MOTOROLA SOLUTIONS KODIAK NETWORKS INDIA PRIVATE LIMITED,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-4(1)(1), BANGALORE

Per N. V. Vasudevan, Vice President :

This is an appeal by the assessee against the final order of assessment dated 29.07.2022 passed by the DCIT, Circle - 4(1)(1), Bengaluru, (hereinafter referred to as the Assessing Officer, “AO” in short) passed under section 143(3) read with Section 144C(13) of the Income Tax Act, 1961 (hereinafter called ‘the Act’) in relation to Assessment Year 2018-19.

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Enabled Services (ITeS), to its wholly owned holding company. In terms of the provisions of Sec.92-A of the Act, the assessee and its wholly owned holding company were Associated Enterprises ("AEs"). In terms of Sec.92B(1) of the Act, the transaction of providing SWD Services was an “international transaction” i.e., a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. The Finance Act. 2001 had introduced a legislation with respect to transfer pricing by substituting the erstwhile section 92 of the Act with a new and separate code or sections, namely sections 92 to 92F, with effect from 1st April, 2002. i.e., the assessment year 2002- 2003. The salient features of the legislation with respect to transfer pricing, to the extent material for the purpose of deciding the question referred to the special bench, are as follows: -

• Section 92(l) of the Act provides that any income arising from an "international transaction" shall be computed having regard to the arms length price. The Explanation to the said section provides that allowance for any expense or interest arising from an international transaction hall also be determined having regard to the arm' s length price.

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• The term "international transaction' has been defined in section 92B(1) or the Act to mean a transaction between two or more "associated enterprises" either or both of whom are non-residents in the nature of inter alia purchase, sale or lease of intangible property or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises. • Section 92A of the Act defines the term "associated enterprise" in relation to another enterprise, in a manner where the enterprise directly or indirectly participates in the Management, control or capital of the other enterprise. • The term "arm's length price" (ALP) has been defined in clause (ii) of section 92F of the Act, to mean a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. Section 92C( 1) of the Act provides that the arm's length price in relation to an international. By virtue of the provisions of section 92CA(1), the Assessing Officer, with the previous approval of the Pr Commissioner / Commissioner is empowered to refer to the Transfer Pricing Officer (TPO) the computation of the arm’s length price of an international transaction or specified domestic transaction entered into by an assessee over whom the Assessing Officer exercises jurisdiction. The TPO, after due enquiry and opportunity of being heard, shall by order in writing determine the ALP in relation to the international transaction in accordance with provisions of section 92CA(3) and send a copy of his order to the Assessing Officer (AO) and to the assessee for finalization of assessment order. Section 92C(2) provides that the variation between the ALP and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been under taken shall be deemed to be the ALP. The AO passes a draft order of assessment against which, the Assessee has a right to file objections before the Dispute Resolution Panel (DRP) u/s.144C of the Act. Under section 144C(5), the Dispute Resolution Panel (DRP) shall issue the directions, as it thinks fit, for

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the guidance of the AO to enable him to complete the assessment after considering report of TPO. The AO passes a final assessment order on the basis of directions of the DRP.

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(OP/OC) as the Profit Level Indicator (PLI) for the purpose of comparison. The OP/OC of the assessee was arrived at 16.60% by the TPO. The assessee chose companies who are engaged in providing similar services such as the assessee. The assessee identified companies whose average arithmetic mean of profit margin was comparable with the Operating margin of the assessee. The assessee therefore claimed that the price it charged in the international transaction should be considered as at Arm’s Length.

Calculation of Arm’s Length Price:

SWD SEGMENT

Particulars Formula Amount (in Rs.) OR Taxpayers Operating Revenue 100,02,32,760

Taxpayers Operating Cost OC 85,77,91,420

Taxpayers Operating Profit OP 14,24,41,340

Taxpayers PLI PLI=OP/OC 16.60%

35th Percentile Margin of comparable set 20.19%

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Adjustment Required (if PLI< 35th Yes Percentile) Median Margin of comparable set M 23.60

Arm's Length Price ALP=(1+M)* 106,02,30,195 OC Price Received OR 100,02,32,760

Shortfall being adjustment ALP-OR 5,99,97,435

Thus a sum of Rs.5,99,94,435/- was added to the total income of the assessee on account of determination of ALP for provision of SWD services by the assessee to its AE.

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F.Year wise OP/OC (%) Wt. SI. No. Company Name Average 2015-16 2016-17 2017-18

1 Inteq Software Pvt. Ltd. 7.82 -15.3 12.16 1.38

2 Batchmaster Software Pvt. Ltd. 1.12 1.39 2.08 1.53

Isummation Technologies Pvt. 3.31 3.98 -0.19 2.26 Ltd. 3

DCIS Dot Corn Solutions India 2.15 3.36 4.44 3.28 Pvt. Ltd. 4

Maveric Systems Pvt. Ltd. 3.31 6.1 10.42 6.82 5

Data collection Infotech Pvt. Ltd. 8.48 8.46 7.36 8.08 6

Infomile Technologies Ltd. 9.86 11.06 8.64 9.69 7

Harbinger Systems Pvt. Ltd. 12.69 12.8 9.46 11.65 8

CG-VAK Software and exports 18.6 9.81 13.08 13.49 9 Ltd.,

Exilant Technologies Pvt. Ltd., 25.82 17.27 8.5 17.17 '0

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Tech Mahindra Ltd. 17.5 18.06 20.03 18.57 11

Larsen & Toubro Infotech Ltd. 20.78 19.21 17.14 18.94 12

Great Software Laboratory Pvt. 17.88 23.87 17.31 19.73 13 Ltd.

Elveego Circuits Pvt. Ltd. 8.3 40.17 6.75 20.19 14

Black Pepper Technologies Pvt. 9.63 13.84 24.83 20.62 15 Ltd.

Mindtree Ltd. 26.11 20.12 18.41 21.21 16

Sagarsoft (India) Pvt. Ltd. 10.58 8.68 34.43 21.92 17

Aptus Software Labs Pvt. Ltd. 27.67 24.83 15.16 22.7 18

AcewinAgriteck Ltd. 26.54 23.23 22.73 24.51 19

Persistent Systems Ltd. 23.9 24.44 26.94 24.98 20

Wipro Ltd. 27.27 26.38 27.03 26.83 21

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Tata Elxsi Ltd. 24.9 29.13 30.56 28.24 22

Infobeans Technologies Ltd. 34.98 23.89 27.82 28.52 23

Nihilent Ltd. 24.46 30.8 35.11 30.17 24

ThreesixtyLogica Testing 48.46 36.63 26.2 36.58 25 Services Pvt. Ltd.

Infosys Ltd. 38.29 38.79 35.27 37.38 26

Cybage Software Pvt. Ltd. 62.04 61.4 47.78 56.81 27

17.17 35th percentile

Median 20.19

65th percentile 22.7

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(ii) Selecting following companies as comparables even though they fail upper turnover filter of more than Rs.200 crores: Exilant Technologies Private Limited  Larsen & Toubro Infotech Ltd  Mindtree Ltd  Persistent Systems Ltd  Wipro Ltd  Tata Elxsi Ltd  Nihilent Ltd  Infosys Ltd  Cybage Software Pvt. Ltd  Tech Mahindra Ltd 

Determination of arm's length price under section 92C . 10B . (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :— (a) to (d)...... (e)transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction [or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or

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assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction];

(f)...... (2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:— (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by

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the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if— (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. 11. A reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market.

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purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines, it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that:  None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or  Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments. 13. The TPO excluded from the list of comparable companies chosen by the assessee in its TP study companies whose turnover was less than Rs.1 Crore. The contention of the assessee before the DRP was that while the TPO excluded companies with low turnover, he failed to apply the same yardstick to exclude companies with high turnover compared to the assessee. The reason for excluding companies with low turnover was that such companies do not reflect the industry trend as their low cost to sales ratio made their results less reliable. The contention of the assessee was that there would be effect on profitability wherever there is high or low turnover and therefore companies with high turnover should also be excluded from the list of comparable companies. The DRP primarily relied on the decision rendered by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors India Pvt.Ltd Vs. DCIT 82 Taxmann.com 167(Del),

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wherein it was held that high turnover ipso facto does not lead to the conclusion that a company which is otherwise comparable on FAR analysis can be excluded and that the effect of such high turnover on the margin should be seen. The DRP therefore held that a company which is otherwise functionally comparable cannot be excluded only on the basis of high turnover. The assessee has raised Grd.No.2 (ii) before the Tribunal challenging the aforesaid view of the DRP.

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“41. We have given a very careful consideration to the rival submissions. ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, relying on Dun and Bradstreet’s analysis, held grouping of companies having turnover of Rs. 1 crore to Rs.200 crores as comparable with each other was held to be proper. The following relevant observations were brought to our notice:- “9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be

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taken into consideration for the purpose of making TP study.” 42. The Assessee’s turnover was around Rs.110 Crores. Therefore the action of the CIT(A) in directing TPO to exclude companies having turnover of more than Rs.200 crores as not comparable with the Assessee was justified. As rightly pointed out by the learned counsel for the Assessee, there are two views expressed by two Hon’ble High Courts of Bombay and Delhi and both are non- jurisdictional High Courts. The view expressed by the Bombay High Court is in favour of the Assessee and therefore following the said view, the action of the CIT(A) excluding companies with turnover of above Rs.200 crores from the list of comparable companies is held to correct and such action does not call for any interference.”

“17.7. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon'ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon'ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015

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has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon'ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee. 17.8. In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5.8.2011. The decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India Pvt.Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding co-ordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of M/S.NTT Data (supra), Societe Generale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon’ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon’ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed.

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Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).”

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Pronounced in the open court on the date mentioned on the caption page.

Sd/- Sd/- (CHANDRA POOJARI) (N. V. VASUDEVAN) Accountant Member Vice President Bangalore, Dated: 10.01.2023. /NS/* Copy to: 1. Appellants 2. Respondent 3. CIT 4. CIT(A) 5. DR 6. Guard file By order

Assistant Registrar, ITAT, Bangalore.