TMI Blog2011 (6) TMI 385X X X X Extracts X X X X X X X X Extracts X X X X ..... are taken by the A.Es only. Whether the data of one year has to be taken or multiple year data has to be taken - Rule 10B(4) of the I.T. Rules, 1962 - Held that:- In the absence of the assessee specifically demonstrating that the data of the prior financial year reveals fact which influence the determination of the transfer price of the transactions being compared, the question of taking into consideration data other than the current year's data does not arise. Rejection of loss making comparables - Held that:- TPO has rightly rejected comparable of ADS Diagnostics Ltd. on the ground that comparison itself is flawed for the reason that enterprise level profits are taken for comparison. The actual margin of servicing segment has not been identified. The main income is from scanning. The function of the assessee is not akin to scanning. Further rejection of NMI (Asia) Ltd is also justified on ground that figures are abnormal and without explaining a huge fall in profits as compared to the fall in turnover. The reason for rejecting the two loss making units is not just because they were loss making units but for the reasons which are already stated in the preceding paragraphs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the order dated 29-10-2009, passed by the Transfer Pricing Officer (hereinafter for short "TPO") under section 92CA(3) of the Act, which is extracted for ready reference : "3. The assessee is a company of the Exxon Mobil Corp. Group of US and is responsible for information dissemination, maintaining customer relationship and market development for its AE Exxon Mobil Chemical Co. USA. It is also providing application research and technical services and back office support services to the AE. 4. The international transactions of the assessee are as under : S. No. Details of transaction Amount (Rs.) 2006-07 1. Technical Services 6,28,71,933 2. Back office support services 4,48,66,645 3. Marketing services 28,29,80,046 4. Global Support services fees 2,06,63,082 5. Reimbursement of expenses (recd.) 25,90,571 6. Reimbursement of expenses (paid) 9,60,283 5. For the purpose of benchmarking segmental financial results have been prepared by the assessee work ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see does not get any compensation in respect of the services rendered to the AEs. (ii) The second agreement is called Technical Representation Agreement entered into by the assessee with Exxon Mobil Research Engg. Company. Under this agreement the assessee has to assist its AE in promotion of its various petroleum processes and other technologies listed out in para 3 of the agreement. In consideration of the services rendered the assessee is paid $ 40000 per annum + 5 per cent of the royalty payments received by the AE in respect of execution of process license agreement exceeding USD 800000 per calendar year. The travelling expenses are also reimbursed on actual basis. 3. Back office support services - The assessee has back office support services agreement with Exxon Mobil International Services Ltd., Exxon Mobil Chemical International Services Ltd., Exxon Mobil Chemical Middle East and Africa and Exxon Mobil Chemical Asia Pacific for rendering various back support services. All the AEs have decided to provide a mark up 10 per cent on the various direct and indirect costs incurred by the AEs for rendering such services. 7. Assessee has preferred a transfer pricing repor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment, dated 17-5-2004 shows that as per Article 2 the assessee (BRDTC) shall provide the following services : 2.1 Application technical development services to Butyl and Ethylene Elastomers customers of EMCAP in Asia Pacific and other regions. 2.2 Develop product applications and undertake new applications development. 2.3 Such other technical services as and when required by EMCAP BRDTC will undertake the above projects as per requests received from EMCAP or its nominees and provide a report of its findings/analysis. 3.5 Further in consideration of these services the assessee receives only a reimbursement of the direct and indirect cost incurred on the Bangalore Research Centre. Plus compensation and travelling expenses of managers/engineers with a mark up of 10 per cent and also expenses incurred on scenario and conference. 3.6 The agreement clearly shows that in respect of rendering specialize services in the filed of application reserves the assessee is not charges anything on account of technical service charges. 3.7 In your explanation dated 4-3-2009, while presenting the segmental accounts you have stated that the application reserves and technical services segme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e stated to be employed in application research and they were stationed at Bangalore. Just because they happened to be with the marketing team for some clarifications cannot be any basis of allocated their cost towards marketing. It is also a fact that the assessee while claiming the reimbursements has claimed the entire establishment cost. 3.7.3 The allocation of expenses therefore, cannot be accepted as a proper allocation of cost in segmental analysis. 3.7.4 As already stated the assessee has not charged any price for the services being rendered by it to its associated enterprise. Only amount it has received from its AE i.e., Rs. 4,98,14,572 represents the reimbursement of costs. Same is also relected in Balance sheet, Profit Loss A/c. of the company. 3.7.5 Further it also appears from your segmental analysis that the common administrative expenses in relation to the Managing Director's office, his staff and Finance office expenses etc., have not been allocated to the 3 segments which would have further increased the recovery of expenses. 3.7.6 In such a scenario you are required to show cause as to why your segmental study be not rejected and the comparable PLI ratio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng documents without any supporting log books or time and motion studies. Such self-serving documents do not carry any evidential value. The total staff strength of the employees is only about 36 persons as stated by the assessee. Out of these 9 persons are in the application research and technical team stationed at Bangalore. There are 14 persons under the marketing segments and 13 another in back office services. These also include the persons in the head office administrating the overall affairs. The Technical agreement with Exxon Mobil Chemical Asia Pacific clearly shows that BRTDC has been carrying out analytical research to the AE. It is precisely for this reasons that the AE has agreed to reimburse the entire cost whether direct or indirect in respect of the expenses incurred for BRTDC. The ATD Managers and the technical persons employed under BRTDC are dedicated employees of the BRTDC, kept for the purposes of research as desired by the AE. Being the employees of the assessee, they can assist other divisions but not at the cost of their primary duty. If some assistance is provided to marketing division in their spare time, the same cannot warrant allocation of a proportio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s Ltd. 69.49% 5. Neeman Medical International (Asia) Ltd. -0.89% 6. ADS Diagnostic Ltd. - seg. -9.20% 7. Pfizer Ltd. - service seg. 4.07% Arithmetic mean 18.47% As discussed above, on his own segmental analysis it has worked out its PLI of 13.13 per cent and considered its pricing to be at arm's length. A perusal of the comparable shown that the assessee had adopted multiple year data for working out the PLI of the comparables and further some of the companies so selected could not be considered as comparable companies. Accordingly, the assessee was issued a show-cause notice dated 17th July, 2009 confronting the above facts and also the reasons for rejection of a few office comparable companies. The correct operating margin was also worked out. 8.6.1 In reply to the show cause the assessee has furnished its submission on 28th July, 2009. His main argument is regarding the rejection of loss making companies, he has analysed the companies and reasons for losses as under : (i) AVS Diagnostic Ltd. - it is stated that the income of diagnost ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7. Medinova Diagnostics Services Ltd. 7.26 Arithmetic mean 28.41% The assessee has further sought working capital adjustments of 0.47 per cent in respect of the working capital being employed by the comparables and the assessee. The assessee has further sought risk adjustments by following the capital asset pricing model. The issue of risk adjustments and the short comings of CAPM model adopted by the assessee are discussed in detail later in the order and therefore, I do not allow any risk adjustments in this case. The assessee will, therefore, suffer an adjustment in respect of services rendered from BRDTC to its AE viz., Exxon Mobil Chemical Asia Pacific as under : Cost of services rendered Rs. 4,98,14,572 Mark up as per the comparables (28.41 - 0.47) = 27.94 per cent = Rs. 1,39,18,191 9. Back office support services : As already mentioned above, the AEs has entered into an agreement with the assessee to provide a mark up 10 per cent on total costs. The segmental results of the assessee however, show a mark up of 21.3 per cent as mentioned above a detailed questionnaire was issued to assessee on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arable PLI considering your PLI to be 10 per cent instead of 21.3 per cent as shown by you in your TP Report. 9.1 In his explanation the assessee has stated that the billings are made on budgeted costs while the books of account show the actual cost incurred and there is likely to be variation. Further, the accounts of the AEs are maintained on calendar year basis while the accounts of the assessee are on financial year basis. This generally results in variations. The assessee has again failed to provide his budgetary figures. It has filed certain reconciliations. In its working it has shown that the budgeted cost was USD 437,000 (Rs. 1,93,18,000) after adjusting the differences in respect of Jan., to Mar., 2005 (USD 115,000) and Jan., 06 to March, 2006 (USD 115,000). Since the actual cost (Rs. 1,58,27,000) was lower than the billed costs, they could achieve a higher mark up. The explanation of the assessee does not seem to be acceptable. The AEs have agreed to provide a mark up of 10 per cent on costs. The accounts of the AEs closed on 31st Dec., of each year. Therefore, while finalizing their accounts there will take into account the actual costs incurred by the assessee duly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al representation Rs. 17,52,400, the mark-up is around 80 per cent. He also observed that the assessee has not denied the fact that, it has not been separately compensated for services rendered at Bangalore Research and Development Technology Centre (for short "BRDTC") (Rs. 4,98,14,572). The assessee allocated a part of cost of the application and research technical segment, towards marketing services as follows : ( a ) 1 per cent R D testing Rs. 4,45,507; ( b ) 10 per cent Butile ATD India cost on Rs. 8,47,107; ( c ) 25 per cent EEB ATD costs Rs. 9,93,833. 5. The allocation has been justified on the ground that the personnel involved in scientific research and ATD managers, do assist marketing team in marketing the product. On the cost incurred under the market head, which is to be allotted to technical service, the assessee furnished correspondence from its employees wherein some employees have estimated that the time spent by them on Butile ATD and R D laboratory would be 10 per cent and 1 per cent respectively. Similar correspondence from other employees was furnished. The c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Arithmetic mean 18.47% As discussed above, on his own segmental analysis it has worked out its PLI of 13.13 per cent and considered its pricing to be at arm's length. A perusal of the comparable shown that the assessee had adopted multiple year data for working out the PLI of the comparables and further some of the companies so selected could not be considered as comparable companies. Accordingly, the assessee was issued a show cause notice dated 17th July, 2009 confronting the above facts and also the reasons for rejection of a few office comparable companies. The correct operating margin was also worked out." 6. Thereafter, the TPO observed that the assessee had undertaking research in its transfer pricing report and selected seven comparable companies for working out the arithmetic means of 18.47 per cent. He also observed that the Profit Level Indicator (PLI) of 13.13 per cent was worked out by the assessee on its own segment analysis and this was taken by the assessee to be the ALP. The assessee adopted multiple data for working out the PLI of comparables. The TPO, on the ground that certain comparables selected by the assessee have to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... very AE is an independent Company and a separate profit centre. None would like to provide a higher expenditure than warranted. The AEs have allowed a mark up of 10 per cent only and if they were finding that the AE is actually making profit of 21 per cent they would have reduced their mark up in the first quarters of 2006 so as to make an overall mark up of 10 per cent for the year. The assessee is not an independent company which can be fool the various group companies by charging a mark up of 21.3 per cent against agreed margins of 10 per cent. In fact, the assessee has reported that in the next years the mark up has been increased for 10 to 15 per cent. If the assessee was actually making a margin of 21.3 per cent no AEs would have increased the margin from 10 to 15 per cent. While filing the explanation the assessee has not been able to explain the head-wise variation and the specific reasons on account of which those variations have arisen. It therefore appears that the allocation of expense by the assessee is not as per the actual budget exercise but only with a basis to work out better margins for the lower priced segments. The explanation/the segmental allocation of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stone Teleservices Ltd. BPO segment Accepted - - 17. Hypersoft Technologies Ltd. BPO segment Rejected Consistent loss 18. CMC Ltd. - ITES segment Rejected It failed in export filter. Its export is only 9% 19. Indus Networks Ltd. Rejected Consistent loss 20. Mapro Industries Ltd. Rejected Consistent loss 9.3.1 the department has conducted the separate search for selection of comparables in the IT industry. The search strategy and the comparables are reproduced below. This was confronted to the assessee vide questionnaire dated 17th July, 2009. The search for suitable comparables is conducted based on the data available in Prowess and capital databases. These two databases were searched and the filters are applied on these data. The information on related party transactions is taken from these databases and Annual Reports. In some of the cases, either the Annual Reports or the information in respect of export turnover, related party transactions, etc., are not available. Such information is asked from the companies und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al information etc., is not available. Thus, these companies were issued notices under section 133(6) to submit this information. 3 Companies have been selected as comparables from the Prowess segment search. Step Description No. of Companies Resulted No. of Companies eliminated 1. Number of companies resulted by the segment search 41 2. Number of companies not already covered under the key word search as above 36 5 3. ITES revenue/segment available for the F.Y. 2005-06 29 7 4. Replies u/s. 133(6) in respect of segmental data 22 7 5. Number of companies with less than 25% RPT 14 8 6. Number of companies with turnover more than Rs. 1 cr. 12 2 7. Number of companies with export revenue more than 25 per cent of the revenues 4 8 8. Reliability of data (Satyam Computer Services Eliminated) 3 1 Balance 3 9.3.5 Capitali ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elated party transactions information, segmental information etc. is not available. Thus these companies were issued notices under section 133(6) to submit this information. Out of these, none of the companies has been selected as a comparable based on the information received from the companies under section 133(6). Additional Comparables While doing the search process for suitable comparables in the software sector, some of the companies though categorized as software service provider are in fact either in the IT enabled services sector or have IT enabled services as one of the business segment. The search criteria for the software sector are summarized as under : Database Description of the Search Keywords used Prowess Keyword Search Computer Software Prowess Segment Search Computer Software, Software Services Consultancy Capitaline Keyword Search Computer - Software - Converts, Computer - Software - Large and Computer - Software - medium/small Capitaline Segment Search 1. Software 2. Software BPO 3. So ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6. Wipro Ltd. The company's annual report for the F.Y. 2005-06 did not have segmental results for BPO segment on stand alone basis. The company was asked under section 133(6) to submit segmental information pertaining to BPO segment. But the company said that it is not able to submit segmental information on stand alone basis. Therefore rejected. 7. Syntle (India) Ltd. Annual report is not available for the F.Y. 2005-06. As per the information and annual report submitted by the company, in response to section 133(6) notice, the company has stated that it is into software services and ITES segment 92 per cent of IT enabled services are rendered to its AEs. Thus it fails RPT filter and is not considered as a comparable. 8. Mold Tek Technologies Ltd. As per the information submitted by the company, the company is into IT enabled services segment. The company earned a profit of Rs. 1,60,28,000 on an operating cost of Rs. 2,14,77,839. As the company's operating profit is 74.63 per cent on cost, the same is not considered as a comparable as it has very high margin by any standard. Thus, it is not considered as a c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12. Transworks Information Services Ltd. 163.3 19.56 13. Vishal Information Technologies Ltd. 25.64 48.03 Arithmetic mean 24.00% Note : 1. All the figures are taken from the annual reports; 2. Costs taken for the computation of margins are the costs before interest charges; 3. Forex gain/loss is not taken as part of the operating expenses as forex gain is categorized as other income; and 4. Loss of sale of assets, etc., are not taken as expenditure." 21. The assessee gave its objections. The Assessing Officer, after considering various contentions, held that the assessee had worked out the adjusted average PLI of the comparables at the rate of 24.43 per cent and this would be used for bench marking the back office support services. Thereafter, the TPO considered the submissions of the assessee, in respect of adjustments of risk being a captive unit. He came to a conclusion that there is no difference between the assessee and the comparable companies. He computed ALP of service would be Rs. 4,76,49,682, as against the actual receipt of Rs. 4,21,23,805, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Tribunal on the following grounds : "1. The Assessing Officer passed in pursuance of the directions issued by the DRP is a vitiated order, as the DRP erred both on facts and in law in partially confirming the addition made by the Dy. CIT, to the appellant's income. 2. The Assessing Officer erred in facts and in law in concluding the assessment under section 143(3) reed with section 144C(13) of the Act in - 2.1 making an adjustment to your appellant's international transactions of provisions of technical services and back office support services at Rs. 1,24,03,828 and Rs. 55,25,877 respectively. 2.2 disregarding the arm's length price (ALP) and the methodical bench marking process carried out by the appellant in the Transfer Pricing (TP) documentation maintained by it in terms of section 92D r/w Rule 10D of the I.T. Rules, 1962. 2.3 not allowing the use of multiple year data as prescribed under Rule 10B(4) of the Rules r/w the OECD TP guidelines, and determining the arm's length price on the basis of financial information of the comparables for the year ended March 31, 2006 identified pursuant to a fresh search for comparables performed during the assessment proceedin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee has taken average of two years' data for comparison but the TPO has taken only one year. He submits that for various reasons, the assessee does not want to press this issue. In view of the above submissions, we dismiss this argument of the assessee. 24. On the second issue of rejection of loss making comparables, the learned Counsel drew the attention of the Bench to Page-226 of the paper book and submits that it is clear from the director's report of the comparable company, ADS Diagnostic Ltd. that the decrease in scanning income is due to stiff competition from the existing and new diagnostic centres that are coming up in and around Delhi. He pointed out that the loss after depreciation has, in fact, decreased from Rs. 21,76,000 to Rs. 14,32,000. His case is that, the company should be accepted as functionally comparable. 25. On the rejection of comparable Neeman Medical International (Asia) Ltd., he points out that gross revenue has increased during the year. He points out that company's clinical trial income has reduced as compared to last year. He submits that this company was wrongly treated as a consistent loss maker as it had a loss of Rs. 28,00,000 in finan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,11,194 Application of the Range-ALP x 0.95 4,10,50,635 The revised ALP (after applying 5 per cent margin) is Rs. 4,10,50,635. As the actual income is Rs. 4,21,23,805, no adjustment would be required." 29. On the issue of ground No. 3, the learned Counsel submits that he is not pressing the same. Thus, this ground is dismissed as "not pressed". 30. Learned Departmental Representative, Mr. D. Songate, on the other hand, controverted the submissions made by the assessee's counsel. On the first issue of adopting multiple year data or single year data, the learned Departmental Representative noted that assessee's counsel has not pressed the same and, hence, made no submissions. 31. On the issue of elimination of loss making units from the list of comparables, the learned Departmental Representative relied on the order of the DRP as well as that of the TPO and submits that consistent loss making companies cannot be treated as proper comparables. He basically relied on the order of the TPO and submits that the assessee has not been receiving any mark-up on technical services provided to it's A.Es in the form of research and development at BRDTC. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es pertains to technical service segment and back office support service. (iii) In the technical service segment, there are three activities i.e., (a) application research at BRDTC; (b) application of technical development services; and (c) promoting the licensing of technology. (iv) For application research carried out at BRDTC, no mark-up is paid by the A.E. As far as the application research is concerned, the A.E. reimbursed cost plus 10 per cent. For the activity of promotion of licensing of technology, US$ 40,000 is annually reimbursed by the A.E. The assessee seeks to club all these three activities and, thereafter, determined the ALP. It is a case of the assessee that all these operations put together generated 13.13 per cent. The TPO rejected the aggregation approach on the ground already stated in the preceding paragraph. We fully agree with the findings of the TPO. We do not understand as to how carrying on application research at BRDTC can be clubbed with, the activity of promoting the licensing of technology owned by the overseas group entity. We note that the A.E. reimbursed only the cost incurred by BRDTC on research. No mark-up is given. Not charging mark-up o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vices has reduced due to stiff competition from existing and new diagnostic centres that were coming up in and around Delhi and the loss is attributable to stiff competition. The assessee also points out that the statutory auditor has not mentioned that the company has been facing any going concern issues. In our opinion, the TPO has rightly rejected this comparable for the following reasons:- The directors' report of ADS Diagnostic Ltd., reads as follows:- "The operational income of the company has increased from Rs. 248.44 lacs to Rs. 271.69 lacs in the current year registering a growth of 9.36 per cent for the year under review. However, income from scanning business has decreased from Rs. 174.34 lacs to Rs. 165.02 lacs during the year under review. The income from trading and servicing has been increased from Rs. 61.51 lacs to Rs. 82.26 lacs and Rs. 7.24 lacs to Rs. 23.24 lacs respectively. Overall income increased by Rs. 23.25 lacs. The decrease in scanning income is due to stiff competition from the existing and new diagnostic centres that are coming up every year in and around Delhi. Loss after depreciation has decreased from Rs. 21.76 to Rs. 14.32 lacs during the year u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of. Here also, they rely on the statutory auditor's report and pointed out that no going concern issues are not raised by the statutory audit. (x) In our opinion, statutory audit not mentioning that they are going concern issue, does not help the case of the assessee. It cannot be said that the loss making units, which are only having going concern issues, are to be eliminated. In the case on hand, the gross revenue of the company has reduced from Rs. 4,45,60,000 to Rs. 2,85,68,000. In the previous year, the company earned net profit of Rs. 18,36,000, whereas in the current year, the loss is Rs. 1,28,53,000. The above figures demonstrate that there is more than a normal change in the profitability of the company. There is a fall in the profit by Rs. 1.47 crores (approx.), when there is a fall in turnover of about Rs. 1.60 crores (approx.). These figures are abnormal and without explaining a huge fall in profits as compared to the fall in turnover, the assessee cannot, in our opinion, argue for inclusion of this comparable. Thus, we uphold the findings of the TPO that these two loss making units are not to be taken as comparables. (xi) Now, coming to the alternative argumen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... zer Ltd. as 4.07 per cent as per transfer pricing study instead of one year up/margin of 7.41 per cent. It is also submitted that the revised ALP is within the range of +/- 5 per cent if the figures are correctly taken and calculations made. Detailed table and working are submitted before us. The learned Departmental Representative was not able to controvert these submissions of the assessee. Under these circumstances, we are of the opinion that the issue of computation has to be set aside to the file of Assessing Officer, for limited purpose of quantification of the transfer pricing adjustment. In case the ALP determined by the Assessing Officer is within the range of 5 per cent of the actual income, then no adjustment need to be made. With these observations, we set aside the matter to the file of Assessing Officer. (xiv) This brings us to the second issue which relates to determination of ALP of back office support services - whether the Assessing Officer is bound by the directions of the DRP. The DRP directed as follows:- "The next TP ground relates to back office services support. The facts are that as per agreement with the AEs, the assessee was to receive 10 per cent mar ..... X X X X Extracts X X X X X X X X Extracts X X X X
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