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TMI Blog2013 (5) TMI 844X X X X Extracts X X X X X X X X Extracts X X X X ..... Provision of Software services TNMM 207,868,050 2. Reimb. of traveling and mis emp. Exp by AE BNR 10,220,308 3. Reimb. of traveling and mis emp. Exp to AE 454,438 3. The main issue in the present appeal is determination of arm's length price of the international transactions representing Software Services provided to the associated enterprise. The arm's length price was determined by applying transactional net margin method (TNMM) considered to be the most appropriate method in the facts and circumstances of the case. The operating profit to total cost (OP/OC) ratio was taken as the profit level indicator (PLI) in the TNMM analysis. The PLI of the company was arrived at 9.51% on cost. Considering the functions performed by assessee, the TPO was of the opinion that the mark up of 9.51% on cost was inadequate. After considering the various filters applied by the assessee and after detailed analysis of the comparables selected by the assessee, the TPO finally selected 36 comparables and arrived at average PLI of 38.13% and, accordingly, concluded that an addition of Rs. 5,43,25,482/- was required as under: Price received : Rs. 207,868,050/- Total cost : Rs. 189,8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n particularly conducting a fresh economic analysis, by applying additional filters than those applied by the appellant, for the determination of the Arm's Length Price ("ALP") of the assessee's international transaction and holding that the international transactions are not at arm's length; 3.3 disregarding multiple year/ prior years' data as sued by the appellant in the TP documentation and holding that current year (i.e. FY 2007-08) data for comparable companies should be used despite the fact that the same was not necessarily available to the appellant at the time of preparing its TP documentation, and in doing so have grossly erred in; 3.3.1interpreting the requirement of 'contemporaneous' data in the Rules to necessarily imply current/single year (i.e. FY 2007-08) data; and 3.3.2 holding that at the time of creating/maintaining the TP documentation, the appellant could have procured current/single year data (i.e. FY 2007-08 data) from sources other than the electronic database, when in fact practically no such other sources were available in case of most companies; 3.4 rejecting comparability analysis in the TP documentation/ appellant's updated comparables analy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... without recording any satisfaction for its initiation." 6. As far as ground no. 1 is concerned, no arguments have been advanced by ld. Counsel for the assessee as to how the assessment order passed by AO pursuant to the directions of ld. Dispute Resolution Panel is bad in law and void-ab-initio. Accordingly, this ground is dismissed. 7. As far as ground no. 2 is concerned, the same is general and needs no specific adjudication. 8. Ground no. 3.1 is with reference to sec. 92C(3) which deals with AO's power to determine the arm's length price in relation to the international transactions if, in his opinion, the price charged in regard to international transaction has not been determined as per sec. 92C(1) & (2). The assessee has not demonstrated as to how the AO was not justified in determining the arm's length price in relation to the international transaction. The reference made by AO to TPO itself shows that in his opinion the international transaction had not been determined as per sec. 92C(1) & (2).We, therefore, dismiss this ground. 9. As far as ground no. 3.2 is concerned, the same relates to rejection of arm's length price as determined by the assessee in the TP documen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hall be the data relating to the financial year in which the international transaction has been entered into. As per proviso to Rule 10D earlier year data can be used in addition to the data pertaining to the relevant financial year only for taking a decision on how much of the factors in earlier years have impact on the profit of the current year for both the tax payer and the comparable. Therefore, it has to be demonstrated as to how the earlier year conditions have influenced the profit of the relevant financial year. Since assessee had not given details in this regard, therefore, the TPO's action was justified on this count. Further in para 5.6 of his order, the TPO has given a detailed list of cases, wherein it has been held that the current year data is to be utilized for the purpose of comparability. In view of above discussion, we do not find any reason to interfere with the order of AO/TPO on this count. 14. In the result, this ground is dismissed. 15. Apropos ground no. 3.4, the assessee has assailed the TPO's order in selecting comparables by applying various filters. The assessee has filed a brief synopsis of the case in which comparable wise contentions of the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion that expense on personnel being extremely low may lead to the conclusion that company is not engaged in software development. The TPO observed that extremely low expenditure on salary/employee cost is an indication that the company is either into further outsourcing of the work or is a software product developer or a software trading company. The assessee's contention was that there are no general accounting norms that govern the disclosure of employee cost in the profit and loss account. It was further contended that some companies may choose to outsource their software development. The claim of the assessee was that there was no comprehensive and exhaustive way in which these expenses can be tracked. The TPO after considering these submissions observed that this filter is just a trigger to see the functionality of the comparable company. He pointed out that he had not out rightly applied this filter. He referred to the decision in the case of Vidaris Technologies Ltd. by the ITAT, Delhi, wherein it was held that companies that have lower levels of employee cost may not be software developers. They may be involved in other activities like trade of software product etc. He poin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ormance of the company. This filter was applied on the ground that such companies have some peculiar problems because of which the revenue's were declining and not in line with the growth of software industry. Ld. DRP confirmed the TPO's action, inter-alia, observing that the average growth rate incorporates top line bottom line has consistently been in positive territory during last decade. Therefore, declining turnover and persistent loss is not a usual phenomenon in the Indian economic time. 25. Having heard both the parties, we do not find any reason to interfere with the order of ld. DRP/AO because the diminishing revenue/persistent losses are not inconformity with the normal operational results in this line of activity. They may be indicator of the company on the verge of closer on account of under utilization of assets or human resources which had been created/ recruited earlier. These exceptional circumstances are not quantifiable and, therefore, these companies cannot be taken as comparable. We, therefore, reject this ground of appeal. 26. In the result, this ground is dismissed. 27. In ground no. 3.5 the assessee has challenged the inclusion of FCS Software Solutions L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he company is providing software services/solutions to its clients. It is seen that all the segments pertain to software development and are various sub-segments of the software development industry. It is nowhere indicated in the report that the assessee is providing e-learning, digital content services and product engineering services on its own to its clients. The annual report clearly states that the income is from software development and main expenditure is on software development. In fact it is clearly mentioned in the annual report that the company is deriving more that 70% of the revenues on the basis of time & material model while the rest are charged on the basis of fixed price and fixed time frame model. The relevant part of the annual report is extracted below this table." 30. The assessee has also assailed the inclusion of this comparable on the ground that this company was earning abnormally high profit in comparison to the assessee. The assessee has also submitted that its profit margins were highly volatile. In support of its contention the assessee has referred to the profit margins of last three years and also for subsequent two years: Name of the Comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the areas where the assessee was providing software services. It does not in any manner bring the FCS software solutions on a different platform. The company essentially was a software service provider only. We, therefore, do not find any reason to exclude FCS software solutions from the list of comparables on the ground of functional dissimilarity. 33. The assessee's next objection is that FCS software solution was earning abnormally high margin. On this issue ld. DR submitted that primarily functional comparability is to be established and if the same is there then there is no need to go to margins. Ld. DR submitted that the fallacy in the argument of ld. Counsel for the assessee lies in the fact that first higher margins have been considered and then functions are examined. On the contrary it should be other way round. He submitted that in comparability analysis loss or higher margin is not a determining factor unless there are any peculiar circumstances in a case making it functionally not comparable. He submitted that comparable has to be selected on the touch stone of FAR analysis and not on the basis of margins. 34. We have considered the submission of both the parties an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on disproportionate to other concern, then that would not be an indicator for the profit or loss resulting from the operation of the company rather some extra reasons would be responsible for the losses or the profit. Therefore, such comparable deserves to be excluded." 37. In our opinion this decision does not in any manner advance the assessee's case. In this decision also it has been clearly stated that low profit or loss would not make a functional comparable company as uncomparable. Further it was pointed out that if the result of a company over a period shows fluctuations disproportionate to other concern, then that would be an indicator for the profit or loss resulting from extra reasons and not merely from operations. This is for assesee to demonstrate that on account of certain extra economic factors the assessee had earned high profits. However, if the high profit is merely the consequence of operations carried out by the assessee in its regular course of business then the same cannot be rejected because of high margins earned by assessee. On the contrary, it depicts the operational efficiency of the concern which is achievable in that particular sector. Moreover, as no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... luded and not because of high profit or low profit. He submitted that extra ordinary economic circumstances only warranted exclusion of Maple E-solutions and not the high/low profits. 40. In view of above discussion, we reject the assessee's contention that a comparable is to be rejected merely on the ground of earning abnormally high margin. 41. The third objection of assessee is regarding non-availability of segmented financials. In principle, we are in agreement with ld. Counsel for the assessee that if a comparable is operating in different lines of activities and thus, performing different functions including the functions performed by tested party then the segmental details have to be available so that the results of assessee could be compared with the relevant segmental detail of comparables. This only can make the functional comparability possible. However, as far as FCS Software Solutions Ltd. is concerned, we are of the opinion that the entire range of activity is in the field of software services and, therefore, this contention of assessee cannot be entertained in this case. 42. The next contention of assessee is that FCS Software Solutions Ltd. has brand value as it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nufacturing industries where substantial marketing expenditure create an intangible. Ld. TPO invited the explanation of the assesseeas to why this filter be not ignored. The assessee has filed a reply to the query of the TPO which has duly been noted by the ld. TPO on pages 24 & 25 of the impugned order. On due consideration of assessee's objections, ld. TPO has observed that the operative force of the assessee's contention is that marketing and advertisement activities carried out by the comparable companies result in creation of marketing intangible, which would give return on such investment. In other words, the expenses incurred on advertisement and marketing creates a marketing intangible. Ld. TPO rejected this contention on the ground that such an argument is not based on any substantial analysis. The assessee made reference to WIPRO & Flex Tronic Software System and submitted that these companies have created marketing intangible, therefore, they are earning more profit then any other captive entity. Ld. TPO rejected the contention of the assessee on the ground that 95% of the revenue of Infosys is from repeat business. The marketing intangible did not help Infosys to get an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 45. As regards second objection ld. DR submitted that this claim had not been made by assessee in its TP Study and, therefore, it cannot be made at this stage of proceeding. In this regard, ld. Counsel relied on the decision in the case of M/s Interra Information Technologies India (P) Ltd. vs. DCIT, wherein in para 79 reproduced as under: 79. "On the claim of adjustment of low capacity utilization or in other words, for the idle capacity, we find that in the Transfer Pricing Study the assessee has not made any such adjustment. The assessee follows cost plus method of billing it's AE. It is not known as to how the costs are arrived at. On the utilization of man power, the fact whether there was assured volumes and the decision as to who bears the cost of idle capacity etc. are not stated. In the absence of such details and data, the question of granting adjustment on the ground of idle utilization of capacity does not arise. The findings of the TPO on this issue based on broad parameter are upheld. The assessee is required to support its claim for any adjustment with robust data and full details and evidences so as to enable the TPO to examine the claim. The burden is on the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion there can be no escape from the proposition that the assessee is entitled to argue at least before the appellate authorities that a wrong stand taken at the time of filing the return of income should be allowed to be modified. The ld. AR has rightly relied on order passed by the Mumbai Bench of the Tribunal in the case of M/s A.M. Tod Company India Pvt. Ltd. vs. ITO (ITA No. 492/Mum./2006). Vide order dated 24.06.2009, the Tribunal accepted the assessee's contention for exclusion of certain cases which were wrongly included in the Transfer Pricing study but were actually not comparable. It is observed that the Special Bench of the Tribunal in the case of DCIT vs. Quark Systems (P) Ltd. [(2010 132 TTJ (Chd.) (SB) 1] also allowed the assessee to claim exclusion of certain cases from the list of comparables which were inadvertently included by it in its transfer pricing study. In view of the afore-noted discussion and the ratio of these precedents, we direct the AO/TPO to examine the correctness of the figures placed on record by the assessee in support of its contention that the case of Goldstone Teleservices Limited was wrongly included by it in the list of comparables, which is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... matics has earned extraordinary profit and has a huge turnover. Besides differences in assets and other characteristics referred to by Shri Aggarwal. The Income Tax Appellate Tribunal is a fact finding body and, therefore, has to take into account all the relevant material and determine the question as per the statutory regulations. 3. In the case of CIT vs. Bharat General Reinsurance Co. Ltd. 81 ITR 303, the Hon'ble Delhi High Court, observed as under: "It is true that the assessee itself had included that dividend income is in return for the year in question but there is no estoppel in the Income Tax Act and the assessee having itself challenged the validity of taxing 'he dividend during the year of assessment in question it must be taken that it had resiled from the position which it had wrongly taken while filing the return. Quit apart from it, it is incumbent on the income tax department to find out whether a particular income was assessable in the particular year or not. Merely because the assessee wrongly included the income in its return for a particular year, it cannot confer jurisdiction on the department to tax that income in that year even though legally such inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his concealed income and he agreed to pay the proper tax upon it. The agreement there related to the quantification of taxable income but in the present case what is sought to be taxed is not a taxable income. The assessee in such a case can certainly raise the plea that his income is not taxable under the Act. We, therefore, reject this plea." 35. In para 4.16 of latest report, the OECD provides the following guidelines: "In practice, neither countries nor taxpayers should misuse the burden of proof in the manner described above because of the difficulties with transfer pricing analysis, it would be appropriate for both taxpayers and tax administrations to take special care and to use restraint in relying on the burden of proof in the course of the examination of a transfer pricing case. More particularly, as a matter of good practice the burden of proof should not be misused by tax administrations or taxpayers as a justification for making groundless or unverifiable assertions about transfer pricing. A tax administration should be prepared to make good faith showing that its determination of transfer pricing is consistent with the arm's length principle even where the burde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... consistencies in selection of compatibles, while we uphold the exclusion of Imercious from comparables, we also deem it fit and proper to remit the matter to the file of the Assessing Officer for adjudication denovo in the light of the above observations and in accordance with the law. We direct the assessee to place all the relevant material before the Assessing Officer and/or Transfer Pricing Officer and fully cooperate in expeditious disposal of the matter in accordance with the law. The matter stands restored to the file of the Assessing Officer as such." 49. These decisions clearly fortify the view which we have taken. However, before concluding discussion on this issue, it is necessary to deal with the elaborate submissions advanced by ld. DR with reference to M/s Quark Systems Pvt. Ltd. (Special Bench) decision. In regard to the decision of Spl. Bench in the case of M/s Quark Systems Pvt. Ltd., Ld. DR submitted that in the case of Quark Systems a comparable M/s Data Matrix Technologies Ltd. was chosen by assessee as its own comparable in TP study. No challenge was made before the ld. CIT(A). Before the ITAT, it was pointed out that owing to mathematical mistake, the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re. Post the correction of such an error, the OP/TC comes out to 138.46% and hence the comparable now deserves to be excluded on the ground of having abnormally high margins. The above mentioned two reasons were independent and thus, it will not be correct to state the case as has been put forth by the ld. DR in our case that only "owing to the mathematical mistake"; the Appellant had held that Datamatics deserves to be excluded from the final set of comparables. Further, in the last line of Para 9 the Special Bench held, "In effect, thus, we are also called upon to adjudicate, subject to the admission of this additional ground so raised by the assessee as to whether or not Datamatics should be excluded from comparables." Further in para 27 also there is an indication that there is more than one mistake which should be corrected and should not be allowed to be carried forward. Para 18 of the Ruling - Reading of the said para of the Hon'ble Special Bench's Order, it is highlighted that the ld. Counsel for Quark pointed out that there were three reasons for the exclusion of Datamatics and they were: 1) Abnormally high margin of 138.46%; 2) Related party transactions of a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be excluded. The assessee's plea is primarily that since it is a low risk captive service provider unit, therefore, it's profit margins are low and it cannot be compared to companies which operate as full fledged risk taking enterprises. The contention of assessee is that it is not taking entrepreneurd risks as it is a captive service provider. 56. Ld. DR submitted that a captive service provider has much more risk to encounter as compared to other entrepreneur who operates in open market. 57. Ld. DR submitted that assessee bears a much bigger market risk with single customer risk as it is wholly dependent on its AE. He submitted that if AE runs out of its business or if AE's business gets reduced substantially the tax payer business will also get adversely affected. 58. We have considered the submissions of both the parties. The TPO has rightly pointed out that in the present case except pointing out various risks, the tax payer has not shown with evidence as to whether each of the risk was actually undertaken by the comparables or not and, if so, how these risks affected the profit margins of comparables and whether such adjustment would improve the comparability. In the b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are the payments for the use of its copyright and, accordingly, taxed as royalty. However, as far as software development service provider is concerned, in our opinion, it imparts twin services- firstly as software developer and secondly as software service provider. As far as software developer companies are concerned they primarily develop the software depending upon the need of its clients, which is primarily a customized service. However, a service provider mainly imparts consultancy regarding software. In common parlance, however, this distinction often gets blurred and both are taken as performing similar functions and, therefore, categorized in one category only. Therefore, at least the segmental details in the case of a company which is both software product as well as software development service provider have to be available in respect of both these segments. While selecting the comparables ld. TPO/Ld. DRP in principle were agreeable that software product company cannot be compared with software service provider. This is evident from the fact that TPO while applying the filters had accepted the assessee's filter of rejecting companies undertaking significantly different ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... will also examine the abnormal factors, if any, brought to his notice by assesse which was the real cause of high volatility of margins for making necessary adjustments. In view of above discussion, ground nos. 3.6 and 3.7 are allowed for statistical purposes. 65. As far as ground no. 3.8 is concerned regarding risk adjustment, we find that assessee has not quantified the same and, therefore, it has not claimed any risk adjustment. Therefore, this ground is misconceived and, accordingly, dismissed. 66. Vide ground no. 3.9 the assessee has assailed the order of ld. TPO/ld. DRP in denying the working capital adjustment to the operating profit margins of the comparables. 67. Before the ld. TPO it was submitted by assessee that in computing the margins earned by comparable companies, differences on account of working capital employed by comparable viz-a-viz the assessee should be factored in order to improve the reliability of the comparable. Therefore, it was submitted that the adjustment is to be made for different levels of accounts receivables, inventory and accounts payable between assessee and the comparable companies. 68. Ld. TPO rejected the assessee's claim observing that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omparables on the first and last day of the accounting period to compute the working capital adjustment. It is quite probable that daily average is substantially different from the average of the amount of working capital deployed by the comparables on the first and last day of the accounting period. The adjustment for functional differences etc. is to be allowed only if it can be ascertained with reasonable accuracy which is impossible in this case because of unavailability of relevant data. Therefore, this panel endorses the proposal of the AO to disallow the working capital adjustment claimed by the assessee." 70. Ld. Counsel for the assessee vehemently assailed the findings of ld. DRP in holding that working capital adjustment is to be made on the basis of daily average of working capital deployed by the assessee as well as comparable. He submitted that working capital deployment is to be considered on the first and last day of accounting period and not for through out the year. He submitted that if ld. DRP's observations are accepted then it would become impossible to arrive at any working capital adjustment. Ld. Counsel referred to page 282 and 283 of paper book, wherein ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons of both the parties and have perused the record of the case. 78. Ld. DRP has observed in para 15 as under: 15. "Ground No. 12 - the assessee has objected that no opportunity of being heard and to support his claim was provided to it before proposing to add fringe benefit tax ('FBT') to compute book profit under provision of sec. 115JB of the Act. However, this panel has heard the assessee and gone through its submissions on this issue very carefully. Therefore, the grievance of the assessee, i.e., it was not provided an opportunity of being heard by the AO, stands redressed. Now, coming to the merits of the issue, the clause (a) of the Explanation 1 below sub-section (2) of sec. 115JB clearly states that the amount of income tax paid or payable and the provision therefore, shall be added to the net profit as shown in P&L A/c to arrive at the amount of 'Book profits' for the purpose of sec. 115JB. The term 'tax' is defined in sub-section (43) of sec. 2 of the Act. As per the definition, tax includes Fringe Benefit Tax (FBT) payable u/s 115WA of the Act. It leaves no doubt that book profits for the purpose of sec. 115JB has to be computed after adding the amount of FBT to the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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