M/S MERITOR L vs. INDIA (P) LTD.,,BANGALOREVS.ACIT, BANGALORE

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.

12) Persistent Systems Ltd. “17.1.1 This company was selected by the TPO as a comparable. The assessee objected to the inclusion of this company as a comparable for the reasons that this company being engaged in software product designing and analytic services, it is functionally different and further that segmental results are not available. The TPO rejected the assessee's objections on the ground that as per the Annual Report for the company for Financial Year 2007-08, it is mainly a software IT(TP)A.1231/Bang/2011 Page - 26 development company and as per the details furnished in reply to the notice under section 133(6) of the Act, software development constitutes 96% of its revenues. In this view of the matter, the Assessing Officer included this company i.e. Persistent Systems Ltd., in the list of comparables as it qualified the functionality criterion. 17.1.2 Before us, the assessee objected to the inclusion of this company as a comparable submitting that this company is functionally different and also that there are several other factors on which this company cannot be taken as a comparable. In this regard, the learned Authorised Representative submitted that : (i) This company is engaged in software designing services and analytic services and therefore it is not purely a software development service provider as is the assessee in the case on hand. (ii) Page 60 of the Annual Report of the company for F.Y. 2007-08 indicates that this company, is predominantly engaged in ‘Outsourced Software Product Development Services’ for independent software vendors and enterprises. (iii) Website extracts indicate that this company is in the business of product design services. (iv) The ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt. Ltd.(supra) while discussing the comparability of another company, namely Lucid Software Ltd. had rendered a finding that in the absence of segmental information, a company be taken into account for comparability analysis. This principle is squarely applicable to the company presently under consideration, which is into product development and product design services and for which the segmental data is not available. The learned Authorised Representative prays that in view of the above, this company i.e. Persistent Systems Ltd. be omitted from the list of comparables. 17.2 Per contra, the learned Departmental Representative support the action of the TPO in including this company in the list of comparables.

IT(TP)A.1231/Bang/2011 Page - 27

17.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details / information a company cannot be taken into account for comparability analysis, we hold that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. It is ordered accordingly.

13) Sasken Communication Technologies Ltd.: “109. Ld TPO noticed that the company was rejected in the TP document on the ground that the company fails its filter of business review and R&D to sales was more than 3%. However, no reasons were given for the business review. 109.1 Ld. TPO pointed out that R&D to sales being more than 3% is not acceptable for which detailed discussion has already been made earlier. He further noticed that the company has software services segment and segmental results are available for software services. He further pointed out that on the basis of information obtained u/s 133(6), the company qualifies onsite revenue filter (onsite revenues were to the extent 27.27% of its export revenues). After considering the assessee’s reply, ld. TPO included this company in the list of comparables. Ld. counsel pointed out that this company has incurred significant expenditure on research and development activity the same being 6.07% of sales. He further submitted that the company had significant intangible inasmuch as it develops siskin branded products. The company owns IPR Further it was pointed out before TPO that during the year the company had acquired Botnia Hightech F. and its two subsidiaries and thus, it had under gone significant restructuring. However, ld. TPO ignored these facts He relied on the following decisions: • IQ Information System (I) Pvt. Ltd., ITA No. 1961/Hyd./2012 (para no. 11 & 23, page 25); IT(TP)A.1231/Bang/2011 Page - 28 • Amerson Process Management India Pvt. Ltd., ITA No. 8118/Mum./2010 (para 16 page 15).

However, since this adjustment was not possible, therefore, this company should not have been included in the list of comparables. Further, we find that the company owns IPR and has branded products which also distinguishes it from the assessee and, therefore, keeping in view the decision of Hon’ble Delhi High Court in the case of Agnity India Technologies Pvt. Ltd.(supra), we direct the ld. TPO to exclude this comparable from the list of comparables.

If we follow the coordinate bench decision in the case of Motorala Solution (India) P. Ltd, Sasken Communication Technologies Ltd needs to be excluded. However, as mentioned by us at para 24 above, where the contested comparable formed part of assessee’s own study, then the AO / TPO has to be given a chance for verification, in view of judgment of Hon’ble Pun jab & Haryana High Court in the case of Quark Systems India P. Ltd (supra). Accordingly we remit the issue of comparability of Sasken Communication Technologies Ltd back to the AO / TPO for consideration afresh as per law. Ordered accordingly.”

14) 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.

IT(TP)A.1231/Bang/2011 Page - 29

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 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 IT(TP)A.1231/Bang/2011 Page - 30 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.”

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 :- (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.

IT(TP)A.1231/Bang/2011 Page - 31

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.”

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 IT(TP)A.1231/Bang/2011 Page - 32 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 that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data.

• The taxpayer is totally dependent oil AE for business. Thus the taxpayer takes the risks associated with heavy dependence oil single customer. In common business parlance it is known as 'single customer risk'. • The taxpayer is not compensated any amount for termination of agreement even if it is terminated without any cause. No independent enterprise would like to agree for a termination clause without compensation if it is terminated without any cause.

• The AE is exposed to the market risk and any fluctuation in the business conditions of the AE affect the contractual terms between the AE and the taxpayer. Thus even if independent comparables undertake some risk, the taxpayer also had to undertake risks like single customer risk, political risk, etc which are not incurred by the comparable companies and hence the risks are evened out. • There are many captive service providers operating in the same environment as the taxpayer and still earning much IT(TP)A.1231/Bang/2011 Page - 35 better margins than independent risk bearings enterprises and vice versa. Thus there is no direct correlation between the margins earned and risks taken. • Many business studies have shown- that the MNCs are actually distributing their risks by opening captive offshore centers. • The independent entrepreneur has to incur expenditure on marketing, etc. which is debited to the profit and loss account. But, it is always not necessary that these risks reflected in the marketing, sales promotion expenses will automatically be compensated by increase in sales or higher margins. For example, increased marketing efforts in some segments of export market may not yield results for a software development company and thereby there may be a loss on this marketing effort which may bring down the overall profitability rather than increase the profitability. Thus if undertaking the market risk etc. helps in earning any extra margin, the benefit is more than set off by the corresponding expenditure. The same applies to credit risk undertaken. • There are many studies conducted on the risk reduction strategies followed by MNCs by shifting their production facilities to other countries based mainly on cost factors. By outsourcing to India, the overall cost of production of goods or services by the AE gets reduced which in turn increases the competitiveness of the AE in the market. Thus the taxpayer is not compensated for the reduction of risk attributable to the operations carried on by the taxpayer in India. • The risk profile of the comparables selected by the taxpayer, acceptable to the taxpayer and those selected by the TPO but not acceptable to the taxpayer is similar. • It is incorrect to say that higher the risk, the higher is the margin though it is true that higher risk expects a higher margin. Thus realization of risk is different from expected return based on risk undertaken. Finally selected comparables had almost similar risks but margins varied IT(TP)A.1231/Bang/2011 Page - 36 from 1.38% to 60.23% on cost. • The taxpayer did not furnish any computation of the risk adjustment in the TP study. However, during the course of TP proceedings, the taxpayer submitted some 1",\ method for computation of the risk, which is discussed above and rejected. • The taxpayer's single customer risk and political / country risk more than offsets any other risk differential between the taxpayer and the comparable companies. • Different comparables can have different risk profiles and different profit margins. The proviso to Sec. 92C(2) of the Act provides for adopting arithmetical mean of the different prices. This provision neutralizes the effect of difference in the risk profile, if any between the tax payer and the comparables as realized risk may pull down the profitability below the risk free return.

• It is not sufficient to merely spell out risks. But, it has to be shown which risk was actually undertaken by the comparables and to what extent it affected the profitability. The taxpayer has not done so.

IT(TP)A.1231/Bang/2011 Page - 38 v. Yokogawa India Ltd [(2013) 341 ITR 0385], unabsorbed loss of profitable units could not be set off with the profits of non-eligible units.

We are of the opinion that in view of the judgment of Hon’ble jurisdictional High Court in the case of CIT (LTU) v. Yokogawa India Ltd (supra) supports the view canvassed by the Ld. AR. We therefore direct that assessee be given deduction u/s.10A of the Act without setting off brought forward loss and unabsorbed depreciation of non-eligible units. Ordered accordingly. Ground 8 of the assessee stands allowed.

20. Ground 9 is consequential in nature and does not need any specific adjudication.

Order pronounced in the open court on 16th day of October, 2015.