TMI Blog2013 (10) TMI 747X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to exercise its option as referred in the proviso to sub-section (2) if the variation between the arithmetical mean and the price at which such transaction has actually been undertaken exceeds 5% of the arithmetical mean As per the retrospective operation of the aforesaid provision, the benefit of (+)/(-) 5% as a standard deduction cannot be allowed. Allowance of risk adjustment of 1% while computing the adjusted average PLI Held that:- There are divergent decision in this regard Therefore, in the facts and circumstances of this case, accepted the view favorable to the assessee - Allowed the benefit of risk adjustments at 1% - Decided against the Revenue. Selection of method for computation of arms length price Held that:- Assessee has itself accepted that TNMM is similar to CPM excepting that CPM is based on gross margins whereas TNMM is based on net margins - The assessee has also accepted that if proper selection criteria are adhered to application of TNMM would also result in the fact that the price at which the assessee has undertaken the international transactions are at arm's length Also, reliance has been placed upon the judgment of Hon'ble Punjab & Har ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... filters. 3. Briefly the facts of the issue are, the assessee is a wholly owned subsidiary of Hellosoft Inc, USA its associated enterprise. The assessee is engaged in the business of development of software on behalf of its Holding Company and transfers the software to the holding company for marketing and licensing to its customers. For this purpose, the assessee has entered into an agreement with its holding company according to which for the services rendered by the assessee the holding company will reimburse all the cost incurred plus 8% markup. In the assessment year under dispute the assessee had international transactions with its holding company worth Rs. 13,37,43,661. The assessee adopted the cost plus Method (CPM) for computing the arm's length price (ALP) for its international transaction. For the assessment year under dispute, the assessee filed its return declaring an income of Rs.1,35,205/- after claiming deduction u/s 10A of the Act. In course of the scrutiny assessment proceeding the Assessing Officer referred the matter to the Transfer Pricing Officer (TPO) u/s 92 CA(2) of the Act for computing the ALP. In course of the proceeding before the TPO the assessee produ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re as in the case of the taxpayer. (d) As per the agreement, the tax payer's cost of providing services includes all costs that have been incurred by the tax paer except interest expenses. All these expenses are reimbursed on cost plus basis. The tax payer is forgetting that it is also getting 8% on other costs which have been excluded by the tax payer in CPM like rent, repairs, insurance, lease and hire charges etc. So, the gross margin shown by the tax payer distorts the true picture of its financials for which TNMM method is the most appropriate method as it captures all expenses except interest, coinciding the cost base of the tax payer for reimbursement (as per the agreement and invoices raised by the tax payer). (e) In the taxpayer's case all the costs were incurred towards rendering of services. Therefore, the gross profit is the same in the taxpayer's case as the net profit. Thus the taxpayer's PLI remains the same whether CPM is applied or the TNMM is applied. The difference between the two methods in the taxpayer's case is thus only an academic interest." 4. The TPO following the decision of the Hon'ble Supreme Court in case of DIT (International Taxation) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r an related party transaction @25%. The gross act on the part of taxpayer to reject all companies with even 1% of RPT, has resulted in a very small base of comparables, which do not reflect the representative sample of the SWD industry." 5. The TPO also found some of the filters adopted by the assessee to be inadequate. The TPO therefore adopted certain additional filters. The final filters adopted by the TPO are:- "1. Companies whose software development service income is less than Rs.1 crore were excluded. 2. Companies whose software development service is less than 75% of the total income were excluded. 3. Companies who have more than 25% related party transactions (sales as well as expenditure combined) of the sales were excluded. 4. Companies who have less than 25% of the sales as export sales were excluded 5. Companies who have diminishing revenues/persistent losses for the period under consideration were excluded 6. Companies having different financial year ending (i.e. not March 31, 2005) or data is not available for 12 months, were rejected. 7. Companies whose employee cost to sales is less than 25% were excluded. 8. C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... kage or in operating expenses. It was further contended by the assessee that the 'onsite income' filter applied by the TPO is not appropriate due to unavailability of data in respect of all the companies in the database and as otherwise the revenue from onsite will not have any impact as the entire income was in foreign exchange. 7. It was further submitted by the assessee that TPO's method of applying filters and selecting comparables was not transparent as the TPO has given only the final set of comparables chosen under TNMM which has prevented the assessee from verifying whether the elimination was done properly or not. It was contended by the assessee that the TPO has followed a pick and choose method instead of restricting himself to the actual search results. The assessee further contended that the TPO failed to appreciate that the assessee's functions and risks were altogether different from the comparable cases adopted by him. As the assessee was a risk free company and was a captive service provider suitable risk adjustment was required to be provided. 8. The CIT(A) upheld the TNMM method adopted by the TPO as the most appropriate method by rejecting contentions of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... parable or not. The learned AR submitted that a company with small turnover cannot be compared with a company with very large turnover. In support of this, the learned AR relied upon a decision of Income-tax Appellate Tribunal, Bangalore Bench in case of Genisys Integrating Systems Ltd., 64 DTR 225 and of Income-tax Appellate Tribunal, Hyderabad Bench in case of Dy. CIT v. Deloitte Consulting 61 DTR 101 The learned AR submitted that the assessee is not exposed to any risk as the ownership of intangibles belongs to the AE. As risk is less profit is also less. In this context, the learned AR relied upon Income-tax Appellate Tribunal, Ahmedabad Bench decision in Mastek Ltd. v. Additional. CIT in ITA No.3120/Ahd/2010 dated 29-2-12, Mentor Graphics (109 ITR 10), Sony India 114 ITD 448, Income-tax Appellate Tribunal, Bangalore Bench decision in case of Continuous Computing (I) Limited 2012-T11-44. The learned AR justifying the observation of the CIT(A) with regard to onsite revenue filter submitted that this filter cannot be applied as relevant information/material are not available. The learned AR further submitted that 'employee cost to sale filter' cannot be applied as many companies, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tribunal, Hyderabad Bench in case of Deloitte Consulting India (P.) Ltd. (supra) held as follows:- "Now, we deal with the issue whether the TPO was correct in selecting Wipro BPO having turnover of 20 times more than the assessee company as comparable or not. We find that this issue is covered in favour of the assessee by the decision of Delhi Income-tax Appellate Tribunal in the case of Agnity India Technologies Pvt. Limited (2010) ITA No.3856/Del/2010. We find that the Wipro BPO is not at all comparable as the assessee company is pigmy compared to giant Wipro. Wipro Company's turnover is 20 times more than the assessee company. Hence, the assessee company is not comparable with Wipro BPO, the reasoning being that the latter is a giant company having 20 times more turnover than the assessee company. In view of this based on the facts and the circumstances of the case, and following the decision of Delhi Bench of Income-tax Appellate Tribunal in the aforesaid case, we are of the view that Wipro BPO should be excluded from the list of comparable companies. Hence, the ground raised by the assessee on this issue is allowed." The same is also the view of the Income-tax Ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (Kol.) and Income-tax Appellate Tribunal's decision in the case of Sony India (P.) Ltd. (supra). The CIT(A) has directed for allowing benefit of (+)/(-) 5% as a standard deduction. The Finance Act, 2012 amended the provision of section 92C of the Act by inserting section (2A) with retrospective effect from 1-4-2002 which reads as follows:- "(2A) Where the first proviso to sub-section (2) as it stood before its amendment by the Finance (No. 2) Act, 2009 (33 of 2009), is applicable in respect of an international transaction for an assessment year and the variation between the arithmetical mean referred to in the said proviso and the price at which such transaction has actually been undertaken exceeds five per cent of the arithmetical mean, then, the assessee shall not be entitled to exercise the option as referred to in the said proviso." The aforesaid provision makes it clear that an assessee shall not be entitled to exercise its option as referred in the proviso to sub-section (2) if the variation between the arithmetical mean and the price at which such transaction has actually been undertaken exceeds 5% of the arithmetical mean. In view of the retrospective operation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on No.40/Hyd/2009 filed by the assessee is concerned, in ground Nos. 1 to 4, the assessee has challenged the adoption of TNMM for computation of ALP. 20. As mentioned hereinbefore the assessee in its TP study report had adopted CPM as the most appropriate method to bench-mark its international transaction. Objecting to the proposed adoption of TNMM by the TPO the assessee had submitted that considering the functional differences and the contractual terms adoption of CPM is more appropriate. It was submitted by the assessee that in TNMM many adjustments needs to be made. It was further submitted OECD has recommended that TNMM should be used as the method of last resort. The TPO has rejected CPM by citing following reasons (a) "The CPM method presents some practical difficulties in identifying the costs incurred for the provision of services like whether an indirect cost is towards rendering services or it is an enterprise level expense. (b) There is no discernible link between the level of costs incurred and a market price in software as the services are usually compensated on a man hourly basis which may not vary much across the industry for same or similar type of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method in the case of the appellant, is upheld. It is also pertinent to mention here that since A.Y. 2002-03, TPO has adopted TNMM method in the case of the appellant for determining the ALP of its international transactions with AE. The same was accepted by the appellant in earlier years." 21. We have heard submissions of the parties. We have also applied our mind to the decisions cited before us. It is seen that the assessee has itself accepted that TNMM is similar to CPM excepting that CPM is based on gross margins whereas TNMM is based on net margins. The assessee has also accepted that if proper selection criteria are adhered to application of TNMM would also result in the fact that the price at which the assessee has undertaken the international transactions are at arm's length. The Hon'ble Punjab Haryana High Court in the case of Coca Cola India Inc v. ACIT (309 ITR page 14) has held that merely because the assessee has chosen one of the methods, it does not take away the discretion of the TPO to select any other method which may be considered to be more appropriate for the purpose of determining the true income. It is also a crucial fact that the assessee has not dispu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng from International transaction and such income is to be computed having regard to arms length price. "International transaction" as defined u/s 92B of the Act, as already observed, certainly stands on a different footing than any other transaction. Arms length price is nothing but a fair price which would have been normal price. There is always a possibility of transaction between a non-resident and its associates being under valued and having regard to such tendency, a provision that income arising out of the said transaction could be computed having regard to arms length price, will not be opened to question and is within the legislative competence to effectuate the charge of taxing real income in India." The Income-tax Appellate Tribunal, Bangalore Bench in case of SAP Labs India (P.) Ltd. (supra) while considering identical issue held in the following manner:- "The argument of the assessee with reference to sec. 10A status also needs a mention. It is the case of the assessee that it is enjoying sec. 10A benefit and no tax is payable on export income, which makes the Indian tax rate more attractive than German tax rate and therefore, there could be no motive to under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Study Report, the assessee had selected 17 companies as comparables. The TPO rejected the CPM method adopted by the assessee by observing that due to lack of assessable information on independent comparable transaction or about the gross profit margins, the TPO held that in assessee's case TNMM is the most appropriate method in view of the available data in public domain. The TPO while examining the TP study report came to a conclusion that most of comparables selected by the assessee are either functionally dissimilar or not working in comparable circumstances. Therefore, the TP study fails the fundamental taste of reliability and correctness. The TPO further observed that the assessee has rejected many companies which otherwise qualifies filters applied by the assessee itself. The TPO further found that the assessee has used earlier two years' data in case of comparables even though they are not comparables as per the assessee's own submission in the TP documentation. 28. It was further observed that the assessee has not applied the 25% related party transactions uniformly and have selected even though they did not qualify this filter. It was further observed that the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wards functions, assets employed and risks while arriving at the ALP. 30. The learned Departmental Representative, on the other hand, strongly supported the order of the DRP and TPO. 31. We have heard rival submissions and perused the material on record. So far as the first issue is concerned, we uphold the orders of the lower authorities in applying TNMM as the most appropriate method, in view of our detailed reasoning given in assessee's C.O. No. 40/Hyd/2009 (supra). Hence the assessee's contention on this issue is rejected. 32. However, so far as comparables selected by the TPO by applying certain filters are concerned, it is seen that while applying the turnover filter though the TPO has excluded companies having turnover of less than Rs.1 crore, he has not applied any upper limit. Eight of the companies, out of 20 selected by the TPO are having turnover of more than Rs.100 crores and at least five of them are having turnover of more than Rs. 200 crores viz., Infosys Limited (Rs. 9028.00 crores), Mindtree Consulting Limited (Rs. 448.78 crores), Persistent Systems Limited (Rs.209.18 crores), Sasken Communication Limited (Rs. 240.03 crores), Flextronics Software Systems Lim ..... X X X X Extracts X X X X X X X X Extracts X X X X
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