TPO to furnish Assessee Info not available in Public domain on which he relied in selecting comparables

ITAT MUMBAI BENCH ‘K’

Wills Processing Services (India) (P.) Ltd.

Versus

Deputy Commissioner of Income-tax

IT Appeal NO. 8772 (MUM.) OF 2010
[ASSESSMENT YEAR 2006-07]

DECEMBER 7, 2012

ORDER

Per Bench.

This is an assessee’s appeal for assessment year 2006-07 against the order of AO u/s 143(3) in pursuance to the directions of the Dispute Resolution Panel-II (DRP) dated 22.09.2010 under section 144C(5) of the I.T. Act on various issues. Assessee has raised detailed grounds on the following issues:

1. Deduction under section 10A of the Act.

2. Reduction of Technical Fees and Satellite Link Charges from Export Turnover (Rs. 17,359,069 & Rs. 20,210,502).

3. Disallowances under section 40(a)(ia) of Rs. 30,55,074.

4. Transfer Pricing Adjustment of Rs. 4,97,24,79 in respect of ITES services rendered by assessee under section 92CA(3) r.w. 92C(3) of the IT Act, 1961.

5. Initiating penalty proceedings under section 271(1)(c) of the Act.

2. We have heard the learned Counsel and the learned DR and perused the paper book filed in two volumes running from page 1 to 764. The learned Counsel also placed a chart summarizing the objections with reference to various issues and relevant pages in the paper book. Learned DR also placed his written submissions issue wise which are considered in this order wherever necessary and applicable.

3. After considering the arguments and examining the record, the grounds are decided as under:

4. Ground No.1 pertains to rejection of claim under section 10A of the Income Tax Act to an extent of Rs. 4,75,07,401. Assessee was originally incorporated on 12.5.1992 as Trinity Computer Processing (P) Ltd which is 99.99% owned subsidiary of Wills Europe BV, a company incorporated in Netherland. Assessee is an Indian provider of IT enabled services (ITES), with its corporate head quarters located at Mumbai. Assessee has rendered IT Enabled Services to Trinity Processing Services Limited (“TPSL”) a company incorporated in England and Wales. Assessee renders services exclusively as a captive service provider to TPSL vide its agreement dated 21 December 2001. ITES include:

♦	Processing of insurance claims, premiums and treaties
♦	Accounting for insurance underwriters and clients
♦	Insurance accounting support services
♦	Data Processing.

5. Assessee has two units one at SEEPZ and another at Vikroli in Mumbai. The unit at Vikroli qualifies for deduction under section 10A of the Act. No separate books were maintained for the units. Since the assessee rendered services only to the TSPL, UK and all its business income is export oriented, claim is that its entire income qualifies for deduction under section 10A of the Act except those that pertains to SEEPZ Unit. Assessee allocates expenditure and income between units in the proportion to the number of employees working in each of the Unit (head count). This method is being followed consistently by assessee every year. The deduction under section 10A was claimed in respect to the net profit earned by the Unit at Vikroli. AO proposed in the draft assessment order disallowance of entire claim under section 10A invoking the sub section-4 and stating that the claim is not in accordance with the provisions of section 10A(4). Without prejudice, it was also considered that the satellite link charges and technical service fees should be excluded from the export turnover while considering the claim of assessee under section 10A. The issue of exclusion of satellite link charges and technical service fees are being agitated in earlier years. However, entire disallowance under section 10A claim was taken up for the first time by AO in this year only. Assessee was claiming deduction in the past six years consistently on the method being followed. Assessee made objection before the DRP and the DRP has noted the following vide Para 3.3:

“We have carefully examined the issue and find that in the earlier years i.e. assessment year 2004-05, the CIT(A) has decided the issue in favour of assessee. However, the Department has not accepted this decision and is before the Hon’ble Mumbai ITAT.

In such circumstances, we are of the view that it will be against the judicial propriety and judicial discipline to intervene in the matter. We therefore, direct AO to finalize the draft assessment order as has been proposed”.

6. AO followed the above direction of the DRP and disallowed the entire deduction under section 10A.

7. It was the submission that disallowance of entire 10A claim was not made in earlier years and the direction of the DRP was not correct. The learned Counsel placed on record the orders of the AYs 2004-05 & 2005-06 on the issue of reworking under section 10A while excluding from the export turnover of satellite link charges and technical service fees (which were agitated in the later grounds) to substantiate that the issue of entire disallowance is not a matter pending before the ITAT. In view of this it was submitted that the direction of the DRP was not correct. Further, it was submitted that the issue of allocation of common expenses between STP and domestic units and method of head count followed by assessee cannot be discarded even though it was not questioned at any time in the past, as was held by the Hon’ble Delhi High Court in the case of CIT v. EHPT India (P.) Ltd [2012] 204 Taxman 639. Relying on the decision it was the submission that AO could not have disallowed the entire deduction rejecting the apportionment on head count. However, it was fairly admitted that assessee was not claiming the deduction on the entire 700 employees in the Vikroli Division and for certain reasons was excluding claim on employees transferred earlier from SEEPZ to Vikroli. Therefore, it would be fair if the deduction is restricted to balance employees out of the claim made.

8. The learned DR however, supported the orders of AO and the DRP.

9. We have considered the issue. AO relied on the provisions of section 10A(4) for disallowing the entire claim under section 10A, which was being allowed in earlier years without any dispute. Provisions of section 10A(4) are as under:

“10A(4): For the purposes of [sub-sections (1) and (1A)], the profits derived from export of articles or things or computer software shall be the amount which bears to the profits of the business of the undertaking, the same proportion as the export turnover in respect of such articles or things or computer software bears to the total turnover of the business carried on by the undertaking”.

9.1 As can be seen, it is only a method provided for arriving at the profits derived from export of articles or things of computer software and assessee has followed head count method for arriving at the export turnover and expenditure for the Vikroli unit in the absence of separate books of account. This is one of the methodologies adopted in arriving at the export turnover and the profits so as to work out the profits of the Units.

9.2 Similar issue was considered by the Hon’ble Delhi High Court in the case of EHPT India (P.) Ltd. (supra) wherein the facts are that the assessee was operating two units, one software Technological Park unit (STP), which was engaged in the development of software and its export, and the other domestic unit (non-STP unit), which was engaged in the implementation of the telecom software for vendors and customers in India. In the returns filed for the years under appeal the assessee computed the profits from the STP unit by apportioning the indirect or common expenses on the basis of the head-count of the employees working in the said unit and the domestic unit and claimed deduction under section 10A in respect of STP unit accordingly. The Assessing Officer, however, took the view that the head count basis of apportionment of common expenses was not appropriate and it resulted in more profits being shown from the STP units. He adopted the basis of turnover of respective units for apportioning the common expenses. As a consequence of re-apportionment, common expenses attributable to the domestic unit came down by Rs. 40 lakhs. The Assessing Officer, therefore, disallowed Rs. 40 lakhs from domestic unit and allocated to STP Unit. On appeal, the Commissioner (Appeals) confirmed the order of the Assessing Officer. On second appeal, the Tribunal upheld methodology adopted by the assessee and deleted the addition made by the Assessing Officer. On further appeal, the Hon’ble Delhi High Court held:

The fate of the appeals must depend upon the answer to the question whether the method adopted by the assessee, namely, that of apportioning the indirect expenses between the STP unit and the non-STP domestic unit on the basis of the ‘head-count’ is an unreasonable method and if it has been followed consistently by the assessee in the past and has also been accepted by the department, should the revenue authorities be permitted to disturb the same in the years under appeal. The settled position in such matters is to examine whether the method which is canvassed for acceptance is the one (a) which has been consistently accepted by both the parties, namely, the assessee and the revenue in the past; (b) which is a reasonable method having regard to the nature of the business and other relevant factors and (c) which does not distort the profits. There is no dispute that the head-count method has been consistently followed and accepted without demur in the past. A departure therefrom is sought to be made only in the years under consideration by the departmental authorities. That it is a reasonable method and fair to both sides is indicated by the conduct of the revenue authorities in accepting it in the past. The reasonableness or fairness of the method of head-count adopted by the assessee can be said to be indicated by the fact that in the assessment year 2002-03 the assessee apportioned more common expenses to the STP unit, thereby reducing its profits and consequently reducing the claim for deduction under section 10A and at the same time offering a higher income in the domestic unit than what would have been offered had the turnover method of apportionment adopted by the Assessing Officer been followed.

It was only as a matter of principle that the Commissioner (Appeals) upheld the method adopted by the Assessing Officer even though the result was in favour of the assessee. Neither the Assessing Officer nor the Commissioner (Appeals) has raised any serious questions about the validity of the head-count method adopted by the assessee nor have they pointed out any commercial accounting principle or accounting standard that repudiates the method. [Para 8]

Section 10A provides for deduction for profits derived from the export of software for a period of ten years. During the period of tax-holiday, it is desirable that the same method of computing the profits of the STP unit is adopted so that any distortion is avoided. It is not to be understood as laying down a proposition that in all cases arising under section 10A, where the question of apportionment of common/indirect expenses between the taxable and the exempt units arises, the head-count method is the most appropriate method. The question will have to depend, in the very nature of things, on the nature of the business and the facts of the particular case. Instant decision is confined to the facts of the present case. In the instant case, there is no finding by the revenue authorities that by adopting the head-count method which was hitherto being accepted by them there was a distortion of the profits nor have they said that the head-count method of accounting is not the correct method of accounting. All that they have said is that in their opinion the turnover basis of apportionment of the expenses is more logical and needs to be applied. In the instant case, the Assessing Officer has accepted the head-count method adopted by the assessee in the past but has rejected it only for the years under appeal. This would disturb or distort the profits. The question whether the head-count method is the most appropriate method has been raised by the Assessing Officer in the course of the assessment proceedings and it has been stated by the assessee that though the turnover basis preferred by the Assessing Officer may be more suited to manufacturing businesses, in the case of service industry such as the assessee’s case the head-count method would be more appropriate to be followed for the purpose of apportioning the indirect expenses. It appears to be a plausible view, though it can possibly also be a debatable view. But merely because there can be more than one method of apportioning the common expenses between the STP and domestic units it cannot be said that the method of head-count followed by the assessee should be discarded, that too mid-way, even though it was not questioned at any time in the past.

The provisions of sub-section (4) of section 10A, relied upon by the Assessing Officer, apply for the purpose of segregating the profits of the business into export profits and domestic profits. It is a statutory formula for ascertaining what are profits derived from the export of the eligible items. It has to be read with sub-section (1). It says that the export profits have to be apportioned on the basis of the ratio which the export turnover bears to the total turnover of all the businesses of the eligible undertaking. The instant case is not concerned with sub-section (4). That sub-section will apply when the combined profits – profits of the exempt unit and those of the non-exempt unit – have been ascertained; the next step will be to apportion them on the basis of the ratio which the export turnover bears to the total turnover. Instant case is concerned with the stage before that. Instant case is concerned with the method by which the indirect or common expenses – expenses which are incurred for both the exempt and taxable units – are to be apportioned between the two units. To apply the formula prescribed in sub-section (4) may be appropriate in a given case considering its peculiar facts. But applying the same formula to all cases of apportionment without having regard to the history of assessments and other relevant factors may not be justified.

In a case where alternative methods of apportionment of the expenses are recognized and there is no statutory or fixed formula, the endeavour can only be towards approximation without any great precision or exactness. If such is the endeavour, it can hardly be said that there is an attempt to distort the profits. On the contrary, distortion of profits may arise if the consistently adopted and accepted method of apportionment is sought to be disturbed in a few years, especially in a case such as the instant one where the deduction under section 10A is available over a period of ten years and only in some years the method of apportionment of income is disturbed. In other words, there is no ‘just cause’ made out for abandoning the past method.

The appeal filed by the revenue is accordingly dismissed.

9.3 Respectfully following the above principles laid down, we are of the opinion that there is no need to disturb the method of apportionment of expenditure and turnover which were accepted by AO in earlier years. Assessee is eligible for deduction under section 10A and the reason for disallowing entire claim cannot be accepted. Even the DRP was not correct in rejecting the assessee objection stating that the issue is pending before the ITAT, the fact of which is not correct. However, in the anxiety of disallowing the entire claim, AO has not examined the apportionment of export turnover and expenses of units. Therefore, as this aspect was not examined by AO, for examination of the actual apportionment and arriving at the profits of the units the matter is restored to the file of AO. AO is free to examine the issue of deriving at the profits of eligible unit. While considering, the submissions with reference to the non-claiming of deduction on employees transferred from SEEPZ to Vikroli should also be examined. Assessee should be given due opportunity. We make it clear that the deduction of claim under section 10A is eligible on Vikroli unit and AO is only directed to examine the quantum of deduction. This quantum of deduction may also depend on the issues in other grounds which are dealt with later. The ground No.1 is considered allowed.

10. Ground No.2 is on the issue of reduction of technical fees and satellite link charges from export turnover. AO while rejecting the entire claim of section 10A however alternately also reduced the technical fees and satellite link charges of Rs. 1,73,59,069 and Rs. 2,02,10,562 respectively from export turnover for the purpose of computing the deduction under section 10A thereby restricting the computation under section 10A. As stated in Ground No.1, the DRP declined to interfere as the matter was pending before the ITAT on this issue.

11. The DRP was not correct fully as the issue on ‘technical fees’ was not pending before the ITAT as the Revenue seems to have accepted the decision of the CIT(A) in AY 2004-05 and 2005-06. There is only an appeal on the issue of ‘satellite charges’. Be that as it may, the issue arises as under. Assessee processes raw data received from TPSL UK and sends them back to UK via computers. To ensure consistent delivery of the above mentioned services, TPSL is providing training of employees to assessee in India for implementation of new process and changes to the existing process. In view of the services rendered by TPSL UK assessee made payment of technical fees to TPSL, UK. At the time of making payment, it was the submission of assessee that the reduction of expenditure incurred in respect of technical fees in foreign exchange from export turnover arises only when assessee provides technical services outside India. Relying on the explanation to Clause-4 of section 10A, it was the submission that the entire processing of data takes place in India and therefore, there is no need to exclude the technical service fees. The learned CIT(A) in assessment year 2004-05 examined this issue elaborately and gave an opportunity to AO. After considering the report of AO and the facts of the case, the CIT(A) deleted the said adjustment made to the export turnover holding as under:

“6.2 However, the submissions relating to technical fees are found to be having some force and merit in view of the fact that for excluding the expenses relating to technical services from the export turnover as per above definition the conditions required to be fulfilled are that the expenses, if any, has been incurred in foreign exchange in providing technical services outside India. As the claim of the appellant that the technical services were not provided outside India is found to be factually correct, therefore, the expenses relating to technical services is not required to be deducted. Accordingly AO is directed not to deduct this amount from the export turnover. To this extent the appellant gets relief. Therefore, Ground No.1 is partly allowed in favour of the appellant”.

Following the above findings in assessment year 2004-05 which the Revenue accepted, the CIT(A) in assessment year 2005-06 also deleted the same. Even in AY 2005-06 there is no appeal by the Revenue to ITAT. Therefore, since the issue was already held in favour of assessee on facts, we are of the opinion that the principles of judicial consistency require that AO should not have excluded the amount from the export turnover. The DRP also was not correct in rejecting the issue. In view of this, we allow the ground raised by assessee on this issue of expenses for ‘technical services’.

11.1 The other amount involved in Ground No.2 is with reference to the ‘satellite expenses’. AO excluded this amount also to arrive at the export turnover as defined under section 10A(4). After considering the submissions in assessment year 2004-05, the ITAT in ITA No.4329/Mum/08 held in favour of assessee as under:

“7. However, while completing the assessment the A.O. treated the above satellite link charges as part of telecommunication charges. This issue was discussed elaborately by the Coordinate Bench in the case of Patni Telecom (P.) Ltd. v. ITO (wherein one of us, the J.M. was a member) 22 SOT 26 (Hyd) wherein on similar facts the issue was considered with reference to export turnover as defined in clause (iv) of section 10A and held as under: –

“Export turnover has been defined in clause (iv) of the Explanation 2 to section 10A. The meaning of ‘export turnover’ is also provided in other sections of the Act, say clause (c) of section 80HHE and Explanation (b) to section 80HHC. According to Explanation (b) to section 80HHC, export turnover means the sale proceeds receivable in foreign exchange as per sub-section 2(a) of section 80HHC of all goods which are exported out of India, but which does not include freight and insurance. Similarly, total turnover for the purpose of deduction under section 80HHC, which is defined in Explanation (ba) at the end of section 80HHC in the negative term, means as not including freight and insurance attributable to transport of goods or merchandise beyond the custom station and profit on sale of licence, cash assistance, duty drawback, etc. Thus, the term ‘export turnover’ does not include freight and insurance attributable to transport. Explanation (c) to section 80HHE is similar to clause (iv) of Explanation 2 to section 10A.

On an analysis of definition of ‘export turnover’ as provided in clause (iv) of the Explanation 2 to section 10A, it is clear that for the purpose of not including in the consideration received in or brought into India in convertible foreign exchange there are two types of expenditures. The first type of expenditure is freight, telecommunication charges, or insurance attributable to the delivery of article or thing or computer software out of India. The second type of expenditure is expenditure, if any, incurred in foreign exchange in providing technical services outside India. The basic idea or intention for deducting the first type of expenditure, i.e. freight, telecommunication charges, or insurance charges is that delivery of goods should be Free on Board (FoB). The CBDT vide its Circular No. 564, dated 5-7-1990 clarified this aspect in respect of deduction under section 80HHC. On the basis of the above discussion, it can be said that only those freight, communication charges of insurance attributable to delivery of goods out of India are to be considered while reducing from consideration received in convertible foreign exchange. Thus, if such expenses are not attributable to delivery of goods outside India, such expenses are not required to be deducted from the consideration. Normally, in a transaction of purchase and sale, there are two types of conditions between the parties. One is where price quoted of goods is inclusive of all expenses or in other words price quoted is only in respect of goods. Another condition is where price of goods and charges of expenses are separately stated. In a case where such expenses are to be separately charged, invoices are prepared showing value of the goods and such expenses. If the quoted price is inclusive of such expenses, then consolidated value of the goods is only mentioned in the invoice. In a case where only value of goods is quoted, expense is borne by the supplier. In cases where expenses have not been separately charged, the convertible foreign exchange received is consideration of the goods only. Where such expenses are separately charged in the invoices, the consideration received in convertible foreign exchange includes the value of the goods and such expenses. If the consideration received is only against the goods, then there is no need to deduct such expenses from the consideration received in convertible foreign exchange. In case where such expenses are separately charged, the expenses are required to be reduced from the consideration received for the purpose of arriving at the export turnover. The logic and reason behind this have been explained by the CBDT vide its Circular No. 564, dated 5-7-1990, that the delivery of the goods should be Free on Board (FoB). The goods exported at FOB is important in the sense that deduction under section 10A is permissible only in respect of consideration received against goods and not for the consideration received against freight, etc. All the assessees should get deduction under section 10A on consideration received against supply of goods at FoB. Therefore, the condition of delivery of goods at FoB has been put and the definition of ‘export turnover’ as provided in clause (iv) of the Explanation 2 to section 10A is required to be interpreted accordingly.

In the instant case, the Assessing Officer had deducted the ISP expenses from foreign exchange consideration treating it as communication charges. The said expenditure on ‘Internet Service Provider (ISP)’ does not come within the scope of telecommunication charges as provided in clause (iv) of Explanation 2 to section 10A, because ISP is for transmitting the data, i.e., software developed by the assessee. The ISP expenses incurred were in respect of development of software, i.e., goods. The ISP expenses were not attributable to the delivery of computer software, outside India and, therefore, such expenses need not be excluded from consideration in foreign exchange. However, if for the sake of arguments it was presumed that the expenditure incurred was attributable to delivery of goods outside India even though same was not to be excluded. The words ‘received’ and ‘but not include’ used in clause (iv) of Explanation 2 to section 10A are significant. What is to be excluded is out of what is received. In the instant case, the assessee received consideration against software, i.e., goods. For this purpose, the assessee had demonstrated by referring to invoices and agreement. The agreement, invoices and the turnover clearly showed that the assessee did not recover any such expenditure. Therefore, there was no scope for any exclusion from the export turnover on account of such expenses. If at all on presumption, it was to be excluded for the purpose of ‘export turnover’, then on the same assumption, reason and analogy it should be excluded from ‘total turnover’. Therefore, the Assessing Officer was not correct in excluding ISP expenses from consideration received in convertible foreign exchange while calculating export turnover for the purpose of section 10A.”

8. The ISP expenses considered in the above said decision are similar to the satellite link charges paid by the assessee. As seen from the bills placed on record before the authorities the assessee has paid satellite link charges to VSNL, MTNL and also to Software Technology Park India (STPI) towards bi-monthly half circuit charges/international half circuit charges and rent for TMI – Frame Relay CCT charges including port charges. The port charges, however, were calculated on the basis of USD per annum basis where as rest of the charges were paid on annual lease agreement periodically and these are fixed charges not connected with the delivery attributable to the export of goods. Even though the assessee has utilized the satellite link for receiving data and also for transferring data this cannot be considered as telecommunication charges for delivery of goods on FOB basis. Not only that what the assessee was getting was a fixed service charge for processing data from the foreign company, Trinity Processing Services Ltd. on a monthly basis in terms of the agreement dated 16th October 2001. There are no separate charges recovered from the foreign company towards telecommunication charges which can be considered as amount recovered in foreign exchange from the foreign party. Since no such amount is recovered or included in the turnover, question of exclusion from the export turnover also does not arise on the facts of the case.

9. Assessee has made an alternate contention that the satellite link charges, in case they are considered as telecommunication charges this should also be excluded from the total turnover as considered by the Special bench in the case of ITO vs. Sak Soft Ltd. 313 ITR 353 (AT)(SB) wherein it was held that parity to be maintained with export turnover to that of total turnover and where expenses on telecommunication charges or insurance attributable to delivery of articles or things or computer software outside India or expenses incurred in foreign exchange in providing technical services outside India required to be excluded from export turnover, they are also to be excluded from total turnover. Since we have considered that the satellite link charges cannot be considered as telecommunication charges to be excluded as per the definition of export turnover there is no need to consider the alternate contention. Accordingly, this alternate ground raised is not considered as it becomes academic in nature.

10. After considering the facts of the case and the principles established by the Coordinate bench in the case of Patni Telecommunication (P) Ltd. v. ITO 22 SOT 26 (Hyd), it is held that the expenses on satellite link charges does not come within the scope of ‘telecommunication charges’ as provided in clause (iv) of Explanation 2 to section 10A and accordingly, the A.O. is directed not to exclude the same from export turnover. A.O. is directed to recalculate the deduction under section 10A. Assessee’s grounds are considered allowed”.

11.2 As seen from the order of the CIT(A) in assessment year 2005-06, it is noticed that the CIT(A) has followed the above order of the ITAT while giving relief on ‘satellite charges’. In view of the order of the ITAT in assessment year 2004-05, we hold that the satellite charges cannot be considered as ‘telecommunication charges’ so as to exclude from the export turnover. We accordingly uphold assessee’s grievance on this issue. Ground No.2 is allowed.

12. Assessee however, raised an alternate ground without prejudice to the above ground no.2 that the technical fees and satellite link charges should also be excluded from the total turnover in case they were to be excluded from the export turnover. There is merit in the argument and is also covered in favour of assessee by various judicial pronouncements. However, in view of the reasoning given above for not excluding the above amounts from the export turnover, there is no need to consider this alternate contention as it becomes an academic issue. Accordingly the alternate contention is rejected.

13. Ground No.3 is on the issue of disallowance under section 40(a)(ia) on the payments made to Equant Network Services Ltd which in the opinion of AO is in the nature of ‘fees for technical services’ and therefore, liable for tax to be deducted at source. Since assessee was not deducting tax, the same was disallowed under section 40(a)(ia). When this disallowance was proposed assessee submitted that the CIT(A) has already adjudicated the issue in his order passed under section 250 r.w. rule 201 & 20(1)A of the Act that the payment made to Equant is neither royalty nor fees for technical services. On the reason that the Department has not accepted the decision and is pending before the ITAT, the DRP did not interfere and directed AO to finalise the draft assessment order as proposed. It was submitted that this issue was already decided by the ITAT in ITA No.5129/Mum/09, dated 31.5.2011 wherein after elaborate discussion running to pages 13, the ITAT held that the payments are not liable for deduction of tax at source. The conclusion by the ITAT vide Para No.11 is as under:

“11. As already noted by us, the payments made by the assessee in the present case to Equant in connection with the satellite link charges were for the use of standard facility which did not involve use or right to use the channel of communication.Equant was providing multipoint data connectivity services to the assessee to facilitate data communication with its clients belonging to Willis group having their offices at Ipswich, UK and Nashville, USA. The intention of the assessee company was to avail connectivity services and it was not concerned as to which equipments were used to provide such connectivity services. The assessee had no right to access the equipments forming part of communication channel except for data communication and transmission. The assessee had no control over the said equipments or physical access to it. There is nothing to show positive act of utilization, application or employment of equipment for the desired purpose. The assessee could not come face to face with the equipments, operate it or control its functions in some manner. It had no possessory rights in relation to the said equipments. It only took advantage of a facility of use of sophisticated equipment installed and provided by the service provider. Having regard to all these facts of the case and keeping in view the decisions of Authority for Advanced Ruling (AAR) in the cases of ISRO Satellite Centre (supra) and Dell International Services (India) P. Ltd. (supra), we are of the view that the payment made by the assessee to Equant in connection with standard communication services made available to anyone who is willing to pay was not in the nature of royalty but the same was in the nature of business profit and in the absence of any P.E. of Equant in India, it was not chargeable to tax in India. The assessee thus was not liable to deduct tax at source from the payment made to Equant for such services and it, therefore, could not be treated as assessee in default u/s 201(1) and interest u/s 201(1A) also could not be charged as rightly held by the learned CIT(Appeals). We, therefore, uphold the impugned order of the learned CIT(A) on this issue and dismiss this appeal filed by the Revenue.”

Since this issue was crystallized by the order of the ITAT in the same assessment year, we are of the opinion that the disallowance under section 40(a)(ia) does not arise, as there is no need to deduct tax on the above amount paid to Equant Network Services Ltd. Accordingly the disallowance made by AO stands deleted. Ground No.3 is allowed.

14. Ground No.4 pertains to the issue of Transfer Pricing adjustment made by AO. As assessee has transactions with AE being 100% service provider to the principal company, the matter was referred to the TPO for determination of arms length price of the ‘international transactions’. It was submitted that assessee is getting reimbursed at cost plus 10% basis. In the TP study, assessee has conducted a search to identify a group of independent comparable companies with publicly available data that are broadly comparable to the functions performed by assessee. Based on this methodology few companies were considered as comparables in the transfer pricing study.

15. The search was conducted by assessee using on the following spectrum of services:

♦ PROWESS

• Computer Software

• Software services and consultancy and

• IT enabled/BPO

♦ CAPITALINE

• Computer (Medium and Small);

• Computer (large) and

• IT enabled/BPO

Below are the comparables selected by assessee in its transfer pricing report and its cost plus margin considering the financial data for year ended 31 March, 2006.

S.No	Name of the comparable company	Cost plus (%)
1	Allsec Technologies Ltd	28.73
2	CrisilMarketwire Ltd	-18.34
3	Newgen Software Technologies Ltd	NA
4	Transworks Information Services Ltd	19.62
5	Trigent Software Ltd	NA
6	VJIL Consulting Ltd	6.36
7	Visualsoft Technologies Ltd	12.70
8	ICRA Online Ltd	10.49
9	Maars Software International Limited	10.83
10	MYM Technologies Limited	33.72
	Average	13.01

16. Assessee and the TPO are in agreement as to the method applied and the PLI used to benchmark the transactions. However, the TPO has rejected most of the comparables selected by assessee in its transfer pricing study on various reasons. Out of the ten companies taken by assessee as comparable, the TPO rejected eight comparables. Further the TPO has applied certain quantitative filters which are not acceptable to assessee. Some of the filters adopted by the TPO are the rejection of companies having financial year data other than pertaining to year ending 31.3.2006, the rejection of companies that have export earnings lesser than 25% of the operating sales and rejection of companies with related party transactions greater than 25% of the operating sales. The TPO selected new comparables after obtaining information under section 133(6) and has taken 11 companies as comparables which were objected by assessee. After making adjustments for working capital and rejecting the risk adjustment claims, the TPO vide his order determined the ALP after arriving at the mark up as per comparables at 22.50%. On a total cost incurred by assessee on back office services at Rs. 41,79,98,644, the ALP was determined at Rs. 9,40,49,695 and as assessee has received less than this there was an addition of Rs. 497,24,794 as an adjustment. Since this amount was more than +/- 5% in terms of proviso to section 92C(4), assessee’s contention on deduction of standard amount was also rejected.

17. Further, for working capital adjustment assessee has worked at 2.05% whereas the TPO arrived at 1.50%. Assessee also asked for risk adjustment which AO has rejected. The revised margin of comparable considered by the TPO was contested to be at 17.45% and assessee submitted that it satisfy the proviso to section 92C and is within +/- 5% range. The DRP agreed with TPO on rejection of comparable selected by assessee and the adoption of new comparable which assessee objected, as valid. Further considering the additions made, the DRP also did not accept assessee’s contention about +/- 5% range. With reference to the working capital and risk adjustment the DRP agreed with the TPO’s observation. Therefore, assessee is aggrieved on the addition so made at Rs. 4.97 crores.

18. The learned Counsel placed his arguments on four main propositions under the following heads:

(i) Wrong comparable companies selected by the TPO and confirmed by the DRP.

(ii) Erroneous rejection of assessee’s comparable companies.

(iii) No adjustment on risk provided by the TPO

(iv) Adjustment on working capital wrongly computed by the TPO.

19. On the issue of wrong comparables selected by the TPO, the learned Counsel made detailed submissions with reference to abnormal high percentage of income, functional profiles being different, information obtained under section 133(6) not being provided to assessee and some of the data not available in public domain and referred to the detailed submissions made to the DRP on various objections and also before the TPO. It was his submission that the TPO has made wrong selection of comparables without considering assessee’s objections and neither the TPO nor the DRP has commented upon various objections raised by assessee. In some of the cases, it was his submission that the TPO’s own filters were not being followed. The detailed submissions are as under: (Objections raised before TPO & DRP).

1. Vishal Information Technologies Ltd. OP/TC as calculated by TPO is 48.03%.

(a) Difference in functional profile. The company is engaged in providing solutions to the print production industry with services like e-publishing, e-book, print on demand, data and document management, data conversion, digital library management etc. Hence it is functionally not comparable to assessee.

(b) Abnormal profits: As per the margins computed by the Transfer Pricing Officer in the notice dated 15-09-2009, the margin earned by the company is 48.03% which is abnormally high. Hence the company ought to be rejected as a comparable from the ambit of comparable companies.

(c) Employees Cost Criteria: The employee cost as a percentage of revenue stands at 1.49% whereas the threshold limit fixed for the acceptance of a company as a comparable under this criterion is for the employee costs to be at least 25% of the revenue.

(d) Difference in quantitative screening: Following criteria can be considered for rejecting this company:

(i) Wages/Total Cost % – 2.35%

Assessee has a wages to total cost ratio of 2.35%. Hence the above company cannot be selected as comparable.

2. Asit C Mehta Financial Services Ltd (formerly Nucleus Net Soft & GIS India Ltd) (OP/TC calculated by TPO – 34.52%):

(a) Difference in functional profile: The company is primarily engaged in providing services such as GIS (Geological Information System); Data Conversion from any format to a GIS/Spatial format; Processing of aerial and satellite imagery; Navigation and fleet management solutions.

(b) Restructuring Exercise: Nucleus Securities Ltd, a company providing portfolio management services amalgamated with Nucleus Net soft & GIS India Ltd during the year and hence the results of the company may have been influenced on account of such restructuring.

(c) Non-availability of Data: The TPO himself whilst formulating the search criteria has rejected the company on account of paucity of data. The search criteria matrix clearly evidences this fact. Hence it is submitted that on the basis of non availability of segmental information, the company ought not to be considered as a comparable company.

(d) Presence of intangibles: An analysis of the fixed assets schedule of the company for the financial year ended 31st March, 2006 reveals the existence of an intangible asset designated as “PMS Intangibles”.

(e) Non-availability of segmental data: The company operates in the following segments:

(1) Information Technology Service

(2) Information Technology Enabled services;

(3) Portfolio Management services and segmental data was not available.

3. Goldstone Infratech Ltd (OP/TC calculated by TPO – 29.01%):

(a) Functionally different: The company is primarily involved in the provision of software development and related services comprising both onsite and offshore operations. The company is also involved in the business of media and IPTV.

(b) Use of secret information: Recourse to issuance of notice under section 133(6) of the Act.

(c) Forex Earnings > 25% of sales to be accepted. The company further has forex earnings of 0.12% which is less than the criteria adopted by the Transfer Pricing Officer, hence the company does not satisfy the filter and cannot be considered for further analysis.

(d) Diminishing revenues: The revenue of the company pertains to the BPO segment are declining year-on-year. The revenue for the financial year 2006 has declined by 16% as compared to the financial year 2005.

(e) Employee Cost Criteria: The employee cost as a percentage of revenue stands at 8.93% whereas the threshold limit fixed for the acceptance of a company as a comparable under this criterion is for the employee costs to be at least 25% of the revenues.

4. DatamaticsFinancials Services Ltd (OP/TC calculated by TPO = 24.99%):

(a) Segmental information: The revenues derived from the ITES activities comprise 28.04% of the total revenues.

(b) Use of secret information: Recourse to issuance of notice under section 133(6) of the Act.

5. Maple eSolutions Ltd (OP/TC calculated by TPO = 32.66%) :

(a) Abnormal profits: As per the margins computed by the TPO in the notice, the margin earned by Maple esolutions is 32.66% which is abnormally high. In view of the decision of the Delhi Tribunal in case of Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 109 ITD 101, the Pune Tribunal in case of E-Gain Communication (P.) Ltd. v. ITO [2009] 118 ITD 243 and the OECD guidelines, assessee requested the TPO to exclude the company as a comparable to assessee. Hence the above company cannot be selected as comparable.

6. Apex Knowledge Solutions Pvt. Ltd (OP/TC calculated by TPO = 20.48%)

(a) Business in diversified segments: The company’s business is into diversified segments such as Engineering solution, Technology products, Content solution. Hence the same is not functionally comparable to the activity undertaken by assessee, as assessee does not perform engineering or technology activities.

(b) Forex earnings to revenue criteria: The company, it is submitted by assessee does not pass the export earnings as a % of revenue criteria. The export earnings as a percentage of revenue is less than 25% whereas the threshold limit fixed for the acceptance of a company as a comparable under this criterion is for the earnings to be at least 25% of the revenues.

(c) Use of secret information: Recourse to issuance of notice under section 133(6) of the Act.

7. Spanco Ltd (Earlier known as SpancoTelesystems& Solutions Ltd) (OP/TC calculated by TPO = 20.86%):

(A) Use of secret information: Recourse to issuance of notice under section 133(6) of the Act.

(B) Difference in quantitative filters:

(a) ITES revenue < 75% of total operating revenues to be rejected.

(b) Forex Earnings > 25% of sales to be accepted. The company further has forex earnings of 23% which is less than the criteria adopted by the TPO, hence the company does not satisfy the filter and cannot be considered for further analysis.

(c) Fluctuation in revenues: The company has wildly fluctuating year-on-year revenues. Further, the company has a CAGR of 80.77% for 2 year period of 2004-06. The extraordinary variations in profitability are indicators of several abnormal business factors which are not apparent from the annual report or even from the responses received in pursuance of the notices issued under section 133(6) of the Act. Therefore, the said companies ought to be rejected.

Balance companies are objected on the basis of secret information so assessee could not make detailed submissions.

20. On the issue of rejecting the comparables selected by assessee, even though assessee is able to demonstrate that the selection of comparables by it are as per the parameters, AO rejected on some reasons which are not acceptable to assessee. The detailed submissions on this are as under case-wise:

a. Crisil Marketwire Ltd: It offers news items daily, including breaking news, analysis, statistics, forecasts, calendars and summarizes data and analytics on the Indian financial market. The company is engaged in the business of real-time financial news market. Assessee contends that the said company is engaged in the activity of data processing which is identical to the activity undertaken by assessee. Since the comparable’s activity is identical to those carried out by assessee, it is the substance which needs to be considered and not the form. Thus, the Transfer Pricing Officer erred in rejecting the said comparable company and the same needs to be accepted.

b. Newgen Software Technologies Ltd: A Software company, data for the year ended March 2006 not available. Assessee would like to state that the company has its own website i.e. “www.newgensoft.com” wherein complete details relating to the functions performed by the company has been mentioned which includes workflow automation, document management, imaging, report archival and distribution. Consequently, the said company is functionally similar to the activity undertaken by assessee via,, data processing as is already mentioned above and hence ought to be considered as a comparable company. Further, assessee also contends that the Transfer Pricing Officer ought to consider that the Act and the Rules, which provide that while conducting the comparability analysis, the data to be used should be contemporaneous. Rule 10B(4) casts an obligation on the taxpayer to conduct the comparability analysis using data for the relevant financial year. However, Rule 10D(4) makes it mandatory for the taxpayer to ensure data that exists by the time specified under the Act, i.e. 31st October of the relevant assessment year. Further, Rule 10C(2)(c) also clarifies that availability of data is a significant factor in conducting a comparability analysis, whether it relates to selection of the most appropriate method or arriving at a set of comparables or computing the margins of such comparables. In other words, if data for a particular comparable company for financial year 2005-06 was not available as on 31 October 2006 (i.e. the specified date) the same cannot be used for conducting the comparability analysis. In view of the above, the stand of rejecting the company on account of unavailability of data for the year ended March 2006 is baseless since the law provides for considering any information which is publically available.

c. Trigent Software Ltd. A Software Company. Assessee would like to state that the company has its own website i.e. “www.trigent.com” wherein complete details relating to the functions performed by the company has been mentioned. The company is engaged in offshore development, maintenance, support and outsourcing. Its services include business analysis, requirement gathering, design, development, maintenance and support services. Assessee contends that the said company is engaged in the activity of support services which is identical to the activity undertaken by assessee. Since the comparable’s activity is identical to those carried out by assessee, it is the substance which needs to be considered and not the form. Thus, the TPO erred in rejecting the said comparable company and the same needs to be accepted.

d. VJIL Consulting Ltd. Company is engaged in the business of Systems Software, student training. Assessee would like to state that the company has its own website i.e. “www.vjil.com” wherein complete details relating to the functions performed by the company has been mentioned. The company is engaged in providing enterprise information management, enterprises integration services and data warehousing services. It delivers a range of contract centre and data processing solutions to the market research, e learning, debt management, insurance and other sectors. Assessee contends that the said company is engaged in the activity of data processing which is identical to the activity undertaken by assessee. Since the comparable’s activity is identical to those carried out by assessee, the TPO erred in rejecting the said comparable company and the same needs to be accepted.

e. Visualsoft Technologies Ltd. Loss making company. The company should be accepted as it satisfies all other filters. Further, the TPO is not correct in rejecting the company due to losses as the company is showing profits for all the three years that is FY 2003-04, 2004-05 and 2005-06.

f. ICRA Online Ltd. Company is engaged in information products and services and services BPO services catering to Mutual Fund houses in India has related party transaction (RPT). The RPT for the company is 0.07 crores and the turnover is 10.75 crores which constitutes only 0.65% of the turnover. Consequently, assessee contends that the stand taken by the TPO in stating that the company has significant related party transactions is incorrect. Under the circumstances, the said company ought to be accepted.

g. Maars Software International Ltd. Software Company. Assessee would like to state that the company has its own website i.e. “www.maars-soft.com” where complete details relating to the functions performed by the company has been mentioned. The company is engaged in software consultancy with capabilities in application integration and enterprise systems. Assessee contends that the said company is engaged in the activity which is identical to the activity undertaken by assessee. Further the TPO himself has selected R Systems International Ltd which has software consultancy revenue. Thus the TPO erred in rejecting the said comparable company and the same needs to be accepted.

h. MYM Technologies Ltd. Software company: Assessee would like to state that the company has its own website i.e. “www.mymtechnologies.com” where complete details relating to the functions performed by the company has been mentioned. The company is engaged in providing business solutions including business/system analysis requirement gathering and documentation, evaluation and selection of technologies to host, develop and maintain applications, prescriptive consultancy through proven design patterns and frameworks. Since the comparable’s activity is identical to those carried out by assessee, it is the substance which needs to be considered and not the form. Thus, the TPO erred in rejecting the said comparable company and the same needs to be accepted.

20.1 With reference to the working capital adjustment it was submission that the TPO has wrongly considered the working capital adjustment at 1.5% whereas assessee’s working it was 2.05%. There is no explanation for arriving at that amount.

21. With reference to the complete denial of risk adjustment, the learned Counsel countered all the arguments raised by the TPO in the order with reference to market risk, single customer risk, capital risk etc., to submit that AO’s observations per se are not correct according to his own order and made detailed submissions on claim of risk adjustment. It was his contention that AO should have considered the risk adjustment. He referred to the submissions made before the DRP in the objections placed in the paper book from Page Nos. 549 to 552 rebutting each of the items considered by the TPO in the order. It was the learned Counsel’s submissions that even though assessee has filed detailed objections before the TPO with reference to selection of comparables and also elaborately contesting each of the case before the DRP, neither of the authorities discussed issue-wise objections raised by assessee.

22. Further it was submitted that the information obtained under section 133(6) has never been furnished to assessee, which make it ‘secret information’. Therefore, assessee is not in a position to either give consent or reject the comparables selected by TPO. Since most of the information obtained was not in public domain and the information was not provided to assessee, assessee is objecting to the selection of comparables per se.

23. The learned CIT DR in his reply submitted that the TPO has made elaborate study and arrived at adjustment and supported the action of the TPO by giving the following submissions issue-wise.

(A) Why the comparables selected by the TPO should not be rejected.

	S.No	Name of the company	Objection
	1	Ace Software Exports Ltd	No oral objections were raised
	2	Allsec Technology Ltd	This was used by assessee also.
	3	Apex Knowledge Solutions Pvt. Ltd	Oral objections as to:

(i) Export earnings

(ii) Issue of 133(6)

4

Asit C. Mehta (Nucleus Netsoft)Oral objections as to;

 

(i) Abnormally high margin

(ii) Functional profile

(iii) Restructuring

(iv) Related party transaction

(v) Fluctuating margins

(vi) Development of software

5

Cosmic Global (Seg)No oral objections were raised

6

Datamatics Financial (seg)Oral objection as to the use of segmental data which was obtained under section 133(6) of the Act.

7

Flextronics Software (Seg.)Oral objections on the issue of 133(6) of the Act.

8

Goldstone Infratech (seg)Oral objections as to

 

(i) Issue of 133(6)

(ii) Difference in functional profile

(iii) Export earning

(iv) Abnormal profits

9

Maple E-solution LtdOral objection of abnormally high margin was taken. However, before the DRP no such specific or general objection was taken by assessee. Reference may be made to the paper book Vol. II Page 447.

10

R Systems International (Seg)Oral objections on the issue of 133(6) of the Act.

11

Spanco Limited (Seg.)Oral objections on the issue of 133(6) of the Act.

12

Transworks Information Services LtdThis was used by assessee also.

13

Vishal Information Technologies LtdOral objections as to:

 

(i) Abnormally high margin

(ii) Functional profile

(iii) Wage to cost ratio

 

(B) The Learned CIT DR has furnished detailed arguments on various objections under the following heads:

“1. Use of comparables with “Abnormally high margin.”

2. Difference in functional profile.

3. Export earnings less than 25% in the case of Apex Knowledge Solutions (P.) Ltd. and Goldstone Infratech (Seg).

4. Related party transactions

5. Wages to cost ratio in the case of Vishal Information Technologies Limited

6. A major objection of the assessee which is applicable to some of the above comparables is”

“collection of information by issue of 133(6) of the Act”.

1. Comparables earning Super Normal Profit

The taxpayer’s main argument is that the comparables should be rejected on the ground that it is earning super-profits.

♦ Firstly, the assessee did not give the basis on which it came to the conclusion that the company earned super profits.

♦ Secondly, the assessee did not point out any peculiar economic circumstances that led to its so-called high profitability.

♦ Thirdly, the TPO has also not found any peculiar economic circumstances that occurred during the current financial year based on the information available with him.

♦ Thus the company cannot be excluded only based on the profitability.

♦ In the same analogy, the taxpayer should also have argued for low margin companies, which earned margins much below the industry average. But, it did not argue on such lines for rejecting low margin companies on the same analogy.

♦ The TPO has selected the companies on the basis of FAR and not on the basis of margins of any of the companies. The assessee has not pointed out any defect in the comparability of such companies accept that these companies have super normal profit.

♦ The ITAT In the case of M/s. Exxon Mobile Company India Pvt Ltd in ITA No.83111 Mum. 12010 as reported in (2011-TII-68-Mum-TP) has held as under:

Para 33(XI) “In other words, as a general principle, both loss making unit and high profit making unit cannot be eliminated from the comparables unless, there are (specific reasons for eliminating the same which is other than the general reason that a comparable has incurred loss or has made abnormal profits.”

♦ A copy of the relevant pages of the OECD guidelines on this issue is also enclosed herewith.

2. Difference in Functional Profile

♦ In the accept/reject matrix, it is seen that verticals of IT enabled industry was not a criteria for rejection/acceptance of a company as a comparable. The companies engaged in IT enabled services were treated as comparables irrespective of the verticals (industries to which it caters)/horizontals (functional lines like back office operations, medical transcription etc).

♦ It is clear from the search strategy depicted in the TP report that the taxpayer searched for comparables which are engaged in IT enabled services immaterial of the vertical/functional or service line in which the company is engaged.

♦ Vertical is the industry segment like Banking, Finance, Insurance, Health care, Retail, Insurance etc to which the services of the company cater to.

♦ The functional or service lines may include but not limited to Back Office operations, Call centers, Content development or animation; Data processing; Engineering and design; Geographic Information System services, Human Resources services; Insurance Claim Processing; Legal databases; Medical Transcription; Payroll; Remote Maintenance; Revenue accounting; Support Centers, and Web site services.

♦ Thus the TPO also did not go into verticals/functional or service lines of the comparable companies. The main search strategy is to identify the companies which are engaged in the IT enabled services or activity.

♦ place reliance on the decision of ITA T Delhi in the case of Act is Advisors Pvt. Limited in ITA No. 5277/De1l2011 and ITA No. 958/De1l2012. Kind reference may be made to Page 44-46 of this order.

3. Export earnings less than 25% in the case of Apex Knowledge Solutions P. Ltd. and Goldstone Infratech (Seg).

* Copy of the relevant pages of the Apex Knowledge Solutions P. Limited is attached herewith. It can be seen from the schedule no. 13 that 100% of the revenue is derived from the exports.

* In the case of Goldstone Infratech (Seg), I rely on the TPO’s order.

4. Related party transactions

* place reliance on the decision of IT A T Delhi in the case of Actis Advisors Pvt. Limited in ITA No. 5277/De1l2011 and ITA No. 958/De1l2012. Kind reference may be made to Page 36-40 of this order.

5. Wages to Cost Ratio

It has been argued that in the case of Vishal Information Technologies Limited, the wages to cost ratio is only 2.35%.

♦ The TPO has not applied filter of wages to sales while selecting the comparables. Hence the low wages to sales does not make any difference.

6. Objections on the issue of 133(6) of the Act

1. The Transfer Pricing Officer collected information about the comparable cases using the powers u/s 133(6) of the IT Act. Such information which was to be used in the case of the assessee was provided to the assessee during the course of the proceedings u/s 92 of the IT Act (before the passing the order u/s 92CA(3) of the IT Act). The assessee has received the information either through a show cause notice or during the course of the proceedings before the TPO. Various objections have been raised by the assessee before the TPO and the DRP on this issue. The issues to be decided by the Honorable ITAT under the facts and circumstances of this case is as to whether the TPO was right in using the powers u/s 133(6) of the IT Act and while doing so has he violated the principles of natural justice?

2. Whether the TPO was right in using the powers under section 133(6) of the IT Act and while doing so has he violated the principles of natural justice?

2.1 Section 92 of the IT Act allows AO/Transfer Pricing Officer to proceed to determine the Arm’s Length Price (ALP) of the international transaction based on the material or information or document in his possession/available with him. Section 92C(1) prescribes the methods being the most appropriate methods in determination of arm’s length price of the international transaction. Section 92C(2) prescribes the manner in which the most appropriate method shall be applied. Section 92C(3) prescribes the circumstances in which the AO can determine the ALP of the international transaction as against what is presented by the assessee. The relevant portion of Section 92C(3) is quoted below:

“92C(3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that-

(a) the price charged or paid in an international transaction or specified domestic transaction has not been determined in accordance with sub-sections (1) and (2); or

(b) any information and document relating to an international transaction or specified domestic transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or

(c) the information or data used in computation of the arm’s length price is not reliable or correct; or

(d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm’s length price in relation to the said international transaction or specified domestic transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him:

Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm’s length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer.”

2.2 Under section 92CA(1), the AO may make a reference to TPO, if he considers it necessary or expedient so to do, with the previous approval of the Commissioner, for computation of ALP of the international transaction u/s 92C of the IT Act. Section 92CA(2), (2A), (2B) and (2C) prescribes the procedure to be adopted by the TPO on receipt of such reference. The TPO passes the order of computation of ALP u/s 92CA(3) of the IT Act which is reproduced below:

“92CA(3) On the date specified in the notice under sub-section (2), or as soon thereafter as may be, after hearing such evidence as the assessee may produce, including any information or documents referred to in sub-section (3) of section 92D and after considering such evidence as the Transfer Pricing Officer may require on any specified points and after taking into account all relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the arm’s length price in relation to the international transaction or specified domestic transaction} in accordance with sub-section (3) of section 92Cand send a copy of his order to the Assessing Officer and to the assessee.”

2.3 The above sections make it abundantly clear that the AO or the TPO are expected to gather material or information or document other than what is produced/ maintained by the assessee. Since this is the intention of the legislation- very explicitly mentioned in section 92C(3) and 92CA(3) of the IT Act- the Act itself provides the machinery to gather this material/information/documents. Section 92CA(7) gives the powers to the TPO (in case of the AO these powers need not be specified again under section 92 since AO can exercise these powers naturally under section 131, 133 and 133A of the IT Act). This sub section is reproduced below:

“92CA(7) The Transfer Pricing Officer may, for the purposes of determining the arm’s length price under this section, exercise all or any of the powers specified in clauses (a) to (d) of sub-section (1) of section 131 or sub-section (6) of section 133 or section 133A.

Explanation.-For the purposes of this section, “Transfer Pricing Officer” means a Joint Commissioner or Deputy Commissioner or Assistant Commissioner authorised by the Board to perform all or any of the functions of an Assessing Officer specified in sections 92C and 92D in respect of any person or class of persons.”

2.4 Now, the power u/s 133(6) reads as follows:

Section 133- “The Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals)] may, for the purposes of this Act,- (6) require any person, including a banking company or any officer thereof, to furnish information in relation to such points or matters, or to furnish statements of accounts and affairs verified in the manner specified by the Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals)], giving information in relation to such points or matters as, in the opinion of the Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals)], will be useful for, or relevant to, any enquiry or proceeding under this Act”.

2.5 Under the above scheme of things, the TPO has used the powers under section 92CA(7) r.w. section 133(6) to gather the information. It is important to note that the TPO has supplied the information so gathered to the assessee and only after giving an opportunity of being heard the TP order is passed. The TPO has issued a show cause notice which contains all the information! document which he intends to use in the case of the assessee. Assessee has also replied to this show cause notice and only after consideration of such reply the TPO has passed the order. It is not the case of the assessee that the information collected is used without putting it across to the assessee before passing the order.

2.6 The nature of the powers under Chapter XIIIC is subject matter of many judgments of the Courts in this country. The relevant decisions are discussed below:

a. The decision of the Hon’ble High Court of Guwahati in the case of Commissioner of Income-tax v. Smt. AmiyaBala Paul [1999] 240 ITR 0378 can be relied upon to understand the nature of this power under section 133(6). The judgment was delivered in the context of calling for the valuation report under section 133(6) of the IT Act by the AO. The relevant portion of the judgment is quoted below:

In view of the decisions referred to in this judgment and in the discussion held above, we are of the view that the assessing authority would be quite competent to call for the report on the valuation of the cost of construction from the Valuation Officer in view of the provisions under sections 131, 133(6) and 142(2) of the Income-tax Act. These are the enabling machinery provisions which vest ample powers in the assessing authority, any wrong mention of provision on the requisition memo will not be material.”

As decided in the case of Commissioner of Income-tax v. Smt. AmiyaBala Paul (supra) the Income Tax Act has various machinery provisions for implementation of the Act. Some of the powers are clearly administrative powers.

b. In the case of C. Vasantlal& Co. v. CIT [1962] 45 ITR 206 the Hon’ble Supreme Court has made the following observation:

“7 ……… The Income Tax Officer is not bound by any technical rules of the law of evidence. It is open to him to collect materials to facilitate assessment even by private enquiry. But if he desires to use the material so collected, the assessee must be informed of the material and must be given an adequate opportunity of explaining it. “

2.8 Therefore, it can be safely said that the Income Tax Act does not expect the AO or the TPO to take the views of the assessee at the time of collection of the information. If this were not so, then, the Act would have specified as such. This will become clearer by reading the proviso to Section 92C(3) of the Act which clearly mandates the AO to provide an opportunity to the assessee by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the ALP should not be so determine on the basis of material or information or document in the possession of the AO. In the same way, the Act provides under section 92CA(3) that the TPO to determine the ALP under sub section 3 of section 92C.

2.9 When the very section itself provides the mechanism of providing opportunity of being heard, there is no need not go for any other measures or ideas, once the action of the TPO is in conformity with the letters and spirit of the section.

2.10 The Income Tax Act under section 92C(1) and (2) provides six methods to determine the ALP of an international transaction. The Central Board of Direct Taxes has prescribed Rule 10B for this purpose. The relevant factors for comparability of the international transaction and a comparable transaction are given in Section 92C as well as Rule 10B. In the present case, TNMM is used as the most appropriate method. The characteristics of the appellant, its functions, assets employed and risk undertaken are identified to find out similar cases of uncontrolled transaction in the market. Rule 10B(2)(d) also mandates the following:

“conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.”

2.11 Rule 10B(2) mandates the AO or TPO to gather information about the conditions prevailing in the market including the size of the market, costs of labour and capital in the market, the laws of Government orders in force, wholesale market or retail market, level of competition in the market. Apart from the above, the TPO should judge having regard to the overall economic development of the market. All these envisage gathering of information about the macro economic factors prevailing in the market. If a revenue officer is expected to accept blindly whatever was produced by the taxpayer as correct, then, the machinery provisions like Section 133(6) or even the wordings of Sections like material or information or document in his possession becomes redundant.

2.12 In the present case, through use of notices u/s 133(6) the TPO has collected information about the third parties without any reference to the assessee in question. Such third parties are asked specific questions regarding their own activities. The information sought is such that was easily available with those companies. This information is for filling the gaps in understanding the nature of activities of these comparable cases and for further classification for comparability.

2.13 Further, the information so collected is general in nature. They are easily available with the companies. For whatsoever reason, this information was not readily available in the public domain and therefore the TPO obtained this information from these companies directly.

2.14 The relevant material so gathered is given to the assessee for their rebuttal, observing the principle of natural justice. Therefore, even under the strict parameters of the above judgments the action of the TPO cannot be faulted.

2.15 No confidential information was considered/used by the TPO as all the companies considered in accept reject matrix of the TPO are searched from the two widely known public databases i.e. Prowess and Capitaline. The TPO had issued the notices u/s 133(6) to gather the information to arrive at FAR of those companies. In many cases replies were received for the notices u/s 133(6). The TPO has supplied the replies to the notices received along with the copies of the notices to the assessee in all the cases which were used as comparables in the appellant’s own case. From the reading of the order of the TPO that only after applying the filters, the TPO has resorted to issue of notices under section 133(6) to obtain certain missing information. The TPO has shared all the information which he had gathered information under section 133(6) with assessee in respect of the accepted/rejected companies.

Based on the above discussion, it can be stated that the TPO is mandated by law to collect such information and the documents”.

(C) The learned DR also submitted that the TPO has power to collect information under section 133(6) by virtue of the statute and assessee cannot question the obtaining of information in the course of proceedings. He relied on various provisions to support that the TPO has powers to obtain information. He also relied on the judgment in the case of Actis Advisers (P.) Ltd. v. Dy. CIT [ITA No.5277/Del/2011 and ITA No.958/Delhi/2012, 12-10-2012] for the proposition that dissection on functional line test or vertical cannot be permitted as there will be no end to the process and it is very subjective exercise.

(D) With reference to the working capital adjustment, since it is a computational error being pointed out by the learned Counsel, he has no objection if the matter is restored for verification of the calculation/computation.

(E) With reference to the risk adjustment it was submitted that the purpose of risk adjustment was to consider whether assessee is bearing more/less risk than the comparable companies. Even though assessee has raised objection before the TPO, it was submitted that no data on the differences in the risk profile has been made by assessee in TP study nor quantified the risk. Assessee used the arbitrage between the prime lending rate for 2006 and bank rate for 2006 at 4.50% as adjustment on account of differences. He objected to the working of the risk adjustment on the basis of the earning rates as it has no connection with the risk bearing capacity of entities and since assessee has not discharged the initial onus to file the requisite information pertaining to the claim, the risk adjustment cannot be allowed to assessee.

24. We have considered the detailed submissions made by the learned Counsel and the learned DR. At the outset we have noted that the information obtained by AO by writing to various companies while selecting the comparables has not been provided to assessee at all. Assessee has raised these objections not only before the TPO but also before the DRP. Since information relied upon by the TPO is not available in public domain, it is incumbent on the TPO to furnish the relevant information to assessee. In a case where the information is not furnished to assessee it becomes secret information which can not be used against assessee. Most of the objections raised by assessee with reference to the selection of comparables by the TPO are with reference to the information not available in the public domain, but obtained by TPO and also with the various filters considered by the TPO in rejecting assessee’s comparables. We also notice that there is no uniformity in rejection of assessee’s comparables and selection of comparables by the TPO (a) on the reason that various filters considered by the TPO himself has not been followed and (b) that some of the companies selected by assessee were rejected on unreasonable grounds (loss making company etc). In order to compare a company with assessee, and to benchmark the same, proper and appropriate FAR analysis is required to be done and when assessee has given detailed objections both to the TPO as well as to the DRP, it is incumbent on them to rebut the objections. It is not proper to reject all the objections without discussing them in the order. We also notice that assessee has given detailed objections. There was no discussion at all by the DRP on these objections. As far as the working capital adjustment is concerned, how the same was arrived at could not be analyzed by us. Even the learned CIT (DR) has also accepted that this issue may be remitted to the TPO for fresh examination.

25. With reference to the risk adjustment so sought by assessee, there is merit in the CIT DR’s argument that assessee has not provided any risk adjustment in TP study submitted by them. In our view, the claim for risk adjustment is only to make adjustments to the ALP so as to leverage the profit margin/profit on cost margin. The action of AO in cherry picking the comparables which has high profit margin and ignoring the low profit margin companies and also assessee’s contention about the risk adjustment so as to leverage the margin cannot be accepted. In fact, all companies conducting business will have the same risk i.e market risk, customer risk, government policy risk etc. and there may be variations in the extent of risk, but risk is associated with conducting business. Unless the risk is quantified in certain objective manner and can be represented by way of numbers, it is very difficult to make adjustment on presumptions and surmises. Unless the risk adjustment is quantified in a scientific manner, this aspect can only be examined in the FAR analysis. In fact it is the duty of assessee as well as the TPO to conduct a proper FAR analysis so that the right comparables are selected. Once the comparables are accepted and selected, except for the working capital adjustment and some other adjustments as may be required, we are of the opinion that no further risk adjustment need to be made. In view of this, we are not fully agreeing with assessee’s contentions as far as risk adjustment is concerned. Further, there is no correlation with bank lending rates and risks involved as claimed by assessee.

26. The Ld. CIT DR made efforts to support the order of TPO on obtaining information. While agreeing with his arguments on power of AO/TPO in obtaining information u/s 133(6), on which there is no dispute, what is objected to by assessee is not providing such information to it. There is nothing on record to suggest that information so obtained by TPO was made available to assessee so as to analyze and accept or reject a company as comparable. Assessee Counsel specifically referred to the submissions made to TPO and DRP on this issue. We are of the opinion that principles of natural justice have not been complied with by authorities in selection of comparables and determining the ALP.

27. Since assessee was not been given proper opportunity to examine the comparables selected by the TPO and as the objections raised by assessee are not examined or rebutted either by the TPO or by DRP and considering the fact that the information obtained by the TPO with reference to certain comparables and segmental data was not even made available to assessee, we are of the opinion that the issue has to be set aside to the file of the TPO for determining the ALP afresh after providing the information to assessee which was collected by TPO. We do not intend to go into merits of arguments raised by rival parties in selection of comparables as the information collected by TPO was not placed on record and the objections of assessee are based on publicly available data. The analysis of acceptance or rejection of comparables on incomplete data may result in skewed results. Therefore, we leave the matter to the domain of TPO to give opportunity to assessee and analyze the objections in an objective manner. The TPO will be free to make FAR analysis again of the comparables selected by the assessee and TPO and can consider the issue of determining the ALP afresh. For this purpose, we set aside the order of the DRP-II and the order of the TPO and restore the issue to the file of the TPO to make selection of comparables afresh and determining the ALP after giving due opportunity to assessee. Thereafter, AO can propose the draft assessment order and if any objections are still raised by assessee, these can be considered by the DRP in the light of the provisions of the Act. With reference to the working capital and risk adjustments also, the issue is restored to the file of the TPO afresh who should consider assessee’s contentions, without being influenced by the observations made above. With these remarks the order of AO, the DRP-II and TPO are set aside. The matter was restored to the file of the TPO to do it afresh. Accordingly Ground No.4 is considered allowed for statistical purposes.

28. Ground No.5 is with reference to the initiation of penalty proceedings under section 271(1)(c) which does not arise for consideration at this moment. Therefore, the ground is rejected.

29. In the result appeal filed by assessee is considered partly allowed.