Loading judgment…
No AI summary yet for this case.
Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI ABRAHAM P. GEORGE
Per N.V. Vasudevan, Judicial Member
IT(TP)A.No.1302/Bang/2011 is an appeal by the Revenue against the order dated 14.12.2011 of CIT(A)-IV, Bangalore, relating to AY 2005-
6. The Assessee has filed Cross-Objection, C.O.No.92/Bang/2012, against the very same order of the CIT(A).
The issue that arises for consideration in the appeal by the Revenue and the C.O. by the Assessee are relating to the addition made to the total income consequent to determination of Arm’s Length Price (ALP) in respect of international transaction entered into by the Assessee with it’s Associated Enterprises (AE) u/s.92 of the Income Tax Act, 1961 (Act). The addition made consequent to determination of ALP by the TPO and addition on account of transfer pricing adjustment was a sum of Rs.2,36,04,205. The CIT(A) gave partial relief to the Assessee. Aggrieved by the relief allowed by the CIT(A), the revenue is in appeal before the Tribunal. Aggrieved by the order of CIT(A) in not applying certain filters while choosing comparable companies the Assessee has filed C.O.
The assessee is a wholly owned subsidiary of Sunquest US and it works as a contract software development service provider. The Assessee develops software and provides support services to Sunquest US and Misys Physicians Systems LLC (both are Associated Enterprises), which enable physicians, hospitals and medical practitioners to effectively
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 3 of 32 manage the complexities in healthcare services. The Assessee is remunerated on a cost plus basis for the software development and support services it provides to its AEs.
During the financial year 2004-05 relevant to the assessment year 2005- 06, the only international transaction that took place between the Assessee and its AEs was provision of software development and support services at a price of Rs. 20,88,57,270/-.
In support of the assessee’s claim that the price charged by it for services rendered to its AE was at arms’ length, the assessee filed a report as required by the provisions of section 92E of the Act in Form 3EB together with detailed analysis. The assessee adopted Transaction Net Margin Method (TNMM) as the most appropriate method for determining the ALP. Operating profits to cost was adopted as the Profit Level Indicator (“PLI”). The PLI of the assessee was arrived at as follows:
Operating Revenue Rs.20,88,57,270 Operating Expenses Rs.18,51,84,000 Operating Profit Rs. 2,36,73,270 (Op.Income – Op.Expenses) Op.Profit/Total cost (OP/TC) 12.78%
The Transfer Pricing Officer (TPO) arrived at a final set of 17 comparable companies. The set of 17 comparable companies is given as Annexure-I to this order.
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 4 of 32
The assessee raised various objections to the methodology adopted and the reasons assigned by the TPO for rejecting the comparable chosen by the assessee in its TP study. The TPO finally passed an order u/s. 92CA of the Act and on the basis of the profit margins of comparable companies set out in Annexure-I to this order, arrived at arithmetic mean of 24.85% after working capital adjustment and 26.59% before working capital adjustment. The computation of the ALP by the TPO in this regard was as follows:-
“19.6 Computation of Arms Length Price: The arithmetic mean of the Profit Level indicators is taken as the arms length margin. (Please see Annexure B for details of computation of PLI of the comparables). Based on this, the arms length price of the software development services rendered by the taxpayer to its AE(s) is computed as under: Arithmetic mean PLI 26.59% Less: Working capital Adjustment (Annexure-C) 1.06% Adj.Arithmetic mean PLU 25.53%
Arm’s Length Price: Operating Cost Rs.18,51,84,000/- Arms Length Margin 25.53% of the operating cost Arms Length Price (ALP) Rs.23,24,61,475/- At 125.53% of operating cost
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 5 of 32
19.7 Price received vis-à-vis the Arms Length Price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length Price as under: Arms Length Price (ALP) Rs.23,24,61,475/- At 125.53% of operating cost Price charged in the Rs.20,88,57,270 international transactions Shortfall being adjustment Rs. 2,36,04,205 u/s.92CA
……………….The difference of Rs.2,36,04,205/- as determined above is the transfer pricing adjustment u/s 92CA.”
On appeal by the Assessee, the CIT(A) partly allowed the appeal of the Assessee. The following were the key findings of the CIT(A):-
(i) Out of the 17 companies chosen by the TPO as the final set of comparable companies, the CIT(A) excluded 10 companies for the reason that these companies had related party transaction. The CIT(A) applied the filter of related party transaction by holding that to be chosen as a comparable company, the comparable companies should not have any related party transaction. Therefore even if there is a single related party transaction, the said companies were excluded from the list of comparable companies. By doing so, the CIT(A) could retain only 7 out of the final 17 comparable companies chosen by the TPO, viz., Bodhtree Consulting Ltd., Lanco Global System Ltd., Sankhya Infotech Ltd., Exensys Software Solution Ltd., and Visual Soft Technology Ltd. In coming to the above conclusion,
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 6 of 32 the CIT(A) followed the decisions of this Hon’ble Tribunal in the case of Mentor Graphics (Noida) (P.) Ltd. vs DCIT (2007] 109 lTD 101 (Del).
(ii) Two companies, Exensys Software Solutions Ltd., and Thirdware
Solutions Ltd., were excluded because they were functionally not comparable and were also having abnormal profits. In coming to the above conclusion, the CIT(A) followed the decision of the ITAT
Bangalore Bench in the case of SAP India Pvt. Ltd v. ITO [ITA No. 398/8/2008 and E-gain Communications (P) Ltd. Vs. ITO Ward 1(4),
Pune (2008) (23) SOT- 385 (Pune-Trib.). Thirdware Solutions Ltd. also gets excluded by applying RPT filter.
(iii) The CIT(A) held that Satyam Computer Services Ltd., has to be excluded from comparable companies for non-reliability of financial data. In doing so, the CIT(A) followed the decision of this Hon’ble
Tribunal in Agnity India Technologies v. ITO (ITA 3856/DeI/2010) and SAP India Pvt. Ltd v. ITO [ITA No. 398/8/2008]. Likewise lnfosys Technologies selected by the TPO, was rejected as a comparable based on high turnover and high risk. In doing so, the CIT(A) followed the decision of this Hon’ble Tribunal in Agnity India
Technologies v. ITO and Genisys Integrated Systems (India) Pvt Ltd v. ITO (supra). Infosys Technologies Ltd., get excluded by applying the related party transaction filter also.
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 7 of 32
The CIT(A) also held that the Assessee would be entitled to 5% standard deduction under the proviso to Sec.92CA(2) of the Act. After giving effect to the findings given above, the Arithmetic mean of the profit margins of the four remaining comparable companies viz., Bodhtree Consulting Ltd., Lanco Global Solutions Ltd., Sankhya Infotech Ltd., and M/s. Visual soft Technologies Ltd., would be 19.99% after working capital adjustment. After 5% standard deduction under proviso to Sec.92CA(2) allowed by the CIT(A), the arithmetic mean would be 14.99% as against the Assessee’s profit margin of 12.78%. Therefore there would still be a very negligible addition that will be sustained even after the CIT(A)’s order.
The Revenue is in appeal before against the order of the CIT(A). The Assessee has filed cross objection before the Tribunal to emphasis the stand of the Assessee that some of the filters which the Assessee submitted should be applied in choosing some comparable companies have not been accepted by the CIT(A).
11. The Revenue is in appeal on the following grounds (ground No.1, 6 and 7 are general and hence not reproduced) as follows-:
“(2) The learned CIT(A) erred in holding that all companies having related party transactions ought to be excluded as comparables irrespective of the percentage of related party transactions. (3) The ld.CIT(A) erred in holding that profit on cost of more than 50% of the comparable company(ies) is abnormal without giving reasons how functions discharged, assets deployed and IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 8 of 32 risks assumed of such companies were different from that of the appellant company. (4) The learned CIT(A) erred in holding that the size, turnover and brand of the company are deciding factors for treating a company as a comparable, and accordingly erred in excluding M/S.Infosys Technologies Ltd., as a comparable. (5) The CIT(A) erred in holding that the Assessee is eligible for a standard deduction of 5% from the arm’s length price under the proviso to Section 92C(2) of the Income-tax Act, 1961.”
12. The grounds raised in the cross objection are as follows (Ground No.1 is general hence not reproduced):-
“(2) That the learned CIT(A) erred in not entirely deleting the adjustment to the arm’s length price made by the learned Assessing Officer (AO)/Transfer Pricing Officer (TPO) amounting to Rs.2,36,04,205/- in respect of the software development services. (3) That in making an adjustment to the Respondent’s transfer price, on the facts and in the circumstances of the case, the learned CIT(A) erred in: (a) Upholding the comparability analysis performed by the learned TPO in the TP Order. (b) Modifying some of the filters applied by the learned TPO in the TP order, without providing an opportunity of being heard to the appellant. (c) Arbitrarily arriving at a set of companies as comparable to the Respondent. (d) Disregarding application of multiple year/prior year data and holding that current year (i.e. Financial Year 2005-06) data for companies should be used for comparability. (e) Upholding the learned TPO’s approach of using data as at the time of assessment proceedings.
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 9 of 32
(f) Upholding the approach adopted by the learned TPO of collecting selecting information of the companies exercising power granted to him under Section 133(6) of the Income Tax Act, 1961 (“Act”) that was not available to the Respondent in the public domain. (g) Not providing appropriate adjustment towards the risk differential between the Respondent and the entrepreneurial companies selected as comparables, while determining the arm’s length price.”
We have heard the rival submissions. As far as the grounds of appeal of the Revenue are concerned, ground No.2 with regard to improper application of the RPT filter by the CIT(A), it is not in dispute before us that this Tribunal, in the cases of 24/7 Customer Pvt. Ltd. (ITA No.227/Bang/2010), Sony India Private Ltd. reported in (2009) 315 ITR (80)
150 (Del.) and various other cases has taken a view that comparables having RPT of upto 15% of total revenues can be considered. In view thereof, the Revenue’s grievance on this issue as projected in ground No.2 has to be allowed. It is held that the CIT(A) ought to have adopted a threshold limit of 15% of the total revenue attributable to related party transaction as ground for rejecting comparable companies. Consequently it is held that comparable companies having RPT upto 15% of the total revenues alone can be excluded.
14. Ground No.3 raised by the Revenue is misconceived and the issue does not arise out of the order of the CIT(A). As we have already seen the CIT(A) rejected some of the comparable companies chosen by the TPO by IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 10 of 32 applying related party transaction filter. The filter of companies dealing in software products and abnormal profits owing to amalgamation of the companies during the relevant period thereby showing abnormal profits was applied to exclude Exensys Software solutions Ltd. Infosys Technologies Ltd., was excluded for reasons of high turnover and high risk profile. Satyam Computer Services Ltd., has to be excluded from the comparable companies for non-reliability of financial data as it was involved in financial scam. In doing so, the CIT(A) followed the decision of this Hon’ble Tribunal in Agnity India Technologies v. ITO (ITA 3856/DeI/2010) and SAP India Pvt. Ltd v. ITO [ITA No. 398/8/2008]. Therefore the grievance as projected by the Revenue in ground No.3 is misconceived. On the facts of the present case, we are of the view that the CIT(A) rightly excluded Exensys Software Solutions Ltd., Infosys Technologies Ltd., and Satyam Computers Ltd., from the list of comparable companies.
15. As regards ground No.4 raised by the revenue, the CIT(A) followed the decision of the ITAT Delhi in the case of Agnity India Technologies v. ITO (ITA 3856/DeI/2010) in coming to the conclusion that Infosys Technologies Ltd., is not comparable for the reason of its size, turnover and brand. The decision of the Tribunal in the case of Agnity India Technologies (supra) has since been confirmed by the Hon’ble Delhi High Court. Therefore the grievance projected by the Revenue in this regard is without any merit.
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 11 of 32
16. As regards the standard deduction of 5% of the arm’s length price allowed to the Appellant by the CIT(A), which is challenged in ground No.5 by the Revenue before the Tribunal, it is not in dispute before us that in view of the substitution of the Second proviso to Section 92C(2) of the Income-tax Act by the Finance (No.2) Act, 2009, the second ground of appeal (Ground No.3 in the appeal filed by the Revenue) may have to be allowed. Consequently it is held that if the difference between the arithmetic mean of the profit margins comparable companies ultimately retained and the profit margin of the Assessee is more than 5% than no deduction under the proviso to Sec.92C(2) of the Act could be allowed to an Assessee.
17. In view of the conclusion above that exclusion of comparable companies with RPT of less than zero percent is not valid, and that companies where RPT is less than 15% alone can be considered, then the comparable rejected by the CIT(A) on the basis of the said filter will have to be included along with the four comparable retained by the CIT(A).
Although 10 comparable which were rejected on the basis of RPT being more than zero percent, one comparable viz., Four Soft Ltd., will have to be included since the RPT is at 19.89% and thus in excess of 15%. Sathyam Computers Ltd., and Infosys Technologies Ltd., will get excluded for the reason that the financial results are not reliable in the case of Sathyam Computers Ltd., and for the reason that the high turnover, brand value, high risks etc. The remaining 7 comparable companies which were IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 12 of 32 excluded by the CIT(A) by applying the Related Party Transaction filter of 0% related party transaction will now have to be included. Their comparability with the Assessee in terms of other filters will be discussed in the following paragraphs.
18. The learned counsel for the Assessee also seeks exclusion of one comparable chosen by the TPO as a comparable viz., Sankhya lnfotech Limited.
Sankhya Infotech Limited (‘Sankhya’)
19. It was submitted by the learned counsel for the Assessee that Sankhya is engaged in the business of development of software products & services and training. The company focuses on the development of niche products for the transport and aviation industry. However, segmental information in relation to the above mentioned activities is not available in public domain. Therefore, as Sankhya engages itself in products and services as well as software training, it cannot be considered as a comparable of the Appellant. The products developed and owned by Sankhya are listed below:
SILICONTM Training Suite of Products: The products are a (1) comprehensive enterprise wide training platform that covers the entire spectrum of training in a paperless environment. It comprises of four products:- SILICONTM LMS (Training Management Information - SILICONTM QT (Online Assessment System) -
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 13 of 32 SILICONTM LCMS (Learning Content Management System) - - IRMAQTM : This is an integrated resource planning, management tracking system exclusively developed for Airline operations. It is an end-to- end solution for all Flight Operations. - Sakai CLE : This is a widely used and popular open source LMS used in many leading educational institutions and corporate. The relevant extract from the Annual report substantiating that the company also engages in different activities is reproduced below: “2. Activities The company as engaged in the business of development of Software Products & Services and training. The production of software is not capable of being expressed in any generic unit and hence 11 is riot possible to give the information as required by certain clauses of paragraphs 3.4C and 4 D of Part II of Schedule VI of the Companies Act, 1956.”
The Delhi Tribunal in ITO v. Colt Technology Services India Pvt. Ltd. (judgment dated 23.10.2012 in for the assessment year 2005-06) has held that the said company is not a comparable to the assessee therein which was also in the business of software development.
20. The submissions made by the learned counsel for the Assessee are considered. The activities set out above and the decision of the Delhi ITAT rendered in the context of a software development company such as the Assessee makes it amply clear that this company Sankhya cannot be regarded as a comparable. The same is directed to be excluded from the list of comparable companies.
The learned counsel for the Assessee submitted before us that two of the comparable companies out of the 10 excluded by the CIT(A) by IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 14 of 32 applying RPT filter and which gets included in the comparable companies because of 15% RPT being adopted as threshold limit for excluding companies for the purpose of comparability , viz., Four Soft Ltd., and Thirdware Solutions Ltd., will have to be excluded as these companies were considered as not comparable. These companies according to him, will however, have to be excluded as these two companies were held to be not comparable with an Assessee such as the Assessee in the present case providing software development services by the ITAT Hyderabad Bench in the case of CNO IT Services (India) Pvt. Ltd. (Formerly known as Conseco Data Services (India) Pvt. Ltd.) Hyderabad vs. DCIT, Circle 1(2) Hyderabad, in ITA.No.1280/Hyd/2010 Assessment Year 2005-2006 order dated 12.2.2014.
We have considered his submission and find that the ITAT Hyderabad Bench on identical facts, held that the aforesaid two companies viz., Four Soft Ltd., and Thirdware Solutions Ltd., are not comparable companies in Software Development Services companies. The following were the relevant observations:-
“15.4. FOURSOFT LIMITED : This comparable is objected on the same reason as this company is involved in product development and owns products namely 4S eTrans and 4S eLog. These products are used in Sun Microsystems Inc, in an Application Verification Kit Certified for Enterprises and assessee have been investing continuously on product developments. Since assessee is in the product development, having I.P. rights, the same is not comparable.
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 15 of 32
15.5. THIRDWARE SOFTWARE SOLUTIONS LIMITED : This company is objected to by the assessee on the reason that the said Thirdware Software Solutions Ltd. is engaged in sale of software licence and related services and not a service provider. Referring to the annual report, it was submitted that this comparable was rejected by the ITAT, Pune in the case of Egain Communications Ltd. This company having revenue from product license and earning extraordinary profit due to intangible owns. 15.6. These three comparable above Flextronics Software Limited, Foursoft Limited and Thirdware Software Solution Limited were analysed by the Coordinate Bench of the Tribunal in the case of Intoto Software Solutions Pvt. Ltd. (supra) wherein it has been held as under : "23. The other companies which are objected to by the assessee are Flextronics Software Limited, Foursoft Limited and Thirdware Software Solution Limited. As far as these three companies are concerned, the learned Counsel appearing on behalf of the assessee submitted that they are into both software as well as product development. He submitted that the TPO has taken note of the fact these companies are also into product development but has selected these companies as comparables by applying the filter of more than 70% of its revenue being from software development services. The learned Counsel submitted that the functions of these companies are different from the assessee who was into sole activity of software development for its associated enterprise. He submitted that the TPO has allocated the expenditure in the proportion of the revenue of these companies from software services and software products and has adopted the figure as segmental margin of the company and has taken these companies as comparables. He submitted that by taking the proportionate expenditure, the correct financial results would not emerge. He submitted that nothing prevented the Assessing Officer/TPO from obtaining the segmental details from the respective comparable companies before adopting them as comparable companies and before taking the operating margin for arriving at the arms length price. He submitted that wherever the segmental details are not available, then the said companies should
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 16 of 32 not be taken as comparables. For this purpose, he placed reliance upon the decision of the Bangalore Tribunal in the case of First Advantage Offshore Services Pvt. Ltd. vs. The DCIT in ITA.No.1252/Bang/2010 wherein these companies were directed to be excluded from the list of comparables.
The learned D.R. however, supported the Orders of the authorities below.
Having heard both the parties and having gone through the material on record, we find that the TPO at page 37of his order has brought out the differences between a product company and a software development services provider. Thus, it is clear that he is aware of the functional dissimilarity between a product company and a software development service provider. Having taken note of the difference between the two functions, the Assessing Officer ought not to have taken the companies which are into both the product development as well as software development service provider as comparables unless the segmental details are available. Even if he has adopted the filter of more than 75% of the revenue from the software services for selecting a comparable company, he ought to have taken the segmental results of the software services only.
The percentage of expenditure towards the development of software products may differ from company to company and also it may not be proportionate to the sales from the sale of software products. Under section 133(6) of the I.T. Act, the TPO has the power to call for the necessary
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 17 of 32 details from the comparable companies. It is seen that the Assessing Officer/TPO as exercised this power to call for details with regard to the various companies. As seen from the annual report of Foursoft Limited which is reproduced at page 7 of the TPO’s Order, the said company has derived income from software licence also and AMCs.
As far as Thirdware Software Solution Limited is concerned, we find from the information furnished by the said company that though the said company is also into product development, there are no software products that the company invoiced during the relevant financial year and the financial results are in respect of services only. Thus, it is clear that there is no sale of software products during the year but the said company might have incurred expenditure towards the development of the software products.
As far as Flextronics Software Limited is concerned, we find that at page 90 of his Order, the TPO has also observed that the said company has incurred expenditure for selling of products and has incurred R & D expenditure for development of the products. The above facts clearly demonstrate that there is functional dissimilarity between the assessee and these companies and without making adjustment for the dissimilarities brought out by the TPO himself, these companies cannot be taken as comparable companies. The method adopted by the TPO to allocate expenditure proportionately to the software development services and IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 18 of 32 software product activity cannot be said to be correct and reasonable.
Wherever, the Assessing Officer/TPO cannot make suitable adjustment to the financial results of the comparable companies with the assessee company to bring them on par with the assessee, these companies are to be excluded from the list of comparables. Therefore, we direct the Assessing Officer/TPO to exclude these three companies from the list of comparables.
The learned counsel for the Assessee submitted before us that TATA Elxsi Ltd., a comparable company out of the 10 excluded by the CIT(A) by applying RPT filter and which gets included in the comparable companies because of 15% RPT being adopted as threshold limit for excluding companies for the purpose of comparability. It was his submission that this company will however, have to be excluded as this company was held to be not comparable with an Assessee such as the Assessee in the present case providing software development services by the ITAT Hyderabad Bench in the case of CNO IT Services (India) Pvt. Ltd. (Formerly known as Conseco Data Services (India) Pvt. Ltd.) Hyderabad vs. DCIT, Circle 1(2) Hyderabad, in ITA.No.1280/Hyd/2010 Assessment Year 2005-2006 order dated 12.2.2014.
We have considered his submission and find that the ITAT Hyderabad Bench on identical facts, held on comparability of TATA Elxsi Ltd. as follows:
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 19 of 32 “15.7. TATA ELXSI LIMITED : The objection of the assessee is that TATA Elxsi operating two segments –system communication services and software development services. The TPO accepted the software development services segment in his T.P. analysis and assessee’s objection is that the software development services segment itself comprises of three sub- services namely (a) product design services (b)design engineering services and (c) visual computing labs. It was submitted that these services are not akin to assessee software services and segmental information of only product design services could have been accepted by the TPO as a comparable but not the entire software development service. Since company’s operations are functionally different as such, the same is not comparable. Further, assessee is also objecting on the basis of intangible scale of operations. The coordinate bench in the case of Intoto (supra) considered the issue as under in para 22: "22 Tata Elxsi Limited : As regards this company, the learned Counsel appearing on behalf of the assessee, filed before us the reply of Tata Elxsi Limited to the Addl. CIT (Transfer Pricing), Hyderabad, wherein the concerned Officer has been informed that Tata Elxsi Limited is specialised Embedded Software Development Service Provider and that it cannot be compared with any other software development company. It was submitted that because of the specialisation and also because of diverse nature of its business, it is very difficult to scale-up the operations of Tata Elxsi Limited. In view of this, Tata Elxsi Limited has informed that it is not fair to use its financial numbers to compare it with any other company. The communication dated 25th August, 2009 to the TPO is placed before us. As this communication was not before the TPO at the time of transfer pricing adjustment we deem it fit and proper to remand this issue also to the file of the TPO to reconsider adopting this company as the comparable in the light of observations of this company to the TPO in the case of another assessee. In the result, the Assessing Officer/TPO is directed to reconsider the issue in accordance with law, after affording a reasonable opportunity of being heard to the assessee.”
Keeping the assessee’s objections and the decisions of the Coordinate Bench, prima facie, we are of the view that TATA
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 20 of 32 Elxsi Limited is functionally different and has incomparable size to that of the assessee. Further, we are unable to verify whether the segmental profits adopted by the TPO pertain to entire software development services or pertain to limited service akin to assessee services. Since, these aspects are not clear from the data furnished before us, we direct the TPO to examine and in case, the segmental profits of a particular service is not available, then, to exclude the TATA Elxsi Limited from the list of comparables. Accordingly, this issue is restored to the file of TPO for examination and to decide in accordance with law and facts, after affording reasonable opportunity of being heard to assessee.”
Though the issue has been set aside to the AO in the aforesaid decision, the ITAT Hyderabad in the case of NTT Data India Enterprise Application Services Pvt.Ltd., order dated 23.10.2013 and in a subsequent ruling in the case of Invensys Development Centre (India) Pvt.Ltd., ITA No.1256/Hyd/2010 order dated 28.2.2014, held that TATA Elxsi is not functionally comparable with that of a software development service provider such as the Assessee.
In view of the aforesaid decision rendered on identical facts and circumstances, we are of the view that TATA Elxsi Ltd., should be excluded from the list of comparable companies.
In the chart filed before us the learned counsel for the Assessee has submitted that four of the comparable companies viz., I gate Global Solutions Ltd., Flextronics Software Systems Ltd., L & T Infotech Ltd. and Infosys Ltd., will have to be rejected applying the upper limit of Rs.200
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 21 of 32 crores turnover in view of the decision of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. ITA No.1054/Bang/2011.
We have considered the submission of the learned counsel for the Assessee and the learned DR. In the case of Trilogy E-Business Software India (P) Ltd. (supra), this Tribunal on application of the turnover filter while selecting comparable companies for comparability analysis held as follows:-
“(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 IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 22 of 32 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 market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: “Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a Rs 1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate.”
13. It was further submitted that the TPO’s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies.
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:-
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 23 of 32
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 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.
It was brought to our notice that the above proposition has also been followed by the Honourable Bangalore ITAT in the following cases: 1. M/s Kodiak Networks (India) Private Limited Vs. ACIT (ITA No.1413/Bang/2010)
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 24 of 32 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.
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 IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 25 of 32
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: 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 IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 26 of 32
(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 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
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 27 of 32 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:— (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—
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 28 of 32 (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 :
Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”
A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO.
In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is RS. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 29 of 32 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.” .
Respectfully following the aforesaid decision of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. (supra), we hold that the following companies should be excluded from the list of comparable companies I gate Global Solutions Ltd., Flextronics Software Systems Ltd., L & T Infotech Ltd. and Infosys Ltd., will have to be rejected applying the upper limit of Rs.200 crores turnover. Flextronics Software Systems Ltd., was also held to be functionally not comparable with a software development service provider such as the Assessee by the ITAT Hyderabad Bench in the case of CN O IT Services (India) P. Ltd. Vs. DCIT (2014) 43 Taxmann.com 231 (Hyderabad-Trib). Infosys Ltd., has also been held to be dissimilar to a captive service providing software development company by the ITAT Bangalore Bench in the case of DCIT Vs. Textron Global Technology Centre Pvt.Ltd. order dated 20.3.2015.
IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 30 of 32
34. The AO is directed to compute the Arithmetic mean by excluding the aforesaid companies from the list of comparable. According to the learned counsel for the Assessee, if the submissions of the assessee are accepted, then the arithmetic mean of the comparables retained would be within the range of +/- 5% of the Assessee’s Net Margin. Therefore, the other grounds raised in the cross objection not pressed at this stage. He has however sought liberty to urge the said grounds in any future proceeding, appellate or otherwise, and in these proceedings at a future point in time.
The prayer sought by the learned counsel for the Assessee in this regard is accepted.
Ground No.6 raised by the Revenue in its appeal is with regard to method of computation of deduction u/s.10A of the Act. The Assessee was entitled to claim deduction u/s.10A of the Act. While computing deduction u/s.10A of the Act, the AO excluded telecommunication expenses of Rs.31,67,629/- from export turnover on the ground that these expenses are incurred in delivery of computer software outside India and therefore to be excluded from the export turnover while computing deduction under section 10A. The Assessee prayed that the aforesaid expenditure are not of the nature set out in Explanation 2(iv) to Sec.10A of the Act which defines “Export Turnover”. The Assessee also made an alternate prayer that expenses that are reduced from the export turnover should also be reduced from the total turnover and in this regard has placed reliance on the decision of the Hon’ble Karnataka High Court in the IT(TP)A No.1302/Bang/2011 & CO No.92/Bang/2012 Page 31 of 32 case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn) wherein the Hon’ble Court held that whatever is excluded from the export turnover should also be excluded from the total turnover for the purpose of computing deduction u/s.10A of the Act. The main prayer as well as the alternate prayer was rejected by the AO but allowed by the CIT(A).
We have heard the ld. counsel for the assessee and the ld. DR on the issues raised in ground No.6 raised by the Revenue. Taking into consideration the decision rendered by the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn), we are of the view that the order of the CIT(A) is just and proper and calls for no interference.
In the result, the appeal by the Revenue and cross-objection by the Assessee are partly allowed.
Pronounced in the open court on this 11th day of June, 2015.