TMI Blog2008 (4) TMI 340X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee on account of employer's contribution should be allowed following the judgment of the Tribunal, Special Bench, Kolkata in the case of I.T.C. Ltd. We also direct the AO to verify the claim of the assessee regarding arithmetical mistake in disallowance to the extent of Rs. 4,08,181. We hold and direct accordingly and accept the ground raised by the assessee for statistical purposes. Transactions entered by the assessee with its AE, DCIL in Bahamas - HELD THAT:- We agree with the view that gross margins of DCIL need to be compared with gross margins of comparable uncontrolled transactions or unrelated enterprises entering into such transactions. We can conclude that DCIL is a company of substance and is performing full-fledged distribution activities. It is not a paper company established to evade taxes as argued by the CIT(A) in his order. Hence, we do not find any justification in the arguments, of the CIT(A) that entire profits should come to the assessee and DCIL should not retain profits. Further the benchmarking exercise and analysis conducted by the assessee has been examined by the CIT(A) and TPO but they have not been able to controvert the analys ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngth. For asst. yr. 2004-05. Selection of time period. We extracted companies, which had sales 0 in at least two out of the three financial years ending during the period 1st April, 2001 and 16th Feb., 2004. This left us with 3,989 companies. As, we already had a set of companies from Prowess we extracted only the extra companies from Capitaline Plus, data for which were not available in Prowess. This gave us a set of 1,228 companies from Capitaline Plus. Various data fields in Capitaline Plus and Prowess were selected and the ones that were relevant to our analysis were extracted companies, which satisfied basis search criteria. A simple average of the raw numeric data fields was then computed, and various computations were performed thereon as well as on the raw data for individual years. Quantitative screening - Quantitative screening is a process under which comparability is assessed by comparing economically significant financial data of ratios. We conclude that the analysis undertaken by the assessee to determine the ALP of the international transaction with Datacore USA is correct and on the basis of the analysis it is seen that transaction undertaken by the tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4. Without prejudice to ground (3) above, in the event Your Honours are of the view that the ld. CIT(A) was right in confirming the adjustment, even assuming but not admitting, the ld. CIT(A) erred in not considering the fact that the maximum amount of adjustment to the price of international transaction of the appellant, would be limited to the gross profit earned by Development Consultant International Ltd., Bahamas and accordingly should have restricted the amount of adjustment in the international transaction of the appellant with Development Consultant Ltd., Bahamas to USD 4,61,174 i.e. INR 2,07,52,830/-. 5. (a) That on facts and in circumstances of the case, the ld. CIT(A)) erred in specifying the reason for confirming the adjustment to the price of international transaction between the Kulijan Corporation, USA and the appellant, by way of a speaking order. (b) Without prejudice to ground (3) above, in the event Your Honours are of the view that ld. CIT(A)) was right in confirming the adjustment, even assuming but not admitting, the ld. CIT(A) erred in not considering the fact that the maximum amount of adjustment to the price of international transaction the appellant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stricted the adjustment in the international transaction of the appellant with The Kulijan Corporation. USA to USD 128,313 i.e. INR 57,14,085/-. 5. At the outset of the appellate proceedings before us, the ld. Counsel for the assessee has submitted that he is not pressing Ground No. 1(a) for A.Yr. 2003-04 and ground No. 1 for A.Yr. 2004-05 hence they are dismissed as not pressed. 6. Arguing on the ground No. 1 (b), the ld. Counsel for the assessee has submitted that the assessee in this case has paid employees' contribution to Provident Fund within the due date of filing of the return therefore, the claim of the assessee should have been allowed in view of the decision of the ITAT Special Bench. Kolkata in the case of JCIT v. I.T.C. Limited in ITA No. 1541/Cal/2000 dated 07.09.2007. 7. The ld. Departmental Representative for the revenue has not raised serious objection to such submission of the ld. AR for the assessee. 8. We after hearing both the parties and perusing the material available on record direct the AO to verify the claim of the assessee and if the employees' contribution have been paid either before the filing of return or before the due date of fil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to additions made on account of transfer pricing adjustments. Incidentally, the Transfer Pricing Officer (TPO) and accordingly, the Assessing Officer, had made additions of Rs. 8,44,78,673/- and Rs. 8,48,82,872/- on account of transfer pricing adjustments for the A.yrs. 2003-04 and 2004-05 respectively. We have observed that the additions for both the years are of the same type and therefore we are of the view that all the grounds relating to the two assessment years may be disposed of together. 14. The facts are that the assessee is a company registered in India, inter alia having three related parties in the form of subsidiaries and further step down subsidiaries incorporated in foreign countries, all the which are admittedly associated, enterprises (AE), within the meaning of Section 92A of the IT Act. The said AEs are as follows (a) Development Consultants International Limited (DCIL), a company incorporated in Bahamas; (b) The Kuljian Corporation (TKS), a company incorporated in USA; and (c) Datacore Systems Inc., (Datacore US), another company incorporated in US. The assessee had entered into the following transactions with the said AEs during the previous years relevant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssary documentation, the assessee had not furnished any details/explanation with the TPO. As a result of such non-compliance on the part of the assessee, the TPO virtually framed a best judgement assessment so far as transfer pricing is concerned for the assessment year 2003-04 and computed a transfer pricing adjustment of Rs. 8,44,78,673/- for the said assessment year. We have also noted that the assessee had again failed to furnish the accountant's report under Section 92B of the IT Act for the assessment year 2004-05. However, it had furnished necessary documents in the form of a report prepared by M/s. Pricewaterhouse Coopers Pvt. Limited (PWC) at the time of the assessment proceedings for the assessment year 2004-05 before the TPO when the TPO required the assessee to substantiate the international transactions having regard to the ALP for the said assessment year, however, The TPO had ignored the justification made by the assessee to the said report that all the transactions with the AEs were at arm's length and proceeded to inflict a similar addition worth Rs. 8,48,82,872/- for the assessment year 2004-05 as well, by adopting an approach similar to the one in the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtunity was also given to the Revenue Officers at the time of the remand proceedings to verify the documents and other evidences filed by the assessee before the Commissioner (Appeals) and therefore it is nobody's case that while the appeals are subjudice before the Tribunal, the additions can be sustained on the ground that the lower authorities did not have a chance to verify in depth and detail, the documents and other explanations/information filed by the assessee. We therefore asked both the AR of the assessee and the learned Departmental Representative (DR) to restrict the arguments on the merits of the case. 17. Now coming to the merits of the case. Shri Rahul Mitra made the following submissions: 1. For the assessment year 2003-04, the TPO, admittedly, being constrained due to paucity of information, had adopted a global approach by computing the assessee's net profit margin as a whole including all its domestic and third party transactions and comparing the same with the mean net profit margins of the comparable companies selected using the 'Prowess' database which is a publicly available database. Based on the aforesaid analysis, the TPO made an adju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on a transaction-by-transaction basis and not on an aggregate basis as done by there TPO and sustained by the Commissioner (Appeals). 5. Before proceeding to discuss the determination of ALP on transaction by transaction basis, Shri Mitra submitted that as per Section- 92C(1) of the IT Act. the arm's length price of an international transaction is required to be determined using any of the prescribed methods, being the most appropriate method-having regard to the nature of transaction or class of transaction. However, in order to determine the most appropriate method for determining the arm's length price, it is first necessary to select the tested party'. The transfer pricing legislation in India does not provide any discussion or mention of the concept of 'tested party'. In order to understand the concept of tested party we need to refer to the transfer pricing legislations of developed countries where the principles of transfer pricing have been in use for a long time and act as a guiding force for all the developing economies. The transfer pricing guidelines issued by the US Internal Revenue Services under Section 482 provide and discuss the concept of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and stated in the transfer pricing documentation report that DCIT is an entrepreneur company and since its inception it has created significant marketing intangibles. It utilizes these intangibles in order to generate work and enters into contract with third party customers. It assumes ail the major risks like market, price and product risks in relation to the work. The marketing efforts undertaken by DCIL over the years and the value of intangible, created cannot be measured and co-related with the costs reflected in the books of account. It is the goodwill of the enterprise developed over the years which helps it procure contracts from third parties and does not necessarily entail a year on year expenditure to the company. DCIL downloads all the design and engineering work it generates to the assessee. Further, he stated that DCIL bears all the market, price and product risks. As such it also holds commercial and marketing intangibles. Therefore, the comparability adjustments that would be required if DCIL were selected as tested party would be both substantial and unreliable. Hence, in the transfer pricing analysis undertaken by the assessee submitted before the Commissioner (A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t without prejudice to the above, since DCIL had incurred losses at the net level and comparing margins at the net level would involve the process of determining the veracity of operating expenses incurred by DCIL, and also since the TPO intended to apply Release Price Method and test the gross margins of DCIL. the assessee on a conservative basis computed the gross margins earned by DCIL. 18. After due consideration of all the facts, we agree with the view that gross margins of DCIL need to be compared with gross margins of comparable uncontrolled transactions or unrelated enterprises entering into such transactions. 19. Shri Rahul Mitra then submitted that the assessee computed the margins earned by DCIL for the period from 1st April 2002 to 31 March, 2003 for A.Y 2003-04 and from 1st April, 2003 to 31st April, 2004 for A.Y 2004-05. The results of such computation as examined by us are as follows: DCIL Year ending March '03 Year ending March '04 Particulars Amount (in LSD) Amount in USD) Turnover 940,822 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Administrative (SG A) Expenses: Companies having nil SG A expenses were not considered as comparable companies to the tested party; - Research Development Expenses/Sales 0%: We have rejected companies who have incurred any research and development expenses since DCIL as a distributor would not undertake any research and developmental activity; -SG A Expenses/Sales falling outside Inter-Quatile Range: SG A expenses/Sales ratio of a distributor represents the intensity of functions performed in order to generate sales. Hence, in order to select our appropriate set of comparable's we have rejected companies which were lying outside the inter-quartile range of SG A expenses/Sales of the 242 comparable companies. -Net Profit 0: Companies having losses were rejected on a conservative basis. On execution of the above steps a set of 98 comparable companies were left. -The above companies were then reviewed with respect to their business descriptions in order to refine the search to include in the final set of comparables, only companies with functions similar to DCIL -this resulted in the exclusion of 54 companies and we were left with a comparable set of 34 companies. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not considered as comparable companies to the tested party; - Research Development Expenses/Sales 0%: We have rejected companies who have incurred any research and development expenses since DCIL as a distributor would not undertake any research and developmental activity: - SG A Expenses/Sales falling outside Inter-Quartile Range: SG A expenses/Sales ratio of a distributor represents the intensity of functions performed in order to generate sales. Hence, in order to select our appropriate set of comparables we have rejected companies which were lying outside the inter-quartile range of SG A expenses/sales of 221 comparable companies. - Net-Profit 0: Companies having losses were rejected on a conservative basis. On execution of die above steps a set of 83 comparable companies were left. The above companies were then reviewed with respect to their business description in order to refine the search to include in the final set of comparables, only companies with functions similar to DCIL -this resulted in the exclusion of 54 companies and we were left with a comparable set of 29 companies. Companies were rejected by qualitative screening due to the following reason ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that DCIL has retained more than the arm's length margin at the gross level. He stated that transfer pricing legislation as provided in the IT Act allows a taxpayer to have an option to compute the ALP which may vary from the IT Act which states that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices or at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean . The assessee computed the arm's length price considering the 5% tolerance range. The results of such computation are given below: Sl. No. Particulars Reference Amount (in USD 1 Actual sales 940,822 2 Actual Cost of Sales 365,924 3 Actual Gross Profit (1-2) 574,898 4 GP/Sales 3/1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the credit issued by the bank and the long standing banking relationship DCIL enjoys with these banks. Shri Rahul Mitra argued that DCIL is a company of substance and not a paper company since no paper company would be having such substantial business operations and having excellent customer relationship with its bankers and no nationalised banks would give such substantial credit limits to a paper company. 25. We have examined all the facts and record and after the due consideration of arguments placed by both the sides, we can see that DCIL has long standing banking relationship with banks like, Bank of India and Indian Overseas Bank. Further, it enjoys substantial credit limits provided by these banks for the purpose of its business operations. No paper company would be having such substantial business operations and have excellent customer relationship with its bankers and no nationalized banks would give such credit limits to a paper company. DCIL has been established after proper permission obtained from the Reserve Bank of India. Hence, based on the facts and our findings we can conclude that DCIL is a company of substance and is performing full-fledged distribution ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... separately, however the TPO ignored the separate analysis made by the assessee for each of the international transaction entered by the assessee and adopted a global approach whereby all the international transactions of the assessee as documented in the said report were aggregated and combined gross profit margin over direct indirect costs for such international transactions was computed and compared with the gross margins earned by the assessee for transactions with third parties. Based on such global approach, the TPO made an adjustment in ALP of the assessee and accordingly made an upward adjustment of Rs. 8,48,82,472/-in the ALP of the assessee. 3. The ld. AR submitted that, TKC is one of the subsidiaries of Am DC Inc, New York USA, which in turn is a subsidiary of DCIL. TKC is a multi-disciplinary Engineering/Architech firm. It is in consulting engineering business for last 50 years. The range of services provided by TKC includes, feasibility study, master planning, preliminary design, design development, detailed engineering, preparation of construction specs construction drawings, bid document preparation and bid evaluation, vendors' drawings review, inspection/ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e international transactions entered by assessee with TKC by giving a strong argument. Hence, based on the facts, we see that even the Commissioner (Appeals) in his order to the status to TKC and did not controvert the analysis done by the assessee. Shri Rahul Mitral submitted that the TPO and accordingly the Assessing Officer had duly considered all the said documents and evidences and furnished remand reports before the Commissioner(Appeals), copies of which were filed with the paper book, however, the Revenue Officers had refused to accept the explanations given by the assessee and suggested to retain the initial additions made by them at the time of the regular assessments. Based on the above facts and our findings, we agree with the arguments of Shri Rahul Mitra that in case of transactions of the assessee with TKC, the transfer pricing analysis should be from the Indian side considering the assessee as the tested party. 6. Shri Rahul Mitra submitted that in case of A.Y 2003-04, the analysis from the Indian side showed that the arm's length GP/DICOP of comparable uncontrolled transactions entered by the assessee with third parties is 334.17% whereas the assessee has ear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enchmarking exercise as conducted by the assessee is filed in the paper book and is extracted below: For assessment year 2003-04 Selection of time period This analysis has generally focused to operating results of service providers over the two-year period 2001 through 200. Basic Search Strategy The cut-off date of Prowess is on February 15, 2003. Basic Search Criteria The first set in our search process was to identify a large set of potentially comparable companies based on Company Main Activity as identified by Prowess. To ensure that we capture all the potential comparables vis-a-vis companies proving service activity, the ratio of other operating income/Sales was taken to be more than 50% for both the years. The completeness of our selection was verified by checking by checking that well-known Indian services companies were included. We also cross-checked the selected companies against those listed in the ERC database for similar industries. Quantitative Screening Quantitative screening is a process under which comparability is assessed by comparing economically significant financial data or rations. To insure comparability, companies with the follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) - Beverages, Contract Manufacturing (Toll Manufacturing) Chemicals, Contract Manufacturing (Toll Manufacturing) - Drugs, contract Manufacturing (Toll Manufacturing) Electronics contract Manufacturing (Toll Manufacturing) - Fabrics, Contract Manufacturing (Toll Manufacturing) Oil, Contract manufacturing (Toll Manufacturing) Paints, Contract Manufacturing (Toll Manufacturing) - Photographic films, contract Manufacturing (Toll Manufacturing) - Type and rubber products, Contract Manufacturing (Toll Manufacturing) - tolls, Cellular Mobile services, Consultancy services. Software Development services - Client server and internet software solutions, Software development services - Design and engineering software (CAD/CAE), engineering software etc.) Software development services - Embedded systems and communication software. Software development services - General, Engineering and construction services (Dams, bridge-railway, etc), Education services, Entertainment media services, Facilities management services, Hotel restaurant services, Investment and financial services, industrial turnkey project execution services, internet service provider and e-commerce, Logistics support servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... This clearly, establishes that the international transaction of DCPL with its associate is at arms length. For assessment year 2004-05 Selection of time period This analysis has generally focused to operating results of service providers over the two-year period 2001 through 2002. Basic Search Strategy: The cut-off of Prowess is on February 16, 2004. We started, with a universe of 7957 companies available in Prowess undated as of February 16,2004. From these we extracted companies, which had Sales in at least two out of the three financial years during the period April 1, 2001 and February 16, 2004. This left us with 3,560 companies. The next step in our search process was to identify a large set of potentially comparable companies in the services domain from prowess. As the analysis pertain to capturing potential comparables within the service industry, the ratio of [oth op inc (other operating income)/sales-internal transfer-exp sales tax)] 50% was used as a cut-off criterion for all the years. The Other operating income definition as per Prowess captures all income generated by a company apart from its manufacturing and trading revenues. This left us with 582 comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Passing the criterion Prowess Capitaline Plus Sales 0 (In at least 2 yrs within 2001-2004) 3560 1228 [othopinc/(sales - internal transfer-exp sales tax)] 50% 582 NA 1 Ownership group 281 2 NA 1 Excel Quantitative filters - (r and d current r and d capital)/sales 3% 570 1227 NFA/Sales 200% 458 1060 Start-ups (Sales Rs. 1 cr. 397 774 Qualitative Selection (Companies involved in manufacturing, trading or any other activities not akin to consultancy services were rejected) 7 3 1. This criterion cannot be used in Capitaline Plus because of database constraints. 2. NSEIT Ltd god eliminated, as prowess did not provide information on the ownership structure. We have selecte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons in nature of deputation of employees with DCIL and TKC and TKC the transaction has been entered at arm' s length for both the assessment years. 30. In case of merits of the case for international transactions entered by the assessee with Datacore US, Shri Rahul Mitra made the following submissions: 1. Similar to the adjustments made for the international transactions with DCIL and TKC, the TPO made adjustments in the ALP of the international transactions entered by the assessee with Datacore US. The Commissioner (Appeals) sustained the adjustments made by the TPO. 2. Shri Rahul Mitra submitted that, Datacore USA is the software arm of the DCPL group. Datacore USA is the entrepreneur company engaged in providing software and back office work to its customers. It downloads part of the work relating to data entry i.e., back office work to the assessee. The assessee in turn downloads the work to Data-Core India Private Limited ('Datacore India') - a 100% subsidiary of the assessee. The transaction is in nature of reimbursements from the assessee's perspective and it acts merely as a pass through entity. The assessee in this case assumes no risk whatsoever a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /TC of the comparable Companies is 24,08% whereas the results of Data-Core India for the year ended 31st March, 2003 indicate that the company has earned a profitability of 26.61% at the operating level on its total costs in relation to this transaction. This clearly establishes that the international transaction of Data-Core India's with its associate is at arms length. In case of A.Y. 2004-05, the results of the analysis show that the arm's length OP/TC of the comparable companies is 27.77% whereas the results of Data-Core India for the year ended 31st March 2004 indicate that the company has carried a profitability of 32.56% at the operating level on its total costs in relation to this transaction. This Shri Rahul Mitra submitted clearly established that the international transaction of the assessee with Datacore US is at arm's length. The entire benchmarking exercise as conducted by the assessee is filed in the paper book and is extracted below: For assessment year 2003-04. The entire Search procedure is the same as discussed above except for the comparable service category selected for Data-Core India. As discussed to the Functional Analysis section Dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the +/-5% range of the arithmetic mean of comparable companies one may refer to Appendix F. This provides evidence that both the pricing basis itself of various transactions that impact the profitability of Data-core India, and the outcome of that pricing, i.e. the profitability are at arm's length and hence satisfy the 'Arm's length standard required under the Indian Regulations. Rejection of Controlled Companies - The selected of four companies (showing a mean, - OP/TC of 30.61%) was tested to determine whether any controlled companies i.e. which have foreign holding or subsidiary companies, existed. On the basis of their holding structure, three companies were determined to have controlled transactions. Since the PLI of Datacore India is any way more than the arm's length PLI determined after rejecting controlled companies, the controlled companies were not rejected for the purpose of this analysis. The Final results are tabulated below PLI AL (Mean) -after application of the +/- 5% range Data-core India's margin Operating Profit/TC (No. of comparable companies = 4) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . A simple average of the raw numeric data fields was then computed, and various computation wee performed thereon as well as on the raw data for individual years. Quantitative Screening Quantitative screening is a process under which comparability is assessed by comparing economically significant financial data or ratios. To insure comparability, companies with the following characteristic were eliminated: (v) had a ratio of research and development (R D) expenses to sales that exceeded 3% indicating the possible ownership of intangibles and/or significant activities not involved in pure service provision; (vi) had net fixed assets (NFA) to sales that exceeded 200%, indicating that these companies did a significant amount of manufacturing or otherwise held substantial assets not used in providing services; (vii) had average sales of less than INR 1 crore during the time period because low sales volumes may indicate that the companies are starting up operations. Moreover, the reliability of the financial data for companies with low levels of sales can be significantly reduced because the same persons are often both major shareholders and key employees, diminishi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenses (VAE) of the service provider i.e. GP/YAE. But a captive service provider does not market its services and therefore would not seek to keep profitability on account of marketing activities. The Indian databases used to conduct the comparable search generally provide information for third party service providers. Therefore, an adjustment may be required to be made to the operating results of the comparable companies to even out the differences on account of the marketing activities. The final results are tabulated below: The results of the economic analysis show that the arm's length OP/TC of the comparable companies is 27.77% whereas the results of Data-Core India for the year ended 31st March, 2004 indicate that the company has earned a profitability of 32.56% on Us international transactions when measured by the OP/TC criteria. This clearly establishes that the international transaction of Data-Core India's with its associate is at arms length . In his orders, the Commissioner (Appeals) contended that the books of Datacore India showed total revenue of Rs.70,673,205/-for AY 2003-04 Rs. 56.738,428/-for AY 2004-05 whereas the appellant while, testing th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4,259,839 8,356,388 Assessment Year: 2004-05 Particulars Segmental results in relation to transactions with Datacore USA (Rs.) Others (Rs.) Total (Rs.) INCOME 28,554,663 27,883,765 56,738,428 EXPENDITURE Salary Benefits 13,407,889 16,782,575 30,190,464 Other Welfare 882,635 1,278,487 2,161,22 Purchase 2,199,119 2,199,119 Rates Taxes 1,250 212,181 213,431 Travelling Conveyance 901,947 2,092,509 2,994,456 Other expenses 5,680,948 9,003,373 14,684,321 Depreciation 860,643 573,762 1,434,405 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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