Income Tax Appellate Tribunal - Delhi
Ciena India Pvt. Ltd., Gurgaon vs Dcit, New Delhi on 22 March, 2017
IN THE INCOME TAX APPELLATE TRIBUNAL
(DELHI BENCH 'I-2' : NEW DELHI)
BEFORE SHRI R.S. SYAL, ACCOUNTANT MEMBER
and
SHRI KULDIP SINGH, JUDICIAL MEMBER
ITA No.783/Del./2015
(ASSESSMENT YEAR : 2010-11)
M/s. Ciena India Pvt. Ltd., vs. DCIT, Circle 6 (1),
FF, Navjyoti Institute, New Delhi.
Sector - B, Pocket 11,
Vasant Kunj,
New Delhi - 110 070.
(PAN : AACCC6131B)
(APPELLANT) (RESPONDENT)
ASSESSEE BY : Shri Himanshu Shekhar Sinha, Advocate
Mohd. Fahad Khalid & Ms. Reetika
Garg, CAs
REVENUE BY : Shri Peeyush Jain, CIT DR
Date of Hearing : 28.02.2017
Date of Order : 22.03.2017
ORDER
PER KULDIP SINGH, JUDICIAL MEMBER :
The Appellant, M/s. Ciena India Private Limited (hereinafter referred to as 'the assessee') by filing the present appeal sought to set aside the impugned order dated 29.12.2014, passed by the AO under section 143(3)/144C of the Income-tax Act, 1961 (for short 'the Act') qua the assessment year 2010-11 in consonance with the orders passed by the ld. DRP/TPO on the grounds inter alia that :- 2 ITA No.783/Del./2015
"1. That on the facts and in the circumstances of the case and in law, the order passed by the Ld. Assessing Officer ('AO') is bad in law.
2. The Ld. AO/ Ld. Transfer Pricing Officer ('TPO') erred on facts and in law in making an adjustment to the arm's length price of the Appellant's international transactions which resulted in the enhancement of returned Income of the Appellant by INR 57,85,27,473.
3. That the reference made by the Ld. AO suffers from jurisdictional error as the Ld. AO has not recorded any reasons in the assessment order based on which he reached the conclusion that it was 'expedient and necessary' to refer the matter to the Ld. TPO for computation of the arm's length price, as is required under section 92CA(1) of the Income-tax Act, 1961 ('the Act').
4. The Ld. AO/Ld. TPO/ Ld. Dispute Resolution Panel ('DRP') erred on facts and in law in making an upward adjustment of the arm's length price of the Appellant's international transaction in relation to provision of captive software development services by:
4.1. Not appreciating that the Appellant is entitled to deduction under section 10A of the Act, with respect to the provision of services and therefore, there is no incentive on the part of the Appellant to shift profits to any other jurisdiction;
4.2 Rejecting the comparable companies selected by the Appellant in its Transfer Pricing documentation;
4.3. Accepting companies, which are not comparable to the Appellant in terms of functions, assets and risks;3 ITA No.783/Del./2015
4.4 Not granting an economic adjustment for the risk mitigated environment in which the Appellant operates.
5. The Ld. AO/Ld. TPO/ Ld. DRP erred on facts and in law in making an upward adjustment of the arm's length price of the Appellant's international transaction in relation to provision of captive marketing support services by:
5.1 Rejecting the comparable companies selected by the Appellant in its Transfer Pricing documentation;
5.2. Accepting companies, which are not comparable to the Appellant in terms of functions, assets and risks;
5.3. Erroneously ignoring comparable companies, obtained by way of a fresh search, provided by the Appellant as a response to the show cause notice;
and 5.4 Not granting an economic adjustment for the risk mitigated environment in which the Appellant operates.
6. The Ld. AO/Ld. TPO/ Ld. DRP erred on facts and in law in determining the arm's length price of import of capital equipment by the Appellant from its Associated Enterprises ('AEs') at NIL by:
6.1. Not appreciating that the international transaction of import of capital equipment being inextricably linked with the primary activity of captive software development services should be benchmarked by using Transactional Net Margin Method on an aggregate basis;
6.2. Not appreciating that the Appellant is a cost plus entity and the depreciation of INR 8,64,69,321 (as per the Companies Act, 1956) on such capital 4 ITA No.783/Del./2015 equipment had only increased the cost base resulting into more taxable income j tax in India;
6.3. Not appreciating that such assets will be depreciated over a period of time, and the Appellant would be offering more income than the cost of such/assets over such period in totality 6.4. Not appreciating the fact that the import price of these capital equipment have been reviewed by the Custom Authorities at the time of import and necessary Custom duties have been paid wherever required;
6.5. Not appreciating that the used capital equipment were imported at fair market values determined by Chartered Engineers (being third party experts);
6.6. Disregarding the fresh evidences submitted by the Appellant to the Ld. DRP which supports the without prejudice contention of the Appellant, for application of Comparable Uncontrolled Price Method as the most appropriate method (purported to be applied by the Ld. TPO). These fresh evidences were in the form of copy of invoices on sample basis of similar capital equipment sold by the AEs to third parties.
7. Without prejudice to above, the Ld. AO erred on the facts and in law by following the order of Ld. TPO and enhancing the income of the Appellant by the amount capitalized in respect of such capital equipment amounting to INR 57,30,63,268, without appreciating the fact that the Appellant has claimed the amount of depreciation of only INR 25,57,43,681 (as per the Act read with the Income-tax Rules, 1962) thereon.
8. That on the facts and circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings under section 274 read with 5 ITA No.783/Del./2015 section 271(1)(c) of the Act for furnishing inaccurate particulars without recording any adequate satisfaction for such initiation.
9. That the Ld. AO erred in facts and in law in charging and computing interest under section 234B, 234C and 234D of the Act."
2. Briefly stated the facts of this case are : the assessee company is a wholly owned subsidiary of Ciena Corporation, USA, and engaged in provision of software development and marketing software services to its overseas group company. Assessee is a 100% EOU under the Software Technology Park Scheme incorporated on June 27, 2005 and commenced its operation w.e.f.
April 10, 2006. Assessee company is remunerated on cost plus basis for providing services, namely, contractual software development and marketing software services. During the year under assessment, the assessee entered into the international transactions detailed in Form 3CEB as under :-
Sr.No. Nature of Transaction Arm's length price as per taxpayer
(i) Software service Rs.1,51,39,91,308
(ii) Market Support service Rs. 4,67,48,181
(iii) Purchase of capital goods Rs. 57,30,63,268
3. Assessee company by using Transactional Net Margin Method (TNMM) as the most appropriate method with OP/OC as Profit Level Indicator (PLI) for both of its segment, namely, 6 ITA No.783/Del./2015 software development services segment and market support services segment. Assessee chosen 12 companies as comparable having average OP/OC of 14.08% for benchmarking software development segment transactions and chosen 18 comparables with the average OP/OC of 6.98% for benchmarking market support services transaction.
4. However, TPO by rejecting the filters applied by assessee company for its TP study rejected 7 comparable companies out of 12 chosen by assessee for software development services segment.
Then, the TPO made addition of 11 new comparable companies on the basis of examination of accept/reject matrix of assessee company and determined the arm's length margin at 30.52% vis-à- vis OP/OC 13.01% earned by the assessee and thereby made an adjustment of Rs.23,45,63,894/-.
5. In case of market support services segment, the TPO rejected all the comparable companies chosen by the assessee in its TP study report. Assessee further submitted 5 comparables by making fresh search in reply to show-cause notice, out of which 3 were rejected and 2 were erroneously ignored by the TPO and the TPO selected 6 new companies as to the market support services segment and thereby determined the arm's length margin at 7 ITA No.783/Del./2015 26.28% vis-à-vis OP/OC of 13.01% earned by the assessee and thereby proposed the adjustment of Rs.54,89,025/-.
6. Assessee company carried the matter before Disputes Resolution Panel by filing objections. For software development services segment, the ld. DRP ordered to exclude two companies as comparables, namely, Infinite Data Systems and Sonata Software Limited and directed to correct the computation margin of comparable company for the purpose of computation of arm's length price; and grant of working capital adjustment for difference in the working capital position of assessee vis-à-vis comparable companies. In accordance with the directions issued by the ld. DRP, the revised arm's length margin of comparable companies was determined at 19.73% vis-à-vis OP/OC of 20.81% earned by the assessee and consequently, adjustment on account of provisions of software development services came to be nil.
7. Ld. DRP granted working capital adjustment in working capital position of the assessee vis-à-vis comparable companies; correct computation of margin of comparable companies qua marketing support services segment and consequently, the revised arm's length margin of comparable companies was determined at 26.22% vis-à-vis OP/OC of 13.01% earned by the assessee and revised adjustment came to be Rs.56,64,205/-. Complying with the 8 ITA No.783/Del./2015 order passed by the ld. TPO/DRP, the AO made an addition of Rs.54,64,205/- and Rs.25,57,43,861/- on account of providing of market support services and purchase of capital equipment respectively.
8. Feeling aggrieved, the assessee has filed the appeal against the order passed by the AO/TPO/DRP.
9. We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case.
GROUNDS NO.1 & 2
10. Grounds Nos.1 & 2 are general in nature, hence need no specific adjudication.
GROUNDS NO.3, 4.1, 4.2, 5.1 & 5.4
11. Ld. AR for the assessee has not pressed the aforesaid grounds, hence determined against the assessee. GROUNDS NO.4 & 4.3
12. The assessee company challenged the upward adjustment of arm's length price of assessee's international transaction qua provision of software development services made by the AO/TPO/DRP by accepting incomparable companies. The final 9 ITA No.783/Del./2015 set of comparables considered by the TPO for benchmarking the international transactions are tabulated as under :-
Sr.No. Name of the company OP/OC
1. Akshay Software Technologies Ltd. -1.07%
2. E-Infochips Bangalore Ltd. 71.38%
3. Infinite Data System Private Ltd. 88.25%
4. Infosys Limited 45.47%
5. Larsen & Tourbo Infotech Ltd. 19.06%
6. LGS Global Limited 12.78%
7. Mindtree Ltd. (Segment) 13.92%
8. Persistent Systems Limited 29.02%
9. Quintegra Solutions Ltd. 1.46%
10. R S Software (India) Ltd. 10.18%
11. Sasken Communication 17.54% Technologies Ltd.
12. Sonata Software 35.87%
13. Thinksoft Global Services Ltd. 17.35%
14. Thirdware Solutions Ltd. 33.43%
15. Tata Elxsi Ltd. 20.29%
16. Wipro Ltd. 73.35% AVG. 30.52%
13. Undisputedly, TNMM with OP/OC as PLI for software development services segment is the most appropriate method for determining the arm's length price of the international transactions in question. Out of the aforesaid final set of comparables companies considered by the TPO for benchmarking the international transaction, the assessee company challenged inclusion of : (i) E-Infochips Bangalore Ltd., (ii) Infosys Limited,
(iii) Persistent Systems Limited, (iv) Thirdware Solutions Ltd. and
(v) Wipro Limited on the ground of functional dissimilarity, risk 10 ITA No.783/Del./2015 assumed, extra ordinary circumstances, etc.. We would like to examine suitability of each of the aforesaid comparable companies for benchmarking the international transactions as under :-
COMPARABLE COMPANIES SOUGHT TO BE EXCLUDED BY THE ASSESSEE COMPANY FROM THE FINAL SET OF COMPARABLES FOR BENCHMARKING THE INTERNATIONAL TRANSACTIONS QUA SOFTWARE DEVELOPMENT SERVICES E-INFOCHIPS BANGALORE LIMITED
14. Assessee company challenged the inclusion of this company as comparable on ground of functional dissimilarity; segmental information not available; fluctuating trend; abnormal super normal profit and significant intangible and relied upon decision rendered by coordinate Bench of ITAT, Delhi in case of Headstrong Services (India) Pvt. Ltd. in ITA No.714/Del/2015 order dated 18.03.2016.
15. However, ld. TPO brushed aside the objections by referring to the annual report. TPO observed that many companies treat IT and ITES as one industry and report them as one segment even though they are not performing any ITE services. TPO also referred to page 54 of the annual report, which is now available at pages 3225 - 3242 of the Paper Book Vol.III-A, showing the income from software services at Rs.7,43,04,66,481/-. TPO further 11 ITA No.783/Del./2015 held that consultation charges constitute a substantial 14% of the total revenue for the FY 2009-10 which is part of the software development services only and in these circumstances, segmental financials are not required and retained the same as a valid comparable.
16. First of all, ld. AR for the assessee opposed the inclusion of this company as comparable on ground of functional dissimilarity vis-à-vis assessee company that this comparable company is engaged in software services as well as ITE services; that this company is giving diversified services including software, firmware, hardware, field programmable gate array (FPGA), application specific integrated circuit (ASIC) and QA & testing in highly specialized and critical industry verticals like aero space, security and surveillance, medical devices and others, hence the requirements and dynamics of this company are very complex and are not comparable to the assessee company. Ld. AR also contended that E-Infochips Bangalore Ltd. engaged in product development and cannot be considered as a comparable vis-à-vis assessee company and relied upon Fiserv India Private Limited in ITA No.6737/Del/2014 order dated 26.06.2015, available at pages 29 to 46 of the compilation of case laws.
12 ITA No.783/Del./2015
17. No doubt, as per Schedule VII, page 59 of the annual report, income from software services and consultancy charges of this company consist of only 14% also pointed out by the TPO, but in the absence of the segmental details, we are unable to correlate both the segments, namely, software services and consultancy services.
18. This comparable company was considered by the coordinate Bench of ITAT, Delhi in the case cited as Headstrong Services (India) Pvt. Ltd. (supra) for the assessment year 2010-11 and this company was ordered to be excluded by making following observations :-
"12.2. After considering the rival submission and perused the relevant material on record, we find from the Annual Report of this company available on page 352 of the paper book that its P & L Account shows `Income from software services' as one unit at Rs.43,04,66,481/-. Schedules 7 gives break up of this income with "Income from Software Services" at Rs. 37.13 crore and "Consultancy Charges" at Rs. 5.90 crore. Segmental information of this company is available on page 66 of its Annual Report which states that : "The Company is primarily engaged in Software Development and I.T. enabled services which is considered the only reportable business segment". This indicates that the revenue from Software Development and ITES has been clubbed by this company which also includes consultancy charges. No doubt Consultancy charges in relation to Software Development are part of overall Software Development, but the inclusion of ITES in the overall segment frustrates the comparability. We are currently dealing with the 13 ITA No.783/Del./2015 international transaction of `Provision of Software Development services' and the international transaction of ITES is separate which has also been benchmarked distinctly. In our considered opinion, e-Infochips Bangalore Ltd. having a pool of both software developments and ITES segments into the overall segment designated as `Software development', cannot be considered as comparable on entity level with the international transaction of `Software development' of the assessee. We, therefore, order for the exclusion of this company from the list of comparables."
19. Following the decision rendered by the coordinate Bench in Headstrong Services (India) Pvt. Ltd. (supra) and the fact that since E-Infochips Bangalore Ltd. is having pool of both software development and ITE services segment and both the segments are designated as software development segment, the same cannot be taken as a valid comparable on entity level vis-à-vis international transaction of software development services of assessee company.
20. In Fiserv India Private Ltd. (supra), the coordinate Bench of ITAT, Delhi also ordered to exclude this company as a comparable for the same AY 2010-11 on the ground that this company being engaged in product development cannot be a valid comparable for benchmarking the international transaction pertaining to software development services. So, in these circumstances, we order to exclude this company from the final list of comparable. 14 ITA No.783/Del./2015 INFOSYS LIMITED
21. Assessee sought exclusion of this company as a comparable by raising objections inter alia that this company has its own brand value; that it is having turnover of 135 times of the assessee; that there are extra ordinary events affecting its profitability and incorrect margin calculations. The ld. AR for the assessee contended that in assessee's own case, this comparable was excluded by the Tribunal by relying upon the judgment of Hon'ble jurisdictional High Court in CIT vs. Agnity India Technologies Pvt. Ltd. in ITA 1204 / 2011 decided on 10.07.2013, order available at pages 126 to 131 of the compilation of case laws.
22. However, TPO rejected the argument addressed by assessee company that marketing and advertising activities carried out by the comparable company created marketing intangibles on the ground that taxpayer has not given the basis on which it can be concluded that the companies have created marketing intangibles. TPO also rejected the arguments addressed by the assessee that this comparable company has spent Rs.78,42,59,246/- on selling and marketing expenses on the ground that as per Schedule 12 of the P&L account, it has spent only Rs.1,33,15,247/- on marketing and other related services. TPO also rejected the assessee's contention that the comparable company is possessing huge brand value 15 ITA No.783/Del./2015 sufficient to influence the pricing policy of the company thereby directly impacting margins of the company on the ground that the company has spent a meager amount of 0.06% of the revenues and could not have generated brand value with this amount and retained this company as a suitable comparable.
23. However, coordinate Bench of the Tribunal in assessee's own case qua AYs 2008-09 and 2009-10 ordered to exclude this company from the list of comparables by relying upon CIT vs. Agnity India Technologies Pvt. Ltd. (supra). Since the comparable company is a giant company in terms of risk profile, nature of services, number of employees, ownership of its branded products and brand related profits and having turnover of 135 times of the assessee, it cannot be a suitable comparable for benchmarking the international transaction of assessee company because assessee company is a captive service provider rendering services of its AE alone without having any intangible in the development of software having limited number of employees and not having any branded product.
24. Assessee company is also operating at minimum risk as the services are being provided to its AE and there is a huge difference in the revenue earned by the comparable company vis-à-vis assessee company. So, by following the decision rendered by 16 ITA No.783/Del./2015 coordinate Bench of the Tribunal in assessee's own case for AYs 2008-09 and 2009-10, we hereby order to exclude this comparable from the final set of comparables for benchmarking the international transaction.
PERSISTENT SYSTEMS LIMITED
25. Assessee sought to exclude this company as a comparable on the grounds inter alia that it is functionally not comparable and that this company is having different business model as it drives its income from sale of software services and its products and that this comparable company has been excluded from the final list of comparable in assessee's own case qua AY 2008-09 in ITA No.3324/Del/2013 decided on 23.04.2015, order available on pages 251 to 277 of the Compilation of Case Laws.
26. Coordinate Bench of the Tribunal in assessee's own case for AY 2008-09 (supra) examined the comparability of this company with assessee company and by relying upon order passed by the Delhi Bench of the Tribunal in case of Toluna India Pvt. Ltd. vs. ACIT in ITA No.5645/Del/2011 order dated 26.08.2014 and Lear Automotive India Pvt. Ltd. vs. ACIT in ITA No.5612/Del/2011 order dated 22.12.2014, found this company to be incomparable vis-à-vis assessee company.
17 ITA No.783/Del./2015
27. Coordinate Bench of the Tribunal on the basis of information supplied by Persistent Systems Limited u/s 133 (6) observed that this company has, "developed a few of its own products in the area of identity management contractors" and revenue from product liaison stands at Rs.288.93 million as against the revenue from the software development services at Rs.4829.57 millions. No doubt, the comparable company is engaged in software development services but it is also a software product company and had entered on entity level it had impacted the total profit of the company.
28. Moreover, since there is no separate segmental information available it has been considered as a comparable on entity level and meaning thereby that total revenue considered also constitute some part of the product licence. Since, in the given circumstances, impact of revenue from product licence on the total revenue of the company cannot be ascertained, as this information is not available in the annual report, this company cannot be retained as a suitable comparable, hence we order to exclude this company from the list of comparables.
THIRDWARE SOLUTIONS
29. Assessee sought the exclusion of this company as a comparable on the grounds inter alia that it is functionally 18 ITA No.783/Del./2015 dissimilar being engaged in product development qua which segmental accounts are not available; that it has abnormal/super normal profit and that it is indicated in diversified services like sale of licences, software services, export and revenue from subscription, development of software product qua which no segmental disclosure have been made by the company in its audited financial statement and relied upon in the case of Fiserv India Private Limited (supra).
30. TPO rejected the objections raised by assessee by observing that the software development, implementation and support services are various sub-segments of software development services only and has also brushed aside the objection of assessee that it is only sale of licence by observing that out of total sale of Rs.67.57 crores, the sale of licence is of Rs.1.51 crores which is only 2.2% of the total sales.
31. Keeping in view the fact that this company is into diversified services like sale of licences, software services, development of software products, etc. qua which segmental financials are not available and the fact that this company is having related party transactions exceeding 50% of the revenue, this company cannot be a suitable comparable for benchmarking the international transaction. Moreover, coordinate Bench in Fiserv India Private 19 ITA No.783/Del./2015 Limited (supra) while examining the comparability of this company with Fiserv India Private Limited (supra) and a similarly placed software development company also ordered to exclude the same by taking into consideration all the aforesaid facts. We are of the considered view that this company cannot be a suitable comparable for benchmarking the international transactions, hence this company is ordered to be excluded from the final list of comparables.
WIPRO TECHNOLOGY SERVICES LTD.
32. Assessee company further sought to exclude this company from the final list of comparable for benchmarking the international transaction on the grounds inter alia that it is functionally dissimilar being engaged in ITES/BPO functions of security assessment, business process management services; that its segmental financials are not available; that it has 100% related party transactions and relied upon the decision rendered by Saxo India Pvt. Ltd. vs. ACIT in ITA No.6148/Del/2015 order dated 05.02.2016. The ld. AR for the assessee also contended that this comparable company was also ordered to be excluded by ITAT, Delhi in assessee's own case for AY 2008-09 on account of dissimilar functional profile.
20 ITA No.783/Del./2015
33. However, TPO ordered to retain this company as a comparable on the ground that this company is classified as software developer in Prowess database and mentions delivery of technology infrastructure services; that the services rendered by the comparable company are to be deemed associated enterprises which are deemed international transactions; that Wipro Technology are unrelated entities and it is not clear that how the transactions of Wipro Limited and Citigroup Inc. are party related transactions and preferred to retain this company as a suitable comparable.
34. Coordinate Bench of ITAT, Delhi in assessee's own case ordered to exclude this company from the final list of comparables by making following observations :-
"10.2. We have heard the rival submissions the perused the relevant material on record. It can be observed from the TPO's order itself that the facts and circumstances of Wipro Ltd., are somewhat similar to Infosys Technologies Ltd., inasmuch as he has proceeded to reject the assessee's objections by relying on the reasoning given by him for the inclusion of Infosys Ltd. It is further observed that Wipro Limited (Seg.) was considered as comparable by the TPO in the case of Toluna India (supra) and Lear Automotive (supra). The Tribunal, in both the cases, has held Wipro Ltd. (Seg.) as not comparable. This company is also operating as a full-fledged risk taking entity; engaged in providing technology infrastructure services, testing services, package implementation having more than 82,000 employees. It has its own R&D centre. It incurred around 11% of net sales as expenditure on research and 21 ITA No.783/Del./2015 development. None of the above factors match with the assessee company. Respectfully following the above precedents, we hold that this company is not comparable.
10.3. There is another reason for holding this company as incomparable. It can be seen that there was a merger of Wipro Infrastructure Engineering Ltd., Wipro Healthcare IT Ltd., Quantech Global Services Ltd., with this company during the year in question. This merger was approved by the Hon'ble Karnataka High Court and the Hon'ble AP High Court during the financial year 2007-08. The Mumbai Bench of the Tribunal in Petro Arandite (P) Ltd. Vs. DCIT (2013) 154 TTJ (Mum) 176 has held that a company cannot be considered as comparable because of financial results distorted due to mergers and demergers, etc. Similar view has been taken by the Delhi Bench of the Tribunal in the case of Toluna India Pvt. Ltd. (supra). As there were amalgamations in Wipro Ltd. during the financial year in question, this fact also makes it incomparable with the assessee company. In view of the foregoing reasons, we direct to exclude Wipro Limited (Seg.) from the list of comparables."
35. So, following the decision rendered by the coordinate Bench in assessee's own case for AY 2008-09 and in view of the facts and circumstances of this case, we are of the considered view that this comparable company being a risk taking entity having huge pool of more than 82,000 employees, having its own R&D centre on which expenditure to the tune of 11% is made, cannot be a suitable comparable vis-à-vis the assessee company which is a captive entities providing services to its AE only. So, we order to exclude this company from the final list of comparables. 22 ITA No.783/Del./2015 ADDITIONAL GROUND NO.4.5
36. The assessee company by raising additional ground no.4.5 sought to consider the correct margin of comparable companies specifically Quintegra Solutions Limited. Since the additional ground raised by the assessee company is necessary to adjudicate the controversy at hand, the additional ground is allowed to be raised.
37. Bare perusal of the TP order passed by the TPO goes to prove that the TPO has considered the operating profit of Quintegra Solutions Limited (supra) "as 1.46%" whereas while making separate computation of the operating margin of Quintegra Solutions Limited (supra) its profit margin is recorded at -8.20%. For facility of reference, a margin computation of the final comparable qua Quintegra Solutions Limited (supra) is reproduced as under :-
Income 373,847,298
Add : Misc. Income 57,538
Total Operating Income 373,904,836
Personnel Expenses 274,051,686
Admn. Expenses 62,973,949
Selling & Marketing Expenses 9,930,847
Depreciation 63,206,615
Total Expenses 410,163,097
Less : Non-operating Expenses
Forex Liss 2,636,924
Total Operating Expenses 407,526,173
23 ITA No.783/Del./2015
38. Assessee raised its objections before the ld. DRP who has issued the direction to the TPO to consider the computation submitted by the assessee to work out the margin of the comparable company but the TPO has failed to do so. Since the factual position as to the operating profit margin of Quintegra Solutions Limited (supra) is not in dispute, the TPO is directed to rectify the margin qua Quintegra Solutions Limited (supra) for benchmarking the international transaction. So, additional ground no.4.5 is determined in favour of the assessee.
COMPANIES SOUGHT TO BE EXCLUDED AS COMPARABLES FROM THE FINAL SET OF COMPARABLES FOR BENCHMARKING THE ASSESSEE'S INTERNATIONAL TRANSACTION QUA MARKETING SUPPORT SERVICES APTICO LIMITED
39. Assessee sought to exclude this company as a comparable on ground of functional dissimilarity being engaged in complex and diversifying technical consultancy services and contended that this company is already ordered to be excluded from the final set of comparables for benchmarking the international transactions in assessee's own case in ITA No.3324/Del/2013 (supra) for AY 24 ITA No.783/Del./2015 2008-09. However, TPO preferred to retain this company as a comparable by overruling the objections raised by the assessee.
40. This comparable company was examined as a comparable for benchmarking the international transaction in assessee's own case for AY 2008-09 (supra) and held the same to be incomparable to the assessee company by upholding the order passed by ld. CIT (A). Following the order passed by the coordinate Bench, we are of the considered view that since this company is providing diversifying services like Micro Enterprises Development, Skill Development, Entrepreneurship Development, Research Studies, Project Related Services, Infrastructure Planning & Development Environment Management, Energy Related Services, Cluster Development, Technology Facilitation, Asset Reconstruction & Management Services, Emerging Areas, which also include infrastructure planning and development along with energy related service and cluster development and it has also come on record that this company has only 12% of the total income from research studies which is same as to the services provided by the assessee company. So, in view of the functional dissimilarity, this company cannot be a suitable comparable, hence ordered to be excluded for benchmarking the international transactions. 25 ITA No.783/Del./2015 HCCA BUSINESS SERVICES PVT. LTD.
41. Assessee sought to exclude this company from the list of comparable for benchmarking the international transaction on the grounds inter alia that this is functionally dissimilar being engaged in providing human resources operations and administrative services; it is providing pay roll processing and compensation structuring; management and labour HR related services and reimbursement processes and accounting services.
42. However, TPO sought to retain this company as a comparable company on the ground that the objections raised by the assessee are not acceptable as while doing TNMM only the broad functional profile of the comparable is to be examined.
43. Comparability of this company was examined by the coordinate Bench of Delhi in LG Chemical India Pvt. Ltd. vs. ACIT in ITA No.1819/Del/2015 order dated 03.05.2016 to benchmark the international transaction pertaining to provisions of marking supporting services same as in the case of assessee company. Coordinate Bench at pages 13 & 14 of the order came to the conclusion that this company is functionally not comparable as well as it possesses business and commercial rights of Rs.3,75,33,159/-. When we go through pages 3564 to 3576 of the annual report of this comparable company, it becomes apparently 26 ITA No.783/Del./2015 clear that this company is engaged in pay roll processing services and has considered itself as an outsourcing service provider and as such, is not functionally comparable. So, in these circumstances, we order to exclude this comparable from the set of comparables for benchmarking the international transaction. TSR DARASHAW LIMITED
44. Assessee sought to exclude this company from the final set of comparables on the grounds inter alia that on ground of functional dissimilarity that this company is into share registry, transfer services, depository services, record management share register services and corporate fixed deposit management, which are not identical to the marketing support services being rendered by the assessee and relied upon Trend Micro India Private Ltd. vs. DCIT in ITA No.1585/Del/2015 order dated 20.11.2015, available at pages 35 to 59 of the compilation of case laws, and LG Chemical India Pvt. Ltd. (supra), TPO again by overruling the objections raised by the assessee company retained this company as a comparable.
45. Coordinate Bench of the Tribunal examined this company as a comparable with Trend Micro India Private Ltd. (supra) which is also into marketing and other technical support services for benchmarking the international transactions. Coordinate Bench of 27 ITA No.783/Del./2015 the Tribunal in Trend Micro India Private Ltd. (supra) ordered to exclude this company as an unsuitable comparable by making following observations :-
"9.2. Having heard the rival submissions and perused the relevant material on record, we find that this company is a broking and investment banking house with its three segments, namely, Registrar and transfer agent activity (R&T); Records management activity (Records); and Payroll and trust fund activity (Payroll). Under the Registrar and Transfer Agent activity, this company undertakes registrar and transfer agent activity functions for Equity and preference shares, debenture instruments and bonds, commercial paper and private placements. It also undertakes transfer processing, customer/query handling and correspondence, split/consolidation/renewal of certificates, processing and distribution of interest/dividend warrants, payments by physical warrants/through ECS/Direct Credit. Under Records Management Activity, this company undertakes storage, retention & retrieval of physical and/or electronic records. Under Payroll and Trust Fund Activity, this company handles the activities normally handled by "Payroll and Retirement Funds" section in any organization, including interface with regulatory authorities. When we compare all the three broader activities undertaken by this company, namely, R&T, Records and Payroll, with the overall pre and post sale services rendered by the assessee to its AE, on a cost plus basis, we find that there is a huge functional disparity between the two. That apart, the consideration of this company on an entity level by the TPO has rendered the entire exercise of comparison meaningless. Finding striking dissimilarities between this company and the assessee, we order to exclude this company from the final set of comparables."28 ITA No.783/Del./2015
46. Keeping in view the stark functional dissimilarity between the assessee company vis-à-vis comparable company and by following the decisions rendered by coordinate Bench, we are of the considered view that since the comparable company is into under record management activity vide which it undertakes storage, retention and retrieval of physical or electronic records and also into Payroll and Trust Fund Activity and is handling Payroll and Retirement Funds, it has no functional comparability with the assessee company to be a suitable comparable. So, we order to exclude this company as a valid comparable.
CYBER MEDIA INDIA ONLINE LTD.
47. Assessee sought to exclude this company as comparable for benchmarking the international transactions qua marketing support services on the grounds inter alia that this company is functionally incomparable; this company is providing high end services entailing higher risk and is having significant intangibles i.e. trademark and websites contributing up to 14.55% of its total net block.
48. However, TPO retained this company as a comparable on the ground that under TNMM method comparability of financials is required to be seen rather than fixing on product/service 29 ITA No.783/Del./2015 comparability as in other methods for benchmarking international transactions.
49. Perusal of the annual report, available at pages 3540 to 3559 of Paper Book Vol. IV of the Paper Book, shows that the company is operating as information technology information website generating revenue by selling of online media space and has incurred amount of Rs.1.97 crores as direct expenses which can be in the nature of media buy cost. Moreover, operating online products falls within the category of IT/BPO/ITES. Apart from this, it is apparent from Schedule IV, available at page 3548 of the Paper Book Vol.IV, the comparable company owns trademark and website in the form of intangibles of the significant value which accounts for 14.55% of its total end block.
50. Ld. AR for the assessee also contended that in FY 2009-10, due to extra ordinary events in the form of amalgamation, profitability has been significantly impacted because in FY 2008- 09 OP/OC is 8.14% and in FY 2009-10 OP/OC is 43.10%. However, perusal of page 3558 of the annual report of comparable company shows that the proposed amalgamation has not yet taken effect but, at the same time, we are of the considered view that even proposed amalgamation has impacted the business of the company due to which OP/OC of the comparable company has 30 ITA No.783/Del./2015 shoot up from 8.14% in FY 2008-09 to 43.10% in FY 2009-10 which is certainly an extra ordinary event and reason or extra ordinary profitability of the comparable company cannot be attributed to the normal business circumstances.
51. So, keeping in view the functional dissimilarity and extra ordinary events impacting profitability of this comparable company vis-à-vis assessee company, the same cannot be a suitable comparable for benchmarking the international transaction, hence we order to exclude the same from the final list of comparables.
COMPARABLE COMPANY SOUGHT TO BE INCLUDED BY THE ASSESSEE COMPANY FOR BENCHMARKING INTERNATIONAL TRANSACTNION QUA MARKETING SUPPORT SERVICES
52. Ld. AR for the assessee contended that TPO/DRP have erroneously excluded Concept Communication Ltd., Gradient Information Limited and Goldmine Advertising Limited from the final set of comparables for benchmarking the international transactions which are suitable comparables. However, during the course of argument, the ld. AR for the assessee fairly conceded not to press the inclusion of aforesaid companies in the final list of comparables for benchmarking the international transactions qua the marketing support services. So grounds no.5, 5.2 and 5.3 are partly determined in favour of the assessee.
31 ITA No.783/Del./2015GROUNDS NO.6, 6.1, 6.2, 6.3, 6.4, 6.5 & 6.6
53. Assessee imported capital equipment to the tune of Rs.57,30,63,268/- from its AE during the year under assessment, the detail of which is tabulated as under :-
Particulars Total amount As per As per
capitalized for Companies Income Tax
import of capital Act Rules
equipment
New equipment 32,23,16,507 5,09,04,398 14,57,25,592
Used equipment 25,41,03,286 3,55,64,922 11,00,18,090
Total 57,64,19,793 8,64,69,321 25,57,43,681
54. Ld. AR for the assessee contended that these equipments were imported from its AE in order to help assessee to develop software. However, the TPO held that the arm's length price of the equipment should be nil.
55. The ld. AR for the assessee further contended that the coordinate Bench of Tribunal in assessee's own case for FY 2009- 10, copy of which is available at page 279 to 311 of the Paper Book, on identical facts held the issue in favour of the assessee. For facility of reference, operative part of the order rendered by the coordinate Bench in assessee's own case for AY 2009-10 is reproduced as under :-
"15.2. We have heard the rival submissions and perused the relevant material on record. It is noticed that the assessee purchased certain fixed assets from its AE with the declared value of Rs.33.50 crore. In our considered opinion the assessee rightly reported Purchase of fixed assets with the transacted value as an international 32 ITA No.783/Del./2015 transaction, since the same is covered within the definition given in sub-section (1) of section 92B, which provides that "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or ..............'. Section 92(1) stipulates that: ` Any income arising from an international transaction shall be computed having regard to the arm's length price'. The manner of computation of arm's length price is set out in section 92C. Sub-section (1) provides that the arm's length price in relation to an international transaction shall be determined by any of the methods given in the provision, being the most appropriate method, having regard to the nature of transaction or class of transaction etc. Amongst others, there is Comparable uncontrolled price (CUP) method and TNMM. The primary onus of proving that the international transaction is at ALP, is always on the assessee.
15.3. Reverting to the facts of the instant case, we find that the assessee applied TNMM as the most appropriate method for showing that this international transaction was at ALP. The TPO held that the correct method to be applied was CUP and as such the assessee was called upon to give uncontrolled comparable instances of the purchase of similar assets, which the assessee failed to do. This led the TPO to treat the ALP of this international transaction at Nil. Normally, if the assessee fails to give any comparable instance, then it becomes the duty of the TPO to search some comparable uncontrolled instances at his own and accordingly determine the ALP of the international transaction. In our view, both the assessee as well the TPO went wrong by not doing what was required to be done by them.
15.4. Once the ALP of an international transaction of purchase of fixed assets is determined, then the difference between the transacted value and the ALP does not directly lead to the transfer pricing adjustment. At this juncture, it is pertinent to note the language of 33 ITA No.783/Del./2015 section 92(1) which provides that any income arising from an international transaction shall be computed having regard to the arm's length price. It does not say that the total income is to be computed in accordance with the ALP. It is rightly so because the international transactions which have no direct bearing on the total income, cannot give rise to addition on account of difference between their transacted value and ALP. Since the transaction of purchase of fixed assets is a capital transaction, this, in itself, does not affect the total income of the assessee. It is only the off-shoot of such transaction in the capital field, being depreciation allowance on such ALP of the transaction, which affects the total income. To illustrate, if a fixed asset is purchased by an enterprise from its AE for a sum of Rs.100 and rate of depreciation on such asset is 10%, then the enterprise will charge depreciation amounting to Rs.10 in its Profit and Loss account. If the ALP of such transaction is determined at Rs. 80, then the difference of Rs.20 cannot be considered as income. Rather, the amount of depreciation will be restricted to Rs.8 instead of Rs.10, thereby increasing the total income by Rs. 2. When we advert to the facts of the extant case, it is found that the TPO has rightly held to the effect that it is the amount of depreciation on the purchase of such fixed assets, which will be considered for making addition and not the difference between the transacted value and the ALP determined at Nil.
15.5. Ordinarily an international transaction of purchase of fixed assets by an assessee engaged in a manufacturing or trading business is required to be determined on CUP method, which is usually the most appropriate method in such circumstances. The TNMM on entity level cannot be applied, because the transaction of purchase of fixed assets can have no relation with the transaction of purchase of raw material from AE or sales of goods to AEs. Rule 10A of the IT Rules, defines `transaction' as including `a number of closely linked transactions'. The Hon'ble Delhi High Court in its judgment of March, 2015 in Sony Ericsson Mobile Communications India Pvt. Ltd. has held that the related transactions should be 34 ITA No.783/Del./2015 considered jointly for determining their ALP. However, in order to consider more than one international transaction as one, it is sine qua non that such transactions must be closely and not remotely linked. Every transaction done by an enterprise is somehow or the other linked with the carrying on of the business. But in order to be eligible for processing two or more transactions jointly for determining their ALP, it is essential that they should be closely linked. If two transactions are not closely linked, then they cannot be considered jointly. Considering the above case of a manufacturer or a trader, it cannot be held that the transaction of purchase of fixed assets is closely linked with the purchase of raw material or sale of finished goods etc. In such a scenario, it becomes important to examine the transaction of purchase of fixed assets independent of other transactions.
15.6. However, the above rule of scrutinizing international transaction of purchase of fixed asset as independent of all other transactions is not universal. It has its own exceptions as well. The instant case is a glaring example of exception to the above rule. It is so for the reason that the assessee is getting remuneration from its AE at costs incurred plus a particular mark-up. The cost base includes not only direct but all the indirect costs. The amount of depreciation allowance on fixed assets, including those purchased from AE, is also compensated with the same mark-up. Thus we can say that depreciation allowance and remuneration to the assessee on such depreciation are inseparable transactions. The income in the shape of remuneration to this extent directly depends upon the amount of deprecation allowance. When the assessee is getting mark-up of 13%, the amount of deprecation at Rs.10 in our above hypothetical example will fetch remuneration of Rs.11.30. If the amount of depreciation is reduced to Nil, the amount of income to that extent will also be Nil, because the mark-up can be applied only if there is depreciation cost to the assessee. In other words, the transactions of depreciation on one hand and the resultant revenue on the other, go hand in hand. In 35 ITA No.783/Del./2015 such a case, where the income is directly based on the costs incurred including depreciation, then these two transactions become 'closely linked' transactions, eligible for processing under the TP provisions on a combined basis. It is illogical to compute the ALP of the transaction of purchase of fixed assets and consequently reduce or nullify the amount of depreciation allowance de hors the consideration of international transaction of the revenue from AE, which is equal to depreciation as claimed with mark-up. Both the transactions of claim of depreciation allowance and revenue of depreciation with mark-up have to be seen jointly. The TPO in the present case has simply reduced the amount of deprecation allowance to Nil without simultaneously considering the revenue side of this transaction. If we consider these closely linked transactions of deduction for depreciation allowance and revenue due to depreciation in unison, the position which follows is that no further addition can be made on account of transfer pricing adjustment due to one- sided consideration of depreciation allowance at Nil. Rather, the determination of ALP of the international transaction of purchase of fixed assets, in the facts and circumstances of the instant case, is tax neutral. As such, we order for the deletion of addition made by disallowing or reducing the amount of depreciation on the assets purchased from AE. This ground is allowed.
16. In the result, the appeal is partly allowed."
56. Undisputedly, the assessee imported capital equipment amounting to Rs.57,30,63,268/- (new equipment of Rs.32,23,16,507/- and used equipment of Rs.25,45,41,03,286/- = Rs.57,30,63,268/-) of which the TPO has held the arm's length price at nil. However, coordinate Bench dealt with the issue in detail on the identical facts for AY 2009-10, and held that in case of service provider, the ALP of import of capital equipment, the 36 ITA No.783/Del./2015 depreciation cost of which is recharged with a markup cannot be determined to be nil because it is a tax neutral transaction and revenue is dependent upon the cost incurred (which includes depreciation).
57. So, in these circumstances, the value as recorded in the books of account is to be upheld and deletion of addition made by disallowing or reducing the amount of depreciation on the assets purchased from AE is not sustainable. Not only this, TPO for FY 2010-11 and FY 2007-08 has upheld that the price charged for import of capital equipment complies with the arm's length standard and the assessee has brought on record the order of TPO for FY 2010-11 and FY 2007-08 holding that the price charged for import of capital equipment complies with the arm's length standard which is available as Appendix 2 and Appendix 3 annexed with the synopsis. So, in these circumstances, we hereby delete the addition on this account made by disallowing or reducing the amount of depreciation on the assets purchased from the AE by determining the grounds no.6, 6.1, 6.2, 6.3, 6.4, 6.5 & 6.6 in favour of the assessee.
GROUND NO.7
58. Ground No.7 is not pressed, hence needs no adjudication. 37 ITA No.783/Del./2015 GROUND NO.8
59. Ground No.8 is premature, hence needs no adjudication. GROUND NO.9
60. Ground No.9 needs no adjudication as the same is consequential in nature.
Order pronounced in open court on this 22nd day of March, 2017.
Sd/- sd/-
(R.S. SYAL) (KULDIP SINGH)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated the 22nd day of March, 2017
TS
Copy forwarded to:
1.Appellant
2.Respondent
3.CIT
4.CIT (A)
5.CIT(ITAT), New Delhi. AR, ITAT
NEW DELHI.