9911796707
TMI Blog2020 (3) TMI 946X X X X Extracts X X X X X X X X Extracts X X X X ..... by assessee stands allowed for statistical purposes. - IT(TP)A 673/Bang/2017 - - - Dated:- 17-3-2020 - Shri. A. K. Garodia, Accountant Member And Smt. Beena Pillai, Judicial Member For the Appellant : Shri Sharath Rao, CA For the Respondent : Mr. Muzaffar Hussain, CIT DR ORDER PER BEENA PILLAI, JUDICIAL MEMBER Present appeal has been filed by assessee against final assessment order dated 20/01/2017 passed by Ld.DCIT Circle 7 (1) (1), Bangalore under section 143 (3) read with section 147 and section 144C (13) of the Act on following revised grounds of appeal: 1. General grounds against the Final Assessment Order: 1.1 The Final Assessment Order ( FAO ) dated January 20, 2017 (served on January 25, 2017) passed by the Learned Assessing Officer ( AO ) under section 143(3) read with section 147 and section 144C(13) of the Income- tax Act, 1961 ( Act ) is not in accordance with the law and is contrary to the facts and circumstances of the present case. 2. Reopening of Assessment: 2.1 The Honourable Dispute Resolution Panel ( DRP ) erred in upholding the reassessment proceedings initiated under section 147 of the Act without appreciatin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Megasoft Limited 13. Thirdware Solutions Limited 3.5 Without prejudice that Megasoft Limited is functionally different to the Appellant and / or fails to meet the legally acceptable criteria for comparability, the DRP and TPO erred in not appreciating that only segmental margin (23.11 percent) ought to be considered for comparability. 3.6 The DRP and AG / TPO have erred in law and on facts in not granting an appropriate working capital adjustment to the margins of the comparable companies, based on the computation provided by the Appellant. 3.7 The AO / TPO have also erred in considering the Prime Lending Rate ( PLR ) at 10.25 percent that was applicable for FY 2005-06 without appreciating that the PLR rate for the subject FY 2006-07 which was 12.50 percent (the Benchmark PLR was between 12.25 percent and 12.75 percent). 3.8 The AO / TPO have further erred in discounting the PLR to its present value (9.30 percent as per the TPO's calculations) without appreciating that the average payables and receivables were taken by the TPO himself for the calculations. 4. Disallowance of depreciation under section 40(a)(ia) of the Act 4.1 The DRP and AO ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under section 234B of the Act; 7.2 The Learned AG has erred in law and on facts by levying higher amount of interest under section 234C of the Act as compared to the interest levied as per the RoI; and 7.3 The Learned AO has erred in law and on facts by initiating penalty proceedings under section 271 read with 274 of the Act. Brief facts of the case are as under: 2. Assessee filed its return of income on 30/10/2007 declaring total income of ₹ 88,89,272/-. Return was processed under section 143 (1) of the Act and case was selected for scrutiny. Accordingly, notice under section 143 (2) was issued to assessee along with notice under section 142 (1) and questionnaire. Ld.AO observed that, assessee had international transaction with associated enterprises for more than ₹ 15 crores and accordingly reference to transfer pricing officer was made for determining. 2.1. On receipt of reference, Transfer Pricing officer called upon assessee to file economic details of international transaction entered into by assessee with its associated enterprises in Form 3 CEB. Ld.TPO observed that, assessee is a subsidiary of Tektronix Inc USA and provider services ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9. iGate Global Solutions Ltd 7.49 % 10. Infosys Technologies Ltd 40.30% 11 Ishier Infotech Ltd 30.12% 12. KALS Information Systems Ltd 30.55% 13. LGS Global Ltd 15.75% 14. Lucid Software Ltd 19.37% 15. Mediasoft Solutions Ltd 3.66 % 16. Megasoft Ltd 60.23% 17. Mindtree Ltd 16.90% 18. Persistent Systems Ltd 24.52% 19. Quintengra Solutions Ltd 12.56% 20. RS Software (India) Ltd 13.47% 21. R Systems International Ltd (SEG) 15.07% 22. SaskenCommuni ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 operation; assign qualified professionals to provide on-going engineering development and software services; carry out overall direction and control of assigned employees; ensure that the employees comply with all Tektronix policies, rules and regulations regarding security and protection of confidential information; program managed to provide necessary control mechanisms including milestone schedules and periodic status reports; and assume full responsibility relating to recruitment and compensation of assigned employees. 5.1.2 Assets employed: it has been submitted that assessee owns primary assets used for providing software services and software development services like employees and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ₹ 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 a comparable for the reason that it is into pure software development activities and is not engaged in R D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT - ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: The learned D.R. however drew our attention to page-389 of the paper book which is an extract from the Directors report which reads as follows: 'The Company has developed a de novo drug des ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 company should be rejected as a comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in 'e- Business Consulting Services', consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised Representative contends, are high end ITES normally categorised as knowledge process Outsourcing ('KPO') services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that sinc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ftware 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 the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010) has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any such intangible and hence does not have an additional advantage in the market. As the assessee in the case on hand does not own any intangibles, following the aforesaid decision of the co- ordinate bench of the Tribunal i.e. 24/7 Customer.Com Pvt. Ltd. (supra), we hold that this company cannot be considered as a comparable to the assessee. We, theref ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 646 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 of ITAT (Mumbai) in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra) also supports the plea of the assessee. We therefore acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reed 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 justification for the TPO to consider the said concern as functionally comparable in the instant assessment year. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 for F.Y. 2007-08 indicates that this company, is predominantly engaged in 'Outsourced Softwa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 Ltd. is not a software development service p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 rendering s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... usal 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 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... td This comparable was included by Ld.TPO and objected by assessee for its functional dissimilarities. It has been submitted that, information of obtained under 133 (6) by Ld.AO is placed at page 1061-1064 of paper book wherein 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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