Ciena India Private Limited, Gurgaon vs Assessee

(Appellant) (Respondent) Assessee By : Shri Himanshu S. Sinha, Advocate & Shri Md. Fahad Khalid, CA Department By : Shri Judy James, Standing Counsel

Date of Hearing : 22.04.2015 Date of Pronouncement : 24.04.2015 ORDER PER R.S. SYAL, AM:

This appeal by the assessee arises out of the final order passed by

the AO on 30.01.2014 u/s 143(3) read with section 144C(13) of the

Income-tax Act, 1961 (hereinafter also called 'the Act') in relation to

the assessment year 2009-10.

ITA No.1453/Del/2014

2. Certain grounds raised in this appeal were either not pressed or

stated to be general not requiring any specific adjudication. Such

grounds stand dismissed.

3. The first issue argued by the ld. AR is against addition on account

of transfer pricing adjustment of Rs.15,43,32,633/- in respect of

international transaction of 'Provision of contract R&D services.'

4. Briefly stated, the facts of the case are that the assessee is a wholly

owned subsidiary of Ciena Corporation, USA and is engaged in the

business of provision of software development services and marketing

support services to its overseas group companies. The assessee reported

certain international transactions. The Assessing Officer (AO) referred

the international transactions to the Transfer Pricing Officer (TPO) for

determination of their Arm's Length Price (ALP). The first dispute is

qua the international transaction of `Provision of software development

services' also referred to as `Provision of contract R&D services' with

transacted value of Rs.1,35,29,54,809/-. The assessee applied the

Transactional Net Margin Method (TNMM) as the most appropriate

2 ITA No.1453/Del/2014

method with the Profit level indicator (PLI) of Operating Profit to Total

Cost (OP/TC) to explain that it was at ALP. The assessee declared profit

margin under this segment at 13%. In order to demonstrate that the

services were provided at arm's length price, it chose 20 companies as

comparables with their average PLI at 14.4%. The TPO rejected 15 out

of such 20 companies and added two new companies to make a final

tally of comparable companies at 7, with their average OP/TC at

25.89%. Following is the final list of comparable companies chosen by

the TPO with their respective profit margins:-

Sl.No. Name of the Company Margins)

1. Akshay Software Technologies ltd. 12.41

2. LGS Global Ltd. 21.26

3. Neilsoft Limited 15.54

4. Sasken Communication Technologies Ltd. 15.99

5. Zylog System Ltd. 15

6. Bodhtree Consulting Ltd. 68.63

7. Infosys Technologies Ltd. 40.94

AVG 27.11

3 ITA No.1453/Del/2014

5. After entertaining the objections raised by the assessee, the TPO

proposed transfer pricing adjustment of Rs.16,89,39,756/-. The assessee

raised objections before the Dispute Resolution Panel (DRP). The Panel

gave certain directions to the TPO and directed to re-determine the ALP

accordingly. Following the directions given by the DRP, the TPO

passed order on 29.1.2014 and re-determined the ALP of this

international transaction at Rs.1,50,72,87,442/-, which led to the

addition on account of transfer pricing adjustment to the tune of

Rs.15.43 crore. The assessee is aggrieved against the making of this

addition.

6. We have heard the rival submissions and perused the relevant

material on record. It can be seen from the orders of the authorities

below that the assessee's adoption of TNMM as the most appropriate

method with the PLI of OP/TC have not been disturbed. The assessee is

aggrieved on two scores on this international transaction, viz., firstly,

against the inclusion/exclusion of certain companies in/from the final list

of comparables and secondly, not allowing the risk adjustment.

4 ITA No.1453/Del/2014

7. First, we are espousing the inclusion/exclusion of certain

companies. Before embarking on the exercise of making comparison of

the companies presently assailed by the assessee, it is significant to first

consider the functional profile of the assessee under this segment. It can

be seen from the TPO's order that he has stated the assessee to be

primarily engaged in the provision of software development services to

its AE. It has also been stated that the role of the assessee is to execute

the work sub-contracted by its AE. We have gone through the assessee's

TP study report, a copy of which is available on pages 11-155 of the

paper book, from which it can be noticed that the Ciena Group is a

supplier of communications networking equipment, software and

services that support the delivery and transport of voice, video and data

services. The products of Ciena Group include optical networking,

broadband networking and data networking products along with network

and services management software used in communication networks and

followed by telecommunications service providers across the globe. The

Group specializes in transitioning legacy communications networks to

be converged, next generation architecture capable of delivering a mix 5 ITA No.1453/Del/2014

of high band width services. The assessee is engaged in design,

development and maintenance of software, which essentially includes

the activities, namely, Software development services; Procurement,

research and technology; Development of design; After-sales activity;

and Accounting/administration. The assessee provides contractual

software development services to its group company alone. These

services include maintenance and updation activities. The assessee is

compensated by its USA Associated enterprise (AE) with aggregate of

direct and indirect costs incurred by it in performing the services to

Ciena, USA plus suitable mark-up to be decided on agreed basis from

time to time. For the year under consideration, the assessee was allowed

a mark-up of 13%. As per the Agreement entered into between the

assessee and Ciena, USA, there is a Confidentiality clause by which all

information communicated to one party by the other can be used only

for the purposes of this Agreement. Clause 9 of the Agreement is

captioned as 'Intellectual Property Rights.' This clause provides that the

assessee, at no time, shall acquire or retain any right, title or interest

whatsoever in the work done by it. This clause further provides that the 6 ITA No.1453/Del/2014

intellectual property rights in the format, presentation, procedures,

process, computer software and other material of whatever nature

created, developed or enhanced by Ciena India in the course of

providing the services to Ciena, USA 'shall be and remain the sole

property of Ciena, USA absolutely.' From the above clauses of the

Agreement, it is manifest that the assessee is simply a captive unit

providing software development services to its AE without acquiring or

retaining any intellectual property rights in the work done by it for and

on behalf of its foreign AE, for which it is compensated with actual costs

incurred plus 13% mark up. Total operating revenue of the assessee

from this segment stands at Rs.135.29 crore with the operating costs at

Rs.119.73 crore, giving profit before interest and tax at Rs.15.56 crore

with profit ratio of 13%. With above understanding of the nature of

services provided by the assessee to its AEs under this segment, we will

take up the disputed companies, one by one, for consideration as to their

comparability.

7 ITA No.1453/Del/2014

Infosys Technologies Ltd.

8.1. The TPO noticed that this company was finding place in the

accept/reject matrix but was rejected in the TP documentation by

claiming that it failed functional area comparability. The TPO found

this company to be into software development services qualifying all the

filters applied by him. The assessee raised certain objections against the

inclusion of this company, but without any success. The TPO computed

operating profit margin of this company at 40.94% and included it in the

final list of comparables. The assessee is aggrieved against the inclusion

of this company in the ultimate set of comparables.

8.2. We have considered the rival submissions and perused the relevant

material on record. It can be seen that the TPO has included this

company in the list of comparables by rejecting the assessee's

contention about the brand of this company helping in earning huge

profits and also the brand-related profits swelling the ultimate profit rate

of this company. We find that the assessee is only a captive unit

rendering services to its AE alone without acquiring any intellectual

8 ITA No.1453/Del/2014

property rights in the work done by it in the development of software.

The Hon'ble Delhi High Court in CIT vs. Agnity India Technologies (P)

Ltd. (2013) 219 Taxmann 26 (Del) considered the giantness of Infosys

Ltd., in terms of risk profile, nature of services, number of employees,

ownership of branded products and brand related profits, etc. in

comparison with such factors prevailing in the case of Agnity India

Technologies Pvt. Ltd., being, a captive unit providing software

development services without having any IP rights in the work done by

it. After making comparison of various factors as enumerated above, the

Hon'ble Delhi High Court held Infosys Ltd. to be incomparable with

Agnity India Technologies Pvt. Ltd. The facts of the instant case are

more or less similar inasmuch as the extant assessee is also a captive

service provider with a limited number of employees at its disposal and

also not owning any branded products but, rendering only offshore

services with no expenditure on R&D etc. When we consider all the

above factors in a holistic manner, there remains absolutely no doubt in

our mind that Infosys Technologies Ltd. is incomparable to the assessee

company. Respectfully following the judgment of the Hon'ble 9 ITA No.1453/Del/2014

jurisdictional High Court in Agnity India (supra), we hold that Infosys

Technologies Ltd., cannot be held as comparable with the assessee

company. This company is, therefore, directed to be excluded from the

list of comparables.

Bodhtree Consulting Ltd.

9.1. The TPO treated Bodhtree Consulting Ltd. as one of the

comparables. The assessee objected to the inclusion of this company on

the ground of functional dissimilarity and its fluctuating profit margins.

The TPO rejected the assessee's contention about the super normal

profits earned by this company during the year and also held the same to

be functionally similar inasmuch as it having only one identifiable

reporting segment, i.e., software development services. The assessee is

upset with the inclusion of this company in the final list of comparables.

9.2. After considering the rival submissions and perusing the relevant

material on record, we find from the Annual report of this company, a

copy of which is available on pages 951 onwards of the paper book, that

it has only one segment, namely, software development. It is engaged

10 ITA No.1453/Del/2014

in providing open and end-to-end web solutions, off-shoring data

management, design and development of solutions. When we consider

the nature of services provided by the assessee under this segment,

namely, software development, there remains no doubt that functionally

Bodhtree Consulting Ltd. is a comparable entity.

9.3. As regards the fluctuating profit margins of this company over the

years, we find from the extractions made in the TPO's order that the

ratio of profit before income-tax to sales for the financial year 2007-08

was at 15.63% which, for the instant year, increased to 44.49%. In the

immediately succeeding year, the profit rate came down to 22.38% and

in the financial year 2010-11, the company has reported loss of (-)

1.89%. Before evaluating the contention of the ld. AR on this aspect, we

want to make it clear that high or low profit margin of a company cannot

be considered as a criteria for treating it as incomparable.

Notwithstanding the simplicitor higher or lower profit margin, a

company otherwise comparable, cannot be ignored. One can consider

11 ITA No.1453/Del/2014

such a company as incomparable only if higher or lower profit is due to

abnormal circumstances.

9.4. The ld. AR submitted that Bodhtree Consulting Ltd. cannot be

considered as comparable because of a different model of revenue

recognition. He invited our attention towards the Annual report of this

company, in which it has been specifically reported that revenue from

software development is recognized based on software developed and

billed to clients. He submitted that the costs incurred by this company in

respect of the projects pending completion at the end of the year are

booked at the time of incurring, but, the income is recognized on the

raising of bills in subsequent year, thereby distorting the figure of

operating profit for a particular year. In contrast to that, the ld. AR

submitted that the assessee was recognizing revenue from software

development side by side without waiting for the completion of the

project.

9.5. Under the mercantile system of accounting, income is recognized

at the time of its accrual and the expenses become deductible when

12 ITA No.1453/Del/2014

liability to pay is incurred. The dates of actual payment of expenses or

receipt of income become insignificant. This is also called `Matching

concept', as per which income is recognized with the incurring of

expenses. To put it simply, if income does not accrue from a particular

transaction, the expenses incurred for such transaction are excluded from

the Trading and Profit & loss account by carrying them to Balance sheet.

To illustrate, if there is an incomplete contract worth Rs.100 for doing a

particular work, and the assessee has incurred Rs.60 on this project till

the close of the year, but the income is to be recognized only on the

completion of the project which event will take place in the subsequent

year, then, the amount of Rs.60 is not considered as expenditure for that

year, but is taken to the Balance sheet as closing work-in-progress,

which becomes opening stock for the subsequent year and the income is

finally computed from such project/contract in the next year on the

raising of bill of Rs.100/- after allowing deduction for the expenses

incurred in the earlier year at Rs. 60 and the further expenses incurred in

the year of raising of the bill. In this way, the profit for the earlier year

of incurring expenses of Rs.60 and the next year of raising invoice of 13 ITA No.1453/Del/2014

Rs.100 gives true and fair view of the profitability of that enterprise for

both the years. If this enterprise, instead of capitalizing Rs. 60 in the

first year, claims deduction in the year of incurring itself but recognizes

income of Rs.100 in the next year, then profit of both the years,

namely, the first and the second, will not give a fair view.

9.6. Coming back to the facts of the instant case, we find from

Schedule 12 that there is a mention of Significant accounting policy at

Sl. no.3, which provides that : "Revenue from software development is

recognized based on software development and billed to clients." If

some software development project is incomplete at the end of the year,

this Note may entail two situations , viz., the first, in which the expenses

incurred in respect of such software development may be capitalized,

which appears to be a more rational manner of depicting the true and fair

view of the profitability of the enterprise; and the second, in which such

expenses may be straightway taken as revenue cost for the year of its

incurring itself, which may not reflect a true and fair view of the profits

on year to year basis. The contention of the ld. AR is that whereas

14 ITA No.1453/Del/2014

Bodhtree fell into the second situation, the assessee was in the first

situation. Though this contention about Bodhtree accounting for

expenses in the year of incurring but considering income only on the

conclusion of the project in the subsequent year sounded a little

awkward, we attempted to find out the amount of capitalized expenses in

respect of incomplete projects at the end of the year. Apparently, we

could not find out any such capitalized value of work-in-progress in the

balance sheet of the company on standalone basis. We directed the ld.

DR to examine the Annual report of this company and point out the

amount of expenses capitalized in respect of incomplete work at the end

of the year. On the next date of hearing, the ld. DR failed to specifically

point out any amount of such capitalized expenses with the opening or

closing balance. This prima facie shows that the expenses incurred in

respect of incomplete projects of software development at the end of the

year, but billed in the subsequent year, were, in fact, treated as expenses

for the current year alone. In the same manner, expenses incurred in the

preceding year for the contracts of software development remaining

incomplete at the end of the year, also must have been included in the 15 ITA No.1453/Del/2014

expenses of the last year alone, but, the income getting recognized on

the raising of bills in the current year. This albeit, patently deforms the

correct profitability on year to year basis, yet, but we cannot help the

situation. When the position of accounts of Bodhtree is such that it does

not properly match expenses with revenue, it loses its credibility for

making a logical comparison with a company that accounts for expenses

matching with the revenue. Once it is held that the profits of Bodhtree

Consulting Ltd. do not represent fair profitability on year to year basis,

this company loses its tag of an effective comparable. We, therefore,

order for the exclusion of this company from the final list of

comparables.

Tutis Technologies Ltd.

10.1. The assessee included this company in the list of comparables,

which the TPO excluded.

10.2. Having heard the rival submissions and perused the relevant

material on record, we get from the show cause notice issued by the

TPO dated 19.12.2012, a copy of which is available from page 221

16 ITA No.1453/Del/2014

onwards of the paper book, that whereas the TPO gave adverse remarks

against other comparables, but mentioned against this company that :

'This is a suitable comparable.' The assessee replied to this show cause

notice on 28.12.2012, a copy of which is available on pages 232

onwards of the paper book. Apart from assailing the objections taken up

by the TPO on other comparables, the assessee submitted that this

company was accepted by the TPO as comparable. However, the TPO

inadvertently omitted to include it in the final set. There is no discussion

either in the TPO's order or the direction given by the DRP as to why

this company was being considered as incomparable. It implies that the

TPO though treated this company as comparable, but, erroneously

omitted to include it in the final set of comparables. In such

circumstances, there is no logic in not placing it in the final set of

comparables. We, therefore, order for treating this company as

comparable.

17 ITA No.1453/Del/2014

Goldstone Technologies Ltd.

11.1. The assessee included this company in its list of 20 comparables.

The TPO held this company to be incomparable on the ground that its

business segments related to ITES, IT services, Media and IPTB. These

remarks find place in the aforesaid show cause notice. During the

course of proceedings, the TPO examined the Annual report of this

company which indicated that the business segment included certain

activities which were dissimilar to the software development. He

rejected this company, inter alia, on the ground of its failing the export

turnover filter. The assessee is aggrieved against the expulsion of this

company from the final set.

11.2. After considering the rival submissions and perusing the relevant

material on record, we find from the Annual report of this company,

which is available in the paper book, that it has only one segment. There

is a mention on page 38 of the Annual report that : 'In the previous year

the company was engaged in the business of software development and

services comprising both on-site and offshore operations. During the

18 ITA No.1453/Del/2014

current year, the company added two more divisions: Media Division

and IPTB Division'. When we consider the functional profile of the

assessee company under the software development segment, we find

Goldstone Technologies Ltd. to be nowhere close to it. This company is

also engaged in providing services comprising on-site and offshore

operations. Apart from that, it added two more new divisions during the

current year, being, Media Division and IPTB Division. By no standard

this company on entity level can be considered as comparable with the

assessee company. In so far as the export filter applied by the TPO for

rejecting this company is concerned, we find that it fails on geographical

factors. The sum and substance of our above discussion is that

Goldstone Technologies Ltd. is not comparable with the assessee

company and has been rightly excluded by the authorities below.

VJIL Consulting Ltd., Think e-global Services Ltd., and RS Software (India) Ltd.

12.1. We have noticed above that the TPO rejected 15 companies from

the assessee's list of comparables and added two new companies by

carrying out fresh search during the course of proceedings before him.

19 ITA No.1453/Del/2014

When this position was confronted, the assessee also came out with the

above three new companies fulfilling the filters applied by the TPO.

The assessee requested the TPO to consider these companies also as

comparable, which is evident from page 251 of the paper book, being

reply dated 28.12.2012 of the assessee to show cause notice issued by

the TPO. The TPO did not at all comment on the inclusion or otherwise

of these three companies in his order. The assessee objected to the non-

inclusion of these three companies before the DRP as well. There is no

mention of the assessee's objections about these three companies in the

direction given by the DRP. As such, we find that the assessee did urge

the inclusion of these three companies in the list of comparables before

the TPO as well as the DRP, but, both of them chose not to comment on

their comparability. Under such circumstances, we direct the AO/TPO to

determine the comparability or otherwise of the above three companies

and then take steps for including them in the list of comparables, if

found to be comparable.

20 ITA No.1453/Del/2014

13.1. The second issue taken up by the assessee in its appeal in

respect of the ALP of the international transaction of `Provision of

software development serves', is about not allowing risk adjustment.

The assessee made a claim before the TPO for granting risk adjustment,

which was jettisoned for the failure on part of the assessee to back such

claim with suitable material. The assessee contested such denial of risk

adjustment before the DRP, giving some details, which was again

negatived. Now, the assessee is before us making a pitch for the grant of

such adjustment.

13.2. We have heard the rival submissions and perused the relevant

material on record. The TPO has referred to several tribunal decisions in

which risk adjustment has been denied to the assessee. At the same

time, the ld. AR has also drawn our attention towards some of the

tribunal decisions, in which such an adjustment has been allowed. In

fact, there cannot be a general rule of allowing or not allowing risk

adjustment. Risk is nothing but a possible adverse perception in the

given circumstances, which may or may not finally fructify. Generally,

21 ITA No.1453/Del/2014

risks and rewards go side by side. Higher the risk, more the profit; and

vice versa. Level of risk depends on the facts and circumstances of each

case. Where the assessee succeeds in ably demonstrating that the

comparables finally selected bore relatively more risk than it, then there

should be no denial of the risk adjustment. If, however, the assessee

fails in specifically pointing out the extra risks undertaken by the

comparables, then, of course, there cannot be any question of granting

risk adjustment. Under the transfer pricing regime, onus is always on

the assessee to show the reasons for claiming any separate adjustment by

pointing out the differences between it and the comparables. Risk

adjustment can be allowed provided the assessee places on record some

appropriate material to demonstrate that the risk undertaken by the

comparable companies were relatively more than it, warranting

downward adjustment in their profit rates. Further, the variation in such

risks, if any, should be capable of quantification on some reasonable and

logical basis.

13.3. The ld. AR stated before us that the assessee was not having any

risk at all inasmuch as its services were to be compensated by the AE 22 ITA No.1453/Del/2014

with an appropriate mark-up in comparison with the full-fledged risk

bearing comparable companies. We are not agreeable with such a

generalized and bald statement made on behalf of the assessee. The

mere fact of the assessee being a captive unit rendering software

development services to its AE alone, cannot make it a no-risk entity.

Several risks are attached to such entities dealing with a single customer.

If single customer, on whom the enterprise's entire survival depends,

closes down its business, the possibility of realization of debts for the

services already rendered, becomes a potential risk. Further, the fear of

termination of agreement between such an enterprise and the single

customer or the possibility of closure of business by such customer,

voluntarily or due to reasons beyond his control, also pose a grave

threat to the existence of such an enterprise. In that sense of the matter,

an enterprise serving a single customer, assumes marked risks. As the

assessee is wholly dependent on its AE for securing business, its entire

existence also depends on the same AE. If such AE runs out of business

or its business is reduced, the assessee is bound to bear severe jolts.

Since the ld. AR has failed to objectively demonstrate the relatively 23 ITA No.1453/Del/2014

higher risks undertaken by the comparables on an overall basis, we are

disinclined to grant any risk adjustment.

14. No other aspect of the computation of ALP of the international

transaction of `Provision of software development services' has been

challenged by the assessee in the present appeal. The impugned order is

ergo set aside on the question of determination of the ALP of the

`Software development services' segment and the matter is remitted to

the file of AO/TPO for computing ALP of the international transaction

of this segment afresh in consonance with our above directions.

Needless to say, the assessee will be allowed a reasonable opportunity of

being heard.

15.1. Ground nos. 5 and 8 are in respect of international transaction of

`Purchase of capital goods'. The factual matrix apropos this issue is

that the assessee reported an international transaction of 'Purchase of

fixed assets' with transacted value of Rs.33,50,51,611/-. The TPO

required the assessee to submit book value of the goods so imported in

the books of AE along with the details of costing methodology applied.

24 ITA No.1453/Del/2014

The assessee was also called upon to file copy of invoices along with the

market price of the same or similar goods at the time of purchase. The

assessee submitted vide its reply dated 3.1.2013 that it operates on a cost

plus basis wherein it recharges all its operating costs including

depreciation to its AE along with a mark up. However, the specific

information called for by the TPO, was not submitted. In the absence of

such details, the TPO computed the ALP of this international transaction

at Nil. As regards the adjustment u/s 92CA, the TPO required the AO to

calculate proper depreciation on fixed assets as per the provisions of the

Act. The DRP directed the assessee to submit item-wise particulars for

the claim made by it with all the documents/evidence/proof showing the

value of assets as appearing in the AE's books to the satisfaction of the

TPO. In case of failure on the part of the assessee to comply with the

above directions, the DRP directed that the ALP of the relevant assets be

taken as Nil. The assessee submitted certain details on sample basis

before the TPO. The AO, in the final order, made an addition of

Rs.32.07 crore by determining the ALP of this transaction at Rs.1.43

crore, against the transacted value of Rs.33.50 crore. Thereafter, 25 ITA No.1453/Del/2014

rectification application was filed u/s 154 of the Act which was disposed

of by the AO vide his order dated 27.03.2014 reducing the income with

`Cost of old fixed assets' by Rs.12.20 crore and adding depreciation of

Rs.3.72 crore. Another rectification application was filed, which was

also disposed of by the AO vide his order dated 26.9.2014, reducing the

total income to Rs.25.48 crore from Rs.40.74 crore. The assessee is

aggrieved against the addition made on account of this international

transaction.

15.2. We have heard the rival submissions and perused the relevant

material on record. It is noticed that the assessee purchased certain fixed

assets from its AE with the declared value of Rs.33.50 crore. In our

considered opinion the assessee rightly reported Purchase of fixed assets

with the transacted value as an international transaction, since the same

is covered within the definition given in sub-section (1) of section 92B,

which provides that "international transaction" means a transaction

between two or more associated enterprises, either or both of whom are

non-residents, in the nature of purchase, sale or lease of tangible or

26 ITA No.1453/Del/2014

intangible property, or ..............'. Section 92(1) stipulates that: ` Any

income arising from an international transaction shall be computed

having regard to the arm's length price'. The manner of computation of

arm's length price is set out in section 92C. Sub-section (1) provides that

the arm's length price in relation to an international transaction shall be

determined by any of the methods given in the provision, being the most

appropriate method, having regard to the nature of transaction or class of

transaction etc. Amongst others, there is Comparable uncontrolled price

(CUP) method and TNMM. The primary onus of proving that the

international transaction is at ALP, is always on the assessee.

15.3. Reverting to the facts of the instant case, we find that the

assessee applied TNMM as the most appropriate method for showing

that this international transaction was at ALP. The TPO held that the

correct method to be applied was CUP and as such the assessee was

called upon to give uncontrolled comparable instances of the purchase of

similar assets, which the assessee failed to do. This led the TPO to treat

the ALP of this international transaction at Nil. Normally, if the

27 ITA No.1453/Del/2014

assessee fails to give any comparable instance, then it becomes the duty

of the TPO to search some comparable uncontrolled instances at his own

and accordingly determine the ALP of the international transaction. In

our view, both the assessee as well the TPO went wrong by not doing

what was required to be done by them.

15.4. Once the ALP of an international transaction of purchase of fixed

assets is determined, then the difference between the transacted value

and the ALP does not directly lead to the transfer pricing adjustment. At

this juncture, it is pertinent to note the language of section 92(1) which

provides that any income arising from an international transaction shall

be computed having regard to the arm's length price. It does not say that

the total income is to be computed in accordance with the ALP. It is

rightly so because the international transactions which have no direct

bearing on the total income, cannot give rise to addition on account of

difference between their transacted value and ALP. Since the

transaction of purchase of fixed assets is a capital transaction, this, in

itself, does not affect the total income of the assessee. It is only the off-

28 ITA No.1453/Del/2014

shoot of such transaction in the capital field, being depreciation

allowance on such ALP of the transaction, which affects the total

income. To illustrate, if a fixed asset is purchased by an enterprise from

its AE for a sum of Rs.100 and rate of depreciation on such asset is 10%,

then the enterprise will charge depreciation amounting to Rs.10 in its

Profit and Loss account. If the ALP of such transaction is determined at

Rs. 80, then the difference of Rs.20 cannot be considered as income.

Rather, the amount of depreciation will be restricted to Rs.8 instead of

Rs.10, thereby increasing the total income by Rs. 2. When we advert to

the facts of the extant case, it is found that the TPO has rightly held to

the effect that it is the amount of depreciation on the purchase of such

fixed assets, which will be considered for making addition and not the

difference between the transacted value and the ALP determined at Nil.

15.5. Ordinarily an international transaction of purchase of fixed assets

by an assessee engaged in a manufacturing or trading business is

required to be determined on CUP method, which is usually the most

appropriate method in such circumstances. The TNMM on entity level

29 ITA No.1453/Del/2014

cannot be applied, because the transaction of purchase of fixed assets

can have no relation with the transaction of purchase of raw material

from AE or sales of goods to AEs. Rule 10A of the IT Rules, defines

`transaction' as including `a number of closely linked transactions'. The

Hon'ble Delhi High Court in its judgment of March, 2015 in Sony

Ericsson Mobile Communications India Pvt. Ltd. has held that the

related transactions should be considered jointly for determining their

ALP. However, in order to consider more than one international

transaction as one, it is sine qua non that such transactions must be

closely and not remotely linked. Every transaction done by an enterprise

is somehow or the other linked with the carrying on of the business. But

in order to be eligible for processing two or more transactions jointly for

determining their ALP, it is essential that they should be closely linked.

If two transactions are not closely linked, then they cannot be considered

jointly. Considering the above case of a manufacturer or a trader, it

cannot be held that the transaction of purchase of fixed assets is closely

linked with the purchase of raw material or sale of finished goods etc. In

30 ITA No.1453/Del/2014

such a scenario, it becomes important to examine the transaction of

purchase of fixed assets independent of other transactions.

15.6. However, the above rule of scrutinizing international transaction

of purchase of fixed asset as independent of all other transactions is not

universal. It has its own exceptions as well. The instant case is a glaring

example of exception to the above rule. It is so for the reason that the

assessee is getting remuneration from its AE at costs incurred plus a

particular mark-up. The cost base includes not only direct but all the

indirect costs. The amount of depreciation allowance on fixed assets,

including those purchased from AE, is also compensated with the same

mark-up. Thus we can say that depreciation allowance and

remuneration to the assessee on such depreciation are inseparable

transactions. The income in the shape of remuneration to this extent

directly depends upon the amount of deprecation allowance. When the

assessee is getting mark-up of 13%, the amount of deprecation at Rs.10

in our above hypothetical example will fetch remuneration of Rs.11.30.

If the amount of depreciation is reduced to Nil, the amount of income to

31 ITA No.1453/Del/2014

that extent will also be Nil, because the mark-up can be applied only if

there is depreciation cost to the assessee. In other words, the transactions

of depreciation on one hand and the resultant revenue on the other, go

hand in hand. In such a case, where the income is directly based on the

costs incurred including depreciation, then these two transactions

become 'closely linked' transactions, eligible for processing under the

TP provisions on a combined basis. It is illogical to compute the ALP of

the transaction of purchase of fixed assets and consequently reduce or

nullify the amount of depreciation allowance de hors the consideration

of international transaction of the revenue from AE, which is equal to

depreciation as claimed with mark-up. Both the transactions of claim of

depreciation allowance and revenue of depreciation with mark-up have

to be seen jointly. The TPO in the present case has simply reduced the

amount of deprecation allowance to Nil without simultaneously

considering the revenue side of this transaction. If we consider these

closely linked transactions of deduction for depreciation allowance and

revenue due to depreciation in unison, the position which follows is that

no further addition can be made on account of transfer pricing 32 ITA No.1453/Del/2014

adjustment due to one-sided consideration of depreciation allowance at

Nil. Rather, the determination of ALP of the international transaction of

purchase of fixed assets, in the facts and circumstances of the instant

case, is tax neutral. As such, we order for the deletion of addition made

by disallowing or reducing the amount of depreciation on the assets

purchased from AE. This ground is allowed.

16. In the result, the appeal is partly allowed.

The order pronounced in the open court on 24.04.2015.

Sd/- Sd/-

[C.M. GARG] [R.S. SYAL] JUDICIAL MEMBER ACCOUNTANT MEMBER Dated, 24th April, 2015. dk Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT (A) 5. DR, ITAT

AR, ITAT, NEW DELHI.

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