Contact us   Feedback   Annual Subscription   New User   Login      
Tax Management India .com
TMI - Tax Management India. Com
Extracts
Home List
← Previous Next →

2015 (4) TMI 949 - DELHI HIGH COURT

2015 (4) TMI 949 - DELHI HIGH COURT - [2015] 376 ITR 183 (Del) - Applicability of proviso to Rule 10B(4) of the Income Tax Rules, 1962 - fluctuations in the operating profit margins of comparable companies during the relevant financial year under question as compared to earlier years - Selection of comparable - whether comparables can be rejected on the ground that they have exceptionally high profit margins as compared to the assessee in transfer pricing analysis Held that:- This Court proceeds .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

10B (3) then underlines what the ALP determining exercise entails, if there are dissimilarities which materially affect the price charged etc: the first attempt has to be to eliminate the components which so materially affect the price or cost. In other words, given the data available, if the distorting factor can be severed and the other data used, that course has to be necessarily adopted.

The mere fact that an entity makes high/extremely high profits/losses does not, ipso facto, le .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

in Rule 10B(4). As a general rule, it is not open to the assessee to rely upon previous year's data.

In the present case, this Court holds that once Brescon, Keynote and Khandwala Securities are held to be functionally similar to the assessee, they would be included as comparables, notwithstanding their high profit margins, provided that the material difference on account of such high profit margins can be eliminated under the Rule 10B(3) analysis. This Court, on a perusal of the orde .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

in the risk profiles of the assessee and Brescon in the present appeal. However, this Court holds that such a contention cannot be raised for the first time at this stage. Therefore, Brescon and Khandwala Securities are held to be functionally similar, and the matter is remitted to the DRP for the purposes of examination under Rule 10B(3) of the Rules. In the event that the material differences arising out of the extremely high profits cannot be eliminated as per Rule 10B(3), these two entities .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

‟s search process. Further, the TPO held that Keynote was engaged in financial consultancy and would therefore be considered as a comparable. The ITAT, for reasons unknown, did not examine this issue. This Court notes that the assessee is engaged in the business of rendering financial research and advisory services. It is responsible for investigation and advice to some of its group companies on structuring potential investments and exit opportunities; advising the group companies of inves .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

pital restructuring, loan and lease syndication, placement services, portfolio management, debenture trustee, managing/advising on international offerings of debt/equity, private placement of securities, etc. Evidently, the assessee does not provide any of these services enumerated above. Given such functional differences and the mandate of Rule 10B(2)(b), there could be merit in the argument that Keynote cannot be considered a comparable for determining the ALP. The fact that the assessee had i .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ply the test indicated in this judgment and analyse the functional similarity of Keynote with the assessee. In the event that the DRP finds them to be functionally comparable, it would proceed to carry out the Rule 10B(3) analysis as in the case of Khandwala Securities and Brescon.

Deduction under Section 36(1)(ii) in respect of the bonus paid by it to its two shareholders - lower authorities denied such claim, holding that the bonus was paid to the shareholders in lieu of dividend wi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the assessee placed on record also indicates that the two shareholders also hold directorial positions in the assessee. Therefore, the assessee‟s contention that the bonus was paid to the shareholders in their managerial capacity, like in the case of other managers, cannot be questioned merely on the basis of a speculation by the revenue that such payment was to avoid tax. In such circumstances, the deduction under Section 36(1)(ii) in respect of payment of bonus to the two shareholder-di .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ndiscriminatingly used to express different and sometimes contradictory ideas". - Justice Felix Frankfurter in Tiller v. Atlantic Coast Line Railroad Co., 318 U.S. 54 (1943) 1. Is there a concept of super profit in the arm‟s length price/transfer price determining process under the Income Tax Act, 1961 ("the Act") or the Rules framed thereunder, entitling tax administrators to include high profit making companies‟ data in the list of "comparables"? Benches of .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

in the operating profit margins of comparable companies during the relevant financial year under question as compared to earlier years? 2) Whether comparables can be rejected on the ground that they have exceptionally high profit margins as compared to the assessee in transfer pricing analysis? 3) Whether factors like differential functional and risk profile coupled with high degree of volatility in operating profit margins is sufficient ground to reject comparables for transfer pricing analysis .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

e assessee in the proportion of 2:l; they were also its full time employees. In AY 2008-09, the assessee entered into international transactions with associated enterprises (AEs) relating to advisory services and reimbursement of expenses incurred on behalf of AEs amounting to ₹ 56,61,99,829/- and ₹ 4,49,72,912/- respectively. For the purposes of determination of arm‟s length price (ALP), the assessee used the Transactional Net Margin Method ( TNMM ). The assessee treated the t .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

. IDFC Investment Advisors Limited -55.50% 17.30% -19.10% 2. Future Capital Holdings Limited - 0.88% 20.53% 10.71% 3. Khandwala Securities Limited 43.35% 42.62% - 42.99% 4. Sumedha Fiscal Services Limited -16.47% -20.36% -18.42% Final Average 4.04% 4. The assessee‟s position was that because of fluctuation in the margins of the comparable entities, multiple year data of the comparables was warranted to remove the effect of year specific aberrations. Against the average Operating Profit Mar .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ting to the financial year in which the international transaction or the specified domestic transaction has been entered into: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.‖ The assessee argued that using multiple year data is consistent with the OECD Guidelines as well as .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

f the Act. On 03.10.2011, the TPO passed an order recommending transfer pricing additions of ₹ 20,93,34,155/- to the income of the Assessee. The TPO computed the Operating Margins of the four comparables above using single year data i.e. for FY 2007-08 and ignoring the data for two prior financial years i.e. 2005-06 and 2006-07 while determining the ALP. The TPO concluded that multiple year data for the assessee‟s comparables could not be used but introduced two new comparables with .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ent year of the assessee or the comparables. 6. Based on the TPO‟s report, the AO passed the assessment order on 21.12.2011, confirming the recommendations of the TPO. The AO also disallowed the bonus paid by the assessee to its shareholder employees - M/s Ashish Dhawan (Rs. 67,91,947) and Kunal Shroff (Rs. 30,19,433) - under Section 36(l)(ii) of the Act. The assessee filed its objections against the draft assessment order before the Dispute Resolution Panel ( DRP ). The DRP, by order date .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the Respondent. 7. All the lower authorities included three entities as comparables which had very high profit margins as compared with that of the assessee. These entities namely, Brescon Corporate Advisors Limited ("Brescon") (Operating Margin of 87.4%), Keynote Corporate Services Limited ("Keynote") (Operating Margin of 191.58%) and Khandwala Securities Limited ("Khandwala") (Operating Margin of 80.79%) had exceptional profit margins as compared with the Assessee .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

he ITAT upheld these findings and held that current year data should be used in the absence of abnormal or exceptional facts/circumstances in existence which could have an influence on the results as well as the determination of the transfer prices for the year under consideration. Further, the ITAT held that Rule 10B does not provide any basis to exclude an entity or eliminate it from the list of companies solely on the basis of high profitability. The authorities - including ITAT, held that th .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

s of the assessee 8. The assessee submits that even if the ITAT‟s ruling on the issue is accepted, Brescon and Keynote should be excluded from the list of comparables as its (the assessee‟s) risk profile is not similar to that of those two companies. They are risk-taking entities whereas the assessee operates on a cost plus model wherein a guaranteed return of 25% on costs is assured to it. The assessee further argues that its functional profile is significantly different from that o .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

considered similar to the services being rendered by the assessee) is not available to be compared with the assessee‟s profitability. The assessee argues that Keynote's profit margins have shown volatility over the years which could be attributed to abnormal business conditions and therefore Keynote should be rejected as a comparable altogether. The Operating Margins of Keynote for the last 5 years are as follows:- Assessment Year Operating Margin 2004-05 (-)6.87% 2005-06 13.33% 2006-0 .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

wever, after analyzing the economic circumstances as highlighted by the assessee and corroborated from the annual report of the year, we do find it may not be a robust comparable. According to the assessee ‗we would like to state that this company has very volatile profit margins and since the Ld. TPO has computed the ALP on the basis of single year data (data for the FY 2005-06 only) this company should not be included in the final set of comparable as it would lead to distortion of the A .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

t page 139 of the paper book dated January 01, 2010 filed before the Hon ble Panel). The operating margin of this company during the FY 2003-04 was negative 6.87% and which converted to positive 13.33. In the FY 2004-05, thereby exhibiting the this margin further increased to 94.06% showing an even higher volatility (80 percent points) vis-à-vis previous year.‖ Further we would also like to state that Keynote can also not be considered a comparable to the assessee (on the basis of s .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

consulting company and with a Swiss based consulting company to offer its clients cross border transaction ability. Thus, the exceptional profit earned by Keynote during the relevant year may be due to such alliance formed by Keynote with other companies in Middle East and Swiss. The profit earned by it due to such alliance cannot be used for the arm s length analysis.‖ 2.3.4 In view of the above reasons, the DRP directs TPO to exclude this comparable as it is not a robust comparable for .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

y, keeping in view their experience, expertise and performance, the assessee had compensated them. The assessee submits that bonus under Section 36(1)(ii) of the Act is allowed as deduction if the same amount would not have been payable to the shareholders as profits or dividends if it had not been paid as bonus. The provision requires the sum paid as bonus to be exactly the same as to be payable as dividend in absence of the bonus for there to be a disallowance. The assessee submits that the bo .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

international transaction has to be determined by applying one of the methods provided in section 92-C (3) of the Act; it should be the most appropriate method and should also take into account prescribed factors. This is, counsel stated, elaborated in Rule 10-B of the Rules, which contemplates adjustment on account of functional and other differences. He contended that adopting of any method ultimately envisages comparison of like functions, transactions and enterprises. Rule 10B(2)(a) provide .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

parability than others, they should be eliminated. He also referred to Section A-5 of OECD guidelines on ―selecting and rejecting potential comparables‖ and pointed out that as per para 3.56, wherever uncontrolled transactions have a lesser degree of comparability than others, they should be eliminated. Counsel stated that similarly, Para 3.57 states that if the range of comparables includes a sizeable number of observations, statistical tools that take account of central tendency to .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

relied on A.7.3 of the OECD guidelines dealing with ―extreme results in the context of comparability considerations‖ to point out that extreme results might consist of losses or unusually high profits. These can affect the financial indicators that are looked at in the chosen method; some potential comparables have extreme results, further examination would be needed to probe such results. This important issue was overlooked by ITAT. Counsel relied on proviso to Rule 10-B (4) and sta .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

te from the list of comparables, on the ground that the said concern had earned abnormally high or super profits. On that occasion, as compared with its previous year (AY 2005-06) profit level of 94%, the profit of the enterprise was 145%, registering a 51% increase over the previous year. This was considered to be too high to be allowed as a comparable. During the current year, the profit registered was 191%. In the circumstances, it was illogical and arbitrary for the revenue to have rejected .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

decisions of the Special Bench in the case of Quark Systems Private Limited v. DCIT (2010 38 SOT 307- Chandigarh Bench) Adobe Systems India Pvt. Ltd. (Del) 2011-(TII)-13-ITAT-DEL); Teva India (P) Ltd v. DCIT, [2011] 44 SOT 105 (Mum); Sapient Corporation (P) Ltd. v. Deputy CIT, [2011] 11 Taxmann 69 (Delhi); Asst CIT vs. Maersk Global Services Centre (India) P. Ltd. (133 ITD 543)(Mum.); Symantec Software Solutions (P) Ltd. v. Assistant CIT [2012] 25 Taxmann 163 (Mum); and a Division Bench decision .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the TPO distorted the margins, the AO and DRP erred in determining the ALP on the basis of data for financial year 2007-08 only and ignoring the data for two prior financial years i.e. FY 2005-06 and FY 2006-07. Learned counsel submitted that the TPO had the option of reaching back to previous years‟ data, since such power exists by virtue of proviso to Rule 10B (4). Learned counsel also relied on Part B.3, Paras 3.75 to 3.78 of OECD guidelines, in support of the submission. Revenue s cont .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ect of property transferred or services provided is relevant for cost plus method. However, there is no mention of any property transferred or services provided in case of TNMM. They are provided for other methods. He contended that the relevant Rule thus makes it clear that specific characterization of the property transferred or services is not relevant for TNMM and this position is in conformity with the relevant OECD guidelines which suggest that broad comparability of functions should be do .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

fit" too cannot be eliminated. Generally, both loss making units and high profit making units cannot be removed from the list of comparables unless, such removal is statutorily permitted by Rule 10-B (2) or (3). Counsel also submitted that this is also evident from a reading of Rule 10-C. It was pointed out that Rule 10B (3) (ii) and Rule 10 C (2)(e) permitted adjustment to eliminate material defects of the difference between the assessee and comparables. Counsel argued that only those fact .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

has held that OECD guidelines cannot be applied because there are specific provisions of Rule 10B (2) & (3) and the first proviso to Section 92C(2) which apply. There, it was held that having held that the comparables given by the assessee were to be accepted and those searched by the TPO were to be rejected, the only option then left to the ITAT was to derive the arithmetical mean of the profit level indicators of the comparables. It was submitted that accepting the theory of "abnorma .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

termining ALP inter alia, reads as follows: "92C. (1) The arm's length price in relation to an international transaction [or specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :- (a)comparable uncontrolled price method; .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

** ** (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that- (a) the price charged or paid in an international transaction [or specified domestic transaction] has not been determined in accordance with sub-sections (1) and (2); or (b)any information and document relating to an international transaction [or specified domestic transaction] have not been kept an .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ngth price in relation to the said international transaction [or specified domestic transaction] in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

(c) cost + method, (d) profit split method, (e) transactional net margin method, (f) any such other method as may be prescribed by the board. Where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be arithmetical mean of such prices.‖ 21. Rule 10B of the Rules prescribes the determination of arm's length price under Section 92C. The first step in all methods is evaluation of differences between the international transaction .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

sactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base." 22. These provisions prescribe, therefore, that even under the TNMM, importance is given to "assets employed or to be employed" as relevant factors for co .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

) 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 parties to the transactions ; (d) conditions prevailing in the markets in which the respective parties to the transactions .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

he enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to be made in application of a method." Rule 10B (3) stipulates the third step, and spells out when the TPO is obliged to hold an uncontrolled transaction as comparable with others. This provision reads as follows: ―(3) An uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if- (i) none of the differences, if any, b .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.‖ 23. The .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

d. (133 ITD 543)(Mum.); Symantec Software Solutions (P) Ltd. v. Assistant CIT [2012] 25 Taxmann 163 (Mum); and a Division Bench ruling of this court in CIT v. Agnity India Technologies (P) Ltd. [2013] 36 Taxmann 289 (Del HC). Besides, this court notices that a similar reasoning - of applying what is known as the turnover filter or the exclusion of superprofit making companies reasoning was applied in Continuous Computing India (P) Ltd. vs. ITO (2012) (52 SOT 45)(Bang)(URO); Centillium India P. L .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

64 (Bang) and Stream International Services P. Ltd. v. Asst. DIT (International Taxation) [2013] 23 ITR (Trib) 70 (Mum) too. 24. Before analysing the relative strengths of the rival contentions, a tabular statement containing the reasoning which persuaded various Benches of the ITAT to conclude one way or the other is reproduced below: S. No. Judgment Finding Rationale 1. ITO v. Saunay Jewels (P) Ltd., [2010] 42 SOT 2 (Mum). 1. One of the four comparables chosen by the TPO (Sovereign Diamonds Lt .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

panies, the arithmetic mean of OP/TC comes to 17.15%, which falls within the +-5% range as permitted by s. 92C(2). Further, the DRP has passed a cursory order without examining the submissions of the assessee. 3. Teva India (P) Ltd v. DCIT, [2011] 44 SOT 105 (Mum) Remitted the matter to the AO to decide the issue of inclusion of M/s Vimta Labs as a comparable M/s Vimta Labs had earned supernormal profits. The ITAT noted the decision in Adobe Systems and directed the matter to be decided in light .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

mpany shows higher margin. 5. Nortel Networks India (P) Ltd. v. Additional CIT, [2013] 36 Taxmann 439 (Delhi) Affirmed the exclusion of M/s Arraycom as a comparable. Further held that the TPO has adequately factored the subjective elements in determining the ALP. A concern will not lose its status merely because it is a loss-making entity. However, TPO has not excluded Arraycom for the sole reason that it is a loss- making entity but because it has been showing persistent losses. Its operation a .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

hant banking and consultancy income accounted for only 0.27% of the total income. Absence of segmental data insofar as the investment advisory service provided by the assessee is concerned led to the exclusion of comparables. 7. Deputy CIT v. Deloitte Consulting India Pvt. Ltd., ITA No. 1082/Hyd/2010 dated 22/07/2011 Inclusion of Vishal Information Technology Limited as a comparable was not incorrect. Wipro cannot be a comparable. Assessee derived its income from software development and IT enab .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

0 times that of the assessee. 8. Symantec Software Solutions (P) Ltd. v. Assistant CIT, [2012] 25 Taxmann 163 (Mum). Two entities (ICC International Agricultural Ltd. and TSR Darashaw Ltd.) were directed to be excluded as comparables. These entities were required to be excluded on account of significantly higher operating margins (82.92% and 78.29%) whereas the next highest was 26.67%. Thus, unless it was demonstrated that these super normal profits were earned in the normal routine of activitie .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ses over a period of several years, had huge unutilized capacity, needs financial restructuring, joint venture of the company stands terminated, etc. Re inclusion of Videocon, there are material differences which cannot be eliminated within the meaning of Rule 10B(3). Thus, Videocon has to be excluded as a comparable. 10. Philips Software Centre v. ACIT, [2008] 26 SOT 226 (Bang.) Companies with supernormal profits should have been excluded from the list of comparables by the TPO. An entity makin .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

hirdware Solutions Ltd. and WTI Advanced Technology as comparables. The margin of profit shown by these two entities was extraordinary. All factors materially affecting the comparability of the assessee with the other entities need to be scrutinized and adjusted, including the operative profit. 12. SAP LABS India (P) Ltd. v. ACIT, [2011] 44 SOT 156 (Bang.) Directed the exclusion of M/s Hinduja TMT and M/s Aftek Infosys Ltd. as comparables. These two entities were earning supernormal profits. Ext .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

bal Centres (India) (P) Ltd. v. ACIT, [2014] 43 Taxmann 100 (Mumbai Special Bench). Entities with abnormally high profit margins cannot be rejected outright as comparables. In the given facts of the case, two comparables sought to be included indicated unusual features for the year, which qualified for their exclusion. The inclusion of entities with supernormal profits would depend upon the facts and circumstances of each case. It should trigger further investigation to establish whether it can .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

rofit margin. 15. Goldman Sachs (India) Securities Pvt. Ltd. v. ACIT, ITA No. 7724/Mum/2011, dated 23.01.2013 Directed the exclusion of comparables ordered by the TPO. Assessee and the comparables were functionally different and not in the same segment. 16. Advance Power Display Systems Ltd. v. ACIT, [2013] 35 Taxmann 145 (Mum) Directed the exclusion of BCC Fuba India Ltd. as a comparable. Comparables have to be tested for each year independently. The fact that an entity has been chosen as a com .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

any cannot be excluded as a comparable solely because it is a high profit making unit. A persistently loss making unit cannot be considered as a comparable. Comparability of an uncontrolled transaction with an international transaction has to be measured by using current year data and only when the current year data does not give a true picture due to abnormal circumstances that multiple year data is used. If profit not supernormal, the mere fact that it is high does not justify exclusion. Unles .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

n of Infosys Technologies Ltd. as a comparable. Tribunal had excluded Infosys as it was a giant company in the area of software development and it assumed all risks leading to higher profits whereas the assessee was a captive unit of the parent company and assumed only a small risk. HC upheld the reasons given by the Tribunal for the exclusion. 20. Cummins Turbo Technologies v. DDIT, [2013] 35 Taxmann 350 Companies with supernormal profits and companies which are loss-making cannot straight away .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ation in this case, i.e whether in the facts of that case ―companies earning abnormally high profit margin should be included in the list of comparable cases for the purpose of determining the arm's length price of international transactions‖. Although the ITAT did not specifically answer the question, in view of its findings that two comparables, i.e eClerx Services Ltd and Mold Tech Technologies Ltd, on account of unusual or peculiar features which were apparent from the materi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

lations in India to exclude certain entities selected as potential comparables on a broad functionality test by applying the functional test at narrow or micro level to attain the relatively equal degree of comparability. On the other hand, rule 10B(3) provides that the uncontrolled transaction selected/judged as per rule 10B(2) shall be comparable to an international transaction only if none of the differences, if any, between the transactions being compared, or between enterprises entering int .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ions which materially affects the cost charged or the profit arising from such transaction in the open market. 69. Keeping in view the relevant portion of the OECD Transfer Pricing Guidelines discussed above and having regard to the relevant transfer pricing regulations as contained in rule 10B(3) of the Income-tax Rules, 1962, we are of the view that further dissection or classification of information technology enabled services can be done depending on the facts and circumstances of each case .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

e lay down that a comparable cannot be eliminated just because it is a loss making unit. Similarly, a higher profit making unit cannot also be automatically eliminated just because the comparable company earned higher profits than the average. The reason for rejecting the two loss making units is not just because they were loss making units but for the reasons which are already stated in the preceding paragraphs. If similar reasons existed in the higher profit making unit, then, it is for the as .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

red loss or has made abnormal profits.‖ This court notices that American Express Services India Ltd v Deputy Commissioner Of Income-Tax, 2013 (57) SOT 22 (ITAT-Del) said, similarly, that: ― If the comparables are performing the same functions then merely on the ground of they being earning super profits, cannot be excluded. Material differences between their business modules, however, are required to be taken care off and duly adjusted. In the case of Sundaram Finance Distribution Lt .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

rate that a comparable supplied by it in the transfer pricing analysis was not correct and had to be excluded. This right of the assessee is not curtailed in any manner, whatsoever, in the rules. A similar reasoning was adopted in M/s. Premier Exploration Services Pvt.Ltd., vs. ITO, Ward 14 (3) [2014] 29 ITR (Trib) 427 (ITAT) [Del] ― Although assessee had taken this company as comparable on the basis of past years data but in our considered view, the Saket Projects Ltd. was not comparable .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

issimilarity. The company is organizing events with various kinds of sponsorships. The facts also suggest that segmental allocation of expenses were not reliable. We also hold that when direct comparables are available then segmental results of companies engaged in other business should not be taken as comparable. On the basis of these facts, we hold that Saket Projects Ltd. was not comparable to the extent wherein the various variations could be ruled out or iron out by provisions of law and ru .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ces a range of figures, a substantial deviation among points in that range may indicate that the data used in establishing the some of the points may not be as reliable as the data used to establish the other points in the range or that the deviation may result from features of the comparable data that require adjustments. Inferring from the above ruling, we requests your goodself to not consider companies displaying abnormal profits since they deviate from the normal trend displayed by the data .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

be the correct approach was given by a Division Bench of this Court in Commissioner of Income Tax v Mentor Graphics (P) Ltd [2013] 259 CTR 1 (Del), where it was held that: ― 21. The sum and substance of the Tribunal's order is that the criteria adopted by the TPO for searching comparables was not correct. Secondly, the TPO had not specifically rejected any of the comparables of the respondent/assessee. The Tribunal was of the view that the comparables of the respondent/assessee ought .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

eunder the AO/TPO may proceed to determine the ALP in relation to an international transaction. If any one of those four conditions is satisfied, it would be open to the AO/TPO to proceed to determine the ALP. This clarification of the observation of the Tribunal was necessary and that is why we have done so. 22. We also note that the Tribunal had gone further and reduced the list of comparables to merely four as indicated in para 46 of the impugned order. We do not think that it was the right a .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

t of PLIs had clearly erred in law. However, in the facts of the present case that would not make any difference to the respondent/assessee's case in as much as even if the arithmetical mean of the comparables as accepted by the Tribunal is taken into account, the PLI would, whether the seven companies are taken into consideration or all eight companies are taken into consideration, be less than 6.99 per cent which is the PLI of the respondent/assessee for the relevant year, that is, financi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

all.‖ It is therefore, evident that the Special Bench and this Court stressed that mere distortion cannot be the basis of exclusion, given the mandate of Section 92C. The assessee had during the hearing, heavily relied on OECD guidelines and another Division Bench ruling in Agnity (supra). This court proposes to take up the latter decision first for discussion. In Agnity (supra), the revenue had questioned, inter alia, the ITAT decision to exclude the data relating to Infosys. One of the .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

he reason latter was a giant company in the area of development of software and it assumed all risks leading to higher profits, whereas the respondent-assessee was a captive unit of the parent company and assumed only a limited risk. It has also stated that Infosys Technologies Ltd. cannot be compared with the respondent-assessee as seen from the financial data etc. to the two companies mentioned earlier in the order i.e. the chart. In the grounds of appeal the Revenue has not been able to contr .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ded in para 3.1.2 of the order passed by the TPO. TPO, as noted above, however had taken three companies, namely, Satyam Computer Service Ltd., L&T Infotech Ltd. and Infosys Technologies as comparable to work out the mean. 8. It is a common case that Satyam Computer Services Ltd. should not be taken into consideration. The Tribunal for valid and good reasons has pointed out that Infosys Technologies Ltd. cannot be taken as a comparable in the present case. This leaves L&T Infotech Ltd. w .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

said position, we do not think that any substantial question of law arises for consideration. The appeal is dismissed.‖ 28. Quite evidently, the Court accepted the assessee‟s contentions with respect to dissimilarity of comparables; given the facts, equally, there was sufficient material to favour that view, in the facts of the case. The Court, unlike in Mentor Graphics (supra) did not undertake an analysis of the provisions involved- it was not also necessary, given the admitted sta .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

.g. the gross margin when applying a resale price, or a net profit indicator when applying a transactional net margin method). They can also affect other items, e.g. exceptional items which are below the line but nonetheless may reflect exceptional circumstances. Where one or more of the potential comparables have extreme results, further examination would be needed to understand the reasons for such extreme results. The reason might be a defect in comparability, or exceptional conditions met by .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

its. See paragraphs 1.70 to 1.72. Simple or low risk functions in particular are not expected to generate losses for a long period of time. This does not mean however that loss-making transactions can never be comparable. In general, all relevant information should be used and there should not be any overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts and circumstances surrounding the company in question that should determine its status as a comparab .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

in controlled transactions. Loss-making comparables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses. 3.66: A similar investigation should be undertaken for potential comparables returning abnormally large profits relative to other potential comparables.‖ On the use of multiple year data, this is what the said guidelines provide: ―B.5 Multiple Year Data 3.75: In practice, examining multiple year data is often useful in .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

The analysis of such information might disclose facts that may have influenced (or should have influenced) the determination of the transfer price. For example, the use of the data from past years will show whether a taxpayer s reported loss on a transaction is part of a history of losses on similar transactions, the result of particular economic conditions in a prior year that increased costs in the subsequent year, or a reflection of the fact that a product is at the end of its life cycle. Su .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ions that needs to be assessed in determining comparability. The data from earlier years may show whether the independent enterprise engaged in a comparable transaction was affected by comparable economic conditions, or whether different conditions in an earlier year materially affected its price or profit so that it should not be used as a comparable. 3.78: Multiple year data can also improve the process of selecting third party comparables, e.g. by identifying results that may indicate a signi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

30. The reasoning adopted in various judgments noticed above, shows that functional analysis seeks to identify and compare the economically significant activities and responsibilities undertaken, assets used and risks assumed by the parties to the transaction. Quantitative and qualitative filters/criteria have been used in different cases to include or exclude comparables. The intuitive logic for excluding big companies from the list of comparables while undertaking the FAR analysis of a smalle .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

fer pricing exercise within the strict mandate of Section 92 C and Rules 10-A to 10-E. 31. Arm's length price determination, in respect of an international transaction has necessarily to confirm to the mandate of Rule 10B. In this case, the method followed for determining the arm's length price of the international transaction adopted by the assessee and the revenue is the TNMM. The comparability of an international transaction with an uncontrolled transaction has, in such cases, to be s .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

d the direct and indirect cost of production incurred by the enterprise in respect of property transferred or services provided go into reckoning comparability analysis in the transaction methods, i.e the comparable uncontrolled price, resale price and cost plus whereas the profit based method such as transactional net margin method takes into account, the net margin realised. In TNMM, comparability of an international transaction with an uncontrolled transaction is to be seen with reference to .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

tering into such transactions ―are likely to materially affect the price or cost charged or paid or the profit arising from such transaction in the open market or reasonably accurate adjustment can be made to eliminate the effects of such difference.‖ 32. Now, the sequitur of Rule 10B (2) and (3) is that if the comparable entity or entity‟s transactions broadly conform to the assessee‟s functioning, it has to enter into the matrix and be appropriately considered. The cruc .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

iminate the material effects should be made: ―(ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.‖ 33. Such being the case, it is clear that exclusion of some companies whose functions are broadly similar and whose profile - in respect of the activity in question can be viewed independently from other activities- cannot be subject to a per se standard of loss making company or an abnormal profit making concern or huge or mega turnov .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ion. The TPO, first, has to be satisfied that such differences do not ―materially affect the price...or cost‖; secondly, an attempt to make reasonable adjustment to eliminate the material effect of such differences has to be made. 34. The Court is also aware of the factors mentioned in Rule 10B (2), i.e characteristics of the service provided, functions performed taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

esale or retail. These elements comprehend the similarities and dissimilarities; clause (f) of Rule 10C(2) specifically provides that ―the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions and the nature, extent and reliability of assumptions required to be made in a .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

nfluence on the determination of price. However, in such instances, the onus lies upon the assessee to establish the relevance of such data. The language of Rule 10B(4) does not leave any scope for ambiguity on this issue. This Court notices that this very ground- i.e applicability of previous years‟ data for reaching out comparables, was sought to be urged in Marubeni India (P) Ltd v DIT 354 ITR 638 but deliberately left moot, because the assessee had given it up before the Tribunal. The .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

e admissibility of previous year‟s data for transfer pricing determination. However, for reasons given in the paragraphs below, this Court is of the opinion that the OECD guidelines have no bearing on this issue. 36. This Court holds that in the facts of the present case, the assessee was incorrect, both in its reliance placed upon previous years‟ data as well as the manner of such reliance. First, the assessee‟s justification for relying on such data is the volatility in the c .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

s to offset the consequence of any extreme margins that comparables may have and arrive at a balanced price. Similarly, the wide fluctuations in profit margins of the same entity on a year-to-year basis would be offset by taking the arithmetic mean of all comparables for the assessment year in question. In any case, in the event that the volatility is on account of a materially different aspect incapable of being accounted for, the analysis under would Rule 10B(3) would exclude such an entity fr .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ransaction. It does not prescribe that once an uncontrolled transaction has been held to be a comparable‟, in order to obviate an apparent volatility in the data, the arithmetic mean of three years (the assessment year in question and two previous years‟) may be taken. That would amount to assigning equal weight to the data for each of the three years, which is against the mandate of Rule 10B(4). The use of the word shall‟ in Rule 10B(4) and, noticeably, may‟ in the provi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

wever, of late been actively co-operating with the organization. The Guidelines of OECD therefore, have only persuasive status; they do not have any legal sanction- unlike, for instance Double Taxation Avoidance Agreements which courts are duty bound to interpret and implement, in terms of municipal law, given the compulsion of provisions of the Income Tax Act. Secondly - and more importantly- the provisions of the Constitution compel a national legislation, to embody the terms of a treaty, for .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

(such as Article 21) it would be read along with such provision or right (Jolly George Varghese and Anr. v. The Bank of Cochin, AIR 1980 SC 470, Apparel Export Promotion Council v. A.K. Chopra, AIR 1999 SC 625; Kubic Dariusz v Union of India AIR 1990 SC 605). Thus, the Courts are primarily bound by the law on the subject in India; if the law is clear and unambiguous, there is no question of resorting to extrinsic sources. The only rider is that if the terms of such conventions or treaties are s .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

to paragraph 3.27 thereof. In the present case, there are specific provisions of sub-rules (2) and (3) of Rule 10B of the said Rules as also of the first proviso to section 92C(2) of the said Act which apply. Therefore, the question of applying OECD guidelines does not arise at all.‖ This Court also notes that a recent decision in Sony Ericsson Mobile Communications India Pvt. Ltd. v. CIT (dated 16.03.2015) relied extensively on the OECD Guidelines. However, the said ruling itself recogniz .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

or the purpose of interpreting domestic statute will depend upon the acceptability of the Conventions in question. If the country is a signatory thereto subject of course to the provisions of the domestic law, the International Covenants can be utilized. Where International Conventions are framed upon undertaking a great deal of exercise upon giving an opportunity of hearing to both the parties and filtered at several levels as also upon taking into consideration the different societal condition .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

h India is not a signatory and with respect to which there is no legislative mandate whatsoever. In any event, the OECD Guidelines relevant herein are in consonance with the Rules. Para 3.63 of the Guidelines states that an extreme comparable cannot be excluded on the sole basis that the results arising from the proposed ‗comparable merely appear to be very different from the results observed in other proposed ‗comparables ‖ and that further examination would be needed to under .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

herefore, both the OECD Guidelines as well as Rule 10B (2) and 10B (3) do not, in any manner, prescribe automatic exclusion of entities with extreme financial results. Similarly, insofar as the use of multiple year data is concerned, Para 3.75 of the OECD Guidelines states that [m]ultiple year data should be used where they add value to the transfer pricing analysis.‖ This is akin to the proviso to Rule 10B(4) which provides for data relating to a period not being more than two years prior .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

of factoring in material changes in, inter alia, economic conditions, third party variables, etc. 39. This Court proceeds on the basis that there is sufficient guidance and clarity in Rule 10B on the principles applicable for determination of ALP. These include the various factors to be taken into consideration, approach to be adopted (functions performed, taking into account risks borne and assets employed, size of the market, the nature of competition, terms of labour, employment and cost of .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ssarily adopted. 40. In the present case, this Court holds that once Brescon, Keynote and Khandwala Securities are held to be functionally similar to the assessee, they would be included as comparables, notwithstanding their high profit margins, provided that the material difference on account of such high profit margins can be eliminated under the Rule 10B(3) analysis. 41. This Court, on a perusal of the orders of the lower authorities and the assessee‟s submissions before them which have .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ever, this Court holds that such a contention cannot be raised for the first time at this stage. Therefore, Brescon and Khandwala Securities are held to be functionally similar, and the matter is remitted to the DRP for the purposes of examination under Rule 10B(3) of the Rules. In the event that the material differences arising out of the extremely high profits cannot be eliminated as per Rule 10B(3), these two entities will have to be discarded as comparables. 42. As far as Keynote is concerne .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

al consultancy and would therefore be considered as a comparable. The ITAT, for reasons unknown, did not examine this issue. This Court notes that the assessee is engaged in the business of rendering financial research and advisory services. It is responsible for investigation and advice to some of its group companies on structuring potential investments and exit opportunities; advising the group companies of investment and disposition opportunities; collection and dissemination of financial inf .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

io management, debenture trustee, managing/advising on international offerings of debt/equity, private placement of securities, etc. Evidently, the assessee does not provide any of these services enumerated above. Given such functional differences and the mandate of Rule 10B(2)(b), there could be merit in the argument that Keynote cannot be considered a comparable for determining the ALP. The fact that the assessee had included it in the previous assessment years does not have any bearing on its .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

Indian profits, the respondent cannot be estopped from claiming the benefit of such deduction, by reason of the fact that it erroneously allocated a part of it towards the profits earned in Karachi. What has therefore to be determined is whether, notwithstanding the apportionment made by the respondent in the profit and loss statements, the deduction is admissible under the law.‖ Further, a Division Bench of this Court in CIT v. Bharat General Reinsurance, 81 ITR 303 has also held that the .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

cumbent on the income-tax department to find out whether a particular income was assessable in the particular year or not. Merely because the assessee wrongly included the income in its return for a particular year, it cannot confer jurisdiction on the department to tax that income in that year even though legally such income did not pertain to that year.‖ For the sake of completion, this Court would also deal with the assessee‟s reliance on the DRP‟s order dated 04.03.2013 (fo .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

n to the DRP to properly apply the test indicated in this judgment and analyse the functional similarity of Keynote with the assessee. In the event that the DRP finds them to be functionally comparable, it would proceed to carry out the Rule 10B(3) analysis as in the case of Khandwala Securities and Brescon. 43. The final question that arises for this Court‟s determination in the present appeal is the assessee‟s claim for deduction under Section 36(1)(ii) of the Act in respect of the .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the AO in his order dated 19.10.2012 contradicts both these facts: a) bonus was not paid in the ratio of 2:1 and b) the assessee had declared interim dividend of ₹ 5,47,47,000/-. Further, the bonuses paid to the two shareholder-directors in the preceding two financial years were in the ratio of 60-65%:40-35%, even though their shareholding was 1:1. The balance sheet of the assessee placed on record also indicates that the two shareholders also hold directorial positions in the assessee. Th .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

 

 

 

 

 



|| Home || Acts and Rules || Notifications || Circulars || Schedules || Tariff || Forms || Case Laws || Manuals ||

|| About us || Contact us || Disclaimer || Terms of Use || Privacy Policy || TMI Database || Members || Site Map ||

© Taxmanagementindia.com [A unit of MS Knowledge Processing Pvt. Ltd.] All rights reserved.

Go to Mobile Version