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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SMT. ASHA VIJAYARAGHAVAN & SHRI INTURI RAMA RAO
Per Asha Vijayaraghavan, Judicial Member
This appeal is by the assessee company directed against the order dated 29.10.2012 of the Assessing Officer passed u/s. 143(3) r.w.s. 144C of the Income-tax Act, 1961 [hereinafter referred to as "the Act"].
The assessee company, Interwoven Software Services India (P) Ltd., is a subsidiary of Interwoven Inc. of US [“IWOV Inc.”] engaged in the IT(TP)A No.1669/Bang/2012 Page 2 of 14 business of contract software development and related technical support services on a dedicated basis for IWOV Inc.
The financial results of the assessee company for the FY 2008-09 are as follows:-
Description Amount (Rs.) Revenue 206644000 Cost 179161000 Operating Profit 27483000 OP/TC 15.33%
(excluding loss on exchange function, loss on sale of asset, donation & finance expenses)
The segmental details pertaining to software development services and IT Enabled Services are as under (as per TP Report):-
Description Software services IT Enabled Pre marketing Services activity Operating revenue 182721000 23922000 15849000 Operating expenses 158888000 20273000 14408000 Operating profit 23833000 3649000 1441000 Profit margin to cost 15% 18% 10% Segment relating to Software
The transactions pertaining to the software development services are analysed as under. As the method followed by the TPO and the tax payer is TNMM, these transactions are aggregated for the transfer pricing study. Even though the assessee has furnished copies of the separate contract agreement with the AEs for the software services and ITES
IT(TP)A No.1669/Bang/2012 Page 3 of 14 segment, it is seen that the TP study was undertaken by the assessee by aggregating the revenues of both the segments. The TPO sought clarification from the assessee as to why aggregation was done for the different segments and he proposed to consider the two segments separately for TP analysis and determination of arm’s length margin accordingly. In reply, the assessee submitted that for both the activities there is only one customer i.e., the AE and both the activities are inter- related as the technical support team carries out support services to the only customers of IWOV Inc. who purchase the products. The TPO accepted the assessee’s contentions. He found that the assessee has a contract agreement with the AE CALLED “IT Enabled backoffice service agreement” dated 1.4.2008 which enumerated the following activities to be performed:-
- Instructing the customer how to repair his product over the telephone. - Dispatching the service pack when an onsite repair of the product is required. - Providing advice, trouble shooting, training and information regarding the selection, maintenance application and debugging of the contract products.
Thus the TPO observed that the ITES segment is only an adjunct to the other segment and from the segmental results the TPO found that the ITES constitute only 19.75% of the revenues. Accordingly, the TPO aggregated both the segments for the transfer pricing analysis.
IT(TP)A No.1669/Bang/2012 Page 4 of 14
The final list of comparables selected by the TPO are as follows:-
Sl. Name of company OP/TC % No 1 Avani Cincom Technologies 25.62 2 Bodhtree Consulting Ltd. 18.72 3 Celestial Biolabs 87.94 4 e-Zest Solutions Ltd. 29.81 5 Flextronics (Aricent) 7.86 6 iGate Global Solutions Ltd. 13.99 7 Infosys 40.37 8 Kals Information Systems Ltd. (Seg) 41.94 9 LGS Global Ltd. 27.52 10 Mindtree Ltd. (Seg) 16.41 11 Persistent Systems Ltd. 20.31 12 Quintegra Solutions Ltd. 21.74 13 R Systems International (Seg) 15.30 14 R S Software (India) Ltd. 7.41 15 Sasken Communication Technologies Ltd. 7.58 (Seg) 16 Tata Elxsi (Seg) 18.97 17 Thirdware Solution Ltd. 19.35 18 Wipro Ltd. (Seg) 28.45 19 Softsol India Ltd. 17.89 20 Lucid Software Ltd. 16.50 AVERAGE 23.65
Further, in the TP order u/s. 92CA, the TPO with respect to additional comparables viz., Celestial Labs, Flextronics (Aricent Technologies) and Avani Cincom stated as follows:-
“While searching for comparables, those selected in A.Y. 2007- 08 were also examined. It was found that though during the search process for the AY 2008-09, the above three companies did not find place in the Capitaline / Prowess databases, but were selected in the preceding year. The annual reports of these companies for the FY 2007-08 were therefore obtained from public domain and it was seen from the annual reports that these were engaged in software development this year also. The companies were also issued notice u/s. 133(6). As per the reply
IT(TP)A No.1669/Bang/2012 Page 5 of 14 received from them, they are mainly software development service company for the FY 2007-08 and qualified all the filters applied by the TPO. Thus these were also proposed as comparables. The revised OECD guidelines support the use of both the approaches viz., deductive and additive. In this connection reference may be made to para 3.40-3.3.46 of the OECD guidelines. The only requirement is that the search of the comparables should be transparent and the other party should know as to how the comparable was identified. This has been done in these cases.”
The TPO computed the working capital adjustment as per the formula given in Annexure to the OECD Guidelines, 2010. He considered the PLR adopted by SBI, the largest schedule bank, for short term working capital loans for the relevant FY 2007-08 and adopted the rate of 12.68% p.a. while computing the working capital adjustment as follows:-
Taxpayer Account 31-03-2008 01-04-2007 Sundry Debtors 31,277,623 5,211,632 Unbilled Revenue Less: Advances from customers Taxpayer’s payable (trade) 10,661,605 9,656,093 Average Receivables (trade) 18,244.327 Average Payables (trade) 10,158,849 On the basis of above data, the TPO computed the working capital adjustment at 1.87%.
The ld. counsel for the assessee pointed out that the ALP determined by the TPO prior to grant of working capital adjustment was 23.65% in comparison to ALP of 14.87% as determined by the assessee. He submitted that on the analysis of comparables chosen in the TP report
IT(TP)A No.1669/Bang/2012 Page 6 of 14 by the assessee, only LGS Global Ltd. was accepted by the TPO as a comparable and the remaining 41 comparables were found to have failed the criteria used by the TPO for selection of comparables.
The assessee has raised the following additional ground of appeal before the Tribunal, which reads as follows:-
The learned TPO has, in his-fresh study, erred in finalising the transfer pricing order with the companies mentioned below as comparable to the Appellant despite these companies failing to meet the legally acceptable criteria for comparability. The Honorable DRP has also erred in confirming the order of the TPO in this regard. These companies should be rejected as comparables, notwithstanding that they were not contended before the lower authorities or were contended on a different parameter. • Avani Cimcon Technologies Ltd; • Bodhtree Consulting Limited; • e-Zest Solutions Limited; • Infosys Systems Limited; • KALS Information Systems Limited; • Lucid Software Limited; • Persistent Systems Limited; • Quintegra Solutions Limited; • Tata Elxsi Limited; • Thirdware Solutions Limited; • Softsol India Limited; and • Wipro Limited
IT(TP)A No.1669/Bang/2012 Page 7 of 14
The said ground is independent and without prejudice to the other grounds of appeal preferred by the Appellant.”
12. At the time of hearing before us, the ld. counsel for the assessee did not press the additional ground raised by the assessee. Hence, the additional ground raised before us is dismissed as not pressed.
The ld. counsel submitted pointed out to the final set of comparables selected by the TPO and contended that Celestial Biolabs Ltd. (Sl.No.3 of final set of comparables) was engaged in development of products in the field of bio-technology, pharmaceuticals etc. and it failed the test of functional similarity. It was submitted that this company also fails employee cost filter. The ld. counsel for the assessee in particular pointed out to the submissions made before the TPO for exclusion of this comparable, which is reproduced below:-
“You have included a company by name Celestial Biolabs Ltd as a comparable. In our view the company is not comparable on functional basis as this company has software development and bio-technology manufacturing divisions (which is evidenced from the management discussion ana1ysis and profit and loss account – which has enzyme project expenses). Moreover the segmental information is also not available. This company should not be selected as comparable due insufficient information on segment details.”
The ld. counsel for the assessee relied upon the decision of the coordinate Bench of this Tribunal in Broadcom Communications Technologies Pvt. Ltd. in IT(TP)A No.1587/Bang/2012 (AY 2008-09) order
IT(TP)A No.1669/Bang/2012 Page 8 of 14 dated 26.06.2015 wherein the relevant observations of the Tribunal was as follows:-
“7.4.1 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial pronouncement relied on by the assessee. We find that a co-ordinate bench of this Tribunal in the case of 3DPLM Software Solutions Ltd. (supra) for A.Y .2008-09 has held that this company be excluded from the list of comparables as it is functionally different from a provider of software development services to its AEs holding as under as paras 9.4.1 to 9.4.2 thereof which is extracted hereunder:- “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 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 Triology 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 IT(TP)A No.1669/Bang/2012 Page 9 of 14 the decision of the co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 in and Triology 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. 7.4.2 Following the above decision of the co-ordinate bench of this Tribunal ……… in the case of 3DPLM Software Solutions Ltd. (supra) for Assessment Year 2008-09, we direct the Assessing Officer / TPO to omit this company from the list of comparables in the case on hand.”
Following the decision of this Tribunal in the case of Broadcom Communications Technologies Pvt. Ltd. (supra), we direct the AO/TPO to exclude Celestial Biolabs Ltd. from the final set of comparables selected by the TPO.
The ld. counsel for the assessee submitted that after exclusion of Celestial Biolabs Ltd. from the final set of comparables selected by the TPO, the arithmetic mean of the comparables (before working capital adjustment) would be 20.83% and the margin of the assessee considering the +5 % range would work out to 21.11% as per the following computation:-
Particulars Amount + 5% Operating Revenue 206,643,000 216,975,150 Operating Cost 179,161,000 179,161,000 Operating Profit 27,482,000 37,814,150 NCP (based on Op Cost) 15.34 21.11
IT(TP)A No.1669/Bang/2012 Page 10 of 14 Since the arm’s length margin after exclusion of Celestial Biolabs Ltd. falls within the range of +/- 5% of the margin of the assessee, the entire TP adjustment of Rs.13,330,876 made by the revenue authorities has to be deleted.
We have heard both the parties and perused the material on record.
After exclusion of Celestial Biolabs Ltd. from the final set of comparables arrived at by the TPO, the arithmetic mean of the comparables, according to the assessee, would be 20.83% which is within the +5% range of 21.11% and the TP adjustment made by the AO/TPO is to be deleted.
We, therefore set aside the issue to the file of the AO/TPO for verification of the assessee’s claim and decide the issue afresh in accordance with law, after providing reasonable opportunity of being heard to the assessee. The AO/TPO is also directed to recompute the working capital/risk adjustment as claimed by the assessee.
The next issue that arises for consideration is that the revenue authorities erred in concluding that expenditure incurred in foreign currency and telecommunication charges are to be excluded from the export turnover for the purpose of computation of deduction u/s. 10A of the Act. Reliance was placed in this regard on the decision of Patni Telecom (P)
Ltd. (308 ITR 414) (Hyd ITAT) and Zylog Systems Ltd., 135 TTJ 129 (Chennai ITAT).
IT(TP)A No.1669/Bang/2012 Page 11 of 14
Without prejudice to the above contention, the ld. counsel for the assessee submitted that if the above expenditure reduced from export turnover should be reduced from total turnover as well in line with the principle emanating from the ruling of Hon’ble Karnataka High Court in the case of Tata Elxsi Ltd. (349 ITR 98) for computing deduction u/s. 10A of the Act.
We have heard both the parties. The Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd., 349 ITR 98 (Karn), held that whatever expenditure is excluded from the export turnover, has to be excluded from the total turnover as well. Respectfully following the decision of the Hon’ble jurisdictional High Court, we allow the alternate ground raised by the assessee in this regard.
Ground No.13 states that the Revenue authorities erred in law and on facts in holding that the relief allowable u/s. 10A of the Act is to be computed after setting off the brought forward depreciation losses of the assessee.
The AO had set off the brought forward depreciation of Rs.1,711,672 while computing the deduction u/s.10A of the Act. The ld. counsel for the assessee submitted that the issue is covered by the decision of the Hon’ble Karnataka High Court in the case of Yokogawa India Ltd., 341 ITR 385 (Karn) however the AO proceed to set off the brought forward depreciation
IT(TP)A No.1669/Bang/2012 Page 12 of 14 on the ground that the Revenue has challenged the decision of Hon’ble Karnataka High Court before the Hon’ble Supreme Court.
The ld. counsel for the assessee pointed out to the decision of this Bench of the Tribunal in the case of Safran Aerospace India Ltd. (ITA No.1261/Bang/2010 dated 31.12.2014) wherein the Tribunal after considering the decision in the case of Himatsingike Siede (56 Taxman 151) held that the decision of Hon’ble Karnataka High Court in the case of Yokogawa India Ltd. (supra) will hold field since the Hon’ble Supreme Court dismissed the SLP of the assessee in the case of Himatsingke Siede (supra) in limine without laying any ratio decendi based on the principle held by the Apex Court in the case of Indian Oil Corporation Ltd. v. State of Bihar & Ors. (167 ITR 897). The Tribunal, further adopting the principle laid down by the Apex Court in the case of Vegetables Products Ltd. (88 ITR 192 (SC) that where two views are possible, the construction in favour of the assessee is to be adopted, held that brought forward losses and unabsorbed depreciation cannot be set off for computing the deduction u/s. 10A of the Act.
We have heard both the parties. We have heard both the parties. We find that similar issue came up for consideration before the Chennai Bench of the Tribunal in the case of S.R.A. Systems Ltd. in and the Tribunal by its order dated 21.02.2014 held as follows:-
IT(TP)A No.1669/Bang/2012 Page 13 of 14
“7. The third issue in appeal relates to the method of computation of deduction u/s.10A of the Act. The assessee has claimed deduction u/s.10A before setting off of unabsorbed depreciation and brought forward losses. The ld.AR of the assessee in order to fortify the stand of assessee has placed reliance on the decision of the Tribunal in assessee’s appeal for the AY.2005-06 and AY.2007-08 (supra). The ld.AR has also drawn support from the judgment of the Hon’ble Karnataka High Court in the case of CIT Vs. Yokogawa India Ltd.(supra). On the other hand, the ld.DR has relied on the latest decision of the Hon’ble Apex Court in the case of M/s.Himatsingka Seide Ltd., Vs. CIT (supra). The Hon’ble Supreme Court of India dismissed the appeal of the assessee and has upheld the judgment of the Hon’ble Karnataka High Court. The Hon’ble High Court has held that the brought forward depreciation has to be adjusted against the profits of the EOU before computing the exemption allowable u/s.10B. The provisions of section 10A are pari materia with the provisions of section 10B of the Act. We find that as far as un-absorbed depreciation is concerned, the Hon’ble Supreme Court of India in the case of M/s.Himatsingka Seide Ltd., Vs. CIT (supra), has up-held the findings of the Hon’ble Karnataka High Court and as such, un- absorbed depreciation has to be set-off before computing the exemption allowable u/s.10A. In respect of setting-off of the brought forward losses, the decision of the Hon’ble Karnataka High Court in the case of CIT Vs. Yokogawa India Ltd.(supra) still holds good. Accordingly, the assessee can claim deduction u/s.10A before setting off of brought forward losses. In view of the above, this ground of appeal of the assessee is partly allowed.”
We are of the view that in the present case, the issue has to be set aside to the file of the Assessing Officer. Accordingly, we remit the issue to the Assessing Officer for fresh consideration and decision in accordance with the decision of the Chennai Bench of the Tribunal in the case of S.R.A. Systems Ltd. (supra).
IT(TP)A No.1669/Bang/2012 Page 14 of 14
In the result, the assessee’s appeal is partly allowed for statistical purposes.
Pronounced in the open court on this 30th day of December, 2015.