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Income Tax Appellate Tribunal, DELHI BENCH “I-2”: NEW DELHI
Before: SHRI AMIT SHUKLA & SHRI O.P. KANT
This appeal by the assessee is directed against final assessment order dated 19/06/2018 passed by the Assistant Commissioner of Income Tax, Circle-18(2), New Delhi [ hereinafter will be referred as the ‘Assessing Officer’] in compliance to the direction dated 16/04/2018 of the Ld. Dispute Resolution Panel (DRP) for assessment year 2014-15. The grounds raised in the appeal are reproduced as under: “1. That on the facts and in the circumstances of the case and in law, the order passed by the Assessing Officer ("AO") is bad in law and void ab-initio.
2. That on facts and circumstances of the case and in law, the reference made by the AO suffers from jurisdictional error as the AO did not record any reasons in assessment order based on which he reached the conclusion that it was "expedient and necessary" to refer the matter to the Transfer Pricing Officer ("TPO") for computation of the arm's length price, as is required under section 92CA(1) of the Income Tax Act, 1961 ("Act").
3. That on facts and circumstances of the case and in law, the TPO/AO/ Dispute Resolution Panel ("DRP") erred in making an addition of INR 42,11,57,036/- to the returned income of the Appellant by re-computing the arm's length price of the international transaction pertaining to provision of software development services under section 92 of the Act. 3.1 The TPO/ AO/ DRP erred in not accepting the quantitative filters selected by the Appellant in its transfer pricing documentation/ fresh search and instead applied his own additional/ quantitative filters which lacked valid and sufficient reasoning. 3.2 The TPO/ AO/ DRP erred in arbitrarily rejecting the set of functionally comparable companies adopted by the Appellant to benchmark the transaction of provision of software development services. 3.3 The TPO/ AO/ DRP erred in accepting companies which were functionally not comparable to the Appellant in terms of functions, assets and risk profile.
3.4 The AO/ TPO erred in not complying with the directions of the DRP with regard to comparability of Thirdware Solutions Ltd. 3.5 The TPO/ AO erred in granting a negative working capital adjustment to the margins of comparable companies without appreciating the fact that the Appellant does not bear any working capital risks. 3.6 The TPO/ AO/ DRP erred in not providing the benefit of economic adjustment on account of difference in risk profile in arriving at the arm's length mean margin. 3.7 The AO/ TPO considered the current year (i.e. financial year 2013-14) data for comparability despite the fact that at the time of comparison done by the Appellant, data for FY 2013-14 was not available within the public domain.
4. That on facts and circumstances of the case and in law, the AO erred in invoking provisions of Chapter X of the Act. relating to avoidance of tax, without appreciating that the Appellant was eligible for tax holiday benefits conferred under the Software Technology Park of India ("STPI") Scheme and therefore, there could not have been any erosion of tax revenue from India 5. That the AO erred in facts and in law in charging and computing interest under section 234B and 234D of the Act.
6. That on the facts and circumstances of the case and in law, the AO erred in initiating penalty proceedings u/s 271(1)(c) of the Act.”
2. Briefly stated facts of the case are that the assessee company formerly known as M/s. Freescale Semiconductor India Private Limited, was incorporated in the month of February 2004. The assessee is a wholly-owned subsidiary of Freescale Semiconductor, Inc., USA. The company provides chip designing software development services to its associated enterprises (AEs). The assessee also provides marketing support services to its associated enterprises. The company operates through its centres at Noida and Bangalore, registered with Software Technology Park of India as 100% export oriented units and Hyderabad, registered with Special Economic Zone. For the services rendered, the assessee is being remunerated on the cost-plus basis by its associated enterprises.
3. For the year under consideration, the assessee filed return of income on 28/11/2004 declaring total income of Rs.51,39,45, 910/-. The case was selected for scrutiny and the statutory notices under the Income Tax Act, 1961 (in short the Act) were issued and complied with. In view of the International Transactions carried out by the assessee with its Associated Enterprises. The Ld. Assessing Officer referred the matter of determination of arm’s length price of those international transactions to the Ld. Transfer Pricing Officer (TPO), who after considering submission of the assessee, proposed transfer pricing adjustment as under: Segments Adjustment (Rs.) Provision of Software 48,43,20,261 Development Service Provision of marketing support 49,80,794 services Total 48,93,01,056
4. After incorporating above adjustments proposed by the Ld. TPO, the Ld. Assessing Officer issued Draft Assessment Order on 26/11/2017. Aggrieved with the adjustment proposed, the assessee filed objections before the Ld. DRP. After taking into account the objections of the assessee, the Ld. DRP issued certain directions. The Ld. TPO complying those directions recomputed the adjustment as under:
Segments Adjustment (Rs.) Provision of Software 421,157,036 Development Service Provision of marketing support Nil services Total 421,157,036
Taking into account the recomputed transfer pricing adjustment, the Assessing Officer passed the impugned final assessment order. Aggrieved, with the adjustment made, the assessee is in appeal before the Tribunal, raising the grounds as reproduced above.
The ground Nos. 1 to 3.1 were claimed by the Ld. Counsel of the assessee as general in nature, and thus were not required to adjudicate upon those specifically by us. 7. In ground Nos. 3.2 to 3.4 , the assessee has challenged adjustment of Rs. 42,11,57,036/-on account of provision of software development services. 5
Before us, the Ld. Counsel submitted that if four comparables, namely M/s InfoBeans Technologies Ltd, M/s Mindtree Limited (segmental) , M/s Persistent Systems Ltd. and M/s Thirdware Solutions Ltd. are excluded from set of comparables and one comparable namely M/s Acropetal Technologies Ltd (IT segment) is included into the final set of the comparables, then average margin of the comparables would be in the range of the margin of the assessee and no adjustment would be required in the case of the assessee. Accordingly the Ld. Counsel chose to argue these comparables only.
Before we take up the issue of exclusion or inclusion of the comparables, brief facts qua the adjustment made to the international transaction of software development services are discussed. 10. Before the Ld. TPO, the assessee claimed to be engaged in providing captive low-end chip designing/software tools and application & development and marketing/sales support services to its group companies. During the year the assessee received software development services charges of Rs. 308,51,97,138/- from its Associated Enterprises. The arm’s length price of this international transaction of software development services was determined by the assessee by applying Transactional Net Margin Method (TNMM). The Operating Profit to Total Cost (OP/TC) ratio is taken as the Profit Level Indicator (PLI) in the TNMM analysis. The PLI of the software segment was worked out to 10% on cost. The assessee selected 9 comparables and worked out their average PLI at 10.07% as per the updated version. Accordingly, the assessee submitted that the value of the International transaction of the software development services was at arm’s length price. 11. The Ld. TPO however, did not accept certain filters for selecting the comparables by the assessee and he rejected 6 comparables of the assessee and accepted balance 3 comparables. The Ld. TPO introduced 5 new comparables making the total comparables to 8. The Ld. TPO worked out the average of adjusted OP/OC of the comparables at 27.27% and worked out that adjustment to Rs. 48,43,20,261/-. The Ld. DRP directed further to include/exclude certain comparables. The final list of the comparables selected by the Ld. DRP and their average margin which is worked out to 25.02 is reproduced as under:
Sl. Name of Company As per TPO AS per DRP No. order direction (adjusted (adjusted OP/OC)% OP/OC)% 1. Akshay Software 1.66 1.66 Technologies Ltd. 2. CG-VAK Software 6.46 6.46 & Exports Ltd. 3. Cigniti 26.33 Deleted Technologies Ltd. 4. Infobeans 49.89 49.89 Technologies Ltd. 5. Mindtree Ltd. 19.8 19,88
6. Persistent 37.58 37.58 Systems Ltd.
RS Software 25.42 Deleted (India) Ltd. 8. Thirdware 50.95 50.95 Solution Ltd. 9. Sasken 8.7 Communications Technologies Average (%) 27.27 25.02
By applying the above average margin of 25.02%, the adjustment to software development services was worked out to Rs. 42,11,57, 036/-.
Now the comparables sought by the assessee for exclusion are discussed as under: 1. Infobeans Technologies Ltd. 13.1. This comparable was selected by the Ld. TPO. The Ld. Counsel of the assessee submitted that this company is engaged in diverse nature of activities such as Service Now implementation, automation engineering i.e. automated testing, building customised software etc. The main ground for rejection or exclusion of the company was claimed as the company being engaged in sale of software products. The Ld. Counsel submitted that according to the Annual Report of the company , main source of the Revenue of the company is from sale of software and no segment information of software development service is available. Thus, the software development service segment of assessee cannot be compared with the company at entity level. The Ld. Counsel relied on the decision of the Tribunal Pune Bench in the case of Pubmatic India (P) Ltd. Vs ACIT (2018) 91 taxmann.com 356 (Pune –Trib) for rejection of the comparable as no separate segment of provision of software service available. 13.2 On the contrary, the Ld. DR referred to page 31 of TPO’s order and submitted that nowhere it is mentioned that the company was engaged in sale of the product and company was basically software development service. The Ld. DR also referred to page 30 of the Annual Report Compilation to support his contention that the company was engaged only in providing software services. He submitted that though the company works in different verticals but main function is of software development only. He submitted that there is no inventory in the balance sheet of software products, which supports the stand of the Revenue that the company was engaged only in software development services. With regard to the decision of the Tribunal in the case of Pubmatic India (P) Ltd. is concerned, he submitted that the decision relates to assessment year 2012-13 and cannot be used as precedent for comparing result with the assessment year in consideration i.e. AY 2014-15. 13.3. We have heard the rival submissions and perused the relevant material on record. The Ld. DRP has held that company is engaged in software development services though in the company’s website “ automation engineering “ is mentioned but that is in context of automated testing services but no separate revenue has been shown in the annual report from such testing services and thus the company has been held to be engaged in software development services only. From the profit and loss account available on page 14 of the paper book and relevant note 20 on page 21 of the paper book, we find that the company has shown revenue of Rs. 32,96,59,883/-from sale of software including domestic and export. We also find that in the balance sheet nowhere inventory of software product is shown. The Ld. Counsel is contesting that company is functionality dissimilar to the assessee and engaged in sale of software products, whereas the Ld. TPO on the basis of the information available on the website of the company, observed that the company is a software service company specialising in enterprise software development for web and mobile. Thus in view of the available information in public domain in respect of the company, it cannot be ascertained beyond doubt whether the company was engaged in sale of software products or it was engaged in software development services. In view of the above facts and circumstances, we feel it appropriate to restore the matter to the file of the Ld. AO/TPO , with the direction to issue notice u/s 133(6) of the Act to the company and ensure the exact functions of the company and then decide the issue of the comparability with the assessee. It is needless to mention that the assessee shall be afforded adequate opportunity of being heard on the issue in dispute.
Mindtree Limited; 10 13.4 The Ld. Counsel submitted that the company is functionally not comparable being engaged in diversified services. According to him, the company is engaged in product engineering (Hitech) and information technology in the field of manufacturing, BFSI,, travel and transportation and others. Though the TPO has taken segment other than Hitech but no segment information is available in case of manufacturing, BFSI, travel and transportation and others. He further submitted that the company was instrumental in carrying out research and development activity and providing preferred technology solutions to many leading Corporation. The Ld. Counsel submitted that the company cannot be compared with assessee because of presence of high value of intangibles (i.e. INR 17 crores) and brand positioning. The Ld. Counsel submitted that the company has been excluded for having high-value intangibles (patents) and diverse nature of services in the case of Agilis information Technologies India (P) Ltd. versus ACIT (2018) 89 taxmann.com 440 (Delhi-Trib). 13.5 On the other hand, the Ld. DR referred to page 153 of the Annual Report compendium and submitted that para 3.9 has clearly mentioned that the company is engaged in software development services. Further he referred to page 154 of the annual report compendium and submitted that the segments of manufacturing, BSFI, travels and transportation and others are different verticals of the software development services function and the functions of product engineering i.e. Hitech segment has been segregated by the Ld. TPO and thus according to the Ld. DR the segment considered by the Ld. TPO is functionally similar to 11 the assessee. On the issue of high-value intangibles, the Ld. DR referred to page 148 of the compilation of the Annual Reports and submitted that the intangible assets of the company as on 31/03/2014 consist of intellectual property of Rs. 1.5 crore and computer software of Rs. 15.50 crores. He also referred to the Annual Report of the assessee available on page 284-322 of the paper book and referred to page 303 containing details of the intangible fixed assets of Rs. 4.33 crores comprising of software of Rs. 3.33 crores, stamp duty Rs. 48.13 lakhs and assets retired from active use Rs. 52.35 lakhs. According to him the claim of the Ld. Counsel of high intellectual property is not correct and thus the company cannot be excluded on the ground of high intellectual property rights. 13.6 We have heard the rival submissions and perused the relevant material on record. The page 90 of the compendium of Annual Reports, which is annexed to the Director’s Report, We find that the company along with software development services, carried out research and development in a specific areas viz. social, mobile, analytics and cloud (SMAC) computing. The Company has developed mobile apps for retail/CPG and transport and logistics, which were adjudged the best in their category at the SAP mobile apps challenge at Techd Las Vegas, October 2013. The company achieved capabilities in Hadoop, NoSQL and allied Big Data technologies and also focusing on memory databases. This annexure further mention this focused HANA services offering now will include consulting services to identify HANA use-cases.
13.7 In this Annexure 2 to the Director’s report, on page 91 of the Annual Report compilation it is mentioned that in the financial year 2013-14 i.e. previous year corresponding to the assessment year under consideration, the company filed a patent application for integrated radio-frequency front-end circuit. Thus the thrust of the company on the R&D activities and earning from mobility apps in retail /CPG and transport and logistics, makes its functionally different from the assessee who is a low- end chip designing software developer. Accordingly, we direct the AO/TPO to exclude the company from the final set of the comparable being functionally not comparable even at the segment level.
Persistent Systems Ltd. 13.8 The Ld. Counsel submitted that the company is in software products and software services and the company has also earned revenue from royalty and maintenance contract, which are incorporated in the revenue stream. No segment information is available vis-à-vis operation relating to software products, software services and technology innovation. The Ld. Counsel submitted that the company is having intangible worth Rs. 16.28 crores comprising of software license, acquired contractual rights and research and development expenditure in certain areas. He further submitted that the company has high research and development tradition, resulting in ideas venturing into viable software products available for commercial use. He further submitted that the company has been excluded in assessee’s own case for assessment year 2012-13.
13.9 On the contrary, the DR referred to page 455 of the Annual Report compendium, which is profit and loss account of the company and page 475 , which is note on Revenue Operation. According to the note on Revenue from Operations, the entire Revenue has been shown from sale of software services. Thus according to the Ld. DR the company is having only one segment of software development services and there is no sale of software products, which is evident even from no stock of software product in the balance sheet. The Ld. DR submitted that matter should be restored to the file of the Ld. TPO for verification of the revenue streams of the company, whether it includes revenue from sale of products. The Ld. DR also submitted that as per the balance sheet, the company has total intangible assets of Rs. 70 crores (which includes contractual rights brought forward of Rs. 54 Crores against total assets of Rs. 280 crore, which is not very significant and thus FAR of the company is similar to that of the assessee. 13.10 We have heard rival submission of the parties. We note from list of intangible assets available on page 469 of the Annual Report Compendium that the company is having net block of intangible assets as on 31st of March 2014 of Rs. 16.28 crores, which comprises only software and no acquired contractual rights. The assessee is having intangible assets in the form of software of around Rs 3.30 crores and thus we do not find any significant variation in the intangible assets of the company vis- à-vis the assessee.
13.11 As far as contention of the Ld. Counsel that Revenue stream consist of royalty and maintenance contract is concerned, we find that the Ld. Counsel has relied on the notes forming part of financial statements, available on page 460 of the annual report compendium. The said note has mentioned the Revenue from royalty recognised in accordance with terms of the relevant agreement. However, as per the note 21 of the financial statement, available on page 475 of the annual report compendium , the Revenue has been shown only from sale of software services. Thus, the issue whether the Revenue of the company is exclusively from the software services or it includes Revenue from royalty or from sale of the software products etc. needs verification. Accordingly we feel it appropriate to restore this issue to the file of the Ld. Assessing Officer for collecting information from the company invoking section 133(6) of the Act about sources of revenues earned during the year under consideration and decide the issue in accordance with law after affording adequate opportunity of being heard to the assessee.
Thirdware solutions Ltd. 13.12 The Ld. Counsel of the assessee submitted that the assessee was engaged in diversified business operations which included software development and implementation, subscription contract and sale of user licenses for software applications and no segment information was available in respect of the different businesses streams reported in Annual Report. The Ld. Counsel submitted that only geographical segment report is available and no segment report related to different functions, is available in 15 Annual Reports. Accordingly, the Ld. Counsel submitted that the company cannot be considered as comparable at entity level. The Ld. Counsel also submitted that the company has been excluded for providing diverse nature of services and no segments being available by the Tribunal in the case of Opera Solutions Management Consulting Services Private Limited Vs ITO (2018) 93 taxmann.com 252 ( Delhi- Trib).
13.13 On the other hand, the Ld. DR relied on the finding of the Ld. TPO of company being a good comparable, wherein he has held that software development, implementation and support services are various sub segment of software development services only and require employment of software engineers.
13.14 We have heard the rival submissions and perused the relevant material on record. We find from the profit and loss account of the company available on page 616 of the Annual Report Compilation, that Revenue of Rs. 20,675.74 of the company has been shown from sale of products and the expenses include purchase of stock in trade amounting to Rs. 4021.19. But on further analysis of the profit and loss account, we find that there is no change in the inventory of stock-in-trade during the year under consideration. Thus there is no effect of purchase of stock-in-trade on the revenue stream, when it has not been sold during the year under consideration. As far as contention of the Ld. Counsel that assessee is having diversify business operation is concerned, we find that for this argument , the Ld. Counsel has relied on the policies followed by the assessee for recognising Revenue from different streams of the Revenue mentioned on page 627 of the Annual Report compilation. This disclosure of accounting policies, nowhere established that assessee was having income from subscription contract or sale of user license as claimed by the Ld. Counsel of the assessee. On perusal of page 598 of the Annual Report compilation (page 78 of the annual report of the company), it is evident that operation of the company comprises of software development, implementation and support services. Further Revenue from different geographical segment has also been reported. But as far as, functions of the company are concerned we do not find any segment other than software development, implementation and support services . In view of the above discussion, we reject the contention of the Ld. Counsel that the company is not functionally similar to the assessee and direct the Ld. AO/TPO to retain the company in the set of comparables.
The Ld. Counsel submitted for including the company namely M/s Acropetal technologies Ltd (IT Segment) in the set of the comparables, which was rejected by the Ld. TPO. 14.1. The Ld. Counsel submitted that the company has three business segments comprising of engineering design services, information technology services and healthcare. He submitted that the information technology segment has been considered by the assessee as functionally similar. The Ld. Counsel submitted that the Ld. TPO rejected the company on the ground that internal revamp /restructuring in the current year had a negative impact on the revenue growth and thus the company is not suitable comparable. According to the Ld. Counsel company is not persistence loss-making and there are no other extra ordinary event, which could be ground for excluding the company from the set of the comparables.
On the other hand, the Ld. DR submitted that the company is having huge amount of intangibles (Rs. 76.81 crores) as compared to small amount of intangibles held by the assessee. The Ld. DR further referred to page 641 of the Annual Report compilation and submitted that the company booked a loss of Rs. 4914.50 Lakhs during the year under consideration mainly on account of Rs. 6490.90 Lakhs and Rs. 1993.63 Lakhs written off as bad debts. He referred to the reporting by the company that the unprecedented attrition witnessed by the company in the previous year has badly affected the continuity of the project. According to the Ld. DR in view of this extraordinary event also this company cannot be compared with the assessee.
We have heard the rival submissions and perused the relevant material on record. We find that intangibles owned by the company are of Rs. 76.81 crores as against the intangibles of Rs. 3.3 crores owned by the assessee. Thus there is very wide variation in the assets owned by the company and assessee. Further, the profit during the year under consideration has been affected by the bad debt of Rs. 6490.49 lakhs and Rs. 1993.63 lakhs, which is an extraordinary transaction and not a routine feature of the business. Thus the profit results of the company during the year under consideration are not reliable for comparing with assessee. In view of the above discussion, we uphold the finding of the Ld. TPO that company is not suitable for considering as comparable.
As far as ground No. 3.5 and 3.6 of the appeal are concerned, neither any arguments were made by the Ld. Counsel nor any documentary evidence to support that the assessee does not bear any working capital risk. No evidences were also furnished in support of risk profile of the company as well as comparables. Accordingly, we are not adjudicating upon those grounds.
In view of the above , we direct the Ld. AO /TPO to recompute the adjustment to the software development transaction after excluding/including the comparables as decided in above paragraphs .
Ground No. 3.7 and 4 of the appeal were not pressed by the Ld. Counsel of the assessee and accordingly dismissed as infructous.
Ground No. 5 and 6 were claimed by the Ld. Counsel to be consequential, accordingly we are not adjudicating those grounds specifically.
In the result, the appeal of the assessee is partly allowed for statistical purposes.