TEKTRONIX (INDIA) PVT LTD ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-7(1)(1), BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL ‘B’ BENCH : BANGALORE BEFORE SHRI. A. K. GARODIA, ACCOUNTANT MEMBER AND SMT. BEENA PILLAI, JUDICIAL MEMBER IT(TP)A 673/Bang/2017 Assessment Year : 2007 – 08

M/s Tektronix (India) Pvt. Deputy Commissioner of Ltd., (formerly known as Income-tax, Circle – 7 (1) Tektronix Engineering (1), Room No. 240, 2nd Development (India) Pvt. Ltd.,) Floor, BMTC Building, 80 Survey No. 16, Feet Road, Koramangala, Salarpuria Premia, Vs. Bangalore – 560 095. Kadubeesana Halli, Varthur Hobli, Sarjapur Outer Ring Road, Bangalore – 560 013.

PAN NO : AAACT 7289 F APPELLANT RESPONDENT

Appellant by : Shri Sharath Rao, CA Respondent by : Mr. Muzaffar Hussain, CIT – DR

Date of Hearing : 10-02-2020 Date of Pronouncement : 17-03-2020

ORDER PER BEENA PILLAI, JUDICIAL MEMBER

Present appeal has been filed by assessee against final assessment order dated 20/01/2017 passed by Ld.DCIT Circle 7 (1) (1), Bangalore under section 143 (3) read with section 147 and

Page 2 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 section 144C (13) of the Act on following revised grounds of appeal:

Page 3 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 adopted by the Appellant and adopting additional filters for undertaking a new search and arriving at a fresh set of comparables. 3.4 The DRP has erred in upholding the action of the learned TPO in finalizing the TP order with the following companies as comparable to the Appellant despite such companies being functionally different to the Appellant and/or fail to meet the legally acceptable criteria for comparability: 1. Avani Cimcon Technologies Limited 2. Celestial Labs Limited 3. E Zest Solutions Limited 4. Infosys Technologies Ltd 5. Kals Information Systems Limited (Seg) 6. Persistent Systems Limited 7. Quintegra Solutions Limited 8. Tata Elxsi Limited (Seg) 9. Wipro Limited (Seg) 10. Helios & Matheson Information Technology Ltd 11. Ishir Infotech Limited 12. Megasoft Limited 13. Thirdware Solutions Limited 3.5 Without prejudice that Megasoft Limited is functionally different to the Appellant and / or fails to meet the legally acceptable criteria for comparability, the DRP and TPO erred in not appreciating that only segmental margin (23.11 percent) ought to be considered for comparability. 3.6 The DRP and AG / TPO have erred in law and on facts in not granting an appropriate working capital adjustment to the margins of the comparable companies, based on the computation provided by the Appellant. 3.7 The AO / TPO have also erred in considering the Prime Lending Rate ("PLR") at 10.25 percent that was applicable for FY 2005-06 without appreciating that the PLR rate for the subject FY 2006-07 which was 12.50 percent (the Benchmark PLR was between 12.25 percent and 12.75 percent). 3.8 The AO / TPO have further erred in discounting the PLR to its present value (9.30 percent as per the TPO's calculations)

Page 4 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 without appreciating that the average payables and receivables were taken by the TPO himself for the calculations. 4. Disallowance of depreciation under section 40(a)(ia) of the Act 4.1 The DRP and AO have erred in law and on facts in disallowing Rs 26,24,742 on account of depreciation claimed on purchase of software products under section 40(a)(ia) of the Act without appreciating that the Appellant on its own had disallowed the software expenditure while arriving at the taxable income since the same was capital in nature.. 4.2 Without prejudice to the above ground, the DRP and AO have erred in law and on facts in disallowing the depreciation claimed on purchase of software products under section 40(a)(ia) of the Act without appreciating that disallowance under section 40(a)(ia) can be made only on revenue expenditure and cannot be extended to depreciation on software capitalised. 4.3 Without prejudice to the above grounds, the DRP and the AO have erred in law and on facts in disallowing excess depreciation of Rs 4,34,119 without appreciating that the underlying software purchases amounting to Rs 14,47,062 were acquired and put to use for less than 180 days and thereby the depreciation claim was restricted to the effective rate of depreciation to 30 percent (50 percent of 60 percent depreciation rate). 5. Disallowance under section 14A of the Act 5.1 The DRP and the AO have erred in law in disallowing an amount of Rs 2,03,335 under section 14A of the Act without appreciating that the investments were made in subsidiary company in the past years and that there was no fresh investments made during the year and that the Appellant had not incurred any expenditure for earning the dividend income from the investments; 5.2 The DRP has erred in law and on facts in holding that the Appellant has to maintain separate books of accounts for investments made, income from which is not includible in the total income of the Appellant without appreciating that no such onus is cast upon the assessee under the provisions of section 14A of the Act. 6. Brought forward losses not granted 6.1 The AO has erred in law and on facts in not giving effect to the directions of the DRP by not granting the set-off of brought forward depreciation allowance of Rs.34,46,195/- claimed by the Appellant in the Return of Income ("Rol") for the AY 2007-08.

Page 5 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 7. Other consequential grounds 7.1 The Learned AO has erred in law and on facts in determining the tax liability by making the aforementioned additions and computing interest under section 234B of the Act; 7.2 The Learned AG has erred in law and on facts by levying higher amount of interest under section 234C of the Act as compared to the interest levied as per the RoI; and 7.3 The Learned AO has erred in law and on facts by initiating penalty proceedings under section 271 read with 274 of the Act.

Brief facts of the case are as under: 2. Assessee filed its return of income on 30/10/2007 declaring total income of Rs.88,89,272/-. Return was processed under section 143 (1) of the Act and case was selected for scrutiny. Accordingly, notice under section 143 (2) was issued to assessee along with notice under section 142 (1) and questionnaire. Ld.AO observed that, assessee had international transaction with associated enterprises for more than Rs.15 crores and accordingly reference to transfer pricing officer was made for determining. 2.1. On receipt of reference, Transfer Pricing officer called upon assessee to file economic details of international transaction entered into by assessee with its associated enterprises in Form 3 CEB. Ld.TPO observed that, assessee is a subsidiary of Tektronix Inc USA and provider services to Tektronix Inc USA and Tektronix International Sales GmbH Switzerland. It was observed that, assessee undertook to provide sales support services, software development services as a contract software development services provider. Ld. TPO observed that, as per agreement with the associated enterprises, Network Appliances

Page 6 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 Inc., USA, assessee is compensated on cost +10% basis in respect of software development services. 2.2. Ld.TPO observed that, following were international transaction entered into by assessee: Particulars of international Amount (in rupees) transactions Receipts for software development services 22,88,46,170/- Recoveries (received) 54,39,231/- Reimbursement of expenses (paid) 46,71,173/- 2.3 Ld.TPO observed that, assessee used TNMM as most appropriate method for software development services and OP/OC as PLI for computing the margin under these segments. Assessee computed its margin at 14.43% for Software development service segment. Assessee used 12 comparables with average margin of 12.15% Thus, it is held the price to be at arm’s length. Ld.TPO rejected the transfer pricing analysis carried out by assessee as according to him it suffered certain defects. Ld.TPO applied various filters to reject comparables selected by assessee. 2.4. Ld.TPO selected new set of 26 comparables with average margine of 25.14% as under: Software Development Segment Sl. No. Comparables Margin Margin 1. Allsec Transmatic Ltd (SEG) 21.11% 2. Avani Cincom Technologies Ltd 52.59%

Page 7 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 3. Celestial Labs Ltd 58.35% 4. Datamatics Ltd 1.38% 5. e-Zest Solutions Ltd 36.12% 6. Flextronics Software Systems Ltd 25.31% (SEG) 7. Geometric Ltd (SEG) 10.71% 8. Helio and Matheson Information 36.63% Technology Ltd 9. iGate Global Solutions Ltd 7.49 % 10. Infosys Technologies Ltd 40.30% 11 Ishier Infotech Ltd 30.12% 12. KALS Information Systems Ltd 30.55% 13. LGS Global Ltd 15.75% 14. Lucid Software Ltd 19.37% 15. Mediasoft Solutions Ltd 3.66 % 16. Megasoft Ltd 60.23% 17. Mindtree Ltd 16.90% 18. Persistent Systems Ltd 24.52% 19. Quintengra Solutions Ltd 12.56% 20. RS Software (India) Ltd 13.47% 21. R Systems International Ltd (SEG) 15.07% 22. SaskenCommunications Technologies 22.16% Ltd (SEG) 23. SIP Technologies and Exports Ltd 13.90% 24. Tata Elxsi Ltd (Seg.) 26.51% 25. Thirdware Solutions Ltd 25.12 % 26. Wipro Ltd 33.65 % Average Margin 25.14%

Page 8 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 2.5. Ld.TPO thus computed proposed adjustment being difference between the margins towards arm’s length price of the transactions as under: Particulars Proposed Adjustment Software Development Service segment Rs. 1,73,02,490/- 2.6. Aggrieved by proposed adjustment, assessee preferred objections before DRP. DRP ignoring various objections raised by assessee regarding functional dissimilarities of comparables, upheld final set of comparables selected by Ld.TPO Against directions of DRP, Ld. AO passed impugned order making addition in the hands of assessee. 2.7. Aggrieved by final assessment order passed, assessee is in appeal before us now. 3. Ld.AR submitted that Ground No.1 are general in nature and therefore do not require any adjudication. 4. He submitted that Ground No.2 is challenging the reopening which is not pressed at the instructions of assessee. 5. Accordingly this ground stands dismissed as not pressed. Ground No.3 is in respect of trans-apprising addition. At the outset, Ld.AR submitted that, in revised grounds of appeal, Assessee seeks exclusion/inclusion of following comparables: • Avani CincomTechnologies • Celestial Labs Ltd., • e-Zest Solutions Ltd • Helios Matheson Information Technology Ltd., • Infosys Technologies Ltd.,

Page 9 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 • Ishir Infotech Ltd • KALS Information Systems Ltd • Megasoft Ltd • Persistant Systems Ltd., • Tata Elxsi Ltd (SEG) • Thirdware Solutions Ltd. • Wipro Ltd (SEG) 5.1 Before we undertake comparability analysis of above comparables, it is sine qua non to understand functions performed, assets owned and risks assumed by assessee under both segments as observed by Ld.TPO in order passed under section 92C of the Act. 5.1.1 Functions: Functions performed by assessee is as per the agreement entered into by assessee with Tek Inc USA and Tektronix International Sales GmbH, Switzerland (TIS) on an exclusive basis. In the TP study report placed in paper book at page 110 it is observed that as per agreement assessee assumes following responsibilities: • provide engineering development and software services from time to time in India as specified by associated enterprises; • identify and recruit competent qualified professionals for its operation; • assign qualified professionals to provide on-going engineering development and software services; • carry out overall direction and control of assigned employees;

Page 10 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 • ensure that the employees comply with all Tektronix policies, rules and regulations regarding security and protection of confidential information; • program managed to provide necessary control mechanisms including milestone schedules and periodic status reports; and • assume full responsibility relating to recruitment and compensation of assigned employees. 5.1.2 Assets employed: it has been submitted that assessee owns primary assets used for providing software services and software development services like employees and plant and machinery equipment etc. All/any intellectual property rights in the software developed by assessee is purely owned by the associated enterprises. 5.1.3 Risks assumed: In TP study report, it has been submitted that except for Ltd financial risk and technology obsolescence risk all other major risks are born by the associated enterprises. Assessee also owns manpower risk and service level quality risk as it has to adhere to the requirements and qualifications of its associated enterprise. 5.1.4 Classification: Based on the above FAR analysis, assessee has been characterised as limited risk service provider with respect to software development services rendered to its group concerns. At the outset both sides submitted that for assessment year 2008-09 in assessee’s own case reported in (2016) 75 Taxmann.com 276 under similar and identical functional profile,

Page 11 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 very same set of comparables alleged for exclusion by assessee has been considered and examined. 5.2 We note that identical set of 26 comparables were selected by Ld.TPO for very same assessment year in case of Meritor LVS India (P)Ltd., by this Tribunal reported in (2015) 64 Taxmann.com 136 and First Advantage Offshore Services Pvt Ltd vs DCIT in ITA (TP) No. 1086/B/2011. We also note that assessee before us and Meritor LVS, First Advantage Offshore Services Pvt. Ltd., renders software development services to associated enterprises under a contract services provider for very same assessment year. This Tribunal in these decisions have held following companies to be not comparable for year under consideration on identical functions which is risks mitigated being a contract service provider like assessee. We refer to observation made by this (Tribunal) in the case of (Meritor LVS, India Pvt. Ltd. (Supra)) in respect of following comparables. Celestial Labs Ltd. 42. As far as this company is concerned, the stand of the assessee is that it is absolutely a research & development company. In this regard, the following submissions were made:- • In the Director's Report (page 20 of PB-Il), it is stated that "the company has applied for Income Tax concession for in-house R&D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act." • As per the Notes to Accounts - Schedule 15, under "Deferred Revenue Expenditure" (page 31 of PB-II), it is mentioned that, "Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred." An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as "Deferred Revenue Expenditure" (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company.

Page 12 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R&D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT - ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: "The learned D.R. however drew our attention to page-389 of the paper book which is an extract from the Directors report which reads as follows: 'The Company has developed a de novo drug design tool "CELSUITE" to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Technology New Delhi) based on our insilico expertise (applying bio-informatics tools). The Company has developed a molecule to treat Leucoderma and multiple cancer and protected the IPR by filing the patent. The patent details have been discussed with Patent officials and the response is very favorable. The cloning and purification under wet lab procedures are under progress with our collaborative Institute, Department of Microbiology, Osmania University, Hyderabad. In the industrial biotechnology area, the company has signed the Technology transfer agreement with IMTECH CHANDIGARH (a very reputed CSIR organization) to manufacture and market initially two Enzymes, Alpha Amylase and Alkaline Protease in India and overseas. The company is planning to set up a biotechnology facility to manufacture industrial enzymes. This facility would also include the research laboratories for carrying out further R & D activities to develop new candidates' drug molecules and license them to Interested Pharma and Bio Companies across the GLOBE. The proposed Facility will be set up in Genome Valley at Hyderabad in Andhra Pradesh.' According to the learned D.R. celestial labs is also in the field of research in pharmaceutical products and should be considered as comparable. As rightly submitted by the learned counsel for the Assessee, the discovery is in relation to a software discovery of new drugs. Moreover the company also is owner of the IPR. There is however a reference to development of a molecule to treat cancer using bio-informatics tools for which patenting process was also being pursued. As explained earlier it is a diversified company and therefore cannot be considered as comparable functionally with that of the Assessee. There has been no attempt made to identify and eliminate and make adjustment of the profit margins so that the difference in functional comparability can be eliminated. By not resorting to such a process of making adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard." 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for

Page 13 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 discovery of new drugs and has developed molecule to treat cancer. In the ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the segmental data for each activity is not available and therefore this company should not be treated as comparable. Besides the above, the Assessee has point out to several references in the annual report for 31.3.2007 highlighting the fact that this company was develops biotechnology products and provides related software development services. The TPO called for segmental data at the entity level from this company. The TPO also called for description of software development process. In response to the request of the TPO this company in its reply dated 29.3.2010 has given details of employees working in software development but it is not clear as to whether any segmental data was given or not. Besides the above there is no other detail in the TPO's order as to the nature of software development services performed by the Assessee. Celestial labs had come out with a public issue of shares and in that connection issued Draft Red Herring Prospectus (DRHP) in which the business of this company was explained as to clinical research. The TPO wanted to know as to whether the primary business of this company is software development services as indicated in the annual report for FY 06-07 or clinical research and manufacture of bio products and other products as stated in the DRHP. There is no reference to any reply by Celestial labs to the above clarification of the TPO. The TPO without any basis has however concluded that the business mentioned in the DRHP are the services or businesses that would be started by utilizing the funds garnered though the Initial Public Offer (IPO) and thus in no way connected with business operations of the company during FY 06-07. We are of the view that in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable."

Page 14 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 E-Zest Solutions Ltd. 14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the information received in response to notice under section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company ought to be excluded from the list of comparables on the ground that it is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in 'e- Business Consulting Services', consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised Representative contends, are high end ITES normally categorised as knowledge process Outsourcing ('KPO') services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that since the Annual Report of the company does not contain detailed descriptive information on the business of the company, the assessee places reliance on the details available on the company's website which should be considered while evaluating the company's functional profile. It is also submitted by the learned Authorised Representative that KPO services are not comparable to software development services and therefore companies rendering KPO services ought not to be considered as comparable to software development companies and relied on the decision of the co- ordinate bench in the case of Capital IQ Information Systems (India) (P) Ltd. in ITA No.1961(Hyd)/2011 dt.23.11.2012 and prayed that in view of the above reasons, this company i.e. e-Zest Solutions Ltd., ought to be omitted from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparables by the TPO. 14.4 We have heard the rival submissions and perused and carefullyconsidered the material on record. It is seen from the record that the TPO has included this company in the list of comparbales only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act. It appears that the TPO has not examined the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I- Q InformationSystems (India) (P) Ltd.

Page 15 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O./TPO is accordingly directed." Infosys Technologies Ltd. 12.1 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. 12.2 Before us, the assessee contended that this company is not functionally comparable to the assessee and in this context has cited various portions of the Annual Report of this company to this effect which is as under:- (i) The company has an Intellectual Property (IP) Cell to guide its employees to leverage the power of IP for their growth. In 2008, this company generated over 102 invention disclosures and filed an aggregate 10 patents in India and the USA. Till date this company has filed an aggregate of 119 patent applications (pending) in India and USA out of which 2 have been granted in the US. (ii) This company has substantial revenues from software products and the break-up of the software product revenues is not available. (iii) This company has incurred huge research and development expenditure to the tune of approximately Rs. 200 Crores. (iv) This company has a revenue sharing agreement towards acquisition of IPR in AUTOLAY, a commercial software product used in designing high performance structural systems. (v) The assessee also placed reliance on the following judicial decisions:- (a) ITAT, Delhi Bench decision in the case of Agnity India Technologies India Pvt. Ltd. (ITA No.3856/Del/2010) and (b) Trilogy E-Business Software India Pvt. Ltd. (ITA No.1054/Bang/2011) 12.3 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 operating

Page 16 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 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. 12.4 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. The argument put forth by assessee's is 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 break up 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." KALS Information Systems Ltd. "46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal's decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: "16. 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.

Page 17 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 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." Wipro Limited "13.1 This company was selected as a comparable by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables or several grounds like functional dis-similarity, brand value, size, etc. The TPO, however, brushed aside the objections of the assessee and included this company in the set of comparables. 13.2 Before us, the assessee contended that this company is functionally not comparable to the assessee for several reasons, which are as under: (i) This company owns significant intangibles in the nature of customer related intangibles and technology related intangibles and quoted extracts from the Annual Report of this company in the submissions made. (ii) The TPO had adopted the consolidated financial statements for comparability purposes and for computing the margins, which contradicts the TPO's own filter of rejecting companies with consolidated financial statements. 13.3. Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables. 13.4.1 We have heard both parties and carefully perused and considered the material on record. We find merit in the contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison.

Page 18 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 13.4.2 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010) has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any such intangible and hence does not have an additional advantage in the market. As the assessee in the case on hand does not own any intangibles, following the aforesaid decision of the co- ordinate bench of the Tribunal i.e. 24/7 Customer.Com Pvt. Ltd. (supra), we hold that this company cannot be considered as a comparable to the assessee. We, therefore, direct the Assessing Officer/TPO to omit this company from the set of comparable companies in the case on hand for the year under consideration." Avani Cimcon Technologies Ltd. "39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company's website, which reveals that this company has developed a software product by name "DXchange", it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT - ITA No.7821/Mum/2011 wherein the Tribunal accepted the assessee's contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- "7.8 Avani Cincom Technologies Ltd. ('Avani Cincom'): Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis." It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures were placed before us:-

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Particulars FYs 05-06 06-07 07-08 08-09 Operating Revenue 35477523 29342809 28039851 21761611 Operating Expns. 16417661 23249646 23359186 31108949 Operating Profit 5343950 1227877 5983623 (3069098) Operating Margin 32.55% 52.59% 25.62% -9.87%

Page 20 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 assessee pointed out this to the TPO in its written submissions, copy of which is placed in the Paper book at page 420.3 to 420.4. The assessee further pointed out that there was no bifurcation available between the business of sale of software products and the business of software services, and therefore, it was not appropriate to adopt the application software segment of the said concern for the purposes of comparability with the assessee's IT-Services Segment. The TPO however, noticed that though the application software segment of the said concern may be engaged in selling of some of the software products which are developed by it, however, the said concern was not into trading of software products as there were no cost of purchases debited in the Profit & Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessee's segment of IT-Services. 18. Before us, apart from reiterating the points raised before the TPO and the DRP, the Ld. Counsel submitted that in the immediately preceeding assessment year of 2006-07, the said concern was evaluated by the assessee and was found functionally incomparable. For the said purpose, our reference has been invited to pages 421 to 542 of the Paper book, which is the copy of the Transfer Pricing study undertaken by the assessee for the A.Y. 2006-07, and in particular, attention was invited to page 454 where the accept reject matrix undertaken by the assessee reflected KALS Information Solutions Ltd. (Seg) as functionally incomparable. The Ld. Counsel pointed out that the aforesaid position has been accepted by the TPO in the earlier A.Y. 2006-07 and therefore, there was no justification for the TPO to consider the said concern as functionally comparable in the instant assessment year. 19. In our considered opinion, the point raised by the assessee is potent in as much as it is quite evident that the said concern has not been found to be functionally comparable with the assessee in the immediately preceding assessment year and in the present year also, on the basis of the Annual Report, referred to in the written submissions addressed to the lower authorities, the assessee has correctly asserted out that the said concern was inter alia engaged in sale of software products, which was quite distinct from the activity undertaken by the assessee in the IT Services segment. At the time of hearing, neither is there any argument put forth by the Revenue and nor is there any discussion emerging from the orders of the lower authorities as to in what manner the functional profile of the said concern has undergone a change from that in the immediately preceding year. Therefore, having regard to the factual aspects brought out by the assessee, it is correctly asserted that the application software segment of the said concern is not comparable to the assessee's segment of IT services.

Page 21 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 20. With regard to the inclusion of Helios & Matheson Information Technology Ltd., the assessee has raised similar arguments as in the case of KALS Information Solutions Ltd. (Seg). We have perused the relevant para of the order of the TPO i.e., 6.3.21, in terms of which the said concern has been included as a comparable concern. The assessee pointed out that as in the case of KALS Information Solutions Ltd. (Seg), in the instant case also for A.Y. 2006-07 the said concern was found functionally incomparable by the assessee in its Transfer pricing study and the said position was not disturbed by the TPO. The relevant portion of the Transfer pricing study, placed at page 432 of the Paper book has been pointed out in support. Considered in the aforesaid light, on the basis of the discussion in relation to KALS Information Solutions Ltd. (Seg), in the instant case also we find that the said concern is liable to be excluded from the list of comparables." Persistent Systems Ltd. "17.1.1 This company was selected by the TPO as a comparable. The assessee objected to the inclusion of this company as a comparable for the reasons that this company being engaged in software product designing and analytic services, it is functionally different and further that segmental results are not available. The TPO rejected the assessee's objections on the ground that as per the Annual Report for the company for Financial Year 2007-08, it is mainly a software development company and as per the details furnished in reply to the notice under section 133(6) of the Act, software development constitutes 96% of its revenues. In this view of the matter, the Assessing Officer included this company i.e. Persistent Systems Ltd., in the list of comparables as it qualified the functionality criterion. 17.1.2 Before us, the assessee objected to the inclusion of this company as a comparable submitting that this company is functionally different and also that there are several other factors on which this company cannot be taken as a comparable. In this regard, the learned Authorised Representative submitted that: (i) This company is engaged in software designing services and analytic services and therefore it is not purely a software development service provider as is the assessee in the case on hand. (ii) Page 60 of the Annual Report of the company for F.Y. 2007-08 indicates that this company, is predominantly engaged in 'Outsourced Software Product Development Services' for independent software vendors and enterprises. (iii) Website extracts indicate that this company is in the business of product design services. (iv) The ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt. Ltd. (supra) while discussing the comparability of

Page 22 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 another company, namely Lucid Software Ltd. had rendered a finding that in the absence of segmental information, a company be taken into account for comparability analysis. This principle is squarely applicable to the company presently under consideration, which is into product development and product design services and for which the segmental data is not available. The learned Authorised Representative prays that in view of the above, this company i.e. Persistent Systems Ltd. be omitted from the list of comparables. 17.2 Per contra, the learned Departmental Representative support the action of the TPO in including this company in the list of comparables. 17.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details/information a company cannot be taken into account for comparability analysis, we hold that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. It is ordered accordingly. Tata Elxsi Ltd. 14.1 This company was a comparable selected by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables on several counts like, functional dis-similarity, significant R&D activity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of comparables. 14.2 Before us, it was reiterated that this company is not functionally comparable to the assessee as it performs a variety of functions under the software development and services segment namely (a) Product design services (b) Innovation design engineering and (c) visual computing labs. In the submissions made the assessee had quoted relevant portions from the Annual Report of the company to this effect. In view of this, the learned Authorised Representative pleaded that this company be excluded from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the stand o the TPO in including this company in the list of comparables.

Page 23 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 14.4.1 We have heard both parties and carefully perused and considered the material on record. From the details on record, we find that this company is predominantly engaged in product designing services and not purely software development services. The details in the Annual Report show that the segment "software development services" relates to design services and are not similar to software development services performed by the assessee. 14.4.2 The Hon'ble Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. V ACIT (ITA No.7821/Mum/2011) has held that Tata Elxsi Ltd. is not a software development service provider and therefore it is not functionally comparable. In this context the relevant portion of this order is extracted and reproduced below :- ". . . . . . . .Tata Elxsi is engaged in development of niche product and development services which is entirely different from the assessee company. We agree with the contention of the learned Authorised Representative that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company as fit for comparability analysis for determining the arm's length price for the assessee, hence, should be excluded from the list of comparable portion." As can be seen from the extracts of the Annual Report of this company produced before us, the facts pertaining to Tata Elxsi have not changed from Assessment Year 2007-08 to Assessment Year 2008-09. We, therefore, hold that this company is not to be considered for inclusion in the set of comparables in the case on hand. It is ordered accordingly." Thirdware Solutions Ltd. (Segment): "15.1 This company was proposed for inclusion in the list of comparables by the TPO. Before the TPO, the assessee objected to the inclusion of this company in the list of comparables on the ground that its turnover was in excess of Rs. 500 Crores. Before us, the assessee has objected to the inclusion of this company as a comparable for the reason that apart from software development services, it is in the business of product development and trading in software and giving licenses for use of software. In this regard, the learned Authorised Representative submitted that :- (i) This company is engaged in product development and earns revenue from sale of licences and subscription. It has been pointed out from the Annual Report that the company has not provided any separate segmental profit and loss account for software development services and product development services.

Page 24 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 (ii) In the case of E-Gain communications Pvt. Ltd. (2008-TII-04- ITAT-PUNE-TP), the Tribunal has directed that this company be omitted as a comparable for software service providers, as its income includes income from sale of licences which has increased the margins of the company. The learned A.R. prayed that in the light of the above facts and in view of the afore cited decision of the Tribunal (supra), this company ought to be omitted from the list of comparables. 15.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 15.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the case of E-Gain Communications Pvt. Ltd. (supra) has directed that since the income of this company includes income from sale of licenses, it ought to be rejected as a comparable for software development services. In the case on hand, the assessee is rendering software development services. In this factual view of the matter and following the afore cited decision of the Pune Tribunal (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand." 13. In so far as Megasoft Ltd, is concerned, findings of the Tribunal in the above case were as under: Megasoft Ltd. : 24. This company was chosen as a comparable by the TPO. The objection of the assessee is that there are two segments in this company viz., (i) software development segment, and (ii) software product segment. The Assessee is a pure software services provider and not a software product developer. According to the Assessee there is no break up of revenue between software products and software services business on a standalone basis of this comparable. The TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius-BCGI Division does the business of product software. This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30

Page 25 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 to 40% of the product software would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to product software) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO's filter of more than 75% of revenues from software development services. The basis on which the TPO arrived at the PLI of 60.23% is given at page-115 and 116 of the order of the TPO. It is clear from the perusal of the same that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data. 25. In the order of the TPO, operating margin was computed for this company at 60.23%. It is the complaint of the assessee that the operating margins have been computed at entity level combining software services and software product segments. It was submitted that the product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions on page 381 to 383 of the PB-I). It was further submitted that Megasoft Limited has provided segmental break-up between the software services segment and software product segment (page 68 of PB-II), which was also adopted by the TPO in his show cause notice (Page 84 of PB-I). The segmental results i.e., results pertaining to software services segment of this company was:

Segmental Operating Revenues Rs.637132544 Segmental Operating Expenses Rs.577513211 Operating Profit Rs.8119619333 OP/TC (PLI) 23.11%

Page 26 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 only should be adopted in the case of Megasoft also, in contrast to the entity level margins. 28. Computation of the net margin for Mega Soft Ltd. Is therefore remitted to the file of the TPO to compute the correct margin by following the direction of the Tribunal in the case of Trilogy E- Business Software India Pvt.Ltd." 23. Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to compute the correct margin of Mega Soft Ltd., as directed by the Tribunal in the case of First Advantage Offshore Services Pvt. Ltd. (supra). Accordingly we hold that Megasoft Ltd can be considered as a good comparable after segmentation as directed in the above order is done.' 5.2.1 There is nothing on record brought by authorities below that factual observations by this (Tribunal) in (Meritor LVS (Supra)) is incorrect. In all the above comparables it has been observed that it cannot be used as comparables to determine ALP of a risk mitigated, contract service provider.

5.2.2 Accordingly, following the above order we direct exclusion of Avani Cimcon Technologies Ltd, Celestial Labs Ltd, E-Zest Solutions Ltd, Infosys Technologies Ltd, KALS Information Systems Ltd(seg), Wipro Ltd (seg), Helios & Matheson Information Technology Ltd, Persistent Systems Ltd, Tata Elxsi Ltd (seg) and Thirdware Solutions Ltd.

5.2.3 In so far as Megasoft Solutions Ltd is concerned, we direct Ld.AO/TPO to rework segmental results and consider its comparability only with regard to software development services segment.

5.3 Ishir Infotech Ltd This comparable was included by Ld.TPO and objected by assessee for its functional dissimilarities. It has been submitted that, information of obtained under 133 (6) by Ld.AO is placed at

Page 27 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 page 1061-1064 of paper book wherein this company is involved in diversified activities like application development and maintenance,, testing services, Web development services, Internet based application, e-commerce application, consulting services. It is also been submitted that all these services have been categorised under one single ahead of software development services 5.4 Ld.AR submitted that, this Tribunal in case Meritor LVS India (P)Ltd., by this Tribunal reported in (2015) 64 Taxmann.com 136 for AY: 2007-08 held that, this company is not comparable in case of captive software development services provider like assessee. 5.5 The Ld.DR however objected to the exclusion of this company from the list of comparables. 5.6 On a careful perusal of material on record, and the reply received from this company under section 133 (6) we find that this company is involved in various activities as compared to captive software service provider like assessee. It is also observed that in the case of Meritor LVS India Pvt Ltd (supra) Ld.TPO used very same 26 comparables for computing arm’s length margin of software development service segment direct. This Tribunal after considering the functions performed by this company was of the opinion that it is not comparable to ours captive software development service provider. For coming to this preposition this Tribunal relied upon decision of this Tribunal in case of First Advantage Offshore Services Pvt Ltd vs DCIT in ITA (TP) No. 1086/B/2011 for assessment year 2007-08.

Page 28 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 Respectfully following decisions of this Tribunal, we direct Ld.AO/TPO to exclude this company from the final list. Accordingly ground No. 3 stands disposed off hereinabove.

6.1 Placing reliance upon this decision Ld. ar submitted that once assessee has capitalised the expenditure and only claimed depreciation than provisions of section 40 (a) (ia) of the Act cannot be invoked for disallowance of the claim of depreciation.

Ld.CIT.DR submitted that the issue needs verification in the light of submissions made by Ld.AR. He’s requested for the issue to be set-aside to Ld.AO.

6.2 We have perused submissions advanced by both sides in light of records placed before us.

6.3 We have also referred to the decision relied upon by Ld.AR in case of M/s Wintac Ltd vs DCIT (supra) wherein this Tribunal relying upon another decision of coordinate bench dated 26/06/2015 in case of M/s Kawasaki microelectronics Inc vs DDIT (international taxation) in IT(TP) A No.1512/2010 remitted the issue back to Ld.AO for due verification.

6.4 It is observed that this tribunal in Rathore of cases has analysed applicability of section 40(a)(i) of the act for disallowance of depreciation on such capitalised expenditure and

Page 29 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 has held that no section 40 (a) (i) of the Act, cannot be applied for claim of deduction under section 32 of the Act. However by way of abundant caution we direct Ld.AO to verify the fact whether assets in respect of which expenditure has been capitalised have been used for business of assessee for a period more than 180 days. AO shall verify all these details in light of arguments advanced by Ld.AR.

Accordingly this ground raised by assessee stands allowed for statistical purposes.

Page 30 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 In the result appeal filed by assessee stands allowed as indicated hereinabove.

Order pronounced in the open court on 17th March, 2020.

Sd/- Sd/- (A. K. GARODIA) (BEENA PILLAI) Accountant Member Judicial Member Bangalore, Dated, the 17th March, 2020. /Vms/

Copy to: 1. Appellant 4. CIT(A) 2. Respondent 5. DR, ITAT, Bangalore 3. CIT 6. Guard file

By order

Assistant Registrar, Income Tax Appellate Tribunal. Bangalore.

Page 31 of 31 IT(TP)A 673/Bang/2017 A. Y : 2007 – 08 Date Initial On Dragon 1. Draft dictated on Sr.PS 11-03-2020 2. Draft placed before Sr.PS author 11-03-2020 3. Draft proposed & placed JM/AM before the second member 11-03-2020 4. Draft discussed/approved JM/AM by Second Member. 11-03-2020 5. Approved Draft comes to Sr.PS/PS the Sr.PS/PS -03-2020 6. Kept for pronouncement Sr.PS on -03-2020 7. Date of uploading the Sr.PS order on Website -- 8. If not uploaded, furnish Sr.PS the reason -03-2020 9. File sent to the Bench Sr.PS Clerk 10. Date on which file goes to the AR 11. Date on which file goes to the Head Clerk. 12. Date of dispatch of Order. No 13. Draft dictation sheets are Sr.PS attached