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Chryscapital Investment Advisors (India) Pvt. Ltd. Versus Deputy Commissioner Of Income Tax

[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 on the basis that there is sufficient .....

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etermining 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, lead to its exclusion from the list of c .....

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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 orders of the lower authorities and the as .....

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nd 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 will have to be discarded as comparabl .....

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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 investment and disposition opportunities; c .....

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ndication, 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 included it in the previous assessment .....

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yse 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 with the objective of avoiding tax - Held that:- p .....

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at 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-directors is allowed. - Decided in favour of asses .....

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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 Income Tax Appellate Tribunal ("ITAT" .....

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mpanies 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? 4) Whether disallowances can be made under Sec .....

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lso 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 transactions relating to reimbursement received b .....

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% -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 Margin ( Operating Margin ) of 4.04% earned by the .....

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ional 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 transfer pricing regulations of several develop .....

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r 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 abnormal business profits. The TPO also retained .....

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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 dated 21.09.2012, confirmed the transfer pricing add .....

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luded 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 (Operating Margin of 27.05%) and rejected three .....

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ent 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 the decisive factors for determining inclusion or .....

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ven 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 of Keynote. Unlike the assessee, Keynote is invol .....

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d 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% 2006-07 94.06% 2007-08 145.83% 2008-09 191.58% 9. The .....

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s 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 ALP. The assessee while determining the ALP consi .....

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010 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 single year data) for the reason that on the basi .....

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lting 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 this year. TP grounds are accordingly disposed o .....

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nd 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 bonus paid to the shareholder employees is not in .....

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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) provides that specific characteristic of services rende .....

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d. 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 narrow the range (e.g. the inter-quartile range .....

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ith ―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 stated that though the mandate of the law is ordina .....

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hat 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 the contention that data in respect of Keynote s .....

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ark 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 of this court, in Commissioner of Income Tax v .....

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red 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 contentions 16. Mr. Rohit Madan, learned counsel for .....

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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 done for TNMM. 17. Countering the submissions of t .....

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oth 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 factors which result in material difference in the c .....

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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 "abnormally high profits" as a ground for rejection .....

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t;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; (b) resale price method; (c)cost plus method; ( .....

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ing 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 and maintained by the assessee in accordance with .....

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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 document in the possession of the Assessing Off .....

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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 undertaken with the ―unrelated enterprise .....

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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 consideration. Rule 10B (2), as the second step, r .....

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ssets 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 operate, including the geographical location and .....

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(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, between the transactions being compared, or betwe .....

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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 assessee's argument is that entities earnin .....

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ons (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. Ltd vs. DCIT (2012)(20 ITR 69) (Bang)(Tri.) and A .....

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td. 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 Ltd.) should be excluded. 2. Simple arithmetic ave .....

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.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 of that decision and taking into account the su .....

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dia (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 also has a reducing tendency. In the absence of e .....

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r 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 enabled services. Assessee itself argued before the .....

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re 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 activities, they could not be included. 9. Sony India (P) .....

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tilized 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 making supernormal profits cannot be a comparable. If .....

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ogy 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. Extreme cases should be avoided while making a comp .....

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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 be taken as a comparable or not - this would dep .....

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es 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 comparable for one year does not ipso facto mean th .....

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cause 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. Unless and until there are specific reasons and facto .....

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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 be rejected as comparables unless abnormal loss .....

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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 materials on record, the Bench did indicate the genera .....

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ected 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 into such transactions are likely to materially aff .....

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r 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 so as to select the entities having a relatively .....

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d 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 assessee to bring out those reasons and seek exclu .....

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is 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 Ltd., we find that the main objection of assessee .....

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nsfer 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 to assessee because the event management was don .....

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ith 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 rules.‖ 26. The assessee‟s position is .....

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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 set." Many decisions of different benches .....

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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 to have been accepted and, had that been the cas .....

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LP 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 approach to be adopted by the Tribunal. The Tribu .....

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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, financial year ending 31st March, 2002. We may also mak .....

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pecial 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 reasons was that the said company was a giant co .....

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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 controvert or deny the data and differences mentioned .....

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. 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. which gives us the figure of 11.11 %, which is le .....

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ial 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 state of facts. 29. Considerable inspiration was dr .....

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e, 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 an otherwise comparable third party. An extreme .....

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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 comparable, not its financial result. 3.65: Generally sp .....

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bles 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 a comparability analysis, but it is not a system .....

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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. Such an analysis may be particularly useful where .....

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mparability. 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 significant variance from the underlying comparabilit .....

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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 smaller company is attractive, given that such big com .....

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f 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 seen with reference to the functions performed, t .....

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urred 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 functions performed as provided in sub-rule (2)( .....

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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 crucial expression giving insight into what was inte .....

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213;(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 turnover company. As explained earlier, Rule 10B (2) g .....

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ch 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; contractual terms of the transactions indicati .....

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imilarities 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 application of a method‖ have to be taken i .....

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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 TPO in his order dated 03.10.2011 has comprehens .....

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r 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 comparables‟ profit margins and the consequ .....

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ns 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 from being considered as a comparable. Secondly, a .....

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ncontrolled 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 proviso, implies that the relevant assessment year .....

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he 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 it to be enforceable in courts in India. This is .....

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h 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 similar to the law applicable in India, courts ma .....

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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 recognized that the provisions of the Act and the Rules .....

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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 conditions in different countries by laying down the mini .....

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hich 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 understand the reasons for such extreme results‖ .....

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le 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 to such financial year [to] be considered if su .....

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, 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 capital, geographical location etc). The extent .....

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ourt 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 been placed on record in this appeal, finds tha .....

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nnot 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 concerned, this Court notices that the assessee had chal .....

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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 information of prospective entities; and other rela .....

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ing 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 inclusion for the subject assessment year. In t .....

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d 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 there is no estoppel against law under the Act. The .....

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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 (for AY 2006-07) for the exclusion of Keynote as a .....

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d 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 bonus paid by it to its two shareholders - Ashi .....

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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. Therefore, the assessee‟s contention that th .....

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