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TMI Blog2013 (9) TMI 189X X X X Extracts X X X X X X X X Extracts X X X X ..... filed its return of income on 31.10.2007 declaring total income of Rs. 8,39,46,266/- after claiming deduction u/s.10A, amounting to Rs.50,75,75,651/- and deduction u/s.80JJAA amounting to Rs.11,09,95,555/-. In the proceedings u/s.143(3) r.w.s.144C, the Assessing Officer and the TPO proposed certain corporate tax and transfer pricing adjustments to the returned income of the assessee which were incorporated in the draft assessment order dated 20.12.2010, The Assessing Officer made the following additions/disallowances to the total income of the assessee : Sl No. Nature of addition/disallowances Amount (Rs.) Amount (Rs.) 1a Reduction of the following amounts from 'export turnover' for computing deduction u/s.10A of the Act -Data link charges 2,35,08,825 -Certain expenditure incurred in foreign currency 33,09,33,846 1b. Reduction in total 10A deduction (Rs.59,75,75,651 - Rs. 56,01,43,562 3,74,32,089 2. Capitalisation of expenses incurred on purchase of software debited to the Profit & Loss account 3,83,71,306 3. Disallowance of entire deduction u/s.80JJAA 11,09,95,555 4. Additions made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sp; Comparability analysis adopted by the TPO/DCIT for determination of arm's length price 12. The learned TPO/DCIT grossly erred on facts in benchmarking the transactions of the captive software services of the Appellant with companies operating as full-fledged entrepreneurs, without considering the differences in the functions performed, assets employed and risk undertaken by the Appellant vis-à-vis comparable companies. 13. The learned TPO/DCIT erred on facts in rejecting the comparable companies arrived at in the Transfer Pricing Study, without considering the functional and risk analysis of the Appellant. 14. The learned TPO/DCIT erred in law in applying arbitrary filters to arrive at a fresh set of companies as comparables to the Appellant, without establishing functional comparability. 15. The learned TPO/DCIT grossly erred in law in deviating from the uncontrolled party transaction definition as per the Income-tax Rules, 1963 and arbitrarily applying a 25% related party criteria in accepting/rejecting comparables. 16. The learn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the Appellant." Though the assessee has taken various grounds as narrated above, the learned representative mainly argued the grounds relating to turnover filter and filter relating to functionally different companies. 5. The assessee undertook a transfer pricing study for establishing the arm's length price of its international transactions with the Associated Enterprises (AEs). The transfer pricing study was carried out by an independent external consultant in accordance with the provisions of the Act, read with Income-tax Rules 1962. An analysis was undertaken to determine the functions performed, risks assumed and assets utilized (FAR analysis) by the assessee and its AEs in respect of the international transactions between them. Based on the TP study, the independent external consultant concluded that the price charged by the assessee in respect of its international transaction with AEs is at arm's length. The key features of the TP study undertaken for software services are as under : As per the functional analysis, the assessee was categorized as a 'risk mitigated service provider' and selected as the tested party. TNM ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted a fresh economic analysis and undertook a fresh analysis, for which the TPO chose the following 26 companies as comparables : No. Name of the Company Turnover Gross Margin 1 Accel Transmatic Ltd.(Segment) 9.68 21.11 2 Avani Cimcom Technologies Ltd. 3.55 52.59 3 Celestial Labs Ltd. 14.13 58.35 4 Batamatics Ltd. 54.51 1.38 5 E-Zest Solutions Ltd. 6.26 36.12 6 Flextronics Software Systems Ltd. (Segment) 848.66 25.31 7 Geometric Ltd. (Segment) 158.38 10.71 8 Helio c Matheson Information Technology Ltd. 178.63 36.63 9 iGate Global Solutions Ltd. 747.27 7.49 10 Infosys Technologies Ltd. 13,149.00 40.30 11 Ishir Infortech Ltd. 7.42 30.12 12 KALS Information Systems Ltd. 2.00 30.55 13 LGS Global Ltd. 45.39 15.75 14 Lucid Software Ltd. 1.70 19.37 15 Media Soft Solutions Pvt. Ltd. 1.85 3.66 16 Megasoft Ltd. 139.33 60.23 17 Mindtree Ltd. 590.35 16.90 18 Persistent Systems Ltd. 293/75 24.52 19 Quintegra Solutions Ltd. 62.72 12.56 20 R 5 Software (India) Ltd. 101.04 13.47 21 R Systems International Ltd(Segment) 112.01 15 07 22 Sasken Communication Technologies Ltd(Segment) 343.57 22.17 23 S I P Tec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this, the ALP of the software development services rendered by the taxpayer to its AE(s) is computed as under : Arithmetic mean PLI : 25.14% Less : Working capital adjustment : 0.64% Adjusted Arithmetic mean PLI : 24.50% Arm's Length Price : Operating cost Rs.519,84,56,000 Arm's Length Margin 24.50% of the operating cost Arm's Length Price (ALP) @ 124.40% of operating cost Rs.647,20,77,720 The price charged by the tax payer to its Associated Enterprises is compared to the Arm's Length Price, as under : Arm's Length Price @ 124.50% of operating cost (a) Rs.647,20,77,720 Price charged in the international transactions (b) Rs.594,15,42,882 Operating revenues (c) Rs.597,97,10,000 Revenues from non-AE parties (d) = (c) - (b) Rs. 3,81,67,118 Arm's length price of international transactions (c) = (a) - (d) Rs.643,39,10,602 Shortfall being adjustment u/s.92CA (f) = (e) - (b) Rs. 49,23,67,720 Aggrieved, the assessee is in appeal before us. 8. While relying on the crux of the grounds of appeal extracted elsewhere, the learned Charter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In case of Triology also, the turnover was of only Rs. 48 crores, and hence turnover filter of Rs. 200 crores was adopted. 4.2 It is submitted that in both these cases, turnover filter has been used for the upper limit of the comparables. Further, the Dun and Bradstreet study (D & B Study) cannot be followed to adopt both the upper and lower limit of turnover as a rigid compartment, assumably segregating different species of software companies for the following reasons: (i) This is not a study of any basic and inherent economic parameters/differences which leads to any conclusion that the three distinct categories of software companies exist in India, in terms of profitability. (ii) The turnover criterion has been adopted merely to facilitate the study of comparative analysis in economic behaviour of three groups of software companies over two years, i.e. 2004 & 2005. It may be compared to a football tournament among four sections of Standard IX students of a school. While the tournament would throw up some section (Say C) as winner and the other would be ranked last (Say A), it cannot be concluded based on the results that stude ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wer turnover limit in a case of with turnover of Rs. 598 crores, as that of the assessee. The case laws may be applied only in cases having similar turnover for the sake of upper turnover margin of Rs. 200 crores as filter. As explained above, there is no finding even in the D&B study that such segments of software industry conform to any fixed rate or range of profit margins to operational cost. 4.4 The assessee's turnover is about Rs. 598 crores, and during the proceedings before the TPO, it agreed to the selection of comparables having minimum turnover of Rs. 100 crores and maximum of Rs.2000 crores. For the purpose of lower turnover limit, it is submitted that Rs. 60 crores may be adopted which would be reasonable being 10 times smaller than the assessee, and upper limit of Rs. 5000 crore, being 8 times higher, Ld. AR has not shown any fundamental economic differences in the comparables having turnover of Rs. 50 crores and above with that of the assessee." 10. We have heard the rival submissions and perused the materials on record. Regarding the turnover filter, we are convinced that this issue is covered by the decision of this Tribunal in Genisys Integrating Systems (India) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the notice u/s 133(6 stated that it cannot be considered as comparable to any other software services company due to its complex nature. Accordingly, the Appellant wishes to submit that Tata Elxsi should be excluded from the list of comparables. Flextronics Software Systems Limited (seg) The company has earned revenues from software services on the basis of a hybrid revenue model (i.e. royalty that would become receivable on successful sale of products by the customers of the company) which is based on the information provided under "Revenue recognition" in the annual report of the company. This model adopted by the company is not similar to the regular models adopted by other software service providers. The Hon'ble Tribunal would appreciate that a regular software services provider cannot be compared to a company having such a conditional/unique revenue model, wherein the revenues of the company from software/product development services depends on the success of the products sold by its clients in the marketplace. Hence, it would be inappropriate to compare the business operations of the Appellant with that of a company which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Appellant wishes to submit detailed depreciation adjustment calculation as follow: Step 1: Depreciation charged by companies selected by TPO was extracted from respective annual reports; Step 2: For the purpose of comparison, the assets were broadly classified under different heads, viz., Computer, Furniture, etc. Step 3: The depreciation rate charged by HTSL was applied to the assets of the comparable companies (except land and building to which the actual rate charged was applied) accepted by the TPO. Step 4: The actual charged by the companies is added back and the revised depreciation is deducted to arrive at the operating profits and operating margin, which is compared with the operating margin of HTSL. The revised arithmetical mean margin of the companies selected by the learned TPO as comparables, after taking into account the depreciation adjustment goes down from 25.14% to 20.36%. The Appellant wishes to submit that to ensure uniformity and to ensure a fair and equitable comparison, the Appellant requests the Hon'ble Bench to grant adjustments for depreciation owing to the differences in depreciation policies." 15. Per contra, the learned DR supported the order of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the ITAT have also taken similar view regarding depreciation adjustment. Hence, following the above decision, we are directing the TPO/Assessing Officer to give the benefit of depreciation adjustment to the assessee as per the chart filed by the assessee which works out to around 3.39%. Thus, after the depreciation adjustment of 3.39%, from 16.56% (105% of 15.77% the ALP will come to 13.17%. Apart from this, the Assessing Officer shall give effect to the proviso to sub-section (2) of Section 92C, as per the latest amended Act, as regards 5% range. Thus, the issue of transfer pricing is restored to the file of the Assessing Officer/TPO, to carry out the above directions, of course, after giving effective opportunity of hearing to the assessee. Though the assessee has taken other grounds relating to TP issue (extracted elsewhere in this order), we are not going into those issues as the learned chartered accountant during the course of hearing submitted that if these adjustments dealt by us, viz., turnover filter, unreasonable comparison filter and depreciation adjustment, are given, the assessee's profit would be within the ALP. It is ordered accordingly. Ground relating to corr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... earned DCIT has erred, in law and in facts, by reducing the expenses incurred by the Appellant towards telecommunication in respect of STP Unit II [amounting to Rs 23,508,825] from the export turnover, as being attributable towards the delivery of computer software outside India in computing the deduction under section 10A of the Act. 4. The learned DCIT has erred in law and in facts, by reducing certain expenditure incurred by the Appellant in foreign currency pertaining to STP Unit II amounting to Rs 330,933,847, without appreciating the fact that the Appellant is engaged in the business of software development and does not render any technical services outside India. 5. Without .prejudice to the above, the learned DCIT has erred, in law, and in facts, by not considering the plea of the Appellant that, if the telecommunication attributable to the delivery of computer software outside India and foreign expenses incurred towards rendering of technical services are reduced from export turnover, a corresponding amount should also be reduced from total turnover for computing the deduction under section 10A of the Act, based on the 'p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appeal of the assessee. Since ground no.5 is allowed as above in favour of the assessee, we are not going into ground nos.3 and 4 as they become infructuous, even according to the learned AR. 25. This issue is allowed in favour of the assessee. 26. Now, let us turn to the ground no.6 relating to software expenses, which reads as under : "The learned DCIT has erred in law and in fact, in capitalizing the software charges expensed by the Appellant, amounting to Rs. 38,371,306 without appreciating the detailed submission made by the Appellant that such software expenses do not result in any enduring benefit to the Appellant." 27. The brief facts are that during the assessment year 2007-08, the assessee has incurred software expenses to the extent of approximately Rs 7.7 crores, pertaining to annual maintenance expenses and purchase of software, which have been debited to the P&L Account. Further, the Company has also capitalized in its books certain software expenses which provide enduring benefit to the Company, amounting to approximately Rs 4 crores. During the course of the assessment proceedings, the learned AO has capitalized software expenses debited ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nature (extract of the case law is enclosed at page 530-533 of the Paperbook II). The above judgement also held that what is required to be seen is the real intent and purpose of the expenditure and whether the expenditure results in creation of fixed capital for the assessee. he expenditure which is incurred, which enables the profit making structure to work more efficiently leaving the source of the profit making structure untouched, would be an expense in the nature of revenue expenditure. 28. The learned AR further submitted that the software expenses debited to the P&L A/c are attributable towards purchase of application software and software licenses which predominantly have a short shelf life. This software is used to carry out the Appellant's business more efficiently and profitably and is not part of the 'profit-making apparatus'. Thus, in accordance with the principles laid out in the cases of Amway and Asahi Glass, the Appellant wishes to submit that the software expenses are revenue in nature. The learned AR placed reliance on certain other case laws which have upheld the above principles, as under : * Raychem RPG Ltd - Bombay High Court (ITA No 4176 of 2009) * CIT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and decide the issue in accordance with the decisions of the Delhi Special Bench in Amway India Enterprises (supra) and the decision. of the Karnataka High Court in Toyota Kirloskar Motors P. Ltd. (supra), after giving effective opportunity of hearing to the assessee. Thus, this issue is allowed for statistical purpose. It is ordered accordingly. 32. Now, let us turn to the ground relating to deduction u/s.80 JJAA of the Act, which reads as under : "The learned DCIT has erred in law and in facts by disallowing the deduction claimed by the Appellant under section 80JJAA of the Act amounting to Rs. 110,995,555, without appreciating the detailed factual and technical submissions made by the Appellant in support of its claim." 33. The brief facts are that while framing the assessment u/s.143(3) r.w.s.144C of the Act, the Assessing Officer noted that during the year, the assessee claimed an amounting of Rs.11,09,55,555/- as deduction u/s.80JJAA of the IT Act. The Assessing Officer disallowed the claim of the assessee the deduction u/s.80JJAA, as the assessee could not substantiate the claim, particularly with respect to the definition of "workman" as given ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... loyment is provided by the assessee company. * In this context, it would be relevant to examine the definition of workmen, and whether the employees of the Company with respect to whom the said deduction has been claimed qualify as 'workmen' under section 8OJJAA. * Workman The basis for deduction under section 8OJJAA is the salary paid to 'new regular workman'. The section contains the definition of 'workman', and is defined to have the same meaning assigned to it in clause (5) of section (2) of the Industrial Disputes Act 1947. The term 'workman' is defined in the Industrial Disputes Act as under: "'Workman means any person (including an apprentice) employed in any industry to do any manual, unskilled, skilled, technical, operational, clerical or supervisory work for hire or reward, whet her the terms of employment be express or implied, and for the purposes of any proceeding under this Act in relation to an ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he mechanical arts and applied science generally, as in technical education, or in technical school". * Whether a work is 'technical' or not depends upon the special mental training or scientific or technical knowledge of a person. The broad test is that if a person is employed because he possesses such faculties and they enable him to produce something as a creation of his own, he would be employed on 'technical work' even though in carrying out that work, he may have to go through a lot of manual labour or routine/ repetitive work. * In the case of a person employed in a technical capacity, the application of knowledge of a particular craft or work is the distinguishing feature. It is not necessary that the work that such a person does must be inventive, but it must necessarily be a work the contours of which are not pre-determined before that work is actually performed by the person employed in a technical capacity. This principle was brought out by the Mumbai High Court in the case of Bombay Dyeing and Manufacturing Co Ltd. v. RA Bidoo(q) [1991] I LLJ 98, 101-2 (extract of the case law enclosed at page 549-550 of the Paperbook II). * We also wish to place reliance on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , wherein the Supreme Court observed the following (extract of the caselaw enclosed at page 551-552 of the Paperbook II): * "...the designation of an employee is not of much importance and what is important is the nature of duties being performed by him. The determinative factor is the main duties of the concerned employee and not some work incidentally done. In other words, what is in substance, the work which employee does or what is in substance he is employed to do. Viewed from this angle, the employee is mainly doing supervisory work but incidentally or for a fraction of time, does also some manual or clerical work, the employee should be held to be doing supervision work. Conversely, if the main work is of manual, clerical or technical nature, the mere fact that some supervisory work or other work is also done by the employee incidentally or only a small fraction of working time is devoted to some supervisory work, the employee will come within the purview of the "workman" as defined in section 2(s) of the Industrial Disputes Act." * The Supreme Court in the case of Ananda Bazar Patrika Pvt Ltd v Its Workmen [1969] [2 LLJ 670-71] also laid out the following similar princi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to employers giving employment to a specified minimum number of employees. Hence, the interpretation of the section should be in a manner which promotes the objective sought to be achieved and not frustrate it. * Further, the Appellant wishes to humbly submit that being a beneficial provision, it must be liberally construed. These were the principles brought out by the Supreme Court while dealing with deduction under section 80J in the case of Bajaj Tempo v CIT (196 ITR 188). Hence, the section would need to be interpreted in a purposive manner. * In view of all the principles enumerated above, we wish to humbly submit that a software engineer would also be covered by the definition of the term workman', and the salary drawn by him would ergo qualify for deduction under section 80JJAA. Further, since the Appellant has satisfied the conditions for being eligible to claim the deduction under section 80JJAA of the Act and has demonstrated the same in detail during the course of scrutiny assessment proceedings, we pray that the deduction not be disallowed in the hands of the Appellant. 35. Per contra, the learned DR reiterated the contents of the assessment order as his submissio ..... X X X X Extracts X X X X X X X X Extracts X X X X
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