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Income Tax Appellate Tribunal, ‘B’ BENCH, BENGALURU
Before: SHRI VIJAY PAL RAO & SHRI INTURI RAMA RAO
This is an appeal filed by the revenue directed against the order of the CIT(A)-IV, Bangalore, dated 04/11/2011 for the assessment year 2006-07.
2. The revenue raised the following grounds of appeal:
IT(TP)A No.25/Bang/2012 Page 2 of 18
Brief facts of the case are as under: The respondent- assessee is a company duly incorporated under the provisions of the Companies Act, 1956. It is a wholly owned subsidiary of Winphoria Networks Holding Inc, which in turn is a wholly owned subsidiary of Winphoria Inc. It is engaged in the business of providing software development services to its Associated Enterprises (AE). Return of income for the assessment year 2005-06 was filed on 31/10/2005 declaring total income of Rs.13,84,202/-. The assessee-company also reported the following international transactions with its AE:
IT(TP)A No.25/Bang/2012 Page 3 of 18
The assessee-company sought to justify the consideration received for above international transactions entered with its AE to be at arm’s length price (ALP). The assessee-company also submitted the Transfer Pricing (TP) study report adopting operating profit to the operating cost (OP/OC) as profit level indicator (PLI) for the TP study. The assessee-company also applied TNMM which was considered to be the most appropriate method for the purpose of bench marking the above transactions. The assessee-company’s profit margin was computed at 14.6%. The assessee-company claimed that the same was comparable to other companies rendering software development services. For the purpose of TP study, the assessee-company had chosen 87 comparable companies whose average profit was computed at 10%:
IT(TP)A No.25/Bang/2012 Page 4 of 18
IT(TP)A No.25/Bang/2012 Page 5 of 18 The Assessing Officer (AO) referred the matter to the Transfer Pricing Officer (TPO) for the purpose of bench marking the above international transactions.
The TPO, by order dated 31/3/2008 passed u/s 92CA(3) of the Act, computed TP adjustment at Rs.3,11,31,449/-. The TPO rejected the TP study report submitted by the assessee- company but accepted the TNMM adopted by the assessee- company. The TPO proceeded to identity set of comparable entities by applying the following filters and finally selected the following 17 comparable entities:
1. Bodhtree Consulting Ltd.
2. Lanco Global Systems Ltd. 3. Exensys Software Solutions Ltd. 4. Sankhya Infotech Ltd. 5. Sasken Network Systms Ltd. 6. Four soft Ltd. 7. Thirdware Solution Ltd. 8. R S Software (India) Ltd. 9. Geometric Software Solutions Co.Ltd.
IT(TP)A No.25/Bang/2012 Page 6 of 18 10. Tata Elxsi Ltd. (seg) 11. Visual Soft Technologies Ltd.(seg) 12. Sasken Communication Technologies Ltd. (seg) 13. Igate (seg.) 14. Flextronics (seg) 15. L&T Infotech 16 Satyam 17. Infosys The TPO computed average profit margin of the comparables finally selected at 26.59% after giving working capital adjustment of 1.47%, adjusted the arithmetic mean PLI was determined at 25.12%. On the above basis, the TPO computed the TP adjustment as follows:
The AO passed the assessment order dated 26/12/2008 incorporating the above TP adjustment and also reducing telecommunication expenses and communication expenditure from the export turnover for the purpose of calculating deduction u/s 10A of the Act.
Being aggrieved by the above order, assessee-company filed an appeal before the CIT(A) contending inter alia that the TPO was not justified in reducing telecommunication expenditure from the export turnover for the purpose of calculating deduction u/s 10A and also the TPO was not justified in using only current
IT(TP)A No.25/Bang/2012 Page 7 of 18 year data. The TP adjustment was contested on the following grounds: i. TPO was not justified in applying RPT filter of 25% ii. Research & Development expenditure to sales in excess of 3% were excluded. iii. Filter of salary and wages to sales ratio in excess of 25%. iv. The revenue from software segment was more than 75% etc. .
8. The CIT(A), vide impugned order, granted relief that the companies having Related Party Transactions should be excluded from the comparables. Accordingly, directed for deletion of the following 12 companies:
Sasken Network Systems Ltd.
Four soft Ltd. 3. Thirdware Solution Ltd. 4. R S Software (India) Ltd. 5. Geometric Software Solutions Co.Ltd. 6. Tata Elxsi Ltd. (seg) 7. Sasken Communication Technologies Ltd. (seg) 8. Igate Solutions Ltd.(seg.) 9. Flextronics Software Ltd.(seg) 10. L&T Infotech 11. Satyam Computer Services Ltd. 12. Infosys Technologies Ltd.
The CIT(A), however, directed exclusion of Satyam Computers as the financial results are unreliable. The CIT(A) also directed to exclude Exensys Software Solutions Ltd., on the ground that there is extraordinary event of amalgamation of Hollol India Pvt.Ltd with the assessee. M/s.Thirdware Solutions Ltd. was excluded on the ground of functional dissimilarity.
IT(TP)A No.25/Bang/2012 Page 8 of 18 9. Being aggrieved by this order, the revenue is in appeal before us in the present appeal.
9.1 Learned Standing Counsel for department contested that the CIT(A) ought not to have held that comparables having related party transactions should be excluded as it is now settled law that the companies having RPT up to 25% can be held to be comparables. He further submitted that no company should be excluded on the ground of abnormal profits. Reliance in this regard was placed on the decision of the co-ordinate bench in the case of M/s.NTT DATA Global Delivery Services Ltd. vs. ACIT IT(TP)A No.1487/Bang/2013 dated 6/4/2016.
9.2 On the other hand, learned authorized representative of the assessee sought exclusion of the following companies on the ground of functional dissimilarities: i. Exensys Software Solutions Ltd. ii. Sankhya Infotech Ltd. iii. Four soft Ltd. iv. Thirdware Solution Ltd. v. Geometric Software Solutions Ltd. vi. Tata Elxsi Ltd.(seg) vii. Flextronics (seg)
We heard rival submissions and perused material on record. The issue of comparability of the above companies has come up for consideration before the co-ordinate bench in the case of M/s.NTT DATA Global Delivery Services Ltd (supra)
IT(TP)A No.25/Bang/2012 Page 9 of 18 wherein the comparability of these companies was discussed as under: “10. As regards Exensys Software Solutions Ltd., this comparable was selected by the TPO. The assessee-company objected to the inclusion of this company in the list of comparables on the ground that it is engaged in the software products and had related party transactions. This contention was rebutted by the TPO by drawing attention to the annual report of the company, wherein it was specifically stated that the company is not engaged in any software product sales. The TPO by exercising the power u/s 133(6) of the IT Act called for information from the said company wherein the said company had stated vide its letter dated 14/11/2007 that it had no related party transactions.
10.1 The ld.AR of the assessee-company had relied on the order of the co-ordinate bench of Tribunal in the case of ITO vs. Sunquest Information Systems (India) Pvt. Ltd. in IT(TP)A No.1302/Bang/2011 dated 11/6/2015 wherein this Tribunal, vide para.14 of its order, had directed the exclusion of this company from the list of comparables on the ground that the company is dealing in the software products and earned abnormal profits on account of amalgamation etc. 10.2 We perused the annual report of this company paced at pages 1097 to 1129 of the paper book. From perusal of page 1104 of the paper book it is clear that the nature of business of the company is software development services. Therefore, the submission of the assessee-company that it is engaged in the software products is not supported by the material on record. However, in the Director’s report (page 1106 of paper book), it is stated that the company Holool India Ltd., is amalgamated with assessee-company w.e.f. 1/4/2004 and it was further stated that the combined financial results were stated in the annual report. But it is not the case of the assessee-company that the amalgamating company is functionally dissimilar. In fact, the notes to accounts states that this amalgamated company i.e. Holool India Ltd. is also engaged in the same business as that of the assessee-company. Therefore, the event of merger itself cannot a factor for exclusion of this company from the list of comparables, as held by the Mumbai bench of the Tribunal in the case of Wills Processing Services (India) (P) Ltd. vs. DCIT (32 taxmann.com 18) (Mum). Hence, this company cannot be excluded from the list of comparables. ”
IT(TP)A No.25/Bang/2012 Page 10 of 18 11. As regards Flextronics Software Systems Ltd., this comparable was introduced by the TPO and the assessee- company objected for inclusion of this company in the list of comparables as it has related party transactions, and derives revenue both from the product sales as well as service. The TPO rebutted the contention of the assessee-company by drawing attention to the financial results of the company wherein it is clearly stated that the related party transactions are less than 25% and the segmental details are made available. It is further noticed that the revenue from the services constitutes more than 85%. Therefore, it can be treated as a software development services company as it passes through revenue filters adopted by TPO. During the course of hearing before us, the ld.AR of the assessee-company had relied on the order of the co-ordinate bench of Tribunal in the case of ITO vs. Sunquest Information Systems (India) Pvt. Ltd. in IT(TP)A No.1302/Bang/2011 dated 11/6/2015 and DCIT vs. Textron Global Technology Centre Pvt. Ltd. in IT(TP)A No.29/Bang/2012 dated 20/03/2015. On the other hand, learned DR relied on the order of the TPO. We heard the rival submissions and perused the material on record. The co-ordinate bench in the case of Sunquest Information Systems (India) Pvt. Ltd. (cited supra) deleted this company as comparable, vide par.26 of the order, on the ground that this company was engaged in the product sales also and therefore, it is functionally dissimilar. But from the order of the TPO as well as the financial results of the company, it is clear that 85% of the revenue of the company is derived from software services. Therefore, it can be safely classified as a software development services. Therefore, this company cannot be excluded from the list of comparables. Geometric Software Solutions: 12. This Company was selected by the assessee-company and accepted by the TPO as it satisfied all the filters applied by him. During the course of hearing, the learned AR of the assessee-company objected to the inclusion of this company on the ground of functional dissimilarities In this connection he relied on the decision of the co-ordinate bench in the case of Sunquest Information Systems (India) Pvt. Ltd. (cited supra). We heard the rival submissions and perused material on record. On perusal of the order in the case of Sunquest Information Systems (India) Pvt. Ltd. (cited supra), we find that this company was not considered in the said decision. Therefore, the reliance placed by the learned AR of the assessee-company on this decision is misplaced. Therefore, we
IT(TP)A No.25/Bang/2012 Page 11 of 18 do not find any reason to exclude this company from the list of comparables.
Sankhya Infotech: 13. This comparable was selected by the TPO. The assessee-company objected to the inclusion of this company as a comparable on the ground that personnel cost (salary) is less than 15% of the sales, which is less than the industry average of 47%. This objection was overruled by the TPO by citing that salary includes consultancy charges and overseas manpower cost and the two items are included in the personnel cost it comes to 26%. 13.1 Learned AR of the assessee-company again relied on the decision of the co-ordinate bench of the Tribunal in the case of Sunquest Information Systems (India) Pvt. Ltd. (cited supra). 13.2 We heard the rival submissions and perused material on record. Perusal of the decision of the co-ordinate bench of Tribunal in the case of Sunquest Information Systems (India) Pvt. Ltd. (cited supra) on this comparable reveals that the co- ordinate bench had followed the decision of Delhi Tribunal in the case of ITO vs. Colt Technology Services India Pvt.Ltd. (in dt.23/10/2012 and no reasons were given by the Tribunal as to why this company cannot be considered as a comparable. Therefore, we are unable to discern any ratio in the decision cited supra. Thus, the learned AR of the assessee-company could not adduce any other evidence in support of exclusion of this company from the list of comparables. In the circumstances, we uphold the action of the TPO in including this company in the list of comparable.
Tata Elxsi Ltd.: 14. This company was selected by the TPO as comparable. The assessee-company objected to the inclusion of this company in the list of comparables on the ground that major portion of the services are rendered only to Tata Consultancy Ltd., and Tata Sons Ltd. In other words, the assessee- company’s contention is that it has related party transactions of more than 25%. This contention of the assessee-company was rebutted by the TPO by holding that the revenue from Tata Consultancy Services was only Rs.8.41 crores out of total revenue of Rs.146.46 crores which amounts to 5.7% of the total revenue. Thus the contention of the assessee-company that it had related party transactions of more than 25% was not accepted by the TPO.
IT(TP)A No.25/Bang/2012 Page 12 of 18 14.1 Before us the learned AR of the assessee-company submitted that this company cannot be considered as comparable on account of functional dissimilarity as Tata Elxsi is engaged in product design services, design engineering services, visual computing labs. In this connection, he has drawn our attention to page 1250 to 1253 of the paper book wherein the activities of the said company were described. A perusal of these pages reveals that it is engaged in the product design services, design engineering services and visual computing labs. Learned AR of the assessee-company placed reliance on the decision of the Tribunal in the case of Sunquest Information Systems (India) Pvt. Ltd. (cited supra) and Textron Global Technology Centre Pvt. Ltd. (cited supra). 14.2 We heard the rival submissions and perused material on record. The co-ordinate bench of Tribunal in the case of Sunquest Information Systems (India) Pvt. Ltd. (cited supra) held (vide paras. 28 and 29 of the order) that it is not comparable with software development provider such as the assessee. “28. We have considered his submission and find that the ITAT Hyderabad Bench on identical facts, held on comparability of TATA Elxsi Ltd. as follows: “15.7. TATA ELXSI LIMITED : The objection of the assessee is that TATA Elxsi operating two segments – system communication services and software development services. The TPO accepted the software development services segment in his T.P. analysis and assessee’s objection is that the software development services segment itself comprises of three subservices namely (a) product design services (b)design engineering services and (c) visual computing labs. It was submitted that these services are not akin to assessee software services and segmental information of only product design services could have been accepted by the TPO as a comparable but not the entire software development service. Since company’s operations are functionally different as such, the same is not comparable. Further, assessee is also objecting on the basis of intangible scale of operations. The coordinate bench in the case of Intoto (supra) considered the issue as under in para 22: "22 Tata Elxsi Limited : As regards this company, the learned Counsel appearing on behalf of the assessee, filed before us the reply of Tata Elxsi Limited to the Addl. CIT (Transfer Pricing), IT(TP)A No.25/Bang/2012 Page 13 of 18 Hyderabad, wherein the concerned Officer has been informed that Tata Elxsi Limited is specialised Embedded Software Development Service Provider and that it cannot be compared with any other software development company. It was submitted that because of the specialisation and also because of diverse nature of its business, it is very difficult to scale-up the operations of Tata Elxsi Limited. In view of this, Tata Elxsi Limited has informed that it is not fair to use its financial numbers to compare it with any other company. The communication dated 25th August, 2009 to the TPO is placed before us. As this communication was not before the TPO at the time of transfer pricing adjustment we deem it fit and proper to remand this issue also to the file of the TPO to reconsider adopting this company as the comparable in the light of observations of this company to the TPO in the case of another assessee. In the result, the Assessing Officer/TPO is directed to reconsider the issue in accordance with law, after affording a reasonable opportunity of being heard to the assessee.” Keeping the assessee’s objections and the decisions of the Coordinate Bench, prima facie, we are of the view that Elxsi Limited is functionally different and has incomparable size to that of the assessee. Further, we are unable to verify whether the segmental profits adopted by the TPO pertain to entire software development services or pertain to limited service akin to assessee services. Since, these aspects are not clear from the data furnished before us, we direct the TPO to examine and in case, the segmental profits of a particular service is not available, then, to exclude the TATA Elxsi Limited from the list of comparables. Accordingly, this issue is restored to the file of TPO for examination and to decide in accordance with law and facts, after affording reasonable opportunity of being heard to assessee.”
Though the issue has been set aside to the AO in the aforesaid decision, the ITAT Hyderabad in the case of NTT Data India Enterprise Application Services Pvt.Ltd., order dated 23.10.2013 and in a subsequent ruling in the case of Invensys Development Centre (India) Pvt.Ltd., ITA
IT(TP)A No.25/Bang/2012 Page 14 of 18 No.1256/Hyd/2010 order dated 28.2.2014, held that TATA Elxsi is not functionally comparable with that of a software development service provider such as the Assessee.”
14.3 We do not find any reason to differ with the decision of the co-ordinate bench in the above cases. Accordingly, we hold that this company cannot be held to be comparable with that of the assessee-company on functional dissimilarities. In our opinion, these activities of the company cannot be equated with the software development service. Thirdware Solutions: 15. This company was selected by the TPO and the assessee- company objected to the inclusion of this company in the list of comparables on the ground that the financial data was not available in the public domain at the time of transfer pricing audit. The TPO held that the data was available in capital line as well as prowess data base. The TPO further held that more than 50% of the revenue is from software development services; this can be considered as a comparable. 15.1 Before us, learned AR of the assessee-company submitted that this company cannot be considered as comparable in the light of the decisions of the co-ordinate bench in the case (i) the Sunquest Information Systems (India) Pvt. Ltd.(cited supra); (ii) Textron Global Technology Centre Pvt. Ltd(cited supra) and (iii) Colt Technology Services India Pvt.Ltd. (cited supra). 15.2 We heard the rival submissions and perused the material on record. The co-ordinate bench (Delhi) of Tribunal in the case Colt Technology Services India Pvt.Ltd. (cited supra) recorded the finding on the above company as follows: “Thirdware Solutions Ltd, it was submitted that the said company has a diversified functional professional profile and is also engaged in sale of software licenses. They invest in R&D and also provides/sells software licenses and there are no segmental results available in its audited financials to segregate profitability from provision of software development services and from sale of software licences. These information were supported by the annual report for Financial year 2004-05 of the said company. In its annual report a generic disclosure was made that the company is involved in trading of software and provision of IT services. Schedule 14 of the Financial statement of the said company provide IT(TP)A No.25/Bang/2012 Page 15 of 18 information on details of purchases as per which the total purchase cost incurred by the company was about Rs. 56871743/- as against the total cost of Rs. 175527264/- which is about 32% of the total cost. Besides the said company earned abnormally high OP/TC margin of 66.11% during Financial Year 2004-05 indicating risk dissimilarity vis a vis the assessee which claimed to be a cost plus low risk captive which cannot be expected to earn such high profitability. ” Similarly co-ordinate bench of Tribunal in the case of Textron Global Technology Centre Pvt. Ltd(cited supra) recorded the finding as under: “26. As far as Thirdware Software Solution Limited is concerned, we find from the information furnished by the said company that though the said company is also into product development, there are no software products that the company invoiced during the relevant financial year and the financial results are in respect of services only. Thus, it is clear that there is no sale of software products during the year but the said company might have incurred expenditure towards the development of the software products.”
In view of the aforesaid decision rendered on identical facts and circumstances, we are of the view that Foursoft Ltd., and Thirdware Solutions Ltd., should be excluded from the list of comparable companies.” Similarly co-ordinate bench of Tribunal in the case of Sunquest Information Systems (India) Pvt. Ltd.(cited supra) “25. As far as Thirdware Software Solution Limited is concerned, we find from the information furnished by the said company that though the said company is also into product development, there are no software products that the company invoiced during the relevant financial year and the financial results are in respect of services only. Thus, it is clear that there is no sale of software products during the year but the said company might have incurred expenditure towards the development of the software products.
As far as Flextronics Software Limited is concerned, we find that at page 90 of his Order, the TPO has also observed that the said company has incurred expenditure for selling of IT(TP)A No.25/Bang/2012 Page 16 of 18 products and has incurred R & D expenditure for development of the products. The above facts clearly demonstrate that there is functional dissimilarity between the assessee and these companies and without making adjustment for the dissimilarities brought out by the TPO himself, these companies cannot be taken as comparable companies. The method adopted by the TPO to allocate expenditure proportionately to the software development services and software product activity cannot be said to be correct and reasonable. Wherever, the Assessing Officer/TPO cannot make suitable adjustment to the financial results of the comparable companies with the assessee company to bring them on par with the assessee, these companies are to be excluded from the list of comparables. Therefore, we direct the Assessing Officer/TPO to exclude these three companies from the list of comparables.”
15.3 The decision in the case of Sunquest Information Systems (India) Pvt. Ltd.(cited supra) is based on the non-availability of information to make suitable adjustments to bring the company on par with the assessee-company. However, in the present case, the TPO made available full details of the revenue and expenditure in respect of each of the segments and segmental details are very much available. However this company does not pass through the filter of 75% of revenue. Therefore, this company cannot be considered as software development service provider. Hence, we direct the TPO/AO to delete this company from the list of comparables.
Respectfully following the ratio of the decision in the case of M/s.NTT DATA Global Delivery Services Ltd (supra) we uphold the order of the TPO/AO in including the following comparable companies:
(i) Exensys Software Solutions Ltd., (ii) Sankhya Infotech (iii) Geometric Software Solutions Ltd., and (iv) Flextronics Software Systems Ltd.
IT(TP)A No.25/Bang/2012 Page 17 of 18 We direct the AO/TPO to exclude the following companies from the list of comparable companies:
(i) Foursoft Ltd., and (ii) Thirdware Solutions Ltd., (iii) Tata Elxsi Ltd.
The ground No.5 is that the CIT(A) was not justified in directing the Assessing Officer (AO) to re-compute the deduction allowable u/s 10A of the Income-tax Act, 1961 after reducing the telecommunication expenses both from the export turnover as well as the total turnover.
We heard rival submissions and perused the material on record. we find that the CIT(A) has followed the decision of the Hon’ble Karnataka High Court in the case of CIT vs. Tata Elxsi (349 ITR 908) for holding that the expenses excluded from the export turnover should also be excluded from the total turnover for computation of deduction u/s 10A of the Act. In view of the same, we see no merit in the ground of appeal of the revenue
In the result, the appeal filed by the revenue is partly allowed.