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TMI Blog2015 (12) TMI 1410X X X X Extracts X X X X X X X X Extracts X X X X ..... ach project execution. However, the TPO had not considered the role of the GDO. In the present case, the TPO mentioned that the shifts in the assessee’s case started from 2005 onwards, however, the assessee chose to change the method in the financial year under consideration, the explanation of the assessee was that though the transition process started from September 2005 which was very gradual and led to the complete shift in the functional matrix of Infogain Group over a period of 2-3 years, therefore, the pricing model was changed w.e.f April 2007, the said explanation appears to be a plausible. In the instant case, the assessee assigned weights to each activity keeping in view the relative importance in the entire value chain, based on interviews with the key management personnel and the functions in the value chain of software services provided by the Infogain Group to the customers based in the US were identified and weights were assigned to the functions having regard to their relative importance in the value chain, which is evident from page nos. 229 to 234 of the assessee’s paper book wherein the functions are clearly designed in a tabular form. In the present case, both ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Assessee : Sh. Salil Kapoor, Sanat Kapoor, Vikas Jain, Advs. and Sh. Rajan Sachdev, CA For The Revenue : Sh. Rahul Garg, Sr. DR ORDER PER N.K. SAINI, A.M. This is an appeal by the assessee against the order dated 01.10.2012 of the AO. 2. Following grounds have been raised in this appeal: The addition amounting to ₹ 145,259,630/- undertaken by the Deputy Commissioner of Income Tax, Circle 11(1), New Delhi ("the Ld. AO") vide Assessment Order dated October 01, 2012 (received by the Appellant on October 12, 2012) passed under section 143 (3) read with section 154 of the Income Tax Act, 1961 (received by the Appellant on November 01, 2012) is not in accordance with the law and therefore not sustainable. Transfer Pricing ("TP") Adjustment: ₹ 145,259,630 That the Hon'ble Dispute Resolution Panel, New Delhi ("the DRP") has erred both in law and on facts by summarily rejecting the Appellant's objections to the draft order passed by the Ld. AO under section 143(3) read with section 144C(1) of the Act. The Hon'ble DRP while issuing directions under section 144C(5) of the Act did not consider the facts and merits of Appellant's objections to the proposed adjustments, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... based on his own conjectures and surmises. Specifically, the Ld. TPO erred by using an approach that had an inherent upward bias and employed erroneous filters, that were designed to select only high margin comparable companies. Accordingly, the fresh search conducted by the Ld. TPO is liable to be quashed. 1.7. The Ld. TPO erred on the facts and circumstances of the case and in law by misconstruing Rule 10B (1) of the Income Tax Rules, 1962 ("Rule") and its applicability on the facts and circumstances of the case. In this context the Ld. TPO has erred in disregarding independent legal status accorded to an overseas branch of an Indian company in view of the provision of clause (iii) of Section 92F of the Income Tax Act, 1961 ("Act"). 1.8. The Ld. TPO erred in the facts and circumstances of the case and in law by using data called pursuant to issuance of notice under Section 133(6) of the Act which was not available to the Assessee at the time of maintenance of Transfer Pricing Documentation. Further, the Ld. TPO also erred by not providing the complete information which was called pursuant to issuance of notice under Section 133(6) of the Act and by conducting the assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... same do not justify the addition made. 2.6. That the addition / disallowance made are illegal, unjust and bad in law and are based on mere surmises and conjunctures and the same cannot be justified by any material on record. 3. From the above grounds it would be clear that only grievance of the assessee in this appeal relates to the addition amounting to ₹ 14,52,89,630/- made by the AO on account of transfer pricing adjustment. 4. Facts of the case in brief are that the assessee was engaged in the business of software development and filed the return of income on 30.03.2010 declaring income of ₹ 1,41,28,871/- which was processed u/s 143(1) of the IT Act, 1961 (hereinafter referred to as the Act). Later on the case was selected for scrutiny. 5. During the course of assessment proceedings it came to the notice of the AO that the assessee had international transactions for which the assessee had filed form no. 3 CEB as per the provisions of Section 92E of the Act relating to international Transactions in access of ₹ 5 crores. The AO as per the provisions of Sec. 92CA(3) referred the matter to the Transfer Pricing Officer (TPO) who proposed an addition of ₹ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... spires that the assessee has provided software development services to its overseas AE. The TP report in its executive summary has also stated that Infogain India provides software services to Infogain US which in turn provides these services to the end customers. However, we are also given the pre migration and post migration flow charts by which we understand that pre migration the contractual arrangement for services was made by the US AE with the customer which further made a contractual arrangement for development with Infogain India. Infogain India, after developing the same delivered it to Infogain US who in turn provided it to the end customer. Post Migration, flow chart shows that there is no shift as far as the contract with end customer and AE and further sub contract to Infogain India is concerned, there is no marked shift. However, the delivery models have been different. Infogain US develops onshore in addition to sales and marketing services and Infogain India after the development process is over delivers directly to clients. The flow charts are only representative of functions and not funds. We however see that the assessee has, by virtue of this diagram carri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... would be evaluated by unrelated enterprises performing comparable functions in similar circumstances. We have nowhere in the submissions, or during the course of discussion seen that the assessee has made any attempt by evaluating the contribution made by Infogain India and Infogain US on the basis of FAR of each one of them and have reliably employed any external market data which may be indicative of how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances. The moot issue here is to reasonably and reliably identify a basic return appropriate for the type of international transaction in which the parties at test are engaged, with reference to market returns achieved for similar types of transactions by independent enterprises. In none of the methods employed for determination of ALP, the issue of comparability is dispensed with. The foremost requirement of determination of ALP is to identify a comparable transaction. In the case of Profit Split Method, the way that has to be done is also mentioned. We do not find that the assessee has demonstrated this comparability anywhere. The TP Report is subjective and comple ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... use it is not suitable. The DRP also directed to exclude rental and corresponding rental expenses to work out the margin in the case of Softsol Limited. As regards to the objection of the assessee with reference to forex and provision for bad debts, the DRP directed the TPO as under: "These are an accounting issue and depend on the facts of the case and whether they are materially impacting the results of the taxpayer and should be accordingly considered for comparables. Provision for doubtful debts is not a normal operating expenses/income hence has been rightly excluded. Issues of forex is to be examined by TPO if it is not materially affecting assessee should not be taken for comparables either." 11. As regards to the objection of the assessee for considering the multiple year data instead of single year data while working out the Arm's Length Price, the DRP observed as under: "This issue has been examined in detail in TPO's order. Briefly summarized, the arguments put forth by TPO are based on the law as it exists. Persuasive value of OECD guidelines have also been considered and the relevant case laws. The TPO has articulated the relationship between Rule 10B(4) and 10D(4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urth since the conversion year. It was further stated that Infogain India assists Infogain US, to a limited extent, in client identification and marketing functions and in respect of international regions (regions other than US and UK), Infogain India is engaged in performing client identifications, marketing and client relationship management functions. It was further stated that the Ingfogain Group provides software services to its clients/customers by adopting any of the following delivery models: 1. Offshore Service Delivery Model; 2. Dual Shore Service Delivery Model. 14. It was stated that Infogain India adopted Profit Split Method (PSM) as the most appropriate method for the financial year 2007-08 relevant to the assessment year under consideration, in view of the fact that it transitioned from a back end software services company of its AE to being fully responsible for the execution and delivery of software services to the end customers. It was submitted that under the offshore service delivery model, the entire project is developed and managed offsite (i.e. in India) by Infogain India while an employee of the AE acts as the onsite coordinators for managing client exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ; Formulating the sales strategy for such regions; and • Account management of clients in such regions. In the software services rendered by the Infogain Group, customer relationship management is a critical function which is performed by Infogain US. In October 2007, for expansion into non-United States regions, another SBU i.e. International was created in India and a General Manager was appointed. This was done in order to reduce Infogain Group's dependence on United States which was experiencing a slow done. This led to a marketing department being instituted in India. The marketing department was responsible to perform marketing and selling activities to target customers/clients in regions where Infogain US/Infogain UK are not operating. Infogain India also performs the marketing fuctions which include the following activities: • Infogain India receives markeing leads through its website, which is operated, maintained and updated from India. Leads in relation to regions where its AEs operate are forwarded to respective AEs, while those from rest of the world are handled and harnessed by Infogain India; • Infogain India also engages in outreach campaign ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tments, create the technology strategy roadmaps, evaluate and promote tools, technology for internal usage; - Launching of the knowledge management portal and head the steering committee; - Assist the development teams in architecture design, frameworks and evaluate current architecture of specific projects, execute gap analysis and suggest improvement, develop new framework based solutions, such as, performance and scalability framework for marine terminal systems, develop, formalize, packaging and adoption of best practices, such as, assessment offerings, managed services offerings; and - Implement center of excellence laboratories in each verticals, publish technology white-papers, review technical design in bids/proposals, etc. The following table depicts the split in the functional responsibilities of Infogain and its AEs: Table 5: Functional Responsibilities of Infogain and its AEs Functions Performed Entity Identifying Clients /Maintaining client relationship/Client contracts Function • Identification of clients •Contract formulation, negotiation, commitment Infogain US/Infogain India (to limited extent) • Lead Generation, Soliciting ord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s deal is taken by the CSO (Sales) and CEO based out of United States. It was emphasized that during the preceding assessment year 2007-08 no joint discussion with Infogain India was held in relation to price decision but the same was changed in the assessment year under consideration, in view of shift in functional matrix. 16. The ld. Counsel for the assessee explained that the Profit Split Method (PSM) is normally used in multiple international transactions, which are so closely interrelated that they cannot be evaluated separately for determining the Arm's length price or in situations involving transfer of unique intangibles. The ld. Counsel for the assessee further explained that based on the functions, asset and risk analysis ("FAR analysis"), as detailed in Chapter 3 of the documentation, it was determined that Infogain India is responsible for the significant delivery functions while Infogain US is responsible for the marketing, client identification and customer relationship management functions. It was pointed out that the functional analysis revealed that the activities performed by Infogain India and Infogain US are inextricably linkage and collaborative functions perf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is most appropriate method. It was pointed out that in the assessment year 2011-12 also the Profit Split Method has been accepted while framing the assessment u/s 92CA(3) of the Act vide order dated 16.12.2014 (copy of the said order was furnished, which is placed on record). It was stated that the assessee's case is also covered by the decision of the ITAT Delhi Bench 'I', New Delhi in the case of Global One India Pvt. Ltd. Vs ACIT in ITA No. 5571/Del/2011 for the assessment year 2007-08 order dated 15.04.2014. It was further stated that the said order was also followed in the case of M/s Orange Business Services India Networks Pvt. Ltd. Vs DCIT in ITA No. 1201/Del/2015 for the assessment year 2010-11 order dated 08.05.2015. The ld. Counsel for the assessee stated that the assessee's case falls in category 1 mentioned in Circular No. 6/2013 dated 29.06.2013 issued by the Income Tax Department. Therefore, the TNMM method adopted by the TPO/AO was not the correct method and the PSM adopted by the assessee was the most appropriate method. The reliance was placed on the decision of the ITAT Delhi Bench 'G', New Delhi in the case of ITO, Ward 7(1), New Delhi Vs Net Freight (India) P. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... DRP raised any objection. It was further stated that in the succeeding assessment year 2009-10, no such adjustment has been made by the department, even when the facts in the said year were similar as were involved in the year under consideration. It was submitted that even on the principle of consistency, the department ought to have accepted the PSM method adopted by the assessee. Reliance was placed on the following case laws: * CIT Vs Neo Poly Pack (P) Ltd. (2000) 245 ITR 492 (Del) * RADHASOAMI SATSANG Vs CIT (1992) 193 ITR 321 (SC) * Azitech Software and Technology Ltd. Vs ACIT 107 ITD 147 20. We have considered the submissions of both the parties and carefully gone through the material available on the record. In the present case, the controversy revolves around the most appropriate method, the claim of the assessee is that the Profit Split Method (PSM) is the most appropriate method while the AO is of the view that the TNMM is the most appropriate method, while working out the Arm's length value in respect of international transactions between Infogain India i.e. assessee and Infogain US i.e. parent company. Rule 10B(1)(d) of the Income Tax Rules, 1962, defines the P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... separately for determining the Arm's Length Price of anyone transaction. The Profit Split Method (PSM) first identifies the profit to be split for the associated enterprise from the controlled transactions in which the AEs are engaged. It then splits these profits between the AEs on an economically valid basis that approximates the division of the profit that would have been anticipated and reflected in an agreement, transaction or a residual profit intended to represent the profit that cannot readily be assigned to one of the parties. The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable standard market data. The functional analysis is an analysis of the functions performed (taking into account assets used and risk assumed) by each enterprise. 22. Before us there are two methods for consideration i.e. PSM and TNMM. A perusal of the function of the assessee company reveals that the international transactions are highly integrated and interrelated. The ITAT Special Bench in the case of Aztech Software and Technology Ltd. Vs ACIT reported at 107 ITD 147 discussed the various methods of determination of ALP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at approximates the divisions of profits that would have been anticipated and reflected in an agreement transactions or a residual profit intended to represent the profit that cannot readily be assigned to one of the parties, such as the profit arising from high value, sometimes unique, intangibles. 183. The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable external market data. The functional analysis is an analysis of the functions performed (taking into account assets used and risks assumed) by each enterprise. The external market criteria may include, for example, profit split percentages or returns observed among independent enterprises with comparable functions." 17.4. The OECD transfer pricing guideline for multinational enterprises and tax administration in Chapter 2 on transfer pricing methods, at page 93, para C.1 states as follows: "C.1 In general 2.108 The transactional profit split method seeks to eliminate the effect on profits of special conditions made or imposed in a controlled transaction (or in controlled transactions that are appropriate to aggregate under the principles of par ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e residual profit over which independent enterprises would bargain. In the second stage, the residual analysis therefore could divide this pool of profit based on an analysis of any factors relevant to the associated enterprises that would indicate how independent enterprises might have split the difference between the seller's minimum price and the buyer's maximum price. 2.123 In some cases an analysis could be performed, perhaps as part of a residual profit split or as a method of splitting profits in its own right, by taking into account the discounted cash flow to the parties to the controlled transactions over the anticipated life of the business. One of the situation in which this may be an effective method could be where a start-up is involved, cash flow projections were carried out as part of assessing the viability of the project, and capital investment and sales could be estimated with a reasonable degree of certainty. However, the reliability of such an approach will depend on the use of an appropriate discount rate, which should be based on market benchmarks. In this regard, it should be noted that industry wide risk premiums used to calculate the discount do not dis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... second step analysis returns to often unique intangible assets based not on comparables but on relative value which is, in many cases, a practical solution. Secondly, potential conflict with the tax authorities is reduced by using the tow step residual approach since it reduces the amount of profit that is to be split in the potentially more controversial second step. 6.3.17.3. In step 1 of the residual analysis, a basic return for the manufacturing function is determined for Company A and Company B. Specially a benchmarking analysis is performed to search for comparable independent manufactures which do not own valuable intangible property. The residual profit, which is the combined profits of company A and company B after deducting the basis (arm's length ) return for the manufacturing function, is then divided between Company A and Company B. This allocation is based on relative R & D expense which are assumed to be a reliable key to measure the relative value of each company's intangible property. Subsequently, the net profits of Company A and Company B are calculated in order to work back to a transfer price." 17.8. In "Practical Guide to U.S. Transfer Pricing by Robert T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 1.482- 1(d) (3)". 18. We now consider TNMM. In Aztek Software and Technology Services (supra) the TNMM is stated as follows: "Transactional Net Margin Method (TNMM) : Rule 10(B)(1)(e) describes TNMM as under: (i) The net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) The net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii)The net profit margin referred to in sub clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv)The net profit margin realized by the enterprise and referred to in sub clause (i) is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9 - 3.12). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net profit indicator of the tax payer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9-3.12) should ideally be established by reference to the net profit indicator that the same tax payer earns in comparable uncontrolled transactions, i.e. by reference to "internal comparables" (see paragraphs 3.27- 3.35). A functional analysis of the controlled and uncontrolled transactions is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results. Further, the other requirements for comparability, and in particular those of paragraphs 2.69-2.75, must be applied. 2.59. A transactional net margin method is u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed party manufacturer or the related party distributor. The choice of the tested party depends on the availability of comparable data. This usually implies that the TNMM is applied to the least complex of the related parties involved in the controlled transaction, because generally more comparable data will then be in existence and fewer adjustments will be required to account for differences in functions and risks between the controlled and uncontrolled transactions. In addition, the tested party should not own valuable intangible property. This, by the way, is also the reason why it is recommended to select the least complex entity for the application of the cost plus method or resale price method." 23. Now by keeping in view the findings given by the Coordinate Bench in the aforesaid referred to case of Global One India P. Ltd. Vs ACIT, 12(1) in ITA Nos. 5571/Del/2011 and 5896/Del/2012 order dated 15.04.2014. In the present case, we have to see as to whether the PSM is the appropriate method as adopted by the assessee or TNMM method as adopted by the AO. In the present case, the different activities performed by the Infogain India i.e. assessee and Infogain US are inextricably ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herefore, we are of the view that the conclusion of the TPO that the PSM is adopted by the assessee only to camouflage loss at the net level is merely an allegation and hence devoid of merit. In the present case, the assessee adopted Profit Split Method, for application of the said method, the provisions are contained in Rule 10B(1)(d) of the Income Tax Rules, 1962. According to the said provisions the Profit Split Method is applicable mainly in international transactions which are so interrelated that they cannot be evaluated separately, for the purpose of determining the arms' length price. The combined net profit is then split amongst the enterprises in proportion to relative contribution as evaluated on the basis of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which indicated how such contribution would be evaluated by unrelated enterprise performing comparable functions in similar circumstances. In the present case, Infogain India i.e the assessee is responsible for the significant delivery functions while Infogain US is responsible for the marketing client identification and c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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