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Income Tax Appellate Tribunal, DELHI BENCH: ‘I-2’ NEW DELHI
Before: SMT DIVA SINGH & SH.L.P.SAHU
PER DIVA SINGH, JUDICIAL MEMBER
The present appeal has been filed by the assessee assailing the correctness of the order dated 21.10.2014 of CIT(A)-XXIX, New Delhi pertaining to 2008-09 assessment year on various grounds. However at the time of hearing, the Ld. AR submitted that he is under instructions only to argue Ground Nos.-2.7, 2.9 and 2.10 and the remaining grounds may be dismissed as not pressed. In view thereof, we reproduce hereunder only the grounds which the assessee wants to agitate:
2. The Ld.CIT(A) erred on facts and in law in partially confirming the adjustment of Rs.2,07,75,061/- computed by the Learned Assessing Officer (‘Ld.AO’) in the assessment order passed under section 143(3) of the Income Tax Act, 1961 (‘the Act’), by holding that the international related party transaction of the Appellant with respect to the provision of software development services do not satisfy the arm’s length principle envisaged under the Act. In doing so the Ld.CIT(A) has erred:- ............................... 2.7. by including certain companies in the final set of comparables which are not comparable to the Appellant in terms of functions performed, assets employed and risks assumed; 2.9 by denying the benefit of a working capital adjustment while computing the ALP and thereby disregarding the law, international guidance and judicial precedents in this regard; 2.10 by ignoring the business/commercial reality that since the Appellant (vis-a-vis its software development services) is remunerated on an arm’s length cost plus basis, undertakes minimal business risks as against comparable companies that are full-fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the Appellant on account of this fact.
2. The assessee in the year under consideration returned an income of Rs.47,11,359/-. In computing such income, a sum of Rs.1,54,91,436/- was claimed as a deduction u/s 10A of the Income Tax Act, 1961. The said return was subjected to scrutiny assessment. Considering the disclosure of international transaction in its Form 3CEB, the TPO proposed certain additions by way of adjustments. These were challenged in appeal before the CIT(A) and lead to the passing of the impugned order under challenge in the present proceedings.
2.1. The relevant facts of the case are that the assessee M/s Virage Logic International a company incorporated in USA is a 100% subsidiary of Virage Logic Corporation which is stated to be a market leader in providing advanced embedded memory intellectual property (hereinafter referred to as “AP”) for the design of complex integrated circuits. The assessee has been operating in India through a Branch office and is in the business of development of computer software. The software developed by the branch office in India is integrated with software developed by the parent entity.
2.2. As per the Transfer Pricing Report accepted by the TPO the products delivered by Virage group consist of various software tools along with supporting files that contain design data for creating the requisite silicon IP (Memory or Logic elements). It is claimed that the engineering site at India since inception has been working on the following activities related to the IP products and platforms offered:-
• Software development in C, C++ and TCL/Tk on our Embedded-IT range of software tools. • Development of programs and files that constitute our Memory Compilers of Logic libraries. - EDA views in TCL/Tk programming language. - Programming files in assessee's proprietary format that describes the physical, functional and timing behavior of the Memory or Logic elements.
2.3. These files it is claimed are developed on UNIX operating systems on Sun platforms or in the Windows NT environment and thereafter the created files are shipped overseas electronically via Internet.
2.4. The nature of activities that lead to the creating of the above-mentioned items have been characterized as:
• Software Development which includes, Electronic Design Automation. • Engineering design services and other functions to support the above disciplines (IT. QA. documentation. etc). 2.5. It has been submitted that the Export invoices are raised at cost (including both direct and indirect costs) plus markup of 15% on the direct and indirect costs incurred by it for the software development activity.
2.6. As per its reporting in Form No.3CEB the assessee in the year under consideration undertook the following international transactions with its AE’s:-
Name of International Value of Transaction International Transaction (INR) Provision of software 180,582,716 development services 2.7. For the purposes of comparability analysis the assessee in its TP study selected TNMM as the most appropriate method and operating profit / total cost (OP/TC) as the Profit Level Indicator (PLI). Benchmarking analysis was made using multiple year data and 13 comparables were selected. The transaction was claimed to be at arm’s length as the average OP/TC of the 13 comparables at 4.07% was lower than 6.95% OP/TC margin of the assessee.
The use of multiple year data resorted to by the assessee was objected to by the TPO. He was of the view that in the absence of any justification for multiple year data the resort to the same was in violation of Rule 10B(4) of the Income Tax Rules, 1962. The filters selected by the assessee also did not meet with the approval of the TPO for reasons set out in his order. Since these are not an issue in the present proceedings discussion thereon is considered not relevant.
3.1. For the purposes of the present proceedings it would be sufficient to refer that after revising the filters and directing the use of single year the assessee was directed to conduct a fresh search.
3.2. Accepting 5 of the 7 comparables offered by the assessee in the fresh search, the TPO included certain other comparables which were thrown up in the fresh search over-ruling the objections posed by the assessee. Thus, considering the 16 comparables so adopted whose average OP/TC margin of 19.26% Page 5 of 35 compared with 6.95% of the assessee was considered to be higher justifying the proposal of an adjustment of Rs.2,07,75,061/-.
4. The proposed additions of the TPO lead to the passing of the order u/s 143(3) by the AO. This order was challenged in appeal before the Ld. CIT(A) who granted part relief to the assessee by directing the exclusion of one comparable i.e Infosys Technologies leading to the retention of the following 15 comparables:-
Sl.No. Name OP/TC (%) 1. Aditya Birla Minacs IT Services Ltd. 7.73% 2. Aditya Birla Minacs Technologies Ltd. 6.04% 3. Akshay Software Technologies Ltd. 7.37% 4. Quintegra Solutions Ltd. 19.33% 5. RS Software India Ltd. 6.30% 6. Acropetal Technolgies Ltd. 40.03% 7. Bodhtree Consulting Ltd. 19.14% 8. Sagarsoft India Ltd. 12.18% 9. I Gate Global Solutions Ltd. 14.77% 10. KALS Informtion Systems Ltd. 41.94% (Segmental) 11. Lucid Software Ltd. 16.50% 12. Mindtree Ltd. (Seg.) 16.41% 13. Persistent Systems Ltd. 27.70% 14. Sasken Communication Technologies Ltd. 13.44% (Segmental) 15. Tata Elxsi Ltd. (Software development 18.97% and services Segment) Mean OP/TC 17.86% 4.1. Still, aggrieved, the assessee is before ITAT seeking the exclusion of the following 7 comparables:-
Persistent Systems Ltd.
Bodhtree Consulting Ltd. 3. KALS Information Systems (Seg.) 4. I Gate Global Solutions Ltd. 5. Tata Elxsi Ltd. 6. Lucid Software Ltd. 7. Acropetal Technologies Ltd. Page 6 of 35
In the said factual background the Ld.AR inviting attention to the grievance of the tax payer submitted that the exclusion of the comparables is sought on the basis of facts and judicial precedent qua each of these comparables.
5.1. The exclusion of Persistent Systems Ltd it was submitted was sought on the ground that it is functionally different. The said company it was submitted derives its income from the sale of software services as well as products. The annual report of the said company it was submitted does not provide any further break-up of income into products and services. Accordingly referring to pages 154, 200, 204, 218 & 226 of the annual report compendium it was submitted that the Company cannot be treated as functionally comparable to the assessee.
5.2. During the year under consideration it was further submitted that there had been several significant events namely Persistent System Ltd. formed a wholly owned subsidiary in Singapore; acquired physical assets and human resources of another company. The company had also converted itself into a public company (evident from pages 156, 166, 168 of Annual Report). All these facts it was submitted have been consistently argued before the tax authorities. By way of the synopsis, we Page 7 of 35 find reliance has been placed on the following judicial precedent however, how these decisions were relevant has not been argued:-
(i) FCG Software Services India P. Ltd. vs ITO [2014] 51 taxmann.com 75 (Bang-Trib.); (ii) LG Soft India P.Ltd. vs Dy.CIT [2014] 48 taxmann.com 237 (Bang-Trib.). BODHTREE CONSULTING LTD.
5.3. The exclusion of Bodhtree Consulting Ltd., it was submitted is justified on the ground that the said comparable over the years has shown high volatile margins ranging from - 4.10% in 2010-11 Financial to 64.04% in 2008-09 Financial Year and 19.14% in the year under consideration. The following chart demonstrating the degree of fluctuation was relied upon:-
Financial Year Margin % age 2004-05 25.24% 2005-06 14.66% 2006-07 33.20% 2007-08 19.14% 2008-09 64.04% 2009-10 34.39% 2010-11 -4.10% 5.3.1. Accordingly relying upon the precedent laid down in the order dated 31.05.2013 in Navisite India Private Limited in directed to examine and address the abnormal factors that cause high volatility margin and make necessary adjustments. Page 8 of 35 5.3.2. Without prejudice to the main argument, it was also submitted that the company had diverse operations as it provides open and end-to-end Web solutions, off shoring data management, data warehousing, software consultancy. Thus, when compared with the assessee’s function Bodhtree Consulting Ltd. in contrast had diverse operation as the assessee was only engaged in contract software development services. Accordingly relying upon Nethawk Networks India Private Limited in copy placed at pages 50-51 of case Laws Paper Book its exclusion was sought. The said prayer was also stated to be supported by M/s Sapient Corporation Pvt. Ltd. (ITA No.5263/Del/2010); M/s Adobe Systems India Pvt.Ltd. 138 TTJ 122; M/s Telecordia Technologies India Pvt.Ltd. (ITA no.7821/Mum/2011); and M/s First Advantage Offshore Services Pvt.Ltd. (ITA No.1252/Bang/2010).
5.3.3. Non-availability of the segmental details, it was submitted was further under-mined by the inclusion of the said comparable. Further its revenue recognition system substantially differed as the income from software development is accounted for on the basis of software developed and billed to clients on acceptance. The decisions rendered by the ITAT in the case of Ciena India Private Limited vs ITO in ITA Page 9 of 35 No.1453/Del/2014 and M/s Mindteck (India) Private Limited vs DICT [IT(TP)] No.70/Bang/2014 were relied upon for the proposition that the company should be excluded as its Revenue recognition policy was on a different basis.
KALS Information Systems (Seg.)
5.4. The exclusion of KALS Information Systems (Seg.) was sought on the ground that it was functionally different. Referring to the information provided in the Annual Report it was submitted that the company is engaged in the business of software services and software products which were functionally different. The absence of segmental data, it was submitted takes the said comparable outside the purview of acceptable comparables. Bindview India P.Ltd. vs DCIT [2013] 145 ITD 436/34 taxmann.com 164 (Pune.-Trib) was relied upon for the proposition that the said comparable has been held to be different from a software development company. Income from software developed it was submitted has been accounted for on the basis of software developed and billed to its clients on acceptance thus financial information was stated to be unreliable. Reliance was placed on Cienna India pvt. Ltd. vs ITO (ITA No.1453/Del/2014) and Mindteck India Ltd. vs ITO [2015] 63 taxmann.com 105 (Banglore-Trib.). Page 10 of 35 5.5. The exclusion of I Gate Global Solutions Ltd. was sought on the ground that it is functionally different. The company’s operations it was stated relate to providing Information Technology (“IT”) services, Contact Center services and IT enabled services. The company it was submitted had diversified businesses and this fact it was submitted would be evident from its Annual Report attached.
5.5.1. It was also submitted that its exclusion was also justified on the ground that in the year under consideration extraordinary circumstances prevailed in the case of this comparable on account of merger. This fact it was submitted would be evident from Paper Book page 38 and 46 of the Annual Report Compendium:-
SUBSIDIARIES AND JOINT VENTURES “I GATE Technology Services Pvt. Ltd. (ITS), an erstwhile wholly owned subsidiary of the company was merged with the Company following the approval of the scheme of amalgamation by the shareholders of both the companies and the Honorable High Court of Karnataka. The Honorable High Court of Karnataka passed its final order on July 27, 2007. Your company terminated its joint venture agreement with Software AG, Germany and sold its 49% holding of 7,84,000 shares in software AG (India) Private Limited to Software AG, Germany.”
3. Merger of I Gate Technolgoy Services Pvt.Ltd. a. During the year the Scheme of Amalgamation of IGS and I Gate Technology Services Private Limited, wholly owned subsidiary of the Company were approved by the Honorable High Court of Karnatka. These Page 11 of 35
financial statements include the effect of amalgamation of I Gate Technology Services Private Limited under the “pooling of interest” method prescribed by AS-14 issued by ICAI per approval granted by the High Court. b. I Gate Technology Services Private Limited being wholly owned subsidiary of the Company, the entire share capital of I Gate Technology Services private Limited stands cancelled and extinguished from the effective date. Tata Elxsi Ltd.
5.6. Exclusion of Tata Elxsi Ltd. as a comparable it was submitted is sought on the ground that the Annual Report as
per Annual Report Compendium at Paper Book page 30 and the website of the company disclose that Revenue in the software development and services segment comprises of the following three activities:- • Product Design services (design and development of hardware and software); • Innovation Design Engineering (Mechanical design with a focus on Industrial design); and • Visual Computing Labs Design (Animation and special effects). 5.6.1. Reliance was placed on the Telcordia Technologies India Private Limited (page 99 of the Paper Book) wherein the Mumbai Bench of the Tribunal has rejected the said comparable for benchmarking software development services.
5.7. The exclusion of Lucid Software Ltd was sought on the ground that the said company was a product company focusing on Advanced Non-destructive Testing (NDT) Technologies. The Page 12 of 35 company it was submitted was actively involved in the Research & Development activities with leading scientific and educational institutions as such it could not be considering to be a comparable. Reliance was placed upon ITO, Bangalore vs Infinera India Ltd [2016] 67 taxmann.com 8 (Banglore-Trib.) wherein Lucid Software ltd. has been held to be non-comparable to a company providing software development services.
5.8. The exclusion of Acropetal Technologies Ltd was sought on the ground that it failed employee cost filter as its ratio of 8.33% was less than the 25% adopted by the TPO himself. The exclusion of this comparable it was submitted is supported by the decision of BP India services Private Ltd vs ACIT, Circle-8(1), Mumbai (2015) 55 taxmann.com 150 (Mumbai – Trib.) and Market Tools Research Private Limited (ITA No.1811/Hyd/2012, (TS)-294-ITAT-2013 (HYD)-TPq, ITAT, Hyderabad).
Before advancing specific arguments qua each of the comparables addressed by the assessee, the Ld.Sr.DR drew attention to the facts on record. Inviting attention to the material on record it was submitted that the assessee’s margin was 6.95% as per its own TP study. TNMM has been selected as the most appropriate method by the assessee which has not been Page 13 of 35 disputed by the Revenue. It was his submission that TNMM presupposes broad FAR comparability and it is an accepted position that it is impossible to find an exact identical or a near identical comparable. Thus as long as broad comparability is established then in a method like TNMM the exclusion of comparable’s cannot be sought on the grounds of minor differences. Thus the assessee cannot now be allowed to selectively pick and choose from the list of comparable companies on the basis of minor difference.
6.1. The issues of comparability it was submitted cannot be decided summarily on the basis of precedent as the facts of each case on record need to be addressed. The issues it was submitted can be decided on the facts alone. It was also his submission that it is necessary to appreciate the fact that the filters applied by the TPO have not been assailed by the assessee and in the absence of any objections on the filters applied it can be safely said that the filters have been accepted by the assessee. In the said background, it was his submission that it needs to be appreciated that these very Objections of the assessee for excluding these comparables have already been considered by the TPO. The said finding of the TPO it was submitted has been upheld by the CIT(A) considering more or less similar arguments Page 14 of 35 as have been advanced before the ITAT. Accordingly it was his submission that in these facts and circumstances the assessee needs to show what is wrong with the conclusion arrived at instead of repeating the very same arguments. In the present appeal, it was his submission that the Revenue would be heavily relying upon these findings of the CIT(A) and the TPO.
6.2. Attention was invited to internal pages 10 to 12 where the TPO conveys his views qua these comparables and requires the assessee to address them. Inviting further attention to internal pages 21 to 23 it was submitted that the very same arguments have been considered and rejected these giving specific reasons which remain unassailed. Heavy reliance was placed on the same. For ready-reference, the same are reproduced hereunder:-
“The assessee has raised objections against certain comparables. These specific objections are discussed below. 4.1. Persistent System Ltd. The assessee has claimed that the company is engaged in sale of software products. The assessee has also claimed that the company owns various IP rights. The annual report of the company shows there is no expense on account of software product development. The conclusion that one can reach is that either the revenue form software product is too less or absent completely. If it would have been substantial, the company would have maintained segmental accounts. Therefore, on this account this company cannot be rejected IP rights, no such matter is evident from the annual report. That apart, during the course of these proceedings, it was brought to the notice of the AR, that one patent that had been registered by the parent company in USA had originated from India. Therefore,
there is no case to reject Persistent Systems as a comparable.
4.2. Lucid Software
The assessee has raised an objection that there is some deviation in the accounting policy followed by the company. I am afraid, that this is a rather lame excuse. There point raised by the assessee does not show that there is any functional difference between it and this company. The assessee had not even raised this issue while rejecting this company at the time of preparing its TP study. The assessee has not been able to show that the so-called difference in accounting is causing any abnormality in the results of this company. This shall be used as a comparable.
4.3. Kals Information Systems Ltd.
The assessee has claimed that the company is engaged in software development and sale of software products. The assessee appears to have overlooked the fact that segmental results are being used in this case. On the issue of IP rights, the matter has been discussed earlier and it has been shown that the assessee is also the point of origin of patents registered in the USA. This company can be very well used as a comparable.
4.4. I-Gate Global Solutions Ltd
The assessee has objected to this company on the ground that it is engaged in IT services and process consulting. The audit report of the company while dealing with the issue of revenue recognition mentions as below
4. Revenue Recognition
(Disclosure as per AS 9 'Revenue Recognition' issued by the Institute of Chartered Accountants of India) The contracts between the Company and its customers are either time and material contracts, fixed price contracts or other contracts like transaction fees, monthly commitment etc., with amounts to be billed upon completion of agreed milestones or application maintenance outsourcing contracts with amounts to be billed periodically.
(i) Time and material contracts Revenues from time and material services are recognized as the respective services are provided,
(ii) Fixed price, milestone based contracts Revenue from fixed-price development contracts are recognized using the percentage of completion method, under which the contract performance is determined by relating the actual work performed to date to the estimated total work for each contract. Any anticipated losses expected upon contract completion are recognized immediately. Changes in job performance, conditions and estimated profitability may result in. revisions and corresponding revenues and costs are recognized in the period in which the changes are identified.
(iii) Other Contracts Revenue from contracts with amounts to be billed on monthly basis is recognized on rendering of services as per the terms of the contracts. Revenue from unit priced contracts is recognized on rendering of the services as per the terms of the contracts. Unbilled receivables represent amounts recognized as revenues for the periods presented based on services performed in accordance with the terms of contracts that will be billed in subsequent periods. Deferred revenue represents amounts billed in excess of revenue earned for which related services are expected to be performed in the next operation cycle. It can be seen that the assessee is engaged in contracts that are in the nature of development contracts, Therefore, there is no problem in the use of this company as a comparable. Whatever be the 'plethora of activities' that the assesses claims that this company is carrying out, they are all in the domain of software development. That is absolutely clear from the annual report. This company can be used as a comparable.
4.5. Acropetal Technologies Ltd.
The assessee has objected to this company on the ground that the employee cost is less than 25%. The annual report shows that the expenditure under the head ‘employee related and on site development expenses’ is 80.22% of the total expenses. The assessee must appreciate that onsite development expense is also a personnel cost and must be reckoned for the analysis.” (emphasis provided)
6.3. Addressing first Persistent Systems Ltd., attention was invited to the reasons set out in para 4.2 of his order which were re-iterated by the CIT(A at page 23 of his order. It was his submission that the Annual Report of the said comparable relied Page 17 of 35 upon by the assessee for exclusion of the said comparable has already been taken into consideration by the TPO and for the reason brought out in his order and the objection has been over- ruled by a speaking order. Accordingly it was his submission that the prayer of the assessee should not be accepted.
6.4. Addressing the arguments seeking the exclusion of KALS Information System Ltd. the reasons set out in para 4.3 of the TP’s order were relied upon. Attention was also invited to page 23 sub para H (iii) of the same to re-iterate that since segmentals were used the argument of the assessee cannot be accepted relying on judicial precedent where segmental may not have been considered.
6.5. For retaining I Gate Global Solutions Ltd. as a comparable it was submitted that in the absence of any functional dissimilarity being pointed out for the reasons set out in para H (iv) of the CIT(A) its retention was sought. It was also his argument that the some of the arguments advanced for its exclusion relies on new facts which have not been canvassed before the TPO or the CIT(A) and thus what is the impact on the profitability of that comparable of these facts has not been addressed.
6.6. Addressing the prayer for retaining Tata Elxsi Ltd. as a comparable it was submitted that there is nothing in the Annual Reports which justifies its exclusion. The argument that the said company was engaged in niche services were not assailed.
6.7. The retention of Lucid software Ltd was justified on the ground that there was no functional dissimilarity and in fact it is a good comparable as considered by the TPO and the CIT(A). The argument that there is a deviation in the accounting policy, it was submitted was considered by the TPO and rejected. It was his submission that it was for the assessee to show the so-called difference in accounting which was stated to be causing any abnormality and despite an opportunity nothing has been shown by the assessee. Heavy reliance was placed on the para 4.2 of the TPO’s order and page 23 para H (ii) of the CIT(A)’s order and page 136 of the Paper Book of Annual Report compendium filed by the assessee.
6.8. Accropetal Technologies Ltd. it was submitted deserves to be retained as a comparables as the argument of the assessee that it failed the employee cost filter is incorrect on facts as discussed by the TPO in para 4.5 of his order, it was his submission that the Annual Report of the said comparable disclosed that the expenditure under the head “employee head Page 19 of 35 expenditure” considering the on-site development expenses was 80.22% of the total expenses. This finding of fact it was submitted is available on record and has not been assailed or distinguished by the assessee.
6.9. BodhTree Consulting Ltd.:-the prayer for exclusion was objected to on the ground that no such prayer had been made before the TPO or the CIT(A). It was also his submission that if at all it was to be considered at this stage then it should be restored back.
We have heard the rival submissions and perused the material on record. Before, we address each of the comparables specifically, we propose to first address the broad principles addressed by the ld.CIT DR in regard to the selection of comparables in TNMM. Considering the same, we are of the view that the Ld.CIT DR is correct in his argument that the issue of comparability should be decided on the basis of facts on record and not on precedents as there cannot be an exact identical comparable and infact a perfect near identical comparable company is a rarity and generally can be said to be a virtually impossible condition incapable of being fully fulfilled. We are of the view that it is for this very purpose that TNMM as a method is often resorted to. The minor difference if any are addressed by Page 20 of 35 comparing net profitability of the comparables. Thus broad comparability of a fairly large number of comparable companies can further ensure that minor variations if any are offset by taking a fairly large sample. Any major impact of their FAR on their net profitability if still so warranted on facts can be addressed by carrying out appropriate adjustments the need for which has to be demonstrated on the basis of record so as to bring their FAR in alignment with that of the tested party i.e. the assessee. The prayer for exclusion of a comparable without even caring to establish how the facts of the case at hand are identical to the facts of the tested part in the precedent cannot be accepted. The facts of the case at hand and that of the precedent cited must also match on the same high standards of strict comparability as insisted upon for in the case of comparable companies vis-a-vis the tested party. The tendency to blindly cite decisions galore without even caring to bring out how the material facts are pari materia which would convey useful and contemporary economic information does not help anyone’s case.
Having so observed, we find that this fundamental exercise which is the foundation on which the case for either side is to be build is unfortunately an exercise which is attempted without adequate care and attention either by the tax payers or by the tax Page 21 of 35 authorities who both rush through this fundamental exercise at the initial stages in undue haste satisfied easily as long as their respective stand appears to be reflected. The selection when challenged at the appellate stage often results in a situation where the entire edifice crumbles despite a valiant patch work attempt to uphold the edifice and the entire selection process offered and considered stands wiped out. Though, we note that the tax payer at the stage of the TP study no doubt may be handicapped by the insufficiency of data in the public domain as it may not be sufficiently robust and readily available completely.
Reverting to the facts of the present case, we note that the year under consideration is 2008-09 AY and an argument may be capable of being advanced that due to lack of exposure, expertise and experience of the litigants on the issue there may be justifiable reasons for the inadequacies in the TP study and the TP Report. Addressing the departmental stand, we agree that in a TNMM methodology identical FAR analysis cannot be insisted upon and the method is infact resorted to when the complete data is not available. In that case the impact on the net profitability of the minor variations in the comparable companies so selected is considered capable of tolerating minor variations in the FAR analysis of the comparables. The selection of this Page 22 of 35 method is resorted to for this very purpose and the method is robust enough to tolerate the variations if any. The Rules moreover permit adjustments in the comparables selected if it can be demonstrated that these would impact the profitability of the comparable selected.
7.1. Examining the other argument advanced by the Ld.CIT DR who has objected that in the absence of challenge to the filter applied the assessee cannot object to the inclusion of a comparable thrown up applying the filter. We find that the argument is misplaced. The objection to the exclusion of a comparable cannot be ousted on the strength of the argument that filter has been accepted. We find that this simplistic argument of the Revenue cannot be accepted. We hold that the assessee having accepted the filters is fully within its right to insist upon the exclusion of a comparable which has remained in the list of comparables accepted if subsequent information/data available in the public domain shows that the said comparable on the basis of new contemporary economic data being available the “comparable” becomes incomparable as its very profitability is impacted by its peculiar mix of its functionality or asset base or risk analysis. Neither the acceptance nor the retention or for that matter lack of objection at the first instance makes an Page 23 of 35 incomparable a comparable. The issue is judicially well-settled by now and we are strongly of the view that a comparable cannot be foisted upon an assessee merely because it was proposed by the assessee, or was not objected to by the assessee in the earlier years or at the initial stages in the year under consideration.
There may be many reasons for not objecting to retention of a comparable in a particular year; there may not be any significant impact; the facts or law may not be fully known or there is a material change in facts qua the comparable in subsequent year which shows that its retention was fundamentally misconceived and ill informed. The reasons may be many and it is not possible to visualise the multifarious possible options in the ever changing dynamics of the reality where the companies exist and function. However, once inclusion of a comparable is challenged then its comparability must be established on the basis of facts available for the year under consideration even if the facts come to light subsequently. The comparable cannot be allowed to remain included on account of a mistake of the parties. If challenged its justification has to be demonstrated. Accordingly the argument that filters not having been challenged act as an estoppel to the assessee cannot be accepted. We see no bar to the prayer of the assessee to argue for the exclusion of a Page 24 of 35 comparable if facts warranting such a prayer can be demonstrated by the tax payer. The Tribunal being the final fact finding body as conceived by the Statute permits the tax payer to demonstrate if so considered fit by the tax payer to plead for the exclusion of a comparable on the basis of robust facts and evidences which may demonstrate that the comparable was wrongly offered or accepted at the initial stages. Thus, we find no bar to the tax payer for pleading for exclusion of a comparable without challenging the filters. Even otherwise selection of comparable is one of the steps for identifying a comparable to tailor the search for the purposes of determining whether adjustment in Arm’s length price of the international transaction undertaken by the assessee is warranted.
7.2. The next step is to establish a functional comparability of the companies thrown up in the search. During this process the companies whose peculiar mix of FAR may directly impact its profitability may be excluded if they are seen to be considered incomparable. Thus wherever it can be shown that the functionality was not established or the necessary details qua its asset base or risk analysis or any extra ordinary event in the period under consideration created situations where the comparability of the company was tainted as impacting its net Page 25 of 35 profitability then the exclusion of the comparable can be requested. Thereafter, if the facts are found supporting the prayer then the comparable can still be excluded for valid reasons justifying its exclusion based on evidence duly recorded and forming part of the reasoning despite the filters not having been challenged. We see no such bar for the assessee contemplated under law.
7.3. Addressing the specific comparables whose exclusion is sought, considering the facts, arguments and position of law, we hold:-
(a) Persistent Systems
We find that exclusion of the said comparable on the ground that it is functionally different as it derives income from software services and products in the face of the consistent finding on record that in the year under consideration no expenses have been booked for software product development and thus the comparable is mainly in the business of software development activity remaining unassailed on record has not been assailed.
Thus the said ground for exclusion of the comparable in the peculiar facts of the present case, is rejected. The assessee has also pleaded extraordinary events in the year under consideration for the first time before the ITAT. However, how these events Page 26 of 35 impact net profitability of the said comparable in the year under consideration has not been demonstrated. Accordingly, considering the prayer and the arguments we deem it appropriate to restore the issue back to the TPO in order to demonstrate its claim on the basis of facts and evidences.
(b) Bodhtree Consulting Ltd.
We find that the exclusion of the said comparable was not assailed by the assessee either before the TPO nor before the CIT(A). We further find that the assessee relying upon the precedent of in the case of Navisite India Pvt. Ltd. has requested for remand to the TPO to examine the abnormal factors responsible for the high volatility in the margins of the said comparable and make necessary adjustments, if so warranted. We find that in the absence of discussion on the issue by the tax authorities as the issue was not agitated by the assessee and considering the request of the Ld.CIT DR that the issue may in the circumstance be restored, we direct accordingly. The issue is restored the TPO afresh following the precedent cited.
(c) KALS Information Systems Ltd. Page 27 of 35
We find that the arguments of the assessee that the said comparable was distinguishable as the said company apart from software services also had software products cannot be accepted.
The assessee has failed to address/rebut the consistent finding on record that segmental data has been used. No arguments controverting this fact have been advanced. No fact contrary to this finding has been referred to. The Ld.AR inviting attention to copy of Schedule 16 of the said company from the copy of its Annual accounts so as to submit that its revenue recognition system is different and following legal precedent the comparable should be excluded. We find that nothing has been placed on record to demonstrate how the impact on the net profitability of the assessee’s segment following the Revenue recognition stated to be different from the assessee. The exercise addressing the impact of the Revenue recognition system allegedly different from the assessee on the segmental net profitability of the comparable has to be established as mere reliance on precedent without addressing the facts is of no relevance. Reliance on precedent where segmental were either not used or available applied would be of no help. Without addressing and demonstrating an impact of revenue recognition policies vis-a-vis segmental details of a comparable will not per se take the said comparable out of the Page 28 of 35 accepted list of comparables. The issue is restored to the TPO for this necessary exercise. The assessee may place necessary facts in support of its prayer.
(d) I.Gate Global Solutions Ltd.
We find that for exclusion of the said comparable the assessee has placed on record copy of Directors Report in support of the argument that extra-ordinary events prevailed justifying its exclusion. It has been argued that not only I Gate Technology Services Pvt. Ltd. (ITS), an erstwhile wholly owned subsidiary of I Gate Global Solutions merged with it also terminated its joint venture agreement with Software AG, Germany and sold its 49% holding of 7,84,000 shares in Software AG (India) Pvt.Ltd. to Software AG, Germany consequently the promoters i.e. I Gate Corporation and I Gate Inc. (Promoters) sought voluntary delisting of the equity shares of the company.
Further the members of the Company, in the Extraordinary General meeting held on November 13, 2007, accorded their consent for voluntary delisting of shares from the Indian stock exchanges and the employees were given an opportunity to participate in the stock option plan of I Gate Corporation (holding company) or to accept the cash settlement offered to them. Thus on the basis of these facts pleading prevalence of extra ordinary Page 29 of 35 events exclusion of the said comparable has been sought relying on precedent laid down in various cases. Wherever the assessee is able to demonstrate impact as net profitability in TNMM the comparable has to be excluded. Prevalence of extra ordinary event can be one factor which may impact net profitability.
However, mere existence of extra ordinary event by itself cannot be said to be a ground for exclusion of a comparable. How the events set out in the Directors Report impacted the net profitability of the said comparable has to be established and has not been addressed on facts. We further find that the Revenue has also argued that even existence of extra ordinary events itself was not canvassed before the tax authorities. Accordingly, in view of this factual deficiency the issue is restored back to the TPO. The assessee’s directed to support its claim for exclusion of the said comparable on the grounds of extra ordinary event impacting the net profitability of the said company so as to justify its exclusion.
(e) TATA ELxsi
We find that as per judicial precedent laid down by a Co- ordinate Bench in the case of Telecordia Technologies Pvt.Ltd. vs ACIT [2012] 22 taxmann.com 96 (Mum) qua the software development related services segment Tata Elxsi has been held to Page 30 of 35 be engaged in development of a niche product justifying its capacity to bargain for higher price. On a perusal of the copy of Annual Reports of this company placed at pages 286 to 353 of the Annual Report Compendium, we find that the facts justifying its exclusion continue to remain on record as the very nature of its activities and customers towards which it is focused shows that the said comparable cannot be said to be a comparable for the assessee who is not existing in a niche area engaged in development of niche products and services. Accordingly the prayer for the exclusion of this comparable on facts is justified.
(f) Lucid Software Ltd. Considering the arguments and the facts alongwith the precedent relied upon, we find that the exclusion of the said comparable has been sought on the grounds of functional imcomparability as the said company is stated to be actively involved in leading scientific and educational institutions; is involved in R& D activities. The said argument on facts has been faulted by the Revenue. The clear recital in the Notes on Accounts in Schedule M at Paper Book page 141 relied upon it is seen clearly shows that there is no software product expenditure.
Further Paper Book page 136 Schedule G relied upon by the Revenue also does not support on facts the precedent relied upon Page 31 of 35 by the assessee. The following clear recital heavily relied upon by the Ld.CIT DR stands non rebutted on record on behalf of the assessee:-
1.4.1. Software Product Development Expenditure “Software products developed in house are valued on the basis of costs directly attributable to the development of such software. In respect of each of the product so developed, the total expenditure gets amortised over a period of thirty six months from the launch date. The un-amortised product development expenditure is shown under Assets till it is fully written off. During the year there is no such expenditure incurred.” (emphasis provided) Accordingly, we find that on facts the prayer of the assessee has no merit. In the light of the facts on record as brought out above, the exclusion of the said comparable prayed on this ground is rejected.
(g) Acropetal Technologies:-
The exclusion of the said comparable has been sought on the ground that it fails the employee cost filter of 8.33% and judicial precedent as laid down in BP India Services P.Ltd. vs
ACIT [2015] 55 taxmann.com 150 (Mum.) has been relied upon for its exclusion. We find that in the face of the clear and consistent findings on record that employee related costs and on site expenses is 80.22% of the total expenses the precedent relied upon is of no value and distinguishable on facts. In the absence of any rebuttal on this fact, the prayer of the assessee is rejected as in the facts as they stand, we find no impediment to the retention of this comparable.
Addressing Ground Nos. 2.9 and 2.10, the Ld. AR has submitted that since these were the initial years when the issues were being developed, considered and understood accordingly for working capital adjustments and risk adjustments in the comparables the issues may be restored to the TPO. Inviting attention to page 19 of the impugned order para 9.10.1, it was submitted that it is not a case where the issues had been given up by the assessee as the following submissions qua working capital were advanced on behalf of the assessee:-
9.10. (J) Denying the Appellant the benefit of working capital adjustment 9.10.1. The appellant submitted that working capital adjustment is an adjustment for the opportunity cost of capital for investments made in working capital. Investments in working capital (i.e. inventories, accounts receivable/debtors and accounts payable/creditors) require capital and operating assets, and an uncontrolled entity is expected to earn a market rate of return on the required capital independent of the services that it provides. However, the amount of capital required to support these services varies greatly, because the level of inventories, debtors and creditors measured as a percentage of the total cost varies. There is an effect on profits from investing in different levels of working capital due to differences reflected in cash collection cycle. Such differences in collection cycle imply differences in credits granted to customers and such a credit function is akin to an additional service for which markets are willing to pay. The Appellant receives payments for services in a stipulated period of time from its AE and hence enjoys a favourable working capital position. Accordingly, a working capital adjustment vis-a-vis the comparable is essential in the instant case.”
8.1. Qua the benefit of risk adjustment, it was submitted that the assessee had advanced the following arguments before the CIT(A):-
9.11. (k) Denying the Appellant the benefit of risk adjustment “The key arguments of the Appellant in relation to the risk adjustment are summarized as follows:- - Several Tribunal Rulings (Mentor, E-gain and Sony Tribunal Rulings amongst others) and OECD TP Guidelines have underscored the need for risk adjustment. - Risk adjustment cannot be denied to the Appellant merely because it faces single customer risk. This may be the more pronounced factor in the case of the Appellant, however, for independent enterprises it could be factors such as majority of the business emanating from a single market, such as the US. In fact, most Indian software services companies consider this as a major risk area with regard to threat to continuity of business. Reliance in this case is also placed int he recent ruling of M/s Intelligent Technologies India Pvt. Ltd. vs ITO (ITA No.1237 (Bang.)/2010).”
8.2. The issues agitated it was submitted have been dismissed in a summary manner. Relying upon the precedent as laid down by the decision of Motorola solutions, it was his submission that the issues may be restored. The said submissions were not opposed by the Ld. Sr.DR.
Considering the submission advanced and the precedent relied upon in view of the above, we are of the view that it would be appropriate in the peculiar facts and circumstances restore the issue back to the TPO. While so restoring it is made clear that the onus for providing the relevant data warranting risk and capital adjustments if any in the comparables has to be provided Page 34 of 35 by the assessee. The TPO thereafter considering the same shall pass a speaking order in accordance with law giving the assessee a reasonable opportunity of being heard in case any adverse conclusions are sought to be drawn.
In the result, the appeal of the assessee is partly allowed for statistical purposes. The order is pronounced in the open court on13th of July, 2016.