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TMI Blog2015 (4) TMI 56X X X X Extracts X X X X X X X X Extracts X X X X ..... o 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, Yodlee Infotech Vs. ITO ITA No.1397/Bang/2010 for A.Y.2006- 07 as considered by this Tribunal in the case of M/s. Actiance India Private Limited Vs. The ITO in IT(TP)A.No.1295/Bang/2010 order dated 17.10.2014. 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), Yodlee Infotech (supra) and M/s. Actiance India Pvt. 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 case of Trilogy E-Business Software In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mean of 20.48%. After factoring the working capital adjustment of -1.65%, the adjusted arithmetic mean was determined at 22.13%. The computation of the ALP by the TPO in this regard was as follows:- "Computation of Arms Length Price: The arithmetic mean of the Profit Level indicators is taken as the arms length margin. (Please see Annexure B for details of computation of PLI of the comparables). Based on this, the arms length price of the software development services rendered by the taxpayer to its AE(s) is computed as under: Arithmetic mean PLI Less: Working capital Adjustment (Annexure-C) Adj.Arithmetic mean PLU 20.48% -1.65% 22.13% Arm's Length Price: Operating Cost Rs.18,00,23,193 Arms Length Margin 22.13% of the operating cost Arms Length Price (ALP) At 119.17% of operating cost Rs.21,98,62,325/- Price received vis-à-vis the Arms Length Price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length Price as under: Arms Length Price (ALP) At 119.17% of operating cost Rs.21,98,62,325/- Price charged in the international transactions Rs.19,47,91,538 Shortfall being adjustment u/s.92CA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction before DRP on the application of turnover filter by excluding companies which have turnover above Rs. 200 crores from the list of comparable companies on the basis of the decision rendered in the case of Trilogy E-Business (supra) rendered by the ITAT Bangalore Benches. The learned counsel for the Assessee has filed before us an application for admission of additional ground of appeal in which he has raised a ground objecting to selection of companies whose turnover is above Rs. 200 crores as a comparable company with that of the Assessee. In the said application for admission of additional ground of appeal, the Assessee has pointed out that the transfer pricing law in India is still an evolving legislation and the judicial trend set into motion by the decision based on which the exclusion of companies with turnover of Rs. 200 crores from the list of comparable companies is sought on the basis of decision rendered subsequent to the filing of this appeal by the Assessee. It was pointed out that the appeal by the Assessee had been filed in Dec.2010 when the decisions referred to above, had not been rendered. Further reliance was placed on the decision of the Hon'ble Special Ben ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch 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 to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:- "Size criteria in terms of Sales, Assets or Number of Employees: The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs. 1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study." 15. It was brought to our notice that the above proposition has also been f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctors 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 subsection (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 shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm's length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm's length price. (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that- (a) the price charged or paid in an international transaction has not been determined i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt 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 to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an internatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.' 14. Respectfully following the aforesaid decision of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. (supra), we hold that the following companies should be excluded from the list of comparable companies"- (1) Flextronics Software Systems Ltd. 595.12 crores (2) iGate Global Solutions Ltd. 527.91 crores (3) Mindtree Ltd. 448.79 crores (4) Persistent Systems Ltd. 209.18 crores (5) Sasken Communication Technologies Ltd.(Seg.) 240.03 crores (6) Infosys Technologies Ltd. 9028 crores. The AO is directed to compute the Arithmetic mean by excluding the aforesaid companies from the list of comparable. 15. Improper selection of comparables: It was submitted by the learned counsel for the Assessee that the following 4 companies are not functionally comparable with that of the Assessee. a) KALS Information Systems Limited b) Accel Transmission Limited. In this regard our attention was drawn to the decision of the Hon'ble ITAT Bangalore Bench in the case of Trilogy E-Bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nformation 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 this company is not comparable." "(e) Accel Transmatic Ltd. 48. With regard to this company, the complaint of the assessee is that this company is not a pure software development service company. It is further submitted that in a Mumbai Tribunal Decision of Capgemini India (F) Ltd v Ad. CIT 12 Taxman.com 51, the DRP accepted the contention of the assessee that Accel Transmatic should be rejected as comparable. The relevant observations of DRP as extracted by the ITAT in its order are as follows: "In regard to Accel Transmatics Ltd. the assessee submitted the company profile and its annual report for financial y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 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 26 comparable arrived at by the TPO. a) KALS Information Systems Limited b) Accel Transmission Limited. 18. As far as the comparable chosen by the TPO viz., TATA Elxsi is concerned, this Tribunal in the case of Yodlee Infotech Pvt. Ltd. Vs. ITO in ITA No.1538/Bang/2010 by its order dated 30.8.2013, held that this company is not functionally comparable with a software development service provider. The following were the relevant observations of the Tribunal in this regard. "15. Tata Elxsi Limited. 15.1.1 This company was selected by the TPO for inclusion in the set of comparables. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables for various reasons such as functional dissimilarity significant R & D activity, brand value, size, etc. The TPO, however, rejected the assessee's objections and included the company in the set of comparables. Before us, in this appeal the learned Authorised Representative reiterated that this co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rdia Technologies India Pvt . Ltd. (ITA No.7821/Mum/2011) has held, that this company, M/s. Tata Elxsi Ltd. is not a software development service provider, at para 7.7 on page 21 of its order which is extracted hereunder : " 7.7 .... Tata Elxsi is engaged in development of niche product and development services, which is entirely different from the assessee company. We agree with the contention of the learned Authorised Representative that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties." As can be seen from the extracts of the Annual Report of this company, placed before us, this factual position pertaining to Tata Elxsi Ltd., has not changed from Assessment Years 2007-08 to 2008-09. In this view of the ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to software development) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO's filter of more than 75% of revenues from software development services. Having drawn the above conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. In terms of Rule 10B(3)(b) of the Rules, an uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparable chosen by him on all the transactions of rendering software services carried out by the Assessee during the previous year, without restricting his action in respect of the transaction of the Assessee of rendering software services only to its AE. In other words the non AE transactions have also been considered for arriving at the Transfer Pricing adjustment to be made by the TPO. In this regard it may be recalled that the total operating revenue from rendering software development services was a sum of Rs. 19,47,91,538/-. Out of the above the revenue from rendering software development services to an Associated Enterprise (AE) was a sum of Rs. 15,87,43,329/-. The plea of the Assessee is that the operating margin of the comparable should be applied by the TPO on the value of transaction with AE i.e., on the sum of Rs. 15,87,43,329 and not on Rs. 19,47,91,538/-. In support of his plea the learned counsel for the Assessee has brought to our notice the decision of the ITAT Bangalore Bench in the case of M/S.Kirloskar Toyota Textile Machinery Private Ltd. Vs. ACIT IT (TP) A.No1401/Bang/2010 order dated 14.11.2014 wherein the Hon'ble Tribunal held as follows:- "7. We have du ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld make multi-fold adjustments, for example if the assessee had made purchase of only Rs. 2.00 crores from the AE and Rs. 91.00 crores from unrelated parties, the adjustment worked out by the TPO in the figure would be more than the total purchases made from the AE. The learned Counsel for the assessee drew our attention towards the order of the ITAT in the case of Polartech India (P) Ltd v. Asstt. CIT (Supra). In this case the Tribunal has followed the order of the ITAT Delhi Bench and made the following observations under a similar situation: "31. For applying the TNMM in case of international transactions constituting a small portion of expenses, the only practical way of applying the TNMM is to adopt the profitability of the entire enterprise as the profitability from international transaction. It has then to be compared with the PLI of the comparable companies and adjustment made only to the international transactions. This will be achieved by taking the total adjustment applicable to the enterprise as a whole and applying pro rata, on the basis of ratio of the value of international transactions forming part of operational cost to the total operational expenses of the enterp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ough international transactions to the total operational expenses of the company. Only this proportion of the overall adjustment can be added as transfer pricing adjustment. We direct the TPO to compute the transfer pricing adjustment along these directions." 8. Taking into the consideration of these factors, we accept the first fold of submission made by the learned Counsel for the assessee and direct the Assessing Officer to confine the adjustment, qua the purchases made by the assessee from the AE. To be more specific, the adjustment is to be made only to the purchases made from the AE. However, this exercise be carried out after verifying the details of purchases available on Page No.47 of the TP study report (extracted supra). The Assessing Officer first determine the purchase of raw material and components from the AE and then determine the ALP having regard to the mean profit margin of comparable cases at 8.26%." 25. The learned DR relied on the order of the TPO. We have considered the rival submissions and are of the view that in the light of the decision rendered in the case of Kirloskar Toyoda Textile Machinery Pvt. Ltd. (supra), the Assessing Officer should confine the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mputing the deduction under Section 10A. 29. The Assessee filed return of income for AY 06-07 declaring loss of Rs. 8,43,640/-. The Assessee had claimed deduction u/s.10A of the Act at Rs. 1,51,13,126/-. The total turnover, Export Turnover and profits of the business on the basis of which the Assessee computed deduction u/s.10A was Total Turnover of Rs. 3,43,60,420, Export turnover of Rs. 3,43,60,420 and profits of the business of Rs. 3,01,66,703/-. The AO excluded travelling expenses and communication expenses from the Export Turnover and adopted Export turnover at Rs. 3,01,66,703/-. By doing so, the AO allowed deduction u/s.10A of the Act only at Rs. 1,32,68,557/-. While deciding Gr.No.9 we have already held that whatever is excluded from the export turnover should also be excluded from the Total Turnover while computing deduction u/s.10A of the Act. We have also seen that the TPO suggested an upward revision of the ALP of the international transaction as a result of which a sum of Rs. 2,49,98,778 had to be added to the total income of the Assessee. We have also adjudicated on the said adjustment in the other grounds of appeal dealt with in the earlier part of this order. The re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o get taxed. 32. Aggrieved by the aforesaid directions of the DRP, the Assessee has raised ground No.10 before the Tribunal, which we have set out earlier. We have heard the submissions of the learned AR who placed reliance on the decision rendered by the Bangalore Bench of ITAT in the case of Karle International (P) Ltd. Vs. ACIT ITA No.381/Bang/2012 order dated 12.10.2012 wherein this Tribunal held that provisions of Sec.10A are not deduction provisions and they are exemption provisions. In doing so the Tribunal followed the decision of the Hon'ble Karnataka High Court in the case of CIT Vs. Yokogawa India Ltd. ITA No.78/2011. In the case of Yokogawa India Ltd. (supra), the High Court had to consider two issues for AY 2001-02 & onwards as to whether, (i) the loss incurred by a non-eligible unit & (ii) the brought forward unabsorbed loss & unabsorbed depreciation of the eligible unit has to be set-off against the profits of the eligible unit before allowing deduction u/s 10A/ 10B. HELD, answering both questions in favour of the assessee:- (a) On issue (i), s. 10A was amended by the FA 2000 w.e.f. 1.4.2001 to convert it from an "exemption" provision to a "deduction" provision. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the order of the DRP. 34. It was pointed out by the Bench that in view of the provisions of Sec.92C(4) proviso, the Assessee would not be entitled to deduction u/s.10A of the Act on the amount added to total income. The same reads thus: "(4) Where an arm's length price is determined by the Assessing Officer under sub-section (3), the Assessing Officer may compute the total income of the assessee having regard to the arm's length price so determined : Provided that no deduction under section 10A or section 10AA or section 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this subsection :" 35. The learned counsel for the Assessee fairly conceded that the addition to total income by way of adjustment to the ALP of international transaction will not be entitled to deduction u/s.10A of the Act. He however submitted that if the brought forward business loss relates to non-10A units the loss should be set off in accordance with the provisions of Sec.72 of the Act. He also submitted that if the carried forward loss contains any loss of 10A unit, to that extent the Assess ..... 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