TaxTMI 
TaxTMI 
2015 (3) TMI 267
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....6-07, the assessee filed its return of income on 30.11.2006 declaring total income of Rs. 48,54,821 after claiming deduction of Rs. 1,92,86,469 under Section 10A of the Act. The case was taken up for scrutiny. In the course of assessment proceedings, the Assessing Officer noticed that the assessee had, inter alia, received payments in excess of Rs. 15 Crores for providing software development services, the details of which are as under :- i) Rendering of Engineering & Software Development Services : Rs. 19,67,38,380. ii) Reimbursement of expenses (received) : Rs. 71,28,098. In view of the above international transactions entered into by the assessee, the Assessing Officer made a reference under Section 92CA of the Act to the Transfer Pricing Officer ('TPO') for determining the Arm's Length Price ('ALP') of these international transactions, after obtaining the approval of the CIT-III, Bangalore. The TPO vide order under Section 92CA of the Act, dt.30.10.2009 proposed a T.P. adjustment of Rs. 1,61,74,393 to the ALP of international transactions in respect of software development services rendered by the assessee. The Assessing Officer then issued a draft assessment order under Sec....
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....on'ble DRP / the ld. Assessing Officer have erred in upholding the TPO's action of determining the operating profit margin of the appellant at lower level at 10.72 percent and not accepting the computation of operating income and operating costs as carried out by the appellant. 4. The Hon'ble DRP / the ld. Assessing Officer have erred in law and in facts in upholding the TPO's action of selecting companies as comparable to the appellant despite such companies failing the test of comparability on some or all of the factors such as having related party transactions, different scale of operations, functional dis-similarity, differing product led revenues, differing asset base, risk profile etc. and failure of his own filters. 5. The Hon'ble DRP / the ld. Assessing Officer have erred in upholding the TPO's action of not providing appropriate working capital adjustment to the appellant and also ignoring the limited risk nature of the services provided by the appellant and upholding the conclusion of the ld. TPO that no adjustment on account of risk differential is required in determining the ALP. 6. The Hon'ble DRP and the ld. Assessing Officer have erred in law and o....
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.... seen that the assessee in its T.P. Study, had adopted TNMM as the Most Appropriate Method ('MAM'), using the search processes Prowess and Capitative, and after applying certain filters, the assessee selected the following eight companies as comparables to it; the details of which are extracted and reproduced hereunder :- S.No. Company OP/TC % 1. Akshay Software 10.19 2. Dynacons Systems & Solutions Ltd. 4.44 3. IKF Technology 12.23 4. Powersoft GSL 20.76 5. Shree Tulsi Online.Com Ltd. 1.71 6. Softsell Technology Ltd. 2.17 7. Sunbeam Infotech 8.21 8. VJIL Consulting Ltd. 11.45 Total : 71.16 Arithmetic Mean (Average) 8.89 Since the assessee's net margin for transactions with its AEs computed at 14.00% was higher than the average net margin of the comparable companies, at 8.89%, the assessee concluded that its international transactions with its AEs was at Arm's Length and that therefore no T.P. Adjustment was required. 5.2 The TPO, while accepting TNMM as the MAM, rejected the assessee's T.P. Study and carried out his own search using 'Prowess' and 'Capitaline', applying various filters. In this process the TPO rejected all 8 comparables selec....
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.....w.s. 144C of the Act dt.11.10.2010. 5.5 In the appellate proceedings before us, the learned Authorised Representative of the assessee filed a chart explaining as to how some of the comparable companies chosen by the TPO are not comparable to the assessee in the case on hand. These are broadly :- i) for the reason that the turnover of those companies were beyond Rs. 200 Crores and therefore cannot be compared with the assessee, whose turnover is Rs. 19.67 Crores; ii) for the reason that certain comparables were functionally dis-similar and therefore not functionally comparable to the assessee; iii) for the reason that Related Party Transactions ('RPT') of some of the comparable companies during the period under consideration were in excess of 15% of its revenues and hence ought not to be included as comparables. The chart also cites the judicial pronouncements of various benches of the ITAT where certain comparable companies have been held to be not comparable with that of a taxpayer providing IT Software Development Services. We will now proceed to consider the comparability of companies chosen by the TPO in his order under Section 92CA of the Act dt.30.10.2009. 6. Turnover ....
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....e between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also....
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....not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & 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 crore to 200 crores have to be taken as a particula....
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....on to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :- (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices: Provided further that if the 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) Wh....
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.... 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 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 which the respective parties to the transactions operate, including the geographical location and size of the marke....
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....ist 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." 6.3.2 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Triology E-business Software India Pvt. Ltd.(supra), we hold the aforesaid 6 companies listed at para 6.1 of this order should be excluded from the list of comparable companies as their turnover is in excess of Rs. 200 Crores. The Assessing Officer is accordingly directed to re-compute the arithmetic mean of the comparable companies after excluding the aforesaid 6 companies from the list of comparables. 7. Related Party Transactions exceeding 15%. 7.1 In respect of the following 3 comparable companies selected by the TPO, the learned Authorised Representative of the assessee has objected to their inclusion in the list of comparables on the grounds of that their RPT is in excess of 15%. Th....
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.... decision of the Tribunal in the case of 24 X 7 Customer.Com Pvt. Ltd. in ITA No.227/Bang/2010, followed by this Tribunal in the case of Logica Private Ltd. (supra) wherein it was held that where the RPT exceeds 15%, such companies should not be taken as comparable companies. Following the said decision, we hold that companies at Sl.Nos. 1 & 2 & 19 referred to above of the list of the comparable companies chosen by the TPO be excluded from the list of comparable companies while working out the ALP." There is no dispute that RPT filter in the case of Megasoft Ltd. was 17.08%, that of Aztech Software Ltd. was 17.78% and that of Geometric Software Ltd. was 19.34%. Coordinate Benches of the Tribunal are consistently following 15% as cut off mark for applying the RPT filter. Accordingly, we direct exclusion of Megasoft Ltd., Aztech Software Ltd. and Geometric Software Ltd. from the comparables." 7.3 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (supra), we hold that the aforesaid three companies listed at para 7.1 of this order be excluded from the list of comparables. 8. Improper Selection of Comparables....
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..... was considered as a software product company in both Trilogy e-business(supra) as well as EMC Data (supra). In these decisions, a host of companies, inter alia, including KALS Information Systems Ltd. were deliberated upon and held as under:- "12. The following were the relevant observations of the Tribunal on the aforesaid comparable companies in the case of Triology E-Business Software India Pvt.Ltd.(supra): "(d) KALS Information Systems Ltd. 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 Q 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 Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being ....
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....ssee submitted the company profile and its annual report for financial year 2005-06 from which the DRP noted that the business activities of the company were 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 therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from t....
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....tentions for exclusion of this company as was made in the case of KALS Information Systems Ltd. (supra). Ld. DR also raised similar objections. We find that Accel Transmatics Ltd. has also been considered as a software product company by this Tribunal in the decisions cited at para 8.7.2 above. Relevant part of the decision has been reproduced by us therein. Accordingly, we direct that Accel Transmatics Ltd. be excluded from the comparables. 8.9 Tata Elxsi Ltd.: Ld. AR submitted that this company was engaged in research & development which resulted in creation of Intellectual Property Rights and therefore was a software product company. Reliance was placed on the decision of coordinate Bench of the Tribunal in the case of EMC Data (supra). 8.9.1 Per contra, the ld. DR submitted that Tata Elxsi Ltd. was not a software product company, but was engaged only in development of software. 8.9.2 We have heard the rival contentions. Whether Tata Elxsi Ltd. could be considered as a software development company was one of the issues which came up for consideration before the this Tribunal in the case of EMC Data (supra), wherein it was held as under:- "17. As far as comparable at Sl....
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....ell. We therefore direct that Tata Elxsi Ltd. be excluded from the comparables." 8.2.3 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. for Assessment Year 2006-07 (supra), we hold that the above mentioned three companies i.e. i) KALS Information Systems Ltd. ii) Tata Elxsi Ltd. (Seg). and iii) Accel Transmatics Ltd. (Seg.) should be excluded from the TPO's final list of comparables. The Assessing Officer is directed to re-compute the ALP of the assessee's international transactions after excluding these three companies. 8.4 R. Systems International Ltd. (Segmental). 8.4.1 In the proceedings before us, the learned Authorised Representative submitted that this company should be excluded from the list of comparable companies as it is functionally different from the assessee and not comparable to it. 8.4.2 This company was selected as a comparable company by the TPO, based on information collected in response to requisition made under Section 133(6) of the Act and on the basis of statements made in this company's Annual Report. As per the reply submitted by this company to the information called for ....
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....ices company like the assessee and pleaded for its exclusion from the list of comparable companies. 8.4.5 Per contra, the learned Departmental Representative pointed out that the product development cost of Rs. 45.07 lakhs shown in the fixed assets constitutes only a miniscule portion of the fixed assets which aggregate to about Rs. 14 Crores and it is inconceivable that such a product could have generated revenues of Rs. 79.41 Crores to the company. The learned Departmental Representative further pointed out that this company itself has categorized revenue of Rs. 79.41 Crores out of its total revenues of Rs. 88.59 Crores as 'Software Development and Customisation Services' in the segmental information furnished along with its final accounts. It was also pointed out that no revenue from product sale in the form of license fee was shown by this company and therefore it is factually incorrect to say that the entire revenue under this head is derived from license fee. Further, the description of transactions as reported in Annexure D to the accounts indicate that the company is primarily engaged in software development services. The learned Departmental Representative also referred t....
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....s inclusion by the TPO in the list of comparables cannot be faulted. This finding of ours is in tune with the decisions in transfer pricing appeals decided by the coordinate benches of this Tribunal, wherein the status of this company as being a software development services entity was not disputed. In this view of the matter, we uphold the inclusion of this company as a comparable company by the TPO and consequently dismiss the assessee's grounds raised in this appeal in this regard. 9. Accordingly, the grounds raised by the assessee at S. Nos. 1 to 7 in respect of transfer pricing issues stand disposed off as indicated above. CORPORATE TAX ISSUES 10. Ground Nos. 8 & 9 : Deduction u/s. 10A of the Act. 10.1 The assessee challenges the action of the authorities below (i.e. the Assessing Officer and the DRP) in excluding expenses incurred in foreign currency towards freight, telecommunication, insurance, etc. from export turnover while computing the deduction under Section 10A of the Act. Without prejudice to its contention that the aforesaid sums should not be excluded from the export turnover, while computing the deduction under Section 10A of the Act, the assessee has also....