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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI JASON P. BOAZ
O R D E R Per N V Vasudevan, Vice President
IT(TP)A No.847/Bang/2013 is an appeal by the Revenue against the order dated 04.03.2013 of the CIT(Appeals)-IV, Bengaluru in relation to the asst. year 2005-06. The Assessee has also filed Cross-Objection against the very same order of the CIT(A).
The dispute raised by the revenue in its appeal and the dispute raised in the CO are with regard to determination of Arm’s length price (ALP) in respect of a transaction of rendering software development service by the Assessee to its Associated enterprise (AE).
First we shall consider the appeal of the revenue. The assessee is a company which is engaged in the business of rendering software development services (SWD Services). Facetime Communications India Pvt. Ltd., (formerly Tumbleweed India Pvt.Ltd., was incorporated on 21.12.2001. It was a wholly owned subsidiary of Tumbleweed communication Corpn., USA. On 9th June, 2004 Tumbleweed Communication Corpn., USA sold its shares to Facetime Communications Inc., USA. Thereafter the Assessee became subsidiary of Facetime Communications Inc., USA.
During the previous year, the Assessee provided SWD services to M/s. Tumbleweed Communications Corpn., USA for which the Assessee received a sum of Rs.1,94,69,571/- and M/s. Facetime Communications Inc., USA also for which the Assessee received a consideration of Rs.6,36,70,924/-. The dispute in this appeal is only with regard to ALP of sum received from M/s. Facetime Communications Inc., USA. It is not IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 3 of 13 disputed that the assessee rendered SWD services to its associated Enterprises and therefore was an international transactions within the meaning of Sec.92 of the Act and therefore, income arising from the said international transaction has to be determined having regard to arms length price (ALP) as laid down u/s 92 of the Act. An adjustment (higher price was determined as receivable by the Assessee from the AE) was done by the TPO to the price charged in the international transaction and the sum suggested as adjustment by TPO was added to the total income of the assessee in SWD services segment. The aforesaid addition was challenged by the assessee before the CIT(A). The CIT(A) gave some relief to the assessee against which revenue has filed appeal to the Tribunal. The Assessee is aggrieved by non-exclusion of certain companies that are not comparable and has filed Cross objection.
As far as SWD services segment is concerned, it is not in dispute that the most appropriate method chosen by the assessee in its Transfer Pricing Analysis (TP Analysis) was Transaction Net Margin Method (TNMM) and that was accepted by the TPO as the Most Appropriate Method (MAM). The profit level indicator (PLI) chosen for the purpose of comparison was operating profit to operating cost. The Operating Income/Operating Cost/Operating Profit and Operating profit/Operating cost percentage according to the Assessee and as drawn by the TPO were as follows:
Operating Income Rs.8,32,56,664 6,36,70,924 Operating Cost Rs.6,91,02,400 5,78,81,989 Operating Profit Rs.1,41,54,264 57,88,935 Operating Profit/ 20.48% ` 10% Operating Cost OP/OC (as percentage)
IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 4 of 13
The Transfer Pricing Officer (TPO) to whom the AO made a reference for determination of ALP u/s 92CA of the Act had chosen 17 comparable companies. The Arithmetic Profit Margin (APM) of these companies were 26.59 before working capital adjustment and 24.99 after working capital adjustment as per the following chart:-
Unadjusted Adjusted SI Margin (%) Margin (%) Particulars No.
Bodhtree Consulting Limited 24.85% 23.57% 2. iGate Global Solutions Limited 4.32% 2.65% 3. Infosys Technologies India Limited 42.83% 42.59% 4. Lanco Global Systems Limited 13.65% 10.44% 5. Larsen & Toubro Infotech Limited 10.33% 9.47% R S Software (India) Limited 8.07% 7.66% 6. 7. Sasken communications Technologies Limited 14.42% 14.26% 8. Sasken Network Systems Limited 16.64% 15.05% 9. Satyam Computers Services Limited 29.44% 28.26% 10. Visualsoft Technologies Limited 23.52% 21.26% Exensys Software Solutions Limited 11. 70.68% 64.95% Sankhya Infotech Limited 12. 27.39% 22.34% Four Soft Limited 22.55% 13. 22.98% Thirdware Solution Limited 14. 66.09% 66.10% Geometric Software Solutions Co. Limited 15. 20.34% 18.86% Tata Elxsi Limited (seg) 16. 24.35% 24.00% Flextronics (seg) 17. 32.19% 30.80%
Arithmetic Mean 26.59% 24.99%
IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 5 of 13
The TPO determined the addition to be made to the total income of the assessee on account of adjustment in ALP at a sum of Rs.2,66,33,145/-. Against the aforesaid proposal of the TPO, which was incorporated in the fair order of assessment by the AO, the assessee preferred appeal before the CIT(A). The CIT(A) accepted the claim of the assessee for exclusion of certain comparable companies and also for inclusion some of the comparable companies that were excluded by the TPO. Against which the revenue has preferred present appeal before the Tribunal. The assessee has filed cross objection seeking to exclude 2 comparable companies that were not excluded by the CIT(A) viz., Sankhya Infotech Ltd., and Thirdware Solutions Ltd. Thirdware Solutions was excluded by CIT(A) on the ground that its profits were abnormal. The Assessee had pleaded for its exclusion on the basis that this company is functionally not comparable with the Assessee which is a SWD service provider. Except these two grounds no other grounds raised in the cross objection were pressed for adjudication.
We have heard the rival submissions on the SWD Services segment. The grounds of appeal raised by the Revenue reads as follows:-
“1 . The order of the Learned CIT (Appeals), in so far as it is prejudicial to the interest of revenue, is opposed to law and the facts and circumstances of the case.
2. The CIT (A) erred in holding that the size and turnover of the company are deciding factors for treating a company as a comparable and consequently erred in excluding M/s. Flextronics Software Services Ltd., iGate Global Solutions Ltd , M/s Infosys Technologies Ltd, L&T Infotech Ltd., Satyam Computers Services Ltd as comparables in the case of the taxpayer.
IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 6 of 13
3. The Ld. CIT(A) erred in rejecting companies on the basis of Abnormal Profit without defining what constitutes abnormal profit filter and how the same is determined and consequently erred in excluding M/s Exensys Software Solutions Ltd and Thirdware Solutions Ltd. as comparables in the case of the taxpayer.
4. The Ld. CIT(A) erred in rejecting the diminishing revenue filter used by the TPO to exclude companies that do not reflect the normal industry trend. 5. The Ld.CIT(A) erred in directing the AO to include M/s. Quintegra Solutions Ltd. as a comparable in the case of the taxpayer without appreciating the fact that the different year ending filter applied by the TPO is necessary to exclude companies which do not have the same or comparable financial cycle as the tested party. 6. The CIT (A) erred, on the facts and in the circumstances of the case, in directing the AO to exclude Bodhtree Consulting Ltd, Geometric Software Solutions Co and Tata Elxsi Ltd from the final set of comparables. 7. The learned CIT (A) erred in directing inclusion of M/s VJIL Consulting Ltd as a comparable. 7. The CIT (A), on the facts and circumstances of the case. erred in directing the AO to allow an appropriate working capital adjustment to the mean margin to the selected set of 9 comparables. 8. The CIT (A) erred in directing the AO to recompute the deduction allowable u/s 10A of the I.T.Act after reducing the telecommunication charges of Rs. 23,91,701/- from the total turnover also. 9. The Ld. CIT(A) erred in not appreciating the fact that there is no provision in Section 10A which requires the concerned expenses, which are required to be reduced from the export turnover as per clause (iv) of the Explanation to Section 10A to be reduced from the total turnover also.
IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 7 of 13
10. The Ld. CIT(A) erred in not appreciating the fact that the jurisdictional High Court's decision relied upon by him has not been accepted by the departmental and an appeal has been filed before the Hon'ble Supreme Court 11. For these and such other grounds that may be urged at the time of hearing. it is humbly prayed that the order of the CIT(A) be reversed and that of the Assessing Officer be restored. 12. The appellant craves leave to add, to alter, to amend or delete any of the grounds that may be urged at the time of hearing of the appeal.” 9. Ground Nos.1, 11 and 12 raised by the revenue are general in nature and calls for no specific adjudication.
Ground No.2 raised by the revenue is with regard to the action of the CIT(A) in excluding M/s. Flextronics Software Services Ltd., iGate Global Solution, M/s. Infosys Technologies Ltd., Satyam Computers Services Ltd., and L&T Infotech Ltd., on the ground that the turnover of these companies was above Rs.200 crores and therefore the Assessee whose turnover is only Rs.6.36 Crores cannot be compared with those companies. The admitted factual position is that these companies have turnover of over Rs.200 crores in the relevant asst. year whereas the assessee’s turnover is only 6.36 crores. It has been held by the Bangalore Bench of ITAT that turnover filter is a valid filter in the matter of exclusion of comparables that companies with turnover below 200 crores cannot be compared with the companies above 200 crores. In this regard, Bangalore Bench of the Tribunal in the case of Auto Desk India Pvt. Ltd. Vs. ACIT in IT(TP)A No. 220/Bang/2016 has taken the aforesaid view after considering several decisions on the issue. In view of the above, we find no grounds to interfere with the exclusion of the aforesaid 5 companies by the CIT(A).
IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 8 of 13
As far as ground No.3 raised by the revenue is concerned, the same relates to exclusion of M/s. Exensys Software Solutions Ltd., and Thirdware Solutions Ltd., as not comparable companies by the CIT(A) on the ground that these companies showed abnormal profits. On the issue of exclusion of companies on account of abnormal profits, the law is well settled that abnormal profits by itself is not a ground to exclude a company which is otherwise comparable, but if the abnormal profits are owing to some unusual circumstances, then those companies can be excluded. As far as exclusion of M/s. Exensys Software Solutions Ltd., is concerned, the same is due to amalgamation that happened between this company and some other company during the relevant previous year and therefore the CIT(A) was justified in excluding this company. As far as Thirdware Solutions Ltd. is concerned, there has been no specific reason for abnormal profits and therefore the exclusion of this company on the ground of abnormal profits by the CIT(A) cannot be sustained. However, the Assessee in ground No.6(b) has prayed that the functional comparability of this company was challenged by the Assessee before CIT(A) but the CIT(A) has not given any decision on the same. He also brought to our notice that the ITAT Bangalore Bench in the case of M/s. Sharp Software Development (India) Pvt.Ltd. Vs. DCIT IT(TP) A.No.1109/BANG/2011 order dated 25.1.2017 vide paragraph 25 & 26 of its order held that this company was a product company and not a SWD service provider such as the Assessee and this company was excluded. We are of the view that in view of the aforesaid order of the Tribunal, we sustain the order of CIT(A) on the basis that this company needs to be excluded as functionally not comparable.
IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 9 of 13
As far as ground No.4 is concerned, it is undisputed that no company was excluded or included by applying the filter of diminishing revenue and therefore this ground of appeal raised by the revenue is purely academic and hence dismissed.
13. As far as ground No.5 raised by the revenue is concerned, M/s. Quintegra Solutions Ltd., had a different accounting year than that of the Assessee and therefore this company ought to have been excluded by the CIT(A) and the learned counsel for the Assessee did not object to its exclusion from the list of comparable companies . Therefore ground No.5 raised by the revenue is allowed.
14. As far as ground No.6 raised by the revenue is concerned, the same relates to exclusion of the following companies Bodhtree Consulting Ltd., Geometric Software Solutions Co. Ltd., and Tata Elxsi Ltd., from the list of comparable companies. These companies were excluded by the CIT(A) on the ground that these companies were functionally different and not comparable with the assessee. The assessee is pure software SWD service provider, whereas these companies were software product companies. The exclusion of these companies in the case of pure software development service provider such as the assessee was considered by this Tribunal in the case of Kodiak Network India Pvt. Ltd. [TS 378 ITAT 2015 (Bang-Trib) and M/s. Sharp Software Development (I) Pvt.Ltd. (supra). Both these cases relate to asst. year 2005-06 and in these cases it was held in that case that the aforesaid companies were software product companies and not software development service provider such as the Assessee and the segmental details of SWD services and SW Products were not available and therefore the profit margin in the SWD services
IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 10 of 13 segment of these companies were not available for comparison. In the light of the aforesaid decision of the Tribunal, we are of the view that the exclusion of the aforesaid companies by the CIT(A) was justified and calls for no inference. Hence, we find no merit in groundNo.6 raised by the revenue.
As far as ground No.7 raised by the revenue is concerned, the same relates to inclusion of M/s. VJIL Consulting Ltd., as not comparable. It was agreed by the parties that this company can be treated as a comparable company and hence ground No.7 raised by the revenue is allowed.
The next ground which is again numbered as ground No.7 is with reference to directing working capital adjustment to be allowed. Even the TPO in his order has allowed working capital adjustment. In transfer pricing analysis allowing working capital adjustment is necessary and it is settled law that such adjustment should be made for proper comparison of profit margin of Assessee and the comparable companies. We find no merit in this ground of appeal raised by the revenue.
17. The Revenue in grounds No.8 to 10 has projected its grievance regarding the action of the learned CIT(A) in excluding, while computing deduction u/s.10A of the Act, internet access charges of Rs.23,91,701/- from the export turnover as well as the total turnover while computing deduction u/s.10A of the Act. The Assessee was entitled to claim deduction u/s.10A of the Act on the profits derived from its Software Technology Parks of India (STPI) registered unit. Sec.10A(4) provides the methodology of computation of deduction u/s.10A of the Act and it lays down that the profits derived from export of articles or things or computer software shall be the amount which bears to the profits of the business of the undertaking, the same proportion as the export turnover in respect of IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 11 of 13 such articles or things or computer software bears to the total turnover of the business carried on by the undertaking. Export turnover has been defined under Explanation 2 (iv) to Sec.10A as:-
means the consideration in respect of export by the undertaking of articles or things or computer software received in, or brought into, India by the assessee in convertible foreign exchange in accordance with sub-section (3), but does not include freight, telecommunication charges or insurance attributable to the delivery of the articles or things or computer software outside India or expenses, if any, incurred in foreign exchange in providing the technical services outside India.
18. While computing the deduction u/s.10A of the Act, the AO noticed that during the relevant assessment year, the Assessee had incurred telecommunication charges (internet access charges) amounting to Rs.23,91,701 in respect of STPI unit which was not reduced from the export turnover while computing deduction under section 10A of the Income Tax Act, 1961. The AO therefore excluded the aforesaid sum from the export turnover without excluding them from the total turnover. As a result, the deduction claimed u/s.10A of the Act by the Assessee was allowed at a lesser sum than what was claimed by the Assessee. It was the plea of the Assessee in the appeal against the assessment order before the CIT(A) that at all times during the relevant previous year, it was engaged in development of computer software and not in rendering any technical services. Communication expenses were incurred not for export of computer software outside India and therefore the exclusion from export turnover as done by the AO was not correct. Without prejudice to its contention that the aforesaid sums should not be excluded from the export turnover while computing deduction u/s.10A of the Act, the Assessee has also made an alternate prayer that expenses that are reduced from the export turnover should also be reduced from the total turnover and in this IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 12 of 13 regard has placed reliance on the decision of the Hon’ble Karnataka High Court in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn) wherein it was held that while computing deduction u/s.10A of the Act expenses that are reduced from the export turnover should also be reduced from the total turnover. The CIT(A) however agreed with the alternative prayer of the AO and reduced the sum in question both from the export turnover and the total turnover.
19. Aggrieved by the order of CIT(A), the revenue has raised grounds No.8 to 10 before the Tribunal. We have considered the rival submissions. Taking into consideration the decision rendered by the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn), we are of the view that communication charges should be excluded both from export turnover and total turnover. We are of the view that as of today, law declared by the Hon'ble High Court of Karnataka which is the jurisdictional High Court is binding on us. Moreover, the order of the Hon’ble Karnataka High Court has been upheld by the Hon’ble Supreme Court in the case of CIT v. HCL Technologies Ltd. in Civil Appeal No.8489- 98490 of 2013 & Ors. dated 24.04.2018. We therefore find no merit in Ground No.8 to 10 raised by the revenue.
20. As far as CO No.162/Bang/2015 is concerned, the ld. counsel for the assessee prayed only for exclusion of the following 2 companies from the list of comparable companies viz., Sankya Infotech Ltd., and Four Soft Ltd. As far as Sankhya Ltd, is concerned, the stand of the assessee is that this company is engaged in software products development also and that the employee cost of this company is only 23% and, therefore, fails the employ cost filter. Besides the above, the contention of the assessee is that this company has in house R&D division which develops software products. On this contention, we find that similar contentions were accepted by the IT(TP)A No.847/Bang/2013 & CO 169/Bang/2015 Page 13 of 13 ITAT Bangalore Bench in excluding aforesaid company from the list of comparable companies in the case of DCIT Vs. M/s. Sharp Software Development (India) Pvt.Ltd. IT(TP)ANo.1109/Bang/2011 order dated 25.1.2017. Following the aforesaid decision, we direct exclusion of this company from the list of comparables.
In the result, IT(TP)A No.847/Bang/2013 is partly allowed and CO No.169/Bang/2015 is also partly allowed.
Pronounced in the open court on this 17th day of July, 2019.