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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 ..... Navisite. The range of services included services such as design and development of custom and ecommerce solutions, application management, problem resolution management and deployment and management of IT networks, customer specific infrastructure and data centre infrastructure. The international transactions undertaken by the assessee company with its associated enterprises were as under: S. No. Nature of transaction Method Value of transaction 1. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le envisaged under the Act. In doing so, the ld. DRP and the ld. AO has grossly erred in agreeing with and upholding the ld. TPO's action of: 3.1not appreciating that none of the conditions set out in sec. 92C(3) of the Act are satisfied in the present case; 3.2disregarding the ALP, as determined by the appellant in the TP documentation maintained by it in terms of sec. 92D of the Act read with Rule 10D of the Rules as well as while submitting the updated comparables analysis; and in 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 'contemporaneo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erating profit margins of the comparables; 3.10 disregarding judicial pronouncements in India in undertaking the TP adjustment. 4. The ld. DRP and the ld. AO, erred both on facts and in law, in adding Fringe Benefit Tax paid by the appellant for computing the book profit u/s 115JB of the Act. 5. That the ld. AO erred on facts and in law in charging interest u/s 234A and 234B of the Act; 6. The ld. AO has grossly erred in initiating penalty u/s 271(1)(c) of the Act mechanically and 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 p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... upon by you and your AE." 12. Ld. Counsel for the assessee submitted that multiple year data was to be used because the current year data was not available at the time of preparation of T.P. Study Report. He further submitted that multiple year data gives correct indicator of the margin of comparables. 13. Having heard both the parties, we find that as per Rule 10B(4), the data to be utilized and analyzing 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. 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 lis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, therefore, do not find any reason to interfere with the order of ld. DRP on this count. 19. In the result, this ground is dismissed. 20. Ground no. 3.4.2 is regarding applying of a filter of excluding companies with employee cost less than 25% of the total cost. The TPO applied this filter on the ground that the companies which are engaged in software development require a minimum level of expenditure on personnel expenses. He referred to certain judicial pronouncements in support of his contention 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 expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wing at a rate of more than 20% and in such an environment a company making persistent losses does not reflect the industry conditions and is in persistent losses because of company specific issues." 24. The TPO had excluded the companies with diminishing revenue because in an environment where software sector is growing at a CAGR (Compounded Annual Growth Rate) of more than 30% during the last 30 years or at least the diminishing revenue for the last three years is not a true indicator of the performance 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 oper ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s the same is, inter-alia, engaged in infrastructure management services, therefore, the same cannot be taken as comparable. The assessee also submitted that the segmental information was also not available. The TPO however, observed that since the FCS Software Solutions was engaged in software services, therefore, the objection of assessee on functional dissimilarity was not acceptable. We find that ld. DRP in this regard has observed at page 21 as under: "It is clear from the annual report that the 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 pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e range of services to carry out the main work of AE. Functions include providing the services in its entirety to AE. Therefore, the assessee's contention on the basis of functional dissimilarity cannot be accepted from the extracts of annual report contained at page 670 of paper book. It is evident that assessee was mainly an IT service provider. This could be in areas like e-learning, digital content services, product engineering services, IT engineering consultant, etc. which are primarily 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... usiness and merely on account of low profit or loss would not make a functional comparables company as uncomparable, but if the ultimate result is of such a nature which demonstrates that such company is not comparable then that company deserves to be excluded e.g. a company may be functionally comparable but if it is showing persistent losses then it is always adviseable to exclude such a company from the list of comparable. Similarly, if the result of a company over a period shows fluctuation 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 reaso ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n alone. It was also brought to the notice of Tribunal that the Hyderabad Bench of the Tribunal in the case of Capital IQ Systems (India) Pvt. Ltd. (ITA No. 1961/Hyd./2011) that the decision of Delhi Bench of Tribunal in the case of CRM Services (I) Pvt. Ltd. had been followed and the case of Maple E-solutions was excluded from the list of comparables. With reference to this decision ld. DR submitted that it was on account of reputation of Rastogi Group Maple Esolutions was directed to be excluded 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld. TPO has considered this aspect. According to the ld. TPO, the filters applied by the assessee in the TP Study report for eliminating the companies who had incurred expenses of more than 3% of the sales on advertisement and marketing is not an appropriate filter. According to the ld. TPO independent enterprises has to incur marketing expenditure. In a service industries like I.T. enabled services, the assessee did not provide the basis on which such expenses resulted in any intangible unlike in manufacturing 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 in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture. But how their FAR is substantially so different could not be explained. Ld. TPO has looked into this aspect. He observed that material showing impact on Information & Technology Industry by such expenses had not been produced by the assessee. After taking into consideration the discussion made by the ld. TPO as well as the DRP on this issue, we do not find any merit in the contentions of ld. Counsel for the assessee for exclusion of eight companies, extracted supra from the list of comparables." 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 whe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an assessee as to his rights. The Hon'ble Bombay High Court in the case of Mirmala L. Mehta vs. A. Balasubramaniam, CIT [2004] 269 ITR 1 has held that there cannot be any estoppel against the statute. Article 265 of the Constitution of India clearly provides that no tax shall be levied or collected except by authority of law. Similar view has been taken recently by the Hon'ble Jurisdictional High Court in Sancheti Software and Solutions P. Ltd. vs. CIT (2012) 349 ITR 404 (Bom.). In our considered opinion 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... el had taken Datamatics as comparable in its I.P. audit, the taxpayer is entitled to point out to the Tribunal that above enterprise has wrongly been taken as comparable. In fact there are vast differences between tested party and the Datamatics. The case of Datamatics is like that of "Imercius Technologies" representing extreme positions. If Imercius Technologies, has suffered heavy losses and, therefore, it is not treated as comparable by the tax authorities, they also have to consider that the Datamatics 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 divid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has therefore to be determined is whether, notwithstanding the apportionment made by the respondent in the profit and loss statements, the deduction is admissible under the law." 34. In the case of CIT vs. V.M.R.P. Firm, Muar (SC) 56 ITR 67, the following observations of their Lordship of Supreme Court are as under: "The decision in Amarendra Narayan Roy vs. CIT AIR 1954 Cal. 271 has no bearing on the question raised before us. There the concessional scheme tempted the assessee to disclose voluntarily ail 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 speci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tages in this year and we are inclined to take a rather liberal approach by giving assessee an opportunity to make out its case properly and place all the relevant facts before the tax authorities so that proper arm's length price can be determined in accordance with the law the proceedings before the tax authorities are not adversarial proceedings and the assessee should not therefore be placed at under advantage because of his inadvertent and bonafide mistakes. With this objective in sight, and having no led inconsistencies 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 is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Special Bench to adjudicate the issue of exclusion of Datamatics from the list of comparables accepted by the Appellant and the ld.TPO. The two reasons for the exclusion of the comparable as submitted were: 1) Firstly, there were related party transactions to the extent of 31.27% and so the comparable ought to be excluded; 2) There was an arithmetical error in the computation of profits of Datamatics and the operating expenses of ₹ 579 had not been taken into account while aggregating total expenditure. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld. CIT(DR) as noted above. 54. In view of above discussion, we are not inclined to accept the assessee's plea of excluding FCS Software Solutions Ltd. from the list of final comparables. 55. The second part of the ground raised by assessee is that TPO erred in including volatile/high profit making companies in the final comparables set for bench marking a low risk captive service provider unit such as the assessee. We have already considered earlier that merely on the ground of high profit margins a comparable cannot 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 busines ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en tested party and the comparable selected, the same cannot be taken as a comparable for bench marking the arm's length price. The arguments of ld. Counsel for the assessee in regard to software product company do not require detailed elaboration. The intellectual property in this case belongs to the company. The company primarily deals in software products per se. Whenever it sells its product it will only grant license to use the software but will not part with the source code. The payment received by this company 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tingLtd.; 5) Softsol India Ltd.; 6) Cat Technologies Ltd.; 7) Goldstone Technologies Ltd.; 8) Infosys Technologies Ltd.; 9) Tata Elxsi Ltd. (Seg). 63. The information contained in Annual Report cannot be taken as sacrosanct unless the same is duly corroborated with the financial statements. 64. We, therefore, restore this issue to the file of AO/TPO for verification of details with reference to financial statements and other relevant documents/information. While examining the aforementioned issue ld. TPO 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing capital deployed by the comparables on the first and last day of the accounting period was known but there are no means of ascertaining the working capital deployed by the comparable through out the year. Ld. DRP pointed out that the working capital adjustment should be computed on the basis of daily average of working capital deployed by the tested party and each of comparables respectively. Ld. DRP further noticed as under: "The assessee has taken the average of the amount of working capital deployed by the comparables 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st, 2005 issued by CBDT clarifying that FBT is an allowable deduction in computation of book profit u/s 115JB of the Act. The AO observed that there is no provision in any of the clause, proviso or explanation of sec. 115JB of the Act to exclude FBT from the profit for the purpose of computing book profit. The assessee's contention was that while computing net profit FBT is to be deducted and in none of the clauses of Explanation 2 to sec. 115JB contemplate for adding back of FBT. 77. We have considered the submissions 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-sec ..... X X X X Extracts X X X X X X X X Extracts X X X X
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