enterprise. The assessee is engaged in the business of development of software on behalf of its Holding Company and transfers th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ices or it is an enterprise level expense. (b) There is no discernible link between the level of costs incurred and a market price in software services as the services are usually compensated on a man hourly basis which may not vary much across the industry for same or similar type of service. So, CPM is not the appropriate method. (c) While applying CPM, the tax payer should have considered all direct and indirect costs incurred in respect of the services rendered by it. But, it is apparent from details given above that the tax payer itself did not include all the direct and indirect costs while computing gross mark up e.g. rent, insurance, repairs were not considered. In the case of comparable companies, the details of indirect costs incurred in rendering services were simply not available. Thus it can not be said that the gross profit worked out in the case of the comparables is after taking into account the same items of expenditure as in the case of the taxpayer. (d) As per the agreement, the tax payer's cost of providing services includes all costs that have been incurred by the tax paer except inte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the comparables. This tantamount to data massaging, to shit its purpose. 4. No audit reports or financial statements were provided to verify the veracity of the cost details furnished, with reference to the comparable company under the CMP method chosen by the taxpayer. 5. The very basis of the turnover filter is misconceived as it is the fallacious believe on the part of the taxpayer that turnover/sales, is intimately linked to profits. This aspect has been explained in detail by the TPO while discussing the turnover filter' adopted by the TPO. 6. Despite being in software business, many companies have been rejected arbitrarily on the ground that they are having related party transaction,. While a span of 5-50 crore was adopted by the assessee for the turnover filter, however, with reference to related party transaction it has not fixed any reasonable limit. This is a myopic approach, as the related party transaction is relevant only if it is in such quantum so as to influence the results of the comparables,. It is for this reason that TPO has opted for an related party transaction @25%. The gross ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO assessment order was passed u/s 143(3) read with section 92C(3) adding the amount of Rs. 1,89,17,669/- to the total income. 6. The assessee challenging the addition made filed appeal before the CIT(A). In course of hearing before the CIT(A) the assessee objected to rejection of CPM adopted by he assessee and selecting TNMM as the most appropriate method. The assessee further submitted that the filters applied by the TPO were defective giving defective results and cannot be accepted as comparables. The assessee submitted that the TPO has selected large size companies having huge turnover with profit margin of more than 22% which cannot be treated as comparables. The assessee submitted that the TPO has selected companies having related party transactions upto 25% which is contrary to Rule 10A(a) and Rule 10B of IT Rules. The assessee further contended that the TPO applied the filter of salary expenses and companies whose employee cost to sale was less than 25% were excluded. Application of this filter was not appropriate as the relevant data/information was not available in respect of all the companies in the data base. It was contended by the assessee that the salary cost may no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd compute the adjusted average PLI after allowing working capital adjustment and risk adjustment @3% and benefit of (+)/(-)5% under the proviso to sec. 92C(2). 9. The learned Departmental Representative submitted before us that the cut off mark of 100 crores adopted by the CIT(A) while applying turnover filter is without any basis in absence of any such cut off provided under the IT Act, IT Rules or OECD guidelines. The learned Departmental Representative submitted that the turnover has no relation with the operating profit to operating cost ratio. The learned Departmental Representative objecting to the CIT(A)'s observation with regard to the employee cost to sale filter submitted that wage to sale ratio is an acceptable filter where the employee cost is too low or too high. In this context, the learned Departmental Representative relied upon a decision of the Delhi Bench of the Tribunal in case of Avaya India (P) Ltd. v. Asstt. CIT in ITA No.5150/Del/2010 dated 25-2-2011. The learned Departmental Representative also objected to the finding of the CIT(A) with regard to the onsite income filter. 10. The learned AR submitted that while applying the turnover filter, the scale of o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r paid, the profit in the open market for arriving at a reasonable and accurate adjustment. If the differences are such that they cannot be subject to evaluation or likely to give a unreasonable result, then such transactions should be avoided or eliminated for the purpose of comparison. The OECD in its guidelines has also stated that though TNMM may afford a practical solution to otherwise insoluble transfer pricing problems but, it has to be used sensibly and with appropriate adjustments keeping in view the differences between the comparables. If the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used it would not be appropriate to apply the TNMM without making adjustments for such differences. Keeping in view the above principles it has to be seen whether the comparables selected by the TPO on applications of different filters is appropriate. While the assessee was having a turnover of about Rs.13.57 crores many of the comparables selected by the TPO are having very high turnover of more than Rs.100 crores. In fact Satyam Computers Services and Infosys Limited are giants in comparison to the assessee. Therefor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... view of the matter, the CIT(A) was correct in holding that rejection of comparables selected by the assessee by applying this filter is not correct. We also fully subscribe to the view of the CIT(A) that loss making companies and companies having super normal profits cannot be considered as comparables in view of the ratio laid down in case of Mentor Graphics (India) (P.) Ltd. (supra) and Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226 (Bang.). In aforesaid view of the matter, the companies selected by the CIT(A) as comparables is rational and appropriate in the facts of the present case. We therefore uphold the order of the CIT(A) in directing the Assessing Officer to compute the arithmetic mean of 11 comparables selected by him and determine the ALP after computing the adjusted average PLI. As result, grounds Nos. 1,2 and 3 are dismissed. 13. In Ground No. 4 the department has challenged the direction of the CIT(A) to give the benefit of (+)/(-) 5% under the proviso to section 92C(2) of the Act. 14. We have heard the submissions of the parties on this issue. It appears from the order of the CIT(A) that by relying upon a decision of the Income-tax Appellate Tri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e business. The learned AR submitted that the assessee being a captive service provider, it does not have any risk at all. In this context, the learned AR referred to the functional analysis checklist at page 96 of the paper book. 17. We have heard the submissions of the parties in this regard. The materials on record clearly prove the fact that the assessee is a captive service provider. It has transactions only with its AE. It is also a fact that all the risks lies with the AE. Different benches of the Tribunal have also taken a divergent view on this issue. The Income-tax Appellate Tribunal, Mumbai Bench in the case of Simontech (supra) has held that no separate adjustment is required on account of risk and functional difference, the Income-tax Appellate Tribunal Delhi Bench in the case of Sony India (P.) Ltd. (supra) has held that deduction on account of ownership of intangibles, risk factors can be allowed. In aforesaid view of the matter, we are inclined to accept the view favorable to the assessee. We therefore uphold the direction of the CIT(A) in this regard in allowing the benefit of risk adjustments at 1%. Accordingly, the ground raised by the department is dismissed. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s which have been excluded by the tax payer in CPM like rent, repairs, insurance, lease and hire charges etc. So, the gross margin shown by the tax payer distorts the true picture of its financials for which TNMM method is the most appropriate method as it captures all expenses except interest, coinciding the cost base of the tax payer for reimbursement (a per the agreement and invoices raised by the tax payer) (e) In the taxpayer's case all the costs were incurred towards rendering of services. Therefore, the gross profit is the same in the taxpayer's case as the net profit. Thus thetaxpayer'sPL1 remains the same whether CPM is applied or the TNMM is applied. The difference between the two methods in the taxpayer's case is thus only an academic interest." The CIT(A) has also sustained the view of the TPO by observing in the following manner:- "I agree with the aforesaid reasoning of the TPO for rejecting the CPM to be applied in the case of the appellant as the most appropriate method. TPO's stand gets support from the decision of Hon'ble Supreme Court in the case of Morgan Stanley (291 ITR 16) where it was held that TNMM was th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtmental Representative on the other hand submitted that there is no need for the Assessing Officer to prove that the assessee had shifted profits to its AE while making adjustments in ALP. In this context the learned Departmental Representative relied upon the decision of the P & H High Court in case of Coca Cola India Inc (supra) and decision of the Income-tax Appellate Tribunal, Bangalore Bench in case of SAP Labs (I) (P.) Ltd. In ITA 398/Bang/2009 dated 30-8-2010. 25. We have heard rival submissions and perused the materials on record. We have also examined the decisions relied upon by the assessee. Our finding on the issue is though it is a fact that assessee's income is exempt u/s 10A of the Act but that does not necessarily mean that the Assessing Officer has to prove the shifting of profits by the assessee to its AE before applying Transfer Pricing Provision. The Hon'ble P & H High Court in the case of Coca Cola India Inc. (supra) while considering somewhat similar issue held in the following manner:- "We do not find any ambiguity or absurd consequence of application of Chapter-X to persons who are subject to jurisdiction of taxing authorities in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lution Panel (DRP). The appeal pertains to the assessment year 2006-07. 27. The grounds raised by the assessee gives rise to the following two issues. (i) TNMM method adopted by the TPO cannot be considered as most appropriate method in place of cost plus method adopted by the assessee. (ii) The addition of Rs. 1,89,17,699/- on account of adjustment to the ALP is without any justified basis as the comparables selected by the TPO by applying certain filters are not proper. The facts being more or less similar to the assessment year 2005-06 dealt in detail hereinbefore in departmental appeal No. 645/Hyd/2010, it is not necessary to deal with all those facts over again in this appeal. For the assessment year under dispute, the assessee entered into international transaction with its AE worth Rs. 16,96,54,026/-. For the impugned assessment year, the assessee filed its return of income on 16-11-2006 declaring a total income of Rs. 1,82,742/- after claiming deduction of Rs. 1,18,73,994/- u/s 10A of the Act. For computing the ALP of internal transaction, the assessee adopted cost plus method (CPM) as was the case in the preceding asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... said adjusted arithmetic mean PLI, the ALP was computed at 119.17% of the operating cost and ALP of the international transaction was determined at Rs.18,60,76,624/-. As there was a shortfall of Rs.1,66,94,486/-, the TPO recommended for the adjustment of the same u/s 92CA of the Act. The adjustment in ALP by the TPO was challenged before the DRP. The DRP however did not accept the contentions raised by the assessee and upheld the ALP calculated by the TPO. 29. The learned AR submitted before us that the rejection of CPM method by TPO is without any proper reasoning and the anomalies pointed by the TPO are on account of mis-interpretation of the OECD guidelines and ICA guidelines. The rejection of the selected comparables under CPM is without any basis. The learned AR submitted that TPO has applied defective selection criteria while selecting comparables which will never give correct results. The learned AR submitted that the TPO has considered comparables having huge turnover compared to the turnover of the assessee. The learned AR submitted that some of the comparables are also functionally dissimilar. The learned AR submitted that companies having extraordinary profits were also ..... X X X X Extracts X X X X X X X X Extracts X X X X
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