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Income Tax Appellate Tribunal, BENGALURU BENCH B, BENGALURU
Before: SHRI. VIJAY PAL RAO
PER S. JAYARAMAN, ACCOUNTANT MEMBER :
This appeal is filed by the assessee against the assessment order
dt.20.09.2011, passed in pursuance to the directions of the DRP, for the
assessment year 2007-08.
The assessee is a wholly owned subsidiary of Sharp Laboratories of
America Inc (“SLA”). SLA is held by Sharp Electronics Corporation, America
(“SEC”), which in turn is held by Sharp Corporation, Japan. The assessee
IT(TP)A.1102/Bang/2011 Page - 2
is in the business of developing, testing, customising and maintaining high
quality software for Sharp Group Companies. Sharp India provides software
development and support services to SLA.
During the year, the assessee had entered into the international
transactions pertaining to provision of software development services with
its Associated Enterprises (AE) for Rs.19,35,17,429/-. In its TP study,
the assessee has adopted TNNM as the most appropriate method, selected
28 comparables and arrived at the arithmetic mean of unadjusted net
margin of the comparable companies at 14.53% of operating cost (with
arm’s length range being 8.8% to 20.25%). Since its net margin of 9.5%
was within + / - 5% of the ALP margin of the comparable companies, the
assessee considered that the price charged by it in respect of software
development service transactions is at arm’s length.
However, the TPO rejected the assessee’s TP study and has
undertaken FAR study. He picked up 26 comparables which included eight
of the following comparables selected by the assessee :
Sl.No. Name of the company 1 Helios & Matheson Information Technology Ltd, 2 Infosys Technologies Ltd 3 Lanco Global Systems Ltd 4 Mindtree Consulting Ltd 5 Quintegra Solutions Ltd 6 R S Software (India) Ltd 7 SIP Technologies and Exports Ltd 8 Sasken Communication Technologies Ltd
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The TPO arrived at arithmetic mean at 25.14% . After giving a deduction on
working capital and risk adjustment of 2.11%, he arrived an adjusted mean
margin of 23.03%. Thus, the TPO arrived a shortfall of Rs. 2,30,62,126/-
and treated it as transfer pricing adjustment u/s 92CA.
The AO while computing the Export Turn Over u/s 10A , since that
provision stipulated that freight, telecommunication charges and insurance
attributable to the delivery of articles or things or computer software
outside India and expenses, if any, incurred in foreign exchange in
providing the technical services outside India should be excluded in
arriving at the figure of export turnover, held that the expenditure
incurred by the assessee on leased line charges at Rs.2,502,447, IPLC
service charges (Leased Circuit) at Rs.1,332,376 & foreign travel
expenses at Rs.23,129,06 require exclusion and accordingly reduced
them from the export turnover but he has not reduced them from the
Total turn over and , thus, arrived the deduction u/s 10A at
Rs.1,67,84,994/- which was lesser from the assessee’s claim by
Rs.5,50,102/-. On an appeal, the DRP agreed with the view of the AO /
TPO and rejected the assessee’s contentions.
Aggrieved, the assessee filed this appeal before this Tribunal. Its
effective grounds of appeal are as under :
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Further, the assessee also filed an additional ground under Rule 11 of
the ITAT Rules, which read as under :
a) "that the learned TPO / DRP has failed to appreciate the fact that the following companies are not functionally comparable to the Appellant and therefore erred in law and facts in considering them as comparable companies :
i. E-Zest Solutions Limited ii. Quintegra Solutions Limited iii. Helios and Matheson Information Technology Limited
7.1 The assessee submitted that the above additional ground is being
(sic , raised) by way of abundant caution. The additional ground raise the
issue which is fundamental to the appeal, the non-admission and non-
adjudication of them would result in an incomplete appreciation and
adjudication of the matter, they are raised based on the ruling of the
Bangalore Tribunal in the case of NXP Semiconductors India Private
Limited Vs. ACIT, (IT(TP)A No. 1174/ Bang/ 2011) for AY 2007-08 wherein,
the above mentioned companies have been rejected as comparable
companies, the failure to raise them at an earlier stage is neither
willful nor wanton but due to the above reasons , no prejudice would
be caused to the Respondent by reason of the above additional grounds
being admitted and adjudicated and accordingly the balance of
convenience is in favour of such an order being passed by this Hon'ble
Tribunal etc and in the above circumstances pleaded that that this Hon'ble
Tribunal may be pleased to;
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admit and adjudicate the above additional ground, (i) pass any other order that may be required in the (ii) circumstances of the case and render justice.
We have considered the above submissions and find merit in them
and hence accepted the additional ground. We have perused the orders
and heard the rival contentions. Assessee is seeking exclusion of 18
comparables out of 26 companies selected by the TPO. This 18
comparables included 5 comparables selected by the assessee and retained
by the TPO Viz Helios & Matheson Information Technology Ltd, Quintegra
Solutions Ltd, Infosys Technologies Ltd, Mindtree Consulting Ltd & Sasken
Communication Technologies Ltd. Out of which, the asssesse filed
additional grounds on Helios & Matheson Information Technology Ltd &
Quintegra Solutions Ltd. For E- Zest Solutions Ltd also , the assessee filed
an additional ground, which we have admitted, supra. In view of the
decision of the special Bench in DCIT v Quark Systems India (2010) 42 DTR
414 which was followed by this Tribunal in M/s. Actiance India P. Ltd v.
ITO in IT(TP)A.1056/Bang/2011, dt.12.06.2015, we are of the opinion that
the assessee can raise a fresh ground for exclusion considering the
evolving nature of the transfer pricing. The assessee mainly sought
rejection of the following comparables based on functional difference and
on the turnover filter relying on this Tribunal decisions reported in M/s
Meriter LVS India (P) Ltd in IT(TP)A No 1231/Bang/2011 dt 16.10.2015 for
ay 2007-08, M/s Actiance India Private Ltd in IT(TP)A No 1056/Bang/2011
dt 12.06.2015 for ay 2007-08, M/s Maxim India Integrated Circuit Design
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Pvt Ltd in IT(TP)A No 28/Bang/2012 dt 31.03.2016 for ay 2005-06 etc ,
which is schematically extracted as under :
Sl Name Assessee’s reasons TPO’s reasons No 1 Avani Cimcon Super-normal profits, Based on Technologies Ltd Functionally different, information received Revenue from software u/s.133(6), it services & software qualifies all the products and no filters applied by the segmental information TPO available
2 Celestial Labs Ltd Functionally different, Based on Company is into information received Bioinformatics and has u/s.133(6), it is earned super normal mainly a R & D profit company and qualifies all the filters applied by the TPO 3 Kals Infosystems Functionally different, As per the reply Ltd Revenue from software received u/s. services & software 133(6), it qualified products and no all filters applied by segmental information the AO available 4 Mega Soft Ltd Functionally different, As per information Revenue from software u/s.133(6), its services & software consulting division is products and TPO has into software disregarded the development segmental information services and its SWD provided and taken the segment qualifies all company as comparable the filters applied by at enterprise level the TPO
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5 E-Zest Solutions Functionally different, Based on the Ltd Company is into high information end technical services u/s.133(6), it is which comes under the engaged in software nature of Knowledge development Process Outsourcing services and services qualifies all the filters applied by the TPO
6 Helios& Matheson Functionally different, Qualifies all the Information Company is engaged in filters applied. Techno-logy Ltd development and sale of Hence to be software products accepted as comparable 7 Quintegra Functionally different, It is in to software Solutions Ltd Company is into development preparatory software services and products, owns qualified all the intangibles. Also filters applied by the engaged in R & D TPO activities and hence creation of IPR 8 Thirdware Functionally different, Based on the Solutions Ltd company is engaged in information u/s product development 133(6), it qualified and earns revenue from all the filters applied sale of licences & by the TPO subscription. Segmental information for product development and software development not given in P & L A/c. 9 Ishir Infotech Outsources the work, As per the reply fails employee cost ˃ Ltd received u/s 133(6), 25% filter it qualifies all filters applied by the AO
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10 Lucid Software Functionally different. Pure software Ltd Company deals with development service software products provider. It is considered comparable as it qualified all the filters applied by the TPO
11 Flextronics Soft- Turnover filter. Qualified all the ware Systems Ltd Contradiction between filters applied hence (seg) 133(6) reply and annual to be accepted as report comparable 12 Infosys Turnover filter. It is into software Technologies Ltd Functionally different, development develops software services and products. Owns qualified all the significant intangibles, filters applied hence brand value, market to be accepted as leader, substantial R & D comparable expenses 13 Persistent Turnover filter. As per reply Systems Ltd Functionally different, received u/s engaged in software 133(6), it qualifies product designing and all filters applied by analytical services the AO 14 Sasken Turnover filter. Qualified all the Communication Functionally different, filters applied hence Technologies Ltd substantial R & D to be accepted as expenses, significant comparable intangibles, owns IPRs, underwent restructuring during the year 15 Tata Elxsi Ltd Turnover filter. Company satisfies (seg Functionally different, all filters. TPO has software segment considered the consists of product software design services. development & Innovation design services segment of engineering and visual the company as a computing labs. comparable Significant R & D, brand value, size
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16 Wipro Ltd TO filter. Functionally As the segmental different, both SWD and details are available product development for SWD segment (no segmental), on standalone basis significant intangibles & the same is market leader considered as a comparable 17 iGate Global TO filter Solutions Ltd (seg) 18 Mindtree TO filter Consulting Ltd
In the case of Meritor LVS (India) P Ltd v. ACIT in
IT(TP)A.1231/Bang/2011, dt.16.10.2015, for the assessment year 2007-08,
this Tribunal found that that assessee’s issues were with regard to
software development services segment as was with the Hewlett-Packard
(India) Globalsoft P. Ltd and hence considered the coordinate bench
decision in Hewlett-Packard (India) Globalsoft P. Ltd v. DCIT in IT(TP)A.
1031/Bang/2011, dt.23.09.2015, as a good precedent and considered
such decision as under:
“1. Avani Cimcon Technologies Ltd.
“39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company’s website, which reveals that this company has developed a software product by name “DXchange”, it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT – ITA No.7821/Mum/2011 wherein the Tribunal accepted the assessee’s contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was
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rendering software development services only and it was held as follows:- “7.8 Avani Cincom Technologies Ltd. (‘Avani Cincom’): Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis.” It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures were placed before us:-
Particulars FYs 05-06 06-07 07-08 08-09
Operating Revenue 21761611 35477523 29342809 28039851 Operating Expns. 16417661 23249646 23359186 31108949 Operating Profit 5343950 12227877 5983623 (3069098) Operating Margin 32.55% 52.59% 25.62% - 9.87%
It was submitted that this company has made unusually high profit during the financial year 06-07. The operating revenues increased 63.03% which indicates that it was an extraordinary year for this company. Even the growth of software industry for the previous year as per NASSCOM was 32%. The growth rate of this company was double the industry average. In view of the above, it was argued that this company ought to have been rejected as a comparable. 41. We have given a careful consideration to the submissions made on behalf of the Assessee and are of the view that the same deserves to be accepted. The reasons given by the Assessee for excluding this company as comparable are found to be acceptable. The decision of ITAT (Mumbai) in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra) also supports the plea of the assessee. We therefore accept the plea of the Assessee to reject this company as a comparable.”
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“Celestial Labs Ltd.
As far as this company is concerned, the stand of the assessee is that it is absolutely a research & development company. In this regard, the following submissions were made:- • In the Director’s Report (page 20 of PB-Il), it is stated that “the company has applied for Income Tax concession for in-house R&D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act.” • As per the Notes to Accounts - Schedule 15, under “Deferred Revenue Expenditure” (page 31 of PB-II), it is mentioned that, “Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred.” An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as “Deferred Revenue Expenditure” (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R&D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT – ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: “The learned D.R. however drew our attention to page-389 of the paper book which is an extract from the Directors report which reads as follows: ‘The Company has developed a de novo drug design tool “CELSUITE” to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Technology New Delhi) based on our insilico expertise (applying bio-informatics tools). The Company has developed a molecule to treat Leucoderma and multiple cancer and protected the IPR by filing the patent. The patent details have been discussed with Patent officials and the response is very favorable. The cloning and purification under wet lab procedures are under progress with our collaborative Institute, Department of Microbiology, Osmania University, Hyderabad. In the industrial biotechnology area, the company has signed the Technology transfer agreement with IMTECH CHANDIGARH (a very reputed CSIR
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organization) to manufacture and market initially two Enzymes, Alpha Amylase and Alkaline Protease in India and overseas. The company is planning to set up a biotechnology facility to manufacture industrial enzymes. This facility would also include the research laboratories for carrying out further R & D activities to develop new candidates’ drug molecules and license them to Interested Pharma and Bio Companies across the GLOBE. The proposed Facility will be set up in Genome Valley at Hyderabad in Andhra Pradesh.’ According to the learned D.R. celestial labs is also in the field of research in pharmaceutical products and should be considered as comparable. As rightly submitted by the learned counsel for the Assessee, the discovery is in relation to a software discovery of new drugs. Moreover the company also is owner of the IPR. There is however a reference to development of a molecule to treat cancer using bio-informatics tools for which patenting process was also being pursued. As explained earlier it is a diversified company and therefore cannot be considered as comparable functionally with that of the Assessee. There has been no attempt made to identify and eliminate and make adjustment of the profit margins so that the difference in functional comparability can be eliminated. By not resorting to such a process of making adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard.” 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for discovery of new drugs and has developed molecule to treat cancer. In the ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07- 08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the
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segmental data for each activity is not available and therefore this company should not be treated as comparable. Besides the above, the Assessee has point out to several references in the annual report for 31.3.2007 highlighting the fact that this company was develops biotechnology products and provides related software development services. The TPO called for segmental data at the entity level from this company. The TPO also called for description of software development process. In response to the request of the TPO this company in its reply dated 29.3.2010 has given details of employees working in software development but it is not clear as to whether any segmental data was given or not. Besides the above there is no other detail in the TPO’s order as to the nature of software development services performed by the Assessee. Celestial labs had come out with a public issue of shares and in that connection issued Draft Red Herring Prospectus (DRHP) in which the business of this company was explained as to clinical research. The TPO wanted to know as to whether the primary business of this company is software development services as indicated in the annual report for FY 06-07 or clinical research and manufacture of bio products and other products as stated in the DRHP. There is no reference to any reply by Celestial labs to the above clarification of the TPO. The TPO without any basis has however concluded that the business mentioned in the DRHP are the services or businesses that would be started by utilizing the funds garnered though the Initial Public Offer (IPO) and thus in no way connected with business operations of the company during FY 06-07. We are of the view that in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable.”
KALS Information Systems Ltd.
“46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal’s decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07
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on account of it being functionally different from software companies. The relevant extract are as follows: “16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds.” Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable. 47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable.”
Megasoft Ltd. : 24. This company was chosen as a comparable by the TPO. The objection of the assessee is that there are two segments in this company viz., (i) software development segment, and (ii) software product segment. The Assessee is a pure software services provider and not a software product developer. According to the Assessee there is no break up of revenue between software products and software services business on a standalone basis of this comparable. The TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius-BCGI Division does the business of product software. This company develops packaged products for the wireless and
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convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product software would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to product software) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO’s filter of more than 75% of revenues from software development services. The basis on which the TPO arrived at the PLI of 60.23% is given at page-115 and 116 of the order of the TPO. It is clear from the perusal of the same that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data.
In the order of the TPO, operating margin was computed for this company at 60.23%. It is the complaint of the assessee that the operating margins have been computed at entity level combining software services and software product segments. It was submitted that the product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions on page 381 to 383 of the PB-I). It was further submitted that Megasoft Limited has provided segmental break-up between the software services segment and software product segment (page 68 of PB-II), which was also adopted by the TPO in his show cause notice (Page 84 of PB-I). The segmental results i.e., results pertaining to software services segment of this company was: Segmental Operating Revenues Rs.63,71,32,544 Segmental Operating Expenses Rs.51,75,13,211 Operating Profit Rs.11,96,19,333 OP/TC (PLI) 23.11%
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It was reiterated that in the given circumstances only PLI of software service segment viz., 23.11% ought to have been selected for comparison. 27. It was further submitted that the learned TPO in case of other comparable, similarly placed, had adopted the margins of only the software service segment for comparability purposes. Consistent with such stand, it was submitted that the margins of the software segment only should be adopted in the case of Megasoft also, in contrast to the entity level margins. 28. Computation of the net margin for Mega Soft Ltd. Is therefore remitted to the file of the TPO to compute the correct margin by following the direction of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd.”
“E-Zest Solutions Ltd. 14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the information received in response to notice under section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company ought to be excluded from the list of comparables on the ground that it is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in ‘e-Business Consulting Services’, consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised Representative contends, are high end ITES normally categorised as knowledge process Outsourcing (‘KPO’) services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that since the Annual Report of the company does not contain detailed descriptive information on the business of the company, the assessee places reliance on the details available on the company’s website which should be considered while evaluating the company’s functional profile. It is also submitted by the learned Authorised Representative that KPO services are not comparable to software development services and therefore companies rendering KPO services ought not to be considered as comparable to software development companies and relied on the decision of the co-ordinate bench in the case of Capital IQ Information Systems (India) (P) Ltd. in
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ITA No.1961(Hyd)/2011 dt.23.11.2012 and prayed that in view of the above reasons, this company i.e. e-Zest Solutions Ltd., ought to be omitted from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparables by the TPO. 14.4 We have heard the rival submissions and perused and carefullyconsidered the material on record. It is seen from the record that the TPO has included this company in the list of comparbales only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act. It appears that the TPO has not examined the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I-Q Information Systems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O. /TPO is accordingly directed.” 6. Helios & Matheson Information Technology Ltd : “16. The next point made out by the assessee is with regard to the inclusion of items at (9) and (11) namely Helios & Matheson Information Technology Ltd., and KALS Information Solutions Ltd. (Seg). The primary plea raised by the assessee to assail the inclusion of the aforesaid two companies from the list of comparables is to be effect that they are functionally incomparable and therefore, are liable to be excluded. In sum and substance, the plea set up by the assessee is that both the aforesaid concerns are engaged in development and sale of software products which is functionally different from the services undertaken by the assessee in its IT-services segment. 17. As per the discussion in para 6.3.2. of the order of the TPO, the reason advanced for including KALS Information Systems Ltd., is to the effect that the said concern’s application software segment is engaged in the development of software which can be considered as comparable to the assessee company. The said concern is engaged in two segments namely application software segment and Training. As per the TPO, the application software segment is functionally
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comparable to the assessee as the said concern is engaged in software services. The stand of the assessee is that a perusal of the Annual Report of the said concern for F.Y. 2006-07 reveals that the application software segment is engaged in the business of sale of software products and software services. The assessee pointed out this to the TPO in its written submissions, copy of which is placed in the Paper book at page 420.3 to 420.4. The assessee further pointed out that there was no bifurcation available between the business of sale of software products and the business of software services, and therefore, it was not appropriate to adopt the application software segment of the said concern for the purposes of comparability with the assessee’s IT-Services Segment. The TPO however, noticed that though the application software segment of the said concern may be engaged in selling of some of the software products which are developed by it, however, the said concern was not into trading of software products as there were no cost of purchases debited in the Profit & Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessee’s segment of IT-Services. 18. Before us, apart from reiterating the points raised before the TPO and the DRP, the Ld. Counsel submitted that in the immediately preceeding assessment year of 2006-07, the said concern was evaluated by the assessee and was found functionally incomparable. For the said purpose, our reference has been invited to pages 421 to 542 of the Paper book, which is the copy of the Transfer Pricing study undertaken by the assessee for the A.Y. 2006-07, and in particular, attention was invited to page 454 where the accept reject matrix undertaken by the assessee reflected KALS Information Solutions Ltd. (Seg) as functionally incomparable. The Ld. Counsel pointed out that the aforesaid position has been accepted by the TPO in the earlier A.Y. 2006-07 and therefore, there was no justification for the TPO to consider the said concern as functionally comparable in the instant assessment year. 19. In our considered opinion, the point raised by the assessee is potent in as much as it is quite evident that the said concern has not been found to be functionally comparable with the assessee in the immediately preceding assessment year and in the present year also, on the basis of the Annual Report, referred to in the written submissions addressed to the lower authorities, the assessee has correctly asserted out that the said concern was inter alia engaged in sale of software products, which was quite distinct from the activity undertaken by the assessee in the IT Services segment. At the time of hearing, neither is there any argument put forth by the Revenue and
IT(TP)A.1102/Bang/2011 Page - 21
nor is there any discussion emerging from the orders of the lower authorities as to in what manner the functional profile of the said concern has undergone a change from that in the immediately preceding year. Therefore, having regard to the factual aspects brought out by the assessee, it is correctly asserted that the application software segment of the said concern is not comparable to the assessee’s segment of IT services. 20. With regard to the inclusion of Helios & Matheson Information Technology Ltd., the assessee has raised similar arguments as in the case of KALS Information Solutions Ltd. (Seg). We have perused the relevant para of the order of the TPO i.e., 6.3.21, in terms of which the said concern has been included as a comparable concern. The assessee pointed out that as in the case of KALS Information Solutions Ltd. (Seg), in the instant case also for A.Y. 2006-07 the said concern was found functionally incomparable by the assessee in its Transfer pricing study and the said position was not disturbed by the TPO. The relevant portion of the Transfer pricing study, placed at page 432 of the Paper book has been pointed out in support. Considered in the aforesaid light, on the basis of the discussion in relation to KALS Information Solutions Ltd. (Seg), in the instant case also we find that the said concern is liable to be excluded from the list of comparables.” 7. Thirdware Solutions Ltd. (Segment) : “15.1 This company was proposed for inclusion in the list of comparables by the TPO. Before the TPO, the assessee objected to the inclusion of this company in the list of comparables on the ground that its turnover was in excess of Rs.500 Crores. Before us, the assessee has objected to the inclusion of this company as a comparable for the reason that apart from software development services, it is in the business of product development and trading in software and giving licenses for use of software. In this regard, the learned Authorised Representative submitted that :- (i) This company is engaged in product development and earns revenue from sale of licences and subscription. It has been pointed out from the Annual Report that the company has not provided any separate segmental profit and loss account for software development services and product development services. (ii) In the case of E-Gain communications Pvt. Ltd. (2008-TII-04-ITAT- PUNE-TP), the Tribunal has directed that this company be omitted as a comparable for software service providers, as its income includes income from sale of licences which has increased the margins of the company.
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The learned A.R. prayed that in the light of the above facts and in view of the afore cited decision of the Tribunal (supra), this company ought to be omitted from the list of comparables. 15.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 15.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the case of E-Gain Communications Pvt. Ltd. (supra) has directed that since the income of this company includes income from sale of licenses, it ought to be rejected as a comparable for software development services. In the case on hand, the assessee is rendering software development services. In this factual view of the matter and following the afore cited decision of the Pune Tribunal (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand.” 8 & 9. M/S.Ishir Infotech Ltd. And Lucid Software Ltd :
“20. As far as comparable companies listed at Sl.No.11 & 14 of the final list of comparable companies chosen by the TPO viz., M/s.Ishir Infotech Ltd. And Lucid Software Ltd., is concerned, this Tribunal in the case of First Advantage Offshore Services Pvt.Ltd. Vs. DCIT IT (TP) No.1086/Bang/2011 for AY 07-08 held that the aforesaid companies are not comparable companies in the case of software development services provider. The nature of services rendered by the Assessee in this appeal and the Assessee in the case of First Advantage Offshore Services Pvt.Ltd.(supra) are one and the same. This fact would be clear from the fact that the very same 26 companies were chosen as comparable in the case of the Assessee as well as in the case of First Advantage Offshore Services Pvt. Ltd.(supra). The following were the relevant observations in the case of First Advantage Offshore Services Pvt.Ltd.(supra):
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The learned counsel for the assessee submitted that these two companies are also to be excluded from the list of comparables on the basis of the finding of this Tribunal in the case of Mercedes Benz Research & Development India Pvt. Ltd. dt 22.2.2013, wherein at pages 17 and 22 of its order the distinctions as to why these companies should be excluded are brought out. He submitted that the facts of the case before us are similar and, therefore, the said decision is applicable to the assessee's case also. 23. The learned DR however objected to the exclusion of these two companies from the list of comparables. On a careful perusal of the material on record, we find that the Tribunal in the case of Mercedes Benz Research & Development India Pvt. Ltd. (cited supra) has taken a note of dissimilarities between the assessee therein and Lucid Software Ltd. As observed therein Lucid Software Ltd. company is also involved in the development of software as compared to the assessee, which is only into software services. Similarly, as regards Ishir Infotech Ltd., the Tribunal has considered the decision of the Tribunal in the case of 24/7 Co. Pvt. Ltd to hold that Ishir Infotech is also out-sourcing its work and, therefore, has not satisfied the 25% employee cost filter and thus has to be excluded from the list of comparables. As the facts of the case before us are similar, respectfully following the decision of the co-ordinate bench, we hold that these two companies are also to be excluded. 21. Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to exclude the aforesaid companies from the final list of comparable companies for the purpose of determining ALP.”
Flextronics Software Systems Ltd (seg) : “26. Now taking up the question of exclusion of Flextronics Software Systems Ltd (seg), it is true that the decision of Motorola Solutions (India) P. Ltd (supra) also was for the very same year and also on software development services sector. This Tribunal held as under : “97.2 For a company to be included in the list of comparables, it is necessary that credible information is available about the company. Unless this basic requirement is fulfilled, the company cannot be taken as a comparable. It is true that ld. TPO is entitled to obtain information
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us/ 133(6), the object of which is primarily only to supplement the information already available on record, but not, as rightly submitted by ld. Counsel for the assessee, to replace the information. If there is a complete contradiction between the information obtained u/s 133(6) and annual report then the said information cannot be substituted for the information contained in annual report. We, therefore, are in ITA No. 5637/D/2011 149 agreement with ld. counsel for the assessee that this company cannot be included as a comparable in the set of comparables selected by ld. TPO on account of clear contradiction between contents of annual report and information obtained u/s 133(6).
Rule 10D(3) specifies the information and documents that are to be maintained by a person who is entering into international transactions. These are official publications, published accounts or those which are in public domain except for agreements and contracts to which assessee is privy. Once the annual report of a company is for a year different from the financial year ending 31st March, then without doubt, it will cease to be a good comparable, unless the information received in pursuance to a notice u/s.133(6) of the Act from such company, is reconciled with the figures available in such annual report. 28. In the case of Flextronics Software Systems Ltd (seg), no doubt the annual report was for the year ending 31.03.2007. However it was only for a nine months period. No reconciliation was attempted by the lower authorities between the figures given in such annual report with the figures which were made available by the said company to the TPO pursuant to notice issued to them u/s.133(6) of the Act. No doubt at page 123 of TP order, TPO has stated that the software development service revenues were more than 75% based on the following figures :
But how this segmentation was done by the TPO and the reconciliation of the said segmentation with the annual report of the assessee was never attempted or done. In such a situation we are of the opinion that Flextronics Software Solutions Ltd (seg) could not be considered as a proper comparable. We direct exclusion thereof.”
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Infosys Technologies Ltd. 12.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment. 12.2 Before us, the assessee contended that this company is not functionally comparable to the assessee and in this context has cited various portions of the Annual Report of this company to this effect which is as under :- (i) The company has an Intellectual Property (IP) Cell to guide its employees to leverage the power of IP for their growth. In 2008, this company generated over 102 invention disclosures and filed an aggregate 10 patents in India and the USA. Till date this company has filed an aggregate of 119 patent applications (pending) in India and USA out of which 2 have been granted in the US. (ii) This company has substantial revenues from software products and the break-up of the software product revenues is not available. (iii) This company has incurred huge research and development expenditure to the tune of approximately Rs.200 Crores. (iv) This company has a revenue sharing agreement towards acquisition of IPR in AUTOLAY, a commercial software product used in designing high performance structural systems. (v) The assessee also placed reliance on the following judicial decisions :- (a) ITAT, Delhi Bench decision in the case of Agnity India Technologies India Pvt. Ltd. (ITA No.3856/Del/2010) and (b) Trilogy E-Business Software India Pvt. Ltd. (ITA No.1054/Bang/2011) 12.3 Per contra, opposing the contentions of the assessee, the learned Departmental Representative submitted that comparability cannot be decided merely on the basis of scale of operations and the operating margins of this company have not been extraordinary. In view of this, the learned Departmental Representative supported the decision of the TPO to include this company in the list of comparable companies. 12.4 We have heard the rival submissions and perused and carefully considered the material on record. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy
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E-Business Software India Pvt. Ltd. (supra) for Assessment Year 2007- 08 is applicable to this year also. The argument put forth by assessee's is that Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the break up of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly.” 12) Persistent Systems Ltd. “17.1.1 This company was selected by the TPO as a comparable. The assessee objected to the inclusion of this company as a comparable for the reasons that this company being engaged in software product designing and analytic services, it is functionally different and further that segmental results are not available. The TPO rejected the assessee's objections on the ground that as per the Annual Report for the company for Financial Year 2007-08, it is mainly a software development company and as per the details furnished in reply to the notice under section 133(6) of the Act, software development constitutes 96% of its revenues. In this view of the matter, the Assessing Officer included this company i.e. Persistent Systems Ltd., in the list of comparables as it qualified the functionality criterion. 17.1.2 Before us, the assessee objected to the inclusion of this company as a comparable submitting that this company is functionally different and also that there are several other factors on which this company cannot be taken as a comparable. In this regard, the learned Authorised Representative submitted that : (i) This company is engaged in software designing services and analytic services and therefore it is not purely a software development service provider as is the assessee in the case on hand. (ii) Page 60 of the Annual Report of the company for F.Y. 2007-08 indicates that this company, is predominantly engaged in ‘Outsourced Software Product Development Services’ for independent software vendors and enterprises. (iii) Website extracts indicate that this company is in the business of product design services. (iv) The ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt. Ltd.(supra) while discussing the comparability of another company, namely Lucid Software Ltd. had rendered a finding that in the absence of segmental information, a company be taken into account for comparability analysis. This principle is squarely applicable to the company presently under consideration, which is
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into product development and product design services and for which the segmental data is not available. The learned Authorised Representative prays that in view of the above, this company i.e. Persistent Systems Ltd. be omitted from the list of comparables. 17.2 Per contra, the learned Departmental Representative support the action of the TPO in including this company in the list of comparables. 17.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details / information a company cannot be taken into account for comparability analysis, we hold that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. It is ordered accordingly.
13) Sasken Communication Technologies Ltd.: “109. Ld TPO noticed that the company was rejected in the TP document on the ground that the company fails its filter of business review and R&D to sales was more than 3%. However, no reasons were given for the business review. 109.1 Ld. TPO pointed out that R&D to sales being more than 3% is not acceptable for which detailed discussion has already been made earlier. He further noticed that the company has software services segment and segmental results are available for software services. He further pointed out that on the basis of information obtained u/s 133(6), the company qualifies onsite revenue filter (onsite revenues were to the extent 27.27% of its export revenues). After considering the assessee’s reply, ld. TPO included this company in the list of comparables. Ld. counsel pointed out that this company has incurred significant expenditure on research and development activity the same being 6.07% of sales. He further submitted that the company had significant intangible inasmuch as it develops siskin branded products. The company owns IPR Further it was pointed out before TPO that during the year the company had acquired Botnia Hightech
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F. and its two subsidiaries and thus, it had under gone significant restructuring. However, ld. TPO ignored these facts He relied on the following decisions: • IQ Information System (I) Pvt. Ltd., ITA No. 1961/Hyd./2012 (para no. 11 & 23, page 25); • Amerson Process Management India Pvt. Ltd., ITA No. 8118/Mum./2010 (para 16 page 15). 110. Ld. DR relied on the order of TPO and submitted that TPO considered the companies software services segment details only. We have considered the rival submissions and have perused the record of the case. 111. Ld. TPO has completely ignored the extraordinary business circumstances pointed out by assessee for which necessary adjustment was required to be made in accordance with Rule 10B(3) of Income Tax Rules.
However, since this adjustment was not possible, therefore, this company should not have been included in the list of comparables. Further, we find that the company owns IPR and has branded products which also distinguishes it from the assessee and, therefore, keeping in view the decision of Hon’ble Delhi High Court in the case of Agnity India Technologies Pvt. Ltd.(supra), we direct the ld. TPO to exclude this comparable from the list of comparables.
If we follow the coordinate bench decision in the case of Motorala Solution (India) P. Ltd, Sasken Communication Technologies Ltd needs to be excluded. However, as mentioned by us at para 24 above, where the contested comparable formed part of assessee’s own study, then the AO / TPO has to be given a chance for verification, in view of judgment of Hon’ble Punjab & Haryana High Court in the case of Quark Systems India P. Ltd (supra). Accordingly we remit the issue of comparability of Sasken Communication Technologies Ltd back to the AO / TPO for consideration afresh as per law. Ordered accordingly.”
14) Tata Elxsi Ltd. 14.1 This company was a comparable selected by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables on several counts like, functional dis-similarity, significant R&D activity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of comparables.
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14.2 Before us, it was reiterated that this company is not functionally comparable to the assessee as it performs a variety of functions under the software development and services segment namely (a) Product design services (b) Innovation design engineering and (c) visual computing labs. In the submissions made the assessee had quoted relevant portions from the Annual Report of the company to this effect. In view of this, the learned Authorised Representative pleaded that this company be excluded from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the stand o the TPO in including this company in the list of comparables. 14.4.1 We have heard both parties and carefully perused and considered the material on record. From the details on record, we find that this company is predominantly engaged in product designing services and not purely software development services. The details in the Annual Report show that the segment “software development services” relates to design services and are not similar to software development services performed by the assessee. 14.4.2 The Hon'ble Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. V ACIT (ITA No.7821/Mum/2011) has held that Tata Elxsi Ltd. is not a software development service provider and therefore it is not functionally comparable. In this context the relevant portion of this order is extracted and reproduced below :- “ …. Tata Elxsi is engaged in development of niche product and development services which is entirely different from the assessee company. We agree with the contention of the learned Authorised Representative that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company as fit for comparability analysis for determining the arm’s length price for the assessee, hence, should be excluded from the list of comparable portion.” As can be seen from the extracts of the Annual Report of this company produced before us, the facts pertaining to Tata Elxsi have not changed from Assessment Year 2007-08 to Assessment Year 2008-09. We, therefore, hold that this company is not to be considered for
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inclusion in the set of comparables in the case on hand. It is ordered accordingly.”
Wipro Limited “13.1 This company was selected as a comparable by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables or several grounds like functional dis-similarity, brand value, size, etc. The TPO, however, brushed aside the objections of the assessee and included this company in the set of comparables. 13.2 Before us, the assessee contended that this company is functionally not comparable to the assessee for several reasons, which are as under : (i) This company owns significant intangibles in the nature of customer related intangibles and technology related intangibles and quoted extracts from the Annual Report of this company in the submissions made. (ii) The TPO had adopted the consolidated financial statements for comparability purposes and for computing the margins, which contradicts the TPO’s own filter of rejecting companies with consolidated financial statements. 13.3. Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables. 13.4.1 We have heard both parties and carefully perused and considered the material on record. We find merit in the contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison. 13.4.2 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010) has held that a company owning intangibles cannot be compared to a low risk captive service provider who does
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not own any such intangible and hence does not have an additional advantage in the market. As the assessee in the case on hand does not own any intangibles, following the aforesaid decision of the co- ordinate bench of the Tribunal i.e. 24/7 Customer.Com Pvt. Ltd. (supra), we hold that this company cannot be considered as a comparable to the assessee. We, therefore, direct the Assessing Officer/TPO to omit this company from the set of comparable companies in the case on hand for the year under consideration.”
Following the above order of the Tribunal in Meritor LVS (India) P.
Ltd (supra), we direct exclusion of Celestial Labs Ltd, E-Zest Solutions Ltd,
Infosys Technologies Ltd, Kals Information Systems Ltd (seg), Lucid
Software Ltd, Wipro Ltd (seg), Accel Transmatic Ltd (seg), Avani Cimcon
Technologies Ltd, Flextronics Software Systems Ltd (seg), Helios &
Matheson Information Technology Ltd, Ishir Infotech Ltd, Persistent
Systems Ltd, Sasken Communication Technologies Ltd (Seg), Tata Elxsi Ltd
(seg) and Thirdware Solutions Ltd. In so far as Megasoft Solutions Ltd is
concerned, we direct the TPO to rework its segmental results and consider
its comparability only with regard to the software development services
segment.
Quintegra Solutions Ltd and other comparables : For exclusion of Quintegra Solutions Ltd and Lucid Software Ltd on the
basis of functional difference and for the exclusion of Infosys Technologies
Ltd, Wipro Ltd (seg), Flextronics Software Systems Ltd (seg), Persistent
Systems Ltd, Sasken Communication Technologies Ltd (Seg), Tata Elxsi Ltd
(seg), iGate Global solutions Ltd (seg) and Mind tree Consulting Ltd on the
basis of turn over filter, the assessee placed relied on the decision of the
coordinate bench of this Tribunal in the case of M/s. Actiance India P. Ltd v.
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ITO in IT(TP)A.1056/Bang/2011, dt.12.06.2015, for the assessment year
2007-08 which was also in software development services like this assessee.
For exclusion of Quintegra Solutions Ltd, the Tribunal held as under in para
18 of its order:
“ 18.1 This case was selected by the TPO as a comparable. Before the TPO, the assessee objected to the inclusion of this company in the set of comparables on the ground that this company is functionally different and also that there were peculiar economic circumstances in the form of acquisitions made during the year. The TPO rejected the assessee's objections holding that this company qualifies all the filters applied by the TPO. On the issue of acquisitions, the TPO rejected the assessee's objections observing that the assessee has not adduced any evidence as to how this event had an any influence on the pricing or the margin earned. 18.1.2 Before us, the assessee objected to the inclusion of this company for the reason that it is functionally different and also that there are other factors for which this company cannot be considered as a comparable. It was submitted that, (i) Quintegra solutions Ltd., the company under consideration, is engaged in product engineering services and not in purely software development services. The Annual Report of this company also states that it is engaged in preparatory software products and is therefore not similar to the assessee in the case on hand. (ii) In its Annual Report, the services rendered by the company are described as under : “ Leveraging its proven global model, Quintegra provides a full range of custom IT solutions (such as development, testing, maintenance, SAP, product engineering and infrastructure management services), proprietary software products and consultancy services in IT on various platforms and technologies.” (iii) This company is also engaged in research and development activities which resulted in the creation of Intellectual Proprietary Rights (IPRs) as can be evidenced from the statements made in the Annual Report of the company for the period under consideration, which is as under : “ Quintegra has taken various measures to preserve its intellectual property. Accordingly, some of the products developed by the company …………… have been covered by the patent rights. The company has also
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applied for trade mark registration for one of its products, viz. Investor Protection Index Fund (IPIF). These measures will help the company enhance its products value and also mitigate risks.” (iv) The TPO has applied the filter of excluding companies having peculiar economic circumstances. Quintegra fails the TPO’s own filter since there have been acquisitions in this case, as is evidenced from the company’s Annual Report for F.Y. 2007-08, the period under consideration. The learned Authorised Representative prays that in view of the submissions made above, it is clear that inter alia, this company i.e. Quintegra Solutions Ltd. being functionally different and possessing its own intangibles / IPRs, it cannot be considered as a comparable to the assessee in the case on hand and therefore ought to be excluded from the list of comparables for the period under consideration. 18.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables to the assessee for the period under consideration. 18.3.1 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details brought on record that this company i.e.Quintegra Solutions Ltd. is engaged in product engineering services and is not purely a software development service provider as is the assessee in the case on hand. It is also seen that this company is also engaged in proprietary software products and has substantial R&D activity which has resulted in creation of its IPRs. Having applied for trade mark registration of its products, it evidences the fact that this company owns intangible assets. The co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010 dt.9.11.2012) has held that if a company possesses or owns intangibles or IPRs, then it cannot be considered as a comparable company to one that does not own intangibles and requires to be omitted form the list of comparables, as in the case on hand. 18.3.2 We also find from the Annual Report of Quintegra Solutions Ltd. that there have been acquisitions made by it in the period under consideration. It is settled principle that where extraordinary events have taken place, which has an effect on the performance of the company, then that company shall be removed from the list of comparables. 18.3.3 Respectfully following the decision of the co-ordinate bench of the Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (supra), we direct that this company i.e. Quintegra Solutions Ltd. be excluded from the list of comparables in the case on hand since it is engaged in proprietary software products and owns its own intangibles unlike the assessee in the case on hand who is a software service provider.”
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In respect of Lucid Software Ltd, the Tribunal’s findings is similar to
the findings as in Meritor LVS (India) P. Ltd (supra), and the same is
extracted in the preceding paragraph in inner para.9 in page 22,supra. The
assessee’s Turn over is Rs. 19.36 crores .With reference to exclusion of
comparables on the basis of Turnover filter, the Tribunal in M/s. Actiance
India P. Ltd v. ITO in IT(TP)A.1056/Bang/2011, dt.12.06.2015, for the
assessment year 2007-08 dealt as under:
“19. Vis-a-vis Flextronics Software Systems Ltd (seg), iGate Global Solutions Ltd (seg), Infosys Technologies Ltd, Mindtree Consulting Ltd, Persistent Systems Ltd, Sasken Communication Technologies Ltd, Tata Elxsi Ltd (seg) and Wipro Ltd, Ld. AR submitted that these were having turnover in excess of Rs.200 crores against the assessee's miniscule turnover of Rs.13.11 crores. According to him, in the case of Triology E- Business Software India Ltd (supra), it was held clearly that companies having turnover in excess of Rs.200 crores could not be considered with companies having turnover much below Rs.100 crores. Coordinate benches have held that companies having turnover up to Rs.200 crores companies could not be compared with companies having turnover in excess of Rs.200 crores.”
Thereafter, the Tribunal considered the decision of Triology E-Business Software India Ltd v DCIT 140 ITD 540 Bang and the relevant portion is extracted ) as under :
“ 19. A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO.
IT(TP)A.1102/Bang/2011 Page - 35
In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is Q- Rs. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010). Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Q (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.
We, therefore, direct that Flextronics Software Systems Ltd (seg), iGate Global Solutions Ltd (seg), Infosys Technologies Ltd, Mindtree Consulting Ltd, Persistent Systems Ltd, Sasken Communication Technologies Ltd, Tata Elxsi Ltd (seg) and Wipro Ltd, be excluded from the list of comparables.”
Following the above order of the Tribunal ie M/s. Actiance India P.
Ltd v. ITO for the assessment year 2007-08, we direct exclusion of
Quintegra Solutions Ltd on the basis of functional difference and
exclusion of Infosys Technologies Ltd, Wipro Ltd (seg), Flextronics
Software Systems Ltd (seg), Persistent Systems Ltd, Sasken
IT(TP)A.1102/Bang/2011 Page - 36
Communication Technologies Ltd (Seg), Tata Elxsi Ltd (seg), iGate Global
solutions Ltd (seg) and Mind tree Consulting Ltd on the basis of turnover
filter .
The next issue is that the TPO erred in not making suitable
adjustments on account of differences in the risk profile of the
appellant vis-à-vis the comparables, while conducting comparability
analysis :
The assessee pleaded that functions under a limited risk
environment with most of the risk being assumed by its AE. It
bears lesser/ limited business risks than independent comparable
companies due to the nature of its revenue model as it is
guaranteed profits by way of a mark-up on costs incurred, in
provision of the software development services. However, the
independent companies have to bear the vagaries of the economic
and business factors that are prevailing in the industry and thus
could either incur losses or earn profits based on market conditions. Rule
10B (1)(e)(iii) provides that an adjustment should be made to the
profit margin of independent comparable companies to take into
account the differences in functions and risks. The OECD
Transfer Pricing guidelines also recognize adjustments to be
made to account for differences between controlled and
uncontrolled situations that would significantly affect the price
charged or return required by independent enterprises.
IT(TP)A.1102/Bang/2011 Page - 37
Accordingly, controlled and uncontrolled transactions are
comparable only when adjustments with respect to significant
differences between them in terms of risks assumed is made. In the
submissions made to the TPO, it has computed the adjustment
for the risk difference of the assessee vis-a-vis of the
comparable companies by placing reliance on the methodology of
risk adjustment as stated in the decision of the Hon'ble Bangalore
Tribunal in case of Philips Software Centre Private Limited vs. Asst.
Commissioner of Income Tax (119 TTJ 721) (2008 26 SOT 226) as below :
Average prime lending rate during FY 2006-07 (A) 11.88 percent
Average bank rate during FY 2006-07 (B) 6.00 percent
Difference between the prime lending rate and bank rate C (A - B) 5.88 percent
Risk Adjustment (C) 5.88 percent
However, the TPO did not provide/ make any risk-adjustment to
the margins on the ground that it does not have material impact
on the profitability and accordingly denied any risk adjustment. The
TPO has stated that the appellant bears the "single customer risk"
which more than offsets the other risks borne by independent
companies. It places reliance in M/s Intellinet Technologies India Pvt. Ltd.
vs ITO [ITA No. 1237 (Bang)/2010] in support of its and highligted
the relevant part as under :
IT(TP)A.1102/Bang/2011 Page - 38
“7.1 As seen from the records, the assessee had acquired the business and also earned income out of the said transaction by cost plus basis. Thus, it can be seen that the assessee has not encountered the risk of having a single customer, whereas the same cannot be said as regards the comparables. As pointed out by the learned counsel for the assessee, the comparables were dealing in open market and therefore, they were prone to the marketing and technical risks. They would have incurred certain expenditure on marketing services and also to safeguard the technical use by them. In such a case, the risk encountered by the assessee cannot be said to be the equivalent risks attached to the comparables. The risk attributed to the assessee by the TPO is an anticipated risk whereas the risk attributed by the assessee to the comparables is an existing risk. In such situation, the TPO ought to have given the risk adjustment to the net margin of the corn parables for bringing them on par with the assessee company. The assessee's contention that the risk adjustment should be at 5.5% or at the difference of prime lending rate of the RBI and the banks is not acceptable to us. Therefore, we direct the TPO to consider all the contentions of the assessee and after taking into account all the relevant material decide the percentage of risk adjustment to be made in accordance with law. This ground is accordingly, allowed for statistical purposes." Following the above decision , we direct the TPO to consider all the
contentions of the assessee and after taking into account all the
relevant material decide the percentage of risk adjustment to be
made in accordance with law. This ground is, accordingly, allowed
for statistical purposes."
With regard to the grounds on Corporate Tax matters :
In those grounds, the assessee pleaded that the leased line charges,
IPLC service charges (Leased Circuit) & foreign travel expenses ought not
to have been excluded or Alternatively, if they are excluded from the
export turnover similar exclusion be made in the Total turnover for arriving
the deduction u/s 10A, which are in accordance with the decision of the
Hon’ble Jurisdictional High Court in CIT v Tata Elxsi 349 ITR 98 and
IT(TP)A.1102/Bang/2011 Page - 39
accordingly we direct the AO to exclude them from the export turnover
and also from the Total turnover, while computing the deduction u/s 10A.
Thus, the corresponding grounds are allowed .
In the result, the assessee’s appeal is treated as allowed .
Order pronounced in the open court on 23rd day of November, 2016.
Sd/- Sd/-
(VIJAY PAL RAO) (S. JAYARAMAN) JUDICIAL MEMBER ACCOUNTANT MEMBER MCN* Copy to: 1. The assessee 2. The Assessing Officer 3. The Commissioner of Income Tax 4. The Commissioner of Income Tax (A) 5. DR 6. GF, ITAT, Bangalore By Order
Assistant Registrar