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Income Tax Appellate Tribunal, DELHI BENCH: ‘I-1’, NEW DELHI
Before: SHRI AMIT SHUKLA & SHRI O.P. KANT
Date of hearing 01.07.2019 Date of pronouncement 04.07.2019 ORDER PER O.P. KANT, A.M.: These cross appeals of the assessee and Revenue are directed against order dated 28/03/2011 passed by the Ld. 2 ITA No.1074/Hyd./2011 & ITA No.1164/Hyd./2011 Commissioner of Income-tax (Appeals), Hyderabad [in short the Ld. CIT(A)] for assessment year 2005-06. 2. The grounds raised in the appeal of the assessee having ITA No. 1074/Hyd./ 2011 are reproduced as under:
1. That on the facts and in the circumstances of the case and in law, the orders passed by the Learned Deputy Commissioner of Income Tax (‘Ld. AO’) and the Learned Commissioner of Income Tax (Appeals) [‘Ld. CIT(A)’], are bad in law and void ab-initio.
2. That the Ld. CIT(A) erred both on facts and in law in confirming an addition of Rs. 42,713,576 out of the total addition of Rs. 43,327,703 made by the Ld. AO to the income of the appellant by holding that its international transaction of “Contract Software Development and Support Services” does not satisfy the arm’s length principle envisaged under the Act. In doing so, the Ld. CIT(A) has grossly erred in agreeing with the Ld. TPO’s/ AO’s action of: 2.1. Selecting companies in the final set as comparables which are functionally dissimilar or have different revenue model or different scale of operations and are thus not comparable to the appellant as per the principles of comparability enunciated in Rule10B(2) of the Income Tax Rules; 2.2. Resorting to arbitrary rejection of low-profit/ loss making companies (forming part of the final set of companies selected by the appellant as comparables) based on erroneous and inconsistent reasons and thereby retaining only high-profit making companies,; 2.3. Not appreciating the functional profile of the appellant and thereby erroneously including Infosys Technologies Limited as a comparable disregarding the fact that the Company has different functional and economic profile as compared to the captive software development services rendered by the appellant; 2.4. Modification of the comparable companies set as identified by the appellant by arbitrarily applying certain erroneous quantitative and qualitative criteria and further rejecting/ modifying the appropriate quantitative and qualitative criteria which were applied by the appellant; 2.5. Disregarding the arm’s length price (‘ALP’) and the methodical benchmarking process carried out by the appellant in the Transfer Pricing (‘TP’) documentation maintained by it in terms of section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 (‘Rules’); 2.6. Grossly violating the principles of natural justice by disregarding the comparable companies identified by the appellant and undertaking ./2011 & ITA No.1164/Hyd./2011 a fresh search using data for FY 2004-05 and arbitrarily including companies in the comparable set used to benchmark the appellant’s contract software development and support services, without providing the appellant a reasonable opportunity of being heard; 2.7. Disregarding multiple year/ prior years’ data as used by the appellant in the TP documentation report and holding that current year (i.e., FY 2004-05) data for comparable companies should be used despite the fact that the same was not available to the appellant at the time of preparing its TP documentation; 2.8. Ignoring the fact that the appellant is entitled to tax holiday under section 10A of the Act on its profits and therefore would not have any untoward motive of deriving a tax advantage by manipulating transfer prices of its international transactions; 2.9. Ignoring the business/ commercial reality that since the appellant is remunerated on an arm’s length cost plus basis, i.e. it is compensated for all its costs plus a pre-agreed markup, the appellant undertakes minimal business risks as against comparable com that are full fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the appellant on account of this fact; 2.10. Not allowing the Appellant the benefit of infrastructure and depreciation adjustments which were claimed by the Appellant on account of differences between the appellant and the comparables in accordance with Rule 10B(1)(e) of the Income tax Rules; 2.11. Disregarding judicial pronouncements in India in undertaking the TP adjustment; and 2.12. Denying the benefit of the +/-5% range from the arithmetical mean margin of comparable companies allowable to the appellant as provided in proviso to 92C(2) of the Income-tax Act 1961. The above grounds are without prejudice to each other. The appellant craves leave to alter, amend or withdraw all or any of the grounds herein or add any further grounds as may be considered necessary either before or during the hearing.
3. The Grounds raised in the appeal of the Revenue having ITA No. 1164/Hyd./2011 reproduced as under:
1. The learned CIT(A) ought to have held that the communication expenses should be excluded from the export turnover and not from the total turnover. ./2011 & ITA No.1164/Hyd./2011 2. The learned CIT(A) ought to have held the arm’s length price determined by the Transfer Pricing Officer. 3. Any other ground(s) that may urged upon at the time of hearing. 4. Briefly stated facts of the case are that the assessee is a company registered in India, is wholly-owned subsidiary of M/s Mentor Graphics Holding Limited, which in turn is a subsidiary of M/s. Mentor Graphics Corporation, USA. The assessee was engaged in the business of providing support for software product development and quality analysis services to the Associated Enterprises (AEs). For the year under consideration, the assessee filed return of income on 24/10/2005, declaring total income of Rs.6,52,720/- after claiming exemption of Rs.5,69,21,923/- under section 10A of the Income-tax Act, 1961 (in short ‘the Act’). The case was selected for scrutiny and notice under section 143(2) of the Act was issued and complied with. The Assessing Officer observed international transactions carried out by the assessee and referred the matter of determination of arm’s length price of those international transactions to the learned Transfer Pricing Officer (TPO). The Ld. TPO determined the arm’s-length price of the International Transaction at Rs.42,45,66,312/- as against the price of Rs.38,12,38,609/-declared by the assessee and thus, he proposed adjustment of Rs.4,33,27,703/-. 4.1 As far as claim of exemption u/s 10A is concerned, according to the Assessing Officer communication charges (Rs.1,47,42,563/-) does not form part of the ‘export turnover’ as per Explanation 2(iv) to section 10A of the Act, thus, Ld. Assessing Officer revised the claim of exemption under section 10A of the Act to Rs.5,47,20,741/-as under:
= Rs. 5, 47, 20, 741/- 4.2 The Assessing Officer accordingly, in the assessment order passed on 21.11.2008 included the transfer pricing adjustment and modified exemption under section 10A of the Act. Aggrieved, the assessee filed appeal before the Ld. CIT(A) and challenged the additions made by the Assessing Officer. On the issue of deduction under section 10A is concerned, the Ld. CIT(A) held that communication expenditure does not have element of profit and the same has necessarily to be excluded both from the export turnover as well as total turnover. On the issue of transfer pricing adjustment, the Ld. CIT(A) upheld the action of the learned TPO of using current year data as well as various filters applied by the Ld. TPO for selection of comparables. The Ld. CIT(A) issued direction to retain/exclude certain compatibles and due to which the transfer pricing adjustment got reduced to Rs.4,27,13,576/-. Aggrieved, both the assessee and the Revenue are in appeal before the Tribunal raising the grounds as reproduced above. 4.3 In the grounds raised by the assessee, the sole issue involved is of transfer pricing adjustment sustained by Ld. CIT(A) of Rs.4,27,13,576/-. The ground No.2 raised by the Revenue is also related with the Transfer Pricing Adjustment. 4.4 Before us the learned counsel of the assessee submitted that if three comparables out of the list of final comparables are 6. ITA No.1074/Hyd./2011 & ITA No.1164/Hyd./2011 excluded, the average margin would be in the plus minus range of 5%, i.e., safe harbour limit, and thus no adjustment would be required in the case of the assessee. 4.5 In its transfer pricing study, the assessee claimed to have engaged in providing Software Development Services and support services to its Associated Enterprises. The International Transactions carried out by the assessee are reproduced as under: a. Contract Software Rs.381,238,609 Development and Support Services b. Purchase of fixed assets Rs. 1,5410,992 c. Sale of fixed assets Rs. 332,340 d. Payment of network Rs. 9,840,381 connectivity charges e. Payment for training charges Rs. 469,102 f. Reimbursement of Expenses Rs. 615,267 4.6 The learned TPO accepted the arm’s-length price of the International transactions except the price in respect of provision of contract software development and support services. As far as the transaction of provision of software development and support services is concerned, the assessee in its transfer pricing documentation, selected the Transactional Net Margin Method (TNMM) and considered Mark up on operating cost ( i.e. operating profit/total operating cost or OP/TC ) is as the appropriate profit level indicator (PLI) in applying the TNMM, which was computed to 12%. The average margin with working capital adjustment of the 87 comparable companies was computed at 10%. The profit margin of the assessee being higher than the average profit margin of the comparables, according to the assessee, the price of ./2011 & ITA No.1164/Hyd./2011 the international transaction shown by it was at arm’s length. The learned TPO directed the assessee to furnish contemporaneous data of the comparables for financial year 2004-05. The assessee carried out rerun of its list of companies and shortlisted 35 comparables whose OP/TC was worked out to 12% (without any adjustment) as against OP/TC of 12% earned by the assessee. The learned TPO rejected the 27 out of 35 comparables selected by the assessee. In addition, the learned TPO also proposed few new comparables in the show-cause notice issued to the assessee. The learned TPO finally selected 17 comparables at a mean PLI of 26.59% and after allowing working capital adjustment of 2.15%, the adjusted mean PLI was worked out to 24.44 percent and adjustment of Rs.4,33,27,703/- to the international transaction was worked out. The Ld. CIT(A) directed exclusion of “M/s Satyam Computer Services”, but rejected the contention of the assessee in respect of the other comparables. In view of the direction of the Ld. CIT(A), the adjustment was reduced to Rs.4,27,13,576/-. The final set of the comparables after the order of the Ld. CIT(A) is as follows:
S.No. Company Name OP/TC Bodhtree Consulting Ltd 24.85% 1. Lanco Global Systems 13.65% 2.
3. Exensys Software Solutions Ltd 70.67% 4. Sankhya Infotech Ltd 27.38% 5. Sasken Network Systems Ltd 16.64% Four soft Ltd 22.98% 6.
Thirdware Solution Limited 66.09% 8. RS Software India 8.07% 9. Geometric Software 20.34% Tata Elxsi Limited 24.35% 10. Visual Soft Technologies 23.52% 11. Sasken Communication Tech 14.42% 12. ./2011 & ITA No.1164/Hyd./2011 13. iGate Global Solutions 4.32% 14. Flextronics 32.19% 15. L&T Infotech 10.33% Infosys Ltd 42.83% 16. Mean 26.41% Less: Working Capital Adjustment 2.15% ALP 24.26% 4.7 Before us, the learned counsel of the assessee filed a paperbook containing pages 1 to 308 and annual reports compendium containing pages 1 to 580 and submitted that if the comparables, namely, ‘Exensys Global Solution Limited’, ‘Third Ware Services Ltd.’ and ‘Infosys Ltd.’ are excluded from the set of the comparables, the margin of the assessee would be in + (-) 5% limit, and no adjustment would be required. Accordingly, the arguments of both the parties on exclusion of these three comparables were heard. The exclusion of these comparables are accordingly adjudicated as under:
Exensys Global Solutions Ltd. 1.1 The learned counsel submitted that that learned TPO called for the information under section 133(6) of the Act in respect of the company, a copy of which is placed on page 308 of the paper book filed by the assessee. The learned counsel submitted that according to the information under section 133(6), the company was engaged in developing and sales of software products and no separate segment for software product is available in the financials of the company. The learned counsel also referred to page 39 of the Annual Report of the company and submitted that during the year under 9 ITA No.1074/Hyd./2011 & ITA No.1164/Hyd./2011 consideration, another company, namely, ‘Holool India Ltd.’ amalgamated with the company, which resulted in exceptional increase in turnover from Rs. 306.28 crore in assessment year 2004-05 to Rs. 737.79 crores in the assessment year 2005-06 i.e. the assessment year under consideration. The learned counsel submitted that due to functional dissimilarity and extraordinary circumstances, the company needs to be excluded. The learned counsel also submitted that the learned TPO in assessment year 2006-07, i.e., succeeding assessment year, has himself excluded the company from the set of the comparables. 1.2 The learned DR, on the other hand, relied on the order of the lower authorities. 1.3 We have heard the rival submissions and perused the relevant material on record. On perusal of the information gathered by the learned TPO under section 133 (6) in respect of the company, we agree with the learned counsel that the assessee was engaged in development and sales of software product. The relevant part of the information is reproduced as under:
“1. Exensys Software Solutions Ltd falls under the following nature of software services: • Software Product Company — who develops software products by following all the steps involved in creating a software product from domain analysis to testing. The intellectual property belongs to the company and the products are sold on license basis wherein right to use the software is transferred without giving a source code. • Software Development Service Provider - who does a portion of the described software development life cycle. It does not generate any intellectual property for its own. The 10 ITA No.1074/Hyd./2011 & ITA No.1164/Hyd./2011 intellectual property generated belongs to the customer and not to company.” 1.4 On perusal of the Annual Report of the company, available on page 30-62 of the Annual Report Compendium, we find from the profit and loss account (page -52) that Revenue streams consist of software export (Rs.6.91 crores), software domestic (Rs. 18.71 Lacs), software training fee (Rs.18.63 lakhs) and other income (Rs. 8.67 lakhs). Thus it is not clear from the revenue streams what is the amount received from sale of software products and amount received from sale of services. Thus, being no separate segmental result, the company cannot be treated as comparable at entity level. We have also noticed the extra ordinary event of amalgamation of another company with the assessee resulting into exceptional increase in the turnover. The extra ordinary event during the year under consideration, also is one of the reason , on the basis of which the company is liable to be excluded. We have also noted that the Assessing Officer in succeeding year has also excluded the company from the final set of the comparables. In view of the above discussion, we direct the Ld. Assessing Officer/TPO to exclude this company from the final set of the comparables.
Thirdware Solutions Ltd. 2.1 Before us, the learned counsel of the assessee submitted that the company is engaged in product development and no separate product segment is available. According to the learned counsel, the company derived revenue from sources like sale of license, software services and revenue from subscriptions etc. ./2011 & ITA No.1164/Hyd./2011 thus, being no segment available, the company cannot be compared at entity level on the ground of functional dissimilarity. 2.2 The learned DR, on the other hand, relied on the finding of the lower authorities. 2.3 We have heard rival submission of the parties and perused the relevant material on the record. On perusal, of page 303 of Annual Report Compendium, we agree with the contention of the learned counsel that sales of the company consist of sale of license, software services, export and revenue from subscription. In absence of any segmental result of software services, the company cannot be compared with the assessee at the entity level. Accordingly, we direct the Ld. AO/TPO to exclude the company from the set of the final comparables.
Infosys Ltd: 3.1 The Ld. counsel of the assessee submitted that the company is engaged in providing end-to-end business solution enabling its client to enhance business performance. According to her, the company provides solutions that span the entire software life cycle encompassing consulting, design, development, reengineering, maintenance, system integration etc and in addition the company offers software products for the banking industry. The learned counsel submitted that no segmental information is available in case of the company and also the company owned substantial intangibles. The learned counsel submitted that the company has been held functionally dissimilar by the Tribunal in the case of the assessee itself for 12 ITA No.1074/Hyd./2011 & ITA No.1164/Hyd./2011 assessment year 2006-07, 2007-08, 2008-09 and 2009-10. The exclusion of the company has been confirmed by the Hon’ble Delhi High Court in the assessee’s own case for assessment year 2006-07. 3.2 The Ld. DR, on the other hand, relied on the order of the lower authorities. 3.3 We have heard the rival submissions of parties. In assessment year 2006-07 in the Tribunal directed to exclude the company with following observation: “5.01 Infosys Limited - The Ld. AR has submitted that the TPO has observed that this Company was functionally similar to the assessee company. However, Infosys is engaged in providing software consulting and products, application design, development, re-engineering and maintenance, system integration, package evaluation and implementation and business process management etc. and, therefore, it was not functionally similar to the assessee company as claimed by the TPO. The Ld. AR has further submitted chat Infosys Limited has a significant turnover of Rs.9,028 crores which is approx. 125 times the assessee’s turnover of INR 72 crores. It was further submitted that Infosys develops/owns proprietary products like Finacle which is not so in the case of the assessee company. It was further submitted that Infosys’s brand value stood at Rs. 22,915 crores, while the assessee has no brand value in India. The Ld. AR has also submitted that Infosys has a significant Advertising/Sales promotion and brand building expenditure of INR 499 crores (i.e. 5.53% of revenue). On the other hand, the assessee does not undertake AMP expenditure. 5.01.1 It is seen that the ITAT Delhi Bench in Agnity India Technologies P. Ltd. vs. ITO , Ward 12(1) in ITA No.3856/Del/2010 for AY 2006-07 ordered to exclude Infosys from the list of comparables by citing - “It is argued that the case of the assessee is not comparable with Infosys Technologies Ltd., the reason being that the letter is joined in the area of development of software and assumes all risks, leading to higher profit. On the other hand, the assessee is a captive unit of its parent company in the USA and it assumes only limited currency risk. Having considered these points, we are of the view that the case of aforesaid Infosys and the assessee are not comparable at all as seen from the financial 13 ITA No.1074/Hyd./2011 & ITA No.1164/Hyd./2011 data etc. of the two companies mentioned earlier in this order. Therefore, we are of the view that this case is required to be excluded. ” This decision of the ITAT was confirmed by the Hon Tie High Court of Delhi in ITA No. 1204/2011. It is also seen that Infosys Limited was rejected in assessee’s own case by the ITAT in ITA No. 2634/Del/2011 for AY 2005-06 and by the Hon’ble DRP in assessment years 2010-11 and 2011-12. Hence, in the light of the above judicial precedent, we order the exclusion of Infosys from the final list of comparables.
3.3 On further challenge by the Revenue, the Hon’ble Delhi High Court upheld on the issue of the comparables decided by the Tribunal, in ITA 318/2017. The relevant part of the decision of the Hon’ble Delhi High Court is reproduced as under:
3. The Court has carefully perused the impugned order of the ITAT and the discussion on this aspect. In the considered view of this Court, while it is true that previous precedents have been relied upon by the ITAT, it would be incorrect to say that ITAT did not take into account the factors that weighed with it for excluding the said comparables. The Court does not find any substantial question of law arising on this aspect and therefore, declines to frame any question.
3.4 We have also perused the Annual Report of the company available on page 417 to 580 of the Annual Reports Compendium. On perusal of the page 469 and 477 of the Annual Report Compendiums, we agree with the contention of the assessee that the company is engaged in multiple activity along with the sale of software products. In our view, in absence of segmental information for software services, the company cannot be considered as comparable at entity level. Following the decision of the Hon’ble Delhi High Court in the case of the assessee itself and in absence of segmental result 14 ITA No.1074/Hyd./2011 & ITA No.1164/Hyd./2011 for software services, we direct the Ld. AO/TPO to exclude the company from the set of the comparables. 4.8 We direct the Ld. AO/TPO to compute the average margin of the remaining comparables sustained by the Ld. CIT(A), and compute the adjustment if any required to made, in accordance with law. 4.9 The issues raised in the transfer pricing grounds of the appeals of assessee and the Revenue are accordingly allowed for statistical purposes. The Grounds of the appeal of the assessee as well as Ground No. 2 of appeal of Revenue are accordingly allowed for statistical purposes.
In Ground No. 1 of the appeal in ITA No.1164/Hyd./2011, the Revenue has raised the issue that communication expenses should be excluded from the export turnover only and not from the total turnover. 5.1 Before us, the learned counsel of the success submitted that issue in dispute is covered in favour of the assessee by the order of the Hon’ble Delhi High Court in the case of the assessee. 5.2 The learned DR, on the other hand, relied on the order of the lower authorities. 5.3 We have heard the rival submission and perused the relevant material on record. We find that the Hon’ble Delhi High Court in in the case of the assessee itself has decided the issue as under: “4. The second issue concerns the deduction under Section 10 A of the Act. The case of the Revenue is that ITAT erred in accepting the case of the Assessee that the communication charges should stand excluded both from the export turnover as well as the total turnover. It is seen that this Court in C1T v. Genpact India 203 Taxman 632 has answered this very issue in favour of the Assessee and against the Revenue. Consequently, no substantial question of law arises on this issue as well.”
5.4 In view of the above, respectfully following the decision of the Hon’ble Delhi High Court in the case of the assessee itself, we uphold the finding of the Ld. CIT(A) on the issue in dispute and dismiss the ground of the appeal of the Revenue. 6. In result, the appeal of the assessee is allowed for statistical purposes, whereas the appeal of the Revenue is allowed partly for statistical purposes. Order is pronounced in the open court on 4th July, 2019.