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TMI Blog2013 (6) TMI 746X X X X Extracts X X X X X X X X Extracts X X X X ..... arm's length margin/price using only financial year 2005-06 data which was not available to the Appellant at the time of complying with the Transfer Pricing document requirements. Further, the TPO has erred in using single year data pertaining to financial year 2005-06 as against multiple year data used by the Appellant. 4. The TPO/AO has erred in law and on facts, in applying certain filters and not undertaking an objective comparative analysis for selection of comparable companies. In arriving at the arm's length price of the international transactions entered by the Appellant with its associated enterprises, the TPO and the AO have erred in rejecting certain comparables identified by the Appellant on the following factors * Related party transaction greater than 15% of operating revenues (as against the related party filter of 25% used by the Appellant); * Functional dissimilarity; * Consistent loss making companies; and * Diminishing revenues. 5. The TPO/AO has erred in law and on facts, in adding two comparables in ascertaining arm's length price, on the basis of the transfer pricing assessment of assessment year 2005-06. 6. The TPO/AO has erred by not making approp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hrough its development Centre in Hyderabad which is registered under the Software Technology Parks (STPI) scheme of Government of India as a 100% Export Oriented Unit (EOU). The Development Centre, Hyderabad is engaged in the carrying out design, development and testing for enhancement and improvement of Qualcomm existing products and development of new products. The Development Centre at Hyderabad is engaged in providing software services to its AEs. b) Mumbai & New Delhi Units; the assessee renders business support services to its associated enterprises through these units i.e. Mumabi & New Delhi. c) Bangalore Unit; pursuant to the merger of Qualcomm Bangalore Design Centre Private Limited and Spike Technologies India Private Limited with the assessee w.e.f 1st April, 2005, the assessee also has a STPI Unit in Bangalore. It is engaged inn providing software services to its AEs. The Bangalore Unit is involved in the Design & Development of CDMA chipsets using advanced technology and processors in accomplishing these tasks. 5. During the relevant period, the assessee had international transactions with its AEs, namely Qualcomm Global Trading Inc & Qualcomm Incorporated. These in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bles for the software services with weighted average operating profit/operating cost of 12.06%. The A.O referred the matter u/s 92CA (1) of the Act to the Transfer Pricing Officer (TPO) for determination of ALP of the international transactions entered by the assessee with its AEs. 8. The Ld. TPO examined the transfer pricing study submitted by the assessee. However, he did not concur with the analysis undertaken by the assessee. The Ld. TPO was of the view that in determining arms length price of international transaction of the assessee, the financial information of comparable companies pertaining to the current financial year 2005-06 should be used, since it is contemporacious as in accordance with the requirements under Rule 10B(4) of the Rules. The Ld. TPO also rejected certain comparable companies identified by the assessee on the following factors: i) Functional dissimilarities. ii) Related party transaction greater than 15% of operating revenues. iii) Consistent loss making companies, & (iv) On account of diminishing revenues. 9. The Ld. TPO also identified new comparables for determining ALP. In the light of fresh economic analysis and identifying certain comparable co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ars data only. 15. In the light of the order of the Ld. DRP, the AO then passed final order by making addition of Rs. 13,19,23,215/- on account of ALP in respect of transactions of software development segment entered into by the assessee with its associate enterprise. This action of the authorities below has been questioned by the assessee on the above grounds of its appeal before the Tribunal. 16. In support of the grounds, the Ld. A.R submitted that the compatibility analysis undertaken by the assessee was based on well accepted TP principle and in absence of any information to the contrary, it was inappropriate to reject the comparability analysis which was undertaken by the assessee in accordance with the provisions of the Act read with Rules. He submitted that as per Circular No- 14 of 2001 of the CBDT read with Section 92C (3), the primary onus is on the tax payer to determine ALP in accordance with Rules and to substantiate the sale with the prescribed documentation. Where such onus is discharged by the assessee and the data used for determining the Arms Length Price is reliable and correct, there can be no intervention by the Assessing Officer. In support, he placed reli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anies were there and they were having diminishing revenues. 19. We thus proceed to decide whether comparables selected by the assessee vis a vis the TPO are proper and justified to benchmark the international transactions entered into by the assessee with its AEs during the relevant period. In this case, the assessee initially selected a set of 36 comparables in its TP study reports. However, before us, it was submitted by the assessee that 20 comparables out of 36 comparables were rightly excluded for consideration. IT was submitted that it was accepted by both the assessee and the TPO that 20 comparables identified by both the parties are not to be considered to benchmark the international transactions in question. This leaves 16 comparables for consideration. Out of remaining 16 comparables selected by the assessee, the TPO has accepted 10 comparables and rejected the balance 6 comparables on one reason or the other. The Ld. AR has submitted that the TPO was not justified in rejecting the following 6 comparables :- A. Melstar Information Technology Ltd. (Melstar) B. Akshay Software Ltd. (Akshay Software) C. Aztec Software Pvt. Ltd. (Aztec) D. KPIT Cummins invoke systems ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ional dissimilarity. 24. The contention of the Ld. A.R remained that the Ld. T.P.O has rejected the company on the basis of functional dissimilarity without providing any opportunity of being heard to the assessee. He submitted that the Akshay Software is also engaged in Software services with miniscule revenue from sale of products. He referred Page No. 90 of the paper book volume 2 i.e. profit and loss account of the company in support. The Ld. A.R submitted that Akshay Software is functionally comparable to the assessee and has to be considered as comparable. He pointed out that Ld. T.P.O himself in the assessment year 2007-08 has accepted Akshay Software as comparable in the light of identical functions. 25. The Ld. D.R on the other hand tried to justify the action of the Ld. T.P.O in rejecting Akshay Software as comparable. He submitted that the company is functionally different to the assessee. It is engaged in SAP and remote infrastructure management (RIM) software applications while the assessee is into design work on embedded software, DSP and integrated circuit hardware design and systems. 26. On perusal of the order of the Ld. T.P.O, we find that the Ld. T.P.O has rej ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted that as the provisions of Section 92A (2) (a) are from the TP Chapter itself, a limit of 25% may be considered more reasonable to be applied on the threshold for the related party transactions. The threshold of 25% is also recognized statistically as being a threshold for removal of extreme in the calculations of statistically disbursal. It was submitted that interquartile range (IQR) is a widely employed statistical tool that incorporates the distance between the first and 3rd quartiles IQR is not affected by outliers or extreme values and incorporations 25% as the breakeven point. It was submitted that even as per OEC guidelines, it is accentuated that large number of similar entities should be taken to make comparison broad based. Accordingly, companies having related party transactions in access of 25% have been rejected as being comparable. The Ld. AR submitted that the decision of the Tribunal in the case of Soni India (P) Ltd (Supra) is not helpful to the revenue in the present case since ruling of the Tribunal are fact specific, hence cannot be applied to the case of the assessee. The term "significant" may vary from company to company and from industry to industry espe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7-08 by the Ld. T.P.O. We thus find that RPT ratio is not excessive so as to reject the Aztec Software as comparable on this account. We, therefore, accept Aztec Software as comparable to determine ALP in the assessee's case in the year. The A.O/TPO is accordingly directed to accept Aztec Software as comparable for determination of ALP in the case of the assessee for the year. 30. So far as KPIT is concerned, the Ld. TPO has rejected it as comparable for the reason that it has related party transactions more than 15% in view of the decision of the Tribunal in the case of Soni India(P) Ltd. (Supra). During the course of hearing, it was admitted by the Ld. Counsel for the assessee that RPT are more than 15% but he has submitted that the threshold limit of 25% is more reasonable to be applied for the related party transactions. He submitted further that decision of the Tribunal in the case of Soni India (P) Ltd. cannot be applied as there the issue has not been discussed in detail keeping in view the various angles/factors in the said decision. We find that it is not in dispute that threshold limit of 15% for RPT has been considered to be reasonable as per Co-ordinate Bench of the Tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lity of the comparable as the negative net worth is on account of brought forward losses of earlier years, which are not relevant for the purpose of comparison. The adoption of negative net worth criteria for rejection of functionally comparable companies is not acceptable as it would be unjust and uncalled for. Based on the provisions of the Income Tax Rule 1962, comparables for the Provision of Software services would have to be companies which provide same or similar services as the assessee and are comparable in terms of functions performed risk assumed and assets utilized. Hence for the purpose of determining the comparables, the assessee had considered functions performed, risk assumed and assets utlized for the international transaction and has not and cannot be considered the debit balance of profit and loss account which is on account of brought forward losses of earlier years as a criteria for rejection. He submitted further that the company having more than 99% of the total revenue from comparable activity of software development services. The Ld. DR on the contrary reiterated the observations made by the Ld. TPO about the company. We find substance in the above content ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... F.Ys 2003-04 & 2004-05 the company had limited export earnings from software development activity, which is evident from the annual report of the company made available at page no. 97 of the paper book-ii. On the other hand 100% of the assessee's revenue is earned from exporting income. Since there is a complete difference in the selling segment of both the companies, the degree of risk (e.g "foreign exchange gain/loss)" and function performed by both the companies would also be different, submitted the Ld. A.R. The Ld. DR however tried to justify the order of the Ld. TPO. 35. On perusal of Annual report for the year of the company we prima facie find substance in the contention of the Ld. A.R that based on the aforesaid reasons Asian CERC cannot be considered as comparable for F.Y 2005-06. We are thus of the view that a fresh consideration on the comparability of this company is also required to be made after verification of the above submission of the Ld. AR and after haring the assessee in this regard. 36. In view of the above findings on the said comparables selected by the parties, we direct the Ld. A.O/T.P.O to rework the ALP of the asessee after affording opportunity of be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions" and therefore bear "entrepreneurial risks". He submitted that it is an established theory that rewards follow risks and therefore companies that bear entrepreneurial risks" are rewarded with more profits for the additional risks borne by them. In this regard he referred page no. 145 to 148 of the paper book volume I for summary of the key risks identified by the assessee which are borne by the comparables companies vis-a-vis the assessee who is insulated from these risks. He submitted further that the assessee bears lesser business risk than independent comparable companies due to the nature of its revenue model. It is guaranteed profits by way of a mark-up on costs incurred regardless of its success or failure. The assessee has been providing services to its AE over the years and has been growing year on year and making profits, irrespective of the performance of IT industry in India. He submitted that while the assesee does not bear any risk of incurring losses due to under utilization of capacity or insufficient business from its AEs as it is compensated on cost basis, the independent companies have to bear the vagaries of the economic and business factors that are prevail ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Pvt. Ltd vs. ITO (2009) 118 ITD 243 (Pune) 4. Sony India (P) Ltd. vs. DCIT (2008) 114 ITD 448 (Delhi) 5. Schefenacker Motherson Limited vs. ITO (2009) 123 TTJ 509 (Delhi) 40. Ld. DR on the other hand tried to justify the orders of the authorities below on the issues of making of suitable adjustment to account for difference in the risk profile and for making of appropriate adjustment to account for differences in working capital employed by the assessee vis-a-vis the comparables companies for software development services. He submitted that the Ld. TPO has denied these claimed adjustment by the assessee after discussing these issues in detail. The Ld. DR submitted that interest as operating cost has been considered or not, is not clear. He contended that initially no such claims on account of risk and working capital adjustments were made by the assessee before the Ld. TPO. He submitted further that the decisions relied upon are having distinguishable facts are not helpful to the assessee on the issues. 41. Considering the above submissions we concur with the submission of the Ld. DR that the issue raised in ground No. 6 & 7 on account of working capital adjustment and risk ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rnational transaction shall be the data relating to the financial year in which the international transaction has been entered into, provided that data relating to a period not being not more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of the transfer prices in relation to the transactions being compared. He submitted further that the fresh Government note dated 22.8.2001 provides that the tax payers have been allowed the use of multiple year data pertaining to comparable transactions in determining the arms length price. Rule 10B (4) provides that transfer pricing documentation should, as far as possible, be contemporaneous and should exist latest by the due date for filing of income tax return i.e. 3.10.2006 for the financial year 2005-06. Thus it is obvious that all the companies do not publish the financial results by the due date and hence the use of financial data only for the financial year 2005-06 is practically not possible. Ld. AR accordingly tried to justify the use of multiple year and contemporaneous data available by the prescribed date to be allowed. 44. Ld. DR on th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... spect thereof as may be prescribed. Rule 10D(1) of the Rules, requires maintenance of a record of the analysis performed to evaluate comparability as well as a record of the analysis performed to evaluate comparability as well as a record of the actual working carried out for determining the ALP. Rule 10D(4) of the Rules , requires that the information and documentation to be maintained under Rule 10D(4) should be contemporaneous as far as possible and should exist latest by the due date of filing of the income-tax return. The Ld. DR submitted that the requirement of existence of information and documentation by the due date of filing of return does not override the provisions of Rule 10B(4) of the Rules regarding mandatory use of current financial year data for conducting comparability analysis. He submitted that Rule 10D(4) of the Rules suggests regarding mandatory use of current year financial year data for conducting comparability analysis. He submitted that Rule 10D (4) only speaks of documentation to be maintained by the taxpayer and mandates that such documentation should be ready latest by the prescribed date of filing of return of income. If such documentation is not maint ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with assistance of some data tried to indicate the impact on the margin of the comparable companies considering various combinations of the comparable companies. 48. Considering the above submission we find that the provisions of Rule 10B (4) are unambiguous and mandatory particularly in view of the use of word 'shall' and not 'may'. Rule 10B(4) prescribes that the data tobe maintained by the taxpayer should be contemporaneous and should exist latest by the specified date. The Rule 10D (4) is thus not directly on the issue of data to be used in comparability analysis. Even if a broader view is taken and both the Rules are read together it would simply mean that the current year's data (as per Rule 10(4) as existing by the specified date (Rule 10D(4) should be used. The provisions of Rule 10D (4) are applicable to the taxpayers regarding maintenance of the documents. The rule does not in any way restrict the powers of the TPO to determine ALP as per the information and documents available with him at the time of TP proceedings. Thus as per Rule 10D (4), the data pertaining to the financial year in which the international transactions are entered into by the taxpayers alone should ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and 92C(2) of the Act. The Ld. AR also referred relevant extract from explanatory memorandum of Finance Bill 2002 and classification made in notes on clauses - Income Tax (Finance Bill 2002). He also referred CBDT circular No. 12(1) dated 23.8.2001 and placed reliance on the following decisions :- UE Trade Corporation (India) (P) Ltd. vs. ACIT, ITAT Nos. 4405 and 4406/D/2009 Sony India (P) Ltd. v. DCIT (2008) 114 ITD 448 (Delhi) SAP Labs India v. ACIT (2010) TII-44-ITAT-BANG Cummins India Ltd. vs. DCIT & ors. ITA Nos. 277/Pune/07 & Others (Asstt. years 2003-04 and 2004-05) order dated 28.2.2011 Toshiba India Pvt. Ltd. (2010) TII-14-ITAT-Delhi. 50. The Ld. AR also cited recent decision of Delhi Bench of the Tribunal in the case of UE Trade Corporation (India) (P) Ltd. vs. ACIT (Supra) holding that the proviso to section 92 C(2) of the Act is a substantive provision and would be applicable retrospectively only if it is specifically mentioned by the Legislature. In the Finance (No. 2) of the Act 2009, the amendment has been made applicable from 1.10.2009 and hence the new proviso is applicable from assessment year 2010-11 onwards only and not for the earlier years. He place ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ision rule of confidence intervals used in the statistical inference. There is no scope for any "standard deduction under this Rule . In other words, if the ALP falls outside the tolerance band TP adjustment would have to be made for the difference between the LP determined by the AO based on the arithmetical mean of prices and the price shown by the assesee. Ld. DR placed reliance on the following decisions :- DCIT vs. Global Vantedge Pvt. Ltd. 2010 -TIOL-24-ITAT-Delhi] Marubeni India Pvt. Ltd., vs. ACIT, ITA 809/D/2009 dated 18.3.2011. 53. Ld. DR submitted further that to avoid any controversy the proviso to section 92C was proposed tobe amended by the Finance (2) Bill 2009. After the amendment the TPO/AO has to take the arithmetic mean in cases where more than one price is determined by the most appropriate method. There is no question of making any other adjustment to this unless the case of the assesee falls in the second proviso. 54. The Ld. DR opposed the submission of the assesee that the amendment to the proviso of section 92 C will be applicable with prospective effect, as in para 37.5 of the CBDT circular No.05/2010 dated 3.6.2010 it has been made clear that the ame ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Mumbai Tribunal ITO vs Zydus Altana Healthcare PVt. Ltd. (2010-TII-29-ITAT-MUM-TP) * Tecnimount ICB Pune Tribunal * ACIT v. MSS India Pvt. Ltd. (123 TTJ 657)(32 SOT 132) * Cummins India Limited v. DCIT (ITA 148/PN/07) 56. The issue raised in ground No. 8 is now fully covered by the decision of the Special Bench of the Tribunal in the case of IHG IT Services (India) Pvt. Ltd. vs. ITO (2013) 23 ITR (Trib) 608 (Del) (SB). In this case after discussing the history of section 92C(2) of I.T. Act as well as amendments made therein time to time and the decisions of Pune Bench in the case of Piagio Vehicles P. Ltd. vs. DCIT (2012) 53 SOT 253 (Pune) and Delhi Bench in the case of Asstt. CIT vs. UE Trade Corporation (India) P. Ltd. (2011) 9ITR (Trib) 400 (Del) the Special Bench has come to the conclusion, summarized as under :- "Before the amendment of section 92C(2) of the Income-tax Act, 1961, by the Finance (No.2) Act, 2009, with effect from October 1, 2009, the assessee had an option to claim the benefit of 5 per cent. tolerance margin while deter-mining the arm's length price. However, after the amendment by the Finance (No.2) Act, 2009 such benefit of 5 per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... led to deduction under the new section 10A for the un-expired tax held period of 10 years. He pointed out referring to substituted section 10A that the proviso clearly refers to "income not included in computation of total income" while the amended section 10A, refers to a "deduction". Therefore, this indicate the conscious shift by the Legislature to provide for a "deduction" in the place of the erstwhile "exemption" of profits. The intention of Legislature was to specifically change the wording and to consciously use the term "deduction" . Therefore this indicate the conscious shift by the legislature to provide for a "deduction" in the place of "exemption" of profits. The intention of the legislature was to specifically change the wording and to consciously use the term "deduction" throughout the amended section 10A. Hence in order to compute the benefit available under the provisions of section 10A of the Act, profits from the STP unit are required to be added to total income and then allowed as a deduction. As a corollary losses from the STP unit would also enter the computation of the total income and could be set-off against the profits of other businesses contended the Ld. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the assesee claimed set off of carry forward business losses amounting to Rs. 4,54,30,632/- pertaining to assessment year 1998-99 against the profits of the assessment year under consideration. The AO disallowed the set off on the ground that no documentary evidence of brought forward losses and its allowability were furnished during the course of assessment. Ground No. 9 61. Having gone through the decisions relied upon by the parties we find that facts of the case of the assessee are distinguishable from the facts of the case before the Special Bench. The assessee has incurred losses in its STPL unit in the asstt. year 2006-07 under consideration and hence the question of claiming deduction u/s 10A of the Act while computing "total income of eligible undertaking" does not arise, whereas in the case of Scientific Atlanta India Technology (P) Ltd. vs. ACIT (supra) before the Special Bench the assesee had suffered loss in non eligible unit and had claimed setting off those losses against the profits of the eligible unit while determining deduction u/s 10A of the Act. The special bench held that loss from non eligible unit can not be set off against the profit of the eligible unit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 000 Less: Deduction under section 10A Nil NA Nil Taxable income after deduction under section 10A Nil INR 10,00,000 INR 10,00,000 Less: Set off of loss of Unit A as per section 70 of the Act (i.e. intra head adjustment) Nil INR (3,00,000) INR (3,00,000) Taxable income/(loss) after adjustment of losses as per section 70 of the Act Nil INR 7,00,000 INR 7,00,000 63. We find that the facts of the case Navin Bharat Industries Ltd. vs. DCIT (Supra) before third member bench of the Tribunal relied upon by Ld. AR are almost similar to the facts of the case of the assessee. In that case also the assessee had claimed set off of loss in a section 10A undertaking against profits of other units. Such adjustment of loss was disallowed by the AO on the basis that profits of the unit being not taxable, loss could not be set off against other income. The Tribunal held that loss incurred in a unit entitled to benefit of section 10A can be set off against profits of other units and set off is not barred by the provisions of section 10A (4) (ii) and 14A. Similarly the Bangalore Bench of the Tribunal in the case of Mindtree vs. ACIT (supra) has held what is allowed u/s 10B as amended w ..... X X X X Extracts X X X X X X X X Extracts X X X X
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