MICRO FOCUS SOFTWARE INDIA PVT LTD,BENGALURU vs. ASSISTANT COMMISSIONER OF INCOME TAX, CIRCLE-4(1)(2), BENGALURU

IN THE INCOME TAX APPELLATE TRIBUNAL ‘C’ BENCH, BENGALURU BEFORE SHRIB.R.BASKARAN, ACCOUNTANT MEMBER and SHRI PAVAN KUMAR GADALE, JUDICIAL MEMBER IT(TP)A No.2778/Bang/2017 (Assessment year: 2013-14) M/s.Micro Focus Software India Pvt. Ltd. (form erly known as Novell Software Development (India) Pvt.Ltd.) ‘Bagmane Tech Park’, D Block, ‘LAUREL’ 65/2, C V Raman Nagar, Byrasandra, Bengaluru-560093. … Appellant PAN:AAACN 6992 K Vs. Asst. Commissioner of Income-tax, Circle 4(1)(2), Bengaluru. … Respondent Appellant by : Smt.Tanmayee Rajkumar, Advocate. Respondent by : Shri Pradeep Kumar, CIT(DR) Date of hearing: 18/11/2019 Date of pronouncement: 06/12/2019 O R D E R Per PAVAN KUMAR GADALE, JM : The assessee has filed appeal against the order of assessment passed u/s 143(3) r.w.s.144C(13) of the Income- tax Act,1961 ['the Act' for short] dated 27/10/2017 passed in pursuance to the directions of the Dispute Resolution Panel(DRP) dated 18/09/2017.

IT(TP)A No.2778/Bang/2017 Page 2 of 20 2. The assessee has raised the following grounds of appeal:

“The Appellant submits as under: 1. Assessment and reference to Transfer Pricing Officer are bad in law a) That the final assessment order passed by the Respondent (hereinafter referred to as 'the Ld. AO') is bad in law and on facts, and has been passed in violation of the principles of natural justice. b) That, without prejudice to the above, the final assessment order passed by the Ld. AO is bad in law to the extent the Ld. AO did not issue to the Appellant a show cause notice as per proviso to Section 92C(3) of the Income-tax Act, 1961 ['the Act']. c) That, on the facts and circumstances of the case and in law, the Respondent erred in not providing the Appellant an opportunity of being heard prior to making a reference to the Deputy Commissioner of Income-Tax (Transfer Pricing) — 2(2)(1), Bangalore ['the Ld. TPO' for short], which is violative of the principles of natural justice. d) That the Respondent erred in making a reference to the Ld. TPO without recording an opinion that any of the conditions in Section 92C(3) of the Act were satisfied in the instant case. e) That the final assessment order passed by the Ld. AO is without jurisdiction insofar as it purports to give effect to an invalid order of the Ld. TPO and to invalid directions of the Dispute Resolution Panel - 2 [`Ld. DRP']. That, on the facts and circumstances of the case f) and in law, the Ld. TPO erred and the Ld. DRP further erred in confirming the action of the Ld. TPO in not demonstrating that the motive of the Appellant was to shift profits outside of India by manipulating the prices charged in its — international transaction which is a pre requisite condition prior to making any adjustment under the provisions of Chapter X of the Act.

2.Determination of arm's length price /Erroneous data used by the Ld. TPO a) That the Ld. TPO erred in rejecting the value of the international transaction relating to

IT(TP)A No.2778/Bang/2017 Page 3 of 20 Telephonic Support Services in the nature of 'IT Enabled Services' as recorded in the books of accounts as the arm's length price of the said services. The Ld. DRP erred in upholding the action of the IA. AO/ Ld. TPO. b) That the I.d. TPO erred in law and on facts in not accepting the Appellant's economic analysis of its international transaction which was undertaken in accordance with the provisions of the Act read with the Income-tax Rules, 1962 (`the Rules' for short). c) That the I.d. AO/ Ld. TPO erred in conducting fresh benchmarking analysis by substituting the Appellant's analysis with fresh benchmarking analysis on his own conjectures and surmises and, in doing so, determining a new arm's length price. The Ld. DRP erred in upholding the actions of the Ld. AO/ Ld. TPO d) That the Ld. AO/Ld. TPO erred and the Ld. DRP further erred in confirming the action of the Ld. TPO in using data which was not available in the public domain at the time of conducting the transfer pricing study by the Appellant. e) That the Ld. AO/ Ld. TPO erred and the Ld. DRP further erred in confirming the non-application of multiple-year data while computing the margins of alleged comparable companies. That the Ld. AO/Ld. TPO grossly erred in f) benchmarking the above international transaction of the Appellant with services provided by companies operating as full-fledged entrepreneurs without considering the differences in the functions performed, assets employed and risks undertaken by the Appellant vis-à-vis the other companies. g) That the Ld. AO/I.d. TPO erred in applying arbitrary filters to arrive at a fresh set of companies allegedly as comparables to the Appellant without establishing their functional comparability. The Ld. DRP further erred to the extent it confirmed the same. h) That the Ld. AO/Ld. TPO erred in deviating from the uncontrolled party transaction definition as per the Rules and arbitrarily applying a 25%

IT(TP)A No.2778/Bang/2017 Page 4 of 20 related party criteria in accepting / rejecting comparables. Ld. The DRP erred in confirming the same. That the Ld. AO/ Ld. TPO erred in arbitrarily i) accepting companies without considering the turnover and size of the Appellant and comparables. The Ld. Panel also erred in confirming the same. That the Ld. Panel erred in upholding the action j) of the Ld. AO / Ld. TPO in not applying the turnover filter at the upper limit so as to reject the high turnover companies selected by the Ld. AO / Ld. TPO such as Capgemini Business Servicese(India) Pvt. Ltd. and Infosys BPO Ltd. k) That the Ld. AO/ Ld. TPO, while applying the said turnover filter at the lower limit so as to reject companies having turnovers less than INR 1 crore in FY 2012-13, erred in notapplying the said filter at the upper end so as to reject high turnover company as well. The Ld. Panel also erred in confirming the same. That the Ld. AO/Ld. TPO erred on facts and in law in l) arbitrarily rejecting companies having a different financial year ending (i.e. other than 31st March 2013) andinconsistently applying such filter. The Ld. DRP erred in confirming the same. m) That the Ld. AO/Ld. TPO also erred in arbitrarily rejecting companies without considering their functional comparability. The Ld. DRP erred in confirming the same. n) That the Ld. AO/Ld. TPO erred in considering data obtained u/s 133(6). The Ld. Panel erred in upholding the actions of the TPO. That the Ld. AO/Ld. TPO erred in considering o) Provision for Doubtful Debts as a non-operating item while computing the margins. The Ld. Panel erred in upholding the same. 3. Determination of arm's length price relating to IT Enabled Services a) That the Ld.AO/Ld.TPO erred in arbitrarily excluding Caliber Point Business Solutions Ltd. from the list of comparables and the Ld. DRP further erred in upholding its exclusion on the

IT(TP)A No.2778/Bang/2017 Page 5 of 20 basis that it had a different financial year ending (i.e. other than 31' March 2013) and that it is functionally dissimilar to the Appellant, although the company is functionally comparable to the Appellant.

b) That the Ld.AO/Ld.TPO erred in arbitrarily rejecting Informed Technologies India Ltd., despite the said company being functionally comparable to the Appellant. The Ld. DRP further erred in confirming the same. c) That the Ld. AO/ Ld.TPO erred in including Acropetal Technologies Ltd., Capgemini Business Services (India) Pvt. Ltd., Infosys BPO Ltd. and Hartron Communications Ltd., in the list of comparables despite the fact that the functions performed, assets employed and risks assumed by these companies are entirely dissimilar and incomparable to that of the Appellant. The DRP further erred in confirming the same. d) That, in any event, Acropetal Technologies Ltd. ought to be excluded from the list of comparables as it also fails the ITE service revenue filter applied by the TPO and upheld by the DRP. e) That, furthermore, Hartron Communications Ltd. ought to be excluded from the list of comparables as it also fails the export revenue and ITE service revenue filters applied by the TPO and upheld by the DRP. f) That, in addition, Infosys BPO Ltd. ought to be excluded from the list of comparables also because it had significant related party transactions in FY 2012-13 and due to the acquisitions effected by it in FY 2012-13 in respect of which no adjustment can be madeto its margin to eliminate the materials effects thereof. g) That, without prejudice and in any event, the Ld. AO/Ld. TPO erred in wrongly computing the margins of Acropetal Technologies Ltd., Capgemini Business Services (India) Pvt. Ltd. and Hartron Communications Ltd. The Ld. DRP erred in upholding the actions of the AO/TPO.

IT(TP)A No.2778/Bang/2017 Page 6 of 20 4. Non-allowance of appropriate adjustment to the comparable companies by the Ld. Panel and Ld. AO/ I.d. TPO That the Ld. AO/ Ld. TPO erred in not allowing appropriate adjustments under Rule 10B to account for, inter alia, differences in (i) accounting practices, (ii) marketing expenditure, (iii) research and development expenditure, (iv) working capital, (v) risk profile, and (vi) depreciation between the Appellant and the comparable companies.

IT(TP)A No.2778/Bang/2017 Page 7 of 20 The Appellant submits that the above grounds are independent of and without prejudice to one another.”

IT(TP)A No.2778/Bang/2017 Page 8 of 20

IT(TP)A No.2778/Bang/2017 Page 9 of 20 financial statements, Annual reports and copies of agreements. The assessee has submitted the details and as per TP document, 9 comparables were selected in respect of software development services activity and 7 comparables in respect of IT eservices(ITeS) and the assessee ha selected companies engaged in same industry whereas the TPO has rejected TP study and adopted filters in respect of usage of current year data and companies having different financial year ending, data of the company which does not fall within 12 months period from 1/4/2012 to 31/3/2013 were rejected, companies whose income was less than Rs.1 crore were excluded, the companies whose ITeS income is less than 75% of its total operating revenue were excluded. The companies who have more than 25% RPT of sales were excluded. Further companies whose export service income is less than 75% of sales were excluded and companies with employees cost less than 25% turnover were excluded.

Finally, TPO rejected comparables selected by the assessee and applying the filters and selected final list of comparable at page 27 para.14.1 which reads as under:

IT(TP)A No.2778/Bang/2017 Page 10 of 20

TPO has computed ALP at para.15.4 as under:

Finally, TPO passed the order u/s 92CA of the Act dated 24/10/2016. Subsequently, Draft assessment order was passed u/s 143(3) r.w.s 144C(1) of the Act 27/12/2016with

IT(TP)A No.2778/Bang/2017 Page 11 of 20 TP adjustment of Rs.37,10,559/- and disallowance u/s 14A of the Act r.w.rule 8D of Rs.4242 and assessed the total income of Rs.11,89,06,761/-.

IT(TP)A No.2778/Bang/2017 Page 12 of 20 i. M/s.Acropetal Technologies Ltd. ii. M/s.Microgenetic Systems Ltd. iii. M/s.JindalIntellicom Ltd., iv. M/s.Harton Communications Ltd. v. M/s.Microland Ltd. vi. M/s.Capgemeni Business Services (India) Ltd. vii. M/s.E4e Healthcare Business Services Pvt. Ltd. viii. M/s.Infosys BPO Ltd.

The ld. AR submitted that the TPO has applied turnover filter at lower limit and erred in not applying the said filter at upper end so as to reject High turnover companies and submitted that 3 comparables viz., M/s.Micrloand, M/s.Capgemeni and M/s.Infosys are to be excluded from the final list on turnover filter. The ld. AR submitted that the TPO has applied service revenue of Rs.1 crore and erred in not applying higher cap on the upper limit of turnover or service revenue while selecting comparable company and whereas the turnover filter is relevant criteria in choosing comparable. The ld. AR prayed for exclusion of 4 comparables out of 8 comparables selected by the TPO and supported with chart and paper book and annual reports and prayed for allowing the appeal. Contra, the learned DR supported the orders of the lower authorities and filed written submissions.

IT(TP)A No.2778/Bang/2017 Page 13 of 20 selected by the TPO from out of final list of comparables. We shall deal with comparables and the application of turnover.

8.1 First, we shall take up the company M/s.CapgemeniBusiness Services (India) Ltd., where the margin is 26.87%and is functionally incomparable as it is engaged in diversified activities such as selling, technology outsourcing services and professional services and the company has also ITeS, BPO services, software development services and KPO and scope of this service on procurement of technical data services and has a High Brand Value. The company has incurred significant expenditure in foreign currency of 11.46% of total operating cost and rendered onsite services adopting different modules and has RPO of 82.32% of its total sales for the financial year 2012-13. The ld. AR relied on the decision of the co-ordinate bench in the case of M/s.Auto desk India (P) Ltd., vs. Dy,CIT in (106 Taxman.com116). We found that this company has been excluded from the final list of comparable at para.17.7 to 17.8 (96 taxman.com 263): “17.7. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or

IT(TP)A No.2778/Bang/2017 Page 14 of 20 fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon'ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon'ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon'ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee. 17.8. In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5.8.2011. The decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India Pvt.Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding co- ordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee

IT(TP)A No.2778/Bang/2017 Page 15 of 20 supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of M/S.NTT Data (supra), SocieteGenerale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have tobe regarded as per incurium. These three decisions also place reliance on the decision of the Hon’ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon’ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).”

Considering the judicial decisions and the facts as discussed above, we direct the TPO to exclude comparable M/s.Capgeminifrom the final list of comparables for determination of ALP.

8.2 In regard to second company M/s. Infosys BPO, the ld. AR submitted that this company has to be excluded as it is engaged in provision of integrated IT and business process outsourcing including banking and capital market sundries and further turnover is more than Rs.200 crores and is functionally not comparable also it is engaged in the provision of services. The company’s profile is different as it provides business sales

IT(TP)A No.2778/Bang/2017 Page 16 of 20 and consultancy services and has High Brand Value and common significant intangibles and has acquired BPO division in this financial year and incurred significant expenditure in foreign currency. Further, the company also incurred expenditure of foreign currency being 22.08% of sales and engaged on onsite services and adopted different business modules and relied on the following decisions: i. Autodesk India (P) Ltd. vs. DCIT (96 Taxmann.com 263) ii. Principal CIT vs. H & S Software Development & Knowledge Management Centre Pvt. Ltd. (ITA No.912/2017 dated 03/01/2018 iii. E4e Business Solutions India (P) Ltd. vs. ITO (IT(TP)A No.1397/Bang/2016 dated 13/01/2017 iv. Hyundai Motor India Engineering (P) Ltd. vs. DCIT (2019) 102 taxmann.com 10 (Hyd. Trib) We found that this company has been considered in M/s.Auto desk India (P) Ltd.,(supra) for exclusion in para.48 as under: “48. In Ground No.4 (a) and (b) the Assessee has sought exclusion of the following four companies viz., Infosys Ltd., Persistent Systems Ltd., Tata Elxsi Limited, and Wipro Limited, on the ground that apart their high turnovers, they are also functionally not comparable with the Assessee which is a SWD service provider. The Assessee's submissions in support of its contention that these four companies ought to remain excluded as they are functionally dissimilar to the Assessee. Reliance is based on the decision of Bangalore Bench ITAT in the case of Telelogic India Pvt Ltd. v. DCIT [(2016) 67 taxmann.com 159 (Bang-Trib) wherein at paras 10 and 11 at pages 9 – 21 (pages 14-15, 18-19, 15-16, and 15 thereof respectively) these four companies were excluded on the ground of functional dissimilarity. We are of the view that

IT(TP)A No.2778/Bang/2017 Page 17 of 20 the aforesaid decision of the Tribunal rendered for AY 2008-09 in the case of a SWD service provider such as the Assessee supports the plea of the Assessee. Therefore these four companies are directed to be excluded from the list of comparable companies on the ground of functional dissimilarity also. As far as exclusion of Celestial Biolabs Ltd. is concerned we have already held while deciding the connected ground of appeal of the revenue that this company has to be excluded on the ground of functional dissimilarity. We reiterate that this company should be excluded from the comparable companies on the said ground. As far as exclusion of e-Zest Solutions Limited, from the list of comparable companies is concerned, the plea of the Assessee is that it is not functionally comparable as the said company is engaged in the business of rendering product engineering and development services, IT services and high end technical services, which come under the category of KPO services. Thus it is not comparable to the Assessee. In this regard, we find that the Bangalore ITAT in the case of Telelogic India Pvt Ltd. v, DCIT [(2016) 67 taxmann.com 159 (Bang-Trib) at paras 10 and 11 at pages 9 — 21 (pages 16-17 thereof) has upheld similar plea of an Assessee engaged in providing SWD service such as the Assessee. We therefore hold that this company should be excluded from the list of comparable companies.”

8.3 Similarly, third comparable M/s.Microland Ltd. has to be excluded by TPO as it fails turnover filter where turnover is Rs.242.39 crores and the decision of the co-ordinate bench in the case of Auto Desk shall apply on turnover filter of Rs.1 to Rs.200 crores.

8.4 The fourth comparable is to be excluded is M/s.Harton Communications Ltd. The ld. AR submitted that the company selected by the TPO is functionally dissimilar and fails the

IT(TP)A No.2778/Bang/2017 Page 18 of 20 export and service revenue filters. The company is engaged in providing BPO, legal process, back office, software development services, tech solutions and medical billing and there is no segmental details and fails the ITeS revenue filter applied by the TPO having 55.05%. The revenue from ITeS and export service income is 54.33%. The TPO erred in holding that application of service income to total income filter does not arise and there is wide fluctuation in the margins of the company and the company has suffered losses during the financial years 2010-11 to 2012-13 and margin vary between 40.57% and 343.43% and the company has loss of -45.5% for the financial year 2010-11 and -27.09% for financial year 2011-12, -.245% for financial year 2013-14 and 20.65 for financial year 2014-15. There is wide fluctuation in the margin. As per Annual Report, policy of recognition of revenue as expenditure are accounted on accrual basis except for income charges (export income) interest and leave encashment are accounted for on cash basis. The ld. AR further supported the stand with reference to audit report at page 1514 and 1525 of paper book on segmental reporting and the ld. AR relied on Tribunal’s decision in the case of M/s.S&PCapital IQ(India) (P) Ltd. vs. DCIT (106 taxman.116).We found the comparable as discussed by the

IT(TP)A No.2778/Bang/2017 Page 19 of 20 co-ordinate bench are with wide fluctuations in the margins or profit and further submissions of the ld. AR are supported with materials, paper book and annual report. We found that the co-ordinate bench has considered the observations and submissions at para 8, 9 and 10 and directed exclusion from the final list of comparable. We found the facts of the assessee in the present case are similar in respect of comparable. Therefore, following the ratio of the judicial decision and similarity on facts, we direct comparable M/s.Harton Communications Ltd., to be excluded from the final list of comparable by TPO.

8.5 In the result, M/s.Microland Ltd., M/s.Capgemeni and M/s.Infosys are directed to be excluded based on turnover criteria relying on the co-ordinate bench decision whereas M/s.Harton Communications Ltd., has to be excluded because of wide fluctuations and the observations of the co-ordinate bench decision. Accordingly, we direct the TPO to exclude four comparables from the final list of comparable in determination of ALP.

IT(TP)A No.2778/Bang/2017 Page 20 of 20 appeal and we direct the AO to grant TDS credit as per Form 26AS and further interest u/s 234B has to be levied as per law.

Order pronounced in the open court on 6th Dec., 2019. Sd/- Sd/- Sd/- Sd/- Sd/- (B.R. BASKARAN) (PAVAN KUMAR GADALE) ACCOUNTANT MEMBER JUDICIAL MEMBER Place : Bengaluru D a t e : 06/12/2019 srinivasulu, sps Copy to : 1 Appellant 2 Respondent 3 CIT(A)- 4 CIT 5 DR, ITAT, Bangalore. 6 Guard file By order

Assistant Registrar Income-tax Appellate Tribunal Bangalore