Income Tax Appellate Tribunal - Delhi
Microsoft India (R&D) Pvt. Ltd., New ... vs Dcit, New Delhi on 23 July, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH „I-1 ‟ NEW DLEHI
BEFORE SMT. DIVA SINGH, JUDICIAL MEMBER
AND
SHRI PRASHANT MAHARISHI, ACCOUNTANT MEMBER
I.T.A. No.1479/Del/2016
Assessment Year: 2011-12
M/s Microsoft India (R&D) P. Ltd. Vs Dy.Commissioner of Income-tax,
807, New Delhi House, Circle 16(2), New Delhi.
Barakhamba Road, New Delhi.
(PAN:AABCM6358F)
( Appellant) (Respondent)
Appellant by: S/Shri Nageshwar Rao & Parth, Advocate
Respondent by: Shri Sanjay I. Bara, CIT-DR
Date of hearing: 05.06.2018
Date of Pronouncement: 23.07.2018
INTERIM ORDER
PER DIVA SINGH The present appeal pertaining to 2011-12 assessment year is a stay granted appeal and has come up for a priority hearing on account of this fact. The assessee in the present appeal, assails the correctness of the final assessment order dated „nil‟ passed by the assessing officer (AO) u/s 143 (3) r.w.s 144 C (1) of the Income Tax Act 1961 (hereinafter called the Act) incorporating the revised Transfer Pricing Officer‟s order dated 04/01/2016 passed pursuant to the Directions dated 08/12/2015 given by the DRP.
2. The issue which falls for consideration in the present proceedings, addressed vide this interim order revolves around the arguments stated to have been advanced before the Co-ordinate Bench on 21/05/2018 qua the challenge posed in ground No. 7 by the assessee. The relevant extract of the handwritten order sheet entry by the bench clerk signed by the ld. Members is reproduced hereunder for ready reference 21/05/2018 Present for the Assessee : Sh. Nageshwar Rao, Adv.
Present for the Deptt.: Shri Sanjay I. Bara, CIT VDR दोनों ऩऺ आधार सं. 7 ऩर लिखित ननवेदन दे ना चाहती हैं। केस की सुनवाई 29.05.2018 के लिए स्थगित की जाती है ।
Sd/- Sd/-
(S.K. Kamble) (N.K. Saini)
3. In the said background on 29.05.2018 the parties invited our attention to the aforesaid order sheet entry. The Ld.AR filed copy of the written ITA No. 1479/Del/16 AY 2011-12 Page 2 of 21 submissions stated to have been filed on the directions of the Bench and stated that these have been emailed to the Department and hard copy thereof was being filed in the Court.
4. The CIT-DR Mr. Bara stated that the TPO‟s reply available was also being filed in the Court. It was also his submission that though the emailed copy had been sent by the Ld. AR however he had not been able to go through the same accordingly an oral request was made seeking time.
5. Departmental request for time was accepted, however the Ld. AR for the sake of clarity about what transpired on an earlier date was required to briefly sum up the submissions stated to have been advanced before the Coordinate Bench. He was also required to address the specific ground under which the prayer for quashing the order was stated to be maintainable.
5.1 Reading out ground No. 7 raised by the assessee in the present appeal and inviting attention to specific internal page - 13 and 61 of the TPO‟s order it was his submission that repeatedly the TPO has noted that the TP study is not being rejected. Thus in the face of this categoric repetition brought out in the order by the TPO himself which he has also been kind enough to highlight it in his order to emphasize its importance the issue on facts, it was stated, stands addressed. Thus, in the face of the admission by the TPO himself it had been argued that the prayer is maintainable relying on the precedent laid down by the jurisdictional High Court in the case of Li & Fung, 361 ITR 85 (Delhi) . The said precedent, it had been argued before the Bench that it had been followed by the Delhi Bench in ITA No.7260/Del/2017 dated 7th May, 2018 in the case of Coim India P. Ltd. Copy of the order was filed. On the basis of these decisions it was his submission that it had been argued that the TPO therefore lacked the jurisdiction to pass the order. In these circumstances it was his submission that in case the assessee succeeds on the basis of facts available on record and the judicial precedent available the issues raised in the remaining grounds assailing the adjustments made would not be required to be addressed in the present appeal.
6. On a reading of the assessee's Ground No. 7, though time had been sought by the Revenue which was being granted considering the record a preliminary view after hearing the ld. AR was conveyed to the parties on behalf of the Bench that the issue it appeared could not be said to be arising on a reading of the aforesaid ground. Since no explanation was offered addressing the specific query of the Bench the Ld. AR merely confined himself to stating ITA No. 1479/Del/16 AY 2011-12 Page 3 of 21 that the plea was raised on 21.5.2018 and the issue was heard at length from both the sides and the Bench in view thereof had given time to the parties to place their written submissions. Accordingly the Ld. AR was required to address the query on the next date. In the said background accepting the oral prayer of the CITDR adjournment was granted.
6.1 The typed copy of the Specific handwritten order sheet entry by the bench is reproduced as under:
" ORDER SHEET ENTRY DATED 29.5.2018"
Adjourned to 5th June, 2018 on the request of the CIT DR Shri S.I. Bora who is handed over the submission by ld.AR. Reply of TPO filed . Mr. Rao, Advocate to place justification of raising the plea in Ground No.7. Mr. Rao seek time to reply thereto the reply of TPO Read out in the Tribunal.
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(Prashant Maharishi) (Diva Singh)
7. On the next date of hearing i.e. 5.6.2018, the learned AR invited attention to application dated 29.5.2018 filed in the Registry praying for admission of the following additional ground as ground No.7A:
"Ground No.7A: Transfer pricing adjustments made by ld. TPO are bad in law inter- alia for the reason that ld. TPO did not reject TP documentation prepared by Appellant and still modified economic analysis undertaken by Appellant."
7.1. Relying upon the decision of the Apex court in the case of NTPC it was his prayer that the raising of the aforesaid additional ground is maintainable as no fresh enquiry into facts is required and in terms of the precedent available in the case of Li and Fung which has been followed by the ITAT in Delhi Benches in the case of Coim India private limited it was his submission that the ground may be admitted and allowed.
7.2 Attention was invited to the "further written submissions" filed on behalf of the assessee regarding non-rejection of TP study. Reading therefrom it was submitted that during the hearing of the subject appeal on 21st May 2018 the ITAT had directed the assessee and Revenue to file synopsis of the oral submissions made in connection with ground No. 7 of assessee‟s appeal wherein relying on decision of the jurisdictional High Court and the ITAT Delhi Bench‟s order it was submitted that when the TPO has categorically asserted in his order that "it is emphasized that transfer pricing study is not rejected at all"
the TPO thereafter could not then make any modifications/supplementation/substitution of the study.
ITA No. 1479/Del/16AY 2011-12 Page 4 of 21 7.3 It was submitted that the assessee has provided advance copy of its synopsis to the Departmental representative however on going through the Report received from the TPO filed by the CIT-DR on the directions of the Bench which had been provided to the Counsel on the last date, it was noticed that the department has not included any submissions/comment on the above arguments advanced before the court on 21/05/2018.
7.4 Thus it was his submission that in the face of the non rejection of the assessee‟s TP documentation. evident from the TPO‟s order dated 30.01. 2015 wherein at internal pages 13 and 61 of his order the TPO has unambiguously emphasized that TP study is not being rejected at all in these facts relying upon para 44 of the decision of the jurisdictional High Court in the case of Li and Fung India it was his submission that the Court has held that it is improper on the part of the Revenue authorities to proceed to their own determination and calculations of ALP without having rejected assessee‟s comparison / assessment in the first place.
7.5 The said proposition of law it was submitted has been followed by the ITAT Delhi Bench in the case of Coim India private limited versus ACIT specific attention was invited to para-11 of the said decision wherein it had been held that without first discarding the methodology of the assessee the TPO cannot proceed to make any alterations 7.6. Accordingly it was his prayer that the TP adjustments made by the TPO/AO are bad in law and deserve to be quashed and the adjustments / addition may be deleted on this preliminary objection. However for the sake of completeness it was submitted the assessee would also want to argue the entire appeal on merits.
8. The Ld. the CIT-DR Mr. Bara on going through the written submissions and the further written submissions made available on behalf of the assessee and on considering the reply of the TPO filed stated that though on the directions of the Bench written reply was required to be filed however the reply filed does not appear to have addressed the objection to the allowability of the said prayer. It was his submission that all along he has argued that the prayer of the assessee was not maintainable on facts and it had been objected to by him before the Bench even on 21.05.2018. It was also his submission that when the TPO‟s order is considered in totality it would be seen that though the words have been used by the TPO by way of abundant caution to say that the entire TP study is not being rejected, it is also highlighted to address the ITA No. 1479/Del/16 AY 2011-12 Page 5 of 21 reasonableness of the view of the TPO who has addressed the objections of the assessee and while doing so, he is only highlighting the salient issues on which he picks out and requires the assessee to address and consequently considers that to the extent the TP study is accepted. The arguments raised by the assessee, it was submitted, were in fact an afterthought and may not be made the basis for granting relief as neither it is raised before the DRP nor the ITAT originally.
8.1 Accordingly, it was submitted that since the issue was never agitated before the DRP and not raised before the ITAT also originally it is an afterthought and thus the additional ground may not be admitted and in case it is admitted, it may be rejected as the TPO repeatedly has given detailed reasons after hearing the assessee clearly stating for what reasons and to what extent, the transfer pricing study was not being accepted. The ground in the eventuality it was admitted it was his prayer may be dismissed.
9. The ld. AR in reply stated that it is an after thought on the part of the Revenue to now defend the speaking observations made by the TPO by way of the oral arguments advanced before the ITAT.
10. We have heard the submissions and perused the material available on record. We first propose to address the arguments qua the allowability of the assessee‟s prayer under the weight of ground No. 7 as it has been worded. The specific ground is extracted hereunder for ready reference :
" Ground No.7:
That on facts and in law, the Hon‟ble DRP and the ld. TPO/Ld.AO have erred by not accepting the economic analysis undertaken by the appellant in accordance with the provisions of the Act read with the Income-tax Rules, 1962 („IT Rules‟), and conducting a fresh economic analysis for the determination of the arm‟s length price („ALP‟) of the impugned transactions and holding that the same are not at arm‟s length."
10.1 On a reading of the above, we find that the challenge therein is posed specifically to the correctness of the decision of the DRP/TPO wherein the economic analysis carried out by the taxpayer is rejected. Thus, we find that by no stretch of imagination, the prayer stated to be advanced by way of oral argument on 21.05.2018 could be addressed under the weight of ground No. 7 as it is worded. Accordingly, we have no hesitation in holding that the same has to be rejected.
11. We note that the assessee taking the hint from the preliminary view expressed on 29.05.2018 has moved an application for admission of additional ITA No. 1479/Del/16 AY 2011-12 Page 6 of 21 ground namely ground number 7A which though has been extracted earlier is reproduced hereunder again for ready reference:
"Ground No.7A: Transfer pricing adjustments made by ld. TPO are bad in law inter- alia for the reason that ld. TPO did not reject TP documentation prepared by Appellant and still modified economic analysis undertaken by Appellant."
11.1 Addressing the admissibility of the said ground taking note of the departmental objections to the raising of the said ground at this stage we deem it appropriate to first address certain salient facts. Admittedly the precedent laid down by the jurisdictional High Court in case of Li & Fung (cited supra) relied upon by the assessee we note was available in the public domain from 16.12.2013. The assessee having filed the Objections before the DRP pursuant to the TPO‟s order dated 30.01.2015 we note could have agitated the same before the DRP and there was no impediment for the assessee to raise the objection either before the DRP or take it as a fresh Ground "inadvertently" not taken before the ITAT. It is a matter of record that no such objection before the DRP or Ground before the ITAT was raised.
11.2 It is seen that the ld. AR has also relied upon a recent decision argued by him before the Delhi Bench in ITA 7260/Del/2017 dated 07/05/2018 in the case of M/s Coim India private limited. On going through the said order we find from the discussion made therein that it is not clear which ground of the assessee was being considered by the coordinate Bench as the Grounds raised before the ITAT are not found extracted in the order. We propose to extract hereinafter the specific finding of the Co-ordinate Bench whereupon heavy reliance is placed upon by the Revenue. On a reading there from we note that though the Ld. AR has relied upon the same as a precedent for allowability of the prayer couched in the additional ground, however, in the order the factual background which lead to the passing of the order is not addressed. It is not clear whether an additional ground was raised in the course of the arguments before the ITAT or was the ground all along before the DRP and stood adjudicated upon by the DRP which had been considered by the co-ordinate Bench. We further note on a reading of the aforesaid order that not only was the assessee represented by the very same counsel Mr. Nageshwar Rao appearing in the present proceeding even the Revenue was also represented by the very same CIT-DR Mr. Bara. On a reading of the order it also appears that the position on facts considered was accepted by the Revenue as apparently no Objections to the allowability of the assessee‟s prayer are found discussed by the Co-ordinate Bench. For ready reference we reproduce para 11 and 12 from the aforesaid decision :
ITA No. 1479/Del/16AY 2011-12 Page 7 of 21 "11. Moreover, it can be seen that neither the TPO nor the DRP has discarded the most appropriate method adopted by the assessee which was TNMM. Without discarding the methodology of the assessee, the TPO cannot proceed further. For this proposition, we draw support from the judgment of the Hon'ble Jurisdictional High Court of Delhi in the case of Li and Fung India [P] Ltd Vs. CIT reported at 361 ITR 85 [DEL]. The relevant findings of the Hon'ble Jurisdictional High Court read as under:
"44. Another important aspect which cannot be overlooked is that the transfer pricing documentation maintained in terms of section 92D of the Act read with rule 10B of the Income- tax Rules, determined the arm's length price of the "international transaction" of the provision of buying services applying the TNMM, by comparing operating profit margin of LFIL with that of the comparable companies, as under:
Weighted average OP/OC per cent of 4.07 per cent
26 comparable companies
OP/OC per cent of LFIL 5.17 percent
This exercise has not been discarded, In other words, the TPO and the appellate fora were aware that in accordance with the rules, a comparison of the profit margin of LFIL with that of other similarly functioning companies was shown, and is, at the first instance, relevant to determine the ALP. The profit margin, as well as the cost plus model adopted by LFIL, was not shown to be distorted or of such magnitude as to persuade the tax authorities into discarding the exercise altogether. Having not contradicted this comparison, the Revenue proceeded to its own determination and calculations. This, however, is improper, given that the assessment carried out by the assessee must first be rejected, for any further alterations to take place. Indeed, it cannot be that the Revenue admits to the correctness of LFIL "s assessment but nonetheless proceeds to adopt a different method.
45. Indeed, once the TNMM was deemed most appropriate method, the distortions, if any, had to be addressed within its framework. Here, the unrelated transactions which were compared by LFIL have not been adversely commented upon, and neither has the choice of the TNMM. The TPO, therefore, ignored the relevant and crucial material, and straightaway proceeded to broaden the base for arriving at the profit margin, for attributed income of the assessee. Not only is this a clear infraction of the terms of the Act and Rules; the TPO went ahead to introduce what is clearly alien to the provisions of law and travelled outside the Rules.
46. The assessee had argued that no such adjustment was made in the earlier assessment years, for which assessment orders of previous four years were submitted, wherein the TNMM with operating profit over total cost (OP/TC) as a profit level indicator was accepted previously. Reliance was placed on decisions of the Supreme Court in Radhasoami Satsang (supra) and CIT V. New Poly Pack (supra) to support the aforementioned argument. Although previous tax assessments do not bar subsequent claims as res judicata, each assessment must be justified on its own terms, and as detailed above, the assessment by the TPO/AO, and the subsequent acceptance of these methods by the appellate authorities, is inconsistent with the IT Rules and the IT Act,"
12. Facts on record show that the TPO has not discarded the exercise undertaken by the assessee in determining the ALP of the international transaction relating to payment of royalty and technical fees. In light of the afore stated judgment of the Hon'ble Jurisdictional High Court [supra], action of the TPO is bad in law and the DRP grossly erred in affirming the action of the TPO.
(emphasis supplied) 11.3 Accordingly, noting that though the judicial precedent available in the case of Li & Fung was available in the public domain from 16.12.2013 and the assessee raised no such objection before the DRP or before the ITAT however emboldened by the precedent as available in the case of M/s COIM India P.Ltd. dated 07.05.2018 the ground has been raised wherein it is successfully pleaded that no fresh enquiry is required to be made for adjudicating the ground No. 7(A). Accordingly, in view of these peculiar facts and circumstances and considering the position of law we deem it appropriate to admit the said ground overruling the departmental objections.
ITA No. 1479/Del/16AY 2011-12 Page 8 of 21
12. Addressing the arguments of the parties for allowability of the prayer in terms of ground No. 7(A), we find that the pleas raised by the assessee referring to page 13 and 61 of the TPO‟s 95 paged order placed at appeal-set pages 336 to 430 wherein the specific observations have been made by the TPO at internal page 13 (348 of the appeal set) and internal page 61 (396 of the appeal set) the prayer of the assessee cannot be accepted. The reasons for the aforesaid conclusion are elaborated hereinafter. Before we elaborate the conclusion so drawn after considering the facts and circumstances the material available on record and the judicial precedent cited which has been duly considered we deem it appropriate to first address certain relevant facts.
12.1. The assessee in the facts of the present case (MIRPL) is a private limited company which is engaged in the business of software development and product support services. The assessee company was incorporated on 15/05/1998 under the Companies Act 1956 and is a wholly owned subsidiary of M/s Microsoft Ireland Capital Ltd (99.99%) which is ultimately owned by Microsoft Corporation, USA. The assessee has two undertakings, one at Bangalore and the other at Hyderabad. The Hyderabad STP unit was setup in 1998 and provides software development services to its associated enterprise ("AE"), MS Corp. The Bangalore STP unit was setup in 2003 and provides IT enabled services to MS Corp. In respect of its Bangalore unit registered with STPI of Bangalore, the assessee has claimed deduction under section 10A. It is seen that the assessee in the TP Study disclosed the following International transactions with the AEs in the year under consideration :
Type of International transaction Method selected Value of Transaction Margin of Margin of in INR assessee comparables Provision of Software Development Services (Hyderabad TNMM using OP/OC 10,720,663,928 14.94% 9.50% Unit) as PL1 Purchase of fixed assets 596,590 Provision of IT Enabled Services (Bangalore Unit) TNMM using 3,234,626,948 15.39% 13.18% OP/OC as PL1 Payment for assignment of personnel services by TNMM using 87,065,082 5% MIRPL OP/OC as PLI Payment of interest on External Commercial CUP Method 571,927 LIBOR Borrowing ("ECB") plus Reimbursement of expenses received from AEs No benchmarking 366,988,222 NA required 12.2. The Ownership Structure of MIRPL as on 31st March,2011 has been addressed by the TPO in the following manner :
2. Group Overview and Ownership structure:ITA No. 1479/Del/16
AY 2011-12 Page 9 of 21 2.1 Ownership structure The ownership structure of MIRPL as on 31 March 2011 is as follows:
S.no List of Shareholder No. of shares Percentage of holding
1. Microsoft Ireland 4,236,002 99.99 Percen t Research limited, Ierland
2. Round Island One 1 0.01 Percent Limited Total 4,236,002 100 percent The diagrammatic representation of the ownership structure of MIRPL as on 31 March 2011 is as follows.
Microsoft Ireland Research 99.99% Outside India India Microsoft India R&D Private Limited 12.3 The profile of M.S Corp has been addressed in the following manner:
2.2 Profile of MS Corp MS Corp, the parent company of the Microsoft Group was founded as a partnership in 1975 and later incorporated in 1981 with its headquarters in Redmond, Washington, the United States of America ("US"}. The headquarters house MS Corp's corporate offices, its US based finance and administrative staff, all of its officers and most of its executives, most of its research and development teams and some of its sales and marketing personnel.
MS Corp develops and markets software, services, hardware, and solutions. MS Corp does business throughout the world and has offices in more than 100 countries. MS Corp generates revenue by developing, manufacturing, licensing, and supporting a wide range of software products and services for many different types of computing devices. Microsoft software products and services Include Operating system for personal computer services and intelligent devices server application for distributed computing environments information worker productivity application busness solutions high- performance computing application software development tools and video garnes ,MS corp Provides consulting and product and solution support services, and train and certify computer system integrators and developers. MS Corp also designs and sells hardware including ITA No. 1479/Del/16 AY 2011-12 Page 10 of 21 the Xbox 360 gaming and entertainment console and accessories, the Zune digital music and entertainment device and accessories, and PC hardware products.
MS Corp earns revenue from customers purchasing its software; that will continue to be an important part of its business, even as MS Corp develops and delivers "cloud- based" computing services. Cloud-based computing involves providing software, services and content over the Internet by way of shared computing resources located in centralized data centers. Consumers and business customers access these resources from a variety of devices. Revenues are earned primarily from usage fees and advertising.
Microsoft's "software plus services" vision reflects its belief that what is most powerful for end users is a computing or communication device running sophisticated software, interacting with cloud-based resources. Examples of consumer-oriented cloud-based computing services MS Corp offers currently include:
> Bing, its Internet search service;
> Windows Live Essentials suite, which allows users to upload and organize
photos, make movies, communicate via email and messaging and enhance online safety; and Xbox LIVE service, which enables online gaming, social networking, and content access.
MS Corp's current cloud-based services for business users include:
> Microsoft Office Web Apps, which are the online companions to Microsoft Word, Excel, PowerPoint, and OneNote;
> Business Productivity Online Suite, offering communications and collaboration solutions with high availability and simplified enterprise IT management; > Microsoft Dynamics Online family of customer relationship management ["CRM") and enterprise resources planning services; .and > The Azure family of services, including a scalable operating system with compute, storage, hosting and management capabilities, a relational database, and a platform that helps developers connect applications and services in the cloud or on premise. While MS Corp and affiliates perform R&D activity around the world (United States, Canada, China, Denmark; France, India, Ireland, Israel, Japan, Norway and the U.K. amongst others), all final development and product release activities are performed in the United States by MS Corp. No local Microsoft subsidiary, Including MIRPL, plays any part in the product release activities. Microsoft subsidiaries may occasionally announce the release or availability of a Microsoft product in their local market. This does not mean that subsidiary had any role in the development, creation, or release of that product to the market The public relations release is merely En performance of the marketing services that MIRPL has been engaged to perform under either the Parent-Subsidiary Agreement with MS Corp."
12.4. The TPO summed up the TP Approach of the assessee in the following manner :
5.1 Assessee had selected the transactional net margin (TNMM) as t h e method for benchmarking of the International transactional for provision, of software services (SWO) with return on operating cost ("OP/OC") as the profit level indicator- (PLl ). For this the PLI of the assessee had been computed at 14.34% and of comparable on the basis of multiple year data at 9.50%.
For provision of IT enabled services (ITES), assessee had selected TNMM as the most appropriate method with OP/OC as a profit level Indicator. The PLI of the assessee was computed at 15.39% and of comparable on the basis of multiple year data at 4.63%. For assignment of personnel, the TNMM was selected as the most appropriate method with OP/TC as a PU. In this case foreign AE was selected as the tested party. The margin of the assessee was shown at 5% and of comparables was shown at 2.51%. On the basis of above analysis, it had been concluded by the assessee that international transactions are at -arm's length price.
ITA No. 1479/Del/16AY 2011-12 Page 11 of 21 For the sake of convenience and clarity the two main segments of the assesses namely ITES segment and the software development related contract R and activity are analysed separately and their arm's length determined accordingly. First the IT enabled services segment Is taken up for consideration as follows in Part A and the Contract R and D segment is dealt after that.
(emphasis supplied) 12.5 We note that the TPO considering the assessee‟s TP Study first addresses the IT enabled Services. He notes that, the assessee has used TNMM as the most appropriate method and OP/OC as the PLI. The assessee has arrived at a set of 17 companies under ITES Segment with an average margin of 4.63%. The assessee has used multiple year data. The assessee's own margin is worked out to be 15.39%, Based on the analysis, the assessee has concluded that its international transactions are at arm's length." On a reading of the TPO's order it is noticed that the use of multiple year data was not approved. Apart from that it is noticed that Show Cause Notice dated 02.12.2014 was issued and taking note of Product Support Services Agreement dated 01.07.2002 entered into by the assessee with M.S. Corp, the TPO though accepting TNMM as a methodology and also accepted the PLI of OP/OC rejected the multiple year data resorted to by the assessee and directed the assessee to carry out a fresh search considering the current year data; modified qualitative as well as quantitative filters applied by the assessee giving justification for overruling the assessee's objections; gave speaking reasons for retaining four comparables as opposed to 17 taken by the assessee; introduced three new comparables and ultimately he worked out average profit margin of 29.53% considering the comparables selected by him and proposed an adjustment of Rs. 39.68 cr. We note on considering the precedent laid down by the Hon‟ble High Court in Li And Fung which we propose to address in detail in later part of this order, we find that the TPO‟s order is fully in compliance with the precedent laid down. Specific attention is invited to para 49 (d) of the said decision.
12.6. Similarly for the Software Development Services, it is seen the TPO accepting TNMM as the MAM and also accepting PLI of OP/OC, the TPO after considering the qualitative and quantitative filters applied by the assessee proceeded to hold that the economic analysis of the assessee was inadequate; the taxpayer was also directed to carry out a fresh search incorporating current year data; filters were modified; out of the five comparables offered by the assessee even after carrying out a fresh search at the instance of the TPO only one comparable was retained and he introduced four comparables giving justification for their inclusion. As a result thereof he worked out the average profit margin of 37.47% considering the comparables selected by him ITA No. 1479/Del/16 AY 2011-12 Page 12 of 21 and he proposed an adjustment of Rs. 201.22 cr. We find that the TPO has given reasons , justification for not accepting the comparables etc. considering FAR applying filters which is infact supported by the decision of the Hon‟ble High Court in case of Li And Fung.
12.7. The actions as noted were challenged before the DRP and pursuant to the directions etc., incorporated by the TPO the final assessment order has been passed.
12.8. Thus, when the order of the TPO is read, it clearly and unambiguously demonstrates that the TPO has variously and innumerably objected to the TP Study and over-ruled the objections of the assessee on various aspects of the TP study. The mere fact that TNMM as a method is retained for both the segments as MAM and fact that the PLI of the assessee stood disturbed by the single year datea etc. demonstrates that the entire TP Study has not been accepted. The multiple observations addressing various other aspects of the TP Study in an endeavour to address the functions performed, assets utilized and risks undertaken by the assessee for having a proper FAR analysis of the assessee and then to being it at par within the acceptable degree of comparability with the FAR of the comparables is an exercise for which not only the agreements; the arrangements and thus the record of the assessee has to be considered but even how the parties have conducted their affairs as borne out from the arrangement etc as per record has to be considered. It is seen on a reading of the TPO‟s order that considering the functions performed, he has held that the assessee is not merely a contract software development service provider but also involved in coding and testing of particular functions /features of product even if final coding testing etc. is done by M.S. Corps i.e. the AE. The assessee's claim that M.S. Corp undertakes final testing prior to final code release and thus the assessee is only a contract software development service provider, has been over-ruled by the TPO. These observations are made only to adjudicate upon the preliminary claim of the taxpayer that the TP study was accepted by the TPO. The correctness of the conclusions drawn by the TPO are not being considered. We deem it appropriate to clarify that these conclusions are for the limited purpose of determining the issues which arises in the present proceeding and shall have no bearing for determining the issues on the merits of the claims made in the appeal filed before the ITAT. Stating the obvious in the present proceeding we are not required to address the correctness of the conclusions drawn by the TPO and the issue for consideration is limited to whether the TPO can be said ITA No. 1479/Del/16 AY 2011-12 Page 13 of 21 to have accepted the TP study; and in case the answer to the former is yes then in terms of the judicial precedent the prayer of the assessee has to be allowed. It is the correctness of the said claim which is being considered. Consequently the findings given are in this limited context only and hence have a limited play. Having so clarified we proceed to further consider the order of the TPO and note that the TPO has also held that the assessee's coding and testing performance is a nature of R & D activity even though final testing of product is being done by M.S. Corp. Again the correctness of these conclusions of TPO is not being affirmed and these observations we make it clear would not in any manner impinge upon the claims to be decided in the grounds raised by the assessee in the present appeal. Reference thereto has been made in order to adjudicate upon the preliminary objections of the assessee namely that the TP study not having been rejected by the TPO. The subsequent adjustments were thus barred to him. We find that the assessee's reading based on these two specific observations of the AO is misconceived. We will also advert specifically to these two specific observations of the TPO, but before that, we deem it appropriate to further take note of the relevant facts qua the filters etc. applied after carrying out a FAR (Function Asserted Risks)analysis of the tax payer. It is seent that the TPO has not accepted the prayer of the assessee for resorting to lower turnover filer. Similarly, the TPO has applied the export sales filter which has been objected to by the assessee. The DRP‟s conclusion that by selecting companies who are operating in the export market the TPO has correctly carried out a search for comparables and the application of the filter by the TPO having been upheld again shows that the TPO in unambiguous terms wherein several countless shortcomings in the TP Report have been addressed clearly demonstrated innumerous times severally that the TPO has not accepted the TP study and the taxpayer was well aware that the TP study was largely modified by the TPO in an endeavor to bring it in conformity with the provisions of the Act and the Rules and the decisions of ITAT and the Courts. As noted, the correctness of the said decisions of the TPO is not being addressed in the present order.
12.9 It is further seen that at internal page 8 and 9 of the TPO‟s order, he has specifically given the reasons for accepting, rejecting or modifying the filters in the IT enabled services applied by the assessee. The TPO in very categoric terms qua the proposed filters has held, "as can be seen, that some of the filters that you have used to select your comparables are inappropriate. This means that your economic analysis is inadequate................." Thereafter, he proposes to apply the specific filters set out in the order alongwith the ITA No. 1479/Del/16 AY 2011-12 Page 14 of 21 justification and addressing the comparables made available by the assessee in its TP report and again made available in the fresh search carried out at his insistence incorporating only the relevant year data. The fresh search updating the original TP study we note has been accepted by the assessee also and thus the fact that the TP study stood modified consequently was not accepted by the TPO is evident on the face of the record itself.
12.10 We now also proceed to consider the specific remarks of the TPO at pages 13 and 61 in the 95 paged order. We note that apart from umpteen observations / findings and conclusion of the TPO noticed it is seen that even if these two specific instances are noticed in isolation it is evident that these are in the context of the assessee‟s specific objections being considered in the respective pages where the assessee at page 13 in para 8 asserts that the methodical search for benchmarking the international transactions in accordance with the Rules, has been rejected by the TPO. Heavy reliance has been placed by the assessee upon the TPO‟s remarks. For ready reference, we reproduce para 7 and 8 from page 13 of the TPO extracted hereunder :
7. The assessee made a reply dated 22.12.2014 and a personal hearing was conducted and submission of the assessee has been discussed. The replies that have been made by the assessee have been carefully considered. The assessee has also been given the opportunity to make oral submissions. After this, the following points are made "8. Assessee argued that it has conducted a methodical search for benchmarking the international transactions in accordance with Rule 10B and Rule 10C of Income-tax Rules, 1962 and this has been rejected by the TPO.
The assessee submitted that applying the provisions of Section 92C(2), the arm‟s length price was computed after considering the average operating profit margin of 4.63% earned by the comparable companies under the IT enabled Services segment. The aforesaid arm‟s length margin was compared to the margin of 15.39% earned by the assessee company. Based on the above, the international transaction undertaken by the assessee Company was claimed to be adhering to the arm‟s length standard.
Assessee concluded that the search carried out in the TP documentation being correct and therefore should be accepted, even considering the result of the fresh search, the margin earned by the assessee company being higher than the margin earned by the comparable companies, the international transactions entered into with the AEs were demonstrated to be at arm‟s length price.
TPO's Remarks:
The assessee has possibly not read the show cause notice carefully, if it had it would have realized that specific reasons have been given for the rejection of filters and comparables. That apart, it is emphasized here that the TP study has not been rejected at all. It has been only modified by the use of current year data and some appropriate filters. Some of the comparables that the assessee has chosen have been accepted. Even the comparables that have been added back to the set of comparables, arise from the search matrix of the assessee. No comparable has been added that does not figure in the search process of the assessee. The OECD Guidelines, 2010 also speak of a combination of the additive and deductive approach to arrive at a potential set of comparables. The relevant portion of the guidelines is quoted below .
QUOTE ITA No. 1479/Del/16 AY 2011-12 Page 15 of 21 3.45 it would not be appropriate to give systematic preference to one approach over the other because, depending on eh circumstances of the case, there would be value in either the "additive" or the "deductive" approach, or in a combination of both. The "additive"
and "deductive" approaches are often not used exclusively. In a typical "deductive" approach, in addition to searching public databases it is common to include third parties, for instance known competitors (or third parties that are known to carry out transactions potentially comparable to those of the taxpayer), which may otherwise not be found following a purely deductive approach, e.g. because they are classified under a different industry code. In such cases, the "additive" approach operates as a tool be refine a search that is based on a "deductive" approach.
UNQUOTE The comparable proposed in the showcause notice, all are taken out of the assessee‟s own search conducted while preparing the TP Study."
12.11. On a reading of the above, we note that the highlighted observation was made in the background of the assessee's arguments/objection in para 8 extracted above wherein the assessee had argued that it had conducted a methodical search for benchmarking the international transactions in accordance with Rule 10B and Rule 10C of Income-tax Rules, 1962 and this has been rejected by the TPO. The TPO addressing the factual background notes that the assessee has possibly not read the show cause notice carefully, if it had it would have realized that specific reasons have been given for the rejection of filters and comparables, it is in that background that the crucial words are highlighted namely That apart, it is emphasized here that the TP study has not been rejected at all. It is seen that the TPO goes on to hold that It has been only modified by the use of current year data and some appropriate filters. Some of the comparables that the assessee has chosen have been accepted. Even the comparables that have been added back to the set of comparables, arise from the search matrix of the assessee. No comparable has been added that does not figure in the search process of the assessee. Accordingly, we find that the prayer of the assessee based on these observations made in the context of the claims being considered cannot be accepted.
12.12. Proceeding to the next observation made by the TPO, on which the assessee is relying it is appropriate to also first extract the relevant observations :
"7. Rejection of the Economic Analysis of the Assessee :
Assessee submitted that the economic analysis conducted by the Assessee, being with the provisions of the Act and being their no infirmity, need to be accepted and TPO is bound to accept the economic analysis done by the Assessee.
TPO's Remarks :
The assessee has possibly not read the show cause notice carefully, if it had it would have realized that specific reasons have been given for the rejection of filters and comparables. That apart, it is emphasized that its TP study has not been rejected at all., it has been only modified by the use of current year data and some appropriate filters.ITA No. 1479/Del/16
AY 2011-12 Page 16 of 21 Some of the comparables that the assessee has chosen have been accepted. Even the comparables that have been added back to the set of comparables, arise from the search matrix of the assessee. No comparable has been added that does not figure in the search process of the assessee. The OECD Guidelines, 2010 also speak of a combination of the additive and deductive approach to arrive at a potential set of comparables. The relevant portion of the guidelines is quoted below .
(QUOTE) 3.45 It would not be appropriate to give systematic preference to one approach over the other because, depending on the circumstances of the case, there could be value in either the "additive" or the "deductive" approach, or in a combination of both. The "additive" and "deductive" approaches are often not used exclusively. In a typical "deductive" approach, in addition to searching public databases it is common to include third parties, for instance known competitiors (or third parties that are known to carry out transactions potentially comparable to those of the taxpayer), which may otherwise not be found following a purely deductive approach, e.g. because they are classified under a different industry code. In such cases, the "additive" approach operates as a tool to refine a search that is based on a "deductive" approach.
(UNQUOTE)
8. Assessee‟s arguments against filters applied by TPO(and opposed by the Assessee applied by the assessee (and rejected by the TPO)
a) CURRENT YEAR DATA Assessee has objected on rejection of use of multiple year data and use of contemporaneous data i.e. FY 2010-11 only.
This filter has already been discussed in the ITES section of this order therefore the same is not repeated here for sake of brevity."
12.13. Herein also in very clear terms, it is seen that the TPO notes that the assessee has possibly not read the show cause notice carefully, if it had it would have realized that specific reasons have been given for the rejection of filters and comparables. That apart, it is emphasized that its TP study has not been rejected at all., it has been only modified by the use of current year data and some appropriate filters. Some of the comparables that the assessee has chosen have been accepted. Even the comparables that have been added back to the set of comparables, arise from the search matrix of the assessee. No comparable has been added that does not figure in the search process of the assessee.
12.14 On a cursory reading of the same we note it is evident in what context the TPO has made the observations. We have given our utmost consideration to these multitudinous observations and also to the above two specific observations in isolation and fail to read the same in the manner the taxpayer would want us to read and thus have concluded that the prayer of the tax payer is not maintainable. It is evident that the TPO was addressing the claims/argument, assertions set out in para 7 of his order whereby as per record the assessee submitted that the economic analysis conducted by the Assessee, being in conformity with the provisions of the Act and the Rules etc. was asserted as a reason on account of which there could be no infirmity and ITA No. 1479/Del/16 AY 2011-12 Page 17 of 21 hence the TPO perforce had to accept the TP Study and was necessarily bound to accept the economic analysis done by the Assessee. The said insistence of the assessee and the conclusions drawn were being addressed by the TPO. We find that the said assertion based on the belief that since the TP study is in compliance with the Act and the Rules is made available the TPO therefore perforce it has to accepted it is an incorrect assumption of the tax payer. It is for the TPO to determine whether the TP Report is in compliance with the Act and Rules. The TPO is very much within his rights to consider and decide the claim of the assessee which has been done and after hearing the assessee he has held that it is not in compliance with the Act and the Rules and consequently TP Report stood modified.
13. Though we have taken into consideration the proposition of law laid down by the Hon‟ble Court before arriving at a conclusion however for the sake of completeness we elaborate the reasons which prevailed with the Hon‟ble Judges to address the position of law as considered by the Hon‟ble Delhi High Court in case of Li and Fung India Pvt. Vs. CIT 361 ITR 85(Delhi) and thereafter the decision of the coordinate Bench in ITA No. 7260/Del/2017 in M/s COIM India Pvt. Ltd. Vs. ACIT on which heavy reliance has been placed by the Ld. AR will be addressed.
13.1 In the case of Li & Fung(cited supra) the issue for consideration was benchmarking of receipt of support services fees received from its AE. The assessee received support services rendered for the supply of high value, time sensitive consumer goods for sourcing of the goods. The assessee benchmarked the transaction adopting TNMM method as most appropriate method adopting the PLI of OP/TC selecting 26 comparables whose PLI was 4.07% and PLI of the assessee was 5.17% and as per TP study report assessee claimed that its international transaction was at arm‟s length. The TPO did not dispute the selection of the most appropriate method as well as selection of the comparable companies. However, over and above the margin he held that the 5% compensation based on cost is inappropriate and he applied a markup of 5% on the FOB value of export. In these circumstances the Hon‟ble High Court vide para No.44 held as under:-
"44. Another important aspect which cannot be overlooked is that the transfer pricing documentation maintained in terms of section 92D of the Act read with rule 10B of the Income-tax Rules, determined the arm's length price of the "international transaction" of the provision of buying services applying the transactional net margin method, by comparing ITA No. 1479/Del/16 AY 2011-12 Page 18 of 21 operating profit margin of LFIL with that of the comparable companies, as under :
Weighted average OP/OC per cent. of 26 4.07 percent.
comparable companies
OP/OC per cent. of LFIL 5.17 percent.
This exercise has not been discarded. In other words, the Transfer Pricing Officer and the appellate fora were aware that in accordance with the rules, a comparison of the profit margin of LFIL with that of other similarly functioning companies was shown, and is, at the first instance, relevant to determine the arm's length price. The profit margin, as well as the cost plus model adopted by LFIL, was not shown to be distorted or of such magnitude as to persuade the tax authorities into discarding the exercise altogether. Having not contradicted this comparison, the Revenue proceeded to its own determination and calculations. This, however, is improper, given that the assessment carried out by the assessee must first be rejected, for any further alterations to take place. Indeed, it cannot be that the Revenue admits to the correctness of LFIL's assessment but none the less proceeds to adopt a different method.
(underline provided by us) 13.2 Thus we note that the Hon'ble High Court has merely held that without contradicting the method, the comparables and the PLI of the TP Study report it is improper to make further alterations. The Hon'ble High Court has not held that such an order passed by the TPO is required to be set aside. The prayer of the ld AR is to consider the word „improper‟ as „invalid‟. We could not read any such finding of the Hon'ble High Court.
13.3 It is appropriate to highlight the observation of the Hon'ble High Court in para No. 45 has further held:-
"45. Indeed, once the transactional net margin method was deemed most appropriate method, the distortions, if any, had to be addressed within its framework. Here, the unrelated transactions which were compared by LFIL have not been adversely commented upon, and neither has the choice of the transactional net margin method. The Transfer Pricing Officer, therefore, ignored the relevant and crucial material, and straightaway proceeded to broaden the base for arriving at the profit margin, for attributed income of the assessee. Not only is this a clear infraction of the terms of the Act and Rules ; the Transfer Pricing Officer went ahead to introduce what is clearly alien to the provisions of law and travelled outside the Rules."
13.4 As noted in the facts of the present case before us the facts clearly show that the Transfer Pricing Officer has rejected the approach of the assessee for determining the profit level indicator of the comparable by taking multiple year data. The Transfer Pricing Officer took the single year data. Further, out of the ITA No. 1479/Del/16 AY 2011-12 Page 19 of 21 17 comparables selected by the assessee in the IT enabled services he rejected 13 comparables either by distinguishing them on functional profile or by applying appropriate filters. The reasons for introducing new comparables are found discussed. In the Software Development Services Segment similarly speaking reasons have been give for rejecting 4 out of the 5 comparables of the assessee and for introducing new comparables. Therefore, it cannot be said that facts of the present case are identical to the facts as considered by the Hon'ble Delhi High Court. In the present case it is apparent that the TPO has questioned the application of appropriate filters, the computation of data and functional comparability study conducted by the assessee. It may also be appropriate to highlight that the Hon'ble Delhi High Court has summarized the whole issue in para No. 49 of the decision as under:-
"49. This court summarizes its conclusions as follows :
"(a) The broad basing of the profit determining denominator as the entire FOB value of the contracts entered into by the associated enter prise to determine the LFIL's arm's length price, as an 'adjustment', is contrary to provisions of the Act and Rules ;
(b) The impugned order has not shown how, and to what extent, LIFIL bears 'significant' risks, or that the associated enterprise enjoys such locational advantages, as to warrant rejection of the transfer pricing exercise undertaken by LFIL ;
(c) Tax authorities should base their conclusions on specific facts, and not on vague generalities, such as 'significant risk', 'functional risk', 'enterprise risk', etc., without any material on record to establish such findings. If such findings are warranted, they should be supported by demonstrable reason, based on objective facts and the relative evaluation of their weight and significance.
(d) Where all elements of a proper transactional net margin method are detailed and disclosed in the assessee's reports, care should be taken by the tax administrators and authorities to analyse them in detail and then proceed to record reasons why some or all of them are unacceptable.
(e) The impugned order, upholding the determination of 3 per cent. margin over the FOB value of the associated enterprise's contract, is in error of law."
13.5 In para No. 49(d) the Hon'ble High Court has also held that where all elements of proper transactional net margin method are detailed and disclosed in assessee‟s report, care would be taken by the tax administrators and authorities to analyse them in detail and then proceed to record reasons why some or all of them are unacceptable. In the facts of the present case the TPO has given detailed reasons in both the segments for rejection of the multiple year data and for the exclusion of comparables selected by the assessee. In the facts as they stand it cannot be said that the TPO has rejected the contentions without recording reasons. In fact proper show cause notice detailing reasons for what has been done was issued and explanation of the assessee was ITA No. 1479/Del/16 AY 2011-12 Page 20 of 21 considered and some of the explanations are rejected by giving reasons. In view of this the reliance placed by the ld AR on the above decision of the Hon'ble Delhi High Court it is our considered opinion is misplaced.
14. Reliance has also been placed on the decision of the coordinate bench in ITA No. 7260/Del/2017. The issue before the bench was in respect of the arm‟s length price determination of payment of royalty and payment for technical assistance fees (para No. 5 of the order). The Transfer Pricing Officer issued the show cause notice dated 27.08.2016 asking the assessee to explain why ALP should not be taken as Nil applying the CUP method. The assessee benchmarked the above by applying TNMM method. The TPO determined the ALP applying the CUP method of technical fees as Nil as assessee failed to satisfy the benefit test, the need test and shareholder activity test as well as the duplicity test. The coordinate bench recorded vide para No. 11 that the TPO as well as the DRP has not discarded the most appropriate method adopted by the assessee as TNMM. Thus on a plain reading of the order of the coordinate bench it can be deciphered that the TPO and DRP has applied the CUP method which is also evident from the show cause notice mentioned in para No. 5 of the order. In view of the above facts of the decision of the coordinate bench, which is quite dissimilar to the facts before us, we find the reliance placed by the assessee on it is also misplaced.
15. Accordingly, on going through the facts, submissions and precedent we find that the prayer of the assessee in the peculiar facts and circumstances of the present case, is not maintainable as not-withstanding the specific bold texted highlighted words in the order of the TPO there can be no doubt that on a reading of the entire 95 paged order of the TPO, one is left in no doubt what- so-ever that the TP study made available by the assessee was found to be not fully in compliance with the Act and the Rules thus stood modified. Multiple year data was not accepted, filters were tweaked, comparables were updated, altered, modified, brought in conformity with what the TPO considered to be in accordance with law. The correctness of the conclusions drawn by the TPO as noted is not being adjudicated upon. The order has been considered in the background of the prayer that once the TP study stands accepted, the adjustments proposed were not in accordance with law. As we have brought out herein above in detail by referring to various observations and conclusions of the TPO, there can be no doubt what-so-ever that the TP study of the assessee was not accepted by the TPO. The procedures followed we find are ITA No. 1479/Del/16 AY 2011-12 Page 21 of 21 fully compliant with the precedent as laid down by the Hon‟ble High Court and the prayer of the assessee on account of the detailed reasons given hereinabove wherein the precedent laid down in facts is found to be of no help to the assessee. Accordingly, ground No. 7(a) of the assessee is rejected.
16. The parties are directed to argue the appeal on merits on 31.07.2018 on which date, the appeal is fixed for hearing.
17. In terms of the above, the issue stands decided against the assessee.
Order pronounced in the open Court 23.07.2018
-Sd/- -Sd/-
PRASHANT MAHARISHI DIVA SINGH
(ACCOUNTANT MEMBER) (JUDICIAL MEMBER)
Dated: 23.07.2018
VS(Del)/Poonam(Chd)/AG(Chd)
Copy forwarded to:
1.Appellant, 2. Respondent, 3. CIT, 4.CIT(Appeals), 5.DR: ITAT