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Income Tax Appellate Tribunal, BENCH- A, BANGALORE
PER ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER
This appeal by the assessee is directed against the order of Dy. Commissioner of Income-tax, Bengaluru dated 30/9/2011 and it pertains to the assessment year 2007-08.
IT(TP)A No.1300/B/11
2 2. The assessee is a private ltd., company incorporated on August 14, 2003 under the provisions of the Companies Act, 1956 with liability limited by shares. It has its registered office at #003, Classique Mansion, 6th Cross, Off Airport Road, HAL 2nd Stage, Bangalore-560 008. It is a 100% export oriented unit registered under the aegis of Software Technology Park of India and eligible for deduction specified u/s 10A of the Act. It is a wholly owned subsidiary of Supportsoft Inc. and provides software development services exclusively to its parent. The company has entered into software development services agreement with Supportsoft Inc. The Company’s operations form a strategic part of Supportsot Inc’s global operations. Since Supportsoft India is engaged in the business of providing software development services, it can be broadly classified as engaged in the business of providing Information Technology (hereinafter referred as IT) services and thereby falling under the Information Technology Services Industry. It is also engaged in the business of providing sales and marketing services exclusively to Supportsoft Inc.
IT(TP)A No.1300/B/11
3 3. The adjustment to the ‘Arms Length Price’ International transaction dealt in by the assessee company with its AE to the extent of Rs.2,14,56,38/- was brought to tax by the DCIT, Circle 12(3) Bangalore.
The assessee is an appeal before us.
The facts are that the methodology employed is external TNMM. The assessee selected comparables.
The following is the Computation of arm’s length price by the AO/TPO and the adjustment made:
Arm’s length mean margin 25.14% Less: Working capital adjustment 1.99% Adjusted mean margin after working capital adjustment23.15% Operating Cost 14,21,11,466 Arm’s length price – 121.87% of operating cost 17,50,10,246 Price received for international transaction 15,35,53,859 Short fall being Adjustment u/s 92CA 2,14,56,387 IT(TP)A No.1300/B/11
4 Comparables Selected by TPO Sl.No. Company Name Operating WC Margin on ci Adjusted cost margins as per TPO 1 Accel Transmatic Ltd (Seg.) 21.11% 20.10% 2 Avani C 52.59% 51.29% 3 Celestial Labs Ltd 58.35% 54.40% 554 Datamatics Ltd 1.38% -0.73% 5 E-Zest Solutions Ltd 36.12% 36.10% 6 Flextronics Software Systems Ltd 25.31% \25.05% 7 Geometric Ltd (seg) 10.71% 9.55% 8 Helios & Matheson Information Technology 36.63% 34.48% Ltd 9 iGate Global Solutions Ltd 7.49% 5.53% 10 Infosys Technologies Ltd 40.30% 39.03% 11 Ishir Infotech Ltd 30.12% 30.43% 12 KALS Information Systems Ltd (Seg.) 30.55% 23.42% 13 LGS Global Ltd (Lanco Global Solutions 15.75% 15.12% Ltd) 14 Lucid Software Ltd 19.37% 17.01% 15 Mediasoft Solutions Pvt Ltd 3.66% 1.47% 16 Megasoft Ltd (Seg.) 60.23% 51.44% 17 Mindtree Ltd 16.90% 15.32% 18 Persistent Systems Ltd 24.52% 23.42% 19 Quintegra Solutions Ltd 12.56% 9.16% 20 RS Software (India) Ltd 13.47% 13.08% 21 R Systems International Ltd (Seg.) 15.07% 13.19% 22 Sasken Communication Technologies Ltd 22.17% 21.06% (Seg.) 23 SIP Technologies & Exports Ltd 13.90% 10.64% 24 Tata Elexi Ltd (Seg.) 26.51% 26.18% 25 Thirdware Solutions Ltd (Seg) 25.12% 21.51% 26 Wipro Ltd (Seg.) 33.65% 34.53% Arithmetic Mean 25.14% 23.15% IT(TP)A No.1300/B/11
5 6. The assessee has given the following chart expressing his opinion that certain companies have to be rejected while some are to be selected.
The ld. counsel for the assessee pointed out that 4 of the comparables selected by the appellant were also selected by the TPO which are as follows: 1) Helios and Metherson Information
Technology Ltd., 2) LGS Global Ltd., , 3) RS software (India) Ltd., 4) SIP Technologies and Exports Ltd.,
Helios & Matheson Information Technology Ltd., Before the TPO, it was submitted that 4.60 In the preceding assessment year, this company had been rejected as a comparable applying onsite revenue filter. In the order under Section 92CA for the preceding year, it is stated that this company has 100% onsite revenues. For the year under consideration, you have stated that this company passes all the filters.
IT(TP)A No.1300/B/11
4.61 As per reply received under Section 133(6), this company has 73% revenues from onsite operation. On what basis the ratio is fixed at 75% is not clear from the Notice. How a 73% onsite revenue company is different than a 75% onsite revenue company has not been demonstrated. This represents arbitrariness in application of the filter. Based on the above, the assessee submits that this company should not be selected as comparable.
4.62 Further while computing the margins of this company, you have included other income of Rs.4,22,41,177 and dividend income of Rs.64,73,573 as part of operating income. Other incomes have been excluded in all other cases while computing operating margins. The same approach had to be adopted for this company also. When the same is excluded from the operating income, the operating revenue stands at Rs. 1,78,63,80,304 and operating profits at Rs 47,88,93,794. The revised margins would therefore be 36.63%.
Before the DRP, it was submitted that 7.55 With respect to this company, the assessee had submitted that assuming that onsite revenue filter IT(TP)A No.1300/B/11
7 should be applied, as per reply received under Section 133(6), this company has 73% revenues from onsite operations. The learned TPO has rejected companies having more than 75% revenues from onsite operation. On what basis the ratio is fixed at 75% is not clear. How a 73% onsite revenue company is different from a 75% onsite revenue company has not been demonstrated. This represents arbitrariness in application of the filter. Based on the above, the assessee submits that this company should not be selected as comparable.
7.56 The TPO has contended that issue of onsite revenue filter has been discussed. Since this company passes onsite revenue filter, it should be selected as comparable.
Additional submission of the Assessee
7.57 The assessee submits that the TPO has not demonstrated the rationale for the fixing the onsite revenue filter at 75%. The same is arbitrary in nature and liable to be rejected.
IT(TP)A No.1300/B/11
8 9. The assessee has filed additional grounds, which are as follows:-
“In the order passed, transfer pricing additions were made to the total income of the appellant for transactions with associated enterprises. The additional grounds of appeal (enclosed herewith) relate to rejection of Helios & Matheson Information Technology Ltd. as comparable. Both the appellant and TPO had selected the company as a comparable in the TP study and in the TP order, respectively.
With respect to rejection of the comparable, the ground pertains to question of facts. All the necessary facts for adjudicating this ground are already on record. The appellant humbly prays that the additional ground be admitted and adjudicated along with the other grounds of appeal in the course of hearing of the appeal.”
10. We admit the additional grounds and following the decision of Quark System, we set aside this issue to the file of the TPO and direct him to give an opportunity to the assessee to submit his contentions with respect to rejection of this comparable.
IT(TP)A No.1300/B/11
With respect to LGS Global Ltd., RS Software (India) Ltd., and SIP Technologies and Exports Ltd., the learned counsel for the assessee accepted the above three comparables to be included by the TPO.
The assessee has further accepted 1) Datamatics Ltd., 2) Mediasoft Solutions Pvt. Ltd 3) Megasoft Ltd (Seg. 4) Quintegra Solutions Ltd., 5) R Systems International Ltd (Seg.).
Megasoft Ltd. : The learned counsel for the assessee submitted that Megasoft Ltd., margin of 23.11% should be considered for computing ALP in view of the decision of the Bangalore Tribunal in the case of M/s Novell software Vs IT(TP)
1287/Bang/2011 for Assessment year 2008, wherein it is held as under:-
This company was chosen as a comparable by the TPO. The objection of the assessee is that there are two segments in this company viz., (i) software development segment, and (ii) software product segment. The Assessee IT(TP)A No.1300/B/11
10 is a pure software services provider and not a software product developer. According to the Assessee there is no break up of revenue between software products and software services business on a standalone basis of this comparable. The TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius-BCGI Division does the business of product software. This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product software would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to product software) internally and that the portion of the revenue from development of software IT(TP)A No.1300/B/11
11 sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO’s filter of IT(TP)A.1287/Bang/2011 Page – 39 more than 75% of revenues from software development services. The basis on which the TPO arrived at the PLI of 60.23% is given at page-115 and 116 of the order of the TPO. It is clear from the perusal of the same that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data.
In the order of the TPO, operating margin was computed for this company at 60.23%. It is the complaint of the assessee that the operating margins have been computed at entity level combining software services and software product segments. It was submitted that the product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions on page 381 to IT(TP)A No.1300/B/11
12 383 of the PB-I). It was further submitted that Megasoft Limited has provided segmental break-up between the software services segment and software product segment (page 68 of PB-II), which was also adopted by the TPO in his show cause notice (Page 84 of PB-I). The segmental results i.e., results pertaining to software services segment of this company was: Segmental Operating Revenues Rs.63,71,32,544Segmental Operating Expenses Rs.51,75,13,211Operating Profit Rs.11,96,19,333 OP/TC (PLI) 23.11%
It was reiterated that in the given circumstances only PLI of software service segment viz., 23.11% ought to have been selected for comparison.
It was further submitted that the learned TPO in case of other comparable, similarly placed, had adopted the margins of only the software service segment for comparability purposes. Consistent with such stand, it was submitted that the margins of the software segment only should be adopted in the case of Megasoft also, in contrast to the entity level margins.
Computation of the net margin for Mega Soft Ltd. Is therefore remitted to the file of the TPO to compute the IT(TP)A No.1300/B/11
13 correct margin by following the direction of the Tribunal in the case of Trilogy EBusiness Software India Pvt.Ltd.”
Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to compute the correct margin of Mega Soft Ltd., as directed by the Tribunal in the case of First Advantage Offshore Services Pvt.Ltd. (supra).
Accordingly we hold that Megasoft Ltd can be considered as a good comparable after segmentation as directed in the above order is done.
Accordingly we are of the opinion that Megasoft Ltd can be considered to be a good comparable after segmentation.
The ld counsel for the assessee submitted that the following comparables selected by the TPO can be accepted.
1. Megasoft 2. Datamatics Ltd. 3. Mediasoft Solution Pvt. Ltd., 4. Quintegra Solutions Ltd. 5. R Systems International Ltd. (Seg)
IT(TP)A No.1300/B/11
14 16. The learned counsel for the assessee submitted that the following companies are to be rejected.
Accel Transmatic Ltd. (Seg.) 2. Avani C 3. Celestial Labs Ltd 4. E-Zest Solutions Ltd 5. Flextronics Software Systems Ltd 6. Geometric Ltd (seg) 7. Gate Global Solutions Ltd 8. Infosys Technologies Ltd 9. Ishir Infotech Ltd 10. KALS Information Systems Ltd (Seg.) 11. Lucid Software Ltd 12. Mindtree Ltd 13. Persistent Systems Ltd 14. Sasken Communication Technologies Ltd (Seg.) 15. Tata Elexi Ltd (Seg.) 16. Thirdware Solutions Ltd (Seg) 17. Wipro Ltd (Seg.)
We are of the opinion that the above 17 comparables requested to be rejected by the assessee are to be restored to the file of TPO, who shall decide following the ratio of the decision in the case of McAfee Software (India) Pvt. Ltd., in IT(TP) No.4/Bang/2012. The relevant para is reproduced hereunder:
IT(TP)A No.1300/B/11
15 “However, there cannot be rigid rule or percentage fixed in adopting various filters. Generally, a turnover filer is adopted to avoid selection of high end companies (big companies) with that of ‘minnows’ in the similar line of business. How to adopt the filter depends on each case. Say for example, in the TP analysis of a company having 20 crores receipts, a company with 2 crores to 200 crores can be stated to be within the range ie, factor of ten as upper and lower limits. In certain cases, the ITAT also accepted turnover filter of 1 crore to 200 crores. But the range cannot be fixed, as the facts may vary from case to case. Simply a comparable cannot be excluded on upper turnover limit when infact in number of cases assessees did not raise any objection on inclusion of companies with very small turnovers. The 200 crores upper limit also cannot be considered in a case whose turnover is, say 300 crores. Therefore, instead of a fixed 1 cr – 200 crore range, what one has to consider is the turnover/receipts of assessee and range of upper limit at ten times and lower limits also ten times. i.e, one tenth. Thus for example the range of 1 300 crores company can be from 30 crores (1/10th) to 3000 crores (ten times). Even this has some limitations. For example if range is considered say 2 to 200 crores, a comparable company cannot be rejected if the turnover IT(TP)A No.1300/B/11
16 is 1.99 crores or say 201 crores. There can be margin of variation. These are broad parameters so that no fixed formula can be adopted on uniform basis across all areas of functions.”
It was further held that he TPO should examine whether the comparable company is within the range of ten times the upper limit.
For eg. – Assessee’s turnover is about 63 crores, the turnover of i-gate Global Solutions Ltd., (seg) is above 405 cores and L & T Infotech Ltd., is of 562 crores, then this is within the range of ten times the upper limit and therefore these two are to be retained.
The AO shall also analyze the functional dissimilarity in certain comparables while deciding the matter restored to his file.
In the result, the appeal is set aside for statistical purposes.
IT(TP)A No.1300/B/11
17 Order pronounced in the open court on 30th September, 2016.