TMI Blog2012 (12) TMI 1018X X X X Extracts X X X X X X X X Extracts X X X X ..... then such sum will also have to be reduced from the total turnover of the company for the purpose of computation of deduction u/s. 10A. - I.T.A. No. 5110/Del/2010 - - - Dated:- 21-12-2012 - I. C. Sudhir (Judicial Member) And Shamim Yahya (Accountant Member) For the Petitioner : Neeraj Jain (Adv.), Abhishek Aggarwal and Ramit Katyal For the Respondent : Peeyush Jain, C.I.T. (D.R.) ORDER Shamim Yahya (Accountant Member) 1. This appeal by the Assessee is directed against the order of the Assessing Officer u/s. 143(3) read with section 144C of the I.T. Act for the assessment year 2006-07. The grounds raised read as under:- 1. That the assessing officer erred on facts and in law in completing assessment under Section 143(3) read with Section 144C of the Income-tax Act, 1961 ( the Act ) at an income of ₹ 8,20,86,272 as against the returned income of ₹ 14,78,675. 2. That the assessing officer erred on facts and in law in making an addition of ₹ 7,87,94,571 on account of the alleged difference in the arm's length price of the 'international transactions' of provision of software design and development services on the basis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there has been decline in the sales of such companies. 5.1 That the assessing officer/the TPO erred on facts and in law in rejecting PSI Data Systems Ltd. as comparable company allegedly on the ground of being functionally different without appreciating that the company provides information technology services similar to that of the appellant. 6. Without prejudice the learned assessing officer/the TPO erred on facts and in law in not appreciating that the appellant is a low-risk-bearing contract service provider and a risk adjustment to the extent of 5% over the cost ought to be provided, as risk and reward to this extent vest with the overseas associated enterprises to which the appellant renders off-shore software services. 7. That the assessing officer/the TPO erred on facts and in law in not appreciating that the income of the appellant is exempt under section 10A of the Income Tax Act and hence, there could not be any motive for the transfer of profits outside India. 8. Without prejudice that the assessing officer/the TPO erred on facts and in law in not allowing the working capital adjustment in respect of the companies proposed to be selected as comparable by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 Goldstone Technologies Ltd. 0.79% 2 California Software Co. Ltd. 22.36% 3 Neilsoft Ltd. 14.69% 4 N.S.E.LT. Ltd. 13.66% 5 Applabs Technologies Pvt. Ltd. 18.17% 6 PSI Data Systems Ltd. 0.12% 7 Kale Consultants Ltd. 13.15% 8, Blue Star Infotech Ltd. 10.66% Average 11.70% 3.2 Since the operating profit margin (OP/OC%) of the appellant at 14.36% was higher than 11.70% of the comparable companies, the international transaction was considered to be at arm's length and no adjustment was required to be made. 3.3 The TPO, however, rejected the filter of OP/OC(%) less than (-)40% and greater than 40% considered in the search process and included 3 companies in the final set of comparables, as under:- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 551,968,000 Difference 78,794,571 3.7 The Dispute Resolution Panel ('DRP') upheld the order of the TPO and accordingly, the assessing officer on the basis the order of the DRP passed the final order. 4. We have heard the rival contentions and perused the records. At the outset, ld. Counsel of the assessee submitted that in the transfer pricing analysis in this case companies having significant related party transactions should be rejected. Ld. Counsel of the assessee submitted in this regard, that an unrelated enterprise having controlled transactions cannot be considered as comparable to the assessee, while applying TNM Method, as a company having substantial related party transactions may influence the profits of the company. 4.1 Ld. Counsel of the assessee submitted that Rule 10B(1)(e) of the Income Tax Rules, 1962, too, provides that net margin of the assessee requires to be compared to an unrelated enterprise form a comparable uncontrolled transactions. 4.2 Ld. Counsel of the assessee has further placed reliance in this regard on the decision of Delhi Bench of Tribunal in the case of Sony In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... epresentative referred to the decision of the Tribunal in the case of M/s. American Express India (P) Lt., ITA No. 4240/D/2009, A.Y. 2003-04, dated 18-05-2012. The relevant para of the tribunal's order is as under:- 16. From the above, it is evident that learned CIT(A) has totalled up the amount received from the related parties for rendering of services together with the payments made to related parties which became ₹ 323.23 lakhs. He compared the same with the total operating expenses which were ₹ 4448.71 lakhs. If the total operating expenses are being compared, then they can be compared only with the total operating expenses paid to the related parties. The amount received from related parties for rendering services can be compared only with the total receipt of Hinduja TMT from rendering of services. Therefore, apparently, the working of learned CIT(A) is incorrect. 5.2 Referring to the above order, Ld. Departmental Representative submitted that capital inflow and capital outflow do not enter into working of related party transactions. Revenue items (includes sales) need to be compared upon a base of Revenue, and expenditure or purchase items need to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he independent enterprises to the extent they are needed profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally, when profit margins of an independent enterprise are used the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise. 5.6 It was further submitted that the OECD Transfer Pricing guidelines further in para 2.79 provides in this regard as under: 2.79 Similarly, when analysing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally, when net profit indicators of an independent enterprise are used the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise. 5.7 Ld. Counsel of the assessee submitted that that any controlled transaction with related parties (i.e. Related party transaction or RPT), whether undertaken by way ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... actions (i.e. transactions of sales and purchase on revenue as well as capital account having a bearing on profitability of the enterprise) to relevant base, i.e. sales or cost does not exceed the limit of 25%. Hence, he submitted that Saksoft limited, Datamatics Technologies Limited, 3DPLM Software Solutions Ltd. and California Software Limited, considered as the comparable companies by the TPO in the assessee's case have related party transactions exceeding 25% the same are to be excluded from the set of comparable companies for applying TNMM. 5.13 We have carefully considered the submission and perused the records. In this case for benchmarking the international transaction the assessee has considered TNMM as the most appropriate method and considered itself to be the tested party with operating profit/operating cost (OP/OC%) as the profit level indicated. In the search process the assessee has considered 8 comparables companies in the transfer pricing documentation with OP/OC of 11.70%. Since the operating profit margin (OP/OC%) of the assessee at 14.36% was higher than 11.70% of the comparable companies, the international transaction was considered to be at arms length ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... length price in relation to the international transaction. 5.16 A reading of the above clearly shows that under the said Rules the net margin of the assessee required to be compared to an unrelated enterprise from a comparable uncontrolled transaction. Thus it follows that comparables having high ratio of related party transaction cannot be taken a comparable. This proposition is also supported by the following case laws:- i) Sony India Pvt. Ltd. vs. DCIT 114 ITD wherein the tribunal has held as under:- We are further of view that an entity can be taken as uncontrolled if its related party transaction du not exceed 10 to 15% of total revenue, Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purposes of comparison, what is to be judged is the impact of the related party transaction vis-a-vis sales and not profit since profit of an enterprise is influenced by large number of other factors. The TPO and on appeal, the learned CIT (Appeals) did not substantiate the allegation by furnishing figures of controlled transactions to show that such transaction had significant impact on the profits of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... considered as un-controlled comparable and the same has to be excluded from the list of comparables finally selected by the TPO. But for the same, the factual aspect has to be examined as to how much percentage of RPT to total revenue is there in the case of this comparable i.e. 3D PLM Software Ltd. Hence, we set aside the assessment order and restore the entire matter to the file of the Assessing Officer for a fresh decision after examining the factual aspect of this claim of the assessee and after obtaining fresh directions from DRP. If it is found that the percentage of RPT to total revenue in the case of this comparable i.e. 3 DPLM Software is more than 25% then this comparable should be excluded from the list of comparables selected by the TPO and the average mean should be worked out after excluding this comparable and if the same is within plus minus 5% of the profit margin declared by the assessee then no transfer pricing adjustment is required to he made. iii) Tribunal decision in the case of Philips Software Pvt. Ltd. vs. ACIT (I.T.A. No. 218/Bang/2008) wherein it was held as under:- The filter of 25% related party transactions have been adopted because transacti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... OP/OC% 1 Neilsoft Ltd. 14.69% 2 N.S.E.LT. Ltd. 13,66% 3 Applabs Technologies Pvt Ltd. 18.17% 4 Kale Consultants Ltd. 13.15% Average 14.92% Global Logic India Pvt. Ltd. 14.36% 5.20 From the above, we hold that since the operating profit margin (OP/OC%) of the assessee at 14.36% is within the safe harbor range of +/- 5% of the average of (OP/OC) of comparable companies at 14.92% the international transaction undertaken by the assessee should be considered at arm's length, and the adjustment proposed by the TPO is unwarranted. 6. Ground No. 11 to 11.2 On these issues Assessing Officer referred to the definition of export turnover as per explanation 2(iv) of section 10A. Export turnover means that the' consideration in respect of export by the undertaking of articles or things-or computer software received in, or bought ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eak-up of these expenses are as follows: Description Amount Telephone expense 1,31,48,431 Internet expenses 43,97,525 Postage and courier charges 3,64,913 Total Communication Expenses 1,79,10,869 In relation to said communication expenses, it is submitted that 5% of the total life cycle of software is used for transmission of software to clients on estimated basis. Further, it is also submitted that the persons employed for a software product are divided as onshore team and offshore team. One of the team gets in touch with the client to understand customer's need through site visit, video/voice conferencing and emails. They also get in touch with the clients, when the software is developed and transmitted to the customers. Therefore, admittedly, only 5% of the internet charges i.e. ₹ 2,19,867 (5% of 43,97,525) is attributable to the delivery of software outside India. Further, it is also submitted that no insurance expense are attributab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Nos. 691 and 1953/MDS/2007) upholding the aforesaid position. 8.5 It was submitted that it would further be appreciated that the Assessing Officer has accepted the contentions of the appellant in the AY 2007-08 and had accordingly reduced freight, telecommunication or insurance expense from total turnover of the assessee while reducing such sum from export turnover. 8.6 Ld. Counsel of the assessee submitted that Delhi Bench of ITAT in the assessee's own case for the assessment year 2005-06, relying on the aforesaid decision of Special Bench of Tribunal in the case of Saksoft India Limited, has allowed the appeal of the appellant and directed the assessing officer to re-compute deduction under section 10A after reducing communication expense from export turnover as well as total turnover. 9. Ld. Departmental Representative relied upon the order of the Assessing Officer in this regard. 10. We have carefully considered the submissions and perused the records. We note that it is the contention of the assessee company that only 5% of the internet charges are attributable to the delivery of software to client, hence, full amount of the above expenses should not be taken ..... X X X X Extracts X X X X X X X X Extracts X X X X
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