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TMI Blog2015 (2) TMI 944X X X X Extracts X X X X X X X X Extracts X X X X ..... ern from software development services falls below 75% of its total income and therefore, it deserves to be excluded even on the basis of the filter applied by the TPO. - Decided in favour of assessee. For inclusion of CG-VAK Software Systems Limited (Software Services Segment) the said concern cannot be excluded merely because of incurrence of loss in this year, especially when the said loss has not been established to be an abnormal business condition and more so in the context that the said concern is not denied to be functionally comparable to the assessee. Therefore, on this aspect, we uphold the plea of the assessee for including the said concern in the final set of comparables in order to determine the arm s length price of the international transaction. - Decided in favour of assessee. For inclusion of M/s. Thinksoft Global Services Limited The argument being set up by the lower authorities that the ‘Verification’ and ‘Validation’ are steps to test the efficiency of the software, but not a part of software development, in our view is a hairsplitting argument, which is not justified in the context of the present comparability analysis. Ostensibly, ‘Verification’ and ‘Validat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aforesaid four concerns in concerned, the same has been adopted by the TPO without giving the assessee any opportunity of being heard and therefore in our view the matter ought to be remanded back to the AO/TPO for consideration afresh. - Decided in favour of assessee for statical purposes. X X X X Extracts X X X X X X X X Extracts X X X X ..... segments cannot be considered to be comparable to the Appellant, since the Appellant is compensated on the basis of cost plus pricing mechanism; 2.4 rejecting the functionally comparable Thinksoft Global Services Limited on the basis of erroneous interpretation that it is engaged in software verification and validation activities which are not a part of software development process; and 2.5 rejecting certain companies functionally similar to that of the Appellant's business operations of provision of software services. Ground No. 3: Erroneous rejection of economic adjustment for differences in levels of risks Hon'ble DRP/ Ld. AO erred in not allowing an adjustment for the difference between the level of risk borne by the comparables and the Appellant, despite the fact that the Appellant has demonstrated these differences by submitting a detailed analysis of Functions performed, Assets employed and Risks assumed ('FAR analysis') before the Hon'ble DRP. In doing so, Hon'ble DRP/ Ld. AO erred in: • failing to appreciate that the Appellant is a routine captive service provider as against the selected comparable companies, which include entrepreneurial c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s with its associated enterprises at ₹ 40,85,97,054/- as against the stated value of ₹ 37,15,99,152/-, thereby resulting in an addition of ₹ 3,69,97,907/- to the returned income. 4. Briefly put, the facts and background of the case relevant to adjudicate the aforesaid controversy can be understood as follows. The appellant is a company incorporated under the provisions of the Companies Act, 1956 and is a wholly owned subsidiary of TIBCO US. The appellant company is registered as a 100% Export Oriented Unit (EOU) under the Software Technology Park of India (STPI) scheme and the profits earned by it enjoy a tax holiday in terms of section 10A of the Act. Broadly speaking, assessee company provides software research and development services to TIBCO US as per the design, production orders, plans, process specification and production schedules provided by TIBCO US. During the year under consideration, assessee had entered into three types of international transactions with its parent company, i.e. TIBCO US, which were Provision of software design and development services; Provision of sales and customer support services; and, Payment of interest on external commercia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssing Officer in line with the order of the TPO dated 31.10.2011. The aforesaid addition is the subject-matter of dispute before us. 6. Before proceeding to adjudicate the specific issues raised before us, we may briefly touch-upon the relevant facts. In its Transfer Pricing Study, assessee had adopted the TNM method to benchmark its international transaction of software development services undertaken with its associated enterprise, and Operating Profits/Operating Cost was used as the Profit Level Indicator (i.e. PLI) for the said purpose. The assessee compared its PLI of 15.19% with arithmetic mean of the margins of the comparable cases selected at 14.84%; and, as assessee's PLI was higher than the arithmetic mean of the margins of the comparable cases, the stated value of the international transactions was said to be at arm's length price. The TPO has not disputed the adoption of TNM method as the most appropriate method for the purpose of undertaking the comparability analysis. The TPO has also not differed with the assessee with regard to the adoption of Operating Profit/Operating Cost as the PLI for the purpose of the comparability analysis. However, the TPO noticed that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ground No.2 raised according to which assessee contends that the TPO/AO erred in accepting certain comparables and/or rejecting certain comparables in order to benchmark the international transactions of Provision of software development services. At the time of hearing, appellant has furnished voluminous Paper Books which, inter-alia, contained copies of the Transfer Pricing study undertaken by the assessee, copies of relevant extract of Annual Reports of the comparable cases as also the submissions on various issues made before the lower authorities, etc.. During the course of hearing, the learned counsel has referred and relied on various material placed in the Paper Book which have been duly considered by us. The leaned CIT-DR has also furnished written submissions which have also been duly considered. 10. The first plea of the assessee is with respect to M/s Kals Information System, (applications software segment), a concern which has been included as a comparable by the TPO for the purposes of comparability analysis. According to the assessee, the inclusion of said concern as a comparable is wrong because the said concern is functionally different from the activities undert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies. It has also been pointed out that the activities of said concern were considered by the Pune Bench of the Tribunal in the case of Bindview India P. Ltd. vide ITA No.1386/PN/2010 order dated 30.11.2011, wherein it has been held that the said concern was functionally different from a software development service provider. A reference has also been made to the decision of the Bangalore Bench of the Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd. vide ITA No.1054/Bang/2011 order dated 23.11.2012, wherein also said concern was held to be not comparable to a software development service provider. 12. On the other hand, the learned CIT-DR has reiterated the stand of the lower authorities by pointing out that mere ownership of software products would not make a concern functionally non-comparable to a software development service provider, who did not own any software product. According to him, such difference is not a material difference contemplated under the TNM method for the purposes of comparability analysis. Apart therefrom, it has been pointed out that the said concern vide a communication dated 13.01.2009 addressed to the Addl.CIT (TP), Hyderabad confirme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Pune Bench of the Tribunal in the case of Bindview India P. Ltd. (supra) also considered a somewhat similar situation and, found M/s Kals Information System Ltd. (applications software segment) to be incomparable to a concern which was Providing software development services, as is the case of the assessee before us. Moreover, the material relied upon by the assessee before the lower authorities, copies of which have also been placed in the Paper Book filed before us, supports the assertions of the assessee that the said concern is engaged in development and sale of software product, etc., which is distinct from the software development services rendered by the assessee to its associated enterprise. Thus, we are inclined to uphold the plea of the assessee that the M/s Kals Information System Ltd. (applications software segment) is functionally incomparable to the assessee. 15. The attempt by the learned CIT-DR to support the stand of the TPO on the basis of a communication received by Addl.CIT (TP), Hyderabad regarding Kals Information System Ltd., in our view, is untenable. Ostensibly, such an information was not available in public domain and therefore it could not have bee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lients which required IT as well as IT enabled services. The aforesaid aspect was asserted on the basis of the statements in the Annual Report of the said concern. The TPO has reproduced the submissions of the assessee before him which inter alia, also include an extract from the Annual Report of the said concern regarding the nature of services being rendered by FCS Software Solutions Limited. 19. The TPO rejected assessee's plea for exclusion of FCS Software Solutions Limited. The TPO referred to a CBDT's Circular No.SO890(E), dated 26.09.2000 which detailed list of products / services which could be categorized as ITES for the purposes of sections 10A and 10B of the Act. According to the TPO, in terms of the CBDT Circular, the Information Technology Enabled Services (ITES) would include running of remote maintenance and support centres also. According to the TPO, E-learning and Digital Consulting activity cannot be categorized as ITES and therefore, the same is to be understood as a segment of software development services. The TPO concluded that substantial part of the said concern's income came from software development services and therefore, it is a comparable concern. 20. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 11% and 15% respectively of the total revenue, are in the nature of IT enabled services and not linked to the software development services. On this basis, it was sought to be pointed out that if the aforesaid income streams are excluded from the segment of software development services, then the income from software development services segment falls below 75% of the total income. The TPO had applied a filter to exclude such concerns from the list of comparables, wherein the income from software development services was less than 75% of the total income. In fact, in the discussion made by the TPO in response to assessee's aforesaid assertions, there is no denial to the same. Though the TPO goes on to rely on the CBDT's Circular dated 26.09.2000 (supra), but that is in relation to the activity of E-learning and Digital Consulting being carried out by the assessee. The segment of E-learning and Digital Consulting is a different segment. In any case, assessee's plea based on the nature of services on account of application support services segment and infrastructure management services segment have not been rebutted by the TPO. Therefore, we are inclined to hold that the application ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tionally comparable to the assessee and therefore, it could not have been rejected merely because it had incurred a loss in this year. It was pointed out that the said concern was not a consistently loss making concern and therefore, it could have been excluded from the list of comparables. In this context, it was pointed out that the TPO had show caused the assessee in the course of transfer pricing proceedings as to why the persistently loss making units be not excluded. So however, the said concern was not persistently loss making, and therefore, it could not have been excluded. In this connection, reference was invited to the detailed margin computations of the said concern for the three years i.e. preceding financial years 2005-06 and 2006-07 and the year under consideration as depicted in working, placed at page 1097 of the Paper Book. In terms of the same, it was pointed out that the said concern was earning profits in its software services segment in the preceding two financial years 2005-06 and 2006-07 and that it was only in the year under consideration, there was a loss. It was also pointed out that the TPO erred in rejecting a concern merely that it incurred a loss whil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... said concern in the final set of comparables in order to determine the arm's length price of the international transaction. Thus, on this aspect, assessee succeeds. 30. The next plea of the assessee is for inclusion of M/s. Thinksoft Global Services Limited in the final set of comparables. The TPO in para 15.11 of his order has justified the exclusion of the said concern from the final set of comparables on the ground that it was engaged in software testing, software validation and verification services to the banking and financial services industry worldwide. Therefore, according to the TPO, the said concern was functionally not comparable to the assessee. Before the lower authorities, plea of the assessee was that the services being rendered by the said concern were part and parcel of the activity of software development services and therefore, it could not be rejected as a comparable. The TPO as well as the DRP observed that the activities of software verification and validation are only steps to examine the efficiency of software, but cannot be said to be a part of a software development activity. The aforesaid assertions have also been reiterated before us in order to ju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and therefore, the finding of the TPO that Thinksoft Global Service Limited, is a functionally different company, appears to be correct". In our considered opinion, the aforesaid finding of the DRP goes to show, in the context of the fact situation of assessee's activities and that of Thinksfot Global Services Limited, that both are engaged in carrying out activities which are parts of the process of software development activities. It is quite justifiable to comprehend that the activity of verification of software and validation of software are activities which are part and parcel of the process of software development. In fact, before the DRP, assessee referred to the Wikipedia meaning of the expression 'Verification' and 'Validation' in the context of software. The expression 'Verification' was explained to be referring to the process of evaluating the software to determine whether the products of a given development phase specified the conditions imposed at the start of that phase. Similarly, the expression 'Validation' was explained to be the process of evaluating software during or at the end of the development process to determine whether it satisfies specified requirements. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is placed the relevant contents of the Directors report of said concern for the year under consideration. The Directors report, while giving an overview of the activities of the concern, states that the major area of revenue generation continues to be SAP consulting and implementation mainly in USA and Middle East. In fact, in the paragraph containing overview of the operations, the aforesaid statement is the only assertion which elucidates the activities being undertaken by the said concern. No doubt, in the financial statement namely Profit & Loss Account, the income / revenue has been classified as "income from software development, training and product" so however, evidently no detailed bifurcation thereof is available. The entire set of financial statements which are in public domain, and placed in the Paper Book at pages 1188 to 1229, contain only a singular observation about the nature of activities, which is in the Directors report, which throws light on the major area of revenue generation. Even if one goes by the nomenclature stated in the Profit & Loss Account i.e. software development, training and product and product, and infer that the concern is in the software devel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not restrict provision of on-site services and that even if assessee would have provided on-site services to its associated enterprise, then also it would have been remunerated on same basis, i.e. cost plus fixed mark-up by the associated enterprise. In sum and substance, the stand of the assessee is that such a filter cannot be applied to hold Akshy Software Technologies Limited as functionally incomparable. 39. The learned CIT-DR has reiterated the stand of the TPO as well the DRP and pointed out that the business model of providing on-site services at the place of the clients, is not comparable with off-shore rendering of services. 40. We have carefully considered the rival submissions. Factually speaking, Akshy Software Technologies Limited was found by the TPO to be predominantly engaged in rendering services to its client's on on-site basis. As per the TPO, Akshy Software Technologies Limited rendered services at client's site unlike the services being provided by the assessee through offshore sites. The difference in operating mechanism of two business models is starkly evident. While under the on-site business model, the service provider positions its personnel on the cli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... over, it is also a fact that part of the employee cost is included by many companies under different other heads. Selection of comparables applying the 'onsite income' filter also stands on the same footing as relevant data / information are not available in respect of all the companies in the database. It is also a fact that though the TPO has himself not applied this filter by observing that the companies having onsite income or more than 75% cannot be treated as comparables but two of the companies i.e. M/s. Foursoft Limited and Sankya Infotech Limited selected as comparables by the TPO were having onsite income / expenses of more than 75%. In this view of the matter, the CIT(A) was correct in holding that rejection of comparables selected by the assessee by applying this filter is not correct. We also fully subscribe to the view of the CIT(A) that loss making companies and companies having super normal profits cannot be considered as comparables in view of the ratio laid down in case of Mentor Graphics (India) Pvt. Ltd. Vs. DCIT (109 ITD 101) and Philips Software (119 TTJ 721). In aforesaid view of the matter, the companies selected by the CIT(A) as comparables is rational and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ftware Technologies Limited, which also was rejected by the TPO on the ground that it was rendering services to its clients on an on-site basis, which was different from the assessee. In the earlier paras, we have upheld the action of the TPO on this count. For similar reasons, we hereby affirm the stand of the TPO in rejecting M/s. R.S. Software (India) Limited from the final set of comparables. 44. Now, we may take-up the plea of the assessee in relation to the exclusion of the following four concerns in the final set of comparables : (i) Persistent Systems Ltd.; (ii) Mindtree Ltd. (IT Services); (iii) Larsen & Turbo Infotech Ltd.; and, (iv) Sasken Communication Technologies Ltd. (Telecom Services Segment). On this aspect, a preliminarily point raised by the assessee is that while in the show-cause notice dated 05.10.2011, the TPO had proposed to consider the aforesaid concerns as comparables whereas in the subsequent order passed u/s 92CA(3) of the Act dated 31.10.2011, the TPO has excluded the same by applying a Turnover filter, whereby the concerns with sales/turnover in excess of ₹ 200 crores have been excluded. It is further explained by the learned counsel that in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such an approach impinges on the principles of natural justice and the assessee is rightfully aggrieved. In so far as the opportunity of raising objections before the DRP is concerned, in our view, the same cannot take the place of an opportunity that was required to be allowed before the TPO; that the assessee had an opportunity before the DRP is of no consequence for it is the fairness and reasonableness of furnishing of an explanation before the TPO which is the issue. In-fact, in a somewhat similar situation the Hon'ble Supreme Court in the case of Tin Box Company vs. CIT (2001) 249 ITR 216 (SC) held that once it is established that the Assessing Officer had not given to the assessee an appropriate opportunity of being heard, that the assessee had an opportunity before the higher appellate authorities was really of no consequence, for it was the assessment order that counted inasmuch as the assessment order was required to be made only after the assessee had been allowed a reasonable opportunity of being heard. Considered in the aforesaid light, in the present case it is axiomatic that so far as the issue of the adoption of Turnover filter of ₹ 200 crores to exclude the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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