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TMI Blog2016 (2) TMI 604X X X X Extracts X X X X X X X X Extracts X X X X ..... any, in our considered opinion, ceases to be comparable. It is obvious that from the common pool of income from both the streams of software products and software services, one cannot deduce the revenue from software services and no one knows the impact of revenue from Products on the overall kitty of profit, which may be significant. Since no segmental data of this company is available indicating operating profit from software development services, we order to exclude this company from the list of comparables. E-Zest Solutions this company is its functional dissimilarity. We have gone through the Annual report of this company which is available in the paper book. Its Profit and loss account specifies `Income from operations’. It is further borne out that it is providing end-to-end development, software project development services. As the assessee is also engaged in the customised software development, we find this company to be functionally similar. The same is, therefore, retained in the list of comparables. L&T Infotech Ltd. - find from the Annual report of this company, which is available in the third paper book that its Profit and loss account shows “Revenue – Revenue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k-up of operating costs and net operating revenues from these two segments have not been given. It is further observed that the TPO has taken entity level figures for the purposes of making comparison. Since such entity level figures contain revenue from both software services and software products, as against the assessee only providing software services, we are disinclined to treat this company as comparable Wipro Technology Services Ltd.earned a revenue from Master services agreement with Citigroup Inc. for the delivery of technology infrastructure services. This agreement was, in fact, executed between the assessee’s AE, Wipro Ltd., and Citigroup Inc., a third person. This unfolds that the transaction of earning revenue from software development support and maintenance services by Wipro Technology Services Ltd., is an international transaction because of the application of section 92B(2) i.e., there exists a prior agreement in relation to such transaction between Citigroup Inc. (third person) and Wipro Ltd. (associated enterprise). In the light of this structure of transaction, it ceases to be uncontrolled transaction and, hence, Wipro Technology Services Ltd., disqualifies ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... irected against the final assessment order dated 26.10.2015 passed by the Assessing Officer (AO) under sections 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called `the Act ) in relation to the assessment year 2011-12. 2. The only assail in this appeal is to the addition on account of transfer pricing adjustment amounting to ₹ 7,76,66,682/-. 3. Succinctly, the assessee company, earlier called Saxo IT India Private Ltd., is a part of Initto Group which teamed up with Saxo Bank. It is engaged in the business of design and development of customized software applications. Apart from that, it also provided technical support services during the relevant year to some unrelated enterprises in India. The assessee reported four international transactions including Provision of Software Development with transacted value of ₹ 20,72,25,235/-, which is disputed in the instant appeal. There is no quarrel on the other three international transactions. The assessee applied the Transactional Net Margin Method (TNMM) as the most appropriate method for demonstrating that the international transaction of Provision of Software development was at Arm s L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 102495 Operating Income 207327730 Expenditure Personnel Cost 156849561 Add: Operating expenditure 78341959 Depreciation 2158188 Operating Expenditure 237349708 Operating Profit -30021978 OP/OC (%) -12.65 4. Thereafter, he took up five comparable companies cited by the assessee in its Transfer pricing study report with their weighted average profit of last three years at 17.91%. The Transfer Pricing Officer restricted the comparison to the current year data of comparables and also made further additions to such a list of comparables, which after the directions given by the Dispute Resolution Panel (DRP), stood at 18. It is on this basis, that the addition of transfer pricing adjustment amounting to ₹ 7.76 crore was made, which is the subject matter of the instant appeal. 5. The assessee has challeng ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profit margin of the comparables. Thus, the foremost question for our consideration is whether capacity adjustment, or for that matter, any other adjustment on account of dissimilarity between the assessee and comparables, is warranted in the assessee s calculation of profit level indicator or that of comparables. 6.4. Chapter-X of the Act contains special provisions relating to avoidance of tax. Section 92, which is the first section of this Chapter, provides for computation of income from an international transaction having regard to arm s length price. Sub-section (1) of the section provides that : Any income arising from an international transaction shall be computed having regard to the arm s length price . Section 92C of the Act enshrines provisions relating to computation of arm s length price. Sub-section (1) of the section states that the arm s length price in relation to an international transaction shall be determined by any of the methods listed herein which include, inter alia, the transactional net margin method. Sub-section (2) of section 92C provides that the most appropriate method referred in sub-section (1) shall be applied for the determination of ALP `in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as determined under sub-clause (iii), which is used as benchmark for the purposes of making comparison with the net profit margin realized by the assessee from its international transaction as per sub-clause (i). Sub-clause (iv) states that the net profit margin realized by the enterprise, as referred in sub clause (i), is established to be the same as a net profit margin referred in sub-clause (iii) of the comparables. Sub-clause (v) states that the net profit margin thus established is then taken into account to arrive at an arm s length price in relation to international transaction. On going through the above sub-clauses of Rule 10B(1)(e), it becomes patent that as per the first step, the net profit margin realized by the enterprise from an international transaction is to be computed. Use of the word realized in the provision richly indicates that it is the calculation of actual operating profit margin of the assessee earned from international transaction, which is not any adjusted figure. Similar position can be traced from the language of sub-clause (iv), where again reference has been made to profit margin `realized by the assessee from the international transaction. Wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ule (3) of Rule 10B brings to the fore that this sub-rule is meant only for ascertaining whether or not a probable comparable uncontrolled transaction is fit for being treated as actual comparable. This is only an entry level judgmental provision for ascertaining the comparability of an otherwise broadly comparable uncontrolled transaction. In other words, if the broader comparable uncontrolled transaction is similar to the international transaction or if there are differences between the two, which are capable of adjustment, then such broadly comparable uncontrolled transactions gains entry in to the final list of comparables to be considered for the purposes of sub-clause (ii) of rule 10B(1)(e). If, on the other hand, there are differences between the two, which are not capable of adjustment, then such otherwise broadly comparable uncontrolled transaction goes out of the reckoning and does not gain entry in the final tally of comparables for the purposes of computing ALP of the international transaction as per the mandate of rule 10B(1)(e). In other words, role of sub-rule (3) to Rule 10B is only to filter out comparable uncontrolled transactions qualifying for inclusion in the d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arables by seeing their capacity utilization vis- -vis that of the assessee. However, adverting to the facts of the instant case, we find that capacity adjustment as claimed by the assessee, is totally unjustified. 7.2. The assessee calculated its profit margin at 22.63% on the basis of working given at page 324 of the paper book. When we peruse this calculation, it becomes vivid that out of total operating expenses of ₹ 25.72 crore, the assessee has not accounted for operating expenses to the tune of ₹ 8.65 crore anywhere, either in the calculation of operating profit margin from the AE or non-AE transactions. On a specific query, the learned Authorized Representative submitted that this cost of ₹ 8.65 crore represents operating expenses of idle capacity which has been considered by the assessee as a third segment with no corresponding revenue. We are hard pressed to concur with such a contention for the obvious reason that the actual costs incurred by the assesse have to be accounted for in the calculation to which they pertain, that is, either AE or non-AE transactions. It is totally absurd to create a separate segment of idle capacity with no revenue and al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fferential capacity adjustment of 30% (80% - 50%). If another comparable, say B, has capacity utilization of 70%, then the profit margin of B is required to be adjusted with the differential of 10% (80% - 70%). If still another comparable, say C, has capacity utilization of 90%, its profit margin is required to be adjusted adversely by (-)10%, being the difference between 80%, that is, the capacity utilization of the assessee and 90%, that is, the capacity utilization of C. It is always the assessee who has to prepare its transfer pricing study report and consider comparables with the respective profit margins duly adjusted to take care of differences between the international transaction and comparable uncontrolled transactions. Then the matter comes up before the TPO to vet the correctness of the assessee s claim. Thus it is apparent that onus to claim any capacity adjustment is always on the assessee, which can be discharged by demonstrating different capacity utilization levels. It is trite law that the burden of proof is always on the one who claims so. It is only when the assessee brings on record some evidence, either from the Annual report of its comparable companies or fro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reement dated 19.01.2009 with Initto -A/S Denmark, whose copy is available at pages 377 onwards of the paper book. This Agreement states that the assessee is engaged in the business of providing certain software and consulting services and solutions to Buyer (i.e. its AE). Definition of `Software services rendered by the assessee to its AE given in this Agreement means and includes services towards software development, software support, software project management services, development of new application, maintenance or upgrading or rework on any existing software projects/appliances, customer support etc. or any other services provided through its software developers. Remuneration to the assessee has been set out under Article 3 read with Appendix 1, which shows that the assessee is entitled to a monthly fixed amount in addition to hourly rate for the actual man-hours used in rendering specific services. The Agreement provides that the : `Software, which the Service Provider (i.e. the assessee) conceives or reduces to practice whether alone or with others during the course of its performance under this Agreement, shall be the exclusive property of Buyer (i.e. its AE) . Next para ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re is no segmental information available as regards the revenue from sale of products and revenue from software development segment. As the assessee is simply engaged in rendering software development services and there is no sale of any software products, this company, in our considered opinion, ceases to be comparable. It is obvious that from the common pool of income from both the streams of software products and software services, one cannot deduce the revenue from software services and no one knows the impact of revenue from Products on the overall kitty of profit, which may be significant. Since no segmental data of this company is available indicating operating profit from software development services, we order to exclude this company from the list of comparables. (ii) E-Zest Solutions 11.1. The Transfer Pricing Officer considered this company as comparable by observing that it provided similar services as were being provided by the assessee. He reproduced the relevant portion from the Annual report of this company indicating that it was engaged in providing software development services. The assessee remained unsuccessful before the DRP. 11.2. We have heard the ri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e development, consultancy and system integration services. He, therefore, considered it as comparable. The assessee is aggrieved. 13.2. We have heard the rival submissions and perused the relevant material on record. The Annual Report of this company has been placed in the second paper book, from which it is lucid that this company is engaged only in providing software development and consultancy services, which is similar to those rendered by the assessee. When confronted, the ld. AR did not raise any objection to the inclusion of this company in the final set of comparables. We, therefore, uphold the impugned order in treating this company as comparable. v) Persistent Systems Ltd. 14.1. The assessee objected to the inclusion of this company in the tally of comparables by arguing that it was functionally different and there was insufficient segmental information. The TPO negatived this contention and included the same in the final set of comparables. 14.2. After considering the rival submissions and perusing the relevant material on record, we find from Profit Loss Account of this company, a copy of which is placed at page 1534 of the paper book, that its income fro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted party transactions and proceeded to include it in the final set of comparables. 16.2. We have heard the rival submissions. Page 57 of the TPO s order is reproduction of the assessee s contention about the related party transactions as under :- Wipro Technology Services Limited (formerly Citi Technology Services Limited) ( the Company ) was incorporated on 15 September, 2004. The entire share capital of the Company was held by Citicorp Banking Corporation, a company incorporated under laws of Delaware, USA, upto 20 January, 2009. Wipro Limited (Wipro) executed an agreement with Citigroup Inc. for acquiring all of Citigroup interest in the Company w.e.f. 21 January 2009. On 21 January 2009, Wipro signed a master service agreement (MSA) with Citigroup Inc. for the delivery of technology infrastructure services and application development and maintenance services for the period of six years. The MSA provides for the delivery of at least $500 million in service revenues over the period of the contract. After the acquisition by Wipro, the name of the Company was changed to Wipro Technology Services Limited ( WTS or the Company ) on 16 March 2009. 16.3. It is observed fro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e exists a prior agreement in relation to the relevant transaction between the third person and the AE or the terms of the relevant transaction are determined in substance between the third person and the AE. When we consider section 92B(2) in combination with Rule 10A(a), it follows that the transaction between non-AEs shall be construed as a transaction between two AEs, if there exists a prior agreement in relation to the relevant transaction between third person and the AE. If such an agreement exists, the third person is also considered as an AE and the transaction with such third person becomes international transaction within the meaning of section 92B. Once there is a transaction between two associated enterprises, it ceases to be an uncontrolled transaction and, thereby, goes out of reckoning under Rule 10B(1)(e)(ii). 16.5. Adverting to the facts of the instant case, we find that Wipro Technology Services Ltd. earned a revenue from Master services agreement with Citigroup Inc. for the delivery of technology infrastructure services. This agreement was, in fact, executed between the assessee s AE, Wipro Ltd., and Citigroup Inc., a third person. This unfolds that the tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the paper book which states that: the company has in-house research and development centre involved in developmental activities for new products in the fields of simulations and training. Once this contention of the assessee is rejected and revenue from software products is excluded to the only inclusion of revenue from software development services segment which is akin to that of assessee, we feel no difficulty in considering this company as comparable on segmental level. The impugned order is upheld. x) Zylog Systems Ltd. 19.1. The TPO considered this company as comparable by noting in his order that the assessee s objections to its inclusion were unsustainable. 19.2. We have heard the rival submissions and perused the relevant material available on record. The ld. AR submitted that the TPO did not confront the assessee with the inclusion of Zylog Systems Ltd. in the set of comparables and it was a shock to see from his order that this company was included without a notice to the assessee. In order to support this contention, the ld. AR invited our attention towards page 9 of the TPO s order containing list of 19 companies on which the assessee s objections were s ..... X X X X Extracts X X X X X X X X Extracts X X X X
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