2019 (8) TMI 930 - AT - Income Tax

Transfer pricing addition - international transaction of Software Development services - Comparable selection - HELD THAT - The assessee renders software development services with the help of intellectual property owned by its AE and further the intellectual property rights in the software developed by the assessee vest in the AE, thus companies functionally dissimilar with that of assessee need to be deselected from final list. Bodhtree is following the model of booking expenses at the time of their incurring notwithstanding the raising of bills in next year. This shows that the revenue recognition model of Bodhtree Consulting Ltd. is quite different from the assessee in as much as unless the software is fully developed and billed, it will go on debiting expenses to the Profit and loss account but the invoice will be raised only in the year of completing the project. This leads to fluctuating margins from year to year. As relying on ALLSCRIPTS (INDIA) PRIVATE LTD 2016 (8) TMI 1187 - GUJARAT HIGH COURT upheld the exclusion of this company from the list of comparables. E-Infochips Limited - No doubt Consultancy charges in relation to Software Development are part of Software Development, but the inclusion of ITES in the overall segment frustrates the comparability. We are currently dealing with the international transaction of Provision of Software Development services and the international transaction of ITES by the assessee is a separate one which has also been benchmarked distinctly - e-Infochips Bangalore Ltd., having a pool of both software development and ITES segments into a common segment cannot be considered as comparable on entity level with the international transaction of Software development of the assessee. We, therefore, order the exclusion of this company from the list of comparables. e-Zest Solutions Ltd - unlike Bodhtree, this company adopted a proper revenue recognition model by identifying income only on its earning and keeping the expenses as work in process to be taken over to the next year till the raising of the bill on the completion of the project. We, therefore, uphold the inclusion of this company in the list of comparables. Helios Matheson Information Technology Ltd - company is engaged into the business of software products as well. There is hardly any need to state difference between the software product company and a software development company. Whereas a software product company would develop a product and then earn revenue from its sale over a period, a simplicitor software development company would render software development services not leading to creation of any software product in its hands and earn revenue from such rendition of services only. The assessee is only a software development service provider, though such service may lead to creation of some product but the same is meant for its AE and not the assessee . Au contraire , Helios and Matheson is also engaged in software products, rendering it unfit for comparison. As the assessee is not engaged in any software product business and is confined only to rendering software development services, we, therefore, exclude this company from the list of comparables. KALS Infosystems Ltd - is engaged in selling of software products which is different from the activities undertaken by assessee, namely, rendering of software service only to its AEs, we hold the same to be incomparable and accordingly direct to exclude it from the final list of comparables. Maars Software International Ltd - Considering on site development impacting operating margins differently vis-a-vis a company providing offshore services, this company is liable to be excluded from the list of comparables. Rendering of sales support services - comparability of TSR Darashaw Limited - HELD THAT - When we compare the nature of the functions carried out by this company with the marketing support services rendered by the assessee to its AEs, we find that both are a way apart from each other. There can be no logical comparison between a pay roll services rendered by a company to its clients along with Registrar and Transfer Agent activity and Records management activity (Records) with the marketing support services rendered by the assessee to its AEs. This company is, therefore, directed to be excluded from the final set of comparables. AR submitted that if TSR Darashaw Limited is excluded from the list of comparables, then he will not be pressing for the inclusion/exclusion of other companies as has been agitated in the instant appeal. In view of our decision on the exclusion of TSR Darashaw, we do not propose to consider other companies from the angle of comparability. We set aside the impugned order on the issue of transfer pricing addition in the international transactions of Rendering of software development services and Rendering of sales support services and remit the matter to the file of AO/TPO for the fresh determination of their ALPs in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings. Computation of deduction u/s.10A - reducing foreign currency expenses from export turnover (without excluding the same from the total turnover of the STP unit) - HELD THAT - Since the amount of foreign currency expenses has been held by the AO himself as not forming part of export turnover , the sequitur is that the same would also not form part of total turnover , as there cannot be two different figures of export turnover , one as an independent numerator in the formula and the other constituting part of total turnover in the denominator. To put it simply, foreign currency expenses which have been excluded by the AO from the ambit of export turnover would also require exclusion from total turnover . The Hon ble Delhi High Court in CIT Vs. Genpact India 2011 (11) TMI 119 - DELHI HIGH COURT has held that any exclusion from export turnover should also be reduced from total turnover for the purpose of deduction u/s.10A. We, therefore, overturn the impugned order on this score and allow the ground of appeal.

Summary

Issues Involved:
1. Transfer pricing addition in the international transaction of "Software Development services".
2. Inclusion/exclusion of specific companies from the list of comparables.
3. Risk adjustment in transfer pricing.
4. Transfer pricing addition in the international transaction of "Rendering of sales support services".
5. Inclusion of revenue from sales support division in export and total turnover.
6. Computation of deduction u/s.10A by reducing foreign currency expenses from export turnover.

Detailed Analysis:

I. SOFTWARE DEVELOPMENT SERVICES SEGMENT

1. Transfer Pricing Addition:
The primary issue is the transfer pricing addition of ?19,23,02,633/- made by the Assessing Officer (AO) for the international transaction of "Software Development services". The assessee, a wholly owned subsidiary of BMC, USA, applied the Transactional Net Margin Method (TNMM) with a Profit Level Indicator (PLI) of Operating profits to Total cost (OP/TC). The Transfer Pricing Officer (TPO) made adjustments to the list of comparables, resulting in a transfer pricing adjustment initially computed at ?25,32,54,961/-, which was later revised to ?19,23,02,633/- following directions from the Dispute Resolution Panel (DRP).

2. Inclusion/Exclusion of Comparables:
- Bodhtree Consulting Ltd.: Excluded due to functional dissimilarity and a different revenue recognition model leading to fluctuating profit margins. The Hon’ble Gujarat High Court in Pr. CIT Vs. Allscripts (India) Private Ltd. upheld the exclusion of this company.
- e-Infochips Limited: Excluded because it combined revenues from Software Development and IT Enabled Services (ITES), which is not comparable to the assessee's software development services.
- e-Zest Solutions Ltd.: Included as it is a pure software development company without any signs of software product sales.
- Helios & Matheson Information Technology Ltd.: Excluded as it is engaged in both software services and software sales, making it functionally different from the assessee.
- KALS Infosystems Ltd.: Excluded due to its engagement in both software development services and software products, which is different from the assessee's activities.
- Maars Software International Ltd.: Excluded due to its on-site service model, which impacts operating margins differently compared to the assessee's offshore services.

3. Risk Adjustment:
The assessee sought risk adjustment, which was not granted by the TPO or the DRP. The Tribunal restored the matter to the file of AO/TPO for computing the risk adjustment, following the precedent set in the assessee's own case for the A.Y. 2006-07.

II. SALES SUPPORT SERVICES SEGMENT

1. Transfer Pricing Addition:
The assessee declared an international transaction of "Rendering of sales support services" with a transacted value of ?2,47,84,351/-. The TPO recommended a transfer pricing adjustment of ?33,09,723/-, which was later revised to ?14,78,560/- following directions from the DRP.

2. Inclusion/Exclusion of Comparables:
- TSR Darashaw Limited: Excluded due to a change in its business profile, making it incomparable with the assessee's marketing support services. The Tribunal followed the decision in Honeywell Turbo Technologies (India) Pvt. Ltd. Vs. DCIT for the A.Y. 2008-09, which recognized the changed business profile of TSR Darashaw.

III. OTHER ISSUES

1. Inclusion of Revenue from Sales Support Division:
The ground against the inclusion of revenue from the sales support division in export and total turnover was not pressed by the assessee and hence dismissed.

2. Computation of Deduction u/s.10A:
The AO excluded foreign currency expenses from 'export turnover' without corresponding exclusion from 'total turnover'. The Tribunal held that any exclusion from export turnover should also be reduced from total turnover for the purpose of deduction u/s.10A, following the Hon’ble Delhi High Court in CIT Vs. Genpact India.

3. Interest and Penalty:
The ground relating to charging of interest is consequential, and the ground for initiation of penalty u/s.271(1)(c) is premature.

Conclusion:
The appeal is partly allowed with directions for fresh determination of ALPs for the international transactions of software development services and sales support services, and the matter is remitted to the file of AO/TPO for further proceedings.