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COMMISSIONER OF INCOME TAX Vs. MENTOR GRAPHICS (NOIDA) PVT.LTD.
May, 22nd 2013
             THE HIGH COURT OF DELHI AT NEW DELHI

%                                 Judgment delivered on: 04.04.2013

+       ITA No. 1114/2008

COMMISSIONER OF INCOME TAX                                 ... Appellant

                                    versus

MENTOR GRAPHICS (NOIDA) PVT.LTD.                           ... Respondent

Advocates who appeared in this case:
For the Appellant    : Ms Suruchii Aggarwal
For the Respondent   : Mr M.S. Syali, Sr. Adv. with Ms Husnal Syali,
                       Mr Mayank Nagi.

CORAM:-
HON'BLE MR JUSTICE BADAR DURREZ AHMED
HON'BLE MR JUSTICE R.V.EASWAR

                                JUDGMENT

BADAR DURREZ AHMED, J (ORAL)


1.      In this appeal, the revenue has challenged the order of the Income
Tax Appellate Tribunal, dated 02.11.2007, passed in ITA No.
1969/Del/2006, relating to the assessment year 2002-03. By virtue of an
order dated 13.01.2011, a Division Bench of this court, while admitting
the appeal, had framed the following substantial question of law:-


             "(i) Whether the finding of the Tribunal that if any
             one margin of a comparable, in a given set of
             comparables is lower than the margin of the taxpayer,


ITA No. 1114/2008                                                Page 1 of 26
             then the transactions are at arm's length, is correct in
             view of the express provisions contained in proviso to
             Section 92C(2) of the Income-tax Act, 1961?"

2.      The counsel for the parties agreed that the above question needs to

be re-framed in the following manner:-

        "(i) Whether, in view of the first proviso to section 92C(2) of
        the Income-tax Act, 1961, the Tribunal was correct in holding
        that if one profit level indicator of a comparable, out of a set of
        comparables, is lower than the profit level indicator of the
        taxpayer, then the transactions reported by the taxpayer is at an
        arm's length price as contemplated in sections 92, 92C and
        other related provisions of the said Act?"

3.      This question has specifically arisen because of the observation of

the Tribunal in paragraph 46.2 of the impugned order which reads as

under:-

        " 46.2        While holding so, we have not adopted mean profit
        of several comparable found by respective parties because in
        spite of our repeated requests, the parties before us, were unable
        to show us any rule or decision under which average or mean
        margin (OP/TC) of different companies is to be taken. Tax
        administration and parties can work different Arm's length
        price i.e. a range by the application of different methods. In
        such a situation, mean of Arm's Length Price as provided in
        proviso to Section 92C(2) of the Act can be taken. But above
        Arm's length range is not the same thing as average operating
        profits of different entities with different FAR worked through
        the same method as done in this case by adopting TNMM. The
        assessee has satisfied not one but several points of arms's
        length range worked out on record. In our considered view, it
        is not necessary for the taxpayer to satisfy all points in the
        range. Even if one point is satisfied, the assessee can be taken to






ITA No. 1114/2008                                                       Page 2 of 26
        have established its case and in that situation, the onus is shifted
        to the department to show why taxpayer's case be not accepted.
        Arm's length price does not mean maximum price or maximum
        profit in the range. A willing buyer in an open market shall pay
        minimum and not maximum price for goods or services. Of
        course, quality and brand name are important but considered
        not so by T.P.O. as TNMM method was applied by him.
        Project profile and other factors were, therefore, not
        erroneously considered. As noted earlier, the case of integrated
        Hitech has been specifically accepted as comparable by both
        the parties. On other four cases noted above, the T.P.O. or
        other revenue authorities have not made any adverse comment
        at any stage of proceeding. It was open to them in proceedings
        before the learned CIT(A) or the Appellate Tribunal to show
        that PIL figure of integrated Hitech or other four companies
        were wrong or on account of their FAR analysis, these entities
        could not be taken as "reliable" comparables for computation of
        the Arm's Length Price. But no material was brought on record,
        no arguments advanced to reject the above transaction.
        Therefore, having regard to facts of the case and material on
        record, we accept them as comparable and accept the price
        disclosed by the taxpayer as Arm's Length Price.
        Consequently, the addition of `. 1,45,73,857 is directed to be
        deleted. The view taken by us finds support from para 1.4 of
        OECD guideline which we quote below:-

                    "1.48 If the relevant conditions of the controlled
                    transactions (e.g. price or margin) are within the
                    arm's length range, no adjustment should be made.
                    If the relevant conditions of the controlled
                    transaction (e.g. price or margin) fall outside the
                    arm's length range asserted by the tax
                    administration, the taxpayer should have the
                    opportunity to present arguments that the
                    conditions of the transaction satisfy the arm's
                    length principle, and that the arm's length range
                    includes their results. If the taxpayer is unable to
                    establish this fact, the tax administration must



ITA No. 1114/2008                                                          Page 3 of 26
                    determine how to adjust the conditions of the
                    controlled transaction taking into account the
                    arm's length rante. It could be argued that any
                    point in the range nevertheless satisfies the arm's
                    length principle."

4.      Insofar as the above observations are concerned, we may

straightway refer to the relevant provisions of the Income-tax Act, 1961

(hereinafter referred to as `the said Act'). Chapter X deals with special

provisions relating to avoidance of tax. Section 92, which is the first

section in that chapter, stipulates that any income arising from an

international transaction is to be computed having regard to the arm's

length price. "Arm's length price" is defined in section 92F to mean a

price which is applied or proposed to be applied in a transaction between

persons other than associated enterprises, in uncontrolled conditions. It

may be pointed out at this juncture that the respondent/assessee is an

Indian company which was incorporated in 1998. It is a wholly owned

subsidiary of IKOS System Inc., a company incorporated in USA and

engaged in the business of software development and also in rendering

marketing systems services to the parent company. The present case, as

pointed out above relates to the assessment year 2002-03 pertaining to the




ITA No. 1114/2008                                                         Page 4 of 26
financial year 2001-02 in respect of which the respondent/assessee filed

its return of income on 31.10.2002.

5.      The respondent/assessee develops software but does so only upon

the instructions of its parent associated enterprise, that is, IKOS Systems

Inc.     It does not create/develop/sell separate software products or

packages and the entire software developed by the respondent/assessee is

used by the parent associated enterprise captively for integrating the same

with other software components developed by IKOS Systems Inc. The

integrated software in turn supports the hardware manufactured by IKOS

Systems Inc. and is sold as a separate package in the open market by the

latter company.     It is, therefore, clear that the respondent/assessee's

business is limited to providing services of software development support

entirely to its parent company, that is, IKOS System Inc.

6.      From the accounts and the auditors report it appears that the

respondent/assessee carried on two sets of transactions with its parent

company. One set related to the export of software development services

and the other set pertained to the export of marketing support service. In

the present appeal we are not concerned with the latter set but are only

concerned with the export of software development service, being the




ITA No. 1114/2008                                                Page 5 of 26
international transaction for which the arm's length price is to be

determined.

7.      Upon the filing of the return by the respondent/assessee, the

assessing officer referred the matter to the Transfer Pricing Officer under

section 92CA of the said Act for determination of the arm's length price.

At this juncture it would be relevant to note the provisions of section

92C, to the extent relevant, which reads as under:-

        "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:



ITA No. 1114/2008                                                       Page 6 of 26
        xxx               xxx                 xxx                 xxx

        (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--

                    (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."



ITA No. 1114/2008                                                        Page 7 of 26
In view of the above provisions, it is apparent that the arm's length price

in relation to an international transaction has to be determined by

following one of the methods prescribed in sub-section (1) of section

92C. In the present case there is no dispute that it is the transactional net

margin method (TNMM) which is the most appropriate method and

which had been adopted both by the respondent/assessee as well as by the

Transfer Pricing Officer. The proviso to sub-section (2) of section 92C

makes it clear that where more than one price is determined by

employing the most appropriate method, the arm's length price shall be

taken to be the arithmetical mean of such prices. There is no dispute that

the prices which are to be considered while computing the arithmetical

mean      as indicated in the said proviso are all prices determined by

following any one of the methods stipulated in section 92C(1). It does

not have any reference to prices being determined by more than one

method. This is so because the reference is to the price determined by the

most appropriate method and that can be only one method. We have

already indicated above that in the present case the most appropriate

method, as accepted both by the respondent/assessee and by the revenue,



ITA No. 1114/2008                                                 Page 8 of 26
was the transactional net margin method. The dispute that has arisen in

the present case is with regard to the observation of the Tribunal to the

effect that where one of the prices determined by the most appropriate

method is less than the price as indicated by the respondent/assessee, that

may be selected and there would be no need to adopt the process of

taking the arithmetical mean of all the prices arrived at through the

employment of the most appropriate method. That observation of the

Tribunal, we may say straightway, is incorrect. When more prices than

one are thrown up by the most appropriate method, the statute requires

that the arm's length price shall be taken to be the arithmetical mean of

such prices. This is the plain and simple meaning of the proviso to

section 92C(2) of the said Act.

8.      Having said so, we may now notice the provisions of sub-section

(3) of section 92C which we have already extracted above. A reading of

the said provision makes it clear that if the assessing officer in the course

of any proceeding of assessment, on the basis of material or information

or documents in his possession, is of the opinion that any of the 4

conditions (a) to (d) stipulated in sub-section (3) are satisfied then, the

assessing officer may proceed to determine the arm's length price in




ITA No. 1114/2008                                                 Page 9 of 26
relation to the international transaction in accordance with the provisions

of sub-section (1) and sub-section (2) of section 92C on the basis of such

material or information or documents available with him. Provided, of

course, that an opportunity is given by the assessing officer to the

assessee to show cause as to 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.      In other words, in the aforesaid

circumstances the assessing officer may himself embark upon the

determination of the arm's length price. However, where the assessing

officer considers it necessary to do so, he may with the previous approval

of the commissioner, refer the computation of the arm's length price to

the Transfer Pricing Officer. This is provided in section 92CA of the said

Act which, to the extent relevant, reads as under:-


        "92CA. (1) Where any person, being the assessee, has
        entered into an international transaction [or specified
        domestic transaction] in any previous year, and the
        Assessing Officer considers it necessary or expedient so to
        do, he may, with the previous approval of the Commissioner,
        refer the computation of the arm's length price in relation to
        the said international transaction [or specified domestic
        transaction] under section 92C to the Transfer Pricing
        Officer.

        xxx         xxx          xxx          xxx          xxx




ITA No. 1114/2008                                                 Page 10 of 26
        (3) On the date specified in the notice under sub-section (2),
        or as soon thereafter as may be, after hearing such evidence
        as the assessee may produce, including any information or
        documents referred to in sub-section (3) of section 92D and
        after considering such evidence as the Transfer Pricing
        Officer may require on any specified points and after taking
        into account all relevant materials which he has gathered, the
        Transfer Pricing Officer shall, by order in writing, determine
        the arm's length price in relation to the international
        transaction [or specified domestic transaction] in accordance
        with sub-section (3) of section 92C and send a copy of his
        order to the Assessing Officer and to the assessee."


9.      Coming back to the facts of the present case, the assessing officer

while considering the assessment of income of the respondent/assessee

had, in terms of section 92CA(1) of the said Act referred the computation

of arm's length price to the Transfer Pricing Officer. That being the

position, it is clear that the Transfer Pricing Officer, in view of the

provisions of section 92CA(3), was also required to follow the same

methodology and approach as was incumbent upon the assessing officer

under section 92C(3) of the said Act. In other words, the Transfer

Pricing Officer would have to, first, form an opinion that any of the four

conditions (a) to (d) set out in sub-section (3) of section 92C existed and

then he could proceed to determine the arm's length price in relation to

the international transactions in question in accordance with sub-sections




ITA No. 1114/2008                                                 Page 11 of 26
(1) and (2) of section 92C on the basis of such material or informaction

or document available with him.       After the Transfer Pricing Officer

determines the arm's length price, it is incumbent upon him to send a

copy of the order to the assessing officer and to the assessee. In the

present case what has happened is that the Transfer Pricing Officer has

generally rejected the comparables submitted by the respondent/assessee

in his transfer pricing report and has rejected the suggested arm's length

price based on a profit level indicator of 6.99% as determined by the

respondent/assessee and, in place thereof, the Transfer Pricing Officer

adopted a profit level indicator of 24.53% and determined the arm's

length price of the international transactions at `. 10,34,40,177/- as

against `. 8,88,66,320/- returned by the respondent/assessee.           This

resulted in an adjustment of `. 1,45,73,857/- in the income of the assessee

being the difference between the arm's length price and the price charged

by the assessee from its associated enterprise (IKOS System Inc.) for

rendering services to them. Thereafter, the assessing officer passed the

assessment order on 28.03.2005, inter alia, after making the aforesaid

addition. We are not concerned with the other aspects of the assessment

order.




ITA No. 1114/2008                                                Page 12 of 26
10.     The CIT (Appeals) confirmed the said addition by virtue of an

order dated 30.03.2006. Being aggrieved by the said order, the

respondent/assessee preferred an appeal before the Income Tax Appellate

Tribunal which has been allowed by the said Tribunal. The revenue is in

appeal before us. While allowing the respondent/assessee's appeal, the

Tribunal made the observations in paragraph 46.2, which we have

already extracted above, to which serious exception was taken by the

revenue. We have already indicated that the question that has been

framed, has to be decided in favour of the revenue and against the

respondent/assessee. But, the matter does not end there inasmuch as we

have to also examine as to what is the effect of such an answer.

11.     It may be pointed out that the Transfer Pricing Officer had rejected

the comparables submitted by the respondent/assessee. However, that

rejection was of all comparables, generally. None of the 16 comparables

submitted by the respondent/assessee were specifically rejected. The

manner in which the comparables were rejected is indicated in Para 7.2 of

the Transfer Pricing Officer's order, which reads as under:-

       "7.2 An analysis of the comparables used by the
       assessee and the search criteria used by it was carried
       out and it was observed that :




ITA No. 1114/2008                                                  Page 13 of 26
              The assessee has not eliminated the companies
              which are not comparable in terms of their size
              i.e. their turnover. It has included all the
              companies without giving any consideration
              to the fact that certain comparable
              companies are new in the business and their
              profits are more likely to be low in initial years.
              The assessee has not used the data for the year
              2002, which is not in line with the
              provisions of Transfer pricing.
              The assessee has rejected certain companies
              stating that they have different product
              profile, which cannot be considered as valid
              reason since while adopting TNMM, the base
              has to be a larger one so as to eliminate
              various functional differences. Further, had
              the product profile to be matched, then even
              all those comparables which were finally
              selected should not have been there since
              n o n e o f t h e m i s i n t o d e v e l o p me n t o f
              c h i p d e s i g n software, which is the main
              business of the assessee.
              Companies having high ratio of trading,
              activity were not excluded."
12.     It may be clarified that while six companies have been specifically

mentioned in the Transfer Pricing Officer's order, there is no such

specific elimination in respect of the other ten comparables. Insofar as

the aforesaid six comparable companies are concerned, the observations

of the Transfer Pricing Officer were as under:-




ITA No. 1114/2008                                                        Page 14 of 26
        "7.5 On 20.01.2005 the assessee was again asked to
        explain as to why the companies having substantially
        low turnover as compared to that of the assessee,
        companies engaged primarily in manufacturing activity
        and companies with low employee cost (as software
        development      companies      typically    have    high
        wages/salaries to total sales ratio), may not be
        eliminated. The list of such companies is as under :



                       Name of the company             Reason for
                                                       elimination
                     Kushagra Software Ltd.         Manufacturing
                                                    concern
                     lntergrated Hitech Ltd.        Low turnover
                     Fare C Software Ltd.           Low employee
                                                    cost
                     Luminaire technologies         Low turnover
                     Ltd.
                     Pentagon globalSolutions       Low employee
                                                    cost. Engaged in
                     Ltd.                           manufacturing
                                                    activity
                     O C L Informatics Ltd.         Low turnover"



13.     On an examination of paragraph 7.2 of the Transfer Pricing

Officer's order, it is apparent that the general grounds for rejection of the

comparables submitted by the respondent/assessee were as under:-

        (a)         The companies suggested by the respondent/assessee
                    were actually not comparable inasmuch as their turnovers
                    were widely different;




ITA No. 1114/2008                                                      Page 15 of 26
        (b)         The respondent/assessee had not used the data of the
                    financial year ending 31.03.2002 which was the relevant
                    year for the purposes of determination of the arm's length
                    price;

        (c)         The respondent/assessee did not include companies in its
                    list of comparables which had a different product profile.
                    According to the Transfer Pricing Officer, companies
                    having different product profiles also ought to have been
                    included inasmuch as the TNMM method for arriving at
                    the arm's length price allowed for functional differences,
                    which included differences in product profiles;

        (d)         The comparable companies suggested by the assessee
                    were not companies involved in chip design software;
                    and

        (e)         The companies having a high ratio of trading activity had
                    not been excluded by the respondent/assessee from its list
                    of comparables."

14.     We find that while these were the general reasons cited by the

Transfer Pricing Officer for rejecting the comparables suggested by the

respondent/assessee, the Transfer Pricing Officer had not indicated as to

how each of the comparables suggested by the respondent/assessee did

not fulfil the criteria which was adopted by him. The Transfer Pricing

Officer suggested that the following filters should have been employed

while searching out the comparables:-

        (1)         Companies engaged in software development having annual
                    turnovers between `.50 lakhs and `.100 crores;







ITA No. 1114/2008                                                      Page 16 of 26
        (2)         Companies whose employees' cost is more than 10% of the
                    turnover;

        (3)         Companies whose sales from manufacturing and trading
                    does not exceed 10% of the total sales; and

        (4)          Companies which do not have any related party
                    transactions.

15.     Based upon the said filters, the Transfer Pricing Officer conducted

his own search from the `Prowess' and `Capitaline' databases and the

Nasscom directory and short listed seven companies as under:-

        "Name of the company                     OP/TC (F.Y.2001-02)

        Blue Star Infotech Ltd.                        27.18%
        Ideaspace Solutions Ltd.                       20.69%
        Integrate Hitech Ltd.                          3.16%
        NIIT Gis Ltd.                                  28.80%
        Quintegra Solutions Ltd.                       37.89%
        Sark Systems India Ltd.                        27.91%
        Teledata Informatics Ltd.                      32.99%

        Average OP/TC                                  26.94%"


16.     The respondent/assessee submitted that all the companies other

than Quintegra Solutions Ltd and Sark Systems India Ltd had either a

foreign parent or subsidiary company and therefore might be involved in

related party transactions and therefore could not be considered to be

comparables.          The respondent/assessee also submitted that insofar as




ITA No. 1114/2008                                                  Page 17 of 26
Quintegra Solutions Ltd was concerned it ought to be eliminated because

it had a different product profile. The Transfer Pricing Officer accepted

the contentions of the respondent/assessee with regard to Blue Star

Infotech Ltd. and NIIT Gis Ltd. and excluded those companies from the

list of comparables. However, the Transfer Pricing Officer rejected the

objections of the respondent/assessee with regard to the other suggested

comparables. As a result, the Transfer Pricing Officer finalised his list of

comparable companies as under:-

       "7.8 In view of the above discussions, the following list of
       comparable companies are finally chosen for analysis.

       Name of the company                OP/TC (F.Y.2001-02)
       Ideaspace Solutions Ltd.           20.69%
       Integrated Hitech Ltd.             3.16%
       Quintegra Solutions Ltd.           37.89%
       Sark Systems India Ltd.            27.91%
       Teledata Informatics Ltd.          32.99%
       Average OP/TC                      24.53%

       Hence, the arithmetic mean of operating profit over the total cost
       margins of the comparable companies for the financial year
       2001-02 works out to 24.53%. The arm's length price of the
       international transactions entered into by the assessee with its
       AE is worked out as under.
       Total cost of provision of services
       by the assessee                              `. 8,30,64,464/-

       Margin @ 24.53% of the above                  `. 2,03,75,713/-

       Arms length price to be charged



ITA No. 1114/2008                                                 Page 18 of 26
       From the AE                                  `. 10,34,40,177/-"



17.     While rejecting the objections of the respondent/assessee with

regard to difference in the product profile insofar as Quintegra Solutions

Ltd. was concerned, the Transfer Pricing Officer, inter alia, observed that

the transactional net margin method was more tolerant to minor

functional differences and was less effected by the transactional

differences and in doing so the Tranfer Pricing Officer referred to

paragraph 3.27 of the OECD Report on Transfer Pricing Guidelines for

Multinational Enterprises and Tax Administrations, July 1995.

18.     We may also note that while rejecting the objections of the

respondent/assessee with regard to the comparables which were taken by

the Transfer Pricing Officer, the data for the relevant year, that is,

financial year ending 31.03.2002 was not available in the database.

However, the Transfer Pricing Officer took the data of the subsequent

year namely the financial year 2003-04 as an indication of the quantum

of related party transactions that might have taken place in the relevant

year, that is, financial year ending 31.03.2002. This, as will be pointed

out subsequently, was found to be erroneous by the Tribunal inasmuch as

the Transfer Pricing Officer could only examine the data for the relevant



ITA No. 1114/2008                                                Page 19 of 26
year and, if at all, of two years prior to the relevant year in terms of rule

10B(4) of the Income-tax Rules, 1962 (hereinafter referred to as `the said

Rules').

19.     The Tribunal while allowing the appeal of the respondent/assessee

noted that the comparables furnished by the Transfer Pricing Officer

ought to be rejected because, first of all, the Transfer Pricing Officer used

data of 2003-04 which could not be used in view of the specific

provisions of rule 10B(4) of the said Rules. Secondly, the Transfer

Pricing Officer did not do any functional asset risk (FAR) analysis and

was of the view that insofar as the TNMM method was concerned it was

more tolerant to functional differences and was less effected by

transactional differences and for this, the Transfer Pricing Officer relied

on para 7.2 of the OECD guidelines referred to above. According to the

Tribunal this was contrary to the provisions of rule 10B(2)(3) as well as

rule 10B(1)(e). The Tribunal also found that the range of turnovers which

was employed by the Transfer Pricing Officer for filtering in

comparables was far too wide inasmuch as the Transfer Pricing Officer

had considered the range of `.50 lakhs to `.100 crores whereas the

turnover of the respondent/assessee was only `.8.8 crores. It may be




ITA No. 1114/2008                                                 Page 20 of 26
pointed out that the respondent/assessee, while selecting its comparables

in its Transfer Pricing Report, had taken the range of `.47 lakhs to

`.25.71 crores.       Thirdly, the Tribunal returned the finding that the

Transfer Pricing Officer should not have rejected the comparables

selected by the respondent/assessee. Apart from this, the Tribunal also

held that the Transfer Pricing Officer had wrongly adopted the criteria of

low employee cost as a percentage of turnover and that such a criteria

ought not to have been employed in selecting comparables. It is also

observed by the Tribunal that a fresh search for comparables could be

done by the Transfer Pricing Officer only if comparables drawn by the

respondent/assessee were insufficient or had other deficiencies.

According to the learned counsel for the appellant/revenue this

observation is contrary to law.

20.     The Tribunal then set out the respondent/assessee's comparables

after applying all of the Transfer Pricing Officer rejection criteria and

came to the conclusion that seven companies fulfilled the criteria of being

comparables. Those seven companies are indicated herein below:-

      "S.                   Company                 OP/TC (FY
      No.                                          2001-02 Data)
      1.        C S Software Enterprise Ltd.       -25.12%



ITA No. 1114/2008                                                Page 21 of 26
      2.        Integrated Hitech Ltd.            3.16%
      3.       Reynolds Software Solutions Ltd.   0.47%
               (formerly Known as 'Shine
               Computech Ltd.')
      4.       Sark Systems India Ltd.            27.91%
     5.         V J I L Consulting Ltd.           5.24%
    6.          Visu International Ltd.           -2.76%
    7.          Zigma Software Ltd.               16.38%
                Arithmetic Mean                   3.61%"



It will be observed that the arithmatic mean of the profit level indicator

(Operating Profit/Total Cost) came to 3.61% as against 6.99% of the

respondent/assessee. The Tribunal also noted that the Transfer Pricing

Officer had not made any adverse comment against eight companies

which had been suggested as comparables by the respondent/assessee.

Those eight companies were as under:-



           "S.No.      Company                             OP/TC
           1.          MYM Technologies                    4.81%
           3.          VJIL Consulting                     5.24%
           5.          Zigna Software                      16.38%
           6.          Sark Systems                        30.00%
           8.          Shine Computech                     0.47%
           10.         Visu Cybertech                      -2.76%
           11.         CS Software                         -25.12%
           15.         VGL Softech                         6.74%



ITA No. 1114/2008                                               Page 22 of 26
           16.      Top Media Entertainment                No data
                                                           available
                    Mean                                   4.47%"


From the aforesaid table it is apparent that although there are nine

companies listed, only eight are relevant inasmuch as there is no data for

Top Media Entertaintment. The arithimatical mean of the PLI in the

cases of these eight companies also comes to 4.47% which is again lower

than the PLI of the respondent/assessee which was 6.99% for the relevant

year.

21.     The sum and substance of the Tribunal's order is that the criteria

adopted by the Transfer Pricing Officer for searching comparables was

not correct. Secondly, the Transfer Pricing Officer had not specifically

rejected any of the comparables of the respondent/assessee. The Tribunal

was of the view that the comparables of the respondent/assesse ought to

have been accepted and, had that been the case, there would have been no

need for the Transfer Pricing Officer 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 tax payer

were rejected, a fresh search by the Transfer Pricing Officer could not be

conducted. However, this has to be tempered with the relevant statutory



ITA No. 1114/2008                                               Page 23 of 26
provisions which are clearly set out in sub-section (3) of section 92C of

the said Act which stipulates four situations whereunder the assessing

officer/ Transfer Pricing Officer may proceed to determine the arm's

length price in relation to an international transaction. If any one of those

four conditions are satisfied, it would be open to the assessing

officer/Transfer Pricing Officer to proceed to determine the arm's length

price. 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 paragraph 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

Transfer Pricing Officer were to be rejected. The only option then left to

the Tribunal was to derive the arithmetical mean of the profit level

indicators 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 profit level indicator out of a set of profit




ITA No. 1114/2008                                                 Page 24 of 26
level indicators 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 inasmuch as even if the arithmetical mean of

the comparables as accepted by the Tribunal are taken into account, the

profit level indicator would, whether the seven companies are taken into

consideration or all eight companies are taken into consideration, be less

than 6.99 % which is the profit level indicator of the respondent/assessee

for the relevant year, that is, financial year ending 31.03.2002. 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 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.

23.     From the foregoing discussion, it is clear that the Tribunal was

wrong in holding that if one profit level indicator of a comparable, out of

a set of comparables, is lower than the profit level indicator of the




ITA No. 1114/2008                                                  Page 25 of 26
taxpayer, then the transaction reported by the taxpayer is at an arm's

length price. The proviso to section 92C(2) is explicit that where more

than one price is determined by most appropriate method, the arm's

length price shall be taken to be the arithmetical mean of such prices. To

this extent the appeal is allowed. However, as pointed out above, if this

principle is applied to the comparables suggested by the assessee (which

have not been rejected by the Transfer Pricing Officer), the arm's length

price suggested by the assessee would yet be acceptable in law. There

shall be no orders as to costs.



                                      BADAR DURREZ AHMED, J




                                              R.V.EASWAR, J
APRIL 04, 2013
kb




ITA No. 1114/2008                                               Page 26 of 26
 
 
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