9911796707
TMI Blog2017 (3) TMI 1963X X X X Extracts X X X X X X X X Extracts X X X X ..... . Thirdware Solutions company cannot be selected as comparable for TP analysis.. Since no distinguishing features of the functional profile of this company and the assessee for the current year vis-a-vis the preceding year have been brought out to our notice, following the preceding, we direct the TPO/AO for removal of this company from the list of comparables. PSI Data Systems company had been merged w.e.f. 12.08.2009 with Aditya Birla Minacs IT Services Ltd. and as such, said company had no locus standi for the whole year. Therefore, the TPO has rightly excluded this company from the list of comparables. Crazy Infotech Ltd.- As assessee company is engaged in 100% export of software development services to its holding company. The total percentage of turnover in software development segment of the aforesaid company is only 4.66% of the total turnover of Assessee Company, which too was generated from the state of Tamilnadu and Andhra Pradesh but not from foreign export as in the case of assessee. Therefore, the TPO has rightly excluded this company from the set of comparables. Infosys Technologies Ltd. cannot be treated as comparable with the assessee company as assessee is als ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee has satisfied all the requisite conditions for availing of the benefit of deduction u/s 10AA, we are of the considered opinion that the authorities below erred in refusing to grant such deduction. Decided in favour of assessee. X X X X Extracts X X X X X X X X Extracts X X X X ..... t appreciating the facts of the appellant case and the relevant provisions of the Act. 13. That the AO/ DRP erred in disallowing the deduction claimed by the Appellant under section 10AA of the Act, on a factually incorrect assumption that the services were provided by the Appellant to 'self, i.e. head office of the Appellant. 14. Without prejudice to above, that on the facts and circumstances of the case and in law, the AO failed to appreciate that even rendering of services by a Branch Office to the Holding Company of its Head Office is 'export' within the meaning of section 10AA of the Act. 15. That on the facts and circumstances of the case and in law, the AO grossly erred in holding that conditions of section 10AA would be satisfied only when profits are made upon sale of software developed by appellant to third parties and that deduction can be claimed under section 10AA only in respect of such profit arising from the sale of software supplied to third parties. 16. That the action of DRP in upholding denial of deduction under section 10AA and consequently the impugned order are contrary to law as the same is contrary to law including provisions of Spec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... led analysis as to how the assessee and M/s Technologies are not different functionally and therefore the case of M/s Agnity India Technologies Pvt. Ltd. is distinguishable." 3. The appeal of the Revenue has been filed delayed by 28 days, for condonation of which the department has filed application, stating that pursuance to the directions of ld. DRP, the TPO informed the AO vide his letter dated 19.09.2014 that there was no variation in the adjustment in the ALP determined by him. The AO accordingly, passed final assessment order on 19.09.2014 making an addition of Rs.6,23,15,808/- as per adjustment in the ALP made by the TPO. However, subsequently, it came to the notice of the AO/TPO that one of the comparable, Infosys Technologies Ltd. was excluded from the list of comparable by DRP, the AO rectified the order dated 19.09.2014 vide order dated 09.12.2014 reducing the addition to Rs.5,57,09,134/-. Therefore, on account of this genuine mistake attributable to oversight, the delay in filing the appeal is liable to be condoned, if the limitation period is reckoned from the date of original final order dated 19.09.2014 and if it is reckoned from the date of order u/s. 154 dated 09 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. (d). Sale of fixed assets. (e). Recharge paid by AEs. 6. From the above, (a) to (e) are interlinked and have been aggregated for the purpose of analysis as a software development services and the assessee has applied TNMM and PLI (OP/TC) calculated at 17.44% whereas OP/TC has been calculated of comparables at 13.18% from software development services. In case of (d) & (e), the assessee has applied CUP method and have been separately evaluated from the transfer pricing prospective. The functional analysis were undertaken, in which functions performed by the group companies and by SEMCI, assets employed and risk assumed, were also analysed in detail in the TP study report. The economic analysis regarding software development services and other international transactions are at page 22 to 28 of TP Study Report which is as under : 5.1. Overview of inter-company transactions As discussed in the functional analysis, SEMCI can be characterized as a contract software development service provider providing routine software development services to its AEs. SEMCI does not own any intangibles vis-a-vis the products and does not have any other additional rights to use or exploit the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity adjustments that would be required if the AEs were selected as tested parties, would be both substantial and unreliable. Moreover, entrepreneurs are often involved in complex product development operations and may produce a wide variety of products for sale in their own domestic markets as well as for export to numerous foreign markets. As a result, segregation of the (i) costs and profits and (ii) net operating assets of the entrepreneur that are attributable solely to related party transactions would be complex and unreliable. The costs incurred and the operating assets owned by SEMCI are, on the other hand, generally easily segregated and identified. Accordingly, SEMCI has been selected as the tested party for this analysis. 5.2.2. The Most Appropriate Method : The Regulations provide no priority of methods. Rather, the selection of the pricing method to be used to test the arm's length character of a controlled transaction must be made under the 'Most Appropriate Method Rule'. The 'Most Appropriate Method' is that method which, under the facts and circumstances of the transaction under review, provides the most reliable measure of an arm's leng ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... per unit prices. Further, abstract factors such as the use of intangibles make it difficult to use the CUP method for benchmarking purposes. In addition, SEMCI does not provide any software development services to unrelated third parties nor do the AEs procure similar services from any third parties in India. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for contract software development services. Table 4: Applicability of CUP Software Development services. Internal CUPs. * SEMCI does not provide any software development services to unrelated third parties. *AEs do not procure similar services from any third parties in India. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for software development services. External CUPs *The arm's length per unit prices to uncontrolled enterprises is substantially dependent upon factors such as volume, contractual terms, locational differences etc. *It may not be possible to estimate, with reasonable reliability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elated party. Under the CPM, comparability is primarily dependent upon the similarity of the functions performed and the risks assumed by the controlled and uncontrolled parties and it is less dependent on the similarity of the services provided or the goods produced. However, as the computation of Gross Margin in case of services is currently not possible under the Indian GAAP. Cost Plus method therefore cannot be used in this analysis and has to be used in modification thus falling within the definition of Transactions! Net Margin Method. Therefore, this method has not been used to benchmark the services rendered by SEMCl. Profit Split Method In general, the Profit Split Method ("PSM") evaluates whether the allocation of the combined profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contribution to that combined profit or loss. The profit split methods typically are applied where each party to the transaction under evaluation has significant intangible assets and/or the operations of the parties to the transaction are highly integrated and cannot be evaluated on a se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... range of gross profit margins but still earn broadly similar levels of net profits. In view of the above, TNMM has been selected as a preferred method for determining the arm's length operating results of SEMCI. 5.2.4. Application of the most appropriate method After reviewing all of the transfer pricing methods discussed herein, we concluded that, given the fact and circumstances, the TNMM provides the most reliable measure of an arm's length operating result forSEMCI. Although the TNMM theoretically is based on transactional data, it recognises that no comparable data at such a transactional level is likely to exist. Further, in case the transactions are closely interlinked, the same can be aggregated under the TNMM. Further, the CUP method has been applied to test the arm's length nature of the international transactions in the nature of cost reimbursements received from group companies. 5.2.5. Search for uncontrolled comparables and determination of Arm's Length Price. We searched the two widely recognised corporate databases to identify potential uncontrolled comparables for SEMCI's transaction. We primarily relied on Prowess and extracted a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on total cost was selected to reliably measure the income of the tested party that it would have earned had it dealt with uncontrolled parties at arm's length. Based on the search process, we arrived at 16 comparable companies / segments. The arithmetic mean of the margins of the comparable companies is tabulated in Table 5. S.No. Name of the Company Data Source Average PLI 1. Akshay Software Technologies Ltd. P 8.64% 2. Compulink Systems Ltd. P -7.08% 3. FCS Software Solutions Ltd. P 38.97% 4. Goldstone Technologies Ltd. P 12.49% 5. LGS Global Ltd. P 22.57% 6. Larsen and Toubro Infotech Ltd. P 21.57% 7. Mindtree Ltd. P 21.52% 8. PSI Data Systems Ltd. P 4.70% 9. Polaris Software Lab Ltd. P 10.81% 10. Reliance Infosolutions Pvt. Ltd. P 0.97% 11. Sasken Communication Technologies Ltd. P 13.45% 12. Synetairos Technologies Ltd. P 21.33% 13. Thinksoft Global Services Ltd. P 17.72% 14. Zensar Obt. Technologies Ltd. P 18.97% 15. Crazy Infotech Ltd. P-Seg 1.35% 16. Teledata Marin Solutions Ltd. C-Seg 2.86% Mean 13.18% Median 12.97% Upper Quartile 21.38% Lower Quartile 4.24% The details of search fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ables which were narrated in the T.P. Study report and calculated average mean margin of OP/TC @ 13.18% by using multiple year data. Based on the analysis, the assessee determined ALP of the impugned international transactions for software development services. The operating profit margin was calculated in TP study report as under : Particulars Amount in Rs. Service Fee 574,714,335 Salaries and benefits 144,095,864 Admin and other expenses 243,260,899 Depreciation 102,026,461 Total Operating cost 489,383,224 Operating Profit 85,331,111 OP/TC (%) 17.44% 9. On the basis of above table, the tested party operating profit margin on cost is 17.44% in the international transactions which is held to be at Arm's length in the T.P. documentation. The observations of the TPO on the filters used by the assessee in the TP study report for arriving at the ALP of the international transactions, are as under : "8. In view of the functional profile of the assessee, the following set of filters have been found to be appropriate. The justification to apply them is discussed as follows: i. Use of current year data: The transfer pricing provisions lay down that primarily current y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... need to be excluded from the benchmarking process. On the issue of threshold of related party transactions, it can be stated that when the RPT exceeds 25% of sales, it can be said to be the stage when it will start affecting the price paid/received. The rationale given for the use of the limit of 25% is sound and this threshold limit has been approved explicitly an implicitly in quite a few judicial pronouncements. vii Companies that have employee cost that is less than 25% of total cost: The rationale for this filter is that companies that are engaged in providing services similar to yours will require a minimum level of expenditure as personnel expense. Employees cost constitutes the major component of cost in any service sector. Very low employee cost, viz., less than 25% of total cost, indicates that company is either engaged in some other business or it has outsourced the service/functions to a third party, i.e., it is not rendering services on its own. Such companies cannot be treated as functionally comparable to the assessee. viii Companies that are affected by some peculiar economic circumstances: Companies that are affected by factors like persistent losses, declin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... complex, PCS is right there to take advantage of such a situation. " It is clear from the above description that this company is in the field of both IT services and e-learning and is presently engaged mainly in the business of education segment It cannot be taken as a comparable. iii. Goldstone Technologies Ltd. As per P-8/AR:- "Goldstone Technologies Limited (GTL) is presently engaged in the business of IT Enabled Services. GTL offers highly complex and mission critical solutions such as software support, software maintenance, business process outsourcing etc. Goldstone has a strong presence in the US and European markets for its highly specialized consulting services and Forte to Java Migration projects. Goldstone has strong initiatives to capture the new markets in the field of IT and IT Enabled Services." It is clear from the above description that this company is in the field of both IT and IT enabled services and is presently engaged mainly in the business of IT enabled services. It cannot be taken as a comparable. iv. PSI Data Systems Ltd As per the Prowess data base, the company has been merged and now is called Aditya Birla Minacs IT Services Ltd. The company do ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [Merged] 88.25 vi. Infosys Ltd. 45.08 vii. Larsen & Toubro Infotech Ltd, 20.48 viii LGS Global Ltd 12.79 ix. MindtreeLtd. 16.62 x. Persistent Systems Pvt Ltd. 30.50 xi. *Persistent Systems and Solutions Ltd. 15.38 xii. RS Software (fadiajitd. 10.29 xiii Sasken Communication Tech, Ltd. 17.54 xiv Tata Elxsi Ltd. 19.82 xv. Thinksoft Global Services Ltd. 17.35 xvi Thirdware Solutions 41.63 Average 27.82% *This company does not find place in the final set of comparables taken by TPO as narrated above. 15. Accordingly, the ld. TPO calculated the ALP of the international transactions with its AE as under : Particulars Amount Operating Cost 489,383,224 Arm's length margin (%) 27.82% Arm's length margin (Rs.) 136,146,413 Arm's length Price 6255,29,637 Price charged by the assessee 574,714,335 105% of Price charged in international transaction 603,450,052 Difference for which adjustment is proposed to be made 50,815,302 16. The ld. TPO has made point wise discussion in detail for rejection of the companies selected by the assessee and also relied on various case laws. The TPO has also made working capital a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and excluding the company, Infosys Ltd. as per directions of the DRP, the AO reduced the addition of Rs.6,23,15,808/- to Rs. 5,57,09,134/- vide order u/s. 154 dated 09.12.2014. The Revenue has challenged the assessment order passed in compliance to DRP directing the exclusion of Infosys Technologies Ltd. and the assessee has also challenged the order of the AO by way of these cross appeals. 19. Grounds Nos. 3 to 8 are decided together. 20. We have heard the rival submissions and perused the relevant material on record. There is no dispute on the determination of ALP of any transaction other than that of `Rendering of services' with the declared value at Rs 574714335/-. Further, there is no dispute on the application of the TNMM as the most appropriate method with PLI of OP/TC. The assessee is aggrieved only against inclusion of four new companies in the final set of comparables, namely, E- Infochips, Bangalore Ltd, Infinite Data Systems Pvt. Ltd.(Merged), Persistent Systems Ltd., Thirdware Solutions Ltd. and rejection of two companies, namely, PSI Data Systems and Crazy Infotech Ltd. We will take up these six companies in seriatim to decide their inclusion/exclusion in the final ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the paper book No.2. For example, invoice dated 06.05.2009 has been raised on SEMC by giving total expenses incurred during the month of April, 2009 to which a markup of 15% has been added. Similar is the position about 15% markup on the costs incurred by the assessee in providing these software services to its AE in other months. However, as per agreement, the assessee has not furnished every year evaluation chart of compensation level for consideration of Arm's length compensation over the multiple years. Keeping the above background in mind about the functional profile of the assessee, we will now try to ascertain as to whether or not the above referred six companies are comparables. i) E-Infochips Banglore Ltd. 22. It has been submitted by the ld. AR that this comparable was selected by ld. TPO (Page No. 32-34 ) of the TPO's order even though assesse objected to the same. The assessee had objected that the company is functionally different and in his annual report for the financial year 2009-10 it is engaged into diversified activities ( apart from software activities) . He submitted that this company is engaged in both Software Development & ITES services. The ld. AR sub ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase of Sunlife India Services Centre Pvt. Ltd. vs. DCIT (ITA No. 750/Del./2015- order dated 27.06.2016) on the basis of functional disparity observing as under : "10.3.After considering the rival contentions and perusing the annual reports placed on record, we are of the opinion that this company cannot be selected as comparable for TP analysis, because it is engaged in both software development as well as ITes. Assessee being characterized as a routine service provider, the above company cannot be considered as comparable on functional basis. 10.4. As this company is functionally different from assessee and in absence of segmental information we direct the AO/TPO to exclude this company from the final list of comparables." 25. Respectfully following the decision of coordinate Bench, we direct the AO/TPO to exclude this comparable from the list of comparables selected by the TPO. (ii). Infinite Data Systems Pvt. Ltd.: 26. This company has been selected by the TPO (page 198 to 200) even though the assessee objected to the same on the premise that the company is functionally not similar and due to insufficient segmental information; that there was abnormal growth in operat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany to be taken as comparable on the premise that the company is functionally dissimilar, as it is engaged in product development and product design services and that the complete segmental information are not available. He relied on the following decisions: (i). Cash Edge (ITA 64/Del./2015 - A.Y. 2010-11 - ITAT) affirmed by Hon'ble Delhi High Court in ITA No 279 of 2016. (ii). Equant Solutions India Pvt. Ltd.(ITA No. 1202/Del./2015-ITAT) (iii). Pyramid IT Consulting (ITA No. 5401/Del./2012 - ITAT) 31. After hearing the submissions of both the sides and perusing the material available on record and we find that this comparable company has been considered by ITAT in the case of Cash Edge (supra) wherein it has not considered as a comparable company in the identical facts and circumstances of the case observing as under : "16. We have considered the rival submission and perused the material on record. A co-ordinate Bench of the Delhi Tribunal in the case of Ciena India Pvt. Ltd. v. DCIT in ITA Nos. 2948, 3324/Del/2013, has held as under : "9.2. We have heard the rival submissions and perused the relevant material on record. It can be seen from the information suppli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... software development services, a co-ordinate Bench of the Delhi Tribunal in ITA No.6737/Del/2014 deleted Persistent from the list of comparables. 17. Further a perusal of page 484 (PB-2) Annual Report of Persistent reveals that it is not only engaged in the business of software development services but also manufacture and sale of software products and owns significant intangibles and that segmental data for services and products is not available and the ld DR, could not controvert this fact, so we concur with the order of co-ordinate bench of the Tribunal, and we direct exclusion of Persistent Systems Ltd. from the list of comparables." 32. The Hon'ble jurisdictional High Court has affirmed the above decision of Tribunal in ITA No. 279 of 2016 observing as under : "6. As far as the first company, i.e., Persistent Systems Ltd. is concerned, the material on record - as found by the ITAT - shows that this company was involved in software development, software products and marketing. Furthermore and perhaps more importantly published segmental data was not available. In these circumstances, having regard to the specificity of the Transfer Pricing Rules under Rule 10(b) to 10(e) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as a positive net worth and it satisfied all the filters of comparability test. 36. The learned DR, on the other hand, submitted that this company has different functional profile, as it is a products company and earns income from license fees. It is also trading in products and as such does not qualify RPT filter. 37. After hearing both the sides, we find that the above company had been merged w.e.f. 12.08.2009 with Aditya Birla Minacs IT Services Ltd. and as such, said company had no locus standi for the whole year. Therefore, the TPO has rightly excluded this company from the list of comparables. (vi). Crazy Infotech Ltd.: 38. This comparable was selected by the assessee, but was rejected by TPO for the reason that the company had three segments, viz., computer hardware, software development and IT training with segmental revenues at Rs.2.46 crores, 2.67 crores and 0.88 crores respectively. Therefore, the relevant segments turnover of this company is less than 5 crores. Therefore, the company did not satisfy the service income filter and was excluded by the TPO from the final set of comparables. The objection of the assessee has been that turnover filter of less than 5 cro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted the objections of the assessee and following the decision of jurisdictional High Court in the case of Agnity India Technologies, 262 CTR 291 (Del.) excluded this company from the final set of comparables, which has been agitated by the Revenue in its appeal. 42. The ld. DR relying on the reasons given by the ld. TPO, submitted that the ld. DRP was not justified in excluding this company, as this comparable satisfies all the filters of comparability test, as given by the ld. TPO. 43. On the other hand, the ld. AR of the assessee submitted that this company has diversified business operations, viz., technical consultancy, designing development, system integration, package integration and implementation, testing and infrastructure management. This company had own intangible assets and spent 1130 cr. on AMP and Rs.57 cr. for brand building Rs.435 cr. for R & D and the company has high turnover of Rs.21,140 crores. Reliance is placed on the following decisions : (i). Sony Mobile Communication International AB (Branch Office) A.Y. 2009-10 (ITA No. 769/Del./2014). (ii). CIT vs. Agnity India Technologies Pvt. Ltd. (263 CTR 291(Del.) (iii). Ciena India Pvt. Ltd. (ITA No. 1453/De ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... issue. The assessee has relied on the decision of ITAT Delhi Bench in Rolls Royce India Pvt. Ltd. vs. DCIT (ITA No. 1310/Del./2015 - para 55). However, the assessee did not specify as to what arithmetical inaccuracies have been committed by the TPO. Therefore, the assessee is directed to demonstrate before the TPO the errors whatsoever. 47. In respect of ground No.9 for the use of multiple year data and determining the Arm's Length Margin, the ld. TPO has rightly dealt with this issue and the decision of ld. DRP upholding the order of the TPO is correct. Rule 10B(4) of the Income-tax Rules clearly stipulates that normally current year data should be used. The proviso to the Rule allows the use of data pertaining to previous years only if the taxpayer can prove that there were certain factors relevant to those years that have affected the transfer prices of the year under review. However, the assessee has failed to bring any fact on record to cover the case of assessee under Rule 10B(4). The TPO has relied on a number of cases for the proposition that normally current year data should be used. Therefore, ground No. 9 of the assessee's appeal is dismissed. 48. In respect of ground ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adjustment and remit the matter to the file of AO/TPO for fresh determination of the ALP of the international transaction of rendering of software services in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings. 52. The only other issue, raised vide grounds Nos. 12 to 16 which survives for our consideration is the disallowance of deduction u/s 10AA of the Act amounting to Rs.10,01,05,706/-. 53. The facts apropos this issue are that the assessee claimed this deduction u/s 10AA. The AO refused it giving three major reasons as recorded on page 11 of his order as under : (a) There is no doubt that a foreign company which is registered with SEZ is eligible for deduction u/s 10AA. But such deduction is available only if the company fulfils all the conditions laid down in the said section. One of the most important criteria for availing the deduction u/s 10AA is to 'export' the software development, upgradation and maintenance of software manufacture by the undertaking. But, in the instant case there is no export. In fact, this is a case where certain services are rendered by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... said section. The assessee has not fulfilled all the conditions laid down in Section 10AA of the Act. For example, it has not remitted back the entire profit arising to it out of its supplies of software outside India. Hence, the deduction is not allowable to the assessee." The assessee is aggrieved against the denial of benefit of deduction u/s 10AA of the Act. 54. This issue is covered by the decision of ITAT, Delhi Bench in ITA No. 769/Del./2014 in the case of assessee itself for A.Y. 2009-10, wherein the Coordinate Bench of Tribunal held as under : "13. We have heard the rival submission and perused the relevant material on record. We find that the assessee furnished complete details about the fulfillment of all the relevant conditions for the eligibility of deduction u/s 10AA before the AO as well as the DRP. Copies of such letters addressed to these authorities are available on pages 138, 166, 167, 173, 184, 193, etc. of the paper book. The AO has denied the deduction, inter alia, by holding that in the instant case there were no exports inasmuch as certain services were rendered by the branch office to its head office on cost plus basis. We do not find this view point o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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