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2015 (5) TMI 1138
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....ted enterprises (AEs) as a captive service provider in the areas of integrated circuits for memory, interface and data communication applications. The above transaction was an international transactions with an Associated Enterprise (AE) and have to pass the Arm's Length Price (ALP) test as provided u/s.92 of the Income Tax Act, 1961 (Act). In this appeal the dispute is with regard to addition made consequent to determination of ALP and consequent upward revision and adjustment made to the price at which international transactions were carried out by the Assessee with its AE in respect of Software development Services. Financial Results of the Assessee for the F Y 2005-06 Description Amount Operating Revenue Rs.65,18,83,190 Operating Cost . . . . Rs.58,92,08,728 Operating Profit (PBIT) Rs. 6,26,74,462 Operating Profit to Cost Ratio 10.64 % Comparable ultimately selected by TPO and their arithmetic mean : Sl. No. Name of company OP/TC (FY 2006- 07) Remarks 1 Accel Transmatic Ltd. (Seg.) 21.11% New comparable 2 Avani Cimcon Technologies Ltd. 52.59% New comparable 3 Celestial Labs Ltd. 58.35% ....
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....,144 Arms Length Margin 23.82% of the operating cost Arms Length Price (ALP) at 123.82% of operating cost Rs.76,54,24,463 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 123.82% of operating cost Rs.76,54,24,463 Price charged in the international transactions Rs.68,08.,49,606 Shortfall being adjustment u/s.92CA Rs.8,45,74,857 The above shortfall of Rs. 8,45,74,857/- is treated as transfer pricing adjustment u/s 92CA." 4. Against the said adjustment proposed by the TPO which was incorporated in the draft assessment order by the AO, the assessee filed objections before the DRP. The DRP rejected those objections and confirmed the transfer pricing adjustment suggested by the TPO. The adjustment confirmed by the DRP was added to the total income of the assessee by the AO in the fair order of assessment. Against the said order of the Assessing Officer, the assessee has preferred the present appeal before the Tribunal. Gr.No.1 to 5 in the grounds of appeal is in relation to the issue ....
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....en in the present case as well as in the case of Logical Pvt.Ltd. (supra). 12. The next aspect which was highlighted by the ld. counsel for the assessee was that out of the 26 comparables, comparables at Sl.No.1, 2, 3 & 12 have to be rejected as they were held to be functionally not similar to a software services provider as held by this Tribunal in the case of Trilogy E-business Software India Pvt. Ltd., IT No.1054/Bang/2011. The relevant paragraphs 39 to 50 of the aforesaid order of the Tribunal are as follows:- (b) Avani Cimcon Technologies Ltd. 39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company's website, which reveals that this company has developed a software product by name "DXchange", it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT - ITA No.7821/Mum/2011 wherein the....
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....f the assessee. We therefore accept the plea of the Assessee to reject this company as a comparable. (c) Celestial Labs Ltd. 42. As far as this company is concerned, the stand of the assessee is that it is absolutely a research & development company. In this regard, the following submissions were made:- In the Director's Report (page 20 of PB-Il), it is stated that "the company has applied for Income Tax concession for in-house R&D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act." As per the Notes to Accounts - Schedule 15, under "Deferred Revenue Expenditure" (page 31 of PB-II), it is mentioned that, "Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred." An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as "Deferred Revenue Expenditure" (page 30 of PBII). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it....
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....io-informatics tools for which patenting process was also being pursued. As explained earlier it is a diversified company and therefore cannot be considered as comparable functionally with that of the Assessee. There has been no attempt made to identify and eliminate and make adjustment of the profit margins so that the difference in functional comparability can be eliminated. By not resorting to such a process of making adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard.'" 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for discovery of new drugs and has developed molecule to treat cancer. In the ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a c....
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.... with business operations of the company during FY 06-07. We are of the view that in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable. (d) KALS Information Systems Ltd. 46. 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....
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....evant observations of DRP as extracted by the ITAT in its order are as follows: "In regard to Accel Transmatics Ltd. the assessee 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 animatio....
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....ooking to the fact that it has developed a software product named as "Muulam" which is used for civil engineering structures and the product development expenditure itself is substantial vis-a-vis the capital employed by the said company, this criteria for being taken as comparable party, gets vitiated. For the purpose of comparability analysis, it is essential that the characteristics and the functions are by and large similar as that of the assessee company and T.P. analysis/study can be made with fewest and most reliable adjustment. If a company has employed heavy capital in development of a product then profitability in the sale of product would be entirely different from the company, who is involved in service sector. Therefore, this company cannot be treated as having same function and profitability ratio. In our view, due to non-availability of full information about the segmental details as to how much is the sale of product and how much is from the services, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case of the assessee. ......... ......... 7.4 Infosys Technolo....
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....me cannot be taken into consideration for comparability analysis. Moreover, 67% of its sales relates to its product which are sold on premium resulting into higher profitability, therefore, cannot be compared with the assessee company at all. There are several judgments of ITAT which have been referred in para 6.5 above, that Wipro cannot be taken as comparable case for comparable case with the company like assessee. In view of these facts and the reasoning given in the case of lnfosys, we hold that Wipro also cannot be considered as a comparability analysis, hence, would not be included in the list of the comparable entities as identified by the TPO." 14. As far as comparable at Sl.No.6 & 24 are concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of the Tribunal in the case of Telcordia Technologies India Private Ltd. (supra) wherein on the aforesaid two companies, the Tribunal held as follows:- "7.6 Flextronics Software Systems Ltd.: As per the statement of the learned AR, this company is also involved in the development of the software product and is also involved in BPO services, besi....
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....services. It was his submission that the aforesaid companies even if they are engaged in providing software services, can be engaged in different sectors to which they cater, like software development in telecommunication, automobile manufacturing sector, etc. It was his submission that it was also necessary to consider as to whether the sectors in which the comparable chosen by the TPO belong and the sector to which the Assessee caters. 17. We have considered the submissions of the ld. counsel for the assessee and the ld. DR. We are of the view that the comparables which are sought to be excluded by the ld. counsel for the assessee have been held to be not comparable with the case of software service provider, in as much as these companies did not satisfy the functional similarity test. E.g., in the case of company at Sl.No.2 of the list of comparables chosen by the TPO viz., Avani Cincom Technologies Ltd., this Tribunal had taken a view that income of this company from rendering software services and sale of software was not available and therefore this was rejected as a comparable company. Similarly, in the case of Celestial Labs Ltd., the Tribunal took a view that this compa....
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....ch is the final list of comparable companies chosen by the TPO, be excluded for the purpose of comparability. 10. As far as comparables at Sl.No.7 & 11 of the list of comparable chosen by the TPO listed at Para-4 of this order, are concerned, it is not in dispute before us that the related party transaction in the case of companies exceed 15% and in view of the decision of the Tribunal in the case of 24 X 7 Customer.Com Pvt. Ltd. in ITA No.227/Bang/2010, that where the RPT exceeds 15%, such companies should not be taken as comparables, we hold that companies at Sl.Nos. 7 and 11 of the list of the comparables chosen by the TPO be excluded from the list of comparable companies while working out the ALP. 11. As far as comparable companies chosen by the TPO viz., iGate Global Solutions Ltd., Mindtree Consulting Ltd., Sasken Communications Ltd., Persistent Systems Ltd., and Flextronics Software Systems Ltd., are concerned, this Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. Vs. DCIT IT(TP) A.No.1054/Bang/2011 AY 07-08 order dated 23.11.2012 has by applying turnover filter held that while selecting comparable companies for comparability analysis turnover will be....
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....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." It was further submitted that the TPO's range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet's analysis, the turnover of Q 1 crore to Q 200....
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....cted as not comparable with the Assessee. 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 Q 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard. We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm's length price. Sec.92-B provides that "international transaction" means a transaction between two or more associated enterprises, either or both of whom are nonresidents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incur....
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....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 subsections (1) and (2), on the basis of such material or information or document available with him: 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 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a)....... to (d)........ (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected....
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....y 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 relation to the transactions being compared." A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. In this regard we find that the pr....
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....es raised on Transfer Pricing issues were not argued and hence does not require adjudication. 14. The next issue that arises for consideration in this appeal by the Assessee is with regard to disallowance of deduction claimed u/s.10A of the Act in respect of profits of the Assessee's Bangalore unit of Rs. 4,08,29,786/-. The Assessee has three units through which it conducts its business. Out of the three units 2 are STP units entitled to deduction u/s.10A of the Act. In so far as one of the STP units at Bangalore, which was taken over from Lara Networks, it claimed a deduction of Rs. 4,08,29,786/- u/s.10A of the Act. The said deduction was however disallowed by the AO on the ground that the said unit was formed by reconstruction of an existing unit and that the business of the said unit had commenced prior to registration with the STPI. In doing so, he relied on the assessment orders for the Assessment years 2002-03 to 2004-05. The said assessment orders for AY 02-03 to 04-05 was subject matter of appeal before this Tribunal in ITA Nos. 748, 852 and 819/Bang/2007 and this tribunal by its order dated 21.6.2008 was pleased to hold that the Bangalore unit was not formed by reconstr....