TMI Blog2013 (9) TMI 120X X X X Extracts X X X X X X X X Extracts X X X X ..... de for such capping of an adjustment. Such an exercise is not permissible under the Transfer Pricing provisions but also, it is not practical as the profits of the entire group are not subject to scrutiny of the Indian authorities. Multinationals have innumerous types of business and have multiple locations with multiple AEs and to lay down such a proposition would make the transfer pricing provisions unworkable. Under the Indian law, the T.P.O. is given a mechanism to determine ALP and make an adjustment. Such power is not subject to the acts of the assessee or it’s A.E. in different jurisdiction. No Transfer pricing adjustment required as the assessee’s income is liable to deduction u/s 10A – Held that:- Relying upon the judgment in the case of Aztec Softwar [2007 (7) TMI 50 - ITAT BANGALORE], the contention of the assessee is rejected – Transfer Pricing adjustment to apply. Adjustment in Transfer Pricing due to risk factor involved - Assessee has come out with this claim of being a captive service provider and hence an adjustment has to be given – Held that:- Any claim for adjustment, on the basis of risk or any other factors, has to be based on proper data and sound calcu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s to which transaction can be taken as a comparable uncontrolled transaction for the purpose of benchmarking the net profit margin with the controlled transaction. Thus the reasoning of both the parties on the issue does not fit into the facts of this case and has to be rejected. In the present case, in the assessment year 2007-08, the assessee has uncontrolled comparable transactions with third parties in export segment to the tune of 15% of total turnover - It has uncontrolled transactions with the third parties in the domestic sector to the tune of 10% of the total turnover. Thus the uncontrolled transactions are significant part of total turnover of the assessee. The argument of the TPO for both the years is that the comparable is miniscule in nature and fails on the comparability of volumes or scale of operation. This argument and finding of the TPO is factually incorrect for the A.Y. 2007-08. 15% of the total turnover is sufficient sample which can be used for the purpose of benchmarking, provided the transactions are functionally comparable. Even domestic uncontrolled transactions are about 10%. In case domestic transactions are functionally comparable these transactions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng intranets and Microsoft Exchange based work flows. Interra KIT India is also engaged in developing software applications on the IBM Mainframe. Focussed on financial and revenue management, these applications are hosted on the MVS and OS/390 platforms on IBM s newsiest S/390 series Mainframe with Parallel Sysplex. The software is developed on Cobol and Assembly language, and uses DB2/5.x as the RDBMS and CICS 4.x as the transaction processor. The R D center is connected online to the Microsoft Developer Network as well as IBM Developer Connection to have access to technology as it emerges in the market. The majority of consultants have an advanced degree in engineering from reputed institutions and considerable years of software development experience in top branded international software companies. The team has significant experience of executing complex software projects for high-profile global customers. To maintain consistency in quality, the company has adopted the best of practices in developing software with strict compliance to object-oriented modeling techniques, use of CASE tools and adhering to component-based development. To ensure that the engineers are in tune ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee used multiple year data. 8. The Transfer Pricing Officer rejected the use of multiple year data by the assessee. He relied on the Special Bench decision in the case of Aztec Software Technology Services Ltd., 294 ITR (AT) 32 and other decisions and only data for the year 2006, which would be the current year data, was taken for the purpose of benchmarking. A show case notice was issued to the assessee by the Transfer Pricing Officer, proposing an additional filter of wages to sales ratio, to the comparables used by the assessee, on the ground that wages and salary constitute a major part of the cost incurred by IT/ITES companies in India. He proposed to treat only those companies which have wages/sales ratio between 45% to 65% as comparable companies. Applying this he arrived at only eight comparable companies. 9. Thereafter the TPO proposed two more additional filters (i) Negative ROG Sales; (ii) Declining operating profit. By this, he further reduced the comparables to five. 10. The assessee objected by stating that internal comparables should be used for benchmarking. Certain Other Objections were also raised by the assessee against the show cause notice, which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eld that, being a captive service provider is itself a big risk as the assessee is dependent on only the AE. He also referred to other risks like human capital risk, intangible etc. Further the TPO held that reasonable accurate adjustment for risk cannot be done. He analyzed various risks and came to a conclusion that no risk analysis was conducted by the assessee and that the assessee has not discharged its initial onus and hence its claim for risk adjustment cannot be granted. 18. The other argument of the assessee such as, it has no intention to shift profits etc. was rejected based on the various judicial pronouncements. Thereafter the TPO has computed the arm s length price at a margin of 16.3%, being arithmetic mean of the final set of four comparables. The assessee has carried the matter before the Dispute Resolution Panel (DRP). The objections were filed. The DRP rejected the objections raised by the assessee by approving the reasoning and finding given by the Transfer Pricing Officer. 19. Aggrieved the assessee is before us on the following grounds:- 1. That the assessing officer erred on facts and in law in completing assessment under section 144C/143(3) of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee that the companies having wages to sales ratio within the band of 42%-62%, (i.e. +/- 10%) should be selected so as to benchmark the international transactions undertaken by the appellant. 2.9 That the assessing officer / TPO erred in rejecting Genesys International Corp. Ltd., Compulink Systems Ltd. as comparables allegedly holding that there has been decline in the sales without considering the financial results of subsequent years. 2.10 That the assessing officer / TPO erred in rejecting Ram Informatics Ltd as part of comparable companies on the reasoning of declining operating profitability and continually loss making company. 2.11 That the assessing officer / TPO erred in not considering the actual computation of operating profitability of Ram Informatics Ltd. furnished by the appellant without appreciating that the operating profit of the company has increased as compared to the preceding year. 2.12 That the assessing officer / TPO erred in rejecting the claim of the appellant that the profitability of only Software development segment of SoftPro Systems Limited should be considered. 2.13 That the assessing officer / TPO erred on facts and in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price of the 'international transactions' 3. That the assessing officer erred on facts and in law in denying deduction amounting Rs.I,93,30,9451- under section 10A of the Income-tax Act, 1961 ('the Act') in respect of profits of Noida Unit, i.e. the undertaking set up in Noida Export Processing Zone ('NEPZ'). 3.1 That the assessing officer erred on facts and in law in holding that the appellant is not entitled to claim deduction under section 10A of the Act by merely following the assessment orders for the assessment years 2002-03 and 2003- 04 even though the said orders have been reversed by the Tribunal. 20. The learned counsel for the assessee Shri Ajay Vohra submitted that the assessee is engaged in the business of rendering low end software maintenance services. His submissions are as follows (a) Internal comparisons are available for the purpose of benchmarking and this should be referred. (b) Rejection of internal comparables on the ground stated by the TPO is unlawful and unsustainable in view of Rule 10B(1)(e) wherein the profit margin from transaction is required to be compared. (c) The Third Member Bench of the Mumba ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee company was essentially a software development company and not an ITES/BPO company and hence, this filter cannot be applied. 27. On excluding comparable companies with negative ROG-Sales i.e. (a) Genesys International Corpn. Ltd. (OP/OC 3.49%); (b) Compulink Systems Ltd. (OP/OC (-) 4.65%), he referred to the objections filed before the DRP which is at pages 47 and 29 of the Paper Book and argued that there has been increase in sales of all the aforesaid companies in the subsequent years and hence, elimination of these comparables on the ground of trend of having negative ROG-Sales is factually not correct. 28. On exclusion of other comparables, he submitted as follows a) On Ram Informatics Ltd. Five years data was produced to demonstrate that the operative margin was actually increasing and hence the facts are wrongly stated by the TPO and the comparable has been wrongly rejected. b) On comparable accepted by the TPO, he submitted that in the case of Soft Pro Systems, it is not functionally comparable as it is receiving lease rental income which has resulted in the assessee declaring profits and that if this is eliminated, it can be seen that a loss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cost incurred and profit declared and it was argued that the adjustments if any, cannot exceed the profits combinedly derived, for the reason that notional income cannot be brought to tax. 33. He relied on the following case laws:- (i) Sony India P. Ltd. Vs. CBDT, 288 ITR 52 (Delhi). (ii) Philip Software Centre Pvt. Ltd. Vs. ACIT (ITA No.218 (Bang.)/2008). (iii) Kyungshin Industrial Motherson Ltd. (ITA No.1396/Del/2009). (iv) DCIT vs. Global Ventedge P. Ltd. (v) Li Fun (India) Pvt. Ltd. Vs. DCIT (ITA No.5156/Del/2010). 34. He submitted that the associated enterprise has incurred a loss and hence the question of shifting profits from India to AE does not arise. He further submitted that there is no motive to divert profits and hence there can be no adjustment in the provisions as the income in India is exempt u/s 10 and no such exemption is available to the AE. 35. He argued that the assessee is a captive service provider, rendering software development services to its overseas affiliates. While rendering services the assessee does not bear significant business and operational risks. Therefore, adjustment of 5% should be given in the operative pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oposition that small value transactions cannot be taken as comparables. Significant volume difference between the two segments has to be considered as a factor for selection of comparables. He argued that domestic transactions cannot be compared with export transactions and hence benchmarking should not be done of PLI of export transactions with the PLI of domestic transactions. He further relied on the following case laws:- (i) Sony India Pvt. Ltd., 315 ITR 150; (ii) Sony India Pvt. Ltd. 114 ITD 448 (Del)(Trib.) 41. He further pointed out that the nature of transactions are different for the reason that in the case of third party transactions the assessee directly deals with the customers and whereas in case of international transactions the assessee routed the same through the AE and that in this indirect transaction with the ultimate customer, the AE is adding some value to the transaction. He relied on the following case laws:- (a) Destination of the World (Subcontinent) Pvt. Ltd. Vs. ACIT (ITA No.5534(Del)/2010). (b) Birlasoft (India) Ltd. (ITA No.3839/Del/2010). He emphasized that concept of materiality has to be considered in cases where comparables ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... On Soft Pro Systems he relied on the findings of the AO and argued that the same should be taken as a comparable. On fresh comparables he submitted that the AO has rightly not allowed the same for the reason that the assessee is picking up comparables with the objective to achieve such results which would lead to a conclusion that the transaction in question is at arm s length. Such biased selection cannot be allowed at a latter stage. He submitted that the assessee has not given any reason as to why these comparables were not taken at an earlier point of time and what is the reason for admitting additional evidence. 48. On the issue of adjustment, he submitted that the assessee, being dependent for its entire work on the AE was at greater risk and hence it should receive more margin as compared to others. Relying on the findings of the AO he also submitted that there is no data based on which the risk could be analyzed and quantified so as to give a proper adjustment. That for quantification of risk, robust data is required and no such exercise was done by the assessee in its Transfer Pricing Study and only when confronted with an adjustment, the assessee invented the theory of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. He argued that each software service assignment is not of significant value, whether it relates to the AE or to the unrelated party and hence are comparable transactions. Similar software services were rendered to domestic customers and could be taken as a comparable. Referring to the Rules he submitted that size of the market does not refer to volume or value of transaction but is refers to nature or characteristics of the market in which the transaction are undertaken. He argued that there is no inconsistency with Rule 10B(2)(d) and Rule 10B(1)(e). He submitted that internal comparable cannot be disregarded on the basis of volume and at best adjustment may be made to eliminate the differences on account of volumes. He submitted that Rule 10B(2)(d) is more relevant to identify the external comparable companies. He vehemently contended that the computation provisions are provided in the Act and that when transaction should be compared on stand alone basis, the mechanism provided cannot be ignored and that the rule has to be followed. 56. On the contention of the learned DR that the transaction entered into with the Associated Enterprise is different from the transaction enter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s only for the purpose of analyzing the trend of turnover and profitability of the comparable companies just to demonstrate that such companies are not suffering from any extra-ordinary circumstances. On Honeywell (supra) the provisions for future loss made, was held as that which cannot be considered for the purpose of computing the operating margin. On Intellinet Technologies India Pvt. Ltd. Vs. ITO (ITA No.1267/Bang/2010) the Tribunal held that single customer risk is a hypothetical risk and the risk faced by the comparable companies is actual risk and therefore, adjustment to account for differences in risk is more than that. In the case of Gharda Chemicals (supra) he submitted that the argument of the assessee is that Transfer Pricing provisions are meant only to allocate the profit earned by the multinational groups from transactions with their associated enterprises whereas the contention of the assessee in Gharda Chemicals was on different footing i.e. even if the higher price charged from the AE, there was no change in the overall tax incidence of the group. 58. In the case of Global Vantage (supra) it only shows that adjustments cannot exceed total revenues and there i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ster concern of the appellant and engaged in provision of identical services. Functionally not comparable, engaged in IT ITES, Biotechnology andmanufacturing business. Segmental results of IT division are not available. Even within the software domain, the company is primarily a software product company. It owns proprietary products such as Cell vision, CLL TOX etc. Super normal profit. Pg 244, 248, 251 250 3. Flextronics Software Systems Ltd. (Seg.) 25.31 very high turnover of ₹ 665 cr. Which is 33 times the turnover of the assessee. also deals in software products. Pg 253 265 4. Infosys Technologies Ltd. 40.30 Very high turnover of ₹ 13,655 Cr which is 680 times the revenue of the appellant. also deals in software products. Pg 289 5. KALS Information Systems Ltd. (Seg.) 30.55 deals in software products Pg 317 6. Mind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3. IGate Global Solutions Ltd. 7.49 4. LSG Global Ltd. (Lanco Global Solutions Ltd.) 15.75 5. Lucid Software Ltd. 19.37 6. Mediasoft Solutions Ltd. 3.66 7. Quintegra Solutions Ltd. 12.56 8. R.S. Software (India) Ltd. 13.47 9. R. Systems International Ltd. (Seg.) 15.07 10. Geometric Ltd. 10.71 11. SIP Technologies Exports Ltd. 13.9 Average 12.20% Appellant 8.18% Re: Exclusion of companies identified as comparable by the assessee (ground 2.15 2.16): It was submitted that the TPO has wrongly excluded the following companies from the list of the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee company, as given in the Transfer Pricing Report and as understood by the Revenue authorities. The claim of the assessee that it is engaged in the business of rendering low end software maintenance services, in its arguments before us, is contrary to the facts. No doubt the assessee stated that it had made claim before the TPO in one of its letters that it is a low end software maintenance service company. But the claim is contrary to the T.P. report filed by the assessee. The nature of business and the type of transactions are of great importance in adjudicating the transfer pricing matters. Such contrary claim made loosely cannot be countenanced. 63. Now we consider certain propositions relied on by the assessee. The assessee in this case relied on more than 15 case laws for emphasizing its claim. Case laws are cited and it is claimed that the ratio laid down by coordinate Benches have to be followed. The Revenue also relied upon more than 20 decisions either for contradicting the claims of the assessee on certain propositions or for supporting the line of argument adopted by the TPO as approved by the DRP. 64. While arguing the case none of the parties have spoken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... question involved. The scope and authority of a precedent should not be expanded beyond the needs of a given situation, mere casual expression carry no weight at all, nor every passing expression of a judge can be treated as an excathedra having the weight of authority (p. 298) 2003 7SCC 197); a decision not expressed, not accompanied by reasons cannot be deemed to be a law so as to have binding effect. (iv) Vinay Extraction P. Ltd. vs. Vijay Khanna, 271 ITR 450 (Guj.) for the proposition that Court should not place reliance on the decisions without discussing how factual situation fits in, they are not to be read as Euclid s theorems nor the observations therein as provisions of statute, observations must be read in the context in which they appear, one should avoid the temptation to decide cases by matching the colour. (v) Ajanta Pharma Ltd. vs. ACIT, 267 ITR 200 (Bom.) for the proposition that no judgement can be read as statute, every decision is an authority for what it decides. (vi) S. Shanmugavel Nadar Vs. State of Tamil Nadu Another, 263 ITR 658 (SC) for the proposition that for a declaration of law there should be a speaking order, a decision which is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... argument to drive home the point of the counsels, when facts are not at all similar is causing unnecessary clogging of the system resulting in slower delivery. We suggest that the law and the rules be applied first, arguments be based on them and broad proposition relied upon when situations warrant. 66. Hence, in transfer pricing cases the parties should devote much time to the nature of the companies business operations, nature of transactions, FAR analysis, study and method of choosing comparables etc. The logic or reasons behind selection of comparables for benchmarking and supporting the T.P. Study should be based on the Act and Rules rather than picking up orders of different benches on the ground that they are precedent, that too without reference to the facts and nature of transactions. It should be understood that businesses are so varied and no two transactions are similar. Business models followed by the AEs and assessees are different. Geographical locations are different. We had to say this because in recent times, in the matter of transfer pricing adjudication, huge paper books running into thousands of papers are being filed and whereas the references are made to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... correct to ask for laying down of such a proposition. Coming to the decision of the Hon ble Delhi High Court in the case of Sony India Pvt. Ltd. (supra) the philosophy or concept behind the Transfer Pricing as stated by the Hon ble Finance Minister in the Budget Speech was culled out by the Court. The Hon ble High Court has nowhere stated that the transfer pricing adjustment should be restricted to the combined profits earned by the entire group minus the profits already offered to tax in different jurisdictions. Hence this argument of Mr. Vohra is hereby rejected as devoid of merit. 70. The decision of Bangalore Bench of the Tribunal in the case of Philips Software Centre (P) Ltd., 26 SOT 226 cannot be followed in view of the law laid down by Larger Bench of the Tribunal in the case of Aztec Software. 71. Coming to the decision of Delhi Bench of Tribunal in the case of Kyungshin Industrial Motherson Ltd. Vs. DCIT (ITA No.1396/Del/2009), it is peculiar to its facts and is not applicable to the facts of the case. 72. In the case of Global Vantedge P. Ltd. (supra) the proposition was that the adjustment cannot exceed the gross amount that the A.E. receives on such transactio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Revenue that being a dependent enterprise results in greater risk cannot be brushed aside. Being dependent on only one source for work is a risk factor to be considered. Higher risk means higher price. Before we go into the issue as to whether such an adjustment can be provided, we are of the opinion that any claim for adjustment, on the basis of risk or any other factors, has to be based on proper data and sound calculation. Ad hoc adjustments should not be granted as it becomes discretionary. The adjustment cannot be used to leverage the desired results, so as to prove or disprove the assessee s claim that its transactions with the AE are at arm s length. In most of these cases the object sought to be achieved, is determining, the means by way of claims for various adjustments. Rarely such adjustment claims are based on Robust data. The arguments of both the parties on this issue have already been recorded by us and both these contradictory arguments have good weightage. The debate as to whether a captive service provider has lesser risk or a higher risk cannot be adjudicated by us in the absence of sufficient material. These are all subjective matters, in which one view cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mes and the decision as to who bears the cost of idle capacity etc. are not stated. In the absence of such details and data, the question of granting adjustment on the ground of idle utilization of capacity does not arise. The findings of the T.P.O. on this issue are based on broad parameter and hence are upheld. The assessee is required to support its claim for any adjustment with robust data and full details and evidences so as to enable the TPO to examine the claim. The burden is on the assessee whenever it makes a claim and in this case, it has not discharged the burden of proof. These adjustments are being claimed by the assessee, only when adjustments are proposed by the T.P.O. that too in a Ad-hoc manner. If the claim was correct, then it should have been made in the T.P. Study itself and not, only to meet the goal of A.L.P. 80. We now consider the issue whether internal comparables has to be taken and if not as to whether the selection of comparables, when external comparables are taken, is correct or not. Before we go into the issue, we first deal with some of the general propositions relied upon by both the parties. Coming to the internal comparables, the assessee argu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the total turnover, in our opinion is sufficient sample which can be used for the purpose of benchmarking, provided the transactions are functionally comparable. Even domestic uncontrolled transactions are about 10%. In case the transactions are functionally comparable these transactions can be used for benchmarking. Though the learned DR argued that the transactions are not comparable, we find that the TPO has not examined this aspect and has rejected the internal comparables on the ground of less volumes and economics of scale. Functional analysis has not been done at the transaction level. Hence for the A.Y. 2007-08, internal comparables have to be examined in the light of our above observation and considered for benchmarking. 83. In view of the above discussion, we are of the considered opinion that ends of justice would be met if the issue is set aside to the AO/TPO, to consider the internal comparables given by the assessee and arrive at a fresh decision on the matter for the Asst. Year 2007-08. The nature of transactions and the functions in these transactions have to be examined. In case there are variations, we direct the Transfer Pricing Officer to make suitable adjus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2,72,653/- Entire Profits of NEPZ were claimed excludible u/s 10A. Rs.102,35,648/- Exemption claimed under section 10A Rs.1,32,72,653/- -do- Rs.102,350,648/- Exemption/Deduction allowed. Under Section 143(3) vide order dated 22.3.2002. Under section 143(1) vide order dated 30.03.2001. Under section 143(3) vide order dated 19.02.2003. 88. In the assessment year 2002-03, the assessee was, for the first time, denied exemption under section 10A of the Act. In the assessment order for that year it was held that since in the previous year relevant to the assessment year 1998-99 the assessee had claimed and was allowed deduction under section 80HHE, the assessee was not entitled to claim exemption under section 10A of the Act. In doing so, the AO had placed reliance on the provisions of sub-sec. (5) of section 80HHE of the Act. In an appeal preferred before the CIT(A) by the assessee, the learned CIT(A) reversed the aforesaid disallowance for the assessment year 2002-03 and upheld th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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