M/S. SCHNEIDER ELECTRIC INDIA PVT. LTD.,GURGAON vs. DCIT, NEW DELHI

(PAN : AABCS1624G) (APPELLANT) (RESPONDENT) ASSESSEE BY : Shri K.M. Gupta, Advocate REVENUE BY : Ms. Swati Joshi, CIT DR Date of Hearing : 23.08.2016 Date of Order : 29.09.2016 O R D E R PER KULDIP SINGH, JUDICIAL MEMBER :

Appellant, M/s. Schneider Electric India Pvt. Ltd. (hereinafter referred to as ‘the assessee’), by filing the present appeal sought to set aside the order passed by the AO/TPO/DRP under section 143 (3) read with section 144C of the Income-tax Act, 1961 (for short ‘the Act’) qua the assessment year 2009-10 on the grounds inter alia that :-

“TRANSFER PRICING ('TP') MATTERS On the facts and circumstances of the case, and in law:

1.

3. The Ld. AO ID RP ITPO erred in enhancing the income of the appellant by making a TP adjustment \ of Rs.60,14,65,390 on account of the manufacturing segment of the appellant by erroneously rejecting the appellant's segmentation of its account for TP purpose as undertaken in the TP Study.

3.1 Without prejudice to ground number 3 and as an alternate, the Ld AO/TPO/DRP erred in failing to consider that in any event, only proportionate TP adjustment should have been made in the appellant's case under the Transactional Net Margin Method ('TNMM'). 3.2 The Ld AO/TPO/DRP erred in failing to appreciate that the international transactions of the appellant relating to its manufacturing segment would meet the arm's length principle even on a transaction-by-transaction basis.

Distribution Segment 4. The Ld. AO/DRP /TPO erred in enhancing the income of the appellant by making a TP adjustment of Rs.37,58,66,000 on account of the distribution segment of the appellant and in doing so have grossly erred in not allowing adjustment on account of customs duty and adverse movement of foreign exchange claimed in TP Study.

4.1 Without prejudice to ground 4 above, the Ld AO/TPO/DRP erred in failing to consider that in any event, only proportionate TP adjustment should have been made in the appellant's case under the TNMM. R&D Support Services Segment 5. The Ld AO/TPO/DRP erred in enhancing the income of the appellant by making a TP adjustment of Rs.4,14,97,971 on account of the R&D support services segment of the appellant and in doing so have erred by distorting the comparability analysis conducted by the appellant in the TP Documentation.

CORPORATE TAX MATTERS 6. That on the facts of the case and in law, the Assessment Order passed by the Ld. AO under section 143(3) read with section 144C of the Act is bad in law in confirming the additions made in the draft assessment order passed under section 144C of the Act without considering the submissions made by the appellant.

7. That on the facts of the case and in law, the Ld AO/Ld. DRP has erred in disallowing 3/4th of the Advertisement and Sales promotion expenses amounting to Rs.6,32,85,750 by erroneously holding that such expenditure is enduring in nature and thus, in the nature of deferred revenue expenditure.

8. That on the facts of the case and in law, the Ld AO/Ld. DRP has erred in disallowing 4/5th of the Recruitment expenditure amounting to Rs.1,12,88,617 by erroneously holding that such expenditure is enduring in nature and thus, in the nature of deferred revenue expenditure.

9. That on the facts of the case and in law, the Ld AO/Ld. DRP has erred in disallowing 3/4th of the Licenses and Permits expenditure amounting to Rs.1,69,93,222 by erroneously holding that such expenditure is enduring in nature and thus, in the nature of deferred revenue expenditure.

11. Without prejudice to the above Ground No.7, 8 and 9, the Ld. AO ought to be directed to recompute the deduction under section 10A of the Act after considering the disallowance of expenses viz. Advertisement and sales promotion expenditure, Recruitment expenditure and Licences and permits expenditure and excluding any adjustment under section 92C(4) of the Act in view of the proviso to section 92C(4) of the Act.

12. That the Ld. AO has grossly erred in law in levying interest under section 234B and 234D of the Act and also withdrawing interest under section 244A of the Act. 13. That the Ld. AO has grossly erred in law in initiating the penalty proceedings under section 271(1)(c) of the Act.”

(a) e-Content / e-Catalogue services; (b) R& D support services; and (c) Business support services.

S.No. Nature of International Amount (in TP Transaction INR) Method (Book Value) 1. Import of components 1,723,098,003 TNMM (Manufacturing Function) 2. Export of manufactured goods 992,576,284 TNMM (Manufacturing Function) 3. Import of capital equipment 2,916,697,233 TNMM (Trading Function) 4. Import of capital equipment 101,075,273 TNMM 5. Payment of royalty 154,278,694 TNMM 6. Provision of repair & 5,664,371 TNMM maintenance services (received/receivable) 7. Receipts of repair & 125,894 TNMM maintenance services (paid/payable) 8. Receipt of IT support services 184,544,993 TNMM (paid/payable) 9. Receipt of management support 150,688,232 TNMM services (paid/payable) 10. Payment of project support fees 48,609,747 TNMM (paid/payable) 11. Provision of e-conduct/ e- 103,344,044 TNMM catalogue Services (receives/receivable) 12. Provision of business support 107,554,362 TNMM services 13. Provision of research & 682,422,512 TNMM development (“R&D”) services (received / receivable) 14. Reimbursement of expenses 98,050,206 TNMM (paid/ payable) 15. Recovery of expenses 62,624,694 Refer Para (received / receivable) 1.15

Assessee in its Transfer Pricing Report (TP Report) used previous data to benchmark the international transactions and has selected OP / Sales as the PLI. Assessee worked out the weighted average of OP/Sales of 7 comparables at7.44%, calculated the average of the raw material import of the total raw material at 17.03% in comparables as against 83.68% of the assessee. For international transactions of “manufacturing export to AEs”, the assessee has taken OP/Sales as PLI with greater average of 7 comparables at 9.55% as against 27.97% of the assessee.

Particulars Total Sales net of excise 61,357.96 Arm’s length margin @ 7.88% 4835 Margin of the assessee -2997.55 Difference in the margin 7832.55

Adjustment proposed to be made 7832.55

10. TPO also enhanced the income of the assessee qua manufacturing segment at Rs.78,32,55,000/- and further made an adjustment of Rs.37,58,66,000/- qua the tradings segment transactions.

GROUND NO.1 13. Ground No.1 is general in nature which has been supplemented in detail in the other grounds raised by the assessee, hence needs no specific adjudication. So, we accordingly decide the same.

TRANSFER PRICING (TP) GROUNDS GROUNDS NO.2, 3, 3.1 & 3.2

“3. BENCHMARKING OF MANUFACTURING BELATED TRANSACTIONS 3.1 The assessee has benchmarked the above stated international transactions using Transactional Net Margin Method. The tested party margin for this segment has been calculated as below :-

Particulars Import of Manufacturing components, and export to manufacturin AEs g and sales to Non AEs Sales net of excise 24,982.14 9,736.05 Total expenses 24,773.04 7.012.86 Operating profit 209.10 2,723.19 OP/OC 0.84% 38.83% OP/Sales 0.72% 27.97%

3.2 In order to benchmark the international transactions in the Manufacturing segment, the assessee in transfer pricing report has selected 7 comparables which ore reproduced hereunder:

S.No. Company Name 1. Havell'S India Ltd 2. Indo Asian Fusegear Ltd 7. JSL Industries Limited 6. K. Dhandapani & Co. Ltd. 5. Kaycee Industries Ltd 3. Reed Relays & Electronics India Ltd 4. Salzer Electronics Ltd

3.3 In the TP Report three year's data has been used to benchmark the international transactions. For the international transactions of "Manufacture using imported components and sold to Non AE's" the assessee has selected the OP/Sales of the as the PLI. The weighted average OP/Sales of the 7 comparables has been worked out at 7.44%. Further, the average of raw material imports to total raw materials and spares was calculated at 17.03% in comparables as against 83.68% of the assessee. The NPM for manufacturing was adjusted for the ratio of high imports in the case of the assessee and the adjusted NPM was calculated at 12.29% (Appendix C5 of TP Report) as against a net level loss of - 3.33%.

3.5 For the international transactions of "Manufacture and exports to AEs" the assessee has selected the OP/sales as the PLI. The weighted average OP/sales of the 7 comparables has been worked out at 9.55% as against 27.97% of the assessee. 3.6 It was noticed from the submission dated 16.04.2012 that six segments have been created for benchmarking purposes.

Besides there are four segments in which there are stated to be no international transaction. It is noticed from this chart furnished by the assessee that there is one segment by the name of Manufacturing (TP) and there is another segment Manufacturing (Local]. Vide order sheet dated 12.06.2012, the assessee was asked to explain as to how the segments have been drawn and to explain the key to allocation. The assessee, vide submissions dated 08.10.2012, submitted the reply. However it is seen that: there are no cogent reasons for creating artificial segmentation for the purposes of transfer pricing. From the examination a/segmentation carried out for TP purposes it is noted that this inter-se segmentation artificially created by bifurcating the manufacturing function is not supported by audited financials. The segmentation for TP purposes is also not supported by audited AS-17 segmented financials. 3.7 In view of the above discussion, it is proposed to aggregate all the manufacturing segments. The results are computed as under:

(Amount in Rs.Lacs) Particulars Import of Manufacturing Manufacturing Total components and export to Local manufacturing AEs and sales to Non AEs Sales net of 24,982.14 9,736.05 26639.77 61357.96 excise Total 24,773.06 7,012.86 32569.61 64355.51 expenses Operating 209.10 2,723.19 -5929.84 -2997.55 profit OP/OC -4.66% OP/Sales -4.89%

On the basis of above analysis and it is proposed to aggregate all the artificially created segments under the manufacturing functions and calculate the tested party margin of this segment using aggregated financials. It is proposed to adopt tested party margin using OP/Sales as the PLI for this segment at (4.29)%. 3.8 In view of the fact that Rule 10D(4) requires only the contemporaneous data to be used, the updated margins of the above com parables using data for FY 2008-09 were called for which have been submitted vide submission dated 22nd October, 2012 and are reproduced as under.

S.No. Company Name OP/Sales (%) 1. Havell'S lndia Ltd 8.68

2. Indo Asian Fuseqear Ltd 13.48 3. JSL Industries Limited 5.42 4. K. Dhandapani & Co. Ltd. 2.36 5. Kaycee Industries Ltd 5.22 6. Reed Relays & Electronics India 10.69 Ltd 7. Salzer Electronics Ltd 9.34 Mean 7.88%

3.9 The comparables selected by the assessee are thus proposed to be used for the purpose of benchmarking. Single year's data is proposed to be used. The mean margin OP /Sales of 7 Comparables 7.88% is proposed to be used as the arm's length margin for computing the arm's length price in this segment, in place of the margin of the tested party which is computed at 4.89%. Thus the amount of adjustment proposed is computed as under:

Particulars Total Sales net of excise 61,357.96 Arm’s length margin @ 7.88% 4835 Margin of the assessee -2997.55 Difference in the margin 7832.55 Adjustment proposed to be made 7832.55

As computed above, an adjustment of Rs: 7832.55 Lakhs is proposed to be made in the manufacturing segment

5.6 REPLY OF THE ASSESSEE • The assessee in reply to show-cause notice issued, has furnished reply dated 24.01.2013, in which the assessee has taken the following arguments: • The assessee has stated that 'Manufacturing Local segment' was created because this segment contains majority of domestic transactions and does not involve significant international transactions. The imported raw material components constitute only 15% of the total cost for manufacture of final products, whereas in the 'Manufacturing imported segment', these account for more than 80% of total cost. • Assessee has relied upon Rule 10B(l)(e) wherein definition of TNMM has been given to state that the NPM margin pertaining to 'Manufacturing Local Segment' involves negligible international transactions and 'Manufacturing Exports Segment' was not comparable.

• Assessee has slated that the ambit of segmentation under transfer pricing is much wider than the objective of segmentation as mandated under AS-17. • The assessee has stated that the basis of allocation of expenses has been broadly explained. • Based on above arguments, assessee has stated that the bifurcation of manufacturing into sub-segments was justified from TP perspective. Consideration of reply of assessee with respect to bifurcation of 'Manufacturing Function Segment': 5.7 The above stated reply of the assessee has been examined and considered. The various contentions made by the assessee have also been considered. It is observed that the assessee has in fact artificially segregated its manufacturing function segment for TP purposes so as to arrive at an inflated tested party margin to bring it within arm's length range. This conclusion is based on following irrefutable facts: i) The reasons given for excluding 'Manufacturing Local Segment' are not convincing. The assessee has stated that the imported raw material components constitute only 15% of the total cost for manufacture of final products. Thus, the assessee has itself admitted that this 'Manufacturing Local Segment' does include international transactions relating to import of raw material components. The assessee in its later part of its reply has also admitted that this segment also includes allocated costs. The assessee has been again unable to explain or justify as to how these international transactions under the 'Manufacturing Local Segment' are getting benchmarked under TNMM by excluding this segment altogether from its benchmarking analysis. Therefore, the contentions with regard to non inclusion of this segment are rejected. However, the contentions regarding segregation of this segment at all are considered separately. ii) The assessee has stated that they have now got their accounts audited and for the above segmental accounts, assessee has furnished certificate from Pankaj Billa & Co., Chartered Accountants dated 21.01.2013. In the above stated certificate, the Firm of CA has only certified what the assessee had carried out in its TP report. No basis for above certification has been given by the auditors except for reiterating what the assessee had itself carried out in its TP report. This post-facto certificate is not valid because of the following reasons: • The segmentation carried out for TP purposes is not supported by audited AS-17 financials. • The original auditors of the company, S R Batliboi & Associates have carried out segmentation on the basis of Accounting Standard AS-l1 issued by Chartered Accountants of India. The segmental reporting is with respect to primary business segments, i.e. industrial, electrical and electronics items. The other segment is the segment relating to services segment which includes research and other services provided to group companies. The segment accounting policies have been specifically laid out in Note B of Schedule 19 to the accounts. No such sub segmenting has been carried out by the original auditors of the company. • Certain expenses have been allocated on the basis of certain keys such as 'hours spent', 'net sales', 'fixed assets' and 'usage'. These allocation keys are not defined so as to arrive at accurate allocation. • It may be mentioned that in the Audited Report which was prepared on the basis of actual audit and physical verification, no such differentiation has been reported by the Auditor. The claim made by the assessee in the certificate is based on an artificial assumption, which is not substantiated by the audited accounts. iii) The contentions of the assessee as per definition under Rule 10B (l)(e) for TNMM and reliance on the judgments in the cases of E-gains and Mentor Graphics also does not help the case of the assessee, wherein the assessee has argued that to make one of the segments comparable, results of other comparable segments need to be artificially segregated and then completely excluded from benchmarking analysis. 5.8 On the basis of above analysis and discussions it is clear that the assessee has created artificial segments for the purpose of transfer pricing which cannot be accepted. Similar issue was involved in the AY 2008-09, where tile assessee had preferred filing of objections before the DRP. The DRP-II, New Delhi vide its directions, bas declined to interfere in the order passed by the TPO and has confirmed the action of taking manufacturing segment has a whole. In view of this the tested party margin with respect to 'Manufacturing Function Segment' is held to be the total income and expense in this segment. The net profit margin (NPM) for this segment shall be taken at 1.64% as calculated in the show- cause notice. 5.9 There is no dispute over the selection of comparables. The margins of the com parables are to be considered for the FY 2008- 09 as discussed in the preceding paragraphs w.r.t use of current year data. The other issue involved is computation of adjustment. The assessee is essentially computing the quantum of adjustment taking the benefit of +/-5%. The assessee has contended that benefit of plus minus S% as stipulated in section 92C(2) of the Act should have been given to it. The taxpayer's above objection is not acceptable in view of the amendments made in the income tax act and various case laws. 5.10 In view of detailed discussions in the foregoing paragraph the quantum of adjustment to be made is computed as under: Particulars Total Sales net of excise 61,357.96 Arm’s length margin @ 7.88% 4835 Margin of the assessee -2997.55 Difference in the margin 7832.55 Adjustment proposed to be made 7832.55 5.11 Since the price charged by the assessee varies by more than 5% from the value of international transactions, an adjustment of Rs.78,32,55,000/- is to be made to the income of the assessee in the Contract R&D Segment, being the difference between the arm's length price and the price charged by the assessee from its AEs for export of services. The Assessing Officer shall enhance the income of the assessee by an amount of Rs.78,32,55,000/- while computing its total income.”

TPO also declined to entertain the reason given by the assessee for excluding “manufacturing local segments” being not convincing as the assessee has itself admitted that the “manufacturing local segment” includes international transaction relating to import of raw material component. TPO also observed that the assessee has failed to explain / adjustment as to how this international transaction under the manufacturing local segment are getting benchmark under TNMM by excluding this segment form its benchmarking analysis. TPO has also not admitted certificate for audited segmental accounts given by Pankaj Billa & Co., CA dated 21.01.2013 on the grounds inter alia that this is a post facto certificate not supported by AS-17 financials; that certain expenses have been allocated on the basis of certain keys, such as, “hours spent”, “net sales”, “fixed assets” and “usage” which are not defined in order to arrive at accurate allocation. TPO also relied upon the order passed by ld. DRP in assessee’s own case qua AY 2008-09 wherein manufacturing functions segment is held to be total income and expenses in this segment and as such, has preferred to benchmark the transaction by aggregating all the segments.

19. Bare perusal of the TP order goes to prove that the additional evidences brought on record by the assessee in order to support its contention to adopt the transaction by transaction approach for benchmarking the international transaction and to select its AEs as tested party has neither been discussed nor answered by the ld. TPO.

“5. We have heard both the sides on the issue. We have also gone through the written submissions made. The ITAT in assessee’s own case Assessment Year 2007-08 in dated 22.11.2012 has restored the issue to the file of the Assessing Officer. The relevant portion of the order of ITAT is as under :- “5. Considering the above submissions we find that in the case Kyungshin Industrial Motherson Ltd. (Supra) the primary contentions of the assessee involved was regarding analysis of suppliers' profitability for imports and limiting the variation on account of transfer pricing only to the proportion of related party transactions. The authorities below did not address the issues for want of data. The Tribunal acceded to the assessee's plea for accepting these additional evidences and remanding the matter to the authorities below for fresh adjudication. Again in the case of Quark Systems India Pvt. Ltd. (Supra) the Special Bench of the Tribunal has held that the appellant can not be estopped from highlighting mistakes in the assessment even though such mistake is the result of evidence adduced by the tax payer. We find that in the present case the assessee has also collated supplementary evidence to corroborate the arm's length nature of its international transactions in adherence to the principles and contentions made before the authorities below. We thus in the interest of justice set aside the matter to the file of the A.O. to first ascertain to his satisfaction that the instances furnished by the assessee by way of supplementary evidence are indeed comparable to the case of the assessee to corroborate the arm's length nature of its international transaction in adherence to the principles of arm's length and then analyse pricing policy of the assessee in the light of the said evidence which was not in the possession of the assessee earlier. It is needless to mention over here that while deciding the issue afresh the A.O. will afford opportunity of being heard to the assessee.” In view of the decision of ITAT in assessee’s own case and also in view of the decision of ITAT relied upon by the assessee, cited supra, in the case of Kyungshin Industrial Motherson Ltd. in ITA No.1396 (Del.)/2009 and in view of the decision of Special Bench in the case of Quark Systems India Pvt. Ltd. reported in 38 SOT 307 (B), we find it appropriate to set aside the matter to the file of the Assessing Officer to first ascertain to his satisfaction that the instances furnished by the assessee by way of supplementary evidences are indeed comparable to the case of the assessee to corroborate the arms length nature of its international transaction in adherence to the principles of arms length and then analyse pricing policy of the assessee in the light of those evidences. Thus, the grounds no.1 to 3 are restored back to the file of the Assessing Officer.”

However, in the light of the findings returned by the Bench on grounds no.3, 3.1 and 3.2, ground no.2 has since become infructuous and needs no adjudication.

GROUND NO.5 :

“i. Use of current year data : It has already been argued earlier that the transfer pricing provisions lay down that primarily current year data should be use. You have objected to the use of this filter. However, you have ignored the/act that the proviso to Rule 10D(4) allows the use of multiple year data only if the assessee is able to demonstrate through relevant data that certain factors of earlier years has affected the transfer prices for the current year. You have not been able to do so in any of your submissions. There are sufficient judicial pronouncements that support the use of current year data. ii. Different financial year : If a company is having an accounting year different from financial year for which financials of your company are being considered, the same has been excluded as the profits and revenue pertain to different period other than current year which is FY 2008-09. This filter is being applied because even after application of this filter, there are several comparable companies available in software development. iii. Reject companies where turnover is less than Rs.5 Crore: This filter is applied because where the turnover and cost base is very small, it is more than likely that the margins will be erratic. That apart, a company that is very small in size does not have sufficient economic significance that it be used as a benchmark. Furthermore, under Rule 10B (2) & (3) of the IT Rules, as also both under UN and OECD TP guidelines, "turnover" per se is not a comparability factor. However, "economies of scale" may at times be a comparability factor. Turnover may be comparability factor in the circumstances where it is proved that turnover Significantly influence price, cost or profit arising from international transaction. However, no such attempt has been made by the assessee in its TP study. iv. Select companies where the ratio of service income to total income is at least 75% : The use of this filter is to ensure that vie choose companies that are primarily in the service sector. This filter ensures that companies that have significant incomes from manufacturing and trading activities are rejected. In your case your entire income is from provision of services. It would not be appropriate to benchmark your Case against a company that has significant income from manufacturing or trading activities. This filter will thus ensure integrity of all comparable data. v. Select companies where income from exports is at least 75% of total income: This filter is required to be applied since you are primarily earning income from exports. Even in cases where an assessee is having income from domestic operations, the transfer pricing audit will benchmark transactions with the AE which will be an export transactions. There are Judicial pronouncements that support the case that exporters should not be compared with domestic companies. Hence, this filter is required to be applied with a threshold 75%. vi. Reject companies where related party transactions exceed 25% of sales: There is no doubt that companies with significant related party transactions need to be excluded from the benchmarking process. On the issue of threshold of related party transactions, it can be stated that when the RPT exceeds 25% of sales, it can be said to be the stage when it will start affecting the price paid/received. The rationale given for the use of the If in it of 25% is sound and this threshold limit has been approved explicitly an implicitly in quite a few judicial pronouncements. However, companies which are having consolidated sales not exceeding 125% of sales of standalone entity and not having large variation in the profit margins between the standalone entity and consolidated entity have been considered at the consolidate level irrespective of the related party transactions as the 'related party transactions cancel out at consolidated level and significant portion of the business (>80%) considers the operations in Indian conditions in which you operate. in case of companies which are not having significant difference between the margins of standalone entity and consolidated entity, it is clear that RPT have not significantly influenced the margins of such companies and hence they have been considered. Further, as per the disclosure norms, related party transactions are mandatorily required to be reported by a company having turnover above Rs.50 crores. Hence, companies where turnover is less than 50 crores and no disclosure in respect of related party transactions has been made have not been considered as there is a possibility that company may be having related party transactions but the same have not been reported. Companies having turnover less than 50 crores where related party transactions' disclosure has been made and related party transactions do not exceed 25% of sales have been considered. vii. Companies that have employee cost that is less than 25% of total cost: The rationale for this filter is that companies that are engaged in software development will require a minimum level of expenditure on personnel expense. There are judicial pronouncements that support the contention that expense on personnel that is extremely low may lead to the conclusion that the company is not engaged in software development The assessee is engaged in providing software development services (SWD). Services are rendered through employees. The expenditure incurred on purchase of raw material/trading goods, etc. is negligible in such cases. Employees cost constitutes the major component of cost in any service sector. Very low employee cost, viz; less than 25% of total cost, indicates that company is either engaged in some other business or it has outsourced the service functions to a third party, i.e., it is not rendering services on its own. Such companies cannot be treated as functionally comparable to the assessee. viii. Companies that are affected by some peculiar economic circumstance : Companies that are affected by factors like persistent: losses, declining sales, extraordinary income or expense, mergers and acquisitions or other such factors which affect the operations of the company substantially should not be used as comparables as they will not prove to be good benchmarks.”

S.No. Name of the company Remark s of this office 1. Aditya Birla Minacs Technologies Reject Ltd. / Birla Technologies Ltd. 2. Akshay Software Technolgies Ltd. Accept 3. Computech International Ltd. Reject 4. Halios & Matheson Information Reject Technology Ltd. 5. L G S Global Ltd. Accept 6. Powersoft Global Solutions Ltd. Reject 7. R Systems International Ltd. Reject 8. Sasken Communication Accept 9. Sonata Software Ltd. Reject 10. Quintegra Solutions Ltd. Reject

S.No. Comparables OP/OC (w/o fx) (%) 1. Akshay Software Technolgies Ltd. 7.99 2. Aztecsoft Ltd. (Consolidated) 27.37 3. Bodhtree Consulting Ltd. 69.80 4. Cat Technolgoies Ltd. 34.43 5. Goldstone Technologies (Seg) 10.28 6. Infosys Technologies Limited 40.74 7. Larsen & Turbo Infotech Limited 21.56 8. LGS Global Ltd. 17.55 9. Mindtree Limited 27.36 10. Persistent Systems Limited 37.77 11. R S Software (I) Limited 10.15 12. Sasken Communication Tech. Ltd. 22.67 13. Tata Consultancy Services Ltd. 31.44 14. Tata Elxsi Ltd. 16.89 15. Think Soft Global 16.56 16. Thirdware Solutions 37.27 Average OP/TC 26.86

“18. DETERMINATION OF ARM’S LENGTH PRICE:

On the basis of above discussion, the average mean margin of comparable companies in ‘ Provision of software development services’ segment comes to 26.86%. This margin shall be adopted for the purpose of benchmarking international transaction in the provision of software development services segment. The arm’s length price of the international transaction is computed as under :-

Particulars Amount INR Operating Cost 650,172,467 Arm’s length margin (%) 26.86% Arm’s length margin (Rs.) 174,636,325 Arm’s length Price 824,808,792 Price charged by the assessee 723,615,888 105% of Price charged in international 759,796,682 transaction Difference for which adjustment is required to 101,192,904 be made Adjustment offered in the TP study 41,100,000 Adjustment now proposed to be made 60,092,904

Moreover, TPO has dealt with all the segments differently showing average OP/TC of comparables at 26.86% vis-à-vis assessee’s OP/TC at 11.14% . Ld. AR further contended that the TPO has not adopted transaction by transaction approach for making TP adjustment.

GROUNDS No.4 & 4.1 29. The ld. AR for the assessee challenging the impugned TP adjustment regarding trading segment to the tune of Rs.37,58,66,000/- contended that there is no dispute with the revenue as to the distribution segment in the earlier years as there was healthy margin and no adjustment was made. But, during the year under assessment, healthy margin could not come on record only due to foreign currency loss.

Assessee has computed adjusted Net Profit Margin (NPM) at 13.97%.

(Amount in Lacs) Particulars Actual Adusted Sales 42,084.56 42,141.20

Cost of Sale 35,763.61 27,943.75 Excise Stores Consumed Wages Industrial Cost Depreciation Industrial Specific Personnel Cost Specific Costs 27.23 Other Expenses (Comm/ Admn) 8,269.97 8,281.10 Total Expenses 44,033.58 36,252.08

Operating Profit (1,949.02) 5,889.12

Operating Profit (%) -4.63% 13.97%

S.No. Name of the comparable OP/Sales (%) (i) Adtech Systems Limited 16.94 (ii) K. Dhandapani & CO. Ltd. 0.32 (iii) Karuna Cables Limited 3.64 (iv) Remi Sales & Engineering Limited 1.98 (v) Chloride International Limited -1.37 4.30

Particulars Total Sales net of excise 42,084.56 Arm’s length margin @ 4.30% 1809.64 Margin of the assessee -1949.02 Difference in the margin 3758.66 Adjustment proposed to be made 3758.66

Particulars Total Sales net of excise 42,084.56 Arm’s length margin @ 4.30% 1809.64 Margin of the assessee -1949.02 Difference in the margin 3758.66

“50. The assessee would further emphasize that the loss in this segment was primarily on account of adverse foreign exchange movement. The assessee, in its distribution segment, imported 100% of finished goods from its AEs and hence the INR value purchases [invoiced in foreign currency by the AEs i.e. EURO C'EUR') in this case] depended highly on the prevailing exchange rates. Thus, the assessee was exposed to high economic foreign exchange risk. This typically occurs when the business generates sales in one currency and incurs costs in another.

rupee depreciated sharply. This adversely affected the margins of the assessee as the cost of imported goods increased due to foreign exchange movements. The same is represented below :-

Average-Monthly.Bid-rates-of-EUR-to-INR

“19. …… On the issue of adjustment of exchange fluctuation, loss incurred by the assessee, we observe that it is a well accepted principle of Transfer Pricing regulations to compare like with like and eliminate the differences if any, by suitable adjustment. The said principle clearly provides for adjustments in margins of the enterprise entering into international transactions for any differences between such international transactions and the transaction of comparables or between the enterprise entering into internationals transactions and comparable companies. The foreign exchange element also needs consideration. Rule 10B(3) of Income Tax Rules, 1962 provides that an appropriate adjustment is required to be made on account of the differences between the controlled and the uncontrolled transactions. This rule clearly stipulates that an uncontrolled transaction shall be comparable to an international transaction, if none of the differences between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market. This rule clearly stipulates that reasonably accurate adjustments can be made to eliminate the material effects of such differences.”

CORPORATE GROUNDS GROUND NO.6

GROUNDS NO.7 & 8 Ld. AO/ld. DRP have disallowed 3/4th of the advertisement 41. and sales promotion expenses to the tune of Rs.6,32,85,750/- and 4/5th of the recruitment expenditure amounting to Rs.1,12,88,617/- by treating the same being enduring in nature and in the nature of deferred revenue expenditure. Ld. DRP also disallowed the advertisement and sales promotion expenditure and recruitment expenditure on the ground that the same have long lasting value having a spread over effect.

“Section 37(1) of the Income-tax Act, 1961 - Business expenditure - Allowability of - Assessment year 1996-97 - Whether a payment made to remove possibility of a recurring disadvantage cannot be considered as payment made to secure an enduring advantage - Held, yes - Whether where advantage consists of merely in facilitating assessee's trading operations or enabling management or conduct of assessee's business to be carried on more efficiently or more profitably, while leaving fixed capital untouched, expenditure would be on revenue account, even though advantage may endure for indefinite future - Held, yes - Whether if expenditure is for initial outlay or for acquiring or bringing into existence an asset or advantage of an enduring benefit to business that is being carried on, or for extension of business that is going on, or for a substantial replacement of an existing business asset, it would be capital expenditure - Held, yes - Whether where, expenditure, although for purpose of acquiring an asset or advantage, is for running of business or for working out that asset with a view to produce profit, it would be revenue expenditure - Held, yes - Whether if amount paid for acquisition of an asset of an enduring nature is settled, mere fact that amount so settled is chalked out into various small amounts or periodic instalments, capital nature of expenditure would not cease to be so or altered into nature of a revenue expenditure - Held, yes - Whether expenditure incurred after business is set up may be allowed even if it is incurred before business has actually commenced - Held, yes - Assessee was engaged in business of share trading and stock braking - Since year under consideration was first year of business, revenue authorities rejected various claims of expenditure made by assessee on ground that expenditure had been incurred for initial outlay or for acquiring or bringing in existence assets or advantage of enduring benefit and hence they were capital in nature and did not fall within purview of section 37(1) - Whether development fee paid to Calcutta Stock Exchange Association to become member thereof, was capital expenditure - Held, yes - Whether expenditure towards fees for operating on floor paid to Calcutta Stock Exchange Association was of revenue in nature - Held, yes - Whether payment of admission fee to OTC Exchange of India (OTCEI) in order to become dealer on OTCEI and to operate counter for conducting assessee's business as a share dealer and payment of Technology cost for imparting training to assessee's employees so as to make them qualified as per guidelines laid down by OTCEI was for purpose of carrying or running assessee's business of share trading in a profitable manner and was revenue expenditure - Held, yes - Whether expenditure towards non- adjustable deposit for admission as a trading member of wholesale debt market of National Stock Exchange of India (NSEI) so as to enable assessee to use and utilize network of NSEI for its trading operations at a nationwide level so as to facilitate it to carryon business smoothly, extensively, effectively and profitably was of revenue in nature - Held, yes - Whether deposit for Very Small Aperture Terminals (VSATs) on account of providing by NSEI on- line Screen Based Trading Facilities on Equal Access basis to all Trading Members, directly related to business operation and trading activities carried on by assessee and was, therefore, allowable as Revenue Expenditure - Held, yes.”

Even otherwise, licence fee for one year has been claimed by the assessee in the year under assessment itself. So, ground no.9 is determined in favour of the assessee and AO is to recompute the deductions in the light of section 10A of the Act.

GROUNDS NO.10 & 10.1 48. Ld. AR for the assessee contended that AO/DRP have erred on facts and in law in not recomputing the deduction u/s 10A after making the disallowance of the expenses in relation to section 10A unit and further contended that during AY 2007-08, this issue was restored to the TPO to decide afresh.

“as to whether in such circumstances the assessee is entitled for section 10A exemption in TP adjustment?”