TMI Blog2017 (2) TMI 1337X X X X Extracts X X X X X X X X Extracts X X X X ..... - Sri N.V.Vasudevan Dr.Arjun Lal Saini For the Appellant: Shri Arvind Sonde, Advocate Shri M.S.Gunjam, AR For the Respondent: Shri G.Mallikarjuna, CIT(DR) ORDER Per N.V.Vasudevan, JM This is an appeal by the Assessee against the order dated 22.05.2015 D.C.I.T., Circle-11(2), Kolkata passed u/s 143(3) r.w.s. 144C of the Act. 2. The only issue for consideration in this appeal by the assessee is with regard to the determination of arm s length (ALT) of an International Transaction carried out by the assessee with its Associated Enterprises (AE) under the provision of section 92 of the Act. 3. The Assessee, amongst other lines of business, is also engaged in the business of software development and it provides software development services to its various group companies. During the previous year relevant to AY 2006-07, the Assessee had a turn over of ₹ 381.3 crores in respect of software development services rendered to its AE. The assessee justified its transactions with its AE as one at an arm s length on the basis of Transaction Net Margin Method (TNMM). For this, operating margin data in respect of comparable Indian companies were ident ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of lower limits of the turnover had to be fixed for the purpose of comparability. The TPO however was of the view that the companies having very low turnover compared to that of the assessee and very high turnover compared to that of the Assessee ought to be excluded from the list of comparable companies. 6. The TPO accepted six out of 20 comparables chosen by the Assessee. In addition to the above the TPO added three more companies namely M/s. Mphasis BFL Ltd., M/s. Visual Soft Technologies Ltd and M/s Blue Star Infotech Ltd., as comparable companies. Thus the TPO arrived at the list of nine comparable companies having the following average arithmetic mean of profit to the total cost as follows :- After such filtration, it is found out that the following companies can be selected for the purposes of comparison out of the list 20 companies submitted by the assessee : Sl. No. Name of the company 2004 OP/TC% 2005 OP/TC% 2006 OP/TC% Total Average OP/TC% 1 M/s. Mphasis BFL Ltd. 53.78 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profit margin taking the operating margin percentage at 18.41 % ₹ 62.S9 crores Arm's Length Price Adjustment - ₹ 21.79 crores Hence, an addition of 1.79 crores has to be made to the total income of the assessee company. 7. The AO proposed to make the above suggestions by the TPO in his order dated 30.10.2009 passed u/s 92CA(3) of the Act and ultimately accepted the TPO s proposal in the draft assessment order dated 14.12.2009. The assessee filed objections to the draft assessment order before the DRP in terms of section 144C of the Act. The primary contention of the assessee was exclusion of certain comparable companies chosen by the TPO. The assessee also prayed for adjustment to the margins determined by the TPO by allowing risk adjustment and working capital adjustments. The DRP by its directions dated 17.06.2010 accepted the stand of the assessee in so far as it relates to exclusion of three comparable companies namely M/s. Mphasis BFL Ltd., M/s. Visual Soft Technologies Ltd and M/s. Blue Star Infotech Ltd. The DRP however refused to allow any adjustment towards working capital adjustment and risk adjustment. The relevant observations of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted that since it is a captive contract service provider, rendering software services to its AEs, the collection cycle of receivables from its customers is shorter as compared to those having third party service providers. Accordingly, the assessee stated, working capital adjustments should be allowed as held in the case of Mentor Graphics by the ITAT, Delhi Bench. The assessee based on the above logic demanded a suitable adjustment for the differences in the working capital position. Other Adjustments: For this, the assessee sought adjustments for R D expenses, marketing expenditure and accounting policies, but did not provide any logic for the above adjustments. 16. The demand for risk adjustments was sought, as. stated above, on the basis of the difference between the PLR and the bank rate. The Prime Lending Rate is a benchmark interest rate to which all loans 'are linked. It is a term applied as a reference interest rate used by banks. Bank rates, also referred to as the discount rate, is the rate of interest which a central bank charges on the loans .and advances that it extends to commercial banks and other financial intermediaries. Both these rates for calc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the order of the DRP clearly shows that the DRP has rejected the assessee s application in Form No.35A in respect of the draft assessment order without giving any specific valid reasons as has been rightly pointed out by the ld. AR. The Co-ordinate Bench of this Tribunal has given the decision in favour of the assessee in respect of working capital adjustments as also risk profile adjustments. Adjustments on this account have not been granted to the assessee nor has any valid reasons been given in denying the adjustments. Admittedly in respect of the risk adjustment the DRP itself admits that an adjustment is to be given and it is permissible under the Income Tax Act. Once it is accepted that an adjustment must be given and it is permissible under the Income Tax Act there is no reason for not giving the adjustment. An adjustment liable to be given as per the provision of the Act must be given, in the failure of which the order itself would become erroneous. Further, the DRP has not given any finding in respect of the claim of the assessee that working capital adjustment is to be given especially when the assessee itself has provided the calculation for the same. The DRP has also n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aptive agency like the assessee is not entirely risk free. The assessee is in a business which requires skilled manpower. Skilled manpower is the human capital related intangible assets. The judgment of Appellate Tax Court, USA in the case of lthaca Industries Inc. v. CIR 97 TC 253, highlights that in a knowledge organization, there is a little machinery other than the employees, because only people can act, employees become both the mind of the machines and machines themselves. Therefore, retention of skilled work force is an issue due to the globalization of trade and consequently many new opportunities are available to skilled staff. The assessee has developed its own human capital intangible at its own cost and all the risks related in creation and maintenance of human intangible are borne by the assessee. Thus, it is not correct on the part of the assessee to say that it does not assume any risk and it is a risk free entity. The risk analysis may be summarized as under: + The taxpayer is totally dependent on the AE for business. Thus, the taxpayer takes the risks associated with heavy dependence on a single customer. In common business parlance it is known as single customer r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o merely spell out risks, it has to be shown which risk was actually undertaken by the comparables and to what extent it affected the profitability. The taxpayer has not done so. 10.3 The computation of risk adjustment has to be based on robust data, which is not shown herein. The taxpayer in the instant case has set up a business in India and therefore it has to be compared with independent business entrepreneurs and not with passive investors. 10.4 In case of Motorola Solutions emphatically referred to by the Ld AR (ITA No 5637/DeI/2011), the Hon'ble bench has not acceded to the request for risk adjustment of accepted CAPM, they have merely restored the matter back for examination. The citation would therefore not help the case of the assessee in seeking the adjustment in absence of clear and precise data to justify the risk adjustment. 10.5 In view of discussion above, the panel is of considered view that objection of the assessee deserves to be rejected. 12. With regard to the claim of the assessee for working capital adjustment the DRP gave the following conclusion :- 7.1. DRP has duly considered the issue. It has been noted that as mentioned ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure and profile of such intangibles, it would be inappropriate to allow its exclusion just on this basis. It would also be pertinent to point out that such plea was not taken before the earlier DRP hearing. Further, the assessee seeks exclusion relying on the case of Qualcomm India Pvt Ltd. in 147 ITD 17 (Delhi) where Aftek was directed to be excluded from comparables list due to different functional profiles of Aftek and Qualcomm. DRP has carefully gone through said the case law and it was seen that Hon'ble ITAT have given functional profile of Qualcomm as being engaged in the business of software development and providing marketing services and being a captive service provider to its AEs. In present case, the assessee company is engaged in business of software development. This clearly demonstrates the functional differentiation between the two and as a result we cannot apply mutatis mutandis the finding given in case of Qualcomm to the facts of the assessee. Therefore, the assessee, in our considered view is not entitled for exclusion of this comparable especially when functional profile differences could not be demonstrated and the assessee is totally silent on its own IRP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lculation of operating profit/operating Cost of the Software services segment of the comparable M/s Sasken communication Technologies Ltd are as under : Segment Software services Particulars 2004 2005 2006 Average PLI Segment Revenue 12378.43 18905.47 24003.42 53.94% Segment Result 4430.89 6916.49 7829.54 Segment Cost 7947.54 11988.98 16173.88 OP/TC(%) 55.75% 57.69% 48.40% Average PLI after including the above as comparable are calculated as under : S.No. Name of the Company 2004 OP/TC 2005 OP/TC 2006 OP/TC Avg- OP/TC 1. M/s. Mphasis BPL Ltd. 53.78 17.39 23.27 31.48 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce adjustment ₹ 32.81 Crores Hence an adjustment of ₹ 32.81 Crores has to be made following the Hon ble DRP, Delhi order. 15. It can be seen from the aforesaid proposal of the AO that the original adjustment by the TPO at the first instance was ₹ 19,61,43,994/- which was increased to ₹ 32,81,00,000/-. The proposal as above was incorporated by the AO in his fair order dated 22.05.2015. Aggrieved by the aforesaid order of the AO dated 22.05.2015giving effect to the directions of the DRP u/s 144C of the Act dated 16.03.2015, the assessee has preferred the present appeal before the Tribunal. 16. The following are the grounds of appeal raised by the assessee:- 1. Order enhancing the income is bad in law 1.1. That on the facts and circumstances of the case and in law, the Ld. AO erred in enhancing the figure of transfer pricing adjustment in respect of Software services to ₹ 32,81,00,000 as against ₹ 19,61,43,994 determined in the final assessment order dated 30 July 2010 passed u/s.143(3) r.w.s. 144C of the Income Tax Act ( the Act ). 1.2. That on the facts and circumstances of the case and in law, the Ld. AO erred in no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the principle of consistency, entity level margin of Sasken should be considered. 3.3 Without prejudice, the Ld. AO, and the TPO erred in not considering the unallocated expenses provided in the segment reporting of the Annual Report of Sasken while doing the segmental margin computation, as a result of which the margin so computed by TPO is significantly skewed and distorted. 4. Non- Rejection of Aftek as a comparable 4.1 The Learned AO, DRP and the TPO erred in not considering the claim of the Appellant for rejecting Aftek as a comparable company. 4.2 The Learned AO, DRP and the TPO erred in not considering that Aftek is functionally dissimilar to the Appellant. 4.3 The learned AO, DRP and the TPO erred in not considering that Aftek should be rejected as it enjoys significant benefits on account of intellectual property rights ('IPR'), which constitutes nearly 81 % of the total net fixed assets of the Company. 4.4 The Learned AO, DRP and the TPO erred in not considering that Aftek underwent a financial reorganization, has changed its financial year from June to March and thus the financial statements of Aftek is not comparable to the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee was on exclusion of companies listed in ground no.2.2 from the list of comparables. In this regard we have already seen that the DRP when it passed order dated 17.06.2010 excluded these three companies from the list of nine comparable companies chosen by the TPO. In the order giving effect to the directions of the DRP dated 16.03.2015 these companies were never sought to be included. In other words, the DRP s directions dated 17.06.2010 was accepted by the revenue and the assessee and had become final. Therefore, the AO was not justified in adding these three companies as comparable companies while giving direction to the DRP in its order dated 16.03.2005. Therefore, these three companies have to be excluded from the list of comparable companies. We are of the view that the stand taken by the assessee in this regard deserves to be accepted. We have already seen in the narration of facts that these three companies chosen by the TPO in its first order dated 30.10.2009 was held to be erroneous by the DRP in its directions dated 17.06.2010 and these directions have become final having been accepted by the revenue and the Assessee. Therefore, it was open to the AO while pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Counsel for the assessee is that the DRP had given direction to take a profit margin at the segmental level whereas it should be taken at the entity level. In this regard it was pointed out by the ld. Counsel for the assessee that the TPO himself has taken the entity level margins in A.Y.2007-08 to 2009-10 as follows : Assessment year Margin as per TPO Order Paper Book Page Reference 2007-08 13.37% 171 2008-09 16.88% 201 2009-10 17.51% 204 2010-11 19.95% 207 2011-12 20.91% 210 Thus going by the above, it was submitted that the corrected computation of profit margins of Sasken at an entity level should be taken as given below: - Sasken Technologies Ltd. Amt in Lakhs Annual Report (AR) Mar 2004 12 months Pg No.60 of AR Annual Report Mar 2005 12 mmonths Pg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5 12 months Pg No.85 of AR Annual Report Mar 2006 12 months Pg No.101 of AR/318 of PB Segment Revenue Software Development and Services 12,378.43 18,905.47 24,003.42 Software Products 4,234.58 3,393.55 2,751.01 Profit Before Interest and Tax ( PBIT ) Software Development and Services 4,430.89 6,916.49 7,829.54 Software Products 1,159.55 411.20 (424.41) Total PBIT 5,590.44 7,327.69 7,405.13 Segment Software Development and Services 15.63 73.70 53.59 Segment Revenue ..... X X X X Extracts X X X X X X X X Extracts X X X X
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