M/S ADVICE AMERICA SOFTWARE DEVELOPMENT CENTRE PVT LTD,BANGALORE vs. INCOME TAX OFFICER WARD-1(1)(1), BANGALORE

The issue that arises for consideration in this appeal is with regard to the correctness of determination of Arm’s Length Price in respect of international transaction of rendering of Software Development Services and Information Technology Enabled Services by the Assessee to its IT(TP)A No.2531/Bang/2017 Page 2 of 15 Associated Enterprise(A.E). The Assessee is a company engaged in the business of providing contract Software Development Services (SWD Services) to its AE. The transaction of rendering software development services to its AE was an international transaction. As per the provisions of Sec.92 of the Act, income from international transaction has to be computed having regard to Arm’s Length Price (ALP).

The details of the international transaction between the Assessee and its AE in AY 2012-13 was as follows:

In this appeal, we are concerned only with the International transaction of providing SWD Services by the Assessee to its AE. It is not in dispute between the Assessee and the revenue that the Transaction Net Margin Method (TNMM) was the Most Appropriate Method (MAM) for determination of ALP and that the profit level indicator to be adopted for comparison of the Assesee’s profit with that of comparable companies was Operating Profit/Total Cost (OP/TC). The OP/TC of the Assessee was 13.09%. The Assessee in its TP study selected 11 comparable companies whose arithmetic mean of OP/TC was arrived at less than the OP/TC of the Assessee. Since the profit margin of the Assessee was more than the arithmetic mean of OP/TC of the 11 comparables selected by the Assessee, it was claimed by the Assessee that the price charged by it in the international transaction was at Arm’s Length. The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred by the AO, accepted 2 out of the 11 comparable companies suggested in the TP study by the Assessee as comparable with the Assessee. The TPO on his own

Based on the above average arithmetic mean of profit margin of the comparable companies, the TPO computed the ALP of the international transaction of rendering of SWD services by the Assessee to its holding company as follows:

The difference between the price charged by the Assessee and the ALP determined by the TPO viz., Rs.1,09,25,580/- was added to the total income by the AO in his drat assessment order dated 5.12.2016 as addition on account of shortfall being adjustment u/s.92CA of the Act.

The Assessee filed objections to the draft assessment order by the AO before the Disputes Resolution Panel (DRP). The DRP in its directions dated 1.9.2014 rejected the objections of the Assessee and confirmed the addition on account of shortfall being adjustment u/s.92CA of the Act. The AO passed a fair order of assessment making the addition on account of determination of ALP by the TPO. Aggrieved by the addition made in the fair order of assessment, the Assessee has raised several grounds of appeal challenging the addition on several counts. However, at the time of hearing of the appeal, the learned counsel for the Assessee submitted that if 3 out of the 7 comparables chosen by the TPO viz., (i) CG VAK Software Exports Ltd., (ii) Larsen & Toubro Infotech Ltd., (iii) Persistent Systems Ltd., are excluded and if two comparable suggested by the Assessee in its Transfer Pricing Study viz., (i) Cigniti Tech Ltd. and (ii) Helios & Mathesons Ltd.,are accepted and if the arithmetic mean of the profit margin of the remaining 6 companies when compared with the price charged by the Assessee, then the price charge by the Assessee would be at Arm’s length. The grievance of the Assesssee in this regard is projected by the Assessee in Grounds No. 6 to 8 of its appeal. The grievance of the Assessee that the correct margins of some of the comparable companies were not computed

Before we deal with the arguments for exclusion and inclusion of companies from the list of comparable companies, We shall briefly recapitulate the statutory provisions that are applicable for exclusion of inclusion of comparable companies. Section 92(l) of the Act provides that any income arising from an "international transaction" shall be computed having regard to the arm’s length price. There is no dispute in the present case that the provisions of Sec.92(1) of the Act are applicable to the transaction of rendering SWD services by the Assessee to its AE. The term "arm's length price" has been defined in clause (ii) of section 92F of the Act, to mean a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. Section 92C( 1) of the Act provides that the arm's length price in relation to an international transaction shall be determined by any of the several methods, specified therein, having regard to the nature of the transaction or class of transaction or class of associated person or functions performed by such persons or such other relevant factors as the Central Board of Direct Taxes (hereinafter referred to as "Board") may prescribe. Rule 10B(1) of the Income Tax Rules, 1962 (Rules) provides that for the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction shall be determined by any of the methods, being the most appropriate method(MAM) prescribed therein. TNMM is the MAM in the present case. Rule 10B(1) (e) of the rules lays down the following criteria for comparison viz., (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to IT(TP)A No.2531/Bang/2017 Page 6 of 15

CG VAK Software Exports Ltd.: The following are the arguments of the Assessee for excluding this company from the list of comparable companies viz., (i) This company owns intangibles which constitutes about 5.60% of its total revenue whereas the Assessee does not own any intangibles. (ii) This company provides array of services such as SWD services, Software Products and BPO services whereas the Assessee is engaged only in providing SWD Services. This company also does Research & Development activities whereas the Assessee does not do any such activity. (iii) The segmental details of the various segments of this company are not available in the public domain and only geographical

A copy of the Annual report of this company for the year 2013 is placed at page-222 of the Paper book Volume-II. The Significant Accounting policies given as annexure to notes forming part of the Account, gives the revenue recognition policy followed by this Company. Revenue from SWD services, products are recognized when services are recognized on completion of contract or stage of completion as per applicable terms and conditions agreed with customers. It is this significant accounting policy that is the basis for the Assessee to contend that this company also develops Software Products and is not only in the business of rendering SWD services and hence not comparable. In a reply to the notice u/s.133(6) of the Act issued by the TPO, this company has responded by pointing out that it develops custom application development services to client. The TPO has relied on the reply by this company to come to a conclusion that the Software products referred to in the accounting policy is products developed for the client. Developing Software products for clients would also be in the nature of rendering software developing services. We agree with this reasoning of the TPO which was confirmed by the DRP.

As far as the objection by the Assessee that this company owns intangibles, it is seen from the order of the TPO that the intangibles are nothing but Operating systems, office tools, development tools, testing tools etc., that are used in the process of rendering SWD services by the IT(TP)A No.2531/Bang/2017 Page 9 of 15 Assessee and therefore cannot be the basis to hold that this company is functionally not comparable with the Assessee. We agree with this reasoning of the TPO which was confirmed by the DRP.

As far as the objection that this company is into R & D activities, we find that this has also been explained by the TPO as pre-defined or re- usable codes, which would simplify and standardize the process of Software Development. We are of the view that this objection of the Assessee is therefore cannot be the basis to hold that this company is functionally not comparable with the Assessee.

Regarding non availability of segmental results, the TPO has brought on record material to show that the segmental details of the two segments viz., SWD services and BPO are available in the Annual Report and that BPO segment is only 1.6% of the total revenue from both the aforesaid segments. The other argument of the Assessee that the TPO has himself rejected this company as a comparable company in Assessee’s case for earlier AY is not substantiated with any supporting document. In these circumstances, we are of the view that this company has to be retained as comparable company.

Larsen & Toubro Infotech Ltd. As far as this company is concerned, this company also renders SWD services. In page-15 of the TPO’s order, the functional similarity of this company with that of the Assessee has been tabulated by the TPO. The objections of the Assessee for rejecting such objections has been set out at page-21 to 23 of the TPO’s order. The DRP upheld the order of the TPO including this company as a comparable company.

The grounds on which the Assessee seeks exclusion of this company from the list of comparable companies is on the ground that (i) this company is functionally dissimilar to that of SWD service provider

As far as functional dissimilarity of this company is concerned, this company also renders SWD services in three clusters, in the form of Service Cluster for banking, financial services, insurance, Media & entertainment and Travel & Logistics), Industrial Cluster comprising of all manufacturing sectors, telecom cluster relating to product engineering services. As rightly held by the DRP all the above activities are SWD services. The fact that the Assessee mainly caters to SWD services in banking industry cannot be the basis to hold that this company and the Assessee are not functionally comparable. The difference pointed out by the Assessee are not material differences in terms of Rule 10B(2) of the Rules.

As far as the objection that this company apart from rendering SWD services is also engaged in developing its own Software Products, the TPO has brought out in his order that the products developed by the Assessee are platforms used by this company to enable design and developing software for use by a customer in particular industry. For e.g., the product UNITRAX is a Software that enables recording keeping enabling fund and insurance companies to manage the administration of their wealth management. Based on this software the Assessee designs Software for specific needs of a customer. No product is sold off the shelf by the company. Hence the objection of the Assessee that this company is a Software Product company was rightly held by the TPO/DRP to be not valid.

The objection with regard to absence of segmental information has been met by the TPO by pointing out that the whole segment of SWD services was considered for comparability. The objection of the Assessee in this regard is not specific and is vague and is on an assumption that this company operates in three segments. The TPO has pointed out that there is only one segment and hence this objection in our view was rightly disregarded by the revenue authorities.

As far as the objections regarding presence of intangibles, it is seen from the order of the TPO that the intangibles are nothing but Operating systems, office tools, development tools, testing tools etc., that are used in the process of rendering SWD services by the Assessee and therefore cannot be the basis to hold that this company is functionally not comparable with the Assessee. As far as the objection regarding presence of brand value is concerned, it has been held by the TPO that there is no intangible in the form of brand owned by this company. The scale of operations of this company cannot be the basis to hold that this company is not comparable when functionally it is found to be comparable.

None of the objections raised by the Assessee meet the criteria for excluding this company in terms of comparability criteria laid down in Rule 10B(2) of the Rules. We therefore uphold the inclusion of this company in the list of comparable companies.

Persistent Systems Ltd.: The objection of the Assessee for excluding this company from the list of comparable companies is on the ground that this company is also engaged in making software products and is not only in providing SWD services and that the segmental details of revenue from sale of Software Products and revenue from rendering SWD services are not available. This objection is examined in the light of the Annual Report of this company for 2013 which is at pages 648 to 841 of IT(TP)A No.2531/Bang/2017 Page 12 of 15 Volume-III Paper Book filed by the Assessee. The learned AR pointed out that even in the annual report this company is stated to be in the business of developing software products. The reference by the learned AR is to the consolidated Accounts, i.e., inclusive of the activities of the group (AE companies). The unconsolidated accounts of this company is at page 787 of Volume-III paper book filed by the Assessee. The profit & Loss account is at page-793 of Volume-III paper book filed by the Assessee. Income from operation is Rs.9967.53 million. Note 21 to the note on accounts gives the break of this revenue which is at page- 814 and it is fully from providing software development services. This revenue has been compared with costs and the OP/TC of this company arrived at by the TPO. Note 26 to the notes on accounts gives the segmental break-up and the segments are all software services segment and there is no product segment at all. The learned AR placed reliance on decisions where this company was excluded from the list of comparable companies. These decisions do not relate to AY 13-14. We can therefore safely proceed on the basis that those decisions are rendered on their facts prevailing in the relevant AY. As far as the present AY 13-14 is concerned, the plea of the Assessee for exclusion of this company on the ground that it is a software product company is held to be without any basis and is rejected. No other arguments were advanced for exclusion of this company. Hence, we uphold the orders of the revenue authorities including this company in the list of comparable companies.

Cigniti Technologies Ltd. :- This company was excluded by the TPO from the list of comparable companies for the reason that this company only performs testing of software already developed and cannot be said to be engaged in providing SWD services. The plea of the Assessee is that even the Assessee does testing of Software it develops and therefore the basis on which the TPO rejected this company as a IT(TP)A No.2531/Bang/2017 Page 13 of 15 comparable company is not correct. It is the plea of the assessee that software testing is an integral part of software development cycle. This contention of the Assessee is not correct. The question therefore would be as to whether software testing services would be equivalent to software development services. Software testing is only part of software development life cycle. It cannot be equated with software development services. The TPO in our view rightly excluded this company for comparability purposes. The learned DR also brought to our notice a decision of the ITAT Bangalore Bench rendered in the case of Triology E- Business Software Ltd. Vs. DCIT (2013) 29 Taxmann.com 310(Bang-Trib) wherein identical view has been taken on an identical issue. We therefore uphold exclusion of this company as a comparable company.

Helios and Matheson Information Technology Ltd.:- The Revenue authorities excluded this company from the list of comparable companies for the reason that the financial results of this company available are for difference accounting year. The plea of the learned AR is that if the financials of this company is available for the relevant accounting year then the same should be considered by the TPO. The learned counsel for the Assessee in this regard placed reliance on the decision of the Hon’ble Punjab & Haryana High Court in the case of CIT Vs. Mercer Consulting (India) Pvt.Ltd. wherein it was held that if it is possible to determine the value of the transactions during the corresponding periods, the purpose of comparability would be served. The question in each case was whether despite the financial years of the Assessee and of the other enterprise being different, the financials of the corresponding period of each of them was available. If they were, the TPO must refer to the corresponding period of both the entities in determining whether or not the two were comparable for the purpose of determining the ALP. The learned AR referred to page-221 of Paper Book Volume-I wherein the required

The learned DR however submitted that Data to be used for comparability should be the same financial year and in this regard placed reliance on decision of Hon’ble Bombay High Court in the case of CIT Vs. PTC Software (I) Pvt.Ltd. 395 ITR 176 (Bom.) & Mumbai ITAT in the case of Tevapharm India Pvt.Ltd. Vs. DCIT (2017) 81 taxmann.com 416(Mum- Trib) wherein it was held that data to be used for comparability analysis should be the same Financial year in which the international transactions were entered into by the Assessee. He also submitted that the question whether this company passes the other filters applied by the TPO has not been examined and in the event of a remand by the Tribunal, the TPO should be permitted to look into applicability of other filters also.

We have considered the rival submission. It is no doubt true that data to be used for comparability analysis should be the same financial year of the Assessee and the comparable company. If a company is otherwise comparable, though that company follows a different financial year as its accounting year but if the results of such company for the financial year followed by the Assessee is available then such company should also be considered for comparability analysis. The Assessee has given the financial results of the comparable company for the same Financial year as that of the Assessee and the same is at page-221 of Vol.- I Paper book. In the decisions cited by the learned DR the availability of the data for the same financial year of the comparable company has not been considered. We therefore remand the question of comparability of this company to the TPO for a fresh consideration. The TPO is free to apply the other filters and if he still comes to the conclusion that this IT(TP)A No.2531/Bang/2017 Page 15 of 15 company is comparable, then he is directed the consider the financials of the comparable company for the financial year as that of the Assessee.

In the result, the appeal of the Assessee is partly allowed for statistical purpose.