DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-7(1)(1), BANGALORE vs. M/S UNISYS INDIA PVT LTD , BANGALORE

O R D E R Per Padmavathy S, Accountant Member

These cross appeals are filed by the assessee and Revenue against the order of the Commissioner of Income Tax, CIT(A)-7 Bengaluru dated 02/08/2017 for the assessment year 2010-11.

3. The international transactions in the Software Development Service (IT segment) & ITES segments with associated enterprises (AE’s) relevant to this appeal are as follows:-

4. The details of segment financials are as follows:-

Software Development Service (IT Segment)

The profit level indicator (PLI) chosen was operating profit to operating cost (OP/OC). The assessee chose the following 16 comparables the average margin of which was 13%.

Markup on S.No. Name of Companies — SWD segment Total Cost' 1 Akshay Software Technologies Ltd 9% 2 Compulink Systems Ltd -7% F C S Software Solutions Ltd 3 39% Goldstone Technologies Ltd 12% 4 L G S Global Ltd 23% 5 #6 Larsen & Toubro Infotech Ltd 22% #7 Mindtree Ltd 22% 8 P S I Data Systems Ltd 5% Polaris Software Lab Ltd 11% 9 1o Reliance Infosolutions Pvt Ltd 1% #11. Sasken Communication Technologies Ltd* 13% Synetairos Technologies Ltd 21% 12 #I3 Thinksoft Global Services Ltd* 18% Zensar Obt Technologies Ltd 19% 14 15 Crazy Infotech Ltd. 1% i6 Teledata Marine Solutions Ltd 3% Average 13%

Comparables selected by Ld. TPO Particulars Pre WC Post WC ICR.A. Techno Analytics Ltd. (seg) 24.62% 24.94% Infosys Ltd. 44.98% 44.43% Kals Information Systems Ltd. (seg) 30.32% 34.41% L&T Infotech Ltd. 19.33% 19.43% Mindtree Ltd. (seg) 14.83% 12.83% Persistent Systems and Solutions Ltd. 15.38% 15.21% Persistent Systems Ltd. 30.35% 28% R S Software (India) Ltd. 10.29% 10.57% Sasken Communication Technologies Ltd. 17.36% 16.45% Tata Elxi Ltd. (seg) 20.93% 17.21% Thinksoft Global Services Ltd. 17.05% 14.04% Average margin 22.71% 21.19%

Adjusted margin (post working capital adjustment) 21.19% Taxpayer operating cost (`OC) Rs. 84,03,24,419 Arm's length price (121.19% of OC) Rs. 101,83,91,597 Price received Rs. 92,52,01,220 Shortfall being adjustment u/s. 92CA Rs. 9,31,90,367

32. Infosys Ltd.:- As far as this company is concerned, it is not in dispute before us that this company has been considered to be functionally different from a company providing simple software development services, as this company owns significant intangibles and has huge revenues from software products. In this regard, we find that the Bangalore Bench of the Tribunal in the case of M/s. TDPLM Software Solutions Ltd. v. DCIT, by order dated 28.11.2013 with regard to this comparable has held as follows:-

“11.0 Infosys Technologies Ltd. 11.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment.

11.2 Before us, the learned Authorised Representative contended that this company is not functionally comparable to the assessee in the case on hand. The learned Authorised Representative drew our attention to various parts of the Annual Report of this company to submit that this company commands substantial brand value, owns intellectual property rights and is a market leader in software development activities, whereas the assessee is merely a software service provider operating its business in India and does not possess either any brand value or own any intangible or intellectual property rights (IPRs). It was also submitted by the learned Authorised Representative that :-

(i) the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. in has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any intangible and hence does not have an additional advantage in the market. It is submitted that this decision is applicable to the assessee's case, as the assessee does not own any intangibles and hence Infosys Technologies Ltd. cannot be comparable to the assessee ;

(ii) the observation of the ITAT, Delhi Bench in the case of Agnity India Technologies Pvt. Ltd. in (Del)/2010 at para 5.2 thereof, that Infosys Technologies Ltd. being a giant company and market leader assuming all risks leading to higher profits cannot be considered as comparable to captive service providers assuming limited risk ;

(iii) the company has generated several inventions and filed for many patents in India and USA ;

(iv) the company has substantial revenues from software products and the break up of such revenues is not available ;

(v) the company has incurred huge expenditure for research and development;

(vi) the company has made arrangements towards acquisition of IPRs in ‘AUTOLAY’, a commercial application product used in designing high performance structural systems.

In view of the above reasons, the learned Authorised Representative pleaded that, this company i.e. Infosys Technologies Ltd., be excluded from the list of comparable companies.

11.3 Per contra, opposing the contentions of the assessee, the learned Departmental Representative submitted that comparability cannot be decided merely on the basis of scale of operations and the brand attributable profit margins of this company have not been extraordinary. In view of this, the learned Departmental Representative supported the decision of the TPO to include this company in the list of comparable companies.

11.4 We have heard the rival submissions and perused and carefully considered the material on record. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) for Assessment Year 2007-08 is applicable to this year also. We are inclined to concur with the argument put forth by the assessee that Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the breakup of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly.”

The decision rendered as aforesaid pertains to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in AY 08-09 as far as this comparable company is concerned. Respectfully following the decision of the Tribunal referred to above, we hold that Infosys Ltd. be excluded from the list of comparable companies.

33. KALS Information Systems Ltd.:- . As far as this company is concerned, it is not in dispute before us that this company has been considered as not comparable to a pure software development services company by the Bangalore Bench of the Tribunal in the case of M/s. Trilogy e-business Software India Pvt. Ltd. (supra). The following were the relevant observations of the Tribunal:-

“(d) KALS Information Systems Ltd.

46. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds.” Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable.

47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable.” Following the aforesaid decision of the Tribunal, we hold that KALS Information Systems Ltd. should not be regarded as a comparable.

34. Tata Elxsi Ltd.,:- As far as this company is concerned, it is not in dispute before us that in assessee’s own case for the A.Y. 2007-

08, this company was not regarded as a comparable in its software development services segment in order dated 29.3.2013. Following were the relevant observations of the Tribunal:-

II. UNREASONABLE COMPARABILITY CRITERIA : 19. The learned Chartered Accountant pleaded that out of the six comparables shortlisted above as comparables based on the turnover filter, the following two companies, namely (i) Tata Elxsi Ltd; and (ii) M/s. Flextronics Software Systems Ltd., deserve to be eliminated for the following reasons : (i) Tata Elxsi Ltd., : The company operates in the segments of software development services which comprises of embedded product design services, industrial design and engineering services and visual computing labs and system integration services segment. There is no sub-services break up/information provided in the annual report or the databases based on which the margin from software services activity only could be computed. The company has also in its response to the notice u/s.133(6) stated that it cannot be considered as comparable to any other software services company because of its complex nature. Hence, Tata Elxsi Ltd., is to be excluded from the list of comparables.

(ii) Flextronics Software Systems Ltd. : The learned TPO has considered this company as a comparable based on 133(6) reply wherein this company reflected its software development services revenues to be more than 75% of the "software products and services" segment revenues. Flextronics has a hybrid revenue model and hence should be rejected as functionally different. Based on the information provided under "Revenue recognition" in its annual report, it can be inferred that the software services revenues are earned on a hybrid revenue model, and the same is not similar to the regular models adopted by other software service providers. The learned representative pleaded that a regular software services provider could not be compared to a company having such a unique revenue model, wherein the revenues of the company from software/product development services depends on the success of the products sold by its clients in the marketplace. Hence, it would be inappropriate to compare the business operations of the assessee with that of a company following hybrid business model comprising of royalty income as well as regular software services income, for which revenue break-up is not available. He finally submitted that this was a good reason to exclude this company also from the list of comparables.

"Thus as stated above by the company, the following facts emerge : 1. The company's software development and services segment constitutes three sub-segments i) product design services; ii) engineering design services and iii) visual computing labs.

2. The product design services sub-segment is into embedded software development. Thus this segment is into software development services.

“It is very pertinent to mention here that the company was considered by the taxpayer as a comparable for the preceding assessment year i.e., AY 2006-07. When the same was accepted by the TPO as a comparable, the same was not objected to it by the taxpayer. As the facts mentioned by the taxpayer are the same and these were there in the earlier FY 2005-06, there is no reason why the taxpayer is objecting to it. How the company is functionally similar in the earlier FY 2005-06 but the same is not functionally similar for the subsequent FY 2006-07 even when no facts have been changed from the preceding year. Thus the taxpayer is arguing against this comparable as the company was not considered as a comparable by the taxpayer for the present FY 2006-07."

35. Following the aforesaid decision of the Tribunal, we hold that M/S.Tata Elxsi Lts should not be regarded as a comparable”

37. Following the said decision we direct that Persistent Systems Ltd., be excluded from the final list of comparable companies chosen by the TPO

15. We respectfully follow the decision of the coordinate bench of the Tribunal in assessee’s own case and uphold the decision of CIT(A) to exclude (i) Infosvs Ltd.; (ii) Tata Elxi Ltd. (iii) Persistent Systems Ltd.; and (iv) KALS Information Systems Ltd

16. With regard to the exclusion of ICRA Techno Analytics Ltd., we find that the coordinate bench of the Tribunal in the case of Cisco Systems (supra) has held that ICRA Techno Analytics Limited

7.1 The learned AR submitted that the company is not a pure software development service provider, and based on the observation in the annual report, the company is engaged in providing host of other services such as engineering services, web hosting and also business process outsourcing. According to the AR, no segmental information is available and therefore, the company cannot be retained as comparable. The DRP held that the segmental information is available for two segments i.e., services and sales. However, it is evident from the annual report that the service segment comprises of software development, software consultancy, engineering services, web development, web hosting etc for which no segmental information is available and therefore, the objection of the assessee is found acceptable. Accordingly, the DRP directed the AO to exclude the above company from the comparables.

7.1.1 We have heard rival submissions and perused the material on record. We find that this issue was considered by the Co- ordinate Bench of the Tribunal in the case of DCIT v. M/s.Electronics for Imaging India Pvt. Ltd. In IT(TP)A No.212/ Bang/ 2015 for assessment year 2010-2011, vide order dated 24.02.2016, wherein the Tribunal held as under:-

“14. At the outset, we note that apart from having the related party revenue at 20.94% of the total revenue, this company was also found to be functionally not comparable with software development services segment of the assessee. The DRP has given its finding at pages 13 to 14 as under:-

“Having heard the contentions, on perusal of the annual report, it is noticed by us that the segmental information is available for two segments i.e., services and sales. However, it is evident from the annual report that the service segment comprises of software development, software development, software consultancy, engineering services, web development, web hosting, etc. for which no segmental information is available and therefore, the objection of the assessee is found acceptable. Accordingly, Assessing Officer is directed to exclude the above company from the comparables.”

16. In view of the above facts, we do not find any error or illegality in the findings of the DRP that this company is functionally not comparable with that of a pure software development service provider.” 7.1.2 In view of the decision of the Co-ordinate Bench, cited supra, we direct the AO/TPO to exclude the comparable on similar reasons.”

17. Respectfully following the decision of the coordinate bench we confirm the decision of the CIT(A) to exclude ICRA Techno Analytics Ltd from the list of comparables.

18. The next issue contended by the revenue is with regard to the working capital adjustment which the CIT(A) directed the TPO to allow on actual basis. The TPO during the TP proceedings restricted the WCA to 0.55% for IT segment stating that ‘in a related party scenario he entire payable/advances cannot be considered as in any business there is an optimum working capital that can be found out only on the basis of comparison with third parties as third parties alone represent the optimum working capital requirement’. The CIT(A) on appeal, held that the working capital adjustment should be allowed on actual basis following the decision of the coordinated bench of the Tribunal in assessee’s own case supra. The revenue is appeal before the Tribunal contending that the working capital adjustment should not be granted on actual and there should be an upper limit.

“13. As regards ground No.3(f), learned counsel for the assessee submitted that the AO/TPO while considering the working capital adjustment, has arrived at the working capital adjustment in the case of the assessee at 5.97%, but while giving effect to the working capital adjustment, has restricted the said adjustment to 1.71% in case of uncontrolled comparables selected by the TPO. The learned counsel for the assessee submitted that the TPO has not given any basis for such restriction of the working capital adjustment. He submitted that the CIT(A) also has not applied his mind to this issue but has summarily confirmed the order of the AO and therefore it has to be set aside.

14. on going through the TPO’s order as well as annexure D referred to in the transfer pricing order on working capital adjustment, we find that the AO has not given any basis for restricting the adjustment to 1.71%. In all the cases relating to transfer pricing adjustment, this Tribunal has been directing to give working capital adjustment on actual basis and the TPO having arrived at 5.97% ought to have adopted the same instead of restricting it to 1.71%. In view of the same, we deem it proper to remand this issue to the file of the AO/TPO for working out the ALP after giving adjustment of working capital as per the calculation of the AO in annexure D annexed to the transfer pricing order. This ground of appeal is accordingly allowed.”

41. Accordingly we direct the AO/TPO to correctly work out the PLI of the final comparables after giving due adjustment for the working capital on actual basis. Related ground of the assessee is therefore allowed.

20. Respectfully following the coordinate bench of the Tribunal we direct the AO / TPO to consider the working capital adjustment on actual basis while working out the PLI of the final comparables. This ground of the revenue is rejected for statistical purposes.

ITES segment 21. In the ITES segment the assessee had selected below listed 15 comparables. Markup on S.No. Name of Companies — ITeS Segment Total Cost2 1 A O K In-House BPO Services Ltd 13% Aditva Birla Minacs Worldwide Ltd 8% 2 Cameo Corporate Services Ltd 10% 3 Cosmic Global Ltd #4 34% Delta Services (I) Pvt Ltd 7% 5 #6 Informed Technologies India Ltd 12% #7 Infosys B P 0 Ltd 24% 8 K N M Services Pvt Ltd 14% Optimus Global Services Ltd -2% 9 1o Sparsh B P 0 Services Ltd 6% 11 Crossdomain Solutions Pvt Ltd 28% 12 Omega Healthcare Management services Pvt Ltd 9% 13 B N R Udyog Ltd — Medical Transcription 38% 14 In House Productions Ltd 4% 15 Timex Group India Pvt. Ltd 8% Average 14%

Comparables selected by Ld. TPO Particulars Pre WC Post WC Accentia Technologies Ltd. 39.69% 43.06% Acropetal Technologies Ltd. (seg) 22.27% 17.67% e-clerx Services Ltd. 52.98% 55.97% Fortune Infotech Ltd. 22.8o% 20.05% ICRA Online Ltd. (seg) 40.72% 43.39% Informed Technologies India Ltd. 26.15% 25.94% Infosys BPO Ltd. 31.23% 28.68% Cosmic Global Ltd. 16.2o% 14.97% Sundaram Business Services Ltd. -12.31% -13.28% Jeevan Scientific Technology Ltd. (seg) 21.05% 37.99% Average margin 26.86% 26.67%

Adjusted margin (post working capital adjustment) 26.67% Taxpayer operating cost (`OC') Rs. 147,51,13,176 Arm's length price (126.66% of OC) Rs. 186,85,25,860 Price received Rs. 165,11,30,616 Shortfall being adjustment u/s. 92CA Rs. 21,73,95,244

25. On appeal before the CIT(A) the assessee contended the inclusion by the TPO. The CIT(A) partly allowed the contentions of the assessee whereby he deleted the inclusion of (i) Infosys BPO and (ii) E-Clerx Services Ltd. relying on the decision of the co-ordinate bench of the Tribunal in assessee’s own case.

26. The CIT(A) confirmed the inclusion of the below comparables of the TPO. a. ICRA Online Ltd., b. Acropetal Technologies Ltd., c. Accentia Technologies Ltd., d. Fortune Infotech Ltd.,

27. The assessee is in appeal before us for the above inclusions (Ground No. 1 to 4 of Consolidated Grounds of Appeal filed by the assessee on 23.11.2021 vide letter dated 15.07.2021)

29. We shall take up for consideration the grounds raised regarding exclusion of comparable companies. In the case of M/s UL India Pvt. Ltd. Vs. DCIT (IT(TP)A No.574/ & 378/Bang/2015 order dated 24.2.2022 exclusion of all these companies was considered by this Tribunal and excluded. The relevant extract from the decision of the Tribunal -

“24. ……..With regard to exclusion of Acropetal technologies Ltd, we find that the expenses incurred on on-site provision of ITeS by the Assessee was 64% of the total expenses and therefore the company was to be regarded as one providing onsite ITeS and cannot be compared with a company providing offshore ITeS such as the Assessee. Secondly the employee cost is less than 25% of the total cost of the company. ITeS services essentially involve and predominantly dependent on employees and therefore wherever the employee cost is less than 25% of the total cost, then the company cannot be regarded as providing ITeS. Therefore, we direct the Assessing Officer to apply 25% employees cost filter and accordingly exclude Acropetal Technologies Limited.

2010-11, wherein on identical circumstances, the exclusion of this company came to be upheld/the company was directed to be excluded. In the case of Outsources Partners International (P) Ltd.,(supra), this Tribunal has adjudicated identical issue and held that this company was not functionally comparable to an ITeS company such as the Assessee and for the reason that this company fails the export earning filter. Respectfully following the said decision, we uphold exclusion of this company from the list of comparable companies for the reasons given in this paragraph.

when credit time is given to the customers. The Assessee however is not an entrepreneur but a captive service provider which is entirely funded by the AEs. This being so, the assessee does not stand to lose anything as it is compensated on a total cost plus basis. The assessee is running the business without any working capital risk as compared to the comparables. Therefore, requirement for adjustment of negative working capital does not arise. It was submitted that in the Assessee's own case for assessment year 2012- 13, the CIT(A) has reversed the order of the TPO making negative working capital adjustments. Detailed submissions in this regard are placed at pages 154-155 and 333-337 of the paperbook.

“Ground No. 8 pertains to the issue of negative working capital. As briefly stated above, after arriving at the arithmetic mean of all comparables at 22.03%, the A.O. worked out negative working capital adjustment of 3.22% thereby, making arms length price at 25.25%. Even though, DRP refused to interfere with the objections of the assessee in its order, we were informed that DRP has directed the TPO/A.O. not to make any negative working capital adjustment in some of the cases in the next assessment year. in the cases of Market Tools Research P. Ltd.. and Mega Systems Worldwide India P. Ltd.. assessee placed on record copies of orders of DRP. In that DRP considered the issue and directed the TPO as under

14. Ground No. 11 Negative Working Capital adjustment - Making a negative working capital adjustment without appreciating the fact that the company does not bear any working capita! risks. On this issue, the assessee submitted as under :-

"The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the differences in working capital between the assessee and the companies considered as comparables. The assessee does not agree with the learned TPO as the company does not bear any working capital risk since it is been iiii1y funded by it's A.E. from its inception and has no working capital contingencies. The company has never taken any loans till date from the date of incorporation nor has incurred any expense for meeting the working capital requirement."

We have gone through the submissions and the order of the TPO. The assessee pleaded that the DRP has acceded such a plea in some other case. On examination, we find that the DRP, Hyderabad in the case of Cordys Software India P. ltd., for A.Y.

2008-09 in its directions dated 3-8-2012 has given a finding as under:-

"7.7.4 Thus, working capital adjustment is made for the time value of money lost when credit time is provided to the customers. The applicant is not an entrepreneur but a captive service provider. Its entire funding needs are provided by the A.E. This being so, the applicant does not stand to lose anything as it is compensated on a total cost plus basis. The TPO probably was carried away by the large amount of receivables appearing in the books of the applicant. But the applicant is running its business without any working capital risk while comparable companies have such a risk for them. If at all any working capital adjustment is to be made to this situation, only a positive adjustment has to be made to the comparables so that they are brought on par with the applicant. In view of the same, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made." In view of the above, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made.

Infosys BPO Ltd :

"This company is listed at sl. 13 in the list of comparable companies chosen by the TPO. As far as this company is concerned, it is the submission of the learned counsel for the assessee that this company has a brand value and therefore there would be significant influence in the pricing policy which will impact the margins. Schedule 13 to the profit and loss account of this company for the F.Y. 2007-08 shows that this company incurred huge selling and marketing expenses. Page 133 of the annual report of this company for the F.Y. 2007-08 shows that this company realizing its brand value has chosen to value the same on the basis of its earnings and that of Infosys. The brand value of the Assessee and Infosys has been valued at Rs.31,863 crores. Infosys BPO, being a subsidiary of Infosys, has an element of brand value associated with it. This is also clear from the presence of brand related expenses incurred by this company. Presence of a brand commands premium price and the customers would be willing to pay, for the services/products of the company. Infosys BPO is an established player who is not only a market leader but also a company employing sheer breadth in terms of economies of scale and diversity and geographical dispersion of customers. The presence of the aforesaid factors will take this company out of the list of comparables. We therefore accept the contention of the assessee that this company cannot be regarded as a comparable."

Eclerx Services Ltd., :

36. We respectfully follow the decision of the coordinate bench of the Tribunal and confirm the decision of the CIT(A)