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TMI Blog2007 (7) TMI 50X X X X Extracts X X X X X X X X Extracts X X X X ..... g Officer under section 92C(3) read with section 92CA(1), is it a condition precedent that the Assessing Officer shall provide an opportunity of being heard to the assessee ? 3. Is the approval granted by the Commissioner of Income-tax under section 92CA(1) justiciable ? If so, can it be called in question in appeal on the ground that it was accorded without due diligence or application of mind ? 4. What is the legal effect of Instruction No. 3 of 2003 issued by the Central Board of Direct Taxes on transfer pricing proceedings ?" 2 At the suggestion of learned counsel for the intervener and with the mutual consent of the parties, the aforesaid questions were permitted to be modified and certain additional questions were also allowed to be raised. Hence, the revised questions to be adjudicated by the present Bench are these "1. Whether it is a legal requirement under the provisions contained in Chapter X of the Income-tax Act, 1961 that the Assessing Officer should prima facie demonstrate that there is tax avoidance before invoking the relevant provisions ? 2. Whether it is a legal requirement under the provisions contained in Chapter X of the Income-tax Act, 1961 that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing regulations have been aptly put in Circular Nos. 121 and 142 of the Central Board of Direct Taxes, issued after enactment of regulations ([2001]252 ITR (St.) 65, 104) "The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country's tax base." 4 Accordingly, legislative changes through the Finance Acts, 2001 and 2002 were made. It was provided in section 92(1) that income arising from international transactions between associated enterprises shall be computed having regard to the arm's length price. In other words, results under contractual obligation of parties, notwithstanding, the authorities will examine whether there is scope to make adjustments, by fixing arm's length price in respect of goods, services, etc., provi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de Adjustment towards onsite services Adjustment towards marketing services Total Rs. 9,06,93,275 9,11,23,568 18,18,16,843 6 On receipt of the order of the TPO, an opportunity in terms of section 92CA(4) was granted to the assessee vide letter dated March 23, 2005. It response to the same, the representative of the assessee attended the office of the Assessing Officer and made the same objections which were raised before the TPO. Apart from the said objections, it was also submitted by the assessee that the order of the TPO was erroneous for two reasons, namely, (i) the TPO was required to determine the ALP only and could not make adjustment; and (ii) the order lacks jurisdiction since the Commissioner's approval had not been obtained before referring the computation of the ALP to the TPO. The Assessing Officer was not convinced with the objections filed by the assessee. The Assessing Officer also observed that the permission of the Commissioner had already been obtained before making a reference to the TPO and the same was on record. According to him, there is no provision in the Act for furnishing the copy of the approval ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CA have not been followed. (f) The order of the TPO passed under section 92CA is not binding on the Assessing Officer and the Assessing Officer has to independently verify and convince himself of the legality of the order before any action is taken. 8 The reference to the TPO under section 92CA of the Act was further a challenged on following grounds vide letter dated July 25, 2005 (1) The reasons for making a reference under section 92CA of the Income-tax Act, 1961, has not been furnished till date, in spite of specific request for the same. This non-furnishing of the reasons militates against the decision of the Supreme Court in GKN Driveshafts ( India ) Ltd. v. ITO [2003] 259 ITR 19 and renders the assessment invalid. (2) A reference purportedly under section 92CA is incorrect. The assessment year involved is 2002-03 and the relevant previous year is from April 1, 2001, to March 31, 2002, whereas the provisions of section 92CA was brought into the Income-tax Act by the Finance Act of 2002 with effect from June 1, 2002. Section 42 of the Finance Act, 2002 specifically mentions that section 92CA has been inserted with effect from June 1, 2002. Reading of sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansactions has made the issue of transfer pricing a matter of serious concern. I had set up an Expert Group in November, 1999 to examine the issues relating to transfer pricing. Their report has been received, proposing a detailed structure for transfer pricing legislation. Necessary legislative changes are being made in the Finance Bill based on these recommendations." (c) The following portion of the Notes on Clauses to the Finance Bill, 2001 also shows the said intent of the Legislature ([2001] 248 ITR (St.) 1,133) : "The new section further provides that where during the course of any proceeding for the assessment of income the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that the price charged in the international transaction has not been determined in accordance with sub-sections (1) and (2) or information and documents relating to the international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D, and the rules made in this behalf or the information or data used in computation of the arm's length price is not reliable o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... country's tax base. The new section 92 is, therefore, not intended to be applied in cases where the adoption of the arm's length price, determined under the regulations would result in a decrease in the overall tax incidence in India in respect of the parties involved in the inter national transaction." "Under the new provisions the primary onus is on the taxpayer to determine an arm's length price in accordance with the rules, and to substantiate the same with the prescribed documentation. Where such onus is discharged by the assessee and the data used for determining the arm's length price is reliable and correct there can be no intervention by the Assessing Officer. This is made clear by sub-section (3) of section 92C which provides that the Assessing Officer may intervene only if he is, on the basis of material or information or document in his possession, of the opinion that the price charged in the international transaction has not been determined in accordance with sub-sections (1) and (2) or information and documents relating to the international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub section (1) o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... existed before enactment of Chapter X. This section takes care of any excessive or unreasonable payment or expenditure having regard to the fair market value of goods or services or facilities for which payment is made to a related party. According to him, this provision can be invoked in general situation while similar provisions qua international transactions contained in Chapter X of the Act are special provisions. Both the provisions intend to curb the avoidance of tax through payment to related parties. Being special provisions, the provisions of Chapter X can be invoked only under the specific circumstances, i.e., avoidance of tax through specific transfer pricing mechanism qua international transactions with associate enterprises. In view of the above discussion, it was held by him that provisions of Chapter X of the Act could not be invoked by the Assessing Officer unless it is shown that there is avoidance of tax by the assessee through the transfer pricing mechanism. 13 Secondly, it was held by him that before embarking on any determination of the ALP, the Assessing authority has to pass through the process as prescribed under clauses (a) to (d) of sub-section (3) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... chanism as prescribed under section 92C(3) that redetermination of the ALP is called for secondly, he has to satisfy that reference to the TPO is unavoidable and essential. 17 Sixthly, it was held that approval of the Commissioner of Income-tax should also not be in mechanical manner. He should also satisfy himself that provisions of section 92C/92CA are fully satisfied. Prior approval is not a mere formality. It involves application of mind by the Commissioner of Income-tax to find out whether the Assessing Officer has complied with the relevant provisions or not. Therefore, the courts can interfere in appropriate cases. Reliance was placed on various cases U. P. Financial Corporation v. Joint CIT [2006] 280 ITR 100 (All). Yum Restaurants India P. Ltd. v. CIT [2005] 278 ITR 401 (Delhi); Central Warehousing Corporation v. Secretary, Department of Revenue [2005] 277 ITR 452 (Delhi) West Bengal State Co-operative Bank Ltd. v. Joint CIT [2004] 267 ITR 345 (Cal) Peerless General Finance and Investment Co. Ltd. v. Deputy CIT [1999] 236 ITR 671 (Cal) 18 It was also held that previous approval of higher authority is an internal matter of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tional transaction with an associate enterprises, that factual information can be gathered by the Assessing Officer from the report in Form No. 3CEB. 21 However, according to the Commissioner of Income-tax (Appeals), the Board was incorrect in stating (1) that the. Assessing Officer can arrive at the prima facie belief merely on the basis of these details and (2) that a reference to the TPO can be made merely on the basis of limited and primary details contained in report in Form No. 3CEB. After going through the said form, the Commissioner of Income-tax (Appeals) observed that only the following information can be gathered by the Assessing Officer: the nature of relationship of assessee with the associate enterprises, brief description of the business carried out by the associate enterprises, the nature of the services rendered and the payment made for such services, the method used for determining the ALP, why the method used was the most appropriate method. 22 In view of the above, he posed the question whether such information was sufficient to invoke the provisions of section 92C(3) for computing the ALP other than that declared by the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the intervener. 25 Now, we proceed to adjudicate the revised questions referred to us. The first question reads as under "1. Whether it is a legal requirement under the provisions contained in Chapter X of the Income-tax Act, 1961, that the Assessing Officer should prima facie demonstrate that there is tax avoidance before invoking the relevant provisions ?" 26 The special counsel for the Revenue Shri Seshachala has contended before us that the language employed by the Legislature either in section 92C or section 92CA or any other section in Chapter X of the Act nowhere says that the Assessing Officer is required to demonstrate the avoidance of tax before invoking the jurisdiction under section 92C/92CA of the Act. According to him, if the language of the Act is clear and unambiguous then resort cannot be made to the aids to the interpretation. Consequently, it was argued by him that the headings or marginal notes as well as the speech of the Finance Minister, Notes on Clauses or the Board's circulars cannot be considered in interpreting/construing the provisions enacted by the Legislature if the language employed by the Legislature is plain and unambiguous. Proceed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "As long as there is no ambiguity in the statutory language, resort to any interpretative process to unfold the legislative intent becomes impermissible. The supposed intention of the Legislature cannot then be appealed to to whittle down the statutory language which is otherwise unambiguous. If the intendment is not in the words, it is nowhere else. The need for interpretation arises when the words used in the statute are, on their own terms, ambivalent and do not manifest the intention of the Legislature." 29 In the case of Gurudevdatta VKSSS Maryadit v. State of Maharashtra, AIR 2001 SC 1980, their Lordships of the apex court held as under (head note) "It is a cardinal principle of interpretation of statute that the words of a statute must be understood in their natural, ordinary or popular sense and construed according to their grammatical meaning, unless such construction leads to some absurdity or unless there is some thing in the context or in the object of the statute to suggest to the contrary. The golden rule is that the words of a statute must prima facie be given their ordinary meaning. It is yet another rule of construction that when the words of the statut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sus omissus and the other in regard to reading the statute as a whole appear to be well-settled. Under the first principle a casus omissus cannot be supplied by the court except in the case of clear necessity and when reason for it is found in the four corners of the statute itself but at the same time a casus omissus should not be readily inferred and for that purpose all the parts of a statute or section must be construed together and every clause of a section should be construed with reference to the context and other clauses thereof so that the construction to be put on a particular provision makes a consistent enactment of the whole statute." 32 The above judgments made it clear beyond doubt that courts are not required to look into the object or intention of the Legislature by resorting to aids to interpretation where the language of the provision is clear and unambiguous. Consequently, the meaning of each word used by the Legislature is to be given its plain and natural meaning and no word should be ignored while interpreting a provision of a statute. 33 Let us now consider the relevant provisions contained in Chapter X of the Act relating to transfer pricing. Sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions preferred by such persons or such other relevant factors as the Board may prescribe, namely: (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub-section (1) shall be applied for determination of arm's length price, in the manner as may be prescribed Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent. of such arithmetical mean. (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that (a) the price charged or paid in an international transaction ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er the computation of the arm's length price in relation to the said international transaction under section 92C to the Transfer Pricing Officer. (2) Where a reference is made under sub-section (1), the Transfer Pricing Officer shall serve a notice on the assessee requiring him to produce or cause to be produced on a date to be specified therein, any evidence on which the assessee may rely in support of the computation made by him of the arm's length price in relation to the inter national transaction referred to in sub-section (1). (3) On the date specified in the notice under sub-section (2), or as soon thereafter as may be, after hearing such evidence as the assessee may produce, including any information or documents referred to in sub-section (3) of section 92D and after considering such evidence as the Transfer Pricing Officer may require of any specified points and after taking into account all relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the arm's length price in relation to the international transaction in accordance with sub-section (3) of section 92C and send a copy of his order to the Assessing Officer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he settled legal position mentioned by us earlier, we are not required to find the intent of the Legislature by referring to the Budget Speech of the Finance Minister, Notes on Clauses, Circulars, etc., when language of the statute is clear and unambiguous. 36 Much reliance has been placed on the heading of Chapter X of the Act. It is also the settled legal position that headings or marginal notes do not control a provision where plain and unambiguous language has been used by the Legislature. It is only when the language is ambiguous that help can be taken from the headings or marginal notes or the Finance Minister's speech or the Notes on Clauses etc. Reference can be made to the judgment of the Supreme Court in the case of Frick India Ltd. v. Union of India, AIR 1990 SC 689 wherein at page 693, it was held as under: "It is well-settled that the headings prefixed to sections or entries cannot control the plain words of the provision; they cannot also be referred to for the purpose of construing the provision when the words used in the provision are clear and unambiguous; nor can they be used to cutting down the plain meaning of the words in the provision. Only in the ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pt such contention of learned counsel for the assessee for the reasons given hereafter. Sub-section (1) of section 40A on which reliance has been placed, reads as under "40A.(1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head 'Profits and gains of business or profession'." 41 The perusal of the above provisions shows section 40A has overriding effect over the provisions relating to the computation of income under the head "Profits and gains of business or profession". That means, it has over riding effect over the provisions contained in Chapter IV-D, i.e., sections 28 to 44DA only. Hence, the provisions of section 40A(2) would not and can not override the provisions contained in Chapter X of the Act. Even otherwise, if there are different provisions over the same subject then in law the specific provisions would prevail. So, even assuming that the provisions of section 40A are attracted, these are the general provisions applicable to all transactions while the provisions of Chapter X are specific provisions relating to international tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act are satisfied in the case of any assessee, before his case is referred to the Transfer Pricing Officer under sub-section (1) of section 92CA for computation of the arm's length price ?" 46 The parties to the appeals as well as the intervener have been heard at great length. At the outset, it may be mentioned that at the suggestion of learned counsel for the assessee, Mr. Pradeep, and with the leave of the Bench, the lead arguments were made by Mr. Poddar, learned senior counsel for the intervener with reference to questions No. 2 to 7. In respect of question No. 2 mentioned above, it has been contended by Mr. Poddar, that the Assessing Officer acquires jurisdiction to redetermine or recompute the ALP if he is satisfied on the basis of material or information in his possession that the circumstances mentioned in sub-section (3) of section 92C of the Act exist. Once such jurisdiction is acquired then the Assessing Officer can refer the matter to compute the ALP to the TPO under section 92CA(1) of the Act if he forms an opinion that it is necessary or expedient to do so. According to him, such reference can only be made if he acquires the jurisdiction under section 92C(3) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ub-section (3) of section 92C exists before referring the matter to the TPO under sub section (4) of section 92CA of the Act. Learned counsel for the assessee, Mr. Pradeep, has also adopted the above reasonings. 48 On the other hand, learned special counsel for the Revenue has submitted that the provisions of both the sections are independent of and distinct from each other and there is no requirement of section 92CA that the circumstances mentioned in sub-section (3) of section 92C of the Act must exist. According to him, the only requirement of section 92CA is that, the opinion of the Assessing Officer, it is necessary or expedient to refer the matter of computation of the ALP to the TPO. Proceeding further, it submitted that the provisions of sub-section (4) of section 92C of the have been incorporated in section 92CA by virtue of the provisions of sub-section (4) of section 92CA of the Act. Had it been the intention of the Legislature as contended by learned senior counsel for the intervener, then the Legislature would have provided specifically in section 92CA of the Act. According to him, the decision of the hon'ble Supreme Court was rendered in a different context and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... No doubt, even in cases covered by section 92C(3) of the Act, the Assessing Officer may in appropriate cases consider it necessary or expedient to refer the case of the assessee to the TPO for determining the ALP but that does not mean that powers of the Assessing Officer to refer the case to the TPO is restricted to those cases which are covered by section 92C(3) of the Act. Had the Legislature contemplated to refer the case of the assessee to the TPO only in the circumstances mentioned in section 92C(3) then the Legislature would have to provide such conditions in place of words "necessary" or "expedient" in sub-section (1) of section 92CA. The requirements under both the sections are quite distinct as procedure to be followed in the sections is different. In the above sub-section 92CA(1), there is no reference to section 92C(3). Moreover, it is mandatory for the TPO to determine the arm's length price in accordance with sub-section (3) of section 92C. If the above section to be applied by the TPO under section 92CA(3) at the prescribed stage, there is no question of applying the same provision at the stage of making reference. What purpose would be served by applying the same p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CA(3). The latter part of section 92CA(3) unambiguously states that the Assessing Officer shall 'by order in writing, determine the arm's length price in relation to the international transaction in accordance with sub-section (3) of section 92C'. It will be pointless to have a duplication of this exercise at two stages one after the other." (emphasis supplied) 53 The judgment of the hon'ble Supreme Court in the case of Paharpur Cooling Towers P. Ltd. [1996] 219 ITR 618 relied upon by learned counsel for the intervener does not help the assessee for the reasons given here after. In that case, a search and seizure action was carried out at various premises of the assessee on October 27, 1976, in the course of which, a number of documents were seized. At that point of time, the assessments for the assessment years 1970-71 to 1974-75 had been completed but the assessment proceedings for the assessment year 1975-76 were pending. On June 24, 1977, the assessee approached the Settlement Commission with an application under section 245C of the Act, wherein against col. 5, the assessment year 1975-76 and any other proceedings that may be decided by the Settlement Commission was me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section cannot be read as empowering the Commission to do indirectly what cannot be done directly." So, the close reading of the judgment reveals that reopening of the assessment under section 245E is permissible only for the benefit of the Revenue and, therefore, the Settlement Commission could not reopen the assessment indirectly for the benefit of the assessee. But, in the present case, section 92C as well as section 92CA provide the procedure for determining the ALP and both the sections are independent sections as observed by us earlier. If the circumstances provided in section 92CA are satisfied, then the reference could be validly made in the absence of any prohibition contemplated by the Legislature. Accordingly, the said judgment, in our opinion, cannot be applied to the present case. 54 In view of the above discussion, we answer question No. 2 in the negative, i.e., in favour of the Revenue and against the assessee. Contrary views expressed by the learned Commissioner of Income-tax (Appeals) are, therefore, erroneous and cannot be sustained. 55 Questions Nos. 3 to 6 are being considered together since these are interrelated in connection with the interpretation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is above submissions, he drew our attention to the judgment of the hon'ble Delhi High Court in the case of Sony India P. Ltd. v. CBDT [2007] 288 ITR 52 and the judgment of the apex court in the case of Rajesh Kumar v. Deputy CIT [2006] 287 1TR 91. He drew our attention to paragraph 19 of the judgment of the hon'ble Delhi High Court to point out that the court has accepted the legal position that exercise of the discretion by the Assessing Officer must be preceded by the formation of an opinion of the Assessing Officer regarding necessity or expediency of making a reference to the TPO though such opinion need not be considered opinion. It would be sufficient if the Assessing Officer forms a prima facie opinion on the basis of material/information that it is necessary or expedient to refer the computation of the ALP to the TPO. 58 However, it was further submitted by him that the decision of the hon'ble Delhi High Court to the effect that no opportunity is required to be given to the assessee before making such reference is contrary to the later judgment of the apex court in the case of Rajesh Kumar [2006] 287 ITR 91. It was submitted by him that the apex court wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and Ajantha Industries v. CBDT [1976] 102 ITR 281, wherein it has been clearly held that where a case of the assessee is transferred from one Income-tax Officer to another Income-tax Officer, within the State or outside the State, the reasons for making the order should be recorded in writing spelling out the necessity for transfer of the case and the assessee must be afforded a reasonable opportunity of being heard and representing his views on the question even though such requirement is not laid down in the statutory provisions. Reliance is also placed on Central Board of Direct Taxes Circular No. 12 of 2001 dated August 23, 2001 ( [2001] 251 ITR (St.) 15), wherein it has been stated that implementation of the transfer pricing regulations may cause hardships to the taxpayers. Therefore, it is submitted that the principles of natural justice must be complied with. Hence, it has been finally contended that recording of reasons and providing of an opportunity to the assessee before referring the matter to the TPO are conditions precedent which must be complied with and failure of which would render such proceedings as bad in law. 59 Proceeding further, it has been submitted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 156 (Mum); and (p) Dr. Arjun D. Bharad v. ITO [2003] 259 ITR (AT) 1 (Nagpur). 61 Coming to the impact of the Central Board of Direct Taxes Instruction No. 3 dated May 20, 2003, it has been submitted that it does not and can not take away the requirement of section 92CA(1). According to him, the hon'ble Delhi High Court has only declared that the said instruction does not violate the provisions of article 14 of the Constitution of India and nothing more. Even the hon'ble court has clearly stated that the provisions of section 92CA(1) are to be complied with. It was further submitted that circulars may be binding on the income-tax authorities but is not binding on the appellate authorities like the Commissioner of Income-tax (Appeals)/Income-tax Appellate Tribunal or the higher courts. Therefore, the assessee can always challenge the action of the Assessing Officer if it contravenes the requirement of the relevant provisions. In such cases, the appellate authorities can ignore such circular and correct the mistakes committed .by the tax authorities. Reliance is placed on various decisions; Kerala Financial Corporation v. CIT [1994] 210 ITR 129 (SC), CWT v. Balbhadradas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nity by the Assessing Officer before referring the matter to the TPO, it has taken the same plea that whenever the Legislature contemplated, it has specifically provided for the same, for example, the proviso to section 92C(3) and section 92CA(3) of the Act. According to him, such requirement cannot be read into the provisions of section 92CA(1). Further, the decision of the apex court cannot be applied since no civil consequences ensue or vested right of the assessee is effected. It has been submitted by him that the assessee would not be saddled with financial burden by making reference to the TPO under sec Hon 92CA(1) unlike the direction under section 142 (2A) of the Act as the assessee can always demonstrate before the TPO that international transactions are at arm's length. Further, the expression "having regard to the nature and complexity" appearing in section 142(2A) is absent in section 92CA. According to him, there is no internal remedy against the direction under section 142(2A) while under section 92CA, the assessee can always demonstrate before the TPO that such transactions are at the arm's length. Further, the assessee has another opportunity before the Assessing Of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 07] 288 ITR 52 and, therefore, no fault can be found with the approval granted by the Commissioner of Income-tax. 66 Lastly, it has been submitted that the provisions of section 92CA are procedural and machinery provisions to facilitate the assessment of income and, therefore, would apply to the pending proceedings as held by the apex court in the case of CWT v. Sharvan Kumar Swarup and Sons [1994] 210 ITR 886. Therefore, the assessee's counsel is not correct in arguing that the provisions of section 92CA cannot be applied to international transactions effected prior to June 1, 2002. 67 Rival submissions of the parties have been considered carefully. In our opinion, there is some merit in the submissions of Mr. Poddar. It is the settled legal position that (i) the tax authorities under taxing statute are quasi-judicial authorities, (ii) the assessment proceedings under the Income-tax Act, 1961 are judicial proceedings in view of the provisions of section 136 of the Act, as held by the apex court in the case of Rajesh Kumar [2006] 287 ITR 91, (iii) the action or orders of such authorities are amenable to. judicial review. The above legal position is not disputed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... good that there should be an end to litigation". ( Mitra's Legal and Commercial Dictionary, Fourth Edition, 1985) "(1) useful for effecting a desired result ; suited to the circum stances; convenient (2) based on what is of use or advantage rather than what is right or just; guided by self-interest", etc. ( Webster's New World Dictionary, Second Indian Reprint, 1976) "Apt and suitable to end in view. Whatever is suitable and appropriate in reason for the accomplishment of a specified object." ( Black's Law Dictionary, Fifth Edition, 1979). 71 Having in mind the above meaning of the two words "necessary or expedient" and their setting and purpose of the legislation, it is clear to us that discretion is given to the Assessing Officer to refer the question of computation of the ALP to the TPO if he consider that it is suitable, appropriate, profitable or convenient to the Revenue. Two words are separated by the word "or" and not by the word "and" and, therefore, should not be read as "necessary and expedient" as done by the learned Commissioner of Income-tax (Appeals) which can lead to a different meaning. The procedure to determine the ALP in section 92CA is di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see has not understated the income or has not computed excessive loss or has not under paid the tax in any manner, serve on the assessee a notice requiring him, on a date to be specified therein, either to attend his office or to produce, or cause to be produced, any evidence on which the assessee may rely in support of the return : Provided that no notice under clause (ii) shall be served on the assessee after the expiry of twelve months from the end of the month in which the return is furnished." 73 The language and purpose of the above provision is quite similar to the section we are dealing with but nobody has to this day contended that before proceedings to issue notice under section 143(2)(ii), the Assessing Officer should record reasons or that he should hear the assessee whether notice should be issued or not. 74 Clause (ii) above authorizes the Assessing Officer to issue notice to the assessee if he considers it necessary or expedient to ensure that the assessee has not understated the income etc. etc. a purpose quite similar to purpose of section 92CA(1). The plain language of the provision does not support any of the arguments taken by learned counsel for the i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y misuse of such exercise of discretion can be corrected by way of judicial review by statutory appellate authorities and ultimately the courts. The words 'necessary and expedient' occurring in other provisions of the Act and other statutes have been interpreted judicially to admit of a strict construction permitting the power to be used only in the manner and subject to the conditions stipulated in the provision." 76 Further, in paragraph 19, it has been observed as under (page 66) : "The exercise of the discretion by the Assessing Officer is required to be preceded by the formation of an opinion by the Assessing Officer of the necessity or expediency of making such a reference." 77 Learned counsel for the assessee and Shri Poddar for the intervener has referred to several decisions in support of their contentions. But those decisions under section 147, 245 or 142(2A) have no application to the interpretation of the provisions before us. Those provisions have been held to effect civil rights of the assessee or related to matters involving final disposal of the issue and do not relate to some interim order or to a step in the process of the assessment. There it was not th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r answer to question No. 6. 81 Now, we proceed to answer question No. 6 to see the legal effect of Instruction No. 3 dated May 20, 2003, issued by the Central Board of Direct Taxes on transfer pricing. As per the above instruction, the Central Board of Direct Taxes has directed all officers of the Department where the aggregate value of international transaction and transactions exceed Rs. 5 crores, to refer the matter of determination of ALP to TPO. The relevant portion of Circular is as under ([2003] 261 JTR (St.) 51, 53) "In the initial years of implementation of these provisions and pending development of adequate database, it would be appropriate if a small number of cases are selected for scrutiny of transfer price and these are dealt with effectively. The Central Board of Direct Taxes, therefore, have decided that wherever the aggregate value of international transaction exceeds Rs. 5 crores, the case should be pricked up for scrutiny and reference under section 92CA be made to the TPO. If there are more than one transaction with an associated enterprise or there are transactions with more than one associated enterprises the aggregate value of which exceeds Rs. 5 crore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... structions. 84 In the case of Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706, their Lordships of the Supreme Court have observed as under (page 730) "Apart from sub-section (1), sub-section (2) of section 119 also enables the Central Board of Direct Taxes 'for the purpose of proper and efficient management of the work of assessment and collection of revenue, to issue appropriate orders, general or special in respect of any class of incomes or class of cases, setting forth directions or instructions (not being prejudicial to assessees) as to the guidelines, principles or procedures to be followed by other income-tax authorities in the work relating to assessment or collection of revenue or the initiation of proceedings for the imposition of penalties'. In our view, the High Court was not justified in reading the circular as not complying with the provisions of section 119. The circular falls well within the parameters of the powers exercisable by the Central Board: of Direct Taxes under section 119 of the Act." 85 Therefore, when the provisions of section 92CA(1) are read with Circular of Central Board of Direct Taxes (Instruction No. 3) dated Ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stand on this question. He drew our attention to the decision of the hon'ble Delhi High Court in the case of Sony India P. Ltd. [2007] 288 ITR 52 wherein their Lordships have held that the Assessing Officer in view of sections 92C(4) and 92CA(4) has not only to consider the report of the TPO but any other material that may be placed before him by the assessee to arrive at a different conclusion. As per their Lordships, the provision strengthen the position that report of the TPO is not binding on the Assessing Officer. 91 The stand of the respondent-assessee was that it is not binding. It is just like any other opinion given or received by the Assessing Officer. The Assessing Officer can modify and change the ALP determined in the order of the TPO. Shri Poddar, learned counsel for the intervener, on the other hand, argued that the order of the TPO was binding on the Assessing Officer. In this connection, he drew our attention to sub-section (6) of section 92CA which provides that the Assessing Officer, "after receipt of copy of amended order of the TPO shall thereafter proceed to amend the order of assessment in conformity with such order of the Transfer Pricing Officer". A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n accountant. . . nominated by the Chief Commissioner or Commissioner in this behalf. Their Lordships of the Supreme Court while holding that it is necessary to hear the assessee before directing audit of the assessee's accounts from a special auditor, took into account the expression "having regard to" in arriving at above conclusion, along with several other facts and circumstances detailed in the judgment. In the light of above decision and provisions of sub-section (6), Shri Poddar argued that the TPO's order was binding on the Assessing Officer. 94 We have given a careful thought to rival submissions of the parties. We, with respect, agree with the view taken by their Lordships of the Delhi High Court in the case of Sony India P. Ltd. [2007] 288 ITR 52, 68. Their Lordships in that case not only took into account the decision of the Supreme Court in the case of Juggilal Kamlapat Bankers v. WTO [1984] 145 ITR 485 but also the decision of the apex court in the case of CIT v. Gangadhar Banerjee and Co. P. Ltd. [1965] 57 ITR 176 wherein the apex court had accepted the reasoning and interpretation of the Privy Council of the words "having regard to" in CIT v. Willi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction (3) of section 92C cannot be treated as final and binding on the Assessing Officer. Having said so, we do not mean to suggest that order of the TPO is of no value or consequence. The words "having regard to" convey definite meaning and are strong enough to enjoin upon the Assessing Officer to pass order and adopt transfer pricing as determined by the TPO, unless there are very good grounds to modify or alter the transfer pricing ordered by the TPO. Only after recording reasons, as above, the Assessing Officer can take transfer pricing other than the one determined by the TPO. There may be cases in which the assessee after the arm's length price is deter mined by the TPO arid before his order is made the basis of assessment, may get such authentic material to show that transfer pricing determined by the TPO is not correct or should not be blindly adopted without modifying it. However, in the cases before us, the Assessing Officer adopted the orders of the TPO and computed assessments accordingly. We see no illegality in the procedure followed by the Assessing Officer and, therefore, do not approve of the contrary observations of the learned Commissioner of Income-tax (Appeals) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ance Act, 2007. Sub-section (4) of section 92CA has been substituted with the following sub-section with effect from June 1, 2007: "(4) On receipt of the order under sub-section (3), the Assessing Officer shall proceed to compute the total income of the assessee under sub-section (4) of section 92C in conformity with the arm's length price as so determined by the Transfer Pricing Officer." 101 Now, the words "having regard to" have been replaced by the words "in conformity with". So now the Assessing Officer after introduction of sub section (4) above is required to pass the assessment order in conformity with the order of the Transfer Pricing Officer determining the arm's length price. Now the order of the TPO has been expressly made binding on the Assessing Officer. From the above it is clear that there was a lacuna in the Act as appropriate language was not used earlier. This has been modified and with effect from June 1, 2007, the order of the TPO is binding on the Assessing Officer who now has no choice but to pass an order in conformity with the order of the TPO. The word "having regard to" did not convey the same meaning. For all the aforesaid reasons, we hold that pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ztec- US a sum of Rs. 28,32,20,103. The assessee debited above expenses in its profit and loss account under the general heading "software development expenses" (Schedule 12) as "onsite service charges". The payment was made by the taxpayer to Aztec, US under an agreement titled "Master Agreement" in operations since April 1, 2001, wherein the taxpayer is described as "company" and Aztec US as "service provider". The pertinent clause of the agreement is as under : " The company intends to engage the services of the service provider to provide onsite software and allied services to the company's customers in the USA, for and on behalf of the company". (Master Agreement - Page 1, Clause-5). 107 Then taxpayer issued work orders to Aztec-US for every client's project. The professionals under the employment of Aztec US performed the stipulated tasks based on the specifications given in the work orders. Sometimes the personnel from the taxpayer were also deployed to assist them. The payment to Aztec US was made on a cost + markup basis, The markup charged was 5 per cent, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with 5 per cent. markup for onsite software services in US dollar as under : Expenses in Markup Total in $ 5,648,232 5% 282,42 $ 5,930,644 114 In respect of sales commission, markup was 10 per cent. instead of 5 per cent. besides expenses reimbursed. The position is as under : Expenses Markup Total In$ 1,776,810 10% 177,681 1,954,491 115 Since the onsite revenue earned by the assessee-taxpayer was less than charges paid to associated enterprises Aztec US, the TPO required the assessee to explain the reasons for higher payments to associated enterprise for onsite services. It was explained that the taxpayer entered into contract with end customers and services of Aztec US are used for providing onsite development services to customers. The taxpayer also pointed out as follows. "Aztec US functions as a contract service provider and operates in a risk-mitigated environment. Aztec US is insulated from entrepreneurial risks. Hence, payments to Aztec US are independent of the commercial outcome of the contracts entered into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elopment under the contract include both offshore and onsite software development. (c) Offshore development was carried out by the company in India. (d) Onsite software development under the above contract of the company with its customer was sub-contracted to Aztec US. 120 Since Aztec US was insulated from most entrepreneurial risks and earned only a fixed percentage of markup for its services, the company did not maintain a one-to-one co-relation between the: (i) Charges paid to Aztec US for the onsite software development services rendered and (ii) Invoices raised on the customers for the onsite services rendered by Aztec US to them on company's behalf. 121 The taxpayer provided details of onsite services billed. There are 22 customers and billing rate varied from 55 to 210 dollars per man hour. The average rate realized worked out to 79 dollars per man hour. 122 After considering the submissions of the taxpayer, the TPO put her proposed the arm's length determination to the taxpayer for its objection vide TPO's letter dated November 2, 2004. The matter was fixed for final hearing. The proposal is summarized as under: (a) Certain companies included in worki ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere classified in the powers database, coupled with a turner criterion. Economic circumstances relevant to availing of marketing support services by the taxpayer from Aztec US in the U.S. market and scope of marketing activity conducted by the set of companies was not evaluated. The arrangement of these companies for undertaking the functions of marketing is not compared vis-a-vis of the company's arrangement in performing these functions. 126 The taxpayer further objected by stating that as per Part II Schedule VI to the Companies Act, 1956, every company was required to disclose expenditure under different heads mentioned therein. Marketing expenditure was not one of such heads. Miscellaneous expenses were required to be shown by a company under a separate head if such expenditure exceeds 1 per cent, of the revenue of company or Rs. 5,000 whichever was higher. Thus companies were not required to disclose marketing expenses under separate head and hence data used by the taxpayer was reliable. In respect of onsite software development services, it was submitted that Aztec functioned as a contract service provider and such payments were not at all comparable to the revenue recei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has procured a profit of Rs. 9,18,66,337 for Aztec-group a lion's share of which should have gone to Aztec-India. But Aztec-India suffered a loss of Rs. 2,62,94,298 from it. Thus, the conditions imposed in the controlled transaction has prevented the accrual of due profits to Aztec-India. This calls for recomputation of profits for taxation purposes as provided in article 9 of OECD Convention as well as section 92 of Income-tax Act." (emphasis supplied) 130 The Transfer Pricing Officer also rejected that cost recovered by Aztec US was the arm's length price taking into account the following circum stances (a) Aztec US in the controlled transaction had limited functions and operated in risk free environment. (b) The taxpayer Aztec-India has brought in a marketing intangible being the brand name Aztec to the transaction. The brand-name was a valuable asset and in order to support this conclusion TPO referred to the fact that Aztec-India was billing its customer at an average rate of US$ 79 per man hour for onsite services against industry average of US$ 58-65 per hour during the same period. The TPO was of the view that on account of the above factors downwards adjustments n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed concern 46 per cent, higher than arm's length rates. On the above basis the TPO determined the following amount required to be adjusted: Arm's length price of services in US Dollars Arm's length price in INR Amount paid as per books Adjustment under section 92CA USD 4,031,522 19,25,26,828 28,32,20,103 9,06,93,275 132 The TPO further justified the above adjustment by applying internal comparable. He found that the profit margin earned on offshore software development services by the taxpayer to other independent concerns was 63.74 per cent. as per the following calculations : Income from software services Software development expenses (excluding onsite charges paid to Aztec US) Profit Percentage of profit 44,58,09,936 16,16,49,904 28,41,60,032 63.74 per cent. 133 In respect of payment made by the assessee to Aztec-US as marketing agent for the TPO worked out "payable" amount at US$ 0.0076 million, but found that the assessee had actually paid 1.9 million US$ to its associated function. The TPO thus concluded that entire bills of annual salary of all non-software per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to 52.36 per cent. (1/1.91). 135 The Transfer Pricing Officer accordingly worked out the arm's length price of marketing expenses (commission) as under Length PLI Arm's length price of marketing expenses incurred by taxpayer Marketing expenses paid by the company Difference =PDIT of taxpayer/82.77 (As per Prowess database) = 1774/82.77 = Rs. 21,43,288 Rs. 9,32,66,856 Rs. 9,11,23,568 136 The TPO then considered in detail the objections raised by the assessee taxpayer against the ALP earlier put to the assessee. These have been discussed and considered in paragraphs 7 and 8 of the Transfer Pricing Officer's order. Reference has already been made to these and it is not considered advisable to repeat them here. Ultimately, the learned TPO made the following adjustments on account of ALP determined by him relating to two international transactions between the assessee and its associated concern: Adjustment towards onsite services Adjustment towards marketing services Total Rs. 9,06,93,275 Rs. 9,11,23,568 Rs. 18,18,16,843 137 During the course of the assessment p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... me-tax (Appeals), after considering the submissions and counter-submissions of the taxpayer and taking into account the comments of the TPO and the Assessing Officer, recorded his decision which can be summarised as under: "(i) On the question of reference to the TPO, the learned Commissioner of Income-tax (Appeals) held that reference to the Transfer Pricing Officer is in relation to the international transaction and hence all transactions have to be explicitly mentioned in the letter of reference. Contrary to this legal and procedural requirement, the Assessing Officer has referred the matter in a general mechanical manner along with a copy of Form No. 3CEB not only in the case of this specific appellant but also combined with similar transactions involving various other assessees. This was in contravention of the letter and spirit of the law and procedure in the matter. (ii) The learned Commissioner of Income-tax (Appeals) rejected the objection of the assessee on reference to the TPO by observing that the claim of the appellant that only the amount representing the mark up over the reimbursement could form subject matter of inter national transaction is not understandable. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... igure so arrived of per hourly rate in the case of the appellant was compared with average rate given by NASSCOM respectively for offshore and for onsite services. Since the average rate arrived by the Transfer Pricing Officer was not within the average rate given by NASSCOM the transaction was not considered at arm's length price. Therefore, the same was re-worked in line with the average rate given by NASSCOM. (v) According to the learned Commissioner of Income-tax (Appeals), what needed was, to be actually compared is the similar data of reimbursement for similar kind of situation and service rendered between two unrelated parties. First of all this would require availability of similar data and related comparisons of the relevant criteria and parameters for such reimbursement . . . a reimbursement cannot be linked and compared with the probable and possible generation of revenue which the appellant would receive. This cannot be treated as comparisons between similar nature of transactions." 139 For the above reasons, the learned Commissioner of Income-tax (Appeals) deleted the addition made on the basis of order of the TPO. 140 The grounds of appeals, against the abov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d other grounds and reasons which may be submitted during the course of hearing of this appeal, the assessee requests that the appeal be allowed as prayed and justice be rendered." 141 The grounds of appeal raised by the Revenue in the Department's appeal ITA No. 585/Bang/06 are "1. The order of the Commissioner of Income-tax (Appeals) is opposed to law and facts of the case. 2. The Commissioner of Income-tax (Appeals) erred in deleting the arm's length price determined by the Transfer Pricing Officer. 3. The Commissioner of Income-tax (Appeals) erred in holding that Instruction No. 3 of 2003 issued by the Central Board of Direct Taxes is bad in law. 4. The Commissioner of Income-tax (Appeals) erred in adjudicating the propriety and legality on the granting of approval of the Commissioner of Income-tax. 5. The learned Commissioner of Income-tax (Appeals) failed to see that the Instruction issued by the Central Board of Direct Taxes requires the Assessing Officer assessing a particular company to see if any foreign transactions are involved with its associated enterprise and in case of transactions above a certain limit, refer the same to the Transfer Pricing Officer w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der of the Com missioner of Income-tax (Appeals) may be set aside and that of the Assessing Officer restored. 13. The appellant craves leave to add/alter/amend/delete any of the grounds on or before the hearing of the appeal." 142 We consider the above grounds relating to transfer pricing hereinafter. It is submitted by the Revenue that the taxpayer has not computed the arm's length price as per audit report, but has only drawn a conclusion that transactions between the taxpayer and Aztec US cannot be said to be inconsistent with the arm's length basis as net operating profit of Aztec US is comparable with 10 selected US based companies engaged in I.T. business. The taxpayer has chosen TNMM method to justify payment for the services rendered at the arm's length price. It is further claimed that the other 4 methods are not applicable in these cases. In this connection, the definition of TNMM found in OECD's transfer pricing guidelines for multinational enterprises and the tax administrators, is brought to our notice (emphasis 1 supplied) 143 It is argued that the learned Commissioner of Income-tax (Appeals) has not commented on the arms' length price computation of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er of Income-tax (Appeals) by deleting computation made by the ITO impliedly restored computation of the assessee. 145 Elaborating on the above, the Revenue has contended that findings of the learned Commissioner of Income-tax (Appeals) were not justified, the claim that transaction was one of reimbursement, was raised for the first time before the Commissioner of Income-tax (Appeals) who wrongly accepted this in violation of the provision of rule 46A of the Income-tax Rules. Besides the claim raised was contrary to all the documents maintained by the taxpayer included the following: (i) Audit report under section 92E in Form 3CEB filed along with the return. (ii) Documents maintained under section 92D filed by the taxpayer. (iii) Taxpayer's own computation of the ALP. (iv) Invoices raised by Aztec US on Aztec India. (v) Master agreement between two associated concerns. 146 The Revenue drew our attention to the following portion of the master agreement between associated concerns dated April 1, 2001. " .the company intends to engage the services of the service provider to provide onsite software and allied services to the company's customers in the USA, for an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a narrower manner and would include number of transactions or class of transactions. Accordingly, it has been prayed that the learned Commissioner of Income-tax (Appeals) objection that reference of the Assessing Officer to the TPO by taking all the transactions together was bad in law is wrong and liable to be set aside. 150 The Revenue, on the basis of financial results available at page 67 of annual report of the assessee, has contended that overall profit in software development business was quite high, i.e., 36.69 per cent, yet as far as dealing with Aztec US was concerned, the assessee suffered loss and paid 10.24 per cent. of revenue to Aztec US out of its own pocket. It suffered loss of Rs. 2,62,94,298 on onsite software services got carried through Aztec US. On the contrary Aztec US earned profit of 41.65 per cent. from business dealing with the assessee. Working of this huge profit is claimed to be given at page 34/35 of the paper-book/written submission filed by the Revenue. It was accordingly submitted that it was a clear case of shifting and diversion of profit by the assessee to the US company. 151 The Revenue has also objected to the stand of the assessee th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess as carried by Aztec US. 154 The observation of the learned Commissioner of Income-tax (Appeals) that while estimating the figure of revenue generation on the basis of mart hours the order of the Transfer Pricing Officer did not take into consideration the man hours unutilised on account of idle time, leaves and overtime, etc., have also been challenged as untenable. 155 It is submitted that every software developer maintains a bench. But nobody raises an invoice for the unutilised or wasted man-hours. The invoices are raised only for utilised man-hours. The billing rates are charged only for those man-hours spent on client's work and accepted by the client. Just as Aztec India as the service provider cannot expect its end customers to pay for unbilled hours (man-hours not accepted by the client or wasted the bench man-hours), Aztec India cannot be expected to pa for the unbillable hours of the service provider either. The amount debited is clearly described in the profit and loss account of Aztec India (schedule 12) as onsite service charges. Hence, this cannot be treated as payment for anything other than onsite services. Therefore, the rate of payment (billing rate) c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the TPO was contrary to transfer pricing regulations. Learned counsel wanted opportunity to address oral arguments. 159 We have given careful consideration to the oral and written submission of the parties on the merits of transfer price disclosed by the taxpayer and determined by the Transfer Pricing Officer. We have also considered in detail, the order of the learned Commissioner of Income-tax (Appeals). The transfer pricing concept, no doubt, is new to Indian tax system, but for the last several decades, the tax authorities and courts have been determining "open market value" of properties of all kinds. For example, under section 23 of the Land Acquisition Act, the courts are required to determine the amount of compensation of acquired property and in the process have to find its "open market value". Under section 7(1) of the Wealth-tax Act, the value of an asset owned by the taxpayer, is provided "to be the price which, in the opinion of the Assessing Officer, it would fetch in the open market". Under section 40A(2) of the Income-tax Act, tax authorities, in case of claim of payment to a close relative or a sister concern, are empowered to substitute for such payment the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transaction shall he determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of trans - action or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: Provided that where more than one price may be determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices, or, at the option of the asses- see, a price which may vary from the arithmetical mean by an amount not exceeding five per cent. of such arithmetical mean/' 162 Section 92(2) deals with the arm's length price as follows: "Where in an international transaction, two or more associated enterprises enter into a mutual agreement or arr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and reliability of assumptions required to be made in application of a method." 165 Rule 10B(2) also lays down the criteria for judging the comparability of an international transaction with an uncontrolled transaction as follows "(2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely : (a) the specific characteristics of the property transferred or ser vices provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall econo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e purpose of benchmarking. In other words, an uncontrolled transaction selected for benchmarking should be adjusted by employing certain techniques like FAR analysis, to be selected on its peculiar factual matrix, for the purpose of enabling comparison of the same with a controlled international transaction so that the differences or variations are ironed out or minimised. The underlying principle being that only likes can be compared with like. The adjustments are suggested to achieve the object of testing and trying to see if both the parties or/and the transactions are similar or nearly similar. At times even after adjustments, the transaction/s or parties sought to be compared may not be identical or there might not be a possibility of adjustment. This is a very subjective exercise and fact based. 169 The selection of the most appropriate method (MAM) is based on the nature of transaction, the availability of relevant data and the possibility of making appropriate adjustments. 170 The various methods are now discussed hereunder: Comparable Uncontrolled Price method (CUP) : CUP is described in rule 10B(a) as follows "(a) comparable uncontrolled price method, by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on in the same way that it is used by uncontrolled taxpayers in the industry; and The amount charged in the controlled transaction is adjusted to reflect product and service variations. 174 The US regulations further warn that data from public exchanges, quotation media should not be used in extraordinary situations such as war period, economic depression, natural calamities period. We are of the considered view that the above principles are of universal application and there is no good reason why they should not be applied in transfer pricing determination in India. Resale Price Method (RPM): Under the Rules, RPM is described in rule 10B(1)(b) as under "(i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled trans action, or a number of such transactions; ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined; (iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii) (v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise." 177 This method is ordinarily used where some semi-finished goods are sold between related parties or similar situations or in respect of joint facility agreements, long- buy and supply arrangements of provisions of services, etc. 178 This is a method, which uses the costs incurred by the supplier of the property or services in a controlled transaction. Here also as in the case of RPM benchmarking of normal gross profit margins is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... engaged. It then splits those profits between the associated enterprises on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm's length. The combined profit may be the total profit from the 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. Transactional Net Margin Method (TNMM): Rule 10B(1)(e) describes TNMM as under (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ay be, is required to determine whether the transactions are comparable and the adjustments that are required to be made to obtain reliable results. The tested party would have to consider other factors, like cost of assets of comparable companies, etc., while applying the return on assets measure. Ordinarily, the tested party, has to be the party provided services because it is on the basis of rate of return on sales or cost or operating assets that transactional margin is computed. These parameters generally available in the case of a party providing services. 187 We may now refer to the proviso to section 92C(2) which specifically provides that : Where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetic mean of such prices. An option has been given to the assessee that he can take a price which may vary from the arithmetical mean by an amount not exceeding 5 per cent. of such arithmetical mean. 188 The burden is on the assessee to select the most appropriate method (MAM). This decision of selecting MAM is to be substantiated by the assessee by an appropriate documentation as well as by substantiat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the documents prescribed, we are to go to rule 10D of the Income-tax Rules, 1962. The said rule is as under "10D.(1) Every person who has entered into an international transaction shall keep and maintain the following information and documents, namely (a) a description of the ownership structure of the assessee enterprise with details of shares or other ownership interest held therein by other enterprises; (b) a profile of the multinational group of which the assessee enterprise is a part along with the name, address, legal status and country of tax residence of each of the enterprises comprised in the group with whom international transactions have been entered into by the assessee, and ownership linkages among them; (c) a broad description of the business of the assessee and the industry in which the assessee operates, and of the business of the associated enterprises with whom the assessee has transacted (d) the nature and terms (including prices) of international trans actions entered into with each associated enterprise, details of property transferred or services provided and the quantum and the value of each such transaction or class of such transaction (e) a de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 92D. The other section namely section 271G provides for levy of penalty for a failure to furnish such information when called upon to do so by departmental authorities. The purpose of providing penal consequences for not maintaining or not producing the requisite documentation emphasises legislative intention to insist upon and ensure compliance by the assessee to produce the necessary inputs. Therefore, it is not possible to argue that onus is not on the assessee. 194 Having regard to the above statutory provisions, it is clear that burden to establish that international transaction was carried at the ALP is on the taxpayer. He has also to furnish comparable transactions, apply appropriate method for determination of the ALP and justify the same by producing the relevant material and documents before the Revenue authorities. In case Revenue authorities are not satisfied with the ALP and the supporting documents/information furnished by the taxpayer, the authorities have ample power to determine the same and make suitable adjustments. In such a situation, as rightly admitted in the ground of appeal by the Revenue, this responsibility of determination of the ALP is shif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vant information has rightly been placed on the assessee. 197 It would not be out of place to mention that almost all countries world over are facing problem of diversion of income by multinational companies and other enterprises to jurisdictions where the tax burden is least or the lowest. Therefore, almost all countries have similar enactments to tackle this menace. We quote below the position of "burden of proof" in some of important countries; it being not possible and practical to note in full details of provision of all the countries. This information is being extracted from Commentaries on Transfer Pricing, 2006 published by Price Water House Burden of proof Denmark The question of burden of proof has been one of the most important issue in relation to the development of transfer pricing in Denmark. In the Texaco and BP Denmark court cases the High Court and Supreme Court confirmed that the burden of proof lies with the tax authorities and that the taxpayer is required to disclose information relevant to the question of whether the arm's length principle has been violated. This information would include items such as prices and gross profit earned by the pare ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the Malaysian tax authorities. In this connection, upon a field audit or enquiry, the relevant tax payers with related party transactions must be able to substantiate with documents, and to the tax authorities' satisfaction, that its transfer prices have been determined in accordance with the arm's length principle and that there has not been any abuse of the transfer prices resulting in an alteration of the incidence of tax in Malaysia. Netherlands As indicated previously, there is a legal obligation for the taxpayer to maintain certain transfer pricing documentation. To the extent that this requirement is not met, the burden of proof is ultimately transferred to the taxpayer. In general, there are no statutory provisions to indicate how the burden of proof is divided between the taxpayer and the tax authorities. The allocation of the burden of proof between the parties is at the discretion of the court. However, in practice and as a result of Dutch case law, if the company's revenue is adjusted upwards because of transfer pricing issues, the burden of proof usually lies with the tax authorities. On the other hand, the burden lies with the taxpayer to prove the dedu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity is to prove that the compensation for any s rendered by the taxpayer or any tangibles or intangibles transferred to a related party does not reach an arm's length level. However, if a taxpayer fails to produce the documents required by the tax authorities, this burden of proof also reverts to the taxpayer. Therefore, it is recommended that the Swiss taxpayers maintain appropriate documentation to justify all income and expenses resulting from related party transactions. This is specifically also true with regard to licence fees Charged to a Swiss entity or support and defence of low profits in connection with limited risk type entities. United States Non-US tax authorities and practitioners alike have tended to be critical of the level of detail included in the US regulations and procedures. However, in considering the US regime, it is important to bear in mind that unlike many of its major trading partners, the US corporate tax system is a self-assessment system where the burden of proof is generally placed on the taxpayer, and where there is an adversarial relationship between the Government and the taxpayer. This additional compliance burden is not unique to the field ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the purpose of the legislation and application of similar enactment world over, it must further be held that adjustments made on account of the ALP by tax authorities can be deleted in appeal only if the appellate authorities are satisfied and record a finding that the ALP submitted by the assessee is fair and reasonable. Merely by finding fault with the transfer price determined by the Revenue authorities (AO/TPO), additions on account of "adjustments" cannot be deleted. This is because the mandate of section 92(1) is that in every case of international transaction, income has to be determined having regard to the ALP. There fore, unless the ALP furnished by the taxpayer is specifically accepted, the appellate authorities on the basis of material available on record has to determine the ALP itself. Subject to the statutory provisions, the appellate authorities can direct lower Revenue authorities to carry this exercise in accordance with law. The matter cannot be left hanging in between. The ALP of the international transaction has to be determined in every case. 201 There would be cases, where taxpayer does not co-operate and fails to furnish the ALP or disclose the full info ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n arithmetical mean of such prices or price at option of the assessee within 5 per cent. variation is to be adopted (proviso to section 92C(2)). 203 In the light of the above general observations, we now proceed to consider various objections of the parties first being clubbing of international transactions for reference to the TPO. The taxpayer, before the learned Commissioner of Income-tax (Appeals), had contended that clubbing of all transactions with mere mention of aggregate value of all the transactions in reference to the TPO was wrong. A separate reference in respect of each international transaction should have been made. Likewise approval granted by the learned Commissioner of Income-tax has also been challenged as mechanical and illegal. Such an objection has also been raised in the grounds of appeal. While answering the seven questions referred to the Special Bench, we have discussed this objection relating to approval of the Commissioner of Income-tax in detail. In the light of the above discussion, we do not find any substance in the technical objections raised by the assessee and accepted by the learned Commissioner of Income-tax (Appeals) in the impugned order. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this claim. 208 We now consider the objection of the Revenue that the learned Commissioner of Income-tax (Appeals) was not justified in treating international transaction relating to "onsite software services" as reimbursement expenses and in holding that the TPO should have found comparable transaction of reimbursement for computing the ALP. It is further claimed such a claim of reimbursement is contrary to the claim made earlier and was permitted to be raised before the Commissioner of Income-tax (Appeals), for the first time. It was done in violation of rule 46A of the Income-tax Rules. It is further claimed that the principles of natural justice were not observed by the learned Commissioner of Income-tax (Appeals) and no opportunity of being heard was provided to the Department on the fresh case made by the taxpayer. 209 On facts of the case, we do not find any force in these technical objections of the Department. We do not see any material difference between the claim of the assessee raised before the Assessing Officer, the TPO or the Commissioner of Income-tax (Appeals). The stand of the taxpayer was clear that it has compensated/paid its associated enterprise, Azte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which the ALP was furnished by the taxpayer. It is contended that taxpayer did not furnish any ALP nor applied any recognised method of determination of the ALP. It claimed to have applied transitional net margin method by taking profits of 10-11 selected companies operating in U.S. and engaged in the information technology business. Average profit for the calendar years 1999-2000 and 2000-01 of the above companies was found to be 6.63 per cent. which was higher than profit of 6.59 per cent. of Aztec U.S. Accordingly it was claimed that the transactions with the taxpayer were not inconsistent with the arm's length basis. In the objection, it is claimed that only an inference, that price of the international transactions was the arm's length price, was drawn. 211 It is claimed that TNMIM method was not correctly applied by the asses- see. In support of such claim, the Revenue has brought to our notice the definition of TNMM method found in OECD Transfer Pricing Guidelines, which, according to the Department, is the simplest one. It is as under : "A transactional profit method that examines the net profit margin any relative to an appropriate base (e.g. costs, sales, assets) t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cceptance of transfer pricing by the learned Commissioner of Income-tax (Appeals) without comments. 214 The learned Departmental representative has further argued that the learned Commissioner of Income-tax (Appeals) could not have left the issue of transfer pricing of international transaction after finding fault with the arm's length price determined by the TPO. He could not delete the addition on facts of the case. As the learned Commissioner of Income-tax (Appeals) was of the opinion that similar comparable transactions of reimbursement of expenses under similar situation should have been found and then adjustments made for points of differences for nature and situations of such comparables, he should have directed the taxpayer to furnish the arm's length price on reimbursement basis supported by authentic data. The learned Commissioner of Income-tax (Appeals) could not leave the pertinent issue of fair ALP and delete additions/adjustments without considering/accepting the ALP shown by the taxpayer. As pointed out above in detail, the taxpayer did not furnish any arm's length price of international transactions. This comparison of operational profit of companies was conside ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot meet the statutory requirement. The taxpayer failed to furnish relevant data of comparable controlled or uncontrolled transactions carried on in same or similar circumstances. In fact, criticism of the learned Commissioner of Income-tax (Appeals), based on arguments taken by taxpayer, that comparable reimbursement data should have been collected was equally applicable to the assessee. It is not the taxpayer's case that relevant data of reimbursed transactions was furnished. The learned Commissioner of Income-tax (Appeals) should have applied the same standard to reject the arm's length price furnished by the taxpayer and considered the legal implication of such an act. In not adopting above approach and by making no adverse comment on the arm's length price furnished by the taxpayer, the learned Commissioner of Income-tax (Appeals) committed an error of law. The learned Commissioner of Income-tax (Appeals) also failed to consider that burden of proof to show that the international transactions were the arm's length transactions, was on the taxpayer; whether the same was discharged. Net effect of the order of the learned Commissioner of Income-tax (Appeals) is that international ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rsement cannot be linked and compared with the probable and possible generation of revenue which the appellant would receive. This cannot be treated as comparison between similar nature of transactions. After all, the reimbursement of expenditure and generation of revenue are two exactly opposite propositions. Such comparison is also not in accordance with legal conceptualisation as discussed in the earlier paragraphs. It is also not in commensuration with the prescribed method and manner to determine the arm's length price as prescribed under section 92CA(1) of the Income-tax Act and the related rules. So, basic presumption itself as adopted by the Transfer Pricing Officer cannot, logically and legally, be endorsed. 220 We are unable to subscribe to the above view of the learned Commissioner of Income-tax (Appeals) either. In our opinion, the learned Commissioner of Income-tax (Appeals) was not correct in holding that the Transfer Pricing Officer should have found comparable transaction of reimbursement for computing the arm's length price of transaction in question. In holding so and in deciding the issue in favour of the taxpayer, the learned Commissioner of Income-tax (Appe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st + markup as stated before the Transfer Pricing Officer or the case set up before the Commissioner of Income-tax (Appeals). There were international transactions subject-matter of transfer pricing and both the parties clearly understood the controversy involved before the Commissioner of Income-tax (Appeals) or the Transfer Pricing Officer. It was the same. It was not the case of reimbursement of expenditure incurred by an agent for its principal. We further find force in the argument of the Revenue that if the learned Commissioner of Income- tax (Appeals) had considered it to be the case of reimbursement, then he should have asked the assessee to furnish the arm's length price of reimbursement transaction. Such a course would have been fair to both the parties but was not adopted and the learned Commissioner of Income-tax (Appeals). He criticised the very logic of the approach of transfer pricing. We respectfully disagree and set aside the above observations. 223 The sample size of data taken by the taxpayer, to support the arm's length price, was too small to come to any general conclusion. The assessee had taken profitability figures of only ten US companies and even it wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n which is in the nature of reimbursement cannot legally be reworked into the probable generation of revenue on man hourly basis as has been done in the order of the Transfer Pricing Officer. After all, the average per hourly rate given by NASSCOM for Computer software service is not a transaction. It is an average of transactions quite different in nature and content from what has been the subject-matter in the case of the appellant. Comparables in the instant case should be reimbursements of similar nature under situations for such comparable reimbursement date between two or more similar uncontrolled transactions. An average as in the case of NASSCOM in the present context is the resultant of the sum total of different integers divided by total number of such integers. It is not understood as to how a single integer out of the all is comparable with the average of all arrived at in the above manner." 226 The Revenue has drawn our attention to rule 10B describing/defining CUP method. In particular, emphasis has been laid on clause (1) providing identification of price charged, etc., in a comparable uncontrolled transaction or a number of such transactions. It is urged that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hod determines the ALP by ascertaining the price charged in a comparable uncontrolled transaction. This is the most direct and hence the most accurate method. In case a Comparable Uncontrolled Price can be identified, CUP method is the most appropriate method". The use of resale price method was rejected on the ground that the assessee is not a reseller of goods and services. Application of "cost plus method" was found unsuitable on the ground that "data regarding gross mark up on the cost earned by the various software developers is not generally available in the public domain as the disclosure of the same is not mandatory under the Indian Company Law" and that "moreover, it is not necessary as the ALP can be computed by means of CUP, the most direct method". Coming to the "profit split method", the Assessing Officer observed that "PSM is not appropriate as the case does not involve either the transfer of unique intangibles or multiple inseparable transactions", and added that "also the PSM is most rarely used method". It was also pointed out by the Transfer Pricing Officer that "it is almost impossible to get the reliable data on the contribution made by various associated enterp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ustified. However, the Commissioner of Income-tax (Appeals) has also made some sweepingly generalised observations while deciding the issue. He proceeds to deal with the issue as to what should be the CUP variables to be taken into account for determining the arm's length price on that basis even before deciding as to whether or not CUP method should indeed be adopted for determination of arm's length price on the facts of this case. The Commissioner of Income- tax (Appeals) did not examine, on the touchstone of parameters set out in rule 10C(2), as to which method should for determining the arm's length price will be most appropriate method on the facts of this case. The nature and class of international transactions, and other relevant factors, were required to be looked into. None of these important aspects of the matter have been dealt by the Commissioner of Income-tax (Appeals) at all. That certainly is not judicious way of dealing with the issue as to what should be the correct arm's length price on the facts of this case, more so when one of the specific grounds of appeal before the Commissioner of Income-tax (Appeals) was that "The Transfer Pricing Officer/the Assessing Off ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this case. The Transfer Pricing Officer did not feel any need to find material differences between transactions even after conceding that differences do exist. On facts, we differ with the above sweeping observations. 230 Faced with the above situation, one can only wonder as to the type of uncontrolled transactions was taken into consideration; what were their characteristics ? Under what economic circumstances, these comparable were performed ? What were the material differences between comparable transactions and how much adjustments were reasonably required to be made ? If the matter is decided purely on a subjective satisfaction as done in the present case, then the appellate authorities are faced with a difficult task while examining the correctness of such action. Without details, how could taxpayer effectively object that controlled and uncontrolled transactions are not comparable ? Differences are not known and adjustments imaginary. Evaluation of transactions is the most important part of transfer pricing and the TPO. In this case failed to carry the same in accordance with law. It has vitiated determination of the ALP. The Commissioner of Income-tax (Appeals) also ad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... situations where separate transactions are so closely-linked or continuous that they cannot be evaluated on a separate basis. Such transactions should be evaluated together using the most appropriate arm's length method or methods. For example, pricing a range of closely-linked products, when it is impractical to determine pricing for each individual product or transaction." (underlined to emphasise 234 Regarding application of CUP method, OECD reports in paragraph 303 of International Transfer Pricing, 2006 published by Price Water House Coopers, proper adjustment of data has been emphasized as under: "The OECD report states that, if it can be used, the CUP method is preferable over all other methods . In practice, this method is often very difficult to apply as it is unusual for multinationals to have the details on appropriately comparable transactions. In response to this, the OECD report suggests that multinationals and tax authorities should take a more adaptable approach to the use of this method, possibly working with data prepared for CUP purposes supplemented by other appropriate methods. The extent of the OECD's support for the CUP method can be seen from t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the arm's length price to the Transfer Pricing Officer. In our view, the Transfer Pricing Officer should use his power and first call upon the taxpayer to furnish the arm's length price and all material and information which he is obliged to maintain under rule 10D of the Income-tax Rules. It would be appropriate to consider and make suitable adjustments in the arm's length price determined by the taxpayer and on the basis of information furnished by him or otherwise available with the Revenue authorities. By this, we do not mean to suggest that the Transfer Pricing Officer cannot determine the arm's length price on some method other than furnished by the taxpayer. However, as we have discussed above, any changes in the most appropriate method of computing the arm's length price is to be dealt with by way of a speaking order. The TPO is also at liberty to collect independent relevant information of. comparable uncontrolled transactions. Let the Revenue authorities determine the fresh arm's length price in the light of the above observation and in accordance with the regulations. Be that as it may, a fair and reasonable arm's length price should be determined as enjoined by the dire ..... X X X X Extracts X X X X X X X X Extracts X X X X
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