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TMI Blog2013 (11) TMI 190X X X X Extracts X X X X X X X X Extracts X X X X ..... penditure incurred by the assessee, if excluded from the Export Turnover should also be excluded from the Total Turnover - Following CIT v. Tata Elxsi Ltd. [2011 (8) TMI 782 - KARNATAKA HIGH COURT] There should be uniformity in the ingredients of both the numerator and the denominator of the formula, Section 10-A was a beneficial section - It was intended to provide incentives to promote exports - If the export turnover in the numerator was to be arrived at after excluding certain expenses, the same should also be excluded in computing the export turnover as a component of total turnover in the denominator - The reason being the total turnover included export turnover - The components of the export turnover in the numerator and the denominator cannot be different The grievance of the assessee projected in the aforesaid grounds would get redressed, if the AO was directed to reduce the communication and travel expenses from the export turnover as well as the total turnover, while computing deduction u/s. 10A of the Act. - IT(TP)A No.1366/Bang/2011 - - - Dated:- 22-2-2013 - N. BARATHVAJA SANKAR AND N.V. VASUDEVAN, JJ. For the Appellant : T. Suryanarayana. For the Res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,54,656/- Operating Profit (Op. Income - Op. Expenses) Rs.2,40,22,242/- Operating/Net margin (OP/TC) 12.21% 5. The assessee chose 11 comparable companies and the arithmetic mean of those comparables was as follows:- A.4. Comparables selected by Witness and their arithmetic mean: Mar - 05 Mar - 06 Company Name Op/tc op/tc Average C S Software Enterprise Ltd. 9 18 14 California Software Co. Ltd. 13 21 17 Compucom Software Ltd. 24 29 27 Danlaw Technologies India Ltd. (4) 1 (2) Four Soft Ltd. 16 14 15 I K F Technologies Ltd. 2 10 6 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7 above but accepted the filters at Sl.Nos.4 and 6 above. 7. The TPO to whom the computation of ALP was referred to by the AO u/s. 92CA of the Act, rejected 4 comparables on the ground that the related party transactions in those comparables were more than 25%. One comparable was rejected on the ground that it had diminishing revenues and predominantly on-site activities generated 85% of its revenue. One more company was rejected for the reason that it was functionally not comparable. Thus, out of 11 comparables chosen by the assessee, only two comparables were accepted by the TPO as comparable with that of the assessee viz., M/s. Quintegra Solutions Ltd. and S I P Technologies Exports Ltd. The TPO adopted his own filters and while doing so, arrived at 26 comparables including the two comparables chosen by the assessee. The 26 comparables chosen by the TPO were as follows:- A.6. Comparables selected by TPO and their arithmetic mean: Sl. No. Name of the Company Unadjusted WC adjusted 1 Accel Transmatic Ltd.(Segment) 21.11 19.61 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0.14 24 Tata Elxsi Ltd. (Segment) 26.51 25.70 25 Thirdware Solutions Ltd. (Segment) 25.12 21.03 26 Wipro Ltd. (Segment) 33.65 34.06 ARITHMETIC MEAN 25.14 22.67 8. After rejecting the various objections raised by the assessee, the TPO computed the ALP and suggested an addition of ₹ 2,05,82,039 as follows:- A.7. Computation of arm's length price by TPO and the adjustment made: Arm's Length Mean Margin 25.14 Less: Working Capital Adjustment 2.47 Adjusted mean margin of the comparables 22.67 Operating Cost 19,67,54,656 Arms Length Margin 22.67% of Operating Cost Arms Length Price (ALP) 122.67% of Operating Cost ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun Bradstreet Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun Bradstreet is more s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm's length price in an international transaction and it provides:- (1) that the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :- (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm's length price ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ther 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 transaction with an uncontrolled transaction shall be judged with reference ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 20. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee's turnover is ₹ 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ls provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis. It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures were placed before us:- Particulars FYs 05-06 06-07 07-08 08-09 Operating Revenue 21761611 35477523 29342809 28039851 Operating Expns. 16417661 23249646 23359186 31108949 Operating Profit 5343950 12227877 5983623 (3069098) Operating Margin 32.55% 52. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: The learned D.R. however drew our attention to page-389 of the paper book which is an extract from the Directors report which reads as follows: 'The Company has developed a de novo drug design tool CELSUITE to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Technology New Delhi) based on our insilico expertise (applying bio-informatics tools). The Company has developed a molecule to treat Leucoderma and multiple cancer and protected the IPR by filing the patent. The patent details have been discussed with Patent officials and the response is very favorable. The cloning and purification under wet lab procedures are under progress with our collaborative Institute, Department of Microbiology, Osmania University, Hyderabad. In the industrial biotechnology area, the company has signed the Technology transfer agreement with IMTECH CHANDIGA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s. 133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the segmental data for each activity is not available and therefore this company should not be treated as comparable. Besides the above, the Assessee has point out to several references in the annual report for 31.3.2007 highlighting the fact that this company was develops biotechnology products and provides related software development services. The TPO called for segmental data at the entity level from this company. The TPO also called for description of software development process. In response to the request of the TPO this company in its reply dated 29.3.2010 has given details of employees working in software development but it is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds. Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable. 47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . from the final list of comparables for the purpose of determining TNMM margin. 49. Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as comparable. The ld. DR, on the other hand, relied on the order of the TPO. 50. We have considered the submissions and are of the view that the plea of the assessee that the aforesaid company should not be treated as comparables was considered by the Tribunal in Capgemini India Ltd (supra) where the assessee was software developer. The Tribunal, in the said decision referred to by the ld. counsel for the assessee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables. 14. In view of the aforesaid decision of the Tribunal, comparables at Sl.Nos.1, 2 3 of the list of comparables chosen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rvices, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case of the assessee. 16. In view of the aforesaid decision of the Mumbai Bench of the Tribunal, which is also in relation to A.Y. 2007-08, we are of the view that the said company is to be excluded as a comparable while determining the ALP of the international transaction impugned in this appeal. 17. As far as companies at Sl.No.7 11 of the list of comparables chosen by the TPO are concerned, it is not in dispute that the related party transaction of these comparable companies was more than 15%. This Tribunal in the case of 24/7 Customer Com (P.) Ltd. (supra), had held that where comparables have related party transactions which are in excess of 15% of its total receipts, then such companies cannot be chosen for the purpose of comparison. Following are the relevant observations of the Tribunal:- 13.0 RELATED PARTY TRANSACTIONS In respect of the ground raised at S.No.1 regarding acceptance of comparable companies having related party transactions as proposed by the TPO, the learned counsel for the assessee argued that the transfer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tware service segment) in the case of Geometric, Kals Info systems, R Systems, Sasken Communication and Tata Elxsi. Before DRP the Assessee pointed out that the segmental margin of 23.11% alone should be taken for comparability. The DRP has not given any specific finding on the above plea of the Assessee. Perusal of the order of the TPO shows that the TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius-BCGI Division does the business of product software (developing software). This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product software (software developed) would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O and after excluding the comparables referred to in the earlier paragraphs, the comparable companies that would remain for comparison and the arithmetic mean of the remaining comparables would be as follows:- C.2. Computation of arithmetic mean of the 11 remaining comparables: If the above argument of the Appellant is accepted, the arithmetic mean of 11 remaining of the 26 comparables would be as follows: SI. No. Name of the Company Operating Revenues Unadjusted WC adjusted 1 Datamatics Ltd 54,50,88,027 1.38 -1.23 2 E-Zest Solutions Ltd. 6,25,94,544 36.12 35.64 3 Helio Matheson Information Technology Ltd. 178,63,80,304 36.63 34.01 4 LGS Global Ltd. 45,38,93,898 15.75 14.62 5 Media Soft Solutions Pvt. Ltd. 1,85,08,785 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n, the assessee had not reduced telecommunication expenses of ₹ 62,35,424/- and travelling expenses of ₹ 40,17,354/- from the export turnover as no part of the expenditure was attributable to the delivery of software outside India. The Assessing Officer, however, proceeded to recompute the deduction by once again reducing the said amount of ₹ 1,02,52,778/- from export turnover but not from total turnover and thereby disallowed the 10A deduction to the extent of ₹ 12,42,705/-. The assessee's submission is that no part of the above expenditure was attributable to the delivery of software outside India and in the alternative, if the same is reduced from export turnover, it should also be reduced from total turnover. The alternative submission is supported by the decision of the Hon'ble High Court of Karnataka in CIT v. Tata Elxsi Ltd. [2012] 349 ITR 98 (Karn). 26. As far as the alternative claim is concerned, we find that the Hon'ble High Court of Karnataka in the case of Tata Elxsi Ltd. (supra) has held that while computing deduction under section 10A of the Income Tax Act, 1961 (the Act ), expenditure incurred by the assessee, if excluded from ..... X X X X Extracts X X X X X X X X Extracts X X X X
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