TMI Blog2013 (2) TMI 607X X X X Extracts X X X X X X X X Extracts X X X X ..... ightly held by the TPO that the assessee is not into simple software development but is engaged in research and development in technical and engineering services on contract basis. Therefore, the TPO has rightly rejected the TP study conducted by the assessee and has rightly proceeded to select his own comparables in the field of Research and Development and redetermine the ALP - against assessee. Whether the comparables adopted by the TPO are relevant and comparable to the assessee - Held that:- As rightly pointed out by the TPO and the CIT(A)/DRP for the relevant assessment years, the assessee is not in the business of software development but it is in the business of research and development in various fields of engineering including the computer software. The outcome of the research and development conducted by the assessee is delivered to the customers/AE through electronic media. The mode of delivery of result of research and development cannot determine the nature of the functions/activities of the assessee. Therefore, the TPO was right in conducting search on the data base 'prowess' using the word 'research and development' Adoption of Vimta Labs as a comparable - Hel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fixed in loan agreement in computation of ALP. Exclusions of telecommunication expenses and travelling expenses incurred in foreign currency from the export turnover but not making the corresponding reduction from the total turnover for the purpose of computation of deduction u/s 10A - Held that:- As decided in Tata Elxi Pvt. Ltd. [2011 (8) TMI 782 - KARNATAKA HIGH COURT] when any expenditure is reduced from the export turnover, then the same should also be reduced from the total turnover for the purposes of computation of deduction u/s 10A. - IT APPEAL NOs. 789 (BANG.) OF 2010 and 487 & 925 (Bang.) of 2011 - - - Dated:- 31-12-2012 - Smt. P. MADHAVI DEVI AND JASON P. BOAZ, JJ. N.V. Venkataraman and Pawan Sharma for the Appellant. S.K Ambastha for the Respondent. ORDER P Madhavi Devi, Judicial Member - These appeals are filed by the assessee. The relevant assessment years are 2004-05, 2005-06 and 2006-07. The appeals for the assessment years 2004-05, 2005-06 are directed against the order of the Commissioner of Income-tax - (Appeals) - IV at Bangalore dated 30.03.2010, while appeal for the assessment year 2006-07 is against the order of the Assessing Of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onal transactions are in the nature of 'Service Provider' working for 'Research and Development' and not 'Software Development' as claimed by the assessee. We shall deal with this issue first. 8. According to the assessee, it has entered into international transactions with its associated enterprises for export of customized electronic data, computer software and any other tangible articles or things as a result of research activity. Therefore, the assessee while conducting its TP study has adopted/chosen the comparables which are all in the field of 'development and export of computer software'. The Assessing Officer made a reference to the transfer pricing officer u/s 92CA of the Act for determination of the ALP (Arms Length Price). During the proceedings u/s 92CA of the Income-tax Act, the TPO observed that the assessee is providing contract services of research and development and other services in various fields of engineering. As per the service agreement dated 13.6.2001, assessee has to provide the following services to the party making such request. Identifying business opportunities and carry out research and development/other services in the following services : ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Information Technology Centre (e) Electrical Systems Technology Laboratory (f) Industrial Engineering Laboratory (g) Advanced Mechanical Engineering Laboratory 3. GEITC employs various qualified scientists and researchers and engineers to carry out research and software development activity in high impact technology areas such as Electromagnetic Analytics, Color Technology, Additive Technology etc. 4. The Scientists and Engineers engaged to carry out the said activity are equipped with highly advanced software development tools and also sophisticated equipments such as NMR, High End Analytical Equipment, High End IT Servers, HPC Nodes, Clean Room Equipment etc. The scientists and engineers employed by the company are highly qualified and company is having more than 600 PhDs and 1000 Masters, who are qualified in the various areas of High Impact Technology. 5. The kind of programs and projects that are provided by the overseas GE affiliate companies can be categorized as NPI (New Product Introduction) projects, products enhancement programs; productivity programs and RTS (Ready to Serve) programs. Inputs along with the clear deliverables are discussed befor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rgi India Co. Ltd. (3) Vimta Labs Ltd. 13. He found that the net profit of Vimta Labs was 61.7%, Lurgi India Co. Ltd. was 18.9% and Alphangeo India Ltd. was 56.25% and the average margin of the comparables was 45.6% as compared to that of the assessee at 16.26%. Therefore, he issued a show cause notice to the assessee proposing to make the transfer pricing adjustment u/s 92CA of the Act. The assessee however, submitted its objections vide letters dated 20.11.2006 and 24.11.2006. The assessee vide letter dated 5.12.2006 filed a summary of its objections stating that the comparables adopted by the TPO did not satisfy the FAR analysis with that of the assessee. The TPO, however held that the assessee is providing 'Research and Development' services and not 'computer software development services' as claimed by the assessee and that the delivery model cannot be confused with the functions and that the service agreements of the assessee with its affiliates as well as the information available from the website do not speak of software development and, therefore, the enterprises developing software cannot be used as comparables. As regards the risk free environment in which the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d., Alphangeo India Ltd. and Lurgi India Co. Ltd., the assessee is in appeal before us. Similarly for the assessment year 2005-06 also the assessee is in appeal before us against the adoption of Vimta Labs and Alphangeo India Ltd. as comparables for making the TP adjustments. For the assessment year 2006-07, the assessee is aggrieved by the adoption of Vimta Labs Ltd., and Celestial Labs Ltd., as comparables by the TPO and as confirmed by the DRP. 16. The learned Sr. counsel for the assessee, Shri N.V Venkataraman, while reiterating the assessee's submissions made before the authorities below for all the three years, submitted that there are no additions made on account of TP adjustments for assessment year 2004-05 and 2005-06 and, therefore, the grounds are only on erroneous inclusion of certain comparables as these comparables have been adopted by the TPO for the assessment year 2006-07 also without giving any opportunity of hearing and adjustment was made to the ALP. On the nature of assessee's activities, the learned counsel for the assessee submitted that the assessee is exporting the computer programs, customized electronic data and engineering analysis and designs. He subm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is engaged in research and development in technical and engineering services on contract basis. Therefore, the TPO has rightly rejected the TP study conducted by the assessee and has rightly proceeded to select his own comparables in the field of Research and Development and redetermine the ALP. 20. The next question to be considered by us is as to whether the comparables adopted by the TPO are relevant and comparable to the assessee. For assessment year 2004-05, the assessee's objection is to the adoption of Vimta Labs, Alphageo Labs, Lurgi India Co. Ltd., while for the assessment year 2005-06 ad 2006-07, the assessee's objection is against the adoption of Celestial Labs and Vimta Labs as comparables. But before us, the learned counsel for the assessee has advanced arguments contesting the adoption of Vimta Labs, Celestial Labs only, as they have resulted in adjustments to the ALP for assessment year 2006-07. It is submitted by the learned counsel for the assessee that in the show-cause notice issued by the TPO, Vimta Labs and Celestial Labs did not find place, but in the final TP order, these two companies have been considered as comparables and their margins considered which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Vimta Labs for the assessment year 2006-07 as compared to the assessment years 2004-05 and 2005-06 and, therefore, its reclassification in the database as a Drug Company for the assessment year 2006-07 shows that Vimta Labs was wrongly classified as 'Technical Consultancy and Engineering Services' or 'R D' for assessment years 2004-05 2005-06. He further submitted that the subsequent classification/reclassification continues till date which also establishes that reclassification truly described the activities carried out by Vimta Labs right from the assessment years 2004-05 onwards and, therefore, for the assessment year 2006-07, Vimta Labs did not appear in the search criteria but the TPO has cherry picked Vimta Labs only because the same was selected in the assessment years 2004-05 and 2005-06. 23. The learned counsel for the assessee further submitted that even as per the FAR analysis, the Vimta Labs could not have been selected as a comparable for the following reasons : (I) Functions Performed : (1) Vimta is a clinical trial company and is engaged in conducting testing of new pharmaceutical drugs on humans and animals to study the effects of drugs, side effects ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by its experiments on the humans. (c) Regulatory risks : Chemical trails industry is increasingly being regulated and profitability of participants would also depend upon regulatory changes. 24. In addition to the above, the learned counsel for the assessee submitted that the TPO has himself adopted the filter of employee cost being less than 25% as a filter for rejecting various companies shortlisted by the assessee. He submitted that the TPO should follow uniformly the same filter while searching for and adopting the comparables. He submitted that Vimta Labs fails the employee cost filter adopted by the TPO as employee cost of the assessee is 32% in 2004-05, 38% in 2005-06 and 42% in 2006-07 as against the employee cost of Vimta Labs being 13% in 2004-05, 14% in 2005-06 and 16% in 2006-07. As the employee cost of Vimta Labs is less than 25% in all the three assessment years, according to the learned counsel for the assessee, it should be excluded from the list of comparables. 25. As regards the adoption of Celestial Labs as a comparable, the learned counsel for the assessee submitted that it is also functionally different from the assessee because of the following featur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... free model. He submitted that being a product-company dealing in medical products, Celestial bears significant product liability risks and is also subject to clinical trials segment subject to same risks as Vimta Labs. 28. Thus, according to the learned counsel for the assessee, both Vimta Labs and Celestial Labs should be excluded from the list of comparables and if done so, the assessee's margin would fall within the ALP of the comparable companies or + 5% thereof and no adjustment would be necessary. 29. The learned DR however, placed reliance upon the orders of the authorities below and submitted that the CIT(A) in his order for the assessment year 2004-05 has discussed at length the nature of the activities of the assessee and the functions performed to hold that the assessee was a service provider working on research and development and also doing engineering analysis and the results of which are captured/computerized and transferred through electronic media, which are merely means of delivery to the AE. 30. As regards the adoption of Vimta Labs as a comparable, he submitted that the assessee is into contract 'Research and Development' as in the case of Vimta and Celes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esult of research and development cannot determine the nature of the functions/activities of the assessee. Therefore, the TPO was right in conducting search on the data base 'prowess' using the word 'research and development'. 33. Now comes the question of selection of comparables. The learned counsel for the assessee has forcefully argued that even if the assessee is to be considered a Research and Development company, then the comparables have to be of the same industry in which the assessee is doing research and development. If this argument of the learned counsel for assessee is accepted, then the comparables selected/shortlisted by the assessee from the ITES Industry are also liable to be rejected as they are not from the same industry. Thus, the argument of the learned counsel for the assessee that the functions are synonymous with or analogous to the industry and the comparable companies have to be from the same industry for comparability analysis under TNMM is not in tune with the principles enunciated by the guidelines of OECD or United Nations Manual which advocate that under TNMM only broad functional and product comparability is to be considered as net margins are les ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and allied products' for A.Y 2006-07. Hence, it was selected as a comparable by the TPO only because of wrong classification in the earlier years. The issue of regarding wrong classification of the company in the database has been raised by the assessee for the first time before us. There is no mention of the same in any of the documents in our record. Whether the change in classification is due to wrong classification in the earlier years or whether there was a change in functional profile necessitating such a change in classification needs to be examined. (ii) As per the FAR analysis, it cannot be selected as a comparable. It is a clinical trial company engaged in testing of new pharmaceutical drugs and works on franchisee model. It has significant investments in tangible and intangible assets and the assets/sales ratio is substantially higher. Being an entrepreneurial company, it assumes significant risks and also has high liability risk due to human involvement and life threatening nature of the clinical trials. The assessee's contention that it is a clinical trial company is only partly true. As the TPO has mentioned, it is into multi-disciplinary research services. It ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company and that the Indian subsidiary engaged in core functions, such as carrying out research and development activities or providing services are risk free entities is something which needs to be demonstrated by the assessee. The conventional wisdom is that the core function of R D services are located in India, which in turn require important strategic decisions by management and employees of Indian subsidiaries or related party to design the direction of R D activities or providing services and control over the operational and other risks. In these circumstances, the ability of the parent company to exercise control over the risk - remotely and from a place where core functions of R D and services are not located - is very limited. Under these circumstances, the claim of the assessee that it is totally risk free is not acceptable. However, the relative risk profile of the comparable company, particularly on the factors of human involvement in the clinical trails needs to be evaluated and a determination made whether such differences in risk needs to be adjusted or whether such risks are not amenable for adjustment at all, as claimed by the assessee. In view of all the abov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o adoption of Lurgi Labs in AY 2004-05 only while no objection was raised for its adoption in AY 2005-06 either before the CIT(A) or before this Tribunal. This is probably because Lurgi Labs incurred loss during AY 2005-06 which when considered by the TPO has resulted in lower arithmetic mean benefitted the assessee. 42. Further, we also had an opportunity to go through the TP order and assessee's objection to the TPO for AY 2008-09 the copies of which are filed by the assessee before us in connection with the other issue arising in the appeal for A.Y 2006-07 i.e., the TP adjustment made towards interest on external commercial borrowing. We find that for the A.Y 2008-09 also, the TPO proposed to adopt Vimta Labs and Celestial Bio Labs Ltd. as comparables with margins of 18% and 88% respectively. From the reply of the assessee to the show cause notice of the TPO proposing TP adjustments, we find that the assessee had raised objections to Celestial Labs and Engineers India Ltd. and Oil Field Instrumentation India Ltd but did not raise any objection to adoption of Vimta Labs as a comparable for A.Y 2008-09, which goes to show that it has accepted Vimta Labs as a comparable for the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AO as regards the computation of deduction u/s 10A of the Income-tax Act. 46. The brief facts of the case are that for the assessment year 2004-05, the assessee earned a profit of Rs. 10,90,56,643/- from 10A undertaking and incurred a loss of Rs. 1,90,02,182/- from non-10A business activities. Further, the assessee also had brought forward losses of 10A undertaking for the assessment year 2002-03 and 2003-04 aggregating to Rs. 22,95,47,384/-. In its return of income for the assessment year 2004-05, the assessee computed its total income by first claiming the deduction of profit u/s 10A of the undertaking at Rs. 10,90,54,643/- and thereafter the set off of carried forward losses of non 10A business activities of Rs. 1,90,02,182/- and also the brought forward losses of 10A undertaking at Rs.22,95,47,384/-. The Assessing Officer however computed the deduction u/s 10A of the Income-tax Act after first reducing the profits of the 10A undertaking by brought forward losses of 10A undertaking from the earlier years and thereafter further reduced the income by the losses from the non-10A undertaking and thereafter arrived at 'Nil' deduction u/s 10A of the Act. Against the said computatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such loss is eligible to be carried forward in the post tax holiday period and, therefore, for the relevant assessment year, the question of setting off of the loss of current years or the previous brought forward business losses of units against the profits of 10A unit does not arise. This issue is also covered by the other decisions relied upon by the learned counsel for the assessee. 50. Respectfully following the decision of the jurisdictional High court, we hold that the losses of non 10A units cannot be set off against the profits of 10A unit and the brought forward losses of 10A units for the assessment years 2002-03, 2003-04 cannot be set off against the current years 10A profits but can be set off against the profits of the post-tax holiday period. This ground of appeal is accordingly allowed. 51. In the result, the appeal for the assessment year 2004-05 is allowed. 52. For the assessment year 2005-06, the only issue is with regard to the transfer pricing adjustment made on account of research and development activity carried on by the assessee and as the issue has already been remanded to the file of the AO/TPO in our order for the assessment year 2004-05, this grou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the case of ITO v. Maharishi Solar Technology (P.) Ltd. in ITA No.4561 and 4393 of 2009. Thus, the learned AR prayed that the addition relating to the above adjustment may be deleted. 56. The learned DR, on the other hand, supported the orders of the authorities below and submitted that for the earlier assessment years, the TPO has not examined the issue at large/length and, therefore, it cannot be said that the issue has been decided on merits in favour of the assessee. In support of his contentions regarding the interest rate on ECB to be adopted for the relevant A.Y, he submitted that two loans or external commercial borrowings were between two cross border entities and, therefore, resulted in an international transaction and each transaction has to be considered every year whether the same is at ALP as the rate of interest on such loans is integral part of determination of ALP. In support of his contention, he placed reliance upon the decision of the Delhi Bench of the Tribunal in the case of Perot Systems TSI (India) Ltd. v. Dy. CIT [2010] 37 SOT 358 (Delhi). 57. Having heard both the parties and having considered their rival contentions, we find that two ECB loans have ..... X X X X Extracts X X X X X X X X Extracts X X X X
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