SIEMENS INDUSTRY SOFTWARE (INDIA) PVT. LTD.,NEW DELHI vs. DCIT, NEW DELHI

3 S.No Particulars Amount (Rs.) 1 Purchase of software and payment of 464,303,526 license fee for maintenance, enhancement and support of software 2 Provision of software development services 1,143,134,444 3 Provision of competency center services 9,609,525 4 Provision of IT support services 146,994,119 5 Reimbursement of expenses 72,591,951 6 Recovery of expenses 21,598,319 4. In respect of the above international transactions, assessee, however, segregated its international transactions into four segments, namely, software distribution, software development, competency center and IT support services. However, the learned TPO rejected the segmental approached adopted by the assessee by benchmarking the international transaction in respect of three segments i.e. software development, competency center and IT support services and clubbed all the three segments and benchmarked the same as well.

Learned TPO after taking into consideration the TP study made by the assessee in its economical analysis and discussing the various filters applicable to the facts of the case finally selected 17 comparables with the PLI of OP/TC of 25.44 as against PLI of 19.32% in respect of software development, 8% in respect of competency center and 7% in respect IT support services, and suggested an adjustment to the tune of Rs.22,02,13,656/-. While doing so, learned TPO regarded the foreign exchange loss or gains as non operating item.

Assessee filed objections with the learned DRP. Learned DRP by way of directions dated 27.12.2013 gave relief to the assessee in part to the extent of deleting one comparable, namely, M/s Bodhtree Ltd. From the final list of comparables selected by the TPO and thereby in the re-computation the transfer pricing adjustment was limited to Rs.18,52,31,649/- as against Rs.22,02,13,656/- originally proposed by the learned TPO. Learned DRP did not interfere with the other disallowances made by the learned AO. Hence, the assessee is in appeal before us.

In so far as transfer pricing issue is concerned, learned TPO accepted the TNMM method adopted by the assessee as the most appropriate method. There is no dispute in respect of the profit level indicator also. However, the assessee’s grievance is against the learned TPO rejecting the segregation approach adopted by them and clubbing of the segments in question for benchmarking the international transactions. Though the assessee challenged this approach of the learned TPO vide ground No.4, at the time of argument, this ground is not pressed and withdrawn. Therefore, what effectively needs to be adjudicated now on this issue relating to the excludability of four comparables selected by the TPO, namely, M/s Cat 5 Technologies Ltd.; M/s Infosys Technologies Ltd.; M/s Tata Elxsi Ltd; and M/s Thirdware Solutions Ltd. on the grounds of functional dissimilarity and other parameters like diversified activities, brand building, sale of products and non availability of segmental data. We shall now proceed to deal with the issue of comparability of all these four companies with the assessee. CAT Technologies Ltd.: 9. It was argued by the assessee before the learned TPO in respect of this company that this company is non-comparable in so far services engaged in the business of medical transcription, training software development and consulting services and BPO services. It is further submitted before the learned TPO that the company has given following description in respect of job portal on page 12 of its annual report: “During the year the company launched job portal viz. Logtalenet.com which was instant success with job aspirants. Encouraged with the success of this portal company proposed to launch 3 to 4 portals during the current financial year in the different fields.”

However, learned TPO observed that this is just a new business opening for CAT Technologies and this activity had not contributed to their business and could be seen from the financials at page no.36 of the report. He further observed that the majority of the income is from the software development and consulting and income from the training and medical transcription is minimal, as such, CAT Technologies is primarily a software developer and a good comparable.

It is argued on behalf of the assessee before us that the CAT Technologies derives income from training, software development and medical transcription and no segmental information is available. Further, it is submitted that during the year under consideration, this company had entered into the field of job placement portal and also plants to expand such operations. It is also submitted that the management has accepted that this company is well placed in the market as a leading HR BPO service provider.

Learned AR brought to our notice that FAR analysis was considered by a coordinate bench of this Tribunal in the case of Sun Life India Service Centre P. Ltd. Vs DCIT (ITA No.1489/Del/2014) for the Assessment year 2009- 10 and it was held that this company is not a good comparable with the company dealing with the only software development and maintenance support services. Inasmuch as CAT Technologies is involved in advisory services also which makes it incomparable to the companies like the assessee. The relevant paras of the Tribunal order is Sun Life India Service Centre P. Ltd. reproduced below: “8.1. The TPO considered this company as comparable. The assessee's objections against the incomparable functional profile of this company were rejected. The TPO noticed that this company launched a job portal viz., Logtalent.com, which was quite successful with job aspirants. The assessee's objection about the incomparability of this function adopted by CAT Technologies Ltd., was held by the TPO to be irrelevant in view of insignificant contribution of such a portal to the assessee's income. The TPO observed that majority of the income of this company was from 7 `Software development & consulting services'. Income of this company from `Training' and `Medical transcription' was found to be minimal. He, therefore, considered this company as predominantly a software development provider. The assessee's request before the DRP for the exclusion of this company met with the fate of dismissal. Now, the assessee is before us assailing the inclusion of this company. 8.2. After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company, a copy of which is available on pages 1 onwards of the paper book, that its total income from operations is Rs.9,35,57,676/-, with the following break-up :- Training Income - Rs. 2,44,107/- Software Development and Consulting Services - Rs.8,49,39,375/- Medical Transcription Receipts - Rs.83,74,194/- 8.3. It is this total figure of Rs.9.36 crore which has been taken by the TPO. It shows that the TPO has included CAT Technologies Ltd. as comparable on entity level. On a perusal of the above detail of income of this company, it is apparent that it not only includes revenues from Medical transcription and Training, but the major component of Rs.8.49 ITA No.1489/Del/2014 crore is income from 'Software Development and Consulting Services.' It is reiterated that the segment under consideration is `Software development and maintenance support services' and the assessee has a separate international transaction of 'Provision of advisory services' with the transacted value at Rs.1.75 crore, whose ALP has been disjointedly determined by the TPO. When we come back to the revenues of CAT Technologies Ltd., it is seen that the major component of Rs.8.49 crore is on account of `Software development and consulting services'. Since the segment of the assessee under consideration is only `Software development and maintenance support services' independent of `Advisory services', it becomes manifest that a company rendering both the software development and also advisory services, cannot be considered as comparable on entity level with the assessee's separate segment of software development maintenance support services. Be that as it may, CAT Technologies Ltd., has also earned Medical transcription receipts of 8 Rs.83.74 lac and Training income of Rs.2.44 lac, both of which have been combined with the income from Software development and consulting services. One cannot ascertain with precision the contribution made by the income from Medical transcription and Training to the overall profitability of CAT Technologies Ltd., so that the other income may be segregated. As such, we fail to comprehend as to how the entity level comparison of this company with the assessee's `Software development and maintenance services' segment can be construed as valid. This company is, therefore, directed to be excluded from the list of comparables.”

Per contra, learned DR submitted that all the three services rendered by the assessee, namely, software development, competency centre and IT support services are very much rendered by the CAT Technologies also and it is very much evident from the annual report at page 11 under the sub heading “Outlook of the company”. He further submitted that in so far as running of job portal is concerned, it is just like Naukri.com and does not know whether anything is charged from the user of such website without which information is not safe to exclude this company from the list of comparables.

On a careful consideration of the annual report and also the observations of the coordinate bench in Sunlife India Service centre (supra), we are convinced that the CAT Technologies, besides the software development and other IT support services onsite and offsite, has also rendered the services in the nature of advisory and consulting besides launching the job portal, namely, Logtalent.com. It is true that the record does not reveal the mode of earning revenues from running such activity by the CAT Technologies. As pointed out by the learned DR is not known 9 whether the users of this website are charged or not. However, in order to render such a service, in the absence of any material to show that it is a comparable one, it is not known whether the revenues are generated on this activity either by charging from the users or through the advertisement on this website.

Besides this, it is found by the coordinate bench in the case of Sunlife India Services (supra) that the CAT Technologies is running both software development and maintenance support services with income-tax support services low or high end whether onsite or offsite. Further, Schedule IX of the Profit and loss account of this company at page 36 of the annual report shows that this company is deriving a sum of Rs.8,49,39,375/- from out of software development and consulting services whereas no segmental data is available and as stated by Item No.7 of the Accounting Policies and Notes on Account that the company’s exclusive business is medical transcription and training software development and consulting services and this should be treated as the only reportable segment. For these reasons, we find it unsafe to continue this company in the final list of comparables. We, therefore, direct the learned TPO to exclude this company from the list of comparables for benchmarking the international transaction. Infosys Technologies Ltd.: 17. Assessee argued before the learned TPO for exclusion of this company on the ground of high turnover. However, learned TPO recorded that in several decisions, the Tribunal accepted the high margins companies are also 10 good comparables and he has referred to the decisions in SAP Labs, Zylog Systems Ltd., M/s BP India Services P. Ltd. Etc. He went by the analogy that when assesses are arguing and the department is accepting that the loss making companies are also good comparables, in such an event, why not the super normal profit companies. According to the learned TPO, excluding the extreme result case, there should either a defect in comparability or exceptional conditions faces by the comparables and in the absence of either, the company continues to be a good comparable.

Vide paras 17 to 20 in for the Asstt. Year 2008- 09 in assessee’s own case, a coordinate bench of this Tribunal recorded the facts and figures and for the purpose of clarity, we deem it necessary to extract the same: “17. The taxpayer sought to exclude Infosys from the final set of comparables on the grounds inter alia that Infosys is functionally dis- similar; it has huge sales/turnover of Rs.15648 crores having substantial 12 intangible assets incurring huge amount on R&D for developing new area of functions; it owns products/leverages on its premium banking solution 'Finacle'; and relied upon the cases of CIT vs. M/s. Agnity India Technologies Private Ltd. - (2013) 36 taxmann.com 289 (Delhi), Systech Integrators India (P.) Ltd. vs. ITO - 44 taxmann.com 324 (Banglaore- Trib.), FCG Software Services (India) P. Ltd. vs. ITO - 51 taxmann.com 75 (Bangalore - Trib.) and CIT II vs. Intoto Software India Pvt. Ltd. in of 2014 (Hon'ble High Court of Andhra Pradesh).

Undisputedly, the taxpayer is a captive service provider and providing services as desired by its AE. However, on the other hand, page 130 of the Annual Report, available in the paper book, shows that Infosys is into providing diversified services viz. providing end to end business solutions that leverage technology thereby enabling clients to enhance business performance. The solutions span the entire software life cycle encompassing technical consulting, design, development, reengineering, maintenance, systems integration, package evaluation and implementation, and testing and infrastructure management services. In addition, the company offers software products for the banking industry.

Moreover, turnover of Infosys is of Rs.15648 crores for AY 2007-08 as against taxpayer's turnover of Rs.109 crores which is 143 times of the turnover of the taxpayer. Infosys is also having huge intangible of Rs.130684 crores as per the detailed report filed at page 128 of the annual report. Infosys is also expending huge amount on R&D for developing and creating new functionalities which is to the tune of 1.3% of the total revenue. Furthermore, it is also not in dispute that Infosys owns product "Finacle" which is a universal banking solution empowering 109 banks across 60 countries helping them serve over 20000 branches (referred at page 80 of the annual report compendium). Perusal of the P&L account, available at page 124 of the annual report also shows that Infosys has income of RS.15648 crores from software services and product of which segmental information is not available.

Infosys has been ordered to be excluded by the Hon'ble Delhi High Court in case cited as CIT vs. Agnity India Technologies (P.) Ltd. (supra) while examining its comparability with Agnity India Technologies which was a captive service provider operating on minimal risk providing software development services which has affirmed the decision 13 rendered by the coordinate Bench of the Tribunal for excluding Infosys from the list of comparables for the reason that Infosys is a giant company in the area of development of software, assumption of risk leading to higher profits etc. Keeping in view the aforesaid discussion, we are of the considered view that Infosys being a giant company operating on full-fledged risk leading to maximum profit having huge revenue and expending 1.3% of its turnover on R&D having huge intangibles is not a suitable comparable vis-à-vis taxpayer which is a captive service provider operating on a minimum risk and only having turnover of RS.109 crores as against turnover of Infosys of Rs.15648 crores. So, we order to exclude Infosys from the final set of comparables. 3K TECHNOLOGIES LTD. (3K).”

The above findings of fact could not be controverted by the Revenue with reference to any material to say that the turnover of Infosys Technologies is around Rs.15,648 crore whereas the turnover of the assessee is around Rs.109 crore as recorded in the immediately preceding assessment year. No change of facts is brought to our notice to take a different view. On consideration of the facts and figures involved in this matter, we are inclined to believe that Infosys Technologies is no match to the assessee with its huge turnover, R&D and other factors. While respectfully following the finding of the coordinate bench in assessee’s own case for the Asstt. Year 2008-09, we hold that Infosys Technologies is not a good comparable to the assessee and is liable to be excluded. We, therefore, direct the learned TPO/AO to exclude this company from the final list of comparables for benchmarking the international transactions. Tata Elxsi: 23. In so far as this company is concerned, the assessee argued before the learned TPO on the ground of non comparability of this company with the 14 assessee because of the diversified business and Tata Exsi deriving income from the sale of software as well as products. However, learned TPO while referring to the annual report at page 12 and 14 held that the Tata Elxsi Ltd. is also providing software services but only with its verticals, as such, it cannot be excluded from the list of comparables. He further recorded that R&D expenses of the company is only 3.26% of its revenue and in no way substantial in nature.

Per contra, it is the argument of the learned DR that like assessee Tata Elxsi is a software developer and they are involved in the product design services. Learned DR contended that in the profit and loss account, there is no break up. However, the learned TPO dealt with all the objections of the assessee at length, as such, on a comparison of the basic function of the assessee and the comparables it can be easily concluded that it is providing software services but with different verticals Tax Elxsi does not cease to a good comparable.

When we turn to the order of the learned DRP, we find a similar reasoning given for this company also and the learned DRP held that this company is engaged in the software development and functionally similar to the assessee. It is argued on behalf of the assessee that this company, namely, Tax Elxsi Ltd. is engaged in diversified services such as product design services, innovation design, visual computing and animation films and systems integration and support besides software development. No segmental information is available.

At page 26 of the annual report it stated that the business of Tata Elxsi involved in designing technology products including hardware, software across the product lifecycle in industries such as Automotive, consumer electronics, networking, semiconductor, storage and telecom. In the profit and loss account of the assessee for the year ended March 31, 2009, the sales and services are shown at Rs.41,851 lacs and sales and support at page no.399 is shown at Rs.2352.41 lacs. Item No.7 of the schedules to the financial statements show that income from sales of goods is recognized 16 upon passage of risk and rewards of ownership to the goods. No segmental information is forthcoming.

In view of the above, we are convinced that Tata Elxsi is not a mere software developer and over and above, it is involved in products and Innovative functions like visual computing labs with the track record of making India’s first full length animated film with all its impact on its comparability. We, therefore, hold that Tata Elxsi is not a good comparable to the assessee, as such, it has to be deleted from the list of comparables for benchmarking the international transaction. We direct the learned AO/TPO to do so. Thirdware Solutions Ltd 29. Now coming to the last comparable i.e. Thirdware Solutions Ltd. It was argued before the learned TPO by the assessee that inasmuch as this Thirdware Solutions is involved in the application implementation, management and development services, it is not a good comparable with the assessee, who is only a captive contract software developer with attendant IT support services.

Learned TPO, however, held that on a perusal of the details of purchase, it was found that the majority of the expenses were in the form of software service charges and salaries which clearly establish that the exports are software service exports. Inasmuch as software development implementation and support services are various sub segments of software development services only and require employment of software engineers, 17 the functions of this company are fairly comparable with the functions of the assessee and on that ground M/s Thirdware Solutions Ltd. Is a good comparable with the assessee.

Learned DRP held this Thirdware Solutions Ltd also on par with Tata Elxsi and held that Thirdware Solutions is also a good comparable with the assessee inasmuch as this company is also engaged in the development of software and functionally similar to the assessee.

It is the argument of the learned AR that the annual report for the Asstt. Year 2009-10 of Thirdware Solutions Ltd. Shows that the company derives revenue from various services, sale of licences, export from SEZ unit, revenue from subscription etc. and the company engaged in diversified business including software products and hence cannot be treated as comparable with the assessee at all as it is not possible to work out and exclude the receipts and expenditure of different categories of income not related to the software development. Besides this, he further submitted that there is no information relating to segmental break up in the annual report of this company for the Asstt. Year 2009-10 providing information on revenue and expenditure from software services and hence, segmental margin cannot be computed for benchmarking the international transaction of providing software development services with attendant ITSS.

Per contra, it is the submission of the learned DR that the Thirdware Solutions ltd. Is also involved in software development and other services but of course, there is revenue from sales also. He also relied upon the 18 observations and findings of the authorities below in respect of this company.

We have gone through the record including the annual report of this company and find from page 318 that this company derives income of Rs.77,03,21,375/- from sales whereas the other income is Rs.2,30,48,603/- Schedule XII relates to sales shows that this company is deriving income of Rs.2,32,37,588/- from sales of licences, Rs.8,91,77,023/- from software services, Rs.47,85,72,420/- from export of SEZ unit, Rs.16,29,00,630/- from export from STPUI unit and a sum of Rs.1,64,33,744/- from subscriptions. No segmental information is available.

On a careful consideration of the diversified functions performed by Thirdware Solutions Ltd. we are of the considered opinion that this company is not suitable to be compared with a captive contract software developer like the assessee and this company is liable to be excluded from the list of the comparables. We accordingly direct learned AO to delete this company from the list of comparables for benchmarking the international transactions.

Now coming to the corporate issues, there are three issues to be dealt with. First one relates to the treatment of forex, second one relates to the adjustment on account of advance billing and the last one relates to the adjustment on account of business promotion and conference.

In so far as the treatment of forex fluctuation is concerned, the assessee contended before the learned TPO that foreign exchange fluctuation income of the assessee should be treated as an operation item of 19 the income. However, learned TPO did not agree with the same and held that the actual profit margin at the end of the year may vary substantially from the expected profit margin at the time of entering into project because of fluctuation in the exchange rate and its risk management policy that is extent to which its forex transactions were hedged, and the margins of two companies entering into similar transactions at the same price may vary substantially depending upon the level of hedging of their forex transactions though at the time of entering into transactions their estimated profit margin was same and therefore, it is logical to exclude forex gain/loss and hedging cost/premium from operating cost/income of the tested party as well as the comparables while calculating the PLI for the purpose of determination of Arm’s length price since this will help in eliminating the differences arising out of risk management policy of individual companies.

Learned DRP on this aspect held that the operating income/expenditure has not yet been decided by the legislature and it has been conventional wisdom which went into the component of operating income/expenditure while calculating the operating profit, but the position has changed since notification of the CBDR issued on 18.9.2013 which is the Safe Harbor Rules. Learned DRP further recorded that Rule 10TA(j)(k) and (l) define the concept of “operating expense” “operating revenue” and “operating profit” respectively according to which loss or income arising out of foreign currency fluctuations are excluded from the calculation of “operating expense” and “operating income respectively. On this term, 20 learned DRP held that the learned TPO was correct in excluding the forex item from the calculation of operating profit.

It is argued by the learned AR before us that while working out operating margin, amount of foreign exchange gain/loss is required to be considered as an item of operating revenue/cost both in case of assessee as well as comparables. The Special bench of the Tribunal in ACIT vs Prakash I. Shah (2008) 115 ITD 167 (Mum)(SB) has held that the gain due to fluctuations in the foreign exchange rate emanating from export is its integral part and cannot be differentiated from the export proceeds simply on the ground that the foreign currency rate has increased subsequent to sale but prior to realization. Further, goods are exported and invoice is raised in currency of the country where such goods are sold and subsequently when the amount is realized in that foreign currency and then converted into Indian rupees, the entire amount is relatable to the exports. In fact it is only the translation of invoice value from the foreign currency to the Indian rupee. Special Bench held that the exchange rate gain or loss cannot have a different character from the transaction to which it pertains.

He further brought to our notice that in a number of decisions including in assessee’s own case for the immediately preceding asstt. Year 2008-09, the Tribunal dealt with this issue and vide para 47 to 50 and while following the decision of a Special bench of the Tribunal in the case of ACIT vs Prakash Shah, 63 Taxman 114 (Delhi) the Tribunal held that the foreign exchange loss/gains arising from the transaction of the revenue nature has to 21 be considered as part of operating profit/cost of the assessee as well as that of the parties.

We have gone through the decision relied by the assessee. Similar is the view of another coordinate bench in the case of Sunlife India Service Centre Ltd. (supra) Since the issue is no longer res Integra while respectfully following the binding decision of the Special bench in the case of Prakash Shah (supra) and other decisions, we hold that the foreign exchange loss or gain arising out of the transaction of revenue nature has to be considered as part of operating profit/cost. We, therefore, set aside the impugned order and remit the matter to the file of AO/TPO for reconsideration of the ALP afresh in consonance with the above directions given in the preceding paragraphs. However, we made it clear that the treatment of forex should be dealt with identically both in the calculation of PLI of the assessee and the comparables.

Now coming to the disallowance on account of advance billing, learned AO found that the assessee had treated a sum of Rs.8,02,68,490/- as advance billing for the purpose and shown the same as part of current liabilities and provisions. After hearing the assessee, learned AO recorded that similar disallowance was allowed in the earlier years in assessee’s own case and as a matter of fact an appeal was admitted in the Hon’ble Delhi High Court as a question of law and in these circumstances, learned AO has chosen to disallow a sum of Rs.3,61,820/- and added back to the income of the assessee.

On a perusal of the record and the decision of a coordinate bench in assessee’s own case for Asstt. Year 2008-09, we found that in para 55 to 58, this issue was dealt and the Tribunal while placing reliance on the decisions of the coordinate benches in assessee’s own case for earlier years more particularly in ITA Nos.584 & 585/Del/2006 and 322/Del/2007 answered the issue in favour of the assessee. This fact is not controverted by the learned DR. We, therefore, while respectfully following the decision of the coordinate benches in respect of earlier years hold and answer this issue in favour of the assessee.

Now coming to the addition of Rs.1,73,97,240/- by disallowing the same from out of the business promotion expenses, it is the submission of the assessee that the details of business promotion and conference expenses were duly submitted before the ld.AO vide submission dated 13th March, 2013 placed at page 110-119 of the paper book-2. The relevant details are placed at page 118 of the paper book. A perusal of these details clearly show that these business promotion expenses were incurred wholly and exclusively for the purpose of business and were necessitated in view of commercial expediency and are earned year after year. Hence, it is prayed 23 that the same may be allowed as business expenses u/s 37 of the Act. Reliance in this regard is placed on the decisions reported in JCIT vs Modi Olivetti Ltd., 84 TTJ 1038,Cox & Kings India P. Ltd., 2010 TII 34,CIT vs Brilliant Tutorials P. Ltd., 292 ITR 399,CIT vs Sabena Detergents Ltd., 303 ITR 320, and CIT vs Berger Paints Ltd.,254 ITR 503 for the principle that advertisement expenses incurred for the purpose of business are allowable as business expenditure: 47. We have gone through the details of business promotion expenses incorporated at page 118 of the paper book: S.No. GL Account Amount (INR) 1 Subscriptions 265,119 2 Professional dues 49,925 3 Global Sis Train 4,0377,355 4 Advertising placement 4,477,358 5 Marketing – Public relations 179,776 6 Marketing- Sponsorships 958,708 7 Promo Gifts 1,162,800 8 Events 3,357,052 9 Marketing 5,431,020 10 Seminars 388,266 11 Marketing and Advertising costs 153,218 12 Other Market expenses 1,282,955 Total 21,743,550 48. Undoubtedly, all the above items of expenditure are revenue in nature and driven by the commercial expediency, as such, we do not find any rationale in disallowing any part thereof by the AO. We, therefore, direct the AO to delete the same.