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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI SUNIL KUMAR YADAV & SHRI S. JAYARAMAN
Per Sunil Kumar Yadav, Judicial Member
This appeal is preferred by the revenue and the cross objection is preferred by the assessee against the order of the CIT(Appeals). These were heard together and are disposed of by this common order.
2. The grounds of appeal raised by the revenue are as follows:-
“1. The order of the Learned CIT (Appeals), in so far as it is prejudicial to the interest of revenue, is opposed to law and the facts and circumstances of the case.
2. The learned CIT(A) erred in excluding iGate Global Solutions Ltd ., M/s L&T Infotech Ltd , Satyam Computers Ltd., lnfosys Technologies Ltd , M/s. Flextronics Software Systems Ltd. from the list of comparables in the segment by holding that the size, turnover of the company are deciding factors for treating a company as a comparable.
3. The learned CIT(A), on the facts and in the circumstances of the case. erred in holding that M/s. Bodhtree Consulting Ltd and Geometric Software Solutions Co. Ltd. can not be taken as comparables, without appreciating that the companies qualify all the quantitative and qualitative filters applied by the TPO in selection of these companies as comparables.
4. The learned CIT (A) has erred in directing inclusion of the M/s. VJIL Consulting Ltd., as a comparable without calling for a remand report from the TPO to ascertain the reasons for rejection of the comparable by the TPO.
5. The learned CIT(A) has erred in directing inclusion of the M/s. VJIL Consulting Ltd., without appreciating the TPO's conclusion that the company was an inappropriate comparable for the purpose of determining the arm's length price as it did not satisfy the qualitative filters applied for the purpose of comparability analysis.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 3 of 35 6. The learned CIT(A), on the facts and in the circumstances of the case, erred in holding that M/s. Tata Elxsi Ltd., can not be taken as a comparable, being functionally different without appreciating the fact that it satisfies all the all the quantitative and qualitative filters applied by the TPO.
7. The Ld. CIT(A) erred in excluding Exensys Software Solutions Ltd and Thirdware Solutions Ltd. from the list of comparables on the basis of Abnormal Profit without defining what constitutes abnormal profit filter and how the same is determined.
8. The learned CIT(A) erred in rejecting the diminishing revenue filter used by the TPO to exclude companies that do not reflect the normal industry trend.
9. The learned CIT(A) erred in rejecting the employee cost filter applied by the TPO to select companies which are predominantly into software development services.
10. The CIT (A) erred in allowing the assessee's claim of deduction u/s 10A in respect of unit-II without appreciating the fact that the custom bonding licenses were obtained only on 29.1.2002 while the business activity had commenced even before obtaining approval from the STPI authorities.
11. The Ld. CIT (A) erred in not appreciating the facts and circumstances brought out by the AO to determine whether the unit-II was a new undertaking or had formed by taking over an existing concern which had already a source of income.
12. The Ld. CIT (A) erred in relying on the decision of the Hon'ble ITAT for the A.Ys 2002-03, 2003-04 & 2004-05 without appreciating the fact that the decision relied upon has not been accepted by the department and further appeals u/s 260A have been filed before Hon'ble High Court which are still pending.
14. For these and such other grounds that may be urged at the time of hearing, it is humbly prayed that the order of the CIT(A) be reversed and that of the Assessing Officer be restored.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 4 of 35 15. The appellant craves leave to add, to alter, to amend or delete any of the grounds that may be urged at the time of hearing of the appeal.”
The grounds raised by the assessee in its CO are as follows:-
“1. That the learned Commissioner of Income-tax (Appeals) - IV, Bangalore ("learned CIT(A)") erred in upholding the learned Additional Director of Income-tax (Transfer Pricing) - I, Bangalore ("learned TPO")'s approach of rejecting the economic analysis undertaken by the Respondent and conducting a fresh economic analysis for determining the arm's length price.
2. That the learned CIT(A) erred in upholding the learned TPO's approach of disregarding application of multiple year/ prior year data as used by the Respondent in the transfer pricing documentation (“TP documentation") and holding that current year (i.e. Financial Year 2004-05) data for companies should be used for comparability.
3. That the learned CIT(A) erred in upholding the learned TPO's approach of using data as at the time of assessment proceedings, instead of that available as on the date of preparing the TP documentation for comparable companies while determining the arm's length price, ignoring the fact that this data was not available to the Respondent at the time of complying with the TP documentation requirements.
4. That the learned CIT(A) erred in upholding the learned TPO's approach of collecting selective information of the companies by exercising powers granted to him under section 133(6) of the Act that was not available to the Respondent in the public domain and relying on the same for comparability purposes.
5. That the learned CIT(A) erred in upholding the learned TPO's approach of ignoring the limited risk nature of the services provided by the Respondent and in not providing an appropriate adjustment towards the risk differential, even when full-fledged entrepreneurial companies are selected as comparables.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 5 of 35 6. That the learned CIT(A) erred in upholding the learned TPO's approach of using the foreign exchange earnings> 25% of total earnings filter for the exclusion of certain companies (Synetarios Technologies Limited and Indus Networks Limited (Segmental)) which are comparable to the Respondent in respect of its software development services.
7. That the learned CIT(A) erred in upholding the learned TPO's approach of using the onsite revenue> 75% of export revenue filter for the exclusion of certain companies (Akshay Software Technologies Limited, Goldstone Technologies Limited and Orient Information Technology Limited) which are comparable to the Respondent in respect of its software development services.
8. That the learned CITCA) erred in upholding the learned TPO's approach of exclusion of Melstar Information Technology Limited which is comparable to the Respondent in respect of its software development services.
9. That the learned CIT(A) ought to have held that certain companies (Flextronics Limited, Infosys Technologies Limited and Satyam Computer Services Limited) fail the test of comparability, even apart from having a turnover> INR 200 crores and thus not comparable to the Respondent in respect of its software development services.
10. That the learned CIT(A) ought to have held that certain companies (Exensys Software Solutions Limited and Thirdware Solutions Limited) fail the test of comparability, even apart from having a abnormally high profits and thus not comparable to the Respondent in respect of its software development services.
11. That the learned CIT(A) ought to have held that certain companies (Bodhtree Consulting Ltd and Geometric Software Solutions Co. Ltd) fail the test of comparability on account of having related party transactions> 15%, even apart from being functionally different and thus not comparable to the Respondent in respect of its software development services.
12. That the learned CIT(A) erred in confirming the action of the learned TPO of accepting Sankhya Infotech Limited which IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 6 of 35 fails the test of comparability, as comparable to the Respondent in respect of its software development services.
13. That the learned CITCA) ought to have held that Four Soft Limited fails the test of comparability on account of having related party transactions> 15% and is also functionally different as comparable to the Respondent in respect of its software development services. 14· That the learned C1T(A) erred in rejecting the Respondent's approach of applying the R&D expenses> 3% of total sales filter and including certain companies (Four Soft Limited, Visualsoft Technologies Limited, Sasken Communication Technologies Limited and Flextronics Limited) which are not comparable to the Respondent in respect of its software development services.
15. That the learned C1T(A) ought to have held that Visualsoft Technologies Limited fails the test of comparability as comparable to the Respondent in respect of its software development services.
16. That the learned C1T(A) ought to have held that companies with related party transactions> 15% are not comparable to the Respondent in respect of its software development services.
17. That the learned C1T(A) ought to haw held that companies which fail the test of comparability on the basis of functional difference, could not be taken as being comparable to the Respondent in respect of its software development services and should be excluded.
18. That the contention of the learned AO is bad in law and on facts while stating that the order of the learned CIT(A) is prejudicial to the interest of revenue and is opposed to law and the facts and circumstances of the case. That the Respondent craves leave to add to and/ or to alter, amend, rescind, modify the grounds herein above or produce further documents before or at the time of hearing of this Appeal.”
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 7 of 35
Apropos ground Nos. 1 to 9 of revenue’s appeal relating to transfer pricing (TP) adjustments, the revenue wants inclusion of certain comparables. The facts in brief on this issue culled out from the orders of authorities below are that the assessee is engaged in the business of Very Large Scale Integration (VLSI), business and development. The assessee is a leading supplier of high performance solution personnel/network access, enterprise, metro switch and core communications system applications, according to the assessee. It designs, manufactures and markets high performance digital and mixed-signal integrated storage for a range of markets. It is a subsidiary of Cypress Semiconductor Technology Ltd., Cayman Island and is engaged in providing software development and testing services to its Associates Enterprise (AE) as a captive service provider in the areas of integrated storage for memory interfaces, data communication applications.
During the impugned financial year relevant to AY 2005-06, the assessee rendered software development services to its AE at a price of Rs.38,92,30,738 for which a TP adjustment was made by the TPO to an extent of Rs.5,07,53,793.
The assessee filed an appeal before the CIT(Appeals), who partly allowed the appeal of the assessee.
The methodology adopted by the assessee for computing the operating profit is TNMM and the methodology adopted by the assessee
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 8 of 35 was not disputed by the TPO. No dispute was raised with respect to Profit Level Indicator (PLI) as the assessee and TPO has adopted PLI as OP/TC. Database used by the assessee as well as TPO is Prowess & Capitaline Plus. While preparing TP study, comparables selected for software development services by the assessee were 87, whereas the TPO has selected the comparables for computing the ALP as 17.
During the course of hearing, the ld. counsel for the assessee has filed a chart detailing the comparables taken by the TPO. In this chart, the assessee has also sought the inclusion of 2 more comparables. The TPO has taken the following 17 comparables:-
1. Bodhtree Consulting Ltd.
Lanco Global Systems Ltd. 3. Exensys Software Solutions Ltd. 4. Sankhya Infotech Ltd. 5. Sasken Network Systems Ltd. 6. Four Soft Ltd. 7. Thirdware Solution Ltd. 8. R S Software (India) Ltd. 9. Geometric Software Solutions Company Ltd. 10. Tata Elxsi Ltd. 11. Visualsoft Technologies Ltd. 12. Sasken Communication Technologies Ltd. 13. iGate Global Solutions Ltd. 14. Flextronics Software Systems Ltd. 15. L&T Infotech Ltd. 16. Satyam Computer Services Ltd. 17. Infosys Technologies Ltd.
The CIT(Appeals) has rejected 10 comparables out of the aforesaid 17 comparables. The rejected comparables are as under:-
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 9 of 35 1. Flextronics Software Systems Ltd. 2. L&T Infotech Ltd. 3. Infosys Technologies Ltd. 4. Satyam Computer Services Ltd. 5. iGate Global Solutions Ltd. 6. Exensys Software Solutions Ltd. 7. Thirdware Solutions Ltd. 8. Bodhtree Consulting Ltd. 9. Geometric Software Solutions Ltd. 10. Tata Elxsi Ltd.
Against the rejection of these comparables by the CIT(Appeals), the revenue has preferred an appeal before the Tribunal and placed heavy reliance upon the order of the TPO for the inclusion. Whereas, the ld. counsel for the assessee has contended that all these comparables were examined by the Tribunal in different cases, therefore they have to be retained. Copies of the orders of Tribunal have been filed.
Having carefully examined the rival submissions, we feel it proper to deal each and every comparable of which exclusion was sought by the revenue.
With respect of Bodhtree Consulting Ltd., the ld. counsel for the assessee has contended that this company’s function is different as it is engaged in product development and ITeS. This company was examined by the Tribunal in the case of Syassaris Software P. Ltd. v. DCIT in IT(TP)A No.1360/Bang/2011 for the AY 2005-06 by the Tribunal and the Tribunal has directed the exclusion of this company from the list of comparables, following the order of Tribunal in the case of Kodiak Networks India Pvt.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 10 of 35 Ltd. [IT(TP)A No.532/Bang/2015 & CO 119/Bang/2015]. A copy of order of Kodiak Networks India Pvt. Ltd. is placed on record. The relevant observations of the Tribunal are extracted hereunder for the sake of reference:-
“20. We have perused the orders and heard the rival contentions. Decision of the coordinate Bench in M/s. Kodiak Networks India Pvt. Ltd. (supra) has considered the comparability of M/s. Bodhtree Consulting Ltd. with M/s. Kodiak Networks India Pvt. Ltd., (supra). M/s. Kodiak Networks India Pvt. Ltd., (supra) was also providing software development services and its revenue came to Rs.16.23 crores. Concerned assessment year was also 2005- 06. Vis-à-vis comparability of M/s. Bodhtree Consulting Ltd., this Tribunal has held as under at para 32 to 34 of its order: “32. In the C.O. the Assessee has also prayed for exclusion of Bodhtree Consulting Ltd., which was considered as a comparable company by the TPO/DRP. Bodhtree Consulting Ltd. was chosen as a comparable company by the assessee in its TP study and same was accepted as a comparable by the TPO also. Even before the DRP, the assessee did not challenge the inclusion of this company as a comparable. However, in the CO filed before the Tribunal, the assessee has sought to challenge the inclusion of this company as a comparable in ground No.5(d). The law by now is well settled that assessee is entitled to raise an objection regarding comparability at any stage of proceedings and even in a case where the assessee has not raised objection for including the same as a comparable before the lower authorities, or the assessee had chosen in its TP study a company which it seeks to exclude as a comparable. The Special Bench of Chandigarh Tribunal in DCIT v. Quark Systems P. Ltd. (2010) 38 SOT 307 has held that the Tribunal is a fact finding body and therefore has to take into account all the relevant material and determine the question as per the statutory regulations and that tax payer is not estopped from pointing out a mistake in the assessment, though such IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 11 of 35 mistake is a result of evidence adduced by the tax payer. We therefore proceed to determine the comparability of Bodhtree Consulting Ltd. In this regard, we find that ITAT Hyderabad Bench in Ivy Computech (P) Ltd. v. ACIT, (2014) 43 taxman.com 183 (Hyd) Trib. Has taken the view that Bodhtree Consulting Ltd. should not be regarded as a comparable in the case of software development service provider. The ld. counsel for the assessee also brought to our notice that comparability of this company with software development provider was considered by this Tribunal in Mindtech India Ltd. v. DCIT, for AY 2009- 10, order dated 21.8.2014 and it was held as under:-
“14. The next aspect that was canvassed by the learned counsel for the assessee was with regard to the exclusion of the following comparables from the list of final comparables chosen by the TPO :
Bodhtree Consulting Ltd : As far as this company is concerned, the submission of the learned counsel for the assessee was that this company made extra ordinary profits during the previous year. Our attention was drawn to the fact that the operating profit / operating cost of this company jumped from 17% for F Y 2007-08 to 56% in FY 2008- 09. It dipped in FY 2009-10 to 40% and in FY 2010-11 it became (- ) 2% and 5% in FY 2011-12 and finally touched (-) 9% in FY 2012-13. Our attention was drawn to the fact that the Special Bench of the Tribunal, Mumbai, in the case of Maersk Global Centres (India) P. Ltd., in ITA.7466/Mum/2012, dt 07.03.2014 for AY 2008-09 had an occasion to consider the question as to whether companies having abnormal profits should be excluded as a comparable. The Special Bench took the view that it has to be shown that the high profit margin does not reflect the normal business conditions and only in such circumstances, high profit margin companies can be excluded. Our attention was drawn to the DRP's observation in its order on the issue which is as follows : "Bodhtree : The assessee has objected to selection of this entity on the basis of following objections:
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 12 of 35 • The entity has fluctuating margins • The company is more of a product company rather than software service company. The Panel has considered the objections of the assessee. Insofar as the contention regarding the rejection of this entity on the basis of fluctuating margin is concerned, in order to appreciate the compatibility or otherwise of this entity, it is important to first note that the Indian software industry uses two different models for revenue recognition. The first is the Time and Material (T&M) Contracts model in which Customer are billed on the basis of hours worked by the employees of supplier software companies. Hourly rates are agreed on by both parties and are applied to the total hours worked to arrive at the revenue that is to be recognized. The second is the Fixed Price Project Model (FPP). Under the Fixed Price Project Model, the total contract price is agreed upon between the parties. Billing may be done either at the end of the contract or over the period of the contract on the basis of the agreed milestone for billing. In this respect, the basis of revenue recognition by this entity can be seen from the annual report as below: 3. Revenue Recognition : Revenue from software development is recognised based on software developed and billed to clients. From perusal of the above, it is seen that this entity is engaged in building revenues through Fixed Price Project model. As is a natural corollary in such type of revenue recognition, some part of the expenditure may be booked in one year, for which the revenue may have been recognised in the earlier or subsequent year. Therefore, it is but natural that there is some fluctuation in the profitability margin of such entity. Merely because of such fluctuations, an entity engaged in the development of software, being functionally comparable to the assessee, cannot be rejected only on this ground."
14. The learned counsel for the assessee drew our attention to the fact that Bodhtree Consulting admittedly follows a fixed price project model whereby revenues from software development is recognized based on software and billed to IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 13 of 35 clients. In such business model expenditure for developing software would be billed in an earlier year but the revenue would be recognized in a subsequent year. It was his submission that this fact is recognized by the DRP in its order. According to him this circumstance would be sufficient to show that the margin reflected of this company does not reflect the normal business condition.
The learned DR placed reliance on the reason given by the DRP in its order.
We have considered the rival submissions. The Special Bench of the ITAT in the case of Maersk Global Centres (supra) had an occasion to deal with the question as to whether high profit margin making companies should be excluded as a comparable. The Special Bench after considering several aspects held in para 88 of its order that the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special bench held that in such cases it would require further investigation to ascertain the reasons for unusually high profit and in order to establish whether the entities with such high profits can be taken as comparable or not. In the light of the aforesaid decision of the Special Bench and in view of the admitted position that the assessee follows Fixed Price Project model where revenues from software development is recognized based on software developed and billed to clients, there is a possibility of the expenditure in relation to the revenue being booked in the earlier year. The results of Bodhtree from FY 2003 to 2008 excluding FY 2007 as given by the learned counsel for the assessee were also perused. Perusal of the same shows, that there has been a consistent change in the operating margins. The chart filed by the assessee in this regard is given as an annexure to this order. It appears to us that the revenue recognition method followed by the assessee is the reason for the drastic variation in the profit margins of this company. In the given circumstances, we are of the view that it would be safe to exclude Bodhtree Consulting from the final list of IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 14 of 35 comparables chosen by the assessee. We hold and direct accordingly.”
33. The ld. counsel for the assessee filed before us a chart showing the fluctuation margins of Bodhtree Consulting Ltd., which are as follows:-
As can be seen from the above analysis, this company has erratic margins and growth over the years. The margins of Bodhtree are consistently changing. This reflects that the revenue recognition policy followed by Bodhtree is not proper and is resulting in consistent change in margins. Further, the growth rate over the years is also fluctuating to extremes. Further, growth in revenues is not supported by growth in expenses. In some cases, expense growth is higher than the revenue growth. Also salary cost ratio is widely fluctuating. These circumstances are peculiar in nature and require further analysis, without which this company should be rejected as a comparable.
Contention of the Ld. DR that assessee was into software product development cannot be accepted since the TPO himself had considered assessee to be into software development services. This is clear from the segmental results compiled by him at para 2 of his order which has been reproduced by us at para six above. Accordingly we are of the opinion that the decision of the coordinate bench in M/s. Kodiak Networks India Pvt. Ltd., would apply on all four squares. We therefore direct exclusion of M/s. Bodhtree Consulting Ltd, from the list of comparables.”
Since the Tribunal has examined the profile and datas of Bodhtree Consulting Ltd. and has come to the conclusion that this company cannot be taken as good comparable for computing the ALP, we find no justification in re-examining the issue again. Accordingly, following the IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 15 of 35 aforesaid order of Tribunal, we uphold the exclusion of Bodhtree Consulting Ltd. from the list of comparables.
With regard to Exensys Software Solutions Ltd., the ld. counsel for the assessee has contended that this comparable was also examined by the Tribunal in the case of Syassaris Software P. Ltd. (supra) in para 10 at page 9 of the Tribunal’s order and the Tribunal has confirmed the order of CIT(Appeals) who excluded this company from the list of comparables. The relevant observation of the Tribunal are extracted hereunder:-
“10. The contentions of both counsels on M/s. Exensys Software Solution Ltd (supra) have been narrated by us at para two and three above. No doubt it has been held by Hon'ble Delhi High Court in Cryscapital Investment Advisors India P. Ltd, (supra) that excessive profits or abnormal loss by itself would not be a reason for exclusion of a company from the list of comparables which was otherwise similar to the tested party. However what we find in the case of Exensys Software Solution Ltd, is that there was an amalgamation of one company named Holool India Ltd, with Exensys Software Solutions Ltd, during the relevant previous year which was clearly mentioned in its annual report. Further the said company also had earnings from BPO services, and segmental results were not available. Thus it was not a case where exclusion was directed by the CIT (A) solely for a reason of abnormal profits. Such directions were given considering the fact that such profits arose out of an extra ordinary event of amalgamation. This has not been rebutted by the Revenue. Revenue has also not produced anything to show that segmental results of the said company was available. We are of the opinion that CIT (A) had directed exclusion of Exensys Software Solutions Ltd, from the list of comparables correctly. We do not find any ground to interfere with the decision of the CIT (A). Ground.2 of the Revenue stands dismissed.”
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 16 of 35 15. Since the Tribunal has already examined the reasonableness of exclusion of this company, we find no justification to deal with the issue again. Accordingly, following the aforesaid order of the Tribunal, we approve the exclusion of this company i.e., Exensys Software Solution Ltd. (supra) from the list of comparables.
16. With respect to Sankhya Infotech Ltd., the ld. counsel for the assessee further contended that this comparable was also examined by the Tribunal in the case of Syassaris Software P. Ltd. (supra) in paras 22 to 24 at pages 16 to 19.
Having carefully examined the contentions of the assessee, we find that undisputedly, Sankhya Infotech Ltd. was examined by the Tribunal and the Tribunal following the view taken in the case of Kodiak Network India Ltd. (supra) has directed the TPO to exclude this company from the list of comparables. The relevant observations of the Tribunal are extracted hereunder for the sake of reference:-
“24. We have perused the orders and heard the rival contentions. In the case of M/s. Kodiak Networks India Pvt.Ltd., this Tribunal at para 29 to 31 of its order held as under : Sankhya Infotech Limited (‘Sankhya’) 29. It was submitted by the learned counsel for the Assessee that Sankhya is engaged in the business of development of software products & services and training. The company focuses on the development of niche products for the transport and aviation industry. However, segmental information in relation to the above mentioned activities is not available in public domain.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 17 of 35 Therefore, as Sankhya engages itself in products and services as well as software training, it cannot be considered as a comparable of the Appellant. The products developed and owned by Sankhya are listed below: (1) SILICONTM Training Suite of Products: The products are a comprehensive enterprise wide training platform that covers the entire spectrum of training in a paperless environment. It comprises of four products:- - SILICONTM LMS (Training Management Information - SILICONTM QT (Online Assessment System) - SILICONTM LCMS (Learning Content Management System) - IRMAQTM : This is an integrated resource planning, management tracking system exclusively developed for Airline operations. It is an end-to-end solution for all Flight Operations. - Sakai CLE : This is a widely used and popular open source LMS used in many leading educational institutions and corporate. The relevant extract from the Annual report substantiating that the company also engages in different activities is reproduced below: “2. Activities The company as engaged in the business of development of Software Products & Services and training. The production of software is not capable of being expressed in any generic unit and hence 11 is riot possible to give the information as required by certain clauses of paragraphs 3.4C and 4 D of Part II of Schedule VI of the Companies Act, 1956.”
30. It was also brought to our notice that the Delhi Tribunal in ITO v. Colt Technology Services India Pvt. Ltd. (judgment dated 23.10.2012 in for the assessment year 2005-06) has held that the said company is not a comparable to the assessee therein which was also in the business of software development.
31. The submissions made by the learned counsel for the Assessee are considered. The activities set out above and the decision of the Delhi ITAT rendered in the context of a software development company such as the Assessee makes it amply clear that this company Sankhya cannot be regarded as a comparable. The same is directed to be excluded from the list of comparable companies.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 18 of 35 Accordingly we direct exclusion of M/s. Sankhya Infotech Ltd, from the list of comparables.”
Since this comparable was examined by the Tribunal in the aforesaid case, we find no justification in re-examining the case. Accordingly, we exclude Sankhya Infotech Ltd. from the list of comparables.
19. With regard to Thirdware Solutions Ltd., it was again submitted by the ld. counsel for the assessee that this comparable was also examined by the Tribunal in the case of Syassaris Software P. Ltd. (supra) in para 31 at pages 21 to 25 of its order.
From the order of the Tribunal, we find that undisputedly Thirdware Solutions Ltd. was examined by the Tribunal in the light of earlier order of Tribunal in the case of Kodiak Network India Ltd. (supra) and it was excluded from the list of comparables. The relevant observations of the Tribunal is extracted hereunder for the sake of reference:-
“31. We have perused the orders and heard the rival contentions. This Tribunal's decision in the case of M/s. Kodiak Networks India P. Ltd, (supra) has held as under at paras 20 to 24 of its order : 20. As regards grounds No. 3 to 6 are concerned, Thirdware Solutions Ltd., and Geometric Software Solutions Ltd., are concerned, were held to be functionally different from a company rendering software development services such as the Assessee in the case of Sunquest Information Systems (I) Pvt.Ltd. by the ITAT Bangalore for AY 05-06 order
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 19 of 35 dated 11.6.2015. The following were the relevant observations of the Tribunal. “ 22. We have considered his submission and find that the ITAT Hyderabad Bench on identical facts, held that the aforesaid two companies viz., Four Soft Ltd., and Thirdware Solutions Ltd., are not comparable companies in Software Development Services companies. The following were the relevant observations:- “15.4. FOURSOFT LIMITED : This comparable is objected on the same reason as this company is involved in product development and owns products namely 4S eTrans and 4S eLog. These products are used in Sun Microsystems Inc, in an Application Verification Kit Certified for Enterprises and assessee have been investing continuously on product developments. Since assessee is in the product development, having I.P. rights, the same is not comparable. 15.5. THIRDWARE SOFTWARE SOLUTIONS LIMITED : This company is objected to by the assessee on the reason that the said Thirdware Software Solutions Ltd. is engaged in sale of software licence and related services and not a service provider. Referring to the annual report, it was submitted that this comparable was rejected by the ITAT, Pune in the case of Egain Communications Ltd. This company having revenue from product license and earning extraordinary profit due to intangible owns. 15.6. These three comparable above Flextronics Software Limited, Foursoft Limited and Thirdware Software Solution Limited were analysed by the Coordinate Bench of the Tribunal in the case of Intoto Software Solutions Pvt. Ltd. (supra) wherein it has been held as under : "23. The other companies which are objected to by the assessee are Flextronics Software Limited, Foursoft Limited and Thirdware Software Solution Limited. As far as these three companies are concerned, the learned Counsel appearing on behalf of the assessee submitted that they are into both software as well as product development. He submitted that the TPO has taken note of the fact these companies are also into product development but has selected these companies as comparables by applying the filter of more than 70% of its revenue being from IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 20 of 35 software development services. The learned Counsel submitted that the functions of these companies are different from the assessee who was into sole activity of software development for its associated enterprise. He submitted that the TPO has allocated the expenditure in the proportion of the revenue of these companies from software services and software products and has adopted the figure as segmental margin of the company and has taken these companies as comparables. He submitted that by taking the proportionate expenditure, the correct financial results would not emerge. He submitted that nothing prevented the Assessing Officer/TPO from obtaining the segmental details from the respective comparable companies before adopting them as comparable companies and before taking the operating margin for arriving at the arms length price. He submitted that wherever the segmental details are not available, then the said companies should not be taken as comparables. For this purpose, he placed reliance upon the decision of the Bangalore Tribunal in the case of First Advantage Offshore Services Pvt. Ltd. vs. The DCIT in ITA.No.1252/Bang/2010 wherein these companies were directed to be excluded from the list of comparables.
21. The learned D.R. however, supported the Orders of the authorities below.
22. Having heard both the parties and having gone through the material on record, we find that the TPO at page 37of his order has brought out the differences between a product company and a software development services provider. Thus, it is clear that he is aware of the functional dissimilarity between a product company and a software development service provider. Having taken note of the difference between the two functions, the Assessing Officer ought not to have taken the companies which are into both the product development as well as software development service provider as comparables unless the segmental details are available. Even if he has adopted the filter of more than 75% of the revenue from the software services for selecting a comparable company, he ought to have taken the segmental results of the software services only. The percentage of expenditure towards the development of software products may differ from company to company and also it may not be proportionate to the sales from the sale of software products. Under section 133(6) of the I.T. Act, the TPO has the power to IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 21 of 35 call for the necessary details from the comparable companies. It is seen that the Assessing Officer/TPO as exercised this power to call for details with regard to the various companies. As seen from the annual report of Foursoft Limited which is reproduced at page 7 of the TPO’s Order, the said company has derived income from software licence also and AMCs.
23. As far as Thirdware Software Solution Limited is concerned, we find from the information furnished by the said company that though the said company is also into product development, there are no software products that the company invoiced during the relevant financial year and the financial results are in respect of services only. Thus, it is clear that there is no sale of software products during the year but the said company might have incurred expenditure towards the development of the software products.
24. In view of the aforesaid decision, we do not find any infirmity in the action of the CIT(A) in excluding the aforesaid two companies from the list of comparable companies for determining ALP.” Following the above decision we direct exclusion of Thirdware Solutions Ltd, from the list of comparables.”
21. Since there is no change in the facts and profile of the assessee, we find no justification to take a contrary view. Accordingly, we approve exclusion of this comparable from the list of comparables.
With regard to Geometric Software Solutions Company Ltd., the ld. counsel for the assessee has contended that comparability of this company was examined by the Tribunal in the case of Net Devices India Pvt. Ltd. in IT(TP)A No.1099/Bang/2011 & CO No.19/Bang/2011 in para Nos.18.3.1. to 18.3.3 of the order and the matter was restored to the AO/TPO for IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 22 of 35 verification of applicability of RPT filter for its exclusion. The RPT in this case was considered to be 22%, but no datas are available.
23. The ld. DR in the light of non-availability of data before us has argued that this issue may be sent back to the AO/TPO for verification of the facts in the light of RPT filter for its exclusion.
24. We find force in the contention of the ld. DR. The relevant observations of the Tribunal in the case of Net Devices India Pvt. Ltd. (supra) in this regard is extracted hereunder for the sake of reference:-
“18.3.1 The learned Authorised Representative of the assessee has submitted that the RPT of this company is 22% whereas the TPO has wrongly considered the RPT at 10.97%. The learned Authorised Representative has referred the computation of RPT at page 561 of the paper book containing Annual Report and submitted that if all the RPTs are taken into consideration as reported in the Annual Report of this company then it comes to 22.52% of the total sales. 18.3.2 On the other hand, the learned Departmental Representative has submitted that the TPO has considered the RPT as taken from the Annual Report of this company and therefore this objection was not raised by the assessee before the TPO. 18.3.3 Having considered the rival submissions as well as the relevant material on record, We note that the assessee has submitted computation of RPT of this company at page No.561 of the paper book wherein the assessee has calculated this percentage by considering the various transactions with the Related Parties which consists of software development services charges and marketing expenses. Therefore, this issue requires a proper examination and verification of the fact as produced by the assessee. Accordingly, in the facts and circumstances of the case, we set aside this issue of comparability of this company to IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 23 of 35 the record of the A.O./TPO for proper verification of the facts as contended and produced by the assessee before us and then decide the issue after giving an opportunity of hearing to the assessee.”
25. Since the datas are not available and even in the aforesaid order of the Tribunal, the Tribunal has restored the matter to the TPO for verification and readjudication on the applicability of RPT filter, we are of the view that this issue should also go back to the TPO to adjudicate the justification of its exclusion on the point of RPT filter.
With regard to Tata Elxsi Ltd., exclusion of this company was upheld by the Tribunal in the case of Syassaris Software P. Ltd. (supra) in paras 35 to 37 at pages 26 to 29 of the order. The relevant observations of the Tribunal are extracted hereunder for the sake of reference:-
“35. Vis-a-vis Tata Elxsi (seg), Ld. AR submitted that this company was also directed to be excluded by the coordinate bench in the case of Kodiak Networks India P. Ltd, (supra) vide paras 18 and 19 of the order which is reproduced hereunder : 18. As regards ground No.7, TATA Elxsi Ltd., has to be excluded as this company was held to be not comparable with an Assessee such as the Assessee in the present case providing software development services by the ITAT Hyderabad Bench in the case of CNO IT Services (India) Pvt. Ltd. (Formerly known as Conseco Data Services (India) Pvt. Ltd.) Hyderabad vs. DCIT, Circle 1(2) Hyderabad, in ITA.No.1280/Hyd/2010 Assessment Year 2005-2006 order dated 12.2.2014. The ITAT Hyderabad Bench on identical facts, held on comparability of TATA Elxsi Ltd. as follows: “15.7. TATA ELXSI LIMITED : The objection of the assessee is that TATA Elxsi operating two segments – system communication
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 24 of 35 services and software development services. The TPO accepted the software development services segment in his T.P. analysis and assessee’s objection is that the software development services segment itself comprises of three sub-services namely (a) product design services (b)design engineering services and (c) visual computing labs. It was submitted that these services are not akin to assessee software services and segmental information of only product design services could have been accepted by the TPO as a comparable but not the entire software development service. Since company’s operations are functionally different as such, the same is not comparable. Further, assessee is also objecting on the basis of intangible scale of operations. The coordinate bench in the case of Intoto (supra) considered the issue as under in para 22: "22 Tata Elxsi Limited : As regards this company, the learned Counsel appearing on behalf of the assessee, filed before us the reply of Tata Elxsi Limited to the Addl. CIT (Transfer Pricing), Hyderabad, wherein the concerned Officer has been informed that Tata Elxsi Limited is specialised Embedded Software Development Service Provider and that it cannot be compared with any other software development company. It was submitted that because of the specialisation and also because of diverse nature of its business, it is very difficult to scale-up the operations of Tata Elxsi Limited. In view of this, Tata Elxsi Limited has informed that it is not fair to use its financial numbers to compare it with any other company. The communication dated 25th August, 2009 to the TPO is placed before us. As this communication was not before the TPO at the time of transfer pricing adjustment we deem it fit and proper to remand this issue also to the file of the TPO to reconsider adopting this company as the comparable in the light of observations of this company to the TPO in the case of another assessee. In the result, the Assessing Officer/TPO is directed to reconsider the issue in accordance with law, after affording a reasonable opportunity of being heard to the assessee.” Keeping the assessee’s objections and the decisions of the Coordinate Bench, prima facie, we are of the view that TATA Elxsi Limited is functionally different and has incomparable size to that of the assessee. Further, we are unable to verify whether the segmental profits adopted by the TPO pertain to entire software development services or pertain to limited service akin to IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 25 of 35 assessee services. Since, these aspects are not clear from the data furnished before us, we direct the TPO to examine and in case, the segmental profits of a particular service is not available, then, to exclude the TATA Elxsi Limited from the list of comparables. Accordingly, this issue is restored to the file of TPO for examination and to decide in accordance with law and facts, after affording reasonable opportunity of being heard to assessee.”
In view of the aforesaid decision rendered on identical facts and circumstances, we are of the view that TATA Elxsi Ltd., was rightly excluded from the list of comparable companies.
36. Per contra, Ld. DR submitted that Tata Elxsi (seg) was doing very similar work as that of the assessee and hence ought not to be excluded.
We have perused the orders and heard the rival contentions. Findings of the Tribunal as it appear at paras 18 and 19 in the case of M/s. Kodiak Networks India P. Ltd (supra) has been reproduced in para 35 above. Accordingly we direct exclusion of Tata Elxsi (seg) from the list of comparables.”
We find that the Tribunal in the light of decision in Kodiak Network India Ltd. (supra) has held that Tata Elxsi Ltd. cannot be included in the list of comparables. We, therefore, following the order of Tribunal in the aforesaid case, approve the exclusion of Tata Elxsi ltd. from the list of comparables.
With regard to iGate Global Solutions Ltd., Flextronics Software Systems Ltd., L&T Infotech Ltd., Satyam Computer Services Ltd. and Infosys Technologies Ltd., our attention was invited to the fact that turnover of this company is more than 10 times of the turnover of the assessee. Therefore, the CIT(Appeals) has rightly applied the turnover filter and IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 26 of 35 excluded them from the list of comparables. It was further contended that these companies were also examined by the Tribunal in the case of Syassaris Software P. Ltd. (supra) in which the Tribunal has taken a view that wherever turnover of the comparables is more than 10 times of the turnover of the assessee, the comparable has to be excluded from the list of comparables. The relevant observations of the Tribunal is extracted hereunder for the sake of reference:-
“15. We have perused the orders and heard the rival contentions. No doubt, Ld. DR has relied on the Hon'ble Delhi High Court in the case of Cryscapital Investment Advisors (India) P. Ltd v. DCIT (supra). However, we also find that Hon'ble Bombay High Court in the case of M/s. Pentair Water India P. Ltd, (supra) had affirmed an order of the Tribunal where large companies having huge turnover were excluded. Bombay High Court had followed the judgment of Hon’ble Delhi High Court in the case of Agnity India Technologies P. Ltd. Considering this conflicting opinions of two non-jurisdictional High Courts, we prefer to go by the view more favourable to the assessee. We cannot say that turnover is having no relevance, especially when the assessee was having a turnover below Rs.10 crores and was being compared with entities having turnover well exceeding Rs.200 crores. We are therefore convinced that CIT (A) was justified in directing exclusion of companies having turnover in excess of Rs.200 crores from the list of comparables. Ground 3 of the Revenue stands dismissed.”
We, therefore, following the aforesaid order of the Tribunal, approve the exclusion of these comparables as their turnover exceeds 10 times of the turnover of the assessee.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 27 of 35
With regard to Four Soft Ltd., it is noticed that the CIT(Appeals) has included this comparable from the list of comparables, but the assessee wants its exclusion by filing CO on the ground of RPT filter; but the datas are not available with regard to Four Soft Ltd. The ld. counsel for the assessee has placed reliance upon the decision of the Tribunal in the case of Syassaris Software P. Ltd. (supra).
We have carefully examined the order of Tribunal and we find that the Tribunal in the aforesaid order has applied RPT filter and excluded this company from the list of comparables, but RPT of this company was not mentioned in the order. Therefore, in the absence of complete details, it is not proper to follow the order of Tribunal blindly. We therefore set aside this issue to the file of TPO/AO to examine the justification of its inclusion/exclusion by applying the RPT filter in the light of available datas of this company.
32. With regard to VJIL Consulting Ltd., the ld. DR has contended that without confronting the report and datas to the TPO, the CIT(Appeals) has included this comparable in the list of comparables. The ld. DR has invited our attention to the order of TPO in which the TPO has categorically observed that details of the company were not furnished by the director of the company on account of pending court cases. In the absence of complete details, the TPO has excluded this company from the list of IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 28 of 35 comparables, whereas the CIT(Appeals) has included this comparable without confronting the details placed before him to the TPO/AO.
The ld. counsel for the assessee, on the other hand, has contended that CIT(Appeals) has examined the datas, annual report of VJIL Consulting Ltd. in the light of TPO’s observation and therefore he has rightly included this comparable in the list of comparables. The ld. counsel further contended that this comparable was examined by the Delhi Bench of the Tribunal in the case of Qualcomm India Pvt. Ltd. in IT(TP)ANo.5239/Del/2010 in paras 31 to 32 of the order and found this comparable to be a good comparable and directed the TPO to include the same in the list of comparables. The relevant extract of the order of the Tribunal is extracted hereunder for the sake of reference:-
“E. VJIL CONSULTING LTD(VJIL) 31. The action of the Ld. TPO in rejecting VJIL has been objected by the assessee. The Ld. A.R submitted that VJIL is functionally comparable to the assessee and has to be considered as such while determining the ALP. He submitted that VJIL is an I.T Consulting Software Development and Outsourcing Services Provider Headquartered in India. The Company is engaged in development of applications and systems software, student training. However, on perusal of the profit and loss account for the financial year 2005-06 it was noticed that VJIL has derived more than 97% of the operating revenues from the export of software services. It is evident from the management discussion and analysis and profit and loss account of the company. It was submitted that during the asstt. year 2006-07 the sales of the company is Rs. 15.38 crores and revenue from exports of software is Rs.14.94 crores and balance of Rs. 43.91 lakhs appears to be from training and domestic operations. In support IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 29 of 35 the Ld. AR referred Page Nos. 18 and 42 of paper book No. III. (i.e. the annual report of the company for the asstt. year 2006-07).
Considering the above submissions we find substance in the contention of the Ld. AR that VJIL is functionally comparable to the assessee since more than 97% of the revenue is from comparable activity. We accordingly direct the A.O/T.P.O to take it into account for determination of ALP in the case of the assessee.”
34. Having carefully examined the rival submissions in the light of TPO’s order, we find that before the TPO, datas of this comparable were not available as the TPO has categorically observed in his order that the director of the company, Shri M. Mallesham, also expressed his inability to furnish further details due to pending court cases. In the absence of clear details, the TPO rejected this comparable. Now the details of this comparable are available and the CIT(A) has included the same in the list of comparables without confronting the audit report and datas to the TPO. We therefore find it proper to remit the matter to the TPO to reconsider the inclusion of this comparable in the list of comparables in the light of the order of the Tribunal in the case of Qualcomm India Pvt. Ltd. (supra). Accordingly adjudication of this comparable is restored to the TPO.
With regard to Melstar Information Technology Ltd., the CIT(Appeals) rejected the inclusion of this comparable in the list of comparables and the assessee is before us with the request that since this company is functionally comparable and passes all the filters applied by the IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 30 of 35 TPO, the same may be included in the list of comparables. In support of his contentions, he has placed reliance upon the judgment of the Tribunal in the case of M/s. Novell Software Development (India) Pvt. Ltd. in IT(TP)A No.1105/Bang/2011 & 1047/Bang/2011.
The ld. DR has contended that the Tribunal has restored the consideration of this comparable to the TPO in the case of M/s. Novell Software Development (India) Pvt. Ltd. (supra), therefore, its inclusion can only be considered by the TPO in the light of directions given by the Tribunal in the case of M/s. Novell Software Development (India) Pvt. Ltd. (supra).
37. Having carefully examined the rival submissions in the light of orders of lower authorities, we find that inclusion of this comparable was not considered by the lower authorities. Now the assessee wants its inclusion in the list of comparables. But the annual report of this company requires proper examination. In the case of M/s. Novell Software Development (India) Pvt. Ltd. (supra), the Tribunal has restored the matter to the file of TPO with a direction to re-examine the claim of inclusion of this comparable in the light of the annual report and details furnished by the assessee. The relevant observations of the Tribunal in the case of M/s. Novell Software Development (India) Pvt. Ltd. (supra) is extracted hereunder for the sake of reference:-
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 31 of 35 “21. Melstar Information Technologies Ltd. (Melstar): As far as this company is considered, the same was chosen as comparable company by the Assessee in its TP study. The TPO rejected Melstar stating the following:- “As per the Director’s Report Melstar has faced adverse economic conditions during the FY 2004-05 and its margins are adversely affected by its peculiar circumstances. The business profile of Melstar is not aligned with the normal trend of the software industry in India. The company therefore is not treated as a comparable.” (page 82 of the TP order) 22. It is the submission of the learned counsel for the Assessee before us that that Melstar passes all filters applied by the TPO in his order and is functionally comparable. The filters applied by TPO and their satisfaction was tabulated as under:
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 32 of 35
It was further pointed out by him that the TPO has concluded that Melstar is not comparable on the ground that there was an extraordinary debit of Rs. 2.85 Cr and on the ground that the company’s sales are diminishing. A perusal of the revenues of the previous financial years (page 81 of the TP order) demonstrates that the revenues are more or less consistent for the previous financial years and has only substantially decreased in the financial year 2004-05. The relevant extract of the Annual Report (Page 4) is reproduced below: C) Financial performance based on given indicators As per the audited financial results for the year ended 31.3.2005:
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 33 of 35
If the above extraordinary expense of Rs. 2.85 Cr is excluded from the operating cost, the mark-up on the cost works out to 3.26%. The detailed working was also give as below:-
In view of the above, it was submitted that since Melstar is functionally comparable to the assessee and clears all the filters applied by the TPO, the same should be considered as comparable with Net Cost Plus margin of 3.26%.
The submissions are considered and found to be acceptable. As rightly pointed out by the learned counsel for the Assessee, Melstar passes all the tests of comparability adopted by the TPO. The extraordinary item of expenditure, if removed, would render this company as a company revenues of which are not diminishing. Melstar therefore deserves to be included as a comparable company. We hold accordingly.”
Following the view taken by the Tribunal in the case of M/s. Novell Software Development (India) Pvt. Ltd. (supra), we restore the matter to the file of AO/TPO to examine the claim of inclusion of this comparable in the light of annual report and other details.
The Revenue has also raised one more ground through ground No.10 that the CIT(A) has erred in allowing deduction u/s. 10A in respect of IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 34 of 35 Unit–II without appreciating the fact that custom bonding licenses were obtained only on 29.1.2002. In this regard, our attention was invited to the order of the CIT(Appeals) wherein he has examined this issue in the light of the order of Tribunal for AYs 2002-03, 2003-04 & 2004-05.
During the course of hearing, the ld. counsel for the assessee has invited our attention that the view taken by the Tribunal in AYs 2002-03 to 2004-05 in assessee’s own case was approved by the Hon’ble High Court of Karnataka in its judgment dated 07.11.2004 in to 1014/2008, therefore, the issue is covered in favour of assessee. This contention of the assessee was not refuted by the ld. DR.
We have carefully examined the order of CIT(Appeals) on this issue and we find that the CIT(Appeals) has examined this issue in the light of various judicial pronouncements of different Benches of the Tribunal and finally having relied upon the order of Tribunal in assessee’s own case for the AYs 2002-03 to 2004-05, the CIT(Appeals) has held that the company is eligible to claim deduction u/s. 10A in respect of Lara Unit income and allowed the relief. Since the CIT(Appeals) has decided the issue following the order of Tribunal which was later on confirmed by the jurisdictional High Court, we find no infirmity in the order of CIT(Appeals), accordingly we confirm the same.
IT(TP)A No.614/Bang/2013 & CO No.166/Bang/2015 Page 35 of 35 42. In the result, the appeal of the revenue as well as CO by the assessee are partly allowed for statistical purposes.
Pronounced in the open court on this 4th day of November, 2016.