CADENCE DESIGN SYSTEMS (INDIA) PVT. LTD.,NOIDA vs. ACIT, NEW DELHI

That on facts of the case and in law, the learned DRP/TPO/AO have erred in conducting a fresh economic analysis by using arbitrary filters for identifying companies comparable to the ITeS provided by the Appellant. The arbitrary filters applied by the learned TPO and confirmed by the learned DRP/AO inter- alia include the following: a. Rejecting companieshaving turnover less than INR 1 Crores; 2 b. Rejecting companies having different accounting year than that of the Appellant; c. Rejecting companieshaving employee cost less than 25 percent of the sales; d. companieshavingpeculiar economic circumstances which are not in line with the industry trend, - companies which showed diminishing revenue trend; and e. Rejecting companies having export revenue less than 75 percent of sales.

That on facts of the case and in law, the learned DRP/TPO/AO have failed to make appropriate adjustments to account for difference in risk profile of the Appellant vis-a- vis the comparables for the transaction involving provision of ITeS, and in this process inter-alia neglected the Indian transfer pricing regulations, international guidelines on transfer pricing and judicial precedence in this regard.

That on facts of the case and in law, the learned DRP/TPO/AO have erred in benchmarking the international transaction pertaining to purchase of fixed assets on standalone basis and rejecting the combined transaction approach adopted by the Assessee to benchmark the said impugned transaction wherein the Assessee considered the Transactional Net Margin Method ('TNMM') as the most appropriate method.

That on the facts and in the circumstances of the case and in law, the Learned AO erred in charging interest under section 234A, 234B and 234C of the Act. The above grounds of appeal are mutually exclusive & without prejudice to each other. The Appellant craves leave to add, amend, modify, vary, omit or substitute any of said grounds of appeal at any time before or at the time of hearing of the appeal.”

Brief facts of the case are as under: For year under consideration assessee filed its return of income declaring total income of Rs.49,56,97,610/-on 26/11/12. The case was selected for scrutiny and notice under section 143 (2) was issued and served on assessee along with questionnaire and notice under section 142(1) of the Income Tax Act, 1961 (the Act). In response to statutory notices, representative of assessee appeared before Ld. AO and filed necessary details as called for. 2.1. It has been submitted that, assessee is wholly owned subsidiary of Cadence Design Systems Inc., and was established in India in order to undertake software development and research services, related information technology, back office support services and related pre-sales marketing and post-sales technological services in India. It is also submitted that assessee provides R&D services and ITeS services from its unit, located in Noida Special Economic Zone (SEZ) and Software Technology Parks Unit located in Bangalore. Further assessee provides system support services to all Cadence group, across the world and derive income in the business of development and export of computer software and providing technical support and training services. Assessee has been therefore categorised as a captive service provider and risk mitigated entity which is compensated on a cost plus markup basis for the services rendered by assessee to its Associated Enterprises (AE) in the T.P.study.

Provision of software R&D Services 2,219,623,967 2. Provision of software R&D Services 540,854,522 3. Provision of Pre-sale marketing support 145,404,538 Services 4. Provision of post-sale technical support 295,714,258 Services 5. Purchase of fixed assets 21,450,372 6. Let out of machine to a person other than 10,490,201 AE pursuant to a global agreement to global agreement between AE and third party 2.4. After considering submissions advanced by assessee in response to notice issued by Ld.TPO, an adjustment was proposed amounting to Rs.5,32,83,934/-to the total income of assessee for international transactions pertaining to IT back office support services. Ld.TPO also directed Ld.AO to disallow amount of depreciation on purchase of fixed assets amounting to Rs.2,14,50,372/-.

Aggrieved by proposed adjustment, assessee filed grounds of objections before DRP who partly allowed appeal of assessee by directing Ld.AO to rectify computational errors and restricted depreciation on fixed asset to 60%. 3.1. On receipt of DRP directions, Ld. TPO passed order giving effect dated 17/11/16, whereby final adjustment proposed was amounting to Rs.4,64,70,282/- and final comparables selected for benchmarking international transaction pertaining to provisions of ITES was as under: 5 Sl. Name of the company OP/OC as computed in the Corrected OP/OC No. TPO Order (Working Capital (Working capital Adjusted) Adjusted) F.Y. 2011-12 F.Y. 2011-12 1. Accential Tehcnologies 8.32% 6.47% Ltd.

Aggrieved by final assessment order passed by Ld. AO, assessee is in appeal before us now. 4.1. Ld.Counsel at the outset, submitted that only issue alleged by assessee is in respect of certain comparables being wrongly included by Ld.TPO in respect of ITES service provided by assessee to its AE. He submitted that in the event comparables sought to be excluded by assessee are considered, other grounds becomes academic in nature. 4.2. Ld.Counsel submitted that assessee has used TNMM as most appropriate method with OP/OC as PLI for computing arm’s length price of transaction under dispute and as per TP study, assessee being the tested party, the margin was computed at 14.83%. He submitted that in the event, following comparables are excluded, assessee would be within the margin of +/-5%:  Eclerx services Ltd  TCS E-Serve Ltd  Infosys BPO Ltd 4.3. Referring to order passed by this Tribunal in dated 02/04/2018 for assessment year 2011-12 in assessee’s own case, Ld.Counsel submitted that this Tribunal has excluded the above referred comparables in assessee’s own case. It has also been submitted that there is no factual difference in terms of FAR, of assessee for year under consideration vis-a-vis assessment year 2011-12. 4.4. Ld.CIT DR on the contrary, placed reliance upon orders passed by authorities below.

We have perused submissions advanced by both sides in light of records placed before us. Before we undertake comparability analysis, it is sine qua non to understand functions performed by assessee, assets owned and risk assumed for year under consideration. DRP has reproduced FAR of assessee for year under consideration which is as under: Functional analysis The functions performed by Cadence Indio and its associated enterprise with regard to the identified transaction are outlined below: Determining the scope of services The broad scope of work to be undertaken by Cadence India in connection with the IT back office support service transaction is outlined in a Service Agreement between Cadence India and CDS. CDS provides guidelines to Cadence India for provision of IT back office support services by Cadence India. Provision of services Cadence India is responsible to provide the agreed services as and when requested by overseas group entities as per terms laid out in the Service Agreement. The IT enabled back office support services rendered by Cadence India to CDS include broadly two categories of services: Voice based IT enabled call centre services IT support centre which renders the following gamut of support services IT enabled Vendor Management Services 7 IT enabled Asset management services Remote Infrastructure management services Application maintenance and support services Any requisition for new hardware or software is entered into an online system, which is then vetted electronically and processed further by the asset management support team based in Cadence India. These new software /hardware are finally procured by CDS US from third party vendors. The IT back office team is not responsible for procuring the hardware and/or software. In very few cases where .such request is not met out of CDS and this is when the same has to be carried out by the facilities department in India to enable Cadence India avail warranty benefits locally from third party vendors. Functions related to niche functions like SAS and cloud computing are wholly carried out of the CDS. The main activities carried out by the IT back office team of Cadence India pertain to customer helpdesk, server maintenance, storage maintenance etc. Quality assurance Cadence India is required to ensure that services provided ore of a certain requisite quality and adhere to established international group standards. However, Cadence India does not face any penalty for a lapse in quality. Manpower planning Cadence India maintains a manpower pool to ensure provision of services to its AE. Based on directions if the AE and estimation of work received from the AE, Cadence India maintains the necessary manpower to execute work of providing IT back office support services. Cadence India is guided by its AE to estimate its resource requirements. The functional analysis for this transaction has been summarized below: Type of Functions Cadence CDS India Determining the scope of services Limited Yes Provision of services Yes Limited* Quality assurance Limited No Manpower planning Yes Yes Risk analysis Briefly summarised below are some of the key business risks, which would be applicable to Cadence India and CDS in relation to the IT back office support services transaction. Business risk/market risk Business risk arises when a firm is subject to adverse sales conditions due to either increased competition in the marketplace, adverse demand conditions within the market, or the inability to develop markets or position products to service targeted customers. Cadence India bears no business risk as it renders IT back office support services only to CDS and is assured of a specified return on its costs. CDS is exposed to open market conditions that directly impact its business and thus it bears market risk. Credit and collection risk Credit and collection risk arises when an entity supplies products or services to a customer in advance c f customer payment and runs the risk of default of such payment. Cadence India does not bear any credit and collection risk since it transacts with its AE i.e. CDS and receives payment for services from its AE. Service liability risk Service liability risk is borne by a company when its service offerings fail to perform at accepted or advertised standards and the company is required to compensate the customer or undertake defect resolution on its own cost. CDS is the ultimate contracting entity and therefore assumes the overall responsibility for the quality of the services rendered by Cadence India. Therefore, CDS bears the ultimate service liability risk. Utilization risk Utilization risk relates to the possibility of non-recovery of fixed costs being incurred. This may happen due to circumstances such as lack of production, lack of demand, inability to recover prices, etc. Provision of services requires substantial investment in infrastructure, in terms of premises, equipment, connectivity, etc. The risk of optimal utilization of capacity is borne by the entity making the investment. Since Cadence India is compensated on a total cost plus mark-up basis by CDS, it is assured of the recovery of costs of any under-utilised / un-utilised resources. Thus, Cadence India is not exposed to utilization risk and the same is borne by CDS. Re-work risk Re-work risk arises in a situation where the product sold/service provided does not meet the requisite quality/delivery standards and requires re-work. In case the services provided by Cadence India do not meet the requisite standards, the same may require re-work. However, Cadence India is reimbursed for all costs including re-work costs along with the specified mark- up which mitigates Cadence India from any risk on account of re-work. Foreign exchange risk 9 Exchange rate risk relates to the potential variability of profits that can arise because of changes in foreign exchange rates and arises whenever the transacting currency of an entity is different from its functional currency. Cadence India invoices CDS for its services in USD, which is different from its own functional currency. Therefore, Cadence India assumes the risk of foreign exchange fluctuations. However, the cost base for the purpose of mark-up includes any loss arising to Cadence India from foreign exchange translations and therefore ultimately the foreign exchange risk would be borne by CDS. Cadence India does not bear any risk on account of foreign exchange fluctuations. The risk analysis for this transaction has been summarized below:

We shall now take up comparability analysis of alleged comparables with that of assessee. EClerx Services Ltd: 7. Ld.Counsel submitted that this comparable is sought to be excluded for year under consideration for the reason that, they are operating in entirely different domain, and not a good comparable. He submitted that, for assessment year 2010-11 DRP itself excluded this comparable from final list, and there is no difference in functions performed by this comparable for assessment year 2010-11, with that of year under consideration. He submitted that considering the aforestated facts this Tribunal had excluded this comparable for assessment year 2011-12.

We have perused submissions advanced by both sides in light of records placed before us. 8.1. It is observed that in immediately preceding assessment year, this Tribunal has excluded this company by observing as under: “81. We have gone through the record. There is no change in the functionality of either of the companies from the earlier years and it is undisputable that for the AY 2009-10, a Coordinate Bench of this Tribunal considered the contentions on either side which are similar to the contentions now advanced before us and reached a conclusion that eClerx is a best KPO company, outsourcing substantial work to third parties during that year whereas the assessee was providing back office support services with their own human resource. On that score applying the ratio of Rampgreen solution (supra), eClerx was directed to be excluded from the list of comparables.

Further for AY 2010-11, vide item No.5 of paragraph no.6.9.25 at page No.44 and 45 ld. DRP considered the functionality of eClerx Services ltd. at length and in detail to held that the eClerx operates in an entirely different domain and not a good comparable. In the absence of any explanation as to the non applicability of these findings for the current year, we do not find any reason not to accept the same or to take a different view. We, therefore, direct the ld. AO/TPO to exclude this company from the list of comparables.” 8.2. From order passed by Ld.TPO, this comparable has been considered at page 220 to be carrying out activities in financial sector like trade processing, reference Data, accounting and finance and expense management activities. It has also been recorded by Ld.TPO that professional service practice includes consulting, business analysis and solution testing. The activities provided by this comparable in manufacturing verticals are online operations and web analytics, CRM and business intelligence data management and reporting competent benchmarking and pricing quality and compliance business process consulting. 8.3. On analysis of aforestated functions performed by this comparable, we agree with the view expressed by this Tribunal for assessment year 2011-12 that this comparable is a best KPO company outsourcing substantial work to 3rd parties and that assessee is only providing back-office support services with its own human resource to the AEs. Further it has not been disputed that there is any change in the functionality of either companies from earlier years. Under such circumstances we direct Ld. TPO to exclude this comparable from the finalist. Infosys BPO Ltd and TCS E-Serve Ltd: 9. Assessee has submitted that these comparables are functionally dissimilar with that of assessee as Infosys BPO Ltd is providing high end integrated services for business platforms, customer services outsourcing, finance and accounting, human resource outsourcing, legal process outsourcing, sales and fulfillment sourcing and procurement outsourcing etc., And TCS E-Serve is engaged in business process service to banking and financial services industry whereas assessee is a captive service provider who provides exclusive services to its AEs only on cost plus basis. Ld.Counsel submitted that these comparables has also been excluded by this Tribunal in assessee’s own case for assessment year 2011-12 (supra) on similar grounds and that there is no change in functions of these comparables and that of assessee during assessment year 2011-12 with that of year under consideration. 9.1. On the contrary Ld.CIT DR placed reliance upon orders passed by authorities below.

We have perused the submissions advanced by both sides in light of the records placed before us. 10.1. It is observed that the segmental information in case of TCS E-Serve shows that this company is engaged in business process services to the banking and financial services industries which is considered as the primary segment.. It is observed that the ownership of TCS e-services with Citibank group and which is a high brand value. 10.2. It is observed that these comparables has been excluded by this Tribunal in assessee’s own case by observing as under: 12 “87. It is, therefore, clear now that in spite of a close functional similarity between the assessee and the TCS E-serve, in view of the close connection between TVS e-serve and Tata Consultancy Services Ltd., which is a high brand value; that distinguished it and marked it out for exclusion. The rationality for exclusion adopted by the Tribunal basing on the brand value associated with TCS Consultancy which reflected an impacted TCS e-serve profitability in a positive manner is upheld by the Hon’ble jurisdictional High Court which is binding on this Tribunal. Merely because the binding precedent of the Hon’ble High Court in this order dated 28.11.2017 was not brought to the notice of the Tribunal when it pronounced its order on 5.11.2018 does not make any difference on the binding nature of this decision or its applicability to the facts of the present case. As a matter of law, had such decision been brought to the notice of the Tribunal in assessee’s own case for the AY 2010-11, still it would have bound the Tribunal to follow the same. In the circumstances, we find no option but to follow the binding precedent of the jurisdictional High Court in the case of B.C. Management Services P. Ltd. (supra) and to hold that. Infosys BPO Limited and TCS E-Serve Limited are not good comparables to the assessee and both these companies deserve to be deleted from the list of comparables from bench marking the international transactions. 10.3. Under such circumstances we find no reason to differ from the binding precedent. It is also observed that this Tribunal while considering these comparables has followed the decision of Hon’ble Delhi High Court in case of B.C Management services Pvt. Ltd., in and 1083/2017 wherein, these comparables were held to be not good comparables. Respectfully following the same, we also direct Ld.TPO to exclude these comparables from the final list.

Ground No. 2 (B), 11 is in respect of benchmarking the international transaction pertaining to purchase of fixed assets at ‘nil’. 12.1. Ld.Counsel submitted that the fixed assets has been purchased based upon the customs regulation and the price of the assets are as per the price determined by the customs authorities. He submitted that difference in hands of assessee as per book value of assets in books of AE and purchase price of assets as submitted by assessee. He submitted that the genuineness of transaction has not been questioned by the authorities below. Placing reliance upon customs valuation report and invoices raised by AE, assessee submitted that the transaction was at arm’s length price. 12.2. On the contrary Ld. CIT DR submitted that actual cost of block of assets in case of transfer from holding company to a subsidiary would be the written down value of the assets in the hands of the transferor company has reduced by the amount of depreciation actually allowed in relation to the said assets in the previous year. He submitted that therefore Ld. TPO was right in considering the book value of assets as per books of AE and adjustment proposed by taking ALP at ‘nil’ is correct. He submitted that assessee has been granted depreciation only to the extent of actual expenses incurred on payment of customs duty and other incidental expenses on import of fixed assets to India.

We have perused submissions advanced by both sides in light of records placed before us. 13.1. Assessee purchased certain fixed assets from its AE wherein it had declared certain value. And the same has been rightly reported as purchase of fixed assets with the transacted value amounting to Rs.2,14,50,372/-, as international transaction. This transaction is definitely covered within the definition of section 92B (1) and for any income arising from an international transaction arm’s length price has to be determined in accordance to section 92C of the Act. We observe that assessee has applied TNMM as most appropriate method for showing that the international transaction is at arm’s length price. 13.2. It is observed from records that the matter needs to be restored back to file of Ld.TPO because markup cannot be taken as ‘zero’ as has been done by Ld.TPO. Admittedly assessee gets depreciation as well as cost plus markup on the fixed assets purchased from AE. From order passed by Ld.TPO at page 225, it is observed that assessee, has not filed documents/evidences/proof showing value of assets as appearing in books of AEs to satisfaction of Ld.TPO. 13.3. Thus we direct Ld.TPO to determine the ALP based upon FAR analysis and on contemporaneous document filed by assessee. Assessee is directed to file all requisite details in respect of price for determining the arm’s length price of the transaction. 13.4. Accordingly this ground raised