Loading judgment…
No AI summary yet for this case.
Detected automatically from the text. The count shows how many other judgments on BharatTax rely on the same authority.
Income Tax Appellate Tribunal, DELHI BENCHES : I : NEW DELHI
Before: SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM
ORDER
PER R.S. SYAL, AM:
This appeal by the assessee is directed against the final assessment order passed by the Assessing Officer (AO) on 26.12.2014 under Headstrong Services (India) Pvt. Ltd. section 144C read with section 143(3) of the Income-tax Act, 1961 (hereinafter also called `the Act’) in relation to the assessment year 2010-11.
I. SOFTWARE DEVELOPMENT SERVICES
First issue raised in this appeal is against the addition on account of transfer pricing adjustment amounting to Rs. 14,71,91,526/- made in the international transaction of `Provision of Software Development Services’. Briefly, stated the facts of the case are that the assessee is 100% subsidiary of Headstrong Services LLC. It is a 100% Export Oriented Unit for manufacture and export of computer software and is engaged in the rendering Software development services and IT Enabled Services (ITES). The assessee reported five international transactions in its audit report in Form no. 3CEB, including “Provision of software development services” with transacted value of Rs. 134,37,46,752/-. The assessee used the Transactional Net Margin Method (TNMM) as the most appropriate method. Profit Level Indicator (PLI) of Operating Profit / Total Cost (OP/TC) was applied. The assessee calculated its PLI Headstrong Services (India) Pvt. Ltd. at 11.79%. Certain companies were selected as comparable for this international transaction with their average margin at 11.43%. That is how, the assessee tried to demonstrate that this international transaction was at arm’s length price (ALP). Unconvinced, the Transfer Pricing Officer (TPO) recast the financials of the assessee for the international transaction of `Software development services’, as under:
Operating Income Income from Operations 176,06,48,375 Misc. Income 864,634 Total Operating Income 1,761,513,009 Operating Expenses Total Cost 1,60,05,39,757 Total Expenses 1,60,05,39,757 Less : Non-Operational Expenses 15,40,275 Financial Expenses Forex Loss 6,00,71,190 Provision for doubtful debts 96,526 Loss on sale/discard of fixed assets 19,21,957 Provision for doubtful advances 20,41,221 Total Operating Expenses 1,53,48,68,589 Operating Profit 22,66,44,420 OP/OC 14.77% Headstrong Services (India) Pvt. Ltd.
After making certain inclusions/exclusions in the list of comparables drawn by the assessee, the TPO worked out average profit margin of the finally selected comparables at 24.88%. Such profit rate of 24.88% was applied on total operating costs incurred by the assesseee at Rs. 153.48 crore to work out transfer pricing adjustment amounting to Rs.31,62,04,137/-. The assessee challenged the TPO’s working of ALP of the international transaction of `Provision of software development services’ before the Dispute Resolution Panel (DRP). Certain reliefs were directed by the DRP. In the order passed by the Transfer Pricing Officer, giving effect to the transactions of the DRP, and certain order u/s 154, finally an addition of Rs.14,71,91,526 has been made towards transfer pricing adjustment on the international transaction of providing software development services. The assessee is aggrieved against such addition.
We have heard the rival submissions and perused the relevant material available on record. There is no dispute on the application of the TNMM as the most appropriate method with PLI of OP/TC. The Headstrong Services (India) Pvt. Ltd. controversy before us revolves around making of Transfer pricing addition on transactions with non-AEs also; computation of the assessee’s profit margin; and selection of comparables.
We will take up these three aspects for consideration in seriatim. a) TP adjustment in respect of transactions with non-AEs?
6.1. The first issue challenged before us under the international transaction of `Provision of Software Development services’ is against the computation of transfer pricing adjustment in respect of transaction with Associated Enterprises (AEs) and non-AEs. Computation of the arm’s length price (ALP) by the TPO on page 48 and 49 of his order divulges that he took total operational costs of the Software development segment at Rs.153,48,68,589/-. By applying arithmetic mean of the profit rate of comparables at 24.88% on such total costs, he proposed a transfer pricing adjustment of Rs.31,62,04,137/-. The ld. AR contended that no transfer pricing adjustment is possible in respect of transactions with non-AEs. Headstrong Services (India) Pvt. Ltd. 6.2. It is uncontroverted, as is also apparent from the TPO’s order, that the transfer pricing adjustment has been made by considering the total costs incurred by the assessee in respect of transactions with the associated enterprises (AE) and non-AEs. It can be seen that the TPO has taken the figure of revenue at Rs.1.76 crore while calculating the ALP of the international transaction from `Provision of software development services’. As against that, when we see page 2 of the TPO’s order detailing the international transactions, it comes to the fore that the amount of revenue from `Provision of software development services’ is only Rs.1.34 crore. This shows that the balance amount is revenue from non-AE transactions. An addition towards transfer pricing adjustment can be made by comparing the assessee’s profit rate from the international transaction with that of comparable uncontrolled transactions. Under the TNMM, the process is simple in initially finding out the operating profit margin of the assessee and then the average adjusted operating profit margin of comparables. Such adjusted profit margin of the comparables constitutes benchmark margin, which is then Headstrong Services (India) Pvt. Ltd. matched with the operating profit margin from the assessee’s international transaction (which is always with AE). It is not permissible to make transfer pricing adjustment, by applying the average operating profit margin of the comparables, on the assessee’s universal transactions entered into with both the AEs and non-AEs. As the entire exercise under Chapter-X is confined to computing total income of the assessee from international transactions having regard to the arm’s length price, there is no scope for computing income from non- international transactions having regard to the ALP. As the TPO has computed the transfer pricing adjustment qua all the transactions carried out by the assessee under this segment with reference to the base of ‘total costs’, also inclusive of costs relevant for transactions with non- AEs, we vacate the impugned order to this extent and restore the matter to the file of the TPO/AO for recalculating the amount of addition of transfer pricing adjustment by taking into consideration the international transactions only under this segment, to the exclusion of transactions with non-AEs. Headstrong Services (India) Pvt. Ltd. b) Computation of the assessee’s profit margin 7.1. The second aspect is about the computation of the assessee’s operating margin at 14.77%. We have reproduced above the working of such profit rate. There is no conflict on the calculation of `Operating income’ at Rs.176,15,13,009/-, except to the extent of inclusion of revenue from non-AEs in it. We have directed hereinabove to restrict the determination of the ALP of international transaction from provision of software development services and the consequential transfer pricing adjustment only in respect of transaction with AEs. Resultantly, it is directed that in finding out the ALP of this international transaction, the amount of revenue from non-AE transactions should be excluded.
7.2. The major controversy rotates around the computation of Operating costs worked out by the TPO at Rs.153.48 crore. In this regard, we find that the starting point of this figure is `Operating expenses’ to the tune of Rs.1,60,05,39,757, which figure has been determined by the TPO by taking the amount of total Expenses from the Profit & loss account at Rs.1,66,69,44,440, which has been apportioned Headstrong Services (India) Pvt. Ltd. between Software development services and ITES in the proportion of revenues at Rs.176.34 crore and Rs.7.30 crore totaling Rs.183.64 crore, thereby giving the figure of Operating costs in relation to Provision of software development services at Rs.1,60,05,39,757. As the figure of Rs.166.69 crore consists of certain expenses, we will take up such expenses one by one for the purposes of distribution between the two segments.
7.3. First item of costs is `Personnel expenses’ amounting to Rs.1,23,85,27,756. We find that the assessee has been remunerated in the other international transaction of rendering ITES at cost plus 50% mark–up. Definition of `Cost’ has been given in Exhibit B of the Agreement between the assessee at its US AE : `to mean all employees expenses’. The term `employees expenses’ has been further defined to mean : `the actual payroll costs of the employees and does not include the employee expenses which are reimbursed separately without mark- up’. This divulges that the assessee has been compensated under ITES at 50% over and above employees cost. Since the revenue from this Headstrong Services (India) Pvt. Ltd. international transaction representing 150% is Rs.7,30,47,418, we hold that the employee cost for rendering ITES be taken at Rs.4,86,98,278 (Rs.7,30,47,418 *100/150). The remaining employee cost is relatable to software development services. We have also gone through an Agreement with M/s Wells Fargo India Solutions Pvt. Ltd., which is a non-AE and the assessee has rendered software development services to this Indian company also. It is common submission that agreements with other non-AEs are on the same terms as with M/s Wells Fargo. No mechanism has been set out under this Agreement for determining the Personnel costs incurred by the assessee in rendering services to non- AE. In the absence of any mechanism for apportionment of employee cost between AE and non-AE transactions of software development services, we direct that the remaining personnel costs (after exclusion of Rs.4,86,98,278) be apportioned between AE and non-AE transactions in the ratio of revenue.
7.4. The next item of expense as per the assessee’s Profit and Loss account is `Operational and other expenses’. The TPO, in the first step, Headstrong Services (India) Pvt. Ltd. has bifurcated such expenses along with others in the ratio of revenue from software development and ITES segments. Then he reduced non- operational expenses of Financial expenses, Forex loss, Provision of doubtful debts, Loss on sale/discarded of fixed assets and Provision for doubtful advances, to find out the amount of total operating expenses other than Personnel expenses. The ld. AR could not point out any rational basis for apportionment of such expenses, other than the revenue from the relevant segments. We, therefore, uphold in principle, the apportionment of such other expenses, except depreciation, in the ratio of revenue from both the segments. As regards the five items treated by the TPO as non-operating nature, the ld. AR did not raise any objection to such treatment. We, therefore, hold that that the other proportionate expenses relating to software development segment as deduced from the bifurcation on the basis of revenue, should be further apportioned between AE and non-AE transactions in the ratio of the revenue from the two streams. The five items of non-operating expenses are also directed to be reduced in the same way. In the alternative, the TPO may Headstrong Services (India) Pvt. Ltd. take the gross figure of such other expenses other than Personnel expenses and Depreciation from Profit and Loss account; reduce the same with the gross figures of five items taken by him as non-operating; divide the balance between software development services and ITES segments in the ratio of revenue from both; and then divide the part relatable to software development services segment between the AE and non-AE transactions on the basis of their respective gross revenue. The proportionate part relatable to the AE transactions be considered in the calculation of OP/OC of the international transaction of rendering software development services. As regards Depreciation, we find that the assessee, inter alia, earned Rent of Rs.88,90,195 and credited it to Profit and Loss account. This amount of rent has been taken as non- operating income and rightly so. Once rent is non-operating, then the amount of depreciation on the assets yielding rent cannot also be treated as operating expenses. Accordingly, we direct that the above discussed exercise of bifurcating `Other Operating expenses’ be carried out in Headstrong Services (India) Pvt. Ltd. respect of Depreciation also, but after reducing such amount of depreciation as relates to the assets fetching rental income. c) Selection of Comparables
The assessee agitated inclusion of certain companies by the TPO in the final list of comparables and also sought intervention on certain companies which, in its opinion, ought to have been included in such list, which have been ignored by the TPO.
Before going into the question of comparability of the companies assailed before us, it is relevant to understand the nature of activity carried out by the assessee in rendering software development services to its AEs. As per Agreement dated 1.1.2009 between the assessee and Hedstrong UK Limited, a copy of which has been placed on record, there is an elaboration of `Services’ as per Exhibit A. This Exhibit stipulates that the assessee is `engaged in the business of providing business oriented technology consulting services and of developing, integrating, enhancing and maintaining computer software for its customers’. The assessee is providing end-to-end systems integration 13 Headstrong Services (India) Pvt. Ltd. and consulting services in focused vertical market segments including Securities and Investment Banking, Airlines & Transport and Technology. The assessee’s TP study report discloses that Sales and Marketing is done by Headstrong US. Though Contract negotiations are done by Headstrong US, but `Headstrong India is responsible for the provision of the requested services.’ Further, whereas Headstrong US is responsible for the conceptualization of services, the assessee is responsible for the performance of such services. Intellectual property rights in the work done by the assessee vest in Headstrong US. It is pertinent to note that unlike the A.Y. 2008-09, for which separate order has been passed by this Bench on 11.2.2016, this year, the assessee has also earned software development revenue from non-AEs as well. The above narration of facts indicates that the assessee is engaged in providing software development services to its AEs. With the above background in mind, we will examine the comparability or otherwise of the companies assailed in the instant appeal. Headstrong Services (India) Pvt. Ltd.
Firstly, we will deal with the companies which have been included by the TPO in the final set of comparables and the assessee claims them to be incomparable. A submission common to some of such companies was made by the ld. AR that certain Benches of the Tribunal in other cases have held them to be not comparable. In that view of the matter, it was urged that those companies, being ex facie incomparable, be automatically excluded from the list of comparables drawn by the TPO.
We express our doubts in accepting such a broad proposition. It is axiomatic that if company ‘A’ is functionally different from company ‘B’, then, such company cannot be considered as comparable. Two companies can be considered as comparable when both are discharging the overall similar functions, though there may be some minor differences in such functions, not marring the otherwise comparability.
Notwithstanding the functional similarity, many a times a company ceases to be comparable because of other reasons as well. To cite an example, if company ‘A’, though functionally similar to company ‘B’, but has related party transactions (RPTs) breaching a particular level, Headstrong Services (India) Pvt. Ltd. then, such company cannot be considered as comparable to company ‘A’ in the year in which the RPTs breach such a level. If, however, in the subsequent year, the related party transactions fall below that limit, then such company would again become comparable. To put it simply, if company ‘A’ has been held to be incomparable vis-a-vis company ‘B’, then it is not essential that company ‘A’ would be incomparable to company ‘C’ also. What is relevant to consider is, firstly, the functional profile of company ‘A’ vis-a-vis company ‘C’. If both are functionally similar, then notwithstanding the fact that company ‘A’ was held to be incomparable to company ‘B’, it may still be comparable to company ‘C’. Despite the fact that company ‘A’ is functionally similar to company ‘B’, it may still have been declared as incomparable to company ‘B’ because of other relevant reasons. If company ‘A’ passes the same reasons vis-a-vis company ‘C’, then company ‘A’ will find its place in the list of comparables of company ‘C’, notwithstanding the fact that it was held to be incomparable to company ‘B’. The crux of the matter is that the mere fact that company ‘A’ has been held to be not Headstrong Services (India) Pvt. Ltd. comparable in a judicial order passed in the case of company ‘B’, does not per se make it incomparable in all the subsequent cases to follow.
Not only company ‘A’ held to be incomparable to company ‘B’ can be comparable to company ‘C’, but company ‘X’ held to be comparable to company ‘Y’ can also be incomparable to company ‘Z’, depending upon the functional profile and the applicability or otherwise of the related factors. There can be no hard and fast rule that if a particular company has been found to be not comparable in the case of another company, then such former company would cease to be comparable to the assessee company also. Comparability of each company needs to be ascertained only after matching the functional profile and the relevant factors of the other company. Ergo, this contention raised on behalf of the assessee cannot be accepted. With the above parameters in mind and the factual matrix at hand, we proceed to examine the companies chosen by the TPO for ascertaining if they are really comparable.
(i) e-Infochips Bangalore Limited Headstrong Services (India) Pvt. Ltd. 12.1. The TPO proposed the inclusion of this company in the set of comparables, which was resisted by the assessee contending that the same was engaged in Software Development and IT Enabled Services, that was their only reportable business segment. The TPO rejected the contention of the assessee by noticing that many companies treat IT and ITES as one segment. No relief was allowed by the DRP. The assessee is against inclusion of this company in the list of comparables.
12.2. After considering the rival submission and perused the relevant material on record, we find from the Annual Report of this company available on page 352 of the paper book that its P & L Account shows `Income from software services’ as one unit at Rs. 43,04,66,481/-.
Schedules 7 gives break up of this income with “Income from Software Services” at Rs. 37.13 crore and “Consultancy Charges” at Rs. 5.90 crore. Segmental information of this company is available on page 66 of its Annual Report which states that : “The Company is primarily engaged in Software Development and I.T. enabled services which is considered the only reportable business segment”. This indicates that the Headstrong Services (India) Pvt. Ltd. revenue from Software Development and ITES has been clubbed by this company which also includes consultancy charges. No doubt Consultancy charges in relation to Software Development are part of overall Software Development, but the inclusion of ITES in the overall segment frustrates the comparability. We are currently dealing with the international transaction of `Provision of Software Development services’ and the international transaction of ITES is separate which has also been benchmarked distinctly. In our considered opinion, e- Infochips Bangalore Ltd. having a pool of both software developments and ITES segments into the overall segment designated as `Software development’, cannot be considered as comparable on entity level with the international transaction of `Software development’ of the assesse.
We, therefore, order for the exclusion of this company from the list of comparables.
(ii) Infinite Data System Pvt. Ltd. 13.1. Rejecting the assessee’s contention that the financial data of this company was not available in the public domain, the TPO included it by Headstrong Services (India) Pvt. Ltd. observing that it was engaged in providing software technical services to sole customer, viz., Fujitsu Services Ltd. The TPO has also narrated the services rendered by this company which were found to be primarily IT Services. Hence, this company was included in the list of comparables, against which the assessee is aggrieved before us.
13.2. After considering the rival submissions and perusing the relevant material on record, we find that the total sales of this company for the corresponding year ending is Rs. 38.31 crore. Para 17.2.13 of the Annual Report of this company provides that: `The company is primarily a services company engaged in technical consulting, design & development of software, maintenance, systems integration, implementation, testing and infrastructure management services’. Next para 17.2.14 dealing with “Segment Reporting” provides that : `The Company’s operations are predominantly related to providing software technical consultancy services to its sole customer Fujitsu Services Ltd.’ Narration of the above facts from the Annual report of this company makes it explicit that it is engaged in providing technical consultancy, Headstrong Services (India) Pvt. Ltd. design and development of software. The Ld. AR’s contention that the assessee is not into consultancy services is incorrect as has been noted above from the relevant parts of its Agreement with Headstrong UK Ltd. showing that the assessee is also into software consultancy. Be that as it may, in our considered opinion, software consultancy services cannot be considered as independent of software development services, which necessarily implies applying such consultancy in the software development. Another contention raised by the ld. AR that Infinite Data System is doing all the activities in the development of software including its conceptualization, whereas some of such activities are done by the assessee’s AE, in our considered opinion is again inconsequential.
We have noticed above that the role of the assessee’s AE is largely that of Sales and marketing including the conceptualization of services but the work of software development is done by the assessee alone. Further, if assessee is doing, say, five parts of the overall six or seven parts of the software development, it cannot be said that the assessee is not into software development. Activities of the asessee, which admittedly Headstrong Services (India) Pvt. Ltd. constitute a major chunk of the overall software development, cannot be considered as different from the software development. We, therefore, refuse to accept this contention urged on behalf of the assessee.
13.3. Thereafter it was also argued that since Infinite Data System is providing Services to its sole customer and the terms of providing services to the sole customer are governed / controlled by the AE of this company and hence it should be treated as a controlled transaction. This submission is in the air. No relevant material worth the name has been placed on record to substantiate this contention of controlled transaction.
13.4. Last argument of the ld. AR about the different business model adopted by this company in the sense of receiving deficit charges arising on account of under utilization of its resources, again, fails to convince us in ordering the exclusion of this otherwise functionally comparable company. Our first reason for such decision is that such charges standing at Rs. 31.38 lakh are less than even 1% of the revenue from the customer. Once the functional comparability is accepted, at the most, this factor may require adjustment in the profit rate of this company Headstrong Services (India) Pvt. Ltd. taken as comparable, rather than excluding the company from the list of comparables. Further, such an adjustment can be made, if it is shown that the assessee’s capacity also remained under-utilized without there being any corresponding compensation. Once the assessee’s idle capacity has not been shown, there can be no question of allowing any adjustment on this score.
13.5. Taking a holistic view of the matter, we decline to interfere with the decision of the authorities below in treating this company as comparable.
(iii) Infosys Technologies Ltd. 14.1. The TPO noticed that this company was finding place in the accept/reject matrix but was rejected in the TP documentation by claiming that it failed functional comparability. The TPO found this company to be into software development services qualifying all the filters applied by him. The assessee raised certain objections against the inclusion of this company, but without any success. The TPO included Headstrong Services (India) Pvt. Ltd. the same in the final list of comparables. The assessee is aggrieved against its inclusion in the ultimate set of comparables.
14.2. We have considered the rival submissions and perused the relevant material on record. It can be seen that the TPO has included this company in the list of comparables by rejecting the assessee’s contention about the brand of this company helping in earning huge profits and also the brand-related products swelling the ultimate profit rate of this company. We find that the assessee is a captive unit rendering services to its AE alone without acquiring any intellectual property rights in the work done by it in the development of software.
The Hon’ble Delhi High Court in CIT vs. Agnity India Technologies (P)
Ltd. (2013) 219 Taxmann 26 (Del) considered the giantness of Infosys Ltd., in terms of risk profile, nature of services, number of employees, ownership of branded products and brand related profits, etc. in comparison with such factors prevailing in the case of Agnity India Technologies Pvt. Ltd., being, a captive unit providing software development services without having any IP rights in the work done by Headstrong Services (India) Pvt. Ltd. it. After making comparison of various factors as enumerated above, the Hon’ble Delhi High Court held Infosys Ltd. to be incomparable to Agnity India Technologies Pvt. Ltd. The facts of the instant case are more or less similar inasmuch as the extant assessee is also a service provider with a limited number of employees at its disposal and also not owning any branded products with no expenditure on R&D etc. When we consider all the above factors in a holistic manner, there remains absolutely no doubt that Infosys Technologies Ltd. is incomparable to the assessee company. Respectfully following the judgment of the Hon’ble jurisdictional High Court in Agnity India (supra), we hold that Infosys Technologies Ltd. cannot be treated as comparable to the assessee company. This company is, therefore, directed to be excluded from the list of comparables.
(iv) Sonata Software Limited 15.1. The TPO proposed this company as comparable which was objected to by the assessee on the ground that it has significant Related Party Transactions (RPTs). The TPO computed RPTs from the items of Headstrong Services (India) Pvt. Ltd. Profit & Loss items of this company at 11.93%. The remaining items pertaining to the balance sheet was ignored. That is how, the TPO found this company to be comparable. The assessee has challenged the computation of the RPTs.
15.2. We have heard both the sides and gone through the relevant material on record. It is found that the predominant view of the Tribunal across the country in several cases is that the transactions of a company having more than 25% of Related Party Transactions (RPTs) are considered as controlled, thereby failing the test of comparability. This view has been taken in several decisions including by the Delhi Bench in Toluna India Pvt. Ltd. (supra) and Actis Advisers Pvt. Ltd. Vs. DCIT, (2012) 20 ITR 138 (Del.)(Trib.). and Mumbai Bench in Stream International Services Pvt. Ltd. Vs. ACIT (IT) (2013) 141 ITD 492 (Mum.).
15.3. As against the TPO’s calculation of RPTs of this company at 11.93%, the Ld. AR has placed on record its calculation of RPTs of this company at 55.95%. We find that none of the calculations is correct. Headstrong Services (India) Pvt. Ltd. Mechanism for calculating the percentage of Related Party Transactions has been broadly laid down by the Delhi bench of the tribunal in Nokia India Private Ltd. Vs. DCIT, 2014-TII- 224-ITAT- DEL-TP. Since the calculation done by both the sides, viz., the TPO and the assessee is not correct, we set aside the impugned order and remit the matter to the file of AO/TPO for fresh determination of the percentage of Related Party Transactions of this company in consonance with the broader principles laid down in the case of Nokia India Private Ltd (supra), to the extent these are applicable. It is made clear that if after doing this exercise, the Related Party Transactions of this company are found to be more than 25%, then it should be excluded from the set of comparables and in the otherwise situation, it should continue in the list of comparables.
(v) Tata Elxi Limited (Segment)
16.1. The TPO proposed this company as comparable, which was objected to by the assessee on the ground of different functional portfolio. He rejected such a contention and included it in the set of comparables. 27 Headstrong Services (India) Pvt. Ltd. 16.2. After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company, whose copy has been provided in the paper book, that it has two primary segments, namely, Systems Integration & Support and Software Development and Services. The TPO has taken second segment of Software Development and Services for the purposes of comparison with the assessee. On a further perusal of the details of this segment, it comes to our notice from page 13 of the Annual report that Design and development of Hardware is also included in it. Since revenue from `hardware’ is also included in the `Software Development and Services’ segment of this company, we fail to see as to how it can be treated as comparable with the assessee company, which has not rendered any hardware services. We, therefore, eliminate this company from the list of comparables.
Now we will examine the companies refused by the TPO, which the assessee claims, as comparable.
(i) CG-VAK Software & Exports Limited Headstrong Services (India) Pvt. Ltd. 18.1. The assessee treated this company as comparable, which the TPO refused to accept. The assessee insists on the inclusion of this company in the list of comparables.
18.2. After going through the relevant material on record including the Annual report of this company, we find that its Profit & loss account indicates `Income from Software Development, Services & Products’. It is further discernible that it is engaged in Research & Development activity. This factor is traceable from page 6 of its Annual report which indicates: `The nature of business of software development involves inbuilt, constant Research and Development as a part of its process of manufacturing (development). The Company is developing application engines, re-usable codes and libraries as a part of its R&D activities’. A perusal of the above narration indicates that this company is also engaged in undertaking Research & Development activities under the `Software development segment’. As the assessee is not doing any R&D, this significant difference takes it into an altogether different business model, vitiating comparability. We, therefore, uphold the Headstrong Services (India) Pvt. Ltd. assessment/TPO’s order in not including this company in the final set of comparables.
(ii) Caliber Point Business Solutions Limited (Other Segment); Helios & Matheson Information Technology Limited; and Silverline Technologies Limited :
19.1. The assessee included these companies in its list of comparables. However, the TPO eliminated them on the ground that these were following different year endings and, hence, were not comparable. The ld. AR fairly accepted that the above companies were following different year endings for maintaining their accounts in contrast to the assessee following financial year ending 31st March. It was, however, submitted that these companies should not have been excluded for this reason alone when they are otherwise functionally similar, a fact which has not been disputed by the TPO. The ld. DR opposed this contention by submitting that since the data for the year ending of these companies does not match with the year ending of the assessee these were rightly excluded. Headstrong Services (India) Pvt. Ltd. 19.2. After considering the rival submissions and perusing the relevant material, it is noticed that the assessee company is having financial year ending covering period 1.4.2009 to 31.3.2010. In that view of the matter, a valid comparison can be made only if the comparable company has also the same financial year. In this regard, we consider it appropriate to note the relevant part of sub-rule (4) of Rule 10B which provides that: “the data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction had been entered into.” It is obvious from the language of sub-rule (4) that the comparability of an uncontrolled transaction can be analyzed only with the “data relating to the financial year” in which the international transaction has been entered into. In other words, if the tested party has March year ending, then, the comparables must also have the data relating to the financial year ending 31st March itself. If such a data is not available, then, a company albeit functionally comparable, disqualifies. Espousing the facts of the extant case, we find Headstrong Services (India) Pvt. Ltd. that insofar as the functional comparability of these companies is concerned, the TPO has not disputed the same. The only reason given for their exclusion is the non-availability of data for the relevant financial year. The ld. AR contended that though the year endings of the above company were different, yet, the assessee was in a position to put forward their data for the Financial year 1.4.2009 to 31.3.2010 from their Annual reports only. It was so stated on the basis of the availability of the quarterly data from the Annual reports of these companies, which could be adjusted for the financial year ending 31.3.2010. If the contention of the assessee is correct, that the relevant data for the concerned financial year can be deduced from the information available from their annual reports, then, there can be no objection to their inclusion in the list of comparables with the adjusted data for the relevant financial year itself. Under such circumstances, we set aside the impugned order and remit the matter to the file of TPO/AO for examining this aspect of the matter. It is clarified that only if the assessee succeeds in providing the relevant data of these companies for Headstrong Services (India) Pvt. Ltd. the concerned financial year on the basis of the information available from their Annual reports only, the TPO should include these companies in the list of comparables by considering their OP/TC on the basis of the financial year ending 31.3.2010. If however, even though the quarterly data is available and can be compiled for the relevant financial year, but the amounts of operating profit or operating cost etc. for the relevant financial year are not directly available without any apportionment or truncation, then these companies should not be considered as comparable.
(iii) Goldstone Technologies Limited :
20.1. The assessee included this company in the list of comparables which was excluded by the TPO on the ground that it was engaged in providing IT services and IT Enabled Services.
20.2. Having regard to the facts of the instant case and the submissions advanced on behalf of both the sides, we find that this company is engaged in providing both IT services and ITE services, which fact has also not been disputed by the ld. AR. Since we are benchmarking the Headstrong Services (India) Pvt. Ltd. international transaction of `software development services’, such a company also rendering ITES, cannot be considered as comparable. The assessment order is accordingly upheld.
(iv) Maveric Systems Limited :
21.1. The assessee considered this company as comparable, which was rejected by the TPO on the ground that its Annual accounts were not available in public domain.
21.2. Having heard both the sides and perused the relevant material on record, we find that the position continues to remain same before us as well. The ld. AR candidly admitted that the Annual accounts of this company are still not available. In the absence of this basic data, we cannot take cognizance of this company from the angle of comparability.
The impugned order is upheld.
II. I.T. ENABLED SERVICES
The assessee reported an International Transaction of `Provision of IT Enabled / BPO services’ with transacted value at Rs. 7,30,47,418/-. Headstrong Services (India) Pvt. Ltd. The assessee used the TNMM as the most appropriate method with OP/TC as its PLI. Eight companies were chosen as comparable with their average margin of profit at 11.79%. The assessee computed its own profit margin at 14.27%. That is how, it was shown that this international transaction was at Arm’s Length price. The TPO changed composition of comparables by including some new companies and excluding some from the list of the assessee. Thereafter, he re-worked out the operating profit margin of the assessee from this international transaction and consequential transfer pricing adjustment, as under :-
Operating Income Income from operations 73,047,418 Misc. Income 35,873 Total Operating Income 73,083,291 Operating Expenses Total Cost 66,404,683 Total Expenses 66,404,683 Less : Non-Operational Expenses Financial Expenses 63,904 Forex Loss 2,492,289 Provision for doubtful debts 4,005 Loss on sale/discared of fixed 79,740 assets Provision for doubtful advances 84,688 Total Operating Expenses 63,680,056 35 Headstrong Services (India) Pvt. Ltd.
Operating Profit 9,403,235 OP/OC 14.77% Operational Cost 63,680,056 Arm’s Length Price at a Margin of 86,655,820 36.08% Price Received 73,083,291 105% of the Price Received 76,737,456 Proposed Adjustment u/s 92CA 13,572,529
This led to the transfer pricing adjustment of Rs. 1,35,72,529/- from the international transaction of provision of ITES/BPO Services. The assessee challenged the TPO’s working of ALP of this international transaction before the DRP. Certain relief was directed. The TPO, giving effect to the directions of the DRP and after passing order u/s 154, worked out fresh amount of transfer pricing adjustment at Rs.96,11,630/-, which is under challenge before us.
We have heard the rival submissions and perused the relevant material available on record. There is no dispute on the application of the TNMM as the most appropriate method with PLI of OP/TC.
Controversy before us is focused on the computation of the assessee’s Headstrong Services (India) Pvt. Ltd. profit margin from this international transaction; and selection of comparables. We will deal with these issues separately. a) Computation of the assessee’s profit margin
First we take up the computation of the assessee’s profit margin by the TPO. While dealing with the computation of assessee’s profit margin from the international transaction of `Provision of Software Development Services’, we have given supra certain directions. Both the sides are in agreement that such directions would mutatis mutandis apply to this international transaction of `Provision of ITES’ as well.
Following the view, we direct to retain the figure of Operating income at Rs. 7.30 crore, as rightly taken by the TPO, which has not been objected by the ld. AR as well. As regards the calculation of Operating expenses, we direct to take Employees expenses at Rs.4,86,98,278/-; total amount of Depreciation is directed to be apportioned between the international transactions of `Software development’ and `ITES’, to the exclusion of the amount relatable to rental income, in the ratio of revenues; remaining amount of Operating expenses are directed to be apportioned, Headstrong Services (India) Pvt. Ltd. as deduced after deduction of five items treated by the TPO as of non- operating nature, in the ratio of revenue from the transactions of Software development with AEs, non-AEs and ITES. This working will give the figure of operating profit margin of the assessee from the international transaction of ITES.
(b) Comparables
Here again the assessee has challenged certain inclusions and exclusions made by the TPO. Before taking up the comparability or otherwise of the companies disputed before us, it is sine qua non to consider the nature of services rendered by the assessee under this international transaction. Exhibit B of the Agreement with Headstrong US, divulges the nature of ITES provided by the assessee, which are - “Accounting Services, Recruitment, Project Management, Human Resources and Quality and Assurance”. Now, we will proceed to examine if the companies chosen by the TPO but challenged by the assessee, are really comparable. Accentia Technologies Ltd (i) Headstrong Services (India) Pvt. Ltd. 27.1. The assessee objected to the inclusion of this company in the list of comparables on several grounds including peculiar economic circumstances owing to acquisition of Asscent Infoserve Pvt. Ltd. during the financial year relevant to the assessment year under consideration.
The TPO discussed the functional comparability of this company and, in the ultimate analysis, came to hold that it was functionally comparable with the assessee company and hence includible.
27.2. We have heard the rival submissions and perused the relevant material on record. We have also gone through the Annual report of this company, a copy of which has been placed in the paper book. Notes to Accounts of this company indicate about the amalgamation of Asscent Infoserve Pvt. Ltd. with it as approved by the shareholders in the court convened meeting held on 25.4.2009 and, subsequently, sanctioned by the Hon’ble High Court on 21.8.2009. The Mumbai Bench of the Tribunal in Petro Araldite (P) Ltd. Vs. DCIT (2013) 154 TTJ (Mum)
176, has held that a company cannot be considered as comparable because of exceptional financial results due to mergers/demergers. Headstrong Services (India) Pvt. Ltd. Similar view has been bolstered by the Delhi Bench of the Tribunal in several cases including Ciena India Pvt. Ltd. Vs. DCIT (ITA No.3324/Del/2013) vide its order dated 23.4.2015. In view of the fact that there was merger of Asscent Infoserve Pvt. Ltd. with Accentia Technologies Ltd. by way of amalgamation during the year itself, we hold that this company cannot be considered as comparable due to this extra-ordinary financial event. Accordingly, the same is directed to be excluded from the final list of comparables.
Infosys BPO (ii)
28.1. The TPO included this company in the list of comparables. The assessee’s objections against its inclusion were overturned.
28.2. After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company, which is available in the paper book, that there was acquisition by this company of McCamish Systems LLC. Such information is available in the paper book. Acquisition of McCamish Systems LLC during the year, being an extraordinary financial event, renders it incomparable. 40 Headstrong Services (India) Pvt. Ltd. Following the reasons taken note of above, we order for the elimination of this company from the final set of comparables.
TCS E-Serve International Ltd. (iii)
29.1. The assessee objected to the inclusion of this company on the ground that it provided financial information processing and customer contact services with high level of foreign expenditure and abnormal profits. The TPO noticed that this company was also offering ITES.
29.2. We have heard the rival submissions and perused the relevant material on record. The Annual report of this company is available in the paper book. Notes to Accounts indicate that this company is engaged in the business of providing IT enabled services/BPO services primarily to Citigroup entities globally. The operations of this company : ‘broadly comprise of transaction processing and technical services.
Transaction processing includes the broad spectrum of activities involving processing, collections, customer care and payments in relation to the services offered by Citigroup to its corporate and retail clients. Technical services involve software testing, verification and 41 Headstrong Services (India) Pvt. Ltd. validation of software at the time of implementation and data centre management activities.’ It is manifest that this company is engaged in rendering BPO services to the banking and financial services industry (BFSI) and Travel, Tourism and Hospitality (TTH). It is providing services to BFSI and TTH and such services include `Transaction processing’ and `Technical services’. In other words, the remuneration of this company from the above referred two segments includes compensation for rendering `Technical services’ and `Transaction processing’. Insofar as the `Transaction processing’ services are concerned, these are ITES, which are broadly similar to those rendered by the assessee, though not specifically similar. However, the `Technical services’ involve software testing, verification and validation of software item, implementation and data centre management activities.
Such `Technical services’ rendered by this company are in the nature of servicing and maintenance of software. At this stage, it is relevant to note that a company providing software services may be of two types, viz., a company providing software development services and a Headstrong Services (India) Pvt. Ltd. company providing software services other than software development services (hereinafter also called ‘a company providing non-development software services’ or ITES). In order to properly appreciate the vital difference between these two types of companies, it is significant to note that a company which develops software is called a company rendering software development services. Software development services also include maintenance of software and updation of the software so as to suit the ever changing requirements of the users. A company using, inter alia, a software for obtaining the desired results, is called a company providing non-development software services or ITES. Thus, it is crystal clear that there is a phenomenal difference between a company providing software development services and a company providing software non-development services in terms of expertise, professional qualification and experience required for rendering such services. A company providing software non-development services (ITES) performs a relatively low-end service. Thus the line of distinction is that whereas a company providing software development services helps in the creation, Headstrong Services (India) Pvt. Ltd. maintenance or updation of a software, on the other hand, a company providing non-development software services obtains the desired result with the use of an existing software. Further, whereas the output of the former is a software in itself or a stage in the ultimate creation of a software, the output of the later is the processed information from the raw data, obtained with the help, inter alia, of a software. From the above discussion, it is overt that a company providing software development services is distinct from and incomparable with a company providing non-development software services.
29.3. We find that the assessee under this international transaction has provided only ITES or non-development software services, in the nature of Accounting, Recruitment and Project management etc. On the other hand, this company is also providing `Technical services’ to its AE involving software testing, verification and validation of software, which are akin to software maintenance services falling, within the overall category of `Software development services’. The TPO has taken entity level figures of TCS E-Serve International Ltd. for comparison. There is Headstrong Services (India) Pvt. Ltd. no bifurcation available in respect of the revenues of this company from Transaction processing (which are in the nature of ITES, the same as provided by the assessee) and Technical services (which are in the nature of software development, absent in the assessee’s case). In the absence of the availability of any such segregation of the total revenue of this company, it is not possible to separately consider its profitability from rendering of `Transaction processing services’. As such, the entity level figures render this company unfit for comparison. Ergo, we order for the removal of this company from the final set of comparables.
TCS E-Serve Ltd. (iv)
30.1. The TPO proposed to treat this company as comparable. The assessee objected to its inclusion by contending that it was providing financial information processing and customer contact services with high operating revenue and peculiar economic circumstances leading to abnormal profits. The TPO repelled the assessee’s objections and included it in the final set of comparables. Headstrong Services (India) Pvt. Ltd. 30.2. We have heard the rival submissions and perused the relevant material on record. A copy of the Annual report of this company is available in the paper book. The company’s overview has been discussed in the paper book, which divulges that this company : “is in the business of providing business process management services in the banking and financial services (BFSI), vertical ( i.e. industry vertical) to help its customers achieve their business objectives by providing innovative best-in-class services.” We find that this company is also providing ITES. Unlike TCS e-Serve International Ltd., this company is not providing any technical services involving software testing, verification and validation of software etc. Since the functional profile of this company on a broader basis is no different from that of the assessee, both being involved in rendering ITES, we are not inclined to treat this company as incomparable. The ld. AR argued that the nature of the ITES provided by this company is different from that of the assessee and hence the same be excluded. We are disinclined to sustain this objection. When we consider the nature of services provided by this Headstrong Services (India) Pvt. Ltd. company, being the ITES, which is similar to that of those rendered by the assessee, again the ITES, we cannot order its exclusion simply for the reason that the verticals of ITES are somewhat different. A company which satisfies the broader parameters of comparability in the overall same segment, cannot be excluded due to slightly different nature of such overall activity. An examination of the comparables chosen by the assessee, which have been accepted by the TPO, also satisfy only the test of overall similarity and not the peculiar similarity, as has been now contended for the exclusion of this company. This argument is, therefore, rejected.
30.3. In so far as the objection of the ld. AR about the high profit/high turnover of this company is concerned, we find that the Hon’ble Delhi High Court in ChrysCapital Investment Advisors (India) P. Ltd. vs. DCIT (2015) 376 ITR 183 (Del) has held that the mere fact that an entity makes high/extremely high profits/losses does not, ipso facto, lead to its exclusion from the list of comparables for the purposes of determination of ALP. Similar view has been taken in Rampgreen Headstrong Services (India) Pvt. Ltd. Solutions Pvt. Ltd vs. CIT (2015) 377 ITR 533 (Del) to the effect that a potential comparable cannot be excluded merely on the ground of its abnormally higher profit. It is further noticed that the Hon’ble Delhi High Court in CIT Vs. Agnity India Technologies (P.) Ltd. (2013 ) 219 Taxman 26 (Del) examined the comparability of Infosys Technologies from the angle of its inclusion or otherwise in the list of comparable of Agnity India Technologies, a captive unit providing ITES to its AE alone. In that case, the TPO treated three companies as comparable, namely, Satyam Computer Service Ltd., L&T Infotech Ltd. and Infosys Technologies. The DRP excluded Satyam Computer only. The Tribunal excluded only Infosys Technologies Ltd., by impliedly retaining L&T Infotech Ltd. as a good comparable. On appeal by the Revenue, the Honourable High Court upheld the Tribunal order excluding Infosys on the strength of certain relevant distinguishing features including its giantness in terms of sales, nature of work and other factors. Thus it follows that L&T Infotech Ltd., which is otherwise a vast company with Headstrong Services (India) Pvt. Ltd. much higher turnover, finally found the status of a comparable with a captive company providing ITES to its AE alone.
30.4. Coming back to the facts of our case, we find that TCS e-Serve Ltd. is functionally comparable with the assessee company on an overall basis and no special reasons for its higher profit/turnover have been brought to our notice. Consequently, we hold that the authorities below were justified in including this company in the list of comparables.
Now we will examine the companies refused by the TPO as comparable. The assessee has challenged non-inclusion of certain companies in the final tally of comparables, which were not treated by the TPO as comparable. The ld. AR wants their inclusion.
(i) CG-Vak Software & Exports Ltd. (BPO segment)
The assessee treated this company as comparable which was removed by the TPO on the ground that its sale was at a lower level.
While discussing this company under the international transaction of `Provision of software development services’, we have found it to be incomparable because of its undertaking Research & Development 49 Headstrong Services (India) Pvt. Ltd. Activities, which can be pertinent to the Software Development services segment alone. There can be no question of any Research &
Development in relation to the ITES. The TPO has excluded this company from comparability only on the basis of low turnover, without disputing the functional similarity. We have discussed above that high or low profit / turnover can be no criteria for excluding an otherwise comparable company from the list of comparables. Following the same view, we hold that CG VAK (BPO segment) should be treated as comparable. The assessee succeeds. (ii) Datamatics Financial Services Ltd.
33.1. The TPO rejected this company as comparable and hence excluded the same. The assessee is insisting on its inclusion.
33.2. We have gone through the Annual report of this company, which is available in the Paper book. Its Profit & Loss Account indicates revenue from operations from ITES. It can be seen from the further data available on the record that it is engaged in providing ITES. We, therefore, hold this company to be comparable. Headstrong Services (India) Pvt. Ltd. (iii) Microgenetics Systems Ltd.
The TPO excluded this company from the list of comparables.
After going through the Annual accounts of this company, a copy of which is available on record, it can be seen that although it is engaged in providing ITES, yet the major part of the services rendered by it are being outsourced from third parties. Whereas, its salaries are Rs. 89.15 lac, Medical transcription charges paid stand at Rs. 95.48 lac. Such Medical transcription charges are in the nature of job work got done by this company from outside. There is hardly any need to emphasize that these two business models, viz., Outsourcing services from outside agencies and rendering in-house services, are completely different from each other. Since this company is providing ITES after outsourcing from third parties, the same cannot be considered as comparable to the assessee company which is rendering exclusively in-house services. We therefore, hold that this company was rightly excluded by the TPO.
(iv) R Systems International Transaction Ltd. (segmental) Headstrong Services (India) Pvt. Ltd. 35.1. The TPO excluded this company on the ground of different year ending. The assessee is aggrieved with this decision of the TPO.
35.2. While dealing with certain companies, such as, Caliber Point Business Solutions Ltd. etc. under the international transaction of `Software Development Services’, we have given certain directions to the TPO for examining if those companies could be considered as comparable. Similar directions are directed to be applied to R Systems International Ltd. as well.
(v) Caliber Points Business Solutions Ltd. (Other Segment) :
36.1. This company was not taken as comparable before the TPO. As such there can be no question of any finding returned in his order on this point. The assessee raised objection before the DRP contending that this company (Segment) should be considered as comparable. Without disposing off the assessee’s objections, the DRP went ahead. We have seen the Annual report of this company, which are available on page 269 of the paper book. It can be seen that certain segmental details are available. In view of fact that none of the authorities below has Headstrong Services (India) Pvt. Ltd. examined the comparability or otherwise of this company, we consider it appropriate to send this matter back to the AO/TPO for evaluating the assessee’s contention about the comparability or otherwise of this company.
With the above directions, we set aside the impugned order on the question of addition on account of transfer pricing adjustment under the international transactions of rendering `Software Development Services’ and providing `ITES’ and remit the matter to the file of AO/TPO for determining the ALP of these two international transactions afresh in conformity with the discussion made in this order. Needless to say, the assessee will be allowed an adequate opportunity of hearing.
38.1. Ground nos. 15 and 16 are against the addition of Rs. 5,53,05,768/- on account of re-allocation of indirect costs amongst eligible units (section 10A) and non eligible unit on the basis of gross revenue receipts. The facts apropos these grounds are that the assessee operated three units namely D-4 II Unit (non eligible), Unit D-4 Unit Headstrong Services (India) Pvt. Ltd. (eligible) and Banglore Unit (eligible). From the computation of income filed by the assessee, the AO observed that the assessee had shown a loss of Rs. 3.90 crore from the non-eligible unit, whereas profits of Rs. 20.76 crore and Rs. 5.66 crore were shown from the eligible units. The working of such profit/loss from eligible/non eligible units has been given on page 4 of the final assessment order. The dispute in the present appeal is only against the allocation of `Indirect costs’ amongst the three units. Whereas the assessee claims to have allocated indirect costs totaling Rs. 63.49 crore amongst the three units in a rational manner, the Assessing Officer apportioned such costs on the basis of unit-wise gross revenue. That is how, the amount of indirect costs in the non-eligible unit was reduced, which led to reduction in the claim of deduction u/s 10A of the Act. The DRP allowed some relief. The assessee is still unsatisfied.
38.2. We have heard the rival submissions and perused the relevant material on record. On a pertinent query, it was submitted by the ld. AR that the assessee was maintaining separate accounts in respect of three Headstrong Services (India) Pvt. Ltd. units, results from which were clubbed for drawing up the final accounts of the assessee-company. On the other hand, ld. DR contended that no such separate unit-wise accounts were maintained. It was only during the course of assessment proceeding that the assessee split up combined accounts in three parts as per its convenience and that too, on the instructions of the AO. We find that if separate accounts are maintained then there can be no difficulty in examining indirect costs incurred in respect of such units separately. However, if consolidated accounts are maintained and allocation is made thereafter for determining the profit/loss from three units separately, then the question arises about the basis of apportionment of indirect costs amongst the three units. It prima facie appears from the language of the assessment order that the assessee maintained consolidated accounts and apportionment of expenses was done at the instance of the AO alone. Be that as it may, we have to decide the basis of allocation of indirect expenses, for which the assessee also conceded to some extent before the DRP for apportionment on certain basis given in the paper book. We agree with Headstrong Services (India) Pvt. Ltd. the Ld. AR that all the expenses cannot be apportioned on the basis of gross receipts from each unit. There are certain expenses which have separate keys for allocations. In such circumstances, each expenditure needs to be viewed from the apportionment angle separately and there cannot be a strait jacket formula for apportioning them on the basis of gross revenue. Under the given circumstances, we set aside the impugned order and remit the matter to the file of AO for making apportionment of all the indirect costs separately on some reasonable basis. If the relevant keys are available for some expenses, then they should be allocated on the basis of such keys. The remaining expenses can be apportioned in the ratio of gross receipts from these three units.
The AO is directed to do it afresh after allowing a reasonable opportunity of being heard to the assessee in this regard.
The last ground is about allowing of foreign tax credit amounting to Rs.2,35,708/-. The Assessing Officer is directed to examine the assessee’s claim and allow relief, if available, as per law. Headstrong Services (India) Pvt. Ltd.
In the result the appeal is partly allowed for statistical purposes.
The order pronounced in the open court on 18. 03.2016.