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TMI Blog2015 (5) TMI 352X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as incomparable. It implies that the TPO though treated this company as comparable, but, erroneously omitted to include it in the final set of comparables. Goldstone Technologies Ltd. is not comparable with the assessee company and has been rightly excluded by the authorities below as company is also engaged in providing services comprising on-site and offshore operations. Apart from that, it added two more new divisions during the current year, being, Media Division and IPTB Division. By no standard this company on entity level can be considered as comparable with the assessee company. In so far as the export filter applied by the TPO for rejecting this company is concerned, we find that it fails on geographical factors. VJIL Consulting Ltd., Think e-global Services Ltd., and RS Software (India) Ltd. - There is no mention of the assessee’s objections about these three companies in the direction given by the DRP. As such, we find that the assessee did urge the inclusion of these three companies in the list of comparables before the TPO as well as the DRP, but, both of them chose not to comment on their comparability. Under such circumstances, we direct the AO/TPO to deter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of fixed assets, in the facts and circumstances of the instant case, is tax neutral. As such, we order for the deletion of addition made by disallowing or reducing the amount of depreciation on the assets purchased from AE. This ground is allowed. - Decided in favour of assessee. - ITA No.1453/Del/2014 - - - Dated:- 24-4-2015 - Shri R.S. Syal And Shri C.M. Garg JJ. For the Appellant : Shri Himanshu S. Sinha, Advocate Shri Md. Fahad Khalid, CA For the Respondent : Shri Judy James, Standing Counsel ORDER Per R.S. Syal, AM: This appeal by the assessee arises out of the final order passed by the AO on 30.01.2014 u/s 143(3) read with section 144C(13) of the Income-tax Act, 1961 (hereinafter also called the Act ) in relation to the assessment year 2009-10. 2. Certain grounds raised in this appeal were either not pressed or stated to be general not requiring any specific adjudication. Such grounds stand dismissed. 3. The first issue argued by the ld. AR is against addition on account of transfer pricing adjustment of ₹ 15,43,32,633/- in respect of international transaction of Provision of contract R D services. 4. Briefly stated, the facts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mine the ALP accordingly. Following the directions given by the DRP, the TPO passed order on 29.1.2014 and re-determined the ALP of this international transaction at ₹ 1,50,72,87,442/-, which led to the addition on account of transfer pricing adjustment to the tune of ₹ 15.43 crore. The assessee is aggrieved against the making of this addition. 6. We have heard the rival submissions and perused the relevant material on record. It can be seen from the orders of the authorities below that the assessee s adoption of TNMM as the most appropriate method with the PLI of OP/TC have not been disturbed. The assessee is aggrieved on two scores on this international transaction, viz., firstly, against the inclusion/exclusion of certain companies in/from the final list of comparables and secondly, not allowing the risk adjustment. 7. First, we are espousing the inclusion/exclusion of certain companies. Before embarking on the exercise of making comparison of the companies presently assailed by the assessee, it is significant to first consider the functional profile of the assessee under this segment. It can be seen from the TPO s order that he has stated the assessee to be pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he sole property of Ciena, USA absolutely. From the above clauses of the Agreement, it is manifest that the assessee is simply a captive unit providing software development services to its AE without acquiring or retaining any intellectual property rights in the work done by it for and on behalf of its foreign AE, for which it is compensated with actual costs incurred plus 13% mark up. Total operating revenue of the assessee from this segment stands at ₹ 135.29 crore with the operating costs at ₹ 119.73 crore, giving profit before interest and tax at ₹ 15.56 crore with profit ratio of 13%. With above understanding of the nature of services provided by the assessee to its AEs under this segment, we will take up the disputed companies, one by one, for consideration as to their comparability. Infosys Technologies Ltd. 8.1. The TPO noticed that this company was finding place in the accept/reject matrix but was rejected in the TP documentation by claiming that it failed functional area comparability. The TPO found this company to be into software development services qualifying all the filters applied by him. The assessee raised certain objections against the in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ional dissimilarity and its fluctuating profit margins. The TPO rejected the assessee s contention about the super normal profits earned by this company during the year and also held the same to be functionally similar inasmuch as it having only one identifiable reporting segment, i.e., software development services. The assessee is upset with the inclusion of this company in the final list of comparables. 9.2. After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company, a copy of which is available on pages 951 onwards of the paper book, that it has only one segment, namely, software development. It is engaged in providing open and end-to-end web solutions, off-shoring data management, design and development of solutions. When we consider the nature of services provided by the assessee under this segment, namely, software development, there remains no doubt that functionally Bodhtree Consulting Ltd. is a comparable entity. 9.3. As regards the fluctuating profit margins of this company over the years, we find from the extractions made in the TPO s order that the ratio of profit before income-tax to sales ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amount of ₹ 60 is not considered as expenditure for that year, but is taken to the Balance sheet as closing work-in-progress, which becomes opening stock for the subsequent year and the income is finally computed from such project/contract in the next year on the raising of bill of ₹ 100/- after allowing deduction for the expenses incurred in the earlier year at ₹ 60 and the further expenses incurred in the year of raising of the bill. In this way, the profit for the earlier year of incurring expenses of ₹ 60 and the next year of raising invoice of ₹ 100 gives true and fair view of the profitability of that enterprise for both the years. If this enterprise, instead of capitalizing ₹ 60 in the first year, claims deduction in the year of incurring itself but recognizes income of ₹ 100 in the next year, then profit of both the years, namely, the first and the second, will not give a fair view. 9.6. Coming back to the facts of the instant case, we find from Schedule 12 that there is a mention of Significant accounting policy at Sl. no.3, which provides that : Revenue from software development is recognized based on software development and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot represent fair profitability on year to year basis, this company loses its tag of an effective comparable. We, therefore, order for the exclusion of this company from the final list of comparables. Tutis Technologies Ltd. 10.1. The assessee included this company in the list of comparables, which the TPO excluded. 10.2. Having heard the rival submissions and perused the relevant material on record, we get from the show cause notice issued by the TPO dated 19.12.2012, a copy of which is available from page 221 onwards of the paper book, that whereas the TPO gave adverse remarks against other comparables, but mentioned against this company that : This is a suitable comparable. The assessee replied to this show cause notice on 28.12.2012, a copy of which is available on pages 232 onwards of the paper book. Apart from assailing the objections taken up by the TPO on other comparables, the assessee submitted that this company was accepted by the TPO as comparable. However, the TPO inadvertently omitted to include it in the final set. There is no discussion either in the TPO s order or the direction given by the DRP as to why this company was being considered as incomparable. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bove that the TPO rejected 15 companies from the assessee s list of comparables and added two new companies by carrying out fresh search during the course of proceedings before him. When this position was confronted, the assessee also came out with the above three new companies fulfilling the filters applied by the TPO. The assessee requested the TPO to consider these companies also as comparable, which is evident from page 251 of the paper book, being reply dated 28.12.2012 of the assessee to show cause notice issued by the TPO. The TPO did not at all comment on the inclusion or otherwise of these three companies in his order. The assessee objected to the noninclusion of these three companies before the DRP as well. There is no mention of the assessee s objections about these three companies in the direction given by the DRP. As such, we find that the assessee did urge the inclusion of these three companies in the list of comparables before the TPO as well as the DRP, but, both of them chose not to comment on their comparability. Under such circumstances, we direct the AO/TPO to determine the comparability or otherwise of the above three companies and then take steps for including ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the AE with an appropriate mark-up in comparison with the full-fledged risk bearing comparable companies. We are not agreeable with such a generalized and bald statement made on behalf of the assessee. The mere fact of the assessee being a captive unit rendering software development services to its AE alone, cannot make it a no-risk entity. Several risks are attached to such entities dealing with a single customer. If single customer, on whom the enterprise s entire survival depends, closes down its business, the possibility of realization of debts for the services already rendered, becomes a potential risk. Further, the fear of termination of agreement between such an enterprise and the single customer or the possibility of closure of business by such customer, voluntarily or due to reasons beyond his control, also pose a grave threat to the existence of such an enterprise. In that sense of the matter, an enterprise serving a single customer, assumes marked risks. As the assessee is wholly dependent on its AE for securing business, its entire existence also depends on the same AE. If such AE runs out of business or its business is reduced, the assessee is bound to bear severe jol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .43 crore, against the transacted value of ₹ 33.50 crore. Thereafter, rectification application was filed u/s 154 of the Act which was disposed of by the AO vide his order dated 27.03.2014 reducing the income with `Cost of old fixed assets by ₹ 12.20 crore and adding depreciation of ₹ 3.72 crore. Another rectification application was filed, which was also disposed of by the AO vide his order dated 26.9.2014, reducing the total income to ₹ 25.48 crore from ₹ 40.74 crore. The assessee is aggrieved against the addition made on account of this international transaction. 15.2. We have heard the rival submissions and perused the relevant material on record. It is noticed that the assessee purchased certain fixed assets from its AE with the declared value of ₹ 33.50 crore. In our considered opinion the assessee rightly reported Purchase of fixed assets with the transacted value as an international transaction, since the same is covered within the definition given in sub-section (1) of section 92B, which provides that international transaction means a transaction between two or more associated enterprises, either or both of whom are non-residents, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect the total income of the assessee. It is only the offITA shoot of such transaction in the capital field, being depreciation allowance on such ALP of the transaction, which affects the total income. To illustrate, if a fixed asset is purchased by an enterprise from its AE for a sum of ₹ 100 and rate of depreciation on such asset is 10%, then the enterprise will charge depreciation amounting to ₹ 10 in its Profit and Loss account. If the ALP of such transaction is determined at ₹ 80, then the difference of ₹ 20 cannot be considered as income. Rather, the amount of depreciation will be restricted to ₹ 8 instead of ₹ 10, thereby increasing the total income by ₹ 2. When we advert to the facts of the extant case, it is found that the TPO has rightly held to the effect that it is the amount of depreciation on the purchase of such fixed assets, which will be considered for making addition and not the difference between the transacted value and the ALP determined at Nil. 15.5. Ordinarily an international transaction of purchase of fixed assets by an assessee engaged in a manufacturing or trading business is required to be determined on CUP met ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eration of ₹ 11.30. If the amount of depreciation is reduced to Nil, the amount of income to that extent will also be Nil, because the mark-up can be applied only if there is depreciation cost to the assessee. In other words, the transactions of depreciation on one hand and the resultant revenue on the other, go hand in hand. In such a case, where the income is directly based on the costs incurred including depreciation, then these two transactions become closely linked transactions, eligible for processing under the TP provisions on a combined basis. It is illogical to compute the ALP of the transaction of purchase of fixed assets and consequently reduce or nullify the amount of depreciation allowance de hors the consideration of international transaction of the revenue from AE, which is equal to depreciation as claimed with mark-up. Both the transactions of claim of depreciation allowance and revenue of depreciation with mark-up have to be seen jointly. The TPO in the present case has simply reduced the amount of deprecation allowance to Nil without simultaneously considering the revenue side of this transaction. If we consider these closely linked transactions of deducti ..... X X X X Extracts X X X X X X X X Extracts X X X X
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