Case Law Details
ITAT HYDERABAD BENCH ‘A’
Deputy Commissioner of Income-tax
versus
Hellosoft India (P.)Ltd.
IT Appeal Nos. 645 (HYD.) OF 2009 & 1411 of 2010
C.O. No. 40 (Hyd.) of 2009
Assessment Years 2005-06 & 2006-07
Date of Pronouncement – 15.01.2013
ORDER
SaktijitDey, Judicial Member – The appeal filed by the department and the Cross Objection filed by the assessee are directed against the order dated 13-3-2009 of CIT (A)-III, Hyderabad pertaining to the assessment year 2005-06.
2. The department has raised the following effective grounds:-
“1. The learned CIT(A) has erred in commenting adversely about the turn over filter applied by the TPO and thereby rejected some of the comparables selected by the TPO. The arguments and the facts relied upon by the CIT(A) in this regard are incorrect.
2. The learned CIT(A) has erred in commenting adversely about the “employee cost to sales” filter applied by the TPO and thereby rejected some of the comparables selected by the TPO. The arguments and the facts relied upon by the CIT(A) in this regard are incorrect.
3. The learned CIT(A) has erred in commenting adversely about the “onsite income/Revenue” filter applied by the TPO and thereby rejected some of the comparables selected by the TPO. The arguments and the facts relied upon by the CIT(A) in this regard are incorrect.
4. The learned CIT(A) has erred in allowing the benefit of deduction of 5% under proviso to sec. 92C(2) of the Act. The arguments and the facts relied upon by the CIT(A) in this are devoid of merit.
5. The learned CIT(A) has erred in allowing the additional benefit of risk adjustment of 1% to the tax payer, the arguments and the facts relied upon by the CIT(A) in this regard are devoid of merit.”
In ground Nos. 1, 2 and 3, the department has challenged the rejection by the CIT(A) of certain comparables selected by the TPO applying different filters.
3. Briefly the facts of the issue are, the assessee is a wholly owned subsidiary of HellosoftInc, USA its associated enterprise. The assessee is engaged in the business of development of software on behalf of its Holding Company and transfers the software to the holding company for marketing and licensing to its customers. For this purpose, the assessee has entered into an agreement with its holding company according to which for the services rendered by the assessee the holding company will reimburse all the cost incurred plus 8% markup. In the assessment year under dispute the assessee had international transactions with its holding company worth Rs. 13,37,43,661. The assessee adopted the cost plus Method (CPM) for computing the arm’s length price (ALP) for its international transaction. For the assessment year under dispute, the assessee filed its return declaring an income of Rs.1,35,205/- after claiming deduction u/s 10A of the Act. In course of the scrutiny assessment proceeding the Assessing Officer referred the matter to the Transfer Pricing Officer (TPO) u/s 92 CA(2) of the Act for computing the ALP. In course of the proceeding before the TPO the assessee produced all the documents as were called for by the TPO. The TPO after verifying TP Study report and other documents submitted by the assessee issued another letter to the assessee mentioning his remarks on the filters adopted by the assessee, additional filters which the assessee has omitted to apply, and acceptability of the comparables adopted by the assessee. The TPO proposed 15 additional comparables and also asked the assessee to explain as to why Transaction Net Margin Method (TNMM) shall not be adopted in place of CPM adopted by assessee. The assessee submitted detailed reply to the queries raised by the TPO. So far as TPO’s proposal for adopting TNMM the assessee submitted that TNMM is similar to CPM except for the reason that CPM is based on gross margins whereas TNMM is based on net margins. TNMM would not be a proper method in view of the fact that many adjustments is required to be made. It was further submitted by the assessee that OECD has recommended that TNMM should be used as a method of last resort. The assessee submitted that under the circumstances CPM is the most appropriate method. The TPO however did not agree with the contention of the assessee that the CPM is the most appropriate method on the following reasons:-
“(a) The CPM method presents some practical difficulties in identifying the costs incurred for the provision of services like whether an indirect cost is towards rendering services or it is an enterprise level expense.
(b) There is no discernible link between the level of costs incurred and a market price in software services as the services are usually compensated on a man hourly basis which may not vary much across the industry for same or similar type of service. So, CPM is not the appropriate method.
(c) While applying CPM, the tax payer should have considered all direct and indirect costs incurred in respect of the services rendered by it. But, it is apparent from details given above that the tax payer itself did not include all the direct and indirect costs while computing gross mark up e.g. rent, insurance, repairs were not considered. In the case of comparable companies, the details of indirect costs incurred in rendering services were simply not available. Thus it can not be said that the gross profit worked out in the case of the comparables is after taking into account the same items of expenditure as in the case of the taxpayer.
(d) As per the agreement, the tax payer’s cost of providing services includes all costs that have been incurred by the tax paer except interest expenses. All these expenses are reimbursed on cost plus basis. The tax payer is forgetting that it is also getting 8% on other costs which have been excluded by the tax payer in CPM like rent, repairs, insurance, lease and hire charges etc. So, the gross margin shown by the tax payer distorts the true picture of its financials for which TNMM method is the most appropriate method as it captures all expenses except interest, coinciding the cost base of the tax payer for reimbursement (as per the agreement and invoices raised by the tax payer).
(e) In the taxpayer’s case all the costs were incurred towards rendering of services. Therefore, the gross profit is the same in the taxpayer’s case as the net profit. Thus the taxpayer’s PLI remains the same whether CPM is applied or the TNMM is applied. The difference between the two methods in the taxpayer’s case is thus only an academic interest.”
4. The TPO following the decision of the Hon’ble Supreme Court in case of DIT (International Taxation) v. Morgan Stanley[2007] 291 ITR 416 rejected the CPM adopted by the assessee and held that TNMM is the most appropriate method to compute the ALP of the international transaction of the assessee. The TPO also rejected the TP Study report of the assessee by mentioning the following reasons:-
The taxpayer itself admits that there were no companies in the database comparable to it and accordingly has considered the activity of software development as the criteria. Having given up the distinction based on verticals of software development and having accepted companies further within the broad area of SWD as comparable to itself it has still objected to many companies as functionally different, on the basis of the verticals in which they were operative. This demonstrates the double standards adopted by the taxpayer w.r.t. selection of comparable companies.
2. The taxpayer as admitted that there were mistakes in its TP report both in FAR analysis and in the computation of profit for the purpose of CPM method. In fact, despite applying the filter of turnover of 5 to 50 crores 6 companies were not considered at all, as pointed by the TPO in the show cause notice dated 5-9-2008.
3. While calculating profit margin many expenditures were not taken to arrive at the total cost of the comparables. This tantamount to data massaging, to shit its purpose.
4. No audit reports or financial statements were provided to verify the veracity of the cost details furnished, with reference to the comparable company under the CMP method chosen by the taxpayer.
5. The very basis of the turnover filter is misconceived as it is the fallacious believe on the part of the taxpayer that turnover/sales, is intimately linked to profits. This aspect has been explained in detail by the TPO while discussing the turnover filter’ adopted by the TPO.
6. Despite being in software business, many companies have been rejected arbitrarily on the ground that they are having related party transaction,. While a span of 5-50 crore was adopted by the assessee for the turnover filter, however, with reference to related party transaction it has not fixed any reasonable limit. This is a myopic approach, as the related party transaction is relevant only if it is in such quantum so as to influence the results of the comparables,. It is for this reason that TPO has opted for an related party transaction @25%. The gross act on the part of taxpayer to reject all companies with even 1% of RPT, has resulted in a very small base of comparables, which do not reflect the representative sample of the SWD industry.”
5. The TPO also found some of the filters adopted by the assessee to be inadequate. The TPO therefore adopted certain additional filters. The final filters adopted by the TPO are:-
“1. Companies whose software development service income is less than Rs.1 crore were excluded.
2. Companies whose software development service is less than 75% of the total income were excluded.
3. Companies who have more than 25% related party transactions (sales as well as expenditure combined) of the sales were excluded.
4. Companies who have less than 25% of the sales as export sales were excluded
5. Companies who have diminishing revenues/persistent losses for the period under consideration were excluded
6. Companies having different financial year ending (i.e. not March 31, 2005) or data is not available for 12 months, were rejected.
7. Companies whose employee cost to sales is less than 25% were excluded.
8. Companies whose onsite income is more than 75% were excluded.”
Out of the 22 companies selected as comparables by the assessee in the TP Study report the TPO rejected 20 companies and only accepted Gate Global Solutions Ltd., and Sasken Network system Ltd. The TPO proposed 15 companies as additional comparables and invited assessee’s objection. Though the assessee objected to the companies proposed as comparables, The TPO rejecting such objections treated the 15 companies selected by him as comparables along with two out of 22 companies selected by the assessee. The TPO determined the arithmetic mean PLI of the comparables selected @ 26.88% and after allowing working capital adjustment of 2.09% determined the adjusted arithmetic mean PLI @24.79%. By applying the arithmetic mean PLI the TPO determined the ALP of the international transaction by the assessee with its holding company at Rs. 15,26,61,330. Since the assessee had disclosed the price received by it at Rs. 13,37,43,661 the shortfall of Rs. 1,89,17,669 was proposed as adjustment u/s 92CA of the Act. In terms with the order passed by the TPO assessment order was passed u/s 143(3) read with section 92C(3) adding the amount of Rs. 1,89,17,669/- to the total income.
6. The assessee challenging the addition made filed appeal before the CIT(A). In course of hearing before the CIT(A) the assessee objected to rejection of CPM adopted by he assessee and selecting TNMM as the most appropriate method. The assessee further submitted that the filters applied by the TPO were defective giving defective results and cannot be accepted as comparables. The assessee submitted that the TPO has selected large size companies having huge turnover with profit margin of more than 22% which cannot be treated as comparables. The assessee submitted that the TPO has selected companies having related party transactions upto 25% which is contrary to Rule 10A(a) and Rule 10B of IT Rules. The assessee further contended that the TPO applied the filter of salary expenses and companies whose employee cost to sale was less than 25% were excluded. Application of this filter was not appropriate as the relevant data/information was not available in respect of all the companies in the data base. It was contended by the assessee that the salary cost may not be shown separately in the accounts and may be included in the cost of software package or in operating expenses. It was further contended by the assessee that the ‘onsite income’ filter applied by the TPO is not appropriate due to unavailability of data in respect of all the companies in the database and as otherwise the revenue from onsite will not have any impact as the entire income was in foreign exchange.
7. It was further submitted by the assessee that TPO’s method of applying filters and selecting comparables was not transparent as the TPO has given only the final set of comparables chosen under TNMM which has prevented the assessee from verifying whether the elimination was done properly or not. It was contended by the assessee that the TPO has followed a pick and choose method instead of restricting himself to the actual search results. The assessee further contended that the TPO failed to appreciate that the assessee’s functions and risks were altogether different from the comparable cases adopted by him. As the assessee was a risk free company and was a captive service provider suitable risk adjustment was required to be provided.
8. The CIT(A) upheld the TNMM method adopted by the TPO as the most appropriate method by rejecting contentions of the assessee in this regard. The CIT(A) however accepted the assessee’s contention that large companies having more than Rs. 100 crore turnovers cannot be treated as comparables. The CIT(A) further held that the ’employee cost to sale’ filter adopted by the TPO is not appropriate as relevant data was not available in respect of all the companies available on the database. Moreover, part of the employee cost was included by certain companies under the different heads like software package companies under the different heads like software package cost or operating expenses etc. As a result of which the filter cannot be uniformly and objectively applied for selection of comparables. The CIT(A) also accepted assessee’s contention that the TPO was not correct in excluding all the companies whose onsite income was more than 75%. The CIT(A) further held that loss making companies and companies having super profits cannot be treated as comparables. On the aforesaid basis the CIT(A) selected 11 companies as comparables and directed the Assessing Officer to find out the arithmetic mean of those eleven companies and compute the adjusted average PLI after allowing working capital adjustment and risk adjustment @3% and benefit of (+)/(-)5% under the proviso to sec. 92C(2).
9. The learned Departmental Representative submitted before us that the cut off mark of 100 crores adopted by the CIT(A) while applying turnover filter is without any basis in absence of any such cut off provided under the IT Act, IT Rules or OECD guidelines. The learned Departmental Representative submitted that the turnover has no relation with the operating profit to operating cost ratio. The learned Departmental Representative objecting to the CIT(A)’s observation with regard to the employee cost to sale filter submitted that wage to sale ratio is an acceptable filter where the employee cost is too low or too high. In this context, the learned Departmental Representative relied upon a decision of the Delhi Bench of the Tribunal in case of Avaya India (P) Ltd. v. Asstt. CIT in ITA No.5150/Del/2010 dated 25-2-2011. The learned Departmental Representative also objected to the finding of the CIT(A) with regard to the onsite income filter.
10. The learned AR submitted that while applying the turnover filter, the scale of operation is a determining factor for deciding whether a particular company is comparable or not. The learned AR submitted that a company with small turnover cannot be compared with a company with very large turnover. In support of this, the learned AR relied upon a decision of Income-tax Appellate Tribunal, Bangalore Bench in case of Genisys Integrating Systems India (P.) Ltd. v. Dy. CIT [2012] 53 SOT 159 and of Income-tax Appellate Tribunal, Hyderabad Bench in case of Dy. CIT v. Deloitte Consulting (India) (P.) Ltd. [2012] 15 ITR 573. The learned AR submitted that the assessee is not exposed to any risk as the ownership of intangibles belongs to the AE. As risk is less profit is also less. In this context, the learned AR relied upon Income-tax Appellate Tribunal, Ahmedabad Bench decision in Mastek Ltd. v. Addl. CIT [2012] 53 SOT 111, Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 18 SOT 76 (Delhi), Sony India (P.)Ltd. v. Dy. CIT [2008] 114 ITD 448 Delhi, Income-tax Appellate Tribunal, Bangalore Bench decision in case of Continuous Computing (I) (P.) Ltd. v. ITO [2012] 52 SOT 45 (Bang.) (URO). The learned AR justifying the observation of the CIT(A) with regard to onsite revenue filter submitted that this filter cannot be applied as relevant information/material are not available. The learned AR further submitted that ’employee cost to sale filter’ cannot be applied as many companies, club employee cost under various heads like software development charges, project charges, product development charges, professional charges etc. The learned AR further submitted that while applying the ‘related party transactions’ filter comparables with related party transactions should be rejected irrespective of the scale/size of transactions with related party. In support, the learned AR relied upon the decision of the Income-tax Appellate Tribunal in case of Sony India (P.) Ltd. (supra).
11. We have heard rival submissions and perused the materials on record. The assessee in its TP study, has selected 22 companies as comparables for computing the ALP. The TPO has come to a conclusion that TNMM is the most appropriate method to compute the ALP. The TPO has accepted only 2 out of 22 companies selected by the assessee. The TPO has selected 15 additional companies in addition to the two from the companies selected by the assessee. When TNMM is adopted for determining ALP one has to be extra cautious to take into account the differences which are likely to materially affect the price, cost charged or paid, the profit in the open market for arriving at a reasonable and accurate adjustment. If the differences are such that they cannot be subject to evaluation or likely to give a unreasonable result, then such transactions should be avoided or eliminated for the purpose of comparison. The OECD in its guidelines has also stated that though TNMM may afford a practical solution to otherwise insoluble transfer pricing problems but, it has to be used sensibly and with appropriate adjustments keeping in view the differences between the comparables. If the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used it would not be appropriate to apply the TNMM without making adjustments for such differences. Keeping in view the above principles it has to be seen whether the comparables selected by the TPO on applications of different filters is appropriate. While the assessee was having a turnover of about Rs.13.57 crores many of the comparables selected by the TPO are having very high turnover of more than Rs.100 crores. In fact Satyam Computers Services and Infosys Limited are giants in comparison to the assessee. Therefore, those companies cannot be considered as comparables. The Income-tax Appellate Tribunal, Hyderabad Bench in case of Deloitte Consulting India (P.) Ltd. (supra) held as follows:-
“Now, we deal with the issue whether the TPO was correct in selecting Wipro BPO having turnover of 20 times more than the assessee company as comparable or not. We find that this issue is covered in favour of the assessee by the decision of Delhi Income-tax Appellate Tribunal in the case of Agnity India Technologies Pvt. Limited (2010) ITA No.3856/Del/2010. We find that the Wipro BPO is not at all comparable as the assessee company is pigmy compared to giant Wipro. Wipro Company’s turnover is 20 times more than the assessee company. Hence, the assessee company is not comparable with Wipro BPO, the reasoning being that the latter is a giant company having 20 times more turnover than the assessee company. In view of this based on the facts and the circumstances of the case, and following the decision of Delhi Bench of Income-tax Appellate Tribunal in the aforesaid case, we are of the view that Wipro BPO should be excluded from the list of comparable companies. Hence, the ground raised by the assessee on this issue is allowed.”
The same is also the view of the Income-tax Appellate Tribunal Bangalore Bench in case of Genesis Integrated Systems Ltd. (supra).
12. In view of the aforesaid, we uphold the decision of the CIT(A) in excluding companies whose turnover is more than Rs. 100 crores. Similarly the CIT(A) is equally correct in not sustaining the rejection of comparables selected by the assessee by applying ’employee cost to sale’ filter as relevant data/information for this filter are not available. Moreover, it is also a fact that part of the employee cost is included by many companies under different other heads. Selection of comparables applying the ‘onsite income’ filter also stands on the same footing as relevant data/information are not available in respect of all the companies in the database. It is also a fact that though the TPO has himself not applied this filter by observing that the companies having onsite income of more than 75% cannot be treated as comparables but two of the companies i.e. M/s Foursoft Limited and SankyaInfotech Limited selected as comparables by the TPO were having onsite income/expenses of more than 75%. In this view of the matter, the CIT(A) was correct in holding that rejection of comparables selected by the assessee by applying this filter is not correct. We also fully subscribe to the view of the CIT(A) that loss making companies and companies having super normal profits cannot be considered as comparables in view of the ratio laid down in case of Mentor Graphics (India) (P.) Ltd. (supra) and Philips Software Centre (P.)Ltd. v. Asstt. CIT [2008] 26 SOT 226 (Bang.). In aforesaid view of the matter, the companies selected by the CIT(A) as comparables is rational and appropriate in the facts of the present case. We therefore uphold the order of the CIT(A) in directing the Assessing Officer to compute the arithmetic mean of 11 comparables selected by him and determine the ALP after computing the adjusted average PLI. As result, grounds Nos. 1,2 and 3 are dismissed.
13. In Ground No. 4 the department has challenged the direction of the CIT(A) to give the benefit of (+)/(-) 5% under the proviso to section 92C(2) of the Act.
14. We have heard the submissions of the parties on this issue. It appears from the order of the CIT(A) that by relying upon a decision of the Income-tax Appellate Tribunal, Kolkota Bench in the case of Development Consultants (P.) Ltd. v. Dy. CIT [2008] 23 SOT 455 (Kol.)and Income-tax Appellate Tribunal’s decision in the case of Sony India (P.) Ltd. (supra). The CIT(A) has directed for allowing benefit of (+)/(-) 5% as a standard deduction. The Finance Act, 2012 amended the provision of section 92C of the Act by inserting section (2A) with retrospective effect from 1-4-2002 which reads as follows:-
“(2A) Where the first proviso to sub-section (2) as it stood before its amendment by the Finance (No. 2) Act, 2009 (33 of 2009), is applicable in respect of an international transaction for an assessment year and the variation between the arithmetical mean referred to in the said proviso and the price at which such transaction has actually been undertaken exceeds five per cent of the arithmetical mean, then, the assessee shall not be entitled to exercise the option as referred to in the said proviso.”
The aforesaid provision makes it clear that an assessee shall not be entitled to exercise its option as referred in the proviso to sub-section (2) if the variation between the arithmetical mean and the price at which such transaction has actually been undertaken exceeds 5% of the arithmetical mean. In view of the retrospective operation of the aforesaid provision, the benefit of (+)/(-) 5% as a standard deduction cannot be allowed. That apart this issue is also covered in favour of the department by the decision of the co-ordinate bench of the Tribunal in case of Deloitte Consulting India (P.) Ltd. (supra). The direction given by the CIT(A) is modified to this extent. Hence, the ground raised by the department is allowed.
15. Ground No. 5 relates to the CIT(A) directing the Assessing Officer to allow risk adjustment of 1% while computing the adjusted average PLI. In this context, the learned Departmental Representative submitted that the TPO has given valid reasons for not allowing any adjustment on account of risks which has been negated by the CIT(A) without making proper discussion. In support of his contention, the learned Departmental Representative relied on the order of the Tribunal in case of Symantec Software Solutions (P.) Ltd. v. Asstt.CIT [2011] 46 SOT 48.
16. The learned AR, on the other hand. Submitted that the TPO has wrongly assumed that the assessee runs all the risks of running the business. The learned AR submitted that the assessee being a captive service provider, it does not have any risk at all. In this context, the learned AR referred to the functional analysis checklist at page 96 of the paper book.
17. We have heard the submissions of the parties in this regard. The materials on record clearly prove the fact that the assessee is a captive service provider. It has transactions only with its AE. It is also a fact that all the risks lies with the AE. Different benches of the Tribunal have also taken a divergent view on this issue. The Income-tax Appellate Tribunal, Mumbai Bench in the case of Simontech (supra) has held that no separate adjustment is required on account of risk and functional difference, the Income-tax Appellate Tribunal Delhi Bench in the case of Sony India (P.) Ltd. (supra) has held that deduction on account of ownership of intangibles, risk factors can be allowed. In aforesaid view of the matter, we are inclined to accept the view favorable to the assessee. We therefore uphold the direction of the CIT(A) in this regard in allowing the benefit of risk adjustments at 1%. Accordingly, the ground raised by the department is dismissed.
18. In the result, the appeal filed by the department stands partly allowed.
19.In so far as the Cross Objection No.40/Hyd/2009 filed by the assessee is concerned, in ground Nos. 1 to 4, the assessee has challenged the adoption of TNMM for computation of ALP.
20. As mentioned hereinbefore the assessee in its TP study report had adopted CPM as the most appropriate method to bench-mark its international transaction. Objecting to the proposed adoption of TNMM by the TPO the assessee had submitted that considering the functional differences and the contractual terms adoption of CPM is more appropriate. It was submitted by the assessee that in TNMM many adjustments needs to be made. It was further submitted OECD has recommended that TNMM should be used as the method of last resort. The TPO has rejected CPM by citing following reasons
(a) “The CPM method presents some practical difficulties in identifying the costs incurred for the provision of services like whether an indirect cost is towards rendering services or it is an enterprise level expense.
(b) There is no discernible link between the level of costs incurred and a market price in software as the services are usually compensated on a man hourly basis which may not vary much across the industry for same or similar type of service. So, CPM is not the appropriate method.
(c) While applying CPM, the tax payer should have considered all direct and indirect costs incurred in respect of the services rendered by it. But, it is apparent from details given above that the tax payer itself did not include all the direct and indirect costs while computing gross mark up e.g. rent, insurance, repairs were not considered. In the case of comparable companies, the details of indirect costs incurred in rendering services were simply not available. Thus, it can not be said that the gross profit worked out in the case f the comparable is after taking into account the same items of expenditure as in the case of the taxpayer.
(d) As per the agreement, the tax payer’s cost of providing services includes all costs that have been incurred by the tax payer except interest expenses. All these expenses are reimbursed on cost plus basis. The tax payer is forgetting that except interest expenses. it is also getting 8% on other costs which have been excluded by the tax payer in CPM like rent, repairs, insurance, lease and hire charges etc. So, the gross margin shown by the tax payer distorts the true picture of its financials for which TNMM method is the most appropriate method as it captures all expenses except interest, coinciding the cost base of the tax payer for reimbursement (a per the agreement and invoices raised by the tax payer)
(e) In the taxpayer’s case all the costs were incurred towards rendering of services. Therefore, the gross profit is the same in the taxpayer’s case as the net profit. Thus thetaxpayer’sPL1 remains the same whether CPM is applied or the TNMM is applied. The difference between the two methods in the taxpayer’s case is thus only an academic interest.”
The CIT(A) has also sustained the view of the TPO by observing in the following manner:-
“I agree with the aforesaid reasoning of the TPO for rejecting the CPM to be applied in the case of the appellant as the most appropriate method. TPO’s stand gets support from the decision of Hon’ble Supreme Court in the case of Morgan Stanley (291 ITR 16) where it was held that TNMM was the most appropriate method in the case of Service PE as the TNMM apportions the total operating profit arising from the transactions on the basis of sales, cost, assets etc. Hence, the adoption of TNMM as the most appropriate method in the case of the appellant, is upheld. It is also pertinent to mention here that since A.Y. 2002-03, TPO has adopted TNMM method in the case of the appellant for determining the ALP of its international transactions with AE. The same was accepted by the appellant in earlier years.”
21. We have heard submissions of the parties. We have also applied our mind to the decisions cited before us. It is seen that the assessee has itself accepted that TNMM is similar to CPM excepting that CPM is based on gross margins whereas TNMM is based on net margins. The assessee has also accepted that if proper selection criteria are adhered to application of TNMM would also result in the fact that the price at which the assessee has undertaken the international transactions are at arm’s length. The Honorable Punjab & Haryana High Court in the case of Coca Cola India Inc v. Asstt. CIT [2009] 309 ITR 194 has held that merely because the assessee has chosen one of the methods, it does not take away the discretion of the TPO to select any other method which may be considered to be more appropriate for the purpose of determining the true income. It is also a crucial fact that the assessee has not disputed adoption of TNMM by the TPO in the earlier assessment years. In aforesaid view of the matter, we are inclined to agree with the finding of the CIT(A) on this issue. Accordingly, the ground raised by the assessee is dismissed.
22. In ground No.5 the assessee has challenged the rejection of its contention that the Assessing Officer has to prove the transfer of profit to AE while making adjustments to ALP as assessee’s income is exempt.
23. In this context, it is the contention of the learned AR that transfer pricing Provisions are intended for checking the shifting of profit from one tax jurisdiction to another. The learned AR submitted that since the assessee’s income in India is exempt u/s 10A of the Act there is no need for shifting profit to its AE. In support of such contention the learned AR relied upon Circular No.12 dated 23-8-2001 of the CBDT and the decisions of the Tribunal in case of Philips Software Centre (P.) Ltd. (supra).
24. The learned Departmental Representative on the other hand submitted that there is no need for the Assessing Officer to prove that the assessee had shifted profits to its AE while making adjustments in ALP. In this context the learned Departmental Representative relied upon the decision of the P & H High Court in case of Coca Cola India Inc (supra) and decision of the Income-tax Appellate Tribunal, Bangalore Bench in case of SAP Labs (I) (P.) Ltd. v. Asstt.CIT [2012] 134 ITD 253.
25. We have heard rival submissions and perused the materials on record. We have also examined the decisions relied upon by the assessee. Our finding on the issue is though it is a fact that assessee’s income is exempt u/s 10A of the Act but that does not necessarily mean that the Assessing Officer has to prove the shifting of profits by the assessee to its AE before applying Transfer Pricing Provision. The Honorable P & H High Court in the case of Coca Cola India Inc. (supra) while considering somewhat similar issue held in the following manner:-
“We do not find any ambiguity or absurd consequence of application of Chapter-X to persons who are subject to jurisdiction of taxing authorities in India nor we find any statutory requirement of establishing that there is transfer of profit outside India or that there is evasion of tax. Only condition precedent for invoking provisions of Chapter X is that there should be income arising from International transaction and such income is to be computed having regard to arms length price. “International transaction” as defined u/s 92B of the Act, as already observed, certainly stands on a different footing than any other transaction. Arms length price is nothing but a fair price which would have been normal price. There is always a possibility of transaction between a non-resident and its associates being under valued and having regard to such tendency, a provision that income arising out of the said transaction could be computed having regard to arms length price, will not be opened to question and is within the legislative competence to effectuate the charge of taxing real income in India.”
The Income-tax Appellate Tribunal, Bangalore Bench in case of SAP Labs India (P.) Ltd. (supra) while considering identical issue held in the following manner:-
“The argument of the assessee with reference to sec. 10A status also needs a mention. It is the case of the assessee that it is enjoying sec. 10A benefit and no tax is payable on export income, which makes the Indian tax rate more attractive than German tax rate and therefore, there could be no motive to understate assessee’s income. This argument could be a good logic, but only for those assessment years covered by sec. 10A benefit. Once the benefit is exhausted, the assessee would be liable for taxation in which case, the German tax rate may be more attractive. If the pricing for the exempted years is accepted without analysis there is every chance that the assessing authority might be estopped, on the doctrine of consistency, from examining the pricing for the subsequent non-exempted years. This is quite uncalled for.”
In view of the aforesaid judicial pronouncements, the contention raised by the assessee is not acceptable. Accordingly, the ground raised by the assessee in its Cross Objection is dismissed.
26. Now, we deal with ITA No. 1411/Hyd/2010 filed by the assessee. In this appeal, the assessee has challenged the assessment order dated 8-10-2010 read with section 92CA and 144C of the Act on the directions of the Dispute Resolution Panel (DRP). The appeal pertains to the assessment year 2006-07.
27. The grounds raised by the assessee gives rise to the following two issues.
(i) TNMM method adopted by the TPO cannot be considered as most appropriate method in place of cost plus method adopted by the assessee.
(ii) The addition of Rs. 1,89,17,699/- on account of adjustment to the ALP is without any justified basis as the comparables selected by the TPO by applying certain filters are not proper.
The facts being more or less similar to the assessment year 2005-06 dealt in detail herein before in departmental appeal No. 645/Hyd/2010, it is not necessary to deal with all those facts over again in this appeal.
For the assessment year under dispute, the assessee entered into international transaction with its AE worth Rs. 16,96,54,026/-. For the impugned assessment year, the assessee filed its return of income on 16-11-2006 declaring a total income of Rs. 1,82,742/- after claiming deduction of Rs. 1,18,73,994/- u/s 10A of the Act. For computing the ALP of internal transaction, the assessee adopted cost plus method (CPM) as was the case in the preceding assessment year 2005-06. In course of assessment proceedings u/s 143(3) of the Act, the Assessing Officer made a reference to the TPO u/s 92CA of the Act to determine the ALP. In course of proceeding before the TPO, the assessee produced various documents along with TP Study Report. In the TP Study Report, the assessee had selected 17 companies as comparables. The TPO rejected the CPM method adopted by the assessee by observing that due to lack of assessable information on independent comparable transaction or about the gross profit margins, the TPO held that in assessee’s case TNMM is the most appropriate method in view of the available data in public domain. The TPO while examining the TP study report came to a conclusion that most of comparables selected by the assessee are either functionally dissimilar or not working in comparable circumstances. Therefore, the TP study fails the fundamental taste of reliability and correctness. The TPO further observed that the assessee has rejected many companies which otherwise qualifies filters applied by the assessee itself. The TPO further found that the assessee has used earlier two years’ data in case of comparables even though they are not comparables as per the assessee’s own submission in the TP documentation.
28. It was further observed that the assessee has not applied the 25% related party transactions uniformly and have selected even though they did not qualify this filter. It was further observed that the assessee has considered many companies having predominantly onsite transaction though the assessee is a 100% offshore research development service provider akin to a software development provider. On the aforesaid basis, the TPO holding that the data used by the assessee as unreliable and incorrect rejected the TP study report and the comparables selected by the assessee and undertook a search process himself for selecting additional comparables. The TPO applied certain additional filters for selection of comparables. By applying the said filters, the TPO selected 20 companies as comparables which are at page 108 of TP order passed by him. The TPO by considering the operational profit to total cost ratio of the comparables selected by him computed arithmetic mean PLI at 20.68% after allowing working capital adjustment of 1.51%, the adjusted arithmetic mean PLI was determined at 19.17%. By applying the aforesaid adjusted arithmetic mean PLI, the ALP was computed at 119.17% of the operating cost and ALP of the international transaction was determined at Rs.18,60,76,624/-. As there was a shortfall of Rs.1,66,94,486/-, the TPO recommended for the adjustment of the same u/s 92CA of the Act. The adjustment in ALP by the TPO was challenged before the DRP. The DRP however did not accept the contentions raised by the assessee and upheld the ALP calculated by the TPO.
29. The learned AR submitted before us that the rejection of CPM method by TPO is without any proper reasoning and the anomalies pointed by the TPO are on account of mis-interpretation of the OECD guidelines and ICA guidelines. The rejection of the selected comparables under CPM is without any basis. The learned AR submitted that TPO has applied defective selection criteria while selecting comparables which will never give correct results. The learned AR submitted that the TPO has considered comparables having huge turnover compared to the turnover of the assessee. The learned AR submitted that some of the comparables are also functionally dissimilar. The learned AR submitted that companies having extraordinary profits were also considered. The learned AR further submitted that the TPO was totally incorrect in selecting/rejecting comparables while applying the “employee cost to sale” filter and “onsite income” filter. It was further submitted by the learned AR that the TPO had also failed to give adjustment towards functions, assets employed and risks while arriving at the ALP.
30. The learned Departmental Representative, on the other hand, strongly supported the order of the DRP and TPO.
31. We have heard rival submissions and perused the material on record. So far as the first issue is concerned, we uphold the orders of the lower authorities in applying TNMM as the most appropriate method, in view of our detailed reasoning given in assessee’s C.O. No. 40/Hyd/2009 (supra). Hence the assessee’s contention on this issue is rejected.
32. However, so far as comparables selected by the TPO by applying certain filters are concerned, it is seen that while applying the turnover filter though the TPO has excluded companies having turnover of less than Rs.1 crore, he has not applied any upper limit. Eight of the companies, out of 20 selected by the TPO are having turnover of more than Rs.100 crores and at least five of them are having turnover of more than Rs. 200 crores viz., Infosys Limited (Rs. 9028.00 crores), Mindtree Consulting Limited (Rs. 448.78 crores), Persistent Systems Limited (Rs.209.18 crores), Sasken Communication Limited (Rs. 240.03 crores), Flextronics Software Systems Limited (Rs. 595.12 crores) and iGate Global Solutions Limited (Rs. 527.91 crores). Compared to the aforesaid companies, the assessee’s turnover is about only Rs. 17 crores. Hence, companies having huge turnover cannot be treated as comparables.
33. Similarly, companies having extraordinarily high profits also cannot be considered as comparables. In this category comes Infosys Limited (40.38%), KALS Infosystems Limited (39.75%), Megasoft Limited (52.74%) and Accel Transmitting Limited (44.07%).
34. The accept/reject matrix of the comparables adopted by the TPO by applying “employee cost to sale” filter and “onsite income” filter also cannot be accepted in view of our observation in department’s appeal No. 645/Hyd/09. These factors have not at all been considered by the DRP in its order passed u/s 144C(5) of the I T Act. In aforesaid view of the matter, we consider it proper to set aside the order passed by the DRP as well as assessment order passed in consequence thereto and remit the matter back to the TPO who shall re-compute the ALP in accordance with the observations made by us herein above and also in the department’s appeal in ITA No.645/Hyd/09 (supra). Needless to mention here that the TPO shall afford a reasonable opportunity of being heard to the assessee. Before parting, we would like to observe that though the TPO is empowered under the provisions of the Act to collect information u/s 133(6) of the Act. But, at the same time, principles of natural justice demand that the information so collected, if proposed to be utilised, then the same has to be confronted to the assessee.
35. In the result, the appeal filed by the assessee is treated as partly allowed for statistical purposes.
36. To sum up, ITA No.645/Hyd/09 filed by the department is partly allowed. C.O. No.40/Hyd/2009 filed by the assessee is dismissed and ITA No. 1411/Hyd/10 filed by the assessee is partly allowed for statistical purposes.
