TMI Blog2017 (3) TMI 1315X X X X Extracts X X X X X X X X Extracts X X X X ..... h markup. Accordingly, we hold that the cost of ₹ 39,14,814/- which is the pre-operative expenditure incurred by the assessee, i.e. before starting its activity of providing services to its Associate Enterprise is to be excluded from the operating cost while computing the operating profits. We find before the Hyderabad Bench of the Tribunal in M/s. Market Tools Research Pvt. Ltd. Vs. DCIT [2014 (2) TMI 312 - ITAT HYDERABAD] similar issue of pre-operating expenses arose, where the assessee was incorporated on 04-06-2004 and the agreement was entered with the Associated Enterprise on 01-09-2004. The question was in respect of the pre-operative expenses prior to the date of the agreement and it was held that there is no question of considering the preoperating expenses as part of the operating cost. Similar proposition has been laid down by the Bangalore Bench of the Tribunal in KHF Components Pvt. Ltd. Accordingly, we direct the Assessing Officer to exclude the pre-operative expenditure from the operating cost and also similarly make adjustments, if any, in the case of comparable companies finally selected, to benchmark the international transaction of the assessee - ITA No ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... benefit under the proviso would be available to the assessee and the ALP as determined under section 92C(1) shall be considered. The question referred to the Special Bench is answered accordingly, i.e. in favour of the Revenue and against the revenue. 7. The second proviso to section 92C(2) of the Act has been inserted by the Finance Act, 2012 with retrospective effect. In view of the amendment of second proviso to section 92C(2) of the Act the benefit of +/-5% on Arms Length Price on the variation between the Arms Length Price and the Price at which the International Transaction was actually undertaken is to be seen in order to determine the Arms Length Price of the international transaction, while applying the transfer pricing provision. Thus, the benefit of margin is available only if the variation is within the tolerance margin. Once the variation exceeds the tolerance margin no benefit is to be allowed on account of +/-5%. 8. The Ld. AR for the assessee fairly pointed that if the margins of the assessee were within the tolerance limits of the margins of the comparables, then no deduction would be claimed by the assessee on account of +/-5%. Accordingly, we allow the g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... est under section 234B and 234C of the Act is consequential and hence the same is also dismissed. 11. Now coming to the ground of appeal No.3(b) i.e. against rejection of companies which are claimed to be functionally comparable and by inclusion of companies that otherwise fail the test of comparability. By way of Ground of appeal No.3(d) the assessee is aggrieved by the order of the CIT(A) in not appreciating the nature of cost of preoperative expenses and by its inclusion as part of operating cost for the purpose of computation of return on total cost. 12. The assessee has also raised certain additional grounds of appeal against the inclusion of certain comparables but the Ld. Authorised Representative for the assessee pointed out that without adjudicating the issue of the several companies picked up as comparables or accepted from the final list of comparables, the only comparable whose inclusion is being opposed was Infosys Systems Ltd. He further pointed out that in case margins of Infosys Systems Ltd. are excluded from the final set of comparables, no adjustment would have to be made in the Arms Length Price of the international transaction. He said that the additional ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erative expenses amounting to ₹ 39,14,814/- were the expenses incurred prior to commencement of software development services, i.e. during the period upto 30-07-2005, were reduced from the operating cost as pre-operating expenses were non-recurring in nature and independent of the regular business operations of assessee. The Assessing Officer however was of the view that the said pre-operating expenses were part of ordinary operating expenses and had to be included for computing operating profits of the assessee. The Assessing Officer issued a show cause notice to the assessee in this regard. The submissions of the assessee are reproduced under Para 6.3 at pages 37 to 39 of the assessment order. The assessee stressed that even the contract with the AE stated that the non-operating expenses had to be excluded from the cost on which markup was to be allowed by the AE. The said expenses were claimed to have been incurred during the course of its India operations and were not specifically for provision of services to the AE and were not part of operating cost. Reference was made to the definition of operating profit wherein it is held that net profit would be arising from normal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rring to the website of the assessee and the press release dated 23-05-2005 the Assessing Officer concluded by holding that the operations of the assessee company started well before the particular date which inturn is evident from the statement of CEO of the assessee. Hence the submission of the assessee to exclude pre-operating expenses from operating cost was rejected. The next set of arguments of assessee was adjustment of working capital and risk adjustment out of which working capital adjustment was allowed out of final margins of the comparables. The Assessing Officer accordingly made adjustment of ₹ 60,44,269/-. 16. The CIT(A) first considered inclusion of the concerns at length and gave certain directions which are not needed to adjudicate the present issue as the assessee has restricted its arguments to the exclusion of Infosys Systems Ltd. only on the turnover filter. The next issue raised before CIT(A) was rejection of the claim to exclude expenses of prior period, i.e. pre-operative expenses. The CIT(A) vide para 7 at page 45 onwards has deliberated upon the issue after considering the submissions of the assessee wherein the first plea was that when the STPI r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erative expenses from AE. He stressed that the PLI as computed by the assessee in such circumstances merits to be accepted. Reliance was placed on the ratio laid down in the following cases : 1. M/s. Market Tools Research Pvt. Ltd. Vs. DCIT in ITA No.1150/Hyd/2011 order dated 05-02-2014 2. M/s. KHF Components Pvt. Ltd. Vs. ITO - IT (TP) A.No.1748/Bang/2013 order dated 17-06-2016 19. The Ld. Authorised Representative for the assessee further referred to the safe harbour rules and pointed out that clause (j) defines operating expenses which would not include pre-operating expenses. Reliance was placed on Notification No.73/2013 dated 18-09-2013. 20. The Ld. Departmental Representative for the revenue on the other hand pointed out that the safe harbour rules cannot be relied upon. He further stated that the assessee incurred certain expenses on its own cost and he claims that he does not earn markup on such cost. However, the list of the expenses reveal that none of the expenses were per se pre-operative expenses. The Ld. Departmental Representative for the revenue thus pointed out that there was no merit in the submission made by the assessee and he also ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the claim of the assessee that the margins of concerns with such huge turnover are not comparable with the margins of the assessee which is a limited risk entity. Accordingly, we direct the Assessing Officer to exclude the margins of Infosys Systems Ltd. from the final set of comparables in order to benchmark the international transaction undertaken by the assessee. As admitted by the Ld. Authorised Representative for the assessee during the course of arguments other issues raised in respect of the Transfer Pricing adjustments are not being adjudicated. The ground No.3(b) is partly allowed. 25. The assessee has also raised additional grounds of appeal against Transfer Pricing adjustment against which the assessee pointed out that the grounds of appeal No.5 to 7 would become academic. Accordingly, the same are dismissed. 26. Now coming to the other issue raised including the pre-operative expenses in operating expenses for the purpose of computation of operating profits. The assessee had entered into a Software Development/services agreement dated 01-04-2005 with Amberpoint Inc., USA, copy of which is placed at pages 91 to 108 of the paper book. The case of the assessee befo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted Enterprises w.e.f. 01-07-2005, i.e. after the registration under STPI scheme. The assessee was compensated for the services provided on cost plus markup basis from 01-07-2005. However, before 01-07-2005, the assessee had incurred certain expenses on employee cost, rent, administrative expenses etc. totaling ₹ 39,14,844/- which the assessee claims to be the cost for setting up of the India operations. The said expenses which were incurred before the commencement of operations, i.e. providing services to the Associated Enterprises, the assessee treated the same to be pre-operative expenses and excluded the same from the operating cost while determining the PLI of the assessee. 29. The issue which arises before us is whether the said pre-operative cost are to be included as part of the operating cost while determining the PLI of the assessee. The question has to be seen from the businessman s point of view wherein admittedly there is contract between the parties, i.e. assessee which is incurring the expenses and its Associate Enterprise which is reimbursing the cost with markup. The question which arises is that all such expenses which have been incurred by the assessee f ..... X X X X Extracts X X X X X X X X Extracts X X X X
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