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TMI Blog2015 (4) TMI 373X X X X Extracts X X X X X X X X Extracts X X X X ..... llowing the said decision, we hold that said companies should be excluded from the list of the comparable companies chosen by the TPO while working out the ALP. After excluding the aforesaid comparable from the list of comparable chosen by the TPO, the arithmetic mean of profit margin of the remaining 7 comparable would be 11.30% (unadjusted) and 9.87% after working capital adjustment. The Assessee’s profit margin operating profit on cost is 10.15% which is within the + / - 5% range permitted under second proviso to Sec.92CA(2) of the Act and therefore the addition made by the TPO and confirmed by the DRP needs to be deleted. Accordingly the same is deleted - Decided in favour of assessee. Disallowance of deduction claimed u/s.10A in respect of profits of the Assessee’s Bangalore unit - Held that:- the Bangalore unit was not formed by reconstruction of an existing unit or the business of the new unit had not commenced prior to registration with the STPI and therefore deduction u/s.10A of the Act ought not to have been denied on the profits of the Bangalore unit. The deduction claimed by the Assessee is directed to be allowed - Decided in favour of assessee. Exclude telecom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Operating Profit (PBIT) ₹ 4,29,98,376/- Operating Profit to Cost Ratio 10.15 % 4. Comparable ultimately selected by TPO and their arithmetic mean : Sl. No Name of company OP / TC (FY 2006-07) Sales (Rs.Cr.) 1 Aztec Software Limited 18.09 128.61 2 Geometric Software Limited (Seg.) 6.70 98.59 3 Infosys Ltd 40.38 9028.00 4 KALS Info Systems Limited 39.75 1.97 5 Mindtree Consulting Ltd 14.67 448.79 6 Persistent Systems Ltd. 24.67 209.18 7 R.Systems International Ltd. (Seg.) 22.20 79.42 8 Sasken Communications Ltd. ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Adj.Arithmetic mean PLI 19.37% Arm s Length Price: Operating Cost Rs.42,36,90,759 Arms Length Margin 19.37% of the operating cost Arms Length Price (ALP)At 119.37% of operating cost Rs.50,57,59,659/- Price received vis- -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 119.37% of operating cost Rs.50,57,59,659 Price charged in the international transactions Rs.46,66,89,135 Shortfall being adjustment u/s.92CA Rs.3,90,70,524 The above shortfall of ₹ 3,90,70,524/- is treated as transfer pricing adjustment u/s 92CA. 6. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... developer like the Assessee. 11. The following were the relevant observations of the Tribunal on the aforesaid comparable companies in the case of Trilogy E-Business Software India Pvt.Ltd.(supra): (d) KALS Information Systems Ltd. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal s decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: 16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gn, development and manufacture of multi function kiosks Queue management system, ticket vending system (ii) Ushus Technologies - offshore development centre for embedded software, net work system, imaging technologies, outsourced product development (iii) Accel IT Academy (the net stop for engineers)- training services in hardware and networking, enterprise system management, embedded system, VLSI designs, CAD/CAM/BPO (iv) Accel Animation Studies software services for 2D/3D animation, special effect, erection, game asset development. 4.3 On careful perusal of the business activities of Accel Transmatic Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee s claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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. 15. In view of the above, the ld. counsel 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. 14. In view of the aforesaid decision, we hold that Tata Elxsi has to be excluded from the list of comparable chosen by the TPO. 15. As far as the comparable chosen by TPO viz., Infosys Limited is concerned, it has been held by the co-ordinate bench of ITAT Bangalore in the case of Logica Pvt.Ltd. Vs. ACIT ITA No.1129/Bang/2011 (AY 07-08) that this company is a full fledge risk assuming en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny. The comparability of lnfosys Technology of the company as that of an assessee has been dealt with ITAT Delhi Bench in the case of Agnity India Technologies Private Limited (ITA No.3856/Delhi/2010), wherein it was held that lnfosys is a giant in the area of development of software and it assumes all risks, leading to higher profit and cannot be compared with the company which is a captive unit of its parent company assuming only limited currency risk. In view of the above finding, we hold that the Infosys cannot be taken as a comparable for determining the arms length price in the case of the assessee. 16. Respectfully following the decision of the Tribunal referred to above, we direct Infosys Limited should be excluded from the list of comparable companies chosen by the TPO. We order accordingly. 17. As far as comparable companies chosen by the TPO viz., iGate Global Solutions Ltd., Mindtree Consulting Ltd., Sasken Communications Ltd., and Flextronics Software Systems Ltd., are concerned, this Tribunal in the case of Trilogy E-Business (supra) has by applying turnover filter held that while selecting comparable companies for comparability analysis turnover will be a re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a ₹ 1,000 crore company cannot be compared with the transaction entered into by a ₹ 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. 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 ₹ 13,149 crores as compared to ₹ 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 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 Q 1 crore to Q 200 crores ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rable with the Assessee. The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than Q 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard. We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding 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 nonITA residents, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm s length price in relation to the said international transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: Rule 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared. 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. 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 im ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of Telcordia Technologies India Private Ltd. in ITA No.7821/MUM/2011, which was followed by the ITAT Bangalore Bench in the case of Logica Private Ltd. ITA No.1129/Bang/2011 for AY 07-08, wherein it was held as under:- 7.2 Lucid Software Limited It has been submitted before us that this company, besides doing software development services, is also involved in development of software product. The learned AR has tried to distinguish by pointing out that product development expenditure in this case is around 39% of the capital employed by the said company, and, therefore, such a company cannot be considered as tested party. Even as per the information received in response to notice under Section 133(6), the company has described its business as software development company or pure software development service provider. This information itself is very vague as the segmental details of operating revenue has not been made available to examine how much is the ratio of sale from software product and sale of software service and development. Looking to the fact that it has developed a software product named as Muulam which is used for civil engineering structures and the product ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 10.15% which is within the + / - 5% range permitted under second proviso to Sec.92CA(2) of the Act and therefore the addition made by the TPO and confirmed by the DRP needs to be deleted. Accordingly the same is deleted. The relevant grounds of appeal of the Assessee are allowed. 24. The next issue that arises for consideration in this appeal by the Assessee is with regard to disallowance of deduction claimed u/s.10A of the Act in respect of profits of the Assessee s Bangalore unit of ₹ 2,35,44,629/-. The Assessee has three units through which it conducts its business. Out of the three units 2 are STP units entitled to deduction u/s.10A of the Act. In so far as one of the STP units at Bangalore, which was taken over from Lara Networks, it claimed a deduction of ₹ 2,35,44,629/- u/s.10A of the Act. The said deduction was however disallowed by the AO on the ground that the said unit was formed by reconstruction of an existing unit and that the business of the said unit had commenced prior to registration with the STPI. In doing so, he relied on the assessment orders for the Assessment years 2002-03 to 2004-05. The said assessment orders for AY 02-03 to 04-05 was subject ma ..... X X X X Extracts X X X X X X X X Extracts X X X X
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