TaxTMI 
TaxTMI 
2011 (8) TMI 952
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....e year under consideration, a return of income was filed by the assessee declaring a total of income of Rs. 81,75,080/-. During assessment proceedings u/s 143(3), it was also noticed that the assessee has received payments from its AE clients for providing the software development services and also IT enabled services exceeding Rs.15 Crores. In view of the same, a reference was made to the TPO (Transfer Pricing Officer) u/s 92CA of the IT Act for determination of ALP of the international transaction. The TPO issued initial notice asking the assessee to furnish the documents required to be maintained u/s 92D and the same was furnished by the assessee. The TPO also issued notice relating to determination of arm's length price (ALP) for Software Development Services and also with regard to the Information Technology Enabled Services(ITES in short). These notices contained remarks on assessee's study, new search methodology adopted for selecting the comparables, new comparables selected by the TPO and copies of replies received u/s 133(6) from these other companies. The assessee filed a detailed reply for both the notices and also raised various objections to the comparables selected b....
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.... held that the filters adopted by the assessee for arriving at the 15 comparables have several defects and the following are the defects:- (i) Verticals of Software Development not considered The tax payer has not gone into the verticals within the software industry in its comparability study. 'Vertical' is the 'industry segment' like banking, finance, insurance, healthcare, retail etc., to which the services of the company cater to. The functional or service lines may include but not limited to application, development and maintenance, package implementation services, independent validation services, enterprise application services, testing services, embedded software services, web development, inter-net based applications, e-commerce applications, consulting services etc. The tax payer has searched for comparables which are engaged in the software development services but has not considered the verticals/functional or service lines in which the company is engaged. Thus, the tax payer considered companies that are into different verticals and functional lines, though the tax payer is involved in software development activities catering to telecommunications and i....
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....rore for the FY: 2005-06. Extremely low expenditure on salary/employee cost is a definite indication that the company is either into further outsourcing of the work or is a software product developer or a software trading company. In view of these facts, filter of 25% of minimum salary expenditure was applied while examining the comparables selected by the tax payer and also while searching for additional comparables. 2. Different year ending filter; The tax payer follows the financial year ending 31^st March, whereas in some of the comparables companies selected by the tax payer, the accounting year ends with June or September or any other month. Those companies whose accounting year does not end with March 31, 2005 were proposed to be rejected, because it ensures that the transactions being compared took place during the same period/financial year either in the tax payer's case or in the comparable company's case and is also being in conformity with Rule 10B(4). 3. Diminishing Revenue Filter As per this filter the companies with diminishing revenue for the last three years upto and including FY: 2005-06 were rejected as comparables. 4. Software De....
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....oftware development process is a structure imposed on development of software products. Often, the first step in attempting to design a new piece of software is to decide whether it would be in addition to existing software or is it new application, a new subsystem or a whole new system. This is what is generally referred to as 'Domain Analysis'. Assuming that the developers are not sufficiently knowledgeable in the subject area of the new software, the first task is to investigate the so called 'domain' of the software, because more knowledgeable they are about the domain already, the less the work that is required. Another objective of this work is to make the analysts who will later try to elicit and gather the requirements from the area experts or professionals, speak with them in the domain's own terminology and to better understand what is being said by these people because otherwise they will not be taken seriously. The next most important task in creating a software product is extracting the requirement of the customers and then precisely describing the software to be written possibly in a rigorous way. In practice, most successful specifications are written to understand a....
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.... source code. Unlike these software development companies, pure software development service provider does a portion of the described software development life cycle. It does not generate any intellectual property of its own. The intellectual property generated belongs to the customer and not to the service provider. A software customization company buys software products in the form of licenses from third party or uses its own software products for customization to suit the requirements of the customer and in this case, only the right to use the software is passed on to the customer and therefore, the same is also considered as software development service providers. A software trading company purchases software products in the form of licenses or on royalty basis as a right to use and sells these products as a reseller. 3.1 The assessee being a software development service provider, it cannot be compared to a software development company or a software trading company. Therefore, the companies that are functionally different from that of the tax payer are to be excluded. 3.2 Applying the above filters, the TPO rejected ten of the comparables adopted by the assessee and made ....
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....s 133(6) was also supplied to the assessee. Thereafter, the TPO worked out the average profit margin at 24% and worked out the working capital adjustments at 1.72%. She also rejected the assessee's quantitative computation of the risk adjustments and arrived at the ALP at 22.28% of the operating cost. She computed the ALP at 22.28% of the operating cost of Rs. 4,23,23,860/- and made the adjustments of the short fall i.e. Rs. 66,38,48/- towards the TP adjustments u/s 92CA of the Act for the ITES. Thus, the total adjustments made to the TP adjustments for the AY: 2006-07 was Rs. 2,86,51,575/-. Aggrieved by the draft order of the AO, the assessee preferred objections to the DRP which approved the draft order and the assessee is in appeal before us. 4.3 The assessee has raised the following grounds of appeal. "1. Grounds relating to natural justice: The lower authorities have erred in passing the order. a. Without considering all the submission and/or without appreciating properly the facts and circumstances of the case and law applicable. b. At the fag end of the limitation period; and c. without affording a proper opportunity of b....
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....inappropriate filers in the process of selecting comparables; c. Adopting companies as comparables even though they are not comparables in respect of functions performed, risks assumed, assets utilized, size turnover etc. d. In adopting companies having unusual circumstances resulting in high margins; and e. Inappropriate computing the operating margins of the comparables and the appellant. In the case of both software as well as ITES segments. 9. Grounds on adjustment for differences: The lower income-tax authorities have erred in not making proper adjustments for enterprise level and transactional level differences between the appellant and the comparable companies. 10. The lower authorities have erred in; a. Ignoring the business, commercial and industry realities and economic circumstances applicable to the appellant vis a vis the comparables; b. Not making any adjustments for qualitative and quantitative difference between the business of the appellant and those of the comparable companies. c. Not recognizing that the company was insulated from risks, as against comparab....
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.... are accordingly, rejected as not pressed. 5.1 As regards the ground of appeal relating to the ALP adjustments suggested by the TPO by rejecting the comparables adopted by the assessee and taking into consideration the other comparables by conducting a fresh TP analysis, the learned counsel for the assessee has submitted the following; 5.2 The assessee is a company engaged in the business of providing software development services and Information Technology Enabled Services segment (ITES). The assessee exports its services to its AE as also other clients. The assessee also renders services to domestic clients. The assessee renders its services to its AE on man day/man hour basis. 5.3 During the year under consideration, the assessee had the following international transaction with its AE (i) rendering of software development and (ii) ITES services and (iii) receipt of interest free loan. There is no objection by the TPO with regard to receipt of interest free loan by the assessee. The international transactions with respect to rendering of services to AE are as follows; (i) Software development services 8,13,17,968/- (ii) ITES 3,50,70,....
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....om other companies(in CD). In reply thereto, the assessee filed a letter dated 14-09-2009 raising various objections to the proposed action of the TPO. However, the TPO passed a final order u/s 92CA selecting 20 companies as comparables, thus the TPO has considered additional companies as comparables without proposing the same to the assessee or affording an opportunity to the assessee to present its objections to their adoption. The arithmetic mean was determined at 20.68% and after making the working capital adjustments of 0.88%, the adjusted arithmetic mean was determined at 19.80% and the transfer pricing adjustments for the software segment was determined at Rs.2,20,12,927/-. However, while computing the transfer pricing adjustments, the TPO has taken the operating cost at Rs.16,69,84,198/-(being the entire cost of the software segment) and operating revenue at Rs.17,80,34,142/- (being the entire revenue of software segment including non-AE and domestic revenue) instead of the costs & revenues referable to the international transaction only. 5.5 Aggrieved by the said transfer pricing adjustments, the assessee filed detailed objections before the dispute resolution panel (DR....
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....f tax and sec.92 therein relates to computation of income from international transactions having regard to ALP. Thus, it can be seen that only international transactions between the associated enterprises either or both of whom are non-resident are to be computed having regard to ALP. This issue is also covered by the decisions relied upon by the learned counsel for the assessee. Accordingly, the AO is directed to make the transfer pricing adjustments by restricting the adjustments to the transactions of the AE only by adopting the operating revenue and operating costs of these transactions only. 7. As regards the filters selected by the assessee in making the transfer pricing study, the learned counsel for the assessee submitted that the assessee has adopted a turnover range of Rs.1.00 crore at the lower end and Rs.200 Crores at the higher end while choosing the comparables. He submitted that this adoption of upper limit of Rs.200 Crores is based on the Dun and Bradstreet's analysis which has classified the software companies into the following categories; 1. Large size firms (Rs.20,000 Mn) 2. Medium size firms (Rs.2,000-20,000 Mn) 3. ....
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....s turnover base. 2. Egain Communications (P.) Ltd., v. ITO [2008] 23 SOT 385 (Pune) 3. Sony India (P) Ltd. v. Dy. CIT [2008] 114 ITD 448 (Delhi) 4. Dy. CIT v Indo American Jewellery Ltd.,[2010] 41 SOT 1 (Mum.) 5. Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226 (Bang.) 6. Asstt. CIT v. NIT [2011] 10 taxmann.com 42 (Delhi) 8.1 He further submitted that size as a criteria for selection of comparables is also recommended by OCED in its TP guidelines. The observation of OCED in para-3.43 of the Chapter on guidelines reads 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". 8.2 The learned counsel for the assessee submitted that similar observations were also made by ICAI in para15.4 of TP guidance Note. He submitted that TPO's range of Rs.1.00 crore to infinity has resulted in selection of companies like M/s Infosys which is having a turnover of Rs.9,028 cores which i....
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....pose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & 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 core 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. 10. The next issue raised by the learned counsel for the assessee is that while making the comparability analysis, the TPO conducted enquiries from certain companies by exercising powers conferred on him u/s 133(6) of the Act and these notices and the replies have been provided to the assessee. He submitted that the TPO has issued notices to 154 companies, but why these companies were selected is not clear. He submitted that the information had been provided to the assessee in th....
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....nce, either the information is incomplete or unreliable apart from being unverifiable. To demonstrate this point, the learned counsel for the assessee submitted that M/s Sankhya Infotech was selected as comparable in the preceding assessment year 2005-06 on the ground that it is a software development company on the basis of reply received to notice u/s133(6) inspite of the objection of the assessee that this company is a software product company. But during the year under consideration, the same company has been rejected on the ground that it is a software product company which is again based on reply received to notice u/s 133(6) of the IT Act. Thus, the learned counsel for the assessee submitted that these inconsistencies in the process of TPO raises doubts regarding transparency and genuineness of the entire process. Another point advanced by the learned counsel for the assessee is that the information obtained by the TPO by issuing notices u/s 133(6) is not available in public domain at the time of study by the assessee. He submitted that Rule-10D prescribes the documents to be kept and maintained u/s 92D and sub-rule (4) thereof deals with the process and the method to be ....
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....ational transaction shall be the data relating to the financial year in which the international transaction has been entered into. Thus, he submitted that not only the comparables adopted by the assessee but information relating to other companies which are available in the public domain at the time of determining the ALP also have to be considered by the TPO, while making the TP adjustments. He submitted that the act or Rules do not specify the date, till which only the information available in the public domain can be utilized. He submitted that though sec.92D and Rule -10D prescribes the information and documents to be kept and maintained u/s 92D of the IT Act, it is not prohibited nor is it specified therein that only the documents maintained by the assessee have to be taken into consideration. He submitted that the TPO is under an obligation to verify the information and documents kept and maintained by the assessee and wherever he feels that some more information is necessary for making the TP adjustment, he may also make his own search and use the relevant years data available in the public domain. Thus, in view of this power of TPO, the TPO has made the search of the databa....
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....ed for a period of 8 years. Rule 10-D of sub-sec.1 specifies the documents and information which are to be kept and maintained by the assessee and sub-rule-2 thereof provides that nothing contained in sub-rule-1 shall apply in a case where the aggregate value as recorded in the books of accounts, the international transactions entered into by the assessee does not exceed 1.00 crore rupees. Sub-rule-3 provides the supporting authentic documents which are to be kept and maintained and sub-rule-4 thereof provides that the information and documents specified under sub-rule 1 & 2 should as far as possible be contemporaneous and should exists latest by the "specified date" referred to in clause-4 of 92F. Clause-4 of sec.92F gives the definition of "specified date" to have the same meaning as assigned to 'due date' in Explanation-2 below sub-sec.1 of sec.139. Explanation-2 to sec.139 defines 'due date' in a case of a company to be '30th day of September of the assessment year'. The assessee before us is a company and therefore, as on '30th day of September' of the relevant assessment year, the assessee is supposed to maintain information and documents. After going through the above provis....
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....he entire information to the assessee. The principles of natural justice requires that when any information is sought to be used against the assessee, the assessee shall be given a fair opportunity of hearing on that material. In the case before us the TPO has furnished all the information to the assessee in the form of CD and the assessee after going into the same has submitted a detailed submission along with its objections for taking various companies as comparables. It is another matter, if the TPO has not considered the objections of the assessee judiciously. In such a case, it would be an error of judgment and not violation of principles of natural justice. The objections of the assessee is that certain companies have been taken into consideration by the TPO as comparables without giving the assessee an opportunity of presenting its objections and also with regard to certain other companies, it had sought opportunity to cross examine them, but the said opportunity was not given. 13. We have already held that if any information is sought to be used against the assessee, the same has to be furnished to the assessee and thereafter, taking into consideration the assessee's obj....
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....the following directions; (a) The operating revenue and the operating cost of the transactions relating to associated enterprises only shall be considered; (b) The comparables having the turnover of more than 1.00 crore but less than 200.00 crores only shall be taken into consideration; (c) All the information relating to comparables which are sought to be used against the assessee shall be furnished to the assessee; (d) The assessee shall be given an opportunity of cross examining the parties whose replies are sought to be used against the assessee if the assessee so desires; (e) To consider the objections of the assessee that relate to additional comparables sought to be adopted by the TPO and pass a detailed order and (f) To give the standard deduction of 5% under the proviso to sec.92C(2) of the Act. 14. Similarly, in the ITES segment also the assessee has raised various grounds i.e. adoption of various companies as comparables and additional filters used by the TPO. For the detailed reasoning given by us for the above software development service segment, we direct the TPO to consider the assessee's objections and comput....