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Income Tax Appellate Tribunal, ‘A’ BENCH : BANGALORE
Before: SMT. ASHA VIJAYARAGHAVAN & SHRI INTURI RAMA RAO
objections by the assessee are against the order of the CIT(A)-IV, Bangalore, dated 30/11/2012 for the assessment year 2008-09.
Brief facts of the case are that the assessee, a wholly owned subsidiary of Infinera Corp, has commenced commercial activity from 1 January 2003 onwards and is registered as a unit under the Software Technology Parks (STP) Scheme. The assessee provides software development services which include embedded and network management, technical documentation, system verification test and associated hardware design for the products developed by Infinera Corp. The assessee is remunerated on a cost plus basis.
3. The assessee has adopted TNMM in respect of international transactions with its Associated Enterprises (AE).
The assessee had selected 23 comparables out of which 7 comparables were found to be suitable for comparison and the final set of comparables considered by the TPO were 20 in number. For the assessment year 2008-09, operating mark up on cost of the assessee works out to 15.71% and the Arithmetical Mean operating mark up on cost of comparable companies works out to 14.84% in the case of the assessee and 23.65% in the IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 3 of 33 case of the comparable companies as per the TPO. The assessee’s total income was determined at Rs.1,82,29,221/- and tax payable thereon was at Rs.61,96,112/-.
Aggrieved by the assessment, the assessee
preferred an appeal before the CIT(A)-IV, Bangalore. With respect to the ground raised before the CIT(A) that the AO had erred in concluding that communication expenses (internet charges) of Rs.21,16,982 were attributable to delivery of computer software outside India and that travelling expenses of Rs.16,38,726 incurred in foreign currency were towards technical services rendered outside India and in reducing these expenses from the assessee’s export turnover for computing the deduction u/s 10A and that the AO has erred in not considering that if communication and travel expenses incurred in foreign currency were reduced from export turnover, equal amounts should also be reduced from total turnover for computing deduction u/s 10A, the CIT(A) held that the issue stands covered by the judgment of the Hon’ble High Court of Karnataka in the case of CIT vs. Tata Elxsi
Ltd., (17 Taxman.com(Kar) where it was held that while computing deduction u/s 10A, if export turnover in the numerator was to be arrived at after excluding certain expenses, the said expenses should also be excluded in computing total turnover in the denominator, as export turnover was but a component of total turnover. Therefore, the CIT(A) allowed this ground of appeal and directed the AO to exclude from the assessee’s total
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 4 of 33 turnover the communication expenses and foreign currency travel expenses which he has already excluded from the export turnover and to accordingly modify the computation of relief allowable u/s 10A.
Aggrieved, the department has come up in appeal in ground Nos.2 to 4 stating that the department has not accepted the decision in the case of Tata Elxsi Ltd., (supra) and an SLP had been filed before the Hon’ble Supreme Court against the order which is pending.
We have heard the parties. We are bound to follow the order of the jurisdictional High Court in the case of Tata Elxsi Ltd. (supra) and hence we confirm the order of the CIT(A) and dismiss the department’s grounds No.2,3 and 4.
With respect to transfer pricing issues, the CIT(A) held that the total turnover has the deciding factor for treating the company as comparable and accordingly excluded (i)
Flextornics Software, (ii) iGate Global Solutions Ltd., (iii) Infosys Technologies Ltd., (iv) Persistent Systems Ltd., (v) Sasken Communications, (vi) Tata Elxsi Ltd., and (vii) Wipro Ltd., as comparable. Aggrieved, revenue is in appeal before us in ground No.5.
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 5 of 33 8. We find that where the turnover is more than Rs.200 crores in the case of (i) Flextronics Software, (ii) iGate Global Solutions Ltd., (iii) Infosys Technologies Ltd., (iv) Persistent Systems Ltd. and (v) Sasken Communication Technologies Ltd. The issue has been dealt with by this Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd. vs. DCIT in wherein it has been held as under:-
“(1) Turnover Filter
11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of RS. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:-
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 6 of 33 “Size criteria in terms of Sales, Assets or Number of Employees: The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the buyer and seller and therefore comparability.”
12. The ICAI TP Guidelines note on this aspect lay down in para 15.4 that a transaction entered into by a Rs. 1,000 crore company cannot be compared with the transaction entered into by a Rs. 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. The fact that they operate in the same market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: “Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a Rs 1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate.”
13. It was further submitted that the TPO’s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies.
Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, wherein relying on Dun and Bradstreet’s analysis, the turnover of RS. 1 crore to RS. 200 crores was held to be proper. The following relevant observations were brought to our notice:- “9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 7 of 33 find that the TPO himself has rejected the companies which .ire (sic) 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 arc 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 & 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.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.”
15. It was brought to our notice that the above proposition has also been followed by the Honourable Bangalore ITAT in the following cases: 1. M/s Kodiak Networks (India) Private Limited Vs. ACIT (ITA No.1413/Bang/2010) 2. M/s Genesis Microchip (I) Private Limited Vs. DCIT (ITA No.1254/Bang/20l0).
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 8 of 33 3. Electronic for Imaging India Private Limited (ITA No. 1171/Bang/2010). It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee.
16. The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than RS. 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard.
We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm’s length price. Sec.92-B provides that “international transaction” means a transaction between two or more associated enterprises, either or both of whom are non- residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92-A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm’s length price in an international transaction and it provides:- (1) that the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :—
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 9 of 33 (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board.
(2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm’s length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm’s length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price.
(3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that— (a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm’s length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D,
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 10 of 33 the Assessing Officer may proceed to determine the arm’s length price in relation to the said international transaction in accordance with sub- sections (1) and (2), on the basis of such material or information or document available with him:”
Rule 10B of the IT Rules, 1962 prescribes rules for Determination of arm’s length price under section 92C:- “10B. (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :— (a)……. to (d)…….. (e) transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 11 of 33 (iv) the net profit margin realised by the enterprise and referred to in sub- clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction.
(2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:— (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.
(3) An uncontrolled transaction shall be comparable to an international transaction if—
(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 12 of 33 paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
(4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”
A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO.
In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is RS. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz.,
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 13 of 33 Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.”
The learned counsel for the assessee submitted that Tata Elxsi Ltd. is not comparable, since it is functionally different
from that of the assessee. The learned counsel for the assessee submitted, that it is evident from the Annual report of Tata Elxsi
Ltd. that it has business units divided into Embedded Product
Design Services, Industrial Design Services, Animation and Visual
Effects, Systems Integration services which are related to the high-end hardware and software development activities and hence is functionally different from that of the assessee. The learned counsel for the assessee relied on the decision in the case of Apigee Technologies (India) Pvt. Ltd., in IT(TP)A
No.870/Bang/2013 dated 23/09/2015 wherein it has been held as under:
“9. The arithmetic mean of the comparables selected by the assessee was at 9.01%, whereas that of the TPO was at 23.65%. The ld. counsel for the assessee before us objected to the following comparables selected by the TPO on the ground of functional dissimilarity:-
1. 1. Avani Cimcon Technologies Ltd. 2. Celestial Biolabs Ltd. 3. E-Zest Solutions Ltd. 4. Infosys Technologies Ltd. 5. Kals Info Systems Ltd. (Seg)
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 14 of 33 6. Persistent Systems Ltd. 7. Quintegra Solutions Ltd. 8. Tata Elxsi Ltd. 9. Thirdware Solutions Ltd. 10. Wipro Ltd. (Seg) 11. Lucid Software Ltd.
In short, out of the 20 comparables selected by the TPO, the assessee objected to 11 comparables listed above as functionally dissimilar and not to be included in the TP study.
10. With respect Avani Cimcon Technologies Ltd., it was the assessee’s submission that the assessee offers diversified operations such as software solutions, software development, consulting and information technology services to various clients. The assessee was also a products development company and has developed innovative product lines such as Dxchange, CARMA etc. Reliance was placed on the decision of 3DPLM Software Solutions Ltd. in IT(TP)A No.1303/Bang/2012 for AY 2008-09 and Trilogy E-Business Software India (P) Ltd. in for AY 2007-08.
11. We find that there is merit in the objection of the ld. counsel for the assessee and hence we direct that Avani Cimcon Technologies Ltd. be excluded from the list of comparables selected by the TPO.
With regard to the other 8 comparables selected by the TPO, the ld. counsel for the assessee submitted that these companies were functionally different from the assessee for the following reasons:- 1 Celestial The company is into bio- Biolabs Ltd. informatics software product/services and in the development of products in the field of bio-technology and pharmaceuticals. 2 E-Zest The company rendered product Solutions Ltd. development services and high- end technical services which came under the category of KPO services. 3 Kals Info It is engaged in the development Systems Ltd. of software products and providing related services. As per the website of KALS, it is IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 15 of 33 evident that the company is a full-fledged software product development company and also provides implementation and maintenance of software products. It also has a training centre engaged in training of software professionals for online projects. 4 Persistent It is a product company. Systems Ltd. Persistent Systems’ product lifecycle offering covers the entire product lifecycle from product concept to product support. 5 Quintegra It is into niche area of Solutions Ltd. Information Technology. The company’s operations consist of CRM, Telecom, Financial Services and other emerging verticals. It is engaged in providing High end IT solutions like development, testing, maintenance, SAP, product engineering and infrastructure management services, proprietary software products and consultancy services in IT on various platforms and technologies. 6 Tata Elxsi Ltd. AS seen from the annual report, it has business units divided into Embedded product Design Services, Industrial Design Services, Animation and Visual Effects ,Systems Integration services which are related to high-end hardware and software development activities. 7 Thirdware As seen from the annual report, it Solutions Ltd. earns revenue by rendering software development services, sale of user licences for software applications and also from sale of investments. 8 Lucid Software It is a product company focusing on Ltd. Advanced Non destructive Testing (NDT) technologies. As per the website, it is actively involved in R&D activities with leading scientific and educational institutions.
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 16 of 33
The assessee placed reliance on the following decisions in support of its contentions:- - 3DPLM Software Solutions Ltd. IT(TP)A No.1303/Bang/2012 (AY 2008-09) - Trilogy E-Business Software India P. Ltd. (ITA No.1054/Bang/2011 (AY 2007-08) - Systech Integrators India Pvt. Ltd., (AY 2008-09) - Telcordia Technologies India Pvt. Ltd., ITA No.7821/Mum/2011 (AY 2007-08) 14. With regard to the other three comparables, the ld. counsel for the assessee submitted that these companies are also to be excluded from the list of comparables selected by the TPO for the following reasons:- Avani Cimcon Functionally different, diversified 1. Technologies Ltd. operations: The company offers software solutions, software development consulting and information technology services to various clients. Product development company The company has developed innovative product lines such as Dxchange, CARMA etc. It was submitted that the website of this company substantiates the same.
2. Infosys Technologies Full-fledged risk assuming entrepreneur Ltd. It is a giant company in the area of software development and assumed all risks leading to higher profits and is therefore not comparable with to the assessee which is a captive unit of the parent company and assumes only limited risks. Holds technology and marketing intangible It is actively engaged in research & development activities and also owns intellectual property. It also partakes in activities and advertising for brand building. Infosys was ranked as the top IT
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 17 of 33 services company in that year and therefore has significant brand value. Functionally different It provides end-to-end solutions encompassing technical consulting, design, development, re-engineering, maintenance, systems integration and implementation.
Wipro Ltd. (Seg) Functionally different It is a product development company. The annual report for FY 2007-08 shows that it has income from both sale of software products and software development services. Full-fledged risk assuming entrepreneur It is a giant company and assumed all risks leading to higher profits and is therefore not comparable to the assessee company which is a captive unit of the parent company and assumes only limited risks. Holds technology and marketing intangible It is actively engaged in research & development activities and also owns intellectual property.
In support of his contentions, the ld. counsel for the assessee placed reliance on the following decisions:- - 3DPLM Software Solutions Ltd. IT(TP)A No.1303/Bang/2012 (AY 2008-09) - Trilogy E-Business Software India P. Ltd. (ITA No.1054/Bang/2011 (AY 2007-08) - Systech Integrators India Pvt. Ltd., (AY 2008-09) - Telcordia Technologies India Pvt. Ltd., ITA No.7821/Mum/2011 (AY 2007-08) - Adaptec (India) Pvt. Ltd., ITA 1758/Hyd/2012 (AY 2008-09)
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 18 of 33 - App Labs Technologies Pvt. Ltd., (AY 2008-09) - CIT v. Agnity India Technologies Pvt. Ltd., ITA No.1204/2011, Delhi High Court.
The assessee’s reliance on 3DPLM Software Solutions Ltd. IT(TP)A No.1303/Bang/2012 (AY 2008-09) is well taken and hence the 11 companies identified by the assessee referred to in paras 12 and 14 hereinabove are functionally different. We therefore direct the TPO to exclude the aforementioned 11 comparables from the list of comparables for the TP study.”
With respect to Wipro Ltd., the learned counsel for the assessee stated that though the turnover of Wipro Ltd., is more than Rs.200 crores, it is also functionally different being product development company. He referred to the Annual report of Wipro Ltd., for financial year 2007-08 which shows that Wipro Ltd., has income from both sale of software products and software development services. He further submitted that this company is to be rejected as a giant company and assumed all risks leading to higher profits and is therefore, not comparable to the assessee which is a captive unit of the parent company and assumes only risks. He further submitted that Wipro Ltd.(segment) is actively engaged in research and development activities and also owns intellectual property. The learned counsel for the assessee relied on the following decisions:
i. Apigee Technologies (India) Pvt. Ltd., in IT(TP)A No.870/Bang/2013 ii. Symbol Technologies India Pvt. Ltd. in IT(TP)A 15/Bang/2013 (para.12,pages 22-23)
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 19 of 33 iii. Bearingpoint Property Services Pvt.Ltd.in IT(TP)A No.1380/Bang/2012 (paras.22-23, pages 22-23) iv. GXS India Technology Centre in IT(TP)A No.1444/Bang/2012 (para.17, pages 36-38)
We have heard both the parties. We are of the opinion that (i) Flextornics Software, (ii) iGate Global Solutions
Ltd., (iii) Infosys Technologies Ltd., (iv) Persistent Systems Ltd.,
(v) Sasken Communications, where turnover is more than Rs.200 crores is to be rejected as comparable to that of the assessee based on the decision of this Tribunal in the case of Triology E-
Business Software India Pvt. Ltd. (supra). We find that Tata Elxsi
Ltd. and Wipro Ltd., are not only having a turnover of more than
Rs.200 crores but are also functionally different as pointed out by the learned counsel for the assessee and hence, cannot be taken as a comparable to that of the assessee. Hence, ground No.5 of the department is dismissed.
12. Ground No.6 by the department is that the CIT(A)
erred in rejecting the diminishing revenue filter used by the TPO to exclude companies that do not reflect the normal industry trend.
13. The CIT(A) on this issue held as follows:-
“129. I find merit in the appellant’s contention that revenue is not a true indicator of a company’s performance that may depend on its own business cycle, and that a company with increasing revenues over a period of time did not necessarily reflect better performance, as increase
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 20 of 33 in expenses in the corresponding period could be higher than that in revenues and the company might still incur losses. Conversely, a company with diminishing revenues over a period of time may not necessarily be performing badly, if it still had a good profit margin achieved through cost efficiency. Growth of the Indian software industry cannot be attributed solely to existing companies, but also to new companies set up. Considering these aspects, I uphold the appellant’s arguments on this issue.”
14. Ground No.7 states that the CIT(A) erred in not appreciating that the different year ending filter applied by the TPO is necessary to exclude companies which do not have the same or comparable financial cycle as the tested party.
15. The CIT(Appeals) on this issue held as under:-
“138. There is force in the appellant’s contention that AS-21 issued by the ICAI on consolidation of accounts as well as section 212 of the Companies Act permit differences in the dates of financial year closure of companies within a six-month time frame. I am inclined to agree with the appellant that where the accounting period of a comparable exceeded the financial year by not more than six months relative to the accounting year of the appellant, it should be considered as a comparable, so long as these companies, even through having different financial year-ending, were operating during the same period of time as the appellant and were also facing the same business cycles and market and economic conditions as the appellant did. In the absence of evidence that there had been a significant impact on margins due to different reporting/accounting periods, it would be incorrect to disregard companies by using this filter. Considering these aspects, I uphold the appellant’s arguments on this issue.”
16. Ground Nos. 6 & 7 raised by the Revenue are merely argumentative and are therefore not specifically dealt with.
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 21 of 33
17. Ground No.8 raised by the department is that the CIT(A) erred in rejecting the employee cost filter applied by the TPO to select companies which are predominantly into software development services and thereby including M/s Maars Software International Ltd., as a comparable.
18. The learned counsel for the assessee argued that M/s.Maars Software International Ltd. is to be taken as a comparable since it is involved in software development activity which is same as that of the assessee. The CIT(Appeals) held as follows:-
“146. Though employee cost forms a significant portion of the total costs of a software company, the problem lies in correctly gauging such costs. All companies do not follow a uniform policy in classifying such costs, but classify them variously as administrative, marketing, operating, or software development expenses and not necessarily as personnel expenses in the profit and loss account. Further, companies may outsource their services rather than employ their own personnel and outsourcing costs may be disclosed under various heads like legal and professional charges, contracts costs, etc. As there is no way of tracking or identifying employee costs, they may not be particularly amenable to be used as a filter in the selection or rejection of comparables.
I find merit in the appellant's contention that when TNMM is adopted as the most appropriate method for determination of ALP, only the net margin of the tested party has to be considered relative to an appropriate base (total cost in this case), without looking into individual elements of cost, as all direct and indirect costs of operation are aggregated, irrespective of their classification and composition. The decision in the case IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 22 of 33 of Mentor Graphics (Noida) Pvt. Ltd. v. DCIT [20071 112 TTJ 408 (Del), where it was held that the TPO had wrongly objected that taxpayer did not exclude companies having low employee cost, also suggests that use of low employee cost as a filter may be inappropriate in cases where TNMM had been used as the most appropriate method to determine the ALP.
For the above reasons, I hold that the TPO was not justified in applying the employee cost filter in some cases, while disregarding it in respect of others. As the suitability of the filter for judging the comparability of entities under the TNMM is not established, I am unable to accept its use in the present case. I therefore direct the AO to include for TP analysis Maars Software International Ltd. that was excluded by the TPO on the basis of the employee cost filter. However, M/s CG- VAK Software & Exports Ltd., which was also excluded on this filter, cannot be considered a comparable in view of its negative operating margin during the year.”
19. We uphold the order of the CIT(Appeals) in directing the AO to include Maars Software International Ltd. as a comparable. Ground No.8 is dismissed.
20. Ground No.9 states that the CIT(A) erred in holding that M/s.Bodhtree Consulting Ltd., being functionally different cannot be taken as comparable.
The company i.e., Bodhtree Consulting Ltd. is functionally dissimilar as it has software products and a hybrid service business model. It is engaged in providing open and end to end web solutions software consultancy and design and development of software using latest technology. The relevant observations of the Tribunal in Cisco Systems India Pvt. Ltd., ITA
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 23 of 33 No.271/Bang/2014 order dated 14.8.2014, are reproduced below:-
““26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute that in the list of comparables chosen by the assessee, this company was also included by the assessee. The assessee, however, submits before us that later on it came to the assessee’s notice that this company is not being considered as a comparable company in the case of companies rendering software development services. In this regard, the ld. counsel for the assessee has brought to our notice the decision of the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. v. ITO, order dated 6.11.2013. In this case, the Tribunal followed the decision rendered by the Mumbai Bench of the Tribunal in the case of Wills Processing Services (I) P. Ltd., ITA No.4547/Mum/2012. In the aforesaid decisions, the Tribunal has taken the view that Bodhtree Consulting Ltd. is in the business of software products and was engaged in providing open & end to end web solutions software consultancy and design & development of software using latest technology. The decision rendered by the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. (supra) is in relation to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in AY 08-09 as far as this comparable company is concerned. Following the aforesaid decision of the Mumbai Bench of the Tribunal, we hold that Bodhtree Consulting Ltd. cannot be regarded as a comparable. In this regards, the fact that the assessee had itself proposed this company as comparable, in our opinion, should not be the basis on which the said company should be retained as a comparable, when factually it is shown that the said company is a software product company and not a software development services company.”
Following the decision of the Tribunal in the case of Cisco Systems India Pvt. Ltd. (supra), this issue is decided
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 24 of 33 against the assessee. Ground No.9 raised by the Revenue is allowed.
With respect to ground No.10 challenging the order of the CIT(A) that he erred in holding that M/s.Celestial Labs being functionally different, cannot be taken as a comparable, the learned counsel for the assessee has relied on the following decisions of this Tribunal:
i. 3DPLM Software Solutions Ltd. in IT(TP)A No.1303/Bang/2012 ii. Apigee Technologies (India) P.Ltd., in IT(TP)A No.870/Bang/2013; iii. Symbol Technologies India Pvt. Ltd., in IT(TP)A
No.15/Bang/2013 iv. Bearingpoint Property Services Pvt. Ltd., in IT(TP)A No1380/Bang/2012 v. GXS India Technology Centre in IT(TP)A No.1444/Bang/2012
M/s.Celestial Biolabs Ltd., is functionally dissimilar i.e. it is into bio-informatics software product/services and in the development of products in the field of bio-technology, pharmaceuticals and hence is not comparable to that of the assessee-company. This Tribunal in the case of 3DPLM Software Solutions Ltd. (supra) regarding comparability of this company, has held as follows:-
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 25 of 33 “9. Celestial Biolabs Ltd. 9.1 This comparable was selected by the TPO for inclusion in the final list of comparables. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables for the reasons that it is functionally different form the assessee and that it fails the employee cost filter. The TPO, however, brushed aside the objections raised by the assessee by stating that the objections of functional dissimilarity has been dealt with in detail in the T.P. order for Assessment Year 2007-08. As regards the objection raised in respect of the employee cost filter issue, the TPO rejected the objections by observing that the employee cost filter is only a trigger to know the functionality of the company. 9.2 Before us, the learned Authorised Representative contended that this company is not functionally comparable, as the company is into bio-informatics software product / services and the segmental break up is not provided. It was submitted that :- (i) This company is engaged in the development of products in the field of bio-technology, pharmaceuticals, etc. and therefore is not functionally comparable to the assessee; (ii) This company has been held to be functionally incomparable to software service providers by the decision of the co-ordinate bench of this Tribunal in the assessee's own case for Assessment Year 2007-08 (supra); (iii) The co-ordinate bench of this Tribunal in its order in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) at para 43 thereof had observed about this company that – “ ….. As explained earlier, it is a diversified company and therefore cannot be considered as comparable functionally with the assessee. There has been no attempt to identify, eliminate and make adjustment of the profit margins so that the difference in functional comparability can be eliminated. By not resorting to such a process of making adjustments, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the assessee in this regard.”
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 26 of 33
(iv) The rejection / exclusion of this company as a comparable for Assessment Year 2007-08 for software service providers has been upheld by the co-ordinate benches of this Tribunal in the cases of LG Soft India Pvt. Ltd. in CSR India Pvt. Ltd. in IT(TP)A No.1119/Bang/2011 and by the ITAT, Delhi Bench in the case of Transwitch India Pvt. Ltd. in ITA No.6083/Del/2010. (v) The facts pertaining to this company has not changed from Assessment Year 2007-08 to Assessment Year 2008-09 and therefore this company cannot be considered for the purpose of comparability in the instant case and hence ought to be rejected. In support of this contention, the assessee has also referred to and quoted from various parts of the Annual Report of the company. 9.3 Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparable companies. The learned Departmental Representative submitted that the decisions cited and relied on by the assessee are for Assessment Year 2007-08 and therefore there cannot be an assumption that it would continue to be applicable for the period under consideration i.e. Assessment Year 2008-09. 9.4.1 We have heard both the parties and perused and carefully considered the material on record. While it is true that the decisions cited and relied on by the assessee were with respect to the immediately previous assessment year, and there cannot be an assumption that it would continue to be applicable for this year as well, the same parity of reasoning is applicable to the TPO as well who seems to have selected this company as a comparable based on the reasoning given in the TPO’s order for the earlier year. It is evidently clear from this, that the TPO has not carried out any independent FAR analysis for this company for this year viz. Assessment Year 2008-09. To that extent, in our considered view, the selection process adopted by the TPO for inclusion of this company in the list of comparables is defective and suffers from serious infirmity. 9.4.2 Apart from relying on the afore cited judicial decisions in the matter (supra), the assessee has brought on record substantial factual evidence to establish that this company is functionally dis-similar and different from the IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 27 of 33 assessee in the case on hand and is therefore not comparable and also that the findings rendered in the cited decisions for the earlier years i.e. Assessment Year 2007- 08 is applicable for this year also. We agree with the submissions of the assessee that this company is functionally different from the assessee. It has also been so held by co-ordinate benches of this Tribunal in the assessee's own case for Assessment Year 2007-08 (supra) as well as in the case of Trilogy E-Business Software India Pvt. Ltd. (supra). In view of the fact that the functional profile of and other parameters of this company have not changed in this year under consideration, which fact has also been demonstrated by the assessee, following the decision of the co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 in and Trilogy E-Business Software India Pvt. Ltd. in ITA No.1054/Bang/2011, we hold that this company ought to be omitted form the list of comparables. The A.O./TPO are accordingly directed.
Following the decision of the coordinate Bench of this Tribunal in the case of 3DPLM Software Solutions Ltd.
(supra), hence this company has to be rejected as a comparable.
Hence, ground No.10 by the Revenue is rejected.
Ground No.11 of the revenue is that the CIT(A) erred
in holding that M/s.Lucid Software Ltd., being functionally different, cannot be taken as a comparable. The learned counsel for the assessee relied on the following decisions: i. 3DPLM Software Solutions Ltd. in IT(TP)A No.1303/Bang/2012 ii. Apigee Technologies (India) P.Ltd., in IT(TP)A No.870/Bang/2013; iii. Symbol Technologies India Pvt. Ltd., in IT(TP)A No.15/Bang/2013
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 28 of 33 iv. Bearingpoint Property Services Pvt. Ltd., in IT(TP)A No1380/Bang/2012 v. GXS India Technology Centre in IT(TP)A No.1444/Bang/2012
M/s.Lucid Software is a product company focusing on Advanced Non-destructive Testing (NDT) Technologies. The company is actively involved in R&D activities with leading scientific and educational institutions and hence is not comparable to that of the assessee.
This Tribunal in the case of 3DPLM Software Solutions Ltd. (supra) regarding comparability of this company viz., Lucid Software, has held as follows:-
“16. Lucid Software Ltd. 16.1 This company was selected as a comparable by the TPO. Before us, the assessee has objected to the inclusion of this company as a comparable on the grounds that it is into software product development and therefore functionally different from the assessee. In this regard, the learned Authorised Representative submitted that – (i) This company is engaged in the development of software products. (ii) This company has been held to be functionally different and therefore not comparable to software service providers by the order of a co-ordinate bench of the Tribunal in the assessee's own case for Assessment Year 2007-08 (IT(TP)A No.845/Bang/2011), following the decision of Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (ITA No.7821/Mum/2011). (iii) The rejection of this company as a comparable to software service providers has been upheld by the co- ordinate benches of this Tribunal in the cases of LG Soft India Pvt. Ltd. (ITA No.1121/Bang/2011) and CSR India
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 29 of 33 Pvt. Ltd. [ IT(TP)A No.1119/Bang/2011 ] and by the Delhi Bench of the Tribunal in the case of Transwitch India Pvt. Ltd. (ITA No.6083/Del/2010). (iv) The factual position and circumstances pertaining to this company has not changed from the earlier Assessment Year 2007-08 to the period under consideration i.e. Assessment Year 2008-09 and therefore on this basis, this company cannot be considered as a comparable in the case on hand. (v) The relevant portion of the Annual Report of this company evidences that it is in the business of product development. The learned Authorised Representative prays that in view of the factual position as laid out above and the decisions of the co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 and other cases cited above, it is clear that this company being into product development cannot be considered as a comparable to the assessee in the case on hand who is a software service provider and therefore this company i.e. Lucid Software Ltd., ought to be omitted from the list of comparables. 16.2 per contra, the learned Departmental Representative supported the action and finding of the TPO in including this company in the list of comparables. 16.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that the company i.e. Lucid Software Ltd., is engaged in the development of software products whereas the assessee, in the case on hand, is in the business of providing software development services. We also find that, co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 (IT(TP)A No.845/Bang/2011), LG Soft India Pvt. Ltd. (supra), CSR India Pvt. Ltd. (supra); the ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt. Ltd. (supra) and the Delhi ITAT in the case of Transwitch India Pvt. Ltd. (supra) have held, that since this company, is engaged in the software product development and not software development services, it is functionally different and dis-similar and is therefore to be omitted from the list of comparables for software development service
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 30 of 33 providers. The assessee has also brought on record details to demonstrate that the factual and other circumstances pertaining to this company have not changed materially from the earlier year i.e. Assessment Year 2007-08 to the period under consideration i.e. Assessment Year 2008-09. In this factual matrix and following the afore cited decisions of the co-ordinate benches of this Tribunal and of the ITAT, Mumbai and Delhi Benches (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand.”
Following the decision of the coordinate Bench of this Tribunal in the case of 3DPLM Software Solutions Ltd. (supra), this company has to be rejected as a comparable. Hence, ground No.11 by the Revenue is rejected.
Ground No.12 is that the CIT(A) erred in including M/s.VMF Soft Tech Ltd., as a comparable on the basis of export earning even though it fails the persistent loss filter. M/s.VMF Soft Tech Ltd., is involved in software development activity comparable to the assessee and passes all filters applied by the TPO. The TPO has rejected the comparable on the basis of failing export revenue filter. It is pointed out that export revenue was erroneously calculated and as per correct computation based on the annual report is 97% of total revenue. In this regard, the CIT(A) held as under: “Export Sales filter 182. Although the appellant and the TPO are in agreement in principle that companies whose export sales were less than 25% of their total sales ought to be excluded, the appellant is aggrieved that the TPO had IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 31 of 33 rejected M/s VMF Soft Tech Ltd. as a comparable stating that it did not have more than 25% export revenue. It was argued that export revenue of this company was 94.36% of its operating revenues, as evidenced by Schedule 9 of its profit and loss account, given on page 25 of the annual report and hence the company passed the export revenue filter adopted by the TPO.
I have, examined the profit and loss account of M/s VMF Soft Tech Ltd. and find that its total sales during the relevant FY was Rs. 1,61,45,213, out of which, export sales amounted to Rs. 1,57,16,663, or about 97% of total revenue. Thus, there was no reason to reject this company as a comparable on applying the export revenue filter. I therefore direct the AO to include this company in the final list of comparables. ”
We are in conformity with the order of the CIT(Appeals) in directing the AO to include VMS Soft Tech Ltd. as a comparable. Ground No.12 raised by the Revenue is dismissed.
Ground Nos.13 & 14 are general in nature and are therefore not adjudicated.
The ld. counsel for the assessee submitted that the comparables at Sl.Nos. 1, 4, 9, 12, 13 & 14 [viz., Avani Cimcon, E-Zest Solutions Ltd., LGS Global Ltd., Quintegra Solutions Ltd., R. Systems International (Seg.) and R.S. Software (India) Ltd.] included by the TPO in the final set of comparable selected by him are not pressed by the assessee at this stage. It was, however, submitted that the same should not be construed as acceptance
IT(TP)A No.294/Bang/2013 & CO No.152/Bang/2015 Page 32 of 33 of these companies by the assessee as comparables. Therefore, we dismiss the assessee’s plea on inclusion of the above comparables by the TPO/AO as not pressed.
The ld. counsel for the assessee submitted that the assessee’s mark-up on cost falls within the +/- 5% range as provided u/s. 92C(2) of the I.T. Act and hence the international transactions in relation to income from contract software development services is at arm’s length. We direct the AO/TPO to examine this issue and decide the same in accordance with law.
The ld. counsel for the assessee submitted that the Cross Objection filed by the assessee is not pressed. Accordingly, the Cross Objection is dismissed as not pressed.
In the result, the appeal by the department is partly allowed and the Cross Objection by the assessee is dismissed.
Pronounced in the open court on 20th January, 2016.