TMI Blog2010 (3) TMI 898X X X X Extracts X X X X X X X X Extracts X X X X ..... applicable where more than one price is determined by the appropriate method - there is only one comparable case of Soffia Software Ltd. Since more than one price has not been determined, the proviso is not applicable on the facts and in the circumstances of this case - appeal of the revenue dismissed - IT APPEAL NO. 4372 (DELHI) OF 2009 C.O. NO. 35 (DELHI) OF 2010 AND STAY NO. 101 (DELHI) OF 2009 - - - Dated:- 31-3-2010 - RAJPAL YADAV AND K.G. BANSAL, JJ. Rajiv Kanvar and Sanjiv Sharma for the Appellant. Sanjiv Sharma for the Respondent. ORDER K.G. Bansal, Accountant Member. - The aforesaid appeal of the assessee and cross-objection of the revenue arise out of the order of CIT(A)-XX, New Delhi, passed on 23-9-2009 in appeal No. 128 of 2006-07, pertaining to assessment year 2002-03. The assessee has taken 7 substantive grounds in the appeal, the sum and substance of which; is that the learned CIT(A) erred in upholding the order of the Assessing Officer in which adjustment of Rs. 1,06,38,003 was made in respect of transactions with the AE, by taking the net profit margin at 16.584 per cent against the margin of 7.82 per cent declared by the assessee. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ables selected by the TPO based on the comparability factors mentioned in rule 10B(2) of the Income-tax Rules, 1962. (3) That the learned CIT(A) has erred in facts and law in not analyzing the comparability of the companies, which were part of set of TPO but not objected by the assessee, on the same or similar criteria/factors by which he held that some of the companies were not the appropriate comparables." 1.2 The assessee had also moved a stay application on 16-11-2009, requesting inter alia that the recovery of demand may be stayed till the passing of the order by the Tribunal on assessee s appeal. This application was heard, but it was decided to hear the appeal out of turn rather than to grant the stay for payment of demand. With the passing of this order on the cross-appeals, the application has become infructuous. 2. Coming to the cross appeals, we may summarize the orders of the Assessing Officer, the TPO and the learned CIT(A). The facts mentioned in the assessment order are that the assessee filed its return of income on 13-10-2002 declaring total income of Rs. 12,91,562. It is engaged in the business of development of software which was sold to Vedaris Ltd., ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al market for long-term exclusive contracts, the developers are charging $ 10 per man-hour ($ 80 per man-day), against which the assessee was charging a higher rate of $ 165 per man-day looking to expertise available with it and the nature of business. On considering the note and the submissions and the fact that requisite documentation was neither maintained nor filed for justifying cost plus method, the TPO came to the conclusion that the mention regarding the aforesaid method in the note and the explanation furnished by the assessee was casual in nature. As proper documents were not maintained to justify the ALP on cost plus method, the matter was discussed further with the assessee and finally the Transactional Net Margin Method ("TNMM" for short) was adopted for determining the ALP. With this view in mind, comparable data was collected from CMIE and PROWESS Database. This data was analysed on a broad basis, taking into account the sales, ratio of trading sales to total sales, ratio of manufacturing sales to total sales, ratio of research and development expenses to sales and ratio of the value of net fixed assets to sales. This led to initial identification of 118 comparab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... panies which had significant related-party transactions of the value of 25 per cent or more of the turnover should not be used, as comparables. Thus, the cases of Blue Star Infotech Ltd., Ideaspace Solutions Ltd. and Max Health Scribe Ltd. were taken out of the purview of the comparables. The second issue was whether comparable cases having very high or very low turnover compared to the turnover of the assessee should have been considered by the TPO. It was mentioned that the cases selected by the TPO had turnovers ranging between Rs. 0.47 crore to Rs. 223.79 crores, while the turnover of the assessee was Rs. 13.29 crores. It was held that turnover filter should have been applied by the TPO as it is one of the important factors in deciding profitability. The case of the assessee was that comparables should have turnover ranging between Rs. 5 crores to Rs. 25 crores. However, the learned CIT(A) was of the view that the range suggested by the assessee was rather narrow, and cases having turnover ranging between Rs. 5 crores to Rs. 66 crores could be termed as comparable cases. Thus, the cases of Aptech Ltd., Advance Technologies Ltd., Eonour Technologies Ltd., Fore C. Software Ltd., ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was mentioned that it was the finding of the TPO that TNMM was the most appropriate method and cost plus method was not the appropriate method in this case. All the objections of the assessee in regard to functional and turnover tests have been considered. The claim for working capital adjustment has also been considered. However, it was held that adjustments on account of working capital cannot be made in a routine manner because the underlying assumption is that all companies are efficient profit-making companies, although poor management may also be a reality. The data in regard to reasonably accurate adjustment has not been made available and, therefore, no adjustment was made on this basis. Thus, the data mentioned in earlier table in regard to five comparables was adopted for working out the ALP. The arithmetical mean in respect of these cases worked out by the TPO was 15.02 per cent while it was 16.42 per cent according to the assessee. In this connection, it was mentioned that the calculation of the assessee is more accurate as it is based on financial accounts. Accordingly, the arithmetical mean was taken at 16.42 per cent to determine the ALP, which led to an addition o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a valid comparable case. If these cases are excluded, the average profit ratio of the remaining three cases comes to about 2.38 per cent. The assessee showed the margin of 7.78 per cent. Therefore, it was argued that there is no justification for making any adjustment to the total income of the assessee on account of transfer pricing. It was further argued that some adjustment ought to have been made by the learned CIT(A) in respect of capital as it had received substantial advances from the Vedaris UK, the parent company. It was also argued that a deduction of 5 per cent ought to have been allowed as per the provision contained in proviso to section 92C(2). 3.4 In order to support his argument, reliance was placed on the decision of the Tribunal in the case of Honeywell Automation India Ltd. v. Dy. CIT [2009] TIOL 104 (Pune - ITAT), UCB India (P.) Ltd. v. Asstt. CIT [2009] 121 ITD 131 (Mum.), Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448 (Delhi), Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 109 ITD 101 (Delhi) and E-Gain Communication (P.) Ltd. v. ITO [2008] 23 SOT 385 (Pune). 4. The learned Departmental Representative filed written submissi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cases found to be comparables by the learned CIT(A)? 4.2 In the case of Tera Software Ltd., it was submitted by the assessee that it is a BPO and call centre company. In respect of Kushal Software Ltd., it was submitted that the use of the word software in its name cannot by itself lead to the conclusion that it is engaged in the business of development of software. This company had purchased software of the value of Rs. 5.05 crores in respect of the sales of Rs. 5.17 crores. It is a trading company having the same nature of business as that of SMR Universal Softech Ltd., which was held to be not comparable by the learned CIT(A). Therefore, it was urged that this case may also be excluded from the list of comparables. In respect of Tera Software Ltd., it was submitted that it is engaged in the business of computer education, BPO and call centre. The total turnover was Rs. 10.15 crores which included sale of software of Rs. 57.02 lakhs only. The software was purchased at the cost of Rs. 51.34 lakhs. The segmental accounts show that it is engaged in the business of integrated solutions, technical services and software services. Since its business is also different from that of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng to the argument of the learned Departmental Representative that Tera Software Ltd. was required to be excluded, it was submitted that the report of the directors merely mentioned that State Government of Andhra Pradesh had granted an order to impart computer education in schools, whose value will be about Rs. 17.80 crores in the next five years; It was also mentioned that the company focused on emerging industries of BPO and entered into the business of call centre. On the basis of these remarks, it was argued that these were only future businesses and otherwise the present business of the company was comparable with the business of the assessee. Coming to its P L a/c, it is seen that the sale of software was in the vicinity of Rs. 57.02 lakhs. The segmental account shows revenues from integrated solutions at about Rs. 5.61 crores and from technical service at about Rs. 3.44 crores. 4.6 In regard to Kushal Software Ltd., it is seen that its software sales amounted to about Rs. 5.17 crores out of which purchases amounted to about Rs. 5.65 crores. 4.7 From the annual report of Sark Systems India Ltd. for the year 2001-02, it is seen that its turnover was about Rs. 5.72 cro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ftware Ltd. and Tera Software Ltd. are not comparable cases and these should be excluded from consideration. At the same time, it was also pleaded that the cases of Sark Systems India Ltd. and Datamatics Technologies Ltd. were valid comparables and, therefore, they should continue to be included for the purpose of determining ALP. This is now the limited controversy pending before us for decision. 5.1 Rule 10C(2) lays down comparability test for discovering an uncontrolled transaction. This rule reads as under : "(2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely ( a )the specific characteristics of the property transferred or services provided in either transaction; ( b )the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; ( c )the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k assumed by respective parties to the transaction shall be one of the criteria for the purpose of comparability. The assessee is engaged in the business of development of software while Kushal Software Ltd. is engaged in the business of trading in software. The two companies are performing totally different functions and, therefore, this case is not a valid comparable case. The differences in the business models are irreconcilably different and no reasonably accurate adjustment can be made to make them comparable cases. The learned Authorised Representative was not able to furnish any valid reason for taking this to be a comparable case under rule 10B. In view of the basic difference in business models, we need not refer to the case law to come to the conclusion that the aforesaid Kushal is not a valid comparable case. Therefore, we are of the view that the learned Departmental Representative rightly argued that this case was not a comparable case. 5.4 Coming to the annual accounts of Tera Software Ltd. for financial year 2001-02, it is seen that the company has taken three activities of sales, technical services and sales of software. The sales amounted to about Rs. 5.60 cror ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the learned CIT(A). On the other hand, the case of the learned Authorised Representative is that the company is in a totally different line of business, i.e., public transport solutions and e-governance, while the assessee is engaged in the area of energy. It is also seen that all the sales of the company are domestic sales while all the sales of the assessee are export sales. Therefore, not only the area of functioning is different but market conditions prevailing in the two cases are also geographically different. Therefore, we are of the view that this case also does not meet the conditions mentioned in rule 10C(2). As the geographical conditions are quite different, which affect the profit ratio, we do not need guidance from any decided case to come to the aforesaid conclusion. 5.6 We have also perused the annual accounts of Datamatics Technology Ltd. The directors report mentions that the company is an early entrant in the IT enabled services/Business Process Outsourcing industry, (BPO). On the cover of the report, it is mentioned that the company spearheaded the BPO activities in India through pioneering pursuite of knowledge management services. The total income o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... development company. That is why, it has to incur expenses on selling and distribution and suffer the risk of debts going bad. Therefore, we are of the view that this is also not a comparable case under rule 10C(2)( b ). 5.8 Thus, we are left with only one comparable case of Soffia Software Ltd., whose profit is about 12.86 per cent. Both the parties have accepted, it to be a valid comparable case and, therefore, we are of the view that the ALP should be determined on the basis of this case as a comparable case. 6. In terms of ground No. 3, it was agitated before us that the learned CIT(A) ought to have granted adjustment in respect of working capital and risks in terms of rule 10B(1)( e )( iii ), wherein it is mentioned that the profit margin arising in the comparable uncontrolled transaction has to be adjusted to take into account the difference arising from a factor which materially affects the net profit margin in the open market. 6.1 In this connection, the main argument taken before the learned CIT(A) is that the TPO selected the cases which had incurred large debts. As against that, the assessee received advance from its parent company in the vicinity of about R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e margin has not been examined by the lower authorities as they simply refused to make adjustment in this regard. Therefore, we restore this matter to the file of the Assessing Officer to consider the working furnished by the assessee and decide the ground of adjustment after hearing the assessee. However, such adjustment shall now be worked only on the basis of the accounts of Soffia Software Ltd. Thus, ground No. 3 is restored to the file of the Assessing Officer for fresh decision to the extent of making this adjustment. 6.3 Coming to the risk factor, the assessee did not furnish the terms of agreement with the Vedaris, UK. The assessee is bearing risk associated with software development by providing onshore and offshore after-sale service. Therefore, there is no way in which such adjustment can be computed. Similarly, no data is available to compare R D expenses. However, the overall adjustment in respect of all the three grounds is sought on an ad hoc basis at 20 per cent on the basis of decisions in the case of Sony India (P.) Ltd. ( supra ) (12/1 of the paper book). However, no firm calculation has been furnished. In absence of such calculation, we are of the view t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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