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Income Tax Appellate Tribunal, DELHI BENCH ‘I - 1’ : NEW DELHI
Before: SHRI R.S. SYAL & SHRI A.T. VARKEY
O R D E R PER A.T. VARKEY, JUDICIAL MEMBER :
This appeal arises from an order passed by Income Tax Officer, Ward 12(4), New Delhi dated 21.01.2015 u/s 144C(13)/143(3) of the Act in pursuance to directions of the DRP dated 14.11.2014 u/s 144C(5) of the Act and relates to assessment year 2010-11.
The grounds raised by the appellant in this appeal are as under:
“1. On the facts and in law, the Learned Income Tax Officer, Ward 12(4), New Delhi (“Ld. AO”) erred in passing the impugned assessment order dated 21 January 2015 pursuant to the directions of the Hon’ble Dispute Resolution Panel (“Hon’ble DRP”) and computing the total income of the Appellant for Assessment Year (“AY”) 2010-11 at Rs. 30,678,470 as against the returned income of Rs. 353,440, thereby making an adjustment of Rs. 30,325,034 to the Officer-1 (2)value of the international transaction of provision of computer software development services by the Appellant to its Associates Enterprises (“AEs”).
2. On facts and in law, the Ld. AO erred in making a reference to the Learned Additional Commissioner of Income Tax, Transfer Pricing Officer-1 (2), New Delhi (“Ld. TPO”), inter alia, since he has not recorded an opinion that any of the conditions in section 92C(3) of the Income Tax Act, 1961 (“the Act”), were satisfied in the instant case. Accordingly, the order passed by the TPO is without jurisdiction.
3. On facts and in the circumstances of the case and in law, the Ld. TPO erred in not demonstrating that the motive of the Appellant was to shift profits outside India by manipulating the prices charged in its international transactions, which is a pre- requisite condition to make any adjustment under the provisions of Chapter X of the Act.
4. On facts and in law, the Ld. TPO/Ld. AO erred in conducting and the Hon’ble DRP further erred in allowing a fresh benchmarking analysis using “non contemporaneous” data and substituting the Appellant’s analysis with the fresh benchmarking analysis on his own conjectures and surmises.
5. On facts and in law, the Ld. TPO/Ld. AO and Hon’ble DRP erred in violating the provisions of Rule 10B(2) of Income Tax Rules, 1962 (“the Rules”) by introducing new companies without considering the differences in the functions performed, assets employed and risks assumed by such companies vis-à-vis the Appellant, thereby resorting to unsubstantiated selection of comparables.
6. On the facts and in law, the Hon’ble DRP violated the provisions of Rule 10B(2) of the Rules by rejecting CG-VAK Software & Exports Limited, a comparable company selected by the Appellant in the TP documentation by modifying the filter of employee cost being less than 25% of turnover as proposed by the Ld. TPO to employee cost of less than 75% of turnover; and further erred in incorrectly computing the filter ratio at less than 75% instead of correct ratio of 79.69% of turnover.
7. On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred, violating provisions of Rule 10B(2) by considering E-Infochips Bangalore Limited as a comparable to the Appellant.
8. On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred, violating provisions of Rule 10B(2) by considering Infinite Data System Private Limited as a comparable to the Appellant. 9. On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred, violating provisions of Rule 10B(2) by considering Infosys Technologies Limited as a comparable to the Appellant. 10. On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred, violating provisions of Rule 10B(2) by considering Persistent Systems Limited as a comparable to the Appellant.
11. On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred, violating provisions of Rule 10B(2) by considering Sasken Communications Technologies Limited as a comparable to the Appellant.
12. On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred, violating provisions of Rule 10B(2) by considering Thirdware Solutions Limited as a comparable to the Appellant.
On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred, violating provisions of Rule 10B(2) by considering Wipro Technology Services Limited as a comparable to the Appellant.
14. On facts and in law, the Ld. TPO, the Ld. AO and the Hon’ble DRP erred in contravening provisions of Rule 10B(1)(e)(i) by considering the unutilized rent and maintenance expenses as expenses incurred in relation to the international transaction of the provision of software development services.
15. On the facts and in law, the Ld. TPO/Ld. AO and the Hon’ble DRP grossly erred in not allowing the risk adjustment under Rule 10B(1)(e)(iii) and Rule 10B(3) to account for differences in the risk profile of the comparable companies vis-à- vis the Appellant. 16. On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred in not granting the benefit of reduction/variation of 5 percent from the arithmetic mean while determining the arm’s length price to the Appellant as per the proviso to section 92C(2) of the Act. 17. On the facts and in circumstances of the case, the Ld. AO erred in levying tax at the rate of 40% on the assessed income vis- à-vis applicable tax rate of 30%, given the fact that the Appellant is a domestic company incorporated under the Companies Act, 1956. 18. On the facts and in the circumstances of the case, the Ld. AO erred in computing interest under section 234B of the Act.
19. On the facts and in the circumstances of the case, Ld. AO erred in demanding an amount of Rs. 162,976 in relation to tax refunded earlier as this amount was never refunded and not received by the Appellant.
20. On the facts and in the circumstances of the case, the Ld. AO erred in levying interest under section 234A and 234D of the Act.
21. On the facts and in law, the Ld. AO erred in initiating penalty proceedings under section 271(1)(c) of the Act.”
Grounds 1 to 15 relate to adjustment of Rs. 3,03,25,034/- to the arm's length price of the international transaction of provision of software development services provided by the appellant company to its holding company M/s ION Trading UK Ltd.
The factual matrix as emanating from the material on record is that the appellant company is a wholly owned subsidiary company of M/s ION Trading UK Ltd. It is engaged in the business of providing computer software development services to its AE on a captive basis. In the instant assessment year, the appellant furnished a return of income on 11.10.2010 declaring an income of Rs. 3,53,440/-. During the year the appellant had entered into following international transaction with its Associated Enterprise (AE):
Sr. Type of International Method Total Value of No. Transaction Selected transaction 1 Computer Software Transactional 21,82,68,570 Development Services Net Margin Method
In view of the above, AO made a reference u/s 92CA(1) to the Transfer Pricing Officer (TPO) for determining the Arm's Length Price (ALP). In course of proceeding before TPO, appellant submitted a TP study report. In the TP analysis, appellant selected Transactional Net Margin Method (TNMM) as the most appropriate method for benchmarking the international transaction and for the purpose of applying TNMM, the assessee company identified itself as the tested party. Further, operating profit to operating cost (OP/OC) was considered as the profit level indicator (PLI) to demonstrate its adherence to the arm’s length provisions contained in the Act. The PLI of the assessee was calculated at 9.37%; whereas average PLI of the comparables was arrived at 6.48%. The calculation of the assessee’s margin is as under:
Particulars As on March 2010 (Amt. in Rs.) Operating income 22,29,50,213 Operating cost 20,38,55,648 Operating profit 1,90,94,565 OP/OC 9.37% It is to be noted here that while calculating the operating cost of Rs.20,38,55,648/-, a deduction of Rs. 82,18,899/- on account of adjustment of cost relating to rent and maintenance charges for under-utilization of capacity was claimed by the appellant.
Furthermore, the appellant had computed the PLI of the comparables by selecting a set of 6 comparables and the margin of these was shown to be 6.48% using the current year data as under:
Sr. No. Name of the company Margin for FY 2009- 10 1 CG- Vak Software & Exports -12.48% Ltd. 2 Quintegra Solutions Ltd. -9.42% 3 R S Software (India) Ltd. 9.29% 4 Tata Elxsi Ltd. 20.60% 5 Thinksoft Global services Ltd. 11.82% 6 Zylog Systems Limited 19.08% Average 6.48%
The TPO vide its order dated 22.01.2014, has observed that appellant has selected 6 companies as comparables on the basis of the search conducted in the public data base Prowess only. Further, TPO applied the following filters:
i) Companies with RPT greater than 25% of revenue should have been excluded; ii) Companies who have less than 75% of the revenue as export sales should have been excluded; and iii) Companies whose employee cost to revenue ratio is less than 25% should have been excluded.
Pursuant to the above, final comparables out of comparables selected by the appellant are as under:
Sr. No. Name of the company Remarks i) Quintegra Solutions This is a suitable comparable but Ltd. the PLI (OP/OC) is 0.75% as on 31st March, 2010 and not -9.42%. ii) R S Software (India) This is a suitable comparable, Ltd. hence accepted. iii) Tata Elxsi Ltd. This is a suitable comparable, hence accepted. iv) Thinksoft Global This is a suitable comparable, services Ltd. hence accepted. v) Zylog Systems This is a suitable comparable, Limited hence accepted.
9. As a further step, based on the above stated filters, search on the Capitaline database was also conducted by the TPO and further 18 comparables were identified and included in the final list of comparables. As a result, 23 comparables were selected and, the margin computed as under::
Sr. No. Name of the company OP/OC with Forex 1 Accelya Kale Solutions Ltd. 12.51% 2 Akshay Software Technologies Ltd. -3.91% 3 Allgo Embedded 8.72% 4 CTIL Ltd. 18.22% 5 E-Infochips Bangalore Ltd. 71.38% 6 Evoke Tech 18.20% 7 E-Zest Solutions 18.38% 8 Infinite Data System Pvt. Ltd. 72.67% 9 Infosys Limited 45.47% 10 Kuliza Technologies Private Limited 12.94%
11 Larsen & Toubro Infotech Ltd. 19.76% 12 Mindtree Limited (Segment) 20.47% 13 Persistent Systems Limited 30.15% 14 Persistent Systems & Solutions 11.37% Limited 15 Quintegra Solutions Ltd. -8.83% 16 RS Software (India) Ltd. 9.07% 17 Sasken Communication Technologies 22.65% Ltd. 18 Sonata Software 32.16% 19 Tata Elxsi Ltd. 17.08% 20 Thinksoft Global services Ltd. 11.22% 21 Thirdware Solutions Limited 29.05% 22 Wipro Technology Services Limited 63.27% (Formerly Citi Technologies) 23 Zylog Systems Limited 19.08% Average 23.99%
On the aforesaid basis, the TPO made an adjustment of Rs. 4,46,82,661/- in the manner as under:
Sr. No. Particulars Amount (Rs.) 1. Total Operating Cost 21,20,74,547* 2. Arm’s Length Price at a margin of 26,29,51,231 23.99% 3. Transfer Price received by the taxpayer 21,82,68,570 4. Shortfall of Transfer Price from ALP 4,46,82,661 *by disallowing deduction of Rs. 82,18,889/- on account of adjustment of cost relating to rend and maintenance charges for under utilization of capacity.
DRP vide directions dated 14.11.2014 out of the set of 23 comparables adopted by the TPO directed for exclusion of one of the comparables, namely, Sonata Software Ltd. and also to grant working capital adjustment. After giving the effect of the aforesaid directions, margin of comparables was re-determined at 17.22% on a set of 22 comparables in the manner as under:
Sr. No. Name of the company OP/OC with Forex 1 Accelya Kale Solutions Ltd. 7.18% 2 Akshay Software Technologies Ltd. -6.83% 3 Allgo Embedded 2.18% 4 CTIL Ltd. 7.47% 5 E-Infochips Bangalore Ltd. 61.40% 6 Evoke Tech 14.60% 7 E-Zest Solutions 12.75% 8 Infinite Data System Pvt. Ltd. 64.96% 9 Infosys Limited 39.83% 10 Kuliza Technologies Private Limited 7.71% 11 Larsen & Toubro Infotech Ltd. 15.51% 12 Mindtree Limited (Segment) 14.46% 13 Persistent Systems Limited 4.80% 14 Persistent Systems & Solutions 24.70% Limited 15 Quintegra Solutions Ltd. -23.63% 16 RS Software (India) Ltd. 5.68% 17 Sasken Communication Technologies 18.32% Ltd. 18 Tata Elxsi Ltd. 12.66% 19 Thinksoft Global services Ltd. 4.53% 20 Thirdware Solutions Limited 22.88% 21 Wipro Technology Services Limited 56.61% (Formerly Citi Technologies) 22 Zylog Systems Limited 11.03% Average 17.22%
The Assessing Officer accordingly passed an order under section 144C(13)/143(3) of the Act determining the adjustment at Rs.3,03,25,034/- and as such, income of the appellant was finally assessed at Rs.3,06,78,474/-. The said adjustment has been computed in the manner hereunder:
Sr. Particulars Amount (Rs.) No. 1. Operational Cost 21,20,74,547 2. Arm’s Length Price at a margin of 17.22% 24,85,93,784 3. Transfer Price received by the taxpayer 21,82,68,570 4. 105% of International Transaction 22,91,82,188 5. Proposed Adjustment u/s 92CA 3,03,25,034
13. Before us the learned counsel for the appellant made oral arguments and also filed written submissions. Both during the course of oral arguments and in written submissions, no specific submission have been made viz-a-viz grounds 1 to 5 of grounds of appeal. It has been contended that ION Trading is engaged in rendering generic, repetitive software development services to its AE-ION Trading UK Limited and is therefore characterized as a captive or low-risk service provider, compensated on a fixed fee basis. It was further submitted that the TPO/DRP/AO have erred in making an adjustment of Rs. 3,03,25,034/- to the value of the international transaction of provision of computer software development services by the appellant to its AE. In support of the above submission, it has prayed for inclusion of the comparable M/s CG-Vak Software and Exports Limited (segmental) and exclusion of (i) M/s E-Infochips Bangalore Ltd., (ii) M/s Infinite Data System (P) Ltd. (iii) M/s Infosys Ltd., (iv) M/s Persistent Systems Ltd., (v)
M/s Sasken Communication Technologies Ltd. (vi) M/s Thirdware Solutions Limited and (vii) M/s Wipro Technologies Services Limited. in the final set of comparables. Apart from the above, it was also prayed that AO/TPO/DRP erred in contravening provision of rule 10B(1)(e)(i) by considering the unutilized rent and maintenance expenses as expenses incurred in relation to the international transaction of the provision of software development services. It was also submitted that the authorities below have grossly erred in not allowing the risk adjustment under Rule 10B(1)(e)(iii) and Rule 10B(3) to account for differences in the risk profile of the comparable companies vis-a-vis the appellant. The learned DR has supported the orders of DRP/TPO/AO and contended that adjustment made should be sustained and, no interference is warranted.
We have considered the rival submissions and perused the material placed on record. The first and foremost substantive contention raised by the learned counsel vis-a-vis Ground 6 of Grounds of Appeal is that DRP violated the provisions of Rule 10B(2) of the Rules by rejecting CG-VAK Software Exports Limited, a comparable company selected by the appellant in the TP documentation by modifying the filter of employee cost being less than 25% of turnover as proposed by the ld. TPO to employee cost of less than 75% of turnover and further erred in incorrectly computing the filter ratio at less than 75% instead of correct ratio of 79.69% of turnover. The TPO had rejected the above comparable by holding as under:
“Rejection of CG-VAK as a comparable by the undersigned is valid for the reasons explained in the show cause notice. Further, the assessee has not submitted any detail to justify that each one of the identified filters are satisfied in this case. Since the assessee company has failed to discharge its onus, the undersigned is constrained, to reject the said company as comparable.”
It is seen that the reasons mentioned in the show cause notice vis-à-vis the said comparable was that the financials do not reflect the details of related party transaction and the other important filters which have been ignored by the assessee from the final list of comparable companies.
16. Before the DRP the appellant contended as under:
“CG-VAK Software & Exports Ltd. was incorporated in 1995. The company specializes in consulting services and offshore software development. It is engaged in providing outsourced software product services (product lifecycle, product maintenance, product migration, product testing, tech writing/documentation); custom software services (e-commercie application, website design, client servicer application); testing services; and professional services. The company has three business segments namely software services; BPO services and training. The software services segment has been considered for the purpose of our analysis. Further, it is submitted that CG-VAK Software & Exports Ltd. does not fall the 25% related party filter applied by the learned TPO. A working of the same was provided to the TPO vide submission dated 15.1.2014 and has been provided below based on the details available in the Annual Report for FY 2010-11: The detailed computation of the related party percentage is as under:
Nature of related party transaction Amount (in INR) Purchase of assets 27,07,672 Interest receipts 7,28,390 Interest BPO 10,979 Salary 33,00,000 Rent 13,20,000 Interest paid on FD 4,36,429 Total related party transactions (A) 85,03,470 Total income as per Annual Report (B) 6,19,81,460 RPT as a % of sales (A/B) 13.72%”
17. However the DRP upheld the exclusion on the following basis:
“Having considered the above and the material placed on record, we are of the opinion that the said company does not satisfy the filter applied by the TPO of employee cost less than 75% of turnover and therefore the same cannot be taken as comparable. In view of the above, action of the TPO is upheld.”
Before us it was submitted that DRP incorrectly applied employee cost filter which was never proposed by the TPO. It was submitted in the profit and loss account, CG-VAK has reported certain “Cost of Services”, however, the breakup of the same is not known (to ascertain whether the same includes any employee cost or not). It was further submitted that from the annual report for financial year 2010-11 and financial year 2011-12, it is can be seen that the employee cost was disclosed as cost of services. The relevant extracts from the annual report is given below:
PROFIT & LOSS STATEMENT FOR THE YEAR ENDED 31ST MARCH 2012 Note 31.3.2012 31.3.2011 (Rs.) No. (Rs.) III Expenditure: 3.03 5,33,80,368 4,73,01,685 Employee Benefit Expenses PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31.3.2011 Schedul 31.3.2011 (Rs.) 31.3.2010 (Rs.) e Expenditures 135 4,73,01,685 4,73,59,185 Cost of services
It was also submitted that the company has followed “different nomenclature” in the FY 2009-10, wherein the employee cost is shown as cost of services. The relevant extract from the annual report of the company is reproduced below:
Schedule 31.3.2010 31.3.2009 (Rs.) (Rs,) Income: Income from Software Development, Services & Products - Overseas 12 5,74,87,587 7,16,87,088 - Domestic 13 19,40,663 6,52,093 5,94,28,250 7,23,39,181 Other Income 14 25,53,210 72,26,721 6,19,81,460 7,95,65,902 Expenditure: Cost of Services 15 4,73,59,185 5,88,05,074 Administrative Expenses 16 1,32,67,939 1,04,53,160 Interest 17 19,16,993 30,47,952 Depreciation 63,65,886 59,23,335 6,89,10,003 7,72,29,521 Net Profit/(Loss) for the year (69,28,543) 23,36,381
20. It was submitted that since the cost of service/employee cost (i.e. Rs.4,73,59,185) is 79.69% of turnover (i.e. Rs.5,94,28,250) it satisfies the filter applied by the Hon’ble DRP and thus, CG-VAK should be accepted as a comparable to the appellant. Reliance was placed on the following judgments:
- Lam Research India (P) Ltd. vs. DCIT [TS 203-ITAT-2015 (Bang)] - Yodlee Infotech (P) Ld. vs. ITO [TS-465-ITAT-2014 (Bang)] - Cisco System India (P) Ltd. vs. DCIT [TS-246-ITAT-2014 (Bang)]
We have considered the submission of the ld. counsel for the assessee and have considered the argument of the ld. DR that the assessee is not producing any product, however, we find that CG- Vak Software and Exports Limited is not only into computer software but it is a product manufacturer too. Since assessee is not into product manufacturing and the segmental details cannot be bifurcated from the financial details, we find that the assessee and the CG-Vak Software and Exports Limited are not comparables.
Therefore, we are inclined to uphold the orders of the authorities below in rejecting this company as a comparable. We direct accordingly.
Now taking up Grounds No.7 to 13 of Grounds of Appeal, the learned counsel made his submission for exclusion of comparables selected by TPO. We will now consider the merits of the arguments of the parties with regard to selection of the these companies as comparables by TPO.
23. E-Infochips Bangalore Limited 24. The learned AR contended that DRP/TPO have erred both in law and on facts by considering E-Infochips Bangalore Limited as a comparable to the appellant. The learned counsel for the assessee contended that the DRP, however has ignored the submissions made by the assessee and upheld the action of the Assessing Officer/TPO to include M/s. E-Infochips Bangalore Ltd. in the list of final comparables. The appellant has objected to the inclusion of the comparable on the ground of functionally not comparable and, abnormal deviation in profit margin. The appellant submitted that the functional profile of M/s. E-Infochips Bangalore Ltd. is different from that of the assessee company. In this regard, he pointed out that the said company is a product engineering services provider having a technical expertise in software, firmware, hardware, FPGPA, ASIC, Quality testing etc. Its key focus area in product engineering services includes conceptualization, Architecture and Design, Sustenance and Support, Development, Production and Quality testing. Further it focuses on wide array of industries including aerospace, security and surveillance, semiconductor, medical devices, consumer devices, software and retail & E- commerce. It also has its IPs and accelerators in software domain namely “Automated Quality Assurance TestBorg (Aqua TestBorg) and the same was supported by the screenshot taken from the company’s website (https://www.einfochips.com/software-ips). He thus contended that M/s. E-Infochips Bangalore Ltd. thus is liable to be excluded, besides due to functional differences, even on the basis of insufficient information available in the public domain from the list of comparables.
25. We have considered the rival submissions and also perused the relevant material on record. The contention raised by the learned counsel for the assessee is that the entity M/s. E-Infochips Bangalore Ltd. taken by the Assessing Officer/TPO as comparable should be excluded from the list of final comparables for the purposes of transfer pricing analysis on the ground of functional differences as well as on the ground of insufficient information available in respect of the said entity in public domain. In order to support and substantiate his contention of functional dissimilarity, the learned counsel for the assessee has heavily relied on the contents of the website www.einfochip.com., the print out of relevant portion of which is placed on record before us. On the basis of the said contents, he has made an attempt to point out that M/s.
E-Infochips Bangalore Ltd. is functionally different form the assessee company in as much as the said company is mainly into development of new products whereas the assessee company is mainly providing software development services. It is seen that reference to the website of company is not of much help as it may not have information which pertained to FY 2009-10. It is possible that these services were provided by E-Infochips Ltd. instead of E- Infochips Bangalore Ltd. Also, it is possible that provision of these services is a subsequent development. Further, many of these services like software, FPGA, ASIC, QA & Testing require software engineers only. Hence, the services and personnel required are not entirely different. The reference made by the taxpayer is in respect of website of E-Infochips Ltd. and not that of E-Infochips Bangalore Ltd. After having gone through the website www.einfochip.com., we however find that the same is in respect of the entire group of E-Infochips, of which M/s. E-Infochips Bangalore Ltd. is only a part. The functional profile given on the said website thus is that of the entire group and not just of the M/s.
E-Infochips Bangalore Ltd. The content of the said website in our opinion, therefore, cannot be relied upon to ascertain the functional profile of M/s. E-Infochips Bangalore Ltd., especially when the nature of functions/services given there are materially different from the functions/services stated to be rendered by M/s. E-Infochips Bangalore Ltd. in its annual report. Even the details of services stated to be rendered by M/s. E-Infochips Bangalore Ltd. at different places in its Annual Report are very sketchy and it is very difficult to ascertain from the same, exact nature of services rendered by the said entity.
A perusal of the order of the DRP/TPO however, shows that no finding/observation has been recorded by them on the ground of functional differences as well as insufficient data/information available in the public domain. It is also worthwhile to note here that the profit margin of M/s. E-Infochips Bangalore Ltd. is abnormally high and although the said entity cannot be excluded from the list of final comparables merely on the ground of high or abnormal profits, as held by in the case of Maersk Global Centres (India) (P.) Ltd. v. Asstt. CIT 147 ITD 83 and by jurisdictional High Court in the case of Chryscapital Investment Advisors (India) (P)
Ltd. It should trigger further investigation in order to establish whether it can be taken as comparable or not. As further held by the Special Bench in the case of Maersk Global Centres (India) (P.) Ltd. (supra), such investigations should be to ascertain as to whether earning of super profits reflects normal business condition or whether it is the result of some abnormal condition prevailing in the relevant year. The profit margin of such entity in the immediately preceding year(s) may also be taken into consideration and the FAR analysis in such cases may be reviewed to ensure that the potential comparable earning higher profit satisfies the comparability condition. Since this exercise has not been done either by the AO/TPO or the DRP in the present case, we are of the view that the matter should go back to the Assessing Officer/TPO for fresh consideration. This, in our opinion, will also take care of the grievance of the assessee relating to the lack of sufficient information in respect of M/s. E-Infochips Bangalore Ltd. available in the public domain in as much as the TPO can obtain such information in the form of relevant schedules of the Profit & Loss Account of the said entity as well as the segmental details, if any, directly from the said entity.
Following the above judgments, we therefore, set aside the impugned order of the Assessing Officer as well as the direction given by the DRP on this issue and restore the matter to the file of the Assessing Officer/TPO for deciding the same afresh after giving the assessee proper and sufficient opportunity of being heard.
Infinite Data System Private Limited
The learned counsel for the assessee further contended that the DRP, has completely ignored the submissions made by the assessee and upheld the action of the Assessing Officer/TPO to include Infinite Data System Private Limited in the list of final comparables. The appellant objected to the inclusion of the comparable before TPO on the following grounds:
i) Functionally not comparable ii) Abnormal/Supernormal profits iii) Significant intangibles iv) Accepted as a non comparable in previous year by TPO
The DRP upheld the order of TPO as under:
“The TPO has dealt the issue in para 8,4, of the order and held that the company is providing software development services which is parimaterial with the functions carried on by the assessee. Having considered the material placed on record we find that the company is mainly involved in software services. Therefore we hold that TPO is right in including the same for the purpose of comparability analysis.”
Before us the learned AR of the appellant has contended as under:
“Substantially Related Party Transactions - Company’s operations relates to providing services to its sole customer-Fujitsu Services Ltd.” (substantially related) which can be substantiated as per the news letter and annual report. As per the News Letter Fujitsu entered into a BOT (Built, Operate & transfer) contract with Infinite Computer Solutions (India) Ltd. holding company of Infinite for development of offshore centre in India. The contract was signed in July 2008 for period of three years. Infinite have been set up as a separate entity for BOT the Indian Offshore centre of Fujuitsu (Source-http:/www.Indianofline.com/article/newsinfite-computer- solutions-india-suffessfull completes-bot-contract-with fujitsu- services-4020499021_1.html) As per the Annual report The company’s operations are predominantly related to providing software technical consultancy services to us sole customer Fujitsu “services Ltd.”
(Refer page 689 of the Paper Book Volume II) b) Functionally not comparable As per Annual Report S(chedule 17) It provides solutions that encompass technical consulting, design and development of software, maintenance, system integration, implementation, testing and infrastructure management services. As per Annual Report (Revenue recognition section) It generates revenue primarily from Technical Support & Infrastructure Management services (Refer Page 685 of Paper Book Volume II) -Segmental information not available for software design and development. -Further, the financial state that more than 10% of the administration expenses & other expenses are towards project implementation expenses, which are different from software development (Refer Page 683 of the Paper book Volume II) c) Ld. TPOs approach of using data from Infinite’s website as on the current date and drawing comparison thereof with FY 2009010 i.e. 4 years prior to the current year is incorrect. (Refer page 70 of the Paper book for TPO’s observation)”
On the other hand, the learned DR supported the order of the lower authorities regarding the inclusion of the same in the list of comparables. He reiterated the contents of the TPO's order which states as under:
“It is seen that Infinite is providing following services:- technical consulting, design & development of software, maintenance, systems integration, implementation, testing and infrastructure management services. These services except infrastructure management services have also been refereed as ‘technical support services’ in Revenue Recognition portion and as ‘software technical consultancy services’ in Segment Reporting portion of the annual report. All these services are in the nature of software development services. …….It can be seen that all the services have been referred primarily as IT services. The objection of the assessee is mainly on verticals of the company. Under TNMM the standards of comparability are relatively relaxed and only broad similarity of functions is required. It is further stated that TNMM can be used with data for companies that are broadly comparable to the taxpayer, as functional differences are likely to be reflected in the level of operating expenses incurred by each company. These expenses are deducted in the calculation of operating profit and are accordingly taken account of in the comparability analysis. It is further seen that this company has been chosen as it is engaged in providing software development, which is broadly similar to the services being provided by the assessee. Since, the assessee is also providing similar services, so this company can be used as a comparable.”
We have heard the rival submissions and considered the facts and materials on record. After considering the submissions, we are in agreement with the conclusion of TPO/DRP held that Infinite is providing following services: technical consulting, design & development of software maintenance, systems integration, implementation, testing and infrastructure management services.
These services except infrastructure management services have been referred as “technical support services in revenue recognition portion and as ‘software technical consultancy services’ in segment reporting portion of the annual report and thus services are in the nature of software development services and having regard to the above it is concluded that the Infinite is a functionally similar company to the appellant company.
We have gone through the annual report of the appellant company. The said company provides solutions that encompass technical consulting, design and development of software, maintenance, system integration, implementation, testing and infrastructure management services which is functionally similar to the appellant company. There is no RPT transaction of the comparable and transaction with a sole customer does not constitute a RPT transaction.
Having regard to the above and for the reasons stated above, we uphold the conclusion of TPO for inclusion of Infinite Data System Private Limited since it is comparable to appellant company.
Infosys Limited
The learned counsel for the assessee contended that the DRP has completely ignored the submissions made by the assessee and upheld the action of the Assessing Officer/TPO to include Infosys Limited in the list of final comparables and submitted that Infosys Limited cannot be considered as a comparable as it is engaged in diversified activities as it has wide spectrum of services such as business services, technology services and outsourcing services. It was contended that Infosys Limited is engaged in significant Research & Development (R&D) that has led to creation of significant Intellectual property. It has been further pointed out that as per Annual Report of FY 2009-10, the company claims itself as the most reputed and admired company in India (Pg. 18 of Director’s Report). Further assessee contended that Infosys Limited has a turnover of Rs 21,140 crores, which is even more than 968 times of that of the assessee. The Ld. Counsel for the appellant has placed reliance upon the various decisions, in which Infosys Limited has been rejected as a comparable considering the same not only as a giant company but is also engaged in development of various niche products, which are as follows:
i) 35 taxmann.com 421 (Hyd) Intoto Software India Pvt. Ltd. vs. Asst. CIT ii) 40 taxmann.com 173 (Hyd) NTT Data India Enterprise Application Services (P.) Ltd. vs. Asst. CIT iii) 38 taxmann.com 306 (Del) Agnity India Technologies (P.) Ltd. vs. DCIT iv) 38 taxmann.com 166 (Hyd) Virtusa (India) (P.) Ltd. vs. DCIT
The TPO has observed as under:
“The brand name may have helped Infosys in increasing its number of clients & retention of existing clients and this an increase in its market share, but it has not necessarily resulted in better profit margins. Brand may bring more revenues but not necessarily higher margins….a brand may generate revenue but with a cost compensating any extra benefit, if any derived from such efforts.” “Assessee had objected on the high turnover of this comparable company which is already discussed in the order. However, TPO has made an analysis in respect of influence of scale of operations on the profitability in the case of Infosys Technologies Ltd. From the year 1997 to 2012 based on the information extracted from the Capitaline Plus database, which shows that there is no positive correlation between the two… Although the turnover of the company has increased 183 times from the year 1997 to 2012, the operating margins has more or less remained the same i.e. ranging between 35% to 51%.... Hence, the taxpayer’s argument that companies having large scale of operations have better margins is without any basis, and is therefore liable for rejection.”
The DRP supported the action of the TPO in including this company in the final list of comparables by holding as under:
“The TPO has dealt the issue in para 8.5 of the order and held that the company is providing software development services which is parimateria with the functions carried on by the assessee.” Having considered the material placed on record we find that the company is mainly involved in software services” Therefore, we hold that TPO is right in including the same for the purpose of comparability analysis.”
We have considered the rival submission and perused the material placed on record. The said comparable was recently considered by the decision of ITAT in the case of Mentor Graphics (Noida) (P) Ltd. 60 taxmann.com 164 wherein following the judgment of Jurisdictional High Court in the case of Agnity India Technologies vs. ITO (Del), it was held as under:
“15. We find that Ld. CIT(A) after considering the facts of the case and the submission of the AR observed that with regard to Infosys Technologies Ltd. it was evident from the Annual Report of the company that Infosys Technologies provides much wider range of services, performs extensive functions, undertakes diversified business activities and assumes significant risks as compared to routine software development service providers like the assessee. Further, the company undertakes substantial R&D activities and derives majority of its revenues the sale of proprietary products unlike the assessee. Also, the turnover of the company is significantly higher than that of the appellant and in no manner is comparable to the size/operations of the assessee.
We note that all the above facts highlight that Infosys Technologies Ltd. is a product owner, undertakes substantial advertising/sales promotion and brand-building activities and is engaged in significant R&D activities, and is very huge in size/volume as compared to the assessee. Hence, it cannot be said to be comparable with the assessee. The said proposition has also been confirmed by Delhi Tribunal in Agnity India Technologies v. ITO [IT Appeal No.3856 (Delhi) of 2010] wherein the Coordinate Bench held as follows :
"Various arguments, as stated earlier, were taken before the DRP which inter-alia included rejection of comparable cases; application of arbitrary filter of wage to sales ratio; ignoring that the assessee is a limited risk company; inclusion of Infosys Technologies Ltd.; and inclusion of Sat yam Computers Services Ltd. in spite of the fact that its data is not reliable as publicly known. On the basis of these arguments, the DRP excluded the case of Sat yam Computers Services Ltd., thereby reducing the arm's length margin to 25.6%. It is argued that the case of the assessee is not comparable with Infosys Technologies Ltd., the reason being that the latter is giant in the area of development of software and it assumes all risks, leading to higher profit. On the other hand, the assessee is a captive unit of its parent company in the USA and it assumes only limited currency risk. Having considered these points, we are of the view that the case of aforesaid Infosys and the assessee are not comparable at all as seen from the financial data etc. of the two companies mentioned earlier in this order. Therefore, we are of the view that this case is required to be excluded. Once that is done, it is the accepted position of both the parties that the results of the assessee are in line with the mean margin of comparable cases even if no adjustment is made on account of capital etc. Therefore, it is held that no adjustment was required to be made to the results declared by the assessee company."
11.5 The aforesaid order was upheld by the Hon'ble Delhi High Court after taking note of the chart as given below:
Basic Particular Infosys Technologies Ltd. Assessee Risk Profile Operate as full-fledged risk Operate at minimal taking entrepreneurs risks as the 100 percent services are provided to AEs Nature of services Diversified-consulting, Contract software application design, development services development, re- engineering and maintenance system integration, package evaluation and implementation and business process management, etc. (refer page 117 of the Paper Book) Turnover 20,264 crores 209.83 crores Ownership Develops/owns proprietary branded/proprietar products like y products Finacle, Infosys Actice Desk, Infosys iProwe, Infosy s Connect. Also the company derives substantial portion of its proprietary products (including its flagship banking product suite „Finacle) Onsite v. Offishore As much as half of the The appellant provides software development only offshore services services rendered by (i.e. remotely from Infosys are onsite (i.e. India) services performed at the customer's location overseas). And offshore (50.20 per cent) Refer p. 117 of the Paper Book) than half of its service, income from onsite services Expenditure on Rs. 80 crores Rs. Nil (as the 1- advertising/sales percent services are promotion and provided to AEs) brand building Expenditure on Rs. 236 crores Rs. Nil Research and Development Other 100 per cent offshore (from India)
11.6 On the basis of the above chart, the Hon'ble High Court affirmed the conclusion that a captive unit of acomparable company which assumed only a limited risk cannot be compared with a giant company in the area of development of software who assumes all types of risks leading to higher profits. The facts of the appellant are akin and therefore, do not warrant any different conclusion. The assessee is also captive service provider to its AE and as such, M/s. Infosys Ltd. is not a valid comparable with the assessee 17. Accordingly, Ld. CIT(A) proposed to exclude this company from comparable set of companies. Therefore, the ld. CIT (A) has rightly ordered exclusion of the Infosys Technologies Ltd. from the comparable and this impugned order is upheld.”
Having regard to the above regard to the above judicial pronouncement, we hold that Infosys Limited cannot be considered as comparable for the purpose of benchmarking international transaction of the assessee.
Persistent Systems Limited
The assessee has sought exclusion of the aforesaid company on the ground that this company is a technology company into software product development services and is focused mainly on three industries i.e. Infrastructure & Systems, Telecom & Wireless, Life Science and Healthcare, whereas the assessee is operating in finance domain which is totally different. It was further submitted that on economy of scales, the company Persistent Systems Limited is very large in comparison with that of the assessee. It was also submitted that the company has revenue from sale of products as well with the software services. It has been submitted that segmental break of sales on sale of products and services has not been given by the company as the pricing consequently the margin would differ that on sale of products and sale of services. Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables.
The TPO has held as under:
“The company does have some products but as has been brought out above, the product revenue (from IP led businesses) are only 7.2%. Hence, the company is predominantly a software service provider and will be taken as a comparable. Under TNMM, the standards of comparability are relatively relaxed and only broad similarity of functions is required.”
The DRP supported the action of the TPO in including this company in the final list of comparables by holding as under “The TPO has dealt the issue in para 8.6 of the order and held that the company is providing software development services which is paramateria with the functions carried on by the assessee. Having considered the material placed on record we find that the company is mainly involved in software services. Therefore, we hold that TPO is right in including the same for the purpose of comparability analysis.”
We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. A Coordinate Bench in the case of Agnity India Technologies (P) Ltd. vs. ITO 154 ITD 293 (Del) regarding the said comparable has held as under:
“11. So far as exclusion of three comparables i.e. Larsen and Tourbo Infotech Ltd., Persistent Systems Ltd. and Mindtree Ltd., it is noted that before the CIT(A) the assessee contended that during the financial year 2008-09, it has a turnover of approx. Rs. 14.45 crores which cannot be compared with certain companies having turnover of more than 200 crores. Support was drawn from the following decisions : (a) Decision of ITAT in the case of appellant for A.Y. 2006-07 A.Y. 2006-07;
(b) Genisys Integrating Systems (India) (P.) Ltd. v. Dy. CIT [2012] 20 taxmann.com 715/53 SOT 159 (Bang.) (c) Centillium India (P.) Ltd. v. Dy. CIT [2012] 23 taxmann.com 34/53 SOT 145 (Bang.) (d) Kodiak Networks (India) (P.) Ltd. v. Asstt. CIT [2012] 18 taxmann.com 32/51 SOT 191 (Bang.) (e) Actis Advisers (P.) Ltd. v. Dy. CIT [IT Appeal No. 5277 (Delhi) of 2011] 13. Having considered the rival submissions and perused the material on record. We find this issue is no longer res-integra. The Hon'ble High Court upholding the decision of Tribunal in the case of the appellant for A.Y. 2006-07 has held in an order dated 10.7.2013 in in [CIT v. Agnity India Technologies (P.) Ltd.[2013] 36 taxmann.com 289/219 Taxman 26 (Delhi)] that a giant company in the area of development of software which assumed all risks leading to higher profits is not comparable with the assessee which was a captive unit of the parent company and assumed only a limited risk.
The Hon'ble High Curt has held as under : "8. It is a common case that Satyam Computer Services Ltd. should not be taken into consideration. The Tribunal for valid and good reasons has pointed out that Infosys Technologies Ltd. cannot be taken as a comparable in the present case. This leaves L&T Infotech Ltd. which gives us the figure of 11.11%, which is less than the figure of 17% margin as declared by the respondent- assessee. This is the finding recorded by the Tribunal. The tribunal in the impugned order has also observed that the age had furnished details of workables in respect of 23 companies and the mean of the comparables worked out to 10%, as against the margin of 17% shown by the assessee. Details of these companies are mentioned in para 5 of the impugned order.
In view of the aforesaid position, we do not think that any substantial question of law arises for consideration. The appeal is dismissed."
16. When considering the exclusion of persistent system Ltd, we find no need to interfere in the order of the Ld CIT(A) because it is engaged in development of software product; and this company was excluded by the Tribunal in assessment year 2006-2007, which has been up held by the Hon'ble High Court, thus the issue about exclusion of persistent system Ltd, while making TP adjustments in it's case stands settled in view of these decisions in its own case. Therefore we do not find any necessity to interfere this company's exclusion.
Having regard to the factual position and respectfully following the judgment of the Hon'ble High Court we partly allow the ground raised by the revenue and uphold the exclusion of persistent system Ltd, and direct inclusion of Larsen & Toubro Infotech Ltd and Mind tree Ltd.”
Similar view has also been expressed in the case of Fiserv India (P) Ltd. vs. DCIT 60 taxmann.com 345 (Del), it was held as under:
“12.2 We have considered the rival submission and perused the material on record. The counsel for the assessee has contended that Persistent Systems Ltd. is functionally different from the assessee as the company is into software development services as well as software products unlike the assessee who is a captive service provider. Moreover, no segmental details are available in the annual report. It can be thus derived that the prices may have been influenced. The rationale of applying a related party filter is defended. 12.3 The Bangalore Bench of the Tribunal in the case of CSR India (P.) Ltd . v. ITO [2013] 31 taxmann.com 265 , has held as under: '(i) Turnover Filter 3.3 We have heard the rival submissions and perused the materials on record. The TPO had, while selecting the above 26 comparables, applied a lower turnover filter of Rs.1 crore but preferred not to apply any upper turnover limit. The size of the comparable is an important factor in comparability. The ICAI TP guidance note has observed that the transaction entered into by a Rs.1000 crores company cannot be compared with the transaction entered into by a Rs.10 crores company and the two most obvious reasons are the size of the two companies and related economies of scale under which they operate. The TPO's range had resulted in selection of companies as comparable such as Infosys which was 277 times bigger than that of the assessee. The Bangalore Bench of the Tribunal in the case of M/s. Genisys Integrating Systems (India) Pvt. Ltd. v. DCIT - relying on Dun and Bradstreet's analysis had held that turnover range of Rs.1 crore to 200 crores is appropriate. The said proposition has followed by the earlier Benches of this Tribunal in the following cases: (i) M/s. Kodiak Networks (I) Pvt. Ltd. v. ACIT - ITA No.1413/Bang/2010; (ii) M/s Genesis Microchip (I) Pvt. Ltd. DCIT - ITA NO.1254/Bang/2010; (iii) Electronic for Imaging India Pvt. Ltd - ITA NO.1171/Bang/2010; & (iv) M/s. Trilogy E-Business Software India Private Ltd . v. DCIT - ITA No.1054/Bang/2011 dated 23.11.2012. 3.3.1 In the case of M/s.Genisys Integrating Systems (India) Pvt. Ltd . v. DCIT (supra ), relying on Dun and Bradstreet', has observed as under:
"9. ………….we find that the TPO himself has rejected the companies which are 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 are 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 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 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 crores only should be taken into consideration for the purpose of making TP Study." 3.3.2 The above view has been followed in the recent order of the Tribunal in the case of Trilogy E -Business (supra ). The relevant findings of the Tribunal are extracted as under:
In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee's turnover is Rs.47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz. Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores".. In view of the above said reasoning and the orders of the Benches of Bangalore Tribunal cited supra, the following 8 companies will have to be eliminated from the list of comparables selected by the TPO, namely: • Flextronics Software Systems Limited; • iGate Global Solutions Limited; • Mindtree Limited; • Persistent Systems Limited; • Sasken Communication Technologies Limited; • Tata Elxsi Limited; • Wipro Limited; & • Infosys Technologies Limited. It is ordered accordingly.' 12.4 Following the aforesaid decision of the Tribunal and the judgment of Hon'ble High Court of Delhi in the case of Aginity
Technologies (supra ) we hold that Persistent Systems Ltd. should not be regarded as a comparable.”
Therefore, following the above judgments we hold that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. It is ordered accordingly.
Sasken Communication Technologies Limited (Sasken)
The assessee has sought exclusion of the aforesaid company on the ground that this company has different business model and there is presence of intangibles. It has also submitted that, as per Annual Report, the company derives revenue from software products, which suggests that the company is a product company unlike the assessee. It was further submitted that the company has inventories amounting to Rs. 166.55 lakhs and being a software service company, it was also provided that should not be holding any inventory in the books of accounts. The assessee also contended that company is also actively engaged in product development and earns revenue also from sale of software products, there were also peculiar economic circumstances as it underwent restructuring during the year which inflated its profit by Rs. 1,519.70 lakhs in addition to other factors affecting its sales and margins. Further, the turnover of the company is more than 19 times of the appellant.
The TPO has held as under:
“It is seen that this cost (contract staff cost) is insignificant in comparison to employee cost of Rs. 213.46 cr.” “All software companies have software in their fixed assets. It is only when it is significant and developed by them and is being amortized on sale of software products exceeding 25% of total income, it can be said to be resulting in different income which changes the profile from pure software developer to a company also selling products. It is further seen that this company has been chosen as it is engaged in providing software development, which is broadly similar to the service being provided by the assessee. Since, the assessee is also providing similar services, so this company can be used as a comparable.”
The DRP supported the action of the TPO in including this company in the final list of comparables by holding as under:
“The TPO has dealt the issue in para 8.8 of the order and held that the company is providing software development services which is parimateria with the functions carried on by the assessee. Having considered the material placed on record we find that the company is mainly involved in software services. Therefore, we hold that TPO is right in including the same for the purpose of comparability analysis.”
We have considered the submission and perused the material placed on record. A Coordinate Bench of Tribunal in the case of Tibco Software (India) (P) Ltd. vs. DCIT dated 10.4.2015, it was held as under:
“32. By way of Ground of Appeal No.4.5, the appellant has assailed the action of the TPO in excluding Sasken Communications Technologies Ltd. from the final set of comparables. As per the discussion in para 11(viii) of the order of the TPO, it is noticed that the said concern has been excluded on the ground that during the year under consideration it has undertaken business restructuring. The Ld. Representative also pointed out that in the show-cause notice dated 31.10.2012 issued by the TPO another reason has been advanced which is to the effect that the said concern fails the export turnover filter of 75% of the total turnover.”
53. Having regard to the above judgment and since it is evident from record that Sasken Communication Technologies Limited is functionally not similar to the appellant and also having gone through restricting in the instant year, it cannot be treated as comparable to assessee. We order accordingly.
Thirdware Solutions Limited (Thirdware)
The assessee has objected to the inclusion of the said comparable on the following ground that the aforesaid company is focused on solutions and services in the Enterprise Allocation Space (EAS) in the Transaction, Analytics, and Collaborative Solution Layers. This includes ERP, customer relationship management (CRM), SCM, BI/DW, BPM etc. Thirdware offers Application Implementation Services (AIS), Application Development Services (ADS) and Application Management-support Services (AMS). It was further submitted that it is engaged in development of own software-PAPA and has incurred expenses towards import of software service, evidencing outsourcing of software services unlike the Applicant company. The TPO has not provided any reason for holding Thirdware as a company comparable to the Appellant whereas, The DRP while upholding Thirdware as comparable to the Appellant company observed as under:
“The audited report of the company reveals that company is mainly engaged in software development. The majority of income is from software development. Having considered the material placed on record we find that the company is mainly involved in software services. Therefore, we hold that TPO is right in including the same for the purpose of comparability analysis.”
We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that the functions of Thirdware are in contrast with the assessee which only provides software development in the finance domain as per the instruction of its AE. Also, Thirdware has incurred expenses towards import of software services, evidencing outsourcing of software services unlike the assessee. Since it is also engaged in outsourcing its activities as it has incurred expenses towards imports of software services, evidencing outsourcing of software services unlike the appellant company. Hence, it is functionally not comparable and cannot be treated as a comparable to assessee. We order accordingly.
57 Wipro Technology Services Limited (Wipro)
As far as this company is concerned, the arguments of the assessee were not only on account of functional dissimilarity but the assessee also raised the other objection that there was an extraordinary event during the year. Wipro provides program management and third party information security assessment services to businesses that outsource technology and operations to third party vendors in India, the Philippines, China and the Russian Federation. It also offers software quality management, quality assurance, and business process management services as well as technology infrastructure support, development and deployment for strategic software applications to information technology and business professionals. During the year, Wipro Limited (Wipro) has reached an agreement with Citigroup Inc. for acquiring all of Citigroup interest in CTS w.e.f. 21 January 2009. On 21 January 2009, Wipro signed a master service agreement (MSA) with Citigroup Inc. for the delivery of technology infrastructure services and application development and maintenance services for the period of six years. Without prejudice, it was submitted that before 20.01.2009, the Company was part of the Citi group and rendered services to various entities of the Citi group worldwide. With effect from 21.01.2009, the Company was acquired by Wipro Ltd. however, in order giving effect to the directions of Hon’ble DRP, Ld. TPO has held that “In the case of M/s Wipro Technology Services Ltd., assessee is submitting that the transaction of rendering services by Wipro Technology to Citi Group are construed as deemed international transactions as per section 92B(2) of the Act. However, Annual Report of the company has been perused and it is seen from the audited Financial that in RPT schedule it is not considered as an Associated Enterprise. The TPO has not provided any reason for holding Wipro as a company comparable to the Appellant whereas The DRP while upholding Wipro as comparable to the Appellant company observed as under:
The audited report of the company reveals that company is mainly engaged in software development. The majority of income is from software development. Having considered the material placed on record we find that the company is mainly involved in software services. However, the assessee has brought to the notice that Wipro Technologies Service Ltd has RPT of more than 25%. The AO is directed to verify the computation provided by the assessee and if RPT is more than 25% than it should not be included for the purpose of comparability analysis.
We have considered the rival submissions, perused the material on record. In our view, Companies that are affected by factors like persistent losses, declining sales, extraordinary Income or expense, mergers and acquisitions or other such factors which affect the operations of the company substantially should not be used as comparables as they will not prove to be good benchmarks.
Further, while repelling the objection regarding extra-ordinary event taking place for this comparable, but for a different reason, i.e. the relevant extra ordinary event took place in the preceding Financial Year i.e. FY 2008-09. However, we concur with the submissions advanced by Ld AR that the Director's Report and Notes to Account for this comparable are not available in public domain. Ld. DR has not been able to controvert this fact. Since sufficient information for this comparable is not available, we direct exclusion of this company as a comparable.
Now taking up Ground No. 14, which relates to adjustment of unutilized rent and maintenance expenses as expenses incurred in relation to the international transaction of the provision of Software development services. The assessee contended that as per the rule 10B(1)(e)(i) of Income Tax Rules, 1962 which details transactional net margin method provides “the net profit margin realized 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 enterprise or having regard to any other relevant base”. In view of the above, for computing margin from an international transaction adjustment claim ought to be allowed.
The TPO has rejected the contention of the assessee by holding that:
“The contention of the assessee company is not acceptable on account of the following reasons:- a) The assessee has admitted that the expansion was at the behest of the AE only. Since the assets for the anticipated increase in business had allegedly gone unutilized, the compensation thereof should have been borne by the AE and in no case should be charged on the assessee company. b) Expenditure on enhancement of business is a routine operating expenditure which is undertaken with the intention of gaining more business. The assessee has done just the same in its case by taking the step of hiring more space. This expenditure cannot be taken to be extra ordinary in nature for the simple reason that it was expended in the hope of gaining business as is done by millions of businesses worldwide and every failure cannot be written off by the tax authorities as being extra ordinary. In this case the assessee has over reached itself in the hurry to get business by committing a sum of money in terms of rental and maintenance charges. c) The assessee is required to support its claim for any adjustment with robust data and full details and evidences so as to enable the TPO to examine the claim. The burden is on the assessee whenever it makes a claim and in this case, it has not discharged the burden of proof. These adjustments are being claimed in an adhoc manner. Further, according to assessee since fixed cost remain constant irrespective level of operation and therefore such costs could not be optimally utilized to low level of capacity utilization. In view of this office capacity adjustment in service industry is not applicable as the business model I s cost plus so there is no question of idle capacity in terms of fixed costs assets. d) If the taxpayer had seen a sudden spike in the volume o f its work during the year, it would have reaped the benefits of advance planning and foresight. This would have resulted in greater profits and better margins owing to its smart moves. However, when the volume of work did not grow as anticipated, it is seeking an adjustment due to the same smart business move. It cannot cut both ways. e) Moreover, the method of computing the adjustment is also not correct. Any comparability adjustment in transfer pricing analysis has to be carried out in respect of the comparable companies. In the instant case, the taxpayer has reduced its own employee costs to achieve the desired goal.
We have considered the rival submissions, perused the material on record. We uphold the order of Hon’ble DRP, as it has rightly held that as there is no objective basis led by the assessee to support its claim; mere submission that there was underutilization does not discharge the burden upon the assessee. Moreover, the assessee has not given any cogent basis to satisfy the reasons for under utilization. Once the assessee is a software service provider to its AE then there can be no claim on account of under utilization of capacity as it was AE who initiates such expansion. Hence, we reject the ground raised by the assessee.
The next issue raising in Ground No. 15 of Grounds of Appeal relates to the risk adjustment under Rule 10B(1)(e)(iii) and Rule 10B(3) to account for differences in the risk profile of the comparable companies vis-à-vis the Appellant.
64. The assessee contended that since it is a captive unit, it does not bear any entrepreneurial risks. However, while proposing the set of comparables in the notice, the Ld. TPO has not understood the risk-free nature of the assessee and has failed to consider the full- risk taking profiles of the companies selected as comparables.
The AR has highlighted the significance of comparing the level of risks between independent comparables and the taxpayer. It was submitted that TPO should consider the risk free nature of the taxpayer’s operations while adjudicating on the transfer prices.
Based on the above, ignoring the risk profile of the Assessee would be unjust on the part of the revenue. He contended that TPO/drip should have appreciated that the intent of the transfer pricing legislation in India is to avoid tax evasion and not to cause any hardship to the assessee.
In view of and taking due cognizance of all the differentiating factors cited above, the assessee contended that an adjustment with regard to the risk premium earned by comparable uncontrolled companies is imperative for a fair and judicious comparison of the transfer prices of the international transactions of the Assessee with the arm’s length price.
The TPO in its order dated 22.01.2014 has held as under:
“The assessee hasn’t claimed raised Risk Adjustment in its submission. However, it may claim at later stage on account of adjustment commensurate to the risk profile of the assessee. After carefully considering the facts of the case and the submissions of the taxpayer, I am not inclined to accept the assessee’s future claim of risk adjustment. Risk adjustment as a general rule cannot be allowed unless it is clearly shown that the comparables had actually undertaken such risk and how the same materially affected their margins. The revised OECD guidelines of 2010 has also stated in Para 3.54 as under:- “Ensuring the needed level of transparency of comparability adjustments may depend upon the availability of an explanation of any adjustments performed, the reasons for the adjustments being considered appropriate, how they were calculated, how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chapter V.” From the above guidelines it can be seen that unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustment, no adjustment can be allowed to the taxpayer. In the present case, except giving proportion of various risks borne, the taxpayer has not shown with evidence as to whether each of the risk was actually undertaken or not by the comparables and if so, how these risks affected each of them and whether such adjustment would improve the comparability. Mechanical adjustment cannot be made to the margins of the comparables without knowing which risk was taken by the entity concerned and how its profitability was affected. Probability of risk and certainty of risk are two different aspects and cannot be equated for the purpose of adjustment. In my view assessee cannot be compared to a risk free security. Even other methodology, whether adhoc adjustment as in case of Sony India, CAPM or Sharpe Ratio (which is a measure of the excess return on risk undertaken by an entity investing in a particular asset), as applied by Hyderabad ITAT in the case of ADP Private Ltd, are based on return of capital which is not the PLI adopted by the assessee and the TPO. All this requires robust and reliable data, both for the assessee and the comparables in the absence of which risk adjustment cannot be considered for enhancing comparability.”
Further, DRP upheld the view of Ld. TPO by holding as under:
“We have carefully considered the facts of the case and the submissions of the assessee. As per Rule 10B(2) and 10B(3) of Income Tax Rules, 1962, Indian Transfer pricing provisions prescribe only for “reasonable accurate adjustment” and further adjustment to the margins of comparables can be made only if they enhance comparability. But at the same time the data for the same must be relevant reliable and robust. Risk adjustment as a general rule cannot be allowed unless it is clearly shown that the comparables had actually undertaken such risk and how the same materially affected their margins. The revised OECD guidelines of 2010 has also stated in para 3.54 as under:- “Ensuring the needed level of transparency of comparability adjustments may depend upon the availability of an explanation of any adjustments performed the reasons for the adjustments being considered appropriate, how they were calculated how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chapter V.” Even the various judicial decisions on the issue of adjustments and even OECD guidelines, impresses upon time and again that the adjustment should be “reasonable accurate adjustment”. 13.10 From the above guidelines, it can be seen that unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustments, no adjustment can be allowed to the assessee. In the present case, except pointing out various risks, the assessee has not shown with evidence as to whether each of the risk was actually undertaken or not by the comparables and if so, how these risks affected each of them and whether such adjustment would improve the comparability. 13.11 Mechanical adjustment cannot be made to the margins of the comparables without knowing which risks were taken by the entity concerned and how its profitability was affected. Probability of risk and certainty of risk are two different aspects and cannot be equated for the purpose of adjustments. The significant of risk depends on its economic significance, likelihood of its realization and predictability. All these requires robust and reliable data, both for the assessee and the comparables in the absence of which tax adjustments cannot be considered for enhancing comparability. Thus the objection is rejected.
13.12 In the various judicial pronouncements the risk adjustment has not been allowed by the ITATs. Some of these decisions are discussed below: (a) Vedaris Technology 2010-TII-10-ITAT-Del-TPL: No risk adjustment to be allowed even on ad hoc basis particularly when the same has not been quantified; (b) Marubeni India Private Ltd. (2010-TII-36-ITAT-Del-TP) in which it was held that as the assessee failed to bring any evidence on record to show that there was any difference in risk profiles of comparable companies and since the assessee failed to file the details exhibiting risk borne by comparables, no risk adjustment can be given, even on ad hoc basis. (c) ADP Private Limited (2011-TII-44-ITAT-Hyd-TP) wherein the ITAT held that there is no thumb rule for allowance of risk adjustment.
(d) Symantec Software Solutions Pvt. Ltd. (2011-TII-60-ITAT- Mum-TP): The ITAT held that;
(i) Until and unless it is shown that the difference in function and risk results in deflation or inflation of financial results of the comparables, it is not a general rule to grant it as a standard adjustment. (ii) The assessee could not show how such difference in risk and functions affected the results of the comparables. (e) ST Micro Electronics (2011-TII-63-ITAT-Del-TP): The assessees claim that it was a risk free captive service provider and hence cannot be compared with comparables who were full entrepreneurs was not accepted by the ITAT. (f) Exxon Mobil Company India Pvt. Ltd. (2011-TII-68-ITAT- Mum-TP): The ITAT held that since working capital adjustment has been given and the assessee has not worked out the risk adjustment, no adjustment can be granted on this account. 13.13 Therefore, for the reasons mentioned above, we decline to interfere with the action of TPO in this regard.”
We have considered the rival submissions and perused the material placed on record. In our view, where the assessee succeeds in ably demonstrating that the comparables finally selected bore relatively more risk than it, then there should be no denial of the risk adjustment. If, however, the assessee fails in specifically pointing out the extra risks undertaken by the comparables, then, of course, there cannot be any question of granting risk adjustment. Under the transfer pricing regime, onus is always on the assessee to show the reasons for claiming any separate adjustment by pointing out the differences between it and the comparables. Risk adjustment can be allowed provided the assessee places on record some appropriate material to demonstrate that the risk undertaken by the comparable companies were relatively more than it, warranting downward adjustment in their profit rates. Further, the variation in such risks, if any, should be capable of quantification on some reasonable and logical basis. Since the ld. AR has failed to objectively demonstrate the relatively higher risks undertaken by the comparables on an overall basis, we are disinclined to grant any risk adjustment.
69.1 In view of the foregoing discussion, we set aside the impugned order and remit the matter of determination of ALP of the international transaction of ‘Provision of IT enabled data conversion services’ to the file of TPO/AO for a fresh decision in accordance with our above observations/directions. Apart from the issues discussed in this order, the decision of the TPO on all other aspects of the determination of the ALP of this international transaction should be considered as final, as no other issue has been agitated before us.
Ground No. 16: On the facts and in law, the Ld. AO/Ld. TPO and the Hon’ble DRP erred in not granting the benefit of reduction/variation of 5 percent from the arithmetic mean while determining the arm’s length price to the Appellant as per the proviso to section 92C(2) of the Act.
This issue has been dealt at great length by the TPO/DRP.
Both have referred to the relevant provisions, circulars and judgments on the issue. Accordingly, We do not find any infirmity in the order of the TPO/ DRP in this respect and the same is therefore upheld.
In Grounds No. 18 assessee has challenged the levy of interest u/s 234B. Since the chargeability of interest u/s 234B will ultimately depend upon the income to be determined in accordance with our directions contained hereinabove, at this stage it is premature to dwell upon this issue. It is open for assessee to raise the issue at the appropriate stage. Similarly, Ground Nos. 19 and 20 are consequential in nature.
Ground No. 21 not connected on merits since the issue emerges when the proceedings under section 271(1)(c) are independently initiated. Therefore this ground is rejected.
In the result, the appeal is disposed off as above.
Order pronounced in open court on this 07th day of December, 2015.