VIRTUSA CONSULTING SERVICES PRIVATE LIMITED,CHENNAI vs. DCIT LARGE TAXPAYERUNIT CIRCLE-1, CHENNAI

आदेश /O R D E R

PER MAHAVIR SINGH, VICE PRESIDENT: This appeal by the assessee is arising out of the final assessment order passed in pursuant to the directions of the Dispute Resolution Panel-2, Bengaluru dated 20.12.2013 by the Assistant

- 2 - IT(TP)A No.25 /Chny/2020 Commissioner of Income Tax, Company Circle V(2), Chennai for the assessment year 2009-10 u/s.143(3) r.ws. 92CA(4) and 144C of the Income Tax Act, 1961 (hereinafter the ‘Act’) vide order dated 24.02.2014.

- 3 - IT(TP)A No.25 /Chny/2020 4. Having regard to the aforesaid submissions made, this Writ Petition is dismissed as withdrawn granting such liberty. It is made clear for the purpose of reckoning limitation for availing the aforesaid remedy, the period from the date of filing of this Writ Petition, viz., 21.01.2014 till the date on which the certified copy of this order is made ready, shall be excluded. Consequently, the connected Miscellaneous Petitions are closed. No costs.”

2.1 We noticed that the judgment of Hon’ble High Court is dated 14.10.2020 and assessee filed appeal on 10.12.2020. Even we go by the judgment of the Hon’ble High Court, the assessee filed appeal within 60 days i.e., within the limitation. Hence, there is no delay in term of the judgment of Hon’ble High Court of Madras.

For this, assessee has raised grounds of appeal in Part I, Transfer Pricing Grounds in Part A, 1 to 8 but he finally stated that apart from the above four comparables, he is not interested in prosecuting any other ground or issue. Hence, we proceed to adjudicate these four comparables.

- 4 - IT(TP)A No.25 /Chny/2020 4. Brief facts leading to the above issue are that the assessee is a computer software development services provider and has earned revenue from provision of software development services to both related and third parties. The assessee namely Virtusa Consulting Services Pvt. Ltd., earlier known as Polaris Consulting & Services Ltd., is a software solution provider, specializing in providing quality and customized IT solutions to several multinational clients in the banking, financial services and insurance. The assessee filed its return of income for the relevant assessment year 2009-10 and accordingly, the AO made a reference to TPO u/s.92CA(4) of the Act for determination of Arms Length Price in respect of international taxation with its associated enterprises, which are as under:- (a) Polaris Software Lab Pre Ltd., Singapore (b) Polaris Software Pty Ltd., Australia (c) Polaris Software Lab Ltd., UK (d) CIB Tech EMEA GCORT, Citibank N.A., Citi Financial, Citi Group, etc.

The assessee before TPO filed a transfer pricing study in relation to notice issued u/s.92CA(2) of the Act. The assessee in its transfer pricing study adopted CUP method for Citi Group entities and TNMM method for transactions with Polaris subsidiaries. The assessee has not submitted transaction-wise comparison with respect of service rendered with Citi Groups and non AEs. The TPO detailed out the transaction of the assessee with the Citi group entities and the

- 5 - IT(TP)A No.25 /Chny/2020 details of transactions with the assessee with Non-AEs which are part of the TPO’s order at pages 7 to 12. The TPO noted that the assessee has not provided information sought by the TPO and accordingly, he noted that the benchmarking done by the assessee of its international transactions was not found to be acceptable and accordingly, a show-cause notice dated 11.01.2013 was issued. The TPO noted the offshore software services and onsite software development services in its show-cause. The AO also noted that the assessee in its TP study has submitted the comparables in number 20 and the weighted average of operating profit on operating costs declared was at 12.91%. The TPO adopted modified filters and criteria for selecting appropriate comparables functionally similar to that of the assessee and for that, he noted that use of financial year data and multiple year data is required. The TPO has gone into each of the comparables and finally noted that the 10 companies do not appear to be comparable with the assessee for the reason given in the TPO’s order at pages 23 & 24 and he excluded these 10 companies and included 9 more companies. According to the TPO, these 9 companies are comparables because of search process and reject matrix to select comparable companies in respect of transactions pertaining to software development services. The TPO therefore included these 9 companies and finally settled for final set

- 6 - IT(TP)A No.25 /Chny/2020 of comparables for benchmarking the international transactions by taking the PLI at 21.20% as against PLI computed by the assessee by taking its comparable at 12.91%. Based on the above final set of comparables, the TPO finally suggested the PLI to be taken at 21.18% of arithmetic mean. Accordingly, the operating profit on total cost of the assessee has to be added at differential figure of 9.38%. Accordingly, the TPO worked out the adjustment at Rs.73,58,03,699/-. Aggrieved, assessee raised objection before DRP.

- 7 - IT(TP)A No.25 /Chny/2020 upheld the order of TPO. The DRP issued directions at pages 7 to 14 and finally held that TPO to exclude export proceeds which have not been realized in time for export turnover as well as total turnover. But the DRP confirmed the inclusion of comparables by TPO. In term of TPO’s order, the AO framed assessment and passed final assessment order u/s.143(3) r.w.s. 92CA(4) and 144C of the Act dated 24.02.2014 concurring with the directions of DRP and finally assessed the adjustment worked out by the TPO at Rs.73,58,03,699/- Aggrieved, now assessee is in appeal before the Tribunal.

- 8 - IT(TP)A No.25 /Chny/2020 to assessee’s paper-book at pages 290 to 293 and stated that the Notes to Financial Statement categorically state the following: “ (i) Note 1 to financial statements of Kals shows it is engaged in development of Software and Software products and Training Software professionals on online projects.

(ii) Kals discloses “Software development” as inventory and work-in- progress. A pure software services provider would not be able to disclose such details as it does not carry any such inventory or work-in-progress. (iii) Segmental data is not available.”

The ld.counsel for the assessee further stated that Kals Information Systems Ltd., cannot be included and it has to be excluded for the reason that the assessee company is engaged in software development services and segmented data is no available and this issue accordingly to ld.counsel is covered by the decision of the Co- ordinate Bench of the Tribunal in assessee’s own case in ITA No.447/Mds/2016 for assessment year 2007-08, dated 02.01.2017. The ld.counsel for the assessee drew our attention to para 8.6, wherein the Tribunal in detail has discussed the Kals Information Systems Ltd., and held that aforesaid concern is engaged in development and sale of software products, which was quite distinct from the activity undertaken by the assessee company in the IT services segment. The Tribunal finally held as under:- “8.6 With regard to KALS Information Systems Ltd. (Seg.), when the TPO has proposed this company for inclusion as comparable, on review of the annual report of the company for the year ended 31st march, 2007, the assessee has observed that the company is into provision of

- 9 - IT(TP)A No.25 /Chny/2020 software development services as well as ale of software products. Before the TPO, the assessee has pointed out that Inventories under the Schedules to the financial statements on page 16 of the Annual Report discloses Software development as inventory and work-in-progress. It is to be noted that a pure software services provider would not be able to disclose such details as it does not carry any such inventory or work-in- progress. Further, it was also pointed before the TPO that the company is engaged in development of software and software products since its inception and earn revenues from the development of software product viz. software La Vision and Virtual Insure as its fixed asset. The company consisting of STPI unit engaged in development of software and software products and a training centre engaged in training of software professionals on online projects. Further, under Revenue recognition under the Notes to the financial statements on page 18 of the annual report clearly states that the company derives its revenues primarily from software services and software products. However, as per the data taken from Capital Line data base, the TPO has noted that 95.69% of the revenue of the company is from software development, he has taken this company as a comparable.

Before us, the primary plea raised by the ld. Counsel for the assessee to assail the inclusion of the aforesaid company from the list of comparables is that they are functionally incomparable and therefore, are liable to be excluded. In sum and substance, the plea set up by the ld. AR is that the aforesaid concern is engaged in development and sale of software products which is functionally different from the services undertaken by the assessee in its IT services segment.

As per the discussion in para 13 at page 43 of the order of the TPO, the reason advanced for including KALS Information Systems Ltd., is to the effect that the said concerns application software segment is engaged in the development of software which can be considered as comparable to the assessee company. The said concern is engaged in two segments namely application software segment and Training. As per the TPO, the application software segment is functionally comparable to the assessee as the said concern is engaged in software services. The stand of the assessee is that a perusal of the Annual Report of the said concern for F.Y. 2006-07 reveals that the application software segment is engaged in the business of sale of software products and software services. The assessee pointed out this to the TPO that there was no bifurcation available between the business of sale of software products and the business of software services, and therefore, it was not appropriate to adopt the application software segment of the said concern for the

- 10 - IT(TP)A No.25 /Chny/2020 purposes of comparability with the assessees IT-Services Segment. The TPO however, noticed that though the application software segment of the said concern may be engaged in selling of some of the software products which are developed by it, however, the said concern was not into trading of software products as there was no cost of purchases debited in the Profit & Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessees segment of IT-Services.

Before us, apart from reiterating the points raised before the TPO and the DRP, by relying on the decision in the case of Novell Software Development (India) P. Ltd. v. DCIT in ITA No. 1287/Bang/2011 dated 31.03.2016 for the assessment year 2007-08, the Bangalore Bench of the Tribunal has observed that in the immediately preceding assessment year of 2006-07, the said concern was evaluated by the assessee and was found functionally incomparable and the aforesaid position has been accepted by the TPO in the earlier A.Y. 2006-07 and therefore, there was no justification for the TPO to consider the said concern as functionally comparable in the instant assessment year. In our considered opinion, the point raised by the assessee is potent in as much as it is quite evident that the said concern has not been found to be functionally comparable with the assessee in the immediately preceding assessment year and in the present year also, on the basis of the Annual Report, referred to in the written submissions addressed to the lower authorities, the assessee has correctly asserted out that the said concern was inter alia engaged in sale of software products, which was quite distinct from the activity undertaken by the assessee in the IT Services segment. At the time of hearing, neither is there any argument put forth by the Revenue and nor is there any discussion emerging from the orders of the lower authorities as to in what manner the functional profile of the said concern has undergone a change from that in the immediately preceding year. Therefore, having regard to the factual aspects brought out by the assessee, it is correctly asserted that the application software segment of the said concern is not comparable to the assessees segment of IT services and accordingly, we direct to exclude the same for the list of comparables.”

- 11 - IT(TP)A No.25 /Chny/2020 7.1 When this was point out to ld. CIT-DR, he could not controvert the above fact situation that the issue is not covered by the Tribunal’s order in earlier year. 7.2 We have gone through the facts of the case and arguments of both the sides and noted that this comparable has already been considered by the Tribunal in ITA No.477/MDS/2016 vide order dated 02.01.2017 and considered in detail the functional difference and segmental data difference and hence, respectfully following the same we direct the AO to exclude this comparable and then compute the ALP.

- 12 - IT(TP)A No.25 /Chny/2020 large turnover i.e., 10 times than the assessee. The ld.counsel relied on various decisions of ITAT and particularly the Karnataka High Court in Acusis Software (I) (P) Ltd., vs. ITO reported in [2018] 98 taxmann.com 183, held that comparable to be excluded if the turnover is more than 10 times. He relied on the decision of Hon’ble Karnataka High Court in the case of Acusis Software (I) (P) Ltd., supra. The ld.counsel also relied on the decision Co-ordinate Bench of this Tribunal in the case of Visual Graphics Computing Services (India) Pvt. Ltd., vs. DCIT, in ITA No.2340/CHNY/2012.

8.1 When these pointed out, the ld.CIT-DR, could not controvert the above fact or could not argue that turnover pointed out by assessee, there is any differential fact.

8.2 After hearing rival contentions and going through the facts of the case, we noted that the Infosys is to be excluded due to its huge incomparable size and scale. Admittedly, the Hon’ble Karnataka High Court has also laid down a ceiling wherein it is held that comparable is to be excluded if the turnover is more than 10 times. This is the fact. Hence, we direct the TPO and AO to exclude Infosys Technology Ltd., as comparable and then compute the ALP.

- 13 - IT(TP)A No.25 /Chny/2020 9. The ld.counsel for the assessee pointed out the next exclusion is with regard to Bodh Tree Consulting Ltd. The ld.counsel for the assessee for exclusion of Bodh Tree as comparable argued that Bodh Tree has revenue from software services and products and diversified services whereas assessee has revenue only from software development services in assessment year 2009-10. For this, he referred to the accounts of the assessee and drew our attention to page 737 & 738 of assessee’s paper-book. He pointed out another differential fact that the general classification of principal product of Bodh Tree is pertaining to goods and he pointed out the ITC code No.852499 but the whole chapter of ITC list in which ITC code appears only relate to goods and not 85comparable with assessee’s business of software development services. The ld.counsel also relied on the decision of Co-ordinate Bench of ITAT, Bangalore in the case of Toshiba India in IT(TP)A No.268/Bang/2014, wherein following the decision for assessment year 2009-10, the Tribunal has excluded Bodh Tree Consulting Ltd., from being a software product company being incomparable to service company. The ld.counsel also relied on the decision of Co- ordinate Bench decision in the case of Kumaran Systems P. Ltd., vs. DCIT in ITA No.906/Mds/2015.

- 14 - IT(TP)A No.25 /Chny/2020 9.1 When these facts were pointed out to ld.CIT-DR, he only relied on the order of TPO and DRP and apart from that could not controvert the above fact situation that the assessee’s revenue are from software development services whereas the comparable has revenue from software services, products and from diversified services. This being covered issue by the decision of Co-ordinate Bench of Bangalore Tribunal in the case of Toshiba India, supra and Chennai Tribunal in the case of Kumaran Systems P. Ltd., supra. Respectfully following the same, we direct the TPO to exclude this as comparable for the purpose of computing PLI of the assessee.

“13.1 The assessee‟s challenge before the DRP was dealt as under the DRP:

- 15 - IT(TP)A No.25 /Chny/2020 "The annual report is verified and it is observed that as per P&L of annual report: "Income service 2,43,57,68,787/- Other Income 1,05,30,957 It can be seen from the above, main income is from software development. Therefore the company is includible so far as its functionality is concerned However, as per annual report of the company RPT of this company is 14.65% and is within the overall limit of 25%. As per the taxpayer‟s argument of taking the receivable into the calculation of RPT, it is seen that it is balance sheet item. The sonata Software limited has 4 related parties it is seen that the service charge credited in the P&L account of Sonata Software Ltd. is Rs. 243.57 crores. The only related party with which this comparable is having transaction in services is Sonata Information Technology Limited (SITL) amounting to Rs. 16.11 crores which is around 6.61% of the total service income. Similarly, the other debit items of the profit and loss account like deputation expenses, travelling expenses, other expenses and reimbursement of expenses have been considered as the part of RPT. The other items like interest, though a P&L account item has not been considered as this is non operational. On the contrary balance sheet items like assets, loans, deposits whether receivables or payables have been excluded from the calculation of RPT. This approach of the TPO was well justified in view of the accounting norms. Therefore, the taxpayer‟s contention to exclude Sonata Software Ltd. is rejected." 13.2 The ld. counsel submitted that M/s Sonata Software majorly deals into product, sale, offshore development services and significant related party transactions. The company is also engaged in research and development. It was submitted as under: "As per segmental results of Sonata Software, the company deals in software products (tab 6 of Vol 4) Extraordinary events: During the relevant previous year, it is also set up a new subsidiary in Dubai which acquired major business in Dubai (Tab 6 of Vol 4) Refer Capital IQ vs. DCIT: Capital IQ vs. DCIT wherein it is held that extraordinary events will have impact on profitability. Failure of RPT filter: Even otherwise, it can be seen that its related party transaction exceeds 25% of the revenues, which makes it an unviable comparable. It is seen from the annual report that the RPT to sales ratio is more than 40% during the relevant previous year. Therefore, it fails the 25% filter applied by the TPO."

- 16 - IT(TP)A No.25 /Chny/2020 13.3 Having considered the rival submissions, we find that in the instant case, aggregate related party transactions are roughly around 95 crores which is approximately about 40% of the total service income of Rs. 243.57 crores. As such, the said comparable is not a valid comparable and hence is directed to be excluded as it fails the RTP filter of 25% applied by the TPO.” 10.1 When these facts were confronted to CIT-DR, he only relied on the order of DRP and TPO.

10.2 After hearing both the sides and going through facts of the case, we direct the DRP to exclude this comparable in view of the above fact that this issue is covered by the decision of Delhi Tribunal and revenue could not point out any differential fact or could not distinguish the Delhi Tribunal decision on facts. Hence, taking a consistent view, we direct the TPO to exclude Sonata Software Ltd., while computing PLI of the assessee.

- 17 - IT(TP)A No.25 /Chny/2020 “B. For grant of economic adjustments 9. The Ld.AO/TPO as well as the Ld.DRP ought to have granted suitable adjustments to account for various differences between the Appellant vis-à- vis comparables including working capital adjustment and, in the process, neglected the Indian Transfer Pricing laws, the OECD Guidelines on Transfer Pricing and various judicial precedents.”

- 18 - IT(TP)A No.25 /Chny/2020 objected. In term of the above, we restore this issue of working capital adjustment to AO/TPO and direct him to consider the numerical data and accordingly, decide the issue as per law.

- 19 - IT(TP)A No.25 /Chny/2020 ld.counsel for the assessee stated that it has interest free funds available with it for making investment in instruments giving raise to exempt income and hence, no disallowance should be made while computing disallowance in relation to exempt income under Rule 8D(2)(ii). The ld.counsel for the assessee drew our attention to financial statements i.e., balance sheet, etc. But at this stage, it is not possible to verify the availability of interest free funds.

15.1 When this was pointed out to ld. CIT-DR, he fairly agreed that for verification purpose matter can be restored to the file of AO.

- 20 - IT(TP)A No.25 /Chny/2020 value of investment and disallowed expenses at Rs.78,23,607/-. The ld.counsel for the assessee stated that the interest free funds available will apply even to applicability of Rule 8D(2)(iii) i.e., 0.5% of average value of investment while computing disallowance. The ld.counsel drew our attention to the decision of Hon’ble Gujarat High Court in the case of PCIT vs. Sintex Industries Ltd., reported in [2017] 82 taxmann.com 171 (Gujarat) and drew our attention to following para 9:- “9. Considering the aforesaid facts and circumstances, more particularly the fact that the assessee was already having its own surplus fund and that too to the extent of Rs.2319.17 Crores against which investment was made of Rs.111.09 Crores, there was no question of making any disallowance of expenditure in respect of interest and administrative expenses under Section 14A of the Act, therefore, there was no question of any estimation of expenditure in respect of interest and administrative expenses of Rs.54,39,916/- under rule 8D of the Rules. Under the circumstances and in the facts of the case, narrated hereinabove, it cannot be said that the learned Tribunal has committed any error in deleting the disallowance of expenditure of Rs.54,39,916/- incurred in respect of interest and administrative expenses under section 14A of the Act. We are in complete agreement with the view taken by the learned Tribunal. AT this stage, decision of Division Bench of this Court in the case of Pr.CIT v. India Gelatine & Chemicals Ltd. [2015] 376 ITR 553/[2016] 66 taxmann.com 356 needs a reference. In the said decision, it is observed and held by the Division Bench of this Court that when the assessee had sufficient interest- free funds out of which concerned investments had been made, disallowance under Section 14A is not justified.”

When it was pointed out that it is not clear from the judgment of Hon’ble Gujarat High Court, whether disallowance was under Rule 8D(2)(ii) or 8D(2)(iii), rather Hon’ble High Court has discussed

- 21 - IT(TP)A No.25 /Chny/2020 having its own surplus funds for the purpose of interest and administrative expenses. As per our understanding and the provisions of the Act, nowhere described anything wherein surplus funds are invested, the provision of Rule 8D(2)(iii) will not apply rather it applies to Rule 8D(2)(ii) only. Hence, this decision will not come to rescue of the assessee in regard to applicability of Rule 8D(2)(iii).

- 22 - IT(TP)A No.25 /Chny/2020

G. Regarding exclusion of expenditure incurred in foreign currency from export turnover

H. Regarding non-exclusion of foreign inward remittances, not received within the prescribed period, from the total turnover

- 23 - IT(TP)A No.25 /Chny/2020 20. The ld.counsel for the assessee stated that the assessee has filed complete details of the amount excluded from export turnover and also non-exclusion of foreign onward remittances but neither DRP nor AO has discussed anything about the exclusion and just excluded these amounts from the total export turnover. According to ld.counsel once this issue is not adjudicated properly this may be remitted back to the file of the AO for proper adjudication. When this was pointed out to ld. CIT-DR, he could not controvert the above fact and relied on the assessment order and DRP.

- 24 - IT(TP)A No.25 /Chny/2020 expenditure from export turnover. On principle, we agree with the contention of the assessee but facts need to be verified. Hence, we restored this issue back to the file of the AO/DRP, who after verification of facts will follow the principle laid down in Tribunal’s decision in assessee’s own case for assessment year 2010-11 in ITA No.2315/CHNY/2016 dated 29.10.2018. In term of the above, we restore this issue back to the file of the AO.

- 25 - IT(TP)A No.25 /Chny/2020 issued or will rectify accordingly. This issue needs to be settled by the AO after verification and also decide the corresponding charging of interest u/s.234D of the Act. In term of the above, we restore this issue back to the file of the AO.

Order pronounced in the open court on 10th May, 2024 at Chennai.

Sd/- Sd/- (महावीर �सह ) (अिमताभ शु�ला) (MAHAVIR SINGH) (AMITABH SHUKLA) उपा�य� /VICE PRESIDENT लेखा सद�य/ACCOUNTANT MEMBER चे�ई/Chennai, �दनांक/Dated, the 10th May, 2024 RSR आदेश क� �ितिलिप अ�ेिषत/Copy to: 1. अपीलाथ�/Appellant 2. ��यथ�/Respondent 3. आयकर आयु� /CIT 4. िवभागीय �ितिनिध/DR 5. गाड� फाईल/GF.