TaxTMI 
TaxTMI 
TaxTMI 
2015 (5) TMI 1138
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....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% New comparable 4 Datamatics Ltd. 1.38% New comparable 5 E-Zest Solutions Ltd. 36.12% New com....
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....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 of addition on account of adjustment in ALP. The Assessee has also filed an application for raising an additional ground of appeal. In the TP study of the Assessee, the Assessee had chosen Mindtree Ltd., as a comparable company. In the proceedings before the Tribunal, the Assessee is seeking exclusion of the said company from the list of comparable companies as....
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....ilogy 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 Tribunal accepted the assessee's contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- "7.8 Avani Cincom Technologies Ltd. ('Avani Cincom'): Here in this case....
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....e 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 is into pure software development activities and is not engaged in R&D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT - ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: "The learned D.R. however drew our at....
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....omparability. 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 comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in whi....
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....red 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. DCIT, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: "16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said....
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....k system, imaging technologies, outsourced product development (iii) Accel IT Academy (the net stop for engineers)- training services in hardware and networking, enterprise system management, embedded system, VLSI designs, CAD/CAM/BPO (iv) Accel Animation Studies software services for 2D/3D animation, special effect, erection, game asset development. 4.3 On careful perusal of the business activities of Accel Transmatic Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee's claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from the final list of comparables for the purpose of determining TNMM margin." 49. Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as compar....
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....tal 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 Technologies Ltd.: The parameter for identifying comparable entity has to be seen from the angle of functions formed by the company, size of the company in terms of the sale revenue, stage of business cycle and company's growth cycle. In the case of Infosys, there are huge intangible assets which as per the information provided by the learned AR are valued at Rs. 69,522 crores, which comprises of brand value itself at Rs. 22,915 crores. Based on such fund valuation, the profit of Infosys is predominantly due to its premium branding. It is India's No.2 software service exporter and Third in the World as a....
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....ntities 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, besides joint software consultancies for the use in telecommunication industries. Thus, being product and service company, it cannot be taken as comparable. However, the learned CIT DR has amply controverted the said contention of the learned AR by submitting before us a copy of profit and loss account of the company for the relevant assessment year, obtained from the public domain. From the perusal of the profit and loss account of the said company, it is seen that the revenue sales from services constitutes almost 90% and the product sales is only 10%. Thus, in this case also not much adjustment is required to be made for tak....
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....ee 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 company was engaged in R&D activity and cannot be compared with a software service provider. It is thus clear that the reason given by the Tribunal in the cases referred to by the ld. counsel for the assessee will equally apply to the present case also. We therefore accept the submissions made on behalf of the assessee and hold that companies at Sl.No.1, 2, 3, 10, 12, 14, 24 & 26 be excluded from the list of comparables chosen by the TPO while computing the ALP." 7. In view of the above decision of the Tribunal, we direct that comparables at Sl.No.1, 2, 3, 10, 12, 14, 24 & 26 of the list of comparables set out in Table given in para-4 of....
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....he 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 a relevant criteria and held as follows: "(1) Turnover Filter 11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Rs. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the ....
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.... 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 crores was held to be proper. The following relevant observations were brought to our notice:- "9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would....
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.... 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 incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92-A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm's length price in an international transaction and it provides:- (1) that 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, having regard to the nature of transaction or class of transaction or class of associated pe....
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.... 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 or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in su....
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.... 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 provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee's turnover is Q 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.....
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.... 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 reconstruction of an existing unit or the business of the new unit had not commenced prior to registration with the STPI and therefore deduction u/s.10A of the Act ought not to have been denied on the profits of the Bangalore unit. The said decision of the Tribunal has since been confirmed by the Hon'ble Karnataka High Court in ITA Nos.1013 to 1015/2008 dated 7.11.2014. Copies of the order of the Tribunal and the Hon'ble High Court were filed before us. In view of the said decision of the Tribunal on identical facts, we are of the view that the Bangalore unit was not formed by reconstruction of an existing unit or the business of the new unit had not commenced prior to registration with the STPI and therefore deduction u/s.10A of the Act ought not to have been denied on the profits of the Bangalore unit. The deduction claimed by the Assessee is directed to be allowed. The relevant grounds of appeal of the Assessee are allowed. 15. The Assessee in the grounds of appeal before the Tribunal has also projected its grievance regarding the action ....