TaxTMI 
TaxTMI 
2013 (11) TMI 772
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....y incorporated in India on 14.12.1999. It is a subsidiary of HCL EAI Services Inc., a company incorporated as per the laws of USA. The assessee provides offshore software development services to its parent company, HCL EAI Services Inc. The transaction by which the offshore software development services were provided by the assessee to HCL EAI Services Inc. was admittedly an international transaction entered into by the assessee with its AE and therefore the consideration received by the assessee for rendering such services had to be at Arm's Length and had to be determined in accordance with the provisions of section 92 of the Act. In support of its stand that the consideration received by the Assessee for rendering software development services to its AE was at Arm's Length, the assessee filed a transfer pricing (TP) study in which it had identified 28 comparables. The assessee had adopted the operating profit to cost as Profit Level Indicator (PLI). The assessee's PLI was 11.4% on operating cost. The arithmetic mean of the 28 comparables chosen by the assessee was at 14.53% on cost. The assessee accordingly after taking the benefit of +/- 5% variation permitted to the arithmetic....
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....p; : 23.22% Arm's Length Price : Operating Cost Rs.19,94,79,454 Arms Length Margin 23.22% of the Operating cost Arms Length Price (ALP) @ 123.22% of operating cost Rs.24,57,98,583 Price Received vis-à-vis the Arms Length Price The price charged by the tax payer to its Associated Enterprise is compared to the Arms Length price as under: Arms Length Price @ 123.22% of operating cost Rs.24,57,98,583 Price charged in the international transactions Rs.21,79,78,822 Shortfall being adjustment u/s 92CA Rs. 2,78,19,761 The above shortfall of Rs.2,78,19,761 is treated as transfer pricing adjustment u/s. 92CA." 6. The AO made the addition as suggested by the TPO in his draft order. The objection to the draft order filed by the assessee was not accepted by the DRP and adjustment as suggested by the TPO to the ALP was confirmed by the DRP. The AO in the fair assessment order made the addition as suggested by the TPO which was confirmed by the DRP. Against the aforesaid ....
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....at 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 24/7 Customer Com (P.) Ltd. ITA No.227/Bang/2010. In this background, we shall now examine the 26 comparable chosen by the TPO and also consider as to what will be the comparable that can be considered for the purpose of determining the ALP. 10. As far as the comparable 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 having turnover of less than Rs....
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....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 th....
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.... 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). 16. It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee. 17. 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. 18. 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 enterprise....
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....ice 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 furnis....
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....nbsp; (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 functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c....
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....he 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 (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.5....
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....ame "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 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 ....
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....enditure 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 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....
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....refore 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 no....
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....ny 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 Rs.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 v. 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: "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....
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....e 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 ther....
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....e performance of services is not a payment on its own behalf and who are not employees of the organization, ought not to have been taken into consideration while arriving at the 25% employee cost filter. The order of the TPO on this aspect is not very clear as to how he has got over the aforesaid objection of the assessee. The TPO seems to have relied on the reply given by the company to the notice issued u/s. 133(6) of the Act. It was further brought to our notice that the Bangalore Bench of the Tribunal in the case of CSR India (P.) Ltd. in ITA No.1119/Bang/2011, order dated 29.01.2013 for AY 07-08, considered the comparable of this company with a software service provider like the assessee and has come to the conclusion that the same is not comparable, on the ground that it does not satisfy the related party transaction filter. The following are the observations of the Tribunal:- "(iii) Related party transaction: 3.5 Ishir Infotech Limited: The assessee had objected to the inclusion of Ishir Infotech Limited as a comparable being related party transaction in excess of 15% of total sales/revenue. The TPO had set a limit of 2....
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....r due verification those comparables from the list with related party transactions or controlled transactions in excess of 15% of total revenues for the financial year 2003-04". 3.5.3 Following the Coordinate Bench order of the Tribunal in the case cited supra, we direct the Assessing Officer/TPO to exclude, after due verification, those comparables from the list with the related party transactions or controlled transactions in excess of 15% of the total revenue for the financial year 2006-07. It is to be mentioned here, Geometric Ltd. is also to be removed from the comparable list, since that company was having RPT at 19.98% (going by assessee's own calculation), however, no argument was raised for its exclusion by the assessee, probably, on account of low margin of Geometric Ltd." 16. Respectfully the aforesaid decision of the Tribunal, comparable at Sl.No.11 of the list of comparable chosen by the TPO has to be excluded for the purpose of comparison while determining the ALP of the impugned transaction in this appeal. 17. As far as Sl.No.14 of the list of comparable chosen by the TPO is concerned viz., Lucid Software Ltd., is concerned, this Tri....
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....f 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". 3.4.3 The objections raised by the assessee for inclusion of Lucid Software Ltd. as a comparable is placed at pages 244 to 248 of the paper book filed by the assessee. We find identical objection has been raised against the inclusion of Lucid Software in case of Telcordia Technologies. Since the facts and the assessment year are identical, following the order of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra), we direct the Assessing Officer/TPO not to include Lucid Software Limited as a comparable." 18. Respectfully the aforesaid decision of the Tribunal, comparable at Sl.No.14 of the list of comparable chosen by the TPO has to be excluded for the purpose of comparison while determining the ALP of the impugned transaction in this appeal. 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 ca....
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....tify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. In terms of Rule 10B(3)(b) of the Rules, 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. 38. Neither the TPO nor the DRP have noticed that there is bound to be a difference between the Assessee and Megasoft and the profit arising to the Megasoft as a result of the existence of the software 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....
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....case. The TPO will afford opportunity of being heard to the assessee for deciding this issue. 23. The assessee also pleads before us that it had chosen Aztech Software as a comparable in its TP study, but the TPO has rejected the said company as a comparable for the reason that the related party transactions were more than 25% of the total transactions. It is seen from pages 51 & 52 of the TPO's order that the assessee has been claiming that the related party transactions have been worked out by the TPO by taking into account the value of reimbursement received from the related party and if reimbursements are not considered, then the related party transaction would be only 22.99%. 24. On the above issue, the ld. DR pointed out before us that this Tribunal in the case of 24/7 Customer.Com (P.) Ltd. (supra) had held that if the related party transaction is more than 15% of the revenue, then the company cannot be taken as a comparable. In view of the decision cited by the ld. DR before us, we are of the view that the rejection of Aztech Software Ltd. as a comparable by the TPO is justified and calls for no interference. 25. The assessee also claims that one of the comparable ....
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.... contention of the taxpayer that the company satisfies functionality criterion as it passes through the employee cost filter if software development expenses and personnel expenses are taken together is incorrect." 26. On the above conclusions of the TPO, we find that this company in response to notice u/s. 133(6) of the Act has specifically submitted that it is not doing any outsourcing work. Therefore, this company is functionally comparable. With regard to 25% employee cost filter, the assessee had clearly demonstrated before the TPO that the employee cost was more than 25% of the revenue as follows:- "As per the annual report of the company for the year ending 31 March 2007, the employee cost of the company as per the Profit & Loss account on Page 20 of the annual report, is 53.62% of the operating revenues of the company. The detailed computation is given below for you reference Particulars Value for FY 2006-07 Personnel expenses (As per Schedule 11 on Page 20 of Annual Report) 5,672,949,50 Operating Revenues 10,577,942 Employee cost/ Operating revenues 53.62% Given the above, it would be incorr....
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....n into account while working out the working capital adjustment. The TPO's computation as done at page 161 of the order shows that he has not considered the aforesaid items pointed out by the Assessee. We are of the view that it would be just and appropriate to set aside this issue to the TPO and direct him to consider this objection in the set aside proceedings as the same has not been considered by the TPO or the DRP. 31. The AO is directed to work out the ALP after taking note of the directions given above. 32. Ground No.3 raised by the assessee in its grounds of appeal reads as follows:- "Reduction of foreign currency travel expense and telecommunication expenses from the export turnover while computing deduction u/s. 10A of the I.T. Act. i. The ACIT/DRP erred in concluding that foreign currency travel expenses and telecommunication expenses need to be reduced from the export turnover while computing deduction u/s. 10A of the Income Tax Act. ii. The ACIT/DRP erred in by ignoring the fact that foreign currency travel expenses & tel....