TaxTMI 
TaxTMI 
2021 (7) TMI 1401
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....n adjustment of Rs. 84,74,69,606 to the transfer price of the Appellant's international transactions in respect of software development services. Further, the Learned Commissioner of Income-tax (Appeals) -III, Bangalore (`Ld. CIT(A)') erred in partially confirming the action of Ld. AO/TPO. 2. On the fact and in the circumstances of the case and in law, with respect to adjustment to the transfer price of the software development services, the Ld. CIT(A) erred in upholding the action of Ld. AO/ TPO in: 2.1. Rejecting the Transfer Pricing (`TP') documentation maintained by the Appellant under Section 92D of the Act, in good faith and with due diligence. 2.2. Rejecting the comparability analysis carried out by the Appellant in the TP documentation and in conducting a fresh comparability analysis for the international transaction of software development services based on the application of additional filters for determining the arm's length price. 2.3. Using data, which was not contemporaneous and which was not available in the public domain at the time of preparing the TP documentation. 2.4. Not considering the multiple year/....
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....peal." 3. The revenue has raised the following grounds:- "1. The order of the learned CIT(A) is opposed to law and facts of the case. 2. Whether the CIT(A) erred in fact in rejecting Cigniti Technologies Ltd & SQS India BSFI Ltd(Thinksoft Global Services Ltd) as a comparable on the grounds that it is functionally different when the primary source of income of the comparables is from provision of software development services. 3. Whether while seeking the exact comparability mentioned above, the CIT(A) was right in fact and in law in imposing conditions beyond law whereas the requirement of law is to acknowledge only those differences that are likely to materially affect the margin. 4. Whether the CIT(A) is correct in fact and law in disregarding the position of law that there could be differences between the enterprises compared under the TNMM method that are not likely to materially affect the price or cost charged or the profits accruing to such enterprises. 5 In the facts and circumstances of the case, whether the CIT(A) erred in fact in directing the TPO to include CG-VAK Software & Exports Ltd as a comparable company without appr....
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....ture (D) 4,578,857,490 Less: Non-operating expenditure 0 Total non-operating expenditure (E) 0 Total operating expenses (F=D-E) 4,578,857,490 Operating Profit (G=C-F) 498,714,496 OP/OC 10.89 % 9. The assessee selected the following comparables:- Sl.No. Name of the Company Wt. Avg(%) 1. Akshay Software Technologies Ltd. 7.46 2. Bell Softech Ltd. 7.92 3. Helios & Matheson Information Technology Ltd. 18.27 4. Locuz Enterprise Solutions Ltd. 6.91 5. CSS Corp Pvt Ltd. 20.01 6. E-Zest Solutions Ltd. 12.60 7. Sasken Communication 10.31 Arithmetic mean 11.93 10. The TPO selected the following comparables:- Amounts in Rs. Lakh S NO NAME OF TAX PAYER OR/SALES OC OP OP/OC (in %) 1 Infosys Ltd. 46,91,700 32,77,700 11.84,200 36.13% 2 Larsen & Toubro Infotech Ltd. 4,54,360 3,64,619 89,741 24.61% 3 Mindtree Ltd. 2,99,010 2,48,290 5,072 20.43% 4 Persistent Systems Ltd. 1,18,412 87,649 3,07,625 35.10% 5 R S Software (India) Ltd. 35,188 28,....
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....was submitted that during the year under consideration too the segmental data is not available and as such this company needs to be excluded from the list of comparables. 18. As regards wrong computation of margin, the ld. DR submitted that the issue of treating provision for bad and doubtful debt as non-operating expense has been discussed in the order of CIT(Appeals) and the action of the AO is to be upheld. So there is no error in computation of margin of this company. 19. On the next argument of the assessee that there was Business restructuring and Extraordinary event, the merger of Infosys Consulting India Limited (ICIL) had been accounted for under pooling of interest method, and that the assets and liabilities of ICIL had been transferred to Infosys Limited on a going concern basis, therefore, Infosys Ltd should be excluded from the list of comparables; the ld. DR submitted that a merger can be considered as extra ordinary event if it had a significant impact on the profits or margins of such other company. The assessee had not indicated that such a merger had impacted the revenue of Infosys Ltd. There is nothing to show that assessee is adversely impacted if this com....
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.... Annual Report at page 50, the development of intangibles and its impact on the revenue and profitability can be inferred as meagre. The assessee has failed to establish that differences, if any, on account of R&D, brand and intangibles have material effect on the margin of the said company. Further the assessee itself considered such companies as comparable which had R&D expenditure to sales ratio less than 3%. The reason given by assessee to apply such a filter was to select companies which do not own intangibles and are pure service providers. Thus this company cannot be rejected as a comparable because of R&D or intangibles. 25. We have heard both the parties and perused the material on record. The issue of comparability of Infosys Ltd. came up for consideration before the Tribunal in the case of Microsoft Research Lab India Pvt. Ltd. [IT(TP)A No.3131/Bang/2018 for the AY 2014-15. Vide order dated 05.02.2020 the Tribunal excluded this company from the comparables holding as follows:- "(i) Infosys Limited : The turnover being rs.44,341 Crores and it is functionally not comparable as the turnover is more than 500 times of the assessee turnover of Rs.84.09 Crores. The ....
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....oft Research Lab India Pvt. Ltd. (supra), we direct exclusion of Infosys Ltd. from the comparables. (ii) Laresen & Toubro Infotech Ltd. 27. The ld. AR submitted that Larsen and Toubro Infotech Limited (L&T) should be excluded from the list of the comparables as it is functionally different from the appellant on account of following: * Significant amount of Intangible assets including IPR and business rights * Significant Brand value * Extraordinary events during the year * Significant Overseas Staff costs and sub-contracting expenses. 28. Further on the assessee's submission that this company has subcontracting expenses, the ld. DR submitted that it is very common practice in the software development sector that personnel for the coding e.g. programmers are taken on contract by the companies for the duration of the project and they are just like employees of the developer as they function under control and direction of the developer. So sub-contracting expenses do not make L&T functionally different from the appellant. This is entirely different from the case where the software development work itself is outsourced to the software develo....
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....imilarly placed as it is providing services to its AE, which uses the same in its own products. So these arguments of the appellant do not have any merit as the company is functionally similar to the appellant. As there is no revenue stream on account of product sales, there is no merit in the argument of the appellant that the company is engaged in product sales. 30. As regards the contention of assessee that the product engineering business segment of L&T was transferred to L&T Technology services Ltd and the same had an impact on the margins of this company, the ld. DR submitted that a perusal of the annual report of L&T shows that the company had three business segments - services cluster, industrials cluster and telecom cluster (product engineering services). W.e.f. Jan 1, 2014, the Product Engineering Services (PES) was transferred to L&T Technology services Limited, and accordingly only the nine month revenue results from Product Engineering Services (PES) were considered in the company's financial statement for the year. As such there wasn't any impact on functional comparability. The appellant has not pointed out any impact on revenue which could have increased ....
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....ase of Microsoft Research Lab India Pvt. Ltd. (supra) wherein it was observed as follows:- "We have perused submissions advanced by both sides in the light of the records placed before us. It is observed that Delhi ITAT in case of Aginity India Technologies India private limited (supra) has held as follows: "Larsen and Toubro Infotech Ltd was excluded from the list of comparable companies by relying on the decision of the Delhi bench ITAT in case of Saxo India d vs ACIT. The discussion is contained at para 4 .8 to 4.10 of tribunal's order. The tribunal held that LMT Infotech Ltd was software product company and segmental information on SWT services was not available. The tribunal also noticed that appeal filed by revenue against rivals order was dismissed by orderable Delhi High Court in ITA No. 682/2016. Respectfully following the same we are of considered opinion that this company deserves to be excluded from the final list." We rely on the coordinate bench decision and direct the TPO/A.O. to exclude the comparable from the final list for determination of ALP." 35. In view of the above decision, we direct exclusion of Larsen & Toubr....
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....is argument does not carry any weight. Firstly page 109 of the annual report of Mindtree relates to consolidated financials of the group. Secondly the borrowing from CSIR is a meager Rs 2.70 crores as against the turnover of the company which is 3031.60 crore. Thirdly there is nothing to suggest in the annual that this has resulted in generation of IP for the company. The TPO has rightly pointed out that total intangibles of Mintree are of Rs 6.7 crore, which is just 1% of the total non-current assets and there is nothing to suggest that these intangibles have driven the revenue of this company. The remaining intangibles of Rs 69.80 crore are the software used for development. Further, even if there is any selfgenerated intangible, not being on account of normal purchase as in case of software, in the case of appellant too, while it is performing its functions of Software Development, substantial intangibles are generated. Considering above, the argument of the appellant cannot not be accepted. 39. This issue came up for consideration before the Tribunal in the case of Microsoft Research Lab India Pvt. Ltd. (supra) wherein this company was excluded from comparables observing as ....
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....sent the status at the time of accessing the same rather than the status during the relevant financial year. Further the purpose of website is to advertise and to attract more clients and thus it may reflect the capabilities of the group rather than the actual functioning during a specific year. On perusal of the annual report of this company, it is observed that at page 158 [clause (iv)] of the unconsolidated annual report, it is mentioned that the activities of the company do not involve purchase of inventory and sale of goods, and its nature of business was rendering of services. The reference of appellant to pages 59, 60, 77 and 105 of annual report is also misplaced, as the same relate to entire group of Persistent Systems and unconsolidated report starts from page 155 of the annual report. The revenue recognition method in the 'Notes forming part of financial statements' on page 166 of the Annual Report also refers to 'income from software services'. It refers to services performed on 'fixed price basis or 'time and material basis'. As per page 181, Note 21 of the Annual Report, the revenue from operations is stated to be on account of sale of soft....
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....ent, it would not matter as to what kind of customer it serves as the broad range of services remain the same and that is the development of software. Further, it will not matter whether the comparable develops complete software for its client e.g. develops a final product as per demand of the client or develops only some software modules for as per the requirements of its client. The function remains same. Thus, a company can be considered in the business of Software Products only if it is itself developing and selling the products developed by it and not if its client is selling the products developed for it by such company. The appellant is also similarly placed as it is also into software development for the products for its AE. So these arguments of the appellant do not have any merit as 'the company is functionally similar to the appellant. In Agnity India Technologies Pvt. (supra) the ITAT held Persistent Systems Ltd to be a proper comparable for software development activities. 42. As regards expenditure incurred towards R&D, the ld. DR submitted that as per page 195 of the annual report the same was Rs.39.61 million, which constitute meager 0.33% of operating revenu....
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....ould not be considered as a comparable. The ld. DR submitted that page 27 of annual report relates to the consolidated financials of the group and the extra ordinary event relates to acquisition by Persistent Systems Inc (PSI) and not by the Indian entity namely Persistent Systems Limited which has been considered as a comparable by the TPO. The appellant has not explained as to how these acts of subsidiaries have impacted the profit margins of Mis Persistent Systems. So this argument of the appellant is to be rejected. 44. On the scale of operations, the ld. DR submitted that the TPO has used employee cost filter of 25% to exclude the companies not in the Software Development segment. The appellant has not explained as to how more number of employees affects the margins of this company. 45. The ld. DR further submitted that this company was upheld to be functionally comparable to a software service provider company by the Hon'ble ITAT Bangalore in the case of M/s. Advice America Software Development Centre Private Limited (in ITA (TP) No. 2531/Bang/2017 dated 23.05.2018 (A.Y. 2013-14). In Agnity India Technologies Pvt. Ltd. (supra) also the ITAT had held Persistent Syste....
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....prises of software, development, implementation and support services. Though at page 2 of the P&L A/c statement the company has mentioned revenue from sale of products at Rs.20675/- lakhs, however it is clearly mentioned that the revenue was on account of export of software services to the tune of Rs.20,194.37/- lakhs, from software services from local unit Rs.414.07/-lakhs, from subscription and training Rs.59.32/- lakhs, from sale of licenses 7.98 lakhs. The revenue from software licence constitutes a meager 0.03% of total operating revenue. Thus it is very clear that this company is predominantly into sale of software services and hence can be safely taken as a comparable. Further at page 7 of annual report it is mentioned that the company has acquired intangible asset relating to software purchased for company's internal use which was capitalized as the cost of acquisition. Thus this company is a proper comparable. 51. On the contention of assessee that the TPO has erroneously considered forex loss as non-operating expense, the ld. DR submitted that the TPO has considered forex gain/loss as operating in nature. The CIT(Appeals) directed the TPO to reverify this aspect in....
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.... field of simulation and Training. The company is mainly into software product development and related R&D activities. During the year under consideration the company has debited an expense of Rs 8.17 crores on account of R&D, and of this Rs 7.99 crore constitutes employee cost. That the company is in research and development and thus developing its own intangibles also becomes evident from the fact that its tangible fixed assets are valued at only Rs 53.48 lacs as against intangible assets of Rs 4848.47 lacs. These intangibles include learning management products, training management products, simulator products, knowledge based content, optimization products etc. as against normal intangible of "software purchased" in case of routine software developer. This makes it evident that the company is mainly in the business of technical training and R&D rather than software development. Nowhere in the annual report there is any reference to the software development activities of the company and it is observed that the company categorizes its activities as software services and software products. Nature of software services has not been indicated specifically and thus has to be interpret....
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....he tune of 5.9% of total operating revenue. 35. At the outset it was submitted that the company is functionally comparable and passes all the filters applied by the TPO. It was submitted that action of the DRP in upholding the exclusion of the company on an altogether new basis without first putting the assessee on notice of the same is wholly erroneous and unsustainable. 36. We are of the view that the comparability of the company should be considered afresh by the TPO both on the export revenue filter and the filters applied by the DRP, because admittedly the assessee was not confronted by the DRP on the new filter it applied nor did it give a finding one way or the other on the export turnover filter." 59. Being so, we remit the issue to the TPO for fresh consideration with a direction to consider the segment data. (ii) i2T2 India Ltd. 60. The ld. AR submitted that this company was rendering software development services and consulting activities and hence comparable to it, however the same had wrongly been not accepted by the TPO by holding that RPT information was not available. It was submitted that the company satisfied all the filters adopted by t....
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....akhs and that the revenue from US was given to be Rs. 924.87 lakhs. Thus it can be seen that the export revenue constitute only 20.34% of the total revenue. Therefore this company cannot be considered as comparable. 66. This company was considered by the Tribunal in the case of Citrix R&D India Pvt. Ltd. in IT(TP)A No.3134/Bang/2018 dated 29.01.2020 wherein it was held as follows:- "15. The assessee seeks inclusion of Evoke Technologies Pvt. Ltd. which was rejected by the TPO as a comparable company for the reason that data relating to this company was not available in the public domain and that it had a different financial year ending. Before the DRP also, the assessee did not challenge the action of the TPO in excluding the aforesaid company because the assessee did not have a data relating to this company. The assessee is now seeking inclusion of this company on the basis of decision rendered by the Hyderabad Bench of ITAT in the case of Infor (India) Pvt. Ltd. ITA No.2307/Hyd/2018 for AY 2014-15. In the aforesaid decision, the Hyderabad Bench took the following view :- "3. As regards Evoke Technologies is concerned, the contentions of the assessee are that ....
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.... any details to show that the relevant data for computation of WCA was produced by it before the AO or it had made a specific request to the AO to collect such data and provide such an adjustment. The appellant's reliance on the decision in the case of Mobis India ITA No 2112/Mds/2011(AY: 2007-08) [2013] 38 taxmann.com is not applicable to it. However, as discussed supra, the appellant has not given any calculation of WCA. This is important to note that the facts were not so in appellant's case for AY 2012-13, as the ITAT had observed that such calculations were provided by the appellant and as such decision in the case of Mobis India(Supra) could not be applied. However on the facts of the present case, when no such details have been provided by the appellant the above decision in the case of Mobis India (Supra) gets squarely applied. In the case W M Global Technology Services (India) (P.) Ltd. v. Assistant Commissioner of Income-tax, Circle - 7(1)(2), Bengaluru of [2018J 91 taxmann.com 403 (Bengaluru - Trib) dt 28.02.2018, the ITAT held as follows:- "24. We have gone through the records and perused the orders passed by the DRP as well as the TPO. In our view, it is f....
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....sed in the annual reports of companies engaged in different segments and therefore proper comparison cannot be made. (iii) Disclose in the balance sheet does not contain break up of trade and non-trade debtors and creditors and therefore working capital adjustment done without such break up would result in computation being skewed. (iv) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results. 16. The CIT(A) also placed reliance on a decision of Chennai ITAT in the case of Mobis India ITA No.2112/Mds/2011 (2013) 38 taxmann.com. That decision was based on the factual aspect that the Assessee was not able to demonstrate how working capital adjustment was arrived at by the Assessee. Therefore nothing turns on the decision relied upon by the CIT(A) in the impugned order. In the matter of determination of Arm's Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm's Length Price. The data available with the Assessee and the Department would ....
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....are of the view that the CIT(A) was not justified in denying adjustment on account of working capital adjustment. Since, the CIT(A) has not found any error in the TPO's working of working capital adjustment, the working capital adjustment as worked out by the TPO has to be allowed. We may also add that the complete working capital adjustment working has been given by the Assessee and a copy of the same is at page 173 & 192 of the Assessee's paper book. No defect whatsoever has been pointed out in these working by the CIT(A). We may also further add that in terms of Rule 10B(1)( e) (iii) of the Rules, the net profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions which could materially affect the amount of net profit margin in the open market. It is not the case of the CIT(A) that differences in working capital requirements of the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by CIT(A) ....
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....was considered by the Tribunal in the case of Microsoft Research Lab India Pvt. Ltd. (supra) wherein this company was excluded from comparables observing as under:- " We found this comparable was excluded by the co-ordinate Bench of the Tribunal in the case of Marwell India Pvt. Ltd. Vs. DCIT (supra) at page 18 para 4.2 (a) of the order as under : "We have perused submissions advanced by both sides in the light of the records placed before us. We have also perused the annual report very carefully and is observed that this company is involved exclusively into software testing and has created innovations in the software testing. It is also observed that this company is acquired hundred percent shares in a U.S.-based software testing service company called Gallop Solutions Inc based in Texas USA. It is also observed that this company has been listed on Bombay stock exchange, Bangalore stock exchange and maybe Madras stock exchange with a paidup capital of Rs. 22.92 crores. It is an undisputed fact that entire revenue has been generated by this company from software testing services rendered to its independent clients as against simple testing carried out by assessee ....
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....mpany has acquired majority stakes in Thinksoft Global Services Ltd. by acquiring 53.35% of its shares during the year. It pertains to change in majority stake of the company (shareholding pattern). The assessee has not demonstrated as to how the above information has had any materialistic impact on the revenue or the profits earned by the company during the year. The assessee has summed up all the related party transactions (i.e. both on revenue side as well as expense side) and computed its percentage over sales. In the formula adopted, while the numerator contains both revenue and expenditure, the denominator contains only revenue. Hence, there is no parity between the denominator and numerator. In case of the revenue based related party transactions. net sales can be used as a base (i.e. Σ(RPT)revenue/ sales). Conversely, for the related party transactions on the expense side, then total expenditure should be considered as a base. (i.e. Σ (RPT) expenses / Total expenditure. Thus, the assessee's practice of combining both revenue and expenses items of related party transactions and comparing it against net sales, would distort the application of the proposed RPT filt....