TaxTMI 
TaxTMI 
2020 (5) TMI 440
X X X X Extracts X X X X
X X X X Extracts X X X X
....related services. It was set up in India as a separate entity to specifically provide software development, research and other services to its AE. During the relevant previous year, respondent had rendered services to its AE and declared its income at Rs. 6,060/- and a book profit of Rs. 4,37,12,441/- under section 115JB of the Act. The price for the international transactions with its AE was valued at Rs. 38,40,88,682/-. The assessee benchmarked the aforesaid international transaction using Transactional Net Margin Method ('TNMM') and computed the Profit Level Indicator ('PLI') of the international transaction at 11.87%. The assessee selected 14 comparable companies engaged in software development services and the arithmetic mean of the PLI was computed at 11.91%. Based on the above, the assessee declared that its profit margins were at arm's length price ('ALP') when compared to similarly situated companies. 3. The Assessing Officer ('AO') picked up the case for scrutiny and a reference was made to the Transfer Pricing Officer ('TPO') under section 92CA of the Act to determine the ALP. The TPO vide order dated 16.01.2014 rejected the transfer pricing study undert....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the assessee company, since it has a diversified profile which entails product conceptualization, core design, research and development, marketing, sales and post sales services, none of which is performed by the assessee company. The asset profile of Infosys Ltd. consists of significant brand value and intangibles. It assumes huge entrepreneurial risk, market risk, commercial risk, project liability risk, technology risk and credit risk, whereas the assessee is risk mitigated captive service provider and therefore such a giant company cannot be compared with the assessee. Wipro Technology Services Ltd. was deleted since its transaction failed the Related Party Transaction (RPT) filter. It was held that the comparable had rendered services to the Citi Group as part of the pre-acquisition understanding, and, therefore, the revenue of the comparable is on account of related party transactions, making the company an unviable comparable . As regards Persistent Systems Ltd, the Tribunal examined its Annual Report and observed that no segmental information is available, as to the revenue earned on account of software services and on account of sale of software products and in absence of....
X X X X Extracts X X X X
X X X X Extracts X X X X
....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 [or the specified domestic 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 sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or &nb....
X X X X Extracts X X X X
X X X X Extracts X X X X
....valuating factor once TNMM has been applied. 12. She also made elaborate submissions with respect to deletion of the four comparables. As regards Infosys Ltd., she argued that only 4.38% of itsoperating revenue is earned from the sale of its software product, whereas around 95% is earned from software development services. The assessee itself had adopted an approach of selecting comparables which are engaged in software development services and, therefore, Infosys is functionally similar and thereby comparable with the assessee. She further contended that since the expenses incurred by Infosys are primarily in relation to development of software services, the difference in expenditure between the assessee and the comparable is not a significant reason to exclude the comparable. Factors such as heavy marketing expenses and recognizable brand value of the comparable are not substantial factors to allow exclusion of the comparable. Brand building and marketing expense constitute only 0.34% of the comparable company's total revenue, which in turn, substantially increases the cost factor of services rendered by the comparable. These factors do not render Infosys Ltd. unsuitable for com....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ofile of the comparable and the assessee should be similar. He submitted that in comparability analysis, the business environment, demand and supply of services, assets employed and competence to provide different services are factors which would have a material bearing on the profitability of these entities. He also argued that the reasoning given in Rampgreen (supra) was followed by this court in M/s Avaya India Pvt. Ltd. V. ACIT, (2019) 416 ITR 638, wherein the impact of brand value in comparability analysis of captive software service providers was examined by this Court. The relevant paragraphs of the said judgment are extracted herein under: "27. There is merit in the contention of the Assessee that the scale of operations of the comparables with the tested entity is a factor that requires to be kept in view. TCS E-Serve has a turnover of Rs. 1359 crores and has no segmental revenue whereas the Assessee's entire segmental revenue is a mere 24 crores. As observed by this Court in its decision dated 5th August 2016 in ITA 417/2016(PCIT v. Actis Global Services Private Limited) "Size and Scale of TCS's operation makes it an inapposite comparable vis-a-vis the Petitioner." As a....
X X X X Extracts X X X X
X X X X Extracts X X X X
....oth the aforementioned orders have been upheld by this Court. 18. As regards to the second comparable- Wipro Technology Services Limited, Mr. Jolly contended that as per the pre-acquisition understanding, Wipro Technology Services has only rendered services to the Citi Group. The entire revenue of Wipro Technology Services is on account of these related party transactions and hence it fails the filter of 25% RPT to sales as applied by the TPO in the original round of proceedings, which was also confirmed by the DRP and such transaction would be a 'tainted transaction' as per Section 92B (2) of the Act. 19. In respect of the deletion of Persistent Systems Private Ltd. and Thirdware Solutions and Sales Ltd., Mr. Jolly argued that the said comparables are functionally dissimilar from the assessee and are engaged in carrying out sales of software products, unlike the assessee company. Moreover there is no separate segmental information available regarding the revenues earned for separate activities conducted by the comparables. He pointed out that the Tribunal has rightly observed that the domestic sales of Persistent Systems Pvt. Ltd. is Rs. 30.4 Crores as compared to 'nil' of t....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 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." The above Rule manifests that in order to ensure a correct estimation of the ALP, it is critical that the entities chosen as comparables are functionally similar to the assessee. In Chryscapital (supra), the Division Bench of this Court held that if the comparable and the assessee are functionally similar, then the comparable cannot be excluded only on the ground that it is operating on supernormal profits. A comparable could nonetheless be included if the material difference on account of such high profits could be eliminated. The relevant portion of the judgment reads as under: "39. This Court proceeds on the basis that there is sufficient guidance and clarity....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d be made to eliminate the components which may materially affect the price. 23. Let's now take note of the views of this Court in Rampgreen (supra). This Court in the said case also held that a further enquiry by the TPO needs to be undertaken to ascertain whether such differences materially affect the cost or the price of the service rendered by the comparable and whether such differences could be reasonably adjusted. On a perusal of the OECD Guidelines, it was concluded that the entities selected as comparable should be functionally similar and entertain similar business environment and risks as the tested party. This Court held as under: "21. In order for the benchmarking studies to be reliable for the purposes of determining the ALP, it would be essential that the entities selected as comparables are functionally similar and are subject to the similar business environment and risks as the tested party. In order to impute an ALP to a controlled transaction, it would be essential to ensure that the instances of uncontrolled entities/transactions selected as comparables are similar in all material aspects that have any bearing on the value or the profitability, as the case may....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nd supply for the services would be different, the assets and capital employed would differ, the competence required to operate the two services would be different. Each of the aforesaid factors would have a material bearing on the profitability of the two entities. Treating the said entities to be comparables only for the reason that they use Information Technology for the delivery of their services, would, in our opinion, be erroneous" [Emphasis Supplied] 24. Further, the Court also expounded on the concept of functional similarity in TNM Method in the following words: "42. Before concluding, there is yet another aspect of the matter that needs consideration. The Tribunal proceeded on the basis that while applying TNMM method, broad functionality is sufficient and it is not necessary that further effort be taken to find a comparable entity rendering services of similar characteristics as the tested entity. The DRP held that TNMM allows flexibility and tolerance in selection of comparables, as functional dissimilarities are subsumed at net margin levels, as compared to Resale Price Method or Comparable Uncontrolled Price Method and, therefore, the functional dissimilarities p....
X X X X Extracts X X X X
X X X X Extracts X X X X
....performed by the tested party and the selected comparable entity are similar including the assets used and the risks assumed; and (b) the difference in services/products offered has no material bearing on the profitability." [Emphasis Supplied] 25. The above decision was followed in Avenue Asia Advisors Pvt. Ltd. v. DCIT, 2017 SCC OnLine Del 10650, wherein the Court observed that 'though in the TNMM method there is sufficient tolerance, a mere broad functionality is by itself insufficient'. The relevant portion is extracted as under: "20. A perusal of the above decision reveals that the following steps ought to be undertaken in identification of comparable transactions/entities. * The principle governing the identification of comparable transactions would be the same, irrespective of whichever transfer pricing method is adopted. * Comparable transactions must be selected on the basis of a similarity with the controlled transaction/entity. * Rule 10B(2) of the Income Tax Rules, 1962 ought to be borne in mind while choosing the factors of comparability in respect of uncontrolled transactions. * Even while adopting the TNMM method, the standard for selection of the compar....
X X X X Extracts X X X X
X X X X Extracts X X X X
....tional transaction has necessarily to confirm to the mandate of Rule 10B. In this case, the method followed for determining the arm's length price of the international transaction adopted by the assessee and the revenue is the TNMM. The comparability of an international transaction with an uncontrolled transaction has, in such cases, to be seen with reference to the functions performed, taking into account the assets employed or to be employed and the risks assumed by the respective parties to the transaction as per rule 10B(2)(b). The specific characteristics of the property transferred or services provided (contemplated by Rule 10B(2)(a)) in either transactions may be secondary, for judging comparability of an international transaction in the TNMM, because the price charged or paid for property transferred or services provided and the direct and indirect cost of production incurred by the enterprise in respect of property transferred or services provided go into reckoning comparability analysis in the transaction methods, i.e. the comparable uncontrolled price, resale price and cost plus whereas the profit based method such as transactional net margin method takes into accoun....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ance of the impugned comparables. The question was not merely whether the margins earned by the Tata group in providing captive service to the Citi entities were at arm's length. The question was whether they offered a reliable basis to re-calibrate the PLI of the Assessee whose scale of operations was of a much lower order than the two impugned comparables. The mere fact that the transactions were identical was not, in terms of the law explained in the above decisions, either a sole or a reliable yardstick to determine the apposite choice of comparables. [Emphasis Supplied] 27. From the exposition of law in Rampgreen Solutions (supra) and the other judgments referred above, it is clear that even while applying the TNM method, comparables cannot be picked on the basis of broad classification under various heads, and that the actual functional profile of the comparable must be similar, if not same, to that of the taxpayer-assessee. In comparability analysis, the business environment; demand and supply of the services; assets employed, and, competence to provide different services are factors which would have a material bearing on the profitability of the entities and, therefor....
X X X X Extracts X X X X
X X X X Extracts X X X X
....es Ltd." Citi Group entered into a Master Agreement with Wipro Ltd., whereby Wipro acquired 100% interest in "Citi Technology Services Ltd." and the comparable was renamed as "Wipro Technology Services Ltd." with effect from 01.01.2009. As per the Master Agreement, Wipro Technology Services Ltd. would continue to provide services such as delivery of technology, infrastructure, services and application, development and maintenance to Citi Group, which were delivered by the erstwhile Citi Technology Services Ltd. The main ground for exclusion of this comparable is that its entire revenue is on account of related party transactions and it fails the criteria of RPT filter. The critical question is whether the pre-arrangement between the Citi group and Wipro Limited would make the subsequent rendition of services by this company to the Citi Group fall within the meaning of "deemed international transaction" as defined under section 92B(2) of the Act. At this juncture, it would be apposite to reproduce Section 92B (2) of the Act: "Section 92B(2): A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....igroup Inc., a third person. This unfolds that the transaction of earning revenue from software development support and maintenance services by Wipro Technology Services Ltd., is an international transaction because of the application of section 92B(2) i.e., there exists a prior agreement in relation to such transaction between Citigroup Inc. (third person) and Wipro Ltd. (associated enterprise). In the light of this structure of transaction, it ceases to be uncontrolled transaction and, hence, Wipro Technology Services Ltd., disqualifies to become a comparable uncontrolled transaction for the purposes of inclusion in the final list of comparables under Rule 10B(1)(e)(ii). We, therefore, direct removal of this company from the list of comparables." [Emphasis Supplied] 31. We also note that the aforesaid comparable has been deleted in the case of the sister company of the assessee herein. The sister company of the assessee also operates in the same business segment as the assessee. The order of deletion has been upheld by this Court in CashEdge India (supra) for the same AY 2010-11. Since, the Courts have consistently upheld the deletion of the said comparable on account of faili....
X X X X Extracts X X X X
X X X X Extracts X X X X
....an be carried out with the assessee which is purely providing software development services. Apart from above it is noticed that in the case of Fiserve, this comparable company has been excluded precisely on the same ground and the said order of the Tribunal stands affirmed by the Hon'ble High Court also. Accordingly, we direct the TPO to exclude the said comparable from the list of comparables." [Emphasis Supplied] 33. Both the aforenoted comparables have been excluded on the ground that apart from rendering software services, the companies are engaged in sale of software products and the segmental data of product and services is not available. Firstly, this is a finding of fact and secondly, in the grounds urged in the present appeal, the Revenue has not disputed this factual position. In the note of arguments filed by the appellant also, there is no challenge to this factual position. We would like to add that the respondent had brought to our notice that this Court in CashEdge (supra)for the very same AY 2010-11 and in identical business vertical i.e. captive software development services had upheld the exclusion of Persistent Systems Ltd. With respect to Thirdware Solutions ....