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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 ..... ection 92C has to be computed having regard to the arm's length price. Section 92CA prescribes various methods such as comparable uncontrolled pricing (CUP) method, resale pricing method, cost plus method, profit split method and transactional net margin method (TNMM), etc. The Assessing Officer during the assessment proceedings referred the issue of determination of the arm's length price to the Transfer Pricing Officer (TPO). The Transfer Pricing Officer, therefore, issued notice under section 92C to the assessee asking the assessee to give details of transfer pricing study conducted by it to compute the arm's length price of the international transaction. The assessee in the transfer pricing study selected transactional net margin method as the most appropriate method for benchmarking the international transaction with respect to uncontrolled transactions. The assessee selected 11 comparables which were engaged in similar line of business and provided services primarily to the U.S. or European market having sufficient public financial and business information. The assessee computed the weighted average margin of these comparable over three years, i.e., financial year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed upon due to massive fraud which had been unearthed in case of the company. In case of VJIL, it was submitted that financial information was not available in the public domain. It was thus submitted that five companies were in fact not comparable. Excluding these five companies, the updated margin in respect of six companies for the financial year 2006-07 was given as under : Sr. No. Name of Company Margin in financial year 2006-07 1. CG-Vak 2.8 2. Infosys Technologies Ltd. 28.1 3. Mascon Global Ltd. 10.4 4. Mastek 12.7 5. Patni Computer Systems Ltd. 19.1 6. Wipro Technologies Ltd. 20.1 2.2. In the working of margin in the above cases, the assessee had used consolidated results of the comparables for the purpose of comparison. The assessee explained that consolidated financial statements had been adopted because in such statements, the effect on margin due to 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Consulting Ltd., the Transfer Pricing Officer noted that it had incurred heavy losses, i.e., 42.94 per cent. during the financial year 2006-07 and therefore held that it was not comparable to the assessee-company which was a cost plus entity. The Transfer Pricing Officer, therefore, found only two companies comparable, i.e., Infosys Technologies Ltd. and Wipro which had margin of 40.26 per cent. and 26 per cent. respectively on standalone basis. 2.4. The assessee during the proceedings before the Transfer Pricing Officer added three more comparables which had not been taken at the time of preparation of transfer pricing study report due to unavailability of financial information. These three companies were as under : (i) Datamatics Ltd. ; (ii) Mindtree Consulting Ltd. ; and (iii) Persistent Systems Private Ltd. 2.5. The Transfer Pricing Officer, however, noted that the assessee in 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 Dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xceptional in nature arising out of acquisition. The assessee, therefore, in the transfer pricing study excluded these costs for the purpose of computation of margin in case of the assessee and this exceptional cost was amortised over a period of five years starting from the financial year 2007-08 in transactional net margin method analysis of subsequent years. 2.6.1. The Transfer Pricing Officer however did not accept the claim of the assessee of making adjustment while computing its margin on account of ESOP cost. It was observed by him that any adjustment in this regard 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 Rs. 46,41,96,501 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rking capital in the hands of comparables. The comparability on the last date of the financial year would give skewed results. The Transfer Pricing Officer thus concluded that reasonable accurate adjustments could not be made on account of working capital and accordingly rejected the claim of the assessee. 2.8. The Transfer Pricing Officer finally computed the arm's length price of the international transaction relating to software programming services at Rs. 6,69,67,04,652 by applying the mean margin of 27.82 per cent. on the operating cost of Rs. 5,23,91,68,090. The transfer pricing adjustment was thus computed at Rs. 1,11,97,50,424 (Rs. 6,69,67,04,652 âEUR" Rs. 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 Rs. 1,11,97,50,424 while computing the total income. Aggrieved by the decisio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... subsequent 5 year period starting from the assessment year 2008-09 which had been reduced from the profit while working out transfer pricing adjustments in the subsequent years as was clear from the details given at page 76 of the paper book which had been filed before the Transfer Pricing Officer vide letter dated October 28, 2010. It was further submitted that the exceptional ESOP cost had been claimed by the assessee in the profit and loss account as same had been incurred during the year and not to reduce any tax liability 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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e this was done, the margin of the assessee was within the 5 per cent. safe labour limit and, therefore, no adjustment was required. Learned senior counsel further submitted that the Transfer Pricing Officer had rejected the comparable, VJIL on the ground of losses. The assessee vide letter dated October 27, 2010 had pointed out to the Transfer Pricing Officer that VJIL was not a persistent loss making company and it was profitable in the assessment years 2005-06 and 2006-07. Therefore, it was submitted that exclusion 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e case of Aginity India Techno logies v. ITO ; (iv) Genisys Integrating Systems (India) P. Ltd. v. Deputy CIT [2012] 15 ITR (Trib) 475 (Bang) in I. T. A. No. 1231/Bang/2010 ; (v) I. T. A. No. 1494/Hyd./2010 in the case of Brigade Global Services Pvt. Ltd. ; and (vi) Asst. CIT v. Frost and Sullivan India P. Ltd. [2012] 50 SOT 517 (Mum). 3.3.3. It was also argued that the assessee had submitted four new comparables before the Dispute Resolution Panel which had not been considered without 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 substa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . He referred to annual reports of the four comparables having related party transactions to point out that in case of Mascon Global Ltd., 75 per cent. of the revenue came from the U.S.A., Moscow and the UK and only about 25 per cent. from India. Similarly in case of CG-Vak Software and Exports, 75 per cent. of the revenue came from other jurisdictions. In case of Patni Computer Systems Ltd., 61 per cent. of revenue came from the U.S.A., the UK, Germany and Brazil whereas in case of 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 u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f turnover. It was pointed out that the argument based on economy of scale was not relevant in case of a service company. It was relevant only in case of manufacturing concern where the cost per unit product increased with rise in turnover, and therefore, profitability rises with rise in turnover which is not a case in service providing companies where fixed costs are nominal. He referred to decision of the Tribunal in case of Symantec Software Solutions P. Ltd. v. Asst. 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 Rs. 294.56 cror ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o show that accurate adjustment could be made which will increase reliability. 5. We have perused the records and considered the rival contentions carefully. The dispute raised in this appeal is regarding transfer pricing adjustment made by the Assessing Officer in relation to international transaction entered into by the assessee with the associated enterprise, i.e., the parent company in the US. In view of the provisions of section 92C, the income arising 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e due to acquisition. We also note from the monthly expenditure on ESOP cost for the relevant year that normal ESOP cost fluctuated between nil cost in January 2007 to the maximum of Rs. 6.1 crores in December 2006. We further note that total ESOP cost in the immediate preceding year was only Rs. 10.25 crores and only because of exceptional item this year, ESOP cost had gone up to Rs. 70.25 crores. There cannot be any dispute that comparison 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the Assessing Officer. 5.3. The next issue on which dispute has arisen is selection of comparables and method of computation of margin in their cases. The assessee in terms of transfer pricing study conducted by it selected eleven comparables which were engaged in similar line of business, providing services primarily to the US or European markets, having sufficient public financial and business information and excluding 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 comparabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Reliance has been placed on several decisions of the Tribunal as mentioned earlier in which turnover filter has been applied 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5.3.4. We now take up the arguments advanced on behalf of the assessee that extreme profit and loss cases should be 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 âEUR" 42.94 per cent. on turnover of Rs. 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. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , which do not require high fixed assets. In these cases employees are the main assets, who in the case 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, therefo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tly related to turnover. We, therefore, reject the argument advanced by learned senior counsel 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iving any cogent and convincing reasons. 5.3.9. Reverting back to the new comparables 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 Rs. 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 fie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apital does have an impact on the profitability of the company and 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 comp ..... X X X X Extracts X X X X X X X X Extracts X X X X
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