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Before: Shri S.K. Yadav & Shri L.P. Sahu
In the Income-Tax Appellate Tribunal, Delhi Bench ‘I-2’, New Delhi Before : Shri S.K. Yadav, Judicial Member And Shri L.P. Sahu, Accountant Member ITA No.6006/Del./2014 Assessment Year: 2010-11 Sony Mobile Communications vs. D.D.I.T., Circle 2(2), International, AB (India Branch International Taxation, Office, A-31, Mohan New Delhi. Cooperative Industrial Estate, Mathura Road, New Delhi. PAN – AAGCS 4829J (Appellant) (Respondent)
ITA No.6751/Del./2014 Assessment Year: 2010-11 vs. Sony Mobile Communications D.D.I.T., Circle 2(2), International Taxation, International, AB (India Branch New Delhi. Office, A-31, Mohan Cooperative (Appellant) Industrial Estate, Mathura Road, New Delhi. (Respondent)
Assessee by Sh. Nageshwar Rao, Advocate Revenue by Sh. T.M. Shiva Kumar, CIT/DR
Date of Hearing 15.02.2017 Date of Pronouncement 22.03.2017
ORDER Per L.P. Sahu, A.M.:
These are cross appeals by the assessee and the Revenue against the final assessment order passed by the Assessing Officer (AO) u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called ‘the
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Act’) on 19.09.2014 in relation to the assessment year 2010-11. The grounds raised by the assessee and the Revenue in their respective appeals, are as under : Grounds in assessee’s appeal: “1. That on the facts and circumstances of the case and in law, the Transfer Pricing Order passed by Transfer Pricing Officer ("TPO"), directions issued by Dispute Resolution Panel ("DRP") and the Assessment Order ("impugned order") passed by Assessing Officer ("AO") pursuant thereto are not in accordance with law and are therefore, bad in law. 2. On the facts and circumstances of the case and in law, the Transfer Pricing order/ Assessment order/ directions passed by the TPO/ AO/ DRP are invalid and bad in law as the said order/ directions violate judicial discipline.
GROUNDS ON TRANSFER PRICING ISSUES 3. The impugned order passed by ignoring the directions issued by the DRP is contrary to provisions of section 144C of the Act.
The TPO/ DRP and consequently the AO have erred, in law and on facts and circumstances of the case, by not accepting the economic analysis undertaken by the appellant in accordance with the provisions of the Act read with the Rules. 5. Without prejudice to above, the TPO has committed certain arithmetical inaccuracies while computing the net margins of comparable companies and the DRP has failed to adjudicate on the objection raised by the Appellant in this regard.
The TPO/ DRP and consequently the AO have erred in law and on facts and circumstances of the case, by rejecting the quantitative / qualitative filters applied by the appellant and substituting incorrect filters for the selection / rejection of comparables. 7. The TPO/ DRP and consequently the AO have erred in law and on facts and circumstances of the case by including companies that are not appropriate as comparables vis-a-vis the Appellant.
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The TPO/ DRP and consequently the AO have erred in law and on facts and circumstances of the case by rejecting comparables selected by the appellant on the basis of incorrect and unsustainable reasoning. 9. That on the facts and circumstances of the case and in law, the DRP has grossly erred in upholding the approach of TPO of not accepting the use of multiple year data and determining the arm's length margins using data pertaining only to FY 2009-10.
That the DRP and consequently the AO in the impugned order has erred in ignoring the error in computation of working capital adjusted margins of the comparable companies by the TPO.
The DRP and consequently the AO have erred in upholding the decision of TPO of not making suitable adjustments to account for differences in the risk profile of the Appellant vis-a-vis the comparable companies. GROUNDS OF APPEAL ON CORPORATE TAX ISSUES- 12. That the AO/ DRP have erred in disallowing the deduction of Rs. 10,01,05,706/- claimed by the Appellant under section 10AA of the Act, without appreciating the facts of the appellant case and the relevant provisions of the Act.
That the AO/ DRP erred in disallowing the deduction claimed by the Appellant under section 10AA of the Act, on a factually incorrect assumption that the services were provided by the Appellant to 'self, i.e. head office of the Appellant. 14. Without prejudice to above, that on the facts and circumstances of the case and in law, the AO failed to appreciate that even rendering of services by a Branch Office to the Holding Company of its Head Office is 'export' within the meaning of section 10AA of the Act.
That on the facts and circumstances of the case and in law, the AO grossly erred in holding that conditions of section 10AA would be satisfied only when profits are made upon sale of software developed by appellant to third parties and that deduction can be
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claimed under section 10AA only in respect of such profit arising from the sale of software supplied to third parties. 16. That the action of DRP in upholding denial of deduction under section 10AA and consequently the impugned order are contrary to law as the same is contrary to law including provisions of Special Economic Zones Act, 2005 which have an overriding effect.
That the AO has erred in incorrectly computing the tax demand payable by the Appellant under the impugned order.
That on the facts and circumstances of the case and in law, the AO erred in holding that the Appellant has furnished inaccurate particulars of income in respect of each item of disallowance/ additions and in initiating penalty proceedings under section 274 read with section 271 of the Act.”
Out of above grounds, the assessee has not pressed ground No. 1 & 2 , ground No. 17 is consequential and ground No. 18 is premature.
Grounds in Department’s Appeal: “1. Whether on the facts and in circumstances of the case, the Hon'ble Dispute Resolution Panel (DRP) has erred in directing the Assessing Officer/Transfer Pricing Officer (AO/TPO) to exclude M/s Infosys Technologies Ltd from the list of comparables for the purpose of benchmarking the international Transaction and computation of Arm's Length Price in relation to software development services. 2.1 Whether the direction of the Hon'ble DRP to exclude M/s Infosys Technologies Ltd is unsustainable in law, being cryptic and having been given without any cogent reasons in the face of detailed analysis given by the TPO for selecting the company as a comparable in benchmarking the international transaction.
2.2 Whether the Hon'ble DRP has erred in summarily holding that M/s Infosys Technologies Ltd is not a proper comparable on account of (i) risk profile, (ii) the revenue ownership of branded products (iii), R&D expense, (iv) Onsite vs Offshore operations, (v) Expenditure on
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Advertisement & Brand-Building, ignoring the TPO's detailed analysis of the company on all these parameters in support of his finding as to how M/s Infosys Technologies Ltd qualifies as a comparable for benchmarking the transaction.
2.3 Whether the Hon'ble DRP has erred in mechanically and selectively relying upon the decision in the case of M/s Agnity India Technologies Pvt Ltd, without appreciating that the decision in the said case turned on the specific fact-situation involved therein as the Hon'ble ITAT had rendered an uncontroverted finding regarding the difference in the functional & risk profiles between the assessee and M/s Infosys Technologies Ltd. In the case under consideration, the TPO has given a detailed analysis as to how the assessee and M/s Technologies are not different functionally and therefore the case of M/s Agnity India Technologies Pvt. Ltd. is distinguishable.”
The appeal of the Revenue has been filed delayed by 28 days, for condonation of which the department has filed application, stating that pursuance to the directions of ld. DRP, the TPO informed the AO vide his letter dated 19.09.2014 that there was no variation in the adjustment in the ALP determined by him. The AO accordingly, passed final assessment order on 19.09.2014 making an addition of Rs.6,23,15,808/- as per adjustment in the ALP made by the TPO. However, subsequently, it came to the notice of the AO/TPO that one of the comparable, Infosys Technologies Ltd. was excluded from the list of comparable by DRP, the AO rectified the order dated 19.09.2014 vide order dated 09.12.2014 reducing the addition to Rs.5,57,09,134/-. Therefore, on account of this genuine mistake attributable to oversight, the delay in filing the appeal is liable to be condoned, if the limitation period is reckoned from the date of original final order dated 19.09.2014 and if it is reckoned from the date of order u/s. 154 dated
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09.12.2014, the appeal has to be treated as filed within the period of limitation. We observe that the reasons assigned by the revenue for filing the appeal with a short delay, are genuine, as nothing contrary is laid on record by the assessee. Accordingly, the delay is condoned.
The first major issue raised by the assessee in his appeal is against the addition of Rs.6,23,15,808/- made by the AO on account of transfer pricing adjustment, which was reduced to Rs.5,57,09,134/- vide rectification order u/s. 154 dated 09.12.2014.
Briefly stated, the facts of the case are that the assessee is an Indian branch office of Sony Mobile Communications International AB (hereinafter referred to as `SMCI’) (formerly called Sony Ericsson Mobile Communications International AB), a company incorporated under the laws of Sweden. The assessee’s Head office is a wholly owned subsidiary of Sony Ericson Mobile Communications AB (hereinafter referred to as `SEMC’). SMCI set up a branch office (R&D Centre) in a Special Economic Zone (SEZ) in Chennai with the objective of entering into research and development activity in the information technology industry. The assessee filed its return along with the audit report in Form No. 3CEB showing four international transactions. On a reference made by the AO to the Transfer Pricing Officer (TPO) for determining the arm’s length price (ALP) of these international transactions, the TPO took up for consideration the international transaction of ‘Rendering services’ with the transacted value
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of Rs.60,34,50,052/-. The TPO noticed that the assessee entered into an agreement with Sony Ericson Mobile Communications (SEMC) for carrying out R&D services relating to Contract software development maintenance and up gradation and Contract design, development, testing and any similar activities in relation to mobile phones, their accessories, communication devices or communication systems. The nature of business carried on by the assessee was characterized by the TPO as that of providing software services to its AE. During the Financial Year, the AEs decided to close the operation of SEMCI and accordingly, SEMCI discontinued its business operations w.e.f. December, 31, 2009. The SEMCI has undertaken the below mentioned international transactions with its AEs: (a). Rendering of Services. (b). Purchase of fixed assets. (c). Recharge paid to AEs. (d). Sale of fixed assets. (e). Recharge paid by AEs.
From the above, (a) to (e) are interlinked and have been aggregated for the purpose of analysis as a software development services and the assessee has applied TNMM and PLI (OP/TC) calculated at 17.44% whereas OP/TC has been calculated of comparables at 13.18% from software development services. In case of (d) & (e), the assessee has applied CUP method and have been separately evaluated from the transfer pricing prospective. The functional analysis were undertaken, in which functions performed by the group companies and by SEMCI, assets employed and risk assumed, were also analysed in detail in the TP study report. The economic
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analysis regarding software development services and other international transactions are at page 22 to 28 of TP Study Report which is as under :
5.1. Overview of inter-company transactions As discussed in the functional analysis, SEMCI can be characterized as a contract software development service provider providing routine software development services to its AEs. SEMCI does not own any intangibles vis-a-vis the products and does not have any other additional rights to use or exploit the intangibles owned by AEs. AEs, on the other hand, are complex entities that are engaged in full- fledged manufacturing and marketing / product development / product selling etc. covering a wide range of activities and other commercial or marketing intangibles (brand names, trademarks etc.) AEs are the developers, owners and licensors of virtually all valuable intellectual property rights including proprietary products and processes. They bear all significant business and entrepreneurial risks, including product development, performance in the market, financial risks etc. All returns / risks attributable to the intangibles should accrue / vest in the entity that owns the intangibles (i.e. AEs). SEMCI has undertaken the below mentioned international transactions with its AEs during FY 2009-10 (Please refer to Appendix D for details): a) Rendering of services; b) Purchase of Fixed Assets; c) Recharges paid to AEs; d) Sale of Fixed Assets; and e) Recharges received from AEs. Transactions mentioned from (a) to (c) above are interlinked and have been aggregated for the purposes of this analysis as "software development services". Transactions set-out as (d) and (e) herein above have been separately evaluated from a transfer pricing perspective. The Indian Regulations require the use of the 'most appropriate' transfer pricing method that can be supported by uncontrolled comparables. 5.2. Provision of Software Development Services 5.2.1. Selection of the Tested Party The tested party is the participant in the controlled transaction whose profit attributable to the controlled transaction can be verified using the most reliable data and requiring the fewest and most reliable
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adjustments. In most cases, the tested party is the least complex of the controlled taxpayers, that is, the taxpayer not owing any valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables. Based on the facts as presented in the functional analysis, SEMCI is a less complex entity than the AEs. Furthermore, SEMCI does not own any significant intangibles and does not undertake any marketing activity that leads to the development of non-routine intangibles / trademarks / brand name, etc. The AEs, on the other hand, own valuable intellectual property rights including commercial and marketing intangibles. Therefore, comparability adjustments that would be required if the AEs were selected as tested parties, would be both substantial and unreliable. Moreover, entrepreneurs are often involved in complex product development operations and may produce a wide variety of products for sale in their own domestic markets as well as for export to numerous foreign markets. As a result, segregation of the (i) costs and profits and (ii) net operating assets of the entrepreneur that are attributable solely to related party transactions would be complex and unreliable. The costs incurred and the operating assets owned by SEMCI are, on the other hand, generally easily segregated and identified. Accordingly, SEMCI has been selected as the tested party for this analysis. 5.2.2. The Most Appropriate Method : The Regulations provide no priority of methods. Rather, the selection of the pricing method to be used to test the arm's length character of a controlled transaction must be made under the 'Most Appropriate Method Rule'. The 'Most Appropriate Method' is that method which, under the facts and circumstances of the transaction under review, provides the most reliable measure of an arm's length result. In determining the reliability of a method, the two most important factors to be taken into account are (i) the degree of comparability between the controlled and uncontrolled transactions and (ii) the coverage and reliability of the available data. As per the Indian Regulations24, other factors such as nature and class of international transactions, conditions prevailing in the markets, extent and reliability of adjustments that can be made, and extent and reliability of assumptions that may be required in applying the method, shall also be taken into account. Because the selection of the "Most Appropriate Method" involves a test of relative merit, a method that may not be perfect is not rejected
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unless some other method can be shown to be more reliable or provide a better estimate of an arm's length result. 5.2.3. Selection of most appropriate method: Comparable Uncontrolled Price Method The Comparable Uncontrolled Price {"CUP") Method compares the price charged for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. Comparability under the CUP method is particularly dependent upon the similarity of products and contractual terms among other things. Differences in geographic markets may also influence the reliability of the comparison under this method, particularly if they are material but cannot be reliably ascertained. Adjustments are therefore necessary to reflect any differences that would affect the price. In practice, there are two types of comparable uncontrolled transactions. The first, known as an "Internal Comparable", is a transaction between one of the parties to the controlled transaction and an unrelated third party. The second, known as an "External Comparable", is a transaction between two unrelated third parties. Generally, specific details regarding internal comparables are more readily available to the parties engaged in the controlled transaction than details regarding external comparables. The arm's length per unit prices to uncontrolled enterprises is substantially dependent upon factors such as volume, contractual terms, locational differences etc. It may not be possible to estimate, with reasonable reliability and accuracy, the combined effect of such factors on per unit prices. Further, abstract factors such as the use of intangibles make it difficult to use the CUP method for benchmarking purposes. In addition, SEMCI does not provide any software development services to unrelated third parties nor do the AEs procure similar services from any third parties in India. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for contract software development services. Table 4: Applicability of CUP Software Development Internal CUPs services.
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• SEMCI does not provide any software development services to unrelated third parties. •AEs do not procure similar services from any third parties in India. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for software development services. External CUPs •The arm's length per unit prices to uncontrolled enterprises is substantially dependent upon factors such as volume, contractual terms, locational differences etc. •It may not be possible to estimate, with reasonable reliability and accuracy, the combined effect of such factors on per unit prices. •Abstract factors such as the use of intangibles make it difficult to use the CUP method for benchmarking purposes. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for software development services. Recharges received Internal CUPs from AEs In case of transactions in the nature of reimbursement of expenses like Recharges received from AEs from Group Companies to SEMCI, the third party cost reimbursed is a CUP for the reimbursement. Accordingly, keeping in view the nature of transaction and the degree of comparability, CUP was considered as the most appropriate method for these transactions. Consequently other methods were not considered Resale Price Method The Resale Price Method ("RPM") evaluates the arm's length nature of a controlled transaction by reference to the gross
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profit margin realised in a comparable uncontrolled transaction. The RPM measures the value of functions performed and is ordinarily appropriate in cases involving the purchase and resale of tangible goods/services in which the buyer/reseller does not add substantial value to the goods by physically altering them or by using marketing intangibles. A distributor's gross profit provides both compensation for the performance of the distribution functions and a return on the capital invested and risks assumed by the distributor. Thus, under the RPM, comparability is primarily dependent upon the similarity of the functions performed and the risks assumed by the controlled and uncontrolled distributors, and it is less dependent on the similarity of the tangible goods bought and resold. SEMCI is a service provider, not a distributor, and therefore RPM is not considered as the most appropriate method to determine the arm's length operating results of SEMCI. Cost Plus Method The Cost Plus Method ("CPM") evaluates the arm's length nature of a controlled transaction by reference to the gross profit mark up (i.e., gross profit divided by direct and indirect costs) that is realised in comparable uncontrolled transactions. The CPM is ordinarily appropriate in two situations: i) the provision of services to a related party; and ii) the manufacture of tangible goods that are sold to a related party. Under the CPM, comparability is primarily dependent upon the similarity of the functions performed and the risks assumed by the controlled and uncontrolled parties and it is less dependent on the similarity of the services provided or the goods produced. However, as the computation of Gross Margin in case of services is currently not possible under the Indian GAAP. Cost Plus method therefore cannot be used in this analysis and has to be used in modification thus falling within the definition of Transactions! Net Margin Method. Therefore, this method has not been used to benchmark the services rendered by SEMCl. Profit Split Method In general, the Profit Split Method ("PSM") evaluates whether the allocation of the combined profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contribution to that combined profit or loss. The profit split methods typically are applied where
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each party to the transaction under evaluation has significant intangible assets and/or the operations of the parties to the transaction are highly integrated and cannot be evaluated on a separate basis. Although the Indian transfer pricing rules list only one PSM, they provide guidance that the PSM can be applied by i) relying entirely on a contribution analysis; or ii) splitting the profits based on a residual analysis. Under the contribution analysis, the total profit earned by the parties to a controlled transaction is divided, based upon the relative contributions of the parties. The residual analysis allocates the combined operating profit or loss from the relevant business activity between the parties to the controlled transaction in two steps. First, a market return is provided to each party's routine contributions. Second, any "residual" profit attributable to intangibles is divided among the parties to the controlled transaction under evaluation based upon the relative value of their non-routine contributions of intangible property. SEMCl does not own any non-routine intangibles and the low risk operations of SEMCl can be independently evaluated. Therefore, the PSM is not considered as an appropriate method to determine the arm's length operating results in the case of SEMCl, which is a routine contract software development service provider. Transactional Net Margin Method The Transactional Net Margin Method ("TNMM") assesses the arm's length character of transfer prices in a controlled transaction by testing the profit results of one participant in the transaction. The TNMM examines the net profit margin26 relative to an appropriate base (e.g. costs, sales, and assets) that a taxpayer realises from a controlled transaction (or transactions that are appropriate to aggregate). Under the TNMM, comparable transactions need to be only broadly similar. Significant product diversity and some functional diversity between the controlled and uncontrolled parties are acceptable. On strength of the TNMM is that net margins (e.g. return on assets, operating income to sales, and possibly other measures of net profit) are less affected by transactional differences than is the case with price, as used in the CUP Method. The net margins also may be more tolerant to some functional differences between the controlled and uncontrolled transactions than gross profit margins. Differences in the functions performed between enterprises are often reflected in variations in operating expenses. Consequently, enterprises may have
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a wide range of gross profit margins but still earn broadly similar levels of net profits. In view of the above, TNMM has been selected as a preferred method for determining the arm's length operating results of SEMCI. 5.2.4. Application of the most appropriate method After reviewing all of the transfer pricing methods discussed herein, we concluded that, given the fact and circumstances, the TNMM provides the most reliable measure of an arm's length operating result forSEMCI. Although the TNMM theoretically is based on transactional data, it recognises that no comparable data at such a transactional level is likely to exist. Further, in case the transactions are closely interlinked, the same can be aggregated under the TNMM. Further, the CUP method has been applied to test the arm's length nature of the international transactions in the nature of cost reimbursements received from group companies. 5.2.5. Search for uncontrolled comparables and determination of Arm's Length Price. We searched the two widely recognised corporate databases to identify potential uncontrolled comparables for SEMCI's transaction. We primarily relied on Prowess and extracted additional companies from Capitaline Plus, i.e., companies for which data was not available in Prowess. For details about these databases and their limitations please refer Appendix E. To comply with the requirements of contemporaneous documentation to exist by the due date of filing the return of income as per the Indian Regulations, the Branch has conducted a benchmarking analysis using information in databases updated till February 19, 2010 focusing on the financial results of companies having financial years ended during the period April 1, 2007 and February 19, 2010. The companies from both databases have been extracted only if they had relevant financial data for at least two out of the three financial years ending during the period April 1, 2007 and February 19, 2010 to account for factors such as changes in economic conditions and leveling of industry and business cycles. For details regarding selection of time period please refer Appendix F. The search for comparables was undertaken, keeping in mind, that SEMCI, in respect to services segment was primarily engaged in providing contract software development services.
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Accordingly, our comparable search strategy covered one broad segment namely service providers and therein a broad similarity in nature/ features / characteristics of services was also considered. Therefore, the comparability analysis identified Indian independent service providers who were broadly comparable to those of SEMCI. For each of the companies we examined the various data fields in Prowess, selected the ones that would be relevant to our analysis for a services company, and extracted the same for those financial years, ended during the period April 1, 2007 and February 19, 2010 in which the company satisfied the aforesaid basic search criteria. A simple average of the raw numeric data fields was then computed, and various computations were performed thereon. The selection may include certain companies having changed their financial year during the period under consideration. The application of TNMM requires the selection of an appropriate Profit Level Indicator ("PLI"). The PLI measures the relationship between (i) profits and (ii) either costs incurred, revenues earned, or assets employed. TNMM aims at arriving at the arm's length operating profit (i.e. profit before financial and non-operating expenses). Return on total cost was selected to reliably measure the income of the tested party that it would have earned had it dealt with uncontrolled parties at arm's length. Based on the search process, we arrived at 16 comparable companies / segments. The arithmetic mean of the margins of the comparable companies is tabulated in Table 5. S.No. Name of the Company Data Source Average PLI 1. Akshay Software Technologies Ltd. P 8.64% 2. Compulink Systems Ltd. P -7.08% 3. FCS Software Solutions Ltd. P 38.97% 4. Goldstone Technologies Ltd. P 12.49% 5. LGS Global Ltd. P 22.57% 6. Larsen and Toubro Infotech Ltd. P 21.57% 7. Mindtree Ltd. P 21.52% 8. PSI Data Systems Ltd. P 4.70% 9. Polaris Software Lab Ltd. P 10.81% 10. Reliance Infosolutions Pvt. Ltd. P 0.97% 11. Sasken Communication Technologies Ltd. P 13.45% 12. Synetairos Technologies Ltd. P 21.33% 13. Thinksoft Global Services Ltd. P 17.72% 14. Zensar Obt. Technologies Ltd. P 18.97% 15. Crazy Infotech Ltd. P-Seg. 1.35% 16. Teledata Marin Solutions Ltd. C-Seg 2.86% Mean 13.18%
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Median 12.97% Upper Quartile 21.38% Lower Quartile 4.24% The details of search for uncontrolled comparables and determination of arm's length price has been given in Appendix G. Our analysis shows that the arithmetic mean OP/TC of comparable companies is 13.18%. Hence, prices of international transactions of SEMCI that achieve an OP/TC of 13.18% or more would meet the arm's length standard required under the Indian Regulations. The financial results of SEMCI provided to us (summarised in Appendix I) indicate that the Branch has an OP/TC of 17.44% during the year ended March 31, 2010. This provides evidence that both the pricing basis itself of international transactions of SEMCI and the outcome of the pricing i.e. the profitability, support our view that the international transactions of SEMCI were in accordance with the 'Arm's Length' standard required under the Indian Regulations. 5.3. Other international Transactions Cost Recharges paid by AEs As mentioned above, the operations of the branch have been to closed and thus, the fixed assets have been sold to the group companies (amounting to Rs. 148,258,176) and remaining fixed assets have been discarded/scrapped. On account of such disposal of fixed assets the branch has incurred a toss of Rs. 285,676,223 which the AEs have reimbursed. Further, other costs incurred by the Branch amounting to Rs. 145,873,325 have also been reimbursed by the parent company. As the above amounts represent actual cost/ losses incurred by the Branch, which have been reimbursed by the AEs on a cost-to-cost basis, therefore the transactions satisfies the arm's length principle.”
During the financial year, SEMCI entered in International Transactions with its AEs, which are as under : S. No. Description of the transactions Amount (Rs.) 1. Purchase of Fixed Assets 413,669 2. Rendering of services 574,714,335 3. Recharge paid to AEs 25,089,458 4. Sale of Fixed Assets 148,258,176 5. Recharges received from AEs 431,549,546
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In the TP study report, the assessee identified the comparable companies by using widely recognized commercial information database, viz., prowess and Capital Line Plus. After the detailed study of the functions performed, risk assumed, assets employed and nature of activity of each company were identified and finally the assessee selected 16 company were identified and finally, the assessee selected 16 companies as comparables which were narrated in the T.P. Study report and calculated average mean margin of OP/TC @ 13.18% by using multiple year data. Based on the analysis, the assessee determined ALP of the impugned international transactions for software development services. The operating profit margin was calculated in TP study report as under : Particulars Amount in Rs. Service Fee 574,714,335 Salaries and benefits 144,095,864 Admin and other expenses 243,260,899 Depreciation 102,026,461 Total Operating cost 489,383,224 Operating Profit 85,331,111 OP/TC (%) 17.44%
On the basis of above table, the tested party operating profit margin on cost is 17.44% in the international transactions which is held to be at Arm’s length in the T.P. documentation. The observations of the TPO on the filters used by the assessee in the TP study report for arriving at the ALP of the international transactions, are as under :
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“8. In view of the functional profile of the assessee, the following set of filters have been found to be appropriate. The justification to apply them is discussed as follows: i. Use of current year data: The transfer pricing provisions lay down that primarily current year data should be use. The proviso to Rule 10D(4) allows the use of multiple year data only if the assessee is able to demonstrate through relevant data that certain factors of earlier years has affected the transfer prices for the current year. There are sufficient judicial pronouncements that support the use of current year data. ii. Different financial year: If a company is having an accounting year different from financial year for which financial of your company are being considered, the same has been excluded as the profits and revenues/expenses pertain to different period other than current year which is FY 2009-10. iii. Reject companies where turnover is less than Rs.5 Crore: This filter is applied because as it will eliminate start-up companies and also where the turnover and cost base is very small, there would be little differentiation between profits and remuneration. That apart, a company that is very small in size does not have sufficient economic significance, that it be used for benchmarking. iv. Select companies where the ratio of service income to tatal income is at least 75%: The use of this filter is to ensure that we choose companies that are primarily in the service sector. This filter ensures that companies that have significant incomes from manufacturing and trading activities are rejected. In your case your entire income is from provision of services and thus, the threshold for applying this filter has been taken at 75%. It would not be appropriate to benchmark your case against a company that has significant income from manufacturing or trading activities. This filter will thus ensure integrity of all comparable data. v- Select companies where income from exports is at least 75% of total income: This filter is required to be applied since you are primarily earning income from exports. Even in cases where an assessee is having income from domestic operations, the transfer pricing audit will benchmark transactions with the AE, which will be an
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export transactions. There are judicial pronouncements that support the case that exporters should not be compared with domestic companies. Hence, this filter is required to be applied with a threshold of at least 75% in your case. vi Reject companies where related party transactions exceed 25% of sales: There is no doubt that companies with significant related party transactions need to be excluded from the benchmarking process. On the issue of threshold of related party transactions, it can be stated that when the RPT exceeds 25% of sales, it can be said to be the stage when it will start affecting the price paid/received. The rationale given for the use of the limit of 25% is sound and this threshold limit has been approved explicitly an implicitly in quite a few judicial pronouncements. vii Companies that have employee cost that is less than 25% of total cost: The rationale for this filter is that companies that are engaged in providing services similar to yours will require a minimum level of expenditure as personnel expense. Employees cost constitutes the major component of cost in any service sector. Very low employee cost, viz., less than 25% of total cost, indicates that company is either engaged in some other business or it has outsourced the service/functions to a third party, i.e., it is not rendering services on its own. Such companies cannot be treated as functionally comparable to the assessee. viii. Companies that are affected by some peculiar economic circumstances: Companies that are affected by factors like persistent losses, declining sales, extraordinary income or expense, mergers and acquisitions or other such factors which affect the operations of the company substantially should not be used as comparables as they will not prove to be good benchmarks.”
Based on the above observations, the ld. TPO applying certain filters, accepted the following companies as comparables: (i). Akshya Software Technologies Ltd. (ii). LGS Global Limited (iii). Larson & Toubro Infotech Ltd. (iv). Mind Tree Ltd.
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(v). Saskin Communication Technologies Ltd. (vi). Think Software Global Services Ltd.
Following companies were rejected by the TPO observing as under :
No. Name of the TPO’s Observation Company i. Compulink Systems Data for FY 2009-10 is not available in public domain/prowess Ltd. and capitaline databases. It cannot be taken as comparable. ii. FCS Software As per P-28/AR- "FCS business is organized into three strategic Solutions Ltd. business units (SBUs): 1. IT Consulting- 2. E-Learning Division-37% 3. Infrastructure Management-" There is significant % of business other than IT consulting. Further, from the following description, it is clear that the company is providing e-learning on its own and is not merely developing e-learning content for others:- 2. E-learning Division: (P-31/AR) "We have earned 37% of our revenues from the Education segment FCS is at cutting edge of the field of internet-based training. We have corporate universities running for blue chip companies with employee bases of many thousand employees. We are managing 5 ITIs in 2 states with an objective to upgrade education. We are in discussions with various bodies to start more locations with creating education opportunities for masses in vocational, academic, and on job training. The SBU also plays a vital role in imparting quality IT education to corporate houses, institutions, central and state government departments, professional establishments and other clients, for whom FCS develops IT solutions. This is especially important in very large and complex projects. For FCS, education and training services is not merely a business area. We see it as our commitment towards building India's IT-personnel power base. One key aspect of our Education SBU is its ability to link education initiatives with delivery technologies. As the role of technology will become more complex, PCS is right there to take advantage of such a situation. " It is clear from the above description that this company is in the field of both IT services and e-learning and is presently engaged mainly in the business of education segment It cannot be taken as a comparable. iii Goldstone As per P-8/AR:- "Goldstone Technologies Limited (GTL) is Technologies Ltd. presently engaged in the business of IT Enabled Services. GTL offers highly complex and mission critical solutions such as software support, software maintenance, business process
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outsourcing etc. Goldstone has a strong presence in the US and European markets for its highly specialized consulting services and Forte to Java Migration projects. Goldstone has strong initiatives to capture the new markets in the field of IT and IT Enabled Services." It is clear from the above description that this company is in the field of both IT and IT enabled services and is presently engaged mainly in the business of IT enabled services. It cannot be taken as a comparable. iv PSI Data Systems As per the Prowess data base, the company has been merged Ltd. and now is called Aditya Birla Minacs IT Services Ltd. The company does not qualify net worth filter as its net worth is (3.86) which is less than zero. It cannot be taken as comparable. v. Polaris Software Lab The name of the company has been changed to Polaris Ltd. Financial Technology Ltd. This company is failing the RPT filter as RPT to sales in this case is 84.72% as per prowess database. It cannot be taken as a comparable. vi. Reliance The company does not qualify export filter as its export sales to infosolutions Pvt. total sales are 3.71% which is less than 75% of sales. It cannot Ltd. be taken as comparable vii Syunetairos The company does not qualify export filter as its export sales Technologies Ltd. are nil. It cannot be taken as comparable. viii ZensarObt The Company does not qualify RPT filter as its RPT to sales are Technologies Ltd. 70.74% which is greater than 25% of sales. It cannot be taken as comparable. ix Crazy Infotech Ltd. The company has 3 segments – computer hardware, software development and IT training with segmental revenues at 2.46 crores, Rs.2.67 crores and Rs.0.88 crores respectively. The relevant segment of this company has revenues less than Rs.5 crores and thus fails the turnover filter. It cannot be taken as comparable. x Teledata marine Rejected. Fails employee cost filter. Employee cost/operating solutions Ltd. cost is 3.86%. It cannot be taken as a comparable.
Some of the companies, which were excluded by the assessee on the basis of different filters, i.e., qualitative analysis, were found by the TPO fit to be included in the final set of comparables. Such companies are as under:
(i). Infosys Technologies Ltd. (ii). Persistent Systems Ltd. (iii). R.S. Software India Ltd. (iv) Tata Elxsi Ltd.
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In addition to the above, the ld. TPO made fresh search and following additional companies were added in the set of comparables : (i). Evoke Technologies Ltd. (ii). Zest Solutions (iii). Infinite Data Systems (iv). Thirdware Solutions Ltd. (v). E Infochips Bangalore Ltd.
On the basis of above comparables accepted and selected by the TPO, the ld. TPO determined OP/TC for benchmarking the international transactions as under :
No Name of the company OP/OC (%) I. Akshay Software -1.04 Technologies Ltd ii. E-infochip Bangalore 72.69 Ltd. iii. Evoke Technologies Ltd 19.02 iv. E-Zest Solutions 18.66 v. Infinite Data Systems 88.25 Pvt. Ltd. [Merged] vi. Infosys Ltd. 45.08 vii. Larsen & Toubro 20.48 Infotech Ltd, viii LGS Global Ltd 12.79 ix. MindtreeLtd. 16.62 x. Persistent Systems Pvt 30.50 Ltd. xi. *Persistent Systems and 15.38 Solutions Ltd. xii. RS Software (fadiajitd. 10.29 xiii Sasken Communication 17.54 Tech, Ltd. xiv Tata Elxsi Ltd. 19.82 xv. Thinksoft Global 17.35 Services Ltd. xvi Thirdware Solutions 41.63 Average 27.82%
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*This company does not find place in the final set of comparables taken by TPO as narrated above.
Accordingly, the ld. TPO calculated the ALP of the international 15. transactions with its AE as under : Particulars Amount Operating Cost 489,383,224 Arm's length margin (%) 27.82% Arm's length margin (Rs.) 136,146,413 Arm's length Price 6255,29,637 Price charged by the assessee 574,714,335 105% of Price charged in 603,450,052 international transaction Difference for which 50,815,302 adjustment is proposed to be made
The ld. TPO has made point wise discussion in detail for rejection of the companies selected by the assessee and also relied on various case laws. The TPO has also made working capital adjustment which works out to 30.17%. Finally, the TPO has determined the ALP of the International transactions by giving effect of the working capital adjustment as under : S.No Company Name OP/OC(%) Working Capital adjusted OP/ OC (%) i Akshay Software Technologies Ltd. -1.04 3.52 ii. E-Infochips Bangalore Ltd. 72.69 70.08 iii. Evoke Technologies Pvt. Ltd 19.02 23.61 iv. E-Zest Solutions Ltd. 18.66 18.75 V, Infinite Data Systems Pvt. Ltd. 88.25 88.67 vi. Infosys Ltd. 45.08 50.34 vii. Larsen & Toubro Infotech Ltd. 20.48. 24.91 viii. LGS Global Ltd. 12.79 12.39 ix. Mindtree Ltd. 16.62 19.43 x. Persistent Systems Ltd. 30.50 32.79 xi. Persistent Systems & Solutions Ltd. 15.38 16.78 [Merged] xii. R S Software (India) Ltd. 10.29 15.11
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xiii. Sasken Communication 17.54 22.80 xiv. Tata Elxsi Ltd. 19.82 21.97 xv. Thinksoft Global Services Ltd. 17.35 18.56 xvi. Thirdware Solution Ltd. 41.63 42.98 Average 27.82% 30.17%
Accordingly, the ld. TPO calculated the ALP of the international transactions related to Software Development Services as under : Particulars Amount Operating cost 489,383,224 Arm’s length Margin (%) 30.17% Arm’s length Margin(Rs) 14,76,46,919 Arm’s length Price 63,70,30,143 Price charged by the assessee 57,47,14,335 105% of price charged in international transaction 60,34,50,052 Difference for which adjustment is proposed to 6,23,15,808 Be made
The AO, accordingly framed the draft assessment order. The assessee filed objections before the learned DRP and the ld. DRP, considering the objections of the assessee, excluded Infosys Technology Ltd. by following the judgment of jurisdictional High Court in the case of Agnity India Technologies (2013) 36 Taxman.com 289 (Del.). The ld. DRP noted that the Infosys was not a proper comparable on account of (i) risk profile (ii) revenue ownership of branded products (iii) R & D expenses (iv) onsite vs. offshore operations (v) expenditure on advertisement/sale promotion and brand building. Accordingly, the ld. DRP directed the AO to exclude this company and confirmed the rest of the order of TPO. The AO, accordingly, passed final order on 10.09.2014, but he did not exclude Infosys as per directions of the DRP. Thereafter, the assessee filed 154 application, which
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was accepted by the AO vide order dated 09.12.2014 and excluding the company, Infosys Ltd. as per directions of the DRP, the AO reduced the addition of Rs.6,23,15,808/- to Rs. 5,57,09,134/- vide order u/s. 154 dated 09.12.2014. The Revenue has challenged the assessment order passed in compliance to DRP directing the exclusion of Infosys Technologies Ltd. and the assessee has also challenged the order of the AO by way of these cross appeals.
Grounds Nos. 3 to 8 are decided together.
We have heard the rival submissions and perused the relevant material on record. There is no dispute on the determination of ALP of any transaction other than that of `Rendering of services’ with the declared value at Rs 574714335/-. Further, there is no dispute on the application of the TNMM as the most appropriate method with PLI of OP/TC. The assessee is aggrieved only against inclusion of four new companies in the final set of comparables, namely, E- Infochips, Bangalore Ltd, Infinite Data Systems Pvt. Ltd.(Merged), Persistent Systems Ltd., Thirdware Solutions Ltd. and rejection of two companies, namely, PSI Data Systems and Crazy Infotech Ltd. We will take up these six companies in seriatim to decide their inclusion/exclusion in the final list of comparables.
Before deciding the comparability or otherwise of these six companies under challenge, it is of paramount importance to first ascertain the
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functional profile of the assessee. It has been noticed above that the assessee is providing research and development services relating to Contract software development maintenance and up gradation and Contract design, development, testing and any similar activities in relation to mobile phones, their accessories, communication devices or communication systems. Such services were provided pursuant to an Agreement entered into between the assessee through its head office, namely, SMCI on the one hand and SEMC on the other. A copy of this Agreement dated 19.9.2008 is available on page 133 onwards of the paper book-2. The nature of services provided by the assessee pursuant to this Agreement are contained in Annexure-A, which are verbatim reproduction of what has been mentioned above. This Agreement provides that the assessee will be compensated by its AE on all Costs incurred in providing such software services with a certain mark up and that the arm’s length compensation has to be considered over multiple years and the compensation level has to be evaluated every year by review of mark-ups on cost achieved by comparable uncontrolled research and development service providers. The term ‘Costs’ has been defined to mean all variable and fixed operating expenses including normal recurring costs, such as, lease rent, communication and linkage charges, salaries, employee benefits, depreciation, amortization and net loss of foreign exchange transactions. It has been provided that the term ‘Costs’ shall not include interest paid, loss in sale of fixed assets and any prior period or extraordinary expenses. As per this Agreement, the assessee, Indian Branch of SMCI, has undertaken to
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perform research and development services for the benefit of SEMC. Clause 6 of the Agreement is important, as per which SEAB shall, at all times, be the sole owner of all rights relating to or emanating from any information or material including intangibles supplied by it to the assessee. It has further been agreed that the assessee will not acquire any ownership or economic interest in the intangibles. We have gone through certain invoices raised by the assessee on SEMC, copies of which are available on page No. 138 onwards of the paper book No.2. For example, invoice dated 06.05.2009 has been raised on SEMC by giving total expenses incurred during the month of April, 2009 to which a markup of 15% has been added. Similar is the position about 15% markup on the costs incurred by the assessee in providing these software services to its AE in other months. However, as per agreement, the assessee has not furnished every year evaluation chart of compensation level for consideration of Arm’s length compensation over the multiple years. Keeping the above background in mind about the functional profile of the assessee, we will now try to ascertain as to whether or not the above referred six companies are comparables.
i) E-Infochips Banglore Ltd. 22. It has been submitted by the ld. AR that this comparable was selected by ld. TPO (Page No. 32-34 ) of the TPO’s order even though assesse objected to the same. The assessee had objected that the company is functionally different and in his annual report for the financial year 2009-10 it is engaged into diversified activities ( apart from software activities) . He
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submitted that this company is engaged in both Software Development & ITES services. The ld. AR submitted that segmental information was not available in respect of this comparable. It was also objected before the TPO that this company earns supernormal profit. It was also submitted that the learned TPO itself has rejected similar comparable, viz., Goldstone, on the ground of insufficient segmental information. The ld. TPO did not accept the contention of the assessee and retained this company as comparable for the reason that many companies treat IT and ITES as one industry and therefore, report them as one segment even though they are not performing any IT enabled services. He further noted that the annual report does not have any reference to ITES services, BPO, Call centre, transcriptions or any other words related to ITES services.
The ld. DR, however, referring to the observations made by the ld. TPO in the order, submitted that E-Infochips Bangalore Ltd. is a comparable company with that of the assessee on the premise that the above comparable is into software development services; that as per TPO’s analysis of the functions performed by the assessee, the assessee is also providing many other services apart from software development service, viz., contact designing, testing services, maintenance and upgradation of software and related services in relation to mobile phones and accessories. It was submitted that though the transactions being benchmarked in the present appeal have been given the nomenclature of “software development services”, but it actually includes related services carried out by the
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assessee and generally terms as ITes. It is submitted that in the case of Trilogy E-Business Software India (P) Ltd. vs. DCIT, Banglore Bench of ITAT in ITA No. 1054/Bang/2011, it has been held that testing services is not same as software development services even if testing could be one of the steps in software development activity. Therefore, even if it is taken for granted that the above comparable was also engaged in ITes, still the same becomes perfect comparable to the transaction being benchmarked, as what is being compared is not pure transaction of software development services but a mixture of SWD services and ITes services.
Having considered the rival submissions, we find that the co-ordinate Bench of ITAT, in the identical facts and circumstances has considered this company as excludable from the final set of comparables in the case of Sunlife India Services Centre Pvt. Ltd. vs. DCIT (ITA No. 750/Del./2015- order dated 27.06.2016) on the basis of functional disparity observing as under : “10.3.After considering the rival contentions and perusing the annual reports placed on record, we are of the opinion that this company cannot be selected as comparable for TP analysis, because it is engaged in both software development as well as ITes. Assessee being characterized as a routine service provider, the above company cannot be considered as comparable on functional basis. 10.4. As this company is functionally different from assessee and in absence of segmental information we direct the AO/TPO to exclude this company from the final list of comparables.”
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Respectfully following the decision of coordinate Bench, we direct the AO/TPO to exclude this comparable from the list of comparables selected by the TPO.
(ii). Infinite Data Systems Pvt. Ltd.: 26. This company has been selected by the TPO (page 198 to 200) even though the assessee objected to the same on the premise that the company is functionally not similar and due to insufficient segmental information; that there was abnormal growth in operations and the said company earns supernormal profits; that the company is engaged in providing primary infrastructure management services which are very different from software development services and that the said company renders services to a single customer, i.e., Fujitsu Services Ltd. The ld. TPO rejected the all the objections of the assessee observing that the company is providing only SWD services and is engaged primarily in Software development services.
The ld. DR, however, referring to the observations made by the ld. TPO in the order, submitted that this company is a comparable company with that of the assessee.
After hearing both the sides and perusing the materials available on record, we are of the opinion that this company has no sufficient segmental information and functionally dissimilar. We rely on the judgment of ITAT in
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the case of Sun Life India Service (supra) wherein while dealing with this company on the comparability test, it has been observed as under : “10.8. After considering the rival contentions and perusing the annual reports placed on record, we are of the opinion that this company cannot be selected as comparable for TP analysis. A perusal of the annual report of this company for assessment year 2010-11, suggests that it is a full fledged IT consulting organization and provides services in the nature of technical consulting, design and development of software, maintenance, system irrigation, implementation, testing and infrastructure management service. Further this company as a sole customer, Jujitsu Services Ltd., and accordingly is exposed to significant single customer risk. The above company cannot be considered as comparable on functional basis. 10.9. As this company is functionally different from assessee and in absence of segmental information, we direct the AO/TPO to exclude this company from the final list of comparables.” 29. Respectfully following the decision of coordinate Bench, we direct the AO/TPO to exclude this comparable from the list of comparables selected by the TPO.
(iii). Persistent Systems Limited: 30. This company has been selected by the TPO (page No. 208-210). The TPO has discussed the functional profile of this company. According to TPO, the company is predominantly engaged in SWD services and concluded that it is fit to be considered as comparable. The assessee objected this company to be taken as comparable on the premise that the company is functionally dissimilar, as it is engaged in product development and product design services and that the complete segmental information are not available. He relied on the following decisions:
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(i). Cash Edge (ITA 64/Del./2015 – A.Y. 2010-11 – ITAT) affirmed by Hon’ble Delhi High Court in ITA No 279 of 2016. (ii). Equant Solutions India Pvt. Ltd.(ITA No. 1202/Del./2015-ITAT) (iii). Pyramid IT Consulting (ITA No. 5401/Del./2012 – ITAT)
After hearing the submissions of both the sides and perusing the material available on record and we find that this comparable company has been considered by ITAT in the case of Cash Edge (supra) wherein it has not considered as a comparable company in the identical facts and circumstances of the case observing as under : “16. We have considered the rival submission and perused the material on record. A co-ordinate Bench of the Delhi Tribunal in the case of Ciena India Pvt. Ltd. v. DCIT in ITA Nos. 2948, 3324/Del/2013, has held as under : “9.2. We have heard the rival submissions and perused the relevant material on record. It can be seen from the information supplied by this company u/s 133(6) of the Act, a part of which has been reproduced in the TPO's order, that this company 'has developed a few of its own products in the area of identity management connectors.' Revenue from product licences stands at Rs.288.93 million as against the revenue from software development services at Rs.4829.57 millions. Though this company is more engaged in software development services, but, is also a software product company, which is evident from the information supplied by it to the TPO. Thus, the total profits of the company on entity level also, inter alia, include revenue from product licences. As there is no separate segmental information and it has been considered as comparable on entity level, it implies that the total revenue considered also consist of some part from product licences. In such circumstances, it is not possible to ascertain the impact of such revenue on the total revenue of this company. Further, there is no information available from the Annual report of this company or the data collected by the TPO u/s 133(6) of the Act to divulge the amount of revenue from software development services alone to the exclusion of revenue from product licences. As the assessee is not engaged in the sale of any software products, this company onentity level, cannot be considered as comparable. The Delhi Bench of the Tribunal in the case of Toluna India Pvt. Ltd. vs. ACIT (ITA No.5645/Del/2011, vide its order dated 26.8.2014 has
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held Persistent Systems Ltd. to be incomparable with Toluna India Pvt. Ltd., also a company engaged in providing software development services to its related parties alone. Similar view has been taken by the Tribunal in Lear Automotive India Pvt. Ltd. vs. ACIT (ITA No.5612/Del/2011) vide its order dated 22.12.2014. The ld. DR could not point out any distinguishing feature in the factual matrix of the assessee in question and Toluna India Pvt. Ltd., and Lear Automotive India Pvt. Ltd. Since both these companies are also engaged in the business of providing software development services to its AEs, similar to the activity done by the assessee, respectfully following the precedents, we order for the exclusion of this company from the list of comparables.”
Similarly, in the case of assessee’s group company, viz., Fiserv India Pvt. Ltd. for AY 2010-11, which company is also in the business of software development services, a co-ordinate Bench of the Delhi Tribunal in ITA No.6737/Del/2014 deleted Persistent from the list of comparables. 17. Further a perusal of page 484 (PB-2) Annual Report of Persistent reveals that it is not only engaged in the business of software development services but also manufacture and sale of software products and owns significant intangibles and that segmental data for services and products is not available and the ld DR, could not controvert this fact, so we concur with the order of co-ordinate bench of the Tribunal, and we direct exclusion of Persistent Systems Ltd. from the list of comparables.” 32. The Hon’ble jurisdictional High Court has affirmed the above decision of Tribunal in ITA No. 279 of 2016 observing as under : “6. As far as the first company, i.e., Persistent Systems Ltd. is concerned, the material on record – as found by the ITAT – shows that this company was involved in software development, software products and marketing. Furthermore and perhaps more importantly published segmental data was not available. In these circumstances, having regard to the specificity of the Transfer Pricing Rules under Rule 10(b) to 10(e) of the Income Tax Rules, the data of the said firm, i.e., Persistent Systems Ltd. could not have been included.”
Respectfully following this decision of Tribunal and the Hon’ble jurisdictional High Court who have considered the functional dissimilarity
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of this comparable, we direct the AO/TPO to exclude this comparable from the final set of comparables.
(iv). Thirdware Solutions: 33. This company was selected by the ld. TPO (page 206 & 207 of TPO’s order). The assessee has objected that this company is functionally different as the company was engaged in implementation, application, management and development services and only 9% revenue is from software services. There is insufficient segmental information and only geographical segmental details are there. This company has earned supernormal profits. Reliance is placed on the decision of ITAT Delhi in Sun Life India Service Centre Pvt. Ltd. (supra) and of ITAT Bangalore Bench I M/s. 3DPLM Software (ITA No. 1303/bang/2012).
Having considered the submissions of both the parties, we find that the comparability test of this company has been well examined by ITAT Delhi Bench in the case of Sun Life India Service Centre Pvt. Ltd. (supra) observing as under :
“10.12. After considering the rival contentions and pursuing the annual reports placed on record, we are of the opinion that this company cannot be selected as comparable for TP analysis. Here it is pertinent to mention that this company was considered by the ld.TPO as a comparable in the immediately preceding year in ITA No. 1489/del/2014 for assessment year 2009-10 as well. The Tribunal by aforenoted order has held it to be incomparable. Since no distinguishing features of the functional profile of this company and the assessee for the current year vis-a-vis the preceding year have been
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brought out to our notice, following the preceding, we direct the TPO/AO for removal of this company from the list of comparables.”
In view of the above decision, this company is directed to be excluded from the final set of comparables.
(v). PSI Data Systems : 35. This company was included by the assessee as comparable, but excluded by the TPO (page 170 & 194 of TPO’s order) for the reason that this company fails in the filter of net worth and stands merged with Aditya Birla Minacs IT Services Ltd. on 12.08.2009. The assessee submitted that the company has a positive net worth and it satisfied all the filters of comparability test.
The learned DR, on the other hand, submitted that this company has different functional profile, as it is a products company and earns income from license fees. It is also trading in products and as such does not qualify RPT filter.
After hearing both the sides, we find that the above company had been merged w.e.f. 12.08.2009 with Aditya Birla Minacs IT Services Ltd. and as such, said company had no locus standi for the whole year. Therefore, the TPO has rightly excluded this company from the list of comparables.
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(vi). Crazy Infotech Ltd.: 38. This comparable was selected by the assessee, but was rejected by TPO for the reason that the company had three segments, viz., computer hardware, software development and IT training with segmental revenues at Rs.2.46 crores, 2.67 crores and 0.88 crores respectively. Therefore, the relevant segments turnover of this company is less than 5 crores. Therefore, the company did not satisfy the service income filter and was excluded by the TPO from the final set of comparables. The objection of the assessee has been that turnover filter of less than 5 crores is not an appropriate filter for the comparability test. The ld. DR also submitted that there is no any foreign exchange revenue. All the turnovers from three segments of the company’s operations are generated around Chennai city and some districts places in Tamilnadu and neighbouring places of Andhra Pradesh. Even during the year under consideration, the company had received only 2.68 crores from software developments. Therefore, it cannot be taken as a comparable. The case law relied by assessee in Chryscapital Investment Advisors (India) Pvt. Ltd. of Hon’ble Delhi High court in ITA No. 417/2014 does not support the case of assessee.
The ld. DR, on the other hand, submitted that this company fails service income filter and has less than 75% of its revenue from services. It also fails export filter as it is a pure domestic company operating only in and around Chennai city and some districts, places in Tamil Nadu and neighboring places in Andhara Pradesh.
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Having considered the rival submissions, we find that the assessee company is engaged in 100% export of software development services to its holding company. The total percentage of turnover in software development segment of the aforesaid company is only 4.66% of the total turnover of Assessee Company, which too was generated from the state of Tamilnadu and Andhra Pradesh but not from foreign export as in the case of assessee. Therefore, the TPO has rightly excluded this company from the set of comparables.
(vii). Infosys Technologies Ltd.: 41. The TPO noticed that this company was finding place in the accept/reject matrix. He found it to be engaged into software development services qualifying all the filters applied by him. The ld. TPO included this company in the comparables for the reason that the turnover does not affect margins of companies in service industry; that the company earns its revenue primarily from providing SWD services and as such functionally comparable; that its 95% of total revenue is on account of SWD Services and only 4.38% of total revenue earns from software product; and that brand building and marketing expenses is only 0.34% of total revenue and R & D expenses constitutes only 2.07% of the Revenue and R &D spending does not necessarily create IPR. The assessee raised certain objections before the DRP against the inclusion of this company, and the ld. DRP accepted the objections of the assessee and following the decision of jurisdictional High
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Court in the case of Agnity India Technologies, 262 CTR 291 (Del.) excluded this company from the final set of comparables, which has been agitated by the Revenue in its appeal.
The ld. DR relying on the reasons given by the ld. TPO, submitted that the ld. DRP was not justified in excluding this company, as this comparable satisfies all the filters of comparability test, as given by the ld. TPO.
On the other hand, the ld. AR of the assessee submitted that this company has diversified business operations, viz., technical consultancy, designing development, system integration, package integration and implementation, testing and infrastructure management. This company had own intangible assets and spent 1130 cr. on AMP and Rs.57 cr. for brand building, Rs.435 cr. for R & D and the company has high turnover of Rs.21,140 crores. Reliance is placed on the following decisions :
(i). Sony Mobile Communication International AB (Branch Office) A.Y. 2009-10 (ITA No. 769/Del./2014). (ii). CIT vs. Agnity India Technologies Pvt. Ltd. (263 CTR 291(Del.) (iii). Ciena India Pvt. Ltd. (ITA No. 1453/Del./2014) ITAT, Delhi Bench (iv). Cash Edge India Pvt. Ltd. (ITA No. 5848/Del./2012 A.Y. 2008-09).
Having considered the rival submissions of both the parties, we find that in the case of assessee itself for A.Y. 2009-10, the coordinate bench of
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ITAT, Delhi has excluded this company from the set of comparables vide order dated 29.04.2016 observing as under :
“6.3. Turning to the functional comparability, we find that the assessee is simply a captive unit rendering services to its AE alone without acquiring any intellectual property rights in the work done by it in the development of software. The Hon’ble Delhi High Court in CIT vs. Agnity India Technologies (P) Ltd. (2013) 219 Taxmann 26 (Del) considered the giantness of Infosys Ltd., in terms of risk profile, nature of services, number of employees, ownership of branded products and brand related profits, etc. in comparison with the factors prevailing in the case of Agnity India Technologies Pvt. Ltd., being, a captive unit providing software development services without having any IP rights in the work done by it. After making comparison of various factors as enumerated above, the Hon’ble Delhi High Court held Infosys Ltd. to be incomparable with Agnity India Technologies Pvt. Ltd. The facts of the instant case are more or less similar inasmuch as the extant assessee is also a captive service provider and also not owning any branded products with no expenditure of its own on R&D etc. When we consider the above factors in a holistic manner, there remains absolutely no doubt in our minds that Infosys Technologies Ltd. is non-comparable with the assessee company. Respectfully following the judgment of the Hon’ble jurisdictional High Court in Agnity India (supra), we hold that Infosys Technologies Ltd., cannot be treated as comparable with the assessee company. This company is, therefore, directed to be excluded from the list of comparables.”
Respectfully following the decision of co-ordinate Bench, we find no good reason to interfere with the directions of ld. DRP with regard to exclusion of this company from the final set of comparables. Therefore, the appeal of the Revenue is liable to fail.
The assessee has raised issue regarding arithmetical errors while computing the net margin of comparable companies and the DRP has failed to adjudicate on the objections raised by the assessee on this issue. The
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assessee has relied on the decision of ITAT Delhi Bench in Rolls Royce India Pvt. Ltd. vs. DCIT (ITA No. 1310/Del./2015 – para 55). However, the assessee did not specify as to what arithmetical inaccuracies have been committed by the TPO. Therefore, the assessee is directed to demonstrate before the TPO the errors whatsoever.
In respect of ground No.9 for the use of multiple year data and determining the Arm’s Length Margin, the ld. TPO has rightly dealt with this issue and the decision of ld. DRP upholding the order of the TPO is correct. Rule 10B(4) of the Income-tax Rules clearly stipulates that normally current year data should be used. The proviso to the Rule allows the use of data pertaining to previous years only if the taxpayer can prove that there were certain factors relevant to those years that have affected the transfer prices of the year under review. However, the assessee has failed to bring any fact on record to cover the case of assessee under Rule 10B(4). The TPO has relied on a number of cases for the proposition that normally current year data should be used. Therefore, ground No. 9 of the assessee’s appeal is dismissed.
In respect of ground No. 10 regarding working capital adjustment margins of the comparable companies, the advances have not been considered for calculating working capital adjustment. The case of the assessee is that working capital does have an impact on the profitability of the company and more accounts receivable in case of a company would
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mean relatively lower profit. Therefore, the companies could be considered as fully comparable if they hold the same level of account receivable and account payable . The Transfer Pricing Officer has, however, rejected the claim of working capital adjustment on advances which has been upheld by the Dispute Resolution Panel and additional evidence filed before the DRP have not been adjudicated. The ld. TPO has calculated the working capital adjustments and dealt with this issue on para no. 32 of TPO order. The main objection of the assessee is that advance has not been considered while calculating the working capital adjustment. The assessee has relied on para 76 of the judgement of ITAT, Bangalore Bench in ITA No. 1112/ Bang /2010 & 1161/Bang/2011 in case of ARM Embedded Technologies Pvt. Ltd. Respectfully following the judgement of coordinate bench (supra), the plea taken by the assessee appears acceptable. However, we are afraid that while calculating the working capital adjustment, it is necessary to ascertain as to whether the advance so given was for revenue items purpose or capital items purpose. If the amount is found to be advanced for Revenue items purposes, then it should be considered for working capital adjustment and if it is found otherwise, the same cannot be considered for working capital adjustment. Therefore this issue is restored to the file of AO/TPO for deciding the same afresh in the light of observations made above. Accordingly, this ground deserves to be allowed for statistical purposes.
By means of Ground No. 11, the assessee has agitated the action of AO in upholding the decision of TPO for not making suitable adjustment to
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account for differences in the risk profile of the assessee, vis a vis, the comparable companies.
This issue has been elaborately discussed by the ld. TPO in his order (para 33). We are disinclined to interfere with the findings reached by the ld. TPO. Therefore, this ground is dismissed.
To sum up, we set aside the impugned order on the issue of addition towards transfer pricing adjustment and remit the matter to the file of AO/TPO for fresh determination of the ALP of the international transaction of rendering of software services in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings.
The only other issue, raised vide grounds Nos. 12 to 16 which survives for our consideration is the disallowance of deduction u/s 10AA of the Act amounting to Rs.10,01,05,706/-.
The facts apropos this issue are that the assessee claimed this deduction u/s 10AA. The AO refused it giving three major reasons as recorded on page 11 of his order as under : (a) There is no doubt that a foreign company which is registered with SEZ is eligible for deduction u/s 10AA. But such deduction is available only if the company fulfils all the conditions laid down in the said section. One of the most important criteria for availing the deduction u/s 10AA is to 'export' the software development, upgradation and maintenance of software
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manufacture by the undertaking. But, in the instant case there is no export. In fact, this is a case where certain services are rendered by the Branch Office to Holding Company on cost plus basis. The assessee tried to establish that the transaction between branch office and head office is basically a transaction between two separate taxable entities and such transaction should not be considered as dealing with self. However, this is not the truth as the subject dealing is essentially a transaction with self. The assessee has also taken an t argument that if the transaction between head office and branch office is transaction with self and if it is not an export then no income would accrue or arise in hand of branch office. The argument of the assessee is not acceptable in view of the fact that by deeming fiction, the branch office is treated as a separate taxable entity for determining the income which accrues or arises in respect of the activities undertaken by it. But the scope of deeming fiction cannot be extended beyond, to treat both the entities as separate legal entities. Therefore, even if the subject dealings represent transactions with self, the profit attributable to the permanent establishment for the activities undertaken by it, is taxable in India. (b) The main purpose of this section was to boost the export and thereby boost the inflow of foreign currency in India. The main reason behind granting of such exemption is to encourage the earning in foreign currency to replenish the depleted foreign reserve in India. So the legislative intent for introducing this section is to maximize the foreign currency reserve in India. So, even if the export is made but the sale proceeds in foreign currency are not received in, or brought into, India by the assessee in foreign exchange within specified period, the exemption shall not be allowed. In the case of the assessee, what has been received in India is only the remuneration, determined on cost plus basis, for development of computer software and not the sale proceeds of software sold by the assessee. (c) From the discussion made above, it is clear that the assessee cannot claim benefit of deduction u/s 10AA of the Act from transfer of its software to its Holding Company. The profit of the assessee from its Indian operation will only be determined once the software supplied by it is sold to third party. The assessee could have claimed deduction u/s 10AA of the Act on such profit subject to fulfillment of other conditions laid down in the said section. The assessee has not fulfilled all the conditions laid down in Section 10AA of the Act. For example, it has not remitted back the entire profit arising to it out of its supplies of software outside India. Hence, the deduction is not allowable to the assessee.”
The assessee is aggrieved against the denial of benefit of deduction u/s 10AA of the Act.
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This issue is covered by the decision of ITAT, Delhi Bench in ITA No. 769/Del./2014 in the case of assessee itself for A.Y. 2009-10, wherein the Coordinate Bench of Tribunal held as under : “13. We have heard the rival submission and perused the relevant material on record. We find that the assessee furnished complete details about the fulfillment of all the relevant conditions for the eligibility of deduction u/s 10AA before the AO as well as the DRP. Copies of such letters addressed to these authorities are available on pages 138, 166, 167, 173, 184, 193, etc. of the paper book. The AO has denied the deduction, inter alia, by holding that in the instant case there were no exports inasmuch as certain services were rendered by the branch office to its head office on cost plus basis. We do not find this view point of the AO as correct for the obvious reason that the assessee did not render these services to its head office, but, to SEMC, which is the holding company of the assessee’s head office. We have discussed in detail about the international transaction of rendering of Software services to its AE, on which transfer pricing adjustment was made. Under such circumstances, the point of view of the AO that the services were rendered by the assessee to its holding company, is wholly incorrect. As regards the other point considered by the AO for denial of deduction about the assessee rendering services to its head office alone, thereby leading to transaction with self, in our considered opinion, is again devoid of merits. Once the law requires an Indian branch of a foreign enterprise to be considered independent of its head office for taxation purpose, the AO cannot make out a case that there is no difference between head office and branch office in India and, hence, no deduction, which is otherwise available, should be given. If the principle of mutuality as invoked by the AO for denial of deduction u/s 10AA is taken to its logical conclusion, then, it would also mean that the assessee did not earn any income at all from its head office again on the principle of mutuality. Obviously, this position is not sustainable. Be that as it may, we are confronted with a situation in which the assessee has rendered software services to its AE and not head office. 14. The other reason of the AO for denial of deduction u/s 10AA is that the assessee did not receive any income at all in foreign currency and what was received was simply the cost incurred plus a certain mark up and the same cannot be considered as sale proceeds of the software sold by the assessee. Again, we are unable to countenance this view of the AO because the assessee brought in India sale proceeds from rendering of services to its AE. The remuneration model has been decided by the parties inter se with a cost plus mark-up, which in the instant case, is 15% of costs. What the assessee has realized in India is
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nothing, but, sale proceeds of software service provided by it to its foreign AE, which include not only the costs incurred by it in providing software services but also such mark-up. This, in our considered opinion, satisfies the requirement of receipt of foreign currency in India. Since the assessee has satisfied all the requisite conditions for availing of the benefit of deduction u/s 10AA, we are of the considered opinion that the authorities below erred in refusing to grant such deduction. We, therefore, overturn the impugned order on this issue and direct the grant of deduction u/s 10AA of the Act.”
Respectfully following the above decision, this issue is decided in favour of the assessee.
In the result, the appeal is partly allowed. The order pronounced in the open court on 22.06.2017. Sd/- Sd/- (S.K. Yadav ) (L.P. Sahu) Judicial member Accountant Member
Dated: 22.06.2017 *aks* Copy of order forwarded to: (1) The appellant (2) The respondent (3) Commissioner (4) CIT(A) (5) Departmental Representative (6) Guard File By order Assistant. Registrar Income Tax Appellate Tribunal Delhi Benches, New Delhi