TaxTMI 
TaxTMI 
2015 (5) TMI 148
X X X X Extracts X X X X
X X X X Extracts X X X X
.... adopted by the Appellant and thereby making a transfer pricing adjustment of Rs. 3,61,96,655/- to the income of the Appellant by holding that the international transaction of provision of software development services of the Appellant does not satisfy the aim's length principle envisaged under the Income-tax Act, 1961 ('the Act'). Ground No.2: Erroneous treatment of Foreign Exchange gain/loss * The Ld. AO/Ld. Transfer Pricing Officer ('Ld.TPO') erred in considering foreign exchange loss/gain as operating cost/income while computing the operating margins of the comparables for computation of the arm's length price of the transaction of provision of software development service. * The Hon'ble DRP erred in interpreting the appellant's objection towards treatment of foreign exchange gain/loss as objection to consider foreign exchange gain/loss as operating, whereas the Appellant had objected to the treatment of the same as operating item, as considered by the Ld.AO/Ld. TPO. In doing so, the Hon'ble DRP erred in confirming the transfer pricing adjustment, though it has "in-principle" agreed to the objection of the Appellant that foreign exch....
X X X X Extracts X X X X
X X X X Extracts X X X X
....g the functionally comparable E-Infochips Ltd., which was duly approved as a comparable by the Hon'ble DRP for the AY 2008-09, on the basis of erroneous reasoning that the year under consideration is an exceptional year based on its financial results; 4.4. rejecting the functionally comparable Avani Cimcon Technologies Ltd. ('Avani'), based on erroneous reason, i.e. unavailability of audited annual accounts for the Financial Year ('FY') 2008-09, despite the fact that the available audited financials for FY 2009-010 had all the financial details pertaining to FY 2008-09; 4.5. rejecting the functionally comparable Software Services Segment of Sasken Communications Ltd., on the erroneous basis of business restructuring of its non comparable segment; 4.6. rejecting the following functionally comparable companies by applying the turnover filter of Rs. 2 to Rs. 200 crores, without giving any opportunity to the Appellant, of being heard: * Persistent Systems Ltd., * IT Services Segment of Mindtree Ltd., and * Larsen and Toubro Infotech Ltd.; 4.7. rejecting a functionally comparable RS Software Ltd. based on earlier year's disposition by the ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....liday under section 10A of the Act on its profits derived from the software development services and therefore would not have any untoward motive of deriving a tax advantage by manipulating transfer prices of its international transactions. The above grounds are without prejudice to each other. Your Appellant craves leave to add, amend, alter, modify and/or substitute, and to withdraw the above grounds of appeal." 3. In this appeal, assessee has raised multiple Grounds of Appeal as aforestated but the sum and substance of the dispute arises from an addition of Rs. 3,61,96,655/- made to the returned income on account of determination of the arm's length price of assessee's international transactions entered with its associated enterprises. 4. The appellant is a company incorporated under the provisions of the Companies Act, 1956 and is a wholly owned subsidiary of TIBCO US. The assessee company is primarily engaged in providing software research and development services to TIBCO US as per the design, production orders, plans, process specification and production schedules provided by the TIBCO US. The unit of the assessee is registered as a 100% Export Oriented U....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... (in short "the DRP") dated 09.12.2013 which were rendered in response to assessee raising objections to the draft assessment order passed by the Assessing Officer dated 19.03.2013 which was also in line with the order of the TPO dated 29.01.2013 (supra). In this background, the rival counsels have been heard with respect to the addition of Rs. 3,61,96,655/- made to the returned income on account of the determination of arm's length price. 5. At the time of hearing, it was a common point between the parties that the substantive issues in this year, which arise from the order of the TPO dated 29.01.2013 (supra) are primarily similar to those considered by the Tribunal in the assessee's own case for the immediately preceding assessment year 2008-09 vide ITA No.2536/PN/2012 dated 11.02.2015. Before we proceed to adjudicate the specific dispute raised before us, it would be appropriate to observe that in its Transfer Pricing Study assessee had benchmarked its international transactions relating to the Provision of software design and development services entered with its associated enterprises by adopting the Transactional Net Margin (TNM) Method. The assessee had used Opera....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t 31.21% (i.e. after working capital adjustment) and compared it with assessee's PLI of 18.72% and accordingly an adjustment of Rs. 3,61,96,655/- has been made to the stated value of the international transactions in order to determine the arm's length price. 8. The aforesaid approach of the TPO is quite pari-materia to the approach adopted by him in the assessee's own case for assessment year 2008-09 (supra). 9. At the time of hearing, in so far as the Ground of Appeal No.1 is concerned, no specific arguments were advanced as it is general in nature. 10. With regard to the issues raised in Ground of Appeal Nos.2 and 3, it was stated that on being approached by the assessee by way of a rectification application, the DRP has passed a rectification order and issued further directions on 06.03.2014 and for the present the said Grounds of Appeal do not require any adjudication. In this background, in so far as the Ground of Appeal Nos.2 and 3 are concerned, they are dismissed as infructuous. 11. The specific arguments put-forth before us at the time of hearing are manifested by the Ground of Appeal No.4 which relates to assessee's stand that the income-tax a....
X X X X Extracts X X X X
X X X X Extracts X X X X
....mparables by the Tribunal in the assessee's own case vide order dated 11.02.2015 (supra). 14. We have carefully considered the rival submissions. In this context, we have perused the order of the Tribunal in the assessee's own case dated 11.02.2015 (supra) wherein the following discussion is relevant :- "23. We have carefully considered the rival submissions. In fact, the TPO has reproduced in para 15.7 the written submissions of the assessee on this aspect. The first plea raised by the assessee was that income earned by the said concern from rendering of application support services and infrastructure management services, which constitute 11% and 15% respectively of the total revenue, are in the nature of IT enabled services and not linked to the software development services. On this basis, it was sought to be pointed out that if the aforesaid income streams are excluded from the segment of software development services, then the income from software development services segment falls below 75% of the total income. The TPO had applied a filter to exclude such concerns from the list of comparables, wherein the income from software development services was less than 7....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e, it deserves to be excluded even on the basis of the filter applied by the TPO. Thus, on this aspect, assessee succeeds." 15. Ostensibly, the Tribunal has excluded the said concern on the ground that its income from software development services was below 75% of the total income. The fact-situation noted by the Tribunal in its order dated 11.02.2015 (supra) continues to hold in the present year also. For this, the Ld. Representative for the assessee has referred to the submissions made before the lower authorities based on the relevant extract of the Annual Report of the said concern placed at pages 1739 to 1742 of the Paper Book. In terms of the aforesaid, it is noticed that the proportionate income of the said concern in various segments is as under :- IT consulting 48%; Infrastructure Management Services 17%; and, E-learning and Digital Consulting 35%. 16. On the basis of the aforesaid, it quite clear that the activities on account of the Infrastructure Management Services and E-learning and Digital Consulting which constitute 17% and 35% respectively of the total revenue are obviously IT enabled services and are not akin to the software desig....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 20. In this context, the following discussion in the order of the Tribunal in the assessee's own case for assessment year 2008-09 dated 11.02.2015 (supra) is relevant :- "10. The first plea of the assessee is with respect to M/s Kals Information System, (applications software segment), a concern which has been included as a comparable by the TPO for the purposes of comparability analysis. According to the assessee, the inclusion of said concern as a comparable is wrong because the said concern is functionally different from the activities undertaken by the assessee in its segment of Provision of software development and design services. As per the assessee, the said concern is engaged in development and sale of software products and such activity is quite different from that of the assessee which relates to rendering of software development services for its customers. Before the TPO, assessee referred to an extract from the Annual Report of the said concern for the financial year 2007-08 to point out that the software development expenditure was reported by the said concern as an element of inventory, which according to the assessee demonstrated that the said concern was a....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 12. On the other hand, the learned CIT-DR has reiterated the stand of the lower authorities by pointing out that mere ownership of software products would not make a concern functionally non-comparable to a software development service provider, who did not own any software product. According to him, such difference is not a material difference contemplated under the TNM method for the purposes of comparability analysis. Apart therefrom, it has been pointed out that the said concern vide a communication dated 13.01.2009 addressed to the Addl.CIT (TP), Hyderabad confirmed that its core business was that of software development service provider. Further, according to the learned CIT-DR even the error in the segmental reporting by the said concern would not alter the bigger picture that it was deriving income mainly from software development service. Accordingly, inclusion of the said concern in the final set of comparables is sought to be defended. 13. We have carefully considered the rival submissions. The pertinent point raised by the assessee is that the said concern is functionally not comparable to the activities undertaken by the assessee on account Provision of software....
X X X X Extracts X X X X
X X X X Extracts X X X X
....is distinct from the software development services rendered by the assessee to its associated enterprise. Thus, we are inclined to uphold the plea of the assessee that the M/s Kals Information System Ltd. (applications software segment) is functionally incomparable to the assessee. 15. The attempt by the learned CIT-DR to support the stand of the TPO on the basis of a communication received by Addl.CIT (TP), Hyderabad regarding Kals Information System Ltd., in our view, is untenable. Ostensibly, such an information was not available in public domain and therefore it could not have been in the realm of consideration by the TPO and moreover, we find that the said assertion is quite contrary to the information available in public domain, namely, the Annual Report, and the website extract of the said concern, which have been pertinently referred to by the assessee. 16. For the aforesaid reasons, we uphold the plea of the assessee for exclusion of M/s Kals Information System Ltd. (applications software segment) from the final set of comparables for the purposes of comparability analysis." 21. Following the aforesaid precedent, we direct the income-tax authorities to exclude M/s....
X X X X Extracts X X X X
X X X X Extracts X X X X
....n is not a consistent loss maker and rather the lower profitability in this year is on account of a normal business cycle and accordingly the said concern cannot be excluded from the final set of comparables. 24. On the other hand, the Ld. CIT-DR appearing for the Revenue has pointed out that the instant assessment year was an exceptional year inasmuch as the said concern has witnessed a substantial drop in its turnover in this year to Rs. 13,30,60,610/- from Rs. 21,03,37,967/- in the immediately preceding year. It has also been pointed out that in this year the said concern has earned an exceptional income by way of sale of units of Rs. 2,90,57,578/- as against a meager income of Rs. 93,31,270/- on this count in the immediately preceding year. It was therefore contended that based on the financial results of the said concern for the instant assessment year, the said concern has not carried out its business in normal circumstances, and its exclusion from the list of comparables is justified. 25. We have carefully considered the rival submissions. In the context of the controversy relating to exclusion of a concern on account of exceptional year, it is to be understood that th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....table to any abnormal business condition which is far removed from the normal business conditions so as to justify its exclusion on the basis of 'exceptional year'. In-fact, the fall in profit margin is attributable to a generic reason, which is applicable to all the industry players and is not specific to the said concern. In any case, there is no case made out by the TPO that the said concern is functionally distinct from the activities being carried out by the assessee. It has also been asserted before us, without controversion from the side of the Revenue, that the said concern has been accepted by the DRP in the assessee's own case for assessment year 2008-09 to be functionally comparable. In the course of hearing, the Ld. Representative also asserted that there has been no change in the business of the profile of the said concern during the year in comparison to preceding assessment year except fall in profit margin. 26. In so far as the plea raised by the Ld. CIT-DR based on the Annual Report is concerned, in our view, it would not be appropriate to compare each and every single item of income and expense in the financial statements in order to measure its com....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... an opportunity of being heard before application of the turnover filter. 30. We have carefully considered the rival submissions. The order of the TPO as well as the show-cause notice issued by him in the course of Transfer Pricing proceedings show that no opportunity was allowed to the assessee before applying the turnover filter. Similar situation has been dealt with by the Tribunal in the assessee's own case for the assessment year 2008-09 vide order dated 11.02.2015 (supra) in the following manner :- "46. We have carefully considered the rival submissions on the above aspect. It is quite evident that at the level of TPO, no opportunity was allowed to the assessee before excluding the aforesaid four concerns from the list of comparables by applying a Turnover limit of Rs. 200 crores. In-fact, the show- cause notice issued by the TPO dated 05.10.2011 did not contain any issue regarding exclusion of the aforesaid four comparables and/or application of Turnover filter of Rs. 200 crores. In-fact, it is also evident from the order of the TPO that no reason has been assigned to adopt the Turnover filter of Rs. 200 crores, especially when no such filter has been applied by th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....12 issued by the TPO another reason has been advanced which is to the effect that the said concern fails the export turnover filter of 75% of the total turnover. 33. The Ld. Representative has assailed both the reasons advanced by the TPO to reject the said concern from the final set of comparables. The Ld. Representative has referred to an extract from the Annual Report of the said concern placed in the Paper Book at page 1742 to point out that the said concern has the following business segments - (i) Telecom Software Services; (ii) Telecom Software Products; (iii) Network Engineering Services; and, (iv) Automotive, Utilities and Industrial. The Ld. Representative pointed out that it is only the Telecom Software Services Segment of the said concern which is comparable to the Provision of software design and development services being undertaken by the assessee for its associated enterprises. It was pointed out that so far as the business restructuring referred by the TPO is concerned, it relates to the segment at item (ii) i.e. Telecom Software Products whereas the segment comparable to the assessee's tested activity is item (i) i.e. Telecom Software Services which has not....
X X X X Extracts X X X X
X X X X Extracts X X X X
....to our direction in Ground of Appeal No.4.6. Thus, on this aspect also assessee succeeds for statistical purposes. 37. By way of Ground of Appeal No.4.7, the plea of the assessee is for inclusion of RS Software India Ltd. in the final set of comparables. The TPO has excluded the said concern from the final set of comparables on the basis of the stand of the DRP in the assessee's own case for earlier assessment year 2008-09. 38. On this aspect, it was a common point between the parties that in assessment year 2008-09 (supra), the Tribunal has upheld the stand of the TPO in excluding M/s RS Software India Ltd. from the final set of comparables. The Ld. Representative for the assessee quite fairly submitted that following the precedent in the assessee's own case, the exclusion of the said concern from the final set of comparables is liable to be affirmed. In view of the decision of the Tribunal dated 11.02.2015 (supra) in the assessee's own case, we hereby affirm the action of the TPO in excluding RS Software India Ltd. from the final set of comparables. Thus, on this aspect assessee fails. 39. By way of Ground of Appeal No.4.8, the plea of the assessee is against....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t plus fixed mark-up by the associated enterprise. In sum and substance, the stand of the assessee is that such a filter cannot be applied to hold Akshy Software Technologies Limited as functionally incomparable. 39. The learned CIT-DR has reiterated the stand of the TPO as well the DRP and pointed out that the business model of providing on-site services at the place of the clients, is not comparable with off-shore rendering of services. 40. We have carefully considered the rival submissions. Factually speaking, Akshy Software Technologies Limited was found by the TPO to be predominantly engaged in rendering services to its client's on on-site basis. As per the TPO, Akshy Software Technologies Limited rendered services at client's site unlike the services being provided by the assessee through off- shore sites. The difference in operating mechanism of two business models is starkly evident. While under the on-site business model, the service provider positions its personnel on the client's site and on the other hand, in the off- shore business model, the service provider positions its personnel on its own site i.e. away from the site of the clients. The TPO in te....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ome' filter also stands on the same footing as relevant data / information are not available in respect of all the companies in the database. It is also a fact that though the TPO has himself not applied this filter by observing that the companies having onsite income or more than 75% cannot be treated as comparables but two of the companies i.e. M/s. Foursoft Limited and Sankya Infotech Limited selected as comparables by the TPO were having onsite income / expenses of more than 75%. In this view of the matter, the CIT(A) was correct in holding that rejection of comparables selected by the assessee by applying this filter is not correct. We also fully subscribe to the view of the CIT(A) that loss making companies and companies having super normal profits cannot be considered as comparables in view of the ratio laid down in case of Mentor Graphics (India) Pvt. Ltd. Vs. DCIT (109 ITD 101) and Philips Software (119 TTJ 721). In aforesaid view of the matter, the companies selected by the CIT(A) as comparables is rational and appropriate in the facts of the present case. We therefore uphold the order of the CIT(A) in directing the Assessing Officer to compute the arithmetic mean of ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....assessee's financial year under consideration is for the period 01.04.2008 to 31.03.2009 whereas the data of the said concern available in public domain is of a different financial year i.e. from 01.04.2008 to 30.09.2009, which comprises of a period of 18 months. In this factual background, we find no error in the approach of the TPO in excluding the said concern from the list of comparables because the financial data of the said concern available in public domain does not correspond to the financial year of the assessee under consideration. Ostensibly, rule 10B(4) of the Income Tax Rules, 1962 (in short "the Rules") provide that the data to be used in analyzing the comparability of an uncontrolled transaction with the international transaction shall be the data relating to the financial year in which the international transactions have been entered into. Quite clearly, in the present situation, the financial data of Helios and Matheson Ltd. available in public domain does not conform to the financial year in which the international transactions in question have been carried out by the assessee. Therefore, the TPO justifiably excluded the said concern from the final set of comp....
X X X X Extracts X X X X
X X X X Extracts X X X X
....sessee in the Transfer Pricing Study itself and therefore there was no justification for the assessee to seek its exclusion at this stage. 46. We have carefully considered the rival submissions. Ostensibly, the controversy as to whether abnormal profit-making concerns ought to be excluded from the list of comparables or not, has been a subject matter of consideration by the Special Bench of the Tribunal in the case of Maersk Global Centres (India) Private Ltd. Vs. ACIT vide ITA No.7466/Mum/2012 dated 07.03.2014. The relevant observations of the Special Bench are as under :- "In generality, we are of the view that the answer to this question will depend on the facts and circumstances of each case inasmuch as potential comparable earning abnormally high profit margin should trigger further investigation in order to establish whether it can be taken as comparable or not. Such investigation should be to ascertain as to whether earning of high profit reflects a normal business condition or whether it is the result of some abnormal conditions prevailing in the relevant year. The profit margin earned by such entity in the immediately preceding year/s may also be taken into considera....
X X X X Extracts X X X X
X X X X Extracts X X X X
....Global Centres (supra) had an occasion to deal with the question as to whether high profit margin making companies should be excluded as a comparable. The Special Bench after considering several aspects held in para 88 of its order that the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special bench held that in such cases it would require further investigation to ascertain the reasons for unusually high profit and in order to establish whether the entities with such high profits can be taken as comparable or not. In the light of the aforesaid decision of the Special Bench and in view of the admitted position that the assessee follows Fixed Price Project model where revenues from software development is recognized based on software developed and billed to clients, there is a possibility of the expenditure in relation to the revenue being booked in the earlier year. The results of Bodhtree from FY 2003 to 2008 excluding FY 2007 as given by the learned counsel for the assessee were also perused. Perusal of the same shows, that there has been a consistent change in the operating margins. The chart filed by the asses....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... from the final list of comparables notwithstanding the fact that assessee had initially considered it as a comparable. 17. In our considered opinion, the plea of the assessee for exclusion of Bodhtree Consulting Ltd. from the final list of comparables cannot be shut out merely because the said comparable has been adopted by the assessee in its Transfer Pricing Study. So however, the aforesaid proposition is not an absolute proposition. In other words, it would be imperative for the assessee to justify exclusion of a concern from the list of comparables if in the initial Transfer Pricing Study undertaken by it, such a concern has been adopted as a comparable. In the present situation, case has been set up by the assessee for exclusion of Bodhtree Consulting Ltd on the ground that the profit margins of the said concern are fluctuating widely and are abnormally high for the period under consideration. Ostensibly, the financial data of the succeeding years which has been pressed into service by the assessee to demonstrate abnormal profit trends of the said concern was not available with the assessee at the time of carrying out its Transfer Pricing Study. Therefor....