IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH C : NEW DELHI BEFORE SHRI C.L. SETHI, JUDICIAL MEMBER & SHRI K.D. RANJAN, ACCOUNTANT MEMBER

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1 IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH C : NEW DELHI BEFORE SHRI C.L. SETHI, JUDICIAL MEMBER & SHRI K.D. RANJAN, ACCOUNTANT MEMBER ITA Nos & 2764/Del/2009 Assessment Years : & Global Vantedge P. Ltd. C/o Luthra & Luthra, Law Offices, A-16/4, Vasant Vihar, New Delhi. PAN: AABCR8435J (Appellant) Vs. DCIT Circle 12(1), New Delhi. (Respondent) ITA Nos & 2321/Del/2009 Assessment Years : & DCIT Circle 12(1), New Delhi. (Appellant) Vs. Global Vantedge (P) Ltd., 77B, IFFCO Road, Sector-28, Gurgaon PAN: AABCR8435J (Respondent) PER: C.L. SETHI, J.M. Assessee by : Shri Vikas Srivastava, C.A. Department by : Shri L.M. Pandey, CIT DR & Shri Pankaj Jindal, Sr. D.R. O R D E R These cross appeals, filed by the assessee as well by the revenue, are directed against two separate orders dated and passed by the ld. CIT(A) in the matter of an assessment made by the A.O. u/s 143(3) of the Income Tax Act, 1961, for the assessment year and respectively.

2 2 2. The grounds or the issues raised by the assessee as well as by revenue in both the assessment years are common and identical. 3. The grounds raised by the assessee in the assessment year are as under:- 1. The order passed by the ld. CIT(A)-XX [hereinafter referred as CIT(A)] u/s 250 of the Income Tax Act, 1961 (hereinafter referred as the Act ) is bad in law and on the facts and circumstances of the case. 2. The ld. CIT(A), as well ld. AO/TPO have erred in law as well as facts of the case in not accepting the Arm s Length Price (hereinafter referred as ALP ) determined by the appellant. 3. The ld. CIT(A), as well ld. AO/TPO have erred in law as well as facts of the case by passing an order in a mechanical manner by ignoring the fact that the appellant is entitled to deduction u/s 10A of the Act and there is not incentive for it to manipulate the price of International Transaction. 4. The ld. CIT(A), as well ld. AO/TPO have ignored the factual position that the associated enterprise of the appellant i.e. RCS Centre Corp., has incurred losses and as such there is no transfer of profits by the appellant to its associated enterprise. 5. The ld. CIT(A), as well ld. AO/TPO have erred in determining the ALP by taking the appellant as the tested party and by rejecting the submission of the appellant that RCS Centre Corp (now known as Global Vantedge Inc.) has to be considered as the tested party. 6. The ld. CIT(A), as well as the ld. AO/TPO have erred in selecting and using certain companies as comparables to determine the ALP by not appreciating the fact that the comparable companies selected by them are not comparable to the appellant and hence, cannot be used in the instant case. 7. The ld. CIT(A) has erred in refusing to allow the corrections sought by the appellant, in the working capital adjustments made by the ld. AO/TPO to account for functional differences between the international transaction and comparable transactions. 8. The ld. CIT(A) has erred in not allowing an adjustment of + 5% while determining the ALP, as provided by proviso to section 92C(2) of the Act.

3 3 9. The ld. CIT(A) has erred in law by ignoring several judicial precedents relied upon by the appellant including few decisions by the jurisdictional bench of Income Tax Appellant Tribunal and High Court. 4. The grounds raised by the revenue for the assessment year are as under: 1 (i) That the ld. CIT(A) ought not to have held that the total adjustments to be made in the hands of the assessee together with the ALP already reported by it cannot exceed the total revenue earned by the assessee and its AE from third party independent clients. (ii) That the TNMN (Transaction Net Margin Method) adopted by the assessee seeks to determine the arm s length price of the tested party only. It cannot capture the profitability of the AE, which is at the other end of the International Transaction. (iii) That the profit sharing motive and tax avoiding purpose cannot be taken as an essential ingredient for the TP purpose as such criteria would burden the operation of arm s length revenue and it would defeat the basic purpose of the arms length principle and its foundation. This is against the internationally accept tenets of Transfer pricing as held in the case of the Australian Tax Office in W.R. Carpenter Holdings Pvt. Ltd. et.al. v. Commissioner of Income Tax (2008) HCA The ld. CIT(A) ought to have upheld the arm s length price as determined by the AO/TPO on a mark-up based average price of the comparables of 11.08% on the total operating costs of the assessee of Rs. 22,46,97,971/- and upheld the adjustment of exceed total revenue earned by the assessee and its AE from third party independent clients. 5. In the light of the grounds of appeal raised by the assessee and by the revenue, it is seen that the grounds raised by the assessee and revenue revolved around the issue regarding the determination of the Arm s Length Price in respect of transactions entered into by the assessee with related parties.

4 4 6. Under the business profile, the TPO mentioned that the assessee is subsidiary of Global Vantedge, Mauritius and which in turn is a wholly owned subsidiary of Global Vantedge, Bermuda. The assessee is engaged in rendering IT enabled services in the field of credit collection and telemarketing services and is eligible for deduction u/s 10A of the Act as a STPI unit. The RCS Centre Crop, a Delaware Corporation, is wholly owned subsidiary of Global Vantedge, Bermuda. As the assessee and RCS have the common shareholder of Global Vantedge, Bermuda, which holds more than 26% shares (directly and indirectly), they are associated enterprise by virtue of provisions of section 92A(2)(b) of the Act. RCS is engaged in the business of contracting with clients located in USA, to provide them debt collection and telemarketing services. RCS does not own the requisite infrastructure or capacity for execution of that work. The work is actually performed in India by the appellant under an arrangement with RCS. The appellant and RCS have entered into an agreement as per which the appellant performs the work for client who entered into contract with RCS. Once a client is identified by RCS and a contract finalizing the terms of services is entered into with it, a corresponding work order is executed by RCS with the appellant to perform that work. During the year the appellant received Rs. 8,32,66,596/- from RCS for clients services by the appellant (which is 90.6% of the revenue earned by RCS from clients). In addition to rendering services to clients of the RCS, the appellant is also engaged in rendering services to other independent clients and during the financial year , approximately 18% of

5 5 the total revenue earned by the appellant was attributable to such independent clients services by the appellant. 7. In the course of assessment proceedings, it was noticed by the A.O. that the following international transactions were entered into by the assessee with its associated enterprises:- Sr. No. Name & address of Associated Enterprises Description of transaction Amount paid/ payable for the services provided Method used for determining the ALP 1. RCS Centre Corp. 700 Larkspur Landing Circle, Suite 235, Larkspur, California 94939, USA Market support services Book value Value of of transaction (Rs.) transaction as computed by the assessee having regard to the ALP (Rs.) 8,32,66,596 8,32,66,596 TNMN 8. Therefore, the A.O. made reference u/s 92CA(1) of the Act to the TPO for computation of Arm s Length Price in respect of the above transaction. The TPO after analyzing the international transaction, business model and the relationship between the assessee and associated enterprise concluded that associated enterprises is not to be treated a tested party. The TPO had chosen the assessee itself as the tested party and identified 9 Indian comparables. The average operating margin of the comparables was 11.88% as against the loss of 53.5% incurred by the assessee. Applying the Arm s Length Margin of 11.88% on the

6 6 total operating cost of Rs. 22,46,97,971/-, the TPO proposed the adjustment to the extent of Rs. 14,70,10,071/-. 9. On the basis of the TPO s report, the A.O. made an adjustment of Rs. 14,70,10,071/- while making the assessment u/s 143(3) of the Act. 10. Being aggrieved with the A.O. s order, the assessee preferred an appeal before the ld. CIT(A) raising as much as 25 grounds of appeal which have been reproduced by the ld. CIT(A) in his order. After considering the various grounds raised by the assessee and submission of the assessee, the following issues were framed by the ld. CIT(A) for his consideration:- 1. Whether AO/TPO have erred while determining the ALP by taking appellant as the tested party as opposed to the analysis carried out by the appellant in which RCS was accepted as the tested party? 2. Can the ALP of the international transaction between the appellant and its associated enterprise exceed the total amount of revenue earned from clients by the appellant and RCS together? 3. Whether A.O./TPO erred in rejecting the ALP determined by the appellant? 4. In case the ALP determined by either the appellant or the AO is found to be improper, what will be the appropriate ALP. 11. The aforesaid four issues have been discussed and decided by the ld. CIT(A) by observing and holding as under:- 12. With regard to the assessee s claim that RCS is to be accepted as the tested party as against the assessee, the ld. CIT(A) has considered the assessee s

7 7 submission and held that international comparables cannot be accepted by giving the following reasons: I have considered the above submission of the appellant and keeping in view the practice involved in selecting the tested party I am in total agreement with the contention of appellant that it is the least complex party which needs to be selected as the tested party for the purpose of carrying out Arm s Length analysis. The reasons for testing the margins of a less complex party is that the simpler party requires a fewer and more reliable adjustments to be made to its operating profit margins. However, it is difficult to accept the appellant s contentions to select a foreign entity as a tested party because it is difficult to compare entitles in different jurisdictions since the facts and circumstances are different in each geographical location. Moreover, it is difficult to obtain all relevant facts that could lead to a proper FAR analysis. Further the relevant data which may be required to make the requisite adjustments is also very difficult to obtain in relation to the foreign comparables. In view of the above, I hold that international comparables cannot be accepted. This issue has accordingly been decided against the appellant. 13. On issue No. 2, the ld. CIT(A) has discussed the matter and given his finding as under: The crux of the contention raised by the appellant is that in a revenue sharing arrangement between the entities, what may be questioned is the proportion of sharing between the entities and not the absolute amount of revenue itself which is subject of sharing because that is beyond the control of either the appellant or its associated enterprise(s). I would agree with such a view because the Indian Transfer Pricing Regulations only require us to analyse the transactions between associated enterprise and not the transactions with third parties since extraneous factors cannot be controlled. Moreover, if an entity is unable to earn adequate profits on account of legitimate business exigencies and not due to manipulation of transactions undertaken by the associated enterprises, such entity cannot be penalized In the case of a revenue sharing model between two entities (say A & B), it may be contended that the amount of revenue received by an entity (say entity A is lower than the fair amount of revenue receivable by it is due to the other entity (say entity B) receiving a larger share. Such unfairness may be mitigated by requiring the entity B to retain only its fair

8 8 share and give up the balance amount in favour of entity A. In the worst case, entity B may be required to give up its entire share of revenue which would result in entity A receiving 100% of the revenue. However, it cannot be logical to say that the fair amount of revenue to be received by entity A is more than 100% of the total revenue earned by both A and B. Under such circumstances, entity B will have to pay the additional amount from its internal sources which in addition to being a highly absurd proposition, may also lead to the bankruptcy of B since this cannot be sustained over a period of time In view of the above discussions, the contention of appellant is found to be acceptable, especially with reference to the object and scheme of transfer pricing regulation which govern the international transaction undertaken by an assessee with its associated enterprise and not when transactions take place between assessee and independent clients. Thus, this issue has been decided in favour of the appellant with an observation that the total adjustment made in the hands of the appellant together with the ALP already reported by it cannot exceed the total revenue earned by the appellant and its associated enterprise from third party independent clients It is also relevant to note that if ALP is determined to be maximum i.e. 100% of the revenue earned by RCS from third party independent clients it would mean that RCS performs the marketing activities without any consideration which again is an absurd proposition since in a commercial world no person of ordinary prudence would perform any activity without any reward. Therefore, before proceeding further it becomes pertinent to determine the fair amount of revenue receivable by RCS for its services It is important to note that while determining the fees payable to any agency responsible for marketing, the complexity of the process being outsourced, the operating margins that the service provider is expected to earn, the size of the contract, etc. all play an important role. In order to determine the remuneration of RCS for its activities, the appellant was asked to furnish an independent research report / survey on the Indian BPO industry. The appellant submitted a report on the Indian BPO Industry prepared by INGRES, a division of ICRA Ltd in December, The report suggests that on an average BPO companies have selling expenses of 1.40% to 4.40% of their turnover (referred as operating income in the report) over a period of three years (FY 2001 to FY 2003). Keeping in view this standard, the revenue retained by RCS (9.40%) seems unreasonable. Though it is recognized that the standard as per the report (4.40% to 1.40%) is not a sacrosanct applicable across all the companies

9 9 and in the absence of requisite information it is not possible to compare the two figures (9.40% and 4.40% %), a reference to it can usefully be made to understand a general magnitude of the item involved vis-à-vis other expenses. It is pertinent to mention here that the average selling/ marketing expenses incurred by the comparables finally selected in the later part of this order, also comes to 1.64% of turnover. Hence the industry average shown by ICRA report for the Financial Year 2003 at 1.40% is very much reliable and authentic figure. Keeping in view the functional profile of the two entities (appellant and RCS) including the FAR analysis and also keeping in view the fact that as per Rule 10B(4) on data for the current year to be used. As in the financial year the average expenditure on selling expenses in the software industry were in the range of 1.4% accordingly I am of the view that a share of 1.40% of the revenue is adequate to compensate RCS for its activities. Thus, as per this hypothesis, the ALP determined cannot exceed 98.60% of the revenue earned by the Global Vantedge Group as a whole i.e. the ALP 98.60% of the revenue earned by the Global Vantedge Group as a whole i.e. the ALP has to be restricted to Rs. 9,16,55,231/- (Rs. 9,29,56,624 X 98.6%). 14. With regard to the question whether TPO or the AO has erred in rejecting the Arms Length Price determined by the assessee, the ld. CIT(A) has given his decision and finding as under: The main argument of the appellant is that the appellant is better equipped to carry the Transfer Pricing Analysis as it has a better understanding of the intricacies of the business and can carry on the analysis on the basis of FAR analysis in a more comprehensive manner. Therefore, the ALP determined by the appellant should have been accepted I have considered the contentions of the appellant and I am of the view that the contentions of the appellant are unacceptable. The case that the appellant is trying to make is that in every case, the ALP determined by the taxpayer should be accepted. This cannot be accepted since if the assessee is given the power to determine the ALP which cannot be challenged by the tax officers, then the transfer pricing regulations introduced into the tax legislation shall become infructuous. The taxpayer should be the one determining the same, however, it should be subject to scrutiny by the tax administration so that any profit shifting methodology being adopted by the assessee can be rejected. However, with this power, also comes the responsibility of being

10 10 judicious and thus, the AO/TPO have to exercise their authority in accordance the Transfer Pricing Regulations. I am though in agreement with the contention of the appellant that FAR Analysis forms the basic foundation on which the ALP is determined and its importance just can not be overemphasized. I have provided full opportunity to the appellant to present the facts of the case, including FAR analysis, and hence, has been adjudicated on merits in the subsequent paras of this order. Thus, for statistical purposes, this issue is decided against the appellant. 15. With regard to the question as what would be the appropriate Arms Length Price in case the Arms Length Price determined either by the assessee or by the TPO found to be improper, the ld. CIT(A) has decided the issue as under: I have carefully gone through the various contentions and submission made by the appellant. Though there is merit in the appellant s argument that there is no tax benefit being obtained by the appellant though shifting of profits. It cannot be the only basis to accept appellant s contentions in this regard. It is well understood that one associated enterprise can try to use its influence to determine the transaction in a manner prejudicial to the interest of the other associated enterprise because of several reasons As regards contention of the appellant that transaction of the appellant with independent clients, should not be benchmarked under TNMN I agree that when TNMN is used as the Most Appropriate Method to determine the Arm s Length Price, the TNMN, as the name itself suggests, evaluates profitability of transactions rather than profitability of an enterprise. Transaction of different nature cannot be aggregated for the purpose of comparison under TNMN. In practice though the profitability of comparable entities is used to benchmark the international transactions of taxpayers, however, in such a scenario an underlying assumption overrides the analysis for the lack of data. The acting assumption in such a scenario is that due to a well designed functional analysis only those companies are selected as comparables which have undertaken homogeneous and comparable transactions. Thus, in such a scenario, the profitability of the comparable entities, in effect, represents the profitability of comparable transactions.

11 11 Even the OECD transfer pricing guidelines for Multinational Enterprises and Tax Administration 1995 supports this view and clause 3.42 states as under: An analysis under the transactional net margin method should consider only the profits of the associated enterprise that are attributable to particular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly, when analyzing the transaction between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally, when profit margins of an independent enterprise are used, the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise. In view of above discussions, I hold that while applying the TNMN to determine ALP, the revenue earned by the appellant from servicing the independent clients, without any involvement of RCS should not be benchmarked. The proportionate costs (18.14%) attributable to such revenue should be ignored while computing ALP of the international transactions As regard the objection raised by the appellant against the selection of comparables performing dissimilar functions, I have perused the profile of Genesys and Hinduja TMT and it is found that they are engaged in dissimilar activity profile vis-à-vis appellant. Hinduja TMT was also found to have substantial related party transactions. These two companies cannot be taken as comparable and are thus rejected for the purpose of determining the ALP. Further in relation to Karvy Consultants, it was noticed that no data is available in the public domain for the relevant financial year i.e. F.Y The TPO erroneously used the data for FY while determining the ALP. Thus, this company is also not considered to be comparable entity of the appellant due to lack of sufficient data Proceeding to the next issue, regarding claim of appellant for giving suitable adjustment on account of idle capacity and that they were in start up phase, I have considered the submissions of the appellant and looking to the fact that the remaining 6 comparables were established entities, accordingly adjustment needs to be made while doing the comparability analysis. Normally wherever an entity is established it

12 12 always carried some surplus capacity vis-à-vis present/ projected business operations. Looking into the IT industries which were in booming stage I hold that a surplus capacity to the extent of 1/3 rd of the existing capacity is treated as normal in this industry in anticipation of future growth in business. Hence an adjustment to the profitability of the comparables should be made to the extent of 33.33%. This is also in accordance with the provision of Rule 10B(2) which states that condition prevailing inn the market in which the tested party and comparables operates have to be considered while judging comparability of an international transaction with an uncontrolled transaction. The working submitted by the appellant, however, tries to adjust the profitability of the appellant by eliminating the idle costs incurred by the appellant due to excess capacity due to initial business phase and low volume of business. However, in order to make a true comparison between the appellant and the comparables such an adjustment is required to be made to the profitability of the comparables i.e. the profitability of the comparables need to be adjusted suitably to bring them to a level of inefficiency that appellant operated at. Such adjustment is being made at the time of final computation of operating margin of comparable companies later in this order. With regard to the working capital adjustment, I have carefully examined the contentions raised by the appellant and I am satisfied that the TPO has already given the suitable adjustment and hence at this stage it does not call for any interference. 16. After deciding all the aforesaid issues, the ld. CIT(A) computed the Arms Length Price as under:- Re-computation of ALP To summarize, the ALP determined by the AO/TPO needs to be recomputed in view of matters adjudicated above. Therefore, the ALP is recomputed after making the following adjustments:- 1. Out of 9 comparables identified by the TPO, 3 companies namely Genesys and Hinduja TMT and Karvy Consultants are rejected. 2. The operating Margin of the remaining 6 comparables has been suitably adjusted to account for the idle capacity costs incurred additionally by the appellant. A statement showing the computation of average of average operating margin of the comparable is as per annexure.

13 13 The computation of ALP on the basis of aforesaid average operating margin of comparables is given hereunder:- Particulars Total operating cost of the appellant as computed by TPO Less: Operating Cost incurred in relation to service to third parties (18.14%) Net operating cost in relation to the international transaction with RCS (A) Arm s Length margin that should have been earned by the appellant i.e % of the Operating Cost (B)=(A) * % Arm s Length Value of the International Transaction undertaken by the appellant (C)=(A) + (B) Value at which international transaction between the appellant and RCS took place (D) Maximum Additions that can be made to the taxable income of the appellant (E) = (C) (D) Amount (Rs.) 22,46,97,971 4,07,60,212/- 18,39,37,759-7,00,98,680 11,38,39,079 8,32,66, ,72,483 Thus the ALP determined on the basis of above working comes to Rs. 11,38,39,079/- which exceeds the total revenue earned by the group as a whole. In view of the adjudication made for ISSUE 2, the ALP cannot exceed Rs. 9,16,55,231/-, therefore, the ALP is determined to be 9,16,55,231/-. Hence additions to the income of the appellant is confirmed at Rs. 83,88,625/- (i.e. Rs. 9,16,55,231 i.e. the maximum ALP less Rs. 8,32,66,596 i.e. the actual value of the international transaction). 17. With regard to the assessee s claim that there should be an adjustment to the extent of + 5% under the proviso to section 92C(2) of the Act, the ld. CIT(A) has decided the point by observing and holding as under:- Adjustment of + 5% under proviso to section 92C(2) As far as relief on account of +5% adjustment under the proviso to section 92C(2) is concerned, in order to examine the contention of the appellant, it becomes pertinent to have a look at the said section, as reproduced hereunder:

14 14 The most appropriate method referred to in sub-section 92C(2) shall be applied, for determination of arms length price, in the manner as may be prescribed:- Provided that where more than one price is determined by the most appropriate method, the arms length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean. It may be sent that there are two limbs of the provision. Its first limb delas with the situation where the Most Appropriate Method leads to more than one ALP and in that situation the ALP should be the arithmetic mean. Second limb of the provision, provides the facility of option to the taxpayer if price varies by an amount not exceeding + 5% of such mean. There is no dispute as to the interpretation of the above part or limb of the provision and the controversy is related to the second limb of the provision where an option is given to the taxpayer to take ALP which may vary from the arithmetic mean by an amount not exceeding 5% of such arithmetic mean. It is clear from the language of the provision that the option is to take ALP which is not in excess of 5% of the said mean. In the present case, since the difference (Rs. 83,88,635) between the ALP determined (9,16,55,231) and value of transaction declared (Rs. 83,266,596) exceeds 5% of the ALP (9,16,55,231/-), no adjustment is allowable to the appellant. Thus this ground is adjudicated against the appellant. 18. Being aggrieved, assessee as well as the department are in appeal before us. 19. During the course of hearing of this appeal, neither the ld. counsel for the assessee nor the ld. D.R. for the revenue have been able to point out any basis or material or criteria to controvert or to rebut the findings and conclusion arrived at by the ld. CIT(A) except by relying upon their respective stand taken before the ld. CIT(A). Though the ld. counsel for the assessee made a specific submission about the benefit of adjustment of + 5% to be given while determining the Arms

15 15 Length Price, the ld. counsel for the assessee has not been point out as to how and in what manner, the order of ld. CIT(A) in rejecting this claim of the assessee is improper and unjustified. Since both the parties have not been able to controvert the findings recorded by the ld CIT(A) or point out any material to enable us to take a view other than view taken by the ld. CIT(A), we are inclined to uphold the order of ld. CIT(A) on the point of determination of Arms Length Price in respect of the transactions entered into by the assessee with its associate enterprises, namely, RCS Centre Corp. Therefore, the order of ld. CIT(A) is upheld, and the grounds raised by the assessee as well as by the revenue on this issue are rejected. 20. Similarly, in the assessment year , an identical issue about the determination of Arm s Length Price is involved and in that year, the ld. CIT(A) determined the Arm s Length Price in the same manner or basis as done in the assessment year The Arm s Length Price determined by the ld. CIT(A) is as under:- 8. Re-computation of ALP To summarize, the ALP determined by the AO/TPO needs to be recomputed in view of matters adjudicated above. Therefore, the ALP is recomputed after making the following adjustments: 1. Out of 6 comparables whose operating margin is used by the TPO to benchmark the international transaction, 2 comparables namely Genesys and Hinduja TMT are rejected. The operating margin of these 4 comparables is summarized as below:

16 S. No. 16 Name of the Company OP/TC 1. Ace Software 1.44% 2. Allsec (36.12)% 3. MCS Limited 15.43% 4. Nucleus 23.95% Mean 1.175% 2. A suitable working capital adjustment has been made to adjust the operating margin of the abovementioned remaining 4 comparables. The final operating margin of the comparables, after giving effect to the said working capital adjustment comes to 0.43%. The detailed computation of the operating is given at Annexure The computation of ALP on the basis of aforesaid average operating margin of comparables is given hereunder: Particulars Total Operating Cost of the appellant as computed by the TPO Less: Operating Cost incurred in relation to service to third parties (0.58%) Amount (Rs.) 393,307,198 2,281,182 Net Operating cost in relation to the international transaction with RCS (A) Arm s Length margin that should have been earned by the appellant i.e. 0.43% of the Operating Cost (B)=(A) * 0.43% Arm s Length Value of the International Transaction undertaken by the appellant (C)=(A) +(B) Value at which international transaction between the appellant and RCS took place 391,026,016 1,681, ,707, ,386,386 Thus the ALP determined on the basis of above working comes to Rs. 393,386,386 which is lower than the book value of the international transaction, as declared by the appellant. Therefore, the book value of the international transactions as declared by the appellant is accepted to be at ALP. Hence entire addition of Rs. 5,22,28,112/- made by the TPO to the income of the appellant is deleted.

17 The ld. CIT(A) has also decided the issue about the adjustment of + 5% as per proviso to section 92C(2) in the same manner as have been decided by him in the assessment year Thus, in the light of the decision we have taken in assessment year , the identical ground about the determination of Arm s Length Price raised by the revenue as well by the assessee in the assessment year are rejected. 23. In the assessment year , the assessee has taken one more ground contending that the authorities below have erred in not considering the interest from fixed deposit placed with bank for bank guarantees and the interest in fixed deposit kept as lien in favour of IBM for the purpose of obtaining computers on lease as business income for the purpose of calculating the deduction u/s 10A of the Act. The assessee has also taken a ground for authorities below have erred in excluding the miscellaneous income while computing the deduction u/s 10A of the Act. 24. We have heard both the parties and have carefully gone through the orders of the authorities below. 25. Section 10A provides for a deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software from the total income of the assessee. It is, thus, clear that deduction to be allowed u/s 10A is in respect of profit and gains derived by an undertaking from the export of articles or things or computer software. The expression used

18 18 by the legislature is derived by undertaking from the export of articles or things or computer. Therefore, earning of interest from fixed deposits pledged with bank for bank guarantees and interest in fixed deposits kept in lien in favour of IBM for the purpose of obtaining computers on lease and the miscellaneous income cannot be considered to be a profit derived by a undertaking from the export of articles or things or computer software. Recently, the Hon ble SC in the case of Liberty India vs. CIT (2009) 317 ITR 218, has considered the meaning of derived from and held as under:- (Extracted from Head Note ) The Income Tax Act, 1961, broadly provides for two types of tax incentives, viz., investment-linked incentives and profit-linked incentives. Chapter VI-A of the Act which provides for incentives in the form of deductions essentially belongs to the category of profit-linked incentives. Therefore, when section 80-IA/80-IB refers to profits derived from eligible business, it is not the ownership of that business which attracts the incentives : what attracts the incentives under section 80- IA/80-IB is the generation of profits (operational profits). It is for this reason that Parliament has confined deduction of profits derived from eligible businesses mentioned in sub-sections (3) to (11A). Each of the business mentioned in sub-sections (3) to (11A) constitutes a stand-alone item in the matter of computation of profits. Section 80-IB and 80-IA are a code by themselves as they contain both substantive as well as procedural provisions. Section 80-IB provides for the allowing of deduction in respect of profits and gains derived from the eligible business. The connotation of the words derived from is narrower as compared to that of the words attributable to. By using the expression derived from Parliament intended to cover sources not beyond the first degree. Sections 80-I, 80-IA and 80-IB are to be read as having a common scheme. Sub-section (5) of section 80-IA (which is required to be read into section 80-IB) provides for the manner of computation of the profits of an eligible business. Such profits are computed as if such eligible business is the only source of income of the assessee. Therefore, devices adopted to

19 19 reduce or inflate the profits of the eligible business have to be rejected in v view of the overriding provisions of section 80-IA(5). Section 80-I, 80-IA and 80-IB provide for incentives in the form of deductions which are linked to profits and not investment. On analysis of sections 80-IA and 80-IB it becomes clear that any industrial undertaking which becomes eligible on satisfying sub-section (2) would be entitled to deduction under sub-section (1) only to the extent of profits derived from such industrial undertaking after the specified date. Apart from eligibility, sub-section (1) purports to restrict the quantum of deduction to a specified percentage of the profits. This is the importance of the words derived from an industrial undertaking as against profits attributable to an industrial undertaking. DEPB/Duty drawback are incentives which flow from the schemes framed by the Central Government or from section 75 of the Customs Act, Incentive profits are not profits derived from eligible business under section 80-IB : they belong to the category of ancillary profits of such undertaking. Profits derived by way of incentives such as DEPB/Duty drawback cannot be credited against the cost of manufacture of goods debited in the profit and loss account and they do not fall within the expression profits derived from industrial undertaking under section 80- IB. 26. In the light of the aforesaid proposition laid down by the Hon ble SC in the case of Liberty India vs. CIT (supra), we do not find any merit in the claim of the assessee that interest from fixed deposit etc. and miscellaneous income should be taken into account for the purpose of computing deduction u/s 10A of the Act. Thus, these grounds raised by the assessee are rejected. 27. In the assessment year , the assessee has also taken a ground about whether setting off of the brought forward business loss and unobserved depreciation is to be made before or after allowing deduction u/s 10A of the Act. 28. This ground raised by the assessee reads as under:- 9. The ld. CIT(A) as well ld. AO have erred in setting off the brought forward business losses and unabsorbed depreciation before allowing deduction u/s 10A of the Act.

20 This ground has been decided by the ld. CIT(A) by observing as under: However with regard to the contention of the appellant the decision by Hon ble High Court of Karnataka in the case of Himatasingike Seide Ltd. (286 ITR 255) also needs to be taken note of. In this decision the High Court has upheld the action of CIT in revising the assessment order under section 263 by holding that before allowing the deduction under section 10A the brought forward losses and unabsorbed depreciation have to be adjusted before allowing the claim under section 10A. In view of this decision of the High Court, I hold that the AO was right in holding the view that the claim under section 10A should be allowed only after adjusting the brought forward losses and unabsorbed depreciation. Therefore, this ground is dismissed. 30. We have heard both the parties and have considered various decisions cited by the ld. counsel for the assessee on this issue. 31. The assessee company is engaged in the business of rendering business process out sourcing business. It started its business operation in the financial year relevant to the assessment year In the assessment year , the assessee was assessed at business loss of Rs. 3,72,77,332/- and also had unabsorbed depreciation to the extent of Rs. 89,08,926/-. In the assessment year , the assessee s total income was initially assessed at Rs. 2,89,84,301/-. Thereafter, the assessee filed an application u/s 154 of the Act stating that brought forward loss of Rs. 3,72,77,332/- and unabsorbed depreciation of Rs. 89,08,926/- pertaining to the assessment year is to be set off against the total income determined for the assessment year On an application u/s 154 of the Act, made by the assessee, the A.O. passed an order u/s 154 of the Act dated whereby he set off the brought forward loss of assessment year to the extent the total income of Rs.

21 21 2,89,84,301/- determined for the assessment year and, thus, arrived at the total income of Rs. Nil. After set off of the loss of assessment year , the business loss and unabsorbed depreciation pertaining to that assessment year still remained to be set off are as under:- (i) Unabsorbed loss brought forward 89,08,926/- from assessment year (ii) Unabsorbed depreciation 82,93,021/- Aggregating Total 1,72,01,947/- The aforesaid amount of Rs. 1,72,01,947/- has been set off against the profit for the assessment year by the A.O. before allowing or determining the amount of deduction available to the assessee u/s 10A of the Act. 32. From the facts narrated in immediately preceding para, it becomes clear that in the assessment year , the assessee has itself made a claim to set off brought forward losses against the income for assessment year and no claim of deduction under section 10A was made with regard to the profit determined before setting off of brought forward loss pertaining to the assessment year However, in the present assessment year , the assessee has advanced a claim that deduction u/s 10A should be claimed before making set off of brought forward unabsorbed business loss and unabsorbed depreciation by the relying on following decisions:- 1. Nous Infosystems Pvt. Ltd. vs. ITO (2008) TIOL 389 ITAT Bench 2. Enercon Wind Farms (Krishna) Ltd. vs. ACIT (2008) 21 SOT 29 (Mum.) 3. ACIT vs. Yokogawa India Ltd. (2008) TIOL 301 (ITAT) (Bang)

22 In the case of CIT vs. Himatasingike Seide Ltd. (2006) 286 ITR 255 (Karnataka), on which reliance has been placed by the ld. CIT(A), the Hon ble Karnataka High Court has held as under:- 8. At this stage, we should notice the definition of total income in terms of section 2(45) of the Income Tax Act. Total income has been defined as the total amount of income referred to in section 5, computed in the manner laid down in this Act. 9. Section 4 provides for charge of income tax. 10. Section 5 provides for scope of total income. 11. Sub section (1) of section 5 says that subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which - (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year; or (c) accrues or arises to him outside India during such year: Provided that in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India. 12. Chapter III provides for incomes which do not form part of total income. 13. Chapter IV provides for computation of total income. 14. Section 32 of the Income-tax Act provides for deduction on depreciation. Section 32(2) provides for adjustment for subsequent years. If we see section 10B, it provides for exemption of payment of tax with reference to profits and gains derived by 100 per cent export-oriented undertakings. To arrive at a profit and gain, one has to necessarily take into consideration the total income in terms of the Act. To arrive at the income one has to take into consideration, the various additions and deletions in terms of the Act. In fact, the petitioner knowing fully well has chosen to take into consideration the allowability of depreciation for the purpose of calculating of total income. But curiously an argument has now been advanced that exemption in terms of section 10B could also be on commercial basis not necessarily in terms of the calculation. We do not accept this submission, section 10B cannot be read in isolation of

23 23 other provisions. It is only an exemption provision. Exemption cannot be fanciful and it has some rationale with other provisions of the Act. Therefore, a combined reading of the definition of exemption, total income-tax liability deductability, etc., one has to come to a conclusion that calculation as far as possible is to be in terms of the Income-tax Act. That is exactly what has been done by the assessee. Having calculated in a particular manner, now it does not lie in the mouth of the assessee to contend contra in these proceedings. It cannot be argued that the calculation so provided is on a mistaken basis or that could be on commercial basis. We are not prepared to accept this argument advanced by the assessee. Exemption also has to be scrutinized by the department as otherwise there is every chance of exemption being misused by an assessee. It may be true that even after taking into consideration, the unabsorbed depreciation, the assessee may get exemption but none the less he cannot take only a portion of depreciation just to suit his income for the purpose of nil liability and adjust the balance of unabsorbed depreciation for other business income once against to show nil liability. When the unabsorbed depreciation could have been taken for arriving at an exempted income, the assessee cannot play with the figures for the purpose of showing nil liability as has been done in the case on hand. The intention of the Legislature is only to provide 100 per cent exemption for export income and not for other income. The petitioner by dividing depreciation contrary to section 32 has virtually taken exemption from payment of tax even for other business income in the case on hand. That cannot be allowed as rightly ruled by the Commissioner. The allowance of the depreciation by the Tribunal, in our view, is prejudicial to the interests of the Revenue as argued by he department. The tribunal has taken a narrow view of the matter without taking into consideration, the laudable object of exemption and at he same time providing for tax liability towards other liability. The interpretation has to be meaningful and acceptable and it cannot be against the intention of the legislation. Legislation never wanted the entire income to be exempted by taking advantage of section 10B of the Act. The approach of the Tribunal to our mind is incorrect and, hence, we find substance in the argument of the revenue. 34. In the light of the aforesaid decision of Hon ble Karnataka High Court in the case of Himatsingike Seide Ltd. (supra), which has been rendered in the context of provisions contained in section 10B, which is analogous to the provisions contained in section 10A of the Act, it is clear that to arrive at a profit

24 24 and gain of eligible undertaking, one has to necessarily take into consideration the total income in terms of the provisions of the Income Tax Act, and section 10A cannot be read in isolation of other provision of the Income Tax Act pertaining to the manner of computation of profit for the purpose of determining total income under the Income Tax Act. The Hon ble High Court has also held that calculation of deduction is to be made in terms of the provisions of Income Tax Act. Therefore, the assessee s contention that the definition of total income given u/s 2(45) of the Act cannot be imported into for the purpose of determining profit to be deducted from the total income u/s 10A cannot be accepted. The assessee s contention that provisions of section 32(2) pertaining to the set-off of brought forward unabsorbed depreciation cannot be applied while determining the profit of undertaking u/s 10A is also not tenable, which contention is against the very scheme of the section 10A read with other provisions of the Income Tax Act. It is not in dispute that under section 10A, the deduction of profit is to be allowed from the total income and, therefore, while determining profit of eligible undertaking under section 10A, the provisions of section 28 to 44D and provisions relating to the adjustment of brought forward losses of the same eligible business are to be taken into account as so propounded in the decision of Hon ble Karnataka High Court in the case of Himatsingike Seide Ltd. (supra). We further observe that mere because the effect to the provisions of section 72 are to be first given as against the effect to the provisions of section 32(2), it would not mean that section 32(2) is not a part of the Chapter IV-D containing

25 25 provisions of section 28 to section 44D of the Act and it should go out of that relevant Chapter IV-D of the Act in which section 32(2) is included. Therefore, the assessee s contention raised in line of decision of ITAT, Banglore Bench in the case of KPIT Cummins Infosystems (India) Pvt. Ltd. vs. ACIT, which decision has not taken into account the ratio of the decision of Hon ble Karnataka High Court in the case of Himatsingike Seide Ltd., are misplaced, and we reject the contention so advanced by the ld. counsel for the assessee. 35. In the case of ACIT vs. Yokogawa India Ltd. (supra), the issue in dispute was whether the loss of non-eligible unit, i.e., non-10a unit can be set off against the income of eligible unit, i.e., 10A unit. In this case, the ld. CIT(A) directed the A.O. to allow exemption under section 10A without setting off the losses of the non-10a unit. On an appeal before the Tribunal, the Tribunal upheld the order of the ld. CIT(A) by observing and holding as under:- 11. Section 10A was inserted by Finance Act, 2000 w.e.f. 1 st April, 2009 mentions the deduction of such profits and gains as derived by undertaking from the export of articles or things or computer software. This section does not refer that such profits and gains derived by undertaking from the export will not be included in the total income. Under section 10, the operative part of the section is that any income falling within the clause in section 10 shall not be included in computing the total income. From wording of sections 10 and 10A, it is clear that the Legislature was fully aware of the meaning of the words amount not to be included and the deduction to be allowed. Hence, we are not inclined to accept the contention of the ld. AR that substituted section 10A should also be interpreted to mean that profits as mentioned under section 10A should not be included in the total income. 12. The ld. Calcutta High Court in the case of Royal Calcutta Turf Club v. CIT (1983) 144 ITR 7091 observed at page 714 as under:-