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TMI Blog2015 (11) TMI 1308X X X X Extracts X X X X X X X X Extracts X X X X ..... initiation of penalty proceedings u/s. 271(1)(( c) of the Act cannot be subject matter of appeal. Ground No.9 & 10 are general in nature and calls for no specific adjudication. Ground No.4 is with regard to exclusion of foreign currency expenses and communication charges from the export turnover/total turnover. Ground No.5 is with regard to the Revenue authorities in not allowing set-off of current year unabsorbed depreciation against the adjustment made to the business income. 3. Grounds 2.5 to 7 and ground No.3 raised by the Assessee are with regard to the addition to 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. July Sytstems & Technologies (P) Ltd., Vs. ITO (2014) 33 ITR (TRIB) 643 (ITAT Bang)., 3DPLM Software Solutions Ltd. Vs. DCIT 2014 12 TMI 612- ITAT Bangalore, Element K.India Private Ltd. Vs. ITO, Ward 11(1), New Delhi ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... LI of the assessee was arrived at as follows: Operating Revenue Rs.18,58,84,791 Operating Cost Rs.17,68,70,698 Operating Profit Rs.90,14,093 Op.pr/cost% 5.09% 7. The TPO arrived at a final set of 26 comparables. The set of 20 comparables is as follows: Sl. No Name of company OP/TC Turnover Rs. in Crores 1 Accel Transmatic Ltd (Seg.) 21.11% 9.68 2 Avani Cimcon Technologies Ltd 52.59% 3.55 3 Celestial Labs Ltd 58.35% 14.13 4 Datamatics Ltd 1.38% 54.51 5 E-Zest Solutions Ltd 36.12% 6.26 6 Flextronics Software Systems Ltd (Seg.) 25.31% 848.66 7 Geometric Ltd (Seg.) 10.71% 158.38 8 Helios & Matheson Information Technology Ltd 36.63% 178.63 9 iGate Global Solutions Ltd 7.49% 747.27 10 Infosys Technologies Ltd 40.30% 131.49 11 Ishir Infotech Ltd 30.12% 7.42 12 KALS Information Systems Ltd (Seg.) 30.55% 2.00 13 LGS Global Ltd (Lanco Global Solutions Ltd) 15.75% 45.39 14 Lucid Software Ltd 19.37% 1.70 15 Mediasoft Solutions Ltd 3.66% 1.85 16 Megasoft Ltd 60.23% 139.33 17 Mindtree Ltd 16.90% 590.35 18 Persistent Systems Ltd 24.52% 293.75 19 Quintegra Solutions Ltd 12.56% 62.72 20 R S So ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... DRP was added to the total income of the assessee by the AO in the fair order of assessment. Against the said order of the Assessing Officer, the assessee has preferred the present appeal before the Tribunal. 10. The ld. counsel for the assessee brought to our notice that out of the 26 comparable companies chosen by the TPO, the following companies will have to be excluded as the turnover of these companies are more than Rs. 200 crores and cannot be compared with the Assessee whose turnover is less than Rs. 200 crores: (1) Flextronics Software Systems Ltd. (2) iGate Global Solutions Ltd. (3) Mindtree Ltd. (4) Persistent Systems Ltd. (5) Sasken Communication Technologies Ltd. (6) Infosys Technologies Ltd. (7) Tata Elxsi Ltd. (8) Wipro Ltd.(seg.) 11. Our attention was drawn to the observations of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. (supra) (ITA No.1338/Bang/2010) for assessment year (07-08) on the application of turnover filter and it was submitted that the aforesaid comparable companies have to be excluded from the final list of comparable selected by the TPO. 12. We have considered the submission of the learned co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpany. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. The fact that they operate in the same market may not make 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 Rs. 1,000 crore company cannot be compared with the transaction entered into by a Rs. 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." 13. 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 Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 14. Reference was made to the decision of the ITAT Bangalore Bench in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... maging India Private Limited (ITA No. 1171/Bang/2010). It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee. 16. 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 Rs. 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard. 17. 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 nonresidents, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm's length price is not reliable or correct; 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:" 18. 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the 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." 19. 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. 20. In this regard we find that the provisions of law pointed out by the ld. counsel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ): "(d) KALS Information Systems Ltd. 3. 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. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is enga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as comparable. The ld. DR, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... I Division does the business of product software (developing software). This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product software (software developed) would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on 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 fil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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 development expenditure itself is substantial vis-a-vis the capital employed by the said company, this criteria for being taken as comparable party, gets vitiated. For the purpose of comparability analysis, it is essential that the characteristics and the functions are by an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ice provider companies. The following are the relevant observations of the Tribunal in this regard:- (b) Avani Cimcon Technologies Ltd. 39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company's website, which reveals that this company has developed a software product by name "DXchange", it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT - ITA No.7821/Mum/2011 wherein the Tribunal accepted the assessee's contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- "7.8 Avani Cincom Technologies Ltd. ('Avani Cincom'): Here in this case also the segmental details of operating income of IT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the Income Tax Act." ii. As per the Notes to Accounts - Schedule 15, under "Deferred Revenue Expenditure" (page 31 of PB-II), it is mentioned that, "Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred." iii. An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as "Deferred Revenue Expenditure" (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R&D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT - ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: "The learned D.R. however drew our attention to page- 389 of the paper book w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lea of the Assessee in this regard.' " 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for discovery of new drugs and has developed molecule to treat cancer. In the ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the busin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... following the decision referred to above, we hold that the aforesaid companies list at Sl.No.2 & 3 of the list of comparables chosen by the TPO be excluded from the list of comparables. 24. As far as Helios & Matherson Information Technology Ltd., at Sl.No.8 of the comparable companies chosen by the TPO is concerned, the ITAT Delhi in the case of Toluna India Pvt. Ltd., (supra) has held in para 23.1 & 23.2 of its order that this company cannot be regarded as a comparable company in the case of Software Development Service Provider such as the Assessee. In view of the above, the said company is directed to be excluded from the list of comparable companies. 25. As far as comparable at Sl.No.5 of the list of comparable chosen by the TPO listed in the chart given at para-4 of this order viz., E-Zest Solutions Ltd., is concerned, the comparability of the aforesaid company with that of the software service provider was considered by the Bangalore Bench of ITAT in the case of 3DPLM Software Solutions Vs. DCIT IT(TP)A No.1303/Bang/2012, wherein on the comparability of the aforesaid company with a software development service provider, the Tribunal held as follows:- "14. E-Zest Solutions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act. It appears that the TPO has not examined the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I-Q Information Systems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O. / TPO is accordingly directed." 26. The learned DR however submitted that the comparability of this comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any so that it can be regarded as comparable with an Assessee rendering software development service such as the Assessee. 29. The TPO is directed to compute ALP after excluding the comparable companies dealt with in this order. The TPO is also directed to take only the software development segment margin of the comparable company M/S.Megasoft Ltd., as was directed and held in the case of Trilogy EBusiness Software India Pvt.Ltd. (supra). The ground relating to Transfer pricing are decided accordingly. 30. Ground No.4 raised by the Assessee project the grievance of the Assessee regarding the action of the learned Assessing Officer and Honorable Dispute Resolution Panel excluding expenses incurred on travel expenses in foreign currency and expenses incurred towards communication expenses from export turnover on the ground that these expenses are incurred in rendering technical services rendered to clients outside India, while computing deduction under section 10A. It is the plea of the Assessee that at all times during the relevant previous year, it was engaged in development of computer software and not in rendering any technical services. Without prejudice to its contention that ..... X X X X Extracts X X X X X X X X Extracts X X X X
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