DCIT, BANGALORE vs. M/S CGI INFORMATION SYSTEMS & MANAGEMENT CONSULTANTION PVT. LTD.,, BANGALORE

This is an appeal by the assessee against the order dated 20/1/2016 of Dy. Commissioner of Income-tax, Circle-2(1)(1), Bangalore relating to assessment year 2011-12 in respect of an order passed by the DCIT, Circle 2(1)(1), Bangalore, u/s 143(3) r.w.s 144C(13) of the Income Tax Act, 1961 (Act). The Assessee has also filed a Cross Objection against the very same order. The Cross- Objection is partly supportive of the order of the DRP.

The Assessee is a wholly owned subsidiary of CGI Technology and Solutions Inc., USA, and is a part of the worldwide CGI Group of companies. The Assessee is engaged in the business of providing contract software development services and related services to its Associated Enterprises (‘AE’ for short). In its return of income for AY 2011-12, the Assessee claimed a deduction under Section 10A of the Act of Rs.3,36,51,428/-, being the profits of business of its Hyderabad unit. In computing the said deduction, the Assessee had not reduced telecommunication charges to the extent of Rs.68,91,773/- from its export turnover as the said charges were not attributable to the delivery of computer software outside India. Further, the Assessee had also not reduced travel expenses to the extent of Rs.58,29,169/- incurred in foreign currency from its export turnover as it was not engaged in the provision of technical services outside India which alone would have warranted reduction of such charges from its export turnover.

It is not in dispute that the Assessee is eligible for deduction u/s.10A of the Income Tax Act, 1961 (Act) on profits and gains as are derived from the export of computer software. Sec.10A(4) provides the methodology of computation of deduction u/s.10A of the Act and it lays down that the profits derived from export of articles or things or computer software shall be the amount which bears to the profits of the business of the undertaking, the same proportion as the export turnover in respect of such articles or things or computer software bears to the total turnover of the business carried on by the undertaking. Export turnover has been defined under Explanation 2 (iv) to Sec.10A as: "export turnover" means the consideration in respect of export by the undertaking of articles or things or computer software received in, or brought into, India by the assessee in convertible foreign exchange in accordance with sub-section (3), but does not include freight, telecommunication charges or insurance attributable to the delivery of the articles or things or computer software outside India or expenses, if any, incurred in foreign exchange in providing the technical services outside India.”

The AO, however, proceeded to re-compute the deduction by reducing the telecommunication charges and travel expenses incurred in foreign currency from only its export turnover without making a corresponding reduction in its total turnover. Thereby, the AO made a disallowance of Rs.6,45,161/- from the deduction claimed under Section 10A.

It was the plea of the Assessee in the objection against the draft order of assessment order before the Dispute Resolution Panel (DRP) that at all times during the relevant previous year, it was engaged in development of computer software and not in rendering any technical services. Communication expenses and travel expenses were incurred not for export of computer software outside India and therefore the exclusion from export turnover as done by the AO was not correct. Without prejudice to its contention that the aforesaid sums should not be excluded from the export turnover while computing deduction u/s.10A of the Act, the Assessee has also made an alternate prayer that expenses that are reduced from the export turnover should also be reduced from the total turnover and in this regard has placed reliance on the decision of the Hon’ble Karnataka High Court in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn) wherein it was held that while computing deduction u/s.10A of the Act expenses that are reduced from the export turnover should also be reduced from the total turnover.

The DRP accepted the alternate prayer of the Assessee and directed that the expenses reduced from the export turnover should also be reduced from the total turnover. As a result, the deduction as claimed by the Assessee u/s.10A of the Act stood allowed. Aggrieved by the relief allowed by the DRP, the revenue has preferred Ground No.1 in its appeal before the Tribunal.

We have heard the ld. counsel for the assessee who relied on the order of the DRP and the ld. DR who relied on the order of the CIT(A). Taking into consideration the decision rendered by the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn), we are of the view that the order of the CIT(A) directing the Assessing Officer to exclude communication charges and travelling and conveyance expenses both from export turnover and total turnover, is just and proper and calls for no interference. The only grievance of the Revenue is that the decision of Hon'ble High Court of Karnataka in Tata Elxsi (supra) has not attained finality and a SLP by the department is pending before the Hon'ble Supreme Court. We are of the view that as of today, law declared by the Hon'ble High Court of Karnataka which is the jurisdictional High Court is binding on us. We therefore hold that the order of DRP does not call for any interference and accordingly the same is confirmed. Gr.No.1 raised by the revenue is dismissed.

Grounds No. 2 to 6 raised by the revenue relate to the addition made consequent to determination of Transfer Price by the Transfer Pricing Officer(TPO), which addition was deleted by the DRP in its directions on the adjustment to Arm’s Length Price (ALP) suggested by the TPO. We have already seen that during the relevant previous year, one of the international transactions that took place between the Assessee and its AEs was the provision of software development services (“SWD services for short) to them at a price of Rs.489,58,99,743/-. Since the transaction of provision of Software service by the Assessee was an international transaction, income from such international transaction has to be determined having regard to Arm’s Length Price (ALP) as laid down in the provisions of Sec.92 of the Act.

The TPO to whom the question of determination of ALP of the international transaction of providing software development services by the Assessee to its AE

The Assessee in support of its stand that the price paid to the AE for rendering software development services was at Arm’s Length filed a Transfer Pricing Analysis containing the following details: Operating Income Rs. 489,58,99,743/- Operating Cost Rs.430,24,69,961/- Operating Profit (Op. Income – Op. Cost) Rs. 59,34,29,782/- Operating/Net mark-up (OP/TC) 13.79% The Assessee as well as the TPO adopted Transaction Net Margin Method as the Most appropriate Method for determination of ALP and the Profit Level Indicator for comparison was Operating Profit to Total Cost (OP/TC)

The Assessee selected 16 companies as comparable companies and computed the arithmetic mean of the profit margins of those companies at 13% which was much lower than the profit margin of the Assessee which was 13.79%. The Assessee therefore claimed that the price received in the international transaction was higher than the arithmetic mean of profit margin of comparable companies and therefore the price received is at Arm’s Length.

The TPO accepted only two of the 16 companies selected as comparable companies by the Assessee viz., Mintree Ltd. and Persistent Systems & Solutions Ltd. The TPO identified 11 other companies as comparable companies and arrived at a set of 13 comparable companies with that of the Assessee and arrived at arithmetic mean of the profit margin of those 13 companies at 24.82% before working capital adjustment and 21.35% after working capital adjustment. The following chart will show the list of 13 comparable companies ultimately chose by the TPO and the arithmetic mean of the profit margin of those companies.

The Assessee objected to the manner of determination of ALP by the TPO before the DRP. Briefly, the directions issued by the DRP are as follows: Functionality Filter: The following companies were directed to be excluded by accepting the contentions of the Assessee: (i) Acropetal Technologies Ltd. (ii) E-Infochips Limited (iii) ICRA Techno Analytics Ltd. (iv) Infosys Ltd. (v) Tata Elxsi Ltd. The DRP, however, rejected the contentions of the Assessee that Persistent Systems Ltd. and Sasken Communication Technologies Ltd. were not functionally comparable to it and consequently upheld their inclusion in the final list of comparables.

Pursuant to the directions of the DRP, as the arithmetical mean of the working capital adjusted margins of the above comparables was within the +/-5% range of the Assessee’s NCP mark-up for provision of SWD services, the TP adjustment made towards the said international transaction came to be deleted in the final assessment order.

Aggrieved by the directions of the DRP which were incorporated by the AO in the final order of assessment, the Revenue has preferred appeal before the Tribunal. Briefly, the grounds in Revenue’s appeal are as follows:

The grounds in the cross-objections which are being pressed are as follows: (i) That the TPO erred and the DRP further erred in including two companies, viz. Persistent Systems Ltd. and Sasken Communications Technologies Ltd., in the list of comparables although they fail the test of comparability. (Ground No.1(g))

As far as Gr.No.2 is Revenue’s appeal is concerned, the sum and substance of the ground of appeal is that the DRP ought not to have excluded 3 comparable companies from the list of final comparable companies chosen by the TPO for comparison of profit margin of the Assessee with comparable companies. The three companies that were excluded by the DRP which is in challenge by the Revenue before the Tribunal are (i) Acropetal Technologies Ltd., (ii) L&T Infotech Ltd. and (iii) RS Software (India) Ltd. 19.Acropetal Technologies Limited - As far as exclusion of this company as a comparable company is concerned, it is seen from the Directions of the DRP at paragraph 2.7 at page-9, that this company was excluded on the grounds that: (i)

L & T Infotech Ltd.– This company was directed to be excluded by the DRP for the following reasons: (i) 48.84% of its total expenses are incurred in IT(TP)A No.502/B/16 CO No.01/B/17 11 foreign currency, which includes substantial expenses on sub-contracting, indicating that the company has high onsite revenue; (ii) the TPO has considered the entire revenue from its 3 segments, viz. financial services, manufacturing and telecom as was disclosed in its Annual Report for FY 2010-11, for the purposes of comparability to the Assessee’s software development services; and (iii) predominantly engaged in the onsite development of software in FY 2010-11. The learned DR submitted before us that the Assessee’s profile also is similar to the profile of L & T Infotech Ltd. and therefore this company should be included as comparable company. He also submitted that what is the quantum of on-site revenue has not been spelt out by the DRP. In this regard it was argued by him that on-site revenue beyond 25% of the total revenue of the company would be beyond the tolerance level and without a finding that on-site revenue is more than 25% of the total revenue, this company ought not to have been excluded from the list of comparable companies. We agree with the submission of the learned DR that for application of on-site revenue filter, the DRP ought to have given a finding regarding the quantum of revenue from on-site software development. Nevertheless, this company goes out of comparability on the ground that the profit margins adopted by the TPO was from 3 divisions of the Assessee. We also find, as submitted by the learned counsel for the Assessee this company was held to be functionally not comparable as it is a market leader and thus enjoys significant benefits on account of ownership of marketing intangibles and intellectual property rights. Also, in addition to the above, the company owns proprietary software products which are developed in-house. Accordingly, the Assessee submits that the company is a product company having significant intangibles and is thus not comparable to captive software service providers such as the Assessee. In this regard the learned counsel for the Assessee has placed reliance on the decisions of this Hon’ble Tribunal in Applied Materials India Pvt. Ltd. v. ACIT [TS-815-ITAT-2016(Bang)-TP at para 19 on pages 35-36] and Commscope Networks (I) Pvt. Ltd. v. ITO [TS-161-ITAT-2017(Bang)-TP at para

As for RS Software (India) Ltd., it wasrejected by the DRP solely on the basis that it was allegedly predominantly engaged in the onsite development of software in FY 2010-11. In this regard, it is seen that this company was selected by the TPO and accepted by the Assessee as a comparable, and it was accordingly included by the TPO in the list of comparables. In the proceedings before the DRP, the Assessee did not object to its inclusion in the list of comparables. However, despite the above, the DRP on its own directed its exclusion. We are of the view that since the revenue as well as the Assessee wants to retain this company as a comparable company, this company should be regarded as comparable company.

As far as Ground No. 3 in the Revenue’s appeal is concerned, the revenue in this ground has challenged the order of the DRP on the ground that the DRP suo moto introduced a new filter i.e. onsite software development filter and thereby rejected companies on the basis that they were predominantly engaged in the onsite development of software in FY 2010-11.

In this regard, we are of the view that On-site revenue filter is an accepted filter to be applied for choosing comparable companies engaged in software development and falls within the parameters of Rule 10B(2) of the Income Tax Rules, 1961 (Rules). In any event, the three companies whose exclusion from the list of comparable companies is challenged before the Tribunal, go out of comparability for other reasons and not solely on the application of on-site revenue filter. Therefore, we find no merit in Gr.No.3 raised by the Revenue.

As far as Ground No.4 raised by the revenue is concerned, the said ground of appeal is vague and in any event comparability of companies that were excluded by the DRP were on valid grounds contemplated by the relevant statutory provisions of the Act and Rules. As far as Ground No. 5 in Revenue’s appeal is concerned, the Revenue seeks to challenge the exclusion of E-Infochips Ltd. on the ground that it failed the software service income filter at 75%. At the outset, the Assessee submits that E-Infochips Ltd. was excluded by the DRP on the ground that: (i) no segmental information regarding its diverse functions is available; (ii) it failed the software service income filter at 75%; (iii) there were major fluctuations in profit and turnover every year which seems to be influenced by extraordinary/peculiar circumstances; and (iv) there is a presence of inventory (Page 10 and 11 of the DRP’s direction). The Revenue, in its appeal, has challenged its exclusion only the second ground. In other words, the Revenue has not challenged its exclusion on the other grounds stated hereinabove and thus its exclusion on these grounds have attained finality and cannot be disturbed by this Hon’ble Tribunal. Even otherwise, we are of the view that the DRP rightly arrived at the finding that the company’s software development service revenue for FY 2010-11 was less than 75% of its total operating revenue for that year. Thus, the above action of the DRP in rejecting the above company is correct.

In the result, appeal of the revenue is partly allowed while the Cross- Objection of the Assessee is dismissed.