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2016 (2) TMI 571 - ITAT DELHI

2016 (2) TMI 571 - ITAT DELHI - TMI - Transfer pricing adjustment - calculation of the assessee’s PLI - Whether projected profit rate of subsequent years can also be considered ? - Held that:- Essence of the entire transfer pricing provisions is to compare the actual price/profit realized/earned by the assessee from an international transaction with the price/profit realized/earned from comparable uncontrolled transactions. It is totally impermissible to substitute actual profit earned by the as .....

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considering figures for the current year and also projected figures for subsequent three years. The impugned order is, therefore, upheld on this score.

Foreign Exchange Fluctuation - Held that:- . On going through all the Agreements entered into by the assessee with its AEs, to which our attention was drawn by the ld. AR, it is manifest that these have been made effective from 1.4.2007, being the current year alone. Under such circumstances, there can be no ground for arguing that the .....

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earlier year, so as to claim any adjustment. It is, therefore, held that neither the assessee can claim any adjustment on account of foreign exchange fluctuation rate in its profit nor such an adjustment, on the facts and circumstances of the instant case, is warranted in the profit margin of comparables.

Revenue sharing formula - Held that:- The assessee was not right in working out its PLI by also considering projected profits for the three subsequent years; no deduction on account .....

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t:- As assessee company, which is engaged in providing software development services to its group concerns companies with different scope of work to be rejected as comparable.

Deduction u/s 10A- whether any TP adjustment is permissible? - Held that:- Eligibility of the assessee to deduction u/s 10A of the Act does not operate as a bar for determining the ALP of international transaction undertaken by it and further the enhancement of income due to such transfer pricing addition cannot .....

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eligible for tax holiday u/s 10A - Held that:- A sum of ₹ 1,22,342/- has been apportioned by the AO himself as relatable to the eligible unit D-4, Noida. This apportionment has been done of sum of two items, namely, ₹ 1,48,180/- which was claimed as deduction by the assessee in earlier years and a sum of ₹ 1,93,018/- which is the amount of bank charges refunded during the year. These two items were claimed as deduction in the earlier years from the eligible income and these ha .....

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n u/s 10A of the Act. We, therefore, overturn the assessment order on this point, and direct the inclusion of a sum of ₹ 1,22,342/- in the eligible profit for the purposes of deduction.

Disallowance of deduction u/s 10A being the amount of depreciation disallowed - Held that:- The opening written down value to the extent of ₹ 2,55,500/- was excessive and ought to have been reduced. Once this amount is reduced, the assessee’s claim for depreciation on such amount to the tun .....

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disallowance on account of depreciation without allowing benefit of section 10A on this disallowance, we hold that the assessee should also be allowed benefit u/s 10A of the Act to this extent. This ground is allowed. - ITA No.6200/Del/2012 - Dated:- 11-2-2016 - SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM For The Assessee : Shri Nageswar Rao and Shri Shailesh Kumar, Advocates For The Department : Shri Amrendra Kumar, CIT,DR Shri Deepak Tiwari, Sr. DR ORDER PER R.S. SYAL, AM: This appeal by t .....

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s LLC. The assessee is a 100% export oriented unit (EOU) for manufacture and export of computer software. It is engaged in the provision of Software development services and IT enabled services (ITES) to its AEs. The assessee reported two international transactions, namely, Provision of software services and Provision of IT enabled services. The AO made reference to the Transfer Pricing Officer (TPO) for determination of the ALP of these international transactions. The TPO made transfer pricing .....

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hted average margin of four years, being the actual figures for the financial year 2007-08 plus projected figures for the coming three years. The assessee chose 23 companies as comparable, with their average PLI at 14.43%. Thus it was demonstrated that this international transaction was at arm s length price (ALP). The TPO accepted the assessee as a tested party and also the TNMM as the most appropriate method. However, the assessee s PLI, computed on the basis of profit of four years including .....

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; 20,18,08,602/- for this international transaction. The assessee challenged the draft order before the Dispute Resolution Panel (DRP). The TPO in his order giving effect to directions given by the DRP, did not make any adjustment in relation to the international transaction of ITES. As regards the other international transaction of Software development services , he recomputed the profit margin of comparables at 19.73%. By applying the same to the total operating cost incurred by the assessee, .....

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on of comparables; and that when the assessee is entitled to deduction u/s 10A, then no transfer pricing adjustment can be made. We will deal with these in seriatim. A. CALCULATION OF ASSESSEE S PLI 5. The ld. AR challenged the calculation of the assessee s PLI by the TPO on different scores, which we will deal with hereinafter separately. a. Whether projected profit rate of subsequent years can also be considered ? 6.1. The assessee adopted PLI of OP/OC and computed its weighted average profit .....

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It was submitted that the assessee took contracts from its AEs in earlier years, which were running beyond a particular year and, hence, the profitability for one year cannot be decisive to calculate the real profits. On being called upon to point out Agreements entered into with its AEs, the ld. AR took us through pages 213 onwards of the paper book, which is copy of an Agreement between the assessee and its AE for providing software development services. This Agreement has been entered into o .....

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heading Other current assets as appearing in the Balance sheet, there is an item of Unbilled revenue amounting to ₹ 3,24,77,983/-. On further inquiry, it transpired that this amount represents work-in-progress of the assessee accounting for expenses incurred during the year for which the work is still incomplete and no revenue is received. The ld. AR accepted that all the expenses booked in the Profit & Loss Account match with the corresponding revenue actually realized and this provis .....

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o approve this argument raised on behalf of the assessee. 6.3. Further, section 92(1) provides that: Any income arising from an international transaction shall be computed having regard to the arm s length price. Section 92C dealing with the computation of arm s length price provides through sub-section (1) that the arm s length price in relation to an international transaction shall be determined by any of the methods given in this provision. When we consider the language of section 92(1) in ju .....

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ion, again, brings out that it is the price charged or paid in international transaction which is taken up for consideration by the AO for examining whether or not the same is at ALP. The above provisions plentifully show that it is the actual income from an international transaction earned during the year, which is taxed at its ALP. The base for comparison, being the actual income of the assessee from an international transaction, cannot be substituted with any hypothetical figure by considerin .....

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well or by taking into account the projected profits of the subsequent years, for the purposes of determining the ALP of an international transaction. Moreover, the figures taken for subsequent three years are mere projections. The correctness of these projections is mystery for us. We, therefore, jettison the view point of the assessee in calculating its PLI by considering figures for the current year and also projected figures for subsequent three years. The impugned order is, therefore, uphe .....

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hange rate for USD in the Financial year 2006-07 was ₹ 45.25 in comparison with ₹ 40.29 for the Financial year 2007-08, relevant to the assessment year under consideration. The effect of such fluctuation in the foreign exchange rate, as explained by the ld. AR was, that decline of 10.96% was registered in the assessee s revenue, which was required to be adjusted against its profit margin for the current year. He submitted that the authorities below erred in not allowing such adjustme .....

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elating to avoidance of tax. Section 92, which is the first section of this Chapter, provides for computation of income from an international transaction having regard to arm s length price. Sub-section (1) of the section provides that any income arising from an international transaction shall be computed having regard to the arm s length price. Section 92C of the Act enshrines provisions relating to computation of arm s length price. Sub-section (1) of the section states that the arm s length p .....

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ribed under Rule 10B(1)(e) of the Income-tax Rules, 1962, which states that for the purposes of section 92C(2), the ALP in relation to the international transaction shall be determined as under : - (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having .....

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n the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market ; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii) ; (v) the net profit margin thus established is then taken into account to arrive at an arm s length price in relation to the international transaction. 7.3. A bare perusal of sub-clause (i) .....

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e differences, if any, between the international transaction and the comparable uncontrolled transactions, ..... which could materially affect the amount of net profit margin in the open market. It is this adjusted net profit margin of the unrelated transactions or of the comparable companies, as determined under subclause (iii), which is used as benchmark for the purposes of making comparison with the net profit margin realized by the assessee from its international transaction as per sub-claus .....

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rofit margin realized by the enterprise from an international transaction is to be computed. Use of the word realized in the provision richly indicates that it is the calculation of actual operating profit margin of the assessee earned from international transaction, which is not any adjusted figure. Similar position can be traced from the language of sub-clause (iv), where again reference has been made to profit margin realized by the assessee from the international transaction. When we conside .....

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ifferences between the international transaction and comparable uncontrolled transactions. On going through all the sub-clauses of Rule 10B(1)(e), the position which follows is that the net profit margin realized by the assessee from its international transaction is taken as such and the adjustments, if any, due to differences between the international transaction and comparable uncontrolled transactions, are given effect to in the profit margin of comparables. The viewpoint canvassed by the lea .....

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fluctuation adjustment, or for that matter any other adjustment, can be legally made only in the profit margin of the comparables, if it is otherwise factually warranted and not in the profit margin of the assessee. 7.4. On going through all the Agreements entered into by the assessee with its AEs, to which our attention was drawn by the ld. AR, it is manifest that these have been made effective from 1.4.2007, being the current year alone. Under such circumstances, there can be no ground for ar .....

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or any other earlier year, so as to claim any adjustment. 7.5. The next leg of the argument of the ld. AR about the foreign exchange fluctuation having adversely affected its profits for the current year on standalone basis, is also unsustainable. It is so for the reason that this is a factor, whose impact is common both to the assessee and comparables. Any northwards or southwards sojourn in the foreign currency rate leaves its impact on the operating profit of the assessee in the same manner .....

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r, we refuse to allow any adjustment in the profit rate of comparables because of fluctuation in the foreign currency rate. 7.6. It is, therefore, held that neither the assessee can claim any adjustment on account of foreign exchange fluctuation rate in its profit nor such an adjustment, on the facts and circumstances of the instant case, is warranted in the profit margin of comparables. (c) Revenue sharing formula 8.1. The ld. AR submitted that the assessee s AE shared 80% of total revenue from .....

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DRP also which has been rejected without any plausible reason. This was countered by the ld. DR, who stated that such a revenue sharing formula has no significance in so far as the assessee s operating profit margin is concerned. 8.2. We have heard the rival submissions and perused the relevant material on record. It is observed that the assessee adopted TNMM as the most appropriate method in its TP study report. The TPO accepted the same. It was only for the first time that the assessee raised .....

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ernational transaction undertaken by the assessee and comparable uncontrolled transactions. Such adjusted price is taken as ALP in respect of the services provided by the assessee in the international transaction. From the machinery provision contained in Rule 10B(1)(a) in this regard, it is clear that the internal CUP provides for comparing the assessee s international transaction with another comparable uncontrolled transaction undertaken by it. We fail to appreciate the logic behind the ld. A .....

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s to make a valid comparison between remuneration paid by such AE to the assessee with that paid to unrelated parties, provided other terms and conditions of the provision of services are similar. Presently, we are dealing with the determination of ALP of the international transaction undertaken by the assessee and not its foreign AE. The assessee can resort to the CUP method only by showing that the price charged by it from its AE was favourably comparable to the price charged by some other com .....

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on, we hold that the assessee was not right in working out its PLI by also considering projected profits for the three subsequent years; no deduction on account of foreign exchange fluctuations can be allowed in the facts and circumstances of the instant case; and the revenue sharing formula as put forth by the assessee as relevant under the CUP method for determining the ALP, is not correct. Consequently, it is held that the calculation of PLI of the assessee done by the TPO under TNMM is corre .....

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out by the assessee. We have briefly noticed above that the assessee is engaged in providing software development services to its AEs. The assessee is providing end-to-end systems integration and consulting services in focused vertical market segments including Securities and Investment Banking, Airlines & Transport and Technology. The assessee s TP study report discloses that it is providing customized software application development for its AE within which it focuses on the services of Ap .....

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above narration of facts indicates that the assessee is a captive unit engaged in providing software development services to its AEs only under this international transaction and is not selling software products under its own ownership. With the above background in mind, we will examine the comparability or otherwise of the companies assailed in the instant appeal. 12. Firstly, we will deal with the companies which have been included by the TPO in the final set of comparables and the assessee c .....

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, then, such company cannot be considered as comparable. Two companies can be considered as comparable when both are discharging the overall similar functions, though there may be some minor differences in such functions, not marring the otherwise comparability. Notwithstanding the functional similarity, many a times a company ceases to be comparable because of other reasons as well. To cite an example, if company A , though functionally similar to company B , but has related party transactions .....

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ly, the functional profile of company A vis-a-vis company C . If both are functionally similar, then notwithstanding the fact that company A was held to be incomparable to company B , it may still be comparable to company C . Despite the fact that company A is functionally similar to company B , it may still have been declared as incomparable to company B because of other relevant reasons. If company A passes the same reasons vis-a-vis company C , then company A will find its place in the list o .....

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any Z , depending upon the functional profile and the applicability or otherwise of the related factors. There can be no hard and fast rule that if a particular company has been held to be not comparable in the case of another company, then such former company would cease to be comparable to the assessee company also. Comparability of each company needs to be ascertained only after matching the functional profile and the relevant factors of the other company. Ergo, this contention raised on beha .....

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the European Union with major focus on the travel and insurance industry. The DRP also rejected the assessee s contention against the inclusion of this company. 14.2. We have perused the Annual accounts of this company available in the assessee s paper book. Apart from its Balance sheet, Profit & loss account and some Schedules, the Director s Report and Auditor s Report, etc. of this company are not available. The ld. AR contended that the information of this company available in the publi .....

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its order dated 20.9.2013, the tribunal considered the functional profile of this company by noticing it to be a Product company owning software products like Dxchange, Travel Solutions, Insurance Solutions, Customer Appreciation, etc. Similar view has been taken by the Mumbai Bench of the Tribunal in the case of NetHawk Networks India Pvt. Ltd. Vs. ITO (ITA No.7633/N/2012). Vide its order dated 6.11.2013, the Tribunal for the assessment year 2008-09 has noticed Avani Cimcon Ltd. to be a Product .....

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r for the elimination of this company from the list of comparables. (ii) Bodhtree Consulting, Persistent Systems Ltd., Quintegra Solutions Ltd., Tata Elxsi, Thirdware Solutions Ltd. 15.1. The assessee accepted these companies as comparable before the TPO which is apparent from his order. No issue was raised before the DRP contesting the comparability of these companies. It is only for the first time that the assessee has challenged before us that these companies are not comparable. It was, there .....

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lso by the TPO in the list of comparables at the time of computing the ALP, can be excluded by the Tribunal if the assessee proves that the same was wrongly included. The ld. DR argued that this Special Bench decision should not be applied because much water has flown since then and the transfer pricing provisions have come out from its nascent stage. We are unable to accept this contention raised on behalf of the Revenue for the obvious reason that the hands of the assessee cannot be tied to ch .....

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Several orders have been passed by the Delhi benches of the tribunal even in the recent past following the ratio of the Special bench decision referred to hereinabove. In view of the fact that the comparability or otherwise of these companies was not examined by the TPO, in our considered opinion, the ends of justice would meet adequately if the impugned order on this issue is set aside and the matter is restored to the file of AO/TPO for examining the assessee s contention afresh as regards the .....

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h is available on page 1 onwards of the paper book. Page 6 of the Annual report, being an annexure to the Auditor s report, clearly indicates under (ii) that: there is no inventory with the company since it is engaged in software development. From the balance sheet of this company, it is noticeable that there is no closing stock of any software products. Since the assessee is also engaged in rendering software development services and this company is also doing the same business, we are of the c .....

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cept/reject matrix but was rejected in the TP documentation by claiming that it failed functional comparability. The TPO found this company to be into software development services qualifying all the filters applied by him. The assessee raised certain objections against the inclusion of this company, but without any success. The TPO included the same in the final list of comparables. The assessee is aggrieved against its inclusion in the ultimate set of comparables. 17.2. We have considered the .....

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pment of software. The Hon ble Delhi High Court in CIT vs. Agnity India Technologies (P) Ltd. (2013) 219 Taxmann 26 (Del) considered the giantness of Infosys Ltd., in terms of risk profile, nature of services, number of employees, ownership of branded products and brand related profits, etc. in comparison with such factors prevailing in the case of Agnity India Technologies Pvt. Ltd., being, a captive unit providing software development services without having any IP rights in the work done by i .....

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olutely no doubt that Infosys Technologies Ltd. is incomparable to the assessee company. Respectfully following the judgment of the Hon ble jurisdictional High Court in Agnity India (supra), we hold that Infosys Technologies Ltd. cannot be treated as comparable to the assessee company. This company is, therefore, directed to be excluded from the list of comparables. (v) KALS Information Systems Ltd. (Seg.) 18.1. This company was not chosen by the assessee as a comparable. However, the TPO includ .....

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ce its inception. This company consists of STPI unit engaged in development of software and software products. Segmental information of this company is available in the paper book which has been divided into two parts, namely, Application software segment and Training segment . It is the Application software segment of this company, which has been adopted by the TPO. The development of software and all software products have been clubbed under the Application software segment. Since the figures .....

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9.1. The TPO included this company in the list of comparables by overruling the assessee s objections about the super normal profits earned by this company; very high turnover; owning significant IPRS in the form of patents; and engaged in R& D activity. The assessee failed to persuade the DRP to fall in line with its reasoning for the exclusion of this company from the final set of comparables. That is how, the assessee is before us. 19.2. We have heard the rival submissions and perused the .....

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in R&D activity. Per contra, the assessee in question is only a captive software development service provider not owning any IPRS. Owning or not owning IPRS in the form of patents in software developed by a company, has an important bearing on the profits earned by it from the Software development services segment. A company which does not own any IPRS and carries on the activity of rendering software development services at its own, cannot be compared with a company which provides software .....

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ve the impugned order in including this company in the list of comparables. 21. Now, we will take up certain comparables which have been excluded by the TPO and the assessee intends their inclusion. (i) Aditya Birla Minacs IT Services Ltd. (formerly known as PSI Data Systems); and Aditya Birla Minacs Tech. Ltd. (Birla Technologies Ltd.) 22.1. These two companies were initially proposed as comparable by the TPO. However, subsequently, it was realized that the same were not comparable. The TPO not .....

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an 25% of Related Party Transactions (RPTs) are considered as controlled, thereby failing the test of comparability. This view has been taken in several decisions including the Delhi Bench in Toluna India Pvt. Ltd. (supra) and Actis Advisers Pvt. Ltd. Vs. DCIT, (2012) 20 ITR 138 (Del.)(Trib.). and Mumbai Bench in Stream International Services Pvt. Ltd. Vs. ACIT (IT) (2013) 141 ITD 492 (Mum.). 22.3. Adverting to the facts of the instant case, it is noticed that the TPO recorded RPT as a percentag .....

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h costs were initially incurred by the AE and then reimbursed, would not alter the position. Further, no material has been placed on record to show that these re-imbursements were without any mark-up. The Hon ble jurisdictional High Court in CIT VS. Cushman And Wakefield (India) Pvt. Ltd. (2014) 367 ITR 730 (Del) has held that reimbursement of expenses even without any mark-up are also required to be processed under TP provisions by benchmarking under one of the methods. 22.5. Be that as it may, .....

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PO as these are also functionally different, engaged in sale of software products as well. We, therefore, approve the view taken by the TPO on this issue. (ii) Indium Software (I) Ltd. 23.1. We have perused the relevant part of the Annual accounts of this company, which has been reproduced on page 41 of the TPO s order. It can be seen that this company, apart from rendering software services, is also engaged in Sale of software. In addition to that, this company has also income from Training ser .....

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mparables. 24.2. We have gone through the Annual accounts of this company, a copy of which has been placed on record. The TPO excluded this company from the list of comparables by holding that it made an investment of ₹ 5 crore in SIP Solutions Ltd., which was more than twice of the total revenue, thereby affecting the working capital and causing abnormal margin/loss. When we go through the Schedule of Investments of this company, which is available at page 608 of the paper book, it transp .....

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that it was outsourcing a major part of its work. 25.2. We have perused the Annual accounts of this company, which are available in the paper book. It can be seen that out of total Software expenses amounting to ₹ 55.11 lac, this company outsourced this activity by means of sub-contract by incurring expenses of ₹ 53.95 lac. Thus, it is palpable that this company has outsourced its major activity and, hence, cannot be compared with a company like the assessee rendering in-house servic .....

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see, eligible for deduction under section 10A, becomes tax neutral irrespective of its quantum. He, therefore, urged that either the international transaction should not be processed in terms of Chapter-X of the Act or higher amount of deduction should be allowed corresponding to the amount of addition on account of transfer pricing adjustment. This was forcefully contested by the ld. DR. 26.2. Having heard the rival submissions and perused the relevant material, we find ourselves unable to acce .....

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y provides that any income arising from an international transaction is required to be computed having regard to its arm s length price. There is no provision exempting the computation of total income arising from an international transaction having regard to its ALP, in the case of an assessee entitled to deduction u/s 10A or 10B or any other relevant provision. Section 92C dealing with computation of ALP clearly provides that the ALP in relation to an international transaction shall be determi .....

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ed to be necessarily computed having regard to its ALP without any exception. Thus, the ld. AR s argument that since its income is subject to deduction u/s 10A, the provisions of the Chapter-X of the Act should not be applied, in our considered opinion, has no force in view of the clear statutory mandate contained in proviso to section 92C(4), which reads as under:- Provided that no deduction under section 10A or section 10AA or section 10B or under Chapter VI-A shall be allowed in respect of th .....

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h the total income of the assessee has been enhanced after computation of income determined on the basis of the ALP of an international transaction. The legislature has unconditionally provided for not allowing the benefit of deduction under any section in respect of the addition made on account of transfer pricing adjustment. Not allowing of any benefit u/s 10A in respect of an addition on account of transfer pricing adjustment pre-supposes the existence of transfer pricing addition in the firs .....

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ion explicitly spelling out the non-granting of deduction u/s 10A on the enhanced income due to transfer pricing addition, we are afraid to accept the assessee s contention, which runs diagonally opposite to the unequivocal language of proviso to section 92C(4). This contention, if taken to a logical conclusion, would amount to obliterating the provisio itself, which is patently incorrect. 26.4. Our view is fortified by the Special Bench order in the case of Aztech Software and Technology Servic .....

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al in the case of DCIT vs. Tata Consultants Services Ltd. (ITA No. 7513/M/2010) dated 4.11.2015, in our considered opinion is misconceived, because, in that case, the Tribunal primarily found that the AO erred in not himself examining the issue of TP and failed to apply his mind to the TP report filed by the assessee. The last sentence in para 54 of the order upholding the assessee s contention that no TP adjustment can be made where the assessee enjoys benefit of deduction u/s 10A or 80HHE, etc .....

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In view of the fact that there is already a Special Bench decision in the case of Aztech Software (supra) which supports the making of transfer pricing adjustment notwithstanding the eligibility of deduction u/s 10A to the assessee, apart from clear statutory mandate contained in proviso to section 92C(4), we are more inclined to go with the view of the Special Bench. 26.5. It is, therefore, held that the eligibility of the assessee to deduction u/s 10A of the Act does not operate as a bar for .....

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ve. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings. 28.1. Ground no. 8 of the appeal is against allowing short deduction u/s 10A to the extent of ₹ 1,22,342/- in respect of Noida unit, which is eligible for tax holiday u/s 10A of the Act. 28.2. The facts apropos this ground are that the assessee computed its eligible profit u/s 10A at ₹ 13.61 crore. The assessee credited its Profit and loss account with Liability no longer .....

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O bifurcated sum of these two amounts in three parts and apportioned a sum of ₹ 1,22,342/- in respect of eligible unit and reduced this amount from the eligible profit of unit D-4 (Noida). The assessee is aggrieved against this decision of the AO. 28.3. After considering the rival submissions and perusing the relevant material on record, we find that a sum of ₹ 1,22,342/- has been apportioned by the AO himself as relatable to the eligible unit D-4, Noida. This apportionment has been .....

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en refunded in the instant year. Since these expenses at the time of their incurring in the earlier years went on to reduce the eligible income of the Noida unit, in our considered opinion, when the excess amount is reversed in the current year, the same should also be made eligible for the benefit of deduction u/s 10A of the Act. We, therefore, overturn the assessment order on this point, and direct the inclusion of a sum of ₹ 1,22,342/- in the eligible profit for the purposes of deductio .....

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