CERNER HEALTHCARE SOLUTIONS PRIVATE LIMITED,BANGALORE vs. ITO, BANGALORE

O R D E R PER S. JAYARAMAN, ACCOUNTANT MEMBER :

These are cross appeals filed by the assessee and the Revenue against the order dt.12.11.2014 of the CIT (A) –IV, Bengaluru, for the assessment year 2010-11.

IT(TP)A.69 & 44/Bang/2015 Page - 2

2. Cerner Healthcare Solutions Private Limited, the assessee , is a captive service provider engaged in the business of rendering

software development services to its Associated Enterprise

("AE") at cost plus 15% mark-up. During the year, its international transaction on provision of software development services was at Rs.84,73,05,146/-.

The assessee undertook a Transfer Pricing ("TP") study, on a set of 15 comparables with weighted average operating profit/operating cost of 14.64% for software development services. The margin was arrived taking the average of three year data. The assessee's net margin of 15.35 percent was higher than the arm's length margin of comparable companies.

However, the TPO on his TP study , rejected assessee’s 10 comparables , retained 5 of them. In the TP proceedings, the TPO

• used single year data and modified certain filters

• undertook a restricted working capital adjustment of 1.98% (actual working capital adjustment is 6.54%)

• computed the operating margins of comparable companies by considering foreign exchange gain/losses as non-operating in nature.

The final set of 11 comparables selected by the TPO and its operating margin are as under : Sl.no Name of the Company Operating Margin

I ICRA Techno Analytics Limited (segmental) 24.94% 2 Infosys Technologies Limited 44.98% 3 Kals Information Systems Limited (segmental) 34.41% 4 Larsen &Toubro Infotech Limited 19.33% 5 Mindtree Limited (segmental) 14.83% 6 Persistent Systems & Solutions Ltd 15.38% 7 Persistent Systems Limited 30.35% 8 R S Software (India) Limited 10.29% 9 Sasken Communication Technologies Limited 17.36% IT(TP)A.69 & 44/Bang/2015 Page - 3

10 Tata Elxsi Limited (segmental) 20.93% 11 Thinksoft Global Services Limited 17.05% Arithmetic mean 22.71% Less: Working capital adjustment 1.98% Adjusted arithmetic mean 20.73%

3. On the corporate tax front, the AO found that the assessee paid Rs.3,47,42,280/- towards reimbursement of salaries, communication expenses, purchase of fixed assets and other miscellaneous expenses to Cerner Corporation , USA . The AO required the assessee to show cause as to why such payments be not treated as fee for technical services and why TDS was not made on such payments. After considering assessee’s reply, relevant documents and other materials, the AO held that the assessee is a subsidiary of Cerner Corporation , USA and is engaged in software development. It required technical knowledge,experience & skill in order to carry on its business which was met by Cerner Corporation , USA by deputing its employees who possessed the necessary technical knowledge, experience & skill. They have imparted the knowledge & skill to the members of assessee which falls within the meaning of technical training as contemplated in the MOU & DTAA and hence the AO held that the reimbursement amount is chargeable to tax. Since the assessee has deducted TDS u/s192 at Rs.83,97,648/-, the AO disallowed the balance sum at Rs.2,59,96,977/-u/s40(a)(i). Further, the AO held that data communication, voice communication and cell phone expenses incurred in foreign currency is attributable to delivery of software outside India and hence it should be excluded from the export turn over while computing deductions u/s 10A & 10AA, respectively.

IT(TP)A.69 & 44/Bang/2015 Page - 4

4. On an appeal, the CIT(A)-IV, Bangalure , intera alia, • upheld the turnover filter of 1 to 200 crores and rejected 5 companies having turnover greater than Rs. 200 crores viz Infosys Ltd, Larsen & Toubro Infotech Ltd, Mindtree Ltd (seg) , Persistent System Ltd, Sasken communication Technologies and Tata Elxsi Ltd(seg) and directed the TPO to exclude them as comparable;

• directed the TPO to rectify the error in the margin computation of Kals Information Systems Limited and errors in computation of receivable and payables of comparable companies for the purpose of working capital computation; and • directed the TPO to accept the claim of the assessee with respect to foreign exchange gain/loses as part operating revenue for computation of operating margins of the assessee and comparables.

• Relying on the Jurisdictional High Court decision in CIT v Tata Elxsi 349 ITR 198, the CIT(A) held that while computing deductions u/s 10A & 10AA, respectively, data communication, voice communication and cell phone expenses incurred in foreign currency should be excluded from the export turn over as well from total turnover .

• Following his decision rendered in ay 2009-10, the CIT(A) upheld the addition made u/s40(a)(i).

5. Aggrieved the assessee filed the appeal in IT (TP)A44/B/2015 with the following grounds :

IT(TP)A.69 & 44/Bang/2015 Page - 5 IT(TP)A.69 & 44/Bang/2015 Page - 6 IT(TP)A.69 & 44/Bang/2015 Page - 7 IT(TP)A.69 & 44/Bang/2015 Page - 8

6. The Revenue filed its appeal in IT (TP) A69/B/2015 with the following grounds :

GROUNDS OF APPEAL ON TRANSFER PRICING ISSUES IT(TP)A.69 & 44/Bang/2015 Page - 9

7. The AR submitted that the AO has not made any disallowances on reimbursement of salaries at Rs 8,397,648 under Section 40(a)(i) on the ground that the assessee has withheld and deposited taxes on Salary under Section 192. However, the CIT (A) has wrongly adjudicated on reimbursement of salaries, which was not the subject matter of appeal before the CIT (A) .

Since the CIT (A) has wrongly adjudicated on the matter, which was never the subject matter of appeal before him, the CIT(A) order has to be quashed.

Further, it was submitted that the AO has held that the reimbursement of expenses (other than salaries) is subject to withholding of taxes under Section

- The AO has erred in law and in facts by holding that there is no obligation to reimburse to Cerner Corporation expenses (in the nature of communication and other miscellaneous expenses) that had been incurred on behalf of the Assessee.

- The AO has erred by concluding that the above expenses are subject to withholding taxes and hence disallowed under Section 40(a)(i) of the Act.

- The AO has erred by treating the expenses as FTS without analysing the taxability of each expense individually

- The AO has erred in computing the deduction allowed under Section 10A and 10AA by not considering the increased amount of profit after disallowance under 40(a)(i).

8. The A R further submitted that for the similar issues, in the assessee's own case, the Hon'ble ITAT for AY 2006-07 [ITA No.627(Bang)/ 2011] has held that reimbursement of expenses is not liable to tax. Thus, the AR submitted that the CIT (A) has committed judicial impropriety and also erred in law in IT(TP)A.69 & 44/Bang/2015 Page - 10 refusing to follow the order passed by the Appellate Tribunal on same issues in the assessee's own case for AY 2006-07.

9. We have considered the rival submissions and gone through relevant documents. It is clear that the AO has not made any disallowances on reimbursement of salaries at Rs 8,397,648 under Section 40(a)(i) on the ground that the assessee has deducted and deposited taxes on salary u/s 192 and hence he added the balance sum at Rs.2,59,96,977/- only u/s 40(a)(i). It appears that the CIT (A), without considering the facts , the grounds of appeal before him and without properly applying his mind with reference to the ratios laid in the decision of this Tribunal in 2011 in the assessee’s case for ay 2006-07 which was brought to his notice , has extracted his earlier year order and concluded the matter that “ My decision taken is hereby followed and the action of the AO is upheld” which resulted in the above impropriety. In the facts and circumstances, the matters connected in the assessee’s appeal grounds nos 2 to 8 including the sub-grounds mentioned below ground no 8 are set aside to the CIT (A). The CIT (A) would decide them afresh after affording due opportunity to the assessee. Assessee’s appeal grounds nos 2 to 8 are treated as allowed for statistical purposes.

10. On the TP matters, the AR submitted that the following comparables are to be rejected as they are functionally different from it and their turn over is more than 10 times of its turnover. The gist of his arguments and the cases relied on, are as under:

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1. Infosys Technologies Ltd is functionally different, it owns significant intangibles and intellectual property. Differences in Risk levels assumed and has huge revenue from software products. Case laws : Electronics for Imaging India P Ltd ay 2010-11in IT (TP)A no. 212/Bang/2015 & CO No 94/ Bang/2015 dt 24.02.2016 , Ikanos Communications India Ltd ,ay 2010-11 in IT (TP)A no. 137/Bang/2015 & CO No 109/ Bang/2015 dt 10.11.2015, Finserv India – a y . 2009-10 etc

11. Further, the AR submitted that the following comparables are to be rejected as they are functionally different based on the judicial precedents. The gist of his arguments and the cases relied on, are as under :

2. KALS Information Systems Ltd is functionally different, its revenue consists of revenue from sale of software products . Its segmental break up is not available. Case laws : M/s. M/s. Mercedes Benz Research & Development India P Ltd, Electronics for Imaging India P Ltd, Ikanos Communications etc.

3. Persistent Systems Ltd is functionally different as it is providing product development and product design services. Earns revenue from licensing and sale of products and services. Its segmental breakup is not available.

Case laws : Electronics for Imaging India P Ltd , Equant Solutions India P Ltd etc

4. Tata Elxsi Ltd is functionally different, the "software development & services" segment includes various diversified services such as product designing, industrial IT(TP)A.69 & 44/Bang/2015 Page - 12 design and engineering, visual computing lab services and the sub-segment breakup of the same is not available.

Case laws : M/s. Mercedes Benz Research & Development India P Ltd , a y 2020-11 in IT(TP)A No 291/Bang/2015 & 427/Bang/2015,Electronics for Imaging India P Ltd etc

5. Sasken Communication Technologies Ltd is functionally different. Its revenue consists revenue from sale of software products. Segmental break up is not available. Further, the company undergone restructuring during the year hence not comparable for the year.

Case laws : Electronics for Imaging India P Ltd , ION Trading India P Ltd etc.

“ 2. The assessee challenged the action of the TPO before the DRP and raised objections against some of the comparables selected by the TPO. The DRP in its directions rejected 8 out of 11 comparables selected by the TPO. Thus, the Revenue is aggrieved by the directions of the DRP insofar as the comparables are directed to be excluded from the set of comparables.

“Having heard the contention, on perusal of the annual report, it is noticed by us that the segmental information is available for two segments i.e., services and sales. However, it is evident from the annual report that the service segment comprises of software development, software consultancy, engineering IT(TP)A.69 & 44/Bang/2015 Page - 13 services, web development, web hosting, etc. for which no segmental information is available and therefore, the objection of the assessee is found acceptable. Accordingly, Assessing Officer is directed to exclude the above company from the comparables.”

6. In view of the above facts, we do not find any error or illegality in the findings of the DRP that this company is functionally not comparable with that of a pure software development service provider. (2) Infosys Ltd.

2. The assessee objected against the selection of this company on the ground that this company has a big name and brand value and therefore it has a bargaining power. It also contended that the turnover of this company is Rs.21,140 crores, which is 442 times higher than the assessee.

3. The DRP accepted the objections of the assessee and by following the decision of the Delhi Benches of the Tribunal in the case of Agnity India Pvt. Ltd. v. ITO [2015] 58 taxmann.com 167 (Delhi – Trib), directed the TPO to exclude this company from the list of comparables.

5. In view of the above facts that Infosys Ltd. having a huge brand value and intangibles as well as having bargaining power, the same cannot be compared with the assessee who is providing services to its AE.

IT(TP)A.69 & 44/Bang/2015 Page - 14 (3) KALS Information Systems Ltd.

(4) Persistent Systems Ltd.

11. Therefore, when this company is engaged in diversified activities and earning revenue from various activities including licencing of products, IT(TP)A.69 & 44/Bang/2015 Page - 15 royalty on sale of products as well as income from maintenance contract, etc., the same cannot be considered as functionally comparable with the assessee. Further, this company also earns income from outsource product development. In the absence of any segmental data of this company, we do not find any error or illegality in the findings of the DRP that this company cannot be compared with the assessee and the same is directed to be excluded from the set of comparables. (5) Sasken Communication Technologies Ltd.

14. Thus, there is no dispute that this company earns revenue from 3 segments. However, the segmental operating margins are not available. Therefore, in the absence of segmental relevant data and particularly operating margins, this composite data cannot be considered as comparable with the assessee for software development services segment. Accordingly, we do not find any error or illegality in the findings of the DRP. (6) Tata Elxsi Ltd.

15. The assessee has raised objections against this company on the ground that the company is functionally different from the assessee. Though the TPO has considered the software development and services segment of this company as comparable to that of assessee, however, the assessee contended that even within the software segment, this company is engaged in diverse activities. The assessee placed reliance on the information in the annual report under the Directors Report and submitted before the DRP that even under the software development services segment, this company is engaged in various diversified activities including product design service, IT(TP)A.69 & 44/Bang/2015 Page - 16 innovation design, engineering service, visual computing labs, etc. The assessee also placed reliance on the decision of Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. v. ACIT, 137 ITD 1 (Mum).

12. The relevant portion of the order from the case of Pegasystems Worldwide India P Ltd ay 2010-11 & 1936/Hyd/2014 dt 16.10.2015 is extracted as under :

L&T Infotech Ltd: 14. Assessee has objected before TPO that the department in earlier years is rejecting this comparable as it has revenue from software services and products and segmental information was not available. Further, company did not respond to the notice issued u/s. 133(6) and challenged the said notice before the Hon'ble Bombay High Court. It was further objected to on the reason that IT(TP)A.69 & 44/Bang/2015 Page - 17 company had less margin in earlier year and therefore, rejected by the department, however, margin is high in this year, the department proposed it as a comparable and there is no consistency. These objections were rejected by TPO vide his analysis in page 40 of the order and from the earnings in foreign exchange reported, TPO considered the company as involved in software development services. The same objections were reiterated before DRP, but DRP rejected.

14.1. It was the submission of the Ld. Counsel that DRP at Hyderabad in the case of M/s. Sumtotal Systems India Pvt. Ltd., [PAN: AABCC9379C] for the same assessment year has excluded the same by stating as under:

We have gone through the submissions of the assessee, International Transactions involved, TP documentation of the Assessee, the most appropriate method adopted by TPO after rejecting the T P documentation of the Assessee, the filters used by TPO and also verified the financials of the comparables with reference to the notes on accounts & website notes. We noticed that certain notes on accounts made in certain cases do not do not match with that of the financials reported. We also noticed that meaning of the words used in the notes on accounts are not defined. Based on certain ITAT decisions, the earlier directions of this panel and other panels, the huge turnovers involved , huge brand value, their predominant presence in the market, in view o f incomplete details etc., this panel is of the view that the following comparables selected by TPO should be excluded from the list of final comparables chosen by TPO in the ALP computation. i)Infosys Technologies Ltd., ii)L&T Infotech Ltd., We direct TPO to exclude the above referred comparables from the list of final comparables chosen by TPO in the ALP computation and re-compute the ALP accordingly 14.2. It was the submission that once DRP has accepted the objections of Assessee whereas in Assessee’s case DRP did not exclude L&T Infotech while excluding Infosys Technologies Ltd., it was the submission that similar facts exist for both the companies and DRP has excluded only Infosys Technologies and not L&T Infotech Ltd., 14.3. After considering the objections of Assessee and perusing the order of DRP in the case of M/s. Sumtotal Systems India Pvt. Ltd., (supra), as extracted above, we are of the opinion that this company cannot be selected as comparable by the same reasons which DRP in the above referred case IT(TP)A.69 & 44/Bang/2015 Page - 18 accepted. Moreover, there are no segmental details and as seen from the annual report, revenues are reported from software development services and products, how much is from services and how much is from products could not be analysed. Even though TPO considered the software exports reported in earning in foreign currency as that of software development services, we are not sure whether the software exports reported therein exclusively pertain to services or products. As there are no segmental details, it is very difficult to analyse whether the incomes earned by the said company do really pertain to the similar services rendered by Assessee. As also seen from the income schedules, engineering services reported in earlier year were not there in this year, therefore, it is very difficult to analyse whether the company is functionally similar or not? Keeping in view of the above difficulties in analyzing the data and considering the reasons given by DRP in the case of M/s. Sumtotal Systems India Pvt. Ltd., (supra), we are of the opinion that L&T Infotech Ltd., cannot be selected as a comparable company. AO/TPO is directed to exclude the same from the list of comparables. Ground No.4 is allowed for statistical purposes.

…………………………………………………………………………………………………………………………………… ………………………………………………….. …………………….. ………………………………………… 22. Ground No.2 pertains to rejection of Infosys Technologies Ltd., from the list of comparables by DRP. We have already considered the opinion of DRP which is consistent not only in Assessee’s case but also in the case of M/s. Sumtotal Systems India Pvt. Ltd., (supra), extracted above while considering the exclusion of L&T Infotech Ltd. Since DRP’s decision is consistent with the stand taken by the Revenue in other cases and also by the ITAT in a number of cases on reason of turnover, brand equity, functional dissimilarity, we are of the opinion that DRP is correct in excluding the above company from the list of comparables. Therefore, there is no merit in the Revenue’s ground and the same is rejected.”

13. We find that the CIT (A) accepted the assessee’s plea by following the decisions of this Tribunal in Genisys Integrating System v DCIT 15 ITR Trib 475, Kodiak Networks v ACIT 15 ITR Trib 610, Trilogy e-Business Software India v DCIT 23 ITR Trib 464 and held that those companies which are within the turnover range of Rs one crore to Rs two hundred crore only should be taken into consideration for the TP study and hence directed the TPO to exclude Infosys Ltd, Larsen & Toubro Infotech Ltd, Mindtree Ltd (seg) , Persistent System Ltd, Sasken communication Technologies and Tata Elxsi Ltd(seg) against which the Revenue filed appeals. However, from the decisions extracted , supra , the assessee has made out a case for the exclusion of ICRA Techno Analytics Ltd. (seg), Infosys Technologies Ltd., KALS Information Systems Ltd, Persistent Systems Ltd, Sasken Communication Technologies Ltd, IT(TP)A.69 & 44/Bang/2015 Page - 19 Tata Elxsi Ltd and L&T Infotech Ltd. Following them, we direct the TPO to exclude them from the list of comparables. To that extent, the assessee’s appeal grounds are allowed and the Revenue’s appeal grounds are dismissed. With regard to the comparable Mindtree Ltd (seg), since the assessee has not opposed the Revenue’s appeal, the Revenue’s appeal on that comparable is treated as allowed.

16. The next issue is Revenue’s appeal against the decision of the CIT(A), who held that while computing deductions u/s 10A & 10AA, respectively, data communication, voice communication and cell phone expenses incurred in foreign currency should be excluded from the export turn over as well from total turnover on the basis of the Jurisdictional High Court decision in CIT v Tata Elxsi 349 ITR 98. We heard rival contentions. We do not find any infirmity in the decision of the CIT(A) and hence uphold it. To that extent, the Revenue’s appeal grounds are dismissed.

IT(TP)A.69 & 44/Bang/2015 Page - 20

17. In the result, the assessee’s appeal is allowed /treated as allowed and the Revenue’s appeal is partly allowed.

Order pronounced in the open court on 16th day of January, 2017.