TMI Blog2013 (6) TMI 746X X X X Extracts X X X X X X X X Extracts X X X X ..... has erred in concurring with findings of the AO/TPO and disregarding the economic analysis undertaken by the Appellant for establishing the arm s length price of the international transactions related to the provision of software development services without appropriate justification. 3. The TPO/AO has erred in determining the arm s length margin/price using only financial year 2005-06 data which was not available to the Appellant at the time of complying with the Transfer Pricing document requirements. Further, the TPO has erred in using single year data pertaining to financial year 2005-06 as against multiple year data used by the Appellant. 4. The TPO/AO has erred in law and on facts, in applying certain filters and not undertaking an objective comparative analysis for selection of comparable companies. In arriving at the arm s length price of the international transactions entered by the Appellant with its associated enterprises, the TPO and the AO have erred in rejecting certain comparables identified by the Appellant on the following factors Related party transaction greater than 15% of operating revenues (as against the related party filter of 25% used by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he business of Software Development and providing marketing services. The assessee is a captive service provider and is engaged in the business of running Software Design and Development Services (Software Services) and business support services to its AEs. The assessee has been operating through the following units:- a) Hyderabad Unit; the Software Development Services are rendered through its development Centre in Hyderabad which is registered under the Software Technology Parks (STPI) scheme of Government of India as a 100% Export Oriented Unit (EOU). The Development Centre, Hyderabad is engaged in the carrying out design, development and testing for enhancement and improvement of Qualcomm existing products and development of new products. The Development Centre at Hyderabad is engaged in providing software services to its AEs. b) Mumbai New Delhi Units; the assessee renders business support services to its associated enterprises through these units i.e. Mumabi New Delhi. c) Bangalore Unit; pursuant to the merger of Qualcomm Bangalore Design Centre Private Limited and Spike Technologies India Private Limited with the assessee w.e.f 1st April, 2005, the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... claimed that the price received by the assessee in respect of its international transaction with its AEs is at arms length. In the TP study, the assessee was selected as the tested party and Transaction Net Margin Method (TNMM) was applied as the most appropriate method to determine the ALP. The assessee used available data updated till 25th August 2006, to select comparable companies. It was the assessee s case that as financial data for the F.Y 2005-06 was not available in all comparable cases, the assessee considered financial data of F.Y 2003-04 along with the data for F.Y 2004-05, wherever available. The assessee selected 36 comparables for the software services with weighted average operating profit/operating cost of 12.06%. The A.O referred the matter u/s 92CA (1) of the Act to the Transfer Pricing Officer (TPO) for determination of ALP of the international transactions entered by the assessee with its AEs. 8. The Ld. TPO examined the transfer pricing study submitted by the assessee. However, he did not concur with the analysis undertaken by the assessee. The Ld. TPO was of the view that in determining arms length price of international transaction of the assessee, the fi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iven by the TPO in para Nos. 5, 6 7 of his order, the Ld. DRP did not find any reason to interfere with the order of the TPO/AO. 12. The next objection of the assessee to the TPO s approach and in using the data which was not available to the assessee at the time of conducting the transfer pricing study by the assessee, was also rejected by the Ld. DRP. 13. The Ld. DRP also rejected the assessee s objection in not allowing benefit of +/- 5 % while determining the ALP. 14. The Ld. DRP also rejected the assessee s claim to use Multiple Year Data for the purpose of computing operating margins and comparable companies. The Ld. DRP upheld the order of the TPO in selecting the current years data only. 15. In the light of the order of the Ld. DRP, the AO then passed final order by making addition of ₹ 13,19,23,215/- on account of ALP in respect of transactions of software development segment entered into by the assessee with its associate enterprise. This action of the authorities below has been questioned by the assessee on the above grounds of its appeal before the Tribunal. 16. In support of the grounds, the Ld. A.R submitted that the compatibility analysis under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the due date for filing of income tax return. Thus, it is obvious that all the companies do not publish the financial results by the due date and hence use of financial data only for the financial year 2005-06 was practically not possible. In such circumstances use of multiple year and contemporaneous data available by the prescribed date should have been allowed. 18. On the issue of application of certain filters raised in Ground No-4 of the appeal, the Ld. A.R submitted that the Ld. T.P.O has rejected certain comparables identified by the assessee on the factors that related party transaction is greater than 15% of operating revenues, there was functional dissimilarity, consistent loss making companies were there and they were having diminishing revenues. 19. We thus proceed to decide whether comparables selected by the assessee vis a vis the TPO are proper and justified to benchmark the international transactions entered into by the assessee with its AEs during the relevant period. In this case, the assessee initially selected a set of 36 comparables in its TP study reports. However, before us, it was submitted by the assessee that 20 comparables out of 36 comparables we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lstar as comparable on the basis that it was persistently a loss making company for the last 3 preceding years which has been disputed by the Ld. AR before us. We thus set aside the matter to the file of the Ld. TPO to verify the correctness of the above submission of the assessee that Melstar had earned operating profit during the year and if it is found correct then include it as a comparable company in determining the A.L.P. The same is thus rejected as comparable. B. AKSHAY SOFTWARE LTD. (Akshay Software). 23. In its show cause notice, the Ld. T.P.O proposed to reject Akshay Software on the basis of applying related party transaction filter of 15%. In its order the Ld. T.P.O has however, rejected the company on the basis of functional dissimilarity. 24. The contention of the Ld. A.R remained that the Ld. T.P.O has rejected the company on the basis of functional dissimilarity without providing any opportunity of being heard to the assessee. He submitted that the Akshay Software is also engaged in Software services with miniscule revenue from sale of products. He referred Page No. 90 of the paper book volume 2 i.e. profit and loss account of the company in support. The L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ese two companies on the basis of applying related party transaction filter of 15% in view of decision of the Tribunal, Delhi Bench in the case of Soni India (P) Ltd. Vs. DCIT (2007) 288 ITR 52 (Delhi). The contention of the Ld. A.R remained that the application of Nil related party transaction filter may curtail the sample size of the comparables and this may not give a substantial and fair base for computation of ALP. The Act does not provide specifically as to what percentage of related party transactions have material effect on the overall margins. However, some guidance may be taken from the definition of A.E in Section 92A (2) (a) of the Act, wherein it is prescribed that one enterprise holding 26% shares in other enterprise can be considered as an A.E. He submitted that as the provisions of Section 92A (2) (a) are from the TP Chapter itself, a limit of 25% may be considered more reasonable to be applied on the threshold for the related party transactions. The threshold of 25% is also recognized statistically as being a threshold for removal of extreme in the calculations of statistically disbursal. It was submitted that interquartile range (IQR) is a widely employed statis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able to the assessee in the light of the decision of the Tribunal in the case of Soni India (P) Ltd (Supra) where upper limit of 15% of related party transactions has been accepted within which limit the transactions cannot be held to be significant to annul the profitability of comparable. However, the Ld. T.P.O in A.Y 2007-08 has accepted Aztec Software as comparable, where the related party transactions are 22.99% being less than 25% and accepting the assesses s contention that receipts and payments on account of reimbursement should not be considered while computing RPT. In the year under consideration, the RPT is marginally in access of the threshold limit of 15% adopted by the T.P.O even if receipt and payment on account of reimbursement is execluded as done in A.Y 2007-08 by the Ld. T.P.O. We thus find that RPT ratio is not excessive so as to reject the Aztec Software as comparable on this account. We, therefore, accept Aztec Software as comparable to determine ALP in the assessee s case in the year. The A.O/TPO is accordingly directed to accept Aztec Software as comparable for determination of ALP in the case of the assessee for the year. 30. So far as KPIT is concerned, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... activity. We accordingly direct the A.O/T.P.O to take it into account for determination of ALP in the case of the assessee. F. R.S. SOFTWARE(INDIA) Ltd.(R.S. SOFTWARE) 33. The Ld. T.P.O. rejected R.S. Software as a comparable company on the basis that the company has negative net worth for the financial years 2003- 04 to 2005-06. The Ld. A.R. submitted that for financial year 2005-06, R.S. Software (India) had reported an operating profit from computer software development services, especially maintenance activities hence is functionally similar to the assessee. The same is evident from the profit and loss account of the company made available at Page No. 95 of the paper book volume (ii). It was submitted further that negative net worth cannot be a criteria for evaluating the current profitability of the comparable as the negative net worth is on account of brought forward losses of earlier years, which are not relevant for the purpose of comparison. The adoption of negative net worth criteria for rejection of functionally comparable companies is not acceptable as it would be unjust and uncalled for. Based on the provisions of the Income Tax Rule 1962, comparables for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d page no. 96 of the paper book ii i.e. copy of the fixed asset schedule of annual report for F.Ys 2004-05 2005-06 of Aftek Infosis. The Ld. A.O/T.P.O was thus not justified in considering Aftek Infosis as comparable for F.Y 2005-06. The Ld. DR on the other hand tried to justify the action of Ld. TPO. 33. On perusal of the details of fixed assets schedule of Aftek we prima facie find substance in the contention of the Ld. A.R that functions performed by Aftek Infosis were different from the function performed by the assessee, hence comparability of the said company is required to be reconsidered as comparable to the assessee for F.Y 2005-06 by the Ld. TPO after verifying the above facts and hearing the assessee in this regard. It is ordered accordingly. 34. Regarding Asian CERC, the Ld. A.R submitted that in the F.Ys 2003-04 2004-05 the company had limited export earnings from software development activity, which is evident from the annual report of the company made available at page no. 97 of the paper book-ii. On the other hand 100% of the assessee s revenue is earned from exporting income. Since there is a complete difference in the selling segment of both the compani ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uncontrolled transactions are comparables only when adjustments with respect to significant differences between them in the risks assumed is made. The Ld. AR submitted that it has been mentioned by the assessee in its TP report that it functions under a limited risk environment with most of the risk being assumed by its AEs. The comparables selected for the analysis include companies, which have fairly diversified areas of specialization perform additional functions viz. marketing etc. and bear more risk occurring to any third party independent service provider. In view of limited functions performed and limited risks born by the assesee it can be characterized as a contract service provider operating in a risk mitigated environment viz a viz the comparable companies who perform entrepreneurial risk taking functions and therefore bear entrepreneurial risks . He submitted that it is an established theory that rewards follow risks and therefore companies that bear entrepreneurial risks are rewarded with more profits for the additional risks borne by them. In this regard he referred page no. 145 to 148 of the paper book volume I for summary of the key risks identified by the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparable companies vis- -vis the assessee so as to make the comparison between the margins earned by the comparable companies and the assessee. As a consequence the margin earned by the assessee would be comparatively lower or reflect the lower level of functions and risk. The Ld. AR also pointed out that in the subsequent asstt. year, the Ld. DRP has granted working capital adjustment. He placed reliance on the following decisions wherein it has been held that adjustments (including working capital adjustment) need tobe made to the margins of the comparables to eliminate difference on account of different functions, assets and risks : 1. Philips Software Centre Private Limited vs. ACIT (2008)119 TTJ 721 (Bang) 2. Mentor Graphics Private Limited vs. ITO (2007) 109 ITD 101 (Delhi) 3. E-Gain Communication Pvt. Ltd vs. ITO (2009) 118 ITD 243 (Pune) 4. Sony India (P) Ltd. vs. DCIT (2008) 114 ITD 448 (Delhi) 5. Schefenacker Motherson Limited vs. ITO (2009) 123 TTJ 509 (Delhi) 40. Ld. DR on the other hand tried to justify the orders of the authorities below on the issues of making of suitable adjustment to account for difference in the risk profile and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO in furnishing the details, break up, datas, etc. or any other necessary information to the satisfaction of the TPO so that reasonably accurate adjustment, if any, can be made as per Indian Transfer Pricing Law (i.e. Rule 10B (3)(iii)) on account of risk and working capital. Ground No. 6 7 are thus allowed for statistical purposes. Ground No. 3 42. In the present case assessee has objected the rejection of the claim of the assessee in the use of multiple year data for the purposes of computation of operating margins of other comparable companies. This issue has been raised in ground No. 3 of the appeal. 43. In support of the grounds Ld. AR submitted that the provisions laid down under Rule 10B(4) of the I.T. Rules makes it clear that the data to be used in analyzing the comparability of an uncontrolled transaction as 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 not 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 the transfer pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rule 10D(4) which provides for the maintenance of contemporaneous documentation. Rule 10D(1) outlines the documents to be maintained by the tax payer. As far the comparability analysis is concerned Rule 10B(4) is the relevant rule which prescribes that the data to be used in analyzing the comparability of an uncontrolled transaction shall be the data to be used in analyzing the comparability of an uncontrolled transactions shall be the date relating to the financial year in which international transaction has been entered into . Thus the only restriction on use of data in comparability analysis is that the data should pertain to the same financial year. He submitted further that under section 92D (1) of the Act, every person entering into an international transaction is required to keep and maintain such information and document in respect thereof as may be prescribed. Rule 10D(1) of the Rules, requires maintenance of a record of the analysis performed to evaluate comparability as well as a record of the analysis performed to evaluate comparability as well as a record of the actual working carried out for determining the ALP. Rule 10D(4) of the Rules , requires that the informatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sumed certain facts without giving adequate supporting evidence. The taxpayer has produced no proof to show that the prowess or the capital line data basis do not upload the current year s company results before the expiry date. Also no evidence has been furnished by the taxpayer to show that it has made efforts to access the current year data either on data base. He should have looked for the availability of data from other sources also like accounts made available to the shareholders, stock exchange, registrar of the companies etc. Many of these companies have their own websites which the taxpayer could have aaccessed. Even quarter to quarter results are being published by many of these companies. The companies cannot be rejected as comparables merely because of his claim that the data was not uploaded by the data basis. 47. In the rejoinder the Ld. AR with assistance of some data tried to indicate the impact on the margin of the comparable companies considering various combinations of the comparable companies. 48. Considering the above submission we find that the provisions of Rule 10B (4) are unambiguous and mandatory particularly in view of the use of word shall and no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Tribunal in the cases of Mentor Graphics Pvt. Ltd. (supra) and Customer Services Pvt. Ltd. (supra). W thus do not find infirmity in the action of the authorities below in rejecting the claim of the asseseee in the use of multiple year data for the purposes of computation of operating margins of other comparable companies. Ground No. 3 is thus rejected. Ground No.8 49. The Contention of the assessee in support of ground No.8 remained that as per the proviso to section 92C(2) of the Act an assessee has the option of charging a price to its AEs which may vary from the ALP by plus / minus 5 %. Section 92C(3) further states that the ALP shall be determined by the AO in accordance with the sub sections (1) and (2) of section 92C. Therefore it should be appreciated that the Ld. TPO/AO is mandatorily required to calculate the ALP in accordance with section 92C(1) and 92C(2) of the Act. The Ld. AR also referred relevant extract from explanatory memorandum of Finance Bill 2002 and classification made in notes on clauses Income Tax (Finance Bill 2002). He also referred CBDT circular No. 12(1) dated 23.8.2001 and placed reliance on the following decisions :- UE Trade Corporation (I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee was not to be disturbed if it was upto 5% less in case of receipts and upto 5% more in case of outgoings. Ld. DR submitted that the relaxation by way of this circular of the CBDT was not intended for those cases where the variations were substantial and exceeded the permissible tolerance band of + / - 5%. He submitted that the relaxation extended by the circular was in substance brought on to the statute by the Finance Act, 2002 by amending the proviso to section 92C(2) of the Act with retrospective effect from 1.4.2002 to provide for the tolerance band. The effect of this amendment is that there will be no TP adjustment in cases of marginal variation upto to +/-5% but substantial variations would result in appropriate TP adjustments. He submitted that the decision rule contained in the proviso to section 92C (2) of the Act containing tolerance band is akin to a similar decision rule of confidence intervals used in the statistical inference. There is no scope for any standard deduction under this Rule . In other words, if the ALP falls outside the tolerance band TP adjustment would have to be made for the difference between the LP determined by the AO based on the ari ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th price should be determined as (i) arithmetic mean of such prices, or (2) at option of assessee , + / - 5% of arithmetic mean of such prices. He submitted that the proviso to section 92 C (2) of the Act does not provide for any tolerance band and the arms length price can be determined by considering a variation of 5% to the arithmetic mean. He also cited the following decisions Sr. No. Hon ble ITAT Bench Ruling Delhi ITAT Electrobug Technologies Ltd. vs. ACIT (37 SOT 270) Customer Service India (P) Ltd. v. ACIT (30 SOT 486) Global Vantedge Pvt. Ltd. v. DCIT (1 ITR 326) Schefenacker Motherson Limited v. ITO (123 TTJ 529) SDRC India (P) Ltd. (2209-TIOL-185- ITAT-Del) ACIT v. Toshiba India Private Limited (2010-TII-14-ITAT-DEL-TP Benguluru Tribunal SAP Labs India (ITA No. 398 418/Bang/2008) Philips Software Centre (P) Ltd. vs. ACIT (119 TTJ 721) Mumbai Tribunal ITO vs Zydus Altana Healthcare PVt. Ltd. (2010-TII-29-ITAT-MUM-TP) Tecnim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... round no. 8 involving the issue is thus rejected. In summary ground Nos. 1 and 2 being general in nature have not been adjudicated independently, ground No. 3 8 are rejected and ground nos. 4 to 7 are partly allowed. Ground No. 9 58. It is regarding not allowing of set off of losses of the STPI Unit with the profits of the non-STPI Unit. In this regard Ld. AR referred the provisions laid down u/s 10A(1) of the Act prior to substitution by the Finance Act 2000 and after its amendment by Finance Act 2000. The Ld. AR submitted that post amendment the section 10A(1) provides that a deduction of such profits and gains of an undertaking shall be allowed from the total income of the assesee. He submitted that the use of word deduction would indicate that the income in question will first enter into the computation of total income and then the deduction as provided in the substituted section would be allowed. Further, proviso I to section 10A (1) states that where profits and gains from the eligible undertaking were not included in the computation of total income u/s 10A of the Act prior to its substitution, then the undertaking will be entitled to deduction under the new section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4 (Del) DCIT vs. A.V. Thomas Leather Allied Products Ltd. 2009 TIOL 434 (Madras) Scientific Atlanta India Technology Pvt. Ltd. 129 TTJ 273 (Special Bench) (Chennai) 59. Ld. DR on the other hand placed reliance in the order of the authorities below and cited following decisions in support : 1. CIT vs. Himatasingike Slide Ltd. (2006) 286 ITR 255 (Kar) 2. ACIT vs. Yokogawa India Ltd. (2002) 13 SOT 470 (Bang) 3. Changepod Technologies (P) Ltd. vs. ACIT (2008) 22 SOT 220 (TNMM) 4. Global Vantedge Pvt. Ltd. vs. DCIT (2010)-TIOL-24-ITAT-DEL 60. We find that during the year the Hyderabad Unit of the assessee had earned profit of ₹ 14,90,62,148/- and the same was claimed as deduction u/s10A of the Act. However the Bangalore unit has suffered a loss and hence no deduction was claimed u/s 10A of the Act. In its return of income filed for the year, the assessee had set of the losses of Bangalore unit of ₹ 1,49,49,710/- with profit derived from Mumbai unit. The AO did not allow the set off of the losses of Bangalore Unit on the basis that income of STPI unit is exempt u/s 10A of the Act and hence cannot be adjusted with other income. Durin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,00,000 INR (3,00,000) INR 7,00,000 Less: Deduction under section 10A INR 10,00,000 NA INR 10,00,000 Taxable income/(loss) after deduction under section 10A Nil INR (3,00,000) INR (3,00,000) Losses to be carried forward Nil INR (3,00,000) INR (3,00,000) 62. With the assistance of cited decisions by the Ld. AR including decision of third member bench of the Tribunal in the case of Navin Bharat Industries Limited vs. DCIT (supra) the Ld. AR tried to submit that if the STPI unit has incurred losses then such loss is eligible to be set off against profits of non-STPI unit as per the provision of section 10A(6)(ii) of the Act. He submitted that before computing total income of the assesee , total loss incurred in the eligible undertaking needs tobe set off against the income from non-eligible undertaking as well as other income as per provisions of section 70-72 of the Act read with section 10A(6)(ii) of the Act. The effect of the revised ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bangalore Bench in this case. Similar view has been expressed also by the Delhi Bench of the Tribunal in the case of Honey well International (India) (P) Ltd. vs DCIT (supra). In that case also set off of losses of eligible unit of the assesee against the profits of the other unit was allowed. It was held that provisions of section 10A as substituted w.e.f 14.2001, provides for a deduction from income and not an exemptions under the scheme of the Act, the profits of the unit eligible for deduction u/s 10A form part of the income computed under the head profits gains of business and profession and deduction u/s 10A is required to be made at the stage of computing income. It was held that total income can be computed only after allowing intra head set off u/s 70 and u/s 71. Thus in case there is loss in the eligible undertaking such losses is to be set off against the profit of the other unit / business u/s 70. Respectfully following these decisions cited by the Ld. AR we are of the view that the authorities below were not justified in denying the claimed set off of loss in eligible unit against the profits of non eligible unit. We thus while setting aside the orders of the author ..... X X X X Extracts X X X X X X X X Extracts X X X X
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