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Income Tax Appellate Tribunal, BANGALORE BENCH ‘A’, BANGALORE
Before: SHRI A. K. GARODIA & SMT ASHA VIJAYARAGHAVAN
This appeal by the assessee is directed against the assessment order passed by the AO u/s 143(3) r.w.s.144C of the IT Act, 1961, as
per the direction of the DRP for the assessment year 2007-08.
The grounds raised by the assessee are as under;
2 IT(TP)A No.1229(B)2011
“Transfer Pricing The Honourable DRP and the learned AO grossly erred in upholding the income adjustment proposed by the learned TPO in arriving at the Arm's Length Price [ALP] of the international transactions entered into by the Appellant in respect to provision of software services.
The Appellant is in appeal before the Honourable bench of the Income Tax Appellate Tribunal (hereinafter referred to as Honourable "ITAT") under section 253 (1) (d) against the order passed by the learned AO in pursuance of the directions of the Honourable DRP.
A. Software services- Transfer Pricing:
The grounds mentioned hereinafter are without prejudice to one another. 1.The learned DRP and the learned TPO grossly erred in law and facts of the case in determining the ALP of the international transaction of the Appellant on account of provision of software services and proposing a transfer pricing adjustment of Rs. 20,362,735. 2.That on the facts and circumstances of the case, the learned DRP and the learned AO erred in upholding the rejection of Transfer Pricing ('TP') documentation by the learned TPO without appreciating the contentions, arguments, and evidentiary data put forward by the Appellant during the course of the proceedings before them, and in doing so have grossly erred: 2.1 in upholding the rejection of comparability analysis carried in the TP documentation and conducting a fresh comparability analysis for determining the arm's length price by the learned TPO. in adopting the arm's length mark up to be 28.44 % 2.2 [working capital adjusted margin] in respect of international transactions of the Appellant. 2.3 in upholding the actions of the learned TPO in completely relying on the unaudited data requisitioned and consequently obtained by taking recourse to the provisions of Section 133(6) of the Income-tax Act, 1961 ('the Act'), which in many instances are inconsistent with the data disclosed in audited reports. 2.4 in considering 25 percent as the threshold limit for the Related Party Transactions filter as this number is an arbitrary number that has been adopted without any judicial precedence or reasonable basis.
3 IT(TP)A No.1229(B)2011
2.5 in upholding the actions of the learned TPO in rejecting the upper limit for sales turnover filter proposed by the assessee without providing any empirical analysis. In doing so, the learned TPO erred in not appreciating that the software industry is clearly demarcated based on size. 2.6 in not maintaining consistency in applying the filters of rejecting Companies with software development revenue less than 75% of the total revenue and companies with different year end for preparing financial statements. 2.7 in upholding the actions of the learned TPO in applying the onsite filter for selection of software comparables with the use of the data obtained under section 133(6) of the Act. In doing so the learned TPO erred in rejecting Akshay Software Technologies Limited and VJIL Consulting Limited. 2.8 in upholding the actions of the learned TPO in accepting co.s like Infosys Limited and Wipro Limited as comparable companies even though the sales of Infosys and Wipro are driven based on brand developed by them, and doing so the learned DRP and learned AO have incorrectly applied the rationale provided in the jurisdictional Delhi Income Tax Appellate Tribunal (ITAT) ruling in Agnity India Technologies India Pvt. Ltd. (reference: ITA No. 3856(Del)/2010). 2.9 in upholding the actions of the learned TPO in accepting Tata Elxsi Limited as a comparable company even though the company in its reply to the learned TPO under section 133(6) had mentioned that the company provides product design services, which is functionally not comparable to the assessee's business. 2.10. in upholding the actions of the learned TPO in accepting companies engaged in the provision of software product development like Megasoft Limited, Flextronics Software Systems Limited, KALS Information Systems Limited, A vani Cimcon Technologies Limited, Lucid Software Limited, Ishir Infotech Limited, E-zest Solutions Limited, Persistent Systems Limited and R Systems International Limited which are functionally not comparable to the assessee's business. 2.11 in upholding the actions of the learned TPO in accepting Celestial Labs Limited as a comparable company even though it is a contract research company which also engaged in bio-informatics and hence functionally dissimilar to the assessee. 2.12 in upholding the actions of the learned TPO in accepting companies like Megasoft Limited, Flextronics Software Systems Limited and Helios & Matheson Information Technology Limited which have abnormal/fluctuating profit margins. In doing so the learned DRP and learned AO have disregarded the jurisdictional IT AT ruling in the case of SAP LABS India Pvt. Ltd. V s. ACIT (reference ITANo. 398/Bang/2008) and E-Gain
4 IT(TP)A No.1229(B)2011
Communication Private Limited (reference: - Pune). 2.13 in upholding the actions of the learned TPO in rejecting Thinksoft Global Services Limited by stating that it is not functionally comparable, 2.14 in upholding the actions of the learned TPO in concluding that Maars Software International Limited is not functionally comparable without even considering the fact that the IT consultancy services forms an integral part of the software development services and cannot be classified as functionally different from that of the assessee. 3.That the learned TPO and the learned DRP erred in disregarding the use of multiple year data and have considered only current year data based on search conducted at the time of the assessment, ignoring non-availability of current year data in the public domain at the time of preparing the documentation. 4.That the learned TPO, the learned AO and the learned DRP erred in disregarding the fact that the assessee did not have any intention to shift profits being eligible for deduction under section lOA. Therefore the adjustment proposed is not called for and is hence misplaced. 5.The learned AO and the learned DRP erred in upholding the actions of the learned TPO in concluding that the assessee is exposed to single customer risk without evaluating the business arrangement of the assessee. 6.The learned TPO, the learned AO and the learned DRP has erred in not appreciating that according to Appellant's transfer pricing policy, 88% of end customer revenue is received by the Appellant even when the associated enterprise is at net operating loss. 7.That the learned TPO, learned AO and the Honourable DRP erred in not allowing the benefits of market risk adjustment to the Appellant. 8.That the learned TPO, learned AO and the learned DRP erred in not allowing the benefit of range of +/- 5% as provided in proviso to Section 92C(2) of the Act to the Appellant, while determining the arm's length price. 9.The Appellant craves to leave/ to add to / to alter/ to amend! to rescind! to modify the grounds herein above or produce further documents, facts and evidence before or at the time of hearing this appeal. II. Corporate Tax 10. Computation of deduction under section lOA of the Act A. Reduction of lease line charges from the export turnover •The learned AO and the Honourable DRP erred in reducing lease line charges, amounting to Rs. 3,160,668, from the export turnover while computing the deduction under section 1OA of the Act.
5 IT(TP)A No.1229(B)2011
•The learned AO and the Honourable DRP erred in disregarding the submission made by the Appellant that the lease line expenses are not wholly attributable to delivery of computer software outside India and hence, the same should not be reduced from the export turnover of the Company. B. Reduction of expenses incurred in foreign currency from the export turnover •The learned AO and the Honourable DRP erred in reducing expenses incurred in foreign currency amounting to Rs. 1,639,970 from the export turnover for the purposes of computing deduction u/s 1OA. •The learned AO and Honourable DRP erred in disregarding the submission made by the Appellant that no part of the expenses incurred in foreign currency was incurred towards providing technical services outside India and hence, the same should not be reduced from the export turnover of the Company. C. No corresponding reduction of expenses from the total turnover •Without prejudice to the above, the learned AO and the Honourable DRP erred in reducing sums of Rs. 3,160,668 towards lease line charges and Rs. 1,639,970 towards expenses incurred in foreign currency only from export turnover without reducing the same from total turnover in computing deduction under section 1OA of the Act. •The learned AO has erred in not relying upon the decision of the jurisdictional Income Tax Appellate Tribunal in the case of KPIT Cummins Infosystems (Bangalore)(P) Ltd. V. ACIT - 26 SOT 529, wherein it has been held that should the expenses be reduced from export turnover then the expenses ought to be reduced from total turnover also.
•Further, the learned AO has also erred in not relying on the decision of the Special Bench of the Chennai Tribunal in the case of Sak Soft Limited v. ITO (ITA No. 691 & 19531Mds/2007) wherein it has been held that if the telecommunication, freight and insurance expenses are reduced from the export turnover then the same would also have to be reduced from the total turnover in order to compute the deduction under section 10A. Further, recently the High Court of Karnataka has decided the matter in favour of the assesse in the case of Honeywell Technologies Solutions Lab Pvt. Ltd. (ITA No. 820 of 2009).
11. Set off of losses incurred in Pune and Noida units •During the AY 2007-08, the Company had three units at Bangalore, Pune and Noida respectively. The Bangalore unit had earned profit
6 IT(TP)A No.1229(B)2011 of Rs. 55,255,951 during the concerned year and the Pune and Noida units had incurred losses amounting to Rs. 6,677,387 and 3,721,094 respectively.
•In its return of income filed by the Company for A Y 2007-08, the company had set off such losses of the Pune and Noida units against the profits of the Bangalore unit and claimed 10A deduction only on the profits of the Bangalore unit of Rs. 44,857,470 remaining after such set off.
•The learned Assessing Officer, in his order, has correctly given 10A deduction on the profits of the Bangalore unit before set off of the losses of the other two units.
•Thereafter the learned Assessing Officer has made a transfer pricing adjustment and computed the taxable income of the Company accordingly.
•However, the learned Assessing Officer has erred in not giving the benefit of the set off of the losses of the Pune and Noida units against such taxable income as computed by him.
12. Levy of interest •The learned Assessing Officer is not justified in levying interest amounting to Rs. 3,611,790 under section 234B of the Act. Levy of interest under section 234B is consequential in nature. •The learned Assessing Officer is not justified in levying interest amounting to Rs. 86,572 under section 234D of the Act. Levy of interest under section 234D is consequential in nature. 13.The Appellant craves leave to add, to alter or amend all or a grounds of appeal.
3. It was submitted by the ld. AR of the assessee that the assessee is pressing only ground no.2.8, 2.10, 2.11 and ground no.10 and the remaining grounds are not pressed. Accordingly, remaining grounds are rejected as not pressed.
4. Regarding ground no.10, he submitted that this issue is covered in favour of the assessee by the judgment of the Hon’ble Karnataka High Court rendered in the case of M/s Tata Elxsi Ltd.,
7 IT(TP)A No.1229(B)2011 reported in 349 ITR 98. Respectfully following this judgment, ground no.10 of the assessee’s appeal is allowed because learned DR of the revenue could point out any basis on which, this issue is not covered in favour of the assessee.
Regarding remaining grounds being pressed, it was submitted that these grounds are in respect of TP issue. He submitted a chart, as
per which, the assessee is requesting for exclusion of 12 comparable companies and in support of this contention, reliance has been placed on the Tribunal order rendered in the case of M/s Hewlett-Packard (India) Globalsoft Pvt.Ltd., Vs DCIT in IT(TP)A No.1031(Bang)/2011 (M/s HPPLtd.,). He submitted a copy of this Tribunal order. He also submitted that in this case, the Tribunal has held that these 12 comparables are to be excluded because, these are functionally dissimilar.
In reply, it was submitted by the ld. DR of the revenue that on page-17 of the order of DRP, the finding has been given by the DRP that the assessee could not justify as to how these entities are functionally different from the eligible assessee because, as per the respective annual reports of each of comparable entities the assessee seeks to reject and as per the same they have similar function profile as that of the assessee. He also submitted that it is also to be seen as to whether the assessee company and the profile of M/s HPP Ltd.,(Supra) are same or not and only after that, the Tribunal order rendered in the case of 8 IT(TP)A No.1229(B)2011 M/s HPPLtd., (Supra) can be considered as applicable in the present case.
In the rejoinder, it was submitted by the ld. AR of the assessee that since the same comparable companies are being considered in both the cases by the TPO, it stands accepted by the TPO himself that the functional profile of the present assessee and M/s HPP LTd(Supra) is same.
We have considered the rival submissions and we find force in the submissions of the ld. AR of the assessee that since the same comparables are being considered in the present case and in the case of M/s HPP Ltd. (Supra), it cannot be said that the functional profile of the assessee company and that company i.e. M/s HPP Ltd.,(Supra) is not comparable unless specific difference in facts is pointed out by any side. Since in the present case, ld. DR of the revenue could not point out any specific difference in facts in the present case and in the case of M/s HPP Ltd., (Supra), we feel that this Tribunal order should be considered and followed in the present case to the extent relevant.
Now, we examine the claim of the assessee regarding each comparable companies for which exclusion is being requested by the ld.AR of the assessee. Regarding M/s Avani Cimcon Technologies Ltd., discussion is on pages 14-15 of the Tribunal order rendered in the case of M/s HPPLtd., (Supra), wherein the Tribunal has noted that based on information available in the company’s website, it is revealed that this 9 IT(TP)A No.1229(B)2011 company has developed software product by the name ‘DXchange” and therefore, the revenue of this company includes revenue from software product sales, apart from rendering of software services and therefore, this is functionally different from assessee company. In the present case also, the assessee company is rendering only software services and not engaged in software product as such and therefore, by respectfully following this Tribunal order, we direct the AO/TPO to exclude this company i.e. M/s Avani Cimcon Technologies Ltd., from the final list of comparables.
The next company for which exclusion is being requested is M/s Celestial labs Ltd. and the relevant discussion regarding this company is available on pages 16 to 19 of the Tribunal’s order rendered in the case of M/s HPPLtd., (Supra). The Tribunal has noted on these pages that this company was basically/admittedly in clinical research and manufacture of bio-products and other products. Under these facts, we find no reason to have a contrary view in the present case, and therefore, by respectfully following this Tribunal’s order, we direct the AO/TPO in the present case also to exclude this company i.e. M/s Celestial Labs Ltd., (Supra) from the final list of comparables.
The third company for which exclusion is being requested is M/s E-Zest Solutions Ltd, and the discussion about this company is available on pages 19-20 of the Tribunal order rendered in the case of M/s HPP Ltd., (Supra). It is noted by the Tribunal on page-20 of the 10 IT(TP)A No.1229(B)2011 Tribunal order that M/s E-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the Co-ordinate Bench of this Tribunal in the case of M/s Capital I-Q Information Systems (India) (P) Ltd., in dated 23-11-2012 that KPO services are not comparable to software development services.
In the present case, ld. DR of the revenue could not pint out any difference in facts and therefore, by respectfully following this Tribunal order, we direct the TPO/AO in the present case also that this company i.e. M/s E-Zest Solutions Ltd. should not be excluded from the list of final comparables.
The next company for which exclusion is being requested is M/s Flextronics Software Systems Ltd (Seg.) and the discussion about this company is available on pages 37 to 38 of Tribunal’s order rendered in the case of M/s HPP Ltd., (Supra). On page-38 of the Tribunal’s order, it is noted by the Tribunal that in the case of M/s Flextronics Software Systems Ltd. (Seg.), the annual report for the year ending 31-03-2007 is only for nine months period and no reconciliation was attempted by the lower authorities between the figures given in such annual report with the figures which were made available by the said company to the TPO pursuant to notice issued to them u/s 133(6) of the Act. Under these facts, it was held by the Tribunal in that case that M/s Flextronics Software Systems Ltd., (Seg.) (Supra) could not be considered as a proper comparable. In the present case also, the 11 IT(TP)A No.1229(B)2011 assessment year is same i.e. AY: 2007-08 and therefore, respectfully following the Tribunal’s order, we direct the AO/TPO in the present case also that this company i.e. Ms/s Flextronis Software Systems Ltd.,(Seg.)(Supra) should be excluded from the list of final comparables.
The next company for which exclusion is being requested is M/s Infosys Ltd. and the discussion about this company is available on pages 20 to 22 of the Tribunal’s order rendered in the case of M/s HPP Ltd., (Supra). In this case, it is noted by the Tribunal that this company owns significant intangibles and has huge revenues from software products and therefore, by respectfully following this tribunal order, we hold that this company i.e. M/s Infosys Ltd., (Supra) also should be excluded from the list of final comparables.
The next company for which exclusion is being requested is M/s Ishir Infotech Ltd. and the discussion about this company is available on pages 23-24 of the tribunal’s order rendered in the case of M/s HPOP Ltd., (Supra). It is noted by the Tribunal on these pages that M/s Ishir Infotech Ltd., is outsourcing its work and has not satisfied 25% employee cost filter and thus has to be excluded from the list of comparables. Respectfully following this Tribunal order, we direct the TPO/AO in the present case also to exclude this company from the list of final comparables.
The next company for which exclusion is being requested is M/s Kals Information Systems Ltd., Regarding this company, it was 12 IT(TP)A No.1229(B)2011 submitted by the ld. AR of the assessee that relevant discussion is on page 25 to26 of the Tribunal order rendered in the case of M/s HPP Ltd., (Supra). On these pages, it is noted by the Tribunal that this company was developing software products and not purely or mainly software development service provider. Therefore, respectfully following this Tribunal’s order, we direct the AO/TPO in the present case also that this company i.e. M/s Kals Information Systems Ltd (Supra) should be exclude from the list of final comparables.
The next company for which exclusion is being requested is M/s Lucid Software Ltd. Regarding this company also, it was submitted by the ld. AR of the assessee that the discussion about this company is available on pages 23-24 of the Tribunals order rendered in the case of M/s HPP Ltd., (Supra). On these pages, it is noted by the Tribunal that M/s Lucid Software Ltd.,(Supra) is involved in the development of software as compared to the assessee which is only into software services. Therefore, in the present case also, by respectfully following this Tribunal order, we direct the AO/TPO to exclude this company i.e. M/s Lucid Software Ltd., from the list of final comparables.
The next company for which exclusion is being requested is M/s Megasoft Ltd. It is submitted by the ld.AR of the assessee that about this company, the discussion is available on pages 34 to 36 of the Tribunal order rendered in the case of M/s HPP Ltd., (Supra). We find that in this case, it was held by the Tribunal that M/s Megasoft Ltd.
13 IT(TP)A No.1229(B)2011 should be considered as a good comparable after segmentation and therefore, in the present case, we direct the AO/TPO to consider this company i.e. M/s Megasoft Ltd., (Supra) as a comparable after segmentation of its result.
The next company for which exclusion is being requested is M/s R Systems International Ltd.,(Seg.). It was submitted by the ld. AR of the assessee that the discussion about this company is available on pages 38-39 of the Tribunal’s order rendered in the case of M/s HPPLtd. (Supra). In para-30 of the Tribunal order, it is noted by the Tribunal that as per the annual report of the said company placed by the assessee in paper book , it is seen that final accounts are being prepared on calendar year basis and the P&L account is for calendar year ending 31-12-2008 and under these facts, by respectfully following this Tribunal order, it was held that this company cannot be considered as a proper comparable.
The ld. DR of the revenue could not point out as to how the Tribunal order on this issue is not to be followed in the present case and therefore, by respectfully following this Tribunal order, we direct the AO/TPO that this company i.e. R Systems International Ltd.,(Seg.) should be excluded from the list of final comparables.
The next company for which exclusion is being requested is M/s Wipro Ltd., It is submitted by the ld. AR of the assessee that discussion about this company is available on pages 32 to33 of the 14 IT(TP)A No.1229(B)2011 Tribunal order rendered in the case of M/s HPP Ltd., (Supra). On these pages, it is noted by the Tribunal that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. Therefore, respectfully following this Tribunal order, we direct the AO/TPO that in the present case also, this company i.e. M/s Wipro Ltd., should be excluded from the final list of comparables.
The next company for which exclusion is being requested is M/s Persistent Systems Ltd., It was submitted by the ld. AR of the assessee that the discussion about this company is available on pages 26 to 27 of the Tribunal order rendered in the case of M/s HPP Ltd. (Supra). On page 27 of this Tribunal order, it is noted by the Tribunal that this company is engaged in product development and product design services, while the assessee is a software development service provider. Facts being similar, respectfully following this Tribunal order, we direct the AO/TPO that in the present case also, this company i.e. M/s Persistent Systems Ltd., should be excluded from the list of final comparables.
As per the above discussion, we have held that one company i.e. M/s Megasoft Ltd., (Supra) should be considered as a comparable but after segmentation of its profit and the remaining eleven companies for which exclusion was being requested by the assessee are directed to be excluded from the list of final comparables. The AO/TPO should determine the PLI after giving effect to these directions and if the same
15 IT(TP)A No.1229(B)2011 is within +/- 5% range of assessee’s profit, then no TP adjustment should be made and in case, the same exceeds +/- 5% range then the TP adjustment should be made as per law.
In the result, the appeal of the assessee is allowed for statistical purposes.
Order pronounced in the open court on the date mentioned on the caption page.