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Chryscapital Investment Advisors (India) Pvt. Ltd. Vs. Deputy Commissioner Of Income Tax
February, 09th 2016
$~
*        IN THE HIGH COURT OF DELHI AT NEW DELHI

                                                      Reserved on: 26.03.2015
                                                    Pronounced on: 27.04.2015
+        ITA 417/2014
         CHRYSCAPITAL INVESTMENT ADVISORS (INDIA) PVT. LTD.
                                                        ............Appellant
                    Through: Sh. Vikas Srivastava, Sh. Parag Mohanty and
                    Ms. Varsha Bhattacharya, Advocates.

                Versus

         DEPUTY COMMISSIONER OF INCOME TAX
                                              .................Respondent
                 Through: Sh. Rohit Madan, Sh. Ruchir Bhatia and Sh. P.
                 Roy Choudhary, Advocates.
         CORAM:
         HON'BLE MR. JUSTICE S. RAVINDRA BHAT
         HON'BLE MR. JUSTICE R.K. GAUBA

MR. JUSTICE S. RAVINDRA BHAT

%

        "A phrase begins life as a literary expression; its felicity leads to
        its lazy repetition; and repetition soon establishes it as a legal
        formula, undiscriminatingly used to express different and
        sometimes contradictory ideas".

     - Justice Felix Frankfurter in Tiller v. Atlantic Coast Line Railroad
       Co., 318 U.S. 54 (1943)


1.       Is there a concept of "super profit" in the arms length price/transfer
price determining process under the Income Tax Act, 1961 ("the Act") or the
Rules framed thereunder, entitling tax administrators to include high profit




ITA 417/2014                                                                Page 1
making companies data in the list of "comparables"? Benches of Income
Tax Appellate Tribunal ("ITAT"), appear to be riven in their opinion on this;
it is the subject matter of the present appeal.
2.     The questions framed for decision in this appeal, under Section 260-A
of the Act, arising from an order of the Income Tax Appellate Tribunal
("ITAT") dated 20.12.2013 in ITA No. 6183/Del/2012 for assessment year
(AY) 2008-09, are as follows:

       1) Whether the proviso to Rule 10B(4) of the Income Tax Rules,
       1962 will be applicable in case of fluctuations in the operating
       profit margins of comparable companies during the relevant
       financial year under question as compared to earlier years?
       2) Whether comparables can be rejected on the ground that they
       have exceptionally high profit margins as compared to the
       assessee in transfer pricing analysis?
       3) Whether factors like differential functional and risk profile
       coupled with high degree of volatility in operating profit margins
       is sufficient ground to reject comparables for transfer pricing
       analysis?
       4) Whether disallowances can be made under Section 36(1)(ii)
       when the bonus paid to shareholders is not in the exact
       proportion of their shareholding and there is no avoidance of
       taxes?
3.     The assessee is a private limited company incorporated under the
Companies Act, 1956 and is engaged in providing investment advisory
services, which were reimbursed on a cost-plus mark-up basis. Ashish
Dhawan and Kunal Shroff, in the concerned assessment year, were its two
shareholders - holding shares in the assessee in the proportion of 2:l; they
were also its full time employees. In AY 2008-09, the assessee entered into
international transactions with associated enterprises (AEs) relating to




ITA 417/2014                                                            Page 2
advisory services and reimbursement of expenses incurred on behalf of AEs
amounting to ` 56,61,99,829/- and ` 4,49,72,912/- respectively. For the
purposes of determination of arms length price (ALP), the assessee used the
Transactional Net Margin Method ("TNMM"). The assessee treated the
transactions relating to reimbursement received by it from its associated
enterprises on actual basis (i.e. without mark-up) at ALP as such since no
value addition was done by it in relation to the said expenses. The assessee
identified four entities which were engaged broadly in the same economic
activities as in its case and identified as comparables. The result of the arms
length analysis is given below:



       S. No.   Comparable              Operating Profit Margins
                Entity
                              2005-06    2006-07   2007-08    Average
           1.   IDFC              -      -55.50% 17.30%       -19.10%
                Investment
                Advisors
                Limited
           2.   Future            -      0.88%     20.53%     10.71%
                Capital
                Holdings
                Limited
           3.   Khandwala     43.35%     42.62%        -      42.99%
                Securities
                Limited
           4.   Sumedha       -16.47% -20.36%          -      -18.42%
                Fiscal
                Services
                Limited




ITA 417/2014                                                             Page 3
               Final Average                                4.04%



4.     The assessees position was that because of fluctuation in the margins
of the comparable entities, multiple year data of the comparables was
warranted to remove the effect of year specific aberrations. Against the
average Operating Profit Margin ("Operating Margin") of 4.04% earned by
the comparable entities, the assessee earned an Operating Margin of 27.05%
and concluded that its transactions with its AEs were at arms length. The
assessee relied on Rule 10B(4) of the Income Tax Rules, 1962 (hereafter
"the Rules"). Rule 10B(4) reads as follows:
       (4) The data to be used in analysing the comparability of an
       uncontrolled transaction with an international transaction or a
       specified domestic transaction shall be the data relating to the
       financial year in which the international transaction or the
       specified domestic transaction has been entered into:

       Provided that data relating to a period not being more than two
       years prior to such financial year may also be considered if such
       data reveals facts which could have an influence on the
       determination of transfer prices in relation to the transactions
       being compared.

The assessee argued that using multiple year data is consistent with the
OECD Guidelines as well as transfer pricing regulations of several
developed jurisdictions. The Operating Margin of the assessee was stable in
contrast to the comparable companies, described below:


                      Financial    Operating
                      Year         Margin




ITA 417/2014                                                           Page 4
                      2005-06      24.15%
                      2006-07      21.14%
                      2007-08      27.05%
                      Average      24.11%


5.     On 30.09.2008, the assessee filed its return for AY 2008-09 declaring
a total income of ` 12,41,83,160. Its case was scrutinized by the AO who
referred the matter to the Transfer Pricing Officer ("TPO") under Section
92CA (3) of the Act. On 03.10.2011, the TPO passed an order
recommending transfer pricing additions of ` 20,93,34,155/- to the income
of the Assessee. The TPO computed the Operating Margins of the four
comparables above using single year data i.e. for FY 2007-08 and ignoring
the data for two prior financial years i.e. 2005-06 and 2006-07 while
determining the ALP. The TPO concluded that multiple year data for the
assessees comparables could not be used but introduced two new
comparables with abnormal business profits. The TPO also retained a
comparable inspite of it showing abnormal growth in the assessment year
under consideration and considered reimbursable expenses as part of
operating expenses and corresponding reimbursement as part of operating
revenue of the assessee for the purpose of determining the arm's length
price. The TPO held that the assessee had not furnished any detail as to how
the data for the earlier years had an impact on the profits in the concerned
assessment year of the assessee or the comparables.
6.     Based on the TPOs report, the AO passed the assessment order on
21.12.2011, confirming the recommendations of the TPO. The AO also




ITA 417/2014                                                           Page 5
disallowed the bonus paid by the assessee to its shareholder employees ­
M/s Ashish Dhawan (` 67,91,947) and Kunal Shroff (` 30,19,433) ­ under
Section 36(l)(ii) of the Act. The assessee filed its objections against the
draft assessment order before the Dispute Resolution Panel ("DRP"). The
DRP, by order dated 21.09.2012, confirmed the transfer pricing additions as
well as the disallowance of the bonus made by the Respondent. Thereafter,
on 19.10.2012, the AO completed the assessment under section 143(3) read
with section 144C of the Act assessing the income of the assessee after
sustaining the transfer pricing additions made by the TPO and disallowing
the bonus paid to its shareholders. The ITAT dismissed the Assessees
appeal by its order dated 20.12.2013 and confirmed the additions made by
the Respondent.
7.     All the lower authorities included three entities as comparables which
had very high profit margins as compared with that of the assessee. These
entities namely, Brescon Corporate Advisors Limited ("Brescon")
(Operating Margin of 87.4%), Keynote Corporate Services Limited
("Keynote") (Operating Margin of 191.58%) and Khandwala Securities
Limited ("Khandwala") (Operating Margin of 80.79%) had exceptional
profit margins as compared with the Assessee (Operating Margin of
27.05%) and rejected three other comparables selected by the assessee (i.e.
IDFC Investment Advisors Ltd. (17.35%), Sumedha Fiscal Services Limited
(9.14%) and Future Capital Holdings Limited (20.56%). Khandwala had
been selected as a comparable by the assessee itself based on the multiple
year data for the comparability analysis. However, the TPO substituted the
same with the data for the concerned financial year, in which Khandwala
had exceptionally high profit margins. The ITAT upheld these findings and




ITA 417/2014                                                            Page 6
held that current year data should be used in the absence of abnormal or
exceptional facts/circumstances in existence which could have an influence
on the results as well as the determination of the transfer prices for the year
under consideration. Further, the ITAT held that Rule 10B does not provide
any basis to exclude an entity or eliminate it from the list of companies
solely on the basis of high profitability. The authorities - including ITAT,
held that the decisive factors for determining inclusion or exclusion of any
entity in/from the list of comparables are the specific characteristics of the
services provided by the said entities, assets employed, risks assumed, the
contractual terms and conditions prevailing including the geographical
location and size of the market, cost of labour and capital in the markets, etc.
and high or low profit margins could not be criteria for inclusion or
exclusion of entities in the list of comparables.
       Arguments of the assessee
8.     The assessee submits that even if the ITATs ruling on the issue is
accepted, Brescon and Keynote should be excluded from the list of
comparables as its (the assessees) risk profile is not similar to that of those
two companies. They are risk-taking entities whereas the assessee operates
on a cost plus model wherein a guaranteed return of 25% on costs is assured
to it. The assessee further argues that its functional profile is significantly
different from that of Keynote. Unlike the assessee, Keynote is involved in
capital market activities, including lead managing IPOs, Rights Offers,
Buybacks and Takeovers. Also, Keynote considers its activities to be a
Merchant Banker as evidenced by its Director's Report and Notes to
Accounts of the concerned financial year. The assessee submits that in the
audited financials of Keynote, there is no service-wise break-up of profits




ITA 417/2014                                                              Page 7
and therefore, the profitability of the advisory services segment (which may
be considered similar to the services being rendered by the assessee) is not
available to be compared with the assessees profitability. The assessee
argues that Keynote's profit margins have shown volatility over the years
which could be attributed to abnormal business conditions and therefore
Keynote should be rejected as a comparable altogether. The Operating
Margins of Keynote for the last 5 years are as follows:-

                   Assessment Year      Operating Margin
                        2004-05              (-)6.87%
                        2005-06              13.33%
                        2006-07              94.06%
                        2007-08              145.83%
                        2008-09              191.58%



9.     The assessee highlights that CIT (Appeals) too had rejected Keynote
in a preceding as well as succeeding assessment year i.e. AY 2007-08 and
2009-10. Further, Keynote has been excluded as a comparable by the DRP
in a preceding assessment year i.e. AY 2006-07. In that order, dated
04.03.2013, the DRP observed:

       As regards choice of Keynote Corporate services as a
       comparable by TPO based on single year data, DRP finds no
       infirmity in principles. However, after analyzing the economic
       circumstances as highlighted by the assessee and corroborated
       from the annual report of the year, we do find it may not be a
       robust comparable.




ITA 417/2014                                                           Page 8
       According to the assessee we would like to state that this
       company has very volatile profit margins and since the Ld. TPO
       has computed the ALP on the basis of single year data (data for
       the FY 2005-06 only) this company should not be included in the
       final set of comparable as it would lead to distortion of the ALP.`
       The assessee while determining the ALP considered data for
       three years which mitigated the high volatility in operating
       margins of this company. However on the basis of single year
       data the operating margins of this company will substantially
       inflate the operating margins.
       The volatility in the operating margin of this company is clearly
       evident from the three year profitability of the comparables
       submitted before you are the Ld. TPO vide submission dated May
       18, 2009 (copy enclosed at page 139 of the paper book dated
       January 01, 2010 filed before the Hon`ble Panel). The operating
       margin of this company during the FY 2003-04 was negative
       6.87% and which converted to positive 13.33. In the FY 2004-05,
       thereby exhibiting the this margin further increased to 94.06%
       showing an even higher volatility (80 percent points) vis-à-vis
       previous year.
       Further we would also like to state that Keynote can also not be
       considered a comparable to the assessee (on the basis of single
       year data) for the reason that on the basis of single year data this
       company is earning exceptionally high profits (i.e. 94%).
       It is further submitted that on the possible reasons due to which
       Keynote has derived exceptional profits during the year may be
       due to some alliances formed by it with some foreign companies
       during the year. The relevant extract (copy enclosed as Annexure
       3) from the annual report of Keynote is given hereunder:
       The company formed alliances with a Middle East based
       consulting company and with a Swiss based consulting company
       to offer its clients cross border transaction ability.
       Thus, the exceptional profit earned by Keynote during the
       relevant year may be due to such alliance formed by Keynote
       with other companies in Middle East and Swiss. The profit




ITA 417/2014                                                              Page 9
       earned by it due to such alliance cannot be used for the arm`s
       length analysis.
       2.3.4 In view of the above reasons, the DRP directs TPO to
       exclude this comparable as it is not a robust comparable for this
       year. TP grounds are accordingly disposed off as above.
10.    On the issue of disallowance of bonuses paid by the assessee to its
two full-time shareholder employees, it is submitted that bonuses were paid
to all its employees during the relevant financial year on the basis of their
performance and qualifications. Both the individuals to whom the bonuses
paid were disallowed have requisite qualifications, experience and expertise
in the field of investment advisory services. Accordingly, keeping in view
their experience, expertise and performance, the assessee had compensated
them. The assessee submits that bonus under Section 36(1)(ii) of the Act is
allowed as deduction if the same amount would not have been payable to the
shareholders as profits or dividends if it had not been paid as bonus. The
provision requires the sum paid as bonus to be exactly the same as to be
payable as dividend in absence of the bonus for there to be a disallowance.
The assessee submits that the bonus paid to the shareholder employees is not
in the same proportion as their shareholding. It is also submitted that the
basis for disallowance of bonus paid ­ that no dividend was declared by the
assessee ­ is incorrect as it paid interim dividend amounting to `
5,47,47,000/- in the concerned assessment year. Thus, the bonus paid to the
two shareholders was not in lieu of dividend and therefore, should be
allowed as tax deductible expenditure.
11.    Learned counsel argued that the ALP of an international transaction
has to be determined by applying one of the methods provided in section 92-
C (3) of the Act; it should be the most appropriate method and should also




ITA 417/2014                                                           Page 10
take into account prescribed factors. This is, counsel stated, elaborated in
Rule 10-B of the Rules, which contemplates adjustment on account of
functional and other differences. He contended that adopting of any method
ultimately envisages comparison of like functions, transactions and
enterprises. Rule 10B(2)(a) provides that specific characteristic of services
rendered by the two entities should be compared in order to treat the same as
comparables for the purpose of transfer pricing analysis. Counsel also
referred to the OECD guidelines and argued that accurate ALP
determination is dependent on flexibility and sound exercise of discretion.
Chapter III of the OECD guidelines was relied on to say that they
recommend that where can it be determined that some uncontrolled
transactions have a lesser degree of comparability than others, they should
be eliminated. He also referred to Section A-5 of OECD guidelines on
selecting and rejecting potential comparables and pointed out that as per
para 3.56, wherever uncontrolled transactions have a lesser degree of
comparability than others, they should be eliminated. Counsel stated that
similarly, Para 3.57 states that if the range of comparables includes a
sizeable number of observations, statistical tools that take account of central
tendency to narrow the range (e.g. the inter-quartile range or other
percentiles); Para 3.59 suggests that where the application of the most
appropriate method produces a range of figures, a substantial deviation
among points in that range may indicate that the data used in establishing
some of the points may not be as reliable as the data used to establish the
other points in the range or that the deviation may result from features of the
comparable data that require adjustments.




ITA 417/2014                                                             Page 11
12.     Learned counsel also relied on A.7.3 of the OECD guidelines dealing
with extreme results in the context of comparability considerations to
point out that extreme results might consist of losses or unusually high
profits. These can affect the financial indicators that are looked at in the
chosen method; some potential comparables have extreme results, further
examination would be needed to probe such results. This important issue
was overlooked by ITAT. Counsel relied on proviso to Rule 10-B (4) and
stated that though the mandate of the law is ordinarily to rely upon
comparables' data for the current year, in certain circumstances, it is possible
for the authorities to rely on previous years' data restricted to two previous
years. This is to eliminate any distorted picture which might be the
consequence of adherence to the contemporaneous data, like in the present
case.
13.     It was argued that the DRP's order for AY 2006-07 had accepted the
assessee's argument and excluded Keynote from the list of comparables, on
the ground that the said concern had earned abnormally high or super
profits. On that occasion, as compared with its previous year (AY 2005-06)
profit level of 94%, the profit of the enterprise was 145%, registering a 51%
increase over the previous year. This was considered to be too high to be
allowed as a comparable. During the current year, the profit registered was
191%. In the circumstances, it was illogical and arbitrary for the revenue to
have rejected the contention that data in respect of Keynote should have
been excluded. It was also similarly argued that the ITAT fell into error in
rejecting the assessee's objection with respect to Brescon whose total
turnover was over ` 14 crores, of which the comparable business was only `
2 crores; the absence of any sectional data with regard to this company,




ITA 417/2014                                                             Page 12
meant that its activities were not comparable, on a fair application of Rule
10-B (2) and (3).
14.    Learned counsel relied on the decisions of the Special Bench in the
case of Quark Systems Private Limited v. DCIT (2010 38 SOT 307-
Chandigarh Bench) Adobe Systems India Pvt. Ltd. (Del) 2011-(TII)-13-
ITAT-DEL); Teva India (P) Ltd v. DCIT, [2011] 44 SOT 105 (Mum);
Sapient Corporation (P) Ltd. v. Deputy CIT, [2011] 11 Taxmann 69 (Delhi);
Asst CIT vs. Maersk Global Services Centre (India) P. Ltd. (133 ITD
543)(Mum.); Symantec Software Solutions (P) Ltd. v. Assistant CIT [2012]
25 Taxmann 163 (Mum); and a Division Bench decision of this court, in
Commissioner of Income Tax v Agnity India Technologies Pvt. Ltd. (2013)
219 Taxman 26 (Del), were relied on. In Agnity India (supra) it was held
that huge turnover companies like Infosys and Wipro cannot be considered
as comparable to smaller companies like assessee.
15.    Learned counsel for the assessee also argued that the rejection of
previous years data, in the facts of the present case, was unwarranted. It
was submitted that given that the comparables introduced by the TPO
distorted the margins, the AO and DRP erred in determining the ALP on the
basis of data for financial year 2007-08 only and ignoring the data for two
prior financial years i.e. FY 2005-06 and FY 2006-07. Learned counsel
submitted that the TPO had the option of reaching back to previous years
data, since such power exists by virtue of proviso to Rule 10B (4). Learned
counsel also relied on Part B.3, Paras 3.75 to 3.78 of OECD guidelines, in
support of the submission.
       Revenue`s contentions




ITA 417/2014                                                          Page 13
16.    Mr. Rohit Madan, learned counsel for the revenue argued that five
methods have been prescribed to determine ALP in relation to an
international transaction and the comparability analysis requirements are
method specific under Rule 10-B (1). Referring to the said Rule it was
submitted that price charged or paid for the property transferred or service
rendered in the comparable transaction is relevant in case of CUP and re-
sale price method while the cost of production incurred in respect of
property transferred or services provided is relevant for cost plus method.
However, there is no mention of any property transferred or services
provided in case of TNMM. They are provided for other methods. He
contended that the relevant Rule thus makes it clear that specific
characterization of the property transferred or services is not relevant for
TNMM and this position is in conformity with the relevant OECD
guidelines which suggest that broad comparability of functions should be
done for TNMM.
17.    Countering the submissions of the assessee, it was argued that neither
the Act, nor the Rule contemplate exclusion of relevant transactions of like
enterprises, in any manner other than what is prescribed. It was argued here
that a comparable cannot be removed from consideration merely because it
suffers loss; likewise, a unit or enterprise which enjoys higher profit (than
the assessee or a significantly high profit in the industry) or even one
making a so called "super profit" too cannot be eliminated. Generally, both
loss making units and high profit making units cannot be removed from the
list of comparables unless, such removal is statutorily permitted by Rule 10-
B (2) or (3). Counsel also submitted that this is also evident from a reading
of Rule 10-C. It was pointed out that Rule 10B (3) (ii) and Rule 10 C (2)(e)




ITA 417/2014                                                           Page 14
permitted adjustment to eliminate material defects of the difference between
the assessee and comparables. Counsel argued that only those factors which
result in material difference in the comparables of transactions as between
the assessee and the unrelated transaction or the third party enterprise, have
to be reasonably adjusted to avoid distortions under the said provisions. The
step envisioned there had to be necessarily followed keeping in view the
mandate "shall".
18.    It was also argued that the decision in Commissioner Of Income Tax v
Mentor Graphics (Noida) Pvt.Ltd (ITA 1114/2008, decided by this court on
04-04-2013) has held that OECD guidelines cannot be applied because there
are specific provisions of Rule 10B (2) & (3) and the first proviso to Section
92C(2) which apply. There, it was held that having held that the
comparables given by the assessee were to be accepted and those searched
by the TPO were to be rejected, the only option then left to the ITAT was to
derive the arithmetical mean of the profit level indicators of the
comparables. It was submitted that accepting the theory of "abnormally high
profits" as a ground for rejection of a comparable would lead to vagueness
and confusion because what constitutes abnormally high has nowhere been
spelt out in the Act or rules. On the other hand, the margin of variation
permitted is ± 3% (proviso to Section 92C (2), reduced from the 5% margin
that existed earlier). Introduction of any other variation not based in law
would not be justified.

       Analysis & Conclusions







ITA 417/2014                                                            Page 15
19.    Section 92-C which is relevant, for the purpose of determining ALP
inter alia, reads as follows:

       "92C. (1) The arm's length price in relation to an international
       transaction [or specified domestic transaction] shall be
       determined by any of the following methods, being the most
       appropriate method, having regard to the nature of transaction
       or class of transaction or class of associated persons or functions
       performed by such persons or such other relevant factors as the
       Board may prescribe, namely :-

       (a)comparable uncontrolled price method;

       (b) resale price method;
       (c)cost plus method;

       (d)profit split method;

       (e)transactional net margin method;
       (f)such other method as may be prescribed by the Board.
       (2) The most appropriate method referred to in sub-section (1)
       shall be applied, for determination of arm's length price, in the
       manner as may be prescribed:
       Provided that where more than one price is determined by the
       most appropriate method, the arm's length price shall be taken to
       be the arithmetical mean of such prices:


                              **     **       **


       (3) Where during the course of any proceeding for the
       assessment of income, the Assessing Officer is, on the basis of
       material or information or document in his possession, of the
       opinion that-




ITA 417/2014                                                            Page 16
       (a) the price charged or paid in an international transaction [or
       specified domestic transaction] has not been determined in
       accordance with sub-sections (1) and (2); or

       (b)any information and document relating to an international
       transaction [or specified domestic transaction] have not been
       kept and maintained by the assessee in accordance with the
       provisions contained in sub-section (1) of section 92D and the
       rules made in this behalf; or

       (c)the information or data used in computation of the arm's
       length price is not reliable or correct; or

       (d)the assessee has failed to furnish, within the specified time,
       any information or document which he was required to furnish
       by a notice issued under sub-section (3) of section 92D, the
       Assessing Officer may proceed to determine the arm's length
       price in relation to the said international transaction [or
       specified domestic transaction] in accordance with sub-sections
       (1) and (2), on the basis of such material or information or
       document available with him:

       Provided that an opportunity shall be given by the Assessing
       Officer by serving a notice calling upon the assessee to show
       cause, on a date and time to be specified in the notice, why the
       arm's length price should not be so determined on the basis of
       material or information or document in the possession of the
       Assessing Officer."

20.    Section 92C(1) thus visualizes determination of the "arms-length
price" (ALP)     by any of five enumerated methods, being the most
appropriate method, having regard to the nature of transaction or class of
transaction or class of associated persons or functions performed by such
persons or such other relevant factors as the board may prescribe, namely
(a) comparable uncontrolled price method, (b) resale price method, (c) cost
+ method, (d) profit split method, (e) transactional net margin method, (f)




ITA 417/2014                                                           Page 17
any such other method as may be prescribed by the board. Where more than
one price is determined by the most appropriate method, the arm's
length price shall be taken to be arithmetical mean of such prices.
21.    Rule 10B of the Rules prescribes the determination of arm's length
price under Section 92C. The first step in all methods is evaluation of
differences between the international transaction undertaken with the
unrelated enterprise performing the comparable functions in similar
circumstances. Rule 10B of the Income-tax Rules inter alia, provides for
various methods for determination of the arm's length price. Rule 10B (1)
(e) prescribes the "transactional net margin method" (TNMM) wi th which
the present case is concerned. Rule 10B (1) (e) (i) is as under:

       "10B. (1) Determination of arm's length price under section 92C
       :-- . .
       *************                                 *********

       (e) transactional net margin method, by which,--
       (i) the net profit margin realised by the enterprise from an
       international transaction entered into with an associated
       enterprise is computed in relation to costs incurred or sales
       effected or assets employed or to be employed by the enterprise
       or having regard to any other relevant base."
22.    These provisions prescribe, therefore, that even under the TNMM,
importance is given to "assets employed or to be employed" as relevant
factors for consideration. Rule 10B (2), as the second step, requires
application of functions, asset, risk test for judging comparability of
international transaction with an uncontrolled transaction. It provides:




ITA 417/2014                                                               Page 18
       "10B (2). For the purposes of sub-rule (1), the comparability of
       an international transaction with an uncontrolled transaction
       shall be judged with reference to the following, namely :--

       (a) the specific characteristics of the property transferred or
       services provided in either transaction ;

       (b) the functions performed, taking into account assets employed
       or to be employed and the risks assumed, by the respective
       parties to the transactions ;

       (c) the contractual terms (whether or not such terms are formal
       or in writing) of the transactions which lay down explicitly or
       implicitly how the responsibilities, risks and benefits are to be
       divided between the respective parties to the transactions ;
       (d) conditions prevailing in the markets in which the respective
       parties to the transactions operate, including the geographical
       location and size of the markets, the laws and the Government
       orders in force, costs of labour and capital in the markets,
       overall economic development and level of competition and
       whether the markets are wholesale or retail.

       (e) the extent to which reliable and accurate adjustments can be
       made to account for differences, if any, between the international
       transaction or the specified domestic transaction and the
       comparable uncontrolled transaction or between the enterprises
       entering into such transactions;

       (f) the nature, extent and reliability of assumptions required to
       be made in application of a method."

Rule 10B (3) stipulates the third step, and spells out when the TPO is
obliged to hold an uncontrolled transaction as comparable with others. This
provision reads as follows:
       (3) An uncontrolled transaction shall be comparable to an
       international transaction or a specified domestic transaction if-




ITA 417/2014                                                            Page 19
       (i) none of the differences, if any, between the transactions being
       compared, or between the enterprises entering into such
       transactions are likely to materially affect the price or cost
       charged or paid in, or the profit arising from, such transactions
       in the open market; or

       (ii) reasonably accurate adjustments can be made to eliminate
       the material effects of such differences.

Rule 10B (4) provides what should be the basis of the calculations in terms
of data, its contemporaneity, etc. It stipulates that:

       (4) The data to be used in analysing 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:

       Provided that data relating to a period not being more than two
       years prior to such financial year may also be considered if such
       data reveals facts which could have an influence on the
       determination of transfer prices in relation to the transactions
       being compared.

23.    The assessee's argument is that entities earning "super normal" or
"abnormal" profits should be excluded from the list of comparables. For this
purpose, it relied on several rulings of various Benches of the ITAT. These
are Adobe Systems India (P) Ltd. v. Additional Commissioner of Income-tax,
[2011] 44 SOT 49 (Delhi) Teva India (P) Ltd v. DCIT, [2011] 44 SOT 105
(Mum); Sapient Corporation (P) Ltd. v. Deputy CIT, [2011] 11 Taxmann 69
(Delhi); Asst CIT vs. Maersk Global Services Centre (India) P. Ltd. (133
ITD 543)(Mum.); Symantec Software Solutions (P) Ltd. v. Assistant CIT
[2012] 25 Taxmann 163 (Mum); and a Division Bench ruling of this court
in CIT v. Agnity India Technologies (P) Ltd. [2013] 36 Taxmann 289 (Del




ITA 417/2014                                                             Page 20
HC). Besides, this court notices that a similar reasoning ­ of applying what
is known as the "turnover" filter or the exclusion of "superprofit" making
companies reasoning was applied in Continuous Computing India (P) Ltd.
vs. ITO (2012) (52 SOT 45)(Bang)(URO); Centillium India P. Ltd vs. DCIT
(2012)(20 ITR 69) (Bang)(Tri.) and Addl CIT vs. Frost and Sullivan India
(P) Ltd (supra). The revenue has on the other hand, relied on contrary views
in Actis Advisers P. Ltd. v. Deputy CIT [2012] 20 ITR (Trib) 138 (Delhi);
24/7 Customer.Com.Pvt.Ltd. v. Deputy CIT [2013] 21 ITR (Trib) 514 (Bang)
and Willis Processing Services (I) P. Ltd. v. Deputy CIT [2014] 30 ITR
(Trib) 39 (Mum). Such views are echoed in Trilogy E-Business Software
India P. Ltd. v. Deputy CIT [2013] 23 ITR (Trib) 464 (Bang) and Stream
International Services P. Ltd. v. Asst. DIT (International Taxation) [2013]
23 ITR (Trib) 70 (Mum) too.
24.      Before analysing the relative strengths of the rival contentions, a
tabular statement containing the reasoning which persuaded various Benches
of the ITAT to conclude one way or the other is reproduced below:

S.             Judgment          Finding                 Rationale
No.
      1. ITO v. Saunay      1.     One of the The excluded comparable had a
         Jewels (P) Ltd.,   four comparables gross profit margin of 53.81%
         [2010] 42 SOT 2    chosen by the TPO which was abnormal profits.
         (Mum).             (Sovereign
                            Diamonds        Ltd.)
                            should be excluded.
                            2.     Simple
                            arithmetic average
                            of    gross    profit
                            margin cannot be
                            adopted as there is
                            a wide variation in




ITA 417/2014                                                          Page 21
                        the      parameters.
                        Weighted average
                        should be taken.
   2. Adobe Systems 1. Directed the                The said entities had shown
      India (P) Ltd. v. exclusion of three         supernormal      profits.     By
      Additional        entities         as        excluding      these       three
      Commissioner of comparables.                 companies, the arithmetic mean
      Income-tax,                                  of OP/TC comes to 17.15%,
      [2011] 44 SOT                                which falls within the +-5%
      49 (Delhi)                                   range as permitted by s. 92C(2).
                                                   Further, the DRP has passed a
                                                   cursory       order   without
                                                   examining the submissions of
                                                   the assessee.
   3. Teva India (P)      Remitted the matter      M/s Vimta Labs had earned
      Ltd v. DCIT,        to the AO to decide      supernormal profits. The ITAT
      [2011] 44 SOT       the issue of inclusion   noted the decision in Adobe
      105 (Mum).          of M/s Vimta Labs        Systems and directed the matter
                          as a comparable          to be decided in light of that
                                                   decision and taking into account
                                                   the submissions of the assessee.
   4. Sapient             Directed           the   TPO cannot exclude all loss
      Corporation (P)     exclusion of one of      making      comparables   and
      Ltd. v. Deputy      the     comparables      include an entity (Zenith)
      CIT, [2011] 11      considered by the        making supernormal profits at
      Taxmann      69     TPO            (Zenith   the same time.
      (Delhi)             Infotech Ltd.)
                                                   Zenith is predominantly a
                                                   software product company
                                                   whereas the assessee is a
                                                   software development services
                                                   company and a software
                                                   product company shows higher
                                                   margin.
   5. Nortel Networks     Affirmed       the A concern will not lose its status
      India (P) Ltd. v.   exclusion of M/s merely because it is a loss-
      Additional CIT,     Arraycom    as   a making entity. However, TPO
      [2013]        36    comparable.        has not excluded Arraycom for
      Taxmann      439                       the sole reason that it is a loss-




ITA 417/2014                                                                Page 22
        (Delhi)                                 making entity but because it has
                                                been showing persistent losses.
                          Further held that the Its operation also has a
                          TPO has adequately reducing tendency.
                          factored          the
                          subjective elements
                          in determining the
                          ALP.                  In the absence of exceptional
                                                circumstances, previous year
                                                data under the proviso to Rule
                                                10B(4) cannot be used.
   6. Carlyle     India   Directed         the   Keynote was into merchant
      Advisors (P) Ltd.   exclusion of, inter    banking whereas the assessee
      v.     Additional   alia,      Keynote     provided investment advisory
      CIT, ITA No.        Corporate Services     and related support services.
      7901/Mum/2011       Ltd. and S.R.E.I
      dated               Capital Markets Ltd.
      04/04/2012.         as comparable          SREI Caps` core business was
                                                 merchant      banking    and
                                                 consultancy income accounted
                                                 for only 0.27% of the total
                                                 income.


                                                 Absence of segmental data
                                                 insofar as the investment
                                                 advisory service provided by the
                                                 assessee is concerned led to the
                                                 exclusion of comparables.
   7. Deputy CIT v.       Inclusion of Vishal Assessee derived its income
      Deloitte            Information         from software development and
      Consulting India    Technology Limited IT enabled services.
      Pvt. Ltd., ITA      as a comparable
      No.                 was not incorrect.
      1082/Hyd/2010                         Assessee itself argued before the
      dated 22/07/2011                      TPO that VTIL is a comparable
                          Wipro cannot be a company offering IT enabled
                          comparable.       services.
                                                 The    intangibles   will      not




ITA 417/2014                                                                 Page 23
                                                 materially affect the price or
                                                 profit-earning     [within  the
                          Previous year data     meaning of Rule 10B(3)]. No
                          can be used for        two comparable companies can
                          comparables     only   be replicas of each other. Rule
                          under    exceptional   10B should be applied on a
                          circumstances.         broader perspective and not
                                                 with technical rigour.
                                                 Wipro cannot be a comparable
                                                 as its turnover is 20 times that
                                                 of the assessee.
   8. Symantec            Two entities (ICC      These entities were required to
      Software            International          be excluded on account of
      Solutions     (P)   Agricultural   Ltd.    significantly higher operating
      Ltd. v. Assistant   and TSR Darashaw       margins (82.92% and 78.29%)
      CIT, [2012] 25      Ltd.) were directed    whereas the next highest was
      Taxmann      163    to be excluded as      26.67%. Thus, unless it was
      (Mum).              comparables.           demonstrated that these super
                                                 normal profits were earned in
                                                 the normal routine of activities,
                                                 they could not be included.
   9. Sony India (P)      Upheld           the   Exclusion may not be justified
      Ltd. v. Deputy      revenue`s decision     on the mere ground of loss and
      CIT, [2008] 114     to exclude Godrej as   competition. However, on the
      ITD 448 (Delhi)     a comparable.          facts of the case, a number of
                                                 factors have the cumulative
                                                 effect of justifying Godrej`s
                          Reversed         the   exclusion. These are: Godrej
                          revenue`s finding on   makes refrigerators and not
                          inclusion         on   TVs, it has suffered huge losses
                          Videocon     as    a   over a period of several years,
                          comparable.            had huge unutilized capacity,
                                                 needs financial restructuring,
                                                 joint venture of the company
                                                 stands terminated, etc.


                                                 Re inclusion of Videocon, there
                                                 are material differences which




ITA 417/2014                                                               Page 24
                                                  cannot be eliminated within the
                                                  meaning of Rule 10B(3). Thus,
                                                  Videocon has to be excluded as
                                                  a comparable.
   10. Philips Software    Companies      with    An entity making supernormal
       Centre v. ACIT,     supernormal profits    profits cannot be a comparable.
       [2008] 26 SOT       should have been       If at all it were to be considered
       226 (Bang.)         excluded from the      as a comparable, appropriate
                           list of comparables    adjustments to the material
                           by the TPO.            differences would have to be
                                                  made. However, normalization
                                                  of the margins of super profit
                                                  making companies is not
                                                  envisaged on an ad hoc basis
                                                  and has to be done as per the
                                                  law.


                                                  The assessee was a captive
                                                  contract service provider and it
                                                  did not bear any business and
                                                  operational risks
   11. E-gain              Excluded Thirdware The margin of profit shown by
       Communication       Solutions Ltd. and these    two   entities   was
       (P) Ltd. v. ITO,    WTI       Advanced extraordinary.
       [2008] 23 SOT       Technology      as
       385 (Pune)          comparables.
                                                  All factors materially affecting
                                                  the comparability of the
                                                  assessee with the other entities
                                                  need to be scrutinized and
                                                  adjusted,      including     the
                                                  operative profit.
   12. SAP LABS India      Directed         the   These two entities were earning
       (P) Ltd. v. ACIT,   exclusion of M/s       supernormal profits. Extreme
       [2011] 44 SOT       Hinduja TMT and        cases should be avoided while
       156 (Bang.)         M/s Aftek Infosys      making a comparative study of
                           Ltd. as comparables.   analogous cases.




ITA 417/2014                                                                 Page 25
   13. Exxon       Mobil    Rejected         the     As regards exclusion of entities
       Company India        assessee`s               earning abnormal profits, a
       P. Ltd. v. Deputy    contention that two      general submission cannot be
       CIT [2012] 15        loss         making      accepted; the assessee should
       ITR (Trib) 353       concerns had to be       bring out the peculiar features
       (Mum)                included     among       why such exclusion is necessary
                            comparables.             in the circumstances of the case.
   14. Maersk Global        Entities          with   The inclusion of entities with
       Centres (India)      abnormally        high   supernormal profits would
       (P) Ltd. v. ACIT,    profit        margins    depend upon the facts and
       [2014]        43     cannot be rejected       circumstances of each case. It
       Taxmann      100     outright            as   should        trigger     further
       (Mumbai Special      comparables. In the      investigation      to   establish
       Bench).              given facts of the       whether it can be taken as a
                            case,              two   comparable or not ­ this would
                            comparables sought       depend upon whether the high
                            to     be    included    profits reflect a normal business
                            indicated     unusual    condition or whether they are a
                            features for the year,   result of some abnormal
                            which qualified for      conditions prevailing in the
                            their exclusion.         relevant year.
                                                     The profit margin earned by
                                                     such entity in the immediately
                                                     preceding year may also be
                                                     taken into account to determine
                                                     this issue.
                                                     If the high profit margin does
                                                     not reflect normal business
                                                     condition, it should be rejected.
                                                     An entity cannot be rejected
                                                     solely on the basis of
                                                     abnormally high profit margin.
   15. Goldman Sachs        Directed         the Assessee and the comparables
       (India) Securities   exclusion         of were functionally different and
       Pvt. Ltd. v. ACIT,   comparables          not in the same segment.
       ITA            No.   ordered by the TPO.
       7724/Mum/2011,




ITA 417/2014                                                                   Page 26
        dated 23.01.2013
   16. Advance Power       Directed         the BCC Fuba India Ltd. was a
       Display Systems     exclusion of BCC persistently loss making unit
       Ltd. v. ACIT,       Fuba India Ltd. as a and therefore, it cannot be
       [2013]       35     comparable.
                                                considered to be a good
       Taxmann     145
       (Mum)                                    comparable.

                           Comparables have
                           to be tested for each
                           year independently.     Further, in respect of another
                           The fact that an        company, the P&L A/c had an
                           entity has been         extraordinary item of income on
                           chosen       as     a   account of sale of business.
                           comparable for one
                                                   Therefore, this makes this
                           year does not ipso
                           facto mean that it      company as not a good
                           would be chosen the     comparable for the year under
                           subsequent year.        consideration.

   17. Syscom              A company cannot    If profit not supernormal, the
       Corporation Ltd.    be excluded as a    mere fact that it is high does not
       v. ACIT, [2013]     comparable solely   justify exclusion. Unless and
       35 Taxmann 600      because it is a high
                                               until there are specific reasons
       (Mum)               profit making unit.
                                               and factors as provided under
                                               Rule 10B, an entity cannot be
                           A persistently loss excluded or eliminated from the
                           making unit cannot list of comparables.
                           be considered as a
                           comparable.


                           Comparability of an
                           uncontrolled
                           transaction with an
                           international
                           transaction has to be
                           measured by using
                           current year data
                           and only when the




ITA 417/2014                                                                Page 27
                           current year data
                           does not give a true
                           picture    due     to
                           abnormal
                           circumstances that
                           multiple year data is
                           used.
   18. Aztec Software v.   The          criteria There should be a proper
       ACIT, ITA No.       prescribed under the analysis of transactions ­ FAR
       584/Bang/2006       Act and Rules is the analysis.
       dt.   12.07.2007    primary basis for
       (Bang ­ Special     testing
       Bench)              comparability.
   19. CIT v. Agnity       Upheld the exclusion    Tribunal had excluded Infosys
       India               of           Infosys    as it was a giant company in the
       Technologies (P)    Technologies Ltd. as    area of software development
       Ltd. [2013] 36      a comparable.           and it assumed all risks leading
       Taxmann      289                            to higher profits whereas the
       (Delhi HC)                                  assessee was a captive unit of
                                                   the parent company and
                                                   assumed only a small risk.
                                                   HC upheld the reasons given by
                                                   the Tribunal for the exclusion.
   20. Cummins Turbo                               Companies with supernormal
       Technologies v.                             profits and companies which are
       DDIT, [2013] 35                             loss-making cannot straight
       Taxmann 350                                 away       be      rejected  as
                                                   comparables unless abnormal
                                                   loss is projected.
   21. Google India (P) Exclusion of two           The Tribunal has consistently
       Ltd. v. DCIT, companies making              held that super profit making
       [2013]        29 supernormal profits.       companies have to excluded
       Taxmann 412.                                from the list of comparables
                                                   before making transfer pricing
                                                   adjustment.




ITA 417/2014                                                                Page 28
25.    Maersk Global Centres (India) (P) Ltd (supra) was a Special Bench (3
Member) decision of ITAT which had to address the precise question which
arises for consideration in this case, i.e whether in the facts of that case
companies earning abnormally high profit margin should be included in
the list of comparable cases for the purpose of determining the arm's length
price of international transactions. Although the ITAT did not specifically
answer the question, in view of its findings that two comparables, i.e eClerx
Services Ltd and Mold Tech Technologies Ltd, on account of unusual or
peculiar features which were apparent from the materials on record, the
Bench did indicate the general approach appropriate in this regard:

       the comparability of an international transaction with an
       uncontrolled transaction for the purpose of determining the
       arm's length price of an international transaction by following
       the transactional net margin method is required to be judged
       with reference to the functions performed as per sub-rule (2)(b)
       of rule 10B read with sub-rule (1)(e) thereof and there is no bar
       in the transfer pricing regulations in India to exclude certain
       entities selected as potential comparables on a broad
       functionality test by applying the functional test at narrow or
       micro level to attain the relatively equal degree of comparability.
       On the other hand, rule 10B(3) provides that the uncontrolled
       transaction selected/judged as per rule 10B(2) shall be
       comparable to an international transaction only if none of the
       differences, if any, between the transactions being compared, or
       between enterprises entering into such transactions are likely to
       materially affect the price or cost charged or paid or the profit
       arising from such transaction in the open market or reasonably
       accurate adjustment can be made to eliminate the effects of such
       difference. In our opinion, sub-rule (3) of rule 10B thus clearly
       provides for further exclusion of the comparables selected by
       applying the test/criteria given in sub-rule (2) of rule 10B if there
       is any difference found between the enterprises entering into the




ITA 417/2014                                                              Page 29
       transactions which materially affects the cost charged or the
       profit arising from such transaction in the open market.
       69. Keeping in view the relevant portion of the OECD Transfer
       Pricing Guidelines discussed above and having regard to the
       relevant transfer pricing regulations as contained in rule 10B(3)
       of the Income-tax Rules, 1962, we are of the view that further
       dissection or classification of information technology enabled
       services can be done depending on the facts and circumstances
       of each case so as to select the entities having a relatively equal
       degree of comparability.

In Exxon Mobil Company India P. Ltd. (supra), a Mumbai Bench decision,
(cited at Sl. No.13 in the table above), the ITAT held:

       "(xi) Now, coming to the alternative arguments of the assessee
       that abnormal profit making unit is also to be eliminated on the
       same analogy on which loss making units are excluded, we, in
       principle, do not dispute this proposition. The various case laws
       relied upon by the assessee lay down that a comparable cannot
       be eliminated just because it is a loss making unit. Similarly, a
       higher profit making unit cannot also be automatically
       eliminated just because the comparable company earned higher
       profits than the average. The reason for rejecting the two loss
       making units is not just because they were loss making units but
       for the reasons which are already stated in the preceding
       paragraphs. If similar reasons existed in the higher profit making
       unit, then, it is for the assessee to bring out those reasons and
       seek exclusion of the same. A general argument that you have to
       exclude units which have high profit range, in case you exclude
       units which have made loss is a general submission which cannot
       be accepted. In other words, as a general principle, both loss
       making unit and high profit making unit cannot be eliminated
       from the comparables unless there are specific reasons for
       eliminating the same which is other than the general reason that
       a comparable has incurred loss or has made abnormal profits.




ITA 417/2014                                                            Page 30
This court notices that American Express Services India Ltd v Deputy
Commissioner Of Income-Tax, 2013 (57) SOT 22 (ITAT-Del) said,
similarly, that:
        If the comparables are performing the same functions then
       merely on the ground of they being earning super profits, cannot
       be excluded. Material differences between their business
       modules, however, are required to be taken care off and duly
       adjusted. In the case of Sundaram Finance Distribution Ltd., we
       find that the main objection of assessee is that the said
       comparable was included because assessee had supplied the
       same and the second objection is that in the said comparable
       there was no staff. As far as first objection is concerned, we are
       in agreement with the assessee's counsel that merely because the
       said comparable was provided by assessee, the same could not
       be included without proper examination to account for the
       differences. The assessee is well within his right to demonstrate
       that a comparable supplied by it in the transfer pricing analysis
       was not correct and had to be excluded. This right of the
       assessee is not curtailed in any manner, whatsoever, in the rules.
A similar reasoning was adopted in M/s. Premier Exploration Services
Pvt.Ltd., vs. ITO, Ward 14 (3) [2014] 29 ITR (Trib) 427 (ITAT) [Del]

       Although assessee had taken this company as comparable on
       the basis of past years data but in our considered view, the Saket
       Projects Ltd. was not comparable to assessee because the event
       management was done by sponsorships which is evident from
       various documents placed in paper book. Further the segment
       allocation of expenses also appears to be not reliable. We agree
       with the view of revenue that no comparable can be rejected
       merely on the basis of high margins if the comparable is
       functionally comparable to the assessee and also that there is
       miner variation in functional similarity. However, in the case of
       Saket Projects Ltd. there is functional dissimilarity. The company
       is organizing events with various kinds of sponsorships. The facts
       also suggest that segmental allocation of expenses were not




ITA 417/2014                                                           Page 31
       reliable. We also hold that when direct comparables are
       available then segmental results of companies engaged in other
       business should not be taken as comparable. On the basis of
       these facts, we hold that Saket Projects Ltd. was not comparable
       to the extent wherein the various variations could be ruled out or
       iron out by provisions of law and rules.
26.    The assessees position is supported by reasoning in cases like the
ITATs decision in Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007]
109 ITD 161 where contentions such as these were accepted:

       ".....The wide difference in the ratio of operating margins in the
       final selection of comparable ... is a clear pointer to the fact that
       the selection made was faulty...The OECD guideline on this point
       is as under

       1.47 Where the application of one or more methods produces a
       range of figures, a substantial deviation among points in that
       range may indicate that the data used in establishing the some of
       the points may not be as reliable as the data used to establish the
       other points in the range or that the deviation may result from
       features of the comparable data that require adjustments.`

       Inferring from the above ruling, we requests your goodself to not
       consider companies displaying abnormal profits since they
       deviate from the normal trend displayed by the data set."

Many decisions of different benches of the ITAT indicate a rote repetition
(in the words of Felix Frankfurter J, quoted in the beginning of this
judgment a "lazy repetition") of this reasoning, without an independent
analysis of the provisions of the Act and the rules. (Ref. IQ Information
Systems India P. Ltd. [2013] 25 ITR (Trib) 185 (Hyderabad Bench)
Symphony Marketing Solutions India P. Ltd. [2013] 27 ITR (Trib) 753
(Bangalore Bench)).




ITA 417/2014                                                              Page 32
27.    An indication of what ought to be the correct approach was given by a
Division Bench of this Court in Commissioner of Income Tax v Mentor
Graphics (P) Ltd [2013] 259 CTR 1 (Del), where it was held that:

       21. The sum and substance of the Tribunal's order is that the
       criteria adopted by the TPO for searching comparables was not
       correct. Secondly, the TPO had not specifically rejected any of
       the comparables of the respondent/assessee. The Tribunal was of
       the view that the comparables of the respondent/assessee ought
       to have been accepted and, had that been the case, there would
       have been no need for the TPO to search for comparables. Of
       course, in passing the order, the Tribunal made certain general
       observations that unless and until the comparables drawn by the
       taxpayer were rejected, a fresh search by the TPO could not be
       conducted. However, this has to be tempered with the relevant
       statutory provisions which are clearly set out in sub-s. (3) of s.
       92C of the said Act which stipulates four situations whereunder
       the AO/TPO may proceed to determine the ALP in relation to an
       international transaction. If any one of those four conditions is
       satisfied, it would be open to the AO/TPO to proceed to
       determine the ALP. This clarification of the observation of the
       Tribunal was necessary and that is why we have done so.

       22. We also note that the Tribunal had gone further and reduced
       the list of comparables to merely four as indicated in para 46 of
       the impugned order. We do not think that it was the right
       approach to be adopted by the Tribunal. The Tribunal should
       have stopped at the point where it decided on facts that the
       comparables given by the respondent/assessee were to be
       accepted and those searched by the TPO were to be rejected. The
       only option then left to the Tribunal was to derive the
       arithmetical mean of the PLIs of the comparables which were
       accepted by it. In this case such comparables happen to be those
       of the respondent/assessee. The Tribunal, in selecting only one
       PLI out of a set of PLIs had clearly erred in law. However, in the
       facts of the present case that would not make any difference to
       the respondent/assessee's case in as much as even if the




ITA 417/2014                                                           Page 33
       arithmetical mean of the comparables as accepted by the
       Tribunal is taken into account, the PLI would, whether the seven
       companies are taken into consideration or all eight companies
       are taken into consideration, be less than 6.99 per cent which is
       the PLI of the respondent/assessee for the relevant year, that is,
       financial year ending 31st March, 2002. We may also make it
       clear that the reference to the OECD Guidelines by the Tribunal
       in the impugned order are in the context of the reliance placed by
       the TPO on the very same guidelines, in particular, to para 3.27
       thereof. In the present case, there are specific provisions of sub-
       rr. (2) and (3) of r. 10B of the said rules as also of the first
       proviso to s. 92C(2) of the said Act which apply. Therefore, the
       question of applying OECD Guidelines does not arise at all.
It is therefore, evident that the Special Bench and this Court stressed that
mere distortion cannot be the basis of exclusion, given the mandate of
Section 92C. The assessee had during the hearing, heavily relied on OECD
guidelines and another Division Bench ruling in Agnity (supra). This court
proposes to take up the latter decision first for discussion. In Agnity (supra),
the revenue had questioned, inter alia, the ITAT decision to exclude the data
relating to Infosys. One of the reasons was that the said company was a
"giant" corporation and was involved in multifarious activities. After
reproducing the comparative chart and noticing the facts, the Court reasoned
as follows:

       6. Learned counsel for the Revenue has submitted that the
       Tribunal after recording the aforesaid table has not affirmed or
       given any finding on the differences. This is partly correct as the
       Tribunal has stated that Infosys Technologies Ltd. should be
       excluded from the list of comparables for the reason latter was a
       giant company in the area of development of software and it
       assumed all risks leading to higher profits, whereas the
       respondent-assessee was a captive unit of the parent company
       and assumed only a limited risk. It has also stated that Infosys







ITA 417/2014                                                             Page 34
       Technologies Ltd. cannot be compared with the respondent-
       assessee as seen from the financial data etc. to the two
       companies mentioned earlier in the order i.e. the chart. In the
       grounds of appeal the Revenue has not been able to controvert or
       deny the data and differences mentioned in the tabulated form.
       The chart has not been controverted.

       7. Learned counsel for the appellant Revenue during the course
       of hearing, drew our attention to the order passed by the TPO
       and it is pointed out that based upon the figures and data made
       available, the TPO had treated a third company as comparable
       when the wage and sale ratio was between 30% to 60%. By
       applying this filter, several companies were excluded. This is
       correct as it is recorded in para 3.1.2 of the order passed by the
       TPO. TPO, as noted above, however had taken three companies,
       namely, Satyam Computer Service Ltd., L&T Infotech Ltd. and
       Infosys Technologies as comparable to work out the mean.

       8. It is a common case that Satyam Computer Services Ltd.
       should not be taken into consideration. The Tribunal for valid
       and good reasons has pointed out that Infosys Technologies Ltd.
       cannot be taken as a comparable in the present case. This leaves
       L&T Infotech Ltd. which gives us the figure of 11.11 %, which is
       less than the figure of 17% margin as declared by the
       respondent-assessee. This is the finding recorded by the
       Tribunal. The Tribunal in the impugned order has also observed
       that the assessee had furnished details of workables in respect of
       23 companies and the mean of the comparables worked out to
       10%, as against the margin of 17% shown by the assessee.
       Details of these companies are mentioned in para 5 of the
       impugned order.

       9. In view of the aforesaid position, we do not think that any
       substantial question of law arises for consideration. The appeal
       is dismissed.
28.    Quite evidently, the Court accepted the assessees contentions with
respect to dissimilarity of comparables; given the facts, equally, there was




ITA 417/2014                                                           Page 35
sufficient material to favour that view, in the facts of the case. The Court,
unlike in Mentor Graphics (supra) did not undertake an analysis of the
provisions involved- it was not also necessary, given the admitted state of
facts.
29.      Considerable inspiration was drawn from OECD guidelines to say
that extraordinary facts in relation to a comparable should lead to its
rejection in the TP analysis. The relevant provisions of the 2010 OECD
Transfer Pricing Guidelines are extracted below:

         A.7.3 ­ Extreme Results: Comparability Considerations
         3.63: Extreme results might consist of losses or unusually high
         profits. Extreme results can affect the financial indicators that
         are looked at in the chosen method (e.g. the gross margin when
         applying a resale price, or a net profit indicator when applying a
         transactional net margin method). They can also affect other
         items, e.g. exceptional items which are below the line but
         nonetheless may reflect exceptional circumstances. Where one or
         more of the potential comparables have extreme results, further
         examination would be needed to understand the reasons for such
         extreme results. The reason might be a defect in comparability,
         or exceptional conditions met by an otherwise comparable third
         party. An extreme result may be excluded on the basis that a
         previously overlooked significant comparability defect has been
         brought to light, not on the sole basis that the results arising
         from the proposed comparable merely appear to be very
         different from the results observed in other proposed
         comparables.
         3.64: An independent enterprise would not continue loss-
         generating activities unless it had reasonable expectations of
         future profits. See paragraphs 1.70 to 1.72. Simple or low risk
         functions in particular are not expected to generate losses for a
         long period of time. This does not mean however that loss-
         making transactions can never be comparable. In general, all
         relevant information should be used and there should not be any




ITA 417/2014                                                              Page 36
       overriding rule on the inclusion or exclusion of loss-making
       comparables. Indeed, it is the facts and circumstances
       surrounding the company in question that should determine its
       status as a comparable, not its financial result.
       3.65: Generally speaking, a loss-making uncontrolled
       transaction should trigger further investigation in order to
       establish whether or not it can be a comparable. Circumstances
       in which loss-making transactions/enterprises should be
       excluded from the list of comparables include cases where losses
       do not reflect normal business conditions, and where the losses
       incurred by third parties reflect a level of risks that is not
       comparable to the one assumed by the taxpayer in controlled
       transactions. Loss-making comparables that satisfy the
       comparability analysis should not however be rejected on the
       sole basis that they suffer losses.
       3.66: A similar investigation should be undertaken for potential
       comparables returning abnormally large profits relative to other
       potential comparables.
On the use of multiple year data, this is what the said guidelines provide:
       B.5 Multiple Year Data
       3.75: In practice, examining multiple year data is often useful in
       a comparability analysis, but it is not a systematic requirement.
       Multiple year data should be used where they add value to the
       transfer pricing analysis. It would not be appropriate to set
       prescriptive guidance as to the number of years to be covered by
       multiple year analyses.
       3.76: In order to obtain a complete understanding of the facts
       and circumstances surrounding the uncontrolled transaction, it
       generally might be useful to examine data from both the year
       under examination and prior years. The analysis of such
       information might disclose facts that may have influenced (or
       should have influenced) the determination of the transfer price.
       For example, the use of the data from past years will show
       whether a taxpayer`s reported loss on a transaction is part of a
       history of losses on similar transactions, the result of particular




ITA 417/2014                                                             Page 37
       economic conditions in a prior year that increased costs in the
       subsequent year, or a reflection of the fact that a product is at the
       end of its life cycle. Such an analysis may be particularly useful
       where a transaction profit method is applied. See paragraph 1.72
       on the usefulness of multiple year data in examining loss
       situations. Multiple year data can also improve the
       understanding of long term arrangements.
       3.77: Multiple year data will also be useful in providing
       information about the relevant business and product life cycles of
       the comparables. Differences in business or product life cycles
       may have a material effect on transfer pricing conditions that
       needs to be assessed in determining comparability. The data
       from earlier years may show whether the independent enterprise
       engaged in a comparable transaction was affected by
       comparable economic conditions, or whether different conditions
       in an earlier year materially affected its price or profit so that it
       should not be used as a comparable.
       3.78: Multiple year data can also improve the process of
       selecting third party comparables, e.g. by identifying results that
       may indicate a significant variance from the underlying
       comparability characteristics of the controlled transaction being
       reviewed, in some cases leading to the rejection of the
       comparable, or to detect anomalies in third party information.
       3.79: The use of multiple year data does not necessarily imply
       the use of multiple year averages. Multiple year data and
       averages can however be used in some circumstances to improve
       reliability of the range. See paragraphs 3.57-3.62 for a
       discussion of statistical tools.
30.    The reasoning adopted in various judgments noticed above, shows
that functional analysis seeks to identify and compare the economically
significant activities and responsibilities undertaken, assets used and risks
assumed by the parties to the transaction. Quantitative and qualitative
filters/criteria have been used in different cases to include or exclude




ITA 417/2014                                                              Page 38
comparables. The intuitive logic for excluding big companies from the list
of comparables while undertaking the FAR analysis of a smaller company is
attractive, given that such big companies provide services to diverse
clientele, perform multifarious functions, often assume risks and employ
intangible assets which are specially designed, unlike in the case of smaller
companies. The bigger companies have an established reputation in the
segment, are well known and employ economies of scale to a telling end. On
the other hand, these obvious ­ and apparent features should not blind the
TPO from the obligation to carry out the transfer pricing exercise within the
strict mandate of Section 92 C and Rules 10-A to 10-E.
31.    Arm's length price determination, in respect of an international
transaction has necessarily to confirm to the mandate of Rule 10B. In this
case, the method followed for determining the arm's length price of the
international transaction adopted by the assessee and the revenue is the
TNMM. The comparability of an international transaction with an
uncontrolled transaction has, in such cases, to be seen with reference to the
functions performed, taking into account the assets employed or to be
employed and the risks assumed by the respective parties to the transaction
as per rule 10B(2)(b). The specific characteristics of the property transferred
or services provided (contemplated by Rule 10B(2)(a)) in either transactions
may be secondary, for judging comparability of an international transaction
in the TNMM, because the price charged or paid for property transferred or
services provided and the direct and indirect cost of production incurred by
the enterprise in respect of property transferred or services provided go into
reckoning comparability analysis in the transaction methods, i.e the
comparable uncontrolled price, resale price and cost plus whereas the profit




ITA 417/2014                                                            Page 39
based method such as transactional net margin method takes into account,
the net margin realised. In TNMM, comparability of an international
transaction with an uncontrolled transaction is to be seen with reference to
functions performed as provided in sub-rule (2)(b) of rule 10B read with
sub-rule (1)(e) of that rule after taking into account assets employed or to be
employed and the risks assumed by the respective parties to the transaction.
As noticed earlier, Rule 10B(3) mandates that a given or select uncontrolled
transaction selected in terms of Rule 10B(2) "shall be comparable to an
international transaction" if none of the differences, if any, between the
compared transactions, or between enterprises entering into such
transactions are likely to materially affect the price or cost charged or paid
or the profit arising from such transaction in the open market or reasonably
accurate adjustment can be made to eliminate the effects of such
difference.
32.    Now, the sequitur of Rule 10B (2) and (3) is that if the comparable
entity or entitys transactions broadly conform to the assessees functioning,
it has to enter into the matrix and be appropriately considered. The crucial
expression giving insight into what was intended by the provision can be
seen by the use of the expression: none of the differences, if any, between
the transactions being compared, or between the enterprises entering into
such transactions are likely to materially affect the price or cost charged or
paid in, .. such transactions in the open market. The other exercise which
the TPO has to necessarily perform is that if there are some differences, an
attempt to "adjust" them to "eliminate the material effects" should be made:

       (ii) reasonably accurate adjustments can be made to eliminate
       the material effects of such differences.




ITA 417/2014                                                             Page 40
33.    Such being the case, it is clear that exclusion of some companies
whose functions are broadly similar and whose profile ­ in respect of the
activity in question can be viewed independently from other activities-
cannot be subject to a per se standard of loss making company or an
"abnormal" profit making concern or huge or "mega" turnover company. As
explained earlier, Rule 10B (2) guides the six methods outlined in clauses
(a) to (f) of Rule 10B(1), while judging comparability. Rule 10B (3) on the
other hand, indicates the approach to be adopted where differences and
dissimilarities are apparent. Therefore, the mere circumstance of a company
- otherwise conforming to the stipulations in Rule 10B (2) in all details,
presenting a peculiar feature - such as a huge profit or a huge turnover, ipso
facto does not lead to its exclusion. The TPO, first, has to be satisfied that
such differences do not materially affect the price...or cost; secondly, an
attempt to make reasonable adjustment to eliminate the material effect of
such differences has to be made.
34.    The Court is also aware of the factors mentioned in Rule 10B (2), i.e
characteristics of the service provided, functions performed taking into
account assets employed or to be employed and the risks assumed, by the
respective parties to the transactions; contractual terms of the transactions
indicating how the responsibilities, risks and benefits are to be divided
between the respective parties to the transactions; conditions prevailing in
the markets in which the respective parties to the transactions operate,
including the geographical location and size of the markets, the laws and the
Government orders in force; costs of labour and capital in the markets,
overall economic development and level of competition and whether the
markets are wholesale or retail. These elements comprehend the similarities




ITA 417/2014                                                            Page 41
and dissimilarities; clause (f) of Rule 10C(2) specifically provides that the
extent to which reliable and accurate adjustments can be made to account
for differences, if any, between the international transaction or the specified
domestic transaction and the comparable uncontrolled transaction or
between the enterprises entering into such transactions and the nature,
extent and reliability of assumptions required to be made in application of a
method have to be taken into consideration by the TPO.
35.    As regards the relevance of multiple year data for transfer pricing
determination, this Court is of the opinion that the general rule as prescribed
in Rule 10B(4) mandates the tax authorities to take into account only the
relevant assessment years data. The proviso to Rule 10B(4) permits data
relating to two years prior to the relevant assessment year to be taken into
account in the event that they have an influence on the determination of
price. However, in such instances, the onus lies upon the assessee to
establish the relevance of such data. The language of Rule 10B(4) does not
leave any scope for ambiguity on this issue. This Court notices that this very
ground- i.e applicability of previous years data for reaching out
comparables, was sought to be urged in Marubeni India (P) Ltd v DIT 354
ITR 638 but deliberately left moot, because the assessee had given it up
before the Tribunal. The TPO in his order dated 03.10.2011 has
comprehensively examined the authorities on this issue and rightly held that
ordinarily, the revenue has to consider only the relevan t assessment years
data under Rule 10B(4) and that data from earlier period may also be
considered if "it reveals certain facts which have an influence on the
determination of transfer prices in relation to the transaction being
considered". The assessee has placed significant reliance on the OECD




ITA 417/2014                                                             Page 42
guidelines to contend the admissibility of previous years data for transfer
pricing determination. However, for reasons given in the paragraphs below,
this Court is of the opinion that the OECD guidelines have no bearing on
this issue.
36.    This Court holds that in the facts of the present case, the assessee was
incorrect, both in its reliance placed upon previous years data as well as the
manner of such reliance. First, the assessees justification for relying on
such data is the volatility in the comparables profit margins and the
consequent inability to transact at a consistent ALP. However, this is not
warranted herein. Whilst there may be a wide fluctuation in the profit
margins of comparables from year-to-year, this by itself does not justify the
need to take into account previous years profit margins. The transfer pricing
mechanism provided in the Act and the Rules prescribes that while
determining the ALP, the arithmetic mean of all comparables is to be
adopted. This is to offset the consequence of any extreme margins that
comparables may have and arrive at a balanced price. Similarly, the wide
fluctuations in profit margins of the same entity on a year-to-year basis
would be offset by taking the arithmetic mean of all comparables for the
assessment year in question. In any case, in the event that the volatility is on
account of a materially different aspect incapable of being accounted for, the
analysis under would Rule 10B(3) would exclude such an entity from being
considered as a comparable. Secondly, as regards the manner of using
previous years data, the assessee has taken the arithmetic mean of the
comparables profit margins for the assessment year in question and two
previous years. This Court disagrees. The proviso to Rule 10B(4), read with
the sub-rule, itself indicates that the purpose for which previous years data




ITA 417/2014                                                             Page 43
may be considered is - analysing the comparability of an uncontrolled
transaction with an international transaction. It does not prescribe that once
an uncontrolled transaction has been held to be a ,,comparable, in order to
obviate an apparent volatility in the data, the arithmetic mean of three years
(the assessment year in question and two previous years) may be taken .
That would amount to assigning equal weight to the data for each of the
three years, which is against the mandate of Rule 10B(4). The use of the
word ,,shall in Rule 10B(4) and, noticeably, ,,may in the proviso, implies
that the relevant assessment years data is of primary consideration, as
opposed to previous years data.
37.    The contention that OECD guidelines have to be taken into
consideration requires a closer scrutiny. The Organisation for Economic Co-
operation      and   Development (OECD)      is   an international   economic
organisation of 34 countries founded in 1961 to stimulate economic progress
and world trade. India is not a member of this grouping; it has an observer
status. She has, however, of late been actively co-operating with the
organization. The Guidelines of OECD therefore, have only persuasive
status; they do not have any legal sanction- unlike, for instance Double
Taxation Avoidance Agreements which courts are duty bound to interpret
and implement, in terms of municipal law, given the compulsion of
provisions of the Income Tax Act. Secondly ­ and more importantly- the
provisions of the Constitution compel a national legislation, to embody the
terms of a treaty, for it to be enforceable in courts in India. This is because
of Article 253 of the Constitution and the dualist tradition (of International
law) followed by India, whereby treaties by themselves are legally
unenforceable in courts, but are to be assimilated through municipal (or




ITA 417/2014                                                             Page 44
national) legislation. Our Supreme Court has, in the area of human rights ­
particularly in personal liberty, been emphasizing that to the extent the
provision of any treaty is in consonance with provision of the Constitution
(such as Article 21) it would be read along with such provision or right
(Jolly George Varghese and Anr. v. The Bank of Cochin, AIR 1980 SC 470,
Apparel Export Promotion Council v. A.K. Chopra, AIR 1999 SC 625;
Kubic Dariusz v Union of India AIR 1990 SC 605). Thus, the Courts are
primarily bound by the law on the subject in India; if the law is clear and
unambiguous, there is no question of resorting to extrinsic sources. The only
rider is that if the terms of such conventions or treaties are similar to the law
applicable in India, courts may consider precedents in that regard; however
those are only of persuasive value.
38.    The aforesaid conclusion is fortified by the Division Bench decision
of this Court in Mentor Graphics (supra), where the Court noted:
       We may also make it clear that the reference to the OECD
       guidelines by the Tribunal in the impugned order are in the
       context of the reliance placed by the Transfer Pricing Officer on
       the very same guidelines, in particular, to paragraph 3.27
       thereof. In the present case, there are specific provisions of sub-
       rules (2) and (3) of Rule 10B of the said Rules as also of the first
       proviso to section 92C(2) of the said Act which apply. Therefore,
       the question of applying OECD guidelines does not arise at all.

This Court also notes that a recent decision in Sony Ericsson Mobile
Communications India Pvt. Ltd. v. CIT (dated 16.03.2015) relied extensively
on the OECD Guidelines. However, the said ruling itself recognized that the
provisions of the Act and the Rules "are supreme". Therefore, this Court
holds that where they (i.e., the Act and the Rules) adequately cover a field,
reliance on the OECD Guidelines is not warranted. At this stage, we deem it




ITA 417/2014                                                              Page 45
fit to quote the following observations of the Supreme Court in
Entertainment Network (India) Ltd. v. Super Cassette Industries Ltd. , (2008)
13 SCC 30:
       However, applicability of the International Conventions and
       Covenants, as also the resolutions, etc. for the purpose of
       interpreting domestic statute will depend upon the acceptability
       of the Conventions in question. If the country is a signatory
       thereto subject of course to the provisions of the domestic law,
       the International Covenants can be utilized. Where
       International Conventions are framed upon undertaking a great
       deal of exercise upon giving an opportunity of hearing to both
       the parties and filtered at several levels as also upon taking into
       consideration the different societal conditions in different
       countries by laying down the minimum norm, as for example, the
       ILO Conventions, the court would freely avail the benefits
       thereof. Those Conventions to which India may not be a
       signatory but have been followed by way of enactment of new
       Parliamentary statute or amendment to the existing enactment,
       recourse to International Convention is permissible.
       (emphasis supplied)

The above excerpt indicates that courts must be cautious of relying upon
international conventions to which India is not a signatory and with respect
to which there is no legislative mandate whatsoever.


In any event, the OECD Guidelines relevant herein are in consonance with
the Rules. Para 3.63 of the Guidelines states that an extreme comparable
cannot be excluded "on the sole basis that the results arising from the
proposed comparable` merely appear to be very different from the results
observed in other proposed comparables` and that "further examination
would be needed to understand the reasons for such extreme results .




ITA 417/2014                                                            Page 46
Similarly, para 3.65 states that "loss-making comparables that satisfy the
comparability analysis should not however be rejected on the sole basis that
they suffer losses. Further, para 3.64 states that "it is the facts and
circumstances surrounding the company in question that should determine
its status as a comparable, not its financial result. The same approach is
prescribed in para 3.66 for entities making supernormal profits. Therefore,
both the OECD Guidelines as well as Rule 10B (2) and 10B (3) do not, in
any manner, prescribe automatic exclusion of entities with extreme financial
results.
Similarly, insofar as the use of multiple year data is concerned, Para 3.75 of
the OECD Guidelines states that "[m]ultiple year data should be used where
they add value to the transfer pricing analysis. This is akin to the proviso
to Rule 10B(4) which provides for "data relating to a period not being more
than two years prior to such financial year [to] be considered if such data
reveals facts which could have an influence on the determination of transfer
prices in relation to the transactions being compared. Crucially, as noted
by the TPO, para 3.79 of the Guidelines states that the "use of multiple year
data does not necessarily imply the use of multiple year averages". Thus,
even if multiple year data is taken into consideration while determining the
arms length price, it may only be for the purposes of factoring in material
changes in, inter alia, economic conditions, third party variables, etc.
39.    This Court proceeds on the basis that there is sufficient guidance and
clarity in Rule 10B on the principles applicable for determination of ALP.
These include the various factors to be taken into consideration, approach to
be adopted (functions performed, taking into account risks borne and assets
employed, size of the market, the nature of competition, terms of labour,




ITA 417/2014                                                               Page 47
employment and cost of capital, geographical location etc). The extent of
accurate adjustments possible, too, is a factor to be considered. Rule 10B (3)
then underlines what the ALP determining exercise entails, if there are
dissimilarities which materially affect the price charged etc: the first attempt
has to be to eliminate the components which so materially affect the price or
cost. In other words, given the data available, if the distorting factor can be
severed and the other data used, that course has to be necessarily adopted.
40.    In the present case, this Court holds that once Brescon, Keynote and
Khandwala Securities are held to be functionally similar to the assessee,
they would be included as comparables, notwithstanding their high profit
margins, provided that the material difference on account of such high profit
margins can be eliminated under the Rule 10B(3) analysis.
41.    This Court, on a perusal of the orders of the lower authorities and the
assessees submissions before them which have been placed on record in
this appeal, finds that the assessees contentions with respect to the
exclusion of Brescon and Khandwala Securities were based only on their
exceptionally high profit margins for the assessment year in question and not
on the grounds of functional dissimilarities. Indeed, the assessee did not
contend the latter before the lower authorities. The assessee has sought to
highlight differences in the risk profiles of the assessee and Brescon in the
present appeal. However, this Court holds that such a contention cannot be
raised for the first time at this stage. Therefore, Brescon and Khandwala
Securities are held to be functionally similar, and the matter is remitted to
the DRP for the purposes of examination under Rule 10B(3) of the Rules. In
the event that the material differences arising out of the extremely high




ITA 417/2014                                                             Page 48
profits cannot be eliminated as per Rule 10B(3), these two entities will have
to be discarded as comparables.
42.    As far as Keynote is concerned, this Court notices that the assessee
had challenged its inclusion as a comparable on two grounds: a) differences
in the activities of Keynote and the assessee; and b) exceptionally high profit
margins. The TPO rejected the first ground relying on the fact that the
assessee had used it as a comparable for previous years and in the subject
assessment year as well, it qualified as a comparable based on the assessees
search process. Further, the TPO held that Keynote was engaged in financial
consultancy and would therefore be considered as a comparable. The ITAT,
for reasons unknown, did not examine this issue. This Court notes that the
assessee is engaged in the business of rendering financial research and
advisory services. It is responsible for investigation and advice to some of its
group companies on structuring potential investments and exit opportunities;
advising the group companies of investment and disposition opportunities;
collection and dissemination of financial information of prospective entities;
and other related services. On the other hand, Keynote, as per its Directors
Report for FY 2007-08, is involved in "Lead Managing IPOs, Rights Offers,
Buybacks and Takeovers. [It] also expanded its reach in Corporate Finance
& M&A Advisory." The services provided by Keynote also include
managing public issue of securities, underwriting, project appraisal, equity
research, capital restructuring, loan and lease syndication, placement
services, portfolio management, debenture trustee, managing/advising on
international offerings of debt/equity, private placement of securities, etc.
Evidently, the assessee does not provide any of these services enumerated
above. Given such functional differences and the mandate of Rule




ITA 417/2014                                                             Page 49
10B(2)(b), there could be merit in the argument that Keynote cannot be
considered a comparable for determining the ALP. The fact that the assessee
had included it in the previous assessment years does not have any bearing
on its inclusion for the subject assessment year. In this regard, this Court
relies on the Supreme Courts decision in Commissioner of Income Tax v. C.
Parakh & Co (India) Ltd, 29 ITR 661, where the Court noted:
       Whether the respondent is entitled to a particular deduction or
       not will depend on the provision of law relating thereto, and not
       on the view which it might take of its rights, and consequently, if
       the whole of the commission is under the law liable to be
       deducted against the Indian profits, the respondent cannot be
       estopped from claiming the benefit of such deduction, by reason
       of the fact that it erroneously allocated a part of it towards the
       profits earned in Karachi. What has therefore to be determined is
       whether, notwithstanding the apportionment made by the
       respondent in the profit and loss statements, the deduction is
       admissible under the law.

Further, a Division Bench of this Court in CIT v. Bharat General
Reinsurance, 81 ITR 303 has also held that there is no estoppel against law
under the Act. The Court therein held as follows:

       It is true that the assessee itself had included that dividend
       income in its return for the year in question but there is no
       estoppel in the Income tax Act and the assessee having itself
       challenged the validity of taxing the dividend during the year of
       assessment in question, it must be taken that it had resiled from
       the position which it had wrongly taken while filing the return.
       Quite apart from it, it is incumbent on the income-tax department
       to find out whether a particular income was assessable in the
       particular year or not. Merely because the assessee wrongly
       included the income in its return for a particular year, it cannot
       confer jurisdiction on the department to tax that income in that
       year even though legally such income did not pertain to that




ITA 417/2014                                                            Page 50
       year.
For the sake of completion, this Court would also deal with the assessees
reliance on the DRPs order dated 04.03.2013 (for AY 2006-07) for the
exclusion of Keynote as a comparable. The DRP directed such exclusion on
two grounds: a) the fact that Keynote was making exceptionally high profits;
and b) only single year data could be considered for determining ALP in the
present case and the volatility in profit margins of Keynote would distort the
ALP. Thus, the DRP did not examine the functional comparability of
Keynote with the assessee.
In light of the discussion above, this Court remits the matter for
consideration to the DRP to properly apply the test indicated in this
judgment and analyse the functional similarity of Keynote with the assessee.
In the event that the DRP finds them to be functionally comparable, it would
proceed to carry out the Rule 10B(3) analysis as in the case of Khandwala
Securities and Brescon.
43.    The final question that arises for this Courts determination in the
present appeal is the assessees claim for deduction under Section 36(1)(ii)
of the Act in respect of the bonus paid by it to its two shareholders - Ashish
Dhawan and Kunal Shroff. The lower authorities denied such claim, holding
that the bonus was paid to the shareholders in lieu of dividend with the
objective of avoiding tax. Such inference was drawn from two facts: a) the
bonus paid was in proportion of their shareholding in the assessee company,
i.e. 2:1; and b) no dividend had been declared by the assessee. However, a
perusal of an excerpt from the DRPs order dated 21.09.2012 quoted by the
AO in his order dated 19.10.2012 contradicts both these facts: a) bonus was
not paid in the ratio of 2:1 and b) the assessee had declared interim dividend




ITA 417/2014                                                            Page 51
of ` 5,47,47,000/-. Further, the bonuses paid to the two shareholder-directors
in the preceding two financial years were in the ratio of 60-65%:40-35%,
even though their shareholding was 1:1. The balance sheet of the assessee
placed on record also indicates that the two shareholders also hold
directorial positions in the assessee. Therefore, the assessees contention that
the bonus was paid to the shareholders in their managerial capacity, like in
the case of other managers, cannot be questioned merely on the basis of a
speculation by the revenue that such payment was to avoid tax. In such
circumstances, the deduction under Section 36(1)(ii) in respect of payment
of bonus to the two shareholder-directors is allowed. The assessee has relied
upon a number of judicial pronouncements to support its contention.
However, we do not consider it necessary to discuss those decisions for
ruling in its favour. Therefore, this question is answered in favour of the
assessee.
44.    In light of the above findings, this Court concludes as follows:
            a. The mere fact that an entity makes high/extremely high
               profits/losses does not, ipso facto, lead to its exclusion from the
               list of comparables for the purposes of determination of ALP.
               In such circumstances, an enquiry under Rule 10B(3) ought to
               be carried out, to determine as to whether the material
               differences between the assessee and the said entity can be
               eliminated. Unless such differences cannot be eliminated, the
               entity should be included as a comparable.
            b. While determining the comparability of transactions, multiple
               year data can only be included in the manner provided in Rule




ITA 417/2014                                                               Page 52
               10B(4). As a general rule, it is not open to the assessee to rely
               upon previous years data.
           c. As regards Khandwala Securities and Brescon, the matter is
               remitted to the DRP to carry out the analysis under Rule 10B(3)
               and determine whether the material differences arising out of
               their exceptionally high profits can be eliminated. If not, the
               said entities cannot be included as comparables. For Keynote,
               firstly, enquiry is to be carried out by the DRP, preceding the
               analysis under Rule 10B(3), as to its functional similarity with
               the assessee; thereafter, the exercise of determining if there are
               material differences on account of exceptionally high profits
               which are capable of elimination has to be carried out.
           d. The deduction claimed by the assessee under Section 36(1)(ii)
               of the Act, in respect of the bonuses paid to its shareholder-
               employees is allowed.
45.      The appeal is accordingly partly allowed, in the above terms. No
costs.


                                                        S. RAVINDRA BHAT
                                                                  (JUDGE)



                                                                 R.K. GAUBA
                                                                    (JUDGE)
APRIL 27, 2015




ITA 417/2014                                                              Page 53

 
 
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