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TMI Blog2015 (4) TMI 586X X X X Extracts X X X X X X X X Extracts X X X X ..... e that one of the comparables, i.e., SIP Tech has only revenue of ₹ 3.6 crores. Obviously, the company has some problems as it is not able to procure enough orders and cannot be considered as established player in the field. It is, in our view, has to be excluded outright. The new comparables also include L&T Infotech and as has been pointed out by learned senior counsel this is a subsidiary of L & T, which is against the filter applied by the assessee that the comparable should not be a subsidiary of another company. We find that, on this ground, we have already excluded Datamatics Ltd. Therefore, this company has to be excluded outright. We are thus left with only two new comparables submitted at the level of the Dispute Resolution Panel, i.e., Goldstone which has turnover of ₹ 41.03 crores and Lanco Infotech, which has turnover of ₹ 45.56 crores. As we have held earlier, the comparables must have certain minimum size as these have to be compared with well established players in the field. In our view on the facts of the case, minimum turnover of ₹ 100 crores has to be fixed and considering this, these two comparables have also to be rejected. Infosys, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y Services Ltd. v. Asst. CIT [2007 (7) TMI 50 - ITAT BANGALORE] and not accepted. - Decided partly in favour of assessee. - ITA No.7861/Mum/2011 - - - Dated:- 28-2-2013 - SHRI RAJENDRA SINGH AND SHRI VIJAY PAL RAO, JJ. For the Appellant : Shri P.J. Pardiwala For the Respondent : Shri Ajeet Kumar Jain ORDER Rajendra Singh (Accountant Member).- This appeal by the assessee is directed against the order dated October 14, 2011 of the Assessing Officer passed in pursuance of direction of the Dispute Resolution Panel under section 144C(5) of the Income-tax Act, 1961. The only dispute raised in the appeal is regarding transfer pricing adjustment made by the Assessing Officer on account of the international transactions. 2. The facts in brief are that the assessee, during the assessment year 2007- 08, had provided software programming services to the parent company in the US for which the assessee had received a sum of ₹ 5,39,40,81,065. Since the assessee had entered into an international transaction with an associate enterprise, the income arising from such transaction in view of the provisions of section 92C has to be computed having regard to the ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9. Sonata 4.8 5.9 - 5.3 10. VJIL 3.7 3.6 - 3.7 11. Wipro 22.1 21.1 20.1 21.1 Arithmetic mean 13.7 2.1. The Transfer Pricing Officer pointed out to the assessee that in terms of the provisions of rule 10B(4) the data to be used for analysing comparability of uncontrolled transactions with international transactions shall be the data relating to the financial year in which international transaction had been entered into. The section also provided that data relating to a period not being more than two years prior to such financial year could also be considered if such data revealed facts which had influence on determination of transfer prices in relation to the transactions being compared. The assessee could not explain as to how the earlier year's data could have an e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... related party transactions with subsidiaries would be nullified. It was pointed out that comparable companies selected on the basis of consolidated financials were Indian parent companies operating in similar environment as the tested party. The subsidiaries of these companies were nothing but mere extension of the Indian parent. Therefore, it was argued that the consolidated financials had been rightly adopted by the assessee. It was further submitted that standalone financials should not be used of companies operating in multiple jurisdictions whether through subsidiaries or branches as these are heavily affected by companies' decisions as to whether to operate internationally through branches or subsidiaries. The Assessing Officer, however, did not accept the contentions raised. It was observed by him that under the provisions of rule 10B(2), comparability of international transactions with uncontrolled transaction has to be judged with reference to functions performed, assets employed, risk assumed and the conditions prevailing in the markets in which respective parties to the transaction operate including geographical locations and size of market, laws and the Government o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the transfer pricing study report had selected only those companies which were not subsidiaries of another company. However from the annual report of Datamatics Ltd. it was seen that the said company was a subsidiary of Sameer Microtronics P. Ltd. The Transfer Pricing Officer, therefore, excluded Datamatics Ltd. He however found that Mindtree Consulting Ltd. and Persistent Systems P. Ltd. fulfilled comparability criteria. The Transfer Pricing Officer thus finally selected four comparables which gave an arithmetic mean margin of 27.82 per cent. on standalone basis as per details given below : Sl.No. Name of Company Operating margin operating cost financial year 2006-07 1. Infosys Technologies Ltd. 40.16% 2. Wipro Ltd. 26.08% 3. Mindtree Consulting Ltd. 19.25% 4. Persistent Systems P. Ltd. 26.01% Arithmetic mean 27.82% 2.6. The Transfer Pricing Offic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... egard had to be made in accordance with rules. He referred to rule 10B(1)(e)(iii) as per which adjustment on account of any difference between international transaction and comparable uncontrolled transaction or between enterprises entering into such transactions could be made only in case of comparable uncontrolled transactions. The Transfer Pricing Officer thus concluded that there was no provision for making adjustment in the margin in case of the assessee which had to be computed as per accounting principles. It was further observed by him that the assessee this year had claimed ESOP expenses of ₹ 46,41,96,501 against accelerated ESOP cost in addition to similar expenses of ₹ 23,90,49,510 booked as part of personal cost. The ESOP cost in the assessment year 2006-07 was only ₹ 10,35,30,274 and in the assessment year 2005-06 it was ₹ 36,02,49,446. The assessee had placed reliance on the decision of the Pune Bench of the Tribunal in the case of Skoda Auto India P. Ltd. v. Asst. CIT [2009] 30 SOT 319 (Pune) in support of the claim for adjustment in case of margin of the assessee. The Transfer Pricing Officer distinguished the case on the ground that in that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of ₹ 5,23,91,68,090. The transfer pricing adjustment was thus computed at ₹ 1,11,97,50,424 (Rs. 6,69,67,04,652 ₹ 5,57,69,54,228). The assessee filed objections against the Transfer Pricing Officer's order before the Dispute Resolution Panel-I (DRP-I), Mumbai who after hearing the assessee rejected all objections raised including benefit of 5 per cent. range as provided under the proviso to section 92C(2). The Dispute Resolution Panel-I confirmed the order of the Transfer Pricing Officer. The Assessing Officer therefore made the adjustment of ₹ 1,11,97,50,424 while computing the total income. Aggrieved by the decision of the Assessing Officer, the assessee is in appeal before the Tribunal. 3. Before us, learned senior counsel appearing on behalf of the assessee argued that the assessment order suffered from several infirmities such as wrong margin adopted by the Assessing Officer in case of the assessee ; mistake in the computation of margin in case of the comparable, Mindtree Consulting Ltd. and Persistent System P. Ltd. ; the rejection of the comparables by the Transfer Pricing Officer ; rejection of claim for working capital adjustment ; and n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y because the assessee was otherwise eligible for exemption under section 10A of the Act. It was also pointed out that ESOP cost had been treated as perquisite in the hands of the employees on which tax had been deducted at source. 3.1.1. It was thus argued that the assessee had rightly excluded ESOP cost while computing margin which was 16.8 per cent. after excluding one time ESOP cost whereas margin adopted by the Transfer Pricing Officer/the Assessing Officer was 6 per cent. which was not correct. It was submitted that for making any proper comparison with the comparables, it was necessary that adjustments were made for any abnormal item of expenditure or income in case of the assessee. The Transfer Pricing Officer had not allowed adjustment on the ground that under the provisions of rule 10B(1)(e)(iii), any adjustment could be made only in case of comparables and not in case of the assessee. It was pointed out that the view taken by the Transfer Pricing Officer was not correct as there are several cases in which the Income-tax Appellate Tribunal has allowed adjustment in case of the assessee for extraordinary factors for the purpose of comparison. The cases cited by learned ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lusion of the said comparable was not justified as the Transfer Pricing Officer is not permitted to do cherry picking of comparables and that comparables could not be rejected only on the ground of loss without pointing out any specific features which make them non-comparables. 3.3.1. Learned senior counsel also pointed out that the assessee had selected three new comparables after show-cause notice had been issued by the Transfer Pricing Officer vide letter dated October 27, 2010 for rejecting the comparables. The show-cause notice had been issued only one week before the time barring date and within this short period, the assessee had given three new comparables, i.e., (i) Datamatics Ltd. (ii) Mindtree Consulting Ltd., and (iii) Persistent Systems P. Ltd. Out of the said three comparables, the Transfer Pricing Officer rejected the Datamatics Ltd. on the ground that it was subsidiary of another company whereas the assessee had used the filter as per which the comparables should not be a subsidiary of another company. The other two comparables were accepted but their margin was wrongly computed by the Transfer Pricing Officer. The standalone margin taken by the Transfer Pricing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... out giving any reasons. It was pointed out that the Transfer Pricing Officer in the show-cause notice for rejection of comparables had given only one week time and, therefore, the assessee did not have sufficient time to conduct further study and accordingly could not submit all the comparables before the Transfer Pricing Officer. The same were however given before the Dispute Resolution Panel but were not considered. It was therefore argued that these comparables which meet the comparability test should also be considered. 3.4. Coming to the working capital adjustment, it was submitted that accounts receivable and accounts payable have an impact on profitability of the company and in case of substantial difference, the two companies cannot be considered as really comparable. Only the companies having similar level of accounts receivable and accounts payable could be considered comparable and in case of differences, suitable adjustments are required, which are also permitted by OECD guidelines. Referring to the observations of the Transfer Pricing Officer that the assessee had not been able to give details of representative level of working capital during the year, learned senio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Mastek Ltd., substantial part of the revenue came from other countries. It was therefore urged that it was not safe to consider the consolidated results. He placed reliance on the decision of the Tribunal in the case of American Express (India) P. Ltd. in I. T. A. No. 4240/Del/ 2009 in which case the Transfer Pricing Officer had taken the consolidated results to nullify the effect of related party transactions but the Income-tax Appellate Tribunal did not allow the same on the ground that substantial revenue came from other markets which were not comparable. 4.1. Coming to the case of VJIL, it was submitted that it was an abnormal loss case and in view of paragraph 3.65 of OECD guidelines loss making uncontrolled transactions should be further investigated and in case loss does not reflect normal business conditions or reflects the level of risk that is not comparable, it should be rejected. The guidelines provide that the comparable should not be rejected on the sole basis of loss if it satisfies comparable analysis. He referred to the annual report of the company which showed that out of total debts of ₹ 9.42 crores, the assessee had made provision for doubtful debt/adv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t. CIT in I. T. A. No. 7894/M/2010 [2012] 15 ITR (Trib) 323 (Mum) in which the Tribunal did not accept the plea of exclusion on the ground of difference in turnover. The Tribunal observed that in a competitive market, high turnover was associated with low margin and low turnover did not necessarily mean high margin. The learned Commissioner of Income-tax-Departmental representative placed on record graph plotted between margin and turnover in respect of comparables selected by the assessee in this case which was placed on record which showed that there was no linear relationship between margin and turnover. For instance, in the case of Persistent Systems P. Ltd. margin was 24.1 per cent. on turnover of ₹ 294.56 crores whereas in the case of Mindtree Consulting Ltd. margin was 17.69 per cent. on turnover of ₹ 446.41 crores. Referring to the argument of learned senior counsel that Infosys and Wipro had substantial on-site work in foreign jurisdiction which involved substantial dead cost as the employees sometimes could not be utilised fully as can be done in the home country, the learned Commissioner of Income-tax-Departmental representative pointed out that the dead cost ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing from international transactions with associated enterprises has to be computed having regard to the arm's length price. Section 92C prescribes various methods such as comparable uncontrolled price (CUP) method, resale price method, cost plus method, profit splitting method and transactional net margin method (TNMM), etc. The Assessing Officer referred the computation of the arm' s length price to the Transfer Pricing Officer who had asked the assessee to give detailed information regarding transfer pricing study made by it for making the transfer pricing adjustment. The assessee in the transfer pricing study, details of which have been placed on record, noted that the comparable uncontrolled pricing method was the most appropriate but there was no internal comparable uncontrolled pricing available as the assessee did not sell services to any outside party and no information was available for application of external comparable uncontrolled pricing. The cost plus method was also found not applicable as data was not available. Resale method was not suited to the facts of the case. The assessee, therefore, selected transactional net margin method which was applied for bench ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arison of margin between assessee and comparables has to be made under identical conditions. No case has been made by the Revenue before us that any of the comparables, have claimed, any extraordinary item of expenditure on account of ESOP cost. Therefore, in our view, for the purpose of making proper comparison of the margin, onetime ESOP cost incurred by the assessee due to acquisition by Capgemini group towards the end of the year, i.e., in February 2007 has to be excluded. There is nothing in the rules that prohibits adjustment in the margin of the assessee to remove impact of any extraordinary factors. 5.2.1. Learned senior counsel for the assessee has also brought to our notice several decisions of the Tribunal in which adjustments made in the case of the assessee (tested party) has been upheld. These cases have been listed in paragraph 3.1 earlier. In the case of Skoda Auto India P. Ltd. [2009] 30 SOT 319 (Pune), it was found that it was the first year of operation in the case of the assessee in which import content of the raw material was as high as 98.55 per cent. whereas in case of comparables it varied from 26 per cent. to 56.83 per cent. The Tribunal held that no com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the cases which were subsidiaries of another company. The study gave eleven comparables details of which have been given in para 2 earlier. However, subsequently during the proceedings before the Transfer Pricing Officer, the assessee submitted that five of the eleven comparables were not comparable to the case of the assessee for the various reasons mentioned in para 2 of the order earlier. The details of six comparables which as per the assessee were found comparable has been tabulated in paragraph 2.2 earlier. The Transfer Pricing Officer, however, after detailed examination of these companies noted that four out of these six comparables, i.e., Mascon Global Limited, Mastek Ltd., Patni Computer Systems Ltd. and CG-Vak Software and Exports were not comparable as these cases had related party transactions exceeding 25 per cent. in each case. The Transfer Pricing Officer therefore, excluded these comparables and thereafter only two comparables, i.e., Infosys and Wipro were found comparable. 5.3.1. The assessee during the proceedings before the Transfer Pricing Officer, on receipt of show-cause notice for rejection of comparables, submitted three more comparables, i.e., Datamati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied for selection of comparables. In addition, it has also been argued that in case high profit cases were selected the case of VJIL which was initially excluded by the assessee before Transfer Pricing Officer on the ground that financial information was not available in public domain and was rejected by the Transfer Pricing Officer on ground of losses, should also be included. It has been further argued that consolidated results of the companies should be considered for the purpose of computation of margin as consolidated results neutralise results of related party transactions. It has been pointed out that in case standalone results are taken, these may not be comparable as some of the comparables may have overseas branches. It has also been pointed out that in case, Datamatics is rejected on the ground of being subsidiary of another company, the same treatment will have to be given to L T Infotech, which was subsidiary of L T. 5.3.3. We first deal with the pleas raised by learned senior counsel for using consolidated results for the purpose of comparison of margins. The learned Commissioner of Income-tax-Departmental representative has pointed out that the four comparables ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... excluded or in case extreme profit cases are included, the case of losses should also be included. This argument is particularly relevant in relation to VJIL which has margin of 42.94 per cent. on turnover of ₹ 13.02 crores and also Infosys Technologies and Wipro which are extreme profit cases. Learned senior counsel has argued that VJIL had been initially excluded by the assessee on the ground of lack of financial information in the public domain and since information was now available, this should be considered. It has also been pointed out that VJIL was not a persistent loss making company and was profitable in the assessment years 2005-06 and 2006-07. Therefore, it has been argued that this should also be included in case Wipro and Infosys Technologies are considered. In our view, comparable cases cannot be rejected only on the ground of extremely high profit or loss. In case the companies satisfy the comparability criteria, and do not involve any abnormal business conditions, the same cannot be rejected only on the ground of loss or high profit. The OECD guidelines also provide that loss making uncontrolled transactions should be further investigated and it should be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee are software engineers, who are recruited from project to project depending upon the requirement. The revenue in these cases is directly related to manpower utilised. With rise in volume cost goes up proportionately. Therefore, as rightly pointed out by the learned Commissioner of Incometax-Departmental representative the concept of economy of scale could not be applied to service oriented companies. The learned Commissioner of Income-tax-Departmental representative has also placed a graph plotted between margin and turnover in case of the comparables selected by the assessee, which shows no linear relationship between margin and turnover. In fact, the graph shows that the margin has come down with the rise in turnover in some cases. Such detailed study was not available before the various Benches of the Tribunal mentioned earlier, who have applied the turnover filter. Therefore, in view of the fresh material, in our view, the decisions of the Tribunal can be followed. 5.3.6. The manpower requirement of software companies vary from project to project and, therefore, all the companies engaged in this line recruit employees depending upon the nature of project as p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsel for applying turnover filter for selection of comparables for the purpose of comparison of their margins with that of the assessee. 5.3.7. However, we may make it clear that for the purpose of comparison, the turnover would be relevant only from the limited purpose to ensure that the comparable selected is an established player capable of executing all types of work relating to software development as the assessee is also an established company in the field. In other words, it must have a certain critical mass to compete successfully in the market, which can be decided by the minimum quantum of work it must have done. Therefore, the filter can be applied to select comparables having a minimum turnover and, thereafter, their margins can be compared provided they meet the comparability test and there are no other material differences, which impair the comparability. It has been argued by learned senior counsel that Infosys and Wipro have substantial income from sale of branded software but the argument based on volume as pointed out earlier is not relevant for the purpose of margin nor any material has been produced before us to show that the margin was very high in case of s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es submitted by the assessee at the level of the Dispute Resolution Panel, we find substance in the submissions by learned senior counsel that the Transfer Pricing Officer had not given sufficient opportunity for study and selection of new comparables as order was passed within a week of issue of show-cause notice. Therefore, the new comparables selected at the level of the Dispute Resolution Panel should have been considered. The Dispute Resolution Panel has not considered the new comparables without giving any reason. In our view, it would be appropriate to take as many comparables as possible so that the mean margin is closer to the correct margin because no two companies can be said to be exactly identical and small differences, if any, could be eliminated by increasing number of comparables. These new comparables, therefore, in our view have to be considered. We, however, note that one of the comparables, i.e., SIP Tech has only revenue of ₹ 3.6 crores. Obviously, the company has some problems as it is not able to procure enough orders and cannot be considered as established player in the field. It is, in our view, has to be excluded outright. The new comparables also in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd more accounts receivable in case of a company would mean relatively lower profit. Therefore, the companies could be considered as fully comparable if they hold the same level of account receivable and account payable. The Transfer Pricing Officer has, however, rejected the claim of working capital adjustment which has been upheld by the Dispute Resolution Panel. The reason given by the authorities below is that the assessee had not made any claim for working capital adjustment in its the transfer pricing study and that it is not possible to make accurate adjustment on this account as it is difficult to find the account receivable/ payable at different points of time during the year. Learned senior counsel has referred OECD guidelines as per which if the account receivable/payable on the last date do not give a representative level of working capital for the whole year, average may be used if it reflects the better level of working capital over the year. In our view, working capital adjustments are required to be made because these do impact the profitability of the company. Rule 10B(2)(d) also provides that the comparability has to be judged with respect to various factors inclu ..... 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