M/S. YAHOO SOFTWARE DEVELOPMENT INDIA PRIVATE LIMITED,BENGALURU vs. THE JOINT COMMISSIONER OF INCOME TAX, SPECIAL RANGE- 7, BANGALORE

Page 2 of 11 IT(TP)A No. 178/Bang/2022 2. At the outset, the Ld.AR submitted that assessee wish to press Ground no. 2.8, wherein it seeks exclusion of a) Infosys Ltd. b) Persistent Systems Ltd. c) Larsen & Toubro Infotech Ltd. d) Mindtree Ltd.

In Ground nos. 2.10 – 2.11, the assessee is seeking working capital adjustment and in Ground no. 3.1, the assessee is seeking rectification of tax credit eligible to assessee under 115JAA.

The Ld.AR submitted that Coordinate Bench of this Tribunal in assessee’s own case in IT(TP)A No. 2657/Bang/2018 & IT(TP)A No. 2365/Bang/2019 for A.Ys. 2014-15 & 2015-16 by order dated 28.02.2020 excluded Infosys Ltd., Mindtree Ltd., L&T Infotech Ltd. and Persistent Systems Ltd. by observing as under: “32. At the time of hearing, the ld. counsel for the assessee has prayed for exclusion of 4 comparable companies that remain after the order of the DRP viz., Persistent Systems Ltd., Infosys Ltd., Mindtree Ltd. and L&T Infotech Ltd. He brought to our notice that as far as Persistent Systems Ltd. is concerned, the reasoning given for excluding this company for AY 2014-15 will equally hold good for the present year as well. In this regard, our attention was drawn to page 601 of the assessee's PB wherein in the annual report of this company, Notes forming part of financial statement in Note (i) which gives the description of income from software services, there is a reference to revenue from licensing & software, which sufficiently indicates that the assessee is not a pure SWD services provider. It was also brought to our notice that the profit & loss account which is at page 596 read with Notes forming part of the financial statement at page 604 wherein the segmental reporting is not based on different segments and the statement presents a consolidated financial statement without any segmental reporting. This company has also significant RPT transaction of 25% on sales. He pointed out that the TPO & DRP on the application of RPT filter has not expressed any opinion. The ld. DR relied on the order of DRP wherein the DRP has made extensive Page 3 of 11 IT(TP)A No. 178/Bang/2022 reference to each of the objections regarding absence of segmental revenue in the accounts and has also noticed that the software products segment had an insignificant revenue and that the ownership of intangibles by the assessee has had no effect whatsoever.

We have considered the rival submissions. We find that on the question of application of RPT filter, the assessee had made the following submission before the DRP:- 4. Fails the Related Party Transaction to Sales filter applied by the learned TPO In the show-cause notice issued, the learned TPO has excluded companies for which the ratio of RPT to sales exceeds 25% during the current year i.e., during FY 2014-15. The relevant extract from the show-cause notice is reproduced below for ease of reference: e) Companies who have more than 25% related parry transactions of the sales were excluded. Companies having related party transactions of more than 25% are proposed to be excluded. A threshold of 25% is being applied following the provisions of Section 92A(2)(a) which provides a limit of 26% of the equity capital carrying voting rights for treating an enterprise as Associated Enterprise. if the limit is reduced further it would only result in eliminating more and more companies, on the other hand if the limit is relaxed then companies with predominantly related party transactions would get included which would not represent uncontrolled transactions. Therefore, on a balancing note, 25% is a proper threshold limit for related party transactions. The companies having more than 25% related party transactions should therefore be rejected as comparables. The Hon'ble IT.AT has upheld the application of this filter by the TPO in its order in the case of M/s. Supporisoft India Pvt. Ltd for AY 2005-G6 in IT (TP)A 1372/B/11 & 20/2012 dated 28.03.2013 following its own decision in the case of M/s. Actis Advertisers Pvt. Ltd vide dated 12.10.2012. On perusal of the Annual Report of Persistent, we observe that the company has RPT in excess of 25% of the sales. The calculation of the same has been provided below for your ease of reference:

This argument has been addressed by the DRP in its order as follows:- "4.4.9 We note that the approach of the TPO in treatment of related party transaction into two sets, are for revenue transactions and other for expense transaction is logical and correct. We also note that the RPT filter was adopted by the TPO was with the above conditions and has adopted consistently. Hence, we do not find any infirmity the approach. Hence, we reject the assessee's plea. We hold that onsite expenses do not adversely affect comparability and hence, such plea is rejected."

Further, the assessee had also raised plea with regard to onsite revenue filter by pointing out that onsite revenue is substantial and therefore this company should not be regarded as a comparable company with a company which does not have any onsite revenue. In this regard, the ld. counsel for the assessee placed reliance on the decision of the ITAT Bangalore Bench in the case of Trilogy e-business Software India P. Ltd. v. DCIT, for AY 2007-08 dated 23.11.2012 wherein this Tribunal took the following view:- "64. The next objection of the Assessee is that when the most appropriate method selected for determining ALP is the TNMM there is no reason as to why one should look at price difference in offshore software development and onsite software development. It is no doubt true that in TNMM it is only the margins in an uncontrolled transaction Page 5 of 11 IT(TP)A No. 178/Bang/2022 that is tested with reference to the controlled transaction but it is not possible to ignore the fact that pricing will have an effect on the margins obtained in a transaction. The argument that if pricing structure were to be considered as criteria, then it will have to be seen as to what is the pricing structure of all the comparable for various projects cannot be accepted because the TPO has not chosen any other onsite software service provider with a revenue composition of more than 75% from onsite software services as comparable. As rightly observed by the TPO, the pricing is different in onsite when compared to offshore operations. The further observations of the TPO that the reasons for the same lie in the fact that while in the case of OFFSHORE projects most of the costs are incurred in India; an ONSITE project has to be carried out abroad significantly increasing the employee cost and other costs.

The next objection of the Assessee is with regard to Assets employed. The companies, which predominantly generate revenues from onsite activity, do not have significant assets as most of the work is carried on the site of customer outside India. The argument that the TPO has himself observed that software service providers do not require much assets cannot be basis to accept the Assessee's plea. Those observations are made by the TPO in the context of application of turnover filter and have been quoted out of context by the Assessee.

The next argument of the Assessee is that TPO has held that margins are lower in onsite software services and that margin is not a criteria to select or reject a comparable under Rule I0B(2) of the I.T. Rules. We are of the view that this argument again ignores the fact that the approach of the TPO has been to highlight the fact that there can be no functional comparability, if the assets employed and risks assumed are taken into consideration. It is in that context the TPO has referred to the margins.

The companies who generate more than 75% of the export revenues from onsite operations outside India are effectively companies working outside India having their own geographical markets, cost of labour etc., and also return commensurate with the economic conditions in those countries. Thus assets and risk profile, pricing as well as prevailing market conditions are different in predominantly onsite companies from predominantly offshore companies like the taxpayer. Since, the entire operations of the tax payer are taking place offshore i.e. in India; it is but natural that it should be compared with companies with major operations offshore, due to the reason that the economics and profitability of onsite Page 6 of 11 IT(TP)A No. 178/Bang/2022 operations are different from that of offshore business model. As already stated the Assessee has limited its analysis only to functions but not to the assets, risks as well as prevailing market conditions in which both the buyer and seller of services located. Hence, the companies in which more than 75% of their export revenues come from onsite operations are to be excluded from the comparability study as they are not functioning in similar economic circumstances to that of the tax payer. Hence, it is held that this filter is appropriately applied by the TPO.

Admittedly the onsite revenue in the case of the following comparable companies identified by the Assessee was more than 75% of its export revenues viz., a) Visu International Ltd. b) Maars Software International Ltd. c) Akshay Software Technologies Ltd. d) VJIL Consulting Ltd. e) Synfosys Business Solutions Ltd. The above companies were therefore rightly not considered as comparable by the TPO. We hold accordingly."

It is seen that the TPO in coming to the conclusion that the onsite revenue filter is not applicable has placed reliance on the decision of the ITAT Mumbai Bench in the case of Capegemini as quoted in para 16 in para 14 of the TPO's order, but that decision does not deal with a case of onsite revenue filter and the decision was rendered on the facts of its own case.

On the issue of RPT filter, we notice that the TPO in para 16 has accepted that the RPT filter should be @ 25%. In the case of Persistent Systems Ltd., the RPT is at 31.32% as extracted in the earlier part of this order and therefore this company should be excluded by application of RPT filter. In view of the above, we do not wish to go into other grounds on which this company is sought to be excluded viz., that it is a product company and there is no segmental data between product and services segment, presence of onsite activity and the impact of extra-ordinary event of acquisition during the relevant previous year. Therefore, this company is directed to be excluded from the list of comparable company.

As far as L&T Infotech Ltd. is concerned, the ld. counsel for the assessee brought to our notice the decision of ITAT Delhi Bench in the case of Saxo India Pvt. Ltd. v. ACIT, for AY 2011- 12, order dated 5.2.2016, wherein the Tribunal took note of the fact that this company was also trading in software and owned insignificant intangible assets. The company was excluded from the list of comparable companies with reference to SWD services provider such as the assessee. The ld.Counsel pointed out that though this decision was Page 7 of 11 IT(TP)A No. 178/Bang/2022 rendered with reference to AY 2011-12, the same reasoning would apply to AY 2015-16 also and in this regard, he drew our attention to page 696 of assessee's PB, which gives the details of the revenue generated by this company without any segmental break-up. Our attention was also drawn to page 682 of PB which shows that there is substantial onsite revenue activity as well as cost incurred on onsite software development. We notice from page 676 of assessee's PB that this company as part of its operating profit in Schedule- O of profit & loss account contains expenditure for 'cost of bought out items for resale' and this is a significant part of the operating expenditure. When we see the revenue in Schedule M of the profit & loss account, there is no break-up of the revenue with regard to software services and software product. In our opinion, this distinction is enough to exclude this company from the list of comparable companies as held by the Hon'ble Delhi ITAT in the case of Saxo India Pvt. Ltd. (supra) which decision was also confirmed by the Hon'ble Delhi High Court.

The next company which the assessee seeks to exclude is Infosys Ltd. As far as this company is concerned, it is seen that the following are the functional dissimilarities brought to our notice:- "Functionally dissimilar - owns intellectual properties, incurs significant R&D costs & onsite activity. - Engaged in diversified business activities. - Involved in development of software products in addition to software services. - Owns intellectual property rights. - Incurs significant research and development costs. - Carries out significant activities based on onsite business. - Owns products such as Finacle, Edge Verve and other product based solutions. Extra-ordinary event of merger with Infosys Consulting India Ltd. Segmental profit & loss account not available. Commands substantial brand value.

The DRP, however, has not thought it fit to exclude this company by observing that this company has substantial pre-dominant revenue from software services and the growth was not attributable to any brand value. Presence of onsite activity and the expenses on R&D have all been brushed aside. In our view, the difference pointed out by the ld. counsel for the assessee before us show that this company cannot be compared with that of the assessee Page 8 of 11 IT(TP)A No. 178/Bang/2022 basically because of its business model, presence of onsite revenue generation and other reasons cited before us. Besides, the reason that turnover of this company is huge and more than 10 times that of the assessee.

The next company sought to be excluded is Mindtree Ltd. The submissions made before us were as follows:- "Functionally dissimilar, diversified operation, significant R&D spend, ownership of intangibles. - Also engaged in business of rendering IP-Led revenue, infrastructure management, package implementation, consultancy services, etc. constituting 45% of overall revenue during FY 2014-15. - Diversified operation i.e. engaged in infrastructure management services, business process management, technology consulting, product engineering and SAP services. Also lacks segmental data. - Significant research & development activity. By incurring R&D expenses, it was able to deliver IP based video surveillance management, recording and analytic products and solutions. It has filed 4 patents in India and US so far in the area of Video analysis. - Ownership of intangibles in the form of intangible property. Significant onsite activity: - 46% of revenue earned under Onsite model. - Incurred overseas branch office expenses amounting to INR 1582 crores - Receives incentives from State of Florida in relation to the development center located overseas. Lack of segmental data - Does not maintain segmental information in respect of profitability reported from business activities in the nature of infrastructure management services, technology consulting and SAP services. - Acquisition of subsidiary - Discoverture Solutions LLC.

The DRP while dealing with the aforesaid objections has merely taken the view that the presence of IPR revenue was insignificant and so also expenses of brand value, R&D & intangibles. More importantly, the DRP did not dispute the presence of 46% of revenue from onsite model, but went on to hold that the presence of revenue is not sufficient to exclude a company, when it is otherwise functionally comparable. On this aspect, we have already referred to the decision of the ITAT Bangalore Bench in the case of Trilogy e-business Software India P. Ltd. (supra) and in the light of this decision and the admitted factual position regarding presence of onsite revenue over and above the threshold limit of 25% of total revenue, we are of Page 9 of 11 IT(TP)A No. 178/Bang/2022 the view that this company should be excluded from the list of comparable companies. We hold and direct accordingly.”

The revenue has not placed anything on record contrary to the above observations. Further admittedly the functions, assets owned and risks assumed by the assessee under the segment is similar with A.Ys. 2014-15 & 2015-16 (supra). Respectfully following the above view, we direct the Ld.AO to exclude Infosys Ltd., Persistent Systems Ltd., Mindtree Ltd. and L&T Infotech Ltd. from the final list.

Ground nos. 2.10 – 2.11 – The Ld.AR submitted that working capital adjustment was not been granted while computing the margin of the comparables.

It is submitted that assessee had given working capital adjustment computation before the authorities below, however, the same were ignored by the Ld.AO and DRP. He placed reliance on the decision of the Coordinate Bench of this Tribunal in case of Mobis India Ltd. reported in (2013) 38 taxmann.com 231. In Mobis India Ltd. (supra), it was held that, it is necessary to eliminate the difference which is possible only by computing the working capital adjustment in the hands of the comparables. Coordinate Bench relied on the decision of Hon’ble Chennai Tribunal observed that, the OECD guidelines are very clear and advocates adopting the rates of interest applicable to commercial enterprise operating in the same market as that of a tested party.

We are therefore of the opinion that the revenue was not justified in denying the working capital adjustment in order to bring the comparable companies for the purposes of broad comparison it is necessary to grant working capital adjustment Page 10 of 11 IT(TP)A No. 178/Bang/2022 that would eliminate the differences. The Ld.AO/TPO is directed to allow the working capital adjustment on actuals based on the materials already available on record. Needless to say that proper opportunity of being heard must be granted to assessee. Accordingly, this ground raised