Qual Core Logic Limited, Hyderabad V. DCIT,Circle-16(3), Hyderabad

ITA 893/HYD/2011

• Counselvise Citation: [2012] 140 COUNSELVISE.COM (IT) 61900 (ITAT-HYDERABAD)
• Duration Of Justice: 1 year(s) 19 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 31-05-2012
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: A
• Assessment Year: 2005-2006
• Appeal Filed On: 12-05-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: SUBHASREE ANANTH KRISHNAN
• Keywords: Related party transaction; Depreciation; Transfer pricing; International transaction
• Section: 92C; 143(3); 194C; 10B; 92

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCH A', HYDERABAD BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SMT. ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER I.T.A. NO. 893/HYD/2011 ASSESSMENT YEAR 2005-06 M/S. QUAL CORE LOGIC LTD. HYDERABAD PAN: AAACQ0360J VS. DY. COMMISSIONER OF INCOME - TAX, CIRCLE-16(3) HYDERABAD APPELLANT RESPONDENT APPELLANT BY: SHRI PVSS PRASAD RESPONDENT BY: SMT. SUBHASREE ANANTH KRISHNAN DATE OF HEARING: 19 . 04 .201 2 DATE OF PRONOUNCEMENT: 31 .05.2012 O R D E R PER CHANDRA POOJARI, AM: THIS APPEAL BY THE ASSESSEE IS DIRECTED AGAINST THE ORDER OF THE CIT(A)-III, HYDERABAD DATED 18.3.2011. 2. THE ASSESSEE HAS RAISED THE FOLLOWING GROUNDS OF AP PEAL. 1. THE LEARNED CIT (A) IS ERRONEOUS IN LAW AND ON THE FACTS OF THE CASE. 2. THE LEARNED CIT (A) IS NOT JUSTIFIED IN LAW IN REJECTING THE MOST APPROPRIATE METHOD (MAM) ADOPTED BY THE APPELLANT-COMPANY AS COMPARABLE UNCONTROLLED PRICE METHOD (CUP) FOR BENCHMARKING THE ARM'S LENGTH PRICE IN RESPECT OF INTERNATIONAL TRANSACTIONS OF EXPORT SALES OF RS . 6,01,83,326/-. 3. THE LEARNED CIT(A) ERRED IN OBSERVING THAT THE SERVICES RENDERED TO THIRD PARTIES ARE NOT SIMILAR TO THAT RENDERED TO THE ASSOCIATED ENTERPRISE AS PER THE AGREEMENT ENTERED INTO BETWEEN THE APPELLANT WITH ITS AE AND THE AGREEMENTS ENTERED INTO BETWEEN THE APPELLANT AND THIRD PARTIES. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 2 4. THE LEARNED CIT (A) OUGHT TO HAVE ACCEPTED CUP METHOD ADOPTED BY THE APPELLANT AS THE MOST APPROPRIATE METHOD AND OUGHT TO HAVE ACCEPTED THE INTERNATIONAL TRANSACTIONS AS COMPLIED WITH ARMS LENGTH PRINCIPLE. 5. THE LEARNED CIT (A) OUGHT TO HAVE ACCEPTED COST PLUS METHOD (CPM) AS AN ALTERNATIVE METHOD SINCE TRANSACTIONS MADE BY THE APPELLANT WITH UNRELATED THIRD PARTIES AND THE INTERNATIONAL TRANSACTIONS WITH AE ARE FUNCTIONALLY COMPARABLE. 6. THE LEARNED CIT(A) ERRED IN ENDORSING THE TPO'S ACTION OF REJECTING THE FOUR COMPARABLES WHICH WERE ACCEPTED IN THE EARLIER ASSESSMENT YEARS I.E., AY 2003-04 AND AY 2004-05 FOR APPLYING TNMM. 7. THE LEARNED CIT (A) IS NOT JUSTIFIED IN LAW IN CONSIDERING THE 16 COMPANIES SELECTED BY THE LD TPO AS COMPARABLES AND ARRIVING AT A PLI OF 26.41% AS A RATIO OF OPERATING PROFIT/TOTAL COST. FOR APPLYING TNMM THE 16 COMPANIES SELECTED AS COMPARABLES ARE ENGAGED IN SOFTWARE DEVELOPMENT SERVICES AND ARE IN NO WAY FUNCTIONALLY SIMILAR TO THE BUSINESS OF THE APPELLANT. 8. THE LEARNED CIT (A) IS NOT JUSTIFIED IN LAW IN ENDORSING THE OBSERVATION OF THE LD TPO BY MAKING AN ADDITION OF -5.12% ON ACCOUNT OF NEGATIVE WORKING CAPITAL ADJUSTMENT. 9. THE LEARNED CIT (A) IS NOT JUSTIFIED IN LAW IN ARRIVING AT ADJUSTED ARITHMETIC MEAN PLI TO THE TUNE OF 31.53% AS PER 7 AND 8 ABOVE (26.41+5.12). 10. THE LEARNED CIT (A) ERRED IN NOT GIVING ADJUSTMENT ON ACCOUNT OF HIGH DEPRECIATION TO THE TOTAL COST IN THE CASE OF THE APPELLANT. THE LEARNED CIT(A) OUGHT TO HAVE GIVEN RELIEF FOR THE HIGH COST OF DEPRECIATION (28.60%) WHEN COMPARED TO OTHER INDIAN COMPANIES WHOSE DEPRECIATION IS ONLY 10 TO 11 % OF THE TOTAL COST. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 3 11. THE LEARNED CIT(A) OUGHT TO HAVE CONSIDERED FOUR COMPARABLES ACCEPTED IN THE EARLIER YEARS FOR APPLYING TNMM AND OUGHT TO HAVE ADOPTED PROFIT BEFORE DEPRECIATION, INTEREST AND TAXES (PBDIT)/TOTAL COST AS THE PROFIT LEVEL INDICATOR (PLI) ON ACCOUNT OF HIGH DEPRECIATION COMPONENT IN THE APPELLANT'S CASE. 3. BRIEF FACTS OF THE CASE ARE THAT THE ASSESSEE IS A COMPANY WHICH DERIVES INCOME FROM SOFTWARE DEVELOPMENT. FO R THE A.Y. 2005-06, IT HAS FILED ITS RETURN OF INCOME ON 29.10 .2005 SHOWING LOSS OF RS. 1,70,30,983. AFTER PROCESSING OF THE S AID RETURN U/S. 143(3) OF THE INCOME-TAX ACT, 1961, THE SAME WAS SE LECTED FOR SCRUTINY ASSESSMENT. DURING THE ASSESSMENT PROCEEDI NGS, THE ASSESSING OFFICER NOTICED THAT THE ASSESSEE DURING THE PREVIOUS YEAR HAS ENTERED INTO INTERNATIONAL TRANSACTIONS WI TH ITS ASSOCIATED ENTERPRISES (AE). FOR COMPUTATION OF THE ARM'S LENGTH PRICE (ALP FOR SHORT) OF SUCH TRANSACTIONS, THE ASS ESSING OFFICER, DURING THE ASSESSMENT PROCEEDINGS, HAS MADE A REFER ENCE TO THE TRANSFER PRICING OFFICER (TPO FOR SHORT) U/S. 92CA( 1) OF THE ACT. IN RESPONSE TO THIS, THE TPO, AFTER CONDUCTING NECESSA RY ENQUIRIES AND VERIFICATION IN THE MATTER, VIDE HIS ORDER DATE D 31.10.2008 PASSED U/S. 92CA(3) OF THE ACT, DETERMINED THE ALP OF SUCH TRANSACTIONS AT RS. 12,74,96,713/-, AS AGAINST RS. 6,97,03,702/- SHOWN BY THE ASSESSEE, THEREBY SUGGESTING FOR ADJUS TMENT OF RS. 5,77,93,011/- U/S. 92CA OF THE ACT. IN THE TRANSFER PRICING ANALYSIS CARRIED ON BY HIM, THE TPO REJECTED THE COMPARABLE UNCONTROLLED PRICE METHOD ('CUP' IN SHOR T) APPLIED BY THE ASSESSEE AND ADOPTED TRANSACTIONAL NET MARGIN M ETHOD (TNMM) AS THE MOST APPROPRIATE METHOD FOR COMPUTATI ON OF ALP IN THIS CASE. LATER, IN CONFORMITY WITH SUCH ORDER OF THE TPO, THE ASSESSING OFFICER, WHILE ADOPTING SUCH ALP AS DETER MINED BY THE TPO, MADE AN ADDITION OF RS. 5,77,93,011/- TO THE R ETURNED INCOME OF THE ASSESSEE U/S. 92CA OF THE ACT. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 4 4. DURING THE ASSESSMENT, THE ASSESSING OFFICER FURTHE R NOTICED THAT THE ASSESSEE HAS PAID AN AMOUNT OF RS. 1,44,00 0/- TOWARDS INTERIOR DESIGN TO M/S. EXPANSE DESIGN SOLUTIONS. ACCORDING TO HIM, SUCH EXPENDITURE BEING COVERED UNDER THE PROVI SIONS OF 194C OF THE ACT, THE ASSESSEE WAS REQUIRED TO DEDUCT TAX AT SOURCE ON THE SAME. BUT, IN ABSENCE OF ANY TDS MADE BY THE A SSESSEE, THE ASSESSING OFFICER DISALLOWED THE SAME, APPLYING THE PROVISIONS OF SECTION 40(A)(IA) OF THE ACT. FURTHER, IN ABSENCE OF ANY TDS MADE ON A SUM OF RS. 26,140/-, INCURRED TOWARDS ADVERTIS EMENT EXPENSES, THE ASSESSING OFFICER DISALLOWED THE SAME U/S. 40(A)(IA) OF THE ACT. SIMILARLY, IN ABSENCE OF TDS MADE ON A N AMOUNT OF RS. 52,435/-, PAID TO ONE M/S. ROSHINI MICRO SYSTEMS, T OWARDS JOB WORK DURING THE PREVIOUS YEAR, THE ASSESSING OFFICE R DISALLOWED THE SAME U/S. 40(A)(IA) OF THE ACT. THE ASSESSING OFFICER FURTHER NOTICED THAT THE ASSESSEE HAS INCURRED EXPENDITURE OF RS. 1,24,160/- TOWARDS GUEST HOUSE CHARGES DURING THE P REVIOUS YEAR. ACCORDING TO HIM, THE ASSESSEE WAS REQUIRED TO DEDU CT TAX AT SOURCE ON SUCH PAYMENT. HOWEVER, IN ABSENCE OF ANY TDS MADE ON THAT AMOUNT, HE DISALLOWED THE SAME, APPLYING TH E PROVISIONS OF SECTION 40(A)(IA) OF THE ACT. LASTLY, IN ABSENCE OF ANY TDS MADE ON AN AMOUNT OF RS. 3,16,324/-, PAID TOWARDS EQUIPM ENT RENT DURING THE PREVIOUS YEAR, THE ASSESSING OFFICER DIS ALLOWED THE SAME U/S. 40(A)(IA) OF THE ACT. WITH THE ABOVE ADD ITIONS, HE COMPLETED THE ASSESSMENT ON A TOTAL INCOME OF RS. 4 ,14,25,087/-, VIDE HIS ORDER DATED 19.12.2008 PASSED U/S. 143(3) R.W.S 92CA OF THE ACT. 5. BEFORE THE CIT(A), THE ASSESSEE HAS RAISED MAINLY T WO ISSUES. AS THE FIRST ISSUE, IT IS STATED THAT THE ASSESSING OFFICER/TPO ARE NOT JUSTIFIED IN REJECTING THE COMPARABLE UNCONTROL LED PRICE METHOD ADOPTED BY THE ASSESSEE, FOR BENCH MARKING T HE PRICE OF THE INTERNATIONAL TRANSACTIONS IN RESPECT OF EXPORT SALES. AS THE ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 5 SECOND ISSUE, IT IS STATED THAT THE TPO WAS NOT JUS TIFIED IN ADOPTING TRANSACTION NET MARGIN METHOD (TNMM IN SHO RT) FOR BENCHMARKING ALP OF THE INTERNATIONAL TRANSACTIONS IN RESPECT OF EXPORT SALES. IN THIS REGARD, UNDER THE SECOND ISSU E, IT IS FURTHER STATED THAT THE TPO WAS NOT JUSTIFIED IN CONSIDERIN G WRONG COMPARABLES AND ARRIVING AT A HIGH ARITHMETIC MEAN OF 26.59% AS A RATIO OF OPM/TOTAL COST, HE WAS NOT JUSTIFIED IN CONSIDERING A NEGATIVE WORKING CAPITAL ADJUSTMENT AND FURTHER WAS NOT JUSTIFIED IN ARRIVING AT ADJUSTED ARITHMETIC MEAN PLI OF 31.7 1%. IT WAS FURTHER STATED THAT THE TPO WAS NOT JUSTIFIED IN NO T CARRYING OUT NECESSARY ADJUSTMENT FOR ARRIVING AT THE ALP WHILE APPLYING TNMM. LASTLY, IT IS FURTHER STATED THAT ALTERNATIV ELY, THE TNMM OUGHT TO HAVE BEEN ADOPTED TAKING THE FOUR COMPARAB LES SELECTED BY THE ASSESSEE. 6. ON APPEAL, THE CIT(A) OBSERVED THAT AS THE FIRST IS SUE, THE ASSESSEE HAS STATED THAT THE TPO WAS NOT JUSTIFIED IN REJECTING THE CUP METHOD ADOPTED BY THEM, FOR COMPUTATION OF ALP OF THE INTERNATIONAL TRANSACTIONS IN THIS CASE. IT IS THEI R CONTENTION THAT CUP METHOD IS THE MOST APPROPRIATE METHOD FOR BENCH MARKING ANALYSIS. WHILE EXPLAINING ABOUT CUP METHOD, UNDER SUB CLAUSE (I) TO CLAUSE (A) TO SUB RULE (1) TO RULE 10B OF THE IN COME-TAX RULES, 1962, IT SAYS, THE PRICE CHARGED OR PAID FOR PROPER TY TRANSFERRED OR SERVICES PROVIDED IN A COMPARABLE UNCONTROLLED TRAN SACTION, OR A NUMBER OF SUCH TRANSACTIONS, IS IDENTIFIED. FURTHE R, IN PARA 2.6 OF THE OECD GUIDELINES, IT SAYS THE CUP METHOD COMPARE S THE PRICE CHARGED FOR PROPERTY OR SERVICES TRANSFERRED IN A C ONTROLLED TRANSACTION TO THE PRICE CHARGED FOR PROPERTY OR SE RVICES TRANSFERRED IN A COMPARABLE UNCONTROLLED TRANSACTIO N IN COMPARABLE CIRCUMSTANCES. THUS, AS PER BOTH THE ABO VE PROVISIONS, I.E., UNDER IT RULES AND UNDER OECD GUI DELINES, FOR APPLICATION OF CUP METHOD, SIMILARITY OF THE TRANSA CTIONS IS OF UTMOST IMPORTANCE. IN OTHER WORDS, THERE SHOULD BE EXISTENCE OF ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 6 TRANSACTIONS RELATING TO TRANSFER OF PROPERTY/ SERV ICES, WHICH ARE SIMILAR, SO AS TO ENABLE COMPARISON BETWEEN THEM. H OWEVER, IN THE INSTANT CASE, AFTER GOING THROUGH THE AGREEMENT ENT ERED INTO BY THE ASSESSEE WITH ITS AE AND THOSE AGREEMENTS ENTER ED INTO WITH THE THIRD PARTIES, THE CIT(A) OBSERVED THAT THAT TH E SERVICES RENDERED TO THOSE THIRD PARTIES, ARE NOT SIMILAR TO THAT RENDERED TO THE AE. 7. AS PER THE CONTRACT/AGREEMENT MADE WITH AVEDIS MICROSYSTEMS PVT. LTD., THE SAID COMPANY HAS REQUES TED THE ASSESSEE TO PROVIDE TWO DESIGN ENGINEERS WITH SPECI FIED EXPERIENCE (AS MENTIONED THEREIN) ON A MONTHLY FEE BASIS AND T HE TERMS AND CONDITIONS IN THAT REGARD ALSO INDICATED THEREIN. F ROM THE COPY OF THE SAID AGREEMENT FILED BEFORE THE CIT(A), THE NAT URE OF SERVICES TO BE RENDERED TO THAT COMPANY IS ASCERTAINABLE. UNDER THE CIRCUMSTANCE, EVEN THOUGH IN THAT DOCUMENT THERE IS MENTION THAT, THE SAID COMPANY SHALL PAY THE ASSESSEE AN AM OUNT OF US$ 3000 PER MAN MONTH, THE SAID COMPANY CANNOT BE CONS IDERED AS A COMPARABLE (INTERNAL COMPARABLE) IN THIS CASE. 8. THE CIT(A) OBSERVED THAT FROM THE SOFTWARE DEVELOPM ENT AGREEMENT MADE BY AGERE SYSTEMS INDIA PVT. LTD., WI TH THE ASSESSEE, THE SAID COMPANY DESIRES TO ENGAGE QCL I. E., THE ASSESSEE COMPANY, TO CARRY OUT CERTAIN SOFTWARE DEV ELOPMENT WORK AND THE ASSESSEE AGREES TO CARRY OUT SUCH WORK, IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF THAT AGREEMENT AND ANY ATTACHMENT REFERENCED THEREIN. THUS, THE WORK TO BE PERFORMED/SERVICES TO BE RENDERED BY THE ASSESSEE, ARE REFERRED TO IN CONCERNED ATTACHMENT. IN THE ENTIRE NARRATIVE OF THE SAID AGREEMENT, THERE IS NO REFERENCE TO THE NATURE OF W ORK/SERVICES TO BE RENDERED BY THE ASSESSEE I.E., QCL. FURTHER, IN ANNEXURE-A (SCOPE AND STATEMENT OF WORK), IT IS MENTIONED THAT THE SAME SHALL BE TO SUPPORT THE DESIGN VERIFICATION ACTIVITIES OF SOCS, BEING ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 7 DESIGNED BY AGERE. THUS, THE ASSESSEE WAS REQUIRED TO CARRY OUT CERTAIN DESIGN VERIFICATION OF SOME ACTIVITIES THAT WERE ASSIGNED BY THAT COMPANY. FROM THIS, IT CLEARLY SHOWS THAT THE SERVICES RENDERED TO THAT COMPANY, WERE TOTALLY DIFFERENT FR OM THAT RENDERED BY THE ASSESSEE TO ITS AE. FURTHER, FROM T HE DETAILS OF PROJECT DELIVERY/EXECUTION AS ENUMERATED IN THAT AN NEXURE, IT IS NOTICED THAT THE SERVICES TO BE PERFORMED BY THE AS SESSEE ARE TOTALLY DIFFERENT FROM THAT RENDERED TO THEIR AE. U NDER THIS CIRCUMSTANCE, THE ABOVE COMPANY, CANNOT BE CONSIDER ED AS AN INTERNAL COMPARABLE IN THIS CASE. 9. THE CIT(A) FURTHER OBSERVED FROM THE MASTER SOFTWAR E DEVELOPMENT AGREEMENT ENTERED INTO BY TEXAS INSTRUM ENTS (INDIA) PVT. LTD., WITH THE ASSESSEE, THE SAID COMPANY HAS DESIRED TO ENGAGE THE ASSESSEE IN CONNECTION WITH DEVELOPMENT OF CERTAIN SOFTWARE APPLICATION THAT ARE MORE SPECIFICALLY SET FORTH AND DESCRIBED IN THE WORK ORDER. HOWEVER, IN THAT WORK ORDER, A COPY OF WHICH WAS FURNISHED VIDE ANNEXURE A, ENCLOSED TO TH E SAID AGREEMENT (FURNISHED BY THE ASSESSEE), UNDER SCOPE AND DETAILS OF THE PROJECT, NOTHING IS MENTIONED. THE COLUMNS AGAI NST 'DESCRIPTION' AND 'SERVICES TO BE PROVIDED' ARE BLA NK. THUS, THE NATURE OF WORK/SERVICES TO BE PERFORMED BY THE ASSE SSEE TO THAT COMPANY IS NOT KNOWN. UNDER THE CIRCUMSTANCE, THE S AID COMPANY WHICH WAS IN THE BUSINESS OF DEVELOPING, MANUFACTUR ING AND SELLING DIGITAL SIGNAL PROCESSING DEVICES, CANNOT B E CONSIDERED AS AN INTERNAL COMPARABLE IN THIS CASE. IN OTHER WORDS THE TRANSACTIONS MADE WITH THAT COMPANY CANNOT BE CONSI DERED FOR THE PURPOSE OF COMPARABILITY ANALYSIS UNDER CUP MET HOD, IN THIS CASE. IN THIS CONTEXT, IT MAY BE FURTHER MENTIONED THAT THOUGH THE ASSESSEE HAS FURNISHED COPY OF A LETTER DATED 29.11 .2004 WRITTEN BY THAT COMPANY AND CERTAIN INVOICES ISSUED BY THAT COMPANY, IN ABSENCE OF THE NATURE OF SERVICES TO BE RENDERED BY THE ASSESSEE TO THAT COMPANY, THOSE DOCUMENTS, HAVE NO APPLICATION IN THIS CASE. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 8 10. AS REGARDS, THE CASE OF FUTURE TECHNO DESIGNS PVT. LTD., IS CONCERNED, THE ASSESSEE HAS MERELY FURNISHED COPIES OF PURCHASE ORDER ISSUED BY THAT COMPANY WHEREIN FOR DESIGN SER VICE CHARGES FOR MULTI-ADAPTOR PROJECT, THE RATE IS SHOWN AT US$ 63,000. BUT, IN ABSENCE OF THE NATURE OF SERVICES TO BE RENDERED INDICATED IN THAT PURCHASE ORDER, IT CANNOT BE SAID THAT THE SER VICES RENDERED TO THAT COMPANY WERE SIMILAR TO THAT RENDERED BY TH E ASSESSEE TO ITS AE. FURTHER IN ABSENCE OF ANY AGREEMENT WITH TH AT COMPANY, IT CANNOT BE ACCEPTED THAT THE SERVICES RENDERED TO TH AT COMPANY ARE SIMILAR TO THOSE RENDERED TO THE AE. HENCE, THE SA ID COMPANY CANNOT BE CONSIDERED AS AN INTERNAL COMPARABLE IN T HIS CASE. IN OTHER WORDS, THE TRANSACTIONS MADE WITH THAT COMPAN Y, CANNOT BE CONSIDERED FOR COMPARABILITY ANALYSIS UNDER CUP MET HOD. 11. THE CIT(A) OBSERVED THAT IN THE CASE OF BECEEM COMMUNICATIONS PVT. LTD., AS PER THE PURCHASE ORDER DATED 05.10.2004 ISSUED BY THAT COMPANY, A COPY OF WHICH WAS FILED BEFORE HIM, THE SAID COMPANY, FOR THE PURPOSE OF VL SI DESIGN CONSULTANCY, HAS REQUISITIONED TWO PERSONS FROM THE ASSESSEE AT A PRICE OF RS. 1,57,650/- (EXTENDED PRICE RS. 3,15,30 0). AS PER THE SAME, THE SAID COMPANY NEEDED TWO PERSONS FROM THE ASSESSEE, IN THE CONTEXT OF SOME DESIGN CONSULTANCY. THE SAME PE RTAINS TO MERE CONSULTATION. UNDER THE CIRCUMSTANCE, IT CANNO T BE SAID THE ASSESSEE HAS RENDERED THE SAME SERVICES TO THAT COM PANY AS IT RENDERED TO THE AE. IN OTHER WORDS, THE SERVICES RE NDERED TO THAT COMPANY CANNOT BE TREATED AS SIMILAR TO THAT RENDER ED TO THE AE. HENCE, THE TRANSACTION MADE WITH THE ABOVE COMPANY, CANNOT BE CONSIDERED FOR COMPARABILITY ANALYSIS UNDER CUP MET HOD IN THIS CASE. 12. THE CIT(A) HELD THAT THE SERVICE RENDERED BY THE AS SESSEE TO THOSE THIRD PARTIES, WERE DIFFERENT FROM THAT RENDE RED BY IT TO THE AE. UNDER THE CIRCUMSTANCE, TRANSACTIONS MADE WITH THOSE ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 9 COMPANIES, CANNOT BE CONSIDERED FOR COMPARABILITY A NALYSIS FOR BENCHMARKING OF THE INTERNATIONAL TRANSACTIONS MADE BY THE ASSESSEE WITH ITS AE. HENCE, THE CUP METHOD IS NOT ALL APPLICABLE TO THIS CASE. THUS, THE CUP METHOD CANNOT BE ADOPTE D FOR DETERMINING THE ARM'S LENGTH PRICE (ALP FOR SHORT) OF THE INTERNATIONAL TRANSACTIONS MADE BY THE ASSESSEE WIT H ITS AE. THEREFORE, THE TPO WAS JUSTIFIED IN REJECTING THE C UP METHOD AND CONSEQUENTLY PROCEEDING TO DETERMINE THE ALP OF SUC H TRANSACTIONS, ADOPTING TNMM IN THIS CASE. THE AR HAS SUBMITTED, IN RESPONSE TO THE REMAND REPORT, THAT T HE TPO HIMSELF OBSERVED THAT CUP METHOD IS MOST APPROPRIATE METHOD IN ASSESSEE'S CASE, BUT HE FURTHER NOTED THAT INFORMAT ION FOR APPLICATION OF THAT METHOD WAS NOT AVAILABLE WITH H IM. HOWEVER, IN THIS CONTEXT, THE CIT(A) CLARIFIED THAT, IN PARA 9 AT PAGE 49 OF HIS ORDER, THE TPO HAS MENTIONED THAT THERE IS ALSO NO DISPUTE THAT THE CUP METHOD IS THE MOST DIRECT AND RELIABLE WAY TO APPLY ARM'S LENGTH PRINCIPLE. IN THE NEXT SENTENCE, IN THAT PAR A, HE HAS FURTHER MENTIONED THAT, BUT WHILE SELECTING CUP METHOD, ONE MORE IMPORTANT ASPECT IGNORED BY THE TAXPAYER IS WHETHER THE DATA USED BY THE TAXPAYER IS RELIABLE AND VERIFIABLE BY THE T PO. FROM SUCH OBSERVATIONS OF THE TPO, IT MAY BE SEEN THAT HE HAS POINTED OUT THAT, THE DATA USED BY THE ASSESSEE ARE NOT RELIABL E AND NOT VERIFIABLE AND FOR THE SAME HE HAS REJECTED SUCH ME THOD ADOPTED BY THE ASSESSEE. IN ANY CASE, SINCE AFTER DETAILED DISCUSSIONS MADE ABOVE, THE CIT(A) HELD THAT CUP METHOD CANNOT BE AD OPTED IN THIS CASE, SUCH DECISION OF THE TPO IN REJECTING SUCH ME THOD ADOPTED BY THE ASSESSEE, IS JUSTIFIED AND HENCE, THE SAME I S UPHELD. FURTHER, FOR THE REASONS STATED BY HIM IN HIS SAID ORDER, ADOPTION OF TNMM BY THE TPO AS THE MOST APPROPRIATE METHOD F OR DETERMINING ALP OF SUCH INTERNATIONAL TRANSACTIONS MADE BY THE ASSESSEE DURING THE F.Y 2004-05 WITH ITS AE, IS HEL D TO BE JUSTIFIED. IT MAY ALSO BE MENTIONED HERE THAT IN TH E PRECEDING TWO ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 10 ASSESSMENT YEARS, TNMM HAS ALSO BEEN APPLIED BY THE TPO AND THE SAME HAS BEEN ACCEPTED. UNDER SUCH CIRCUMSTANCE S, APPLICATION OF THE SAID METHOD I.E., TNMM BY THE TP O FOR COMPUTING ALP OF THE INTERNATIONAL TRANSACTIONS MAD E BY THE ASSESSEE WITH ITS AE IN THIS CASE IS UPHELD. FURTHE R, AS REGARDS, THE ALTERNATIVE CONTENTION OF THE ASSESSEE FOR APPL YING COST PLUS METHOD (CPM) IS CONCERNED, SINCE THE TRANSACTIONS M ADE BY IT WITH THOSE DOMESTIC PARTIES ARE NOT SIMILAR TO THOSE REN DERED TO THE AE, THE SAID METHOD CANNOT BE APPLIED IN THIS CASE. ACC ORDINGLY, THE CIT(A) REJECTED THE PLEA OF THE ASSESSEE. 13. COMING TO THE PLEA OF THE ASSESSEE THAT ONLY THOSE FOUR COMPANIES, WHICH WERE CONSIDERED AS COMPARABLES IN THE PRECEDING TWO ASSESSMENT YEARS I.E., A.YS. 2003-04 AND 2004-05, SHOULD BE CONSIDERED IN THIS CASE, THE CIT(A) OBSER VED THAT THERE IS NO MERIT IN SUCH CONTENTION. AS ADMITTED BY THE ASS ESSEE IN ITS WRITTEN SUBMISSIONS MADE VIDE LETTER DATED 02.01.20 10 BEFORE THE CIT(A), THE COMPANY IN ITS CASE, IS ENGAGED IN THE BUSINESS OF SOFTWARE DEVELOPMENT SERVICES IN THE FIELD OF APPLI CATION OF ASIC AND VLSI. THUS, IT WAS IN THE BUSINESS OF SOFTWARE DEVELOPMENT, THOUGH PERTAINING TO A DIFFERENT FIELD. SINCE, SUCH FIELDS COME UNDER PURVIEW OF A VERTICAL, UNDER SOFTWARE DEVELOP MENT SERVICES, THE DIFFERENT COMPARABLE COMPANIES REFERRED TO BY T HE TPO AT PAGE 106, FOR THE REASONS STATED BY HIM AGAINST EACH SUC H COMPANY, SHOULD BE CONSIDERED AS COMPARABLES FOR THE PURPOSE OF DETERMINING ALP OF THE INTERNATIONAL TRANSACTIONS I N THIS CASE. THE TPO HAS SELECTED THOSE COMPARABLES ON BASIS OF DIFF ERENT FILTERS ADOPTED BY HIM, REFERRED TO UNDER PARA 12 AT PAGE 9 2. WHEN THE ASSESSEE WAS MAINLY ENGAGED IN SOFTWARE DEVELOPMENT SERVICES, THOUGH IN A DIFFERENT VERTICAL, HAVING REGARD TO TH E OVERALL CIRCUMSTANCES OF THE CASE, SUCH COMPARABLE COMPANIE S SELECTED BY THE TPO SHOULD BE CONSIDERED AS COMPARABLES IN T HIS CASE. AS REGARDS THOSE FOUR COMPANIES REFERRED TO BY THE ASS ESSEE ARE ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 11 CONCERNED, AFTER DISCUSSING THE FACTUAL POSITION IN RESPECT OF THOSE COMPANIES AND APPLYING THOSE FILTERS ADOPTED BY HIM , IN PARA 13 AT PAGE 93-94 OF HIS ORDER, HE HAS CLEARLY HELD THA T THE SAME CANNOT BE CONSIDERED AS COMPARABLES IN THIS CASE. I N FACT, HAVING REGARD TO THE FACTUAL FINDINGS GIVEN BY THE TPO IN THAT PARA, HIS DECISION IN REJECTING THOSE FOUR COMPANIES AS COMPA RABLES, IS JUSTIFIED. ACCORDINGLY, THE CIT(A) REJECTED THE PLE A OF THE ASSESSEE. 14. THE CIT(A) OPINED THAT THE 17 COMPANIES WHICH HAVE BEEN CONSIDERED BY THE TPO AS COMPARABLES ARE REFERRED T O BY HIM AT PAGE 106 OF HIS ORDER. THE REASONS FOR SELECTING EA CH SUCH COMPANY AS COMPARABLE ARE DISCUSSED BY HIM IN THAT ORDER. THOUGH THE ASSESSEE HAS NOT MADE ANY SUBMISSION WIT H REFERENCE TO THOSE COMPANIES, AFTER EXCLUDING ONLY SATYAM COM PUTER SERVICES LIMITED, WHOSE FINANCIAL STATEMENTS, IN TH E WAKE OF THE RECENT MEDIA REPORTS REGARDING MANIPULATION IN THEI R ACCOUNTS, ARE NOT RELIABLE, AS ALREADY HELD BY HIM IN THE CASE OF INTERGRAPH CONSULTING PVT. LTD., VIDE HIS ORDER IN ITA. NO. 02 10/CIT(A)- III/OB-09 DATED 31.03.2010, THE OTHER 16 COMPANIES, FOR THE REASONS STATED IN THAT ORDER, SHOULD BE CONSIDERED AS COMPARABLES FOR THE PURPOSE OF DETERMINING ALP OF THE INTERNATI ONAL TRANSACTIONS IN THIS CASE. THE WORKINGS RELATING TO RATIO OF OPERATING PROFIT TO TOTAL COST IN CASE OF EACH COMP ANY, I.E., THE PROFIT MARGIN ARE GIVEN BY THE TPO IN ANNEXURE B TO HIS SAID ORDER. AFTER EXCLUDING SATYAM COMPUTER SERVICES LI MITED; ON THE BASIS OF SUCH DATA GIVEN BY THE TPO, IN RESPECT OF THE REMAINING 16 COMPANIES, THE AVERAGE PROFIT MARGIN I.E., ARITH METIC MEAN PU, COMES TO 26.41%. 15. WITH REGARD TO THE WORKING CAPITAL ADJUSTMENT ALLOW ED BY THE TPO FROM THE AVERAGE PROFIT MARGIN, DETERMINED IN RESPECT OF THE COMPARABLE COMPANIES, IT IS STATED THAT HE WAS NOT JUSTIFIED IN CONSIDERING NEGATIVE WORKING CAPITAL ADJUSTMENT TO THE TUNE OF ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 12 5.12% AND THUS ARRIVING AT ADJUSTED ARITHMETIC MEAN PU AT 31.71%. THE CIT(A) OBSERVED THAT THE ASSESSEE HAS NOT FURNISHED ANY WORKING WITH REFERENCE TO THE SAME. FURTHER, A S NOTED BY THE TPO IN PARA 17.1 OF HIS ORDER, THE ASSESSEE HAS NOT FURNISHED ANY WORKING IN THAT REGARD BEFORE HIM. UNDER THE CIRCU MSTANCE, HE COMPUTED THE WORKING CAPITAL ADJUSTMENT TO BE ALLOW ED IN THIS CASE, FOLLOWING THE OECD GUIDELINES AND APPROVED FO RMULA IN THAT REGARD. THE DETAILED FORMULA APPLIED BY THE TPO FOR THAT PURPOSE, ARE DISCUSSED UNDER THAT PARA 17.1, AT PAGE 108 - 1 09 OF HIS ORDER. THE ACTUAL WORKINGS MADE BY HIM ON THAT ACCOUNT, AR E GIVEN IN ANNEXURE - C TO HIS ORDER, AS PER WHICH SUCH WORKIN G CAPITAL ADJUSTMENT TO BE ALLOWED HAS BEEN WORKED OUT AT -5. 12%. SINCE, THE TPO HAS MADE SUCH WORKINGS ON BASIS OF OECD GUI DELINES/ FORMULA IN THAT REGARD AND IN ABSENCE OF ANY ERROR POINTED OUT BY THE ASSESSEE IN SUCH CALCULATION, SUCH WORKING AS M ADE BY THE TPO IS UPHELD BY THE CIT(A). ACCORDINGLY, THE CIT(A ) DECIDED THE ISSUE AGAINST THE ASSESSEE. AGGRIEVED, THE ASSESSE E IS IN APPEAL BEFORE US. 16. THE LEARNED AR SUBMITTED THAT M/S. QUALCORE LOGIC L TD, BEING THE ASSESSEE IS A COMPANY REGISTERED IN INDIA UNDER THE COMPANIES ACT, 1956. LT IS A WHOLLY OWNED SUBSIDIAR Y OF QUALCORE GROUP INC. USA. THE ASSESSEE-COMPANY IS ENGAGED IN THE BUSINESS OF SOFTWARE DEVELOPMENT SERVICES IN THE FI ELD OF APPLICATION SPECIFIC INTEGRATED CIRCUITS (ASIC), VE RY LARGE SCALE INTEGRATION (VLSI) AND EMBEDDED SYSTEM SOLUTIONS AN D THEIR EXPORT. THE ASSESSEE-COMPANY FILED ITS RETURN OF I NCOME FOR THE ASSESSMENT YEAR 2005-06 ON 29.10.2005 ADMITTING A L OSS OF RS. 1,70,30,983/-. THE RETURN WAS PROCESSED U/S 143(1) ON 17.03.2006 AND SUBSEQUENTLY THE CASE WAS SELECTED F OR SCRUTINY. DURING THE COURSE OF ASSESSMENT, A REFERENCE U/S 92 CA OF THE INCOME-TAX ACT, 1961 HAS BEEN MADE TO THE ADDL. COM MISSIONER OF INCOME-TAX (TRANSFER PRICING), HYDERABAD. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 13 17. THE ASSESSEE-COMPANY HAD ENTERED INTO THE FOLLOWING INTERNATIONAL TRANSACTIONS WITH QUALCORE LOGIC INC. USA, DURING THE FINANCIAL YEAR 2004-05: S. NO. ITEM AMOUNT (RS.) 1. PURCHASE OF SOFTWARE TOOLS & LICENCES AND TERM CHARGES 4,21,16,034 2. SALE OF SOFTWARE SERVICES AND DESIGNS 6,01,83,326 3. REIMBURSEMENT OF PAYMENTS MADE AND PROCUREMENT COSTS INCURRED 5,11,588 18. THE ASSESSEE-COMPANY ADOPTED THE INTERNAL COMPARAB LE UNCONTROLLED PRICE (CUP) METHOD FOR DETERMINING THE ARM'S LENGTH PRICE FOR SALE OF SOFTWARE SERVICES TO ITS ASSOCIAT ED ENTERPRISE. THE ASSESSEE-COMPANY SUBMITTED THE FOLLOWING INFORMATIO N, IN ADDITION TO FORM NO. 3CEB AND COMPANY AUDIT REPORT, TO THE T RANSFER PRICING OFFICER, DURING THE PROCEEDINGS. (A) DETAILS OF SALES MADE DURING THE YEAR, WHICH INCLUDED AMOUNT CHARGED, NO. OF ENGINEERS EMPLOYED, TOTAL NUMBER OF MAN MONTHS, THE RATE IN INR AND USD PER MAN MONTH TO UNRELATED PARTIES, (B) JUSTIFICATION FOR THE METHODS ADOPTED. (C) DETAILS OF OWNERSHIP STRUCTURE, BROAD DESCRIPT ION OF BUSINESS, NATURE AND TERMS OF INTERNATIONAL TRANSACTIONS AND FUNCTIONAL ANALYSIS, ASSETS EMPLOY ED AND RISKS UNDERTAKEN OF THE ASSESSEE-COMPANY. 19. THE LEARNED AR SUBMITTED THAT COMPARABLE UNCONTROLL ED PRICE (CUP) METHOD ADOPTED FOR BENCHMARKING OF EXPO RT SALES TO QUALCORE LOGIC INC. USA WAS THE MOST APPROPRIATE ME THOD IN VIEW OF OTHER INTERNAL COMPARABLES BEING AVAILABLE IN TH E FORM OF SALES MADE TO OTHER UNRELATED PARTIES. SUCH SUBMISSIONS M ADE BY THE ASSESSEE-COMPANY WERE NOT CONSIDERED AND THE TRANSF ER PRICING OFFICER IN AN ARBITRARY MANNER REJECTED CUP METHOD AS APPROPRIATE ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 14 METHOD FOR BENCHMARKING EXPORT SALES TO QUALCORE LO GIC INC. USA. INTERNAL COMPARABLES BEING AVAILABLE WITH THE ASSES SEE WERE NOT DULY CONSIDERED BY THE LEARNED TRANSFER PRICING OFF ICER. IGNORING THE VITAL INFORMATION BEING AVAILABLE WITH THE ASSE SSEE- COMPANY, THE TRANSFER PRICING OFFICER ADOPTED TRANSACTION NE T MARGIN METHOD AS THE APPROPRIATE METHOD. FOR THIS PURPOSE 17 COMPANIES WERE SELECTED BY THE TRANSFER PRICING OFFICER. 20. COMPARABLES WERE SELECTED FROM DIFFERENT DATA BASES LIKE 'PROWESS' AND 'CAPITAL LINE'. THE COMPARABLES SELE CTED ARE HIGHLY INAPPROPRIATE AS COMPARABLES. ACCORDINGLY, ARITHME TIC MEAN PLI WAS ARRIVED AT 26.59% WHICH IS ABSOLUTELY HIGH AND UNREALISTIC LOOKING AT THE BACKGROUND OF THE ASSESSEE-COMPANY. 21. THE AR SUBMITTED THAT THE TRANSFER PRICING OFFICER HAS ALSO MADE A NEGATIVE WORKING CAPITAL ADJUSTMENT TO THE P LI TO THE TUNE OF 5.12% AND ARRIVED AT THE FINAL PLI OF 31.71 % WH ICH IS VERY HIGH AND UNREALISTIC. DURING THE RELEVANT FINANCIAL YEAR THE COMPANY'S DEPRECIATION CHARGE IS 28.60% TO THAT OF THE TOTAL COST WHERE AS THE INDIAN COMPANIES ENGAGED IN SIMILAR SERVICES AVERAG E CHARGE WAS AROUND 10 TO 11 % TO THAT OF THE TOTAL COST. THIS A DJUSTMENT WAS NOT CARRIED OUT IN ARRIVING AT THE ALP BY THE LEARN ED TPO. 22. WITHOUT PREJUDICE TO THE CUP METHOD ADOPTED BY THE ASSESSEE COMPANY, IT SUBMITTED A LIST OF 4 COMPANIE S TO BE ADOPTED AS COMPARABLES UNDER TNMM AS AN ALTERNATIVE BASIS. THE SAID 4 COMPANIES HAVE BEEN SELECTED WITH PROPER CRI TERIA AND ECONOMIC ACTIVITY DEALING WITH VLSI AND ASCII PRODU CTS OF SEMI CONDUCTOR INDUSTRY. THESE 4 COMPANIES INVOLVED WERE FUNCTIONALLY SIMILAR TO THE ASSESSEE COMPANY. HOWEVER THE SAME W ERE REJECTED BY THE LEARNED TRANSFER PRICING OFFICER ON THE GROU ND THAT THEY WERE NOT FUNCTIONALLY SIMILAR, THAT NO SEARCH WAS M ADE FOR SELECTION OF COMPARABLES AND NO SEARCH PROCESS WAS MENTIONED. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 15 THESE 4 COMPANIES WHICH WERE SELECTED BY THE ASSESS EE WERE THE SAME AS SELECTED FOR THE EARLIER YEAR I.E. ASSESSME NT YEAR 2004-05 AND ACCEPTED BY THE LEARNED TPO. IN THE CURRENT YEA R, THE LEARNED TPO NOT ONLY CHOSE WRONG COMPARABLES AND ADOPTED A WRONG METHOD BUT ALSO ABSTAINED TO FACTOR OUT LEGITIMATE TRANSFER PRICING ADJUSTMENTS TO THE ARM'S LENGTH PRICE COMPUTED. 23. HE SUBMITTED THAT THE TRANSFER PRICING OFFICER, AFT ER PERUSAL OF INFORMATION AND EVIDENCE SUBMITTED BY ASSESSEE-C OMPANY COMPLETED THE REFERENCE BY PASSING THE ORDER U/S 92 CA(3) AS UNDER: (A) THE CUP METHOD ADOPTED BY ASSESSEE-COMPANY FOR EXPORT TRANSACTIONS WITH THE ASSOCIATED ENTERPRISE WAS REJECTED. (B) IN PLACE OF CUP, THE TRANSFER PRICING OFFICER, ADOPTED THE TRANSACTIONAL NET MARGIN METHOD ( TNMM ) FOR TH E EXPORT TRANSACTIONS MENTIONED ABOVE AND REVISED THE ARM'S LENGTH PRICE IN ACCORDANCE WITH TNMM.THE LEARNED TPO SELECTED 17 COMPANIES FOR THE PURPOSE OF BENCHMARKING. THE 17 COMPANIES SELECTED AS COMPARABLES BY THE LEARNED TPO ARE ENGAGED IN SOFTWARE DEVELOPMENT SERVICES AND ARE IN NO WAY FUNCTIONALLY SIMILAR TO THE BUSINESS OF THE ASSESSE E. (C) REVISED SALES FIGURE AS PER TNMM CAME TO RS. 12,74,96,713 AS AGAINST ACTUAL SALES OF RS. 6,01,83,326 MADE BY THE ASSESSEE-COMPANY. (D) THE ABOVE DIFFERENCE LEAD TO A TRANSFER PRICI NG ADJUSTMENT TO THE TUNE OF RS. 5,77,93,011. 24. THE ASSESSING OFFICER ON THE BASIS OF ORDER U/S 92C A(3) MENTIONED ABOVE, MADE AN ADDITION OF RS. 5,77,93,01 1 IN THE ASSESSMENT U/S 143(3). THE ADDITION RESULTED IN RED UCING LOSS ADMITTED BY THE ASSESSEE-COMPANY, AND ARRIVING AT A PROFIT OF RS. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 16 4,14,25,087/-. AGGRIEVED BY THE ABOVE DECISION THE ASSESSEE COMPANY WENT ON APPEAL BEFORE THE CIT(A). THE CIT( A) CONFIRMED THE ADDITION MADE BY THE ASSESSING OFFICER. HOWEVE R THE CIT(A) ARRIVED AT AN ADDITION OF RS. 5,76,18,769 AS AGAIN ST ADDITION OF RS 5,77,93,011/- ARRIVED AT BY THE ASSESSING OFFICER. 25. HE SUBMITTED THAT THE CIT(A) WRONGLY OBSERVED THAT THE ASSESSEE COMPANY BELONGS TO THE SEMICONDUCTOR TYPE OF SOFTWARE INDUSTRY, WHICH IS SPECIALIZED IN THE FIELD OF CHIP DESIGNING. THE BASIC SERVICE THAT IS RENDERED IS CHIP DESIGNING AN D LAYOUT TO VARIOUS CUSTOMERS IN INDIA AND ALSO TO THE ASSOCIAT ED ENTERPRISE IN USA. IT IS ESSENTIAL TO BE NOTED THAT THOUGH THE AS SESSEE BELONGS BROADLY TO THE SOFTWARE INDUSTRY, IT NEEDS TO BE SP ECIFICALLY IDENTIFIED WITH CHIP DESIGNING - VLSI INDUSTRY. THI S PARTICULAR FACT BEARS LOT OF IMPORTANCE AND IS CRITICAL IN APPRECIA TING FACTS OF THE ASSESSEE'S CASE. HENCE ASSESSEE'S PERFORMANCE CANNO T BE COMPARED WITH GENERAL SOFTWARE COMPANIES AND IT SHA LL BE DONE ONLY WITH THOSE COMPANIES WHICH ARE INTO CHIP DESIG NING UNDER VLSI. DURING THE YEAR UNDER CONSIDERATION THE SAME CHIP DESIGNING SERVICES HAVE BEEN RENDERED TO UNRELATED PARTIES RESULTING IN REVENUE OF RS. 95,20,376/- OUT OF THE TOTAL TURN OVER RS. 6,97,03,702/-. SUCH SIGNIFICANT PROPORTION OF UNRELATED PARTY TRANSACTIONS INVARIABLY CONSTITUTE INTERNAL COMPARA BLES FOR THE PURPOSE OF BENCH MARKING TRANSACTIONS OF THE ASSESS EE COMPANY WITH ITS ASSOCIATED ENTERPRISE (AE). OECD GUIDELINE S IN PARA 2.7 CATEGORICALLY HIGHLIGHT THE IMPORTANCE OF INTERNAL COMPARABLES UNDER THE TRANSFER PRICING REGULATIONS FOR BENCH MA RKING PURPOSES, WHICH READS AS UNDER: 26. HE DREW OUR ATTENTION TO PARA 2.14 OF THE OECD GUID ELINES ENDORSES THE POSITION THAT CUP METHOD IS MOST PREFE RABLE OVER ALL METHODS IN CASE, COMPARABLE UNCONTROLLED TRANSACTIO NS ARE AVAILABLE WITH THE TAX PAYER. EXTRACTS OF RELEVANT PORTIONS OF PARA ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 17 2.14 ARE BEING REPRODUCED. WHERE IT IS POSSIBLE TO LOCATE COMPARABLE UNCONTROLLED TRANSACTIONS, THE CUP METHO D IS THE MOST DIRECT AND RELIABLE WAY TO APPLY THE ARM'S LEN GTH PRINCIPLE. CONSEQUENTLY, IN SUCH CASES THE CUP METHOD IS PREFE RABLE OVER ALL OTHER METHODS. 27. HE SUBMITTED THAT IT IS ALSO PROVIDED IN THE OECD G UIDELINES THAT APPLICATION OF CUP METHOD IS JUSTIFIABLE EVEN WITH SOME DIFFERENCES BETWEEN INTERNATIONAL TRANSACTIONS AND COMPARABLE UNCONTROLLED TRANSACTIONS SUBJECT TO PROPER ADJUSTM ENTS FOR REMOVING THE DIFFERENCES. IT IS STRONGLY RECOMMENDE D THAT THE CUP METHOD SHOULD NOT BE DENIED ON THE BASIS OF DIFFERE NCES. IN THIS REGARDS THE RELEVANT PORTION OF THE TEXT OF PARA 2. 16 IS REPRODUCED. WHERE DIFFERENCES EXIST BETWEEN THE CONTROLLED AND UNCONTROLLED TRANSACTIONS OR BETWEEN THE ENTERPRISE S UNDERTAKING THOSE TRANSACTIONS, IT MAY BE DIFFICULT TO DETERMINE REASONABLY ACCURATE ADJUSTMENTS TO ELIMINATE THE EFFECT ON PRICE. 'THE DIFFICULTIES TH AT ARISE IN ATTEMPTING TO MAKE REASONABLY ACCURATE ADJUSTMEN TS SHOULD NOT ROUTINELY PRECLUDE THE POSSIBLE APPLICAT ION OF THE CUP METHOD. 28. ACCORDING TO THE AR, THE ASSESSEE COMPANY APPLIED C UP METHOD AS THE MOST APPROPRIATE METHOD (MAM) BY CONS IDERING INTERNAL COMPARABLES AS EXPLAINED ABOVE. AS THE SER VICE RENDERED TO AE AND UNRELATED PARTIES ARE SIMILAR IT IS PERMI TTED TO MAKE THE COMPARISON OF MAN HOUR / MAN MONTH RATE BETWEEN BOT H SUCH SERVICES. IN THE CHIP DESIGNING INDUSTRY, IT IS COM MON PRACTICE TO QUOTE FOR THE SERVICES IN TERMS OF MAN-HOUR / MAN-M ONTH BASIS. THE INVOICES WITH UNRELATED PARTIES FOR THE SERVICE S RENDERED DURING THE YEAR ARE ENCLOSED AS PART OF THE PAPER B OOK. ALL SUCH AGREEMENTS CARRY MAN MONTH RATE AS BASIS FOR CALCUL ATION OF SERVICES CHARGES. SUCH MAN MONTH RATE WOULD VARY BE TWEEN OFFSITE AND ONSITE SERVICES. IT IS ECONOMICALLY ACCEPTED PR OPOSITION TO COMPARE SUCH RATES BETWEEN AE AND UNRELATED PARTIES TRANSACTIONS TO EXAMINE ARM'S LENGTH PRINCIPLE. IN OTHER WORDS ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 18 MAN MONTH RATE IS THE BASIC CRITERIA USED FOR COMPA RISON OF TWO SERVICES. IN VIEW OF THE SAME, ADOPTION OF CUP METH OD ON THE BASIS OF MAN MONTH RATE BETWEEN AE AND NON-AE TRANSACTION S IS LEGALLY PERMITTED. CUP METHOD IS A DIRECT AND MOST RELIABLE METHOD UNDER THE TP REGULATIONS. THE CIT(A) OBSERVED THAT THE AG REEMENT ENTERED INTO BY THE ASSESSEE WITH ITS AE AND THOSE AGREEMENTS ENTERED INTO WITH THE THIRD PARTIES ARE NOT SIMILAR (PARA 5.1 OF THE LD CIRCA) ORDER -PAGE 315 OF PAPER BOOK). THE ASSESSEE COMPANY FURNISHED COPIES OF AGREEMENTS WITH THIRD PARTIES L IKE AVENDIS MICROSYSTEMS LTD, TEXAS INSTRUMENTS(LNDIA) LTD, AGE RE SYSTEMS INDIA PVT LTD WHEREIN THE SERVICES RENDERED BY THES E PARTIES ARE SIMILAR TO THOSE RENDERED BY THE AE OF THE ASSESSEE . SUCH AGREEMENTS WERE REJECTED BY THE LD CIT(A) ON THE GR OUND THAT THE SAME CANNOT BE CONSIDERED AS INTERNAL COMPARABLES.( PARAS 5.3,5,4,5,5 AND 5.6 OF THE ORDER) THE LD CIT(A) OBS ERVED THAT THE CUP METHOD CANNOT BE ADOPTED FOR DETERMINING THE AR MS LENGTH PRICE OF THE INTERNATIONAL TRANSACTIONS MADE BY THE ASSESSEE WITH ITS AE 29. IN THIS CONNECTION THE AR PLACED RELIANCE ON THE FO LLOWING CASE LAWS WHEREIN IT WAS HELD THAT THE CUP METHOD I S THE MOST APPROPRIATE METHOD: (A) IN THE CASE OF DESTINATION OF THE WORLD (SUBCO NTINENT) (P.) LTD. VS ASSISTANT COMMISSIONER OF INCOME-TAX, CIRCLE 10(1), NEW DELHI [2011] 12 TAXMANN.COM 310 (DELHI) WHEREIN THE DELHI TRIBUNAL HELD THAT IN THE FIRST INSTANCE, ATTEMPT SHOULD BE MADE TO DETERMINE ARM'S LENGTH PRICE OF CONTROLLED TRANSACTIONS BY COMPARIN G SAME WITH INTERNAL UNCONTROLLED TRANSACTIONS UNDERTAKEN IN SAME OR SIMILAR ECONOMIC SCENARIO. (B) IN SERDIA PHARMACEUTICALS (INDIA) (P.) LTD. VS ASSISTANT COMMISSIONER OF INCOME -TAX, CIRCLE 7(2), MUMBAI [2011] 44 SOT 391 (MUM.) THE TRIBUNAL HELD THAT COMPARABLE UNCONTROLLED PRICE (CUP) METHOD IS TO BE ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 19 PREFERRED, BECAUSE IT OFFERS MOST DIRECT METHOD OF NEUTRALIZING IMPACT OF INTERRELATIONSHIP BETWEEN ASSOCIATED ENTERPRISES (AES), ON PRICE AT WHICH TRANSACTIONS HAVE BEEN ENTERED INTO BY SUCH AES - (C) IN CLEAR PLUS INDIA (P.) LTD. VS DEPUTY COMMISSIONER OF INCOME-TAX, CIRCLE-3(1), DELHI (10 TAXMAN 249) THE DELHI TRIBUNAL OBSERVED THAT CUP METHOD WAS MOST SUITABLE METHOD FOR DETERMINING ALP (D) IN DCIT VS. 3 GLOBAL SERVICES PVT. LTD (11 TAX MAN 136) (MUM) THE TRIBUNAL HELD THAT THE COMPARABLE UNCONTROLLED METHOD (CUP) FOLLOWED BY THE ASSESSEE COMPANY IS THE MOST APPROPRIATE METHOD. 30. THE AR SUBMITTED THAT THE ARMS LENGTH PRICE BE BENCHMARKED BY USING THE CUP METHOD FOR WHICH TRANS ACTIONS WITH UNRELATED PARTIES WERE SUBMITTED. 31. THE AR SUBMITTED THAT THE ASSESSEE'S CASE WOULD BE FURTHER STRENGTHENED BY APPLICATION OF COST PLUS METHOD (CP M) AS AN EXTENSION TO CUP METHOD. RULE 108(1)(C) READS AS UN DER:- (I) THE DIRECT AND INDIRECT COSTS OF PRODUCTION I NCURRED BY THE ENTERPRISE IN RESPECT OF PROPERLY TRANSFERRED O R SERVICES PROVIDED TO AN ASSOCIATED ENTERPRISE, ARE DETERMINED; (II) THE AMOUNT OF A NORMAL GROSS PROFIT MARK-UP TO SUCH COSTS (COMPUTED ACCORDING TO THE SAME ACCOUNTING NORMS) ARISING FROM THE TRANSFER OR PROVISION OF TH E SAME OR SIMILAR PROPERTY OR SERVICES BY THE ENTERPR ISE, OR BY AN UNRELATED ENTERPRISE, IN A COMPARABLE UNCONTROLLED TRANSACTION, OR A NUMBER OF SUCH TRANSACTIONS, IS DETERMINED; (III) THE NORMAL GROSS PROFIT MARK-UP REFERRED TO IN SUB- ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 20 CLAUSE (II) IS ADJUSTED TO TAKE INTO ACCOUNT THE FUNCTIONAL AND OTHER DIFFERENCE, IF ANY, BETWEEN TH E INTERNATIONAL TRANSACTIONS AND THE COMPARABLE UNCONTROLLED TRANSACTIONS, OR BETWEEN THE ENTERPRIS ES ENTERING INTO SUCH TRANSACTIONS, WHICH COULD MATERIALLY AFFECT SUCH PROFIT MARK-UP IN THE OPEN MARKET; (IV) THE COSTS REFERRED TO IN SUB-CLAUSE (I) ARE INCREASED BY THE ADJUSTED PROFIT MARK-UP ARRIVED AT UNDER SUB- CLAUSE (III); (V) THE SUM SO ARRIVED AT IS TAKEN TO BE AN ARM'S LENGTH PRICE IN RELATION TO THE SUPPLY OF THE PROPERTY OR PROVISION OF SERVICES BY THE ENTERPRISE. 32. ACCORDING TO THE AR, BENCH MARKING UNDER CPM WILL B E DONE ON THE BASIS OF FUNCTIONAL COMPARABILITY BETWEEN RE LATED AND UNRELATED PARTY TRANSACTIONS. IN THIS SCENARIO, DIF FERENCES IN CHARACTERISTIC OF THE PRODUCTS OR SERVICE IS PERMIT TED. IN OTHER WORDS THE PRODUCTS/ SERVICES THAT ARE BEING COMPARE D SHOULD BELONG TO THE SAME CATEGORY/FAMILY OF TRANSACTIONS. MOREOVER, CPM IS ALSO ACCEPTABLE IN PROVISION OF SERVICES TO AE AS PER OECD GUIDELINES AND AS PER RULE 10B(1)(C). WITHOUT PREJU DICE TO THE CHOICE OF CUP METHOD, THE AR SUBMITTED THAT CPM IS ALSO AN ACCEPTABLE METHOD IN THE CASE OF THE ASSESSEE. THE GROSS MARGIN COMPARISON ON THE BASIS OF FUNCTIONAL SIMILARITY AS PRESCRIBED BY CPM IS PRACTICALLY POSSIBLE ONLY WITH INTERNAL COMP ARABLES. THIS IS SO, ON ACCOUNT OF NON AVAILABILITY OF GROSS MARGIN RATIO DETAILS OF THE COMPARABLE COMPANIES IN THE PUBLIC DOMAIN. IN T HE INSTANT CASE THE ARE SIGNIFICANT SIZE OF INTERNAL COMPARABL ES. 33. HE SUBMITTED THAT THE LD CIT(A) OBSERVED THAT THE ALTERNATIVE CONTENTION OF THE ASSESSEE FOR APPLYING COST PLUS ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 21 METHOD (CPM) IS CONCERNED THE TRANSACTIONS MADE BY IT WITH DOMESTIC PARTIES ARE NOT SIMILAR TO THOSE RENDERED TO THE AE SAND HENCE REJECTED THE CPM WHICH IS FACTUALLY AND LEGAL LY INCORRECT. THE AR SUBMITTED THAT THE CPM MAY BE CONSIDERED AS AN ALTERNATIVE TO THE CUP METHOD. 34. THE AR FURTHER SUBMITTED THAT IN THE APPEAL PROCEED INGS RELATING TO AY 2002-03 CIT (APPEALS) OBSERVED THAT IN HIS ORDER VIDE ITA NO. 154, DT. 14-12-2005, THAT 'THE PRESENT CASE CANNOT BE COMPARED TO THE CASE OF A NORMAL COMPANY ENGAGED IN DEVELOPMENT OF SOFTWARE IN ITS OWN AND SELLING IT I N THE OPEN MARKET '. SUBSEQUENTLY FOR THE YEARS AY 2003-04 AN D AY 2004-05 THE TPO ACCEPTED THE FOLLOWING FOUR COMPANIES AS AP PROPRIATE COMPARABLES FOR BENCHMARKING THE ASSESSEE'S RESULTS UNDER TNM METHOD: 1. M/S. SPEL SEMICONDUCTOR LTD. 2. M/S. MRO-TEK LTD. 3. M/S. SOLECTRON CENTUM ELECTRONICS LTD. 4. M/S. TERA SOFTWARE LTD. 35. THE SAME FOUR COMPANIES ARE APPROPRIATE FOR BENCHMA RKING UNDER TNM METHOD EVEN FOR THE YEAR UNDER CONSIDERAT ION. THE ASSESSEE SUBMITTED BEFORE THE LEARNED CIT(A) THAT T HE SAME COMPARABLES WHICH WERE ACCEPTED EARLIER MAY BE CONS IDERED FOR THE CURRENT YEAR ALSO. THIS SUBMISSION WAS REJECTED BY THE CIT(A) AND 17 COMPARABLES WHICH ARE FUNCTIONALLY DIFFERENT AND WERE SELECTED BY THE LEARNED TPO WERE CONFIRMED BY THE C IT(A). THE AR SUBMITTED THAT THE SAID FOUR COMPARABLES WHICH WERE EARLIER ACCEPTED AS APPROPRIATE MAY BE CONSIDERED FOR THE C URRENT YEAR ALSO UNDER THE TNM METHOD. 36. IN RESPECT OF THE COMPANIES SELECTED AS COMPARABLES AND CONFIRMED BY THE CIT(A), THE LEARNED AR HAS EXPRESS ED STRONG OBJECTIONS. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 22 37. THE LEARNED AR SUBMITTED THAT NONE OF THE 16 COMPAR ABLES (AFTER REMOVAL OF SATYAM COMPUTER SERVICES) SELECTE D BY THE TPO AND CONFIRMED BY THE CIT(A) ARE COMPARABLE. EITHER THESE COMPANIES ARE FUNCTIONALLY DIFFERENT OR THE TURNOVE R IS VERY HIGH WHEN COMPARED TO THAT OF THE ASSESSEE COMPANY. ACC ORDINGLY, THE AR SUBMITTED THAT THE ABOVE 16 COMPANIES BE NOT CON SIDERED FOR BENCHMARKING PURPOSES AND CONSIDER THE ABOVE 4 COMP ANIES SELECTED BY THE ASSESSEE. 38. THE DR RELIED ON THE ORDER OF THE CIT(A) AND THE AS SESSMENT ORDER. 39. WE HAVE HEARD BOTH THE PARTIES AND PERUSED THE MATE RIAL ON RECORD. GROUND NOS. 1 TO 6 AND GROUND NO. 11 RAISE D BY THE ASSESSEE ARE WITH REGARD TO REJECTION OF CUP METHOD ADOPTED BY THE ASSESSEE FOR COMPUTATION OF ALP OF THE INTERNAT IONAL TRANSACTIONS AND FOLLOWING THE TNM METHOD. THE ASS ESSEE ARGUED BEFORE US THAT THE CUP METHOD (COMPARABLE UNCONTROL LED PRICE METHOD) IS APPROPRIATE METHOD IN THIS CASE. FOR TH E PURPOSE OF APPLICATION OF CUP METHOD THERE SHOULD BE SIMILARIT Y OF TRANSACTIONS TO BE COMPARED. IN OTHER WORDS, THE P RICE CHARGED OR PAID FOR PROPERTY TRANSFER OR SERVICE PROVIDED IN C OMPARABLE UNCONTROLLED TRANSACTION FOR WHICH CUP METHOD CAN B E APPLIED. HOWEVER, THIS METHOD IS NOT SUITABLE IF THERE ARE M ATERIAL PRODUCT DIFFERENCES OR SUBSTANTIAL ADJUSTMENTS. SIMILARITY OF PRODUCT IS UTMOST IMPORTANT. IF THE PRODUCT IS SIMILAR THEN A DJUSTMENT TOWARDS DIFFERENCES WHICH COULD MATERIALLY AFFECT T HE PRICE IN OPEN MARKET SUCH AS QUALITY OF PRODUCT, TERMS OF CONTRAC T, FOREIGN CURRENCY, ETC., CAN BE MADE. HOWEVER, IN THE INSTA NT CASE, AS SEEN FROM THE AGREEMENT ENTERED INTO BY THE ASSESSEE WIT H THE AE AND THOSE AGREEMENTS ENTERED INTO WITH THE THIRD PARTIE S, THE SERVICE RENDERED TO THOSE THIRD PARTIES ARE NOT SIMILAR TO THAT RENDERED TO THE AE. THERE IS A CLEAR CUT FINDING REGARDING THI S ASPECT BY THE ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 23 CIT(A) IN HIS ORDER AT PARA 5.1. THE LEARNED AR WA S NOT ABLE TO CONTROVERT THE ABOVE FINDING OF THE CIT(A). FOR CL ARITY WE WILL GO BY CERTAIN AGREEMENTS ENTERED INTO BY THE ASSESSEE. 40. AS PER THE CONTRACT/AGREEMENT MADE WITH AVEDIS MICROSYSTEMS PVT. LTD., THE SAID COMPANY HAS REQUES TED THE ASSESSEE TO PROVIDE TWO DESIGN ENGINEERS WITH SPECI FIED EXPERIENCE (AS MENTIONED THEREIN) ON A MONTHLY FEE BASIS AND T HE TERMS AND CONDITIONS IN THAT REGARD ALSO INDICATED THEREIN. F ROM THE COPY OF THE SAID AGREEMENT FILED BEFORE THE CIT(A), THE NAT URE OF SERVICES TO BE RENDERED TO THAT COMPANY IS ASCERTAINABLE. UNDER THE CIRCUMSTANCE, EVEN THOUGH IN THAT DOCUMENT THERE IS MENTION THAT, THE SAID COMPANY SHALL PAY THE ASSESSEE AN AM OUNT OF US$ 3000 PER MAN MONTH, THE SAID COMPANY CANNOT BE CONS IDERED AS A COMPARABLE (INTERNAL COMPARABLE) IN THIS CASE. 41. THE SOFTWARE DEVELOPMENT AGREEMENT MADE BY AGERE SYSTEMS INDIA PVT. LTD., WITH THE ASSESSEE, THE SAI D COMPANY DESIRES TO ENGAGE QCL I.E., THE ASSESSEE COMPANY, T O CARRY OUT CERTAIN SOFTWARE DEVELOPMENT WORK AND THE ASSESSEE AGREES TO CARRY OUT SUCH WORK, IN ACCORDANCE WITH THE TERMS A ND CONDITIONS OF THAT AGREEMENT AND ANY ATTACHMENT REFERENCED THE REIN. THUS, THE WORK TO BE PERFORMED/SERVICES TO BE RENDERED BY THE ASSESSEE, ARE REFERRED TO IN CONCERNED ATTACHMENT. IN THE ENT IRE NARRATIVE OF THE SAID AGREEMENT, THERE IS NO REFERENCE TO THE NA TURE OF WORK/SERVICES TO BE RENDERED BY THE ASSESSEE I.E., QCL. FURTHER, IN ANNEXURE-A (SCOPE AND STATEMENT OF WORK), IT IS MENTIONED THAT THE SAME SHALL BE TO SUPPORT THE DESIGN VERIFICATIO N ACTIVITIES OF SOCS, BEING DESIGNED BY AGERE. THUS, THE ASSESSEE W AS REQUIRED TO CARRY OUT CERTAIN DESIGN VERIFICATION OF SOME ACTIV ITIES THAT WERE ASSIGNED BY THAT COMPANY. FROM THIS, IT CLEARLY SH OWS THAT THE SERVICES RENDERED TO THAT COMPANY, WERE TOTALLY DIF FERENT FROM THAT RENDERED BY THE ASSESSEE TO ITS AE. FURTHER, FROM T HE DETAILS OF ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 24 PROJECT DELIVERY/EXECUTION AS ENUMERATED IN THAT AN NEXURE, IT IS NOTICED THAT THE SERVICES TO BE PERFORMED BY THE AS SESSEE ARE TOTALLY DIFFERENT FROM THAT RENDERED TO THEIR AE. U NDER THIS CIRCUMSTANCE, THE ABOVE COMPANY, CANNOT BE CONSIDER ED AS AN INTERNAL COMPARABLE IN THIS CASE. 42. THE MASTER SOFTWARE DEVELOPMENT AGREEMENT ENTERED I NTO BY TEXAS INSTRUMENTS (INDIA) PVT. LTD., WITH THE ASSES SEE, THE SAID COMPANY HAS DESIRED TO ENGAGE THE ASSESSEE IN CONNE CTION WITH DEVELOPMENT OF CERTAIN SOFTWARE APPLICATION THAT AR E MORE SPECIFICALLY SET FORTH AND DESCRIBED IN THE WORK OR DER. HOWEVER, IN THAT WORK ORDER, A COPY OF WHICH WAS FURNISHED VIDE ANNEXURE A, ENCLOSED TO THE SAID AGREEMENT (FURNISHED BY THE AS SESSEE), UNDER SCOPE AND DETAILS OF THE PROJECT, NOTHING IS MENTIO NED. THE COLUMNS AGAINST 'DESCRIPTION' AND 'SERVICES TO BE P ROVIDED' ARE BLANK. THUS, THE NATURE OF WORK/SERVICES TO BE PERF ORMED BY THE ASSESSEE TO THAT COMPANY IS NOT KNOWN. UNDER THE CI RCUMSTANCE, THE SAID COMPANY WHICH WAS IN THE BUSINESS OF DEVEL OPING, MANUFACTURING AND SELLING DIGITAL SIGNAL PROCESSING DEVICES, CANNOT BE CONSIDERED AS AN INTERNAL COMPARABLE IN T HIS CASE. IN OTHER WORDS THE TRANSACTIONS MADE WITH THAT COMPANY CANNOT BE CONSIDERED FOR THE PURPOSE OF COMPARABILITY ANALYSI S UNDER CUP METHOD, IN THIS CASE. IN THIS CONTEXT, IT MAY BE FU RTHER MENTIONED THAT THOUGH THE ASSESSEE HAS FURNISHED COPY OF A LE TTER DATED 29.11.2004 WRITTEN BY THAT COMPANY AND CERTAIN INVO ICES ISSUED BY THAT COMPANY, IN ABSENCE OF THE NATURE OF SERVIC ES TO BE RENDERED BY THE ASSESSEE TO THAT COMPANY, THOSE DOC UMENTS, HAVE NO APPLICATION IN THIS CASE. 43. THE AGREEMENT WITH FUTURE TECHNO DESIGNS PVT. LTD., IS CONCERNED, THE ASSESSEE HAS MERELY FURNISHED COPIES OF PURCHASE ORDER ISSUED BY THAT COMPANY WHEREIN FOR DESIGN SER VICE CHARGES FOR MULTI-ADAPTOR PROJECT, THE RATE IS SHOWN AT US$ 63,000. BUT, ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 25 IN ABSENCE OF THE NATURE OF SERVICES TO BE RENDERED INDICATED IN THAT PURCHASE ORDER, IT CANNOT BE SAID THAT THE SER VICES RENDERED TO THAT COMPANY WERE SIMILAR TO THAT RENDERED BY TH E ASSESSEE TO ITS AE. FURTHER IN ABSENCE OF ANY AGREEMENT WITH TH AT COMPANY, IT CANNOT BE ACCEPTED THAT THE SERVICES RENDERED TO TH AT COMPANY ARE SIMILAR TO THOSE RENDERED TO THE AE. HENCE, THE SA ID COMPANY CANNOT BE CONSIDERED AS AN INTERNAL COMPARABLE IN T HIS CASE. IN OTHER WORDS, THE TRANSACTIONS MADE WITH THAT COMPAN Y, CANNOT BE CONSIDERED FOR COMPARABILITY ANALYSIS UNDER CUP MET HOD. 44. THE AGREEMENT WITH BECEEM COMMUNICATIONS PVT. LTD., AS PER THE PURCHASE ORDER DATED 05.10.2004 ISSUED BY T HAT COMPANY, A COPY OF WHICH WAS FILED BEFORE HIM, THE SAID COMP ANY, FOR THE PURPOSE OF VLSI DESIGN CONSULTANCY, HAS REQUISITION ED TWO PERSONS FROM THE ASSESSEE AT A PRICE OF RS. 1,57,650/- (EXT ENDED PRICE RS. 3,15,300). AS PER THE SAME, THE SAID COMPANY NEEDED TWO PERSONS FROM THE ASSESSEE, IN THE CONTEXT OF SOME DESIGN CO NSULTANCY. THE SAME PERTAINS TO MERE CONSULTATION. UNDER THE CIRCU MSTANCE, IT CANNOT BE SAID THE ASSESSEE HAS RENDERED THE SAME S ERVICES TO THAT COMPANY AS IT RENDERED TO THE AE. IN OTHER WOR DS, THE SERVICES RENDERED TO THAT COMPANY CANNOT BE TREATED AS SIMIL AR TO THAT RENDERED TO THE AE. HENCE, THE TRANSACTION MADE WIT H THE ABOVE COMPANY, CANNOT BE CONSIDERED FOR COMPARABILITY ANA LYSIS UNDER CUP METHOD IN THIS CASE. 45. IT IS CLEAR THAT THE SERVICE RENDERED BY THE ASSESS EE TO THOSE THIRD PARTIES, WERE DIFFERENT FROM THAT RENDERED BY IT TO THE AE. UNDER THE CIRCUMSTANCE, TRANSACTIONS MADE WITH THOS E COMPANIES, CANNOT BE CONSIDERED FOR COMPARABILITY ANALYSIS FOR BENCHMARKING OF THE INTERNATIONAL TRANSACTIONS MADE BY THE ASSES SEE WITH ITS AE. HENCE, THE CUP METHOD IS NOT ALL APPLICABLE TO THIS CASE. THUS, THE CUP METHOD CANNOT BE ADOPTED FOR DETERMINING THE AR M'S LENGTH PRICE (ALP FOR SHORT) OF THE INTERNATIONAL TRANSACT IONS MADE BY THE ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 26 ASSESSEE WITH ITS AE. THEREFORE, THE TPO WAS JUSTIF IED IN REJECTING THE CUP METHOD AND CONSEQUENTLY PROCEEDING TO DETER MINE THE ALP OF SUCH TRANSACTIONS, ADOPTING TNMM IN THIS CAS E. THE AR SUBMITTED THAT THE TPO HIMSELF OBSERVED THAT CUP ME THOD IS MOST APPROPRIATE METHOD IN ASSESSEE'S CASE, BUT HE FURTH ER NOTED THAT INFORMATION FOR APPLICATION OF THAT METHOD WAS NOT AVAILABLE WITH HIM. HOWEVER, IN THIS CONTEXT, THE CIT(A) CLARIFIE D THAT, IN PARA 9 AT PAGE 49 OF HIS ORDER, THE TPO HAS MENTIONED THAT THERE IS ALSO NO DISPUTE THAT THE CUP METHOD IS THE MOST DIRECT A ND RELIABLE WAY TO APPLY ARM'S LENGTH PRINCIPLE. IN THE NEXT SE NTENCE, IN THAT PARA, HE HAS FURTHER MENTIONED THAT, BUT WHILE SELE CTING CUP METHOD, ONE MORE IMPORTANT ASPECT IGNORED BY THE TA XPAYER IS WHETHER THE DATA USED BY THE TAXPAYER IS RELIABLE A ND VERIFIABLE BY THE TPO. FROM SUCH OBSERVATIONS OF THE TPO, IT MAY BE SEEN THAT HE HAS POINTED OUT THAT, THE DATA USED BY THE ASSES SEE ARE NOT RELIABLE AND NOT VERIFIABLE AND FOR THE SAME HE HAS REJECTED SUCH METHOD ADOPTED BY THE ASSESSEE. IN ANY CASE, SINCE AFTER DETAILED DISCUSSIONS MADE ABOVE, THE CIT(A) HELD THAT CUP ME THOD CANNOT BE ADOPTED IN THIS CASE, SUCH DECISION OF THE TPO I N REJECTING SUCH METHOD ADOPTED BY THE ASSESSEE, IS JUSTIFIED AND HE NCE, THE SAME IS UPHELD. FURTHER, FOR THE REASONS STATED BY HIM IN HIS SAID ORDER, ADOPTION OF TNMM BY THE TPO AS THE MOST APPR OPRIATE METHOD FOR DETERMINING ALP OF SUCH INTERNATIONAL TR ANSACTIONS MADE BY THE ASSESSEE DURING THE F.Y 2004-05 WITH IT S AE, IS HELD TO BE JUSTIFIED. IT MAY ALSO BE MENTIONED HERE THAT IN THE PRECEDING TWO ASSESSMENT YEARS, TNMM HAS ALSO BEEN APPLIED BY THE TPO AND THE SAME HAS BEEN ACCEPTED. UNDER SUCH CIRCUMST ANCES, APPLICATION OF THE SAID METHOD I.E., TNMM BY THE TP O FOR COMPUTING ALP OF THE INTERNATIONAL TRANSACTIONS MAD E BY THE ASSESSEE WITH ITS AE IN THIS CASE IS UPHELD. FURTHE R, AS REGARDS, THE ALTERNATIVE CONTENTION OF THE ASSESSEE FOR APPL YING COST PLUS METHOD (CPM) IS CONCERNED, SINCE THE TRANSACTIONS M ADE BY IT WITH ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 27 THOSE DOMESTIC PARTIES ARE NOT SIMILAR TO THOSE REN DERED TO THE AE, THE SAID METHOD CANNOT BE APPLIED IN THIS CASE. ACC ORDINGLY, WE REJECT THE PLEA OF THE ASSESSEE. 46. COMING TO THE PLEA OF THE ASSESSEE THAT ONLY THOSE FOUR COMPANIES, WHICH WERE CONSIDERED AS COMPARABLES IN THE PRECEDING TWO ASSESSMENT YEARS I.E., A.YS. 2003-04 AND 2004-05, SHOULD BE CONSIDERED IN THIS CASE, THE CIT(A) OBSER VED THAT THERE IS NO MERIT IN SUCH CONTENTION. AS ADMITTED BY THE ASS ESSEE IN ITS WRITTEN SUBMISSIONS MADE VIDE LETTER DATED 02.01.20 10, THE COMPANY IN ITS CASE, IS ENGAGED IN THE BUSINESS OF SOFTWARE DEVELOPMENT SERVICES IN THE FIELD OF APPLICATION OF ASIC AND VLSI. THUS, IT WAS IN THE BUSINESS OF SOFTWARE DEVELOPMEN T, THOUGH PERTAINING TO A DIFFERENT FIELD. SINCE, SUCH FIELDS COME UNDER PURVIEW OF A VERTICAL, UNDER SOFTWARE DEVELOPMENT S ERVICES, THE DIFFERENT COMPARABLE COMPANIES REFERRED TO BY THE T PO AT PAGE 106, FOR THE REASONS STATED BY HIM AGAINST EACH SUC H COMPANY, SHOULD BE CONSIDERED AS COMPARABLES FOR THE PURPOSE OF DETERMINING ALP OF THE INTERNATIONAL TRANSACTIONS I N THIS CASE. THE TPO HAS SELECTED THOSE COMPARABLES ON BASIS OF DIFF ERENT FILTERS ADOPTED BY HIM, REFERRED TO UNDER PARA 12 AT PAGE 9 2. WHEN THE ASSESSEE WAS MAINLY ENGAGED IN SOFTWARE DEVELOPMENT SERVICES, THOUGH IN A DIFFERENT VERTICAL, HAVING REGARD TO TH E OVERALL CIRCUMSTANCES OF THE CASE, SUCH COMPARABLE COMPANIE S SELECTED BY THE TPO SHOULD BE CONSIDERED AS COMPARABLES IN T HIS CASE. AS REGARDS THOSE FOUR COMPANIES REFERRED TO BY THE ASS ESSEE ARE CONCERNED, AFTER DISCUSSING THE FACTUAL POSITION IN RESPECT OF THOSE COMPANIES AND APPLYING THOSE FILTERS ADOPTED BY HIM , IN PARA 13 AT PAGE 93-94 OF HIS ORDER, HE HAS CLEARLY HELD THA T THE SAME CANNOT BE CONSIDERED AS COMPARABLES IN THIS CASE. I N FACT, HAVING REGARD TO THE FACTUAL FINDINGS GIVEN BY THE TPO IN THAT PARA, HIS DECISION IN REJECTING THOSE FOUR COMPANIES AS COMPA RABLES, IS JUSTIFIED. ACCORDINGLY, WE REJECT THE PLEA OF THE A SSESSEE. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 28 47. IN VIEW OF THE ABOVE, WE ARE INCLINED TO CONFIRM TH E ORDER OF THE CIT(A) ON THIS ISSUE. 48. THE NEXT GROUND FOR CONSIDERATION IS GROUND NO. 7 I N THE GROUNDS OF APPEAL. WE HAVE HEARD ON THIS ISSUE. T HE LEARNED AR WAS NOT ABLE TO SHOW HOW THE 16 COMPANIES SELECTED AS COMPARABLE BY THE TPO ARE FUNCTIONALLY DIFFERENT FR OM THE ASSESSEE COMPANY. BEING SO, WE ARE NOT INCLINED TO DISTURB THE COMPARABLES SELECTED BY THE TPO. ACCORDINGLY, THIS GROUND IS REJECTED. 49. THE NEXT GROUND FOR OUR CONSIDERATION IS GROUND NO. 8. WE HAVE HEARD BOTH THE PARTIES ON THIS ISSUE. THE ASS ESSEE HAS NOT FURNISHED ANY WORKING WITH REGARD TO WORKING CAPITA L ADJUSTMENT. THIS WAS NOTED BY THE TPO AT PARA 17.1 OF HIS ORDER . UNDER THESE CIRCUMSTANCES, AS NOTED BY THE TPO IN PARA 17.1 OF HIS ORDER, THE ASSESSEE HAS NOT FURNISHED ANY WORKING IN THAT REGA RD BEFORE HIM. UNDER THE CIRCUMSTANCE, HE COMPUTED THE WORKING CAP ITAL ADJUSTMENT TO BE ALLOWED IN THIS CASE, FOLLOWING TH E OECD GUIDELINES AND APPROVED FORMULA IN THAT REGARD. THE DETAILED FORMULA APPLIED BY THE TPO FOR THAT PURPOSE, ARE DI SCUSSED UNDER THAT PARA 17.1, AT PAGE 108 - 109 OF HIS ORDER. THE ACTUAL WORKINGS MADE BY HIM ON THAT ACCOUNT, ARE GIVEN IN ANNEXURE - C TO HIS ORDER, AS PER WHICH SUCH WORKING CAPITAL ADJUSTMENT TO BE ALLOWED HAS BEEN WORKED OUT AT -5.12%. SINCE, THE TPO HAS M ADE SUCH WORKINGS ON BASIS OF OECD GUIDELINES/ FORMULA IN TH AT REGARD AND IN ABSENCE OF ANY ERROR POINTED OUT BY THE ASSESSEE IN SUCH CALCULATION, SUCH WORKING AS MADE BY THE TPO IS UPH ELD BY THE CIT(A). THIS GROUND IS REJECTED. 50. THE NEXT GROUND IS GROUND NO. 9. THIS GROUND IS IN CORRELATION TO GROUND NOS. 7 AND 8. BEING SO, THIS GROUND DOES NOT REQUIRE ANY ADJUDICATION AND IS REJECTED. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 29 51. THE LAST GROUND FOR ADJUDICATION IS WITH REGARD TO NOT GIVING ADJUSTMENT ON ACCOUNT OF HIGH DEPRECIATION TO THE T OTAL COST IN THE CASE OF THE ASSESSEE. 52. BRIEF FACTS OF THE ISSUE ARE THAT THE TOTAL COST IN CLUDING DEPRECIATION AND EXCLUDING INTEREST IS RS 9.69 CROR ES AND DEPRECIATION IS RS 2.78 CRORES. DEPRECIATION/TOTAL COST WORKS OUT TO 28.69%. THIS ABNORMAL DEPRECIATION COST SHOULD B E ADJUSTED WHILE COMPUTING MARGIN OF COMPARABLE COMPANIES UNDE R TNMM. HENCE THE PBDIT/EXPENDITURE OF THE COMPANY WORKS OU T TO 5.23% WHEREAS THE PBDIT/EXPENDITURE OF COMPARABLE COMPANI ES IS 0.80%. THE AR REQUESTED TO CONSIDER PBDIT/EXPENDIT URE AS THE PROFIT LEVEL INDICATOR 53. THE AR RELIED ON THE DECISION OF DELHI BENCH OF THE TRIBUNAL IN THE CASE OF SCHEFENACKER MOTHERSON LTD. VS ITO ( 123 TTJ 509) FOR AY 2003-04 AND SCHEFENACKER MOTHERSON LTD. VS D CIT IN ITA NO. 4460/DEL/07 FOR AY 2004-05 HAS AGREED THAT WHER E DEPRECIATION COMPONENT VARIES SIGNIFICANTLY BETWEEN THE TESTED PART OF COMPARABLE COMPANIES IT IS ECONOMICALLY JUS TIFIED TO TAKE CASH PROFIT I.E. PBDIT/COST AS THE PROFIT LEVEL IND ICATOR. THE FACTS OF THE PRESENT CASE ARE SIMILAR TO THE ABOVE CASE A ND THE AR SUBMITTED THAT PBDIT/OPERATING COST MAY BE CONSIDER ED AS THE PROFIT LEVEL INDICATOR IN THE ASSESSEE'S CASE. 54. THE LEARNED AR SUBMITTED THAT THE DEPRECIATION COST AS A PERCENTAGE OF TOTAL COST IN THE CASE OF THE ASSESSE E WAS VERY HIGH. THE SAME AMOUNTS TO 28.60% OF THE TOTAL COST. THE COMPARABLE COMPANIES SELECTED BY THE TPO HAVE A DEPRECIATION C OST AT 2.72% TO 12.55%, GIVING AN AVERAGE OF 6.36%. STATING THA T THE DEPRECIATION COST IN THEIR CASE IS VERY HIGH, THE A R SUBMITTED THAT THE SAME SHOULD BE EXCLUDED FOR COMPUTING THE PROFI T MARGIN FOR THE PURPOSE OF COMPUTING THE ALP OF THE INTERNATION AL ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 30 TRANSACTIONS. THE AR RELIED ON THE DECISION OF THE ITAT, DELHI BENCH IN THE CASE OF SCHEFENACHKER MOTHERSON LTD. V S. ITO (123 TTJ 509). 55. THE LEARNED DR SUBMITTED THAT THIS ISSUE WAS RAISED BEFORE THE TPO AND THE TPO DISCUSSED THE SAME AT PAGES 59- 60 OF HIS ORDER. AS PER THE TPO, UNDER TNMM, ALL EXPENDITURE , EXCLUDING INTEREST AND OTHER NON-OPERATING EXPENDITURE, SHOUL D BE CONSIDERED FOR ARRIVING AT THE TOTAL COST AND THE O PERATING PROFIT ON THAT BASIS IN CASE OF ANY COMPANY. THE DR SUBMITTE D THAT THERE IS NO JUSTIFICATION FOR THE CONTENTION OF THE ASSESSEE THAT SINCE THE DEPRECIATION COST IN ITS CASE IS VERY HIGH, AS COMP ARED TO THE SAME IN RESPECT OF THE COMPARABLE COMPANIES, THE SAME SH OULD BE EXCLUDED. 56. THE DR SUBMITTED THAT FROM THE 'DISTRIBUTOR AGREEME NT' WHICH IS THE SERVICE AGREEMENT ENTERED INTO BY THE ASSESSEE WITH ITS AE IN THIS CASE, IT IS SEEN THAT THE ASSESSEE H AS APPOINTED ARM SEMICONDUCTOR (USA) INC., AS THE EXCLUSIVE DISTRIBU TOR FOR THE SALE OF ITS INTELLECTUAL PROPERTIES AND DESIGN SERVICES WORLDWIDE OUTSIDE INDIA. DESIGN SERVICES ARE CONTRACTED WORK SPECIFI C TO INDIVIDUAL CUSTOMERS ON A PROJECT OR TIME BASIS. AS REGARDS P RICING IS CONCERNED, AT PAGE 4 OF THE SAID AGREEMENT, UNDER S ECTION 3.02, IT IS STATED, COMPANY SHALL HAVE THE RIGHT TO ESTABLIS H THE PRICES CHARGED FOR ITS INTELLECTUAL PROPERTIES AND DESIGN SERVICES, BUT AGREES TO REASONABLY CONSIDER THE ADVICE OF DISTRIB UTOR. COMPANY SHALL PROVIDE DISTRIBUTOR WITH A PRICELIST. AS REG ARDS, FEES AND COMMISSION PAYABLE TO THE DISTRIBUTOR ARE CONCERNED , AT THE SAME PAGE OF THE AGREEMENT, UNDER SECTION 3.03, IT IS ME NTIONED THAT THE FEES AND/OR COMMISSIONS TO BE CHARGED BY DISTRIBUTO R SHALL BE DETERMINED BY MUTUAL AGREEMENT OF DISTRIBUTOR AND C OMPANY ON A CASE BY CASE BASIS WITH RESPECT TO EACH OTHER. FRO M SUCH TERMS OF THE SAID AGREEMENT, IT IS SEEN THAT THE COMPANY I.E ., ASSESSEE COMPANY IN THIS CASE, HAS FULL RIGHT TO FIX THE PRI CE TO BE CHARGED ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 31 IN RESPECT OF INTELLECTUAL PROPERTIES AND DESIGN SE RVICES, DEVELOPED BY IT AND IT SHALL PROVIDE THE SAID DISTRIBUTOR I.E ., THE AE IN THIS CASE, A PRICELIST IN THIS REGARD. FROM THE SAME, I T SHOWS, WHEN THE ASSESSEE WAS FIXING THE PRICE, IT HAS TAKEN INTO AC COUNT ALL COSTS INCURRED BY IT, BOTH DIRECT COST AND INDIRECT COST, IN DEVELOPMENT OF SUCH INTELLECTUAL PROPERTY/DESIGN SERVICES. UNDER THIS CIRCUMSTANCE, I.E., WHEN THE ASSESSEE, AS PER THE S AID AGREEMENT, WAS TO GET THE PRICE, COVERING ALL COSTS INCURRED B Y IT, IN RESPECT OF SUCH INTELLECTUAL PROPERTIES, ETC., DEVELOPED BY IT , THE ASSESSEE CANNOT CLAIM EXCLUSION OF DEPRECIATION IN RESPECT O F THE ASSETS, FOR THE PURPOSE OF COMPUTING OPERATING PROFIT. FURTHER , WHEN INTHIS CASE, THE MATTER RELATES TO DETERMINATION OF ARM'S LENGTH PRICE OF SUCH INTERNATIONAL TRANSACTIONS MADE BY THE ASSESSE E WITH ITS SAID AE, IT CANNOT CLAIM FOR EXCLUSION OF SUCH EXPENSES FROM OPERATIONAL COST, WHICH IS NOT IN CONSONANCE WITH T HE SAID DISTRIBUTOR AGREEMENT ENTERED INTO BY IT WITH THAT AE. THEREFORE, AND WHEN THE RATES OF DEPRECIATION IN RESPECT OF DI FFERENT ASSETS USED BY THE ASSESSEE AND THOSE COMPARABLE COMPANIES , ARE SAME AND MORE OVER TNMM IS APPLIED FOR DETERMINING ALP O F SUCH TRANSACTIONS, THERE IS NO MERIT IN SUCH PLEA OF THE ASSESSEE FOR EXCLUDING DEPRECIATION. AS REGARDS REFERENCE BY TH E ASSESSEE TO THE SAID DECISION OF THE ITAT DELHI BENCH, IN THE C ASE OF SCHEFENACHKER MOTHERSON LTD. (SUPRA) IS CONCERNED, IT IS SUBMITTED THAT THE FACTS IN THAT CASE ARE DISTINGUI SHABLE FROM THAT OF THE ASSESSEE. IN THAT CASE, APPARENTLY THAT COM PANY WAS HAVING CASH PROFIT ON SALES, EVEN AFTER CONSIDERING DEPREC IATION. HOWEVER, IN THE FACE OF SUCH AGREEMENT ENTERED INTO BY THE A SSESSEE WITH ITS AE, WHICH WAS APPLICABLE DURING THE F.Y. 2004-05 FO R THE A.Y. 2005-06, SUCH PLEA FOR EXCLUDING DEPRECIATION, FOR COMPUTING THE OPERATING PROFIT CANNOT BE ACCEPTED. ACCORDINGLY, HE SUBMITTED THAT THE GROUND RAISED BY THE ASSESSEE MAY BE REJEC TED AND THE PLI ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 32 AS ADOPTED BY THE TPO IN THIS CASE, BE HELD TO BE J USTIFIED AND THE SAME SHOULD BE UPHELD. 57. WE HAVE HEARD BOTH THE PARTIES ON THIS AND PERUSED THE MATERIAL ON RECORD. IN THE PRESENT APPEAL, ALP OF TRANSACTIONS CARRIED WAS TO BE DETERMINED BY COMPARING NET PROFI T OF THE TAXPAYER (TESTED PARTY) WITH MEAN NET PROFIT OF COM PARABLES. ONLY RECEIPTS AND EXPENDITURE, HAVING CONNECTION WITH IN TERNATIONAL TRANSACTIONS, WERE REQUIRED TO BE TAKEN INTO ACCOUN T. ANY RECEIPT OR EXPENDITURE HAVING NO BEARING ON PRICE OR MARGIN OF PROFIT COULD NOT BE TAKEN INTO CONSIDERATION. IT IS EVIDENT FROM STATUTORY PROVISIONS THAT IT IS NOWHERE PROVIDED THAT DEDUCTI ON OF DEPRECIATION IS A MUST. DEPRECIATION CAN BE TAKEN I NTO ACCOUNT OR DISREGARDED IN COMPUTING PROFIT DEPENDING UPON THE CONTEXT AND PURPOSE FOR WHICH PROFIT IS TO BE COMPUTED. THERE I S NO FORMULA WHICH WOULD BE APPLICABLE UNIVERSALLY AND IN ALL CI RCUMSTANCES. 'NET PROFIT' USED IN RULE 10B CAN BE TAKEN TO MEAN COMMERCIAL PROFIT. BUT DEPRECIATION IN SUCH PROFIT ON COMMERCI AL PRINCIPLES HAS TO BE THE 'ACTUAL' AMOUNT BY WHICH THE ASSETS O F BUSINESS GOT DEPLETED BETWEEN THE TWO DATES SEPARATED BY A YEAR. IT CANNOT BE DEPRECIATION UNDER TAX OR COMPANIES RULES OR AS PER POLICY OF THE COMPANY. IN THE CASE IN HAND, REVENUE AUTHORITIES W ENT WRONG IN DISREGARDING THE CONTEXT AND PURPOSE FOR WHICH THE 'NET PROFIT' WAS TO BE COMPUTED. DEPRECIATION, WHICH CAN HAVE VA RIED BASIS AND IS ALLOWED AT DIFFERENT RATES, IS NOT SUCH AN E XPENDITURE WHICH MUST BE DEDUCTED IN ALL SITUATIONS. IT HAS NO DIREC T CONNECTION OR BEARING ON PRICE, COST OR PROFIT MARGIN OF THE INTE RNATIONAL TRANSACTIONS. OBJECT AND PURPOSE OF THE TRANSFER PR ICING TO COMPARE LIKE WITH THE LIKE, AND TO ELIMINATE DIFFER ENCES, IF ANY, BY SUITABLE ADJUSTMENT IS TO BE SEEN. THEREFORE, THERE WAS JUSTIFICATION ON THE PART OF THE ASSESSEE IN PLEADI NG THAT PROFITS BE TAKEN WITHOUT DEDUCTION OF DEPRECIATION AS DEPRECIA TION WAS LEADING TO LARGE DIFFERENCES IN MARGINS FOR VARIOUS REASONS. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 33 CONTENTION THAT DEPRECIATION WOULD DEPEND UPON TYPE OF TECHNOLOGY EMPLOYED, AGE AND NATURE OF MACHINERY US ED, IS QUITE WELL-FOUNDED. ABOVE, ALONG WITH SIZE OF ENTERPRISE AND INVESTMENT IN PLANT/MACHINERY WERE IMPORTANT FACTORS TO BE TAK EN INTO ACCOUNT FOR COMPARISON AND FOR COMPUTING PROFIT. TH ERE IS CONSIDERABLE SUPPORT FOR THE CONTENTION RAISED ON B EHALF OF THE ASSESSEE IN THE OECD GUIDELINES ON TRANSFER PRICING . THE CLAIM OF DEPRECIATION CAN LEAD TO GREAT DIFFERENCE IN COMPUT ING PROFITS OF COMPARABLES AS DEPRECIATION IS PERMITTED DEPENDING UPON NATURE OF PLANT/MACHINERY AND YEAR OF USE. OBVIOUSLY THER E ARE DIFFERENCES BETWEEN THE MACHINERY EMPLOYED BY THE T AXPAYER AND OTHER COMPARABLE CONCERNS WHICH IS REFLECTED IN AMO UNT AND PERCENTAGE OF DEPRECIATION CLAIMED. HOW THIS VARIA TION AND DIFFERENCE COULD BE IGNORED UNDER TP REGULATIONS IS NEITHER SHOWN NOR EXPLAINED. THE ASSESSEE HAS DEBITED HIGH AMOUNT /RATIO OF DEPRECIATION. OTHER ENTERPRISES HAVE CLAIMED DEPREC IATION AT MUCH LOWER AMOUNTS. SIZE OF THE ASSETS BESIDES THE AGE O F THE ASSETS OF COMPARABLES WAS LEADING TO DIFFERENCE IN THE PROFIT MARGINS AND IN MEAN MARGIN. ON THE CONTRARY, CLAIM OF DEPRECIATION IS EATING UP LARGE CHUNK OF PROFIT IN THE CASE OF THE TAXPAYER. THE CIT(A) HAS NOT SAID A WORD ON 'ASSET' EMPLOYED AND 'RISKS' SUF FERED BY THE TESTED PARTY AND THE COMPARABLES. THUS, MATERIAL DI FFERENCES NEEDING SUITABLE ADJUSTMENT WERE IGNORED AND A FLAW ED ANALYSIS WAS CARRIED EVEN IN APPELLATE PROCEEDINGS. WITHOUT CONSIDERING OBVIOUS MATERIAL DIFFERENCES, THE CONTENTION OF THE ASSESSEE TO TAKE PROFIT WITHOUT DEPRECIATION WAS REJECTED. THIS REJE CTION IS NOT SOUND IN LAW. THIS GROUND IS ALLOWED. ACCORDINGLY, WE DIRECT THE ASSESSING OFFICER TO RECOMPUTE THE ALP. ITA NO. 893/HYD/2011 M/S. QUAL CORE LOGIC LTD. ================== 34 58. IN THE RESULT, ASSESSEE'S APPEAL IS PARTLY ALLOWED. ORDER PRONOUNCED IN THE OPEN COURT ON 31 ST MAY, 2012. SD/ - (ASHA VIJAYARAGHAVAN) JUDICIAL MEMBER SD/ - (CHANDRA POOJARI) ACCOUNTANT MEMBER HYDERABAD, DATED THE 31 ST MAY, 2012 COPY FORWARDED TO: 1. M/S. QUAL CORE LOGIC LTD., C/O. M/S. PRASAD & PRASA D, CHARTERED ACCOUNTANTS, FLAT NO. 302, KR TOWERS, ROA D NO. 12, BANJARA HILLS, HYDERABAD. 2. THE DEPUTY COMMISSIONER OF INCOME - TAX, CIRCLE - 16(3), HYDERABAD. 3. THE CIT(A) - III, HYDERABAD. 4 . THE CIT - IV, HYDERABAD 5. THE DR A BENCH, ITAT, HYDERABAD. TPRAO