TaxTMI 
TaxTMI 
2015 (6) TMI 979
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...., Mindtree Ltd., Persistent Systems Ltd., Sasken Communication Technologies Ltd., Tata Elxsi Ltd. and Wipro Limited as comparables. 3. The learned CIT(A) in the facts and circumstances of the case erred in excluding the comparable company M/s Celestial Biolabs Ltd. on the basis of high profit margin. 4. The ld. CIT(A) erred in rejecting the diminishing revenue filter used by the TPO to exclude companies that do not reflect the normal industry trend. 5. The ld. CIT(A) erred in not appreciating that the different year ending filter applied by the TPO is necessary to exclude companies which do not have the same or comparable financial cycle as the tested party. 6. The ld. erred in rejecting the employee cost filter applied by the TPO to select companies which are predominantly into software development services and thereby including M/s Indus Networks Ltd. as a comparable. 7. The learned CIT(A) in the facts and circumstances of the case erred in holding that M/s. Avani Cincom Technologies can be taken as a comparable. 8. The learned CIT(A) in the facts and circumstances of the case erred in holding that M/s KALS Informations System....
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....rability analysis using non contemporaneous data conducted by the TPO and further substituting the Appellant's analysis with fresh benchmarking analysis on his own conjectures and surmises. Thus, the Appellant prays that the fresh benchmarking analysis conducted by the TPO is liable to be quashed. 4 Comparability Analysis adopted by the TPO for determination of arm's length price a) The AO/TPO grossly erred on facts and the CIT(A) erred in confirming the benchmarking of transactions of software development services of the Appellant with companies operating as full fledged entrepreneurs without considering the differences in the functions performed, assets employed and risk undertaken by the Appellant vis-à-vis comparable companies. b) The AO/TPO erred in law in applying arbitrary filters to arrive at a fresh set of companies as comparable to the Appellant, without establishing functional comparability and the Ld.CIT(A) also erred in confirming the same. c) The AO/TPO erred on facts in arbitrarily rejecting companies having onsite revenues more than 75% of total sales and the Ld.CIT(A) also erred in confirming the same. d) The AO/TPO grossly erred in law in dev....
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.... adjustments, (c) marketing expenditure adjustment, (d) research and development expenditure adjustment and (e) risk profile between the Appellant and the comparable companies. The Ld. CIT(A) erred in confirming the findings of the TPO/AO and not commenting on the depreciation adjustment claimed by the Appellant. 7 Variation of 5% from the arithmetic mean The AO/TPO erred in law and the Ld. CIT(A) erred in not granting the variation as per the proviso to Section 92C(2) of the Act. 8 Interest under section 234B of the Act On the facts, and circumstances of the case, and in law, the learned CIT(A) erred in not directing the learned AO on the specific ground taken in appeal that the learned AO had erred in levying interest under section 234B. 4. The assessee has also filed an additional ground of appeal which reads as follows:- "1. The lower authorities have erred in selecting Quintegra Solutions Ltd, Bodhtree Ltd, Thirdware Solutions Ltd and Lucid Software Ltd as comparables despite them being functionally different from the Appellant." 5. In the application for admission of additional ground, the assessee has submitted that the assessee did not object to the afo....
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....companies, having an average net cost plus margin of 14.53% as against that of 11.01% of the Appellant. Since the Appellant's margin was in the 5% (as provided in the second proviso to section 92C(2) of the Act) range of the arithmetical mean of the comparables, the international transactions of the Appellant were claimed by the Assessee to be at arm's length. 10. The financial results of the assessee in its software development services segment were as follows:- Description Amount (Rs.) Operating revenues 669498745 Operating Expenditure (*) 603081554 Operating Profit 66417191 OP/TC 11.01% 11. Further to the above, the TPO issued a show-cause notice dated 14 October 2011, proposing to: a) reject 11 out of 20 comparable companies identified by the Appellant in the TP Study; b) select 17 new companies and proposed to compare the same with the Appellant; c) determine the arm's length margin of 32.07% (working capital adjustment not provided); and d) proposed a transfer pricing adjustment to the international transactions to the tune of Rs. 126,991,063. 12. In response to the above, the Appellant made detailed submissions on ....
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.... Arithmetic mean PLI 23.65% Less: Working capital Adjustment(Annexure-C) 1.01% Adj.Arithmetic mean PLI 22.64% Arm's Length Price: Operating Cost Rs.603091554 * Arms Length Margin 22.64% of the operating cost Arms Length Price (ALP) At 122.64% of operating cost Rs.739610218 * excluding Exchange loss, financial expenses 23.7 Price received vis-à-vis the Arms Length Price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length Price as under: Arms Length Price (ALP) At 122.64% of operating cost Rs. 739619218 Price charged in the international transactions Rs. 669498745 Shortfall being adjustment u/s.92CA Rs.3,43,55,770 The above shortfall of Rs. 3,43,55,770/- is treated as transfer pricing adjustment u/s 92CA." 17. Aggrieved by the aforesaid order of the AO, the assessee filed appeal before the CIT(Appeals). The CIT(Appeals) accepted some of the contentions put forth by the assessee with regard to the application of turnover filter, high profit margin, etc. and excluded 10 of the comparables chosen by the TPO. As a result o....
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....ssessee has filed the appeal before the Tribunal. 20. We have heard the submissions of the ld. counsel for the assessee and the ld. DR. The ld. DR besides relying on the order of CIT(A) in support of the grounds of appeal raised by the assessee in its appeal, relied on the grounds raised by the Revenue in its appeal so far as it relates to appeal by the Revenue. 21. The ld. counsel for the assessee filed before us a chart showing as to how companies retained by the CIT(A) have to be accepted and also showing as to how some of the comparable companies included by the CIT(A) are validly excluded based on the decisions rendered by the Tribunal in several cases. We shall deal with this argument by taking up individual companies chosen by the TPO and excluded by the CIT(Appeals). 16. (1) Avani Cincom Technologies Ltd. (2) KALS Information Systems Ltd. (3) Celestial Labs Ltd. The comparability of these companies with a software development service provider such as the assessee was considered in several decisions of the ITAT. These have been listed in the chart filed by the assessee before us. We, however, find that making a reference to all those decisions will not be o....
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.... 2007-08) to the period under consideration (i.e. Assessment Year 2008-09). In support of this contention, it was submitted that :- (i) The extract from the Website of the company clearly indicates that it is primarily engaged in development of software products. The extract mentions that this company offers customised solutions and services in different areas; (ii) The Website of this company evidences that this company develops and sells customizable software solutions like "DX Change, CARMA, etc. 7.4 The learned Authorised Representative submitted that a co-ordinate bench of the Tribunal in its order in Curram Software International Pvt. Ltd., in its order in ITA No.1280/Bang/2012 dt.31.7.2013 has remanded the matter back to the file of the Assessing Officer / TPO to examine the comparability of this company afresh, by making the following observations at paras 9.5.2 and 9.5.3 thereof :- " 9.5.2 As regards the submission of the learned Authorised Representative, we are unable to agree that this company has to be deleted from the list of comparables only because it has been deleted from the set of comparables in the case of Trilogy E-Business Software India Pvt. Lt....
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....) of the Act and to afford the assessee adequate opportunity of being heard and to make its submissions in the matter, which shall be duly considered before passing orders thereon. It is ordered accordingly." The learned Authorised Representative submits that this company was selected as a comparable by the TPO not by any FAR analysis or as per the search process conducted by the TPO, but only as an additional comparable for the reason that it was selected as a comparable in the earlier year i.e. Assessment Year 2007-08 on the basis of information obtained under section 133(6) of the Act. In this regard, the learned Authorised Representative took us through the relevant portions of the TP order under section 92CA of the Act and the show cause notices for both the earlier year i.e. Assessment Year 2007-08 and for this year and contended that the selection of this company as a comparable violates the principle enunciated in Curram Software International Pvt. Ltd. (supra) that a company can be selected as a comparable only on the basis of FAR analysis conducted for that year and therefore pleaded for its exclusion. The learned Authorised Representative also submitted that he has....
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.... assessee's own case for Assessment Year 2007-08 in ITA No.845/Bang/2011 dt.22.2.2013, and in the case of Trilogy EBusiness Software India Pvt. Ltd. (ITA No.1054/Bang/2011), we direct the A.O./TPO to omit this company from the list of comparables." ........ "9. Celestial Biolabs Ltd. 9.1 This comparable was selected by the TPO for inclusion in the final list of comparables. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables for the reasons that it is functionally different form the assessee and that it fails the employee cost filter. The TPO, however, brushed aside the objections raised by the assessee by stating that the objections of functional dissimilarity has been dealt with in detail in the T.P. order for Assessment Year 2007- 08. As regards the objection raised in respect of the employee cost filter issue, the TPO rejected the objections by observing that the employee cost filter is only a trigger to know the functionality of the company. 9.2 Before us, the learned Authorised Representative contended that this company is not functionally comparable, as the company is into bio-informatics software product / se....
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....erused and carefully considered the material on record. While it is true that the decisions cited and relied on by the assessee were with respect to the immediately previous assessment year, and there cannot be an assumption that it would continue to be applicable for this year as well, the same parity of reasoning is applicable to the TPO as well who seems to have selected this company as a comparable based on the reasoning given in the TPO's order for the earlier year. It is evidently clear from this, that the TPO has not carried out any independent FAR analysis for this company for this year viz. Assessment Year 2008-09. To that extent, in our considered view, the selection process adopted by the TPO for inclusion of this company in the list of comparables is defective and suffers from serious infirmity. 9.4.2 Apart from relying on the afore cited judicial decisions in the matter (supra), the assessee has brought on record substantial factual evidence to establish that this company is functionally dissimilar and different from the assessee in the case on hand and is therefore not comparable and also that the findings rendered in the cited decisions for the earlier years i.e. ....
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....ompany as a comparable has been upheld by co-ordinate benches of the Tribunal in the case of - Trilogy E-Business Software India Pvt. Ltd. (ITA No.1054/Bang/2011). LG Soft India Pvt. Ltd. (IT (TP) A No.112/Bang/2011) CSR India Pvt. Ltd. (IT (TP) A No.1119/Bang/2011) and Transwitch India Pvt. Ltd. (IA No.6083/Del/2010) (iv) The facts pertaining to this company has not changed from Assessment Year 2007-08 to Assessment Year 2008-09 and therefore this company cannot be considered for the purpose of comparability in the case on hand and hence ought to be excluded from the list of comparables. In support of this contention, the learned Authorised Representative drew our attention to various parts of the Annual Report of this company. (v) This company is engaged not only in the development of software products but also in the provision of training services as can be seen from the website and the Annual Report of the company for the year ended 31.3.2008. (vi) This company has two segments; namely, a) Application Software Segment which includes software product revenues from two products i.e. 'Virtual Insure' and 'La-Vision' and b) The Training segment which does no....
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....e companies. 18. Bodhtree Consulting Ltd. : As far as this company is concerned, the Mumbai Tribunal in the case of Nethawk Networks India (P.) Ltd. v. ITO, ITA No.7633/Mum/2012 for A.Y. 2008-09, order dated 6.11.2013, held that this company is not functionally comparable with a software development service provider. Following were the relevant observations of the Tribunal in this regard:- "C. Bodhtree Consulting Limited 21. On this comparable, case of the assessee is that the company is not a good comparable in view of the software products produced by the company. As such, no segmental data is adequately available too. 22. On the other hand, Ld DR filed a copy of the financial statement and argued vehemently stating that this company is not engaged in the software products. In this regard, Ld DR relied on the note no.3, relating to the relating to the revenue recommendation in Schedule 12, note no.5 relating to the segmental information etc to mention that the company is engaged in the software development only. However, the assessee argued vehemently stating that this company is engaged in the software based products. Further, Ld Counsel mentioned that the said....
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.... goes against the TPO/AO. Accordingly, we dismiss the argument of the Ld DR in this regard. Ex consequenti, the AO/TPO is directed to exclude the same from the list of final comparables for working out the arithmetic mean." 19. Respectfully following the aforesaid decision of the ITAT Mumbai Bench of the Tribunal, we hold that the aforesaid company be excluded from the list of comparable companies. 20. (1) E-Zest Solutions Ltd. (2) Quintegra Solutions Ltd. As far as these companies are concerned, this Tribunal in the case of 3DPLM Software Solutions Pvt. Ltd. (supra) held as follows:- "14. E-Zest Solutions Ltd. 14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the information received in response to notice under section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company o....
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....me under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I-Q Information Systems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O. / TPO is accordingly directed. 18. Quintegra Solutions Ltd. 18.1 This case was selected by the TPO as a comparable. Before the TPO, the assessee objected to the inclusion of this company in the set of comparables on the ground that this company is functionally different and also that there were peculiar economic circumstances in the form of acquisitions made during the year. The TPO rejected the assessee's objections holding that this company qualifies all the filters applied by the TPO. On the issue of acquisitions, the TPO rejected the assessee's objections observing that the assessee has not adduced any evidence as to how this event had ....
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....nder consideration. 18.3 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables to the assessee for the period under consideration. 18.4 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details brought on record that this company i.e. Quintegra Solutions Ltd. is engaged in product engineering services and is not purely a software development service provider as is the assessee in the case on hand. It is also seen that this company is also engaged in proprietary software products and has substantial R&D activity which has resulted in creation of its IPRs. Having applied for trade mark registration of its products, it evidences the fact that this company owns intangible assets. The co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010 dt.9.11.2012) has held that if a company possesses or owns intangibles or IPRs, then it cannot be considered as a comparable company to one that does not own intangibles and requires to be omitted form the list of comparables, as in the case on hand. 18....
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....h 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 made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:- "Size criteria in terms of Sales, Assets or Number of Employees: The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the buyer and seller and therefore comparability." 12. The ICAI TP Guidelines note on this aspect lay down in para ....
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.... 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 particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study." 15. It was brought to our notice that the above proposition has also been followed by the Honourable Bangalore ITAT in the following cases: 1. M/s Kodiak Networks (India) Pri....
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.... (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 subsection (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) 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 infor....
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....elation 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 markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction if- (i) non....
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....) 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." 24. Respectfully following the aforesaid decision, we direct the aforesaid companies be excluded from the list of comparables. 25. Tata Elxsi Ltd.: Comparability of this company was considered by this Tribunal in the case of 3DPLM Software Solutions Ltd. (supra) and it was held as under:- "13. Tata Elxsi Ltd. 13.1 This company was a comparable selected by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables on several counts like, functional dis-similarity, significant R&D activity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of comparables. 13.2 Before us it was reiterated by the learned Authorised Representative that this company is not functionally comparable to the assessee as it performs a variety of functions under software development and services segment namely - a) product design, (b) innovation design engineering and ....
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.... :- " .... Tata Elxsi is engaged in development of niche product and development services which is entirely different from the assessee company. We agree with the contention of the learned Authorised Representative that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company as fit for comparability analysis for determining the arm's length price for the assessee, hence, should be excluded from the list of comparable portion." As can be seen from the extracts of the Annual Report of this company produced before us, the facts pertaining to Tata Elxsi have not changed from Assessment Year 2007-08 to Assessment Year 2008-09. We, therefore, hold that this company is not to be considered for inclusion in the set of comparables in the case on hand. It is ordered accordingly." 26. Wipro Ltd.: As far as this company is concerned, this Tribunal in the case of 3DP....
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.... contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison. 12.5 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010) has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any such intangible and hence does not have an additional advantage in the mar....
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....3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the case of E-Gain Communications Pvt. Ltd. (supra) has directed that since the income of this company includes income from sale of licenses, it ought to be rejected as a comparable for software development services. In the case on hand, the assessee is rendering software development services. In this factual view of the matter and following the afore cited decision of the Pune Tribunal (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand. 16. Lucid Software Ltd. 16.1 This company was selected as a comparable by the TPO. Before us, the assessee has objected to the inclusion of this company as a comparable on the grounds that it ....
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....software development services. We also find that, co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 (IT(TP)A No.845/Bang/2011), LG Soft India Pvt. Ltd. (supra), CSR India Pvt. Ltd. (supra); the ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt. Ltd. (supra) and the Delhi ITAT in the case of Transwitch India Pvt. Ltd. (supra) have held, that since this company, is engaged in the software product development and not software development services, it is functionally different and dis-similar and is therefore to be omitted from the list of comparables for software development service providers. The assessee has also brought on record details to demonstrate that the factual and other circumstances pertaining to this company have not changed materially from the earlier year i.e. Assessment Year 2007-08 to the period under consideration i.e. Assessment Year 2008-09. In this factual matrix and following the afore cited decisions of the co-ordinate benches of this Tribunal and of the ITAT, Mumbai and Delhi Benches (supra), we direct that this company be omitted from the list of comparables for the period under consideration in t....
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....y be taken into account for comparability analysis. This principle is squarely applicable to the company presently under consideration, which is into product development and product design services and for which the segmental data is not available. The learned Authorised Representative prays that in view of the above, this company i.e. Persistent Systems Ltd. be omitted from the list of comparables. 17.3 Per contra, the learned Departmental Representative support the action of the TPO in including this company in the list of comparables. 17.4 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details / information a company cannot be taken into account....
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....the company has export sales of less than 25% of the total sales is on an erroneous basis. We therefore, hold that this company should be taken as a comparable as there is no other basis for rejecting this company as comparable assigned by the TPO." 34. Indium Software (India) Ltd.: This company was also rejected by the TPO and the CIT(A) confirmed the same on the ground that this company fails the export revenue filter. It has been pointed out before us by the ld. counsel for the assessee that export turnover filter of this company was 37.77% of its total turnover and therefore this company passes the export revenue filter of more than 25% of the turnover and has to be regarded as a comparable. 35. We therefore are of the view that it would be just and proper to direct the TPO to consider the aforesaid claim of the assessee and if found correct, to include the above two companies as a comparable. 36. Now, we shall deal with the specific grounds raised by the Revenue. As far as ground No.2 is concerned, we have already given reasons as to why size and turnover was a relevant criterion for choosing companies as a comparable. The decisions referred to while deciding the relevan....