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TMI Blog2016 (9) TMI 1458X X X X Extracts X X X X X X X X Extracts X X X X ..... Applied Inc as a captive service provider. The financials of the assessee as well as international transactions for the year under consideration have been reproduced by the Transfer Pricing Officer (TPO) as under : Software development & Engineering Services Rs.2,063,193,768 Total Expenditure Rs.1,875,630,698 Less : Foreign Exchange Loss Rs.23,976,188 Operating Expenditure Rs.1,851,654,510 Operating Profit Rs.211,539,258 OP/OC 11.42% Particulars Paid Received Software development services 1,955,823,476 Support Services 107,370,292 Reimbursement of expenses 31,949,528 Recovery of expenses 8,584,353 Recovery of withholding taxes of employees on Restricted Stocks Unit granted and remitted to local tax authorities. 13,610,607 3. The only dispute in these appeals is regarding the Arm's Length Price ('ALP') of software development services to the AE and consequent adjustment by the TPO apart from the issue of exclusion of expenses incurred in foreign currency while computing the deduction under Section 10A of the Act. The other international transactions have been accepted by the TPO at ALP. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO and the adjustment made : Arm's Length Mean Margin 24.82% Less: Working Capital Adjustment 0.05% Adjusted mean margin of the comparables 24.77% Operating Cost Rs. 175,52,43,966/- Arm's Length Price - 124.77% of Operating Cost Rs. 219,00,17,896/- Price Received Rs.195,58,23,477/- Shortfall being adjustment u/S. 92CA Rs.23,41,94,419/- The assessee challenged the action of the TPO/A.O. before DRP and raised various objections including the comparability of certain companies selected by the TPO as well as the issue of rejection of certain companies selected by the assessee in the TP Study. The DRP rejected 9 companies out of the set of 13 comparables selected by the TPO on various criteria and filters applied by it. The final list of comparables after the directions of the DRP is as under : SI. No. Name of the Company Mark-up on Total Costs (WC-unadj) (in %) Mark-up on Total Costs (WC - adj) (in %) 1 e-Zest Solutions Limited 21.03 19.97 2 Persistent Systems & Solutions Ltd. 22.12 22.16 3 Persistent Systems Ltd. 22.84 23.60 4 Sasken Communication Technologies Ltd. 24.13 25.46 ARITHMETICAL MEAN 22.53 22.80 Thus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red in determining a new arm's length price in substitution of the arm's length price as determined by the Appellant. 4. Determination of Net Cost Margin of the Appellant 4.1 The AO / TPO had grossly erred on facts and in law in benchmarking the transactions of the Appellant without considering the differences in the functions performed, assets employed and risk undertaken by the Appellant visà- vis comparable companies. The Ld. Panel erred in confirming the same. 4.2 The Ld. AO / Ld. TPO had erred on facts and in law in not acknowledging that the sub-contracting charges, incurred by the Appellant, represents arm's length consideration, and thereby was required to be considered as pass-through cost. The Ld. Panel erred in confirming the same. 5. The fresh comparable search undertaken by the TPO is bad in law The AO/ TPO erred in law in holding that the fresh comparability analysis using non contemporaneous data conducted by the TPO and further substituting the Appellant's analysis with fresh benchmarking analysis on his own conjectures and surmises. Thus, the Appellant prays that the fresh benchmarking analysis conducted by the TPO is liable to be quashed. 6. Compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) and the Ld. Panel also erred in confirming the same. 6.10 The AO/ TPO erred in facts in arbitrarily rejecting companies based on their financial results without considering the functional comparability. 6.11 The AO/ TPO also erred on facts in wrongly computing the margins of a certain companies identified as comparable by the TPO. 6.12 The AO/ TPO erred in rejecting Akshay Software Technologies Ltd, L G S Global Ltd, Powersoft Global Solutions Ltd, Helios & Matheson Information Technology Ltd. and Vama Industries Ltd despite these companies being functionally comparable. The Ld. Panel also erred in confirming the same. 6.13 The AO/ TPO erred in including Sasken Communication Technologies Ltd, Persistent Systems & Solutions Ltd and Persistent Systems Ltd despite these companies being functionally dissimilar to the Appellant. The Ld. Panel also erred in confirming the same. 6.14 The Ld. Panel erred in arbitrarily rejecting Evoke Technologies Private Limited and R S Software (India) Ltd. despite being functionally comparable companies. 7. Erroneous data used by the TPO 7.1 The AO/ TPO has erred in law and the Ld. Panel further erred in confirming use of data, which was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed on the facts and circumstances of the case, there was no basis for the AO to initiate proceedings under section 274 read with section 271 of the Act. 12. Relief 12.1 The Appellant prays that directions be given to grant all such relief arising from the above grounds and also all relief consequential thereto. 12.2 The Appellant desires leave to add to or alter, by deletion, substitution or otherwise, any or all of the above grounds of objections, at any time before or during the hearing of the Appeal. 12.3 Further, the Appellant prays that the adjustment in relation to transfer pricing matters made by the learned AO/ TPO and upheld by the Ld. Panel is bad in law and liable to be deleted." Revenue's Grounds : 4. The first effective issue is regarding sub-contracting charges being part of operating cost as well as corresponding revenue from AE for the purpose of operating income. The assessee took the plea that subcontracting charges incurred by the assessee are to be treated as pass through cost and therefore shall be excluded from the operating profit and operating cost of the assessee while computing the ALP in respect of the software development services segment. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... without any value addition but the assessee is providing software development services to the AE and charging margin on the same. Therefore the cost on the software development activity is incurred by the assessee and charging the AE on the said services with a mark up of 10% on cost. The cost of subcontracting in software development services is also charged with 10% mark up to the AE. When the margin on the cost of sub-contracting charges is part of the operating revenue of the assessee then only the cost of sub-contracting activity cannot be excluded as pass through. It would amount to artificially inflate the margins of the assessee on the other revenue from the services other than sub-contracting activity. In any case, pass through cost can be considered only when the activity of providing services to the AE does not involve value addition on the part of the AE. The decision of the Delhi Benches of the Tribunal in the case of DCIT Vs. Cheil Communications India Pvt. Ltd. (supra) would not help the case of the assessee as in the said case the activity of the assessee was only a distributor without any value addition. It is pertinent to note that outsourcing cost in software de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee has raised objections against this company before the DRP. However the DRP did not adjudicate the objections raised by the assessee. The decision of this Tribunal in the case of M/s. Electronics for Imaging India Pvt. Ltd. Vs. DCIT (supra) relied upon by the learned Authorised Representative is based on two aspects. (i) The information received under Section 133(6) of the Act was considered by the TPO without sharing with the assessee and (ii) nature of the activity is KPO. It is pertinent to note that the question of BPO and KPO is relevant only in ITES segment and not for software development services segment. On the contrary, the decision in the case of Toluna India Pvt. Ltd. Vs. ACIT (supra), pertains to the Assessment Year 2007-08, therefore the facts of the different year cannot be applied without verification. Accordingly, we set aside this issue of comparability of E-Just Solution Ltd. to the record of the Assessing Officer / TPO for deciding the same after verification of the relevant facts as well as considering the objections of the assessee. (ii) Persistent Systems and Solutions Ltd. (iii) Persistent Systems Ltd. 9.2.1 These two companies were part of the TP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l submissions as well as relevant material on record, at the outset, we note that the DRP has examined the functional comparability of this company by considering the relevant details as given in the annual report of this company. The DRP has given the finding that the entire revenue has been earned by this company from the sale of software services and products and in the absence of segmental details, it cannot be considered as comparable with software services segment. We find that this company has shown the income from sale of software services and products to the tune of Rs. 6.67 crores. We further note that as per Schedule 11, the entire revenue has been shown under one segment i.e., sale of software services and products. Therefore, no separate segment has been given in respect of software services. Accordingly, the composite data of revenue as well as margins of this company pertaining to the sale of software services and products cannot be considered as comparable with the software development services segment of the assessee. In view of the above facts and circumstances, we do not find any error or illegality in the directions of the DRP in excluding this company from the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pany is functionally not comparable to the assessee. The ld. AR has referred to the Annual Report of this company and submitted that it derives income from software products specifically new products launched called 'Vyaparaseva' during F.Y. 2010-11. Thus this company is engaged in product development cannot be compared with the assessee when segmental details are not available. He has relied upon the decision dt.24.2.2016 of the co-ordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra). 9.3.2 On the other hand, the learned Departmental Representative has submitted that the inventory shown at page 70 of the report is very negligible. The product launched is for future period and not generated any revenue during the year under consideration. He has relied upon the orders of authorities below. 9.3.3 We have considered the rival submissions as well as the relevant material on record. The co-ordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra) has considered the comparability of this company in paras 27 to 29 as under : " (5) Sasken Communication Technologies Ltd. 27. The assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd that its functions appear to be more in the nature of support services or ITES. The DRP has confirmed the rejection on a different ground by applying a filter that the expenditure in foreign currency was higher when compared to its total revenue. Thus DRP was of the view that this company was predominantly engaged in the 'on site' development of software. The ld. AR has submitted that such filter was neither applied by the TPO nor sought to be applied by the assessee. Therefore the DRP was not asked to apply this filter. Secondly the DRP did not arrive at the finding that the said company was in fact engaged in 'on site' development of software. The finding of the DRP are based mainly on the assumption that because of its expenditure in foreign currency was high it must have been engaged in the 'on site' development of software. The ld. AR has further contended that this filter of 'on site' development services have been applied by the DRP without giving an opportunity of filing its objections to the assessee. Thus the ld. AR has submitted that the rejection of the said company by applying a filter not applied by the TPO is liable to be set aside. He has relied upon the decision ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee has to succeed in its claim that M/s. Akshay Software Technologies Ltd, is a proper comparable. We direct the TPO to include the said company as a comparable along with the two comparables, namely, M/s. R. S. Software (India) Ltd and M/s. Thinksoft Global Services Ltd, and rework the mean PLI. ALP adjustment, if any, required shall be based on such mean PLI, after considering the working capital adjusted. Ordered accordingly. Ground 12 of the assessee is allowed. 09. Vide its ground 13, we find that assessee is aggrieved that DRP had directed treatment of foreign exchange loss/gain as non-operating in nature. We find that DRP had at para 2.9 of its directions dated 26.11.2014 directed inclusion of foreign exchange gain / loss as part of the operating expenditure and not the other way. Therefore, the said ground is ill conceived and dismissed." Therefore other than the employee cost the issue of functional similarity was not before the Tribunal in the said case. However, we note that as per the financial results reported in the Annual Report at page 2 and 15, the income shown in the profit and loss account is from software services and products. Further as per the sch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss to say the information under Section 133(6) may be obtained for the purpose of ascertaining the annual employee cost of this company. 14. The assessee is also seeking inclusion of couple of companies which were selected by the TPO but rejected by the DRP as under : (i) Evoke Technology Ltd. (ii) R S Software (India) Ltd. 14.1 We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record. These two companies were selected by the TPO in the set of comparables however the DRP has rejected these companies on the ground that the company Evoke Technology Ltd. is having low margin and the company R S Software (India) Ltd. is engaged in 'on site' activity. Both the assessee as well as revenue are seeking inclusion of these companies in the list of comparables. Accordingly, when the assessee as well as revenue are seeking inclusion of these two companies, we direct the TPO to include these two companies in the list of comparables. 15. The revenue is also seeking inclusion of some of the companies in the list of comparables which were reflected by the DRP. We will deal with the issues one by one as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for Imaging India Pvt. Ltd. (supra) has considered the comparability of this company in paras 14 to 16 as under : " (1) ICRA Techno Analytics Ltd. (seg) 14. At the outset, we note that apart from having the related party revenue at 20.94% of the total revenue, this company was also found to be functionally not comparable with software development services segment of the assessee. The DRP has given its finding at pages 13 to 14 as under:- "Having heard the contention, on perusal of the annual report, it is noticed by us that the segmental information is available for two segments i.e., services and sales. However, it is evident from the annual report that the service segment comprises of software development, software consultancy, engineering services, web development, web hosting, etc. for which no segmental information is available and therefore, the objection of the assessee is found acceptable. Accordingly, Assessing Officer is directed to exclude the above company from the comparables." 15. We find that the facts recorded by the DRP in respect of business activity of this company are not in dispute. Therefore, when this company is engaged in diversified activities of so ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... DRP rejected objections of the assessee on the ground that TPO has applied 25% filter of RPT and annual report of the company does not show any other services rendered other than software development services provided by this company. Thus the DRP held that software development segment is comparable to the assessee and therefore this company has to be retained as comparable. 63. We have heard the ld. AR as well as ld. DR and considered the relevant material on record. The ld. AR has submitted that this company is having 18.66% RPT and further this company earns revenue from both services and products. Thus, the ld. AR submitted this company is also in the software products and therefore cannot be considered as good comparable. He has further contended that in a series of decisions, the Tribunal has applied 15% RPT filter and since this company is having more than 15% RPT, the same cannot be considered as a good comparable. 64. On the other hand, the ld. DR has submitted that TPO has applied RPT filter of 25% and therefore only for this company, the RPT cannot be reduced to 15%. Further, the DRP has examined annual report of this company and found that this company earns revenu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee company as it is engaged in diversified activities even in the software development services. The DRP has followed the decision of the Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. (supra). 32. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. We find that this company even in the software development segment is engaged in diversified activities of product design services, innovation design, engineering services, visual computing labs, etc. We further note that in the case of Telcordia Technologies Pvt. Ltd. (supra), the Mumbai Bench of the Tribunal vide its order dated 11.5.2012 in para 9.7 has held as under:- "7.7 From the facts and material on record and submissions made by the learned AR, it is seen that the 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 AR 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 provid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e deduction under Section 10A of the Act. The DRP though has allowed the claim of the assessee so far as the travelling expenses incurred in the foreign currency by directing the Assessing Officer to exclude the same from total turnover as well as by following the decision of the Hon'ble jurisdictional High Court in the case of CIT Vs. Tata Elxsi Ltd. 349 ITR 98 however, not allowed the claim in respect of the sub-contracting charges which were reduced from the export turnover. 22.2 The learned Authorised Representative of the assessee has submitted that the sub-contracting charges ought not to have been reduced from the export turnover as the assessee is engaged in the export of computer software outside India and not in the provisions of technical services outside India. Therefore the said sum were not required to have been reduced from the export turnover. The subcontracting charges paid to third party service provider as consideration for provision of service by them in India for which payment was made in foreign currency because third party service provider operated from their EOU unit. The sums were not incurred for rendering technical services outside India. Therefore t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... otal turnover of the business carried or by the undertaking. The formula which is prescribed by sub-section (4) of section 10A is as follows: Profits derived from export of articles or things or Computer software = Profits of the business of the undertaking X Export turnover in respect of the articles or things or computer software Profits derived from export of articles or things or Computer software = Profits of the business of the undertaking x Export turnover in respect of the articles or things or computer software Total turnover of the business carried on by the undertakin The total turnover of the business carried on by the undertaking would consist of the turnover from export and the turnover from local sales. The export turnover constitutes the numerator in the formula prescribed by sub-section (4). Export turnover also forms a constituent element of the denominator inasmuch as the export turnover is a part of the total turnover. The export turnover, in the numerator must have the same meaning as the export turnover which is a constituent element of the total turnover in the denominator. The legislature has provided a definition of the expression "export turnove ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39;total turnover'. After referring to the various judgments of the High Court as well as the Supreme Court held as under: "53. For the above reasons, we hold that for the purpose of applying the formula under sub-section (4) of Section 10-B, the freight telecom charges or insurance attributable to the delivery of articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing the technical services outside India are to be excluded both from the export turnover and from the total turnover, which are the numerator and the denominator respectively in the formula." The formula for computation of the deduction under Section 10-A would be as under: Profits of the business X export turnover Total turnover From the aforesaid judgments, what emerges is that, there should be uniformity in the ingredients of both the numerator and the denominator of the formula, since otherwise it would produce anomalies or absurd results. Section 10-A is a beneficial section. It is intended to provide incentives to promote exports. The incentive is to exempt profits relatable to exports. In the case of combined business of an asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent of total turnover, such an interpretation would run counter to the legislative intent and impermissible. If that were the intention of the legislature, they would have expressly stated so. If they have not chosen to expressly define what the total turnover means, then, when the total turnover includes export turnover, the meaning assigned by the legislature to the export turnover is to be respected and given effect to, while interpreting the total turnover which is inclusive of the export turnover. Therefore, the formula for computation of the deduction under Section 10-A, would be as under: Profits of the business of the undertaking X Export turn over (Export turnover + domestic turn over) Total Turn Over Profits of the business of the undertaking Export turn over X (Export turnover + domestic turn over) Total Turn Over 11. In that view of the matter, we do not see any error committed by the Tribunal in following the judgments rendered in the context of Section 80HHC in interpreting Section 10- A when the principle underlying both these provisions is one and the same. Therefore, we do not see any merit in these appeals. The substantial question of law framed is ans ..... X X X X Extracts X X X X X X X X Extracts X X X X
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