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TMI Blog2016 (1) TMI 1277X X X X Extracts X X X X X X X X Extracts X X X X ..... of international transactions with its Associated Enterprises (AE). The assessee had selected 23 comparables out of which 7 comparables were found to be suitable for comparison and the final set of comparables considered by the TPO were 20 in number. For the assessment year 2008-09, operating mark up on cost of the assessee works out to 15.71% and the Arithmetical Mean operating mark up on cost of comparable companies works out to 14.84% in the case of the assessee and 23.65% in the case of the comparable companies as per the TPO. The assessee's total income was determined at Rs. 1,82,29,221/- and tax payable thereon was at Rs. 61,96,112/-. 4. Aggrieved by the assessment, the assessee preferred an appeal before the CIT(A)-IV, Bangalore. With respect to the ground raised before the CIT(A) that the AO had erred in concluding that communication expenses (internet charges) of Rs. 21,16,982 were attributable to delivery of computer software outside India and that travelling expenses of Rs. 16,38,726 incurred in foreign currency were towards technical services rendered outside India and in reducing these expenses from the assessee's export turnover for computing the deduction u/s 10A a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Rs. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - "9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of such enterprises. Sec.92-A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm's length price in an international transaction and it provides:- (1) that 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, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :- (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 subclause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction. (2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) I nfosys Technologies Ltd. 13149 crores." 9. The learned counsel for the assessee submitted that Tata Elxsi Ltd. is not comparable, since it is functionally different from that of the assessee. The learned counsel for the assessee submitted, that it is evident from the Annual report of Tata Elxsi Ltd. that it has business units divided into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns Ltd. The company rendered product development services and high- end technical services which came under the category of KPO services. 3 Kals Info Systems Ltd. It is engaged in the development of software products and providing related services. As per the website of KALS, it is evident that the company is a full-fledged software product development company and also provides implementation and maintenance of software products. It also has a training centre engaged in training of software professionals for online projects. 4 Persistent Systems Ltd. It is a product company. Persistent Systems' product lifecycle offering covers the entire product lifecycle from product concept to product support. 5 Quintegra Solutions Ltd. It is into niche area of Information Technology. The company's operations consist of CRM, Telecom, Financial Services and other emerging verticals. It is engaged in providing High end IT solutions like development, testing, maintenance, SAP, product engineering and infrastructure management services, proprietary software products and consultancy services in IT on various platforms and technologies. 6 Tata Elxsi Ltd. AS seen from the annual re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onsulting, design, development, re-engineering, maintenance, systems integration and implementation. 3. Wipro Ltd. (Seg) Functionally different It is a product development company. The annual report for FY 2007-08 shows that it has income from both sale of software products and software development services. Full-fledged risk assuming entrepreneur It is a giant company and assumed all risks leading to higher profits and is therefore not comparable to the assessee company which is a captive unit of the parent company and assumes only limited risks. Holds technology and marketing intangible It is actively engaged in research & development activities and also owns intellectual property. 15. In support of his contentions, the ld. counsel for the assessee placed reliance on the following decisions:- - 3DPLM Software Solutions Ltd. IT(TP)A No.1303/Bang/2012 (AY 2008-09) - Trilogy E-Business Software India P. Ltd. (ITA No.1054/Bang/2011 (AY 2007-08) - Systech Integrators India Pvt. Ltd., ITA No.1283/Bang/2012 (AY 2008-09) - Telcordia Technologies India Pvt. Ltd., ITA No.7821/Mum/2011 (AY 2007-08) - Adaptec (India) Pvt. Ltd., ITA 1758/Hyd/2012 (AY 2008-09 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee. Hence, ground No.5 of the department is dismissed. 12. Ground No.6 by the department is that the CIT(A) erred in rejecting the diminishing revenue filter used by the TPO to exclude companies that do not reflect the normal industry trend. 13. The CIT(A) on this issue held as follows:- "129. I find merit in the appellant's contention that revenue is not a true indicator of a company's performance that may depend on its own business cycle, and that a company with increasing revenues over a period of time did not necessarily reflect better performance, as increase in expenses in the corresponding period could be higher than that in revenues and the company might still incur losses. Conversely, a company with diminishing revenues over a period of time may not necessarily be performing badly, if it still had a good profit margin achieved through cost efficiency. Growth of the Indian software industry cannot be attributed solely to existing companies, but also to new companies set up. Considering these aspects, I uphold the appellant's arguments on this issue." 14. Ground No.7 states that the CIT(A) erred in not appreciating that the different year ending filter applied by the T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... charges, contracts costs, etc. As there is no way of tracking or identifying employee costs, they may not be particularly amenable to be used as a filter in the selection or rejection of comparables. 147. I find merit in the appellant's contention that when TNMM is adopted as the most appropriate method for determination of ALP, only the net margin of the tested party has to be considered relative to an appropriate base (total cost in this case), without looking into individual elements of cost, as all direct and indirect costs of operation are aggregated, irrespective of their classification and composition. The decision in the case of Mentor Graphics (Noida) Pvt. Ltd. v. DCIT [20071 112 TTJ 408 (Del), where it was held that the TPO had wrongly objected that taxpayer did not exclude companies having low employee cost, also suggests that use of low employee cost as a filter may be inappropriate in cases where TNMM had been used as the most appropriate method to determine the ALP. 148. For the above reasons, I hold that the TPO was not justified in applying the employee cost filter in some cases, while disregarding it in respect of others. As the suitability of the filter f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in AY 08-09 as far as this comparable company is concerned. Following the aforesaid decision of the Mumbai Bench of the Tribunal, we hold that Bodhtree Consulting Ltd. cannot be regarded as a comparable. In this regards, the fact that the assessee had itself proposed this company as comparable, in our opinion, should not be the basis on which the said company should be retained as a comparable, when factually it is shown that the said company is a software product company and not a software development services company." 22. Following the decision of the Tribunal in the case of Cisco Systems India Pvt. Ltd. (supra), this issue is decided against the assessee. Ground No.9 raised by the Revenue is allowed. 23. With respect to ground No.10 challenging the order of the CIT(A) that he erred in holding that M/s.Celestial Labs being functionally different, cannot be taken as a comparable, the learned counsel for the assessee has relied on the following decisions of this Tribunal: i. 3DPLM Sof ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sidered as comparable functionally with the assessee. There has been no attempt to identify, eliminate and make adjustment of the profit margins so that the difference in functional comparability can be eliminated. By not resorting to such a process of making adjustments, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the assessee in this regard." (iv) The rejection / exclusion of this company as a comparable for Assessment Year 2007-08 for software service providers has been upheld by the co-ordinate benches of this Tribunal in the cases of LG Soft India Pvt. Ltd. in ITA No.112/Bang/2011, CSR India Pvt. Ltd. in IT(TP)A No.1119/Bang/2011 and by the ITAT, Delhi Bench in the case of Transwitch India Pvt. Ltd. in ITA No.6083/Del/2010. (v) The facts pertaining to this company has not changed from Assessment Year 2007-08 to Assessment Year 2008-09 and therefore this company cannot be considered for the purpose of comparability in the instant case and hence ought to be rejected. In support of this contention, the assessee has also referred to and quoted from various parts of the Annual Report of the company. 9.3 Per contra, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndia Pvt. Ltd. in ITA No.1054/Bang/2011, we hold that this company ought to be omitted form the list of comparables. The A.O./TPO are accordingly directed. 25. Following the decision of the coordinate Bench of this Tribunal in the case of 3DPLM Software Solutions Ltd. (supra), hence this company has to be rejected as a comparable. Hence, ground No.10 by the Revenue is rejected. 26. Ground No.11 of the revenue is that the CIT(A) erred in holding that M/s.Lucid Software Ltd., being functionally different, cannot be taken as a comparable. The learned counsel for the assessee relied on the following decisions: i. 3DPLM Software Solutions Ltd. in IT(TP)A No.1303/Bang/2012 ii. Apigee Technologies (India) P.Ltd., in IT(TP)A No.870/Bang/2013; iii. Symbol Technologies India Pvt. Ltd., in IT(TP)A No.15/Bang/2013 iv. Bearingpoint Property Services Pvt. Ltd., in IT(TP)A No1380/Bang/2012 v. GXS India Technology Centre in IT(TP)A No.1444/Bang/2012 27. M/s.Lucid Software is a product company focusing on Advanced Non-destructive Testing (NDT) Technologies. The company is actively involved in R&D activities with leading scientific and educational institutions and hence is not comparabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e TPO in including this company in the list of comparables. 16.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that the company i.e. Lucid Software Ltd., is engaged in the development of software products whereas the assessee, in the case on hand, is in the business of providing software development services. We also find that, co-ordinate benches of the Tribunal in the assessee's own case for Assessment Year 2007-08 (IT(TP)A No.845/Bang/2011), LG Soft India Pvt. Ltd. (supra), CSR India Pvt. Ltd. (supra); the ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt. Ltd. (supra) and the Delhi ITAT in the case of Transwitch India Pvt. Ltd. (supra) have held, that since this company, is engaged in the software product development and not software development services, it is functionally different and dis-similar and is therefore to be omitted from the list of comparables for software development service providers. The assessee has also brought on record details to demonstrate that the factual and other circumstances pertaining to this company have not changed materially from the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssed. 32. Ground Nos.13 & 14 are general in nature and are therefore not adjudicated. 33. The ld. counsel for the assessee submitted that the comparables at Sl.Nos. 1, 4, 9, 12, 13 & 14 [viz., Avani Cimcon, E-Zest Solutions Ltd., LGS Global Ltd., Quintegra Solutions Ltd., R. Systems International (Seg.) and R.S. Software (India) Ltd.] included by the TPO in the final set of comparable selected by him are not pressed by the assessee at this stage. It was, however, submitted that the same should not be construed as acceptance of these companies by the assessee as comparables. Therefore, we dismiss the assessee's plea on inclusion of the above comparables by the TPO/AO as not pressed. 34. The ld. counsel for the assessee submitted that the assessee's mark-up on cost falls within the +/- 5% range as provided u/s. 92C(2) of the I.T. Act and hence the international transactions in relation to income from contract software development services is at arm's length. We direct the AO/TPO to examine this issue and decide the same in accordance with law. 35. The ld. counsel for the assessee submitted that the Cross Objection filed by the assessee is not pressed. Accordingly, the Cross Objec ..... X X X X Extracts X X X X X X X X Extracts X X X X
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