UTSTARCOM INC. (INDIA BRANCH),GURGAON vs. DDIT, NEW DELHI

ASSESSEE BY : Shri Rajan Sachdev, CA REVENUE BY : Shri T.M. Shiva Kumar, CIT DR Date of Hearing : 07.12.2016 Date of Order : 23.12.2016

O R D E R

PER KULDIP SINGH, JUDICIAL MEMBER :

“On the facts and in the circumstances of the case and in law, the learned Additional Director of Income Tax, Transfer Pricing Officer - 11(4), New Delhi ("Ld. TPO") and the learned Deputy Director of Income-tax, Circle 2(2), International Tax, New Delhi ("Ld. AO") under directions issued by the Hon'ble Dispute Resolution Panel - II, New Delhi ("DRP"), erred in making an addition to the Appellant's total income of INR 5,45,17,350 (i.e. INR 2,07,82,181 based on the provisions of Chapter X of the Income-tax Act, 1961 ('the Act') and INR 3,37,35,169 based on the other provisions of the Act.)

1. Transfer Pricing adjustment

1.1 On the facts and in the circumstances of the case, the Ld. TPO/ AO has erred in misconstruing the directions of Hon'ble DRP issued under section 144C( 5) of the Act while issuing final assessment order under section 143(3) read with section 144C(13) of the Act resulting in incorrect transfer pricing adjustment of INR 2,07,82,181 instead of INR 23,98,098.

1.2 On the facts and in the circumstances of the case and in law, the Ld. TPO has erred and the Hon'ble DRP has further erred in upholding / confirming the action of the Ld. TPO of disregarding, without material defects, the benchmarking analysis and comparable companies selected by the Appellant based on the contemporaneous data in the transfer pricing study report maintained as per section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 ('the Rules') and the various submissions made by the Appellant.

1.3 On the facts and in the circumstances of the case and in law, the Ld. TPO and Hon'ble DRP has erred, in adopting an arbitrary search strategy for selection of alleged comparable companies. Specifically, the Ld. TPO and Hon'ble DRP has grossly erred -

1.3.1 By adopting a flawed process of using notices under section (6) of the Act and relying on the same without providing complete information to the Appellant or an opportunity to cross examine the parties.

1.3.2 By disregarding the multiple year data approach and considering the data which was not available to the Appellant at the time of complying with the transfer pricing documentation requirements.

1.3.3 By adopting inappropriate filters in the process of selecting comparable companies;

1.3.4 By adopting companies as comparables having complete disregard to their functional comparability;

1.3.5 By inappropriately computing the operating margins of the alleged comparable companies.

1.4 On the facts and in the circumstances of the case and in law, the Ld. TPO has erred and the Hon'ble DRP has further erred in upholding / confirming the action of the Ld. TPO in not allowing appropriate adjustment(s) in accordance with the provisions of rule 1 OB of the Rules.

1.5 On the facts and in the circumstances of the case and in law, the Ld. TPO has erred and the Hon'ble DRP has further erred in upholding / confirming the action of the Ld. TPO in making in adjustment to the arm's length price of international transactions without giving benefit of the proviso to section 92C(2) of the Act.

1.6 On the facts and in the circumstances of the case and in law, the Ld. TPO has erred and the Hon'ble DRP has further erred in upholding / confirming the action of the Ld. TPO in not following principle of consistency

1.7 On the facts and in the circumstances of the case and in law, the Ld. TPO has erred and the Hon'ble DRP has further erred in upholding / confirming the action of the Ld. TPO in making the adjustment without demonstrating that the Appellant had any motive to shift profits outside of India.

1.8 On the facts and in the circumstances of the case and in law, the Ld. TPO followed an unjustified approach by issuing two show-cause notices without providing appropriate responses against the replies filed by the Appellant in response to the first show-cause notice. Accordingly, the change in the approach followed by the Ld. TPO clearly demonstrates a biased state of mind and is against the principle of natural justice.

1.9 On the facts and in the circumstances of the case and in law, the Hon'ble DRP and the Ld. AO/ TPO has erred not granting reasonable and adequate opportunity to the Appellant.

2. Denial of claim under Section 10A of the Act

2.1 That on the facts and in the circumstances of the case and in law, the Ld. AO has erred in denying and the Hon'ble

DRP has further erred in confirming the disallowance of Appellant's claim of deduction under Section 1 OA of the Act amounting to Rs. 3,37,35,169/-.

2.2 That on the facts and circumstances of the case and in law, the Ld. AO has erred in holding and the Hon'ble DRP has further erred in confirming the action of Ld. AO, that there is no export of software by the Branch in India to the Head Office.

2.3 That on the facts and circumstances of the case and in law, the Ld. AO has erred in holding and the Hon'ble DRP has further erred in confirming the action of Ld. AO, that the Appellant is not a separate taxable entity and as a consequence a person cannot earn profit from itself.

2.4 That on the facts and circumstances of the case and in law, the Ld. AO is not appreciating and the Hon'ble DRP has further failed to appreciate that if the approach adopted by them is considered to be in accordance with law, no income could be said to result in the hands of the appellant.

2.5 That on the facts and circumstances of the case and in law, the Ld. AO and the Hon'ble DRP have reached to erroneous conclusion of disallowing the deduction u/s 10A of the Act by placing their reliance on certain judicial precedents which are not applicable to the Appellant's case.

2.6 That on the facts and circumstances of the case and in law, the Ld. AO has erred in and the Hon'ble DRP has further erred in not following principle of consistency.

3. Interest under Section 234B of the Act

That on the facts and circumstances of the case and in law, the Ld. AO has erred in levying interest under section 234B of the Act consequent to the above disallowances.

4. Penalty proceedings u/s 271 (1)(c ) of the Act

That on the facts and circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings u/s 271 (1 )(c) of the Act as per the impugned order consequential to the above disallowances.

The above grounds are notwithstanding and without prejudice to each other. The objections embodied in the above grounds are mutually exclusive.”

S.No. Description of transaction Method Value (in Rs.) 1. Software development services TNMM 10,69,48,787 2. IT Enabled Services TNMM 4,43,50,895 3. Sales and marketing Support Services TNMM 6,60,79,561 4. Cost recharges paid TNMM 70,02,078 5. Purchase of fixed assets TNMM 1,34,73,082 6. Purchase of finished goods TNMM 169,44,92,221 7. Sale of fixed assets CUP 2,53,66,396 8. Reimbursement of expenses (Received) CUP 40,90,599 Total 196,18,03,618

6. Assessee company has claimed working capital adjustment on the ground that due to difference in level of working capital employed by the assessee vis-à-vis comparable companies working capital adjustment is required in this case. TPO in order to determine the liability of working capital adjustment (WCA) examined major comparables of the assessee and came to the conclusion that the companies are efficient profit maximizer but poor management may be the reason and as such, disallowed the working capital adjustment. Similarly, assessee also claimed risk adjustment while computing the margin on the ground that assessee is a risk free entity and operates in a controlled business atmosphere and consequently claimed the risk adjustment borne by comparables vis-à-vis assessee. So, the TPO computed the arms length price of international transactions qua software development services segment at Rs.87,71,509/- and IT Enabled Customer Support Services (ITES) segment at Rs.47,47,215/- and directed the AO to enhance the income of the assessee by Rs.1,35,18,724/-

TRANSFER PRICING GROUNDS GROUND NO.1.1

“74. Working capital adjustment: The taxpayer has objected to the TPO's action in not allowing adjustment on account working capital. According to the taxpayer the TPO was not justified in denying the claim on the ground of non availability of data about payables and receivables. It was submitted that such data is available and working capital adjustment can be computed.

Ltd 2011-TII-39-ITAT BANG-TP/etcl. The AO/TPO is, therefore, directed to grant working capital adjustment based on the OECD formula by taking 10.25% as PLR as this is the rate charged by the State Bank of India which is the leading bank in India on working capital loans. The aforesaid rates should, therefore, be adopted. However, for this purpose, the assessee shall have to provide reasonably accurate information about payables and receivables in both the segments i.e. SWD and ITES.”

So, when we examine the contentions raised by the ld. AR for the assessee in the light of the directions issued by DRP reproduced in the preceding paras, the only conclusion can be drawn is that the TPO while computing the working capital adjustment margin of comparable companies for software development and ITES, he has to take it on relevant standalone balances of assessee company only. So, in the given circumstances, we restore the matter to the TPO to compute working capital adjustment margin of comparable companies for software development and ITES segment of the assessee by taking into consideration the segmental position in respect of consolidated entity level position afresh by providing an opportunity of being heard to the assessee. So, grounds no.1.1 is determined in favour of the assessee.

GROUNDS NO.1.2 TO 1.9

12. For benchmarking the international transactions qua Software Development Segment (SDS), the assessee challenged the selection of three comparables, namely, Infosys Technologies Limited, KALS Information System Limited and Tata Elxsi Limited by the TPO benchmarking the international transaction qua software development segment and sought exclusion of three companies, namely, Vishal Information Technologies Limited (now known as Coral Hub Limited), Triton Corporation Limited and Maple eSolutions Limited in ITES segment on account of functional dis-similarity. We would take aforesaid comparables selected by the TPO for benchmarking SDS segment transactions one by one.

SOFTWARE DEVELOPMENT SEGMENT INFOSYS TECHNOLOGIES LIMITED

13. The assessee challenged this comparable on three grounds, viz., (i) it operates as a full-fledged enterprise; (ii) it has significant intangibles; and (iii) this comparable is having 1231 times the turnover of the assessee and it is a giant in software development.

However, ld. DR contended that huge difference in turnover is not a ground for exclusion of any comparable as the profitability element is a determining factor for inclusion or exclusion of any comparable company.

“5. The tribunal has observed that the assessee was not comparable with Infosys Technologies Ltd., as Infosys Technologies Ltd. was a large and bigger company in the area of development of software and, therefore, the profits earned cannot be a bench marked or equated with the respondent, to determine the results declared by the respondent-assessee. In paragraph 3.3 the tribunal has referred to the difference between the respondent- assessee and Infosys Technologies Ltd. For the sake of convenience, we are reproducing the same: “ Basic Particular Infosys Agnity India Technologies Ltd. Risk Profile Operate as full- Operate at fledged risk taking minimal risks as entrepreneurs the 100% services are provided to AEs Nature of Services Diversified- Contract consulting, Software application design, Development development, re- Services. engineering and maintenance system integration, package evaluation and implementation and business process management, etc. (refer page 117 of the paper book) Revenue Rs.9, 028 Crore Rs.16.09 Crores Ownership of Develops/owns branded/proprietary proprietary products products like Finacle, Infosys Actice Desk, Infosys iProwe, Infosys mConnect, Also, the company derives substantial portion of its proprietary products (including its flagship banking product suite ‘Finacle’) Onsite Vs. -As much as half of The appellant Offshore the software provides only development offshore services rendered services (i.e., by Infosys are remotely from onsite (i.e., services India) performed at the customer’s location overseas). And offshore (50.20%) (Refer page 117 of the paper book) than half of its service, income from onsite services. Expenditure on Rs.61 Crores Rs. Nil (as the Advertising/Sales 100% services promotion and are provide to brand building AEs) Expenditure on Rs. 102 crores Rs. Nil Research & Development Other 100% offshore (from India)

7. Learned counsel for the appellant Revenue during the course of hearing, drew our attention to the order passed by the TPO and it is pointed out that based upon the figures and data made available, the TPO had treated a third company as comparable when the wage and sale ratio was between 30% to 60%. By applying this filter, several companies were excluded. This is correct as it is recorded in para 3.1.2 of the order passed by the TPO. TPO, as noted above, however had taken three companies, namely, Satyam Computer Service Ltd., L&T Infotech Ltd. and Infosys Technologies as comparable to work out the mean.

8. It is a common case that Satyam Computer Services Ltd. should not be taken into consideration. The tribunal for valid and good reasons has pointed out that Infosys Technologies Ltd. cannot be taken as a comparable in the present case. This leaves L&T Infotech Ltd. which gives us the figure of 11.11 %, which is less than the figure of 17% margin as declared by the respondent- assessee. This is the finding recorded by the tribunal. The tribunal in the impugned order has also observed that the assessee had furnished details of workables in respect of 23 companies and the mean of the comparables worked out to 10%, as against the margin of 17% shown by the assessee. Details of these companies are mentioned in para 5 of the impugned order.”

KALS INFORMATION SYSTEMS LIMITED (KALS) 16. Assessee sought exclusion of KALS on ground of functional dis-similarity as it is engaged in executing end to end project through the entire value chain of Software Development Life Cycle (SDLC) right from design to delivery, testing and training as has been incorporated by ld. DRP at page 9 of its order. The ld. AR for the assessee contended that so far as functions performed by the assessee company are concerned it only confines to cutting and testing in India whereas intangibles are created in the US and relied upon Global Logic India Limited vs. DCIT (order dated June 6, 2015) (order available at page pages 313 to 321 of the compendium of case laws), NetHawk Networks India Pvt. Ltd. (order dated November 6, 2013) (order available at page pages 322 to 328 of the compendium of case laws) and LG Soft India Private Limited (order dated March 22, 2013) (order available at page pages 369 to 375 of the compendium of case laws).

Limited has been examined by the coordinate Bench, a similarly placed company which is also into the software development as in the case of assessee company, and held to be not a comparable company. When we peruse TP study available at page 47 of the paper book-1, it is not in dispute that the assessee company is only into cutting and testing of software development in India whereas the core design is made in US and intangibles are created in US.

Whereas, on the other hand, KALS has undisputedly drawn its income from software product and is engaged in executing end to end project through the entire value chain of software development life cycle and this issue has been determined by the coordinate Bench in the order (supra).

TATA ELEXI LIMITED (TEL)

Pvt. Ltd. which is also into software development services to its group company and ordered its exclusion on the ground that in response to the notice u/s 133(6) of the Act, the TEL has stated that it cannot be considered as comparable to any other software company due to its complex nature of business. The Hyderabad Bench of ITAT by following the decision of ITAT, Mumbai Bench held that due to complex nature of business as admitted by TEL itself, it cannot be treated as a valid comparable. Moreover, when numerous software development companies are available for comparability to benchmarking international transaction, the TEL having complex business model cannot be a valid comparable in assessee’s case.

ITES SEGMENT VISHAL INFORMATION TECHNOLOGIES LIMITED (NOW KNOWN AS CORAL HUB LIMITED) (VITL)

On the other hand, ld. DR opposed the exclusion of this company by relying upon para 35 of the ld. DRP order at page 30 wherein vide letter dated 05.02.2010 assessee relied upon data for the FY 2007-08 and not for FY 2006-07 required for the comparability of this company.

“38. In our view, even Vishal could not be considered as a comparable, as admittedly, its business model was completely different. Admittedly, Vishal’s expenditure on employment cost during the relevant period was a small fraction of the proportionate cost incurred by the Assessee, apparently, for the reason that most of its work was outsourced to other vendors/service providers. The DRP and the Tribunal erred in brushing aside this vital difference by observing that outsourcing was common in ITeS industry and the same would not have a bearing on profitability. Plainly, a business model where services are rendered by employing own employees and using one’s own infrastructure would have a different cost structure as compared to a business model where services are outsourced. There was no material for the Tribunal to conclude that the outsourcing of services by Vishal would have no bearing on the profitability of the said entity.”

TRITON CORPORATION LIMITED AND MAPLE eSOLUTIONS LIMITED

(order available at page pages 201 to 208 of the compendium of case laws) also ordered to exclude both these comparables for benchmarking the international transactions on ground of financial irregularities and criminal proceedings initiated against the Director of the company.

Furthermore, it is categorically mentioned in Director’s report that for most of the year, IT and ITES operations of the company continued to be suspended due to ongoing global crisis and unfavourable market conditions. In these circumstances, we order to exclude Triton Corporation Limited and Maple eSolutions Limited from the list of comparables for benchmarking international transactions.

CORPORATE GROUNDS GROUNDS NO.2.1, 2.2, 2.3, 2.4, 2.5, & 2.6 32. Ld. AR for the assessee contended that the benefit of section 10A was granted to the assessee company in Assessment Year 2003-04 and continued upto AY 2006-07 and further relied upon the judgment passed by Hon’ble jurisdictional High Court in the case of DDIT vs. Virage Logic International (ITA No.1108/2007 order dated 09.11.2016) & Ors. However, on the other hand, ld. DR relied upon the order passed by ld. DRP/AO.

“(i) Whether the transfer of computer software by the Indian branch to the head office can be said to be ‘sale’ to the head office out of India?

(ii) Whether the assessee is entitled to claim benefit of Section 10A of the Income Tax Act, 1961, as the software is developed by the branch as per the requirement of Head Office and not sold to any third party?”

“11. The decision in Moser Baer (supra) specifically dealt with the ITAT’s logic and reasoning in the present case. There the Division Bench of this Court noted that transmission of computer software from an Indian entity to its head office on the basis of an arm’s length price determined for export entitled the assessee to exemption under Section 10A. The Court is in agreement with the assessee’s contention that mere omission of a provision kin to Section 80HHC Explanation (2) or the omission to make a provision of a similar kind of that encompasses Explanation 2(iv) to Section 10A by itself does not rule out the possibility of treatment of transfer/ transmission of software from the branch office to the head office as an export. A plain reading of Section 80-IA(8) shows that transfer of any goods or service “for the purpose of the eligible business” to “any other business carried on by the assessee”, are covered. The only condition insisted upon by the Parliament was that the face value of such transactions was inconclusive and that the AO could determine the market value: for such transactions or sales. The incorporation in its entirety without any change in this provision [Section 80-IA(8)] to Section 10A through sub-Section (7) is for the purpose of ensuring that inter- branch transfers involving exports are treated as such as long as the other ingredients for a sale are satisfied.