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2015 (5) TMI 352 - ITAT DELHI

2015 (5) TMI 352 - ITAT DELHI - TMI - Transfer pricing adjustment - international transaction of ‘Provision of contract R&D services.’ - inclusion/exclusion of certain companies as comparables - Held that:- Infosys Technologies Ltd. directed to be excluded from the list of comparables as the extant assessee is a captive service provider with a limited number of employees at its disposal and also not owning any branded products but, rendering only offshore services with no expenditure on R&D etc .....

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O inadvertently omitted to include it in the final set. There is no discussion either in the TPO’s order or the direction given by the DRP as to why this company was being considered as incomparable. It implies that the TPO though treated this company as comparable, but, erroneously omitted to include it in the final set of comparables.

Goldstone Technologies Ltd. is not comparable with the assessee company and has been rightly excluded by the authorities below as company is also enga .....

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ware (India) Ltd. - There is no mention of the assessee’s objections about these three companies in the direction given by the DRP. As such, we find that the assessee did urge the inclusion of these three companies in the list of comparables before the TPO as well as the DRP, but, both of them chose not to comment on their comparability. Under such circumstances, we direct the AO/TPO to determine the comparability or otherwise of the above three companies and then take steps for including them i .....

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objectively demonstrate the relatively higher risks undertaken by the comparables on an overall basis, we are disinclined to grant any risk adjustment. No other aspect of the computation of ALP of the international transaction of `Provision of software development services’ has been challenged by the assessee in the present appeal. The impugned order is ergo set aside on the question of determination of the ALP of the `Software development services’ segment and the matter is remitted to the fil .....

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lowance de hors the consideration of international transaction of the revenue from AE, which is equal to depreciation as claimed with mark-up. Both the transactions of claim of depreciation allowance and revenue of depreciation with mark-up have to be seen jointly. The TPO in the present case has simply reduced the amount of deprecation allowance to Nil without simultaneously considering the revenue side of this transaction. If we consider these closely linked transactions of deduction for depre .....

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ion on the assets purchased from AE. This ground is allowed. - Decided in favour of assessee. - ITA No.1453/Del/2014 - Dated:- 24-4-2015 - Shri R.S. Syal And Shri C.M. Garg JJ. For the Appellant : Shri Himanshu S. Sinha, Advocate & Shri Md. Fahad Khalid, CA For the Respondent : Shri Judy James, Standing Counsel ORDER Per R.S. Syal, AM: This appeal by the assessee arises out of the final order passed by the AO on 30.01.2014 u/s 143(3) read with section 144C(13) of the Income-tax Act, 1961 (he .....

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assessee is a wholly owned subsidiary of Ciena Corporation, USA and is engaged in the business of provision of software development services and marketing support services to its overseas group companies. The assessee reported certain international transactions. The Assessing Officer (AO) referred the international transactions to the Transfer Pricing Officer (TPO) for determination of their Arm s Length Price (ALP). The first dispute is qua the international transaction of Provision of softwar .....

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es as comparables with their average PLI at 14.4%. The TPO rejected 15 out of such 20 companies and added two new companies to make a final tally of comparable companies at 7, with their average OP/TC at 25.89%. Following is the final list of comparable companies chosen by the TPO with their respective profit margins:- Sl.No. Name of the Company Margins 1. Akshay Software Technologies ltd. 12.41 2. LGS Global Ltd. 21.26 3. Neilsoft Limited 15.54 4. Sasken Communication Technologies Ltd. 15.99 5. .....

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e ALP of this international transaction at ₹ 1,50,72,87,442/-, which led to the addition on account of transfer pricing adjustment to the tune of ₹ 15.43 crore. The assessee is aggrieved against the making of this addition. 6. We have heard the rival submissions and perused the relevant material on record. It can be seen from the orders of the authorities below that the assessee s adoption of TNMM as the most appropriate method with the PLI of OP/TC have not been disturbed. The asses .....

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n be seen from the TPO s order that he has stated the assessee to be primarily engaged in the provision of software development services to its AE. It has also been stated that the role of the assessee is to execute the work sub-contracted by its AE. We have gone through the assessee s TP study report, a copy of which is available on pages 11-155 of the paper book, from which it can be noticed that the Ciena Group is a supplier of communications networking equipment, software and services that s .....

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. The assessee is engaged in design, development and maintenance of software, which essentially includes the activities, namely, Software development services; Procurement, research and technology; Development of design; After-sales activity; and Accounting/administration. The assessee provides contractual software development services to its group company alone. These services include maintenance and updation activities. The assessee is compensated by its USA Associated enterprise (AE) with agg .....

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as Intellectual Property Rights. This clause provides that the assessee, at no time, shall acquire or retain any right, title or interest whatsoever in the work done by it. This clause further provides that the intellectual property rights in the format, presentation, procedures, process, computer software and other material of whatever nature created, developed or enhanced by Ciena India in the course of providing the services to Ciena, USA shall be and remain the sole property of Ciena, USA a .....

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ng profit before interest and tax at ₹ 15.56 crore with profit ratio of 13%. With above understanding of the nature of services provided by the assessee to its AEs under this segment, we will take up the disputed companies, one by one, for consideration as to their comparability. Infosys Technologies Ltd. 8.1. The TPO noticed that this company was finding place in the accept/reject matrix but was rejected in the TP documentation by claiming that it failed functional area comparability. The .....

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aterial on record. It can be seen that the TPO has included this company in the list of comparables by rejecting the assessee s contention about the brand of this company helping in earning huge profits and also the brand-related profits swelling the ultimate profit rate of this company. We find that the assessee is only a captive unit rendering services to its AE alone without acquiring any intellectual property rights in the work done by it in the development of software. The Hon ble Delhi Hig .....

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ctors as enumerated above, the Hon ble Delhi High Court held Infosys Ltd. to be incomparable with Agnity India Technologies Pvt. Ltd. The facts of the instant case are more or less similar inasmuch as the extant assessee is also a captive service provider with a limited number of employees at its disposal and also not owning any branded products but, rendering only offshore services with no expenditure on R&D etc. When we consider all the above factors in a holistic manner, there remains abs .....

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to the inclusion of this company on the ground of functional dissimilarity and its fluctuating profit margins. The TPO rejected the assessee s contention about the super normal profits earned by this company during the year and also held the same to be functionally similar inasmuch as it having only one identifiable reporting segment, i.e., software development services. The assessee is upset with the inclusion of this company in the final list of comparables. 9.2. After considering the rival s .....

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that functionally Bodhtree Consulting Ltd. is a comparable entity. 9.3. As regards the fluctuating profit margins of this company over the years, we find from the extractions made in the TPO s order that the ratio of profit before income-tax to sales for the financial year 2007-08 was at 15.63% which, for the instant year, increased to 44.49%. In the immediately succeeding year, the profit rate came down to 22.38% and in the financial year 2010-11, the company has reported loss of (-) 1.89%. Bef .....

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as comparable because of a different model of revenue recognition. He invited our attention towards the Annual report of this company, in which it has been specifically reported that revenue from software development is recognized based on software developed and billed to clients. He submitted that the costs incurred by this company in respect of the projects pending completion at the end of the year are booked at the time of incurring, but, the income is recognized on the raising of bills in s .....

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ignificant. This is also called Matching concept , as per which income is recognized with the incurring of expenses. To put it simply, if income does not accrue from a particular transaction, the expenses incurred for such transaction are excluded from the Trading and Profit & loss account by carrying them to Balance sheet. To illustrate, if there is an incomplete contract worth ₹ 100 for doing a particular work, and the assessee has incurred ₹ 60 on this project till the close o .....

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in the earlier year at ₹ 60 and the further expenses incurred in the year of raising of the bill. In this way, the profit for the earlier year of incurring expenses of ₹ 60 and the next year of raising invoice of ₹ 100 gives true and fair view of the profitability of that enterprise for both the years. If this enterprise, instead of capitalizing ₹ 60 in the first year, claims deduction in the year of incurring itself but recognizes income of ₹ 100 in the next year, .....

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the expenses incurred in respect of such software development may be capitalized, which appears to be a more rational manner of depicting the true and fair view of the profitability of the enterprise; and the second, in which such expenses may be straightway taken as revenue cost for the year of its incurring itself, which may not reflect a true and fair view of the profits on year to year basis. The contention of the ld. AR is that whereas Bodhtree fell into the second situation, the assessee .....

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DR to examine the Annual report of this company and point out the amount of expenses capitalized in respect of incomplete work at the end of the year. On the next date of hearing, the ld. DR failed to specifically point out any amount of such capitalized expenses with the opening or closing balance. This prima facie shows that the expenses incurred in respect of incomplete projects of software development at the end of the year, but billed in the subsequent year, were, in fact, treated as expen .....

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it does not properly match expenses with revenue, it loses its credibility for making a logical comparison with a company that accounts for expenses matching with the revenue. Once it is held that the profits of Bodhtree Consulting Ltd. do not represent fair profitability on year to year basis, this company loses its tag of an effective comparable. We, therefore, order for the exclusion of this company from the final list of comparables. Tutis Technologies Ltd. 10.1. The assessee included this .....

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which is available on pages 232 onwards of the paper book. Apart from assailing the objections taken up by the TPO on other comparables, the assessee submitted that this company was accepted by the TPO as comparable. However, the TPO inadvertently omitted to include it in the final set. There is no discussion either in the TPO s order or the direction given by the DRP as to why this company was being considered as incomparable. It implies that the TPO though treated this company as comparable, b .....

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how cause notice. During the course of proceedings, the TPO examined the Annual report of this company which indicated that the business segment included certain activities which were dissimilar to the software development. He rejected this company, inter alia, on the ground of its failing the export turnover filter. The assessee is aggrieved against the expulsion of this company from the final set. 11.2. After considering the rival submissions and perusing the relevant material on record, we fi .....

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elopment segment, we find Goldstone Technologies Ltd. to be nowhere close to it. This company is also engaged in providing services comprising on-site and offshore operations. Apart from that, it added two more new divisions during the current year, being, Media Division and IPTB Division. By no standard this company on entity level can be considered as comparable with the assessee company. In so far as the export filter applied by the TPO for rejecting this company is concerned, we find that it .....

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When this position was confronted, the assessee also came out with the above three new companies fulfilling the filters applied by the TPO. The assessee requested the TPO to consider these companies also as comparable, which is evident from page 251 of the paper book, being reply dated 28.12.2012 of the assessee to show cause notice issued by the TPO. The TPO did not at all comment on the inclusion or otherwise of these three companies in his order. The assessee objected to the noninclusion of t .....

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teps for including them in the list of comparables, if found to be comparable. 13.1. The second issue taken up by the assessee in its appeal in respect of the ALP of the international transaction of Provision of software development serves , is about not allowing risk adjustment. The assessee made a claim before the TPO for granting risk adjustment, which was jettisoned for the failure on part of the assessee to back such claim with suitable material. The assessee contested such denial of risk a .....

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t, there cannot be a general rule of allowing or not allowing risk adjustment. Risk is nothing but a possible adverse perception in the given circumstances, which may or may not finally fructify. Generally, risks and rewards go side by side. Higher the risk, more the profit; and vice versa. Level of risk depends on the facts and circumstances of each case. Where the assessee succeeds in ably demonstrating that the comparables finally selected bore relatively more risk than it, then there should .....

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al to demonstrate that the risk undertaken by the comparable companies were relatively more than it, warranting downward adjustment in their profit rates. Further, the variation in such risks, if any, should be capable of quantification on some reasonable and logical basis. 13.3. The ld. AR stated before us that the assessee was not having any risk at all inasmuch as its services were to be compensated by the AE with an appropriate mark-up in comparison with the full-fledged risk bearing compara .....

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ecomes a potential risk. Further, the fear of termination of agreement between such an enterprise and the single customer or the possibility of closure of business by such customer, voluntarily or due to reasons beyond his control, also pose a grave threat to the existence of such an enterprise. In that sense of the matter, an enterprise serving a single customer, assumes marked risks. As the assessee is wholly dependent on its AE for securing business, its entire existence also depends on the s .....

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ergo set aside on the question of determination of the ALP of the Software development services segment and the matter is remitted to the file of AO/TPO for computing ALP of the international transaction of this segment afresh in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard. 15.1. Ground nos. 5 and 8 are in respect of international transaction of Purchase of capital goods . The factual matrix apropos this issue is th .....

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t plus basis wherein it recharges all its operating costs including depreciation to its AE along with a mark up. However, the specific information called for by the TPO, was not submitted. In the absence of such details, the TPO computed the ALP of this international transaction at Nil. As regards the adjustment u/s 92CA, the TPO required the AO to calculate proper depreciation on fixed assets as per the provisions of the Act. The DRP directed the assessee to submit item-wise particulars for the .....

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rore, against the transacted value of ₹ 33.50 crore. Thereafter, rectification application was filed u/s 154 of the Act which was disposed of by the AO vide his order dated 27.03.2014 reducing the income with Cost of old fixed assets by ₹ 12.20 crore and adding depreciation of ₹ 3.72 crore. Another rectification application was filed, which was also disposed of by the AO vide his order dated 26.9.2014, reducing the total income to ₹ 25.48 crore from ₹ 40.74 crore. T .....

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in sub-section (1) of section 92B, which provides that "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or .............. . Section 92(1) stipulates that: Any income arising from an international transaction shall be computed having regard to the arm's length price . The manner of computation of arm's length price is .....

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facts of the instant case, we find that the assessee applied TNMM as the most appropriate method for showing that this international transaction was at ALP. The TPO held that the correct method to be applied was CUP and as such the assessee was called upon to give uncontrolled comparable instances of the purchase of similar assets, which the assessee failed to do. This led the TPO to treat the ALP of this international transaction at Nil. Normally, if the assessee fails to give any comparable in .....

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is juncture, it is pertinent to note the language of section 92(1) which provides that any income arising from an international transaction shall be computed having regard to the arm's length price. It does not say that the total income is to be computed in accordance with the ALP. It is rightly so because the international transactions which have no direct bearing on the total income, cannot give rise to addition on account of difference between their transacted value and ALP. Since the tra .....

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377; 10 in its Profit and Loss account. If the ALP of such transaction is determined at ₹ 80, then the difference of ₹ 20 cannot be considered as income. Rather, the amount of depreciation will be restricted to ₹ 8 instead of ₹ 10, thereby increasing the total income by ₹ 2. When we advert to the facts of the extant case, it is found that the TPO has rightly held to the effect that it is the amount of depreciation on the purchase of such fixed assets, which will be .....

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of purchase of raw material from AE or sales of goods to AEs. Rule 10A of the IT Rules, defines transaction as including a number of closely linked transactions . The Hon ble Delhi High Court in its judgment of March, 2015 in Sony Ericsson Mobile Communications India Pvt. Ltd. has held that the related transactions should be considered jointly for determining their ALP. However, in order to consider more than one international transaction as one, it is sine qua non that such transactions must be .....

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assets is closely linked with the purchase of raw material or sale of finished goods etc. In such a scenario, it becomes important to examine the transaction of purchase of fixed assets independent of other transactions. 15.6. However, the above rule of scrutinizing international transaction of purchase of fixed asset as independent of all other transactions is not universal. It has its own exceptions as well. The instant case is a glaring example of exception to the above rule. It is so for the .....

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pends upon the amount of deprecation allowance. When the assessee is getting mark-up of 13%, the amount of deprecation at ₹ 10 in our above hypothetical example will fetch remuneration of ₹ 11.30. If the amount of depreciation is reduced to Nil, the amount of income to that extent will also be Nil, because the mark-up can be applied only if there is depreciation cost to the assessee. In other words, the transactions of depreciation on one hand and the resultant revenue on the other, .....

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