M/s. Motorola Solutions India Pvt. Ltd., Gurgaon V. ACIT, Gurgaon

ITA 5637/DEL/2011

• Counselvise Citation: 563720114 RSA 2011
• Duration Of Justice: 2 year(s) 7 month(s) 30 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 14-08-2014
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: I
• Next Hearing Date: 17-10-2013
• Assessment Year: 2007-2008
• Appeal Filed On: 15-12-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: PEEYUSH JAIN TP
• Keywords: Related party transaction; Business income; Depreciation; Transfer pricing; Opportunity of being heard; International transaction; Additional evidence; Question of law; Cost of acquisition; Bad and doubtful debts; Corroborative evidences; Avoidance of tax; Revenue expenditure; Capital expenditure
• Section: 92D; 92B; 92A; 234B; 133(6); 10B; 263; 92

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH I: NEW DELHI BEFORE SHRI S.V. MEHROTRA, ACCOUNTANT MEMBER AND SMT. DIVA SINGH, JUDICIAL MEMBER ITA NO. 5637/DEL/2011 ASSESSMENT YEAR: 2007-08 M/S MOTOROLA SOLUTIONS INDIA PRIVATE LIMITED, MEHRAULI GURGAON ROAD, GURGAON. PAN NO. AAACM9343D VS. ACIT, CIRCLE-2, 4 TH FLOOR, VANIJYA KUNJ, HSIIDC BLDG., UDYOG VIHAR, PHASE-V, NR. SHANKAR CHOWK, N.H-8. GURGAON. (APPELLANT) (RESPONDENT) APPELLANT BY: SH. HIMANSHU SHEKHAR SINHA, ADV., SH. ANKIT ARORA, CA, MS. SOMYA SETH, CA RESPONDENT BY: SH. PEEYUSH JAIN, CIT/DR (T.P) O R D E R PER S.V. MEHROTRA, A.M. THIS APPEAL FILED BY THE ASSESSEE IS DIRECTED AGAI NST THE ORDER OF LD. CIT(A)- , GURGAON, DATED 31/10/2011 FOR A.Y. 2007-08. BUSINESS PROFILE OF ASSESSEE:- 2. THE ASSESSEE, A MOTOROLA GROUP COMPANY, IS A LEA DING SUPPLIER OF MOBILE PHONES AND EQUIPMENTS FOR MOBILE BROADBAND AND AUTO MOBILE NETWORKS. THE COMPANY WAS ORIGINALLY FOUNDED AS GALVANIZING MANUF ACTURING CORPORATION IN 1928, WITH THE FIRST PRODUCT BEING THE BATTERY ELIM INATOR. 2.1 THE BUSINESS DESCRIPTION OF GROUP, AS MENTIONED IN TP REPORT, IS AS UNDER: ITA NO. 5637/D/2011 2 1) MOTOROLA INC. (GROUP COMPANIES): MOTOROLA INC. IS A COMPANY HEADQUARTERED IN SCHAUMBURG, USA, HOWEVER, ITS GROU P COMPANIES ARE SPREAD ACROSS THE WORLD. THE MAIN AREAS OF OPERATIONS OF THE MOTOROLA GROUP ARE BROADLY STRUCTURED AROUND WIRELESS, BROADBAND AND A UTOMOTIVE SOLUTIONS. MOTOROLA IS OPERATIONALLY STRUCTURED IN THE FOLLOWI NG SEGMENTS: A) CONNECTED HOME SOLUTION; MOTOROLAS CONNECTED HOME SOLUTIONS (CHS) BUSINESS IS FOCUSED AROUND BROADBAND SOLUTIONS FOR THE DELIVERY OF VOICE, VIDE O AND DATA OVER HFC NETWORKS. CHS CORE BUSINESS REVOLVES AROUND THE DE LIVERY OF DIGITAL AUDIO AND VIDEO INTERACTIVE APPLICATIONS, INTERNET ACCESS AND HIGH SPEED DATA. B) GOVERNMENT & ENTERPRISE MOBILITY SOLUTIONS ; THIS SEGMENT IS A PROVIDER OF INTEGRATED RADIO COMM UNICATIONS AND INFORMATION SOLUTIONS, WITH A FOCUS ON GOVERNMENT AND ENTERPRIS E CUSTOMERS WORLDWIDE. IT ALSO DESIGNS, MANUFACTURES AND SELLS AUTOMOTIVE AND INDUSTRIAL ELECTRONICS SYSTEMS AND TELEMATICS SYSTEMS THAT ENABLE AUTOMATE D ROADSIDE ASSISTANCE, NAVIGATIONS AND ADVANCE SAFETY FEATURES FOR AUTOMOB ILES. C) MOBILE DEVICES ; THIS SEGMENT DESIGNS, MANUFACTURES, SELLS AND SERVI CES WIRELESS SUBSCRIPTION AND SERVER EQUIPMENT FOR CELLULAR SYSTEMS AND IDRN INTEGRATED DIGITAL AND ENHANCED NETWORKS, ADVANCED MESSAGING DEVICES, PERS ONAL TWO WAY RADIOS AND A BROAD RANGE OF MOBILE DATA SERVICES, SERVERS AND SOFTWARE SOLUTIONS, PORTABLE ENERGY STORAGE PRODUCTS AND SYSTEMS, SERVE RS AND SOFTWARE SOLUTIONS AND RELATED SOFTWARE AND ACCESSORIES PRODUCTS. D) NETWORKS; MOTOROLA IS ENGAGED IN THE DESIGN, MANUFACTURE AND SALE OF END TO END CDMA AND GSM WIRELESS COMMUNICATIONS SYSTEM. E) INTEGRATED ELECTRONIC SYSTEMS SECTOR ; ITA NO. 5637/D/2011 3 THIS SEGMENT DESIGN, MANUFACTURES AND SELLS AUTOMOT IVE AND INDUSTRIAL ELECTRONICS SYSTEMS, TELEMATICS SYSTEMS THAT ENABLE AUTOMATED ROADSIDE ASSISTANCE, NAVIGATION AND ADVANCED SAFETY FEATURES FOR AUTOMOBILES, PORTABLE ENERGY STORAGE PRODUCTS AND SYSTEMS EMBEDDED COMPUT ING SYSTEMS. 1.1 MOTOROLA INDIA PVT. LTD. (MIPL) - THE ASSESSEE, MOTOROLA INDIA PVT. LTD., WAS INCORPORATED IN 1989. ITS MAJORITY SHARES ARE HELD BY MOTOROLA INTERNATIONAL CREDIT CORPORATION, USA (MICC), WHICH IS IN TURN, W HOLLY OWNED SUBSIDIARY OF MINC. MOTOROLA INDIA IS PRIMARILY ENGAGED IN THE D ISTRIBUTION OF TELE-CURRENT EQUIPMENT, MOBILE PHONES AND PROVISION OF TELE-COMM UNICATION SERVICE IN INDIA. THE COMPANY ALSO PROVIDES SOFTWARE DEVELOPMENT SERV ICES TO THE GROUP COMPANIES. ADDITIONALLY, THE COMPANY ALSO PROVIDES MARKETING AND ADMINISTRATIVE SUPPORT SERVICES TO ITS GROUP COMPAN IES. 1.2 SHAREHOLDING PATTERN : 30% 65% 3% 1% 1.3 MIPLS HEADQUARTER IS AT GURGAON WITH SALES OFF ICES AT DELHI, MUMBAI AND BANGALORE. IT OPERATES ITS SOFTWARE DEVELOPMENT CE NTRE AT BANGALORE & HYDERABAD. MOTOROLA INC. (MNC) MOTOROLA INTERNATIONAL CREDIT CORP. USA WINPHORIA INC. (WINC) FO RCE COMP INC. (FINC) MOTOROLA INDIA PVT. LTD. (MIPL) ITA NO. 5637/D/2011 4 ISSUES :- 3. THE ASSESSEE E-FILED ITS RETURN OF INCOME DECLAR ING LOSS OF RS. 8,82,63,570/-. THE AO NOTICED THAT ASSESSEE HAD UN DERTAKEN FOLLOWING MAJOR INTERNATIONAL TRANSACTIONS WITH ITS ASSOCIATE ENTER PRISE (AE) DURING THE F.Y. 2006-07: A.PROVISION OF SOFTWARE DEVELOPMENT SERVICES RS.6,8 12,082,673/- B.PROVISION OF ADMINISTRATIVE AND MARKET SUPPORT SE RVICES RS.759645791/- C.DISTRIBUTION OF TELECOM EQUIPMENTS AND HANDSETS R S.22,271,592,925/- D.REIMBURSEMENT OF EXPENSES FROM GROUP COMPANIES RS .9,10,352/-. 3.1 THE AO, ACCORDINGLY, REFERRED THE MATTER TO TRA NSFER PRICING OFFICER (TPO) U/S 92CA(1) FOR DETERMINATION OF THE ARMS LENGTH P RICE OF THE INTERNATIONAL TRANSACTIONS UNDERTAKEN BY ASSESSEE. THE TPO VIDE HIS ORDER DATED 28THN OCTOBER, 2010, DETERMINED THE ARMS LENGTH PRICE OF THE AFOREMENTIONED TRANSACTIONS AND CORRESPONDING ADJUSTMENTS TO BE MA DE TO THE DECLARED PRICES, AS UNDER: NATURE OF INTERNATIONAL TRANSACTION ALP ADJUSTMENT SOFTWARE DEVELOPMENT SERVICES 7,883,525,000 107,14,42,327 ADVERTISING AND MARKET PROMOTION 179,31,42,647 179,31,42,647 ADMINISTRATIVE SUPPORT SERVICES 837,490,784 7,78,44,993 TOTAL 294,24,29,967 4. THE ASSESSEE FILED OBJECTIONS BEFORE DISPUTE RES OLUTION PANEL, WHICH, VIDE ITS ORDER DATED 20 TH SEPTEMBER, 2011, GAVE VARIOUS DIRECTIONS U/S 144C( 5). THE ITA NO. 5637/D/2011 5 AO, IN CONSEQUENCE TO THESE DIRECTIONS, MADE A TOTA L ADJUSTMENT TO THE DECLARED PRICES OF INTERNATIONAL TRANSACTIONS OF RS . 289,70,16,463/-, AS UNDER: SEGMENT ADJUSTMENT U/S 92CA (ORIGINAL) ADJUSTMENT U/S 92CA (REVISED) AMP SEGMENT 179,31,42,647 176,26,38,353 SOFTWARE DEVELOPMENT SERVICES 1,071,442,327 105,57,45,127 MARKET SUPPORT SERVICE SEGMENT 7,78,44,993 7,86,32,983 TOTAL 2,94,24,29,967 289,70,16,463 5. BEING AGGRIEVED WITH THE ORDER OF AO, THE ASSESS EE IS IN APPEAL BEFORE US AND HAS TAKEN VARIOUS GROUNDS OF APPEAL: 1. THAT ON THE FACTS AND CIRCUMSTANCES OF THE CASE, THE ASSESSMENT ORDER PASSED BY THE LD. ASSESSING OFFICER IS BAD IN LAW; 2. THAT ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE LD. AO/TRANSFER PRICING OFFICER AND LD. DRP ERRED IN HOLDING THAT T HE EXCESSIVE ADVERTISING, MARKETING AND PROMOTION (AMP) EXPENSES INCURRED B Y THE ASSESSEE IS A BRAND PROMOTION SERVICE RENDERED BY THE ASSESSEE TO ITS A SSOCIATED ENTERPRISES (AE) AND THAT THE APPELLANT SHOULD RECEIVE ADDITIONAL ARMS LENGTH PRICE (ALP) OF RS. 1,76,26,38,353/- FROM ITS ASSOCIATED ENTERPRISE FOR SUCH SERVICE. WHILE CONCLUDING AS ABOVE, THE LD. AO/TPO AND LD. DRP HAVE ERRED IN: 2.1DISREGARDING THE FACT THAT THE AMP EXPENSES INCU RRED BY THE ASSESSEE ARE TRANSACTIONS WITH DOMESTIC INDEPENDENT ENTITIES NOT COVERED BY SECTION 92 OF THE ACT AND THAT THE ANALYSIS OF DOMESTIC TRANSACTIONS WITH THI RD PARTIES, IN RESPECT OF WHICH NO REFERENCE HAS BEEN MADE TO TPO, IS BEYOND THE POWER S VESTED WITH THE TPO U/S 92CA OF THE ACT; 2.2DISREGARDING THE FACT THAT THE LD. AO FAILED TO INDEPENDENTLY APPLY HIS MIND WHILE MAKING A REFERENCE TO THE LD. TPO IN A MECHANICAL M ANNER WITHOUT RECORDING THE REASONS SHOWING THE NECESSITY AND EXPEDIENCY OF THE SAME; ITA NO. 5637/D/2011 6 2.3IGNORING THE FACT THAT ONCE THE ASSESSEES TRANS ACTIONS ARE ACCEPTED TO BE AT ARMS LENGTH AFTER APPLICATION OF TRANSACTION NET MARGIN METHOD AS THE MOST APPROPRIATE METHOD, CHALLENGING THE INDIVIDUAL ELEMENTS OF COST S (LIKE THE AMP COST) IS INCONSISTENT WITH THE PROVISIONS OF TRANSFER PRICING; 2.4IGNORING THAT THE PRICING MODEL OF THE APPELLANT WITH ITS AES IN RELATION TO ITS DISTRIBUTION ACTIVITIES SUITABLY COMPENSATES THE AP PELLANT FOR THE ALLEGED EXCESS AMP EXPENSES; 2.5COMPLETELY DISREGARDED THE FACT THAT PURSUANT TO THE GROUPS GLOBAL TRANSFER PRICING POLICY, DURING FY 2006-07, THE APPELLANT RE CEIVED AN AMOUNT OF RS. 1,506,756,362 FROM ITS AES AS A COST CREDIT/PURCHAS E PRICE ADJUSTMENT. POST SUCH CREDIT FROM ITS AES, THE OP/SALES MARGIN EARNED BY THE APPELLANT WAS HIGHER THAN THE OP/SALES MARGIN OF COMPARABLE DISTRIBUTION COMPANIE S IN INDIA; 2.6IGNORING THAT THE AMP EXPENSES ARE INCURRED BY T HE APPELLANT SOLELY FOR HIS OWN BUSINESS AND ANY BENEFIT FLOWING TO AE IS ONLY AN I NDIRECT OR INCIDENTAL BENEFIT; 2.7INCORRECTLY CONSIDERING THE TOTAL LOCAL DISTRIBU TION AND SELLING EXPENSES AS PART OF THE AMP EXPENSE FOR COMPARISON WITH THE BRIGHT LINE LIM IT, WHEREAS THE CORRECT VIEW SHOULD HAVE BEEN TO INCLUDE ONLY THE BRAND PROMOTION EXPEN SES; 2.8INCORRECTLY DETERMINING THE AMP EXPENSE AS EXCE SSIVE BY COMPARING AGAINST THE BRIGHT LINE LIMIT ARRIVED AT USING INAPPROPRIATE CO MPARABLES THAT : (I) ARE NOT OPERATING ON THE SAME LEVEL OF THE BUSINESS VALUE CHAIN AS TH AT OF THE APPELLANT; AND (II) ARE WHOLLY DISSIMILAR TO THE APPELLANT IN RESPECT OF TH E BRANDS PROMOTED BY THEM; 2.9HOLDING THAT THE ALLEGED EXCESSIVE AMP EXPENSE INCURRED BY THE APPELLANT CONSTITUTES AMP SERVICE PROVIDED TO THE OVERSEAS AES AND THEREBY ADDING A MARK-UP OVER AND ABOVE THE EXPENSE AMOUNT ON ARMS LENGTH BASIS; AND 2.10DETERMINING THE ARMS LENGTH PRICE OF THE ALLEG ED AMP SERVICE BY APPLYING A MARK-UP OF 11.11% ON THE ALLEGED EXCESSIVE AMP EX PENSE COMPUTED ON THE BASIS OF INAPPROPRIATE COMPARABLES WHICH ARE OPERATING IN BU SINESS FUNCTIONS DIFFERENT FROM THAT OF THE APPELLANT; ITA NO. 5637/D/2011 7 3. THAT THE LD. AO AND LD. TPO, ON THE FACTS AND CI RCUMSTANCES OF THE CASE AND IN LAW HAVE ERRED IN NOT FOLLOWING THE BINDING DIRECTION I SSUED BY THE LD. DRP REGARDING THE INCLUSION OF M/S SPICE MOBILITY LTD. AND M/S GENERA L SALES LTD. AS COMPARABLES OF THE APPELLANT FOR THE PURPOSE OF COMPUTING THE ARMS LE NGTH PRICE OF THE ALLEGED INTERNATIONAL TRANSACTION OF EXCESSIVE AMP EXPENS ES; 5. THAT ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE LD. AO/TPO AND LD. DRP ERRED IN ENHANCING THE INCOME OF THE APPELLANT BY RS. 7,86,32,983/- BY RE- COMPUTING THE ALP OF THE INTERNATIONAL TRANSACTIONS PERTAINING TO ADMINISTRATIVE AND MARKETING SUPPORT SERVICE BUSINESS SEGMENT OF THE A PPELLANT, AND WHILE DOING SO HAVE GROSSLY ERRED IN: 5.1 REJECTING THE ALP DETERMINED BY THE ASSESSEE UN DER THE TP DOCUMENTATION MAINTAINED BY THE ASSESSEE U/S 92D OF THE ACT READ WITH RULE 10D OF THE RULES AND ALSO UNDER THE NEW SEARCH CONDUCTED BY THE APPELLANT DUR ING THE PROCEEDINGS BEFORE THE LD. TPO WITHOUT APPRECIATING THAT NONE OF THE CONDITION S GIVEN U/S 92C(3) HAVE BEEN SATISFIED. THE AUTHORITIES HAVE ALSO ERRED IN CARR YING OUT A FRESH SEARCH BY REJECTING/MODIFYING THE FILTERS APPLIED BY THE ASSE SSEE; 5.2 DISREGARDING MULTIPLE YEAR/PRIOR YEARS DATA AS USED BY THE ASSESSEE IN THE TP DOCUMENTATION AND HOLDING THAT CURRENT YEAR (I.E. F Y 2006-07) DATA FOR THE COMPARABLE COMPANIES SHOULD HAVE BEEN USED DESPITE THE FACT TH AT THE SAME WAS NOT AVAILABLE TO THE ASSESSEE AT THE TIME OF PREPARATION OF ITS TP DOCUM ENTATION; 5.3 REJECTING COMPARABILITY ANALYSIS IN THE TP DOCU MENTATION/ASSESSEES FRESH SEARCH AND IN CONDUCTING A FRESH COMPARABILITY ANALYSIS BA SED ON APPLICATION OF THE FOLLOWING ADDITIONAL/REVISED FILTERS IN DETERMINING THE ALP F OR THE ADMINISTRATIVE AND MARKETING SUPPORT SERVICE BUSINESS SEGMENT; 5.3.1 EXCLUSION OF COMPANIES HAVING DIFFERENT FINAN CIAL YEAR ENDING (I.E. NOT MARCH 31, 2007); 5.3.2 EXCLUSION OF COMPANIES WITH DIMINISHING REVEN UES/PERSISTENT LOSSES FOR LAST THREE YEAS UPTO AND INCLUDING FY 2006-07; 5.3.3 COMPANIES HAVING OTHER OPERATING INCOME (OTHE R THAN MANUFACTURING AND TRADING INCOME) TO SALES GREATER THAN 75% WERE ACCE PTED; ITA NO. 5637/D/2011 8 AND REJECTING THE FOLLOWING FILTERS APPLIED BY THE APPELLANT IN HIS TP DOCUMENTATION/FRESH SEARCH: 5.3.4 COMPANIES HAVING OTHER OPERATING INCOME (OTHE R THAN MANUFACTURING AND TRADING INCOME) TO SALES GREATER THAN 50% WERE ACCE PTED; 5.3.5 COMPANIES WITH NET WORTH LESS THAN ZERO WERE REJECTED; 5.3.6 COMPANIES HAVING RESEARCH AND DEVELOPMENT COS TS TO SALES LESS 3% WERE ACCEPTED; AND 5.3.7 COMPANIES HAVING ADVERTISING, MARKETING AND DISTRIBUTION COSTS TO SALES LESS THAN 3% WERE ACCEPTED; 5.4 INCLUDING HIGH PROFIT MAKING COMPANIES IN THE F INAL COMPARABLES SET FOR BENCH MARKING A LOW RISK CAPTIVE UNIT SUCH AS THE ASSESSE E (DISREGARDING JUDICIAL PRONOUNCEMENTS ON THE ISSUE), THUS DEMONSTRATING AN INTENTION TO ARRIVE AT A PRE- FORMULATED OPINION WITHOUT COMPLETE AND ADEQUATE AP PLICATION ON MIND WITH THE SINGLE- MINDED INTENTION OF MAKING AN ADDITION TO THE RETUR NED INCOME OF THE ASSESSEE; 5.5 INCLUDING CERTAIN COMPANIES THAT ARE NOT COMPAR ABLE TO THE ASSESSEE IN TERMS OF FUNCTIONS PERFORMED, ASSETS EMPLOYED AND RISK ASSUM ED; 5.6 RESORTING TO ARBITRARY REJECTION OF LOW-PROFIT/ LOSS MAKING COMPANIES BASED ON ERRONEOUS AND INCONSISTENT REASONS; 5.7 EXCLUDING CERTAIN COMPANIES ON ARBITRARY/FRIVOL OUS GROUNDS EVEN THOUGH THEY ARE COMPARABLE TO THE ASSESSEE IN TERMS OF THE FUNCTION S PERFORMED, ASSETS EMPLOYED AND RISK ASSUMED; 5.8 IGNORING THE BUSINESS/COMMERCIAL REALITY SINCE THE ASSESSEE IS REMUNERATED ON AN ARMS LENGTH BASIS, I.E. IT IS COMPENSATED FOR ALL ITS OPERATING COSTS PLUS A PRE-AGREED MARK-UP BASED ON A BENCHMARKING ANALYSIS, THE ASSES SEE UNDERTAKES MINIMAL BUSINESS RISKS AS AGAINST COMPARABLE COMPANIES THAT ARE FULL Y FLEDGED RISK TAKING ENTREPRENEURS, AND BY NOT ALLOWING A RISK ADJUSTMENT TO THE ASSESS EE ON ACCOUNT OF THIS FACT; AND 5.9 COMMITTING A NUMBER OF FACTUAL ERRORS IN ACCEPT -REJECT OF COMPARABLES AND/OR IN THE COMPUTATION OF THE OPERATING PROFIT MARGINS OF THE COMPARABLES; ITA NO. 5637/D/2011 9 6. THAT ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE LD.TPO AND LD. AO ERRED IN NOT FOLLOWING THE BINDING DIRECTIONS ISSUE D BY THE LD. DRP IN RESPECT OF THE FOLLOWING: (A) TO MAKE ADJUSTMENT IN THE OPERATING PROFIT MAR GINS OF THE COMPARABLES CHOSEN FOR ADMINISTRATIVE AND MARKETING SUPPORT SERVICE SE GMENT TO ACCOUNT FOR THE DIFFERENCE IN THE WORKING CAPITAL LEVELS OF THE APPELLANT AND THE COMPARABLES; (B) TO VERIFY THE CORRECT POSITION REGARDING EMPLO YEE COST TO SALES FILTER IN RESPECT OF COMPUTECH INTERNATIONAL LTD. (SOFTWARE DIVISION) ; AND (C) TO VERIFY THE CORRECT POSITION REGARDING EXPOR T EARNING FILTER IN RESPECT OF SQL STAR INTERNATIONAL LTD. (SOFTWARE DEVELOPMENT AND S ERVICES). 7. THAT ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE LD. AO AND LD. DRP ERRED IN DISALLOWING THE PROVISION FOR LIQUIDATED D AMAGES AMOUNTING TO RS. 20,15,37,175/-; 7.1 THE LD. AO AND LD. DRP ERRED BOTH ON FACTS AND IN LAW IN HOLDING THAT THE CLAIM FOR LIQUIDATED DAMAGES IS A LIABILITY OF FUTURE AND NOT LIABILITY OF PRESENT AND THUS DOES NOT REPRESENT LIABILITY FOR AY 2007-08; 7.2 WITHOUT PREJUDICE TO THE ABOVE, THE LD. AO ERRE D IN NOT FOLLOWING THE DIRECTIONS OF THE LD. DRP IN ALLOWING THE REVERSAL OF RS. 30,67,7 9,345/- OF THE PROVISION FOR LIQUIDATED DAMAGES; 8. THAT THE LD. AO AND THE LD. DRP IN COMPLETE DISR EGARD TO THE FACTS AND LEGAL POSITION ERRED IN DISALLOWING THE COMPUTER SOFTWARE EXPENSES OF RS. 1,10,00,000/- ON THE GROUND THAT THESE ARE CAPITAL IN NATURE; 8.1 WITHOUT PREJUDICE TO THE ABOVE, THE LD. AO ERRE D IN NOT FOLLOWING THE DIRECTION OF THE LD. DRP STATING THAT DEPRECIATION BE ALLOWED ON THE SOFTWARE EXPENSES; 9. THE LD. AO ERRED IN BOTH FACT AND IN LAW IN DISA LLOWING RS. 8,82,63,570/- U/S 10A & 10B ON THE GROUND THAT THE SAME WAS IN THE NATURE O F DEDUCTION AND, THEREFORE, ALLOWABLE TO THE EXTENT OF GROSS TOTAL INCOME OF RS . 8,67,60,023/-; 9.1 WITHOUT PREJUDICE TO THE ABOVE, THE LD. AO FURT HER ERRED IN RESTRICTING THE 10A/10B DEDUCTION TO THE RETURNED INCOME AND NOT FOLLOWING THE DIRECTIONS OF THE DRP TO ITA NO. 5637/D/2011 10 COMPUTE THE INCOME OF THE ASSESSEE UNIT-WISE AND AL LOW THE HIGHER DEDUCTION U/S 10A/10B THAN THAT CLAIMED IN THE RETURN; 9.2 WITHOUT PREJUDICE TO THE ABOVE, THE LD. AO HAS ERRED IN NOT INCREASING THE DEDUCTION U/S 10A/10B BY DISALLOWANCE ON ACCOUNT OF COMPUTER SOFTWARE EXPENSES; 10. THE LD. AO WHILE DETERMINING THE TAX PAYABLE ER RED IN NOT ALLOWING CREDIT OF ADVANCE TAX OF RS. 15,19,97,800/- AND TDS OF RS. 14 ,46,51,326/-; 11. THAT THE LD. AO ERRED IN FACTS AND IN LAW IN LE VYING INTEREST U/S 234D AND SEC. 244A(3) AMOUNTING TO RS. 58,59,630/- AND RS. 17,03, 000/-. 12. THE LD. AO HAS ERRED ON THE FACTS AND THE CIRCU MSTANCES OF THE CASE AND IN LAW IN ARBITRARILY INTIATING A PENALTY PROCEEDINGS U/S 271 (1)(C) AGAINST THE APPELLANT FOR FURNISHING INACCURATE PARTICULARS OF INCOME. 5.1 GROUND NO.1 IS GENERAL AND DOES NOT REQUIRE AN Y ADJUDICATION. GROUND NO.2 :- ISSUE RELATING TO AMP EXPENSES 6. BRIEF FACTS APROPOS GROUND NO. 2 ARE THAT WHILE EXAMINING THE DISTRIBUTION SEGMENTAL PROFITABILITY CHART SUBMITTED BY THE ASSE SSEE, TPO NOTICED THAT THE ASSESSEE HAD DEBITED FOLLOWING EXPENSES UNDER THE H EAD ADVERTISEMENT AND MARKET PROMOTION ACTIVITIES (IN SHORT AMP EXPENSES ) TO THE PROFIT & LOSS ACCOUNT: 1) ADVERTISEMENT AND SALES PROMOTION 1469952312/ - 2) BUSINESS MEETINGS AND CONFERENCES 182405029/- 3) DEALER COMMISSION 8,71,07,635/- TOTAL 173,95,24,976/-. THE TPO POINTED OUT THAT THIS WAS AROUND 7.385% OF THE TOTAL SALES (2355.44 CRORES) MADE BY THE ASSESSEE. HE, ACCORDINGLY, ISS UED SHOW CAUSE NOTICE TO ASSESSEE WHICH HAS BEEN REPRODUCED AT PAGES 192 TO 194 OF HIS ORDER. IN THIS NOTICE TPO, INTER-ALIA, MADE FOLLOWING OBSERVATIONS : ITA NO. 5637/D/2011 11 I) BY INCURRING THIS EXPENDITURE, THE TRADE NAME O F MOTOROLA INC. IS BEING PROMOTED. II) FROM THE TP REPORT IT IS EVIDENT THAT THERE IS NO AGREEMENT BETWEEN MOTOROLA INC., USA AND MIPL (ASSESSEE) FOR INCURRING OF ADVE RTISEMENT AND SELLING EXPENSES AND COMPENSATION FOR THE SAME. III) THE EXPENDITURE IS IN THE NATURE OF INTRA GRO UP SERVICES PROVIDED BY THE ASSESSEE COMPANY FOR WHICH NO COST OR MARK UP THERE OF HAVE BEEN RECEIVED BY THE ASSESSEE COMPANY. 6.1 THE ASSESSEES REPLY HAS BEEN SUMMARIZED AT PAG E 194 TO 195 OF HIS ORDER AS UNDER: THE POWERS OF TPO VESTED U/S 92CA(2) ARE LIMITED T O THE REFERENCE MADE TO HIM BY THE AO; ONCE THE TNMM METHOD IS APPLIED, THE TRANSACTIONS C ANNOT BE BENCHMARKED SEPARATELY. THE APPLICATION OF TNMM NE CESSARILY STIPULATES AGGREGATION OF TRANSACTION; THE AR FOR THE ASSESSEE HAS PLACED RELIANCE ON THE FOLLOWING JUDGMENTS: STAR INDIA PVT. LTD. VS. ACIT (3585/M/2006); NESTLE INDIA LTD. VS. DCIT (111 TTJ 53) AND SONY INDIA PVT. LTD. VS. DCIT (1189/DEL/2005). THE ASSESSEE PERFORMED ALL MARKETING ACTIVITIES ON ITS OWN ACCOUNT AND NOT FOR THE BENEFIT/ON BEHALF OF ITS AE. NO DIRECT BEN EFIT ACCRUED TO AE AS A RESULT OF MARKETING ACTIVITIES UNDERTAKEN BY MOTOROLA INDIA. IT WAS FURTHER SUBMITTED THAT THE ASSESSEE HAD INCURRED EXPENDITURE ON ADVERTISEM ENT AND SALES PROMOTION ITA NO. 5637/D/2011 12 IN RESPECT OF ONLY THOSE PRODUCTS IN WHICH MOTOROLA INDIA WAS DEALING AND THE EXPENDITURE WAS INCURRED WHOLLY AND EXCLUSIVELY FOR THE PURPOSE OF BUSINESS OF MOTOROLA INDIA. THE AMP EXPENDITURE IS NECESSARY AND INCURRED IN OR DINARY COURSE OF BUSINESS. AS A RESULT OF ADVERTISEMENTS AND SALES PROMOTION A CTIVITIES, THE SALE OF MOTOROLA PRODUCTS HAD INCREASED IN INDIA WHICH HAD BENEFITED THE ASSESSEE MORE THAN BECAUSE THE HOLDING COMPANY I.E., AE HAD NEVER SOLD GOODS DIRECTLY TO CUSTOMER IN INDIA. ACCORDINGLY, ULTIMATE BENEFI CIARY OF ADVERTISING AND SALE PROMOTION ACTIVITY WAS THE ASSESSEE AND NOT THE AES . MOTOROLA INDIA INCURRED EXPENSE ON ACCOUNT OF ADVER TISEMENT AND SALE PROMOTION ACTIVITIES WITH A SOLE INTENTION OF DEVEL OPING MARKETING IN INDIA FOR ITS PRODUCT. THE BUSINESS MODEL OF THE ASSESSEE IS SUCH THAT THE ASSESSEE COMPANY IS ALREADY GETTING CREDIT NOTES FOR REIMBURSEMENT IN T RADING ACCOUNT, TO SUSTAIN A CONSTANT PROFIT MARGIN. AS PER THE GROUPS GLOBAL TRANSFER POLICY, DURING FY 2006-07,THEASSESSEE RECEIVED AN AMOUNT OF RS. 1,506 ,756,362 FROM ITS AES AS A COST CREDIT/PURCHASE PRICE ADJUSTMENT. 6.2 THE TPO DISPOSED OFF THE ASSESSEES OBJECTIONS AS UNDER: 1) AS REGARDS THE FIRST OBJECTION RAISED BY THE A SSESSEE THAT TPO IS TO DETERMINE THE ALP OF THE INTERNATIONAL TRANSACTIONS ON REFERENCE BEING MADE BY THE AO TO THE TPO, THE TPO POINTED OUT THAT THE AO HAD SENT SEPARATE REFERENCE FOR AMP EXPENSES VIDE HIS LETTER DATED 19 TH OCTOBER, 2010. ITA NO. 5637/D/2011 13 2) THE TPO FURTHER POINTED OUT THAT IT WAS A MATT ER OF RECORD THAT THE AE OF THE ASSESSEE AND ITS PARENT COMPANY MOTOROLA INC. H AD ACKNOWLEDGED AN INCREASE IN ITS SALE DUE TO THE MARKETING EFFORTS O F THE ASSESSEE IN INDIA AND, THEREFORE, SINCE THE BENEFIT HAD BEEN RECEIVED BY T HE PARENT COMPANY FROM THE EFFORT OF ASSESSEE, FOR WHICH ASSESSEE HAD NOT BEEN COMPENSATED, THEREFORE, UNDER THE TRANSFER PRICING REGULATIONS, THE ARMS L ENGTH PRICE OF SUCH COMPENSATION HAD TO BE DETERMINED. HE FURTHER POIN TED OUT THAT THE ASSESSEE HAD NOT BENCH MARKED THE INTERNATIONAL TRANSACTION OF RECEIPT OF REIMBURSEMENT AND, THEREFORE, THE INTERNATIONAL TRANSACTION OF RE CEIPT OF REIMBURSEMENT HAD TO BE DETERMINED. 3) AS REGARDS THE ASSESSEES OBJECTION THAT THE BUSINESS MEETINGS AND CONFERENCES AND DEALER COMMISSION EXPENSES ARE IN NO MANNER RELATED TO BRAND BUILDING ACTIVITIES/PROMOTING BRAND NAME OF AES, THE TPO POINTED OUT THAT THE CONTENTION OF THE ASSESSEE WAS NOT BASED U PON ANY REASONING. HE FURTHER POINTED OUT THAT IT IS NOT UNDERSTANDABLE A S TO WHY A DISTRIBUTOR WOULD SPEND IN EVENTS LIKE BUSINESS MEETINGS AND CONFEREN CES BUT FOR THE PROMOTION OF ITS PRODUCTS AND BRANDS. HE POINTED OUT THAT BY INCURRING THESE EXPENSES, ASSESSEE WAS CREATING INTANGIBLES, THE FRUITS OF WH ICH, IT WAS GOING TO REAP OVER THE TIMES TO COME. SIMILARLY, HE POINTED OUT THAT THE SAME WAS THE SITUATION WITH DEALER COMMISSION. HE, ACCORDINGLY, REJECTED THIS CONTENTION OF THE ASSESSEE. 4) AS REGARDS THE LAST CONTENTION OF ASSESSEE THA T ASSESSEE COMPANY WAS ALREADY GETTING CREDIT NOTES TOWARDS REIMBURSEMENT IN TRADING ACCOUNT, TO ITA NO. 5637/D/2011 14 SUSTAIN A CONSTANT PROFIT MARGIN AS PER THE GROUPS GLOBAL TRANSFER PRICING POLICY, THE ASSESSEE RECEIVED AN AMOUNT OF RS. 1506756362/- FROM ITS AE AS A COST CREDIT/PURCHASE PRICE ADJUSTMENT, THE TPO OBSERVED AS UNDER: ANOTHER CONTENTION OF THE ASSESSEE IS REGARDING TH E GLOBAL TRANSFER PRICE POLICY OF THE GROUP. AS PER THIS POLICY, DURING FY 2006-07, THE ASSESSEE RECEIVED AN AMOUNT OF RS. 1,506,756,362/- FROM ITS AES AS A COST CREDIT/PURCHASE PRICE ADJUSTMENT. THE ASSESSEE IS TRYING TO CLAIM IT IN THE FORM OF COMPENSATION OF AMP ACTIVITIES DONE BY IT. THE CONTENTION OF THE ASSESSEE DOES NOT HAVE ANY FORCE. NOWHERE IN THE TP STUDY, IT IS MENTIONED THAT THE ASSESSEE IS RECEIVING SOME COMPENSATION FROM ITS AE IN THE FORM OF CREDIT NOTES FOR THE AMP ACTIVITIES BEING UNDERTAKEN BY TH E ASSESSEE. IT WAS ONLY DURING THE TP AUDIT PROCEEDINGS THAT WHEN THE ISSUE OF AMP WAS TAKEN UP, THE ASSESSEE STARTED CLAIMING THE CREDIT NOTES TO BE TH E COMPENSATION FOR AMP ACTIVITIES. THE ASSESSEE HAS NOT BEEN ABLE TO PROD UCE ANY DOCUMENTARY EVIDENCE IN THE FORM OF CREDIT NOTES ITSELF, OR ANY OTHER COMMUNICATION OR ANY OTHER SUPPORTING EVIDENCE TO PROVE THAT THE CREDITS RECEIVED BY THE ASSESSEE FROM ITS AE ARE THE COMPENSATION FOR AMP EXPENSES. IN FACT THE ASSESSEE ITSELF IS STATING THAT THESE ARE THE CREDITS FOR PURCHASE PRICE ADJUSTMENTS. THEREFORE, BY NO STRETCH OF IMAGINATION THE PURCHASE PRICE ADJ USTMENT CREDITS, CAN BE TAKEN AS COMPENSATION FOR AMP ACTIVITIES UNDERTAKEN BY THE ASSESSEE. THEREFORE, THE CONTENTION OF THE ASSESSEE IN THIS R EGARD IS WITHOUT ANY BASIS AND IS THEREFORE REJECTED. ITA NO. 5637/D/2011 15 6.3 THE ASSESSEES OBJECTIONS AS REGARDS COMPARABL ES SELECTED BY TPO, IN REGARD TO AMP EXPENSES, WERE DISPOSED OF AS UNDER: A. AS REGARDS CYBER MEDIA ONLINE, THE OBJECTION OF THE ASSESSEE WAS THAT THE COMPANY HAS HIGH RELATED PARTY TRANSACTION. TH E DATA ON PROWESS SHOWS THAT THE COMPANY HAS 100% OF ITS REVENUE FROM ADVE RTISEMENT ACTIVITIES. THE RPT IN THE CASE OF THIS COMPANY IS LESS THAN 25% HE NCE THIS OBJECTION IS ALSO REJECTED. THIS COMPANY WAS ITSELF TAKEN BY THE ASS ESSEE AS COMPARABLES IN ITS TRANSFER PRICING REPORT IN CLASS III CATEGORY OF TR ANSACTIONS. THERE IS NO EFFECT OF SHARED EXPENSES ON THE OPERATING RESULTS OF THE ASSESSEE, AS OBJECTED BY THE ASSESSEE AND, HENCE, THIS COMPANY IS ACCEPTED A S A COMPARABLE. B. AS REGARDS M/S ROCKMAN ADVERTISEMENT AND MARKETING INDIA LIMITED, THE ASSESSEE HAS SUBMITTED THAT THE COMPANY IS ALSO ACT IVELY INVOLVED IN OTHER RELATED ACTIVITIES SUCH AS FILM AND DOCUMENTARY PRO DUCTION. THE ASSESSEE HAS RELIED ON THE PART INFORMATION TAKEN FROM THE WEBSI TE. I HAVE EXAMINED THE DATA AVAILABLE ON THE PROWESS DATABASE AND IT IS SEEN TH AT 100% OF ITS REVENUE IS FROM ADVERTISEMENT ACTIVITIES. I, THEREFORE, REJEC T THE OBJECTIONS OF THE ASSESSEE IN THIS REGARD. THIS COMPANY IS ACCEPTED AS A COMP ARABLE. 7. ACCORDINGLY, THE TPO PROPOSED TO COMPARE AMP EXP ENSES OF THE TESTED PARTY WITH AMP EXPENSES OF OTHER COMPARABLES ENGAGE D IN DISTRIBUTION BUSINESS IN ORDER TO BENCH MARK THE COST OF INTRA-G ROUP SERVICES PROVIDED BY THE ASSESSEE COMPANY TO MOTOROLA INC. HE ADOPTED A MP EXPENSES TO SALES AS PLI RATIO FOR COMPARABILITY ANALYSIS. THE TPO REFE RRED TO FIVE COMPARABLES USED BY ASSESSEE AND POINTED OUT AS UNDER: ITA NO. 5637/D/2011 16 A) MOBILE TELECOMMUNICATION LTD. NO ANNUAL REPORT AVAILABLE FOR FY 2006-07. B) HCL INFINET LTD. NO ANNUAL REPORT AVAILABLE FO R F.Y. 2006-07. C) HCL INFOSYSTEM LTD., FROM THE ANNUAL REPORT IT WAS SEEN THAT THIS COMPANY WAS ENGAGED IN BRAND BUILDING AND WAS GETTING REIMB URSEMENT FROM THE GROUP COMPANY SO IT COULD NOT BE TAKEN AS COMPARABLE FOR THIS ANALYSIS. D) SALORA INTERNATIONAL LTD . DISCOUNT COMMISSION AND PUBLICITY RS. 79.23 LAKHS . ADVERTISEMENT AND PUBLICITY RS. 98.38 LAKHS TOTAL RS.177.61 LAKHS TOTAL SALES RS.1727.94 LAKHS ( % OF AMP TO SALES .19%) E) SHYAM TELECOM LTD. AMP EXPENSES RS. 2676364/- SALES RS. 2393579206/- (% OF AMP TO SALES 1.11%) 7.1 CONSIDERING THE AFOREMENTIONED FIVE COMPARABLES , THE TPO PROPOSED THE BRIGHT LINE PERCENTAGE OF AMP AT .65% TO SALES BEIN G AVERAGE OF THE AMP EXPENSES INCURRED BY SALORA INTERNATIONAL LTD. AND SHYAM TELECOM LTD. HE, ACCORDINGLY, PROPOSED TO TREAT 6.735% (7.385 - .65) OF THE EXPENDITURE OF THE ASSESSEE COMPANY, WHICH WORKED OUT TO RS. 158639382 /-, AS EXPENDITURE WHICH THE ASSESSEE HAD INCURRED ON ADVERTISEMENT AN D PUBLICITY FOR PROMOTING THE BRAND NAME OF MOTOROLA INC. FOR WHICH NO PAYMEN T HAD BEEN RECEIVED BY THE ASSESSEE COMPANY. IN VIEW OF THESE FACTS HE TR EATED THE EXPENDITURE ITA NO. 5637/D/2011 17 INCURRED BY ASSESSEE, OVER AND ABOVE THE BRIGHT LIN E, AS AN INTERNATIONAL TRANSACTION U/S 92B(1) READ WITH CLAUSE (V) OF SECT ION 92F. 7.2 HE FURTHER POINTED OUT THAT NO INDEPENDENT ENTE RPRISE WOULD INCUR EXPENDITURE FOR PROMOTING THE TRADE NAMES OWNED BY SOME THIRD PARTY UNLESS DULY COMPENSATED FOR SUCH EFFORTS. HE PROPOSED A MARK UP @ 13.04% ON THE AMP EXPENDITURE. 7.3 HE, ACCORDINGLY, DETERMINED THE ARMS LENGTH CO MPENSATION FOR AMP SERVICES AS UNDER: EXPENDITURE IN EXCESS OF BRIGHT LINE (A) 158,63,9 0,382 MARKUP ON ABOVE @ 13.04% (B) 20,68,52,265 TOTAL OF (A) & (B) ABOVE 179,31,42,647 7.4 THE ASSESSEE FILED OBJECTIONS BEFORE DRP AFTER CONSIDERING WHICH, DRP DIRECTED THE TPO TO EXAMINE THE ASSESSEES OBJE CTION IN REGARD TO EXCLUSION OF COMPARABLES BY TPO, AS UNDER:- AS REGARDS EXCLUSION OF SPICE MOBILITY LTD. BY T PO ON THE GROUNDS THAT IT IS PROMOTING ITS OWN BRANDS, WE HAVE CONSIDERED THE SU BMISSIONS OF ASSESSEE. ACCORDING TO ASSESSEE, SPICE BRAND IS OWNED NOT BY SPICE MOBILITY (COMPANY PROPOSED BY ASSESSEE) BUT BY SPICEORP ENTERTAINMENT LTD. SIMILARLY, LEXUS BRAND IS NOT OWNED BY GENERAL SALES LTD. (CO. PROPO SED BY ASSESSEE) BUT BY USHA SRIRAM ENTRPRISES. IN VIEW OF THE ABOVE EXPLA NATION, SPICE MOBILITY AND GENERAL SALES LTD. BEING FUNCTIONALLY SIMILAR MUST BE TAKEN AS A COMPARABLES. TPO IS DIRECTED TO INCLUDE BOTH AFTER VERIFICATION REGARDING OWNERSHIP OF BRAND. ITA NO. 5637/D/2011 18 7.5 AS REGARDS, ROCKMEN ADVERTISEMENT & MARKETING I NDIA LIMITED, THE ASSESSEE, WITH REFERENCE TO WEBSITE OF COMPANY, POI NTED OUT THAT THIS COMPANY WAS ENGAGED IN CARRYING OUT ACTIVITIES RELATING TO FILM AND, DOCUMENTARY PRODUCTION AND, THEREFORE, COULD NOT BE INCLUDED AS A COMPARABLE TO DETERMINE THE MARKUP ON THE EXCESS AMP. IT WAS FURTHER POINTE D OUT THAT THE TURNOVER OF THIS COMPANY WAS VERY LOW INASMUCH AS IT HAD BOOKED SALES REVENUE OF RS. 1.4 CRORES DURING THE SAID YEAR. AS AGAINST THIS, ALLE GED EXCESS AMP ON WHICH A MARKUP WAS PROPOSED TO BE APPLIED WAS 158 CRORES. THE ASSESSEE, RELYING ON THE DECISION IN THE CASE OF SONY INDIA, PLEADED FOR EXCLUSION OF THIS COMPARABLE. 7.6 AFTER CONSIDERING THE DIRECTIONS OF LD. DRP, TH E AO, IN HIS FINAL ORDER REVISED THE ADJUSTMENT AT RS. 176,26,38,353/-. 8. AT THE OUTSET, LD. COUNSEL FOR THE ASSESSEE FILE D BEFORE US AN APPLICATION FOR ADMISSION OF ADDITIONAL EVIDENCE WHICH IS REPRODUCE D HEREUNDER: FILING OF ADDITIONAL EVIDENCE (AS PER RULE 18(4) RE AD WITH RULE 29 OF THE ITAT RULES ADVERTISEMENT AND MARKETING PROMOTION EXPENSES (GRO UND NO. 1 OF THE APPEAL ) 1. BACKGROUND AN ADDITION OF RS. 2,17,04,89,288 HAS BEEN MADE ON ACCOUNT OF THE ORDER PASSED BY THE LD. TPO HOLDING THAT THE APPELLANT HAS INCURRED ADV ERTISING AND MARKETING PROMOTION (AMP) EXPENSES INCURRED BY THE APPELLANT IS A BRA ND PROMOTION SERVICE RENDERED BY THE APPELLANT TO ITS ASSOCIATE ENTERPRISE (AES) A ND THIS EXCESS EXPENSE OUGHT TO BE REIMBURSED BY THE PARENT OF THE APPELLANT ALONG WIT H A MARK UP THEREON. DURING THE PROCEEDINGS BEFORE THE LD. TPO, THE APPE LLANT HAD SUBMITTED THAT CERTAIN CREDIT NOTES WERE RECEIVED BY THE APPELLANT FOR NOT MEETING THE ARMS LENGTH MARK UP FOR ITS TRADING OPERATIONS AND IS IN THE NATURE OF COMP ENSATION/SUBSIDY RECEIVED BY WAY OF DISCOUNTED TRANSFER PRICE FOR PRODUCTS PURCHASED FR OM THE AES WHICH SHOULD BE TAKEN INTO ACCOUNT IN CONSIDERING THE PRESENT ISSUE OF AM P. HOWEVER, THESE INTER-COMPANY ITA NO. 5637/D/2011 19 RECEIPTS WERE NOT CONSIDERED BY THE LD. TPO. IN TH E PROCEEDINGS BEFORE THE DRP, THESE CREDIT NOTES WERE NOT DISCUSSED SINCE THE METHODOLO GY OF HOW TO COMPUTE THE ADDITION ON THE AMP EXPENSES WAS NOT CLEAR. THE HONBLE DRP NEVER ASKED THE APPELLANT TO FURNISH ANY SUPPORTING EVIDENCE IN RESPECT OF CREDI T NOTES. IN THE RECENT RULING [ITA 5140/DEL/2011] OF THE SPE CIAL BENCH OF DELHI INCOME-TAX APPELLATE TRIBUNAL (SB) IN A GROUP OF CASES INVOLVI NG SEVERAL TAXPAYERS, WITH LEAD CASE BEING THAT OF MS. L.G. ELECTRONICS INDIA PRIVATE LI MITED VS. ACIT, THE SPECIAL BENCH HAS CATEGORICALLY MENTIONED SUBSIDY ON PURCHASES AS A FACTOR TO BE TAKEN INTO ACCOUNT WHILE COMPUTING BRIGHT LINE. FOLLOWING THIS NEW DEVELOPMENT, THE APPELLANT WISHE S TO REITERATE ITS FACTS WITH ADDITIONAL EVIDENCE IN THE FORM OF SUMMARY OF CREDI T NOTES RECEIVED, SAMPLE COPIES OF THE CREDIT NOTES AND SAMPLE COPIES OF THE FOREIGN I NWARD REMITTANCE CERTIFICATES. THIS ADDITIONAL EVIDENCE GOES INTO THE ROOT OF THE MATTE R AND MAY BY ADMITTED IN THE INTEREST OF JUSTICE. 2. ADDITIONAL EVIDENCE THE APPELLANT WOULD LIKE TO BRING TO YOUR NOTICE TH AT RS. 3,465,141,270. OF CREDIT NOTES WERE RECEIVED BY THE APPELLANT IN AY 2008-09 IN ITS TRADING OPERATIONS. A SUMMARY OF CREDIT NOTES RECEIVED IN THIS REGARD ARE ENCLOSED A S ANNEXURE 1. SAMPLE COPIES OF THE CREDIT NOTES ARE ENCLOSED AS ANNEXURE 2. SAMPLE CO PIES OF THE FOREIGN INWARD REMITTANCE CERTIFICATES ISSUED BY THE BANK ON RECEI PT OF THE MONEY ARE ENCLOSED AS ANNEXURE 3. PRAYER THE APPELLANT HUMBLY PRAYS BEFORE YOUR HONOUR TO KI NDLY TAKE THE ADDITIONAL EVIDENCES ON RECORD. THANKING YOU, YOURS FAITHFULLY SD/- FOR MOTOROLA SOLUTIONS INDIA PRIVATE LIMITED (RAMADORAI RAGHUPATHY MEYOOR) (DIRECTOR) DATED: APRIL 5, 2013. ITA NO. 5637/D/2011 20 17.1 LD. COUNSEL SUBMITTED THAT THE SPL. BENCH IN L GS DECISION HAS, INTER-ALIA, RULED THAT SUBSIDY GIVEN BY THE FOREIGN AE IN ANY FORM IN CLUDING IN THE FORM OF SUBSIDIARY TOWARDS PURCHASES MADE FROM THE AE HAS TO BE OFF SE T FROM THE EXCESS AMP EXPENDITURE. 9. LD. COUNSEL FOR THE ASSESSEE RELIED ON THE DETAI LED WRITTEN SUBMISSIONS IN THIS REGARD CONTAINED IN THE PAPER BOOK. THE BASIC CONTENTION ADVANCED BY LD. COUNSEL FOR THE ASSESSEE, SH. HIMANSHU SINHA, IS TH AT AS THE PROFIT MARGIN OF THE ASSESSEE BEING 5% WAS MUCH MORE THAN THAT OF TH E INDEPENDENT COMPARABLE BEING 1%, THE ASSESSEES INTERNATIONAL T RANSACTIONS WERE AT ARMS LENGTH. LD. COUNSEL SUBMITTED THAT THE CREDIT NOTE S ISSUED BY MOTOROLA INC. FULLY REIMBURSED ANY EXPENDITURE, IF ANY, INCURRED BY ASS ESSEE BENEFITTING THE PRINCIPAL. THE CONTENTION IS BASED ON THE GUIDELINE S LAID DOWN BY SPL. BENCH IN THE CASE OF M/S LG ELECTRONICS INDIA PVT. LTD. VS. ACIT WHEREIN IT HAS BEEN, INTER-ALIA, LAID DOWN THAT IF AE HAS ,IN ANY MANNER LIKE SUBSIDY ON PURCHASES, HAS REIMBURSED THE ASSESSEE, THEN THE SAME HAS TO BE CONSIDERED FOR DETERMINING EXCESS AMP EXPENDITURE. 9.1 LD. COUNSEL SUBMITTED THAT AS PER THE TRANSFER PRICING POLICY OF THE MOTOROLA GROUP, THE COMPENSATION MODEL OF THE ASSESSEE IS ST RUCTURED IN SUCH A MANNER THAT THE REIMBURSEMENT OF ANY EXCESS THIRD PARTY EX PENSES (INCLUDING THE ALLEGED AMP EXPENSES) IS ALREADY BUILT IN THE TRANS FER PRICING ADJUSTMENT COMPENSATION RECEIVED BY THE ASSESSEE WHICH ALLOWS IT TO CONSISTENTLY EARN AN OPERATING MARGIN WHICH IS HIGHER THAN THE COMPARABL ES. IN THIS REGARD LD. COUNSEL REFERRED TO PAGE NOS. 245 TO 264 OF PAPER B OOK, WHEREIN THE METHOD OF ITA NO. 5637/D/2011 21 ADJUSTMENT IN THE TRANSFER PRICE IS PROVIDED. HE R EFERRED TO PARA 4.1 OF TRANSFER PRICING POLICY WHICH READS AS UNDER: THE DISTRIBUTOR NET MARGIN METHOD OF TRANSFER PRI CING DETERMINES TRANSFER PRICE BY REFERENCE TO BOTH A THIRD PARTY END USER PRODUCT PRICE AND A COMPARABLE DISTRIBUTION NET MARGIN. THE METHOD FOCUSES ON THE PROFITS/LOSSES GENERATED BY THE RELATED PARTY DISTRIBUTION OPERATIONS. SPECIFI CALLY, THE METHOD REQUIRES THAT A RANGE OF NET MARGINS BE GENERATED FOR COMPARABLE, UNCONTROLLED DISTRIBUTORS. A RANGE OF COMPARABLE RESULTS IS USED BECAUSE OF TH E VARIETY OF PRICE AND PROFIT OUTCOMES THAT ARISE IN ARMS LENGTH TRANSACTIONS. C OMPARABLE, UNCONTROLLED DISTRIBUTOR RESULTS ARE OBTAINED FROM PUBLISHED IND USTRY DATABASES THROUGH A SCREENING PROCESS THAT LOOKS AT THE INDUSTRY SIC CO DES AND USES THE SUBSIDIARY FUNCTIONAL ANALYSES TO DETERMINE THE COMPARABLE, UN CONTROLLED DISTRIBUTORS. FROM THE COMPARABLE RANGES WHICH ARE GENERATED,PRIC ES ARE ESTABLISHED BY THE FACTORY LEGAL ENTITY THAT AIM TO RETURN TO THE RELA TED PARTY DISTRIBUTION OPERATIONS A NET MARGIN FOR THE CURRENT YEAR THAT FALLS AT THE MIDPOINT OF THE MULTI-YEAR NET MARGIN RANGE. HOWEVER, IF THE RELATED PARTY DISTRI BUTION OPERATION HAS AN AVERAGE NET MARGIN FOR THE CURRENT YEAR PLUS THE TW O PRECEDING YEARS (THE 3 YEAR AVERAGE), WHICH IS OUTSIDE THE MULTI YEAR NET MARGIN RANGE, THEN THE CURRENT YEARS TRANSFER PRICE WILL BE SET TO MOVE T HE 3 YEAR AVERAGE CLOSER TO THE MULTI YEAR NET MARGIN RANGE, WHILE STILL KEEPING TH E CURRENT YEAR WITHIN THE NET MARGIN RANGE. 9.2 LD. COUNSEL SUBMITTED THAT THIS PLEA WAS TAKEN BEFORE TPO ALSO. IN THIS REGARD HE REFERRED TO PAGE 293 OF PAPER BOOK CONTAINING THE SUBMISSIONS ITA NO. 5637/D/2011 22 MADE BEFORE LOWER REVENUE AUTHORITIES WHEREIN IT WA S, INTER-ALIA, SUBMITTED AS UNDER: THUS, GIVEN THE FACTS OF THE PRESENT CASE, THE AS SESSEE ALREADY HAS A FAVOURABLE PRICING POLICY WITH ITS OVERSEAS GROUP C OMPANIES. ACCORDINGLY, SINCE THE PRICING MODEL OF THE COMPANY ALREADY TAKES INTO ACCOUNT THE AMP EXPENSES INCURRED BY THE INDIAN ENTITY, THE QUESTIO N OF RECOVERY OF THE SAME AGAIN FROM THE OVERSEAS GROUP COMPANIES DOES NOT AR ISE. SUCH AN ACT/ADJUSTMENT BY YOUR GOODSELF WOULD TANTAMOUNT TO CONSIDERING/SETTING OFF/RECOVERING THE SAME AMOUNT TWICE BY THE INDIAN COMPANY FROM THE OVERSEAS GROUP COMPANIES, WHICH CANNOT BE A LOGICAL CONCLUSI ON BY ANY STRETCH OF IMAGINATION. 9.3 THUS, IT WAS SUBMITTED BEFORE THE TPO THAT ASS ESSEE HAD RECEIVED MORE THAN ADEQUATE SUBSIDY AS PRICE ADJUSTMENTS BY WAY OF CREDIT NOTES AND, THEREFORE, EXCESS AMP EXPENDITURE, IF ANY, GOT ADEQ UATELY COMPENSATED BY THIS SUBSIDY. HOWEVER, THE TPO REJECTED THE ASSESSEES CONTENTION ON THE GROUND THAT THE ASSESSEE HAD NOT BEEN ABLE TO PRODUCE ANY DOCUMENTARY EVIDENCE TO PROVE THAT THE CREDIT NOTES RECEIVED BY THE ASSESSE E FROM ITS AE WERE TOWARDS COMPENSATION FOR AMP EXPENSES. LD. COUNSE, THEREFOR E, SUBMITTED THAT CREDIT NOTES NEEDS TO BE ADMITTED. HE FURTHER SUBMITTED THAT TPO SHOULD BE DIRECTED NOT TO INSIST ON ESTABLISHING DIRECT NEXUS OF CREDI T NOTES WITH THE AMP EXPENSES. IN THIS REGARD LD. COUNSEL POINTED OUT THAT IN LGS CASE IN PARA 17.4, FACTOR NO. 9, SPL. BENCH HAS MERELY LAID DOWN THAT ONE OF THE CONSIDERATIONS IS WHERE THE FOREIGN AES COMPENSATED THE INDIAN ENTITY FOR THE PROMOTION OF ITS BRAND IN ANY ITA NO. 5637/D/2011 23 FORM, SUCH AS SUBSIDY ON THE GOODS SOLD TO THE INDI AN AE, THE SAME HAS TO BE SET OFF AGAINST THE EXCESS AMP EXPENSES AND IN FACT OR 10 IT IS LAID DOWN THAT WHERE SUCH SUBSIDY IS ALLOWED BY THE FOREIGN AE, WH ETHER THE AMOUNT OF SUBSIDY IS COMMENSURATE OR NOT WITH THE EXPENSES IN CURRED BY THE INDIAN ENTITY ON THE PROMOTION OF BRAND FOR THE FOREIGN AE IS TO BE EXAMINED. HE, THEREFORE, SUBMITTED THAT IT IS NOT NECESSARY THAT THERE SHOUL D BE A DIRECT NEXUS WITH THE SUBSIDY AND AMP EXPENDITURE AND IF IT CAN BE ESTABL ISHED THAT ASSESSEE WAS DULY COMPENSATED TOWARDS THE ALLEGED EXCESS AMP EXP ENDITURE BY DEMONSTRATING THAT THE OPERATING PROFIT MARGIN TO S ALES WAS COMMENSURATE OR BETTER THAN THAT OF THE INDEPENDENT COMPARABLES THE N NO FURTHER ADDITION CAN BE MADE ON ACCOUNT OF TP ADJUSTMENT ELSE IT WOULD LEAD TO DOUBLE ADDITION. 9.4 IN SUPPORT OF HIS CONTENTIONS ,LD. COUNSEL REL IED ON THE DECISION IN THE CASE OF BMW INDIA PVT. LTD. VS. ADDL. CIT WHICH WAS FILED BEFORE US BY WAY OF ADDITIONAL SUBMISSIONS DATED 27 TH AUGUST, 2013, AFTER THE HEARING WAS OVER. IN THE PETITION THE ASSESSEE STATED AS UNDER: THE HEARING IN THE ABOVE-CAPTIONED APPEAL WAS CON CLUDED ON JULY 18, 2013 BEFORE BENCH I COMPRISING OF HONBLE MEMBERS MRS. S.V. MEHROTRA AND MS. DIVA SINGH AND THE ORDER HAS BEEN RESERVED IN THE C ASE. THE ORDER IS STILL AWAITED IN THIS MATTER. IN THE MEANTIME, I BENCH HAS DELIVERED ITS JUDGM ENT IN THE CASE OF BMW INDIA PVT. LTD. VS. ADDL. CIT (ITA NO. 5354/DEL/201 2) WHICH HAS A DIRECT BEARING ON ONE OF THE MAIN GROUNDS OF APPEAL IN THE ABOVE-CAPTIONED APPEAL. ITA NO. 5637/D/2011 24 THE APPELLANT, IS ACCORDINGLY, FILING AN APPLICATI ON ALONG WITH THE COPY OF THE BMW INDIA JUDGMENT FOR THE KIND CONSIDERATION O F THE HONBLE MEMBERS WHO HAVE HEARD OUR CASE. THE APPLICATION AND COPY OF THE SAID JUDGMENT ARE ATTACHED HEREWITH. YOUR ARE REQUESTED TO KINDLY PLACE THE APPLICATION ALONG WITH THE JUDGMENT BEFORE THE HONBLE MEMBERS SO THAT THE SAME MAY BE CONSIDERED BY THEM WHILE DECIDING THE GROUNDS WHICH STAND COVERED BY T HE SAID JUDGMENT. ADDITIONAL WRITTEN SUBMISSION AND APPLICATION TO CO NSIDER THE JUDGMENT OF BMW INDIA P. LTD. VS. ADDL. CIT (ITA NO. 5354/D/2012): 1) THAT THE HEARING IN APPEAL NO. ITA 5637/DEL/2011 FOR A.Y. 2007-08 WERE CONCLUDED ON JULY 18, 2013 AND THE ORDER WAS RESERV ED ON THAT DATE. THE MATTER IS NOW AWAITING PRONOUNCEMENT OF THE DECISIO N BY YOUR HONOURS. 2) THAT IN THE MEANTIME, THE I BENCH OF THE HONB LE INCOME TAX APPELLATE TRIBUNAL, NEW DELHI HAS PRONOUNCED ITS DECISION IN THE CASE OF BMW INDIA PVT. LTD. VS. ADDL. CIT (ITA NO. 5354/D/2012 FOR AY 2008 -09). THE SAID ORDER WAS PASSED ON AUGUST 16, 2013. 3) THE MAIN ISSUE DECIDED IN THE SAID BMW INDIA JUD GMENT IS IN RESPECT OF AMP EXPENDITURE. IN THE PRESENT APPEAL, GROUND NOS . 2.1 TO 2.10 AND 3 ARE ALSO IN RESPECT OF THE AMP ISSUE. 4) DUE TO HIGH DEGREE OF SIMILARITY OF FACTS BETWEE N OUR CASE AND THAT OF THE BMW INDIA CASE HAS A DIRECT BEARING ON THE AMP ISSU E WHICH IS PART OF GROUNDS NO. 2.1 TO 2.10 AND 3 OF OUR APPEAL. ITA NO. 5637/D/2011 25 10. AFTER CONSIDERING THE CONTENTS OF APPLICATION, IT WAS CONSIDERED NECESSARY TO HEAR BOTH THE PARTIES IN REGARD TO THE APPLICABI LITY OF DECISION TO ASSESSEES FACTS. ACCORDINGLY, ON 3 RD SEPTEMBER, 2013 THE CASE WAS RE-FIXED FOR FURTHER HEARING AFTER RECORDING FOLLOWING ORDER-SHEET NOTIN G: THE ASSESSEE HAS FILED ADDITIONAL SUBMISSIONS DT. 2 7/08/2013 ENCLOSING THEREWITH A COPY OF ORDER IN THE CASE OF BMW INDIA P. LTD. VS. ADDL. CIT (ITA NO. 5354/D/2012). THE COPY OF SUBMISSION, AS PER E NDORSEMENT ON PETITION, HAS ALSO BEEN DELIVERED TO LD. CIT(DR), BENCH-I BY ASSESSEE. THEREFORE, THE APPEAL IS POSTED FOR FURTHER HEARING AS PART-HEARD ON 26/09/2013 AT 2.30 P.M. ISSUE NOTICE TO BOTH THE PARTIES. 11. THE ASSESSEE FILED A SUMMARY OF DECISION IN BMW INDIA PVT. LTD. VS. ADDL. CIT TO DEMONSTRATE THE SIMILARITY OF FACT S BETWEEN BMW AND ASSESSEE ON THE GROUND THAT THE ASSESSEE IS THE SOLE DISTRIB UTOR OF MOBILE PHONES, TELECOM EQUIPMENT AND OTHER ANCILLARY PRODUCT MANUF ACTURED BY ITS PARENT MOTOROLA, US LIKE BMW WHICH IS ALSO A SOLE DISTRIBU TOR. 12. LD.CIT( DR) SUBMITTED THAT BEFORE TPO, THE ASS ESSEE HAD NOT FILED ANY DOCUMENTARY EVIDENCE TO SUPPORT ITS CONTENTION THAT AMP EXPENSES HAD DULY BEEN COMPENSATED BY THE ALLEGED CREDIT NOTES. HE, THEREFORE, VEHEMENTLY OPPOSED THE ADMISSION OF THESE ADDITIONAL EVIDENCES . 12.1 LD. CIT(DR) FURTHER SUBMITTED THAT IF ASSESSEE S CONTENTION IS ACCEPTED THEN IT WOULD LEAD TO AN ANOMALOUS SITUATI ON. IN THIS REGARD LD. CIT(DR) HAS FILED FOLLOWING WORKING WHICH IS REPROD UCED HEREUNDER: ITA NO. 5637/D/2011 26 SITUATION 1 WORKING OF TAXABLE INCOME RELATING TO SERVICE OF B RAND BUILDING BY INCURRING EXCESS AMP EXPENDITURE (OVER ALP OR OVER BRIGHTLINE ) LET US SAY DESCRIPTION AMT. (RS.) A SALE 2000 B ALP OR BRIGHT LINE LIMIT OF AMP EXPENDITURE @ 3% OF SALES. 60 C ACTUAL AMP EXPENDITURE BY INDIAN ENTITY. 100 D EXCESS AMP EXPENDITURE [RS. 100 LESS RS. 60] 40 E ALP MARK UP ON SERVICE OF BRAND BUILDING @ 10% ON EXCESS AMP EXPENDITURE I.E. 10% OF RS. 40 4 F TOTAL RECOVERY TO BE MADE BY INDIAN ENTITY [RS. 40 + RS. 4] 44 G TAXABLE INCOME ON A/C SERVICE OF BRAND BUILDING FOR FOREIGN AE, BY INCURRING EXCESS AMP EXPENDITURE OVER BRIGHT LINE ALP 4 SITUATION 2 EXCESS AMP SPEND [D] RS. 40 AMOUNT ACTUALLY REIMBURSED ON A/C OF SUBSIDY RE CEIVED [H] RS. 30 REMAINING AMT. TO BE RECEIVED [I] RS. 10 ALP MARKUP ON BRAND BUILDING @ 10% OF EXCESS AMP SP END HAS TO BE 10% OF RS. 40 WHICH IS RS. 4. [G]. HOWEVER, ACCORDING TO ASSESSEE, A MARK UP ON BRAND BUILDING HAS TO BE ON THE SUM OF RS. 10 WHICH @ 10% OF EXCESS AMOUNT SPENT HA S TO BE RS. 1 [J]. THUS, BY THE NON-SPECIFICATION OF PURPOSE OF SUBSID Y THE ASSESSEE HAS REDUCED THE INCOME BY RS. 3. ITA NO. 5637/D/2011 27 12.2 LD. CIT( DR) FURTHER SUBMITTED THAT DETERMINAT ION OF ARMS LENGTH PRICE IN REGARD TO AMP EXPENSES IN CASE OF DISTRIB UTORS IS SQUARELY COVERED BY THE DECISION OF LG ELECTRONICS PARA 21 PAGE 99 10 0. HE SUBMITTED THAT EACH INTERNATIONAL TRANSACTION HAS TO BE SEPARATELY EVAL UATED AS HELD IN LG ELECTRONICS CASE. LD. CIT(DR) FURTHER SUBMITTED TH AT SUBSIDY HAS BEEN GIVEN FOR SALE OF GOODS IN INDIA AND NOT FOR INTANGIBLE I TEMS LIKE BRAND BUILDING. THEREFORE, THE SUBSIDY CANNOT BE TAKEN AS GIVEN FOR DEVELOPING BRAND IN INDIA. HE SUBMITTED THAT CROSS SUBSIDIZING CONCEPT IS NOT ALLOWED IN INDIA. THE MATTER NEEDS TO BE EXAMINED BY AO. LD. CIT(DR) SUBMITTED THAT THERE HAS TO BE AN AGREEMENT BETWEEN ASSESSEE AND ITS AE REGARDING EXP ENDITURE IN CONNECTION WITH BRAND BUILDING THEN ONLY SUBSIDY COULD BE ALLO CATED. EXPRESS UNDERSTANDING REGARDING BRAND BUILDING HAD TO BE TH ERE FOR APPROPRIATING SUBSIDY. LD. CIT(DR) SUBMITTED THAT NEXUS HAS TO B E THERE WITH BRAND BUILDING BECAUSE THERE MAY BE DIFFERENT INTERNATIONAL TRANSA CTIONS AGAINST WHICH SUBSIDY MIGHT HAVE BEEN GIVEN. THEREFORE, IT IS NECESSARY THAT FACTS BE PROPERLY APPRECIATED IN ORDER TO FIND OUT AGAINST WHICH INTE RNATIONAL TRANSACTION SUBSIDY IS TO BE APPLIED. LD. CIT(DR) POINTED OUT THAT THE PROMOTION OF BRAND HAS TO BE SPECIFIC BUT IN THE PRESENT CASE THERE WAS NO SPECI FIC AGREEMENT TO THIS EFFECT. HE FURTHER POINTED OUT THAT BRAND BUILDING WAS NOT REPORTED AS A SEPARATE INTERNATIONAL TRANSACTION BY ASSESSEE. LD. CIT(DR) FURTHER SUBMITTED THAT TPO HAS DETERMINED EXCESS AMP EXPENSES AT RS. 176,26,38 ,353/- AS AGAINST WHICH SUBSIDY HAS BEEN CLAIMED OF RS. 1506756362/-. THUS, IF ASSESSEES CONTENTION IS TO BE ACCEPTED THEN ENTIRE SUBSIDY WAS TOWARDS B RAND BUILDING EXPENSES ITA NO. 5637/D/2011 28 WHICH OBVIOUSLY WAS NOT. LD.CIT( DR) FURTHER EXPLA INED WITH THE HELP OF AN EXAMPLE THAT SUPPOSING AGAINST EXCESS AMP EXPENSES OF RS. 110/- SUBSIDY OF RS. 171/- IS RECEIVED THEN DIFFERENCE MAY BE FOR SO ME OTHER TRANSACTIONS AND NOT FOR BRAND BUILDING. HE FURTHER SUBMITTED THAT THE CONCEPT OF SUBSIDY BEING BROUGHT IN BEFORE TPO IS PRIMARILY AN AFTER THOUGHT BECAUSE ONCE TPO HELD THE BRAND BUILDING AS INTERNATIONAL TRANSACTION THEN AS SESSEE CAME FORWARD WITH PLEA THAT CREDIT NOTES WERE TOWARDS BRAND BUILDING. 12.3 LD. DR FILED WRITTEN SUBMISSIONS WHICH ARE PLA CED ON RECORD AND SUBMITTED THAT THE ISSUE REGARDING AMP EXPENSES HAS TO BE DECIDED IN VIEW OF LGS DECISION AND THE DECISION IN THE CASE OF BMWS CASE HAS BEEN RENDERED KEEPING IN VIEW THE PECULIAR FACTS OBTAINING IN THA T CASE. 12.4 REGARDING LD. DRS SUBMISSION THAT EACH INTERN ATIONAL TRANSACTION HAS TO BE SEPARATELY BENCH MARKED, LD. DR HAS FILED WRI TTEN SUBMISSIONS WHICH ARE REPRODUCED HEREUNDER: THIS IS FOR THE REASON THAT LAW MANDATES THAT EAC H INTERNATIONAL TRANSACTION HAS TO BE SEPARATELY BENCH MARKED. (PLEASE REFER TO PARA 15. 1 OF THE ORDER IN THE CASE OF M/S LG ELECTRONICS INDIA P. LTD. A.Y. 2007-08, ITA NO. 514 0/D/11). THE WHOLE PARA IS RELEVANT, AND THE FIRST 5 LINES ARE INDICATIVE OF T HE DISCUSSION IN THIS PARAGRAPH,- 15.1 AT THIS STAGE, WE FEEL IT PRODUCTIVE TO HAVE A MACRO VIEW OF THE TRANSFER PRICING PROVISIONS. SECTION 92 PROVIDES THAT THE INCOME FR OM AN INTERNATIONAL TRANSACTION SHALL BE COMPUTED HAVING REGARD TO ALP. WHAT IS AN INTER NATIONAL TRANSACTION AND WHO IS AN ASSOCIATED ENTERPRISE HAS BEEN DEFINED IN SECTIONS 92B AND 92A RESPECTIVELY. THE NEED FOR SPECIFIC ATTRIBUTION OF SUBSIDY TOWARD S A SPECIFIC INTERNATIONAL TRANSACTION CAN BE UNDERSTOOD BY THE FOLLOWING EXAMPLE- ITA NO. 5637/D/2011 29 S.NO NATURES OF TRANSACTION BOOK PRICE (RS.) ARMS LENGTH PRICE (RS.), AS DETERMIN ED BY TPO REMARKS 1. IMPORT OF TV TUBES (PRICE PAID) 1,00,000 60,000 THE ASSESSEE HAS PAID EXCESS PRICE TO THE EXTENT OF RS. 40,000/- 2. AMP EXPENDITURE TOWARDS BRAND BUILDING (THAT SHOULD HAVE BEEN RECEIVED FROM AE), (A TRANSACTION NOT REPORTED BY ASSESSEE). NIL 20,000 THE ASSESSEE HAS NOT RECEIVED RS. 20,000/- FROM THE AE, THOUGH IT SHOULD HAVE RECEIVED THE SAME. 3. SUBSIDY RECEIVED 30,000 IT HAS NOT BEEN SPECIFIED, AS TO THE PURPOSE FOR WHICH SUBSIDY HAS BEEN RECEIVED. ACCORDING TO THE ASSESSEE, THE SUBSIDY IS TO BE APP LIED TO AMP EXPENDITURE. IF SUCH IS THE SITUATION THEN ALP OF AMP EXPENDITURE, ACCORDIN G TO THE ASSESSEE, WOULD BE RS. (-) 10,000/-, (RS. 20,000 BEING ALP OF AMP EXPENDITURE LESS RS. 30,000 BEING SUBSIDY). THIS IS AN ABSURD RESULT. 12.5 LD. CIT(DR) FURTHER SUBMITTED THAT FOLLOWING O BSERVATIONS IN LGS CASE ARE ALSO RELEVANT FOR THE PROPOSITION THAT EAC H TRANSACTION HAS TO BE SEPARATELY BENCH MARKED AND THE OVERALL PROFIT MARG IN IS NOT RELEVANT FOR DECIDING THIS ISSUE:- 21.1 THE LD. COUNSEL FOR THE APPELLANT STARTED H IS CONTENTIONS ON THIS POINT BY URGING IN THE VERY BEGINNING THAT NO DISALLOWANCE CAN BE M ADE OUT OF AMP EXPENSES BY BENCHMARKING THEM SEPARATELY WHEN THE OVERALL NET P ROFIT RATE DECLARED BY THE ASSESSEE IS HIGHER THAN OTHER COMPARABLE CASES. IT WAS SUBM ITTED THAT THE ASSESSEE MADE IMPORTS FROM ITS FOREIGN AE WHICH WERE SUBJECTED TO THE TP PROVISIONS UNDER THE TRANSACTIONAL ITA NO. 5637/D/2011 30 NET MARGIN METHOD (HEREINAFTER CALLED THE TNMM) AND HENCE THERE WAS NO WARRANT FOR MAKING ANY FURTHER ADDITION ON THE TRANSACTION OF B RAND BUILDING EXPENSES INCURRED BY THE ASSESSEE FOR THE FOREIGN AE. THE LD. COUNSEL S TATED THAT THE OVERALL HIGHER NET PROFIT RATE IMPLIES THAT, FIRSTLY, THERE WAS NO ADVERTISEM ENT BY THE ASSESSEE FOR THE BRAND OF THE FOREIGN AE AND SECONDLY, IF AT ALL IT WAS THERE, TH E SAME STOOD COMPENSATED BY THE FOREIGN AE IN TERMS OF SALE OF GOODS TO THE ASSESSE E AT LOWER RATES. THE SALE OF GOODS AT LOWER PRICES TO THE ASSESSEE BY THE FOREIGN AE SHOU LD BE CONSIDERED AS A QUID PRO QUO FOR THE FOREIGN BRAND BUILDING. FOR ASCERTAINING A S TO WHETHER OR NOT THE FOREIGN ENTERPRISE SOLD GOODS TO THE ASSESSEE AT A LOWER PR ICE, THE LD. AR URGED THAT THE OVERALL NET PROFIT RATE OF THE ASSESEE SHOULD BE CONSIDERED , WHICH WILL NATURALLY ABSORB THE EFFECT OF INCURRING SUCH BRAND BUILDING EXPENSES. IF THE OVERALL PROFIT RATE IS HIGHER, IT WILL MEAN THAT THE EXPENSES INCURRED BY THE ASSESSE E ON BRAND BUILDING WERE COMPENSATED BY THE FOREIGN AE IN TERMS OF LOWER PRI CE OF GOODS CHARGED FROM THE INDIAN AE, NECESSITATING NO SEPARATE FURTHER ADDITI ON ON THE ALLEGED PRESUMPTION OF THE ASSESSEE HAVING INCURRED ANY AMP EXPENSES TOWARDS B RAND BUILDING. THE LD. AR RELIED ON THE CASE OF THE HONBLE SUPREME COURT IN CIT VS. CALCUTTA DISCOUNT CO. LTD. (1973) 91 ITR 8 (SC), TO CANVASS THE VIEW THAT THE ASSESSE E CANNOT BE EXPECTED TO EARN MAXIMUM PROFIT. IT WAS SUBMITTED THAT THE ACTION O F THE REVENUE IN FIRSTLY TAXING HIGHER RATE OF NET PROFIT ON SALES AND THEREAFTER FURTHER INCREASING THE INCOME BY MAKING ADDITION ON ACCOUNT OF AMP EXPENSES, RUNS CONTRARY TO THE CARDINAL PRINCIPLE LAID DOWN IN THAT CASE. HE EXPLAIN THAT IN THAT CASE THE REV ENUE OPINED THAT THE ASSESSEE SHOULD HAVE TRANSFERRED ITS GOODS AT A HIGHER PRICE THAN T HAT DECLARED. REJECTING THIS CONTENTION, THE HONBLE SUPREME COURT CAME TO HOLD THAT ONCE A TRANSACTION IS BONA FIDE, THE PROFIT CANNOT BE COMPUTED BY TAKING MARKE T PRICE, IGNORING THE REAL PRICE FETCHED. IN THE LIGHT OF THIS JUDGMENT IT WAS CONT ENDED THAT THE ACTION OF THE REVENUE IN FIRSTLY BENCHMARKING THE NET PROFIT BY APPLYING TNM M ON THE INTERNATIONAL TRANSACTION OF IMPORTS AND THEN MAKING SEPARATE ADDITION FOR AM P EXPENSES IS AKIN TO THE STAND OF THE REVENUE IN THAT CASE, BEING THE MAXIMIZATION OF PROFIT IN ALL POSSIBLE WAYS, WHICH CANNOT BE SUSTAINED. WITH REFERENCE TO CERTAIN MAT ERIAL FROM THE PAPER BOOK, THE LD. AR SUBMITTED THAT THE ASSESSEES NET PROFIT RATE WAS B ETTER THAN CERTAIN OTHER COMPARABLE ITA NO. 5637/D/2011 31 CASES. SINCE THE OVERALL NET PROFIT OF THE ASSESSE E WAS RELATIVELY HIGHER, IT WAS PLEADED THAT NO ADDITION WAS CALLED FOR BY SEPARATELY PROCE SSING ANY ITEM OF EXPENSE INCLUDING THE AMP UNDER THE TP PROVISION. SIMILAR ARGUMENTS WERE ADVANCED BY THE LD. COUNSEL FOR SOME OF THE INTERVENERS. 21.2 PER CONTRA, THE LD. DR STRONGLY OPPOSED THIS CONTENTION BY SUBMITTING THAT THERE IS NO REQUIREMENT UNDER LAW THAT IF ONE TRANSACTION HA S BEEN SUBJECTED TO THE TRANSFER PRICING PROVISIONS BY APPLYING THE TNMM THEN NO OTH ER INTERNATIONAL TRANSACTION CAN BE SEPARATELY CONSIDERED. IT WAS ACCENTUATED THAT ALL THE INTERNATIONAL TRANSACTIONS ARE REQUIRED TO BE VIEWED INDEPENDENT OF EACH OTHER. 21.3 WE HAVE HEARD THE RIVAL SUBMISSIONS ON THIS ISSUE IN THE LIGHT OF MATERIAL PLACED BEFORE US AND PRECEDENT RELIED. THE CRUX OF THE LD . ARS SUBMISSION IN THIS REGARD IS THAT WHEN THE INTERNATIONAL TRANSACTION OF IMPORT O F RAW MATERIAL WAS SCRUTINIZED BY THE TPO UNDER TNMM AND THE OVERALL NET PROFIT OF THE AS SESSEE WAS FOUND TO BE HIGHER THAN OTHER COMPARABLES, THEN NO OTHER INTERNATIONAL TRANSACTION COULD HAVE BEEN PROCESSED UNDER THE TP PROVISIONS. THERE ARE TWO S UB-ARGUMENTS IN THIS MAIN ARGUMENT OF THE LD. AR. FIRST, THAT THE INTERNATIO NAL TRANSACTION OF IMPORT OF RAW MATERIAL HAS BEEN PROCESSED UNDER THE TNMM ON ENTIT Y LEVEL AND SECOND THAT WHEN ON DOING THIS EXERCISE, THE OVERALL NET PROFIT WAS FOU ND TO BE BETTER THAN OTHER COMPARABLES, THEN THE NO ADDITION WAS CALLED FOR BY SUBJECTING THE AMP EXPENSES TO THE TP PROVISIONS. 21.4 THERE IS A BASIC FALLACY IN THE FIRST SUB-ARGUMENT, WHICH LIES IN NOT PROPERLY APPRECIATING THE MODUS OPERANDI OF APPLYING THE TNM M. THIS METHOD PROVIDES FOR BENCHMARKING OF AN INTERNATIONAL TRANSACTION BY CON SIDERING THE OPERATING PROFIT FROM THE CONCERNED INTERNATIONAL TRANSACTION VIS--VIS C ERTAIN BASIS AS GIVEN IN RULE 10B(1)(E), BEING TOTAL COST, SALES, CAPITAL EMPLOYE D ETC. HERE IT IS SIGNIFICANT TO NOTE THE MEANING OF THE TERM TRANSACTION AS GIVEN IN RULE 10A(D). IT PROVIDES THAT: TRANSACTION INCLUDES A NUMBER OF CLOSELY LINKED TRANSACTIONS. PLURAL OF TRANSACTIONS BECOMES SINGULAR WHEN THE TRANSACTIONS ARE CLOSELY LINKED T O EACH OTHER OR ARE IDENTICAL. THESE CLOSELY LINKED TRANSACTIONS CAN BE PROCESSED AS ONE TRANSACTION UNDER ANY OF THE PRESCRIBED METHODS. IF AN INDIAN ENTERPRISE HAS MA DE SALE OF SIMILAR GOODS TO ITS ITA NO. 5637/D/2011 32 FOREIGN AE THROUGH SEVERAL INVOICES AND HAS ALSO IN CURRED SOME EXPENSES OR PAID INTEREST TO IT, IT WOULD MEAN THAT ALL THE TRANSACT IONS OF SALES ARE CLOSELY LINKED AND THESE CAN BE PROCESSED AS ONE UNIT. HOWEVER, THE T RANSACTIONS OF PAYMENT OF INTEREST OR INCURRING OF ANY OTHER EXPENSE WOULD BE REQUIRED TO BE SEPARATELY SCRUTINIZED UNDER CHAPTER-X BECAUSE THESE ARE OF A DIFFERENT NATURE V IS--VIS THE TRANSACTIONS OF SALES. 21.5 IT IS UNDISPUTED THAT UNDER THE TNMM, IT IS ALWAYS THE OPERATING PROFIT FROM THE CONCERNED INTERNATIONAL TRANSACTION THAT IS VIEWED IN RELATION TO THE TOTAL COST, SALES OR CAPITAL EMPLOYED ETC. OF THAT INTERNATIONAL TRANSAC TION. IT IS NOT AS IF THE PERCENTAGE OF THE MARGIN IS TO BE DETERMINED BY CONSIDERING THE N ET PROFIT OF THE ENTITY IN RELATION TO THE TOTAL SALES OF THE ENTITY. WHEN WE CONSIDER OP ERATING PROFIT TO TOTAL COSTS OF AN INTERNATIONAL TRANSACTIONS, ALL THE ITEMS OF NON-OP ERATING EXPENSES AND NON-OPERATING INCOME QUA SUCH INTERNATIONAL TRANSACTION ARE LIABL E TO BE EXCLUDED. THE CORRECT APPROACH UNDER THE TNMM IS TO CONSIDER THE OPERATIN G PROFIT FROM EACH INTERNATIONAL TRANSACTION IN RELATION TO THE TOTAL COST OR SALES OR CAPITAL EMPLOYED ETC. OF SUCH INTERNATIONAL TRANSACTION AND NO THE NET PROFIT, TO TAL COSTS, SALES, CAPITAL EMPLOYED OF THE ASSESSEE AS A WHOLE ON ENTITY LEVEL. SECTION 9 2C UNEQUIVOCALLY PROVIDES THAT THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION S HALL BE DETERMINED BY ANY OF THE PRESCRIBED METHODS. IN TURN, RULE 10B(1)(E) ALSO T ALKS OF THE NET PROFIT MARGIN REALIZED BY THE ENTERPRISE FROM AN INTERNATIONAL TRANSACTI ON. WHEN THE MANDATE OF THE SECTION AND THE RELEVANT RULE IS UNAMBIGUOUS SO AS TO APPLY ON EACH TRANSACTION, AS IS APPARENT FROM THE USE OF THE ARTICLE AN, THEN THE COMPUTAT ION OF THE ALP OF AN INTERNATIONAL TRANSACTION ON THE ENTITY LEVEL IS INAPPROPRIATE. OUR CONCLUSION THAT EACH INTERNATIONAL TRANSACTION IS REQUIRED TO BE SEPARATELY SCRUTINIZE D UNDER CHAPTER X ALSO BECOMES APPARENT FROM THE LANGUAGE OF SECTION 92(3) AS DISC USSED INFRA. THUS, IT IS CLEAR THAT THE SANCTION IS FOR APPLYING THE TNMM ONLY ON A TRA NSACTIONAL LEVEL AND NOT ON ENTITY LEVEL. OF COURSE, THE TNMM CAN BE CORRECTLY APPLIE D ON ENTITY LEVEL IF ALL THE INTERNATIONAL TRANSACTIONS ARE OF SALE BY THE ASSES SEE TO ITS FOREIGN AE AND THERE IS NO OTHER TRANSACTION OF SALE TO ANY OUTSIDER AND ALSO THERE IS NO OTHER TRANSACTION OF SALE TO ANY OUTSIDER AND ALSO THERE IS NO OTHER INTERNATION AL TRANSACTION. BUT IF THERE ARE SEVERAL UNRELATED INTERNATIONAL TRANSACTIONS, AS IS THE CASE BEFORE US AND THE ASSESSEE ITA NO. 5637/D/2011 3 3 OR THE TPO HAS APPLIED THE TNMM IN A WRONG MANNER O R ENTITY LEVEL FOR TESTING ANY OF SUCH TRANSACTIONS, THEN THE REMEDY LIES IN CORRECTI NG SUCH MISTAKE RATHER THAN DRAWING LEGALLY UNSUSTAINABLE CONCLUSIONS BY TAKING SUCH MI STAKE AS A CORRECT LEGAL POSITION. 21.6. NOW WE ESPOUSE THE SECOND SUB-ARGUMENT THAT W HEN ON APPLYING THE TNMM ON ENTITY LEVEL FOR THE TRANSACTION OF IMPORT OF RAW M ATERIAL THE OVERALL NET PROFIT IS BETTER THAN OTHER COMPARABLES, THEN NO ADDITION IS CALLED FOR BY SUBJECTING THE AMP EXPENSES TO THE TP PROVISIONS. WE HAVE HELD IN AN EARLIER PA RA THAT WHEN THERE ARE DIFFERENT UNRELATED INTERNATIONAL TRANSACTIONS, THE APPLICATI ON OF TNMM ON ENTITY LEVEL FOR EXAMINING ONE OF SUCH TRANSACTIONS, IS ITSELF AN IN CORRECT APPROACH. NOTWITHSTANDING THAT, WE DEEM IT EXPEDIENT TO DEAL WITH THE ARGUMEN T OF THE LD. AR THAT IF RATE OF NET PROFIT OF THE ASSESSEE IS BETTER THAN OTHER COMPARA BLES, THEN NO ADJUSTMENT CAN BE DONE UNDER CHAPTER-X. 21.7. ON A SPECIFIC QUERY FROM THE BENCH, IT WAS AD MITTED BY THE LD. AR THAT NO ADDITION WAS MADE BY THE TPO ON ACCOUNT OFAPPLICATION OF THE TNMM ON THE IMPORTS MADE BY THE ASSESSEE FROM ITS FOREIGN AE. IN OUR CONSIDERED OPINION, THERE IS A NOTEWORTHY DIFFERENCE BETWEEN TWO SITUATIONS, VIZ., ONE WHERE THE TNMM IS WRONGLY APPLIED ON ENTITY LEVEL AND SOME ADDITION IS MADE TO THE OVERA LL NET PROFIT OF THE INDIAN AE WHILE TESTING THE INTERNATIONAL TRANSACTION OF IMPORTS OF RAW MATERIAL AND ALSO SOME FURTHER ADDITION IS MADE BY APPLYING THE TP PROVISION ON AM P EXPENSES; AND THE SITUATION IN WHICH NO ADDITION IS MADE TO THE OVERALL PROFIT ON ACCOUNT OF APPLICATION OF THE TNMM BUT AN ADDITION IS MADE BY APPLYING THE TP PROVISIO NS ON THE TRANSACTION OF AMP EXPENSES INCURRED TOWARDS BRAND BUILDING FOR THE FO REIGN AE. 21.8. WE FIND NO BAR ON THE POWER OF THE TPO IN PRO CESSING ALL INTERNATIONAL TRANSACTIONS UNDER THE TP PROVISIONS WHEN THE OVERA LL NET PROFIT EARNED BY THE ASSESSEE IS BETTER THAN OTHERS. EARNING AN OVERALL HIGHER PR OFIT RATE IN COMPARISON WITH OTHER COMPARABLE CASES CANNOT BE CONSIDERED AS A LICENCE TO THE ASSESSEE TO RECORD OTHER EXPENSES IN INTERNATIONAL TRANSACTIONS WITHOUT CONS IDERING THE BENEFIT, SERVICE OR FACILITY OUT OF SUCH EXPENSES AT ARMS L ENGTH. ALL THE TRANSACTIONS ARE TO BE SEPARATELY VIEWED. THIS POSITION CAN BE SEEN WITH A SIMPLE ILLUSTRATION. SUPPOSE AN INDIAN ENTITY IS ENGAGED IN MANUFACTURING OF SOME P RODUCTS AND ALL THE SALES ARE TO ITS ITA NO. 5637/D/2011 34 FOREIGN AE. IN SUCH INTERNATIONAL TRANSACTION, IT E ARNS ACTUAL PROFIT OF, SAY, 120/-. FURTHER SUPPOSE THE ARMS LENGTH PROFIT ON TOTAL SA LES EARNED IN COMPARABLE UNCONTROLLED TRANSACTIONS IS `100. IN SUCH A CASE, THERE CAN BE NO QUESTION OF MAKING ANY ADDITION ON ACCOUNT OF ARMS LENGTH PROFIT FROM SUCH INTERNATIONAL TRANSACTION OF SALE TO FOREIGN AE BECAUSE THE ACTUAL OVERALL PROFI T IS MORE THAN THE ARMS LENGTH PROFIT. IT MAY ALSO BE POSSIBLE THAT THE ACTUAL PROFIT OF T HE INDIAN AE WAS 140/- BUT THE AMP EXPENSES HAVE BEEN SO CLAIMED AS DEDUCTION SO AS TO INCLUDE A PART REPRESENTING BRANDING BUILDING FOR THE FOREIGN AE TO THE TUNE OF `20/-. IN SUCH A CASE, NOTWITHSTANDING THE FACT THAT THE ASSESSEES OVERAL L PROFIT AT `120/- IS MORE THAN THE ARMS LENGTH PROFIT EARNED BY COMPARABLE CASES AT ` 100/-, STILL THERE WILL BE A REQUIREMENT FOR MAKING ADJUSTMENT OF `20/- ON ACCOU NT OF ADVERTISEMENT EXPENSES INCURRED BY THE ASSESSEE TOWARDS THE BRAND BUILDING ON BEHALF OF THE FOREIGN AE. IF WE ACCEPT THE ASSESSEES CONTENTION THAT SINCE `120/-, BEING THE PROFIT DECLARED BY THE ASSESSEE FROM THE INTERNATIONAL TRANSACTION IS MORE THAN THE ARMS LENGTH PROFIT OF `100/- AND HENCE NO FURTHER ADJUSTMENT ON ACCOUN T OF AMP EXPENSES SHOULD BE MADE, THEN THE ASSESSEES INCOME WOULD STAND REDUCED TO ` 120/- AS AGAINST THE ACTUAL INCOME OF `140/-. WE FAIL TO APPRECIATE AS TO HOW THE JUDG MENT IN THE CASE OF CALCUTTA DISCOUNT CO. LTD. (SUPRA) ADVANCES THE CASE OF THE ASSESSEE. THERE CANNOT BE ANY QUARREL ON THE PROPOSITION THAT THE ASSESSEE CANNOT BE COMPELLED T O EARN MAXIMUM PROFIT. AS IT IS THE REAL PROFIT WHICH IS TO BE TAXED AND THE ASSESSEE C ANNOT BE EXPECTED TO EARN MAXIMUM PROFIT, IN THE SAME WAY, THE ASSESSEE CANNOT BE ALL OWED TO REDUCE ITS REAL PROFIT BY INCLUDING CERTAIN EXPENSES WHICH ARE FOR THE BENEFI T OF THE FOREIGN AE. 21.9. IT IS PERTINENT TO NOTE THAT PRESENTLY WE ARE DEALING WITH A CASE IN WHICH THE MAJORITY OF THE ASSESSEES SALES IS TO INDIAN CUSTO MERS. NATURALLY THE TP PROVISIONS CANNOT BE APPLIED IN RESPECT OF SALES TO INDIAN CUS TOMERS BECAUSE THESE ARE NOT INTERNATIONAL TRANSACTIONS. IN SUCH A CASE, THERE C AN BE NO BENCHMARKING OF THE PROFITS REALIZED FROM SUCH INDIAN CUSTOMERS SO AS TO FORM A PLATFORM FOR CONTENDING THAT THE TNMM HAS BEEN APPLIED ON THE OVERALL PROFITS AND HE NCE THE AMP EXPENSES SHOULD NOT BE SUBJECTED TO THE TP PROVISIONS. IN FACT, THE ASS ESSEE IS A MANUFACTURER AND ONLY RAW MATERIALS ARE IMPORTED FROM ITS FOREIGN AE. THE TRA NSACTION OF IMPORT OF RAW-MATERIAL ITA NO. 5637/D/2011 35 IS A SEPARATE INTERNATIONAL TRANSACTION LIABLE TO B E SUBJECTED TO THE TP PROVISIONS. APART FROM SUCH PURCHASE OF RAW MATERIAL, THE ASSESSEE, A S A MANUFACTURER IS ALSO REQUIRED TO INCUR SEVERAL OTHER EXPENSES ON MANUFACTURING, FINA NCING AND SELLING WHICH CONSTITUTE PART OF THE TOTAL COST OF PRODUCT ALONG WITH THE CO ST OF RAW MATERIALS. SUBJECTING THE INTERNATIONAL TRANSACTION OF PURCHASE OF RAW MATERI AL TO THE TP PROVISIONS WOULD ONLY SHOW THAT PURCHASE PRICE OF RAW-MATERIAL IS NOT UNN ECESSARILY INFLATED. IT IS SELF EVIDENT THAT NET PROFIT IS NOT DEPENDENT ONLY ON THE PURCHA SE COST. A HOST OF OTHER FACTORS CONTRIBUTE TO THE EARNING OF PROFIT. IT MAY BE POSS IBLE THAT A MANUFACTURER SUCCEEDS IN MAKING ECONOMICAL PURCHASES BUT SUFFERS SETBACK IN INCURRING OTHER EXPENSES THEREBY RESULTING INTO A COMPARATIVELY LOW PROFIT. SIMILARL Y THERE CAN BE A CONVERSE SITUATION IN WHICH THE PURCHASES ARE MADE COSTLY BUT THE ECONOMI ES IN OTHER AREAS ARE ACHIEVED THEREBY LEADING TO HIGHER PROFIT. THE CRUX IS THAT PURCHASE COST IS ONLY ONE OF SEVERAL OTHER IMPORTANT FACTORS HAVING A BEARING ON THE OVE RALL PROFIT. ALL OTHER COSTS, INCLUDING THE AMP EXPENSES ARE INDEPENDENT OF SUCH COST OF IM PORT OF RAW MATERIAL, HAVING SOME CORRELATION WITH THE OVERALL PROFIT. IN OUR CONSIDE RED OPINION THERE IS NO LOGIC IN NOT APPLYING THE TP PROVISIONS ON AMPEXPENSES, IF THE I NTERNATIONAL TRANSACTION OF IMPORT OF RAW-MATERIAL FROM THE FOREIGN AE HAS BEEN SUBJEC TED TO THE TP PROVISIONS. AS THE TRANSACTIONS OF IMPORT OF RAW-MATERIAL AND AMP EXPE NSES ARE DISTINCT FROM EACH OTHER, HAVING INDEPENDENT EFFECT ON THE OVERALL NET PROFIT OF THE INDIAN AE, BOTH ARE REQUIRED TO BE SEPARATELY PROCESSED AS PER THE TP PROVISIONS . 21.10. IT WAS ALSO CONTENDED ON BEHALF OF THE ASSES SEE THAT IF THE OVERALL PROFIT OF THE INDIAN ENTITY IS MORE THAN THE COMPARABLE CASES THE N IT SHOULD BE PRESUMED THAT THE FOREIGN ENTERPRISE SUPPLIED GOODS AT RELATIVELY LOW PRICE TO MAKE UP FOR THE AMP EXPENSES INCURRED IN INDIA TOWARDS BRAND PROMOTION. IN OUR CONSIDERED OPINION THERE ARE NO ROOTS FOR SUCH A PRESUMPTION. IN ORDER TO TA KE BENEFIT OF SUCH A CONTENTION THE ASSESSEE IS REQUIRED TO DIRECTLY PROVE THE FACT OF CHEAP PURCHASES DE HORS THE OVERALL HIGHER NET PROFIT RATE. THIS FACT CAN BE ESTABLISHE D BY DEMONSTRATING THAT THE FOREIGN AE CHARGED A SPECIALLY LOW PRICE FROM THE ASSESSEE IN COMPARISON WITH THAT CHARGED FOR THE SIMILAR GOODS SUPPLIED TO OTHER INDEPENDENT ENTITIE S DEALING WITH IT IN ITA NO. 5637/D/2011 36 INDIA OR IN CASE THERE IS NO OTHER INDEPENDENT ENTI TY IN INDIA, THEN THE PRICE CHARGED FOR SIMILAR GOODS FROM OTHER FOREIGN PARTIES. IT CAN AL SO BE PROVED BY SHOWING THAT GOODS WITH IDENTICAL FEATURES ARE AVAILABLE IN THE INDIAN MARKET AT A HIGHER PRICE. THE FACT TH AT THE ASSESSEE HAS A BETTER NET PROFIT RATE IN COMPARISON WITH OTHER COMPARABLE ENTITIES I S NOT DECISIVE IN ITSELF OF THE ASSESSEE HAVING PURCHASED THE GOODS AT A CONCESSION AL RATE FROM ITS FOREIGN AE AS A COMPENSATION FOR ITS INCURRING AMP EXPENSES TOWARDS THE PROMOTION OF THEIR BRAND. 21.11. AT THIS STAGE, IT IS RELEVANT TO NOTE SUB-SE CTION (1) OF SECTION 92, WHICH PROVIDES THAT : `ANY INCOME ARISING FROM AN INTERNATIONAL TR ANSACTION SHALL BE COMPUTED HAVING REGARD TO THE ARMS LENGTH PRICE. SIMILARLY IT IS PERTINENT TO TAKE STOCK OF SUB-SECTION (3) OF SECTION 92, WHICH PROVIDES THAT : `THE PROVI SIONS OF THIS SECTION SHALL NOT APPLY IN A CASE WHERE THE COMPUTATION OF INCOME UNDER SUBSEC TION (1) OR THE DETERMINATION OF THE ALLOWANCE FOR ANY EXPENSE OR INTEREST UNDER THA T SUB-SECTION, OR THE DETERMINATION OF ANY COST OR EXPENSE ALLOCATED OR APPORTIONED, OR , AS THE CASE MAY BE, CONTRIBUTED UNDER SUB-SECTION (2), HAS THE EFFECT OF REDUCING T HE INCOME CHARGEABLE TO TAX OR INCREASING THE LOSS, AS THE CASE MAY BE, COMPUTED O N THE BASIS OF ENTRIES MADE IN THE BOOKS OF ACCOUNT IN RESPECT OF THE PREVIOUS YEAR IN WHICH THE INTERNATIONAL TRANSACTION WAS ENTERED INTO. ON A CAREFUL PERUSAL OF SUB-SECTI ON (3) IN COMBINATION WITH SUBSECTION (1), IT TRANSPIRES THAT IF THE COMPUTATI ON OF INCOME HAVING REGARD TO ALP OF AN INTERNATIONAL TRANSACTION HAS THE EFFECT OF REDU CING THE INCOME CHARGEABLE TO TAX COMPUTED ON THE BASIS OF ENTRIES MADE IN THE BOOKS OF ACCOUNT, THEN THE PROVISIONS OF SECTION92 WILL BE IGNORED. IT CAN BE UNDERSTOOD BY WAY OF A SIMPLE EXAMPLE. IF THE ARMS LENGTH PRICE OF AN INTERNATIONAL TRANSACTION IN THE NATURE OF EXPENSE IS `100 AND THE AMOUNT OF ACTUAL EXPENSE RECORDED IN THE BOOKS OF A CCOUNT IS `80/-, THEN THE ARMS LENGTH PRICE OF SUCH EXPENSE AT `100 WILL BE IGNORE D, BECAUSE ACTING UPON SUCH ALP WILL LEAD TO LOWERING OF THE TOTAL INCOME BY `20, WHICH ISNT PERMISSIBLE AS PER SUB-SECTION (3). IF HOWEVER THE ALP OF SUCH EXPENSE TURNS OUT T O BE LOWER AT `60, THEN SUB-SECTION (1) OF SECTION 92 WILL APPLY AND THE TOTAL INCOME O F THE ASSESSEE WILL BE COMPUTED BY CONSIDERING THE ALP OF EXPENSE AT `60, MAKING A NOR THWARDS SOJOURN TO THE TOTAL INCOME BY `20. ITA NO. 5637/D/2011 37 21.12. WE HAVE NOTICED ABOVE THAT SUB-SECTION (1) O F SECTION 92 READ WITH RULE 10B REQUIRES COMPUTATION OF INCOME FROM `AN INTERNATIO NAL TRANSACTION HAVING REGARD TO ITS ARMS LENGTH PRICE. IT MEANS THAT EACH INTERNATIONA L TRANSACTION IS REQUIRED TO BE SUBJECTED TO THE TP PROVISIONS DISTINCTLY. WHAT IS RELEVANT TO NOTE ON A CONJOINT READING OF SUB-SECTION (1) AND SUB-SECTION (3) OF SECTION 9 2 IS THAT IF THERE ARE TWO DISTINCT INTERNATIONAL TRANSACTIONS AND THE DETERMINATION OF ALP IN RESPECT OF THE FIRST TRANSACTION LEADS TO AN INCREASE IN TOTAL INCOME AS PER SUB-SECTION (1) BUT NO ADJUSTMENT IS CALLED FOR IN RESPECT OF THE SECOND T RANSACTION AS PER SUB-SECTION (3) BECAUSE OF THE ALP ON THE NEGATIVE SIDE, THEN THE A LP IN RESPECT OF THE FIRST TRANSACTION SHALL BE CONSIDERED IN COMPUTING THE TOTAL INCOME, BUT THE ALP OF THE SECOND TRANSACTION SHALL BE IGNORED. THERE IS NO PROVISION WHICH PERMITS SET OFF OF NEGATIVE ADJUSTMENT WITH THE POSITIVE ADJUSTMENT TO THE INCO ME ON ACCOUNT OF DIFFERENT INTERNATIONAL TRANSACTIONS. THE OUTCOME OF BOTH THE TRANSACTIONS HAS TO BE GIVEN EFFECT DISTINCTLY. IT, THEREFORE, DIVULGES THAT TWO OR MOR E INTERNATIONAL TRANSACTIONS ARE REQUIRED TO BE SEPARATELY PROCESSED UNDER THE TP PR OVISIONS. THE CONTENTION THAT IF TNMM HAS BEEN APPLIED ON ONE INTERNATIONAL TRANSACT ION, THEN IT WOULD OUST THE JURISDICTION OF THE TPO TO PROCESS OTHER INTERNATIO NAL TRANSACTIONS UNDER CHAPTER-X, REALLY DOES NOT STAND IN THE SCHEME OF THE PROVISIO NS. FURTHER, IT THIS CONTENTION IS TAKEN TO LOGICAL CONCLUSION, THEN SUB-SECTION (3) OF SEC. 92 WILL BECOME REDUNDANT TO SOME EXTENT. 21.13. THERE IS ONE MORE WAY OF FORTIFYING OUR ABOV E CONCLUSION. TNMM IS ONE OF THE FIVE RECOGNIZED METHODS FOR DETERMINING THE ALP OF AN INTERNATIONAL TRANSACTION. SUCH ALP CAN BE DETERMINED INTER ALIA BY COMPARABLE UNCO NTROLLED PRICE (CUP) METHOD OR COST PLUS METHOD OR EVEN BY THE TNMM. ALL THE FIVE METHODS, AS PRESCRIBED UNDER SECTION 92(1) AND RULE 10B, AIM AT DETERMINING THE ALP OF AN INTERNATIONAL TRANSACTION IN ONE WAY OR THE OTHER. FIRST IS THE CUP METHOD, B Y WHICH THE PRICE CHARGED OR PAID FOR PROPERTY TRANSFERRED ETC. IN A COMPARABLE UNCON TROLLED TRANSACTION IS IDENTIFIED. SUCH PRICE IS ADJUSTED TO ACCOUNT FOR DIFFERENCES, IF ANY, BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSAC TION. THE ADJUSTED PRICE ARRIVED AT IS TAKEN AS ALP IN RESPECT OF THE PROPERTY TRANSFER RED ETC. IN THE INTERNATIONAL ITA NO. 5637/D/2011 38 TRANSACTION. IN THE LIKE MANNER ALL THE METHODS INC LUDING TNMM PROVIDE FOR DETERMINING THE ALP OF AN INTERNATIONAL TRANSACTION . THE MAIN FOCUS OF THE LD. AR WAS ON RESTRICTING THE APPLICATION OF THE PROVISION S OF CHAPTER-X TO OTHER INTERNATIONAL TRANSACTIONS WHEN ONE TRANSACTION HAS BEEN PROCESSE D UNDER THE TNMM. IT HAS BEEN ARGUED SO ON THE GROUND THAT UNDER THE TNMM, THE NE T PROFIT OF THE ENTITY IS CONSIDERED WHICH INCLUDES THE EFFECT OF ALL OTHER TRANSACTIONS ALSO. THE NATURAL CONSEQUENCE OF THE LD. ARS ARGUMENT ON THIS ISSUE IS THAT IF THE ALP OF AN INTERNATIONAL TRANSACTION IS DETERMINED BY THE TNMM THEN NO OTHER INTERNATIONAL TRANSACTION CAN BE SUBJECTED TO THE TP PROVISIONS. FROM HERE IT FOLLOWS THAT IF ANY OTHER METHOD, SUCH AS CUP OR RESALE PRICE METHOD ETC., IS APPLIED FOR DETERMINING THE ALP OF AN INTERNATIO NAL TRANSACTION, THEN THE PROCESSING OF THE OTHER INTERNATIONAL TRANSACTIONS IS PERMISSI BLE. THE IRRATIONALITY OF THE CONTENTION CAN BE MEASURED FROM THIS FACTOR ALONE. AS ALL THE FIVE METHODS ARE AIMED TOWARDS ONE END, BEING THE DETERMINATION OF ALP OF AN INTERNATI ONAL TRANSACTION, IT IS BUT NATURAL THAT THE CONSEQUENCES OF APPLICATION OF EACH SUCH M ETHOD QUA THE OTHER INTERNATIONAL TRANSACTIONS CANNOT BE VARYING. IT IS NOT POSSIBLE TO HOLD THAT IF ONE METHOD IS EMPLOYED FOR DETERMINING THE ALP OF AN INTERNATIONAL TRANSAC TION THEN IT IS OPEN TO THE TPO TO PROCESS OTHER INTERNATIONAL TRANSACTIONS THROUGH TH E TP PROVISIONS, BUT IF SOME OTHER METHOD IS SO USED, THEN ALL OTHER INTERNATIONAL TRA NSACTIONS ARE IMMUNE FROM SUCH PROCESSING. THE LD. AR COULD NOT DRAW OUR ATTENTION TOWARDS ANY SUCH PROVISION IN THE ACT. AT BEST, THE APPLICATION OF ANY METHOD INCLUDI NG TNMM SHOWS THAT THE SAID TRANSACTION IS AT ALP. IN OUR CONSIDERED OPINION, T HE REQUIREMENT OF BENCHMARKING ALL OTHER INTERNATIONAL TRANSACTIONS OF EXPENSES INCLUD ING AMP, ALSO NEEDS TO BE SCRUPULOUSLY DONE, APART FROM TESTING ONE INTERNATI ONAL TRANSACTION UNDER THE TNMM. 13. LD. COUNSEL FOR THE ASSESSEE IN HIS WRITTEN SU BMISSIONS, IN REPLY, HAS POINTED OUT AS UNDER: IT IS SUBMITTED THAT THIS CONTENTION IS BASED ON AN ERRONEOUS UNDERSTANDING OF THE IMPLICATIONS OF THE LG DECISION. THE SPECIAL BENCH IN LG DECISION HAS NOT MANDATED ITA NO. 5637/D/2011 39 THAT SUBSIDY SHOULD BE FULLY ADJUSTED AGAINST THE EXCESS AMP EXPENDITURE. IT HAS HELD THAT IT NEEDS TO BE SEEN WHETHER THE VALUE OF SUBSIDY RECEIVED BY THE ASSESSEE IN ANY FORM (INCLUDING IN THE FORM OF SUBSIDY AGAINST PURCHASES FROM AE) IS COMMENSURATE WITH THE EXCESS AMP EXPENDITURE. THEREFORE, IN C ASES WHERE THE VALUE OF SUBSIDY EXCEEDS THE EXCESS AMP EXPENDITURE, THE SET-OFF W OULD BE LIMITED TO THE VALUE OF EXCESS AMP EXPENDITURE SO THAT THE VALUE OF THIS TRANSACTION GETS REDUCED TO NIL. THE BALANCE SUBSIDY REMAINING AFTER THE SET-OFF WOULD B E AVAILABLE FOR SET-OFF/ADJUSTMENT AGAINST THE OTHER INTERNATIONAL TRANSACTION/S THAT HAVE TO BE SEPARATELY BENCHMARKED. THIS IS SHOWN IN THE TABLE BELOW: S.NO NATURE OF TRANSACTION BOOK PRICE ARMS LENGTHP RICE ALP) SUBSIDY ADJUSTED ADJUSTMENT TO THE ALP 1. IMPORT OF TV TUBES 1,00,000 60,000 10,000 30,000 2. AMP EXPENDITURE INCURRED ON BRAND BUILDING NIL 20,000 20,000 NIL TOTAL ADJUSTMENT 30,000 IT CAN BE SEEN FROM ABOVE, THAT AS PER LG DECISION, OUT OF SUBSIDY OF RS. 30,000 RECEIVED FROM THE GROUP COMPANIES, RS. 20,000 WOULD BE ADJUSTED TOWARDS EXCESS AMP EXPENDITURE. ACCORDINGLY, THE VALUE OF EXCESS AM P EXPENDITURE WOULD BE NIL AND NO ADJUSTMENT IN RESPECT OF AMP EXPENDITURE WOULD BE W ARRANTED. BALANCE SUBSIDY OF RS. 10,000 WILL BE ADJUSTED TOWARDS IMPORT PRICE, RESUL TING IN AN IMPORT PRICE OF RS. 90,000. ACCORDINGLY, ADJUSTMENT IN RESPECT OF IMPO RT TRANSACTION WOULD BE RS. 30,000 (I.E. RS. 90,000 LESS ALP OF RS. 60,000). ALTERNATIVELY, IN CASE THE ENTIRE SUBSIDY OF RS. 30 ,000 IS OFF-SET AGAINST IMPORT TRANSACTION, THEN ADJUSTMENT IN RESPECT OF IMPORT T RANSACTION WOULD BE RS. 10,000 (I.E. RS. 70,000 LESS ALP OF RS. 60,000). FURTHER, SINCE NO SUBSIDY REMAINS AFTER SETTING-OFF THE SAME WITH IMPORT VALUE, ADJUSTMENT IN RESPECT O F AMP EXPENDITURE WOULD BE RS. 20,000. THEREBY, IT WOULD RESULT IN A TOTAL ADJUST MENT OF RS. 30,000. THEREFORE, IN EITHER CASE THE AMOUNT OF ADJUSTMENT TO ALP OF THE ASSESSEE WOULD BE SAME. 14. AS REGARDS THE CIT(DR)S CONTENTION THAT THE PR ICE ADJUSTMENTS OBTAINED BY THE ASSESSEE BY WAY OF CREDIT NOTES SHOULD NOT BE T AKEN INTO ACCOUNT TO DETERMINE WHETHER THE ASSESSEE HAS BEEN ADEQUATELY COMPENSATED BY THE AE ITA NO. 5637/D/2011 40 FOR THE NON ROUTINE AMP EXPENDITURE AS THERE WAS NO FORMAL AGREEMENT BETWEEN THE AE AND THE ASSESSEE TO THE EFFECT THAT THE CREDIT NOTES WERE TOWARDS COMPENSATION FOR EXCESS OR NON-ROUTINE AMP EXPENDITURE, LD. COUNSEL SUBMITTED THAT THIS PLEA HAS BEEN SPECIFICALLY REJE CTED BY TRIBUNAL IN BMWS CASE. 14.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH THE PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. APPLICABILITY OF DECISION IN THE CASE OF BMW INDIA PVT. LTD. : 15. THE ASSESSEE HAS RELIED ON THE DECISION OF BMW INDIA PVT. LTD. VS. ADDL. CIT (ITA NO. 5354/D/2012) DATED 16 TH AUGUST, 2013. THE ASSESSEE HAS FILED FOLLOWING ADDITIONAL WRITTEN SUBMISSIONS TO C ONSIDER THE JUDGMENT OF BMW INDIA P. LTD. (SUPRA) WHILE DECIDING THE ISSUE RELA TING TO AMP ON BEHALF OF THE ASSESSEE: SUBJECT: ADDITIONAL WRITTEN SUBMISSION TO CONSIDE R THE JUDGMENT OF BMW INDIA PVT. LTD. VS. ADD!. CIT (I.T.A .NO.-5354/DEIL2012) WHILE DECIDING THE ISSUE RELATING TO ADVERTISING, MARKETING AND PROMOTION ('AMP') ON BEH ALF OF THE APPELLANT THIS IS WITH RESPECT TO MOTOROLA SOLUTIONS INDIA PR IVATE LIMITED ('MSILP') APPEAL NO. ITA 56371 DELL 2011 FOR ASSESSMENT YEAR ('AY') 2007 -08. THE HEARINGS FOR THE SAME WERE CONCLUDED ON JULY 18, 2013 AND THE ORDER WAS R ESERVED ON THAT DATE. THE MATTER IS NOW AWAITING PRONOUNCEMENT OF THE DECISION BY YOUR HONOURS. IN THE MEANTIME THE'!' BENCH OF THE HON'BLE INCOME TAX APPELLATE TRIBUNAL ('TRIBUNAL'), NEW DELHI HAS PRONOUNCED ITS DECISION IN THE CASE OF BMW INDIA PV T. LTD. VS. ADD!. CIT (I.T.A .NO.- 5354/DEI/2012 FOR AY 2008-09) ('BMW INDIA ORDER'). THE SAID ORDER WAS PASSED ON AUGUST 16,2013. YOUR HONOURS ATTENTION MAY KINDLY B E DRAWN TO THE FOLLOWING: AS MENTIONED IN THE BMW INDIA ORDER, BMW INDIA ACTE D AS A DISTRIBUTOR OF MOTOR VEHICLES AND PARTS. DURING THE YEAR UNDER CONSIDERA TION IN THE ORDER, UNDER THE TRANSACTIONAL NET MARGIN METHOD ('TNMM') APPLIED BY BMW INDIA ITS OPERATING ITA NO. 5637/D/2011 41 PROFIT MARGIN WAS HIGHER THAN THE OPERATING PROFIT MARGIN OF THE COMPARABLE COMPANIES. DURING THE TRANSFER PRICING ASSESSMENT P ROCEEDINGS, THE LD. TRANSFER PRICING OFFICER ('TPO'), HAD ALLEGED THAT BMW INDIA HAD INCURRED EXCESSIVE AMP EXPENSES VIS A VIS THE COMPARABLE COMPANIES AND THE REFORE, SHOULD HAVE BEEN REIMBURSED BY THE BMW GROUP FOR THE EXCESSIVE AMP S PEND BASED ON THE BRIGHT LINE ANALYSIS ALONG WITH A MARK-UP. THE HON'BLE DISPUTE RESOLUTION PANEL ('DRP') CONFIRMED THE ADDITIONS MADE BY THE LD. TPO. ON APPEAL BY BMW INDIA TO THE HON'BLE TRIBUNAL, THE HON'BLE TRIBUNAL PRONOUNCED ITS DECISION ON VARIOUS ISSUES RELATED TO AMP. AS ALREA DY MENTIONED ABOVE, BMW INDIA WAS A DISTRIBUTOR DURING THE YEAR CONSIDERED IN THE ORDER. ON THESE FACTS, THE HON'BLE TRIBUNAL HELD THAT THIS CASE IS DISTINGUISHABLE FRO M THE DECISION OF THE SPECIAL BENCH IN L.G. ELECTRONICS CASE ('SPECIAL BENCH') AS THE FACT UNDER CONSIDERATION IN BMW INDIA IS THE REMUNERATION MODEL OF A DISTRIBUTOR AND NOT THAT OF A LICENSED MANUFACTURER. THE RELEVANT TEXT OF THE DECISION HAS BEEN PROVIDED HER EUNDER: (PARA 6.20, PAGE 50 OF BMW INDIA ORDER): QUOTE ON EXAMINATION OF CONTEMPORARY GUIDELINES/JURISPRUD ENCE ON THE SUBJECT, WE ARE OF THE VIEW THAT A DISTRIBUTOR IS REWARDED BY THE ENTITY F OR WHOM THE DISTRIBUTOR WORKS AND THE REWARDS ARE GUARANTEED UPTO AN EXTENT AND THE RISK COMPONENT VIS-A-VIS A MANUFACTURER IS NECESSARILY VERY LESS. THE REWARDS CAN BE AND GE NERALLY ARE BASED ON PRICING ADJUSTMENTS AND CAN ALSO BE COMPENSATED OVER AND AB OVE THAT IF GREATER SERVICES ARE RENDERED AND PRICING ADJUSTMENTS HAVE NOT COVERED T HE COST OF ROUTINE SERVICES RENDERED. GENERALLY SPEAKING THE REMUNERATION MODEL FOR A DISTRIBUTOR IS REWARD-BASED AND REWARDS ARE BASED ON THE QUANTITY OF SALES. UNQUOTE THE SECOND POINT PRONOUNCED BY THE HON'BLE TRIBUNAL WAS THAT DURING THE YEAR UNDER CONSIDERATION IN THE ORDER, BMW INDIA'S OPERATING P ROFIT MARGIN WAS HIGHER THAN THAT OF THE COMPARABLES. THE COMPARABLE COMPANIES SET AN D THEIR MARGINS WERE NOT DISPUTED BY THE LD. TPO AND THE HON'BLE DRP. HENCE, THE HON'BLE TRIBUNAL HELD THAT THE COMPENSATION FOR AMP SERVICES WAS EMBEDDED IN T HE PRICING ARRANGEMENT OF THE ITA NO. 5637/D/2011 42 CONTRACT GOODS ITSELF AND THAT NO FURTHER COMPENSAT ION WAS REQUIRED TO BE MADE BY THE ASSOCIATED ENTERPRISE ('AE'). IN OTHER WORDS, BMW I NDIA HAD RECEIVED COMPENSATION FOR AMP EXPENSES THROUGH PREMIUM PRICING WHICH WAS DEMONSTRATED THROUGH ITS HIGHER PROFIT MARGINS. THE RELEVANT TEXT OF THE HON'BLE TR IBUNAL RULING IN CASE OF BMW INDIA IS PROVIDED HERE BELOW(PARA 6.25, 6.26 PAGE 53, 55 OF BMW INDIA ORDER): QUOTE WE HOLD THAT IN THE FACTS OF THE PRESENT CASE THE A SSESSEE HAS DEMONSTRATED THAT THE COMPENSATION FOR THE HIGHER SERVICES WAS EMBEDDED I N THE PRICING ARRANGEMENT OF THE CONTRACT GOODS ITSELF IT IS SEEN THAT THE COMPARABL ES IDENTIFIED BY THE ASSESSEE AND ACCEPTED BY THE TPO AS HAVING SIMILAR INTENSITY FUN CTIONS HAVE EARNED PROFIT AT THE GROSS AND NET LEVELS FAR BELOW THE PROFITS BOTH AT GROSS AND NET LEVELS AS ACHIEVED BY THE ASSESSEE. IN THE CIRCUMSTANCES AS EVIDENCED FROM RE CORD, WE ARE INCLINED TO AGREE WITH THE SUBMISSIONS ADVANCED ON BEHALF OF THE ASSESSEE THAT NO FURTHER COMPENSATION WAS REQUIRED TO BE MADE BY THE AE AS THE SAME HAS ALREA DY BEEN RECEIVED. THIRDLY, THE HON'BLE TRIBUNAL IN BMW INDIA ORDER PR OVIDED THAT BMW INDIA WAS REWARDED BY PRICE ADJUSTMENTS TO EARN PROFITS WHICH INCLUDED THE COST OF AMP WITH MARK UP. IT HELD THAT THE TAX DEPARTMENT CANNOT INS IST THAT THE MODE OF COMPENSATION RECEIVED BY BMW INDIA FROM ITS AE NECESSARILY HAD T O BE DIRECT COMPENSATION AND THAT PRICING ADJUSTMENT WAS NOT ACCEPTABLE. THE RELEVANT TEXT OF THE HON'BLE TRIBUNAL RULING IN CASE OF BMW INDIA IS PROVIDED HERE BELOW(PARA 6.27, PAGE 56 OF BMW INDIA ORDER): QUOTE THE CLAIM OF THE ASSESSEE HAS MERIT AS THE ASSESSEE WITH THE AE CAN AGREE TO BE REWARDED/ REMUNERATED BY PRICE ADJUSTMENTS TO EARN PROFITS WHICH INCLUDE THE COST OF RENDERING SERVICES WITH PROFIT. THE DEPARTMENT CANN OT INSIST IN THE ABSENCE OF ANY PROVISION UNDER THE ACT THAT THE MODE OF COMPENSATI ON TO THE ASSESSEE BY THE FOREIGN AE NECESSARILY HAS TO BE DIRECTED COMPENSATION AND PRI CING ADJUSTMENT IS NOT ACCEPTED. UNQUOTE THE HON'BLE TRIBUNAL FURTHER HELD THAT (PARA 6.26, PAGE 55 OF BMW INDIA ORDER): QUOTE ITA NO. 5637/D/2011 43 IN SUPPORT OF THE REMUNERATION MODEL OF THE ASSESSE E WHO IS A DISTRIBUTOR REWARDED BY WAY OF PRICE ADJUSTMENTS TO ENSURE PROFITABILITY UP TO MUTUALLY ACCEPTED TERMS IS A WELL- RECOGNIZED AND WELL-ACCEPTED METHOD FOR COMPENSATIN G A DISTRIBUTOR. UNQUOTE FURTHER, ON THE ISSUE OF THE MARK UP THE HON'BLE TR IBUNAL IN THE BMW INDIA ORDER HELD AS UNDER (PARA 6.28, PAGE 58 OF BMW INDIA ORDER): QUOTE WE HOLD THAT IN THE FACTS OF THE PRESENT CASE THERE WAS NO OCCASION FOR THE AE TO FURTHER COMPENSATE THE ASSESSEE FOR THE SERVICES RENDERED T OWARDS BUILDING THE BRAND OF THE AE AS THE SAME ALREADY STOOD FACTORED IN THE PRICING A DJUSTMENT OF THE CONTRACT GOODS. AS SUCH THE OCCASION TO CONSIDER THE APPLICABILITY OF MARK-UP DOES NOT ARISE. UNQUOTE THE HON'BLE TRIBUNAL, IN PARA NO. 6.27 OF THE BMW I NDIA ORDER HAS ALSO MENTIONED THAT THE SPECIAL BENCH HAS ACCEPTED THAT THERE ARE DIVER SE NATURE OF FACTS, BUSINESS MODELS AND PECULIAR TERMS AND CONDITIONS OF DIFFERENT ASSE SSES AND THERE CANNOT BE ANY STRAIGHT JACKET FORMULA. APPLICABILITY TO MSIPL AS PROVIDED IN THE DETAILED HEARINGS AND SUBMISSION S PROVIDED, MSIPL FOR THE RELEVANT YEAR UNDER CONSIDERATION ALSO ACTED AS A DISTRIBUTO R OF MOBILE HANDSETS, WALKIE-TALKIES AND TELECOM EQUIPMENT. DURING THE YEAR UNDER CONSID ERATION, UNDER THE TNMM ANALYSIS THE OPERATING PROFIT MARGIN ON SALES (OP/S ALES) OF MSIPL WAS HIGHER THAN THAT OF THE COMPARABLE COMPANIES. THIS HAS BEEN MENTIONE D IN PARA 1 OF PAGE 1 OF THE WRITTEN SUBMISSION FILED WITH YOUR HONOURS ON MAY 2 0, 2013 AND AGAIN ON PARA 5 OF PAGE 133 OF THE WRITTEN SUBMISSION FILED WITH YOUR HONOURS ON MAY 20,2013. THE LD. TPO DID NOT HAVE ANY DISPUTE RELATING TO TH E TNMM ANALYSIS CONDUCTED BY THE APPELLANT. THE ONLY DISPUTE WAS ON THE MATTER OF AM P EXPENSES. THE LD. TPO BASED ON THE BRIGHT LINE ANALYSIS HELD THAT MSIPL SHOULD HAV E BEEN REIMBURSED BY THE AE FOR THE EXCESS AMP EXPENSES INCURRED BY IT ALONG WITH A MAR K-UP. THE APPELLANT FILED AN APPEAL BEFORE THE HON'BLE TR IBUNAL. THE GROUNDS RELATED TO AMP ISSUE ARE COVERED IN GROUNDS NOS. 2.1 TO 2.10 AND 3 . (THE DETAILS HAVE BEEN MENTIONED ITA NO. 5637/D/2011 44 IN PARA 4-43 OF PAGE 2-23 OF THE WRITTEN SUBMISSION FILED WITH YOUR HONOURS ON MAY 20, 2013 AND AGAIN IN PARA 8 OF PAGE 133-138 OF THE WRI TTEN SUBMISSION FILED WITH YOUR HONOURS ON MAY 20, 2013.) IN THIS REGARD WE HUMBLY SUBMIT THAT THE DECISION I N CASE OF BMW INDIA ORDER ALSO APPLIES TO MSIPL, AS THE FACTS OF MSIPL ARE SIMILAR TO THAT IN THE BMW INDIA ORDER. HENCE, WE HUMBLY SUBMIT THAT THE DECISION RENDERED IN THE BMW CASE HAS A DIRECT BEARING ON THE AMP ISSUE. THIS HAS BEEN SUMMARIZED AS UNDER: 1.BMW INDIA IS A DISTRIBUTOR OF MOTOR VEHICLES AND RELATED PARTS. MSIPL IS ALSO A DISTRIBUTOR. HENCE, WHAT IS RELEVANT FOR CONSIDERAT ION IS THE REMUNERATION MODEL OF A DISTRIBUTOR IN BOTH THE CASES. 2.BMW INDIA'S OPERATING MARGIN WAS HIGHER THAN THAT OF THE COMPARABLES. SIMILARLY, MSIPL ALSO OPERATED AT A HIGHER NET OPERATING MARGI N THAN THAT OF THE COMPARABLES. THIS IS DEMONSTRATIVE OF THE FACT THAT THE COMPENSA TION FOR THE ALLEGED HIGHER SERVICES WAS EMBEDDED IN THE PRICING ARRANGEMENT OF THE CONT RACT GOODS ITSELF AND THAT NO ADDITIONAL REMUNERATION WAS REQUIRED FROM THE AES. IN OTHER WORDS, LIKE IT HAS BEEN HELD IN THE BMW INDIA ORDER, THE COMPENSATION FOR T HE ALLEGED EXCESS AMP EXPENSES WAS RECEIVED THROUGH PREMIUM PRICING WHICH CAN ALSO BE DEMONSTRATED THROUGH ITS HIGHER PROFIT MARGINS. IN THE BMW INDIA ORDER, THE HON'BLE TRIBUNAL HAS HE LD THAT THE DEPARTMENT CANNOT INSIST THAT PRICING ADJUSTMENT CANNOT BE ACCEPTED A S MODE OF COMPENSATION. HEREIN, IT MAY BE REITERATED, THAT MSIPL HAS ALREADY RECEIVED THE SAID PRICING ADJUSTMENT THROUGH CREDIT NOTES AS A COST CREDIT! PURCHASE PRI CE ADJUSTMENT FROM ITS AES. THIS HAS BEEN MENTIONED IN PARA NO 18 OF PAGE 11 OF THE WRIT TEN SUBMISSION FILED WITH YOUR HONOURS ON MAY 20, 2013 AND IN PARA 8(1) OF PAGE 13 4 OF THE WRITTEN SUBMISSION FILED WITH YOUR HONOURS ON MAY 20, 2013. 15.1 THUS, THE MAIN CONTENTION OF ASSESSEE IS THAT REMUNERATION MODEL IN CASE OF DISTRIBUTOR TOWARDS AMP EXPENSES IS DIFFERE NT FROM THE COMPENSATION MODEL IN CASE OF LICENSE MANUFACTURER. THEREFORE, BEFORE CONSIDERING THE ITA NO. 5637/D/2011 45 APPLICATION OF BMWS CASE TO ASSESSEES CASE, IT IS NECESSARY THAT THE BUSINESS PROFILE OF ASSESSEES CASE VIZ-A-VIZ BMWS CASE WIT H REFERENCE TO LGS SPL. BENCH CASE IS TO BE CONSIDERED. ADMITTEDLY, THE DE CISION IN THE LGS CASE HAS BEEN RENDERED IN REGARD TO AMP EXPENSES AND FOR QUA NTIFICATION OF AMP EXPENSES ALSO DETAILED GUIDELINES HAVE BEEN LAID DO WN IN THE CASE OF LG. 15.2 IN CASE OF LG ELECTRONICS BRIEF FACTS WERE AS UNDER: THE FACTUAL MATRIX OF THE CASE IS THAT L.G. ELECT RONICS INC. (HEREINAFTER CALLED AS LGK ), IS A KOREAN BASED COMPANY, ENGAGED IN THE BUSINE SS OF MANUFACTURE, SALE AND DISTRIBUTION OF ELECTRONIC PRODUCTS AND ELECTRICAL APPLIANCES SUCH AS TELEVISION, AUDIO/VIDEO EQUIPMENTS, WASHING MACHINES, REFRIGERATORS AND AIR- CONDITIONERS ETC. PURSUANT TO THE APPROVAL OF THE G OVT. OF INDIA, CONVEYED VIDE LETTER DATED 29-1-1997, LGK WAS PERMITTED TO ESTABLISH A W HOLLY OWNED SUBSIDIARY IN INDIA. L.G. ELECTRONICS INDIA PVT. LTD. (HEREINAFTER CALLE D AS LGI ), THAT IS THE ASSESSEE IN QUESTION, WAS INCORPORATED IN 1997 AS A WHOLLY OWNE D SUBSIDIARY OF LGK. AN AGREEMENT WAS ENTERED BETWEEN LGK AND LGI ON 10TH M ARCH 1997, AS PER WHICH BOTH ENTERED INTO A MUTUAL FOREIGN COLLABORATION AGREEME NT. THEREAFTER A TECHNICAL ASSISTANCE AND ROYALTY AGREEMENT WAS ENTERED INTO B ETWEEN THESE TWO ENTITIES ON 1-7- 2001 BY WHICH LGI, IN THE CAPACITY OF A LICENSEE, O BTAINED A RIGHT TO USE THE TECHNICAL INFORMATION, DESIGNS, DRAWINGS AND INDUSTRIAL PROPE RTY RIGHTS FOR THE MANUFACTURE, MARKETING, SALE AND SERVICES OF THE AG REED PRODUCTS FROM THE LGK I.E. THE LICENSOR. 16. IN ASSESSEES CASE THE FACTUAL MATRIX HAS BEEN REPRODUCED EARLIER. ASSESSEE IS PRIMARILY ENGAGED IN THE DISTRIBUTION O F TELECOM EQUIPMENT, MOBILE PHONES AND PROVISION OF TELECOMMUNICATION SERVICE I N INDIA. THE COMPANY ALSO PROVIDES SOFTWARE DEVELOPMENT SERVICES TO THE GROUP COMPANIES. ADDITIONALLY THE COMPANY ALSO PROVIDES MARKETING AND ADMINISTRAT IVE SUPPORT SERVICES TO ITS GROUP COMPANY. IN THE CASE OF BMW THE FACTUAL MATR IX WAS AS UNDER: ITA NO. 5637/D/2011 46 2.4 A PERUSAL OF THE SAME SHOWS THAT THE TPO TOOK NOTE OF THE FACTS THAT THE BMW GROUP HAS GLOBAL OPERATIONS IN 3 SEGMENTS NAMELY AU TOMOBILES, MOTORCYCLES AND FINANCIAL SERVICES. THE PARENT COMPANY OF THE GROU P IS BMW AG I.E. THE ASSOCIATED ENTERPRISE (HEREINAFTER REFERRED TO AS THE AE) WH ICH IS HEADQUARTERED IN MUNICH, GERMANY AND IS PRIMARILY ENGAGED IN THE MANUFACTURI NG OF AUTOMOBILES AND MOTORCYCLES. THE MAJOR CAR BRANDS MANUFACTURED BY BMW AG ARE STATED TO BE BMW, MINI AND ROLLS-ROYCE. THE TPO TAKES NOTE OF THE FA CT THAT THE ASSESSEE HAD UNDERTAKEN THE FOLLOWING INTERNATIONAL TRANSACTIONS: S.NO . DESCRIPTION OF TRANSACTION VALUE (IN RS.) METHOD 1. PURCHASE OF RAW MATERIAL 167,051,934 TNMM 2. PURCHASE OF TRADED VEHICLE 535,438,461 RPM 3. PURCHASE OF SPARE PARTS 18,057,016 RPM 4. PURCHASE OF FIXED ASSETS 175,346,819 CUP 5. PURCHASE OF SOFTWARE 78,880,000 CUP 6. RECEIPT OF TECHNICAL SUPPORT SERVICE 29,449,506 CUP 7. RECEIPT OF IT SUPPORT SERVICES 2,739,917 CUP 8. MARKET SURVEY EXPENSES 11,711,690 CUP 9. REIMBURSEMENT OF PERSONAL COST 17,252,074 CUP 10. REIMBURSEMENT OF EXPENSES 12,270,724 CUP 11. INTEREST OF LOAN 12,9773,291 CUP 2.5 REFERRING TO THE TRANSFER PRICING STUDY OF THE ASSESSEE, THE TPO OBSERVED THAT THE ASSESSEE DESCRIBED ITS ACTIVITIES AS THAT OF A DIST RIBUTOR. THE TPO REFERRED TO THE IMPORTATION AGREEMENT BETWEEN THE PARENT COMPANY BM W AG AND THE ASSESSEE AND OBSERVED THAT THE SAME HAD BEEN ENTERED INTO W.E.F. 01.01.2006 AND IT STATED THAT THE ASSESSEE HAD THE FOLLOWING DUTIES IN REGARD TO MARK ETING AND PROMOTION OF THE PRODUCTS OF THE PARENT COMPANY: 2.2. RESPONSIBILITY IN THE CONTRACT TERRITORY BMW INDIA REPRESENTS THE INTEREST OF BMW AG IN THE CONTRACT TERRITORY. IT IS RESPONSIBLE FOR THE SALE PROMOTION AND THE FULL UTILIZATION OF THE MARKET PO TENTIAL FOR THE CONTRACT GOODS IN THE CONTRACT TERRITORY. IT IS FURTHER RESPONSIBLE FOR ENSURING THE PROVISIO N OF THE BEST POSSIBLE CUSTOMER SERVICE AND ADEQUAT E STOCKS OF ORIGINAL BMW PARTS IN THE CONTRACT TERRIT ORY. FURTHERMORE, BMW INDIA UNDERTAKES THE FOLLOWING FUN CTIONS IN THE CONTRACT TERRITORY IN ACCORDANCE WITH THE LAWS OF THE CONTRACTING TERRITORY: ESTABLISHMENT AND SUPERVISION OF AN EFFICIENT BMW D ISTRIBUTION NETWORK; ITA NO. 5637/D/2011 47 PERFORMANCE OF AN ADEQUATE ADVERTISEMENT AND SALES PROMOTION AS WELL AS PUBLIC AND MEDIA RELATIONS. COLLECTION, EVALUATION AND COMMUNICATION OF MARKET INFORMATION TO BMW AG. 3. SCOPE OF THE ACTIVITY OF BMW INDIA 3.1 BMW INDIA WILL MEET ITS RESPONSIBILITY FOR THE PROM OTION OF SALES AND THE FULL UTILIZATION OF THE MARKET POTENTIAL FOR THE CONTRACT GOODS BY APPLYING ITS BEST EFFORTS AND ADEQUATE RESOURCES TOWARD EFFECTIVE SALES PROMOTION AND ADVERTISING FOR THE C ONTRACT GOODS INCLUDING AVAILABLE OPTIONAL EQUIPMENT AND ACCESSORIES. 16.1 FROM THE ABOVE FACTUAL MATRIX REGARDING BUSINE SS PROFILE OF THE THREE ENTITIES UNDER CONSIDERATION, IT IS QUITE EVIDENT T HAT BUSINESS PROFILE OF NONE WAS IDENTICAL. AS FAR AS BMWS CASE WAS CONCERNED, TRI BUNAL HELD THAT THE SAME WAS PREDOMINANTLY A DISTRIBUTOR OF AUTOMOBILES WIT H INSIGNIFICANT OR LOW VALUE ADDED ASSEMBLY FUNCTIONS. THEREFORE, IT WAS HELD T HAT THE DECISION IN LGS CASE WAS NOT APPLICABLE BEING DISTINGUISHABLE ON FACTS A ND ACCEPTED THE ASSESSEES CONTENTION THAT SINCE THE REMUNERATION MODEL OF THE ASSESSEE WHO WAS A DISTRIBUTOR GOT REWARDED BY WAY OF PRICE ADJUSTMENT TO ENSURE PROFITABILITY THEREFORE, NO FURTHER ADDITION WAS REQUIRED OBSERVI NG AS UNDER:- 6.27 WE ON CONSIDERATIONS OF THE CONTEMPORANEOUS I NTERNATIONAL JURISPRUDENCE WHICH SUPPORTS THE CLAIM OF THE ASSESSEE ARE OF THE VIEW THAT EVEN IF CONSIDERING THE ARGUMENTS OF THE LD. CIT DR FOR A MOMENT, THE CONTEMPORANEOUS INTERNATIONAL JURISPRUDENCE IS IGNORED EVEN THEN THE CLAIM OF THE ASSESSEE HAS MER IT AS THE ASSESSEE WITH THE AE CAN AGREE TO BE REWARDED/REMUNERATED BY PRICE ADJUSTMEN TS TO EARN PROFITS WHICH INCLUDE THE COST OF RENDERING SERVICES WITH PROFIT. THE DE PARTMENT CANNOT INSIST IN THE ABSENCE OF ANY PROVISION UNDER THE ACT THAT THE MODE OF COM PENSATION TO THE ASSESSEE BY THE FOREIGN AE NECESSARILY HAS TO BE DIRECTED COMPENSAT ION AND PRICING ADJUSTMENT IS NOT ACCEPTED. IN THE ABSENCE OF ANY SUCH RULE OR PROVI SION IN THE ACT BARING SUCH MODE, THE ASSESSEE IS FREE TO ADJUST AND APPLY ANY METHOD WHI CH IT FINDS MOST SUITABLE TO MANAGE ITS AFFAIRS. HAD IT BEEN SPECIFICALLY REQUIRED BY THE STATUTE AND THE RULES THEREUNDER ITA NO. 5637/D/2011 48 THAT THE REMUNERATION/COMPENSATION FOR THE PERFORMA NCE OF NON-ROUTINE FUNCTIONS OF A DISTRIBUTOR HAS TO NECESSARILY BE REMITTED/REIMBURS ED SEPARATELY WITH A COST PLUS THE OCCASION TO REFER AND RELY ON THE TERMS OF THEN IMP ORTATION AGREEMENT WOULD HAVE NOT ARISEN AS THE MANDATE OF THE STATUTE NECESSARILY PR EVAILS ON THE TERMS OF THE AGREEMENT ENTERED INTO BETWEEN THE PARTIES. SIMILARLY RELIAN CE ON OECD TP GUIDELINES ETC. WOULD THEN HAVE NO RELEVANCE. IN THE ABSENCE OF ANY SUCH BAR IN THE STATUTE AND THE PROVISION, WE DO NOT SEE ANY INFIRMITY IF IN THE TERMS OF THE IMPORTATION AGREEMENT, THE ASSESSEE FOR ITS FUNCTIONS PERFORMED BEYOND THE ROUTINE FUNC TIONS AS CALCULATED BY APPLYING THE BRIGHT-LINE TEST HAS BEEN COMPENSATED BY THE AE BY MAKING PRICING ADJUSTMENTS SO AS TO ENSURE THAT THE ASSESSEE IS LEFT WITH REPRESENTATIV E PROFITS AFTER MEETING IT COSTS. THE FACT THAT ASSESSEES PROFITS VIS--VIS THE COMPARAB LES WITH SIMILAR INTENSITY FUNCTIONS FAR EXCEEDS THE MEAN MARGIN OF THE COMPARABLE STANDS ES TABLISHED. THE CONTEMPORANEOUS INTERNATIONAL JURISPRUDENCE SUPPORTS THIS AND EVEN THE SPECIAL BENCH LEAVES THE ISSUE OPEN BY ACCEPTING ITS LIMITATIONS WHILE GIVING VOIC E TO THE DIVERSE NATURE OF FACTS, BUSINESS MODELS AND PECULIAR TERMS AND CONDITIONS O F DIFFERENT ASSESSEE BY OBSERVING THAT THERE CANNOT BE ANY STRAIGHT-JACKET FORMULA. 6.28 ACCORDINGLY AFTER A DETAILED ANALYSIS OF THE R ELEVANT PROVISIONS OF THE ACT, THE FAR ANALYSIS OF THE ASSESSEE, THE TERMS OF THE IMPORTAT ION AGREEMENT ENTERED INTO BY THE ASSESSEE WITH ITS AE, THE ORDERS AND JUDGMENTS RELI ED UPON AND CONSIDERED BY US IN ORDER TO DECIDE THE ISSUES AND WEIGH THE MERITS AND RELEVANCE OF THE COMPREHENSIVE ARGUMENTS MADE AT LENGTH BY BOTH THE SIDES JUXTA PO SED WITH THE FACTS AND FIGURES OF THE ASSESSEE IN THE YEAR UNDER CONSIDERATION AND THE CO MPARABLES AS ADDRESSED IN THE ORDERS AND REFERRED TO BY THE PARTIES BEFORE THE BE NCH, WE HOLD THAT IN THE FACTS OF THE PRESENT CASE THERE WAS NO OCCASION FOR THE AE TO FU RTHER COMPENSATE THE ASSESSEE FOR THE SERVICES RENDERED TOWARDS BUILDING THE BRAND OF THE AE AS THE SAME ALREADY STOOD FACTORED IN THE PRICING ADJUSTMENT OF THE CONTRACT GOODS. AS SUCH THE OCCASION TO CONSIDER THE APPLICABILITY OF MARK-UP DOES NOT ARIS E. WE FURTHER FIND SUPPORT FROM THE DECISION OF THE SPECIAL BENCH IN L.G. ELECTRONICS C ASE WHICH CONSIDERS A DEVIANCE FROM THE VIEW TAKEN IN THE CASE OF AN ASSESSEE WHO INCUR RED HIGHER AMP VIS--VIS THE COMPARABLES IN THE INITIAL YEARS. AS DISCUSSED IN THE EARLIER PART OF THIS ORDER, THE DRP ITA NO. 5637/D/2011 49 SPECIFICALLY NOTES THAT THIS IS THE FIRST FULL YEAR OF ASSESSEES FUNCTIONING. THE TP STUDY REFERRED TO BY US IN THE EARLIER PART OF THIS ORDER ADDRESSES THE PREVALENT COMPETITION IN THE MARKET AND THE FACT THAT THE SECTOR IS HIGHLY C OMPETITIVE BECOMES MORE SO FAR A NEW ENTRANT WHERE THERE IS A DECLINING TREND SEEN IN TH E AUTOMOBILE SALE MARKET COUPLED WITH NENTRENCHED POSITION OF EARLY ENTRANTS IN THE SECTOR. 16.2 HOWEVER, IN THE PRESENT CASE, WE FIND THAT UNL IKE BMWS CASE, THE ASSESSEE HAS CARRIED OUT APART FROM ACTING AS A DIS TRIBUTOR, THE FUNCTION OF SOFTWARE DEVELOPMENT SERVICES TO THE GROUP COMPANIE S AND ALSO PROVIDED MARKETING AND ADMINISTRATIVE SUPPORT SERVICES TO IT S GROUP COMPANY. THEREFORE, THE DECISION IN THE CASE OF BMW, IN OUR HUMBLE OPIN ION, IS NOT APPLICABLE TO THE PRESENT SET OF FACTS. 17. IN BMWS CASE THE TRIBUNAL HAS OBSERVED THAT A SSESSEE HAS PERFORMED THE FUNCTIONS OF SALES PROMOTION AND ADVE RTISEMENT IN ORDER TO MAKE A DENT IN THE MARKET WHILE PERFORMING THE FUNCTIONS OF A DISTRIBUTOR WITH GREATER INTENSITY AS OPPOSED TO A ROUTINE DISTRIBUTOR. THE REFORE, THIS DECISION IS NOT APPLICABLE TO THE FACTS OF THE PRESENT CASE. THE T RIBUNAL ALSO TOOK NOTE OF THE FACT THAT BMW AS DISTRIBUTOR PERFORMED HIGHER FUNCT IONS AND UNDERTOOK TO ESTABLISH DISTRIBUTORSHIP NETWORK, ADVERTISE, PROMO TE AND MARKET THE BRAND REMUNERATION/COMPENSATION/REWARDS OF DISTRIBUTORSHI P WERE ALSO GUARANTEED. THUS, TRIBUNAL PRIMARILY PROCEEDED ON THE PREMISE T HAT IN THE REMUNERATION MODEL THE COMPENSATION FOR AMP EXPENSES WAS DULY EM BEDDED. THIS ASPECT IN THE PRESENT CASE NEEDS TO BE DEMONSTRATED BY ASS ESSEE WITH REFERENCE TO GLOBAL TRANSFER PRICING POLICY, AS PER FACTOR 9 LAI D DOWN IN LGS CASE OUT OF 14 CONDITIONS IN PARA 17.4. ITA NO. 5637/D/2011 50 17.1 HOWEVER, IN ANY VIEW OF THE MATTER, IN OUR OPI NION THE DECISION OF SPL. BENCH IN THE CASE OF LG IS APPLICABLE TO DISTRIBUT ORS ALSO AS IS EVIDENT FROM THE FOLLOWING OBSERVATIONS IN LGS CASE:- 17.4 IN OUR CONSIDERED OPINION, FOLLOWING ARE SOME OF THE RELEVANT, WHOSE ANSWERS HAVE CONSIDERABLE BEARING ON THE QUESTION O F DETERMINATION OF THE COST/VALUE OF THE INTERNATIONAL TRANSACTION OF BRAN D/LOGO PROMOTION THROUGH 1. WHETHER THE INDIAN AE IS SIMPLY A DISTRIBUTOR OR IS A HOLDING A MANUFACTURING LICENCE FROM ITS FOREIGN AE? 17.2 THUS, IT IS EVIDENT THAT LGS DECISION IS SQUA RELY APPLICABLE IN THE CASE OF ALL KINDS OF DISTRIBUTORS AND THE DISTINCT ION BETWEEN DISTRIBUTOR AND AN ASSESSEE HOLDING A MANUFACTURING LICENSE HAS BEEN M ADE FOR DETERMINATION OF EXCESS AMP EXPENSES BECAUSE THE CONSIDERATIONS BETW EEN THE TWO DIFFER. THEREFORE, GUIDELINES LAID DOWN THEREIN WOULD GOVER N THE DETERMINATION OF ALP OF IMPUGNED INTERNATIONAL TRANSACTION. 17.3 IN VIEW OF ABOVE DISCUSSION, WE ARE OF THE CON SIDERED OPINION THAT THE DECISION IN THE CASE OF BMW HAS NO APPLICATION TO THE PRESENT CASE. 18. LD. COUNSEL ELABORATING HIS ARGUMENTS SUBMITTE D THAT SINCE ASSESSEE WAS EARNING 5% PROFIT MARGIN AS AGAINST 1% EARNED B Y COMPARABLES. THEREFORE, CREDIT NOTES RECEIVED BY ASSESSEE IN PUR SUANCE TO GLOBAL TRANSFER PRICING POLICY COVERS THE EXCESS AMP EXPENSES ALSO HIS CONTENTION IS THAT IF ANY FURTHER ADDITION IS MADE THEN IT WILL AMOUNT TO DOU BLE ADDITION. WE FIND THAT SPL. BENCH IN LGS CASE HAS CONSIDERED THIS SPECIFIC PLE A AND HAS REJECTED THE SAME ITA NO. 5637/D/2011 51 VIDE PARA 21.1 TO 21.13 OF ITS ORDER NOTED EARLIER. WE FIND THAT WHILE ENUMERATING THE 9 TH FACTOR TO BE TAKEN INTO CONSIDERATION FOR DETERMIN ATION OF COST/VALUE OF INTERNATIONAL TRANSACTION WITH REFERENCE TO AMP EXP ENSES, SPL. BENCH ITSELF HAS TAKEN NOTE OF THE FACT THAT IF THE COMPENSATION HAS BEEN RECEIVED FOR EXCESS AMP EXPENSES REGARDING BRAND BUILDING THEN THE SAME IS A RELEVANT CONSIDERATION AND THIS WILL ENSURE NO DOUBLE ADDITI ON AS PLEADED BY LD. COUNSEL FOR THE ASSESSEE. HOWEVER, THE ASSESSEE HAS TO ESTABLISH THAT IN ITS GLOBAL TRANSFER PRICING POLICY THE AMP EXPENSES HAD DULY B EEN TAKEN INTO CONSIDERATION. 18.1 ADMITTEDLY, THE ASSESSEE DID NOT TREAT THE E XCESS AMP EXPENDITURE AS INTERNATIONAL TRANSACTION AND, THEREFORE, IT DID NO T FORM PART OF TP STUDY SUBMITTED BY ASSESSEE. WE FIND THAT BEFORE TPO THE ASSESSEE HAD TAKEN A SPECIFIC PLEA TO THIS EFFECT BUT DID NOT PRODUCE ANY DOCUMENTARY EVI DENCE IN SUPPORT OF ITS CONTENTION. IT IS FURTHER STATED IN THE ABOVE APPL ICATION FOR ADMISSION OF ADDITIONAL EVIDENCE THAT DRP NEVER ASKED THE ASSESSEE TO FURNI SH ANY SUPPORTING EVIDENCE IN RESPECT OF CREDIT NOTES. AFTER CONSIDERING THE ASSESSEES SUBMISSIONS AND TAKING INTO CONSIDERATION THE DECISION OF SPL. BENC H IN THE CASE OF LG ELECTRONICS INDIA P. LTD. PARTICULARLY WITH REFERENCE TO GUIDE LINES LAID DOWN THEREIN WITH REGARD TO SUBSIDY ON THE GOODS SOLD TO THE INDIAN A E , AS NOTED EARLIER , THE BENEFIT OF WHICH WAS NOT AVAILABLE TO EITHER SIDE B EFORE TPO OR LD.DRP, WE ARE OF THE OPINION THAT CREDIT NOTES, NOW SOUGHT TO BE PRO DUCED BEFORE US, A SUMMARY OF WHICH HAS BEEN FILED WITH THE APPLICATION ALONG WI TH SAMPLE CREDIT NOTES, NEEDS TO BE ADMITTED IN ORDER TO ARRIVE AT CORRECT CONCLU SION IN REGARD TO EXCESS AMP ITA NO. 5637/D/2011 52 EXPENDITURE. WE, ACCORDINGLY, ADMIT THE ADDITIONAL EVIDENCE. THESE CREDIT NOTES NEEDS FRESH EXAMINATION BY TPO WITH REFERENCE TO FO URTEEN FACTORS PARTICULARLY FACTOR NO. 9 & 10 FOR DETERMINATION OF THE COST OF THE VALUE OF THE INTERNATIONAL TRANSACTION OF BRAND/LOGO PROMOTION THROUGH AMP EXP ENSES ENUMERATED IN PARA 17.4 OF TRIBUNALS DECISION IN THE CASE OF LG ELECT RONICS WHICH ARE AS UNDER: 17.4. IN OUR CONSIDERED OPINION, FOLLOWING ARE SO ME OF THE RELEVANT QUESTIONS, WHOSE ANSWERS HAVE CONSIDERABLE BEARING ON THE QUESTION O F DETERMINATION OF THE COST/VALUE OF THE INTERNATIONAL TRANSACTION OF BRAND/LOGO PROMOTI ON THROUGH AMP EXPENSES INCURRED BY THE INDIAN AE FOR ITS FOREIGN ENTITY :- 1. WHETHER THE INDIAN AE IS SIMPLY A DISTRIBUTOR OR IS A HOLDING A MANUFACTURING LICENCE FROM ITS FOREIGN AE ? 2. WHERE THE INDIAN AE IS NOT A FULL FLEDGED MANUFA CTURER, IS IT SELLING THE GOODS PURCHASED FROM THE FOREIGN AE AS SUCH OR IS IT MAKI NG SOME VALUE ADDITION TO THE GOODS PURCHASED FROM ITS FOREIGN AE BEFORE SELLING IT TO CUSTOMERS ? 3. WHETHER THE GOODS SOLD BY THE INDIAN AE BEAR THE SAME BRAND NAME OR LOGO WHICH IS THAT OF ITS FOREIGN AE ? 4. WHETHER THE GOODS SOLD BEAR LOGO ONLY OF FOREIGN AE OR A LOGO WHICH IS ONLY OF THE INDIAN AE OR IS IT A JOINT LOGO OF BOTH THE INDIAN ENTITY AND ITS FOREIGN COUNTERPART ? 5. WHETHER INDIAN AE, A MANUFACTURER, IS PAYING ANY ROYALTY OR ANY SIMILAR AMOUNT BY WHATEVER NAME CALLED TO ITS FOREIGN AE AS A CONSIDE RATION FOR THE USE OF THE BRAND/LOGO OF ITS FOREIGN AE? 6. WHETHER THE PAYMENT MADE AS ROYALTY TO THE FOREI GN AE IS COMPARABLE WITH WHAT OTHER DOMESTIC ENTITIES PAY TO INDEPENDENT FOREIGN PARTIES IN A SIMILAR SITUATION. 7. WHERE THE INDIAN AE HAS GOT A MANUFACTURING LICE NCE FROM THE FOREIGN AE, IS IT ALSO USING ANY TECHNOLOGY OR TECHNICAL INPUT OR TECHNICA L KNOWHOW ACQUIRED FROM ITS FOREIGN AE FOR THE PURPOSES OF MANUFACTURING SUCH GOODS ? 8. WHERE THE INDIAN AE IS USING TECHNICAL KNOW-HOW RECEIVED FROM THE FOREIGN AE AND IS PAYING ANY AMOUNT TO THE FOREIGN AE, WHETHER THE PAYMENT IS ONLY TOWARDS FEES FOR ITA NO. 5637/D/2011 53 TECHNICAL SERVICES OR INCLUDES ROYALTY PART FOR THE USE OF BRAND NAME OR BRAND LOGO ALSO ? 9. WHETHER THE FOREIGN AE IS COMPENSATING THE INDIA N ENTITY FOR THE PROMOTION OF ITS BRAND IN ANY FORM, SUCH AS SUBSIDY ON THE GOODS SOL D TO THE INDIAN AE ? 10 . WHERE SUCH SUBSIDY IS ALLOWED BY THE FOREIGN A E , WHETHER THE AMOUNT OF SUBSIDY IS COMMENSURATE WITH THE EXPENSES INCURRED BY THE INDI AN ENTITY ON THE PROMOTION OF BRAND FOR THE FOREIGN AE ? 11. WHETHER THE FOREIGN AE HAS ITS PRESENCE IN INDI A ONLY IN ONE FIELD OR DIFFERENT FIELDS ? WHERE IT IS INVOLVED IN DIFFERENT FIELDS, THEN IS THERE ONLY ONE INDIAN ENTITY LOOKING AFTER ALL THE FIELDS OR THERE ARE DIFFERENT INDIAN AES FOR DIFFERENT FIELDS ? IF THERE ARE DIFFERENT ENTITIES IN INDIA, THEN WHAT IS THE PATTE RN OF AMP EXPENSES IN THE OTHER INDIAN ENTITIES ? 12. WHETHER THE YEAR UNDER CONSIDERATION IS THE ENT RY LEVEL OF THE FOREIGN AE IN INDIA OR IS IT A CASE OF ESTABLISHED BRAND IN INDIA ? 13. WHETHER ANY NEW PRODUCTS ARE LAUNCHED IN INDIA DURING THE RELEVANT PERIOD OR IS IT CONTINUATION OF THE BUSINESS WITH THE EXISTING RANG E OF PRODUCTS ? 14. HOW THE BRAND WILL BE DEALT WITH AFTER THE TERM INATION OF AGREEMENT BETWEEN AES? 18.2 THE MAIN POINT FOR OUR CONSIDERATION AT PRESE NT IS WHETHER ASSESSEE IS REQUIRED TO ESTABLISH DIRECT NEXUS BETWEEN THE A MP EXPENDITURE INCURRED BY THE ASSESSEE AND CREDIT NOTES RECEIVED FROM AE. IN OUR OPINION, PARA 17.5 READ WITH PARAS 21.1 TO 21.13 REPRODUCED EARLIER, OF LG S DECISION, CLEARLY ANSWER THIS ISSUE. PARA 17.5 IS REPRODUCED HEREUNDER: 17.5. IN FACT, IT IS THE COLLECTIVE EFFECT OF THE ABOVE FACTORS IN THE COMPARABLE CASE AND THE CASE TO BE COMPARED WITH, WHICH NEEDS TO BE KEP T IN VIEW BEFORE DETERMINING THE COST/VALUE OF THE INTERNATIONAL TRANSACTION. THERE CAN BE NO STRAITJACKET FORMULA FOR GIVING WEIGHT TO EACH OF THESE FACTORS. WHAT IS RES ULT OF EACH OF SUCH FACTORS IN DETERMINING THE COST/VALUE OF INTERNATIONAL TRANSAC TION DEPENDS ON THE FACTS OF EACH CASE. IT IS THE DUTY OF THE TPO TO GIVE DUE REGARD TO SUCH FACTORS BY MAKING SUITABLE PLUS OR MINUS ADJUSTMENTS BEFORE FINALLY DETERMINING THE COST/VALUE OF THE INTERNATIONAL TRA NSACTION. ITA NO. 5637/D/2011 54 18.3 IN VIEW OF ABOVE OBSERVATIONS READ WITH THE OB SERVATIONS IN PARAS 21.1 TO 21.13 IN LGS CASE REPRODUCED EARLIER, WE A RE IN AGREEMENT WITH LD.CIT (DR) THAT AS PER THE SPL. BENCH DECISION, IT HAS TO BE ESTABLISHED BY ASSESSEE THAT FOREIGN AE WAS COMPENSATING THE INDIAN ENTITY FOR THE PROMOTION OF ITS BRAND IN ANY FORM, SUCH AS SUBSIDY (CREDIT NOTES IN THE PRESENT CASE, AS CLAIMED) ON THE GOODS SOLD BY THE INDIAN AE. IN VI EW OF SPECIFIC OBSERVATIONS MADE, INTER-ALIA, IN PARA NO.21.5 OF LGS CASE, WE ARE NOT INCLINED TO ACCEPT LD. COUNSELS CONTENTION THAT MERELY BECAUSE OPERATING MARGIN TO SALES IS BETTER THAN THE OTHER COMPARABLES, IT HAS TO BE INFERRED T HAT ASSESSEE HAD DULY BEEN COMPENSATED TOWARDS AMP EXPENSES. IN THIS REGARD L D. DRS CONTENTIONS ARE WELL FOUNDED THAT EACH INTERNATIONAL TRANSACTION HA S TO BE SEPARATELY BENCH MARKED AND OVERALL PROFITABILITY CANNOT BE A DETERM INATIVE FACTOR AS HELD IN LGS CASE ALSO. FURTHER, IN FACTOR NO. 10 SPL. BENCH HAS SPECIFICALLY QUALIFIED SUCH SUBSIDY FOR THE PURPOSES OF ADEQUACY OR SUFFICIENCY OF QUANTIFICATION AND THIS ALSO SUPPORTS THE CONTENTION OF REVENUE THAT THE SU BSIDY HAS TO BE SPECIFICALLY RECEIVED FOR PROMOTION OF BRAND. WHEN SPECIFIC GUI DELINES HAVE BEEN LAID DOWN IN SPL. BENCH IT CANNOT BE HELD THAT UNLESS THIS NE XUS, THOUGH NOT NECESSARILY ONE TO ONE, IS ESTABLISHED, THE CREDIT NOTES CAN BE CONSIDERED TOWARDS EXCESS AMP EXPENSES FOR BRAND PROMOTION. HOWEVER, WE AGREE WITH LD. COUNSEL THAT WHILE DETERMINING THE COST/VALUE OF THE AMP TRANSAC TION ON A STAND-ALONE BASIS, THE DIRECTION OF SPECIAL BENCH WITH REGARD T O THE 14 ECONOMIC AND BUSINESS FACTS HAS TO BE FOLLOWED. IT IS MANDATORY FOR THE TPO TO CONSIDER ALL FACTS AND EVIDENCE, AS MAY BE SUBMITTED BY THE ASSE SSEE TO SUBSTANTIATE THAT IT ITA NO. 5637/D/2011 55 HAD RECEIVED CREDIT NOTES/SUBSIDY FOR PROJECTS OF G OODS AS PER FACTOR 9 AND THE VALUE OF THE SUBSIDY SO RECEIVED WAS COMMENSURATE WITH THE EXPENSES INCURRED BY THE ASSESSEE ON AMP AS PER FACTOR 10. FURTHER, AS RIGHTLY SUBMITTED BY LD. COUNSEL, PRESENCE OR LACK OF AGREE MENTS BETWEEN RELATED PARTIES DO NOT MATTER MUCH. WHAT MATTERS IS THE CO NDUCT OF PARTIES. IN THIS REGARD IT HAS TO BE DEMONSTRATED BY ASSESSEE THAT T HE GLOBAL TRANSFER PRICING POLICY OF ASSESSEE TAKES INTO CONSIDERATION THE COM PENSATION/CONTRIBUTION TOWARDS EXCESS AMP EXPENSES (BRAND PROMOTION EXPENS ES) INCURRED BY ASSESSEE. THE OECD GUIDELINES CANNOT TAKE PRECEDEN CE OVER THE DECISION OF SPL. BENCH AND, THEREFORE, ONCE THE SPL. BENCH HAS HELD THAT ONE OF THE FACTORS TO BE TAKEN INTO CONSIDERATION IS THAT FOREIGN AE I S COMPENSATING THE INDIAN ENTITY FOR THE PROMOTION OF ITS BRAND IN ANY FORM S UCH AS SUBSIDY ON THE GOODS SOLD, THEN, MERELY WITH REFERENCE TO THE OVERALL OP ERATING MARGIN OF THE ADMINISTRATIVE AND MARKETING DIVISION SEGMENT, IT C ANNOT BE HELD THAT NEXUS IS NOT REQUIRED TO BE ESTABLISHED. THERE IS NO GAINSAY ING THAT DECISION OF SPL. BENCH IS BINDING ON DIVISION BENCH AND, THEREFORE, WHEN SPL. BENCH HAS SPECIFICALLY LAID DOWN THAT ONE OF THE ASPECTS TO B E TAKEN INTO CONSIDERATION, WHILE DETERMINING THE COST/VALUE OF TRANSACTION, IS THAT HOW FOREIGN AE HAS COMPENSATED THE INDIAN ENTITY FOR THE PROMOTION OF ITS BRAND THEN IT CANNOT BE HELD THAT OVERALL PERCENTAGE OF OPERATING PROFIT MA Y BE TAKEN INTO CONSIDERATION FOR HOLDING THAT CREDIT NOTES ISSUED BY THE FOREIGN AE IN PURSUANCE TO TRANSFER PRICING POLICY WERE TOWARDS THE COMPENSATION FOR PR OMOTION OF ITS BRAND. IT HAS TO BE SPECIFICALLY DEMONSTRATED BY ASSESSEE. ONE OF THE CONTENTIONS OF THE LD. ITA NO. 5637/D/2011 56 COUNSEL FOR THE ASSESSEE IS THAT THERE IS NO ROYALT Y PAYMENT BY ASSESSEE TO ITS AE. WE AGREE WITH LD. COUNSEL THAT THIS IS A RELEV ANT FACTOR WHICH HAS TO BE TAKEN INTO CONSIDERATION FOR DETERMINATION OF EXCES S AMP EXPENDITURE IN THE LIGHT OF LG DECISION. IN OUR OPINION ALL THESE ASP ECTS NEED TO BE EXAMINED AFRESH BY TPO. 18.4 IN THE LIGHT OF ABOVE OBSERVATIONS, WE RESTOR E THE MATTER TO THE FILE OF LD. TPO FOR DECIDING THE ISSUE AFRESH IN THE LIGHT OF DECISION OF LGS CASE AFTER TAKING INTO CONSIDERATION THE CREDIT NOTES, THE GLO BAL TRANSFER PRICING POLICY AND OTHER DOCUMENTS TO BE PRODUCED BY ASSESSEE FOR SUBS TANTIATING ITS PLEA THAT CREDIT NOTES WERE ISSUED BY FOREIGN AE TOWARDS COMP ENSATION FOR PROMOTION OF BRAND. 19. IN THE RESULT THE ADDITIONAL GROUND RAISED BY ASSESSEE IS ALLOWED FOR STATISTICAL PURPOSES. NOW WE WILL CONSIDER THE VAR IOUS OTHER GROUNDS TAKEN BE ASSESSEE WITH REFERENCE TO AMP EXPENSES. 20. LD. COUNSEL IN THE WRITTEN SUBMISSIONS HAS FIR ST GIVEN A BRIEF NOTE ON THE DECISION RENDERED BY SPL. BENCH IN THE CASE OF M/S LG ELECTRONICS INDIA PVT. LTD. VS. ACIT. AFTER CONSIDERING THE SAME LD. COUNSEL HAS FAIRLY CONCEDED THAT GROUND NOS. 2.1, 2.2, 2.3, 2.6, AND 2.9 ARE CO VERED AGAINST THE ASSESSEE BY LGS DECISION AND MAY BE DECIDED ACCORDINGLY AS THE ASSESSEE RESERVES THE RIGHT TO PREFER AN APPEAL BEFORE THE HONBLE DELHI HIGH COURT. 20.1 WE WILL, THEREFORE, FIRST IN BRIEF REFER TO TH E FINDINGS OF SPL. BENCH APROPOS THESE GROUNDS. ITA NO. 5637/D/2011 57 21. APROPOS GROUND NOS. 2.1 & 2.2, AS NOTED EARLIE R, TPO HAS DISPOSED OFF THIS OBJECTION BY POINTING OUT THAT REFERENCE H AD SEPARATELY BEEN MADE BY AO FOR DETERMINATION OF ARMS LENGTH COMPENSATION F OR AMP EXPENSES. . THEREFORE, THESE GROUNDS ARE DISMISSED. 22. APROPOS GROUND NO. 2.3, WE FIND THAT IN PARA 2 1.3 TO 21.8 IN LGS CASE (SB), REPRODUCED EARLIER, IT HAS BEEN HELD THAT CON SIDERATION OF INDIVIDUAL ELEMENTS OF COSTS (LIKE AMP EXPENDITURE) IS NOT INC ONSISTENT WITH TNMM METHOD BEING ACCEPTED AT ENTITY LEVEL. 22.1 RESPECTFULLY FOLLOWING THE DECISION, THIS GROU ND IS DISMISSED. 23. GROUND NO. 2.6 IS REGARDING ONLY INDIRECT OR I NCIDENTAL BENEFIT TO AE AND GROUND NO.2.9 IS REGARDING ADDITION OF MARK UP ON THE EXCESS AMP EXPENSES. WE FIND THAT IN LGS CASE IN PARA 23.4 IT HAS BEEN OBSERVED AS UNDER: 23.4. IT IS RELEVANT TO NOTE THAT UNDER SECOND AN D THIRD STEPS WHAT IS REQUIRED TO BE DETERMINED IS THE RATE OF NORMAL GROSS PROFIT MARK- UP AS ARISING TO THE ENTERPRISE FROM AN UNCONTROLLED TRANSACTION OR TO AN UNRELATED ENTE RPRISE IN A SIMILAR SITUATION. HERE IT IS SIGNIFICANT TO NOTE THAT A COMPARABLE UNCONTROLL ED TRANSACTION TO BE CONSIDERED FOR BENCHMARKING THE NORMAL GROSS PROFIT MARK-UP HAS TO BE SIMILAR TO THE INTERNATIONAL TRANSACTION UNDER CONSIDERATION. CONSEQUENTLY, THE PROFIT MARK-UP UNDER STEPS 2 AND 3 SHOULD IN THE PRESENT CASE BE THE RATE WHICH AN IND EPENDENT THIRD PARTY EARNS FOR CREATING MARKETING INTANGIBLE FOR AND ON BEHALF OF THE FOREIGN ENTERPRISE. IN THE PRESENT CASE, THE DRP SUGGESTED 13% MARK-UP. THE DRP WENT W RONG IN APPLYING STEPS 2 AND 3 BY ARBITRARILY DETERMINING THE RATE OF MARK-UP AT 1 3% WITHOUT SHOWING AS TO HOW MUCH AN INDEPENDENT COMPARABLE ENTITY HAS EARNED FROM AN INTERNATIONAL TRANSACTION SIMILAR TO ONE WHICH IS UNDER CONSIDERATION. ITA NO. 5637/D/2011 58 24. RESPECTFULLY FOLLOWING THE DECISION OF SPL. BE NCH, BOTH THE GROUNDS ARE DISMISSED. 25. GROUND NOS. 2.4 AND 2.5 ARE IN REGARD TO NON- CONSIDERATION OF GROUPS GLOBAL TRANSFER PRICING POLICY PURSUANT TO WHICH AE WAS COMPENSATING THE ASSESSEE TOWARDS EXCESS AMP EXPENSES BY WAY OF CREDIT NOTES. BOTH THESE GROUNDS HAVE BEEN DISCUSSED IN DETAIL WHILE A DMITTING THE ADDITIONAL EVIDENCE IN THE FORM OF CREDIT NOTES FILED BY ASSES SEE. THEREFORE, BOTH THESE GROUNDS STANDS ALLOWED FOR STATISTICAL PURPOSES. 26. APROPOS GROUND NO. 2.7, WE FIND THAT SPL. BENC H IN THE CASE OF LG, WHILE CONSIDERING THE COST/VALUE OF TRANSACTION, CO NSIDERED THE SCOPE OF AMP EXPENSES WITH REFERENCE TO SELLING EXPENSES AND OBS ERVED FROM PARA 18.1 TO PARA 19 AS UNDER: SCOPE OF AMP EXPENSES : 18.1. THE LD. COUNSEL FOR THE ASSESSEE AND SOME OF THE INTERVENERS CONTENDED THAT THE TPO HAS INCLUDED SELLING EXPENSES IN THE TOTAL AMP EXPENSES FOR THE PURPOSES OF DETERMINING THE ALP. IT WAS SUBMITTED THAT SELLING EXPENSES CANNOT CONSTITUTE PART OF AMP EXPENSES. OUR ATTENTION WAS DRAWN TOWARDS THE E RSTWHILE SECTIONS 37(3A) AND 37(3B), IN WHICH DISALLOWANCE U/S 37(3A) WAS PRESCR IBED IN RESPECT OF EXPENSES REFERRED TO IN SUB-SEC. (3A), WHICH, INTER ALIA, IN CLUDED ADVERTISEMENT, PUBLICITY AND SALES PROMOTION. IT WAS SUBMITTED THAT VARIOUS COUR TS HAVE HELD THAT THE SELLING EXPENSES CANNOT BE INCLUDED WITHIN THE SCOPE OF SEC . 37(3B). 18.2. THE LEARNED DEPARTMENTAL REPRESENTATIVE OPPOS ED THIS CONTENTION BY STATING THAT THERE IS NO LOGIC IN THE CONTENTION OF THE LEARNED AR THAT THE EXPENSES CAUSING SALES SHOULD BE TAKEN OUT OF THE TOTAL AMP EXPENSES FOR C ONSIDERATION. ALL THE AMP EXPENSES INCLUDING THE EXPENSES IN CONNECTION WITH THE SALES SHOULD BE CONSIDERED AS ONE BASKET OF EXPENSES, OUT OF WHICH THE AMP EXPENSES FOR THE CREATION OR PROMOTION OF MARKETING ITA NO. 5637/D/2011 59 INTANGIBLES ON BEHALF OF THE FOREIGN ENTERPRISE ARE TO BE SEGREGATED. IT WAS CONTENDED THAT SINCE BY THEIR VERY NATURE MOST OF THE AMP EXP ENSES ARE COMMON HAVING BEEN INCURRED FOR OWN BUSINESS AND BRAND BUILDING FOR TH E FOREIGN AE, THE REDUCTION OF EXPENSES IN CONNECTION WITH SALES WOULD PREJUDICE T HE COMPUTATION OF THE AMP EXPENSES FOR THE BRAND BUILDING. 18.3. HAVING HEARD THE RIVAL SUBMISSIONS ON THIS IS SUE, WE FIND THAT THE AMP EXPENSES REFER ONLY TO ADVERTISEMENT, MARKETING AND PUBLICIT Y EXPENSES. A DIVIDER NEEDS TO BE PLACED BETWEEN THE EXPENSES FOR THE PROMOTION OF SA LES ON ONE HAND AND EXPENSES IN CONNECTION WITH THE SALES ON THE OTHER. BOTH THESE EXPENSES ARE REQUIRED TO BE KEPT IN DIFFERENT COMPARTMENTS. WHILE EXPENSES FOR THE PROM OTION OF SALES DIRECTLY LEAD TO BRAND BUILDING, THE EXPENSES DIRECTLY IN CONNECTION WITH SALES ARE ONLY SALES SPECIFIC. 18.4. SUB-SECTION (3A) OF SEC. 37, BEFORE ITS OMISS ION, PROVIDED THAT WHERE THE EXPENSES INCURRED BY THE ASSESSEE ON ANY ONE OR MORE OF THE ITEMS SPECIFIED IN SEC. 37(3B) EXCEED ONE LAC OF RUPEES, THEN TWENTY PERCENT OF SUCH EXCE SS SHALL NOT BE ALLOWED AS DEDUCTION IN COMPUTING THE INCOME CHARGEABLE UNDER THE HEAD ` PROFITS AND GAINS OF BUSINESS OR PROFESSION. CLAUSE (I) OF SUB-SEC. (3B) REFERRED T O ADVERTISEMENT, PUBLICITY AND SALES PROMOTION. THE HONBLE URISDICTIONAL HIGH COURT IN THE CASE OF CIT VS. KHETU RAM BISHAMBAR DASS [(2008) 166 TAXMAN 273 (DEL.)], HAS HELD THAT BONUS PAID TO DEALERS IS NOT IN THE NATURE OF SALES PROMOTION EXPENSES AN D HENCE THE PROVISIONS OF SEC. 37(3A) CANNOT BE APPLIED TO IT. THE HONBLE CALCUTTA HIGH COURT IN CIT VS. THE STATESMAN LTD. [(1992) 198 ITR 582 (CAL.)] HAS ENUNCIATED THAT THE EXPENSES INCURRED BY WAY OF COMMISSION PAID TO SALES AGENT DO NOT ATTRACT DISAL LOWANCE UNDER SUB-SECTIONS (3A) & (3B) OF SEC. 37. THE HONBLE M.P. HIGH COURT IN THE CASE OF CIT VS. MOHD. ISHAQUE GULAM [(1998) 232 ITR 869 (MP)] HAS HELD THAT THE D EALERS COMMISSION AND SALES AGENT COMMISSION ETC. CANNOT BE BROUGHT WITHIN THE PURVIEW OF ADVERTISEMENT, PUBLICITY AND SALES PROMOTION EXPENSES, AS REFERRED TO IN SEC . 37. 18.5. WE DO NOT FIND ANY FORCE IN THE CONTENTION OF THE LEARNED DR MADE IN THIS REGARD. THE LOGIC IN THE EXERCISE OF FINDING OUT THE AMP EX PENSES TOWARDS CREATION OF MARKETING INTANGIBLES FOR THE FOREIGN AE STARTS WIT H THE EXPENSES WHICH ARE OTHERWISE IN THE NATURE OF ADVERTISEMENT, MARKETING AND PROMO TION. IF AN EXPENDITURE ITSELF IS NOT ITA NO. 5637/D/2011 60 IN THE NATURE OF ADVERTISING, MARKETING OR PROMOTIO N, THAT OUGHT TO BE EXCLUDED AT THE VERY OUTSET. WE, THEREFORE, REJECT THIS CONTENTION RAISED BY THE LEARNED DR. 18.6. AS WE ARE PRESENTLY CONSIDERING THE TERM `ADV ERTISEMENT MARKETING AND PROMOTION EXPENSES, WHICH IS ANALOGOUS TO, IF NOT LESSER IN SCOPE THAN THE TERM `ADVERTISEMENT, PUBLICITY AND SALES PROMOTION AS EMPLOYED IN THE E RSTWHILE SUB-SEC. (3B) OF SEC. 37, ALL THE JUDGMENTS RENDERED IN THE CONTEXT OF SUB-SEC. ( 3A) & (3B) OF SEC. 37 WILL SQUARELY APPLY TO THE INTERPRETATION OF THE SCOPE OF AMP EXP ENSES. WE, THEREFORE, HOLD THAT THE EXPENSES IN CONNECTION WITH THE SALES WHICH DO NOT LEAD TO BRAND PROMOTION CANNOT BE BROUGHT WITHIN THE AMBIT OF ADVERTISEMENT, MARKETING AND PROMOTION EXPENSES FOR DETERMINING THE COST/VALUE OF THE INTERNATIONAL TRA NSACTION. 19. IN THE FACTS AND CIRCUMSTANCES OF THE PRESENT C ASE, IT IS FOUND THAT THE TPO RESTRICTED THE COMPARABLE CASES TO ONLY TWO WITHOUT DISCUSSING AS TO HOW OTHER CASES CITED BY THE ASSESSEE WERE NOT COMPARABLE. FURTHER IT CAN BE SEEN THAT THE TPO HAS NOT CONSIDERED THE EFFECT OF ANY OF THE RELEVANT FACTOR S AS DISCUSSED ABOVE. A BALD COMPARISON WITH THE RATIO OF AMP EXPENSES TO SALES OF THE COMPARABLE CASES WITHOUT GIVING EFFECT TO THE RELEVANT FACTORS AS DISCUSSED ABOVE, CANNOT PRODUCE CORRECT RESULT. IT CAN BE ILLUSTRATED BY A SIMPLE EXAMPLE. IF THERE IS NO SUBSIDY IN A COMPARABLE CASE BUT THE ASSESSEE HAS RECEIVED SOME AMOUNT OF SUBSIDY FR OM ITS FOREIGN AE ON IMPORTS OR IN ANY OTHER MANNER, WHICH FACT OTHERWISE NEEDS TO BE SPECIFICALLY ESTABLISHED BY THE ASSESSEE, THEN THE INITIAL AMOUNT SO COMPUTED WOULD REQUIRE REDUCTION TO THE EXTENT OF SUCH SUBSIDY OR VICE VERSA. AS THE TPO HAS NEITHER PROPERLY CONSIDERED THE REQUEST OF THE ASSESSEE FOR INCLUSION OF SOME OTHER COMPARABLE CASES NOR EXAMINED THE EFFECT OF THE ABOVE DISCUSSED RELEVANT FACTORS ON THE QUESTIO N OF DETERMINATION OF THE COST/VALUE OF INTERNATIONAL TRANSACTION, IN OUR CONSIDERED OPI NION THE ENDS OF JUSTICE WILL MEET ADEQUATELY IF THE ORDER OF THE TPO AND THAT OF THE AO GIVING EFFECT TO SUCH ORDER IS SET ASIDE AND THE MATTER IS RESTORED TO THE FILE OF THE TPO FOR DETERMINING THE COST/VALUE OF THE INTERNATIONAL TRANSACTION AND THE CONSEQUENT AL P AFRESH AS PER LAW AFTER ALLOWING A REASONABLE OPPORTUNITY OF BEING HEARD TO THE ASSESSEE. ITA NO. 5637/D/2011 61 26.1 WE, THEREFORE, RESTORE THIS ISSUE ALSO TO THE FILE OF TPO FOR EXAMINING THE SAME AFRESH IN THE LIGHT OF LGS DECISION. IN T HE RESULT THIS GROUND IS ALLOWED FOR STATISTICAL PURPOSES. 27. APROPOS GROUND NO. 2.8 AND 2.10 LD. CIT(DR) SU BMITTED THAT THE AO/TPO HAS TO REDO THE EXERCISE IN THE LIGHT OF LG ELECTRONICS DECISION. THE MAIN DISPUTE IS REGARDING INCLUSION OF SALORA INTER NATIONAL LTD. AND SHYAM TELECOM LTD. ON THE GROUND THAT THESE TWO COMPARABL ES WERE NOT APPROPRIATE FOR DETERMINATION OF BRIGHT LINE AS ASSESSEE IS PRI NCIPAL DISTRIBUTOR WHEREAS THESE TWO COMPARABLES ARE SECONDARY LEVEL DISTRIBUT ORS. HENCE, THESE TWO COMPANIES DO NOT MEET THE CRITERIA OF COMPARABILITY AS PER THE INDIAN TP REGULATION. IN OUR OPINION, THE ASSESSEES CONTENT ION IS DEPRIVED OF ANY MERIT BECAUSE ADMITTEDLY THESE TWO COMPARABLES WERE SELEC TED BY ASSESSEE ITSELF IN ITS TP REPORT AND IT IS NOT DISPUTED THAT THEY ARE ALSO DISTRIBUTORS. AS WE ARE RESTORING THE MATTER TO THE FILE OF TPO FOR DECIDIN G THE ISSUE IN THE LIGHT OF LGS DECISION, WE DIRECT THE TPO TO CARRY OUT FRESH SEAR CH TO FIND OUT MORE COMPARABLES WHICH MEET THE CRITERIA OF PRINCIPAL DI STRIBUTOR ALSO. 28. APROPOS GROUND NO. 2.10 THE MAIN CONTENTION IS THAT THE TPO DETERMINED THE MARK UP WITH REFERENCE TO FOLLOWING FIVE COMPARABLES THE BUSINESS DESCRIPTION OF WHICH WAS AS UNDER: S.NO. COMPANY NAME BUSINESS DESCRIPTION 1. ROCKMAN ADVERTISING & MARKETING (INDIA) LTD. ROCKMAN ADVERTISING & MARKETING (I) LTD. IS ENGAGED IN PROVISION OF COMPLETE COMMUNICATION SOLUTIONS. IT IS ALSO ENGAGED IN CARRYING ITA NO. 5637/D/2011 62 OUT ACTIVITIES RELATED TO FILM AND DOCUMENTARY PRODUCTION, FABRICATION OF HOARDINGS, ETC. 2. GOLDMINE ADVERTISING LTD. GOLDMINE ADVERTISING LTD. IS ENGAGED IN PROVISION OF FULL- FLEDGED COMMUNICATION SOLUTIONS, DELIVERING SOLUTIONS RANGING FROM PRESS TO ELECTRONIC AND OUTDOOR MEDIA. 3. MARKETING CONSULTANTS & AGENCIES LTD. MARKETING CONSULTANTS & AGENCIES LTD. IS ENGAGED IN RENDERING ADVERTISING AND OTHER RELATED SERVICES. 4. NEEDWISE ADVERTISING PVT. LTD. NEEDWISE ADVERTISING P. LTD. IS ENGAGED IN PROVISION OF ADVERTISING SERVICES. 5. ADBUR PVT. LTD. ADBUR PVT. LTD. IS ENGAGED IN PROVISION OF ADVERTISING AND MARKETING SERVICES. 28.1 HE, THEREFORE, SUBMITTED THAT THE COMPARABLES SELECTED ARE NOT IN CONFORMITY WITH THE DECISION OF LGS CASE. HE FURT HER SUBMITTED THAT AS FAR AS ROCKMAN ADVERTISEMENT AND MARKETING IS CONCERNED TH E SAME IS ENGAGED IN THE SAME BUSINESS OF FILM AND DOCUMENTARY PRODUCTIO N, FABRICATION OF HOLDING ETC. THEREFORE, THIS COMPANY IS IN NO MANNER ENGAG ED IN THE PROVISION OF BRAND BUILDING OR MARKETING SERVICES. 29. LD. COUNSEL REFERRED TO DRPS ORDER AND POINTE D OUT THAT THOUGH THIS FACT WAS BROUGHT TO THE NOTICE OF DRP BUT THE SAME HAS NOT BEEN CONSIDERED. 29.1 WE HAVE CONSIDERED THE SUBMISSIONS OF LD. COUN SEL FOR THE ASSESSEE. WE FIND THAT AT PAGE 3 OF DRPS ORDER IT HAS BEEN, INTER-ALIA, OBSERVED AS UNDER: ITA NO. 5637/D/2011 63 THE OTHER COMPARABLE OBJECTED TO BY ASSESSEE ROCKM AN ADVERTISEMENT IS FOUND TO BE COMPARABLE BY THE DRP 29.2 THEREFORE, THE PLEA OF LD. COUNSEL THAT LD. DR P HAS NOT CONSIDERED THE ISSUE CANNOT BE ACCEPTED. FURTHER, WE FIND THAT TP O AT PAGE 205 HAS REFERRED TO THE DATA AVAILABLE ON THE PROWESS DATA BASE FROM WHERE HE HAS POINTED OUT THAT 100% OF ITS REVENUE WAS FROM ADVERTISEMENT ACT IVITIES. HOWEVER, WE FIND THAT ASSESSEE, WHILE FILING ITS OBJECTION BEFORE DR P AT PAGE 58, HAD REITERATED THAT COMPANY WAS ALSO ENGAGED IN CARRYING OUT ACTIV ITIES RELATED TO FILM AND DOCUMENTARY PRODUCTION, FABRICATION OF HOLDINGS ETC . IT WAS FURTHER POINTED OUT THAT THE COMPANY HAS BOOKED THE SALES REVENUE OF RS . 1.4 CRORE DURING THE SAID YEAR. AS AGAINST THIS, THE ASSESSEES ALLEGED EXCE SS AMP EXPENSES ON WHICH A MARKUP WAS APPLIED BY THE TPO WAS RS. 158 CRORES. THESE OBJECTIONS HAVE NOT BEEN CONSIDERED BY LD. DRP AND THE TPO HAS ALSO RELIED ON THE PROWESS DATA BASE. UNDER SUCH CIRCUMSTANCES, WE ARE OF THE CONSIDERED OPINION THAT THE MATTER NEEDS TO BE RESTORED BACK TO THE FILE OF TPO FOR EXAMINING THE ISSUE AFRESH IN THE LIGHT OF OBJECTIONS RAISED BY ASSESSE E. ACCORDINGLY, THIS GROUND IS ALLOWED FOR STATISTICAL PURPOSES. 29.3 IN VIEW OF ABOVE DISCUSSION, GROUND NOS. 2.4, 2.5, 2.7, 2.8 & 2.10 ARE ALLOWED FOR STATISTICAL PURPOSES. 30. APROPOS GROUND NO. 3, WE FIND THAT DRP HAS ALR EADY GIVEN DIRECTION, WHICH HAS BEEN REPRODUCED EARLIER, THAT THE TWO CO MPARABLES SPICE MOBILITY AND GENERAL SALES LTD., ARE TO BE INCLUDED AFTER DU E VERIFICATION. THE TPO IS DIRECTED TO CARRY OUT THE DIRECTION OF LD. DRP. ITA NO. 5637/D/2011 64 31. IN THE RESULT, THIS GROUND IS ALLOWED FOR STAT ISTICAL PURPOSES. 32. GROUND NO. 4 IS WITH REGARD TO ADJUSTMENT OF R S. 1055745127/- WHILE RE-COMPUTING THE ARMS LENGTH PRICE OF THE INTERNAT IONAL TRANSACTIONS PERTAINING TO CONTRACTS SOFTWARE DEVELOPMENT SERVICE SEGMENT. THE ASSESSEE HAS CHALLENGED THIS ADDITION ON VARIOUS COUNTS AS PER G ROUND NOS. 4.1 TO 4.11. 32.1 AS PER TRANSFER PRICING STUDY SUBMITTED BY ASS ESSEE, IN THE SOFTWARE DEVELOPMENT SEGMENT, ASSESSEE PERFORMS ACTIVITIES R ELATING TO SOFTWARE DEVELOPMENT/CODING RELATING TO PARTY CONTROL AND DO CUMENTATION, TESTING, IMPLEMENTATION AND MAINTENANCE. THIS WORK WAS CARR IED OUT BY ASSESSEE IN ACCORDANCE WITH THE GUIDELINES PROVIDED BY THE AES. AS PER THE FUNCTIONAL ANALYSIS DOCUMENTED IN THE TRANSFER PRICING DOCUMEN TATION, ASSESSEE CHARACTERIZED ITSELF AS A CAPTIVE SERVICE PROVIDER CLAIMING THAT IT ASSUMED LESS THAN NORMAL RISK ASSOCIATED WITH CARRYING OUT SUCH BUSINESS. ASSESSEE BENCH MARKED ITS SDS SEGMENT BY APPLYING TNMM AS THE MOST APPROPRIATE METHOD WITH OPERATING PROFIT/TOTAL COST AS THE PROFIT LEVE L INDICATOR. THE ASSESSEE HAD USED FOLLOWING QUANTITATIVE FILTERS IN ITS TRANSFER PRICING DOCUMENTATION AS CONTAINED AT PAGE 1019 TO 1020 OF PAPER BOOK: CRITERIA AND REASON FOR USAGE NO. OF COMPANIES PASSING THE CRITERION TOTAL UNIVERSE OF COMPANIES AVAILABLE IN PROWESS AS OF FEBRUARY 15, 2007. 9,801 COMPANIES WITH POSITIVE SALES AND RATIO OF OTHER OPERATING I NCOME TO SALES MORE THAN 50% OVER THE TIME PERIOD UNDER CONSIDERATION WERE SELECTED SO AS TO CAPTURE ALL POTENTIAL COMPARABLES WITHIN THE SERVICE INDUSTRY. 682 COMPANIES WITH THE RATIO OF RESEARCH AND DEVELOPMENT EXPENSE S TO SALES LESS THAN OR EQUAL TO 3%,WERE SELECTED. SUCH COMPARABLES DO NOT HAVE OWNERSHIP OF INTANGIBLES AND ARE PURE SERVICE PROVIDERS. 669 COMPANIES WITH THE RATIO OF NET FIXED ASSETS TO SALES LESS THAN OR EQUAL 538 ITA NO. 5637/D/2011 65 TO 200%, WERE SELECTED. SUCH COMPARABLES DO NOT UNDERTAKE MANUFACTURING OR HOLD SUBSTANTIAL ASSETS, WHICH ARE NOT UTILIZED FOR PROVISION OF SERVICE. COMPANIES WITH AVERAGE SALES OF MORE THAN OR EQUAL TO I NR 1 CRORE OVER THE PERIOD UNDER CONSIDERATION WERE SELECTED. THE COMPANIES WITH LOW L EVELS OF SALES MAY INDICATE START-UP OPERATIONS OR THE SAME PERSONS BEING BOTH SHAREHOLDERS AND KEY EMPLOYEES, DIMINISHING THE ECONOMIC DISTINCTION BETWEEN PROFI TS AND SALARIES. 484 COMPANIES WITH NET WORTH MORE THAN OR EQUAL TO ZERO WERE SELE CTED. IMPLYING THAT THE COMPANIES ARE IN OPERATIONS. 447 COMPANIES WITH THE RATIO OF THE SUM OF ADVERTISING, MARKETI NG AND DISTRIBUTION EXPENSES TO SALES LESS THAN OR EQUAL TO 3%, WE RE SELECTED. SUCH COMPARABLES DO NOT HAVE OWNERSHIP OF MARKETING INTANGIBLES AND ARE ENGAGED IN PROVISION OF SERVI CE. 340 QUALITATIVE (COMPANIES ENGAGED SOFTWARE DEVELOPMENT ACTIVITIES BROADLY SIMILAR TO THOSE CARRIED OUT BY MIPL IN RESPECT OF ITS CLASS II ACTI VITIES) 11 32.2 THE SEARCH PROCESS CARRIED OUT BY ASSESSEE BY APPLYING THE AFOREMENTIONED FILTERS RESULTED INTO SELECTION OF 1 7 COMPARABLES AS UNDER: S.NO. NAME OF THE COMPANY DATA SOU RCE UN- ADJUS TED MARK- UP ON TOTAL COST 1. BODHTREE CONSULTING LTD. P 18% 2. FCS SOFTWARE SOLUTIONS LTD. P 14% 3. GOLDSTONE TECHNOLOGIES LTD. P 3% 4. LARSEN & TOUBRO INFOTECH LTD. P 11% 5. MELSTAR INFORMATION TECHNOLOGIES LTD. P 0% 6. ORIENT INFORMATION TECHNOLOGY LTD. P -6% 7. POWERSOFT GLOBAL SOLUTIONS LTD. P 19% 8. SIP TECHNOLOGIES & EXPORTS LTD. P 25% ITA NO. 5637/D/2011 66 9. SONATA SOFTWARE LTD. P 9% 10. SYNETAIROS TECHNOLOGIES LTD. P 11% 11. VJIL CONSULTING LTD. P 7% 12. AKSHAY SOFTWARE TECHNOLOGIES LTD. C 7% 13. CAMBRIDGE TECHNOLOGY ENTERPRISES LTD. C 21% 14. ICRA TECHNO ANALYTICS LTD. C 15% 15. MINDTREE CONSULTING LTD. C 11% 16. COMPUTECH INTERNATIONAL LTD. SEG- P 7% 17. KARUTURI NETWORKS LTD. SEG- P 4% MEAN 10% 33. THE ASSESSEE EARNED AN OPERATING PROFIT/TOTAL COST MARGIN OF 7% FOR ITS SOFTWARE DEVELOPMENT SERVICES ACTIVITIES. THIS WAS COMPUTED AS UNDER: OPERATING INCOME 6812082673/- LESS TOTAL COST 6350000000 /- OPERATING PROFIT 462082673 /- OPERATING PROFIT/TOTAL COST 7%. 33.1 THE ASSESSEE POINTED OUT THAT AS PER INDIAN T AX REGULATIONS, IT CAN CHOOSE A PRICE WHICH DOES NOT VERY FROM THE PRICE O F COMPARABLES BY MORE THAN 5% (PROVISO TO SECTION 92(2) OF THE ACT). SINCE TH E PRICE OF COMPARABLES WAS WITHIN THIS RANGE, ASSESSEE CLAIMED THAT THE TRANSA CTIONS UNDERTAKEN BY IT WERE AT ARMS LENGTH. 34. AS AGAINST THE AFORESAID APPROACH OF ASSESSEE, THE TPO ADOPTED THE FOLLOWING APPROACH: A. THE TPO REJECTED THE TP STUDY PREPARED BY THE AS SESSEE STATING THAT QUANTITATIVE FILTERS WERE INCORRECT; SELECTION/REJE CTION OF COMPARABLE COMPANIES ITA NO. 5637/D/2011 67 WAS BASED ON QUALITATIVE FILTER FUNCTIONAL DIFFERE NCE IS NOT OBJECTED AND UNIFORM; DATA FOR CURRENT YEAR IS NOT USED; RPT AND OTHER FILTERS ARE NOT APPLIED AND AS A RESULT REJECTED THE BENCH MARKING ANALYSIS CONDUCTED BY ASSESSEE ON THE BASIS OF SEVERAL ADDITIONAL QUANTITATIVE FILTER S SELECTED BY HIM. THE DEFECTS AS HIGHLIGHTED BY TPO ARE REPRODUCED HEREUNDER: AS PER THE RULE 10B(4), THE DATA TO BE USED IN ANALYZING THE COMPARABILITY OF AN UNCONTROLLED TRANSACTIONS WITH AN INTERNATIONAL TRA NSACTION SHALL BE THE DATA RELATING TO THE FINANCIAL YEAR IN WHICH THE INTERNATIONAL TR ANSACTION HAS BEEN ENTERED INTO . THE WORD USED IS ' SHALL ', INDICATING THAT NEITHER THE TAX PAYER NOR THE TP O HAS ANY CHOICE BUT TO USE THE DATA PERTAINING TO THE FY 200 6-07. EARLIER YEAR DATA, IN ADDITION TO CURRENT YEAR'S DATA, CAN BE USED ONLY IF THE CON DITIONS MENTIONED IN PROVISO TO RULE 10B(4) ARE FULFILLED. AS CAN BE SEEN FROM THE TP RE PORT THAT THE TAX PAYER HAS NOT USED AT ALL THE DATA PERTAINING TO THE FY 2006-07 IN ALL THE 18 COMPARABLES. THIS ISSUE IS DISCUSSED IN DETAIL UNDER THE HEAD 'USE OF CURRENT YEAR DATA'. THE TP STUDY THUS SUFFERS FROM LEGAL INFIRMITY. THIS HAS LED TO THE U SE OF INCORRECT DATA. 2.THE TAX PAYER HAS NOT GIVEN ANY DETAILS REGARDING THE APPLICATION OF CONTROLLED-PARTY TRANSACTION FILTER. AS THE TAX PAYER HAS NOT AT ALL CONSIDERED THE DATA FOR THE FY 2006-07 IN ALL THE COMPARABLE CASES, THE FOLLOWING COMPANIE S HAVE BEEN CONSIDERED AS COMPARABLES, WHICH OTHERWISE DO NOT PASS THE TAX PA YER'S OWN ADMITTED FILTER OF RPT LESS THAN 15% OF REVENUES. NAME OF THE COMPARABLE COMPANY CONSIDERED RELATED PARTY TRANSACTIONS AS A % BY THE TAX PAYER OF OPERATING REVENUE FOR THE FY 2006-07 FCS SOFTWARE SOLUTIONS LTD 28.10% SONATA SOFTWARE LTD 38.07% CAMBRIDGE TECHNOLOGY ENTERPRISES LTD 99.94% IN FACT, THE ABOVE COMPANIES FAIL THE TAXPAYER'S OW N 15% RELATED PARTY TRANSACTIONS ITA NO. 5637/D/2011 68 FILTER EVEN BASED ON THE EARLIER YEAR DATA. 3.THE TAXPAYER SELECTED DOMESTIC COMPANIES SUCH AS SYNETAIROS TECHNOLOGIES LTD, THOUGH IT IS MAINLY AN, EXPORT ORIENTED SOFTWARE DE VELOPMENT SERVICE PROVIDER, 4.THE TAXPAYER SELECTED COMPANIES SUCH AS AKSHAY SO FTWARE TECHNOLOGIES LTD, MELSTAR INFORMATION TECHNOLOGIES LTD, ORIENT INFORMATION TE CHNOLOGY LTD, VNL CONSULTING LTD ETC. WHICH ARE: PREDOMINANTLY ONSITE SOFTWARE COMPA NIES ( GENERATING MORE THAN 75% OF THEIR EXPORT REVENUES FROM ONSITE SOFTWARE DEVELOPM ENT SERVICES) RENDERING SERVICES AT THE SITE OF CLIENT OR THROUGH THEIR BRANCHES LOCAT ED OUTSIDE INDIA WHEREAS THE TAXPAYER IS MAINLY AN OFFSHORE COMPANY DELIVERING ALL THE SE RVICES THROUGH ITS CENTERS IN INDIA. 5.THE TAX PAYER HAS CONSIDERED COMPANIES AS COMPARA BLES EVEN THOUGH THEY ARE NOT FUNCTIONALLY SIMILAR TO THE TAX PAYER. SOME ADDITIO NAL FILTERS ARE APPLIED BY THE TPO LIKE EXPORT EARNINGS FILTER (COMPANIES WITH EXPORT EARNI NGS LESS THAN 25% OF THE REVENUES ARE REJECTED AS COMPARABLES), SALARY FILTER (COMPAN IES IN WHICH SALARY EXPENSES ARE LESS THAN 25% OF OPERATING REVENUES ARE REJECTED AS COMP ARABLES), SERVICE INCOME FILTER (COMPANIES IN WHICH SOFTWARE SERVICES INCOME IS MOR E THAN 75% OF THE REVENUES WERE CONSIDERED AS COMPARABLE) ETC SO AS TO MAKE THE COM PARABLES FUNCTIONALLY SIMILAR AND ALSO ECONOMIC CIRCUMSTANCES ALSO SIMILAR TO THAT OF THE TAXPAYER. THESE FILTERS ARE DISCUSSED IN DETAIL UNDER THEIR RESPECTIVE HEADS IN THE ORDER. 6.THE TAX PAYER HAS TAKEN COMPANIES AS COMPARABLE E VEN IF THEY DO NOT WORK IN SAME ECONOMIC CIRCUMSTANCES AS THAT OF THE TAX PAYER. TH E COMPARABILITY STUDY IS CORRECT OR RELIABLE ONLY IF THE ECONOMIC CIRCUMSTANCES IN WHIC H THE TAX PAYER IS PLACED ARE SIMILAR TO THOSE IN WHICH THE COMPARABLE COMPANIES ARE PLAC ED. THIS IS EVIDENT FROM RULE IOB(2), WHICH BROADLY SAYS THAT UNCONTROLLED TRANSACTIONS S HOULD BE JUDGED NOT ONLY WITH REFERENCE TO THE SPECIFIC CHARACTERISTIC OF TH E SERVICES RENDERED BY THE TAX PAYER (SOFTWARE SERVICES), FUNCTIONS PERFORMED (FAR ANALY SIS), AND CONTRACTUAL TERMS BUT ALSO WITH REFERENCE TO CONDITIONS PREVAILING IN THE MARK ETS IN WHICH THE RESPECTIVE PARTIES TO THEINTERNATIONAL TRANSACTIONS OPERATE, INCLUDING GEOGRAPHICAL LOCATION AND SIZE OF THE MARKET, THE LAWS AND GOVERNMENT ORDERS IN FORCE, CO STS OF LABOUR AND CAPITAL IN THE MARKETS, OVERALL ECONOMIC DEVELOPMENT AND LEVEL OF COMPETITION ETC. THE MAJOR ITA NO. 5637/D/2011 69 ATTRIBUTE OF ECONOMIC CIRCUMSTANCES IN COMPARABILIT Y WAS IGNORED BY THE TAXPAYER AND THEREBY, THE TPO HAS TO APPLY ADDITIONAL QUANTITATI VE CRITERIA SUCH AS ONSITE REVENUE FILTER, DIMINISHING REVENUES FILTER ETC. TO MAKE TH E ECONOMIC CIRCUMSTANCES COMPARABLE. 7.SOME COMPANIES WERE REJECTED BY THE TAX PAYER ON THE FUNCTIONALITY GROUND / BUSINESS REVIEW IN ITS TP STUDY THOUGH THEY ARE INTO SOFTWAR E DEVELOPMENT SERVICES OR THEY HAVE SOFTWARE DEVELOPMENT SERVICES SEGMENT AND QUALIFY A LL THE FILTERS APPLIED BY THE TAX PAYER BASED ON THE DATA PERTAINING TO THE FY 2006-0 7 AND ALSO TO THE EARLIER YEARS, IN SOME CASES. 8.AS DISCUSSED BELOW, EXCEPT TWO NONE OF THE TAXPAY ER'S COMPARABLE DO NOT STAND SCRUTINY OF FAR ANALYSIS. THE TAXPAYER ITSELF ACCEP TED THE REJECTION OF SOME OF THE COMPARABLES ON THE GROUND OF RPT, FUNCTIONALLY DIFF ERENT ETC. THIS ITSELF SHOWS THAT THE COMPARABLES WERE NOT PROPERLY SELECTED AND THE DATA USED IN THE TP DOCUMENTATION WAS NEITHER RELIABLE NOR CORRECT . DUE TO THE ABOVE PERTINENT DEFECTS IN THE TRANSFER PRICING STUDY, WHICH IS NOT BASED ON RULE LOB, THE TP STUDY DONE BY THE TAX PAYER WAS PROPOSED TO BE REJECTED ULS 92C(3) R.W.S. 92CA(3). THE TPO APPLIED FOLLOWING ADDITIONAL QUANTITATIVE FILTERS WHILE CONDUCTING THE FRESH BENCH MARKING ANALYSIS: A. THE COMPANIES WHOSE DATA WAS NOT AVAILABLE FOR T HE F.Y. 2006-07 WERE EXCLUDED; B. COMPANIES WHOSE SOFTWARE DEVELOPMENT SERVICES TU RNOVER WAS LESS THAN 1 CRORE WERE EXCLUDED; C. COMPANIES WHOSE SOFTWARE DEVELOPMENT SERVICE REV ENUE WAS LESS THAN 75% OF THE TOTAL OPERATING REVENUES WERE EXCLUDED U NLESS SEGMENTAL DETAILS WERE AVAILABLE AND THE SEGMENT QUALIFIED THIS FILTE R. D. COMPANIES WHO HAD MORE THAN 25% RELATED PARTY TR ANSACTIONS (INCOME AS WELL AS EXPENDITURE COMBINED) OF THE OPERATING REVE NUES WERE EXCLUDED; E. COMPANIES WHICH HAD LESS THAN 25% OF THE OPERATI NG REVENUES AS EXPORT SALES WERE EXCLUDED; ITA NO. 5637/D/2011 70 F. COMPANIES WHICH HAD DIMINISHING REVENUES/PERSIST ENT LOSSES FOR THE PERIOD UNDER CONSIDERATION WERE EXCLUDED; G. COMPANIES HAVING DIFFERENT FINANCIAL YEAR ENDING (I.E. NOT MARCH 31, 2007) OR DATA OF THE COMPANY WHICH DID NOT FALL WITHIN 12 MONTHS PERIOD I.E. 01/04/2006 TO 31/03/2007, WERE REJECTED; H. COMPANIES WHOSE EMPLOYEE COST TO OPERATING REVEN UES WAS LESS THAN 25% OF THE REVENUE WERE EXCLUDED; I. COMPANIES WHOSE ON-SITE REVENUE WAS MORE THAN 75 % OF THE EXPORT REVENUES WERE EXCLUDED; J. COMPANIES THAT WERE FUNCTIONALLY DIFFERENT FROM THAT OF THE TAX PAYER WERE EXCLUDED. APPLYING THE AFORESAID FILTERS, THE TPO IDENTIFIED 26 COMPARABLE COMPANIES WHICH WERE AS UNDER: 1) ACCEL TRANSMATIC LTD. (SEG.) 2) AVANI CIMCON TECHNOLOGIES LTD. 3) CELESTIAL LABS LTD. 4) DATAMATICS LTD. 5) E-ZEST SOLUTIONS LTD. 6) FLEXTRONICS SOFTWARE SYSTEMS LTD. (SEG.) 7) GEOMETRIC LTD. (SEG.) 8) HELIOS & MATHESON INFORMATION TECHNOLOGY LTD. 9) IGATE GLOBAL SOLUTIONS LTD. 10) INFOSYS TECHNOLOGIES LTD. 11) ISHIR INFOTECH LTD. 12) KALS INFORMATION SYSTEMS LTD. (SEG.) 13) LGS GLOBAL LTD. (LANCO GLOBAL SOLUTIONS LTD.) 14) LUCID SOFTWARE LTD. 15) MEDIASOFT SOLUTIONS LTD. 16) MEGASOFT LTD. 17) MINDTREE LTD. ITA NO. 5637/D/2011 71 18) PERSISTENT SYSTEMS LTD. 19) QUINTEGRA SOLUTIONS LTD. 20) R S SOFTWARE (INDIA) LTD. 21) R SYSTEMS INTERNATIONAL LTD. (SEG.) 22) SASKEN COMMUNICATION TECHNOLOGIES LTD. (SEG.) 23) SIP TECHNOLOGIES & EXPORTS LTD. 24) TATA ELXSI LTD. (SEG.) 25) THIRDWARE SOLUTIONS LTD. 26) WIPRO LTD. (SEG.) 35. LD. DRP DIRECTED THE TPO TO EXCLUDE TWO COMPAR ABLE COMPANIES VIZ PERSISTENT SYSTEMS LTD. & MEGA SOFT SOLUTIONS LTD. AFTER RECEIVING THE DIRECTIONS OF LD. DRP, THE AO ONLY EXCLUDED PERSIST ENT SYSTEMS LTD. AND COMPUTED THE ARMS LENGTH PROFIT MARGIN AT 23.90 A S UNDER: NAME OF THE COMPANY WORKING CAPITAL ADJUSTED OP/TC WORKING CAPITAL ADJUSTED OP/TC AS PER ORIGINAL TRANSFER PRICING ORDER AFTER THE DIRECTIONS OF HONBLE DRP-1 ACCEL TRANSMATIC LTD. (SEG.) 21.07% 21.07% AVANI CIMCON TECHNOLOGIES LTD. 49.91% 49.91% CELESTIAL LABS LTD. 55.26% 55.26% DATAMATICS LTD. 0.62% 0.62% E-ZEST SOLUTIONS LTD. 36.63% 36.63% FLEXTRONICS SOFTWARE SYSTEMS LTD. (SEG.) 26.17% 26.17% GEOMETRIC LTD. (SEG.) 10.80% 10.80% HELIOS & MATHESON INFORMATION TECHNOLOGY LTD. 35.51% 35.51% IGATE GLOBAL SOLUTIONS LTD. 6.82% 6.82% INFOSYS TECHNOLOGIES LTD. 40.03% 40.03% ISHIR INFOTECH LTD. 31.50% 31.50% KALS INFORMATION SYSTEMS LTD. (SEG.) 24.55% 24.55% ITA NO. 5637/D/2011 72 LGS GLOBAL LTD. (LANCO GLOBAL SOLUTIONS LTD.) 16.33% 16.33% LUCID SOFTWARE LTD. 2.80% 2.80% MEGASOFT LTD. 52.32% 52.32% MINDTREE LTD. 16.52% 16.52% PERSISTENT SYSTEMS LTD. 24.22% EXCLUDED AS PER DIRECTIONS OF THE HONBLE DRP QUINTEGRA SOLUTIONS LTD. 10.42% 10.42% R S SOFTWARE (INDIA) LTD. 14.31% 14.31% R SYSTEMS INTERNATIONALLTD. (SEG.) 14.42% 14.42% SASKEN COMMUNICATION TECHNOLOGIES LTD., (SEG.) 22.22% 22.22% SIP TECHNOLOGIES & EXPORTS LTD., 11.89% 11.89% TATA ELXSI LTD., (SEG.) 27.30% 27.30% THIRDWARE SOLUTIONS LTD., (SEG.) 22.66% 22.66% WIPRO LTD., (SEG.) 35.36% 35.36% MEAN 24.15% 23.90% 35.1 HE, ACCORDINGLY, MADE A TRANSFER PRICING ADJUS TMENT OF RS. 1055745127/- AS UNDER: PARTICULARS AMOUNT IN INR OPERATING COST OF THE ASSESSEE UNDER CSD SEGMENT (A) 6,350,000,000 ADD: MARK-UP @23.90% (AS PER HONBLE DRPS DIRECTIONS) (B) = (A*23.90%) 1,51,78,27,800 ALP OF CSD SEGMENT (C) = (A) + (B) 7,86,78,27,800 PRICE CHARGED IN THE INTERNATIONAL TRANSACTIONS RS. 6,812,082,673 SHORTFALL BEING ADJUSTMENT U/S 92CA RS. 1,05,57,45,127 ITA NO. 5637/D/2011 73 35.2 IN THE BACKDROP OF AFOREMENTIONED FACTS, THE A SSESSEE HAS ASSAILED THE ASSESSMENT ORDER ON VARIOUS GROUNDS WITH REFERE NCE TO SOFTWARE DEVELOPMENT SERVICE SEGMENT NOTED EARLIER. BEFORE WE CONSIDER SEPARATE GROUNDS, WE REPRODUCE T HE SUBMISSIONS OF LD. CIT(DR) WHICH WOULD BE RELEVANT FOR DIFFERENT GROUN DS MISCELLANEOUS 1. THE POWER OF TPO TO MAKE INQUIRIES U/S 133(6) HA S BEEN OKAYED IN A PLETHORA OF CASES. EVEN IF THE INFORMA TION GATHERED U/S 133(6) IS AT VARIANCE WITH PUBLISHED A NNUAL REPORT, INFORMATION OBTAINED BY TPO U/S 133(6) IS T O BE CONSIDERED MORE AUTHENTIC. (PL. SEE PARA 72 OF THE ORDER OF M/S TRILOGY E-BUSINESS SOFTWARE (I) P. LTD., ITA NO . 1054/BANG/2011, A.Y. 07-08, DTD. 23/11/2012. PARA 47 OF THIS ORDER IS AT VARIANCE WITH PARA 72). 2. IN A MEAN SITUATION, TRANSACTIONS ARE EVENED OUT . QUARK SYSTEMS (SB). PARA 25. ASSESSEES OWN CASE. 3. OECD NEED NOT BE RELIED UPON, WHEN WE HAVE OUR O WN LEGISLATION AND JURISPRUDENCE ON THE ISSUE. SUPPOR T IS FOUND FROM HONBLE DELHI HIGH COURT IN THE CASE OF M/S CIT VS. MENTOR GRAPHICS (NOIDA) P. LTD., ITA NO. 1114/2 008, DTD. 04/04/2013, PARA 25 THEREOF. ITA NO. 5637/D/2011 74 4. IN CASE OF ITES (AND LOGICALLY IT) SITUATION, EV EN 40% MARGIN IS COMPARED AS NORMAL. (M/S NEXTLINK INDIA P. LTD., ITA NO. 454/BANG/2011, DTD. 19/10/2012, PARA 40. 5. THERE CANNOT BE A SITUATION OF LOSS, IN A COST P LUS SITUATION, LIKE THE ASSESSEE WHICH IS GETTING REMUNERATED AT C OST + 7% PARA 85 OF M/S SAP LABS, 418/BANG/2008. 6. SOME OF THE ASSESSEES COMPARABLES HAVE BEEN FOU ND TO BE COMPARABLES IN OTHER CASE LAWS. FOR EG: - THE A SSESSEE HAS PLEADED THAT M/S CELESTIAL LABS LTD. IS NOT ACC EPTABLE AS PER HIS CASE LAW M/S TEVAPHARMA P. LTD. 6623/M/2 011, DTD. 23/12/2011, PARA 5 ON PAGES 29 AND 30. BUT IN ANOTHER CASE LAW RELIED UPON BY HIM FOR ANOTHER PRO POSITION (M/S TELECORDIA TECHNOLOGIES ITA NO. 7821/M/2011), PARA 6.3, PAGE 9, CELESTIAL LABS LTD., HAS BEEN FOUND TO BE COMPARABLE. 7. THE ITAT ORDER OF M/S PHILIPS SOFTWARE CENTRE P. LTD. ITA NO. 218/BANG/08, HAS BEEN STAYED BY HONBLE KARNATA KA HIGH COURT. HENCE, RELIANCE ON THIS ITAT ORDER, BY THE ASSESSEE IS MISPLACED. 8. THE ASSESSEE GETS REMUNERATED AT A LOWLY COST +7 %. 9. THE ASSESSEE HAS NOT ESTABLISHED AS TO HOW DO SO FTWARE PRODUCT COMPANIES DIFFER FROM OTHER SOFTWARE COMPAN IES, ITA NO. 5637/D/2011 75 IN TERMS OF FAR ANALYSIS. EVEN THE ASSESSEE HAD NO T RELIED UPON PRODUCT COMPANY AS A DISTINGUISHING FAC TOR. 10. ANY ADJUSTMENT HAS TO BE SUPPORTED BY ROBUST DA TA AND CORRELATION NEEDS TO BE ESTABLISHED, BY EMPIRICAL E VIDENCE. 11. THE TPO HAS USED CURRENT YEAR DATA ONLY, FOR WO RKING OUT THE MEAN. DATA OF EARLIER YEARS HAS BEEN USED FOR WORKING OUT THE TREND ONLY. THE ASSESSEE IS TRYING TO MISL EAD ON THIS ISSUE. 12. THE POWERS U/S 133(6) NEED TO BE USED BY THE TP O. THE ONLY FETTER IS THAT THE DATA SO OBTAINED IS TO BE S HARED WITH THE ASSESSEE IN CASE IT IS PROPOSED TO BE USED AGAI NST THE ASSESSEE. THE POWER OF TPO TO MAKE INQUIRIES U/S 133(6) HAS B EEN OKAYED IN A PLETHORA OF CASES. EVEN IF THE INFORMATION GATHERED U/S 133(6) IS AT V ARIANCE WITH PUBLISHED ANNUAL REPORT, INFORMATION OBTAINED BY TPO U/S 133(6) IS T O BE CONSIDERED MORE AUTHENTIC. (PL. SEE PARA 72 OF THE ORDER OF M/S TR ILOGY E-BUSINESS SOFTWARE (I) (P) LTD., ITA NO. 1054/BANG/2011, A.Y. 2007-08, DTD . 23/11/2012. PARA 47 OF THIS ORDER IS AT VARIANCE WITH PARA 72). SUPPORT IS FOUND FROM M/S WILLS PROCESSING MUMBAI ORDER, 8722/MUM/2010, DTD. 07/12/2012, PARA 26 THEREOF. M/S ACTIS P. LTD. 5277/D/11, PARA 37. ITA NO. 5637/D/2011 76 M/S TRILOGY E BUSINESS SOFTWARE INDIA P. LTD. ITA N O. 1054/BANG/2011, PARA 21 AND 22, AND PARA 72. THIS IS ASSESSEES OWN CASE LAW. IN THE CASE OF M/S HEADSTRONG SERVICES INDIA P. LTD ., ITA NO. 5466/D/2011, DTD. 17/07/2012, PARA 40, THE USE OF POWERS U/S 133(6) BY TPO HAS BEEN OKAYED. THIS CASE IS ONLY FOR PURPOSES OF MENTIONING, NOT BEING PART OF MAIN SUBMISSION. 13. EVEN ABNORMAL CIRCUMSTANCES NEED TO BE EXAMINED , WHETHER THEY HAVE THE ABILITY TO IMPACT, FAR ANALYS IS, M/S TRILOGY E BUSINESS SOFTWARE INDIA P. LTD. ITA NO. 1054/BANG/2011, PARA 36. (THIS IS ASSESSEES OWN C ASE LAW), IS BEING RELIED UPON. 14. ASSESSEES OWN COMPARABLES WERE MIXED UP IN TER MS OF FUNCTIONS, PRODUCTS, RISK, ENTREPRENEURSHIP ETC. T HE ENTITIES WHICH WERE NOT CAPTIVE, HAD ALREADY SUFFER ED COSTS WHICH HAD IMPACTED THEIR RESPECTIVE PROFIT AND LOSS ACCOUNTS. IN FACT THE ASSESSEE, A CAPTIVE, BY NOT INCURRING THESE COSTS WAS AT AN ADVANTAGE. 15. TO START WITH, ASSESSEES OWN BENCHMARKING MARG IN AT COST +7% WAS FAR BELOW ITS OWN SELF DETERMINED ARM S LENGTH MARGIN OF COST +10%. ITA NO. 5637/D/2011 77 16. EVERY PROPOSITION SOUGHT TO BE LAID DOWN BY THE ASSESSEE NEEDED TO BE CORRELATED BY EMPIRICAL DATA. THE ASS ESSEE FAILED TO DO SO. 36. AT THE TIME OF HEARING, LD. COUNSEL FOR THE AS SESSEE, DID NOT PRESS GROUND NOS. 4.1, 4.4, 4.5.1 & 4.5.2, 4.5.7, AND 4.5 .8. THEREFORE, THESE GROUNDS ARE DISMISSED AS NOT PRESSED. 37. APROPOS GROUND NO. 4.2, THE REASON FOR REJECTI NG THE USE OF MULTIPLE YEAR DATA HAS BEEN NOTED IN THE DEFECTS HIGHLIGHTED BY TPO. THE ASSESSEES CONTENTION IS THAT TPO HAS UTILIZED THE DATA FOR EA RLIER YEARS ALSO WHILE EXAMINING THE TREND OF COMPANIES INCURRING LOSSES. THEREFORE, THE MULTIPLE YEAR DATA SHOULD HAVE BEEN USED FOR COMPUTING THE AVERAG E MARGIN ALSO. 37.1 HAVING HEARD BOTH THE PARTIES, WE DO NOT FIND MUCH SUBSTANCE IN THE ARGUMENT OF LD. COUNSEL FOR THE ASSESSEE BECAUSE AS PER RULE 10B(4),THE DATA TO BE UTILIZED AND FOR ANALYZING THE COMPARABILITY OF UNCONTROLLED TRANSACTION WITH AN INTERNATIONAL TRANSACTION IS TO BE THE DATA RELATING TO THE FINANCIAL YEAR IN WHICH THE INTERNATIONAL TRANSACTION HAS BEEN ENTERE D INTO. AS PER PROVISO TO RULE 10D, EARLIER YEAR DATA CAN BE USED, IN ADDITIO N TO THE DATA PERTAINING TO THE RELEVANT FINANCIAL YEAR, ONLY FOR TAKING A DECISION AS TO HOW MUCH THE FACTORS OBTAINING IN EARLIER YEARS IMPACT THE PROFIT OF THE CURRENT YEAR, FOR BOTH THE TAX PAYER AND THE COMPARABLE. THEREFORE, AS RIGHTLY SU BMITTED BY LD.CIT(DR), IT HAS TO BE DEMONSTRATED AS TO HOW THE EARLIER YEAR CONDI TIONS HAVE INFLUENCED THE PROFIT OF THE RELEVANT FINANCIAL YEAR. SINCE ASSES SEE HAD NOT GIVEN DETAILS IN THIS REGARD, THEREFORE, THE TPOS ACTION WAS JUSTIFIED O N THIS COUNT. AT PAGES 17 TO ITA NO. 5637/D/2011 78 19, THE TPO HAS GIVEN VARIOUS JUDICIAL PRONOUNCEMEN TS HOLDING THAT ONLY CURRENT YEAR DATA HAS TO BE USED FOR CARRYING OUT T RANSFER PRICING ANALYSIS. LD. COUNSEL HAS VERY FAIRLY CONCEDED THAT THIS ISSUE ST ANDS DECIDED AGAINST THE ASSESSEE IN NUMEROUS CASES (MENTOR GRAPHICS (NOIDA) PVT. LTD. 109 ITD 101 DELHI, CUSTOMER SERVICES INDIA PVT. LTD. V ACIT 30 SOT 486. 37.2 IN VIEW OF ABOVE DISCUSSION, WE DO NOT FIND AN Y REASON TO INTERFERE WITH THE ORDER OF AO/TPO ON THIS COUNT. 38. IN THE RESULT, THIS GROUND IS DISMISSED. 39. VIDE GROUND NO. 4.3 THE ASSESSEE SUBMITS THAT SINCE IT WAS ENTITLED TO TAX HOLIDAY U/S 10A/10B OF THE ACT ON PART OF ITS P ROFIT FROM CSD SERVICES AND, THEREFORE, HAD NO MOTIVE OF DERIVING A TAX ADVANTAG E BY MANIPULATING TRANSFER PRICES OF ITS INTERNATIONAL TRANSACTIONS. IN THIS REGARD IT MAY BE POINTED OUT THAT THE COMPUTATION OF ARMS LENGTH PRICE IS TO BE DONE AS PER THE PROVISIONS CONTAINED UNDER CHAPTER X OF THE I.T. ACT DEALING W ITH SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAX. MERELY BECAUSE ASSES SEE WAS ENTITLED TO TAX HOLIDAY U/S 10A/10B OF THE ACT, IT CANNOT BE INFERR ED THAT INTERNATIONAL TRANSACTION HAS BEEN ENTERED INTO AS PER ARMS LENG TH PRICE. THERE IS NOTHING U/S 10A/10B WHICH ENTITLES AN ASSESSEE TO GET DEDUC TION IN RESPECT OF ADDITION MADE UNDER CHAPTER X. LD. COUNSEL FOR THE ASSESSEE FAIRLY CONCEDES THAT THIS ISSUE STANDS DECIDED AGAINST ASSESSEE BY TRIBUNAL I N FEW CASES INCLUDING AZTEC SOFTWARE V ACIT 294 ITR 32(SB). WE, THEREFORE, DO NOT FIND ANY SUBSTANCE IN THE GR OUND RAISED BY THE ASSESSEE. 40. IN THE RESULT, THIS GROUND IS DISMISSED. ITA NO. 5637/D/2011 79 41. GROUND NO. 4.5 REJECTING THE COMPARABILITY ANALYSIS IN THE TP DOCU MENTATION/ASSESSEES FRESH SEARCH AND IN CONDUCTING A FRESH COMPARABILITY ANAL YSIS BASED ON APPLICATION OF THE FOLLOWING ADDITIONAL/REVISED FILTERS IN DETERMI NING THE ALP FOR THE CSD SEGMENT: IN THIS REGARD LD. CIT (DR) HAS SUBMITTED AS UNDER. 1. DATA UPTO THE DATE OF ASSESSMENT IS ALLOWED TO BE USED BY THE TPO, AND THE TPO IS ALLOWED TO CARRY OUT A FRESH SEARCH. THE FOLLOWING CASE LAWS ARE BEING RELIED UPON: I. M/S MENTOR GRAPHICS - HONBLE DELHI HIGH COURT IN ITA NO. 1114/2008 DATED 04/04/2013, FOR THE PROPOSITION THA T A TPO, CAN CARRY OUT A FRESH SEARCH. II. M/S AZTEC SOFTWARE & TECHNOLOGY SERVICES LTD. ( 2007) 294 ITR (AT) 32, PAGE 130 THEREOF. III. M/S SYMENTEC MUMBAI, ITA NO. 7894/M/2010, A.Y. 2006-07, PARA IV. M/S ST MICRO DELHI [15 ITR (TRIB)410 DEL], PARA 28 TILL 32 OF THIS ORDER. [ITA 1806/1807/DEL/2008, ORDER DTD. 03/06/2 011]. V. M/S DELOITTE CONSULTING HYDERABAD ITA NO. 1082/1 084 OF 2010 (PARAGRAPH 30 THEREOF). VI. M/S CUSTOMER SERVICES (I) (P) LTD. (2009) (30 S OT 486 DELHI). FRESH SEARCH HAS BEEN APPROVED BY TPO IN THE AFORES AID CASES. 42. LD. COUNSEL FOR THE ASSESSEE DID NOT SERIOUSLY DISPUTED THE SUBMISSIONS OF LD. DR. THIS GROUND IS DISMISSED. ITA NO. 5637/D/2011 80 43. VIDE GROUND NO. 4.5.3 THE ASSESSEE HAS ASSAILED THE TPOS ACTION IN EXCLUDING COMPANIES WITH DIMINISHING REVENUES/PERSI STENT LOSSES FOR LAST THREE YEARS UPTO AND INCLUDING F.Y. 2006-07. LD. TPO EXC LUDED THE COMPANIES WITH CONSISTENT LOSSES ON THE GROUND THAT IN AN ENVIRONM ENT WHERE SOFTWARE SECTOR WAS GROWING AT A CAGR (COMPOUND ANNUAL GROWTH RATE) OF MORE THAN 30% DURING THE LAST 10 YEARS OR AT LEAST FOR THE LAST T HREE YEARS, THE COMPANY INCURRING CONSISTENT LOSSES CANNOT BE TAKEN AS A RE PRESENTATIVE OF THE INDUSTRY. THE ASSESSEES CONTENTIONS WERE AS UNDER: THE LOSS MAKING COMPANIES ARE AS MUCH A PART AND P ARCEL OF AN INDUSTRY AS ARE PROFIT MAKING COMPANIES; THE ARITHMETICAL MEAN IS A SCALE TENDENCY AND LOSS MAKING COMPANIES WOULD INTRODUCE SKEWNESS IN THE SET OF COMPARABLES THAT WOULD RESULT IN HIGHER MEAN MARGIN; THE RETENTION OF LOSS MAKING COMPANIES ALONG SIDE PROFITABLE COMPANIES TENDS TO EVEN OUT THE RISK PROFILE OF COMPARABLE CO MPANIES; IF LOSS MAKING COMPANIES ARE TO BE ELIMINATED ON T HE GROUND OF PREVIOUS YEAR LOSSES, THEN FOR OTHER PROFIT MAKING COMPANIE S, PREVIOUS YEAR AVERAGE FINANCIAL DATA SHOULD ALSO BE TAKEN INTO ACCOUNT RA THER THAN SINGLE YEAR FINANCIAL INFORMATION; THE TPO SHOULD RESTRICT THE FUNCTIONAL AND FINANCI AL DATA COMPARABILITY ONLY TO THE DATA OF THE RELEVANT FINANCIAL YEAR. THE TP OS APPROACH BY APPLYING CRITERIA FAVORABLE TO THE REVENUE WOULD BE PREJUDIC IAL TO THE INTEREST OF THE TAX PAYER. 44. THE TPO DID NOT ACCEPT THE ASSESSEES CONTENTI ON FOR THE FOLLOWING REASONS: A COMPANY WHOSE PERFORMANCE IS EXTREMELY DIVERGENT FROM THE NORMAL INDUSTRY TREND CANNOT BE CONSIDERED AS A NORMAL COMPARABLE. ON TH E FACE OF IT, THE CONTRARY BEHAVIOR ITA NO. 5637/D/2011 81 OF THE PARTICULAR COMPANY IS INDICATIVE OF SOME PEC ULIAR FACTS AND CIRCUMSTANCES OF THAT COMPANY WHICH LEAD TO SUCH DIVERGENT BEHAVIOR. THE OECD GUIDELINES SAY THAT EXCEPT IN START-UP SIT UATION, LOSS COMPANIES GENERALLY WILL NOT BE APPROPRIATE COMPARABLES FOR CONTROLLED COMPANIES, BECAUSE THEY OBVIOUSLY HAVE BORNE MORE RISK THAN CONTROLLED COMPANIES NORM ALLY ARE EXPECTED TO BEAR. THE LOSS MAKING COMPARABLES MAY PERFORM SAME FUNCTI ONS, USING GREATER ASSETS, AND/OR ASSUMING GREATER RISKS THAN THE TESTED PARTY , THEREFORE, PERSISTENT LOSS OBSERVED IN THE PROPOSED COMPARABLES UNDERSTATE THOSE THAT W OULD BE EXPECTED IN THE TESTED PARTY. THE TAXPAYERS ARGUMENT IS THAT ARITHMETICAL MEAN I S A CENTRAL TENDENCY AND THUS, LOSS MAKING COMPANIES SHOULD ALSO BE CONSIDERED. IN THI S REGARD, IT IS VERY PERTINENT TO MENTION HERE THAT THE TPO DID NOT EXCLUDE LOSS MAKI NG COMPANIES. HE EXCLUDED ONLY PERSISTENT LOSS MAKING COMPANIES. THE COMPARABILIT Y EXERCISE CANNOT BE RELAXED JUST TO GET A LOSS MAKING COMPANY AS A COMPARABLE. THE TAXPAYERS ARGUMENT THAT THE RETENTION OF LOSS MAKING COMPANIES ALONGSIDE PROFITABLE COMPANIES TENDS TO EVEN OUT THE RISK PRO FILE OF COMPARABLE COMPANIES IS ALSO FAR FETCHING. IF THE RISK OF A COMPARABLE COMPANY IS VERY HIGH, THE SAME IS NOT COMPARABLE AS THE TAXPAYER AND OTHER COMPARABLE COM PANIES ARE NOT ASSUMING THAT EXTREME RISK RESULTING IN PERSISTENT LOSSES. AS ME NTIONED ABOVE, JUST BECAUSE MEAN TAKES CARE OF DIFFENCES IN RISK, EVERY LOSS MAKING SOFTWARE DEVELOPMENT COMPANY CANNOT BE CONSIDERED AS A COMPARABLE IF IT HAS PERSISTENT LOSS ARISING DUE TO THE PECULIAR ECONOMIC CIRCUMSTANCES WITH ITS GREATER ASSETS THAN THE TESTED PARTY. THEREFORE, PERSISTENT LOSSES OBSERVED IN THE PROPOSED COMPARAB LES UNDERSTATE THOSE THAT WOULD BE EXPECTED IN THE TESTED PARTY. THE TAX PAYER ARGUED THAT THE TPO HAS USED THE MULT IPLE YEAR DATA FOR HIS COMPARABILITY STUDY, WHEREAS, THE TAX PAYER HAS BEE N DENIED USING THE MULTIPLE YEAR DATA WHILE COMPUTING THE MEAN ALP. IN THIS ORDER, MULTIPLE YEAR DATA HAS BEEN USED ONLY TO FIND OUT WHETHER THE COMPARABLE COMPANY IS PERSISTENTLY IN LOSSES YEAR AFTER YEAR. APPARENTLY THE TAXPAYER HAS CONFUSED USE OF MULTIPLE YEAR DATA FOR FUNCTIONAL ANALYSIS OF A COMPARABLE WITH USE OF THE SAME FOR W ORKING OUT THE ARITHMETICAL MEAN ITA NO. 5637/D/2011 82 PLI. ONCE A COMPARABLE COMPANY IS SELECTED, ITS MA RGIN OF THE RELEVANT FINANCIAL YEAR ONLY IS CONSIDERED FOR DETERMINING THE PLI. THEREF ORE, THERE IS NO INCONSISTENCY IN USE OF MULTIPLE YEAR DATA TO EXAMINE THE COMPARABILITY OF A COMPANY AND ONCE THE COMPANY IS FOUND COMPARABLE, ONLY ITS CURRENT YEARS PLI HA S BEEN CONSIDERED. IT IS ONLY TO SEE THE FUNCTIONALITY AND THE PECULIAR FEATURES OF A CO MPARABLE SO AS TO KNOW WHETHER THE COMPARABLE IS OPERATING IN COMPARABLE (ECONOMIC) CI RCUMSTANCES. THIS ISSUE HAS BEEN DEALT BY ITAT, DELHI BENCH IN T HE CASE OF SONY INDIA (P) LIMITED VS. DCIT, (114 ITD 448) AS UNDER IN FAVOUR OF THE REVEN UE. GODREJ IN THE FIRST PLACE IS MAKING REFRIGERATOR A ND NOT TVS. SECONDLY, IT HAS SUFFERED HUGE LOSSES OVER A PERIOD OF SEVERAL YEARS. IT HAS RECORDED NEGATIVE GROWTH AS ADMITTED AT PAGE 6 & 7 OF ITS ANNUAL REPORT FOR F.Y. 2000-01 . IT HAD HUGE UNUTILIZED CAPACITY. IT NEEDS FINANCIAL RESTRUCTURING. IT IS CARRYING ON D ISPUTES ON ACCOUNT OF DEMANDS RAISED BY PUNJAB SMALL SCALE INDUSTRIES AND EXPORT CORPN. LTD., APART FROM THE DISPUTES MADE BY ITS EMPLOYEES FOR INCREASED WAGES, REINSTATEMENT OR TERMINATION AND SUSPENDED EMPLOYEES. THE JOINT VENTURE OF THE COMPANY STANDS TERMINATED. ALL THIS IS ADMITTED IN THE OFFICIAL REPORT OF GODREJ. BESIDES, IT IS ALSO CARRYING ON RELATED PARTY TRANSACTIONS. EACH OF ABOVE FACTORS WHICH IS CONSIDERED AND HIGHL IGHTED IN THE ANNUAL REPORT, MAY NOT HAVE A SIGNIFICANT EFFECT, IF TAKEN SINGLY. HOWEVER, WHEN CUMMULATIVE EFFECT OF ALL THE FACTORS IS CONSIDERED, ONE GETS A TOTALLY DIFFE RENT PICTURE. IT HAS THEREFORE TO BEHELD THAT GODREJ WAS RIGHTLY EXCLUDED FROM THE LI ST OF THE COMPARABLES. WE CONCUR WITH THE VIEW TAKEN BY THE REVENUE AUTHORITIES AND REJECT ALL THE ARGUMENTS ADVANCED BY LD. COUNSEL FOR THE TAXPAYER. THIS GROUND OF APPEA L IS REJECTED. AS MENTIONED ABOVE, THE PERSISTENT LOSSES FILTER IS A TOOL TO SEE THE EXCEPTIONAL CIRCUMSTANCES IN A COMPARABLE COMPANY. THUS, IN SUMMARY, THE TPO HAS NOT EXCLUDED LOSS MAK ING CASES. TPO HAS EXCLUDED ONLY THOSE COMPANIES WHICH INCURRED PERSISTENT LOSS ES OVER A PERIOD OF THREE YEARS. THIS STAND HAS BEEN APPROVED IN THE JUDICIAL PRONOU NCEMENTS IN THE CASE OF QUARK SYSTEMS PVT. LTD. 2010-TIOL-31-ITAT-CHD-SB AND SONY INDIA LTD. 114 ITD 488 (DEL) WHEREIN THE REJECTION OF COMPARABLES HAVING PERSIST ENT LOSSES, DIMINISHING ITA NO. 5637/D/2011 83 REVENUE, RESTRUCTURING, ETC. WAS UPHELD. IN FACT I N THE RECENT DECISION OF THE HONBLE ITAT BANGALORE IN THE CASE OF SAP LABS LTD., THE IT AT HAS REMOVED ALL COMPARABLES THAT HAD A LOSS IN THE RELEVANT FINANCIAL YEAR. TH E TPO HAS ONLY REMOVED COMPARABLES THAT ARE PERSISTENT LOSS MAKERS. 45. THE ASSESSEE FILED OBJECTIONS BEFORE DRP. LD. DRP AFTER CONSIDERING THE ASSESSEES OBJECTIONS, CONFIRMED TH E TPOS ACTION. LD. DRP ALSO REFERRED TO REVISED OECD GUIDELINES, 2010 WHIC H ALSO SUPPORTS THIS INSTANCE. THEY REFERRED TO PARA 6.63 WHICH STATE T HAT WHERE ONE OR MORE OF THE COMPARABLES HAVE EXTREME RESULTS, FURTHER EXAMINATI ON WOULD BE NEEDED TO UNDERSTAND THE REASON FOR SUCH EXTREME RESULT. FURT HER IN PARA 3.64 IT IS STATED THAT AN INDEPENDENT ENTERPRISE WOULD NOT CONTINUE L OSS GENERATING ACTIVITIES UNLESS IT HAD REASONABLE EXPECTATION OF FUTURE PROF IT. IN PARA 3.65 IT IS STATED THAT A LOSS MAKING UNCONTROLLED TRANSACTION SHOULD TRIGG ER FURTHER INVESTIGATION IN ORDER TO ESTABLISH WHETHER OR NOT IT CAN BE A COMPA RABLE. CIRCUMSTANCES IN WHICH LOSS MAKING TRANSACTIONS/ENTERPRISES EXCLUDED FROM THE LIST OF COMPARABLES INCLUDE CASES WHERE LOSSES DO NOT REFLE CT NORMAL BUSINESS CONDITION, AND WHERE THE LOSSES INCURRED BY THE THI RD PARTIES REFLECT A LEVEL OF RISK THAT IS NOT COMPARABLE TO THE ONE ASSUMED BY T HE TAX PAYER IN ITS CONTROLLED TRANSACTIONS. IT IS CLARIFIED BY THE OECD GUIDELIN ES THAT LOSS MAKING COMPARABLES THAT SATISFIED THE COMPARABILITY ANALYS IS SHOULD HOWEVER, NOT BE REJECTED ON THE SOLE BASIS THAT THEY SUFFER LOSSES. LD. DRP POINTED OUT THAT SINCE TPO HAS INDIVIDUALLY EXAMINED EACH OF THE COM PARABLE, LOOKED INTO THE ECONOMIC CIRCUMSTANCES AS TO WHY SUCH COMPARABLE WA S INCURRING LOSSES AND ITA NO. 5637/D/2011 84 CONFIRMED THE SAME WITH ECONOMIC CIRCUMSTANCE OF TH E TESTED PARTY, THAT IS THE ASSESSEE, THEREFORE, THE TPO HAD APPROPRIATELY APPL IED THIS FILTER. 46. LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT TH IS FILTER IS NOT AN APPROPRIATE FILTER TO BE APPLIED FOR THE PURPOSE OF COMPARABILITY ANALYSIS FOR THE FOLLOWING REASONS: 1. THE COMPANY IS JUDGED AS COMPARABLE OR OTHERWISE BASED ON PARAMETERS RELATING TO FUNCTIONS RISKS AND ASSETS. THE COMPAR ABILITY ANALYSIS AS PER LAW HAS TO BE IN ACCORDANCE WITH RULE 10B(2) OF THE INC OME TAX RULES. 2. DIMINISHING REVENUE DOES NOT MEAN THAT A COMPANY IS FUNCTIONALLY NOT COMPARABLE. FURTHER REASONS OF DIMINISHING REVENUE SHOULD BE INVESTIGATED AND IN CASE ANY ABNORMAL FACTOR IS FOUND TO BE PRES ENT THEN THE COMPANY SHOULD BE EXCLUDED FROM THE LIST OF COMPARABLE COMP ANY. 3. LD. TPO HAS CONSIDERED THE DATA FOR PREVIOUS THR EE YEARS TO APPLY THIS FILTER OF DIMINISHING REVENUE. THUS, THERE IS A COMPLETE CONTRADICTION IN TPOS OWN APPROACH OF USING ONLY CURRENT YEAR DATA AS PER RUL E 10B(4). 4. THE TPO HAS REJECTED THE COMPANIES WITH DIMINISH ING REVENUE BUT ACCEPTED COMPANIES WITH ABNORMAL REVENUE TREND, SUC H AS AVANI CIMCON TECHNOLOGIES LTD., HELIOS & MATHESON INFORMATION TE CHNOLOGY & LUCID SOFTWARE LTD. WHICH HAS SHOWN MORE THAN 60%, 50% & 65% GROWTH IN ONE YEAR RESPECTIVELY. THUS, TPO HAS BEEN SELECTIVE IN HIS APPROACH. THE TPOS REASONING THAT COMPANIES INCURRING PERSISTENT LOSSE S ARE MOVING CONTRARY TO THE GROWING MARKET IS NOT CORRECT BECAUSE THE AVERAGE R ATE OF GROWTH OF THE MARKET IS AVERAGE OF RATES OF GROWTH ACROSS THE INDUSTRY W HICH INCLUDES ALL TYPES OF ITA NO. 5637/D/2011 85 COMPANIES AND COMPANIES THAT GROW MUCH FASTER THAN THE AVERAGE, COMPANIES WHICH GROW MUCH LOWER THAN THE AVERAGE AND COMPANIE S THAT GROW CLOSE OR AROUND THE AVERAGE. THE RATIONAL OF TAKING THE ARI THMETIC MEAN OR THE AVERAGE AS THE ARMS LENGTH RATE IS BASED ON THIS PRINCIPLE . EXCLUSION OF LOW OR LOSS MAKING COMPANIES MAKES THE AVERAGE MARGIN ARTIFICIA LLY SCREWED TO THE PROJECT OF THE ASSESSEE BECAUSE WHILE THE COMPARABLES AT TH E LOWER END OF THE RANGE ARE EXCLUDED THOSE AT THE HIGHER END WERE LEFT UNTO UCHED. LD. COUNSEL POINTED OUT THAT AUDITORS CERTIFY A COMPANY AS SICK IN THE AUDIT REPORT IF THE LOSSES ARE VERY HIGH, THEREFORE, THE ANNUAL REPORT OF SUCH COM PANIES SHOULD BE ANALYZED BEFORE REJECTING THEM. MARGIN CANNOT BE STARTING P OINT OF DETERMINATION OF ARMS LENGTH MARGIN BUT IT IS THE END RESULT OF A CAREFUL PROCESS OF FUNCTIONAL AND ECONOMIC ANALYSIS PROVIDED UNDER LAW. THE ASSESSEE RELIED ON FOLLOWING CASE LAWS: S.NO. NAME OF THE CASE RELEVANT EXTRACT FORM THE CASE LAW 1. TRILOGY E BUSINESS INDIA SOFTWARE P. LTD., ITA NO. 1054/BANG/2011 PARA 35 IT HAS BEEN HELD THAT PROFIT/LOSS SHOULD NOT DETERMINE THE FUNCTIONAL COMPARABILITY AND THE SPECIFIC REASONS OF LACK OF COMPARABILITY SHOULD BE BROUGHT OUT. 2. EXXON MOBIL CO. INDIA P. LTD., ITA NO. 8311/MUM./2010 PARA 33(XI) IF A LOSS MAKING COMPANY IS TO BE EXCLUDED THEN ON THE SAME PRINCIPLE ABNORMAL PROFIT MAKING COMPANY SHOULD ALSO BE EXCLUDED. THE REASONS FOR REJECTING THE COMPARABLE COMPANY SHOULD NOT BE JUST LOSS MAKING RATHER THEIR FUNCTIONAL ITA NO. 5637/D/2011 86 COMPARABILITY. THUS, THE REASONS FOR REJECTION SHOULD CLEARLY BE BROUGHT OUT. 3. QUARK SYSTEMS PRIVATE LIMITED, 32 TTJ 1 (SB) (CHD.) PARA 25 THE TRIBUNAL HELD THATIT IS OBVIOUS THAT THE VERY RATIONALE OF HAVING AVERAGE IN CASE OF MORE THAN ONE TRANSACTION IS TO IRON OUT THE EFFECT OF EXTREME CASES IN FINDING THE PROFIT MARGIN AS A REPRESENTATIVE OF THE WHOLE LOT. 47. LD. (CIT) DR SUBMITTED THAT PERSISTENT LOSSE S DEPICTS EXISTENCE OF ABNORMAL CIRCUMSTANCES. LD. DR FURTHER REFERRED TO PAGE 321 OF APPEAL SET (PAGE 53 OF TRANSFER PRICING OFFICERS ORDER), WHER EIN TPO HAS SUMMARIZED HIS CONCLUSION ON THIS ISSUE, NOTED EARLIER. 47.1 LD. DR FURTHER CLARIFIED THAT DATA FOR LAST TH REE YEARS HAS NOT BEEN USED TO WORK OUT THE MEAN BUT TO WORK OUT THE TREND . HE SUBMITTED THAT ONLY ONE YEAR DATA HAS BEEN USED FOR COMPUTING ARITHMETI C MEAN. LD. DR FURTHER POINTED OUT THAT IN SOFTWARE INDUSTRY THERE IS NO I NSTALLED CAPACITY BUT THE ACTIVITY IS PERSONAL EXTRINSIC. THE PERSISTENT LOSSES IN SU CH AN INDUSTRY IS AN INDICATOR OF ASSESSEE NOT UTILIZING ITS FULL CAPACITY, WHICH IS AN ABNORMAL FACTOR, MAKING THE COMPANY NON-COMPARABLE. LD. DR FURTHER CLARIFIED T HAT LOSS MAKING COMPANIES AND PERSISTENT LOSSES MAKING COMPANIES ARE TWO DIFF ERENT ASPECTS AND IT IS ONLY THE PERSISTENT LOSS MAKING COMPANIES THAT HAVE BEEN EXCLUDED BY TPO. 47.2 LD. CIT(DR) SUBMITTED AS UNDER:- ITA NO. 5637/D/2011 87 EXCLUSION OF COMPANIES WITH DIMINISHING REVENUES/PE RSISTENT LOSSES FOR LAST THREE YEARS UPTO AND INCLUDING F.Y. 2006-07. COUNTER : IT IS SUBMITTED THAT ONLY CURRENT YEARS DATA HAS B EEN USED FOR WORKING OUT THE MEAN. EARLIER YEARS DATA HAS BEEN SEEN, ONLY TO W ORK OUT THE TREND, SINCE REVENUE IS USING THE FILTER OF DIMINISHING REVENUE/ PERSISTENT LOSSES. IT IS MADE CLEAR THAT DATA OF EARLIER YEARS HAS NOT BEEN USED TO WORK OUT THE MEAN. (PAGES 51 TILL 55 OF TPOS ORDER HAVE ELABORATION O F THIS ISSUE) THE CASE LAWS IN SUPPORT ARE I. M/S ACTIS ADVISERS (P) LTD. DELHI 5227/DEL/201 1, (PARAGRAPH 22) II. M/S BRIGADE GLOBAL 1494/HYD./2012, A.Y. 2004- 05 (PARA 26 LAST 4 LINES) III. FILTER OF REJECTION OF PERSISTENT LOSSES OKAYE D IN M/S CRM SERVICES (I) (P) LTD. 4068/4796/DEL/2010, DTD. 30/06/2011 (P ARAS 13, 13.1 AND 13.2) IV. THESE FILTERS HAVE ALSO BEEN OKAYED IN M/S QUAR K SYSTEMS 4 ITR (TRIB.) 606. V. M/S SONY INDIA P. LTD. VS. DCIT 114 ITD 448 (I NTERNAL PAGE 54 OF TPOS ORDER) VI. NAVISITE INDIA PVT. LTD., ITA NO. 5329/DEL/2012 DA TED 31 ST MAY,2013. ITA NO. 5637/D/2011 88 THE ASSESSEE HAS TRIED TO SIDETRACK THE ISSUE BY BR INGING IN ISSUE OF VOLATILITY OF MARGINS AND EXTREME RESULTS. THIS IS NOT THE CASE HERE. 48. LD. COUNSEL IN THE REJOINDER SUBMITTED THAT TH E DECISIONS RELIED UPON BY LD.CIT(DR) ARE DISTINGUISHABLE AND MADE FOLLOWIN G SUBMISSIONS: 48. THE DECISION OF SONY INDIA V. DCIT (114 ITO 4 48) SUPPORTS THE CASE OF THE APPELLANT. IN THIS CASE THE HON'BLE ITAT HELD THAT A PERSISTENT LOSS MAKING COMPANY LIKE GODREJ HAS TO BE EXCLUDED FROM THE LIST OF COMPARAB LES NOT BECAUSE IT WAS MAKING LOSSES BUT THERE WERE NUMEROUS FACTORS DEMONSTRATIN G EXTRAORDINARY ECONOMIC CIRCUMSTANCES (LIKE LABOUR ISSUES, FINANCIAL RESTRU CTURING AND HUGE UNUTILIZED CAPACITY). PLEASE REFER TO PAGE 322 OF THE APPEAL (INTERNAL PA GE 54 OF THE TP ORDER) WHERE THE LD. TPO HAS REPRODUCED THE RELEVANT EXTRACT FROM THIS D ECISION. 49.SIMILARLY, THE SPECIAL BENCH DECISION OF QUARK S YSTEMS 32 TTJ I ALSO SUPPORTS THE ASSESSEE'S CONTENTION THAT JUST BECAUSE A COMPANY I S MAKING LOSS IT CANNOT BE EXCLUDED. IF THE LOSS IS ON ACCOUNT OF NORMAL BUSINESS REASON S SUCH AN EXCLUSION IS NOT PERMISSIBLE. THIS CASE WAS RELIED UPON BY THE HON'B LE ITAT IN BRIGADE GLOBAL ITA 1494/HYD/2010 WHICH HAS BEEN CITED BY THE LD. CIT ( DR) (PARA 26 OF THIS RULING). THE HOLDING IN THIS CASE IS IN FAVOUR OF THE ASSESSEE. 50.THE RELIANCE ON THE ACTIS ADVISERS PVT ITD ITA 5 277/0EI/20 II (PARA 22) IS AGAIN MISPLACED AS THE ISSUE IN THIS CASE, AS IS EVIDENT FROM THE READING OF PARAS 2 I AND 22 OF THE ORDER, WAS THE JUSTIFICATION OF INCLUDING A PAR TICULAR COMPARABLE MAPLE E-SOLUTION WHICH HAD WILDLY FLUCTUATING MARGINS RANGING FROM L OSS OF 100% TO PROFITS OF 37.38%. THE HON'BLE ITAT WAS NOT ADJUDICATING THE APPLICABI LITY OF A FILTER OF DIMINISHING REVENUE OR PERSISTENT LOSSES AT A GENERAL LEVEL BUT ONLY IN RESPECT OF A PARTICULAR COMPARABLE. 51.SIMILARLY, RELIANCE ON CRM SERVICES INDIA PVT. L TD. ITA NO. 4068/0E1/2009 IS ALSO OF NO ASSISTANCE TO THE REVENUE AS THE ISSUE IN THI S CASE WAS INCLUSION/EXCLUSION OF A ITA NO. 5637/D/2011 89 PARTICULAR COMPARABLE WHOSE CAPITAL BASE HAD BEEN ERODED DUE T O PERSISTENT LOSSES. (PLEASE REFER TO PARA 13.2 OF THE ORDER). THE QUESTION OF S UITABILITY OF THE FILTER OF PERSISTENT LOSSES OR DIMINISHING REVENUE WAS NOT BEFORE THE HON'BLE ITAT . 52.THE INDUSTRY IS AN AVERAGE OF BOTH HIGH AND LOW PROFIT EARNING COMPANIES. FURTHER IN THE SEARCH PROCESS UNDERTAKEN BY THE LD. TPO 51 OUT OF A TOTAL OF 765 COMPANIES SHOWED DIMINISHING REVENUE WHICH IS APPROXIMATELY 7% OF TH E INDUSTRY SELECTION MADE BY THE TPO. THIS MEANS IF HE ELIMINATES COMPANIES WITH DIMINISH ING REVENUE THEN HE IS ELIMINATING 7% OF THE TOTAL POPULATION OF THE COMPARABLES 53.THE SWEEPING GENERALIZATION THAT PERSISTENT LOSS ES SHOW SOME ABNORMAL ECONOMIC CIRCUMSTANCES IS BASED ON CONJECTURES. THERE IS NO SUCH ECONOMIC PRINCIPLE OR CORRELATION THAT CAN BE SUBSTANTIATED. INCIDENCE OF LOSS USUALLY ARI SES DUE TO MARKET FORCES - COMPETITION, EMERGENCE OF NEW TECHNOLOGY OR PROCESSES, INCREASE IN COSTS, VARIATION IN DEMAND AND SUPPLY - AND THESE ARE ALL NORMAL ECONOMIC FACTORS WHICH IMP ACT ALL INDUSTRY PLAYERS. IT IS JUST THAT SOME COMPANIES ARE BETTER ABLE TO RESPOND TO THESE FACTO RS THAN OTHERS WHICH LEADS TO A SITUATION WHERE SOME COMPANIES MAKES PROFITS WHILE FEW OTHERS MAKE LOSSES. ONLY DIMINISHING REVENUE OR CONSISTENT LOSSES CANNOT BE TERMED AS AB NORMALITY IN ANY INDUSTRY. FOR THE PURPOSE OF CHOOSING COMPARABLES, ONE HAS TO LOOK AT THE FAC TORS OF COMPARABILITY PROVIDED IN RULE 108(2) - WHICH ARE CHARACTERISTICS OF GOODS AND SERVICES; FUNCTIONS, ASSETS AND RISKS; CONTRACTUAL ARRANGEMENTS; AND CHARACTERISTIC S OF THE MARKET ETC .. DECLINING REVENUES AND PERSISTENT LOSSES ARE NOT FACTORS OF COMPARABIL ITY BUT MERELY MANIFESTATIONS OF A COMPANY'S ABILITY TO RESPOND TO THE MARKET CONDITIO NS. 54.FURTHER FINAL COMPARABLE COMPANIES SELECTED BY T HE TPO, IN HIS TP ORDER, DO NOT SHOW A UNIFORM TREND. IT HAS BEEN HIGHLIGHTED BY THE APPEL LANT THAT MANY OF THE COMPANIES SELECTED BY ID. TPO HAVE WITNESSED A DECLINE IN REVENUE IN THE FUTURE YEARS WHILE THEY HAVE RETAINED HEALTHY PROFIT AND ARE FUNCTIONALLY COMPARABLE. IF THE FILTER OF DIMINISHING REVENUE WAS TO BE ACCEPTED THEN IT WOULD LEAD TO AN ANOMALY THAT A CO MPANY MAY BE COMPARABLE IN ONE YEAR BUT NOT IN THE OTHER DESPITE NO CHANGE IN THE FUNCTIONA L PROFILE. 55.THE LD. CIT (DR) IS OF THE VIEW THAT DATA FOR MU LTIPLE YEAR IS USED ONLY FOR WORKING ITA NO. 5637/D/2011 90 OUT THE TRENDS AND NOT TO COMPUTE THE MARGINS OF TH E COMPARABLE COMPANIES. HEREIN THE APPELLANT WOULD LIKE TO HIGHLIGHT RULE 10B(4) WHICH STATES AS BELOW: 'THE DATA TO BE USED IN ANALYSING THE COMPARABILITY OF AN UNCONTROLLED TRANSACTION WITH AN INTERNATIONAL TRANSACTION SHALL BE THE DATA RELA TING TO THE FINANCIAL YEAR IN WHICH THE INTERNATIONAL TRANSACTION HAS BEEN ENTERED INTO' 56.IT IS QUITE EVIDENT FROM THE ABOVE THAT THE DATA USED FOR COMPARABILITY ANALYSIS SHOULD BE THAT OF THE CURRENT FINANCIAL YEAR. THE L D. TPO HAS IN THIS CASE CONSIDERED THE REVENUE AND LOSS TREND OF EARLIER YEARS IN ORDE R TO DETERMINE THE COMPARABILITY WHICH IS NOT IN ACCORDANCE WITH THE SAID RULE. A BA RE PERUSAL OF RULE 108(4) MAKES IT CLEAR THAT THE CONTENTION OF THE LD. CIT DR, THAT E ARLIER YEAR DATA IS USED ONLY FOR THE PURPOSE OF COMPUTING MEAN, IS NOT TENABLE. 57.FURTHER THE APPELLANT WISHES TO HIGHLIGHT THAT T HE BUSINESS CYCLE FOR ANY COMPANY STARTS FROM A TROUGH (LOWER POINT) AND PASSES THROU GH A RECOVERY PHASE FOLLOWED BY A PERIOD OF EXPANSION (UPPER TURNING POINT) AND PROSP ERITY. AFTER THE PEAK POINT IS REACHED THERE IS A DECLINING PHASE OF RECESSION FOL LOWED BY A DEPRESSION. AGAIN THE BUSINESS CYCLE CONTINUES SIMILARLY WITH UPS AND DOW NS. 58.THUS, EVERY COMPANY WOULD BE IN A DIFFERENT PHAS E OF BUSINESS CYCLE AT A GIVEN POINT OF TIME AND THUS ELIMINATION OF A COMPANY BASED ON THE REVENUE/PROFIT WOULD NOT BE CORRECT. 59.ON THE ISSUE OF UNDERUTILIZATION OF CAPACITY AS POINTED OUT BY THE LD. CIT DR, THE APPELLANT WISHES TO SUBMIT THAT A DECLINING SALES W OULD NOT ALWAYS MEAN AN UNDERUTILIZATION OF CAPACITY. INCREASE OR DECREASE OF SALES CAN BE BECAUSE OF INCREASE OR DECREASE OF HOURLY RATES CHARGED BY THE SOFTWARE COMPANIES DUE TO VARIATION OF DEMAND AND SUPPLY. FURTHERMORE, IN THE SOFTWARE IND USTRY CAPACITY CAN BE INCREASED OR DECREASED QUITE QUICKLY DEPENDING UPON MARKET NEEDS BECAUSE RECRUITMENT OR RETRENCHMENT OF SOFTWARE PERSONNEL CAN EASILY BE CA RRIED OUT. THIS IS WELL-KNOWN INDUSTRY PRACTICE OF THIS SECTOR. IT IS FOR THIS RE ASON THAT DECREASE IN SALES NEED NOT NECESSARILY LEAD TO DECR EASE IN PROFIT MARGIN - BECAUSE LOSS ITA NO. 5637/D/2011 91 IN REVENUE IS MATCHED BY PLANNED REDUCTION OF CORRE SPONDING COST ARISING FROM RETRENCHMENT OF EXCESS WORK-FORCE. SO IN THESE CASE S WHEN THERE IS A DECLINE IN SALES THE CORRESPONDING COSTS ALSO COME DOWN, AND AS CONTENDE D BY LD. CLT DR IT IS NOT NECESSARY THAT DECLINING SALES WOULD ALWAYS HAVE AN ADVERSE EFFECT ON PROFITABILITY. IN THIS REGARD, THE APPELLANT PLACES RELIANCE ON THE I TAT RULING OF CAPGEMINI INDIA PVT. LTD. ITA NO. 7861/MUM/2011. 60.IN ORDER TO SUBSTANTIATE OUR POINT WE WISH TO HI GHLIGHT SOME OF THE COMPANIES REJECTED BY THE ID. TPO ON DECLINING SALES FILTER W HICH HAVE ACTUALLY WITNESSED AN INCREASING TREND IN PROFIT DURING THESE YEARS OP/OC MARGINS SALES IN CRORES COM PANY NAM E 2 0 0 4 - 0 5 2 0 0 5 - 0 6 2 0 0 6 - 0 7 2 0 0 4 - 0 5 2 0 0 5 - 0 6 2 0 0 6 - 0 7 MAS CON GLOB AL LTD. N A 1 2 . 2 1 % 3 3 . 8 2 % N A 1 8 1 . 7 5 1 4 0 . 7 1 PENT ASOFT TECH NOLO GIES LTD. [ME RGED ] 6 . 9 6 % 7 . 5 1 % 8 . 2 5 % 5 5 . 9 4 1 6 . 1 7 9 . 4 5 THUS, THERE IS NO CORRELATION BETWEEN DECLINE OR IN CREASE IN SALES AND THE MARGINS. 48.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND H AVE PERUSED THE RECORD OF THE CASE. THE TPO HAD EXCLUDED THE COMPA NIES WITH DIMINISHING REVENUE BECAUSE IN AN ENVIRONMENT WHERE SOFTWARE SE CTOR IS GROWING AT A CAGR (COMPOUNDED ANNUAL GROWTH RATE) OF MORE THAN 3 0% DURING THE LAST 30 YEARS, DIMINISHING REVENUE FOR THE LAST 3 YEARS CAN NOT BE SAID TO BE A TRUE INDICATOR OF THE PERFORMANCE OF THE COMPANY. IN TH IS REGARD WE FIND THAT TPO ITA NO. 5637/D/2011 92 HAD UNDERTAKEN AN INDEPENDENT ANALYSIS WHICH WAS BA SED ON VARIOUS SOURCES INCLUDING NASSCOM REPORTS, ARTICLES APPEARING IN PR INT MEDIA AND ON THE INTERNET ETC. IT WAS FOUND THAT DURING THE LAST D ECADE THE INFORMATION TECHNOLOGY INDUSTRY IN INDIA EMERGED AS AN IMPORTAN T CONSTITUENT OF THE GLOBAL SOFTWARE INDUSTRY. THE FOLLOWING IMPORTANT ASPECTS WERE NOTICED IN THIS REGARD: THE INDIAN IT INDUSTRY IS BROADLY CATEGORIZED INTO IT SERVICES AND SOFTWARE, ITES/BPO AND SOFTWARE SEGMENT; THE INDIAN IT INDUSTRY STOOD AT US 37.5 MILLION DO LLARS IN F.Y. 2005-06 AND US 48 BILLION DOLLARS IN F.Y. 2006-07 IN TERMS OF R EVENUE, TRANSLATING INTO A GROWTH RATE OF 28% Y-O-Y THE TOTAL IT INDUSTRY CONTRIBUTION TO THE INDIAN G DP HAD INCREASED FROM 1.4% IN 1998-99 TO 5.4% IN 2006-07 WITH GROWTH RATE OF ABOUT 30% (SOURCE NESS COM); THE EXPORTS CONTRIBUTED AROUND 66% OF THE TOTAL IN DIAN IT INDUSTRY; THE KEY SEGMENTS THAT HAVE CONTRIBUTED SIGNIFICANT LY (ABOUT 98%) TO THE EXPORT GROWTH ARE ITS & ITES. 49. ALL THIS STATISTICAL DATA CLEARLY DEMONSTRATE THAT IT INDUSTRY WAS GROWING WITH RAPID PACE AND, THEREFORE, THE ARGUMEN T ADVANCED BY TPO CANNOT BE FAULTED. AS FAR AS ASSESSEES CONTENTION REGARD ING CONTRADICTORY STAND ADOPTED BY TPO IN NOT CONSIDERING THE PERSISTENT LO SS MAKING COMPANIES BASED ON EARLIER YEARS DATA BUT TAKING INTO CONSIDERATIO N THE CURRENT YEARS DATA FOR COMPUTING THE MEAN IS CONCERNED, WE DO NOT FIND ANY MERIT IN THE SUBMISSION OF LD. COUNSEL FOR THE ASSESSEE BECAUSE, AS RIGHTLY SU BMITTED BY LD. CIT(DR), THE TPO HAS NOT EXCLUDED LOSS MAKING COMPANIES BUT ONLY THOSE COMPANIES WHICH INCURRED PERSISTENT LOSSES. IT CANNOT BE DISPUTED T HAT PERSISTENT LOSS MAKING BY ITA NO. 5637/D/2011 93 A COMPANY IN THIS SECTOR IS NOT IN NORMAL BEHAVIORA L PATTERN OF THE INDUSTRY AS A WHOLE. THEREFORE, IT TRIGGERS THE ENQUIRY INTO THE CAUSES OF LOSSES. WE ARE IN AGREEMENT WITH LD. COUNSEL FOR THE ASSESSEE THAT IF A PARTICULAR COMPARABLE IS INCURRING PERSISTENT LOSSES ON ACCOUNT OF CERTAIN E XTRAORDINARY CIRCUMSTANCES THEN ONLY THE SAME IS TO BE EXCLUDED. HOWEVER, TH E ONUS LIES ON ASSESSEE TO DEMONSTRATE SUCH EXTRAORDINARY ECONOMIC CIRCUMSTANC ES. WE FIND THAT TPO HAS MENTIONED THE DISTINCTION BETWEEN THE LOSS MAKI NG COMPANY AND A PERSISTENT LOSSES/DIMINISHING REVENUE MAKING COMPAN Y. LD. DRP HAS OBSERVED THAT TPO HAS EXAMINED THE REASONS FOR PERSISTENT LO SSES. THIS FILTER WAS APPLIED ON THE GROUND THAT SUCH COMPANIES HAVE SOME PECULIAR PROBLEMS BECAUSE OF WHICH THE REVENUE WAS DECLINING AND NOT IN LINE WITH THE GROWTH OF SOFTWARE INDUSTRY. CONSIDERING THE STATISTICAL DAT A NOTED EARLIER, IT CAN SAFELY BE OBSERVED THAT DECLINING TURNOVER AND PERSISTENT LOS S IS NOT A NORMAL PHENOMENON OF THIS SECTOR UNDER THE INDIAN ECONOMIC CONDITIONS. DIMINISHING REVENUE/PERSISTENT LOSS ARE NOT IN CONFORMITY WITH THE NORMAL OPERATIONAL RESULTS IN THIS LINE OF ACTIVITY. THEREFORE THE REASONS FO R PERSISTENT LOSSES INCURRED BY A COMPANY NEEDS TO BE IDENTIFIED. 50. LD. COUNSEL HAS POINTED OUT VARIOUS ASPECTS IN REGARD TO DECISIONS RELIED UPON BY LD. CIT(DR) WHICH ARE NOTED IN HIS S UBMISSIONS EARLIER. IN OUR OPINION MERELY BECAUSE ONE COMPARABLE HAS BEEN ACCE PTED OR REJECTED IN A PARTICULAR CASE CANNOT BE A BASIS FOR ACCEPTING OR REJECTING THE SAME IN EVERY TRANSFER PRICING ANALYSIS. EACH CASE HAS TO BE CON SIDERED ON ITS OWN FACTS AND ITA NO. 5637/D/2011 94 ONLY BROAD GUIDANCE CAN BE TAKEN FROM THE DECISIONS RENDERED IN REGARD TO TRANSFER PRICING ISSUES. 50.1 LD. COUNSEL FOR THE ASSESSEE HAS REFERRED TO T HE DECISION OF SPL. BENCH IN THE CASE OF QUARK SYSTEMS, 32 TTJ 1 IN SUP PORT OF ITS CONTENTION THAT JUST BECAUSE A COMPANY IS MAKING LOSS IT CANNOT BE EXCLUDED. IN THIS REGARD IT WOULD SUFFICE TO OBSERVE THAT TPO HAS NOT EXCLUDED THE COMPARABLES MERELY ON THE GROUND THAT THEY WERE INCURRING LOSSES BUT ONLY WHEN THE COMPARABLE WAS INCURRING PERSISTENT LOSES AND THE REVENUE WAS DIMI NISHING DUE TO SOME ABNORMAL CIRCUMSTANCES. WE APPRECIATE THE ARGUMENT OF LD. COUNSEL FOR THE ASSESSEE THAT THE SWEEPING GENERALIZATION THAT PERS ISTENT LOSSES SHOW SOME ABNORMAL CIRCUMSTANCES IS BASED ON CONJECTURES. HO WEVER, WHEN TPO HAS EXAMINED THE COMPARABLES INDEPENDENTLY AND HAS EXAM INED THE REASONS FOR SAME THEN IT CANNOT BE SAID THAT THE EXERCISE UNDER TAKEN BY THE TPO WAS NOT IN CONSONANCE WITH THE GENERAL PRINCIPLES GUIDING THE SELECTION OF COMPARABLES. WE APPRECIATE LD. COUNSELS SUBMISSIONS THAT INSTAN ,CE OF LOSS USUALLY ARISES DUE TO MARKET FORCES/COMPUTATION, EMERGENCE OF NEW TECHNOLOGIES OR PROCESSES, INCREASED COSTS, VARIATION IN DEMAND AND SUBJECT, AND THESE ARE ALL NORMAL ECONOMIC FACTOR WHICH IMPACT ALL INDUSTRY PL AYER. HOWEVER, THIS ARGUMENT, WHEN CONSIDERED TAKING INTO ACCOUNT THE H OLISTIC VIEW OF THE IT INDUSTRY, CANNOT BE ACCEPTED BECAUSE ALL THE FACTOR S ENUMERATED BY LD. COUNSEL, WHICH RESULTS INTO LOSS, DO OCCUR IN ALL C OMPARABLES BUT STILL OVERALL INDUSTRY IN THIS SECTOR HAD SHOWN CONSIDERABLE GROW TH. WE WILL CONSIDER EACH AND EVERY COMPARABLE SEPARATELY AND WHILE UNDERTAKI NG THAT EXERCISE TAKE INTO ITA NO. 5637/D/2011 95 CONSIDERATION ALL THE ASPECTS EMPHASIZED BY LD. COU NSEL FOR THE ASSESSEE. HOWEVER, IN PRINCIPLE WE ARE IN AGREEMENT WITH TPO THAT GIVEN THE TREND OF IT INDUSTRY GROWTH PERSISTENT LOSS MAKING COMPANIES CA NNOT BE TAKEN AS COMPARABLE BECAUSE THAT IN ITSELF REFLECTS EXISTENC E OF ABNORMAL CIRCUMSTANCES WHICH. OF COURSE, NEEDS TO BE IDENTIFIED. THEREFOR E, THE IMPUGNED COMPARABLE CAN BE TAKEN INTO CONSIDERATION ONLY IF REASONABLY ACCURATE ADJUSTMENT CAN BE MADE TO ELIMINATE THE MATERIAL EFFECTS OF SUCH DIFF ERENCES BUT IF THAT IS NOT POSSIBLE THEN IN CONFORMITY WITH THE REQUIREMENTS O F RULE10B(3) OF THE INCOME- TAX RULES, 1962, THE SAID COMPARABLE IS TO BE EXCLU DED. 51. IN THE RESULT, THIS GROUND IS DISMISSED. 52. VIDE GROUND NO. 4.5.4, THE ASSESSEE HAS ASSAIL ED THE TPOS ACTION IN APPLYING THE FILTER OF EXCLUDING THE COMPANIES WHIC H HAVE RELATED PARTY TRANSACTIONS OF MORE THAN 25%. THE TPO NOTICED THA T ASSESSEE DID NOT MENTION ANYTHING REGARDING RELATED PARTY TRANSACTIO N FILTER. HE, THEREFORE, ISSUED SHOW CAUSE NOTICE STATING THEREIN THAT THIS FILTER IS APPROPRIATE TO ELIMINATE THE COMPANIES WHICH HAVE CONTROLLED TRANS ACTIONS AND, THEREBY, HAVE ITS SIGNIFICANT INFLUENCE ON THE MARGIN EARNED. TH E TPO, AFTER DEALING WITH THE OBJECTIONS OF THE ASSESSEE AND AFTER TAKING INTO CO NSIDERATION THE DEFINITION OF THE ASSOCIATED ENTERPRISES U/S 92A(2)(A), 40A(20)(B ), OECD GUIDELINES AND THE MANDATE OF RULE 10B(1)(E)(III) THAT NET PROFIT MARG IN IS REQUIRED TO BE ADJUSTED TO TAKE INTO ACCOUNT DIFFERENCES WHICH COULD MATERIALL Y AFFECT THE AMOUNT OF NET PROFIT MARGIN IN THE OPEN MARKET AND ALSO RULE 10B( 3)(I) MANDATING SUCH ADJUSTMENT, CONCLUDED THAT RELATED PARTY FILTER OF 25% IS AN ADEQUATE FILTER ITA NO. 5637/D/2011 96 BECAUSE ON THE ONE HAND IT WILL HELP IN EXCLUDING T HE COMPANIES WITH SIGNIFICANT CONTROLLED TRANSACTIONS AND AT THE SAME TIME IT ALS O HELPS IN OBTAINING AN ADEQUATELY LARGE SAMPLE SIZE. 53. LD. DRP, AFTER CONSIDERING THE ASSESSEES SUBM ISSIONS, UPHELD THE TPOS ACTION. IT RELIED ON THE DECISION OF DELHI ITAT IN THE CASE OF SONY INDIA PVT. LTD. AS REGARDS THE CONTRARY VIEW TAKEN BY BA NGALORE BENCH OF ITAT IN THE CASE OF PHILIPS SOFTWARE CENTRE PVT. LTD. VS. ACIT (2008) 26 SOT 226, LD. DRP POINTED OUT THAT HONBLE KARNATAKA HIGH COURT HAD A DMITTED THE ISSUE OF EFFECT OF RELATED PARTY TRANSACTION IN SELECTION OF COMPAR ABLE AS SUBSTANTIAL QUESTION OF LAW FOR ADJUDICATION AND HAD STAYED THE JUDGMENT OF BANGALORE BENCH ITAT VIDE ORDER DATED 16/02/2009 IN ITA NO. 49/2009 REPORTED IN 2009-TIOL-123-HC- KAR.-IT. 54. LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT AP PLICATION OF THIS FILTER DEPENDS ON THE FACTS AND CIRCUMSTANCES OF EACH CASE AND THERE CANNOT BE ANY THUMB RULE FOR APPLYING FILTER OF 25% RPT. AN OBJE CTIVE CRITERIA HAS TO BE ADOPTED. LD. COUNSEL SUBMITTED THAT THE IDEAL SITU ATION WOULD BE WHERE ENOUGH COMPARABLES ARE AVAILABLE BY NOT APPLYING THIS FILT ER. HOWEVER, IF SUFFICIENT COMPARABLES ARE NOT AVAILABLE THEN GRADUALLY THE LI MIT HAS TO BE INCREASED. LD. COUNSEL SUBMITTED THAT THERE IS CONFLICT OF JUDICIA L OPINION ON THIS ISSUE AND, THEREFORE, NO STANDARD FIGURE CAN BE TAKEN. 55. LD. CIT(DR) REFERRED TO PARA 8.1PAGE 36 OF TPO S ORDER AND POINTED OUT THAT ASSESSEE IN PRINCIPLE HAD NO OBJECTION FOR APPLYING THIS FILTER. HE SUBMITTED THAT THRESHOLD LIMIT OF 25% WAS QUITE REA SONABLE, AS APPLIED BY TPO ITA NO. 5637/D/2011 9 7 BECAUSE OTHERWISE SUFFICIENT NUMBER OF COMPARABLES WOULD NOT BE AVAILABLE. IN THIS REGARD LD. CIT(DR) REFERRED TO PARA 28, 29 & P ARA 40 OF ACTIS, WHEREIN THIS THRESHOLD HAS BEEN ACCEPTED. HE SUBMITTED THAT IF MORE THAN 25% RELATED PARTY TRANSACTIONS ARE THERE THEN ONLY IT IS UNCONTROLLED . LD.CIT(DR) FURTHER POINTED OUT THAT IN THE CASE OF GLOBAL LOGIC INDIA PVT. LTD . FOR A.Y. 2006-07 VIDE ORDER DATED 31/12/2012, IT HAS BEEN CLARIFIED IN PARA 5.1 7 AS TO WHAT SHOULD BE INCLUDED FOR DETERMINING RELATED PARTY TRANSACTION. IN THIS CASE, THE CAPITAL WAS OF 50 CRORES AND OUT OF THE TOTAL SALE OF 45 CRORES , SALE TO RELATED PARTIES WERE ONLY 25 CRORES AND THE BALANCE 20 CRORE SALE WAS TO THE THIRD PARTY. THEREFORE, THIS WAS EXCLUDED APPLYING RPT FILTER. 55.1 LD.CIT(DR) SUBMITTED THAT THIS FILTER HAS RIGH TLY BEEN APPLIED BECAUSE RELATED PARTY TRANSACTIONS INFLUENCE THE PRICE OF T RANSACTION. HE SUBMITTED THAT EXCLUSION OF COMPANIES WITH RELATED PARTY TRANSACTI ON UP TO 25% WAS QUITE REASONABLE FOR WHICH GUIDANCE HAS BEEN TAKEN FROM T HE PROVISIONS OF SECTION 92A(2)(A) WHICH PROVIDES A LIMIT OF 26% FOR TREATIN G AN ENTERPRISE AS ASSOCIATED ENTERPRISE. HIS SUBMISSIONS ARE REPRODUCED HEREUNDE R:- EXCLUSION OF COMPANIES WITH RELATED PARTY TRANSACTI ONS UP TO 25% OF THEIR SALES; COUNTER : THIS IS THE FILTER OF RELATED PARTY TRANSACTIONS UP TO 25% OF SALES. (PL. SEE PAGES 36 TILL 38, BEING PARA 8.1 OF TPO) THE FOLLOWING CASE LAWS SUPPORT REVENUE, WHEREIN TH IS LIMIT HAS BEEN APPROVED. I. M/S ACTIS ADVISERS (I) (P) LTD. 5227/DEL/2011 (PARAS 28 AND 29) ITA NO. 5637/D/2011 98 II. M/S DELOIETTE HYDERABAD, ITA NO. 1082/HYD./2010 , DTD. 22/07/2011 (PARA 35 OF THIS ORDER) III. M/S ST MICRO ELECTRONICS (I) (P) LTD. (15 ITR (TRIB.) 410 DEL) - PARAS 40 AND 41 IV. M/S GLOBAL LOGIC (I) (P) LTD. 2011-T11-35-ITAT- DELHI-TP. DTD. 25/03/2011, PARAS 4 AND 5, TILL PARA 5-17 (ITA NOS. 6082/DEL/2010, A.Y. 05-06) V. M/S HAPAG LOYD, ITA NO. 8499/MUM./2010, DTD. 28/ 02/2013, PARA 6-2, WHEREIN THEY HAVE RELIED ON THE CASE OF M /S THYSEN KRUPP, MUMBAI, ITA NO. 6460/MUM./2012. 55.2 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE PERUSED THE RECORD OF THE CASE. 56. WE ARE IN AGREEMENT WITH TPO IN PRINCIPLE THAT THIS FILTER IS APPROPRIATE TO ELIMINATE THE COMPANIES WHICH HAVE C ONTROLLED TRANSACTIONS AND THEREBY HAVE A SIGNIFICANT INFLUENCE ON THE MARGINS EARNED. THE TPO IN HIS ORDER HAS OBSERVED THAT IN PRINCIPLE THE TAX PAYER HAS NO OBJECTION FOR APPLYING THIS FILTER. HOWEVER, ITS TWO MAIN CONTENTIONS ARE -ONE-AVAILABILITY OF RPT INFORMATION AND SECOND THE THRESHOLD LIMIT OF 15% I N PLACE OF 25%. AT THE SAME TIME WE ALSO FIND CONSIDERABLE FORCE IN THE SUBMISS ION OF LD. COUNSEL FOR THE ASSESSEE THAT IDEALLY IF SUFFICIENT NUMBER OF 100% UNCONTROLLED COMPARABLES ARE FOUND, THEN NO COMPARABLE HAVING RELATED PARTY TRAN SACTIONS SHOULD BE CONSIDERED. WE ARE IN AGREEMENT WITH LD. COUNSEL T HAT ONLY WHEN SUFFICIENT COMPARABLES ARE NOT FOUND, THE RELATED PARTY THRESH OLD SHOULD BE RELAXED AND ITA NO. 5637/D/2011 99 ONLY GRADUALLY TO THE EXTENT THAT SUFFICIENT COMPAR ABLES ARE FOUND, THE LIMIT SHOULD BE RELAXED. THEREFORE, WE ACCEPT THE ASSESS ES PLEA THAT NO SACROSANCT THRESHOLD LIMIT SHOULD BE FIXED FOR THIS FILTER. L D. DRP HAS ALSO NOTED THAT NEITHER THERE IS ANY JUDICIAL CONSENSUS ON THE NUMERICAL LI MIT NOR THE SECTION SO PRESCRIBES. HOWEVER, THERE IS CONSENSUS ON THE EFFE CT OF RPT I.E. IT SHOULD NOT MATERIALLY AFFECT THE INTERNATIONAL TRANSACTION. T HEREFORE, CONSIDERING THE SUBMISSIONS OF BOTH THE SIDES, WE ARE OF THE OPINIO N THAT IF BY APPLYING THE THRESHOLD LIMIT OF 15% OF RELATED PARTY TRANSACTION , SUFFICIENT COMPARABLES ARE AVAILABLE THEN THERE IS NO REASON TO FURTHER EXTEND THE LIMIT TO 25%. THEREFORE, WE DIRECT THE TPO TO TAKE INTO CONSIDERATION ONLY T HOSE COMPARABLES WHERE RELATED PARTY TRANSACTIONS ARE TO THE EXTENT OF 15% BECAUSE IT IS NOT THE CASE OF REVENUE THAT BY APPLYING THE THRESHOLD LIMIT OF 15% , IT WILL NOT GET SUFFICIENT NUMBER OF COMPARABLES. 57. IN THE RESULT, THIS GROUND IS ALLOWED. 58. VIDE GROUND NO. 4.5.5, THE ASSESSEE HAS ASSAIL ED THE APPLICATION OF FILTER BY TPO OF ADOPTING EMPLOYEE COST GREATER THA N 25% OF THEIR TOTAL REVENUES AS A SEARCH CRITERIA FOR SHORT LISTING AND EVALUATI NG COMPARABLES FOR SOFTWARE DEVELOPMENT SERVICES. THE TPO NOTICED THAT THE ASS ESSEE IS A SOFTWARE DEVELOPMENT SERVICES PROVIDER AND INCURS 64% OF SAL ES AS SALARY EXPENDITURE. HE POINTED OUT THAT IN THE CASE OF A SOFTWARE DEVEL OPMENT COMPANY, EMPLOYEES ARE THE MAIN ASSET OF THE COMPANY AND DIR ECTLY REFLECT THE NATURE OF BUSINESS UNDERTAKEN BY THE COMPANY. HE NOTED THAT AS PER PROWESS DATA BASE, THE AVERAGE EMPLOYEE COST WORKS OUT TO ABOUT 35% OF SALES IN THE CASE ITA NO. 5637/D/2011 100 OF COMPANIES HAVING TURNOVER MORE THAN 1 CRORE FOR THE F.Y. 2006-07. HE POINTED OUT THAT EXTREMELY LOW EXPENDITURE ON SALAR Y/EMPLOYEE COST IS A DEFINITE INDICATION THAT THE COMPANY IS EITHER INTO FURTHER OUTSOURCING OF THE WORK OR IS A SOFTWARE PRODUCT DEVELOPER OR A SOFTWARE TRADING CO MPANY. HE, THEREFORE, APPLIED FILTER OF 25% OF MINIMUM SALARY EXPENDITURE TO SALES WHILE SEARCHING FOR COMPARABLES. THE TPO, AFTER DEALING WITH VARIOUS OB JECTIONS OF ASSESSEE, CONCLUDED THAT APPLICATION OF THIS FILTER WAS FULLY JUSTIFIED. HE FURTHER POINTED OUT THAT NO COMPARABLE HAD BEEN ACCEPTED/REJECTED MEREL Y ON THIS COUNT AND THIS FILTER WAS APPLIED JUST TO CONSIDER FUNCTIONALITY O F SUCH COMPANIES IN DETAIL. HE POINTED OUT THAT DETAILED ANALYSIS OF COMPANIES WIT H EMPLOYEE COST LESS THAN 25% WAS DONE. LD. DRP CONFIRMED THE TPOS ACTION, INTER-ALIA, OBSERVING THAT SINCE THIS IS THE MAIN COST COMPONENT IN THE SECTOR , USE OF THE FILTER CANNOT BE CONSIDERED AS INAPPROPRIATE. IT FURTHER POINTED OU T THAT, IN ANY CASE, THE TPO DID NOT REJECT ANY COMPANY ONLY ON THE BASIS OF EMP LOYEE COST. WHERE A COMPANY HAD FAILED THIS FILTER, A NOTICE U/S 133(6) HAD BEEN SENT TO ASCERTAIN THE ACTUAL FUNCTIONAL PROFILE OF THE COMPANY. THEREFOR E, THIS FILTER HAD BEEN USED AS A STARTING POINT TO CARRY OUT A MORE THOROUGH FUNCT IONAL ANALYSIS. 59. LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT T HIS IS NOT A FILTER OF COMPARABILITY PROVIDED IN RULE 10B(2). HE SUBMITTE D THAT THE COMPARABILITY ANALYSIS HAS TO BE NECESSARILY BASED ON AN IMAGING OF THE FUNCTION ASSET RISK (FAR) PROFILE OF THE TESTED PARTY AGAINST THE COMPARABLE COMPANY. HE POINTED OUT THAT EVEN THOUGH TWO COMPANIES MAY BE E MPLOYING SAME LEVEL OF PERSONNEL, YET THE MANNER IN WHICH THE REMUNERATION TO THOSE PERSONNEL IS PAID ITA NO. 5637/D/2011 101 AND CLASSIFIED FROM AN ACCOUNTING PERSPECTIVE MAY H AVE A SIGNIFICANT BEARING ON THEIR RESPECTIVE WAGES/SALES RATIO AND, THUS, RE DUCE RELIABILITY OF ANY ANALYSIS BASED ON USE OF WAGES/SALES RATIO. HE FURTHER POIN TED OUT LEVEL OF WAGES DEPENDS UPON COMPANY POLICY AND MARKET FORCES. IT IS A KNOWN FACT THAT BIG MNCS, OUTSOURCING THEIR WORK IN INDIA, GENERALLY HA VE BETTER PAY SCALES THAN CERTAIN INDIAN COMPANIES PERFORMING SIMILAR OR MORE COMPLEX ACTIVITIES. HE REFERRED TO THE DECISION OF HYDERABAD BENCH IN HELL O SOFT INDIA PVT. LTD. VIDE ITA NO. 645/HYD./09 AND POINTED OUT THAT ITAT REJEC TED THIS FILTER AS THE RELEVANT DATA IN THIS REGARD WAS NOT AVAILABLE AND MANY COMP ANIES INCLUDE EMPLOYEE COST DATA UNDER DIFFERENT HEADS. LD. COUNSEL POINT ED OUT THAT TPO HAD OBTAINED INFORMATION U/S 133(6) FOR APPLYING THIS F ILTER. HE SUBMITTED THAT DATA USED SHOULD BE AVAILABLE IN PUBLIC DOMAIN. 59.1 LD.CIT(DR) SUBMITTED THAT IN SOFTWARE COMPANIE S MAJOR COST IS SALARY COST. SOFTWARE DEVELOPMENT INVOLVES USING MAN POWER OR BRAIN POWER. THEREFORE, THERE HAS TO BE A CUT OFF FOR FINDING OU T WHETHER THE COMPANY IS IN SOFTWARE DEVELOPMENT SECTOR OR ONLY A TRADING COMPA NY. THEREFORE, THE THRESHOLD OF 25% OF EMPLOYEE COST BEING CONSIDERED AS MINIMUM EMPLOYEE COST FOR SELECTING COMPARABLES IS QUITE REASONABLE. 59.2 LD. CIT(DR) RELIED ON THE ORDER OF TPO IN THIS REGARD AND SUBMITTED THAT HIS FILTER HAS BEEN APPROVED IN FOLLOWING CASE S: M/S BITHARIS TECHNOLOGIES (PARA 5.3) (ITA NO. 4372 /DEL/09) M/S ASIA INDIA PVT. LTD. (ITA NO. 5350/DEL/2010) ( PARA 19) NAVISITE (PARAS 20 TO 22) ITA NO. 5637/D/2011 102 59.3 HE SUBMITTED THAT IN THE CASE OF M/S HELLO SOF T INDIA PVT. LTD., RELIED BY ASESSEE, THERE WAS ONLY CRYPTIC REFERENCE, AS OP POSED TO DETAILED DISCUSSION IN CASES RELIED BY REVENUE. 60. IN THE REJOINDER, LD. COUNSEL SUBMITTED THAT I N THE CASE OF ASIA INDIA PVT. LTD., CONSIDERING THE FACT THAT EMPLOYEE COST TO SALES WAS 46%, THE RANGE OF EMPLOYEE COST TO SALES WAS FIXED AT 30% TO 60%. HE, THEREFORE, SUBMITTED THAT IN THE CASE OF ASSESSEE SINCE THE EMPLOYEE COS T TO SALES RATIO IS 64%, THE THRESHOLD OF 25% WOULD BE INAPPROPRIATE. LD. COUNS EL, THEREFORE, SUBMITTED THAT IF, AT ALL THIS FILTER IS TO BE APPLIED, THEN, THE APPROPRIATE RANGE WOULD BE 50% TO 80%. 60.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND H AVE PERUSED THE RECORD OF THE CASE. 61. AS FAR AS LD. COUNSELS OBJECTIONS OF DATA BEI NG NOT AVAILABLE IN PUBLIC DOMAIN IS CONCERNED, FOR WHICH TPO RESORTED TO OBTA IN INFORMATION U/S 133(6), WE FIND THAT THIS OBJECTION OF LD. COUNSEL IS NOT S USTAINABLE PARTICULARLY BECAUSE GROUND NO. 4.4 DEALING WITH THIS ISSUE HAS NOT BEEN PRESSED BY HIM. EVEN OTHERWISE, WE FIND THAT TPO HAS BEEN VESTED WITH SP ECIFIC POWERS U/S 92CA(7) TO OBTAIN INFORMATION U/S 133(6) IF HE SO CONSIDERS FOR THE PURPOSES OF DETERMINING THE ARMS LENGTH PRICE. THE WHOLE EXER CISE OF TRANSFER PRICING ANALYSIS CENTRIFUGE TOWARDS DETERMINING THE ARMS L ENGTH PRICE OF THE INTERNATIONAL TRANSACTION AND FOR THAT PURPOSE TPO HAS BEEN VESTED WITH WIDE POWERS SO AS TO ARRIVE AT ARMS LENGTH PRICE. HE H AS TO TAKE INTO CONSIDERATION VARIOUS FACTORS AFFECTING THE PRICE OF INTERNATIONA L TRANSACTION AND COLLECT THE ITA NO. 5637/D/2011 103 QUANTITATIVE INFORMATION IN THAT REGARD EITHER FROM DATA AVAILABLE IN VARIOUS DATA BASES E.G. PROWESS AND CAPITALINE OR RESORT TO OBTA INING INDEPENDENT INFORMATION U/S 133(6). THE POWERS CONTAINED U/S 92 CA(7) CANNOT BE CURTAILED OR ABRIDGED BY PUTTING UNREALISTIC IMPEDIMENTS. TH ESE POWERS HAVE BEEN GIVEN FOR COLLECTING THE NECESSARY INFORMATION. HOWEVE R, BEFORE RELYING ON THIS INFORMATION, ASSESSEE HAS TO BE CONFRONTED WITH THE INFORMATION. THE NEXT OBJECTION OF LD. COUNSEL FOR THE ASSESSEE IS THAT T HE COMPARABILITY ANALYSIS HAS TO BE NECESSARILY BASED ON A MAPPING OF FAR PROFILE OF THE TESTED PARTY AGAINST THE COMPARABLE COMPANY. THERE CANNOT BE ANY QUARREL WITH THIS PROPOSITION. THE TPO HAS NOT GIVEN A GO BYE TO FAR ANALYSIS WHIL E APPLYING THIS FILTER. THIS IS A FUNCTIONAL FILTER AND IF A COMPANY FAILS THIS FILTER, IT INDICATES THAT EITHER IT IS OUTSOURCING MAJOR PART OF THE WORK; A PREDOMINANTLY ON-SITE COMPANY (AS IT DOES NOT SHOW THE PAYMENTS MADE TO ON-SITE CONSULTANT UN DER THE EMPLOYEE COST); A SOFTWARE PRODUCT COMPANY OR TRADING COMPANY OR A CO MPANY WITH PECULIAR ECONOMIC CIRCUMSTANCES. THE SUBMISSIONS OF LD. COU NSEL, THEREFORE, CANNOT BE ACCEPTED. THIS FILTER HAS BEEN APPLIED ON THE GROU ND THAT COMPANIES WHICH ARE ENGAGED IN SOFTWARE DEVELOPMENT REQUIRE A MINIMUM L EVEL OF EXPENDITURE ON PERSONNEL EXPENSES. IN OUR OPINION, IN ORDER TO CO NSIDER THE FUNCTIONAL SIMILARITY OF TWO COMPARABLES, IT IS NECESSARY THAT SUCH QUANT ITATIVE FILTERS ARE APPLIED TO REACH A REASONABLE CONCLUSION REGARDING FUNCTIONAL SIMILARITY. HOWEVER, WE FIND CONSIDERABLE FORCE IN THE SUBMISSION OF LD. COUNSEL FOR THE ASSESSEE THAT WHILE FIXING THE RANGE FOR APPLYING THIS FILTER, REGARD S HOULD FIRST BE TO THE EMPLOYEE COST TO SALES RATIO OF TESTED PARTY VIZ. ASSESSEE. HE HAS RIGHTLY POINTED OUT THAT ITA NO. 5637/D/2011 104 IN ASIA INDIA PVT. LIMITED (SUPRA) SINCE THE EMPLOY EE COST TO SALES WAS 46%, THEREFORE, THE RANGE OF EMPLOYEE COST TO SALES WAS FIXED AT 30% TO 60%. IN THE PRESENT CASE SINCE THE EMPLOYEE COST TO SALES RATIO IS 64%, WE ACCEPT THE ASSESSEES CONTENTION THAT THE FILTER HAS TO BE APP LIED BY APPLYING THE RANGE OF EMPLOYEE COST TO SALES OF 50% TO 80%. WE DIRECT ACC ORDINGLY. 62. IN THE RESULT, THIS GROUND IS PARTLY ALLOWED. 63. VIDE GROUND NO. 4.5.6 THE ASSESSEE HAS ASSAILE D THE TPOS ACTION OF APPLYING ON-SITE REVENUE FILTER. BY APPLYING THIS FILTER, THE COMPANYS WHOSE ON- SITE REVENUES EXCEEDED THE 75% OF TOTAL EXPORT REVE NUES, WERE REJECTED AS COMPARABLE. 64. LD. TPO SUMMARIZED THE ASSESSEES OBJECTIONS TO THIS FILTER AS UNDER: (A) THE INDIAN SOFTWARE SECTOR PROVIDES BOTH ON-SITE AND OFFSHORE SERVICES. (B) THE INDIAN VENDORS HAVE SUCCEEDED IN RAISING THE SH ARE OF OFFSHORE REVENUE FROM 44% IN 2000-01 TO 64% IN 2003-04, 71 % IN 2004-05 AND TO 74% IN 2005-06. THOUGH THE DATA IS NOT AVAILABLE FOR THE FY 2006-07, THE ANNUAL REPORT OF BIG SOFTWARE COMPANIES SHOWS THAT THIS RATIO IS INCREASED FURTHER DURING T HE FY 2006-07. MOST OF THE UNCONTROLLED ENTERPRISES FOLLOWS HYBRID MODEL WITH REVENUE MIX BOTH FROM ONSITE AND OFFSHORE. THE TAXPAYER IS MAINLY OFFSHORE SERVICE P ROVIDER AND IT IS DIFFICULT TO GET INDEPENDENT COMPANIES WHICH GENERATE REVENUES ONLY FORM OFFSHORE SOFTWARE DEVELOPMENT SERVICE PROVIDERS. (C) THE PRICING IS DIFFERENT IN ONSITE WHEN COMPARED TO OFFSHORE OPERATIONS. THE REASONS FOR THE SAME LIE IN THE FACT THAT WHILE IN THE CASE OF OFFSHORE PROJECTS MOST OF THE COSTS ARE INCURRED IN INDIA; AN ONSITE PROJE CT HAS TO BE CARRIED OUT ABROAD SIGNIFICANTLY INCREASING THE EMPLOYEE COST AND OTHE R COSTS. THE INDIAN COMPANIES HAVE THEREFORE BEEN SLOWLY MOVING TOWARDS THE OFFSHORE W ORK MORE AND MORE. (D) THE COMPANIES WHICH ARE PREDOMINANTLY ONSITE COMPAN IES DO NOT HAVE SIGNIFICANT ITA NO. 5637/D/2011 105 ASSETS AS MOST OF THE WORK IS CARRIED ON THE SITE O F CUSTOMER OUTSIDE INDIA. (E) THE COMPANIES WHO GENERATE MORE THAN 75% OF THE EXPORT REVENUES FROM ONSITE OPERATIONS OUTSIDE INDIA ARE EFFECTIVELY COMPANIES WORKING OUTSIDE INDIA HAVING THEIR OWN GEOGRAPHICAL MARKETS, COST OF LABOUR ETC AND AL SO RETURN IN COMMENSURATE WITH THE ECONOMIC CONDITIONS IN THOSE COUNTRIES. (F) THUS ASSETS AND RISK PROFILE, PRICING AS WELL AS PR EVAILING MARKET CONDITIONS ARE DIFFERENT IN PREDOMINANTLY ONSITE COMPANIES FROM PR EDOMINANTLY OFFSHORE COMPANIES LIKE THE TAXPAYER. 64.1 THE TPO, HOWEVER, DID NOT ACCEPT THE ASSESSEE S OBJECTIONS AND POINTED OUT THAT THE BUSINESS DYNAMICS OF ON-SITE A ND OFFSHORE VARIES A LOT. HE SUMMARIZED HIS FINDINGS BASED ON INDUSTRY OVER VIEW OF SOFTWARE SERVICES SECTOR, AS UNDER: THE INDIAN SOFTWARE SECTOR PROVIDES BOTH ON-SITE A ND OFFSHORE SERVICES; THE INDIAN VENDORS HAVE SUCCEEDED IN RAISING THE S HARE OF OFFSHORE REVENUE FROM 44% IN 2000-01 TO 64% IN 2003-04 AND T O 71% IN 2004-05; THERE IS A SUBSTANTIAL RATE DIFFERENCE BETWEEN THE ON-SITE AND OFFSHORE PROJECTS/CONTRACTS; 64.2 HE POINTED OUT THAT AS PER THE INDUSTRY REPORT S (SOURCE-ANNUAL REPORT OF EMPHASIS BFL F.Y. 2004-05), IN THE YEAR 2004-05 AVERAGE RATE PER MAN HOUR IN THE CASE OF OFFSHORE PROJECTS WAS US-18 DOLLARS, WHEREAS THE SAME WAS CONSIDERABLY HIGHER IN THE CASE OF ON-SITE PROJECT AT ABOUT 66US DOLLARS PER MAN HOUR. HE, THEREFORE, POINTED OUT THAT THE PROFIT M ARGIN ALSO ACCORDINGLY VARY SIGNIFICANTLY; THE OFFSHORE PROJECTS HAVE MUCH HIGH ER MARGINS. THE REASONS FOR THE SAME LIE IN THE FACT THAT WHILE IN THE CASE OF OFFSHORE PROJECTS MOST OF THE ITA NO. 5637/D/2011 106 COSTS ARE INCURRED IN INDIA, AN ON-SITE PROJECT HAS TO BE CARRIED OUT ABROAD SIGNIFICANTLY INCREASING THE EMPLOYEE COST AND OTHE R COST. THE INDIAN COMPANIES HAVE THEREFORE, BEEN SLOWLY MOVING TOWARD S THE OFFSHORE WORK MORE AND MORE. HE POINTED OUT THAT THE HIGHER COST OF O N-SITE WORKERS HOLDS OPERATING MARGINS IN THE LOW OF 20%. THE TPO REFER RED TO VARIOUS SOURCES TO BUTTRESSES HIS CONTENTION. HE, THEREFORE, CONCLUDE D THAT THE TAX PAYER, WHOSE BUSINESS IS ENTIRELY OFFSHORE, CANNOT BE COMPARED W ITH A COMPANY WHICH HAS SUBSTANTIAL REVENUES GENERATED FROM ITS ON-SITE OPE RATIONS. AS REGARDS THE ASSESSEES OBJECTIONS THAT NATURE OF ACTIVITY REGAR DING SOFTWARE DEVELOPMENT SERVICES DO NOT CHANGE BETWEEN ON-SITE AND OFFSHORE SOFTWARE DEVELOPMENT SERVICES, THE TPO OBSERVED THAT MERELY BECAUSE A CO MPANY IS INTO SOFTWARE DEVELOPMENT DOES NOT AUTOMATICALLY BECOME COMPARABL E BECAUSE THE ECONOMIC CIRCUMSTANCES SHOULD ALSO BE COMPARABLE BE TWEEN THE TAX PAYER AND THE COMPARABLE. THE TPO FURTHER POINTED OUT THAT T HERE IS NO DISPUTE THAT INDIAN SOFTWARE COMPANIES DO FOLLOW HYBRID MODEL. HE POINTED OUT THAT AS PER NASSCOM, DURING THE FINANCIAL YEAR 2005-06, 74% OF THE REVENUES WAS FROM OFFSHORE SOFTWARE DEVELOPMENT. THAT IS THE MAIN RE ASON WHY ALL THE INDEPENDENT COMPARABLE COMPANIES DO HAVE SOME PART OF THEIR REVENUES GENERATED FROM THEIR ON-SITE OPERATIONS. HE FURTHE R POINTED OUT THAT FROM THE ANALYSIS OF VARIOUS ANNUAL REPORTS OF SOFTWARE DEVE LOPMENT COMPANIES, IT IS EVIDENT THAT THE PROFITABILITY OF THE COMPANY GETS AFFECTED ADVERSELY IF THE ON-SITE REVENUE MIX GO BEYOND 75% OF THE EXPORT REVENUES. THEREFORE, THE APPLICATION OF 75% ON-SITE REVENUE FILTER WAS JUSTIFIED. ITA NO. 5637/D/2011 107 64.3 THE TPO FURTHER POINTED OUT THAT ASSESSEE LIM ITED ITS ANALYSIS ONLY TO FUNCTIONS BUT NOT TO THE ASSETS, RISKS AS W ELL AS PREVAILING MARKET CONDITIONS IN WHICH BOTH THE BUYER AND SELLER OF SE RVICE WERE LOCATED. THE TPO REFERRED TO RULE 10B(2) AND POINTED OUT THAT APART FROM THE FUNCTIONS, THE FOLLOWING CHARACTERISTICS ARE ALSO IMPORTANT IN COM PARABILITY ANALYSIS: ASSETS EMPLOYED AND RISKS ASSUMED; CONDITIONS PREVAILING IN THE MARKET IN WHICH BOTH THE BUYER AND SELLER OF SERVICES ARE LOCATED INCLUDING THE GEOGRAPHICAL LOC ATION, SIZE OF THE MARKET, COST OF LABOUR AND CAPITAL IN THE MARKET, OVERALL ECONOM IC DEVELOPMENT AND LEVEL OF COMPETITION. 65. IN SUM AND SUBSTANCE, THE TPOS CONCLUSIONS WE RE AS UNDER:- A COMPANY WHICH OPERATES PREDOMINANTLY ON ON-SITE WOR K DIFFERS FROM TAX PAYER AS UNDER: O THE MARKET CONDITIONS ARE DIFFERENT FOR ON-SITE TH EN OFFSHORE WORK; O THE PRICING STRUCTURE IS DIFFERENT ON THE INSIDE W ORK; O THE ASSETS ARE NEGLIGIBLE IN THE OPERATING ON-SITE COMPANIES AS THEY UTILISE THE ASSETS OF THEIR CUSTOMER; O THE MARGINS FOR ON-SITE ARE LOWER WHEN COMPARED TO OFFSHORE WORK; O THE LABOUR MARKETS ARE DIFFERENT FOR OFFSHORE AND ON-SITE WORK AS THE PEOPLE WHO ARE WORKING FROM ON-SITE GET COMPETITIVE SALARIES OF THE COUNTRIES WHERE THE WORK IS ACTUALLY PERFORMED; O COST ARBITRAGE IS NOT AVAILABLE FOR THE ON SITE WO RK; ITA NO. 5637/D/2011 108 O THE COMPANIES WHOSE REVENUES ARE GENERATED MAINLY FROM ON-SITE WORK ALMOST MIMIC A COMPANY WHICH IS RESIDENT IN THAT CO MPANY. HE FURTHER POINTED OUT THAT THE COMPANIES WHO WERE ALSO OPERATING THRO UGH THEIR BRANCHES FOR THEIR ON-SITE WORK WERE ALSO SUBJECTED TO THIS FILTER. 66. AS REGARDS THE ASSESSEES ARGUMENT THAT OFFSHO RE AND ON-SITE REVENUES MAY INDIVIDUALLY YIELD DIFERRING PROFIT MA RGINS AND , THEREFORE, NEEDS TO BE CONSIDERED ON A HOLISTIC BASIS, THE TPO POINTED OUT THAT COMPARABLES MARGINS WERE CONSIDERED AT THE ENTERPRISE/SEGMENTAL LEVEL. THE OFFSHORE MARGINS NEITHER WERE CALCULATED FOR THE COMPARABLES NOR OBTAINED FROM THE COMPANIES U/S 133(6). 66.1 IN VIEW OF ABOVE FINDINGS, THE TPO APPLIED THE ON-SITE REVENUES FILTER WHEREIN THE COMPANIES GENERATING MORE THAN 75% OF T HEIR EXPORT REVENUES FROM ON-SITE OPERATIONS WERE REJECTED AS COMPARABLE S. 67. LD. DRP CONCURRED WITH THE FINDINGS OF TPO. 68. LD. COUNSEL HAS ADVANCED FOLLOWING SUBMISSIONS IN THIS REGARD: IF THIS FILTER IS TO BE APPLIED THEN WHOLE PROCESS OF DETERMINATION OF ARMS LENGTH PRICE WILL GET DELAYED TILL TPO EXAMINES THE ISSUE BECAUSE THE ANNUAL REPORT DOES NOT CONTAIN INFORMATION IN REGARD TO ON SITE AND OFFSHORE REVENUE SEPARATELY. THIS INFORMATION HAS BEEN OBTAINED BY TPO U/S 133(6). SUCH A FILTER IS CONTRARY TO THE STATUTORY SCHEME PROVIDED IN THE ACT & RULES; A COMPANY IS JUDGED TO BE A COMPARABLE OR OTHERWIS E BASED ON PARAMETERS RELATING TO FUNCTIONS RISKS AND ASSETS; ITA NO. 5637/D/2011 109 SOFTWARE DEVELOPMENT ACTIVITY COMPRISES BOTH OFFSH ORE AND ON-SITE DEVELOPMENT. THESE SERVICES ARE PROVIDED IN BUNDLE D MANNER. SO EVEN IF A PROFIT MARGIN MAY BE LOW IN ON-SITE WORK, IT SHOULD NOT BE VIEWED IN ISOLATION BUT IN CONJUNCTION OF OFFSHORE WORK BECAUSE BOTH THE AC TIVITIES ARE PERFORMED AS A COMPLIMENT TO EACH OTHER AND NOT AS INDEPENDENT ACT IVITIES. ALSO LOWER MARGINS CAN BE COMPENSATED BY HIGHER VOLUMES; PROFITABILITY CANNOT BE CONSIDERED AS A COMPARABIL ITY FACTOR UNDER RULE 10B(2). THERE IS NO EMPIRICAL ANALYSIS PERFORMED B Y TPO THAT THE OPERATING MODEL OF COST, REVENUE AND CONSEQUENT MARGIN ARE SI GNIFICANTLY DIFFERENT FOR A SET OF PREDOMINANTLY ON-SITE COMPANIES VS. PREDOMIN ANTLY OFFSHORE COMPANIES; TPO HAS NOT PROVIDED ANY EMPIRICAL EVIDENCE TO SHO W THAT FUNCTION, ASSET AND RISK PROFILE OF A PREDOMINANTLY ON-SITE SOFTWAR E SERVICE COMPANY IS DIFFERENT FROM AN OFFSHORE SOFTWARE SERVICE PROVIDER. AS REGA RDS REVENUES CONTENTIONS THAT THE CONSIDERATION OF MARKET CANNOT BE IGNORED IN VIEW OF RULE 10B(2), LD. COUNSEL SUBMITTED THAT MARKET IS A PLACE WHERE COMP ETITION HAPPENS NOT WHERE THE WORK IS PERFORMED. HE SUBMITTED THAT AS PER RE VENUE, ASSETS AND MARKET ARE DIFFERENT AND ASSET IS NOT IMPORTANT. HE POINT ED OUT THAT ASSESSEE HAD APPLIED ASSET FILTER WHICH TPO REJECTED. ; THE FILTER IS SELF CONTRADICTORY BECAUSE THE THRES HOLD OF 75% IS QUITE HIGH. IF ON-SITE REVENUE IS A MATERIAL FACTOR THEN WHY TPO S HOULD ALLOW SUCH A HIGH THRESHOLD. 69. LD. COUNSEL RELIED ON THE DECISION OF HELLO SO FT INDIA PVT. LTD. (ITA NO. 645/HYD./2009), WHEREIN TRIBUNAL REJECTED THIS FILTER OBSERVING THAT RELEVANT ITA NO. 5637/D/2011 110 DATA IN THIS RESPECT IS NOT AVAILABLE IN THE DATA B ASE. ALL THE ON-SITE INFORMATION HAD BEEN OBTAINED BY THE TPO U/S 133(6) WHICH IS UN -AUDITED. 70. LD. CIT(DR) SUBMITTED THAT THIS FILTER HAS BE EN APPROVED IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT. LTD., ITA NO. 1054/BANG./2011 DATED 23/11/2012 A.Y. 2007-08 (PARAS 52 TILL 67 OF THE OR DER). AS REGARDS THE DECISION RELIED UPON BY LD. COUNSEL FOR THE ASSESSEE, LD. CI T(DR) POINTED OUT THAT THIS DECISION HAS JUST MADE A PASSING AND CRYPTIC REFERE NCE, AS OPPOSED TO DETAILED DISCUSSION IN M/S TRILOGY E-BUSINESS INDIA SOFTWARE LTD. (SUPRA). HE FURTHER POINTED OUT THAT ASSESSEE HAD RELIED UPON THIS DECI SION FOR DIFFERENT PROPOSITION. 70.1 LD. DR EXPLAINED THAT ON-SITE AND OFF SITE DI STINCTION HAS TO BE TAKEN INTO CONSIDERATION IN ORDER TO SELECT COMPARABLES. IN THIS REGARD LD. DR EXPLAINED THAT MEDICAL COMPANY MAY BE EARNING EXPOR T REVENUES FROM X-RAY DIGITALLY TRANSFERRED AND ALSO FROM SPECIALIST GOIN G ABROAD. HE SUBMITTED THAT IN CASE OF FIRST VIZ. X-RAY DIGITALLY TRANSFERRED, THE SAME IS OFFSHORE REVENUE THOUGH EXPORT EARNING BUT THE OTHER ONE VIZ. SPECIALIST GO ING ABROAD IS ON-SITE REVENUE BECAUSE THE SERVICES WERE RENDERED ON-SITE. HE SUB MITTED THAT THE REVENUE EARNED FROM BOTH THESE ACTIVITIES ENTAIL ALTOGETHER DIFFERENT COST STRUCTURE AND CANNOT BE COMPARED WITH EACH OTHER. HE SUBMITTED T HAT MARGINS OF PROFIT FROM ON-SITE REVENUE IS MUCH LESS THAN THE PROFIT MARGIN S EARNED FROM OFF SITE REVENUES. LD. DR FURTHER SUBMITTED THAT IF ON-SITE REVENUES EARNED FROM EXPORT WERE MORE THAN 75% THEN THE SAID COMPANY HAD TO BE EXCLUDED SINCE ASSESSEE WAS MAINLY EARNING OFFSHORE REVENUES FROM EXPORT. HE SUBMITTED THAT THIS IS IN LINE WITH RULE 10B(2) PARTICULARLY CLAUS ES (B) & (D) WHICH REQUIRE THAT ITA NO. 5637/D/2011 111 COMPARABILITY OF AN INTERNATIONAL TRANSACTION WITH AN UNCONTROLLED TRANSACTION IS TO BE JUDGED WITH REFERENCE, INTER-ALIA, TO THE FUN CTIONS PERFORMED, TAKING INTO ACCOUNT ASSETS EMPLOYED OR TO BE EMPLOYED AND THE R ISKS ASSUMED, BY THE RESPECTIVE PARTIES AND ALSO THE CONDITIONS PREVAILI NG IN THE MARKET IN WHICH THE RESPECTIVE PARTIES TO THE TRANSACTION OPERATE, INCL UDING THE GEOGRAPHICAL LOCATION AND SIZE OF THE MARKET, THE LAWS AND GOVERNMENT ORD ERS IN FORCE, COST OF LABOUR AND CAPITAL IN THE MARKETS, OVERALL ECONOMIC DEVELO PMENT AND LEVEL OF COMPETITION, ETC. LD. DR FURTHER POINTED OUT THAT THE AE IS LOCATED IN USA WHERE MINIMUM WAGES PAYABLE TO AN EMPLOYEE ARE MUCH MORE THAN INDIAN WAGES. LD. DR REFERRED TO THE DECISION IN THE CASE OF TRILOGY AND POINTED OUT THAT PARA 67 OF THE SAID DECISION COVERS THIS ISSUE . LD. CIT(DR) SUBMITTED THAT ASSETS EMPLOYED WILL BE LESSER IN CASE OF ON-SITE O PERATOR AND WILL AFFECT FAR ANALYSIS. HE SUBMITTED THAT COMPANIES HAVING ON-SI TE REVENUE OF MORE THAN 75% ARE NOT SELECTED ON BASIS OF PROFIT MARGINS. L D. DR POINTED OUT THAT OFFSHORE COMPANIES ARE THRIVING BECAUSE OF COST ADV ANTAGE AND ECONOMIC CONDITIONS OF MARKET. HE SUBMITTED THAT AS PER RUL E 10B(2)(D), WHICH SPECIFICALLY REQUIRES CONSIDERATION OF CONDITIONS P REVAILING IN THE MARKETS IN WHICH THE RESPECTIVE PARTIES PERFORMS, ON ACCOUNT OF GEOGRAPHICAL DIFFERENCES, SUCH COMPANIES ARE NOT COMPARABLE. LD. DR FURTHER SUBMITTED THAT UNDER TNMM METHOD, THERE HAS TO BE BROUGHT COMPARABILITY ONLY WITHIN THE FRAMEWORK OF OUR LEGISLATION. 70.2 WE HAVE CONSIDERED THE RIVAL SUBMISSION AND H AVE PERUSED THE RECORD OF THE CASE. ITA NO. 5637/D/2011 112 71. FROM THE SUBMISSIONS ADVANCED BY LD. COUNSEL F OR THE ASSESSEE, IT IS CLEAR THAT IT IS NOT DISPUTED THAT THE PROFIT MARGI N IN CASE OF ON-SITE WORK IS NORMALLY LOW AS COMPARED TO OFFSHORE WORK. THE TPO HAS CLEARLY DEMONSTRATED WITH FACTS AND FIGURES THAT THERE IS CONSIDERABLE D IFFERENCE BETWEEN THE AVERAGE RATE PER HOUR IN THE CASE OF OFFSHORE PROJECTS VIS- A-VIS ON-SITE PROJECTS. THE REASONS GIVEN BY TPO ARE WELL FOUNDED. AS THE ON-S ITE PROJECT IS ALTOGETHER A DIFFERENT SEGMENT OF THE BUSINESS AND, THEREFORE, T HE FACTORS WHICH INFLUENCE THE PROFITABILITY OF THAT SEGMENT HAVE TO BE CONSIDERED BEFORE CONSIDERING THE SAME FOR COMPARABILITY STUDY. IN ON-SITE PROJECTS THE A SSESSEE UTILIZES THE ASSETS OF THE CLIENT WHEREAS IN OFFSHORE PROJECT THE ASSESSEE UTILIZES ITS OWN ASSEETS. THIS ITSELF BRINGS CONSIDERABLE DIFFERENCE IN THE C OMPARABILITY OF THE TWO SEGMENTS BY AFFECTING THE PROFITABILITY. THE SALARY STRUCTURE IN CASE OF ON-SITE PROJECT IS GOVERNED BY THE ECONOMIC CONDITIONS PREV AILING IN THE RESIDENT COUNTRY WHERE WORK IS ACTUALLY PERFORMED, WHEREAS I N OFFSHORE PROJECTS, INDIAN CONDITIONS GOVERN THE SALARY STRUCTURE WHICH IS MUC H LOWER AS COMPARED TO THE COUNTRY WHERE ASSOCIATED ENTERPRISE IS LOCATED. WE , THEREFORE, DO NOT FIND ANY REASON FOR NOT ACCEPTING THE TPOS CONTENTION IN TH IS REGARD. 72. LD. COUNSEL HAS SUBMITTED THAT THE THRESHOLD O F 75% IS QUITE HIGH. IN OUR OPINION, THIS ARGUMENT OF LD. COUNSEL CANNOT BE ACCEPTED BECAUSE, ADMITTEDLY, THE PROFITABILITY IN CASE OF ON-SITE PR OJECT IS MUCH LESS THAN OFFSHORE PROJECTS. THEREFORE, TPO WAS QUITE FAIR WHEN IT AP PLIED THE ON-SITE REVENUES FILTER CONSIDERING THE COMPANIES GENERATING MORE TH AN 75% OF THEIR EXPORT REVENUES FROM ON-SITE OPERATIONS. THIS RESULTED IN TO ACCEPTING THOSE ITA NO. 5637/D/2011 113 COMPARABLES WHERE COMPANIES WERE GENERATING LESS TH AN 75% OF THEIR EXPORT REVENUES FROM ON-SITE OPERATIONS. THIS RESULTED IN EXCLUDING ONLY THOSE COMPARABLES WHICH WERE PREDOMINANTLY EARNING FROM O N-SITE OPERATIONS. THIS TOOK CARE OF THE ASSESSEES SUBMISSIONS ALSO THAT INDIAN SOFTWARE COMPANIES FOLLOW HYBRID MODEL WITH A MIX OF ON-SITE AND OFFSH ORE OPERATIONS. 72.1 IN VIEW OF ABOVE DISCUSSION, THE GROUND RAISED BY ASSESSEE STANDS REJECTED. 73. BRIEF FACTS APROPOS GROUND NO. 4.5.9 ARE THAT TPO NOTICED THAT ASSESSEE HAD EXCLUDED THE COMPANIES WHICH INCUR EXP ENSES ON R&D MORE THAN 3% OF REVENUES. THE ASSESSEE JUSTIFIED ITS SE ARCH PROCESS ON FOLLOWING GROUNDS: 1. IT ELIMINATES COMPANIES OWNING INTELLECTUAL PROP ERTY RIGHTS; 2. IT ELIMINATES COMPANIES THAT ENTAIL DIFFERENT LE VEL OF RISKS AND ARE FUNCTIONALLY DIFFERENT. INCURRING R&D EXPENDITURE AT A MATERIAL LEVEL MAKES THE COMPANY A SIGNIFICANT RISK BEARING ENTITY BECAUSE R &D ACTIVITY IS NOT A PREDICTABLE PROCESS. IT CAN SUCCEED OR FAIL DEPEND ING UPON UNKNOWN FACTORS. IF IT FAILS, THE ASSESSEE WILL INCUR A DENT IN ITS PRO FIT AND ON THE CONTRARY IF IT SUCCEEDS THEN IT STANDS TO GAIN SIGNIFICANTLY BY WA Y OF INCREASED REVENUES. OTHER COMPANIES THAT DO NOT INCUR R&D EXPENDITURE A T A SUBSTANTIAL LEVEL DO NOT BARE THIS RISK AND DO NOT STAND TO GAIN OR LOOSE IN THIS REGARD. FURTHER A SOFTWARE DEVELOPMENT COMPANY CANNOT BE COMPARED WIT H A SIMPLE SOFTWARE SERVICE PROVIDER IN THE CASE OF CAPTIVE SERVICE PRO VIDER OF A MULTI NATIONAL LIKE ASSESSEE, THE OVERSEAS PARENT, COMPANY THE ENTREPRE NEUR ORGANIZATION DRIVE ITA NO. 5637/D/2011 114 THE R&D. ACCORDINGLY, IT BARES THE RISKS RELATED T O THE SUCCESS OR FAILURE OF THE R&D AND THE POSSIBILITY OF THE INVENTION OR THE DIS COVERY BEING CREATED THROUGH SUCH R&D. THE ASSESSEE DOES NOT INCUR ANY AMOUNT O N R&D. 3. THE ASSESSEE ITSELF HAS TAKEN THE COMPARABLES IN CURRING UPTO 0 TO 3% OF TOTAL REVENUES ON R&D BUT EXCLUDED VARIOUS COMPANIE S WITH VERY HIGH EXPENSES ON R&D EXPENSES SUCH AS ELECTRONICS SOFTWA RE SYSTEMS, WIPRO LTD., TATA ELXSI LTD., SASKEN COMMUNICATION TECHNOLOGIES LTD., SAB LAB LTD., ALL THESE COMPANIES ARE SOFTWARE PRODUCT DEVELOPMENT CO MPANIES AND HAVE THEIR OWN PROPRIETARY PRODUCTS AND PATENTS. IT IS NOT A COINCIDENCE THAT COMPANIES THAT INCUR SUBSTANTIAL R&D EXPENDITURE ARE PRODUCT COMPANIES AND OWN INTELLECTUAL PROPERTY RIGHTS. 74. THE TPO DID NOT ACCEPT THE ASSESSEES CONTENTI ON OBSERVING THAT FOR CREATING INTELLECTUAL PROPERTY RIGHTS, R&D IS REQUI RED BUT THE CONVERSE IS NOT TRUE I.E. EACH COMPANY IS SPENDING ON R&D AUTOMATICALLY IS NOT TOWARDS CREATING AN IPR. THE R&D ACTIVITY IN A SOFTWARE DEVELOPMENT CO MPANY IS TO IMPROVE THE PROCESSES IN DELIVERING THE SOFTWARE DEVELOPMENT SE RVICES AND NOT IN CREATING INTANGIBLE. TPO FURTHER POINTED OUT THAT EVEN BIGG ER COMPANIES LIKE INFOSYS SPEND ON R&D BUT NOT IN CREATING INTANGIBLE (OTHER THAN RELATING TO PRODUCTS). TPO HAS REPRODUCED AT PAGE 25 EXTRACTS FROM AN ANNU AL REPORT OF INFOSYS FOR THE F.Y. 2006-07, WHEREIN IT HAS BEEN, INTER-ALIA, OBSERVED AS UNDER: R&D OF NEW SERVICES, DESIGNS, FRAMEWORKS, PROCESSE S AND METHODOLOGY CONTINUE TO BE AN IMPORTANCE OF US. THIS ALLOWS US TO ENHANCE QUALITY, PRODUCTIVITY AND CUSTOMER SATISFACTION THROUGH CONT INUOUS INNOVATION. ITA NO. 5637/D/2011 115 74.1 TPO FURTHER POINTED OUT THAT INFOSYS HAD SPEN T AN AMOUNT OF RS. 167 CRORES AS R&D OUT OF WHICH RS. 48 CRORES WAS SPENT ON ITS BANKING SOFTWARE PRODUCT, FINACLE. THE REMAINING AMOUNT OF RS. 119 CRORES WAS SPENT ON OTHER ACTIVITIES. THEREFORE, THE MAIN INTENTION OF R&D I NFOSYS WAS EITHER TO DEVELOP ITS SOFTWARE PRODUCT, FINACLE OR TO ENHANCE QUALITY PRODUCTIVITY AND CUSTOMER SATISFACTION THROUGH CONTINUOUS INNOVATION OF DESIG NS FRAMEWORK PROCESSES AND METHODOLOGY OF THE SERVICES DELIVERED BY IT. THERE FORE, IT CAN BE INFERRED THAT R&D SOFTWARE INDUSTRY IS ALWAYS NOT TO CREATE ONLY IPRS BUT ALSO TO CREATE TOOLS/PROCESSES TO IMPROVE THE QUALITY OF SERVICES BEING RENDERED. AS REGARDS ASSESSEES CONTENTION THAT IT BEING A CAPTIVE SERVI CE PROVIDER DOES NOT INVEST IN R&D BUT ITS PARENT COMPANY INVEST IN R&D, TPO OBSER VED THAT RISK OF R&D IS BORNE BY A PARENT COMPANY. TPO FURTHER POINTED OUT THAT THE COMPARABLE COMPANIES ARE ALSO MAINLY INVOLVED IN THE DEVELOPME NT OF SOFTWARE SIMILAR TO THE TAX PAYER. HE POINTED OUT THAT THIS FILTER IS NOT RELEVANT AS THE EXPENDITURE ON R&D IS ALSO TOWARDS IMPROVING THE PROCESSES AS W ELL. WITH REFERENCE TO THE RELIANCE PLACED ON OECD GUIDELINES REGARDING HIGH R ISK OF FAILURE OF INVESTMENT IN R&D AND CONSEQUENTLY HIGH COST PRESSURE OF SUCCE SSFUL PRODUCT COMING OUT THE R&D ACTIVITY, TPO POINTED OUT THAT THERE IS NO DISPUTE THAT COMPANIES INVESTING IN HUGE R&D SPECIFICALLY IN PHARMACEUTICA L AND OTHER R&D INTENSIVE INDUSTRY LIKE SOFTWARE PRODUCTS, THE RISK OF FAILUR E IS VERY HIGH. THEREFORE, THE INTENTION OF THE ASSESSEE IN APPLYING R&D FILTER AP PEARED TO REJECT COMPANIES WITH PRODUCST BASED ON THE R&D EXPENDITURE. HOWEVE R, IN A SERVICE INDUSTRY LIKE SOFTWARE INDUSTRY, R&D EXPENSES DO NOT INDICAT E WHETHER A COMPANY IS A ITA NO. 5637/D/2011 116 SOFTWARE PRODUCT COMPANY OR NOT. HE POINTED OUT TH AT BY APPLICATION OF THIS FILTER, SOME COMPANIES WERE REJECTED AS COMPARABLES EVEN THOUGH THEY ARE NOT SOFTWARE PRODUCTS OR THEY DO NOT HAVE SIGNIFICANT R EVENUES (MORE THAN 25%) FROM SOFTWARE PRODUCTS E.G. FLEXTRONICS SOFTWARE SY STEMS LTD. WAS REJECTED BY THE COMPANY BY APPLYING THIS FILTER. BUT THE COMPA NIES PRODUCT AND SERVICES SEGMENT HAD PRODUCT REVENUES ONLY TO THE EXTENT OF 10.87% OF THE SEGMENTAL REVENUES. THEREFORE, THE FILTER APPLICATION DID NO T YIELD INTENDED RESULTS. SIMILARLY, THE FILTER DID NOT REJECT ALL THE COMPAN IES WITH PRODUCTS THOUGH THE ASSESSEE IS MAINLY SOFTWARE DEVELOPMENT COMPANY. T HEREFORE, THE COMPARABLES HAD TO BE PRE-DOMINANTLY ENGAGED IN SOF TWARE DEVELOPMENT SERVICES. HOWEVER, BY APPLYING THIS FILTER, THE AS SESSEE COULD NOT ELIMINATE SOFTWARE PRODUCT COMPANIES. FURTHER, SOME OF SUCH COMPANIES WERE REJECTED BY THE ASSESSEE COMPANY BEING PRODUCT COMPANIES THO UGH THEY QUALIFIED THE R&D FILTER AS UNDER: 1. AFTEK LTD. 2. ESSEL SOFTWARE & SERVICES LTD. 3. IFLEX SOLUTIONS LTD. 4. INTENSE TECHNOLOGIES LTD. 5. MAARS SOFTWARE INTERNATIONAL LTD. 6. MIRCO TECHNOLOGIES (INDIA) LTD. 7. TELEDATA INFORMATICS LTD. 8. TRANSWORLD INFOTECH LTD. 9. TUTIS TECHNOLOGIES LTD. 10. VAKRANGEE SOFTWARES LTD. 11. ZENITH INFOTECH LTD. 12. TAKE SOLUTIONS LTD. ITA NO. 5637/D/2011 117 13. ABM KNOWLEDGEWARE LTD. 14. ASIAN CERC INFORMATION TECHNOLOGIES LTD. 15. SHYAM TELECOM LTD. 16. KALS INFORMATION SYSTEMS LTD. 74.2 THUS, THE AFOREMENTIONED COMPANIES THOUGH PASS ED THE R&D FILTER APPLIED BY ASSESSEE BUT HAD TO BE REJECTED BY ASSES SEE ON THE GROUND THAT THEY WERE PRODUCT INTENSIVE COMPANIES. THEREFORE, IT IS EVIDENT THAT THE EXPENDITURE DEBITED IN THE PROFIT AND LOSS ACCOUNT UNDER THE HEAD R&D IS NOT CONCLUSIVE PROOF OF THE COMPANY BEING A PRODUCT COM PANY PARTICULARLY IN THE CASE OF SOFTWARE SERVICE PROVIDER. 75. IN CONTRAST, LD. TPO POINTED OUT THAT HE HAD A PPLIED A FILTER, WHEREIN ALL THOSE COMPANIES WHOSE REVENUES FROM SOFTWARE DE VELOPMENT SERVICES WAS LESS THAN 75% OF THE OVERALL REVENUES/SEGMENTAL REV ENUES WERE REJECTED. THIS FILTER ELIMINATES COMPANIES WHICH WERE SOFTWARE PRO DUCT COMPANY AS WELL. LD. TPO FURTHER DEMONSTRATED THAT R&D FILTER APPLIED BY THE ASSESSEE HAD ON THE ONE HAND FAILED TO ELIMINATE THE PRODUCT COMPANIES AND ON THE OTHER HAND RESULTED IN ELIMINATION OF FOLLOWING NON-PRODUCT CO MPANIES WHICH WERE ACTUALLY COMPANIES ENGAGED IN SOFTWARE DEVELOPMENT SERVICES: - S.NO. NAME OF THE COMPANY REMARKS OF THE TPO 1. QUINTEGRA SOLUTIONS LTD. THE COMPANY IS INTO SOFTWARE DEVELOPMENT SERVICES AND IT DOES NOT HAVE ANY REVENUES FROM SALE OF SOFTWARE PRODUCTS. 2. SASKEN COMMUNICATIONS TECHNOLOGIES LTD. THE COMPANY HAS SOFTWARE SERVICES SEGMENT. THIS SEGMENT DOES NOT CONTAIN ANY REVENUE BY WAY OF SALE OF ITA NO. 5637/D/2011 118 PRODUCTS. SASKEN COMMUNICATION TECHNOLOGIES LTD. CLEARLY STATED IN ITS REPLY THAT IT HAS NOT INCURRED ANY R&D EXPENSES IN THE SOFTWARE DEVELOPMENT SERVICES SEGMENT. THOUGH OVERALL, THE COMPANY SPENT MORE THAN 3% OF THE REVENUES ON RESEARCH AND DEVELOP- MENT, THESE EXPENSES ARE SPENT IN THE SOFTWARE PRODUCTS SEGMENT VINDICATING THE POSITION OF THE TPO THAT SOFTWARE PRODUCT COMPANIES INCUR SUBSTANTIAL R&D EXPENSES BUT SUBSTANTIAL R&D EXPENSES MAY NOT INDICATE THAT A COMPANY IS A SOFTWARE PRODUCT COMPANY OR GENERATING INTANGIBLES. 3. TATA ELXSI LTD. THE COMPANY HAS SOFTWARE DEVELOPMENT AND SERVICES SEGMENT. THIS SEGMENT DOES NOT CONTAIN ANY REVENUE BY WAY OF SALE OF PRODUCTS. 4. FLEXTRONICS SOFTWARE SYSTEMS LTD. THE COMPANY HAS SOFTWARE PRODUCTS AND SERVICES SEGMENT. IN THIS SEGMENT, MORE THAN 75% OF THE REVENUES ARE GENERATED FROM SOFTWARE DEVELOPMENT SERVICES. 75.1 HE, THEREFORE, POINTED OUT THAT THE FILTER IS INAPPROPRIATE. 76. AS REGARDS, ASSESSEES ARGUMENT THAT R&D FILTE R WAS APPLIED NOT JUST TO FILTER OUT PRODUCT COMPANIES AS MENTIONED IN THE SHOW CAUSE NOTICE BUT TO FILTER OUT COMPARABLE COMPANIES WITH TECHNOLOGY INT ANGIBLE, INTELLECTUAL PROPERTY ETC., LD. TPO POINTED OUT THAT ASSESSEE DID NOT SHO W ANY SINGLE INSTANCE WHERE ITA NO. 5637/D/2011 119 THE APPLICATION OF THIS FILTER ELIMINATED COMPANIES WITH TECHNOLOGY INTANGIBLES, INTELLECTUAL PROPERTY ETC., EVEN THOUGH SUCH COMPAN IES WERE NOT DEVELOPING SOFTWARE PRODUCTS. LD. TPO FURTHER POINTED OUT THAT ASSESSEE HAD NOT EXPLAINED ANY RATIONALE FOR PUTTING THE LIMIT OF 3%. 77. ACCORDINGLY, LD. TPO CONCLUDED THAT THERE IS N O REASON TO EXCLUDE COMPARABLE COMPANIES ENGAGED IN R&D IF THEY ARE SOF TWARE SERVICE PROVIDERS. HE OBSERVED THAT THE CRITERIA MAY BE A TRIGGER TO E XAMINE FURTHER WHETHER THE COMPANY HAS ANY SALES BY WAY OF PRODUCTS OR CREATED ANY INTANGIBLE WHICH WAS EXPLOITED COMMERCIALLY FOR SALE. BUT IT CANNOT BE APPLIED AS A FILTER BECAUSE THIS FILTER ALSO ELIMINATES SOFTWARE DEVELOPMENT COMPANI ES. LD. TPO DEMONSTRATED THAT R&D EXPENSES OF THE COMPANY AND THE MARGIN EAR NED BY THE COMPARABLE HAD NO CORRELATION BY CONSIDERING FOLLOWING COMPARA BLE SELECTED BY HIM: S.N O. COMPANY NAME SALES (RS. CR.) OP TO TOTAL COST% % OF R&D OVER SALES 1. ACCEL TRANSMATI C LTD. (SEG.) 9.68 20.90 % 0.00% 2. AVANI CIMCONN TECHNOLOG IES LTD. 3.55 50.29 % 0.00% 3. CELESTIAL LABS LTD. 14.13 58.35 % 17.83 % 4. DATAMATIC S LTD. 54.51 1.38% 0.00% 5. E-ZEST SOLUTIONS LTD. 6.26 35.63 % 0.00% 6. FLEXTRONIC S SOFTWARE SYSTEMS LTD. (SEG.) 848.66 25.31 % 0.46% 7. GEOMETRIC LTD. (SEG.) 158.38 % 10.71 % 0.00% 8. HELIOS & MATHESON 178.63 35.63 % 0.00% ITA NO. 5637/D/2011 120 INFORMATI ON TECHNOLOG Y LTD. 9. IGATE GLOBAL SOLUTIONS LTD. 747.27 7.49% 0.00% 10. INFOSYS TECHNOLOG IES LTD. 131.49 40.30 % 1.27% 11. ISHIR INFOTECH LTD. 7.42 30.12 % 0.00% 12. KALS INFORMATI ON SYSTEMS LTD. (SEG.) 2.00 30.55 % 0.00% 13. LGS GLOBAL LTD. (LANCO GLOBAL SOLUTIONS LTD.) 45.39 15.75 % 0.00% 14. LUCID SOFTWARE LTD. 1.70 19.37 % 0.00% 15. MEDIASOFT SOLUTIONS LTD. 1.85 3.66% 0.00% 16. MEGASOFT LTD. 139.33 60.23 % 0.00% 17. MINDTREE LTD. 590.35 16.90 % 0.00% 18. PERSISTENT SYSTEMS LTD. 293.75 24.18 % 0.92% 19. QUINTEGRA SOLUTIONS LTD. 62.72 12.56 % 0.62% 20. R S SOFTWARE (INDIA) LTD. 101.04 13.47 % 0.00% 21. R SYSTEMS INTERNATIO NAL LTD. (SEG.) 112.01 15.07 % 0.56% 22. SASKEN COMMUNI CATION TECHNOLOG IES LTD. (SEG.) 343.57 22.16 % 0.00% 23. SIP 3.80 13.90 0.00% ITA NO. 5637/D/2011 121 TECHNOLOG IES & EXPORTS LTD. % 24. TATA ELXSI LTD. (SEG.) 262.58 26.51 % 4.15% 25. THIRDWARE SOLUTIONS LTD. 36.08 25.12 % 0.00% 26. WIPRO LTD. (SEG.) 9616.0 9 33.48 % 8.50% 77.1 HE POINTED OUT THAT THREE COMPANIES VIZ. TATA ELXSI, CELESTIAL LABS & WIPRO LTD. HAD A RATIO OF MARKETING EXPENSES TO SAL ES OF MORE THAN 3% BUT STILL THEY REMAIN SOFTWARE DEVELOPMENT COMPANIES. 78. LD. DRP ACCEPTED THE LD. TPOS CONTENTION THAT REJECTION OF THIS FILTER HAD NO MATERIAL IMPACT IN THE CASE OF ASSESSEE. LD . DRP, INTER-ALIA, POINTED OUT THAT SPENDING ON R&D DOES NOT NECESSARILY RESULT IN CREATION OF IPR. THE R&D ACTIVITY IN A SOFTWARE COMPANY MAY BE WITH RESPECT TO IMPROVING PROCESS OF DELIVERY OF SERVICES (SOFTWARE DEVELOPMENT SERVICES ) RATHER THAN CREATION OF INTANGIBLE. LD. DRP RELIED ON ANALYSIS OF STATISTI CAL DATA OF VARIOUS COMPANIES AS DEMONSTRATED BY LD. TPO, NOTED ABOVE. 79. LD. COUNSEL FOR THE ASSESSEE RELIED ON THE WRI TTEN SUBMISSIONS FILED BY IT AS NOTED EARLIER. 80. LD.CIT(DR) SUBMITTED THAT THERE IS NO BASIS FO R ADOPTING 3% LIMIT OF R&D EXPENSES TO SALES. HE POINTED OUT THAT ASSESSE E HAS NOT DEMONSTRATED AS TO HOW PROFITABILITY GOT AFFECTED BY INCURRING E XPENDITURE MORE THAN 3% ON R&D TO SALES. LD. DR FURTHER SUBMITTED THAT SINCE EXPENDITURE HAD ALREADY BEEN DEBITED TO THE PROFIT AND LOSS ACCOUNT, THERE FORE, THE PROFITS WERE LOWER AND HENCE HAD NO IMPACT ON OPERATING PROFITABILITY OF COMPARABLE. HE ITA NO. 5637/D/2011 122 SUBMITTED THAT THE ASSESSEE HAD NOT DEMONSTRATED TH AT R&D ACTIVITY CHANGES THE FUNCTIONALITY OF A SOFTWARE DEVELOPMENT. THE SUBMISSIONS OF LD. CIT(DR) ARE REPRODUCED AS UN DER:- REJECTING ASSESSEES FILTER OF ACCEPTING COMPANIES HAVING RESEARCH AND DEVELOPMENT COSTS TO SALES LESS 3%. COUNTER : THE TPO HAS COVERED THIS IN HIS ORDER ON PAGE 29 TI LL 32. HOW DOES R&D EXPENDITURE INFLUENCE PROFITS OR FAR A NALYSIS, NEEDS TO BE ESTABLISHED. THE CUT-OFF FIGURE OF 3% IS ADHOC, RA NDOM AND WITHOUT ANY BASIS. REVENUE FINDS SUPPORT FROM THE CASE OF M/S DELOITTE CONSULTING (I) (P) LTD. 1082/1084/HYD./2010, PARA 36 THEREOF. FURTHER, THE NEED FOR CORRELATING EXPENDITURE TO FA R AND PROFITS HAS BEEN DEMONSTRATED IN THE CASE OF M/S ACTIS ADVISERS P. L TD. ITA NO. 5277/DEL/2011, PARA 19, 20 AND 26 THEREOF. 80.1 LD. DR REFERRED TO THE ORDER OF TPO AND POINTE D OUT THAT THIS CAN ONLY BE A CRITERIA TO TRIGGER THE FURTHER EXAMINATION AS TO WHETHER THE COMPANY HAS ANY SALES BY WAY OF PRODUCTS OR CREATED ANY INTANGI BLE WHICH WAS EXPLOITED COMMERCIALLY FOR SALES. BUT IT CANNOT BE APPLIED A S A FILTER BECAUSE THIS FILTER ALSO ELIMINATES SOFTWARE DEVELOPMENT COMPANIES. LD . DR REFERRED TO THE TRANSFER PRICING STUDY CONTAINED AT PAPER BOOK VOL. III AND REFERRED TO PAGE NO. 1020 OF THE SAME TO DEMONSTRATE THAT IN THE SEARCH PROCESS COMPANIES WITH THE RATIO OF THE SUM OF ADVERTISING MARKETING AND DISTR IBUTION EXPENSES TO SALES LESS THAN OR EQUAL TO 3% WERE 340. HOWEVER, WHEN QUALIT ATIVE FILTERS WERE APPLIED ITA NO. 5637/D/2011 123 BY CONSIDERING COMPANIES ENGAGED IN SOFTWARE DEVELO PMENT ACTIVITIES BROADLY SIMILAR TO THOSE CARRIED OUT BY ASSESSEE THEN ONLY 11 COMPARABLES WERE LEFT. THEREFORE, BY APPLYING THIS FILTER SUFFICIENT NUMBE R OF COMPARABLES WHICH WERE FUNCTIONALLY SIMILAR GOT EXCLUDED. LD. DR FURTHER SUBMITTED THAT PARA 19 TO PARA 24 OF ACTIS COVERS THIS ISSUE. LD. CIT(DR) POINTED OUT THAT HOW DOES R&D EXPENDITURE INFLUENCES PROFITS AND FAR ANALYSIS, NE EDS TO BE ESTABLISHED. HE SUBMITTED THAT RESEARCH ACTIVITY DOES NOT CHANGE TH E FUNCTIONAL PROFILE OF AN ENTITY AND THUS, DOES NOT MAKE THE SAME AS NOT COMP ARABLE TO THE ASSESSEE. RESEARCH ACTIVITY HAS NO DIRECT CORRELATION TO PROF ITS OR MARGIN. 81. IN THE REJOINDER, LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT THE DECISION OF DELOITE CONSULTING INDIA P. LTD. (SUPRA ) IS OF NO ASSISTANCE TO REVENUE AS THE ISSUE DISCUSSED IN PARA 36 IS NOT I N RELATION TO THE FILTER IN QUESTION I.E. R&D EXPENDITURE BEING 3% OR MORE OF T HE SALES. IN THIS CASE, THE SUITABILITY OF ONE PARTICULAR COMPARABLE WAS DISCUS SED BASED ON PECULIAR FACTS OF THE COMPARABLE. HE SUBMITTED THAT IT IS PERTINE NT TO NOTE THAT DELOITE CONSULTING INDIA P. LTD. AND THE COMPARABLE IN QUES TION WERE NOT SOFTWARE DEVELOPMENT COMPANIES, BUT COMPANIES PROVIDING INFO RMATION TECHNOLOGY ENABLED SERVICES WHICH ARE IN THE NATURE OF BUSINES S PROCESS OUTSOURCING. IN THIS CASE, THE R&D INVESTMENT DOES NOT MATTER MUCH AS THE SERVICES ARE IN THE NATURE OF BACK OFFICE SUPPORT. LD. COUNSEL FURTHER POINTED OUT THAT AS PER RULE 10B(2) FUNCTIONAL COMPARABILITY IS THE MOST IMPORTA NT DETERMINING FACTOR IN SELECTING COMPARABLES. HOWEVER, RESEARCH IS AN ADD ITIONAL FUNCTION WHICH THE ASSESSEE DOES NOT UNDERTAKE AND HENCE INCURRED ZERO EXPENDITURE ON ANY ITA NO. 5637/D/2011 124 RESEARCH ACTIVITY. THEREFORE, THE ASSESSEE HAD EXC LUDED THE COMPANIES ENGAGED IN ANY KIND OF RESEARCH ACTIVITY. AS REGAR DS LD. CIT(DRS) SUBMISSION THAT A CORRELATION HAS TO BE ESTABLISHED BETWEEN RE SEARCH AND DEVELOPMENT ACTIVITY AND PROFITABILITY TO DETERMINE WHETHER THI S FILTER SHOULD AT ALL BE APPLIED OR NOT, LD. COUNSEL SUBMITTED THAT R&D EXPENDITURE IS AN INVESTMENT I.E. MADE WITH THE HOPE OF REAPING BENEFIT THERE FROM. IF SU BSTANTIAL EXPENDITURE IS INCURRED ON R&D THE COMPANY EXPOSES ITSELF TO ADDIT IONAL RISK NOT BORNE BY COMPANIES THAT DO NOT INCUR ANY R&D EXPENDITURE. H E POINTED OUT THAT RULE 10(B)(3) DOES NOT REQUIRE THE ASSESSEE TO DEMONSTRA TE A POSITIVE CORRELATION BETWEEN ANY DIFFERENCE AND PROFITABILITY. WHAT NEE DS TO BE SEEN IS WHETHER ON THE FACTS & CIRCUMSTANCES IF ANY DIFFERENCES ARE LI KELY TO IMPACT THE PROFIT MARGIN IN A MATERIAL MANNER, SUCH A DIFFERENCE SHOULD BE A CCOUNTED FOR BY WAY OF AN ADJUSTMENT. IN THE EVENT OF SUCH AN ADJUSTMENT NOT BEING POSSIBLE, THE COMPARABLE HAS TO BE EXCLUDED. LD. COUNSEL FURTHER POINTED OUT THAT THE FACT THAT FLEXTRONICS, INFOSYS & SUSKINS TECHNOLOGIES HA VE UNDERTAKEN SIGNIFICANT RESEARCH ACTIVITY AND AS A RESULT DEVELOPED SIGNIFI CANT INTELLECTUAL PROPERTY AND HAVE ALSO INCREASED R&D EXPENDITURE PROVES THE ASS ESSEES CONTENTION THAT THERE IS A POSITIVE CORRELATION BETWEEN INTANGIBLES AND R&D EXPENDITURE. HENCE, SUCH COMPANIES CANNOT BE CONSIDERED TO BE CO MPARABLE TO THE ASSESSEE. AS REGARDS THE THRESHOLD LIMIT OF 3% APP LIED BY ASSESSE IN REGARD TO R&D EXPENDITURE TO SALES, LD. COUNSEL POINTED OUT T HAT WHAT NEEDS TO BE CONSIDERED IS WHETHER SUCH PRINCIPLE PASSES THE TES T OF MATERIALITY OR NOT. HE ITA NO. 5637/D/2011 125 SUBMITTED THAT 3% OF SALES IS A MATERIAL AMOUNT WHI CH HAS THE POSSIBILITY OF REDUCING THE PROFITS OF A COMPANY MATERIALLY. 81.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH THE PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. WE ARE IN AGREEMENT WITH LD. TPOS OBSERVATIONS THAT FOR CREATING INTELLECTUAL PROPERT Y RIGHTS, R&D IS REQUIRED BUT THE CONVERSE IS NOT TRUE I.E. EACH COMPANY SPENDING ON R&D AUTOMATICALLY IS NOT TOWARDS CREATING AN IPR. WE ARE ALSO IN AGREEM ENT WITH THE OBSERVATION OF LD. TPO THAT R&D ACTIVITY IN A SOFTWARE DEVELOPMENT COMPANY IS TO IMPROVE THE PROCESSES IN DELIVERING THE SOFTWARE DEVELOPMENT SE RVICES AND NOT FOR CREATING AN INTANGLIBLE. BUT AT THE SAME TIME THE SUBMISSION S OF LD. COUNSEL FOR THE ASSESSEE THAT PROFITABILITY OF COMPANIES HAVING INT ANGIBLES IS MORE CANNOT BE LOST SIGHT OFF. IF A COMPANY IS HAVING BRAND THEN I T IS DEFINITELY IN A BETTER POSITION TO COMMAND HIGHER PROFITS. LD. COUNSEL IN HIS SUBMI SSIONS HAS POINTED OUT THAT COMPANIES HAVING PATENT HAD INCURRED SUBSTANTIAL SU MS ON R&D TO DEVELOP ITS OWN PRODUCTS. THUS, BOTH SIDES HAVE THEIR LOGICAL V IEW POINT. UNDER SUCH CIRCUMSTANCES, THE BALANCE HAS TO BE DRAWN KEEPING IN VIEW THE PRIMARY OBJECT OF TRANSFER PRICING STUDY. THE OBJECT OF SELECTION OF COMPARABLES IS TO FIND OUT COMPANIES WHICH ARE PERFORMING SIMILAR FUNCTIONS AS ASSESSEE WITH ALMOST SIMILAR ASSET BASE AND SIMILAR RISKS. THESE COMPAR ABLES ARE TO BE CONSIDERED FOR FINDING OUT THE ARMS LENGTH PRICE. IF BY APPL YING A PARTICULAR FILTER MANY, OTHERWISE COMPARABLES, GETS EXCLUDED THEN SUCH A FI LTER SHOULD BE APPLIED AFTER MAKING NECESSARY ADJUSTMENTS FOR MATERIAL FACTORS. THUS, IF A COMPARABLE HAS DEVELOPED ITS OWN INTELLECTUAL PROPERTY RIGHT RESUL TING INTO DEVELOPMENT OF A ITA NO. 5637/D/2011 126 PATENTED PRODUCT BY INCURRING HUGE EXPENDITURE ON R &D THEN EVEN IF IT IS PERFORMING SOFTWARE DEVELOPMENT FUNCTIONS, IT HAS T O BE EXCLUDED. HOWEVER, IF A COMPANY IS INCURRING HUGE EXPENDITURE ON R&D ONLY F OR IMPROVING THE PROCESSES IN DELIVERING THE SOFTWARE DEVELOPMENT SE RVICES THEN THE SAID COMPARABLE CANNOT BE REJECTED MERELY BECAUSE IT IS INCURRING R&D EXPENDITURE MORE THAN 3% OF ITS TOTAL SALES REVENUE BECAUSE SU FFICIENT NUMBER OF COMPARABLES ARE TO BE FOUND FOR DETERMINING ALP. AN OBJECTIVE DECISION HAS TO BE TAKEN IN EACH CASE. LD. TPO HAS CLEARLY DEMONSTR ATED THAT BY APPLYING THIS FILTER EVEN FUNCTIONALLY SIMILAR COMPANIES GETS EXC LUDED. THIS WILL RESULT IN LIMITING THE NUMBER OF COMPARABLES TO A VERY SMALL NUMBER. THUS, THIS WILL ENTIRELY FRUSTRATE THE OBJECT OF DETERMINATION OF T HE ARMS LENGTH PRICE. THE CONTENTION OF ASSESSEE THAT COMPANIES INCURRING EXP ENDITURE GREATER THAN 3% ON R&D WERE NECESSARILY CREATING IP PRODUCTS IS DEV OID OF ANY MERIT. THEREFORE, THIS FILTER IS TO APPLIED SUBJECT TO PRO PER ANALYSIS AS OBSERVED EARLIER. IN THE RESULT THIS GROUND IS PARTLY ALLOWED IN TERM S OF AFOREMENTIONED OBSERVATIONS. 82. VIDE GROUND NO. 4.5.10 THE ASSESSEE HAS CHALL ENGED THE REJECTION OF ITS FILTER OF ACCEPTING ONLY THOSE COMPANIES HAVING RATIO OF ADVERTISING MARKETING AND DISTRIBUTION EXPENSES TO SALES LESS THAN 3% AS COMPARABLES. LD. TPO DID NOT ACCEPT THIS FILTER FOR THE SAME LOGIC AS FOR R& D EXPENSES TO SALES. LD. TPO OBSERVED THAT EVERY INDEPENDENT ENTERPRISE HAS TO I NCUR MARKETING EXPENDITURE. IN A SERVICE INDUSTRY LIKE SOFTWARE SERVICE, THE AS SESSEE DID NOT PROVIDE THE BASIS ON WHICH SUCH EXPENSES RESULTED IN ANY INTANG IBLE UNLIKE IN ITA NO. 5637/D/2011 127 MANUFACTURING INDUSTRY WHERE SUBSTANTIAL MARKETING EXPENDITURE CREATES AN INTANGIBLE. HE, THEREFORE, OBSERVED THAT THIS FILT ER IS NOT RELEVANT IN SERVICE INDUSTRY LIKE SOFTWARE DEVELOPMENT SERVICES. ACCOR DINGLY, LD.TPO SHOW CAUSED THE ASSESSEE. IN ITS REPLY THE ASSESSEE, INT ER-ALIA, POINTED OUT THAT MARKETING AND ADVERTISING ACTIVITIES CARRIED OUT BY THE ENTREPRENEURIAL COMPANIES RESULT IN CREATION OF MARKETING INTANGIBL ES AND THEREBY DEMAND A RETURN OF SUCH INVESTMENT MADE IN CREATION OF SUCH INTANGIBLE. THE ASSESSEE POINTED OUT THAT INFOSYS TECHNOLOGIES LTD., WIPRO L TD., TATA ELECSIS LTD., FLEXTRONICS HAVE CREATED A BRAND NAME FOR ITSELF IN THE MARKET AND HAVE MADE SIGNIFICANT INVESTMENT IN CREATING SUCH INTANGIBLES . THE ASSESSEE FURTHER POINTED OUT THAT ALONG WITH APPLICATION OF THIS QUA NTITATIVE FILTER, QUALITATIVE ANALYSIS WAS ALSO CARRIED OUT FOR DETERMINING WHETH ER ANY MARKETING INTANGIBLE EXISTED OR NOT. LD. TPO, HOWEVER, DID NOT ACCEPT T HE ASSESEES CONTENTION, INTER-ALIA, OBSERVING THAT ASSESSEE DID NOT GIVE TH E BASIS ON WHICH IT CONCLUDED THAT INFOSYS TECHNOLOGY LTD. ETC., NOTED EARLIER, H AD CREATED MARKETING INTANGIBLE. HE OBSERVED THAT IN THE CASE OF MANUFA CTURING OR DISTRIBUTION COMPANIES, EXPENSES OVER A PERIOD OF TIME MAY CREAT E MARKETING INTANGIBLE. HOWEVER, THE SAME MAY NOT BE TRUE FOR SERVICE INDUS TRY LIKE SOFTWARE DEVELOPMENT SERVICES. LD.TPO FURTHER DEMONSTRATED THAT IT IS NOT ALWAYS TRUE THAT MARKETING EXPENSES RESULT IN BETTER PROFITABIL ITY. HE POINTED OUT THAT IN THE CASE OF INFOSYS 95% OF ITS REVENUE FOR F.Y. 2006-0 7 WAS DERIVED FROM REPEAT BUSINESSES WHICH IMPLIES THAT MARKETING EXPENDITURE HAD LITTLE IMPACT ON THE PROFITABILITY OF ASSESSEE COMPANY. LD. TPO HAS GIV EN THE OPERATING PROFIT TO ITA NO. 5637/D/2011 128 SALES RATIO OF VARIOUS COMPANIES ALONG WITH THE MAR KETING EXPENDITURE INCURRED BY THE SAID COMPANIES TO DEMONSTRATE THAT EXPENDITU RE ON MARKETING HAS NO CORRELATION TO THE MARGIN EARNED. EVEN IN CASE OF COMPANIES THAT HAVE A MARKETING EXPENSE MORE THAN 3% OF SALES THEY ARE AL SO SOFTWARE DEVELOPMENT COMPANIES. 83. LD. DRP CONFIRMED THE TPOS ACTION, INTER-ALIA , OBSERVING THAT MARKETING EXPENDITURE IN THE CASE OF SERVICE INDUST RY MAY LEAD TO INCREASED REVENUE BUT IT HAS NOT BEEN DEMONSTRATED WITH FIGUR ES THAT SUCH EXPENDITURE IN THE CASE OF SOFTWARE SERVICE FIRMS HAS LEAD TO INCR EASED PROFITABILITY. LD. DRP ALSO REFERRED TO THE DECISION OF ITAT HYDERABAD IN M/S DELOITE CONSULTING INDIA PVT. LTD. IN ITA NO. 1082 & 1084/2010. 84. LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT AS SESSEE DOES NOT TAKE ANY MARKETING OR ADVERTISING ACTIVITY AS THE ASSOCI ATED ENTERPRISE ARE CONTRACTUALLY OBLIGED TO OBTAIN THE SERVICE FROM TH E ASSESSEE. THEREFORE, ENTREPRENEURIAL COMPANIES, SELECTED AS COMPARABLE C OMPANIES, CARRYING OUT MARKETING AND ADVERTISING ACTIVITY TO CREATE DEMAND FOR THEIR SERVICES AND THEREBY TO INCREASE THE SHARE IN THE MARKET CANNOT BE TAKEN AS COMPARABLES. HE SUBMITTED THAT RETURN OF SUCH COMPANIES WOULD IN CLUDE AN EMBEDDED RETURN TOWARDS MARKETING ACTIVITIES/EFFORTS AND RELATED IN VESTMENT AND RISK. HENCE, AS IN CASE OF THE R&D/SALES FILTER, THIS FILTER ALSO H ELPS IN THE SELECTION OF THE RIGHT SET OF COMPANIES BY ELIMINATING COMPANIES THAT MAY POSSIBLY OWN MARKETING INTANGIBLES. LD. COUNSEL SUBMITTED THAT NON-INTANG IBLE COMPANIES CANNOT BE COMPARED WITH THE COMPANIES HAVING TANGIBLES. LD. COUNSEL FURTHER POINTED OUT ITA NO. 5637/D/2011 129 THAT IT IS AN ECONOMIC CONCEPT AND FOR THIS NO EVID ENCE IS REQUIRED TO DEMONSTRATE ITS APPLICATION AND CONSEQUENCE. LD. CIT(DR) SUBMITTED AS UNDER:- REJECTING ASSESSEES FILTER OF ACCEPTING COMPANIES HAVING ADVERTISING, MARKETING AND DISTRIBUTION COSTS TO SALES LESS THAN 3%. COUNTER : THE NEED TO CORRELATE THE EXPENDITURE ON ADVERTISIN G, MARKETING AND DISTRIBUTION COSTS WITH PROFITS OR WITH FAR ANALYSI S NEEDS TO BE DEMONSTRATED WITH EMPIRICAL EVIDENCE. THE ASSESSEE HAS FAILED T O DO SO. THE FIGURE OF 3% IS ADHOC, RANDOM, ARBITRARY AND IS DESIGNED/TAKEN BY T HE ASSESSEE TO ARRIVE AT A PREFIXED CONCLUSION. REVENUE FINDS SUPPORT FROM THE CASES OF I. M/S ACTIS ADVISERS P. LTD. ITA NO. 5277/DEL/2011 , PARA 19, 20AND 26 THEREOF. (DIRECTLY ON THIS ISSUE). II. M/S DELOIETTE CONSULTING INDIA (P) LTD. ITA NO. 1082/1084/HYD./2010, PARAS 36 & 40. 84.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE PERUSED THE RECORD OF THE CASE. ADMITTEDLY THE REASONS FOR REJE CTION OF THIS FILTER BY LD. TPO WERE SIMILAR TO THAT FOR REJECTION OF R&D FILTER AP PLIED BY ASSESSEE. LD. COUNSELS SUBMISSIONS WITH RESPECT OF MARKET INTANG IBLES IN THE FORM OF BRAND BEING CREATED BY INCURRING HEAVY EXPENDITURE ON ADV ERTISING AND MARKETING ARE WELL FOUNDED. IF A COMPARABLE IS HAVING BRAND THEN ITS PROFITABILITY IS DEFINITELY BETTER. WE ARE IN AGREEMENT WITH LD. COUNSEL FOR TH E ASSESSEE THAT FOR ECONOMIC ITA NO. 5637/D/2011 130 CONCEPTS EVIDENCE IS NOT REQUIRED BUT IF THE VERY O BJECTIVE OF TP STUDY VIZ. FINDING OUT SUITABLE NUMBER OF COMPARABLE FAILS THE N THE PROPOSED FILTER CAN BE APPLIED SUBJECT TO NECESSARY ADJUSTMENT. IN SUCH C IRCUMSTANCES A HOLISTIC VIEW HAS TO BE TAKEN. IT IS TRUE THAT BY INCURRING HEAVY EXPENDITURE ON ADVERTISEMENT MARKETING AND DISTRIBUTION THE COMPANIES CARRYING O N MANUFACTURING ACTIVITIES DO CREATE MARKETING INTANGIBLES AND IN THESE CASES A BROAD CORRELATION BETWEEN TWO VIZ. MARKETING INTANGIBLE AND SALES WOULD BE RE FLECTED. HOWEVER, AS POINTED OUT BY LD. TPO, IN CASE OF INFOSYS THOUGH H EAVY EXPENDITURE WAS INCURRED ON ADVERTISEMENT, MARKETING, ETC. BUT 95% WERE THE REPEAT CUSTOMER. BUT, THIS FACTOR ON STAND ALONE BASIS CANNOT BE A D ECIDING FACTOR. WE AGREE WITH LD. CIT(DR) THAT ASSESSEE NEED TO CORRELATE THE EXP ENDITURE ON ADVERTISING, MARKETING AND DISTRIBUTION COSTS WITH PROFITS OR WI TH FAR ANALYSIS WITH EMPIRICAL EVIDENCE. THEREFORE, BOTH, THE OUTRIGHT REJECTION A S WELL AS ACCEPTANCE OF THIS FILTER AS SUCH, CANNOT BE ACCEPTED. THEREFORE, FOR THE REASONS GIVEN IN REGARD TO GROUND NO. 4.5.9 THIS GROUND IS PARTLY ALLOWED. 85. VIDE GROUND NOS. 4.6 TO 4.9, THE ASSESSEE HAS CHALLENGED SELECTION OF VARIOUS COMPARABLES BY LD. TPO ON VARIOUS GROUNDS W HICH WE SHALL NOW DISCUSS EACH COMPARABLE WISE. HOWEVER, BEFORE THAT WE MAY REPRODUCE THE SUBMISSIONS OF LD. CIT(DR) GROUND NO. 4.6 AND 4.9 INCLUDING CERTAIN COMPANIES THAT ARE NOT COMPARABLE TO THE ASSESSEE IN TERMS OF FUNCTIONS PERFORMED, ASSETS EMPLOYED AND RISK AS SUMED; ITA NO. 5637/D/2011 131 EXCLUDING CERTAIN COMPANIES ON ARBITRARY/FRIVOLOUS GROUNDS EVEN THOUGH THEY ARE COMPARABLE TO THE ASSESSEE IN TERMS OF THE FUNC TIONS PERFORMED, ASSETS EMPLOYED AND RISK ASSUMED; COUNTER : IT IS NOT POSSIBLE TO FIND EXACT REPLICAS OF AN ENT ITY. IN A TNMM SITUATION, BROAD COMPARABILITY IS REQUIRED. THE ASSESSEE TOO, HAS, IN ITS TP STUDY REPORT CHOSEN BROADLY COMPARABLE ENTITIES. PLEASE SEE PAG ES 1019 TILL 1022 OF PAPER BOOK (BEING PAGES 53 TILL 56 OF TP STUDY REPORT). FURTHER, THE FINAL COMPARABLES CHOSEN BY THE ASSESS EE IN ITS TP STUDY REPORT ARE ON PAPER BOOK PAGES 1043 TILL 1045, BEING PAGES 77 TILL 79 OF TP STUDY REPORT. AN EXAMINATION OF ENTITIES CHOSEN BY THE A SSESSEE REVCALS THAT THE COMPARABLE ENTITIES ARE INTO VARIED BUSINESSES SUCH AS CUSTOM SOFTWARE DEVELOPMENT, PRODUCTIZED SOLUTION, TURNKEY SERVICES BUSINESS ANALYSIS SERVICES, PROJECT CONSULTING, APPLICATION PRODUCT ENGINEERING SERVICES, ETC. IN THE CASE OF M/S HAPAG LLOYD SERVICES P. LTD. ITA NO. 8499/M/2010, DTD. 28/02/2013. IT HAS BEEN HELD THAT THE MERE FACT TH AT A COMPARABLE HAS BEEN ACCEPTED IN ONE CASE, DOES NOT MEAN THAT IT SHOULD BE ACCEPTABLE IN ALL OTHER CASES, PARA 4.3. FURTHER, THERE CANNOT BE EXACT REPLICAS OF AN ENTIT Y. ONLY BROAD COMPARABILITY IS REQUIRED. IN FACT, THIS IS THE REASON THAT THEN BE NEFIT OF +-5% SAFE HARBOUR LIMIT HAS BEEN PROVIDED. ALSO, IN A SITUATION OF MEAN, D IFFERENCES GET EVENED OUT. SUPPORT IS FOUND FROM THE FOLLOWING CASE LAWS: ITA NO. 5637/D/2011 132 I. M/S SYMANTEC SOFTWARE SOLUTIONS P. LTD. ITA NO. 7894/MUM./2010, PARA 16. II. M/S ACTIS ADVISORS P. LTD. ITA NO. 5277/DEL/201 1, PARA 35. III. M/S DELOITTE CONSULTING HYDERABAD. ITA NO. 10 82- 84/HYD./2010, PARA 36 AND 40. IV. M/S ST MICROELECTRONICS (P) LTD. ITA NO. 1806-1 807/DEL/2008, PARA 40. V. M/S CRM SERVICES I (P) LTD. ITA NO. 4068/DEL/200 9, PARA 8.1. VI. M/S QUARK SYSTEMS (P) LTD. SB CHD. 41 ITR 606, PARA 25. (FOR THE PROPOSITION THAT IN A MEAN SITUATION, DIFF ERENCES GET EVENED OUT). VII. M/S BAYER MATERIAL SCIENCES P. LTD. 134 ITD 58 2, PARAS 23 AND 24. VIII. M/S CAPGEMINI (ITA NO. 7861/MUM./2011), PARA 4.3.6, FOR THE PROPOSITION THAT SIZE MATTERS IN MANUFACTURING INDU STRY ONLY, AND NOT IN SERVICE INCLUDING SUCH AS SOFTWARE. IT IS ALSO TO BE NOTED THAT BRAND/INTANGIBLE DOES N OT (PER SE) MAKE ANY DIFFERENCE I. M/S DELOIETTE CONSULTING (I) P. LTD. ITA NO. 108 2/HYD./2010, PARA 36. II. M/S ACTIS ADVISORS P. LTD. ITA NO. 5277/DEL/201 1, PARA 25. III. M/S WILLS PROCESSING SERVICE (I) PVT. LTD. ITA NO. 4547- 4429/MUM./2012, PARA 45.1 AND 45.2 DATED 01.03.2013 . ITA NO. 5637/D/2011 133 GROUND 4.8 RESORTING TO ARBITRARY REJECTION OF LOW PROFIT/LOSS MAKING COMPANIES BASED ON ERRONEOUS AND INCONSISTENT REASONS; COUNTER : IT IS POINTED OUT THAT THERE HAS BEEN NO ARBITRARY REJECTION OF LOSS MAKERS OR LOW PROFIT MAKERS, AND NO ARBITRARY INCLUSION OF HIGH PROFIT MAKERS. THE REJECTION HAS BEEN ON BASIS OF FAR ANALYSIS AND ON ACCOUNT OF ABNORMAL CIRCUMSTANCES. SUPPORT IS FOUND FROM THE FOLLOWING DECISIONS: I. M/S WILLS PROCESSING SERVICES (I) P. LTD. ITA NO. 4 547- 4429/MUM./2012, DTD. 01/03/2013, PARAS 34.4, 34.5, 35.6. IN THIS CASE THEY HAVE RELIED UPON, M/S EXXON MOBILE (PARA 34.6), A CASE ALSO RELIED UPON BY THE ASSESSEE. II. M/S SYMANTEC, MUMBAI, ITA NO. 7894/M/2010, PARAS 15 AND 15.1. III. M/S B.P. INDIA SERVICES P. LTD. ITA NO. 4425/MUM/20 10, DTD. 23/09/2011, PARA 12. IV. M/S CAPGEMINI INDIA P. LTD., ITA NO. 7861/MUM./2011 , DTD. 28/02/2013, PARA 5.3-4. V. M/S ACTIS ADVISORS P. LTD. ITA NO. 5247/D/2011, PAR A 22. VI. M/S SAP LABS INDIA P. LTD., ITA NO. 418/BANG/2008. ORDER DTD. 30/08/2010, AT PARA 86, IT HAS BEEN HELD THAT EXCLU SIONS HAVE BEEN CONSIDERED ON THE BASIS OF FAR ANALYSIS ALSO. 86. NOW WE WILL CONSIDER EACH COMPARABLE. ACCEL TRANSMATIC LTD . : LD. TPO NOTICED THAT THIS COMPANY WAS FINDING PLACE IN THE ACCEPT/REJECT MATRIX OF THE TAX PAYER AND WAS R EJECTED IN THE TP DOCUMENT ON THE GROUND THAT IT FAILED FILTER OF ADVERTISING MARKETING AND DISTRIBUTION EXPENSES TO SALES BEING LESS THAN 3%. LD. TPO OBSE RVED THAT SINCE ITS SOFTWARE SEGMENT QUALIFIED ALL THE FILTERS APPLIED BY THE TPO, THE SAME WAS ITA NO. 5637/D/2011 134 PROPOSED AS A COMPARABLE BUT THE TAX PAYER DID NOT OFFER ANY COMMENTS. LD. TPO OBSERVED THAT ONLY SOFTWARE SEGMENT WAS CONSIDE RED AND FROM THE SEGMENTAL FINANCIAL SUBMITTED BY THE COMPANY, IT WA S CLEAR THAT IT SATISFIED EVEN THE ASSESSEES FILTER OF ADVERTISING, MARKETI NG AND DISTRIBUTION EXPENSES TO SALES BEING LESS THAN 3%. HE, THEREFORE, CONSID ERED THE COMPANY AS A COMPARABLE AS IT DERIVED ITS ENTIRE SOFTWARE SERVIC ES SEGMENT REVENUE FROM THE SOFTWARE DEVELOPMENT ACTIVITIES. 87. LD. COUNSEL SUBMITTED THAT THE COMPANY IS MAIN LY INTO DEVELOPMENT AND SOFTWARE PRODUCTS. HE SUBMITTED THAT IN THE FO LLOWING CASES THIS COMPANY HAS BEEN REJECTED BY ITAT: A. M/S TRILOGY E-BUSINESS SOFTWARE INDIA PVT. LTD. V. DCIT, BANGALORE (ITA NO. 1054/BANG/2011 B. M/S BEARING POINT BUSINESS CONSULTING PVT. LTD. V. DCIT, BANGALORE (ITA NO. 1124/BANG/2011 C. M/S CSR INDIA PVT. LTD. V. ITO, BANGALORE (ITA NO. 1119/BANG/2011 D. M/S L.G. SOFT INDIA PVT. LTD. V. DCIT, BANGALORE (ITA NO. 1121/BANG/2011 E. M/S TRANSWITCH INDIA PVT. LTD. V. DCIT, BANGALOR E (ITA NO. 948/BANG/2011 F. M/S HCL EAI SERVICES LTD. V. DCIT, BANGALORE (IT A NO. 1348/BANG/2011 ITA NO. 5637/D/2011 135 G. M/S LOGICA PVT. LTD. V ASSTT.CIT, BANGALORE (ITA NO. 1129/BANG/2011 H. M/S MERCEDEZ BENZ RESEARCH & DEVELOPMENT INDIA P VT. LTD. DCIT, BANGALORE (ITA NO. 1369/BANG/2011 87.1 LD. COUNSEL SUBMITTED THAT ACCEL TRANSMATIC HA S BEEN SPECIFICALLY REJECTED ON THE GROUND THAT A SOFTWARE DEVELOPMENT COMPANY CANNOT BE COMPARED WITH THE SOFTWARE PRODUCT COMPANY: 88. LD. CIT(DR) SUBMITTED THAT IN TNMM METHOD ONLY BROAD FUNCTIONALITY IS TO BE CONSIDERED. HE POINTED OUT THAT LD. TPO H AS CONSIDERED THE SOFTWARE SERVICE SEGMENT ONLY AND, THEREFORE, THIS COMPARABL E IS NOT TO BE EXCLUDED. 88.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE PERUSED THE RECORD OF THE CASE. 89. LD. TPO HAS REPRODUCED AT PAGE 99 OF HIS ORDER THE SEGMENTAL DETAILS FROM THE ANNUAL REPORT WHICH SEPARATELY CON TAINS THE DETAILS OF SOFTWARE SERVICES. IN THE CASES RELIED UPON BY ASSESSEE THES E DETAILS WERE NOT CONSIDERED AND, THEREFORE, ON THE BASIS OF THOSE DE CISIONS THIS COMPARABLE CANNOT BE EXCLUDED. HOWEVER, WE FIND THAT IN TRILOG Y E-BUSINESS SOFTWARE INDIA PVT. LTD. (SUPRA), AS CONSIDERED IN HCL EAI SERVICE S (SUPRA), IT WAS, INTER-ALIA, OBSERVED IN PARA 49 THAT THIS COMPANY HAS RELATED P ARTY TRANSACTIONS WHICH ARE MORE THAN PERMITTED LEVEL. LD. TPO HAS NOT RECORDED ANY FINDING TO THIS EFFECT. THEREFORE, AS HELD BY US EARLIER THAT IF RPT IS MOR E THAN 15% THAN THE SAID COMPANY CANNOT BE CONSIDERED AS UNCONTROLLED COMPAR ABLE. WE, THEREFORE, RESTORE THIS ISSUE TO THE FILE OF LD. TPO TO CONSID ER THE INCLUSION/EXCLUSION OF ITA NO. 5637/D/2011 136 THIS COMPARABLE DEPENDING UPON THE FINDINGS ON RPT. THIS ISSUE IS ALLOWED FOR STATISTICAL PURPOSES. B. AVANI CIMCOM TECHNOLOGIES LTD. LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT THIS IS SOFTWARE PRODUCT COMPANY AND HENCE FUN CTIONALLY DIFFERENT. HE SUBMITTED THAT THE COMPANY IS MAINLY INTO SOFTWARE PRODUCT DEVELOPMENT FOR THE TRAVEL INDUSTRY. HE SUBMITTED THAT AS PER THE DETA ILS AVAILABLE ON THE WEB SITE OF AVANI TECHNOLOGIES, IT IS EVIDENT THAT THE COMPANY IS INVOLVED IN PROVISION OF SOFTWARE DEVELOPMENT AND IT SERVICES. FURTHER, IT O WNS PRODUCTS LIKE DXCHANGE, TRAVEL SOLUTION, INSURANCE SOLUTION, CUSTOMER APPLI CATION AND RELATIONSHIP MANAGEMENT APPLICATION (CARA), CONTENT MANAGEMENT S YSTEM ETC. HE SUBMITTED THAT SEGMENTAL DETAILS ARE NOT AVAILABLE. HE RELIED ON THE SAME DECISIONS AS FOR ACCEL TRANSMATIC LTD. 90. LD. DR REFERRED TO PAGE 101 OF LD. TPOS ORDER AND POINTED OUT THAT AS REGARD ASSESSEES CONTENTION THAT THE PROPOSED COMPARABLE IS A SOFTWARE PRODUCT COMPANY, LD. TPO REFERRED TO THE REPLY REC EIVED FROM AVANI, WHEREIN IT WAS SPECIFICALLY POINTED OUT THAT IT IS A PURE SOFT WARE DEVELOPMENT SERVICE PROVIDER. FURTHER AS PER THE ANNUAL REPORT ALSO TH ERE IS NO PRESENCE OF SOFTWARE PRODUCTS. HE REFERRED TO THE ACCOUNTING POLICY OF REVENUE RECOGNITION, WHEREIN IT IS MENTIONED THAT REVENUE FROM SOFTWARE DEVELOPM ENT CONTRACTS IS GENERALLY RECOGNIZED ON SUCCESSFUL COMPLETION OF THE PROJECT OR IN CASE OF SPECIFIC CONTRACT, THE SAME IS ACCOUNTED AS PER THE TERMS OF CONTRACT. LD. DR POINTED OUT THAT THE WORD CONTRACT IMPLIES THAT IT IS ALSO SOFTWARE DEVELOPMENT SERVICES AND NOT SOFTWARE PRODUCT DEVELOPMENT. FURTHER, IT IS MENTIONED THAT THE ITA NO. 5637/D/2011 137 COMPANY IS IN SOFTWARE DEVELOPMENT AND AS SUCH IN S ERVICES SECTOR. HE, THEREFORE, SUBMITTED THAT THIS COMPARABLE WAS RIGHT LY SELECTED BY LD. TPO. 90.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND H AVE PERUSED THE RECORD OF THE CASE. THE COMPANY HAS SPECIFICALLY C ONFIRMED IN RESPONSE TO INFORMATION SOUGHT U/S 133(6) THAT IT IS A PURE SOF TWARE DEVELOPMENT SERVICE PROVIDER AND, THEREFORE, THE CONTENTION OF ASSESSEE THAT IT IS SOFTWARE PRODUCT COMPANY CANNOT BE ACCEPTED PARTICULARLY WHEN IT DOE S NOT HAVE ANY REVENUES FROM SALE OF PRODUCTS. FURTHER, AS PER THE INFORMA TION RECEIVED U/S 133(6) IT IS CLEARLY STATED THAT THIS COMPANY IS IN PROVIDING SO FTWARE DEVELOPMENT AND CONSULTING IT SERVICES TO ITS INTERNATIONAL CLIENTS . IT IS FURTHER STATED THAT IT UTILIZED PRUDENT TECHNOLOGIES TO ENABLE CUSTOMERS BUSINESS SYSTEMS. WHEN THIS INFORMATION IS READ ALONG WITH THE CONTENTS OF ANNUAL REPORT ON THE WEB SITE OF THIS COMPANY, WE DO NOT FIND ANY CONTRADICTION INASMUCH AS IT IS ALSO STATED THAT THE COMPANY IS INVOLVED IN PROVISION OF SOFTWA RE DEVELOPMENT AND IT SERVICES. LD. COUNSELS CONTENTION THAT IT IS A PR ODUCT COMPANY IS PRIMARILY BASED ON THE DETAILS GIVEN ON WEB SITE THAT IT OWNS PRODUCT LIKE DXCHANGE TRAVEL SOLUTIONS, INSURANCE SOLUTIONS, CUSTOMER APPRECIATI ON AND RELATIONSHIP MANAGEMENT APPLICATION, CONTENT MANAGEMENT SYSTEMS. THESE PRODUCTS APPEAR TO HAVE BEEN DEVELOPED BY THIS COMPANY FOR B EING UTILIZED FOR BUSINESS SOLUTIONS OF ITS CLIENTS. THEREFORE, IT IS PRIMARIL Y IN A SOFTWARE DEVELOPMENT SERVICE SECTOR. THE REVENUES HAVE BEEN DERIVED MAI NLY FROM SOFTWARE EXPORTS. IN THE CASE OF TRILOGY (SUPRA) THIS COMPANY WAS EXC LUDED ON THE GROUND OF HAVING HIGH OPERATING REVENUES AND DETAILS OF PERCE NTAGE OF EXPORTS OF PRODUCTS ITA NO. 5637/D/2011 138 OR SERVICES WERE NOT AVAILABLE. THERE IS NO GAINSAY ING THAT IT IS NOT ONLY THE FUNCTIONAL PROFILE OF A COMPANY WHICH IS RELEVANT B UT ALSO THE ASSETS UTILIZED BY IT AND RISK UNDERTAKEN. IN OUR OPINION, THIS COMPANY B EING OWNING CERTAIN SOFTWARES DEVELOPED BY IT, THEREFORE, IT WAS IN A B ETTER POSITION TO CATER TO THE NEEDS OF TRAVEL SECTOR. THIS PARTICULAR ASSET BROUG HT THIS COMPANY IN AN ADVANTAGEOUS POSITION OVER OTHER SOFTWARE DEVELOPME NT COMPANIES IN SAME SECTOR. THE REVENUE EARNED BY THIS COMPANY WAS NOT MERELY ON ACCOUNT OF DEVELOPING A NEW SOFTWARE FROM SCRATCH BUT BECAUSE OF UTILIZATION OF THE OWNED SOFTWARE BY THIS COMPANY. THUS, THE ASSET BASE OF T HIS COMPANY COULD NOT BE COMPARED WITH TESTED PARTY. THEREFORE, WE ARE IN AG REEMENT WITH LD. COUNSEL FOR THE ASSESSEE THAT ON ACCOUNT OF HIGH OPERATING MARG INS ON ACCOUNT OF DIFFERENCE IN ASSET BASE THIS COMPANY CANNOT BE TAK EN AS A COMPARABLE. IN VIEW OF ABOVE DISCUSSION, WE DIRECT LD.TPO TO EXCLU DE THIS COMPANY FROM THE LIST OF COMPARABLES BECAUSE THERE IS NO EMPIRICAL D ATA ON RECORD TO IDENTIFY THE CONTRIBUTION TOWARDS PROFITABILITY ON ACCOUNT OF OW NED SOFTWARES. IN THE RESULT THIS ISSUE IS ALLOWED. C. CELESTIAL LABS : LD. TPO HAS OBSERVED THAT DURING THE SEARCH PROC ESS FOR THE EARLIER A.Y. 2006-07 FOR TAXPAYERS ENGAGED IN R &D, THIS COMPANY WAS FINDING PLACE AS R&D COMPANY FOR THE F.Y. 2005-06. BUT, DURING THE SUBSEQUENT FINANCIAL YEAR 2006-07, THE COMPANY WAS NOT FINDING PLACE AS R&D COMPANY IN THE CAPITALINE/PROVESS DATA BASE. HE NO TED THAT AS PER ANNUAL REPORT, THE COMPANY WAS CATEGORIZED AS SOFTWARE DEV ELOPMENT SERVICE PROVIDER. FURTHER, HE NOTED THAT ON THE BASIS OF INFORMATION OBTAINED U/S ITA NO. 5637/D/2011 139 133(6), IT WAS EVIDENT THAT THE COMPANY WAS MAINLY A SOFTWARE DEVELOPMENT SERVICE COMPANY AND IT QUALIFIED ALL THE FILTERS AP PLIED BY THE TPO. THE ASSESSEE OBJECTED THE SELECTION OF THIS COMPARABLE ON THE GROUND THAT AS PER INFORMATION PROVIDED BY CELESTIAL LABS UNDER SECTIO N 133(6), THE COMPANY IS PRIMARILY INTO DEVELOPMENT OF SOFTWARE TOOLS AS PRO DUCTS FOR APPLICATION IN THE FIELD OF BIO TECHNOLOGY, PHARMACEUTICALS & HEALTHCA RE INDUSTRY. IT WAS FURTHER POINTED OUT THAT THE SOFTWARE TOOLS DEVELOPED BY CE LESTIAL LAB WERE PROPRIETARY IN NATURE AND PROTECTED USING PATENT. THUS, IT WAS SU BMITTED THAT THIS COMPANY IS PRODUCT COMPANY OWNING INTANGIBLE PROPERTY. THE AS SESSEE ALSO REFERRED TO THE ANNUAL REPORT WHEREIN IT IS, INTER-ALIA, STATED THA T THE COMPANY HAS DEVELOPED A DE NOVO DRUG DESIGN TOOL CELSUITE TO DRUG DISCOVE RY AND PROTECTED THE IPR BY FILING UNDER THE COPYRIGHT / PATENT ACT. IT WAS FURTHER POINTED OUT THAT BASED ON ITS SILICO EXPERTISE (APPLYING BIO-INFORMATICS T OOLS), IT HAD DEVELOPED A MOLECULE TO TREAT LEUCODERMA AND MULTIPLE CANCER AN D PROTECTED THE IPR BY FILING THE PATENT. THE COMPANY ALSO OUTLINED ITS FU TURE PLANS IN THE FIELD OF BIOTECHNOLOGY. THUS, IN SUM AND SUBSTANCE, THE AS SESSEE SUBMITTED THAT THE COMPANY WAS FUNCTIONALLY DISSIMILAR TO THE ASSESSEE AS THE COMPANY WAS ENGAGED IN THE BIOPHARMA & BIOTECH MANUFACTURING WI TH CUSTOMIZED IT SOLUTIONS, MANUFACTURE OF DRUGS, CLINICAL TRIALS AN D CONTRACT RESEARCH ACTIVITIES. THE ASSESSEE RELIED ON SAME DECISIONS AS FOR ACCEL TRANSMATIC, NOTED EARLIER AND ALSO ON FOLLOWING DECISIONS IN SUPPORT OF ITS C ONTENTION THAT CELESTIAL LAB HAS BEEN REJECTED AS A COMPARABLE: ITA NO. 5637/D/2011 140 TRILOGY E BUSINESS INDIA SOFTWARE PRIVATE LIMITED, ITA NO. 1054/BANG/2011 PARA 35, EXXON MOBIL COMPANY INDIA PRIVATE LIMITED, ITA NO. 8311/MUM./2010 PARA 33 (XI), QUARK SYSTEMS PRIVATE LIMITED, 32 TTJ 1 (SB) (CHD.) , PARA 25. 91. THE ASSESSEE FURTHER POINTED OUT IN THE SYNOPS IS THAT THIS COMPARABLE HAD BEEN REJECTED BY DRP IN THE SUBSEQUE NT YEAR I.E. A.Y. 2008-09 FROM THE LIST OF COMPARABLE, STATING THE COMPANY D OES NOT MEET THE EMPLOYEE COST FILTER AND IT HAS BEEN RECEIVING LOANS FROM TH E DEPARTMENT OF SCIENCE & INDUSTRIAL RESEARCH. LD. COUNSEL SUBMITTED THAT TH E SAME FACTS HOLD GOODS IN THE CURRENT YEAR AS WELL. 92. LD.CIT(DR) SUBMITTED THAT LD. TPO HAD ISSUED D ETAILED NOTICE OF SIX PAGES CONTAINED FROM PAGES 372 TO 378 OF APPEAL SET AND AFTER CONSIDERING THE RESPONSE OF THE COMPANY VIDE ITS LETTER DATED 29/03 /2010, WHEREIN IT WAS CATEGORICALLY STATED THAT THE COMPANY WAS MAINLY P ROVIDING THE SERVICES IN THE FIELD OF SOFTWARE DEVELOPMENT, CONSIDERED THIS COM PANY AS COMPARABLE.. LD. DR FURTHER SUBMITTED THAT IN THE CASE OF M/S TEVA P HARMA PVT. LTD. VS. ADDL. CIT (2012-TII-20-ITAT-MUM.-TP), IT HAS BEEN ACCEPTE D BY THE ASSESSEE THAT THIS COMPANY IS A SOFTWARE DEVELOPMENT COMPANY. IN THIS REGARD HE POINTED OUT THAT IT WAS NOTED IN THIS CASE THAT THE ACTIVIT IES UNDERTAKEN BY CELESTIAL LABS WERE IN THE NATURE OF PROVIDING HOST OF IT RELATED SERVICES AND SOME TRADING ACTIVITIES WHICH ARE NOT COMPARABLE TO THE ASSESSEE . THEREFORE, LD. DR SUBMITTED THAT THE CELESTIAL LABS IS NOT FUNCTIONAL LY DIFFERENT. LD. DR FURTHER POINTED OUT THAT THIS COMPANY WAS REQUIRED TO GIVE INFORMATION U/S 133(6) FOR THE FOLLOWING QUERY: ITA NO. 5637/D/2011 141 IF YOUR COMPANY IS INTO CUSTOMIZATION OF SOFTWARE, PLEASE GIVE THE DETAILS OF REVENUES BY WAY OF SOFTWARE PRODUCTS EITHER PURCHAS ED FROM THIRD PARTIES OR DEVELOPED BY YOUR OWN WHICH ARE USED IN THE CUSTOMI ZATION FOR THE FY 2006-07 AND FY 2007-08 RESPECTIVELY. IF THE SOFTWARE PRODU CTS ARE PURCHASED BY THE CUSTOMS DIRECTLY FROM THE VENDORS, PLEASE MENTIONED THE SAME. IN RESPONSE TO THIS QUERY THE COMPANY REPLIED AS UN DER: FINANCIAL YEAR 2006-07 2007-08 REVENUE FROM CUSTOMIZED SERVICES THROUGH INHOUSE DEVELOPED PRODUCTS. 50,75,100 20,21,12,145 REVENUE FROM THIRD PARTY PRODUCTS NIL NIL TOTAL 50,75,100 20,21,12,145 FROM THIS INFORMATION, THE LD. TPO POINTED OUT THAT THE REVENUE FROM IN HOUSE DEVELOPED PRODUCTS WAS ONLY TO THE EXTENT OF RS. 50 ,75,100/- FOR FY 2006-07 I.E. ONLY 3.6% OF ITS OPERATING REVENUES OF RS. 14, 12,75,776/-. THUS, MORE THAN 75% OF REVENUES WERE FROM SOFTWARE DEVELOPMENT ONLY . HE FURTHER SUBMITTED THAT AS REGARDS ASSESSEES CONTENTION THAT THE SOFT WARE PRODUCTS MENTIONED BY THE TAX PAYER WERE USED FOR RENDERING SOFTWARE DEVE LOPMENT SERVICES, LD. TPO HAS CLARIFIED MANY SOFTWARE DEVELOPMENT COMPANIES U SE IN HOUSE DEVELOPED LIBRARIES/FRAMEWORK FOR RENDERING SOFTWARE DEVELOPM ENT SERVICES AND THE PRESENCE OF THESE IN HOUSE DEVELOPED SOFTWARE TOOLS IN NO WAY CHANGES THE CHARACTERISTIC OF THE SERVICES AS THESE TOOLS ARE N OT SOLD AS A PRODUCT. 93. AS REGARDS THE SUBMISSION OF LD. COUNSEL THAT IN AY 2008-09 THIS COMPARABLE WAS NOT TAKEN INTO CONSIDERATION AS IT D ID NOT MEET THE EMPLOYEE ITA NO. 5637/D/2011 142 COST, LD. DR POINTED OUT THAT THE TPO ALSO STUDIED THE PROSPECTUS FILED BY THE COMPANY BEFORE SEBI AND BASED ON ITS EXAMINATION IS SUED NOTICE U/S 133(6) WHICH HAS BEEN REPRODUCED AT PAGES 105 TO 110 OF HI S ORDER AND IN RESPONSE TO THE SAME, THE COMPANY POINTED OUT THAT IT WAS MAINL Y PROVIDING THE SERVICES IN THE FIELD OF SOFTWARE DEVELOPMENT. 93.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH THE PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. 93.2 THERE IS NO GAINSAYING THAT IT IS IMPOSSIBLE T O FIND EXACT REPLICAS OF AN ENTITY. IN A TNMM SITUATION ONLY BROAD COMPARABILI TY IS TO BE CONSIDERED. THIS IS THE PRECISE REASON DUE TO WHICH BENEFIT OF (+/-) 5% SAFE HARBOR LIMIT HAS BEEN PROVIDED IN THE ACT ITSELF. THE MINOR DIFFERENCES, IF ANY, GETS IRONED OUT WHEN MEAN IS CALCULATED. FROM THE SUBMISSIONS NOTED ABO VE, IT IS EVIDENT THAT CELESTIAL LABS IS MAINLY INTO SOFTWARE DEVELOPMENT SERVICES INASMUCH AS THE R&D FACILITIES HAVE BEEN USED BY IT IN RELATION TO DEVELOPMENT OF A SOFTWARE FOR DISCOVERY OF NEW DRUGS. ADMITTEDLY, THIS COMPANY W AS ENGAGED IN THE BIO PHARMA AND BIOTECH MANUFACTURING ON THE CUSTOMIZED IT SOLUTIONS, MANUFACTURE OF DRUGS, CLINICAL TRIALS AND CONTRACT RESEARCH ACTIVITIES. THUS, THE EXTENSIVE RESEARCH ACTIVITY WAS CARRIED OUT BY THIS COMPANY IN ORDER TO DEVELOP SOFTWARE FOR SPECIFIC PURPOSES. THE SOFTWARE WAS F OR THE DISCOVERY OF NEW DRUGS AND, THEREFORE, THIS KIND OF SOFTWARE DEVELOP MENT SERVICES COULD NOT BE EQUATED WITH A NORMAL SERVICE PROVIDER FOR VARIOUS BUSINESS SOLUTIONS. THIS COMPANY DID NOT FULFILL EVEN THE FUNCTIONAL COMPARA BILITY CRITERIA. MERELY BECAUSE A COMPANY IS IN SOFTWARE DEVELOPMENT, DOES NOT MAKE IT COMPARABLE WITH ITA NO. 5637/D/2011 143 TESTED PARTY DIVORCED OF ALL OTHER CONSIDERATIONS. A HOLISTIC VIEW HAS TO BE TAKEN IN SUCH CIRCUMSTANCES. IF A COMPANY IS CATERING TO THE NEEDS OF ONLY PARTICULAR SECTOR THEN ALL THE RELEVANT FEATURES OF THAT SECTO R HAVE TO BE GIVEN DUE CONSIDERATION AS THE SAME MATERIALLY AFFECT THE PRO FIT MARGINS. THIS COMPANY WAS OWNING IPR IN RESPECT OF BIO TECHNOLOGY AND, TH US, THE SOFTWARE DEVELOPMENT ACTIVITIES WERE CONFINED ONLY TO THIS P ARTICULAR FIELD. IN OUR OPINION, THIS COMPANY DOES NOT COME WITHIN THE BROAD COMPARA BILITY CRITERIA WHICH IS THE GUIDING FACTOR FOR SELECTION OF A COMPARABLE ALSO F OR THE REASONS GIVEN IN RESPECT OF AVANI CIMCON LTD. WE, THEREFORE, ACCEPT THE ASSESSEES CONTENTION THAT THIS COMPARABLE SHOULD NOT HAVE BEEN SELECTED BY LD. TPO. FURTHER, LD. COUNSELS SUBMISSIONS THAT IN AY 08-09 THIS WAS EXC LUDED ON THE GROUND OF EMPLOYEE COST FILTER HAS NOT BEEN CONTROVERTED BY D EPARTMENT.. 93.3 IN VIEW OF ABOVE DISCUSSION, WE DIRECT EXCLUS ION OF THIS COMPARABLE FROM THE LIST OF COMPARABLES SELECTED BY THE LD. TP O. D. KALS INFORMATION SYSTEMS : LD. COUNSEL POINTED OUT THAT AS PER THE ANNUAL REPORT, KALS IS ENGAGED IN THE BUSINESS OF SOFTWARE SERVICES AND SOFTWARE PRODUCTS. FURTHER, AT PAGE 17 OF THE ANNUAL REPORT IT ALSO SHOWS THAT THERE IS CONSUMPTION OF SOFTWARE INVENTORY AS EXPENDITURE WHICH IMPLIES THAT THE COMPANY IS INTO TRADING OF SOFTWARE. THE ASSESSEE R ELIED ON SAME DECISIONS AS FOR ACCEL TRANSMATIC, NOTED EARLIER, AND ALSO ON FO LLOWING DECISIONS IN SUPPORT OF ITS CONTENTION THAT KALS INFO SYSTEMS LTD. HAS BEEN REJECTED AS A COMPARABLE: ITA NO. 5637/D/2011 144 TRILOGY E BUSINESS INDIA SOFTWARE PRIVATE LIMITED, ITA NO. 1054/BANG/2011 PARA 35, EXXON MOBIL COMPANY INDIA PRIVATE LIMITED, ITA NO. 8311/MUM./2010 PARA 33 (XI), QUARK SYSTEMS PRIVATE LIMITED, 32 TTJ 1 (SB) (CHD.), PARA 25 94. LD.CIT(DR) REFERRED TO PAGE 127 OF LD. TPOS O RDER (PAGE 395 OF APPEAL SET) AND POINTED OUT THAT IN THE TP DOCUMENT THIS COMPANY WAS REJECTED BY OBSERVING BUSINESS REVIEW. HOWEVER, NO REASON S WERE GIVEN. LD. DR POINTED OUT THAT AS PER THE INFORMATION SUBMITTED B Y THE COMPANY IN RESPONSE TO NOTICE UNDER SECTION 133(6) THAT IT IS INTO TWO SEG MENTS VIZ. SOFTWARE DEVELOPMENT SERVICES AND TRAINING. THE SEGMENTAL D ETAILS WERE ALSO SUBMITTED. HE POINTED OUT THAT THE CONCLUSION DRAWN BY THE TPO THAT ITS SWD SEGMENT HAS PRE-DOMINANT REVENUES FROM SOFTWARE DEVELOPMENT SER VICES ONLY IS BASED ON THE CATEGORICAL INFORMATION FURNISHED BY THE COMPAN Y. IN THE INFORMATION FURNISHED IT WAS POINTED OUT THAT THE USE OF READYM ADE OBJECT LIBRARIES WERE ONLY TO THE TUNE OF ABOUT (0.33 TO 3)% IN THE YEAR OF 20 05-06 AND 2006-07. FURTHER IT WAS POINTED OUT THAT VERY SMALL AMOUNT OF REVENUES WAS FROM DOMESTIC TRAINING ACTIVITIES CONTRIBUTING BETWEEN 7% TO 8.56% IN THE YEAR 05-06 TO 06-07. THUS, THE REVENUES FROM SOFTWARE DEVELOPMENT SERVICES CON STITUTED MORE THAN 88% OF THE TOTAL OPERATING REVENUES. LD. DR FURTHER POINTE D OUT THAT LD. TPO HAS ONLY TAKEN THE SEGMENTAL DETAILS. AS REGARDS THE SUBMISS IONS OF LD. COUNSEL REGARDING CONSUMPTION OF SOFTWARE INVENTORY, LD. D R CLARIFIED THAT SOFTWARE WAS BOUGHT ONLY FOR MAKING SOFTWARE. THUS, CONSUMP TION OF SOFTWARE INVENTORY IS PRIMARILY OPERATING EXPENDITURE AND HAS BEEN CLA SSIFIED UNDER SOFTWARE DEVELOPMENT EXPENDITURE. ITA NO. 5637/D/2011 145 94.1 HAVING HEARD BOTH THE PARTIES, WE FIND THAT LD . TPO HAS PRIMARILY BEEN GUIDED BY THE SEGMENTAL INFORMATION OBTAINED B Y IT AND NOT BY THE RESULTS OF THE COMPANY AS A WHOLE. LD. COUNSEL HAS RELIED SOLELY ON THE ANNUAL REPORT BUT THE SPECIFIC INFORMATION OBTAINED U/S 133(6) SU PPLEMENTS THE INFORMATION CONTAINED IN THE ANNUAL REPORT. HOWEVER, THE SUBMI SSION OF LD. COUNSEL OF ANORMOUS DIFFERENCE IN THE ASSET BASE OF THE TWO CO MPANIES CANNOT BE IGNORED BECAUSE THAT CERTAINLY HAS TREMENDOUS BEARING ON PR OFITABILITY OF A COMPANY. IN FAR ANALYSIS ASSET BASE IS ONE OF THE IMPORTANT FA CTOR FOR DETERMINING THE COMPARABILITY CRITERIA. 95. WE, THEREFORE, DIRECT LD. TPO TO EXCLUDE THIS COMPANY FROM THE LIST OF COMPARABLES. 5. E-ZEST SOLUTIONS : LD. TPO NOTICED THAT THIS COMPANY WAS NOT FINDIN G PLACE IN THE ACCEPT/REJECT MATRIX OF THE ASSESSEE. BUT, THE COMPANY,S DATA WAS AVAILABLE IN THE PROVESS DATA BASE. HE POINTED OUT THAT THE ANNUAL REPORT FOR THE FY 06-07 WAS AVAILABLE. BUT, THE FUNCTIONALITY WAS NOT CLEAR FROM THE ANNUAL REPORT AND ALSO RELATED PARTY TRANSACTION IN FORMATION WAS NOT AVAILABLE IN THE ANNUAL REPORT. THEREFORE, NOTICE U/S 133(6) WAS ISSUED TO THE COMPANY FROM WHICH IT TRANSPIRED THAT THE COMPANY WAS ENGAG ED IN SOFTWARE DEVELOPMENT SERVICES AND QUALIFIED ALL THE FILTERS APPLIED BY THE TPO INCLUDING RPT FILTERS. LD. TPO, THEREFORE, PROPOSED TO INCLU DE THIS COMPANY AS A COMPARABLE TO THE ASSESSE AND ACCORDINGLY, ISSUED S HOW CAUSE NOTICE TO ASSESSEE. HE HAS POINTED OUT THAT ASSESSEE DID NOT OFFER ANY COMMENTS AND, THEREFORE, THIS COMPANY WAS CONSIDERED AS COMPARABL E. LD. COUNSEL REFERRED ITA NO. 5637/D/2011 146 TO PAGE 386& 387 OF PAPER BOOK, WHEREIN THE REPLY D ATED 14 TH SEPTEMBER, 2010 CONTAINED FROM PAGES 317 TO 408 IS CONTAINED T O DEMONSTRATE THAT ASSESSEE HAD GIVEN SPECIFIC REPLY IN THIS REGARD BU T THE SAME HAD NOT BEEN CONSIDERED. 95.1 HAVING HEARD BOTH THE PARTIES, WE RESTORE THE MATTER BACK TO THE FILE OF LD. TPO TO EXAMINE THE ASSESSEES REPLY AND THEN DECIDE THE INCLUSION/EXCLUSION OF THIS COMPARABLE. A. FLEXTRONICS SOFTWARE SYSTEMS LTD. : LD. TPO NOTICED THAT THIS COMPANY WAS FINDING PLACE IN THE ACCEPT/REJECT MATRIX OF THE TA X PAYER AND WAS REJECTED IN THE TP DOCUMENT SAYING THAT IT FAILED R&D FILTER. HE O BSERVED THAT BASED ON THE INFORMATION SUBMITTED BY THE COMPANY, IT QUALIFIED ALL THE FILTERS APPLIED BY THE TPO. FROM THE DETAILS OF THE PRODUCT REVENUE SUBMI TTED BY COMPANY, IT WAS EVIDENT THAT THE SAME WERE ONLY 10.8% OF THE TOTAL REVENUE. HE, THEREFORE, PROPOSED TO INCLUDE THIS COMPANY AS A COMPARABLE TO THE TAX PAYER. THE ASSESSEE IN ITS REPLY POINTED OUT THAT INFORMATION OBTAINED U/S 133(6) IS IN CONTRADICTION TO THE INFORMATION CONTAINED IN THE A NNUAL REPORT. THE ASSESSEE POINTED OUT THAT FLEXTRONICS CLAIMED THAT THE INVES TMENT IN R&D WAS ONLY FOR THE PURPOSE OF IMPROVING THE PROCESS AND DID NOT RE SULT IN ANY IPRS WHEREAS FROM THE ANNUAL REPORT IT WAS CLEAR THAT R&D ACTIVI TIES RESULTED IN CREATION OF IPRS. FURTHER IT WAS POINTED OUT THAT THE FLEXTRO NICS HAD DISCLOSED DATA FROM PRODUCTS AND SERVICES AS A COMPOSITE SEGMENT AND, T HEREFORE, NO BIFURCATION WAS AVAILABLE BETWEEN TWO ACTIVITIES OF THE COMPANY . LD. TPO REFERRING TO THE REPLY RECEIVED FROM FLEXTRONICS POINTED OUT THAT CO MPANY HAD NOT CREATED ANY ITA NO. 5637/D/2011 147 UNIQUE INTANGIBLE BY INCURRING R&D EXPENSES. THE R &D EXPENSES WERE INCURRED ONLY TO IMPROVE THE PROCESS. HE FURTHER P OINTED OUT THAT THE SOFTWARE PRODUCT REVENUE WAS 10.87% OF THE SEGMENTAL REVENUE S AND, THEREFORE, QUALIFIED THE FILTER OF 75% REVENUES FROM SOFTWARE SERVICES. IN REGARD TO THE ASSESSEES SUBMISSION THAT THERE WAS A THIN DIFFERE NCE BETWEEN REVENUE FROM SERVICES AND REVENUE FROM PRODUCTS AS THE CONTRACT ITSELF WAS A SINGLE COMPOSITE CONTRACT AND IT WAS QUITE EVIDENT THAT TH ERE COULD BE CROSS SUBSIDIZING BETWEEN THE PRICING SERVICING AND PRODU CTS AT THE POINT OF SALE, LD. TPO POINTED OUT THAT THE SERVICES SEGMENT AND PRODU CT SEGMENT WERE NOT SEPARATELY CONSIDERED AS THE SAME WERE NOT AVAILABL E. THEREFORE, THE CROSS SUBSIDIZING WOULD CANCEL AS THE TPO CONSIDERED THE ENTIRE SEGMENT OF PRODUCTS AND SERVICES AND ALSO SERVICES CONTRIBUT ED MORE THAN 75% OF THE SEGMENTAL REVENUE. LD. TPO FURTHER POINTED OUT THA T THE BIFURCATION BETWEEN PRODUCT AND SERVICE REVENUES WAS MADE AVAILABLE BY FLEXTRONICS. HE, THEREFORE, INCLUDED THIS COMPARABLE IN THE LIST OF COMPARABLE SELECTED BY HIM. LD. COUNSEL SUBMITTED THAT AS PER THE DISCLOSURE ON SEGMENT DATA IN THE NOTES TO ACCOUNTS, THE COMPANY DEVELOPS SOFTWARE PRODUCTS AND PROVIDE SOFTWARE CONSULTANCY SERVICES FOR USE IN THE TELECOMMUNICATI ON INDUSTRY AND ALSO SALES TELECOMMUNICATION EQUIPMENT AND PROVIDE SERVICES ON BUSINESS PROCESSES OUTSOURCING. THE SEGMENT RELATING TO SOFTWARE IS C OMBINED FOR SOFTWARE PRODUCT AND SERVICES AND A BRAKE UP HAS NOT BEEN PR OVIDED. HE POINTED OUT THAT IN FOLLOWING THREE CASES THIS COMPANY HAS BEEN EXCLUDED BY ITAT AS THE SEGMENTAL BREAKUP WAS NOT AVAILABLE: ITA NO. 5637/D/2011 148 TRILOGY E BUSINESS INDIA SOFTWARE PRIVATE LIMITED, ITA NO. 1054/BANG/2011 PARA 35, EXXON MOBIL COMPANY INDIA PRIVATE LIMITED, ITA NO. 8311/MUM./2010 PARA 33 (XI), QUARK SYSTEMS PRIVATE LIMITED, 32 TTJ 1 (SB) (CHD.) , PARA 25 96. LD. COUNSEL FURTHER SUBMITTED THAT THE DETAILS PROVIDED BY THE FLEXTRONICS U/S 133(6) WERE UNRELIABLE AND CONTRADI CTORY AS ON ONE HAND IT STATES THAT IT DOES NOT OWN ANY IPR FOR PRODUCTS AN D ON THE OTHER ITS FINANCIAL DETAILS SHOW THAT IT HAS EARNED AROUND RS. 100 CROR ES AS SOFTWARE PRODUCT REVENUE. LD. COUNSEL FURTHER SUBMITTED THAT INFORMATION U/S 133(6) CAN BE AN ELABORATION OF THE ANNUAL REPORT BUT CANNOT REPLACE THE ANNUAL REPORT. 97. LD.CIT(DR) SUBMITTED THAT THE INFORMATION U/S 133(6) WILL PREVAIL OVER THE INFORMATION CONTAINED IN THE ANNUAL REPORT. HE SUBMITTED THAT THE PRODUCT REVENUE IS AROUND 10% OF THE TOTAL REVENUE AS PER T HE INFORMATION OBTAINED U/S 133(6). 97.1 WE HAVE CONSIDERED THE SUBMISSION OF BOTH THE PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. 97.2 FOR A COMPANY TO BE INCLUDED IN THE LIST OF CO MPARABLES, IT IS NECESSARY THAT CREDIBLE INFORMATION IS AVAILABLE AB OUT THE COMPANY. UNLESS THIS BASIC REQUIREMENT IS FULFILLED, THE COMPANY CANNOT BE TAKEN AS A COMPARABLE. IT IS TRUE THAT LD. TPO IS ENTITLED TO OBTAIN INFORMAT ION US/ 133(6), THE OBJECT OF WHICH IS PRIMARILY ONLY TO SUPPLEMENT THE INFORMATI ON ALREADY AVAILABLE ON RECORD, BUT NOT, AS RIGHTLY SUBMITTED BY LD. COUNSE L FOR THE ASSESSEE, TO REPLACE THE INFORMATION. IF THERE IS A COMPLETE CONTRADICTI ON BETWEEN THE INFORMATION OBTAINED U/S 133(6) AND ANNUAL REPORT THEN THE SAID INFORMATION CANNOT BE SUBSTITUTED FOR THE INFORMATION CONTAINED IN ANNUAL REPORT. WE, THEREFORE, ARE IN ITA NO. 5637/D/2011 149 AGREEMENT WITH LD. COUNSEL FOR THE ASSESSEE THAT TH IS COMPANY CANNOT BE INCLUDED AS A COMPARABLE IN THE SET OF COMPARABLES SELECTED BY LD. TPO ON ACCOUNT OF CLEAR CONTRADICTION BETWEEN CONTENTS OF ANNUAL REPORT AND INFORMATION OBTAINED U/S 133(6). 7. INFOSYS TECHNOLOGIES : LD. TPO NOTICED THAT THIS COMPANY WAS FINDING PL ACE IN THE ACCEPT/REJECT MATRIX OF THE ASSESSEE BUT WAS REJECTED IN THE TP DOCUMENT ON THE GROUND THAT IT FAILED BUSINESS REVIEW. HE NOTICED THAT NO REASONS WERE GIVEN FOR REJECTION ON FUNCTIONAL GROUNDS OR QUALIT ATIVE CRITERIA. HE NOTICED FROM THE ANNUAL REPORT THAT THE COMPANY WAS INTO SOFTWAR E DEVELOPMENT SERVICES AND QUALIFIED ALL THE FILTERS APPLIED BY THE TPO. THE ASSESSEE POINTED OUT THAT THE PROFITS DERIVED BY INFOSYS WERE PREDOMINANTLY D UE TO BRAND BUILDING EXERCISE UNDERTAKEN BY THE COMPANY. THIS BY ITSELF ALLOWED THE COMPANY TO HAVE A PREMIUM PRICING FOR ITS PROVISION OF SOFTWARE SERVI CES. HOWEVER, THE ASSESSEE BEING A CAPTIVE SERVICE PROVIDER, RENDERING SERVICE TO ITS OVERSEAS AFFILIATE WITHIN A RISK INSULIN WAS NOT REQUIRED TO LOCATE BRAND AWA RENESS AND THEREBY A PREMIUM PRICING. THE ASSESSEE POINTED OUT THAT DUR ING THE RELEVANT FINANCIAL YEAR, INFOSYS HAD A TURNOVER OF INR 13,149/- CRORES WHEREAS ASSESSEES TURNOVER DURING THE YEAR FOR THE SOFTWARE DEVELOPME NT SERVICES WAS INR680 CRORES. IT WAS SUBMITTED THAT GREATER SIZE IMPLIES ECONOMICS OF SCALE AND MORE BARGAINING POWER THAT MAY IMPACT PROFITABILITY OF A COMPANY. IT WAS FURTHER SUBMITTED THAT INFOSYS FOCUSES ON R&D AS PER THE AN NUAL REPORT. FURTHER INFOSYS OWNS PRODUCT AND LEVERAGE ON ITS PREMIUM BA NKING SOLUTION FINACLE AS IS EVIDENT FROM THE ANNUAL REPORT. FURTHER THE COM PANY ALSO OWNS VARIOUS ITA NO. 5637/D/2011 150 PRODUCTS WHICH DISTINGUISHED THE COMPANY FROM THE A SSESSEE AND, THEREFORE, THE COMPANY CANNOT BE CONSIDERED AS A COMPARABLE. LD. TPO, HOWEVER, DID NOT ACCEPT THE ASSESSEES CONTENTION AND POINTED OU T THAT AS PER THE ASSESSEES CONTENTION THE COMPETITIVE STRENGTH OF I NFOSYS WAS DUE TO ON ACCOUNT OF FOLLOWING FACTORS: A. INNOVATION AND LEADERSHIP B. PROVESS GLOBAL MOBILE C. COMPREHENSIVE AND SOPHISTICATED SOLUTION D. LONG STANDING OF THE RELATIONSHIPS E. STATES AS AN EMPLOYER OR CHOICE F. ABILITY TO SCALE. 97.3 LD. TPO POINTED OUT THAT ALL THE ABOVE FACTORS ARE THERE IN THE SERVICES BEING RENDERED BY THE TAX PAYER TO THE ASS OCIATED ENTERPRISE. IF THE MARGINS EARNED BY A COMPARABLE COMPANY ARE AFFECTED BY THE FACTORS LIKE BRAND VALUE ETC. APPROPRIATE ADJUSTMENTS CAN BE MAD E. HE POINTED OUT THAT ASSESSEE HAD NOT GIVEN ANY COGENT EVIDENCE OR DATA TO SUPPORT THE PRESUMPTION THAT THE MARGINS EARNED BY INFOSYS OR A NY OTHER COMPANY IN THE SOFTWARE INDUSTRY WERE AFFECTED BY THE SO CALLED BR AND VALUE. HE SUBMITTED THAT THE ULTIMATE PROFITS EARNED BY ANY COMPANY INCLUDIN G INFOSYS DEPENDENT UPON THE OVER ALL MARKET CONDITIONS AND THE SERVICES REN DERED. HE DEMONSTRATED WITH REFERENCE TO FINAL COMPARABLE SELECTED BY HIM THAT BRAND VALUE HAD NOTHING TO DO WITH THE MARGIN. THE SAID TABLE IS REPRODUCE D HEREUNDER: ITA NO. 5637/D/2011 151 S.NO. COMPANY NAME SALES (RS. CR.) OP TO TOTAL COST % 1. ACCEL TRANSMATIC LTD. (SEG.) 9.68 20.90% 2. AVANI CIMCONN TECHNOLOGI ES LTD. 3.55 50.29% 3. CELESTIAL LABS LTD. 14.13 58.35% 4. DATAMATICS LTD. 54.51 1.38% 5. E-ZEST SOLUTIONS LTD. 6.26 36.12% 6. FLEXTRONICS SOFTWARE SYSTEMS LTD. (SEG.) 848.66 25.31% 7. GEOMETRIC LTD. (SEG.) 158.38 10.71% 8. HELIOS & MATHESON INFORMATIO N TECHNOLOG Y LTD. 178.63 36.63% 9. IGATE GLOBAL SOLUTIONS LTD. 747.27 7.49% 10. INFOSYS TECHNOLOGI ES LTD. 131.49 40.30% 11. ISHIR INFOTECH LTD. 7.42 30.12% 12. KALS INFORMATIO N SYSTEMS LTD. (SEG.) 2.00 30.55% 13. LGS GLOBAL LTD. (LANCO GLOBAL SOLUTIONS LTD.) 45.39 15.75% 14. LUCID SOFTWARE LTD. 1.70 19.37% 15. MEDIASOFT SOLUTIONS LTD. 1.85 3.66% 16. MEGASOFT LTD. 139.33 60.23% ITA NO. 5637/D/2011 152 17. MINDTREE LTD. 590.35 16.90% 18. PERSISTENT SYSTEMS LTD. 293.75 24.18% 19. QUINTEGRA SOLUTIONS LTD. 62.72 12.56% 20. R S SOFTWARE (INDIA) LTD. 101.04 13.47% 21. R SYSTEMS INTERNATION AL LTD. (SEG.) 112.01 15.07% 22. SASKEN COMMUNIC ATION TECHNOLOGI ES LTD. (SEG.) 343.57 22.16% 23. SIP TECHNOLOGI ES & EXPORTS LTD. 3.80 13.90% 24. TATA ELXSI LTD. (SEG.) 262.58 26.51% 25. THIRDWARE SOLUTIONS LTD. 36.08 25.12% 26. WIPRO LTD. (SEG.) 9616.09 33.48% 97.4 WITH REFERENCE TO THE ABOVE TABLE HE POINTED O UT THAT LESSER KNOWN COMPANIES LIKE AVNI SIMCOM LTD., CELESTIAL LABS LTD . & MEGA SOFT WERE HAVING ALMOST THE SAME OR BETTER MARGINS THAN INFOSYS WHIC H IMPLIES THAT BRAND PER SE DOES NOT AFFECT THE MARGINS. SIMILARLY HE POINTED OUT THAT MIND TREE CONSULTED LTD. AND EYE GLOBAL SOLUTION LTD. WHICH HAVE BRAND VALUE HAD VERY THIN MARGINS. THUS, HE POINTED OUT THAT BRAND VALUE HAS NO CORRELATION WITH THE MARGINS EARNED BY A COMPANY. HE POINTED OUT THAT A SSESSEE DID NOT GIVE ANY EVIDENCE EXCEPT THE MARGINS OF INFOSYS TO SAY THAT IT CHARGES PREMIUM OVER MARKET FOR ITS SERVICES. FURTHER HE POINTED OUT TH AT BRAND COMES WITH A COST I.E. HUGE EXPENSES WERE REQUIRED TO BE INCURRED TO BUILD BRAND VALUE. THUS, A ITA NO. 5637/D/2011 153 BRAND MAY GENERATE REVENUE BUT WITH A COST COMPENSA TED ANY EXTRA BENEFIT, IF ANY DERIVED FROM SUCH EFFORT. HE FURTHER POINTED O UT THAT THE BRAND INFOSYS OR IN ANY OTHER SOFTWARE COMPANY IMPROVES THE ABILITY TO SUSTAIN EARNINGS INTO THE FUTURE WITH THE LEAST RISKS. THUS, THE BRAND IMPRO VES THE VOLUME OF THE BUSINESS WITH LIMITED RISK BUT NOT NECESSARILY THE MARGIN. THEREFORE, BRAND IN INFOSYS IMPROVES THE VOLUMES BUT MATERIALLY DOES NOT AFFECT THE PROFITABILITY. LD. TPO FURTHER POINTED OUT THAT IN THE CASE OF SOFTWARE IN DUSTRY, THE PRICES FOR EXPORT OF SOFTWARE SERVICES ARE USUALLY BUILT IN MAN HOURS FO R WHICH THE RATES ARE NEARLY SAME ACROSS THE INDUSTRY FOR SAME TYPE OF RESOURCE IN TERMS OF EXPERIENCE EXPERTISE AS WELL AS FUNCTIONAL LINE. THE LD. TPO FURTHER POINTED OUT THAT INFOSYS WAS MORE COMPARABLE TO THE ASSESSEE THAN ANY OTHER COMPARABLE COMPANY AS IT CAN BE TREATED AS CONGLOMERATE OF CAPTIVE SOFTWA RE SERVICE PROVIDERS AS IT GENERATE ITS REVENUES FROM LONG STANDING CUSTOMERS SIMILAR TO THAT OF THE TAX PAYER. AS REGARDS ASSESSEES SUBMISSION THAT INFOS YS INCURS HUGE EXPENSES ON R&D EXPENSES, LD. TPO POINTED OUT THAT INFOSYS INCURRED ONLY RS. 167 CRORES I.E. 1.3% OF TOTAL REVENUES FOR THE FY 2006- 07 AND, THEREFORE, QUALIFIED ASSESSEES OWN FILTER OF R&D EXPENSES, R&D EXPENSE S TO SALES BEING LESS THAN 3% OF REVENUE. LD. TPO FURTHER POINTED OUT TH AT FROM THE ANNUAL REPORT IT WAS EVIDENT THAT INFOSYS INCURRED AN AMOUNT OF RS. 48 CRORES OF ITS R&D EXPENSES ON DEVELOPING ITS SOFTWARE PRODUCT FINACLE . THEREFORE, ONLY 119 CRORES HAD BEEN SPENT IN R&D IN SOFTWARE DEVELOPMEN T SERVICES MAINLY TO IMPROVE THE PROCESSES IN DELIVERING SOFTWARE DEVELO PMENT SERVICES. AS REGARDS ASSESSEES CONTENTION THAT INFOSYS HAD SOFTWARE PRO DUCTS, LD. TPO POINTED OUT ITA NO. 5637/D/2011 154 THAT THE REVENUES FROM SOFTWARE PRODUCTS WERE ONLY 538 CRORES OUT OF TOTAL OPERATING REVENUES OF RS. 13149 CRORES. THEREFORE, THE REVENUE FROM SOFTWARE PRODUCT CONSTITUTED ONLY 4.1% OF OPERATING REVENUES . HENCE IT QUALIFIED THE FILTER OF MORE THAN 75% REVENUES FROM SOFTWARE DEVE LOPMENT SERVICES. HE, ACCORDINGLY, INCLUDED THIS IN THE LIST OF COMPARABL ES. 98. LD. COUNSEL FOR THE ASSESSEE REITERATED THE SU BMISSIONS MADE BEFORE LD. TPO AND POINTED OUT THAT THE SPL. BENCH OF LG C ASE CLEARLY BRINGS OUT THE IMPORTANCE OF BRAND AND MARKETING INTANGIBLE IN THE RAMP ON TRANSFER PRICING. HE SUBMITTED THAT THIS CASE CLEARLY LAYS DOWN THAT RISK BEARING ACTIVITIES THAT COMPETE IN THE MARKET PLACE NEED TO INCUR AMP EXPEN DITURE TO ESTABLISH AND MAINTAIN THEIR BRAND. 99. LD. CIT(DR) RELIED ON FOLLOWING DECISIONS IN S UPPORT OF HIS CONTENTION THAT BRAND/INTANGIBLE DOES NOT PER SE MAKE ANY DIFFERENCE: 1. M/S DELOITE CONSULTING INDIA PVT. LTD., 108/HYD. /2010 (PARA 36); 2. M/S ACTIS ADVISORS PVT. LTD., ITA NO. 5277/D/201 1 (PARA 25); 3. M/S WILLS PROCESSING INDIA PVT. LTD., ITA NO. 44 29 TO 4547/MUM./2012 (PARA 45.1 & 45.2) DATED 01/03/2013; 4. M/S NAVISITE INDIA PVT. LTD., ITA NO. 5329/D/201 2 (PARA 53 & 54); 5. M/S CAB GEMINI, ITA NO. 7861/MUM./2011 TO CONTEN D THAT ECONOMIES OF SCALE IS RELEVANT FOR MANUFACTURING SECTOR AND NOT IMPORTANCE FOR SERVICE INDUSTRY. 100. LD. COUNSEL, IN THE REJOINDER, SUBMITTED THAT IN THE CASE OF DELOITE CONSULTING (SUPRA), ITAT WAS EXAMINING THE SUITABIL ITY OF ONE PARTICULAR ITA NO. 5637/D/2011 155 COMPARABLE VIZ. VISHAL INFORMATION TECHNOLOGY LTD. VIZ-A-VIZ THE ASSESSEE WHICH WAS ENGAGED IN IT ENABLED SERVICES. IN THIS CASE THE ASSESSEE ITSELF HAD CHOSEN VITL AS A COMPARABLE IN ITS TP REPORT AN D LETTER ON SOUGHT TO EXCLUDE ON THE GROUND THAT IT HAD INTANGIBLE AND LO W EMPLOYEE COST TO SALES RATIO. THE TRIBUNAL DID NOT ACCEPT THE ASSESSEES ARGUMENT PRIMARILY ON THE GROUND THAT IT IS NOT CORRECT ON THE PART OF THE A SSESSEE COMPANY TO RAISE A NEW PLEA THAT VITL HAS LOW EMPLOYEE COST. THE OBSERVA TION REGARDING INTANGIBLES NOT MATERIALLY IMPACTING PROFITABILITY HAS TO BE SO LELY SEEN IN THE CONTEXT OF THE FACTS OF VITL. THEREFORE, THIS DECISION DOES NOT L AY DOWN THE GENERAL PROPOSITION THAT INTANGIBLES DO NOT MATTER AND DO N OT IMPACT PROFITABILITY. HE SUBMITTED THAT IT IS A FUNDAMENTAL ECONOMIC PRINCIP LE THAT INTANGIBLES PLAY A SIGNIFICANT RULE IN ANY TRANSFER PRICING EXERCISE B ECAUSE PRICE AND MARKET MARGIN, BOTH VARY WITH THE PRESENCE OR ABSENCE OF INTANGIBLES. HE SUBMITTED THAT IT IS AXIOMATIC THAT A BRANDED PRODUCT OR SERV ICES IS MORE EXPENSIVE THAN AN UNBRANDED PRODUCT. SIGNIFICANT INVESTMENT AND RISK IS INVOLVED IN CREATING BUILDING AND MAINTAINING INTANGIBLES. HE FURTHER S UBMITTED THAT SECTION 92B WAS AMENDED IN 2012 TO INCLUDE AN EXTENSIVE DEFINITION OF INTANGIBLES. OECD AND UN GUIDELINES CONTAINED EXTENSIVE REFERENCE OF INTA NGIBLE IN TRANSFER PRICING. AS FAR AS RELIANCE ON THE CASE OF WILLS PROCESSING WAS CONCERNED, LD. COUNSEL POINTED OUT THAT THIS CASE IS OF NO ASSISTANCE TO T HE REVENUE AS IT CAN BE SEEN FROM THE PERUSAL OF PARA 45.1 OF THE ORDER, THAT IT WAS BASED ON THE FACTS OF THE CASE. THE TRIBUNAL OBSERVED THAT THE CLAIM OF MARK ETING EXPENDITURE BEING DISTINGUISHING FACTOR WAS NOT SUSTAINABLE AS THE QU ANTUM OF EXPENDITURE WAS ITA NO. 5637/D/2011 156 NOT MATERIAL. SIMILARLY, IN PARA 45.2 TRIBUNAL CIT ED THE DECISION IN THE CASE OF ACTIS ADVISORS PVT. LTD. TO HOLD THAT MARKETING EXP ENDITURE WAS NOT A FACTOR THAT IMPACTS PROFITABILITY OF SOFTWARE AND IT ENABLED SE RVICES. HE POINTED OUT THAT ASSESSEE IS NOT CONTENDING THAT INFOSYS SHOULD BE EXCLUDED BECAUSE IT INCURRED HIGH LEVEL OF MARKETING EXPENDITURE BUT BECAUSE IT HAD SIGNIFICANT BRAND WHICH ITSELF HAD VALUE AT MORE THAN RS. 20,000/- CRORE. FURTHER AS PER ANNUAL REPORT ALSO LARGE PROFITS WERE DERIVED BECAUSE OF BRAND. 100.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE PERUSED THE RECORD OF THE CASE. 101. THE EARNING OF PROFIT I.E. THAT PROFIT MARGIN OF AN ENTITY DEPENDS ON SEVERAL FACTORS SUCH AS GEOGRAPHICAL LOCATION OF EN TITY, OPERATIONAL EFFICIENCY, PREVAILING MARKET CONDITIONS, GOODWILL OF THE COMPA NY, INTANGIBLES IN THE FORM OF BRAND VALUE OF ENTITY , ECONOMIES OF SCALES, ETC.. HOWEVER, WHILE SELECTING A COMPARABLE FOR DETERMINING THE ARMS LENGTH PRICE O F AN INTERNATIONAL TRANSACTION, THE PRE DOMINANT ASPECT WHICH HAS TO B E TAKEN INTO CONSIDERATION IS THE FUNCTIONAL PROFILE OF THE COMPARABLE. IF A COM PARABLE IS PERFORMING THE SAME FUNCTIONS AS THE ASSESSEE THEN A FURTHER EXERC ISE IS TO BE TAKEN REGARDING ASSETS UTILIZED AND RISK ASSUMED IN CARRYING OUT TH OSE FUNCTIONS. IF THE ASSET BASE PRE-DOMINANTLY DIFFERS OR THE RISK ASSUMED BY A COMPARABLE ARE PRE- DOMINANTLY DIFFERENT THEN THE SAID ENTITY HAS TO BE EXCLUDED FROM THE LIST OF COMPARABLES SELECTED FOR DETERMINING ARMS LENGTH P RICE. LD. COUNSEL HAS RELIED ON THE DECISION IN THE CASE OF CIT VS. AGNIT Y INDIA TECHNOLOGIES PVT. LTD. ITA NO. 1204/2011 DATED 10/07/2013, WHEREIN THE HON BLE DELHI HIGH COURT HAS ITA NO. 5637/D/2011 157 CONFIRMED THE DECISION OF TRIBUNAL IN EXCLUDING INF OSYS TECHNOLOGIES AFTER TAKING INTO CONSIDERATION FOLLOWING DIFFERENCES: BASIC PARTICULAR INFOSYS TECHNOLOGIES LTD. AGNITY INDIA RISK PROFILE OPERATE AS FULL-FLEDGED RISK TAKING ENTREPRENEURS OPERATE AT MINIMAL RISKS AS THE 100% SERVICES ARE PROVIDED TO AES NATURE OF SERVICES DIVERSIFIED- CONSULTING, APPLICATION DESIGN, DEVELOP- MENT, RE- ENGINEERING AND MAINTENANCE SYSTEM INTEGRATION, PACKAGE EVALUATION AND IMPLEMENTATION AND BUSINESS PROCESS MANAGEMENT, ETC. (REFER PAGE 117 OF THE PAPER BOOK) CONTRACT SOFTWARE DEVELOPMENT SERVICES. REVENUE RS. 9,028 CRORES RS. 16.09 CRORES OWNERSHIP OF BRANDED/PROPRIETARY PRODUCTS DEVELOPS/OWNS PROPRIETARY PRODUCTS LIKE FINACLE, INFOSYS ACTICE DESK, INFOSYS IPROWE, INFOSYS MCONNECT, ALSO, THE COMPANY DERIVES SUBSTANTIAL PORTION OF ITS PROPRIETARY PRODUCTS (INCLUDING ITS ITA NO. 5637/D/2011 158 FLAGSHIP BANKING PRODUCT SUITE FINACLE) ONSITE VS. OFFSHORE AS MUCH AS HALF OF THE SOFTWARE DEVELOPMENT SERVICES RENDERED BY INFOSYS ARE ONSITE (I.E. SERVICES PERFORMED AT THE CUSTOMERS LOCATION OVERSEAS). AND OFFSHORE (50.20%) (REFER PAGE 117 OF THE PAPER BOOK) THAN HALF OF ITS SERVICE, INCOME FROM ONSITE SERVICES. THE APPELLANT PROVIDES ONLY OFFSHORE SERVICES (I.E. REMOTELY FROM INDIA). EXPENDITURE ON ADVERTISING/ SALES PROMOTION AND BRAND BUILDING RS. 61 CRORES RS. NIL (AS THE 100% SERVICES ARE PROVIDED TO AES) EXPENDITURE ON RESEARCH & DEVELOPMENT RS. 102 CRORES RS. NIL OTHER 100% OFFSHORE (FROM INDIA) 101.1 THUS, ONE OF THE CONSIDERATION IS OWNERSHIP O F BRANDED/PROPRIETARY PRODUCTS . RESPECTFULLY FOLLOWING THE DECISION OF H ONBLE DELHI HIGH COURT, WE DIRECT LD.TPO TO EXCLUDE THIS COMPANY FROM THE LIST OF COMPARABLES TAKEN BY TPO. 8. ASIAN INFOTECH LTD. : 102. LD. TPO NOTICED THAT THIS COMPANY WAS NOT FIND ING PLACE IN THE ACCEPT/REJECT MATRIX OF THE ASSESSEE. HE OBSERVED THAT THOUGH, AS PER THE DATA ITA NO. 5637/D/2011 159 AVAILABLE IN CAPITALINE DATA BASE, THE COMPANY FAIL ED EMPLOYEE COST FILTER OF 25% EMPLOYEE COST. HOWEVER, ON THE BASIS OF INFORM ATION OBTAINED U/S 133(6), IT QUALIFIED 25% EMPLOYEE COST FILTER. THE ASSESSE E OBJECTED TO INCLUSION OF THIS COMPANY ON THE GROUND THAT IT HAD RELATED PARTY TR ANSACTION MORE THAN 15% OF REVENUES. THE LD. TPO POINTED OUT THAT SINCE 25% R ELATED PARTY TRANSACTION FILTER HAS BEEN APPLIED AND THE RELATED PARTY TRANS ACTIONS WERE ONLY TO THE EXTENT OF 22% OF THE REVENUES, THEREFORE, IT QUALIFIES TO BE INCLUDED IN THE LIST OF COMPARABLES. LD. COUNSEL POINTED OUT THAT AS PER T HE ANNUAL REPORT, THE EMPLOYEE COST TO SALES OF THE COMPANY IS 3.96% BUT ON THE BASIS OF INFORMATION OBTAINED U/S 133(6), THE COMPANY HAS BEEN CONSIDERE D AS A COMPARABLE. HE FURTHER POINTED OUT THAT HIGH ADVERTISEMENT AND MAR KETING EXPENDITURE HAS BEEN SPENT BY THIS COMPANY. HE POINTED OUT THAT THE SAM E IS 7.72% OF SALES AND 7.82% AND THE LD. TPO HAS NOT COMMENTED UPON THIS A SPECT. HE FURTHER SUBMITTED THAT NOTICE U/S 133(6) SEEKING INFORMATIO N IN THE FIRST PLACE HAD NOT BEEN SENT TO ASIAN AND SECONDLY THE INFORMATION HAS NOT BEEN SHARED WITH THE ASSESSEE. 102.1 HAVING HEARD BOTH THE PARTIES, WE RESTORE THI S ISSUE TO THE FILE OF LD. AO/TPO FOR PROVIDE THE INFORMATION OBTAINED U/S 133 (6) TO ASSESSEE AND THEREAFTER DECIDE THE ISSUE DENOVO. 9. HELIOS AND MATHESON INFORMATION TECHNOLOGY LTD. : 103. THE LD. TPO NOTICED THAT THIS COMPANY WAS FIND ING PLACE IN THE ACCEPT/REJECT MATRIX OF THE ASSESSEE BUT WAS REJEC TED IN THE TP DOCUMENT ON THE GROUND THAT IT FAILED BUSINESS REVIEW. HOWEVER , NO REASONS WERE GIVEN FOR ITA NO. 5637/D/2011 160 REJECTION ON FUNCTIONAL GROUNDS OR QUALITATIVE CRIT ERIA. ON THE BASIS OF INFORMATION RECEIVED U/S 133(6), HE OBSERVED THAT T HE COMPANY IS INTO SOFTWARE DEVELOPMENT SERVICES AND QUALIFIED EMPLOYEE COST FI LTER AND ALL OTHER FILTERS APPLIED BY THE TPO. THEREFORE, IT WAS CONSIDERED A S COMPARABLE. THE ASSESSEE WAS SHOW CAUSED. HOWEVER, ASSESSEE DID NOT OFFER ANY COMMENTS EXCEPT SAYING THAT THE COMPUTATION OF PLI WAS WRONG AS DIVIDEND INCOME AND OTHER INCOME WAS CONSIDERED BY THE TPO. THE LD. TP O ACCORDINGLY, CORRECTED THE PLI AND INCLUDED THE COMPANY AS COMPARABLE. LD . COUNSEL POINTED OUT THAT THE COMPANY WAS ENGAGED IN PROVIDING SERVICES SUCH AS APPLICATION MANAGEMENT SERVICES, BUSINESS AND TECHNOLOGY CONSUL TANT ITES & BPO SERVICES, MARITIME PRACTICE, ETC. LD. COUNSEL REFE RRED TO PAGE 388 OF PAPER BOOK AND POINTED OUT FOLLOWING OBJECTIONS WERE RAIS ED BY ASSESSEE IN THIS REGARD: 1. THIS COMPANY FAILED THE EMPLOYEE COST/SALES FILT ER OF MORE THAN 25% APPLIED BY LD. TPO. HOWEVER, THE COMPANY WAS SELEC TED ON THE BASIS OF INFORMATION OBTAINED U/S 133(6); 2. THE NOTICE U/S 133(6) WAS NOT SENT TO HELOIS AND MATHISON AND THE INFORMATION OBTAINED WAS NOT SHARED WITH THE ASSESS EE; 3. THE COMPANYS ADVERTISING AND MARKETING EXPENDIT URE TO SALES RATIO WAS 3.52% AND, THUS, THE COMPANY ENJOYED A RETURN ON AC COUNT OF MARKETING INTANGIBLE. 104. LD. COUNSEL POINTED OUT THAT LD. TPO HAS NOT D EALT WITH THE OBJECTIONS RAISED BY ASSESSEE. 104.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH TH E PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. ITA NO. 5637/D/2011 161 105. AS FAR AS ASSESSEES CHALLENGE TO INFORMATION U/S 133(6) BEING IN CONTRADICTION TO THE INFORMATION AVAILABLE IN THE A NNUAL REPORT IN REGARD TO EMPLOYEE COST IS CONCERNED, WE DO NOT FIND MUCH SUB STANCE IN THE SAME BECAUSE IN THE INFORMATION OBTAINED U/S 133(6) THE COMPANY MUST HAVE SEGREGATED THE INFORMATION FROM THE ANNUAL REPORT A ND THEN FURNISHED TO THE AO. HOWEVER, WE ARE IN AGREEMENT WITH THE LD. COUNSEL F OR THE ASSESSEE THAT THE INFORMATION OBTAINED U/S 133(6) SHOULD HAVE BEEN SH ARED WITH THE ASSESSEE. SINCE THE SAME HAS NOT BEEN DONE, WE RESTORE THIS I SSUE TO THE FILE OF LD. TPO TO EXAMINE AFRESH AFTER DEALING WITH VARIOUS OBJECTION S RAISED BY ASSESSEE. 10. LUCID SOFTWARE LTD. : 106. LD. TPO NOTICED THAT THE COMPANY WAS NOT CONSI DERED IN THE ACCEPT/REJECT MATRIX OF THE SEARCH PROCESS GIVEN IN THE TP REPORT. HOWEVER, THE DATA OF THE COMPANY WAS AVAILABLE IN THE DATA BASE AND ALSO APPEARED IN THE SEARCH PROCESS CARRIED ON BY THE TPO. AS PER THE I NFORMATION OBTAINED U/S 133(6) IT WAS FOUND THAT THE COMPANY WAS A PURE SOF TWARE DEVELOPMENT SERVICE COMPANY AND HAD NO RELATED PARTY TRANSACTIONS. HE FURTHER OBSERVED THAT THE COMPANY WAS NOT HAVING ANY REVENUE FROM SALE OF PRO DUCTS/LICENSES AS PER THE CONTENTS OF ANNUAL REPORT. LD. TPO AFTER CONSIDERI NG THE ASSESSEES OBJECTIONS, IN REGARD TO NON INCLUSION OF DEPRECIATION AMORTIZA TION RECOMPUTED THE PLI AND INCLUDED THE SAME IN THE LIST OF COMPARABLES. LD. COUNSEL POINTED OUT THAT THE COMPANY IS A PRODUCT COMPANY FOCUSING ON ADVANCE NO N DESTRUCTIVE TESTING (NDT) TECHNOLOGIES. HE FURTHER POINTED OUT THAT AS PER THE WEB SITE THE COMPANY IS ACTIVELY INVOLVED IN RESEARCH AND DEVELO PMENT WITH LEADING ITA NO. 5637/D/2011 162 SCIENTIFIC & EDUCATIONAL INSTITUTIONS. FURTHER THE COMPANY HAS DEVELOPED PROPRIETARY MUULAM SOSFTWARE. IN THIS REGARD HE RE FERRED TO PAGE 405 TO 408 OF PAPER BOOK, WHEREIN THE BROCHURE OF THIS SOFTWARE I S CONTAINED. FURTHER IN A.Y. 2008-09 TPO HIMSELF HAS EXCLUDED THIS COMPANY AS A COMPARABLE. IN THIS REGARD LD. COUNSEL REFERRED TO PAGE 425 OF THE MAIN APPEAL SET FOR A.Y. 2008-09 AND PAGE 60 OF THE TP ORDER FOR AY 2008-09. 107. LD. DR RELIED ON THE ORDER OF TPO AND SUBMITTE D THAT AS PER THE INFORMATION RECEIVED U/S 133(6), THE LUCID SOFTWARE IS A PURE SOFTWARE DEVELOPMENT SERVICE PROVIDER AND DOES NOT HAVE ANY REVENUE BY WAY OF SALE OF PRODUCT/LICENSES. 107.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH TH E PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. SINCE THIS COMPARA BLE HAS BEEN EXCLUDED BY TPO HIMSELF IN AY 2008-09, WE DO NOT FIND ANY JUSTI FICATION FOR INCLUSION OF THIS COMPARABLE FOR AY 2007-08 UNDER THE SAME SET OF FAC TS AND CIRCUMSTANCES. NO DISTINGUISHING FEATURE HAS BEEN BROUGHT ON RECORD I N REGARD TO THIS COMPANY BETWEEN A.Y. 2007-08 AND 2008-09. 107.2 ACCORDINGLY, WE DIRECT LD. TPO TO EXCLUDE THI S COMPARABLE FROM THE LIST OF COMPARABLES. 11. THIRD WARE SOLUTIONS LTD. : 108. AT THE TIME OF HEARING, LD. COUNSEL FOR THE AS SESSEE DID NOT PRESS EXCLUSION FOR THIS COMPARABLE FROM THE LIST OF COMP ARABLES. 12. SISKIN COMMUNICATION TECHNOLOGIES LTD. : ITA NO. 5637/D/2011 163 109. LD TPO NOTICED THAT THE COMPANY WAS REJECTED I N THE TP DOCUMENT ON THE GROUND THAT THE COMPANY FAILS ITS FILTER OF BUSINESS REVIEW AND R&D TO SALES WAS MORE THAN 3%. HOWEVER, NO REASONS WERE G IVEN FOR THE BUSINESS REVIEW. 109.1 LD. TPO POINTED OUT THAT R&D TO SALES BEING M ORE THAN 3% IS NOT ACCEPTABLE FOR WHICH DETAILED DISCUSSION HAS ALREAD Y BEEN MADE EARLIER. HE FURTHER NOTICED THAT THE COMPANY HAS SOFTWARE SERVI CES SEGMENT AND SEGMENTAL RESULTS ARE AVAILABLE FOR SOFTWARE SERVICES. HE FU RTHER POINTED OUT THAT ON THE BASIS OF INFORMATION OBTAINED U/S 133(6), THE COMPA NY QUALIFIES ONSITE REVENUE FILTER (ONSITE REVENUES WERE TO THE EXTENT 27.27% O F ITS EXPORT REVENUES). AFTER CONSIDERING THE ASSESSEES REPLY, LD. TPO INCLUDED THIS COMPANY IN THE LIST OF COMPARABLES. LD. COUNSEL POINTED OUT THAT THIS COM PANY HAS INCURRED SIGNIFICANT EXPENDITURE ON RESEARCH AND DEVELOPMENT ACTIVITY THE SAME BEING 6.07% OF SALES. HE FURTHER SUBMITTED THAT THE COMP ANY HAD SIGNIFICANT INTANGIBLE INASMUCH AS IT DEVELOPS SISKIN BRANDED P RODUCTS. THE COMPANY OWNS IPR FURTHER IT WAS POINTED OUT BEFORE TPO THAT DURING THE YEAR THE COMPANY HAD ACQUIRED BOTNIA HIGHTECH F. AND ITS TWO SUBSIDIARIES AND THUS, IT HAD UNDER GONE SIGNIFICANT RESTRUCTURING. HOWEVER, LD. TPO IGNORED THESE FACTS HE RELIED ON THE FOLLOWING DECISIONS: IQ INFORMATION SYSTEM (I) PVT. LTD., ITA NO. 1961/ HYD./2012 (PARA NO. 11 & 23, PAGE 25); AMERSON PROCESS MANAGEMENT INDIA PVT. LTD., ITA NO . 8118/MUM./2010 (PARA 16 PAGE 15). ITA NO. 5637/D/2011 164 110. LD. DR RELIED ON THE ORDER OF TPO AND SUBMITTE D THAT TPO CONSIDERED THE COMPANIES SOFTWARE SERVICES SEGMENT DETAILS ONLY. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE P ERUSED THE RECORD OF THE CASE. 111. LD. TPO HAS COMPLETELY IGNORED THE EXTRAORDINA RY BUSINESS CIRCUMSTANCES POINTED OUT BY ASSESSEE FOR WHICH NEC ESSARY ADJUSTMENT WAS REQUIRED TO BE MADE IN ACCORDANCE WITH RULE 10B(3) OF INCOME TAX RULES. HOWEVER, SINCE THIS ADJUSTMENT WAS NOT POSSIBLE, TH EREFORE, THIS COMPANY SHOULD NOT HAVE BEEN INCLUDED IN THE LIST OF COMPAR ABLES. FURTHER, WE FIND THAT THE COMPANY OWNS IPR AND HAS BRANDED PRODUCTS WHICH ALSO DISTINGUISHES IT FROM THE ASSESSEE AND, THEREFORE, KEEPING IN VIEW T HE DECISION OF HONBLE DELHI HIGH COURT IN THE CASE OF AGNIY INDIA TECHNOLOGIES PVT. LTD.(SUPRA), WE DIRECT THE LD. TPO TO EXCLUDE THIS COMPARABLE FROM THE LIS T OF COMPARABLES. 13. TATA ELEXI LTD. : 112. LD. TPO NOTICED THAT THE COMPANY WAS REJECTED IN THE TP DOCUMENT SAYING THAT THE COMPANY FAILED ITS FILTER OF BUSINE SS REVIEW AND R&D TO SALES MORE THAN 3%. HOWEVER, NO REASONS WERE GIVEN FOR T HE BUSINESS REVIEW. FROM THE ANNUAL REPORT, LD. TPO NOTICED THAT THIS COMPAN Y HAS TWO SEGMENTS ONE SOFTWARE DEVELOPMENT AND SERVICES SEGMENT AND SECON D SYSTEMS INTEGRATION AND SUPPORT SEGMENT. SEGMENTAL DETAILS WERE AVAILA BLE AND THE COMPANY SATISFIES ALL THE FILTERS. THE TPO, ACCORDINGLY, C ONSIDERED SOFTWARE DEVELOPMENT AND SERVICES SEGMENT AS A COMPARABLE. THE ASSESSEE , INTER-ALIA, POINTED OUT THAT AS PER THE INFORMATION RECEIVED U/S 133(6), IT HAS BEEN SPECIFICALLY PROVIDED ITA NO. 5637/D/2011 165 THAT THE COMPANY IS INTO PRODUCTION OF SPECIALIZED EMBEDDED SOFTWARE DEVELOPMENT SERVICES TO ITS CUSTOMERS. FURTHER, TH E COMPANY HAS TERMED THE SERVICES PROVIDED BY IT AS UNIQUE AND NON-REPETITIV E IN NATURE INVOLVING DEVELOPMENT OF EMBEDDED SOFTWARE FOR USE BY THE CUS TOMER, WHEREAS IN THE CASE OF ASSESSEE THE SOFTWARE DEVELOPMENT SERVICE P ROVIDED WERE OF ROUTINE NATURE AND INVOLVED LOW LEVEL CODING, TESTING AND D OCUMENTATION SERVICES. THE ASSESSEE FURTHER POINTED OUT THAT IN THE INFORMATIO N OBTAINED U/S 133(6), THE COMPANY ITSELF HAS URGED NOT TO USE THE FINANCIAL O F THE COMPANY FOR MAKING COMPARISON WITH THE TESTED PARTY DUE TO THE SPECIAL IZED NATURE OF ACTIVITIES PERFORMED. THE LD. TPO, HOWEVER, DID NOT ACCEPT TH E ASSESSEES CONTENTION AND INCLUDED THIS COMPANY IN THE LIST OF COMPARABLE S. LD. COUNSEL SUBMITTED THAT IN RESPONSE TO NOTICE U/S 133(6), COMPANY ITSE LF ADMITTED ITS COMPLEX FUNCTIONAL PROFILE. HE POINTED OUT THAT THE COMPAN Y IS INTO HARDWARE DESIGN. FURTHER, THE COMPANY EMPLOY WIDE VARIETY OF PERSONN EL SUCH AS HARDWARE ENGINEERS, STYLING AND MECHANICAL DESIGNERS, GRAPHI C DESIGNERS, AND SPECIAL EFFECT ARTISTS. THIS IS AMPLE TESTIMONY TO THE FAC T THAT COMPANY IS NOT ENGAGED IN PURE SOFTWARE DEVELOPMENT ACTIVITY UNLIKE THE AS SESSEE. HE FURTHER SUBMITTED THAT NASSCOM, WHICH IS THE PREMIUM BODY O F IT/ITES COMPANIES IN INDIA, ALSO CLASSIFIES HARDWARE AND SOFTWARE DESIGN ING ACTIVITY AS FUNCTIONALLY DIFFERENT TO SOFTWARE DEVELOPMENT ACTIVITIES. 112.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE PERUSED THE RECORD OF THE CASE. 113. LD. TPO HAS OBSERVED AS UNDER: ITA NO. 5637/D/2011 166 THE TAXPAYER ARGUES THAT THE COMPANY'S R&D ACTIVI TIES RESULTED IN IPRS. BUT, THE R&D ACTIVITIES RESULTED ONLY M REUSABLE SOFTWARE CO MPONENTS AND READY-TO-DEPLOY PRODUCT FRAMEWORKS DEVELOPED BY TECHNOLOGY TEAMS WI THIN PRODUCT DESIGN SERVICES WHICH ARE USED IN DELIVERING THE SOFTWARE DEVELOPME NT SERVICES. IN FACT, THIS SEGMENT IS PERFECTLY COMPARABLE TO THE TAXPAYER AS IT IS ALSO A SOFTWARE DEVELOPMENT SERVICES WHICH USES SUCH SOFTWARE COMPONENTS AND READY-TO-DE PLOY FRAMEWORKS WHICH ARE SUPPLIED BY THE AE I DEVELOPED BY THE TAXPAYER WHICH ARE ASSIGNED TO THE AE WITHOUT ANY COMPENSATION. THOUGH THE R&D EXPENSES INCURRED CREATED TOOLS, THESE TOOLS ARE NOT SOLD TO GET THE REVENUE FOR THE COMPANY BUT THE Y ARE USED IN QUICK AND FAST DELIVERY OF SERVICES TO CUSTOMERS. IN FACT, AS DISCUSSED UND ER THE HEAD 'R&D SALES > 3%' AS ABOVE, THIS FILTER DOES NOT GIVE ANY INDICATION OF FUNCTIONALITY OF THE COMPANIES. IN THE SOFTWARE INDUSTRY AS EACH COMPANY HAS TO BE SEEN IN DETAIL WHETHER A COMPANY IS GETTING REVENUE BY WAY OF SALE OF IPRS IN THE FORM SOFTWARE PRODUCTS I LICENSE FEES AND WHETHER THESE IPRS ARE USED BY THE COMPANY INTERNAL LY TO IMPROVE THE DELIVERY OF THE SERVICES. IN THE LATER CASE, THE COMPANY IS FUNCTI ONALLY SIMILAR. FURTHER, THESE TOOLS/FRAMEWORKS ARE NECESSARY AS A COMPANY BECOMES BIGGER IN SIZE AS MOST OF THE PROCESSES HAD TO BE STANDARDIZED TO HAV E A CONTROL, WHICH BECOMES DIFFICULT IN BIGGER COMPANIES. THUS, INCURRING R&D IS A NATUR AL PROCESS OF EVOLUTION OF A SMALL COMPANY INTO A BIGGER COMPANY, WITHOUT WHICH THE CO MPANY MAY NOT SURVIVE. IT MAY FAIL TO DELIVER THE PROJECTS IN TIME AND ALSO TO TH E SATISFACTION OF THE CLIENTS. SO, IN BIGGER COMPANIES MANY PROCESSES ARE STREAMLINED BAS ED ON THE PAST EXPERIENCE AND CONVERTING THE SAME IN STANDARDIZING IN THE FORM OF READYMADE TOOLS. THUS, THE PRESENCE OF R&D EXPENSES IS A MINOR FUNCTIONAL DIFF ERENCE AND DOES NOT HAVE MATERIAL IMPACT ON PROFITABILITY. THUS, AS THE SOFTWARE DEV ELOPMENT AND SERVICES SEGMENT DOES NOT CONTAIN ANY REVENUE BY WAY OF SALE OF SOFTWARE PRODUCTS/IPRS/LICENSE FEES, THE SAME IS CONSIDERED AS A COMPARABLE. 113.1 THE SUBMISSION OF LD. COUNSEL FOR THE ASSESSE E THAT NASSCOM, WHICH IS THE PREMIUM BODY OF IT/ITES COMPANIES IN I NDIA, HAS CLASSIFIED HARDWARE AND SOFTWARE DESIGNING ACTIVITY AS FUNCTIO NALLY DIFFERENT TO SOFTWARE ITA NO. 5637/D/2011 167 DEVELOPMENT ACTIVITIES CANNOT BE IGNORED. HOWEVER, SINCE SEGMENTAL DETAILS WERE AVAILABLE, THE OBJECTION RAISED BY LD. COUNSEL CANNOT BE ACCEPTED. AS FAR AS ASSEESSEES OBJECTION WITH REGARD TO IPR IS CONC ERNED, WE FIND THAT THE SOFTWARE DEVELOPED BY ASSESSEE WERE USED AS TOOL IN DEVELOPMENT OF NEW SOFTWARES. THIS DEFINITELY CONTRIBUTED TOWARDS HIGH ER PROFITS. WE HAVE ELABORATELY CONSIDERED THIS ASPECT IN EARLIER PART OF OUR ORDER. WE, THEREFORE, DIRECT FOR EXCLUSION OF THIS COMPANY FROM THE LIST OF COMPARABLES. 14. WIPRO LTD. : 114. WITHOUT GOING IN DETAILED DISCUSSION ON THIS I SSUE, WE FIND THAT IN VIEW OF THE DECISION OF HONBLE DELHI HIGH COURT IN THE CASE OF AGNITY INDIA TECHNOLOGIES LTD., THIS CANNOT BE INCLUDED IN THE L IST OF COMPARABLES. 115. GROUND NO. 4.10 IS WITH REGARD TO DENIAL OF EC ONOMIC ADJUSTMENT FOR DIFFERENCE IN RISK PROFILE. 116. LD. TPO NOTICED THAT IN THE TP REPORT VARIOUS RISKS LIKE MARKET RISK, PRODUCT AND TECHNOLOGY RISK, CREDIT RISK AND FOREIG N EXCHANGE RISK WERE CONSIDERED. HOWEVER, NO ADJUSTMENT HAD BEEN MADE O N ACCOUNT OF SO CALLED GREATER RISK OF THE COMPARABLE COMPANIES AS ALLEGED BY THE ASSESSEE. ACCORDINGLY, HE ISSUED FOLLOWING SHOW CAUSE NOTICE TO ASSESSEE: FIRST OF ALL, PLEASE JUSTIFY HOW EACH OF THESE RI SKS IS BORNE BY EACH OF THE COMPARABLES SELECTED BY YOU. HOW THESE RISKS ARE GREATER IN CO MPARABLES THAN IN YOUR CASE. IT IS ALSO REQUESTED TO QUANTIFY HOW EACH TYPE OF RISK OR THE DIFFERENCE IN EACH RISK AFFECTED THE PROFITABILITY OF EACH OF THE COMPARABLE COMPANI ES BASED ON THE DATA FOR THE FY 2006-07 OR FOR THE YEARS CONSIDERED BY YOU. ITA NO. 5637/D/2011 168 THE TAXPAYER IS REQUESTED TO SUBMIT HIS CLAIM OF RI SK ADJUSTMENT, IF ANY, INCLUDING QUANTIFICATION THEREOF. WHILE SUBMITTING THE RISK ADJUSTMENT, THE TAXPAYER IS REQUESTED TO SUBMIT THE BASIS ON WHICH IT IS COMPUTED AND ALS O CONSIDER THE SINGLE CUSTOMER RISK POLITICAL RISK AND OTHER RISKS BORNE BY THE TAXPAYE R BUT NOT BY THE COMPARABLE COMPANIES. UNLESS THE TAXPAYER SUBMITS QUANTIFICATION OF RISK ADJUSTMENT INCLUDING SINGLE CUSTOMER RISK AND POLITICAL RISK IN THE CASE OF TAXPAYER, NO ADJUSTMENT WOULD BE GIVEN ON THIS ACCOUNT. 116.1 LD. TPO, AFTER DETAILED DISCUSSION, IN RESPEC T OF VARIOUS RISKS CLAIMED BY ASSESSEE, REJECTED THE ASSESSEES CLAIM FOR FOLL OWING REASONS: 1. THE TAX PAYER HAS NOT GIVEN ANY DETAILS REGARDING T HE AUTHORITY OF THE ABOVE METHOD DESCRIBING CAPM MODEL FOR ADJUSTMENT TOWARDS RISK. IT IS NOT CLEAR WHETHER THIS TYPE OF CALCULATION IS ACCEPTABLE IN ANY TAX J URISDICTION FOR THE PURPOSE OF RISK PREMIUM ADJUSTMENTS. ITS ACCEPTABILITY BY ANY RENOW NED AND RECOGNIZED RESEARCH INSTITUTION ACROSS THE WORLD HAS ALSO NOT BEEN SHOW N. THE MANNER IN WHICH THE RISK ADJUSTMENT IS COMPUTED BY THE TAXPAYER IS NOT FOLLO WED BY ANY COUNTRY OR ORGANIZATION OF INTERNATIONAL REPUTE LIKE OECD. IN FACT, EVEN TH E OECD IS RELUCTANT TO TAKE THE RISK ADJUSTMENT AS PART OF THE GUIDELIN ES AS THERE ARE DIVERGENT VIEWS ON THIS ISSUE AMONG THE MEMBER COUNTRIES OF OECD AND MANY C OUNTRIES FEEL THAT THERE IS NO STRAIGHT JACKET FORMULA FOR RISK ADJUSTMENT AS IT D EPENDS ENTIRELY ON THE FACTS AND CIRCUMSTANCES OF THE CASE. THUS RISK ADJUSTMENT IS CASE SPECIFIC, FUNCTION SPECIFIC AND ALSO DEPENDS ON THE NATURE OF FUNCTIONS (INCLUDING RISKS) CARRIED OUT BY THE COMPARABLE COMPANIES. 2. THE TAX PAYER HAD NOT GIVEN ANY EVIDENCE OR ARGUMEN T REGARDING HOW THE ASSUMPTIONS OF CAPM MODEL ARE TRUE IN THE CASE OF T HE AE WHEN IT IS DOING BUSINESS WITH THE TAXPAYER. 3. THE CAPM MODEL HAS SOME WEAKNESS, THE MAIN BEING TH AT THE MODEL DOES NOT RECOGNIZE THE PRESENCE OF HUMAN CAPITAL, WHICH IS T HE MAIN DRIVING SOURCE FOR REVENUES IN THE SOFTWARE SERVICE INDUSTRY. 4. THE TAXPAYER CONSIDERED ONLY LISTED COMPANIES. BUT , THERE IS A METHOD OF ITA NO. 5637/D/2011 169 COMPUTATIONOF SIMILAR NATURE IN THE INDEX. THERE I S A MANNER IN WHICH UNLISTED COMPANIES BETA WOULD BE CALCULATED. 5. WHEREVER MARKET DATA WAS NOT AVAILABLE, THE BETA IS COMPUTED BASED ON GUIDELINE COMPANIES FROM THE SMALL CAP AND MADCAP INDICES OF BSE AND NSE. BUT, THE RISK ADJUSTMENT SHOULD ALWAYS BE BASED ON THE COMPARABLE S SELECTED BY THE TAXPAYER OR THE TPO AND NOT ON THE OTHER COMPANIES, WHICH ARE NOT E XAMINED AND OTHERWISE, NOT COMPARABLE FUNCTIONALLY. THUS, THE BETA OF UNLISTE D COMPANIES OR COMPANIES WHERE DATA WAS NOT AVAILABLE SHOULD BE THE AVERAGE OF THE BETA OF THE REMAINING COMPARABLE COMPANIES. 6. THE TAXPAYER IGNORED NEGATIVE RISK ADJUSTMENT IN SO ME OF THE COMPARABLE COMPANIES. THIS LOOKS ABSURD AS ANY RISK UNDERTAKIN G ENTERPRISE MAY GET A NEGATIVE RETURN FOR THE RISK UNDERTAKEN AND IS POSSIBLE DUE TO THE ACTUAL REALIZATION OF RISK BRINGING DOWN THE PROFITABILITY BELOW THE RISK FREE RATE OF RETURN. THUS, ITS PROFITABILITY WOULD HAVE BEEN MORE BUT FOR THE RISK UNDERTAKEN. THUS, NEGATIVE RISK ADJUSTMENT HAS TO BE CONSIDERED AND CANNOT BE IGNORED. FOR EXAMPL E, WHEN THE INDIAN STOCK MARKETS TUMBLED IN 2007 AND 2008, THE EQUITY INVESTMENTS GI VEN A NEGATIVE RETURN EVEN THOUGH THE RISK FREE RETURN IS DECENT. SO, IT IS TO IGNOR E NEGATIVE RISK ADJUSTMENT. 7. THE RISK ADJUSTMENT HAS TO BE COMPUTED BASED ON THE RISK DIFFERENTIAL IF ANY, BETWEEN THE TAXPAYER AND THE COMPARABLE COMPANIES. HOWEVER, THE TAXPAYER IGNORED WEIGHTED COST OF CAPITAL IN THE CASE OF TAXPAYER AN D RISK OF THE TAXPAYER IN TERMS OF BETA. EFFECTIVELY, THE RISK FREE RETURN WOULD BE NULLIFIE D AS THERE IS NO DIFFERENCE BETWEEN THE TAXPAYER AND THE COMPARABLE COMPANIES AND ALSO THE TAX PAYER ASSUMED THAT ITS BETA IS ZERO, WHEREAS WHEN THE RETURN IS GUARANTEED ON SALE S OR COST, THE BETA IS NOT ZERO AS THE RETURN ON CAPITAL FLUCTUATES WITH REVENUE. 8. THE TAXPAYER DID NOT CONSIDER THE DIFFERENTIAL RISK ADJUSTMENT I.E. IT DID NOT CONSIDERED THE WEIGHTED COST OF CAPITAL OF COMPARAB LES TO BRING IT IN LINE WITH THE TAXPAYER. 9. THE BETA OF A CAPTIVE SOFTWARE SERVICE PROVIDER IS NOT ZERO AS THE RETURN ON CAPITAL FLUCTUATES WITH REVENUES AS THE TAXPAYER IS FOLLOWI NG COST PLUS METHOD ON EXPENSES. 10. AS DISCUSSED ABOVE, THE TAXPAYER BEARS SIGNIFICANT SINGLE CUSTOMER RISK AND ITA NO. 5637/D/2011 170 POLITICAL/COUNTRY RISK, WHICH MAY NOT BE COMPENSATE D ADEQUATELY BY PASSING ON OTHER RISKS LIKE MARKETING RISKS ETC. TO THE PARENT. FUR THER THESE RISKS ARE NOT CONSIDERED IN THE CASE OF TAXPAYER WHILE COMPUTING THE RISK ADJUS TMENT. 11. THE TAXPAYER CONSIDERED TOTAL ASSETS INCLUDING CURR ENT ASSETS AND CURRENT LIABILITIES, BUT THE CAPM HINGES UPON RETURN ON EQU ITY OR CAPITAL EMPLOYED. THE OPERATING ASSETS ARE THE MAJOR INDICTOR OF CAPITAL EMPLOYED RATHER THAN TOTAL ASSETS. OPERATING ASSETS INCLUDES FIXED ASSETS, TRADE RECEI VABLES NET OF TRADE PAYABLES. 12. THE TAX PAYER HAS ASSUMED THAT OPERATING EXPENSES O F THE COMPARABLES WOULD NOT CHANGE AFTER RISK ADJUSTMENT. BUT, AFTER GIVING EF FECT TO RISK ADJUSTMENT, THE FINANCIAL STATEMENTS OF THE COMPARABLES SHOULD LOOK LIKE THAT OF THE TAX PAYER I.E., STRIPPING THE RISK COMPONENT. SO, THE EXPENSES PERTAINING TO THE RISK LIKE SALES AND MARKETING EXPENSES, BAD DEBTS ETC. SHOULD BE REMOVED FROM OPE RATING EXPENSES AND CORRESPONDING RISK PREMIUM ADJUSTED AMOUNT HAS TO BE REDUCED FROM THE OPERATING REVENUES. HENCE, AS PER THE ABOVE DETAILED DISCUSSION, THE CO MPUTATION OF RISK ADJUSTMENT BY THE TAXPAYER IS NOT ACCEPTABLE. THERE IS NO SCIENTIFIC BASIS FOR WORKING OUT THE TAXPAYER COMPANYS BETA OR BETA OF THE UNLISTED COMPARABLE C OMPANIES. THE TAXPAYER ALTOGETHER FORGOTTEN THAT THE RISK ADJUSTMENT, IF A T ALL TO BE COMPUTED, IS TO BE COMPUTED BASED ON THE DIFFERENCE BETWEEN THE ACTUAL WEIGHTED COST OF CAPITAL OF THE COMPARABLES AND WEIGHTED COST OF CAPITAL OF THE COM PARABLE COMPANIES ASSUMING SAME LEVEL OF EQUITY IN THE TOTAL FINANCES AND RISK LEVEL AS EVIDENCED BY BETA OF THE TAXPAYER. THIS DIFFERENTIAL IS ALTOGETHER IS IGNOR ED MAKING THE ENTIRE EXERCISE REDUNDANT. 117. LD. COUNSEL SUBMITTED THAT ASSESSEE IS RISK MI TIGATED/INSULATED/ LOW RISK COMPANY AND, THEREFORE, IN VIEW OF THE PROVISI ONS CONTAINED UNDER RULE 10B(1)(E) READ WITH RULE 10B(2) AND 10B(3)(II), ADJ USTMENT WAS REQUIRED TO BE MADE TO THE PROFIT MARGINS OF THE COMPARABLES BUT T HE SAME WAS DENIED BY TPO. LD. COUNSEL SUBMITTED THAT ASSESSEE HAD ASSUR ED ORDERS AND, THEREFORE, ITA NO. 5637/D/2011 171 A TRADE OFF BETWEEN RISK AND RETURN HAD TO BE DRAWN . HE POINTED OUT THAT ASSESSEE IS A CAPTIVE SERVICE PROVIDER AND, THEREFO RE, HAS NONE OF THE FOLLOWING RISKS: MARKET RISK, CREDIT RISK, TECHNOLOGY RISK, CAPACIT Y UTILIZATION RISK, PRICE RISK, SERVICE LIABILITY RISK. HE POINTED OUT THAT AS A C APTIVE SERVICE PROVIDER, ASSESSEE IS INSULATED FROM VARIOUS RISKS THAT ARE BORNE BY I NDEPENDENT COMPARABLE COMPANIES OPERATING AS FULL-FLEDGED ENTREPRENEUR CO MPANIES. THE ASSESSEE ALSO RELIED ON THE US TAX CODE RULING IN THE CASE O F WESTRECO VS. COMMISSIONER, 64 TCM 849 (1992), WHEREIN IT WAS HELD THAT A CAPTI VE SERVICE PROVIDER ENTITY OPERATING ON AN ASSURED COST PLUS METHOD DOES NOT B EAR MARKET AND OTHER ALLIED RISK BORNE BY INDEPENDENT SERVICE PROVIDER. 117.1 LD. COUNSEL SUBMITTED THAT IN REPLY TO TPOS SHOW CAUSE NOTICE, THE ASSESSEE FURNISHED COMPUTATION OF RISK ADJUSTMENT O N ACCOUNT OF MARKET RISK DIFFERENCE FOLLOWING WIDELY ACCEPTED METHOD OF CAP ITAL ASSET PRICING MODEL (CAPM) ON THE BASIS OF WHICH THE AMOUNT OF ADJUSTM ENT WORKED OUT TO 6.9% THUS, THE MEAN MARGIN COMPUTED BY THE TPO AS THE A LP BASED ON HIS COMPARABLES WHICH WAS 26.71% HAD TO BE REDUCED TO 1 9.8% USING THE CAPM FORMULA. 117.2 LD. COUNSEL SUBMITTED THAT AS FAR AS SINGLE C USTOMER RISK, AS PLEADED BY LD. CIT(DR) WAS CONCERNED, THE SAME WAS AN ANTIC IPATED RISK WHICH IS CONTRARY TO COMMERCIAL WISDOM. HE POINTED OUT THAT EXISTING RISK NEEDS TO BE ACCEPTED NOT ANTICIPATED RISK. LD. COUNSEL FURTHER SUBMITTED THAT THE FACT THAT CAPTIVE SOFTWARE SERVICE PROVIDER DOES NOT BEAR MAR KET AND MANY OTHER RISKS AS ITA NO. 5637/D/2011 172 A PRINCIPLE IS WELL RECOGNIZED AND IN FOLLOWING CAS ES TRIBUNAL HAS HELD THAT THERE IS DIFFERENCE IN RISK PROFILE OF A CAPTIVE SERVICE PROVIDER AND FULL-FLEDGED ENTREPRENEUR SOFTWARE DEVELOPMENT COMPANIES THAT AR E SELECTED AS COMPARABLES: S.NO. CASE LAW RELEVANT ISSUE PARA NO. (ITAT ORDER) 1. HELLOSOFT INDIA P. LTD. ITA NO. 645/HYD/0 9 THE ASSESSEE IS A CAPTIVE SERVICE PROVIDER. IT HAS TRANSACTION ONLY WITH AES. IT IS ALSO A FACT THAT ALL THE RISK LIES WITH THE AES. THEREFORE, IT IS ALLOWED A BENEFIT OF RISK ADJUSTMENT AT 1%. PARAGRAPH 17 PAGE 17 2. M/S CORDYS R&D (INDIA) PVT. LTD., HYDERABAD (ITA NO. 212/HYD/0 6) RISK FACTOR ACTUALLY INVOLVED BETWEEN THE ASSESSEE AND THE ASSOCIATED ENTERPRISES HAS TO BE TAKEN INTO ACCOUNT. PARAGRAPH 5 PAGE 4 3. SONY INDIA P. LTD. VS. DCIT (114 ITD 448) ITAT HAS ACKNOWLEDGED THE NEED FOR COMPARABILITY ADJUSTMENTS ON ACCOUNT OF RESEARCH AND DEVELOPMENT, RISK AND WORKING CAPITAL AND HAS ALLOWED AN ADHOC ADJUSTMENT OF 20%. PARAGRAPH 132 4. MENTOR GRAPHICS (NOIDA) P. LTD. ITA NO. 196/D/200 6 .FINAL SET OF COMPARABLES MAY NEED TO ELIMINATE DIFFERENCES BY MAKING ADJUSTMENTS FOR THE FOLLOWING: A) WORKING CAPITAL B) ADJUSTMENT FOR RISK AND PARAGRAPH 27 & PAGE 14 ITA NO. 5637/D/2011 173 GROWTH C) ADJUSTMENT OF R&D EXPENSES 5. EGAIN COMMUNIC ATION P. LTD. ITA NO. 1685/PN/2 007 HELD THAT THE BENEFIT OF ADJUSTMENT WAS REQUIRED TO BE GIVEN IN WORKING THE MARGIN OF PROFIT OF THE TAXPAYER FOR NOT UNDERTAKING ANY RISK IN THE TRANSACTIONS INVOLVED WITH ITS PARENT COMPANY. PARAGRAPH 40 6. PHILIPS SOFTWARE CENTRE P. LTD. ITA NO. 218 (BNG)/08 THE HONBLE ITAT HAS APPROVED ADJUSTMENT ON ACCOUNT OF RISK. PARAGRAPH 5.71 (IX) & PAGE 170 117.3 HE FURTHER POINTED OUT THAT IN SONY INDIA PVT . LTD. 114 ITD 448, TRIBUNAL HAS APPROVED AN AD-HOC ADJUSTMENT FOR DIFF ERENCE IN RISK ON ACCOUNT OF R&D AND WORKING CAPITAL. FURTHER, IN PHILIPS SOFTW ARE CENTRE (SUPRA), TRIBUNAL APPROVED COMPUTATION OF ADJUSTMENT ON ACCOUNT OF DI FFERENCE IN RISK BY LOOKING AT THE DIFFERENCE BETWEEN THE BANK RATE (RATE AT WH ICH RBI LENDS TO THE BANK) AND THE PRIME LENDING RATE (PLR) WHICH IS THE RATE AT WHICH BANKS LEND TO CUSTOMERS. HE SUBMITTED THAT MATTER MAY GO BACK TO LD. TPO BEFORE WHOM ASSESSEE WILL FILE COMPUTATION AS PER CAPM MODEL DU LY SUPPORTED BY EXPERT OPINION AND TPO COULD REBUT THE SAME WITH AN EXPERT OPINION. 118. LD. CIT(DR) SUBMITTED AS UNDER:- GROUND 4.7 AND 4.10 INCLUDING CERTAIN COMPANIES THAT HAD EXTRAORDINARIL Y HIGH PROFIT MARGINS AND HENCE WERE NOT COMPARABLE TO A LOW RISK CAPTIVE UNI T SUCH AS THE APPELLANT: ITA NO. 5637/D/2011 174 IGNORING THE BUSINESS/COMMERCIAL REALITY SINCE THE ASSESSEE IS REMUNERATED ON AN ARMS LENGTH BASIS, I.E. IT IS COMPENSATED FOR A LL ITS OPERATING COSTS PLUS A PRE-AGREED MARK-UP BASED ON A BENCHMARKING ANALYSIS , THE ASSESSEE UNDERTAKES MINIMAL BUSINESS RISKS AS AGAINST COMAPA RABLE COMPANIES THAT ARE FULL FLEDGED RISK TAKING ENTREPRENEURS, AND BY NOT ALLOWING A RISK ADJUSTMENT TO THE ASSESSEE ON ACCOUNT OF THIS FACT; AND COUNTER : IT HAS BEEN ESTABLISHED THAT A CAPTIVE SERVICE PROV IDER HAS ALL THE NORMAL RISKS AND EVEN MORE, BECAUSE ITS ENTIRE EXISTENCE IS BASE D ON ITS PARENT GROUP. THE FOLLOWING CASE LAWS ARE BEING RELIED UPON: I. M/S DELOIETTE CONSULTING (I) P. LTD. ITA NO. 108 2/HYD/2010, PARA 15, 21 AND 40. II. M/S INTERRA INFORMATION TECHNOLOGIES (I) P. LTD . ITA NO. 5568/DEL/2010, PARA 76 AND 79. III. M/S SYMANTEC, MUMBAI ITA NO. 7894/MUM./2010, P ARA 16. IV. M/S ST MICROELECTRONICS (P) LTD. 15 ITR TRIB. 4 10 DEL, PARA 40. V. M/S WILLS PROCESSING SERVICE (I) P. LTD. ITA NO. 8772/MUM./2010, PARA 25, ORDER DT. 7.12.2012. VI. M/S GE INDIA TECHNOLOGY CENTRE P. LTD. ITA NO. 789/BANG/2010, PARA 36. 118. LD.CIT(DR) SUBMITTED THAT AS FAR AS THE DECISI ON IN THE CASE OF PHILIPS SOFTWARE IS CONCERNED, THE SAME HAS BEEN STAYED BY THE HONBLE KARNATAKA HIGH COURT. HE RELIED ON THE ORDER OF TRANSFER PRI CING OFFICER AND SUBMITTED ITA NO. 5637/D/2011 175 THAT CAPTIVE SERVICE PROVIDER UNDERTAKE HIGH RISK AS AGAINST INDEPENDENT SERVICE PROVIDER. THE ASSESSEES AE CAN SHUT THE B USINESS ANY DAY AND SO THE ASSESSEE WILL HAVE NO WORK. THUS, THERE IS A HIGH R ISK IN CASE OF A SERVICE PROVIDER CATERING TO A SINGLE CUSTOMER. HENCE THER E IS NO ASSURANCE OF WORK. HE SUBMITTED THAT ASSESSEE CLAIMED AN ADJUSTMENT ON ACCOUNT OF RISK BUT NOT CONSIDERED THE RISK OF CATERING TO A SINGLE CUSTOME R. HE SUBMITTED THAT THE INDEPENDENT SERVICE PROVIDERS CATER TO DIFFERENT CL IENTS AND, THUS, UNDERTAKE RISK OF REALIZATION OF DUES FROM THEM. FOR THIS RISK TH EY ACCOUNT FOR IN THE BOOKS OF ACCOUNT BY WAY OF WRITING OFF THE BAD DEBTS. THUS, IMPACTED THE P&L STATEMENT BY REDUCING THE PROFITS TO THAT EXTENT. HE SUBMITTE D THAT TNMM REQUIRES A BROAD COMPARABILITY AND, THUS, THE RISK GETS MITIGATED WH EN THE MARGINS WERE COMPUTED. HE SUBMITTED THAT COST PLUS 7% IS A VERY LOW MARGIN TO EARN. HE POINTED OUT THAT FIRSTLY, THERE MUST BE CLAIM FOR A NY ADJUSTMENT BACKED BY FIGURES AND, SECONDLY, IT SHOULD ALSO BE DEMONSTRAT ED THAT HOW WILL THE SAME AFFECT THE MARGINS OF THE ASSESSEE. THE QUANTIFICA TION OF RISK ADJUSTMENT SHOULD BE SUCH AS TO BE EASILY UNDERSTANDABLE AND NOT BY R ESORTING TO COMPLICATED METHODS. LD. CIT(DR) RELIED ON THE DECISION OF ITAT , DELHI BENCHES IN THE CASE OF M/S PREMIER EXPLORATION SERVICES PVT. LTD. V ITO 2013-TII-134-ITAT-DEL-TP FOR THE PROPOSITION THAT RISK ADJUSTMENT CAN BE CON SIDERED WHEN IT IS DEMONSTRATED THAT COMPARABLES HAD ACTUALLY UNDERTAK EN SUCH RISKS AND THESE MATERIALLY AFFECTED THEIR MARGIN. ITA NO. 5637/D/2011 176 118.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH TH E PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. WE HAVE PERUSED TH E RECORD OF THE CASE. WE HAVE ALSO GONE THROUGH THE DETAILED WRITTEN SUBMISS IONS FILED BY ASSESSEE FROM PAGES 92 TO 104 OF THE WRITTEN SUBMISSIONS THE MAI N CONTENTION OF ASSESSEE IS IN REGARD TO ADJUSTMENT ON ACCOUNT OF MARKET RISK B Y APPLYING CAPM MODEL. IN THIS REGARD LD. TPO HAS OBSERVED THAT THE SERVICES RENDERED BY THE ASSESSEE FORMS A COMPONENT WITHIN THE PRODUCTS DEVELOPED BY THE ASSESSEE. THUS, THE ASSOCIATED ENTERPRISE INCURS MARKETING FOR ITS PROD UCTS AND NOT ON THE SERVICES RENDERED BY THE ASSESSEE AS THEY ARE CONSIDERED IN THE PRODUCT SOLD BY THE ASSOCIATED ENTERPRISE. THE RELATIONSHIP BETWEEN TH E TAX PAYER AND ITS PARENT COMPANY IS EXACTLY THE SAME AS THAT OF THE INDEPEND ENT COMPANY AND ITS CLIENT IN THE CASE OF SOFTWARE DESIGN AND DEVELOPMENT SERV ICES. LD. TPO HAS OBSERVED THAT IT IS A FACT THAT THE INDEPENDENT ENT ERPRISES HAVE TO BEAR THE VAGARIES OF MARKET CONDITIONS. BUT SINCE THE SOFTW ARE SECTOR IS GROWING AT MORE THAN 30% CAGR (COMPOUNDED ANNUAL GROWTH RATE) FOR T HE LAST 10 YEARS, IT IS NOT SHOWING OR AFFECTED BY ANY ADVERSE MARKET CONDI TIONS. IN THE ABSENCE OF ADVERSE MARKET CONDITIONS, THE ASSESSEE HAS NOT SHO WN HOW THESE MARKET RISKS BORNE BY THE INDEPENDENT ENTERPRISES HAD AN EFFECT ON THE PRICE AND, THUS, ON ITA NO. 5637/D/2011 177 THE PROFITS DURING THE F.Y. 2005-06. FROM THESE FIN DINGS OF LD. TPO, IT IS EVIDENT THAT HE HIMSELF IS AGREEABLE THAT MARKET CONDITIONS DO INFLUENCE THE INDEPENDENT ENTERPRISES. LD. TPO HAS DENIED THIS A DJUSTMENT MAINLY ON THE GROUND THAT ASSOCIATED ENTERPRISE AND OTHER INDEPEN DENT COMPARABLES ARE OPERATING ON A SIMILAR MODEL I.E. ONE BY ESTABLISHI NG ITS SUBSIDIARY IN LOW EMPLOYEE COST ZONE VIZ. INDIA AND THE OTHERS BY OUT SOURCING THEIR ACTIVITIES TO OTHER ENTITIES OPERATING IN INDIA. LD. TPO HAS DRA WN PARITY BETWEEN INDEPENDENT COMPARABLES AND THE ASSESSEE ON THIS BA SIS. IN OUR OPINION, THIS REASONING CANNOT BE FULLY ACCEPTED PARTICULARLY BEC AUSE IT IS NOT THAT ALL THE INDEPENDENT COMPARABLES ARE DOING ONLY THE WORK OUT SOURCED TO THEM BY VARIOUS AES. THIS IS ONLY A CONJECTURE ON THE PART OF LD. TPO. WE, THEREFORE, ARE OF THE OPINION THAT MARKET RISK, IF QUANTIFIABL E, HAS TO BE ADJUSTED IN VIEW OF RULE 10B(1)(E)(III). 119. LD. CIT(DR) HAS SUBMITTED THAT RISK OF INDEPEN DENT COMPARABLES GETS ACCOUNTED IN ITS FINANCIAL STATEMENTS. THERE IS NO DENYING OF THIS FACT AND AS RIGHTLY POINTED OUT IN THE WRITTEN SUBMISSIONS BY T HE ASSESSEE, THIS IS THE REASON WHY THE ASSESSEE HAS TAKEN FINANCIAL STATEMENTS AS THE BASE FOR COMPUTATION OF RISK ADJUSTMENTS. WE AGREE WITH THE SUBMISSIONS OF LD. COUNSEL FOR THE ASSESSEE THAT KEY RISKS SUCH AS BAD DEBT RISK, MARK ET RISK, CONTRACTUAL RISK WOULD FACTOR IN THE ADDITIONAL RETURN/PREMIUM OF IN DEPENDENT COMPANIES FOR TAKING SUCH RISK IN THE PRICE IT WOULD CHARGE FROM THE THIRD PARTY CUSTOMER. THIS ITA NO. 5637/D/2011 178 IS IN LINE WITH THE GENERALLY ACCEPTED ECONOMIC PRI NCIPLE THAT RETURN IS PROPORTIONAL TO RISK. RULE 10B(2)(B) REQUIRES THE RISKS OF AN UNCONTROLLED TRANSACTION TO BE COMPARABLE TO A CONTROLLED TRANSA CTION TO DETERMINE THE ALP OF SUCH A CONTROLLED TRANSACTION. RULE 10B(3) REQU IRES THE ADJUSTMENT TO BE MADE FOR MATERIAL DIFFERENCES IN RISK PROFILE. THE REFORE, RISK ADJUSTMENT HAS STATUTORY RECOGNITION. LD. TPO CARRIED OUT ALTERNAT IVE ANALYSIS AFTER RISK ADJUSTMENT ON THE BASIS OF CAPM MODEL AND WORKED OU T THE RISK ADJUSTMENT AT .73% FROM THE MEAN PLI OF 25% (BEFORE WORKING CAPIT AL ADJUSTMENT) AS AGAINST 5.32% COMPUTED BY ASSESSEE IN RESPECT OF 22 COMPARA BLES CONSIDERED BY IT AND 8.99% IN RESPECT OF COMPARABLES PROPOSED BY TPO . LD. TPO OBSERVED THAT .73% DIFFERENCE CAUSED BY RISK TO NEAR PLI WAS NOT MUCH SO AS TO REQUIRE ANY ADJUSTMENT. LD. TPO SUMMARIZED THE RISK ANALYS IS AS UNDER: 15.1.3 SUMMARY OF ANALYSIS OF RISK THE DISCUSSION ON THE RISK ANALYSIS IS SUMMARIZED A S UNDER: THE TAXPAYER IS TOTALLY DEPENDENT ON THE AE FOR BUS INESS. THUS, THE TAXPAYER TAKES THE RISKS ASSOCIATED WITH HEAVY DEPE NDENCE ON A SINGLE CUSTOMER. IN COMMON BUSINESS PARLANCE IT IS KNOWN AS SINGLE CUSTOMER RISK. THE COST PLUS AGREEMENT WITH THE AE DOES NOT GUARAN TEE SUFFICIENT VOLUME OF BUSINESS NOR PERIOD AS THE AGREEMENT IS F OR A PERIOD OF ONE YEAR AND RENEWED ONE YEAR AT A TIME UNLESS TERM INATED OTHERWISE. THE AGREEMENT CAN BE TERMINATED BY ANY PARTY AT ANY TIME AFTER GIVING A STIPULATED PERIOD NOTICE. THUS , THE TAXPAYER IS NOT FREE FROM THE RISK OF LOSING BUSINESS ENTIRELY OR LOSING VOLUME OF BUSINESS. ITA NO. 5637/D/2011 179 THE TAXPAYER IS NOT COMPENSATED ANY AMOUNT FOR TERM INATION OF AGREEMENT EVEN IF IT IS TERMINATED WITHOUT ANY CAUS E. NO INDEPENDENT ENTERPRISE WOULD LIKE TO AGREE FOR A TE RMINATION CLAUSE WITHOUT COMPENSATION IF IT IS TERMINATED WITHOUT AN Y CAUSE. THE AE IS EXPOSED TO THE MARKET RISK AND ANY FLUCTU ATION IN THE BUSINESS CONDITIONS OF THE AE AFFECT THE CONTRACTUA L TERMS BETWEEN THE AE AND THE TAXPAYER. THUS EVEN IF INDEPENDENT COMPARABLES UNDERTAKE SOME RISK, THE TAXPAYER ALSO HAD TO UNDER TAKE RISKS LIKE SINGLE CUSTOMER RISK, POLITICAL RISK, ETC. WHICH AR E NOT INCURRED BY THE COMPARABLE COMPANIES AND HENCE THE RISKS ARE EV ENED OUT. THERE ARE MANY CAPTIVE SERVICE PROVIDERS OPERATING IN THE SAME ENVIRONMENT AS THE TAXPAYER AND STILL EARNING MUCH BETTER MARGINS THAN INDEPENDENT RISK BEARINGS ENTERPRISES AND VICE VERSA. THUS, THERE IS NO DIRECT CORRELATION BETWEEN THE MARGINS EARNED AND RISKS TAKEN. 120. LD. COUNSEL SUBMITTED THAT IN VIEW OF THE CONF LICTING STAND OF ASSESSEE AND LD. TPO, IT WOULD BE IN THE INTEREST O F JUSTICE THAT KEEPING IN VIEW THE COMPLEXITY OF COMPUTATION OF RISK FACTOR AS PER CAPM MODEL, THE MATTER IS RESTORED TO THE FILE OF LD. TPO FOR COMPUTING THE V ALUE OF RISK FACTOR AS PER CAPM MODEL. WE AGREE WITH THIS PLEA KEEPING IN VIE W THE FACT THAT THERE IS SUBSTANTIAL DIFFERENCE IN COMPUTATION OF RISK FACTO R EMBEDDED IN THE PROFITABILITY OF COMPARABLES BETWEEN ASSESSEE AND LD. TPO. 121. WE, THEREFORE, IN THE INTEREST OF JUSTICE, RES TORE THIS MATTER TO THE FILE OF ASSESSING OFFICER/TPO TO CONSIDER THE COMPUTATIO N OF RISK ADJUSTMENT AS PER CAPM MODEL BY AVAILING THE SERVICES OF TECHNICAL EX PERTS. THE EXPERTS OF THE FIELD ARE TO BE APPOINTED BY BOTH THE SIDES TO COME TO AN ACCEPTABLE CONCLUSION. ITA NO. 5637/D/2011 180 122. IN THE RESULT, THIS GROUND IS ALLOWED FOR STAT ISTICAL PURPOSES IN TERMS OF AFOREMENTIONED OBSERVATIONS. 123. GROUND NO. 4.11 WAS NOT PRESSED BY ASSESSEE AS IT IS GENERAL IN NATURE. THE ASSESSEE HAS TAKEN AN ADDITIONAL GROUN D THAT LD. TPO/ASSESSING OFFICER ERRED IN NOT FOLLOWING THE BINDING DIRECTIO N OF THE LD. DRP TO EXCLUDE MEGA SOFT LTD. FROM THE LIST OF COMPARABLES CHOSEN FOR SOFTWARE SEGMENT. 123.1 WE HAVE CONSIDERED THE SUBMISSION OF BOTH THE PARTIES. WE FIND THAT LD. DRP AT PAGE 12 OF HIS ORDER IN REGARD TO GROUND NO. 4.11 HAS OBSERVED AS UNDER: INCLUSION OF COMPARABLES BY TPO IN CDS SECTOR HAS BEEN CONSIDERED BY DRP. WE FIND MEGASOFT SHOULD BE EXCLUDED AS IT HAS DIFFEREN T FINANCIAL YEAR END AND WENT UNDER RESTRUCTURING HENCE HAS EXTRAORDINARY BUSINESS CIRC UMSTANCES. PERSISTENT SYSTEMS LTD. ALSO UNDERWENT RESTRUCTURING. SO BOTH ARE TO BE EX CLUDED AS COMPARABLES. IN CASE OF R SYSTEMS ASSESSEE HAS POINTED OUT THAT THE CORRECT M ARGIN IS 10.09% INSTEAD OF 15.07%. TPO TO VERIFY AND ADOPT CORRECT MARGIN . 124. LD. COUNSEL HAS ALSO POINTED OUT THAT AN APPLI CATION UNDER SECTION 154 WAS FILED BY LD. TPO BEFORE LD. DRP WHICH HAS B EEN REJECTED. ACCORDINGLY, LD. TPO IS DIRECTED TO CARRY OUT THE DIRECTIONS OF LD. DRP. 125. IN THE RESULT, THIS GROUND IS ALLOWED FOR STAT ISTICAL PURPOSES. 126. NOW, WE WILL TAKE UP GROUNDS RELATING TO ADMIN ISTRATIVE AND MARKETING SUPPORT SERVICES SEGMENT OF THE ASSESSEE. 127. THE BRIEF DESCRIPTION ON FUNCTIONS OF THE COMP ANY IN THIS SEGMENT AS UNDER: THE CORPORATE SEGMENT (CS) IS THE ADMINISTRATIV E ARM OF MIPL. IT COMPRISES VARIOUS TEAMS RENDERING SERVICES THAT ARE ESSENTIAL LY ADMINISTRATIVE IN NATURE. APART ITA NO. 5637/D/2011 181 FROM RENDERING THESE SERVICES TO OTHER SEGMENT/BUSI NESS UNITS OF MIPL THE VARIOUS TEAMS WITHIN CS ALSO PROVIDE/RECEIVE ADMINISTRATIVE SERVICES TO/FROM VARIOUS OVERSEAS MOTOROLA GROUP COMPANIES. THE ADMINISTRATIVE SUPPORT SERVICES RENDERED WITH C SC, GLOBAL VENDOR OF MOTOROLA GROUP COMPANIES DURING THE FY 2006-07 ARE BRIEFLY D ESCRIBED BELOW: COORDINATION/LIASIONING WITH CSC, GLOBAL VENDOR OF MOTOROLA GROUP FOR IT SUPPORT SERVICES AND IT SYSTEMS. THE CORPORATE SEG MENT IS REQUIRED TO SUPERVISE THE PERSONNEL PROVIDED BY CSC FOR IT SYSTEM MAINTENANCE . CS IS ALSO INVOLVED IN IDENTIFICATION OF POTENTIAL DOMESTIC VENDORS WHICH CAN PROVIDE IT SUPPORT SERVICES TO MOTOROLA GROUP. THI S ROLE IS LIMITED TO IDENTIFYING THE VENDOR AND EVALUATING WHETHER THE VENDORS CAN MEET THE BRO AD REQUIREMENT OF THE MOTOROLA GROUP. THE DECISION WITH REGARD TO HIRING THE VENDO R, PRICE NEGOTIATION ETC., IS DONE SOLELY BY THE PARENT COMPANY WITH THE POTENTIAL VENDOR. CS ALSO PROVIDES LIMITED HR SUPPORT AND AUDIT SUPPORT SERVICES TO MOTOROLA GROUP COMPANIES. FURTHER, MIPL ALSO UNDERTAKES LIMITED SUPPORT SERVI CES TO THE GROUP COMPANIES UNDER. THE MDB SEGMENT. IN RESPECT OF THIS ACTIVITY, MIP L PRO VIDES THEM WITH INPUTS ON THE BUSINESS OPPORTUNITIES IN THE INDIAN MARKET. IT GATHERS KNOW LEDGE ABOUT THE INDIAN MARKET, REQUIREMENTS OF THE CUSTOMERS AND SUPPLIES SUCH INFORMATION TO T HE GROUP COMPANIES. FOR THIS ACTIVITY, MIPL IS REMUNERATED ON A COST PLUS BASIS BY THE GRO UP COMPANIES. [UNQUOTE] 128. LD. TPO NOTICED THAT ASSESSEE HAD PROVIDED ADM INISTRATIVE AND MARKET SUPPORT SERVICES AMOUNTING TO RS. 759645791/ - TO ITS GROUP COMPANIES. THE ASSESSEE HAD USED TNMM AS THE MOST APPROPRIATE METHOD AND OP/TC AS PLI. HE FURTHER NOTICED THAT ASSESSEE WAS SHOWING A PROFIT OF 6% IN THIS SEGMENT, WHICH, IN HIS OPINION, WAS VERY LOW. THE ASSESSING OFFICER AFTER CONSIDERING THE ASSESSEES REPLY IN RESPECT OF VARI OUS COMPARABLES, DETERMINED ITA NO. 5637/D/2011 182 THE PLI AT 16.91% AND, ACCORDINGLY, MADE AN ADJUSTM ENT OF RS. 77,844,993/- AS UNDER: TOTAL COST RS. 716,355,131/- ALP AT A MARGIN OF 16.91% RS. 837,490,784/- PRICE RECEIVED R S. 759,645,791/- ADJUSTMENT U/S 92CA RS. 77, 844,993/- 129. GROUND NO. 5.1 NOT PRESSED BY THE ASSESSEE. 130. APROPOS GROUND NO. 5.2, LD. COUNSEL FAIRLY CON CEDED THAT THIS GROUND STANDS DECIDED AGAINST THE ASSESSEE IN NUMEROUS CAS ES (MENTOR GRAPHICS) (NOIDA PVT. LTD.) 109 ITD 101 (DEL.), CUSTOMERS SER VICES INDIA PVT. LTD. VS. ACIT, 30 SOT 486. ACCORDINGLY, THIS GROUND IS DISM ISSED. 131. GROUND NO. 5.3.1, 5.3.3, 5.3.4 AND 5.3.5 WERE NOT PRESSED BY ASSESSEE AT THE TIME OF HEARING. 132. AS FAR AS GROUND NO. 5.3.2 IS CONCERNED, THIS ISSUE HAS BEEN DECIDED BY US WHILE CONSIDERING GROUND NO. 4.5.3 IN REGARD TO SOFTWARE DEVELOPMENT SERVICE SEGMENT. THEREFORE, THIS GROUND IS PARTLY ALLOWED IN TERMS OF OBSERVATIONS MADE THEREIN. 133. AS FAR AS GROUND NO. 5.3.6 RELATING TO REJECTI ON OF ASSESSEES FILTER OF EXCLUDING COMPANIES HAVING RESEARCH AND DEVELOPMENT COST TO SALES BEING MORE THAN 3% IS CONCERNED, THE SAID ISSUE HAS BEEN DECIDED WHILE CONSIDERING THE GROUND NO. 4.5.9 IN SOFTWARE DEVELOPMENT SERVIC E SEGMENT AND, THEREFORE, FOR THE REASONS STATED THEREIN THIS GROUND IS DISMI SSED. ITA NO. 5637/D/2011 18 3 134. AS FAR AS GROUND NO. 5.3.7 IS CONCERNED THE SA ME RELATES TO ADVERTISEMENT MARKETING AND DISTRIBUTION COST MORE THAN 3% FILTER WHICH WAS APPLIED BY THE ASSESSEE. THIS GROUND HAS BEEN CONSI DERED WHILE DECIDING GROUND NO. 4.5.10 OF SOFTWARE DEVELOPMENT SEGMENT A ND, THEREFORE, FOR THE REASONS STATED THEREIN THIS GROUND IS DISMISSED. 135. AS FAR AS GROUND NO. 5.4 IS CONCERNED, THE SAM E RELATES TO CHALLENGE BY ASSESSEE TO TPOS ACTION IN INCLUDING HIGH PROFI T MAKING COMPANIES IN THE FINAL SET OF COMPARABLES FOR BENCH MARKING LOW RISK CAPTIVE UNIT SUCH AS THE ASSESSEE. IN THIS REGARD WE MAY OBSERVE THAT MERE HIGH PROFIT MARGIN CANNOT BE A BASIS FOR EXCLUDING A PARTICULAR COMPARABLE UN LESS IT IS DEMONSTRATED THAT THE PROFIT MARGIN WAS INFLUENCED BY CERTAIN EXTRAOR DINARY FACTORS OR THE COMPARABLE WAS NOT MEETING THE FAR ANALYSIS. AS FA R AS THE ASSESSEES PLEA THAT THE PROFIT MARGINS OF THE COMPANY WERE INFLUEN CED ON ACCOUNT OF ITS BEING CAPTIVE UNIT, WE HAVE RESTORED THE ISSUE FOR RISK A DJUSTMENT IN THE SOFTWARE DEVELOPMENT SEGMENT TO THE FILE OF TPO AFTER DETAIL ED DISCUSSION. THEREFORE, IF ON ACCOUNT OF RISK ADJUSTMENT THE PROFITABILITY OF A COMPARABLE IS TO BE ADJUSTED THEN THE SAME IS TO BE ADJUSTED FOR THIS SEGMENT AL SO. 135.1 IN VIEW OF THE ABOVE OBSERVATION, THIS GROUND IS ALLOWED FOR STATISTICAL PURPOSES. 136. VIDE GROUND NO. 5.5 THE ASSESSEE HAS ASSAILED THE TPOS ACTION IN INCLUDING CERTAIN COMPANIES THAT ARE NOT COMPARABLE TO THE ASSESSEE IN TERMS OF FUNCTIONS PERFORMED, ASSETS EMPLOYED AND RISKS A SSUMED. ITA NO. 5637/D/2011 184 137. VIDE GROUND NO. 5.6 THE ASSESSEE HAS ASSAILED THE TPOS ACTION IN RESORTING TO REJECTION OF LOW PROFIT/LOSS MAKING CO MPANIES AND VIDE GROUND NO. 5.7 IN INCLUDING CERTAIN COMPANIES WHICH ALLEGEDLY ARE NOT COMPARABLE TO THE ASSESSEE IN TERMS OF FUNCTIONS PERFORMED, ASSETS EM PLOYED AND RISKS ASSUMED. 138. LD. COUNSEL REFERRED TO PAGE 26 OF HIS SYNOPSI S AND POINTED OUT THAT ASSESSEE COORDINATES AND MONITORS GLOBAL SUPPORT PR OVIDED BY INDIAN VENDORS FOR IT SERVICES AND IT SYSTEMS, IDENTIFIES POTENTIA L DOMESTIC VENDORS THAT CAN PROVIDE IT SUPPORT TO THE GROUP. THE ASSESSEE PROV IDES LIMITED INPUT ON BUSINESS OPPORTUNITIES IN THE INDIAN MARKET. 138.1 LD. COUNSEL POINTED OUT THAT ASSESSEE HAD IDE NTIFIED SEVEN COMPARABLE COMPANIES ON THE BASIS OF VARIOUS FILTER S APPLIED BY IT, THE MEAN OF OP/TC MARGIN OF WHICH CAME TO 4% AS AGAINST THE MAR GIN OF 5% DECLARED BY THE ASSESSEE. HOWEVER, LD. TPO IDENTIFIED 16 COMPA RABLE COMPANIES WITH THE MEAN MARGIN AT 16.91%. THEREAFTER, LD. TPO EXCLUDE D VAPI WASTE & MANAGEMENT AFFLUENT COMPANY AND DETERMINED THE REVI SED ARMS LENGTH MARGIN BASED ON 15 COMPARABLES AT 17.20%. LD. COUN SEL REFERRED TO PAGE 29 OF SYNOPSIS AND POINTED OUT THAT THE FILTERS SELECT ED BY ASSESSEE WERE APPROPRIATE FILTERS. HOWEVER, LD. TPO APPLIED FOLLO WING FILTERS: 1) COMPANIES WITH DIMINISHING REVENUE AND CONSISTEN T LOSSES WERE ELIMINATED; 2) COMPANIES WHICH HAD MORE THAN 25% RELATED PARTY TRANSACTIONS (INCOME AS WELL AS EXPENDITURE COMBINED) OF THE OPERATING REVE NUES WERE EXCLUDED; ITA NO. 5637/D/2011 185 3) COMPANIES WITH RESEARCH AND DEVELOPMENT EXPENDIT URE IN EXCESS OF 3% OF SALES WERE INCLUDED. 138.2 LD. COUNSEL SUBMITTED THAT COMPARABLES SELECT ED BY APPLYING THESE FILTERS COULD NOT BE CONSIDERED. HE HAS ASSAILED V ARIOUS COMPARABLES SELECTED BY TPO ON DIFFERENT GROUNDS WHICH WE WILL CONSIDER NOW. WE HAVE ALREADY DISCUSSED THE SCOPE OF APPLICABILITY OF ABOVE THREE FILTERS WHILE CONSIDERING THE SOFTWARE DEVELOPMENT SEGMENT. WE, THEREFORE, PROCE ED TO CONSIDER EACH COMPARABLE SEPARATELY: 1) GENINS INDIA TPA LTD. : 138.3 LD. COUNSEL SUBMITTED THAT THIS COMPANY IS A THIRD PARTY ADMINISTRATOR IN HEALTH INSURANCE AND, THEREFORE, CANNOT BE CONSI DERED TO BE IN THE PROVISION OF MARKET SUPPORT SERVICES. 139. LD. TPO HAS NOT ESTABLISHED THE FUNCTIONAL SIM ILARITY. 139.1 HAVING HEARD BOTH THE PARTIES, WE FIND THAT L D. TPO HAS POINTED OUT FROM THE DETAILS PROVIDED BY THE ASSESSEE THAT THIS COMPANY HANDLES CUSTOMER RELATED QUERIES, POCESSES OF CLAIMS, CASHLESS AUTHO RIZATION ETC. THEREFORE, WE AGREE WITH LD. COUNSEL FOR THE ASSESSEE THAT THIS C OMPANY WAS PROVIDING SPECIFIC SERVICES AND NOT MARKET RELATED INFORMATIO N. WE, THEREFORE DIRECT LD.TPO TO EXCLUDE THIS COMPANY FROM THE LIST OF COMPARABLE S. HIGH TEMP-TECH-MAT PVT. LTD. : 140. THE MAIN CHALLENGE TO THE INCLUSION OF THIS CO MPANY AS COMPARABLE IS ON THE GROUND THAT THE PROPORTION OF RAW MATERIAL E XPENSES TO TOTAL EXPENSES WAS 31.20% AND, THEREFORE, IT WAS NOT A PURE SERVIC E PROVIDER. ITA NO. 5637/D/2011 186 141. LD. TPO POINTED OUT THAT AS PER THE ASSESSEES REPLY, IT IS EVIDENT THAT THE BUSINESS OF THE COMPANY IS TO PROVIDE BUSINESS CONSULTING SERVICES. HE FURTHER POINTED OUT THAT THE EXPENSE DETAILS PROVID ED BY THE ASSESSEE ALSO SHOWED THAT THE COMPANY PROVIDED FEE BASED SERVICES . HE FURTHER REFERRED TO THE DETAILS ON PROWESS DATA BASE TO WHICH SHOWED TH AT THE COMPANY WAS INVOLVED IN PROVIDING HEAT TREATMENT SERVICES TO TH E RUBBER/TYRE INDUSTRY. FROM THE AFOREMENTIONED OBSERVATIONS OF LD. TPO, IT IS E VIDENT THAT THE ASSESSEES CONTENTION REGARDING PROPORTION OF RAW MATERIAL EXP ENSES TO TOTAL EXPENSES BEING 31.20% BEING QUITE SIGNIFICANT HAS NOT BEEN C ONTROVERTED BY LD. TPO AND, THEREFORE, THIS COMPANY COULD NOT BE CONSIDERED AS A PURE SERVICE PROVIDER LIKE THE ASSESSEE AND, THEREFORE, COULD NOT BE INCLUDED IN THE LIST OF COMPARABLES. 142. WE, ACCORDINGLY, DIRECT FOR EXCLUSION OF THIS COMPANY FROM THE LIST OF COMPARABLE SELECTED BY LD. TPO. 2) ICRA MANAGEMENT CONSULTING SERVICES LTD. : 143. LD. COUNSEL POINTED OUT THAT IT IS A MULTI LIN E MANAGEMENT AND CONSULTING FIRM. IT HAS AN ESTABLISHED TRACK RECOR D IN CONSULTING AND DIVERSIFIED CLIENTS BASED ACROSS VARIOUS SECTORS AND COUNTRIES. LD. COUNSEL REFERRED TO PAGE 233 OF APPEAL MEMO TO DEMONSTRATE THAT THE SER VICES OFFERED BY THE COMPANY ARE IN DIVERSIFIED FIELD SUCH AS BANKING AN D FINANCIAL SERVICES, CORPORATE ADVERTISERY, ENERGY, INFRASTRUCTURE, ETC. THUS, HE SUBMITTED THAT THE COMPANY IS ENGAGED IN HIGH END CONSULTING SERVICES AND, HENCE, NOT COMPARABLE. ITA NO. 5637/D/2011 187 144. LD. CIT(DR) SUBMITTED THAT THIS COMPANY IS A R ATING COMPANY, LIKE THE ASSESSEE, WHICH PROVIDES VENDOR INFORMATION TO THE ASSOCIATED ENTERPRISE. 145. LD. COUNSEL IN THE REJOINDER SUBMITTED THAT TH ERE IS NO COMPARISON BETWEEN VENDOR INFORMATION SERVICE RENDERED BY THE ASSESSEE AND THE MANAGEMENT CONSULTING SERVICES RENDERED BY ICR WHIC H REQUIRED MUCH HIGHER DEGREE OF SKILL. ACCORDINGLY, THE QUALITIES OF PER SONNEL ARE ALSO VERY DIFFERENT. 145.1 LD. COUNSEL FURTHER POINTED OUT THAT DURING 2 006-07 ICRA DEMERGED ITS CONSULTING SERVICES SUBSIDIARY ICRA MANAGEMENT CONSULTING SERVICES. THEREFORE, THIS WAS AN EXTRAORDINARY EVENT WHICH HA D THE EFFECT ON PROFITABILITY BUT WAS NOT ASCERTAINABLE. 145.2 HAVING HEARD BOTH THE PARTIES, WE ARE NOT IN AGREEMENT WITH LD. COUNSEL FOR THE ASSESSEE THAT THIS COMPANY IS TO BE EXCLUDED ON THE GROUND OF FUNCTIONAL PROFILE BECAUSE ADMITTEDLY IT WAS IMPART ING CONSULTING AND ADVISORY SERVICES. FURTHER, WE FIND CONSIDERABLE FORCE IN THE ARGUMENT OF LD. COUNSEL FOR THE ASSESSEE THAT THE FACT OF DEMERGER BEING AN EXT RAORDINARY EVENT HAD IMPACT ON PROFITABILITY BUT THIS ASPECT HAD NOT BEEN CONSI DERED BY LD. TPO. LD. COUNSEL HAS ALSO CHALLENGED THE INCLUSION OF THIS COMPARABL E ON THE GROUND OF EXPENDITURE ON R&D. IN THIS REGARD LD. COUNSEL REF ERRED TO EXTRACTS FROM ANNUAL REPORT TO DEMONSTRATE THAT COMPANY CONTINUOUSLY INV ESTS IN CREATING NEW PRODUCTS AND SERVICES. MOST OF THE PRODUCT/SERVICE OFFERINGS OF COMPANY INVOLVE INNOVATION AND ORIGINAL THINKING. FURTHER, COMPANY ALSO TAKES STEPS TO REGISTER ITS RIGHT OVER THE INTELLECTUAL PROPERTY. THEREFORE, IN THE THE LIGHT OF THE ITA NO. 5637/D/2011 188 DECISION OF HONBLE DELHI HIGH COURT IN THE CASE OF AGNITY INDIA TECHNOLOGIES PVT. LTD. (SUPRA) ALSO THIS COMPANY CANNOT BE TAKEN AS COMPARABLE. WE, THEREFORE, DIRECT LD. TPO TO EXCLUDE THIS COMP ANY FROM LIST OF COMPARABLES. IDC(INDIA) LTD. : 146. LD. COUNSEL SUBMITTED THAT THE COMPANY IS IN P ROVIDING CONSULTING SERVICES IN ASIA PACIFIC REGION. IT PROVIDES THE M OST RIGOROUS AND EXHAUSTIVE PRIMARY RESEARCH. FURTHER, IT ALSO PROVIDES SERVIC ES LIKE CMO ADVISORY RESEARCH, INVESTMENT RESEARCH SERVICED, IT ADVISORY TOOLS ETC. THUS, THE COMPANY IS PROVIDING SERVICES WHICH ARE NO WAY COMP ARABLE TO THE MARKET SUPPORT SERVICES. 146.1 HAVING HEARD BOTH THE PARTIES, WE FIND THAT L D. TPO HAS ONLY OBSERVED THAT THE ASSESSEE OBJECTED TO THE INCLUSION OF THIS COMPARABLE ON THE GROUND OF RELATED PARTY TRANSACTION. THUS, THE INCLUSION OF THIS COMPARABLE HAS NOT PROPERLY BEEN CONSIDERED BY LD. TPO AND, THEREFORE, WE RESTORE THIS MATTER TO THE FILE OF LD. TPO FOR CONSIDERING THE ASSESSEES OBJECTIONS AFRESH. 3) IL&FS ECO SMART LTD. : 147. LD. COUNSEL SUBMITTED THAT THIS COMPANY OFFERS SERVICES IN ENVIRONMENTAL INFORMATION PROCESSING, GEO SPATIAL SOLUTIONS, URBAN INFRASTRUCTURE, SOLID BASED MANAGEMENT, RESTATEMENT AND REHABILITATIONS ENVIRONMENTAL MANAGEMENT, ENVIRONMENTAL POLICY INTE RVENTIONS AND REGULATIONS, RISK MANAGEMENT AND ENVIRONMENTAL CAPA CITY BUILDING AND TRAINING. THE SERVICES ARE PARTICULARLY CATEGORIZE D AS ENVIRONMENT AND SOCIAL ITA NO. 5637/D/2011 189 ADVISORY SERVICES, GEO SPECIAL SOLUTIONS, RESOURCE CONVERSATION AND MANAGEMENT ETC. MANAGEMENT. THUS, COMPANY IS NOT C OMPARABLE TO ASSESSEE AS IT IS PROVIDING DIVERSIFIED SERVICES. 147.1 HAVING HEARD BOTH THE PARTIES, WE DO NOT FIND ANY REASON TO EXCLUDE THIS COMPANY FROM THE LIST OF COMPARABLES BECAUSE I T IS NOT DISPUTED THAT THE COMPANY IS EARNING INCOME MAINLY FROM ADVISORY AND CONSULTANCY SERVICES. MERELY BECAUSE ASSESSEE IS PROVIDING DIVERSIFIED SE RVICES, THE SAME CANNOT BE EXCLUDED ON THE GROUND OF FUNCTIONAL DISSIMILARITY BECAUSE THE PRIMARY FUNCTION IS OF IMPARTING CONSULTANCY IN VARIOUS FIELDS ONLY. THE ASSESSEES CHALLENGE ON THE GROUND OF EXPENDITURE ON RPT HAS SUITABLY BEEN ANSWERED BY LD. TPO. 4) IN MACS MANAGEMENT SERVICES : 148. LD. COUNSEL SUBMITTED THAT THIS COMPARABLE SEL ECTED BY LD. TPO SHOULD BE EXCLUDED BECAUSE IT IS FUNCTIONALLY UN-CO MPARABLE INASMUCH AS THE COMPANY IS ENGAGED IN PROVIDING PLACEMENT CONSULTAN CY SERVICES AND, THEREFORE, THESE ARE NOT COMPARABLE TO THE ASSESSEE S ROUTINE ADMINISTRATIVE AND MARKETING SUPPORT SERVICES. FURTHER, THE INCLU SION OF THIS COMPANY IS ALSO NOT WARRANTED ON THE GROUND OF EARNING ABNORMAL MAR GIN AND UN-COMPARABLE SALES TURNOVER. HE FURTHER SUBMITTED THAT THIS COM PANY HAS INCURRED EXPENDITURE ON ADVERTISEMENT AND MARKETING WHICH EX CEEDS 3% OF SALES. HE FURTHER SUBMITTED THAT LD. TPOS OBSERVATION THAT A SSESSEE HAD INCURRED ONLY 2.54% OF SALES ON ADVERTISING IS INCORRECT AS THE A SSESSEE IS A CAPTIVE SERVICE PROVIDER AND IT DOES NOT NEED TO SPEND ON ADVERTISI NG AND MARKETING. LD. TPO, ITA NO. 5637/D/2011 190 HOWEVER, HAS NOT ACCEPTED THE ASSESSEES CONTENTION S FOR THE FOLLOWING REASONS: 1) THE ASSESSEE IS ALSO IMPARTING CONSULTANCY SERVI CE LIKE THE COMPARABLE SELECTED BY HIM; 2) EXPENDITURE ON ADVERTISEMENT AND MARKETING DOES NOT MAKE THE COMPANY FUNCTIONALLY DISSIMILAR; 3) ASSESSEE HAS NOT POINTED OUT ANY FACT THAT WOULD LEAD ONE TO BELIEVE THAT THERE IS SOME FACTOR IN THE ACCOUNTS OF THE CO MPANY THAT MAKES THE PROFIT MARGIN OF 38.46% AS EXTRAORDINARY. 148.1 LD. COUNSEL POINTED OUT THAT IN THE CASE OF M /S MCICOM INDIA PVT. LIMITED AND M/S VARISON INDIA PVT. LTD. (ITA NOS. 4 187/DEL/2010, 2766/DEL/2010 & CO 218/D/2010), THIS COMPANY HAS BE EN REJECTED ON THE GROUND OF FUNCTIONAL PROFILE BEING DIFFERENT. 149. LD. CIT(DR) SUBMITTED THAT THE INDUSTRY VERTIC ALS MUST NOT BE LOOKED INTO FOR COMPARABILITY PURPOSES AND THE ASSESSEE HA S REJECTED THE COMPARABLE ON THE GROUND OF HIGH PROFITABILITY ONLY. 149.1 HAVING HEARD BOTH THE PARTIES, WE DO NOT FIND ANY REASON TO EXCLUDE THIS COMPARABLE FROM THE LIST OF COMPARABLES SELECT ED BY LD. TPO ONLY BECAUSE OF HIGH PROFIT MARGIN EARNED BY THE COMPANY. ADMIT TEDLY, THE COMPANY IS IMPARTING CONSULTING SERVICES AND, THEREFORE, THE A REA IN WHICH IT IS IMPARTING CONSULTING SERVICES DOES NOT MAKE THE COMPANY UN-CO MPARABLE UNLESS ASSESSEE POINTS OUT SOME EXTRAORDINARY FEATURE RESU LTING INTO HIGH PROFIT EARNING ITA NO. 5637/D/2011 191 BY THE COMPANY. WE, THEREFORE, DO NOT FIND ANY REA SON TO EXCLUDE THIS COMPARABLE FROM THE LIST OF COMPARABLES. 5) RITES LIMITED : 150. LD. COUNSEL SUBMITTED THAT THIS COMPANY IS IN MULTI DISCIPLINARY INFRASTRUCTURE AND ENGINEERING CONSULTING SERVICES. HE POINTED OUT THAT THE SERVICES UNDERTAKEN BY THE COMPANY INCLUDE: PRE PROJECT PLANNING INVOLVING PROJECT IDENTIFICAT ION, FEASIBILITY STUDIES AND PROJECT APPRAISAL; PROJECT SUPPORT ACTIVITIES PRICING SURVEYS, ENVIRO NMENTAL AND SOCIAL IMPACT ASSESSMENT, GEO-TECHNICAL AND OTHER INVESTIGATIONS; PROJECT IMPLEMENTATION/MANAGEMENT COVERING CONTRAC T ADMINISTRATION, FIELD ENGINEERING AND CONSTRUCTION SUPERVISION, PRODUCT C ERTIFICATION, QUALITY ASSURANCE; COMMISSIONING, OPERATION, MAINTENANCE OF ROLLING C OST AND WORK SHOP MANAGEMENT. 150.1 LD. COUNSEL FURTHER POINTED OUT THAT THIS COM PANY IS A 100% GOVERNMENT COMPANY AND SUCH WHOLLY OWNED COMPANY SH OULD NOT BE TAKEN AS COMPARABLES BECAUSE GOVERNMENT COMPANIES OFTEN WORK ON CONSIDERATIONS OTHER THAN PURE PROFIT. 150.2 HE, FURTHER POINTED OUT THAT IN THE CASE OF M /S MCICOM INDIA PVT. LIMITED AND M/S VARISON INDIA PVT. LTD. (ITA NOS. 4 187/DEL/2010, 2766/DEL/2010 & CO 218/D/2010) THIS COMPANY HAS BEE N REJECTED ON THE GROUND OF FUNCTIONAL PROFILE BEING DIFFERENT. ITA NO. 5637/D/2011 192 151. LD. DR SUBMITTED THAT THE INDUSTRY VERTICALS M UST NOT BE LOOKED INTO FOR COMPARABILITY PURPOSES AND THE ASSESSEE HAS REJ ECTED THE SAME ON THE GROUND OF HIGH PROFITABILITY ONLY. LD. DR POINTED O UT THAT MERELY BECAUSE THE SHARES ARE HELD BY THE GOVERNMENT OF INDIA DOES NOT MAKE THE COMPANY UN- COMPARABLE, IF THE COMPANY IS FUNCTIONALLY COMPARAB LE. 151.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH TH E PARTIES AND HAVE PERUSED THE RECORD OF THE CASE. WE FIND THAT IN THE CASE OF MCICOM INDIA PVT. LIMITED AND OTHERS (SUPRA) IT HAS BEEN HELD AS UNDE R: MARKETING SUPPORT SERVICES CANNOT BE COMPARED WIT H TURNKEY ENGINEERING SERVICES. WE AGREE WITH THE VIEW OF THE FIRST APPELLATE AUTHO RITY THAT EIL, RITES, WAPSOS AND TCE ARE ENGINEERING COMPANIES AND PROVIDE END-TO-EN D SOLUTIONS AND WHEREAS THE ASSESSEE COMPANY PROVIDES MARKETING SUPPORT SERVICE S TO THE PARENT COMPANY, WHICH IS IN THE NATURE OF SUPPORT SERVICE AND HENCE NOT FUNC TIONALLY COMPARABLE. SHE RIGHTLY CONCLUDED THAT THE RISK PROFILE IS VASTLY DIFFERENT AND HENCE ON THIS COUNT ALSO THEY ARE NOT COMPARABLE. WE ARE IN AGREEMENT WITH LD. CIT(DR) THAT MERELY BE CAUSE OF SHARES BEING HELD BY THE GOVERNMENT OF INDIA, THE C OMPANY CANNOT BE EXCLUDED, UNLESS IT IS ESTABLISHED THAT THE COMPANY IS NOT FUNCTIONALLY COMPARABLE. HOWEVER, WE FIND THAT ASSESSEE WAS IMPA RTING ONLY MARKETING SUPPORT SERVICES BUT RITES LTD. ADMITTEDLY WAS PRIM ARILY IMPARTING TURNKEY ENGINEERING SERVICES. THEREFORE, IN VIEW OF THE OB SERVATIONS IN THE CASE OF M/S MCI COM INDIA P. LTD. AND OTHERS (SUPRA), WE DIRECT THE LD. TPO TO EXCLUDE THIS COMPANY FROM THE LIST OF COMPARABLES. 8) TECHNICOM-CHEMIE (INDIA) LIMITED : ITA NO. 5637/D/2011 193 152. LD. COUNSEL SUBMITTED THAT THIS COMPANY DEALS IN HIGH-TECH MACHINERY AND HAS AN EXCELLENT SET UP OF COMPANY TR AINED SERVICE ENGINEERS ALONG WITH SUITABLE SPARE PARTS INVENTORY FOR PROVI DING TECHNICAL SUPPORT DURING AND AFTER THE SALES. THE AREAS OF OPERATION ARE AS UNDER: SOLAR ENERGY, PHARMACEUTICALS AND HEALTH CARE CHEM ICALS INFRASTRUCTURE DEVELOPMENT. 152.1 THUS, BUSINESS PROFILE OF TECHNICOM IS COMPLE TELY DIFFERENT FROM THAT OF THE ASSESSEES ADMINISTRATION AND MARKETING SUPP ORT SERVICE SEGMENT. 153. LD. TPO DID NOT ACCEPT THE ASSESSEES CONTENTI ON, INTER-ALIA, OBSERVING THAT FROM THE DETAILS PROVIDED BY THE ASS ESSEE, IT IS EVIDENT THAT THIS COMPANY COORDINATES TECHNICAL TIE UPS, TECHNICAL TR ANSFER AND FACILITIES FORMATION OF JOINT VENTURES. 153.1 WE HAVE CONSIDERED THE SUBMISSIONS OF BOTH TH E PARTIES. THIS COMPANY IS PRIMARILY A SERVICE PROVIDER FOR AFTER S ALES SERVICES AND, THEREFORE, CANNOT BE COMPARED WITH ROUTINE CONSULTANCY SERVICE S. THIS COMPANY HAS EARNED INCOME FROM COMMISSION, CONSULTANCY AND SERV ICES. FURTHER THE COMPANY IS ALSO HOLDING SPARE PARTS INVENTORY FOR P ROVIDING TECHNICAL SUPPORT DURING AND AFTER THE SALES. THEREFORE, THE BUSINES S PROFILE OF THIS COMPANY IS NOT COMPARABLE TO ASSESSEE WHICH IS PROVIDING ONLY MARKET SUPPORT CONSULTANCY. WE, THEREFORE, DIRECT LD. TPO TO EXCL UDE THIS COMPANY FROM THE LIST OF COMPARABLES. ITA NO. 5637/D/2011 194 9) WAPOS LTD. : 154. LD. COUNSEL SUBMITTED THAT THIS COMPANY IS ENG AGED IN THE PROVISION OF CONSULTANCY SERVICES IN ALL FACETS OF WATER RESO URCES, POWER AND INFRASTRUCTURE SECTORS. FURTHER, THE COMPANY IS A PUBLIC SECTOR COMPANY WHOLLY OWNED BY THE GOVERNMENT OF INDIA AND, THEREFORE, IT CANNOT BE COMPARED WITH THE ASSESSEE. 154.1 LD. COUNSEL FURTHER POINTED OUT THAT IN THYSS ENKRUPP ITA NO. 6460/MUM./2012 (PARA 12.8.1 & 12.8.2), IT HAS BEEN HELD THAT GOVERNMENT OWNED COMPANIES SHOULD NOT BE TAKEN AS COMPARABLES AS THEY HAVE SOCIAL OBLIGATIONS. FURTHER, IF THEY DERIVED INCOME FROM OTHER GOVERNMENT COMPANIES OR AGENCIES, THERE WOULD FURTHER BE PROBLEM OF RELA TED PARTY TRANSACTIONS. 155. LD. DR SUBMITTED THAT THIS COMPANY IS PURELY I MPARTING CONSULTANCY SERVICES AND, THEREFORE, MERELY BECAUSE THE SHARES ARE HELD BY GOVERNMENT OF INDIA, IT CANNOT BE EXCLUDED. 155.1 HAVING HEARD BOTH THE PARTIES, WE DO NOT FIND OURSELVES IN AGREEMENT WITH LD. COUNSEL FOR THE ASSESSEE FOR EXCLUSION OF THIS COMPANY FROM THE LIST OF COMPARABLES. IN OUR OPINION, UNLESS IT IS DEMONSTR ATED WITH ROBUST DATA THAT BECAUSE OF SHARES BEING HELD BY THE GOVERNMENT OF I NDIA, THERE IS IMPACT ON PROFITABILITY OF COMPANY, THE SAME CANNOT BE EXCLUD ED MERELY ON THE GROUND OF GENERAL PERCEPTION. FURTHER, WE FIND CLEAR CUT CON TRADICTION IN THE ARGUMENT OF LD. COUNSEL FOR THE ASSESSEE BECAUSE THE EFFECT OF UNDERTAKING SOCIAL OBLIGATION BY GOVERNMENT COMPANY AT BEST RESULTS IN REDUCTION OF PROFIT AND NOT IN INCREASING THE PROFITS. AS FAR AS, THE DECISION RE LIED UPON BY LD. COUNSEL IS ITA NO. 5637/D/2011 195 CONCERNED, THE SAME HAS BEEN RENDERED HAVING REGARD TO RELATED PARTY TRANSACTIONS BUT NO DATA HAS BEEN PROVIDED IN THE P RESENT CASE. WE, THEREFORE, UPHOLD THE LD. TPOS CONTENTION IN THIS REGARD. 10) CONSULTING ENGINEERING SERVICES (INDIA) PVT. L TD. : 156. LD. COUNSEL SUBMITTED THAT THIS COMPANY IS ENG AGED IN THE BUSINESS OF RENDERING SERVICES IN DIVERSIFIED AREAS SUCH AS AGRICULTURAL AND RURAL DEVELOPMENT, ARCHITECTURE, BRIDGES AND STRUCTURE, R OADS AND HIGHWAYS ETC. HE POINTED OUT THAT LD. TPO HAS NOT CONTROVERTED THE C ONTENTION OF THE ASSESSEE. 157. LD. DR SUBMITTED THAT THIS COMPANY IS IMPARTIN G CONSULTANCY SERVICES AND, THEREFORE, FUNCTIONALLY COMPARABLE TO ASSESSEE . 157.1 HAVING HEARD BOTH THE PARTIES, WE DO NOT FIND ANY REASON TO EXCLUDE THIS COMPANY FROM THE LIST OF COMPARABLES MERELY ON THE GROUND OF THE COMPANY IMPARTING CONSULTANCY SERVICES IN DIVERSIFIED FIELD . UNDER TNMM METHOD BROAD COMPARABILITY IS TO BE CONSIDERED AND IF A COMPARAB LE IS HORIZONTALLY COMPARABLE THEN THE SAME CANNOT BE EXCLUDED BECAUSE OF DIFFERENT VERTICAL FIELDS IN WHICH IT IS PROVIDING ITS SERVICES. 11) PRIYA LIMITED : 158. LD. COUNSEL SUBMITTED THAT THIS COMPANY IS ENG AGED IN THE TRADE OF ELECTRICAL PRODUCTS AND EXPORT OF DIE STUFFS, BULK PHARMACEUTICALS AND INTER- MEDIATES. THE TWO REPORTABLE SEGMENTS ARE ELECTRON ICS AND CHEMICALS. THEREFORE, THIS COMPANY IS PRODUCT COMPANY AND NOT IN CONSULTANCY SERVICES. 158.1 HAVING HEARD BOTH THE PARTIES, WE FIND THAT T HERE IS NO DISCUSSION, IN THE ORDER OF LD. TPO IN REGARD TO THIS COMPARABLE A ND, THEREFORE, WE RESTORE THE ITA NO. 5637/D/2011 196 MATTER TO THE FILE OF LD. TPO TO EXAMINE CONTENTION S OF ASSESSEE AND IF IT IS FOUND THAT THE COMPANY IS TRADING IN PRODUCTS THEN THE SAME IS TO BE EXCLUDED FROM THE LIST OF COMPARABLES. 158.2 THE COMPARABLES CHOSEN BY THE ASSESSEE BUT NO T INCLUDED IN THE LIST OF COMPARABLES SELECTED BY LD. TPO. 159. APROPOS GROUND NO. 5.7, LD. COUNSEL SUBMITTED THAT FOLLOWING FOUR COMPARABLES CHOSEN BY ASSESSEE ARE IMPARTING FUNCTI ONS AKIN TO THE FUNCTIONS IMPARTED BY THE ASSESSEE: A. SOFTWARE EXPERTS LTD.; B. ASK ME INFONAUTS LTD.; C. HINDUSTAN HOUSING COMPANY LTD.; D. CYBER MEDIA EVENTS LTD. 159.1 HAVING HEARD BOTH THE PARTIES, WE RESTORE THI S MATTER TO THE FILE OF LD. TPO TO EXAMINE THE ASSESSEES CONTENTION DENOVO VIZ -A-VIZ FILTERS APPLIED BY HIM. 160. VIDE GROUND NO. 5.8, THE ASESSEE IS AGGRIEVED WITH THE LD. TPOS ACTION IN NOT ALLOWING RISK ADJUSTMENT TO THE ASSES SEE ON ACCOUNT OF VARIOUS FACTORS MENTIONED IN THE GROUND OF APPEAL NOTED EAR LIER. BOTH THE SIDES AGREE THAT THIS GROUND IS SIMILAR TO GROUND NO. 4.10 IN R EGARD TO SOFTWARE DEVELOPMENT SERVICE SEGMENT AND, THEREFORE, FOR THE DETAILED RE ASONS STATED THEREIN, WE RESTORE THIS ISSUE TO THE FILE OF LD. AO/TPO FOR FR ESH ADJUDICATION. 161. GROUND NO. 5.9 IS GENERAL. 162. VIDE GROUND NO. 6, THE ASSESSEE HAS ASSAILED L D. TPOS ACTION IN NOT ALLOWING THE ADJUSTMENT IN REGARD TO OPERATING PROF IT MARGINS OF THE COMPARABLES ITA NO. 5637/D/2011 197 CHOSEN FOR ADMINISTRATIVE AND MARKETING SUPPORT SER VICE SEGMENT TO ACCOUNT FOR THE DIFFERENCES IN THE WORKING CAPITAL LEVELS OF TH E ASSESSEE AND THE COMPARABLES. THE OTHER TWO SUB-GROUNDS VIZ. (B) AN D (C) WERE NOT PRESSED BY ASSESSEE. IN REGARD TO THIS, LD. COUNSEL SUBMITTED THAT THE BINDING DIRECTION OF THE LD. DRP IN RESPECT OF ALLOWING ADJUSTMENT ON AC COUNT OF WORKING CAPITAL DIFFERENCES IN THE OPERATING MARGINS OF THE COMPARA BLES SHOULD BE DIRECTED TO BE FOLLOWED BY LD. TPO. 162.1 HAVING HEARD BOTH THE PARTIES, WE FIND THAT W HILE CONSIDERING GROUND NO. 4.9 RELATING TO WORKING CAPITAL ADJUSTMENT, LD. DRP HAS DIRECTED AO/TPO TO GRANT WORKING CAPITAL ADJUSTMENT BASED ON THE OECD FORMULA AND BY TAKING 10.25% AS THE PLR. WE, THEREFORE, DIRECT THE LD. T PO/AO TO CARRY OUT THE DIRECTIONS GIVEN BY LD. DRP. 163. IN THE RESULT, THIS GROUND IS ALLOWED FOR STAT ISTICAL PURPOSES. CORPORATE ISSUES: 164. VIDE GROUND NO.7, THE ASSESSEE HAS ASSAILED TH E ORDER OF LD. AO AS PER THE DIRECTIONS OF LD. DRP IN DISALLOWING PROVIS ION FOR LIQUIDITY DAMAGES AMOUNTING TO RS. 201537175/- ON THE GROUND THAT THE CLAIM FOR LIQUIDATED DAMAGES IS A LIABILITY OF FUTURE AND NOT PRESENT LI ABILITY. FURTHER, AO ERRED IN NOT FOLLOWING THE DIRECTIONS OF LD. DRP IN ALLOWING THE REVERSAL OF RS. 306779345/- OF THE PROVISION FOR LIQUIDATED DAMAGES. 165. BRIEF FACTS APROPOS THIS ISSUE ARE THAT AO NOT ICED THAT ASSESSEE HAD DEBITED PROVISION FOR LIQUIDATED DAMAGES AMOUNTING TO RS. 201537175/- IN ITS PROFIT AND LOSS ACCOUNT. THE AO OBSERVED THAT ASSE SSEE WAS ENGAGED, INTER- ITA NO. 5637/D/2011 198 ALIA, IN THE BUSINESS OF INSTALLATION AND COMMISSIO NING OF TELECOMMUNICATION EQUIPMENTS AND NETWORK AND PROVIDED TECHNICAL SUPPO RT SERVICES IN RELATION TO THE SAME FOR VARIOUS TELECOM OPERATORS IN INDIA. A LL THESE PROJECTS WERE COVERED UNDER THE CLAUSE OF LIQUIDATED DAMAGES IN A CCORDANCE WITH THE NORMAL INDUSTRY PRACTICE. HE NOTED THAT THE DAMAGES WERE QUANTIFIED ON THE BASIS OF THE CONTRACTUAL TERMS AGREED BETWEEN THE PARTIES, A ND THE PURCHASE ORDERS PLACED BY THE CUSTOMERS CLEARLY STIPULATED THE AMOU NT AT WHICH THE LIQUIDATED DAMAGES WOULD BE RECOVERED FROM THE ASSESSEE FOR NO T MEETING THE DELIVERY DEAD LINES. HE FURTHER NOTICED THAT IN CASE OF ANY DELAY IN THE EXECUTION/COMPLETION OF ANY CONTRACT, THE ASSESSEE BECOMES LIABLE FOR DAMAGES IN TERMS OF THE COVENANTS OF THE PURCHASE O RDER PLACED BY THE CUSTOMERS, WHICH WAS QUANTIFIED ON THE BASIS OF THE CONTRACTUAL TERMS AND, ACCORDINGLY, THE PROVISION WAS MADE. THE ASSESSEE RELIED ON THE DECISION OF HONBLE SUPREME COURT IN THE CASE OF ROTORK CONTROL S INDIA PVT. LTD., WHEREIN HONBLE SC HELD THAT THERE ARE FOUR IMPORTANT ASPEC TS OF PROVISION: 1. PROVISION WHICH RELATES TO PRESENT OBLIGATION; 2. IT ARISES OUT OF OBLIGATING EVENTS; 3. IT INVOLVES OUTFLOW OF RESOURCES; AND 4. IT INVOLVES RELIABLE ESTIMATION OBLIGATION. 166. THE AO, HOWEVER, DID NOT ACCEPT THE ASSESSEES CONTENTIONS, INTER- ALIA, OBSERVING THAT THE LIQUIDATED DAMAGES BECOME ACTUAL WHEN THE ASSESSEE IS NOT ABLE TO MEET THE DELIVERY DEADLINES. THE LI ABILITY DOES NOT BECOME REAL TILL ITA NO. 5637/D/2011 199 THEN. THEREFORE, HE DISALLOWED THE PROVISION FOR L IQUIDITY DAMAGES AMOUNTING TO RS. 201537175/-. 167. LD. COUNSEL SUBMITTED THAT THE LIQUIDATED DAMA GES WERE PART OF THE SALE PROCESS AND THE SAME WAS AS PER THE POLICY OF ACCOUNTING STANDARD-29 ISSUED BY INSTITUTE OF CHARTERED ACCOUNTANTS OF IN DIA. 167.1 LD. COUNSEL POINTED OUT THAT LD. DRP DID NOT ACCEPT THE ASSESSEES CONTENTION, INTER-ALIA, OBSERVING AS UNDER: IN THE INSTANT CASE, IT IS AN ADMITTED FACT THAT T HE PROVISIONS ARE MADE AND ALSO WRITTEN BACK WHEN NO LONGER REQUIRED. THIS INDICATE S THAT NO GENERALIZATION CAN BE MADE ABOUT LIQUIDATED DAMAGES. THERE IS A GREAT DEAL OF CONTINGENCY AND IT CANNOT BE ACCURATELY PREDICTED. THEREFORE, IT WOUL D BE IN THE FITNESS OF THINGS TO UPHOLD THIS DISALLOWANCE. BUT AT THE SAME TIME THE ENTIRE REVERSAL OF THE SAID PROVISION OF RS. 306779345/- SHOULD HAVE BEEN REDUC ED IN COMPUTING TAXABLE INCOME. 167.2 LD. COUNSEL SUBMITTED THAT THE ASSESSEE IS EN GAGED, INTER-ALIA, IN THE BUSINESS OF INSTALLATION AND COMMISSIONING OF TELEC OMMUNICATION AND EQUIPMENT NETWORK AND PROVIDES TECHNICAL SUPPORT SE RVICES IN RELATION TO THE SAME FOR VARIOUS TELECOM OPERATORS IN INDIA. ALL T HE PROJECTS EXECUTED BY THE ASSESSEE COMPANY ARE DONE UNDER CONTRACTS WHICH CON TAIN THE CLAUSE FOR LIQUIDATED DAMAGES IN ACCORDANCE WITH THE NORMAL IN DUSTRY PRACTICE. IN THIS REGARD, LD. COUNSEL REFERRED TO A SAMPLE AGREEMENT FOR SUPPLY OF SERVICES BETWEEN TATA TELESERVICES (MAHARASHTRA) LTD. & MOTO ROLA INDIA PVT. LTD. DATED 10/10/2003 CONTAINED FROM PAGES 798 TO 838 OF PAPER BOOK AND SPECIFICALLY ITA NO. 5637/D/2011 200 REFERRED TO PAGE 818, WHEREIN THE CLAUSE RELATING T O DELAYS AND LIQUIDATED DAMAGES IS CONTAINED. THE SAME READS AS UNDER: 13.2 THE CONTRACTOR SPECIFICALLY ACKNOWLEDGES AND AGRE ES THAT TIME IS OF ESSENCE IN THE PERFORMANCE OF ALL THE CONTRACTORS OBLIGATIONS INCLUDING, WITHOUT LIMITATION, THE PROVISION OF ALL THE SERVICES SET FORTH IN THIS AGR EEMENT; 13.3 IN THE EVENT THAT PROVISIONAL ACCEPTANCE OF AN EQUI PMENT, OR ELEMENT OR PROVISION OF EQUIPMENT IS DELAYED BEYOND THE TIME SCHEDULE SP ECIFIED IN THE ORDER, SOLELY FOR REASONS ATTRIBUTABLE TO THE SERVICES BEING PROVIDED BY THE CONTRACTOR, THEN THE CONTRACTOR SHALL BE REQUIRED TO PAY TO TTML AN AMOU NT OF LIQUIDATED DAMAGES FOR SUCH DELAY, CALCULATED ON THE BASIS OF THE PRICE OF THE DELAYED PORTION OF THE SERVICES AT THE RATE OF 0.5% PER EACH FULL CALENDAR WEEK OF DELAY O R PART THEREOF SUBJECT TO A MAXIMUM OF 5% OF THE PRICE OF THE DELAYED PORTION OF THE SE RVICES. THE PARTIES AGREE THAT THE AFORESAID AMOUNT IS REASONABLE IN LIGHT OF THE ANTI CIPATED ACTUAL HARM, WHICH MIGHT BE CAUSED BY ANY DELAY TO TTML. 13.4 THE PRICE OF DELAYED PORTION DESCRIBED IN ARTICLE 1 3.3 OF THIS AGREEMENT SHALL BE THE PRICE OF THE SERVICES, WHICH IS AFFECTED AND CO ULD NOT BE DEPLOYED AND BE ASSOCIATED WITH THE NETWORK. 167.3 LD. COUNSEL SUBMITTED THAT THE PROVISION WAS CREATED ON THE BASIS OF PERIOD OF DELAY IN EXECUTION OF PROJECTS AND THE RA TE OF LIQUIDATED DAMAGES PROVIDED IN THE CONTRACT. LD. COUNSEL REFERRED TO PAGE 779 OF PAPER BOOK III, WHEREIN SCHEDULE 19 TO THE BALANCE SHEET CONTAINING NOTES TO ACCOUNTS IS CONTAINED, WHICH READS AS UNDER: PROVISION FOR LIQUIDATED DAMAGES LIQUIDATED DAMAGES/PENALTIES ARE PROVIDED FOR WHERE VER THERE IS A DELAYED DELIVERY ATTRIBUTABLE TO THE COMPANY. THE PROVISION FOR LIQ UIDATED DAMAGES ARE MADE BASED ON THE MANAGEMENTS ESTIMATES. RS. IN MILLION RS. IN MILLION PARTICULARS 31 MARCH, 2007 31 MARCH, 2006 ITA NO. 5637/D/2011 201 OPENING BALANCE 493 171 ADD: PROVISION 202 322 LESS: REVERSALS 39 - LESS: UTILISATIONS 268 - CLOSING BALANCE 388 493 167.4 LD. COUNSEL FURTHER POINTED OUT THAT USUALLY THE ASSESSEE ENTERS INTO DISCUSSION/NEGOTIATION REGARDING THE QUANTUM OF LIQ UIDATED DAMAGES. SOMETIMES, THE ASSESSEE ALSO ENTERS INTO ARBITRATIO N PROCEEDINGS IN THIS REGARD. WHEN CERTAINTY/FINALITY IS REACHED IN RESPECT OF TH E NEGOTIATION/DISCUSSION/ARBITRATION PROCEEDINGS WITH THE CUSTOMERS, THE RELEVANT AMOUNT IS SHOWN AS UTILIZED FROM THE PROVISION ACCO UNT. IN CASE WHERE THE CUSTOMER AGREES TO WAIVE THE LIQUIDATED DAMAGES EIT HER, PARTLY OR FULLY, THE PROVISION IS REVERSED TO THAT EXTENT. THIS AMOUNT IS OFFERED TO TAX AS INCOME IN THE YEAR IN WHICH THIS REVERSAL IS DONE. HE FURTHE R POINTED OUT THAT THIS YEAR, THE AMOUNT OF REVERSAL IS MORE THAN THE AMOUNT ADDED TO THE PROVISION, I.E., TAXABLE INCOME OF THE ASSESSEE HAS GONE UP ON ACCOUNT OF TH E REVERSAL. LD. COUNSEL RELIED ON FOLLOWING CASE LAWS IN SUPPORT OF HIS CON TENTION THAT PROVISION FOR LIQUIDATED DAMAGES IS AN ALLOWABLE DEDUCTION: 1. BHARAT EARTH MOVERS VS. CIT, 245 ITR 428; 2. DELHI HIGH COURT IN THE CASE OF ERICSON COMMUNIC ATION, 318 ITR 340; 3. KCP LIMITED, 34 ITD 50 (HYD.) ITAT SPL. BENCH; 4. MADRAS ITAT IN THE CASE OF KAVERI ENGINEERING SE RVICES, 43 ITD 527; 5. FFE MINERALS INDIA PVT. LTD. VS. JCIT, 84 TTJ 90 7 (CHEN.) ITAT; ITA NO. 5637/D/2011 202 6. PUNE ITAT IN THERMAX BABCOCK AND WILLCOX LTD. VS . ADDL. CIT, 304 ITR 130; 7. DELHI ITAT IN ADDL. CIT VS. ERICSON INDIA PVT. L TD., ITA NO. 516/DEL/2005. 168. LD. DR SUBMITTED THAT PROVISION FOR LIQUIDATED DAMAGES IS ACTUALLY PROVISION FOR UNLIQUIDATED DAMAGES BECAUSE LIABILIT Y HAS NOT CRYSTALLIZED. HE SUBMITTED THAT UNLESS THE DAMAGES ARE CRYSTALLIZED, THE SAME CANNOT BE ALLOWED. HE SUBMITTED THAT THE DEDUCTION FOR UNLIQ UIDATED DAMAGES CAN BE ALLOWED ONLY WHEN THE SAME GETS CRYSTALLIZED. THE ESTIMATION OF EXPENDITURE AND CRYSTALLIZATION OF EXPENDITURE ARE TWO SEPARATE THINGS. IN SUPPORT OF HIS CONTENTION LD. DR RELIED ON FOLLOWING DECISIONS: 1. NSUNDARE SWARAN VS. CIT, 226 ITR 142 (KER.); 2. NAVJEVAN ROLLER FLOOR PULSE LTD. VS. DCIT, 73 IT D 265. 169. LD. COUNSEL IN THE REJOINDER SUBMITTED THAT PR OVISION FOR LIQUIDATED DAMAGES AND UNLIQUIDATED DAMAGES ARE TWO SEPARA TE CONCEPTS. LIQUIDATED DAMAGES ARE SUCH DAMAGES AS HAVE BEEN AGREED UPON A ND FIXED BY THE PARTIES IN ANTICIPATION OF THE BREACH OF CONTRACT. UNLIQUIDATED DAMAGES ARE SUCH DAMAGES WHICH ARE REQUIRED TO BE ASCERTAINED AND/OR NOT FIXED BY THE PARTIES IN THE CONTRACT OR AGREEMENT AND WHICH CAN BE QUANTIFI ED AFTER THE MATTER IS SETTLED BY THE COURTS. LIQUIDATED DAMAGES REPRESEN T AN ASCERTAINED LIABILITY WHEREAS UNLIQUIDATED DAMAGES REPRESENT THE LIABILIT Y WHOSE AMOUNT IS NOT ASCERTAINABLE AND IS TO BE ASCERTAINED IN THE COURS E OF LAW. 169.1 WE HAVE CONSIDERED THE RIVAL SUBMISSION AND H AVE PERUSED THE RECORD OF THE CASE. ADMITTEDLY THE CONTRACT ENTERE D INTO BY THE ASSESSEE WITH ITA NO. 5637/D/2011 203 ITS CUSTOMER CONTAINED A SPECIFIC CLAUSE ON LIQUIDA TED DAMAGES WHICH DEFINE TERMS AND CONDITIONS OF LIQUIDATED DAMAGES INCLUDIN G THE METHOD OF CALCULATION AS NOTED EARLIER. IT IS NOT DISPUTED THAT ASSESSEE HAS CREATED THE PROVISION ONLY IN THOSE CASES WHERE THE DELAY HAD ACTUALLY OCCURRE D AND ON THE BASIS OF TERMS AND CONDITIONS OF CONTRACT. THE TERMS OF CONTRACT CONTEMPLATED THAT THE MOMENT DELAY OCCURS IN THE EXECUTION OF CONTRACT TH EN ASSESSEE WILL BECOME LIABLE FOR PAYMENT OF LIQUIDATED DAMAGES. THE LIAB ILITY, THUS, CRYSTALLIZED WITH THE OCCURRENCE OF EVENT OF DELAY IN THE EXECUTION O F CONTRACT. THE ASSESSEE MIGHT, AFTER ENTERING INTO NEGOTIATION WITH THE PAR TY, GET A WAIVER OR PARTIAL DEDUCTION IN ITS LIABILITY BUT THAT DOES NOT ABSOLV E THE ASSESSEE FROM BEING LIABLE FOR LIQUIDATED DAMAGES ON OCCURRENCE OF THE EVENT O F DELAY IN EXECUTION OF THE CONTRACT. 170. LD. DR HAS RELIED ON THE DECISION OF HONBLE K ERALA HIGH COURT IN THE CASE OF N.SUDERASHAM. IN THIS CASE THE ASSESSEE HA D ENTERED INTO CONTRACT WITH FOREIGN BUYERS FOR THE SUPPLY OF CASHEW KERNEL S. HOWEVER, THE ASSESSEE COULD NOT FULFILL THE OBLIGATIONS UNDER THE CONTRAC T DUE TO THE SHORTAGE IN THE SUPPLY OF RAW CASHEW NUTS AND CONSEQUENT HIGH IN PR ICES. DUE TO THE FAILURE TO SUPPLY THE CHASHEW NUTS AS PER THE TERMS OF THE CON TRACT, THERE WAS BREACH OF CONTRACT AND THE ASSESSEE, THEREFORE, CLAIMED A DED UCTION OF RS. 1251625/- TOWARDS DAMAGES PAYABLE TO THE FOREIGN COMPANIES. THE CLAIM WAS REJECTED BY TRIBUNAL AGAINST WHICH ASSESSEE PREFERRED APPEAL WH ICH WAS DISMISSED AS THE ASSESSEE FAILED TO ESTABLISH ITS CLAIM. THE HONBL E HIGH COURT, INTER-ALIA, OBSERVED THAT THE DETAILS REGARDING THE PERIOD OF C ONTRACTS, THE MANNER OF THEIR ITA NO. 5637/D/2011 204 PERFORMANCE, QUANTIFICATION OF DAMAGES ETC. WERE NO T SPECIFICALLY BROUGHT TO THEIR NOTICE. ONLY THE FACT REGARDING ARBITRATION PROCEEDINGS WAS BROUGHT TO THE HONBLE COURTS NOTICE. UNDER THESE FACTS, IT WAS HELD THAT THE DAMAGES HAD NOT CRYSTALLIZED PARTICULARLY BECAUSE THERE WAS NO STIP ULATION IN CONTRACT AND ASSESSEE HAD DENIED ITS LIABILITY. IN THE PRESENT, CASE, HOWEVER, AS NOTICED EARLIER, THE PROVISION HAD BEEN MADE ON THE BASIS O F SPECIFIC TERMS OF CONTRACT IN REGARD TO LIQUIDATED DAMAGES. THEREFORE, THIS D ECISION IS OF NO ASSISTANCE TO THE REVENUE. 171. THE NEXT DECISION RELIED UPON BY LD. DR IS IN THE CASE OF NAVJEEVAN ROLLAR AND FLOOR LTD. IN THIS CASE, THE ASSESSEE C OMPANY WAS ENGAGED IN THE BUSINESS OF MANUFACTURING OF DAL, BESAN, SUJI, ETC. ON 23/07/1986, THE ASSESSEE HAD ENTERED INTO A CONTRACT WITH A FOREIGN COMPANY FOR THE IMPORT OF YELLOW GRAM. UNDER THE CONTRACT LETTER OF CREDIT W ERE TO BE OPENED LATEST BY 14/08/1986. THE ASSESSEE, FAILED TO OPEN LETTER OF CREDIT. PROTRACTED LITIGATION ENSUED. THE FOREIGN PARTY CLAIMED DAMAGES FOR BREA CH OF THE CONTRACT. THE ASSESSEE DISPUTED THE PAYMENT OF DAMAGES. THERE WA S NO STIPULATION IN THE CONTRACT NOTES REGARDING THE DAMAGES TO BE PAID BY THE PARTY BREACHING THE TERMS OF THE CONTRACT. THE ARBITRATOR ON 25 TH MAY, 1987 AWARDED CERTAIN DAMAGES UNDER THE ARBITRATION AGREEMENT. THE ASSES SEE CHALLENGED THE LEGALITY OF THE ARBITRATION AWARD AND PREFERRED APP EAL BEFORE THE BOARD OF APPEAL CONSTITUTED BY THE GRAIN AND FREE TRADE ASSOCIATION , WHICH GAVE DECISION AGAINST THE ASSESSEE ON 20/03/1989. FOR THE A.Y. 1 988-89 THE ASSESSEE CLAIMED DEDUCTION ON ACCOUNT OF DAMAGES AND CERTAIN AMOUNT ON ACCOUNT OF ITA NO. 5637/D/2011 205 EXPENDITURE FOR LEGAL FEES. THE AO ALLOWED THE ASS ESSEES CLAIM, HOWEVER, THE COMMISSIONER INITIATED PROCEEDINGS U/S 263 AND SET ASIDE THE ASSESSMENT WITH THE DIRECTION TO THE AO TO REDO THE ASSESSMENT FRES H. THE AO, CCORDINGLY, MADE THE ADDITION WHICH WAS DELETED BY CIT(A) ON TH E GROUND THAT THE LIABILITY ON ACCOUNT OF DAMAGES ON BREACH OF CONTRACT ACCRUED ON 28 TH MAY, 1987 WHEN THE AWARD OF ARBITRATION WAS PASSED. THE TRIBUNAL UPHELD THE REVENUES CONTENTION, INTER-ALIA, OBSERVING AS UNDER: THE LIABILITY FOR THE UNLIQUIDATED DAMAGES WAS IN CHOATE, UNCERTAIN AND DISPUTED AND THE AMBIT OF THE DISPUTE WAS NOT MERELY CONFINED TO QUANTIFICATION OF THE DAMAGES. THE DISPUTE IN FACT INVOLVED THE VERY LIABILITY OF THE ASSESSEE TO PAY ANY DAMAGES TO THE FOREIGN PARTY. UNLESS THE DISPUTE WAS FINALLY SETT LED, IT COULD NOT BE SAID THAT ANY LIABILITY FOR PAYMENT OF DAMAGES HAD ACCRUED OR ARI SEN DURING THE YEAR. AS HELD BY THE SUPREME COUT IN CIT VS. HINDUSTAN HOUSING & LAND DE VELOPMENT TRUST LTD. (1986) 161 ITR 524 /27 TAXMAN 458, AN ENFORCEABLE LIABILITY WILL SPRIN G INTO EXISTENCE ONLY WHEN IT IS DETERMINED AND FINALLY FIXED BY A COURT OR ANY OTHER MUTUALLY AGREED FORUM. IN THE INSTANT CASE ON THE BASIS OF AVAILABLE MATER IALS IT WAS CLEAR THAT THE CONTRACT DID NOT PROVIDE FOR PAYMENT OF ANY PARTICULAR AMOUNT AS DAMAGES IN CASE OF BREACH OF THE CONTRACT AND THE CLAIM BY THE FOREIGN PARTY WAS FOR UNLIQUIDATED DAMAGES. 170.1 THUS, IN THIS CASE ALSO THE PROVISION WAS NOT MADE ON THE BASIS OF SOME CONTRACTUAL OBLIGATIONS BUT ON ACCOUNT OF ARBI TRATORS AWARD WHICH HAD NOT BECOME FINAL. 171. FROM THE ANALYSIS OF THE TWO DECISIONS RELIED UPON BY LD. DR, IT IS EVIDENT THAT BOTH ARE NOT APPLICABLE TO THE FACTS OF THE CASE. 172. ON THE OTHER HAND, WE FIND THAT THE CASE LAWS RELIED UPON BY LD. COUNSEL FOR THE ASSESSEE CLEARLY SUPPORT THE ASSESS EES CASE PARTICULARLY BECAUSE TERMS AND CONDITIONS OF AGREEMENT WITH CUST OMERS CONTAINED DELAYED ITA NO. 5637/D/2011 206 DELIVERY CLAUSE WHEREUNDER SPECIFIED PENALTY WAS TO BE PAID BY ASSESSEE FOR DELAY IN DELIVERY. WE FIND THAT HYDERABAD ITAT SPL . BENCH IN THE CASE OF KCP LIMITED, 34 ITD 50 IN PARA 8, INTER-ALIA, OBSERVED AS UNDER: 8. AS WE HAVE NOTED ABOVE, IT IS NOT IN DISPUTE THAT IN TERMS OF THE AGREEMENTS OF THE ASSESSEE FOR THE SUPPLY OF GO ODS, TIME WAS THE ESSENCE OF THE CONTRACT AND ANY DELAY IN THE DE LIVERY OF THE GOODS WOULD RESULT IN THE LIABILITY TO PAY DAMAGES. THAT THE PARTIES MEAN IT SERIOUSLY IS PROVED BY THE FACT OF PROVISION FOR BANK GUARANTEE UP TO THE MAXIMUM VALUE OF LIQUIDATED DAM AGES. IT IS ALSO NOW SETTLED THAT EVEN CONTINGENT LIABILITIES, IF PROPERLY VALUED ON SCIENTIFIC BASIS, CAN BE TAKEN INTO ACCOUNT AS T RADING EXPENSES IF THEY ARE SUFFICIENTLY CERTAIN AND CAPABLE OF VALUAT ION AND PROFITS CANNOT BE PROPERLY ESTIMATED WITHOUT TAKING THEM IN TO ACCOUNT METAL BOX CO. OF INDIA LTD. VS. THEIR WORKEN [1969] 73 ITR 53 AT 64 (SC)]. BUT, THIS IS NOT TO ACCEPT THAT THE PROV ISION MADE FOR LIQUIDATED DAMAGES IS A CONTINGENT LIABILITY. THE STIPULATION IN THE CONTRACT CLEARLY SHOWS THAT THE LIABILITY FOR LIQUI DATED DAMAGES IS CERTAIN, ACCRUED AND IS NOT TO DEPEND UPON THE HAPP ENING OF ANY EVENT OTHER THAN DELAY IN DELIVERIES. THE ONLY POI NT IN DISPUTE IN THE PRESENT CASE IS WHETHER THE LIABILITY FOR PAYME NT OF DAMAGES SHOULD BE TAKEN AT THE POINT OF TIME WHEN THE BREAC H OCCURRED OR AT THE POINT OF TIME WHEN THE ASSESSEE DELIVERED THE G OODS AND RAISED THE BILL. THE DISTANCE BETWEEN THESE TWO POINTS OF TIME WOULD MADE NO DIFFERENCE IF THEY HAPPEN TO BE IN THE SAME PREV IOUS YEAR AND WOULD MAKE NO DIFFERENCE EVEN IF THEY ARE IN TWO DI FFERENT PREVIOUS YEARS, AS IN THE PRESENT CASE OF A COMPANY, THE RAT E OF TAX IS THE SAME. THE REVENUE INSISTS ON THE LIABILITY BEING A CCOUNTED FOR ONLY AT THE POINT OF DELIVERY ON THE GROUND THAT THERE I S A LIKELIHOOD OF THE CLAIM BEING MADE FOR DAMAGES BY THE OTHER PARTY ONLY AT THAT ITA NO. 5637/D/2011 207 POINT OF TIME, AND ON THE DATE OF BREACH THERE WAS ONLY A UNILATERAL PROVISION FOR POSSIBLE CLAIM FOR DAMAGES. THIS, HO WEVER, DOES NOT SEEM TO BE THE AGREEMENT BETWEEN THE PARTIES, NOR E VEN UNDER CONTEMPLATION. ON THE OTHER HAND, THE CLAUSE IN TH E AGREEMENT EXTRACTED ABOVE DOES CLEARLY PROVIDE FOR THE PAYMEN T OF LIQUIDATED DAMAGES NO SOONER THAN THE DELAY TAKES PLACE AND AS A GUARANTEE FOR PAYMENT OF LIQUIDATED DAMAGES BANK GUARANTEE WA S TO BE GIVEN FOR THE FULL AMOUNT OF LIQUIDATED DAMAGES. THERE M AY BE A POSSIBILITY FOR THE DEDUCTION OF LIQUIDATED DAMAGES ON NEGOTIATION. BUT THAT IS NOT TO SAY THAT THE LIABILITY TO PAY LI QUIDATED DAMAGES DID NOT ACCRUE. NOR DOES IT STAND TO REASON BECAUS E THE DELAY IN THE DELIVERY OF THE GOODS UNDER THE TERMS OF THE AG REEMENTS IN QUESTION CONSTITUTED BREACH, IT DOES NOT DISCHARGE THE CONTRACT AS SUCH, BECAUSE ADMITTEDLY THE CONTRACTS HAVE NOT BEE N AVOIDED BY THE OTHER SIDE AT ALL. THE REASON IS THAT THEY WER E CONTINUING CONTRACTS FOR MANUFACTURING OF ARTICLES TO THE SPEC IFICATION OF THE PURCHASER AND TIME WAS STIPULATED AS THE ESSENCE OF THE CONTRACT ; NONETHELESS IT WOULD HAVE SERVED NO PURPOSE IF THE PURCHASER HAD CANCELLED THE CONTRACT WHEN THE WORK ON THE MANUFAC TURE OF THE MACHINERY HAD PROGRESSED PERHAPS A VERY LARGE EXTEN T AND PAYMENTS WERE MADE IN THE MEAN TIME AS PER THE TERM S OF CONTRACT. THAT WAS THE REASON WHY PENALTIES HAVE BEEN PROVIDE D IN THE AGREEMENT ITSELF DEPENDING ON THE PERIOD OF DELAY W HICH IS INTENDED TO ACT AS A DETERRENT AGAINST DELAYS IN DE LIVERIES AND THIS IS TO AVOID FUTURE LITIGATION AS TO THE QUANTUM OF DAMAGES. UNDER SECTION 74 OF THE INDIAN CONTRACT ACT, EVEN IF THER E IS A STIPULATION BY WAY OF PENALTY, THE PARTY COMPLAINING IS ENTITLE D TO RECEIVE ONLY REASONABLE COMPENSATION NOT EXCEEDING THE AMOUNT NA MED. SECTION 74 READS AS FOLLOWS: ITA NO. 5637/D/2011 208 WHEN A CONTRACT HAS BEEN BROKEN, IF A SUM IS NAMED IN THE CONTRACT AS THE AMOUNT TO BE PAID IN CASE OF SUCH B REACH, OR IF THE CONTRACT CONTAINS ANY OTHER STIPULATION BY WAY OF P ENALTY, THE PARTY COMPLAINING OF THE BREACH IS ENTITLED, WHETHER OR N OT ACTUAL DAMAGE OR LOSS IS PROVED TO HAVE BEEN CAUSED THEREB Y, TO RECEIVE FROM THE PARTY WHO HAS BROKEN THE CONTRACT REASONAB LE COMPENSATION NOT EXCEEDING THE AMOUNT SO NAMED OR, AS THE CASE MAY BE, THE PENALTY STIPULATED FOR. THIS SHOWS THAT THE CLAIM FOR DAMAGES ARISES AT THE POINT OF BREACH BUT THE QUANTIFICATION OF DAMAGES IS SUBJECT TO NEG OTIATION, THOUGH THE CEILING OF THE AMOUNT IS STIPULATED IN THE CONT RACT. AS FAR AS THE ASSESSEE IS CONCERNED, THE LIABILITY TO PAY DAMAGES AROSE AT THE POINT OF TIME WHEN THE BREACH OCCURRED I.E., WHEN I T FAILED TO DELIVER ON THE DUE DATE, AND AT THAT POINT OF TIME THE LIABILITY ACCRUED WHICH AS A PRUDENT TRADER IT COULD QUANTIFY AND TAKE INTO ACCOUNT BY MEANS OF A PROVISION. SINCE THE AGREEME NTS HAVE ALREADY STIPULATED THE AMOUNT, THERE WAS NOTHING WR ONG IN ADOPTING THE SAME FORMULA FOR COMPUTING THE AMOUNT. ALL THAT HAS HAPPENED IS SINCE THE DELAY STRETCHED BEYOND THE PR EVIOUS YEAR, THE ASSESSEE HAS APPORTIONED THE DAMAGES AND HAS TAKEN INTO ACCOUNT ONLY THAT AMOUNT WHICH IS RELATABLE TO THE DELAY TH AT HAS OCCURRED IN THE PREVIOUS YEAR IN QUESTION. THIS IS PERHAPS PROPER AND RATIONAL AND WE CAN SEE NOTHING WRONG IN THIS METHO D OF ACCOUNTING EITHER IN LAW OR AS A MATTER OF METHOD O F ACCOUNTING WHICH HAS BEEN CONSISTENTLY FOLLOWED BY THE ASSESSE E, TO WHICH NO OBJECTION WAS TAKEN BY THE REGULAR AUDIT AS WELL AS BY THE TAX AUDIT. THE DEPARTMENT DOES NOT EITHER DISPUTE THE ACCRUAL OF LIABILITY TO PAY LIQUIDATED DAMAGES, BUT IN FACT IT ACTUALLY ALLOWED THE WHOLE AMOUNT IN THE YEAR IN WHICH DELIVERIES WE RE GIVEN. AS WE HAVE POINTED OUT ABOVE, THE CONTRACT DOES NOT PR OVIDE FOR SUCH ITA NO. 5637/D/2011 209 A SITUATION, NOR DOES THE LIABILITY TO PAY THE LIQU IDATED DAMAGES ARISE ON DELIVERY. CLAIMING THE LIQUIDATED DAMAGES AS AND WHEN DELAYS TAKE PLACE IS AN EASIER METHOD, AND SHOULD T HERE BE ANY DIFFICULTY IN CALCULATIONS OR QUANTIFICATION, THAT MAY RENDER THE AMOUNT PROVIDED AS DAMAGES INCORRECT BUT THAT DOES NOT POSTPONE OF ACCRUAL OF LIABILITY. AS WE HAVE POINTED OUT, W HAT WAS IN DISPUTE WAS THE POINT OF ACCRUAL OF LIABILITY UNDER THE TER MS OF THE CONTRACT, BUT NOT EITHER QUANTIFICATION OR THE FACT THAT THE LIABILITY TO PAY LIQUIDATED DAMAGES AS AND WHEN DELAYS HAD TAKEN PLA CE. 173. SIMILAR VIEW HAS BEEN TAKEN IN OTHER CASES ALS O. IN THE CASE OF FFE MINERALS PVT. LTD. (SUPRA), WHILE ALLOWING THE PROV ISION FOR LIQUIDATED DAMAGES, INTER-ALIA, OBSERVED IN PARA 13 THAT THE DECISION O F HONBLE KERALA HIGH COURT IN N. SUDERSHARAM (SUPRA) IS NOT RELEVANT IN DECIDING THE ISSUE. 174. WE FURTHER NOTICE THAT PUNE ITAT IN THERMAX BE BCOCK AND WILCOX LTD. (SUPRA) 304 ITR 130 IN PARA 24.5 TO PARA 25, H AS OBSERVED AS UNDER: 33. HAVING REGARD TO THE FACTS AND CIRCUMSTANCES O F THE CASE AND SUBMISSIONS OF BOTH THE PARTIES, THERE IS NO DI SPUTE AS TO THE FACT THAT THE STIPULATION PROVIDING THE PAYMENT OF LIQUIDATED DAMAGES TO THE OTHER PARTY FOR DELAY IN COMPLETING THE WORK, IS A PART OF THE CONTRACT AGREEMENT ENTERED INTO BY BOTH THE PARTIES FOR EXECUTING AND COMPLETING THE WORK. IN OTHER WO RDS, THE CONDITION FOR PAYMENT OF LIQUIDATED DAMAGES FOR DEL AY IN WORK IS IN-BUILT IN THE CONTRACT AGREEMENT ITSELF. THEREFO RE, THERE EXISTS AN UNDERTAKING GIVEN BY THE PARTIES TO EXECUTE THE WORK WITHIN THE SPECIFIED TIME, THE DEFAULTER HAS AGREED TO PAY DAMAGES ON ACCOUNT THEREOF. THIS UNDERTAKING IS NOT FOUND TO BE CONDITIONAL. THUS, THIS UNDERTAKING IMPORTED A DEFINITE LIABILIT Y ON THE ASSESSEE WHICH ACCRUED AS SOON AS THE DELAY IN EXEC UTING THE ITA NO. 5637/D/2011 210 WORKS HAD FIRST OCCURRED AND CONTINUED TILL THE WOR K WAS FULLY COMPLETED, THOUGH THAT LIABILITY WAS TO BE QUANTIFI ED PRECISELY AND DISCHARGED AT A FUTURE DATE. ON THIS ASPECT, W E MAY AGAIN USEFULLY6 REFER TO A DECISION OF THE HONBLE SUPREM E COURT IN THE CASE OF CALCUTTA CO. LTD. [1959] 37 ITR 1 WHERE THE ASSESSEES LIABILITY TOWARDS UNDERTAKING TO CARRY OUT DEVELOPM ENT WORK WITHIN SIX MONTHS FROM THE DATE OF THE DEEDS OF SAL E WAS HELD TO HAVE BEEN ACCRUED ON THE DATES OF THE DEEDS OF SALE , THOUGH THAT LIABILITY WAS TO BE DISCHARGED AT A FUTURE DATE. I N THIS CASE THE HONBLE SUPREME COURT FURTHER HELD THAT IT WAS AN A CCRUED LIABILITY, AND THE ESTIMATED EXPENDITURE WHICH WOUL D BE INCURRED IN DISCHARGING THE SAME COULD BE DEDUCTED FROM THE PROFITS AND GAINS OF BUSINESS AND THE AMOUNT TO BE EXPENDED COU LD BE DEBITED IN ACCOUNTS MAINTAINED IN THE MERCANTILE SY STEM OF ACCOUNTING BEFORE IT WAS ACTUALLY DISBURSED, AND TH E DIFFICULTY IN THE ESTIMATION THEREOF DID NOT CONVERT THE ACCRUED LIABILITY INTO A CONDITIONAL ONE, BECAUSE IT WAS ALWAYS OPEN TO THE INCOME-TAX AUTHORITIES CONCERNED TO ARRIVE AT A PROPER ESTIMAT E THEREOF HAVING REGARD TO ALL THE CIRCUMSTANCES OF THE CASE. IN THIS CASE, THE HONBLE SUPREME COURT HAS GIVEN EMPHASIS ON THE ASSESSEES OWN UNCONDITIONAL UNDERTAKING TO CARRY OUT DEVELOPM ENT WORKS WITHIN SIX MONTHS FROM THE DATES OF THE DED OF SALE WHEREBY THE ASSESSEE BOUNDED ITSELF ABSOLUTELY TO CARRY OUT THE SAME, THOUGH THE WORK WAS TO BE CARRIED OUT WITHIN SIX MONTHS FR OM THE DEED OF SALE. THE VERY UNDERTAKING GIVEN BY THE ASSESSEE T O CARRY OUT THE DEVELOPMENT WORK WITHIN SIX MONTHS FROM THE DATES O F DEEDS OF SALE HAS IMPORTED A LIABILITY ON THE ASSESSEE WHICH ACCRUED ON THE DATES OF THE DEEDS OF SALE, THOUGH THAT LIABILI TY WAS TO BE DISCHARGED AT A FUTURE DATE. IN THIS CASE, THE HON BLE SUPREME COURT HAS ALSO POINTED OUT THAT THE TAXABLE INCOME IS NOT ON ITA NO. 5637/D/2011 211 GROSS RECEIPTS, BUT ON PROFITS AND GAINS OF THE BUS INESS. THE PROFITS SHOULD BE UNDERSTOOD IN ITS NATURAL AND PRO PER SENSE, IN A SENSE WHICH NO COMMERCIAL MAN WOULD MISUNDERSTAND. IT HAS TO BE REAL PROFITS. IT WAS FOR THIS REASON THAT A DED UCTION OF A PROVISION IN RESPECT OF THE LIABILITY THE ASSESSEE HAD UNDERTAKEN BY WAY OF PROVIDING AMENITIES OR DEVELOPMENT WORK W ITHIN SIX MONTHS FROM THE DATE OF DEED OF SALE WAS ALLOWED AS A DEDUCTION. APPLYING THE SAME ANALOGY TO THE PRESENT CASE, WE F IND THAT THE ASSESSEE HAS IMPORTED A LIABILITY ON ITSELF TO PAY LIQUIDATED DAMAGES FOR THE DELAY IN COMPLETING THE WORK WITHIN THE SPECIFIED TIME, AND AS SUCH, THE ESTIMATED EXPENDITURE WHICH WOULD BE INCURRED TOWARDS LIQUIDATED DAMAGES WOULD BE DEDUCT IBLE FROM THE RECEIPTS OF THE YEAR. THIS CERTAIN ACT OR EVEN T OF NOT COMPLETING THE WORK WITHIN STIPULATED TIME HAS IMPO RTED A DEFINITE AND ABSOLUTE LIABILITY ON THE ASSESSEE AND MERELY BECAUSE OF THE FACT THAT LIABILITY WOULD BE DISCHARGED AT A FUTURE DATE AND, THERE IS A DIFFICULTY IN ESTIMATING THE CORRECT AMO UNT THEREOF WOULD NOT CONVERT THIS DEFINITE AND ABSOLUTE LIABIL ITY INTO CONDITIONAL ONE AS HAS BEEN HELD BY THE HONBLE SUP REME COURT IN THE CASE OF CALCUTTA CO. LTD. VS. CIT [1959] 37 ITR 1 (SC), METAL BOX COMPANY OF INDIA LTD. VS. THEIR WORKMEN [ 1969] 37 ITR 53 (SC) AND BHARAT EARTH MOVERS VS. CIT [2000] 245 ITR 428 (SC). IN THIS VIEW OF THE MATTER, WE MAY, THER EFORE, SAY THAT THE REASONS GIVEN BY THE AO AS WELL AS BY THE CIT(A PPEALS) FOR REJECTING THE ASSESSEES CLAIM IS NOT IN CONSONANCE WITH THE PRINCIPLE LAID DOWN BY THE HONBLE SUPREME COURT IN THE CASE OF CALCUTTA CO. LTD. VS. CIT [1959] 37 ITR 1 AND BHARA T EARTH MOVERS VS. CIT [2000] 245 ITR 428 (SC). THE VERY P RINCIPLES LAID DOWN BY THE HONBLE SC IN THE CASE OF CALCUTTA CO. LTD. VS. CIT [1959] 37 ITR 1 WERE ALSO FOLLOWED BY THE KERAL A HIGH ITA NO. 5637/D/2011 212 COURT IN THE CASE OF CIT VS. INDIAN TRANSFORMERS LT D. [2004] 270 ITR 259 AND THE HONBLE DELHI HIGH COURT IN CIT VS. VINITEC CORPORATION P. LTD. [2005] 278 ITR 337 WHILE DECIDI NG THE ASSESSEES CLAIM FOR LIABILITY TOWARDS WARRANTY CLA USE PROVIDED IN THE SALE AGREEMENT ITSELF. IN THIS CASE, IT WAS HELD THAT THE TAXPAYER WAS IN THE YEAR OF SALE UNDER AN ACCRUED L EGAL OBLIGATION TO MAKE PAYMENTS UNDER WARRANTY CLAIMS, EVEN FURTHER HELD THEREIN THAT IN COMPUTING THE PROFITS OR GAINS DERIVED BY TAXPAYER IN ITS BUSINESS IN THE YEAR IN WHICH THE V EHICLES WERE SOLD THE TAX PAYER WAS ENTITLED TO DEDUCT FROM ITS TOTAL INCOME THE PROVISION WHICH IT HAD MADE FOR THE COST OF ITS ANT ICIPATED LIABILITIES UNDER OUTSTANDING WARRANTIES IN RESPECT OF THE VEHICLES SOLD IN THAT YEAR. IN THE CASE OF WARRANTY, ALTHOU GH IT CANNOT OF COURSE BE PREDICTED WHETHER ANY PARTICULAR VEHICLE WILL TURN OUT TO BE DEFECTIVE OR HOW SERIOUS THE DEFECT WILL BE, THE TAXPAYER CAN MAKE A REASONABLY ACCURATE FORECAST BASED ON PREVIO US EXPERIENCE, OF WHAT WILL BE THE TOTAL COST OF REMED IAL WORK FOR ALL THE VEHICLES SOLD IN A GIVEN YEAR. IN THESE CASES, A VIEW WAS THEREFORE TAKEN THAT THE ANTICIPATED LIABILITIES UN DER UNEXPIRED WARRANTIES WHEN ESTIMATED WITH REFERENCE TO STATIST ICAL INFORMATION WOULD BE A CHARGE ON THE PROFIT ARISING FROM THE SALE OF THE GOODS IN RESPECT OF WHICH WARRANTY WAS GIVEN AND, THUS, HAVE TO BE ALLOWED AS DEDUCTION. ON THE ISSUE OF C LAIM OF DEDUCTION ON ACCOUNT OF WARRANTY IN RESPECT OF THE GOODS SOLD IN PARTICULAR YEAR, A REFERENCE WAS ALSO MADE TO THE D ECISION OF THE PRIVY COUNCIL IN THE CASE OF IRC VS. MITSUBISHI MOT ORS NEW ZEALAND LTD. [1996] 222 ITR 697 BY THE HONBLE DELH I HIGH COURT IN THE CASE OF CIT VS. VINITEC CORPORATION P. LTD. [2005] 278 ITR 337. THE HONBLE DELHI HIGH COURT AS WELL AS THE HONBLE KERALA HIGH COURT IN THE AFORESAID TWO CASE S HAVE TAKEN ITA NO. 5637/D/2011 213 NOTE OF THE PRINCIPLES LAID DOWN BY THE HONBLE SUP REME COURT IN THE CASES OF CALCUTTA CO. LTD. VS. CIT [1959] 37 IT R 1AND BHARAT EARTH MOVERS V. CIT [2000] 245 ITR 428. THEREFORE, APPLYING THE SAME ANALOGY AS APPLIED IN THE CASE OF WARRANTY BY THE HONBLE KERALA HIGH COURTS, THE DELHI HIGH COURT A ND THE PRIVY COUNCIL IN THE CASES OF (I) CIT VS. INDIAN TR ANSFORMERS LTD. [2004] 270 ITR 259, (II) CIT VS. VINITEC CORPORATIO N P. LTD. [2005] 278 ITR 337 AND (III) IRC VS. MITSUBISHI MOT ORS NEW ZEALAND LTD. [1996] 222 ITR 697 RESPECTIVELY. IN T HE PRESENT CASE CAN BE EASILY RESOLVED IN FAVOUR OF THE ASSESS EE. IN THE PRESENT CASE, THE WORKS HAVE BEEN EXECUTED AFTER TH E EXPIRY OF THE STIPULATED PERIOD. THE STIPULATION AS TO THE PAYME NT OF LIQUIDATED DAMAGES TOWARDS DELAY IN EXECUTING THE CONTRACT WOR K IS RELATED TO THE CONTRACT WORK, REVENUE THEREOF HAS BEEN ACCO UNTED FOR IN THE YEAR UNDER CONSIDERATION. ALTHOUGH EXACT QUANT IFICATION OF THE CLAIM OF LIQUIDATED DAMAGES MAY BE MADE AT A FU TURE DATE, THE ASSESSEE PAYER WAS, IN OBLIGATION TO PAY LIQUID ATED DAMAGES FOR THE DELAY IN WORK DID ACCRUE ON THE DATE WHEN T HE DELAY WAS FIRST OCCURRED AND CONTINUED UPTO THE DATE OF COMPL ETION OF THE WORK, AND THUS, IN COMPUTING THE PROFIT AND GAINS D ERIVED BY THE TAXPAYER FROM SUCH CONTRACT WORKS IN THE PRESENT YE AR, THE ASSESSEE TAX PAYER IS ENTITLED TO DEDUCT FROM THE P ROFITS FROM THE AFORESAID CONTRACT WORKS A PROVISION, FOR THE COST OF THE ANTICIPATED LIQUIDATED DAMAGES IN SO FAR AS THE SAM E IS RELATED TO THE PERIOD OF DELAY FALLING WITHIN THE YEAR UNDER C ONSIDERATION. 174.1 IT HAS ALSO ALLOWED THE ASSESSEES CLAIM OF L IQUIDATED DAMAGES FOLLOWING THE DECISION OF HONBLE SUPREME COURT IN THE CASE OF CALCUTTA COMPANY LTD. VS. CIT (1959) 37 ITR 1 AND BHARAT EAR TH MOVERS VS. CIT,245 ITR 428 (SC). ITA NO. 5637/D/2011 214 175. IN VIEW OF ABOVE DISCUSSION, THIS GROUND IS AL LOWED FOR STATISTICAL PURPOSES. 176. APROPOS GROUND NO. 7.2 LD. COUNSEL SUBMITTED T HAT THE SAME HAS BECOME INFRUCTUOUS BECAUSE RELIEF HAS BEEN GIVEN TO ASSESSEE. 177. GROUND NO. 8 IS IN REGARD TO DISALLOWANCE OF C OMPUTER SOFTWARE EXPENSES AGGREGATING TO RS. 1CRORE 10 LAKHS ON THE GROUND THAT THESE ARE CAPITAL IN NATURE. 178. BRIEF FACTS OF THE CASE ARE THAT THE ASSESSEE CLAIMED SOFTWARE EXPENSES (PRICING OF AMCS, SOFTWARE PURCHASES WITH LESS THAN ONE YEAR LIFE AND SOFTWARE UPGRADES) AMOUNTING TO RS. 1,10,00000/ - AS REVENUE EXPENDITURE. THE AO DISALLOWED THE ASSESSEES CLAIM TREATING THE SAME AS CAPITAL EXPENDITURE. 178.1 HAVING HEARD BOTH THE PARTIES, WE RESTORE THI S ISSUE TO THE FILE OF AO TO DECIDE THIS IN THE LIGHT OF GUIDELINES LAID DOWN BY SPL. BENCH OF ITAT DELHI IN THE CASE OF AMWAY INDIA ENTERPRISES VS. DCIT, 301 I TR 1. 179. IN THE RESULT, THIS GROUND IS ALLOWED FOR STAT ISTICAL PURPOSES. 180. GROUND NO. 9 WAS NOT PRESSED AT THE TIME OF HE ARING. 181. GROUND NO. 10 DEALS WITH NON-ALLOWANCES OF TDS AND ADVANCED TAX CREDIT. 182. LD. COUNSEL SUBMITTED THAT ASSESSEE HAS PROVID ED ORIGINAL TDS CERTIFICATES AND ADVANCED TAX CHALLANS TO THE AO. HOWEVER, THE AO DID NOT ALLOW THE CREDIT OF TDS AND ADVANCED TAX WHILE PASS ING THE ASSESSMENT ORDER. HAVING HEARD BOTH THE PARTIES, WE RESTORE THIS ISSU E TO THE FILE OF AO TO ALLOW THE ASSESSEES CLAIM IN ACCORDANCE WITH LAW. ITA NO. 5637/D/2011 215 183. GROUND NO. 11 WAS NOT PRESSED AT THE TIME OF H EARING. 184. GROUND NO. 12 DEALS WITH WRONG LEVY OF INTER EST U/S 234C THE ASSESSEE BY WAY OF ADDITIONAL GROUND HAS ASSAILED T HE LEVY OF INTEREST U/S 234C BY AO WHILE PASSING THE ORDER U/S 154. THE ASSESSE ES SUBMISSION IS THAT INTEREST U/S 234C IS TO BE COMPUTED AS PER THE RETU RNED INCOME AND NOT AS PER THE ASSET INCOME. IN REGARD TO THE SUBMISSION OF L D. DR THAT IN THE CASE OF ANJUM GASWALLA, SUPREME COURT IT HAS BEEN HELD THAT THE INTEREST U/S 234A, 234B & 234C IS MANDATORY, LD. COUNSEL SUBMITTED THA T THE SAID CASE LAW DOES NOT DEAL WITH THE ISSUE AS TO WHETHER THE INTEREST U/S 234C IS APPLICABLE ON RETURNED INCOME OR ASSET INCOME. HE, THEREFORE, SU BMITTED THAT THE SAID DECISION IS NOT APPLICABLE IN THE PRESENT CASE. 184.1 WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE PERUSED THE RECORD OF THE CASE. WE FIND CONSIDERABLE FORCE IN THE SUBMISSION OF LD. COUNSEL FOR THE ASSESSEE THAT AS PER SECTION 234C, THE INTE REST IS TO BE COMPUTED WITH REFERENCE TO RETURNED INCOME AND NOT ASSESSED INCOM E. ACCORDINGLY, THE AO IS DIRECTED TO COMPUTE THE INTEREST AS PER RETURNED IN COME IN ACCORDANCE WITH LAW. 185. IN THE RESULT, THIS GROUND IS ALLOWED FOR STAT ISTICAL PURPOSES. 186. WHILE PARTING, WE WOULD LIKE TO PLACE ON RECO RD OUR DEEP APPRECIATION FOR THE UNRELENTING ASSISTANCE EXTENDED BY SHRI PI YUSH JAIN LD. CIT(DR) ON BEHALF OF DEPARTMENT AND THE TEAM LED BY SHRI HIMAN SHU SINHA ON BEHALF OF THE REPRESENTATIVES OF BOTH THE PARTIES, DUE TO WHI CH WE HAVE BEEN ABLE TO ASSESS THE LEGAL POSITION AS EMANATING FROM THE INN UMERABLE NUMBER OF CASES CITED BY BOTH THE PARTIES. ITA NO. 5637/D/2011 216 187. IN THE RESULT, THE ASSESSEES APPEAL IS PARTLY ALLOWED FOR STATISTICAL PURPOSES. ORDER PRONOUNCED IN THE OPEN COURT ON 14/08/2014 SD/- SD/- (DIVA SINGH) JUDICIAL MEMBER (S.V. MEHROTRA) ACCOUNTANT MEMBER DATED: 14/08/2014 *KAVITA COPY TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT(A) 5. DR, ITAT, NEW DELHI. TRUE COPY BY ORDER ASSISTANT REGISTRAR