M/S.CISCO VIDEO TECHNOLOGIES INDIA PRIVATE LIMITED,BANGALORE vs. ASSISTANT COMMISSIONER OF INCOME TAX, BANGALORE

This appeal by the assessee is against the fair order of assessment dated 25.11.2016 passed u/s. 143(3) r.w.s. 144C of the Income-tax Act, 1961 [the Act] by the ACIT, Circle 2(1)(1), Bangalore relating to assessment year 2012-13.

The only issue that arises for consideration in this appeal is with regard to addition made bey the AO consequent to determination of ALP in respect of an international transaction entered into by the assessee with its AE. The assessee is a company which is engaged in the business of rendering software development and related services. It is not in dispute that the assessee rendered software development services to its Associate Enterprise (AE), NDS, UK. The aforesaid transaction was an international transaction and as laid down under the provisions of section 92 of the Act and accordingly the income from the aforesaid transaction has to be determined keeping in mind the arm’s length price.

The assessee in support of its claim, that the price received in the international transaction was at arm’s length, filed a TP analysis for which the assessee had chosen TNMM as the most appropriate method for determining the ALP. The Profit Level Indicator (PLI) chosen for the purpose of comparison of the profit margin of the assessee with the comparable companies was OP/OC. The OP/OC as worked out by the assessee and as done by the TPO was as follows:-

As can be seen from the above table, the PLI computed by the assessee was modified by the TPO and this is because of the action of the TPO in considering the foreign exchange gain of Rs.15,13,57,335 as not part of the operating income of the assessee. This is the reason why the PLI computed by the assessee was 14.34%, while TPO computed the PLI at 10.07%.

After rejecting the TP analysis of the assessee, the TPO chose 10 comparable companies and the average arithmetic profit margin of those 10 companies was as follows:-

The TPO determined the ALP and the consequent addition to be made to the total income of the assessee as follows:- “12.4 The arithmetic mean of the Profit Level indicators is taken as the arm’s length margin. Please see Annexure B for details of computation of PLI of the comparables. Based on this, the arm’s length price of the services rendered by the tax payer to its AE(s) is computed as under: SOFTWARE DEVELOPMENT SERVICES

Aggrieved by the order of TPO, which was incorporated in the draft order of assessment by the AO, the assessee preferred objections before the DRP. The DRP accepted the plea of the assessee that out of 10 comparable companies chosen by the TPO, 6 companies cannot be regarded as good comparables and only the following four can be regarded as companies:- Adjusted OP/OC after Sl. OP/OC Names of the companies working capital No. % adjustment 1 Larsen & Toubro Infotech Ltd. 25.47% 26.50% 2 Mindtree Ltd. 15.01% 15.76% 3 Persistent Systems Ltd. 27.20% 27.90% 4 R S Software (India) Ltd. 15.34% 18.58% Mean margin 20.75% 22.18%

The DRP, however, opined that it would be appropriate to consider the entire 10 set of comparables as by doing so, the larger set of comparables will take care of differences between the comparables. With regard to the action of the TPO in considering the foreign exchange gain as not part of operating profits for the purpose of computing OP/OC, the DRP held that foreign exchange gain has to be treated as part of the OP while computing OP/OC of the assessee and in doing so, following the decision of the Bangalore Tribunal in the case of SAP Labs (I) P. Ltd. v. ACIT [2011] 44 SOT 156 (Bang. Trib). Despite the above direction, the TPO while giving effect to the directions of the DRP dated 24.11.2016, excluded six comparable companies which was held by the DRP to be not comparable with the assessee. In the aforesaid order, the TPO did not give effect to the directions of the DRP to consider foreign exchange gain as part of operating profits of the assessee.

Before us, the ld. counsel for the assessee seeks exclusion of 2 out of 4 comparable companies that remain after the order of DRP and order giving effect to the directions of the DRP passed by the TPO dated 24.11.2016. The 2 companies which the assessee seeks exclusion are L&T Infotech Ltd. and Persistent Systems Ltd.

The ld. counsel for the assessee filed before us an order of the Tribunal dated 21.12.2018 in IT(TP)A No.216/Bang/2017 for AY 2012-13 in the case of Evolving Systems Network (I) P. Ltd. In this decision also with reference to the software development services provider such as the assessee where the very same 10 comparables were chosen by the TPO as in the present case, the Tribunal held that L&T Infotech Ltd. and Persistent Systems Ltd. cannot be regarded as comparable with the following observations :- “8. We have considered the rival submissions. In the case of Agilis Information Technologies India (P) Ltd., (supra), this Tribunal considered the comparability of the 3 companies which the Assessee seeks to exclude from the final list of comparable companies chosen by the TPO. The functional profile of the Assessee and that of the Assessee in the case of Agilis Technologies India (P) Ltd., is identical in as much as the said company was also involved in providing SWD services to its AE and the TPO had chosen some comparable companies which were also chosen by the TPO in the case of the Assessee for the purpose of comparability. In the aforesaid decision the Tribunal held on the comparability of the 3 companies which the Assessee seeks to exclude as follows:

Following the aforesaid decision of the Tribunal, we direct the exclusion of Larsen & Toubro Infotech Ltd. and Persistent Systems Ltd. from the list of comparable companies.

It was submitted that with the exclusion of the aforesaid companies from the list of comparable companies and if foreign exchange gain is regarded as operating profit and the PLI is reworked, then the profit margin of the assessee and the average arithmetic profit mean of the comparable companies that remain after exclusion of the aforesaid two companies would be within the arm’s length range and therefore no addition could be made on account of determination of ALP. Hence the other grounds of appeal raised by the assessee in the appeal were not pressed for adjudication.

We are of the view that the aforesaid submission is accepted and the other grounds of appeal in challenging the TP adjustment are held to be academic and not decided. We, however, direct the TPO to consider the foreign exchange gain as part of operating profit of assessee and work out the PLI.

Only two comparable companies remain after exclusion of 8 out of 10 companies chosen by the TPO viz., Mindtree Ltd. and R S Software (I) Ltd. The TPO is directed to determine the ALP as per the directions contained in this order, after affording due opportunity to the assessee.

In the result, the appeal by the assessee is partly allowed.