STMICROELECTRONICS PVT. LTD.,NEW DELHI vs. DCIT, NEW DELHI

Briefly stated the facts necessary for adjudication of the issue at hand are : ST Microelectronics Pvt. Ltd. (STMI, India), the taxpayer, is a subsidiary of ST Microelectronics Pte. Ltd. (ST Singapore) which in turn is a wholly owned subsidiary of ST Microelectronics NV, Netherlands. The taxpayer is into the business of Integrated Circuit Design, CAD Tools and software development for its overseas group concerns. It also provides marketing support services to a group company. The taxpayer is also engaged in software development services related to design implementation and maintenance with respect to Integrated Circuits as required by guidelines/instructions. During the year under assessment, the taxpayer entered into international transactions with its Associated Enterprises (AE) as under :-

The taxpayer in order to benchmark its international transactions qua provision of software development services and qua provision of marketing support services used Transactional Net Margin Method (TNMM) with Operating Profit/Operating Cost as the Profit Level Indicator (PLI) being the Most Appropriate Method (MAM), computed its own margin at 11.11% as against weighted average arithmetic mean margin of 19 comparables at 11.31% and found its international transactions at arm’s length.

Ld. Transfer Pricing Officer (TPO) by applying qualitative and quantitative filters finally selected 13 comparables and computed their margin at 23.20% and thereby computed the adjustment of Rs.38,30,91,011/-.

The taxpayer carried the matter before the ld. Disputes Resolution Panel (DRP) by way of filing objections who has excluded one comparable and included another comparable in the final list and recomputed the margin of Kals Information Systems Ltd. at 30.88% and consequently margin of comparable company comes down to 21.53%. Ld. TPO after giving effect to the ld. DRP’s order revised the adjustment at Rs.33,01,81,949/-. Feeling aggrieved, the taxpayer has come up before the Tribunal by way of filing the present appeal.

We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the Revenue authorities below in the light of the facts and circumstances of the case.

Undisputedly, ld. TPO in order to benchmark the international transactions qua software development services accepted TNMM with OP/OC as PLI as the Most Appropriate Method (MAM) applied by the taxpayer. After giving effect to the directions issued by the ld. DRP, final set of comparable companies with mean margin of 21.53% is as under :-

Consequently, ld. TPO proposed transfer pricing adjustment on account of provision of software development services as under:-

Ld. AR for the taxpayer challenging the impugned order passed by the AO/DRP/TPO now compressed the controversy to the extent of seeking exclusion of five comparables to bring the taxpayer to home viz. Helios & Matheson Information Technology Ltd., Tata Elxsi Ltd., Infosys Technologies Ltd., Persistent Systems Ltd. and Kals Information Systems Ltd.. We would discuss the suitability of aforesaid comparables vis-à-vis the taxpayer one by one as under.

The taxpayer sought exclusion of Helios & Matheson as a comparable on the grounds inter alia that it is functionally dissimilar; that it has low employee cost and high software services & development expenses; that it is into brand development and on the ground that this comparable was ordered to be excluded by the Tribunal in taxpayer’s own case in AY 2007-08 in copy available at pages 2128 to 2141 of the case law paper book vol.6.

Perusal of the annual report, available at pages 993/997 of the Paper Book Vol.3, shows that Helios & Matheson has income of Rs.213.37 crores from software sales and services but, in the Notes to Accounts to the companies, it is recorded that there is no segmental information available. Furthermore, information given at page 942 of the Paper Book Vol.3 shows that Helios & Matheson is into providing cutting edge solutions in the health care and IT vertical segment.

The disclosure made by Helios & Matheson in its financials, available at page 993 of the Paper Book Vol.3, shows that it has incurred Rs.2.83 crores towards staff welfare which amounts to 1.30% of the sales whereas the TPO has applied filter of employee cost less than 25% for selection/rejection of the comparables. At the same time, Helios & Matheson disclosed software services and development expenses to the tune of Rs.120.18 crores which constituted 55% of the revenue of the company. Furthermore, Helios & Matheson has incurred an amount of Rs.6.71 crores towards Advertisement, Marketing & Promotion (AMP) expenses which is more than 3% of the sales of this company.

Ld. DR for the Revenue supported the order passed by the TPO/DRP qua retention of Helios & Matheson and drew our attention to para 8.16 at page 65 on the ground that this comparable has not been objected to by the taxpayer. However, we are of the considered view that since there is no estoppel against the statute if some wrong legal position has been enunciated at any point of the proceedings, the same can be rectified by the taxpayer at any stage.

Coordinate Bench of the Tribunal in taxpayer’s own case in AY 2007-08 (supra) rejected Helios & Matheson by returning following findings :-

So, in view of the matter, we are of the considered view that on account of functional dissimilarity, Helios & Matheson being into software sales and services with no segmental information is available, on account of low employee cost, high software service & development expenses and has incurred 3% of its sales towards AMP expenses is not a suitable comparable vis-à-vis the taxpayer which is a routine software development service provider working on cost plus model and a risk insulated entity, hence ordered to be excluded.

The taxpayer sought exclusion of Tata Elxsi on ground of functional dissimilarity and having benefit of Tata brand. Perusal of annual report, available at page 1492 of the paper book, shows that it is engaged in specialized and niche domain of software products/services. In the Director’s Report of this company, it is also recorded that it is into product design services, innovation design engineering, and visual computing labs. Furthermore, Tata Elxsi is having benefit of a big brand being part of the Tata group.

Ld. DR for the Revenue relied upon the orders of the AO/DRP/TPO.

Coordinate Bench of the Tribunal in the taxpayer’s own case for AY 2007-08 (supra) rejected Tata Elxsi as a comparable on the ground of its functional dissimilarity. So, we are of the considered view that Tata Elxsi is not a suitable comparable on account of functional dissimilarity being into software product design services, innovation design engineering and visual computing labs and on account of part of the Tata group having benefits/returns of Tata brand vis-à-vis the taxpayer who is a captive routine software development service provider working on cost plus model as a risk insulated entity, hence ordered to exclude the Tata Elxsi from the final set of comparables.

The taxpayer sought exclusion of Infosys on the grounds inter alia that it is functionally dissimilar; that it has significant brand value and that it has significant high turnover. Ld. AR for the taxpayer further contended that Infosys has been excluded by the ld. CIT (A) in taxpayer’s own case for AY 2011-12.

Perusal of the functional profile of Infosys, copy of annual report available at pages 1545 – 1696 of Annual Report Paper Book, shows that Infosys is into providing end to end business solution to its clients including consulting, design, custom application, software reengineering, maintenance, systems integration, etc.. It is also providing financial services, manufacturing, telecommunications, retail, utility, logistics and other industries to its clients. Perusal of the annual report at page 1677 of the paper book shows that Infosys has brand value of Rs.31,863 crores which itself shows the value of intangibles; Infosys is also having high turnover for AY 2008-09 of Rs.15,648 crores, as is evident at page 1611 of the paper book, as against turnover of taxpayer of Rs.343 crores.

Ld. DR for the Revenue by relying upon para 8.38 of the TP order contended that subsequent to the Agnity Technology decision, ITAT, Delhi Bench in case of ST Micro – 2011-TII-63- ITAT-DEL-TP has upheld the inclusion of Infosys as a comparable and as such Infosys may be retained as a comparable. However, we are of the considered view that when the Tribunal has accepted Infosys as a comparable vis-à-vis routine software development services provider, decision of Hon’ble Delhi High Court in case of Agnity Technologies was not available, so contention of ld. DR for the Revenue is not tenable as the taxpayer is a routine captive software development service provider working on cost-plus and risk insulated entity and cannot be compared with Infosys.

Infosys has also been excluded by the Tribunal in the case of Tolana India Pvt. Ltd. in ((2014) 35 ITR (T) 388 (Delhi)) on the ground of functional dissimilarity with a contract software development service provider.

So, in view of the matter, we are of the considered view that Infosys is not a suitable comparable being functionally dissimilar having huge brand value and a giant in the field of software development service assuming all the risks whereas taxpayer is captive routine software development service provider working on cost plus model as a risk insulated entity, hence ordered to be excluded from final set of comparables.

The taxpayer sought exclusion of Persistent on the ground of functional dissimilarity being into the business of software products which is incomparable with software development services being rendered by the taxpayer. Perusal of the annual report of Persistent at pages 1235 & 1256 of the paper book shows that it is in the software product development and found the profit & loss account. It is apparent that its revenue comes from sales of software services and products but no bifurcation in the form of segmental information is available. In the annual report, available at pages 1166 & 1173 of the paper book, it is also recorded that Persistent is a leader in product development business and this company has won awards for best shrink wrapped software products.

Ld. DR for the Revenue supported the order passed by the TPO/DRP qua retention of Persistent and drew our attention to para 8.16 at page 65 on the ground that this comparable has neither been objected to by the taxpayer. However, we are of the considered view that since there is no estoppel against the statute if some wrong legal position has been enunciated at any time of the proceedings, the same can be rectified by the taxpayer at any stage.

Coordinate Bench of the Tribunal in case of ST Ericsson India Pvt. Ltd. in rejected Persistent as a comparable vis-à-vis routine software service development provider on the ground of different business model with no segmental information available and also on the ground that this company has huge intangibles

Coordinate Bench of the Tribunal also rejected Persistent in case of Cash Edge India Pvt. Ltd. vs. ITO in ITO No.64/Del/2015, copy available at pages 2486 to 2519 of the paper book, on ground of functional dissimilarity and the appeal preferred by the Revenue has been dismissed by the Hon’ble Delhi High Court in ITA 279/2016 vide order dated 04.05.2016, copy available at pages 2482 to 2485 of the paper book.

So, in view of the matter, we are of the considered view that Persistent is not a suitable comparable being into the business of software products and its revenue are from the sale of software services and products having no segmental information available vis-à-vis the taxpayer, hence ordered to be excluded from the final set of comparables.

The taxpayer sought exclusion of Kals as a comparable on ground of functional dissimilarity, it being into the business of development of software product. When we examine annual report at page 1714 of the annual report paper book, it is specifically recorded that Kals drives its revenue from software services and software products but no segmental information in respect of services and products is available. In Schedule 16 of Note to Financial Statement, it is also recorded that Kals is into development of software and software products since its inception.

So, in view of the matter, we are of the considered view that Kals being into the business of development of software products and services with no segmental financials available is not a suitable comparable vis-à-vis the taxpayer who is a captive routine software development service provider working on cost plus model as a risk insulated entity, hence ordered to be excluded.

TPO/DRP have denied the working capital adjustment to the taxpayer. It is the case of the taxpayer that in AYs 2007-08, 2010- 11 to 2013-14 and 2014-15, working capital adjustment to the taxpayer whose business profile has not undergone any change since AY 2007-08, has been given by the ld. DRP and also relied upon the order passed by the coordinate Bench of the Tribunal in the case of Demag Cranes and Components Pvt. Ltd. vs. DCIT in order dated 04.01.2012, copy available at pages 2819 to 2845 of the paper book, wherein working capital adjustment has been granted to arrive at the operating net margins by returning following findings :-

So, in view of the matter, we are of the considered view that keeping in view the fact that in taxpayer’s own case whose business profile has not undergone any change since AY 2007-08 and the working capital adjustment has since been granted since 2007-08, the taxpayer is entitled for working capital adjustment by following the rule of consistency. So, TPO is directed to verify the data supplied by the taxpayer and grant working capital adjustment to arrive at the correct operating net margin of taxpayer vis-à-vis comparables.

AO treated the purchase of time licences of computer software of Rs.3,40,08,682/- as capital expenditure otherwise claimed by the taxpayer as revenue expenditure. Ld. AR for the taxpayer contended that this issue is already covered in his favour in his own case for AY 2007-08 (supra) passed by the coordinate Bench of the Tribunal.

We have perused the order passed by the coordinate Bench of the Tribunal in taxpayer’s own case for AY 2007-08 (supra) vide which this addition made by the AO treating payment of licences of computer software as capital in nature has been deleted by treating the same as revenue in nature by returning following findings :-

So, following the aforesaid decision rendered by the coordinate Bench of the Tribunal, which is based upon the decision rendered by the Special Bench of the Tribunal in case of Amway India Enterprises, 111 ITD 112 (Del) (SB) and decision rendered by Hon’ble Delhi High Court in the case of CIT vs. Asahi India Safety Glass 346 ITR 329, we are of the considered view that since software licences are different from software which does not become the asset of the taxpayer having no enduring benefits and it can only be used during the period for which fee is paid, so it fails the test of ownership in case of licences, hence we order to treat the amount incurred by the taxpayer for purchase of time licences of computer software as revenue expenditure. So, Ground no.3 is determined in favour of the taxpayer.

AO also treated an amount of Rs.1,82,00680/- as capital expenditure claimed by the taxpayer as revenue expenditure and added the same to the income of the taxpayer. Ld. AR for the taxpayer contended that when the training expenses incurred by the taxpayer on imparting training to its executor is not part of the enduring benefits as the trained workforce may move out any time, it cannot be treated as capital expenditure and relied upon the decision rendered by the coordinate Bench of the Tribunal in case of sister concern of the taxpayer i.e. ST Ericsson India Pvt. Ltd. for AY 2010-11 in and also placed reliance on Hon’ble Delhi High Court in case of CIT vs. Munjal Showa Ltd. 329 ITR 449. Operative part of the decision rendered by the Hon’ble High Court is as under :-

So, following the aforesaid decision rendered by Hon’ble Delhi High Court, we are of the considered view that when training imparted by the taxpayer company to its executives, though increased its profitability, is not of any enduring benefit as the trained workforce can move out any time and the taxpayer company pays tax on the enhanced income on account of enhanced efficiency of its trained staff, this has to be treated as revenue in nature. Consequently, AO is directed to treat the training expenses as revenue in nature. Accordingly, this ground is determined in favour of the taxpayer.