TMI Blog2013 (8) TMI 812X X X X Extracts X X X X X X X X Extracts X X X X ..... aced on record and instead embarking upon a less direct benchmarking exercise by resorting to comparison of profits of external comparables - The internal comparables available in case of an assessee are to be preferred for the purpose of benchmarking of international transactions even in the case where TNMM is applied, instead of relying on external comparables - Decided in favour of assessee. The revenue derived from unrelated party transactions at 20.30% of the aggregate revenue of the appellant, cannot be the reason for disregarding internal comparability analysis undertaken by the appellant. It would be appreciated that the appellant in the course of its business enters into several software development contracts of small volume. TPO in his order, while conducting fresh search has selected companies with turnover in excess of 1 crore. However, the TPO himself has rejected the internal comparable with a turnover of 2.97 crores used by the appellant for benchmarking analysis, holding is to be very small as against the sales made to associated enterprise. Since the TPO himself has accepted companies with turnover more than 1 crore, this argument of the TPO seems inconsisten ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessing officer u/s 143(3) after seeking directions from DRP u/s 144C(13) of the Income-tax Act, 1961 ("the Act"). Both the appeals are heard together and disposed of by this common order for the sake of convenience. 2. The principal grounds of appeal, common in both the years under consideration, raised by the appellant are as under; others being supplementary and argumentative grounds are not pressed hence dismissed. 2. That the assessing officer erred on facts and in law in making an addition of Rs. 129,356,670/- (A.Y. 2007-08) Rs. 17,28,83,745/- (A.Y. 2008-09) on account of the alleged difference in the arm's length price of the 'international transaction' of (i) provision of software services, and (ii) marketing support services, on the basis of the order passed under section 92CA(3) read with section 144C(5) of the Act by the Transfer Pricing Officer ("the TPO"). 2.1. That the assessing officer / DRP erred on facts and in law in disregarding the internal benchmarking undertaken by the assessee for determining the arm's length price of the international transactions applying TNMM on the ground that (i) the transactions undertaken with unrelated party at 20.60% of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s with its associated enterprise, viz., Hughes Network Systems, USA. 3.2. This international transaction of rendering of software development services to the associated enterprise was reported to be at arm's length in the following manner by the appellant: (i) Benchmarking of international transaction of software development services applying TNMM considering internal comparables. 3.3. Besides undertaking software development for the associated enterprise, viz., Hughes Network Systems Inc., USA, the appellant also entered into direct contracts with other unrelated party customers during the relevant previous years. Since an internal comparables were available for benchmarking the international transactions of provision of software design and development services, the appellant applied Transactional Net Margin Method ("TNMM") as the most appropriate method and considered internal comparables for applying TNMM. The result of the benchmarking analysis, as aforesaid, is tabulated as under: Onsite software development services 7.55% -9.29% Offshore software development services -50.81% -56.73% 3.4. In respect of the internation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d from associated enterprise for providing onsite software development services was higher than the price charged from unrelated party, such international transaction of rendering of onsite software development services were to be considered being at arms length price TPO's/DRP's orders: 3.9. The TPO in his report disregarded the internal benchmarking analysis undertaken by the appellant applying Transactional Net Margin Method ("TNMM"), holding that transactions with unrelated party constituted minor share of 20.30% of the total transactions and, therefore, did not provide a robust measure of comparability and further, internal benchmarking was adopted by the appellant to gloss over entity level loss. 3.10. The Dispute Resolution Panel (DRP), affirming the conclusions of the TPO, held that "in view of DRP, internal comparables can be used but only if they provide a correct measure of comparability. If the transaction with non AEs constitutes a minor share of 20.60% of total transaction it cannot provide a robust measure of comparability as considerations other than market factors can be embedded in it." 3.11. The TPO has, instead, undertaken the benchmarking analysis apply ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ently DRP's order also becomes non speaking in nature. 4.3. Consequent to such non speaking rejection of its comparable, the assessee has collected the aforesaid additional evidence from its associated enterprise. The same becomes necessary for consideration by way of additional evidence. Without the consideration of this evidence the T.P. adjustment will remain lopsided based on surmises. 4.4. The prices of comparable uncontrolled transactions of software development services on offshore basis received by the associated enterprise, viz., Hughes Network Systems Inc. and from unrelated party, viz. Aricent Technologies India Limited, which are lower than what is charged by the appellant, as under: Nature of service Per Man Month rate paid to appellant Per Man Month rate paid to unrelated party Software Development USD 3834 3700 (till 31.12.2007) USD 4000 (01.01.2008 onwards) USD 3700 (Up to December, 2010) 4.5. Since price paid by Hughes Network Systems Inc. to the appellant (USD 3700-4000) is higher than the price paid to unrelated parties, i.e. Aricent Technologies India Limited (USD 3700) for the offshore software developme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decide the ALP these documents are very relevant. 5. Ld. CIT(DR) is heard on admission of additional evidence, who opposed the admission of additional evidence. 6. On merits, it is pleaded by the ld. Counsel that the international transactions of rendering of offshore software development services as well as onsite software development services, therefore, have been validly demonstrated to be at arm's length applying CUP method. Therefore, such adjustment calls for being deleted in respect of prices of such international transactions on following contentions: 6.1. Regarding international transactions of software development services, ld.Counsel contends that: (i) Re: CUP method being the most direct method is to be applied. 6.2. Rule 10B(1)(a) of the Income-tax Rules ("the Rules") provides that for application of CUP, the price charged or paid for services provided in a comparables uncontrolled transaction or a number of such transactions are to be compared with price charged from international transaction undertaken by the enterprise (tested party) from the international transaction undertaken with an associated enterprise. Rule 10B(1)(a) of the Rules reads as follows: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the case of ACIT vs. MSS India (P) Ltd.: 123 TTJ 657, wherein, the appellant had determined the arm's length price of the international transactions with associated enterprise applying CUP/ Cost Plus method. The TPO, however, rejecting the application of CUP/ Cost Plus method by the appellant, made adjustment applying TNMM. The Tribunal, while holding that the TPO was not justified in rejecting the CUP/ Cost Plus method, which was transactional based method, and instead making adjustment applying TNMM even if the assessee has suffered loss in those transactions with its associated enterprise, observed as under. "However, whenever necessary inputs for applying one of these methods are available and there is no dispute about comparability of those inputs, there is no good reason to resort to transactional profit methods. It would thus follow that in a situation in which the assessee has followed one of the standard methods of determining ALP, such a method cannot be discarded in preference over transactional profit methods unless the revenue authorities are able to demonstrate the fallacies in application of standard methods. In any event, any preference of one method over the othe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ), too, held that internal comparable should be preferred over external comparables. The relevant extract of the judgment is reproduced below: "Internal CUP method envisages comparing the uncontrolled transactions of the appellant itself with other unrelated parties so as to determine the ALP with the AE. However the External CUP method disregards the price charged or paid by the appellant to or from its unrelated parties and contemplates the comparison of the price so charged from or paid to its AE with some external independent reliable price data under similar circumstances of transactions with AE. Ordinarily the Internal CUP method should be preferred over the External CUP method as it neutralizes several distinguishing factors, such as the local factors and the economies available or unavailable to the appellant in particular, having bearing over the comparison of price charged from unrelated parties and AE." 6.10. In case of the appellant, it would be appreciated, the most direct comparison has been provided by way of comparable uncontrolled transactions entered into by the associated enterprise with unrelated parties, in India, for rendering similar software development ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at an arm's length price in relation to the international transaction." 6.13. The internal comparables available in case of an assessee are to be preferred for the purpose of benchmarking of international transactions even in the case where TNMM is applied, instead of relying on external comparables, as provided in Paragraph 3.26 of the OECD Guidelines which reads as under: "3.26. The transactional net margin method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction or transactions that are appropriate to aggregate under the principles of Chapter I). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter I) should ideally be established by reference t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vt. Ltd. vs. ACIT (ITA No. 4608 5085/Mum/2010), while explaining the import of clause (i) of Rule 10B(e) of the Act, held that the rule itself provides that preference shall be given to internal comparable uncontrolled transactions vis- -vis externally comparable uncontrolled transactions. (ii) The Hon'ble Tribunal in the case of Birlasoft (India) Ltd. vs. ACIT 136 TTJ 505, too, upheld the internal benchmarking analysis undertaken by the appellant while justifying the international transactions of provision for software development services as at arm's length applying TNMM as against external benchmarking referred by the TPO. Further, the revenue is not before the High Court on the issue of internal comparability. (iii) On the same lines, the co-ordinate bench of Delhi Tribunal in the case of Destination of the World vs. DCIT [ITA No 5534/Del/2010] and Interra Information Technologies India (P) Ltd. Vs. DCIT (ITA No. 5568 5680/Del/2011), too, held that transfer pricing analysis should be done by taking recourse to internal uncontrolled transactions. (iv) Reliance is also placed on the decision of Hon'ble Mumbai Bench of the Tribunal in the case of UCB India (P) Ltd. v ACIT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are development services rendered to the associated enterprise, calls for being deleted. 6.22. The international transactions of rendering software development services having been established to be at arm's length, the Transfer Pricing adjustment of Rs.3,80,75,810 made by the TPO, is, therefore, liable to be deleted. II. Transfer Pricing adjustment of Rs. 9,12,80,860 in respect of international transactions of payment of marketing and management support services: 6.23. The appellant has entered into an agreement dated 1st April, 2006 with the US associated enterprise, viz., Hughes Systique Corporation ("HSC USA") for availing the following marketing and management support services: (a) assisting the appellant with sales promotion of the products/ services. (b) obtains customers and solicit orders and sell the appellant's products/ services, its licenses and services. (c) Rendering of strategic and leadership services to the appellant, i.e. performing regular reviews of operations of the appellant and including reviewing of financial statements, staffing status, cash flow requirement, facilities management, etc. (d) Formulation of business strategies for the appellant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cept for c d the other services can be rendered directly from India in view of instant communication facilities at the most a liaison office is required. So to have an AE exclusively for such services seems inappropriate and if AE is surviving only on mark up for its income, no wonder it is in losses. The losses in the circumstances appear to be contrived. As far as c d is concerned how effectively can such services be rendered is also a moot point. These services are needed to be performed locally either inhouse or by a local party which knows local business environment. Services at d are being rendered for the querist in US and can perhaps be considered as being actually provided actually. But there is no way of quantifying them and establishing their veracity. So, on the whole after considering TPO's reasons and our own analysis, DRP concurs with the disallowance made by the TPO." Assessee's contentions on AO DRP order: 8. There is no bar under the Act to have transactions with the group companies and the querist is free to conduct business in the manner most suitable to it and the commercial or business expediency of incurring any expenditure is to be seen from the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above. ...... So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised." 8.4. The Tribunal in the case of M/s. Ericsson India Pvt. Ltd. vs. DCIT (ITA No. 5141/Del/2011), too, following the law laid down by the Hon'ble jurisdictional High Court, held that "..... it would be wrong to hold that the expenditure should be disallowed only on the ground that these expenses were not required to be incurred by the assessee......." 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stion whether an intragroup service has been rendered when an activity is performed for one or more group members by another group member should depend on whether the activity provides a respective group member with economic or commercial value to enhance its commercial position. This can be determined by considering whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity in-house for itself." 9.1. The assessee does not conduct any sales or marketing activity for promotion of its products and services outside India. Further, the appellant does not have any marketing or sales office outside India for selling its services to independent third parties. HSC, USA on behalf of the appellant is inter-facing the customers and soliciting the software development business. The associated enterprise has the necessary contacts and network to reach the customers to get the business for the appellant. The appellant on the other hand does not have any other person or network and therefore depends solely on HSC USA for selling the products and services of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as laid down by the OECD Guidelines. 10.4. The Transfer Pricing adjustment made by the TPO in respect of international transactions of payment of marketing and management support services amounting to Rs.9,12,80,860, therefore, is not sustainable and is liable to be deleted. Re: Ground of appeal Nos. 4: 11. The appellant in the relevant previous year claimed depreciation @60% on the purchases of computer accessories and peripherals amounting to Rs. 4,329,055. 11.1. The assessing officer restricted the claim of depreciation on computer peripherals at 15% as against 60% claimed by the appellant stating it to be a part of plant and machinery and accordingly made the disallowance of Rs. 1,495,560. 11.2. It is a settled proposition that a 'computer system' comprises of not only the central processing unit (CPU) but also all input / output devices including printer, monitor and other devices, etc. Reference is made to CIT vs. IBM World Trade Corporation : 130 ITR 739 (Mum). 11.3. Further, the issue stands covered by the decision of Special Bench of Mumbai Tribunal in the case of DCIT vs. Datacraft India Ltd. (2010) 6 Taxman.com 85 and Delhi High Court in the case of CIT v. BS ..... X X X X Extracts X X X X X X X X Extracts X X X X
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