Kodiak Networks (India) Private Limited, Bangalore V. ACIT, Bangalore

ITA 970/BANG/2011

• Counselvise Citation: [2012] 140 COUNSELVISE.COM (IT) 57520 (ITAT-BANGALORE)
• Duration Of Justice: 4 month(s) 15 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 16-03-2012
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: B
• Next Hearing Date: 07-03-2012
• Assessment Year: 2007-2008
• Appeal Filed On: 31-10-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: ETWA MUNDA CITIII
• Assessee Lawyers: R VIJAYARAGHAVAN
• Keywords: Business income; Depreciation; Transfer pricing; Opportunity of being heard; Principle of natural justice; International transaction; Revenue expenditure
• Section: 92C; 143(3); 80HHC; 234B; 133(6); 10B; 37

Judgement Text

PAGE 1 OF 36 ITA NO. 970/BANG/2011 1 INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCHES B BEFORE SHRI N K SAINI, ACCOUNANT MEMBER AND SHRI GEORGE GEORGE K, JUDICIAL MEMBER ITA NO.970/BANG/2011 (ASST. YEAR 2007-08) M/S KODIAK NETWORKS (INDIA) PRIVATE LTD., 401, 4 TH FLOOR, PRESTIGE SIGMA, 3, VITTAL MALLYA ROAD, BANGALORE-1. PA NO.AACCK0978J VS THE ASST. COMMISSIONER OF INCOME TAX, CIRCLE- 11(5), BANGALORE (APPELLANT) (RESPONDENT) DATE OF HEARING : 07.03.20 12 DATE OF PRONOUNCEMENT : 16.03.2012 APPELLANT BY : SHRI R VIJAYARAGHAVAN, C.A. RESPONDENT BY : SHRI ETWA MUNDA, CIT-III O R D E R PER GEORGE GEORGE K : THIS APPEAL OF THE ASSESSEE COMPANY IS DIRECTED AG AINST THE ASSESSMENT COMPLETED UNDER SECTION 143(3) RWS 144C OF THE I T ACT. THE RELEVANT ASSESSMENT YEAR IS 2007-08. THE ASSESSEE I S AGGRIEVED BY THE ORDER OF THE DISPUTE RESOLUTION PANEL (DRP) DATED 1 6 TH AUGUST, 2011. THE DRP HAS ISSUED DIRECTIONS UNDER SECTION 144C(5) RWS 144C(8). THE DRP HAS APPROVED THE DRAFT ORDER OF ASSESSMENT MAKING TRANS FER PRICING ADJUSTMENT AS SUGGESTED BY THE TRANSFER PRICING OFFI CER (TPO) UNDER SECTION 92CA OF THE ACT. PAGE 2 OF 36 ITA NO. 970/BANG/2011 2 2. THE ASSESSEE HAS RAISED THE FOLLOWING GROUNDS:- 1) THE ORDER OF THE LEARNED ASSESSING OFFICER AND DIR ECTIONS OF THE HONBLE DRP ARE BASED ON INCORRECT INTERPRET ATION OF LAW AND THEREFORE ARE BAD IN LAW. 2) ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE A ND IN LAW AND BASED ON THE DIRECTIONS OF DRP, THE LEARNED ASS ESSING OFFICER ERRED IN ASSESSING THE TOTAL INCOME AT RS.3,25,93,235/- AS AGAINST RETURNED INCOME OF RS.13,60,601/- COMPUTED BY THE APPELLANT. 3) ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CA SE AND IN LAW AND BASED ON THE DIRECTIONS OF HONBLE DRP, THE LEA RNED AO ERRED IN DISALLOWING THE SOFTWARE EXPENSES AMOUNTIN G TO RS. 22,94,928 INCURRED BY THE APPELLANT TOWARDS ANNU AL SOFTWARE LICENSE FEES WHICH WAS CHARGED OFF AS SOFT WARE EXPENSES TO THE PROFIT AND LOSS ACCOUNT AS IT DOES NOT RESULT IN ANY ENDURING BENEFIT TO THE COMPANY. 4) ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CAS E AND IN LAW AND BASED ON THE DIRECTIONS OF HONBLE DRP, THE LEA RNED AO ERRED IN DISALLOWING THE FOREIGN EXCHANGE LOSS AMOU NTING TO RS.63,30,156 INCURRED BY THE APPELLANT ON RESTATEMENT OF EXPORT PROCEEDS, IMPORT PAYABLES, TRAVELLING EXPENSE S, ETC., WHICH IS REVENUE IN NATURE AND WHICH HAS ARISEN IN THE NORMAL COURSE OF BUSINESS. 5) ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CAS E AND IN LAW AND BASED ON THE DIRECTIONS OF HONBLE DRP, THE LEA RNED AO ERRED IN HOLDING THAT THE TELECOMMUNICATION EXPENSE S AMOUNTING TO RS.8,69,205 IS ATTRIBUTABLE TO THE DEL IVERY OF COMPUTER SOFTWARE OUTSIDE INDIA SHOULD BE REDUCED F ROM EXPORT TURNOVER WHILE COMPUTING THE DEDUCTION UNDER SECTION 1OA OF THE ACT AND 6) ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CAS E AND IN LAW AND BASED ON THE DIRECTIONS OF HONBLE DRP, THE LEA RNED AO ERRED IN HOLDING THAT TRAVEL EXPENSES AMOUNT TO PAGE 3 OF 36 ITA NO. 970/BANG/2011 3 RS. 1,24,78,9 19 INCURRED IN FOREIGN CURRENCY IS FOR PROVIDING TECHNICAL SERVICES AND HENCE SHOULD BE REDUCED FROM EXPORT TURNOVER WHILE COMPUTING THE DEDUCTION U/S 1OA OF T HE ACT. 7) ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CAS E AND IN LAW AND BASED ON THE DIRECTIONS OF HONBLE DRP, THE LEA RNED AO ERRED IN LAW BY NOT CONSIDERING THE ALTERNATIVE PLEA OF THE APPELLANT THAT, IF THE TELECOMMUNICATION EXPENSES ATTRIBUTABLE TO THE DELIVERY OF COMPUTER SOFTWARE OU TSIDE INDIA AND TRAVEL EXPENSES INCURRED IN FOREIGN CURRE NCY ARE REDUCED FROM EXPORT TURNOVER, AN EQUAL AMOUNT SHOUL D ALSO BE REDUCED FROM TOTAL TURNOVER FOR COMPUTING THE DE DUCTION U/S 1OA OF THE ACT. TRANSFER PRICING ADJUSTMENT ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE A ND IN LAW: 8) THE LEARNED AO / TRANSFER PRICING OFFICER (TPO ) ERRED IN MAKING AN ADDITION OF RS. 25,423,419 AND RS. 3,962,020, TO THE TOTAL INCOME OF THE APPELLANT ON ACCOUNT OF ADJ USTMENT IN THE ARMS LENGTH PRICE OF THE SOFTWARE DEVELOPME NT AND RELATED SERVICES AND CUSTOMER SUPPORT SERVICES TRAN SACTIONS ENTERED BY THE APPELLANT WITH ITS ASSOCIATED ENTERPR ISE. 9) THE LEARNED AO/TPO ERRED IN DISREGARDING THE ECO NOMIC ANALYSIS UNDERTAKEN BY THE APPELLANT WITHOUT PROPER JUSTIFICATION AND CONDUCTING A FRESH ECONOMIC ANALYS IS FOR THE DETERMINATION OF THE ARMS LENGTH PRICE IN CONN ECTION WITH THE IMPUGNED INTERNATIONAL TRANSACTIONS AND HO LDING THAT THE APPELLANTS INTERNATIONAL TRANSACTIONS ARE NOT AT ARMS LENGTH. 10) THE LEARNED AO / TPO HAVE ERRED IN IGNORING THE FACT THAT SINCE THAT APPELLANT IS AVAILING TAX HOLIDAY U/S 1OA OF THE ACT, THERE IS NO INTENTION TO SHIFT THE PROFIT BASE OUT OF INDIA, WHICH IS ONE OF THE BASIC INTENTIONS OF THE INTRODUCTION OF TRANSFER PRICING PROVISIONS. PAGE 4 OF 36 ITA NO. 970/BANG/2011 4 11) THE LEARNED AO / TPO ERRED IN DETERMINING THE A RMS LENGTH MARGIN/PRICE USING ONLY FINANCIAL YEAR 2006-07 DATA, WHICH WAS NOT AVAILABLE TO THE APPELLANT AT THE TIME OF C OMPLYING WITH THE TRANSFER PRICING DOCUMENTATION REQUIREMENT S. 12) THE LEARNED ASSESSING OFFICER/TPO ERRED IN REJE CTING CERTAIN COMPARABLES CONSIDERED BY THE APPELLANT IN T HE COMPARABILITY ANALYSIS BY APPLYING DIFFERENT QUANTITATI VE AND QUALITATIVE FILTERS: A. THE LEARNED AO / TPO ERRED IN REJECTING CERTAIN COMPARABLE COMPANIES IDENTIFIED BY THE APPELLANT USI NG TURNOVER < RS. 1 CRORE AS A COMPARABILITY CRITERION; AND B. THE LEARNED ASSESSING OFFICER/TPO ERRED IN REJEC TING CERTAIN COMPARABLE COMPANIES IDENTIFIED BY THE APPEL LANT AS HAVING ECONOMIC PERFORMANCE CONTRARY TO THE INDUS TRY BEHAVIOR (E.G. COMPANIES WHICH SHOWED A DIMINISHING REVENUE TREND); AND 13) THE LEARNED TPO ERRED IN OBTAINING INFORMATION WHICH WAS NOT AVAILABLE IN PUBLIC DOMAIN BY EXERCISING POW ERS U/S 133(6) OF THE ACT AND RELYING ON THE INFORMATION FOR COMPARABILITY ANALYSIS. 14) THE LEARNED AO / TPO ERRED IN NOT CONSIDERING T HE FOREIGN EXCHANGE FLUCTUATION GAIN (LOSS) AS PART OF THE OPERATING INCOME WHILE COMPUTING THE OPERATING MARG IN. 15) THE LEARNED AO / TPO ERRED IN NOT MAKING SUITAB LE ADJUSTMENTS ON ACCOUNT OF DIFFERENCES IN THE RISK P ROFILE OF THE APPELLANT VIS-A-VIS THE COMPARABLES, WHILE CONDUCTING COMPARABILITY ANALYSIS. 16) THE LEARNED AO/TPO ERRED IN COMPUTING THE ARMS LENGTH PRICE WITHOUT GIVING BENEFIT OF +/- 5 PERCENT UNDER THE PROVISO TO SECTION 92C OF THE ACT. PAGE 5 OF 36 ITA NO. 970/BANG/2011 5 17) THE LEARNED TPO HAS ERRED BY PERFORMING A FRESH SEARCH USING BOTH PROWESS AND CAPITALINE DATABASES. TRANSACTION SPECIFIC GROUNDS OF APPEAL RELATING TO TRANSFER PRICING - SOFTWARE DEVELOPMENT AND RELATED SERVICES TRANSACTION 18) THE LEARNED AO / TPO ERRED BY ACCEPTING! REJECTI NG CERTAIN COMPANIES BASED ON UNREASONABLE COMPARABILI TY CRITERIA. 19) THE LEARNED AO / TPO ERRED IN REJECTING CERTAIN COMPARABLES IDENTIFIED BY THE APPELLANT USING ONSIT E REVENUES GREATER THAN 75% OF THE EXPORT REVENUES A S A COMPARABILITY CRITERION. 20) THE LEARNED AO / TPO ERRED IN WRONGLY COMPUTING THE OPERATING MARGINS OF SOME OF THE COMPARABLE COMPANI ES. TRANSACTION SPECIFIC GROUNDS OF APPEAL RELATING TO TRANSFER PRICING-CUSTOMER SUPPORT SERVICES TRANSACTION 21) THE LEARNED AO / TPO ERRED BY ACCEPTING/REJECTIN G CERTAIN COMPANIES BASED ON UNREASONABLE COMPARABILI TY CRITERIA. COMMON GROUNDS OF APPEAL RELATING TO CORPORATE TAX AND TRANSFER PRICING MATTERS 22) THE LEARNED AO ERRED IN LEVYING INTEREST OF RS.56,08,016 AND RS. 15,662/- U/S 234B AND 234D OF THE ACT RESPECTIVELY. 23) THE LEARNED AO ERRED, IN LAW AND IN FACTS, IN INITI ATING PENALTY PROCEEDINGS U/S 271(1)(C) OF THE ACT. 3. GROUND NOS. 1, 2 AND 8 ARE GENERAL IN NATURE AN D NO SPECIFIC ADJUDICATION IS CALLED FOR. HENCE, THESE GROUNDS A RE DISMISSED. PAGE 6 OF 36 ITA NO. 970/BANG/2011 6 3.1. GROUND NOS.22 AND 23 IS CONSEQUENTIAL AND HEN CE, THESE GROUNDS ARE ALSO REJECTED. 3.2. GROUND NOS.3 TO 7 MENTIONED ABOVE RELATES TO THE CORPORATE TAX MATTERS. GROUND NOS.9 TO 21 RELATES TO TRANSFER PRICING ADJUSTMENT. WE SHALL CONSIDER THE GROUNDS CHRONOLOGICALLY. CORPORATE TAX MATTERS 4. GROUND NO.3 : SOFTWARE EXPENSES DEBITED TO P&L ACCOUNT DURING THE PREVIOUS YEAR RELEVANT TO THE CONCERNED ASST. YEAR, THE ASSESSEE COMPANY HAD DEBITED TO THE P&L ACCOUNT AN AMOUNT OF RS.22,94,928/- AS SOFTWARE EXPENSES. THE DETAILS O F THE SAME ARE AS FOLLOWS:- I) ANNUAL SOFTWARE LICENCE FEE RS. 19,29,480 II) SOFTWARE PURCHASE RS. 3,65,511 THE ASSESSEE SUBMITTED THAT THE SOFTWARE EXPENSES C HARGED TO THE P&L ACCOUNT LARGELY REPRESENT EXPENSES INCURRED TOWARDS ANNUAL SOFTWARE LICENCE FEE WHICH ARE IN THE NATURE OF ANNUAL MAINTENANCE C HARGES (AMC) AND PURCHASE OF OTHER APPLICATION SOFTWARE. IT WAS SUB MITTED BEFORE THE ASSESSING OFFICER THAT BY INCURRING THESE EXPENSES, THERE WAS NO ENDURING BENEFIT TO THE ASSESSEE AND THE SAME IS ALLOWABLE E XPENDITURE UNDER SECTION 37 OF THE ACT. THE ASSESSING OFFICER HOWEVER DISAL LOWED THE SOFTWARE EXPENSES OF RS.22,94,928/- PAID TOWARDS THE PURCHAS E OF APPLICATION SOFTWARE AND ANNUAL LICENCE FEE, CONSIDERING THE SA ME TO BE CAPITAL IN NATURE. THE ASSESSING OFFICER HELD THAT SINCE THE ASSESSEE HAS USED THE WORDS PAGE 7 OF 36 ITA NO. 970/BANG/2011 7 SOFTWARE WORTH RS.3,65,511/- HAS BEEN PURCHASED, IT HAS BEEN DEFINITELY BROUGHT IN ENDURING BENEFIT IN PERPETUITY AND HENCE, THE SAME IS TO BE CAPITALIZED. FURTHER, THE ASSESSING OFFICER HELD THAT THE REMAINING PART OF THE SOFTWARE EXPENDITURE AMOUNTING TO RS.19,29,418/ - WAS EXPENDED TO OBTAIN CONTINUOUS UNINTERRUPTED USAGE OF THE SOFTWA RE AND HENCE, IT IS NOTHING BUT AN ENDURING BENEFIT OBTAINED BY THE ASSE SSEE. 4.1 AGGRIEVED, THE ASSESSEE IS IN APPEAL BEFORE US . 4.2 IT WAS SUBMITTED THAT THE SAID EXPENDITURE IS AN ALLOWABLE EXPENDITURE UNDER SECTION 37 OF THE ACT ON ACCOUNT OF THE FOLLOWING REASONS:- THESE EXPENSES WERE INCURRED FOR ACQUIRING LICENSED SOFTWARE IN THE NATURE OF APPLICATION SOFTWARE PURCHASED/LICENS ED FROM VARIOUS VENDORS WHICH GRANTS PERMISSION TO USE SOFT WARE ONLY FOR A PERIOD OF ONE YEAR. SINCE, THE EXPENSES WERE INC URRED FOR RENEWING THE LICENSE OF THE SOFTWARE FOR A PERIOD O F ONLY ONE YEAR (AND DO NOT HAVE AN INDEFINITE PERIOD OF LIFE), THE SE WERE TREATED AS REVENUE EXPENDITURE AND CHARGED TO PROFIT AND LO SS ACCOUNT. THE SOFTWARE TECHNOLOGY IS UNDERGOING RAPID CHANGES , AND NEW AND IMPROVED SOFTWARE IS LAUNCHED IN THE MARKET EVERY D AY, RENDERING SOFTWARE OBSOLETE WITHIN A SHORT TIME-FRAME. GIVEN THAT THE ORIGINAL SOFTWARE PURCHASED BECOMES REDUNDANT VERY QUICKLY; THIS NECESSITATES RECURRING EXPENDITURE TO BE INCURRED B Y KODIAK INDIA ON CONSTANT UP GRADATION OF THE SAME. WHEREVER THE SOFTWARE PURCHASED BY KODIAK INDIA RES ULTS IN ENDURING BENEFIT, SUCH SOFTWARE HAVE BEEN CAPITALIZ ED BY KODIAK INDIA AND ONLY THE DEPRECIATION IS BEING CLAIMED ON A YEAR ON YEAR BASIS. THE ASSESSEE ALSO RELIED ON THE FOLLOWING JUDGEMENT S OF VARIOUS HIGH COURTS AND THE ORDERS OF VARIOUS TRIBUNALS:- PAGE 8 OF 36 ITA NO. 970/BANG/2011 8 AMWAY INDIA ENTERPRISES V DCIT (301 ITR (AT) 1) (DE L.); CIT V M/S RAYCHEM RPG LIMITED (BOM.); BANK OF PUNJAB LTD. V JCIT (2002) 122 TAXMAN MAG 23 5) (CHANDIGARH ITAT); MOHD ISHAQUE,MOHD GULAM (1994) (210 ITR 817) (MP); JCIT V CITICORP OVERSEAS SOFTWARES LTD. (2004) 85 T TJ 87 (MUM. ITAT); LUBI ELECTRICALS PVT. LTD. V DCIT (AHM.) (ITA NO.16 3 /AHD/1992); BUSINESS INFORMATION PROCESSING LIMITED V ACIT (AHM .) (ITA NO.163/AHD/1992); MEDIA VIDEO LTD. V JCIT (2002) 122 TAXMAN (MAG.) 28 (DEL. ITAT); ACIT V JASPER INVESTMENTS LTD. 109 TTJ 530 (MUM.); GE CAPITAL SERVICES INDIA V DCIT 106 TTJ 65 (DEL.); CIT(A) V SOUTHERN ROADWAYS LIMITED (2009) 183 TAXMA N 234 (CHENNAI); & IBM INDIA LTD. V CIT (2006) 290 ITR 183 (BANG.) 4.3 THE LEARNED DR SUPPORTED THE ASSESSMENT ORDER. 4.4 WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUSE D THE MATERIALS ON RECORD. THE HONBLE JURISDICTIONAL HIGH COURT I N THE CASE OF CIT V M/S TOYOTA KRILOSKAR MOTORS PVT. LTD. (ITA NO.174/2009 D ATED 23 RD MARCH, 2011) HAS CONSIDERED WHETHER THE EXPENDITURE IN RES PECT OF PURCHASE OF SOFTWARE IS CAPITAL OR REVENUE. THE HONBLE HIGH C OURT AT PARA 3 OF ITS JUDGEMENT HELD AS FOLLOWS :- AS RIGHTLY POINTED OUT BY THE AUTHORITIES, WHEN THE LIFE OF A COMPUTER OR SOFTWARE IS LESS THAN TWO YEARS AND AS SUCH, THE RIGHT TO USE IT IS FOR A LIMITED PERIOD, THE FEE PAID FOR ACQUISITION OF THE SAID RIGHT IS ALLOWABLE AS REVENUE EXPENDITURE AND THESE SOFTWARE IF THEY ARE LICENCED FOR A PARTICULAR PERIOD, FOR UTILISING THE SAME FOR THE SUBSEQUENT YEARS FRESH LICENCE FEE IS TO BE PAID . THEREFORE, WITHOUT RENEWING THE LICENCE OR WITHOUT PAYING THE FEE ON SUCH RENEWAL, IT IS NOT POSSIBLE T O USE THOSE SOFTWARE. IN THOSE CIRCUMSTANCES, THE FINDIN GS RECORDED BY THE AUTHORITIES THAT THE FEE PAID FOR PAGE 9 OF 36 ITA NO. 970/BANG/2011 9 OBTAINING THE SOFTWARE AND THE LICENCE AND FOR RENE WING THE SAME IS TO BE CONSTRUED AS ONLY REVENUE EXPENDIT URE DO NOT CALL FOR INTERFERENCE BY THIS COURT. 4.5 THE SPECIAL BENCH IN THE CASE OF AMWAY INDIA EN TERPRISES V DCIT (301 ITR (AT) 1) HAD LAID DOWN VARIOUS TESTS T O DETERMINE WHETHER THE EXPENDITURE INCURRED FOR PURCHASE OF COMPUTER SOFTW ARE IS CAPITAL OR REVENUE. IN THE INSTANT CASE, THE ASSESSING OFFICE R DID HAVE THE BENEFIT OF THE JUDGEMENT OF HONBLE JURISDICTIONAL HIGH COURT IN THE CASE OF CIT V M/S TOYOTA KRILOSKAR MOTORS PVT. LTD. (SUPRA) WHEN SHE P ASSED THE IMPUGNED ASSESSMENT ORDER. THE ASSESSING OFFICER HAS ALSO NOT REFERRED TO THE ORDER OF THE SPECIAL BENCH OF THE TRIBUNAL IN THE C ASE OF AMWAY INDIA ENTERPRISES (SUPRA). THE SPECIAL BENCH HAD LAID VA RIOUS PRINCIPLES TO DETERMINE WHETHER THE EXPENDITURE INCURRED FOR THE PURCHASE OF A SOFTWARE LICENCE IS CAPITAL OR REVENUE. THE JUDGEMENT OF HO NBLE JURISDICTIONAL HIGH COURT AND THE ORDER OF THE SPECIAL BENCH CITED SUPR A ARE DIRECTLY APPLICABLE TO THE FACTS OF THE INSTANT CASE. SINCE THE IMPUGN ED ORDER OF THE ASSESSING OFFICER DID NOT CONSIDER THE JUDGEMENT OF THE HONB LE HIGH COURT AND THE ORDER OF THE SPECIAL BENCH, WE DEEM IT FIT AND PROP ER TO RESTORE THE MATTER TO THE ASSESSING OFFICER FOR AN ELABORATE DISCUSSIO N ON THE SAME. THE ASSESSEE SHALL PRODUCE THE DETAILS WITH REFERENCE T O THE EXPENDITURE INCURRED AND SHALL COOPERATE WITH THE ASSESSING OFF ICER FOR EXPEDITIOUS DISPOSAL OF THE MATTER. IT IS ORDERED ACCORDINGLY. THEREFORE, GROUND NOS.3 IS ALLOWED FOR STATISTICAL PURPOSES. PAGE 10 OF 36 ITA NO .970/BANG/2011 10 5. GROUND NO.4 : FOREIGN EXCHANGE LOSS DEBITED TO P&L ACCOUNT DURING THE ASSESSMENT YEAR 2007-08, THE ASSESSEE C OMPANY HAD DEBITED THE P&L ACCOUNT WITH THE NET FOREIGN EX CHANGE LOSS OF RS.58,40,841/-. THE BREAK-UP OF THE SAME IS AS FOL LOWS:- SL. NO. PARTICULARS AMOUNT (IN RS.) 1. RESTATEMENT OF EXPORT SALE PROCEEDS, DEBTORS & BANK BALANCES 62,04,206 2. TRAVEL & OTHER EXPENSES 1,25,950 3. TRADE IMPORTS PAYABLE FOR ASSETS PURCHASED (4,89,314) TOTAL 58,40,841 IT WAS CLAIMED BEFORE THE ASSESSING OFFICER THAT TH E LOSS DEBITED TO THE P&L ACCOUNT IS IN ACCORDANCE WITH ACCOUNTING STANDA RD 11 AS PRESCRIBED BY THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA. I T WAS FURTHER SUBMITTED THAT THESE WERE LOSSES ARISES IN THE NORMAL COURSE OF DOING BUSINESS AND THEREFORE, SHOULD BE CONSIDERED AS REVENUE IN NATUR E. THE ASSESSING OFFICER HOWEVER DISALLOWED THE FOREIGN EXCHANGE LOS S AMOUNTING TO RS.63,30,156/- CONSIDERING THE SAME TO BE CONTINGEN T IN NATURE. 5.1 AGGRIEVED, THE ASSESSEE IS IN APPEAL BEFORE US . 5.2 IT WAS SUBMITTED THAT THE FOREIGN EXCHANGE LOS S WAS ON ACCOUNT OF RESTATEMENT OF EXPORT SALE PROCEEDS, DEBTORS AND BANK BALANCES AND TOWARDS TRAVELLING EXPENSES, WHICH HAVE ARISEN IN T HE NORMAL COURSE OF BUSINESS AND THEREFORE SHOULD BE CONSIDERED AS REVE NUE IN NATURE. FURTHER IT WAS SUBMITTED THAT THE LOSS ON ACCOUNT OF EXCHAN GE RATE FLUCTUATION HAS BEEN EXPENSED IN THE BOOKS OF ACCOUNTS DURING THE A SSESSMENT YEAR 2007-08 AS : PAGE 11 OF 36 ITA NO .970/BANG/2011 11 I) SUCH LOSS/GAIN HAS ARISEN ON TRADING ACCOUNT, DURING THE COURSE OF BUSINESS OPERATIONS AND IS INCIDENTAL TO THE SAME. II) SINCE KODIAK INDIA IS FOLLOWING MERCANTILE SYSTEM OF ACCOUNTING, EXCHANGE LOSS INCURRED BY KODIAK INDIA CANNOT BE CONSIDERED AS CONTINGENT IN NATURE. THE ASSESSEE ALSO PLACED RELIANCE ON THE JUDGEMENT OF THE HONBLE APEX COURT IN THE CASE OF CIT V WOODWARD GOVERNOR INDIA PRIVATE LIMITED (312 ITR 254), SUTLEJ COTTON MILLS LTD. V CIT (116 ITR 1 ), OIL AND NATURAL GAS CORPORATION LIMITED V DCIT (261 ITR 1) (DEL.) AND S UJATA GROVER (74 TTJ 347) (DEL.). 5.3 THE LEARNED DR PRESENT WAS DULY HEARD. 5.4 WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUSE D THE MATERIALS ON RECORD. IN THE CASE OF CIT V WOODWARD GOVERNOR INDIA PRIVATE LIMITED (312 ITR 254), THE HONBLE SUPREME COURT ANALYSED VA RIOUS ISSUES RELATING TO TREATMENT OF EXCHANGE GAIN/LOSS ARISING ON ACCOU NT OF THE INCREASE OR DECREASE IN THE VALUE OF THE FOREIGN CURRENCY HELD O N REVENUE ACCOUNT AND UPHELD THE CONTENTIONS OF ASSESSEE THAT MARKET LOSS WAS ALLOWABLE IN THE YEAR IN WHICH IT WAS RECOGNIZED AND DEBITED TO PROFI T AND LOSS ACCOUNT, IN TERMS OF THE MERCANTILE METHOD OF ACCOUNTING FOLLOW ED AS PER THE MANDATORY ACCOUNTANT STANDARD. IN THE INSTANT CASE, THE JUDGEMENT OF THE HONBLE APEX COURT HAS NOT BEEN CONSIDERED BY THE AS SESSING OFFICER. THEREFORE, THIS ISSUE NEEDS TO BE RESTORED TO THE A SSESSING OFFICER FOR A PROPER DELIBERATION. HENCE, THIS MATTER IS RESTOR ED TO THE FILE OF THE ASSESSING OFFICER. SHE SHALL DECIDE THE MATTER IN ACCORDANCE WITH THE PROVISIONS OF LAW AND AS PER DICTUM LAID DOWN BY THE HONBLE APEX COURT IN PAGE 12 OF 36 ITA NO .970/BANG/2011 12 THE CASE OF CIT V WOODWARD GOVERNOR INDIA PRIVATE L IMITED (SUPRA). THE ASSESSEE SHALL BE AFFORDED A REASONABLE OPPORTUNITY OF BEING HEARD BEFORE ANY DECISION IS RENDERED ON THE MATTER. IT IS ORDER ED ACCORDINGLY. HENCE, GROUND NO.4 IS ALLOWED FOR STATISTICAL PURPOSES. 6. GROUND NOS.5,6 & 7 : RE-COMPUTATION OF DEDUCTION UNDER SECTION 10A THE ASSESSEE IN ITS RETURN OF INCOME HAD CLAIMED DEDUCTION UNDER SECTION 10A OF THE ACT TO THE TUNE OF RS.3,42 ,45,811/-. THE ASSESSING OFFICER RE-COMPUTED THE DEDUCTION UNDER S ECTION 10A OF THE ACT BY REDUCING FROM THE EXPORT TURNOVER A SUM OF RS.8,6 9,205/- BEING TELECOMMUNICATION EXPENSES AND A SUM OF RS.1,24,78, 919/- BEING TRAVELING EXPENSES INCURRED IN FOREIGN CURRENCY. THE ASSESSIN G OFFICER HOWEVER DID NOT REDUCE THE ABOVE SAID EXPENSES FROM THE TOTAL T URNOVER WHILE COMPUTING DEDUCTION UNDER SECTION 10A OF THE ACT. 6.1 AGGRIEVED BY THE RE-COMPUTATION OF DEDUCTION UN DER SECTION 10A OF THE ACT, THE ASSESSEE IS IN APPEAL BEFORE US . 6.2 IT WAS SUBMITTED THAT THE TELECOMMUNICATION EX PENSES AND THE EXPENSES INCURRED IN FOREIGN EXCHANGE FOR TRAVEL OU GHT NOT TO BE EXCLUDED FROM THE EXPORT TURNOVER. ALTERNATIVELY, IT WAS CON TENDED THAT IF THE EXPENSES ARE REDUCED FROM THE EXPORT TURNOVER, THE SAME OUGHT TO BE REDUCED ALSO FROM THE TOTAL TURNOVER IN THE PROCESS OF DEDUCTION UNDER SECTION 10A OF THE ACT. IT WAS SUBMITTED THAT THE ASSESSEES TURNOVER IS EXCLUSIVELY FROM THE EXPORTS AND HENCE, THE ASSESSEE IS ONLY PRESSING FOR THE ALTERNATIVE GROUND, NAMELY, GROUND NO.7. IT WAS SUBMITTED THAT THE PAGE 13 OF 36 ITA NO .970/BANG/2011 13 ALTERNATIVE SUBMISSION, NAMELY, WHEN THE EXPENSES AR E REDUCED FROM THE EXPORT TURNOVER, THE SAME SHOULD ALSO BE REDUCED FR OM THE TOTAL TURNOVER IS COVERED BY THE JUDGEMENT OF THE HONBLE JURISDICTION AL HIGH COURT IN THE CASE OF CIT V M/S TATA ELXSI LTD. & OTHERS (ITA NO. 70 OF 2009 DATED 30/8/2011), HONBLE MUMBAI HIGH COURT IN THE CASE O F CIT V GEM PLUS JEWELLERY INDIA LTD. 330 ITR 175 AND THE ORDER OF TH E SPECIAL BENCH IN THE CASE OF ITO V M/S SAK SOFT LTD. 313 ITR (AT) 353, I N WHICH IT HAS BEEN HELD THE FOLLOWING :- THAT THE EXPENSES SHOULD BE REDUCED NOT ONLY FROM EXPORT TURNOVER BUT ALSO FROM THE TOTAL TURNOVER WH ILE COMPUTING DEDUCTION UNDER SECTION 10A OF THE ACT. 6.3 THE LEARNED DR UNABLE TO CONTROVERT THE SUBMIS SIONS MADE BY THE LEARNED AR. 6.4 WE HAVE HEARD THE RIVAL SUBMISSION AND PERUSED THE MATERIAL ON RECORD. THE HONBLE KARNATAKA HIGH COURT IN THE C ASE OF CIT V M/S TATA ELXSI LTD. & OTHERS HAD HELD THAT WHILE COMPUTING T HE EXEMPTION U/S 10A, IF THE EXPORT TURNOVER IN THE NUMERATOR IS TO BE ARRIV ED AT AFTER EXCLUDING CERTAIN EXPENSES, THE SAME SHOULD ALSO BE EXCLUDED FROM THE TOTAL TURNOVER IN THE DENOMINATOR. THE RELEVANT FINDING OF THE HON BLE JURISDICTIONAL HIGH COURT READS AS FOLLOWS:- ..SECTION 10A IS ENACTED AS AN INCENTIVE TO EXP ORTERS TO ENABLE THEIR PRODUCTS TO BE COMPETITIVE IN THE G LOBAL MARKET AND CONSEQUENTLY EARN PRECIOUS FOREIGN EXCHAN GE FOR THE COUNTRY. THIS ASPECT HAS TO BE BORNE IN MIN D. WHILE COMPUTING THE CONSIDERATION RECEIVED FROM SUC H PAGE 14 OF 36 ITA NO .970/BANG/2011 14 EXPORT TURNOVER, THE EXPENSES INCURRED TOWARDS FREI GHT, TELECOMMUNICATION CHARGES, OR INSURANCE ATTRIBUTABL E TO THE DELIVERY OF THE ARTICLES OR THINGS OR COMPUTER SOFTWARE OUTSIDE INDIA, OR EXPENSES IF ANY INCURRED IN FOREIGN EXCHANGE, IN PROVIDING THE TECHNICAL SERVIC ES OUTSIDE INDIA SHOULD NOT BE INCLUDED. HOWEVER, THE WORD TOTAL TURNOVER IS NOT DEFINED FOR THE PURPOSE OF TH IS SECTION. IT IS BECAUSE OF THIS OMISSION TO DEFINE TOTAL TURNOVER, THE WORD TOTAL TURNOVER FALLS FOR INTERPRETATION BY THIS COURT; ..IN SECTION 10A, NOT ONLY THE WORD TOTAL TURNOVE R IS NOT DEFINED, THERE IS NO CLUE REGARDING WHAT IS TO BE EXCLUDED WHILE ARRIVING AT THE TOTAL TURNOVER. HOW EVER, WHILE INTERPRETING THE PROVISIONS OF SECTION 80HHC, THE COURTS HAVE LAID DOWN VARIOUS PRINCIPLES, WHICH ARE INDEPENDENT OF THE STATUTORY PROVISIONS. THERE SHOU LD BE UNIFORMITY IN THE INGREDIENTS OF BOTH THE NUMERATOR AND THE DENOMINATOR OF THE FORMULA, SINCE OTHERWISE IT WOULD PRODUCE ANOMALIES OR ABSURD RESULTS. SECTION 10A I S A BENEFICIAL SECTION WHICH INTENDS TO PROVIDE INCENTI VES TO PROMOTE EXPORTS. IN THE CASE OF COMBINED BUSINESS OF AN ASSESSEE, HAVING EXPORT BUSINESS AND DOMESTIC BUSIN ESS, THE LEGISLATURE INTENDED TO HAVE A FORMULA TO ASCER TAIN THE PROFITS FROM EXPORT BUSINESS BY APPORTIONING THE TOTAL PROFITS OF THE BUSINESS ON THE BASIS OF TURNO VERS. APPORTIONMENT OF PROFITS ON THE BASIS OF TURNOVER W AS ACCEPTED AS A METHOD OF ARRIVING AT EXPORT PROFITS. IN THE CASE OF SECTION 80HHC, THE EXPORT PROFIT IS TO BE DERIVED FROM THE TOTAL BUSINESS INCOME OF THE ASSXCESSEE, WHEREAS IN SECTION 10-A, THE EXPORT PRO FIT IS TO BE DERIVED FROM THE TOTAL BUSINESS OF THE UNDERT AKING. EVEN IN THE CASE OF BUSINESS OF AN UNDERTAKING, IT MAY INCLUDE EXPORT BUSINESS AND DOMESTIC BUSINESS, IN O THER WORDS, EXPORT TURNOVER AND DOMESTIC TURNOVER. TO T HE EXTENT OF EXPORT TURNOVER, THERE WOULD BE A COMMONA LITY BETWEEN THE NUMERATOR AND THE DENOMINATOR OF THE FORMULA. IF THE EXPORT TURNOVER IN THE NUMERATOR I S TO PAGE 15 OF 36 ITA NO .970/BANG/2011 15 BE ARRIVED AT AFTER EXCLUDING CERTAIN EXPENSES, THE SAME SHOULD ALSO BE EXCLUDED IN COMPUTING THE EXPORT TUR NOVER AS A COMPONENT OF TOTAL TURNOVER IN THE DENOMINATOR . THE REASON BEING THE TOTAL TURNOVER INCLUDES EXPORT TUR NOVER. THE COMPONENTS OF THE EXPORT TURNOVER IN THE NUMERA TOR AND THE DENOMINATOR CANNOT BE DIFFERENT. THEREFORE , THOUGH THERE IS NO DEFINITION OF THE TERM TOTAL TU RNOVER IN SECTION 10A, THERE IS NOTHING IN THE SAID SECTIO N TO MANDATE THAT, WHAT IS EXCLUDED FROM THE NUMERATOR T HAT IS EXPORT TURNOVER WOULD NEVERTHELESS FORM PART OF THE DENOMINATOR. WHEN THE STATUTE PRESCRIBED A FORMULA AND IN THE SAID FORMULA, EXPORT TURNOVER IS DEFINED, AND WHEN THE TOTAL TURNOVER INCLUDES EXPORT TURNOVER, THE VERY SAME MEANING GIVEN TO THE EXPORT TURNOVER BY THE LEGISLATURE IS TO BE ADOPTED WHILE UNDERSTANDING TH E MEANING OF THE TOTAL TURNOVER, WHEN THE TOTAL TURNO VER INCLUDES EXPORT TURNOVER. IF WHAT IS EXCLUDED IN COMPUTING THE EXPORT TURNOVER IS INCLUDED WHILE ARR IVING AT THE TOTAL TURNOVER, WHEN THE EXPORT TURNOVER IS AS A COMPONENT OF TOTAL TURNOVER, SUCH AN INTERPRETATION WOULD RUN COUNTER TO THE LEGISLATIVE INTENT AND IMPERMISSIBLE. THUS, THERE IS NO ERROR COMMITTED B Y THE TRIBUNAL IN FOLLOWING THE JUDGEMENTS RENDERED IN TH E CONTEXT OF SECTION 80HHC IN INTERPRETING SECTION 10 A WHEN THE PRINCIPLE UNDERLYING BOTH THESE PROVISIONS IS ONE AND THE SAME. 6.5 THE HONBLE MUMBAI HIGH COURT IN THE CASE OF G EM PLUS JEWELLERY INDIA LTD. (SUPRA), IN IDENTICAL CIRCUMSTA NCES, HELD THAT SINCE THE EXPORT TURNOVER FORMS PART OF THE TOTAL TURNOVER, I F AN ITEM IS EXCLUDED FROM THE EXPORT TURNOVER, THE SAME SHOULD ALSO BE R EDUCED FROM THE TOTAL TURNOVER TO MAINTAIN PARITY BETWEEN NUMERATOR AND DE NOMINATOR WHILE CALCULATING DEDUCTION U/S 10A OF THE ACT. THE RELE VANT FINDING OF THE HONBLE MUMBAI HIGH COURT READS AS FOLLOWS:- PAGE 16 OF 36 ITA NO .970/BANG/2011 16 THE TOTAL TURNOVER OF THE BUSINESS CARRIED ON BY TH E UNDERTAKING WOULD CONSIST OF THE TURNOVER FROM EXPO RT AND THE TURNOVER FROM LOCAL SALES. THE EXPORT TURNOVER CONSTITUTES THE NUMERATOR IN THE FORMULA PRESCRIBED BY SUB-SECTION (4). EXPORT TURNOVER ALSO FORMS A CONS TITUENT ELEMENT OF THE DENOMINATOR IN AS MUCH AS THE EXPORT TURNOVER IS A PART OF THE TOTAL TURNOVER. THE EXPO RT TURNOVER, IN THE NUMERATOR MUST HAVE THE SAME MEANI NG AS THE EXPORT TURNOVER WHICH IS CONSTITUENT ELEMENT OF THE TOTAL TURNOVER IN THE DENOMINATOR. THE LEGISLATURE HAS PROVIDED A DEFINITION OF THE EXPRESSION EXPORT TUR NOVER IN EXPLN.2 TO S.10A WHICH THE EXPRESSION IS DEFINED TO MEAN THE CONSIDERATION IN RESPECT OF EXPORT BY THE UNDERT AKING OF ARTICLES, THINGS OR COMPUTER SOFTWARE RECEIVED I N OR BROUGHT INTO INDIA BY THE ASSESSEE IN CONVERTIBLE FO REIGN EXCHANGE BUT SO AS NOT TO INCLUDE INTER ALIA FREIGH T, TELECOMMUNICATION CHARGES OR INSURANCE ATTRIBUTABLE TO THE DELIVERY OF THE ARTICLES, THINGS OR SOFTWARE OUTSIDE INDIA. THEREFORE IN COMPUTING THE EXPORT TURNOVER THE LEGI SLATURE HAS MADE A SPECIFIC EXCLUSION OF FREIGHT AND INSURA NCE CHARGES. THE SUBMISSION WHICH HAS BEEN URGED ON BE HALF OF THE REVENUE IS THAT WHILE FREIGHT AND INSURANCE CHA RGES ARE LIABLE TO BE EXCLUDED IN COMPUTING EXPORT TURNOVER, A SIMILAR EXCLUSION HAS NOT BEEN PROVIDED IN REGARD TO TOTAL TURNOVER. THE SUBMISSION OF THE REVENUE, HOWEVER, MISSES THE POINT THAT THE EXPRESSION TOTAL TURNOVER HAS NOT BEEN D EFINED AT ALL BY PARLIAMENT FOR THE PURPOSES OF S.10A. HOW EVER, THE EXPRESSION EXPORT TURNOVER HAS BEEN DEFINED. THE DEFINITION OF EXPORT TURNOVER EXCLUDES FREIGHT AN D INSURANCE. SINCE EXPORT TURNOVER HAS BEEN DEFINED BY PARLIAMENT AND THERE IS A SPECIFIC EXCLUSION OF FRE IGHT AND INSURANCE, THE EXPRESSION EXPORT TURNOVER CANNOT HAVE A DIFFERENT MEANING WHEN IT FORMS A CONSTITUENT PART OF THE TOTAL TURNOVER FOR THE PURPOSES OF THE APPLICATION OF THE FORMULA. UNDOUBTEDLY, IT WAS OPEN TO PARLIAMENT TO MAKE A PROVISION WHICH HAS BEEN ENUNCIATED EARLIER MUST PR EVAIL AS A MATTER OF CORRECT STATUTORY INTERPRETATION. ANY OT HER INTERPRETATION WOULD LEAD TO AN ABSURDITY. IF THE C ONTENTION PAGE 17 OF 36 ITA NO .970/BANG/2011 17 OF THE REVENUE WERE TO BE ACCEPTED, THE SAME EXPRES SION VIZ. EXPORT TURNOVER WOULD HAVE A DIFFERENT CONNO TATION IN THE APPLICATION OF THE SAME FORMULA. THE SUBMISSIO N OF THE REVENUE WOULD LEAD TO A SITUATION WHERE FREIGHT AND INSURANCE, THOUGH THESE HAVE BEEN SPECIFICALLY EXCLU DED FROM EXPORT TURNOVER FOR THE PURPOSES OF THE NUME RATOR WOULD BE BROUGHT IN AS PART OF THE EXPORT TURNOVER WHEN IT FORMS AN ELEMENT OF THE TOTAL TURNOVER AS A DENOMIN ATOR IN THE FORMULA. A CONSTRUCTION OF A STATUTORY PROVISIO N WHICH WOULD LEAD TO AN ABSURDITY MUST BE AVOIDED. MOREOVE R, A RECEIPT SUCH AS FREIGHT AND INSURANCE WHICH DOES NO T HAVE ANY ELEMENT OF PROFIT CANNOT BE INCLUDED IN THE TOTA L TURNOVER. FREIGHT AND INSURANCE CHARGES DO NOT HAV E ANY ELEMENT OF TURNOVER. FOR THIS REASON IN ADDITION, THESE TWO ITEMS WOULD HAVE TO BE EXCLUDED FROM THE TOTAL TURN OVER PARTICULARLY IN THE ABSENCE OF A LEGISLATIVE PRESCRI PTION TO THE CONTRARY CIT V SUDARSHAN CHEMICALS INDUSTRIES LTD. (2000) 163 CTR (BOM) 596: (2000) 245 ITR 769 (BOM) APPLIED; CIT V LAKSHMI MACHINE WORKS (2007) 210 CTR (SC) 1: (2007) 290 ITR 667 (SC) AND CIT V CATAPHARMA (IN DIA) (P) LTD. (2007) 211 CTR (SC) 83: (2007) 292 ITR 641 (SC) RELIED ON 6.6. IN THE CASE OF SAK SOFT LTD. (SUPRA), THE ASS ESSEE WAS ENGAGED IN THE BUSINESS OF EXPORTING COMPUTER SOFTWARE AND CLAIMED DEDUCTION U/S 10B OF THE ACT. IN COMPLETING THE ASSESSMENT U/S 1 43(3) OF THE ACT, THE AO REDUCED THE EXPENDITURE INCURRED IN FOREIGN EXCH ANGE IN PROVIDING THE TECHNICAL SERVICES OUTSIDE INDIA, FROM THE EXPORT T URNOVER WITHOUT CORRESPONDING REDUCTION FROM TOTAL TURNOVER, THEREB Y REDUCING THE DEDUCTION CLAIMED BY THE ASSESSMENT U/S 10B OF THE A CT. 6.7. IN LIGHT OF THE ABOVE FACTS, THE SPECIAL BENC H HELD AS UNDER:- PAGE 18 OF 36 ITA NO .970/BANG/2011 18 FOR THE ABOVE REASONS, WE HOLD THAT FOR THE PURPOS E OF APPLYING THE FORMULA UNDER SUB-SECTION (4) OF SECTIO N 10B, THE FREIGHT, TELECOM CHARGES OR INSURANCE ATTRIBUTA BLE TO THE DELIVERY OF ARTICLES OR THINGS OR COMPUTER SOFTW ARE OUTSIDE INDIA OR THE EXPENSES, IF ANY, INCURRED IN F OREIGN EXCHANGE IN PROVIDING THE TECHNICAL SERVICES OUTSID E INDIA ARE TO BE EXCLUDED BOTH FROM THE EXPORT TURNOVER AN D FROM THE TOTAL TURNOVER, WHICH ARE THE NUMERATOR AND THE DENOMINATOR RESPECTIVELY IN THE FORMULA. THE APPEAL S FILED BY THE DEPARTMENT ARE THUS DISMISSED. 6.8 IN THE LIGHT OF THE ABOVE JUDGEMENTS AND THE O RDER OF THE SPECIAL BENCH (SUPRA), WE DIRECT THE AO TO EXCLUDE THE ABOVE MENTIONED EXPENSES BOTH FROM THE EXPORT TURNOVER AS WELL AS F ROM THE TOTAL TURNOVER WHILE CALCULATING DEDUCTION U/S 10A OF THE ACT. IT IS ORDERED ACCORDINGLY. HENCE, THE GROUND NO. 7 IS ALLOWED. SINCE THE ALT ERNATIVE PLEA OF THE ASSESSEE IS ALLOWED, THE GROUND NOS. 5 & 6 RAISED B Y THE ASSESSEE IS NOT ADJUDICATED. 7. GROUND NOS. 9 TO 21 : TRANSFER PRICING ADJUSTMENT BRIEFLY STATED THE FACTS IN RELATION TO TRANSFER P RICING ADJUSTMENT ARE AS FOLLOWS:- ACCORDING TO THE ASSESSEE, IT IS A CAPTIVE SERVIC E PROVIDER ENGAGED IN PROVIDING SOFTWARE DEVELOPMENT AND RELAT ED SERVICES (SOFTWARE SERVICES), SALES AND MARKETING SUPPORT AND CUSTOMER SUPPORT SERVICES (CSS OR ITES) TO ITS ASSOCIATED ENTERPRISES (AE). FOR T HE ASSESSMENT YEAR 2007-08, THE IMPUGNED INTERNATIONAL TRANSACTIONS OF THE ASSESSEE COMPANY WITH ITS ASSOCIATED ENTERPRISES WAS AS UNDER:- PAGE 19 OF 36 ITA NO .970/BANG/2011 19 NATURE OF INTERNATIONAL TRANSACTIONS AMOUNT IN RS. SOFTWARE SERVICES 28,57,55,540 SALES & MARKETING SUPPORT AND CUSTOMER SUPPORT SERVICES (CSS/ITES) 2,57,18,896 FOR THE PURPOSE OF ESTABLISHING THE ARMS LENGTH PR ICE (ALP) OF ITS INTERNATIONAL TRANSACTIONS WITH ITS AES, THE ASSESS EE HAD UNDERTAKEN A TRANSFER PRICING (TP) STUDY, CARRIED OUT BY AN INDEPE NDENT EXTERNAL CONSULTANT. BASED ON THE TP STUDY, THE INDEPENDENT EXTERNAL CONSULTANT CONCLUDED THAT THE PRICE RECEIVED BY THE ASSESSEE I N RESPECT OF ITS TRANSACTIONS WITH AES IS AT ARMS LENGTH. THE KEY F EATURES OF THE TP STUDY UNDERTAKEN BY THE ASSESSEE FOR SOFTWARE SERVICES AND ITES ARE SUMMARIZED BELOW:- I) AS PER THE FUNCTIONAL ANALYSIS, THE ASSESSEE WAS SEL ECTED AS THE TESTED PARTY; II) TRANSACTIONAL NET MARGIN METHOD (TNMM) WAS DETERMINED AS THE MOST APPROPRIATE METHOD TO DETERM INE THE ALP; III) THE SEARCH WAS CONDUCTED ON PROWESS DATABASE FOR OBTAINING PUBLICLY AVAILABLE FINANCIAL INFORMATION O F COMPANIES IN INDIA ENGAGED IN SIMILAR BUSINESS ACTI VITY AS THAT OF THE ASSESSEE TO SELECT COMPARABLE COMPANIES . IV) GIVEN THE NATURE OF THE INTERNATIONAL TRANSACTIONS UNDER REVIEW, ECONOMIC CONDITIONS, DIFFERENCES IN BUSINES S OR PRODUCT LIFE CYCLES AND OTHER RELEVANT FACTORS, FINA NCIAL DATA FOR FY 2004-05, FY 2005-06 AND FY 2006-07 WAS CONSIDERED. V) THE SEARCHES ON THE DATABASES YIELDED A SET OF 28 COMPARABLES AND 4 COMPARABLES FOR SOFTWARE SERVICES AND ITES RESPECTIVELY, WITH WEIGHTED AVERAGE OPERATI NG PROFIT/OPERATING COST OF 10.62% AND 13.30% FOR SOFT WARE SERVICES AND ITES, RESPECTIVELY. VI) NO ADJUSTMENT WAS MADE TO THE MARGINS OF THE COMPARABLE COMPANIES TO TAKE INTO CONSIDERATION THE PAGE 20 OF 36 ITA NO .970/BANG/2011 20 DIFFERENCE IN RISKS ASSUMED BY THE COMPARABLE COMPAN IES VIS--VIS THE ASSESSEE. 7.1 THE TRANSFER PRICING OFFICER RE-DETERMINED THE ALP FOR THE PROVISION OF SOFTWARE SERVICES AND ITES TRANSACTION S. THE DETAILS OF STUDY UNDERTAKEN BY THE TPO READS AS FOLLOWS:- THE TPO DID NOT ACCEPT THE ECONOMIC ANALYSIS UNDERT AKEN BY THE ASSESSEE COMPANY AND IDENTIFIED NEW COMPARABLE S AT THE TIME OF ASSESSMENT PROCEEDINGS. THE TPO USED SINGLE YEAR DATA (FY 2006-07) FOR ECONOMIC ANALYSIS, INSTEAD OF DATA FOR FY 2004-05 TO 2006-07 USED BY THE ASSESSEE COMPANY; THE TPO HAS RE-DETERMINED THE OPERATING MARGINS OF COMPARABLE COMPANIES BY CONSIDERING FOREIGN EXCHANGE GAIN/LOSSES AS NON-OPERATING IN NATURE; THE TPO WAS OF THE VIEW THAT SOME OF THE COMPARABLE COMPANIES IDENTIFIED BY THE ASSESSEE COMPANY AND THE APPROACH ADOPTED FOR UNDERTAKING THE ECONOMIC ANALYS IS WERE NOT APPROPRIATE. THE TPO APPLIED CERTAIN FILT ERS FOR THE SELECTION OF COMPARABLE COMPANIES. IN ARRI VING AT THE ALP, THE TPO REJECTED CERTAIN COMPARABLES IDENTIFIED BY THE ASSESSEE COMPANY ON THE FOLLOWING FILTERS:- O COMPANIES HAVING TURNOVER LESS THAN 1 CRORE WERE REJECTED FOR SOFTWARE SERVICES AND ITES; O COMPANIES HAVING ECONOMIC PERFORMANCE CONTRARY TO THE INDUSTRY BEHAVIOR (E.G. COMPANIES WHICH SHOWED A DIMINISHING REVENUE TREND); PAGE 21 OF 36 ITA NO .970/BANG/2011 21 O COMPANIES HAVING ONSITE REVENUES GREATER THAN 75% OF THE EXPORT REVENUES WERE REJECTED FOR SOFTWARE SERVICES. THE TPO OBTAINED INFORMATION BY EXERCISING HIS POWER VESTED UNDER SECTION 133(6) OF THE ACT AND USED THE SAME FOR JUDGING COMPARABILITY WITH THE ASSESSEE COMPANY; THE TPO PROVIDED AN ADJUSTMENT TOWARDS CAPITAL OF 2.23% AND 2.89% FOR SOFTWARE SERVICES AND ITES RESPECTIVELY. THE ADJUSTED NET MARGINS OF COMPARABLE COMPANIES AFTER PROVIDING THE WORKING CAPITAL ADJUSTMENT WAS DETERMINED AT 22.91% AND 27.66% ON OPERATING COST FOR SOFTWARE SERVICES AND ITES RESPECTIVELY. 7.2 THE DETAILS OF THE COMPARABLE COMPANIES AS PE R TPO IN SOFTWARE DEVELOPMENT AND RELATED SERVICES AND THE C USTOMER SUPPORT SERVICES ARE AS FOLLOWS:- SOFTWARE DEVELOPMENT AND RELATED SERVICES SL. NO. NAME OF THE COMPANY AS PER ORDER OF TPO SALES IN RS. CRORE OPERATING MARGIN 1 ACCEL TRANSMATICS LIMITED (SEG.) 9.68 2 1.11% 2 AVANI CIMCON TECHNOLOGIES LIMITED 3.55 52.59% 3 CELESTIAL LABS LIMITED 14.13 58.35% 4 DATAMATICS LIMITED 54.51 1.38% 5 E-ZEST SOLUTIONS LIMITED 6.26 36.12% 6 FLEXTRONICS SOFTWARE SYSTEMS LIMITED 848.66 25.31% 7 GEOMETRIC LIMITED (SEG.) 158.38 10.71% 8 HELIOS & MATHESON INFORMATION TECHNOLOGY LIMITED 178.63 36.63% 9 IGATE GLOBAL SOLUTIONS LIMITED (SEG.) 747.27 7.49% 10 INFOSYS TECHNOLOGIES LIMITED 13,149.00 40.30% PAGE 22 OF 36 ITA NO .970/BANG/2011 22 11 ISHIR INFOTECH LIMITED 7.42 30.12% 12 KALS INFOSYSTEMS LIMITED 2.00 30.55% 13 LANCO GLOBAL SYSTEMS LIMITED 45.39 15.75 % 14 LUCID SOFTWARE LIMITED 1.70 19.37% 15 MEDIASOFT SOLUTIONS (P) LIMITED 1.85 3.66% 16 MEGASOFT LIMITED 139.33 60.23% 17 MINDTREE CONSULTING LIMITED 590.35 16.90% 18 PERSISTENT SYSTEMS LIMITED 293.75 24.52% 19 QUINTEGRA SOLUTIONS LIMITED 62.72 12.56 % 20 R S SOFTWARE (INDIA) LIMITED 101.04 13.47 % 21 R SYSTEMS INTERNATIONAL LIMITED (SEG.) 112.01 15.07% 22 S I P TECHNOLOGIES AND EXPORTS LIMITED 3.8 0 13.90% 23 SASKEN COMMUNICATION TECHNOLOGIES LTD. 343.57 22.16% 24 TATA ELXSI LIMITED (SEG.) 262.58 26.51% 25 THIRDWARE SOLUTIONS LIMITED 36.08 25.12% 26 WIPRO LIMITED 9,616.09 33.65% ARITHMETIC MEAN BEFORE WORKING CAPITAL RISK ADJUSTMENT 25.14% LESS WORKING CAPITAL ADJUSTMENT 2.23% ARITHMETIC MEAN AFTER WORKING CAPITAL ADJUSTMENT 22.91% MARGIN EARNED BY KODIAK INDIA AS PER TP OR DER 12.84% CUSTOMER SUPPORT SERVICES SL. NO. NAME OF THE COMPANY AS PER ORDER OF TPO SALES IN RS. CRORE OPERATING MARGIN 1 ACCENTIA TECHNOLOGIST LIMITED (SEG.) 16.57 30.61% 2 ADITYA BIRLA MINCAS WORLDWIDE LIMITED (FORMERLY KNOWN AS TRANSWORKS INFORM) 197.06 11.98% 3 ALLSEC TECHNOLOGIES LIMITED 113.28 27.31% 4 APEX KNOWLEDGE SOLUTIONS PVT. LTD. 6.64 12.83% 5 APPOLLO HEALTHSTREET LIMITED 47.84 13.55% 6 ASIT C MEHTA FINANCIAL SERVICES LIMITED 6. 09 24.21% 7 BODTHTREE CONSULTING LIMITED (SEG.) 2.94 29.58% 8 CALIBER POINT BUSINESS SOLUTIONS LIMITED 39. 30 21.26% 9 COSMIC GLOBAL LIMITED 4.28 12.40% 10 DATANMATICS FINBANCIAL SERVICES LIMITED (SEG.) 2.92 5.07% 11 ECERX SERVICES LIMITED 86.12 89.33% 12 FLEXTRONICS SOFTWARE SYSTEMS LIMITED (SEG.) 12.93 8.62% 13 GENSYS INTERNATIONAL CORPORATION LIMITED 19. 17 13.35% 14 HCL COMNET SYSTEMS & SERVICES LIMITED (SEG) 26 0.18 44.99% 15 ICRA TECHNO ANALYTICS LIMITED (SEG) 7.23 12.24% PAGE 23 OF 36 ITA NO .970/BANG/2011 23 16 INFORMED TECHNOLOGIES INDIA LIMITED 4.08 35.56% 17 INFOSYS BPO LIMITED 649.56 28.78% 18 ISERVICES INDIA PRIVATE LIMITED 16.29 49. 27% 19 MAPLE ESOLUTIONS LIMITED 12.21 34.05% 20 MOLD TEK TECHNOLOGIES LIMITED (SEG) 11.40 113.49% 21 R SYSTEMS INTERNATIONAL LIMITED (SEG) 17.34 20.18% 22 SPANCO LIMITED (SEG) 17.34 25.81% 23 TRITON CORP LIMITED 35.00 34.93% 24 VISHAL INFORMATION TECHNOLOGIES LIMITED 30. 60 51.19% 25 WIPRO LIMITED (SEG) 939.78 29.70% 26 NITTANY OUTSOURCING SERVICES PVT. LTD. 23.2 3 11.50% 27 ACCURATE DATA CONVERTERS 4.33 50.68% 28 APEX ADVANCED TECHNOLOGY PVT. LIMITED 7.93 39.89% ARITHMETIC MEAN BEFORE WORKING CAPITAL AND RISK ADJUSTMENT 30.55% LESS : WORKING CAPITAL ADJUSTMENT 2.89% ARITHMETIC MEAN AFTER WORKING CAPITAL ADJUSTMENT 27.66% MARGIN EARNED BY KODIAK INDIA AS PER TP ORDER 10.62% 7.3 THE ASSESSING OFFICER ISSUED DRAFT ASSESSMENT ORDER DATED 18 TH NOVEMBER, 2010 PROPOSING AN ADDITION OF RS.2,93,85 ,439/- ON ACCOUNT OF TP ADJUSTMENT. THE ASSESSEE COMPANY OBJECTED AGAIN ST THE DRAFT ASSESSMENT ORDER ISSUED BY THE ASSESSING OFFICER UND ER SECTION 143(3) RWS 144C(1) OF THE ACT BEFORE THE DRP. THE DRP AGREED WITH THE VIEWS OF THE ASSESSING OFFICER/TPO AND REJECTED THE CONTENTIONS RAISED BY THE ASSESSEE COMPANY. 7.4 THE ASSESSEE COMPANY BEING AGGRIEVED IS IN APPE AL BEFORE US. 7.5 THE LEARNED AR SUBMITTED THAT THE TPO HAS ERRE D IN IDENTIFYING NEW COMPARABLES AT THE TIME OF ASSESSMEN T PROCEEDINGS. IT WAS SUBMITTED THAT THE TPO FAILED TO APPRECIATE THAT SU CH DATA WAS NOT AVAILABLE IN PUBLIC DOMAIN AT THE TIME OF COMPLYING WITH THE M ANDATORY TP PAGE 24 OF 36 ITA NO .970/BANG/2011 24 DOCUMENTATION REQUIRED BY THE PRESCRIBED DUE DATE. IT WAS STATED THAT THE TPO HAS ERRED IN USING ONLY SINGLE YEAR DATA FOR HIS ECONOMIC ANALYSIS. THE ASSESSEE, IT WAS SUBMITTED, HAD USED THE DATA FOR T HE FY 2004-05 AND FY 2005-06, APART FROM THE DATA AVAILABLE FOR THE FY 2 006-07 IN THE CASE OF ALL THE COMPANIES IDENTIFIED AS COMPARABLES TO THE SOFT WARE SERVICES AND ITES TRANSACTIONS. IT WAS ARGUED THAT THE TPO APPLIED C ERTAIN FILTERS AND DID NOT UNDERTAKE AN OBJECTIVE COMPARATIVE ANALYSIS FOR SELE CTION OF COMPARABLE COMPANIES. IT WAS FURTHER SUBMITTED THAT THE TPO H AD OBTAINED INFORMATION, WHICH WAS NOT AVAILABLE IN PUBLIC DOMA IN FROM SOME OTHER COMPANIES BY EXERCISING HIS POWERS VESTED UNDER SECT ION 133(6) OF THE ACT AND USING THE SAME FOR JUDGING THE COMPARABILITY WIT H THE ASSESSEE COMPANY. 7.5.1 IT WAS CONTENDED THAT THE TPO DID NOT MAKE S UITABLE ADJUSTMENTS TO ACCOUNT FOR DIFFERENCES IN THE RISK PROFILE OF THE ASSESSEE VIS--VIS THE COMPARABLE COMPANIES. THE LEARNED AR CONTENDED THAT THE TPO BASED ON ADDITIONAL ANALYSIS AND INFORMATION OBT AINED UNDER SECTION 133(6), IDENTIFIED 3 NEW COMPANIES AS COMPARABLE TO ASSESSEE COMPANY WHICH DID NOT FEATURE IN THE SHOW CAUSE NOTICE FOR THE ITES TRANSACTION AND THE ASSESSEE WAS NOT PROVIDED AN OPPORTUNITY TO EVAL UATE THESE COMPANIES FOR COMPARABILITY PURPOSE. IT WAS STATED THAT THE T PO DID NOT CONSIDER THAT THE ADJUSTMENT TO THE ALP, IF ANY, SHOULD BE LIMITED TO THE LOWER END OF THE 5% RANGE AS THE ASSESSEE HAS THE RIGHT TO EXERCISE THIS OPTION UNDER THE PROVISO TO SECTION 92C(2) OF THE ACT. 7.5.2. THE LD. A R FINALLY STATED THAT MOST OF THE ABOVE ISSUES RAISED IN THE PRESENT APPEAL UNDER CONSIDERATION HAVE SINC E BEEN COVERED IN THE PAGE 25 OF 36 ITA NO .970/BANG/2011 25 ASSESSEES OWN CASE IN ITA NO.1413/BANG/2010 DATED 27.1.2012 FOR THE AY 2006-07, SUCH OF THE ISSUES, NAMELY: (I) THE COMPARABLE HAVING THE TURNOVER OF MORE THAN RS. 1 CRORE, BUT, LESS THAN RS.200 CRORES; (II) ALL THE INFORMATION RELATING TO COMPARABLES WHICH W ERE SOUGHT TO BE USED AGAINST THE APPELLANT TO BE FURNISHED TO TH E APPELLANT; (III) THE APPELLANT HAS TO BE EXTENDED AN OPPORTUNITY TO C ROSS-EXAMINE THE PARTIES WHOSE REPLIES SOUGHT TO BE USED AGAINST THE APPELLANT; (IV) TO GIVE THE BENEFIT OF +/- 5 PER CENT UNDER THE PRO VISO TO S.92C(2) OF THE ACT; (V) WITH REGARD TO DEDUCTION U/S 10A OF THE ACT, ETC., 7.5.3. THE LD. A. R., HOWEVER, AGAIN PUT STRESS O N THE FOLLOWING THREE ISSUES, NAMELY: (1) THE AO/TPO ERRED IN NOT CONSIDERING THE F OREIGN EXCHANGE FLUCTUATION GAIN (LOSS) AS PART OF THE OPE RATING INCOME WHILE COMPUTING THE OPERATIONAL MARGIN. IN THIS CONNECTION, IT WAS ARGUED THAT THE APPELLAN T HAD USED TNMM AS THE MOST APPROPRIATE METHOD WHICH PROVIDES THAT IN APPL YING THE METHOD, THE NET MARGIN WAS TO BE COMPUTED IN RELATION TO COSTS INCURRED OR SALES EFFECTED OR ASSETS EMPLOYED BY THE ENTERPRISE. HOWEV ER, IT WAS ARGUED THAT THE TPO HAD EXCLUDED THE FOREIGN EXCHANGE FLUCTUATI ON (INCOME/EXPENSES) STATING THAT THESE WERE NON-OPERATING IN NATURE. I T WAS, HOWEVER, ARGUED BY THE LD. A R THAT THE FOREIGN EXCHANGE FLUCTUATION G AIN (LOSS) WERE CLOSED LINKED TO THE BUSINESS OPERATION AND DID NOT CONSTI TUTE ABNORMAL-EXTRA- PAGE 26 OF 36 ITA NO .970/BANG/2011 26 ORDINARY ITEMS. THOSE DIFFERENCES ARISE ON ACCOUNT OF NUMBER OF FACTORS, SOME OF WHICH, WERE EXPLAINED AS UNDER: (I) REALIZED FOREIGN EXCHANGE GAIN/LOSS: (A) EXPORT PROCEEDS AT A RATE HIGHER/LOWER THAN THE RATE AT WHICH THEY WERE BOOKED; (B) IMPORT PAYABLES AT A RATE LOWER/HIGHER THAN THE RATE AT WHICH THEY WERE BOOKED; (C) ADJUSTMENT OF CUSTOMER ADVANCES (RECEIVED IN FO REIGN CURRENCY) AGAINST EXPORT INVOICES RELIES ON CASE LAWS: SUJATA GROVER 74 TTJ (DEL); RENAISSANCE JEWELLERY (P) LTD V. ITO (2006) 101 ITD 830 (MUM) SAP LABS INDIA PVT. LTD 44 SOT 156 (BANG); CIT V. GEM PLUS JEWELLERY INDIA LTD (2011) 330 ITR 1 75(BOM); & M/S. FOUR SOFT LTD [ITA NO;1495/HYD/2010 ITAT, HYDE RABAD. (II) UNREALIZED FOREIGN EXCHANGE GAINS/LOSS ON ACCO UNT OF RESTATEMENT (IN THE FINANCIAL STATEMENTS) OF THE FOLLOWING AS ON T HE LAST DAY OF THE YEAR EXPORT RECEIVABLES/IMPORT PAYABLES; & ADVANCES RECEIVED FROM CUSTOMERS IN FOREIGN CURRENC Y DEUTSCHE BANK A.G V. DCIT 86 ITD 431; BESTOBELL (INDIA) LTD V. CIT 117 ITR 789 (CAL); ONGC LTD V. DCIT (2003) 261 ITR 1 (DELHI ITAT); CIT V. WOODWARD GOVERNOR INDIA (P) LTD (2007) 162 TAXMAN 60 PAGE 27 OF 36 ITA NO .970/BANG/2011 27 THUS, IT WAS SUBMITTED THAT THE EXCHANGE GAINS/LOSS ES IN CONNECTION WITH THE INCOME/EXPENSES EARNED/INCURRED IN FOREIGN CURRENCY RETAINS THE SAME CHARACTER OF THE INCOME/EXPENSE IN CONNECTION WITH WHICH IT HAS BEEN EARNED/INCURRED. THESE ITEMS OF INCOME AND EXPENDI TURE WOULD GENERALLY BE IN THE NATURE OF EXPORT PROCEEDS, IMPORT PAYABLES, T RAVELING EXPENSES ETC., IT WAS, FURTHER, SUBMITTED THAT THOSE ITEMS HAVE DIREC T NEXUS WITH THE OPERATING PROFIT/LOSS OF THE ENTERPRISES. WITHOUT APPRECIATING THE ABOVE, IT WAS SUBMITTED THAT THE TPO HAD ERRED IN NOT CONSIDE RING THE REALIZED/UNREALIZED FOREIGN EXCHANGE GAIN/LOSS AS O PERATING IN NATURE. IN CONCLUSION, IT WAS SUBMITTED THAT AS THE SAME WAS N ORMAL EXPENDITURE INCURRED IN THE ORDINARY COURSE OF BUSINESS AND, THE REFORE, SHOULD NOT HAVE BEEN EXCLUDED BY TREATING THEM AS NON-RECURRING ITEM OF EXPENDITURE WHILE COMPUTING THE OPERATING MARGIN. (2) WITH REGARD TO DIFFERENCE IN THE RISK PROFIL E, IT WAS THE SUBMISSION OF THE LD. A R THAT THE AUTHORITIES BELO W HAVE ERRED BY NOT MAKING SUITABLE ADJUSTMENTS TO ACCOUNT FOR DIFFEREN CES IN THE RISK PROFILE OF THE ASSESSEE VIS--VIS THE COMPARABLES; THAT THE AS SESSEE UNDERTAKES FUNCTIONS UNDER A LIMITED RISK ENVIRONMENT VIS--VI S COMPARABLE COMPANIES WHO BEAR ENTREPRENEURIAL RISK BEING INDEPENDENT SER VICE PROVIDERS AND, ACCORDINGLY, AN ADJUSTMENT FOR RISK LEVEL DIFFERENCE S WAS WARRANTED. IT WAS, FURTHER, CONTENDED THAT THE ASSESSEE HAD USED THE T NMM IN DETERMINING THE ALP FOR THE INTERNATIONAL TRANSACTION ENTERED I NTO DURING THE FY 2006- 07; THAT THE PROVISIONS OF RULE 10B OF THE RULES PR ESCRIBES THE METHODS TO BE USED AND MANNER IN WHICH IT WAS TO BE USED IN DE TERMINING THE ALP RELATING TO ANY INTERNATIONAL TRANSACTION. PAGE 28 OF 36 ITA NO .970/BANG/2011 28 EXTENSIVELY QUOTING THE PROVISIONS OF RULE 10B (1)(E ) OF I.T. RULES, IT WAS ARGUED THAT: ONE OF THE PRINCIPAL ELEMENTS FOR TP PURPOSES IS TH E ANALYSIS OF RISKS ASSUMED BY THE RESPECTIVE PARTIES . IN THE OPEN MARKET THEORY, THE ASSUMPTION OF INCREASED RIS K IS NORMALLY COMPENSATED BY AN INCREASE IN THE EXPECTED RETURN. ACCORDINGLY, CONTROLLED AND UNCONTROLLED TRANSACTIO NS ARE COMPARABLE ONLY WHEN ADJUSTMENTS WITH RESPECT TO SIGNIFICANT DIFFERENCES BETWEEN THEM IN THE RISKS A SSUMED IS MADE. A RISK ANALYSIS BEGINS WITH THE IDENTIFICATION OF S PECIFIC AND REALISTIC RISKS BORNE BY EACH RELATED PARTY. IT IS ALSO IMPORTANT TO NOTE THAT ECONOMICALLY SIGNIFICANT RIS KS COUNT FOR TRANSFER PRICING PURPOSES. NON-ECONOMICALLY SI GNIFICANT RISKS ARE OF MINOR IMPORTANCE DUE TO THEIR SMALL OR NEGLIGIBLE IMPACT ON THE PROFITS. ALSO, IT IS THE SIGNIFICANC E OF RISKS THAT POSITIVELY CORRELATES TO THE AMOUNT OF EXPECTE D RETURN. AS EVIDENT FROM THE TRANSFER PRICING REPORT, THE AP PELLANT FUNCTIONS UNDER A LIMITED RISK ENVIRONMENT VIS--VI S ENTREPRENEURIAL RISK BORNE BY COMPARABLE COMPANIES WHO ARE INDEPENDENT SERVICE PROVIDERS. ACCORDINGLY, IT IS OPERATING UNDER ECONOMIC CIRCUMSTANCES THAT WARRANT ADJUSTMEN TS TO THE MARGINS EARNED BY THE COMPARABLE COMPANIES, SO AS TO MAKE THE COMPARISON BETWEEN THE MARGINS EARNED BY T HE COMPARABLE COMPANIES AND THE APPELLANT APPROPRIATE. THE COMPARABLES SELECTED FOR THE ANALYSIS INCLUDE C OMPANIES WHICH HAVE FAIRLY DIVERSIFIED AREAS OF SPECIALIZATI ON, PERFORM ADDITIONAL FUNCTIONS VIZ., MARKETING, ETC, AND BEAR MORE RISKS AKIN TO ANY THIRD PARTY INDEPENDENT SERVICE P ROVIDER VIS--VIS THE APPELLANT. THE RISKS SUCH AS LEGAL R ISK, MARKETING RISK, BUSINESS RISK, ETC., ARE NORMALLY A SSOCIATED WITH EVERY INDEPENDENT COMPANY WHEREAS THE APPELLAN T IS GENERALLY INSULATED FROM THESE RISKS. FURTHER, THE APPELLANT PAGE 29 OF 36 ITA NO .970/BANG/2011 29 BEARS LESSER BUSINESS RISK THAN INDEPENDENT COMPARA BLE ENTERPRISES DUE TO THE NATURE OF ITS REVENUE MODEL. IT IS GUARANTEED PROFITS BY WAY OF A MARK-UP ON COSTS INC URRED, REGARDLESS OF ITS SUCCESS OR FAILURE. AS A CONSEQU ENCE, THE MARGINS EARNED BY THE APPELLANT WOULD BE COMPARATIV ELY LOWER TO REFLECT THE LOWER LEVEL OF BUSINESS RISK. IN ADDITION, IT MAY BE NOTED THAT AMONG OTHER RISKS, T HE APPELLANT DOES NOT BEAR ANY CREDIT RISK. WHERE A RELATED PARTY SETS PRICES FOR INTER-COMPANY TRANSACTIONS SO THAT THE APPELLANT RECEIVES A SPECI FIED LEVEL OF OPERATING PROFITABILITY, THE PRICING POLICY CAN HAVE THE EFFECT OF REMOVING VIRTUALLY ALL BUSINESS RISK FROM THE CONTROLLED ENTITY. WHEN ANALYZING CONTROLLED ENTIT IES THAT BEAR SUCH A LOW LEVEL OF RISK BY REFERENCE TO A SET OF BROADLY COMPARABLE INDEPENDENT FIRMS AS IS THE CA SE UNDER TNMM IT IS A CHALLENGE TO IDENTIFY INDEPENDENT FI RMS THAT ARE SUFFICIENTLY COMPARABLE TO THE CONTROLLED ENTIT IES IN TERMS OF RISKS ASSUMED. IN CIRCUMSTANCES WHERE THE APPELLANT HAS BEEN EFFECTIVELY GUARANTEED A FIXED R ETURN, FUNCTIONAL SIMILARITY DOES NOT ADEQUATELY ADDRESS T HIS RISK DIFFERENTIAL. IN SUCH CASES, AN ADJUSTMENT TO THE COMPARABLES FOR THIS RISK DIFFERENTIAL SEEMS WARRAN TED UNDER THE RULES AND WOULD PROVIDE A MORE PRECISE PR ICING OF THE TRUE RISK BORNE BY THE APPELLANT. TO BUTTRESS ITS CLAIM, THE ASSESSEE PLACED RELIANCE ON THE FOLLOWING CASE LAWS: (A) WESTRECO INC. 64 CCH TCM 849; (B) MENTOR GRAPHICS (DELHI ITAT); (C) PHILIPS SOFTWARE CENTRE PVT. LTD. (ITA, BNG) (D) E-GAIN COMMUNICATION PVT. LTD (ITAT, PUNE) IN RESPECT OF SINGLE CUSTOMER RISK , IT WAS SUBMITTED THAT THOUGH, THE ASSESSEE (A CAPTIVE SERVICE PROVIDER ) DID NOT TRANSACT WITH ANY OTHER INDEPENDENT PARTY AND PROVIDE D ALL THE SERVICES ONLY PAGE 30 OF 36 ITA NO .970/BANG/2011 30 TO ITS AE AND THAT THE SINGLE CUSTOMER RISK WAS INS IGNIFICANT BASED ON THE FOLLOWING: O THE APPELLANT HAS BEEN PROVIDING SOFTWARE DEVELOPME NT AND RELATED SERVICES AND ITES TO ITS AE (I.E., SINGLE C USTOMER) FOR A LONG TIME. THE APPELLANT SINCE THE COMMENCEM ENT OF ITS OPERATIONS IN INDIA HAS BEEN MAKING PROFITS IRR ESPECTIVE OF THE PERFORMANCE OF THE IT/ITES INDUSTRY IN INDIA . THE APPELLANT DOES NOT BEAR ANY RISK OF INCURRING LOSSE S DUE TO UNDER UTILIZATION OF CAPACITY OR INSUFFICIENT BUSIN ESS FROM ITS AE AS IT IS COMPENSATED ON COST PLUS BASIS I.E., AL L THE COST INCURRED BY THE APPELLANT ARE BORNE BY THE AE AND REIMBURSED ALONG WITH A MARK-UP; O GIVEN THE CONTINUED OPERATIONS OF THE APPELLANT FOR THE SUBSEQUENT YEARS (I.E., FY 2007-08 TO 2009-10), IT IS QUITE UNLIKELY THAT THE APPELLANT WOULD BE WINDING OFF IT S BUSINESS/OPERATIONS IN INDIA O AS MENTIONED IN THE DOCUMENTATION REPORT, THE AE DO ES NOT AVAIL SIMILAR SERVICES FROM ANY OTHER THIRD PARTY I N INDIA AND IS, IN A WAY, SOMEWHAT DEPENDENT ON THE APPELLANT F OR DELIVERABLES/EXECUTION. WHILE THE APPELLANT DOES N OT UNDERTAKE ANY MARKING ACTIVITY AND IS DEPENDENT ON ITS PARENT/GROUP FOR BUSINESS, THE AE IS ALSO SOMEWHAT DEPENDENT ON THE INDIAN ENTITY FOR ITS OPERATIONS/DELIVERABLES. GIVEN THE ABOVE AND KEEPI NG IN MIND THE FACT THAT THE AE HAS NOT ATTEMPTED TO ENGA GE ANOTHER INDIAN PERSON TO PERFORM SOFTWARE DEVELOPME NT SUPPORT SERVICES IN THE SUBSEQUENT YEARS, IT IS QUI TE UNLIKELY THAT THE AE WOULD DISASSOCIATE ITSELF FROM THIS ARR ANGEMENT WITH THE APPELLANT. EXHAUSTIVELY DELIBERATING MARKET RISK, POLITICAL/COU NTRY RISK AND ALSO TAKING CUE FROM THE FINDINGS OF THE EARLIER BENCH IN THE C ASE OF PHILIPS SOFTWARE CENTRE PRIVATE LIMITED V. ACIT AND BASED ON THE MET HODOLOGY OUTLINED IN THE PAGE 31 OF 36 ITA NO .970/BANG/2011 31 SAID FINDINGS, THE ASSESSEE HAD COMPUTED THE RISK A DJUSTMENTS TO BE MADE TO THE MARGINS OF THE COMPARABLE COMPANIES AND THE SUMMARY COMPUTATION IS AS UNDER: AVERAGE PRIME LENDING RATE DURING FY 2006-07 (A) 11 .88 PERCENT AVERAGE BANK RATE DURING FY 2006-07 (B) 06.00 PERCE NT DIFFERENCE BETWEEN THE PRIME LENDING RATE AND BANK RATE 05.88 PERCENT RISK ADJUSTMENT (C) 05.88 PERCENT IN CONCLUSION, IT WAS PLEADED THAT IN THE LIGHT OF THE PRINCIPLES EMBODIED IN THE ABOVE FINDINGS, THE BENEFIT OF A RISK ADJUSTMEN T BE EXTENDED TO THE ASSESSEEE. (3) ANOTHER GRIEVANCE OF THE ASSESSEE WAS THAT CEL ESTIAL LAB LIMITED (CELESTIAL LABS) OUGHT NOT TO HAVE BEEN SEL ECTED AS A COMPARABLE. IN THIS CONNECTION, THE LD. AR HAD SUBMITTED THAT CELE STIAL LABS WAS A DIVERSIFIED COMPANY OPERATING IN VARIED FIELDS SUCH AS RENDERING IT SERVICES ENCOMPASSING APPLICATION DEVELOPMENT AND MAINTENANC E PRODUCTION SUPPORT, EERP, DATA WARE-HOUSING SAP IMPLEMENTATION. CELEST IAL LABS WAS ALSO IS INTO MANUFACTURING AND TRADING OF PRODUCTS SUCH AS ERP P ACKAGE FOR MANUFACTURING AND HAD A PRODUCT SANJIVANI WHICH W AS A PORTAL FOR LIVE AYURVEDIC CONSULTATION. THE COMPANY WAS ALSO ENGAGE D IN THE DISTRIBUTION OF HERBAL AYURVEDIC PRODUCTS. FURTHER ILLUSTRATING, IT WAS EXPLAINED THAT SAP SERVICES: CELESTIAL DELIVERS SAP CONSULTING, SAP IMPLEMENTA TION AND POST-SAP IMPLEMENTATION SERVICES FOR ITS CUSTOMERS. CELESTIAL WAS ENGAGED IN IMPLEMENTING SAP FOR CUSTOMERS FROM INITIAL PLAN NING, DESIGN AND PAGE 32 OF 36 ITA NO .970/BANG/2011 32 IMPLEMENTATION TO MAINTENANCE AND ON GOING OPTIMIZA TION. CELESTIAL HELPS THE COMPANY ALIGN IT SOLUTIONS WITH BUSINESS STRATEGIES. CEL SANJIVANI PRODUCTS : CEL SANJIVANI WAS A PART OF CELESTIAL LABS LTD, AN ISO 9001-2000 COMPANY WORKING IN THIS SPACE OF BIO-I NFORMATICS AND GIO- TECHNOLOGY. THE GOAL WAS TO BECOME A PRIMARY MARKET PLACE FOR THE HERBAL PRODUCTS PROVIDING QUALITY PRODUCTS TO THE CUSTOMERS AND INDUSTRIAL COMMUNITY. THIS IS AN AYURVEDIC PORTAL DEDICATED TO B28 & C MARKET WITH ONLINE LIVE CONSULTING WITH OUT AYURVEDIC CONSULTANT S. IT PROVIDES EXCELLENT PLATFORM FOR TRADING OF HERBAL PRODUCTS WITH IDENTI FICATION RAW HERBS, SCIENTIFIC DATA, MARKET AND TRADE DATA, MONOGRAPHS, POLICY, LAWS, GOOD MANUFACTURING PRACTICES, DNA FINGER PRINTING ETC. I T FACILITATES CONTACTS WITH SUPPLIERS, MANUFACTURERS AND DEALERS OF HERBAL PHARMA INDUSTRY. IN CONCLUSION, THE ESSENCE OF THE LD. A.RS SUBM ISSION WAS THAT THE ACTIVITIES UNDERTAKEN CELESTIAL LABS WERE IN TH E NATURE OF PROVIDING MULTITUDE OF IT RELATED SERVICES AND SOME TRADING A CTIVITY WHICH WAS NOT COMPARABLE WITH THE ASSESSEE AND, THUS, IT WAS NOT COMPARABLE TO THE FUNCTIONAL PROFILE OF THE ASSESSEE AND, ACCORDINGLY, OUGHT NOT TO HAVE BEEN CONSIDERED AS COMPARABLE. 7.6 ON THE OTHER HAND, THE LD. D R FAIRLY SUBMITTE D THAT MOST OF THE ISSUES RAISED BY THE ASSESSEE HAVE SINCE BEEN DE ALT WITH IN THE ASSESSEES OWN CASE IN THE IMMEDIATELY PRECEDING ASS ESSMENT YEAR WHEREIN THE EARLIER BENCH HAD REMITTED BACK THE ISSUES TO T HE TPO FOR FRESH CONSIDERATION. AS SUCH, THE LD. D R WAS IN AGREEME NT WITH THE PLEA OF THE PAGE 33 OF 36 ITA NO .970/BANG/2011 33 LD. A R TO THE EFFECT THAT IT WOULD BE APPROPRIATE TO REMIT BACK THE PRESENT ISSUES TOO TO THE TPO FOR FRESH CONSIDERATION AS IN THE CASE OF THE PRECEDING ASSESSMENT YEAR. 7.7 WE HAVE CAREFULLY CONSIDERED THE RIVAL SUBMISS IONS AND ALSO DILIGENTLY PERUSED THE RELEVANT RECORDS AS WELL AS T HE CASE LAWS ON WHICH THE LD. A R HAD PLACED RELIANCE. IT IS A FACT, AS CON CEDED BY BOTH THE COUNSELS, THAT MOST OF THE ISSUES RAISED UNDER THE HEADS TRA NSFER PRICING ADJUSTMENTS HAVE ALSO CROPPED UP IN THE ASSESSEES OWN CASE FOR THE AY 2006-07 WHEREIN THE EARLIER BENCH HAD, AFTER DUE CO NSIDERATION OF THE FACTS AND FOR THE REASONS RECORDED THEREIN, REMITTE D BACK THE ISSUES TO THE TPO FOR FRESH CONSIDERATION. IN CONSONANCE WITH TH E FINDINGS OF THE EARLIER BENCH, WE ARE OF THE FIRM VIEW THAT THE ISSUES LIST ED OUT BY THE APPELLANT REQUIRE FRESH CONSIDERATION AT THE LEVEL OF THE TPO . ACCORDINGLY, WE REMIT BACK THE ENTIRE ISSUES TO THE FILE OF THE TPO FOR N EEDFUL. IT IS NEEDLESS TO REITERATE THAT THE DIRECTIONS OF THE EARLIER BENCH CONTAINED ITS FINDINGS IN THE ASSESSEES OWN CASE FOR THE AY 2006-07 HOLD-GOO D FOR THIS ASSESSMENT YEAR UNDER CONSIDERATION ALSO. THE SPECIFIC DIRECTI ONS IN ASSESSEES CASE FOR ASSESSMENT YEAR 2006-07, FOR READY REFERENCE REPRODUC ED BELOW :- (I) THE OPERATING REVENUE AND THE OPERATING COST OF THE TRANSACTIONS RELATING TO ASSOCIATED ENTERPRISES ONL Y SHALL BE CONSIDERED; (II) THE COMPARABLES HAVING THE TURNOVER OF MORE THAN RS.1 CRORE, BUT, LESS THAN RS.200 CRORES ONLY SHALL BE TAKEN INTO CONSIDERATION; PAGE 34 OF 36 ITA NO .970/BANG/2011 34 (III) ALL THE INFORMATION RELATING TO COMPARABLES WHICH W ERE SOUGHT TO BE USED AGAINST THE APPELLANT SHALL BE FURNISHED TO THE APPELLANT; (IV) THE APPELLANT SHALL ALSO BE EXTENDED AN OPPORTUNITY TO CROSS-EXAMINE THE PARTIES WHOSE REPLIES WERE SOUGHT TO BE USED AGAINST THE APPELLANT; (V) TO CONSIDER THE OBJECTIONS OF THE APPELLANT THAT RE LATE TO ADDITIONAL COMPARABLES SOUGHT TO BE ADOPTED BY TH E TPO AND TO PASS A DETAILED ORDER; AND (VI) TO GIVE THE STANDARD DEDUCTION OF 5% UNDER THE PROVISO TO S.92C(2) OF THE ACT. THE TPO SHALL ALSO KEEP IN VIEW THE FINDINGS HANDED DOWN IN THE CASE OF M/S. GENISYS INTEGRATING SYSTEMS (INDIA) LTD V. DCIT [ITA NO;1231(BANG)/2010 DATED 5.8.2011] WHILE CONSIDERING THE APPELLANTS C ASE AFRESH. 7.7.1. WITH REGARD TO THE SUBMISSIONS OF THE LD. A R IN RESPECT OF (1) FOREIGN EXCHANGE FLUCTUATION GAIN (LOSS) AND (2) RI SK PROFILE, WE ARE OF THE CONSIDERED VIEW THAT THERE IS CONSIDERABLE FORCE IN THE ARGUMENTS PUT FORTH BY THE LD. A R. THE CONTENTIONS OF THE APPELLANT HAV E NOT BEEN GIVEN DUE WEIGHT-AGE AT THE TIME OF FINALIZING THE ISSUES BY THE TPO AS ALLEGED BY THE ASSESSEE IN ITS SUBMISSIONS (SUPRA). IN THE INTERE STS OF PRINCIPLES OF NATURAL JUSTICE AND FAIR-PLAY AND SINCE MANY OF THE ISSUES HA VE ALREADY BEEN REVERTED BACK TO THE FILE OF THE TPO FOR FRESH CONS IDERATION, WE ARE OF THE CONSIDERED VIEW THAT THESE ISSUES REQUIRE TO BE LOO KED INTO AFRESH BY THE TPO IN VIEW OF THE ASSESSEES ASSERTIONS CITED SUPR A, BOTH OF THESE ISSUES ARE ALSO REQUIRED TO BE REMITTED BACK TO THE FILE O F THE TPO FOR FRESH CONSIDERATION. IT IS ORDERED ACCORDINGLY. PAGE 35 OF 36 ITA NO .970/BANG/2011 35 7.7.2. IN RESPECT OF THE APPELLANTS OTHER CONTEN TION I.E., CELESTIAL LABS LIMITED AS A COMPARABLE, WE WOULD LIKE TO RECA LL THE FINDINGS OF THE HONBLE MUMBAI BENCH E IN THE CASE OF M/S. TEVAPH ARM PRIVATE LIMITED V. ADDL. CIT 10(3) IN ITA NO.6623/MUM/2011 (AY 2007- 08) DATED: 23.12.2011. THE ISSUE, IN BRIEF, BEFORE THE HONBL E BENCH WAS THAT THE ASSESSEE HAD IN ONE OF ITS GROUNDS OBJECTED TO IN P ICKING UP CELESTIAL LABS LIMITED AS A COMPARABLE FOR THE REASON WAS THAT 5THE ACTIVITIES UNDERTAKEN CELESTIAL LABS ARE IN THE NATURE OF PROV IDING HOST OF IT RELATED SERVICES AND SOME TRADING ACTIVITY WHICH IS NOT COMPARABLE TO THE ASSESSEE. HENCE, IT IS CLEAR THAT IT IS NOT CO MPARABLE TO THE FUNCTIONAL PROFILE OF THE COMPANY AND, ACCORDINGLY, OUGHT NOT TO BE CONSIDERED A COMPARABLE. AFTER CONSIDERING THE RIVAL SUBMISSIONS, THE HON BLE BENCH HAD OBSERVED THUS: 5.ACCORDING TO THE LEARNED D.R CELESTIAL LABS IS ALSO IN THE FILED OF RESEARCH IN PHARMACEUTICAL PRODUCTS AND SHOULD BE CONSIDERED AS COMPARABLE. AS RIGHTLY SUB MITTED BY THE LEARNED COUNSEL FOR THE ASSESSEE, THE DISCOV ERY IS IN RELATION TO A SOFTWARE FOR DISCOVERY OF NEW DRUGS. MOREOVER, THE COMPANY ALSO IS OWNER OF THE IPR. TH ERE IS, HOWEVER, A REFERENCE TO DEVELOPMENT OF A MOLECULE T O TREAT CANCER USING BIO-INFORMATICS TOOLS FOR WHICH PATENT ING PROCESS WAS ALSO BEING PURSUED. AS EXPLAINED EARLI ER IT IS A DIVERSIFIED COMPANY AND, THEREFORE, CANNOT BE CONSI DERED AS COMPARABLE FUNCTIONALLY WITH THAT OF THE ASSESSEE. THERE HAS BEEN NO ATTEMPT MADE TO IDENTIFY AND ELIMINATE AND MAKE ADJUSTMENT OF THE PROFIT MARGINS SO THAT THE DIFFERENCE IN FUNCTIONAL COMPARABILITY CAN BE ELIMI NATED. BY NOT RESORTING TO SUCH A PROCESS OF MAKING ADJUSTMEN T, THE PAGE 36 OF 36 ITA NO .970/BANG/2011 36 TPO HAS RENDERED THIS COMPANY AS NOT QUALIFYING FOR COMPARABILITY. WE, THEREFORE, ACCEPT THE PLEA OF T HE ASSESSEE IN THIS REGARD. CONCURRING WITH THE FINDINGS OF THE HONBLE MUMBAI BENCH (SUPRA) AND ALSO THE APPELLANTS VEHEMENT OBJECTION IN CHOOSING CELE STIAL LABS LIMITED AS COMPARABLE, WE ARE OF THE CONSIDERED VIEW THAT THIS ISSUE ALSO REQUIRES A FRESH LOOK AT THE TPOS LEVEL. TO FACILITATE THE T PO TO COMPLY WITH THE DIRECTIONS OF THIS BENCH (SUPRA), WE REMIT BACK THI S ISSUE ALSO TO THE FILE OF THE TPO. 8. IN THE RESULT, THE APPEAL FILED BY THE ASSESSEE IS PARTLY ALLOWED AS INDICATED ABOVE. ORDER PRONOUNCED IN THE OPEN COURT ON 16 TH DAY OF MARCH, 2012. SD/- SD/- (N K SAINI) (GEORGE GEORGE K) ACCOUNTANT MEMBER JUDICIAL MEMBER COPY TO:- 1. THE REVENUE 2. THE ASSESSEE 3. THE CIT CONC ERNED 4. THE CIT(A) CONCERNED 5. THE DR 6. GF MSP/- BY ORDER ASST. REGISTRAR, ITAT, BANGALORE.