Income Tax Appellate Tribunal Delhi Mentor Graphics (Noida) (P) Ltd. vs Dy. Cit on 2 November, 2007 Equivalent citations: [2007]109ITD101(DELHI), (2007)112TTJ(DELHI)408 ORDER Vimal Gandhi, President 1. This appeal by the taxpayer for the Asstt. Year 200203 (F.A.200102) is directed against the order of Commissioner of Income Tax(Appeals)[in short CIT(A)] New Delhi dated 3.3.2006. The main dispute pertains to adjustment/addition of INR 1,45,73,857 in the income of the taxpayer by the revenue authorities on account of determination of arm's length price (ALP) for software services provided to its Associated Enterprises(AE). The deduction claimed by the taxpayer under Section 10A of the Income Tax Act but denied by the tax authorities is also subject matter of dispute in appeal. 2. The facts in short compass, the taxpayer, a domestic company incorporated on Feb.27, 1998 under the Indian Companies Act is the wholly owned subsidiary of IKOS Systems Inc., a company incorporated in USA and engaged in the business of software development and also rendering marketing systems services to the parent company. The taxpayer filed its return of income for the year under consideration on October 31, 2002 declaring total income at INR 3,99,080/ for the F.A.200102. The income disclosed included profit from export of computer software to its parent company for which deduction under Section 10A was claimed. 2.1 The taxpayer appellant as noted earlier is a software development support service provider. However, software are developed only as instructed by its parent AE. It does not create/develop/sell software products and packages. The software developed by the appellant is used by the parent AE inhouse for integrating the same with other software components developed by the parent AE itself. The whole software in turn supports the hardware manufactured by the parent, and sold as a package in the open market by the parent AE. Therefore the appellant's business is limited to providing services of software development support. 3. The accounts and auditor's report of the taxpayer showed that the taxpayer had carried the following transaction with its associated enterprises (AEs): Sl. No International Transactions(IT) With IKOS SYSTEMS USA Book value of the International Transactions 1. Export of Software Development Services 88,866,320 2. Export of Marketing Support Services 3,436,194 4. The taxpayer in order to show that transactions with AEs were arm's length transactions selected Transactional Net Margin Method (TNMM) as the most appropriate method under Section 92C of the Income Tax Act and further justified the price charged for services as arm's length price with following certificate in the auditor's report: Based on the study, the arithmetic mean of three year weighted average margins for financial years ended March 31, 2000, March 31, 2001 and March 31, 2002 to the extent available of broadly comparable independent companies calculated using Net Cost Plus Margin as the profit level indicator was compared by the assessee with its three year weighted average margin for financial years March 31, 2000, March 31, 2001 and March 31, 2002. In the opinion of the assessee its Net Cost Plus Margin, having regard to economic and commercial factors, appears to be arm's length as provided under Section 92C of the Act. Accordingly, the amounts received/receivable in respect of the above transactions have been computed by the assessee having regard to the arm's length price. 5. The Assessing Officer referred the question of computation of Arm's length price of International transactions to Transfer Pricing Officer (TPO). The TPO accepted that export of marketing support services have been rendered at the arm's length price and, therefore, the amount disclosed by the assessee as per books needed no adjustment. In the above situation, we thought it appropriate not to make any comment on the transaction relating to export marketing support services. The discussion hereafter is confined to other transaction of export of software development services. 6. Export of software development services, has been shown at total value at INR 88,866,320 for the entire year. Taxpayer has further explained that software was supplied by the taxpayer to its parent company and price was worked out at the rate of US$ 180 per man day. The transactions were priced on average and should have been compared with either an internal comparable, uncontrolled price (internal CUP) or an external comparable uncontrolled price (external CUP). The parent company did not receive similar services from any independent third party, nor the taxpayer provided such services to any uncontrolled party and, therefore, internal CUP did not exist. Even external CUP was not available. Average billing rates (man days/ man month