TaxTMI 
TaxTMI 
2013 (11) TMI 772
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....ubsidiary 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 mean of the comparables under the proviso to se....
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....; 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 order of the AO, the assessee has raised ground No.2 before the Tribunal. 7. Before us, the ld....
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....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.200 crores. The following are the relevant observations of the Tribunal in this regard:- "(1) Turnover Filter 11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Rs.1 crore, but has n....
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....nces 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:....
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....p; 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 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 agr....
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....f 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 t....
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....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) 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....
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....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. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores." 21. Respectfully following the decision of the Tribunal referred to above, we hold that the comparables chosen by the TPO at Sl. Nos. 6,9,10,17,18, 22, 24 & 26 have to be excluded as comparables for the purpose of determining the ALP of the impugned transaction i....
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....venue 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:- Pa....
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....t 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 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 ....
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....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....
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....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 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....
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....g, 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 ....
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.....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 25% on the related party transaction. According to the assessee, the recent order of the Tribunal in the case of 24/7 Customer Com Private Ltd. had held that if comparable company has related party transaction exceeded 15% of the total sales/revenue, the same should not be comparable. 3.5.1 The learned DR present was duly heard. 3.5.2 The Tribunal in the case of 24/7 Customer Com Private Ltd. had held that if the related party transaction exceeded 15% of the total sales/revenue, the same cannot be taken....
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....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 Tribunal in the case of CSR India Ltd. (supra), had 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 this company was software developer. The following were the relevant observations of the Tribunal:- "(E) Lucid Software Limited 3.4.2. The above company has been rejected as comparable in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra). The submissions and the finding of the Hon'ble Mum....
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....acts 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 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 ....
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....tions 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 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. As far a....
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.... 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 chosen by it was VMF Softech Ltd., but the same was rejected by the TPO for the reason that this company does not satisfy the 25% employee cost filter and also for the reason that this company was predominantly outsourcing its business. Finally, after considering the taxpayer's submissions, the TPO has observed as follows:- "The taxpayer's objections are dealt with as under. 1. There is no dispute that the company derives its revenues from software services. 2. The taxpayer's claim regard....
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....nbsp; "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 incorrect to reject the company using the 25% employee cost to sales filter." 27. The TPO, in our view, has come to a wrong conclusion that 25% employee cost filter is not satisfied by excluding the cost of outsourcing incurred by this company. The fact remains that this company has never outsourced any of the project. The conclusions of the TPO are therefore erroneous. This company is therefore directed to be accepted as a comparable company. 28. The ld. counsel for the assessee also brought to our notice that while working out the TP adjustment, the TPO has considered the operating revenues at Rs.19.94 crores, whereas the receipt on account of....
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....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 & telecommunication expenses do not form part of the export turnover and hence cannot be excluded from the export turnover as held in Patni Telecom (P) Ltd. v. ITO (120 ITD 105 Hyd.). iii. The assessee submits that, in any event, as held by the jurisdictional High Court in the case of CIT v. M/s. Tata Elxsi Ltd. 2011-TIOL-684-HC-KAR-IT, the total turnover consists of export turnover + domestic turnover. Therefore whatever is excluded from the export turnover should also be excluded from the total turnover." 33. There is no dispute between the parties that in view of the judgment of the Hon'ble High Court of Karnatak....