Where the assessee was rendering captive contract software development services to its’ associated enterprises on a “cost plus” basis and its profits enjoyed exemption u/s 10A and the question arose whether the AO/TPO were justified in rejecting the assessee’s transfer pricing study and substituting it with their own, HELD allowing the appeal that:

(i) While the motive of tax avoidance need not be shown at the time of initiating transfer pricing provisions, the same is required to be shown at the stage of making the assessment. The AO has to show that the assessee manipulated prices to shift profits outside India. In view of the fact that the assessee enjoyed exemption u/s 10A, the transfer pricing provisions ought not to have been applied;

(ii) The AO/TPO have to satisfy and communicate to the taxpayer which one of the four conditions prescribed in s. 92C (3) are satisfied before applying the transfer pricing provisions and the failure to demonstrate this to the assessee renders the transfer pricing order void;

(iii) The assessee’s selection of the Cost Plus Method (CPM) using the Capitaline database as the most appropriate method could not be substituted by the AO/TPO with the Transactional Net Margin Method (TNMM) using the Prowess database without showing how the assessee’s method was erroneous;

(iv) For purposes of making a comparability analysis it is essential that (a) the data should relate to the financial year and (b) be contemporaneous i.e. exist on the specified date. If one of the conditions is not fulfilled, the data should not be included for comparison;

(v) In view of the definition of “uncontrolled transaction” in Rule 10A (a), for purposes of comparability analysis, the comparables should not have any transactions with its associated enterprises. A company having even a single rupee of related party transaction cannot be considered as a comparable transaction;

(vi) Adjustment needs to be made to the margins of the comparables to eliminate differences on account of different functions, assets and risks and in particular for (a) differences in risk profile (b) difference in working capital position and (c) differences in accounting policies;

(vii) The profits of super profit companies should not be “normalized”; instead they should be excluded from the list of comparables;

(viii) The proviso to section 92 C (2) provides a standard deduction of 5% to the taxpayers at their option.

See Also: Sony India vs. DCIT (ITAT Delhi), E-Gain Communication vs. ITO (ITAT Pune) and Development Consultants vs. DCIT (ITAT Kol)

Where pursuant to action u/s 132, the assessee made a declaration of income u/s 132 (4) and opted to pay taxes from out of the seized shares and securities and requested that the shares be expeditiously disposed of and the sale proceeds there from be appropriated towards taxes and the revenue did not act on this request and thereafter the assessee applied for waiver of interest under section 220(2A) on the ground that the failure of the department to sell the shares had caused “genuine hardship”, HELD:

(i) Levy of interest is for compensating the revenue from loss suffered by non-deposit of tax by the assessee within the time specified therefor. This principle should also be applied for determining whether any hardship had been caused or not. A genuine hardship means a genuine difficulty. It cannot be concluded that a person having large assets would never be in difficulty as he can sell those assets and pay the amount of interest levied.

(ii) A person cannot take advantage of his own wrong. A statutory authority on receipt of a request from the assessee top sell the shares could not have kept mum and should have taken action and responded to the prayer of the assessee. It would have been in the interests of the revenue to do so;

(iii) U/s 220 (2A), the CIT has the discretion not to waive interest but that discretion must be judiciously exercised. He has to arrive at a satisfaction that the three conditions laid down therein have been fulfilled before passing an order waiving interest.

(iv) As the issue had not been considered by the CIT in the proper perspective, matter remanded.

Where the Transactional Net Margin Method (TNMM) was accepted as the method for determining the Arm’s Length Price and the taxpayer was taken as a tested party and the Operating profit margin on sales had been chosen as the profit level indicator and disputes arose as to how the operating profit had to be computed and what parties had to be taken as comparables, HELD

(i) Under Rule 10B (2) (c) the comparability of an international transaction with an uncontrolled transaction has to be judged with reference to the contractual terms. Accordingly, the actual transaction, as entered into between the parties, has to be considered and the authorities have no right to re-write the transaction unless it is held that it is sham or bogus or entered into by the parties in bad faith to avoid and evade taxes.

(ii) Where the assessee had received moneys towards reimbursement of advertisement expenses under an agreement with the Associated Enterprise and the genuineness of the same was not disputed, the TPO was not justified in treating the said funds as a windfall and bounty. The same had to be treated as a part of the normal operating profit of the assessee and could not be ignored in computing the comparable margins.

(iii) Other amounts received by way of reimbursement of cost, provision written back, balances written back, interest received from customers and other miscellaneous revenue receipts also constitute a part of the operating profit and could not be ignored in computing the operating profit.

(iv) Statutory levies paid to the State Govt. had to be ignored in computing the operating profits of the taxpayer as other enterprises taken into account by the TPO were not subjected to such levy.

(v) For purposes of determining what parties should be considered for purposes of comparison under Rule 10B (3), what is to be judged is the impact of the related party transaction vis-à-vis sales and not just profit since profit of an enterprise is influenced by large number of other factors. The facts and circumstances surrounding the company in question that should determine its status as a comparable and not its financial result. The cumulative effect of all factors have to be considered.

(vi) While comparing controlled and uncontrolled transactions or enterprises, one has to look for the differences and whether such differences are likely to affect the price, cost charged or paid or profit arising from the transaction in the open market. It has further to be examined whether a reasonable accurate adjustment can be made to eliminate the material effect of the differences between the transactions or entities. If a reasonable accurate adjustment for the difference to eliminate material effect of the differences cannot possibly be made, then such comparables (uncontrolled) have to be rejected.

(vii) The proviso to s. 92C (2) consists of two limbs. Under the first limb, where, through the Most Appropriate Method, more than one price is determined, the arithmetic mean of such price has to be taken to be the Arm’s Length Price in relation to the international transaction. The second limb gives “an option” to the taxpayer to take Arm’s Length Price which may vary from the arithmetic mean by an amount not exceeding 5% of such arithmetic mean. This option is applicable even to cases where the taxpayer intends to challenge the Arm’s Length Price taken as arithmetic mean and determined through the Most Appropriate Method. The argument of the Revenue that where the difference is much more than 5%, then the taxpayer cannot have the benefit of the said provision, particularly where the taxpayer has not accepted such arithmetic mean, is not correct.

See Also: E-Gain Communication vs. ITO (ITAT Pune) and Development Consultants vs. DCIT (ITAT Kol)