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TMI Blog2021 (12) TMI 1421X X X X Extracts X X X X X X X X Extracts X X X X ..... all be computed having regard to the arm's length price. In this appeal by the assessee, the dispute is with regard to determination of Arms' Length Price (ALP) in respect of the international transaction of rendering SWD services to the AE. 3. As far as the provision of Software Development services are concerned, the assessee filed a Transfer Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The profit level indicator (PLI) chosen for the purpose of comparison of the assessee's margin with that of the comparable companies was Operating Profit /Operating Revenue (OP/OR). The assessee selected Atmecs US as tested party and selected 7 comparable companies engaged in the same industry vertical as that of the Assessee in North America and arrived at the Summary of margins of comparable companies in North America engaged in software distribution Comparable Companies OM PLI Summary Comparable Companies OM PLI Summary Sl. No. Company Name 2016 2015 2014 2014-2016 Weighted Average 1. Tech Data Corp 1.12% 1 01% 0.92% 1.02% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsaction relating to software company by applying TNMM. In response to this notice, the taxpayer has given a detailed reply dated 11/10/2019 stating that the assessee objects to the TPOs proposed rejection of choice of foreign AE as tested party by citing various reasons supported by several case laws. 5. The TPO rejected the TP study of the assessee choosing foreign AE as tested party. According to the TPO, the OECD transfer pricing guidelines and the UN transfer pricing manual provide guidance on selection of tested party. The tested party is the party to the transaction which is least complex and for which reliable data is available without requiring significant adjustments. The taxpayer is engaged in providing information technology consultation service, software development and testing services. The assessee is an offshore resource provider helping businesses to accurately determine the technical, business and team composition, while supporting them through a variety of team project models that range from contract staffing to project-based staffing. The TPO made a examination of the relevant statutory provisions of the Act and the Income Tax Rules, 1962 (Rules) He referred to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred to in sub-clause (iii) (ii) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction. According to the TPO a cursory look at the above provisions indicates that firstly, a transaction between two or more associated enterprises is called an international transaction; secondly, any income from such an international transaction is required to be determined at ALP: thirdly, the ALP in respect of such an international transaction should be determined by one of the prescribed methods, which also includes the TNMM. The term 'enterprise' under the TNM method, and for that matter all other methods, has been used to indicate the assessee in whose hands the benchmarking of the international transaction is done and the term associated enterprise' has been used to denote the foreign/AE, being the other related party to the international transaction. As regard to the TNM method, rule 10B(1)(e)(i) provides that the net profit margin realized by the enterprise from an international transaction entered into 'with an associated enterprise is computed in relation to costs incurred or s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ght to be ensured at ALP. He therefore rejected the TP study of the assessee holding that the foreign/AE cannot be considered as a tested party for determining the ALP of the international transaction, as it has no statutory sanction. He also drew support for his conclusions as above from the decisions of ITAT Mumbai Bench of the Tribunal in Onward Technology Ltd. Vs. DCIT (2013) 36 CCH 46 (Mumbai) holding that Foreign/ Associated Enterprise cannot be a tested party. Similar view has been taken in Aurionpro Solutions Ltd. Vs. ACIT (TS-75-I TA T- 2013 (Mum)-TP) - (2013) 27 ITR (Trib) 276 (Mumbai). In the light of the foregoing discussion, the TPO rejected the foreign/Associated Enterprises as a tested parties. 6. The TPO also referred to Rule 10B 2(d) which specifies that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to condition prevailing in market in which the respective parties to the transaction operate including the geographic location and the size of the market, laws and government order in force, cost of labour and capital in the market. overall economic development and level of competition and whether the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 Kals Information Systems Pvt. Ltd. 4.33 5.77 16.94 8.73 2 Rheal Software Pvt. Ltd. 3.29 3.02 36.38 14.54 3 CG-V A K Software & Exports Ltd. 20.16 19.87 13.81 18.05 4 Inteq Software Pvt. Ltd. 7.64 32.95 45.36 20.47 5 Tata Elxsi Ltd. 26.69 20.55 13.16 20.60 6 R S Software (India) Ltd. -1.96 32.66 24.14 20.87 7 Larsen & Toubro Infotech Ltd. 21.12 24.24 23.07 22.69 8 Nihilent Ltd. 15.94 29.19 33.12 25.64 9 Cigniti Technologies Ltd. 27.27 4.99 27.59 27.34 10 Persistent Systems Ltd. 23.95 30.40 35.10 29.25 11 Infobeans Technologies Ltd 35.19 20.92 42.60 32.71 12 Aspire Systems (India) Pvt. Ltd. 33.63 30.45 37.21 33.55 13 Infosys Ltd. 38.62 41.38 36.16 38.74 14 Thirdware Solution Ltd. 30.18 42.46 48.17 39.86 15 Cybage Software Pvt. Ltd. 62.06 68.30 68.97 66.03 35th Percentile 20.87 Median 25.64 65th Percentile 33.55 * For FYs 2013-14 & FY 2014-15, if the comparable fails one of the quantitative filters or is found to be not carrying out similar functions, then margin for that year was not included." 9. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f benchmarking the transactions between the Assessee and ATMECS USA. 4. The Ld DRP/AO erred in rejecting the transfer pricing study maintained by the Assessee, thereby rejecting ATEMCS USA, our AE as tested party at the threshold. 5. The Ld DRP/AO erred in not appreciating the fact that selection of foreign AE as a tested party is in line with the OECD TP guidelines and UN TP Manual. 6. The Ld DRP/AO erred in not providing certain capacity utilization adjustments, risk adjustments and working capital adjustments in accordance with Rule 10B of the Act. 7. The Ld DRP/AO are not justified in law in considering wrong comparables and consequently arriving at a high operating profit margin of 25.64% as a ratio of OP/OC. 8. The Ld DRP/AO is not justified in law in making an adjustment u/s 92CA of Rs 5,28,04,851/- to the price received by the appellant. 9. The Ld. TPO, while including the Companies as comparables has erred in applying the appropriate filters. 10. Without prejudice to the above grounds, the Ld DRP/AO erred in selecting the below companies as comparables on the grounds of functional comparability, super profit, high turnover or other appropriate filter e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows: Determination of arm's length price under section 92C. 10B . (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) to (d)...... (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction [or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in subclause (ii) arising in comparable uncont ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. 16. Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the "TPG") contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm's length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that: * None of the diffe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 13.10.2017, took note of the decision of the ITAT Bangalore Bench in the case of Sysarris Software Pvt.Ltd. Vs. DCIT (2016) 67 Taxmann.com 243 (Bangalore-Trib) wherein the Tribunal after noticing the decision of the Hon'ble Delhi High Court in the case of Chryscapital (supra) and the decision to the contrary in the case of CIT Vs. Pentair Water India Pvt.Ltd., Tax Appeal No.18 of 2015 dated 16.9.2015 wherein it was held that high turnover is a ground to exclude a company from the list of comparable companies in determining ALP, held that there were contrary views on the issue and hence the view favourable to the Assessee laid down in the case of Pentair Water (supra) should be adopted. The following were the conclusions of the Tribunal in the case of Dell International (supra): "41. We have given a very careful consideration to the rival submissions. ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, relying on Dun and Bradstreet's analysis, held grouping of companies having turnover of Rs. 1 crore to Rs.200 crores as comparable with each other was held to be proper. The following relevant observations were brought to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... above Rs.200 crores from the list of comparable companies is held to correct and such action does not call for any interference." 19. The Tribunal in the case of Autodesk India Pvt.Ltd. Vs. DCIT (2018) 96 Taxmann.com 263 (Bangalore-Tribunal), took note of all the conflicting decision on the issue and rendered its decision and in paragraph 17.7. of the decision held as that high turnover is a ground for excluding companies as not comparable with a company that has low turnover. The following were the relevant observations: 17.7. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon'ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal shoul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... upra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon'ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon'ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra). 20. In view of the aforesaid decision, we hold that the 8 companies listed in Sl.No.(a) to (i) in paragraph -13 of this order, which the assessee seeks exclusion and whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with law. In this regard, we find that the DRP has not called for the computation of manner of risk adjustment and has merely proceeded to hold that the risk adjustment cannot be granted unless it is established that differences has a material effect on the margin of the comparable companies and computation can be made on reliable data without calling for working of risk adjustment. Such conclusions in our view cannot be sustained. 23. The next grievance of the assessee is with regard to not allowing adjustment towards capacity utilization. In this regard, it has been submitted by the learned Counsel for the assessee submitted that during the previous year, the assessee was is in its initial year of operations and has earned lower margin (2.75%) compared to established comparable companies selected by the TPO in his TP order. He submitted that due to its initial year of operation, the TPO ought to have provided additional adjustments because of the extra ordinary conditions that comparables do not face, i.e., capacity utilisation adjustment. The tested party as selected by the i.e. ATMECS India has incurred high costs in its profit and loss account as the capacity of the asset, b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "2.5.2.2 It is relevant to note that an independent enterprise outsourcing its functions in software industry would not bear any risk towards capacity unutilization and would have negotiated for the same as part of its operating cost. Further, no independent software service provider will be able to demand markup on account of creation of any excess capacity in normal course of business. It is not therefore appropriate on the part of the assessee to seek separate adjustment for capacity underutilization. We also note that there is no reference made or justification given in the TP study report for capacity utilization adjustment. The information giver as to the basis for the plea of capacity underutilization is only related to underutilisation of workforce in provision of software development services. Therefore, prima fade, we are not convinced with the assessec's plea for capacity adjustment. We reject this claim for adjustment on account of capacity underutilisation for the reason that the Rules do not provide for any adjustment in the hands of the tested party. The assessee also failed to demonstrate that these factors are unique and peculiar to the assessee's case and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O collates the same from the comparable companies by exercising his powers under section 133(6) of the Act. The Tribunal gave the following directions in this regard, viz., the TPO to exercise powers under section 133(6) of the Act to call for information on capacity utilization of the comparable companies such as -- * Installed Capacity, * Actual Production in Units, * Break-up of Fixed Cost and Variable Cost; * Segmental/ product wise information, if any. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. 27. We are of the view that it would be just and appropriate to set aside this issue to the AO/TPO by directing the assessee to furnish required details and in the event of the assessee not being in a position to get the required details, request the TPO to exercise his powers under section 133(6) of the Act and call for the required details form the comparable companies and if he finds that the capacity utilization differs between the assessee and the comparable companies, to allow appropriate adjustment as per the relevant provisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee of comparability or would require lesser adjustment. Thus, for the purpose of undertaking a rational transfer pricing comparability analysis, tested party has to be the enterprise which would be the least complex and assumes lesser risk amongst the transacting parties. (ii) separate 'India' section of the UN TP Manual which states as under: "...10.3.1.3. The regulation prescribes mandatory annual filing requirements as well as maintenance of contemporaneous documentation by the taxpayer in case international transactions between associated enterprises cross a threshold and contains stringent penalty implications in case of noncompliance. The primary onus of proving arm's length price of the transaction lies with the taxpayer. Indian transfer pricing administration prefer Indian comparables in most of the cases and also accept foreign comparables in cases where foreign associated enterprises is less or least complex entity and requisite information are available about tested party and comparables." Based on the above, he submitted that even the Indian Government's stated / declared position on the issue is that the foreign AE can be considered as the tested p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nderstanding the clients' requirements. The engineers supporting and providing the services in ATMECS India interact directly with the third-party customers, understand the requirements, modifications, alterations or any additional features required in the services delivered. Thus, ATMECS India is primarily responsible for the assessment of client requirements. * ATMECS India is responsible for the management of the off-shore projects undertaken by it. ATMECS India's software development team undertakes software coding according to the functional specifications and requirement analysis agreed with the client. Further, ATMECS India is responsible for the quality of the services rendered by it. ATMECS India undertakes the initial testing during the development process, and also on completion of the development, to ensure that the service meets the specification/ requirements of the project as agreed with the client. * ATMECS India recruits, trains and retains skilled technical professionals and is responsible for reviewing and approving the overall plan/ strategy of resource allocation/ utilization. Retaining the talent and resources is a significant driver to maintain th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erprets respective parties to transaction to mean "Assessee", is prima-facie inappropriate, and it would be rationale to consider that legislation by design, by using an open-ended phrase (i.e respective parties to the transactions), has kept the possibilities of considering both parties to transactions as tested parties alive. It was submitted that the Indian TP legislation has been consistent in using such open ended or generic phrase (i.e enterprise, respective parties to the transactions), across the relevant rules and provisions, basis which considering only party (i.e Assessee) as the relevant party would tantamount to reading something which is neither written nor intended by the legislation. The Indian TP regulation could be constructively construed to allow considering both Indian Assessee as well as overseas AE in the periphery of tested party. Even if Indian TP regulations were silent on this issue, it would be in line with common judicial position that international guidelines (such as OECD & UN TP Guidelines) could be restored to for interpreting local regulation unless they are expressly repugnant to each other. Thus, the term 'Enterprise' under TNMM and all o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see's transfer pricing documentation, global transfer pricing reports of the foreign AE at United Kingdom, Australia and German; extracts of inter-company service agreement, reconciliation of operating credits earned by the overseas subsidiaries. etc. So far as the risks assumed by the assessee, the same has been elaborately brought out in the TP documentation as could be seen from paragraph 4.03.3 under the sub heading Risks Assumed and paragraph 4.06 under the sub heading Associates Employed. This vital material has not been considered by the TPO but the assessee has been precluded from canvassing the said issue on the ground that the stand taken during the course of TP proceedings was not what was the subject matter of the TP documentation/TP study of the assessee. The question would be whether this could be the reason for rejecting the assessee's plea. This issue has been considered by the Tribunal in several decisions. 25. In Yamaha Motor (P.) Ltd., the question arose as to whether the word 'Associated Enterprise' can be given a restrictive meaning to mean the other party to whom the assesee has sold or purchased goods. It was held that under the Act and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ex entities which should be taken note of. 27. The revenue seeks to pin the assessee based upon the auditor's certification as filed in Form 3CED. As could be seen from the statutory form, it pertains only to the transactional claims and has got nothing to do with a tested party. The revenue cannot compare the case of the assessee with that of the assessee who fails to claim in his return of income a deduction or a benefit which he would be otherwise entitled to. In fact the TPO was rightly aware of his role when he has made an observation in paragraph 17.2 of the order dated 29-1-2015, wherein he would state that his office is responsible to ensure sufficiency of information/data and accordingly cannot be precluded to conduct a fresh search. However, when such is the legal position, as rightly understood by the TPO, the assessee should not have been foreclosed. Therefore, we are of the clear view that the findings rendered by the TPO, DRP and the Tribunal foreclosing the assessee's claim to refer to the foreign AEs as tested party is legally not sustainable." 34. The facts of the Assessee's case is similar to the case decided by the Hon'ble Madras High Court in as muc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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