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TMI Blog2017 (2) TMI 1337X X X X Extracts X X X X X X X X Extracts X X X X ..... AE as one at an arm's length on the basis of Transaction Net Margin Method (TNMM). For this, operating margin data in respect of comparable Indian companies were identified by the assessee. Hence, TNMM, using operating margin on operating cost as the PLI (Profit Level Indicator) was selected as the most appropriate method. 4. Based on the above analysis, 20 companies were selected by the assessee and their net margin was analysed. It was seen that the average operating margin on operating costs percentage of these companies was between (-) 61.5% to 46.4%. The arithmetic mean of the above mentioned companies was 9.6%. This margin was taken as the benchmark for comparison of the operating margin over operating cost earned by the Assessee from its software development services rendered to its AE. During the year the Assessee had earned an operating margin of 12% on transactions with the AE. Hence, it was concluded by the assessee that the provision of software development and software services to its overseas AEs were at an arm's length. 5. The AO on consideration of the above transfer pricing study conducted by the Assessee was of the view that the assessee had included loss makin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... M/s. Visual Soft Technologies Ltd. 26.92 14.37 10.06 51.35 17.11 3 M/s. Blue Star Infotech Ltd. 21.31 13.1 5.16 39.57 13.19 4 M/s. Infotech Ltd. Loss 4.02 7.83 11.85 5.92 5 M/s Ftech Infosys Ltd. 51.08. 43.25 NA 94.33 47.16 6 M/s Aztec Software & Technology Services Ltd Loss 19.4 22.79 42.19 21.09 7 M/s K P I T Cummins Infosystems Limited 13.29 12.87 12.15 38.31 12.77 8 M/s Prithvi Information Solutions Ltd. 8.3 10.53 NA 18.83 9.41 9 M/s R.S.Software Ltd. Loss 7.57 NA 7.57 7.57 Average 18.41 The arithmetic mean of the operating profit on operating cost comes to 18.41% as compared to the operating margin on operating cost of the software division of the assessee company. which is 12%. Hence. by taking the operating profit on operating cost percentage as 18.41 % as the benchmark, the arm's length price of international transactions representing provision of software development services by the assessee company to its AEs during the year 200405 are re-determined as under ;- Operating margin declared by the assessee At 12% operating martin percentage- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts. 15. The assessee in its submission dated 02.06.2010 to the Panel also stated it had submitted before the TPO requesting to make adjustments to the comparable companies' margins on account of the various' differences. These adjustments are on account of the following: * Risk. Adjustment: This adjustment, according to the assessee, was sought on account of the difference in the risk profile of a captive service provider (assuming less than the normal risks) and full-fledged entrepreneurs (bearing business and operational risks). The assessee stated that where a risk-insulated captive service provider would earn low returns, a full-fledged 'entrepreneur would earn higher returns, on the basis of higher the risk higher the returns. The assessee sought the above adjustment to be calculated on the basis of the difference between prime 'lending rate (PLR) and the bank rate, and determined the same at 4.75% (PLR, 10.75% - Bank Rate, 6.00%). It was also contended by the assessee that the above computation of risk adjustment was upheld by the ITAT, Bangalore Bench in the assessee's own case for AY 2003-04. .* Working Capital Adjustments: The assessee stated t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... It would be beyond this Panel to come up with a specific number for adjustments. Hence in view of the same, the adjustments as requested by the assessee are denied. In fact, there. was no force in the submission of the assessee and the demand by them was neither specific nor accurate." 8. After the order of DRP the TPO passed the order of assessment u/s 143(3) r.w.s. 144C of the Act dated 30.07.2010. Against the aforesaid fair order of the assessment the assessee preferred appeal before the Tribunal in ITA No.1887/Kol/2010. The Tribunal vide its order dated 07.03.2010 had not allowed any relief to the assessee. The assessee filed an appeal before the Hon'ble Calcutta High Court and the Hon'ble Calcutta High Court vide its order dated 13.10.2012 in its G.A.No.2012 held that the entire matter should be remanded for fresh hearing by the Tribunal. Accordingly the appeal was restored to the file of the tribunal for fresh hearing. 9. The Tribunal by an order dated 19.06.2013 remanded certain issue to the DRP for fresh consideration. The following are the relevant observations of the ITAT : "6. We have considered the rival submissions. At the outset a perusal of the order of the DRP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... td.) sought by the assessee. 11. As far as the claim of the assessee for risk adjustment and workiing capital adjustments is concerned the DRP held as follows :- " 10.0 Finding: 10.1 DRP has carefully considered the facts of the case and the submissions of the taxpayer. The panel is not inclined to accept the assessee's claim of risk adjustment. Risk adjustment as a general rule cannot be allowed unless it is clearly shown that the comparables had actually undertaken such risk and how the same materially affected their margins. Unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustment, no adjustment can be allowed to the taxpayer. ln the present case, except pointing out various risks, the taxpayer has not shown with evidence as to whether each of the risk was actually undertaken or not by the comparables and if so, how these risks affected each of them and whether such adjustment would improve the comparability. 10.2 Further, the panel is of the view that a purpose specific captive agency like the assessee is not entirely risk fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ay bring down the overall profitability rather than increase the profitability. Thus if undertaking the market risk etc. helps in earning any extra margin, the benefit is more than set off by the corresponding expenditure. The same applies to credit risk undertaken. * It is incorrect to say that higher the risk, the higher is the margin though it is true that higher risk expects a higher margin. Thus realization of risk is different from expected return based on risk undertaken. Finally selected cornparables had almost similar risks but margins varied. * The taxpayer's single customer risk more than offsets any other risk differential between the taxpayer and the comparable companies. * Different comparables can have different risk profiles and different profit margins. The proviso to s. 92C(2) of the Act provides for adopting arithmetical mean of the different prices. This provision neutralizes the effect of difference in the risk profile, if any between the taxpayer and the comparables as realized risk may pull down the profitability below the risk free return. ** It is not sufficient to merely spell out risks, it has to be shown which risk was actually undertaken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ry. 7.2 Further, this adjustment is not generic to be allowed as a routine. The assessee has to demonstrate unambiguously for the relevant period that variations in Working Capital profile would indeed have impact on the margins of the comparables. The factum of working capital adjustment having been allowed in other years would have no binding proposition unless it is demonstrated that the capital profiles were identical to such periods. In view of above discussion, the panel is of the considered view that this objection deserves to be rejected." 12. On excluding Aftek Infosys Ltd. As comparable the DRP took the following view:- "DRP has duly considered submissions of the assessee. There is no evidence furnished to DRP about functional differentiation of the comparable. The functional profile of Aftek as per first page of the annual report does not give any indications of its functionality so as to enable us to specify the differences in functionality of the comparable and the assessee. Though the comparable has shown significant IPRs, in absence of any details about the nature and profile of such intangibles, it would be inappropriate to allow its exclusion just on this ba ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dated 16.03.2015as follows :- " 4. The Hon'ble DRP, Delhi in its order dated 16.03.2015 has rejected the all the claims of the assessee except for claim 4 i.e. inclusion of Sasken Technologies Ltd as among the comparable. 5. The assessee in its original transfer pricing study has rejected the company as functionally not comparable. However, this office has consistently taken a view that the M/s Sasken Communication Technologies Ltd as a comparable in subsequent years for the same assessee and as no difference in functionality of the above comparable is observed the decision of the DRP, Delhi accepted and no further appeal is suggested. It is also seen that after giving effect to the directions of DRP the adjustment is 32.81 Crores in place of Rs. 21.79 crores as is calculated in the order u/s 92CA (3) dated 30.10.2009. 6. The company Sasken Communication Technologies Ltd has two segment viz Software services and Software product segment. The segment Software services segment is considered as comparable to the functions of the assessee. The calculation of operating profit/operating Cost of the Software services segment of the comparable M/s Sasken communication Technolo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the DRP u/s 144C of the Act dated 16.03.2015, the assessee has preferred the present appeal before the Tribunal. 16. The following are the grounds of appeal raised by the assessee:- "1. Order enhancing the income is bad in law 1.1. That on the facts and circumstances of the case and in law, the Ld. AO erred in enhancing the figure of transfer pricing adjustment in respect of Software services to Rs. 32,81,00,000 as against Rs. 19,61,43,994 determined in the final assessment order dated 30 July 2010 passed u/s.143(3) r.w.s. 144C of the Income Tax Act ("the Act"). 1.2. That on the facts and circumstances of the case and in law, the Ld. AO erred in not appreciating that where the Appellate Tribunal remands the matter to the lower authorities, the enhancement of income cannot be made. 2. Erroneous inclusion of the companies as comparable in respect of Software services which are already rejected by DRP vide its Order dated 17 June 2010 2.1 The Ld. AO, and the TPO while passing the comments giving effect to DRP directions dated 16 March 2015 has erroneously considered the same set of comparables as given in the TPO order dated 30 October 2009. 2.2 The Ld. AO, and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le company. 4.2 The Learned AO, DRP and the TPO erred in not considering that Aftek is functionally dissimilar to the Appellant. 4.3 The learned AO, DRP and the TPO erred in not considering that Aftek should be rejected as it enjoys significant benefits on account of intellectual property rights ('IPR'), which constitutes nearly 81 % of the total net fixed assets of the Company. 4.4 The Learned AO, DRP and the TPO erred in not considering that Aftek underwent a financial reorganization, has changed its financial year from June to March and thus the financial statements of Aftek is not comparable to the Appellant. 5. Variation of 5% from the arithmetic mean 5.1. The Ld. AO, DRP and TPO erred in law in not granting the benefits of +/-5% variance as per proviso to section 92C(2) of the Act to the Appellant. 6. Non-allowance of appropriate adjustments as per Rule 10B 6.1. The Ld. AO, DRP and TPO erred in law and on facts in not granting the adjustment on account of the differences in the working capital adjustments between the appellant and the comparable companies. 6.2. The Ld. AO, DRP and the TPO erred in law and on facts in not granting the adjustment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rection to the DRP in its order dated 16.03.2005. Therefore, these three companies have to be excluded from the list of comparable companies. We are of the view that the stand taken by the assessee in this regard deserves to be accepted. We have already seen in the narration of facts that these three companies chosen by the TPO in its first order dated 30.10.2009 was held to be erroneous by the DRP in its directions dated 17.06.2010 and these directions have become final having been accepted by the revenue and the Assessee. Therefore, it was open to the AO while passing the order giving effect to the DRP dated 16.03.2015 to consider these companies as comparable companies. We therefore direct the TPO/AO to exclude these three companies from the list of comparable companies. 18. The next issue that needs to be addressed is as to whether Aftek InInfosys Ltd., should be considered as comparable company or not. In this regard we find that the objections by the assessee before the DRP after remand by the Tribunal was that this company had IPR in the Schedule of fixed assets and therefore its business model was completely different which rendered this company as not comparable with the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be taken as given below: - Sasken Technologies Ltd. Amt in Lakhs Annual Report (AR) Mar 2004 12 months Pg No.60 of AR Annual Report Mar 2005 12 mmonths Pg No.60 of AR Annual Report Mar 2006 12 months Pg No.71 of AR/288 of PB Revenue 16,613.01 22,299.04 26,754.43 Total Revenue 16,613.01 22,299.04 26,754.43 Total Operating Cost Cost of Revenues, including Research and Development Exp. 9662.66 13181.43 19349.30 Product Engineering Expense 1553.71 2061.68 Selling Expenses 1890.87 2146.69 2094.97 Administrative and General Expenses 1903.43 2856.21 3313.59 Employee stock 15.63 73.70 53.59 option compensaiton cost (net) Other Expenses - - - Total Operating Cost 15026.30 20,319.71 24,811.45 Total Operating Profit 1,586.71 1,979.33 1,942.98 NCP%(on cost) 10.56% 9.74% 7.83% It was submitted that the computation for the relevant year, i.e. AY 2006-07 was also submitted before DRP and forms part of the Paper Book ('PB '). It was further submitted that the TPO while computing the segmental margin in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ether. Hence, an overall adjustment of (-2%) is given towards working capital level differences and also towards risk level differences. " 22. After considering the submissions of the learned counsel for the Assessee, we are of the view that similar adjustments should also be allowed in the present assessment year. We hold and direct accordingly. We also observe that the principle reasons assigned by the DRP in the present assessment year was lack of details furnished by the assessee. In this regard we find that all the details have been given by the assessee in its transfer pricing study and we find that the observations of the DRP in this regard cannot be sustained. We accordingly direct that adjustment of 2% towards working capital adjustment and risk adjustment should be allowed to the assessee as was done in A.Y.2004-05. We hold and direct accordingly. 23. Ground no.5 raised by the assessee will not survive because of the retrospective amendment to the statutory provision of section 92C(2) of the Act and hence dismissed. 24. As far as ground no.7 is concerned it will be just and appropriate to direct the AO to verify the claim of the assessee in this regard and allow appro ..... X X X X Extracts X X X X X X X X Extracts X X X X
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