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TMI Blog2014 (8) TMI 863X X X X Extracts X X X X X X X X Extracts X X X X ..... a speaking order on the adjustment in the operating margin of CDR unit, as has been asked for by appellant, in relation to in- house work performed by CDR unit of the company for its manufacturing plant at Goa and thereby disregarding revenue of Rs. 23,03,510/-. 4. The Ld. CIT (A) erred in applying the upper filter for turnover of Rs. 200 crore for selecting comparable companies as against the turnover of the appellant unit that was only Rs. 1.34 crore. 5. The Ld. CIT (A) erred in confirming the stand of AO on selecting Vishal Information Technologies and Tulsyan Technologies as comparable companies (vide para 38 on page 13 of the appeal order). 6. The Ld. CIT (A) erred in neither considering nor passing a speaking order on the relief for business & operational risk adjustment @ 5.25%, as was asked for by the appellant. 7. The Ld. CIT (A) erred in not considering the functional differences between the appellant's CDR unit and comparable companies selected by TPO." 3. In Revenue's appeal, the Revenue has taken the following effective grounds of appeal : &nbs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ded the said amount in the order passed u/s 143(3). Besides this, the AO also disallowed depreciation on the Goodwill amounting to Rs. 47,19,133/-. The Assessee went in appeal before the CIT(A). CIT(A) has partly allowed the appeal of the Assessee. Both the parties have come in appeal before us. 5. Ground no. 3 in Revenue's appeal filed originally and ground nos. 1-4 in the grounds of appeal filed by the Revenue on 7.2.2013 and ground nos. 2-7 in the Assessee's appeal relate to the common issue relating to adjustment in the operating margin of CDR unit and thereby making addition therein to the extent of Rs. 19,05,947/- by the AO which was by taking average operating margin @ 23.68% while the CIT(A) directed the AO to take this margin @ 20.96% and sustained the addition on that basis by holding as under : "28. I have considered the appellant's arguments on the turnover filter adopted by the TPO. While I consider that use of this filter is valid, I am of the opinion that if there is a limit at the lower end of turnover for identifying comparables, there is no reason why there should not be an upper limit also, as size matters in business. This ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incorrect and liable to be rejected for the following reasons: M/s Allsec Technologies Ltd. 32. It was argued that M/s Allsec Technologies Ltd. had a turnover of Rs. 57.56 crore and should therefore be rejected, applying the upper turnover filter of Rs. 20 crore. The TPO had incorrectly computed the margin of this company at 29.85%, as against the correct margin of 26.91%. 33. I am not in agreement with the appellant that given its segmental turnover of Rs. 1.34 crore, a turnover range of Rs. 1 crore to Rs. 20 crore ought to be adopted. As this goes against the basis laid down in Genisys Integrating Systems (India) (P.) Ltd. (supra) for considering companies within the turnover range of Rs. 1 crore to Rs. 200 crore, I reject this argument. However, I find from a perusal of the company's profit and loss account that its operating income was Rs. 57,55,24,067, as against operating expenses of Rs. 45,35,00,314, resulting in an operating profit of Rs. 12,20,24,293. Thus the ratio of operating margin to operating cost works out to 26.91%. I therefore direct the AO to adopt the correct operating margin of 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble portion of their business and as the assessee had carried out the entire operations by itself, these two cases were rightly excluded. 38. I have carefully considered the appellant's submissions. Though employee cost may form a significant portion of the total costs of a software company, the problem lies in correctly gauging such costs. All companies do not follow a uniform policy in classifying employee cost, but categorise it variously as administrative, marketing, operating, or software development expenses and not necessarily as personnel expenses in the profit and loss account. Further, as in these two cases, companies may outsource tasks rather than employ their own personnel and outsourcing costs may be disclosed under heads like legal and professional charges, contracts costs, etc. As there is no way of tracking or identifying employee costs, companies may not be particularly amenable to be used as a filter in the selection or rejection of comparables. I therefore reject the appellant's argument that the two companies ought to have been rejected on the ground that their employee costs were less relative to turnover. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as 22.28% of its operating income in AY 2004-05, which rendered it incomparable as the tolerable limit of related party transactions would be in the vicinity of 10% to 15%. As M/s Nucleus Netsoft had substantial RPT in the earlier year, it was logical to conclude that the company would have had substantial RPT in the current year as well, as facts and circumstances of the case had remained same, as evident from the annual report of the company. In the absence of adequate details for analysis, this company should be rejected as comparable. 44. I do not agree with the appellant's argument about the export revenue filter. The TPO has mentioned on page 63 of his order that he had thought it proper to exclude companies that did not have export turnover that was at least 25% of their total turnover in view of the fact that the appellant was a 100% export company. The appellant has misinterpreted the filter to imply that companies with export turnover of more than 25% of total revenue were rejected, whereas the actual implication of the filter was to exclude companies with export turnover of less than 25% of turnover. Therefore, its suggestion to reject compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quality assurance, designing and product development. The said division is internally named as CDR Division. From this division, the Assessee has generated revenue from export services amounting to Rs. 1,34,20,939/-. This division was also rendering services to the other divisions of the Assessee in India. The total operating costs incurred by the Assessee was to the extent of Rs. 1,23,92,372/- which has not been disputed by the TPO. For this, our attention was drawn towards the order the TPO and it was contended that while computing the operating margin, the AO has computed the operating profit only in respect of the said activities by reducing from the revenue received from support services, the operating margin @ 8.30% while in fact if the notional revenue was worked out in respect of the services rendered to the Assessee's Goa plant at the same rate at which services were rendered to the AE abroad, the operating profit would have come @ 26.06%. It was contended that on an average the revenue has been received from the AE abroad @ Rs. 452/- as the CDR unit has spent 29,685 hrs. while to the Goa unit, the services were rendered for 4,870 hrs. If the said 4,870 hrs. are taken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssue 3 Vishal Information Technologies Ltd 20.82 45.62% Objection of Appellant - Company's business model is different from that of assessee and the selected company had super profit. But CIT (A) did not agree to the objection of the appellant. Company enjoying tax free platform - income exempt u/s 10A. Relief was denied by CIT(A). 4 Cosmic Global Ltd 1.9 17.02% Objection of Appellant - Company's business model is different from that of assessee - But CIT(A) did not agree to the objection of the appellant. Company enjoying tax free platform - income exempt u/s 10A. Relief was denied by CIT(A). 5 Transworks Information Services Ltd 108.23 2.81% No issue 6 Wipro BPO Solutions Ltd 617.71 0.00% Objection of Appellant - Selected company's turnover was very high than of the assessee and size wise is not comparable. CIT(A) agreed to the objection of appellant assessee and excluded this company from the list of comparable companies (para 30 of appeal order). Relief was granted by CIT(A). 7 Ace Software Exports Ltd 5.9 14.50% No issue 8 Nucleus Netsoft & GIS Ltd 2.79 0.00% Objection of Appellant - Selected company does not qualify to be selected ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bsp; (iii) E- gain Communications Pvt. Ltd. v. ITO 118 TTJ 354 (Pune)- the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study. (iv) M/s. Sony India (P) Limited v DCIT, 114 ITD 448 (Delhi) (v) ITO v CRM Services India P Ltd. ITA No. 4068/Del/2009 Whether where turnover of assessee in inst ant year amounted to Rs. 31.64 crores, whereas turnover of comparable case from similar business was Rs. 91.24 lakhs only and thus, having difference of about 33 times in turnover from same business, such a case could not be taken as a comparable case (14.2) (vi) Agnity India Technologies Pvt. Ltd. v Income-tax Officer ITA No.3856(Del)/2010 (vii) Philips Software Centre Pvt. Ltd. 26 SOT 226 (Bang) (viii) M/s Deloitte Consulting India Pvt Ltd v DCIT, ITA No.1084/Hyd/2010-High turnover to be excluded (ix) Frost & Sullivan (I) Pvt. Ltd. v. ACIT, ITA No. 2073/Mum/2010 AY: 2004-05-Para 9 High Profit making companies to be excluded. (x) CIT v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee carried out entire operations by itself, in our considered opinion, these two cases were rightly excluded." (ii) Sapient Corporation Pvt. Ltd. vs. DCIT (ITAT Delhi) - held that loss - making & super - profit companies are not comparable. In brief, it was contended at the cost of repetition that :- 1. Companies having turnover exceeding 20 crore should not considered as comparable to that of the assessee's unit that had a turnover of Rs. 1.34 crore only. 2. Vishal Information Technology that earned operating margin of 45.62% should be considered as super profit making company and be excluded from the list of comparables. 3. In view of the decision of ITAT delivered in Maersk Global Services Center India (P.) Ltd.'s case (supra), M/s Cosmic Global & Vishal Information should be not considered for comparison as they followed entirely different business model for job execution. Besides the above two companies, another company namely Saffron Global should also be excluded as it belongs to the tainted management group of Maple E-Solutions and Triton Corp Ltd. Saffron ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ief to the Assessee. In this regard an adjustment u/s 92CA was required to be made. The Assessee has incurred operating costs of Rs. 1,23,92,372/- in the CDR unit and if the adjustment at arm's length margin @ 23.68% is made, the revenue received should have been Rs. 1,53,26,886/- against which the Assessee has received revenue of Rs. 1,34,20,939/- from the associated enterprises. It was contended that the transfer pricing cannot be an exact science. Evaluation of the transaction through which process of determination is carried out is an art where mathematical certainty is indeed not possible and some approximation cannot be ruled out. The instances taken by the TPO were totally comparable instances. The Assessee was given sufficient opportunity. On an inquiry from the Bench why the notional revenue in respect of the time spent for the services rendered by the CDR unit to Goa plant was not taken into account for the purpose of computing the operating profit ratio of the CDR unit, the ld. DR could not express anything on this except relying on the order of the TPO. 5.3 We have heard the rival submissions, perused the material on record alongwith the order of the tax authoritie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ant by the CDR unit. Since the total cost of the CDR unit has been taken, therefore, the notional revenue in respect of Goa plant should also be considered while computing the net operating profit. If the notional revenue for rendering services to the Goa plant is taken into account, we noted that the operating profit on the basis of the formula adopted by the TPO from the CDR unit will work out as under : Before considering In House service to Goa Plant After considering In House service to Goa Plant Particulars Hours Average per hour Rate INR Assessee Assessee Revenue from rendering of engineering support services to AEs abroad 29,685 452 13,420,939 13,420,939 Notional revenue for rendering services to Goa Plant 4,870 452 2,201,240 Total 34,555 13,420,939 15,622,179 Total Operating Cost 12,392,372 12,392,372 Operating Profits 1,028,567 3,229,807 Net Operating Profit/ Operating Cost 8.30% 26.06% Thus, if notional revenue is assigned to the services rendered by the CDR unit to the Goa plant and taken into account, the net operating profit will be 26.06% which is much ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his income from the marketing expenses of Dubai office and taken the net balance for working out the expense ratio. However, it could not have been done. Office expenses remained unchanged irrespective of the income or recovery. Pentair Italy had only compensated the Assessee @ 10% of its sales in the region and the correct ratio of the expenses to revenue was claimed @ 17.64% instead of 4.08% as taken by TPO in the following manner : 1. Expenses of Dubai office (Rs.) 2,52,83,510 2. Commission earned from AEs for using Dubai office (Rs.) 2,02,65,126 3. Appellant's sales from Dubai office (Rs.) 12,30,55,612 4. Appellant's gross revenue from Dubai office [(2)+(3)] (Rs.) 14,33,20,738 5. Ratio of expenses to revenue [(1)/(4)] % 17.64 The AO relied on the order of the CIT(A) for the preceding A.Y 2004-05 which was confirmed by the ITAT. Ultimately, on the basis of the A.Y 2004-05 an adjustment of 19.35% was claimed in the following manner : 1. Non-AE export sales (Rs.) 23,21,91,702 2. Non-AE domestic sales (Rs.) 21,27,38,585 3. Commission income from AEs (Rs.) 2,02,65,126 4. Expenses of marketing office in Dubai (Rs.) 2,52,83,510 5. Expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on was to adopt total marketing expenses, including those incurred in the company's European and Indian offices. Secondly, the TPO had netted off the Dubai office expenditure against the Dubai office income, without considering the ratio of total marketing expenses to total non-AE export sales as directed by the CIT(A). 17. That there is merit in the appellant's contention seeking a higher rate of adjustment was accepted by CIT(A) in AY 2004-05, following which an upward adjustment was made in that year from 4.39% to 14.80%. As the facts and circumstances of the case are identical in the current year, the same principle needs to be followed. Therefore, considering the merit of the appellant's contentions and the TPO's remand report, I direct the AO to allow an adjustment of 12.31% for marketing expenses consistent with the CIT(A)'s direction. However, the AO may thoroughly verify the correctness of the relevant data before allowing relied as directed above." 6.2 The ld. DR relied on the order of the TPO while the Assessee relied on the order of CIT(A). 6.3 We have heard the rival submissions and carefully considered the same. In our o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... id to the AEs happened to be higher than those paid to local vendors, but has simply ignored 11 other products where prices paid to the AEs happened to be much lower than domestic prices. If the average of prices paid for all the 19 products were considered, it turns out that the average price paid for imports was much lower at Rs. 195.58 than the average price of Rs. 204.68 paid to local vendors. 25. Thus, I find that the TPO's analysis in this segment suffers from factual errors, inconsistency in considering only a part of the transactions, and a bias against the appellant, which render the analysis unreliable. Further, purchases of components and spares from AEs constituted an insignificant 3% of the total purchases and one cannot argue that the appellant had understated its purchases of the value of Rs. 3 crore by Rs. 1 lakh for the purpose of shifting of profits outside India. For these reasons, I delete the addition of Rs. 1,07,017 on account of TP adjustment on import of components and spares." 7.2 We have heard the rival submissions and carefully considered the same alongwith the order of the tax authorities below. The ld. DR even though vehem ..... 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