M/S ARM EMBEDDED TECHNOLOGIES PVT. LTD.,,BANGALORE vs. DCIT, BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL “A” BENCH : BANGALORE

BEFORE SMT. ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER AND SHRI ABRAHAM P. GEORGE, ACCOUNTANT MEMBER

IT(TP)A Nos.1112/Bang/2010 & 1161/Bang/2011 Assessment years : 2006-07 & 2007-08

M/s. ARM Embedded Technologies Vs. The Deputy Commissioner of Pvt. Ltd., Income Tax, Bagmane World Technology Center- Circle 11(1), SEZ, Citrine Block, 5th & 6th Floor, Bangalore. Marathahalli Outer Ring Road, Doddanakundi Village, Mahadevapura, Bangalore – 560 048. PAN: AAECA 1582E

APPELLANT RESPONDENT

Appellant by : Shri T. Suryanarayana, Advocate Respondent by : Shri I.P.S. Bindra, CIT(DR-I)

Date of hearing : 13.10.2015 Date of Pronouncement : 01.12.2015

O R D E R Per Asha Vijayaraghavan, Judicial Member

These are appeals filed by the assessee company directed against the order dated 26.07.2010 and 20.09.2011 passed by the Assessing

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 2 of 78

Officer u/s. 143(3) r.w.s. 144C of the Income-tax Act, 1961 [“the Act”] relating to assessment years 2006-07 and 2007-08 respectively.

A.Y. 2006-07

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 3 of 78

(AEs) in respect of software design, development and maintenance services, pursuant to the order dated 26.10.2009 passed by the Transfer

Pricing Officer (TPO). The AO also made an addition of Rs. 16,05,774 on account of re-computation of deduction claimed u/s. 10A of the Act.

Aggrieved by the draft assessment order, the assessee filed its objections before the Dispute Resolution Panel (DRP). The DRP upheld the order

passed by the AO. Consequently, the AO passed the final order dated

26.07.2010 raising a demand for the balance tax payable of Rs. 1,12,22,415.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 4 of 78

Transactional Net Margin Method (TNMM) was adopted as the most appropriate method by the assessee and the TPO.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 5 of 78

Megasoft Ltd. and Accel Transmatic Ltd. and rejected the remaining 41.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 6 of 78

made by the TPO is as under:-

time the issue was pending consideration before the Special Bench of the

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 7 of 78 Tribunal. However, the assessee has now raised the additional grounds of appeal after ground No.5.4 which read as follows:-

“5.5 That, Lucid Software Ltd. ought to stand rejected in view of it being functionally dissimilar to the Appellant. 5.6 That, Flextronics Software Systems Ltd., iGate Global Solutions Ltd., Mindtree Ltd., Persistent Systems Ltd., and Sasken Communication Technology Ltd. ought to stand rejected in view of their turnovers being Rs.595.12 crores, Rs.527.91 crores, Rs.448.79 crores, Rs.209.18 crores and Rs.240.03 crores, respectively, and thus beyond the upper limit of Rs.200 crores by applying the turnover filter, as is consistently being held by this Hon’ble Tribunal. 5.7 That, Geometric Software Solutions Co. Ltd. ought to stand rejected in view of its related party transactions exceeding 15% of its sales.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 8 of 78

learned AR that by virtue of Special Bench decision in the case of M/s Quark Systems Pvt. Ltd (Supra), assessee can raise additional grounds

seeking exclusion of comparables selected by it or not objected by it before the lower authorities. However, the Hon’ble Punjab & Haryana High Court

in (2011) 62 DTR 0182 had upheld the Special Bench decision in the case

of M/s Quark Systems Pvt. Ltd. ( Supra) specifically noting that the Special Bench had remitted the issue of comparability of such companies to the

AO/TPO for verification afresh. Hence, we are admitting the additional grounds. However, the comparability of the companies assailed in such

additional grounds will be dealt by us, considering the judgment of the

Hon’ble Punjab & Haryana High Court judgment in the case of CIT Vs M/s Quark Systems India (P) Ltd., (2011) 62 DTR 0182. Hence the additional

grounds are set aside to the file of the Assessing Officer.

Nos. 4, 5, 10, 11 & 16 of the final set of comparables selected by the TPO

may be rejected as being functionally dissimilar on the basis of decision of the Tribunal in the case of Cypress Semiconductor India P. Ltd. v. DCIT,

ITA No.1167/Bang/2010 dated 27.03.2015. The relevant paragraphs of the Tribunal’s order are as follows:-

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 9 of 78

“11. The following were the relevant observations of the Tribunal on the aforesaid comparable companies in the case of Trilogy E-Business Software India Pvt. Ltd. (supra):- “(d) KALS Information Systems Ltd. 46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual report, the salary cost debited under the software development expenditure was Rs. 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal’s decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: “16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011

Page 10 of 78

Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable. 47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable. (e) Accel Transmatic Ltd. 48. With regard to this company, the complaint of the assessee is that this company is not a pure software development service company. It is further submitted that in a Mumbai Tribunal Decision of Capgemini India (F) Ltd v Ad. CIT 12 Taxman.com 51, the DRP accepted the contention of the assessee that Accel Transmatic should be rejected as comparable. The relevant observations of DRP as extracted by the ITAT in its order are as follows: “In regard to Accel Transmatics Ltd. the assessee submitted the company profile and its annual report for financial year 2005-06 from which the DRP noted that the business activities of the company were as under. (i) Transmatic system - design, development and manufacture of multi function kiosks Queue management system, ticket vending system (ii) Ushus Technologies - offshore development centre for embedded software, net work system, imaging technologies, outsourced product development

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011

Page 11 of 78

(iii) Accel IT Academy (the net stop for engineers)- training services in hardware and networking, enterprise system management, embedded system, VLSI designs, CAD/CAM/BPO (iv) Accel Animation Studies software services for 2D/3D animation, special effect, erection, game asset development. 4.3 On careful perusal of the business activities of Accel Transmatic Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee’s claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from the final list of comparables for the purpose of determining TNMM margin.” 49. Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as comparable. The ld. DR, on the other hand, relied on the order of the TPO. 50. We have considered the submissions and are of the view that the plea of the assessee that the aforesaid company should not be treated as comparables was considered by the Tribunal in Capgemini India Ltd (supra) where the assessee was software developer. The Tribunal, in the said decision referred to by the ld. counsel for the assessee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables.” 12. The facts and circumstances under which the aforesaid companies were considered as comparable are identical in the

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 12 of 78 case of the Assessee as well as in the case of Trilogy E-Business Software India Pvt.Ltd. (supra). Respectfully following the decision of the Tribunal referred to above in the case of Trilogy E-Business Software India Pvt.Ltd.(supra), we direct that KALS Information Systems Limited and Accel Transmatics Ltd., be excluded from the list of 20 comparable arrived at by the TPO. ……… 15. As far as the comparable chosen by TPO viz., Infosys Limited is concerned, it has been held by the co-ordinate bench of ITAT Bangalore in the case of Logica Pvt.Ltd. Vs. ACIT ITA No.1129/Bang/2011 (AY 07-08) that this company is a full fledge risk assuming entrepreneur, holds technology and marketing intangible and is functionally different providing end- to-end solutions encompassing technical consulting, design, development, re-engineering, maintenance, systems integration and package evaluation and implementation. The company generates around 3.96% of its revenue from software products. The relevant observations of the Tribunal in the case of Logica Pvt. Ltd. (supra) were as follows: “13. So also, the comparables listed at Sl.Nos. 10, 14 and 26 have to be rejected as functionally not comparable with that of the assessee in view of the decision of the Mumbai Bench of the Tribunal in the case of Telcordia Technologies India Private Ltd. in ITA No.7821/MUM/2011, wherein it was held as under:-

“7.2 Lucid Software Limited It has been submitted before us that this company, besides doing software development services, is also involved in development of software product. The learned AR has tried to distinguish by pointing out that product development expenditure in this case is around 39% of the capital employed by the said company, and, therefore, such a company cannot be considered as tested party. Even as per

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 13 of 78

the information received in response to notice under Section 133(6), the company has described its business as software development company or pure software development service provider. This information itself is very vague as the segmental details of operating revenue has not been made available to examine how much is the ratio of sale from software product and sale of software service and development. Looking to the fact that it has developed a software product named as “Muulam” which is used for civil engineering structures and the product development expenditure itself is substantial vis-a-vis the capital employed by the said company, this criteria for being taken as comparable party, gets vitiated. For the purpose of comparability analysis, it is essential that the characteristics and the functions are by and large similar as that of the assessee company and T.P. analysis/study can be made with fewest and most reliable adjustment. If a company has employed heavy capital in development of a product then profitability in the sale of product would be entirely different from the company, who is involved in service sector. Therefore, this company cannot be treated as having same function and profitability ratio. In our view, due to non-availability of full information about the segmental details as to how much is the sale of product and how much is from the services, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case of the assessee.” ……… 7.4 Infosys Technologies Ltd.: The parameter for identifying comparable entity has to be seen from the angle of functions formed by the company, size of the company in terms of the sale revenue, stage of business cycle and company’s growth cycle. In the case of Infosys, there are huge intangible assets which as per the information provided by the

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 14 of 78 learned AR are valued at Rs.69,522 crores, which comprises of brand value itself at Rs.22,915 crores. Based on such fund valuation, the profit of Infosys is predominantly due to its premium branding. It is India’s No.2 software service exporter and Third in the World as an IT Service company. It is a giant company which is evident from its revenue fund from the sales which itself is more than Rs.13145 crores and expenditure on advertisement/sales promotion and expenditure on R&D is at Rs.69 crores and Rs.167 crores respectively, whereas in the case of the assessee the revenue is only 10.7 crores with no expenditure on advertisement, sales and promotion etc., which are borne by the associated enterprises. Even from the test of ‘FAR’ ie. function performed, assets employed and risk assumed, comparability analysis miserably fails in this case. The comparison of function and profile as has been reproduced in para 6(iv) above, mostly shows that the profit level indicators in relation to return of cost, return of sales and return of assets are huge between Infosys and the assessee company and therefore, the Infosys cannot be treated as comparable entity for making comparability analysis with the assessee company. The comparability of lnfosys Technology of the company as that of an assessee has been dealt with ITAT Delhi Bench in the case of ‘Agnity India Technologies Private Limited’ (ITA No.3856/Delhi/2010), wherein it was held that lnfosys is a giant in the area of development of software and it assumes all risks, leading to higher profit and cannot be compared with the company which is a captive unit of its parent company assuming only limited currency risk. In view of the above finding, we hold that the Infosys cannot be taken as a comparable for determining the arms length price in the case of the assessee.” ……. “13. As far as comparable Tata Elxsi Ltd., is concerned, the comparability of this company with that of the software service provider was considered by the Mumbai Bench of this Tribunal in the case of Logica Pvt.Ltd. IT (TP) 1129/Bang/2011 (AY 07- 08) wherein on the aforesaid company, the Tribunal held as follows:-

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 15 of 78

“14. As far as comparable at Sl.No.6 & 24 are concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of the Tribunal in the case of Telcordia Technologies India Private Ltd. (supra) wherein on the aforesaid two companies, the Tribunal held as follows:- “7.6 Flextronics Software Systems Ltd. ……….. 7.7. Tata Elxsi Limited.: From the facts and material on record and submissions made by the learned AR, it is seen that the Tata Elxsi is engaged in development of niche product and development services, which is entirely different from the assessee company. We agree with the contention of the learned AR that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties.” 15. In view of the above, the ld. counsel for the assessee fairly admitted that comparable company at Sl.No.6 viz., Flextronics Software Systems Pvt. Ltd. should be taken as a comparable, while comparable at Sl.No.24 viz., Tata Elxsi Ltd. should be rejected as a comparable.” 14. In view of the aforesaid decision, we hold that Tata Elxsi has to be excluded from the list of comparable chosen by the TPO.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 16 of 78 and Accel Transmatics Ltd. being functionally dissimilar be excluded from the final list of comparables selected by the TPO.

“17. As far as comparable companies chosen by the TPO viz., iGate Global Solutions Ltd., Mindtree Consulting Ltd., Sasken Communications Ltd., and Flextronics Software Systems Ltd., are concerned, this Tribunal in the case of Trilogy E-Business (supra) has by applying turnover filter held that while selecting comparable companies for comparability analysis turnover will be a relevant criteria and held as follows: “(1) Turnover Filter

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 17 of 78 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:- “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)]:

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 18 of 78

“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. 14. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, 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 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

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 19 of 78

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). 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.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 20 of 78 17. 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 :— (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:

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 21 of 78 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, 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:”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 22 of 78

“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; (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.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 23 of 78

(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 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.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 24 of 78 (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.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 25 of 78

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 26 of 78 paras 22 & 23 in the case of Cypress Semiconductor India Pvt. Ltd. (supra) in this regard are as follows:-

“22. As far as comparable companies chosen by the TPO viz., Aztec Software Limited and Geometric Software Ltd. (Seg.) and Megasoft Ltd., are concerned, it is not in dispute before us that the related party transaction in the case of companies exceeds 15% and in view of the decision of the Tribunal in the case of 24 X 7 Customer.Com Pvt. Ltd. in ITA No.227/Bang/2010, followed by this Tribunal in the case of Logica Private Ltd. (supra) wherein it was held that where the RPT exceeds 15%, such companies should not be taken as comparable companies. Following the said decision, we hold that said companies should be excluded from the list of the comparable companies chosen by the TPO while working out the ALP. 23. After excluding the aforesaid comparable from the list of comparable chosen by the TPO, the arithmetic mean of profit margin of the remaining 7 comparable would be 11.30% (unadjusted) and 9.87% after working capital adjustment. The Assessee’s profit margin operating profit on cost is 10.15% which is within the + / - 5% range permitted under second proviso to Sec.92CA(2) of the Act and therefore the addition made by the TPO and confirmed by the DRP needs to be deleted. Accordingly the same is deleted. The relevant grounds of appeal of the Assessee are allowed.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 27 of 78

the Assessing Officer to examine whether Geometric Solutions Ltd. exceeds 15% RPT, following the decision in case of Cypress

Semiconductor India P. Ltd. (supra) / M/s. Quark Systems India (P) Ltd., (2011) 62 DTR 0182.

assessee, the arithmetic mean of the remaining 7 comparables would be as follows:-

software development services would be as follows:-

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 28 of 78

mean and if so, the TP adjustment made by the TPO is liable to be set aside. Accordingly, we set aside the issue of determination of NCP margin

to the file of the Assessing Officer.

operating revenue of the assessee company. The TPO has included the reimbursement of expenses received amounting to Rs. 4,371,178/- as part

of the cost base for applying the adjusted operating cost plus markup. In

this regard, the assessee submitted that the reimbursement of expenses received by the Company was incurred by it on behalf of its AEs, following

the policy of reimbursing such expenses on cost to cost basis and no services have been rendered by the assessee in relation to the

reimbursements, therefore, reimbursements purely relate to third party expenses incurred on behalf of the AEs. It was submitted that the Company

had received reimbursement of these expenses at cost from its AEs and

consequently, the amount received/receivable is deemed to be the arm’s length price.

assessee argued that even if the reimbursement of expenses received was considered in both operating income and expense, the NCP margin of the

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 29 of 78

assessee would be 11.30% which is within the range of + / - 5% of the arithmetical mean of comparable companies as under:-

company has received reimbursement of these expenses as cost from its AE and consequently the amount received/receivable is deemed to be at

arm’s length price. Hence this ground of appeal is allowed.

mean for software development services is achieved by applying working

capital adjustment as computed by the TPO, the AO/TPO erred in not considering the advances received from the customers as part of trade

payables in determination of working capital adjustment and thereby erred in not providing an appropriate adjustment towards working capital. It was

submitted that in the TP order, the TPO has determined the arm’s length

markup as 20.08% (after working capital adjustment of 0.59%) for software development services provided by the assessee. However, the TPO has

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 30 of 78

not considered advances from ARM Ltd. UK and ARM Inc., USA in computation of the working capital adjustment.

2006 at Rs. 11,79,063. The TPO has thereby not considered the advances

received from ARM Ltd. UK amounting to Rs. 13,62,30,811 as on March 31, 2006 and Rs. 6,27,66,411 as on April 1, 2005 (schedule 8A of audited

financial statements — Current Liabilities). The assessee’s contention is that it receives compensation for their contractual services in advance and

subsequently adjusts these advances against the invoices raised. Given

that the assessee is a captive service provider, it may choose to invest such advances towards either purchase of assets or for incurring

expenses, but ultimately such an advance is utilized towards performing contractual services. Therefore, it was the submission of the ld. counsel for

the assessee that the advances received from its AEs should be considered as a part of trade payables in computation of working capital

adjustment. The workings for average trade payables furnished by the

assessee are as follows:-

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 31 of 78

capital adjusted arm’s length mark-up for the 20 comparables selected by the TPO would be 15.55% (after working capital adjustment of 5.13%) for

software development services provided by the assessee. Based on the

remaining 7 out of the 20 comparables selected by the TPO the assessee’s margin of 11.52% is within the +/- 5% of the working capital adjusted mean

of 10.56% as computed by the TPO. If the working capital adjustment is computed by including “Advances received from AEs” as part of trade

payables, the working capital adjusted mark-up for the above 7

comparables would be even lower.

considered as a part of trade payables in the computation of working capital adjustment. Hence, the TPO/AO is directed to consider advances

from ARM Ltd. UK and ARM Inc., USA in the computation of working

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 32 of 78

capital adjustment and rework the same. This ground is allowed for statistical purposes.

the Act. In computing the deduction, the assessee had not reduced travel expenses of Rs.97,89,659 and telecommunication charges Rs. 14,62,515

from export turnover as, according to the assessee, no part of the

expenditure was attributable to the delivery of software outside India. The Assessing Officer, however, proceeded to recompute the deduction by

reducing the said amounts from export turnover but not from total turnover and thereby disallowed the 10A deduction to the extent of Rs.16,05,774/-.

The assessee’s submission is that no part of the above expenditure was

attributable to the delivery of software outside India and in the alternative, if the same is reduced from export turnover it should also be reduced from

total turnover. On the alternative submission, reliance was placed upon the decision of the Hon’ble High Court of Karnataka in CIT v. Tata Elxsi Ltd

[2012] 349 ITR 98 (Kar). In this judgment, it has been held that whatever is excluded from the export turnover, has also to be excluded from the total

turnover. Accordingly, we direct the AO to recompute the deduction u/s.

10A in respect of travel expenses and telecommunication charges by reducing the same from total turnover also.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 33 of 78 A.Y. 2007-08

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 34 of 78

(a) the income from onsite activities of 4 companies were more than 75% of the export revenues;

(b) 3 companies were found to be functionally dissimilar;

(c) RPT exceeded 25% of sales in respect of 3 companies;

(d) Export earnings of 2 companies were less than 25% of revenues;

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 35 of 78 (e) 1 company had diminishing revenues and predominantly onsite activities;

(f) 1 company on account of different year ending and employees cost being less than 25% of revenues;

(g) No financial data for FY 2006-07 was available for 1 company; and

(h) Another company had abnormal profitability.

Sl. Name of the company Mark up (% age) No. Unadjusted WC

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 36 of 78

as follows:-

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 37 of 78 46. The assessee has raised the following additional grounds of appeal in continuation of the existing grounds:-

“7. That, Accel Transmatics Ltd., E-Zest Solutions Ltd., Helios & Matheson Information Technology Ltd., Quintegra Solutions Ltd. and Thirdware Solutions Ltd. ought to stand rejected in view of them being functionally dissimilar to the appellant. 8. That, iGate Global Solutions Ltd., Mindtree Ltd. and Sasken Communication Technology Ltd. ought to stand rejected in view of their turnovers being Rs.747.27 crores, Rs.590.35 crores and Rs.343.57 crores respectively, and thus beyond the upper limit of Rs.200 crores by applying the turnover filter, as is consistently being held by this Hon’ble Tribunal. 9. That Persistent Systems Ltd. ought to stand rejected in view of it being functionally dissimilar to the Appellant and also in view of its turnover being Rs.293.75 crores and thus beyond the upper limit of Rs.200 crores by applying the turnover filter, as is consistently being held by this Tribunal.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 38 of 78

“18. As far as Sl.No.16 viz., Megasoft is concerned, only software services segment margin is to be taken as held by this Tribunal in the

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 39 of 78 case of Trilogy E-business Software India Pvt. Ltd. (supra). The relevant observations of the Tribunal are at paragraphs 24 to 38 of the order of the Tribunal in that case which reads as under:- (3) Improper selection of comparables (a) Megasoft Ltd. : 24. This company was chosen as a comparable by the TPO. The objection of the assessee is that there are two segments in this company viz., (i) software development segment, and (ii) software product segment. The Assessee is a pure software services provider and not a software product developer. According to the Assessee there is no break up of revenue between software products and software services business on a standalone basis of this comparable. The TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius- BCGI Division does the business of product software. This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product software would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to product software) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO’s filter of more than 75% of revenues from software development services. The basis on which the TPO arrived at the PLI of 60.23% is given at page-115 and 116 of the order of the TPO. It is clear from the perusal of the same

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 40 of 78 that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data. 25. In the order of the TPO, operating margin was computed for this company at 60.23%. It is the complaint of the assessee that the operating margins have been computed at entity level combining software services and software product segments. It was submitted that the product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions on page 381 to 383 of the PB-I). It was further submitted that Megasoft Limited has provided segmental break-up between the software services segment and software product segment (page 68 of PB-II), which was also adopted by the TPO in his show cause notice (Page 84 of PB-I). The segmental results i.e., results pertaining to software services segment of this company was: Segmental Operating Revenues Rs.63,71,32,544 Segmental Operating Expenses Rs.51,75,13,211 Operating Profit Rs.11,96,19,333 OP/TC (PLI) 23.11% 26. It was reiterated that in the given circumstances only PLI of software service segment viz., 23.11% ought to have been selected for comparison. 27. It was further submitted that the learned TPO in case of other comparable, similarly placed, had adopted the margins of only the software service segment for comparability purposes. Consistent with such stand, it was submitted that the margins of the software segment only should be adopted in the case of Megasoft also, in contrast to the entity level margins. 28. The margins at entity level and segment level of other comparables considered by the TPO in his first show cause notice were as follows (page 382 of PB-I):

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 41 of 78

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 42 of 78 ITAT in the case of Emersons & Process Management India Pvt. Ltd. v. Addl. CIT 13 Taxmann.com 149. 31. The learned DR relied on the order of the TPO and the DRP on this aspect. 32. We have considered the rival submissions. First we will consider the submission of the Assessee that companies with abnormal margins should not be regarded as comparable. In the case of Quark Systems Pvt. Ltd. (supra), the Special Bench had to deal with cases where the results were abnormal. The special Bench observed as follows: “Even if the taxpayer or its counsel had taken Datamatics as comparable in its T.P. audit, the taxpayer is entitled to point out to the Tribunal that above enterprise has wrongly been taken as comparable. In fact there are vast differences between tested party and the Datamatics. The case of Datamatics is like that of "Imercius Technologies" representing extreme positions. If Imercius Technologies has suffered heavy losses and, therefore, it is not treated as comparable by the tax authorities, they also have to consider that the Datamatics has earned extraordinary profit and has a huge turnover, besides differences in assets and other characteristics referred to by Shri Aggarwal.” The above observations of the special Bench is a pointer to the fact that where there are extraordinary profits and those companies are considered by the TPO for comparability but loss making companies are not considered as comparable, that would improper. The Tribunal found that such contradiction in approach should not be permitted. Similarly in the case of M/S. Sap Labs India Pvt. Ltd. 2010-TII-44-ITAT Bang-TP had observed as follows: “86. At the cost of repetition, we have to say that extreme cases should not be included in samples and extreme comparables mean not only the positive higher side but also the lower side. In the list of 22 comparables, many of them are having very low margin

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 43 of 78 rate, not only less than 10 or 5, even below that. We have already considered that the agreement entered into by the assessee with its German associate concern has contemplated a compensation of cost plus 6 per cent, or 1.5 times of the total wages bill, whichever is higher. This point we have to consider in the light of the fact that the assessee is working in a risk mitigated environment. That is why we have agreed with the argument of the assessee-company that there may not be extreme profits in the case of the assessee. When extremes are excluded from the samples, all sorts of extremes should be avoided. Otherwise, samples selected for comparative study may not be representative.” 33. Even in the aforesaid decision the point that has been emphasized is that when the margins of comparable companies are either extremely low or high, the approach should be to eliminate both and not consider only the high or low margin comparables as it suits either the TPO or the Assessee. 34. As far as the provisions of the Act are concerned, they lay down that the comparable companies should be functionally comparable to the tested party. There are no specific standards of comparability on the basis of abnormal profits or loss. Rule 10B(2) provides that 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;

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 44 of 78 (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. 35. There is therefore no bar to considering companies with either abnormal profits or abnormal losses as comparable to the tested party, as long as they are functionally comparable. The OECD guidelines and in US TP regulations, this question may not arise at all because those regulations advocate the quartile method for determining ALP. Indian regulations specifically deviate from OECD guidelines and provide Arithmetic Mean method for determining ALP. In the quartile method, companies that fall in the extreme quartiles get excluded and only those that fall in the middle quartiles are reckoned for comparability. Hence, cases of either abnormal profits or losses (which are referred to as outliners) get automatically excluded. In the arithmetic mean method, all companies that are in the sample are considered, without exception and the average of all the companies are considered as the ALP. Hence, a general rule that companies with abnormal profits should be excluded may be in tune with the principles enunciated in OECD guidelines but cannot be said to be in tune with Indian TP regulations. However, if there are specific reasons for abnormal profits or losses or other general reasons as to why they should not be regarded as comparables, then they can be excluded for comparability. It is for the Assessee to demonstrate existence of abnormal factors. 36. In the present case factors for abnormal profits have not been highlighted by the Assessee. In such circumstances it is not possible to accept the submission of the Assessee to exclude this company for the purpose of comparison. 37. The next plea of the Assessee is that if at all this company is considered as a comparable then the segmental margin of 23.11% (which is the margin for software service segment) alone should be considered for comparability. On the above submission, we find that the TPO considered the segmental margin (Software service segment) in the case of Geometric, Kals

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 45 of 78 Info systems, R Systems, Sasken Communication and Tata Elxsi. Before DRP the Assessee pointed out that the segmental margin of 23.11% alone should be taken for comparability. The DRP has not given any specific finding on the above plea of the Assessee. Perusal of the order of the TPO shows that the TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius- BCGI Division does the business of product software (developing software). This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product software (software developed) would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to software development) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO’s filter of more than 75% of revenues from software development services. Having drawn the above conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. In terms of Rule 10B(3)(b) of the Rules, 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 paid in,

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 46 of 78 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.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 47 of 78

(i) Accel Transmatic Ltd. (Seg.)

(ii) Avani Cincom Technologies Ltd.

(iii) Celestial Labs Ltd.

(iv) E-Zest Solutions Ltd.

(v) Helios & Matheson Information Technology Ltd.

(vi) KALS Information Systems Ltd.

(vii) Lucid Software Ltd.

(viii) Quintegra Solutions Ltd.

(ix) Thirdware Solutions Ltd. (Seg.)

“18. As far as comparable companies listed at Sl.No.1,2,3 and 12 of the final list of comparable companies chosen by the TPO viz., M/S.Accel

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 48 of 78 Transmatic Limited (seg.), Avani Cincom Technologies Ltd., Celestial labs Limited and KALS Infosystems Ltd., are concerned, this Tribunal in the case of First Advantage Offshore Services Pvt.Ltd. Vs. DCIT IT (TP) No.1086/Bang/2011 for AY 07-08 held that the aforesaid companies are not comparable companies in the case of software development services provider. The nature of services rendered by the Assessee in this appeal and the Assessee in the case of First Advantage Offshore Services Pvt.Ltd.(supra) are one and the same. This fact would be clear from the fact that the very same 26 companies were chosen as comparable in the case of the Assessee as well as in the case of First Advantage Offshore Services Pvt.Ltd.(supra). In coming to the aforesaid conclusion, the Tribunal in the case of First Advantage Offshore Services Pvt.Ltd.(supra) followed the decision rendered in the case of Trilogy E-Business Software India Pvt.Ltd. Vs. DCIT ITA No.1064/Bang/2011 for AY 07-08 order dated 23.11.2012. The following were the relevant observations in the case of First Advantage Offshore Services Pvt.Ltd.(supra): “18. As regards the group 2 companies which are to be excluded as functionally different based on the Tribunal’s order in the case of Trilogy E-Business Software India Pvt.Ltd., we find that these companies are- 1) Accel Transmatic 2) Avani Cimcon Technologies Ltd. 3) Celestial Labs Ltd. 4) KALS Information Systems Ltd. 19. The Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd., while considering the issue of improper selection of comparables has held as under:

“(b) Avani Cimcon Technologies Ltd. 39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company’s website, which reveals that this company has developed a

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 49 of 78 software product by name “DXchange”, it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT – ITA No.7821/Mum/2011 wherein the Tribunal accepted the assessee’s contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- “7.8 Avani Cincom Technologies Ltd. (‘Avani Cincom’): Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis.” It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures were placed before us:- Particulars FYs 05-06 06-07 07-08 08-09 Operating Revenue 21761611 35477523 29342809 28039851 Operating Expns. 16417661 23249646 23359186 31108949 Operating Profit 5343950 12227877 5983623 (3069098) Operating Margin 32.55% 52.59% 25.62% - 9.87%

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 50 of 78 40. It was submitted that this company has made unusually high profit during the financial year 06-07. The operating revenues increased 63.03% which indicates that it was an extraordinary year for this company. Even the growth of software industry for the previous year as per NASSCOM was 32%. The growth rate of this company was double the industry average. In view of the above, it was argued that this company ought to have been rejected as a comparable. 41. We have given a careful consideration to the submissions made on behalf of the Assessee and are of the view that the same deserves to be accepted. The reasons given by the Assessee for excluding this company as comparable are found to be acceptable. The decision of ITAT (Mumbai) in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra) also supports the plea of the assessee. We therefore accept the plea of the Assessee to reject this company as a comparable.

(c) Celestial Labs Ltd. 42. As far as this company is concerned, the stand of the assessee is that it is absolutely a research & development company. In this regard, the following submissions were made:- i. In the Director’s Report (page 20 of PB-Il), it is stated that “the company has applied for Income Tax concession for in-house R&D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act.” ii. As per the Notes to Accounts - Schedule 15, under “Deferred Revenue Expenditure” (page 31 of PB-II), it is mentioned that, “Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred.” An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as “Deferred Revenue

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 51 of 78 Expenditure” (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R&D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT – ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: “The learned D.R. however drew our attention to page- 389 of the paper book which is an extract from the Directors report which reads as follows: ‘The Company has developed a de novo drug design tool “CELSUITE” to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Technology New Delhi) based on our insilico expertise (applying bio-informatics tools). The Company has developed a molecule to treat Leucoderma and multiple cancer and protected the IPR by filing the patent. The patent details have been discussed with Patent officials and the response is very favorable. The cloning and purification under wet lab procedures are under progress with our collaborative Institute, Department of Microbiology, Osmania University, Hyderabad. In the industrial biotechnology area, the company has signed the Technology transfer agreement with IMTECH CHANDIGARH (a very reputed CSIR organization) to manufacture and market initially two Enzymes, Alpha Amylase and Alkaline Protease in India and overseas. The company is planning to set up a biotechnology facility to manufacture industrial enzymes. This facility would also include the research laboratories

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 52 of 78 for carrying out further R & D activities to develop new candidates’ drug molecules and license them to Interested Pharma and Bio Companies across the GLOBE. The proposed Facility will be set up in Genome Valley at Hyderabad in Andhra Pradesh.’ According to the learned D.R. celestial labs is also in the field of research in pharmaceutical products and should be considered as comparable. As rightly submitted by the learned counsel for the Assessee, the discovery is in relation to a software discovery of new drugs. Moreover the company also is owner of the IPR. There is however a reference to development of a molecule to treat cancer using bio-informatics tools for which patenting process was also being pursued. As explained earlier it is a diversified company and therefore cannot be considered as comparable functionally with that of the Assessee. There has been no attempt made to identify and 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 adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard.’ ” 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for discovery of new drugs and has developed molecule to treat cancer. In the ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 53 of 78 TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the segmental data for each activity is not available and therefore this company should not be treated as comparable. Besides the above, the Assessee has point out to several references in the annual report for 31.3.2007 highlighting the fact that this company was develops biotechnology products and provides related software development services. The TPO called for segmental data at the entity level from this company. The TPO also called for description of software development process. In response to the request of the TPO this company in its reply dated 29.3.2010 has given details of employees working in software development but it is not clear as to whether any segmental data was given or not. Besides the above there is no other detail in the TPO’s order as to the nature of software development services performed by the Assessee. Celestial labs had come out with a public issue of shares and in that connection issued Draft Red Herring Prospectus (DRHP) in which the business of this company was explained as to clinical research. The TPO wanted to know as to whether the primary business of this company is software development services as indicated in the annual report for FY 06-07 or clinical research and manufacture of bio products and other products as stated in the DRHP. There is no reference to any reply by Celestial labs to the above clarification of the TPO. The TPO without any basis has however concluded that the business mentioned in the DRHP are the services or businesses that would be started by utilizing the funds garnered though the Initial Public Offer (IPO) and thus in no way connected with business operations of the company during FY 06-07. We are of the view that in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 54 of 78

“26. As far as comparable companies at Sl.No.5, 18, 19 and 25 of the final list of comparable companies chosen by the TPO are concerned, viz., M/S. E-Zest Solutions Ltd., Persistent Systems Ltd., Quintegra Solutions Limited and Third ware Solutions Ltd., this Tribunal in the case of 3DPLM Software Solutions Ltd. I.T (T.P) A.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 55 of 78 No.1303/Bang/2012 (Assessment Year : 2008-09) order dated 28.11.2013 was pleased to hold that the aforesaid companies are not comparable with a company engaged in Software Development Services such as the Assessee. The following were the relevant observations of the Tribunal: “14. E-Zest Solutions Ltd. 14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the information received in response to notice under section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company ought to be excluded from the list of comparables on the ground that it is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in ‘e-Business Consulting Services’, consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised Representative contends, are high end ITES normally categorised as knowledge process Outsourcing (‘KPO’) services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that since the Annual Report of the company does not contain detailed descriptive information on the business of the company, the assessee places reliance on the details available on the company’s website which should be considered while evaluating the company’s functional profile. It is also submitted by the learned Authorised Representative that KPO services are not comparable to software development services and therefore companies rendering KPO services ought not to be considered as comparable to software development companies and relied on the decision of the co-ordinate bench in the case of Capital IQ Information Systems (India) (P) Ltd. in ITA No.1961(Hyd)/2011 dt.23.11.2012 and prayed that in view of the above reasons, this

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 56 of 78 company i.e. e-Zest Solutions Ltd., ought to be omitted from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparables by the TPO. 14.4 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the record that the TPO has included this company in the list of comparbales only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act. It appears that the TPO has not examined the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I-Q Information Systems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O. /TPO is accordingly directed. 15. Thirdware Solutions Ltd. (Segment) 15.1 This company was proposed for inclusion in the list of comparables by the TPO. Before the TPO, the assessee objected to the inclusion of this company in the list of comparables on the ground that its turnover was in excess of Rs.500 Crores. Before us, the assessee has objected to the inclusion of this company as a comparable for the reason that apart from software development services, it is in the business of product development and trading in software and giving licenses for use of software. In this regard, the learned Authorised Representative submitted that :-

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 57 of 78 (i) This company is engaged in product development and earns revenue from sale of licences and subscription. It has been pointed out from the Annual Report that the company has not provided any separate segmental profit and loss account for software development services and product development services. (ii) In the case of E-Gain communications Pvt. Ltd. (2008-TII- 04-ITAT-PUNE-TP), the Tribunal has directed that this company be omitted as a comparable for software service providers, as its income includes income from sale of licences which has increased the margins of the company. The learned A.R. prayed that in the light of the above facts and in view of the afore cited decision of the Tribunal (supra), this company ought to be omitted from the list of comparables. 15.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 15.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the case of E-Gain Communications Pvt. Ltd. (supra) has directed that since the income of this company includes income from sale of licenses, it ought to be rejected as a comparable for software development services. In the case on hand, the assessee is rendering software development services. In this factual view of the matter and following the afore cited decision of the Pune Tribunal (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand. 17. ………

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 58 of 78 18. Quintegra Solutions Ltd. 18.1 This case was selected by the TPO as a comparable. Before the TPO, the assessee objected to the inclusion of this company in the set of comparables on the ground that this company is functionally different and also that there were peculiar economic circumstances in the form of acquisitions made during the year. The TPO rejected the assessee's objections holding that this company qualifies all the filters applied by the TPO. On the issue of acquisitions, the TPO rejected the assessee's objections observing that the assessee has not adduced any evidence as to how this event had an any influence on the pricing or the margin earned. 18.1.2 Before us, the assessee objected to the inclusion of this company for the reason that it is functionally different and also that there are other factors for which this company cannot be considered as a comparable. It was submitted that, (i) Quintegra solutions Ltd., the company under consideration, is engaged in product engineering services and not in purely software development services. The Annual Report of this company also states that it is engaged in preparatory software products and is therefore not similar to the assessee in the case on hand. (ii) In its Annual Report, the services rendered by the company are described as under : “ Leveraging its proven global model, Quintegra provides a full range of custom IT solutions (such as development, testing, maintenance, SAP, product engineering and infrastructure management services), proprietary software products and consultancy services in IT on various platforms and technologies.” (iii) This company is also engaged in research and development activities which resulted in the creation of Intellectual Proprietary Rights (IPRs) as can be evidenced from the statements made in the Annual Report of the company for the period under consideration, which is as under :

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 59 of 78 “ Quintegra has taken various measures to preserve its intellectual property. Accordingly, some of the products developed by the company …………… have been covered by the patent rights. The company has also applied for trade mark registration for one of its products, viz. Investor Protection Index Fund (IPIF). These measures will help the company enhance its products value and also mitigate risks.” (iv) The TPO has applied the filter of excluding companies having peculiar economic circumstances. Quintegra fails the TPO’s own filter since there have been acquisitions in this case, as is evidenced from the company’s Annual Report for F.Y. 2007-08, the period under consideration. The learned Authorised Representative prays that in view of the submissions made above, it is clear that inter alia, this company i.e. Quintegra Solutions Ltd. being functionally different and possessing its own intangibles / IPRs, it cannot be considered as a comparable to the assessee in the case on hand and therefore ought to be excluded from the list of comparables for the period under consideration. 18.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables to the assessee for the period under consideration. 18.3.1 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details brought on record that this company i.e.Quintegra Solutions Ltd. is engaged in product engineering services and is not purely a software development service provider as is the assessee in the case on hand. It is also seen that this company is also engaged in proprietary software products and has substantial R&D activity which has resulted in creation of its IPRs. Having applied for trade mark registration of its products, it evidences the fact that this company owns intangible assets. The co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010 dt.9.11.2012) has held that if a company possesses or owns intangibles or IPRs, then it cannot be considered as a comparable company to one that does not own

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 60 of 78 intangibles and requires to be omitted form the list of comparables, as in the case on hand. 18.3.2 We also find from the Annual Report of Quintegra Solutions Ltd. that there have been acquisitions made by it in the period under consideration. It is settled principle that where extraordinary events have taken place, which has an effect on the performance of the company, then that company shall be removed from the list of comparables. 18.3.3 Respectfully following the decision of the co-ordinate bench of the Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (supra), we direct that this company i.e. Quintegra Solutions Ltd. be excluded from the list of comparables in the case on hand since it is engaged in proprietary software products and owns its own intangibles unlike the assessee in the case on hand who is a software service provider. 27. ……… 28. As far as comparable chosen by the TPO at Sl.No.8 of the final list of comparable viz., M/S. Helios & Matheson Information Technology Ltd., we find that the said company has been held to be not comparable with a software service provider like the Assessee by the ITAT Pune Bench in the case of PTC Software (India)Pvt.Ltd. ITA.No.1605/PN/2011 (Asstt. Year : 2007-08) order dated 30.4.2013. The following were the relevant observations of the Tribunal: “16. The next point made out by the assessee is with regard to the inclusion of items at (9) and (11) namely Helios & Matheson Information Technology Ltd., and KALS Information Solutions Ltd. (Seg). The primary plea raised by the assessee to assail the inclusion of the aforesaid two companies from the list of comparables is to be effect that they are functionally incomparable and therefore, are liable to be excluded. In sum and substance, the plea set up by the assessee is that both the aforesaid concerns are engaged in development and sale of software products which is functionally different from the services undertaken by the assessee in its IT-services segment. 17. As per the discussion in para 6.3.2. of the order of the TPO, the reason advanced for including KALS Information

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 61 of 78 Systems Ltd., is to the effect that the said concern’s application software segment is engaged in the development of software which can be considered as comparable to the assessee company. The said concern is engaged in two segments namely application software segment and Training. As per the TPO, the application software segment is functionally comparable to the assessee as the said concern is engaged in software services. The stand of the assessee is that a perusal of the Annual Report of the said concern for F.Y. 2006-07 reveals that the application software segment is engaged in the business of sale of software products and software services. The assessee pointed out this to the TPO in its written submissions, copy of which is placed in the Paper book at page 420.3 to 420.4. The assessee further pointed out that there was no bifurcation available between the business of sale of software products and the business of software services, and therefore, it was not appropriate to adopt the application software segment of the said concern for the purposes of comparability with the assessee’s IT-Services Segment. The TPO however, noticed that though the application software segment of the said concern may be engaged in selling of some of the software products which are developed by it, however, the said concern was not into trading of software products as there were no cost of purchases debited in the Profit & Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessee’s segment of IT-Services. 18. Before us, apart from reiterating the points raised before the TPO and the DRP, the Ld. Counsel submitted that in the immediately preceeding assessment year of 2006-07, the said concern was evaluated by the assessee and was found functionally incomparable. For the said purpose, our reference has been invited to pages 421 to 542 of the Paper book, which is the copy of the Transfer Pricing study undertaken by the assessee for the A.Y. 2006-07, and in particular, attention was invited to page 454 where the accept reject matrix undertaken by the assessee reflected KALS Information Solutions Ltd. (Seg) as functionally incomparable. The Ld. Counsel pointed out that the aforesaid position has been accepted by the TPO in the earlier

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 62 of 78 A.Y. 2006-07 and therefore, there was no justification for the TPO to consider the said concern as functionally comparable in the instant assessment year. 19. In our considered opinion, the point raised by the assessee is potent in as much as it is quite evident that the said concern has not been found to be functionally comparable with the assessee in the immediately preceding assessment year and in the present year also, on the basis of the Annual Report, referred to in the written submissions addressed to the lower authorities, the assessee has correctly asserted out that the said concern was inter alia engaged in sale of software products, which was quite distinct from the activity undertaken by the assessee in the IT Services segment. At the time of hearing, neither is there any argument put forth by the Revenue and nor is there any discussion emerging from the orders of the lower authorities as to in what manner the functional profile of the said concern has undergone a change from that in the immediately preceding year. Therefore, having regard to the factual aspects brought out by the assessee, it is correctly asserted that the application software segment of the said concern is not comparable to the assessee’s segment of IT services. 20. With regard to the inclusion of Helios & Matheson Information Technology Ltd., the assessee has raised similar arguments as in the case of KALS Information Solutions Ltd. (Seg). We have perused the relevant para of the order of the TPO i.e., 6.3.21, in terms of which the said concern has been included as a comparable concern. The assessee pointed out that as in the case of KALS Information Solutions Ltd. (Seg), in the instant case also for A.Y. 2006-07 the said concern was found functionally incomparable by the assessee in its Transfer pricing study and the said position was not disturbed by the TPO. The relevant portion of the Transfer pricing study, placed at page 432 of the Paper book has been pointed out in support. Considered in the aforesaid light, on the basis of the discussion in relation to KALS Information Solutions Ltd. (Seg), in the instant case also we find that the said concern is liable to be excluded from the list of comparables.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 63 of 78

Technology Ltd., Quintegra Solutions Ltd. and Thirdware Solutions Ltd. (Seg) from the final list of comparable companies for the purpose of

determining ALP, following the decision of the Tribunal in the case of NXP Semiconductors India Pvt. Ltd., (supra).

Ltd. (Seg). selected by the TPO as a comparable has to be excluded as its RPT exceeds 15% in view of the decision of the Tribunal in the case of

24/7 Customer.Com Pvt. Ltd. in ITA No.227/Bang/2010 and Logical Pvt.

Ltd. (supra).

(supra) has held that the RPT of Geometric Ltd. exceeds 15% and such company should not be taken as a comparable. The relevant observations

of the Tribunal have been extracted at para 22 of this order while dealing

with A.Y. 2006-07. Following the aforesaid decision, Geometric Ltd. is directed to be excluded from the list of comparables for A.Y. 2007-08.

the decision of the coordinate Bench of this Tribunal in the case of Cypress Semiconductor India P. Ltd. (supra), we have already held at paras 20 & 21

hereinabove that the companies viz., iGate Global Solutions Ltd. (Seg.),

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 64 of 78

Mindtree Consulting Ltd., Sasken Communication Ltd. (Seg.) and Flextronics Software Systems Ltd., having turnover exceeding Rs.200

crores be excluded from the final list of comparables selected by the TPO. Accordingly, Flextronics Ltd. is directed to be excluded from the list of

comparables for the A.Y. 2007-08. The other 3 companies viz., iGate Global Solutions Ltd. (Seg.), Mindtree Consulting Ltd. and Sasken

Communication Ltd. (Seg.) sought for exclusion by the assessee by way of

additional grounds are set aside to the file of the Assessing Officer to decide whether these are to be excluded from the final list of comparables

on the turnover filter exceeding Rs.200 crores, following the decisions of Trilogy E-Business Software India Pvt. Ltd. (ITA No.1054/Bang/2011) and

Cypress Semiconductor India P. Ltd. v. DCIT, ITA No.1167/Bang/2010

dated 27.03.2015.

Technologies Limited, Tata Elxsi Ltd. (Seg.) & Wipro Limited are concerned, the ld. counsel for the assessee submitted that these

companies have to be excluded on application of more than one filter.

These companies are functionally dissimilar in view of the decision of this Tribunal in the case of NXP Semiconductors India Pvt. Ltd. (supra) and

M/s. Curam Software International Pvt. Ltd. Vs. ITO ITA No.1280/Bang/2012 for AY 08-09 order dated 31.7.2013, wherein it was

held that the aforesaid companies are not comparable companies in the

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 65 of 78 case of software development services provider. The following were the relevant observations in the case of M/S.Curam Software International Pvt.Ltd.(supra):-

“12. (4) Infosys Technologies Ltd.

12.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment.

12.2 Before us, the assessee contended that this company is not functionally comparable to the assessee and in this context has cited various portions of the Annual Report of this company to this effect which is as under :-

(i) The company has an Intellectual Property (IP) Cell to guide its employees to leverage the power of IP for their growth. In 2008, this company generated over 102 invention disclosures and filed an aggregate 10 patents in India and the USA. Till date this company has filed an aggregate of 119 patent applications (pending) in India and USA out of which 2 have been granted in the US.

(ii) This company has substantial revenues from software products and the break-up of the software product revenues is not available.

(iii) This company has incurred huge research and development expenditure to the tune of approximately Rs.200 Crores.

(iv) This company has a revenue sharing agreement towards acquisition of IPR in AUTOLAY, a commercial software product used in designing high performance structural systems.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 66 of 78 (v) The assessee also placed reliance on the following judicial decisions:- (a) ITAT, Delhi Bench decision in the case of Agnity India Technologies India Pvt. Ltd. (ITA No.3856/Del/2010) and (b) Trilogy E-Business Software India Pvt. Ltd. (ITA No.1054/Bang/2011) 12.3 Per contra, opposing the contentions of the assessee, the learned Departmental Representative submitted that comparability cannot be decided merely on the basis of scale of operations and the operating margins of this company have not been extraordinary. In view of this, the learned Departmental Representative supported the decision of the TPO to include this company in the list of comparable companies. 12.4 We have heard the rival submissions and perused and carefully considered the material on record. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy E- Business Software India Pvt. Ltd. (supra) for Assessment Year 2007-08 is applicable to this year also. The argument put forth by assessee's is that Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the break up of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly.

13.0 (5) Wipro Limited 13.1 This company was selected as a comparable by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables or several grounds like functional dis-similarity, brand value, size, etc. The TPO, however, brushed aside the objections of the assessee and included this company in the set of comparables.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 67 of 78 13.2 Before us, the assessee contended that this company is functionally not comparable to the assessee for several reasons, which are as under : (i) This company owns significant intangibles in the nature of customer related intangibles and technology related intangibles and quoted extracts from the Annual Report of this company in the submissions made. (ii) The TPO had adopted the consolidated financial statements for comparability purposes and for computing the margins, which contradicts the TPO’s own filter of rejecting companies with consolidated financial statements. 13.3. Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables. 13.4.1 We have heard both parties and carefully perused and considered the material on record. We find merit in the contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison. 13.4.2 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010) has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any such intangible and hence does not have an additional advantage in the market. As the assessee in the case on hand does not own any intangibles, following the aforesaid decision of the co-ordinate bench of the Tribunal i.e. 24/7 Customer.Com Pvt. Ltd. (supra), we hold that this

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 68 of 78 company cannot be considered as a comparable to the assessee. We, therefore, direct the Assessing Officer/TPO to omit this company from the set of comparable companies in the case on hand for the year under consideration. 14.0 (6) Tata Elxsi Ltd. 14.1 This company was a comparable selected by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables on several counts like, functional dis-similarity, significant R&D activity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of comparables. 14.2 Before us, it was reiterated that this company is not functionally comparable to the assessee as it performs a variety of functions under the software development and services segment namely (a) Product design services (b) Innovation design engineering and (c) visual computing labs. In the submissions made the assessee had quoted relevant portions from the Annual Report of the company to this effect. In view of this, the learned Authorised Representative pleaded that this company be excluded from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the stand o the TPO in including this company in the list of comparables. 14.4.1 We have heard both parties and carefully perused and considered the material on record. From the details on record, we find that this company is predominantly engaged in product designing services and not purely software development services. The details in the Annual Report show that the segment “software development services” relates to design services and are not similar to software development services performed by the assessee. 14.4.2 The Hon'ble Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. V ACIT (ITA No.7821/Mum/2011) has

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 69 of 78 held that Tata Elxsi Ltd. is not a software development service provider and therefore it is not functionally comparable. In this context the relevant portion of this order is extracted and reproduced below :- “ …. Tata Elxsi is engaged in development of niche product and development services which is entirely different from the assessee company. We agree with the contention of the learned Authorised Representative that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company as fit for comparability analysis for determining the arm’s length price for the assessee, hence, should be excluded from the list of comparable portion.”

As can be seen from the extracts of the Annual Report of this company produced before us, the facts pertaining to Tata Elxsi have not changed from Assessment Year 2007-08 to Assessment Year 2008-09. We, therefore, hold that this company is not to be considered for inclusion in the set of comparables in the case on hand. It is ordered accordingly.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 70 of 78 aside to the Assessing Officer to examine whether this company having turnover exceeding Rs.200 crores is to be excluded from the final list of comparables selected by the TPO in the light of decision of the coordinate Bench of this Tribunal in the case of Cypress Semiconductor India P. Ltd. (ITA No.1167/Bang/2010 dated 27.03.2015). Accordingly, for the present AY 2007-08 also, the issue is set aside to the file of the Assessing Officer with similar observations.

“20. As far as comparable companies listed at Sl.No.11 & 14 of the final list of comparable companies chosen by the TPO viz., M/S.Ishir Infotech Ltd. And Lucid Software Ltd., is concerned, this Tribunal in the case of First Advantage Offshore Services Pvt.Ltd. Vs. DCIT IT (TP) No.1086/Bang/2011 for AY 07-08 held that the aforesaid companies are not comparable companies in the case of software development services provider. The nature of services rendered by the Assessee in this appeal and the Assessee in the case of First Advantage Offshore Services Pvt.Ltd.(supra) are one and the same. This fact would be clear from the fact that the very same 26 companies were chosen as comparable in the case of the Assessee as well as in the case of First Advantage Offshore Services Pvt.Ltd.(supra). The following were the relevant observations in the case of First Advantage Offshore Services Pvt.Ltd.(supra): 22. The learned counsel for the assessee submitted that these two companies are also to be excluded from the list of comparables on the basis of the finding of this Tribunal in the

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 71 of 78 case of Mercedes Benz Research & Development India Pvt. Ltd. dt 22.2.2013, wherein at pages 17 and 22 of its order the distinctions as to why these companies should be excluded are brought out. He submitted that the facts of the case before us are similar and, therefore, the said decision is applicable to the assessee's case also. 23. The learned DR however objected to the exclusion of these two companies from the list of comparables. On a careful perusal of the material on record, we find that the Tribunal in the case of Mercedes Benz Research & Development India Pvt. Ltd. (cited supra) has taken a note of dissimilarities between the assessee therein and Lucid Software Ltd. As observed therein Lucid Software Ltd. company is also involved in the development of software as compared to the assessee, which is only into software services. Similarly, as regards Ishir Infotech Ltd., the Tribunal has considered the decision of the Tribunal in the case of 24/7 Co. Pvt. Ltd to hold that Ishir Infotech is also out-sourcing its work and, therefore, has not satisfied the 25% employee cost filter and thus has to be excluded from the list of comparables. As the facts of the case before us are similar, respectfully following the decision of the co-ordinate bench, we hold that these two companies are also to be excluded.”

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 72 of 78

software development services are as follows:-

assessee company would be within the range of + / - 5% of the arithmetical mean and if so, the TP adjustment made by the TPO is liable to be set

aside. Accordingly we set aside the issue to the file of AO for

determination of NCP margin.

inclusion of reimbursement of expenses in the operating cost as well as

operating revenue of the assessee company. The TPO has included the reimbursement of expenses received amounting to Rs. 2,935,123/- as part

of the cost base for applying the adjusted operating cost plus markup. In

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 73 of 78

this regard, the assessee submitted that the reimbursement of expenses received by the Company was incurred by it on behalf of its AEs, following

the policy of reimbursing such expenses on cost to cost basis and no services have been rendered by the assessee in relation to the

reimbursements, therefore, reimbursements purely relate to third party expenses incurred on behalf of the AEs. It was submitted that the Company

had received reimbursement of these expenses at cost from its AEs and

consequently, the amount received/receivable is deemed to be the arm’s length price.

assessee argued that even if the reimbursement of expenses received was considered in both operating income and expense, the NCP margin of the

assessee would be 11.41% which is within the range of + / - 5% of the arithmetical mean of comparable companies as under:-

Operating Income (including reimbursement of Rs.2,935,123) 524,740,693 Operating Expenses (including reimbursement of Rs.2,935,123) 470,998,591 Operating Profit (OP. Income – Op. Expenses) 25,517,383 Operating/Net Margin (OP/TC) 11.41%

company has received reimbursement of these expenses as cost from its

AE and consequently the amount received/receivable is deemed to be at arm’s length price. Hence this ground of appeal is allowed.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 74 of 78

mean for software development services is achieved by applying working capital adjustment as computed by the TPO, the AO/TPO erred in not

considering the advances received from the customers as part of trade payables in determination of working capital adjustment and thereby erred

in not providing an appropriate adjustment towards working capital. It was

submitted that in the TP order, the TPO has determined the arm’s length markup as 23.70% (after working capital adjustment of 1.44%) for software

development services provided by the assessee. However, the TPO has not considered advances from ARM Ltd. UK and ARM Inc., USA in

computation of the working capital adjustment.

2006 at Rs. 50,29,849. The TPO has thereby not considered the advances received from ARM Ltd. UK amounting to Rs. 13,62,30,811 as on April 1,

2006 and Rs. 6,27,66,411 as on April 1, 2005 (schedule 8A of audited

financial statements — Current Liabilities). The assessee’s contention is that it receives compensation for their contractual services in advance and

subsequently adjusts these advances against the invoices raised. Given that the assessee is a captive service provider, it may choose to invest

such advances towards either purchase of assets or for incurring

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 75 of 78

expenses, but ultimately such an advance is utilized towards performing contractual services. Therefore, it was the submission of the ld. counsel for

the assessee that the advances received from its AEs should be considered as a part of trade payables in computation of working capital

adjustment. The workings for average trade payables furnished by the assessee are as follows:-

the 26 comparables selected by the TPO would be 20.38% (after working

capital adjustment of 3.33%) for software development services provided by the assessee. Based on the remaining 7 out of the 26 comparables

selected by the TPO, the assessee’s margin of 11.48% is within the +/- 5% of the working capital adjusted mean of 10.43% as computed by the TPO.

If the working capital adjustment is computed by including “Advances received from AEs” as part of trade payables, the working capital adjusted

mark-up for the above 7 comparables would be even lower.

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 76 of 78

capital adjustment. Hence, the TPO/AO is directed to consider advances from ARM Ltd. UK and ARM Inc., USA in the computation of working

capital adjustment and rework the same. This ground is allowed for statistical purposes.

Act. The assessee claimed a deduction of Rs.9,212,57,120 u/s. 10A of the Act. In computing the deduction, the assessee had not reduced travel

expenses of Rs.93,35,997 and telecommunication charges Rs. 14,36,441

from export turnover as, according to the assessee, no part of the expenditure was attributable to the delivery of software outside India. The

Assessing Officer, however, proceeded to recompute the deduction by reducing the said amounts from export turnover but not from total turnover

and thereby disallowed the 10A deduction to the extent of Rs.17,08,902. The assessee’s submission is that no part of the above expenditure was

attributable to the delivery of software outside India and in the alternative, if

the same is reduced from export turnover it should also be reduced from total turnover. On the alternative submission, reliance was placed upon the

decision of the Hon’ble High Court of Karnataka in CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Kar). In this judgment, it has been held that whatever is

excluded from the export turnover, has also to be excluded from the total

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 77 of 78 turnover. Accordingly, we direct the AO to recompute the deduction u/s. 10A in respect of travel expenses and telecommunication charges by reducing the same from total turnover also.

Pronounced in the open court on this 1st day of December, 2015.

Sd/- Sd/-

( ABRAHAM P. GEORGE ) (ASHA VIJAYARAGHAVAN ) Accountant Member Judicial Member

Bangalore, Dated, the 1st December, 2015. /D S/

IT(TP)A Nos.1112/B/10 & 1161/Bang/2011 Page 78 of 78

Copy to:

By order

Assistant Registrar, ITAT, Bangalore.