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TMI Blog2015 (1) TMI 838X X X X Extracts X X X X X X X X Extracts X X X X ..... regarding the action of the learned Assessing Officer and Honorable Dispute Resolution Panel making an addition to the total income by way of adjustment to the Arms' Length Price ("ALP") to an international transaction carried out by the assessee u/s. 92CA of the Act. At the time of hearing of the appeal it was submitted that the comparable companies chosen by the TPO and the addition made by the AO in the draft assessment order which was confirmed by the DRP are identical to the case decided by the Tribunal in ITA No.1054/Bang/2011 for AY 07-08 in M/s. Trilogy E-Business Software India Pvt. Ltd. Vs. DCIT, Circle 12(4), Bangalore, Logica Pvt. Ltd., 36 Taxmann.com 374 (Bang-Trib), 3DPLM Software Solutions Ltd. Vs. DCIT 42 taxmann.com 333 (Bang-Trib). It was also submitted that the business profile of the Assessee and that of the Assessee in the case of M/s. Trilogy E-Business Software India Pvt.Ltd. (supra) and Logica Pvt.Ltd.(supra) and 3DPLM Software Solutions Ltd. (supra) were also identical. This submission was found to be correct at the time of hearing. With this background we will now consider the factual basis of the present case and the decision rendered in the cases referr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omputed as under : Arithmetic mean PLI 21.72% Less: Working capital Adjustment (Annexure-C) 0.51% Adj.Arithmetic mean PLU 21.21% Operating Cost Rs.15,26,41,104 Arms Length Margin 21.21% of the operating cost Arms Length Price (ALP) At 119.17% of operating cost Rs.18,50,16,278/- Price Received Rs.17,14,54,932 Shortfall being adjustment u/s.92CA Rs.1,35,61,346 The above shortfall of Rs. 1,35,61,346/- is being treated as an adjustment to the price shown by the tax payer in its books of account." 7. Against the said adjustment proposed by the TPO which was incorporated in the draft assessment order by the AO, the assessee filed objections before the DRP. The DRP rejected those objections and confirmed the transfer pricing adjustment suggested by the TPO except one modification viz., PLI of M/s. Megasoft Ltd. whose profit margin was adopted by the TPO at 52.74% was directed to be adopted at 51.73% and consequential relief if any in working capital adjustment was also directed to be given. The adjustment confirmed by the DRP was added to the total income of the assessee by the AO in the fair order of assessment. Against the said order of the Ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sh 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. 11. 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 information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a 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." 10. The facts and circumstances under which the aforesaid companies were considered as comparable is identical in the case of the Assessee as well as in the case of Trilogy E-Business Software India Pvt.Ltd. (supra). Respectfully following the decision of the Tribunal referred to above in the case of Trilogy E-Business Software India Pvt.Ltd.(supra), we direct that the following companies be excluded from the list of 14 comparable arrived at by the TPO. a) KALS Information Systems Limited b) Accel Transmatic 11. As far as the comparable chosen by the TPO viz., TATA Elxsi(Seg.) (Sl.No.8 of the final list of comparable chosen by TPO) is concerned, this Tribunal in the case of Logica Pvt.Ltd.(supra) held that this company is not functionally comparable with a software development servic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l for the assessee fairly admitted that comparable company at Sl.No.6 viz., Flextronics Software Systems Pvt. Ltd. should be taken as a comparable, while comparable at Sl.No.24 viz., Tata Elxsi Ltd. should be rejected as a comparable. 16. On the above submissions of the ld. counsel for the assessee, the ld. DR submitted that as far as functional comparability is concerned, it is not enough only to look at the fact that in the decisions relied upon by the ld. counsel for the assessee, also dealt with the case of software development and the assessee is also a software developer rendering software development services. It was his submission that the aforesaid companies even if they are engaged in providing software services, can be engaged in different sectors to which they cater, like software development in telecommunication, automobile manufacturing sector, etc. It was his submission that it was also necessary to consider as to whether the sectors in which the comparable chosen by the TPO belong and the sector to which the Assessee caters. 17. We have considered the submissions of the ld. counsel for the assessee and the ld. DR. We are of the view that the comparables which are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Technologies India Pvt. Ltd. (ITA No.7821/Mum/2011). (iii) The rejection of this company as a comparable to software service providers has been upheld by the co-ordinate benches of this Tribunal in the cases of LG Soft India Pvt. Ltd. (ITA No.1121/Bang/2011) and CSR India Pvt. Ltd. [ IT(TP)A No.1119/Bang/2011 ] and by the Delhi Bench of the Tribunal in the case of Transwitch India Pvt. Ltd. (ITA No.6083/Del/2010). (iv) The factual position and circumstances pertaining to this company has not changed from the earlier Assessment Year 2007-08 to the period under consideration i.e. Assessment Year 2008-09 and therefore on this basis, this company cannot be considered as a comparable in the case on hand. (v) The relevant portion of the Annual Report of this company evidences that it is in the business of product development. The learned Authorised Representative prays that in view of the factual position as laid out above and the decisions of the co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 and other cases cited above, it is clear that this company being into product development cannot be considered as a comparable to the assessee i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dered as at Arms Length. He prayed for a limited direction to the TPO on the lines set out above and determine the ALP. It also submitted that the other issues raised by the Assessee in the grounds of appeal need not be gone into. 16. We are of the view that the prayer sought for by the learned counsel for the Assessee is acceptable and accordingly, the TPO is directed to compute ALP after excluding the 8 comparable companies dealt with in this order. 17. The learned counsel for the Assessee filed before us an application for raising additional ground of appeal. The Assessee was entitled to claim deduction u/s.10A of the Act. While computing deduction u/s.10A of the Act, the AO excluded softlink & internet charges amounting to Rs. 5,52,456/- being telecommunication expenses from export turnover on the ground that these expenses are incurred in rendering technical services rendered to clients outside India and therefore to be excluded from the export turnover while computing deduction under section 10A. The Assessee in the additional ground has made prayer that expenses that are reduced from the export turnover should also be reduced from the total turnover and in this regard has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... month from the end of the month in which,- (a) the acceptance is received; or (b) the period of filing of objections under sub-section (2) expires. (5) The Dispute Resolution Panel shall, in a case where any objection is received under sub-section (2), issue such directions, as it thinks fit, for the guidance of the Assessing Officer to enable him to complete the assessment. (6) The Dispute Resolution Panel shall issue the directions referred to in sub-section (5), after considering the following, namely:- (a) draft order; (b) objections filed by the assessee; (c) evidence furnished by the assessee; (d) report, if any, of the Assessing Officer, Valuation Officer or Transfer Pricing Officer or any other authority; (e) records relating to the draft order; (f) evidence collected by, or caused to be collected by, it; and (g) result of any enquiry made by, or caused to be made by, it. (7) ....... (8) The Dispute Resolution Panel may confirm, reduce or enhance the variations proposed in the draft order so, however, that it shall not set aside any proposed variation or issue any direction under sub-section (5) for further enquiry and passing of the assessment order. Explanat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dering software development services rendered by the Assessee to M/S. Pivotal Corporation of Canada was an international transaction with an AE and therefore the price receive by the Assessee for rendering such services has to pass the Arm's Length price (ALP) test as laid down in Sec.92 of the Act. During the financial year 2005-06, the assessee provided software development services to its AE and was remunerated on a 'cost plus' basis. The total value of international transaction with respect to the provision of software development services by the assessee to its AE was Rs. 29,03,80,299. 23. In support of the assessee's claim that the price charged by it for services rendered to its AE was at arms' length, the assessee filed a report as required by the provisions of section 92E of the Act in Form 3EB together with detailed analysis. The assessee adopted Transaction Net Margin Method (TNMM) as the most appropriate method for determining the ALP. Operating profits to cost was adopted as the Profit Level Indicator ("PLI"). The PLI of the assessee was arrived at 15.02%. 24. The TPO arrived at a final set of 11 comparable companies. The set of 11 comparable companies and their prof ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sasken Communication Technologies Ltd. 405.31crores (7) Infosys Technologies Ltd. 20264 crores. The above companies are listed at Sl.No.5 to 11 of the final list of comparables chosen by the TPO. 28. Our attention was drawn to the observations of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. (supra) on the application of turnover filter and it was submitted that the aforesaid comparable companies have to be excluded from the final list of comparables selected by the TPO. The learned DR relied on the order of the DRP. 29. We have considered the submission of the learned counsel for the Assessee and the learned DR. In the case of Trilogy E-Business Software India (P) Ltd. (supra), this Tribunal on application of the turnover filter while selecting comparable companies for comparability analysis held as follows: "(1) Turnover Filter 11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Rs. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... saction entered into by a Rs. 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate." 13. It was further submitted that the TPO's range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 14. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet's analysis, the turnover of Rs. 1 crore to Rs. 200 crores was held to be proper. The following relevant observations were brought to our notice:- "9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm's length price. Sec.92-B provides that "international transaction" means a transaction between two or more associated enterprises, either or both of whom are nonresidents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92- A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction 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 inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 10B of the IT Rules, 1962 prescribes rules for Determination of arm's length price under section 92C:- "10B. (1) For the purposes of sub-section (2) of section 92C, 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, in the following manner, namely :- (a)....... to (d)........ (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated 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 subclause (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 enterp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of transfer prices in relation to the transactions being compared." 19. A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. 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 Rs. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with a software development service provider: "14. The next aspect that was canvassed by the learned counsel for the assessee was with regard to the exclusion of the following comparables from the list of final comparables chosen by the TPO : 1. Bodhtree Consulting Ltd : As far as this company is concerned, the submission of the learned counsel for the assessee was that this company made extra ordinary profits during the previous year. Our attention was drawn to the fact that the operating profit / operating cost of this company jumped from 17% for F Y 2007-08 to 56% in FY 2008- 09. It dipped in FY 2009-10 to 40% and in FY 2010-11 it became (-) 2% and 5% in FY 2011-12 and finally touched (-) 9% in FY 2012-13. Our attention was drawn to the fact that the Special Bench of the Tribunal, Mumbai, in the case of Maersk Global Centres (India) P. Ltd., in ITA.7466/Mum/2012, dt 07.03.2014 for AY 2008-09 had an occasion to consider the question as to whether companies having abnormal profits should be excluded as a comparable. The Special Bench took the view that it has to be shown that the high profit margin does not reflect the normal business conditions and only in such circumstances, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In such business model expenditure for developing software would be billed in an earlier year but the revenue would be recognized in a subsequent year. It was his submission that this fact is recognized by the DRP in its order. According to him this circumstance would be sufficient to show that the margin reflected of this company does not reflect the normal business condition. 15. The learned DR placed reliance on the reason given by the DRP in its order. 16. We have considered the rival submissions. The Special Bench of the ITAT in the case of Maersk Global Centres (supra) had an occasion to deal with the question as to whether high profit margin making companies should be excluded as a comparable. The Special Bench after considering several aspects held in para 88 of its order that the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special bench held that in such cases it would require further investigation to ascertain the reasons for unusually high profit and in order to establish whether the entities with such high profits can be taken as comparable or not. In the light of the aforesaid decision of the Specia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f implementation of transfer pricing legislation in India and taxpayers as well as tax consultants were not fully conversant, with this new branch of law when proceedings were initiated or even at appellate stage. Besides, Revenue authorities, including TPO were required to apply statutory provisions and consider for purposes of comparison functions, assets and risks (turnover), profit and technology employed by the tested party and other enterprises taken as comparable. Statutory duty is cast on them to undertake above exercise. This has not been done in this case. Prima facie, as per the material, DM does not appear to be comparable. Even if the taxpayer or its counsel had taken DM as comparable in its T.P. audit, the taxpayer is entitled to point out to the Tribunal that above enterprise has wrongly been taken as comparable. In fact there are vast differences between tested party and the DM. The case of DM is like that of IC representing extreme positions. If IC has suffered heavy losses and, therefore, it is not treated as comparable by the tax authorities, they also have to consider that the DM has earned extraordinary profit and has a huge turnover. Besides differences in ass ..... X X X X Extracts X X X X X X X X Extracts X X X X
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