TaxTMI 
TaxTMI 
TaxTMI 
2011 (8) TMI 952
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....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 by the TPO. The TPO however, was not convinced by these ob....
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....rables 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 inter-net sector. (ii) Filters or criteria adopted by the tax payer....
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.... 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 31st 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 Development Service revenue 75% For the Transfer Pricing study, the search criterion should basically....
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....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 and fine tune applications that were already well developed, although safety critical software systems are ofte....
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....ion 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 a search of his own for the appropriate comparables on the prowess database as well as capitaline data bases and arri....
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....e 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 being heard to the appellant. 2. Grounds relating to procedure: The lower authorities have erred in a. Making a reference fo....
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....formed, 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 comparables, which assume these risks and therefore, have to be credited with a risk premium on this account; and d. Not appropriately computing the working capital adjustment while computing....
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....rables 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 3,50,70,406/- Total Rs.1,16,388,374/- 5.4 As the assessee renders service to AE as well as to non-AE, the AE exports are to the tune of Rs. 8,13,17,968/-. The assessee has adopted the transactional net margin method (TNMM) to justify the price ch....
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....mined 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 (DRP) on 27-01-2010 and the DRP approved the draft order except rectifying an error in the margin computation of one comparable namely M/s Megasoft. 5.6 Aggrieved by this order of the DRP and the consequential assessment made by the AO the assessee has filed this appeal and has raised the following points; 1. Restrict TP adjustments to AE transactions only:- The transactions with AE only are international transactions and it is only with reference to....
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.... 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. Small size firms (Rs.2,000 Mn) 7.1 The learned counsel for the assessee submitted that the TPO has rejected the upper limit of Rs.200 Crores on the ground that there is no relationship between sales and margins in the service sector as fixed assets are very minimal. He submitted that this is not correct because, the size of the comparable is an important factor of comparability and that it is also recognized by the statute, especially the Rules. He submitted that Rule 10B(3) lays down guidelin....
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....D 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 is 1,1007 times bigger than the assessee company which has a turnover of Rs.8.15 crores. He further submitted that NASSOM was also categorized the companies based on the turnover as follows; 1. Greater than USD 1 Billion (approximately 5,0000 crores) 2. Between USD 100 Million to USD 1 Billion(Rs.500 crores to Rs.5,000 crores) and 3. Others having less than USD 100 Million (Rs.500 croes) Thus, the learned counsel for the assessee submitted that an appropriate turnover range should be....
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....e 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 the form of CD but it is not clear as to whether all the responses have been incorporated in the CD given to the assessee. He submitted that the entire process lacks transparency and fairness because six companies which have been finally taken by the TPO do not find place in the initial list of companies generated by the learned TPO. He submitted that the TPO selected Megasoft Ltd., as comparable and as seen from the details provided to the assessee alongwith the initial show cause notice, he rejected companies which fail in RPT and empl....
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....hat 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 adopted in making the comparability analysis. He submitted that as per this sub-rule, the information and documents should as far as possible be contemporaneous and should exist latest by the specified date referred to in clause(iv) of sec.92F. According to him, the dictionary meaning of contemporaneous is 'existing or occurring at the same time, of the same historical or geographical period'. 10.2 As per Rule 10D, the information and documents prescribed there in must be kept and maintained by the assessee latest by the prescribed date i....
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....hat 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 databases and has issued notices to the relevant parties u/s133(6) of the Act to gather information which is not available in the public domain. After considering replies to the said notices, the TPO has rejected many companies and has selected only the relevant comparables and all the information which is sought to be used by the TPO for making the TP adjustments has been supplied to the assessee and the assessee was given ample opportunity of making its objections. He submitted that the TPO after considering the assessee's objections only has made ....
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....ed 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 provisions of law, it is clear that the Act has not provided for any cut off date upto which only the information available in public domain has to be taken into consideration by the TPO, while making the TP adjustments and arriving at arm's length price. The assessee as well as the revenue are both bound by the Act and the Rules there under and therefore, as provided under the Act and Rules they are supposed to be taking into consideration, the contemporaneous data relevant to the previous year in which the transaction has taken place. The assessee had stre....
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....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 objections, if any, only then can the TPO proceed to take a decision. If the assessee seeks an opportunity to cross examine the party, the assessee shall be provided such an opportunity. It is only during a cross examination that the assessee can rebut the stand of that particular company. The assessee has also brought out various defects in the additional comparables selected by the TPO and has brought out the glaring differences between the functions of those comparables as compared to assessee and also as to how the entire revenue of the assessee has bee....
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.... 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 compute the ALP, after giving the assessee an opportunity of hearing after observing our directions given above. 15. With regard to low capacity utilization, adjustments to be given in the determination of ALP in ITES sector, the learned counsel for the assessee submitted that during the year under consideration the assessee had under utilized its facilities to the extent of 51.89% and therefore, this adjustments also should be given while determining the ALP. After giving adjustments, according to him the net operating margin on cost would be 27.46%. He submitted that the learned TPO has rejected ....