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TMI Blog2024 (12) TMI 324X X X X Extracts X X X X X X X X Extracts X X X X ..... , essentially on three grounds. First, that the learned CIT (A) had erred in deleting the Transfer Pricing Adjustment of Rs. 4,95,51,723/- as directed by the Transfer Pricing Officer (TPO) under Section 92CA (3) of the Act. Second, in respect of the learned CIT (A)'s decision to delete an addition of Rs. 19,26,120/- on account of prior period expenses. And third, relating to allowing deduction under Section 10A of the Act in respect of the Assessee's income relating to its new undertaking. However, the learned ITAT had not found any merit in the said appeal and accordingly, dismissed the same. QUESTIONS OF LAW 3. This Court admitted the present appeal by an order dated 29.11.2011, on the following questions of law: "(1) Whether the Income Tax Appellate Tribunal was right in holding that the "second unit" is entitled to deduction under Section 10A of the Income Tax Act, 1961 and was not a part or mere extension of the "first unit"? (2) Whether the directions given by the Income Tax Appellate Tribunal for computation and exemption under Section 10A of the Income Tax Act, 1961 are in accordance with law and as per the said provisions? (3) Whether the Income Tax Appellate Tribu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vices, which were in the nature of developing and supplying customized software and related software services during the financial year (FY) 2003-2004 relevant to the AY 2004-2005. 9. The Assessee filed its return of income for the AY 2004-05 on 01.11.2004 enclosing from - disclosing the following international transactions with its AE's. "S.No. Description of transaction Method Value (in Rs.) 1. Software development services TNMM 1,53,16,98,060 2. Chargeback of expenses by AEs 3,31,30,369 3. Chargeback of expenses by AEs 4,01,580" ASSESSMENT ORDER 10. The return filed by the Assessee was selected for scrutiny. The Assessing Officer (hereafter AO) issued a notice under Section 143(2) of the Act calling upon the Assessee to furnish certain information. The Assessee also issued another notice as to why the NOIDA-II unit should not be considered as an extension of its existing STP unit. The AO also made a reference to the TPO in respect of the Assessee's international transactions for determination of the Arm's length Price (ALP). 11. During the course of the assessment proceedings, the AO found that the tax audit report furnished by the Assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies and unrelated entities. The TPO also examined the profit margins of non-STP units. A comparison of the operating margins of the controlled transactions and uncontrolled transactions indicate the profit margin of the controlled transaction was higher than the internal comparable uncontrolled transactions. However, the TPO concluded that the segmental accounts were not credible, and therefore it was not feasible to explore the possibility of using the comparable uncontrolled price method (CUP Method) using internal comparable transactions. The TPO then proceeded to determine the transfer pricing adjustment in respect of each of the STP units. The TPO found that the profit margin of the new unit (NOIDA-II unit) was 17.11% and therefore no transfer pricing adjustments were recommended in respect of the said unit. However, in respect of the other two units [NOIDA-I unit and Chennai unit], the PLI was lower and the TPO directed the transfer pricing adjustment for amounts of Rs. 2,27,05,996/- and Rs. 2,68,45,727/- in respect of the aforesaid STP units. Thus, in aggregate an addition of Rs. 4,95,51,723/- was directed to be made to the Assessee's income. 16. Accordingly, the AO passed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or things or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce such articles or things or computer software, as the case may be, shall be allowed from the total income of the assessee: *** *** *** (2) This section applies to any undertaking which fulfils all the following conditions, namely:- *** *** *** (ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence: Provided that this condition shall not apply in respect of any undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such undertakings as is referred to in section 33B, in the circumstances and within the period specified in that section; (iii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose. Explanation-The provisions of Explanation 1 and Explanation 2 to sub-section (2) of section 80-I shall apply for the purposes of clause (iii) of this sub-section as they apply for the purposes of clause (ii) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly, the AO had also noted that the period for which the benefit of Section 10A of the Act, was available to NOIDA-I unit would lapse in the year 2005 and would not be available from the following assessment year. 27. NOIDA-II unit was set up in the year 2001 and it commenced its operations in April, 2001. The income from NOIDA-II unit was a subject matter of assessment of income for the FY 2001-02 relevant to AY 2002-03. During the said period deduction under Section 10A of the Act was allowed by the AO in respect of the AY 2002-03. 28. The Assessee had also explained that in the year 1999, General Electric (GE) had acquired certain equity stake in Birlasoft. In partnership with GE, Birlasoft had prepared an aggressive business plans for its growth. The seating capacity at the Assessee's NOIDA-I unit was a constraint to meet its growth plans as the same was limited to only 300 (three hundred) seats, which was found to be insufficient for the company's growth. Accordingly, the Assessee had taken the third floor of the same building (Block-III, Sector-29, Noida) on a long-term lease from NOIDA (New Okhla Industrial Development Authority) to set up a new facility. The Assessee had t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Act in respect of NOIDA-II unit are not in dispute. It is apparent from the facts and figures as furnished by the Assessee that its gross block at the end of FY 2002 had practically doubled. The seating capacity had increased from 300 (three hundred) to 700 (seven hundred). The Assessee had also claimed that NOIDA-II unit was operated separately from the unit located at the second floor of the same building (NOIDA-I unit). 36. There is no dispute that the Assessee was carrying on the same business, however, it is not necessary that in order to be eligible for deduction under Section 10A of the Act, the new undertaking must be in a different field of business. There is no such stipulation under Section 10A of the Act 37. The Assessee's claim that the new unit (NOIDA-II unit) was independent and separate from NOIDA-I unit and its revenues for the FY 2001-02 to 2003-04 were higher than the revenue from NOIDA-I remains uncontroverted. 38. The turnover of NOIDA-I unit and the new unit (NOIDA-II unit) as mentioned in the assessment order is set out below: Previous Year NOIDA-I unit NOIDA-II unit Total 2001-2002 65,757,615 182,479,051 248,236,666 2002-2003 127,172,783 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is formed out of the existing business if the physical identity with the old unit is preserved. This has not happened here in the case of the two undertakings which are separate and distinct." 42. In Bajaj Tempo Ltd., Bombay v. CIT 1992 (196) ITR 188- a decision rendered in the context of the exclusionary clause under Section 15C of the Indian Income Tax Act, 1922 which is similar in its import as the exclusionary clauses (ii) and (iii) of sub-section (2) of Section 10A of the Act - the Supreme Court referred to the earlier decision of the Textile Machinery Corpn. Ltd. v. CIT (1977) 107 ITR 195 and explained that the emphasis of the Court was on the expression "not formed" and the same was "construed to mean that the undertaking should not be a continuation of the old but emergence of a new unit." The Supreme Court further observed that "the initial exercise, therefore should be to find out if the undertaking was a new one. Once this test is satisfied then clause (i) should be applied reasonably and liberally in keeping with the spirit of Section 15C (1) of the Act". 43. We also consider it apposite to refer to the following extract from the opinion of Masud J. of the Calcutta Hi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 15C, the subsequent undertaking must not be formed or constituted by remodelling or reconstituting the earlier business. It is significant that, apart from the head-note, the words "new business" have only been specifically mentioned in the case of transfer of building, machinery or plant used in the original business. Thus the new, separate or independent character of subsequent business is relevant but not important elements in construing the word "reconstruction". Even any enlargement or expanded unit may be called "new industrial undertaking" in the sense that the subsequent unit was not originally existing but the new undertaking must be understood in the context of the word "reconstruction". The legal meaning of the term "reconstruction" is, in my opinion, a mixed question of fact and law. It will be incorrect to say that "reconstruction" must include or exclude all kinds of expansions, irrespective of the nature constitution or character of the subsequent undertaking. All the facts relating to the original business and the subsequent undertaking, as found by the Tribunal, have to be examined before a decision is made on the question whether an assessee is entitled to get ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... struction of business already in existence only because the newly set up units manufacture and produce the same commodity, viz., aluminium ingots. The ultimate end product of the industrial undertaking is not of any material consequence in judging whether the industrial undertaking has been formed by the reconstruction of business already in existence. The stage which is relevant and has to be considered is the stage of formation of the industrial undertaking and not the stage when the industrial undertaking goes into manufacture." [Emphasis added] 45. In the present case, the fact that NOIDA-II unit was engaged in the same business is not dispositive of the question whether the said undertaking does not fulfil the criteria as specified in Clauses (ii) and (iii) of sub-section (2) of Section 10A of the Act. The Assessee had explained that it would set up the new undertaking to cater to its growth plans. It had hired a separate space from NOIDA (New Okhla Industrial Development Authority) for establishing the said unit. It had made an investment in the additional assets for setting up the said unit and resultantly not only the Assessee's gross block but also the seating capacity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n it cannot be said that the new undertaking was not the new industrial unit by itself. It was also held that establishment of new industrial unit as a part of already existing industrial establishment may result in an extension of the industry, but if the newly established unit itself is an integrated unit in which new plant and machinery are put up and the same itself independently of the old unit capable of production of goods, then it can be classified as a newly established industrial undertaking. This makes it abundantly clear that even if the new unit was established by the assessee company as expansion of its existing unit, a substantial fresh capital having been invested in the said unit and it was capable of doing business of its own independent of the old unit, the same was eligible to be treated as a newly established undertaking. In our opinion, the learned CIT (Appeals) thus was not correct in holding that both the units were liable to be treated as one unit for the purpose of computing deduction under section 10A." 47. Admittedly, the Revenue had accepted the aforesaid findings of the learned ITAT, which is evident from the fact that the Revenue had not appealed the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see from the gross total income. The somewhat discordant use of the expression "total income of the assessee" in Section 10-A has already been dealt with earlier and in the overall scenario unfolded by the provisions of Section 10-A the aforesaid discord can be reconciled by understanding the expression "total income of the assessee" in Section 10-A as "total income of the undertaking". 49. The question whether a new undertaking has been set up, which is eligible for deduction under Section 10A of the Act is, therefore, most relevant in the initial year of operation. In CIT v. Heartland Delhi Transcription Services Private Limited (2015) 228 Taxmann 326 (Del), this court had in the context of Section 10B of the Act - which includes similar exclusionary clauses - observed as under: 10. Sub-section (1) refers to deduction of profit and gains of an undertaking. The deduction is to be allowed for a period of 10 years from the year in which undertaking begins to manufacture, produce etc. articles, things or computer software. The beginning and end points for claiming the deduction are stipulated. These have reference to the eligible undertaking. Sub-clause (ii) to Section 10B (2) inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t coming to light. 51. The proceeding relating to each assessment year are separate and it is settled law that the principle of res judicata does not apply to the subsequent assessment proceedings. However, this is a fit case where it would be apposite to apply the principles enunciated by the Supreme Court in the case of Radhasoami Satsang Saomi Bagh, Agra v. CIT: (1992) 193 ITR 321 SC. In the said case, the Supreme Court had observed as under: "13. One of the contentions which the learned senior counsel for the assessee-appellant raised at the hearing was that in the absence of any change in the circumstances, the Revenue should have felt bound by the previous decisions and no attempt should have been made to reopen the question. He relied upon some authorities in support of his stand. A Full Bench of the Madras High Court considered this question in T.M.M. Sankaralinga Nadar & Bros. v. CIT [4 ITC 226 (Mad) (FB)]. After dealing with the contention the Full Bench expressed the following opinion: "The principle to be deduced from these two cases is that where the question relating to assessment does not vary with the income every year but depends on the nature of the property ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... act one way or the other and parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year. 17. On these reasonings in the absence of any material change justifying the Revenue to take a different view of the matter - and if there was no change it was in support of the assessee - we do not think the question should have been reopened and contrary to what had been decided by the Commissioner of Income Tax in the earlier proceedings, a different and contradictory stand should have been taken. We are, therefore, of the view that these appeals should be allowed and the question should be answered in the affirmative, namely, that the Tribunal was justified in holding that the income derived by the Radhasoami Satsang was entitled to exemption under Sections 11 and 12 of the Income Tax Act of 1961. 18. Counsel for the Revenue had told us that the facts of this case being very special nothing should be said in a manner which would have general application. To are inclined to accept this submission and would like to state in clear terms that the decision is confined to the fact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t appeal. The learned counsel for the Revenue has also confined the present appeal insofar as it relates to question no.3 to the said issue. 57. The learned CIT (A) had sustained the Assessee's challenge to the TP adjustment as directed by the TPO, inter alia, on the ground that there was no significant functional difference in the software development and maintenance services. The services rendered by the STP units were rendered to the same AEs of the Assessee - Birla Soft Inc. US and Birla Soft UK. The terms and conditions for rendering the services was also covered under a single agreement entered into with the AEs. There was unity of funds and management. And, the PLI's of the comparable transactions were computed at an enterprise level and not at the undertaking level. The learned ITAT accepted that the PLI was required to be computed at entity level and not at the level of the units and held that the TPO had erred in ignoring the unity of the business, administrative control and unity of funds. The learned ITAT further held that independent FAR analysis of each unit with the comparable entities was not practically possible because of the common management and interlacing of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re different rates for two related units (on account of different status, area based incentives, nature of activity, etc.) and if profit is diverted towards the unit on the lower side of tax arbitrage. For example, sale of goods or services from non-SEZ area (taxable division) to SEZ unit (non-taxable unit) at a price below the market price so that taxable division will have less profit taxable and non-taxable division will have a higher profit exemption." 59. He submitted that under Section 92 of the Act, the benchmarking was required to be done for an international transaction and it was, therefore, not permissible to bundle the international transactions that were materially different. He also referred to Rule 10B (1)(e) of the Rules and submitted that TNMM method is required to be applied on the basis of net operating margin realised by an enterprise. He submits that the word "enterprise" was not used synonymously with the term "person", which would include a company. He referred to Clause (b) of Section 92A(2) of the Act, which uses the expression "any person or enterprise" and submitted that use of the said terms together clearly indicates that the said terms - 'enterprise' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e parties were not related i.e. if the parties were independent of each other and the outcome (price or margins) was determined by (open) market forces. This is the basis of the "arm's length principle". The principle set out above in the UN Model has also been reiterated in the OECD Model Tax Convention and the OECD Transfer Pricing Guidelines as supplemented and amended. 2.4.1.3 The arm's length principle is thus the generally accepted guiding principle in establishing an appropriate transfer price under Article 9 of the UN Model. The arm's length principle by itself is not new; it has its origins in contract law to arrange an equitable agreement that will stand up to legal scrutiny, even though the parties involved may have shared interests. 2.4.1.4 Under the arm's length principle, transactions within a group are compared to transactions between unrelated entities under comparable circumstances to determine acceptable transfer prices. Thus, the marketplace comprising independent entities is the measure or benchmark for verifying the transfer prices for intragroup transactions and their acceptability for tax purposes. 2.4.1.5 The rationale for the arm's length principle it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... atutory construction is that singular includes plural and vice versa. This rule applies unless a contrary intention is manifest and exhibited. Merely because a statutory provision is drafted in singularity as opposed to plurality, is not enough to exclude application of the general rule that singular includes plural. The rule is not to be discarded on the ground that the relevant provision is singular or plural and the subsidiary and ancillary provision follow the same pattern. Contrary intention to exclude this generic rule is not to be lightly inferred. Contrary intention is not assumed or formed by confining attention to a specific provision but it would be apposite to consider the provision in the setting and placement of the legislation. It is a substance and tenure of the statute which would be meaningfully and critically determinative. This is the mandate of section 13 (2) of the General Clauses Act, 1897 (see Newspapers Ltd. v. State Industrial Tribunal, AIR 1957 SC 532, Narashimaha Murthy v. Smt. Susheelabai (1996) 3 SCC 644, J. Jayalalitha v. Union of India (1999) 5 SCC 138, Blue Metal Industries Ltd. v. R. W. Dilley (1969) 3 All ER 437, Floor v. Davis (Inspector of Taxes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad furnished the benchmarking analysis by using the TNMM. And, there is no dispute that TNMM is the most appropriate method for benchmarking the international transactions in question. There is also no dispute as to the use of OP to TC as the PLI. 68. The method for calculating the ALP by TNMM is set out in Rule 10B (1)(e) of the Rules. The same is reproduced below: "10B. Determination of arm's length price under section 92C. (1) *** *** *** (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 sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lding, underwriting or dealing with shares, debentures or other securities of any other body corporate, whether such activity or business is carried on, directly or through one or more of its units or divisions or subsidiaries, or whether such unit or division or subsidiary is located at the same place where the enterprise is located or at a different place or places;" 71. As is apparent from the above, the expression "enterprise" is defined in wide terms. However, the opening words of the said Clause (iii) of Section 92F clearly indicate that "an enterprise" means "a person". The term "person" is defined under Section 2(31) of the Act as under: "2(31) "person" includes- (i) an individual, (ii) a Hindu undivided family, (iii) a company, (iv) a firm, (v) an association of persons or a body of individuals, whether incorporated or not, (vi) a local authority, and (vii) every artificial juridical person, not falling within any of the preceding sub-clauses." 72. The word "person" is expressed in expansive terms and includes "a company". Section 92F (iii) of the Act also includes a permanent establishment of a person within the meaning of "enterprise". The meaning of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on, with profit margins from uncontrolled transactions. The expression 'net profit margin' realized by an enterprise clearly indicates that the profit margins are required to be compared with the profit margins of an enterprise and not that of any sub-unit or division of an enterprise. However, it is necessary to determine a profit margin that is realized from an international transaction. Clearly, the exercise is to determine the profit margins which are realized from an international transaction (or a specific domestic transaction). The method entails comparing the profit margin of an enterprise (in this case the Assessee) from an international transaction with the net profit margin of a comparable uncontrolled transaction. 76. The net profit margin of a tested party from an international transaction with an AE may be tested with, either by an uncontrolled internal comparable or by an external comparable. In the case of an internal comparable, the profit margin realized by a tested party from an uncontrolled transaction is compared with the profit margin realized from a controlled transaction (that is, transaction between two or more AE). 77. In the present case, the Assessee h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ute of Chartered Accountants of India. Paragraph 6.41 of the said Guidance Note is reproduced below: "6.41 The steps involved in the application of this method are: (i) Identify the net profit margin realised by the enterprise from an international transaction [or the specified domestic transaction]. Where the assessee also has transactions, segments or businesses where the international transactions [or the specified domestic transaction] with AEs are not relevant, then the net profit margin to be considered for the purposes of this TNMM method should be such net profit margin as is derived only from the transactions, segments or businesses related to the international transaction [or the specified domestic transaction]. The net profit margin may be computed in relation to costs incurred or sales effected or assets employed or any other relevant base. For example, * In case where the assessee acts as a distributor and the transaction pertains to import, the revenue may be used as base. * In case the transaction involves export of services/goods, costs may be taken as base provided the exporting entity acts as a contract service provider / contract manufacturer. * Retur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n arising from the said transaction. In the present case, the learned CIT (A) had faulted the TPO for comparing entity level margins with margins derived by an undertaking. In addition, the learned CIT (A) also noted that the international transactions are covered under the same agreement with the AE. Thus, splitting the transaction unit wise for the purpose of determining the ALP would not be apposite. As noted at the outset, the object of undertaking the transfer pricing analysis is to impute a real value to the transaction that would obtain in case the same was not controlled on account of being inter se AE. Thus, it is necessary to determine the profit margin if a similar transaction was executed by an unrelated entity. In this regard, the facts that the agreement between the AE under which services were rendered by the Assessee through its various undertaking is the same, it would be apposite to compare the services provided by unrelated entity under a similar agreement. The singularity of an agreement would be relevant for determining the overarching transaction that is required to be benchmarked. This would not permit the overarching transactions to be split up between vario ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee, it was entitled to deduction of Rs. 19,26,120/- paid on account of payroll taxes. The Assessee explained that the liability to pay the reconciled payroll taxes had accrued and crystallized on 30.06.2003 when reconciliation of the Australian payroll taxes was done pursuant to the closure of the Australian tax year. The Assessee's submission as noted in the order dated 28.07.2009, is reproduced below: "The appellant had incurred a sum of Rs 19, 26,120 in July 2003 on account of payroll taxes, in respect of contracted employees engaged in its branch in Australia. As per the facts of the case, every employer in Australia is required to pay the payroll taxes on monthly basis which is calculated as a percentage of the monthly wages. Further, at the end of the year, the employer is obligated to reconcile the annual wages and pay the differential or is entitled receive the excess paid. The accounting period for this activity is 1 July to 30 June of the following year. The provisions of payroll taxes in Australia are similar to the withholding tax provisions in India as the employer is required to deduct taxes from the salary of the employees on an estimated basis. Based on the reconc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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