DCIT, BANGALORE vs. M/S SUNQUEST INFORMATION SYSTEMS (INDIA) PVT. LTD.,, BANGALORE

Facts apropos are that assessee engaged in providing software development services, design and support, had filed a return declaring income of Rs.9,18,153/-. Since assessee had international transactions with its Associated Enterprise (AE) exceeding the limits laid down, pricing of such international transactions was referred to the TPO by the AO. Profile of the assessee mentioned by the TPO in para 2 of his order, is as a contract software development service provider. Assessee was a wholly owned subsidiary of one M/s. Sunquest, US, and was primarily developing software and providing support to its principal. Sunquest, US, was providing solutions in healthcare services which helped physicians, hospitals and medical practitioners to effectively manage the complexities in healthcare services. For the support services rendered by the assessee, Sunquest, US, was remunerating on cost plus basis. Assessee’s financial results for relevant previous year read as under :

Whole of the revenue of the assessee came from the software development services rendered to its principal. Though it had also received certain cost reimbursements and expenses from the principal, such reimbursements were considered by the TPO to be at arms length and the adjustments made by him were confined to the software development services.

In order to justify its profit on cost of 11.63% assessee had selected 21 comparables. These 21 comparables and their average of operating profit on operating cost as derived by the assessee, read as under :

Assessee there upon chose to move the CIT(A) in appeal. Before the CIT (A), argument of the assessee was that its comparables were unjustly rejected citing software development revenue being less than 75% of total income. Assessee also assailed application of RPT filter by the TPO. Though the assessee pleaded for application of turnover filter, it seems the said ground was not pressed by the assessee before the CIT (A). Assessee also sought exclusion of eleven number of companies falling in the list of comparables citing functional dissimilarity. However, CIT (A) did not accept these contentions, but on the other hand confirmed the addition IT(TP)A.1604 & 1666/Bang/2014 Page - 7 made by the AO. However, CIT (A) accepted assessee’s request for granting it risk adjustment. CIT (A) was of the opinion that such a risk adjustment had to be given to the assessee based on prevailing norms.

Continuing his arguments, Ld. AR submitted that M/s. Bodhtree Consulting Ltd, was also one among the comparables which were disputed in the case of Lam Research India (P) Ltd (supra). According to him, at para 10 of the said order, it was held by this Tribunal that Bodhtree Consulting Ltd, was not a proper comparable in the software development services segment.

Vis-a-vis, Tata Elxsi Ltd, Sasken Communication Technologies Ltd, Persistent Systems P. Ltd, Mindtree Ltd (seg) and Infosys Technologies Ltd, Ld. AR submitted that in the same decision, these were directed to be excluded since the turnover of the said companies exceeded Rs.200 crores. As per the Ld. AR, assessee’s turnover was negligible and came to only Rs.22.71 crores. As per the Ld. AR, turnover of the above companies was more than ten times of that of the assessee and hence could not be considered as good comparable.

Vis-a-vis, Zylog Systems Ltd, Ld. AR submitted that this company also had a turnover of Rs.734.93 crores. According to him, this was evident from para 6 of the order of the Tribunal in of Lam Research (India) P. Ltd, (supra). Similarly, according to him, the turnover of L & T Infotech Ltd, came to Rs.1950 crores and had to go out of the list of comparables on application of turnover filter.

With regard to the adjustment for foreign currency fluctuation, Ld. AR submitted that this was rightly considered by the CIT (A) to be operational in nature. However according to him, while working out the margins of the comparables also, foreign exchange gains and losses IT(TP)A.1604 & 1666/Bang/2014 Page - 10 considered as operational revenue had to be reckoned. As per the Ld. AR, directions in this regard were required to be given by the Tribunal.

Per contra, Ld. DR submitted that assessee himself has not pressed the application of turnover filter before the CIT (A) and therefore could not now turn back and require its application. As per the Ld. DR the said aspect was never considered by the CIT (A) and hence required a fresh look by him. Further as per the Ld. DR, if assessee’s contentions were accepted what would be left were only four comparables and this would not be sufficient enough to make a meaningful arms length pricing study.

We have perused the orders and heard the rival contentions. Assessee’s first submission is for application of turnover filter as applied by this Tribunal in the case of M/s Genisys Pvt Ltd Vs DCIT(2011)64 DTR 225. Reliance has also been placed on the case of Yodlee Infotech Pvt. Ltd., vs. ITO (IT(TP)A.108/Bang/2014, dt.12.12.2014). No doubt before the CIT (A) though assessee had raised a ground for applying the turnover filter, it was not pressed. Nevertheless, assessee has raised an additional ground before us for application of turnover filter of Rs.200 crores. By virtue of the Special Bench decision in the case of Quark Systems P. Ltd, (supra), an assessee cannot be deprived of the right to raise IT(TP)A.1604 & 1666/Bang/2014 Page - 11 such a pleading as additional ground, since the Transfer Pricing is an evolving area. As per the Ld. DR if the turnover filter is to be applied, matter has to be sent to the CIT (A) for consideration since he had not adjudicated the issue. Assessee is seeking application of turnover filter in the case of Tata Elxsi Ltd, Sasken Communication Technologies Ltd, Persistent Systems Ltd, Zylog Systems Ltd, Mindtree Consulting Ltd (seg), L & T Infotech Ltd, and Infosys Ltd. Reliance has been placed by the assessee on the decision of coordinate bench in the case of Lam Research (India) P. Ltd, (supra). Profile of the assessee, as we have already captured in para 02 of this order is one of providing software development services to its principal abroad. Lam Research (India) P. Ltd, (supra) had two segments, namely, software development services and ITES. With regard to software development services, it was providing software development services to its principal called Novelleus Systems International Inc. USA. Thus vis-a-vis software development services, adjudication done by the Tribunal in the case of Lam Research (India) P. Ltd, (supra) can be applied here also, since the said case was also for the very same assessment year. Turnover of various companies considered in the comparables of the said case appears at para 6 of the order and this is reproduced hereunder :

It is clear from the above, that turnover of Tata Elxsi Ltd was Rs.378.43 crores, that of Sasken Communication Technologies Ltd, came to Rs.405.31 crores, that of Persistent Systems Ltd, was Rs.519.69 crores, that of Zylog Systems Ltd was Rs.734.9 crores, that of Mindtree Ltd (seg) was Rs.793.22 crores, that of L & T Infotech Ltd, was Rs.1,950.83 crores and that of Infosys Ltd, was Rs.20,264 crores. Turnover of the assessee was only Rs. 22.72 crores. Obviously the volume of activity of the above mentioned companies were much higher to that of the assessee. It was more than ten times that of the assessee. In the case of Lam Research (India) P. Ltd, (supra) with regard to application of turnover filter, it was held as under at para 13 of the order dt.30.04.2015 :

Dy. CIT vs. Quark Systems (P) Ltd. (2010) 132 TTJ (Chd)(SB) 1 : (2010) 42 DTR (Chd)(SB)(Trib) 414 : (2010) 38 SOT 307 (Chd)(SB), wherein it was held that even the filter of lower turnover of Rs. 1 crore is without any reasonable basis and there is no filter for higher turnover also. The application of turnover filter also leaves much to be desired and has to no rationale basis. In our considered view, it is improper to proceed on the basis that the turnover of Rs. 1 crore to infinite is a reasonable classification as turnover base.

Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which are making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various Benches of the Tribunal, when companies which are loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs. 1 crore to Rs. 200 crores have to be taken as a particular range and the assessee being in that range having turnover of Rs. 8.15 crores, the companies which also have turnover of Rs. 1 to Rs. 200 crores only should be taken into consideration for the purpose of making TP study.

Even if we say that applying turnover limit of Rs.200 crores may not be a wise and prudent one, the turnover of the comparables mentioned above would clearly show that these were much beyond that of the assessee taking them out of the reasonable realm of comparability. Just because the IT(TP)A.1604 & 1666/Bang/2014 Page - 20 matter was not adjudicated by the CIT (A) may not be a reason for sending it back to him when the facts are clearly on record. There can be no dispute on the position of facts as mentioned above. In such a situation it would be fruitless exercise to remit the issue of application of turnover filter back to the CIT (A). We therefore direct exclusion of Tata Elxsi Ltd, Sasken Communication Technologies Ltd (seg), Persistent Systems Ltd, Zylog Systems Ltd, Mindtree Ltd (seg), L & T Infotech Ltd, and Infosys Ltd, from the list of comparables.

No doubt we are alive to the fact that Sasken Communication Technologies Ltd, Persistent Systems Ltd, Zylog Systems Ltd, Mindtree Ltd (seg), L & T Infotech Ltd, Infosys Ltd, were a part of assessee’s own comparables. However as mentioned by us, assessee had taken a ground before the CIT (A) seeking exclusion based on turnover, though it has not pressed it. At least in the case of Persistent Systems Ltd, CIT (A) specifically mentioned this plea of the assessee though he had not directed its exclusion, for a reason that assessee was not pressing application of turnover filter. In such circumstances, we are of the opinion that assessee can very well plead for exclusion of these companies from the list of comparables.

Coming to Bodhtree Consulting Ltd, argument of the assessee is that it is functionally dissimilar. In the case of Lam Research India P. Ltd, (supra), comparability of Bodhtree Consulting Ltd, was an issue. In the software development services segment, it was held as under by this Tribunal at para 18 of its order :

Now taking the pleading of the assessee that CG-VAK was unjustly rejected from the list of comparables, we find that the said company was also one of the comparables , which had come up before this Tribunal in the case of Lam Research (India) P. Ltd, (supra). This Tribunal had held as under at para 21 of the order, as under :

As a result of the above discussion, we direct exclusion of Bodhtree Consulting Ltd, Tata Elxsi Ltd (seg), Sasken Communication Technologies Ltd (seg), Persistent Systems Ltd, Zylog Systems Ltd, Mindtree Ltd (seg), IT(TP)A.1604 & 1666/Bang/2014 Page - 24 L & T Infotech Ltd, and Infosys Ltd from the list of comparables and direct inclusion of M/s. CG-VAK as a good comparable. Ordered accordingly.

Coming to the pleading of the assessee that foreign exchange adjustment once allowed as operational in nature should also be considered while working out the operating margin of the comparables, we are inclined to agree. This is because comparability should be done based on equal footing and if foreign exchange gains / losses are considered as part of operational income / loss of the assessee, then such items of expenditure , are also to be considered as operational in nature in the case of comparables also. TPO is therefore directed to work out the margin of the comparables that are left in the list after considering foreign exchange gains / losses as operational in nature. Ordered accordingly.

Since the Ld. AR had submitted that he was not pressing any grounds other than the grounds relating to application of turnover filter in grounds 5, 6 and 9, other grounds are not considered for adjudication by us.

In the result, appeal of the assessee is partly allowed for statistical purpose.

Now we take up appeal of the Revenue. Revenue has altogether taken nine grounds of which grounds 1, 8 and 9 are general in nature needing no adjudication. Vide its grounds 2 and 3, grievance raised by Revenue is that CIT (A) directed the AO to exclude from total turnover items which were excluded from export turnover also while working out the deduction available to the assessee u/s.10A of the Act. What we find is that the CIT (A) had followed the judgment of Hon’ble jurisdictional High Court in CIT v. Tata Elxsi Ltd, [349 ITR 98]. Just because of a reason that the Revenue has moved an appeal before the Hon’ble Apex Court against the judgment of Hon’ble jurisdictional High Court, we cannot say that Hon’ble jurisdictional High Court judgment should not be followed. We are of the opinion that CIT (A) was justified in giving directions which were in accordance with the law laid down by the Hon’ble jurisdictional High Court in Tata Elxsi Ltd (supra). Grounds 2 and 3 are dismissed.

Vide its ground 4, Revenue is aggrieved on the directions of the CIT (A) to give a risk adjustment to the assessee. CIT (A) had directed the TPO to give risk adjustments at prevailing norms suitable / applicable to the assessee. As per the CIT (A), there was no working capital adjustment actually given by the TPO since the adjustment carried out was negative in IT(TP)A.1604 & 1666/Bang/2014 Page - 26 its impact. On this issue what we find is that TPO at para 3.7 of his order had clearly stated that working capital adjustment is restricted to 1.71% considering the uncontrolled comparables selected by him. However, in the actual working of the adjustment u/s.92CA of the Act, reproduced by us at para six above, working capital adjustment has been made at (-) 5,12% . In such a situation, we cannot say that risk adjustment directed by the CIT (A) was incorrect. TPO having not restricted himself to a working capital adjustment of 1.71% as mentioned by him at para 3.7 of his order ought have considered assessee’s plea for a risk-adjustment, if found reasonable. In such circumstances, we find that direction given by the CIT (A) was justified and we do not find any reason to interfere. Ground 4 of the Revenue stands dismissed.

Vide its grounds 5 and 6, grievance of the Revenue is that loss /gain was considered as operating in nature by the CIT (A). Ld. DR submitted that there was no finding by the CIT (A) that foreign exchange gain / loss was incidental to the operating activity.

Per contra, Ld. AR supported the orders of authorities below.

We have heard the rival contentions and perused the material on record. Ground 6 of the Revenue clearly admits that forex gain / loss were IT(TP)A.1604 & 1666/Bang/2014 Page - 27 incidental to the operating activity of the assessee. Just because it was not critical to the operating activity, we cannot say that these had to be excluded. This Tribunal in the case of Triology E Business Software India P. Ltd v. DCIT [(2013) 147 ITD 540], had held that forex gains / loss are required to be added to the operating revenue relying on another coordinate bench decision in SAP Labs India (P) Ltd, [(2011) 44 SOT 156]. We therefore do not find any error in the directions given by the CIT (A) . Grounds 5 and 6 stand dismissed.

To summarise the result, appeal of the assessee is partly allowed whereas appeal of the Revenue is dismissed.