ASST.C.I.T., BANGALORE vs. M/S MISYS SOFTWARE SOLUTIONS (INDIA) PVT. LTD.,, BANGALORE

IT(TP)A Nos.491 & 529/B/16 2 directed against the order dated 27.1.2016 of ACIT, Circle-4(1)(2), Bangalore (hereinafter referred to as the Assessing Officer, “AO” in short) passed u/s.143(3) read with Section 144C(13) of the Income Tax Act, 1961 (Act).

The Assessee is a wholly owned subsidiary of Misys India Holding Ltd., United Kingdom, which is a part of the Misys Group. The Assessee in engaged in the business of provision of Software Development Services (SWD services), Information Technology Enabled Services (ITES) and Management Support Services (MSS) to its wholly owned holding company. In terms of the provisions of Sec.92-A of the Act, the Assessee and its wholly owned holding company were Associated Enterprises ("AEs"). In terms of Sec.92B(1) of the Act, the transaction of providing SWD Services, ITES and MSS was an “international transaction” i.e., a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. In terms of Sec.92(1) of the Act, the Any income arising from an international transaction shall be computed having regard to the arm’s length price.

As already stated the Assessee provided SWD Servies, ITES and MS Services during the previous year relevant to the assessment year 2011-12. In terms of Sec.92 of the Act, the Arm’s Length Price (ALP) of the three of the international transactions was determined by the Transfer Pricing Officer (TPO), in terms of Sec.92CA of the Act. (i) As far as provision of SWD Services are concerned, the TPO was of the view that the as against a price of IT(TP)A Nos.491 & 529/B/16 3 Rs.187,42,64,681/- which was the consideration received by the Assessee from its AE for providing SWD Services, the TPO was of the view that the Assessee ought to have charged a price which was more by a sum of Rs.21,64,56,0871- and accordingly an addition to the total income by way of adjustment to ALP to the extent of Rs.21,64,56,087/- was made by the AO in the draft order of assessment dated 30.3.2015. (ii) As far as provision of ITES is concerned, the TPO was of the view that the as against a price of Rs.10,70,09,444/- which was the consideration received by the Assessee from its AE for providing ITES, the TPO was of the view that the Assessee ought to have charged a price which was more by a sum of Rs.94,66,683/- and accordingly an addition to the total income by way of adjustment to ALP to the extent of Rs.94,66,683/- was made by the AO in the draft order of assessment dated 30.3.2015. (iii) As far as provision of MSS is concerned the price charged in the international transaction by the Assessee was Rs. 2,23,74,447/- but the ALP for providing such services was determined by the TPO at a higher sum by Rs. 1133279/- and addition to that extent was made by the AO to the total income of the Assessee in the draft order of assessment dated 30.3.2015.

Aggrieved by the additions proposed in the draft assessment order by the AO, the Assessee filed its objections before the Disputes Resolution Panel (DRP) which, vide its directions dated 30.11.2015, partly allowed the objections raised by the Assessee.

Pursuant to the directions of the DRP, the AO passed the final assessment order dated 27.01.2016 in which the addition made on account of determination of ALP as made in the draft assessment order stood reduced.

The Assessee has preferred the present appeal before the Tribunal against the final order of assessment dated 27.1.2016 aggrieved by the order of the AO to the extent the addition made on account of adjustment to ALP survives.

The following Chart will explain the international transactions between the Assessee and its AE and the addition made to the total income pursuant to determination of ALP by the TPO.

We shall deal with each of the international Transaction of providing SWD Services, ITES and MSS, separately.

SOFTWARE DEVELOPMENT SERVICES SEGMENT: As far as the provision of Software Development services are concerned, the Assessee filed a Transfer Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The Assessee selected Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI) for the purpose of comparison. The OP/TC of the Assessee was arrived at 12.50% by the Assessee in its TP study. The operating income was Rs.187,51,48,124/- and the Operating Cost was IT(TP)A Nos.491 & 529/B/16 5 Rs.166,67,49,710/-. The Operating profit (Operating income – Operating cost was Rs.20,83,98,414/-. Thus the OP/TC was arrived at 12.50%. The Assessee chose companies who are engaged in providing similar services such as the Assessee from the prowess and capitaline Plus Data Base. The Assessee identified 16 companies whose average arithmetic mean of profit margin was less than the Operating margin of the Assessee. The Assessee therefore claimed that the price it charged in the international transaction should be considered as at Arm’s Length.

The TPO to whom the determination of ALP was referred to by the AO, accepted TNMM as the MAM and also used the same PLI for comparison i.e., OP/TC. He also selected comparable companies from the same database from which the Assessee had chosen comparable companies, viz., Prowess and Capitaline Plus. The TPO accepted only 2 out of the 16 companies chosen as comparable company by the Assessee viz., Mintree Ltd., and Persistent Systems & Solutions Ltd. He rejected the remaining 14 companies as not comparable with the Assessee. The TPO on his own identified 11 other companies as comparable with the Assessee company and worked out the average arithmetic mean of their profit margins as follows:

The TPO computed the Addition to total income on account of adjustment to ALP as follows:

The Assessee filed objections before the DRP on the addition suggested by the TPO as adjustment to ALP. The DRP gave the following directions on the objections filed by the Assessee: I. Functionality:

Pursuant to the directions of the DRP, the aggregate TP adjustment made by the TPO stood reduced to Rs. 21,64,56,087/-. Aggrieved by the directions of the DRP which was incorporated in the final assessment order of the AO, the Assessee has preferred the present appeal before the Tribunal.

We will deal with the grounds raised

We will first deal with the plea of the Assessee for exclusion of comparable companies chosen by the TPO. The first company which the Assessee seeks exclusion is Accropetal Technologies Ltd. On exclusion of this company, we have heard the rival submissions. We find that the TPO has himself applied a filter for exclusion of companies for the purpose of comparison, viz., revenue from software development service should be more than 75% of the total operating revenue. The admitted factual position is that revenue from software development service of this company was 81.40 Crores out of the total operating revenue of Rs.141 Crores. Thus the revenue from software development is admittedly less than 75% of the total operating revenue of this company. Therefore his company has to be excluded from the list of comparable companies. It was also brought to our notice that the ITAT Bangalore in the case of Applied Materials Pvt.Ltd., in IT (TP) A.No.17 & 39/Bang/2016 for AY 2011-12 order dated 21.9.2016 noticing the aforesaid facts excluded this company from the list of comparable companies in the case of a software development service provider such as the Assessee. We therefore hold that this company should be excluded from the list of comparable companies.

The Assessee seeks to exclude from the list of comparable company E- Zest Solutions Ltd. The Assessee sought to exclude this company from the list of comparable companies on the ground that this company was functionally different in the sense it was engaged in product engineering and software development, owns inventories etc. and that segmental data was not available. The TPO held that this company was engaged in software development and that this company had only one reportable segement in accordance with Accounting Standard 17. The DRP endorsed the view of the TPO. ITAT Bangalore in the case of Applied Materials Pvt.Ltd., a company which was IT(TP)A Nos.491 & 529/B/16 9 also engaged in providing software development services, in IT (TP) A.No.17 & 39/Bang/2016 for AY 2011-12 order dated 21.9.2016, was pleased to remand the question of exclusion of this company for fresh consideration by the AO/TPO. Respectfully following the decision of the Tribunal, we set aside the order of the TPO/DRP/AO including this company as a comparable company and remand the issue of comparability of this company be considered afresh by the TPO/AO.

The following 7 companies were excluded by the Tribunal ITAT Bangalore in the case of Applied Materials Pvt.Ltd., a company which is also engaged in providing software development services in IT (TP) A.No.17 & 39/Bang/2016 for AY 2011-12 order dated 21.9.2016. Following the said decision the ITAT Bangalore in the case of Commonscope Networks (India) Pvt.Ltd. IT (TP) A.No.166 and 181/Bang/2016 for AY 2011-12 order dated 22.02.2017 (vide Paragraph-9 of the said order). The seven companies so excluded were E-Inforchips Ltd., ICRA Technonogies Ltd., Infosys Ltd., Larsen & Toubro Infotech Ltd., Persistent Systems Ltd., Sasken Communication Technologies Ltd., and Tata Elxsi Ltd. Respectfully following the said decisions, we direct exclusion of these 7 companies from the list of comparable companies.

We now come to the plea of the Assessee for inclusion of 3 companies, viz., LGC Global Ltd., Thinksoft Global Ltd., and FCS Software. As far as LGC Global Ltd., is concerned, ITAT Bangalore in the case of Applied Materials Pvt.Ltd., a company which was also engaged in providing software development services, in IT (TP) A.No.17 & 39/Bang/2016 for AY 2011-12 order dated 21.9.2016, was pleased to remand the question of inclusion of this company for fresh consideration by the AO/TPO. Respectfully following the decision of the Tribunal, we set aside the order of the TPO/DRP/AO excluding this company as a comparable company and remand the issue of comparability of this company be considered afresh by the TPO/AO.

As far as the plea for including the other two companies viz., Thinksoft Global Ltd., and FCS Software Ltd., we find both these companies were excluded by the TPO for the reason that the working capital adjustment was very high. ITAT Bangalore Bench in the case of VMware Software India Pvt.Ltd. Vs. DCIT in IT (TP) A.No.1311/Bang/2014 order dated 6.1.2017 has held that a company which is otherwise comparable cannot be excluded for the reason that the working capital adjustment to be done was very high. In view of the aforesaid decision, we are of the view that this company, which was otherwise found to be comparable, be included in the list of comparable companies.

INFORMATION TECHNOLOGY ENABLED SERVICES (ITES) SEGMENT As far as the provision of ITES are concerned, the Assessee filed a Transfer Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The Assessee selected Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI) for the purpose of comparison. The OP/TC of the Assessee was arrived at 15.50% by the Assessee in its TP study. The operating income was Rs.10,70,59,883/- and the Operating Cost was Rs.92,69,747/-. The Operating profit (Operating income – Operating cost was Rs.1,43,65,136/-. Thus the OP/TC was arrived at 15.50%. The Assessee chose companies who are engaged in providing similar services such as the Assessee from the prowess and capitaline Plus Data Base. The Assessee identified 14 companies whose average arithmetic mean of profit margin was 13.42% which was less than the Operating margin of the Assessee. The Assessee therefore claimed that the price it charged in the international transaction should be considered as at Arm’s Length.

The TPO to whom the determination of ALP was referred to by the AO, accepted TNMM as the MAM and also used the same PLI for comparison i.e., OP/TC. He also selected comparable companies from the same database from which the Assessee had chosen comparable companies, viz., Prowess and Capitaline Plus. The TPO accepted only 4 out of the 14 companies chosen as comparable company by the Assessee viz., Cosmic Global Ltd., Infosys BPO Ltd., Jindal Intellicom Pvt.Ltd. and e4e Healthcare Business Services Pvt.Ltd. He rejected the remaining 10 companies as not comparable with the Assessee. The TPO on his own identified 6 other companies as comparable with the Assessee company and worked out the average arithmetic mean of their profit margins and adjustment to ALP as follows:

Aggrieved by the addition of Rs.94,66,683/- to the total income of the Assessee, the Assessee filed objections before the DRP. Briefly, the directions issued by the DRP were similar to the directions that were issued while dealing with determination of ALP for SWD services. The Assessee's contentions challenging the exclusion/inclusion of companies for the ITES segment of the Assessee were rejected by the DRP. The DRP directed (i) the inclusion of foreign exchange gain while computing the margin of the Assessee, (ii) verification and rectification of errors in computing the margins of the Assessee and (iii) verification and rectification of errors in computing the working capital adjusted margins of the comparables as was done in SWD segment. The DRP, for this segment also upheld the methodology adopted by the TPO in computing the working capital adjustment and the restriction of the same.

Pursuant to the directions of the DRP, the aggregate TP adjustment made by the TPO stood reduced. In effect, the TP adjustment made by the TPO in respect of the ITES segment of the Assessee survived post the DRP's directions.

Before the Tribunal, the Assessee seeks exclusion of the following 5 companies from the list of comparable companies adopted by the TPO viz., (i) Accentia Technologies Ltd., (ii) Accropetal Technologies Ltd., (iii) ICRA

As far as Accentia Technologies Ltd., Accropetal Technologies Ltd., and Jeevan Scientific Technology Ltd., are concerned, ITAT Bangalore Bench in the case of Swiss Re Shared India Pvt. Ltd. Vs. ACIT for AY 2011-12, in the decision reported in (2016) 76 taxmann.com 22 (Bang-Trib), ( a company which is also engaged in providing ITES such as the Assessee), was pleased to hold that these three companies cannot be regarded as comparable companies with companies providing ITES. Following the said decision, we hold that these three companies have to be excluded from the comparable companies.

As far as the company ICRA Online Ltd. is concerned, this tribunal in the case of M/S.Zyme solutions Pvt.Ltd. Vs. ACIT IT(TP) A.No.85/Bang/2016 for AY 2011-12 order dated 28.4.2017 in paragraph-26 of its order was pleased to remand to TPO/AO for fresh consideration, the comparability of this company with the Assessee. Following the said decision, we set aside the order of the AO in this regard and remand to the TPO/AO for fresh consideration the comparability of this company with the Assessee on the lines indicated in the order in the case of M/S.Zyme solutions Pvt.Ltd. (supra).

As far as the comparability of the company iGate Global Solutions Ltd., is concerned, the argument of the learned counsel for the Assessee was that segmental details of this company was not available and therefore comparability of this company with the Assessee cannot be ascertained. The learned DR prayed that the comparability of this company can be remanded to the TPO/AO to enable them to issue notices u/s.133(6) of the Act to get the required segmental details to consider the comparability of this company. We accept the prayer of the learned DR and remand for consideration afresh the comparability of this company by the TPO/AO after exercising powers u/s.133(6) of the Act.

MARKETING SUPPORT SERVICES SEGMENT SEGMENT: As far as the provision of MSS is concerned, the Assessee filed a Transfer Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The Assessee selected Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI) for the purpose of comparison. The OP/TC of the Assessee was arrived at 12.55% by the Assessee in its TP study. The operating income was Rs.2,23,84,993/- and the Operating Cost was Rs.1,98,88,602/-. The Operating profit (Operating income – Operating cost was Rs.24,96,391/-. Thus the OP/TC was arrived at 12.55%. The Assessee chose companies who are engaged in providing similar services such as the Assessee from the prowess and capitaline Plus Data Base. The Assessee identified 5 companies whose average arithmetic mean of profit margin was 9.39% which was less than the Operating margin of the Assessee. The Assessee therefore claimed that the price it charged in the international transaction should be considered as at Arm’s Length.

The TPO to whom the determination of ALP was referred to by the AO, accepted TNMM as the MAM and also used the same PLI for comparison i.e., OP/TC. He also selected comparable companies from the same database from which the Assessee had chosen comparable companies, viz., Prowess and Capitaline Plus. The TPO rejected all the companies chosen as comparable company by the Assessee and on his own chose three companies and worked out the average arithmetic mean of their profit margins and adjustment to ALP as follows:

On objections to the addition made by the AO based on the report of the TPO, the DRP rejected the Assessee's contentions challenging the exclusion/inclusion of companies for the MSS segment of the Assessee. The reliefs as regards (i) the inclusion of foreign exchange gain while computing the margin of the Assessee, and (ii) verification and rectification of errors in computing the margins of the Assessee as provided for the SWD segment were also provided for the MSS segment.

Pursuant to the directions of the DRP, the aggregate TP adjustment made by the TPO stood reduced. In effect, the TP adjustment made by the TPO in respect of the MSS segment of the Assessee survived post the DRP's directions.

Before the Tribunal, the Assessee seeks exclusion of two out of the three comparable companies chosen by the TPO viz., Asian Business Exhibition & confereces Ltd., and ICC International Agencies Ltd. It was brought to our notice by the learned counsel for the Assessee that in the case of AMD India Pvt.Ltd. Vs. ACIT in IT(TP) A.No.1487 & 1496/Bang/2015 order dated

We shall now deal with the other grounds of appeal which are common to all the three segments. In Gr.No.8 of its appeal, the Assessee has submitted that the AO/TPO erred in passing the final assessment order without rectifying the arithmetical errors in computation of margins of certain comparables. It was submitted that the TPO, while computing the margins of (i) L & T Infotech Ltd. and Tata Elxsi Ltd. in respect of the SWD segment, (ii) e4e Healthcare Business Services Pvt. Ltd., ICRA Online Ltd. and Jeevan Scientific Technology Ltd. in respect of the ITES segment and (iii) ICC International Agencies Ltd. in respect of the MSS segment has committed certain arithmetical errors and therefore the margins computed do not represent the actual figures. In its objections before the DRP, the Assessee had specifically contested the same and the DRP, upon taking the same into consideration had directed the AO/TPO to undertake verification of the same and rectify the errors if any that had crept into the computation (page No. 9 of the DRP's directions). However, it is submitted that the TPO/AO failed to pass orders in line with the DRP's directions and therefore there exist certain errors in the margins of the above comparables. It is thus submitted that the AO/TPO be directed to verify the operating margins of the companies that survive. We are of the view that the prayer made on behalf of the Assessee deserves acceptance. The TPO/AO is directed to verify the errors pointed out as above and do fresh computation as may be necessary.

The next grievance common to all the three segments projected by the Assessee is that AO/TPO erred in not granting an appropriate working capital adjustment to the margins of the comparable companies and further erred in IT(TP)A Nos.491 & 529/B/16 17 not rectifying the mistakes in the computation of the same (Ground Nos. 9 of the revised concise grounds of appeal).

The learned counsel for the Assessee also submitted that the working capital adjustment as computed by the TPO was also erroneous inasmuch as the average receivables and payables of the comparable companies are wrongly considered which ought to be rectified. The details regarding the average receivables and payables of the comparables are provided at page Nos. 512-514 of the paperbook. Therefore, the working capital adjustment ought to be allowed on actuals upon taking into consideration the correct value of receivables and payables. We are of the view that it would be appropriate to direct the TPO/AO to examine the grievance of the Assessee in this regard and re work the working capital adjustment in accordance with law. IT(TP)A No.491/Bang/2016 (Revenue’s Appeal) 37. As far as the grievance projected in its appeal is concerned, the same are as follows: 1. The DRP has erred in holding that the foreign exchange fluctuation is operating in nature and therefore the margin of the Assessee has to be computed upon including the gains from the said fluctuation. (Ground Nos. 2 to 4)

As far the issue treating foreign exchange gain as operating revenue is concerned, it has been held in several decisions of various Benches of ITAT that foreign exchange gain, to the extent it relates to or connected with the business for which ALP is determined, is to be regarded as operating revenue or loss as the case may be. In the case of SAP Labs India (Pvt.) Ltd. [6 ITR (Trib) 81] and Trilogy E Business Software India (Pvt.) Ltd. vs. DOlT [(2011) 12 taxmann.com 464], which decisions have subsequently been consistently followed by this Tribunal, lays down the proposition that foreign exchange gain or loss has to be regarded as operating revenue or loss. The learned DR however brought to our notice a decision of the ITAT Bangalore Bench in the case of Comscope Networks (India) Pvt.Ltd. Vs. The ITO IT(TP) A.No.166 & 181/Bang/2016 order dated 22.2.2017 wherein it was the foreign exchange gain or loss that arises should relate to the concerned AY because what is compared is the profit margin of a particular AY. According to him therefore the TPO/AO should examine the nature of foreign exchange gain or loss in the case of the Assessee and the comparable companies and to the extent it relates to turnover of the relevant AY and the segment for which ALP is being determined, the same should alone be considered as part of the operating revenue or loss. The learned counsel for the Assessee pointed out that it is impossible to carry out such an exercise. The Assessee might be willing to carry out such an exercise but the same cannot be expected from the comparable companies who have to furnish the relevant data. He also pointed out that under rule 10B (3) of the criteria for comparability is the effect of profit on account of differences. Rule 10B(3) reads thus: “(3) An uncontrolled transaction shall be comparable to an international transaction if— (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.”

We have considered the rival submissions and are of the view that the in the light of Rule 10B(3) of the Rules and the business cycle in the relevant business, the comparability will not be materially affected if the foreign exchange gain is considered as reflected in the accounts of the comparable companies as available in public domain. To this extent the decision rendered by the Bangalore Bench of ITAT in the case of Comscope Networks (India) Pvt.Ltd. (supra) is distinguishable. Therefore respectfully following the decision of the ITAT Bangalore in the case of SAP Labs (supra), we hold that the DRP was justified in directing the AO to consider the foreign exchange gain or loss as operating in nature. Therefore, in light of the above, this ground of the Revenue is liable to be dismissed

As far as the other ground in revenue appeal regarding 1% risk adjustment, it is settled position that assesses that are captive service providers assume less risk compared to companies in an uncontrolled situation and therefore, an adjustment is to be provided to the margins of the comparables to mitigate the said difference. This Hon'ble Tribunal has consistently upheld the above approach and has directed the grant of risk adjustment to the margins of the comparables. In this regard, reference may be made to the decision of ITAT Bangalore Bench in the case of Bearing Point Business Consulting (PR) Ltd. v. DOlT (reported in (2013) 33 taxmann.com 92 (Bang- Trib.))(para 5.5.), where this Hon'ble Tribunal has directed the grant of risk adjustment in the case of an assessee placed similarly to that of the Assessee herein. In light of the above legal position, we find no grounds IT(TP)A Nos.491 & 529/B/16 21 to interfere with the order of the DRP in this regard and dismiss the relevant ground of appeal of the Revenue.

In the result, IT(TP) A.No. 529/Bang/2016 is partly allowed while IT(TP) A.No.491/Bang/2016 is dismissed.