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TMI Blog2020 (3) TMI 946X X X X Extracts X X X X X X X X Extracts X X X X ..... eopening of Assessment: 2.1 The Honourable Dispute Resolution Panel ("DRP") erred in upholding the reassessment proceedings initiated under section 147 of the Act without appreciating that no "fresh tangible material" was available with the AO for forming a belief that the Appellant not made full and true disclosure of material facts leading to income escaping assessment. 2.2 The DRP erred in upholding the notice issued by the AO under section 148 of the Act to initiate the reassessment proceedings without appreciating that the said notice was issued by the AO beyond four years from the end of the Assessment Year ("AY") even when there was no failure on the part of the Appellant to "fully and truly" disclose all material facts relevant for assessment. 2.3 The DRP erred in law and on facts in holding that information available in the course of initial reassessment proceedings which were rendered void can be used to initiate subsequent reassessment proceedings. 3. Transfer Pricing Grounds: 3.1 The TPO has erred in completing the Transfer Pricing assessment without providing an opportunity of being heard to the Appellant by simply relying on the earlier order passed by the T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ulations. 4. Disallowance of depreciation under section 40(a)(ia) of the Act 4.1 The DRP and AO have erred in law and on facts in disallowing Rs. 26,24,742 on account of depreciation claimed on purchase of software products under section 40(a)(ia) of the Act without appreciating that the Appellant on its own had disallowed the software expenditure while arriving at the taxable income since the same was capital in nature.. 4.2 Without prejudice to the above ground, the DRP and AO have erred in law and on facts in disallowing the depreciation claimed on purchase of software products under section 40(a)(ia) of the Act without appreciating that disallowance under section 40(a)(ia) can be made only on revenue expenditure and cannot be extended to depreciation on software capitalised. 4.3 Without prejudice to the above grounds, the DRP and the AO have erred in law and on facts in disallowing excess depreciation of Rs. 4,34,119 without appreciating that the underlying software purchases amounting to Rs. 14,47,062 were acquired and put to use for less than 180 days and thereby the depreciation claim was restricted to the effective rate of depreciation to 30 percent (50 percent of 6 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nc USA and provider services to Tektronix Inc USA and Tektronix International Sales GmbH Switzerland. It was observed that, assessee undertook to provide sales support services, software development services as a contract software development services provider. Ld. TPO observed that, as per agreement with the associated enterprises, Network Appliances Inc., USA, assessee is compensated on cost +10% basis in respect of software development services. 2.2. Ld.TPO observed that, following were international transaction entered into by assessee: Particulars of international transactions Amount (in rupees) Receipts for software development services 22,88,46,170/- Recoveries (received) 54,39,231/- Reimbursement of expenses (paid) 46,71,173/- 2.3 Ld.TPO observed that, assessee used TNMM as most appropriate method for software development services and OP/OC as PLI for computing the margin under these segments. Assessee computed its margin at 14.43% for Software development service segment. Assessee used 12 comparables with average margin of 12.15% Thus, it is held the price to be at arm's length. Ld.TPO rejected the transfer pricing analysis carried out by assessee as accordi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rounds of appeal, Assessee seeks exclusion/inclusion of following comparables: * Avani CincomTechnologies * Celestial Labs Ltd., * e-Zest Solutions Ltd * Helios Matheson Information Technology Ltd., * Infosys Technologies Ltd., * Ishir Infotech Ltd * KALS Information Systems Ltd * Megasoft Ltd * Persistant Systems Ltd., * Tata Elxsi Ltd (SEG) * Thirdware Solutions Ltd. * Wipro Ltd (SEG) 5.1 Before we undertake comparability analysis of above comparables, it is sine qua non to understand functions performed, assets owned and risks assumed by assessee under both segments as observed by Ld.TPO in order passed under section 92C of the Act. 5.1.1 Functions: Functions performed by assessee is as per the agreement entered into by assessee with Tek Inc USA and Tektronix International Sales GmbH, Switzerland (TIS) on an exclusive basis. In the TP study report placed in paper book at page 110 it is observed that as per agreement assessee assumes following responsibilities: * provide engineering development and software services from time to time in India as specified by associated enterprises; * identify and recruit competent qualified professionals for its ope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... like assessee. We refer to observation made by this (Tribunal) in the case of (Meritor LVS, India Pvt. Ltd. (Supra)) in respect of following comparables. Celestial Labs Ltd. 42. As far as this company is concerned, the stand of the assessee is that it is absolutely a research & development company. In this regard, the following submissions were made:- * In the Director's Report (page 20 of PB-Il), it is stated that "the company has applied for Income Tax concession for in-house R&D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act." * As per the Notes to Accounts - Schedule 15, under "Deferred Revenue Expenditure" (page 31 of PB-II), it is mentioned that, "Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred." An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as "Deferred Revenue Expenditure" (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecule 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 been no attempt made to identify and 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 adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard." 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for discovery of new drugs and has developed molecule to treat cancer. In the ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) 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 manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable." E-Zest Solutions Ltd. 14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the information received in response to notice under section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company ought to be excluded from the list of comparables on the ground that it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been held by the co-ordinate 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 co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O./TPO is accordingly directed." Infosys Technologies Ltd. 12.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, 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 Intellec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal's decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: "16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3. Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables. 13.4.1 We have heard both parties and carefully perused and considered the material on record. We find merit in the contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison. 13.4.2 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r comparability analysis." It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures were placed before us:- Particulars FYs 05-06 06-07 07-08 08-09 Operating Revenue 21761611 35477523 29342809 28039851 Operating Expns. 16417661 23249646 23359186 31108949 Operating Profit 5343950 1227877 5983623 (3069098) 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 2006-07 and therefore, there was no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ged in software product designing and analytic services, it is functionally different and further that segmental results are not available. The TPO rejected the assessee's objections on the ground that as per the Annual Report for the company for Financial Year 2007-08, it is mainly a software development company and as per the details furnished in reply to the notice under section 133(6) of the Act, software development constitutes 96% of its revenues. In this view of the matter, the Assessing Officer included this company i.e. Persistent Systems Ltd., in the list of comparables as it qualified the functionality criterion. 17.1.2 Before us, the assessee objected to the inclusion of this company as a comparable submitting that this company is functionally different and also that there are several other factors on which this company cannot be taken as a comparable. In this regard, the learned Authorised Representative submitted that: (i) This company is engaged in software designing services and analytic services and therefore it is not purely a software development service provider as is the assessee in the case on hand. (ii) Page 60 of the Annual Report of the company fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble to the assessee as it performs a variety of functions under the software development and services segment namely (a) Product design services (b) Innovation design engineering and (c) visual computing labs. In the submissions made the assessee had quoted relevant portions from the Annual Report of the company to this effect. In view of this, the learned Authorised Representative pleaded that this company be excluded from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the stand o the TPO in including this company in the list of comparables. 14.4.1 We have heard both parties and carefully perused and considered the material on record. From the details 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... service providers, as its income includes income from sale of licences which has increased the margins of the company. The learned A.R. prayed that in the light of the above facts and in view of the afore cited decision of the Tribunal (supra), this company ought to be omitted from the list of comparables. 15.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 15.3 We have heard the rival submissions 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 rend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 on page 381 to 383 of the PB-I). It was further submitted that Megasoft Limited has provided segmental break-up between the software services segment and software product segment (page 68 of PB-II), which was also adopted by the TPO in his show cause notice (Page 84 of PB-I). The segmental results i.e., results pertaining to software serv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rein this company is involved in diversified activities like application development and maintenance,, testing services, Web development services, Internet based application, e-commerce application, consulting services. It is also been submitted that all these services have been categorised under one single ahead of software development services 5.4 Ld.AR submitted that, this Tribunal in case Meritor LVS India (P)Ltd., by this Tribunal reported in (2015) 64 Taxmann.com 136 for AY: 2007-08 held that, this company is not comparable in case of captive software development services provider like assessee. 5.5 The Ld.DR however objected to the exclusion of this company from the list of comparables. 5.6 On a careful perusal of material on record, and the reply received from this company under section 133 (6) we find that this company is involved in various activities as compared to captive software service provider like assessee. It is also observed that in the case of Meritor LVS India Pvt Ltd (supra) Ld.TPO used very same 26 comparables for computing arm's length margin of software development service segment direct. This Tribunal after considering the functions performed by this co ..... 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