DCIT, New Delhi V. M/s Innodata India Pvt. Ltd., New Delhi

ITA 1528/DEL/2011

• Counselvise Citation: [2015] 121 COUNSELVISE.COM (IT) 0156 (ITAT-DELHI)
• Duration Of Justice: 4 year(s) 3 month(s) 1 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 30-06-2015
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: I
• Next Hearing Date: 10-04-2015
• Assessment Year: 2005-2006
• Appeal Filed On: 29-03-2011
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: JUDY JAMES
• Keywords: Transfer pricing; International transaction
• Section: 92C; 10B

Judgement Text

INCOME TAX APPELLATE TRIBUNAL DELHI BENCH I: NEW DELHI BEFORE SHRI S.V.MEHTORA, ACCOUNTANT MEMBER AND SHRI A. T. VARKEY, JUDICIAL MEMBER ITA 1528 /DEL/ 2011 (ASSESSMENT YEAR: 2005 - 06 ) DCIT CIRCLE - 11(1), ROOM NO - 312, C.R.BUILDING, NEW DELHI VS INNODATA ISOGEN INDIA PVT LTD, 19 K G MARG, 708 SURYA KIRAN BUILDING, NEW DELHI PAN NO - AAACI2425G (APPELLANT) (RESPONDENT) APPELLANT BY : SH. AJAY VOHRA , ADV, SH. M.L. KRISHNAMURTY, CA RESPONDENT BY : SH JUDY JAMES, STANDING COUNSEL DATE OF HEARING 10.04.2015 DATE OF PRONOUNCEMENT 30 . 06 .2015 O R D E R PER A. T. VARKEY, JUDICIAL MEMBER THIS APPEAL FILED BY THE REVENUE ARISES OUT OF THE ORDER PASSED BY THE LD. CIT(A) - XX, NEW DELHI DATED 31.01.2011 PERTAINING TO ASSESSMENT YEAR 2005 - 06 . 2. THE SOLE GROUND RAISED IN THE REVENUES APPEAL READ AS UNDER: - THE LD. CIT(A) ERRED IN DELETING THE ADDITION OF RS. 3,00,60,788/ - MADE TO THE PRICE TO THE INTERNATIONAL TRANSACTION. 3 . FACTS, IN BRIEF ARE THAT THE ASSESSEE COMPANY IS ENGAGED IN THE BUSINESS OF PROVIDING CONTENT RELATED SERVICES SUCH AS DATA CONVERSION, PAGE 2 OF 18 COMPOSITION EDITORIAL SERVICES AND INDEXING ETC. TO ITS PARENT COMPANY INNODATA US. THE RETURN OF INCOME HAS BEEN FILED BY THE ASSESSEE ON 31.10.2005 DECLAR ING RS.5,71,340/ - . THE RETURN WAS PROCESSED U/S. 143(1) OF THE INCOME TAX ACT, 1961 (HEREIN AFTER THE ACT) ON 20.04.2006 . THE CASE WAS SELECTED FOR SCRUTINY. A REFERENCE WAS MADE TO TPO, NEW DELHI FOR DETERMINING THE A RMS LENGTH PRICE U/S. 92CA(3) OF THE ACT IN RESPECT OF INTERNATIONAL TRANSACTION S ENTERED INTO BY THE ASSESSEE DURING THE FINANCIAL YEAR 2004 - 05 . THE TPO VIDE HIS ORDER DATED 16.09.2008 HAS EXAMINED AND DETERMINED THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTIONS OF THE ASSESSEE WITH ITS ASSOCIATED ENTERPRISES USING THE CURRENT YEAR DATA WHEN ASSESSEE HAD CONSIDERED MULTIPLE YEAR DATA IN RESPECT OF COMPARABLE, AS UNDER: - 'INNODAT A INDIA IS RETAINING ONLY 60% OF THE PROFIT, WHEREAS, INNODATA US IS RETAINING 40% OF THE PROFIT. AS DISCUSSED IN THE PREVIOUS PARAGRAPHS THE ASSOCIATED ENTERPRISE IS MAINLY PERFORMING THE FUNCTIONS OF MARKETING ACTIVITIES AND THE ASSESSEE IN INDIA PERFORM S ALL OTHER FUNCTIONS. THEREFORE, THE COMPENSATION TO THE ASSESSEE AS PER THE MARKETING SERVICE AGREEMENT IS NOT REFLECTING THE MARKET REALITY AS ASSOCIATED ENTERPRISE IS RETAINING MORE PROFIT THAN THE ASSESSEE AND THIS PROFITABILITY IS NOT IN PROPORTION T O THE F UNCTI ONS PERFORMED BY THE ASSOCIATED ENTERPRISE. FURTHER, THE INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE ASSESSEE ARE WITH ONE OF ITS AE M/ S INNODATA ASIA HOLDINGS LTD. WHICH IS LOCATED IN BERMUDA, WHICH IS THE IMMEDIATE HOLDING COMPANY OF THE AS SESSEE. THE ULTIMATE PARENT HOLDING COMPANY IS LOCATED IN THE USA. FROM THE ANALYSIS SUBMITTED BY THE ASSESSEE, IT IS NOTICED THAT GROUP COMPANY IS EARNING 8.68% AND INNODATA US IS EARNING 3.35% FROM INDIA OPERATION. THE GROUP PROFIT RETAINED BY INNODATA U S IS 40% WHEREAS IT IS 60% IN THE CASE OF PAGE 3 OF 18 ASSESSEE. FURTHER, ASSESSEE IS EARNING 6.65% AT ENTITY LEVEL. AS DISCUSSED THE MAJOR FUNCTIONS ARE PERFORMED IN INDIA AND THE AE OF THE ASSESSEE IS PERFORMING FUNCTIONS RELATING TO MARKETING ACTIVITIES AND COORDINA TION. IN SPITE OF THIS, THE DIFFERENCES IN THE FUNCTIONS OF THE ASSESSEE AND ITS AE, THE PROFITABILITY RETAINED BY THE AE OF ASSESSEE IS IN LARGER PROPORTION THAN THE FUNCTIONS PERFORMED BY THE AE. THE ASSESSEE IS NOT GETTING COMPENSATED FROM ITS AE ON THE BASIS OF ARM'S LENGTH PRICE. THEREFORE, IT IS CONCLUDED THAT COMPENSATION RECEIVED BY THE ASSESSEE FROM ITS AE IS NOT COMMENSURATE WITH THE FUNCTIONS PERFORMED BY THE ASSESSEE. THE COMPENSATION RECEIVED BY THE ASSESSEE NEEDS TO BE ADJUSTED TO REFLECT THE MARKET REALITY. 8. DETERMINATION OF ARM'S LENGTH PRICE: THE ARM'S LENGTH PRICE OF THE INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE ASSESSEE RELATING TO IT ENABLED SERVICES TO ITS ASSOCIATED ENTERPRISE IS DETERMINED AS UNDER: AVERAGE OP/TC OF THE COMPA RABLES = 17.70% TOTAL COST OF THE ASSESSEE = RS.27,20,71,890 ARM'S LENGTH REVENUE = 117.70 % RS. 27,20,71,890 = 32,02,27,439 BOOK VALUE = 29,01,66,650 DIFFERENCE = 3,00,60,788 THE INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE ASSESSEE IS UNDERSTATED BY RS.3, 00,60,788 / - . THE RATIO OF QUANTUM OF ADJUSTMENT TO ARM'S LENGTH PRICE IS 9.4%, THEREFORE, PROVISO TO SEE. 92C (2) IS NOT ATTRACTED. 9. THE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTIONS RELATING TO IT ENABLED SERVICES RE FERRED BY ASSESSING OFFICERS IS DETERMINED A T RS.32,02,27,438 / - . THE BOOK VALUE OF THESE INTERNATIONAL TRANSACTIONS IS RS.29, 0 L,66,650 / - . THEREFORE, THE BOOK VALUE OF INTERNATIONAL TRANSACTIONS IS UNDERSTATED BY RS.3, 00,60,788 / - . THE PAGE 4 OF 18 OTHER INTERNATIONAL TR ANSACTIONS REFERRED BY AO ARE HELD TO BE AT ARM'S LENGTH PRICE. IN VIEW OF ABOVE, AO SHALL ENHANCE THE TOTAL INCOME OF THE ASSESSEE BY RS.3, 00, 60,788 / - FOR THE A.Y.2005 - 06 FOR THE INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE ASSESSEE DURING THE F.Y. 2004 - 05 TO BRING THE INTERNATIONAL TRANSACTIONS RELATING TO IT ENABLED SERVICES AT ARM'S LENGTH PRICE.' 4 . IN VIEW OF ABOVE, THE DIFFERENCE AMOUNTING TO RS. 3,00,60,788 / - BETWEEN ARM'S LENGTH OPERATING PROFIT AND ADJUSTED OPERATING PROFIT WAS ADDED TO THE INCOME OF THE ASSESSEE COMPANY BY THE AO VIDE HIS ORDER DATED 16.09.2008 . 5 . AGAINST THE AFORESAID ORDER OF THE ASSESSING OFFICER, ASSESSEE APPEALED BEFORE THE LD. CIT(A), WHO VIDE HER ORDER DATED 31.01.2011 HAS ALLOWED THE APPEAL OF THE AS SESSEE BY DELETING THE ADDITION. 6 . NOW THE REVENUE IS IN APPEAL BEFORE US. 7 . LD. DR RELIED UPON THE ORDER OF THE ASSESSING OFFICER AND TPO. 8 . ON THE CONTRARY, LD . COUNSEL OF THE ASSESSEE RELIED UPON THE ORDER OF THE LD . CIT(A) AND DOES NOT WANT US TO INTERFERE IN THE SAME. 9 . WE HAVE HEARD BOTH THE PARTIES AND PERUSED THE RECORDS. WE HAVE CAREFULLY CONSIDERED THE FACTS AND THE DETAILED SUBMISSIONS OF REVENUE AND THE ASSESSEE IN PURSUANCE TO THE VARIOUS OBSERVATIONS OF THE TPO, AS CONTAINED IN HIS ORDER UNDER SECTION 92CA(3) OF THE INCOME ACT DATED 16.09.2008 AND ALSO THE PAPER BOOK FILED BEFORE US. IN THIS CASE, WE TAKE NOTE THAT THE ASSESSEE AND ITS PARENT COMPANY INNODATA US ARE INDEPENDENT SERVICE PROVIDERS. THE PARENT COMPANY INNODATA US , SECURES BUSINESS FROM ITS CUSTOMERS AND IS THEN SUB - CONTRACTED TO THE PAGE 5 OF 18 ASSESSEE. SO IF THE PARENT COMPANY DOES NOT SECURE BUSINESS IT CANNOT PASS IT ON TO THE ASSESSEE. LIKEWISE IF THE PARENT COMPANY SECURES GOOD WORK THEN IT WILL PASS IT ON TO THE ASSESS EE AND THE ASSESSEE IN TURN WILL HAVE GOOD WORK/ BUSINESS. THEREFORE, LIKE OTHER SERVICE PROVIDERS, THE ASSESSEE AND ITS PARENT ARE EXPOSED TO RISKS OF BUSINESS FLUCTUATIONS. 10 . THE A SSESSEE HAS BEEN INCORPORATED PRIMARILY WITH THE PURPOSE OF PROVIDING IT ENABLED SERVICES FOR ITS GROUP ENTITIES INNODATA US/INNODATA ASIA. IT ENABLED SERVICES PROVIDED BY THE ASSESSEE IS USED BY INNODATA US/ INNODATA ASIA IN THE SERVICES PROVIDED BY THEM TO THE ULTIMATE CUSTOMERS. ASSESSEE IS ESTAB LISHED AS A SOFTWARE TECH NOLOGY PARK (STP) UNIT. ASSESSEE MAIN ACTIVITIES I NCLUDE DATA CAPTURE AND CONVERSION, IMAGING, ELECTRONIC PUBLISHING SERVICES, INDEXING AND ABSTRACTING. 11 . DURING THE YEAR, THE ASSESSEE HAS UNDERTAKEN THE FOLLOWING INTERNATIONAL TRANSACTIONS: S.NO. NATURE OF TRANSACTION VALUE (IN RS.) 1 PURCHASE OF COMPUTER & COMMUNICATION RELATED PERIPHERALS 3,71,428 2 PROVISION OF IT ENABLED SERVICES 29,01,12,906 3 RECOVERY OF MICROSOFT LICENSE FEE 1,44,10,725 12. THE ASSESSEE HAS RELIED UPON TNMM FOR BENCHMARKING INTERNATIONAL TRANSACTIONS OF PROVISION OF SERVICE I.E. ITES USING NET OPERATING PROFIT MARGIN OVER TOTAL OPERATING EXPENSE AS PROFIT LEVEL INDICATOR. ON PAGE 30 OF THE TP REPORT, ASSESSEE HAS COMPUTED PAGE 6 OF 18 WEIGHTED AVERAGE OF 13 COMP A R A BLES AS 10.25% ON PAGE 31 OF THE TP REPORT, THE OP/TC OF ASSESSEE HAS BEEN COMPUTED AS 6.65%. 13. WHILE CALCULATING NET PROFIT MARGIN, THE A SSESSEE COMPANY HAS TAKEN OPERATING REVENUES FROM P & L ACCOUNT WHICH COMES TO RS. 29 ,01, 66 , 650 / - , AGAINST WHICH OPERATING COST IS SHOWN AT RS.27,20,71,890 / - . IN THIS MANNER A PROFIT OF RS.1,80,94,760 / - IS ARRIVED AT WHICH WORKS OUT TO 6.65%. THUS IT HAS BEEN CONCLUDED BY THE A SSESSEE THAT ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION IS WITHI N + 5% OF ARITHMETIC MEAN. 14. THE A SSESSEE REVENUE MODEL IS BASED ON A PRICE PER TRANSACTION/ TRANSMISSION UNDERTAKEN FOR ITS AES. THE PER TRANSACTION PRICE RECEIVED BY THE ASSESSEE IS DETERMINED AS A % OF THE SALE PRICE DERIVED BY THE AES FROM THE SALE TO THE ULTIMATE END CUSTOMER. DURING THE FINANCIAL YEAR UNDER CONSIDERATION, THE A SSESSEE RECEIVED AS ITS REVENUES 76% OF THE END CUSTOMER REVENUE GENERATED BY THE AE S FROM SALE OF SE RVICES PROVIDED BY THE ASSESSEE . 15. ACCORDINGLY, THE ASSESSEE REVENUES (AND CONSEQUENTLY ITS MARGINS) ARE DIRECTLY INTERLINKED TO THE REVENUES GENERATED BY THE AES. THE ASSESSEE THUS SHARES THE MARKET AND RELATED RISKS WITH THE AES AND IS NOT A RISK FREE SERVICE PROVIDER WHO IS GENERALLY COMPENSATED ON A COST PLUS BASIS BY THE BUYER OF THE SERVICES. 16. CONSEQUENT TO THE REVENUE MODEL OF THE ASSESSEE , ITS REVENUES AND MARGINS FLUCTUATE ON A YEAR TO YEAR BASIS, DEPENDING ON THE REVENUES PAGE 7 OF 18 GENERATED BY ITS A ES. ACCORDINGLY, THE ASSESSEE ANNUAL MARGINS CAN FLUCTUATE WIDELY, ALTHOUGH ON A LONG TERM BASIS IT WOULD TEND TO EARN A MARGIN COMMENSURATE WITH ITS FUNCTIONS AND RISKS. THIS IS A DIFFERENT MODEL AS COMPARED TO A COST PLUS SERVICE ENTITY WHICH WOULD EARN A LOW AND CONSISTENT RETURNS ON A YEAR ON YEAR BASIS. 17. THE TPO PASSED AN ORDER UNDER SECTION 92CA(3) AND DETERMINED THE ARM'S LENGTH PRICE TO BE RECEIVED BY THE ASSESSEE FROM ITS ASSOCIATED ENTERPRISES TO BE RS.32,02,27,438 / - INSTEAD OF RS.29,01,66,650 / - RESULTING IN AN ADDITION OF RS.3,00,60,788/ - . 18. IN THE TRANSFER PRICING REVIEW STUDY, ON PAGE 30, THE COMPANIES WERE IDENTIFIED AS COMPARABLES AND THE DA TA FOR THE FINANCIAL YEARS 2002 - 2003, 2003 - 2004 AND 2004 - 2005 (TO THE EXTENT AVAILABLE) WERE LIS TED, WHEREAS IN THE FINAL ANALYSIS, THE TPO HAS TAKEN THE DATA FOR THE FINANCIAL YEAR 2004 - 2005 IN RESPECT OF ELEVEN COMPANIES AGAINST THE THIRTEEN COMPANIES SELECTED FOR COMPARABLES FOR REJECTING THE MULTIPLE YEAR DATA RELIED ON BY THE ASSESSEE. THE TPO AT PAGES 9 OF HIS ORDER HAS REASONED AS UNDER: - 'USE OF MULTIPLE YEAR DATA: - THE TAXPAYER HAS SELECTED TNMM AS THE MOST APPROPRIATE METHOD WITH OP/TC AS A PROFIT LEVEL INDICATOR. KEEPING IN VIEW THE FACTS AND CIRCUMSTANCES OF THE APPELLANT, THE SELECTIO N OF TNMM WITH OP/TC FOUND TO BE ACCEPTABLE; HOWEVER, THE USE OF MULTIPLE YEAR DATA OF COMPARABLES IS NOT AS PER THE PROVISIONS OF THE ACT. 19. IN THIS REGARD, THE LD CIT(A) AT PAGE 13 - 16 HAS TAKEN A NOTE OF THE ASSESSEES CONTENTION AS UNDER: - PAGE 8 OF 18 THE USAGE O F MULTIPLE YEAR DATA MITIGATES THE EFFECT CAUSED BY BUSINESS CYCLES OR OTHER ECONOMIC DISTORTIONS. IT ADDS VALUE TO THE TRANSFER PRICING ANALYSIS AND HELPS THE APPELLANT GAIN INFORMATION ABOUT THE CYCLE WHICH MAY AFFECT THE APPELLANT'S TRANSACTIONS. MOST IMPORTANTLY, USING MULTIPLE YEAR DATA HELPS ELIMINATE POSSIBLE SEASONAL EFFECTS IN THE FINANCIAL RESULTS OF THE COMPARABLES. AS ALREADY NOTED THERE ARE PEAKS AND TROUGHS, WHICH THE APPELLANT IS SUBJECT TO. IT IS LIKELY THAT THE COMPARABLE COMPANY COULD A LSO BE IN A SIMILAR SITUATION, WHERE THEY FEEL THE BRUNT OF BUSINESS VOLATILITY. A CAREFUL EXAMINATION OF THE MULTIPLE YEAR DATA FOR THE COMPARABLE COMPANY USED IN THE TRANSFER PRICING STUDY INDICATES A SIGNIFICANT VARIABILITY IN THEIR PLI (OP /TC). THUS, TO EVEN OUT SIGNIFICANT FLUCTUATIONS AND AVOID ERRORS, BY COMPARING THE APPELLANT TO A COMPARABLE COMPANY, IN CIRCUMSTANCES WHERE BOTH THE ENTITIES ARE ON A DIFFERENT TRAJECTORY IN THEIR PROFIT CYCLE, THE APPELLANT HAS CHOSEN MULTIPLE YEAR DATA, TO AVOID I NCONSISTENCIES' AND THUS REFLECT A TRUE COMPARISON. THE PARENT COMPANY IS ALSO SUBJECT TO FLUCTUATION IN THE REVENUES AS THE RESULT OF THE OP/TC RATIO. BETWEEN THE YEARS 2000 - 200 I AND 2007 - 2008 IT HAS FLUCTUATED FROM - 19.51 % (IN THE YEAR 2002 - 2003) TO 18.81 (IN THE YEAR 2004 - 20 0 5). LIKEWISE THE REVENUES AND (O P /TC PERCENTAGE OF THE APPELLANTS HAS ALSO FLUCTUATED FROM - 9.07% (IN THE YEAR 2002 - 2003) TO 83.79% (IN THE FINANCIAL YEAR 2000 - 200 I). IT MAY BE MENTIONED THAT FINANCIAL YEAR 2000 - 2001 WAS A N UNUSUAL YEAR, WHICH HAS ALSO BEEN REFERRED TO BY THE TPO IN HIS ORDER FOR THE FINANCIAL YEAR 2002 - 2003 (ASSESSMENT YEAR 2003 - 2004). IT IS PRECISELY ON ACCOUNT OF THE FLUCTUATIONS IN THE REVENUES AND IN THE OP /TC PERCENTAGE THAT THE APPELLANT HAS ADOPTED THE WEIGHTED AVERAGE DATA FOR THE CURRENT YEAR AS WELL AS THE PREVIOUS TWO YEARS. IN FACT THE DATA OF PREVIOUS TWO YEARS REVEALS FACT S, WHICH HAS AN INFLUENCE ON THE DETERMINATION OF TRANSFER PRICES IN RELATION TO THE TRANSACTIONS BEING COMPARED. PAGE 9 OF 18 THE SERVICES THAT THE APPELLANT PROVIDES CAN BE CHARACTERIZED INTO RECURRING AND NON - RECURRING CATEGORIES. SERVICES THAT ARE ONGOING IN NATU RE, GENERATE WHAT APPELLANT REGARDS AS RECURRING REVENUES. IT CONSISTS OF SERVICES WHICH IT ANTICIPATES A CLIENT WILL REQUIRE FOR AT LEAST 3 YEARS. SOME SERVICES COULD EVEN LAST LONGER. THE FACTS COULD VARY FROM PROJECT TO PROJECT. SERVICES THAT TERMINATE UPON COMPLETION OF A DEFINED TASK, GENERATE WHAT IS REGARDS AS NON - RECURRING REVENUES. A SERVICE FOR A DISCRETE PROJECT IS CHARACTERIZED AS NON - RECURRING. ON SERVICES WHERE THE COMPANY ANTICIPATES THAT REVENUE IS RECURRING, VOLUME OF WORK RECEIVED FROM T HE CLIENT ON A PERIODIC BASIS COULD FLUCTUATE. IN FEW INSTANCES, A CERTAIN TENTATIVE VOLUME OF WORK IS AGREED UPON AT THE ONSET OF THE PROJECT. IRRESPECTIVE OF THE AGREED THRESHOLDS, THE ACTUAL VOLUME OF THE WORK RECEIVED FROM THE CLIENT WITHIN A PROJECT C OULD FLUCTUATE ON A MONTH TO MONTH BASIS. IN FEW CASES, VOLUME OF WORK RECEIVED FROM THE CLIENT AND THE, PRODUCTION WORK GRADUALLY INCREASES CONSIDERING THE TIME REQUIRED FOR THE RAMP - UP. IN CERTAIN OTHER CASES, NO AGREED LEVEL OF VOLUME IS DECIDED UPFRONT . DESPITE THE FACT THAT THE VOLUME COULD FLUCTUATE WITHIN A PROJECT, THE BILL RATE TO THE CLIENT IS CONSISTENT, AS THE BILL RATES ARE AGREED UPON AT THE CONTRACT NEGOTIATION STAGE. THUS, THE PROJECT CONTINUITY IS KEY DETERMINING FACTOR. A STATEMENT SHOWI NG THE SUMMARY OF REVENUES EARNED BY THE APPELLANT COMPANY IN RESPECT OF PROJECTS UNDER TAKEN BY THE APPELLANT ON BEHALT OF THE PARENT COMPANY IN THE FINANCIAL YEARS 2002 - 2003, 2003 - 2004, 2004 - 2005 AND 2005 - 2006 (IN USD) IS ENCLOSED. THE USD FIGURES HAVE A LSO BEEN CONVERTED INTO INRS. WE WOULD LIKE TO POINT HEREIN THAT THE ENTIRE REVENUE EARNED BY THE APPELLANT IS FROM THE PARENT COMPANY I HOLDING COMPANY. A PERUSAL OF THE STATEMENT REFERRED TO ABOVE INDICATES THE FOLLOWING: - I. IN FINANCIAL YEAR 2002 - 2003 ( ASSESSMENT YEAR 2003 - 2004) THE RECURRING REVENUE EARNED BY THE APPELLANT CONSTITUTED 66% OF THE TOTAL REVENUE. PAGE 10 OF 18 II. IN FINANCIAL YEAR 2003 - 2004 (ASSESSMENT YEAR 2004 - 2005) THE RECURRING REVENUE EARNED BY THE APPELLANT CONSTITUTED 89% OF THE TOTAL REVENUE. III. IN F INANCIAL YEAR 2004 - 2005 (ASSESSMENT YEAR 2005 - 2006 - YEAR UNDER APPEAL) THE RECURRING REVENUE EARNED BY THE APPELLANT CONSTITUTED 94% OF THE TOTAL REVENUE. IV. IN FINANCIAL YEAR 2005 - 2006 (ASSESSMENT YEAR 2006 - 2007) THE RECURRING REVENUE EARNED BY THE APPELL ANT CONSTITUTED 99% OF THE TOTAL REVENUE. THE VARIOUS END CUSTOMERS, WHOSE PROJECTS WERE UNDERTAKEN BY THE APPELLANT COMPANY AND WHICH WERE RECURRING IN NATURE ARE HIGHLIGHTED IN THE ATTACHED STATEMENT. AS STATED IN THE FOREGOING PARAGRAPHS, THE BILLING R ATE TO THE END CUSTOMER BY THE PARENT COMPANY IN RESPECT OF RECURRING PROJECTS IS CONSISTENT AS THE BILLING RATES ARE AGREED UPON AT THE CONTRACT NEGOTIATION STAGE. IN OTHER WORDS, WHILST THE VOLUMES MAY FLUCTUATE, THE BILLING RATE IS CONSTANT. IT IS FOR T HIS REASON THAT THE APPELLANT USED MULTIPLE YEAR DATA IN RESPECT OF THE COMPARABLES, TO ARRIVE AT THE WEIGHTED AVERAGE OF OP/TC OF EACH COMPARABLE COMPANY. COMING BACK TO THE PROVISO TO RULE 10B(4) OF THE INCOME TAX RULES, 1962, WHICH IS REPRODUCED HEREI N BELOW: - 'PROVIDED THAT DATA RELATING TO A PERIOD NOT BEING MORE THAN TWO YEARS PRIOR TO SUCH FINANCIAL YEAR MAY ALSO BE CONSIDERED IF SUCH DATA REVEALS FACTS WHICH COULD HAVE AN INFLUENCE ON THE DETERMINATION OF TRANSFER PRICES IN RELATION TO THE, TRANSACTIONS BEING COMPARED.' THE PROVISO CLEARLY STATES THAT DATA RELATING TO A PERIOD NOT BEING MORE THAN TWO YEARS PRIOR TO SUCH FINANCIAL YEAR IS ALSO TO BE CONSIDERED IF SUCH DATA REVEALS FACTS WHICH COULD HAVE AN INFLUENCE ON THE DETERMINATION OF TR ANSFER PRICES IN RELATION TO THE TRANSACTIONS BEING COMPARED. AS STATED IN THE FOREGOING PARAGRAPHS, THE NATURE OF BUSINESS OF THE APPELLANT COMPANY RECURRING PROJECTS - CONSTITUTES 94% OF THE TOTAL REVENUE IN FINANCIAL YEAR 2004 - 2005 PAGE 11 OF 18 AND SUCH RECURRING PR OJECTS HAD BEEN CONTRACTED IN THE PREVIOUS FINANCIAL YEAR 2003 - 2004 OR BEFORE AND CONTINUED IN FINANCIAL YEAR 2004 - 2005 AND 2005 - 2006 AT THE BILLING RATES CONTRACTED IN FINANCIAL YEAR 2003 - 2004, WHICH RATES CONTINUED IN THE FINANCIAL YEAR 2004 - 2005 AND 200 5 - 2006. THIS NECESSITATED THE USE OF MULTIPLE YEAR DATA FOR THE PREVIOUS TWO FINANCIAL YEARS TO DETERMINE THE TRANSFER PRICES IN RELATION TO THE TRANSACTIONS BEING COMPARED. BASED ON THE ABOVE FACTS, THE APPELLANT'S CASE IS SQUARELY COVERED BY THE PROVISO AND IF THAT BE THE CASE, THE PROVISO, WHICH IS A PART OF THE RULE HAS TO BE APPLIED. IT IS A FUNDAMENTAL RULE OF CONSTRUCTION THAT A PROVISO MUST BE CONSIDERED WITH RELATION TO THE PRINCIPAL MATTER TO WHICH IT STANDS AS A PROVISO. THEREFORE, IT IS TO BE CO NSTRUED HARMONIOUSLY WITH THE MAIN ENACTMENT. IF THE PROVISO BECOMES APPLICABLE ON THE FACTS AND IN THE CIRCUMSTANCE OF THE CASE, IT BECOMES A PART OF THE SUBSTANTIVE CLAUSE. . ANOTHER IMPORTANT FACTOR WHICH HAS TO BE CONSIDERED IS THAT IN THE TRANSFER PRI CING AUDIT FOR THE FINANCIAL YEARS 2002 - 2003 AND 2003 - 2004, THE TPO HAD ACCEPTED THE PRINCIPLE OF MULTIPLE YEAR DATA. THE ASSESSEE HAD USED MULTIPLE YEAR DATA IN RESPECT OF THE COMPARABLE COMPANIES AND AFTER ARRIVING AT THE WEIGHTED AVERAGE OF EACH COM PARABLE COMPANY, CALCULATED THE ARITHMETIC MEAN OF THE COMPARABLE COMPANIES SELECTED. 20 . HAVING REGARD TO THE ABOVE CONTENTION OF THE TAX - PAYER, THE LD CIT(A), HELD AS UNDER : - I HAVE CAREFULLY CONSIDERED THE FACTS AND THE DETAILED SUBMISSIONS FILED BY THE APPELLANT IN PURSUANCE TO THE VARIOUS OBSERVATIONS OF THE TPO, AS CONTAINED IN HIS ORDER UNDER SECTION 92CA(3) OF THE INCOME TAX ACT, 1961 DATED 16.09.2008 AND ALSO THE FIVE VOLUMES OF PAPER BOOK FILED AT THE TIME OF THE HEARING. SINCE ALL THE ISSUES S TATED ABOVE ARE INTERCONNECTED, MY FINDINGS ALSO COVER ALL THESE INTERCONNECTED ISSUES AND THE VARIOUS GROUNDS RAISED. PAGE 12 OF 18 IT IS NOTED THAT THE INTERNATIONAL TRANSACTIONS OF THE APPELLANT WITH ITS AES DURING THE RELEVANT ASSESSMENT YEAR PRIMARILY CONSISTED OF THE PROVISION OF IT ENABLED SERVICES ( CONTENT SEGMENT) TO ITS AES. DURING THE FINANCIAL YEAR UNDER CONSIDERATION, THE APPELLANT RECEIVED AS ITS REVENUES 76% OF THE END CUSTOMER REVENUE GENERATED BY THE AES FROM SALE PROVIDED BY THE APPELLANT. THE APPELLANT HAS USED MULTIPLE YEAR DATA TO MITIGATE THE EFFECT CAUSED BY BUSINESS CYCLES OR OTHER ECONOMIC DISTORTIONS. THE VARIOUS END CUSTOMERS, WHOSE PROJECTS WERE UNDERTAKEN BY THE APPELLANT COMPANY WERE RECURRING IN NATURE AND THE BILLING RATE TO THE END CUSTOME R BY THE PARENT COMPANY IN RESPECT OF RECURRING PROJECTS IS CONSISTENT, AS THE BILLING RATES ARE AGREED UPON AT THE CONTRACT NEGOTIATION STAGE. IN OTHER WORDS, WHILST THE VOLUMES MAY FLUCTUATE, THE BILLING RATE IS CONSTANT. I AGREE WITH THE CONTENTION O F T HE APPELLANT THAT THE PROVISO TO RULE 10B (4) OF THE INCOME TAX RULES, 1962 WILL APPLY TO THE INSTANT CASE BECAUSE THE DATA OF THE APPELLANT REVEALS FACTS WHICH HAS AN INFLUENCE ON THE DETERMINATION OF THE TRANSFER PRICES IN RELATION TO THE TRANSACTIONS BE ING COMPARED. IT IS FOR THIS REASON THAT THE APPELLANT USED MULTIPLE YEAR DATA IN RESPECT OF THE COMPARABLES TO ARRIVE AT THE WEIGHTED AVERAGE OF OP/TC OF EACH COMPARABLE COMPANY. 2 1. IN THE LIGHT OF THE ABOVE FACTUAL BACKGROUND, WE NOTICE THAT, IT IS AS MATTER OF FACT THAT IN PARA 5.1 OF THE ORDER FOR ASSESSMENT YEAR 2002 - 03, (A.Y. 2003 - 04), THE TPO HIMSELF HAS HELD AS UNDER: - THE ASSESSEE COMPANY HAS USED WEIGHTED AVERAGE DATA FOR THREE FINANCIAL YEARS IN THE CASE OF COMPARABLES TO ARRIVE AT AN ARITHMET ICAL MEAN OF 10.12% IN CASE OF COMPARABLE COMPANIES. THREE FINANCIAL YEARS IN THE CASE OF COMPARABLES TO ARRIVE AT AN ARITHMETICAL MEAN OF 10.12% IN CASE OF COMPARABLE COMPANIES. THE DETAILS ARE PROVIDED AT PAGE 31 OF TRANSFER PRICING REPORT, THE PROVISION OF RULE 10B(4) CAST AN OBLIGATION OF USE OF DATA FOR THE YEAR IN WHICH INTERNATIONAL TRANSACTION TOOK PLACE. HOWEVER, AS PER THE PROVISO ATTACHED TO THE RULE PRIOR TWO YEARS DATA CAN PAGE 13 OF 18 ALSO BE CONSIDERED IF SUCH DATA REVEALS FACTS WHICH COULD HAVE INFLUENCE ON DETERMINATION OF TRANSFER PRICE IN RELATION TO TRANSACTIONS BEING COMPARED. IT IS NOTICED ABOVE THAT THERE IS WIDE VARIATIONS IN THE PROFIT MARGINS OF THE ASSESSEE COMPANY OVER LAST MANY YEARS THEREFORE, IN SUCH CASES WHERE THERE IS SUCH A VARIATION US E OF DATA OF MULTIPLE YEAR WOULD RESULT INTO BETTER COMPARABILITY. IN VIEW OF THE SPECIAL CIRCUMSTANCES FINANCIAL DATA OF EARLIER YEARS IS ALSO BEING CONSIDERED IN THIS CASE '. 2 2. FROM THE AFORESAID, IT IS EVIDENT THAT, IN THE PRECEDING YEARS, THE REVENUE HAS ADOPTED MULTIPLE YEAR DATA FOR DETERMINATION OF MARGIN OF COMPARABLES. NO COGENT REASONS HAVE BEEN GIVEN IN THE INSTANT YEAR BY THE TPO TO DEVIATE FROM THE SAME AND F OR M A DIFFERENT VIEW. THUS, THE FACTS REMAINING THE SAME, THE NATURE OF BUSINESS AND BUSINESS MODEL REMAINING THE SAME, THE ADJUSTMENT MADE BY USING ONLY THE CURRENT YEAR DATA IGNORING THE MULTIPLE YEAR DATA IS ARBITRARY AND UN REASONABLE, SO CANNOT BE JUSTIFIED ON THE FACT S OF THE CASE. THEREFORE WE UPHO LD THE DECISION OF THE LD CIT(A) TO TAKE MULTIPLE YEAR DATA FOR DETERMINATION OF ALP, SINCE IT FALLS IN THE KEN OF PROVISO TO RULE 10B(4) OF THE RULES. 2 3. IN RESPECT TO THE DELETION OF ADDITION OF RS.3,00,60,7488/ - MADE TO THE PRICE OF THE INTERNATIONAL TRANSACTION WE FIND THAT THE LD CIT( A) HELD AS FOLLOWS: - DURING THE COURSE OF THE HEARING, THE APPELLANT HAD FILED A COPY OF THE TRANSFER PRICING AUDIT CONDUCTED BY THE INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY US. I HAVE GONE THROUGH THE SUBMISSIONS OF THE APPELLANT. TRANSFER PR ICING ANALYSIS OF THE PARENT COMPANY AND ALSO THE FORM 10K AND L0QS FILED BY THE PARENT COMPANY WHICH JUSTIFIES THE USAGE OF MULTIPLE YEAR DATA. PAGE 14 OF 18 I HAVE ALSO CONSIDERED THE VARIOUS JUDGMENTS CITED BY THE APPELLANT IN SUPPORT OF THEIR DETAILED SUBMISSIONS. I ALSO FOUND THAT THE OBSERVATIONS OF THE TPO IN REJECTING COMPARABLES ON THE PREMISE OF NIL FOREIGN EXCHANGE EARNINGS AS PER HIS ORDER IS NOT CONSISTENT. TPO HAS HIMSELF CONSIDERED SOME COMPANIES HAVING NIL OR LOW EARNINGS FROM FOREIGN SOURCES IN HIS COMPA RABLES LIST. THE TPO HAS INCORRECTLY STATED IN HIS ORDER THAT THE PARENT COMPANY IS ONLY PERFORMING THE FUNCTION OF MARKETING AND THE APPELLANT PERFORMS ALL OTHER FUNCTIONS AND COMPENSATION TO THE APPELLANT. THIS IS NOT REFLECTIVE OF THE FACTS. DURING THE COURSE OF THE HEARING, THE APPELLANT HAS EXPLAINED THAT THE PARENT COMPANY SHARES GREATER RISKS THAN THE APPELLANT. THE APPELLANT IS NOT A BACK OFFICE OR A CAPTIVE UNIT, BUT FACES RISKS AND UNCERTAINTIES AS DOES THE PARENT COMPANY AS ANY VOLUME FLUCTUATION S IN BUSINESS OF PARENT COMPANY HAVE A DIRECT BEARING ON THE REVENUE OF THE APPELLANT. DESPITE THIS FACT, THE PARENT COMPANY RETAINS ONLY 3.38% OF ITS REVENUE GENERATED FROM ACTIVITIES IN INDIA AS AGAINST OPERATING PROFIT OF 6.63% EARNED BY THE APPELLANT. BASED ON THE ABOVE FINDINGS, I HOLD THAT THE APPELLANT WAS JUSTIFIED IN USING MULTIPLE YEAR DATA AND THE COMPARABLES PROVIDED BY THE APPELLANT IS ACCEPTABLE. THE ARITHMETICAL MEAN OF THE WEIGHTED AVERAGES OF THE COMPARABLE COMPANIES AS COMPILED BY THE APPE LLANT AND ALSO TO BY THE TPO IS 10.25%. SINCE THE APPELLANT'S OPERATING MARGINS FALLS WITHIN (+/ - ) 5% OF THE ARITHMETICAL MEAN OF COMPARABLE PRICES. I HOLD THE APPELLANT'S INTERNATIONAL TRANSACTION WITH ITS ASSOCIATED ENTERPRISES DURING THE YEAR TO BE AT A RM'S LENGTH. CONSEQUENTLY THE ADDITION OF RS.3,00,60,788/ - MADE TO THE PRICE OF INTERNATIONAL TRANSACTIONS IS HEREBY DIRECTED TO BE DELETED. ACCORDINGLY, THE ADDITION MADE BY THE ASSESSING OFFICER ON ACCOUNT OF DIFFERENCE IN ARM'S LENGTH PRICE OF RS.3,00.60,788/ - IS HEREBY DELETED. PAGE 15 OF 18 2 4. WE HAVE HEARD BOTH THE PARTIES AND PERUSED THE RECORDS AND FIND FORCE IN THE CONTENTION OF THE TAX PAYER, THAT THE PARENT COMPANY RETAINS ONLY 3.38% OF ITS REVENUE GENERATED FROM ACTIVITIES IN INDIA AS AGAINST OP ERATING PROFIT OF 6.63% EARNED BY THE TAX PAYER. THE TABLE REPRODUCED BY THE L D CIT(A) IN PAGE 33 IS AS UNDER: - TABLE 1.7: INNODATA GROUP, US AND INDIA PROFITABILITY COMPUTATION OF INNODATA US PROFITABILITY FROM INDIA ACTIVITY COMPUTATION OF INNODATA US PROFITABILITY FROM INDIA ACTIVITY PARTICULARS INR REVENUE EARNED BY INNODATA US FROM INDIA ACTIVITY (A) 38,05,4 1.601 SALES. MARKETING AND GENERAL AND ADMINISTRATION COST OF GROUP ALLOCABLE TO INDIA OPERATIONS (B) 7.80.80.245 TRANSFER PRICE PAID TO INDIA (C) 29,01,12.910 TOTAL OPERATING COST OF INNODATA US FOR INDIA ACTIVITY D = (B+C) 36,8 I ,93.155 OPERATING PROFIT OF LNNODATA US FROM INDIA ACTIVITY E = (A - D) 1,23,48,446 OP/TC 3.35% COMPUTATION OF INNODATA INDIA PROFITABILITY PARTICULARS INR REVENUE EARNED BY LNNODATA INDIA (A) 29,01,12,910 TOTAL OPERATING COST OF INNODATA INDIA (B) 27,20,71,890 OPERATING PROFIT OF INNODATA INDIA C = (A - B) 1 ,80,41 ,020 OP/TC 6.63% AN ANALYSIS OF THE ABOVE TABLES WOULD INDICATE THAT OUT OF THE TOTAL REVENUE EARNED BY THE PARENT COMPANY FROM INDIA ACTIVITY, IT HAS TRANSFERRED 76% OF THE REVENUE TO THE APPELLANT AND HAS INCURRED ABOUT 20.6% OF THE REVENUE TOWARDS SALES, MARKETING, GENE RAL AND ADMINISTRATION ALLOCABLE TO INDIA OPERATIONS. IN OTHER WORDS, IT RETAINS ONLY 3.38% OF THE REVENUE WHICH IT HAS EARNED FROM INDIA OPERATIONS AND WHICH IS THE OPERATING PROFIT. WHEREAS, THE APPELLANT HAS EARNED AN OPERATING PROFIT OF 6.63%. PAGE 16 OF 18 2 5. IN RESPECT TO THE FINDING OF THE TPO THAT THE PARENT COMPANY IS ONLY PREFERRING THE FUNCTIONS OF MARKETING AND THE TAX PAYER PERFORMS ALL OTHER FUNCTIONS, IS NOT CORRECT. A PERUSAL OF THE CHART AT PG. 34 AND 35 OF THE LD CIT(A) CLEARLY REVEALS THAT THE PARENT COMPANY IS EXPOSED TO MARKET RISK, SERVICE LIABILITY RISK, TECHNOLOGY RISK, CREDIT RISK AND PRICE RISK AND THE PARENT COMPANY IS ENGAGED IN RESEARCH AND DEVELOPMENT (R&D) OF NEW PROCESS/ SERVICE. SO WE CONCUR WITH THE LD CIT(A) THAT TPO HAS INCORRECTLY ST ATED PARENT COMPANY IS ONLY PERFORMING THE FUNCTIONS OF MARKETING. 2 6 . TABLE 6 INDICATES THE REVENUE OF THE GROUP AND THE TAX - PAYER FOR FIVE YEARS, WHICH IS AS UNDER: - TABLE 6: REVENUES (FIGURES IN RS. MILLION) YEAR MARCH 2001 MARCH 2002 MARCH 2003 MARCH 2004 MARCH 2005 REVENUE (GROUP) 2,739.7 0 2,518.99 1,478.07 1,943.29 2,381.01 REVENUE (IIPL) 331.50 282.80 202.70 249.40 290.10 % OF IIPL REVENUE OVER GROUP REVENUE 12.1% 11.2% 13.7% 12.8% 12.2% 27 . WE TAKE NOTE THAT DURING THE COURSE OF THE APPELLATE PROCEEDINGS BEFORE THE LD CIT(A), THE ASSESSEE HAD FILED A COPY OF THE, TRANSFER PRICING AUDIT CONDUCTED BY THE INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY US. THE ASSESSEE WAS AUDI TED BY INTERNAL REVENUE SERVICE - INTERNATIONAL DIVISION US FOR THE CALENDAR YEARS 2003, 2004 AND 2005. PAGE 17 OF 18 28 . THE ARITHMETICAL MEAN OF THE WEIGHTED AVERAGES OF THE COMPARABLE COMPANIES AS COMPILED BY THE ASSESSEE AND AS ALSO REFERRED TO AND ACCEPTED BY THE TPO IN HIS ORDER IS 10. 25 %. SINCE THE ASSESSEES OPERATING MARGINS FALLS WITHIN ( + 1) 5% OF THE ARITHMETICAL MEAN OF COMPARABLE PRICES, LD. CIT(A) HAS RIGHTLY HELD THAT THE ASSESSEES INTERNATIONAL TRANSACTIONS WITH ITS ASSOCIATED ENTERPRISES DURING THE YEAR TO BE AT ARM'S LENGTH. CONSEQUENTLY THE ADDITION OF RS. 3,00,60,788/ - MADE TO THE PRICE OF INTERNATIONAL TRANSACTION WAS DIRECTED TO BE DELETED BY THE LD CIT(A). FOR THE REASONS ENUMERATED ABOVE BY THE LD CIT(A), SHE RIGHTLY DELETED THE ADDITION MADE BY THE ASSESSING OFFICER ON ACCOUNT OF DIFFERENCE IN ARM'S LENGTH PRICE OF RS. 3,00,60,788 / - . IN THE BACKGROUND OF THE AFORESAID DISCUSSIONS, THE IMPUGNED ORDER OF LD. CIT(A) DOES NOT NEED ANY INTERFERENCE ON OUR PART, HENCE, WE UPHOLD THE SAME. THEREFORE, THE ISSUE IN DI SPUTE RAISED BY THE REVENUE IS REJECTED. 29 . IN THE RESULT, THE APPEAL FILED BY THE REVENUE STANDS DISMISSED. ORDER PRONOUNCED IN THE OPEN COURT ON 30 . 06 .2015 . - S D / - - S D / - (S.V.MEHROTRA) (A. T. VARKEY) ACCOUNTANT MEMBER JUDICIAL MEMBER DATED: 30 / 06 /2015 *A K KEOT COPY FORWARDED TO 1. APPLICANT 2. RESPONDENT 3. CIT PAGE 18 OF 18 4. CIT (A) 5. DR:ITAT ASSISTANT REGISTRAR ITAT, NEW DELHI