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TMI Blog2025 (1) TMI 646X X X X Extracts X X X X X X X X Extracts X X X X ..... vice agreement. TPO has to determine only the ALP for such international transactions carried on by the assessee. TPO selected various comparables for which various financial statements of comparable comparison were prepared on the basis of going concern whereas financial statements of the assessee are prepared not on the basis of going concern. This was disclosed in appropriate places in the audited Balance Sheet itself. TP study has to be carried on comparable basis on equal terms. This itself makes all the comparables selected by the TPO are liable to be rejected. TPO has determined the ALP on the basis of presumption. No tax can be levied on notional income which was determined on the basis of transactions which are not technically international transaction. All funds remitted to India will not fall under services or under international transaction having economic impact. No doubt holding company has set up infrastructure in India to do business in order to receive services, no doubt for captive services still the ALP has to be on the basis of services provided by the Indian entity and as per the agreement it can charge mark-up only on the services provided by the assessee not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ers across Asia and the US. Motricity India have also installed data centre in New Delhi, significant enough to handle expected growth in Indian market. It would be providing full mCore Solution. 4. The assessee entered into service agreement with its AE (USA) with agreed revenue model. Based upon cost plus 20% mark up was agreed upon. The service agreement was entered effectively from 1st January 2011 to 31st December 2011. The effective period covered during the current assessment year is nine months i.e. from 01.04.2011 to 31.12.2011. As the assessee provides services to its AE, during the year it has reported international transaction in Form 3CEB as provision of services to the total value of Rs. 23,86,70,931/- and reimbursement of expenses of fixed assets expenditure of Rs. 21,19,26,943/-. The assessee prepared Transfer Pricing (TP) study and considered only the income earned during the period of nine months and submitted TP study report for software development expenses provided to its AE and Arms Length Price (ALP) is determined by applying Transactional Net Margin Method (TNMM). Operating profit of total cost ratio is determined as PLI in the TNMM analysis. The PLI of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as under :- 5. In response to the above-mentioned show cause notice, the assessee submitted its reply vide letter dated 20.01,2016 in which raised objections inter alia to the rejection of the assessee s comparables. The submissions of the assessee have been examined and duly considered as under: In the financial statements prepared for the year ended March 31st2012 March 31st2013 it was stated that the management of the Holding Company has decided to close dawn the operations of the Company. Accordingly, these financial statements are not prepared on going concern basis and all assets bind liabilities are stated at estimated realizable value. For profitability analysis, the assessee company has divided its analysis in two periods: Pre termination of service arrangement i.e. April, 2011 to December, 2011. During this period, total operating cost incurred by the Motricity India for providing services to it AE was equal to Rs,199,889,205/-. On the same Motricity India charged a margin of 20% and earned a service revenue equal to Rs. 238,670,931/-. Post termination of service arrangement i.e. January, 2012 to March 2012 In this period Motricity India has not provided any services t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ered OP/OC based on the numbers submitted in -the audited financial statements. However, we wish to inform your good-self that since ail expenses after 1st Jan 2011 (during non-agreement period] are revenue expenses and are therefore required to be charged to profit Loss Account The assessee company in its transfer pricing documentation prepared has shown the breakup of opera ting expenses non operation expenses. The expenses incurred after 1st Jan 2011 are all non operation expenses since these are incurred for services not provided to AE. Considering the facts, that the assessee company has shown a mark-up of 20% during the operating period and has a OP/OC margin of 19.40%, the OP/OCs computed by your good-self is 20.92%. Since the variation between the margin earned by the broadly comparable companies, so determined and the margin actually earned by Motricity India does not exceeds%, according to proviso to Sec 92C it is reasonable to conclude that Motricity India s International transaction is at arm s length price. 9. After considering the above submissions, TPO has rejected the same and sustained the ALP adjustment made by him at Rs. 10,98,54,500/- under section 92CA of the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -12 have been filed by the appellant. The Notes to of accounts states that The management of the Holding Company has decided to close down the operations of the Company. 8.7 Thus, clearly the company was set up by the parent company for receiving certain services on cost plus 20 % basis. Under the relevant agreement, the appellant had the assurance of getting markup on all the costs. The decision to terminate the service agreement and windup the appellant company just after one year has been taken by the holding company and the appellant did not have any say in the said decision of closing down operations in India. 8.8 As the setting up of appellant company, its business, revenue and closing down, everything was in absolute control of the holding company, the appellant was entitled to markup as decided in the service on all costs irrespective of the nature of costs. The decision to terminate the agreement was that of holding company. The appellant company cannot be denied markup on such costs in an arm's length condition. No independent party would have agreed to not charging any markup on such costs. Therefore, the argument that no markup needs to be charged on the winding up ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ld. TPO/AO has made additions of INR 109,854,500 on gross basis i.e. without allowing the deduction of expenses incurred by the assessee company and has increased the taxable income accordingly. 7. The Hon ble CIT(A)/ Ld. TPO/learned AO while passing the final assessment order has failed to give allowance of the expenses which have been considered as operating expenses by them for the purpose of computation of Arm s length price. In respect of the same, the assessee company request your good-self to allow claim of expense which were treated as operating expenses in nature by the Hon ble CIT(A)/ Ld. TPO/learned AO. 8. The Hon ble CIT(A)/Ld. TPO/Ld. AO have erred in disregarding judicial pronouncements in India in undertaking the TP adjustment. 9. The AO has grossly erred in proposing to initiate penalty proceedings under section 271(1)(c) of the Act. 12. At the time of hearing, ld. AR of the assessee submitted that assessee was providing software services to its AE in USA and it installed data centre in New Delhi. Assessee has entered into a service agreement with its AE for a period of one year commencing from 01.11.2011 o 31.12.2011. The abovesaid service agreement which expired ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 43,277 5,17,16,310 1,55,25,483 3,61,90,827 Admin Cost 7,76,54,101 1,59,74,301 1,34,23,281 25,51,020 Finance charges 1,27,128 4,309 4309 0 Depreciation 3,56,64,698 209,76,810 2,09,76,810 0 Total Operating Cost 19,98,89,205 8,86,71,730 499,29,883 387,41,847 Operating Profit 3,87,81,726 (8,86,71,730) (499,29,883) (387,41,847) OP/OC 19.40% - - Impairment Cost 10,19,36,658 12.3 Accordingly, he submitted that in the TP analysis, based upon the average margin earned by the comparable selected, the profit earned by the assessee was determined to be at arm s length. He submitted that since the service agreement was valid till 31st December 2011, hence the assessee company divided its profitability in two periods i.e. Pre expiration of service arrangement (i.e. April 2011 -December 2011) and during this period, total operating cost incurred by the assessee for providing services to it AE was equal to Rs. 19,98,89,205/-. On the same, the assessee charged a margin of 20% and earned a service revenue equal to Rs. 23,86,70,931/-. 12.4 Further, with regard to return of income and treatment of losses suffered, he submitted that the assessee filed its return of income wherein it itself disallowed t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sed upon operating cost incurred for the entire year and in turn, considered revenue even for the period (Jan to March 2012) when the assessee has neither rendered any service nor there was any agreement with its AE for the said purpose. He submitted that in his approach, the TPO also made certain changes in selection of comparable, however the assessee chose not to record any resistance for the same. He submitted that the TPO then has proceeded to compute the ALP as below: Operating Cost 28,82,28,110 Arm s Length Margin (%) 20.92 Arm s Length Price (ALP) 34,85,25,431 Price Received 23,86,70,931 Shortfall Being adjustment u/s 92 CA 10,98,54,50 12.7 Further ld. AR of the assessee submitted that afterward the assessee moved appeal before the ld. CIT(A), who also declined to grant relief to the assessee for the reasons recorded in his order and referred to paras 8.5 to 8.9 of the ld. CIT (A) s order. 12.8 He submitted that it is a matter of admitted fact that post 31.12.2011, no service has been rendered by the appellant company either to its AE nor to any other entity. This is neither disputed by the TPO nor by the Ld. CIT(A). Further he submitted that it is also a matter of fact tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AY 12-13 as vide note no. 19, it is clearly stated that the accounts of the assessee company have been drawn NOT on GOING concern basis. 12.12 With regard to grounds of appeal No.1, 2, 3, 4 5 that International Transaction cannot be deemed, he submitted that the TPO has erred in determination of incorrect arm s length price of Rs. 34,85,25,431/- by considering the revenue for the entire 12 months period from April 1st 2011 till 31st March 2012 whereas there was no international transaction between the AE and the assessee company for the period from 1st Jan 2012 till 31st March 2012. He submitted that there is no provision in the Act or in the relevant rules to deem an international transaction in the manner in which the ;d. TPO has deemed the revenue for the 3 month s period after cessation/expiry of the service agreement between the AE and assessee. He submitted that it is trite law that it is the sole discretion of the businessman as to how he would structure run his business and does not warrant any dictate from anyone much less from the revenue authority. He further submitted that the assessee, received a revenue of Rs. 23,86,70,931/- for services rendered over a nine month pe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nuary to March 2012) in determining the Arm s Length Price (ALP), despite no services being rendered to the associated enterprise (AE) during this time. He submitted that the service agreement was operational only for one year, from January 1, 2011, to December 31, 2011, and all services were provided within this timeframe and consequently, expenses incurred in the subsequent period (January- March 2012) fell outside the operational scope of the agreement. He further submitted that the TPO considered basis the expenses incurred during the non-operational period (January to March 2012) is notional income, which is not taxable under Indian law unless explicitly provided. He submitted that this aligns with the ruling in Hon ble Supreme Court in CIT v Shoorji Vallabhdas Co [1962] 46 ITR 144 (SC) where the Hon ble Supreme Court emphasized that only real income, not hypothetical or notional income, can be taxed. Since no services were rendered during this period, no real income accrued and referred to that ruling as under :- If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a hypothetical income , which does not materialise. Wher ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed. He submitted that the judgment reinforced the principle that income must be real, rather than theoretical, for it to be subject to taxation, and that tax cannot be levied on unrealized or notional income. (i) Three tests were also laid down by various decisions of the Supreme Court to determine when income can be said to have accrued: (a) whether the income is real or hypothetical; (b) whether there is a corresponding liability of the other party to pay the amount to the assessee (c) the probability or improbability of realisation of the income by the assessee has to be considered from a realistic and practical point of view. 12.19 As regards Ground No. 6 7, he submitted that without prejudice to above and in alternative, the TPO in his quest to deem notional income pertaining to 3 months period from Jan to March 2012, also skipped to brings such income to tax after duly allowing the expenses incurred. He submitted that in other words, even if the incremental (notional) income of Rs. 10,98,54,500/- was to be added by TPO, the assessee deserves to have been allowed the expense/cost incurred during this 3 months period i.e. Rs. 8,86,71,730/-. He submitted that this cost has not b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eet which was prepared and certified by the statutory auditor based on the observation that the holding company has decided to close down the operations of the assessee company and accordingly, the financial statements are not prepared on going concern basis and all the assets and liabilities are stated at estimated realizable value. Further it is also brought to our notice that even in notes forming part of the financials , the basis of preparation of accounts were clearly stated that financial statements are preferred not on the basis of going concern. Further the assessee has submitted computation of margin sheets which is placed at page 138 of the paper book wherein assessee has bifurcated the business transaction for the period of April to December 2011 and January 2012 to March 2012. Further it is brought to our notice that in computation of total income, the assessee has disallowed the expenses relating to post closure of business to the extent of Rs. 8,76,63,710/- and also impairment loss debited in the Profit Loss account to the extent of Rs. 10,19,36,658/-. We observed from the ITR filed by the assessee that all above disallowances were made by the assessee. From the abov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to do business in order to receive services, no doubt for captive services still the ALP has to be on the basis of services provided by the Indian entity and as per the agreement it can charge mark-up only on the services provided by the assessee not for the negative services for which the holding company already by investing in India eroded the capital by such decision to create facility in India and on the top of it Revenue authorities cannot presume and impose further mark-up on the expenses which are incurred technically to shut down the business. 18. After careful consideration, we observed that TPO has determined the ALP on the basis of presumption. No tax can be levied on notional income which was determined on the basis of transactions which are not technically international transaction. All funds remitted to India will not fall under services or under international transaction having economic impact. On similar ground, the Hon ble Supreme Court held in the case of Excel Industries Ltd. (supra) and Hon ble jurisdictional High Court in the case of Ravi Kumar Sinha (supra) expressed similar view that the tax levied on actual income that has accrued or received and not on the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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