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2016 (11) TMI 205 - ITAT DELHI

2016 (11) TMI 205 - ITAT DELHI - TMI - Determination of arm’s length price (ALP) in respect of transactions of the assessee with its Branch Office in Canada - Held that:- Not only the income but, also the expenses and all the items of balance sheet of branch office, Canada have also been merged with the figures of head office. It is the total income as also including the total revenue earned by branch office Canada, which has been offered for taxation. Under such circumstances and in the backdro .....

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rd. When functionally similar companies are chosen and then average of the profit rate of such similarly functional companies is taken into account for determining the ALP of the international transaction undertaken by the assessee, the size of some of the companies in the whole lot of comparable companies, becomes meaningless. Averaging of the profit rates of the whole lot of functionally similar companies of different sizes, viz., some having higher while some others having lower turnover vis- .....

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this filter. - Companies who have less than 25% of the revenues as export sales were excluded - Held that:- the assessee’s export revenue is roughly 21% of total revenue. If we apply the filter of excluding the companies having less than 25% of the revenue’s from export sales, it would tend to eliminate the companies which are similarly placed as the assessee. - Both the sides agreed that if, in the given circumstances, the filter of excluding the companies with export sales of more than 3 .....

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o such percentages of RPTs. If either of the two breaches the 25% threshold, then the company will cease to be comparable. The impugned order, combining sales and expenses, for calculating the percentage of the RPTs is set aside to this extent and the TPO is, accordingly, directed to apply this filter in the manner discussed above. - Companies who have diminishing revenues/persistent losses for the period under consideration were excluded - Held that:- if we exclude the companies having dimi .....

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not be excluded, but, only the companies having persistent losses should be expelled from the final tally of comparables. - Companies whose onsite income is more than 75% of the export revenues were excluded - Held that:- the companies whose onsite income is more than 75% of the export limit should be rather included. Since the necessary complete information is not available with the ld. AR for verifying the veracity of the contention of the foreign branch earning 100% onsite services, we c .....

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trolled transactions. There is no mandate for adjusting the assessee’s profit margin under the provisions of Rule 10B(1)(e). The assessee’s contention that its operating costs should be reduced to the extent its employees remained idle is, ergo, incapable of acceptance. The adjustment, if any, could have been allowed, if the assessee had demonstrated that the comparable companies had more under-utilization of their labour force vis-à-vis the assessee. The onus to prove such under-utilization of .....

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, JUDICIAL MEMBER Assessee By : Shri Akhilesh Gupta, Advocate Department By : Shri Neeraj Kumar, Sr. DR ORDER PER R.S. SYAL, AM: This appeal by the assessee emanates from the final assessment order dated 31.10.2012 passed by the Assessing Officer (AO) u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called the Act ) in relation to the assessment year 2008-09. 2. The first issue agitated in this appeal is against the determination of arm s length price (ALP) in resp .....

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f ALP of the transactions between the head office and branch office. 4. We have heard the rival submissions and perused the relevant material on record. It is undisputed that the assessee is an Indian enterprise having its branch office in Canada. Under these circumstances, a question arises as to whether a separate determination of ALP of the transactions between Indian head office and branch office, Canada, should be made so as to make an addition on account of transfer pricing adjustment. 5. .....

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n ble Apex Court including Sir Kikabhai Prem Chand VS CIT (1953) 24 ITR 506 (SC) and also the Hon ble High Courts. In Betts Hartley Huett & Co. Ltd. (1979) VS. CIT 116 ITR 425 (Cal), it has been held that there cannot be a valid transaction of sale between branch office and head office and hence profit on such sales is not includible in assessee's computation of total income. Similar view has been taken in Ram Lal Bechairam VS. CIT (1946) 14 ITR 1 (All). 6. Coming to the context of trans .....

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d office and branch office as an international transaction. At this juncture, it is pertinent to note that section 92F(iii) defines "enterprise" to mean a person (including a permanent establishment of such person) who is….. engaged in any activity, relating to the production, storage, supply, distribution, acquisition or control of articles or goods…..of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights….. whe .....

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ing services is an enterprise as a permanent establishment of the general enterprise, all the transactions between the branch office and the general enterprise be subjected to the transfer pricing provisions. However, this prima facie impression loses its substance when the general enterprise is an Indian entity and the branch office is located outside India. It is so for the reason that section 5 defining scope of total income provides through sub-section (1) that Subject to the provisions of t .....

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Indian income but also the income which accrues or arises to him outside India during such year . The final accounts of foreign branch office, including all the items of income, expenses, assets and liabilities are merged with the accounts of head office and the accumulated income so determined is liable to tax in India. When the sale made by the Indian Head office is considered as purchase of the foreign branch office and the figures of head office and branch office are consolidated, any under .....

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rstood with the help of a simple example. Suppose the Indian head office purchases goods worth ₹ 95 and transfers the same to foreign branch office at ₹ 100, which are in turn sold by the branch office for a sum of ₹ 120. The profit of the head office will be ₹ 5 (Rs.100 minus ₹ 95) and the profit of the branch office will be ₹ 20 (Rs.120 minus ₹ 100). The Indian general enterprise will be chargeable to tax in India on its world income of ₹ 25 (Rs. .....

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an Indian enterprise to over or under invoice the goods or services to its foreign branch office because by virtue of section 5(1), it is its world income which is going to be charged to tax in India, which in all circumstances will remain same at ₹ 25 in the above example. So the over or under invoicing between the Indian head office and foreign branch office is always income-tax neutral in the case of an Indian enterprise having a permanent establishment outside India. Making a transfer .....

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rise has a branch office in India, such Indian branch office will be considered as an enterprise u/s 92F(iii) and the transactions between the foreign head office and the Indian branch office will be International transactions in terms of section 92B. This is for the reason that the total income of a non-resident in terms of section 5(2) includes all income from whatever source derived which (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) .....

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ternational transactions are reported at ALP. Some foreign associated enterprise instead of having an Indian enterprise may opt to have a branch office in India and then claim that since the Indian branch office is not a separate enterprise, the transfer pricing provisions should not be applied. Section 92F(iii) has been incorporated to ensure that not only the transactions between the foreign enterprise and its Indian associated enterprise but also the transactions between the foreign enterpris .....

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ident and as such is liable for tax in respect of the income earned in India (through its Head office in India) and also the income accruing from outside India (through its Branch office in Canada). The assessee has rightly offered income for taxation not only the amount earned by the Indian head office, but also whole of the income earned by Canada branch office. This position can be ascertained from the Annual accounts of the assessee, whose copy has been placed on record. Page C-6 of the pape .....

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ve also been merged with the figures of head office. It is the total income as also including the total revenue earned by branch office Canada, which has been offered for taxation. Under such circumstances and in the backdrop of the foregoing discussion, the transfer pricing provisions cannot apply in respect of transactions between the Indian head office and branch office in Canada. The impugned order is set aside pro tanto. 9. The next issue raised in this appeal is against the addition due to .....

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how, the assessee claimed that its international transactions were at ALP. Not satisfied, the AO made reference to the TPO for determination of the ALP of this international transaction. The TPO disagreed with certain filters adopted by the assessee and finally applied the following filters for selecting the comparable companies : - Companies whose data is not available for the FY 2007-08 were excluded. Companies whose Software Development Service revenue is less than 75% of the total operating .....

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f the company does not fall within 12 months period i.e., 01.04.2007 to 31.03.2008, were rejected. Companies who have diminishing revenues/persistent losses for the period under consideration were excluded. Companies whose onsite income is more than 75% of the export revenues were excluded. Companies that are functionally different from that of taxpayer. 10. By applying the above filters, the list of comparables drawn by the assessee underwent change inasmuch as the TPO inducted certain new comp .....

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d certain directions. Giving effect to the direction given by the DRP, the TPO passed the consequential order on 9.10.2012 down scaling the amount of transfer pricing adjustment to ₹ 2.59 crore by way of revision in the arithmetical mean of OP/TC at 20.57% of the surviving 18 companies in the list of comparables. The assessee is aggrieved against the inclusion of several companies in the list of comparables and also the exclusion of some of the companies which were claimed by it as compara .....

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tness of such filters. The ld. DR fairly agreed to this proposition. Ex consequenti, we will take up the filters as adopted by the TPO that are under challenge. (i) Companies whose software development service revenue<Rs.1 crore were excluded. 11.1. The ld. AR contended that the assessee company earned revenue from services to the tune of ₹ 45.42 crore. It was submitted that the filter of exclusion of companies with service revenue of less than ₹ 1 crore was not fully correct. He .....

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is taken into account for determining the ALP of the international transaction undertaken by the assessee, the size of some of the companies in the whole lot of comparable companies, becomes meaningless. Averaging of the profit rates of the whole lot of functionally similar companies of different sizes, viz., some having higher while some others having lower turnover vis-à-vis the assessee, irons out the effect of such differences. The Hon ble jurisdictional High Court in the case of Chr .....

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ubmissions and perusing the relevant material on record, we find that the assessee s export sales are ₹ 9.49 crore as against the total sales of ₹ 45.42 crore. This shows that the assessee s export revenue is roughly 21% of total revenue. If we apply the filter of excluding the companies having less than 25% of the revenue s from export sales, it would tend to eliminate the companies which are similarly placed as the assessee. In our considered opinion, this filter should not have be .....

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revenues were excluded. 13.1. The TPO applied the filter of related party transactions (RPTs) of more than 25% of the operating revenue and accordingly short listed the companies in the final set of comparables. The ld. AR did not dispute the percentage of 25%. He, however, objected to the application of this 25% related party transactions to sales as well as expenditure combined. 13.2. Having heard the rival submissions and perused the relevant material on record, we find that the TPO has incl .....

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one nature, like, comparing RPT of purchase with the total purchases or RPT of sales with the total amount of sales of the company. It is also possible to club small transactions of a distinct but related income producing activity with a large transactions of major income producing activity as one unit, both in the numerator as well as in the denominator. For example, RPT of major sale transaction and minor job income can be combined to find out the percentage of RPTs with the total of sales an .....

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company will cease to be comparable. The impugned order, combining sales and expenses, for calculating the percentage of the RPTs is set aside to this extent and the TPO is, accordingly, directed to apply this filter in the manner discussed above. (iv) Companies who have diminishing revenues/persistent losses for the period under consideration were excluded. 14.1. The TPO applied this filter for excluding the companies from the final set of comparables which were having diminishing revenues or .....

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Profit/loss (as per Audited Financials) 2001-02 2,81,18,307 2002-03 -5,58,88,557 2003-04 -7,62,57,307 2004-05 -4,85,47,772 2005-06 -1,32,74,909 2006-07 92,74,632 2007-08 62,39,414 14.3. A careful perusal of the pattern of profit/loss earned by the assessee as per its audited accounts divulges that as against the current year s profit of ₹ 62.39 lac, the earlier years profit was ₹ 92.74 lac. This manifests that the profit for this year has diminished from the earlier year. When we co .....

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he assessee would face the axe. Doing so would mean excluding the comparable companies from the final tally, which is not appropriate. However, the companies having persistent losses, obviously, cannot be compared with the assessee because it has earned positive income not only in this year, but, in the preceding year as well. We, therefore, hold that the companies having diminishing revenue should not be excluded, but, only the companies having persistent losses should be expelled from the fina .....

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site services by the branch office, Japan. The DR, however, opposed the argument of the ld. AR. 15.2. Having heard the rival submissions and perused the relevant material on record, we find that out of total revenue of ₹ 45.42 crore earned by the assessee, its revenue of the foreign branch is to the tune of ₹ 35.92 crore, which is roughly 80% of the total revenue. The ld. AR contended that the entire income earned by branch office, Canada, was from rendering onsite services. However, .....

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f the export limit should be rather included. Since the necessary complete information is not available with the ld. AR for verifying the veracity of the contention of the foreign branch earning 100% onsite services, we consider it expedient to direct the TPO/AO to examine the break-up of the revenues earned by branch office, Canada, for seeing if the same is from onsite/offsite services. The application of the filter will be then decided accordingly by the TPO. 16. Having discussed the applicab .....

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capacity. The assessee claimed that during the year 42% of its employees remained idle and, hence, sought reduction in its operating cost to the extent of such extraordinary expense. The TPO jettisoned this proposition. The assessee now seeks reduction in its operating costs on account of such idle labour cost for the purposes of computing the transfer pricing adjustment. 18. We have heard both the sides and perused the relevant material on record. It is obvious that the TPO used the TNMM as th .....

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yed or to be employed by the enterprise or having regard to any other relevant base ; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base ; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and th .....

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