Commissioner Of Income Tax v. Mentor Graphics (Noida) Pvt.ltd

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 AppellantFor the Respondent : Ms Suruchii Aggarwal: Mr M.S. Syali, Sr. Adv. with Ms Husnal Syali,Mr Mayank Nagi. CORAM:-HON’BLE MR JUSTICE BADAR DURREZ AHMEDHON’BLE MR JUSTICE R.V.EASWAR JUDGMENT BADAR DURREZ AHMED, J (ORAL) 1.In this appeal, the revenue has challenged the order of the IncomeTaxAppellateTribunal,dated02.11.2007,passedinITANo.1969/Del/2006, relating to the assessment year 2002-03. By virtue of anorder dated 13.01.2011, a Division Bench of this court, while admittingthe appeal, had framed the following substantial question of law:- “(i) Whether the finding of the Tribunal that if anyone margin of a comparable, in a given set ofcomparables is lower than the margin of the taxpayer, then the transactions are at arm’s length, is correct inview of the express provisions contained in proviso toSection 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) ofthe Income-tax Act, 1961, the Tribunal was correct in holdingthat if one profit level indicator of a comparable, out of a set ofcomparables, is lower than the profit level indicator of thetaxpayer, then the transactions reported by the taxpayer is at anarm’s length price as contemplated in sections 92, 92C andother related provisions of the said Act?” 3.This question has specifically arisen because of the observation ofthe Tribunal in paragraph 46.2 of the impugned order which reads asunder:- “ 46.2While holding so, we have not adopted mean profitof several comparable found by respective parties because inspite of our repeated requests, the parties before us, were unableto show us any rule or decision under which average or meanmargin (OP/TC) of different companies is to be taken.Taxadministration and parties can work different Arm’s lengthprice i.e. a range by the application of different methods. Insuch a situation, mean of Arm’s Length Price as provided inproviso to Section 92C(2) of the Act can be taken. But aboveArm’s length range is not the same thing as average operatingprofits of different entities with different FAR worked throughthe same method as done in this case by adopting TNMM. Theassessee has satisfied not one but several points of arms’slength range worked out on record. In our considered view, itis not necessary for the taxpayer to satisfy all points in therange. Even if one point is satisfied, the assessee can be taken to have established its case and in that situation, the onus is shiftedto the department to show why taxpayer’s case be not accepted.Arm’s length price does not mean maximum price or maximumprofit in the range. A willing buyer in an open market shall payminimum and not maximum price for goods or services.Ofcourse, quality and brand name are important but considerednot so by T.P.O. as TNMM method was applied by him.Projectprofileandotherfactorswere,therefore,noterroneously considered. As noted earlier, the case of integratedHitech has been specifically accepted as comparable by boththe parties.On other four cases noted above, the T.P.O. orother revenue authorities have not made any adverse commentat any stage of proceeding. It was open to them in proceedingsbefore the learned CIT(A) or the Appellate Tribunal to showthat PIL figure of integrated Hitech or other four companieswere wrong or on account of their FAR analysis, these entitiescould not be taken as “reliable” comparables for computation ofthe 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 onrecord, we accept them as comparable and accept the pricedisclosedbythetaxpayerasArm’sLengthPrice.Consequently, the addition of `. 1,45,73,857 is directed to bedeleted. The view taken by us finds support from para 1.4 ofOECD guideline which we quote below:- “1.48 If the relevant conditions of the controlledtransactions (e.g. price or margin) are within thearm’s length range, no adjustment should be made.Iftherelevantconditionsofthecontrolledtransaction (e.g. price or margin) fall outside thearm’slengthrangeassertedbythetaxadministration,thetaxpayershouldhavetheopportunitytopresentargumentsthattheconditions of the transaction satisfy the arm’slength principle, and that the arm’s length rangeincludes their results. If the taxpayer is unable toestablish this fact, the tax administration must determine how to adjust the conditions of thecontrolled transaction taking into account thearm’s length rante.It could be argued that anypoint in the range nevertheless satisfies the arm’slength 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 firstsection in that chapter, stipulates that any income arising from aninternational transaction is to be computed having regard to the arm’slength price. “Arm’s length price” is defined in section 92F to mean aprice which is applied or proposed to be applied in a transaction betweenpersons other than associated enterprises, in uncontrolled conditions. Itmay be pointed out at this juncture that the respondent/assessee is anIndian company which was incorporated in 1998. It is a wholly ownedsubsidiary of IKOS System Inc., a company incorporated in USA andengaged in the business of software development and also in renderingmarketing systems services to the parent company. The present case, aspointed out above relates to the assessment year 2002-03 pertaining to the financial year 2001-02 in respect of which the respondent/assessee filedits return of income on 31.10.2002. 5.The respondent/assessee develops software but does so only uponthe instructions of its parent associated enterprise, that is, IKOS Systems financial year 2001-02 in respect of which the respondent/assessee filedits return of income on 31.10.2002. 5.The respondent/assessee develops software but does so only uponthe instructions of its parent associated enterprise, that is, IKOS Systems Inc.It does not create/develop/sell separate software products orpackages and the entire software developed by the respondent/assessee isused by the parent associated enterprise captively for integrating the samewith other software components developed by IKOS Systems Inc. Theintegrated software in turn supports the hardware manufactured by IKOSSystems Inc. and is sold as a separate package in the open market by thelatter company.It is, therefore, clear that the respondent/assessee’sbusiness is limited to providing services of software development supportentirely to its parent company, that is, IKOS System Inc. 6.From the accounts and the auditors report it appears that therespondent/assessee carried on two sets of transactions with its parentcompany. One set related to the export of software development servicesand the other set pertained to the export of marketing support service. Inthe present appeal we are not concerned with the latter set but are onlyconcerned with the export of software development service, being the international transaction for which the arm’s length price is to bedetermined. 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 internationaltransaction[orspecifieddomestictransaction]shallbedetermined by any of the following methods, being the mostappropriate method, having regard to the nature of transactionor class of transaction or class of associated persons orfunctions performed by such persons or such other relevantfactors 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 theBoard. (2) The most appropriate method referred to in sub-section (1)shall be applied, for determination of arm's length price, in themanner as may be prescribed: Provided that where more than one price is determined by the mostappropriate method, the arm's length price shall be taken to be thearithmetical mean of such prices: xxxxxxxxxxxx (3) Where during the course of any proceeding for theassessment of income, the Assessing Officer is, on the basis ofmaterial or information or document in his possession, of theopinion that— (a) the price charged or paid in an internationaltransaction [or specified domestic transaction] has notbeen determined in accordance with sub-sections (1) and(2); or (b)any informationand documentrelatingtoaninternationaltransaction[orspecifieddomestictransaction] have not been kept and maintained by theassessee in accordance with the provisions contained insub-section (1) of section 92D and the rules made in thisbehalf; or (c) the information or data used in computation of thearm's length price is not reliable or correct; orarm's length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specifiedtime, any information or document which he wasrequired to furnish by a notice issued under sub-section(3) of section 92D, the Assessing Officer may proceed to determine the arm'slength price in relation to the said international transaction [orspecified domestic transaction] in accordance with sub-sections(1) and (2), on the basis of such material or information ordocument available with him: (c) the information or data used in computation of thearm's length price is not reliable or correct; orarm's length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specifiedtime, any information or document which he wasrequired to furnish by a notice issued under sub-section(3) of section 92D, the Assessing Officer may proceed to determine the arm'slength price in relation to the said international transaction [orspecified domestic transaction] in accordance with sub-sections(1) and (2), on the basis of such material or information ordocument available with him: Provided that an opportunity shall be given by the AssessingOfficer by serving a notice calling upon the assessee to showcause, on a date and time to be specified in the notice, why thearm's length price should not be so determined on the basis ofmaterial or information or document in the possession of theAssessing Officer.” In view of the above provisions, it is apparent that the arm’s length pricein relation to an international transaction has to be determined byfollowing one of the methods prescribed in sub-section (1) of section92C. In the present case there is no dispute that it is the transactional net margin method (TNMM) which is the most appropriate method andwhich had been adopted both by the respondent/assessee as well as by theTransfer Pricing Officer. The proviso to sub-section (2) of section 92Cmakes it clear that where more than one price is determined byemploying the most appropriate method, the arm’s length price shall betaken to be the arithmetical mean of such prices. There is no dispute thatthe prices which are to be considered while computing the arithmeticalmeanas indicated in the said proviso are all prices determined byfollowing any one of the methods stipulated in section 92C(1). It doesnot have any reference to prices being determined by more than onemethod. This is so because the reference is to the price determined by themost appropriate method and that can be only one method.We havealready indicated above that in the present case the most appropriatemethod, as accepted both by the respondent/assessee and by the revenue, was the transactional net margin method. The dispute that has arisen inthe present case is with regard to the observation of the Tribunal to theeffect that where one of the prices determined by the most appropriatemethod is less than the price as indicated by the respondent/assessee, thatmay be selected and there would be no need to adopt the process oftaking the arithmetical mean of all the prices arrived at through theemployment of the most appropriate method.That observation of theTribunal, we may say straightway, is incorrect. When more prices thanone are thrown up by the most appropriate method, the statute requiresthat the arm’s length price shall be taken to be the arithmetical mean ofsuch prices.This is the plain and simple meaning of the proviso tosection 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 courseof any proceeding of assessment, on the basis of material or informationor documents in his possession, is of the opinion that any of the 4conditions (a) to (d) stipulated in sub-section (3) are satisfied then, theassessing officer may proceed to determine the arm’s length price in the said provision makes it clear that if the assessing officer in the courseof any proceeding of assessment, on the basis of material or informationor documents in his possession, is of the opinion that any of the 4conditions (a) to (d) stipulated in sub-section (3) are satisfied then, theassessing officer may proceed to determine the arm’s length price in relation to the international transaction in accordance with the provisionsof sub-section (1) and sub-section (2) of section 92C on the basis of suchmaterial or information or documents available with him. Provided, ofcourse, that an opportunity is given by the assessing officer to theassessee to show cause as to why the arm’s length price should not be sodetermined on the basis of material or information or document in thepossession of the assessing officer.In other words, in the aforesaidcircumstances the assessing officer may himself embark upon thedetermination of the arm’s length price. However, where the assessingofficer considers it necessary to do so, he may with the previous approvalof the commissioner, refer the computation of the arm’s length price tothe Transfer Pricing Officer. This is provided in section 92CA of the saidAct which, to the extent relevant, reads as under:- “92CA. (1) Where any person, being the assessee, hasenteredintoaninternationaltransaction[orspecifieddomestictransaction]inanypreviousyear,andtheAssessing Officer considers it necessary or expedient so todo, he may, with the previous approval of the Commissioner,refer the computation of the arm's length price in relation tothe said international transaction [or specified domestictransaction] under section 92C to the Transfer PricingOfficer. (3) On the date specified in the notice under sub-section (2),or as soon thereafter as may be, after hearing such evidenceas the assessee may produce, including any information ordocuments referred to in sub-section (3) of section 92D andafter considering such evidence as the Transfer PricingOfficer may require on any specified points and after takinginto account all relevant materials which he has gathered, theTransfer Pricing Officer shall, by order in writing, determinethe arm's length price in relation to the internationaltransaction [or specified domestic transaction] in accordancewith sub-section (3) of section 92C and send a copy of hisorder 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/assesseehad, in terms of section 92CA(1) of the said Act referred the computationof arm’s length price to the Transfer Pricing Officer.That being theposition, it is clear that the Transfer Pricing Officer, in view of theprovisions of section 92CA(3), was also required to follow the samemethodology and approach as was incumbent upon the assessing officerunder section 92C(3) of the said Act.In other words, the TransferPricing Officer would have to, first, form an opinion that any of the fourconditions (a) to (d) set out in sub-section (3) of section 92C existed andthen he could proceed to determine the arm’s length price in relation tothe international transactions in question in accordance with sub-sections while considering the assessment of income of the respondent/assesseehad, in terms of section 92CA(1) of the said Act referred the computationof arm’s length price to the Transfer Pricing Officer.That being theposition, it is clear that the Transfer Pricing Officer, in view of theprovisions of section 92CA(3), was also required to follow the samemethodology and approach as was incumbent upon the assessing officerunder section 92C(3) of the said Act.In other words, the TransferPricing Officer would have to, first, form an opinion that any of the fourconditions (a) to (d) set out in sub-section (3) of section 92C existed andthen he could proceed to determine the arm’s length price in relation tothe international transactions in question in accordance with sub-sections (1) and (2) of section 92C on the basis of such material or informactionor document available with him.After the Transfer Pricing Officerdetermines the arm’s length price, it is incumbent upon him to send acopy of the order to the assessing officer and to the assessee.In thepresent case what has happened is that the Transfer Pricing Officer hasgenerally rejected the comparables submitted by the respondent/assesseein his transfer pricing report and has rejected the suggested arm’s lengthprice based on a profit level indicator of 6.99% as determined by therespondent/assessee and, in place thereof, the Transfer Pricing Officeradopted a profit level indicator of 24.53% and determined the arm’slength price of the international transactions at `. 10,34,40,177/- asagainst `. 8,88,66,320/- returned by the respondent/assessee.Thisresulted in an adjustment of `. 1,45,73,857/- in the income of the assesseebeing the difference between the arm’s length price and the price chargedby the assessee from its associated enterprise (IKOS System Inc.) forrendering services to them. Thereafter, the assessing officer passed theassessment order on 28.03.2005, inter alia, after making the aforesaidaddition. We are not concerned with the other aspects of the assessmentorder. 10.The CIT (Appeals) confirmed the said addition by virtue of anorder dated 30.03.2006. Being aggrieved by the said order, therespondent/assessee preferred an appeal before the Income Tax AppellateTribunal which has been allowed by the said Tribunal. The revenue is inappeal before us. While allowing the respondent/assessee’s appeal, the Tribunal made the observations in paragraph 46.2, which we havealready extracted above, to which serious exception was taken by therevenue.We have already indicated that the question that has beenframed, has to be decided in favour of the revenue and against therespondent/assessee. But, the matter does not end there inasmuch as wehave 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 rejectedthe comparables submitted by the respondent/assessee.However, thatrejection was of all comparables, generally. None of the 16 comparablessubmitted by the respondent/assessee were specifically rejected.Themanner in which the comparables were rejected is indicated in Para 7.2 ofthe Transfer Pricing Officer’s order, which reads as under:- “7.2 An analysis of the comparables used by theassessee and the search criteria used by it was carriedout and it was observed that : The assessee has not eliminated the companieswhich are not comparable in terms of their sizei.e. their turnover. It has included all thecompanies without giving any considerationtothefactthatcertaincomparablecompanies are new in the business and theirprofits are more likely to be low in initial years.which are not comparable in terms of their sizei.e. their turnover. It has included all thecompanies without giving any considerationtothefactthatcertaincomparablecompanies are new in the business and theirprofits are more likely to be low in initial years.The assessee has not used the data for the year2002,whichisnotinlinewiththeprovisions of Transfer pricing.2002,whichisnotinlinewiththeprovisions of Transfer pricing. The assessee has not eliminated the companieswhich are not comparable in terms of their sizei.e. their turnover. It has included all thecompanies without giving any considerationtothefactthatcertaincomparablecompanies are new in the business and theirprofits are more likely to be low in initial years.which are not comparable in terms of their sizei.e. their turnover. It has included all thecompanies without giving any considerationtothefactthatcertaincomparablecompanies are new in the business and theirprofits are more likely to be low in initial years.The assessee has not used the data for the year2002,whichisnotinlinewiththeprovisions of Transfer pricing.2002,whichisnotinlinewiththeprovisions of Transfer pricing. The assessee has rejected certain companiesstatingthattheyhavedifferentproductprofile, which cannot be considered as validreason since while adopting TNMM, the basehas to be a larger one so as to eliminatevarious functional differences. Further, hadthe product profile to be matched, then evenall those comparables which were finallyselected should not have been there sincenone of them is into development ofchipdesignsoftware, which is the mainbusiness of the assessee.statingthattheyhavedifferentproductprofile, which cannot be considered as validreason since while adopting TNMM, the basehas to be a larger one so as to eliminatevarious functional differences. Further, hadthe product profile to be matched, then evenall those comparables which were finallyselected should not have been there sincenone of them is into development ofchipdesignsoftware, which is the mainbusiness of the assessee.Companieshavinghighratiooftrading,activity were not excluded.”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 suchspecific elimination in respect of the other ten comparables. Insofar asthe aforesaid six comparable companies are concerned, the observationsof the Transfer Pricing Officer were as under:- “7.5 On 20.01.2005 the assessee was again asked toexplain as to why the companies having substantiallylow turnover as compared to that of the assessee,companies engaged primarily in manufacturing activityand companies with low employee cost (as softwaredevelopmentcompaniestypicallyhavehighwages/salariestototalsalesratio),maynotbeeliminated. The list of such companies is as under : Name of the companyReason foreliminationKushagra Software Ltd.Manufacturingconcernlntergrated Hitech Ltd.Low turnoverFare C Software Ltd.Low employeecostLuminaire technologiesLow turnoverLtd.Pentagon globalSolutionsLow employeecost. Engaged inLtd.manufacturingactivityO 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/assesseewere actually not comparable inasmuch as their turnoverswere widely different;were actually not comparable inasmuch as their turnoverswere widely different; (b)The respondent/assessee had not used the data of thefinancial year ending 31.03.2002 which was the relevantyear for the purposes of determination of the arm’s lengthprice;financial year ending 31.03.2002 which was the relevantyear for the purposes of determination of the arm’s lengthprice; 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/assesseewere actually not comparable inasmuch as their turnoverswere widely different;were actually not comparable inasmuch as their turnoverswere widely different; (b)The respondent/assessee had not used the data of thefinancial year ending 31.03.2002 which was the relevantyear for the purposes of determination of the arm’s lengthprice;financial year ending 31.03.2002 which was the relevantyear for the purposes of determination of the arm’s lengthprice; (c)The respondent/assessee did not include companies in itslist of comparables which had a different product profile.According to the Transfer Pricing Officer, companieshaving different product profiles also ought to have beenincluded inasmuch as the TNMM method for arriving atthe arm’s length price allowed for functional differences,which included differences in product profiles;list of comparables which had a different product profile.According to the Transfer Pricing Officer, companieshaving different product profiles also ought to have beenincluded inasmuch as the TNMM method for arriving atthe arm’s length price allowed for functional differences,which included differences in product profiles; (d)The comparable companies suggested by the assesseewere not companies involved in chip design software;andwere not companies involved in chip design software;and (e)The companies having a high ratio of trading activity hadnot been excluded by the respondent/assessee from its listof comparables.”not been excluded by the respondent/assessee from its listof comparables.” 14.We find that while these were the general reasons cited by theTransfer Pricing Officer for rejecting the comparables suggested by therespondent/assessee, the Transfer Pricing Officer had not indicated as tohow each of the comparables suggested by the respondent/assessee didnot fulfil the criteria which was adopted by him. The Transfer PricingOfficer suggested that the following filters should have been employedwhile searching out the comparables:- (1)Companies engaged in software development having annualturnovers between `.50 lakhs and `.100 crores;turnovers between `.50 lakhs and `.100 crores; (2)Companies whose employees’ cost is more than 10% of theturnover;turnover; (3)Companies whose sales from manufacturing and tradingdoes not exceed 10% of the total sales; anddoes not exceed 10% of the total sales; and (4)Companieswhichdonothaveanyrelatedpartytransactions.transactions. 15.Based upon the said filters, the Transfer Pricing Officer conducted his own search from the ‘Prowess’ and ‘Capitaline’ databases and theNasscom directory and short listed seven companies as under:- 16.The respondent/assessee submitted that all the companies other than Quintegra Solutions Ltd and Sark Systems India Ltd had either aforeign parent or subsidiary company and therefore might be involved inrelated party transactions and therefore could not be considered to becomparables.The respondent/assessee also submitted that insofar as Quintegra Solutions Ltd was concerned it ought to be eliminated becauseit had a different product profile. The Transfer Pricing Officer acceptedthe contentions of the respondent/assessee with regard to Blue StarInfotech Ltd. and NIIT Gis Ltd. and excluded those companies from thelist of comparables. However, the Transfer Pricing Officer rejected theobjections of the respondent/assessee with regard to the other suggestedcomparables. As a result, the Transfer Pricing Officer finalised his list ofcomparable companies as under:- “7.8In view of the above discussions, the following list ofcomparable companies are finally chosen for analysis. Quintegra Solutions Ltd was concerned it ought to be eliminated becauseit had a different product profile. The Transfer Pricing Officer acceptedthe contentions of the respondent/assessee with regard to Blue StarInfotech Ltd. and NIIT Gis Ltd. and excluded those companies from thelist of comparables. However, the Transfer Pricing Officer rejected theobjections of the respondent/assessee with regard to the other suggestedcomparables. As a result, the Transfer Pricing Officer finalised his list ofcomparable companies as under:- “7.8In view of the above discussions, the following list ofcomparable companies are finally chosen for analysis. Hence, the arithmetic mean of operating profit over the total costmargins of the comparable companies for the financial year2001-02 works out to 24.53%.The arm’s length price of theinternational transactions entered into by the assessee with itsAE is worked out as under.Total cost of provision of servicesby the assessee`. 8,30,64,464/-Margin @ 24.53% of the above`. 2,03,75,713/- Margin @ 24.53% of the above Arms length price to be charged From the AE `. 10,34,40,177/-” 17.While rejecting the objections of the respondent/assessee withregard to difference in the product profile insofar as Quintegra SolutionsLtd. was concerned, the Transfer Pricing Officer, inter alia, observed thatthe transactional net margin method was more tolerant to minorfunctional differences and was less effected by the transactionaldifferences and in doing so the Tranfer Pricing Officer referred toparagraph 3.27 of the OECD Report on Transfer Pricing Guidelines forMultinational Enterprises and Tax Administrations, July 1995. 18.We may also note that while rejecting the objections of therespondent/assessee with regard to the comparables which were taken bythe 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 subsequentyear namely the financial year 2003-04 as an indication of the quantumof related party transactions that might have taken place in the relevantyear, that is, financial year ending 31.03.2002. This, as will be pointedout subsequently, was found to be erroneous by the Tribunal inasmuch asthe Transfer Pricing Officer could only examine the data for the relevant year and, if at all, of two years prior to the relevant year in terms of rule10B(4) of the Income-tax Rules, 1962 (hereinafter referred to as ‘the saidRules’). 19.The Tribunal while allowing the appeal of the respondent/assesseenoted that the comparables furnished by the Transfer Pricing Officerought to be rejected because, first of all, the Transfer Pricing Officer useddata of 2003-04 which could not be used in view of the specificprovisions of rule 10B(4) of the said Rules.Secondly, the TransferPricing Officer did not do any functional asset risk (FAR) analysis andwas of the view that insofar as the TNMM method was concerned it wasmore tolerant to functional differences and was less effected bytransactional differences and for this, the Transfer Pricing Officer reliedon para 7.2 of the OECD guidelines referred to above. According to theTribunal this was contrary to the provisions of rule 10B(2)(3) as well asrule 10B(1)(e). The Tribunal also found that the range of turnovers whichwasemployedbytheTransferPricingOfficerforfilteringincomparables was far too wide inasmuch as the Transfer Pricing Officerhad considered the range of `.50 lakhs to `.100 crores whereas theturnover of the respondent/assessee was only `.8.8 crores.It may be pointed out that the respondent/assessee, while selecting its comparablesin its Transfer Pricing Report, had taken the range of `.47 lakhs to`.25.71 crores.Thirdly, the Tribunal returned the finding that theTransfer Pricing Officer should not have rejected the comparablesselected by the respondent/assessee. Apart from this, the Tribunal alsoheld that the Transfer Pricing Officer had wrongly adopted the criteria oflow employee cost as a percentage of turnover and that such a criteriaought not to have been employed in selecting comparables.It is alsoobserved by the Tribunal that a fresh search for comparables could bedone by the Transfer Pricing Officer only if comparables drawn by therespondent/assesseewereinsufficientorhadotherdeficiencies.Accordingto the learnedcounselfor theappellant/revenuethisobservation is contrary to law. 20.The Tribunal then set out the respondent/assessee’s comparablesafter applying all of the Transfer Pricing Officer rejection criteria andcame to the conclusion that seven companies fulfilled the criteria of beingcomparables. Those seven companies are indicated herein below:- 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 therespondent/assessee. The Tribunal also noted that the Transfer PricingOfficer had not made any adverse comment against eight companieswhich had been suggested as comparables by the respondent/assessee.Those eight companies were as under:- From the aforesaid table it is apparent that although there are ninecompanies listed, only eight are relevant inasmuch as there is no data forTop Media Entertaintment.The arithimatical mean of the PLI in thecases of these eight companies also comes to 4.47% which is again lowerthan 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 criteriaadopted by the Transfer Pricing Officer for searching comparables wasnot correct. Secondly, the Transfer Pricing Officer had not specificallyrejected any of the comparables of the respondent/assessee. The Tribunalwas of the view that the comparables of the respondent/assesse ought tohave been accepted and, had that been the case, there would have been noneed for the Transfer Pricing Officer to search for comparables. Ofcourse, in passing the order, the Tribunal made certain generalobservations that unless and until the comparables drawn by the tax payerwere rejected, a fresh search by the Transfer Pricing Officer could not beconducted. However, this has to be tempered with the relevant statutory provisions which are clearly set out in sub-section (3) of section 92C ofthe said Act which stipulates four situations whereunder the assessingofficer/ Transfer Pricing Officer may proceed to determine the arm’slength price in relation to an international transaction. If any one of thosefour conditions are satisfied, it would be open to the assessingofficer/Transfer Pricing Officer to proceed to determine the arm’s lengthprice. This clarification of the observation of the Tribunal was necessaryand that is why we have done so. 22.We also note that the Tribunal had gone further and reduced thelist of comparables to merely four as indicated in paragraph 46 of theimpugned order. We do not think that it was the right approach to beadopted by the Tribunal. The Tribunal should have stopped at the pointwhereitdecidedonfactsthatthecomparablesgivenbytherespondent/assessee were to be accepted and those searched by theTransfer Pricing Officer were to be rejected. The only option then left tothe Tribunal was to derive the arithmetical mean of the profit levelindicators of the comparables which were accepted by it.In this casesuch comparables happen to be those of the respondent/assessee.TheTribunal, in selecting only one profit level indicator out of a set of profit 22.We also note that the Tribunal had gone further and reduced thelist of comparables to merely four as indicated in paragraph 46 of theimpugned order. We do not think that it was the right approach to beadopted by the Tribunal. The Tribunal should have stopped at the pointwhereitdecidedonfactsthatthecomparablesgivenbytherespondent/assessee were to be accepted and those searched by theTransfer Pricing Officer were to be rejected. The only option then left tothe Tribunal was to derive the arithmetical mean of the profit levelindicators of the comparables which were accepted by it.In this casesuch comparables happen to be those of the respondent/assessee.TheTribunal, in selecting only one profit level indicator out of a set of profit level indicators had clearly erred in law. However, in the facts of thepresentcasethatwouldnotmakeanydifferencetotherespondent/assessee’s case inasmuch as even if the arithmetical mean ofthe comparables as accepted by the Tribunal are taken into account, theprofit level indicator would, whether the seven companies are taken intoconsideration or all eight companies are taken into consideration, be lessthan 6.99 % which is the profit level indicator of the respondent/assesseefor the relevant year, that is, financial year ending 31.03.2002. We mayalso make it clear that the reference to the OECD guidelines by theTribunal in the impugned order are in the context of the reliance placedby the Transfer Pricing Officer on the very same guidelines, in particular,to paragraph 3.27 thereof.In the present case, there are specificprovisions of sub-rules (2) and (3) of Rule 10B of the said Rules as alsoof the first proviso to section 92C(2) of the said Act which apply.Therefore, the question of applying OECD guidelines does not arise atall. 23.From the foregoing discussion, it is clear that the Tribunal waswrong in holding that if one profit level indicator of a comparable, out ofa set of comparables, is lower than the profit level indicator of the taxpayer, then the transaction reported by the taxpayer is at an arm’slength price. The proviso to section 92C(2) is explicit that where morethan one price is determined by most appropriate method, the arm’slength price shall be taken to be the arithmetical mean of such prices. Tothis extent the appeal is allowed. However, as pointed out above, if thisprinciple is applied to the comparables suggested by the assessee (whichhave not been rejected by the Transfer Pricing Officer), the arm’s lengthprice suggested by the assessee would yet be acceptable in law. Thereshall be no orders as to costs. BADAR DURREZ AHMED, J APRIL 04, 2013kb R.V.EASWAR, J