M/S. FIRST APEX SOFTWARE TECHNOLOGIES PVT. LTD.,,BANGALORE vs. DCIT, BANGALORE

PER N. V. VASUDEVAN, JUDICIAL MEMBER :

This appeal by the assessee is against the order dated 19.8.2010 of the

Deputy Commissioner of Income Tax, Circle11(3), Bangalore passed u/s. 143(3)

r.w.s. 144C of the Act relating to AY 2006-07.

IT(TP)No.1311/Bang/2010

Singapore. The Assessee is engaged in the business providing software

development Services to group companies. During the previous year, the

Assessee entered into the following international transactions viz., The business

of the Assessee is organized into three divisions viz., (1) Software Development

Services from which it received a sum of Rs.7,51,78,503 from its Associated

Enterprise (AE) (2) Reimbursement of expenses received from its AE of

Rs.27,02,741/- (3) Reimbursement of expenses paid of Rs.14,23,145/-. The

Assessee provides software development services to its Associated enterprises.

All the above transactions were international transactions with an Associated

Enterprise (AE) and have to pass the Arm’s Length Price (ALP) test as provided

u/s.92 of the Income Tax Act, 1961 (Act). In this appeal the dispute is with

regard to addition made consequent to determination of ALP and consequent

upward revision and adjustment made to the price at which international

transactions were carried out by the Assessee with its AE in respect of (1)

Software development Services and (2) Reimbursement of expenses received

from AE.

IT(TP)No.1311/Bang/2010

Rs.7,51,78,503/- Operating Revenue Operating Cost . . . . Rs.6,75,15,662/- Operating Profit (PBIT) Rs.76,62,841/- Operating Profit to Cost Rati 11.35%

International Transactions (as mentioned in the 92 CE report) : Software development Services - Rs. 7,51,78,503/- Reimbursement of expenses received - Rs. 27,02,741/- Reimbursement of expenses paid - Rs 14,23,145/-

TP ADJUSTMENT RELATING TO IT SERVICES (Software Development Services

Sl. Name of company OP / TC Sales No (FY 2006-07) (Rs.Cr.) 1 Aztec Software Limited 18.09 128.61 2 Geometric Software Limited (Seg.) 6.70 98.59 3 Infosys Ltd 40.38 9028.00 4 KALS Info Systems Limited 39.75 1.97 5 Mindtree Consulting Ltd 14.67 448.79 6 Persistent Systems Ltd. 24.67 209.18 7 R.Systems International Ltd. (Seg.) 22.20 79.42 8 Sasken Communications Ltd. (Seg.) 13.90 240.03 9 Tata Elxsi Ltd (Seg.) 27.65 188.81 10 Lucid Software Ltd 8.92 1.02 11 Mediasoft Solutions Ltd 6.29 1.76 12 R S Software (India) Ltd 15.69 91.57 13 S I P Technologies & Exports Ltd 3.06 6.53 14 Bodhtree Consulting Ltd. 15.99 5.32 15 Accel Transmatic Ltd. (Seg.) 44.07 8.02 16 Synfosys Business solutions Ltd. 10.61 4.49 17 Flextronics Software Systems Ltd. 27.24 595.12 3

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18 Lanco Global Solutions Ltd 5.27 35.63 19 Megasoft Ltd 52.74 56.15 20 iGate Global solutions Ltd.(Seg.) 15.61 527.91 Arithmetic Mean 20.68%

comparables set out above, arrived at arithmetic mean of 20.68%. After

factoring the working capital adjustment of -4.75%, the adjusted arithmetic

mean was determined at 25.43%. The computation of the ALP by the TPO in

this regard was as follows:-

“18.6. 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 you is computed as under: Arithmetic mean PLI 20.68% Less: Working capital Adjustment(Annexure-C) -4.75% Adj.Arithmetic mean PLI 25.43% Arm’s Length Price: Operating Cost 6,75,15,662+ Rs.7,02,18,403 RS.27,02,741* Arms Length Margin 25.43% of the operating cost Arms Length Price (ALP) Rs.8,80,74,993/- At 118.44% of operating cost 18.7. 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:

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Arms Length Price (ALP) Rs.8,80,74,993 At 125.43% of operating cost Price charged in the international Rs.7,78,81,244 transactions Shortfall being adjustment Rs.1,01,93,749/- u/s.92CA *Reimbursement of expense received The above shortfall of Rs.1,01,93,749/- is treated as transfer pricing adjustment u/s 92CA.”

the draft assessment order by the AO, the assessee filed objections before the

DRP. The DRP rejected those objections and confirmed the transfer pricing

adjustment suggested by the TPO. The adjustment confirmed by the DRP was

added to the total income of the assessee by the AO in the fair order of

assessment. Against the said order of the Assessing Officer, the assessee has

preferred the present appeal before the Tribunal.

companies finally chosen by the TPO to arrive at arithmetic mean of profit

margins for the purpose of comparison with the profit margins of the Assessee,

are not comparable (a) for the reason that the turnover of those companies were

beyond Rs.200 crores and therefore cannot be compared with the Assessee

whose turnover is only Rs.12.99 Crores, (b) for the reason that these companies

were not functionally comparable; (c) for the reason that the related party 5

IT(TP)No.1311/Bang/2010

transaction (RPT) carried out by the comparable companies during the previous

year was beyond 15% of its revenue and hence ought not to be included as a

comparable. The Chart also gives the cases decided by various Benches of the

ITAT where the comparable companies have been held to be not comparable

with that of an Assessee providing IT Software development Services. The

learned DR relied on the order of the TPO/DRP. We will proceed to consider

the comparability of companies chosen by the TPO and listed in para- 4 of this

order. The other dispute in this appeal by the Assessee with regard to the action

of the TPO in adding the sum of Rs.27,02,741/- being reimbursement of

expenses received from the AE as part of the operating cost. According to the

Assessee, the above receipts are not towards rendering of any services to the AE

and are therefore not to be included in the operating cost. Except the above two

issues, viz., (1) excluding 6 companies from the final set of 20 comparable

companies finally chosen by the TPO for the purpose of comparison and (2)

excluding the sum of Rs.27,02,741/- being reimbursement of expenses received

from the AE as part of the operating cost, other issues raised in the grounds of

appeal and the revised grounds of appeal were not pressed.

comparable companies chosen by the TPO, the following companies will have

to be excluded as the turnover of these companies are more than Rs.200 crores

IT(TP)No.1311/Bang/2010

and cannot be compared with the Assessee whose turnover is less than Rs.100

crores:

(1) Flextronics Software Systems Ltd. 595.12 crores (2) Infosys Technologies Ltd. 9028.00 crores.

Our attention was drawn to the observations of the Tribunal in the case of

Triology E-Business Software India Pvt.Ltd. (supra) (ITA No.1338/Bang/2010)

for assessment year (07-08) on the application of turnover filter and it was

submitted that the aforesaid comparable companies have to be excluded from

the final list of comparable selected by the TPO.

and the learned DR. In the case of Triology 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

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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.” 12. 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 8

IT(TP)No.1311/Bang/2010

compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 14.Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet’s analysis, the turnover of Q 1 crore to Q 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 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

IT(TP)No.1311/Bang/2010

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.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). 16.It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee. 17. 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 Q 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard. 18. 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. 10

IT(TP)No.1311/Bang/2010

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: 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

IT(TP)No.1311/Bang/2010

(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 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; 12

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(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— (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

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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 Q 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, ITA No.1231/Bang/2010) . 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 14

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(6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores”

Triology E-Business Software India Pvt.Ltd. (supra), we hold that the following

companies

(1) Flextronics Software Systems Ltd. 595.12 crores (2) Infosys Technologies Ltd. 9028.00 crores whose turnover is above Rs.200 Crores should be excluded from the list of

comparable companies. The AO is directed to compute the Arithmetic mean by

excluding the aforesaid companies from the list of comparable.

counsel for the Assessee that the following 2 companies are not functionally

comparable with that of the Assessee.

a) KALS Information Systems Limited b) TATA Elxsi c) Accel Transmission Limited.

In this regard our attention was drawn to the decision of the Hon’ble ITAT

Bangalore Bench in the case of Tektronix Engineering Dvt. India P.Ltd. Vs.

DCIT IT (TP) A.No.1465/Bang/2010 order dated 20.2.2015 wherein the above

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companies were held to be not functionally comparable with that of a pure

software developer like the Assessee.

aforesaid comparable companies in the case of Tektronix Engineering Dvt. India

P.Ltd. (supra):

“8. Improper Selection of Comparables – Functionally Different. 8.1 The learned Authorised Representative submitted that the following four companies be excluded from the list of comparables selected by the TPO as they are functionally different and not comparable to the assessee. i) KALS Information Systems Ltd. ii) Tata Elxsi Ltd. (Seg). iii) Accel Transmatics Ltd. (Seg.) and iv) R Systems International Ltd. (Seg.) In this connection, the learned Authorised Representative drew the attention of the bench to the decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (Supra) for Assessment Year 2006-07, wherein the companies listed at S.Nos.(i), (ii) and (iii) supra were held to be not functionally comparable with that of a pure software developer like the assessee.

8.2.1 We have heard the rival contentions of both the learned Authorised Representative and the learned Departmental Representative, perused and carefully considered the material on record; including the judicial decision cited and placed reliance upon by the assessee. On a perusal of the decision of the co-ordinate bench of the Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (supra) for Assessment Year 2006-07, relied upon by the assessee, we find that the following three companies were excluded from the TPO’s list of comparables as they were held to be functionally different from the assessee, who was into pure software development services :- i) KALS Information Systems Ltd. ii) Tata Elxsi Ltd. (Seg). 16

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iii) Accel Transmatics Ltd. (Seg.) and

8.2.2 In this context, the relevant observations and findings of the co- ordinate bench in the case of Agile Software Enterprises Pvt. Ltd. (supra) at para 8.7 to 8.9.3 thereof are extracted hereunder :- “ 8.7 KALS Information Systems Ltd: The ld. AR submitted that this company was a software product company and could not be compared with that of the assessee. The assessee was a software services company and not a software product company. Reliance was placed on the decision of Trilogy e-business Software (I) Pvt. Ltd. (supra). As per the ld. AR, same view was taken in EMC Data (supra) also. 8.7.1 Per contra, the ld. DR submitted that KALS Information Systems Ltd. could not be considered as a software product company. 8.7.2 We have perused the orders and heard the rival contentions. We find that KALS Information Systems Ltd. was considered as a software product company in both Trilogy e- business(supra) as well as EMCData (supra). In these decisions, a host of companies, inter alia, including KALS Information Systems Ltd. were deliberated upon and held as under:- “12. The following were the relevant observations of the Tribunal on the aforesaid comparable companies in the case of Triology E-Business Software India Pvt.Ltd.(supra): “(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 Q 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, ITA No. ITA 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: 17

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“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. a careful consideration to the We have given 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.” “(e) Accel Transmatic Ltd. 48. With regard to this company, the complaint of the assessee is that this company is not a pure software development service company. It is further submitted that in a Mumbai Tribunal Decision of Capgemini India (F) Ltd 18

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v Ad. CIT 12 Taxman.com 51, the DRP accepted the contention of the assessee that Accel Transmatic should be rejected as comparable. The relevant observations of DRP as extracted by the ITAT in its order are as follows: “In regard to Accel Transmatics Ltd. the assessee submitted the company profile and its annual report for financial year 2005-06 from which the DRP noted that the business activities of the company were as under. (i) Transmatic system - design, development and manufacture of multi function kiosks Queue management system, ticket vending system (ii) Ushus Technologies - offshore development centre for embedded software, net work system, imaging technologies, outsourced product development (iii) Accel IT Academy (the net stop for engineers)- training services in hardware and networking,enterprise system management, embedded system, VLSI designs, CAD/CAM/BPO (iv) Accel Animation Studies software services for 2D/3D animation, special effect, erection, game asset development. 49 On careful perusal of the business activities of Accel Transmatic Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee’s claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from the final list of comparables for the purpose of determining TNMM margin.” Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as comparable. The ld. DR, on the other hand, relied on the order of the TPO. 50. We have considered the submissions and are of the view that the plea of the assessee that the aforesaid company should not be treated as comparables was considered 19

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by the Tribunal in Capgemini India Ltd (supra) where the assessee was software developer. The Tribunal, in the said decision referred to by the ld. counsel for the assessee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables.” 13. The facts and circumstances under which the aforesaid companies were considered as comparable is identical in the case of the Assessee as well as in the case of Triology E-Business Software India Pvt.Ltd. (supra). Respectfully following the decision of the Tribunal referred to above in the case of Triology E-Business Software India Pvt.Ltd.(supra), we direct that the following companies (listed as Sl.No.4 & 15 of the list of comparable companies chosen by the TPO and listed in para-4 of this order) be excluded from the list of 20 comparable arrived at by the TPO.” 8.7.3 It might be true that a number of software development companies in their TP studies might have considered KALS Infosystems Ltd. as a comparable and not as a software product company. However this, in our opinion, will not dilute the findings in this regard given by the Tribunal. The assessee having relied on the decision of the Tribunal wherein it has been held that KALS is a software product company, unless the decision of a higher authority which is different from the one given by the coordinate Bench is shown by the revenue, it will not be possible to deviate from the view earlier taken by a coordinate Bench. Accordingly, we direct that KALS Information Systems Ltd. be excluded from the comparables. 8.8 Accel Transmatics Ltd.: Ld. AR raised similar contentions for exclusion of this company as was made in the case of KALS Information Systems Ltd. (supra). Ld. DR also raised similar objections. We find that Accel Transmatics Ltd. has also been considered as a software product company by this Tribunal in the decisions cited at para 8.7.2 above. Relevant part of the decision has been reproduced by us therein. Accordingly, we direct that Accel Transmatics Ltd. be excluded from the comparables.

8.9 Tata Elxsi Ltd.: Ld. AR submitted that this company was engaged in research & development which resulted in creation of Intellectual Property Rights and therefore was a software product company. Reliance was placed on the decision of coordinate Bench of the Tribunal in the case of EMC Data (supra).

IT(TP)No.1311/Bang/2010

8.9.1 Per contra, the ld. DR submitted that Tata Elxsi Ltd. was not a software product company, but was engaged only in development of software. 8.9.2 We have heard the rival contentions. Whether Tata Elxsi Ltd. could be considered as a software development company was one of the issues which came up for consideration before the this Tribunal in the case of EMC Data (supra), wherein it was held as under:-

“17. As far as comparable at Sl.No.9 of the list of comparable chosen by the TPO listed in the chart given at para-4 of this order viz., Tata Elxsi Ltd., is concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of this Tribunal in the case of Logica Pvt.Ltd. IT (TP) 1129/Bang/2011 AY 07-08) wherein on the aforesaid company, the Tribunal held as follows:- “14. As far as comparable at Sl.No.6 & 24 are concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of the Tribunal in the case of Telcordia Technologies India Private Ltd. (supra) wherein the on aforesaid two companies, the Tribunal held as follows:- 7.7. Tata Elxsi Limited.: From the facts and material on record and submissions made by the learned AR, it is seen that the Tata Elxsi is engaged in development of niche product and development services, which is entirely different from the assessee company. We agree with the contention of the learned AR that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are 21

IT(TP)No.1311/Bang/2010

unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties.” 15. In view of the above, the ld. counsel for the assessee fairly admitted that comparable company at Sl.No.6 viz., Flextronics Software Systems Pvt. Ltd. should be taken as a comparable, while comparable at Sl.No.24 viz., Tata Elxsi Ltd. should be rejected as a comparable.” 18. In view of the aforesaid decision, we hold that Tata Elxsi has to be excluded from the list of comparable chosen by the TPO.” 8.9.3 The assessee before us is not developing any niche product. As held by the coordinate Bench of the Tribunal (supra), Tata Elxsi Ltd. could not be considered as a software development company simplicitor. That Tata Elxsi Ltd. was functionally different, has been held by the coordinate Bench of the Tribunal in the case of Yodlee Infotech Pvt. Ltd. (ITA No.1397/Bang/2010 dated 15.2.2013) as well. We therefore direct that Tata Elxsi Ltd. be excluded from the comparables.”

8.2.3 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. for Assessment Year 2006-07 (supra), we hold that the above mentioned three companies i.e. i) KALS Information Systems Ltd. ii) Tata Elxsi Ltd. (Seg). and iii) Accel Transmatics Ltd. (Seg.) should be excluded from the TPO’s final list of comparables. The Assessing Officer is directed to re-compute the ALP of the assessee's international transactions after excluding these three companies.”

considered as comparable is identical in the case of the Assessee as well as in

the case of Tektroni Engineering (supra). Respectfully following the decision of

IT(TP)No.1311/Bang/2010

the Tribunal referred to above in the case of Tektronix Engineering (supra), we

direct that KALS InfoSystems Ltd. And Accel Transmatic Ltd. And TATA

Elxsi be excluded from the list of 20 comparable arrived at by the TPO.

out of the 20 comparable companies chosen by the TPO viz., Megasoft Ltd., has

related parties transaction exceeding 15% and therefore should not be regarded

as comparable and in this regard drew our attention to the following

observations of the ITAT Bangalore Bench in the case of Tektronix Engineering

Devt. (supra):

“7. Related Party Transactions exceeding 15%. 7.1 In respect of the following 3 comparable companies selected by the TPO, the learned Authorised Representative of the assessee has objected to their inclusion in the list of comparables on the grounds of that their RPT is in excess of 15%. The three comparables are – S.No. Name of company RPT % (i) Aztec Software Ltd. 17.78 (ii) Geometric Software Ltd. (Seg) 19.34 (iii) Megasoft Ltd. 17.08

In support of their exclusion, the learned Authorised Representative has placed reliance on the decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. in IT(TP)A No.1172/Bang/2010 dt.26.9.2014; which is also for Assessment Year 2006- 07; the period under consideration. The learned Authorised Representative prayed that in view of the above, these three comparables be excluded from the list of comparable companies to the assessee. 7.2 We have heard the rival contentions of both the learned Authorised Representative and learned Departmental Representative, perused and 23

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carefully considered the material on record; including the judicial decision cited and placed reliance upon by the assessee. The fact is that the RPT in the case of the above three comparable companies listed at para 7.1 (supra) exceed 15%. The co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (supra) for Assessment Year 2006-07, as in many other decisions of this Tribunal, has held that where the RPT exceeds 15%, such companies should not be taken as comparables. The operative portion of this order of the co-ordinate bench (supra) in paras 8.11 and 8.12 at pages 16 & 17 thereof is extracted hereunder :- “ 8.11 Megasoft Ltd. 8.12 Aztech Software Ltd. 8.13 Geometric Software Ltd. Ld. AR submitted that in each of the above companies the RPT filter exceeded 15%. According to him, RPT filter has been upheld by this Tribunal in a host of decisions including that of EMC Data (supra). Per contra, the ld. DR supported the orders of authorities below. We have perused the orders and heard the rival contentions. Application of RPT filter while selecting the comparables has been held to be an appropriate criteria by this Tribunal in a number of decisions. In the case of EMC Data (supra), it was held as under:- “16. As far as comparable companies at Sl.No.1 & 2 &19 of the chart of comparable companies chosen by the TPO at page-4 of this order viz., Aztec Software Limited and Geometric Software Ltd. (Seg.) and Megasoft Ltd., is concerned, it is not in dispute before us that the related party transaction in the case of companies exceeds 15% and in view of the decision of the Tribunal in the case of 24 X 7 Customer.Com Pvt. Ltd. in ITA No.227/Bang/2010, followed by this Tribunal in the case of Logica Private Ltd. (supra) wherein it was held that where the RPT exceeds 15%, such companies should not be taken as comparable companies. Following the said decision, we hold that companies at Sl.Nos. 1 & 2 & 19 referred to above of the list of the comparable companies chosen by the TPO be excluded from the list of comparable companies while working out the ALP.”

There is no dispute that RPT filter in the case of Megasoft Ltd. was 17.08%, that of Aztech Software Ltd. was 17.78% and that of Geometric Software Ltd. was 19.34%. Coordinate Benches of the Tribunal are consistently following 15% as cut off mark for applying the RPT filter. Accordingly, we direct exclusion of Megasoft Ltd., Aztech Software Ltd. and Geometric Software Ltd. from the comparables.”

IT(TP)No.1311/Bang/2010

7.3 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (supra), we hold that the aforesaid three companies listed at para 7.1 of this order be excluded from the list of comparables.”

Ltd., be excluded from the final list of 20 comparable companies chosen by

the TPO.

in the appeal, viz., the action of the TPO in including the reimbursement of

expenses of Rs.27,02,741/- by the AE to the Assessee as part of the operating

cost while working the adjustment on account of ALP. The learned counsel for

the Assessee pointed out that the TPO in his order has not discussed anything

about the nature of these expenses but has simply added the same to the

operating cost for the purpose of working out the ALP adjustment. Though it

was highlighted in the objections before the DRP that the above expenses are in

the nature of travelling expenses, hotel expenses, per diems, and visa and travel

insurance charges etc., and are therefore not related to the consideration received

by the Assessee for services rendered and are purely in the nature of out of

pocket expenses, the DRP did not choose to consider the submissions and have

merely endorsed the action of the TPO.

IT(TP)No.1311/Bang/2010

of “Expenses recoverable-Apex Japan” A/C. and “Expenses Recoverable-Apex

Singapore” A/C. and pointed out that the perusal of the same would show that

these were out of pocket expenses incurred by the Assessee on behalf of the AE

and were reimbursed by the AE and has nothing to do with the consideration

that the Assessee received for rendering software development services. The

learned counsel for the Assessee submitted that the reimbursement of expenses

can neither be treated as operating revenue or operating expense and should be

wholly excluded from the profit and loss account. Our attention was also drawn

to the agreement between the Assessee and its holding company wherein it was

provided that the Assessee will reimburse expenses in relation to travel of

Assessee’s staff for onsite projects. It was thus submitted that reimbursement of

expenses receivable should be treated as non-operating and neither be

considered as operating income nor should be considered as operating expenses

for the purpose of calculating margin of the Assessee. The learned counsel for

the Assessee drew out attention to the decision rendered by the ITAT Bangalore

Bench in the case of M/S.L.G.Soft India Pvt.Ltd. Vs. The DCIT IT (TP)

A.No.1121/Bang/2011 for AY 07-08 wherein the Tribunal held that

reimbursement of expenses should not be added back to the cost base for the

purpose of mark up.

IT(TP)No.1311/Bang/2010

question as to whether the receipts in question are really reimbursement of

expenses has not been examined by the TPO and therefore in any event, the

issue should be remanded to the TPO to verify the claim of the Assessee that the

sum in question is purely reimbursement of expenses.

rendered by the co-ordinate bench in the case of L.G.Soft India Pvt.Ltd. (supra)

that reimbursement of expenses cannot be considered as receipts for rendering

services and should not be added back to the cost base for the purpose of mark

up. Following the said decision, we hold that reimbursement of expenses cannot

be considered as receipts for rendering services and should not be added back to

the cost base for the purpose of mark up. As submitted by the learned DR

neither the TPO not the DRP have gone into the question as to whether the

receipt in question is reimbursement. We therefore remand the issue to the

limited extent of verification regarding the nature of the receipt only and hold

that if the receipts are purely reimbursement of expenses they should neither be

considered as operating income nor operating expenses for the purpose of

calculating margins of the Assessee. We hold and direct accordingly.

IT(TP)No.1311/Bang/2010

Pronounced in the open court on this 20th day of March, 2015.

Sd/- Sd/-

( JASON P. BOAZ) ( N.V. VASUDEVAN ) ACCOUNTANT MEMBER JUDICIAL MEMBER Bangalore, Dated, the 20th March, 2015.

DSM Copy to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard file

By order

Assistant Registrar ITAT, Bangalore.