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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 ..... ty of both assessee as well as the comparables. Accordingly, the issue is decided against the assessee. Companies functionally dissimilar with that of assessee need to be deselected from final list. Companies with export revenue less than 75% applied by the TPO need to be deselected. Exclusion of sub-contracting charges from export turnover while computing deduction under Section 10A - Held that:- As in the case of Tata Elxsi Ltd vs. ACIT [1980 (4) TMI 12 - PUNJAB AND HARYANA HIGH COURT] expenses reduced from the export turnover ought to be reduced from the total turnover as well. Exclusion of forex loss from export turnover while computing the deduction under Section 10A - Held that:- It is pertinent to note that the turnover is considered on mercantile basis and not on realization basis. Therefore any loss on account of fluctuation of forex rate would be a business loss and should have effect of reduction of profits and corresponding eligible profits for deduction under Section 10A - Such loss cannot be reduced from export turnover based on the invoices and the loss on realization is a business loss not affecting the turnover. Therefore we direct the Assessing Officer to recomput ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the TPO at ALP. The operating profit claimed by the assessee is 11.42%. The assessee selected 10 comparable companies in its TP Study analysis and claimed its international transactions at arm's length as under : Comparables selected by Assessee and their arithmetic mean: Sl.No. Name of the company NCP2008-09 (%) NCP 2009-10 (%) NCP 2010-11 (%) Weighted Average (%) 1 Akshay Software Technologies Ltd. 12.47 -3.16 0.66 3.33 2 Evoke Technologies Pvt. Ltd. 17.49 15.13 15.16 16.04 3 Helios & Matheson Information Technology Ltd. 21.27 10.83 13.94 14.67 4 L G S Global Limited 24.63 10.00 4.61 13.31 5 Powersoft Global Solutions Ltd. 9.96 9.88 16.35 12.26 6 RS Software (India) Ltd. 12.20 21.17 7.71 13.52 7 R Systems International Ltd. 15.97 25.05 27.10 22.14 8 Sasken Communication Technologies Ltd. 20.29 17.09 9.69 18.09 9 Tata Elxsi Ltd. 6.53 9.33 14.59 9.87 10 Vama Industries Ltd. 20.72 18.99 NA 19.92 Arithmetical Mean 14.31 The TPO rejected 6 comparable companies from the TP Study and accepted 4 companies from the set of comparables. The TPO has carried out a fresh search and added 9 more companies to the set of 4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appeals. The assessee and department raised the following grounds respectively as under : Assessee's Grounds : 1. " Order/ Directions bad in law and on facts 1.1 The order passed by the Assistant Commissioner of Income Tax, Circle 1(1)(1) ['the AO'], under section 143(3) read with section 144C of the Income-tax Act, 1961 ('the Act'), is bad in law and on facts and is in violation of the principles of natural justice. Without prejudice to the generality of the above, the order issued by the AO is bad in law in so far as the fact that the AO did not issue to Applied Materials India Private Limited ('the Appellant or 'the Company'), a show cause notice as per proviso to section 92C(3) of the Act. 1.2 The AO has erred in law in making a reference to the Additional Commissioner of Income Tax (Transfer Pricing) - 1(1) ['TPO'], inter alia, since he has not recorded an opinion that any of the conditions in section 92C(3) of the Act, were satisfied in the instant case. Accordingly, the order passed by the TPO is without jurisdiction 1.3 The directions issued by the Ld. Dispute Resolution Panel ('DRP/ Ld. Panel') did not take cognizance of the objections raised by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erred on facts and the Ld. Panel erred in confirming the benchmarking of transactions of software development services of the Appellant with companies operating as full-fledged entrepreneurs without considering the differences in the functions performed, assets employed and risk undertaken by the Appellant vis-à-vis comparable companies. 6.2 The AO/ TPO erred on facts in rejecting the comparable companies arrived at in the Transfer Pricing Study without considering the functional and risk analysis of the Appellant and the Ld. Panel also erred in confirming the same. 6.3 The AO/ TPO erred in law in applying arbitrary filters to arrive at a fresh set of companies as comparables to the Appellant, without establishing functional comparability and the Ld. Panel also erred in confirming the same. 6.4 The AO/ TPO erred on facts in arbitrarily accepting companies without considering the turnover and size of the Assessee and comparables. The Ld. Panel also erred in confirming the same. In view of the high turnover of Infosys Ltd, L & T Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd , Sasken Communication Technologies Ltd., and Tata Elxsi Ltd therefore, the said companies ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansfer pricing study by the Appellant. 7.2 The AO/ TPO erred in law and the Ld. Panel further erred in confirming nonapplication of multiple-year data while computing the margin of alleged comparable companies as such data had an influence in determining the transfer pricing policy of the Assessee. 8. Non-allowance of appropriate adjustment to the comparable companies by the Ld. Panel and AO/ TPO AO/ TPO erred in law and on facts in not allowing appropriate adjustments under Rule 10B to account for, inter alia, differences in (i) accounting practices, (ii) marketing expenditure adjustment, (iii) research and development expenditure adjustment, (iv) working capital, and (iv) risk profile between the Appellant and the comparable companies. 9. Variation of 5% from the arithmetic mean The AO/ TPO erred in law in not granting the benefits of proviso to section 92C(2) of the Act available to the Appellant. 10. Reduction of expenses from export and total turnover for computation of deduction under section 10A of the Act 10.1 The Ld. Panel erred in upholding the action of the Ld. AO in reducing subcontracting charges of ₹ 594,413,108 incurred towards export of computer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting charges and receipts as part of the operating cost and operating income of the assessee for the purpose of determining the ALP. 5. Before us, the learned Authorised Representative of the assessee has submitted that for the earlier assessment years the TPO accepted the sub-contracting charges as pass through cost while determining the operating profit/margins of the assessee. He has also relied upon the decision of the Delhi Bench of the Tribunal in the case of DCIT Vs. Cheil Communications India Pvt. Ltd. (2015) 11 taxmann.com 205. Thus the learned Authorised Representative has submitted that sub-contract charges ought to be considered as pass through cost and should be excluded both from the operating cost as well as operating income of the assessee for the purpose of computing the operating margins of the software development segment. Alternatively, the learned Authorised Representative has submitted that the comparables should also be having sub-contract charges if this is not considered as pass through cost. 6. On the other hand, the learned Departmental Representative has submitted that while computing the margins on the cost of software development services segment, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nnot be separated from the operating cost and operating revenue of the said segment of services. Accordingly, the cost of software development services cannot be treated in this fashion as claimed by the assessee. Hence we do not find any merit or substance in the contention raised by the assessee on this issue. 8. As regards the alternative plea raised by the ld. AR that the comparables should also have similar activity, we find that the TPO has applied a filter of cost of employee which subsumes the outsourcing activity of both assessee as well as the comparables. Accordingly, the issue is decided against the assessee. 9. The next ground in the assessee's appeal is regarding seeking exclusion of 4 comparable companies retained by the DRP. We will deal with the comparability of these 4 companies as under : (i) E-Just Solution Ltd. 9.1.1 The learned Authorised Representative has submitted that the assessee raised the objection before the DRP for exclusion of this company from the set of comparables but the DRP has not adjudicated the objections of the assessee. He has referred the objections raised before the DRP at page No. 1373 of the paper book as well as referred the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... well as DRP. 9.2.2 Before us, the learned Authorised Representative of the assessee has submitted that these companies are functionally not comparable to the assessee as these are engaged in diversified activity i.e. rendering of software development services and licensing, royalty of software products. Thus without having the separate segmental details and data these diversified activities cannot be compared with the assessee. He has further pointed out that the company Persistent Systems Ltd. also engaged in developing products and therefore the activities are not comparable with that of the assessee. In support of his contention, he has relied upon the decision of this Tribunal dt.24.2.2016 in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra) and submitted that this company was found to be not comparable with the software development services provider. He has further pointed out that in assessee's own case for the Assessment Year 2010-11, the DRP vide its order dt.24.11.2014 has excluded Persistent Systems and Solutions Ltd. from the list of comparables by holding that this company is not comparable to the assessee. 9.2.3 On the other hand, the ld. DR ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have heard the ld. DR as well as ld. AR and considered the relevant material on record. The assessee raised objections against selection of this company on the ground that this company is functionally not comparable as engaged in the product development. The segmental information for services and product is not available. Further, the assessee has also pointed out that there was an acquisition and restructuring during the year under consideration. 25. The DRP has noted the fact that this company has reported the entire receipt from sales and software services and product. Therefore, no segmental information was found to be available for sale of software services and product. Further, the DRP has noted that as per Note 1 of Schedule 15, this company is predominantly engaged in outsource software development service. Apart from the revenue from software services, it also earns income from licence of products, royalty on sale of products, income from maintenance contract, etc. These facts recorded by the DRP has not been disputed before us. 26. Therefore, when this company is engaged in diversified activities and earning revenue from various activities including licencing of produ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd other services. The DRP has come to the conclusion that this company earned revenue from 3 segments. However, no segmental information is available. Accordingly, the DRP directed the AO to exclude this company from the comparables. 28. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. The DRP has reproduced the break-up of revenue in the impugned order as under:- Amount in Rs. lakhs ______________________________________________________________________________ Year ended Year ended March 31, 2010 March 31, 2019 Software Services 37,736.22 40,531.20 Software products 2,041.00 6,146.43 Other services 372.77 1,297.05 Total revenues 40,150.89 47,974.68 29. Thus, there is no dispute that this company earns revenue from 3 segments. However, the segmental operating margins are not available. Therefore, in the absence of segmental relevant data and particularly operating margins, this composite data cannot be considered as comparable with the assessee for software development services segment. Accordingly, we do not find any error or illegality in the findings of the DRP." We further note that the DRP has not adjudicated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gmental reporting it cannot be considered as functionally comparable with the assessee. 12.3 We have considered the rival submissions as well as the relevant material on record. As regards the decision of the co-ordinate bench in the case of Arowana Consulting Ltd. Vs. ITO (supra), the Tribunal has dealt with only one objection of employee cost in paras 8 & 9 as under : " 08. What is left for consideration is assessee's grievance regarding M/s. Akshay Software Technologies Ltd. DRP directed exclusion of the said company for a reason that its employee cost was more than 89% of its total operating expenditure. We find that assessee had employee cost in excess of 90% of its operating expenditure. In our opinion, it is normal to have a high percentage of employee cost in a software development company, especially so, when the company is involved in development of software for clients at the site of the clients. Reason given by the DRP, in our opinion, was not correct. Higher employee cost is a normal feature for a software development company for the simple reason that it is a skill oriented business. The skill-set required for the employees in the case of the assessee, required kno ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngly, we reject this ground of assessee. (ii) LGS Global Ltd. 13.1 The TPO rejected this company on the ground that the Annual Report did not give break up of employee cost and thus he could not compute its employee cost factor. The DRP upheld the rejection on the basis that the separate details of employee cost were not available. 13.2 Before us, the ld.AR of the assessee has submitted that this company has shown purchase and employee cost under a composite head which is 83.91% of the sale. Therefore this company satisfied the employee cost of 25% of total sales. The learned Authorised Representative has pointed out that in case of service provider the major component is employee cost and there is hardly any purchases therefore even if the employee cost is not separately reported, the composite of purchase and employee cost constitute 83.91% of sales. Thus he has submitted that this company should be included in the list of comparables. 13.3 On the other hand, the learned Departmental Representative has relied upon the orders of the authorities below and submitted that there is no dispute that this company has not reported employee cost separately and therefore it is not p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... total employee cost of this company is 11.51 of the total operating revenue therefore it fails the employee cost filter of 25%. Further he has pointed out that this company also fails the software development services revenue filter of 75%. He has referred the details at page Nos.39 and 53 of the Annual Report and submitted that the income from software development is ₹ 81.40 Crores out of total revenue of ₹ 141 Crores. Therefore this company fails this filter. 16.3 In a rejoinder the ld. DR has submitted that the TPO has considered only Information Technology transactions segment and therefore it satisfies software development services income filter as well as employee cost filter. 16.4 We have considered the rival submissions as well as the relevant material on record. As per the segmental reporting at page 53 of the Annual Report the income from Information Technology Services is ₹ 81.40 Crores out of the total income of ₹ 141 Crores. Therefore the revenue from Information Technology transactions services is less than 75% and consequently this company does not satisfy the filter of information technology revenue applied by the TPO itself. Accordingly, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s to its AE. 16. In view of the above facts, we do not find any error or illegality in the findings of the DRP that this company is functionally not comparable with that of a pure software development service provider." Nothing has been brought before us to show that the facts recorded by the DRP as well as by the co-ordinate bench of this Tribunal are not correct. Accordingly, in view of the decision of the co-ordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra), we do not find any error or illegality in the order of the DRP on this issue. (iii) Infosys Ltd. 18. We have heard the learned D.R. as well as learned A.R. and considered the relevant material on record. At the outset, we note that the co-ordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra) has considered this issue in para 17 as under : " (2) Infosys Ltd. 17. The assessee objected against the selection of this company on the ground that this company has a big name and brand value and therefore it has a bargaining power. It also contended that the turnover of this company is ₹ 21,140 crores, which is 442 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d therefore we do agree with the view taken by the coordinate Benches of the Tribunal that the threshold limit of tolerance range should not exceed 15% as far as RPT revenue is concerned. Therefore, we direct the AO/TPO to apply 15% RPT filter in respect of all the comparables." In view of the facts recorded by the DRP as well as the decision of the coordinate bench, we do not find any reason to interfere with the directions of the DRP. (v) Tata Elxsi Ltd. (Seg.) : 20. We have heard the learned Departmental Representative as well as learned Authorised Representative and considered the relevant material on record. The DRP has rejected this company by discussing the fact at page 16 as under : We further note that the DRP has also recorded the fact that export revenue of this company is 73.30% which is less than 75% applied by the TPO. Therefore this company does not qualify the export earning filter applied by the TPO. Further the co-ordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra) has considered this issue in paras 30 to 33 as under : 30. The assessee has raised objections against this company on the ground that the compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . No contrary view has been brought to our notice regarding comparability of this company with that of a pure software development service provider. Accordingly, in view of the decision of the Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. (supra), we do not find any reason to interfere with the finding of the DRP." In view of the facts recorded by the DRP as well as thedecision of the Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra), we do not find any error or illegality in the directions of the DRP to exclude this company form the set of comparables. 21. The revenue is also seeking inclusion of the following companies which were rejected by the DRP. (i) Evoke Technology Pvt. Ltd. (ii) Mindtree Limited (Seg.) (iii) R S Software India Pvt. Ltd. 21.1 At the time of hearing, the learned Authorised Representative of the assessee has submitted that the assessee has no objections if these three companies are restored to the set of comparables as the assessee did not raise any objection before the DRP but the DRP rejected this company suo moto. 21.2 In view of the fact that both the revenue as well as the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... judgment of Hon'ble jurisdictional High Court in the case of CIT Vs. Tata Elxsi Ltd. (supra). 22.3 On the other hand, the ld. DR has relied upon the orders of the authorities below. 22.4 We have considered the rival submissions as well as the relevant material on record. The DRP has directed the Assessing Officer that the travel expenses incurred in foreign currency should also be excluded from the export turnover while computing the deduction under Section 10A of the Act by following the Hon'ble jurisdictional High Court in the case of Tata Elxsi Ltd. (supra). We do not find any contradictions in the proposition of law applicable in respect of the definition of turnover and total turnover as laid down by the Hon'ble High Court in the case of Tata Elxsi Ltd. (supra). A similar issue has been raised by the revenue regarding exclusion of telecommunication and travel expenses from export turnover which is also covered by the decision in the case of Tata Elxsi Ltd. (supra). The Hon'ble High Court while dealing with the definition of export turnover as well as total turnover as per the provisions of section 10A has held as under : "10. The Bombay High Court had an oc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... charges or insurance attributable to the delivery of the articles things or software outside India. Therefore in computing the export turnover the Legislature has made a specific exclusion of freight and insurance charges. The submission which has been urged on behalf of the Revenue is that while freight and insurance charges are liable to be excluded in computing export turnover, a similar exclusion has not been provided in regard to total turnover. The submission of the Revenue, however, misses the point that the expression "total turnover" has not been defined at all by Parliament for the purposes of section 10A. However the expression "export turnover" has been defined. The definition of "export turnover" excludes freight and insurance. Since export turnover has been defined be Parliament and there is a specific exclusion of freight and insurance, the expression "export turnover" cannot have a different meaning when it forms a constituent part of the total turnover for the purposes of the application of the formula. Undoubtedly, it was open to Parliament to make a provision to the contrary. However, no such provision having been made, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the basis of turnover was accepted as a method of arriving at export profits. In the ease of Section 80HHC, the export profit is to be derived from the total business income of the assessee, whereas in Section 10-A, the export profit is to be derived from the total business of the undertaking. Even in the case of business of an undertaking, it may include export business and domestic business, in other words, export turnover and domestic turnover. The export turnover would be a component or part of a denominator, the other component being the domestic turnover. In other words, to the extent of export turnover, there would be a commonality between the numerator and the denominator of the formula. In view of the commonality, the understanding should also be the same. In other words, if the export turnover in the numerator is to be arrived at after excluding certain expenses, the same should also be excluded in computing the export turnover as a component of total turnover in the denominator. The reason being the total turnover includes export turnover. The components of the export turnover in the numerator and the denominator cannot be different. Therefore, though there is no defini ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nue's appeal stand dismissed. 23.1 The next ground is regarding exclusion of forex loss from export turnover while computing the deduction under Section 10A of the Act. The Assessing Officer has reduced the amount of forex loss from export turnover while computing the deduction under Section 10A of the Act. The ld. AR of the assessee has submitted that the sum was reduced from the export turnover while computing the deduction available under Section 10A , it must also be correspondingly be reduced from its total turnover in view of the ratio of the judgment of Hon'ble jurisdictional High Court in the case of Tata Elxsi Ltd. (supra). 23.2 On the other hand, the learned Departmental Representative has relied upon the orders of the authorities below. 23.3 We have considered the rival submissions as well as the relevant material on record. It is pertinent to note that the turnover is considered on mercantile basis and not on realization basis. Therefore any loss on account of fluctuation of forex rate would be a business loss and should have effect of reduction of profits and corresponding eligible profits for deduction under Section 10A of the Act. Such loss cannot be reduced f ..... X X X X Extracts X X X X X X X X Extracts X X X X
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