Dr. O.K. Narayanan, Vice President. - These are two appeals filed by the assessee and the revenue. These cross appeals relate to the assessment year 2003-04. The appeals are directed against the order of the CIT(A)-IV at Bangalore dated 28-1-2008 and arise out of the assessment completed under section 143(3) of the Income-tax Act, 1961.

2. The assessee, M/s. SAP Labs India Pvt. Ltd., is a wholly owned subsidiary of a German Company, SAP AG. SAP AG develops software products under the brand name of SAP. The software products are sold world wide. SAP AG has established development centers throughout the world for developing the necessary software. The assessee in the present case is one of such development centers established by SAP AG in India as 100 per cent Export Oriented Unit (EOU). The assessee has obtained the EOU status under the software technology parks [STP] Scheme of the Government of India. The principal business carried on by the assessee in India is providing software development and related services to its associate concern SAP AG. In order to deliver the above-mentioned services, the assessee has entered into an R & D agreement with SAP AG. As per the agreement, the assessee-company is to be paid remuneration by SAP AG on cost plus basis. In this case, it is cost plus 6 per cent or 1.5 times of the wages bill of assessee-company, whichever is higher.

3. The assessee-company has returned a loss of Rs. 7,57,430 for the assessment year under appeal. The activity of the assessee-company being to provide software development support to SAP AG, it has resulted in overseas transactions and such export turnover exceeded Rs. 5 crores. The Assessing Officer has referred the case to the Transfer Pricing Officer (TPO) to decide the Arms Length Price (ALP), so as to proceed in the assessment.

4. The assessee has accounted for an operating revenue of Rs. 71,69,87,294. The operating cost as per the books of account worked out to Rs. 68,00,34,163. The operating profit declared by the assessee is Rs. 4,85,08,975 but revised by the TPO to Rs. 3,69,53,131. According to the TPO, this revised profit before interest tax works out to an operating profit ratio of 5.43 per cent. On studying the above variables, the TPO concluded that the margin disclosed by the assessee is far below the margin reflected in comparable cases. The TPO has adopted Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) to make the analysis. On the basis of the comparative analysis made by the TPO under TNMM, the percentage of profit to the cost of international transaction has been worked out to 22.24 per cent. This is against the margin of 5.43 per cent noted by the TPO on the basis of the accounts of the assessee-company. The TPO adopted the percentage of profit at 22.24 per cent and worked out the Arm’s Length Revenue attributable to the assessee-company. This revenue has been worked out at Rs. 83,12,73,760. The operating revenue reported by the assessee as per the books of account is Rs. 71,69,87,294. The differential amount is Rs. 11,42,86,466. The TPO quantified the ALP adjustment to the above differential amount of Rs. 11,42,86,466 under section 92CA of the Income-tax Act, 1961. When this ALP adjustment was placed before the assessee-company, a series of objections were raised before the TPO. The assessee had a lot of grievances regarding the filtering of comparable cases on a turnover basis adopted by the TPO and working out the revenue and cost without excluding extraordinary items and for the disparity in the selection of comparable cases. The objections were ruled out. The assessing authority, therefore, treated this ALP adjustment of Rs. 11,42,86,466 as the taxable income of the assessee-company under section 92C(4) of the Income-tax Act, 1961.

5. Another addition made by the assessing authority is an amount of Rs. 1.05 crores. The assessee had paid a compensation of Rs. 1 crore on termination of a property purchase agreeme