NTS TECHNOLOGY SERVICES PRIVATE LIMITED ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-3(1)(1), BANGALORE

The assessee has preferred the following grounds of appeal :-

The brief facts of the case show that assessee is an Indian company incorporated on 10.6.2016 which is subsidiary of a Singapore Company. It is engaged in the business of IT infrastructure support and consulting services, information cyber security services, software development support and solution providers of software products of all types of applications and to provide software application system. Assessee renders these support services to various group entities situated in UK, Australia and North America.

It filed its return of income on 14.1.2021 at a total income of Rs.18,38,29,890 which was processed u/s. 143(1) on 24.11.2021 at the same income. The return was selected for scrutiny. As it has entered into international transaction of provision of IT services to its UK, Australia and other group entities amounting to Rs.107,01,02,580/- titled as ‘Provision of IT support services’, international transaction of

The ld. TPO found that as per Form 3CEB and TP Study Report, the assessee selects itself as a tested party using Capitaline Neo and AceTP databases, adopted TNMM as the most appropriate method and selected PLI of Operating Profit/Operating Cost (OP/OC) applying 13 filters, selected 18 comparable companies whose margin was 35thnPercentile at 9.57% 65th percentile at 15.31% and Median margin of 13.75% and stated that international transaction of software development services having the margin of 15% is at arm’s length.

The ld. TPO examined the filters applied by the assessee and found that some of the filters are ambiguous and inappropriate, held that the database used in the computation is not reliable or correct. He conducted a fresh search by employing fresh filters, adopted the keywords of ‘computer software’, ‘software services’ and ‘consultancy’ on Prowess & AceTP databases, selecting 17 comparables. A show cause notice was issued to the assessee and after considering the objections of the asse, the ld. TPO reached at a final set of 17 comparables whose 35th percentile margin was 19.91% and 65th percentile margin was 30.15% resulting into median margin of 23.85% and computing the ALP of the international transaction at Rs.115,23,86,669/- against the revenue of price received amounting to Rs.107,01,02,580/- computing the shortfall of Rs.8,22,84,089/-.

He also found that assessee has outstanding overdue from AE and therefore granting a credit period of 60 days, he made an adjustment of Rs.1,93,21,199/- on account of interest receivable on overdue charging the interest based on SBI PLR of 13.62%.

Accordingly the order u/s. 92CA was passed on 27.6.2023 which resulted into a draft assessment order on 29.1.2023 determining total income of assessee at Rs.28,54,35,178/-.

Objections were filed before the ld. DRP which issued direction on 1.5.2024 and based on such direction, the ld. TPO passed the Order Giving Effect on 15.5.2024 wherein the adjustment with respect to software development services segment was restricted to Rs.5,22,29,920/- and interest receivable on overdue receivables was retained at Rs.1,93,21,199/-. Based on this, a final assessment order was passed on 25.6.2024 at Rs.25,53,81,009.

The ld. AR, Ms. Tanmayee Rajkumar, Advocate, submitted that ground Nos. 1 to 9 are general in nature and therefore not pressed. Accordingly these are dismissed.

She pressed into service ground No.10 of the appeal submitting that the ld. TPO has taken a lower turnover filter at 1 crore and did not apply the upper turnover filter. She submitted that the turnover of the assessee is Rs.107 crores and the set of comparables selected by the TPO are companies having huge turnover as well as huge brand value. She referred to the filter No.5 adopted by the assessee of excluding the

She also objected to the inclusion of selection of Consilient Technologies Pvt. Ltd. and submitted it does not pass the export filter. Further it was stated that this company is also engaged in the licensed software products and therefore functionally dissimilar. The main contention was that the total income of the company from service is Rs.4.27 crores against total income of Rs.6.64 crores, hence revenue from services constitute only 64% failing the service income filter applied by the TPO of 75%. It was further stated that it does not have any export and therefore also fails the export turnover filter. Ld AR also challenged the not including of R Systems International Limited despite complete data submitted before the ld DRP.

On the issue of notional interest on delayed receivable, she submits that if the working capital adjustment is granted to the assessee, no separate adjustment is required on this ground. It was further stated that it cannot be considered as a separate international transaction. It was further contended that the application of SBI PLR could not have been taken as the benchmark interest rate for the reason that the assessee raises the invoices in US $ and therefore even if the interest is to be charged, then it can only be on LIBOR basis.

The ld. DR vehemently objected that upper turnover filter has not been applied by assessee in its TP Study Report and the ld. TPO has also not applied, therefore, now the assessee cannot say that upper turnover filter should be applied. He otherwise submitted that assessee is engaged in the business of providing software services and it does not have substantial fixed assets and therefore there is no requirement of providing upper turnover filter. It was further stated that even otherwise the impact of turnover for profit margin is proved by the ld. DRP that it does not impact the margins. He relied upon para 3.1 of the direction of the DRP and submitted that there is no requirement of applicability of upper turnover filter. She also submitted that before the ld. TPO assessee did not object to either the non-application of upper turnover filter or the comparable and the grant of working capital adjustment.

With respect to the exclusion of Consilient Technologies Pvt. Ltd., the ld. DR submitted that it has passed the filters and therefore now it

With respect to interest receivable on overdue, the ld. DR vehemently submitted that after the amendment in the I.T. Act, interest on receivable is a separate international transaction and does not concern with the transaction of software development services. It was further stated that so far as working capital adjustment is concerned, assessee has not challenged or objected before the ld. DRP.

The ld. DR further referred to para 10 of the direction of the DRP and submitted that all these issues have been considered by the ld. DRP.

The ld. AR vehemently submitted that para 10.9 is specifically referring to the working capital adjustment where the outstanding receivable of the assessee and the comparable companies are challenged. In view of this, it was submitted that the assessee challenged the order of the TPO that if the working capital adjustment is granted, no separate adjustment is required to be made. She referred to para 11 of the direction of the DRP and with respect to the applicability of SBI PLR, it was specifically submitted that the ld. TPO himself stated that in para 15.22 if the invoices are raised in domestic turnover, then only the SBI PLR could be applied and when invoices are raised in foreign currency, it is proposed to be benchmarked on the basis of prevailing LIBOR rate. In view of this, she submitted that the

The ld. AR vehemently referred to ground No.12 of the appeal and submitted that in assessee’s own case for AY 2018-19, the application of upper turnover filter was held to be applicable and therefore the issue is squarely covered in favour of the assessee. She submits that though the assessee could not submit response to SCN before the ld TPO but before ethe ld. DRP all these grounds are raised.

In the end, the ld. AR vehemently submitted that one of the comparable R. Systems International though appearing in the search matrix of TPO, but is excluded for the reason that it has the calendar year as the accounting year. She submitted that R. Systems International Ltd. is a listed entity wherein according to clause (41) of the listed agreement, it is bound to submit quarterly financial results and therefore same can be reconstructed. She submitted a statement reconstructing the financial results of that particular company and submitted that when it passes all the filters and also appears in the search matrix of the TPO, same should have been included.

The ld. DR vehemently objected to the same and stated that when R. Systems International Ltd. is following different accounting year, it cannot be selected as a comparable because reliable financial data of the same are not available.

We have carefully considered the rival contention and perused the orders of the learned lower authorities. Facts of the case shows that assessee has entered into an international transaction of software support services amounting to ₹ 1,070,102,580/– with associated enterprises, it was benchmarked by taking the assessee as tested party adopting Transactional Net Margin Method [ TNMM] as the most appropriate method , taking profit level indicator of operating profit to operating cost [ OP/OC] . Assessee using the Ace Tp and Capitaline Neo database selected 17 comparable companies based on 13 different filters wherein the margin of the comparable companies was 35th percentile is at 9.57% and 65th percentile at 15.31% giving the median margin of 13.75%. The margin of the assessee is 15% and therefore it was held to be at arm’s-length.

The learned transfer pricing officer examined the transfer pricing study report [ TPSR] of the assessee and found that some of the filters applied by the assessee are not appropriate and therefore rejected the transfer pricing study report. He adopted the transactional net margin method as the most appropriate method, profit level indicator of OP/OC carried out fresh search on Prowess database selected 17 comparable based on nine filters found the margin at 35th percentile at 19.91% and 65th percentile at 30.15% and median margin of 23.85%. Based on this Arm's length price for services of ₹ 1,070,102,580/- was determined at Rs. 115,23,86,669/- and shortfall of ₹ 8, 22,84,089/-. The learned assessing officer further found that dues of the AE beyond 60 days credit period has not been recovered , therefore, computed

Assessee did not submit any response to SCN issued by the ld. TPO.

On objections before the ld. Dispute Resolution Panel, transfer pricing adjustment with respect to software development segment was reduced to ₹ 52,229,920/- and interest on delayed receivable remains unchanged. Thus, assessee has challenged the computation of arm’s- length price in software development segment and interest on overdue receivable from its associated enterprises.

The first argument of the assessee is that the learned transfer pricing officer has not applied upper turnover filter at the time of computation of arm’s-length price.

We find that the learned transfer pricing officer has adopted nine filters and one of them is that companies whose income was less than ₹ 1 crores were excluded. That is lower turnover filter. However no upper turnover filter was applied. It is important to note here that the transaction value of the assessee is ₹ 1,070,102,580. It is also true that before the learned transfer pricing Officer assessee did not object to the show cause notice issued which is mentioned at paragraph number 12 of the order of the learned transfer pricing officer which is not disputed.

However, the assessee objected to the same as per ground of objection number 2 before the learned dispute resolution panel wherein it was contended that the companies who have turnover is more than ₹ 200 crores should be excluded. The learned dispute resolution panel held that it is the consistent stand of the revenue that the turnover is not relevant factor in the software industry as the size does not have any influence on the margins earned by the company. It was further the stand of the revenue that economies of scale are relevant only in capital intensive companies which has substantial fixed assets in the form of plant and machinery. In the service industry, size does not matter, what matters is the human capital. The learned transfer pricing officer has applied only the lower limit of turnover filter of excluding companies having turnover less than Rs 1 Crore as margin earned by these companies fluctuate to extremes because of the competitive strength, operational efficiency and human resources. They often escape the eye of regulators to. Hence appropriate lower turnover filter is applied by the learned transfer pricing officer to select the companies. Many taxpayers also apply such filter. However, the issue arises is to whether any upper turnover limit also need to be applied in the selection of comparable. In this regard empirical analysis was made as could be seen from the information in the table given which indicated that margin does not show proportionate increase with increasing turnover. The learned dispute resolution panel thereafter analysed the results of Infosys technologies Ltd pertaining to the years 1996 – 1997 to 2019 – 20 on Capitaline database and thereafter it was held that

We find that the turnover of Mind Tree Limited is ₹ 7764 crores, Larsen and Toubro Infotech limited of 10,184 crores, Wipro Ltd of Rs. 50,387 crores, Tata Elexis of ₹ 1609 crores, Infosys Ltd of ₹ 79,470

It is undisputed that lower turnover filter of Rs 1 Crore is accepted by assessee as well as the learned transfer pricing officer to remove insignificant companies from comparability analysis. In TNMM method the applicability of 35th and 65th Margin Percentile to derive median, to apply lower turnover, export filter, related party filter is with the sole object to derive near to the international transaction carried out by the assessee. Object is to derive meaningful comparable so that it can be ascertained that international transaction carried out by the assessee is at arm’s length.

If higher and lower turnover filter is applied, it truncates large number of comparables, by eliminating comparables which have fairly large turnover compared to the tested entity. Naturally, large turnover companies have economies of scale compared to lower turnover entity and as held by the ld DRP that lower turnover companies have vagaries of margins.

Para number 3.43 in OECD Guidelines on Transfer Pricing (2022) says that in practice, both quantitative and qualitative criteria are used to include or reject potential comparables. Examples of qualitative criteria are found in product portfolios and business strategies. The most commonly observed quantitative criteria are Size criteria in terms of Sales, Assets or Number of Employees. The size of the transaction in

The various studies carried out by NASSCOM and Dun Bradstreet also supports it. Though such studies have compartmentalised turnover filter of Rs. 1-200 crores. Naturally in transfer pricing analysis lower turnover filter and upper turnover filter cannot be fixed and how to adopt the same depends upon the facts of each case looking at the turnover of the tested entity. In fact, the purpose of applying a filter is to have a manageable level of independent business concern having broadly similar level of turnover, intangibles, employees, and other assets. Guidance note issued by ICAI also advocates the same reasoning for adopting turnover filter.

In fact, the simplest way of explaining what an arm's-length price is how independent parties price a particular transaction therefore that is how related parties should also price it. To arrive at such an arm's- length price, economies of scale should be similar/ comparable. Therefore, the upper turnover filter is necessarily required to be employed for better determination of arm's-length price. Honourable Bombay High Court in case of Pentair Water India Pvt Ltd [TS-566- HC-2015(BOM)-TP] and Honourable Delhi High Court in Agnity

This issue has been considered by the Hon'ble Karnataka High Court in PCIT v. Softbrands India Pvt. Ltd. in 406 ITR 513 has also upheld the order of Tribunal that giant companies cannot be compared with small size companies. As there is no dispute that turnover of these comparable companies is more than several times of the turnover of the assessee company, naturally from the comparability analysis, those should be excluded.

We have also examined the analysis made by the ld. DRP by considering the annual accounts of Infosys limited. The claim of the ld. DRP is that increase in turnover did not impact margins. With respect to Infosys limited it says that with the increase in turnover of the company for the year 2002 to 2022 margins were hovering around 40 % only. When above analysis looked at from the tables produced, wide variation in margin from 63.30 % to 29.25 % in case of Infosys

Undoubtedly in commercial word such a huge turnover companies have bullwork strength of soliciting and winning clientele as those can afford, retain attract the best talent changing their human assets factor also.

We also direct to exclude the above comparable selected by the ld TPO for one more reason. All these companies are a part of renowned conglomerate and has huge brand value in the market of ITes / software development. These brands do have an added advantage in gaining new clients, extracting / mining new work from existing clients and larger pitch before public and Private sector. This is due to the intangible [whether recorded in books or not] of these brands. Thus, this makes a lot of different in asset size of the comparable with a captive service provider working on cost plus basis of remuneration.

We are also conscious of the decision that in assessee's own case for assessment year 2018 – 19 the coordinate bench has directed the learned assessing officer/transfer pricing officer to apply the filter of upper turnover also.

Therefore, respectfully following the decision of the coordinate bench in assessee's own case in earlier year, we direct the learned transfer pricing officer to remove all these above companies from comparability analysis. In view of this, we direct the ld. AO to exclude Mindtree Limited, Larsen & Toubro Infotech limited, Wipro Limited, Tat Elxsi Limited, Infosys Limited, Tata Consultancy Services Limited.

However we do not agree with the contention of the assessee for exclusion of Nihilent Ltd having turnover of Rs. 353 crore, Cybage software private limited having a turnover of ₹ 998 crores for the reason that the turnover of these companies are merely three or nine times more than the assessee. It is also not shown that these comparable have any other functional or asset base or risk different than the assessee.

The second contention raised is with respect to inclusion of Rheal software private limited on the ground that it is a persistent loss-making company. This company was in the list of comparables of transfer pricing study report prepared by the assessee. However it was argued before us that this company has incurred losses in only two out of three financial year and has not incurred losses in all the three financial years. Several judicial precedents were also cited before us. We find that if the company has incurred losses in only two years and not in all three years or more years, it cannot be said to be a persistent loss- making company. It was also be shown that in the subsequent years also this company is a loss making company. This needs examination

The assessee has further claimed that R. Systems International Ltd. which is part of the search matrix of the assessee at sl.No. 10 having weighted margin of 14.93% on segmental basis was requested for its inclusion before the ld. DRP. This was as per objection No.7 before the ld. DRP as the assessee did not represent to the show cause notice before the AO. The claim of assessee is that R. Systems International Ltd. is functionally comparable. The ld. DRP rejected the same stating that this company fails different financial year filter. It was the opinion of the DRP that as per Rule 10B(4), the data to be used in analysing the comparability of a uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into. They found that R. Systems International Ltd. is following the calendar year and not the financial year and therefore it cannot be included. It was also of the view that it is not practically feasible to analyse and no reliable data would be available. Accordingly they rejected the contention of the assessee for inclusion of the above comparable company.

We are of the view that the DRP has not rejected the inclusion of the comparable that it never appeared in the Accept/Reject matrix of the TPO. Had that been the case, the inclusion of any comparable beyond the search matrix of the TPO despite being the same in the search

However, the situation here is different as the TPO himself considered beyond his search matrix the inclusion of certain comparables which were part of the search matrix of the assessee. Therefore the TPO also adopted the approach of cherry picking, now the same cannot be denied to the assessee.

Before us with respect to R. Systems International Ltd., the assessee has submitted a reconstructed annual accounts on the basis of clause 41 of the listed agreement wherein quarterly results are to be published. We reject the contention of the ld. DRP that data would not be reliable in case 2 financial years are to be compared. The reason being that clause 41 of the listing agreement has more stringent action if inaccurate data are furnished to the stock exchange. If a listed entity furnishes inaccurate data to the stock exchange, it would result into market cap erosion as well as severe penalty on the company and the auditor who has limited revied the results. Therefore it is more than the tax liability that the company would be incurring for such a

The next issue involved is with respect to the exclusion of Consilient Technologies Pvt. Ltd. where the assessee has contested that it does not have any export and therefore it cannot pass the export filter. It is contested that even otherwise the revenue from services constitutes only 64% which fails the service income filter also. As the company does not have any income, it cannot be selected as a comparable as it fails the filter adopted by the TPO of 75% of the export income. Even otherwise it is contested that it is engaged in providing software products and also functionally not comparable. We direct the ld. AO to examine the facts and decide the issue in accordance with law. The reason for the set aside is that even before the DRP also while arguing in objection No.8, it was not argued that the comparable company fails the export filter.

The next issue is with respect to the interest on outstanding due from the AEs beyond 60 days. As it is not contested before that it is not a separate international transaction to be benchmarked, but it is argued that if the assessee is granted the working capital adjustment, the

Before the DRP, it was challenged as per objection No. 9(x), and same was dealt at para 10.3 of the direction wherein it was held that the TPO has adopted the LIBOR for invoices raised in foreign currency and hence the objection of the assessee was dismissed. Looking at the

No other grounds are argued before us.

In the result, the appeal of the assessee is partly allowed.

Appellant 2. Respondent 3. Pr. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. By order