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THE COMMISSIONER OF INCOME TAX-IV Vs. STRATEX NET WORKS (INDIA) PVT. LTD.
May, 30th 2013
        THE HIGH COURT OF DELHI AT NEW DELHI
%                                      Judgment delivered on: 06.05.2013

+       ITA No. 353/2011

THE COMMISSIONER OF INCOME TAX-IV                                 ... Appellant

                                        versus

STRATEX NET WORKS (INDIA) PVT. LTD.                               ... Respondent
Advocates who appeared in this case:
For the Appellant            : Mr Sanjeev Sabharwal
For the Respondent           : Dr Rakesh Gupta, Ms Rani Kiyala,
                               Mr Shubham Rastogi


CORAM:-
HON'BLE MR JUSTICE BADAR DURREZ AHMED
HON'BLE MR JUSTICE VIBHU BAKHRU

                                  JUDGMENT

BADAR DURREZ AHMED, J (ORAL)

1.      This appeal has been filed by the revenue under section 260A of
the Income Tax Act, 1961 and is directed against the order dated
30.04.2010 passed by the Income Tax Appellate Tribunal, New Delhi, in
respect of the assessment year 2004-05. The issue sought to be raised by
the learned counsel for the appellant/revenue relates to the manner in
which the profit level indicator has been computed by the Transfer
Pricing Officer for the purposes of determing the arm's length price of the
international transactions entered into between the respondent/assessee
and its associated enterprise.







ITA No. 353/2011                                                        Page 1 of 8
2.      The Assessing Officer, on receipt of the report of the Transfer
Pricing Officer under section 92CA(3) of the Income-tax Act, 1961
(hereinafter referred to as `the said Act'), finalised the assessment of the
assessee by making an addition of ` 1,19,41,893/- on account of the arm's
length price adjustment.     Being aggrieved by the said addition, the
respondent/assessee preferred an appeal before the Commissioner of
Income Tax (Appeals), who, allowed the appeal and deleted the said
addition. The revenue preferred an appeal before the Tribunal being ITA
No. 3640/Del/2007. That appeal, has been dismissed by the Tribunal by
virtue of the impugned order dated 30.04.2010. That is how the revenue
is in appeal before us.
3.      The respondent/assessee is a wholly owned subsidiary of Digital
Microwave (Mauritius) Ltd. which in turn is a wholly owned subsidiary
of Digital Microwave Corporation USA. The assessee is engaged mainly
in the undertaking for installation, commissioning and maintenance of
microwave link equipments.
4.      There is no doubt that Digital Microwave Corporation USA is an
associated enterprise of the respondent/assessee. All the equipments for
microwave links are manufactured by the said associated enterprise. The
orders in India for installation of those equipments are booked by the
respondent/assessee. However the equipments are supplied directly to the
customers in India by Digital Microwave Corporation USA. For this
activity, the respondent/assessee receives commission from the associated
enterprise. Thus, the transaction involving commission is admittedly an
international transaction. Apart from this, the equipments supplied by
Digital Microwave Corproation USA are covered under a warranty given



ITA No. 353/2011                                                 Page 2 of 8
by the said USA Company. The service under the warranty is provided by
the respondent/assessee in India. Therefore, the transaction with regard
to warranty is also an international transaction.
5.      Apart from the two admitted international transactions involving
commission and warranty, the respondent/assessee also undertakes
installation of the said equipment. It also provides for annual maintenance
under the head of re-engineering and maintenance contracts.              The
respondent/assessee, carries out these activities of installation and
maintenance in India under independent contracts. It is, therefore, the
case of the respondent/assessee that the transaction of installation and
maintenance are not international transactions but are pure and simple
domestic transactions.
6.      The point in issue before us is with regard to the manner of
computing the profit level indicator. The Transfer Pricing Officer had
adopted the Transactional Net Margin Method (TNMM) as the most
appropriate method under section 92C(1)(e) of the said Act. While doing
so, the Transfer Pricing Officer had to compute the profit level indicator
in respect of the international transactions of warranty services and
commission income. What the Transfer Pricing Officer did was to include
the operating revenue and operating cost of not only the warranty services
and commission income but also the installation/commissioning and
maintenance charges while computing the operating profit so as to
determine the profit level indicator. This would be clear from the table as
given below which has been re-produced from the Transfer Pricing
Officer's report:-




ITA No. 353/2011                                                 Page 3 of 8
        "Computation of PLI of the Assessee
               During the course of proceedings the assessee has filed a
        detail of computation of net margin from various activities.
        The operating (revenue ­ sic) and operating cost in respect of
        activities of installation and commissioning, re-engineering and
        maintenance, warranty support services and commission
        income as under:

          S.No     Activity                         Operating     Operating
          .                                         revenue       cost
          1.       Installation and commissioning     74,96,321   1,46,31,089
          2.       Re-engineering and maintenance   3,49,91,750   3,40,30,354
          3.       Warranty services                2,32,37,906   1,91,75,407
          4.       Commission income                1,47,96,910   1,16,41,215
                   Total                            8,05,22,887   7,94,78,065


        Operating Profit       =      Operating revenue - Operating cost
                               =      ` 8,05,22,887 ­ ` 7,94,79,065

                               =      ` 10,44,822/-

        PLI                    =      1.31%"


7.      After taking the profit level indicator to be 1.31%, the Transfer
Pricing Officer then went ahead with the selection of comparables and
determined the arm's length operating margin in respect of the
comparables at a figure of 16.34%. Thereafter, the Transfer Pricing
Officer determined the arm's length price in respect of the international
transactions of warranty support services and commission income as
under:-
        "Determination of Arm's Length Price
              The arm's length price of the international transactions
        entered into with the AE is computed in the flowing manner:-




ITA No. 353/2011                                                         Page 4 of 8
          Total Cost                              ` 7,94,78,065
          Operating Profit                        ` 10,44,822
          Operating Profit margin                  1.31 %
          Arm's Length Operating profit 16.34%
          Margin
          Arm's Length Operating Profit ` 1,29,86,715
          Difference     being       adjustment ` 1,19,41,893
          required


              Accordingly, the adjustment of ` 1,19,41,893/- is
        required to be made value of International transaction related to
        commission on sales and warranty support services. The
        adjustment is being made proportionately to both the
        transactions. The arm's length price of these transactions is
        computed in following manner:-

          S.No International        Value        of Proportionate   Arm's length
          .    transaction          international   adjustment      price       of
                                    transaction                     international
                                                                    transaction
          1        Warranty         2,32,37,906     72,95,302       3,50,33,208
                   support
                   service
          2        Commission       1,47,96,910     46,46,591       1,94,43,501
                   Income


               The Arm's Length Price of the international transaction
        related to warranty support services has thus been computed at
        ` 3,05,33,208/-. The (±) range of the Arm's Length Price is `
        3,20,59,868/- (+5%) to ` 2,90,06,547/- (-5%). Since the value
        of international transaction is ` 2,32,37,906/-, which falls
        outside the (± 5%) tolerance band, the assessee is not entitled to
        the benefit of proviso to sub-section (2) to section 92C of the
        Income Tax Act.
               The Arm's Length Price of the international transaction
        related to commission income has thus been computed at `
        19,45,43,501/-. The (± range of the Arm's Length Price is `
        2,04,15,676/- (+5%) to 1,84,71,325/- (-5%). Since the value of


ITA No. 353/2011                                                           Page 5 of 8
        international transaction is ` 1,47,96,910/-, which falls outside
        the (± 5%) tolerance band, the assessee is not entitled to the
        benefit of proviso to sub-section (2) to section 92C of the
        Income Tax Act.
               No adverse inference is drawn in respect of other
        international transactions."

8.      From the above, it is apparent that while computing the profit level
indicator, the Transfer Pricing Officer took into account not only the
operating revenue and operating costs of the international transactions
involving warranty services and commission income but, he also took
into account the operating revenue and operating costs of the
installation/commissioning and maintenance services which were
domestic transactions. It is also evident that the Transfer Pricing Officer,
himself, did not consider installation/commissioning and maintenance to
be international transactions inasmuch as no adjustment was made by him
in respect thereof. The adjustments made to the extent of `. 1,19,41,893/-
were only with regard to the value of international transactions relating to
commission on sales and warranty support service.
9.      Mr Sabharwal, the learned counsel appearing on behalf of the
revenue submitted that there was nothing wrong in taking the operating
cost and operating revenue of the installation and commissioning services
as also the maintenance services while computing the profit level
indicator because the said services were intricately connected with the
international transactions of warranty support services and commission
income. However, we find, on going through the order passed by the
Commissioner of Income Tax (Appeals) as also the impugned order
passed by the Tribunal, that both these authorities have returned a finding






ITA No. 353/2011                                                  Page 6 of 8
of fact that the installation/commissioning and maintenance services were
not part of the international transactions. In fact, the Tribunal held that
the installation/commissioning and maintenance agreements were
independent agreements unconnected with the transactions of warranty
support services and the transaction which generated the commission
income. The Tribunal noted that the equipment had been supplied to 40
customers           by   the   respondent's/assessee's   associated   enterprise.
However, only three of them had availed of the installation services from
the assessee. The Tribunal also noted that a corroborative circumstance
for construing the transactions of installation/commissioning and
maintenance as domestic transactions was that, in the order of the
Transfer Pricing Officer itself, no adjustment was made in respect of
these trnasactions. The Tribunal further held that since the profit level
indicator          shown by the assessee on the internationl transactions of
waranty service and commission income was 18.98%, there was no need
for any adjustment in the arm's length prices of these transactions
inasmuch as the profit level indicator of the comparables were determined
by the Transfer Pricing Officer at 16.34%, which was lower. It is in this
backdrop that the Tribunal felt that there was no reason to examine the
issue on the argument of the assessee that the Transfer Pricing Officer
had not applied the proper comparables while working out the profit level
indicator of comparables.
10.     From the foregoing discussion, it is evident that the transactions
pertaining to the installation/commissioning and maintenance services
were not international transactions as contemplated under section 92B(1).
They were also not deemed international transactions under section



ITA No. 353/2011                                                      Page 7 of 8
92B(2) of the said Act because none of the conditions stipulated therein
of a prior agreement existing between the customers of the
respondent/assessee and the associated enterparises have been established
as a fact. Moreover, there is no finding that the terms of the transaction
of installation/commissining as well as maintenance had been determined
in substance between the customers and the respondent/assessee by the
associated enterprise. In the absence of such findings, it cannot be
deemed that the transaction of installation/commissioning as well as
provision of maintenance services by the respondent to its domestic
customers in India were international transactions falling within section
92B(2) of the said Act.
11.     Consequently, the findings of fact do not support the contention
raised by Mr Sabharwal. As such, no substantial question of law arises
for the consideration of this court.
12.     The appeal is dismissed.



                                       BADAR DURREZ AHMED, J



                                              VIBHU BAKHRU, J
MAY 06, 2013
kb




ITA No. 353/2011                                                Page 8 of 8
 
 
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