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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SMT. ASHA VIJAYARAGHAVAN & SHRI JASON P. BOAZ
O R D E R Per Asha Vijayaraghavan, Judicial Member
This appeal by the assessee is directed against the order dated 08.10.2010 passed u/s. 143(3) r.w.s. 144C of the Income-tax Act, 1961 [“the Act”] pursuant to the directions of the DRP.
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The assessee company provides software development and marketing support services for and on behalf of its parent company, SupportSoft Inc., USA. Under the master services agreement with its Associated Enterprise (AE), the assessee is remunerated at cost plus 8% for software development services. Under another services agreement between the taxpayer and its parent company SupportSoft Inc., USA, the assessee is compensated at cost plus 5% for marketing support services.
3. The transfer pricing (TP) proceedings were taken up and TP documentation contained three comparables selected by the assessee by applying certain filter and the CPM method was adopted. The TPO held at para 18.7 as follows:-
“18.7 Price Received vis-à-vis the Arms Length Price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length price as under: Arms Length Price @ 118.31% of operating cost Rs.14,46,93,444 Price shown in the international transaction Rs.13,20,83,370 Shortfall being adjustment u/s 92CA Rs. 1,26,10,074
The TPO further observed that no adverse conclusions have been drawn in respect of other international transactions. The TPO held that TNMM is the most appropriate method taking into account the facts and circumstances of the case. The TPO selected the final set of comparables as follows:-
IT(TP)A No.1340/Bang/2010 Page 3 of 25 Sl. Name of company Sales Operating No (Rs. in Margin on crores) Cost 1 Aztec Software Ltd. 128.61 18.09% 2 Geometric Software Ltd. (Seg) 98.60 6.70% 3 iGate Global Solutions Ltd. (Seg) 527.91 15.61% 4 Infosys Ltd. 9,028.00 40.38% 5 KALS Information Systems Ltd. 1.97 39.75% 6 Mindtree Consulting Ltd. 448.79 14.67% 7 Persistent Systems Ltd. 209.18 24.67% 8 R Systems International Ltd. (Seg) 79.42 22.20% 9 Sasken Communication Ltd. (Seg) 240.03 13.90% 10 Tata Elxsi Ltd. (Seg) 188.81 27.65% 11 Lucid Software 1.02 8.92% 12 Media Soft Solutions Pvt. Ltd. 1.76 6.29% 13 R S Software (India) Ltd. 91.57 15,69% 14 SIP Technologies & Exports Ltd. 6.53 3.06% 15 Bodhtree Consulting Ltd. 5.32 15.99% 16 Accel Transmatics Ltd. (Seg) 8.02 44.07% 17 Synfosys Business Solutions Ltd. 4.49 10.61% 18 Megasoft Ltd. 56.15 51.74% 19 Lanco Global Solutions Ltd. 35.63 5.27% 20 Flextronics Software Systems Ltd. 595.12 27.24% Arithmetic Mean 20.63%
The comparables selected by the assessee in the TP study with respect to software development services are as follows:-
VJIL Consulting Ltd.
2. Sankhya Infotech Ltd. 3. Foursoft Ltd.
Aggrieved, the assessee preferred appeal before the DRP against the order passed by the TPO u/s. 92CA of the Act. The revised margin of Megasoft is as per direction of the DRP at page 23 of its order.
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Consequent to the directions of the DRP, the AO passed the order revising the ALP worked out earlier by the TPO as follows:-
“The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length Price as under: Arms Length Price @ 118.25% of operation cost Rs.14,46,20,063 Price Shown in the International Transactions Rs.13,20,83,370 Shortfall being adjustment u/s. 92CA Rs. 1,25,36,693 The shortfall of Rs.1,25,36,693/- is treated as Transfer Pricing adjustment u/s. 92CA. Hence the original adjustment of Rs.1,26,10,074/- stands revised to Rs.1,25,36,693/-.”
Aggrieved, the assessee is in appeal before us.
Ground Nos. 1 to 8 are general in nature.
Ground No.9 is with respect to the TP analysis of the TPO. The ld. counsel for the assessee pointed out that the comparables viz., Aztech Software Ltd., Geometric Software Ltd. (Seg) and Megasoft Ltd. chosen by the TPO and submitted that undisputedly the related party transactions of these comparables was more than 15%. He relied on the decision of this Tribunal in the case of M/s. Huawei Technologies India Pvt. Ltd. v. ITO in IT(TP)A No.1338/Bang/2010 dated 30.4.2013, wherein it was held as under:-
“16. As far as Megasoft Ltd., Aztec Software Ltd., and Geometric Software Ltd., chosen by the TPO as comparables are concerned, It is not in dispute that the related party transactions of these comparable companies was more than 15%. This Tribunal in the case of 24/7 Customer Com Pvt. Ltd., ITA
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No.227/Bang/2010 (supra), had held that where comparables have related party transactions which are in excess of 15% of its total receipts, then such companies cannot be chosen for the purpose of comparison. Following are the relevant observations of this Tribunal:- “13.0 RELATED PARTY TRANSACTIONS In respect of the ground raised at S.No.1 regarding acceptance of comparable companies having related party transactions as proposed by the TPO, the learned counsel for the assessee argued that the transfer pricing regulations do not stipulate any minimum limit of related party transactions which form the threshold for exclusion as a comparable. In this regard, the learned counsel for the assessee objected to the TPO’s setting a limit of 25% on related party transactions. He objected to the inclusion of comparables being related party transactions in excess of 15% of sales / revenue. In support of this proposition, the learned counsel for the assessee placed reliance on the decision of the Hon'ble Bench of the ITAT, Delhi in the case of Sony India (P) Ltd. reported in 2008-TIOL-439- ITAT-Delhi dt.23.12.2008. The learned counsel for the assessee drew our attention to para 115.3 of the order wherein the Tribunal has held that - “ ...........We are further of the view that an entity can be taken as uncontrolled if its related party transactions do not exceed 10 to 15% of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of the comparables. For the purpose of comparison what is to be judged is the impact of the related party transactions vis-à-vis sales and not profit since profit of an enterprise is influenced by large number of other factors ....” Respectfully following the decision of the Tribunal in the case of Sony India (P) Ltd (supra), the Assessing Officer / TPO are directed to exclude after due verification those comparables from the list with related party transactions or controlled transactions in excess of 15% of total revenues for the financial year 2003-04.”
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17. In view of the above, the aforesaid comparable should also be excluded for the purpose of comparison while determining the ALP of the international transaction in question.”
11. Respectfully following the decision of the coordinate Bench of this Tribunal in M/s. Huawei Technologies India Pvt. Ltd. (supra), we hold that the companies viz., Aztech Software Ltd., Geometric Software Ltd. (Seg) and Megasoft Ltd. are to be excluded from the list of comparables chosen by the TPO.
12. With respect to iGate Global Solutions Ltd. (Seg); Infosys Ltd.; Mindtree Consulting Ltd.; Persistent Systems Ltd.; Sasken Communication Ltd. (Seg); and Flextronics Software Systems Ltd., the ld. counsel for the assessee submitted that these comparables selected by the TPO should be rejected on the ground that the turnover is more than Rs.200 crores. The ld. counsel for the assessee relied upon the decision of M/s. Huawei Technologies India Pvt. Ltd. (supra), wherein the relevant observations at paras 10 & 11 of the order are as follows:-
“10. Insofar as Infosys Ltd., Flextronics Software Systems Ltd., iGate Global Solutions Ltd., Mindtree Consulting Ltd., Persistent Systems Ltd., and Sasken Communication Ltd. chosen by the TPO as comparables, it is not in dispute that the turnover of these companies is more than Rs.200 crores. The turnover of the assessee in the present case is Rs.114.13 crores (approx.). It has been held by this Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) that companies with a turnover of more than Rs.200 crores cannot be taken as comparables while determining the ALP in the case of companies having turnover of less than Rs.200 crores. The following are the relevant observations of the Tribunal in this regard:-
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“(1) Turnover Filter
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.”
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
IT(TP)A No.1340/Bang/2010 Page 8 of 25 market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: “Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a Rs 1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate.”
13. It was further submitted that the TPO’s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies.
14. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, wherein relying on Dun and Bradstreet’s analysis, the turnover of RS. 1 crore to RS. 200 crores was held to be proper. The following relevant observations were brought to our notice:- “9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we 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
IT(TP)A No.1340/Bang/2010 Page 9 of 25 benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.”
15. It was brought to our notice that the above proposition has also been followed by the Honourable Bangalore ITAT in the following cases:
1. 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.
16. The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than RS. 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard.
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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:
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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:”
18. Rule 10B of the IT Rules, 1962 prescribes rules for Determination of arm’s length price under section 92C:- “10B. (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international
IT(TP)A No.1340/Bang/2010 Page 12 of 25 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.
(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:—
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(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.
(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 :
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Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”
A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO.
In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is RS. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.”
11. Respectfully following the decision of the Tribunal referred to above, we direct that Infosys Ltd., Flextronics Software Systems Ltd., iGate Global Solutions Ltd., Mindtree Consulting Ltd., Persistent
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Systems Ltd., and Sasken Communication Ltd., are to be excluded as comparables for the purpose of determining the ALP of the impugned transaction in this appeal.”
Respectfully following the decision of the Tribunal cited supra, the companies viz., iGate Global Solutions Ltd. (Seg); Infosys Ltd.; Mindtree Consulting Ltd.; Persistent Systems Ltd.; Sasken Communication Ltd. (Seg); and Flextronics Software Systems Ltd. are directed to be excluded from the list of comparables chosen by the TPO.
14. With respect to KALS Information Systems Ltd., and Accel Transmatics Ltd. (Seg), it was contended that they have to be rejected as functionally different, following the decision of ITAT Bangalore Bench in the case of M/s. Huawei Technologies India Pvt. Ltd. (supra) where it was held as follows:-
“12. In so far Kals Info Systems Ltd., and Accel Transmatics Ltd. chosen by the TPO as comparables, this Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) has taken a view that these companies are not comparable to the software service provider companies as they are functionally different. The following are the relevant observations of the Tribunal in this regard:- “(d) KALS Information Systems Ltd.
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 repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in IT(TP)A No.1340/Bang/2010 Page 16 of 25 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, 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.” Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable.
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.
With regard to this company, the complaint of the assessee is that this company is not a pure software development service
IT(TP)A No.1340/Bang/2010 Page 17 of 25 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 (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.”
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 IT(TP)A No.1340/Bang/2010 Page 18 of 25 comparable. The ld. DR, on the other hand, relied on the order of the TPO.
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.”
13. In view of the aforesaid decision of the Tribunal, Kals Info Systems Ltd., and Accel Transmatics Ltd. are to be excluded for the purpose of comparison while determining the ALP of the impugned transaction in this regard. It is ordered accordingly.”
15. Respectfully following the decision of the coordinate Bench of this Tribunal in the case of M/s. Huawei Technologies India Pvt. Ltd. (supra), we direct that KALS Information Systems Ltd., and Accel Transmatics Ltd. (Seg) be excluded from the list of comparables.
With respect to Tata Elxsi Ltd. (Seg) and Lucid Software Ltd., the ld. counsel for the assessee pleaded that the same are to be rejected as functionally different in view of the decision of the coordinate Bench of this Tribunal in the case of M/s. Huawei Technologies India Pvt. Ltd. (supra) wherein it was held as follows:-
“14. As far as Lucid Software Ltd. and Tata Elxsi Ltd. chosen by the TPO as comparables, we find that the Mumbai Bench of the IT(TP)A No.1340/Bang/2010 Page 19 of 25 Tribunal in the case of Telcordia Technologies India Pvt. Ltd. (supra) while dealing with the case of software services provider like the assessee, considered the comparability of Lucid Software Ltd. with similar software service provider and the Tribunal held as follows:- “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 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.”
15. In view of the aforesaid decision of the Mumbai Bench of the Tribunal, which is in relation to A.Y. 2006-07, we are of the view that IT(TP)A No.1340/Bang/2010 Page 20 of 25
Lucid Software Ltd. and Tata Elxsi Ltd. are also to be excluded as comparables while determining the ALP of the international transaction impugned in this appeal.”
17. Respectfully following the decision of the coordinate Bench of this Tribunal in the case of M/s. Huawei Technologies India Pvt. Ltd. (supra), we are of the view that Tata Elxsi Ltd. (Seg) and Lucid Software Ltd. are to be excluded from the list of comparables.
The ld. counsel for the assessee pointed out that Bodhtree Consulting Ltd. was functionally different to be selected as comparable by the TPO. He referred to the decision of ITAT Bangalore Bench in the case of Mindteck (India) Ltd. in IT(TP)A 70/Bang/2014, wherein it has been held as follows:-
“1. Bodhtree Consulting Ltd : As far as this company is concerned, the submission of the learned counsel for the assessee was that this company made extra ordinary profits during the previous year. Our attention was drawn to the fact that the operating profit / operating cost of this company jumped from 17% for F Y 2007-08 to 56% in FY 2008- 09. It dipped in FY 2009-10 to 40% and in FY 2010-11 it became (-) 2% and 5% in FY 2011-12 and finally touched (-) 9% in FY 2012-13. Our attention was drawn to the fact that the Special Bench of the Tribunal, Mumbai, in the case of Maersk Global Centres (India) P. Ltd., in ITA.7466/Mum/2012, dt 07.03.2014 for AY 2008-09 had an occasion to consider the question as to whether companies having abnormal profits should be excluded as a comparable. The Special Bench took the view that it has to be shown that the high profit margin does not reflect the normal business conditions and only in such circumstances, high profit margin companies can be excluded. Our attention was IT(TP)A No.1340/Bang/2010 Page 21 of 25 drawn to the DRP's observation in its order on the issue which is as follows : "Bodhtree : The assessee has objected to selection of this entity on the basis of following objections:
• The entity has fluctuating margins • The company is more of a product company rather than software service company.
The Panel has considered the objections of the assessee. Insofar as the contention regarding the rejection of this entity on the basis of fluctuating margin is concerned, in order to appreciate the compatibility or otherwise of this entity, it is important to first note that the Indian software industry uses two different models for revenue recognition. The first is the Time and Material (T&M) Contracts model in which Customer are billed on the basis of hours worked by the employees of supplier software companies. Hourly rates are agreed on by both parties and are applied to the total hours worked to arrive at the revenue that is to be recognized. The second is the Fixed Price Project Model (FPP). Under the Fixed Price Project Model, the total contract price is agreed upon between the parties. Billing may be done either at the end of the contract or over the period of the contract on the basis of the agreed milestone for billing. In this respect, the basis of revenue recognition by this entity can be seen from the annual report as below:
Revenue Recognition : Revenue from software development is recognised based on software developed and billed to clients.
From perusal of the above, it is seen that this entity is engaged in building revenues through Fixed Price Project model. As is a natural corollary in such type of revenue recognition, some part of the expenditure may be booked in one year, for which the revenue may have IT(TP)A No.1340/Bang/2010 Page 22 of 25 been recognised in the earlier or subsequent year. Therefore, it is but natural that there is some fluctuation in the profitability margin of such entity. Merely because of such fluctuations, an entity engaged in the development of software, being functionally comparable to the assessee, cannot be rejected only on this ground."
The learned counsel for the assessee drew our attention to the fact that Bodhtree Consulting admittedly follows a fixed price project model whereby revenues from software development is recognized based on software and billed to clients. In such business model expenditure for developing software would be billed in an earlier year but the revenue would be recognized in a subsequent year. It was his submission that this fact is recognized by the DRP in its order. According to him this circumstance would be sufficient to show that the margin reflected of this company does not reflect the normal business condition.
The learned DR placed reliance on the reason given by the DRP in its order. 16. We have considered the rival submissions. The Special Bench of the ITAT in the case of Maersk Global Centres (supra) had an occasion to deal with the question as to whether high profit margin making companies should be excluded as a comparable. The Special Bench after considering several aspects held in para 88 of its order that the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special bench held that in such cases it would require further investigation to ascertain the reasons for unusually high profit and in order to establish whether the entities with such high profits can be taken as comparable or not. In the light of the aforesaid decision of the Special Bench and in view of the admitted position that the assessee follows Fixed Price Project model where revenues from software development is recognized based on software developed and billed to clients, there is a possibility of the expenditure in relation to the revenue being booked in the earlier year. The results of Bodhtree from FY 2003 to 2008 excluding FY 2007 as given by the learned counsel for the assessee were also perused. Perusal of the same shows, that there has been a consistent
IT(TP)A No.1340/Bang/2010 Page 23 of 25 change in the operating margins. The chart filed by the assessee in this regard is given as an annexure to this order. It appears to us that the revenue recognition method followed by the assessee is the reason for the drastic variation in the profit margins of this company. In the given circumstances, we are of the view that it would be safe to exclude Bodhtree Consulting from the final list of comparables chosen by the assessee. We hold and direct accordingly.”
19. Following the aforesaid decision of the coordinate Bench of this Tribunal, we therefore hold that Bodhtree Consulting Ltd. is to be excluded from the list of comparables chosen by the TPO.
20. The additional ground raised by the assessee regarding exclusion of Helios & Matheson Information Technology Ltd. as a comparable was not pressed.
Thus, the margins of the final comparables are as follows:-
Sl. Name of the company Operating Margin Working Capital No. on Cost Adjusted Margin 1 R Systems International Ltd. (Seg.) 22.20% 19.38% 2 Media Soft Solutions Pvt. Ltd. 6.29% 3.30% 3 R S Software (India) Ltd. 15.69% 14.34% 4 SIP Technologies & Exports Ltd. 3.06% 0.20% 5 Synfosys Business Solutions Ltd. 10.61% 6.47% 6 Lanco Global Solutions Ltd. 5.27% 3.97% Arithmetic Mean 10.52% 7.94%
Computation of ALP – Software Development Services Avg. Margin of final comparables after working capital adjustment 7.94%
IT(TP)A No.1340/Bang/2010 Page 24 of 25
Computation of Operating Margin of the Assessee Particulars Amount in INR (As per TPO) Operating Income 13,20,83,370 Total Operating Cost 12,23,00,265 Operating Profit 97,83,105 Operating Profit Margin 8.00%
Since the assessee’s margin of 8.00% is higher than the average mean of the comparables, the international transaction relating to software development services can be concluded to be at arm’s length price.
In view of the above, Grounds No.10, 11 and 12 do not survive for adjudication.
Ground No.13 is academic in nature and hence not adjudicated.
Ground No.14 relating to computation of deduction u/s. 10A reads as follows:-
“14, The lower authorities have erred in not: a. excluding telecommunication charges and foreign exchange loss from the total turnover in the process of computation of deduction u/s. 10A; b. appreciating that, under similar facts and circumstances of the case, the Bangalore Bench of the ITAT as well as other Tribunals have held that if some expenses, for any reason, are excluded in arriving at the ‘export turnover’, the same should also be reduced from ‘total turnover’.”
IT(TP)A No.1340/Bang/2010 Page 25 of 25
The Hon’ble High Court in the case of Tata Elxsi Ltd., 349 ITR 98 (Karn), has held that whatever is excluded from the export turnover, has also to be excluded from the total turnover. Respectfully following this decision, we hold that the expenditure of telecommunication charges and foreign exchange loss be excluded from the total turnover also in the process of computation of deduction u/s. 10A.
Ground No.15 with respect to levy of interest of a sum of Rs.23,41,075 u/s. 234B is consequential.
In the result, the appeal filed by the assessee is partly allowed.
Pronounced in the open court on this 4th day of November, 2015.