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

ITA 4375/DEL/2011

• Counselvise Citation: [2017] 127 COUNSELVISE.COM (IT) 3528 (ITAT-DELHI)
• Duration Of Justice: 6 year(s) 1 month(s) 3 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 06-11-2017
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: I1
• Next Hearing Date: 08-06-2017
• Assessment Year: 2005-2006
• Appeal Filed On: 03-10-2011
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Keywords: Related party transaction; Capital asset; Transfer pricing; International transaction; Wholly owned subsidiary

Judgement Text

1 ITA NO. 4375/DEL/2011 IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH: I-1 NEW DELHI BEFORE SHRI R. K. PANDA, ACCOUNTANT MEM BER AND MS SUCHITRA KAMBLE, JUDI CIAL MEMBER I.T.A .NO. 4375/DEL/2 011 (A.Y 2005-06) DCIT CIRCLE-16(1) NEW DELHI (APPELLANT) VS TRANSWITCH INDIA PVT. LTD. A-27, MOHAN COOPERATIVE INDL. ESTATE, MATHURA ROAD NEW DELHI AAACT4902H (RESPONDENT) APPELLANT BY SH. KUMAR PRANAV, SR. DR RESPONDENT BY NONE ORDER PER SUCHITRA KAMBLE, JM THIS APPEAL HAS BEEN FILED BY THE REVENUE AGAINST T HE ORDER DATED 29/7/2011 PASSED BY CIT(A)-XX, NEW DELHI. 2. THE GROUNDS OF APPEAL ARE AS UNDER:- 1. ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE A ND IN LAW, THE LD.CIT(A) HAS ERRED IN DELETING THE ADDITION OF RS. 1,17,97,001/- MADE BY THE A.O ON ACCOUNT OF DIFFERENCE IN ARMS L ENGTH PRICE AS DATE OF HEARING 10.08.2017 DATE OF PRONOUNCEMENT 06.11.2017 2 ITA NO. 4375/DEL/2011 WORKED OUT BY THE TPO IN HIS REPORT U/S 92CA (3) OF THE INCOME TAX ACT, 1961. 3. THE ASSESSEE COMPANY IS A 100% SUBSIDIARY OF TRA NSWITCH CORPORATION USA (TXC) AND IS ESTABLISHED PRIMARILY AS A DESIGN CENTRE FOR TXC TO CARRY OUT ACTIVITIES, WHICH ARE IN THE NATURE OF DESIGNING AN D DEVELOPMENT OF SOFTWARE DATABASE, PARTICULARLY VLSI SOFTWARE AND SUPPLY OF VLSI SOLUTIONS. TRANSWITCH CORPORATION, USA (XC) IS A LEADING DEVELOPER AND GL OBAL SUPPLIER OF INNOVATIVE HIGH SPEED (VERY LARGE SCALE) INTEGRATIONS SEMICOND UCTOR SOLUTIONS TO COMMUNICATIONS NETWORK EQUIPMENT MANUFACTURERS WHO SERVE THREE FAST- GROWING END-MARKETS I.E. PUBLIC NETWORK INFRASTRUCT URE, INTERNET INFRASTRUCTURE AND WIDE AREA NETWORKS (WANS). THE ASSESSEE HAD FIL ED TRANSFER PRICING DOCUMENTATION BEFORE THE TPO. THE ASSESSEE CHARACTE RIZED ITSELF AS A SOFTWARE DESIGNER AND DEVELOPER. TRANSACTIONAL NET MARGIN ME THOD (TNMM) WAS CHOSEN AS THE MOST APPROPRIATE METHOD. NET OPERATING PROFI T MARGIN WHICH IS THE RATIO OF NET OPERATING PROFIT TO TOTAL EXPENSES (OP/TC) W AS TAKEN AS PROFIT LEVEL INDICATOR. THE ASSESSEE HAS SEARCHED FOR THE COMPAR ABLE CASES IN THE PUBLIC DATABASE TREATING ITSELF AS THE TESTED PARTY. THE O P/TC OF THE ASSESSEE IS AT 13%. THE TP REPORT HAS A FINAL SET 21 COMPARABLES. DATA FOR THE F.Y. 2003, 2004 AND 2005 ARE TAKEN. THE WEIGHTED AVERAGE ARITH METICAL MEAN OF THESE COMPARABLES COME TO 10.48%. THEREFORE, THE TP REPOR T CONCLUDES THAT THE INTERNATIONAL TRANSACTIONS ARE AT ARMS LENGTH PRIC E. DURING THE COURSE OF THE PROCEEDINGS, AS MANY OF THE COMPARABLES WERE NOT HA VING THE DATA FOR FY 2004-05, THE TRANSFER PRICING OFFICER ASKED FOR THE LATEST FINANCIALS OF THE COMPARABLE COMPANIES AND INSISTED UPON USING CURREN T YEAR DATA. WHILE SUBMITTING THE CURRENT YEAR DATA, THE ASSESSEE CONT ENDED THAT IN THE CASE OF THREE COMPANIES THE DATA WERE STILL NOT AVAILABLE A ND REJECTED TWO COMPANIES OUT OF ITS OWN SET OF 21 COMPARABLE COMPANIES. THE TPO CONDUCTED A SEPARATE SEARCH FOR COMPARABLES AND INTRODUCED SANKHYA INFOT ECH LTD. AND FORE C SOFTWARE LTD. HE REJECTED 8 COMPANIES SELECTED BY T HE ASSESSEE. THE TPO 3 ITA NO. 4375/DEL/2011 REJECTED THE FOLLOWING COMPARABLES BY GIVING THE RE ASONS FOR REJECTION IN THE THIRD COLUMN OF THE TABLE WHICH IS REPRODUCED BELOW :- S. NO. NAME OF COMPARABLE REASON FOR REJECTION 1 ASIA H R TECHNOLOGIES LTD. ABNORMAL INCREASE IN E XPENSE (300%) 2 CRESSANDA SOLUTION LTD. SIGNIFICANT LOSSES 3 FORE C SOFTWARE LTD. AS HELIOS & MATHESON INFORMATION TECHNOLOGY LTD. HAS BEEN REJECTED DUE TO RELATED PARTY TRANSACTION THESE COMPANIES ALSO HAVE RELATED PARTY TRANSACTIONS. 4 TELESYS SOFTWARE LTD. 5 MEGASOFT LTD. 6 BLUE STAR INFOTECH LTD. 7 PENTASOFT TECHNOLOGIES LTD. 8 GEOMETRIC SOFTWARE SOLUTIONS LTD. THE ADDITION WAS MADE BY ASSESSING OFFICER TO THE R ETURN OF INCOME ON ACCOUNT OF TRANSFER PRICING ADJUSTMENTS EMANATING O UT OF THE ORDER OF THE TRASNFER PRICING OFFICER. 4. AGGRIEVED BY THE SAID ADDITIONS, THE ASSESSEE FI LED APPEAL BEFORE THE CIT(A). THE CIT(A) PARTLY ALLOWED THE APPEAL OF THE ASSESSEE AND HELD THAT THE INTERNATIONAL TRANSACTION OF THE ASSESSEE COMPANY I S AT ARMS LENGTH PRICE (ALP). 5. THE LD. DR SUBMITTED THAT THE CIT(A) ERRED IN DE LETING THE ADDITION OF RS.1,17,97,001/- MADE BY THE ASSESSING OFFICER ON ACCOUNT OF DIFFERENCE IN ARMS LENGTH PRICE AS WORK OUT BY THE TRANSFER PRIC ING OFFICER. IN HIS REPORT U/S 92CA(3), THE CIT(A) HAS NOT AT ALL CONSIDERED T HAT THE TRANSFER PRICING OFFICER HAS ASKED FOR UPDATED FINANCIAL DATA OF TH E COMPARABLE COMPANIES AND INSISTED UPON USING CURRENT YEAR DATA SINCE THE DAT A OF TWO COMPANIES WERE NOT AVAILABLE. THE LD. DR FURTHER SUBMITTED THAT TH E ASSESSEE ITSELF REJECTED TWO COMPANIES OUT OF ITS OWN SET OF 21 COMPARABLE C OMPANIES. THE TPO HAS RIGHTLY CONDUCTED A SEPARATE SEARCH FOR COMPARABLE AND INTRODUCE TWO NEW 4 ITA NO. 4375/DEL/2011 COMPARABLES. THEREFORE, THE CIT(A) SHOULD HAVE TAK EN INTO CONSIDERATION OF ALL THE RELEVANT MATERIALS BEFORE THE TPO. 6. WE HAVE HEARD THE LD. DR AND PERUSED THE ORDER O F THE CIT(A). ENTIRE ISSUE OF DISPUTE IS BASED ON THE INTRODUCTION OF TW O COMPARABLES BY TPO AND REJECTION OF 8 COMPARABLES OF THE ASSESSEE. AS RELA TES TO COMPARABLES THE CIT(A) HAS CALLED FOR THE REMAND REPORT FROM THE TPO AND T HE SAME WAS TAKEN INTO ACCOUNT BY THE CIT(A). THE RELEVANT EXTRACT OF THE CIT(A) ORDER IS AS FOLLOWS: 4.7. THE LD. TPO HAS NOT GIVEN ANY OTHER REASON O THER THAN THAT THESE THREE COMPANIES ARE HAVING SIGNIFICANT LOSSES. IN T HE REMAND REPORT DATED 02.12.2009, THE TPO HAS JUSTIFIED THE ACTION AS FOL LOWS: IN THIS CONNECTION, IT IS SUBMITTED THAT THE ASSES SEES CONTENTIONS REGARDING LOSS MAKING COMPANIES DO NOT SEEM ACCEPTA BLE BECAUSE ASSESSEES POSITIVE MARGINS ARE OBTAINED IN SIMILAR MARKET CONDITIONS, THE LOSS IF ARISES DUE TO INDIVIDUAL FACTORS, THEN ANY COMPARISON WITH THIS LOSS MAKING COMPANYS RESULT WOULD RESULT IN A N ABERRATION AND AN ANOMALOUS SITUATION. THE PURPOSE OF THIRD PARTY COM PARISON OF PRICES IS TO JUDGE THE OPERATIONAL COMPARABILITY OF THE RELAT ED PARTY TRANSACTIONS OF THE ASSESSEE WITH UNRELATED PARTIES. IF THESE RE SULT IN LOSSES IN ASSESSEE, THEN COMPARISON WITH LOSS MAKING UNRELATE D COMPANIES WOULD BE FAIR, BUT WHEN ASSESSEES RELATED PARTY TR ANSACTIONS RESULT IN PROFIT FOR THE ASSESSEE, THEN IT WOULD BE ILLOGICAL TO COMPARE ITS OPERATING MARGIN WITH LOSS MAKING COMPANIES OR NEGA TIVE PROFIT MARGINS. FURTHER, THE ASSESSEE HAS WRONGLY INFERRED THAT TH E TPO HAS NOT COMMENTED ON THE HIGH PROFIT MAKING COMPARABLES. IN FACT, THE ORDER OF THE TPO SHOWS THAT COMPANIES WITH HIGH PROFIT MARGI NS LIKE ASIA HR TECHNOLOGIES LTD., GEOMETRIES SOFTWARE SOLUTION LTD ., MEGASOFT LTD., 5 ITA NO. 4375/DEL/2011 BLUE STAR INFOTECH LTD. AND PENTASOFT TECHNOLOGIES WERE ALSO REJECTED FOR VARIOUS REASONS. IN LIGHT OF THIS AND AFTER PER USAL OF THE DOCUMENTS ENCLOSED AND PUBLIC DATA BASES, THE LOSS MAKING COM PARABLES ARE FURTHER DISCUSSED AS UNDER. 4.8. AS IT IS SEEN FROM THE CAPITALINE DATABASE, T HESE 3 COMPANIES ARE NOT PERSISTENT LOSS MAKERS. THEY HAVE POSITIVE NET-WORT H. AS PER THE TP REPORT OF THE ASSESSEE WHICH IS NOT QUESTIONED BY THE TPO, THESE COMPANIES ARE IN THE SIMILAR SEGMENT OF THE SOFTWARE INDUSTRY (TP REPORT FOR THE AY 2004- 05 DATED OCTOBER 2005 PAGE NO. 12 AND 13 OF SUBMISS ION DATED 19.11.2009). ONLY LOSS FOR ONE YEAR SHOULD NOT BE THE CAUSE FOR REJECTION. THEREFORE, THESE 3 COMPANIES ARE RESTORED BACK IN THE SET OF C OMPARABLE OF THE ASSESSEE. 4.9. REGARDING THE EXCLUSION OF MEGASOFT LTD., BLU E STAR INFOTECH LTD., PENTASOFT TECHNOLOGIES LTD. AND GEOMETRIC SOFTWARE SOLUTIONS LTD., (APPEARING AT 5, 6, 7 8S 8 IN TABLE-1) ASSESSEE HAS NOT RAISED ANY OBJECTION AS THEY ARE FOUND TO BE HAVING RELATED PA RTY TRANSACTIONS. 4.10. INFOTECH ENTERPRISES LTD. AND SUBEX SYSTEMS LTD. : THROUGH THE SUBMISSION DATED 19.11.2009, THE ASSESSEE HAS STATE D THAT THESE TWO COMPANIES ARE HAVING RELATED PARTY TRANSACTIONS TO THE EXTENT OF 45.03% AND 41.86% RESPECTIVELY. IN THE CASE OF SUBEX SYSTE MS LTD., THE ASSESSEE HAS RAISED THE OBJECTION AT THE APPELLATE STAGE BY SAYING THE OPERATION OF THE COMPANY COMPRISES OF SOFTWARE DEVELOPMENT, SERV ICES AND SALE OF TELECOM PRODUCTS AND IT HAS RELATED PARTY TRANSACTI ONS IN THE SERVICE SEGMENT. I HAVE CONSIDERED THE SUBMISSION BY THE APPELLANT. AS THESE TWO COMPARABLES ARE HAVING SUBSTANTIALLY HIGH PROPORTIO N OF RELATED PARTY TRANSACTION, INFOTECH ENTERPRISES LTD AND SUBEX SYS TEMS LTD. ARE TO BE EXCLUDED FROM THE SET OF COMPARABLES. 6 ITA NO. 4375/DEL/2011 4.11. ASSESSEE HAS SUBMITTED THAT FOUR SOFT LTD. AN D MELSTAR LTD. INFORMATION TECHNOLOGY LTD. ALSO HAVING RELATED PAR TY TRANSACTION TO THE EXTENT OF 19.86% AND 3.19% RESPECTIVELY. SINCE THES E RELATED PARTY TRANSACTIONS ARE NOT SIGNIFICANTLY HIGH, LOOKING IN TO THE CIRCUMSTANCES OF THE CASE, THESE COMPANIES ARE TO BE KEPT IN THE LIS T OF COMPARABLES. 4.12. ZIGMA SOFTWARE LTD.: IN THE TP REPORT OF OC TOBER, 2005, ASSESSEE ITSELF HAD SELECTED ZIGMA SOFTWARE LTD. AS A COMPAR ABLE COMPANY. IN APPENDIX F OF THE TP REPORT, UNDER THE HEADING BRI EF BUSINESS DESCRIPTION OF THE COMPARABLE COMPANY, ZIGMA SOFTWARE LTD. IS MENTIONED AS THE COMPANY IS ENGAGED IN THE BUSINESS OF EPIC, COMPUTE R AIDED DESIGN 8S ENGINEERING (CAD/ CAE), GEROGRAPHICAL INFORMATION S YSTEMS (GIS) AND SMS FOR THE CELLULAR TELECOM SECTOR. IN THE SUBMIS SION DATED 19.11.2009 ON PAGE NO. 7 AND 8, THE ASSESSEE HAS MENTIONED AS BELOW :- 2.9 THE FINAL SET OF 21 BROADLY COMPARABLE INDEPEN DENT COMPANIES OBTAINED BY THE APPELLANT ARE AS BELOW (NAME OF THE 21 COMPANIES INCLUDING ZIGMA SOFTWARE LTD. AND SUBEX SYSTEMS LTD . ARE MENTIONED) 2.10 THE ABOVE MENTIONED COMPANIES WERE SELECTED AF TER CONDUCTING A DETAILED FAR ANALYSIS OF THE COMPARABLE COMPANIES. THE FAR ANALYSIS ENABLED APPELLANT TO MAP THE ECONOMICALLY RELEVANT FACTS AND CHARACTERISTICS OF THE UNCONTROLLED TRANSACTION WIT H THAT OF THE CONTROLLED TRANSACTION AND TO SELECT APPROPRIATE COMPARABLE CO MPANIES IN ORDER TO ASCERTAIN THE ARMS LENGTH NATURE OF THE APPELLANT S INTERNATIONAL TRANSACTIONS WITH IT AES. 4.13. DURING THE COURSE OF THE TP PROCEEDINGS, THE ASSESSEE STATED BEFORE THE TPO THAT ZIGMA SOFTWARE LTD. IS NOT A COMPARABL E COMPANY DUE TO ITS PROPOSED EXPANSION PLANS IN THE FIELD OF BIOTECH. T HE TPO HAS STATED THAT THIS IS NOT A VALID REASON SINCE ANY EXPANSION PLAN AND INVESTMENT IN CAPITAL ASSETS BY AN ENTERPRISE HAVE NO BEARING ON THE CALCULATION OF 7 ITA NO. 4375/DEL/2011 OP/TC MARGINS. THE OP/TC MARGIN OF THIS COMPARABLE IS 42.26%. IT WILL ALSO BE USED AS A COMPARABLE. ASSESSEE HAS STATED IN THE STATEMENT OF FACTS FILED ALONG WITH FORM NO. 35 ON 26.07.2008 HAS STATED THAT ZIGMA SOFTWARE LTD . SHOULD BE REJECTED ON THE GROUND THAT THE COMPANY IS IN THE B USINESS OF IT ENABLE SERVICES, ADVANCE PDF FORMAT FILES PASSWORD RECOVER Y, MAPING SERVICES, ENGINEERING SERVICES AND THEREFORE ZIGMA SOFTWARE L TD. CANNOT BE CONSIDERED AS A COMPARABLE COMPANY. 4.14. I HAVE GONE THROUGH THE RECORDS AND THE SUBM ISSIONS MADE BY THE ASSESSEE. ZIGMA SOFTWARE LTD. IS A COMPARABLE T O THE ASSESSEE COMPANY FOR THE FOLLOWING REASONS 1. THIS COMPANY WAS SELECTED BY ASSESSEE AFTER CONDU CTING A DETAILED FAR ANALYSIS OF THE COMPARABLE COMPANIES. ASSESSEE KNOWS ITS FUNCTIONS, RISKS AND ASSETS BETTER THAN ANYONE ELSE. ALL THE MATERIAL FACTS REGARDING ZIGMA SOFTWARE LTD. WAS KNOWN TO TH E ASSESSEE AT THE TIME OF DOCUMENTATION. 2. AFTER CAREFULLY GOING THROUGH THE RECORDS I AM FIN DING NO SUBSTANTIAL DIFFERENCE IN THE FUNCTIONS OF THE ASSE SSEE COMPANY AND THAT OF ZIGMA SOFTWARE LTD. BOTH ARE UNDER SOFTWARE DEVELOPMENT SEGMENT. 3. COMPARABILITY ANALYSIS UNDER TNMM AS THE MOST APPR OPRIATE METHOD CANNOT BE STRETCHED TOO FAR TO SAY THAT THE COMPARABLE SHOULD DO EXACTLY SAME BUSINESS AS THAT OF THE ASSESSEE. S OFTWARE DEVELOPMENT ENCOMPASSES A BROAD AREA OF SIMILAR ACT IVITIES. 4. CHERRY PICKING IS NOT A HEALTHY TREND ON EITHER SIDE OF THE FENCE. SUMMARY OF THE TREATMENTS GIVEN TO COMPARABL ES BY THE APPELLANT 5. PLI FOR THE APPELLANT IS AT 13%. THIS CALCULATION I S NOT DISPUTED BY 8 ITA NO. 4375/DEL/2011 THE TPO. THE AVERAGE PLI OF THE COMPARABLES IS AT 1 2.11%. THEREFORE, THE INTERNATIONAL TRANSACTION OF THE APPELLANT IS A T ALP. THE CIT(A) IN ITS ORDER HAS CLEARLY SET OUT THE REA SONS WHY THE ACTION OF THE TPO IS NOT JUST AND PROPER. THEREFORE, THER E IS NO NEED TO INTERFERE WITH THE ORDER OF THE CIT(A). IT IS A DETAILED AND REASONED ORDER. THEREFORE, THE ORDER OF THE CIT(A) IS SUSTAINED. 7. IN RESULT, APPEAL OF THE REVENUE IS DISMISSED. ORDER PRONOUNCED IN THE OPEN COURT ON 06 TH NOVEMBER, 2017 . SD/- SD/- (R. K. PANDA) (SUCHITRA KAMBLE) ACCOUNTANT MEMBER JUDICIAL MEM BER DATED: 06/11/2017 R. NAHEED * COPY FORWARDED TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT(APPEALS) 5. DR: ITAT ASSISTANT REGISTRAR ITAT NEW DELHI DATE 1. DRAFT DICTATED ON 11/08/2017 PS 9 ITA NO. 4375/DEL/2011 2. DRAFT PLACED BEFORE AUTHOR 14/08/2017 PS 3. DRAFT PROPOSED & PLACED BEFORE THE SECOND MEMBER .2017 JM/AM 4. DRAFT DISCUSSED/APPROVED BY SECOND MEMBER. JM/AM 5. APPROVED DRAFT COMES TO THE SR.PS/PS 06.11.2017 PS/PS 6. KEPT FOR PRONOUNCEMENT ON PS 7. FILE SENT TO THE BENCH CLERK 0 6 .11.2017 PS 8. DATE ON WHICH FILE GOES TO THE AR 9. DATE ON WHICH FILE GOES TO THE HEAD CLERK. 10. DATE OF DISPATCH OF ORDER.