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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI CHANDRA POOJARI
O R D E R
Per N.V. Vasudevan, Vice President This is an appeal by the Assessee directed against the final order of assessment dated 23.12.2015 of the ACIT, Circle3(1)(1), Bangalore, passed u/s. 143(3) r.w.s. 144C of the Income-Tax Act, 1961 [“the Act”] in relation to AY 2011-12.
The Assessee is engaged in providing software development services 2. (SWD services) to its Associated Enterprises (AE). The transaction of providing SWD services to its AE by the Assessee was an international transaction and the price received for rendering such services by the Assessee from its AE has to pass the Arm’s Length Price (ALP) test as provided u/s.92 of the Income Tax Act, 1961 (Act). In this appeal the disputes is with regard to addition made consequent to determination of ALP and consequent upward revision and adjustment made to IT(TP)A No.239/Bang/2016 Page 2 of 8 the price at which international transaction was carried out by the Assessee with its AE in respect of Software development Services(SWD services).
There is no dispute that the Most Appropriate Method chosen for the purpose of comparison of the profit margin of the Assessee with that of the comparable companies was the Transaction Net Margin Method (TNMM) and the Profit Level Indicator (PLI) chosen for the purpose of such comparison was Operating Profit to Operating Cost (OP/OC). The OP/OC of the Assessee in the SWD services segment was as follows:-
Description Amount Operating Revenue Rs.16,25,43,160/- Operating Cost Rs.14,06,95,730/- Operating Profit (OP) Rs.2,18,47,430/- Operating Profit to Cost(OP/OC) 15.52%
The TPO rejected the Transfer Pricing Study of the Assessee and arrived at 4. a set of 13 comparable companies with that of the Assessee and arrived at arithmetic mean of the profit margin of those 13 companies at 24.82% before working capital adjustment. The following chart will show the list of 13 comparable companies ultimately chose by the TPO and the arithmetic mean of the profit margin of those companies and the manner in which the TPO determined the ALP of the international transaction:
Sl. Name of the Company No. 1. Acropetal Technologies Ltd. (seg) 31.98 2. eZest Solutions Ltd. 21.03 3. E-Infochips Ltd. 56.44 4. Evoke Technologies Pvt. Ltd. 8.11 5. ICRA Techno Analytics Ltd. 24.83 6. Infosys Ltd. 43.39 7. Larsen & Toubro Infotech Ltd. 19.83 8. Mindtree Ltd.(seg) 10.66 9. Persistent Systems & Solutions Ltd. 22.12 10. Persistent Systems Ltd. 22.84
IT(TP)A No.239/Bang/2016 Page 3 of 8 11. R S Software R.S.Software (India) Ltd. 16.37 12. Sasken Communication Technologies 24.13 Ltd., 13. Tata Elxsi Ltd.(seg) 20.91 AVERAGE MARK-UP 24.82 Determination of ALP:
Arm’s Length Mean Margin on cost 24.82% Less: working capital Adjustment -2.04% (As per Annex -C) Adjusted margin 26.82% Operating cost Rs.14,06,95,730/- Arms Length Price (ALP) Rs.17,84,86,603/- 126.82% of Operating cost) Price Receive Price Received Rs.16,25,43,160 Shortfall bei Shortfall being adjustment u/s. 92CA Rs.1,59,43,443
The adjustment suggested by the TPO was incorporated by the AO in the 5. draft order of assessment. The Assessee objected to the manner of determination of ALP by the TPO before the DRP. The DRP excluded some of the comparable companies chosen by the TPO and retained only three comparable companies viz., Persistent Systems Ltd., Persistent Systems & Solutions Ltd., and Sasken Technologies Ltd. Aggrieved by the inclusion of the aforesaid three comparable companies the Assessee has filed this appeal before the Tribunal. The Assessee is also aggrieved by the exclusion of Evoke Technologies Ltd., CG Vak Software and Exports Ltd,. And RS Software Ltd., and has filed the appeal against the order of the AO. No other grounds were pressed for adjudication except the relief with regard to exclusion and inclusion of comparable companies, though several grounds of appeal and additional grounds of appeal had been raised by the Assessee in the grounds of appeal and application for raising additional grounds.
6. By way of additional ground No. 15 to 17, the Assessee has sought exclusion of the following three companies from the list of comparable companies viz.,
IT(TP)A No.239/Bang/2016 Page 4 of 8 Persistents Systems & Solutions Ltd., Persisten Systems Ltd., and Sasken Communication Technologies Ltd., and inclusion of the The Assessee is also aggrieved by the exclusion of Evoke Technologies Ltd., CG Vak Software and Exports Ltd,. And RS Software Ltd. The Assessee has not chosen to challenge inclusion of these companies in the grounds of appeal before the Tribunal, exclusion of these three companies from the list of comparable companies. The reason for not doing so has been explained as non-availability of more details in public domain and subsequent availability of details in public domain which renders these companies as not comparable with Assessee engaged in SWD services such as the Assessee. The learned counsel for the Assessee has relied upon the decision of the Special Bench in the case of DCIT v. Quark Systems P. Ltd, [42 DTR 414] wherein the functionally comparability of these companies have been examined by this Tribunal and pleaded that the additional ground raised by the assessee may be admitted for adjudication on merits. Ld. AR has submitted that in a series of decisions, the Tribunal has held that there cannot be estoppel against the law and the non-comparable companies even if selected by the assessee in TP study, the same should be rejected. On the other hand, Ld. DR has vehemently objected to the admission of the additional ground raised by the assessee.
We have considered the rival submissions. Even, if the assessee had included these three companies in the list of comparables as part of the TP study analysis, however, mere inclusion of the companies in the list of comparables does not operate as estoppel against the assessee, if on examination of the relevant facts it is found that these companies are functionally not comparable with that of assessee. Therefore, the selection of the companies by the assessee itself is not the finality of the comparability of the entities when the TPO has to examine the functional comparability as well as the other filters for inclusion or exclusion of the companies in the list of comparables for determination of ALP. We find that prima facie assessee has made out a case that in a series of decisions of this Tribunal, these three companies are held to be not comparable on various reasons
IT(TP)A No.239/Bang/2016 Page 5 of 8 and therefore it necessitates the functional examination of these companies for the purpose of inclusion or exclusion in the list of comparables. The Special Bench of this Tribunal at Chandigarh in the case of Quark Systems P. Ltd, (supra) has held that if a company is otherwise not found to be comparable with the assessee then simply it is included in the list of comparables in the TP study would not be considered as estoppel for raising an objection by the assessee for exclusion of such company for the purpose of determination of ALP. We therefore accept the plea of the Assessee, for admission of exclusion of the aforesaid three companies.
As far as the plea for exclusion of Persistents Systems & Solutions Ltd., Persisten Systems Ltd., and Sasken Communication Technologies Ltd., is concerned,this Tribunal in the case of a software development service provider such as the Assessee for the very same AY 2011-12 in the case of Autodesk India Ltd. Vs. ACIT in IT(TP) A.No.156 & 220/Bang/2016 by order dated 21.12.2018 held that these three companies are not comparable companies. It is pertinent to mention that the very same thirteen companies chosen in the case of the Assessee in this appeal and in the case of Autodesk India Ltd. (supra) were identical. The tribunal held on the comparability of the aforesaid three companies as follows:
“26. In ground No. 3(k), the assessee has prayed for exclusion of all 3 companies which were retained by the DRP in the impugned order. In this IT(TP)A.No.156 & 220/Bang/2016 Page 15 of 18 regard, the ld. counsel for the assessee has brought to our notice that Persistent Systems & Solutions Ltd. was regarded not comparable for the reason that it had diverse functions and segmental details were not available and that it was product company and that there was abnormal increase in turnover due to funding from holding company. These aspects were considered by the Tribunal in the case of Applied Materials (I) P. Ltd. (supra) and vide para 9.2.1 to 9.2.4, the Tribunal regarded this company as not comparable. Persistent Systems Ltd. was also considered as not comparable in the aforesaid order vide same paras referred to above for the reason that it was engaged in diverse activities and in the absence of segmental details, besides holding IPRs.
The other company is Sasken Communication Technologies Ltd. which was retained by the DRP. As far as this company is concerned, the plea of the assessee is that this company is a software product company and IT(TP)A No.239/Bang/2016 Page 6 of 8 segmental details between the software development services and software products is not available. Our attention was drawn to the decision of the Bangalore Bench of the Tri in the case of Applied Materials (I) P. Ltd. (supra) wherein in para 9.3.1 to 9.3.3 this Tribunal came to the conclusion that comparability of this company has to be decided afresh by the TPO after considering the facts as recorded in the decisions rendered by the Tribunal in the case of Electronics for Imaging India P. Ltd. (2017) 85 taxmann.com 124 (Bang.Trib.). We are of the view that similar directions would be appropriate in the present assessment year also. Thus, ground No.3(k) is decided accordingly.” Respectfully following the aforesaid decision, we direct exclusion of the aforesaid three comparable companies from the list of comparable companies chosen by the TPO.
As far as the issue with regard to inclusion of Evoke Technologies Pvt.Ltd., as comparable company, the admitted factual position is that both the Assessee and the Revenue want its inclusion. The Assessee had chosen this company as comparable company in its TP study and the TPO accepted this company as comparable company. The DRP suo motto excluded this company from the list of comparable companies. The reasons assigned by the DRP for excluding this company was (i) that the margin of this company was abnormally low as compared to other comparable companies and (ii) Expenses on consultancy charges increased by 1,118% which indicated that the low margins during the relevant period was due to peculiar circumstances. It is the plea of the Assessee before us that this company is functionally comparable as it was also a SWD service provider and that low margins cannot be the basis to exclude this company. It was submitted that the DRP has not spelt out as to how increase in consultancy charges resulted in peculiar circumstances prevailing in the case of this company. Our attention was drawn to a decision of the ITAT Bangalore in the case of M/S.Applied Materials India Pvt.Ltd. IT(TP) A.No.17/Bang/2016 & IT(TP)A.No.39/Bang/2016 order dated 21.9.2016 for AY 2011-12 wherein this company was regarded as comparable and include as comparable. The learned DR relied on the order of the DRP.
IT(TP)A No.239/Bang/2016 Page 7 of 8
We are of the view that the reasons for exclusion of this company are not sound. When both the Assessee and the revenue seek inclusion of this company, there was no valid basis for the DRP to suo motto exclude this company from the list of comparable companies. In the decision cited by the learned counsel for the Assessee in the case of a SWD service provider such as the Assessee, this company was held to be a valid comparable company and included in the list of comparable companies. We therefore direct inclusion of this company in the list of comparable companies.
As for RS Software (India) Ltd., it was rejected by the DRP solely on the basis that it was allegedly predominantly engaged in the onsite development of software in FY 2010-11. In this regard, it is seen that this company was selected by the TPO and accepted by the Assessee as a comparable, and it was accordingly included by the TPO in the list of comparables. In the proceedings before the DRP, the Assessee did not object to its inclusion in the list of comparables. However, despite the above, the DRP on its own directed its exclusion. We are of the view that since the revenue as well as the Assessee wants to retain this company as a comparable company, this company should be regarded as comparable company.
As far as CG Vak Software & Export Ltd. is concerned, this company was excluded for the reason that details regarding employee cost was not available and therefore it was not possible to apply the employee cost filter. The contention of the assessee before us is that:- (a) Major expenditure for a service provider is employee cost. (b) Expenses recorded under head Cost to service are in excess of 25% of the total sales and hence the company passes the filter. (c) The TPO for the assessment year 2009-10 in assessee’s own case has included the company in the final list of comparables. 25. The assessee has also placed reliance on the order dated 29.09.2016 passed by the TPO in assessee’s own case for the AY 2009- 10.
IT(TP)A No.239/Bang/2016 Page 8 of 8 In the aforesaid case for AY 2009-10, the ITAT remanded the issue to the TPO for fresh consideration regarding inclusion of this company after verification of employee cost. In the order giving effect to the order of Tribunal, the TPO has found that the employee cost was more than 25% of the revenue of this company and therefore this company was to be regarded as a comparable company. In our view, it would be just and appropriate to set aside the order of DRP and remand for consideration afresh by the TPO, the employee cost in this year and thereafter decide the comparability of this company in accordance with the law.
The TPO is directed to compute the ALP in accordance with the directions in this order after affording Assessee opportunity of being heard.
In the result, appeal by the Assessee is partly allowed and that by the revenue is dismissed.
Pronounced in the open court on the date mentioned on the caption page.