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TMI Blog2012 (5) TMI 414X X X X Extracts X X X X X X X X Extracts X X X X ..... be made to the margin arrived at by the AO for any differences at transaction level between the transaction of the assessee and that of the comparable companies. Appeal allowed by way of remand. - IT APPEAL NO. 6863 (MUM.) OF 2010 - - - Dated:- 31-10-2011 - N.V. VASUDEVAN, R.K. PANDA, JJ. D.V. Lakhani for the Appellant. G.P. Trivedi for the Respondent. ORDER N.V. Vasudevan, Judicial Member This is an appeal by the assessee against the order dated 1/9/2010 of the ACIT 5(3), Mumbai (hereinafter referred to as the AO) passed under section 143(3) of the Act r.w.s. 144C(13) of the Income Tax Act, 1961 (the Act). The grounds raised by the assessee in its appeal read as follows: "1. On the facts circumstances of the case the Learned Dispute Resolution Panel (DRP) has erred in directing the Assessing Officer to make addition of Rs. 1,71,28,081/- in compliance of Section 92C(4) of Income Tax Act, 1961. The appellant prays that the addition made of Rs. 1,71,28,081/- may be deleted. 2. On the facts and circumstances of the case the appellant prays that the DRP has not dealt with issues raised before them during the course of hearing and has arbitrarily re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee is a company. It is engaged in the business of software engineering and development. The assessee is a wholly owned subsidiary company of Trigent Software Inc.(TSI). There is no dispute that TSI was an associate enterprise and, therefore, any income arising out of international transaction between the assessee and TSI will have to be computed having regard to the Arms Length Price(ALP) as laid down in Section 92 of the Act. As already stated the assessee is in the business of software engineering development. TSI procures work for the assessee in USA. The assessee raises invoices on TSI and TSI in turn raises invoices for the sale amount on the US clients. According to the assessee it was receiving consideration for the work done for the US clients through TSI. Since there was no margin in the transactions there was no question of determining ALP. The sales of the assessee during the previous year total Rs. 20,35,04,602/-. It comprises of export sales of Rs. 15,44,99,316/- and local sales of Rs. 4,90,05,286/-. It is not in dispute that all the exports sales were through TSI. The AO made reference for determining Arm's Length Price (ALP) of the international transaction be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12. Mediasoft Solutions P Ltd. 1.76 6.29 13. R S Software (India) Ltd. 91.57 15.69 14. SIP Technologies Exports Ltd. 6.53 3.06 15. Bodhtree Consulting Ltd. 5.32 15.99 16. Accel Transmatics Ltd. (seg) 8.02 44.07 17. Synfoys Business Solutions Ltd. 4.49 10.61 18. Megasoft Ltd. 56.15 52.74 19. Lanco Global Solutions Ltd. 35.63 5.27 20. Flextronics Software Systems Ltd. 595.12 27.24 Average 20.68% The TPO was of the view that the Assessee's margin was less than the average margin derived in the above table. After giving margin of + 5% or -5% to the above average (second Proviso to Sec. 92C(2) lays down that the ALP determined by the AO is less or more than 5% as adopted by the AO then to that extent the difference can be ignored) the TPO was of the view that the following adjustment has to be made to the price declared by the assessee. (Amt. in Rs.) Softwar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arket. The assessee also pointed out that the geography mix of the product and service mix was different in the case of comparable companies. The assessee also pointed out that it does not sell third party product or their own IP based products. Within services there are many segments like pure net and Java based technical services, services with vertical domain knowledge, third party product implementation. The assessee pointed out that each of the above has different revenue rates, delivery costs and marketing costs. The assessee submitted that some of the comparable companies have good market in India and therefore they have better revenue and margins as compared to some of the companies who do not serve these kinds of markets. It was also submitted that the assessee provided pure net and java based services and had high delivery cost model besides high marketing cost. The assessee submitted that it does not have software based products where margins are high. It was submitted that the Assessee's software development team was small and the comparable companies had larger development teams giving them better margin. It was highlighted that the comparable companies had team sizes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e that each assessment year Is different to the other, The case laws c1uoted in this regard are distinguishable on facts. pat from this, there Is a fresh finding of facts having regard to the applicability of CUP in the year under consideration. Various other objections taken by the assessee are ruled out in view of the principles of TNMM which compare the transactions not on. product to product basis but on the operational basis. The reference to differences in the size of business in the case of certain comparables is not tenable as the assessee company's results are not compared with only one company. The comparison is based on the set of companies and only the average of their results is taken for the analysis. In view of the provisions U/s. 92C(3) of the I.T. Act, the international transactions as reported by the assessee are not found at arm's length. Therefore, the TNMM Is selected as the most appropriate method with operating profit on total cost profit level Indicator. As demonstrated in the foregoing paras, the comparison of the operating margin of the assessee company with those of comparable companies calls for an adjustment of Rs. 1,71,28,081/-. 8. The assessee has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the additional evidence now sought to be filed by the assessee would show that out of the 20 comparable instances taken by the AO, 13 companies are not comparable. The reasons for such non comparability have been stated as follows: Reasons for not comparing OP to TC of Tringent with - Aztec Software Ltd. Aztec Tringent 1. Revenue : Rs. 128.61 Cr. Revenue : Rs. 20.35 Cr. Op. Profit: Rs. Cr. Profit : 2.07 Cr. Op to TC : 18.09% Op to TC : 11.3% (IT Services + Staffing) 2. Provide Services in developing educational software solutions to teach real life academic and work force skills and emphasized on Student Learning, Empowerment Elevate. It Services has plain/vanilla coding services. Tringent has expert coders/programmer but do not have domain experts. Tringent gets its domain knowledge from the client and develops the application based on it. 3. Aztec has various products in Learning, skill building, administrative services for students data base. Also provides solution support towards adult education, post secondary distance education. Margins will be high due to less overhead exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has much lower margin compared to IT Services. This brings down the average margin. c. Consulting services will get higher margin than vanilla coding services. 3. Infosy execute large projects. Often the projects are publicized as multi million $ project. The larger the project the better is the margin due to size. Tringent on an average has project size of 1 to 5 people. Some of the smaller projects do not pay for manager cost. This has an affect on the margin as free managerial supervision needs to be provided in such case. Tringent has only one project which is large, having $1.6m in revenue. 4. Revenue of 9000+ Cr. It is 450 times the size of Tringent. Not comparable to Tringent due to its size of the company. Reasons for not comparing OP to TC of Tringent with- KALS Info Systems Ltd. KALS Info: Tringent 1. Revenue : Rs. 1.97 Cr. Revenue : Rs. 20.35 Cr. Op. Profit: Rs. 0.55 Cr. Profit : 2.07 Cr. Op to TC : 39.75% Op to TC : 11.3% (IT Services + Staffing) 2.Sales of Rs. 1.97 crs. With profit of Rs. 0.56 cr. a. Sales of Rs. 20 cr. Wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Services and Staffing division. 3. Persistent deals in third party products and gives specialized service for Microsoft Azure, Amazon Web Services, Google Apps and Salesforce.com's, Force.co. 3. IT Services has plain/vanilla coding services. Tringent has expert coders/programmer but do not have domain experts. Tringent gets its domain knowledge from the client and develops the application based on it. 4. Persistent has invested in veterans in product development culture. Their team of industry specialist have understandings of industries their customers operate in. Since the specialist are in demand, they carry higher/premium rates and thus better margin. 4.Tringent Staffing Services has lower risk compared to Tringent IT Services. Thus it has much lower margin compared to IT Services. This brings down the average margin 5. Having developed dozens of carrier-grade mobile applications across a broad array of platforms and handsets, Persistent is uniquely qualified as a mobile applications development partner. Whether it is building an end-to-end solution, or porting an application from one platform to another- or even building connectors int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anufactures total solutions. This being specialized knowledge, carries premium rate. IT Services has plain/vanilla coding services. Tringent has expert coders/programmer but do not have domain experts. Tringent gets its domain knowledge from the client and develops the application based on it. 3. Sasken Inc is a leading provider of embedded multimedia software solutions that enable the creation, delivery, management and presentation of rich multimedia content. This being specialized knowledge, carries premium rate. Trigent has plain Vanilla coding service in Java, Net, C++ etc. 4. Revenue is very high. Not comparable to Trigent. Not comparable to Tringent due to its size. 5. Revenue of 240 Cr. It is 12 times the size of Trigent. Reasons for not comparing OP to TC of Tringent with- Tata Elxsi Ltd. Tata Elxsi Tringent 1. Revenue : Rs. 188.81 Cr. Revenue : Rs. 20.35 Cr. Op. Profit: Rs. Cr. Profit : 2.07 Cr. Op to TC : 27.65% Op to TC : 11.3% (IT Services + Staffing) 2. Has intellectual property (IP) rights in communication and networking, sem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er Trigent Calculations As per Trigent Calculations 1a. Revenue : Rs. 35.04 Cr. Revenue : Rs. 20.35 Cr. Op. Profit: Rs. 10.94 Cr. Profit : 2.07 Cr. Op to TC : 45.04% Op to TC : 11.3% (IT Services + Staffing) Op Profit to Revenue : 31.22% Revenue to Op Profit: 10.2% 1b. As per TP Officer As per TP Officer Revenue : Rs. 8.02 Cr. Revenue : Rs. 20.35 Op. Profit ; Rs. Profit : Rs. 2.07 Op to TC : 44.07% OP to TC : 10.16%(IT Service+Staffing) Op. Profit to Revenue: Op Profit to Revenue: 2. Has three division. a. Technologies division: Operates in high end software domains like embedded software, multimedia communications, networks, image processing and process automation. a. Trigent does not have repeat business in the same domain. So people have to spend time to learn the domain before executing the project. Since extra time needs to be put in to learn the domain, this puts pressure on the margin. High end domains generally have better margins. Also has IP rights for few appl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o provides services in manufacturing, logistics, procurement, design, engineering and ODM services across a wide range of products and customer segments. IT Services has plain/vanilla coding services. Tringent has expert coders/programmer but do not have domain experts. Tringent gets its domain knowledge from the client and develops the application based on it. 3. Worldwide electronics design, fabrication, assembly, and test company. Services include printed circuit board, metal and plastics fabrication. Not comparable as Trigent does not manufacture or sell electronic fabrications. 4. Revenue of 595 Cr. It is 9 times the size of Trigent Not comparable to Tringent due to its size. 9. According to the assessee, it is a small public limited company and cannot be compared with the above companies whose turnover is large. According to the assessee the above companies should be excluded for the purpose of comparison, due to the nature of activity and business model etc. it was the prayer of the learned counsel for the assessee that since these details are available in public domain and are necessary for proper decision on the issue invol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iated 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 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. (2) For the purposes of sub-rule (1), the comparability of an international tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5 had an occasion to deal with a case where TNMM method was adopted by taking the overall operating profits of an assessee with the overall operating profits of certain other companies. The Tribunal on such approach held as follows: "75. In our understanding, the international transaction or an aggregate of similar international transactions, have to be evaluated, on a stand-alone basis and then compared with similar analysis undertaken on independent transactions. Comparison of the operating profits of the assessee-company as a whole, with the overall operating profits of certain other companies, without any adjustments, in our considered opinion, would not satisfy the requirements of evaluating an international transaction under TNMM, for the purpose of arriving at the arm's length price. In this case, the assessee has taken all the activities of the company as one unit and on an analysis of its profit loss account, arrived at an overall operating profit margin of 27 per cent. This is compared with the chart of overall operating profit margins of identified comparable companies, which is summarized in Table 5 of the report. No adjustments or segregations have been made betwee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... data. 14. The question whether the overall profitability of the comparable companies can be taken as the yardstick is again a matter which will depend on the functions performed by the comparable companies and to what extent they are similar to that of the assessee. Though as laid down in the decisions referred to above overall profitability cannot be taken as a yardstick but if transactions or set of transactions undertaken by the assessee and the comparable companies are substantially the same, there can be no objection to applying the overall profitability. However proper adjustments have to be made to the margin arrived at by the AO for any differences at transaction level between the transaction of the assessee and that of the comparable companies. 15. We are of the view that the determination of ALP has not been done in the present case in accordance with the law. The data filed by the assessee before us also requires consideration by the TPO. We are therefore of the view that it would be appropriate to set aside the impugned order and direct the AO to consider the objections raised by the assessee before us in accordance with law and determine the ALP after obtainin ..... X X X X Extracts X X X X X X X X Extracts X X X X
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