MERCEDES- BENZ RESEARCH & DEVELOPMENT INDIA PRIVATE LIMITED,BANGALORE vs. ASST.C.I.T., BANGALORE

Per Shri Vijay Pal Rao, J.M. : These cross appeals are directed against the assessment order dt.30.1.2015 passed under Section 143(3) r.w.s. 144C(5) of the Income Tax Act, 1961 (in

relating to transfer pricing matters On the facts and in the circumstances of the case and in law:

2. The learned AO/Transfer Pricing Officer (‘TPO’)erred in making an addition of Rs. 87,551,355 to the total income of the Appellant on account of adjustment in the arm’s length price of the software research and development services transaction entered by the Appellant with its associated enterprise; Grounds of objections relating to Cost Plus Method (“CPM”)/Comparable Uncontrolled Price (“CUP”): The learned AO/TPO erred in rejecting the CPM/ CUP method adopted by the Appellant and 3. using Transactional Net Margin Method (“TNMM”) as the most appropriate method for determining arm’s length price; Grounds of objections relating to TNMM:

4. The learned AO/TPOerred, in law and in facts, by not accepting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Rules, and conducting a fresh economic analysis for the determination of the ALP in connection with the impugned international transaction and holding that the Appellant’s international transaction is not at arm’s length;

5. The learned AO/ TPOerred, in law and in facts, by determining the arm’s length margin/ price using only FY 2009-10 data which was not available to the Appellant at the time of complying with the transfer pricing documentation requirements;

6. The learned AO/TPOerred in rejecting certain comparable companies by applying the following quantitative and qualitative filters: a) The learned AO/TPO erred, in law and in facts, by rejecting certain comparable companies identified by the Appellant for having different accounting year (i.e. companies having accounting year other than March 31 or companies whose financial statements were for a period other than 12 months);

3 IT(TP)A Nos.291 & 427/Bang/2015 b) The learned AO/TPO erred in applying ‘employee cost greater than 25% of the total revenues’ as a comparability criterion in the search strategy to identify comparable companies; c) The learned AO/ TPO erred, in law and in facts, by rejecting certain comparable companies identified by the Appellant where consolidated results had been used for analysis. The Appellant had considered the consolidated results in only those cases where the income of the Indian company constituted more than 75% of the consolidated company-wide/ segmental revenues. d) The learned AO/ TPO erred, in law and in facts, by rejecting certain comparable companies identified by the Appellant using export earnings greater than 75% of the sales as a comparability criterion; and e) The Hon’ble DRP erred, in law and in facts, by suo-moto modifying the related party filter (“RPT”) of ‘less than 25 percent’ to ‘equal to 0 percent’ and thereby rejecting certain companies, which otherwise were passing the filter of RPT < 25 percent, applied and not disputed by both the Appellant and the AO/TPO; 7. The learned AO/ TPO erred, in law and in facts, by accepting / rejecting companies based on unreasonable comparability criteria; 8. The learned AO/ TPO erred, in law and in facts, by artificially restricting the benefit of working capital adjustment; 9. The learned AO/TPO erred, in law and in facts, by not making suitable adjustments on account of differences in the risk profile of the Appellant vis-à-vis the comparables, while conducting comparability analysis; 10. The learned AO/TPO erred, in law and in facts, by incorrectly considering pass through costs in the nature of technical consultancy and software license costs as operating in nature while computing the operating margin of the Appellant; 11. The learned AO/TPO erred, in law and in facts, by computing the arm’s length price without giving benefit of +/- 5 percent under the proviso to section 92C of the Act; Grounds of appeal relating to general matters

12. The learned AO erred, in law and in facts, by levying interest of Rs.16,422,055,Rs. 560,081and Rs. 425,858 under section 234B, 234C and 234Dof the Income Tax Act, 1961, respectively.

13. The learned AO erred, in law and in facts, in initiating penalty proceedings u/s 271(1)(c) of the Act. The Appellant submits that each of the above grounds is independent and without prejudice to one another. The Appellant craves leave to add, alter, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal, so as to enable the Hon’ble Tribunal to decide on the appeal in accordance with the law.”

4 IT(TP)A Nos.291 & 427/Bang/2015

5 IT(TP)A Nos.291 & 427/Bang/2015 “ Financial Results for the F Y 2009-10.

Operating Revenues 108,32,66,644. Operating Expenses 98,36,06,532 Operating (Profit)/Loss 9,96,60,112 Op. Profit on cost % 10.13%

International transactions (as mentioned in the 92 CE report)

Sl.No. Type of Transcription Amount (Rs.) 1. Software development services (Recd) 108,32,66,644 2. Communication and Software License Fees 87,81,099 (Paid) 3. Reimbursement of expenses (paid) 8,97,64,920 4. Reimbursement of expenses (Recd) 64,84,753 5. Repairs & Maintenance (Paid) 9,09,044”

The assessee applied cost plus method as MAM for benchmarking its international transactions in the Transfer Pricing study analysis. The assessee has also given the TP analysis by alternative method under CUP as MAM based on man hourly rates. The TPO rejected the method adopted by the assessee and applied TNMM as MAM for determining the ALP. The TPO has used the final set of 13 comparables with average PLI 21.6% as under :

Sl.No. Name of the company Margin % 1 Zylog Systems 19.06 2 Evoke Technologies Ltd. 18.75 3 E-Zest Solutions Ltd. 16.79

6 IT(TP)A Nos.291 & 427/Bang/2015 4 Infosys Ltd. 45.01 5 Kals Information Systems Ltd. 38.37 6 LGS Global Ltd. 11.95 7 Persistent Systems Ltd. 30.35 8 R S Software (India) Ltd. 10.29 9 Tata Elxsi Ltd. 21.88 10 Thinksoft Global Services Ltd. 17.05 11 Sasken Technologies 17.36 12 Mindtree Ltd. (Seg.) 14.83 13 L&T Infotech Ltd. 19.33 Average PLI 21.62% After allowing working capital adjustment of 1.29%, the adjusted mean margin was arrived at 23.33%. Accordingly, the TPO proposed an adjustment of Rs.9,88,09,023 under Section 92CA of the Act. Aggrieved by the order of the TPO as well as A.O, the assessee filed objections before the DRP regarding the rejection of the MAM adopted by the assessee and using TNMM as MAM by the TPO for determining the ALP. The DRP did not accept the objections of the assessee on this issue while passing the impugned directions.

At the outset we note that an identical issue has come up before this Tribunal

7 IT(TP)A Nos.291 & 427/Bang/2015 for the Assessment Year 2008-09 and vide order dt.16.3.2016 in IT(TP)A No.1336/Bang/2012 the Tribunal has held in paras 5.5 to 5.8 as under :

“ 5.5 Against the Cost Plus Method, the assessee states that OECD guidelines called for adoption of this method in cases where semi-finished goods are sold between associates or where there are long term buy and supply arrangements or in the case or provision of services, particularly where these are of subsidiary or peripheral nature. It was stated that appropriate method for attracting R&D services is Cost Plus Method which is ideally suited for the case of the assessee. It was submitted that all costs have been considered and arrived at the gross profit and operating profit margin of around 32% is quite reasonable. The net margin of 5% of overall cost is also very significant and reasonable, especially because the company does not resume any significant business risks. Thereafter, the assessee has taken 15% of the profits of companies who have R&D activities as per decision of ITAT in Rolls Royce case and analysed the Cost Plus Method.

5.6 However, as the ld. TPO has stated in the report, there is no data furnished by the assessee with reference to Cost Plus method. Even when we enquired, the ld. counsel fairly admitted that assessee would prefer CUP method over Cost Plus Method. In view of this, in the absence of any data, we are not in a position to appreciate the Cost Plus Method. More over, most of captive service provides work on Cost Plus Method ranging from 5% mark-up to 25% mark-up. All the transactions are related party transactions. Therefore, uncontrolled comparable prices are generally not available in the Cost Plus Method. Even the assessee’s analysis of 32% Gross Profit and 5% Net Profit cannot be accepted as there cannot be any Gross Profit in the case of assessee, who is operating on Cost Plus Method. More over, even though the assessee is stated to have been operating on Cost Plus 5% Method, OP/Cost as computed by the assessee itself is at 3.2% and if foreign exchange gain was added to the operating margin, then only it comes to 5%. Generally in a Cost Plus situation, the entire cost spent by the assessee with a mark-up of 5% would be billed to the AE on a periodical basis. The conversion generally done at the prevailing rate of USD or foreign currency involved. Therefore, the basic concept is the margin would be about 5%. In case of any foreign exchange gain, this could increase the margin to that extent. In case of foreign exchange loss on the USD / foreign currency quoted by the assessee, then the margin would come down to that extent. However, as seen in this case, the margin without foreign exchange gain itself is less than 5%. Therefore, in the absence of correct cost structure and billing procedure, it is very difficult to accept the Cost Plus Method and analyse the issue.

5.7 The next contention of the assessee is with reference to CUP method. The assessee states in the Annexure III to 3CEB report that ‘there are no internal comparables within the group as entire services of assessee are bought back by AE. Offshore software development work by other companies may represent external comparables. However, data in respect of the same which is available in terms of Euros per hour is not comparable without making suitable adjustments to the differences in the nature and terms of contract/transactions’. As necessary information required for these adjustments is not readily available in the public domain, assessee submits that this cannot be done. Thereafter, assessee proceeded to analyse and submit that on a rough and ready basis, this analysis was done with reference to rates charges by major Indian companies although the functions

8 IT(TP)A Nos.291 & 427/Bang/2015 performed or risk assumed by them are significantly higher, as this will provide the connection of upper price charge at which arm’s length transactions takes place. The assessee has given Annexure- IV working out the USD rates and INR rates worked out at rate per hour to submit that this was external CUP and assessee’s margin at Rs.1333.63 is higher than other comparable companies. After examining Annexure-VIII of the report, we have asked the ld. counsel about the working adopted by the assessee in arriving at the rate per hour either in USD terms or INR terms. It was submitted that by taking general accounts and annual repot of the respective companies, assessee has derived offshore consultancy amount and thereafter assumed the persons who have worked offshore and then the rate per day at 20 days per month working and rate per hour at 8 hours per day, thus on various assumptions and presumptions, the rate per hour was arrived from the total profits as reported in the public domain. It was fairly admitted that rate per hour is not available for strict comparison. It was also submitted that the assessee has not taken NASCOM rates as the basis in comparing the rate per hour. This indicates that assessee’s comparability under the CUP method is based on various assumptions of (a) estimating the offshore profits, (b) estimating number of employees, (c) estimating the working hours per employee per day per month, and then dividing the profit by so many assumptions/ numbers. This analysis of the assessee cannot be relied on as an external CUP. As can be seen from the above, there is no internal CUP which can be relied on in order to accept the CUP method. Therefore, in our view, the analysis undertaken by the assessee is not only faulty, but devoid of any data or proper analysis. In view of this, we have no option than to accept the TPO’s contention of TNMM as the most appropriate method.

5.8 Under section 92C of the Act, ALP has to be examined adopting the most appropriate method. Section 92C prescribes five methods – CUP, RPM, CPM, PSM and TNMM. Rule 10C provides the relevant guidelines for analyzing the most appropriate method to be selected. Under the Indian TP regulations, there is no priority or preference to any of the methods. There are also no regulations which prescribe any circumstances under which method is to be adopted, except for PSM. The above 5 methods are categorised generally as 1.Traditional methods i.e., CUP, RPM and CPM, and 2. Transactional profit methods of PSM and TNMM. In the absence of reliable data to undertake the exercise under the traditional methods, the only option is go for the transactional profit methods, when standard methods are not reasonably applied. In view of absence of reliable data either to adopt Cost Plus Method or to analyse the data on the basis of CUP method, either internal CUP or external CUP, we are of the opinion that under given facts and circumstances of the case, TNMM is the only option available to the TPO to analyse the assessee’s transactions in order to arrive at the ALP. Therefore, we reject the assessee’s contentions on CUP/CPM as most appropriate method and approve the approach taken by the TPO for analyzing transactions under TNMM.”

The assessee has not disputed that the facts and circumstances for the year under consideration are identical as for the Assessment Year 2008-09.

Accordingly, following the earlier order of this Tribunal in assessee's own case

9 IT(TP)A Nos.291 & 427/Bang/2015 this issue is decided against the assessee and confirmed the order of the TPO in adopting TNMM as MAM.

8.1 We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record.

There is no dispute that as per the Rule 10B(4) as well as Rule 10D (4) so far as possible the current year and contemporaneous data has to be considered for determining comparable price. Only in the case of exceptional circumstances where current year data cannot be relied upon and does not give the true and correct state of affairs of the functional comparability then multiyear data up to 2 earlier years can be used. The assessee has failed to demonstrate that the current year data of the comparables are not reliable. Accordingly, we do not find any substance or merit in this ground of the assessee’s appeal and the same is rejected.

10 IT(TP)A Nos.291 & 427/Bang/2015 9. Ground Nos.6 & 7 are regarding selection of comparable companies by the TPO and consequential adjustments. Though the assessee has raised various objections regarding the filters applied by the TPO as well as by the DRP however at the time of hearing, the learned Authorised Representative of the assessee has pressed only the grounds regarding filter applied by the DRP in respect of the Related Party Transaction (‘RPT’) at 0%. We find that the department has also raised this ground in Ground No.3, therefore we will deal with this issue while deciding the departmental appeal.

10. The assessee has also raised additional ground vide petition dt.26.5.2016 which reads as under :

14. Without prejudice to submission that following companies have rightly been excluded on the basis of turnover , the learned DRP/AO/TPO have failed to appreciate that even otherwise these companies are not comparable to the Appellant for other reasons such as functional dissimilarity and / or extraordinary events and consequently erred in considering the same as comparable companies; i. Persistent Systems Limited ii. Sasken Communication Technologies Limited iii. Zylog Systems Limited iv. In the above circumstances the Petitioner prays that this Hon’ble Tribunal be pleased to admit and adjudicate the above additional ground, i. pass any other order that may be required in the circumstances of the case and render justice.”

11 IT(TP)A Nos.291 & 427/Bang/2015 10.1 We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record on the admission of the additional ground raised by the assessee. The assessee is seeking exclusion of 3 companies from the set of comparables which are part of the TP analysis study. The learned Authorised Representative of the assessee has submitted that these companies were selected by the assessee in the TP analysis however, the assessee raised the objection before the DRP regarding the functional dissimilarity as well as extra-ordinary events during the year which has not been considered by the DRP and excluded these companies on the ground of turnover filter. The learned Authorised Representative has submitted that from the record it is apparent that these companies are functionally not comparable with the assessee and further there are precedence wherein the Tribunal has held that these companies cannot be considered as good comparables. He has relied upon the decision of the Special Bench of the Tribunal in the case of CIT Vs M/s Quark Systems Pvt.Ltd.,(2010)

38. SOT 0307.

10.2 On the other hand, the learned Departmental Representative has objected to the admission of the additional ground and submitted that when

12 IT(TP)A Nos.291 & 427/Bang/2015 the assessee itself has selected these companies and the authorities below had no occasion to consider the objections raised by the assessee at this stage, then the additional ground cannot be admitted at this stage.

10.3 Having considered the rival submissions as well as the relevant material on record, we find that the functional comparability of these three companies have been considered by the Tribunal in various cases which has been relied upon by the learned Authorised Representative. By way of the additional grounds, the assessee is raising objection regarding the functional dissimilarity and/or extraordinary events during the year and exclusion of three comparable companies which was considered by the TPO/A.O for determining the Arm’s Length Price (‘ALP’). We are of the view that the assessee cannot be precluded from raising an objection against a company which is found to be not comparable even if the said company was wrongly selected by the assessee in its T.P. Study. This view was taken by the Special Bench of the ITAT, Chandigarh in the case of Quark Systems Pvt. Ltd.(supra) in paras 30 and 38 as under :

“30. Learned special counsel for the Revenue Shri Kapila has vehemently argued that "Datamatics" was taken as one of the comparables by the taxpayer and no objection to its inclusion was raised before the TPO or before the learned CIT(A) in appeal. Therefore, the taxpayer should not be permitted to raise additional ground and ask for exclusion of the above enterprise in the determination of the average margins. We are unable to accept above contention. In the first place, these are initial years of implementation of transfer pricing legislation in India and taxpayers as well as tax consultants were not fully conversant with this new branch of law when proceedings were initiated or even at 13 IT(TP)A Nos.291 & 427/Bang/2015 appellate stage. Besides, Revenue authorities, including TPO were required to apply statutory provisions and consider for purposes of comparison functions, assets and risks (turnover), profit and technology employed by the tested party and other enterprises taken as comparable. Statutory duty is cast on them to undertake above exercise. This has not been done in this case. We would only say that prima facie, as per the material, to which reference has been drawn by Shri Aggarwal, Datamatics does not appear to be comparable. Even if the taxpayer or its counsel had taken Datamatics as comparable in its T.P. audit, the taxpayer is entitled to point out to the Tribunal that above enterprise has wrongly been taken as comparable. In fact there are vast differences between tested party and the Datamatics. The case of Datamatics is like that of "Imercius Technologies" representing extreme positions. If Imercius Technologies has suffered heavy losses and, therefore, it is not treated as comparable by the tax authorities, they also have to consider that the Datamatics has earned extraordinary profit and has a huge turnover, besides differences in assets and other characteristics referred to by Shri Aggarwal. 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.” “38. Accordingly, on facts and circumstances of the case, we hold that taxpayer is not estopped from pointing out that Datamatics has wrongly been taken as comparable. While admitting additional ground of appeal raised by the assessee to require us to consider whether or not Datamatics should be included in the comparable, we make no comments on merit except observing that assessee from record has shown its prima facie case. Further claim may be examined by the AO. This course we adopt as objection to the inclusion of Datamatics as comparable has been raised now and not before Revenue authorities. Therefore, we deem it fit and proper to remit the matter to the file of the AO for consideration of claim of the taxpayer and make a de novo adjudication of the ALP after providing reasonable opportunity of being heard to the assessee. We order accordingly.” Accordingly, we admit the additional ground for deciding on merits.

(i) KALS Information System :

12.1 The learned Authorised Representative of the assessee has submitted that this company is developing software product and was not purely a software development provider. He has further submitted that an identical

14 IT(TP)A Nos.291 & 427/Bang/2015 issue was considered by this Tribunal in assessee's own case for the Assessment Year 2007-08 as well as 2008-09. The Tribunal has taken a consistent view that this company is functionally not comparable with a pure software development services provider.

12.2 On the other hand, the learned Departmental Representative has submitted that the decisions relied upon by the assessee are not for the year under consideration and therefore cannot be considered on the comparability of this company during the year under consideration. He has relied upon the orders of the authorities below.

12.3 We have considered the rival submissions as well as the relevant material on record. At the outset we note that for the assessment years 2007- 08 and 2008-09 the Tribunal in assessee's own case found that this company is not comparable. Further in the case of Obopay Mobile Technology India Pvt. Ltd. Vs. DCIT vide its decision dt.8.1.2016 in for the Assessment Year 2010-11 has again examined the functional comparability of this company with software development services provider in para 37, as under :

“ 37. As far as exclusion of M/S.Kals Information Systems Ltd., is concerned, we find that for AY 2010- 11, in the case of a software development service provider, the ITAT Hyderabad Bench in the case of 15 IT(TP)A Nos.291 & 427/Bang/2015 Pega Systems Worldwide India Pvt.Ltd. Vs. ACIT TS 488-ITAT-2015 (hyd) has taken the following view on adopting this company as a comparable company in software development segment:

“Kals Information Systems Ltd :

In view of the finding of this Tribunal in assessee's own case as well as in the case of Obopay Mobile Technology India Pvt.Ltd. (supra), we hold that this company cannot be considered as functionally comparable with the assessee as this company was found to be engaged in the software product development. Accordingly, we direct the A.O/TPO to exclude this company from the list of comparables.

(ii) Persistent Systems Ltd.

16 IT(TP)A Nos.291 & 427/Bang/2015 13. We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record. We find that the RPT in this case is 15.47%. In view of our finding on this issue raised by the revenue, the RPT limit shall not exceed 15% therefore we direct the A.O/TPO to exclude this company form the set of comparables.

(iii) Sasken Communication Technology Ltd. 14.1 The learned Authorised Representative of the assessee has relied upon the decision of the Delhi Benches of the Tribunal dt.7.12.2015 in the case of M/s. Ion Trading India Pvt. Ltd. Vs. ITO in and submitted that the Tribunal has held that this company cannot be treated as a comparable to the assessee.

14.2 On the other hand, the learned Departmental Representative ahs submitted that the assessee did not raise any objection before the TPO as this company was selected by the assessee itself. Further the Tribunal has not found any functional dissimilarity but the Tribunal has followed some other order of the bench wherein it was found that this company failed the export turnover filter of 75% of the total turnover. He has further contended that 17 IT(TP)A Nos.291 & 427/Bang/2015 there is nothing on record to show that the export turnover during the year was less than the filter applied by the TPO in the case of the assessee.

14.3 Having considered the rival submissions as well as the relevant material on record, we note that the Delhi Bench of the Tribunal in the case of Ion Trading India Pvt. Ltd. (supra) has considered this issue in paras 52 & 53 as under :

“ 52. We have considered the submission and perused the material placed on record. A Coordinate Bench of Tribunal in the case of Tibco Software (India) (P) Ltd. vs. DCIT dated 10.4.2015, it was held as under: “32. By way of Ground of Appeal

No.4.5, the appellant has assailed the action of the TPO in excluding Sasken Communications Technologies Ltd. from the final set of comparables. As per the discussion in para 11(viii) of the order of the TPO, it is noticed that the said concern has been excluded on the ground that during the year under consideration it has undertaken business restructuring. The Ld. Representative also pointed out that in the show-cause notice dated 31.10.2012 issued by the TPO another reason has been advanced which is to the effect that the said concern fails the export turnover filter of 75% of the total turnover.”

53. Having regard to the above judgment and since it is evident from record that Sasken Communication Technologies Limited is functionally not similar to the appellant and also having gone through restricting in the instant year, it cannot be treated as comparable to assessee. We order accordingly.”

As it is clear from the finding of the Tribunal that the Tribunal has followed the decision in the case of Tibco Software (India) Pvt. Ltd. Vs. DCIT in PN/2014 Dt.10.4.2015 wherein the Tribunal found that this company failed export turnover filter of 75% and accordingly cannot be treated as comparable.

It is not clear from the finding of the Tribunal in the case of Ion Trading India

18 IT(TP)A Nos.291 & 427/Bang/2015 Pvt. Ltd. (supra) whether the finding in the case of Tibco Software (India) Pvt.

Ltd. (supra) was for the same assessment year so that the turnover filter can be applied for the year under consideration. We find that the TPO has applied export turnover filter of 75% in this case. Accordingly, we set aside this issue to the record of the TPO/A.O to verify whether this company satisfies this export turnover filter of 75% or not and then decide the comparability of the same.

15.1 This company was selected by the TPO and the assessee raised objection before the DRP against the comparability of this company. However, the DRP excluded this company by applying turnover filter. The assessee now challenging the functional comparability of this company without insisting and applying the turnover filter.

15.2 The learned Authorised Representative of the assessee has submitted that the co-ordinate bench of this Tribunal in the case of Citrix R&D India Pvt. Ltd. Vs. DCIT vide order dt.19.2.2016 in IT(TP)A No.1289/Bang/2014 has held that this company cannot be considered as a good comparable.

15.3 On the other hand, the learned Departmental Representative has submitted that this company satisfies all the criteria and filters applied by the 19 IT(TP)A Nos.291 & 427/Bang/2015 TPO for selecting as a comparable. He has further contended that neither the assessee nor the TPO has gone into the verticals of the software development services segment and therefore merely because this company provides software development services in various fields, it cannot be treated as a functionally different company when the prominent activity is only software development services.

15.4 We have considered the rival submissions as well as the relevant material on record. At the outset we note that the co-ordinate bench of this Tribunal in the case of Ion Trading India Pvt Ltd (supra) has considered the comparability of this company in para 11 as under :

“ 11. Observations of the Co-ordinate Bench with regard to M/s Tata Elxsi Ltd. as it appears at para-26.4 of the very same order is re-produced hereunder; “26.4 Tata Elxsi Ltd.:- As far as this company is concerned, it is not in dispute before us that in assessee’s own case for the A.Y. 2007-08, this company was not regarded as a comparable in its ITA software development services segment in No.1076/Bang/2011, order dated 29.3.2013. Following were the relevant observations of the Tribunal:- II. UNREASONABLE COMPARABILITY CRITERIA : 19. The learned Chartered Accountant pleaded that out of the six comparables shortlisted above as comparables based on the turnover filter, the following two companies, namely (i) Tata Elxsi Ltd; and (ii) M/s. Flextronics Software Systems Ltd., deserve to be eliminated for the following reasons :

20 IT(TP)A Nos.291 & 427/Bang/2015 (i) Tata Elxsi Ltd., : The company operates in the segments of software development services which comprises of embedded product design services, industrial design and engineering services and visual computing labs and system integration services segment. There is no sub-services break up/information provided in the annual report or the databases based on which the margin from software services activity only could be computed. The company has also in its response to the notice u/s.133(6) stated that it cannot be considered as comparable to any other software services company because of its complex nature. Hence, Tata Elxsi Ltd., is to be excluded from the list of comparables.

1. 1. The company's software development and services segment constitutes three sub-segments i) product design services; ii) engineering design services and iii) visual computing labs.

2. The product design services sub-segment is into embedded software development. Thus this segment is into software development services.

3. The contribution of the embedded services segment is to the tune of Rs.230 crores in the total segment revenue of Rs.263 crores. Even if we consider the other two sub-segments pertain to IT enabled services, the 87.45% (›75%) of the segment's revenues is from software development services.

4. This segment qualifies all the filters applied by the TPO." Regarding Flextronics Software Systems, the following extract from page 143 of TPO's order was read out by him as his submissions : "It is very pertinent to mention here that the company was considered by the taxpayer as a comparable for the preceding assessment year i.e., AY 2006-07. When the same was accepted by the TPO as a comparable, the same was not objected to it by the taxpayer. As the facts mentioned by the taxpayer are the same and these were there in the earlier FY 2005-06, there is no reason why the taxpayer is 21 IT(TP)A Nos.291 & 427/Bang/2015 objecting to it. How the company is functionally similar in the earlier FY 2005-06 but the same is not functionally similar for the subsequent FY 2006-07 even when no facts have been changed from the preceding year. Thus the taxpayer is arguing against this comparable as the company was not considered as a comparable by the taxpayer for the present FY 2006-07."

The co-ordinate bench in the said case has followed the decision of the Tribunal of M/s. Cisco Systems Pvt. Ltd. dt.14.8.2014 in IT(TP)A No.271/Bang/2014 and directed the A.O/TPO to exclude this company form the list of comparables. We concur with the view of the co-ordinate bench of this Tribunal and accordingly direct the A.O./TPO to exclude this company from the list of comparables.

16.1 The learned Authorised Representative of the assessee has submitted that the comparability of this company has been examined by the co-ordinate bench of Delhi Tribunal in the case of Equant Solutions India Pvt. Ltd. Vs. DCIT vide order dt.21.1.2016 in IT(TP)A No.1202/Del/2015 and held that this 22 IT(TP)A Nos.291 & 427/Bang/2015 company is having significant intangibles and carrying on R&D activities as well as significant intangibles cannot be considered to be a good comparable with the assessee.

16.2 On the other hand, the learned Departmental Representative has submitted that this company satisfies all the criteria and filters applied by the TPO for selecting as a comparable. He has further contended that neither the assessee nor the TPO has gone into the verticals of the software development services segment and therefore merely because this company provides software development services in various fields, it cannot be treated as a functionally different company when the prominent activity is only software development services.

16.3 We have considered the rival submissions as well as the relevant material on record. At the outset we note that the Delhi Benches of the Tribunal in the case of Equant Solutions India Pvt. Ltd. (supra) has considered the comparability of this company in para 16 as under :

“ 16. Zylog Systems Limited a. The TPO has included Zylog Systems Ltd, which has having a margin of 25.07%, and according to the TPO, it is functionally similar. The ld DRP has conquered with the view of the TPO. Before us, ld. AR submitted that this company derives its income from sale of software services as well the products and has diversified operation in Wifi space and broadband connectivity. It is predominantly and onsite Service Company therefore it is functionally different. It was also contended that this 23 IT(TP)A Nos.291 & 427/Bang/2015 company has commenced acquisition during the year, therefore there are extraordinary special events, and hence this comparable should be rejected. It was also stated that 62% of the total asset of the company is intangible and therefore it should be excluded. b. Ld Dr relied on the orders of lower authorities. c. We have considered the rival contention, wherein it is stated the Zylog Systems Ltd is engaged in the sale of software service as well as its products and has operation in Wifi place and broadband connectivity. It is apparently an onsite service company. This is evident from the various comparables of only reports and related documents produced before us. Zylog System Ltd also undergone into the business of restructuring where it is clear Dugout fair flex matrix. Therefore, it is apparent that the company, which have undergone the business restructuring process during the year, cannot be held to be a comparable in view of the extraordinary circumstances. The company is also owning significant intangibles and carrying on research and development activities ownership significant intangibles cannot be held to be a comparable with the assessee and therefore on this ground too this comparable is ordered accordingly to be excluded.”

No contrary view has been brought before us therefore following the order of the Delhi Bench of the Tribunal (supra), we direct the A.O/TPO to exclude this company from the list of comparables.

17.1 The learned Authorised Representative of the assessee has submitted that the TPO has worked out the working capital as per Annexure C to the impugned order. However, the adjustment on account of working capital was restricted by the TPO to 1.7% which is against the law as well as the facts but based on arbitrary estimation made by the A.O/TPO. In support of his contention, he has relied upon the decision dt.21.12.2012 in case of Bearing Point Business Consulting Private Ltd. Vs. DCIT in and 24 IT(TP)A Nos.291 & 427/Bang/2015 submitted that the Tribunal has held that the TPO cannot restrict the working capital adjustment.

17.2 On the other hand, the learned Departmental Representative has relied upon the orders of the authorities below.

17.3 Having considered the rival submissions as well as the relevant material on record, we note that the TPO has worked out the working capital as per Annexure C to the order passed under Section 92CA however the TPO has restricted the working capital adjustment and not granted the actual computation in the case of each comparable. We note that in the case of Bearing Point Business Consulting Pvt. Ltd. (supra) in paras 5.4 to 5.4.2 held as under :

5.4 With regard to the working capital adjustment, the assessee submitted that the computation of the TPO was erroneous. It is seen that the TPO had worked out the working capital adjustment at - 1.27 % [Working at Annexure C of the order of TPO]. 5.4.1 In this regard, the assessee has submitted that in arriving at the total amount of trade payables, the TPO had considered only sundry creditors for expenses and not the inter company payables which are actually trade payables of the assessee company [source: page 6 of PB-I]. 5.4.2 We have duly considered the rival submissions. If the above contention of the assessee is to be taken into account, the revised working capital adjustment comes to 2.04% instead of -1.27% arrived by the TPO. Since the issue is factual which requires verification at the AO/TPO’s level, the same is remitted back to the file of the AO/TPO with a direction to examine the veracity of the assessee’s claim and to take appropriate decision in correctly computing the working capital adjustment. It is ordered accordingly.

Accordingly, by following the order of the co-ordinate bench of this Tribunal in the case of Bearing Point Business Consulting Pvt. Ltd. (supra), we direct the 25 IT(TP)A Nos.291 & 427/Bang/2015 A.O/TPO to reconsider the issue and allow the appropriate actual working capital adjustment as per the working in case of each comparable.

19.1 If the comparable price is within the range of + or – 5% of the assessee's price then the benefit of proviso to section 92C shall be granted to the assessee. Accordingly, we direct the A.O/TPO to consider the same at the time of passing the order to give effect this order of the Tribunal.

20. The revenue has raised the following grounds :

“1. On the facts and in the circumstances of the case the Dispute Resolution Panel erred in holding that the size and turnover of the company are deciding factors for treating the company as a comparable and accordingly erred in excluding M/s. Tata Elxsi Ltd., Sasken Communication Technologies Ltd., Persistent Systems Ltd., Zylog Systems Ltd., Mind Tree Ltd., L&T Infotech and Infosys Limited as comparables.

2. The ld. DRP Member erred in excluding uncontrolled comparables having turnover more than Rs.200 Crores in the absence of turnover criterion 26 IT(TP)A Nos.291 & 427/Bang/2015 prescribed in Rule 10B of Income Tax Rules and also there being no correlation between turnover and profit margin.

3. The Hon'ble DRP has erred in applying 0% RPT.

4. The Hon'ble DRP has erred in directing the TPO to compute Risk Adjustment in the case of the taxpayer without adducing any method for the same.

5. In the facts and circumstance of the case, the Hon'ble DRP Member erred in holding the foreign exchange loss/gain in operating in nature when such loss/gain that is attributable to the operating activity is not derived from the operating activity.

6. The Hon'ble DRP has erred in law in directing to include forex gain/loss as part of operating income / loss without ascertaining the nexus with the business activity of the tax payer.

7. The Hon'ble DRP has erred in concluding that forex gain / loss are to be treated as operating in nature as while they may be incidental but cannot be deemed as operating in nature since, they are not critical to operational activities of the business conducted by the tax payer. The appellant craves leave to add, alter, amend and / or delete any of the grounds mentioned above.”

21. Ground No.1 of revenue is regarding exclusion of certain companies by the DRP by applying turnover filter. Though all these companies were excluded by the DRP by applying the turnover filter however these companies have already been examined by us on functional comparability in the appeal of the assessee therefore, this issue raised by revenue becomes infructuous. Even otherwise, the learned Authorised Representative has submitted that the assessee has no objection if the turnover filter is not applied. Accordingly, to that extent the Ground No.1 of the revenue’s appeal stands disposed off.

27 IT(TP)A Nos.291 & 427/Bang/2015 22. Ground No.3 is regarding the 0% related party filter applied by the DRP.

22.1. We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record. The TPO has applied the filter of 25% RPT while selecting comparable companies. The DRP has applied 0% RPT filter and excluded some of the companies from the list of comparables selected by the TPO. The assessee has contended that the filter of revenue from RPT should be applied at 15% instead of 25% applied by the TPO. The learned Departmental Representative has submitted that there is no standard rule for applying the filter of 15% regarding the RPT. It is pertinent to note that the ALP as per the provisions of the TP has to be determined by considering uncontrolled comparable prices and therefore only unrelated prices have to be taken into account to bench marked international transactions. However, 0% RPT of the comparable price is an impossible situation and therefore a reasonable tolerance range from revenue from RPT can be considered for selecting uncontrolled comparables.

There is no dispute that there cannot be a single criteria/parameter to be applied as a general rule in all the cases. The tolerance range varies from case to case and depending upon the availability of comparables for a particular

28 IT(TP)A Nos.291 & 427/Bang/2015 case. Thus if the comparables of an international transactions are easily available in sufficient number then this tolerance range of RPT should be restricted to minimum. Though there is no specified range in the provisions of Act or Rules, however, in due course of discussion and adjudication of this issue in a series of decisions of this Tribunal, a commonly accepted tolerance range of 5% to 25% of total revenue from RPT has been considered as reasonable depending upon the facts and circumstances of each case. In the case of the assessee before us, the TPO/A.O. selected 13 comparables. Therefore, the availability of the comparables of the international transactions of the assessee is not a difficult task. Thus, when a good number of comparables are available then the RPT cannot be allowed to the extreme limit of 25% of revenue.

Accordingly, in order to determine the ALP considering by considering the uncontrolled comparable transactions, it should be kept in mind that the uncontrolled transactions should be least influenced by the controlled and related prices. This Tribunal in the series of decisions has taken a view that when good number of comparables are available, then the threshold limit of RPT shall not be more than 15% of total revenue. In view of the facts and circumstances of the case when good number of comparables available, then

29 IT(TP)A Nos.291 & 427/Bang/2015 we are of the considered opinion that the RPT filter of 15% is proper in the case of the assessee. Consequently, the impugned order of the CIT (Appeals) whereby applied filter of 0% RPT is set aside. Hence we direct the Assessing Officer/TPO to apply the RPT filter of 15% and then select the comparables.

22.2 In view of the above, one company namely Thinksoft Global Services Ltd. stands restored to the list of comparables.

22.3 Though the assessee has objected to the inclusion of Infosys Ltd. in the companies however we find that this was selected by the assessee itself and no ground has been raised before us for exclusion of the company from the list of comparables. Though the assessee has objected against the inclusion of Infosys Ltd. in the comparables however we find that this company was selected by the assessee itself and no ground has been raised before us for exclusion of the said company from the list of comparables by the assessee. The DRP has excluded this company form the list of comparables on the ground of turnover filter on which the learned Authorised Representative of the assessee has given the concession that the turnover filter may not be applied for inclusion or exclusion of this company. In the absence of any ground or additional ground 30 IT(TP)A Nos.291 & 427/Bang/2015 seeking exclusion of this company. The issue of examining the functional comparbility of this company does not arise in the appeal of the assessee.

24.1 We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record.

At the outset we note that the DRP has decided this issue by following various decisions of this Tribunal in para 14.5 and 14.6 as under :-

“ 14.5 The decision of the jurisdictional ITAT which is binding on the Panel was examined. It is seen that the Hon'ble Bangalore ITAT in case of Intellinet Technologies India Pvt. Ltd. Vs. ITO (ITA No.1237/Bang/200&) rejected the tax department’s argument that a single customer risk borne by the tax payer in its status of a captive service provider was equivalent to the marketing and technical risk attached to the comparables. The Hon'ble ITAT held that the risk of having a single customer is an anticipated risk which may or may not happen unlike the marketing and technical risks which have to be contemporaneously dealt with by the comparables. The ITAT did not accept that the risk adjustment should be 5.5% or at the difference of PLR of the RBI and the banks, and directed the TPO to consider all the contentions and decide the percentage of risk adjustments to be made in accordance with law. In the case of Bearing Point

31 IT(TP)A Nos.291 & 427/Bang/2015 Business Consulting Pvt. Ltd. Vs. DCIT (ITA No.1124/Bang/2011) this decision was once again followed by the jurisdictional ITAT.

14.6 After consideration of the various facets of this matter, and respectfully following the decision of the Hon'ble ITAT Bangalore as above, the TPO is directed to decide the percentage of risk adjustments to be calculated in this case. by means of guidance, it may be mentioned that in the case of DCIT Vs. Hello Soft Pvt. Ltd. (2013) 32 taxmann.com 101 (ITAT, Hyd) 1% adjustment to the average margin was provided towards risk differential.”

As it is manifest from the findings of the DRP it has given the cogent reasoning for allowing the risk adjustment and therefore we do not find any reason to interfere with the findings of the DRP on this issue.

25.1 We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record. At the outset we note that an identical issue has been considered by the co-ordinate bench of this Tribunal in assessee's own case for the Assessment Year 2008-09 vide order dt.16.3.2015 in in paras 8 & 8.1 as under :

“ 8. The next objection is about exclusion of foreign exchange fluctuation from the working of operating margins of the company. This issues was already considered in the assessee’s own case in A.Y. 2006-07 as under:-

32 IT(TP)A Nos.291 & 427/Bang/2015 “II) Foreign Exchange gains/Loss impact (ground no.12)

5.8 The Tribunal in the case of Trilogy E-Business had directed that the foreign exchange gain or loss should be considered as operating revenue or cost while computing the operating margin of the assessee as well as the comparable. The relevant finding of the Tribunal read as follows:

79 (B) As far as foreign exchange gain/loss being considered as not forming part of the operating cost, the reasoning of the revenue is that such loss or gain cannot be said to be one realized from international transaction though they may form part of the gain/loss of the enterprise and therefore they should be excluded while determining operating cost. On the above issue we find that the Bangalore Bench of ITAT in the case of Sap Labs India (P) Ltd. Vs. ACIT (2011) 44 SOT 156 (Bang.) has taken the view that Foreign Exchange Fluctuation gains are required to be added to operating revenue. Following the same, the AO is directed to accept the claim of the Assessee in this regard.....................

5.8.1 In conformity with the above finding, we direct the AO/TPO to consider the foreign exchange gain or loss as part of the operating cost or revenue, as the case may be, for both the assessee as well for the comparable companies.”

8.1 In conformity with the above finding, we direct the TPO to consider accordingly. Ground is allowed.”

Following the earlier order of the Tribunal in assessee's own case, we do not find any error in the directions of the DRP on this issue.

Order pronounced in the open court on 24.06.2016.