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TMI Blog2015 (11) TMI 64X X X X Extracts X X X X X X X X Extracts X X X X ..... y reduced by the CIT(A) in the appeal filed by the assessee. To the extent the transfer pricing adjustment survives pursuant to the impugned order of the CIT(A), the Assessee is in appeal before the Tribunal. The Revenue is in appeal before the Tribunal challenging the reliefs allowed by the CIT(A). 3. The assessee, Novell India, is a subsidiary of Novell, USA and is a captive service provider. It is engaged in the business of providing software development and support services to Novell, USA. During the financial year 2007-08 relevant to the assessment year 2008- 09, the only international transaction that took place between Novell India and Novell US was provision of software development and support services to Novell US at a price of Rs. 82,78,21,000/-. 4. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. 200 crores. The CIT(A) applied high profit margin criteria and excluded Celestial Bio labs Ltd., as it had profit beyond 50% during the relevant previous year. Two companies viz., Avani Cincom Technologies Ltd., and Kals Information Systems Ltd., were excluded as functionally not comparable. As a result of such exclusion, the following companies alone were retained for the purpose of determining the profit margin (arithmetic mean):- Sl. No Name of company OP on Cost as per OGE to CIT(A) order Adjusted Margin 1 Bodhtree Consulting Ltd. 19.14% 20.15% 2 e-zest Solutions Ltd. 28.97% 29.22% 3 LGS Global Ltd. 26.66% 25.93% 4 Quintegra Solution Ltd. 23.06% 20.35% 5 R S Software (India) Ltd. 6.46% 7.73% 6 R Systems International Ltd. (Seg.) 16.87% 15.02% 7 Thirdware Solution Ltd. 21.92% 20.11% 8 Softsol India Ltd. 15.16% 13.22% 9 Lucid Software Ltd. 16.88% 16.79% Average 9.36% 15.92% 8. On giving effect to the CIT(A)'s order, the Assessee's margin of 10.48% would be within the range of + / - 5% of the working capital adjusted arithmetic mean of the comparables. 9. The grounds primarily urged in the assessee's appeal are as fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... und that it is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in 'e-Business Consulting Services', consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised Representative contends, are high end ITES normally categorised as knowledge process Outsourcing ('KPO') services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that since the Annual Report of the company does not contain detailed descriptive information on the business of the company, the assessee places reliance on the details available on the company's website which should be considered while evaluating the company's functional profile. It is also submitted by the learned Authorised Representative that KPO services are not comparable to software development services and therefore companies rendering KPO services ought not to be considered as comparable to software development companies and relied on the decision of the co-ordina ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provider such as the Assessee in the case of 3DPLM Software Solutions Ltd. (supra) and hence on this ground also, the aforesaid three companies should be excluded. 15. We have considered his submission and find that these three companies have been held to be functionally not comparable with a software development service provider such as the Assessee in the case of 3DPLM Software Solutions Ltd. (supra). The following were the relevant observations of the Tribunal: "11.0 Infosys Technologies Ltd. 11.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment. 11.2 Before us, the learned Authorised Representative contended that this company is not functionally comparable to the assessee in the case on hand. The learned Authorised Representative drew our attention to various parts of the Annual Report of this company to submit that this company commands substa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) for Assessment Year 2007-08 is applicable to this year also. We are inclined to concur with the argument put forth by the assessee that Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the break up of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly." "13. Tata Elxsi Ltd. 13.1 This company was a comparable selected by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables on several counts like, functional dis-similarity, significant R&D activity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lecordia Technologies India Pvt. Ltd. V ACIT (ITA No.7821/Mum/2011) has held that Tata Elxsi Ltd. is not a software development service provider and therefore it is not functionally comparable. In this context the relevant portion of this order is extracted and reproduced below :- " .... 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 as fit for comparability analysis for determining the arm's length price for the assessee, hence, should be excluded from the list of comparable portion." As can be seen from the extracts of the Annual Report of this company produced before us, the facts pertaining to Tata Elxsi have not changed from Assessment Year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 12.4 We have heard both parties and carefully perused and considered the material on record. We find merit in the contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison. 12.5 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in the cas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would 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 v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm's length price in an international transaction and it provides:- (1) that 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, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors 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 act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nces, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken 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." 19. Respectfully following the aforesaid decision, we uphold the order of the CIT(A) excluding the aforesaid companies from the list of comparable companies chosen by the TPO. 20. The next grievance of the revenue projected in ground no.3 of its appeal is exclusion of Celestial Biolabs Ltd., as a comparable company by the CIT(A). On this issue this tribunal has already taken a view (for AY 08-09) that Celestial Biolabs Ltd. is not a comparable company with a software development service provider such as the Assessee in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Ltd. in ITA No.112/Bang/2011, CSR India Pvt. Ltd. in IT(TP)A No.1119/Bang/2011 and by the ITAT, Delhi Bench in the case of Transwitch India Pvt. Ltd. in ITA No.6083/Del/2010. (v) The facts pertaining to this company has not changed from Assessment Year 2007-08 to Assessment Year 2008-09 and therefore this company cannot be considered for the purpose of comparability in the instant case and hence ought to be rejected. In support of this contention, the assessee has also referred to and quoted from various parts of the Annual Report of the company. 9.3 Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparable companies. The learned Departmental Representative submitted that the decisions cited and relied on by the assessee are for Assessment Year 2007-08 and therefore there cannot be an assumption that it would continue to be applicable for the period under consideration i.e. Assessment Year 2008-09. 9.4.1 We have heard both the parties and perused and carefully considered the material on record. While it is true that the decisions cited and relied on by the assessee were with respect to the immediately previous asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he order of the CIT(A). 23. As far as ground Nos. 7 & 8 raised by the revenue are concerned it projects the grievance of the revenue in the action of the CIT(A) in excluding Avani Cincom Technologies and Kals Information Systems Ltd., from the list of comparable chosen by the TPO. The comparability of these companies with a software development service provider such as the assessee was considered in several decisions of the ITAT. These have been listed in the chart filed by the assessee before us. We, however, find that making a reference to all those decisions will not be of any help and making a reference to one such decision would be sufficient. In the case of 3DPLM Software Solutions Ltd. v. DCIT, IT(TP)A No.1303/Bang/2012 for A.Y. 2008-09, order dated 28.11.2013, this Tribunal has held as under on choosing this company as a comparable:- "7.0 Avani Cincom Technologies Ltd. 7.1 This company was selected by the TPO as a comparable. The assessee objects to the inclusion of this company as a comparable on the ground that this company is not functionally comparable to the assessee as it is into software products whereas the assessee offers software development services to its AEs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tional Pvt. Ltd., in its order in ITA No.1280/Bang/2012 dt.31.7.2013 has remanded the matter back to the file of the Assessing Officer / TPO to examine the comparability of this company afresh, by making the following observations at paras 9.5.2 and 9.5.3 thereof :- " 9.5.2 As regards the submission of the learned Authorised Representative, we are unable to agree that this company has to be deleted from the list of comparables only because it has been deleted from the set of comparables in the case of Trilogy E-Business Software India Pvt. Ltd. (supra). No doubt this company has been deleted as a comparable in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) and this can be a good guidance to decide on the comparability in the case on hand also. This alone, however, will not suffice for the following reasons :- (i) The assessee needs to demonstrate that the FAR analysis and other relevant facts of the Trilogy case are equally applicable to the facts of the assessee's case also. Unless the facts and the FAR analysis of Trilogy case is comparable to that of the assessee in the case on hand, comparison between the two is not tenable. (ii) After demonstrating the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ugh the relevant portions of the TP order under section 92CA of the Act and the show cause notices for both the earlier year i.e. Assessment Year 2007-08 and for this year and contended that the selection of this company as a comparable violates the principle enunciated in Curram Software International Pvt. Ltd. (supra) that a company can be selected as a comparable only on the basis of FAR analysis conducted for that year and therefore pleaded for its exclusion. The learned Authorised Representative also submitted that he has brought on record sufficient evidence to show that the functional profile of this company remains unchanged from the earlier year and hence the findings rendered by the co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 (supra) and in other cases like Trilogy E-Business Software India Pvt. Ltd. (supra) are applicable to the year under consideration as well. 7.5 Per contra, the learned Departmental Representative supported the order of the TPO / DRP for inclusion of this company Avani Cincom Technologies Ltd. in the final set of comparables. 7.6.1 We have heard both parties and perused and carefully considered the mate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns of the assessee observing that the software products and training constitutes only 4.24% of total revenues and the revenue from software development services constitutes more than 75% of the total operating revenues for the F.Y. 2007-08 and qualifies as a comparable by the service income filter. 10.2 Before us, the learned Authorised Representative contended that this company is not functionally comparable to the assessee and ought to be rejected / excluded from the list of comparables for the following reasons :- (i) This company is functionally different from the software activity of the assessee as it is into software products. (ii) This company has been held to be functionally not comparable to software service providers for Assessment Year 2007-08 by the co-ordinate bench of this Tribunal in the assessee's own case. This company has been held to be different from a software development company in the decision of the Tribunal in the case of Bindview India Pvt. Ltd. V DCIT in ITA No.1386/PN/2010. (iii) The rejection of this company as a comparable has been upheld by co-ordinate benches of the Tribunal in the case of - Trilogy E-Business Software India Pvt. Ltd. (ITA No.1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ve held that this company was developing software products and was not purely or mainly a software service provider. Apart from relying of the above cited decisions of co-ordinate benches of the Tribunal (supra), the assessee has also brought on record evidence from various portions of the company's Annual Report to establish that this company is functionally dis-similar and different form the assessee and that since the findings rendered in the decisions of the co-ordinate benches of the Tribunal for Assessment Year 2007-08 (cited supra) are applicable for this year i.e. Assessment Year 2008-09 also, this company ought to be excluded from the list of comparables. In this view of the matter, we hold that this company i.e. KALS Information Systems Ltd., is to be omitted form the list of comparable companies. It is ordered accordingly." 24. Respectfully following the aforesaid decision rendered by the coordinate Bench of this Tribunal, we uphold the order of CIT(A) directing exclusion of the aforesaid two companies from the list of comparable companies chosen by the TPO. 25. The TPO/AO is directed to compute the arithmetic mean of the remaining comparable companies and allow adjust ..... X X X X Extracts X X X X X X X X Extracts X X X X
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