The Commissioner Of Income Tax-Iv v. Stratex Net Works (India) Pvt. Ltd

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 SabharwalFor the Respondent: Dr Rakesh Gupta, Ms Rani Kiyala,Mr Shubham Rastogi CORAM:-HON’BLE MR JUSTICE BADAR DURREZ AHMEDHON’BLE MR JUSTICE VIBHU BAKHRU JUDGMENT BADAR DURREZ AHMED, J (ORAL) 1.This appeal has been filed by the revenue under section 260A ofthe Income Tax Act, 1961 and is directed against the order dated30.04.2010 passed by the Income Tax Appellate Tribunal, New Delhi, inrespect of the assessment year 2004-05. The issue sought to be raised bythe learned counsel for the appellant/revenue relates to the manner inwhich the profit level indicator has been computed by the TransferPricing Officer for the purposes of determing the arm’s length price of theinternational transactions entered into between the respondent/assesseeand its associated enterprise. 2.The Assessing Officer, on receipt of the report of the TransferPricing Officer under section 92CA(3) of the Income-tax Act, 1961(hereinafter referred to as ‘the said Act’), finalised the assessment of theassessee by making an addition of ` 1,19,41,893/- on account of the arm’slength price adjustment.Being aggrieved by the said addition, therespondent/assessee preferred an appeal before the Commissioner ofIncome Tax (Appeals), who, allowed the appeal and deleted the saidaddition. The revenue preferred an appeal before the Tribunal being ITANo. 3640/Del/2007. That appeal, has been dismissed by the Tribunal byvirtue of the impugned order dated 30.04.2010. That is how the revenueis in appeal before us. 3.The respondent/assessee is a wholly owned subsidiary of DigitalMicrowave (Mauritius) Ltd. which in turn is a wholly owned subsidiaryof Digital Microwave Corporation USA. The assessee is engaged mainlyin the undertaking for installation, commissioning and maintenance ofmicrowave link equipments. 4.There is no doubt that Digital Microwave Corporation USA is anassociated enterprise of the respondent/assessee. All the equipments formicrowave links are manufactured by the said associated enterprise. Theorders in India for installation of those equipments are booked by therespondent/assessee. However the equipments are supplied directly to thecustomers in India by Digital Microwave Corporation USA.For thisactivity, the respondent/assessee receives commission from the associatedenterprise. Thus, the transaction involving commission is admittedly aninternational transaction.Apart from this, the equipments supplied byDigital Microwave Corproation USA are covered under a warranty given by the said USA Company. The service under the warranty is provided bythe respondent/assessee in India. Therefore, the transaction with regardto warranty is also an international transaction. 5.Apart from the two admitted international transactions involvingcommission and warranty, the respondent/assessee also undertakesinstallation of the said equipment. It also provides for annual maintenanceunder the head of re-engineering and maintenance contracts.Therespondent/assessee, carries out these activities of installation andmaintenance in India under independent contracts.It is, therefore, thecase of the respondent/assessee that the transaction of installation andmaintenance are not international transactions but are pure and simpledomestic transactions. by the said USA Company. The service under the warranty is provided bythe respondent/assessee in India. Therefore, the transaction with regardto warranty is also an international transaction. 5.Apart from the two admitted international transactions involvingcommission and warranty, the respondent/assessee also undertakesinstallation of the said equipment. It also provides for annual maintenanceunder the head of re-engineering and maintenance contracts.Therespondent/assessee, carries out these activities of installation andmaintenance in India under independent contracts.It is, therefore, thecase of the respondent/assessee that the transaction of installation andmaintenance are not international transactions but are pure and simpledomestic transactions. 6.The point in issue before us is with regard to the manner ofcomputing the profit level indicator.The Transfer Pricing Officer hadadopted the Transactional Net Margin Method (TNMM) as the mostappropriate method under section 92C(1)(e) of the said Act. While doingso, the Transfer Pricing Officer had to compute the profit level indicatorin respect of the international transactions of warranty services andcommission income. What the Transfer Pricing Officer did was to includethe operating revenue and operating cost of not only the warranty servicesand commission income but also the installation/commissioning andmaintenance charges while computing the operating profit so as todetermine the profit level indicator. This would be clear from the table asgiven below which has been re-produced from the Transfer PricingOfficer’s report:- “Computation of PLI of the Assessee During the course of proceedings the assessee has filed adetail of computation of net margin from various activities.The operating (revenue – sic) and operating cost in respect ofactivities of installation and commissioning, re-engineering andmaintenance,warrantysupportservicesandcommissionincome as under: 7.After taking the profit level indicator to be 1.31%, the TransferPricing Officer then went ahead with the selection of comparables anddetermined the arm’s length operating margin in respect of thecomparables at a figure of 16.34%.Thereafter, the Transfer PricingOfficer determined the arm’s length price in respect of the internationaltransactions of warranty support services and commission income asunder:- “Determination of Arm’s Length PriceThe arm’s length price of the international transactionsentered into with the AE is computed in the flowing manner:- Accordingly,theadjustmentof`1,19,41,893/-isrequired to be made value of International transaction related tocommission on sales and warranty support services.Theadjustmentisbeingmadeproportionatelytoboththetransactions.The arm’s length price of these transactions iscomputed in following manner:- S.NoInternationalValueofProportionateArm’s length.transactioninternationaladjustmentpriceoftransactioninternationaltransaction1Warranty2,32,37,90672,95,3023,50,33,208supportservice2Commission1,47,96,91046,46,5911,94,43,501Income The Arm’s Length Price of the international transactionrelated 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 valueof international transaction is ` 2,32,37,906/-, which fallsoutside the (± 5%) tolerance band, the assessee is not entitled tothe benefit of proviso to sub-section (2) to section 92C of theIncome Tax Act. The Arm’s Length Price of the international transactionrelated 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 international transaction is ` 1,47,96,910/-, which falls outsidethe (± 5%) tolerance band, the assessee is not entitled to thebenefit of proviso to sub-section (2) to section 92C of theIncome Tax Act.No adverse inference is drawn in respect of otherinternational transactions.” The Arm’s Length Price of the international transactionrelated 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 international transaction is ` 1,47,96,910/-, which falls outsidethe (± 5%) tolerance band, the assessee is not entitled to thebenefit of proviso to sub-section (2) to section 92C of theIncome Tax Act.No adverse inference is drawn in respect of otherinternational transactions.” 8.From the above, it is apparent that while computing the profit levelindicator, the Transfer Pricing Officer took into account not only theoperating revenue and operating costs of the international transactionsinvolving warranty services and commission income but, he also tookintoaccounttheoperatingrevenueandoperatingcostsoftheinstallation/commissioningandmaintenanceserviceswhichweredomestic transactions. It is also evident that the Transfer Pricing Officer,himself, did not consider installation/commissioning and maintenance tobe international transactions inasmuch as no adjustment was made by himin respect thereof. The adjustments made to the extent of `. 1,19,41,893/-were only with regard to the value of international transactions relating tocommission on sales and warranty support service. 9.Mr Sabharwal, the learned counsel appearing on behalf of therevenue submitted that there was nothing wrong in taking the operatingcost and operating revenue of the installation and commissioning servicesas also the maintenance services while computing the profit levelindicator because the said services were intricately connected with theinternational transactions of warranty support services and commissionincome.However, we find, on going through the order passed by theCommissioner of Income Tax (Appeals) as also the impugned orderpassed by the Tribunal, that both these authorities have returned a finding of fact that the installation/commissioning and maintenance services werenot part of the international transactions. In fact, the Tribunal held thattheinstallation/commissioningandmaintenanceagreementswereindependent agreements unconnected with the transactions of warrantysupport services and the transaction which generated the commissionincome. The Tribunal noted that the equipment had been supplied to 40customersbytherespondent’s/assessee’sassociatedenterprise.However, only three of them had availed of the installation services fromthe assessee. The Tribunal also noted that a corroborative circumstanceforconstruingthetransactionsofinstallation/commissioningandmaintenance as domestic transactions was that, in the order of theTransfer Pricing Officer itself, no adjustment was made in respect ofthese trnasactions. The Tribunal further held that since the profit levelindicatorshown by the assessee on the internationl transactions ofwaranty service and commission income was 18.98%, there was no needfor any adjustment in the arm’s length prices of these transactionsinasmuch as the profit level indicator of the comparables were determinedby the Transfer Pricing Officer at 16.34%, which was lower. It is in thisbackdrop that the Tribunal felt that there was no reason to examine theissue on the argument of the assessee that the Transfer Pricing Officerhad not applied the proper comparables while working out the profit levelindicator of comparables. 10.From the foregoing discussion, it is evident that the transactionspertaining to the installation/commissioning and maintenance serviceswere not international transactions as contemplated under section 92B(1).They were also not deemed international transactions under section 10.From the foregoing discussion, it is evident that the transactionspertaining to the installation/commissioning and maintenance serviceswere not international transactions as contemplated under section 92B(1).They were also not deemed international transactions under section 92B(2) of the said Act because none of the conditions stipulated thereinofaprioragreementexistingbetweenthecustomersoftherespondent/assessee and the associated enterparises have been establishedas a fact. Moreover, there is no finding that the terms of the transactionof installation/commissining as well as maintenance had been determinedin substance between the customers and the respondent/assessee by theassociated enterprise. In the absence of such findings, it cannot bedeemed that the transaction of installation/commissioning as well asprovision of maintenance services by the respondent to its domesticcustomers in India were international transactions falling within section92B(2) of the said Act. 11.Consequently, the findings of fact do not support the contentionraised by Mr Sabharwal. As such, no substantial question of law arisesfor the consideration of this court. 12.The appeal is dismissed. BADAR DURREZ AHMED, J MAY 06, 2013kb VIBHU BAKHRU, J