9911796707
TMI Blog2025 (1) TMI 646X X X X Extracts X X X X X X X X Extracts X X X X ..... ns entered by the assessee during the current assessment year. 3. The relevant facts of the case are, the assessee was incorporated on 3RD December, 2010 as a wholly owned subsidiary of Motricity Pte. Ltd., Singapore being part of Motricity Group USA. It was set up as a captive service provider to the group company i.e. Motricity Inc., USA. Motricity India provides software development lifecycle, future product developments, manage served and business analysis services to its Associated Enterprise (AE). A separate Motricity professional services team has also been set up for providing support to customers across Asia and the US. Motricity India have also installed data centre in New Delhi, significant enough to handle expected growth in Indian market. It would be providing full mCore Solution. 4. The assessee entered into service agreement with its AE (USA) with agreed revenue model. Based upon cost plus 20% mark up was agreed upon. The service agreement was entered effectively from 1st January 2011 to 31st December 2011. The effective period covered during the current assessment year is nine months i.e. from 01.04.2011 to 31.12.2011. As the assessee provides services to its AE, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd. 5.68 14 Sasken Communication Technologies Ltd. 14.58 15 Spy Resources Pvt. Ltd. 33.59 16 Tata Elxsi 14.32 17 Thirdware Solution Ltd. (overseas segment) 11.10 18 Zylog System Ltd. 33.01 Average 20.92% 6. Based on the above chart, the TPO has computed the adjustment of arm's length price as under :- Operating cost 28,82,28,110 Arm's Length Margin (%) 20.92 Arm's Length Price (ALP) 34,85,25,431 Price Received 23,86,70,931 Shortfall Being adjustment u/s. 92CA 10,98,54,500 7. Accordingly, he determined the short fall in ALP at Rs. 10,98,54,500/-. 8. A show-cause notice was issued to the assessee and the assessee raised several objections and also objected to the determination of ALP for fourth quarter and on its submission, assessee has submitted as under :- "5. In response to the above-mentioned show cause notice, the assessee submitted its reply vide letter dated 20.01,2016 in which raised objections inter alia to the rejection of the assessee's comparables. The submissions of the assessee have been examined and duly considered as under: In the financial statements prepared for the year ended March 31st2012 & March 31st2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d herewith. All these expenses was incurred for services not provided to AE but are for needed for closure of business. Admin & Other Operating Expenses: The expenses incurred under this head in the non agreement period comprises of balance's w/off, legal fees for closure, rental expenses, accounting fees all needed for maintenance of the company and closure thereafter. Because of termination of contract, Motriciiy India also vacated the office premises before the minimum committed period. So the security amounting to Rs. 2,551,020/- lying with the landlord also got forfeited. Depreciation is a non cash expense and is based on the life of the asset. The assets were not used for the business but as per the terms of Indian Accounting standard, depreciation had to be charged. This is to again highlight to your good-self that the assessee has not claimed all these expenses as deductible u/s 37 of the Income Tax Act, 1961. Your good-self in-your queries raised have considered OP/OC based on the numbers submitted in -the audited financial statements. However, we wish to inform your good-self that since ail expenses after 1st Jan 2011 (during non-agreement period] are revenue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 011 to December 2011, total operating cost incurred by the Motricity India for providing services to it AE was Rs. 199,889,205/- on which it charged a margin of 20% and earned a service revenue equal to Rs. 238,670,931/-. It is claimed that expenses of Rs. 190,608,389/- incurred post 31.12.2011 were all related to closure of business of appellant company on which no markup was charged. 8.4 The moot issue here is whether in the facts of the case, the appellant in arm's length conditions, should have charged markup on the costs incurred post termination of service agreement with the AE. 8.5 It is observed that the appellant is a typical captive service provider. It had been set up to provide captive services only to its AEs and not to any outside party. The service agreement was terminated by the AE at the end of first year itself. Undisputedly any cost incurred post termination of agreement was incurred only because of the decision of the holding company. 8.6 The final accounts for the FY 2011-12 have been filed by the appellant. The Notes to of accounts states that "The management of the Holding Company has decided to close down the operations of the Company." 8.7 Thus, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in not properly appreciating the fact that the assessee company has decided to close down its operations and the service agreement with the AE was terminated w.e.f. 1 January 2012 and accordingly its financial statements are not prepared on going concern basis. 5. The Hon'ble CIT(A)/Ld. TPO/Ld. AO have erred in not properly considering the fact that assessee company has not provided any services to its AE, post the termination of service agreement with them, and the incurrence of expenses post the termination of service agreement was with an object to close down the business of assessee company after 01.01.2012. 6. The Hon'ble CIT(A)/Ld. TPO/Ld. AO have erred in not properly considering the facts and submission of assessee company that, if for the sake of argument, it is accepted that the expenses post termination of service agreement i.e. 31.12.2011 are operating in nature, the learned TPO/AO should make addition to the extent of mark-up on such expenses which would have been Rs. 19,005,592 (Rs. 90,848,908*20.92%). The Ld. TPO/AO has made additions of INR 109,854,500 on gross basis i.e. without allowing the deduction of expenses incurred by the assessee company and has incr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unt of the assessee was also not drawn on 'GOING CONCERN' basis as duly mentioned in the Auditor's report vide para no 3 of the Auditor's Report and referred to page139 of the appeal set. 12.2 As regards Transfer Pricing Study Report(TPSR) & determination of 'ALP', he submitted that since the international transaction of providing services to its AE were confined to the 9 months period in the impugned year (April to Dec 2011), hence in the TPSR, for the purpose of determination of 'ALP', the relevant cost incurred in the 9 months period ending 31st Dec 2011 were considered and the same was analysed against the revenue earned for the said period. He referred to Annexure 6 of the TPSR which is placed at page 138 of appeal set and depicts the segregation of the cost incurred for the 9 month period between April to December 2011 and for 3 months period January to March 2012 as briefly reproduced below: Exp Apr - Dec 2011 Total Cost Jan - March 2012 Normal Cost Jan - March 2012 Abnormal Cost - Jan - Mar 2012 Sales 23,87,60,931 Total Revenue 23,87,60,931 0 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee had argued for considering the expense related to post termination of service arrangements i.e. January 2012 to March 2012 as non-operating and thereby OP/OC margin is at arm's length. The reply by the assessee and the documents submitted by the assessee has been perused and analyzed. The assessee has failed to bring out on the record why did it incur expenses after termination of agreement arrangements from January 2012 to March 2012 i.e for the three months in which the expenses is more than expenses for remaining 9 month of agreement period. The assessee has not made any counter submission against the comparables selected by the TPO for AY 2012-13 for the benchmarking the international transaction of providing the software development services. In the light of the above discussion and submission on the record, the reply of the assessee with regard to expense bifurcation between normal and abnormal expenses is not acceptable. Therefore, the operating profit by operating cost ratio has been derived by taking into account the entire financial year revenue and expenses. In absence of any objection by the assessee over the comparables given in the showcause notice dated 15. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re able to bring on record evidence of any ulterior motive. 12.10 He submitted that the TPO and ld. CIT (A) also failed to realise that the entire loss caused by the disruption of the business would also be entirely suffered by the group only as there is neither any sale of business nor transfer of business entity. Further, he submitted that the cost incurred after 31.12.2011 has been suo moto disallowed in the return of income since entire cost was post the date of discontinuation of business. He submitted that the accounts of the company have been prepared on the basis that the business has been discontinued and hence not on GOING CONCERN BASIS. He further submitted that there is a substantial impairment loss cost of Rs. 10,19,36,658/- has also been recorded and same has neither been claimed in the return of income. 12.11 He further submitted that the initial agreement was entered into for only 1 year period beginning 1st January 2011 and hence the period of 12 months was split into two assessment years i.e. AY 11-12 and AY 12-13 and no assessment took place during AY 2011-12. He submitted that during impugned year, since the agreement was not renewed due to adverse business sc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d erroneous findings. In this regard, he brought to our notice Rule 10TA of IT Rules which is as under :- (j) "operating expense" means the costs incurred in the previous year by the assessee in relation to the international transaction during the course of its normal operations including depreciation and amortisation expenses relating to the assets used by the assessee, but not including the following, namely: -" He submitted that thus, it is crystal clear that operating expenses means only those expenses which are incurred in relation to the international transactions. In the present case, he submitted that since the international transaction of provision of service to the AE is undertaken till 31st Dec 2011 only hence the operating cost incurred till such date only could be considered for the purpose of analysis and determination of ALP as required under the ITA. 12.13 He submitted that in the present case, the expenditures incurred after the expiration of the agreement i.e. January 2012 to March 2012, do not pertain to international transactions or normal business operations. Instead, these are winding-up costs incurred solely for the purpose of closing down operations. He ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... culation. 12.16 He submitted that in the case of Ravi Kumar Sinha vs CIT (TS/590/High Court/2024/Delhi), the jurisdictional High Court (HC) reaffirmed the well-established legal position under the Income Tax Act, stating that tax cannot be levied on notional income. The HC relied on the Supreme Court's judgment in Excel Industries Ltd. to support its stance, emphasizing that the Act does not contemplate the taxation of hypothetical or notional income. 12.17 He further relied on the judgment of Hon'ble Supreme Court in Excel Industries Ltd. 358/ITR/295 (SC) which is a landmark decision that addresses the issue of notional or hypothetical income in the context of taxability under the Income Tax Act. In this case, the Hon'ble Supreme Court held that the tax authorities cannot tax notional or hypothetical income. Further he submitted that specifically, the Court clarified that tax is levied on actual income that has accrued or is received, and not on income that is merely an accounting entry or a notional figure. 12.18 He submitted that the case involved a situation where a company had claimed a tax deduction for a particular item, but the income related to it had not actually b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with its AE considering the fact that the unit was established by the group and also decision to terminate the facility also lies only with its AE, therefore, assessee has no role either in set up or closure of the business. Accordingly, he supported the findings of the lower authorities. 14. Considered the rival submissions and the material placed on record. We observed that the assessee has established a data centre at Delhi and also created a facility to provide software services to its AE by entering into a service agreement for the initial period of 12 months commencing from 01.01.2011 to 31.12.2011. The assessee has functioned effectively during the current assessment year for nine months and the operation of the assessee was stopped due to non-renewable of service agreement with its AE effectively from 01.01.2012. It is a fact on record that assessee has declared income for the period of nine months and also booked the relevant operating expenditure for the same period. While determining the ALP for the services, the TPO observed that the assessee has booked more expenditure post service agreement i.e. 01.01.2012 to 31.03.2012 and has not booked any income. Accordingly, he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the provisions of the Act, the TPO has to determine the ALP of the international transactions carried on by the assessee. In this case, assessee has effectively carried on the international transaction only during period of service agreement. The TPO has to determine only the ALP for such international transactions carried on by the assessee. The TPO selected various comparables for which various financial statements of comparable comparison were prepared on the basis of going concern whereas financial statements of the assessee are prepared not on the basis of going concern. This was disclosed in appropriate places in the audited Balance Sheet itself. The TP study has to be carried on comparable basis on equal terms. This itself makes all the comparables selected by the TPO are liable to be rejected. 17. The ld. CIT(A) came up with a new finding that the assessee has to charge mark-up on reimbursement of expenditure relating to closure of business also with the observation that the assessee is a typical captive service provider. It was set up to provide captive services only to its AE and not to any outside party. The service agreement was terminated by the AE itself at the end o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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