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TMI Blog2016 (3) TMI 1242X X X X Extracts X X X X X X X X Extracts X X X X ..... oreign currency expenditure on telecommunication expenditure not excluded from the export turnover - Held that:- Submission of the assessee that what has been reduced from export turnover should also be deducted from the total turnover while working out the deduction u/s.10A of the Act, needs to be accepted in view of the judgment of Hon’ble jurisdictional High Court in the case of CIT v. Tata Elxsi Ltd (2011 (8) TMI 782 - KARNATAKA HIGH COURT ). Allowability of software expenditure - revenue or capital expenditure - Held that:- What we find is that the nature of software expenditure was not analysed by the lower authorities. AO had simply considered it as a capital outgo without verifying whether the expenditure was relatable to application software or system software, which gave enduring benefit to the assessee. It is true that some application software can have enduring quality. A close analysis of the expenditure is required for coming to a reasoned conclusion We are of the opinion that the matter requires a fresh look by the AO. We remit the issue back to the file of the AO for consideration in accordance with law. - I.T(TP).A No.1304/Bang/2011 - - - Dated:- 9-3-2016 - ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in this appeal are also of the same segment. For justifying its pricing of the international transactions with its AE, assessee had selected 46 comparables and the average PLI of the 46 comparables came to 12.52%. As per the assessee, this was within + / - 5% margin of its own PLI and therefore there was no requirement of any adjustment for the pricing of the transactions with its AE. Assessee had adopted TNMM method as the most appropriate one. TPO while agreeing with TNMM, was of the opinion that many of the comparables selected by the assessee were not appropriate for various reasons mentioned in the TP order. He rejected all, but 38 comparables for functional dissimilarity, unreliable data, lack of complete information, difference in economic circumstances and existence of related party transactions. Comparables which were accepted by the TPO were Accel Transmatic Ltd, LGS Global Ltd, Mind Tree Ltd, Quintegra Solutions Ltd, R S Software (India) Ltd, R Systems International (Seg), Sasken Communication Technologies Ltd (seg) and Tata Elxsi Ltd. Relying on the very same data base, namely, capitaline plus and Prowess, TPO in addition to the eight companies mentioned above zeroed i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n Systems Ltd (Seg) 2.00 30.55% 106/3% 0 0.00% 13 LGS Global Ltd (Lanco Global Solutions Ltd) 45.39 15.75% 0 1.22 2.69% 14 Lucid Software Ltd 1.70 19.37% 0 0 0.00% 15 Mediasoft Solutions Ltd 1.85 3.66% 0 0 0.00% 16 Megasoft Ltd 139.33 60.23% 26.47/19% 10.21 7.33% 17 Mindtree Ltd 590.35 16.90% 0 0 0.00% 18 Persistent. Systems Ltd 293.75 24.52% 2.16/0.73% 28.55 9.72% 19 Quintegra Solutions Ltd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) ₹ 670,51,97,796/- Shortfall being adjustment u/s 92CA (f) = (e) - (c) ₹ 85,04,41,839/- 07. When a proposal on the above lines was put before the assessee, it chose to move the DRP. Though assessee asserted a number of grounds before the DRP for excluding comparables which as per the assessee were functionally different, DRP was not impressed. Thereafter final assessment order was passed by making an addition of ₹ 85,04,41,839/- as ALP adjustment. 08. Now before us, Ld. AR submitted that he was seeking for exclusion of Avani Cimcon Technologies Ltd, Celestial Labs Ltd, E- Zest Solutions Ltd, Flextronics Software Systems Ltd (seg), Helios Matheson Information Technology Ltd, Infosys Technologies Ltd, Ishir Infotech Ltd, Kals Information Systems Ltd, Lucid Software Ltd, Persistent Systems Ltd, Tata Elxsi Ltd (seg) and Wipro Ltd (seg), from the list of comparables considered by the TPO. Further according to him, M/s. Megasoft Ltd, could be considered as comparable only after segmentising its results. For seeking the above exclusions, Ld. AR placed reliance on a coordinate bench order in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... opment services in the fields of e-commerce, e-solutions internet security and management etc. During the FY 2006-07, HP ISO has undertaken software research and development services for various Hewlett Packard entities. Thus we are inclined to accept the contention of the Ld. AR that the companies which were excluded from list of comparables considered in software development services segment in the case of Hewlett Packard Global Soft P. Ltd (supra) have to be excluded here also. This Tribunal following the decision of another coordinate bench in the case of NXP Semiconductors (India) P. Ltd, v. ACIT [IT(TP)A.1174/Bang/2011, dt.14.11.2014], has held as under in paras 23 and 24 of its order in the case of M/s. Hewlett Packard Global Soft P. Ltd (supra) : 23. We have perused the orders and heard the rival contentions. In so far as Accel Transmatic Ltd (seg), Avani Cimcon Technologies Ltd, Celestial Labs Ltd, E-Zest Solutions Ltd,, Helios Matheson Information Technology Ltd, Infosys Technologies Ltd, Ishir Infotech Ltd, Kals Information Systems Ltd (seg), Lucid Software Ltd, Persistent Systems Ltd, Quintegra Solutions Ltd, Tata Elxsi Ltd (seg), Thirdware Solutions Ltd (seg) a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... termining TNMM margin. 49. Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as comparable. The ld. DR, on the other hand, relied on the order of the TPO. 50. We have considered the submissions and are of the view that the plea of the assessee that the aforesaid company should not be treated as comparables was considered by the Tribunal in Capgemini India Ltd (supra) where the assessee was software developer. The Tribunal, in the said decision referred to by the ld. counsel for the assessee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables. 20. Respectfully following the decision of the Tribunal in similar set of facts, these companies are directed to be excluded from the list of comparables. ii) Avani Cimcon Technolog ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 98) Operating Margin 32.55% 52.59% 25.62% - 9.87% 40. It was submitted that this company has made unusually high profit during the financial year 06-07. The operating revenues increased 63.03% which indicates that it was an extraordinary year for this company. Even the growth of software industry for the previous year as per NASSCOM was 32%. The growth rate of this company was double the industry average. In view of the above, it was argued that this company ought to have been rejected as a comparable. 41. We have given a careful consideration to the submissions made on behalf of the Assessee and are of the view that the same deserves to be accepted. The reasons given by the Assessee for excluding this company as comparable are found to be acceptable. The decision of ITAT (Mumbai) in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra) also supports the plea of the assessee. We therefore accept the plea of the Assessee to reject this company as a comparable. iii) Celestial Labs Ltd. 42. As far as this company is concerned, the stand of the assessee is that it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eement with IMTECH CHANDIGARH (a very reputed CSIR organization) to manufacture and market initially two Enzymes, Alpha Amylase and Alkaline Protease in India and overseas. The company is planning to set up a biotechnology facility to manufacture industrial enzymes. This facility would also include the research laboratories for carrying out further R D activities to develop new candidates drug molecules and license them to Interested Pharma and Bio Companies across the GLOBE. The proposed Facility will be set up in Genome Valley at Hyderabad in Andhra Pradesh. According to the learned D.R. celestial labs is also in the field of research in pharmaceutical products and should be considered as comparable. As rightly submitted by the learned counsel for the Assessee, the discovery is in relation to a software discovery of new drugs. Moreover the company also is owner of the IPR. There is however a reference to development of a molecule to treat cancer using bio-informatics tools for which patenting process was also being pursued. As explained earlier it is a diversified company and therefore cannot be considered as comparable functionally with that of the Assessee. There has b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not clear as to whether any segmental data was given or not. Besides the above there is no other detail in the TPO s order as to the nature of software development services performed by the Assessee. Celestial labs had come out with a public issue of shares and in that connection issued Draft Red Herring Prospectus (DRHP) in which the business of this company was explained as to clinical research. The TPO wanted to know as to whether the primary business of this company is software development services as indicated in the annual report for FY 06-07 or clinical research and manufacture of bio products and other products as stated in the DRHP. There is no reference to any reply by Celestial labs to the above clarification of the TPO. The TPO without any basis has however concluded that the business mentioned in the DRHP are the services or businesses that would be started by utilizing the funds garnered though the Initial Public Offer (IPO) and thus in no way connected with business operations of the company during FY 06-07. We are of the view that in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparables by the TPO. 14.4 We have heard the rival submissions and perused and carefullyconsidered the material on record. It is seen from the record that the TPO has included this company in the list of comparbales only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act. It appears that the TPO has not examined the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the coordinate bench of this Tribunal in the case of Capital I-Q InformationSystems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the coor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... however, the said concern was not into trading of software products as there were no cost of purchases debited in the Profit Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessee s segment of IT-Services. 18. Before us, apart from reiterating the points raised before the TPO and the DRP, the Ld. Counsel submitted that in the immediately preceeding assessment year of 2006-07, the said concern was evaluated by the assessee and was found functionally incomparable. For the said purpose, our reference has been invited to pages 421 to 542 of the Paper book, which is the copy of the Transfer Pricing study undertaken by the assessee for the A.Y. 2006-07, and in particular, attention was invited to page 454 where the accept reject matrix undertaken by the assessee reflected KALS Information Solutions Ltd. (Seg) as functionally incomparable. The Ld. Counsel pointed out that the aforesaid position has been accepted by the TPO in the earlier A.Y. 20 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment. 12.2 Before us, the assessee contended that this company is not functionally comparable to the assessee and in this context has cited various portions of the Annual Report of this company to this effect which is as under :- (i) The company has an Intellectual Property (IP) Cell to guide its employees to leverage the power of IP for their growth. In 2008, this company generated over 102 invention disclosures and filed an aggregate 10 patents in India and the USA. Till date this company has filed an aggregate of 119 patent applications (pending) in India and USA out of which 2 have been granted in the US. (ii) This company has substantial revenues from software products and the break-up of the software product revenues is not available. (iii) This company has incurred huge research and development expenditure to the tune of approximately ₹ 200 Crores. (iv) This company has a revenue sharing agreement towards acquisiti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... panies were chosen as comparable in the case of the Assessee as well as in the case of First Advantage Offshore Services Pvt.Ltd.(supra). The following were the relevant observations in the case of First Advantage Offshore Services Pvt.Ltd.(supra): 22. The learned counsel for the assessee submitted that these two companies are also to be excluded from the list of comparables on the basis of the finding of this Tribunal in the case of Mercedes Benz Research Development India Pvt. Ltd. dt 22.2.2013, wherein at pages 17 and 22 of its order the distinctions as to why these companies should be excluded are brought out. He submitted that the facts of the case before us are similar and, therefore, the said decision is applicable to the assessee's case also. 23. The learned DR however objected to the exclusion of these two companies from the list of comparables. On a careful perusal of the material on record, we find that the Tribunal in the case of Mercedes Benz Research Development India Pvt. Ltd. (cited supra) has taken a note of dissimilarities between the assessee therein and Lucid Software Ltd. As observed therein Lucid Software Ltd. company is also involved in the deve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds. Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable. 47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable. x) Persistent Systems Ltd. 17.1.1 This company was selected by the TPO as a comparable. The assessee objected to the inclusion ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details / information a company cannot be taken into account for comparability analysis, we hold that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. It is ordered accordingly. xi) Quintegra Solutions Ltd. 18.1 This case was selected by the TPO as a comparable. Before the TPO, the assessee objected to the inclusion of this company in the set of comparables on the ground that this company is functionally different and also that there were peculiar economic circumstances in the form of acquisitions made during the year. The TPO rejected the assessee's objections h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctionally different and possessing its own intangibles / IPRs, it cannot be considered as a comparable to the assessee in the case on hand and therefore ought to be excluded from the list of comparables for the period under consideration. 18.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables to the assessee for the period under consideration. 18.3.1 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details brought on record that this company i.e.Quintegra Solutions Ltd. is engaged in product engineering services and is not purely a software development service provider as is the assessee in the case on hand. It is also seen that this company is also engaged in proprietary software products and has substantial R D activity which has resulted in creation of its IPRs. Having applied for trade mark registration of its products, it evidences the fact that this company owns intangible assets. The co-ordinate bench of this Tribunal in thecase of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010 dt.9.11.2012) has held that if a comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ails on record, we find that this company is predominantly engaged in product designing services and not purely software development services. The details in the Annual Report show that the segment software development services relates to design services and are not similar to software development services performed by the assessee. 14.4.2 The Hon'ble Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. V ACIT (ITA No.7821/Mum/2011) has held that Tata Elxsi Ltd. is not a software development service provider and therefore it is not functionally comparable. In this context the relevant portion of this order is extracted and reproduced below :- . Tata Elxsi is engaged in development of niche product and development services which is entirely different from the assessee company. We agree with the contention of the learned Authorised Representative that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the case of E-Gain Communications Pvt. Ltd. (supra) has directed that since the income of this company includes income from sale of licenses, it ought to be rejected as a comparable for software development services. In the case on hand, the assessee is rendering software development services. In this factual view of the matter and following the afore cited decision of the Pune Tribunal (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand. xiv) Wipro Limited 13.1 This company was selected as a comparable by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables or several grounds like functional dis-similar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this company cannot be considered as a comparable to the assessee. We, therefore, direct the Assessing Officer/TPO to omit this company from the set of comparable companies in the case on hand for the year under consideration. 24. No doubt if we follow the above decision M/s. Accel Transmatic Ltd (seg), Avani Cimcon Technologies Ltd, Celestial Labs Ltd, E-Zest Solutions Ltd,, Helios Matheson Information Technology Ltd, Infosys Technologies Ltd, Ishir Infotech Ltd, Kals Information Systems Ltd (seg), Lucid Software Ltd, Persistent Systems Ltd, Quintegra Solutions Ltd, Tata Elxsi Ltd (seg), Thirdware Solutions Ltd (seg) and Wipro Ltd (seg) have to be excluded from the list of comparables. However out of these, M/s. Accel Transmatics Ltd (seg), Quintegra Solutions Ltd and Tata Elxsi Ltd (seg) were a part of assessee s own TP study. Hon ble Punjab Haryana High Court in CIT v. Quark Systems India (P) Ltd (supra), upheld the Special Bench decision in DCIT v. Quark Systems (P) Ltd [(2010) 42 DTR 414], noting that latter had only remitted the issue of comparability of comparables considered in assessee s own TP study, back to TPO. Hence we are of the opinion that the issue of compar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 85,51 4.851 78.72 Products-related parties 10 0.12 10 0.17 Products - others 896 10.1 970 15.74 BPO 129 1.5 214 3.17 Goods and others 15 0.17 45 0.71 Total Sales 8,616 106 6,165 100 But how this segmentation was done by the TPO and the reconciliation of the said segmentation with the annual report of the assessee was never attempted or done. In such a situation we are of the opinion that Flextronics Software Solutions Ltd (seg) could not be considered as a proper comparable. We direct exclusion thereof. Accordingly we direct that Flextronics Software Systems Ltd (seg) also be excluded from the list of comparables. 13. In so far as Megasoft Ltd, is concerned, direction of the Tribunal in para 25 of its order in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO s filter of more than 75% of revenues from software development services. The basis on which the TPO arrived at the PLI of 60.23% is given at page-115 and 116 of the order of the TPO. It is clear from the perusal of the same that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data. 25. In the order of the TPO, operating margin was computed for this company at 60.23%. It is the complaint of the assessee that the operating margins have been computed at entity level combining software services and software product segments. It was submitted that the product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r inclusion only after segmentation of its results. Needless to say working capital adjustment shall be reworked by the AO / TPO confining to the comparables that are left after exclusions. Concise grounds 2.4, 2.6 and 2.7 are treated as partly allowed. 15. Ld. AR did not press ground 3. Hence it is dismissed as not pressed. 16. Vide grounds 4 and 5, assessee states that foreign currency expenditure on telecommunication expenditure ought not be excluded from the export turnover and in the alternative it should be reduced from total turnover also while computing the relief u/s.10A of the Act. 17. We find that submission of the assessee that what has been reduced from export turnover should also be deducted from the total turnover while working out the deduction u/s.10A of the Act, needs to be accepted in view of the judgment of Hon ble jurisdictional High Court in the case of CIT v. Tata Elxsi Ltd (349 ITR 98). Accordingly, grounds 4 and 5 are treated as partly allowed. 18. Vide ground 6 grievance raised by the assessee is that software expenditure was not allowed as a revenue outgo but was considered as capital expenditure. 19. Facts apropos are that assessee had cla ..... X X X X Extracts X X X X X X X X Extracts X X X X
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