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Before: SHRI N. K. SAINI & SMT SUCHITRA KAMBLE
ORDER PER SUCHITRA KAMBLE, JM
This appeal is filed by the assessee against the order dated 31/01/2012 passed by Ld. CIT (A)-XX, New Delhi. 2. The grounds of appeal are as follows:-
“1. The Learned commissioner of Income Tax (Appeals) has erred both on facts and in law in upholding the action of the learned Assessing Officer in making an addition of Rs.1,52,47,482/- in respect of GIS and Spatial Services representing alleged difference in Arm’s Length Price (ALP) of international transactions as returned by the appellant company by following TNMM method of valuation in terms of Section 92C of the Act by including data of earlier years in terms of proviso to Rule 10B(4) which has summarily been rejected by the Learned Transfer Pricing Officer in computing the average operating profit margin of comparables to justify the assessed ALP. 1.1 The Learned commissioner of Income Tax (Appeals) has erred both on facts and in law in upholding the action of the learned Assessing Officer in excluding allegedly consistently loss making comparable companies while determining the arithmetic mean of operating profit/total cost (Profit Level Indicator) of the final set of comparables for computing the assessed Arm’s Length Price (ALP). Learned Ld. CIT (A) further erred both on facts and in law in not accepting alternative submission of the appellant company that if loss making companies were taken out by the TPO from the final set of comparables, companies which had shown super normal profits should also be excluded while determining the arithmetic mean of operating profit/total cost (Profit Level Indicator) of the said final set of comparables.
The Learned commissioner of Income Tax (Appeals) has erred both on facts and in law in upholding the action of the learned Assessing Officer in making an addition of Rs.51,59,406/- in respect of software development services representing alleged difference in Arm’s Length Price (ALP) of international transactions as returned by the appellant company by following TNMM method of valuation in terms of Section 92C of the Act by including date of earlier years of comparable companies in terms of proviso to Rule 10B (4) of the Income Tax Rules, 1962 which has summarily been rejected by the Learned Transfer Pricing Officer in computing the average operating profit margin of comparables to justify the assessed Arm’s Length Price.
2.1. The Learned commissioner of Income Tax (Appeals) has erred both on facts and in law in upholding the action of the learned Assessing Officer in excluding allegedly consistently loss making comparable companies while determining the arithmetic mean of operating profit/total cost (Profit Level Indicator) of the final set of comparables for computing the assessed Arm’s Length Price (ALP). Learned Ld. CIT (A) further erred both on facts and in law in not accepting alternative submission of the appellant company that if loss making companies were taken out by the TPO from the final set of comparables, companies which had shown super normal profits should also be excluded while determining the arithmetic mean of operating profit/total cost (Profit Level Indicator) of the said final set of comparables.
3. The assessment so made is illegal in as much as the Transfer Pricing Officer has not complied with the legal obligations cast upon him before passing his order and the Assessing Officer has erred in accepting the Transfer Pricing Officer’s order in its full entirely.
4. Without prejudice to above grounds, the Learned Commissioner of Income Tax (Appeals) has erred in not providing the benefit of + - 5% under proviso to Section 92C of Act for purposes of computing the arm’s length price in respect of international transactions.
The company is engaged in providing software development services in two business segments Geographic Information System (GIS) and Application Software Services. In these segments the company undertakes business transactions with its Associated Enterprises (AE) and Non Associated Enterprises (Non AE).
RMSI was earlier known as R. M. Software India Pvt. Ltd. and it started its operation in India in 1992. RMSI was engaged in providing services o Risk Managemetn Solutions Inc., USA (RMS USA), which became RMSI’s parent company in August 92 by acquiring equity in the company. Both RMSI and RMS USA further are subsidiaries of DMG Information Inc. USA, which is also a subsidiary of the Daily Mail and General Trust (DMGT), a UK based media company.
RMSI provided software development services to DMGT Group and its international clients during the year 2004-05. RMSI is engaged in providing software and engineering solutions in the area of Geographic Information Systems (GIS) and Digital Mapping to clients overseas. During the year, the assessee has undertaken the following international transactions:
Table-1:
S. No. Description of transaction Method Value (in Rs.) 1 Income from software activities TNMM 7,87,72,411 2 Income from GIS activities TNMM 15,64,38,886
The assessee filed its Return of Income with DCIT, Circle 15(1), New Delhi. A reference was received from the Assessing Officer to determine the ‘arm’s length price’ u/s 92CA (3) of the ‘international transactions’ entered into by the assessee during the F. Y 2004-05. In response to notice u/s 92CA, the authorized representatives of the assessee appeared from time to time. The documentation prescribed under Rule 10D of the Income Tax Rules was submitted and placed on the record.
In the TP Study, in software segment, Transactional Net Margin Method (TNMM), Operating Profit/Total Cost (OP/TC) as Profit Level Indicator (PLI), 77 comparables are used. The margin of the assessee is 10.5% and that of the comparables is calculated at 5.56% and therefore the transaction is held to be at arm’s length price. TPO rejected use of 35 companies on various grounds. Using the single year data, the margin is calculated at 15.90%. Which is resulted into the addition of Rs.77, 65,242/-to the international transaction of the assessee.
8. In GIS and special services segment, the assessee is providing geographic information system services and digital mapping to its overseas clients. The assessee had used 10 comparable companies for justifying its international transaction under TNMM. The TPO rejected one persistent loss making company from the list of 10 companies submitted by the assessee and F. I. Sofex Ltd. was not considered because of non availability of data. Therefore, the margin of 8 comparables was calculated at 21.27%. The assessee had shown a margin of 10.50%. Therefore, an addition of Rs.52, 47,482/- was added to the international transaction by the A.O/TPO.
The main objection of the assessee to the treatment given by TPO are that exclusion of consistently loss making companies by the TPO is not correct and if consistently loss making companies are eliminated super normal profit companies also should be removed. Companies which have significant Related Party Transactions (RPT) should be removed from the list of comparables. Comparables with different financial year endings should not be rejected. Further objection of the assessee was use of single year data by the TPO is not proper. The assessee also objected and stated that interpretation of Proviso to Section 92C(2) which gives the benefit of 5% standard benefit and allowable to all taxpayers irrespective of the fact that price of international transaction determined exceeds the margin provided in the provision.
The Ld. AR contended that as TPO has rejected consistent loss making companies, therefore those companies which are making super normal profits should also be excluded from the set of comparables. According to the assessee, the objective of this exercise is to consider equals or almost equals and not extremes. The Ld. AR also contended that those companies, namely, Patni Computer Systems Ltd., 3DPLM Software System Ltd. and Saksoft Ltd are having significant Related Party Transactions (RPT) and therefore should be deleted from the list of comparables. The Ld. AR pleaded before the TPO that Satyam Computer Services Ltd should be excluded because of the unreliability of the financial statements of the company. The assessee had contended that those companies which have different year ending other than 31st March should not be deleted from the list of comparables.
9. The matter was remanded back to the TPO. The remand report strongly objected to the argument of the assessee. On the issue of exclusion of loss making companies, the TPO stated following in remand report:
“Therefore, a threshold limit of related party transactions has to be set at a level where on the one hand it permits sufficient number of companies to be included in the comparability criteria and at the same time it excludes the companies whose overall margins would have been significantly affected by the controlled or related party transactions. The threshold of RPT not being more than 25% has been consistently applied from A. Y 2007-08 only. As in this case, the assessee has not analyzed its comparables with regard to RPT on any threshold limit, the argument forwarded now that 3 companies have high RPT is not tenable.”
On the issue of elimination of super normal profit, the TPO in remand report has mentioned as follows:-
The contention of the assessee was examined and it is seen that after application of filter of persistent loss making companies, only 7 comparables out of set of 77 companies selected by the assessee have been rejected as they were found to be having consistent losses. The TPO in the set of 42 comparables has considered 5 loss making companies as well. This shows that the intention of TPO was not to reject negative margin companies, out rightly but only to consider comparables after proper FAR analysis. The comparables rejected had persistent losses.
As per the study report by NASSCOM titled INDIAN IT/ITES INDUSTRY IMAPCTING ECONOMY AND SOCIETY 2007-08, it has been reported that the software industry’s contribution to the country’s GDP has been steadily increasing from a share of 1.2% in F.Y 1998 to 5.2% in F. Y 2007. The comparable companies excluded by the TPO have been incurring persistent losses, it indicates that these companies have some peculiar economic problems because of which the losses are increasing and not in line with the growth in the software industry. The contention of the assessee , that the comparables have been reflected by the TPO only because it has negative operating margins is not proper as the comparables have been rejected based on financial analysis. The contention of the assessee was therefore, rejected by TPO.
The contention of the assessee regarding inclusion of super profit companies were examined and found that since, the total number of companies found comparables to the assessee’s functionality by the TPO consisted of 42 comparables, which contained both high and low margins, hence it was a representative set because:
• Indian regulations provide for use of arithmetic mean which even outs all the margin variations. • Indian regulations do not permit the use of inter quartile range, hence there is no question of removing the outliers. • It is important to mention here that the TPO has chosen companies depending upon their functional comparability without going into the margins. • It is the view of the OECD that abnormal profit making comparable cannot be excluded without making analysis to know whether there is exceptional circumstances. In order to exclude the extreme result cases there should be either a defect in comparability or exceptional conditions faced by the comparables.
The Assessee filed appeal before the CIT(A). The CIT(A) held that in the present case under consideration, the assessee sought exclusion of some comparables used by the TPO on the ground of abnormal results without disputing the functional comparability or showing any exceptional economic circumstances. It is seen that the high margins of these companies are normal incident of business and merely because it has very high margins during F.Y 2004-05, exclusion of these companies may not be justified. At the same time TPO has considered comparables having negative margin of (19.63%) as well. There have been no peculiar economic circumstances highlighted in any of the annual reports and the companies are engaged in software development services related activities. Therefore, rejected those companies as comparables.
The CIT(A) further held that even, the facts and circumstances in the case of the assessee are different from the decisions relied upon by the assessee, as in those decisions, the comparables selected, having super normal profits were found functionally not comparable with the concerned assessee company and were therefore, held to be not comparable. Therefore, this contention of the assessee was rejected by CIT(A).
The Assessee filed present appeal. The Ld. AR sought the permission under Rule 29 of the Income Tax Rules, 1962 to file the additional evidence and submitted that the certified segmental profitability statement was filed to substantiate the assessee’s contention that the profitability of the assessee from business transaction with AEs is better than the assessee’s business transactions with third parties. In the TP Study because of the then professional advice available and in view of the fact that the transfer pricing provisions were going through evolution, the two segments were not analyzed between transaction to AE and third parties (None AE). The entire transfer pricing proceedings were in a very nascent stage. The analytical skills were still evolving, and new dimensions and methods were being studied in order to determine the MAM for finding out ALP. These were initial years for implementation of transfer pricing provisions in India and the assessee company had restricted knowledge with regard to practical execution of the provisions of transfer pricing. In this context, and because of non availability of experienced inhouse staff, the assessee company could not carry out a proper transfer pricing analysis. The transfer pricing proceedings have so evolved that it’s accepted proposition, that internal TNMM is preferred over external TNMM in order to determine the Arms Length Price of International controlled transactions. The fact that the assessee company did not distinguish its GIS and Application software business transactions between controlled transaction and uncontrolled transactions has resulted in transfer pricing adjustments on the entire business turnover of the company in the two segments without distinguishing business transactions with AEs and Non AEs whereas the adjustments should have been restricted only to the International transactions. This is the situation where correct PLI cannot be determined as per provisions of the Act and the Rules thereon, so as to appropriately determine ALP of the International transaction entered into by the assessee with its associated enterprises.
Therefore, the Ld. AR submitted that the additional evidence has to be filed in the present matter for the reasons set out hereinabove under Rule 29 of the Income Tax Rules as it will ensure determination of assessee’s tax liability in most satisfactory manner. It is a trite law that it is necessary for the authorities to ensure that the assessee has been made on a correct income. It is necessary for the appellate authorities to correct all errors in the proceedings under appeal so as to achieve a final objective of assessing the correct income. This proposition has been so held by the Hon’ble Supreme Court in Kapurchand Shrimal 131 ITR 451 (Hon'ble Supreme Court).
Quote
“It is well known that an appellate authority has the jurisdiction as well as the duty to correct all errors in the proceedings under appeal and to issue, if necessary, appropriate directions to the authority against whose decision the appeal is preferred to dispose of the whole or any part of the matter afresh, unless forbidden from doing so by statute.”
The DR submitted that the said additional evidence was not before the CIT (A) and no effort on behalf of the assessee was made before the Assessing Officer to furnish the copy of certified segmental study. Therefore, the appeal may be dismissed.
We have perused all the records and heard both the parties. The CIT(A) has no occasion to go through the certified segmental profitability statement as the same was not filed before the CIT(A). The two segments were not analyzed between transaction to AE and third parties (None AE). The entire transfer pricing proceedings is required to be looked into. The fact that the assessee company did not distinguish its GIS and Application software business transactions between controlled transaction and uncontrolled transactions which has resulted in transfer pricing adjustments on the entire business turnover of the company in the two segments without distinguishing business transactions with AEs and Non AEs whereas the adjustments should have been restricted only to the International transactions, this fact has to be looked into by the CIT(A). This is the situation where correct PLI cannot be determined as per provisions of the Act and the Rules thereon, so as to appropriately determine ALP of the International transaction entered into by the assessee with its associated enterprises. The additional evidence is necessary in this matter and the reasons are well given by the assessee. In view of this, the additional evidence is admitted and the same may be looked into by the CIT (A). Needless to say the proper opportunity of being heard may be given to both the parties. Hence, the matter is remitted back to the CIT (A).
In result, the appeal is partly allowed for statistical purpose.
The order is pronounced in the open court on 10th of March 2016.