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TMI Blog2012 (12) TMI 1018X X X X Extracts X X X X X X X X Extracts X X X X ..... lecommunication or insurance charges during the year that are reduced from the export turnover, then such sum will also have to be reduced from the total turnover of the company for the purpose of computation of deduction u/s. 10A. X X X X Extracts X X X X X X X X Extracts X X X X ..... on the ground that there has been decline in the sales of such companies. 5.1 That the assessing officer/the TPO erred on facts and in law in rejecting PSI Data Systems Ltd. as comparable company allegedly on the ground of being functionally different without appreciating that the company provides information technology services similar to that of the appellant. 6. Without prejudice the learned assessing officer/the TPO erred on facts and in law in not appreciating that the appellant is a low-risk-bearing contract service provider and a risk adjustment to the extent of 5% over the cost ought to be provided, as risk and reward to this extent vest with the overseas associated enterprises to which the appellant renders off-shore software services. 7. That the assessing officer/the TPO erred on facts and in law in not appreciating that the income of the appellant is exempt under section 10A of the Income Tax Act and hence, there could not be any motive for the transfer of profits outside India. 8. Without prejudice that the assessing officer/the TPO erred on facts and in law in not allowing the working capital adjustment in respect of the companies proposed to be selected as compar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... California Software Co. Ltd. 22.36% 3 Neilsoft Ltd. 14.69% 4 N.S.E.LT. Ltd. 13.66% 5 Applabs Technologies Pvt. Ltd. 18.17% 6 PSI Data Systems Ltd. 0.12% 7 Kale Consultants Ltd. 13.15% 8, Blue Star Infotech Ltd. 10.66% Average 11.70% 3.2 Since the operating profit margin (OP/OC%) of the appellant at 14.36% was higher than 11.70% of the comparable companies, the international transaction was considered to be at arm's length and no adjustment was required to be made. 3.3 The TPO, however, rejected the filter of OP/OC(%) less than (-)40% and greater than 40% considered in the search process and included 3 companies in the final set of comparables, as under:- i) Saksoft Ltd. (ii) Datamatics Technologies Ltd. (iii) 3D PLM Software Ltd. 3.4 The TPO, further applied additional filter of declining sales for rejection of the comparable companies and rejected following companies on various grounds, as under: Sl. No. Name Reasons for rejection 1 Goldstone Technologies Ltd Declining sales and functionally different 2 PSI Data Systems Ltd. NFA/Sales and functionally different 3 Blue Star Infotech Ltd. Declining sales and functionally different 3.5 The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the aforesaid provisions of the Act and decisions, it was submitted that following companies considered by the TPO in his order, having significant related party transactions should be rejected from the final set of comparable companies: Sl. No. Company Name Related party transaction /Total income 1 California Software Co. Ltd. 71.53% 2 Saksoft Ltd. 67.81% 3 Datamatics Technologies Ltd. 44.86% 4 3D PLM Software Ltd. 1 18.04% 4.5 It was further submitted that after excluding the above companies, the operating profit margin (OP/OC) of the remaining companies works out to 14.92%, as under: Sl. No. Name of the company OP/OC% 1 NeilsoftLtd. 14.69% 2 N.S.E.LT. Ltd. 13.66% 3 Applabs Technologies Pvt. Ltd. 18.17% 4 Kale Consultants Ltd. 13.15% Average 14.92% Global Logic India Pvt. Ltd. 14.36% 4.6 Ld. Counsel of the assessee submitted that since, the operating profit margin (OP/OC%) of the appellant at 14.36% is within safe harbor range of +/- 5% of the average of (OP/OC%) of comparable companies at 14.92%, the international transaction undertaken by the assessee should be considered at arm's length and the adjustment proposed by the TPO should be de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uncontrolled transaction or a number of such transactions is to be computed having regard to the same base. In the converse for applying TNMM in terms of clause (ii) of rule 10B(1)(e) of the Rules, the net profit margin realized by an unrelated enterprise from a controlled transactions is not to be considered. In other words, in case the net profit margin of the comparable companies is distorted by controlled or related party transactions the same is to be excluded. Therefore it is net profit margin, which is not influenced or distorted by the presence of controlled transactions, only is to be taken into account for the purpose of applying the TNMM. 5.5 Ld. Counsel of the assessee submitted that the OECD guidelines regarding adoption of enterprise level profits in TNMM and treatment of partial controlled transactions are reproduced below: "3.42 An analysis under the transactional net margin method should consider only the profits of the associated enterprise that are attributable to particular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controll ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ital asset having bearing on the net profit margin of the comparable uncontrolled enterprise, by way of charge of depreciation or amortization is to be considered as the relevant related party transactions. 5.8 Ld. Counsel of the assessee submitted that the Delhi Bench of the Tribunal in the case of Sony India Pvt Ltd vs. DCIT 114 ITD 448 held that companies having related party transactions in excess of 10-15% of the sales have to be rejected and cannot be considered as comparable for the purpose of comparability analysis. 5.9 Ld. Counsel of the assessee referred the decision of the Tribunal in the case of Philips Software Centre Pvt Ltd vs. ACIT (ITA No 218/Bang/2008). 5.10 He also referred the Delhi Bench Tribunal decision in the case of Actis Advisors Pvt Ltd vs. DCIT (ITA No. 5277/Del/2011). 5.11 It was further submitted that the decision of the Hon'ble Tribunal in the case of DCIT vs. American Express India Pvt. Ltd. (ITA No. 1338/Del/2009), it was rendered on its own facts wherein the aforesaid contentions were not canvassed and the ratio of the aforesaid decisions were not brought to the notice of the Hon'ble Tribunal. 5.12 Ld. Counsel of the assessee according ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the company. In this regard, we can gainfully refer to the 10B(1)(e) of the Income Tax Rules as under:- 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 to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) The net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see's own case for A.Y. 2005-06 (I.T.A. No. 6082/Del/2010) wherein it was held as under:- Still, if it is found that RPT is 97% as has been claimed by the appellant before us, it has to be accepted that this comparable is not un-controlled and therefore, the same has to be excluded from the list of comparables adopted by the TPO. Even if the percentage of RPT to total revenue is not 97% but is more than 25%, even then, this comparable cannot be considered as uncontrolled comparable and the same has to be excluded from the list of comparables finally selected by the TPO. As per the Tribunal decision rendered in the case of Sony India Ltd. (supra), it was held by the Tribunal that comparables having RPT in the range of 10 to 15% of total revenue cannot be taken or considered as controlled. No specific percentage of RPT had been pointed out by the Tribunal in this case which will render the comparable as controlled comparable. Still, if it is found that RPT is 97% as has been claimed by the assessee before us, it has to be accepted that this comparable is not un-controlled and therefore, the same has to be excluded from the list of com parables adopted by the TPO. Even if the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .17 In the background of the aforesaid discussion and precedents, we hold that an enterprise is to be considered as uncontrolled for the purpose of benchmarking analysis of the ratio of related party transaction to the relevant base i.e. sales or cost does not exceed the limit of 25%. The related party transaction referred here are those which have a bearing on the net profit of the enterprise. 5.18 Thus, we agree with the assessee's submission that following companies considered by the TPO in his order, having significant related party transaction should be rejected from the final set of comparables. Sl. No. Company Name Related party transaction/Total income 1 California Software Co. Ltd. 71.53% 2 Saksoft Ltd. 67.81% 3 Datamatics Technologies Ltd. 44.86% 4 3D PLM Software Ltd. 118.04% 5.19 After exclusion of the above companies the operating profit margin (OP/OC) of the remaining companies works out to 14.92% as under:- Sl. No. Name of the company OP/OC% 1 Neilsoft Ltd. 14.69% 2 N.S.E.LT. Ltd. 13,66% 3 Applabs Technologies Pvt Ltd. 18.17% 4 Kale Consultants Ltd. 13.15% Average 14.92% Global Logic India Pvt. Ltd. 14.36% 5.20 From the above, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld be reduced from export turnover for calculation of deduction u/s. 10A. 6.4 The Disputes Resolution Panel (DRP) on this issue has rejected the assessee's contention and held that communication expenses related to export of software and hence, the order of the Assessing Officer is not interfered. 7. Against the above order the assessee is in appeal before us. 8. The submissions of the ld. Counsel of the assessee in this regard was as under:- During the year, the assessee has incurred ₹ 1,79,10,869 as communication expenses and the same were debited to the PandL account as part of operating expenses. The break-up of these expenses are as follows: Description Amount Telephone expense 1,31,48,431 Internet expenses 43,97,525 Postage and courier charges 3,64,913 Total Communication Expenses 1,79,10,869 In relation to said communication expenses, it is submitted that 5% of the total life cycle of software is used for transmission of software to clients on estimated basis. Further, it is also submitted that the persons employed for a software product are divided as onshore team and offshore team. One of the team gets in touch with the client to understa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Mphasis Ltd. vs. ACIT : I.T.A. No. 884/Bang/07 (Bang.) Patni Telecom (P) Ltd. vs. ITO 22 SOT 26 (Hyd.) DCIT vs. Softsol India Ltd. : 22 SOT 271 (Hyd.) DCIT vs. Binary Semantics Ltd. : I.T.A. No. 293/Del/2005 8.4 Ld. Counsel of the assessee further invited attention to the recent decision from the Special Bench of the Tribunal in the case of ITO vs. SakSoft Limited (ITA Nos. 691 and 1953/MDS/2007) upholding the aforesaid position. 8.5 It was submitted that it would further be appreciated that the Assessing Officer has accepted the contentions of the appellant in the AY 2007-08 and had accordingly reduced freight, telecommunication or insurance expense from total turnover of the assessee while reducing such sum from export turnover. 8.6 Ld. Counsel of the assessee submitted that Delhi Bench of ITAT in the assessee's own case for the assessment year 2005-06, relying on the aforesaid decision of Special Bench of Tribunal in the case of Saksoft India Limited, has allowed the appeal of the appellant and directed the assessing officer to re-compute deduction under section 10A after reducing communication expense from export turnover as well as total turnover. 9. Ld. Departmenta ..... X X X X Extracts X X X X X X X X Extracts X X X X
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