ITO vs. M/S FACE TIME COMMUNICATION INDIA PVT LTD, BANGALORE

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

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:

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:-

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%

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:-

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).

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.

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.

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.

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

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.

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

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.

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

In the result, IT(TP)A No.847/Bang/2013 is partly allowed and CO No.169/Bang/2015 is also partly allowed.