M/S. SCHNEIDER ELECTRIC IT BUSINESS SERVICES INDIA PRIVATE LIMITED ,BANGALORE vs. DCIT, BANGALORE

In connection with the payment of license fee, the Learned AO and the Learned Panel erred in facts and in law in confirming the action of the Learned TPO in determining the arm's length price of payment of license fee to be NIL, and in doing so grossly erred in; 6.1. concluding that the Appellant has not received any tangible economic benefit. 6.2. did not appreciate the fact that the Appellant is a licensed manufacturer in India and is entirely dependent on the associated enterprise for the related technical know-how, expertise, etc. 6.3 concluding that no supporting evidence were furnished to justify the payment of license fee; 6.4 erred in ignoring the fact that the Appellant had used Comparable Uncontrollable Price (CUP') Method to benchmark the transaction.

Consequently, the Learned AO erred in charging interest under section 234B of the Act.

Consequently. the Learned AO erred in charging interest under section 234D of the Act.

Brief facts of the case are as under: Assessee filed its return of income for year under consideration on 13/11/06 declaring income of Rs.22,98,86,248/-. The same was processed under section 143 (2) and statutory notices was subsequently issued to assessee, in response to which, representative of assessee appeared before Ld.AO and filed requisite details as called for.

Ld.AO observed that assessee has 3 units, enjoying benefit of section 10 A known as EHTP Units-I and II and Software unit, besides a domestic unit. It was observed by Ld.AO that assessee had debited an amount of Rs.44,31,074/-towards communication charges, which formed part of deduction claimed under section 10A. Ld.AO was of opinion that, as per Clause (iv) of Explanation 2 to Section 10A, export turnover for purposes of claiming deduction, does not include fright, telecommunication charges, insurance attributable to the delivery of the articles or things or computer software outside Page 8 of 25 IT(TP)A No. 1415/Bang/2010 India or expenses if any incurred in foreign exchange in providing technical services outside India. Ld.AO accordingly disallowed sum of Rs.44,31,074/-. 4. Thereafter, Ld.AO observed that assessee entered into international transaction with its associated enterprises, and therefore for determining arms length price of international transaction, case was referred to Ld.TPO. Ld.TPO upon receipt of reference called for economic analysis of international transaction entered into by assessee. 5. From documentation so filed, it was observed that, assessee was a subsidiary of American Power Conversion Corporation, U.S., primarily engaged in manufacture of power protection equipment and undertakes trading of UPS and accessories. Ld.TPO observed that, assessee primarily exported by way of sales to its associated enterprises and also had sales of manufactured products in the domestic market within India. 6. In the TP study, it has been submitted that AE provides all technical support services in the nature of software application development and maintenance and research and development in the nature of software design and testing services. Ld.TPO observed that assessee entered into following international transactions with its associated enterprise: Description Amount (Rs.) Import of raw materials & Components 127,54,06,961 Export of Manufactured UPS 1344,79,58,216 Royalty 6,92,64,977 Cross charge by APC Group (paid) 42,41,753 Cross charge by APC India (received) 10,03,07,680 Page 9 of 25 IT(TP)A No. 1415/Bang/2010 7. Ld.TPO observed that assessee paid a sum of Rs.6,92,64,977/-as royalty to its AE. FromTP study, Ld.TPO observed that each of the manufacturing subsidiaries of AE entered into non-exclusive license agreement with AE, for license of technology and trademark intangibles, for using in manufacturing, and royalty was payable on such revenues from sale of products in their local territories. Ld.TPO observed that assessee during the year under consideration entered into similar exclusive license agreement with its AE, according to which, royalty at 4.5 % was payable on domestic sale of manufactured products by assessee in local markets within India. It has been submitted that, it is the AE who owns all intellectual property rights, trademarks, patents, copyrights, trade secrets, confidential business information, inventions, discoveries and know-how is, manufacturing and product processes and techniques, research and development information, copyrightable works and all other proprietary rights.

Ld.TPO on perusal of submissions advances by assessee concluded that assessee did not prove any tangible benefit derived by paying royalty for the so-called superior technology and that any independent enterprise would like to pay royalty for to access superior technology, only if the same results in either reduction of cost or improved profitability. It was therefore concluded by Ld.TPO that in the instant case, loss incurred in domestic segment was mainly due to payment of Page 10 of 25 IT(TP)A No. 1415/Bang/2010 royalty, which otherwise would not be paid between two independent enterprises, dealing at arms length.

Ld.TPO thus determined ALP of royalty as ‘nil”. He thus proposed adjustment of Rs.6,92,64,977/- as value of these transaction in uncontrolled conditions.

Software development services Ld.TPO observed that during the year assessee rendered technical support services to its AE’s, against which revenue amounting to Rs.7,30,12,000/-was received. It was observed that in the TP study assessee has used TNMM as the most appropriate method, with the PLI of OP/TC and determined margin of assessee to be at 10.01%. Assessee selected following 36 comparables in transfer pricing study with an average margin of 12.06%, and since assessee’s margin was within the range of +/-5%, transaction with its AE’s was considered to be at arms length.

Ld.TPO on examination of TP documentation filed by assessee was of the opinion that assessee is mainly into offshore research and development service provider and these services are akin to software development services. Ld.TPO accordingly rejected 19 comparables selected by assessee and selected 7 comparables. In the finalist of comparables by Ld.TPO there were other comparables, with an average margin of 20.68% which were included as under:

Ld.TPO thus proposed adjustment under this segment amounting to Rs.70,78,623/-.

Aggrieved by adjustment proposed by Ld.TPO, assessee raised objections before DRP, who upheld the view of Ld. TPO. 14. On receipt of DRP directions, Ld.AO passed final impugned assessment order, wherein total transfer pricing addition amounted to Rs.7,63,43,600/- and deduction claimed by assessee under section 10A of the Act, was restricted to Rs.56,87,840/-, thereby disallowing communication expenses claimed by assessee amounting to Rs.44,31,0474/-. Aggrieved by order passed by Ld.AO, assessee is in appeal before us now.

Ground No. 3-7 is in respect of the treatment of royalty paid by assessee to its AE by the authorities below is.

Contentions raised by Ld.AR is that, assessee in its manufacturing activity, uses various marketing intangibles, technology intangibles, process manuals and standards, quality standards etc which is owned by its AE-UK. It has been submitted that assessee also has access to subsequent product improvements and development through licensing agreement, received by assessee enables assessee to update technological development in the market. He submitted that vide this license agreement entered into by assessee with its AE, also allows assessee to sell such manufactured products in India in domestic market. Ld.AR further submitted that on such sale in domestic market, assessee is to pay 4.5% of the net revenues earned as per the terms and conditions of the exclusive license agreement to AE. He thus submitted that assessee while benchmarking payment of royalty, used CUP as most appropriate method, referring to page 59 of TP documentation filed, Ld.AR then pointed out that in TP order Ld. TPO wrongly held that assessee applied TNMM as most appropriate method for benchmarking transaction, which is evident from page 9 of TP order. It has been submitted that Ld.TPO while concluding his remark on this issue proceeded on the footing that TNMM has been used as most appropriate method.

Ld.AR submitted that, both authorities below proceeded on the footing that, no evidence has been provided by assessee to prove tangible benefit derived from AE for which royalty has been paid by assessee. Referring to pages 323-367 of paper book, Ld.AR submitted that additional evidences has been placed which includes documents to establish that assessee is a licensed manufacturer, that products manufactured by assessee cannot be carried out without technological and R & D assistance from its AE, details establishing actual receipt of technical knowhow from its AE, against which royalty has been paid, details to prove that IPRs and know-how received from AE are confidential property of AE being guidelines, directions, screenshots etc, that helps assessee to manufacture the products. It has been submitted that these documents were not placed before authorities below and therefore requires consideration. Ld.CIT DR supported Ld.AR, that based upon these documents, the issue needs to be reconsidered for establishing actual nature of payments made by assessee.

We have perused submissions advanced by both sides in the light of the records placed before us. It is observed that assessee placed substantial evidence which was not before the authorities below for consideration. We are therefore inclined to set aside this issue back to Ld.TPO/AO, for determination

Before we go into compatibility analysis of these comparables with that of assessee, it is sine qua non to understand functions performed, assets owned and risks assumed by assessee under this segment.

Functions performed: Functional analysis  Information and specifications The technical support services performed by APC India are based on the instructions and specifications provided by APCC US. There are regular interactions with APCC US regarding project specifications and obtaining certain clarifications/information on the projects provided by APCC US to APC India.  Technical assistance and clarifications We understand that APCC US provides technical assistance, information and certain technical clarifications in the provision of technical support services provided by APC India. There are regular weekly updates by the IDC to APCC US on the status of the projects/activity assigned by APCC US.  Training APC India provides both internal and external training to its employees. These training programs could be organized either in the US or in India.  Design and software development APC India does not develop software products for sale in open market. It caters to the specific needs of APCC US and its associated enterprises worldwide that help exploiting new opportunities by harnessing knowledge of business processes with proven skills in applying technology.  Technical support and maintenance activity APC India provides internal technical support services which includes creating, maintaining or enhancing APC company- wide internal use software infrastructure.  Billing and collection APC India is responsible for raising invoices and their subsequent collection.

In our considered opinion, comparibility is to be carried out on broad object of benchmarking international transaction and according to the law laid down under section 92B of the Act, read with rule 10 B (2) Income tax Rules, 1963. Comparables must be similar in material aspects and must be compared on the basis of the products/services characteristics, functions undertaken, assets used and risk assumed. Merely because certain comparables has been upheld for its exclusion/inclusion by various decisions, does not ipso facto lead to exclusion/inclusion in a given set of facts. In our considered opinion, exclusion/inclusion of any comparables must be strictly analysed on basis of FAR, in accordance with rule 10 B (2). We also are of opinion that comparables selected must be for the relevant year which is to be compared and unless contemporaneous data as section 92D read with Rule 10 D (4), is not available for the relevant year, multiple year data should not be used. With aforestated understanding, let us analyse comparables alleged to be excluded by assessee before us.

Based upon above FAR analysis, we shall now undertake compatibility tests of assessee with comparables under objection for inclusion.

Infosys technologies Ltd It has been submitted that this comparable has been included by Ld.TPO, and is functionally different with that of assessee. He submitted that this comparable is dealing in both services and products had is involved in huge research and development activities. Ld.AR submitted that, this comparable owns substantial intangibles thereby making it very different from a captive service provider who caters only to its AE and their customers, on cost plus basis. On the contrary, Ld. CIT DR placed reliance upon the view taken by authorities below.

We have perused submissions advanced by both sides in the light of the records placed before us. It is observed that this comparable has a high turnover with the huge margin of 40.3% as compared to 9% earned by assessee. The turnover filter fixed by Ld.TPO does not satisfy for inclusion of this Page 20 of 25 IT(TP)A No. 1415/Bang/2010 comparable. Further it is observed that this comparable owns huge intangibles, as it undertakes, research and development activities, owns branded/proprietary products. Whereas, in case of assessee, is contract service provider for its AE’s. Further that in the process of software development, in the event any intangibles are created, the same is exclusively owned by AE. Under such circumstances we do not find appropriate for this comparable to be included to determine arms length price. Accordingly we direct Ld.TPO to exclude this comparable from the final list.

KALS Information Systems Ltd: It has been submitted that this comparable has been included by Ld.TPO though it is functionally dissimilar with that of assessee. Ld.AR submitted that this comparable is engaged in development of software and software products and also has a training centre for drop software professionals or online projects. Ld. CIT DR placed reliance upon the observations of authorities below and prayed for its inclusion. We have perused submissions advanced by both sides in the light of the records placed before us. Excellent from the audited accounts and annual reports placed in the paper book in respect of this comparable it is observed that this company is engaged in development of software and software products since its inception. Further it is observed that in the year 2000 this company has been converted into a public limited company is which itself makes it not a fit comparable with assessee who is a captive service provider to its AE is only in Page 21 of 25 IT(TP)A No. 1415/Bang/2010 respect of technical assistance. Accordingly we direct this company to be excluded from the final list of comparables.

Tata Elxi Ltd (Seg.): It has been submitted that this comparable has been included by Ld.TPO, even though it is functionally not similar with that of assessee. Ld.AR submitted that this company is engaged in research and development activities which results in creation of intellectual property rights. Ld. CIT DR supported observations of authorities below and prayed for its inclusion. We have perused submissions advanced by both sides in the light of the records placed before us. It is observed that this comparable caters basically in providing software development services wherein, huge intangibles are generated owned by this comparable. It is also observed that this comparable is a group concern of TATA, which makes it to be economically different with that of assessee’s who undertakes limited risks and provides technical assistance to its AE’s in products developed for AE. We do not find this comparable to be functionally similar in any manner whatsoever with that of assessee. Accordingly we direct this comparable to be excluded from the final list.

Accel Transmatic Ltd (Seg.): It has been submitted that this comparable has been included by Ld.TPO even though this functionally dissimilar with that of assessee. He further submitted that this comparable has sold its intellectual property rights in “Prodigy” and receives Page 22 of 25 IT(TP)A No. 1415/Bang/2010 royalties on sale of software. Ld.AR thus submitted that the segment applied by Ld.TPO itself is not identical with that of assessee. Ld. CIT DR placed reliance upon the observations of authorities below and prayed for its inclusion. We have perused submissions advanced by both sides in the light of records placed before us. It is observed that Ld.TPO used segmental information in respect of products of this comparable. However, from various products developed by this comparable, it is observed that, they are not into contract software development, which is the case of assessee, developing software for its AE only, for which assessee is remunerated on cost +10% markup. Further that in the process of software development, in the event any intangibles are created, the same is exclusively owned by AE. As we have already analyse the functions and the risks assumed, it is observed that assessee do not even undertake the pricing risk as the prices are decided by its AE only. Under such circumstances we do not find it functionally similar even though taking the segmental details of sale of products as there is a huge difference in the products sold by this comparable with that of assessee.

Accordingly, we direct Ld.TPO to exclude this comparable from the final list. 37. Megasoft Ltd.: It has been submitted that this comparable has been included by Ld.TPO. Ld.AR submitted that the information collected by Ld.TPO is by issuing notice under section 133 (6) of the act.

Accordingly, we direct Ld.TPO to exclude this comparable from the final list.

We also mention that, not considering of other comparables alledged by assessee does not ipso fact lead to upholding their inclusion, as with exclusion of comparables considered herein above, assessee falls into +/- 5% range. However, we grant Page 24 of 25 IT(TP)A No. 1415/Bang/2010 liberty to assesse to allege other comparables, not considered by us in an appropriate instance. 40. Accordingly we allow Ground no.8-10 along with additional grounds raised in respect of comparables discussed herein above.

Grounds 11-13 These grounds has been raised by assessee, is in respect of exclusion of telecommunication expenses while computing deduction under section 10 A of the act upheld by Ld. CIT (A). Ld.AR placed reliance upon the decision of Hon’ble Karnataka High Court in case of CIT vs Tata Elxsi Ltd reported in 349 ITR 98 and submitted that this issue stands covered in favour of assessee. On the contrary,Ld.CIT DR placed reliance upon the order passed by Ld.AO. We have perused submissions advanced by both sides in the light of the records placed before us. It is observed that, Hon’ble Karnataka High Court in case of CIT vs Tata Elxsi Ltd(supra) on identical issue held that telecommunication expenses is to be included while computing deduction under section 10 A of the act as it is directly linked with earning of income. Ld CIT DR has not brought before us any contradictory/distinguishable facts in respect of present case before us. Respectfully following Hon’ble Karnataka High Court in case of CIT vs Tata Elxsi Ltd(supra), we direct Ld.AO to include telecommunication expenses while computing exempt income u/s10A of the Act.