TaxTMI 
TaxTMI 
2013 (11) TMI 190
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....tems Inc. [WSI]. The assessee carried out software designing research and development activities for development of software, software quality assistance, testing, software maintenance and support function (which includes technical support, documentation, it integration, configuration management) for WSI. During the previous year, the assessee received the following amounts from its AE for the various services that it provided to the AE. RECEIPTS Rs. Software designing and development charges 22,07,76,898/- PAYMENTS Rs. Purchase of computer hardware and software 1,55,39,781/- Unsecured loans 28,69,890/- 4. In this appeal, we are concerned only with transfer pricing adjustment made by the TPO in respect of the receipts by the assessee for providing software designing and development services. The assessee filed transfer pricing analysis justifying the payment that it had received from its AE as at arm's length. It is not in dispute that the most appropriate method for computation of ALP is the Transactional Net Margin Method (TNMM). The net margin to cost was chosen as the Profit Level Indicator (PLI) for the purpose of comparison. The assessee&#....
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....P was referred to by the AO u/s. 92CA of the Act, rejected 4 comparables on the ground that the related party transactions in those comparables were more than 25%. One comparable was rejected on the ground that it had diminishing revenues and predominantly on-site activities generated 85% of its revenue. One more company was rejected for the reason that it was functionally not comparable. Thus, out of 11 comparables chosen by the assessee, only two comparables were accepted by the TPO as comparable with that of the assessee viz., M/s. Quintegra Solutions Ltd. and S I P Technologies & Exports Ltd. The TPO adopted his own filters and while doing so, arrived at 26 comparables including the two comparables chosen by the assessee. The 26 comparables chosen by the TPO were as follows:- A.6. Comparables selected by TPO and their arithmetic mean: Sl. No. Name of the Company Unadjusted WC adjusted 1 Accel Transmatic Ltd.(Segment) 21.11 19.61 2 Avani Cimcom Technologies Ltd 52.59 50.85 3 Celestial Labs Ltd. 58.35 53.96 4 Datamatics Ltd 1.38 -1.23 5 E-Zest Solutions Ltd. 36.12 35.64 6 Flextronics Software Systems....
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....s agreed by the parties that the aforesaid decision, which incidentally is also for the A.Y. 2007-08, will apply to the case of the assessee in this appeal also. It was also accepted by the parties that some of the comparables chosen by the TPO have also been considered by the Mumbai Bench of the Tribunal in the case of Telcordia Technologies India (P.) Ltd. ITA No.7821/Mum/2011 ; and by the Bangalore Bench of the Tribunal in the case of 24x7 Customer Com (P.) Ltd. TA No.227/Bang/2010. In this background, we shall now examine the 26 comparables chosen by the TPO and also consider as to what will be the comparables that can be considered for the purpose of determining the ALP. 11. As far as the comparables chosen by the TPO at Sl. Nos. 6,9,10,17,18, 22, 24 & 26 are concerned, it is not in dispute that the turnover of these companies are more than Rs. 200 crores. The turnover of the assessee in the present case is Rs. 22.08 crores (approx.). It has been held by this Tribunal in the case of Trilogy E-Business Software India (P.) Ltd. (supra) that companies with a turnover of more than Rs. 200 crores cannot be taken as comparables while determining the ALP in the case of companies h....
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....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. ....
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....Kodiak Networks (India) Private Limited v. ACIT (ITA No.1413/Bang/2010) 2. M/s Genesis Microchip (I) Private Limited v. 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. 16. 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 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 be....
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....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 corre....
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....controlled 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. (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 funct....
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....tion. 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.....
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.... 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% 40. It was submitted that this company has made unusually high profit during the fi....
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....nal in the case of Teva Pharma Private Ltd. v. Addl. CIT - ITA No.6623/Mum/2011 (for AY 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 indust....
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....ial 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 pro....
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.... ITA No. ITA No 1386/PN/10 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: "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 Inform....
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.... 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 Tri....
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....he functions are by and large similar as that of the assessee company and T.P. analysis/study can be made with fewest and most reliable adjustment. If a company has employed heavy capital in development of a product then profitability in the sale of product would be entirely different from the company, who is involved in service sector. Therefore, this company cannot be treated as having same function and profitability ratio. In our view, due to non-availability of full information about the segmental details as to how much is the sale of product and how much is from the services, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case of the assessee." 16. In view of the aforesaid decision of the Mumbai Bench of the Tribunal, which is also in relation to A.Y. 2007-08, we are of the view that the said company is to be excluded as a comparable while determining the ALP of the international transaction impugned in this appeal. 17. As far as companies at Sl.No.7 & 11 of the list of comparables chosen by the TPO are concerned, it is not in dispute that the related party transaction of....
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....mining the ALP of the international transaction in question. 19. As far as Sl.No.16 viz., Megasoft Ltd. of the list of comparables chosen by the TPO is concerned, this Tribunal in the case of Trilogy E-Business Software India (P.) Ltd. (supra) had held that only segmental data should be taken for the purpose of comparison. Following are the relevant observations of the Tribunal:- "37. The next plea of the Assessee is that if at all this company is considered as a comparable then the segmental margin of 23.11% (which is the margin for software service segment) alone should be considered for comparability. On the above submission, we find that the TPO considered the segmental margin (Software service segment) in the case of Geometric, Kals Info systems, R Systems, Sasken Communication and Tata Elxsi. Before DRP the Assessee pointed out that the segmental margin of 23.11% alone should be taken for comparability. The DRP has not given any specific finding on the above plea of the Assessee. Perusal of the order of the TPO shows that the TPO relied on information which was given by this company in which this company had explained that it has two divisions v....
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....product segment and no finding has been given that reasonably accurate adjustments can be made to eliminate the material effects of such differences. For this reason, we are inclined to hold that the profit margin of 23.11% which is the margin of the software service segment be taken for comparability. In view of the above conclusion, we do not wish to go into the question as to whether 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." 20. In view of the aforesaid decision of the Tribunal, segmental margins in so far as it relates to providing software services by Megasoft alone be taken for the purpose of comparison. 21. Out of the 26 comparables chosen by the TPO and after excluding the comparables referred to in the earlier paragraphs, the comparable companies that would remain for comparison and the arithmetic mean of the remaining comparables would be as follows:- C.2. Computation of arithmetic mean of the 11 remaining comparables: If the above argument of the Appellant is accepted, the arithmetic mean of 11 remaining of....
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....table to the delivery of software outside India. The Assessing Officer, however, proceeded to recompute the deduction by once again reducing the said amount of Rs. 1,02,52,778/- from export turnover but not from total turnover and thereby disallowed the 10A deduction to the extent of Rs. 12,42,705/-. The assessee's submission is that no part of the above expenditure was attributable to the delivery of software outside India and in the alternative, if the same is reduced from export turnover, it should also be reduced from total turnover. The alternative submission is supported by the decision of the Hon'ble High Court of Karnataka in CIT v. Tata Elxsi Ltd. [2012] 349 ITR 98 (Karn). 26. As far as the alternative claim is concerned, we find that the Hon'ble High Court of Karnataka in the case of Tata Elxsi Ltd. (supra) has held that while computing deduction under section 10A of the Income Tax Act, 1961 (the "Act"), expenditure incurred by the assessee, if excluded from the export turnover ("ET"), should also be excluded from the total turnover ("TT"). It has been held that, * The TT would have two components - ET and Domestic Turnover. Therefore, if the ET in the n....