HEADSTRONG SERVICES INDIA PVT. LTD.,NEW DELHI vs. DCIT, NEW DELHI

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCHES : I-1 : NEW DELHI BEFORE SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM

ITA No.6200/Del/2012 Assessment Year : 2008-09

Headstrong Services India Vs. DCIT, Pvt. Ltd., Circle-12(1), 103, Ashoka Estate, New Delhi. Barakhamba Road, New Delhi. PAN: AABCT7650D (Appellant) (Respondent)

Assessee By : Shri Nageswar Rao & Shri Shailesh Kumar, Advocates Department By : Shri Amrendra Kumar, CIT,DR Shri Deepak Tiwari, Sr. DR

Date of Hearing : 10.02.2016 Date of Pronouncement : 11.02.2016

ORDER PER R.S. SYAL, AM: This appeal by the assessee is directed against the final assessment order passed on 17.10.2012 by the Assessing Officer (AO) u/s 143(3)

ITA No.6200/Del/2012

read with section 144C of the Income-tax Act, 1961 (hereinafter also

called ‘the Act’) in relation to the assessment year 2008-09.

towards transfer pricing adjustment amounting to Rs.15,41,06,180/-.

subsidiary of Headstrong Services LLC. The assessee is a 100% export

oriented unit (EOU) for manufacture and export of computer software.

It is engaged in the provision of Software development services and IT

enabled services (ITES) to its AEs. The assessee reported two

international transactions, namely, Provision of software services and

Provision of IT enabled services. The AO made reference to the

Transfer Pricing Officer (TPO) for determination of the ALP of these

international transactions. The TPO made transfer pricing adjustment

amounting to Rs.60,39,585/- for the international transaction of ITES.

He also took up the international transaction of ‘Software services’ with

transacted value of Rs.128,96,15,682/-. It was noticed that the assessee

selected itself as a Tested party by choosing the Transactional Net

ITA No.6200/Del/2012

Margin Method (TNMM) as the most appropriate method. The assessee

used Operating Profit/Total Cost (OP/TC) as its Profit Level Indicator

(PLI) which was shown at 16.53%, calculated by taking weighted

average margin of four years, being the actual figures for the financial

year 2007-08 plus projected figures for the coming three years. The

assessee chose 23 companies as comparable, with their average PLI at

14.43%. Thus it was demonstrated that this international transaction was

at arm’s length price (ALP). The TPO accepted the assessee as a tested

party and also the TNMM as the most appropriate method. However,

the assessee’s PLI, computed on the basis of profit of four years

including projected profit of three years, was rejected. The TPO

considered the operating profit margin of the assessee for the current

year alone, calculated on the basis of actual figures. He made certain

amendments in the list of comparables in the sense that some of the

comparables chosen by the assessee were removed while a few new

were introduced. Average PLI of comparables, being OP/OC computed

at 23.82%, was applied as a benchmark for working out the transfer

pricing adjustment amounting to Rs.20,18,08,602/- for this international 3

ITA No.6200/Del/2012

transaction. The assessee challenged the draft order before the Dispute

Resolution Panel (DRP). The TPO in his order giving effect to

directions given by the DRP, did not make any adjustment in relation to

the international transaction of ITES. As regards the other international

transaction of `Software development services’, he recomputed the

profit margin of comparables at 19.73%. By applying the same to the

total operating cost incurred by the assessee, the TPO downscaled

transfer pricing adjustment to Rs.15,41,06,180/-. It is this amount which

was added by the AO in the final assessment order, which is subject

matter of the instant appeal.

material on record. The ld. AR challenged the addition on account of

transfer pricing adjustment from the international transaction of

`Software development services’ broadly on three counts, namely,

Calculation of the assessee’s PLI; Selection of comparables; and that

when the assessee is entitled to deduction u/s 10A, then no transfer

pricing adjustment can be made. We will deal with these in seriatim.

ITA No.6200/Del/2012

A. CALCULATION OF ASSESSEE’S PLI

TPO on different scores, which we will deal with hereinafter separately.

a. Whether projected profit rate of subsequent years can also be

considered ?

6.1. The assessee adopted PLI of OP/OC and computed its weighted

average profit rate of 16.53%, by taking profit margins for a period of

four years, being actual figure for the current year at 6.52% and

projected figures for coming three years at 17.23%, 19.05% and 19.05%.

The TPO rejected this approach and held that only profit for the current

year could be considered as the assessee’s PLI.

6.2. The ld. AR vehemently opposed the action of the authorities

below in rejecting the assessee’s PLI computed by considering, inter

alia, the projected figures for coming three years. It was submitted that

the assessee took contracts from its AEs in earlier years, which were

running beyond a particular year and, hence, the profitability for one

year cannot be decisive to calculate the real profits. On being called 5

ITA No.6200/Del/2012

upon to point out Agreements entered into with its AEs, the ld. AR took

us through pages 213 onwards of the paper book, which is copy of an

Agreement between the assessee and its AE for providing software

development services. This Agreement has been entered into on

25.2.2008 w.e.f. 1.4.2007. The ld. AR candidly admitted that all other

Agreements which generated revenue for the assessee during the year were effective from 1st April, 2007. As the previous year relevant to the

assessment year under consideration also begins from 1.4.2007, we

cannot accept the assessee’s contention that the Agreements were

entered in earlier years and would spill over in the subsequent years as

well. On going through the assessee’s Annual accounts, it emerges that

under the heading ‘Other current assets’ as appearing in the Balance

sheet, there is an item of ‘Unbilled revenue amounting to

Rs.3,24,77,983/-.’ On further inquiry, it transpired that this amount

represents work-in-progress of the assessee accounting for expenses

incurred during the year for which the work is still incomplete and no

revenue is received. The ld. AR accepted that all the expenses booked in

the Profit & Loss Account match with the corresponding revenue 6

ITA No.6200/Del/2012

actually realized and this provision of work-in-progress is a standard

accounting procedure adopted for excluding expenses incurred on work

done for which revenue is yet to be accounted for. This divulges that the

assessee debits expenses to its Profit & Loss account only to the extent

for which corresponding revenue is recognized in accounts and as such,

there is no possibility of shifting revenue or expenses from one year to

another, so as to distort the figure of profit for each year independently.

We are, ergo, unable to approve this argument raised on behalf of the

assessee.

6.3. Further, section 92(1) provides that: ‘Any income arising from an

international transaction shall be computed having regard to the arm’s

length price.’ Section 92C dealing with the computation of arm’s length

price provides through sub-section (1) that the arm’s length price in

relation to an international transaction shall be determined by any of the

methods given in this provision. When we consider the language of

section 92(1) in juxtaposition to that of section 92C(1), it emerges that it

is the income arising from an international transaction which is to be

ITA No.6200/Del/2012

computed having regard to its ALP. Sub-section (3) (a) of section 92C

provides that where the AO, during the course of any proceedings for

assessment is of the opinion that “the price charged or paid in an

international transaction” has not been determined as per ALP, then, he

may proceed to determine the ALP in relation to the said international

transaction. This provision, again, brings out that it is ‘the price charged

or paid in international transaction’ which is taken up for consideration

by the AO for examining whether or not the same is at ALP. The above

provisions plentifully show that it is the actual income from an

international transaction earned during the year, which is taxed at its

ALP. The base for comparison, being the actual income of the assessee

from an international transaction, cannot be substituted with any

hypothetical figure by considering, inter alia, projected profits for the

subsequent years. Essence of the entire transfer pricing provisions is to

compare the actual price/profit realized/earned by the assessee from an

international transaction with the price/profit realized/earned from

comparable uncontrolled transactions. It is totally impermissible to

substitute actual profit earned by the assessee from an international 8

ITA No.6200/Del/2012

transaction with any other profit base, either by considering the actual

profits for the earlier years as well or by taking into account the

projected profits of the subsequent years, for the purposes of

determining the ALP of an international transaction. Moreover, the

figures taken for subsequent three years are mere projections. The

correctness of these projections is mystery for us. We, therefore,

jettison the view point of the assessee in calculating its PLI by

considering figures for the current year and also projected figures for

subsequent three years. The impugned order is, therefore, upheld on this

score.

(b) Foreign Exchange Fluctuation

7.1. The ld. AR contended that the adjustment on account of difference

in foreign exchange rates for the year under consideration vis-à-vis the

earlier year was claimed by the assessee by means of adjustment to its

operating profit, which was wrongly refused by the TPO. He submitted

that the value of Indian Rupees appreciated in comparison with all the

major foreign currencies, especially the US dollars. It was argued that

ITA No.6200/Del/2012

the average exchange rate for USD in the Financial year 2006-07 was

Rs.45.25 in comparison with Rs.40.29 for the Financial year 2007-08,

relevant to the assessment year under consideration. The effect of such

fluctuation in the foreign exchange rate, as explained by the ld. AR was,

that decline of 10.96% was registered in the assessee’s revenue, which

was required to be adjusted against its profit margin for the current year.

He submitted that the authorities below erred in not allowing such

adjustment to the assessee’s PLI. The ld. DR opposed granting of any

adjustment in the PLI of the assessee in principle and also on merits. He

submitted that adjustment, if any, can be allowed only in the profit rate

of comparables and not that of the assessee. As such, we need to first

determine, if any adjustment to the actual profit margin of the assessee is

at all possible for the purposes of determining the ALP of an

international transaction?

7.2. Chapter-X of the Act contains special provisions relating to

avoidance of tax. Section 92, which is the first section of this Chapter,

provides for computation of income from an international transaction

ITA No.6200/Del/2012

having regard to arm’s length price. Sub-section (1) of the section

provides that any income arising from an international transaction shall

be computed having regard to the arm’s length price. Section 92C of the

Act enshrines provisions relating to computation of arm’s length price.

Sub-section (1) of the section states that the arm’s length price in

relation to an international transaction shall be determined by any of the

methods listed herein which include, inter alia, the transactional net

margin method. Sub-section (2) of section 92C provides that the most

appropriate method referred in sub-section (1) shall be applied for

determination of the ALP in the manner as may be prescribed.

Calculation of ALP under the TNMM, which method has been accepted

by the assessee as the most appropriate method in the instant case, has

been prescribed under Rule 10B(1)(e) of the Income-tax Rules, 1962,

which states that for the purposes of section 92C(2), the ALP in relation

to the international transaction shall be determined as under : -

`(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

ITA No.6200/Del/2012

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.’ 7.3. A bare perusal of sub-clause (i) of Rule 10B(1)(e) brings out that

the net profit margin realized by the enterprise from an international

transaction is to be computed in relation to a particular base. Sub-clause

(ii) provides that the net profit margin realized by the enterprise from the

comparable uncontrolled transaction is computed having regard to the 12

ITA No.6200/Del/2012

same base. Sub-clause (iii) provides that the net profit margin realized

by a comparable company, determined as per sub-clause (ii) above, ‘is

adjusted to take into account the differences, if any, between the

international transaction and the comparable uncontrolled transactions,

..... which could materially affect the amount of net profit margin in the

open market.’ It is this adjusted net profit margin of the unrelated

transactions or of the comparable companies, as determined under sub-

clause (iii), which is used as benchmark for the purposes of making

comparison with the net profit margin realized by the assessee from its

international transaction as per sub-clause (i). Sub-clause (iv) states that

the net profit margin realized by the enterprise, as referred in sub clause

(i), is established to be the same as a net profit margin referred in sub-

clause (iii) of the comparables. Sub-clause (v) states that the net profit

margin thus established is then taken into account to arrive at an arm’s

length price in relation to international transaction. On going through the

above sub-clauses of Rule 10B(1)(e), it becomes patent that as per the

first step, the net profit margin ‘realized’ by the enterprise from an

international transaction is to be computed. Use of the word ‘realized’ in 13

ITA No.6200/Del/2012

the provision richly indicates that it is the calculation of actual operating

profit margin of the assessee earned from international transaction,

which is not any adjusted figure. Similar position can be traced from the

language of sub-clause (iv), where again reference has been made to

profit margin `realized’ by the assessee from the international

transaction. When we consider sub-clauses (ii) and (iii), it turns out

that, firstly, the net operating margin actually realized from the

comparable uncontrolled transaction is computed, which is determined

in the same way as that of the assessee as per clause (i), that is, actual

figures without making any adjustment. Then sub-clause (iii) talks of

adjusting the actually realized margin of comparables to bring the same

at par with the international transaction undertaken by the assessee, so as

to iron out the effects of differences between the international

transaction and comparable uncontrolled transactions. On going through

all the sub-clauses of Rule 10B(1)(e), the position which follows is that

the net profit margin realized by the assessee from its international

transaction is taken as such and the adjustments, if any, due to

differences between the international transaction and comparable 14

ITA No.6200/Del/2012

uncontrolled transactions, are given effect to in the profit margin of

comparables. The viewpoint canvassed by the learned Authorized

Representative that the adjustment should be carried out in the profit

margin of the assessee is, ergo, devoid of merit and contrary to the legal

provisions, which is hereby repelled. Our view is supported by several

orders passed by the Delhi benches of the tribunal on this issue including

DCIT vs. Claas India Pvt. Ltd. (ITA No.1783/Del/2011) dt. 12.08.2015

and Saxo India Pvt. Ltd. VS. ACIT (ITA No. 6148/Del/2015) dt.

February, 2016. Resultantly, it is held that foreign exchange fluctuation

adjustment, or for that matter any other adjustment, can be legally made

only in the profit margin of the comparables, if it is otherwise factually

warranted and not in the profit margin of the assessee.

7.4. On going through all the Agreements entered into by the assessee

with its AEs, to which our attention was drawn by the ld. AR, it is

manifest that these have been made effective from 1.4.2007, being the

current year alone. Under such circumstances, there can be no ground

for arguing that the Agreements were entered in the preceding year and

ITA No.6200/Del/2012

the remuneration as realized in the current year on the basis of the

foreign exchange rates as applicable, adversely affected its profit margin

for the current year, thereby requiring an upward revision in PLI of the

assessee. Once the Agreements have been entered into with effect from

the first day of the previous year, there can be no scope for comparing

the rate of foreign exchange during the year with that of the preceding

year or any other earlier year, so as to claim any adjustment.

7.5. The next leg of the argument of the ld. AR about the foreign

exchange fluctuation having adversely affected its profits for the current

year on standalone basis, is also unsustainable. It is so for the reason

that this is a factor, whose impact is common both to the assessee and

comparables. Any northwards or southwards sojourn in the foreign

currency rate leaves its impact on the operating profit of the assessee in

the same manner as on that of the comparables. If the assessee’s profit

margin got shrinked due to adverse fluctuation in the foreign exchange

rate, the same rate when applied to the comparables, would have

affected their profit margins as well. Since adjustment is permissible in

ITA No.6200/Del/2012

the profit margin of comparables only due to differences between the

international transaction and the comparable uncontrolled transaction,

and not due to a factor affecting profit of both the assessee and

comparables in the same manner, we refuse to allow any adjustment in

the profit rate of comparables because of fluctuation in the foreign

currency rate.

7.6. It is, therefore, held that neither the assessee can claim any

adjustment on account of foreign exchange fluctuation rate in its profit

nor such an adjustment, on the facts and circumstances of the instant

case, is warranted in the profit margin of comparables.

(c) Revenue sharing formula

8.1. The ld. AR submitted that the assessee’s AE shared 80% of total

revenue from its clients with the assessee and for similar services

obtained from unrelated parties, the AE shared 78.5% of the revenue

with such third parties. In the light of this arrangement with the assessee

for sharing higher profit percentage by its AE with it vis-à-vis the third

parties, the ld. AR contended that its international transaction should be

ITA No.6200/Del/2012

considered at ALP within the meaning of Comparable uncontrolled price

(CUP) method. The ld. AR stated that such submission was made

before the DRP also which has been rejected without any plausible

reason. This was countered by the ld. DR, who stated that such a

revenue sharing formula has no significance in so far as the assessee’s

operating profit margin is concerned.

8.2. We have heard the rival submissions and perused the relevant

material on record. It is observed that the assessee adopted TNMM as

the most appropriate method in its TP study report. The TPO accepted

the same. It was only for the first time that the assessee raised this

alternative submission before the DRP for applying the alleged internal

CUP method, which came to be turned down by the DRP.

8.3. It is noticed that the assessee has treated itself as a tested party in

its transfer pricing study report, which has been accepted by the TPO.

Under the CUP method as prescribed under Rule 10B(1)(a), price

charged for services rendered in a comparable uncontrolled transaction

is identified which is then adjusted to account for differences, if any,

ITA No.6200/Del/2012

between the international transaction undertaken by the assessee and

comparable uncontrolled transactions. Such adjusted price is taken as

ALP in respect of the services provided by the assessee in the

international transaction. From the machinery provision contained in

Rule 10B(1)(a) in this regard, it is clear that the internal CUP provides

for comparing the assessee’s international transaction with another

comparable uncontrolled transaction undertaken by it. We fail to

appreciate the logic behind the ld. AR’s submission in comparing the

Revenue sharing formula between the assessee and its AE on the one

hand and its AE and third parties on the other. As the assessee is a

tested party, under the CUP method, it is only the price charged by it

which can be compared with the price charged by some comparable(s) in

uncontrolled transactions. The argument put forth on behalf of the

assessee can be successfully applied only in determining the ALP of the

international transactions undertaken by its AE so as to make a valid

comparison between remuneration paid by such AE to the assessee with

that paid to unrelated parties, provided other terms and conditions of the

provision of services are similar. Presently, we are dealing with the 19

ITA No.6200/Del/2012

determination of ALP of the international transaction undertaken by the

assessee and not its foreign AE. The assessee can resort to the CUP

method only by showing that the price charged by it from its AE was

favourably comparable to the price charged by some other comparable

company(ies) in uncontrolled transaction(s). The ld. AR has brought no

material on record to show the price charged in a comparable

uncontrolled situation. We, therefore, hold that the view canvassed

before the DRP for the first time in resorting to the CUP method is

devoid of merits and as such, the most appropriate method in the facts

and circumstances of the instant case is TNMM, which was originally

adopted by the assessee and also approved by the TPO.

right in working out its PLI by also considering projected profits for the

three subsequent years; no deduction on account of foreign exchange

fluctuations can be allowed in the facts and circumstances of the instant

case; and the revenue sharing formula as put forth by the assessee as

relevant under the CUP method for determining the ALP, is not correct.

ITA No.6200/Del/2012

Consequently, it is held that the calculation of PLI of the assessee done

by the TPO under TNMM is correct, which does not warrant any

interference. We, therefore, countenance the same. The assessee fails on

this issue.

B. SELECTION OF COMPARABLES.

the final list of comparables and also exclusion of certain companies

which, in its opinion, ought to have been included in such list.

assailed before us, it is relevant to understand the nature of business

carried out by the assessee. We have briefly noticed above that the

assessee is engaged in providing software development services to its

AEs. The assessee is providing end-to-end systems integration 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 it is

providing customized software application development for its AE

ITA No.6200/Del/2012

within which it focuses on the services of Application development, Re-

engineering and legacy applications, Maintenance of existing

applications, Enterprise application integration and specialized quality

assurance and testing services. The assessee is providing services in two

kinds of projects, namely, Integrated projects (in which work is done

both by the assessee and its US based AE to be finally delivered to the

client) and Non-integrated projects (in which work is done by the

assessee alone and this work is end product in itself). The above

narration of facts indicates that the assessee is a captive unit engaged in

providing software development services to its AEs only under this

international transaction and is not selling software products under its

own ownership. With the above background in mind, we will examine

the comparability or otherwise of the companies assailed in the instant

appeal.

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

ITA No.6200/Del/2012

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.

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, 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

ITA No.6200/Del/2012

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 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 24

ITA No.6200/Del/2012

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 held 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 and the factual matrix, we will

distinctly examine the companies chosen by the TPO to ascertain if they

are really comparable.

(i) Avani Cimcon Ltd.

14.1. This company was not chosen by the assessee as a comparable

for the international transaction of Software development services. The

TPO included it by observing that it was also engaged into software

development consulting company with client base in Australia, US, UK,

ITA No.6200/Del/2012

Africa and the European Union with major focus on the travel and

insurance industry. The DRP also rejected the assessee’s contention

against the inclusion of this company.

14.2. We have perused the Annual accounts of this company available

in the assessee’s paper book. Apart from its Balance sheet, Profit & loss

account and some Schedules, the Director’s Report and Auditor’s

Report, etc. of this company are not available. The ld. AR contended

that the information of this company available in the public domain for

the year under consideration has been downloaded and placed before us

and except for these documents, no other reports etc., constituting part

of Annual report for the year ending 31.3.2008, are available. However,

our attention was drawn towards certain Tribunal orders which have

considered the functional profile of this company on the basis of

information available on its website. First is Tribunal order in Agnity

India Technologies Pvt. Ltd. Vs. DCIT (ITA No.6485/Del/2012). Vide its

order dated 20.9.2013, the tribunal considered the functional profile of

this company by noticing it to be a Product company owning software

ITA No.6200/Del/2012

products like Dxchange, Travel Solutions, Insurance Solutions,

Customer Appreciation, etc. Similar view has been taken by the

Mumbai Bench of the Tribunal in the case of NetHawk Networks India

Pvt. Ltd. Vs. ITO (ITA No.7633/N/2012). Vide its order dated

6.11.2013, the Tribunal for the assessment year 2008-09 has noticed

Avani Cimcon Ltd. to be a Product company. No contrary material has

been placed before us by the ld. DR to show the functional profile of this

company matching with the assessee. When contrasted with the

assessee company, which is engaged in providing software development

services to its group concerns, we fail to see as to how a software

product company like Avani Cimcon Ltd., having intellectual property

rights over some of the products developed by it, can be compared with

the assessee on an entity level. We, therefore, order for the elimination

of this company from the list of comparables.

(ii) Bodhtree Consulting, Persistent Systems Ltd., Quintegra Solutions Ltd., Tata Elxsi, Thirdware Solutions Ltd.

15.1. The assessee accepted these companies as comparable before

the TPO which is apparent from his order. No issue was raised before 27

ITA No.6200/Del/2012

the DRP contesting the comparability of these companies. It is only for

the first time that the assessee has challenged before us that these

companies are not comparable. It was, therefore, prayed that these

companies be excluded from the list of comparables. This was opposed

by the ld. DR, who argued that once the assessee has accepted a

particular company as comparable before the TPO and/or DRP, it cannot

be allowed to resile from its stand in contesting before the Tribunal that

the same is not comparable.

15.2. The Special Bench of the Tribunal in DCIT vs. Quark Systems

Pvt. Ltd., (2010) 132 TTJ (Chd) (SB) 1, has held that a company which

was included by the assessee and also by the TPO in the list of

comparables at the time of computing the ALP, can be excluded by the

Tribunal if the assessee proves that the same was wrongly included. The

ld. DR argued that this Special Bench decision should not be applied

because much water has flown since then and the transfer pricing

provisions have come out from its nascent stage. We are unable to

accept this contention raised on behalf of the Revenue for the obvious

ITA No.6200/Del/2012

reason that the hands of the assessee cannot be tied to challenge the

comparability of a company before the Tribunal for the first time if it is

really incomparable. A mere challenge to the comparability of a

company before the Tribunal does not itself lead to the acceptance of

comparability. Rather, the facts are required to be probed and examined

for ascertaining whether such a company is, in fact, comparable or not.

There can be no estoppel against the exclusion of certain comparables

from the list of comparables which are, in fact, not comparable. Several

orders have been passed by the Delhi benches of the tribunal even in the

recent past following the ratio of the Special bench decision referred to

hereinabove. In view of the fact that the comparability or otherwise of

these companies was not examined by the TPO, in our considered

opinion, the ends of justice would meet adequately if the impugned

order on this issue is set aside and the matter is restored to the file of

AO/TPO for examining the assessee’s contention afresh as regards the

comparability of these companies. We order accordingly.

ITA No.6200/Del/2012

(iii) e-Zest Solutions

16.1. The TPO included this company in the list of comparables after

collecting information u/s 133(6) which disclosed that it was engaged in

rendering software development services only. The assessee’s objections

about the unreliable information and non-availability of information in

public domain, were rejected by the TPO.

16.2. We have heard the rival submissions and perused the Annual

report of this company, which is available on page 1 onwards of the

paper book. Page 6 of the Annual report, being an annexure to the

Auditor’s report, clearly indicates under (ii) that: ‘there is no inventory

with the company since it is engaged in software development.’ From

the balance sheet of this company, it is noticeable that there is no closing

stock of any software products. Since the assessee is also engaged in

rendering software development services and this company is also doing

the same business, we are of the considered opinion that this company

was rightly included in the list of comparables.

ITA No.6200/Del/2012

16.3. The ld. AR’s contention this company, being in KPO business as

against the assessee’s BPO business, is unsubstantiated. Neither it has

been shown that the assessee is rendering BPO services nor that e-Zest is

providing KPO services. We, therefore, approve the view taken by the

authorities below on this issue.

(iv) Infosys Technologies Ltd.

17.1. 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

the same in the final list of comparables. The assessee is aggrieved

against its inclusion in the ultimate set of comparables.

17.2. 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

ITA No.6200/Del/2012

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

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 captive

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. 32

ITA No.6200/Del/2012

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.

(v) KALS Information Systems Ltd. (Seg.)

18.1. This company was not chosen by the assessee as a comparable.

However, the TPO included it in the final list. The sum and substance of

the reasoning adopted by the TPO for considering this company as

comparable is that it is also a software development and consulting

company, meeting the filters adopted by him.

18.2. We have gone through the Annual accounts of this company, a

copy of which is available in the paper book. Schedule no. 16

comprising Notes to the Financial Statements gives background of this

company to be ‘engaged in development of software and software

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products since its inception.’ This company consists of STPI unit

engaged in development of software and software products. Segmental

information of this company is available in the paper book which has

been divided into two parts, namely, `Application software segment’

and `Training segment’. It is the `Application software segment’ of this

company, which has been adopted by the TPO. The development of

software and all software products have been clubbed under the

‘Application software’ segment. Since the figures of this company taken

by the TPO for making comparison with the assessee include the effect

of software products as well, apart from software development services,

the same cannot be considered as comparable. It is obvious that a

product company cannot be compared with a company engaged in

providing software development services because of difference in the

inherent characteristics of both. We, therefore, order for the removal of

this company from the set of comparables.

ITA No.6200/Del/2012

(vi) Wipro Ltd. (Seg.)

19.1. The TPO included this company in the list of comparables by

overruling the assessee’s objections about the super normal profits

earned by this company; very high turnover; owning significant IPRS in

the form of patents; and engaged in R& D activity. The assessee failed

to persuade the DRP to fall in line with its reasoning for the exclusion of

this company from the final set of comparables. That is how, the

assessee is before us.

19.2. We have heard the rival submissions and perused the relevant

material on record. It is noticed that the TPO has taken ‘Software

development’ segment of this company on standalone basis. We agree

with the TPO that super normal profits or very high turnover cannot be

criterion for treating an otherwise functionally comparable company as

incomparable. However, the fact remains that this company own

significant IPRS in the form of patents which are obviously used in the

rendering software development services. Apart from that, this company

is engaged in R&D activity. Per contra, the assessee in question is only

ITA No.6200/Del/2012

a captive software development service provider not owning any IPRS.

Owning or not owning IPRS in the form of patents in software

developed by a company, has an important bearing on the profits earned

by it from the ‘Software development services’ segment. A company

which does not own any IPRS and carries on the activity of rendering

software development services at its own, cannot be compared with a

company which provides software development services by using its

own IPRS in the form of patents of software. Under such circumstances,

we hold that this company cannot be considered as comparable at

segmental level. The same is ex consequenti directed to expelled from

the set of comparables.

(vii) Softsol India Ltd.

20.1. This company was included by the TPO in the list of

comparables. Though the ld. AR initially challenged its inclusion,

however, later on, the comparability of this company was accepted. We,

therefore, approve the impugned order in including this company in the

list of comparables.

ITA No.6200/Del/2012

excluded by the TPO and the assessee intends their inclusion.

(i) Aditya Birla Minacs IT Services Ltd. (formerly known as PSI Data Systems); and Aditya Birla Minacs Tech. Ltd. (Birla Technologies Ltd.)

22.1. These two companies were initially proposed as comparable

by the TPO. However, subsequently, it was realized that the same were

not comparable. The TPO noticed that the ratio of related party

transactions (RPT) to sales of these companies was 33.65% and 94.09%,

respectively, which made them controlled transactions and hence

incomparable. The assessee is aggrieved against the non-inclusion of

these companies in the final list of comparables.

22.2. We have heard the rival submissions and perused the relevant

material on record. It is found that the predominant view of the Tribunal

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 the Delhi Bench in Toluna India Pvt. Ltd.

ITA No.6200/Del/2012

(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.).

22.3. Adverting to the facts of the instant case, it is noticed that

the TPO recorded RPT as a percentage of sales at a level higher than

25% for both the companies so as to exclude them. The ld. AR

contended that while computing the related party transactions, the TPO

also considered ‘Reimbursement of expenses (Net)’, which ought not to

have been included.

22.4. We do not find any substance in this argument for the reason

that the reimbursement of expenses debited by the assessee to its Profit

& Loss Account are, in fact, part of the total costs incurred by the

assessee. The mere fact that such costs were initially incurred by the AE

and then reimbursed, would not alter the position. Further, no material

has been placed on record to show that these re-imbursements were

without any mark-up. The Hon’ble jurisdictional High Court in CIT VS.

Cushman And Wakefield (India) Pvt. Ltd. (2014) 367 ITR 730 (Del) has

ITA No.6200/Del/2012

held that reimbursement of expenses even without any mark-up are also

required to be processed under TP provisions by benchmarking under

one of the methods.

22.5. Be that as it may, we find that both these companies are also into

sale of software products. It is apparent from their Annual accounts,

copies of which have been placed on record. While analyzing the

exclusion of certain companies challenged by the assessee above, we

have held that a company with software product cannot be compared

with the assessee company, which is engaged in providing software

development services. Applying the same analogy, we hold that these

two companies were also rightly excluded by the TPO as these are also

functionally different, engaged in sale of software products as well. We,

therefore, approve the view taken by the TPO on this issue.

(ii) Indium Software (I) Ltd.

23.1. We have perused the relevant part of the Annual accounts of

this company, which has been reproduced on page 41 of the TPO’s

order. It can be seen that this company, apart from rendering software

ITA No.6200/Del/2012

services, is also engaged in ‘Sale of software.’ In addition to that, this

company has also income from `Training services’. Even though the

amount of revenue from training services is less, still one cannot

anticipate the impact of revenue from `Training’ in the overall

profitability of this company. We, therefore, hold this company to be

incomparable and approve the view taken by the authorities in its

exclusion.

(iii) SIP Technologies and Exports Ltd.

24.1. This company was originally the assessee’s comparable

which was excluded by the TPO. The assessee wants inclusion of this

company in the final tally of comparables.

24.2. We have gone through the Annual accounts of this company,

a copy of which has been placed on record. The TPO excluded this

company from the list of comparables by holding that it made an

investment of Rs.5 crore in SIP Solutions Ltd., which was more than

twice of the total revenue, thereby affecting the working capital and

causing abnormal margin/loss. When we go through the Schedule of

ITA No.6200/Del/2012

Investments of this company, which is available at page 608 of the paper

book, it transpires that Investment of Rs.5 crore in Siptech Solutions

Ltd., was made in some earlier year inasmuch as the same figure is

appearing in the balance sheet of the preceding year as well. Thus, it is

clear that there is no abnormal activity of this company. Since this

company is also exclusively engaged in providing software development

services, we hold it to be comparable.

(iv) VMF Soft Tech Ltd.

25.1. This was originally the assessee’s comparable, which was

excluded by the TPO by observing that it was outsourcing a major part

of its work.

25.2. We have perused the Annual accounts of this company, which are

available in the paper book. It can be seen that out of total ‘Software

expenses’ amounting to Rs.55.11 lac, this company outsourced this

activity by means of sub-contract by incurring expenses of Rs.53.95 lac.

Thus, it is palpable that this company has outsourced its major activity

and, hence, cannot be compared with a company like the assessee

ITA No.6200/Del/2012

rendering in-house services. We, therefore, hold that this company was

rightly excluded from the list of comparables.

C. DEDUCTION U/S 10A- WHETHER ANY TP ADDITION IS PERMISSIBLE? 26.1. The ld. AR vehemently argued that its profit is deductible u/s

10A of the Act. He submitted that once the profit from rendering of

software development services is deductible u/s 10A, then, no motive

can be attributed for artificially reducing the profit by manipulating the

price with its AE. It was elaborated that the profit of an assessee,

eligible for deduction under section 10A, becomes tax neutral

irrespective of its quantum. He, therefore, urged that either the

international transaction should not be processed in terms of Chapter-X

of the Act or higher amount of deduction should be allowed

corresponding to the amount of addition on account of transfer pricing

adjustment. This was forcefully contested by the ld. DR.

26.2. Having heard the rival submissions and perused the relevant

material, we find ourselves unable to accept both the submissions

advanced by the ld. AR on this aspect of the matter. In so far as the first

ITA No.6200/Del/2012

submission for not carrying out any transfer pricing adjustment in view

of the benefit enjoyed by it u/s 10A of the Act is concerned, we find that

no exception has carved out by the statute for non-determination of the

ALP of an international transaction of an assessee who is eligible for the

benefit of deduction section 10A/10B or any other section of Chapter-

VIA of the Act. Section 92(1) clearly provides that any income arising

from an international transaction is required to be computed having

regard to its arm’s length price. There is no provision exempting the

computation of total income arising from an international transaction

having regard to its ALP, in the case of an assessee entitled to deduction

u/s 10A or 10B or any other relevant provision. Section 92C dealing

with computation of ALP clearly provides that the ALP in relation to an

international transaction shall be determined by one of the methods

given in this provision. This section also does not immune an

international transaction from the computation of its ALP when income

is otherwise eligible for deduction. On the contrary, we find that sub-

section (4) of section 92C plainly stipulates that where an ALP is

determined, the AO may compute the total income of the assessee 43

ITA No.6200/Del/2012

having regard to the ALP so determined. This shows that the total

income of an assessee entering into an international transaction, is

required to be necessarily computed having regard to its ALP without

any exception. Thus, the ld. AR’s argument that since its income is

subject to deduction u/s 10A, the provisions of the Chapter-X of the Act

should not be applied, in our considered opinion, has no force in view of

the clear statutory mandate contained in proviso to section 92C(4),

which reads as under:-

`Provided that no deduction under section 10A or section 10AA or section

10B or under Chapter VI-A shall be allowed in respect of the amount of

income by which the total income of the assessee is enhanced after computation of income under this sub-section:’.

26.3. A circumspect perusal of this proviso read along with sub-

section (4) of section 92C divulges that when the total income of an

assessee from an international transaction is computed having regard to

its ALP, then, no deduction u/s 10A or any other section including those

covered under Chapter VIA of the Act shall be allowed in respect of the

ITA No.6200/Del/2012

amount of income by which the total income of the assessee has been

enhanced after computation of income determined on the basis of the

ALP of an international transaction. The legislature has unconditionally

provided for not allowing the benefit of deduction under any section in

respect of the addition made on account of transfer pricing adjustment.

Not allowing of any benefit u/s 10A in respect of an addition on account

of transfer pricing adjustment pre-supposes the existence of transfer

pricing addition in the first instance to an assessee who is otherwise

eligible to the benefit of deduction under this section. If one was to

presume that no addition towards transfer pricing adjustment is

comprehensible in the case of an assessee enjoying the benefit of

deduction u/s 10A, then there was no need to enshrine an express

provision forbidding the grant of deduction under this section in respect

of enhancement of income due to transfer pricing adjustment. Once the

legislature has engrafted an unambiguous provision explicitly spelling

out the non-granting of deduction u/s 10A on the enhanced income due

to transfer pricing addition, we are afraid to accept the assessee’s

contention, which runs diagonally opposite to the unequivocal language 45

ITA No.6200/Del/2012

of proviso to section 92C(4). This contention, if taken to a logical

conclusion, would amount to obliterating the provisio itself, which is

patently incorrect.

26.4. Our view is fortified by the Special Bench order in the case of

Aztech Software and Technology Services Ltd. vs. ACIT (2007) 107 ITD

141 (SB) (Bangalore) in which similar issue has been decided by the

Special Bench by holding that availability of exemption u/s 10A to the

assessee is no bar to applicability of sections 92C and 92CA. Similar

view has been taken by Pune Bench of the Tribunal in the case of ACIT

vs. MSS India (P) Ltd. (2009) 123 TTJ 657 (Pune) and several other

orders referred to on page 5 of the TPO’s order. The reliance of the ld.

AR on the order of the Mumbai Bench of the Tribunal in the case of

DCIT vs. Tata Consultants Services Ltd. (ITA No. 7513/M/2010) dated

4.11.2015, in our considered opinion is misconceived, because, in that

case, the Tribunal primarily found that the AO erred in not himself

examining the issue of TP and failed to apply his mind to the TP report

filed by the assessee. The last sentence in para 54 of the order

ITA No.6200/Del/2012

upholding the assessee’s contention that no TP adjustment can be made

where the assessee enjoys benefit of deduction u/s 10A or 80HHE, etc.,

is only obiter dicta inasmuch as the addition was found to be not

sustainable on the other main grounds as discussed in the body of the

order. On the contrary, we find that the decision of the Special bench in

Aztech Software (supra) permitting the applicability of sections 92C and

92CA to an assessee availing the benefit of section 10A of the Act is its

ratio decidendi. On a specific query, the ld. AR could not point out any

judgment of some Hon’ble High Court deciding this point either way. In

view of the fact that there is already a Special Bench decision in the case

of Aztech Software (supra) which supports the making of transfer

pricing adjustment notwithstanding the eligibility of deduction u/s 10A

to the assessee, apart from clear statutory mandate contained in proviso

to section 92C(4), we are more inclined to go with the view of the

Special Bench.

26.5. It is, therefore, held that the eligibility of the assessee to

deduction u/s 10A of the Act does not operate as a bar for determining

ITA No.6200/Del/2012

the ALP of international transaction undertaken by it and further the

enhancement of income due to such transfer pricing addition cannot be

considered for allowing the benefit of deduction under this section.

order and remit the matter to the file of AO/TPO for a fresh

determination of the ALP of the international transaction of `Software

development services’ in consonance with our decision on various

aspects given above. Needless to say, the assessee will be allowed a

reasonable opportunity of hearing in such fresh proceedings.

28.1. Ground no. 8 of the appeal is against allowing short deduction

u/s 10A to the extent of Rs.1,22,342/- in respect of Noida unit, which is

eligible for tax holiday u/s 10A of the Act.

28.2. The facts apropos this ground are that the assessee computed its

eligible profit u/s 10A at Rs.13.61 crore. The assessee credited its Profit

and loss account with ‘Liability no longer required - written back’

amounting to Rs.1,48,180/- and ‘Miscellaneous income’ amounting to

Rs.1,93,018/-. Deduction u/s 10A was also claimed in respect of these

ITA No.6200/Del/2012

two items. It was argued that these expenses were claimed in earlier

years, which led to reduction of eligible income of such years. But, in

this year, these were reversed to the above extent as there was excess

deduction in earlier years and accordingly, the assessee was entitled to

benefit of section 10A on these amounts. The AO bifurcated sum of

these two amounts in three parts and apportioned a sum of Rs.1,22,342/-

in respect of eligible unit and reduced this amount from the eligible

profit of unit D-4 (Noida). The assessee is aggrieved against this

decision of the AO.

28.3. After considering the rival submissions and perusing the

relevant material on record, we find that a sum of Rs. 1,22,342/- has

been apportioned by the AO himself as relatable to the eligible unit D-4,

Noida. This apportionment has been done of sum of two items, namely,

Rs.1,48,180/- which was claimed as deduction by the assessee in earlier

years and a sum of Rs.1,93,018/- which is the amount of bank charges

refunded during the year. These two items were claimed as deduction in

the earlier years from the eligible income and these have turned out to be

ITA No.6200/Del/2012

excessive to this extent, either because of the excess provision created in

the earlier year which has been now reversed or the excess bank charges

claimed which have been refunded in the instant year. Since these

expenses at the time of their incurring in the earlier years went on to

reduce the eligible income of the Noida unit, in our considered opinion,

when the excess amount is reversed in the current year, the same should

also be made eligible for the benefit of deduction u/s 10A of the Act.

We, therefore, overturn the assessment order on this point, and direct the

inclusion of a sum of Rs. 1,22,342/- in the eligible profit for the

purposes of deduction.

29.1. Ground no. 9 is against not allowing deduction u/s 10A on a

sum of Rs.1,53,300/-, being the amount of depreciation disallowed. The

assessee claimed depreciation during the assessment year 2007-08 on

`Provision of computer software’ amounting to Rs.3,65,000/-, which

was disallowed. Since the closing WDV of last year i.e., 2,55,500/-

(Rs.3,65,000 – 1,09,500/-) would be included in the opening written

down value of current year, the AO opined that the depreciation claimed

ITA No.6200/Del/2012

in the current year on this amount should also be disallowed.

Accordingly, depreciation amount of Rs.1,53,300/- (Rs.2,55,500x60%)

was disallowed.

29.2. Having heard both the sides and perused the relevant material on

record, we find it as an undisputed position that the `Provision of

computer software’ amounting to Rs.3,65,000/- disallowed in the

preceding year, namely, AY 2007-08, has not been further assailed by

the assessee. The ld. AR submitted that such disallowance was accepted

and no further appeal was filed on this issue. The ld. DR did not

controvert this position. In that view of the matter, it becomes explicit

that the opening written down value to the extent of Rs.2,55,500/- was

excessive and ought to have been reduced. Once this amount is reduced,

the assessee’s claim for depreciation on such amount to the tune of

Rs.1,53,300/- also becomes disallowable. We, therefore, approve the

action of the AO in making addition for a sum of Rs.1,53,300/-.

29.3. However, the disallowance of depreciation to this extent will

correspondingly enhance the eligible profits of Noida unit and the

ITA No.6200/Del/2012

resultant amount of deduction u/s 10A to this extent. Thus, the

disallowance so made would be set off with the increased claim of

deduction u/s 10A resulting into no ultimate addition on this score. As

the AO has simply made disallowance on account of depreciation

without allowing benefit of section 10A on this disallowance, we hold

that the assessee should also be allowed benefit u/s 10A of the Act to

this extent. This ground is allowed.

is consequential and, accordingly, disposed of.

The order pronounced in the open court on 11.02.2016.

Sd/- Sd/-

[KULDIP SINGH] [R.S. SYAL] JUDICIAL MEMBER ACCOUNTANT MEMBER Dated, 11th February, 2016. dk

ITA No.6200/Del/2012