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TMI Blog2014 (10) TMI 358X X X X Extracts X X X X X X X X Extracts X X X X ..... g of the profits realized from Indian customers so as to form a platform for contending that the TNMM has been applied on the overall profits and hence the AMP expenses should not be subjected to the TP provisions. A distributor is rewarded by the entity for whom the distributor works and the rewards are guaranteed upto an extent and the risk component vis-a-vis a manufacturer is necessarily very less - The rewards can be and generally are based on pricing adjustments and can also be compensated over and above that if greater services are rendered and pricing adjustments have not covered the cost of routine services rendered - assessee is primarily engaged in the distribution of telecom equipment, mobile phones and provision of telecommunication service in India - The company also provides software development services to the group companies. The assessee did not treat the excess AMP expenditure as international transaction and, therefore, it did not form part of TP study submitted by assesse - before TPO the assessee had taken a specific plea to this effect but did not produce any documentary evidence in support of its contention – Following the decision in LG. Electronics ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the promotion of sales directly lead to brand building, the expenses directly in connection with sales are only sales specific - As the TPO has neither properly considered the request of the assessee for inclusion of some other comparable cases nor examined the effect of the above discussed relevant factors on the question of determination of the cost/value of international transaction – thus, the matter is to be remitted back to the TPO for fresh adjudication – Decided in favour of assesse. Adjustment made while re-computation of ALP – Contracts Software Development Service segment – Rejection of use of multiple year data - Held that:- Held that:- There was not much substance in the argument of the assessee because as per Rule 10B(4),the data to be utilized and for analyzing the comparability of uncontrolled transaction with an international transaction is to be the data relating to the financial year in which the international transaction has been entered into - As per proviso to Rule 10D, earlier year data can be used, in addition to the data pertaining to the relevant financial year, only for taking a decision as to how much the factors obtaining in earlier years impact the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Income tax Rules, 1962, the comparable is to be excluded – Decided against assessee. Exclusion of companies – Related party transaction of more than 25% - Held that:- TPO was rightly of the view that this filter is appropriate to eliminate the companies which have controlled transactions and thereby have a significant influence on the margins earned - in principle the tax payer has no objection for applying this filter – assesse also rightly contended that if sufficient number of 100% uncontrolled comparables are found, then no comparable having related party transactions should be considered - no sacrosanct threshold limit should be fixed for this filter - if by applying the threshold limit of 15% of related party transaction, sufficient comparables are available then there is no reason to further extend the limit to 25% - the TPO is directed to take into consideration only those comparables where related party transactions are to the extent of 15% because it is not the case of revenue that by applying the threshold limit of 15%, it will not get sufficient number of comparables – Decided in favour of assesse. Employee cost greater than 25% of total revenues – Held tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ating less than 75% of their export revenues from on-site operations – Decided against assesse. R&D expenses incurred more than 3% of revenue – Held that:- TPO was rightly of the view that for creating intellectual property rights, R&D is required but the converse is not true i.e. each company spending on R&D automatically is not towards creating an IPR - R&D activity in a software development company is to improve the processes in delivering the software development services and not for creating an intanglible - the contention of the assessee that profitability of companies having intangibles is more cannot be lost sight off is also tenable - both sides have their logical view point. Under such circumstances, the balance has to be drawn keeping in view the primary object of transfer pricing study - if a comparable has developed its own intellectual property right resulting into development of a patented product by incurring huge expenditure on R&D then even if it is performing software development functions, it has to be excluded - if a company is incurring huge expenditure on R&D only for improving the processes in delivering the software development services then the said co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s in the execution of contract then assessee will become liable for payment of liquidated damages - The liability, thus, crystallized with the occurrence of event of delay in the execution of contract - The assessee might, after entering into negotiation with the party, get a waiver or partial deduction in its liability but that does not absolve the assessee from being liable for liquidated damages on occurrence of the event of delay in execution of the contract – relying upon FFE. Minerals India (P) Limited. Versus Joint Commissioner Of Income-tax [2004 (7) TMI 331 - ITAT MADRAS-C] - the assessee’s claim of liquidated damages is to be allowed – Decided in favour of assesse. - ITA No. 5637/Del/2011 - - - Dated:- 14-8-2014 - SHRI S.V. MEHROTRA AND SMT. DIVA SINGH, JJ. For the Appellant by :- Sh. Himanshu Shekhar Sinha, Adv., Sh. Ankit Arora, CA, Ms. Somya Seth, CA For the Respondent by:- Sh. Peeyush Jain, CIT/DR (T.P) ORDER PER S.V. MEHROTRA, A.M. This appeal filed by the assessee is directed against the order of ld. CIT(A)- , Gurgaon, dated 31/10/2011 for A.Y. 2007-08. BUSINESS PROFILE OF ASSESSEE:- 2. The assessee, a Motorola Group company, is a lea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in 1989. Its majority shares are held by Motorola International Credit Corporation, USA (MICC), which is in turn, wholly owned subsidiary of MINC. Motorola India is primarily engaged in the distribution of tele-current equipment, mobile phones and provision of tele-communication service in India. The company also provides software development services to the group companies. Additionally, the company also provides marketing and administrative support services to its group companies. 1.2 Shareholding Pattern: 1.3 MIPL s Headquarter is at Gurgaon with sales offices at Delhi, Mumbai and Bangalore. It operates its software development centre at Bangalore Hyderabad. ISSUES:- 3. The assessee e-filed its return of income declaring loss of ₹ 8,82,63,570/-. The AO noticed that assessee had undertaken following major international transactions with its Associate Enterprise (AE) during the F.Y. 2006-07: a.Provision of software development services ₹ 6,812,082,673/- b.Provision of administrative and market support services ₹ 759645791/- c.Distribution of telecom equipments and handsets ₹ 22,271,592,925/- d.Reimbursement of expenses from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee is a Brand Promotion service rendered by the assessee to its Associated Enterprises ( AE ) and that the appellant should receive additional arm s length price ( ALP ) of ₹ 1,76,26,38,353/- from its Associated enterprise for such service. While concluding as above, the ld. AO/TPO and ld. DRP have erred in: 2.1disregarding the fact that the AMP expenses incurred by the assessee are transactions with domestic independent entities not covered by section 92 of the Act and that the analysis of domestic transactions with third parties, in respect of which no reference has been made to TPO, is beyond the powers vested with the TPO u/s 92CA of the Act; 2.2disregarding the fact that the ld. AO failed to independently apply his mind while making a reference to the ld. TPO in a mechanical manner without recording the reasons showing the necessity and expediency of the same; 2.3ignoring the fact that once the assessee s transactions are accepted to be at arm s length after application of Transaction Net Margin Method as the most appropriate method, challenging the individual elements of costs (like the AMP cost) is inconsistent with the provisions of Transfer Pricing; 2.4 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the international transactions pertaining to Administrative and Marketing Support Service business segment of the appellant, and while doing so have grossly erred in: 5.1 rejecting the ALP determined by the assessee under the TP documentation maintained by the assessee u/s 92D of the Act read with Rule 10D of the Rules and also under the new search conducted by the appellant during the proceedings before the ld. TPO without appreciating that none of the conditions given u/s 92C(3) have been satisfied. The authorities have also erred in carrying out a fresh search by rejecting/modifying the filters applied by the assessee; 5.2 disregarding multiple year/prior years data as used by the assessee in the TP documentation and holding that current year (i.e. FY 2006-07) data for the comparable companies should have been used despite the fact that the same was not available to the assessee at the time of preparation of its TP documentation; 5.3 rejecting comparability analysis in the TP documentation/assessee s fresh search and in conducting a fresh comparability analysis based on application of the following additional/revised filters in determining the ALP for the administrat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the case and in law, the ld.TPO and ld. AO erred in not following the binding directions issued by the ld. DRP in respect of the following: (a) to make adjustment in the operating profit margins of the comparables chosen for administrative and marketing support service segment to account for the difference in the working capital levels of the appellant and the comparables; (b) to verify the correct position regarding employee cost to sales filter in respect of Computech International Ltd. (Software Division); and (c) to verify the correct position regarding export earning filter in respect of SQL Star International Ltd. (Software Development and Services). 7. That on the facts and circumstances of the case and in law, the ld. AO and ld. DRP erred in disallowing the provision for liquidated damages amounting to ₹ 20,15,37,175/-; 7.1 The ld. AO and ld. DRP erred both on facts and in law in holding that the claim for liquidated damages is a liability of future and not liability of present and thus does not represent liability for AY 2007-08; 7.2 Without prejudice to the above, the ld. AO erred in not following the directions of the ld. DRP in allowing the rever ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - Total 173,95,24,976/-. The TPO pointed out that this was around 7.385% of the total sales (2355.44 crores) made by the assessee. He, accordingly, issued show cause notice to assessee which has been reproduced at pages 192 to 194 of his order. In this notice TPO, inter-alia, made following observations: i) By incurring this expenditure, the trade name of Motorola Inc. is being promoted. ii) From the TP report it is evident that there is no agreement between Motorola Inc., USA and MIPL (Assessee) for incurring of advertisement and selling expenses and compensation for the same. iii) The expenditure is in the nature of Intra Group Services provided by the assessee company for which no cost or mark up thereof have been received by the assessee company. 6.1 The assessee s reply has been summarized at page 194 to 195 of his order as under: The powers of TPO vested u/s 92CA(2) are limited to the reference made to him by the AO; Once the TNMM method is applied, the transactions cannot be benchmarked separately. The application of TNMM necessarily stipulates aggregation of transaction; Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompensated, therefore, under the transfer pricing regulations, the arm s length price of such compensation had to be determined. He further pointed out that the assessee had not bench marked the international transaction of receipt of reimbursement and, therefore, the international transaction of receipt of reimbursement had to be determined. 3) As regards the assessee s objection that the business meetings and conferences and dealer commission expenses are in no manner related to brand building activities /promoting brand name of AE s, the TPO pointed out that the contention of the assessee was not based upon any reasoning. He further pointed out that it is not understandable as to why a distributor would spend in events like business meetings and conferences but for the promotion of its products and brands. He pointed out that by incurring these expenses, assessee was creating intangibles, the fruits of which, it was going to reap over the times to come. Similarly, he pointed out that the same was the situation with dealer commission. He, accordingly, rejected this contention of the assessee. 4) As regards the last contention of assessee that assessee company was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pted as a comparable. b. As regards M/s Rockman Advertisement and Marketing India Limited, the assessee has submitted that the company is also actively involved in other related activities such as film and documentary production. The assessee has relied on the part information taken from the website. I have examined the data available on the Prowess database and it is seen that 100% of its revenue is from Advertisement activities. I, therefore, reject the objections of the assessee in this regard. This company is accepted as a comparable. 7. Accordingly, the TPO proposed to compare AMP Expenses of the tested party with AMP expenses of other comparables engaged in distribution business in order to bench mark the cost of Intra-Group Services provided by the assessee company to Motorola Inc. He adopted AMP Expenses to sales as PLI ratio for comparability analysis. The TPO referred to five comparables used by assessee and pointed out as under: a) Mobile Telecommunication Ltd. No annual report available for FY 2006-07. b) HCL Infinet Ltd. No annual report available for F.Y. 2006-07. c) HCL Infosystem Ltd., from the annual report it was seen that this company was engaged ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es. In view of the above explanation, Spice Mobility and General Sales Ltd. being functionally similar must be taken as a comparables. TPO is directed to include both after verification regarding ownership of brand. 7.5 As regards, Rockmen Advertisement Marketing India Limited, the assessee, with reference to website of company, pointed out that this company was engaged in carrying out activities relating to film and, documentary production and, therefore, could not be included as a comparable to determine the markup on the excess AMP. It was further pointed out that the turnover of this company was very low inasmuch as it had booked sales revenue of ₹ 1.4 crores during the said year. As against this, alleged excess AMP on which a markup was proposed to be applied was 158 crores. The assessee, relying on the decision in the case of Sony India, pleaded for exclusion of this comparable. 7.6 After considering the directions of ld. DRP, the AO, in his final order revised the adjustment at ₹ 176,26,38,353/-. 8. At the outset, ld. Counsel for the assessee filed before us an application for admission of additional evidence which is reproduced hereunder: Filing o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sample copies of the Foreign Inward Remittance Certificates issued by the bank on receipt of the money are enclosed as Annexure 3. Prayer The appellant humbly prays before your Honour to kindly take the additional evidences on record. Thanking you, Yours Faithfully Sd/- For Motorola Solutions India Private Limited (Ramadorai Raghupathy Meyoor) (Director) Dated: April 5, 2013. 17.1 Ld. Counsel submitted that the Spl. Bench in LG s decision has, inter-alia, ruled that subsidy given by the foreign AE in any form including in the form of subsidiary towards purchases made from the AE has to be off set from the excess AMP expenditure. 9. Ld. Counsel for the assessee relied on the detailed written submissions in this regard contained in the paper book. The basic contention advanced by ld. Counsel for the assessee, Sh. Himanshu Sinha, is that as the profit margin of the assessee being 5% was much more than that of the independent comparable being 1%, the assessee s international transactions were at arm s length. Ld. Counsel submitted that the credit notes issued by Motorola Inc. fully reimbursed any expenditure, if any, incurred by assessee benefitting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt year within the Net Margin Range. 9.2 Ld. Counsel submitted that this plea was taken before TPO also. In this regard he referred to page 293 of paper book containing the submissions made before lower revenue authorities wherein it was, inter-alia, submitted as under: Thus, given the facts of the present case, the assessee already has a favourable pricing policy with its overseas group companies. Accordingly, since the pricing model of the Company already takes into account the AMP expenses incurred by the Indian entity, the question of recovery of the same again from the overseas group companies does not arise. Such an act/adjustment by your goodself would tantamount to considering/setting off/recovering the same amount twice by the Indian company from the overseas group companies, which cannot be a logical conclusion by any stretch of imagination. 9.3 Thus, it was submitted before the TPO that assessee had received more than adequate subsidy as price adjustments by way of credit notes and, therefore, excess AMP expenditure, if any, got adequately compensated by this subsidy. However, the TPO rejected the assessee s contention on the ground that the assessee had not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... id judgment are attached herewith. Your are requested to kindly place the application along with the judgment before the Hon ble Members so that the same may be considered by them while deciding the grounds which stand covered by the said judgment. Additional Written Submission and Application to consider the judgment of BMW India P. Ltd. vs. Addl. CIT (ITA No. 5354/D/2012): 1) That the hearing in appeal no. ITA 5637/Del/2011 for A.Y. 2007-08 were concluded on July 18, 2013 and the order was reserved on that date. The matter is now awaiting pronouncement of the decision by Your Honours. 2) That in the meantime, the I Bench of the Hon ble Income Tax Appellate Tribunal, New Delhi has pronounced its decision in the case of BMW India Pvt. Ltd. vs. Addl. CIT (ITA No. 5354/D/2012 for AY 2008-09). The said order was passed on August 16, 2013. 3) The main issue decided in the said BMW India judgment is in respect of AMP expenditure. In the present appeal, Ground Nos. 2.1 to 2.10 and 3 are also in respect of the AMP issue. 4) Due to high degree of similarity of facts between our case and that of the BMW India case has a direct bearing on the AMP issue which is part o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenditure i.e. 10% of ₹ 40 4 F Total Recovery to be made by Indian entity [Rs. 40 + ₹ 4] 44 G Taxable Income on a/c service of Brand Building for foreign AE, by incurring excess AMP expenditure over Bright Line ALP 4 Situation 2 Excess AMP Spend [D] ₹ 40 Amount actually reimbursed on a/c of Subsidy Received [H] ₹ 30 Remaining Amt. to be received [I] ₹ 10 ALP markup on brand building @ 10% of excess AMP spend has to be 10% of ₹ 40 which is ₹ 4. [G]. However, according to assessee, a mark up on brand building has to be on the sum of ₹ 10 which @ 10% of excess amount spent has to be ₹ 1 [J]. Thus, by the non-specification of purpose of subsidy the assessee has reduced the income by ₹ 3. 12.2 Ld. CIT( DR) further submitted that determination of arm s length price in regard to AMP Expenses in case of Distributors is squarely covered by the decision of LG Electronics para 21 page 99 100. He submitted that each int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on has to be separately bench marked, ld. DR has filed written submissions which are reproduced hereunder: This is for the reason that law mandates that each international transaction has to be separately bench marked. (Please refer to para 15.1 of the order in the case of M/s LG Electronics India P. Ltd. A.Y. 2007-08, ITA No. 5140/D/11). The whole para is relevant, and the first 5 lines are indicative of the discussion in this paragraph,- 15.1 At this stage, we feel it productive to have a macro view of the transfer pricing provisions. Section 92 provides that the income from an international transaction shall be computed having regard to ALP. What is an international transaction and who is an associated enterprise has been defined in sections 92B and 92A respectively. The need for specific attribution of subsidy towards a specific international transaction can be understood by the following example- S.No Natures of Transaction Book Price (Rs.) Arms Length Price (Rs.), as Determin ed by TPO Remarks 1 Import o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oods at lower prices to the assessee by the foreign AE should be considered as a quid pro quo for the foreign brand building. For ascertaining as to whether or not the foreign enterprise sold goods to the assessee at a lower price, the ld. AR urged that the overall net profit rate of the assesee should be considered, which will naturally absorb the effect of incurring such brand building expenses. If the overall profit rate is higher, it will mean that the expenses incurred by the assessee on brand building were compensated by the foreign AE in terms of lower price of goods charged from the Indian AE, necessitating no separate further addition on the alleged presumption of the assessee having incurred any AMP expenses towards brand building. The ld. AR relied on the case of the Hon ble Supreme Court in CIT vs. Calcutta Discount Co. Ltd. (1973) 91 ITR 8 (SC), to canvass the view that the assessee cannot be expected to earn maximum profit. It was submitted that the action of the Revenue in firstly taxing higher rate of net profit on sales and thereafter further increasing the income by making addition on account of AMP expenses, runs contrary to the cardinal principle laid down in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re is a basic fallacy in the first sub-argument, which lies in not properly appreciating the modus operandi of applying the TNMM. This method provides for benchmarking of an international transaction by considering the operating profit from the concerned international transaction vis- -vis certain basis as given in Rule 10B(1)(e), being total cost, sales, capital employed etc. Here it is significant to note the meaning of the term transaction as given in rule 10A(d). It provides that: transaction includes a number of closely linked transactions . Plural of transactions becomes singular when the transactions are closely linked to each other or are identical. These closely linked transactions can be processed as one transaction under any of the prescribed methods. If an Indian enterprise has made sale of similar goods to its foreign AE through several invoices and has also incurred some expenses or paid interest to it, it would mean that all the transactions of sales are closely linked and these can be processed as one unit. However, the transactions of payment of interest or incurring of any other expense would be required to be separately scrutinized under Chapter-X because the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wing legally unsustainable conclusions by taking such mistake as a correct legal position. 21.6. Now we espouse the second sub-argument that when on applying the TNMM on entity level for the transaction of import of raw material the overall net profit is better than other comparables, then no addition is called for by subjecting the AMP expenses to the TP provisions. We have held in an earlier para that when there are different unrelated international transactions, the application of TNMM on entity level for examining one of such transactions, is itself an incorrect approach. Notwithstanding that, we deem it expedient to deal with the argument of the ld. AR that if rate of net profit of the assessee is better than other comparables, then no adjustment can be done under Chapter-X. 21.7. On a specific query from the Bench, it was admitted by the ld. AR that no addition was made by the TPO on account ofapplication of the TNMM on the imports made by the assessee from its foreign AE. In our considered opinion, there is a noteworthy difference between two situations, viz., one where the TNMM is wrongly applied on entity level and some addition is made to the overall net profit of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee s income would stand reduced to ₹ 120/- as against the actual income of ₹ 140/-. We fail to appreciate as to how the judgment in the case of Calcutta Discount Co. Ltd. (supra) advances the case of the assessee. There cannot be any quarrel on the proposition that the assessee cannot be compelled to earn maximum profit. As it is the real profit which is to be taxed and the assessee cannot be expected to earn maximum profit, in the same way, the assessee cannot be allowed to reduce its real profit by including certain expenses which are for the benefit of the foreign AE. 21.9. It is pertinent to note that presently we are dealing with a case in which the majority of the assessee s sales is to Indian customers. Naturally the TP provisions cannot be applied in respect of sales to Indian customers because these are not international transactions. In such a case, there can be no benchmarking of the profits realized from such Indian customers so as to form a platform for contending that the TNMM has been applied on the overall profits and hence the AMP expenses should not be subjected to the TP provisions. In fact, the assessee is a manufacturer and only raw materials a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ially low price from the assessee in comparison with that charged for the similar goods supplied to other independent entities dealing with it in India or in case there is no other independent entity in India, then the price charged for similar goods from other foreign parties. It can also be proved by showing that goods with identical features are available in the Indian market at a higher price. The fact that the assessee has a better net profit rate in comparison with other comparable entities is not decisive in itself of the assessee having purchased the goods at a concessional rate from its foreign AE as a compensation for its incurring AMP expenses towards the promotion of their brand. 21.11. At this stage, it is relevant to note sub-section (1) of section 92, which provides that : Rs.Any income arising from an international transaction shall be computed having regard to the arm s length price. Similarly it is pertinent to take stock of sub-section (3) of section 92, which provides that : Rs.The provisions of this section shall not apply in a case where the computation of income under subsection (1) or the determination of the allowance for any expense or interest under t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adjustment with the positive adjustment to the income on account of different international transactions. The outcome of both the transactions has to be given effect distinctly. It, therefore, divulges that two or more international transactions are required to be separately processed under the TP provisions. The contention that if TNMM has been applied on one international transaction, then it would oust the jurisdiction of the TPO to process other international transactions under Chapter-X, really does not stand in the scheme of the provisions. Further, it this contention is taken to logical conclusion, then sub-section (3) of sec. 92 will become redundant to some extent. 21.13. There is one more way of fortifying our above conclusion. TNMM is one of the five recognized methods for determining the ALP of an international transaction. Such ALP can be determined inter alia by comparable uncontrolled price (CUP) method or Cost Plus method or even by the TNMM. All the five methods, as prescribed under section 92(1) and rule 10B, aim at determining the ALP of an international transaction in one way or the other. First is the CUP method, by which the price charged or paid for proper ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er: It is submitted that this contention is based on an erroneous understanding of the implications of the LG decision. The Special Bench in LG decision has not mandated that subsidy should be fully adjusted against the excess AMP expenditure. It has held that it needs to be seen whether the value of subsidy received by the assessee in any form (including in the form of subsidy against purchases from AE) is commensurate with the excess AMP expenditure. Therefore, in cases where the value of subsidy exceeds the excess AMP expenditure, the set-off would be limited to the value of excess AMP expenditure so that the value of this transaction gets reduced to Nil. The balance subsidy remaining after the set-off would be available for set-off/adjustment against the other international transaction/s that have to be separately benchmarked. This is shown in the table below: S.No Nature of Transaction Book Price Arm s LengthPrice ALP) Subsidy adjusted Adjustment to the ALP 1 Import of TV tubes 1,00,000 60,000 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Ltd. (supra) while deciding the issue relating to AMP on behalf of the assessee: Subject: Additional Written Submission to consider the judgment of BMW India Pvt. Ltd. vs. Add!. CIT (I.T.A .No.-5354/DeIl2012) while deciding the issue relating to advertising, marketing and promotion ( AMP ) on behalf of the Appellant This is with respect to Motorola Solutions India Private Limited ( MSILP ) appeal no. ITA 56371 Dell 2011 for Assessment Year ( AY ) 2007-08. The hearings for the same were concluded on July 18, 2013 and the order was reserved on that date. The matter is now awaiting pronouncement of the decision by Your Honours. In the meantime the'!' Bench of the Hon'ble Income Tax Appellate Tribunal ( Tribunal ), New Delhi has pronounced its decision in the case of BMW India Pvt. Ltd. vs. Add!. CIT (I.T.A .No.- 5354/DeI/2012 for AY 2008-09) ( BMW India order ). The said order was passed on August 16,2013. Your Honours attention may kindly be drawn to the following: As mentioned in the BMW India order, BMW India acted as a distributor of motor vehicles and parts. During the year under consideration in the order, under the Transactional Net Margin method ( TNMM ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ds, BMW India had received compensation for AMP expenses through premium pricing which was demonstrated through its higher profit margins. The relevant text of the Hon'ble Tribunal ruling in case of BMW India is provided here below(Para 6.25, 6.26 page 53, 55 of BMW India order): Quote We hold that in the facts of the present case the assessee has demonstrated that the compensation for the higher services was embedded in the pricing arrangement of the contract goods itself It is seen that the comparables identified by the assessee and accepted by the TPO as having similar intensity functions have earned profit at the gross and net levels far below the profits both at gross and net levels as achieved by the assessee. In the circumstances as evidenced from record, we are inclined to agree with the submissions advanced on behalf of the assessee that no further compensation was required to be made by the AE as the same has already been received. Thirdly, the Hon'ble Tribunal in BMW India order provided that BMW India was rewarded by price adjustments to earn profits which included the cost of AMP with mark up. It held that the tax department cannot insist that the mode of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the written submission filed with Your Honours on May 20,2013. The Ld. TPO did not have any dispute relating to the TNMM analysis conducted by the Appellant. The only dispute was on the matter of AMP expenses. The Ld. TPO based on the bright line analysis held that MSIPL should have been reimbursed by the AE for the excess AMP expenses incurred by it along with a mark-up. The Appellant filed an appeal before the Hon'ble Tribunal. The grounds related to AMP issue are covered in grounds nos. 2.1 to 2.10 and 3. (The details have been mentioned in para 4-43 of page 2-23 of the written submission filed with Your Honours on May 20, 2013 and again in para 8 of page 133-138 of the written submission filed with Your Honours on May 20, 2013.) In this regard we humbly submit that the decision in case of BMW India order also applies to MSIPL, as the facts of MSIPL are similar to that in the BMW India order. Hence, we humbly submit that the decision rendered in the BMW case has a direct bearing on the AMP issue. This has been summarized as under: 1.BMW India is a distributor of motor vehicles and related parts. MSIPL is also a distributor. Hence, what is relevant for consideration is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ereinafter called as LGI?), that is the assessee in question, was incorporated in 1997 as a wholly owned subsidiary of LGK. An agreement was entered between LGK and LGI on 10th March 1997, as per which both entered into a mutual foreign collaboration agreement. Thereafter a Technical assistance and royalty agreement was entered into between these two entities on 1-7- 2001 by which LGI, in the capacity of a licensee, obtained a right to use the technical information, designs, drawings and industrial property rights for the manufacture, marketing, sale and services of the agreed products from the LGK i.e. the licensor. 16. In assessee s case the factual matrix has been reproduced earlier. Assessee is primarily engaged in the distribution of telecom equipment, mobile phones and provision of telecommunication service in India. The company also provides software development services to the group companies. Additionally the company also provides marketing and administrative support services to its group company. In the case of BMW the factual matrix was as under: 2.4 A perusal of the same shows that the TPO took note of the facts that the BMW Group has global operations in 3 segm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st of BMW AG in the Contract Territory. It is responsible for the sale promotion and the full utilization of the market potential for the Contract Goods in the Contract Territory. It is further responsible for ensuring the provision of the best possible customer service and adequate stocks of original BMW parts in the Contract Territory. Furthermore, BMW India undertakes the following functions in the Contract Territory in accordance with the laws of the contracting territory: Establishment and supervision of an efficient BMW distribution network; Performance of an adequate advertisement and sales promotion as well as public and media relations. Collection, evaluation and communication of market information to BMW AG. 3. Scope of the Activity of BMW India 3.1 BMW India will meet its responsibility for the promotion of sales and the full utilization of the market potential for the Contract Goods by applying its best efforts and adequate resources toward effective sales promotion and advertising for the Contract Goods including available optional equipment and accessories. 16.1 From the above factual matrix regarding business profile of the three entities ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng it costs. The fact that assessee s profits vis- -vis the comparables with similar intensity functions far exceeds the mean margin of the comparable stands established. The contemporaneous international jurisprudence supports this and even the Special Bench leaves the issue open by accepting its limitations while giving voice to the diverse nature of facts, business models and peculiar terms and conditions of different assessee by observing that there cannot be any straight-jacket formula. 6.28 Accordingly after a detailed analysis of the relevant provisions of the Act, the FAR analysis of the assessee, the terms of the Importation Agreement entered into by the assessee with its AE, the orders and judgments relied upon and considered by us in order to decide the issues and weigh the merits and relevance of the comprehensive arguments made at length by both the sides juxta posed with the facts and figures of the assessee in the year under consideration and the comparables as addressed in the orders and referred to by the parties before the Bench, we hold that in the facts of the present case there was no occasion for the AE to further compensate the assessee for the services ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dent from the following observations in LG s case:- 17.4 In our considered opinion, following are some of the relevant, whose answers have considerable bearing on the question of determination of the cost/value of the international transaction of brand/logo promotion through 1. Whether the Indian AE is simply a distributor or is a holding a manufacturing licence from its foreign AE? 17.2 Thus, it is evident that LG s decision is squarely applicable in the case of all kinds of distributors and the distinction between distributor and an assessee holding a manufacturing license has been made for determination of excess AMP expenses because the considerations between the two differ. Therefore, guidelines laid down therein would govern the determination of ALP of impugned international transaction. 17.3 In view of above discussion, we are of the considered opinion that the decision in the case of BMW has no application to the present case. 18. Ld. Counsel elaborating his arguments submitted that since assessee was earning 5% profit margin as against 1% earned by comparables. Therefore, credit notes received by assessee in pursuance to glob ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 17.4. In our considered opinion, following are some of the relevant questions, whose answers have considerable bearing on the question of determination of the cost/value of the international transaction of brand/logo promotion through AMP expenses incurred by the Indian AE for its foreign entity :- 1. Whether the Indian AE is simply a distributor or is a holding a manufacturing licence from its foreign AE ? 2. Where the Indian AE is not a full fledged manufacturer, is it selling the goods purchased from the foreign AE as such or is it making some value addition to the goods purchased from its foreign AE before selling it to customers ? 3. Whether the goods sold by the Indian AE bear the same brand name or logo which is that of its foreign AE ? 4. Whether the goods sold bear logo only of foreign AE or a logo which is only of the Indian AE or is it a joint logo of both the Indian entity and its foreign counterpart ? 5. Whether Indian AE, a manufacturer, is paying any royalty or any similar amount by whatever name called to its foreign AE as a consideration for the use of the brand/logo of its foreign AE? 6. Whether the payment made as royalty to the foreign AE is c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such factors in determining the cost/value of international transaction depends on the facts of each case. It is the duty of the TPO to give due regard to such factors by making suitable plus or minus adjustments before finally determining the cost/value of the international transaction. 18.3 In view of above observations read with the observations in paras 21.1 to 21.13 in LG s case reproduced earlier, we are in agreement with ld.CIT (DR) that as per the Spl. Bench decision, it has to be established by assessee that foreign AE was compensating the Indian entity for the promotion of its brand in any form, such as subsidy (credit notes in the present case, as claimed) on the goods sold by the Indian AE. In view of specific observations made, inter-alia, in para no.21.5 of LG s case, we are not inclined to accept ld. Counsel s contention that merely because operating margin to sales is better than the other comparables, it has to be inferred that assessee had duly been compensated towards AMP expenses. In this regard ld. DR s contentions are well founded that each international transaction has to be separately bench marked and overall profitability cannot be a determinative facto ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... redit notes issued by the foreign AE in pursuance to transfer pricing policy were towards the compensation for promotion of its brand. It has to be specifically demonstrated by assessee. One of the contentions of the ld. Counsel for the assessee is that there is no royalty payment by assessee to its AE. We agree with ld. Counsel that this is a relevant factor which has to be taken into consideration for determination of excess AMP expenditure in the light of LG decision. In our opinion all these aspects need to be examined afresh by TPO. 18.4 In the light of above observations, we restore the matter to the file of ld. TPO for deciding the issue afresh in the light of decision of LG s case after taking into consideration the credit notes, the global transfer pricing policy and other documents to be produced by assessee for substantiating its plea that credit notes were issued by foreign AE towards compensation for promotion of brand. 19. In the result the additional ground raised by assessee is allowed for statistical purposes. Now we will consider the various other grounds taken be assessee with reference to AMP Expenses. 20. Ld. Counsel in the written submissions has firs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 25. Ground nos. 2.4 and 2.5 are in regard to non-consideration of Group s Global Transfer Pricing Policy pursuant to which AE was compensating the assessee towards excess AMP expenses by way of credit notes. Both these grounds have been discussed In detail while admitting the additional evidence in the form of credit notes filed by assessee. Therefore, both these grounds stands allowed for statistical purposes. 26. Apropos ground no. 2.7, we find that Spl. Bench in the case of LG, while considering the cost/value of transaction, considered the scope of AMP expenses with reference to selling expenses and observed from para 18.1 to para 19 as under: Scope of AMP Expenses: 18.1. The ld. counsel for the assessee and some of the interveners contended that the TPO has included selling expenses in the total AMP expenses for the purposes of determining the ALP. It was submitted that selling expenses cannot constitute part of AMP expenses. Our attention was drawn towards the erstwhile sections 37(3A) and 37(3B), in which disallowance u/s 37(3A) was prescribed in respect of expenses referred to in sub-sec. (3A), which, inter alia, included advertisement, publicity and sales promo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 37. The Hon ble M.P. High Court in the case of CIT Vs. Mohd. Ishaque Gulam [(1998) 232 ITR 869 (MP)] has held that the dealer s commission and sales agent commission etc. cannot be brought within the purview of advertisement, publicity and sales promotion expenses, as referred to in sec. 37. 18.5. We do not find any force in the contention of the learned DR made in this regard. The logic in the exercise of finding out the AMP expenses towards creation of marketing intangibles for the foreign AE starts with the expenses which are otherwise in the nature of advertisement, marketing and promotion. If an expenditure itself is not in the nature of advertising, marketing or promotion, that ought to be excluded at the very outset. We, therefore, reject this contention raised by the learned DR. 18.6. As we are presently considering the term Rs.advertisement marketing and promotion expenses , which is analogous to, if not lesser in scope than the term Rs.advertisement, publicity and sales promotion as employed in the erstwhile sub-sec. (3B) of sec. 37, all the judgments rendered in the context of sub-sec. (3A) (3B) of sec. 37 will squarely apply to the interpretation of the scope o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... distributors. Hence, these two companies do not meet the criteria of comparability as per the Indian TP Regulation. In our opinion, the assessee s contention is deprived of any merit because admittedly these two comparables were selected by assessee itself in its TP report and it is not disputed that they are also distributors. As we are restoring the matter to the file of TPO for deciding the issue in the light of LG s decision, we direct the TPO to carry out fresh search to find out more comparables which meet the criteria of principal distributor also. 28. Apropos ground no. 2.10 the main contention is that the TPO determined the mark up with reference to following five comparables the business description of which was as under: S.No. Company Name Business description 1 Rockman Advertising Marketing (India) Ltd. Rockman Advertising Marketing (I) Ltd. is engaged in provision of complete communication solutions. It is also engaged in carrying out activities related to film and documentary produc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enue of ₹ 1.4 crore during the said year. As against this, the assessee s alleged excess AMP expenses on which a markup was applied by the TPO was ₹ 158 crores. These objections have not been considered by ld. DRP and the TPO has also relied on the Prowess Data Base. Under such circumstances, we are of the considered opinion that the matter needs to be restored back to the file of TPO for examining the issue afresh in the light of objections raised by assessee. Accordingly, this ground is allowed for statistical purposes. 29.3 In view of above discussion, ground nos. 2.4, 2.5, 2.7, 2.8 2.10 are allowed for statistical purposes. 30. Apropos ground no. 3, we find that DRP has already given direction, which has been reproduced earlier, that the two comparables Spice Mobility and General Sales Ltd., are to be included after due verification. The TPO is directed to carry out the direction of ld. DRP. 31. In the result, this ground is allowed for statistical purposes. 32. Ground no. 4 is with regard to adjustment of ₹ 1055745127/- while re-computing the arm s length price of the international transactions pertaining to Contracts Software Development Servic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and salaries. 484 Companies with net worth more than or equal to zero were selected. Implying that the Companies are in operations. 447 Companies with the ratio of the sum of advertising, marketing and distribution expenses to sales less than or equal to 3%, were selected. Such comparables do not have ownership of marketing intangibles and are engaged in provision of service. 340 Qualitative (Companies engaged software development activities broadly similar to Those carried out by MIPL in respect of its Class II activities) 11 32.2 The search process carried out by assessee by applying the aforementioned filters resulted into selection of 17 comparables as under: S.No. Name of the Company Data Source Unadjusted Markup On Total cost 1 Bodhtree Consulting Ltd. P 18% 2 FCS ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nge, assessee claimed that the transactions undertaken by it were at arm s length. 34. As against the aforesaid approach of assessee, the TPO adopted the following approach: a. The TPO rejected the TP Study prepared by the assessee stating that quantitative filters were incorrect; selection/rejection of comparable companies was based on qualitative filter functional difference is not objected and uniform; data for current year is not used; RPT and other filters are not applied and as a result rejected the bench marking analysis conducted by assessee on the basis of several additional quantitative filters selected by him. The defects as highlighted by TPO are reproduced hereunder: As per the Rule 10B(4), the data to be used in analyzing the comparability of an uncontrolled transactions with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into. The word used is shall , indicating that neither the tax payer nor the TPO has any choice but to use the data pertaining to the FY 2006-07. Earlier year data, in addition to current year's data, can be used only if the conditions mentioned i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompanies in which software services income is more than 75% of the revenues were considered as comparable) etc so as to make the comparables functionally similar and also economic circumstances also similar to that of the taxpayer. These filters are discussed in detail under their respective heads in the order. 6.The tax payer has taken companies as comparable even if they do not work in same economic circumstances as that of the tax payer. The comparability study is correct or reliable only if the economic circumstances in which the tax payer is placed are similar to those in which the comparable companies are placed. This is evident from Rule IOB(2), which broadly says that uncontrolled transactions should be judged not only with reference to the specific characteristic of the services rendered by the tax payer (software services), functions performed (FAR analysis), and contractual terms but also with reference to conditions prevailing in the markets in which the respective parties to theinternational transactions operate, including geographical location and size of the market, the laws and Government orders in force, costs of labour and capital in the markets, overall econom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... i. Companies whose on-site revenue was more than 75% of the export revenue s were excluded; j. Companies that were functionally different from that of the tax payer were excluded. Applying the aforesaid filters, the TPO identified 26 comparable companies which were as under: 1) Accel Transmatic Ltd. (Seg.) 2) Avani Cimcon Technologies Ltd. 3) Celestial Labs Ltd. 4) Datamatics Ltd. 5) E-Zest Solutions Ltd. 6) Flextronics Software Systems Ltd. (Seg.) 7) Geometric Ltd. (Seg.) 8) Helios Matheson Information Technology Ltd. 9) IGate Global Solutions Ltd. 10) Infosys Technologies Ltd. 11) Ishir Infotech Ltd. 12) KALS Information Systems Ltd. (Seg.) 13) LGS Global Ltd. (Lanco Global Solutions Ltd.) 14) Lucid Software Ltd. 15) Mediasoft Solutions Ltd. 16) Megasoft Ltd. 17) Mindtree Ltd. 18) Persistent Systems Ltd. 19) Quintegra Solutions Ltd. 20) R S Software (India) Ltd. 21) R Systems International Ltd. (Seg.) 22) Sasken Communication Technologies Ltd. (Seg.) 23) SIP Technologies Exports Ltd. 24) Tata Elxsi Ltd. (Seg.) 25) Thirdware Solutions Ltd. 26) Wipro Ltd. (Seg.) 35. Ld. DRP directed the TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is getting remunerated at Cost + 7% para 85 of M/s SAP Labs, 418/Bang/2008. 6. Some of the assessee s comparables have been found to be comparables in other case laws. For eg: - the assessee has pleaded that M/s Celestial Labs Ltd. is not acceptable as per his case law M/s Tevapharma P. Ltd. 6623/M/2011, dtd. 23/12/2011, para 5 on pages 29 and 30. But in another case law relied upon by him for another proposition (M/s Telecordia Technologies ITA No. 7821/M/2011), para 6.3, page 9, Celestial Labs Ltd., has been found to be comparable. 7. The ITAT order of M/s Philips Software Centre P. Ltd. ITA No. 218/Bang/08, has been stayed by Hon ble Karnataka High Court. Hence, reliance on this ITAT order, by the assessee is misplaced. 8. The assessee gets remunerated at a lowly cost +7%. 9. The assessee has not established as to how do software product companies differ from other Software companies, in terms of FAR analysis. Even the assessee had not relied upon Product company as a distinguishing factor. 10. Any adjustment has to be supported by robust data and correlation needs to be established, by empirical evidence. 11. The TPO has used current year data only, for wor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tiple year data has been noted in the defects highlighted by TPO. The assessee s contention is that TPO has utilized the data for earlier years also while examining the trend of companies incurring losses. Therefore, the multiple year data should have been used for computing the average margin also. 37.1 Having heard both the parties, we do not find much substance in the argument of ld. Counsel for the assessee because as per Rule 10B(4),the data to be utilized and for analyzing the comparability of uncontrolled transaction with an international transaction is to be the data relating to the financial year in which the international transaction has been entered into. As per proviso to Rule 10D, earlier year data can be used, in addition to the data pertaining to the relevant financial year, only for taking a decision as to how much the factors obtaining in earlier years impact the profit of the current year, for both the tax payer and the comparable. Therefore, as rightly submitted by ld.CIT(DR), it has to be demonstrated as to how the earlier year conditions have influenced the profit of the relevant financial year. Since assessee had not given details in this regard, therefore, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 32, page 130 thereof. iii. M/s Symentec Mumbai, ITA No. 7894/M/2010, A.Y. 2006-07, para iv. M/s ST Micro Delhi [15 ITR (Trib)410 Del], para 28 till 32 of this order. [ITA 1806/1807/Del/2008, order dtd. 03/06/2011]. v. M/s Deloitte Consulting Hyderabad ITA No. 1082/1084 of 2010 (paragraph 30 thereof). vi. M/s Customer Services (I) (P) Ltd. (2009) (30 SOT 486 Delhi). Fresh search has been approved by TPO in the aforesaid cases. 42. Ld. counsel for the assessee did not seriously disputed the submissions of ld. DR. This ground is dismissed. 43. Vide ground no. 4.5.3 the assessee has assailed the TPO s action in excluding companies with diminishing revenues/persistent losses for last three years upto and including F.Y. 2006-07. Ld. TPO excluded the companies with consistent losses on the ground that in an environment where software sector was growing at a CAGR (Compound Annual Growth Rate) of more than 30% during the last 10 years or at least for the last three years, the company incurring consistent losses cannot be taken as a representative of the industry. The assessee s contentions were as under: The loss making companies are as much a part and parcel of an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... axpayer and other comparable companies are not assuming that extreme risk resulting in persistent losses. As mentioned above, just because mean takes care of diffences in risk, every loss making software development company cannot be considered as a comparable if it has persistent loss arising due to the peculiar economic circumstances with its greater assets than the tested party. Therefore, persistent losses observed in the proposed comparables understate those that would be expected in the tested party. The tax payer argued that the TPO has used the multiple year data for his comparability study, whereas, the tax payer has been denied using the multiple year data while computing the mean ALP. In this order, multiple year data has been used only to find out whether the comparable company is persistently in losses year after year. Apparently the taxpayer has confused use of multiple year data for functional analysis of a comparable with use of the same for working out the arithmetical mean PLI. Once a comparable company is selected, its margin of the relevant financial year only is considered for determining the PLI. Therefore, there is no inconsistency in use of multiple yea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO has only removed comparables that are persistent loss makers. 45. The assessee filed objections before DRP. Ld. DRP after considering the assessee s objections, confirmed the TPO s action. Ld. DRP also referred to revised OECD Guidelines, 2010 which also supports this instance. They referred to para 6.63 which state that where one or more of the comparables have extreme results, further examination would be needed to understand the reason for such extreme result. Further in para 3.64 it is stated that an independent enterprise would not continue loss generating activities unless it had reasonable expectation of future profit. In para 3.65 it is stated that a loss making uncontrolled transaction should trigger further investigation in order to establish whether or not it can be a comparable. Circumstances in which loss making transactions/enterprises excluded from the list of comparables include cases where losses do not reflect normal business condition, and where the losses incurred by the third parties reflect a level of risk that is not comparable to the one assumed by the tax payer in its controlled transactions. It is clarified by the OECD Guidelines that loss making co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hose at the higher end were left untouched. Ld. counsel pointed out that auditors certify a company as sick in the audit report if the losses are very high, therefore, the annual report of such companies should be analyzed before rejecting them. Margin cannot be starting point of determination of arm s length margin but it is the end result of a careful process of functional and economic analysis provided under law. The assessee relied on following case laws: S.No. Name of the case Relevant extract form the case law 1. Trilogy E business India Software P. Ltd., ITA No. 1054/Bang/2011 Para 35 It has been held that profit/loss should not determine the functional comparability and the specific reasons of lack of comparability should be brought out. 2. Exxon Mobil Co. India P. Ltd., ITA No. 8311/Mum./2010 para 33(xi) If a loss making company is to be excluded Then on the same principle abnormal profit Making company should also be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... osses okayed in M/s CRM Services (I) (P) Ltd. 4068/4796/Del/2010, dtd. 30/06/2011 (paras 13, 13.1 and 13.2) iv. These filters have also been okayed in M/s Quark Systems 4 ITR (Trib.) 606. v. M/s Sony India P. Ltd. vs. DCIT 114 ITD 448 (Internal page 54 of TPO s order) vi. Navisite India Pvt. Ltd., ITA No. 5329/Del/2012 dated 31st May,2013. The assessee has tried to sidetrack the issue by bringing in issue of volatility of margins and extreme results. This is not the case here. 48. Ld. Counsel in the rejoinder submitted that the decisions relied upon by ld.CIT(DR) are distinguishable and made following submissions: 48. The decision of Sony India v. DCIT (114 ITO 448) supports the case of the appellant. In this case the Hon'ble ITAT held that a persistent loss making company like Godrej has to be excluded from the list of comparables not because it was making losses but there were numerous factors demonstrating extraordinary economic circumstances (like labour issues, financial restructuring and huge unutilized capacity). Please refer to Page 322 of the Appeal (internal page 54 of the TP order) where the Ld. TPO has reproduced the relevant extract from th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on where some companies makes profits while few others make losses. Only diminishing revenue or consistent losses cannot be termed as abnormality in any industry. For the purpose of choosing comparables, one has to look at the factors of comparability provided in Rule 108(2) - which are characteristics of goods and services; functions, assets and risks; contractual arrangements; and characteristics of the market etc .. Declining revenues and persistent losses are not factors of comparability but merely manifestations of a company's ability to respond to the market conditions. 54.Further final comparable companies selected by the TPO, in his TP order, do not show a uniform trend. It has been highlighted by the Appellant that many of the companies selected by Id. TPO have witnessed a decline in revenue in the future years while they have retained healthy profit and are functionally comparable. If the filter of diminishing revenue was to be accepted then it would lead to an anomaly that a company may be comparable in one year but not in the other despite no change in the functional profile. 55.The Ld. CIT (DR) is of the view that data for multiple year is used only for worki ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is not necessary that declining sales would always have an adverse effect on profitability. In this regard, the Appellant places reliance on the ITAT ruling of Capgemini India Pvt. Ltd. ITA no. 7861/Mum/2011. 60.In order to substantiate our point we wish to highlight some of the companies rejected by the Id. TPO on declining sales filter which have actually witnessed an increasing trend in profit during these years Company Name OP/OC Margins Sales in crores 2004-05 2005-06 2006-07 2004-05 2005-06 2006-07 Mascon Global Ltd. NA 12.21% 33.82% NA 181.75 140.71 Pent asoft Technologies Ltd. [Me rged] 6.96% 7.51% 8.25% 55.94 16.17 9.45 Thus, there is no correlation between decline or increase in sales and the margins. 48.1 We have considered the rival submi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aordinary circumstances then only the same is to be excluded. However, the onus lies on assessee to demonstrate such extraordinary economic circumstances. We find that TPO has mentioned the distinction between the loss making company and a persistent losses/diminishing revenue making company. Ld. DRP has observed that TPO has examined the reasons for persistent losses. This filter was applied on the ground that such companies have some peculiar problems because of which the revenue was declining and not in line with the growth of software industry. Considering the statistical data noted earlier, it can safely be observed that declining turnover and persistent loss is not a normal phenomenon of this sector under the Indian economic conditions. Diminishing revenue/persistent loss are not in conformity with the normal operational results in this line of activity. Therefore the reasons for persistent losses incurred by a company needs to be identified. 50. Ld. Counsel has pointed out various aspects in regard to decisions relied upon by ld. CIT(DR) which are noted in his submissions earlier. In our opinion merely because one comparable has been accepted or rejected in a particular c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ments of Rule10B(3) of the Incometax Rules, 1962, the said comparable is to be excluded. 51. In the result, this ground is dismissed. 52. Vide ground no. 4.5.4, the assessee has assailed the TPO s action in applying the filter of excluding the companies which have related party transactions of more than 25%. The TPO noticed that assessee did not mention anything regarding related party transaction filter. He, therefore, issued show cause notice stating therein that this filter is appropriate to eliminate the companies which have controlled transactions and, thereby, have its significant influence on the margin earned. The TPO, after dealing with the objections of the assessee and after taking into consideration the definition of the associated enterprises u/s 92A(2)(a), 40A(20)(b), OECD Guidelines and the mandate of Rule 10B(1)(e)(iii) that net profit margin is required to be adjusted to take into account differences which could materially affect the amount of net profit margin in the open market and also Rule 10B(3)(i) mandating such adjustment, concluded that related party filter of 25% is an adequate filter because on the one hand it will help in excluding the companies wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e related party transactions influence the price of transaction. He submitted that exclusion of companies with related party transaction up to 25% was quite reasonable for which guidance has been taken from the provisions of section 92A(2)(a) which provides a limit of 26% for treating an enterprise as associated enterprise. His submissions are reproduced hereunder:- Exclusion of companies with related party transactions up to 25% of their sales; Counter: This is the filter of Related Party Transactions up to 25% of Sales. (Pl. See Pages 36 till 38, being para 8.1 of TPO) The following case laws support Revenue, wherein this limit has been approved. i. M/s Actis Advisers (I) (P) Ltd. 5227/Del/2011 (paras 28 and 29) ii. M/s Deloiette Hyderabad, ITA No. 1082/Hyd./2010, dtd. 22/07/2011 (para 35 of this order) iii. M/s ST Micro Electronics (I) (P) Ltd. (15 ITR (Trib.) 410 Del) - paras 40 and 41 iv. M/s Global Logic (I) (P) Ltd. 2011-T11-35-ITAT-Delhi-TP. Dtd. 25/03/2011, paras 4 and 5, till para 5-17 (ITA Nos. 6082/Del/2010, A.Y. 05-06) v. M/s Hapag Loyd, ITA No. 8499/Mum./2010, dtd. 28/02/2013, para 6-2, wherein they have relied on the case of M/s Thysen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Software Development Company, employees are the main asset of the company and directly reflect the nature of business undertaken by the company. He noted that as per prowess data base, the average employee cost works out to about 35% of sales in the case of companies having turnover more than 1 crore for the F.Y. 2006-07. He pointed out that extremely low expenditure on salary/employee cost is a definite indication that the company is either into further outsourcing of the work or is a software product developer or a software trading company. He, therefore, applied filter of 25% of minimum salary expenditure to sales while searching for comparables. The TPO, after dealing with various objections of assessee, concluded that application of this filter was fully justified. He further pointed out that no comparable had been accepted/rejected merely on this count and this filter was applied just to consider functionality of such companies in detail. He pointed out that detailed analysis of companies with employee cost less than 25% was done. Ld. DRP confirmed the TPO s action, inter-alia, observing that since this is the main cost component in the sector, use of the filter cannot be con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l/2010) (para 19) Navisite (paras 20 to 22) 59.3 He submitted that in the case of M/s Hello Soft India Pvt. Ltd., relied by asessee, there was only cryptic reference, as opposed to detailed discussion in cases relied by revenue. 60. In the rejoinder, ld. Counsel submitted that in the case of Asia India Pvt. Ltd., considering the fact that employee cost to sales was 46%, the range of employee cost to sales was fixed at 30% to 60%. He, therefore, submitted that in the case of assessee since the employee cost to sales ratio is 64%, the threshold of 25% would be inappropriate. Ld. Counsel, therefore, submitted that if, at all this filter is to be applied, then, the appropriate range would be 50% to 80%. 60.1 We have considered the rival submissions and have perused the record of the case. 61. As far as ld. Counsel s objections of data being not available in public domain is concerned, for which TPO resorted to obtain information u/s 133(6), we find that this objection of ld. Counsel is not sustainable particularly because ground no. 4.4 dealing with this issue has not been pressed by him. Even otherwise, we find that TPO has been vested with specific powers u/s 92CA(7) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 30% to 60%. In the present case since the employee cost to sales ratio is 64%, we accept the assessee s contention that the filter has to be applied by applying the range of employee cost to sales of 50% to 80%. We direct accordingly. 62. In the result, this ground is partly allowed. 63. Vide ground no. 4.5.6 the assessee has assailed the TPO s action of applying on-site revenue filter. By applying this filter, the company s whose onsite revenues exceeded the 75% of total export revenues, were rejected as comparable. 64. Ld. TPO summarized the assessee s objections to this filter as under: (a) The Indian software sector provides both on-site and offshore services. (b) The Indian vendors have succeeded in raising the share of offshore revenue from 44% in 2000-01 to 64% in 2003-04, 71 % in 2004-05 and to 74% in 2005-06. Though the data is not available for the FY 2006-07, the annual report of big software companies shows that this ratio is increased further during the FY 2006-07. Most of the uncontrolled enterprises follows hybrid model with revenue mix both from onsite and offshore. The taxpayer is mainly offshore service provider and it is difficult to get independe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Indian companies have therefore, been slowly moving towards the offshore work more and more. He pointed out that the higher cost of on-site workers holds operating margins in the low of 20%. The TPO referred to various sources to buttresses his contention. He, therefore, concluded that the tax payer, whose business is entirely offshore, cannot be compared with a company which has substantial revenues generated from its on-site operations. As regards the assessee s objections that nature of activity regarding software development services do not change between on-site and offshore software development services, the TPO observed that merely because a company is into software development does not automatically become comparable because the economic circumstances should also be comparable between the tax payer and the comparable. The TPO further pointed out that there is no dispute that Indian Software Companies do follow hybrid model. He pointed out that as per NASSCOM, during the financial year 2005-06, 74% of the revenues was from offshore software development. That is the main reason why all the independent comparable companies do have some part of their revenues generated from the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 66.1 In view of above findings, the TPO applied the on-site revenues filter wherein the companies generating more than 75% of their export revenues from on-site operations were rejected as comparables. 67. Ld. DRP concurred with the findings of TPO. 68. Ld. Counsel has advanced following submissions in this regard: If this filter is to be applied then whole process of determination of arm s length price will get delayed till TPO examines the issue because the annual report does not contain information in regard to onsite and offshore revenue separately. This information has been obtained by TPO u/s 133(6). Such a filter is contrary to the statutory scheme provided in the Act Rules; A company is judged to be a comparable or otherwise based on parameters relating to functions risks and assets; Software development activity comprises both offshore and on-site development. These services are provided in bundled manner. So even if a profit margin may be low in on-site work, it should not be viewed in isolation but in conjunction of offshore work because both the activities are performed as a compliment to each other and not as independent activities. Also ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... specialist going abroad is on-site revenue because the services were rendered on-site. He submitted that the revenue earned from both these activities entail altogether different cost structure and cannot be compared with each other. He submitted that margins of profit from on-site revenue is much less than the profit margins earned from off site revenues. Ld. DR further submitted that if on-site revenues earned from export were more than 75% then the said company had to be excluded since assessee was mainly earning offshore revenues from export. He submitted that this is in line with Rule 10B(2) particularly clauses (b) (d) which require that comparability of an international transaction with an uncontrolled transaction is to be judged with reference, inter-alia, to the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties and also the conditions prevailing in the market in which the respective parties to the transaction operate, including the geographical location and size of the market, the laws and government orders in force, cost of labour and capital in the markets, overall economic development and level ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ard. 72. Ld. Counsel has submitted that the threshold of 75% is quite high. In our opinion, this argument of ld. Counsel cannot be accepted because, admittedly, the profitability in case of on-site project is much less than offshore projects. Therefore, TPO was quite fair when it applied the on-site revenue s filter considering the companies generating more than 75% of their export revenues from on-site operations. This resulted into accepting those comparables where companies were generating less than 75% of their export revenues from on-site operations. This resulted in excluding only those comparables which were predominantly earning from on-site operations. This took care of the assessee s submissions also that Indian Software Companies follow hybrid model with a mix of on-site and offshore operations. 72.1 In view of above discussion, the ground raised by assessee stands rejected. 73. Brief facts apropos ground no. 4.5.9 are that TPO noticed that assessee had excluded the companies which incur expenses on R D more than 3% of revenues. The assessee justified its search process on following grounds: 1. It eliminates companies owning intellectual property rights; 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . This allows us to enhance quality, productivity and customer satisfaction through continuous innovation. 74.1 TPO further pointed out that Infosys had spent an amount of ₹ 167 crores as R D out of which ₹ 48 crores was spent on its banking software product, Finacle. The remaining amount of ₹ 119 crores was spent on other activities. Therefore, the main intention of R D Infosys was either to develop its software product, Finacle or to enhance quality productivity and customer satisfaction through continuous innovation of designs framework processes and methodology of the services delivered by it. Therefore, it can be inferred that R D Software Industry is always not to create only IPR s but also to create tools/processes to improve the quality of services being rendered. As regards assessee s contention that it being a captive service provider does not invest in R D but its parent company invest in R D, TPO observed that risk of R D is borne by a parent company. TPO further pointed out that the comparable companies are also mainly involved in the development of software similar to the tax payer. He pointed out that this filter is not relevant as the expenditu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is evident that the expenditure debited in the profit and loss account under the head R D is not conclusive proof of the company being a product company particularly in the case of Software Service Provider. 75. In contrast, ld. TPO pointed out that he had applied a filter, wherein all those companies whose revenues from software development services was less than 75% of the overall revenues/segmental revenues were rejected. This filter eliminates companies which were software product company as well. Ld. TPO further demonstrated that R D filter applied by the assessee had on the one hand failed to eliminate the product companies and on the other hand resulted in elimination of following non-product companies which were actually companies engaged in software development services:- S.No. Name of the company Remarks of the TPO 1. Quintegra Solutions Ltd. The company is into software development Services and it does not have any revenues From sale of software products. 2. Sasken Communication ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s a filter because this filter also eliminates software development companies. Ld. TPO demonstrated that R D expenses of the company and the margin earned by the comparable had no correlation by considering following comparable selected by him: 77.1 He pointed out that three companies viz. Tata Elxsi, Celestial Labs Wipro Ltd. had a ratio of marketing expenses to sales of more than 3% but still they remain software development companies. 78. Ld. DRP accepted the ld. TPO s contention that rejection of this filter had no material impact in the case of assessee. Ld. DRP, inter-alia, pointed out that spending on R D does not necessarily result in creation of IPR. The R D activity in a software company may be with respect to improving process of delivery of services (software development services) rather than creation of intangible. Ld. DRP relied on analysis of statistical data of various companies as demonstrated by ld. TPO, noted above. 79. Ld. Counsel for the assessee relied on the written submissions filed by it as noted earlier. 80. Ld.CIT(DR) submitted that there is no basis for adopting 3% limit of R D expenses to sales. He pointed out that assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ke the same as not comparable to the assessee. Research activity has no direct correlation to profits or margin. 81. In the rejoinder, ld. Counsel for the assessee submitted that the decision of Deloite Consulting India P. Ltd. (supra) is of no assistance to revenue as the issue discussed in para 36 is not in relation to the filter in question i.e. R D expenditure being 3% or more of the sales. In this case, the suitability of one particular comparable was discussed based on peculiar facts of the comparable. He submitted that it is pertinent to note that Deloite Consulting India P. Ltd. and the comparable in question were not software development companies, but companies providing information technology enabled services which are in the nature of business process outsourcing. In this case, the R D Investment does not matter much as the services are in the nature of back office support. Ld. Counsel further pointed out that as per Rule 10B(2) functional comparability is the most important determining factor in selecting comparables. However, research is an additional function which the assessee does not undertake and hence incurred zero expenditure on any research activity. Theref ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tability of companies having intangibles is more cannot be lost sight off. If a company is having brand then it is definitely in a better position to command higher profits. Ld. Counsel in his submissions has pointed out that companies having patent had incurred substantial sums on R D to develop its own products. Thus, both sides have their logical view point. Under such circumstances, the balance has to be drawn keeping in view the primary object of transfer pricing study. The object of selection of comparables is to find out companies which are performing similar functions as assessee with almost similar asset base and similar risks. These comparables are to be considered for finding out the arm s length price. If by applying a particular filter many, otherwise comparables, gets excluded then such a filter should be applied after making necessary adjustments for material factors. Thus, if a comparable has developed its own intellectual property right resulting into development of a patented product by incurring huge expenditure on R D then even if it is performing software development functions, it has to be excluded. However, if a company is incurring huge expenditure on R D o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not. Ld. TPO, however, did not accept the assesee s contention, inter-alia, observing that assessee did not give the basis on which it concluded that Infosys Technology Ltd. etc., noted earlier, had created marketing intangible. He observed that in the case of manufacturing or distribution companies, expenses over a period of time may create marketing intangible. However, the same may not be true for service industry like software development services. Ld.TPO further demonstrated that it is not always true that marketing expenses result in better profitability. He pointed out that in the case of Infosys 95% of its revenue for F.Y. 2006-07 was derived from repeat businesses which implies that marketing expenditure had little impact on the profitability of assessee company. Ld. TPO has given the operating profit to sales ratio of various companies along with the marketing expenditure incurred by the said companies to demonstrate that expenditure on marketing has no correlation to the margin earned. Even in case of companies that have a marketing expense more than 3% of sales they are also software development companies. 83. Ld. DRP confirmed the TPO s action, inter-alia, observing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of market intangibles in the form of brand being created by incurring heavy expenditure on advertising and marketing are well founded. If a comparable is having brand then its profitability is definitely better. We are in agreement with ld. Counsel for the assessee that for economic concepts evidence is not required but if the very objective of TP Study viz. finding out suitable number of comparable fails then the proposed filter can be applied subject to necessary adjustment. In such circumstances a holistic view has to be taken. It is true that by incurring heavy expenditure on advertisement marketing and distribution the companies carrying on manufacturing activities do create marketing intangibles and in these cases a broad correlation between two viz. marketing intangible and sales would be reflected. However, as pointed out by ld. TPO, in case of Infosys though heavy expenditure was incurred on advertisement, marketing, etc. but 95% were the repeat customer. But, this factor on stand alone basis cannot be a deciding factor. We agree with Ld. CIT(DR) that assessee need to correlate the expenditure on advertising, marketing and distribution costs with profits or with FAR analys ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... para 40. v. M/s CRM Services I (P) Ltd. ITA No. 4068/Del/2009, para 8.1. vi. M/s Quark Systems (P) Ltd. SB Chd. 41 ITR 606, para 25. (For the proposition that in a mean situation, differences get evened out). vii. M/s Bayer Material Sciences P. Ltd. 134 ITD 582, paras 23 and 24. viii. M/s Capgemini (ITA No. 7861/Mum./2011), para 4.3.6, for the proposition that size matters in manufacturing industry only, and not in service including such as software. It is also to be noted that Brand/Intangible does not (Per se) make any difference i. M/s Deloiette Consulting (I) P. Ltd. ITA No. 1082/Hyd./2010, para 36. ii. M/s Actis Advisors P. Ltd. ITA No. 5277/Del/2011, para 25. iii. M/s Wills Processing Service (I) Pvt. Ltd. ITA No. 4547- 4429/Mum./2012, para 45.1 and 45.2 dated 01.03.2013. Ground 4.8 Resorting to arbitrary rejection of low profit/loss making companies based on erroneous and inconsistent reasons; Counter: It is pointed out that there has been no arbitrary rejection of loss makers or low profit makers, and no arbitrary inclusion of high profit makers. The rejection has been on basis of FAR analysis and on account of abnormal circumstances. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... galore (ITA No. 1129/BANG/2011 h. M/s Mercedez Benz Research Development India Pvt. Ltd. DCIT, Bangalore (ITA No. 1369/BANG/2011 87.1 Ld. Counsel submitted that Accel Transmatic has been specifically rejected on the ground that a software development company cannot be compared with the software product company: 88. Ld. CIT(DR) submitted that in TNMM Method only broad functionality is to be considered. He pointed out that ld. TPO has considered the software service segment only and, therefore, this comparable is not to be excluded. 88.1 We have considered the rival submissions and have perused the record of the case. 89. Ld. TPO has reproduced at page 99 of his order the segmental details from the annual report which separately contains the details of software services. In the cases relied upon by assessee these details were not considered and, therefore, on the basis of those decisions this comparable cannot be excluded. However, we find that in Trilogy E-Business Software India Pvt. Ltd. (supra), as considered in HCL EAI Services (supra), it was, inter-alia, observed in para 49 that this company has related party transactions which are more than permitted level. L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany cannot be accepted particularly when it does not have any revenues from sale of products. Further, as per the information received u/s 133(6) it is clearly stated that this company is in providing software development and consulting IT services to its international clients. It is further stated that it utilized prudent technologies to enable customer s business systems. When this information is read along with the contents of annual report on the web site of this company, we do not find any contradiction Inasmuch as it is also stated that the company is involved in provision of software development and IT services. Ld. counsel s contention that it is a product company is primarily based on the details given on web site that it owns product like Dxchange travel solutions, insurance solutions, customer appreciation and relationship management application, content management systems. These products appear to have been developed by this company for being utilized for business solutions of its clients. Therefore, it is primarily in a software development service sector. The revenues have been derived mainly from software exports. In the case of Trilogy (supra) this company was ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y is product company owning intangible property. The assessee also referred to the annual report wherein it is, inter-alia, stated that the company has developed a de novo drug design tool CELSUITE to drug discovery and protected the IPR by filing under the Copyright / patent Act. It was further pointed out that based on its silico expertise (applying bio-informatics tools), it had developed a molecule to treat leucoderma and multiple cancer and protected the IPR by filing the patent. The company also outlined its future plans in the field of biotechnology. Thus, in sum and substance, the assessee submitted that the company was functionally dissimilar to the assessee as the company was engaged in the biopharma biotech manufacturing with customized IT Solutions, manufacture of drugs, clinical trials and contract research activities. The assessee relied on same decisions as for Accel Transmatic, noted earlier and also on following decisions in support of its contention that Celestial Lab has been rejected as a comparable: Trilogy E business India Software Private Limited, ITA No. 1054/Bang/2011 para 35, Exxon Mobil Company India Private Limited, ITA No. 8311/Mum./2010 para 33 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO pointed out that the revenue from in house developed products was only to the extent of ₹ 50,75,100/- for FY 2006-07 i.e. only 3.6% of its operating revenues of ₹ 14,12,75,776/-. Thus, more than 75% of revenues were from software development only. He further submitted that as regards assessee s contention that the software products mentioned by the tax payer were used for rendering software development services, Ld. TPO has clarified many software development companies use in house developed libraries/framework for rendering software development services and the presence of these in house developed software tools in no way changes the characteristic of the services as these tools are not sold as a product. 93. As regards the submission of ld. Counsel that in AY 2008-09 this comparable was not taken into consideration as it did not meet the employee cost, Ld. DR pointed out that the TPO also studied the prospectus filed by the company before SEBI and based on its examination issued notice u/s 133(6) which has been reproduced at pages 105 to 110 of his order and in response to the same, the company pointed out that it was mainly providing the services in the field ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO. D. KALS Information Systems: Ld. Counsel pointed out that as per the Annual Report, KALS is engaged in the business of software services and software products. Further, at page 17 of the Annual Report it also shows that there is consumption of software inventory as expenditure which implies that the company is into trading of software. The assessee relied on same decisions as for Accel Transmatic, noted earlier, and also on following decisions in support of its contention that KALS Info Systems Ltd. has been rejected as a comparable: Trilogy E business India Software Private Limited, ITA No. 1054/Bang/2011 para 35, Exxon Mobil Company India Private Limited, ITA No. 8311/Mum./2010 para 33 (xi), Quark Systems Private Limited, 32 TTJ 1 (SB) (Chd.), para 25 94. Ld.CIT(DR) referred to page 127 of ld. TPO s order (page 395 of appeal set) and pointed out that in the TP document this company was rejected by observing Business Review . However, no reasons were given. Ld. DR pointed out that as per the information submitted by the company in response to notice under section 133(6) that it is into two segments viz. software development services and training. The segmental details ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , therefore, proposed to include this company as a comparable to the assesse and accordingly, issued show cause notice to assessee. He has pointed out that assessee did not offer any comments and, therefore, this company was considered as comparable. Ld. Counsel referred to page 386 387 of paper book, wherein the reply dated 14th September, 2010 contained from pages 317 to 408 is contained to demonstrate that assessee had given specific reply in this regard but the same had not been considered. 95.1 Having heard both the parties, we restore the matter back to the file of ld. TPO to examine the assessee s reply and then decide the inclusion/exclusion of this comparable. a. Flextronics Software Systems Ltd.: Ld. TPO noticed that this company was finding place in the accept/reject matrix of the tax payer and was rejected in the TP document saying that it failed R D filter. He observed that based on the information submitted by the company, it qualified all the filters applied by the TPO. From the details of the product revenue submitted by company, it was evident that the same were only 10.8% of the total revenue. He, therefore, proposed to include this company as a comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness India Software Private Limited, ITA No. 1054/Bang/2011 para 35, Exxon Mobil Company India Private Limited, ITA No. 8311/Mum./2010 para 33 (xi), Quark Systems Private Limited, 32 TTJ 1 (SB) (Chd.), para 25 96. Ld. Counsel further submitted that the details provided by the Flextronics u/s 133(6) were unreliable and contradictory as on one hand it states that it does not own any IPR for products and on the other its financial details show that it has earned around ₹ 100 crores as software product revenue. Ld. Counsel further submitted that information u/s 133(6) can be an elaboration of the annual report but cannot replace the annual report. 97. Ld.CIT(DR) submitted that the information u/s 133(6) will prevail over the information contained in the annual report. He submitted that the product revenue is around 10% of the total revenue as per the information obtained u/s 133(6). 97.1 We have considered the submission of both the parties and have perused the record of the case. 97.2 For a company to be included in the list of comparables, it is necessary that credible information is available about the company. Unless this basic requirement is fulfilled, the comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tention and pointed out that as per the assessee s contention the competitive strength of Infosys was due to on account of following factors: a. Innovation and leadership b. Provess Global Mobile c. Comprehensive and sophisticated solution d. Long standing of the relationships e. States as an employer or choice f. Ability to scale. 97.3 Ld. TPO pointed out that all the above factors are there in the services being rendered by the tax payer to the associated enterprise. If the margins earned by a comparable company are affected by the factors like brand value etc. appropriate adjustments can be made. He pointed out that assessee had not given any cogent evidence or data to support the presumption that the margins earned by Infosys or any other company in the software industry were affected by the so called brand value. He submitted that the ultimate profits earned by any company including Infosys dependent upon the over all market conditions and the services rendered. He demonstrated with reference to final comparable selected by him that brand value had nothing to do with the margin. The said table is reproduced hereunder: 97.4 With reference to th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are development services. As regards assessee s contention that Infosys had software products, ld. TPO pointed out that the revenue s from software products were only 538 crores out of total operating revenues of ₹ 13149 crores. Therefore, the revenue from software product constituted only 4.1% of operating revenues. Hence it qualified the filter of more than 75% revenues from software development services. He, accordingly, included this in the list of comparables. 98. Ld. Counsel for the assessee reiterated the submissions made before ld. TPO and pointed out that the Spl. Bench of LG case clearly brings out the importance of brand and marketing intangible in the ramp on transfer pricing. He submitted that this case clearly lays down that risk bearing activities that compete in the market place need to incur AMP Expenditure to establish and maintain their brand. 99. Ld. CIT(DR) relied on following decisions in support of his contention that brand/intangible does not per se make any difference: 1. M/s Deloite Consulting India Pvt. Ltd., 108/Hyd./2010 (para 36); 2. M/s Actis Advisors Pvt. Ltd., ITA No. 5277/D/2011 (para 25); 3. M/s Wills Processing India Pvt. Ltd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofitability of software and IT Enabled Services. He pointed out that assessee is not contending that Infosys should be excluded because it incurred high level of marketing expenditure but because it had significant brand which itself had value at more than ₹ 20,000/- crore. Further as per annual report also large profits were derived because of brand. 100.1 We have considered the rival submissions and have perused the record of the case. 101. The earning of profit i.e. that profit margin of an entity depends on several factors such as geographical location of entity, operational efficiency, prevailing market conditions, goodwill of the company, intangibles in the form of brand value of entity , economies of scales, etc.. However, while selecting a comparable for determining the arm s length price of an international transaction, the pre dominant aspect which has to be taken into consideration is the functional profile of the comparable. If a comparable is performing the same functions as the assessee then a further exercise is to be taken regarding assets utilized and risk assumed in carrying out those functions. If the asset base pre-dominantly differs or the risk assu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t was rejected in the TP document on the ground that it failed business review. However, no reasons were given for rejection on functional grounds or qualitative criteria. On the basis of information received u/s 133(6), he observed that the company is into software development services and qualified employee cost filter and all other filters applied by the TPO. Therefore, it was considered as comparable. The assessee was show caused. However, assessee did not offer any comments except saying that the computation of PLI was wrong as dividend income and other income was considered by the TPO. The ld. TPO accordingly, corrected the PLI and included the company as comparable. Ld. Counsel pointed out that the company was engaged in providing services such as application management services, business and technology consultant ITES BPO services, Maritime practice, etc. Ld. Counsel referred to page 388 of paper book and pointed out following objections were raised by assessee in this regard: 1. This company failed the employee cost/sales filter of more than 25% applied by ld. TPO. However, the company was selected on the basis of information obtained u/s 133(6); 2. The notice u/s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... himself has excluded this company as a comparable. In this regard ld. Counsel referred to page 425 of the main appeal set for A.Y. 2008-09 and page 60 of the TP order for AY 2008-09. 107. Ld. DR relied on the order of TPO and submitted that as per the information received u/s 133(6), the Lucid Software is a pure Software Development Service Provider and does not have any revenue by way of sale of product/licenses. 107.1 We have considered the submissions of both the parties and have perused the record of the case. Since this comparable has been excluded by TPO himself in AY 2008-09, we do not find any justification for inclusion of this comparable for AY 2007-08 under the same set of facts and circumstances. No distinguishing feature has been brought on record in regard to this company between A.Y. 2007-08 and 2008-09. 107.2 Accordingly, we direct Ld. TPO to exclude this comparable from the list of comparables. 11. Third Ware Solutions Ltd.: 108. At the time of hearing, ld. Counsel for the assessee did not press exclusion for this comparable from the list of comparables. 12. Siskin Communication Technologies Ltd.: 109. Ld TPO noticed that the company was reject ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company was rejected in the TP document saying that the company failed its filter of business review and R D to sales more than 3%. However, no reasons were given for the business review. From the annual report, ld. TPO noticed that this company has two segments one software development and services segment and second systems integration and support segment. Segmental details were available and the company satisfies all the filters. The TPO, accordingly, considered software development and services segment as a comparable. The assessee, inter-alia, pointed out that as per the information received u/s 133(6), it has been specifically provided that the company is into production of specialized embedded software development services to its customers. Further, the company has termed the services provided by it as unique and non-repetitive in nature involving development of embedded software for use by the customer, whereas in the case of assessee the software development service provided were of routine nature and involved low level coding, testing and documentation services. The assessee further pointed out that in the information obtained u/s 133(6), the company itself has urged not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ocesses had to be standardized to have a control, which becomes difficult in bigger companies. Thus, incurring R D is a natural process of evolution of a small company into a bigger company, without which the company may not survive. It may fail to deliver the projects in time and also to the satisfaction of the clients. So, in bigger companies many processes are streamlined based on the past experience and converting the same in standardizing in the form of readymade tools. Thus, the presence of R D expenses is a minor functional difference and does not have material impact on profitability. Thus, as the software development and services segment does not contain any revenue by way of sale of software products/IPRs/license fees, the same is considered as a comparable. 113.1 The submission of ld. Counsel for the assessee that NASSCOM, which is the premium body of IT/ITES Companies in India, has classified hardware and software designing activity as functionally different to software development activities cannot be ignored. However, since segmental details were available, the objection raised by ld. Counsel cannot be accepted. As far as asseessee s objection with regard to IPR i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... owned and recognized research institution across the world has also not been shown. The manner in which the risk adjustment is computed by the taxpayer is not followed by any country or organization of international repute like OECD. In fact, even the OECD is reluctant to take the risk adjustment as part of the guidelines as there are divergent views on this issue among the member countries of OECD and many countries feel that there is no straight jacket formula for risk adjustment as it depends entirely on the facts and circumstances of the case. Thus risk adjustment is case specific, function specific and also depends on the nature of functions (including risks) carried out by the comparable companies. 2. The tax payer had not given any evidence or argument regarding how the assumptions of CAPM model are true in the case of the AE when it is doing business with the taxpayer. 3. The CAPM model has some weakness, the main being that the model does not recognize the presence of human capital, which is the main driving source for revenues in the software service industry. 4. The taxpayer considered only listed companies. But, there is a method of computationof similar nature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er these risks are not considered in the case of taxpayer while computing the risk adjustment. 11. The taxpayer considered total assets including current assets and current liabilities, but the CAPM hinges upon return on equity or capital employed. The operating assets are the major indictor of capital employed rather than total assets. Operating assets includes fixed assets, trade receivables net of trade payables. 12. The tax payer has assumed that operating expenses of the comparables would not change after risk adjustment. But, after giving effect to risk adjustment, the financial statements of the comparables should look like that of the tax payer i.e., stripping the risk component. So, the expenses pertaining to the risk like sales and marketing expenses, bad debts etc. should be removed from operating expenses and corresponding risk premium adjusted amount has to be reduced from the operating revenues. Hence, as per the above detailed discussion, the computation of risk adjustment by the taxpayer is not acceptable. There is no scientific basis for working out the taxpayer company s beta or beta of the unlisted comparable companies. The taxpayer altogether forgotten tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and in following cases Tribunal has held that there is difference in risk profile of a captive service provider and full-fledged entrepreneur software development companies that are selected as comparables: 117.3 He further pointed out that in Sony India Pvt. Ltd. 114 ITD 448, Tribunal has approved an ad-hoc adjustment for difference in risk on account of R D and working capital. Further, in Philips Software Centre (supra), Tribunal approved computation of adjustment on account of difference in risk by looking at the difference between the bank rate (rate at which RBI lends to the bank) and the Prime Lending Rate (PLR) which is the rate at which banks lend to customers. He submitted that matter may go back to ld. TPO before whom assessee will file computation as per CAPM Model duly supported by expert opinion and TPO could rebut the same with an expert opinion. 118. Ld. CIT(DR) submitted as under:- Ground 4.7 and 4.10 Including certain companies that had extraordinarily high profit margins and hence were not comparable to a low risk captive unit such as the appellant: Ignoring the business/commercial reality since the assessee is remunerated on an arm s length b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of risk adjustment should be such as to be easily understandable and not by resorting to complicated methods. Ld. CIT(DR) relied on the decision of ITAT, Delhi Benches in the case of M/s Premier Exploration Services Pvt. Ltd. v ITO 2013-TII-134-ITAT-DEL-TP for the proposition that risk adjustment can be considered when it is demonstrated that comparables had actually undertaken such risks and these materially affected their margin. 118.1 We have considered the submissions of both the parties and have perused the record of the case. We have perused the record of the case. We have also gone through the detailed written submissions filed by assessee from pages 92 to 104 of the written submissions The main contention of assessee is in regard to adjustment on account of market risk by applying CAPM Model. In this regard ld. TPO has observed that the services rendered by the assessee forms a component within the products developed by the assessee. Thus, the associated enterprise incurs marketing for its products and not on the services rendered by the assessee as they are considered in the product sold by the associated enterprise. The relationship between the tax payer and its paren ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... controlled transaction. Rule 10B(3) requires the adjustment to be made for material differences in risk profile. Therefore, risk adjustment has statutory recognition. Ld. TPO carried out alternative analysis after risk adjustment on the basis of CAPM model and worked out the risk adjustment at .73% from the mean PLI of 25% (before working capital adjustment) as against 5.32% computed by assessee in respect of 22 comparables considered by it and 8.99% in respect of comparables proposed by TPO. Ld. TPO observed that .73% difference caused by risk to near PLI was not much so as to require any adjustment. Ld. TPO summarized the risk analysis as under: 15.1.3 Summary of analysis of risk The discussion on the risk analysis is summarized as under: The taxpayer is totally dependent on the AE for business. Thus, the taxpayer takes the risks associated with heavy dependence on a single customer. In common business parlance it is known as single customer risk . The cost plus agreement with the AE does not guarantee sufficient volume of business nor period as the agreement is for a period of one year and renewed one year at a time unless terminated otherwise. The agreement c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h the parties. We find that ld. DRP at page 12 of his order in regard to ground no. 4.11 has observed as under: Inclusion of comparables by TPO in CDS sector has been considered by DRP. We find Megasoft should be excluded as it has different financial year end and went under restructuring hence has extraordinary business circumstances. Persistent Systems Ltd. also underwent restructuring. So both are to be excluded as comparables. In case of R Systems assessee has pointed out that the correct margin is 10.09% instead of 15.07%. TPO to verify and adopt correct margin. 124. Ld. Counsel has also pointed out that an application under Section 154 was filed by ld. TPO before ld. DRP which has been rejected. Accordingly, ld. TPO is directed to carry out the directions of ld. DRP. 125. In the result, this ground is allowed for statistical purposes. 126. Now, we will take up grounds relating to Administrative and Marketing Support Services segment of the assessee. 127. The brief description on functions of the company in this segment as under: The corporate segment ( CS ) is the administrative arm of MIPL. It comprises various teams rendering services that are essential ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee in numerous cases (Mentor Graphics) (Noida Pvt. Ltd.) 109 ITD 101 (Del.), Customers Services India Pvt. Ltd. vs. ACIT, 30 SOT 486. Accordingly, this ground is dismissed. 131. Ground no. 5.3.1, 5.3.3, 5.3.4 and 5.3.5 were not pressed by assessee at the time of hearing. 132. As far as ground no. 5.3.2 is concerned, this issue has been decided by us while considering ground no. 4.5.3 in regard to software development service segment. Therefore, this ground is partly allowed in terms of observations made therein. 133. As far as ground no. 5.3.6 relating to rejection of assessee s filter of excluding companies having research and development cost to sales being more than 3% is concerned, the said issue has been decided while considering the ground no. 4.5.9 in software development service segment and, therefore, for the reasons stated therein this ground is dismissed. 134. As far as ground no. 5.3.7 is concerned the same relates to advertisement marketing and distribution cost more than 3% filter which was applied by the assessee. This ground has been considered while deciding ground no. 4.5.10 of software development segment and, therefore, for the reasons stated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to page 29 of synopsis and pointed out that the filters selected by assessee were appropriate filters. However, ld. TPO applied following filters: 1) companies with diminishing revenue and consistent losses were eliminated; 2) companies which had more than 25% related party transactions (income as well as expenditure combined) of the operating revenues were excluded; 3) companies with research and development expenditure in excess of 3% of sales were included. 138.2 Ld. Counsel submitted that comparables selected by applying these filters could not be considered. He has assailed various comparables selected by TPO on different grounds which we will consider now. We have already discussed the scope of applicability of above three filters while considering the software development segment. We, therefore, proceed to consider each comparable separately: 1) Genins India TPA Ltd.: 138.3 Ld. Counsel submitted that this company is a third party administrator in health insurance and, therefore, cannot be considered to be in the provision of market support services. 139. Ld. TPO has not established the functional similarity. 139.1 Having heard both the parties, we f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no comparison between vendor information service rendered by the assessee and the management consulting services rendered by ICR which required much higher degree of skill. Accordingly, the qualities of personnel are also very different. 145.1 Ld. Counsel further pointed out that during 2006-07 ICRA demerged its consulting services subsidiary ICRA Management Consulting Services. Therefore, this was an extraordinary event which had the effect on profitability but was not ascertainable. 145.2 Having heard both the parties, we are not in agreement with ld. Counsel for the assessee that this company is to be excluded on the ground of functional profile because admittedly it was imparting consulting and advisory services. Further, we find considerable force in the argument of ld. Counsel for the assessee that the fact of demerger being an extraordinary event had impact on profitability but this aspect had not been considered by ld. TPO. Ld. Counsel has also challenged the inclusion of this comparable on the ground of expenditure on R D. In this regard ld. Counsel referred to extracts from annual report to demonstrate that company continuously invests in creating new products and s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO. 4) In Macs Management Services: 148. Ld. Counsel submitted that this comparable selected by ld. TPO should be excluded because it is functionally un-comparable inasmuch as the company is engaged in providing placement consultancy services and, therefore, these are not comparable to the assessee s routine administrative and marketing support services. Further, the inclusion of this company is also not warranted on the ground of earning abnormal margin and un-comparable sales turnover. He further submitted that this company has incurred expenditure on advertisement and marketing which exceeds 3% of sales. He further submitted that ld. TPO s observation that assessee had incurred only 2.54% of sales on advertising is incorrect as the assessee is a captive service provider and it does not need to spend on advertising and marketing. Ld. TPO, however, has not accepted the assessee s contentions for the following reasons: 1) the assessee is also imparting consultancy service like the comparable selected by him; 2) expenditure on advertisement and marketing does not make the company functionally dissimilar; 3) assessee has not pointed out any fact that would lead one to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... into for comparability purposes and the assessee has rejected the same on the ground of high profitability only. Ld. DR pointed out that merely because the shares are held by the Government of India does not make the company uncomparable, if the company is functionally comparable. 151.1 We have considered the submissions of both the parties and have perused the record of the case. We find that in the case of Mcicom India Pvt. Limited and others (supra) it has been held as under: Marketing support services cannot be compared with turnkey Engineering Services. We agree with the view of the First Appellate Authority that EIL, Rites, Wapsos and TCE are engineering companies and provide end-to-end solutions and whereas the assessee company provides marketing support services to the parent company, which is in the nature of support service and hence not functionally comparable. She rightly concluded that the risk profile is vastly different and hence on this count also they are not comparable. We are in agreement with ld. CIT(DR) that merely because of shares being held by the Government of India, the company cannot be excluded, unless it is established that the company is not f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or agencies, there would further be problem of related party transactions. 155. Ld. DR submitted that this company is purely imparting consultancy services and, therefore, merely because the shares are held by Government of India, it cannot be excluded. 155.1 Having heard both the parties, we do not find ourselves in agreement with ld. Counsel for the assessee for exclusion of this company from the list of comparables. In our opinion, unless it is demonstrated with robust data that because of shares being held by the Government of India, there is impact on profitability of company, the same cannot be excluded merely on the ground of general perception. Further, we find clear cut contradiction in the argument of ld. Counsel for the assessee because the effect of undertaking social obligation by Government Company at best results in reduction of profit and not in increasing the profits. As far as, the decision relied upon by ld. Counsel is concerned, the same has been rendered having regard to related party transactions but no data has been provided in the present case. We, therefore, uphold the ld. TPO s contention in this regard. 10) Consulting Engineering Services (India ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to software development service segment and, therefore, for the detailed reasons stated therein, we restore this issue to the file of ld. AO/TPO for fresh adjudication. 161. Ground no. 5.9 is general. 162. Vide Ground no. 6, the assessee has assailed ld. TPO s action in not allowing the adjustment in regard to operating profit margins of the comparables chosen for administrative and marketing support service segment to account for the differences in the working capital levels of the assessee and the comparables. The other two sub-grounds viz. (b) and (c) were not pressed by assessee. In regard to this, ld. Counsel submitted that the binding direction of the ld. DRP in respect of allowing adjustment on account of working capital differences in the operating margins of the comparables should be directed to be followed by ld. TPO. 162.1 Having heard both the parties, we find that while considering ground no. 4.9 relating to working capital adjustment, ld. DRP has directed AO/TPO to grant working capital adjustment based on the OECD formula and by taking 10.25% as the PLR. We, therefore, direct the ld. TPO/AO to carry out the directions given by ld. DRP. 163. In the result, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Ld. Counsel submitted that the liquidated damages were part of the sale process and the same was as per the policy of Accounting Standard-29 issued by Institute of Chartered Accountant s of India. 167.1 Ld. Counsel pointed out that ld. DRP did not accept the assessee s contention, inter-alia, observing as under: In the instant case, it is an admitted fact that the provisions are made and also written back when no longer required. This indicates that no generalization can be made about liquidated damages. There is a great deal of contingency and it cannot be accurately predicted. Therefore, it would be in the fitness of things to uphold this disallowance. But at the same time the entire reversal of the said provision of ₹ 306779345/- should have been reduced in computing taxable income . 167.2 Ld. Counsel submitted that the assessee is engaged, inter-alia, in the business of installation and commissioning of telecommunication and equipment network and provides technical support services in relation to the same for various telecom operators in India. All the projects executed by the assessee company are done under contracts which contain the clause for liquidated da ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Add: Provision 202 322 Less: reversals 39 - Less: Utilisations 268 - Closing balance 388 493 167.4 Ld. Counsel further pointed out that usually the assessee enters into discussion/negotiation regarding the quantum of liquidated damages. Sometimes, the assessee also enters into arbitration proceedings in this regard. When certainty/finality is reached in respect of the negotiation/discussion/arbitration proceedings with the customers, the relevant amount is shown as utilized from the provision account. In case where the customer agrees to waive the liquidated damages either, partly or fully, the provision is reversed to that extent. This amount is offered to tax as income in the year in which this reversal is done. He further pointed out that this year, the amount of reversal is more than the amount added to the provision, i.e., taxable income of the assessee has gone up on account of the reversal. Ld. Counsel relied on following case laws in suppo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the execution of contract then assessee will become liable for payment of liquidated damages. The liability, thus, crystallized with the occurrence of event of delay in the execution of contract. The assessee might, after entering into negotiation with the party, get a waiver or partial deduction in its liability but that does not absolve the assessee from being liable for liquidated damages on occurrence of the event of delay in execution of the contract. 170. Ld. DR has relied on the decision of Hon ble Kerala High Court in the case of N.Suderasham. In this case the assessee had entered into contract with foreign buyers for the supply of cashew kernels. However, the assessee could not fulfill the obligations under the contract due to the shortage in the supply of raw cashew nuts and consequent high in prices. Due to the failure to supply the chashew nuts as per the terms of the contract, there was breach of contract and the assessee, therefore, claimed a deduction of ₹ 1251625/- towards damages payable to the foreign companies. The claim was rejected by Tribunal against which assessee preferred appeal which was dismissed as the assessee failed to establish its claim. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the dispute was not merely confined to quantification of the damages. The dispute in fact involved the very liability of the assessee to pay any damages to the foreign party. Unless the dispute was finally settled, it could not be said that any liability for payment of damages had accrued or arisen during the year. As held by the Supreme Cout in CIT vs. Hindustan Housing Land Development Trust Ltd. (1986) 161 ITR 524/27 Taxman 458, an enforceable liability will spring into existence only when it is determined and finally fixed by a court or any other mutually agreed forum. In the instant case on the basis of available materials it was clear that the contract did not provide for payment of any particular amount as damages in case of breach of the contract and the claim by the foreign party was for unliquidated damages. 170.1 Thus, in this case also the provision was not made on the basis of some contractual obligations but on account of Arbitrator s Award which had not become final. 171. From the analysis of the two decisions relied upon by ld. DR, it is evident that both are not applicable to the facts of the case. 172. On the other hand, we find that the case laws reli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de for the payment of liquidated damages no sooner than the delay takes place and as a guarantee for payment of liquidated damages bank guarantee was to be given for the full amount of liquidated damages. There may be a possibility for the deduction of liquidated damages on negotiation. But that is not to say that the liability to pay liquidated damages did not accrue. Nor does it stand to reason because the delay in the delivery of the goods under the terms of the agreements in question constituted breach, it does not discharge the contract as such, because admittedly the contracts have not been avoided by the other side at all. The reason is that they were continuing contracts for manufacturing of articles to the specification of the purchaser and time was stipulated as the essence of the contract ; nonetheless it would have served no purpose if the purchaser had cancelled the contract when the work on the manufacture of the machinery had progressed perhaps a very large extent and payments were made in the mean time as per the terms of contract. That was the reason why penalties have been provided in the agreement itself depending on the period of delay which is intended to act a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method, and should there be any difficulty in calculations or quantification, that may render the amount provided as damages incorrect but that does not postpone of accrual of liability. As we have pointed out, what was in dispute was the point of accrual of liability under the terms of the contract, but not either quantification or the fact that the liability to pay liquidated damages as and when delays had taken place. 173. Similar view has been taken in other cases also. In the case of FFE Minerals Pvt. Ltd. (supra), while allowing the provision for liquidated damages, inter-alia, observed in para 13 that the decision of Hon ble Kerala High Court in N. Sudersharam (supra) is not relevant in deciding the issue. 174. We further notice that Pune ITAT in Thermax Bebcock and Wilcox Ltd. (supra) 304 ITR 130 in para 24.5 to para 25, has observed as under: 33. Having regard to the facts and circumstances of the case and submissions of both the parties, there is no dispute as to the fact that the stipulation providing the payment of liquidated damages to the other party for delay in completing the work, is a part of the contract agreement entered into by both the parties for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oss receipts, but on profits and gains of the business. The profits should be understood in its natural and proper sense, in a sense which no commercial man would misunderstand. It has to be real profits. It was for this reason that a deduction of a provision in respect of the liability the assessee had undertaken by way of providing amenities or development work within six months from the date of deed of sale was allowed as a deduction. Applying the same analogy to the present case, we find that the assessee has imported a liability on itself to pay liquidated damages for the delay in completing the work within the specified time, and as such, the estimated expenditure which would be incurred towards liquidated damages would be deductible from the receipts of the year. This certain act or event of not completing the work within stipulated time has imported a definite and absolute liability on the assessee and merely because of the fact that liability would be discharged at a future date and, there is a difficulty in estimating the correct amount thereof would not convert this definite and absolute liability into conditional one as has been held by the Hon ble Supreme Court in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... c Corporation P. Ltd. [2005] 278 ITR 337. The Hon ble Delhi High Court as well as the Hon ble Kerala High Court in the aforesaid two cases have taken note of the principles laid down by the Hon ble Supreme Court in the cases of Calcutta Co. Ltd. vs. CIT [1959] 37 ITR 1and Bharat Earth Movers v. CIT [2000] 245 ITR 428. Therefore, applying the same analogy as applied in the case of warranty by the Hon ble Kerala High Court s, the Delhi High Court and the Privy Council in the cases of (i) CIT vs. Indian Transformers Ltd. [2004] 270 ITR 259, (ii) CIT vs. Vinitec Corporation P. Ltd. [2005] 278 ITR 337 and (iii) IRC vs. Mitsubishi Motors New Zealand Ltd. [1996] 222 ITR 697 respectively. In the present case can be easily resolved in favour of the assessee. In the present case, the works have been executed after the expiry of the stipulated period. The stipulation as to the payment of liquidated damages towards delay in executing the contract work is related to the contract work, revenue thereof has been accounted for in the year under consideration. Although exact quantification of the claim of liquidated damages may be made at a future date, the assessee payer was, in obligation to pay l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has assailed the levy of interest u/s 234C by AO while passing the order u/s 154. The assessee s submission is that interest u/s 234C is to be computed as per the returned income and not as per the asset income. In regard to the submission of ld. DR that in the case of Anjum Gaswalla, Supreme Court it has been held that the interest u/s 234A, 234B 234C is mandatory, ld. Counsel submitted that the said case law does not deal with the issue as to whether the interest u/s 234C is applicable on returned income or asset income. He, therefore, submitted that the said decision is not applicable in the present case. 184.1 We have considered the rival submissions and have perused the record of the case. We find considerable force in the submission of ld. Counsel for the assessee that as per section 234C, the interest is to be computed with reference to returned income and not assessed income. Accordingly, the AO is directed to compute the interest as per returned income in accordance with law. 185. In the result, this ground is allowed for statistical purposes. 186. While parting, we would like to place on record our deep appreciation for the unrelenting assistance extended by S ..... X X X X Extracts X X X X X X X X Extracts X X X X
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