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TMI Blog2015 (7) TMI 124X X X X Extracts X X X X X X X X Extracts X X X X ..... roducts and, the annual report of the Thirdware does not reveal the bifurcation of sale of ₹ 47 crores and ₹ 16 cores from SEZ of STPI Unit. Therefore we direct the exclusion of this company from the list of comparables. SONATA SOFTWARE - In the instant case, aggregate related party transactions are roughly around 95 crores which is approximately about 40% of the total service income of ₹ 243.57 crores.As such, the said comparable is not a valid comparable and hence is directed to be excluded as it fails the RTP filter of 25% applied by the TPO. Mindtree - we direct in the interest of justice that this fact may be taken into account to adjudicate whether this event of amalgamation will effect in treating this company as a comparable to the assessee company. The precedents relied upon on by the learned counsel for the assessee may be taken into account before the TPO decides whether to include the company as comparable or not. Kals Information System should not be regarded as a comparable as this company was developing software products and not purely or mainly software development service provider. Treatment of foreign exchange fluctuation gain/lo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Income Tax Act, 1961 ( Act ) without recording reasons on the basis which the AO considered it necessary or expedient to refer the international transaction entered into by the Appellant with its associated enterprise ( AE ). 3. That on facts and in circumstances of the case and in law, the AO and Dispute Resolution Panel ( DRP ) erred in partly confirming the action of the Transfer Pricing Officer ( TPO ) in making an addition to the extent of ₹ 19,04,65,871/- to the income of the Appellant without appreciating that the Appellant had computed arm's length price in respect of international transaction entered into by the Appellant with its Associated Enterprise ( AE ) using the most appropriate method (i.e. the transactional net margin method), maintained all the information and documentation required under section 92D of the Act, used information/data available in the database (Prowess database and Capitaline database) all the time of filing the income tax-return on a bonafide belief that the data in the database is reliable and correct and furnish the Transfer Pricing Study ( TP Study ). 4. That the AO and DRP erred in confirming the action of the TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y comparable to the Appellant for the purposes of benchmarking the international transaction entered into by the Appellant: a) Bodhtree Consulting b) Comp-U-Tech Indian Ltd. c) Sonata Software Ltd. d) Infosys e) LGS Global Services Ltd. f) Thirdware Solutions 9. That the AO and DRP erred in confirming the action of the TPO in selecting the following companies whose turnover exceeded ₹ 500 crores and those comparables which are making abnormally high profits or are functionally dissimilar: a) Igate Global Solutions Ltd. b) Infosys Technologies Ltd. c) Mindtree Limited d) Sasken Communications Technologies Ltd. e) Zylog Systems Ltd. 10. That the AO and DRP erred in confirming and not setting aside the action of the TPO in applying -c. flawed and inconsistent search process for its benchmarking analysis by selecting Bodhtree Consulting Ltd as a comparable company without appreciating the fact that the said company was deleted as a comparable by the Hon‟ble DRP in the case of the Appellant's group company viz Open Solutions Software Services Pvt. Ltd. on the ground of abnormal gr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Reimbursement of expenses 3,601,498 5. The arm‟s length price of the international transactions representing software development services provided to the associated enterprises (AE) is determined by applying transactional net margin method (TNMM), which is stated to be the most appropriate method in the facts and circumstances of the case. The operating profit to total cost (OP/TC) ratio is taken as the profit level indicator (PLI) in the TNMM analysis. The PLI of the company is arrived at 15.00% on cost; whereas the average PLI of the comparables is arrived at 9.54% as per the analysis in the TP document. It is further seen that average Profit Level Indicator (PLI) was directed on the basis of 29 comparables selected by the tax payers. The mean margin of the comparables selected by the assessee as stated above was 9.54% and since the profit margin of the assessee was within +/= 5% range of the mean margin of the comparables, no transfer pricing adjustment was offered in the return of income. The results as submitted by the tax payer can be summarized as under: Particulars Software ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 11. Sasken Communication Ltd. 16.30% 12. Sonata Software Ltd. 32.07% 13. Thirdware Solution 28.03% 14. Zylog Systems Ltd. 6.52% Average 22.25% 7. As a result of the above, the final assessment was completed vide order dated 24.02.2014, passed u/s 143(3) r.w.s. 144C of the IT Act, 1961 (the Act) assessing the total income of the assessee at ₹ 19,14,56,510/- after making a transfer pricing addition of ₹ 19,04,65,871/- which has been computed as under:- Operational Cost 182,49,05,345 Arm s length price at a margin of 22.25% 223,09,46,784 Price Received 204,04,80,913 105% of International Transaction 214,25,04,956 Adjustment u/s 92CA 19,04,65,871 8. During the course of hearing, the learned ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (4,000,933) PBIT/Sales 1.74% 44.68% 15.63% 44.49% 22.38% -1.89% Sales Increase in % taking FY 2005-06 as the base) Base Year 195% 100 155% 141% 94% PBIT (increase in % taking FY 2005-06 as the base) Base Year 4998% 35% 441% 71% -8% 10.1 On the basis of above, it was stated that increase in PBIT is 441% for FY 2008-09 whereas the increase in sales is 155%, which indicates that there is a disproportionate increase in the profit of the company, hence the same ought to be rejected.: 10.2 The Ld. AR also draw attention to annual report of Bodhtree for subsequent year where it has categorically mentioned that margin of the company has fallen down due to termination of a contract with a customer. Based on the above the Ld. AR submitted it can be reasonably concluded that the operating margins of FY 2008-09 were significant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Systems (India) (P) Ltd. vs. DCIT 66 SOT 82 (Bang) has held as under: 26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute that in the list of comparables chosen by the assessee, this company was also included by the assessee. The assessee, however, submits before us that later on it came to the assessee's notice that this company is not being considered as a comparable company in the case of companies rendering software development services. In this regard, the ld. counsel for the assessee has brought to our notice the decision of the Mumbai Bench of the Tribunal in the case of Nethawk Networks (P.) Ltd. v. ITO [2014] 41 taxmann.com 250 (Mum - Trib.). In this case, the Tribunal followed the decision rendered by the Mumbai Bench of the Tribunal in the case of Wills Processing Services (I) P. Ltd. v. Dy. CIT IT Appeal No.4547/Mum/2012, dated 13-11-2013. In the aforesaid decisions, the Tribunal has taken the view that Bodhtree Consulting Ltd. is in the business of software products and was engaged in providing open end to end web solutions software consultancy and design development of software using latest technology. The decision r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , more than 95% of its revenues are from software development services and thus qualify the TPO‟s filter of more than 75% revenues from software development services. Taxpayer has argued that this comparable has incurred substantial R D and, therefore functions are different from those of the taxpayer. However, it is seen that R D expense is only ₹ 267 crores which is only 1.3% of the revenue. This cannot be said to be substantial by any standards. Therefore, this objection of the taxpayer is not acceptable. 11.1 The Ld counsel referred to following distinguishing parameters to submit that M/s. Infosys Ltd. is not comparable with the appellant: Diversified business v. Contract software development Turnover of ₹ 20,264 crores v. ₹ 209.83 crores Significant intangibles of ₹ 1,34,478 crores v. NIL Onsite (49.3) and offshore (50.7) v. Only services from India Sales, advertisement and brand building expenses of ₹ 80 crores v. NIL. R D expenditure of ₹ 236 crores v. NIL. 11.2 He has referred to following decision: a) Aginity Technologies ITA No. 3856/D/2010 b) CIT v. Aginity Tech ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ry products Develops/owns proprietary products like Finacle, Infosys Actice Desk, Infosys iProwe, Infosys mConnect. Also the company derives substantial portion of its proprietary products (including its flagship banking product suite Finacle ) Onsite vs. Offishore As much as half of the software development services rendered by Infosys are onsite (i.e. services performed at the customer s location overseas). And offshore (50.20 per cent) Refer p. 117 of the Paper Book) than half of its service, income from onsite services The appellant provides only offshore services (i.e. remotely from India) Expenditure on advertising/sales promotion and brand building ₹ 80 crores Rs. Nil (as the 1-percent services are provided to AEs) Expenditure on Research and Development ₹ 236 crores Rs. Nil Other 100 per cent offshore (from India) 11.6 On the basis of the above chart, the Hon‟ble High Court affirmed the concl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Segment reporting The company‟s operation comprises of software development implemention and support services. Software development, implementation and support services are various sub-segments of support services are various sub-segments of software development services only and require employment of software engineers. Hence, this company is valid comparable. 12.1 The ld. counsel for the assessee submitted that Thirdware Solutions Ltd. is functionally different; deals in product/license sale and significant related party transactions. It was submitted that out of total sales of ₹ 77 crores, approx. ₹ 4 crores in on account of sale of licenses and subscription. Further, there is no segmental information regarding what is the bifurcation of sales of ₹ 47 crores and ₹ 16 crores from the SEZ and STPI units respectively. It was submitted that in the absence of such details, Thirdware cannot be taken as comparable. Reliance was placed on the decision in the case of Carlyl India Advisors vs. DCIT ITA No. 717/Mum/2011 dated 4.4.2012 (pages 940-949 of Paper Book Vol 3) wherein it was held that if reliable segmental data is not available ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es from software services and software products and has adopted the figure as segmental margin of the company and has taken these companies as comparables. He submitted that by taking the proportionate expenditure, the correct financial results would not emerge. He submitted that nothing prevented the Assessing Officer/TPO from obtaining the segmental details from the respective comparable companies before adopting them as comparable companies and before taking the operating margin for arriving at the arms length price. He submitted that wherever the segmental details are not available, then the said companies should not be taken as comparables. For this purpose, he placed reliance upon the decision of the Bangalore Tribunal in the case of First Advantage Offshore Services Pvt. Ltd. vs. The DCIT in ITA.No.1252/Bang/2010 wherein these companies were directed to be excluded from the list of comparables. The learned D.R. however, supported the Orders of the authorities below. Having heard both the parties and having gone through the material on record, we find that the TPO at page 37 of his order has brought out the differences between a product company and a software de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... As per the taxpayer‟s argument of taking the receivable into the calculation of RPT, it is seen that it is balance sheet item. The sonata Software limited has 4 related parties it is seen that the service charge credited in the P L account of Sonata Software Ltd. is ₹ 243.57 crores. The only related party with which this comparable is having transaction in services is Sonata Information Technology Limited (SITL) amounting to ₹ 16.11 crores which is around 6.61% of the total service income. Similarly, the other debit items of the profit and loss account like deputation expenses, travelling expenses, other expenses and reimbursement of expenses have been considered as the part of RPT. The other items like interest, though a P L account item has not been considered as this is non operational. On the contrary balance sheet items like assets, loans, deposits whether receivables or payables have been excluded from the calculation of RPT. This approach of the TPO was well justified in view of the accounting norms. Therefore, the taxpayer‟s contention to exclude Sonata Software Ltd. is rejected. 13.2 The ld. counsel submitted that M/s Sonata Software majorly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d a range of services that included hardware product design cycle, system design cycle (board design development), embedded software services, turnkey silicon design, coverage, IP-ReD, EDA Solutions, embedded system solutions, system/board design and intellectual properties. TES PV was subsequently renamed as MindTree Technologies Private Limited ( MTPL‟). The total consideration of ₹ 25,99,25,675 (including direct transactions costs of ₹ 17,62,093/-) were allocated to net assets of ₹ 3,66,89,086 resulting in goodwill of ₹ 22,32,36,589 14.2 It is evident from the annual report that subsequent to the acquisition the company vide a scheme of amalgamation ( the scheme ) approved by the shareholders of the Company in June 2008 proposed to merge MTPL with itself. Approval of Hon‟ble High Court of Karnataka was received in January 2009 and the scheme became effective April 1, 2008. In terms of the scheme, MTPL was amalgamated with the company with effect from April 1, 2008. The company has accounted for the amalgamation as amalgamation in the nature of purchase under AS 4 Accounting for amalgamations. The following are the salient feature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -book vol.3 @ pg.729-730) Trilogy E-Business Software v. DCIT: (pg.735-795 of paper-book vol.3 @ pg.767-768) PTC Software (India) Pvt. Ltd. v. DCIT I.T.A. No.336/PN/2014 dated 31.10.2014 Toluna India Pvt. Ltd. (formerly Greenfield Online Pvt. Ltd.) (TS-247-ITAT-2014(DEL)-TP]- Para 27.1, Pg 32 Planet Online Pvt. Ltd. v. ACIT: ITA Nos. 464 and 608/Hyd/2014 dated 30.01.2015 ITO v. Prana Studios Pvt. Ltd.: ITA No. 2077/Mum/2014 dated 16.01.2015 Kals was excluded on the ground that it is purely into software development products. 15.2 We have considered the rival submission and perused the material on record. The Bangalore Bench of the Tribunal in the case of M/s. Trilogy e-business Software India Pvt. Ltd. vs. DCIT 23 ITR (Trib) 464 has held as under: 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 report, the salary cost debited under the software ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld not be regarded as a comparable. 16. The next issue relates to treatment of foreign exchange fluctuation gain/loss as operating item. During the course of hearing, the learned counsel submitted that the foreign exchange loss cannot be accepted for the purpose of calculation of the margin and in support, he relied upon the following decisions: a) SAP Labs India Pvt. Ltd. v. ACIT (2010) 6 ITR (Trib) 81 dated 30.08.2010 wherein ITAT held that foreign exchange fluctuations are an integral part of the sale proceeds of the assessee carrying on export business and thus could not be excluded from the computation of the operating margin of the assessee. b) Four Soft v. DCIT (2012) 16 ITR (Trib) 73 (Hyd): c) Capital IQ Information Systems (I) P. Ltd. v. DCIT 25 ITR (Trib) 185 (Hyd) dated 23.11.2012: relied on SAP Labs decision, that foreign exchange fluctuations are an integral part of the sale proceeds of the assessee carrying on export business.. Further, this Order of Capital IQ has been affirmed by the Hon‟ble Andhra Pradesh High Court vide an Order dated 05.06.2014 in ITA No. 305/2014 wherein the High Court declined to interfere with the Order of the ITAT on a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat of the Special Bench in case of Prakash I Shah (supra), there remains no doubt that forex gain or loss from a trading transaction is not only an item of revenue nature, but is, in fact, a part of the price of import or value of export transaction, as the case may be. Operating expense is ordinarily an expense that a business incurs as a result of performing its normal business operations. As the business of 'Assembly' done by the assessee under this segment is not possible without purchases and forex gain is in relation to such purchase transactions, we have no hesitation in holding that it is an item of operating cost. 18. In light of the above, we direct the AO/TPO to treat the foreign exchange gain/loss as an operating item. As such, the ground raised by the appellant is allowed. 19. Having regard to the above, we direct the Assessing Officer/Transfer Pricing Officer to compute the arm‟s length price of the international transaction entered into by the assessee with its associated enterprise keeping in view the observations made by us in the preceding paragraphs. 20. In the result appeal is allowed in terms of the directions above. Order pro ..... X X X X Extracts X X X X X X X X Extracts X X X X
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