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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI S. RIFAUR RAHMAN
Per N.V. Vasudevan, Judicial Member
IT(TP)A No.1291/B/14 is an appeal by the assessee, while IT(TP)A No.1343/B/14 is an appeal by the Revenue. Both these appeals are directed against the order dated 18.8.2014 of the CIT(Appeals)-IV, Bangalore relating to assessment year 2009-10.
In grounds No.1 to 10 of its appeal, the assessee has challenged the order of the CIT(Appeals) insofar as it is against the assessee in the matter of determination of arm’s length price (ALP) in respect of an international transaction entered into with its Associated Enterprise (AE) under the provisions of section 92 of the Income-tax Act, 1961 [“the Act”]. The Revenue also in its appeal in grounds No.3 to 6 has challenged the order of the CIT(Appeals) insofar it is against the Revenue in the matter of determination of ALP of an international transaction entered into with its AE under the provisions of section 92 of the Act.
We shall first take up for consideration the appeal of the assessee. The assessee has before the Tribunal sought to press adjudication of only grounds No.6 & 7 which read as follows:-
“6. The learned CIT(A) has erred, in law and in facts, by upholding the action of AO/TPO in accepting/rejecting certain comparables based on unreasonable comparability criteria.
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 3 of 29 7. The learned CIT(A) has erred, in law and in facts, by not adjudicating the Appellant’s plea on the computational errors in the working capital adjustment performed by the learned TPO.”
4. The assessee has also filed an application seeking adjudication of an additional ground, which reads as follows:-
“The learned TPO and the learned AO have erred, in law and in facts, by applying only the lower turnover filter as a comparability criterion and accepting companies having turnover greater than Rs.200 crores.”
It has been submitted in the application for admission of additional ground that the application of turnover filter for chosing companies as comaprables for determining the ALP is a well accepted filter as laid down in the decision of the Bangalore Bench of the Tribunal in the case of Trilogy e-business Software India Pvt. Ltd., ITA No.1054/Bang/2011. The assessee has further submitted that the assessee is entitled to raise by way of an additional ground a legal issue which could be adjudicated on the basis of facts already being available on record. It was further submitted that in the matter of determination of ALP u/s. 92 of the Act, the assessee is entitled to raise any objection. In this regard, reliance was placed on the decision of the Hon’ble Supreme Court in the case of NTPC v. CIT, 229 ITR 383 (SC) and Special Bench of ITAT Chandigarh in the case of DCIT v. Quark Systems (P) Ltd., OF 2009).
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 4 of 29
We have considered the submissions of the assessee for admission of additional ground of appeal. We are of the view that the question as to whether the aforesaid companies are comparable or not with the Assessee company in terms of application of upper limit for the turnover filter, has to be decided on the basis of data which is available in the public domain. Therefore facts necessary to apply the filter sought to be relied upon by the Assessee in the additional ground of appeal are already available on record. Therefore there can be no valid objection to deciding the question of applying the aforesaid filter, if otherwise it is found to be a valid filter.
The decision of the Special Bench, Chandigarh in the case of Quark Systems (supra) clearly supports the plea of the Assessee. The Special Bench in the aforesaid decision in the case of Quark Systems (supra) has after considering the OECD Commentaries observed as follows:-
“35. In para 4.16 of latest report, the OECD provides the following guidelines : "In practice, neither countries nor taxpayers should misuse the burden of proof in the manner described above. Because of the difficulties with transfer pricing analysis, it would be appropriate for both taxpayers and tax administrations to take special care and to use restraint in relying on the burden of proof in the course of the examination of a transfer pricing case. More particularly, as a matter of good practice the burden of proof should not be misused by tax administrations or taxpayers as a justification for making groundless or unverifiable assertions about transfer pricing. A tax administration should be prepared to make good faith showing that its determination of transfer pricing is consistent with the arm’s length principle even where the burden of proof is on the taxpayer, and the taxpayers similarly should be prepared to make good faith showing IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 5 of 29 that their transfer pricing is consistent with the arm’s length principle regardless of where the burden of proof lies."
The aforesaid decisions and guidelines may not be exactly on identical facts before us but they emphatically show that taxpayer is not estopped from pointing out a mistake in the assessment though such mistake is the result of evidence adduced by the taxpayer.
37. When substantial justice and technical considerations are pitted against each other, the cause of substantial justice deserves to be preferred. For the other side cannot claim to have a vested right in injustice being done due to some mistakes on its part.
Accordingly, on facts and circumstances of the case, we hold that taxpayer is not estopped from pointing out that Datamatics has wrongly been taken as comparable. While admitting additional ground of appeal raised by the assessee to require us to consider whether or not Datamatics should be included in the comparable, we make no comments on merit except observing that assessee from record has shown its prima facie case. Further claim may be examined by the Assessing Officer. This course we adopt as objection to the inclusion of Datamatics as comparable has been raised now and not before revenue authorities. Therefore, we deem it fit and proper to remit the matter to the file of the Assessing Officer for consideration of claim of the taxpayer and make a de novo adjudication of the arm’s length price after providing reasonable opportunity of being heard to the assessee. We order accordingly.”
7. In view of the above, the additional ground sought to be raised by the assessee is admitted for adjudication.
The facts and circumstances with regard to determination of ALP in respect of an international transaction between the assessee and its AE are as follows.
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 6 of 29 9. WebMethods India i.e., the erstwhile name of the Assessee, was incorporated in the year 2004. It provides software development and implementation services to SAG Group, which includes research & development services of all traditional aspects of enterprise application software development such as architecture, design and coding, testing and maintenance. It also provides deliverables covering the entire webMethods suite such as core components, core features, adapters, modules and industry specific solutions.
Financial Results for the F Y 2009-10 (Rs.) Operating Revenues* 32,84,37,059 Operating Expenses ** 28,95,80,735 Operating (Profit)/Loss 3,88,56,324 Operating Profit on cost % 13.42% * Excluding other income ** Excluding impairment of assets TP Study of the taxpayer on software development services
The salient features of the TP report and the issues arising therefrom are:-
The taxpayer company has been selected as the tested party.
2. In the FAR analysis, the taxpayer company has been characterized as provider of routine software support services to its AE. 3. TNMM was selected as the most appropriate method.
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 7 of 29
The search and databases yielded a set of 21 comparables with an average profit margin @ 14.13% on cost. Hence the margin earned by the taxpayer (as arrived at by the taxpayer) at 14.72% on the total cost was treated as being at arm’s length.
11. Out of 21 comparables chosen by the assessee in its TP study, the TPO accepted the companies as comparables viz., Akshay Software Technologies Ltd., Infosys Technologies Ltd., L&T Infotech Ltd., Mind Tree Ltd., Persistent Systems Pvt. Ltd., R S Software (India) Ltd., Sasken Communication Technologies Ltd., and Zylog Systems Ltd. The TPO on a search of database chose 3 more companies as comparable companies and finally arrived at a set of 11 comparable companies, which were as follows:-
Sl Name of the Comparable Sales Cost Margin No (in Rs.) (in Rs.) 1 KALS Information 2,14,04,686 1,87,93813 13.89% Systems Ltd. 2 Akshay Software 12,23,21,483 11,31,49,350 8.11% Technologies Ltd. 3 Bodhtree Consulting Ltd. 16,05,75,212 9,89,56,821 62.27% 4 R S Software (India) Ltd. 1,49,57,12,634 1,36,01,02,589 9.97% 5 Tata Elxsi Ltd. 3,78,43,03,000 3,14,63,15,000 27.91% (segmental) 6 Sasken Communication 4,05,31,20,000 3,18,69,97,000 27.91% Technologies Ltd. (seg) 7 Persistent Systems Ltd. 5,19,69,10,000 3,67,52,70,000 27.91% 8 Zylog Systems Ltd. 7,34,93,51,475 7.81% 9 Mindtree Ltd. (seg) 7,93,22,79,326 5,74,06,73,058 5.52% 10 Larsen and Toubro 19,50,83,81,374 15,64,83,81,374 24.72% Infotech 11 Infosys Ltd. 2,02,64,00,00,000 1,39,17,00,00,000 45.61% Average Mean 24.32%
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 8 of 29 12. The TPO arrived at a negative working capital of 0.02% and finally determined the ALP as follows:-
“3.9.3 Computation of Arms Length Price: The arithmetic mean of the Profit Level indicators is taken as the arms length margin. Please Annexure B for details of computation of PLI of the comparables. Based on this, the arms length price of the services rendered by the taxpayer to its AE is computed as under:- Software Development Services Arm’s Length mean Margin on cost 24.32% Less: Working Capital Adjustment (Annex c) - 0.02% Adjusted margin 24.34% Operating Cost 28,95,80,735 Arms Length Price (ALP) 124.34% of Operating Cost 36,00,64,686 Price Received 32,84,37,059 Shortfall being adjustment u/s 92CA 3,16,27,627 The above shortfall of Rs.3,16,27,627/- is treated as transfer pricing adjustment u/s 92CA in respect of software development segment of the taxpayer’s international transactions.”
13. The adjustment by way of determination of ALP suggested by the TPO was incorporated in the fair assessment order by the AO. Aggrieved by the order of AO, the assessee preferred appeal before the CIT(Appeals).
14. Before the CIT(Appeals), the assessee sought exclusion of the following companies from the list of comparable companies viz., Bodhtree Consulting Ltd., Infosys Ltd., KALS Information Systems Ltd. and Tata Elxsi Ltd. The assessee also challenged the order of the TPO insofar as it
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 9 of 29 relates to action of the TPO in not treating the foreign exchange gain as part of the operating revenue of the assessee and the comparable companies while working out the profit margins of the assessee and the comparable companies. The assessee also challenged the order of TPO in working out the negative working capital adjustment.
The CIT(Appeals) upheld the order of the AO insofar as comparability of 4 companies that were objected to by the assessee before him. With regard to considering the foreign exchange gain as part of the operating profits of the assessee, the CIT(Appeals) following the decision of the Tribunal in the Trilogy e-business Software India Pvt. Ltd. [23 ITR (Trib.) 464], held that gain foreign exchange fluctuation had to be treated as part of the operating revenue for the purpose of working out the profit margins. Following were the relevant observations of the CIT(Appeals):-
“10.5.3 Thus, the fundamental principle, emerging is that if an expense has direct nexus with the revenues, it has to be taken as operating cost. Moereover, if foreign exchange gain is considered as a part of operating revenue, it naturally follows that foreign exchange losses have to be considered a part of operating costs. On applying the principles emerging from the orders of the Delhi & Bangalore Benches of the Hon’ble Tribunal, the TPO is directed to accept the claim of the assessee with respect to forex gain/losses. It is ordered accordingly.”
16. Insofar as the challenge to computation of risk adjustment and working capital adjustment is concerned, the CIT(Appeals) held as follows:-
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 10 of 29 “10.4.(iv) Risk adjustment / working capital : 10.4.1. I have examined the TPO’s working and find that he has provided a working capital adjustment on the basis of the detailed working as per Annexure-C of his order. Recently, the Mumbai Bench of the Hon’ble Tribunal in Exxon Mobil Company India P. Ltd. v. Deputy Commissioner of Income-tax (15 ITR (Trib) 353) has observed :- “The other issue is grant of’ adjustments, i.e, working capital adjustment and risk adjustment while arriving at the arm length price. In this case, the assessee in his transfer pricing study, has not made any working capital adjustment or risk adjustment. The Assessing Officer has, in fact, granted working capital adjustment. When the assessee is confronted with the possible transfer pricing adjustment due to change of some comparables and addition of certain other comparables by the Transfer Pricing Officer, this claim of risk adjustment is made by the assessee. Though, in principle, these adjustments have to be made while arriving at the arm’s length price, on the facts and circumstances of the case, as the assessee has not worked out the risk adjustment and as the Assessing Officer has already allowed 0.47 per cent as working capital adjustment, we are of the opinion that no further adjustment is necessary.” 104.2. On the basis of the aforesaid line of reasoning, I am of the view that once the AO / TPO has granted working capital adjustment, there is no necessity of providing any further adjustments. But however, in the instant case, it cannot be said that the TPO has provided working capital adjustment. As a matter of fact, he has provided it at (-)3.18% which has increased the arm’s length mean margin on cost from 25.05% to 28.22%. Before me, it was argued that the appellant is a captive service provider and assumes the less normal risks relating to business and operations and entrepreneurial risks borne by its AES outside India and is therefore insulated from most of the business and operational risks which the comparable companies are exposed to. Therefore, controlled and uncontrolled transactions are comparable only when adjustments with respect to significant differences between them in the risks assumed are made. I have considered the facts and circumstances of the case and find that the working capital adjustment provided by the TPO has a IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 11 of 29 negative impact on adjusted margin and therefore, it cannot be said that a working capital adjustment has been provided in the positive sense. Hence, the Hon’ble Tribunal’s ruling will not apply in the instant case. Therefore, in my view, the appellant is entitled to risk adjustment as per prevailing norms which shall be worked out by the TPO and granted to the appellant. It is ordered accordingly.”
Aggrieved by the order of CIT(Appeals) in not computing working capital adjustment as required by the assessee and upholding the comparability criteria adopted by the TPO, the assessee has preferred the present appeal before the Tribunal.
18. Aggrieved by the order of CIT(Appeals) holding that gain foreign exchange fluctuation should be treated as operating revenue of the assessee and the direction of the CIT(Appeals) to allow risk adjustment because of negative working capital adjustment given by the assessee, the Revenue has preferred the present appeal before the Tribunal.
19. As far as appeal of the assessee is concerned, it would be appropriate to adjudicate only the additional ground of appeal. It has been the stand of the assessee that turnover filter is an accepted filter and in this regard drew our attention to the decision of the Tribunal in the case of Trilogy e-business Software India Pvt. Ltd. (supra). In the aforesaid decision, this Tribunal has taken the following view:-
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 12 of 29 “(1) Turnover Filter
The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of RS. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:- “Size criteria in terms of Sales, Assets or Number of Employees: The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the buyer and seller and therefore comparability.”
The ICAI TP Guidelines note on this aspect lay down in para 15.4 that a transaction entered into by a Rs. 1,000 crore company cannot be compared with the transaction entered into by a Rs. 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. The fact that they operate in the same
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 13 of 29 market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: “Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a Rs 1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate.”
It was further submitted that the TPO’s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies.
Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, wherein relying on Dun and Bradstreet’s analysis, the turnover of RS. 1 crore to RS. 200 crores was held to be proper. The following relevant observations were brought to our notice:- “9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 14 of 29 benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.”
15. It was brought to our notice that the above proposition has also been followed by the Honourable Bangalore ITAT in the following cases:
1. 1. M/s Kodiak Networks (India) Private Limited Vs. ACIT (ITA No.1413/Bang/2010) 2. M/s Genesis Microchip (I) Private Limited Vs. DCIT (ITA No.1254/Bang/20l0).
3. Electronic for Imaging India Private Limited (ITA No. 1171/Bang/2010). It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee.
The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than RS. 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard.
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 15 of 29 17. We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm’s length price. Sec.92-B provides that “international transaction” means a transaction between two or more associated enterprises, either or both of whom are non- residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92- A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm’s length price in an international transaction and it provides:- (1) that the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :— (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub- section (1) shall be applied, for determination of arm’s length price, in the manner as may be prescribed:
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 16 of 29 Provided that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm’s length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price.
(3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that— (a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm’s length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm’s length price in relation to the said international transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him:”
Rule 10B of the IT Rules, 1962 prescribes rules for Determination of arm’s length price under section 92C:- “10B. (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction shall be determined by any of the following IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 17 of 29
methods, being the most appropriate method, in the following manner, namely :— (a)……. to (d)…….. (e) transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub- clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction.
(2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:—
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 18 of 29
(a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.
(3) An uncontrolled transaction shall be comparable to an international transaction if—
(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
(4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into :
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 19 of 29 Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”
A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO.
20. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is RS. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.”
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 20 of 29
It is the stand of the assessee that applying the aforesaid decision, the following 5 companies whose turnover is more than Rs.200 crores should be excluded from the list of comparable companies finally chosen by the TPO viz., Tata Elxsi Ltd., Sasken Communication Technologies Ltd., Persistent Systems Ltd., Larsen & Toubro Infotech Ltd. & Infosys Ltd.
We have considered the submissions of the ld. counsel for the assessee and are of the view that in the light of judicial precedent cited by the ld. counsel for the assessee, turnover filter has to be applied in the present case. The assessee’s turnover is Rs.32.84 crores and the assessee cannot be compared with a company whose turnover is more than 200 crores as laid down in the decision referred to above. Following the aforesaid decision, we hold that the aforesaid 5 companies be excluded from the list of comparable companies.
The ld. counsel then brought to our notice that Bodhtree Consulting Ltd. and KALS Information Systems Ltd. have been held to be functionally not comparable with a company like the assessee, which is purely a software development service provider. In this regard, the ld. counsel for the assessee drew our attention to the ITAT Bangalore Bench decision in the case of CISCO Systems India Pvt. Ltd., IT(TP)A No.271/Bang/2014, order dated 14.8.2014. In this case for the AY 2009-10, the Tribunal considered the comparability of Bodhtree Consulting Ltd. as well as KALS Information Systems Ltd. with a company engaged in the business of IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 21 of 29 software development services. Following were the relevant observations of the Tribunal:-
“26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute that in the list of comparables chosen by the assessee, this company was also included by the assessee. The assessee, however, submits before us that later on it came to the assessee’s notice that this company is not being considered as a comparable company in the case of companies rendering software development services. In this regard, the ld. counsel for the assessee has brought to our notice the decision of the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. v. ITO, order dated 6.11.2013. In this case, the Tribunal followed the decision rendered by the Mumbai Bench of the Tribunal in the case of Wills Processing Services (I) P. Ltd., ITA No.4547/Mum/2012. In the aforesaid decisions, the Tribunal has taken the view that Bodhtree Consulting Ltd. is in the business of software products and was engaged in providing open & end to end web solutions software consultancy and design & development of software using latest technology. The decision rendered by the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. (supra) is in relation to A.Y. 2008- 09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in AY 08- 09 as far as this comparable company is concerned. Following the aforesaid decision of the Mumbai Bench of the Tribunal, we hold that Bodhtree Consulting Ltd. cannot be regarded as a comparable. In this regards, the fact that the assessee had itself proposed this company as comparable, in our opinion, should not be the basis on which the said company should be retained as a comparable, when factually it is shown that the said company is a software product company and not a software development services company.” 26.3 KALS Information Systems Ltd.:- As far as this company is concerned, it is not in dispute before us that this company has been considered as not comparable to a pure software development services company by the Bangalore Bench
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 22 of 29 of the Tribunal in the case of M/s. Trilogy e-business Software India Pvt. Ltd. (supra). The following were the relevant observations of the Tribunal:- “(d) KALS Information Systems Ltd.
As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Rs. 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal’s decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: “16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds.” Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable.
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 23 of 29
We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable.”
Following the aforesaid decision of the Tribunal in the case of an assessee similarly placed with that of the assessee in the present case, we are of the view that Bodhtree Consulting Ltd. and KALS Information Systems Ltd. should be excluded from the list of comparable companies for the purpose of determining the ALP. It is also relevant to point out that in the case of CISCO Systems India Pvt. Ltd. (supra), the very same 11 companies had been chosen by the TPO as comparables, thereby making it clear that the assessee in the present case and CISCO Systems India Pvt. Ltd. have the same business profile.
The ld. counsel for the assessee further contended before us that the working capital adjustment worked out by the TPO was incorrect and in this regard submitted as follows:-
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 24 of 29 “34. The Appellant wish to submit before your Hon’ble member that, we had provided the learned TPO with the detailed updated margin computation along with working capital adjustment for some of the identified companies.
35. The learned TPO has erred, in law and facts, in computing the benefit on account of working capital adjustment by considering incorrect value of receivables and payables amount for comparable companies and this has resulted in negative working capital adjustment. The summarised details of working capital computation is provided below for your Hon’ble member’s reference:
36. Further, it would be relevant to note that the Appellant does not bear any working capital risk with regard to transactions with AEs. The Appellant has neither taken any loan from any bank for its working capital requirement nor paid any interest.
The Appellant wishes to submit that in the circumstances and facts of the case no negative working capital adjustment is warranted as Appellant functions in a risk mitigated environment and is reimbursed on cost plus model by the AEs and is fully funded by the AEs for its working capital requirements.”
The detailed working capital adjustment is annexed as Annexure-I to this order. It is the limited prayer of the ld. counsel for the assessee that IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 25 of 29 the CIT(Appeals) has not considered the aforesaid claim made by the assessee and therefore the proper computation of working capital adjustment should be directed to be done by the TPO afresh.
We have considered the submissions of the ld. counsel for the assessee. We find that in ground No.15 raised before the CIT(Appeals), the assessee has taken a specific plea that the TPO has used incorrect value of receivables and payables for comparable companies. In Annexure-II to the submissions before the CIT(Appeals), the assessee has also given the details which are enclosed to this order. Perusal of the order of the CIT(Appeals) shows that none of these contentions have been considered by him. We are, therefore, of the view that the order of CIT(Appeals) on this issue should be set aside and the AO/TPO should be directed to examine the details and arrive at the correct working capital adjustment.
We hold and direct accordingly.
As far as grievance of the Revenue in its appeal is concerned, ground No.2 is with regard to treating the expenses incurred in foreign currency towards telecommunication expenses and other expenses as part of total turnover and export turnover.
According to the AO, as per the definition of export turnover given in clause (iv) to Explanation 2, the expenses incurred for freight expenses attributable to the delivery of the product or software outside India should be reduced from the export turnover. However, the provisions of section IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 26 of 29 10A do not provide for exclusion of such expenditure from total turnover. In the absence of a definition for total turnover in section 10A, the normal definition of total turnover has to be adopted and as such the expenses which are reduced from the export turnover in accordance with the specific definition cannot be reduced from the total turnover.
On appeal by the assessee, the CIT(Appeals) following the decision of the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd., 349 ITR 98 (Karn), held that whatever is excluded from the export turnover, has also to be excluded from the total turnover.
Aggrieved by the order of the CIT(Appeals), the revenue is in appeal before the Tribunal.
In view of the binding precedent of the judgment of Hon'ble High Court of Karnataka which is the jurisdictional High Court followed by the CIT(Appeals), we do not find any merits in ground No.2 raised by the Revenue and the same is dismissed.
As far as grounds No.3 to 5 are concerned relating to treating the gain on account of foreign exchange fluctuation as part of the operating revenue for the purpose of working the profit margins, this Tribunal in the case of Trilogy e-business Software India Pvt. Ltd. (supra) has held as follows:-
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 27 of 29 “(B) Treating foreign exchange gain or loss and provision for bad debts as non-operating in nature and fringe benefit tax as part of operating cost: As far as foreign exchange gain/loss being considered as not forming part of the operating cost, the reasoning of the revenue is that such loss or gain cannot be said to be one realized from international transaction though they may form part of the gain/loss of the enterprise and therefore they should be excluded while determining operating cost. On the above issue we find that the Bangalore Bench of ITAT in the case of Sap Labs India (P) Ltd. Vs. ACIT (2011) 44 SOT 156 (Bang.) has taken the view that Foreign Exchange Fluctuation gains are required to be added to operating revenue. Following the same, the AO is directed to accept the claim of the Assessee in this regard. As far as provision for bad debts are concerned, the TPO has accepted that the same would be part of operating expenses provided the same is incurred every year for at least three years and the manner in which provision is made is consistent. The Assessee in reply to the query of the TPO on the above aspect has not furnished any details. We are of the view that the Assessee should be afforded opportunity to explain its position on the above and the AO is directed to consider the same in accordance with law. As far as Fringe Benefit Tax (FBT) is concerned, the same was not considered by the TPO as part of operating cost in the case of comparables and therefore the same should also not be considered as part of operating cost of the Assessee. We hold accordingly and direct the AO to compute the operating cost of the Assessee.”
In view of the aforesaid decision, we do not find any merit in grounds No. 3 to 5 raised by the Revenue and they are dismissed as such.
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 28 of 29 34. As far as ground No.6 is concerned, the same reads as follows:-
“6. In so far as the issue of working capital adjustment is concerned, the learned CIT(A) erred in holding that working capital adjustment has not been provided as it has negative impact. This is because working capital adjustment is given to increase comparability on the uncontrolled comparables with tested party and not to provide benefit to the assessee. Incidentally, the adjustment may or may not lead to a benefit for the assessee. In the instant case wrong capital adjustment made by the TPO.”
We are of the view that working capital adjustment has to be allowed on the basis of requirements of working capital in the case of the assessee and the comparable companies. Just because if on a proper working of the working capital adjustment, it reflects a negative working capital adjustment, that cannot be the basis not to grant working capital adjustment. In other words, working capital adjustment has to be allowed based on the working capital requirements of the assessee and the comparable companies irrespective of the fact, whether such adjustment is negative or positive. To this extent, we are of the view that the observations of the CIT(Appeals) are incorrect. We have already directed the AO/TPO to work out the proper working capital adjustment. This ground of appeal is therefore treated as allowed for statistical purposes.
IT(TP)A Nos. 1291 & 1343/Bang/2014 Page 29 of 29 36. In the result, both the appeals by the assessee and the Revenue are partly allowed.
Pronounced in the open court on this 4th day of September, 2015.