ORDER

Chandra Poojari, Accountant Member. - These cross appeals - one by the assessee and the other by the Department - are directed against the order of the CIT(A) III, Hyderabad dated 18-11-2008 for the assessment year 2004-05.

2. The main issue arising for consideration in these cross appeals is against the adjustments made under section 92CA of the Act.

3. Facts of the case in brief are that the assessee company is engaged in rendering software development services to its Associated Enterprises. During the previous year relevant to assessment year 2004-05, assessee received a sum of Rs. 39,04,34,858 for the services rendered at a cost plus mark up of 10 per cent. For the purpose of establishing the Arm's Length Price (ALP) of its international transactions with Associated Enterprises, the assessee undertook the transfer pricing study and submitted the Transfer Pricing Document to the Transfer Pricing Officer to whom the case was referred by the Assessing Officer. The TPO however did not agree with the Arm's Length Price determined by the assessee for the reason that the assessee used two years data, viz. financial years 2002-03 and 2003-04. Out of the fourteen comparable cases selected by the assessee, ten comparable cases were not accepted by the Transfer Pricing Officer on the ground that they had substantially related party transactions or the companies were functionally different. The Transfer Pricing Officer accepted the remaining four comparable cases and computed the arithmetic mean of operating profit/cost at 17.66 per cent as against 10.56 per cent shown by the assessee. He accordingly, determined the Arm's Length Price at Rs. 41,54,91,785 as against the export turnover shown by the assessee at Rs. 39,04,34,858. This resulted in an addition of Rs. 2,50,56,927, being made by the Assessing Officer on account of differential adjustment under section 92CA of the Act, vide completing the assessment on a total income of Rs. 2,60,41,830 vide order dated 18-12-2006 passed under section 143(3) of the Act.

4. On appeal, the CIT(A) upheld the action of the Assessing Officer as far as the rejection of the ten comparable cases is concerned, but accepted the contention of the assessee with regard to marginal benefit of 5 per cent in terms of section 92C(2) of the Act, observing that the same was not considered by the Transfer Pricing Officer, as there is no discussion on this issue in the order of the Transfer Pricing Officer. He accordingly directed the Assessing Officer to allow the benefit of 5 per cent margin to the assessee in terms of section 92C(2) of the Act. On that basis, he concluded that the lower range of Arm's Length Price after allowing 5 per cent margin comes to Rs. 39,47,17,196, as against the Arm's Length Price determined by the Assessing Officer at Rs. 41,54,91,785 and the export turnover shown by the assessee of Rs. 39,04,34,858, which resulted in the restriction of differential adjustment only to Rs. 42,82,338. The CIT(A) thus, partly allowed the claim of the assessee on this issue.

5. Aggrieved by the order of the CIT(A), assessee as well as the Department preferred appeals on this issue.

6. The learned counsel for the assessee, reiterating the contentions urged before the lower authorities, submitted that the CIT(A) was not justified in confirming the application of the Transactional Net Margin Method without making appropriate adjustments for difference in accounting policies and risks between the controlled transactions and comparable uncontrolled transactions in accordance with provisions of Rule 10B(1)(e). He further submitted that the lower authorities were not justified in rejecting of contemporaneous data, i.e., data existing by the due date of filing of return of income and multiple year data of comparable companies in determination of Arm's Length Price. He also submitted that the Assessing Officer was not justified in using the financial information of the comparable companies pertaining to the financial year 2003-04 only, as the same was not available at the time of preparing the documentation. He also questioned the action of the Assessing Officer in not undertaking an objective analysis of the companies vis-a-vis the functions and risks undertaken by the assessee for selection of the comparable companies. Referring to Rule 10B(1)(e) of the Rules, it is submitted that Rule 10B(1)(e)( iii) provides that an adjustment should be made to the profit margin of independent comparable companies to take into account the differences in functions and risks. International commentaries on Transfer Pricing also recognize that adjustments must be made to account for differences between controlled and uncontrolled situations that would significantly effect the price charged or return required by independent Enterprises and as such in no event can unadjusted industry's average returns themselves establish arm's length conditions. He submitted that one of the principal elements for transfer pricing purposes is the analysis of risks assured by the respective parties in the open market in theory and the assumption of increased risk is normally compensated by an increase in the expected return. Accordingly, he submitted that controlled and uncontrolled transactions are comparable only when adjustments with respect to significant differences between them in the risks assumed is made. It is further submitted that as mentioned in the transfer pricing report, the assessee functions under a limited risk environment with most of the risk being assumed by the Associated Enterprises, which is an undisputed fact. The comparable selected for the analysis include companies, which have fairly diversified area of specialization, perform additional functions, viz. marketing etc. and bear more risks akin to any third party independent service provider. In view of the limited functions performed and limited risk borne by the assessee it can be characterized as a contract service provider operating in a 'risk mitigated environment' vis-a-vis the comparable companies who perform 'entrepreneurial risk taking functions' and therefore bear 'entrepreneurial risks'. He submitted that it is an established theory that rewards follow risks and therefore companies that bear entrepreneurial risk are rewarded with more profits for the additional risks borne by them. In this context, attention is invited to pages 54, 75 to 83 of the paper book, wherein summary of the key risks identified by the assessee which are borne by the comparable companies vis-a-vis the assessee who is insulated from those risks, is furnished. Further, it is submitted that the assessee company bears lesser business risk than independent comparable companies due to the nature of its revenue model. It is guaranteed of profits by way of a mark-up-on costs incurred, regardless of its success or failure. The assessee has been providing services to its Associated Enterprises over the last ten years and has been growing year after year and making profits, irrespective of general performance of the IT industry in India. While the assessee does not bear any risk of incurring losses due to under utilization of capacity or insufficient business form the Associated Enterprises as it is compensated on cost plus basis, the independent companies have to bear the vagaries of the economic and business factors that are prevailing in the industry and thus could either incur losses or earn profits based on market conditions.

7. The learned counsel for the assessee, dealing with the working capital adjustments, further submitted that there exist differences in the accounts receivable and accounts payables of comparable companies vis-a-vis the assessee, and submitted that appropriate adjustment is required to be made to factor the difference in the working capital employed to improve the reliability of the results. The adjustments ensure that the absolute levels of the relevant balance sheet items are normalized, by measuring them against the total cost. He further submitted that working capital adjustment is the most common adjustment applies worldwide by taxpayers and by several business commentators. Asset intensity or balance sheet adjustments are intended to account for the fact that the amount of capital used in a business affects its economic profit. Inviting our attention to pages 168 to 180 of the paper-book No. 1, learned counsel for the assessee submitted that adjustments to reflect the differing levels of accounts receivable and account payable, viz. working capital adjustments, between the taxpayer and potential comparables were also made by the Transfer Pricing Officer in the subsequent years when performing transfer pricing analysis.

8. Referring to the letter of the assessee dated 11-12-2009, the learned counsel for the assessee summarized the workings of the risk adjustments under various methods as follows-

Learned counsel for the assessee submitted that in the TP documentation maintained by the assessee, no risk adjustment was warranted, since as per the comparables selected the international transactions were within arm's length range and the assessee's requests during the assessment and appellate proceedings before the CIT(A), for the risk adjustments, if warranted, were unduly rejected.

9. In this view of the matter, learned counsel for the assessee submitted that from a transfer pricing perspective, it would be necessary to make adjustments for the entrepreneurial risk, business risks and working capital risks, borne by the comparable companies vis-a-vis the assessee so as to make the comparison between the margins earned by the comparable companies and the assessee Enterprises, and as a consequence, the margins earned by the assessee would be comparatively lower to reflect the lower level of functions and risks. Inviting our specific attention to pages 323 to 325 of the paper-book, he submitted that on this basis, if any of these adjustments, i.e., working capital or risk is provided; the margin of the assessee would fall within arm's length range.

10. In support of the above contentions, learned counsel for the assessee placed reliance on the following decisions-

11. He also questioned the action of the revenue authorities in rejecting the comparable cases taken into account by the assessee, and invited our specific attention in this behalf to pages 84 to 125 of PB with regard to Aztec Software & Technology Services Ltd.; pages 126 to 152 of PB with regard to Quintegra Solutions Limited and submitted that if any of the above comparables is selected then the assessee's margin falls within the arm's length price, even without considering the adjustment on account of risk or working capital adjustment and consequently, the entire adjustment made by the Transfer Pricing Officer and partially upheld by the CIT(A), shall be deleted.

12. With regard to use of multiple year data, learned counsel for the assessee, placing reliance on Rule 10D(4) submitted that transfer pricing documentation should, as far as possible be contemporaneous and should exist latest by the due date for filing of income-tax return, i.e., 31-10-2004 for the assessment year 2004-05. Since all the companies do not publish the financial year results by the due date, it is submitted that use of financial data only for the financial year 2003-04 is practically not possible and as such it is submitted that use of multiple year and contemporaneous data available by the prescribed date should be allowed. He filed detailed written submission reiterating and elaborating the above submissions.

13. Learned Departmental Representative on the other hand, opposed the above submissions of the assessee, and on the above aspects arising out of the appeal of the assessee, supported the order of the CIT(A). Strongly supporting action of the Transfer Pricing Officer in rejecting ten out of 14 comparable companies documented by the assessee, she submitted that the assessee itself agreed for the rejection of eight companies and the only dispute between the assessee and the Transfer Pricing Officer was only in respect of rejection of two comparable companies, viz. Aztec Software & Technology Services Ltd. and Quintegra Solutions Ltd. The first of these comparables, viz. Aztec Software & Technology Services was rejected by the Transfer Pricing Officer since it had substantial related party transactions of more than 25 per cent of sales. She also submitted that as correctly held by the Transfer Pricing Officer, when the consolidated results of Aztec Software & Technology Services and its subsidiary companies are not comparable with the stand-alone results of the assessee. Even with regard to Quintegra Solutions Ltd., she submitted that the financial results of this company are for the year ending September, 2004 and not March, 2004 as in the case of the assessee company. Placing reliance on Rule 10B(4), she submitted that data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into, with the only exception being that data of earlier two years may also be considered, if such data reveals facts which could have an influence on the determination of the transfer prices in relation to the transactions being compared. She further submitted that since the assessee itself has not provided for any adjustment on account of working capital risk in the Transfer Pricing Document, there is no justification for allowing the same at the assessment or appellate stages. She submitted that there is no thumb rule to provide for such adjustments, and such allowance of working capital risks would depend on the facts and circumstances of each case. Since the assessee has not been able to make out any case for such adjustment, the Transfer Pricing Officer, according to her was justified in not allowing the same. She however, submitted that the CIT(A) was not justified in allowing benefit of 5 per cent in terms of section 92C(2) of the Act. She submitted the case of the assessee is not comparable and the decisions relied on by the learned CIT(A) are distinguishable and in any event, they are not jurisdictional and binding.

14. Learned counsel for the assessee, in his reply and in the context of the grievance of the Revenue in its appeal, strongly supported the order of the CIT(A) insofar as allowance of 5 per cent margin is concerned. He submitted that as per proviso to section 92C(2) of the Act, an assessee has the option of charging a price to its Associated Enterprises, which may vary from the Arm's Length Price by plus or minus 5 per cent. According to section 92C(3) of the Act, he submitted that the Arm's length price shall be determined by the Assessing Officer in accordance with sub-sections (1) and (2) of section 92C and therefore, it should be appreciated that the Assessing Officer/Transfer Pricing Officer is mandatorily required to calculate the Arm's Length Price in accordance with section 92C(1) and 92C(2) of the Act. In support of these contentions, reliance is also placed on the Explanatory Memorandum to Finance Bill, 2001 and the clarifications contained in Notes on Clauses - Income-tax (Finance Bill, 2002). Learned counsel for the assessee, justified ± 5 per cent adjustment, inviting our attention to relevant portions of the CBDT Circulars No. 12/2001, dated 23-8-2001 and No. 05/2010, dated 3-6-2010, and also placing reliance on the following judicial pronouncements, copies of which are also furnished in the paper-book—

15. We have considered the rival submissions and perused the orders of the lower authorities. We have carefully examined the written submissions of the learned counsel for the assessee, besides voluminous paper-books filed by the learned counsel for the assessee and other material available on record. We have also gone through the case-law relied upon by the parties. First, we may take up the appeal of the assessee, wherein the first grievance of the assessee is that the TPO should have provided working capital risk adjustment and other adjustments in accordance with Rule 10B(1)(e), while arriving at the ALP. We find that as per the report of the TPO at page No. 19 of his order that the comparables were selected by the assessee after undertaking FAR analysis of the controlled and uncontrolled parties and the transactions are in terms of similarities. The assessee has not quantified or identified any differences, while undertaking the FAR analysis in the transfer price documentation and no adjustment was made on that count. Hence, at this stage, the assessee cannot take any plea in that regard. Since the assessee itself has not made any such adjustment, the case-law relied upon by the assessee in this behalf, is not applicable to the facts of the present case. Risk adjustments can be given only on company to company basis, considering the peculiar facts and circumstances of the case. In the circumstances, we agree with the CIT(A) that there is no thumb rule for allowing such risk adjustment. The other contention of the assessee is with regard to the rejection of the comparable companies satisfying all the filters adopted by the TPO. On this issue, the CIT(A) clearly observed in his order that out of fourteen comparable companies selected by the assessee, only four companies were selected by the TPO. The assessee agreed with the TPO for rejection of eight companies, and the other companies available were only two companies. That is one Aztec Software and the other one is Quintegra Solutions Ltd. These companies were rejected by the TPO for the reason that it had substantial related party transactions, which work out to more than 25 per cent of the total sales. Hence, the findings given by the CIT(A) in rejecting these two companies as not comparable, in our considered opinion, are in order. One other contention of the assessee relates to use of multiple year and contemporaneous data available by the prescribed data. As per Rule 10B(4), data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into, with the only exception being that data of earlier two years may also be considered, if such data reveals facts which could have an influence on the determination of the transfer prices in relation to the transactions being compared. In view of the above, the CIT(A) is right in holding that the data of the subsequent period cannot be considered for comparison. Accordingly, assessee's grounds on these aspects of the matter are rejected.

16. The next grievance of the assessee in its appeal is that the CIT(A) was not justified in confirming that the data link charges are completely attributable to the delivery of computer software outside India for the purpose of computation of deduction under section 10A of the Act. Related grievance of the Revenue in its appeal on this issue is that the CIT(A) erred in directing the Assessing Officer to exclude the expenses under communication charges from the total turnover similar to export turnover while computing the exemption under section 10A of the Act. It is the case of the Revenue that the CIT(A) was not correcting in merging the conditions for the purpose of deduction under sections 10A and 80HHC of the Act, since they are independent of each other and the provisions of section 80HHC are not applicable to section 10A of the Act.

17. The Learned Departmental Representative strongly relying on the order of the Assessing Officer submitted that the CIT(A) was not correct in directing the Assessing Officer to exclude the expenses under communication charges from the total turnover.

18. The learned counsel for the assessee, besides opposing the above contentions of the Learned Departmental Representative submitted that the assessee develops computer software in synchronization with other development teams across the globe and requires to be networked with the other teams on a continuous basis. In this process, the assessee has obtained data links service from service providers. Though the software developed by the assessee is delivered through the data links in India, the assessee has neither incurred any expenses specifically for data link charges towards the delivery of the computer software outside India nor has it charged any clients towards delivery of computer software. According to him, the above charges are largely incurred for inter office and intra office communication, as the nature of business of the assessee is such that it requires substantial interaction between the personnel of the assessee and personnel of other entities across the globe in addition to being marginally incurred for export/delivery of computer software outside India. As such, the CIT(A), according to him was not justified in holding that data link charges are completely attributable to the delivery of computer software outside India. Placing reliance on the decision of the Special Bench of the Tribunal in ITO v. Sak Soft Ltd. [2009] 30 SOT 55 (Chennai)(SB) and the decision of the Coordinate Bench of the Tribunal in assessee's own case for the assessment year 2003-04, wherein it has been held that if data link charges are reduced from export turnover, then the same should also be reduced from total turnover. In any event, it is contended that there is no revenue impact as 100 per cent profits of the assessee come from export business, and as such, the assessee is not interested in pressing its ground on this issue.

19. We have considered the rival submissions and perused the orders of the lower authorities. At the outset, we may reject the ground of the assessee on this issue, since as noted above, it is contended by the learned counsel for the assessee that though the view taken by the CIT(A) that entire data link charges are attributable to delivery of computer software outside India is not acceptable, he is not pressing this ground since it is does not have ultimately any revenue impact and as such it is only of academic interest. As for the grounds of the Revenue in its appeal on this issue, we find that the decision of the CIT(A) in directing Assessing Officer to exclude the data link charges from the total turnover, having excluded the same from export turnover, is based on the decision of the Coordinate Bench of the Tribunal in assessee's own case for assessment year 2003-04 in ITA No. 579/Hyd./2007. Further, we find that in the recent decision of the Special Bench (Chennai) of the Tribunal in the case of Sak Soft Ltd. (supra), it has been held that if data link charges are reduced from export turnover, then the same should also be reduced from total turnover. Respectfully following the said decision of the Special Bench of the Tribunal, we find no infirmity in the order of the CIT(A) on this issue. We accordingly confirm the view taken by the CIT(A). In this view of the matter, we reject the respective grounds of the assessee as well as the revenue on this issue.

20. Now, we will take up the issue, in revenue's appeal, whether the assessee company is entitled to the adjustment of 5 per cent as stipulated under section 92C(1) of the Act. The undisputed fact in the case under consideration is that only one method called TNMM was applied to find out the ALP price. In our considered opinion, where the ALP has been determined by applying only one out of the several methods specified under section 92C(1) of the Act, the assessee is not entitled for deduction of 5 per cent adjustment from the ALP as stipulated under section 92C(2) of the Act. In other words, section 92C(2) of the Act specifies that the adjustment of 5 per cent is not applicable if a single price is determined by the assessee. Our view is fortified by the decision of the Delhi Bench of the Tribunal in the case of Perot Systems TSI (India) Ltd. v. Dy. CIT [2010] 37 SOT 358 and the decisions relied on by the learned counsel for the assessee including that of Sony (India) (P.) Ltd.'s case (supra) does not apply to the facts of the instant case. Even the Circular No. 12, dated 23-8-2001 issued by the CBDT does not apply to the case under consideration as the price variation is more than 5 per cent and said circular is applicable only if the variation in price with the associated enterprise, vis-a-vis the unrelated party is within the limit of [+] or [-] 5 per cent. In view of the above, we hold that the CIT(A) is not justified in allowing 5 per cent adjustment in terms of section 92C(1) of the Act. We accordingly set aside the order of the CIT(A) on this aspect, allowing the ground raised by the Revenue.

21. In the result, both the appeals of the assessee as well as revenue are partly allowed.