No cut off date for info available in public domain to be considered by TPO for computing ALP

IN THE ITAT BANGALORE BENCH ‘A’

Centillium India (P.) Ltd.

v.

Deputy Commissioner of Income-tax

IT APPEAL NO. 1354 (BANG.) OF 2010

[ASSESSMENT YEAR 2006-07]

FEBRUARY 29, 2012

ORDER

George George K., Judicial Member–

This appeal instituted by the assessee is directed against the assessment concluded u/s 143(3) r.w.s 144C of the I T Act, 1961. The relevant assessment year is 2006-07. The assessee is aggrieved by the direction issued by the Dispute Resolution Panel (DRP) dated 17/09/2010. The DRP had approved but for minor modification, the draft order of assessment, making transfer price adjustment as suggested by the Transfer Pricing Officer (TPO) u/s 92CA of the Act.

2. The assessee has raised the following grounds in an exhaustive and narrative manner. For the sake of clarity, they are reformulated as under.-

(1)  As directed by the DRP, the AO has erred in holding that the communication expenses attributable to the delivery of computer software outside India should be reduced from export turnover while computing the deduction u/s 10A of the Act;

(2)  On the facts and in the circumstances of the case and in law, the learned AO has erred in law by not considering that, if the communication expenses (i.e. lease line charges) attributable to the delivery of computer software outside India are reduced from export turnover, an equal amount should also be reduced from total turnover for computing the deduction u/s 10A of the Act.

The lower authorities (the AO, TPO and DRP) have erred in –

(3)  making an addition of Rs. 2.82 crores to the total income on account of adjustment in Arm’s Length Price (ALP) of the software development services transaction entered with its Associate Enterprise (AE);

(4)  conducting afresh economic analysis for determination of ALP with regard to international transaction disowning the analysis under taken by the assessee;

(5)  ignoring the fact that the assessee has been availing tax holiday u/s 10A of the Act and there was no intention to shift the profit base out of India which was one of the basic intentions of introduction of transfer pricing provisions;

(6)  determining the arm’s length margin/price using only FY 2005-06 data which was not available to the assessee at the time of complying with the transfer pricing documentation requirements;

(7)  rejecting certain comparables considered by the assessee in the comparability analysis by applying different quantitative/qualitative filters:

AO/TOP erred by rejecting certain comparable companies identified by the assessee:

  –  where consolidated results have been used for analysis; that the assessee had considered the consolidated results in only those cases where the software services related income of the Indian operations constituted more than 75% of the consolidated company-wide/segmental revenue;

  –  using turnover < Rs. 1 crore as a comparability criterion;

  –  as having economic performance contrary to the industry behaviour (e.g. companies showed diminishing revenue trends);

  –  in the comparability analysis as the comparables were having different accounting year (other than 31st March or companies whose financial statements were for a period other than 12 months);

  –  in the comparability analysis using ‘onsite revenues greater than 75 per cent of the export revenues as a comparability criteria; &

  –  in the comparability analysis using ’employee cost greater than 25 per cent of the total revenues’ as a comparability criteria;

(8)  by accepting certain companies using unreasonable comparability criteria;

(9)  obtaining information which was not available in public domain by exercising powers u/s 133(6) of the Act and relying on the information for comparability analysis;

(10)  not considering the foreign exchange fluctuation gain (loss) as part of the operating income while computing the operating margin;

(11)  not considering the provisions written back as part of he operating income while computing the operating margin;

(12)  not making suitable adjustments on account of difference in the risk profile of the assessee vis-à-vis the comparables while conducting comparability analysis;

(13)  computing the ALP without giving benefit of +/- 5% under the proviso to s. 92C of the Act;

(14)  charging of interest 234B and 234D of the Act; &

(15)  initiation of penal proceedings u/s 271(1)(c) of the Act.

Brief facts of the case are as follows:

3. The assessee is engaged in the business of providing software development service of its AE in USA. The return of income for concerned asst. year was filed on 15/11/2006 declaring an income of Rs. 8,45,107/-. During the course of hearing, the AO observed that for the period of relevant financial year, the assessee had international transaction to the extent of Rs. 27 crores. With the approval of the jurisdictional CIT, a reference was made to the TPO to determine the ALP as per the provisions of s. 92CA of the Act. For the reasons recoded, the ALP of the international transaction pertaining to providing software development was determined by the TPO at Rs. 29.91 crores instead of Rs. 27.07crores, resulting in an adjustment to the extent of Rs. 2.83 crores and the excess claim of deduction u/s 10A of the Act at Rs. 3.1 lakhs.

3.1 Aggrieved by the said order, the assessee had approached the DRP for relief. However, the DRP in its directions dated 17.9.2010 had almost ratified the TPO’s stand, except a marginal relief of Rs. 1.5 lakhs.

4. Agitated, the assessee is in appeal before us. The assessee’s appeal is largely confined to the following counts:

(i)  determination of ALP in respect of international transactions;

(ii)  the authorities below erred by holding that the communication software attributable to the delivery of computer software outside India were not to be reduced from export turnover while computing deduction u/s 10A of the Act; or alternatively if the expenditure is reduced from the export turnover, the same should be reduced also from the total turnover while computing deduction under section 10A of the Act; and

(iii)  charging of interest u/s 234B and 234D of the Act and also initiation of penal proceedings u/s 271(1)(c) of the Act.

4.1 During the course of hearing the Ld. A R had submitted his submission in an exhaustive manner narrating various contentions put forth before the TPO as well as before the DRP. The submissions of the Ld. A R are summarized as under:

(1)  the international transactions of the assessee with its AEs during the relevant AY for the provision of software development services at Rs. 27.07 crores; that for the purpose of establishing the ALP of its international transaction with its AE, the assessee had undertaken a transfer pricing study in accordance with the provisions of the Act. Based on a detailed analysis with regard to the functions performed, risks assumed and assets utilized by the assessee and its AEs in respect of international transactions between them and, accordingly, concluded that the price received by the assessee in respect of its transactions with AEs was at arm’s length;

(2)  that the key features of the TP study undertaken for software development services were that –

  –  as per the functional analysis, the assessee was categorized as a risk mitigated contract service provider and selected as the tested party;

  –  that the TNMM was determined as the most appropriate method to determine the ALP; that a search was conducted on prowess database and Capitoline database up-dated till 25.8.2006 to select comparable companies;

  –  that given the nature of the international transaction under review, economic conditions, differences in business or product life cycles and other similar factors and also the fact that financial date for the FY 2005-06 was not available in all cases, financial data of FY 2003-04 was also considered along with date for FY 2004-05 wherever available;

(3)  however, the TPO had not accepted the economic analysis undertaken by the assessee and conducted a fresh economic analysis; that the TPO failed to appreciate that such data was not available in the public domain at the time of complying with the mandatory TP documentation rules by the prescribed due data; that the TPO applied certain filters and did not undertake an objective comparative analysis for selection of comparable companies; that while arriving at the ALP, the TPO rejected certain comparables identified by the assessee on the following filters:

  –  in the case of companies where consolidated results has been used for analysis;

  –  companies with turnover less than Rs. 1 crore;

  –  companies having economic performance contrary to the industry behaviour (e.g., companies which showed a diminishing revenue trend);

  –  companies having different accounting year (other than March 31 or companies whose financial statements were for a period other than 12 months);

  –  in the case of companies where on site revenues were greater than 75 per cent of the export revenues; that in the case of companies where employee cost was less than 25 per cent of the total revenues; &

(a)  the TPO had excluded the foreign exchange gain or loss in computing the operating margin of the comparable companies;

(b)  the TPO provided an adjustment towards working capital 1.72 per cent; that the adjusted net margin of comparable companies after providing the working capital adjustment was determined at 18.96 per cent on operating cost;

(c)  the TPO did not make suitable adjustments to account for differences in the risk profile of the assessee vis-à-vis the comparable companies;

(d)  that the TPO did not consider that the adjustment to the ALP, if any, should be limited to the lower end of 5% range as the assessee had the right to exercise this potion under the proviso to s.92C(2) of the Act; and

(e)  the TPO initiated penalty proceedings under Explanation 7 to s. 271(1)(c) of the Act.

(4)  that the AO had issued draft assessment order proposing to make an addition of Rs. 2.83 crores on account of TP adjustment and recomputed the deduction u/s 10A of the Act by reducing the communication charges (i.e.; lease line charges of Rs. 25.31 lakhs from the export turnover without simultaneously reducing the same from the total turnover) hence, reducing the deduction u/s 10A of the Act to the extent of Rs. 3.1 lakhs;

(5)  Even the DRP agreed with the stand of the AO/TPO and rejected the assessee’s reasonable contentions with a marginal relief of Rs. 1.5 lakhs on account of re-computation of operating margin of Megasoft Limited whereby re-determining the ALP at Rs. 2.82 crores.

(6)  Corporate tax: Disputing the AO’s stand by holding that the communication expenses attributable to the delivery of computer software outside India should be reduced from export turnover while computing the deduction u/s 10A of the Act, it was claimed, among others, that for the purpose of adjustment specified u/s 10A of the Act, only the expenditure incurred in foreign currency in providing technical services outside India alone needs to be excluded from export turnover. In this context, it was pertinent to note that the assessee was engaged in the business of development and export of software and, thus, as the assessee was not engaged in rendering any ‘technical services’ outside India, the question of excluding expenditure incurred in foreign currency did not arise;

Relies on case laws:

  (i) Infosys Technologies Ltd v. Jt. CIT [2008] 19 SOT 7 (Bang.)

(ii) Patni Telecom (P) Ltd v. ITO [2008] 22 SOT 26 (Hyd.)

(iii) Mphasis Ltd – (2008

(7)  Communication expenses:

That even if communication expenses were reduced from ‘export turnover’ an equal amount should be reduced from the ‘total turnover’ for computing the profits eligible for deduction u/s 10A of the Act.

Relies on case laws:

  (i) ITO v. Sak Soft Ltd. [2009] 30 SOT 55 (Chennai) (SB);

(ii) ITO v. Motorola India (P.) Ltd  [IT Appeal No. 645 (Bang.) of 2008, dated 1-5-2009]

(iii) Asstt. CIT v. Khoday India Ltd. [2009] 33 SOT 178 (Bang.)

That the communication expenses should not be reduced from the ‘export turnover’ while computing the eligible deduction u/s 10A of the Act and prays that the deduction u/s 10A of the Act be recomputed on this basis; &

Without prejudice, if communication expenses were to be reduced for computing the export turnover, the expenses should also be reduced from the total turnover for the purpose of computation of deduction u/s 10A of the Act;

(8)  Transfer pricing matters:

That the assessee conducted a comparable search analysis using data from the two recognized databases and had determined the ALP of the international transaction by using the financial information of the comparable companies pertaining to FYs 2003-04 to 2005-06 as was available to the assessee at the time of complying with the transfer pricing documentation requirements;

  –  with regard to provisions of s.92C(3) of the Act, the AO could determine the price only under the circumstances enumerated in clauses (a) to (d), for which, it was submitted that –

(a)  the ALP in the case of the international transaction has been determined by applying the prescribed method in accordance with sub-sec. (1) and (2) of  s. 92C;

(b)  all the relevant information and documents relating to the international transaction has been maintained as prescribed and provided to the TPO;

(c)  the data used in computation of ALP was taken from the two databases for obtaining publicly available financial information in India, namely, prowess (a database compiled and managed by The Centre for Monitoring Indian Economy) and Capitoline (a corporate database compiled and managed by Capital Market Publishers); that the assessee had used the contemporaneous data for computation of ALP as on the date of filing of return of income in accordance with rule 10D(4), as such, the data used for computation of the ALP was reliable and correct; &

(d)  the TP documentation, detailed workings of the economic analysis and all the other documents requested by the TPO have been provided during the course of assessment;

  –  that the assessee had under taken the comparability analysis based on well accepted TP principles and in the absence of any information to the contrary, that it was inappropriate on the part of the Revenue to reject the comparability analysis which was undertaken in accordance with the provisions of the Act read with rules;

  –  taking cue from the Board’s Circulars 12 of 23.8.2001 and 14 of 2001 and also placing reliance on the judicial views in the cases of (i) Mentor Graphics (Noida) (P.) Ltd. v. CIT [2007] 109 ITD 101 (Delhi); (ii) Sony India (P) Ltd v. CBDT [2007] 288 ITR 52/[2006] 157  Taxman 125 (Delhi); (iii) Dy. CIT v. Indo American Jewellery Ltd. [2010] 41 SOT  1 (Mum) and (iv) Sony India (P.) Ltd (supra), it was argued that the TPO was required to accept the assessee’s analysis on account of the reasons that (i) analysis undertaken in accordance with law; (ii) analysis undertaken by an external agency; & (iii) the AO/TPO had no reasons to believe that the transactions were not at arm’s length.

(9)  Availing tax holiday u/s 10A of the Act:

The assessee has been availing tax exemption u/s 10A and there was no reason or motive for avoidance of tax in India through reduced payments by the parent company outside India to the assessee which enjoys tax holiday in India and thereby erode the Indian tax base.

Relies on case laws:

(i)  Philips Software Centre (P.) Ltd v. Asstt. CIT [2008] 26 SOT 226 (Bang);

(ii) Indo American Jwellery (supra);

(iii) Zydus Atlana Healthcare (P.) Ltd v. ITO [2011] 44 SOT 132 (Mum);

(iv)  ITO v. Panasonic India (P.) Ltd [2011] 43 SOT 68/[2010] 7 taxmann.com 117 (Delhi)

(10)  Determining the ALP using only FY 2005-06 data:

That it was submitted before the TPO that conducting a search in the databases after the specified date for determining the arm’s length nature of the international transaction based on the financial information of the comparable companies for the FY 05-06, the data pertaining to which was not available to the assessee at the time of complying with the transfer pricing documentation requirements and was not in accordance with the provisions of the law;

  –  that the assessee was a subsidiary of Centillium Communications Inc., USA which was acquired by Transwitch Corporation in Oct. 08; that Transwitch has been incurring losses at the net level over the years from 2005 to 2010; that in spite of the parent company incurring operating losses, the assessee had earned income on cost plus margin consistently over the said period; and that the assessee earned a consistent margin irrespective of the losses incurred by the parent company reiterates that the assessee is a limited risk service provider and, thus, it was argued, an adjustment to the ALP proposed by the TPO was not warranted;

(11)  that the comparable data for the FY 2005-06 was not available in most cases at the time of complying with the TP documentation requirements under the provisions of the Act; that the rejection of the comparability data used by the assessee on the above ground would be contrary to what was prescribed under the Act and the relevant rules;

  –  that extensively quoting the provisions of s. 92(1) of the Act read with Rule 10B and also  s. 92B read with rule 10D, it was submitted that-

In compliance with the regulations the assessee maintained the documentation as per Rule 10D based on the data that was available on the public databases before the prescribed date. Further, rule 10D(4) provides that transfer pricing documentation should, as far as possible, be contemporaneous and should exist latest by the due date for filing of income-tax return i.e., 31.10.2006 for the FY 2005-06; that all the companies do not publish the financial results by the due date and, hence, use of financial data only for the FY 2005-06 was practically not possible and that even the press note dated 22.8.2001 had clarified that multiple year data pertaining to comparable transactions can be considered for determining the arm’s length price.

Relies on case laws:

  (i) Philips Software Centre (P.) Ltd (supra)

(ii)  Spud of Taxes, Dhubri (1975 CTR (SC) 172

4.1.1 In conclusion it was claimed that the use of multiple year and contemporaneous data available by the prescribed date be allowed to the assessee.

4.2 On the other hand, the Ld. D R also came up with equally exhaustive submission running into forty six pages. The submission of the Ld. D R is summarized in caption-wise as below:

Corporate tax matters:

Quoting a number of judicial pronouncements, among others, on a similar issue, the Ld. D R, relying on the findings of the Hon’ble Chennai Tribunal (SB) in the case ofSak Soft Ltd (supra) had submitted that “From the facts available (sic) on record, it is not clear whether export turnover include communication charges. In view of the observation above, the Hon’ble ITAT is requested to remand back to the matter to the AO for re-examination the issue in the interest of justice.’

Transfer pricing matters:

After commenting on the assessee’s contentions coupled with various case-laws, the Ld. D R, extensively explaining the provisions of s. 92 and also quoting the findings in the case of M/s. Aztec Software & Technology Service Ltd v. Asstt. CIT [2007] 107 ITD 141 (SB) (Bang), submitted that there is no merit in the assessee’s objection which deserves to be rejected. He had also submitted that out of the comparables selected by the assessee, the TPO accepted Accel Transmatic Ltd (Seg), Aztec Software & Technology Service  Ltd. (supra) and Mega Soft Ltd. and, thus, comparables eliminated as comparable after detailed analysis and, hence, this ground of the assessee requires to be rejected.

Transfer pricing documentation:

Placing reliance on the findings in the case of M/s. Aztec Software & Technology Services Ltd. (supra), the Ld. D R opined that the assessee’s ground is not sustainable.

Determination of the arm’s length margin/price:

Contesting the assessee’s arguments, the Ld. D R, by illustrating the provisions of rule 10B (4),  s. 92B read with rule 10D, 10D (3) and also 10D (4), maintained that the aspect raised by the assessee has been discussed by the TPO in his impugned order; that the DRP was also in agreement with the TPO’s view and held that ordinarily only the data pertaining to the FY of the transaction can be considered. It was, further, explained that the proviso to rule 10B (4) which permits the use of data relating to other than financial year in which the international transactions have been entered into being not more than two years prior to such FY data but it has a limited role only when the data of earlier years reveals facts which could have influenced on determination on the transfer pricing in relation to the transactions being compared. It was, further, argued that the assessee had not made out a case that taking data for only the current FY will not present the concept and fair financial result of the comparables, the claim for multi-year data has been rejected.

Relies on the case laws:

(i) Symantec Software Solution (P.) Ltd. v. Asstt. CIT [2011] 46 SOT 48/11 taxmann.com 264 (Mum.)

(ii) Avaya India (P) Ltd v. ACIT ITA No. 5150 (Delhi) 2010;

(iii)  TNT India (P) Ltd v. Asstt. CIT [2011] 45 SOT 411/10 taxmann.com 161 (Bang.)

(iv) Exxon Mobile Co. India (P.) Ltd v. Dy. CIT [2011] 46 SOT 294/12 taxmann.com 84 (Mum.) (URO)

It was the case of the Ld. D R that, as the TPO and the DRP have rightly held, the contemporaneous data of relevant FY was to be used for making the comparable analysis for arriving at the ALP as the assessee unable to prove that the pricing pattern of the assessee for the relevant FY has been influenced by the market conditions, business cycle/product life cycle of the earlier years

Rejection of certain comparables considered by the assessee in the comparability analysis by applying different quantitative and qualitative filters:

The Ld. D R has detailed the following reasons for eliminating the companies as comparables by the TPO:

The companies having in business of IT enable services –

(i)  the accounting periods were different from the financial year;

(ii)  the companies having diminishing revenue as the trend of the software services sector is increasing;

(iii)  Use of multiple year data instead of relevant financial year data;

(iv)  the companies having onsite revenue is more than 75% of export revenue;

(v)  the companies have employee cost is less 25% of export revenue.

It was the contention of the Ld. D R that these were the certain filter criterion for non-inclusion as comparable. There were other factors, the TPO had eliminated despite of the facts that high margins, for instance:

Mphasis BFL Ltd	52.87%
Intertec Communication	46.07%
Visual Soft Technologies Ltd	29.02%
Trans World Infotech	26.34%
Satyam Computer Services Ltd.	30.00%

Citing the above reasons, it was the contention of the Ld. D R that the TPO eliminated the comparable chosen by the assessee by applying filter criteria adopted by him and, hence, there is no merit in the objection of the assessee.

By accepting certain companies by the AO/TPO using unreasonable comparability criteria:

Contesting the assessee’s various contentions to exclude six companies, namely, (i) Mega Soft Limited; (ii) Infosys Technologies Limited; (iii) KALS Information System Limited; (iv) Tata Elxi Limited; (v) Accel Transmatic Limited; and (vi) Flectronics Software System Limited, the Ld. D R submitted that for the detailed reasons recorded in his impugned order, the TPO was justified in considering as comparables. Further, it was argued that in the margin computation sheet as per Annexure ‘B’, the TPO had correctly adopted segmental data for the calculation of margins and, thus, there was no merit in the assessee’s argument. It was, further, submitted that the assessee had raised those objections only because out of 20 comparables, 6 of the comparables were having high profit and high difference in the turn over and not because of the high or low turnover had influenced the operating margin of the comparables; that all the objections and contentions raised by the assessee in respect of those issues were general in nature and no specific fact had been brought on record to show that due to the difference in turn over the comparables become non-comparables. It was, further, argued that the assessee had not demonstrated as to how the difference in the turnover had influenced the result of comparables; that it was accepted economic principles and commercial practice that in highly competitive market condition, one can survive and sustain only by keeping low margin but high turnover. Thus, high turnover and low margin were necessary of the highly competitive market to survive.

It was submitted that the arithmetic mean of operating profits of the companies selected as comparable by the TPO was 19.45% while the operating profits earned by the following super normal profit making companies selected by the TPO which were significantly more than the arithmetic mean seven companies were out-liners and cannot be considered as comparable to a risk mitigated service provider.

Obtaining information not available in public domain by exercising powers u/s 133(6) of the Act:

It was the case of the Ld. D R that all the information received during the period from 29.4.09 to 20.7.09 were furnished to the assessee by the TPO, and that all the information/adverse used against the assessee was duly intimated in due course. Also copies of notices u/s 133(6) issued to the companies and the copies of replies received from such companies were furnished to the assessee in a soft copy for its comments; and that the findings of the TPO based on information collected was communicated to the assessee. It was, further, submitted that after due consideration of the assessee’s objection, the DRP upheld the TPO’s action in collecting the relevant information requiring for better comparability analysis. It was also contended that the TPO used the data for information that was available to him in the public domain whenever a company did not submit the information or wherever the notice u/s 133(6) not served at the latest address available even after repeated attempts.

With regard to the assessee’s contention that the foreign exchange gain/loss arise in the normal course of business and, therefore, should be considered as operating in nature, the Ld. D R claimed that the Mumbai Tribunal in the case of DHL Express (India) (P.) Ltd v. Asstt CIT [2011] 46 SOT 379/11 taxmann.com 40 (Mum.) contrary view on the issue. However, in the financial statement for the FY 2005-06 income credited on account of gain on foreign exchange fluctuation only sum of Rs. 7.2 lakhs shown as loss on foreign exchange fluctuation, thus, there was no merit in the assessee’s contentions. It was the case of the Revenue that even loss claimed seems to be meagre and not much effect in determination of ALP.

Not making suitable adjustments on account of diff. in the risk profile:

It was contended by the Ld. D R that as the assessee failed to bring any evidence on record to show that their exist any difference in the risk profile of the comparable companies vis-à-vis of the assessee, the TPO/DRP had rejected the assessee’s claim, that to avail benefit of such adjustment, information should be submitted along with details maintained by the assessee under rule 10D. It was, further, argued that s. 92D(1) provides that every person entering into an international transaction was required to keep and maintain such information and document in respect thereof, as was being prescribed under rule 10D(1) of IT. Rules. This rule requires to maintenance of a record of the analysis performed to evaluate comparable as well as a record of the actual working carried out for determining the ALP. It was, further, explained that rule 10D(4) requires that the information and documentation to be maintained; and that under rule 10D(1) should be contemporaneous as far as possible and should exist latest by the due date of filing of the return. It was the case of the Ld D R that the assessee admitted that it did not undertake any risk adjustment in the TP document report and in the absence of that comparability; it was difficult to make adjustment.

Relies on the case laws:

(i)  Marubeni India (P.) Ltd v. Addl CIT   [ITA NO. 945 (Del.) of 2009]

(ii) Symantec Software Solution (P.) Ltd (supra)

(iii)  Exxon Mobil Co. India (P.) Ltd (supra)

(iv) ADP (P.) Ltd v. Dy. CIT [2011] 45 SOT 172/10 taxmann.com 160 (Hyd.)

(v) Vedaris Technology (P) Ltd v. Asstt. CIT [2011] 44 SOT 316 (Delhi)

(vi) St. Micro Electronics (P.) Ltd v. CIT(A) [ITA Nos. 1806 & 1807 (Del.) of 2008]

Computation of ALP without giving benefit of +/- 5% under the proviso to sec.92C of the Act:

Extensively quoting the Proviso to s.92C(2) as substituted by the Finance Act, 2002 w.e.f. 1.4.2002 and also countering the assessee’s contentions coupled with a number of judicial pronouncements, the Ld. D R contended that the TPO had held that proviso to s. 92C(2) was amended w.e. f 1.10.2009 by introducing a clarificatory amendment; that the second provision says that if arithmetical mean price determined is within +/- 5% from price charged in the international transaction, the price charged by the tax payer has been treated as arm’s length price. It was, further, argued that no adjustment would be made, if the arithmetical mean price falls beyond +/- 5% from the price charged in the international transaction, and then second proviso was not applicable; that in such case, only the first proviso shall alone be applicable as per which the arithmetical mean price shall be taken to be the arm’s length price. Meaning thereby, it was submitted, the transfer pricing adjustment would be made only from arithmetical mean price. Thus, it was argued by the Ld. D R, according to the TPO, by virtue of amendment, +/- 5% variation is allowable only the case of the price charged in the international transactions and not the adjustment.

Relies on the case laws:

(i) ADP (P.) Ltd (supra)

(ii) Marubeni India (P.) Ltd (supra).

In conclusion, the Ld. D R pleaded that the stand of the authorities below requires to be sustained.

5. We have duly considered rival submissions, carefully perused the relevant case records and also voluminous Paper Books furnished by the Ld. A.R. With due respects, we have also perused various case laws on which either party had placed their confidence.

The prime thrust and grievances of the appellant being:

(i)  that the AO had erred by holding that the communication expenses attributable to the delivery of computer software outside India should be reduced from export turnover while computing the deduction u/s 10A of the Act;

(ii)  that the TPO had selected six companies in the order passed u/s 92CA of the Act as comparables in addition to those proposed in the notice without giving an opportunity to the appellant to present its objection(s)/comments;

(ii)  Even under TNMM, considering turnover range of Rs. 1 crore to Rs. 200 crores and Rs. 1 crore to Rs. 500 crores and rejecting certain comparables selected by TPO, the appellant’s transactions were at arm’s length;

(iii)  Six companies which did not even appear in the initial search list of the TPO were issued notice u/s 133(6) of the Act to collate information. The process adopted in issuing notice u/s 133 (6) of the Act was not detailed. The information obtained in response thereto had not been fully shared;

(iv)  That the AO/TPO erred in determining the arm’s length margin/price using only FY 2005-06 data which was not available to the assessee at the time of complying with the transfer pricing documentation requirements;

(v)  The assessee had made detailed submissions for rejection of KALS as comparable, however, the appellants submissions have not been commented either by the TPO or the DRP;

(vi)  In the case of Megasoft, the TPO and the DRP have considered entity-wide margins on the ground that software product segment also consists software services and, therefore, at entity level software services were more than 75% of operating revenues. However, similar situation in the case of other comparables have been ignored. If at all Megasoft was to be adopted as a comparable, the margin of the software segment may be used;

(vii)  The AO/TPO erred in not considering the foreign exchange fluctuation gain (loss) as part of the operating income while computing the operating margin;

(viii)  Also erred in not considering the provisions written back as part of the operating income while computing the operating margin; &

(ix)  Benefit of 5% deduction in determining the arm’s length price in accordance with proviso to  s. 92C of the Act not given.

5.1 After analyzing the submissions of rival parties and also deliberating the specific apprehensions of the appellant as narrated above, the matter has now been narrowed down for consideration, the following issues, namely:

(1)  What is the data to be considered by the TPO at the time of determining ALP? &

(2)  Whether the appellant should have been given an opportunity to refute the material sought to be utilized by the TPO?

5.2 As far as the data to be used by the TPO while determining the ALP was concerned, it is observed that it is covered by the provisions of rule 10D sub-rule  (4) of the Income-tax Rules. Section 92C provides that the arm’s length price in relation to an international transaction shall be determined by any of the methods being the most appropriate method having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors for computing the ALP and also any other method as may be prescribed by the Board. Section 92D provides that (i) every person who has entered into an international transaction shall maintain and keep such information and documents in respect thereof; (ii) the Board may also prescribe the period for which the information and documents shall be kept and maintained; and (iii) the AO or the CIT(A) may, in the course of any proceeding under the Act, require any person who has entered into an international transaction to furnish any information or document in respect thereof. Thus, it subscribes that the requirement is only to maintain and keep the information and documents relating to international transactions so that they are available as and when required during any proceeding under the Act. The section does not provide that the information and documents are to be kept and maintained for a period of eight years. Rule 10-D of sub-sec. 1 specifies the documents and information which are to be kept and maintained by the assessee and sub-rule  (2) thereof provides that nothing contained in sub-rule 1 shall apply in a case where the aggregate value as recorded in the books of accounts, the international transactions entered into by the assessee does not exceed Rs. 1 crore. Sub-rule 3 provides the supporting authentic documents which are to be kept and maintained and sub-rule 4 thereof provides that the information and documents specified under sub-rules  (1) & (2) should as far as possible be contemporaneous and should exists latest by the ‘specified date’ referred to in clause-4 of section 92F. Clause  (4) of section 92F gives the definition of ‘specified date’ to have the same meaning as assigned to ‘due date’ in Explanation 2 below sub-section  (1) of section 139. Explanation 2 to section 139 defines ‘due date’ in a case of a company to be 30th of September of the relevant assessment year, the assessee is supposed to maintain information and documents. After going through the above provisions of law, it is clear that the Act has not provided for any cut off date up-to which only the information available in public domain has to be taken into consideration by the TPO, while making the transfer pricing adjustments and arriving at arm’s length price. The assessee as well as the Revenue is both bound by the Act and the rules there-under and, therefore, as provided under the Act and rules, they are supposed to be taking into consideration, the contemporaneous data relevant to the previous year in which the transaction has taken place. The assessee had strenuously argued that the provisions of section 92D and Rule 10D is defeated, if the TPO takes the data which is available in the public domain after the specified date and the ALP would be fluid and there would be no certainty for the same. We are, however, not in agreement with the arguments put-forth by the Ld. A.R. The ALP has to be determined by the TPO in accordance with law and the Act provides that the TPO shall take into consideration the contemporaneous data. The assessee was only required to maintain the information and documents as may be necessary relating to the international transactions so that it can be made available to the TPO or the AO or any other authority in any proceedings under the Act. By providing a specified date in the Act, the obligation is cast upon the assessee to keep and maintain the documents for that period. But, it does not restrict the TPO from making enquiries thereafter for determining the correct ALP.

5.3 Having held so, we shall now glimpse at the next question, as to whether the TPO can make his own enquiries and call for information from various entities keeping the assessee in the dark. Under sub-sec. (3) & (7) of s. 92CA, the TPO is entrusted with all the powers under clauses (a) to (d) of sub-section (1) of section 131 or sub-section (6) of section 133 to call for and gather any information as may be required. When the TPO is making the search for a relevant comparable, he can issue notices to the parties whom he considers as relevant to gather requisite information and on being satisfied with regard to relevancy of the material which can be used against the assessee only then the assessee has to be given an opportunity of presenting its objections, if any. Thus, the TPO need not inform the assessee about the process used by him for issuing the notices u/s 133(6) of the Act nor is he under any obligation to furnish the entire information to the assessee.

5.4 However, we are of the firm view that the principles of natural justice requires that when any information is sought to be used against the appellant, the appellant has to be given a reasonable opportunity of hearing on that material. In the present case, the TPO had furnished all the information to the appellant in the form of CD and the appellant, after perusing the same, had submitted a detailed submission along with its objections for taking various companies as comparables. It was another matter, if the TPO had not considered the objections of the appellant judiciously. In such a case, it would be an error of judgment, but, not violation of principles of natural justice. The objections of the appellant were that certain companies have been taken into consideration by the TPO as comparables without affording the appellant an opportunity of furnishing its objections, if any, and also with regard to certain other companies, it had sought opportunity to cross-examine them, but, it has been observed that no such an opportunity has been extended to the appellant.

5.5 As recorded earlier, if any information is sought to be used against the appellant, the same has to be furnished to the appellant and thereafter, taking into consideration the appellant’s objections, if any, only then can the TPO proceed to take a decision. If the appellant seeks an opportunity to cross-examine the parties concerned, the appellant shall be provided such an opportunity. It is only during a cross-examination that the appellant can rebut the stand of that particular party (company). As listed out earlier, the appellant had also brought out various defects in the additional comparables selected by the TPO and had brought out the striking differences between the functions of those comparables as compared to the appellant and also as to how the entire revenue of the appellant has been taken into consideration in spite of there being income from unrelated party transactions also. All these objections have been detailed in its written submission which has also been incorporated in this order in a summarized manner. It has been observed that the TPO had not considered those objections while determining the ALP. Further, it was also the stand of the appellant that it should be given a standard deduction of 5% as provided under the proviso to  s. 92C (2) before making adjustments for the transfer price. To drive home its point, the assessee had placed strong reliance on the following decisions:

(1) iPolicy Network (P.) Ltd v. ITO [2011] 46 SOT 38/11 taxmann.com 406 (Delhi) (URO)

(2)  Symantec Software Solutions (P.) Ltd (supra)

(3) SAP Labs India (P.) Ltd v. Asstt. CIT [2011] 44 SOT 156/[2010] 8 taxmann.com  207 (Bang.)

(4) TNT India (P.) Ltd (supra)

(5) Genisys Integrating Systems (India) (P.) Ltd v. Dy. CIT [IT Appeal No. 1231 (Bang) of 2010, dated 5-8-2011]

(6) Diageo India (P.) Ltd v. Dy. CIT [2011] 47 SOT 252/13 taxmann.com 62 (Mum.)

(7) Exxon Mobil Co. India (P.) Ltd (supra)

(8) Emerson Process Management India (P.) Ltd v. Addl. CIT [2011] 47 SOT 107/13 taxmann.com 149 (Mum.)

(9)  Haworth (India) (P.) Ltd v. Dy. CIT [2011] 131 ITD 215/11 taxmann.com 76 (Delhi)

(10) UE Trade Corpn. (India) (P.) Ltd v. Asstt. CIT [2011] 44 SOT 457/9 taxmann.com  75  (Delhi)

(11)  Cummins India Ltd v. Dy. CIT [2011] 45 SOT 78 (Pune) (URO)

(12) CIT v. Kerala Electric Lamp Works [2003] 261 ITR 721/129 Taxman 549 (Ker.);

(13) CIT v. Rajasthan Mercantile Co. Ltd [1995] 211 ITR 400 (Delhi);

(14) K.P. Varghese v. ITO [1981] 131 ITR 597/7 Taxman 13 (SC)

(15)  CIT v. Alom Extrusions Ltd [2009] 319 ITR 306/185 Taxman 416 (SC)

On the other hand, the Ld. D R, placing strong reliance on the stand of the authorities below, submitted that 5% was not the standard, but, it was the range within which if the ALP fails, then, the ALP of the appellant has to be accepted.

We have considered rival submissions and of the firm view that this issue has already been covered by the decisions which have been relied on by the appellant.

5.6 Turnover filter: As regard the assessee’s objection of TPO adopting infinity figures for upper limit turnover for the selection of comparables, we find that the issue is squarely covered by the order of Bangalore Bench of Tribunal in the case of M/s Genisys Integrating Systems (India) Pvt. Ltd. The relevant finding of the Tribunal at para 9 reads as follows:

“9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which are making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various Benches of the Tribunal, when companies which are loss making are excluded from comparables, then the super profit making companies should also be excluded.

For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs. 1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.

In the instant case, the turnover of the company is in the range of 30 crores, therefore, the companies, which have turnover of Rs. 1.00 crore to 200 crores alone should be taken into consideration for the purpose of making TP study.

5.7 In these circumstances, we are of the considered view that this issue requires to be remitted back to the file of the TPO for fresh consideration with the following directions:

(i)  the operating revenue and the operating cost of the transactions relating to associated enterprises only shall be considered;

(ii)  the comparables having the turnover of more than Rs. 1 crore, but, less than Rs. 200 crores only shall be taken into consideration;

(iii)  all the information relating to comparables which were sought to be used against the appellant shall be furnished to the appellant;

(iv)  to consider the objections of the appellant that relate to additional comparables sought to be adopted by the TPO and to pass a detailed order; and

(v)  to give the standard deduction of 5% under the proviso to s.92C(2) of the Act.

6. Before parting with, we would like to recall that most of the issues raised in this appeal had also cropped up in the earlier Bench in the cases of (1) Genisys Integrating Systems (India) (P.) Ltd (supra) and (2) Kodiak Networks (India) (P.) Ltd v. Asstt. CIT [2012]  18 taxmann.com 32 (Bang.) wherein the Hon’ble Bench, after due consideration, had taken similar views.

7. With regard to deduction u/s 10A of the Act, it was contended by the assessee that if the communication expenses attributable to the delivery of computer software outside India were reduced from export turnover, an equal amount should also be reduced from total turnover for computing the deduction u/s 10A of the Act.

7.1 The Ld. AR submitted that the issue in question is squarely covered by the judgment of the Hon’ble Karnataka High Court in the case of CIT v. Tata Elxsi Ltd [2012] 204 Taxman 321/17 taxamnn.com 100 (Kar.) Mumbai High Court in the case of CIT v. Gem Plus Jewellery India Ltd [2011] 330 ITR 175/[2010] 194 Taxmann 192 (Bom.) and the order of the Special Bench in the case of Sak Soft Ltd.  (supra)

7.2 We have heard the rival submission and perused the material on record. The Hon’ble Karnataka High Court in the case of Tata Elxsi Ltd (supra) had held that while computing the exemption u/s 10A, if the export turnover in the numerator is to be arrived at after excluding certain expenses; the same should also be excluded in computing the export turnover as a component of total turnover in the denominator. The relevant finding of the Hon’ble Court reads as follows:

“….Section 10A is enacted as an incentive to exporters to enable their products to be competitive in the global market and consequently earn precious foreign exchange for the country. This aspect has to be borne in mind while computing the consideration received from such export turnover, the expenses incurred towards freight, tele-communication charges, or insurance attributable to the delivery of the articles or things or computer software outside India, or expenses if any incurred in foreign exchange, in providing the technical services outside India should not be included. However, the work total turnover is not defined for the purpose of this section. It is because of this omission to define ‘total turnover,’ falls for interpretation by this Court;

……In section 10A, not only the word ‘total turnover’ is not defined, there is no clue regarding what is to be excluded while arriving at the total turnover. However, while interpreting the provisions of section 80HHC, the Courts have laid down various principles which are independent of the statutory provisions. There should be uniformity in the ingredients of both the numerator and the denominator of the formula, since otherwise it would produce anomalies or absurd results. Section 20A is a beneficial section which intends to provide incentives to promote exports. In the case of combined business of an assessee, having export business and domestic business, the legislature intended to have a formula to ascertain the profits from export business by apportioning the total profits of the business on the basis of turnovers. Apportionment of profits on the basis of turnover was accepted as a method of arriving at export profits. In the case of section 80HHC, the export profit is to be derived from the total business income of the assessee, whereas in section 10-A, the export profit is to be derived from the total business of the undertaking. Even in the case of business of an undertaking it may include export business and domestic business, in other words, export turnover and domestic turnover. To the extent export turnover, there would be a commonality between the numerator and the denominator of the formula. If the export turnover in the numerator is to be arrived at after excluding certain expenses, the same should also be excluded in computing the export turnover as a component of total turnover in the denominator. The reason being the total turnover includes export turnover. The components of the export turnover in the numerator and the denominator cannot be different. Therefore, though there is no definition of the term ‘total turnover’ in section 10A, there is nothing in the said section to mandate that what is excluded from the numerator that is export turnover would nevertheless form part of the denominator. When the statute prescribed a formula and in the said formula, ‘export turnover’ is defined, and when the ‘total turnover’ includes export turnover, the very same meaning given to the export turnover by the Legislature is to be adopted while understanding the meaning of the total turnover, when the total turnover includes export turnover. If what is excluded in computing the export turnover is included while arriving at the total turnover, when the export turnover is a component of total turnover, such an interpretation would run counter to the Legislative intent and impermissible. Thus, there is no error committed by the Tribunal in following the judgments rendered in the context of section 80HHC in interpreting section 10A when the principle underlying both these provisions is one and the same.”

7.3 Further, it may worthwhile to recall the ruling of the Hon’ble Bombay High Court in the case of Gem Plus Jewellery India Ltd (supra) in identical circumstances, held that since the export turnover forms part of the total turnover, if an item is excluded from the total turnover to maintain parity between numerator and denominator while calculating deduction u/s 10A of the Act. The relevant finding of the Hon’ble Bombay High Court reads as follows:

“The total turnover of the business carried on by the undertaking would consist of the turnover from export and the turnover from local sales. The export turnover constitutes the numerator in the formula prescribed by sub-section (4). Export turnover also forms a constituent element of the denominator in as much as the export turnover is apart of the total turnover. The export turnover, in the numerator must have the same meaning as the export turnover which is constituent element of the total turnover in the denominator. The Legislature has provided a definition of the expression ‘export turnover’ in Expln. 2 to s. 10A which the expression is defined to mean the consideration in respect of export by the undertaking of articles, things or computer software received in or brought into India by the assessee in convertible foreign exchange but so as not to include inter alia freight, telecommunication charges or insurance attributable to the delivery of the articles, things, or software outside India. Therefore, in computing the export turnover the Legislature has made a specific exclusion of freight and insurance charges. The submission which has been urged on behalf of the revenue is that while freight and insurance charges are liable to be excluded in computing export turnover, a similar exclusion has not been provided in regard to total turnover. The submission of the revenue, however, misses the point that the expression ‘total turnover’ has not been defined at all by Parliament for the purposes of s. 10A. However, the expression ‘export turnover’ has been defined. The definition of ‘export turnover’ excludes freight and insurance. Since export turnover has been defined by Parliament and there is a specific exclusion of freight and insurance, the expression ‘export turnover’ cannot have a different meaning when it forms a constituent part of the total turnover for the purposes of the application of the formula. Undoubtedly, it was open to Parliament to make a provision which has been enunciated earlier must prevail as a matter of correct statutory interpretation. Any other interpretation would lead to an absurdity. If the contention of the Revenue were to be accepted, the same expression viz., ‘export turnover’ would have a different connotation in the application of the same formula. The submission of the Revenue would lead to a situation where freight and insurance, though these have been specifically excluded from ‘export turnover’ for the purposes of the numerator would be brought in as part of the ‘export turnover’ when it forms an element of the total turnover as a denominator in the formula. A construction of a statutory provision which would lead to an absurdity must be avoided. Moreover, a receipt such as freight and insurance which does not have any element of profit cannot be included in the total turnover. Freight and insurance charges do not have any element of turnover. For this reason in addition, these two items would have to be excluded from the total turnover particularly in the absence of a Legislative prescription to the contrary – CIT v. Sudarshan Chemicals Industries Ltd  [2000] 163 CTR (Bom) 596; [2000] 245 ITR 769 (Bom) applied; CIT v. Lakshmi Machine Works  [2007] 210 CTR (SC) 1; [2007] 290 ITR 667 (5C) and CIT v. Catapharma (India) (P) Ltd  [2007] 211 CTR (SC) 83; [2007] 292 ITR 641 (SC) relied on.”

7.4 n the case of Sak Soft Ltd. (supra), the assessee was engaged in the business of exporting computer software and claimed deduction u/s 10B of the Act. In concluding the assessment u/s 143(3) of the Act, the AO reduced the expenditure incurred in foreign exchange in providing the technical services outside India from the export turnover without corresponding reduction from total turnover, thereby reducing the deduction claimed by the assessee u/s 10B of the Act.

7.5 In the light of the above facts, the Special Bench held as under:

“For the above reasons, we hold that for the purpose of applying the formula under sub-section (4) of section 10B, the freight, telecom charges or insurance attributable to the delivery of articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing the technical services outside India are to be excluded both from the export turnover and from the total turnover, which are the numerator and the denominator respectively in the formula. The appeals filed by the department are thus dismissed.”

Although the order of Special Bench is in the context of s. 10B of the Act, the ratio laid down in the above decision applies to s. 10A of the Act as well, as the provisions of s. 10A and 10B are identical on all material aspects. More particularly, both the sections define only ‘export turnover’ but not ‘total turn over’ and sub-section (4) of both the sections prescribe an identical formula for computing the export profits.

7.6 We, therefore, direct that when the communications expenses should be reduced not only from the export turnover but also from the total turnover while computing deduction u/s 10A of the Act. It is ordered accordingly.

8. The issue of levying of interest u/s 234B of the Act is mandatory and consequential in nature and, therefore, it has not been addressed to. However, interest u/s 234D of the Act for the AY under consideration has been correctly charged. The action of the AO is in consonance with the finding of the Hon’ble ITAT, Delhi (SB) in the case of ITO v. Ekta Promoters (P.) Ltd. [2008] 113 ITD 719 (Delhi) (SB).

9. The initiation of penal proceeding u/s 271(1)(c) of the Act was in its infancy when the assessment was concluded and, therefore, it cannot be agitated in this quantum appeal. Thus, this ground is dismissed as not maintainable.

10. In the result, the appellant’s appeal is treated as partly allowed for statistical purposes.