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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI ABRAHAM P. GEORGE
IN THE INCOME TAX APPELLATE TRIBUNAL “A” BENCH : BANGALORE
BEFORE SHRI N.V. VASUDEVAN, JUDICIAL MEMBER AND SHRI ABRAHAM P. GEORGE, ACCOUNTANT MEMBER
IT(TP)A No. 1180/Bang/2011 Assessment year : 2007-08
Broadcom India Research Vs. The Deputy Commissioner of Private Limited, Income-Tax, 4th Floor, Campus 3 A, Circle 11(2), RMZ Ecospace, Bangalore. Bellandur Village, Varthur Hobli, Bangalore 560 037. PAN : AACCB 6307L APPELLANT RESPONDENT
Appellant by : Shri Sreeram Seshadri, Advocate. Respondent by : Shri.C.H. Sundar Rao, CIT-I (DR)
Date of hearing : 21.01.2015 Date of Pronouncement : 28.01.2015
O R D E R Per N.V. Vasudevan, Judicial Member This appeal by the assessee is against the order dated 30.9.2011 of the Deputy Commissioner of Income-Tax, Circle 11(2), Bangalore passed u/s. 143(3) r.w.s. 144C of the Income Tax Act, 1961 (Act).
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The Assessee is a wholly owned subsidiary of Broadcom Netherlands BV., Netherlands, which in turn is a subsidiary of Broadcom Corporation, USA. The Assessee focuses on delivering semiconductor solutions for communications to the home, enterprise and mobile markets. Their product portfolio includes: Bluetooth, short-range wireless products for PC, Mobile phones, PDAs, Keyboards, mice and automotive electronics.
The Assessee has filed concise grounds of appeal and those grounds are taken up for consideration. Grounds No.1 to 6 of the concise grounds of appeal filed by the Assessee relate to the addition made by the AO of Rs.2,92,24,427/- to the total income of the Assessee on account of adjustment in the arm’s length price (ALP) of international transaction entered into by the Assessee with it’s Associated Enterprise (AE) under the provisions of Sec.92 of the Income Tax Act, 1961 (Act).
The Assessee provided Software Development Services to its AE. The said transaction was an international transaction 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). Financial Results of the Assessee for the F Y 2006-07 Description Amount Rs.25,95,40,100/- Operating Revenue Operating Cost Rs.23,50,18,401/- Operating Profit (PBIT) Rs.2,45,21,699/- Operating Profit to Cost Ratio 10.43 %
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The segmental details pertaining to software development Services is as
under (as per the TP report).
Software development Description services Operating Revenue Rs.25,95,40,100 Operating Expenses Rs.23,19,89,306 Operating Profit Rs 2,75,50,794 Operating Profit to Cost Ratio 11.88 %
Comparables ultimately selected by TPO and their arithmetic mean were as follows:-
Sl. Name of company OP / TC Turnover No Rs. In Crores 1 Accel Transmatic Ltd (Seg. 21.11% 9.68 2 Avani Cimcon Technologies Ltd 52.59% 3.55 3 Celestial Labs Ltd 58.35% 14.13 4 Datamatics Ltd 1.38% 54.51 5 E-Zest Solutions Ltd 36.12% 6.26 6 Flextronics Software Systems 25.31% 848.66 Ltd (Seg.) 7 Geometric Ltd (Seg.) 10.71% 158.38 8 Helios & Matheson Information 36.63% 178.63 Technology Ltd 9 iGate Global Solutions Ltd 7.49% 747.27 10 Infosys Technologies Ltd 40.30% 131.49 11 Ishir Infotech Ltd 30.12% 7.42 12 KALS Information Systems Ltd 30.55% 2.00 (Seg.) 13 LGS Global Ltd (Lanco Global 15.75% 45.39 Solutions Ltd)
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14 Lucid Software Ltd 19.37% 1.70 15 Mediasoft Solutions Ltd 3.66% 1.85 16 Megasoft Ltd 60.23% 139.33 17 Mindtree Ltd 16.90% 590.35 18 Persistent Systems Ltd 24.52% 293.75 19 Quintegra Solutions Ltd 12.56% 62.72 20 R S Software (India) Ltd 13.47% 101.04 21 R Systems International Ltd 15.07% 112.01 (Seg.) 22 S I P Technologies & Exports 13.90% 3.80 Ltd 23 Sasken Communication 22.16% 343.57 Technologies Ltd (Seg.) 24 Tata Elxsi Ltd (Seg.) 26.51% 262.58 25 Thirdware Solutions Ltd 25.12% 36.08 26 Wipro Ltd (Seg.) 33.65% 961.09 Arithmetic Mean 25.14% Assessee’s OP / TC for FY 2006-07 11.88%
The TPO finally passed an order u/s. 92CA of the Act and on the basis of the comparables set out above, arrived at arithmetic mean of 25.14%. After factoring the working capital adjustment of 1.96%, the adjusted arithmetic mean was determined at 23.18%. The computation of the ALP by the TPO in this regard was as follows:-
“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:
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Arithmetic mean PLI 25.14% Less: Working capital Adjustment(Annexure-C) 1.96% Adj.Arithmetic mean PLI 23.18% Arm’s Length Price: Operating Cost Rs.23,19,89,306 Arms Length Margin 23.18% of the operating cost Arms Length Price (ALP) at 123.18% of operating Rs.28,57,64,427/- cost Price received vis-à-vis the Arms Length Price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length Price as under: Arms Length Price (ALP) Rs.28,57,64,427/- at 123.18% of operating cost Price charged in the Rs.25,95.,40,100/- international transactions Shortfall being Rs.2,62,24,427/- adjustment u/s. 92CA The above shortfall of Rs.2,62,24,427/- is treated as transfer pricing adjustment u/s 92CA.”
Against the said adjustment proposed by the TPO which was incorporated in 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
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of the Assessing Officer, the assessee has preferred the present appeal before the Tribunal.
The assessee filed a chart explaining as how some of the
comparable companies chosen by the TPO were not comparable for the reason that these companies were not functionally 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 for reasons of functionally being different, turnover being huge, employee cost not being
upto the threshold limit. Before we proceed to consider the chart filed by
the Assessee, we have to deal with the application for admission of additional ground filed by the Assessee. In the additional ground of appeal,
the Assessee has prayed for exclusion of the comparable chosen at Sl.No.8 and 12 viz., Helios and Matherson Information Technology Pvt.Ltd.
and Kals Info Systems Ltd., even though these companies were chosen as
comparable by the Assessee in their transfer pricing study. The Assessee seeks to exclude these two companies from the final list of comparable
companies chosen by the TPO. The Assessee had considered both the aforesaid companies as comparable in its TP study. The TPO also
expressed the opinion that the two companies satisfied all the filters applied by him for choosing comparable companies. Even before DRP the
Assessee did not object to choosing these two companies as comparable
companies. The learned counsel for the Assessee in support of the
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admission of additional ground placed reliance on the decision of the Hon’ble Special Bench in the case of the ITAT Chandigarh Bench in the
case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207 wherein it
was held that a taxpayer is not estopped from pointing out a mistake in the assessment though such mistake is the result of evidence adduced by the taxpayer. The learned counsel further submitted that the aforesaid two companies were held to be software product companies and therefore not comparable with software development service provider such as the Assessee in several decisions rendered by the Tribunal. The decisions rendered by the Tribunal are later in point of time to the Transfer Pricing Study undertaken by the Assessee. The Assessee is entitled to take note of the subsequent judicial pronouncement and seek to exclude a company which is functionally not comparable with that of the Assessee. The learned DR opposed the prayer for admission of additional ground. He pointed out that the Assessee in their Transfer Pricing study accepted these companies as comparable and therefore cannot now seek to exclude the said companies.
We have given a very careful consideration to the rival submissions. We are of the view that the question as to whether the aforesaid two companies are comparable or not with the Assessee company in terms of FAR analysis, has to be decided on the basis of data which is available in the public domain i.e., published annual report of these two companies.. Therefore facts necessary to apply the filter sought to be relied upon by the
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Assessee in the additional ground of appeal are already available on record. Therefore there can be no valid objection to deciding the question of applying the aforesaid filter, if otherwise it is found to be a valid filter. On the question of the Assessee having chosen the aforesaid two companies as comparable and therefore cannot be permitted to chance its stand now, we are of the view that the decision of the Special Bench, Chandigarh in the case of Quark Systems (supra) clearly supports the
plea of the Assessee. The Special Bench in the aforesaid decision in the
case of Quark Systems (supra) has after considering the OECD
Commentaries observed as follows:
In para 4.16 of latest report, the OECD provides the following guidelines :
"In practice, neither countries nor taxpayers should misuse the burden of proof in the manner described above. Because of the difficulties with transfer pricing analysis, it would be appropriate for both taxpayers and tax administrations to take special care and to use restraint in relying on the burden of proof in the course of the examination of a transfer pricing case. More particularly, as a matter of good practice the burden of proof should not be misused by tax administrations or taxpayers as a justification for making groundless or unverifiable assertions about transfer pricing. A tax administration should be prepared to make good faith showing that its determination of transfer pricing is consistent with the arm’s length principle even where the burden of proof is on the taxpayer, and the taxpayers similarly should be prepared to make good faith showing that their transfer pricing is consistent with the arm’s length principle regardless of where the burden of proof lies."
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The aforesaid decisions and guidelines may not be exactly on identical facts before us but they emphatically show that taxpayer is not estopped from pointing out a mistake in the assessment though such mistake is the result of evidence adduced by the taxpayer. 37. When substantial justice and technical considerations are pitted against each other, the cause of substantial justice deserves to be preferred. For the other side cannot claim to have a vested right in injustice being done due to some mistakes on its part. 38. Accordingly, on facts and circumstances of the case, we hold that taxpayer is not estopped from pointing out that Datamatics has wrongly been taken as comparable. While admitting additional ground of appeal raised by the assessee to require us to consider whether or not Datamatics should be included in the comparable, we make no comments on merit except observing that assessee from record has shown its prima facie case. Further claim may be examined by the Assessing Officer. This course we adopt as objection to the inclusion of Datamatics as comparable has been raised now and not before revenue authorities. Therefore, we deem it fit and proper to remit the matter to the file of the Assessing Officer for consideration of claim of the taxpayer and make a de novo adjudication of the arm’s length price after providing reasonable opportunity of being heard to the assessee. We order accordingly.”
We also find that the aforesaid two companies were held to be software product companies and therefore not comparable with software development service provider such as the Assessee in several decisions rendered by the Tribunal, the main decision being in the case of Trilogy
E-Business Software India Pvt. Ltd., ITA No.1054/Bang/2011
Bangalore ITAT. The decisions rendered by the Tribunal are later in point of time to the Transfer Pricing Study undertaken by the Assessee. The
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Assessee is entitled to take note of the subsequent judicial pronouncement and seek to exclude a company which is functionally not comparable with that of the Assessee. As held by the Special Bench in the case of Quark
Systems (supra), there cannot be any tax liability on the basis of
admission and the determination of tax liability has to be in accordance with law. In the light of the aforesaid judicial pronouncement, we are of the view that the additional ground of appeal deserves to be admitted for adjudication. Accordingly, the additional ground is admitted for adjudication.
We will proceed to consider the comparability of companies chosen by the TPO and listed in para-5 of this order.
As far as comparable companies listed at Sl.No.1,2,3 and 12 of the final list of comparable companies chosen by the TPO viz., M/S.Accel Transmatic Limited (seg.), Avani Cincom Technologies Ltd., Celestial labs Limited and KALS Infosystems Ltd., are concerned, this Tribunal in the case of First Advantage Offshore Services Pvt. Ltd. Vs. DCIT IT
(TP) No.1086/Bang/2011 for AY 07-08 held that the aforesaid companies are not comparable companies in the case of software development services provider. The nature of services rendered by the Assessee in this appeal and the Assessee in the case of First Advantage Offshore Services Pvt.Ltd.(supra) are one and the same. This fact would be clear from the fact that the very same 26 companies were chosen as comparable in the
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case of the Assessee as well as in the case of First Advantage Offshore Services Pvt.Ltd.(supra). In coming to the aforesaid conclusion, the Tribunal in the case of First Advantage Offshore Services Pvt.Ltd.(supra) followed the decision rendered in the case of Trilogy E-Business Software India Pvt.Ltd. Vs. DCIT ITA No.1064/Bang/2011 for AY 07-08 order dated 23.11.2012. The following were the relevant observations in the case of First Advantage Offshore Services Pvt. Ltd.(supra):
“18. As regards the group 2 companies which are to be excluded as functionally different based on the Tribunal’s order in the case of Trilogy E-Business Software India Pvt.Ltd., we find that these companies are- 1) Accel Transmatic 2) Avani Cimcon Technologies Ltd. 3) Celestial Labs Ltd. 4) KALS Information Systems Ltd.
The Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd., while considering the issue of improper selection of comparables has held as under: Avani Cimcon Technologies Ltd. (b) 39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company’s website, which reveals that this company has developed a software product by name “DXchange”, it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT – ITA No.7821/Mum/2011 wherein the Tribunal accepted the
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assessee’s contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- “7.8 Avani Cincom Technologies Ltd. (‘Avani Cincom’): Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis.” It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures were placed before us:- Particulars FYs 05-06 06-07 07-08 08-09 Operating Revenue 21761611 35477523 29342809 28039851 Operating Expns. 16417661 23249646 23359186 31108949 Operating Profit 5343950 12227877 5983623 (3069098) Operating Margin 32.55% 52.59% 25.62% - 9.87%
It was submitted that this company has made unusually high profit during the financial year 06-07. The operating revenues increased 63.03% which indicates that it was an extraordinary year for this company. Even the growth of software industry for the previous year as per NASSCOM was 32%. The growth rate of this company was double the industry average. In view of the above, it was argued that this company ought to have been rejected as a comparable.
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We have given a careful consideration to the submissions made on behalf of the Assessee and are of the view that the same deserves to be accepted. The reasons given by the Assessee for excluding this company as comparable are found to be acceptable. The decision of ITAT (Mumbai) in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra) also supports the plea of the assessee. We therefore accept the plea of the Assessee to reject this company as a comparable. (c) Celestial Labs Ltd. 42. As far as this company is concerned, the stand of the assessee is that it is absolutely a research & development company. In this regard, the following submissions were made:- i. In the Director’s Report (page 20 of PB-Il), it is stated that “the company has applied for Income Tax concession for in-house R&D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act.” ii. As per the Notes to Accounts - Schedule 15, under “Deferred Revenue Expenditure” (page 31 of PB-II), it is mentioned that, “Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred.” An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as “Deferred Revenue Expenditure” (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R&D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT – ITA No.6623/Mum/2011 (for AY
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2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: “The learned D.R. however drew our attention to page- 389 of the paper book which is an extract from the Directors report which reads as follows: ‘The Company has developed a de novo drug design tool “CELSUITE” to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Technology New Delhi) based on our insilico expertise (applying bio- informatics tools). The Company has developed a molecule to treat Leucoderma and multiple cancer and protected the IPR by filing the patent. The patent details have been discussed with Patent officials and the response is very favorable. The cloning and purification under wet lab procedures are under progress with our collaborative Institute, Department of Microbiology, Osmania University, Hyderabad. In the industrial biotechnology area, the company has signed the Technology transfer agreement with IMTECH CHANDIGARH (a very reputed CSIR organization) to manufacture and market initially two Enzymes, Alpha Amylase and Alkaline Protease in India and overseas. The company is planning to set up a biotechnology facility to manufacture industrial enzymes. This facility would also include the research laboratories for carrying out further R & D activities to develop new candidates’ drug molecules and license them to Interested Pharma and Bio Companies across the GLOBE. The proposed Facility will be set up in Genome Valley at Hyderabad in Andhra Pradesh.’ According to the learned D.R. celestial labs is also in the field of research in pharmaceutical products and should be considered as comparable. As rightly submitted by the learned counsel for the Assessee, the discovery is in relation to a software discovery of new drugs. Moreover the company also is owner of the IPR. There is however a reference to development of a molecule to treat cancer using bio-informatics tools for which patenting process was also being pursued. As explained earlier it is a diversified company and therefore cannot be considered as comparable functionally with that of the Assessee.
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There has been no attempt made to identify and eliminate and make adjustment of the profit margins so that the difference in functional comparability can be eliminated. By not resorting to such a process of making adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard.’ ” 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for discovery of new drugs and has developed molecule to treat cancer. In the ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the segmental data for each activity is not available and therefore this company should not be treated as comparable. Besides the above, the Assessee has point out to several references in the annual report for 31.3.2007 highlighting the fact that this company was develops biotechnology products and provides related software development services. The TPO called for segmental data at the entity level from this company. The TPO also called for description of software development process. In response to the request of the TPO this company in its reply dated 29.3.2010 has given details of employees working in software development but it is not clear as to whether any segmental data
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was given or not. Besides the above there is no other detail in the TPO’s order as to the nature of software development services performed by the Assessee. Celestial labs had come out with a public issue of shares and in that connection issued Draft Red Herring Prospectus (DRHP) in which the business of this company was explained as to clinical research. The TPO wanted to know as to whether the primary business of this company is software development services as indicated in the annual report for FY 06-07 or clinical research and manufacture of bio products and other products as stated in the DRHP. There is no reference to any reply by Celestial labs to the above clarification of the TPO. The TPO without any basis has however concluded that the business mentioned in the DRHP are the services or businesses that would be started by utilizing the funds garnered though the Initial Public Offer (IPO) and thus in no way connected with business operations of the company during FY 06-07. We are of the view that in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable. (d) KALS Information Systems Ltd. 46. 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:
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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. 47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable. (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 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:
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“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. 4.3 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.” 49. 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 by the Tribunal in Capgemini India Ltd (supra) where the assessee was software developer. The Tribunal, in the said decision referred to by the
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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.”
Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to exclude the aforesaid companies from the final list of comparable companies for the purpose of determining ALP.
As far as comparable companies listed at Sl.No.11 & 14 of the final list of comparable companies chosen by the TPO viz., M/S.Ishir Infotech Ltd. And Lucid Software Ltd., is concerned, this Tribunal in the case of First Advantage Offshore Services Pvt. Ltd. Vs. DCIT IT (TP)
No.1086/Bang/2011 for AY 07-08 held that the aforesaid companies are not comparable companies in the case of software development services provider. The nature of services rendered by the Assessee in this appeal and the Assessee in the case of First Advantage Offshore Services Pvt.Ltd.(supra) are one and the same. This fact would be clear from the fact that the very same 26 companies were chosen as comparable in the case of the Assessee as well as in the case of First Advantage Offshore Services Pvt.Ltd.(supra). The following were the relevant observations in the case of First Advantage Offshore Services Pvt.Ltd.(supra):-
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“22. The learned counsel for the assessee submitted that these two companies are also to be excluded from the list of comparables on the basis of the finding of this Tribunal in the case of Mercedes Benz Research & Development India Pvt. Ltd. dt 22.2.2013, wherein at pages 17 and 22 of its order the distinctions as to why these companies should be excluded are brought out. He submitted that the facts of the case before us are similar and, therefore, the said decision is applicable to the assessee's case also. 23. The learned DR however objected to the exclusion of these two companies from the list of comparables. On a careful perusal of the material on record, we find that the Tribunal in the case of Mercedes Benz Research & Development India Pvt. Ltd. (cited supra) has taken a note of dissimilarities between the assessee therein and Lucid Software Ltd. As observed therein Lucid Software Ltd. company is also involved in the development of software as compared to the assessee, which is only into software services. Similarly, as regards Ishir Infotech Ltd., the Tribunal has considered the decision of the Tribunal in the case of 24/7 Co. Pvt. Ltd to hold that Ishir Infotech is also out-sourcing its work and, therefore, has not satisfied the 25% employee cost filter and thus has to be excluded from the list of comparables. As the facts of the case before us are similar, respectfully following the decision of the co-ordinate bench, we hold that these two companies are also to be excluded.”
Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to exclude the aforesaid companies from the final list of comparable companies for the purpose of determining ALP.
As far as comparable companies listed at Sl.No.16 of the final list of comparable companies chosen by the TPO viz., M/S.Megasoft Limited is concerned, this Tribunal in the case of First Advantage Offshore Services Pvt.Ltd. Vs. DCIT IT (TP) No.1086/Bang/2011 for AY 07-08 held that the
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aforesaid companies are not comparable companies in the case of software development services provider. The nature of services rendered by the Assessee in this appeal and the Assessee in the case of First Advantage Offshore Services Pvt.Ltd.(supra) are one and the same. This fact would be clear from the fact that the very same 26 companies were chosen as comparable in the case of the Assessee as well as in the case of First Advantage Offshore Services Pvt.Ltd.(supra). In coming to the aforesaid conclusion, the Tribunal in the case of First Advantage Offshore Services Pvt.Ltd.(supra) followed the decision rendered in the case of Trilogy E-Business Software India Pvt. Ltd. Vs. DCIT ITA No.1064/Bang/2011 for AY 07-08 order dated 23.11.2012. The following were the relevant observations in the case of First Advantage Offshore Services Pvt.Ltd.(supra):
“27. As far as adoption of Mega Soft Ltd., as one of comparables, the learned counsel for the assessee submitted that there is an error in computing its net margin. He has drawn our attention to the order of the Tribunal in the case of Trilogy E- Business Software India Pvt.Ltd., at para 24 to 27 at page 18, wherein the error in computing the net margin of this company has been taken note of and it has been directed as under: (a) Megasoft Ltd. : 24. This company was chosen as a comparable by the TPO. The objection of the assessee is that there are two segments in this company viz., (i) software development segment, and (ii) software product segment. The Assessee is a pure software services provider and not a software product developer. According to the Assessee there is no break up of revenue between software products and software services business on a standalone basis of this
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comparable. The TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius-BCGI Division does the business of product software. This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product software would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to product software) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO’s filter of more than 75% of revenues from software development services. The basis on which the TPO arrived at the PLI of 60.23% is given at page-115 and 116 of the order of the TPO. It is clear from the perusal of the same that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data. 25. In the order of the TPO, operating margin was computed for this company at 60.23%. It is the complaint of the assessee that the operating margins have been computed at entity level combining software services and software product segments. It was submitted that the product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments
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are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions on page 381 to 383 of the PB-I). It was further submitted that Megasoft Limited has provided segmental break-up between the software services segment and software product segment (page 68 of PB-II), which was also adopted by the TPO in his show cause notice (Page 84 of PB-I). The segmental results i.e., results pertaining to software services segment of this company was: Segmental Operating Revenues Rs.63,71,32,544 Segmental Operating Expenses Rs.51,75,13,211 Operating Profit Rs.11,96,19,333 OP/TC (PLI) 23.11%
It was reiterated that in the given circumstances only PLI of software service segment viz., 23.11% ought to have been selected for comparison. 27. It was further submitted that the learned TPO in case of other comparable, similarly placed, had adopted the margins of only the software service segment for comparability purposes. Consistent with such stand, it was submitted that the margins of the software segment only should be adopted in the case of Megasoft also, in contrast to the entity level margins. 28. Computation of the net margin for Mega Soft Ltd. Is therefore remitted to the file of the TPO to compute the correct margin by following the direction of the Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd.”
Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to compute the correct margin of Mega Soft Ltd., as directed by the Tribunal in the case of First Advantage Offshore Services Pvt.Ltd. (supra).
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As far as comparable companies listed at Sl.No.10, 24 & 26 of the final list of comparable companies chosen by the TPO viz., M/S.Infosys Technologies Limited, Tata Elxsi Ltd. (Seg.) & Wipro Limited are concerned, this Tribunal in the case of M/S. Curam Software International Pvt.Ltd. Vs. ITO ITA No.1280/Bang/2012 for AY 08-09 order dated 31.7.2013 has held that the aforesaid companies are not comparable companies in the case of software development services provider. The following were the relevant observations in the case of M/S.Curam Software International Pvt. Ltd.(supra):
“12. (4) Infosys Technologies Ltd. 12.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment. 12.2 Before us, the assessee contended that this company is not functionally comparable to the assessee and in this context has cited various portions of the Annual Report of this company to this effect which is as under :- (i) The company has an Intellectual Property (IP) Cell to guide its employees to leverage the power of IP for their growth. In 2008, this company generated over 102 invention disclosures and filed an aggregate 10 patents in India and the USA. Till date this company has filed an aggregate of 119 patent applications (pending) in India and USA out of which 2 have been granted in the US. (ii) This company has substantial revenues from software products and the break-up of the software product revenues is not available.
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(iii) This company has incurred huge research and development expenditure to the tune of approximately Rs.200 Crores. (iv) This company has a revenue sharing agreement towards acquisition of IPR in AUTOLAY, a commercial software product used in designing high performance structural systems. (v) The assessee also placed reliance on the following judicial decisions :- (a) ITAT, Delhi Bench decision in the case of Agnity India Technologies India Pvt. Ltd. (ITA No.3856/Del/2010) and (b) Trilogy E-Business Software India Pvt. Ltd. (ITA No.1054/Bang/2011)
12.3 Per contra, opposing the contentions of the assessee, the learned Departmental Representative submitted that comparability cannot be decided merely on the basis of scale of operations and the operating margins of this company have not been extraordinary. In view of this, the learned Departmental Representative supported the decision of the TPO to include this company in the list of comparable companies. 12.4 We have heard the rival submissions and perused and carefully considered the material on record. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) for Assessment Year 2007-08 is applicable to this year also. The argument put forth by assessee's is that Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the break up of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly.
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13.0 (5) Wipro Limited 13.1 This company was selected as a comparable by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables or several grounds like functional dis-similarity, brand value, size, etc. The TPO, however, brushed aside the objections of the assessee and included this company in the set of comparables. 13.2 Before us, the assessee contended that this company is functionally not comparable to the assessee for several reasons, which are as under : (i) This company owns significant intangibles in the nature of customer related intangibles and technology related intangibles and quoted extracts from the Annual Report of this company in the submissions made. (ii) The TPO had adopted the consolidated financial statements for comparability purposes and for computing the margins, which contradicts the TPO’s own filter of rejecting companies with consolidated financial statements. 13.3. Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables. 13.4.1 We have heard both parties and carefully perused and considered the material on record. We find merit in the contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison.
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13.4.2 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010) has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any such intangible and hence does not have an additional advantage in the market. As the assessee in the case on hand does not own any intangibles, following the aforesaid decision of the co-ordinate bench of the Tribunal i.e. 24/7 Customer.Com Pvt. Ltd. (supra), we hold that this company cannot be considered as a comparable to the assessee. We, therefore, direct the Assessing Officer/TPO to omit this company from the set of comparable companies in the case on hand for the year under consideration. 14.0 (6) Tata Elxsi Ltd. 14.1 This company was a comparable selected by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables on several counts like, functional dis-similarity, significant R&D activity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of comparables. 14.2 Before us, it was reiterated that this company is not functionally comparable to the assessee as it performs a variety of functions under the software development and services segment namely (a) Product design services (b) Innovation design engineering and ( c ) visual computing labs. In the submissions made the assessee had quoted relevant portions from the Annual Report of the company to this effect. In view of this, the learned Authorised Representative pleaded that this company be excluded from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the stand o the TPO in including this company in the list of comparables.
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14.4.1 We have heard both parties and carefully perused and considered the material on record. From the details on record, we find that this company is predominantly engaged in product designing services and not purely software development services. The details in the Annual Report show that the segment “software development services” relates to design services and are not similar to software development services performed by the assessee. 14.4.2 The Hon'ble Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. V ACIT (ITA No.7821/Mum/2011) has held that Tata Elxsi Ltd. is not a software development service provider and therefore it is not functionally comparable. In this context the relevant portion of this order is extracted and reproduced below :- “ …. 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 Authorised Representative 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 unable to treat this company as fit for comparability analysis for determining the arm’s length price for the assessee, hence, should be excluded from the list of comparable portion.”
As can be seen from the extracts of the Annual Report of this company produced before us, the facts pertaining to Tata Elxsi have not changed from Assessment Year 2007-08 to Assessment Year 2008-09. We, therefore, hold that this company is not to be considered for inclusion in the set of comparables in the case on hand. It is ordered accordingly.”
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Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to exclude the aforesaid companies from the final list of comparable companies for the purpose of determining ALP.
As far as comparable companies at Sl.No.5, 18, 19 and 25 of the final list of comparable companies chosen by the TPO are concerned, viz., M/S. E-Zest Solutions Ltd., Persistent Systems Ltd., Quintegra Solutions Limited and Third ware Solutions Ltd., this Tribunal in the case of 3DPLM Software Solutions Ltd. I.T (T.P) A. No.1303/Bang/2012 (Assessment Year: 2008-09) order dated 28.11.2013 was pleased to hold that the aforesaid companies are not comparable with a company engaged in Software Development Services such as the Assessee. The following were the relevant observations of the Tribunal:
“14. E-Zest Solutions Ltd. 14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the information received in response to notice under section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company ought to be excluded from the list of comparables on the ground that it is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in ‘e-Business Consulting Services’, consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised
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Representative contends, are high end ITES normally categorised as knowledge process Outsourcing (‘KPO’) services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that since the Annual Report of the company does not contain detailed descriptive information on the business of the company, the assessee places reliance on the details available on the company’s website which should be considered while evaluating the company’s functional profile. It is also submitted by the learned Authorised Representative that KPO services are not comparable to software development services and therefore companies rendering KPO services ought not to be considered as comparable to software development companies and relied on the decision of the co-ordinate bench in the case of Capital IQ Information Systems (India) (P) Ltd. in ITA No.1961(Hyd)/2011 dt.23.11.2012 and prayed that in view of the above reasons, this company i.e. e-Zest Solutions Ltd., ought to be omitted from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparables by the TPO. 14.4 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the record that the TPO has included this company in the list of comparables only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act. It appears that the TPO has not examined the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I-Q Information Systems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under
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consideration in the case on hand. The A.O. /TPO is accordingly directed. 15. Thirdware Solutions Ltd. (Segment) 15.1 This company was proposed for inclusion in the list of comparables by the TPO. Before the TPO, the assessee objected to the inclusion of this company in the list of comparables on the ground that its turnover was in excess of Rs.500 Crores. Before us, the assessee has objected to the inclusion of this company as a comparable for the reason that apart from software development services, it is in the business of product development and trading in software and giving licenses for use of software. In this regard, the learned Authorised Representative submitted that :- (i) This company is engaged in product development and earns revenue from sale of licences and subscription. It has been pointed out from the Annual Report that the company has not provided any separate segmental profit and loss account for software development services and product development services. (ii) In the case of E-Gain communications Pvt. Ltd. (2008-TII-04- ITAT-PUNE-TP), the Tribunal has directed that this company be omitted as a comparable for software service providers, as its income includes income from sale of licences which has increased the margins of the company. The learned A.R. prayed that in the light of the above facts and in view of the afore cited decision of the Tribunal (supra), this company ought to be omitted from the list of comparables. 15.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 15.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the
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case of E-Gain Communications Pvt. Ltd. (supra) has directed that since the income of this company includes income from sale of licenses, it ought to be rejected as a comparable for software development services. In the case on hand, the assessee is rendering software development services. In this factual view of the matter and following the afore cited decision of the Pune Tribunal (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand.” “17. Persistent Systems Ltd. 17.1.1 This company was selected by the TPO as a comparable. The assessee objected to the inclusion of this company as a comparable for the reasons that this company being engaged in software product designing and analytic services, it is functionally different and further that segmental results are not available. The TPO rejected the assessee's objections on the ground that as per the Annual Report for the company for Financial Year 2007-08, it is mainly a software development company and as per the details furnished in reply to the notice under section 133(6) of the Act, software development constitutes 96% of its revenues. In this view of the matter, the Assessing Officer included this company i.e. Persistent Systems Ltd., in the list of comparables as it qualified the functionality criterion. 17.1.2 Before us, the assessee objected to the inclusion of this company as a comparable submitting that this company is functionally different and also that there are several other factors on which this company cannot be taken as a comparable. In this regard, the learned Authorised Representative submitted that : (i) This company is engaged in software designing services and analytic services and therefore it is not purely a software development service provider as is the assessee in the case on hand. (ii) Page 60 of the Annual Report of the company for F.Y. 2007- 08 indicates that this company, is predominantly engaged in ‘Outsourced Software Product Development Services’ for independent software vendors and enterprises.
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(iii) Website extracts indicate that this company is in the business of product design services. (iv) The ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt. Ltd.(supra) while discussing the comparability of another company, namely Lucid Software Ltd. had rendered a finding that in the absence of segmental information, a company be taken into account for comparability analysis. This principle is squarely applicable to the company presently under consideration, which is into product development and product design services and for which the segmental data is not available. The learned Authorised Representative prays that in view of the above, this company i.e. Persistent Systems Ltd. be omitted from the list of comparables. 17.2 Per contra, the learned Departmental Representative support the action of the TPO in including this company in the list of comparables. 17.3 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. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details / information a company cannot be taken into account for comparability analysis, 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. 18. Quintegra Solutions Ltd. 18.1 This case was selected by the TPO as a comparable. Before the TPO, the assessee objected to the inclusion of this company in the set of comparables on the ground that this company is functionally different and also that there were peculiar economic circumstances in the form of acquisitions made during the year. The TPO rejected the assessee's objections holding that this
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company qualifies all the filters applied by the TPO. On the issue of acquisitions, the TPO rejected the assessee's objections observing that the assessee has not adduced any evidence as to how this event had an any influence on the pricing or the margin earned. 18.1.2 Before us, the assessee objected to the inclusion of this company for the reason that it is functionally different and also that there are other factors for which this company cannot be considered as a comparable. It was submitted that, (i) Quintegra solutions Ltd., the company under consideration, is engaged in product engineering services and not in purely software development services. The Annual Report of this company also states that it is engaged in preparatory software products and is therefore not similar to the assessee in the case on hand. (ii) In its Annual Report, the services rendered by the company are described as under : “ Leveraging its proven global model, Quintegra provides a full range of custom IT solutions (such as development, testing, maintenance, SAP, product engineering and infrastructure management services), proprietary software products and consultancy services in IT on various platforms and technologies.” (iii) This company is also engaged in research and development activities which resulted in the creation of Intellectual Proprietary Rights (IPRs) as can be evidenced from the statements made in the Annual Report of the company for the period under consideration, which is as under : “ Quintegra has taken various measures to preserve its intellectual property. Accordingly, some of the products developed by the company …………… have been covered by the patent rights. The company has also applied for trade mark registration for one of its products, viz. Investor Protection Index Fund (IPIF). These measures will help the company enhance its products value and also mitigate risks.” (iv) The TPO has applied the filter of excluding companies having peculiar economic circumstances. Quintegra fails the
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TPO’s own filter since there have been acquisitions in this case, as is evidenced from the company’s Annual Report for F.Y. 2007-08, the period under consideration. The learned Authorised Representative prays that in view of the submissions made above, it is clear that inter alia, this company i.e. Quintegra Solutions Ltd. being functionally different and possessing its own intangibles / IPRs, it cannot be considered as a comparable to the assessee in the case on hand and therefore ought to be excluded from the list of comparables for the period under consideration. 18.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables to the assessee for the period under consideration. 18.3.1 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details brought on record that this company i.e.Quintegra Solutions Ltd. is engaged in product engineering services and is not purely a software development service provider as is the assessee in the case on hand. It is also seen that this company is also engaged in proprietary software products and has substantial R&D activity which has resulted in creation of its IPRs. Having applied for trade mark registration of its products, it evidences the fact that this company owns intangible assets. The co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010 dt.9.11.2012) has held that if a company possesses or owns intangibles or IPRs, then it cannot be considered as a comparable company to one that does not own intangibles and requires to be omitted form the list of comparables, as in the case on hand. 18.3.2 We also find from the Annual Report of Quintegra Solutions Ltd. that there have been acquisitions made by it in the period under consideration. It is settled principle that where extraordinary events have taken place, which has an effect on the performance of the company, then that company shall be removed from the list of comparables. 18.3.3 Respectfully following the decision of the co-ordinate bench of the Tribunal in the case of 24/7 Customer.Com Pvt. Ltd.
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(supra), we direct that this company i.e. Quintegra Solutions Ltd. be excluded from the list of comparables in the case on hand since it is engaged in proprietary software products and owns its own intangibles unlike the assessee in the case on hand who is a software service provider.”
Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to exclude the aforesaid companies from the final list of comparable companies for the purpose of determining ALP.
As far as comparable chosen by the TPO at Sl.No.8 of the final list of comparable viz., M/S.Helios & Matheson Information Technology Ltd., we find that the said company has been held to be not comparable with a software service provider like the Assessee by the ITAT Pune Bench in the case of PTC Software (India)Pvt.Ltd. ITA.No.1605/PN/2011 (Asstt. Year : 2007-08) order dated 30.4.2013. The following were the relevant observations of the Tribunal:
“16. The next point made out by the assessee is with regard to the inclusion of items at (9) and (11) namely Helios & Matheson Information Technology Ltd., and KALS Information Solutions Ltd. (Seg). The primary plea raised by the assessee to assail the inclusion of the aforesaid two companies from the list of comparables is to be effect that they are functionally incomparable and therefore, are liable to be excluded. In sum and substance, the plea set up by the assessee is that both the aforesaid concerns are engaged in development and sale of software products which is functionally different from the services undertaken by the assessee in its IT-services segment. 17. As per the discussion in para 6.3.2. of the order of the TPO, the reason advanced for including KALS Information Systems Ltd., is to the effect that the said concern’s application software
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segment is engaged in the development of software which can be considered as comparable to the assessee company. The said concern is engaged in two segments namely application software segment and Training. As per the TPO, the application software segment is functionally comparable to the assessee as the said concern is engaged in software services. The stand of the assessee is that a perusal of the Annual Report of the said concern for F.Y. 2006-07 reveals that the application software segment is engaged in the business of sale of software products and software services. The assessee pointed out this to the TPO in its written submissions, copy of which is placed in the Paper book at page 420.3 to 420.4. The assessee further pointed out that there was no bifurcation available between the business of sale of software products and the business of software services, and therefore, it was not appropriate to adopt the application software segment of the said concern for the purposes of comparability with the assessee’s IT-Services Segment. The TPO however, noticed that though the application software segment of the said concern may be engaged in selling of some of the software products which are developed by it, however, the said concern was not into trading of software products as there were no cost of purchases debited in the Profit & Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessee’s segment of IT-Services. 18. Before us, apart from reiterating the points raised before the TPO and the DRP, the Ld. Counsel submitted that in the immediately preceding assessment year of 2006-07, the said concern was evaluated by the assessee and was found functionally incomparable. For the said purpose, our reference has been invited to pages 421 to 542 of the Paper book, which is the copy of the Transfer Pricing study undertaken by the assessee for the A.Y. 2006-07, and in particular, attention was invited to page 454 where the accept reject matrix undertaken by the assessee reflected KALS Information Solutions Ltd. (Seg) as functionally incomparable. The Ld. Counsel pointed out that the aforesaid position has been accepted by the TPO in the earlier A.Y. 2006-07 and therefore, there was no justification for the TPO to consider the said concern as functionally comparable in the instant assessment year.
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In our considered opinion, the point raised by the assessee is potent in as much as it is quite evident that the said concern has not been found to be functionally comparable with the assessee in the immediately preceding assessment year and in the present year also, on the basis of the Annual Report, referred to in the written submissions addressed to the lower authorities, the assessee has correctly asserted out that the said concern was inter alia engaged in sale of software products, which was quite distinct from the activity undertaken by the assessee in the IT Services segment. At the time of hearing, neither is there any argument put forth by the Revenue and nor is there any discussion emerging from the orders of the lower authorities as to in what manner the functional profile of the said concern has undergone a change from that in the immediately preceding year. Therefore, having regard to the factual aspects brought out by the assessee, it is correctly asserted that the application software segment of the said concern is not comparable to the assessee’s segment of IT services. 20. With regard to the inclusion of Helios & Matheson Information Technology Ltd., the assessee has raised similar arguments as in the case of KALS Information Solutions Ltd. (Seg). We have perused the relevant para of the order of the TPO i.e., 6.3.21, in terms of which the said concern has been included as a comparable concern. The assessee pointed out that as in the case of KALS Information Solutions Ltd. (Seg), in the instant case also for A.Y. 2006-07 the said concern was found functionally incomparable by the assessee in its Transfer pricing study and the said position was not disturbed by the TPO. The relevant portion of the Transfer pricing study, placed at page 432 of the Paper book has been pointed out in support. Considered in the aforesaid light, on the basis of the discussion in relation to KALS Information Solutions Ltd. (Seg), in the instant case also we find that the said concern is liable to be excluded from the list of comparables.”
Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to exclude the aforesaid company from the final list of comparable companies for the purpose of determining ALP.
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The ld. counsel for the assessee brought to our notice that out of the 26 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 and cannot be compared with the Assessee whose turnover is less than Rs.20 crores:
(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. 9616.09 crores (8) Infosys Technologies Ltd. 13149 crores
Our attention was drawn to the observations of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. (supra) (ITA No.1338/Bang/2010) for same assessment year on the application of turnover filter and it was submitted that the aforesaid comparable companies have to be excluded from the final list of comparables selected by the TPO.
We have considered the submission of the learned counsel for the Assessee and the learned DR. In the case of Trilogy E-Business Software
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India (P) Ltd. (supra), this Tribunal on application of the turnover filter while selecting comparable companies for comparability analysis held as follows:
“(1) Turnover Filter
The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of RS. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special 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
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company cannot be compared with the transaction entered into by a Rs. 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. The fact that they operate in the same market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: “Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a Rs 1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate.” 13. It was further submitted that the TPO’s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 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 RS. 1 crore to RS. 200 crores was held to be proper. The following relevant observations were brought to our notice:- “9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company
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would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.” 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). It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee.
The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than RS. 200 crores as comparables. In these
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circumstances, it was submitted by him that the assessee cannot have any grievance in this regard. 17. We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm’s length price. Sec.92-B provides that “international transaction” means a transaction between two or more associated enterprises, either or both of whom are non- residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92- A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm’s length price in an international transaction and it provides:- (1) that the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :— (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board.
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(2) The most appropriate method referred to in sub- section (1) shall be applied, for determination of arm’s length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices:
Provided further that if the variation between the arm’s length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price.
(3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that— (a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm’s length price is not reliable or correct; or (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:”
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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; (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.
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(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.
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(4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into :
Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”
A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. 20. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is RS. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, 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
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(4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.”
Respectfully following the aforesaid decision of the Tribunal in the
case of Trilogy E-Business Software India Pvt.Ltd. (supra), we hold that the aforesaid companies 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.
The AO/TPO is directed to compute the arithmetic mean of the
profit margins of the remaining comparable companies after excluding the companies from the final list of 26 comparable companies chosen by the
TPO and compare the same with the profit margin of the Assessee in
accordance with the provisions of Sec.92C of the Act.
No other arguments were raised on the other issues raised in the
concise grounds of appeal No.1 to 6 and therefore the issue with regard to
determination of ALP of the international transaction of providing software development services to the AE by the Assessee is decided as set out in
the earlier paragraphs.
Concise Ground No.7 & 8 raised by the Assessee project the
grievance of the Assessee regarding the action of the learned Assessing
Officer and Honorable Dispute Resolution Panel in excluding while
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computing deduction u/s.10A of the Act telecommunication charges, consultancy charges, repairs and maintenance and certain other expenses
incurred by the Assessee (including expenses incurred in foreign currency) are to be excluded from export turnover on the ground that these
expenses (except telecommunication charges) are not incurred in
rendering technical services rendered to clients outside India. It is the plea of the Assessee that at all times during the relevant previous year, it was
engaged in development of computer software and not in rendering any technical services. Without prejudice to its contention that the aforesaid
sums should not be excluded from the export turnover while computing deduction u/s.10A of the Act, the Assessee has also made an alternate
prayer( in concise ground No.8) that expenses that are reduced from the
export turnover should also be reduced from the total turnover and in this regard has placed reliance on the decision of the Hon’ble Karnataka High
Court in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn).
We have heard the ld. counsel for the assessee and the ld. DR on the issues raised in concise ground Nos.7 & 8. Taking into consideration
the decision rendered by the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn), we are of the view that it
would be just and appropriate to direct the Assessing Officer to exclude telecommunication charges, consultancy charges, repairs and maintenance
and certain other expenses incurred by the Assessee (including expenses
incurred in foreign currency), both from export turnover and total turnover,
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as has been prayed for by the assessee in concise ground No.8. In view of the acceptance of the alternative prayer in concise ground No.8, we are of
the view that no adjudication is required on concise ground No.7.
Gr.No.9 raised by the Assessee in the concise grounds of appeal relate to disallowance of interest expenses debited to the Profit & Loss A/C
by invoking the provisions of Sec.40(a)(i) of the Act i.e., on the ground that tax at source has not been deducted at source. The material facts relevant
for adjudication of the aforesaid grounds are as follows.
The Assessee had borrowed loans from Broadcom Singapore Pte. Ltd. On such External Commercial Borrowing (ECB) interest was payable
by the Assessee. Interest for the period from 1-4-2006 to 31.3.2007 debited in the interest account of the Assessee and credited in the account
of the payee, was a sum of Rs.28,65,514/. The Assessee did not deduct
tax at source on the aforesaid sum at the time of credit to the account of the payee in the books of accounts of the Assessee. According to the AO
as per the provisions of Sec.195 of the Act, any person responsible for paying to a non-resident any interest chargeable under the provisions of
this Act shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque
or draft or by any other mode, whichever is earlier, deduct income-tax
thereon at the rates in force. Since the Assessee had not deducted tax at source on the sum credited to the account of the non-resident payee, the
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AO was of the view that as per the provisions of Sec.40(a)(i) of the Act, the amount on which tax has not been deducted in accordance with the provisions of Sec.195 of the Act and which is claimed as a deduction while computing total income, should be disallowed. Sec.40(a)(i) of the Act provides as follows:
“Sec.40: Amounts not deductible. Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession": (a) in the case of any assessee— (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,— (A) outside India; or (B) in India to a non-resident, not being a company or to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200 : Provided that where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.”
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The AO accordingly disallowed the claim of the Assessee for deduction of the aforesaid sum and added the same to the total income of the Assessee.
Before the DRP the Assessee submitted that the payee Broadcom Singapore Pte.Ltd. is a tax resident of Singapore. The Assessee submitted that the interest income that accrues or arises to the non-resident viz., Broadcom Singapore Pte.Ltd. will be taxable in India as per the provisions of DTAA between India and Singapore. The Assessee pointed out that taxability of the interest income in India is as per Article 11 of the Double Taxation Avoidance Agreement (DTAA) between India and Singapore which reads thus:-
“ARTICLE 11 Interest 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed : (a) 10% of the gross amount of the interest if such interest is paid on a loan granted by a bank carrying on a bona fide banking business or by a similar financial institution (including an insurance company); (b) 15% of the gross amount of the interest in all other cases. .........”
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The Assessee pointed out that as per Article 11 interest income is taxable both in India and Singapore. Under Article 11(1) above interest
income is taxable in Singapore in the hands of Broadcom Singapore Pte.Lte. only on receipt basis because the relevant article refers to “Interest
arising in a contracting State and Paid to a resident of the other contracting
state”. Article 11(2) under which India has a right to tax the same interest income refers to “Such Interest” and therefore even in India interest income
is chargeable to tax only on receipt basis. Since interest was payable and not paid, there was no accrual of income chargeable to tax in the hands of
the non-resident and therefore there was no obligation to deduct tax at source. The Assessee thus submitted that there was no obligation to
deduct tax at source on the part of the Assessee and therefore the
provisions of Sec.40(a)(i) could not be invoked to make disallowance.
The DRP did not consider the submissions and merely observed
that the Assessee did not furnish any detail or explanation to substantiate
its argument and confirmed the order of the AO.
Before us, the learned counsel for the Assessee pointed out that as
on 1-4-2006 the opening balance of interest payable to the non-resident was Rs.12,42,739 and the interest for the months April, May, June & July,
2006 was credited to the account of the non-resident of Rs.2,32,839.13,
Rs.2,97,790.19, Rs.2,26,631.79 and Rs.2,68,977.23 respectively have been credited. On 29.8.2006 the Assessee deducted tax at source on the
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sum total of the opening balance and accrued interest up to 31.7.2006 and deposited the same to the credit of the Central Government on 29.8.2006. His first submission was that to the extent of tax deducted and paid on 29.8.2006 on the interest credited to the account of the non-resident for the months April, May, June & July, 2006 was credited to the account of the non-resident of Rs.2,32,839.13, Rs.2,97,790.19, Rs.2,26,631.79 and Rs.2,68,977.23 respectively, there can be no disallowance u/s.40(a)(i) of the Act in view of the proviso to Sec.40(a)(i) which lays down that
“where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid”
The learned DR on the above submission of the learned counsel for the Assessee, submitted that the claim of the Assessee may be directed to be verified by the AO and if found correct, to the extent tax deducted and paid to the credit of the Government, the disallowance may be deleted.
We are of the view that it would be just and appropriate to direct the AO to verify the claim of the Assessee as aforesaid and if found correct, to the extent tax deducted and paid to the credit of the Government, the disallowance should be deleted.
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The learned counsel for the Assessee further submitted that in view of Article 11(2) of the DTAA between India and Singapore interest income
is taxable in India only when the non-resident receives the same. In this regard our attention was drawn to the following decisions in which it has
been held in the context of different treaties where similar expression of
“interest arising and paid” are used Tribunals have taken a view that interest income can be taxed only on receipt basis and not on accrual
basis. (i) Pizza Hut International LLC Vs. DDIT ITA Nos. 1600, 1601 & 1656/Del/2011 order dated 8.6.2012; (ii) DCIT Vs. Uhde Gmbh 54 TTJ
Mumbai 355; (iii) CSC Technology Singapore Pte.Lte VS. ADIT (2012) 50 SOT 399 (ITAT) |(Del); (iv) Booz Allen and Hamilton India Ltd and Co.Kg.
Vs. ADIT (2013) 56 SOT 96 (Mumbai)(ITAT). The learned counsel for the
Assessee therefore submitted that interest for the months August, 2006 to March, 2007 admitted were not paid to the non-resident and therefore the
same cannot be brought to tax in India. Since the obligation to deduct tax is linked to chargeability to tax in the hands of the non-resident as held in
the case of Eli Lilly & Co. 312 ITR 225 (SC), it was submitted by him that
there was no obligation to deduct tax at source and consequently no disallowance could be made u/s.40(a)(i) of the Act.
The learned DR submitted that none of the decisions on which reliance was placed by the learned counsel for the Assessee are in the
context of obligation to deduct tax at source u/s.195 of the Act. He pointed
out that all the cases relate to taxation of interest income in the hands of
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the non-resident and the year in which interest income is to be taxed in the hands of the non-resident. According to him the question in the present
case is different and has nothing to do with taxability of interest income in the hands of the non-resident. According to him the obligation to deduct
tax at source u/s.195(1) of the Act on the Assessee is “at the time of credit
of such income to the account of the payee or at the time of payment thereof in case or by the issue of a cheque or draft or by any other mode, whichever is earlier”. The year in which accrual of income and the
chargeability to tax in the hands of the non-resident is to be determined,
according to him will not be relevant.
We have given a careful consideration to the rival submissions. In CIT Vs. Eli Lilly & Company (India) (P) Ltd. & others 312 ITR 225 (SC) The
Hon’ble Supreme Court had to decide applicability of TDS provisions u/s. 192 of the Act in respect of Home salary/special allowances paid by foreign
company/head office to expatriate employees outside India. The Hon’ble
Supreme Court observed that TDS provisions which are in the nature of machinery provisions to enable collection and recovery of tax are not
independent of the charging provisions which determine the assessability in the hands of the employee. The learned counsel for the Assessee relying
on the aforesaid observations submitted that unless the income is chargeable to tax in the hands of the non-resident for the relevant previous
year, there is no obligation to deduct tax at source. According to him
interest income as per Article 11 of the DTAA between India and Singapore
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of which the payee non-resident is a tax resident, taxability of the interest income in the hands of the non-resident in India is only at the point of time of receipt and not earlier. Since the machinery provisions for collection and recovery of tax and the charging provisions form an integral code and cannot be looked at independently, the obligation to deduct tax at source should also be at the point of time when the income is taxable in India in the hands of the non-resident.
We have given a careful consideration to the submissions made by the learned counsel for the Assessee and of the view that the same are not acceptable. The Hon’ble Supreme Court in the case of Eliy Lilly & Co. (supra) was not concerned with the case of year of taxability of a sum in the hands of non-resident. In the present case, the Assessee does not dispute the fact that interest income is chargeable to tax in India. The Assessee claims that the point of accrual of income and taxation of income in the hands of the non-resident is only when the payment is received by the non- resident and that will also decide the point of time at which tax deductible at source has to be deducted. The obligation of the Assessee to deduct tax at source is laid down by Sec.195 of the Act. Sec.195 (1) of the Act reads thus:
“(1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LB or section 194LC or 194LD or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salaries" shall, at the time of credit of such income to the account of the payee or at the
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time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income- tax thereon at the rates in force:”
A reading of the aforesaid provisions shows that the first part talks about the chargeability to tax of interest income or any other sum. The second part talks about the point of time at which tax has to be deducted, if the sum in question is chargeable to tax. The second part makes it clear that the point of time at which tax has to be deducted at source is “at the time of credit of such income to the account of the payee or at the time of payment thereof in case or by the issue of a cheque or draft or by any other mode, whichever is earlier”. Once chargeability of the sum in question to
tax is admitted, then the Second part of Section 195(1) comes into operation and the accrual of income in the hands of the non-resident or the year of chargeability of income in the hands of the non-resident become irrelevant. The person making payment to the non-resident has to deduct tax at source. He cannot be heard to say that non-resident is liable to tax only when the interest income is received by him and therefore only on receipt of interest income by the non-resident, tax at source should be deducted by the person making payment.
As rightly contended by the learned DR, the decisions relied upon by the learned counsel for the Assessee are rendered in the context of taxation of interest income in the hands of the non-resident and are not in the context of point of time at which obligation to deduct tax at source lies
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on the person making payment to a non-resident. We agree with the submission of the learned DR that the said decisions are therefore not
relevant to the facts of the present case. We therefore hold that disallowance u/s.40(a)(i)of the Act, in the facts and circumstances of the
case, is justified. The quantum of sum to be disallowed as we have already
stated is to be decided by the AO afresh in view of the discussion on the issue raised in ground no.9 in the earlier part of this order. We however
hasten to add that the decision on ground No.9 would be subject to the decision on Gr.No.11 which we will deal with in the later part of this order.
Thus ground No.9 is treated as partly allowed.
In Concise ground No.10, the assessee has challenged the action of the AO/DRP in making a disallowance of Rs.4,22,867 considering the
provisions of section 40(a)(ia) of the Act. In the tax audit report in Form 3CD filed by the assessee; the auditors, in column 27(b) of the report, have
mentioned that the assessee failed to deduct at source and pay tax of
Rs.2534 in respect of payments made to contractors for carrying out work u/s. 194C of the Act and a further sum of Rs.53,579 in respect of payments
for professional services rendered u/s. 194J of the Act. In respect of the aforesaid two items for which tax was not deducted at source and paid by
the assessee, the amount to be disallowed u/s. 40(a)(ia) is on sums of Rs.12,932 and Rs.9,55,062 respectively, which is arrived at as follows:-
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Particulars Amount Amount of TDS not deducted u/s. 194C of the Act – as per 2,534 Form 3CD Amount to be disallowed 1,12,923 (TDS not deducted *100/2.244) - (A) Amount disallowed in the STI 1,12,923 Amount of TDS not deducted u/s. 194J of the Act – As per 53,579 Form 3CD - (B) Amount to be disallowed 9,55,062 (TDS not deducted * 100/5.61) Amount disallowed in the STI 9,55,062 The AO grossed up the TDS amount u/s. 194J at the rate of 5,35,790 10% - (C) [{(B) * 100}/10] The AO subtracted such an amount from the amount 4,22,867 disallowed for non-deduction u/s. 194C – (D) [ (C) – (A)] Amount disallowed by the AO in the final assessment 4,22,867 order
The assessee filed gross return of income declaring Gross Total Income (GTI) of Rs.3,18,87,823. The entire GTI was claimed as deduction u/s. 10A of the Act and therefore the total income declared by the assessee in the return of income was NIL. While arriving at income from business, the assessee has added to the profit as per Profit & Loss Account of Rs.2,45,21,699 a sum of Rs.1,12,923 and Rs.9,55,060 which is the sum to be disallowed u/s. 40(a)(ia) for non-deduction of tax at source.
In the order of assessment, the AO computed total income by starting from the profit as per P&L account of Rs.2,45,21,699 and added the sum of Rs.1,12,923 and Rs.9,55,060 which are the sums to be disallowed u/s. 40(a)(ia) of the Act. There is no dispute between the assessee and the Revenue upto this point. The AO added a further sum of
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Rs.4,22,867 u/s. 40(a)(ia) of the Act. The addition was made by the AO on the assumption that rate of tax for TDS on Fees for FTS is 10%. The AO grossed up tax deductible of Rs.53,579 at 10 times and arrived at a figure of Rs.5,35,790. After deducting this sum of Rs.5,35,790 from Rs.9,55,062, the AO arrived at a further disallowance of Rs.4,22,867. This is shown in the chart given in the earlier part of this order in the last two columns. The AO thus proceeded on a wrong assumption that amount disallowed by the assessee in the return of income u/s. 40(a)(ia) was incorrect, whereas the amount disallowed by the Assessee was correct. It is this addition that is subject matter of dispute between the assessee and Revenue raised in concise ground No.10. According to the assessee, it is a double addition and the figure of Rs.4,22,867 has been arrived at in the manner set out in the table given in the earlier paragraph of this order.
We have seen the computation of total income in the return filed by the assessee as also in the order of assessment and are of the view that the further disallowance of Rs.4,22,867 u/s. 40(a)(ia) is uncalled for, as the assessee has already in its computation of total income, disallowed the correct figure of Rs.9,55,060 to be disallowed u/s. 40(a)(ia) and a further disallowance of Rs.4,22,867 is without any basis. The said addition is therefore hereby deleted. Concise ground No.10 is allowed.
Concise ground No.11 reads as under:- 51.
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“11. Without prejudice to the our above claim that no addition ought to have been made on account of non-deduction or short deduction of TDS, the Hon’ble DRP and the learned AO has erred in law and facts in upholding the action of providing relief under section 10A of the Act on the profits of business in returned income instead of assessed profits (i.e., after adjustments are made to the profit on account of short and non-deduction of TDS).”
The prayer of the assessee is that in the event of disallowance u/s. 40(a)(ia) being sustained, then the same would go to increase the profits of the business in respect of which the assessee is entitled to deduction u/s. 10A of the Act and that the assessee should be allowed deduction u/s. 10A of the Act on such enhanced profits. In support of the claim of assessee as aforesaid, reliance is placed on the decision of the Hon’ble Gujarat High court in the case of ITO v. Keval Construction, 354 ITR 13 (Guj). In
the aforesaid decision, the Hon’ble Gujarat High Court was dealing with a case, where the assessee claimed deduction u/s. 80IB(10) of the Act in respect of profits derived from the business of developing housing projects. In the course of assessment, certain expenses claimed as deduction while computing profits on developing housing projects were disallowed invoking the provisions of section 40(a)(ia) of the Act. The assessee claimed deduction on the enhanced profit after the disallowance u/s. 40(a)(ia) of the Act. The Hon’ble Gujarat High Court held that assessee should be allowed deduction u/s. 80IB(10) of the Act on the enhanced profits, consequent to disallowance u/s. 40(a)(ia) of the Act. We have considered the
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submissions of the ld. counsel for the assessee and are of the view that the same are acceptable.
The computation of profits and gains from the eligible business has to be made in accordance with the provisions of section 30 to section 43D of the Act. The disallowance sought to be made by the revenue are disallowances which are made under the provisions falling within the provisions of section 30 to 43D of the Act (viz., disallowance under section 40(a)(ia) & 40(a)(i) of the Act. Such disallowance, will naturally go to increase the profits derived from the eligible business. It is on such increased profits that the assessee has claimed deduction under section 80IB of the Act. We fail to see as to how because of the disallowances made, the amount ceased to be profits derived from the eligible business.
A similar issue was considered by the ITAT Mumbai in the case of S.B. Builders and Developers vs. ITO, 136 TTJ (Mum) 420. The
Assessee in that case claimed deduction under s. 80-IB of the Act on the Profits and gains from housing project. The AO made addition on account of disallowance under s. 40(a)(ia) and disallowed certain payments relating to the cost of construction, RCC consultancy, architect’s fees, commission and professional charges aggregating to Rs.4,50,12,485/- as the assessee had not deducted tax at source as stipulated in s.40(a)(ia) of the Act. As a result, the gross total income stood enhanced at Rs.8,26,90,888. The AO however restricted deduction under s. 80-IB(10) based on original profit of
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Rs. 3,76,78,403 declared. The Tribunal held that the action of the AO was not justified. The Tribunal held that under s. 80AB the income that is derived from the eligible business must be computed in accordance with the provisions of ss.30 to 43D, as provided in s. 29. Sec.29 provides that the income chargeable to tax under the head “Profits and gains of business” “shall be computed in accordance with the provisions contained in ss.30 to 43D”. The Tribunal held that unquestionably, s. 40(a)(ia) is a section falling between ss. 30 to 43D and therefore effect must be given to the same in computing the profits and gains derived from the eligible business, which in that case was a housing project. The Tribunal further held that while giving effect to the computation provisions contained in ss. 30 43D one should not be bogged down by the theory that the disallowed expenditure cannot be considered as profits ‘derived” from the housing project or as “operational profits. The above ruling of the Tribunal, in our view, would squarely apply to the present case also. Similar is the ruling rendered by the Hon’ble Gujarat High Court in the case of Keval
Construction (supra).
In the light of the aforesaid judicial pronouncements, we are of the view that the claim of the assessee as raised in concise ground No.11 deserves to be allowed. Accordingly, the same is allowed.
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In the result the appeal by the Assessee is partly allowed. 56.
Pronounced in the open court on this 28th day of January, 2015.
Sd/- Sd/-
( ABRAHAM P. GEORGE ) ( N.V. VASUDEVAN ) Accountant Member Judicial Member
Bangalore, Dated, the 28th January, 2015.
/D S/
Copy to:
Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard file
By order
Assistant Registrar / Senior Private Secretary ITAT, Bangalore.