AOL ONLINE INDIA PRIVATE LIMITED,BANGALORE vs. DCIT, BANGALORE

Per B. Ramakotaiah, Accountant Member

2. Briefly stated, assessee, AOL Online India Private Limited was incorporated on 8th November, 2000 as Net Scape Communications India Pvt. Ltd., and subsequently changed by way of series of name changes, to the present. Assessee is engaged in providing software development and IT(TP)A No. 1036/Bang/2011 Page 2 of 20 call centre services only to its Associated Enterprise [AE]. Being the captive service provider, it has remunerated for the services on the basis of cost + 15% mark up. During the year, assessee had provided software development services to an extent of Rs. 50.20 Crores and provision for call centre services to an extent of Rs. 161 Crores. AO referred the matter to the Transfer Pricing Officer [TPO]. In the software development services segment, assessee has selected a set of 17 comparable companies with an average of 10.86% and justified the Arm’s Length Price [ALP] of 15.35% of assessee. In the call centre service agreement, assessee selected set of 22 comparable companies with the margin of 13.30% viz-a-viz that of 15.46% of assessee. Since both the TP studies indicate that assessee’s receipts are above the average mean, assessee justified its receipts. However, TPO did not accept assessee’s TP study and proposed to reject 13 out of 17 comparable companies in the software development services and selected new companies. In the call centre service segment also, TPO accepted six comparables and proposed 25 new comparables. After accepting assessee’s objections, TPO has finalized the order proposing the adjustments as under:

Particulars Software development Call Centre services services segment segment Arithmetical mean of the NCP 25.14% 30.12% margin of comparables Transfer Pricing adjustment Rs. 3,21,70,813 Rs. 71,60,87,449

IT(TP)A No. 1036/Bang/2011 Page 3 of 20 2.1. Since there is a mistake in computation of working under the call centre services, TPO rectified the same later and reduced the adjustment to 17.49 Crores. DRP rejected the contentions of assessee. Accordingly, AO made the following adjustments: a. TP adjustment of Rs. 20,71,18,264/-; and b. Adjustment of deduction u/s. 10A of the Act of Rs. 1,02,21,521/-; Assessee aggrieved and raised various grounds.

TP adjustment in software development sector:

4. Final selection of comparable companies in software development segment is as under:

Sl. No. Name of the company Turnover NCP as per (INR Crores) computed TP order by TPO (%) 1. Accel Transmatic Ltd., 9.68 21.11 2. Avani Cimcon Technologies Ltd., 3.55 52.59 3. Celestial Labs Ltd., 14.13 58.35

IT(TP)A No. 1036/Bang/2011 Page 4 of 20

Sl. No. Name of the company Turnover NCP as per (INR Crores) computed TP order by TPO (%) 4. Datamatics Ltd., (Merged) 54.51 1.38 7. Geometric Ltd., 158.38 10.71 13. LGS Global Ltd., 45.39 15.75 15. Mediasoft Solutions Pvt. Ltd., 1.85 3.66 19. Quintegra Solutions Ltd., 62.72 12.56 20. RS Software (India) Ltd., 101.04 13.47 21. R Systems International Ltd., 112.01 15.07 23. SIP Technologies & Exports Ltd., 3.8 13.90

IT(TP)A No. 1036/Bang/2011 Page 5 of 20 4.2. Assessee is objecting to the balance of the comparables and objections on each of the comparables are as under:

Sl. No. Name of the company Turn NCP Summary of Applicant’s as per over computed Objections & Relevant references TP (INR by TPO to the paper-book filed by the order Crores) (%) appellant 1. Accel Transmatic Ltd., 9.68 21.11 Functionally not comparable – engaged in 2D/3D animation, embedded software, outsourced product development, manufacture of multi function kiosks etc.

3. Abnormally high profit margins (52.59%) 3. Celestial Labs Ltd., 14.13 58.35 1. Functionally Not Comparable – the company is engaged in Contract research –bioinformatics as well as development of molecules and enzymes.

2. The R&D expenses debited to P&L A/c of Celestial constitutes 8.28% of the revenue.

5. E-Zest Solutions Ltd., 6.26 36.12 1. Functionally Not Comparable – company engaged in providing KPO services as well development of software products.

2. Rejected as a comparable by the assessee in its TP study for AY. 2006-07 on functional comparability.

10. Infosys Technologies Ltd., 13,149 40.30 1. Company earning significant amount of brand profits.

2. Owns significant intangibles – had 44 global development centres of which 20 were located outside India. Also filed 38 patents and generated over 80 inventional disclosures during FY. 2006-07.

3. Company not comparable based on turnover criterion.

11. Ishir Infotech Ltd., 7.42 30.12 Fails employee cost filter – only

IT(TP)A No. 1036/Bang/2011 Page 6 of 20

3.96% of the operating revenue of the company (schedule 15 on page 13 of the Annual Report and page 7 of the Annual Report for operating revenue) – Ishir is engaged in trading of services.

2. Incurs R&D expenditure amounting to 8.50%.

3. Owns significant intangibles – 4.1% of revenue generated by selling intellectual property products. Company filed 13 patents during FY 2006-07 with additional 11 patents in pipeline.

4. Company not comparable on turnover criterion.

It was admitted that these objections were considered in the Co-ordinate Bench decision in the case of Broadcom India Research Private Limited in IT(TP)A No. 1180/Bang/2011. Further, in the case of NXP Semiconductors India P. Ltd., Vs. ACIT in IT(TP)A No. 1174/Bang/2011 also examined the above comparables. Similarly in the case of Capgemini India P. Ltd., Vs. ACIT [46 SOT 195] (Mum) has also examined these comparables. In all these decision of the Co-ordinate Benches, the objections as stated in the above column were examined in detail and the above said companies were held to be not comparable to the functionality of the said assessee’s company. Since the facts are similar and assessee’s business is also similar and TPO has selected the same comparables, we are of the opinion that the said comparables listed above cannot be considered as suitable for inclusion in the list for TP analysis. AO/TPO is directed to exclude the above comparables.

IT(TP)A No. 1036/Bang/2011 Page 8 of 20 4.3. The assessee is also objecting to the comparables of Flextronics Software Systems Ltd., at Sr. No. 6, IGate Global Solutions Limited at Sr.

No. 9, Mindtree Limited at Sr. No. 17, Sasken Communication Technologies Limited at Sr. No. 22 on a single argument of application of turnover filter. Admittedly, Co-ordinate Benches have been following and accepting turnover filter in some cases in the range of Rs. 1 Crore to 200 Crores, and in the above said Co-ordinate Bench decisions stated supra, these companies were excluded on turnover filter. However, assessee’s turnover in the software development sector is itself was about 50.20 Crores. Consequently, in our view, the 200 Crores upper filter cannot be accepted to eliminate the companies only on turnover filter. As seen from Flextronics, the turnover is 848 Crores and iGate Solutions is about 747 Crores, Mindtree is about 590 Crores, Sasken Technolgies is about 343 Crores. Considering the assessee’s receipts, we are of the opinion that only Flextronics Software Solutions at Sr. No. 6 and iGate Global Solutions at Sr. No. 9 can be excluded, as these are exceeding the upper turnover filter of ten times the assessee’s turnover. Mindtree is little marginally over the upper filter but considering the small margin, we are of the opinion that this comparable can be included in the list of comparables, as the company fulfils all other filters. Sasken Technolgoies is however, within the range and also fulfils the other comparability filters. In view of this, we direct the AO/TPO to exclude only the two companies i.e., Flextronics and iGate

IT(TP)A No. 1036/Bang/2011 Page 9 of 20 Solutions from the list of comparables. The ground on this is partly allowed.

TP Analysis in ITeS Segment:

6. In this segment, final list of comparables are as under:

Sl. No. Name of the company Turnover TPO as per (INR Crores) margins (%) TP order (Pre WC adj) 1. Accentia Technologies Limited – Seg. 16.57 30.61 2. Aditya Birla Minacs Worldwide Ltd., 197.06 11.98 (earlier known as Transworks Information Services Ltd) 3. Allsee Technologies Ltd., 113.28 27.31 4. Apex Knowledge Solutions Ltd., 6.64 12.83 5. Apollo Healthstreet Ltd., 47.84 -13.55 6. Asit C Mehta Financial Services Ltd., 6.09 24.21 7. Bodhtree Consulting Ltd., 2.94 29.58 8. Caliber Business Solutions Ltd., 39.30 21.26 9. Cosmic Global Ltd., 4.28 12.40 10. Datamatics Financial Services Ltd –Seg 2.92 5.07 11. Eclerx Services Ltd., 86.12 89.33 12. Flextronics Software Systems Limited 12.93 8.62 13. Genesys International Corporation 19.17 13.35 14. HCL Comnet Systems & Services Ltd – 260.18 44.99 Seg 15. ICRA Techno Analytics Ltd., 7.23 12.24 16. Informed Technologies Ltd., 4.08 35.56 17. Infosys BPO Ltd., 649.56 28.78 18. I-Services India Pvt. Ltd., 16.29 49.47 19. Maple Esolutions Ltd., 12.21 34.05

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Sl. No. Name of the company Turnover NCP as per (INR Crores) computed TP order by TPO (%) 2. Aditya Birla Minacs Worldwide Ltd., 197.06 11.98 (earlier known as Transworks Information Services Ltd) 4. Apex Knowledge Solutions Ltd., 6.64 12.83 8. Caliber Business Solutions Ltd., 39.30 21.26 9. Cosmic Global Ltd., 4.28 12.40 10. Datamatics Financial Services Ltd –Seg 2.92 5.07 12. Flextronics Software Systems Limited 12.93 8.62 13. Genesys International Corporation 19.17 13.35 15. ICRA Techno Analytics Ltd., 7.23 12.24 21. R Systems International Ltd., 17.34 20.18 26. Nittany Outsourcing Services Pvt Ltd., 23.23 11.50 6.2. Assessee is objecting to the balance of the comparables and objections of each of the comparables are as under:

Sl. No. Name of the company Turnover TPO Summary of Applicant’s as per (INR margins Objections TP Crores) (%) (Pre order WC adj) 1. Accentia Technologies 16.57 30.61 1. Extraordinary Events during the Limited – Seg. year – Amalgamation of subsidiaries resulting in growth of revenues by 100683% (refer pg 48 of the Annual Report FY 06-07) – Amalgamated the company Iridium Technologies which is a software product company. 2. Functionally not comparable –

IT(TP)A No. 1036/Bang/2011 Page 11 of 20 The activity of Medical transcription (considered by the TPO), Billing and coding and software development and implementation is not comparable to the services proved by the Appellant.

3. The business promotion expenses constitute 28.34% of the total operating revenue earned by the company.

3. Low employee cost = 24.79% of sales.

4. Outsourcing of functions – 18.44% of total operating revenue.

5. Functionally not comparable – engaged in portfolio management services and investment activities which is not comparable to the functions performed by the Appellant.

6. Incurs marketing expenses – 5.34%.

7. Bodhtree Consulting Ltd., 2.94 29.58 1. Functionally not comparable – provides open and end to end web solutions, software consultancy, design and development of solutions which cannot be compared to a BPO company (refer Management Discussion Analysis on 133(6) and considered the data cleansing segment to be in the nature of IT enabled services. The company provides data cleansing services to those companies for which they have developed the software (as per reply u/s. 133(6). Thus, the two segments are inextricably linked to each other since data cleansing also includes an element of software development in the upgradation process. Further the TPO had selected this company as comparable for the IT Segment in the Appellant’s own case for AY. 2006-07. However for AY. 2007-08, the TPO rejected this company for the IT segment citing peculiar economic circumstances (appropriate adjustments cannot be made for IT(TP)A No. 1036/Bang/2011 Page 12 of 20 the expenses transferred by Bodhtree to other companies which related to the entity as a whole and which resulted in the improved profitability for the company including the ITes Segment) (Pg 1162-1163 of PB 5). Thus, the TPO ought to have rejected Bodhtree as a comparable for AY. 2007-08 for the ITeS segment as well.

2. Peculiar circumstances – The company hived off certain business expenses without hiving off the revenue streame. The revenue of the company grew by 96.22% and the profitability of the company improved by 78.88% in AY. 2007-08 vis-à-vis AY. 2006- 07.

3. Segmental details not available in the Annual Report.

4. Segmental Information Obtained u/s. 133(6) contrary to the Annual Report.

5. Unique Intangibles (incurred trade mark expenses).

6. The entity has fluctuating margins.

2. Launched and IPO in Dec 2007 – Reported high profits for 3 years on account of booking building for its upcoming IPO in December 2007.

3. Abnormal profits.

4. Directors involved in legal and regulatory proceedings.

5. Business promotion Expenses – 9.72% of sales.

2. Functionally not comparable – product and services in the area of connectivity services, security services and IT infrastructure management services.

3. Different accounting year – June year ending.

4. Enjoys unique position in the market – The company enjoys a leading position in the BPO segment on account of its brand and unique intangibles.

5. Fails upper turnover filtes –

IT(TP)A No. 1036/Bang/2011 Page 13 of 20 260.19 Crores.

2. Low employee cost = 21.77% of sales.

3. Fails RPT>15% filter – 15.93% of sales.

4. Functionally not comparable – The company is engaged in collecting and analyzing the data on financial fundamentals, corporate governance, director- executive compensation and capital market.

5. The company earns fluctuating returns – FY 2006-2007 has been unique since it has made a margin of more than 35% in this year as compared to losses incurred in the previous years and marginal profit in the next year. (-44.51% in FY 2005-06 & 3.63% in FY. 2007-08).

6. Abnormal Growth – 171% growth in sales over previous year.

7. Business Promotion Expenses – 14.95% of sales.

2. Significant brand – related profits (refer Schedule 12 – Selling & Marketing Expenses) to the P&L A/c for the FY. 2006-07.

3. Significant benefits on account of intangibles.

4. Incurs significant Marketing Expenses – 6.39% of sales.

5. Fails upper turnover filter – 649.56 Crores.

2. Functionally not comparable – Voice – Outbound, Voice – Inbound, Data 3. Peculiar economic circumstances – Merger with IT(TP)A No. 1036/Bang/2011 Page 14 of 20 Triton 4. Extraordinary growth – more than 64% growth in sales over previous year.

20. Mold-Tek Technologies 11.14 113.49 1. Employee cost filter Ltd., - Seg inconsistently applied – The TPO applied the filter of employee cost to operating revenue less than 25% for the IT Segment but the same filter was not applied for the IT enabled services segment.

2. Low Employee cost -7.59% of sales.

3. Functionally not comparable – provides engineering design services for construction of building by using design tools like CAD/CAM, stadd pro by employing highly skilled software engineers.

4. Abnormal Growth – Growth of 204% in sales over previous year.

5. Extraordinary Profits – 113.49% (The TPO had rejected Mold Tek for AY. 2006-07 in the Appellant’s own case on account of having high profitability at 74.63% pg. 890 of PB 5 for AY. 2006-07), however he chose to retain the same comparable at 113.49% for AY. 2007-08).

6. Incurs significant Marketing Expenses – 7.46% of sales.

2. Functionally not comparable – Trading of IT Peripherals, providing of call centre services and support services; Absence of segmental information.

2. Low employee cost = 2.30% of total sales.

3. Outsourced substantial business to outside vendors – 42.88% of total operating income 4. Functionally not comparable –

IT(TP)A No. 1036/Bang/2011 Page 15 of 20 Engaged in providing solutions to the print production industry with services like e-publishing, e-book, print on demand, data and document management, data conversion, digital library management etc., 5. Abnormal profits.

2. Extraordinary Event during the year – the company invested significantly in business acquisitions during the year (six companies and two joint ventures).

3. Owns significant intangibles – Filed over 13 patents FY. 2006-07 along with additional 11 patents in pipeline.

4. Incurs R&D expenses – 8.50% of total revenue.

5. Fails upper turnover filter - 939.78 Crs.

It was admitted that these objections were considered in the Co-ordinate Bench decision in the case of i. Stream International Services (P) Ltd., [53 taxmann.com 19 (Mumbai-Trib) ; ii. M/s. Capital IQ Information (Systems) India Pvt. Ltd., - Hyd Trib. (AY. 2007-08) (ITA No. 1961/Hyd/2011); iii. Avineon India (P) Ltd., Vs. DCIT – Hyd Trib (AY. 2007-08) (ITA No. 1989/Hyd/2011; iv. Zavata India (P) Ltd., Vs. DCIT – Hyd Trib (AY. 2007-08) (ITA No. 1781/Hyd/2011; In all these decision of the Co-ordinate Benches, the objections as stated in the above column were examined in detail and the above said companies were held to be not comparable to the functionality of the said assessee’s

IT(TP)A No. 1036/Bang/2011 Page 16 of 20 company. Since the facts are similar and assessee’s business is also similar and TPO has selected the same comparables, we are of the opinion that the said comparables listed above cannot be considered as suitable for inclusion in the list for TP analysis. AO/TPO is directed to exclude the above comparables.

6.3. The assessee is also objecting to the following comparables of Allsec Technologies Ltd (Sr. No. 3):

Assessee has objected to the above comparable on the reason that it incurs marketing expenses, developed in-house software and sales and returns are fluctuating over a period of five to six years. It relied on the cases pertaining to AY. 2006-07 for exclusion of the same. However, after examining the TPO’s report and the data available on record, we are of the opinion that assessee has not made out a case to exclude the above comparable. Hence, this comparable is directed to be retained.

Apollo Healthstreet Ltd (Sr. No. 5):

Assessee objects to the above comparable on the reason of RPT filter. Even though RPT filter at 15% is accepted in some of the cases by the Co-ordinate Benches, the RPT filter can be considered upto 25% depending on the facts of the case. As worked out by assessee, RPT filter is only 17.7%. How it is worked out is not available. Since TPO has given valid reasons to include the above comparable, we are of the opinion that IT(TP)A No. 1036/Bang/2011 Page 17 of 20 the same cannot be excluded. Moreover, as seen from the other orders also, no other assessee has objected to inclusion of the above company may be on the reason that its margin is a negative margin. Be that as it may, we are of the opinion that there is no need to exclude that comparable from the list of comparables selected by the TPO.

I-Services India Pvt. Ltd (Sr. No. 18):

Assessee objects to the above comparable on the reason that there were abnormal profits. As seen from the report of the TPO and objection of assessee, we are not convinced with the argument that the company may be excluded only on the basis of abnormal profits. As seen from the TPO’s margin also it is not abnormal and therefore, we are of the opinion that there are no reasons to exclude the above comparable.

Spanco Ltd (Sr. No. 22):

The objections of assessee is about functionality of the above comparable. It fails employee cost filter, adopted by the TPO in IT segment but not in ITeS segment. It was submitted that employee cost of 7.20% of sales which indicate outsourcing of services. Moreover, the companies involved in telecom business, BPO services. It was submitted that principle of employee cost filter was upheld in Co-ordinate Bench decision in the case of First Advantage Offshore Services P. Ltd., Vs. DCIT in ITA No. 1086/Bang/2011. Considering that assessee is also having BPO services

IT(TP)A No. 1036/Bang/2011 Page 18 of 20 and employee cost is very less when compared to similar businesses. We are of the opinion that this comparable can be excluded from the list of comparables.

Accurate Data Convertors Ltd (Sr. No. 27):

This comparable was objected to on the basis of employee cost filter as well as being in software development services. Considering the turnover of only Rs. 4.33 Crores, as compared to assessee’s turnover of Rs. 161 Crores, we are of the opinion that this comparable is at the lower end of the turnover filter of ten times to assessee’s turnover. In addition that considering the low employee’s cost, we are of the opinion that this comparable can be excluded.

Corporate Tax:

8. Assessee is objecting to computation done by the AO u/s. 10A by excluding expenditure of travel expenses, telecommunication expenses from the definition of export turnover. There is no evidence on record that IT(TP)A No. 1036/Bang/2011 Page 19 of 20 travel expenses pertain to rendering of services. Travel expenses cannot be included in freight. Therefore, we are of the opinion that travel expenses incurred in foreign exchange alone cannot be disallowed from the export turnover. Therefore, we direct the AO to exclude this amount.

Coming to the issue of telecommunication expenses, nothing was brought on record that the same was not incurred in connection with export of software or rendering of services. This expenditure can be attributable to the telecommunication expenses which the provisions require exclusion from export turnover. However, since the amount of Rs. 1,38,70,965/- was considered as ‘telecommunication expenses’, which are reduced from export turnover, we direct the AO/TPO to exclude the same from also the total turnover while computing the deduction u/s. 10A of the Act. The jurisdictional High Court in the case of CIT Vs. Tata Elxsi Ltd., [342 ITR 98] has held that whatever is excluded from export turnover should also be excluded from the total turnover. Consequently, AO is directed to exclude the same from total turnover as well. With this, Ground No. 7 is considered allowed.