TaxTMI 
TaxTMI 
2015 (11) TMI 1719
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....umentation regarding its software development activity:- The assessee earned an OP/TC of 14.60 percent for FY 2008-09, with respect to the provision of software development services to its AEs. As the OP/TC of 14.60 percent was higher than the average OP/TC earned by comparable companies identified in the transfer pricing report, it was concluded that the international transactions were at arm's length. 5. The comparable companies selected by the TPO in his TP order for the AY 2009-10 are as follows:- 6. The arm's length price (ALP) worked out by the TPO was as under:- 7. Aggrieved by the order of the lower authorities, the assessee is in appeal before us on the following grounds of appeal:- "1. The learned Assessing Officer ("AO"), the learned Deputy Commissioner of Income Tax (Transfer Pricing Officer - II), Bangalore ("Transfer Pricing officer" or "TPO") and the Honourable Commissioner of Income Tax (Appeals) ("Hon'ble CIT (A)") have erred in law and facts of the case in proposing a transfer pricing adjustment under section 92CA of the Income-tax Act, 1961 ("the Act") amounting to Rs. 91,03,983/- in relation to the provision of software development ser....
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.... of company Sales (in Rs.) Cost (in Rs.) Margin 1 Kals Information System Ltd. 2,14,04,686 1,87,93,813 13.89% 2 Akshay Software Technologies Ltd. 12,23,21,483 11,31,49,350 8.11% 3 Bodhtree Consulting Ltd. 16,05,75,212 9,89,56,821 62.27% 4 R S Software (India) Ltd. 1,49,57,12,634 1,36,01,02,589 9.97% 5 Tata Elxsi Ltd. (Seg.) 3,78,43,03,000 3,14,63,15,000 20.28% 6 Sasken Communication Technologies Ltd. 4,05,31,20,000 3,18,69,97,000 7.91% 7 Persistent Systems Ltd. 5,19,69,10,000 3,67,52,70,000 41.40% 8 Zylog Systems Ltd. 7,34,93,51,475 6,81,69,98,160 7.81% 9 Mindtree Ltd. (Seg.) 7,93,22,79,326 5,74,06,73,058 5.52% 10 Larsen & Toubro Infotech 19,50,83,81,374 15,64,12,76,626 24.72% 11 Infosys Ltd. 2,02,64,00,00,000 1,39,17,00,00,000 45.61% AVERAGE MEAN 24.32% 9. With respect to Sl.Nos.5, 6, 7, 8, 9, 10 & 11 of the final list of comparables selected by the TPO, the ld. counsel for the assessee pleaded that these comparables have to be rejected since the....
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.... therefore comparability." 12. The ICAI TP Guidelines note on this aspect lay down in para 15.4 that 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. The fact that they operate in the same market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: "Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a Rs. 1,000 crore company cannot be compared with the transaction entered into by a Rs. 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate." 13. It was further submitted that the TPO's range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs....
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.... proposition has also been followed by the Honourable Bangalore ITAT in the following cases: 1. M/s Kodiak Networks (India) Private Limited Vs. ACIT (ITA No.1413/Bang/2010) 2. M/s Genesis Microchip (I) Private Limited Vs. DCIT (ITA No.1254/Bang/20l0). 3. Electronic for Imaging India Private Limited (ITA No. 1171/Bang/2010). It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee. 16. 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. 17. 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 enterpr....
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.... 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 the basis of such material or information or document available with him:" 18. Rule 10B of the IT Rules, 1962 prescribes rules for Determination of arm's length price under section 92C:- "10B. (1) For the purposes of sub-section (2) of section 92....
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....hical 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) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relat....
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....Ltd.; Zylog Systems Ltd.; Mindtree Ltd.; Larsen and Toubro Infotech (Seg.) and Infosys Technologies Ltd., are directed to be excluded from the list of comparables chosen by the TPO. 12. With respect to KALS Information Systems Ltd., the ld. counsel for the assessee stated that the assessee had accepted the same as a comparable before the CIT(Appeals), but it is now sought to be rejected as a comparable on the ground that it is functionally dissimilar. It was also contended that the company is into development of software products and there is presence of significant inventory. The ld. counsel for the assessee relied on the decision of CISCO Systems (India) Pvt. Ltd. in IT(TP)A No.271/Bang/2014, order dated 14.08.2014, wherein it was held as follows:- 26.3 KALS Information Systems Ltd.:- As far as this company is concerned, it is not in dispute before us that this company has been considered as not comparable to a pure software development services company by the Bangalore Bench of the Tribunal in the case of M/s. Trilogy e-business Software India Pvt. Ltd. (supra). The following were the relevant observations of the Tribunal:- "(d) KALS Information Systems Ltd.....
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....o by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable." 13. Following the aforesaid decision of the Tribunal in the case of CISCO Systems (India) Pvt. Ltd. (supra), we are of the opinion that KALS Information Systems Ltd. is functionally dissimilar to that of the assessee and hence it is not to be regarded as a comparable. 14. With respect to Bodhtree Consulting Ltd., the CIT(Appeals) had accepted the same as a comparable. The CIT(Appeals) relied on the decision of the Bangalore Bench decision in the case of Trilogy E-Business Software India (P.) Ltd. (supra) and 24/7 Customer.com (P) Ltd. 28 taxmann.com 258 (Bang). The CIT(A) observed that in the above decisions it has been made clear that there is no bar in considering companies with abnormal profits/losses as comparables unless the assessee demonstrates and establishes that some abnormal event took place which led to abnormal results. Hence, the CIT(A) rejected the contentions of the assessee for exclusion o....
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.... the Tribunal, we hold that Bodhtree Consulting Ltd. cannot be regarded as a comparable. In this regards, the fact that the assessee had itself proposed this company as comparable, in our opinion, should not be the basis on which the said company should be retained as a comparable, when factually it is shown that the said company is a software product company and not a software development services company. 17. In the case of Ciena India Pvt. Ltd. (supra), the Delhi Bench of the Tribunal with respect to mismatch in the revenue cost held as under:- "9.6 Coming back to the facts of the instant case, we find from Schedule 12 that there is a mention of Significant accounting policy at Sl. no.3, which provides that : "Revenue from software development is recognized based on software development and billed to clients." If some software development project is incomplete at the end of the year, this Note may entail two situations , viz., the first, in which the expenses incurred in respect of such software development may be capitalized, which appears to be a more rational manner of depicting the true and fair view of the profitability of the enterprise; and the second, i....
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.... Bodhtree Consulting Ltd. is to be excluded from the list of comparables selected by the TPO. 19. With respect to Akshay Software Technologies Ltd. and R.S. Software (India) Ltd., no objection has been raised by the assessee even before us. Hence these two companies are to be retained as comparables. 20. The ld. counsel for the assessee thereafter stated that market risk adjustment should be allowed and argued that the comparable companies selected by the TPO are independent, risk-bearing entities, whereas the assessee is a captive service provider assuming minimum risk. In the open market, any entity assuming increased risk will also be compensated by an increase in the expected return in the long run. Hence it is essential to perform a risk adjustment to bridge the disparities in risk profile. 21. It was submitted that in the case of lntellinet Technologies India Private Ltd., ITA No.1237/Bang/2010, order dated 30.03.2012, the jurisdictional Bench of ITAT has held that the single customer risk borne by a captive service provider is only an 'anticipated' risk vis-a-vis the 'existing' market risk borne by independent comparables. and has allowed market risk adjustment. ....
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....round is accordingly, allowed for statistical purposes." 23. Following the decision of the coordinate Bench of this Tribunal cited supra, we are of the opinion that the TPO has to verify whether comparable companies remaining after the exclusions are independent risk bearing entities or captive service providers. Risk adjustment can be allowed only in case the former condition is satisfied and such risk adjustment if required has to be worked out based on scientific analysis and data. Hence this issue is set aside to the TPO. 24. The next contention of the assessee is that the working capital adjustment should not have an upper limit. It was submitted that the average cost of capital cannot be used as a upper threshold for working capital adjustment. 25. The TPO in the order has stated that the profit margin computed in TNMM is a composite figure which includes two components. They are the profit margin on account of operating profit and profit margin on account of cost of capital recovered. Therefore, when the arithmetical average of net profit margins computed in the case of uncontrolled comparables is considered as arm's length profit margin in transfer pricing that ari....
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....lity between the tested party and the companies selected as comparable without any upper cap, which is not based on any sound rationale. The ld. counsel for the assessee relied on the decision of the Mumbai Bench of the Tribunal in the case of Dresser-Rand India Pvt. Ltd. v. ACIT (ITA No.8753/Mum/2010) has held that "The soul of an order is in its reasoning, and unless the reasons for coming to a conclusion in the order are not set out, it is not possible to do a meaningful scrutiny of the order." The Mumbai Bench in the above case has referred to the observations made by Hon'ble Supreme Court in the case of Union of India vs. Mohan Lal Capoor (AIR 1974 SC 87) wherein Their Lordships have, inter alia, observed as follows:- "If the statute requires recording of reasons, then it is the statutory requirement and, therefore, there is no scope for further inquiry. But even when the statute does not impose such an obligation it is necessary for the quasi-judicial authorities to record reason as it is only visible safeguard against possible injustice and arbitrariness and affords protection to the person adversely affected. Reasons are the links between the material on which cert....
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....t neither provides any enduring benefit to the assessee company nor brings into existence any asset to provide enduring benefit. 33. EPR Maintenance and IT allocation charges: The assessee company has paid an amount of Rs. 1,333,427 towards maintenance of MFGpro software licenses as per clause 9 of the aforesaid agreement between Moog IFSC and the assessee. Further, the assessee had incurred an amount of Rs. 3,626,423 as IT allocation charges which was paid to assessee's parent company, Moog Inc. Moog Inc. has entered into a global contract for usage of certain Information Technology services, which is to be used in the daily business operation of group companies of Moog Inc. globally. 34. In the present case, Moog Inc. has cross-charged the amount of Rs. 3,626,423 to the assessee as its share of IT usage charges. These expenses being IT usage charges are recurring in nature and required to be paid every year depending on the yearly usage of IT system. The Company does not acquire any right or ownership in any of the assets upon payment of such allocation charges. 35. The AO has disallowed the above software expenditure on the ground that the same is capital in nature and ....
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..... The application software has limited life unlike system software, which is used as tools of business. It is like any component or consumable item or spare part in a plant and machinery. By using such software, merely the efficiency is enhanced but by itself no capital asset is brought into existence. 37. The ld. counsel for the assessee further submitted that the provisions of the Act do not provide for a definition of "Capital expenditure" and "Revenue expenditure". Accordingly, the principles laid down by the Courts in numerous decisions would have to be looked into to determine whether the expenditure is a capital or revenue expenditure. In general, there is no particular rule to determine whether a particular expenditure is capital expenditure or revenue expenditure. The same would have to be determined based on the facts and circumstances of each particular case. 38. It was also submitted that as per section 37(1) of the Act, "Any expenditure (not being in the nature described in section 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profe....
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....Ltd. v. CIT, ITA No.755/Bang/2003. - Meritor Light Vehicle Systems India Pvt. Ltd., ITA No.140/Bang/2011. - Danfoss Industries (P) Ltd., 37 taxmann.com 240, ITAT Chennai. - Amway India Enterprises, 111 ITD 112 (SB) (Del) - Glaxo Smith Kline Consumer Healthcare Ltd. v. ACIT, 112 TTJ 94, ITAT, Chd. - Sharp Business Systems (I) Ltd. v. DCIT, 59 DTR 385, ITAT Del. - Business Information Processing Services v. ACIT, 239 ITR S-19, ITAT Jaipur. - CIT v. G.E. Capital Services Ltd., ITA No.560/Del/2007. 43. We find that In the present case, the license fee paid represents usage charges of leased licenses. Further, the use of license does not give any ownership of the software to the assessee and thereby does not lead to creation of any capital asset. The license used by the assessee is application software designed to perform various business processes. The application software enables the assessee to carry out its business operations efficiently and smoothly and does not provide any enduring benefit. Such software enhances the efficiency of the operations. It is an aid in the manufacturing process. Considering the abov....
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....% -19.50% 6 Prithvi Information Solutions Ltd. 11.08% 8.61% 7 R S Software Ltd. 9.56% 9.78% 8 Sagarsoft (India) Ltd 14.66% 13.60% 9 Serveall Enterprise Solutions Ltd. 16.08% 16.01% 10 SIP Technologies & Exports Ltd -9.78% -10.33% 11 Thirdware Solutions Ltd 21.43% 20.99% 12 VMF Soft Tech Ltd. 0.20% 0.20% 13 Zylog Systems Ltd. 17.64% 17.54% Arithmetic Mean 9.80% 7.50% Document 4 Sl. No. Company Name 1 KALS Information Systems Limited Unadjusted Margin on Cost (FY 2008-09) 13.89% 2 Akshay Software Technologies Limited 8.11% 3 Bodhtree Consulting Limited 62.27% 4 RS Software (India) Limited 9.97% 5 Tata Elxsi Limited 20.28% 6 Sasken Communication Technologies Limited 27.91% 7 Persistent Systems Limited 41.40% 8 Zylog Systems Limited 7.81% 9 Mindtree Limited (Segmental) 5.52% 10 Larson & Toubro Infotech Limited 24.72% 11 Infosys Limited 45.61% Unadjusted Arithmetic Mean 24.32% Less: Working Capital Adjustment -0.44% Adjusted Arithmetic Mean 23.88% Docume....