M/s. Tally Solutions Private Ltd, Bangalore V. DCIT, Bangalore

ITA 1235/BANG/2010

• Counselvise Citation: [2011] 140 COUNSELVISE.COM (IT) 51298 (ITAT-BANGALORE)
• Duration Of Justice: 10 month(s) 13 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 26-09-2011
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: B
• Next Hearing Date: 15-09-2011
• Assessment Year: 2006-2007
• Appeal Filed On: 12-11-2010
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: ETWA MUNDA CITIII
• Assessee Lawyers: ARVIND V SONDE
• Keywords: Related party transaction; Capital asset; Business income; Depreciation; Transfer pricing; International transaction; Period of limitation; Permanent establishment; Bad and doubtful debts; Valuation report; Time period of passing order
• Section: 92C; 143(3); 234B; 10B; 92

Judgement Text

PAGE 1 OF 61 1 ITA NO.1235/BANG/2010 IN THE INCOME TAX APPELLATE TRIBUNAL, BANGALORE BENCH B BEFORE SHRI N BARATHVAJA SANKAR, VICE PRESIDENT AND SHRI GEORGE GEORGE K, J.M ITA NO.1235/BANG/2010 (ASSESSMENT YEAR 2006-07) M/S TALLY SOLUTIONS PRIVATE LTD., 331-336, RAHEJA ARCADE, KORAMANGALA, BANGALORE. - APPELLANT VS THE DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-12(4), BANGALORE. - RESPONDENT APPELLANT BY : SHRI ARVIND V SONDE, C.A. RESPONDENT BY : SHRI ETWA MUNDA, CIT-III DATE OF HEARING : 15/9 /2011 DATE OF PRONOUNCEMENT :26/09/2011 ORD ER PER GEORGE GEORGE K : THIS APPEAL INSTITUTED BY THE ASSESS EE COMPANY TALLY SOLUTIONS PVT. LTD IS DIRECTED AGAINST THE ORDER OF THE LD. AO PASSED U/S 143(3) R.W.S.144C OF THE ACT DATED: 20.10.2010 FOR THE ASSESSMENT YEAR 2006-07. 2) THE ASSESSEE COMPANY IN ITS GROUNDS OF APPEAL HAD RAISED THIRTEEN GROUNDS UNDER VARIOUS CAPTIONS IN AN ILLUSTRATIVE AND EXTENSIVE PAGE 2 OF 61 2 ITA NO.1235/BANG/2010 MANNER. HOWEVER, ON SCRUTINIZING THE SAME ATTENTIV ELY, IT WAS NOTICED THAT THE GRIEVANCES OF THE ASSESSEE ARE CHIEFLY CONF INED TO THE FOLLOWING ISSUES, NAMELY: (I) THAT THE IMPUGNED ORDER PASSED BY THE LD. AO REQUIRES TO BE QUASHED; OR IN THE ALTERNATIVE (A) THE DEFICIENCIES/SHORTCOMINGS IN THE PROCESS B E MADE GOOD/RECTIFIED; (B) THE ADJUSTMENTS MADE BY THE TPO/AO AND CONFIRMED BY THE DRP VARYING THE REPORTED VALUE OF THE INTERNATIONAL TRANSACTION BE DELETED; & (C) INTEREST CHARGED U/S 234B AND S.234D OF THE AC T BE DELETED. 2.1) CHARGING OF INTEREST U/S 234B OF THE ACT IS M ANDATORY AND CONSEQUENTIAL IN NATURE AND, THUS, THIS GROUND IS N OT MAINTAINABLE AND, ACCORDINGLY, DISMISSED AS NOT MAINTAINABLE. THE LEVY OF INTEREST U/S 234D IS A LEGAL GROUND WHICH IS CHARGEABLE FOR THE AY 2 006-07, FOLLOWING THE FINDING OF THE HONBLE DELHI E SPECIAL BENCH IN THE CASE OF ITO V. EKTA PROMOTERS P. LTD. REPORTED IN (2008) 113 ITD 719. I T IS ORDERED ACCORDINGLY. 2.2) THE ASSESSEE COMPANYS ASSERTIONS THAT THE LOW ER AUTHORITIES ERRED IN PASSING THE IMPUGNED ORDERS (I) WITHOUT CONSIDERING ALL THE SUBMISSIONS AND/OR W ITHOUT APPRECIATING PROPERLY THE FACTS AND CIRCUMSTANCES O F THE CASE AND THE LAW APPLICABLE; (II) IN A MECHANICAL MANNER AND WITHOUT APPLICATIO N OF MIND; (III) AT THE FAG END OF THE LIMITATION PERIOD; AND PAGE 3 OF 61 3 ITA NO.1235/BANG/2010 (IV) WITHOUT AFFORDING A PROPER OPPORTUNITY OF BEI NG HEARD TO THE ASSESSEE ARE FOUND TO BE WANTING AS THE RECORDS TESTIFY THAT THE ASSESSEE COMPANY WAS PROVIDED WITH AS MANY AS EIGHTEEN OPPORTU NITIES DURING THE COURSE OF ASSESSMENT PROCEEDINGS BY THE LD. AO AND AT A GLANCE AT THE IMPUGNED ORDERS OF THE LD. TPO AS WELL AS DRP, IT W AS NOTICED THAT WHILE PASSING THE ORDERS, THE AUTHORITIES CONCERNED HAVE DULY TAKEN COGNIZANCE OF THE RELEVANT FACTS IN ARRIVING AT SUC H CONCLUSIONS WHICH CANNOT BE MERELY TERMED AS THE ORDERS HAVE SINCE BEEN PASSED IN A MECHANICAL MANNER WITHOUT APPLICATION OF MIND . AS NO CONCRETE EVIDENCE WAS FORTH-COMING TO SUGGEST THAT THE IMPUG NED ORDERS WERE SUFFERED FROM THOSE SHORT-COMINGS, WE VENTURE TO DI SMISS THIS GROUND OF THE ASSESSEE COMPANY AS NOT SUSTAINABLE. 3) WE SHALL NOW PROCEED TO DEAL WITH THE PRIMARY IS SUES RAISED BY THE ASSESSEE COMPANY IN THE FOLLOWING PARAG RAPHS: 4) BRIEFLY STATED, THE ASSESSEE COMPANY [ THE ASSESSEE HENCEFORTH] HAS BEEN ENGAGED IN THE BUSINESS OF SOF TWARE DEVELOPMENT, MARKETING AND SALES OF TALLY BRAND FINANCIAL ACCOUNT ING AND MANAGEMENT SOFTWARE. THE ASSESSEE HAS ASSOCIATED EN TERPRISES (AE) IN UK, DUBAI AND OTHER COUNTRIES. IN DUBAIS AE, T HE ASSESSEE HAS 40% SHAREHOLDING. DURING THE YEAR UNDER DISPUTE, THE A SSESSEE SOLD INTELLECTUAL PROPERTY HELD BY IT INCLUDING PATENT, CO PY RIGHTS AND TRADE MARKS TO TALLY SOLUTIONS FZLLC, DUBAI (TALLY DUBAI) O N 31-1-2006 FOR A TOTAL CONSIDERATION OF RS.38.50 CRORES. IT WAS CLA IMED THAT AFTER RESTRUCTURING, FOR THE FIRST 10 MONTHS OF FY 2005-0 6, THE ASSESSEE PAGE 4 OF 61 4 ITA NO.1235/BANG/2010 CONTINUED TO CARRY ON ITS BUSINESS OF SALE OF LICENS E FOR THE RIGHT TO USE OF ITS SOFTWARE PRODUCTS AND LATER TWO MONTHS, IT P ROVIDED SOFTWARE SERVICES TO TALLY DUBAI. 4.1) THE ASSESSEES CASE WAS REFERRED TO THE TPO F OR COMPUTATION OF ARMS LENGTH PRICE U/S 92CA OF THE A CT. AFTER CONSIDERATION OF THE DETAILS FURNISHED BY THE ASSESS EE, THE TPO PROPOSED TO ADOPT VARIOUS COMPARABLES FOR SOFTWARE SEGMENTS TO DETERMINE THE ALP WITH REFERENCE TO SALE OF INTELLE CTUAL PROPERTY RIGHT (IPR) AND BRUSHING ASIDE THE ASSESSEES OBJEC TIONS IN RESPONSE TO THE SAID PROPOSAL, THE TPO DETERMINED THE ALP AT RS .501.46 CRORES [AS ENUMERATED AT PAGE 171 OF HIS IMPUGNED ORDER] WITH RESPECT TO SALE OF IPR TO ITS AE AT DUBAI. 5) AGGRIEVED, THE ASSESSEE TOOK UP THE ISSUE WITH THE DISPUTE RESOLUTION PANEL [DRP] FOR RELIEF. TAKING COGNIZANCE OF THE ASSESSEES CONTENTIONS, THE DRP IN ITS IMPUGNED ORD ER DIRECTED THE TPO TO RECONSIDER THE OBJECTIONS OF THE ASSESSEE ON THE ISSUE AND SUBMIT A FRESH VALUATION REPORT WITH REGARD TO THE SALE OF I PR. THE TPO FURNISHED A REVISED VALUATION OF THE IPR AT RS.260. 63 CRORES WHICH WAS UPHELD BY THE DRP AND, ACCORDINGLY, DIRECTED THE AO T O MAKE THE ADJUSTMENT ON THE BASIS OF THE REVISED WORKING OF T HE TPO AT RS.222.13 CRORES (260.63 CRORES ALP OF RS.38.50 CRORES). T HE AO PASSED THE FINAL ORDER ON 20.10.2010 IN PURSUANCE OF THE DIREC TIONS OF THE DRP DATED 30-9-2010. PAGE 5 OF 61 5 ITA NO.1235/BANG/2010 6) AGITATED, THE ASSESSEE HAS COME UP WITH THE PRE SENT APPEAL AGAINST THE ADJUSTMENT MADE BY THE TPO WHICH WAS UPHELD BY THE DRP TO THE VALUATION OF IPR SOLD BY THE ASSESSEE TO ITS AE - TALLY DUBAI - AND INCORPORATED BY THE AO IN HIS FINAL ORDE R CITED SUPRA. 6.1) DURING THE COURSE OF HEARING, THE SUBMISSIONS MADE BY THE LD. A.R ARE SUMMARIZED AS UNDER: (1) THE ASSESSEE CHALLENGES THE LEGALITY OF REFERENCE T O TPO THE AO WITHOUT FORMING A CONSIDERED OPINION: THE ASSESSEE CHALLENGES THE LEGALITY OF THE REFEREN CE MADE BY THE AO TO THE TPO AS ACCORDING TO THE LD. AR, A REFERENCE HAS BEEN MADE BY THE AO TO THE TPO WITHOU T FORMING A CONSIDERED OPINION ON THE ISSUES UNDER REFERENCE. THE AO REFERRED THE MATTER TO TPO, FOLL OWING CBDT INSTRUCTION NO.3 OF 2003 DATED 20/5/2003. TH E SAID INSTRUCTION PROVIDES THAT THE AO AFTER FORMING PRIMA- FACIE BELIEF ON THE DETAILS AVAILABLE ON RECORD WIT H REFERENCE TO THE INTERNATIONAL TRANSACTIONS, REFER THE CASE TO TPO, IF THE AGGREGATE VALUE OF THESE TRANSACTION S EXCEEDS RS.5 CRORES, AFTER OBTAINING THE APPROVAL O F THE CIT. THE SAID INSTRUCTION FURTHER PROVIDES THAT TH E AO SHALL GIVE FINAL OPPORTUNITY TO THE ASSESSEE AFTER RECEIPT OF THE ORDER OF THE TPO, THAT PRIOR TO THE AMENDMENT M ADE BY THE FA 2007 TO SUB-SECTION (4) OF SEC 92CA OF TH E ACT, THE AO COULD MAKE REFERENCE TO TPO ON ARRIVING AT A PRIMA FACIE OPINION ON THE INTERNATIONAL TRANSACTION AND COULD REACH A CONSIDERED OPINION AFTER RECEIPT OF THE R EPORT FROM THE TPO AFTER PROVIDING OPPORTUNITY TO THE ASS ESSEE. AS PER SUB-SECTION (4) PRIOR TO ITS AMENDMENT, THE AO COULD PROCEED TO COMPUTE THE TOTAL INCOME OF THE ASSESSEE HAVING REGARD TO THE ARMS LENGTH PRICE DETERMINED UNDER SU B- SECTION (3) OF THE TPO. THUS, IT WAS CONTENDED TH AT THERE WAS ALWAYS A SCOPE FOR THE ASSESSEE TO PUT FORTH IT S PAGE 6 OF 61 6 ITA NO.1235/BANG/2010 OBJECTION BEFORE THE AO CONCERNING THE CONTENTS OF THE TPO REPORT AND THE AO, AFTER CONSIDERING THE OBJECTION OF THE ASSESSEE, COULD EITHER AGREE WITH THE TPO REPORT OR AGREE WITH THE OBJECTION OF THE ASSESSEE AND REJECT OR MODIFY THE TPO REPORT WHILE PASSING THE ASSESSMENT ORDER U/S 143 OF THE I.T. ACT. - UNDER THE CIRCUMSTANCES, IT WAS JUSTIFIED THAT THE AO COULD MAKE REFERENCE TO THE TPO U/S 92CA (1) MERELY BY ARRIVING AT THE PRIMA FACIE OPINION AS HE COULD R EACH A CONSIDERED OPINION AFTER RECEIPT OF THE TPOS REPO RT. THIS ASPECT OF FORMING PRIMA FACIE OPINION BEFORE A REFE RENCE TO TPO AND CONSIDERED THE OPINION AFTER RECEIPT OF THE TPO REPORT. - RELIES ON THE RULING OF THE HONBLE DELHI HIGH COURT IN THE CASE OF SONY INDIA P. LTD. VS. CBDT AND ANOTHER [288 ITR 52(2007)] (DEL). - HOWEVER SUBSEQUENT TO THE AMENDMENT IN SUB-SECTI ON (4) OF SECTION 92CA OF THE ACT BY THE FA, 2007, THE AO HAS TO PASS THE ORDER IN CONFORMITY WITH THE ARMS LE NGTH PRICE AS SO DETERMINED BY THE TRANSFER PRICING OF FICER AND, HENCE, POST AMENDMENT, THE AO HAS NO OPTION B UT TO PASS THE ASSESSMENT ORDER IN CONFORMITY WITH THE AL P DETERMINED BY THE TPO. SECTION 92CA READS AS UNDER: 92CA. (1) WHERE ANY PERSON, BEING THE ASSESSEE, HAS ENTERED INTO AN INTERNATIONAL TRANSACTION IN ANY PR EVIOUS YEAR, AND THE ASSESSING OFFICER CONSIDERS IT NECESS ARY OR EXPEDIENT SO TO DO, HE MAY, WITH THE PREVIOUS APPROVAL OF THE COMMISSIONER, REFER THE COMPUTATION OF THE ARM S LENGTH PRICE IN RELATION TO THE SAID INTERNATIONAL TRANSACTION UNDER SECTION 92C TO THE TRANSFER PRICING OFFICER. (2) (3) .. PAGE 7 OF 61 7 ITA NO.1235/BANG/2010 (4) ON RECEIPT OF THE ORDER UNDER SUB-SECTION (3), THE ASSESSING OFFICER SHALL PROCEED TO COMPUTE THE TOTA L INCOME OF THE ASSESSEE UNDER SUB-SECTION (4) OF SECTION 92 C IN CONFORMITY WITH THE ARMS LENGTH PRICE AS SO DETER MINED BY THE TRANSFER PRICING OFFICER.] (5) .. (6) (7) .. SUB-SECTION(4) OF SECTION 92CA HAS BEEN AMENDED BY FINANCE ACT, 2007 W.E.F. 1.6.2007 AND PRIOR TO ITS SUBSTITUTION, SUB-SECTION(4) READ AS UNDER : (4) ON RECEIPT OF THE ORDER UNDER SUB-SECTION(3), THE ASSESSING OFFICER SHALL PROCEED TO COMPUTE THE TOTA L INCOME OF THE ASSESSEE UNDER SUB-SECTION (4) OF SECTION 92C HAVING REGARD TO THE ARMS LENGTH PRICE DETERMINED UNDER SUB-SECTION (3) BY THE TRANSFER PRICING OFFICER. - THE CBDTS INSTRUCTION NO.3 OF 2003 WAS CHALLENG ED IN SONY INDIA (P) LTD VS. CBDT & ANR [288 ITR 52(DEL)] . THE HONBLE DELHI HIGH COURT AFTER CONSIDERING THE PROVISIONS AS THEY STOOD AT THE RELEVANT TIME UPHEL D THE INSTRUCTIONS AS CORRECT AND CONSISTENT WITH SECTION 119 OF THE IT ACT AND OBSERVED THUS - THE EXERCISE OF THE DISCRETION BY THE ASSESSING OF FICER IS REQUIRED TO BE PRECEDED BY THE FORMATION OF AN OPIN ION BY THE ASSESSING OFFICER OF THE NECESSITY OR EXPEDIENC Y OF MAKING SUCH A REFERENCE. HOWEVER, WHAT IS NOT APPAR ENT IS THE NATURE OF SUCH OPINION. IS THIS A PRIMA FACIE O PINION OR A CONSIDERED OPINION AFTER EXAMINING ALL AVAILABLE MA TERIALS ? THE ANSWER TO THIS WILL DETERMINE THE STAGE AT WHI CH THE REFERENCE CAN BE MADE TO THE TRANSFER PRICING OFFI CER. THIS WILL HAVE TO BE UNDERSTOOD FROM THE WORDING O F THE STATUTE ITSELF. A READING OF SECTION 92C AND SECTIO N 92CA PAGE 8 OF 61 8 ITA NO.1235/BANG/2010 DOES NOT INDICATE THAT THE ASSESSING OFFICER IS REQ UIRED TO FORM A PRIOR CONSIDERED OPINION AFTER CONSIDERING A LL THE AVAILABLE MATERIALS EVEN BEFORE MAKING A REFERENCE TO THE TRANSFER PRICING OFFICER. FOR INSTANCE, SECTION 92C A(1) CAN BE CONTRASTED WITH SECTION 55A OF THE ACT WHERE AGA IN THE ASSESSING OFFICER IS EMPOWERED TO REFER TO THE VAL UATION OFFICER THE QUESTION OF ASCERTAINING THE FAIR MARKE T VALUE OF A CAPITAL ASSET. THE WORDING OF SECTION 55A IS UNAMBIGUOUS THAT THE ASSESSING OFFICER HAS TO FIRST FORM AN OPINION THAT THE VALUE DECLARED IS LESS THAN THE FA IR MARKET VALUE BEFORE HE CAN REFER THE QUESTION TO THE VALUA TION OFFICER. IF HE DOES NOT, THEN THE REFERENCE IS ITSE LF BAD. TURNING TO SECTION 92CA, THE QUESTION IS WHETHER TH E REFERENCE TO THE TRANSFER PRICING OFFICER BY THE AS SESSING OFFICER HAS TO BE MADE BY THE ASSESSING OFFICER ONL Y AFTER HE IS SATISFIED BY GOING THROUGH THE STEPS ENLISTED AT SECTION 92C (1) TO (3) AND CONCLUDING THAT THE PRICE DECLAR ED BY THE ASSESSEE IS NOT TO BE ACCEPTED OR CAN HE MAKE SUCH A REFERENCE AT AN ANTERIOR STAGE? THERE IS NOTHING IN SECTION 92CA ITSELF THAT REQUIR ES THE ASSESSING OFFICER TO FIRST FORM A CONSIDERED OPINIO N IN THE MANNER INDICATED IN SECTION 92C (3) BEFORE HE CAN M AKE A REFERENCE TO THE TRANSFER PRICING OFFICER. IN OUR VIEW, IT IS NOT POSSIBLE TO READ SUCH A REQUIREMENT INTO SEC TION 92CA (1). HOWEVER, IT WILL SUFFICE IF THE ASSESSING OFFI CER FORMS A PRIMA FACIE OPINION THAT IT IS NECESSARY AND EXPE DIENT TO MAKE SUCH A REFERENCE. ONE POSSIBLE REASON FOR THE ABSENCE OF SUCH A REQUIREMENT OF FORMATION OF A PRI OR CONSIDERED OPINION BY THE ASSESSING OFFICER IS THAT THE TRANSFER PRICING OFFICER IS EXPECTED TO PERFORM TH E SAME EXERCISE AS ENVISAGED UNDER : SECTION 92C (1) TO (3) WHILE DETERMINING THE ALP UN DER SECTION 92CA (3). THE LATTER PART OF SECTION 92CA( 3) UNAMBIGUOUSLY STATES THAT THE ASSESSING OFFICER SH ALL BY ORDER IN WRITING, DETERMINE THE ARMS LENGTH PRICE IN RELATION TO THE INTERNATIONAL TRANSACTION IN ACCORDANCE WITH SUB- PAGE 9 OF 61 9 ITA NO.1235/BANG/2010 SECTION (3) OF THE SECTION 92C. IT WILL BE POINTL ESS TO HAVE A DUPLICATION OF THIS EXERCISE AT TWO STAGES ONE AF TER THE OTHER. ON THE OTHER HAND, THE SCHEME IS THAT AFTER THE TRANSFER PRICING OFFICER DETERMINES THE ALP THE MAT TER REVIVES BEFORE THE ALP AT SECTION 92C(4) STAGE WHE RE, IN TERMS OF SECTION 92CA(4) THE ASSESSING OFFICER WIL L COMPUTE THE TOTAL INCOME HAVING REGARD TO THE AL P DETERMINED BY THE TRANSFER PRICING OFFICER. THE TWO ASPECTS REQUIRE TO BE TAKEN NOTE OF IN THIS CONTEXT. THE ASSESSING OFFICER WILL NECESSARILY HAVE TO GIV E AN OPPORTUNITY TO THE ASSESSEE AFTER RECEIVING THE RE PORT OF THE TRANSFER PRICING OFFICER AND BEFORE HE FINALIZE S THE ASSESSMENT COMPUTING THE TOTAL INCOME. SECONDLY, TH E PROVISIONS DO NOT MANDATE THAT THE ASSESSING OFFIC ER IS BOUND TO ACCEPT THE ALP AS DETERMINED BY THE TRANS FER PRICING OFFICER . AND FOR GOOD REASON BECAUSE THE ASSESSING OFFICER HAS HIMSELF NOT MADE UP HIS MIND AT THE STA GE ABOUT THE ALP. HE HAS, IN A SENSE, ONLY OUTSOURCED THI S EXERCISE TO THE TRANSFER PRICING OFFICER. HE CAN A LWAYS BE PERSUADED BY THE ASSESSEE AT THAT STAGE TO REJECT T HE TRANSFER PRICING OFFICERS REPORT AND PROCEED TO S TILL DETERMINE THE ALP HIMSELF . IT MUST BE RECALLED THAT IT IS THE ASSESSING OFFICER WHO IS THE AUTHORITY TO FINAL IZE THE ASSESSMENT AND THAT POWER CANNOT BE USURPED, AS IT WERE, BY THE TRANSFER PRICING OFFICER OR ANY OTHER AUTHO RITY CONTRARY TO THE SCHEME OF THE ACT. IF ON THE OTHER HAND ONE WERE TO INTERPRET THE PROVISIONS TO REQUIRE THE ASSESSING OFFICER TO FIRST FORM A CONSIDERED OPINION ON THE A LP BEFORE REFERRING THE MATTER TO THE TRANSFER PRICIN G OFFICER, THEN THE ASSESSING OFFICER WILL THEREAFTER HAVE NO OPTION BUT TO ACCEPT THE REPORT OF THE TRANSFER PRI CING OFFICER AND TO THAT EXTENT THE ASSESSING OFFICERS FINAL SAY ON THE ALP WHILE COMPUTING THE TOTAL INCOME GET S DILUTED. BY PRESERVING THE POWER OF THE ASSESSING OFFICER TO DETERMINE THE ALP EVEN AFTER THE DETERMINATION B Y THE TRANSFER PRICING OFFICER, FULL EFFECT CAN BE GIVEN TO THE PAGE 10 OF 61 10 ITA NO.1235/BANG/2010 WORDS HAVING REGARD TO OCCURRING IN BOTH SECTION 92C(4) AND SECTION 92CA(4). .... IN VIEW OF THE SETTLED LEGAL POSITION, WE ARE OF T HE VIEW THAT THE EXPRESSION HAVING REGARD TO IN SECTION 9 2C(4) AND SECTION 92CA(4) ENABLES THE ASSESSING OFFICER TO C ONSIDER NOT ONLY THE REPORT OF THE TRANSFER PRICING OFFICE R BUT ANY OTHER MATERIAL THAT MAY BE PLACED BEFORE HIM BY THE ASSESSEE TO ARRIVE AT A DIFFERENT CONCLUSION. THIS ALSO STRENGTHENS THE POSITION THAT THE REPORT OF THE TR ANSFER PRICING OFFICER IS NOT BINDING ON THE ASSESSING OFF ICER. .. THE SALIENT POINTS EMERGING FROM THE ABOVE DISCUSSI ON MAY BE RECAPITULATED THUS: (A) THE DISCRETION OF THE ASSESSING OFFICER TO REFE R THE MATTER OF COMPUTATION OF ALP TO THE TRANSFER PRICIN G OFFICER IS NOT UNFETTERED. IT IS TRITE THAT ANY MIS USE OF SUCH EXERCISE OF DISCRETION CAN BE CORRECTED BY WAY OF JUDICIAL REVIEW BY STATUTORY APPELLATE AUTHORITIES AND ULTIMATELY THE COURTS. (B) THE WORDS NECESSARY AND EXPEDIENT OCCURRING I N OTHER PROVISIONS OF THE ACT AND OTHER STATUTES HAVE BEEN INTERPRETED JUDICIALLY TO ADMIT OF A STRICT CONSTRU CTION PERMITTING THE POWER TO BE USED ONLY IN THE MANNER AND SUBJECT TO THE CONDITIONS STIPULATED IN THE PROVISI ON. (C) THE WORDS NECESSARY AND EXPEDIENT POSIT THE F ORMATION OF AN OPINION BY THE ASSESSING OFFICER OF THE NEED TO MAKE SUCH A REFERENCE. HOWEVER, A READING OF SECTION 92 C AND SECTION 92CA DOES NOT INDICATE THAT THE ASSESSING O FFICER IS REQUIRED TO FORM A PRIOR CONSIDERED OPINION AFTER C ONSIDERING ALL THE AVAILABLE MATERIALS EVEN BEFORE MAKING A RE FERENCE TO THE TRANSFER PRICING OFFICER. A PRIMA FACIE OPI NION WOULD SUFFICE AT THE STAGE OF MAKING THE REFERENCE. PAGE 11 OF 61 11 ITA NO.1235/BANG/2010 (D) THE TRANSFER PRICING OFFICER IS EXPECTED TO PER FORM THE SAME EXERCISE AS ENVISAGED UNDER SECTION 92C(1) TO (3) WHILE DETERMINING THE ALP UNDER SECTION 92CA(3). (E) THE ASSESSING OFFICER IS NOT BOUND TO ACCEPT TH E ALP AS DETERMINED BY THE TRANSFER PRICING OFFICER. HE CAN ALWAYS BE PERSUADED BY THE ASSESSEE AT THAT STAGE TO REJEC T THE TRANSFER PRICING OFFICERS REPORT AND PROCEED TO ST ILL DETERMINE THE ALP HIMSELF. THIS IS HOW THE EXPRESSI ON HAVING REGARD TO OCCURRING IN BOTH SECTIONS 92C ( 4) AND 92CA(4) CAN BE GIVEN FULL EFFECT. (F) THIS INTERPRETATION DOES NOT PREJUDICE THE ASSE SSEE BECAUSE IN EFFECT THE ASSESSEE GETS TWO OPPORTUNIT IES TO DEMONSTRATE THAT THE ALP DECLARED BY IT REQUIRES ACCEPTANCE. THE FIRST IS BEFORE THE TRANSFER PRICIN G OFFICER IN TERMS OF SECTION 92CA (3) AND THE SECOND BEFORE THE ASSESSING OFFICER UNDER SECTION 92C (4) (EMPHASIS SUPPLIED). - ON READING OF SEC 92CA OF THE ACT AND DELHI HIGH CO URT JUDGMENT IN THE CASE OF SONY INDIA (P) LTD, IT IS V ERY CLEAR THAT THE AO CAN MAKE REFERENCE TO THE TPO FOLLOWING THE INSTRUCTIONS OF THE CBDT BY FORMING A PRIMA FACIE O PINION AS HE IS NOT BOUND BY THE REPORT OF TPO AND CAN FORM A CONSIDERED OPINION WITH REFERENCE TO THE ISSUES UND ER REFERENCE BEFORE FINALIZING THE ASSESSMENT. IT IS AN ADMITTED POSITION IN LAW THAT AO HAS THE AUTHORITY TO FINALIZE THE ASSESSMENT AND HIS POWER CANNOT BE USU RPED BY THE TPO OR ANY OTHER AUTHORITY CONTRARY TO THE ACT. THE AO CAN ONLY OUTSOURCE THE EXERCISE OF DETERMINATION OF ARMS LENGTH PRICE TO THE TPO BY ARRIVING AT A PRIMA FACIE OPINION AND CAN FORM THE CONSIDERED OPINION AFTER R ECEIPT OF THE TPOS ORDER. HOWEVER, THERE HAS BEEN A CHANGE IN THE PROVISIONS OF THE LAW W.E.F 01.06.2007. THE AO HAS TO COMPUTE TOTAL INCOME OF THE ASSESSEE IN CONFORMITY WITH THE ARMS LENGTH PRICE DETERMINED BY THE TPO. UNDER THE SE CIRCUMSTANCES MERE FORMING THE PRIMA FACIE OPINION BEFORE PAGE 12 OF 61 12 ITA NO.1235/BANG/2010 MAKING REFERENCE TO THE TPO IS NOT SUFFICIENT AS OT HERWISE AO WILL HAVE NO OPPORTUNITY TO FORM A CONSIDERED OP INION ON THE ISSUES UNDER REFERENCE. AO HAS TO PASS THE ORD ER IN CONFORMITY WITH THE ALP DETERMINED BY THE TPO AND IF HE HAS NOT FORMED ANY CONSIDERED OPINION BEFORE MAKING REFERENCE TO THE TPO THEN THE POWERS OF AO HAVE BEE N USURPED BY THE TPO. THE HONBLE DELHI HIGH COURT H AS UPHELD THE INSTRUCTION NO.3 OF 2003 AND HELD THAT P RIMA FACIE OPINION WOULD BE SUFFICIENT FOR MAKING REFERE NCE TO TPO AS AO WILL HAVE CONSIDERED OPINION ON RECEIPT OF THE TPOS ORDER. BUT NOW AFTER THE AMENDMENT TO SEC 92 CA (4), THE AO HAS TO PASS THE ORDER IN CONFORMITY WIT H THE ORDER PASSED BY THE TPO AND, HENCE, THE AO HAS TO H AVE CONSIDERED OPINION BEFORE MAKING REFERENCE TO THE TPO. IT IS , THEREFORE, SUBMITTED THAT THE HONBLE BENCH SHALL ASCERTAIN WHETHER THE AO HAS FORMED A CONSIDERED OP INION BEFORE MAKING REFERENCE TO THE TPO U/S.92CA(1) OF T HE INCOME-TAX ACT, 1961 AND THE COMMISSIONER HAS ACCOR DED HIS APPROVAL FOR THE REFERENCE AFTER DUE CONSIDERAT ION AS THE MECHANICAL APPROVAL CAN NOT BE CONSIDERED TO BE VALID APPROVAL UNDER THE ACT. (2) THE TPO FOLLOWED EXCESS EARNING METHOD WHICH IS NOT A PRESCRIBED METHOD UNDER THE ACT OR RULES : - THAT THE TPO HAS FOLLOWED EXCESS EARNING METHO D AND NOT COMPARABLE UNCONTROLLED PRICE METHOD (CUP) AS THERE WAS NO COMPARABLES AVAILABLE WITH REFERENCE TO THE IPR SOLD BY THE ASSESSEE. THE EXCESS EARNING METHOD IS PART OF THE DRAFT GUIDANCE NOT ISSUED BY THE INTERNATION AL VALUATION STANDARD COUNCIL IN APRIL, 2009, THAT THE TPO DETERMINED THE ALP FOLLOWING THE EXCESS EARNING MET HOD AND MADE ADJUSTMENT TO THE SALE VALUE OF THE IPR. HOWEVER, AS PER SECTION 92C OF THE ACT THE ALP IN R ELATION TO AN INTERNATIONAL TRANSACTION HAS TO BE DETERMI NED WITH REFERENCE TO THE PRESCRIBED METHOD THE RELEVANT PA RT OF SECTION 92C OF THE ACT. PAGE 13 OF 61 13 ITA NO.1235/BANG/2010 - THE TPO HAS TO DETERMINE THE ALP ONLY BY FOLLOWING ONE OR MORE OF THE MOST APPROPRIATE METHOD REFERRED TO IN SECTION 92C(1) OF THE ACT READ WITH RULE 10B AND IN THE MANNER PRESCRIBED UNDER RULE 10C OF THE RULES. T HE EXCESS EARNING METHOD FOLLOWED BY THE TPO IS NOT ON E OF THE METHODS SPECIFIED IN THE ACT READ WITH THE RULE S. THE ASSESSEE THEREFORE SUBMITTED THAT HOWEVER AUTHENT IC AND WELL ACCEPTED THE EXCESS EARNING METHOD MAY BE, THE AO COULD NOT ADOPT THE SAME AS IT IS NOT ONE OF THO SE METHOD RECOGNIZED BY THE INCOME TAX ACT THE ASSE SSEE FURTHER SUBMITS THAT IRRESPECTIVE OF THE VALIDITY OF THE EXCESS EARNING METHOD THE SAME CAN NOT BE APPLI ED FOR DETERMINATION OF ALP UNDER THE I.T. ACT AS IT IS NO T ONE OF THE SPECIFIED METHOD U/S 92C OF THE I.T. ACT. - THAT THE ALP OF IPR SHALL BE ACCEPTED AT RS.3 8.50 CR. AS STATED BY THE ASSESSEE. MOREOVER SINCE THERE W AS NO COMPARABLE UNCONTROLLED TRANSACTION OF SIMILAR NAT URE AVAILABLE AND NO OTHER METHOD CAN BE TAKEN TO BE MOST APPROPRIATE METHOD FOR DETERMINATION OF ALP OF T HE IPR U/S 92C(1) OF THE ACT, THE VALUE OF THE IPR DECLAR ED BY THE ASSESSEE SHALL BE ACCEPTED TO BE THE ALP OF TH E INTERNATIONAL TRANSACTION BY THE AO . - RELIANCE PLACED IN THE CASE OF CA COMPUTER ASSOCIATES PVT. LTD. VS. DCIT (2010) 37 SOT 306(MUM)] WHEREIN THE HONBLE BENCH HAS HELD: THE MANNER IN WHICH THE ALP IS TO BE DETERMINED BY ANY OF THE METHOD PRESCRIBED IN SECTION 92C IS PROVIDED IN RULE 10B OF THE INCOME TAX RULES, 1962. AFTER EXAMINING THE PARAMETERS PRESCRIBED IN RULE 10B, IT CAN BE SEEN THAT BAD DEBTS WRITTEN OFF CAN NOT BE FACTOR TO DETERMINE THE ARMS LENGTH PRICE O F NAY INTERNATIONAL TRANSACTION. IN OUR OPINION, THE TPO HAS EXCEEDED HIS LIMITATION BY FOLLOWING THE METHOD WHICH IS NOT AUTHORIZED UNDER THE ACT OR RULES. WE PAGE 14 OF 61 14 ITA NO.1235/BANG/2010 THEREFORE, HOLD THAT THE ARMS LENGTH PRICE DETERMINED BY THE TPO AND ADOPTED BY THE AO TO THE EXTENT OF ROYALTY PAYABLE TO THE CA INC MANAGEMENT, USA IS NOT AS PER THE PROCEDURE PRESCRIBED AND SAM E CAN NOT BE SUSTAINED. WE THEREFORE DIRECT THE AO T O ADOPT THE ARMS LENGTH PRICE OF THE ROYALTY PAYABLE TO CA INC MANAGEMENT, USA AS DECLARED BY THE ASSESSEE IN BOTH THE YEARS. - THAT IN THE ABSENCE OF APPROPRIATE METHOD FOR DETERMINATION OF ALP OF IPR, THE PROVISION CANNOT BE APPLIED AND VALUE OF IPR DECLARED BY THE ASSESSEE SHALL BE ACCEPTED AS ALP. THE CUP PRESUPPOSES AN EXISTENCE OF COMPARABLE TRANSACTION AND IN THE ABSENCE OF ANY SUCH COMPARABLE THE CUP METHOD CANNOT BE APPLIED FOR DETERMINATION OF ALP, THAT THERE IS NO OTHER METHOD WHICH CAN BE APPLIED FOR DETERMINATION OF ALP, THE PROVISION RELATING TO DETERMINATION OF ALP CAN NOT BE APPLIED TO THE TRANSACTION OF THE ASSESSEE. - RELIES ON THE RULING OF THE SUPREME COURT IN THE CASE OF CIT VS. OFFICIAL LIQUIDATOR, PALAI CENTRAL BANK LTD.[150 ITR 544] WHEREIN IT WAS HELD THAT I F THE PROVISION OF A PARTICULAR ACT ARE INCAPABLE O F ITS APPLICATION, THE CHARGE OF SUCH SECTION FAILS AND THE SAME CAN NOT BE APPLIED. THE HONBLE COURT WAS DEALING WITH APPLICATION OF PROVISIONS CONTAINED IN SUPER PROFITS TAX ACT, 1963 IN RESPECT OF THE COMPANY IN LIQUIDATION SUBSEQUENT TO THE DATE OF IT S WINDING UP. THE COURT FOLLOWING ITS EARLIER JUDG MENT HAS HELD AS UNDER : IN CIT V. B. C. SRINIVASA SETTY [1981] 128 ITR 294 , THIS COURT POINTED OUT THAT UNDER THE SCHEME OF THE I.T. ACT, 1961, CHARGE OF TAX WILL NOT GET ATTRACTE D UNLESS THE CASE OR TRANSACTION FALLS UNDER THE GOVERNANCE OF THE RELEVANT COMPUTATION PROVISIONS. ' PAGE 15 OF 61 15 ITA NO.1235/BANG/2010 THE CHARACTER OF THE COMPUTATION PROVISIONS IN EACH CASE BEARS A RELATIONSHIP TO THE NATURE OF THE CHAR GE. THUS, THE CHARGING SECTION AND THE COMPUTATION PROVISIONS TOGETHER CONSTITUTE AN INTEGRATED CODE. WHEN THERE IS A CASE TO WHICH THE COMPUTATION PROVISIONS CANNOT APPLY AT ALL, IT IS EVIDENT THAT SUCH A CASE WAS NOT INTENDED TO FALL WITHIN THE CHARGING SECTION. OTHERWISE, ONE WOULD BE DRIVEN TO CONCLUDE THAT WHILE A CERTAIN INCOME SEEMS TO FALL WITHIN TH E CHARGING SECTION, THERE IS NO SCHEME OF COMPUTATION FOR QUANTIFYING IT. THE LEGISLATIVE PATTERN DISCERN IBLE IN THE ACT IS AGAINST SUCH A CONCLUSION. EXACTLY SIMILAR BEING THE SCHEME OF THE SUPER PROFITS TAX ACT, 1963, THE ABOVE OBSERVATIONS FULLY APPLY TO TH E CASE BEFORE US. HENCE, IT HAS TO BE HELD THAT INASMUCH AS THE PROVISIONS CONTAINED IN THE ACT FOR COMPUTING THE CAPITAL OF THE COMPANY AND ITS RESERV ES CANNOT HAVE ANY APPLICATION IN RESPECT OF A COMPANY IN LIQUIDATION AND, CONSEQUENTLY, THE ' STANDARD DEDUC TION ' IS INCAPABLE OF ASCERTAINMENT, THE CHARGE OF SUPE R PROFITS TAX UNDER S. 4 OF THE ACT IS NOT ATTRACTED TO SUCH A CASE. THE JUDGMENT OF THE HIGH COURT DOES NOT, THEREFORE, CALL FOR ANY INTERFERENCE. THAT IN VIEW OF THE ABOVE THE SALE VALUE DECLARE D BY THE ASSESSEE AT RS.38.50 CR. OF IPR TRANSFERRED TO TALLY DUBAI, SHALL BE DIRECTED TO BE ACCEPTED AS ALP FOR COMPUTATION OF INCOME FROM INTERNATIONAL TRANSACTION. (3) ON MERITS, IT WAS CONTENDED THAT THE ORDER OF THE TPO SUFFERS FROM THE FOLLOWING INFIRMITIES: (I) T HE TPO HAS RELIED ON ESTIMATES AND SURMISES IN PROJECTING THE FUTURE CASH FLOWS WHILE COMPLETELY DISREGARDING DOCUMENTARY EVIDENCE IN THE FORM OF AUDITED FINANCIAL STATEMENTS THAT WERE AVAILABLE AT THE TIME OF FRAMING THE ORDER. PAGE 16 OF 61 16 ITA NO.1235/BANG/2010 SUCH DOCUMENTS EMPHATICALLY REBUT THE PRESUMPTIONS MADE BY THE TPO (II) THE TPO HAS ERRED IN EXCLUDING LICENSE REVENU ES FOR THE PERIOD 01-4-2005 TO 31-1-2006 IN COMPUTING THE VALUE OF THE IPRS. SINCE THE IPRS WERE SOLD ON 31-1-2006, LICENSE REVENUES TILL THE DATE OF SALE OF IPRS HAVE TO BE CONSIDERED IN DETERMINING THE VALUE OF THE IPRS (III) THE TPO HAS ERRED IN IGNORING SALES RETURNS OF AY 2005-06 AMOUNTING TO RS.111.,03 CRORES. SINCE THE BASIS OF THE TPOS ESTIMATION OF FUTURE REVENUES IS SALES OF AY 2005-06, NON- CONSIDERATION OF SUCH SALES RETURNS GROSSLY INFLATES THE FUTURE EARNINGS POTENTIAL DERIVED FROM THE MODEL ADOPTED BY THE TPO (IV) COMPOUNDED ANNUAL GROWTH RATE (CAGR) IS A FUNCTION OF TWO VARIABLES IN A GIVEN RANGE, I.E THE FIRST AND LAST VARIABLE. VALUES WITHIN THE GIVEN RANGE, I.E. OTHER THAN THE FIRST AND LAST VALUE, DO NOT HAVE A BEARING ON THE CAGR. THIS BEING THE CASE, CAGR IS NOT A GOOD METRIC TO MEASURE GROWTH, ESPECIALLY SO IN THE CASE OF THE APPELLANT WHERE GROWTH HAS BEEN UNEVEN, ERRATIC AND ALSO NEGATIVE IN A FEW YEARS; (V) THE CHOICE OF CAGR ADOPTED BY THE LEARNED TPO IS WHIMSICAL, ILLOGICAL AND WHOLLY UNFOUNDED (VI) USEFUL LIFE OF THE IPR, WHICH IS INEXTRICABLY LINKED WITH TECHNOLOGY, HAS BEEN WRONGLY ESTIMATED BY THE TPO TO BE SIX YEARS WHEREAS IN REALITY, USEFUL LIFE IS INARGUABLY LESS THAN THREE YEARS. INHERENT FLAWS IN THE IPR, WHICH COULD POTENTIALLY CRIPPLE AND FURTHER REDUCE THE PAGE 17 OF 61 17 ITA NO.1235/BANG/2010 USEFUL LIFE OF THE IPR, HAVE NOT BEEN TAKEN COGNIZANCE OF BY THE TPO (VII) THE TPO HAS FOLLOWED THE PRINCIPLES OF CONVENIENCE RATHER THAN ESTABLISHED AND WELL SETTLED PRINCIPLES IN DETERMINING THE DISCOUNT FACTOR (VIII) WORKING CAPITAL RATIO HAS BEEN INCORRECTLY COMPUTED BY THE LEARNED TPO IN THE LIGHT OF THE ABOVE, IT WAS SUBMITTED THAT - (A) WDV OF THE IPRS BE CONSIDERED THE ARMS LENGTH PRICE OF SUCH IPRS; OR (B) THE REVENUES OF AY 2005-06 BE REDUCED BY THE AMOUNT OF SUBSEQUENT SALES RETURNS OF RS.111.4 CRORES, IMPLICIT PERIOD FOR REVENUE PROJECTION BE CONSIDERED FROM 01-4-1999 TO 31-1-2006, USEFUL LIFE OF THE IPR BE TAKEN AT THREE YEARS, DISCOUNT FACTOR OF 23.14% BE CONSIDERED AND IN COMPUTING THE RETURN ON WORKING CAPITAL, ALL CURRENT ASSETS AND CURRENT LIABILITIES BE TAKEN INTO CONSIDERATION. THE ABOVE CONTENTIONS ON MERITS WERE ELABORATED BY GIVING THE FOLLOWING SUBMISSIONS: 1. COMPUTATION OF FUTURE CASH FLOWS: - THE LEARNED TPO AS A FIRST STEP ESTIMATED THE FUT URE TURNOVER OF THE APPELLANT. THE TPO HAS ESTIMATED T HE FUTURE TURNOVER TILL 2012 BASED ON THE PAST PERFORM ANCE AS WELL AS DATA AVAILABLE IN PUBLIC DOMAIN (PAGE 163 O F THE TP ORDER). THE APPELLANTS PAST SALES ARE CONSIDERED AS FOLLOWS(PAGE 165 OF THE TP ORDER): PAGE 18 OF 61 18 ITA NO.1235/BANG/2010 TABLE I (RS. IN CRORES) ASSESSMENT YEAR TOTAL OPERATING REVENUE 2000-01 7.84 2001-02 20.20 2002-03 26.22 2003-04 56.71 2004-05 35.27 2005-06 198.15 TOTAL 344.39 BASED ON THE ABOVE, THE CAGR WORKS OUT TO 90.80% BU T THE LEARNED TPO HAS TAKEN THE CAGR AT 20.39%. THIS GRO WTH RATE IS ASSUMED FOR FUTURE YEARS AND ACCORDINGLY FUTURE REV ENUES AS ESTIMATED BY THE LEARNED TPO ARE AS BELOW: TABLE 2 (RS IN CRORES) ASSESSMENT YEAR TOTAL OPERATING REVENUE 2007-08 287.20 2008-09 345.75 2009-10 416.26 2010-11 501.13 2011-12 603.31 2012-13 726.32 TOTAL 2,879.97 WITH RESPECT TO COMPUTATION OF FUTURE REVENUES - THE LEARNED TPO HAS CONSIDERED THE SALES OF THE APP ELLANT FROM A.Y 2000-01 TO 2005-06. BASED ON THIS DATA, T HE TPO HAS COMPUTED CAGR AND THEN ESTIMATED THE FUTURE PAGE 19 OF 61 19 ITA NO.1235/BANG/2010 REVENUE, THAT THE METHODOLOGY ADOPTED BY THE TPO G IVES ABSURD RESULTS. TO DEMONSTRATE THIS, THE FIGURES O F ACTUAL SALES ARE TABULATED BELOW. TABLE -3 COMPARISON OF ACTUAL REVENUES WITH TPOS ESTIMATED REVENUES ASSESSMENT YEAR INDIAN LICENSE REVENUE GLOBAL REVENUE TPOS ESTIMATES NO. OF TIMES OVERVALUED 2007-08 18,63,30,924 27,73,70,160 287,19,63,050 10 2008-09 86,98,16,178 99,65,09,130 345,75,56,316 3 2009-10 94,66,53,438 102,48,61,182 416,25,52,049 4 2010-11 91,70,80,310 91,70,80,310 501,12,96,411 5 AS CAN BE SEEN FROM THE ABOVE, AS PER THE TPO, THE ASSESSEE WOULD HAVE CUMULATIVE TURNOVER OF AROUND R S. 2,880 CRORES. AS PER THE TPO IN AY 10-11, THE APPE LLANT WOULD HAVE HAD RS.501 CRORES OF TURNOVERS. IN REAL ITY THE TURNOVER IS RS.91.70 CRORES. THERE IS NO PRODUCT C OMPANY IN INDIA WHICH HAS TURNOVER OF 500 CRORES TO 700 CR ORES. THE FIGURES BEING UNREALISTIC ARE LIABLE TO BE REJE CTED; THAT INSTEAD OF ADOPTING UNREALISTIC PROJECTIONS, THE AC TUAL SALES FIGURE AVAILABLE FROM THE AUDITED FINANCIAL STATEME NTS SHOULD BE ADOPTED. - WITH RESPECT TO APPELLANTS CONTENTION THAT ACTUA L SALES FIGURE SHOULD BE ADOPTED, THE TPO HAS CONTENDED THA T TO ARRIVE AT SALE PRICE OF IPR ONE NEEDS TO LOOK AT TH E REVENUE POTENTIAL AT THE TIME OF SALE. HE HAS FURTHER CONT ENDED THAT THE MD OF THE APPELLANT HAS MADE A STATEMENT T HAT THE SALES OF THE COMPANY WOULD BE RS. 5,000 CRORE B Y MARCH 2012. IN THIS REGARD, THE APPELLANT SUBMITS T HAT THEN IF THIS IS TRUE THE TPO HAS COMPLETELY IGNORED THE FACT THAT THE ASSESSEE SALES HAVE NEVER SHOWN A LINEAR G ROWTH. THE TPO HAS ASSUMED THAT THE SALES OF THE APPELLANT WILL KEEP GROWING DESPITE THE FACT THAT APPELLANTS REVE NUES DIPPED IN A.Y. 2004-05 AND A.Y 2006-07. THIS ASPEC T HAS PAGE 20 OF 61 20 ITA NO.1235/BANG/2010 NOT BEEN FACTORED IN REVENUE PROJECTIONS. FURTHER AFTER STATING THAT EVENTS AFTER SALE ARE NOT RELEVANT, TH E TPO IS RELYING ON THE STATEMENT OF THE MD OF THE APPELLANT WHICH IS MADE ON MARCH 17, 2009 (PAGE 146 OF THE TP ORDER ). THE APPELLANT SUBMITS THAT SAME IS NOT RELEVANT FOR AY 2006-07. IF THE STATEMENT IS RELEVANT, THEN THE AC TUAL SALES FIGURE ARE ALSO RELEVANT AND SHOULD BE CONSID ERED WHILE COMPUTING ALP OF IPR SALE. EVEN OTHERWISE MDS STA TEMENT IS A VISION AND NOT REALITY. SUCH VISION OR DREAM CANNOT AUTHORIZE THE TPO TO MAKE INCREDIBLY HIGH PROJECTIO NS WHICH ARE BEREFT OF REALITY. THE DETERMINATION OF ALP HA S TO BE BASED ON THE LAW PREVAILING AND NOT VISION OR DREAM OF THE MD. ACCORDINGLY, THE APPELLANT SUBMITS THAT THE AL P SHOULD BE COMPUTED BASED ON ACTUAL SALES AND NOT PROJECTIO NS. THE TPO HAS CONSIDERED THE SALES OF THE APPELLANT F ROM A.Y. 2000-01 TO 2005-06. BASED ON THIS DATA, THE T PO HAS COMPUTED CAGR AND THEN ESTIMATED THE FUTURE REV ENUE. THE YEAR UNDER CONSIDERATION IS AY 2006-07. THE IP R WAS SOLD ON 31.01.06. THE SALES (LICENSE REVENUE) FOR 10 MONTH PERIOD (APRIL 05 TO JAN 06) IS RS. 60,17,36,844, T HAT SINCE THE SALE OF IPR IS ON 31.01.06, SALES DATA OF THE C URRENT YEAR SHOULD ALSO BE INCLUDED TO COMPUTE THE FUTURE REVENUES. THE APPELLANT SUBMITS THAT CONSIDERING APPROPRIATE SALES DATA IS VITAL FOR CORRECT PROJECT IONS. THE CURRENT YEAR SALES DATA IS CRITICAL BECAUSE IT REFL ECTS THE SALES OF PERIOD IMMEDIATELY PRECEDING THE SALE OF I P AND THEREFORE REFLECTS THE TRUE EARNING POTENTIAL OF TH E IP AT THE TIME OF SALE. - THAT THE TPO IN THE REMAND REPORT (PAGE 11 OF THE REMAND REPORT) HAS STATED THAT CURRENT YEAR DATA WA S NOT TAKEN SINCE THE SAME INVOLVED THE RELATED PARTY TRA NSACTIONS AND THE TRANSACTION INVOLVING IPR TOOK PLACE IN THI S YEAR. IN THIS REGARD, THE APPELLANT SUBMITS THAT THE SALE OF TALLY LICENSES IS TO THIRD PARTIES AND NOT TO RELATED PAR TIES AS CONTENDED BY THE TPO. WHAT IS SOLD BY THE APPELLAN T IS IPR. IPR GENERATES LICENSE REVENUES. THEREFORE TO VALUE PAGE 21 OF 61 21 ITA NO.1235/BANG/2010 IPR WHAT NEEDS TO BE CONSIDERED IS REVENUE FROM TAL LY LICENSEES WHICH ARE SOLD TO THIRD PARTIES. THE OTH ER RELATED PARTY TRANSACTIONS HAVE NO RELEVANCE FOR THIS PURPO SE. THE SITUATION IN AY 2006-07 IS SIMILAR TO SITUATION IN ALL THE YEARS CONSIDERED BY THE TPO. THEREFORE THIS REASON OF THE TPO IS BASELESS. WITH RESPECT TO TPOS CONTENTION THAT THE TRANSACTION INVOLVING IPR TOOK PLACE IN THIS YEAR A ND THEREFORE CURRENT YEAR DATA IS EXCLUDED, THE APPELL ANT SUBMITS THAT SINCE THE SALE IS IN CURRENT YEAR, IT IS MORE SO IMPORTANT TO CONSIDER CURRENT YEAR SALES. THIS IS ALSO IN ACCORDANCE WITH PROVISIONS OF RULE 10B(4) WHICH MAN DATES USE OF CURRENT YEAR DATA WHICH SHOULD BE USED TO E STIMATE FUTURE REVENUES. - THAT THE SALES FOR A.Y. 2005-06 ARE CONSIDERED BY THE TPO AT RS.198.15 CRORES. THE TPO HAS CONSIDERED TH IS YEAR AS THE BASE FOR COMPUTING CAGR AND FUTURE REVE NUES. IT CAN BE NOTICED FROM THE TABLE ABOVE THAT THERE I S A SUBSTANTIAL JUMP IN THE TURNOVER DURING THE AY 2005 -06. IN THE IMMEDIATELY PRECEDING YEAR AND IMMEDIATELY SUCC EEDING YEAR, THERE IS A DIP IN TURNOVER. THE TPO HAS COMP LETELY IGNORED THE EXTRA-ORDINARY CIRCUMSTANCES GIVING RIS E TO THIS TURNOVER. - THAT THE STATE GOVERNMENTS IN INDIA INTRODUCED VA T WITH EFFECT FROM APRIL 1, 2005. THE APPELLANT SENSED A HUGE BUSINESS OPPORTUNITY WITH THE PROPOSED CHANGE IN TH E BUSINESS ENVIRONMENT. WITH VAT BEING INTRODUCED, M ORE AND MORE TRADERS WOULD REQUIRE AUTOMATED SYSTEMS TO SUP PORT THE INCREASED WORK. THIS ALSO PROVIDED AN OPPORTUN ITY TO CONVERT PIRATED USERS TO LICENSED VERSIONS. THE DI STRIBUTORS WERE FORCED TO OFF-TAKE GREATER QUANTITIES OF THE S OFTWARE PACKAGE. THE SAME WAS ACCOUNTED AS TURNOVER IN THE BOOKS OF THE APPELLANT. IN THE LAST THREE MONTHS OF A.Y. 2005- 06, THE SALES ACCOUNTED WERE ALMOST 100% NOT RECEIV ED. IN FACT 95% OF SALES OF A.Y. 2005-06 WERE IN THE MONTH OF MARCH. THE DEBTOR OUTSTANDING AS ON MARCH 31, 2005 WAS AT RS. 197.14 CRORES. RECEIVABLE CONSTITUTED ALMOS T 100% PAGE 22 OF 61 22 ITA NO.1235/BANG/2010 OF SALES. THE APPELLANT HAD DUMPED THE STOCK WITH THE DEALERS IN ANTICIPATION OF GOOD OFF- TAKE DUE TO IN TRODUCTION OF VAT. THOUGH THE APPELLANTS ACCOUNTED REVENUES INCREASED IN A.Y. 2005-06, THE DEALERS COULD NOT SE LL THE WHOLE STOCK. THE SAME WERE RETURNED BY THE DEALERS TO THE ASSESSEE. THERE WAS A SALES RETURN TO THE EXTENT O F RS. 111.04 CRORES IN THE PERTAINING TO SALES MADE IN A. Y. 2005- 06. THE TURNOVER AS REPORTED DID NOT MATERIALIZE. TO ASSUME A GROWTH RATE ON UNREALIZED FIGURES IS BAD I N LAW. THIS IS ESPECIALLY SO WHEN THE CAGR IS SUBSTANTIALL Y INFLUENCED BY THE FIGURE OF TURNOVER FOR THE A.Y. 2 005-06. WHEN THE CONTRIBUTORY FIGURE TO THE DERIVATION OF THE RATE OF GROWTH HAS NOT FRUCTIFIED, THE VERY ASSUMPTION O F THE TPO IS VITIATED. THE PROJECTION OF THE FUTURE TURN OVER ON THE BASIS OF SUCH VITIATED TURNOVER IS THEREFORE BA D IN LAW AND, THUS, THE SALES RETURN MUST BE EXCLUDED FROM T HE TURNOVER OF A.Y. 2005-06. - WITH RESPECT TO THIS CONTENTION OF THE APPELLANT , THE TPO ON PAGE 10 OF THE REMAND REPORT HAS CONTENDED T HAT SALES FIGURES HAVE BEEN TAKEN FROM ANNUAL REPORT OF THE APPELLANT AND THEREFORE SALES RETURN HAVE BEEN TAKE N CARE OF. THE TPO HAS FURTHER CONTENDED THAT HE HAS BEEN VERY CONSERVATIVE AND TAKEN CAGR AT 20.39% INSTEAD OF 90 .80%. THE TPO HAS CONTENDED THAT LOWER CAGR TAKES CARE OF ALL POSSIBLE ADVERSE EFFECTS ON FUTURE CASH FLOWS. - WITH RESPECT TO TPOS CONTENTION THAT SALES RETUR N HAVE BEEN TAKEN CARE OF, THE APPELLANT SUBMITS THAT SALE S RETURNS HAVE NOT BEEN REDUCED FROM THE YEAR TO WHICH THEY PERTAIN.. THEREFORE THE QUESTION OF SAME BEING CON SIDERED DOES NOT ARISE. GOING BY TPOS OWN ADMISSION THAT SALES RETURN AND THAT SALE OF A.Y. 2005-06 SHOULD BE ACCO RDINGLY ADJUSTED. - WITH RESPECT TO TPOS CONTENTION ON CAGR, THE APP ELLANT SUBMITS THAT IF CAGR OF 90.80% IS ADOPTED, THE TOTA L SALES PROJECTION AS PER TPOS METHOD WOULD BE RS. 37,535. 55 PAGE 23 OF 61 23 ITA NO.1235/BANG/2010 CRORES. THIS REFLECTS THE ABSURDITY OF THE TPOS CALCULATION. CAGR OF 90.80% IS NOT POSSIBLE IN REA L LIFE. THIS OUGHT TO HAVE PUT THE TPO ON GUARD TO MAKE FUR THER ANALYSIS AND INVESTIGATION. INSTEAD THE TPO STATES THAT HE HAS BEEN LENIENT. THE LAW OF TRANSFER PRICING IS N OT BASED ON CONCESSION. BENEVOLENCE WOULD NOT LEND CREDENCE TO AN ORDER OTHERWISE BEREFT OF LEGAL SUBSTANCE OR BASIS. THE ORDER IS THEREFORE BAD IN LAW. - ATTENTION WAS DRAWN TO ILLUSTRATIVE CAGR CHART SUB MITTED DURING THE COURSE OF HEARING. THE ASSESSEE SUBMITS THAT THE CAGR VARIES DRASTICALLY BASED ON THE VALUE OF FIRST YEAR AND LAST YEAR EVEN THOUGH THE TOTAL SALES REMAIN SAME. THE HIGH CAGR IN APPELLANTS CASE IS ATTRIBUTED TO SALES IN AY 2005- 06, WHICH NEVER MATERIALIZED. HIGH CAGR HAS RESULT ED IN HIGHER REVENUE PROJECTION FOR FUTURE YEARS WITHOUT CONSIDERING UPS AND DOWNS WHICH IS REALITY IN APPELLANTS CASE. THIS HAS RESULTED IN HIGH VALUATION OF THE IP. THE APPELLAN T SUBMITS THAT THE CHOICE OF CAGR ADOPTED BY THE TPO IS ILLOG ICAL AND WHOLLY UNFOUNDED 2) USEFUL LIFE: - THE TPO HAS ESTIMATED FUTURE REVENUES FOR SIX YEA RS. WHY SIX YEARS WERE SELECTED HAS NOT BEEN STATED. N O REASON OR RATIONALE IS AVAILABLE IN THE ORDER JUSTIFYING T HE ADOPTING A SIX YEAR PERIOD. - PARA 5.8 OF THE EXPOSURE DRAFT (AS RELIED BY THE TPO) STATES AS FOLLOWS: THE FORECAST PERIOD NEEDS TO BE ASSESSED APPROPRIATELY SO THAT IT IS CONSISTENT WITH THE EXPECTED USEFUL LIFE OF THE SUBJECT INTANGIBLE ASSE T . AS THE LIFE OF AN INTANGIBLE ASSET MAY BE FINITE OR ASSUMED TO BE INFINITE, FORECAST CASH FLOWS MAY BE FOR A FINITE PERIOD OR MAY RUN INTO PERPETUITY. PAGE 24 OF 61 24 ITA NO.1235/BANG/2010 AS PER THE EXPOSURE DRAFT, THE VALUE OF INTANGIBLE ASSET IS TO BE DETERMINED BASED ON THE CASH FLOWS ATTRIBUTABLE TO THE SUBJECT INTANGIBLE ASSET. IT IS TO BE BASED ON EXP ECTED USEFUL LIFE OF THE SUBJECT INTANGIBLE ASSET. THE IPR WAS ORIGINALLY ACQUIRED BY THE APPELLANT DU RING THE PREVIOUS YEAR RELEVANT TO A.Y. 2000-01. TALLY IS A N ACCOUNTING PACKAGE WHICH HAS TO BE UPDATED YEAR AFT ER YEAR TO SUIT THE REQUIREMENTS OF THE MARKET AND THE CUST OMER. RIGHT FROM A.Y. 2000-01 UPTO A.Y. 2006-07 DURING WH ICH PERIOD THE IPR WAS SOLD, VARIOUS VERSIONS HAVE BEEN DEVELOPED AND MARKETED. EACH VERSION HAS BEEN IN THE MARKET FOR A VERY SHORT PERIOD AND MOST OF THE TIMES FOR A SPAN NOT EXCEEDING A YEAR. FOR EXAMPLE TALLY VERSION 3 OR V ERSION 4 RELEASED IN 1990S DOES NOT HAVE ANY MARKET TODAY. TABULATED BELOW ARE THE RELEASE DATES OF NEWER VERSIONS: TABLE 4 AS EVIDENT FROM THE ABOVE TABLE, NEWER VERSIONS NEE D TO BE RELEASED AT REGULAR INTERVALS TO SUIT THE MARKET REQUIREMENTS. IN CASE NEWER VERSIONS ARE NOT RELEAS ED, THE DEMAND FOR THE PRODUCTS WILL FALL. WHAT WAS TRANSFE RRED IS IP OF THE EXISTING PRODUCTS, I.E TALLY 7.2. THE MAR KET FOR THE EXISTING PRODUCT IS NOT SIX YEARS. ITS LIFE IS MUCH SHORTER. THE BASE PRODUCT WITHOUT UPGRADES AND NEWER VERSION S WOULD NOT SELL IN THE MARKET. THE ACCOUNTING PACKAGES HA VE TO CONTINUOUSLY EVOLVE. CONTINUOUS DEVELOPMENT IS THE KEY TO ENSURE SUITABILITY OF THE PACKAGE TO ADAPT TO CHANG ING REQUIREMENTS OF THE USER. THEIR SHELF LIFE IS VERY SHORT. COMPETITION IN THE FIELD IS INTENSE. OBSOLESCENCE IS FAST VERSION RELEASE DATE 7.2 01.03.2005 8.1 07.07.2006 9.0 01.12.2006 PAGE 25 OF 61 25 ITA NO.1235/BANG/2010 PACED. CLIENT LOYALTY IS FICKLE. UNDER THE CIRCUM STANCES THE IPR OF AN ACCOUNTING PACKAGE HAS HARDLY ANY VAL UE. THE APPELLANT THEREFORE SUBMITS THAT USEFUL LIFE OF IPR SHOULD BE CONSIDERED AT THREE YEARS AND ACCORDINGLY FUTURE RE VENUES SHOULD BE ESTIMATED FOR THREE YEARS. ATTENTION WAS DRAWN TO THE PREAMBLE (ALSO EXTRACTED BY THE TPO ON PAGE 142 OF THE TP ORDER) OF THE INTELLECTUA L PROPERTY SALE AGREEMENT WITH THE JV PARTNER (GLOBAL CAPITAL PARTNERS, DUBAI AN UNRELATED PARTY AND MA JORITY SHAREHOLDER IN TALLY DUBAI). THE PERMEABLE READS A S FOLLOWS: TSPL 1 IS CONVINCED THAT TALLY AS AN ACCOUNTING SOFTWARE PRODUCT IN THE CURRENT FORM HAS CERTAIN INHERENT FLAWS IN ITS FEATURES AND SUFFERS FROM WEA K MARKET ACCEPTANCE AGAINST SEVERAL COMPETING PRODUCTS PRESENTLY AVAILABLE IN THE MARKET; THAT IT CALLS FO R INTENSE DEVELOPMENT INPUTS OF VERY HIGH MAGNITUDE O N A CONTINUOUS BASIS ON THE PRODUCT DESIGN, TECHNOLOGY AND SECURITY FEATURES AND OTHER VALUE ADDED MODULES ; THAT IT NECESSITATES DEEP STUDY AND GREATER INSIGHT INTO CUSTOMER AND GEOGRAPHICAL REQUIREMENTS FROM THE MARKET STANDPOINT; THAT THE DEVELOPMENT OF ITS INTELLECTUAL PROPERTY IN THE CURRENT FORM HAS REACH ED SATURATION POINT , REQUIRES FRESH AND INNOVATIVE APPROACH IN PRODUCT DESIGN AND DEVELOPMENT, EITHER ALONE OR IN COMBINATION WITH OTHER VALUE ADDED MODU LES AND FEATURES; THAT THERE IS NEED FOR GREATER PENETRATION INTO MARKETS, DEVELOPMENT OF NEW MARKET TERRITORIES TO DRIVE BIGGER VOLUMES TO JUSTIFY THE INCREASE IN THE DEVELOPMENT EFFORTS UNDERTAKEN ; THAT IT DOES NOT HAVE THE RESOURCES IN TERMS OF FINANCE, TECHNOLOGY, ALTERNATIVE VALUE ADDED FEATURES FOR INTEGRATING WITH CORE PRODUCT STRENGTHS AND REQUISI TE KNOW-HOW IN TERMS OF MARKET KNOWLEDGE. PAGE 26 OF 61 26 ITA NO.1235/BANG/2010 AS CAN BE SEEN FROM THE ABOVE, THERE WERE VARIOUS R EASONS FOR SALE OF IPR. THE SAME ARE SUMMARIZED BELOW: (I) THE APPELLANT WAS CONVINCED THAT THERE WERE CERTAIN INHERENT FLAWS IN THE FEATURES OF THE EXISTING PROD UCT. WHEN THE TALLY PACKAGE WAS INTRODUCED, THE APPELLAN T WAS THE ONLY PLAYER (OR PROBABLY ONE OF THE VERY FEW) I N THE MARKET. OVER A PERIOD OF TIME MANY OTHER PLAYERS E NTERED THE MARKET WITH THEIR PACKAGES. IF THE INHERENT FL AWS WERE NOT CORRECTED THE APPELLANT WOULD HAVE LOST THE MAR KET SHARE. FOR EXAMPLE, THE EXISTING PRODUCT DID NOT H AVE SECURITY FEATURES LEADING TO LARGE SCALE PIRACY. T HE TALLY PACKAGE WAS AMENABLE TO COPYING AS THE SECURITY SYS TEM IN THE PRODUCT WAS WEAK. MANY PIRATED VERSIONS CAME I NTO THE MARKET WHICH WAS AVAILABLE AT A FAR LESSER PRICE. (II) TO CORRECT THE ABOVE FLAWS INTENSE DEVELOPM ENT INPUTS OF VERY HIGH MAGNITUDE WERE REQUIRED ON A CONTINUOU S BASIS ON THE PRODUCT DESIGN, TECHNOLOGY AND SECURITY FEAT URES AND OTHER VALUE ADDED MODULES. THE CONTINUOUS DEVELOPM ENT WOULD NECESSITATE DEEP STUDY AND GREATER INSIGHT IN TO CUSTOMER AND GEOGRAPHICAL REQUIREMENTS FROM THE MAR KET STANDPOINT. THE ASSESSEES PRODUCTS TARGETS SMALL AND MEDIUM BUSINESSES. MOST OF THEM ARE RUN BY INDIVID UALS OR SMALL FIRM. UNDERSTANDING THEIR INDIVIDUAL AND MUL TITUDE REQUIREMENTS AND PREFERENCES AND TRANSLATING THAT I NTO PRODUCT REQUIRES DEEP STUDY. (III) IN THE INITIAL YEARS, THE TALLY PRODUCT WAS JUST AN ACCOUNTING PACKAGE. TO EXPAND THE MARKET, VARIOUS OTHERS FEATURES WERE REQUIRED TO BE INTEGRATED. MEDIUM SI ZED BUSINESSES REQUIRE FEATURES LIKE INVENTORY, PAYROLL , E-TDS, SERVICE TAX RETURNS, COST CENTRES, FBT ETC. THE CU STOMERS WANT ONE-STOP SOLUTION FOR ALL THE REQUIREMENTS. W HEN ASSESSEE SOLD THE IP, VERSION 7.2 WAS IN VOGUE. IN THE LATTER VERSIONS, THE PRODUCT CONSISTING OF FBT, VAT RETURNS, INTEREST CALCULATIONS, STOCK VALUATION, SE RVICE TAX RETURNS ETC FEATURE WERE RELEASED. ADDING THESE FE ATURES PAGE 27 OF 61 27 ITA NO.1235/BANG/2010 REQUIRED IN DEPTH STUDY OF REQUIREMENTS, INNOVATIVE DESIGN AND DEVELOPMENT TECHNIQUES. THE SAME REQUIRED FUND S. THE APPELLANT THEREFORE FORMED A JV WITH THE GLOBAL CAP ITAL PARTNERS. THE JV PARTNERS ARRANGED A LOAN OF USD 5,110,500 TO THE ASSOCIATED ENTERPRISE OF THE APPEL LANT. THE SAME WAS USED FOR DEVELOPMENT OF NEWER VERSIONS . THE APPELLANT INITIALLY HAD A SMALL TEAM OF SOFTWARE DE VELOPERS. THE TEAM WAS EXPANDED TO 332 EMPLOYEES BY 31 MARCH 2005. THE TEAM WAS FURTHER EXPANDED TO 814 EMPLOYE ES BY 31 JANUARY 2006. THIS WOULD NOT HAVE BEEN POSSI BLE WITHOUT THE FUNDS AND INPUTS PROVIDED BY THE JV PAR TNERS. AS CAN BE SEEN FROM THE ABOVE, TALLY SOFTWARE HAD V ARIOUS FLAWS AT THE TIME OF THE SALE. THE SAME REQUIRED I NTENSE DEVELOPMENT INPUTS OF VERY HIGH MAGNITUDE ON A CONT INUOUS BASIS. WITHOUT THESE DEVELOPMENT EFFORTS, THE PROD UCT WOULD NOT BE ABLE TO SELL IN THE MARKET. THEREFORE , THE BASE PRODUCT AS SOLD ON 31.01.06 WOULD NOT LAST LON G IN THE MARKET. THEREFORE, IT WOULD NOT BE APPROPRIATE TO CONSIDER THE SHELF LIFE AND REVENUE PROJECTION FOR SIX YEARS . THE APPELLANT SUBMITS THAT IN THE FACTS AND CIRCUMSTANC ES OF THE CASE, THREE YEAR REVENUE PROJECTIONS WOULD BE APPRO PRIATE . 3. CALCULATION OF DISCOUNT FACTOR BETA : 4.1.1 FOR COMPUTING THE BETA, THE LEARNED TPO HAS ADOPTED BETA OF A SIMILAR COMPANY. IT IS STATED ON PAGE 163 OF THE TP ORDER THAT SANKHYA INFOTECH LIMITED I S A SIMILAR COMPANY. THE SAID COMPANY IS ENGAGED IN DEVELOPMENT AND SALE OF SOFTWARE PRODUCTS FOR AVIAT ION INDUSTRY. IT IS DIFFICULT TO FATHOM HOW A COMPANY DEVELOPING SOFTWARE PRODUCT FOR AVIATION INDUSTRY CAN BE COMPA RED TO APPELLANT WHICH IS DEVELOPING SOFTWARE FOR ACCOUNTI NG. FURTHER, THE LEARNED TPO HAS CONSIDERED 3 COMPANIES AS COMPARABLE TO THE APPELLANTS SEGMENT OF DISTRIBUTI ON OF PRODUCTS. THESE COMPANIES ARE LIFETREE CONVERGENCE PAGE 28 OF 61 28 ITA NO.1235/BANG/2010 LIMITED, EXENSYS SOFTWARE SOLUTIONS LIMITED AND SAN KHYA INFOTECH LIMTIED (PAGE 139 OF THE TP ORDER). OUT O F THESE THREE, ONLY SANKHYA INFOTECHS BETA HAS BEEN CONSID ERED. WHY THE OTHER TWO COMPANIES ARE NOT CONSIDERED IS N OT CLEAR. THE APPELLANT SUBMITS WITHOUT PREJUDICE THA T BETA SHOULD BE COMPUTED AFTER CONSIDERING ALL THE THREE COMPANIES. THE AVERAGE BETA OF THREE COMPANIES WOU LD BE 1 (COMPUTATION OF BETA ON PAGES 408 TO 414 OF THE P APER BOOK). RISK PREMIUM WHILE COMPUTING THE DISCOUNT RATE, THE LEARNED TPO (PAGE 166 OF THE TP ORDER) HAS TAKEN THE RISK PREMIUM AT 8.80%. IT IS STATED THAT RISK PREMIUM OF BENCH MARK BSE IN DEX HAS BEEN CONSIDERED. IN THIS REGARD, THE APPELLANT SUBMITS THAT IT IS ENGAGED IN THE BUSINESS OF SOFTWARE DEVE LOPMENT AND COMPARING RETURN OF BSE INDEX WHICH IS COMPOSIT ION OF COMPANIES FROM VARIOUS INDUSTRIES IS NOT APPROPRIAT E. THE RISK PREMIUM SHOULD BE BASED ON RETURN OF COMPANIES ENGAGED IN SOFTWARE INDUSTRY. THEREFORE THE APPELL ANT SUBMITS THAT MARKET RETURN ON CAPITAL EMPLOYED FR OM CAPITALINE DATABASE OF SOFTWARE INDUSTRY (MEDIUM AN D SMALL COMPANIES) BEING 11.61% SHOULD BE ADOPTED. RATE OF INFLATION THE TPO HAS CONSIDERED THE AVERAGE INFLATION RATE A T 4%. IT IS STATED THAT THE INFLATION RATE IS ON THE BASI S OF RBIS FUTURE PROJECTION OF INFLATION (PAGE 167 OF THE TP ORDER). THERE IS NO FURTHER SUBSTANTIATION. IN THIS REGARD , THE APPELLANT SUBMITS THAT THE INFLATION RATE AS ADOPTE D BY THE TPO IS ON THE LOWER SIDE. THE APPELLANT SUBMITS TH AT INFLATION RATE SHOULD BE CONSIDERED AT 5.45% BEING AVERAGE OF A.Y. 2005-06 AND 2006-07 . THIS IS BASED ON ECONOMIC SURVEY 2009-10 PAGE 29 OF 61 29 ITA NO.1235/BANG/2010 CALCULATION OF WORKING CAPITAL WHILE COMPUTING WORKING CAPITAL (PAGE 169 OF THE TP ORDER) THE LEARNED TPO HAS CONSIDERED SUNDRY DEBTORS, WORK IN PROGRESS AND SUNDRY CREDITORS ONLY. THE LEARNED TP O HAS NOT CONSIDERED CASH &BANK BALANCES, OTHER CURRENT A SSETS (EXCEPT INTER-CORPORATE DEPOSITS) AND PROVISIONS. THE ASSESSEE SUBMITS THAT SAME SHOULD BE CONSIDERED WHI LE COMPUTING WORKING CAPITAL RATIO. WDV IS AN APPROPRIATE ALP TALLY DUBAI WAS JV BETWEEN THE APPELLANT AND GLOBAL CAPITAL PARTNERS. THE JV PARTNER IS IN NO WAY RELATED TO T HE APPELLANT. GLOBAL CAPITAL PARTNERS WAS NOT A MINOR ITY SHAREHOLDER. IT WAS IN FACT A MAJORITY SHAREHOLDER . THE VALUE FOR TRANSFER OF IPR WAS ARRIVED AT AFTER DUE NEGOTIATIONS AND DELIBERATIONS. THE JV PARTNER HAD 60% STAKE IN TALLY DUBAI. THE APPELLANT CANNOT BE IMPU TED WITH A MOTIVE TO UNDER SELL THE IPRS. THIS WOULD HAVE BEEN A FINANCIAL LOSS TO THE APPELLANT. NOBODY WOULD INVI TE AN ACTUAL FINANCIAL LOSS SOLELY DRIVEN BY TAX AVOIDANC E MOTIVE, ESPECIALLY WHEN THE TRANSACTION INVOLVES A THIRD PA RTY. IN SUCH CIRCUMSTANCES PAYING TAXES WOULD BE A FAR SMAL LER COST THEN THE LOSS OF THE MONEY ITSELF THROUGH AN UNDERV ALUED SALE. THE OECD GUIDELINES INDICATE THAT THE PRESENCE OF M INORITY SHAREHOLDERS AS AN INDICATION OF ARMS LENGTH CONDI TION. THIS PRESUMPTION WOULD ACT MUCH STRENGTHENED THAT IN THE INSTANT CASE THE THIRD PARTY IS A MAJORITY SHAREHOLDER. IN THIS REGARD, THE ASSESSEE INVITES YOUR HONOURS ATTENTION TO THE FOLLOWING EXTRACTS FROM THE PROPOSED AMENDME NTS TO OECD GUIDELINES: 3.26 THE PRESENCE OF MINORITY SHAREHOLDERS MAY BE ONE FACTOR LEADING TO THE OUTCOMES OF A TAXPAYERS PAGE 30 OF 61 30 ITA NO.1235/BANG/2010 CONTROLLED TRANSACTIONS BEING CLOSER TO ARMS LENGT H, BUT IT IS NOT DETERMINATIVE IN AND OF ITSELF. THE INFLUENCE OF MINORITY SHAREHOLDERS DEPENDS ON A NUMBER OF FACTORS, INCLUDING WHETHER THE MINORITY SHAREHOLDER HAS A PARTICIPATION IN THE CAPITAL OF T HE PARENT COMPANY OR IN THE CAPITAL OF A SUBSIDIARY, A ND WHETHER IT HAS AND ACTUALLY EXERCISES SOME INFLUENC E ON THE PRICING OF INTRA-GROUP TRANSACTIONS THE TPO HAS NOT APPRECIATED THE BUSINESS, COMMERCIA L AND ECONOMIC REALITIES. IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE IPR BEING TRANSFERRED AT WDV IS TO BE CON SIDERED AS AT ARMS LENGTH. TO SUPPORT ITS CONTENTION, THE APPELLANT RELIES ON THE BANGALORE ITAT DECISION IN THE CASE OF INTEL ASIA E LECTRONIC INC V ADIT 2011-TII-14-ITAT-BANG-TP. IN THIS CASE, THE ASSESSEE HAD SOLD ITS PE AS A GOING CONCERN TO ITS AE. THE HONBLE ITAT HELD THAT THE ONLY REASONABLE APPR OACH WOULD BE VALUE THE ASSETS BY APPLYING THE DEPRECIAT ION RATES AS PROVIDED BY THE INCOME TAX ACT. THE RELEVANT EX TRACTS ARE AS FOLLOWS: 12. TO BREAK THE ICE IN SUCH A SITUATION, THE ONLY REASONABLE APPROACH WOULD BE TO VALUE THE ASSETS BY APPLYING THE DEPRECIATION RATES AS PROVIDED BY THE INCOME TAX ACT FOR IT IS MORE DYNAMIC AND SO SCHEMED TO BRING IN A NOTIONAL CHARGE ON THE PROFIT AND LOSS ACCOUNT TO ARRIVE AT THE ACTUAL INCOME OF AN ASSESSEE KEEPING IN VIEW OF THE DEPLETION OF THE ASSETS. BASED ON THE ABOVE, THE APPELLANT SUBMITS THAT THE IPR BEING TRANSFERRED AT WDV IS TO BE CONSIDERED AS AT ARMS LENGTH. PAGE 31 OF 61 31 ITA NO.1235/BANG/2010 DURING THE COURSE OF HEARING, THE APPELLANT SUBMITT ED CHART CONTAINING 6 ALTERNATIVE COMPUTATIONS. METHOD I IS THE COMPUTATION AS DONE BY THE TPO. IN METHOD II, THE COMPUTATION PROCEEDS TAKING THE CORRECT CAGR (90.80 %). AS PER THIS METHOD, THE TOTAL SALES COME TO RS. 37,535 .55 CRORES AND VALUE OF IPR COMES TO RS. 2,871.96. AS ALREADY SUBMITTED THIS REFLECTS THE ABSURDITY OF TPOS METHOD. ASSUMING WITHOUT ADMITTING THAT THE METHOD ADOPTED BY TPO IS CORRECT, THE APPELLANT SUBMITS METHOD III TO VI FOR CONSIDERATION. METHOD III FOLLOWING CHANGES MADE TO TPOS COMP UTATION: 1. SUBSEQUENT SALES RETURN IN AY 2007-08 REDUC ED FROM SALES OF AY 2005-06. CHANGES IN WORKING CAPITAL AS DETAILED ABOVE MADE D ISCOUNT RATE CONSIDERED AT 23.14% AFTER CONSIDERING CHANGES IN B ETA, RISK PREMIUM AND INFLATION RATE AS DETAILED ABOVE. WORKING CAPITAL CHANGES AS DETAILED ABOVE. BASED ON THE ABOVE CHANGES, THE ALP COMES T O RS. 19.12 CRORES METHOD IV FOLLOWING CHANGES MADE TO TPOS COM PUTATION: IMPLICIT PERIOD CHANGED 01.04.99 TO 31.01.06 (UPTO DATE OF SALE OF IPR). CHANGES IN WORKING CAPITAL AS DETAILED ABOVE MADE DISCOUNT RATE CONSIDERED AT 23.14% AFTER CONSIDERIN G CHANGES IN BETA, RISK PREMIUM AND INFLATION RATE AS DETAILED A BOVE. WORKING CAPITAL CHANGES AS DETAILED ABOVE. BASED ON THE ABOVE CHANGES, THE ALP COMES TO RS. 30 .77 CRORES METHOD V FOLLOWING CHANGES MADE TO TPOS COMPUT ATION: ACTUAL SALES (OF TALLY DUBAI) FIGURES FOR AY 2007-08 TO 2010-11 CONSIDERED. SALES FOR AY 2011-12 AND AY 2012-13 AR E ESTIMATED BASED ON CAGR COMPUTED BASED ON AY 2000-01 TO AY 20 10-11. PAGE 32 OF 61 32 ITA NO.1235/BANG/2010 CHANGES IN WORKING CAPITAL AS DETAILED ABOVE MADE DISCOUNT RATE CONSIDERED AT 23.14% AFTER CONSIDERIN G CHANGES IN BETA, RISK PREMIUM AND INFLATION RATE AS DETAILED A BOVE. WORKING CAPITAL CHANGES AS DETAILED ABOVE BASED ON THE ABOVE CHANGES, THE ALP COMES TO RS. 14 .70 CRORES METHOD VI FOLLOWING CHANGES MADE TO TPOS COMPU TATION: IMPLICIT PERIOD CHANGED 01.04.99 TO 31.01.06 (UPTO DATE OF SALE OF IPR). ACTUAL SALES (OF TALLY DUBAI) FIGURES FOR AY 2007-08 TO 2010-11 CONSIDERED. SALES FOR AY 2011-12 AND AY 20 12-13 ARE ESTIMATED BASED ON CAGR COMPUTED BASED ON AY 2000-0 1 TO AY 2010-11. CHANGES IN WORKING CAPITAL AS DETAILED ABOVE MADE. DISCOUNT RATE CONSIDERED AT 23.14% AFTER CONSIDERIN G CHANGES IN BETA, RISK PREMIUM AND INFLATION RATE AS DETAILED A BOVE. WORKING CAPITAL CHANGES AS DETAILED ABOVE. BASED ON THE ABOVE CHANGES, THE ALP COMES TO RS. (12.64) CRORES - THAT UNDER EVERY METHOD THE ARMS LENGTH PRICE IS LESS THAN RS. 38.50 CRORES BEING THE PRICE RECEIVED (RS. 11.81 CR ORES BEING SALE PRICE + RS. 26.69 CRORES AMOUNTS RECEIVED TOWARDS I MPROVEMENT TILL THE DATE OF SALE). THEREFORE, THE ADDITIONS M ADE BY THE TPO ARE WITHOUT BASIS. 6.2) THE LD. A R CAME UP WITH VARIOUS CASE LAWS IN SUPPORT OF HIS STAND AND ALSO FURNISHED A VOLUMINOUS PAPER BOO K CONTAINING 1 414 PAGES WHICH CONSIST OF INTER ALIA COPIES OF (I) EXT RACTS OF FINANCIAL STATEMENTS, (III) WRITTEN SUBMISSIONS AND CORRESPON DENCES WITH VARIOUS AUTHORITIES ETC., 6.3) ON THE OTHER HAND, THE LD. D R ARGUED THAT TH E LD.AO WAS WITHIN HIS REALM TO REFER THE ASSESSEES CASE T O THE TPO FOR COMPUTATION OF ALP U/S 92C OF THE ACT. ALSO, ON HI S PART, THE TPO HAD, PAGE 33 OF 61 33 ITA NO.1235/BANG/2010 AFTER DUE CONSIDERATION OF THE ISSUE AT LENGTH AND ALSO ANALYZING THE ISSUE FROM VARIOUS ANGLES, ARRIVED AT A CONCLUSION IN A JUDICIOUS MANNER WHICH HAS BEEN UPHELD BY THE DRP WITH SUITABLE MODIF ICATION AS ENUMERATED IN ITS FINAL DIRECTIONS. IT WAS, THEREF ORE, PLEADED THAT THE IMPUGNED ORDER OF THE LD. AO U/S 143(3) R.W.S. 144C OF THE ACT REQUIRES TO BE SUSTAINED IN TOTO. THE REVENUE HA S GIVEN SPECIFIC REBUTTALS TO THE CERTAIN POINTS RAISED BY THE ASSESS EE WHICH ARE EXTRACTED IN THE COURSE OF THIS ORDER. 7) WE HAVE CAREFULLY EXAMINED THE RIVAL SUBMISSIONS , DILIGENTLY PERUSED THE RELEVANT CASE RECORDS AND ALS O THE VOLUMINOUS DOCUMENTARY EVIDENCES COUPLED WITH VARIOUS CASE LAWS ADVANCED BY EITHER PARTY TO DRIVE HOME THEIR RESPECTIVE STAND. 8) WE SHALL FIRST TAKE UP THE LEGAL ISSUES RAISED BY THE ASSESSEE. I. REFERRING THE CASE TO TPO U/S 92CA OF THE ACT . 8.1) IT WAS THE CONTENTION OF THE ASSESSEE THAT T HE REFERENCE OF ITS CASE TO THE TPO BY THE AO WAS NOT IN ACCORDAN CE WITH THE LAW SINCE, ACCORDING TO THE ASSESSEE, AS PER THE RULING OF HONBLE DELHI HIGH COURT IN THE CASE OF SONY INDIA P. LTD. V. CBDT REPO RTED IN [2007] 288 ITR 52 (DEL), A PRIMA FACIE SATISFACTION IS ONLY APPLICABLE WHEN T HE TAXPAYER IS GIVEN A SECOND INNINGS TO EXPLAIN HIS CASE BEFORE THE AO AFTER THE TPO REFERENCE IS RECEIVED. THIS WAS COUNTERED BY THE REVENUE THUS PAGE 34 OF 61 34 ITA NO.1235/BANG/2010 (1) IN THE CASE OF SONY INDIA REFERRED SUPRA, THE HO NBLE COURT CLEARLY HELD THAT - A DISCRETION IS GIVEN TO THE ASSESSING OFFICER TO REFER THE QUESTION OF COMPUTATION OF THE ARMS LENGTH PRICE T O THE TRANSFER PRICING OFFICER, IF HE CONSIDERS THAT IT I S SUITABLE, APPROPRIATE, PROFITABLE OR CONVENIENT TO THE REVENU E. THE TWO WORDS NECESSARY OR EXPEDIENT ARE SEPARATED BY THE WORD OR AND NOT BY THE WORD AND AND, THEREFORE, SHOU LD NOT BE READ AS NECESSARY AND EXPEDIENT. THERE IS NOTHING IN S.92CA ITSELF THAT REQUIRES TH E AO TO FIRST FORM A CONSIDERED OPINION IN THE MANNER INDIC ATED IN S. 92C (3) BEFORE HE CAN MAKE A REFERENCE TO THE TPO. IN OUR VIEW, IT IS NOT POSSIBLE TO READ SUCH A REQUIREMEN T INTO S.92CA(1). HOWEVER, IT WILL SUFFICE, IF THE AO FOR MS A PRIMA FACIE OPINION THAT IT IS NECESSARY AND EXPEDIENT TO MAKE SUCH A REFERENCE. ONE POSSIBLE REASON FOR THE ABSENCE O F SUCH A REQUIREMENT OF FORMATION OF AS PRIOR CONSIDERED OPI NION BY THE AO IS THAT THE TPO IS EXPECTED TO PERFORM THE SAME EXERCISE AS ENVISAGED UNDER S.92C(1) TO (3) WHILE D ETERMINING THE ALP UNDER S.92CA(3). THE LATTER PART OF S.92CA (3) UNAMBIGUOUSLY STATES THAT THE AO SHALL BY AN ORDER IN WRITING; DETERMINE THE ARMS LENGTH PRICE IN RELATI ON TO THE INTERNATIONAL TRANSACTION IN ACCORDANCE WITH SUB-SE CTION (3) OF S.92C. IT WILL BE POINTLESS TO HAVE A DUPLICATION OF THIS EXERCISE AT TWO STAGES ONE AFTER THE OTHER. ON THE OTHER HAND, THE SCHEME IS THAT AFTER THE TPO DETERMINES T HE ALP THE MATTER REVIVES BEFORE THE ALP AT THE S.92C (4) STAGE WHERE IN TERMS OF S.92CA(4) THE AO WILL COMPUTE THE TOTAL INCOME HAVING REGARD TO THE ALP DETERMINED BY THE T PO. (2) THUS, EVEN AS PER THE DECISION OF SONY INDIAS C ASE, THE AO HAS TO MAKE ONLY A PRIMA FACIE OPINION THAT IT IS NECESS ARY OR EXPEDIENT TO REFER AS CASE TO THE TPO. THIS APPLIE S TO ALL CASE IMMATERIAL OR AGGREGATE VALUE OF INTERNATIONAL TRAN SACTIONS . PAGE 35 OF 61 35 ITA NO.1235/BANG/2010 (3) AS PER INSTRUCTION NO.3/2003 THE CBDT DECIDED T HAT WHEREVER THE AGGREGATE VALUE OF INTERNATIONAL TRANSACTIONS E XCEEDS RS.5 CRORES, THE CASE SHOULD BE PICKED UP FOR SCRUTINY AN D REFERENCE U/S 92CA BE MADE TO THE TPO. THUS, IT IS MANDATORY FOR THE AO TO REFER ALL THE CASES WHEREVER THE AGGREGATE VALUE OF INTERNATIONAL TRANSACTIONS IS MORE THAN RS.5 CRORES . THESE INSTRUCTIONS ARE BINDING ON ALL THE AOS. IN THESE CASES, THERE IS NO NEED FOR THE AO TO MAKE A PRIMA FACIE OPINION, E XCEPT THAT HE/SHE NEEDS TO EXAMINE THE 3CEB REPORT TO SEE THE AGGREGATE VALUE OF INTERNATIONAL TRANSACTIONS. AS THE BOARD ISSUED INSTRUCTION U/S 119(2)(A), THE CBDT FELT IT NECESSA RY AND EXPEDIENT TO REFER ALL THE CASES WHEREIN THE AGGREG ATE VALUE OF INTERNATIONAL TRANSACTIONS EXCEED RS.5 CRORES. IN THE INSTANT CASE, AS THE AGGREGATE VALUE OF INTERNATIONAL TRANS ACTIONS, BASED ON 3CEB REPORT FILED BY THE TAXPAYER BEFORE THE AO, E XCEEDED RS.5 CRORES, HE REFERRED THE CASE TO THE TPO AND IS AS PER THE LAW. (4) REFERRING TO THE FINDING OF THE HONBLE DELHI T RIBUNAL IN THE CASE OF RANBAXY LABORATORIES LTD. V. ADDL. CIT - (2008) 2 99 ITR 175 (DELHI), IT WAS ARGUED THAT INSTRUCTION NO.3/2003 O F THE CBDT IS BINDING ON THE AO AND THERE IS NO NEED TO MAKE ANY P RIMA FACIE OPINION BEFORE THE AO CAN MAKE A REFERENCE TO THE T PO IN ALL CASES WHERE THE AGGREGATE VALUE OF INTERNATIONAL TR ANSACTIONS EXCEED RS.5 CRORES. 8.2) WE HAVE ATTENTIVELY CONSIDERED THE RIVAL SUBMISSIONS AND ALSO WITH DUE REGARDS PERUSED THE RULING OF HONBLE DELHI HIGH COURT AS WELL AS THE HONBLE DELHI TRIBUNAL CITED SUPRA ON A SIMILAR ISSUE. MORE SIGNIFICANTLY, THE HONBLE TRIBUNAL HELD THUS - 71. WE ARE ASTONISHED AT THE SUBMISSION OF SHRI V OHRA TO THE EFFECT THAT IT IS STILL OPEN TO THE ASSESSING OFFIC ER EVEN IN CASES WHERE VALUE OF INTERNATIONAL TRANSACTION EXCEEDED R S. 5 CRORE TO REFER OR NOT TO REFER THE MATTER TO THE TPO AS T HE INSTRUCTIONS DID NOT AFFECT DISCRETION VESTED IN TH E ASSESSING PAGE 36 OF 61 36 ITA NO.1235/BANG/2010 OFFICER. IF IT WAS SO, THEN WHAT WAS THE NEED TO CH ALLENGE THE INSTRUCTIONS AND ITS CLASSIFICATIONS BEFORE THE HON BLE HIGH COURT? SHRI VOHRA STATED THAT PERHAPS THE PETITIONE R IN THAT CASE DID NOT CORRECTLY INTERPRET THE RELEVANT STATUT ORY PROVISION AND INSTRUCTIONS AND, THEREFORE, RUSHED T O THE COURT. WE ARE UNABLE TO AGREE WITH ABOVE SUBMISSION OF SHR I VOHRA. IT IS NOT POSSIBLE FOR US TO HOLD THAT INSTRUCTIONS ISSUED BY CBDT U/S 119 OF THE ACT TO REGULATE ASSESSMENT PROC EEDING CAN BE TREATED AS A WASTE PAPER BY OFFICERS FUNCTIONING UNDER THE BOARD (CBDT). IF SUCH A VIEW IS TAKEN, IT WOULD L EAD TO CHAOS IN THE COUNTRY. IF VARIOUS GUIDELINES ISSUED BY CBDT FO R ADMINISTRATION OF INCOME-TAX DEPARTMENT AND FOR REG ULATION OF ASSESSMENT ETC., ARE NOT ADHERED TO OR MADE OPTIONA L, THEN ALL SCHEMES OF ASSESSMENT MAY FAIL AND JEOPARDIZE THE WO RKING OF THE DEPARTMENT. THIS IS NEITHER THE LAW OF LAND NO T THERE IS ANY JUSTIFICATION TO ACCEPT SUCH AN ARGUMENT. WE ARE, THEREFORE, OF THE VIEW THAT ASSESSING OFFICER, IN THE LIGHT OF INSTRUCTION OF CBDT, WAS DUTY BOUND TO REFER THE MATTER TO TPO, HAV ING REGARD TO THE PURPOSE OF SPECIALIZED CELL CREATED B Y THE REVENUE DEPARTMENT TO DEAL WITH COMPLICATED AND COM PLEX ISSUE ARISING UNDER THE TRANSFER PRICING MECHANISM. THIS CASE ITSELF IS A GOOD EXAMPLE AS TO HOW DEPARTMENT CAN BE HOODW INKED UNLESS CASE IS PROPERLY EXAMINED BY PERSONS HAVING KN OWLEDGE OF PRINCIPLES OF TRANSFER PRICING 8.3) TAKING INTO ACCOUNT THE SUBMISSION OF THE AS SESSEE WHICH WAS EFFECTIVELY COUNTERED BY THE REVENUE WE ARE OF TH E VIEW THAT THE DECISION TO MAKE A REFERENCE DOES NOT IN ANY MANNER VISIT THE ASSESSEE WITH ANY CIVIL CONSEQUENCE. THE DECISION IS TO BE T AKEN BY THE ASSESSING OFFICER HAVING REGARD TO THE QUESTION WHETHER IT WI LL BE PROPER FOR THE ASSESSING OFFICER HIMSELF TO DETERMINE THE ARMS LE NGTH PRICE OR IT WILL BE EXPEDIENT TO HAVE IT DETERMINED BY THE TRANSFER P RICING OFFICER. THERE IS THE SAFEGUARD OF SEEKING PRIOR APPROVAL OF THE COMMISSIONER. WHETHER COMPUTATION OF THE ARMS LENGTH PRICE IS MA DE BY ONE OFFICER PAGE 37 OF 61 37 ITA NO.1235/BANG/2010 OR BY THE OTHER DOES NOT IN ANY MANNER AFFECT THE ASS ESSEE. EVEN THOUGH THE ASSESSING OFFICER MAY IN VIEW OF THE LATE ST AMENDMENT BE BOUND BY THE COMPUTATION BY THE TRANSFER PRICING OFFI CER, THE ASSESSEE HAS OPPORTUNITY TO CHALLENGE THE SAME AT HI GHER LEVELS AS PER HIERARCHY LAID DOWN IN THE STATUTE. THERE IS NOTHING IN SECTION 92CA TO SUGGEST THAT THE ASSESSING OFFICER SHOULD HEAR THE ASSESSEE OR RECORD REASONS BEFORE MAKING A REFERENCE TO THE TPO NOR IS THERE ANYTHING IN THE SECTION TO SUGGEST THAT THE AO SHOULD ASK THE A SSESSEE WHETHER HE SHOULD HIMSELF PROCEED TO DETERMINE THE ARMS LENGT H PRICE OR SHOULD INVOLVE THE TPO FOR THIS PURPOSE. THE REFERENCE IS A STEP IN THE COLLECTION OF MATERIAL WHICH MIGHT BE USEFUL FOR MA KING ASSESSMENT. NO VIOLATION OF ANY CIVIL RIGHTS OF THE ASSESSEE IS INV OLVED HERE. MERE REFERENCE DOES NOT TANTAMOUNT TO ANY ADVERSE ASSESSM ENT OR USE OF ADVERSE MATERIAL. MOREOVER, BY VIRTUE OF BOARDS IN STRUCTION NO.3 OF 2003 DATED 20.5.2003 THE CBDT DECIDED THAT WHEREVER THE AGGREGATE VALUE OF INTERNATIONAL TRANSACTIONS EXCEEDS RS.5 CR ORES, THE CASE SHOULD BE PICKED UP FOR SCRUTINY AND REFERENCE U/S 92CA BE MADE TO THE TPO. THUS, IT IS MANDATORY FOR THE AO TO REFER ALL THE C ASES WHEREVER THE AGGREGATE VALUE OF INTERNATIONAL TRANSACTIONS IS MO RE THAN RS.5 CRORES. THESE INSTRUCTIONS ARE BINDING ON ALL THE AOS. IN THESE CASES, THERE IS NO NEED FOR THE AO TO MAKE A PRIMA FACIE OPINION, E XCEPT THAT HE/SHE NEEDS TO EXAMINE THE 3CEB REPORT TO SEE THE AGGREGA TE VALUE OF INTERNATIONAL TRANSACTIONS. IN THE INSTANT CASE, AS THE AGGREGATE VALUE OF INTERNATIONAL TRANSACTIONS, BASED ON 3CEB REPORT FILED BY THE TAXPAYER BEFORE THE AO, EXCEEDED RS.5 CRORES, HE REF ERRED THE CASE TO THE TPO. THEREFORE, WE SEE NO INFIRMITY IN REFER RING THE MATTER TO PAGE 38 OF 61 38 ITA NO.1235/BANG/2010 TPO WITHOUT FORMING A CONSIDERED OPINION. IN THE LIGHT OF THE ABOVE REASONING, THE FIRST LEGAL POINT RAISED BY THE ASSES SEE, NAMELY, THE REFERENCE TO THE TPO BY THE AO WITHOUT FORMING A CO NSIDERED OPINION DOES NOT STAND THE TEST OF LAW AND CANNOT BE SUSTAI NED, AND, THEREFORE, THIS PLEA OF THE ASSESSEE IS REJECTED. IT IS ORDER ED ACCORDINGLY. II. THE TPO ADOPTED A NON-STATUTORY METHOD FOR VALUATIN G IPR, WHICH IS A METHOD NOT KNOWN TO LAW. 8.4) THE OTHER LEGAL GRIEVANCE OF THE ASSESSEE BE ING THAT THE TPO HAS FOLLOWED EXCESS EARNING METHOD AND NOT COMP ARABLE UNCONTROLLED PRICE METHOD (CUP) AS THERE WAS NO COM PARABLES AVAILABLE WITH REFERENCE TO THE IPR SOLD BY THE ASSESSEE. IT WAS SUBMITTED THAT THE TPO WRONGLY RELIED ON AN EXPOSURE DRAFT OF THE I NTERNATIONAL VALUATION STANDARD, WHICH IS A NON-STATUTORY BODY, A ND MOREOVER, THE DRAFT IS DATED 2009, AFTER THE DATE OF SALE OF TALL Y BY THE ASSESSEE IN 2006. IT IS FURTHER SUBMITTED THAT THE TPO DETERMI NED THE ALP FOLLOWING THE EXCESS EARNING METHOD AND MADE ADJUST MENT TO THE SALE VALUE OF THE IPR. HOWEVER, AS PER SECTION 92C OF T HE ACT, THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION HAS TO BE DETERMINED ONLY WITH REFERENCE TO THE PRESCRIBED METHOD. 8.5) WHEN THIS WAS POSED BEFORE THE RE VENUE, IT WAS EXPLAINED BY THE REVENUE THAT THE IVSC IS A WELL-RECOGNISED BODY FOR VALUERS, HAV ING BEEN IN EXISTENCE FOR 25 YEARS. IT IS RECOGNIZED BY SEVERAL REPUTED AGENCIES SUCH AS THE UK FINANCIAL SERVICES AUTHORIT Y, THE PAGE 39 OF 61 39 ITA NO.1235/BANG/2010 HONGKONG SECURITIES AND FUTURES COMMISSION, THE SEB I AND THE EUROPEAN PUBLIC REAL ESTATE ASSOCIATION, AMONG OTHE RS. MOREOVER, THE VALUATION METHOD ADOPTED IS NOT PART OF EXPOSURE DRAFT, BUT THE FINAL GUIDANCE NOTE NO.34 ( PARA 4.20) RELEASED IN FEBRUARY, 2010. SALE OF AN IPR IS NOT A ROUTINE TRANSACTION INVOLVI NG REGULAR PURCHASES AND SALES. IT IS A HIGHLY SPECIALIZED P ROCESS AND VALUATION IS THE KEY. IN THIS CASE, THE TAXPAYER I TSELF ADMITS THAT THERE ARE NO COMPARABLES. SO, THE TPO HAS USED AN ESTABLISHED METHOD [EXCESS EARNINGS METHOD] WHICH IS RECOGNIZED WIDELY. IN FACT, THIS METHOD SUPPLEM ENTS THE VALUATION WHICH IN EFFECT IS DONE BY THE CUP METHOD WITH THE FINAL VALUATION DETERMINED BEING THE COMPARABLE . THE TPO APPLIED ONLY CUP METHOD. EXCESS EARNINGS M ETHOD IS USED ONLY TO ARRIVE AT THE CUP PRICE, THE PRICE AT WHICH THE TAXPAYER WOULD HAVE SOLD IN AN UNCONTROLLED CON DITION. FOR APPLYING CUP METHOD, WE REQUIRE COMPARABLE UNCONTROLLED TRANSACTION (CUT). AS IN THIS CASE, T HERE IS NO EXTERNAL COMPARABLE PRICE AVAILABLE IN THE PUBLIC D OMAIN, AS NO INDEPENDENT ENTITY SOLD ANY SOFTWARE PRODUCT SIM ILAR TO THAT OF THE TAXPAYER. IN SUCH CIRCUMSTANCES, INDIR ECT METHOD IS USED TO SEE THE PRICE THAT WOULD HAVE BEE N ARRIVED AT, IF THE TAXPAYER SOLD THE SAME TALLY SOF TWARE PRODUCT TO AN INDEPENDENT ENTITY. ALL THE FACTORS THAT ARE CONSIDERED BY AN INDEPENDENT PARTY, WHEN IT SELLS S IMILAR SOFTWARE PRODUCT ARE CONSIDERED BY THE TPO WHILE AR RIVING AT THE COMPARABLE UNCONTROLLED PRICE. WHAT IS IMPO RTANT IS THE ARMS LENGTH STANDARD. THE METHODS ARE ONLY TO OLS TO SEE THE ARMS LENGTH STANDARD. THE METHODS SHOULD NOT BIND THE TPO WHILE ARRIVING AT THE ARMS LENGTH PRICE. THE MAIN ISSUE TO BE SEEN HERE IS WHETHER THE TPO APPLIED AR MS LENGTH PRINCIPLE CORRECTLY. THE DECISIONS QUOTED B Y THE TAXPAYER ARE NOT RELEVANT AS IN THOSE CASES, THE TP O DID NOT APPLY ANY METHOD IN THIS CASE, AND THE TPO APPL IED CUP METHOD. PAGE 40 OF 61 40 ITA NO.1235/BANG/2010 WITH REGARD TO THE ASSESSEES ACCUSATION THAT THE A RMS LENGTH PRICE WAS DETERMINED WITHOUT CONSIDERING ANY COMPARABLE CA SES, FOR WHICH, THE REVENUE CAME UP WITH AN ANSWER THAT (I) IN THE ABSENCE OF UNCONTROLLED INDEPENDENT COMP ARABLE COMPANIES, THE TPO TRIED TO APPLY INTERNAL CUP METH OD, WHEREIN IT IS SEEN WHAT IS THE PRICE FOR WHICH THE SAME PRODUCT WOULD HAVE BEEN SOLD BY THE TAXPAYER TO AN INDEPENDENT ENTITY. ALL THE DATA CONSIDERED BY THE TPO FROM FY 1999-2000 TO 2004-05 IS BASED ON UNCONTROLL ED TRANSACTIONS BETWEEN THE TAXPAYER AND INDEPENDENT E NTITIES. FOR THE SAME REASON, THE TPO DID NOT CONSIDER THE D ATA FOR THE FY 2005-06, AS THERE ARE SUBSTANTIAL RELATED PA RTY TRANSACTIONS DURING FY 2005-06 WITH ITS ASSOCIATED ENTERPRISES; (II) IN FACT, THE HONBLE TRIBUNAL UPHELD THAT VAL UATION METHOD CAN BE ADOPTED TO ARRIVE AT THE CUP PRICE IN THE CASE OF INTEL ASIA ELECTRONICS INC. V. ADIT (2011-TII-14- ITAT-BANG-TP). 8.6) RIVAL SUBMISSIONS ARE CAREFULLY CONSIDERED. IT IS TO BE POINTED OUT IN THIS CASE THE SALE OF IPR IS NOT A R OUTINE TRANSACTION INVOLVING REGULAR PURCHASE AND SALE. THE ASSESSEE ITSELF ADMITS THAT THERE IS NO COMPARABLE AND THE ASSESSEE HAS ARRIVED AT THE SALE CONSIDERATION AT RS.38.50 CRORES BASED ON ITS OWN V ALUATION. THE TPO HAS USED AN ESTABLISHED METHOD (EXCESS EARNING METH OD) AND THIS KIND OF VALUATION IS UPHELD BY THE U.S COURTS. IN FACT, T HIS METHOD SUPPLEMENTS THE VALUATION WHICH IN EFFECT DONE BY CU P METHOD, WITH A FINAL VALUATION DETERMINED BEING THE COMPARABLE. T HE BANGALORE BENCH OF THE TRIBUNAL IN THE CASE OF INTEL ASIA ELECTRONI CS INC. V. ADIT CITED PAGE 41 OF 61 41 ITA NO.1235/BANG/2010 SUPRA HAD UPHELD THAT THE VALUATION METHOD CAN BE A DOPTED TO ARRIVE AT CUP PRICE. THE RELEVANT FINDING OF THE TRIBUNAL IS EXTRACTED AS UNDER: 11. IN THE INSTANT CASE, THIS IS AN ISOLATED TRAN SACTION OF SALE OF THEN ASSESSEES PERMANENT ESTABLISHMENT (PE ) AS A GOING CONCERN TO THE ASSESSEES AE AND, THEREFORE , THERE ARE NO SIMILAR TRANSACTIONS IN AN UNCONTROLLED SITU ATION TO COMPARE WITH THE CONTROLLED SITUATION. HOWEVER, TH E CONTENTIONS OF THE ASSESSEE ARE JUSTIFIABLE THAT TH E ACTUAL MARKET VALUE OF THE ASSET HAS TO BE DETERMINED IN A N UNCONTROLLED SITUATION TO DETERMINE THE ALP IN THIS CASE. IN ORDER TO DETERMINE THE ACTUAL MARKET VALUE, IN THE ABSENCE OF ANY SUCH IDENTICAL TRANSACTION/TRANSACTIONS, AS OPTED BY THE ASSESSEE, THE VALUATION DETERMINED BY THE REGIS TERED VALUER COULD BE THE MOST APPROPRIATE MEANS UNDER CU P METHOD. 8.7) IN THE LIGHT OF THE ABOVE, IT CAN BE STATED THAT THE TPO HAD APPLIED ONLY THE CUP METHOD. THE EXCESS EARNING METHOD IS USED ONLY TO ARRIVE AT THE CUP PRICE, THE PRICE AT WHICH THE ASSESSEE WOULD HAVE SOLD IN AN UNCONTROLLED CONDITION. IN THE ABOV E CIRCUMSTANCES, THE SECOND LEGAL ISSUE RAISED BY THE ASSESSEE - THE TPO HAD ADOPTED A METHOD OF VALUATION OF IPR WHICH IS NOT A METHOD P RESCRIBED UNDER THE ACT OR RULES IS DISMISSED. 9) LET US NOW TURN OUR ATTENTION TO THE ISSUES RAISED BY THE ASSESSEE ON MERITS . I. THE ASSESSEES GRIEVANCE WAS THAT THE TPO SHOULD HAVE CONSIDERED THE ACTUAL VALUES OF SALE OF SOFTWARE LI CENSES DURING THE FUTURE YEARS AS THE DATA IS AVAILABLE UP-TO MARCH, 2 010 AND THESE FIGURES ARE MUCH LOWER THAN THE FIGURES ADOPTED BY T HE TPO. PAGE 42 OF 61 42 ITA NO.1235/BANG/2010 WHEN THIS WAS PLACED BEFORE THE REVENUE, THE REVENU E CAME UP WITH A CLAIM THAT FIRSTLY, WHEN AN INTANGIBLE IS SOLD, THE RISK OF FU TURE INCOME POTENTIAL LIES WITH THE BUYER IE., THE AE. SECONDL Y, WHEN THE TALLY SOFTWARE PRODUCT WAS SOLD IN 2006, THERE WAS NO FORECAST, NOT EVEN ANY IOTA DOUBT ABOUT GLOBAL ECON OMIC RECESSION. THAT THE SUBSEQUENT DIP IN SALES DUE TO GLOBAL ECONOMIC SLOW DOWN DOES NOT HAVE RELEVANCE AT THE T IME OF SALE AS THIS WAS NOT CONTEMPLATED OR COMPREHENDED A T THE TIME OF SALE. FOR EXAMPLE, IF A MANGO ORCHARD IS S OLD TO A BUYER AND THERE IS A CROP FAILURE FOR THE NEXT TWO TO THREE YEARS DUE TO HEAVY RAINS AT THE TIME OF FLOWERING, THIS RISK IS THAT OF THE BUYER AND IN NO WAY DETERMINES THE P RICE ON THE DATE OF SALE, AS THESE EVENTS ARE NOT COMPREHEN DED AT THE TIME OF SALE; FURTHER, EVEN IF THE HONBLE TRIBUNAL CONSIDERS ACT UAL REVENUES, THE REVENUES OF ASSESSEE COMPANY ALONG CA NNOT BE CONSIDERED AS SUBSEQUENT TO THE SALE OF TALLY SOFTW ARE, THE TAXPAYER IS RESPONSIBLE FOR SELLING IN ASIA ALONE. AS THE TAXPAYER HAS DISTRIBUTORS ALL OVER THE WORLD AND TH ESE DISTRIBUTORS ARE BUYING DIRECTLY FROM THE AE, AFTER JANUARY, 2006, IT WAS PLEADED THAT THE BENCH BE PLEASED TO A FFORD AN OPPORTUNITY TO VERIFY THE FIGURES SUBMITTED BY T HE TAXPAYER. II. IT WAS CONTENDED BY THE ASSESSEE THAT THE TPO HAD ER RED IN EXCLUDING LICENSE REVENUES FOR THE PERIOD 1.4.2005 TO 31.1.2006 IN COMPUTING THE VALUE OF THE IPRS. SINCE THE IPRS WE RE SOLD ON 31.1.2006, LICENSE REVENUES TILL THE DATE OF SALE O F IPRS HAVE TO BE CONSIDERED IN DETERMINING THE VALUE OF THE IPRS. PAGE 43 OF 61 43 ITA NO.1235/BANG/2010 IT WAS COUNTERED BY THE REVENUE THAT ALL THE DATA CONSIDERED BY THE TPO FROM FY 1999-2000 TO 2004-05 I S BASED ON UNCONTROLLED TRANSACTIONS BETWEEN THE TAXPAYER AND I NDEPENDENT ENTITIES. FOR THE SAME REASON, THE TPO DID NOT CON SIDER THE DATA FOR THE FY 2005-06, AS THERE ARE SUBSTANTIAL RELATED PA RTY TRANSACTIONS DURING FY 2005-06 WITH ITS ASSOCIATED ENTERPRISES. III. IN RESPECT OF VARIOUS ALTERNATIVE CALCULATIONS SUGG ESTED BY THE ASSESSEE FOR THE VALUATION OF THE INTANGIBLE, THE REVENUE SUBMITTED THAT - (I) THE TAXPAYER CONSIDERED THE DATA FROM THE FY 19 99- 2000 TO FY 2005-06 WHEREAS THE TPO CONSIDERED THE D ATA FROM THE FY 1999-2000 TO FY 2004-05 AS THE TPO CONSCIOUSLY DID NOT CONSIDER THE DATA FOR THE FY 20 05-06 AS IN THIS YEAR, THERE ARE SUBSTANTIAL RELATED PARTY O R CONTROLLED PARTY TRANSACTIONS AND, THUS, THE FINANC IALS MAY NOT BE RELIABLE; (II) THE TAXPAYER CONSIDERED THE INFLATION FOR THE FY 2003- 04 AND 2004-05. BUT, THE RELEVANT INFLATION RATE I S THE RATE FOR THE PROSPECTIVE OR FUTURE YEARS. THE TPO CONSIDERED THE PROJECTED INFLATION RATE BASED ON TH E STUDY CARRIED BY THE RBI; (III) THERE ARE VARIOUS OTHER PARAMETERS THAT ARE T INKERED BY THE TAXPAYER WITHOUT GIVING ANY VALID REASONS; & (IV) IT WAS THE PLEA OF THE REVENUE THAT IT MAY BE AFFORDED AN OPPORTUNITY TO VERIFY ALL THE FIGURES SUBMITTED BY THE TAXPAYER BEFORE ANY DECISION IS TAKEN ON THE QUANTU M. 10) WE HAVE DULY CONSIDERED THE RIVAL SUBMISSIONS AND PERUSED THE MATERIALS ON RECORDS. THE TPO, BY ENUMER ATING THE EEM IN PAGE 44 OF 61 44 ITA NO.1235/BANG/2010 HIS IMPUGNED ORDER, THE VALUE OF INTANGIBLE ASSET W AS COMPUTED BY APPLYING THE FORMULA, NAMELY: THE VALUE OF INTANGIBLE ASSET = A-B-C-D-E = F A = THE FUTURE CASH FLOWS AS REDUCED BY THE COST OF IMPROVEMENT ARE DISCOUNTED USING WACC AS DISCOUNTING FACTOR TO ARRI VE AT TOTAL NET PRESENT VALUE OF THE CASH FLOWS OF THE BUSINESS FOR THE YEARS FROM FY 2006-07 TO FY 2011-12 B = RETURN OF FIXED ASSETS : THE DISCOUNTED RETURN ON CAPITAL IS COMPUTED BASED ON AVERAGE DEPRECIATION CHARGE ON SA LES FOR THE PERIOD FROM FY 1999-2000 TO 2004-05 AND APPLYING THE SAME F OR THE FUTURE YEARS AND DISCOUNTED TO THE NET PRESENT VALUE OF RET URN ON FIXED ASSETS; C = RETURN ON WORKING CAPITAL : TO CONSIDER THE RETURN ON WORKING CAPITAL, THE AVERAGE WORKING CAPITA LEVELS AS A PER CENTAGE OF SALES HAVE BEEN COMPUTED FOR THE YEARS FROM FY 1999-00 TO 2004- 05. BASED ON THE PAST HISTORY, THE SAME RATIO IS APPLIED FOR THE FUTURE YEARS AND DISCOUNTED AT THE ABOVE DISCOUNT RATE [WACC] TO ARR IVE AT THE PRESENT VALUE OF WORKING CAPITAL REQUIREMENTS. THE SBIS P LR RATE FOR SHORT TERM WORKING CAPITAL LOANS FOR THE FY 2005-06 AT 10 .25% PER ANNUM IS CONSIDERED AS RETURN ON WORKING CAPITAL. BASED ON THE ABOVE RATE, THE RETURN ON NET PRESENT VALUE ON WORKING CAPITAL VALU E HAS BEEN ARRIVED AT. D = RETURN ON HUMAN CAPITAL: THE AVERAGE EMPLOYEE COST AS PERCENTAGE OF SALES FOR THE FY 1999-2000 TO FY2004-05 HAS BEEN CONSIDERED AND PAGE 45 OF 61 45 ITA NO.1235/BANG/2010 APPLIED FOR FUTURE YEARS TO ARRIVE AT THE ESTIMATED COST OF HUMAN CAPITAL. SUCH EXERCISE IS DONE FOR THE FUTURE YEARS FROM FY2006-07 TO 2011-1D2. THE SAID COST OF HUMAN CAPITAL IS DISCOUNTED TO THE PRESENT VALUE USING THE ABOVE DISCOUNTING FACTOR (W ACC) FOR EACH OF THE FUTURE YEARS. THE VALUE OF INTANGIBLE ASSETS SOLD = NET DISCOUNTE D CASH FLOW AFTER CONSIDERING THE COST OF IMPROVEMENT (A) RETURN ON FIXED ASSETS(B) RETURN ON WORKING CAPITAL (C)-RETURN ON HUMAN CAPIT AL (D). NET DISCOUNTED CASH FLOW AFTER CONSIDERING THE COST OF IMPROVEMENT (A) RS.666,92,37 ,810 LESS: RETURN ON FIXED ASSETS 100,27,51,104 RETURN ON WORKING CAPITAL(C) 57,32,27,882 RETURN ON HUMAN CAPITAL (D) 7,86,25,072 THE VALUE OF INTANGIBLE RS.501,46,33,752 PRICE RECEIVED VIS--VIS THE ARMS LENGTH PRICE: THE CONSIDERATION RECEIVED BY THE TAXPAYER = RS.11,81 ,03,800/- (SALE OF INTELLECTUAL PROPERTY RIGHTS AS PER THE AGREEMENT DA TED 31.3.2006)+RS.26,69,43,026/- (EXPENDITURE INCURRED BY THE TAXPAYER ON DEVELOPMENT OF TALLY ASCENT SOFTWARE DURING THE PERI OD 1.4.2005TO 31.1.2006 REIMBURSED BY THE AE). THUS, THE TOTAL PA YMENTS BY THE AE TOWARDS THE PURCHASE OF THE IPR WERE RS.38,50-,46,8 26/-. THE PRICE CHARGED BY THE TAX PAYER TO ITS ASSOCIATED ENTERPRISE S IS COMPARED TO THE ARMS LENGTH PRICE AS UNDER: ARMS LENGTH PRICE AS ARRIVED AT RS.501,46,33,75 2 PRICE SHOWN IN THE INTERNATIONAL TRANSACTIONS 38,50,46,826 SHORT FALL BEING ADJUSTMENT U/S 92CA RS.462 ,95,86,926 PAGE 46 OF 61 46 ITA NO.1235/BANG/2010 TOTAL ADJUSTMENT ARRIVED AT RS.466,47,93,251/- HAS BEEN BROUGHT DOWN TO RS.260,63,921,602/- AS PER REVISED VALUATION DAT ED: 23.9.2010 AT THE INSTANCE OF DRP. SINCE THERE WERE, ADMITTEDLY, NO C OMPARABLES AVAILABLE WITH REFERENCE TO THE IPR SOLD BY THE ASSE SSEE, THE TPO HAD DETERMINED THE ALP FOLLOWING THE EXCESS EARNING MET HOD AND MADE ADJUSTMENT TO THE SALE VALUE OF THE IPR. 10.1) THE DRP INITIALLY REJECTED THE TPOS CONCLUS ION IN ARRIVING AT THE ADJUSTMENT OF RS.466.47 CRORES. ON BEING DI RECTED BY THE DRP ON THE BASIS OF THE ASSESSEES STRONG OBJECTION, TH E TPO CAME UP WITH A REVISED VALUATION REPORT WHICH SUGGESTS THAT THE ADJUSTMENT TO BE MADE AT RS.222.13 CRORES. AS THE DRP WAS UNABLE TO BRING THE WARRING GROUPS [AS THE LD. TPO AS WELL AS THE LD. AR HAVE D ISAGREED TO NARROW DOWN THEIR DIFFERENCES TO THE REVISED VALUATION REP ORT OF THE TPO] TO FORE, IT CAME UP WITH A VIA MEDIA, ACCORDING TO WHI CH, THE ASSESSEE WAS ASKED TO SUBMIT ITS OWN VALUATION OF THE IPR. THE ASSESSEE HAD ARRIVED AT THE VALUE ON FIRST METHOD AT RS.40.42 CRORES AND BY A SECOND METHOD AT RS.64.05 CRORES WITH A FERVENT SUBMISSION TO ADO PT RS.52.23 CRORES BEING AVERAGE OF THE FIRST AND SECOND METHODS WHICH WAS, HOWEVER, NOT FOUND FAVOUR WITH THE REVENUE. STRANGELY, THE DRP U PHELD THE REVISED VALUATION REPORT OF THE LD. TPO BY TERMING THE VALUA TION REPORTS FURNISHED BY THE ASSESSEE AS EXTREMELY PERFUNCTORY WITH NO ILLUSTRATION AS TO HOW THE REPORT OF THE ASSESSEE H AD BECOME AS SUCH. THE ADJUSTMENT TO BE MADE ON THE BASIS OF THE REVIS ED WORKING OF THE TPO WAS OPTED AT RS.222.13 CRORES AS AGAINST RS.466 .47 CRORES ADOPTED IN THE DRAFT ASSESSMENT ORDER. TO DEMONSTRATE FURT HER THE PAGE 47 OF 61 47 ITA NO.1235/BANG/2010 GENUINENESS IN THE TRANSACTION, THE ASSESSEE, DURIN G THE COURSE OF HEARING, CAME UP WITH ALTERNATIVE COMPUTATION AS DE TAILED IN ITS SUBMISSION CITED SUPRA. ACCORDING TO VARIOUS METHO D ADOPTED, THE ARMS LENGTH PRICE WAS LESS THAN WHAT WAS THE PRICE RECEI VED AS ADMITTED BY THE ASSESSEE AT RS.38.50 CRORES. IT IS TRUE THAT IT IS DIFFICULT TO VALUE BUSINESS MORE PARTICULARLY TO VALUE A CLOSELY-HELD CO NCERN BECAUSE EACH COMPANY HAS ITS OWN UNIQUE CHARACTERISTICS. OFTEN, CONSIDERATION HAS TO BE GIVEN TO THE FUTURE PROFITS THE COMPANY WILL BE A BLE TO EARN. THE VALUATION MAY BE INFLUENCED BY THE REASON FOR IT. FO R EXAMPLE, A DIFFERENT APPROACH MAY BE APPROPRIATE FOR DIVORCE LI TIGATION COMPARED TO THE PRICE TO PAY FOR A TARGETED COMPANY COMPARED T O VALUATION FOR ESTATE TAX PURPOSES. THUS, VALUATION DEPENDS ON TH E PURPOSE AT HAND. THE VALUATION PROCESS IS AN ART AND NOT A SCIENCE, SINCE EVERYONES PERCEPTION IS SLIGHTLY DIFFERENT. IN LITIGATION MAT TERS, THE VALUATION METHOD SELECTED SHOULD BE LOGICALLY CONSISTENT, REAS ONABLE, COST- EFFECTIVE AND SIMPLY EXPLAINED. 10.2) THE EXCESS EARNING METHOD IS THE METHOD THA T IS ADOPTED BY THE TPO. WE SEE NO INFIRMITY IN ADOPTION OF THIS METHOD FOR THE SIMPLE REASON THAT THE RELEVANT DATA IS AVAILABLE W ITH REASONABLE ACCURACY, CLOSING IN ON REAL VALUATION OF A SOFTWARE PRODUCT. THIS VALUATION IS UPHELD BY THE US COURTS WHILE ARRIVING AT THE SALE VALUE OF A SOFTWARE PRODUCT. FURTHER, THE VALUATION UNDER THE METHOD MAINLY REVOLVES AROUND DISCOUNTED CASH FLOW (DCF) ANALYSIS WHICH IS KNOWN TO ECONOMISTS FOR THE TIMES IMMEMORIAL. THUS, THE TP O USED A REASONABLE WELL ACCEPTED METHOD OF VALUATION OF INTANGIBLES IN CLUDING SOFTWARE PAGE 48 OF 61 48 ITA NO.1235/BANG/2010 PRODUCTS AND ACCEPTED BY COURTS IN THE COUNTRIES LIK E IN USA, WHERE THE TP REGIME IS WELL DEVELOPED. AT THE RISK OF REPE TITION, THE EXCESS EARNING METHOD FOLLOWED BY THE TPO IS SUMMARIZED AS UNDER:- THE EXCESS EARNING METHOD DETERMINES THE VALUE OF A N INTANGIBLE ASSET AS THE PRESENT VALUE OF THE CASH F LOWS ATTRIBUTABLE TO THE SUBJECT. INTANGIBLE ASSET AFTE R EXCLUDING THE PROPORTION OF THE CASH FLOWS THAT ARE ATTRIBUTABLE TO THE OTHER ASSETS. THE METHOD INVOLVES FORECASTING THE CASH FLOWS EXPE CTED TO ARISE FROM THE BUSINESS OR THE BUSINESSES THAT U SES THE SUBJECT INTANGIBLE. FROM THE ABOVE FORECAST OF THE CASH FLOWS A DEDUCTI ON IS MADE IN RESPECT OF THE CONTRIBUTION OF THE CASH FLO W THAT IS MADE BY THE ASSETS TANGIBLE OR INTANGIBLE AND THE FINANCIALS, OTHER THAN THE SUBJECT INTANGIBLE ASSET . FORECAST CASH FLOWS ARE BROUGHT TO THE CAPITAL VALU E BY APPLYING THE PRESENT VALUE TECHNIQUES AND THE SUITAB LE DISCOUNT RATES. THE CONTRIBUTORY ASSET CHARGES ARE DERIVED AS FOLLOW S:- 1. FOR THE RETURN ON THE TANGIBLE ASSET, A NOTIONAL DEPRECIATION CHARGE IS USED AS A SURROGATE FOR THE RETURN OF THE ASSET. 2. A FAIR RETURN ON THE WORKING CAPITAL IS DISCOUNTED TO THE PRESENT VALUE. 3. RETURN ON THE WORK FORCE IS DETERMINED AS A RETURN CHANGED ON THE FAIR VALUE OF THE WORK FORCE ASSET. WORK FORCE ASSET IS USUALLY VALUED USING THE WORK COST APPROACH. 4. A FAIR RETURN ON THE OTHER INTANGIBLE ASSETS BY THE WAY OF HYPOTHETICAL ROYALTY RATE THAT WOULD BE CHANGED TO LEASE THE ASSET. FOR DISCUSSING THE NET PRESENT VALUE (NPV), A UNIFO RM DISCOUNT RATE IS USED TO ARRIVE AT THE DISCOUNTED CASH FLOW. OFTEN THE WEIGHTED AVERAGE COST OF THE CAPITAL (WACC) IS USED AS THE D ISCOUNTING FACTOR. PAGE 49 OF 61 49 ITA NO.1235/BANG/2010 THE WACC IS THE WEIGHTED AVERAGE OF THE COST OF THE DEBT AND THE COST OF THE EQUITY. IN THE CASE OF THE TAXPAYER, THERE IS NO ACTIVE MARK ET IN IDENTICAL OR NEAR SIMILAR INTANGIBLE ASSET. THEREFORE, THE IPR SOLD BY THE TAXPAYER IS TO BE VALUED PRIMARILY USING AN INCOME CAPITALIZA TION METHOD. IN THE INCOME CAPITALIZATION METHOD, THE TPO USED THE EXCE SS EARNINGS METHOD (EEM) AS DESCRIBED ABOVE. THIS IS BECAUSE Q UALITATIVE AND SUBJECTIVE ADJUSTMENTS ARE REQUIRED TO APPLY THE TRA NSACTION DATA FROM THE NON-IDENTICAL ASSETS, WHICH ADVERSELY AFFEC T RELIABILITY. TO SUM UP, THE INTANGIBLES I.E. THE SALE OF THE TALLY SOFTWARE PRODUCTS ALONG WITH ITS COPYRIGHT AND TRADE MARKS ARE VALUED BY THE FOLLOWING STEPS UNDER EXCESS EARNINGS METHOD: STEP 1 : ESTIMATING FUTURE TURNOVER TILL 2012 BASED ON T HE PAST PERFORMANCE AS WELL AS THE DATA AVAILABLE IN THE PUBLIC DOMAIN. STEP 2 : THE CASH FLOWS (EBIDTA EARNING BEFORE INTEREST-TAX, DEPRECIATION AND AMORTIZATION) ARE ESTIMATED IN THE FUTURE YEARS BASED ON THE PERFORMANCE OF THE TAXPAYER IN TERMS OF EBIDTA TO SALES FROM F.Y. 1999-2000 TO F.Y. 2004-2005. THE DATA FOR THE FY 2005-2006 WAS NOT CONSIDERED AS THE INTANGIBLES IS TRANSFERRED DURING THE YEAR AND THERE ARE RELATED PARTY TRANSACTIONS DURING THE YEAR WHICH MAY INITIATE THE RELIABILITY OF THE DATA. STEP 3 : THE FUTURE CASH FLOW ARE DISCOUNTED TO THE PRESENT VALUE BY USING A CONSTANT DISCOUNTING FACTOR WHICH IS WACC WACC = WE CE + WD CD WHERE WE = WEIGHT OF EQUITY CE = COST OF EQUITY WE = WEIGHT OF DEBT PAGE 50 OF 61 50 ITA NO.1235/BANG/2010 CD = COST OF DEBT THE CE = RF + BXRF WHERE RF = RISK FREE RETURN OR RETURN ON LONG TERM GOVERNMENT BONDS B = B OF THE TAXPAYER AS THE TAXPAYER IS NOT A LISTED COMPANY, THE B OF A SIMILAR COMPANY, SANKHYA INFOTECH LTD. HAS BEEN CONSIDERED. THIS COMPANY IS IN DEVELOPMENT AND SALE OF SOFTWARE PRODU CTS FOR AVIATION INDUSTRY. B HAS BEEN TAKEN FROM BSE INDEX WHICH IS 0.58. RP = RISK PREMIUM OF THE INDEX (THAT IS BSI INDEX) = 8.8 (AS VERIFIED FROM THE PUBLIC SOURCES). COST OF DEBT = PREVALENT PI R RATE OF SBI (10.57%) EQUITY = AVERAGE OF PAID OF SHARE CAPITAL AND RESERVES & SURPLUSES DEBT = AVERAGE OF LONG TERM BORROWINGS (SECURED LOANS). STEP 4 : PRESENT VALUE OF IMPROVEMENTS THE EXPECTED COST OF IMPROVEMENT IN THE FUTURE YEARS IS COMPUTED BASED ON THE PAST EXPENDITURE ON R&D ON CAPITAL ACCOUNT. AS THE R&D ON REVENUE ACCOUNT STANDS ALREADY CONSIDERS WHILE COMPUTING THE CASH FLOWS IN TERMS OF EBIDA AS THE TAXPAYER IS CHARGING THE ENTIRE R&D EXPENDITURE ON REVENUE ACCOUNT TO THE PROFIT & LOSS ACCOUNT. BASED ON THE AVERAGE COST OF IMPROVEMENT, THE COST OF IMPROVEMENT FOR THE FUTURE YEARS FROM FY 2006- 07 TO FY 2011-12 ARE ESTIMATED AND DISCOUNTED BY THE ABOVE DISCOUNTING FACTOR (WACC) TO ARRIVE AT THE PRESENT VALUE OF COST OF IMPROVEMENT. PAGE 51 OF 61 51 ITA NO.1235/BANG/2010 STEP 5 : (A) THE ABOVE FUTURE CASH FLOWS AS REDUCED BY THE COST OF IMPROVEMENT ARE DISCOUNTED USING WACC AS DISCOUNTING FACTOR TO ARRIVE AT TOTAL NET PRESENT VALUE OF THE CASH FLOWS OF THE BUSINESS FOR THE YEARS FROM FY 2006-07 TO FY 2011-12. STEP 6 : (B) RETURN ON FIXED ASSETS THE DISCOUNTED RETURN ON CAPITAL IS COMPUTED BASED ON AVERAGE DEPRECIATION CHARGE ON SALES FOR THE PERIOD FROM FY 1999-2000 TO FY 2004-05 AND APPLYING THE SAME FOR THE FUTURE YEARS AND DISCOUNTED TO THE NET PRESENT VALUE OF RETURN ON FIXED ASSETS. STEP 7 : (C) RETURN ON WORKING CAPITAL TO CONSIDER THE RETURN ON WORKING CAPITAL, THE AVERAGE WORKING CAPITAL LEVELS AS A PERCENTAGE OF SALES HAVE BEEN COMPUTED FOR THE YEARS FROM FY 1999-2000 TO FY 2004-05. BASED ON THE PAST HISTORY, THE SAME RATIO IS APPLIED FOR THE FUTURE YEARS AND DISCOUNTED AT THE ABOVE DISCOUNT RATE (WACC) TO ARRIVE AT THE PRESENT VALUE OF WORKING CAPITAL REQUIREMENTS. THE STATE BANK OF INDIAS PLR RATE FOR SHORT TERM WORKING CAPITAL LOANS FOR THE FY 2005-06 AT 10.25% PER ANNUM IS CONSIDERED AS RETURN ON WORKING CAPITAL. BASED ON THE ABOVE RATE, THE RETURN ON NET PRESENT VALUE ON WORKING CAPITAL VALUE HAS BEEN ARRIVED AT. STEP 8 : (D) RETURN ON HUMAN CAPITAL THE AVERAGE EMPLOYEE COST AS PERCENTAGE OF SALES FOR THE FY 1999-2000 TO FY 2004-05 HAS BEEN CONSIDERED AND APPLIED FOR FUTURE YEARS TO ARRIVE AT THE ESTIMATED COST OF HUMAN CAPITAL. SUCH EXERCISE IS DONE FOR THE FUTURE YEARS FROM FY PAGE 52 OF 61 52 ITA NO.1235/BANG/2010 2006-07 TO 2011-12. THE SAID COST OF HUMAN CAPITAL IS DISCOUNTED TO THE PRESENT VALUE USING TH E ABOVE DISCOUNTING FACTOR (WACC) FOR EACH OF THE FUTURE YEARS. TO CONSIDER THE RETURN ON HUMAN CAPITAL, VARIOUS AR TICLE HAVE BEEN READ. AS FOR THE ANNUAL REPORT OF THE INFOSYS TECHNOLOGY LTD. FOR THE FY 2005-06, THE COMPANY EARNED 5% RETUR N ON ITS HUMAN CAPITAL. THE SAME RETURN HAS BEEN APPLIED IN THE CASE OF THE TAX PAYER ON THE ABOVE ARRIVED VALUE OF HUMAN CA PIAL. THUS, THE VALUE OF INTANGIBLE ASSET IS COMPUTED AS UNDER: THE VALUE OF INTANGIBLE ASSET = A-B-C-D-E = F THE ARMS LENGTH PRICE OF THE INTANGIBLE ASSET IS T HEREFORE F AS COMPUTED ABOVE. WE AGREE WITH THE TPO IN ADOPTING THE ABOVE METHOD AND HAVING CONCLUDED IN THE PRECEDING PARAGRAPH THAT THE EXCES S EARNING METHOD ADOPTED BY THE TPO TO ARRIVE AT THE ALP IS CORRECT, WE REJECT THE ASSESSEES CONTENTION THAT THE ALP SHOULD BE COMPUT ED BASED ON ACTUAL SALES AND NOT PROJECTION ADOPTED BY TPO. THE REASON S FOR REJECTING THE ABOVE CONTENTION OF THE ASSESSEE ARE AS FOLLOWS: I) W HEN AN INTANGIBLE IS SOLD, THE RISK OF FUTURE INCOM E POTENTIAL LIE WITH THE BUYER. II) WHEN TALLY SOFTWARE WAS SOLD IN 2006, THERE WAS NO FORECAST ABOUT THE GLOBAL ECONOMY RECESSION. THE SUBSEQUENT DIP IN SALE DUE TO GLOBAL ECONOMIC SLOW DOWN DOES NOT HAVE RELEVANCE A T THE TIME OF SALE AS THIS IS NOT CONTEMPLATED OR COMPREHENDED AT THE TIME OF SALE. PAGE 53 OF 61 53 ITA NO.1235/BANG/2010 III) THE ESSENCE OF EXCESS EARNING METHOD IS TO PRO JECT THE FUTURE REVENUE EARNING, BASED ON PAST YEAR DATA. 10.3) HOWEVER, WE DISAGREE WITH CERTAIN FIGURES A DOPTED BY THE TPO IN ARRIVING AT THE VALUE OF ALP OF THE SALE OF IPR. TO ARRIVE AT THE ALP THE TPO HAD TAKEN THE ACTUAL TOTAL OPERATIN G REVENUE FOR THE ASSESSMENT YEARS 2000-01 TO 2005-06 AND BASED ON THE SAME, HE HAD COMPUTED CAGR AT 20.39% AND THE PROJECTED EXPECTED REVENUE FOR THE PERIOD FROM THE AYS 2007-08 TO 2011-12. THE TPO HA D IGNORED THE ACTUAL FACTS THAT THE REVENUES FOR THE AYS 2004-05 AND 2006-07 WERE DIPPED, INSTEAD, THE TPO ASSUMED THEORETICALLY THAT THE SALES WILL KEEP GROWING. THE IPR WAS SOLD ONLY ON 31.1.2006, THEREF ORE, THE SALES FOR TEN MONTHS I.E., FROM 1.4.2005 TO THE DATE OF SALE SHOULD HAVE BEEN INCLUDED FOR COMPUTING THE FUTURE REVENUES. THIS H AS BEEN IGNORED BY THE TPO. THE TPO IN HIS REMAND REPORT HAD STATED THAT THE CURRENT YEAR [AY 2006-07] DATA WAS NOT TAKEN SINCE THE SAME INVOLVED THE RELATED PARTY TRANSACTIONS AND THE TRANSACTION INVOL VING IPR TOOK PLACE THIS YEAR. THIS STAND OF THE TPO WAS HOTLY CONTESTED BY THE ASSESSEE THAT THE SALES OF TALLY LICENSES WERE TO THIRD PARTI ES AND NOT TO RELATED PARTIES AS PORTRAYED BY THE TPO. IT WAS, FURTHER, CL AIMED BY THE ASSESSEE THAT WHAT WAS SOLD BY ASSESSEE WAS IPR WHIC H GENERATES LICENSE REVENUES AND, THUS, TO VALUE IPR WHAT NEEDS TO BE CONSIDERED WAS REVENUE FROM TALLY LICENSES WHICH WERE SOLD TO T HIRD PARTIES. THE OTHER RELATED PARTY TRANSACTIONS HAVE NO RELEVANCE FACTORS. THE SITUATION IN THE AY 2006-07 WAS SIMILAR TO SITUATIO N IN ALL THE YEARS CONSIDERED BY THE TPO. THEREFORE, IT WAS CLAIMED BY THE ASSESSEE THAT PAGE 54 OF 61 54 ITA NO.1235/BANG/2010 THE REASONING OF THE TPO WAS BASELESS. REFUTING THE TPOS REASONING THAT THE TRANSACTION INVOLVING IPR TOOK PLACE IN TH IS YEAR AND, THEREFORE, CURRENT YEAR DATA WAS EXCLUDED, THE ASSE SSEE SUBMITTED THAT SINCE THE SALE WAS IN THE CURRENT YEAR, IT WAS MORE SO IMPORTANT TO CONSIDER THE CURRENT YEARS SALES WHICH, ACCORDING T O THE ASSESSEE, IN CONSONANCE WITH THE PROVISIONS OF RULE 10B (4) WHIC H MANDATE USE OF CURRENT YEARS DATA. IT WAS, THEREFORE, CONTENDED B Y THE ASSESSEE THAT THE CURRENT YEAR DATA SHOULD HAVE BEEN USED TO ESTIM ATE FUTURE REVENUES. THERE IS FORCE IN THE CONTENTION OF THE ASSESSEE THAT THE SALE DATA FOR THE PERIOD FROM APRIL, 2005 TO JAN 20 06 WAS VITAL TO ARRIVE AT CORRECT PROJECTION WHICH REFLECTS THE TRU E EARNING POTENTIAL OF THE IPR AT THE TIME OF SALE. THEREFORE, IN THE CO URSE OF THIS ORDER, WE ARE DIRECTING THE TPO TO INCLUDE THE FIGURE FOR AY 2006-07 FOR ARRIVING AT THE VALUE OF ALP. 10.4) IN THE AY 2005-06, IT WAS THE CLAIM OF THE ASSESS EE THAT THERE HAS BEEN A SALE RETURN OF RS. 111.04 CRO RES. THE SALE RETURN HAS TO BE REDUCED WHILE CALCULATING CAGR WHICH IS, IN OUR VIEW, REASONABLE AND JUSTIFIABLE. THIS VITAL FACT HAS BE EN GIVEN A GO-BY. THE TPO HAD CONSIDERED THE SALES FOR THE AY 2005-06 AT RS.198.15 CRORES WHICH WAS TERMED BY THE TPO AS THE BASE FOR COMPUTIN G CAGR AND FUTURE REVENUES. IT WAS TRUE THAT THERE WAS A SUBS TANTIAL UPWARD TREND IN THE TURNOVER DURING THE AY 2005-06, HOWEVER, IN THE IMMEDIATELY PRECEDING AND SUCCEEDING AYS THERE WAS PLUNGE IN T HE TURNOVER [SOURCE: FIGURES SUPPLIED BY THE ASSESSEE]. THIS VI TAL FACT SHOULD HAVE BEEN TAKEN COGNIZANCE OF WHILE COMPUTING CAGR AND E STIMATING FUTURE PAGE 55 OF 61 55 ITA NO.1235/BANG/2010 REVENUES BY THE TPO. DURING THE COURSE OF HEARIN G, IT WAS SUBMITTED THAT WITH THE INTRODUCTION OF VAT ACROSS THE COUNTR Y W.E.F. 1.4.2005, MORE TRADERS WERE REQUIRED TO AUTOMATED SYSTEMS TO S UPPORT THE INCREASED WORK AND, THUS, DISTRIBUTORS WERE FORCED TO OFF-TAKE LARGE QUANTITIES OF SOFTWARE PACKAGE WHICH WAS ACCOUNTED FOR AS TURNOVER IN THE ASSESSEES BOOKS. HOWEVER, IN THE LAST THREE M ONTHS OF THE AY 2005-06, THE SALES ACCOUNTED FOR WERE ALMOST 100% N OT RECEIVED AND, IN FACT, 95% OF SALES FOR 2005-06 WERE IN THE MONT H OF MARCH AND THE DEBTOR OUTSTANDING AS ON 31.3.2005 WAS TO THE TUNE OF RS.197.14 CRORES. THOUGH THE ASSESSEES ACCOUNTED REVENUE INCREASED I N THE AY 2005-06, THE DEALERS COULD NOT SELL THE WHOLE STOCKS WHICH W ERE DUMPED BY THE ASSESSEE WITH THEM IN ANTICIPATION OF FAVOURABLE CL IMATE IN SALES. THERE WAS A SALE RETURN TO THE TUNE OF RS.111.04 CRORES P ERTAINING TO THE SALES MADE IN AY 2005-06. IT WAS CLAIMED THAT THE TURNOV ER AS REPORTED DID NOT MATERIALIZE. THESE FACTS HAVE NOT BEEN TAKEN C ARE OF BY THE TPO WHILE ASSUMING THE FUTURE TURNOVER PROJECTION. IT WAS, FURTHER, CONTENDED THAT THE TPOS CONTENTION THAT HE WAS VER Y CONSERVATIVE AND TAKEN CAGR AT 20.39% INSTEAD OF 90.80% THAT THE LOW ER CAGR TAKES CARE OF ALL POSSIBLE EFFECTS ON FUTURE CASH FLOWS W AS TERMED BY THE ASSESSEE A MERE ASSUMPTION AND PRESUMPTION ON THE P ART OF THE TPO AND NOTHING ELSE. AS STATED EARLIER, WE ARE OF THE VIEW THAT SALE RETURN, AS ARRIVED ABOVE, HAS TO BE REDUCED WHILE CALCULATI NG CAGR. FURTHER, WE ADD THAT THE ACTUAL CAGR IS TO BE CONSIDERED FOR PROJECTION WITHOUT ANY DISCOUNT. PAGE 56 OF 61 56 ITA NO.1235/BANG/2010 10.5) WE ALSO FIND PRIMA FACIE FLAW IN THE CALCUL ATION OF DISCOUNT FACTOR GIVEN BY THE TPO. THE TPO HAS CONSI DERED 3 COMPANIES AS COMPARABLE TO THE ASSESSEES SEGMENT OF DISTRIBU TION OF PRODUCTS. THESE COMPANIES ARE LIFETREE CONVERGENCE LIMITED, E XENSYS SOFTWARE SOLUTIONS LIMITED AND SANKHYA INFOTECH LIMITED (PAGE 139 OF THE TP ORDER). OUT OF THESE THREE, ONLY SANKHYA INFOTECHS BETA HAS BEEN CONSIDERED. WHY THE OTHER TWO COMPANIES ARE NOT CON SIDERED IS NOT CLEAR. WE ARE OF THE VIEW THAT BETA SHOULD BE COMP UTED AFTER CONSIDERING ALL THE THREE COMPANIES. THE AVERAGE BETA OF THE THREE COMPANIES, IT WAS SUBMITTED, WOULD BE 1 AND THE COM PUTATION OF BETA IS FURNISHED AT PAGE 408 TO 414 OF THE PAPER BOOK (SUB MITTED BY THE ASSESSEE). THIS COMPUTATION NEEDS TO BE EXAMINED BY THE TPO. WHILE CALCULATING THE WORKING CAPITAL, THE TPO HAS NOT CO NSIDERED THE CASH AND BANK BALANCES AND OTHER CURRENT ASSETS (EXCEPT INTER-CORPORATE DEPOSITS) AND PROVISIONS. FURTHER, IT IS DIRECTED T HAT THE SALE RETURNS OF RS.111.04 CRORES HAS TO BE REDUCED FROM THE SUNDRY DEBTORS WHILE CALCULATING THE WORKING CAPITAL. WE ARE OF THE VIE W THE SAME SHOULD ALSO BE CONSIDERED WHILE COMPUTING WORKING CAPITAL RATIO. 11) TAKING INTO ACCOUNT THE RIVA L SUBMISSIONS, DILIGENT PERUSAL OF THE RELEVANT RECORDS AND ALSO THE DOCUME NTARY EVIDENCES ADDUCED BY EITHER PARTY, THE TPO IS DIRECTED TO RECAL CULATE THE ALP KEEPING IN VIEW THE FOLLOWING SPECIFIC DIRECTIONS OF THIS BENCH, NAMELY: PAGE 57 OF 61 57 ITA NO.1235/BANG/2010 I. METHOD OF VALUATION OF ALP: (I) CONSIDERING THE NATURE OF TRANSACTION AND I N THE ABSENCE OF UNCONTROLLED INDEPENDENT COMPARABLE COMPANIES, WE A RE OF THE CONSIDERED VIEW THAT THE EXCESS EARNING METHOD [EEM] ADOPTED B Y THE TPO IN THE PRESENT CIRCUMSTANCE IS REASONABLE AND, THEREFORE, HE IS DIRECTED TO ADOPT THE SAME EEM WHILE RECALCULATING THE ALP; (II) THE REASON FOR ADOPTING EEM METHOD THAT I T IS ONLY AN INTERNAL CUP METHOD, WHEREIN, IT IS SEEN WHAT IS TH E PRICE FOR WHICH THE SAME PRODUCT WOULD HAVE BEEN SOLD BY THE ASSESSEE TO AN I NDEPENDENT ENTITY. THIS PRICE ALSO REFLECTS THE PRICE AT WHICH THE ASSESSEE WOULD HAVE SOLD IN AN UNCONTROLLED CONDITION, BUT, AS THERE WERE NO COMPA RABLE PRICES AVAILABLE IN THE PUBLIC DOMAIN FOR SALE OF IPR PRODUCE SIMILAR T O THAT OF THE ASSESSEE, THIS EEM IS USED TO DETERMINE THE PRICE THAT WOULD HAVE BEEN ARRIVED AT, IF THE ASSESSEE SOLD THE IPR TO AN INDEPENDENT ENTITY. WHILE CALCULATING THE ALP UNDER EEM, THE TPO IS DIR ECTED TO ADHERE THE FOLLOWING STEPS, NAMELY: II. ESTIMATING FUTURE TURNOVER BASED ON THE PAST P ERFORMANCE: (I) WITH REFERENCE TO THE ACTUAL OPERATING REVEN UE FROM THE AY 1999-2000 TO 2006-07, THE SALE RETURN OF RS.111.04 CRORES FOR THE AY 2005-06 HAS TO BE REDUCED FROM THE OPERATING REVEN UE AND ONLY THE NET HAS TO BE TAKEN AS THIS IS THE CORRECT ACCOUNTI NG STANDARD TO BE FOLLOWED FOR ARRIVING AT CAGR. AS CAN BE SEEN FRO M THE RECORDS, THE REVENUE FOR THE AY 2005-06 LOOKS ABNORMAL COMPARED TO OTHER AYS AND PAGE 58 OF 61 58 ITA NO.1235/BANG/2010 THERE WAS ALSO REVENUE TO THE EXTENT OF RS.111.04 C RORES WHICH DID NOT MATERIALIZE DUE TO DISTRIBUTORS BEING NOT ABLE TO S ELL THE STOCKS WHICH WAS FORCED ON THEM IN A GREATER QUANTITY WITH AN ANT ICIPATION OF GOOD REVENUES DUE TO INTRODUCTION OF VAT. IN THE SAME C ALCULATION, THE REVENUE FOR THE YEAR 2006-07 HAS TO BE ADOPTED. AS THE DATE OF VALUATION OF IPR WAS ON 31.1.2006, THE ACTUAL REVEN UES UPTO JANUARY, 2006 HAS TO BE TAKEN AND THE NEXT TWO MONTHS WILL H AVE TO BE PROJECTED BASED ON THE PERFORMANCE OF THE PREVIOUS TEN MONTHS . AS THE ASSESSEE HAD SOLD ONLY IPR AND THE CALCULATION OF REVENUES AR E FROM TALLY LICENSES WHICH WERE SOLD TO THIRD PARTIES, THE SALE OF IPR TO A RELATED PARTY TRANSACTION HAS NO RELEVANCE FOR THIS SALE OF TALLY LICENSE. HENCE, THE CURRENT YEAR DATA I.E., AY 2006-07 HAS TO BE INC LUDED AS THEY RELATE TO THIRD PARTY TRANSACTIONS AND THE PROJECTIONS HAVE TO BE MADE FOR THE FUTURE YEARS BASED ON THE REVENUES OF AY 2006-07 WHI CH IS ALSO IN ACCORDANCE WITH THE PROVISIONS OF RULE 10B(IV) WHIC H MANDATE THE USE OF CURRENT YEAR DATA. THE PROJECTION HAS TO BE MADE FO R NEXT SIX YEARS WHICH HAS RIGHTLY BEEN ADOPTED BY THE TPO. FURTHER, THE ASSESSEES CONTENTION TO ADOPT THE ACTUAL REVENUES FOR THE FUT URE YEARS WHICH ARE AVAILABLE NOW CANNOT BE ACCEPTED NOW FOR A SIMPLE R EASON THAT THE ALP WAS CALCULATED ON THE DATE OF SALE WHICH WAS IN JAN UARY, 2006 ITSELF AND ALSO UNDER EEM FUTURE REVENUES WILL BE PROJECTED BA SED ON THE PREVIOUS YEAR DATA KEEPING THE CURRENT YEARS DATA AS THE BASE WHICH HAS GOT NO RELEVANCE ON THE ACTUAL REVENUES DURING THE FUTURE YEARS. WE ALSO MAKE IT CLEAR THAT THE ACTUAL CAGR SHALL BE ADOPTED BY THE TPO WITHOUT ANY DISCOUNT. PAGE 59 OF 61 59 ITA NO.1235/BANG/2010 (II) ESTIMATION OF FUTURE CASH FLOWS : WE ARE IN AGREEMENT WITH THE METHOD ADOPTED BY THE TPO IN ESTIMATING THE CASH FLOWS EXCEPT THAT THE REVENUES FOR THE AY 2006-07 HAS TO BE CON SIDERED AND IS TO BE TAKEN AS THE BASE YEAR FOR FUTURE PROJE CTION OF REVENUE FOR THE REASONS RECORDED SUPRA [PARA (I)]. (III) ESTIMATION OF DISCOUNTED FUTURE CASH FLOWS : WE ARE IN TOTAL AGREEMENT WITH THE TPO IN ESTIMATING OF DISCOUNTED FUTURE CASH FLOWS EXCEPT IN CALCULATION OF BETA WHERE THE TPO, EVEN AFTER HA VING CONSIDERED THREE COMPANIES AS COMPARABLE TO THE ASS ESSEES SEGMENT OF DISTRIBUTION OF PRODUCTS, HAD WRONGLY TOOK ONLY ONE C OMPANYS BETA WHICH, IN OUR CONSIDERED VIEW, WAS NOT REASONABLE. THEREFORE, AN AVERAGE OF THREE COMPANIES BETA HAS TO BE TAKEN FO R CALCULATION. (IV) PRESENT VALUE OF IMPROVEMENT : WE AGREE WITH THE TPO ON THIS SCORE. (V) FUTURE CASH FLOWS : WE AGREE WITH THE TPO ON THIS POINT. (VI) RETURN ON FIXED ASSETS : WE AGREE WITH THE STAND OF THE TPO ON THIS ISSUE. (VII) RETURN ON WORKING CAPITAL : WE DO AGREE WITH THE TPOS WORKING EXCEPT THAT THE SALE RETURN OF RS.111.04 CRORES HAS TO BE REDUCED FROM SUNDRY DEBTORS FOR THE AY 2005-06 AND THE CASH, BANK BALANCES AND OTHER CURRENT ASSETS HAVE TO BE CONSID ERED FOR CALCULATION OF CURRENT ASSETS FOR ALL THE YEARS. (VIII) RETURN ON HUMAN CAPITAL : WE ARE IN AGREEMENT WITH THE TPOS WORKING. PAGE 60 OF 61 60 ITA NO.1235/BANG/2010 AFTER FOLLOWING THE ABOVE FORMULAE, THE TPO SHOULD CALCULATE THE ALP ACCORDINGLY. IF THE AMOUNT SO ARRIVED AT WERE TO BE HIGHER THAN THE TOTAL ACTUAL CONSIDERATION [RS.38.50 CRORES] RECEIV ED, THE TPO SHOULD ADOPT THE HIGHER PRICE ARRIVED AT. WITH REGARD TO THE CALCULATION O F IPR AS ON 31.1.2006 AS COMPARED TO REPURCHASE OF IPR BY THE ASSESSEE ON 30.9.2008 FOR A SUM OF RS.53,67,52,505/- [SOURCE: P 385 OF PB AR], WE ARE IN AGREEMENT WITH THE CONTENTION OF THE REVENUE THAT THE VALUE PAID BY THE ASSESSEE TO AE FOR SUBSEQUENT PURCHASE OF THE S AME SOFTWARE PRODUCT CANNOT BE CONSIDERED AS UNCONTROLLED TRANSA CTION AS THE SAID TRANSACTION WAS BETWEEN TWO ASSOCIATED ENTERPRISES. FURTHER, AS THERE WAS A LONG GAP OF ALMOST THREE YEARS BETWEEN T HE TWO TRANSACTIONS; WE ARE OF THE VIEW THAT THE POINT RAI SED BY THE ASSESSEE FOR COMPARISON IS UNREASONABLE DUE TO THE SUBSEQUEN T VALUE ADDITIONS MADE TO THE IPR AND DISCOUNTING FACTORS. 12. IN VIEW OF THE ABOVE, THE APPEAL FILED BY THE A SSESSEE IS PARTLY ALLOWED FOR STATISTICAL PURPOSES. THE ORDER PRONOUNCED ON MONDAY, THE 26 TH DAY OF SEPTEMBER, 2011 AT BANGALORE. SD/- SD/- (N BARATHVAJA SANKAR) (GEORGE GEORGE K) VICE PRESIDENT JUDICIAL MEMBER PAGE 61 OF 61 61 ITA NO.1235/BANG/2010 COPY TO : 1. THE REVENUE 2. THE ASSESSEE 3. THE C IT CONCERNED. 4. THE CIT(A) CONCERNED. 5. DR 6. GF MSP/ BY ORDER ASST. REGISTRAR, ITAT, BANGALORE.