TMI Blog2013 (9) TMI 189X X X X Extracts X X X X X X X X Extracts X X X X ..... nefit of depreciation adjustment be given to the assessee as per the chart filed by the assessee which works out to around 3.39% - Thus, after the depreciation adjustment of 3.39%, from 16.56% (105% of 15.77% the ALP will come to 13.17%. Apart from this, the Assessing Officer shall give effect to the proviso to sub-section (2) of Section 92C, as per the latest amended Act, as regards 5% range – Decided in favor of Assessee. Computation of deduction u/s 10A of the Income Tax Act – Held that:- If what is excluded in computing the export turnover is included while arriving at the total turnover is included while arriving at the total turnover, when the export turnover is a component of total turnover, such an interpretation would run counter to the legislative intent and impermissible. If that were the intention of the legislature, they would have expressly stated so. If they have not chosen to expressly define what the total turnover means, then, when the total turnover includes export turnover, the meaning assigned by the legislature to the export turnover is to be respected and given effect to, while interpreting the total turnover which is inclusive of the export turnover – In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /disallowances Amount (Rs.) Amount (Rs.) 1a Reduction of the following amounts from 'export turnover' for computing deduction u/s.10A of the Act -Data link charges 2,35,08,825 -Certain expenditure incurred in foreign currency 33,09,33,846 1b. Reduction in total 10A deduction (Rs.59,75,75,651 - Rs. 56,01,43,562 3,74,32,089 2. Capitalisation of expenses incurred on purchase of software debited to the Profit Loss account 3,83,71,306 3. Disallowance of entire deduction u/s.80JJAA 11,09,95,555 4. Additions made on account of TP adjustments 49,23,67,726 Thus the total taxable income determined in the draft assessment order was Rs. 74,96,05,889/-, as against the returned income of Rs. 8,39,46,266/-. The matter also became the subject matter of the order u/s.92CA of the IT Act by the TPO by order dated.14.10.2010. After considering the submissions of the assessee's counsel, the Assessing Officer passed the final assessment order dated.13.10.2011. Aggrie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring the functional and risk analysis of the Appellant. 14. The learned TPO/DCIT erred in law in applying arbitrary filters to arrive at a fresh set of companies as comparables to the Appellant, without establishing functional comparability. 15. The learned TPO/DCIT grossly erred in law in deviating from the uncontrolled party transaction definition as per the Income-tax Rules, 1963 and arbitrarily applying a 25% related party criteria in accepting/rejecting comparables. 16. The learned TPO/DCIT also erred on facts and in law in arbitrarily rejecting companies with different year ending (i.e. other than 31 March 2007). 17. The learned TPO/DCIT erred on facts in arbitrarily rejecting companies having employee cost less than 25% of the operating revenue. 18. The learned TPO/DCIT also erred on facts in arbitrarily rejecting companies having export revenues less than 25% of their total sales. 19. The learned TPOI DCIT erred on facts in arbitrarily rejecting companies having onsite revenue more than 75% of the export revenue. 20. The learned TPO/DCIT grossly erred on facts in arbitrarily rejecting companies having software development reven ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with AEs is at arm's length. The key features of the TP study undertaken for software services are as under : As per the functional analysis, the assessee was categorized as a 'risk mitigated service provider' and selected as the tested party. TNMM was determined as the most appropriate method to determine the ALP. The search was conducted on Prowess database and Capitaline database to select comparable companies. Given the nature of the international transactions under review, economic conditions, differences in business or product life cycles and other relevant factors and also the fact that financial data for the financial year 2006-07 was not available in all cases, financial data for financial years 2004-05 and 2005-06, wherever available, was also considered. The searches on the databases yielded a set of 17 comparables for software services, with weighted average operating profit/operating cost of 10.86%. As the operating margin of the assessee was 15.07% on operating cost (i.e., higher than the arithmetic mean margin of the identified comparables), the international transaction was considered to be at arm's length from an Indian TP regulations' standpoint. The compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m Technologies Ltd. 3.55 52.59 3 Celestial Labs Ltd. 14.13 58.35 4 Batamatics Ltd. 54.51 1.38 5 E-Zest Solutions Ltd. 6.26 36.12 6 Flextronics Software Systems Ltd. (Segment) 848.66 25.31 7 Geometric Ltd. (Segment) 158.38 10.71 8 Helio c Matheson Information Technology Ltd. 178.63 36.63 9 iGate Global Solutions Ltd. 747.27 7.49 10 Infosys Technologies Ltd. 13,149.00 40.30 11 Ishir Infortech Ltd. 7.42 30.12 12 KALS Information Systems Ltd. 2.00 30.55 13 LGS Global Ltd. 45.39 15.75 14 Lucid Software Ltd. 1.70 19.37 15 Media Soft Solutions Pvt. Ltd. 1.85 3.66 16 Megasoft Ltd. 139.33 60.23 17 Mindtree Ltd. 590.35 16.90 18 Persistent Systems Ltd. 293/75 24.52 19 Quintegra Solutions Ltd. 62.72 12.56 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... making TP adjustment of Rs.49,23,67,720/-, which was arrived at as under, considering the computation of ALP, price received vis- -vis the Arm's length price : Computation of Arm's Length Price: The arithmetic mean of the PLI is taken as the arm's length margin. Based on this, the ALP of the software development services rendered by the taxpayer to its AE(s) is computed as under : Arithmetic mean PLI : 25.14% Less : Working capital adjustment : 0.64% Adjusted Arithmetic mean PLI : 24.50% Arm's Length Price : Operating cost Rs.519,84,56,000 Arm's Length Margin 24.50% of the operating cost Arm's Length Price (ALP) @ 124.40% of operating cost Rs.647,20,77,720 The price charged by the tax payer to its Associated Enterprises is compared to the Arm's Length Price, as under : Arm's Length Price @ 124.50% of operating cost (a) Rs.647,20,77,720 Price charged in the international transactions (b) Rs.594,15,42,882 Operating revenues (c) Rs.597,97,10,000 Revenues from non-AE parties (d) = (c) - (b) Rs. 3,81,67,118 Ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urnover was merely Rs. 8 crores, it was held that the turnover filter (upper limit) of Rs. 200 crores (being 25 times of the tested company) should be applied to exclude the super big companies, as comparables. For this basis, a mere reference has been made to Dun and Bradstreet study of 2005 of software industry in India, which has categorisied the software companies of India on the basis of turnover in order to study their financial trends over the period of study (two years). In case of Triology also, the turnover was of only Rs. 48 crores, and hence turnover filter of Rs. 200 crores was adopted. 4.2 It is submitted that in both these cases, turnover filter has been used for the upper limit of the comparables. Further, the Dun and Bradstreet study (D B Study) cannot be followed to adopt both the upper and lower limit of turnover as a rigid compartment, assumably segregating different species of software companies for the following reasons: (i) This is not a study of any basic and inherent economic parameters/differences which leads to any conclusion that the three distinct categories of software companies exist in India, in terms of profitability. (ii) The turnov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the turnover of Rs. 190 crores of the tested company, for the sake of conforming to the unreliable D B study, which is not basically and fundamentally relevant to adopting a turnover filter for the transfer pricing study. Even other-wise, the Tribunal orders do not lay down any all encompassing principle to be universally applied, at least not with regard to the lower turnover limit in a case of with turnover of Rs. 598 crores, as that of the assessee. The case laws may be applied only in cases having similar turnover for the sake of upper turnover margin of Rs. 200 crores as filter. As explained above, there is no finding even in the D B study that such segments of software industry conform to any fixed rate or range of profit margins to operational cost. 4.4 The assessee's turnover is about Rs. 598 crores, and during the proceedings before the TPO, it agreed to the selection of comparables having minimum turnover of Rs. 100 crores and maximum of Rs.2000 crores. For the purpose of lower turnover limit, it is submitted that Rs. 60 crores may be adopted which would be reasonable being 10 times smaller than the assessee, and upper limit of Rs. 5000 crore, being 8 times higher, L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... filter, the following two companies, namely (i) Tata Elxsi Ltd; and (ii) M/s. Flextronics Software Systems Ltd., deserve to be eliminated for the following reasons : Tata Elxsi Limited (seg) : The company operates in the segments of software development services segment which comprises of embedded product design services, industrial design and engineering services and visual computing labs system integration services segment. There is no sub services break up/information provided in the annual report or the databases based on which we could compute the margin from software services activity only. The company has also in its response to the notice u/s 133(6 stated that it cannot be considered as comparable to any other software services company due to its complex nature. Accordingly, the Appellant wishes to submit that Tata Elxsi should be excluded from the list of comparables. Flextronics Software Systems Limited (seg) The company has earned revenues from software services on the basis of a hybrid revenue model (i.e. royalty that would become receivable on successful sale of products by the customers of the company) which is based on the information ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n to the assessee. Given the above, as stated under Rule 10B of the Income tax rules 1962, there is a need to make appropriate depreciation adjustment to eliminate the difference in the accounting policies of the Appellant and the comparable companies. 13. The Appellant's contentions find support in the following rulings: Mentor Graphics (Noida) Pvt. Ltd. v. Dy. Commissioner of Income tax [(2007) 109 ITD 101 (Delhi)] (Page 573-576 of Paperbook II) E-gain Communication Pvt. Ltd. v. ITO [2008-TIOL-282-ITAT-PUNE] (Page 581-584 of Paperbook II) Schefenacker Motherson Ltd. v. Income Tax Officer [2009-TIOL-376-ITAT-DEL] (Page 585- 586 of Paperbook II) 24/7 Customer.com Pvt. Ltd. v. DCIT [ITA No. 227/Bang/2010] 14. The Appellant wishes to submit detailed depreciation adjustment calculation as follow: Step 1: Depreciation charged by companies selected by TPO was extracted from respective annual reports; Step 2: For the purpose of comparison, the assets were broadly classified under different heads, viz., Computer, Furniture, etc. Step 3: The depreciation rate charged by HTSL was applied to the assets of the comparable companies (except land and building to which the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on, age of the assets etc., and therefore adjustment towards depreciation can be granted only if there are operational differences that affect comparability. We remit the issue of depreciation raised by the assessee in the additional grounds to the file of the Assessing Officer/TPO with direction to examine and consider the claim for adjustment towards depreciation in the light of our observations from paras 19.3 to 19.8 of this order and to dispose the matter expeditiously after affording adequate opportunity of being heard to the assessee. It is ordered accordingly." Apart from the above Tribunal decision, the other decisions of Delhi and Pune benches of the ITAT have also taken similar view regarding depreciation adjustment. Hence, following the above decision, we are directing the TPO/Assessing Officer to give the benefit of depreciation adjustment to the assessee as per the chart filed by the assessee which works out to around 3.39%. Thus, after the depreciation adjustment of 3.39%, from 16.56% (105% of 15.77% the ALP will come to 13.17%. Apart from this, the Assessing Officer shall give effect to the proviso to sub-section (2) of Section 92C, as per the latest amended Act, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 643.07,57,666 Adjustment F=(E) - (B) 59,23,67,720 48,92,14,784 Margins 15.07% 15.77% 19. The learned DR submitted that if any arithmetical mistakes are there, this may be sent back to the Assessing Officer for reappraisal of the claim of the assessee. 20. We have heard the rival submissions and considered the facts and materials on record. As this mistake has to be verified at the level of the Assessing Officer, we accept the contention of the learned DR and restore this issue back to the file of the Assessing Officer for doing the needful adjustment. 21. Now let us turn to the corporate tax issues. Regarding the computation of deduction u/s.10A of the Act, the assessee has taken the following grounds : 3. The learned DCIT has erred, in law and in facts, by reducing the expenses incurred by the Appellant towards telecommunication in respect of STP Unit II [amounting to Rs 23,508,825] from the export turnover, as being attributable towards the delivery of computer software outside India in computing the deduction under section 10A of the Act. 4. The learned DCIT has erred in law and in facts, by reducing cert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n 10A when the principle underlying both these provisions is one and the same. Therefore, we do not see any merit in this appeals." 24. We have heard the learned DR and considered the facts and materials on record. The decision of the Hon'ble Karnataka High Court in assesee's own case has been filed on record. The Hon'ble High Court has allowed the claim of the assessee. In a nutshell, this issue has been decided in favour of the assessee by the Hon'ble High Court for the assessment year 2004-05. Respectfully following the same, we also allow this ground of appeal of the assessee. Since ground no.5 is allowed as above in favour of the assessee, we are not going into ground nos.3 and 4 as they become infructuous, even according to the learned AR. 25. This issue is allowed in favour of the assessee. 26. Now, let us turn to the ground no.6 relating to software expenses, which reads as under : "The learned DCIT has erred in law and in fact, in capitalizing the software charges expensed by the Appellant, amounting to Rs. 38,371,306 without appreciating the detailed submission made by the Appellant that such software expenses do not result in any enduring benefit to the Appe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... beyond 2 years can be considered as accrual of benefit of enduring nature. However, that by itself will not make expenditure incurred on software as capital in nature and the functional tests as discussed above will also need to be satisfied" The Delhi High Court, in the case of CIT v. Asahi India Safety Glass Ltd. (TS-640-HC-2011)held that expenditure incurred for licence fee, annual technical support fee, etc does not result in creation of new asset or a new source of income for the assessee and hence, would be revenue in nature (extract of the case law is enclosed at page 530-533 of the Paperbook II). The above judgement also held that what is required to be seen is the real intent and purpose of the expenditure and whether the expenditure results in creation of fixed capital for the assessee. he expenditure which is incurred, which enables the profit making structure to work more efficiently leaving the source of the profit making structure untouched, would be an expense in the nature of revenue expenditure. 28. The learned AR further submitted that the software expenses debited to the P L A/c are attributable towards purchase of application software and software licenses w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ses as capital and revenue. 30. In his rejoinder, the learned chartered accountant submitted that he has no objection if the Tribunal is restoring this issue back to the Assessing Officer to reappraise this issue with respect to the expenditure of Rs. 10 lakhs and above. 31. We have heard the rival submissions and considered the facts and materials on record. We deem it fit and proper to restore this issue back to the file of the Assessing Officer to reappraise the expenditure in respect of Rs.10 lakhs and above and decide the issue in accordance with the decisions of the Delhi Special Bench in Amway India Enterprises (supra) and the decision. of the Karnataka High Court in Toyota Kirloskar Motors P. Ltd. (supra), after giving effective opportunity of hearing to the assessee. Thus, this issue is allowed for statistical purpose. It is ordered accordingly. 32. Now, let us turn to the ground relating to deduction u/s.80 JJAA of the Act, which reads as under : "The learned DCIT has erred in law and in facts by disallowing the deduction claimed by the Appellant under section 80JJAA of the Act amounting to Rs. 110,995,555, without appreciating the detailed factual and tech ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , the eligible assessee would be able to claim 30% of the 'additional wages' as a deduction, which would be over and above the expenditure on wages which is otherwise allowable as business expenditure to the Company. Further, the deduction would be allowable for three years, including the AY relevant to the previous year in which such employment is provided by the assessee company. In this context, it would be relevant to examine the definition of workmen, and whether the employees of the Company with respect to whom the said deduction has been claimed qualify as 'workmen' under section 8OJJAA. Workman The basis for deduction under section 8OJJAA is the salary paid to 'new regular workman'. The section contains the definition of 'workman', and is defined to have the same meaning assigned to it in clause (5) of section (2) of the Industrial Disputes Act 1947. The term 'workman' is defined in the Industrial Disputes Act as under: "'Workman means any person (including an apprentice) employed in any industry to do any manual, unskilled, skilled, technical, operational, clerical or supervisory work for hire or reward, whet her ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... faculties and they enable him to produce something as a creation of his own, he would be employed on 'technical work' even though in carrying out that work, he may have to go through a lot of manual labour or routine/ repetitive work. In the case of a person employed in a technical capacity, the application of knowledge of a particular craft or work is the distinguishing feature. It is not necessary that the work that such a person does must be inventive, but it must necessarily be a work the contours of which are not pre-determined before that work is actually performed by the person employed in a technical capacity. This principle was brought out by the Mumbai High Court in the case of Bombay Dyeing and Manufacturing Co Ltd. v. RA Bidoo(q) [1991] I LLJ 98, 101-2 (extract of the case law enclosed at page 549-550 of the Paperbook II). We also wish to place reliance on the guiding principles brought out in the "The Law of Industrial Disputes" by O P Malhotra on the Industrial Disputes Act, 1947. While analysing which persons are considered to be employed in a technical capacity, it has been concluded that persons doing technical work such as draftsman, engineers, assistant engi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or clerical work, the employee should be held to be doing supervision work. Conversely, if the main work is of manual, clerical or technical nature, the mere fact that some supervisory work or other work is also done by the employee incidentally or only a small fraction of working time is devoted to some supervisory work, the employee will come within the purview of the "workman" as defined in section 2(s) of the Industrial Disputes Act." The Supreme Court in the case of Ananda Bazar Patrika Pvt Ltd v Its Workmen [1969] [2 LLJ 670-71] also laid out the following similar principle (extract of the case law enclosed at page 553- 554 of the Paperbook II): "The question, whether a person is employed in a supervisory capacity or on clerical work, in our opinion, depends upon whether the main and principal duties carried out by him are those of a supervisory character, or of a nature carried out by a clerk. If a person is mainly doing supervisory work, but, incidentally or for a fraction of the time, also does some clerical work, it would have to be held that he is employed in supervisory capacity; and, conversely, if the main work done is of clerical nature the mere fact that some s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t that a software engineer would also be covered by the definition of the term workman', and the salary drawn by him would ergo qualify for deduction under section 80JJAA. Further, since the Appellant has satisfied the conditions for being eligible to claim the deduction under section 80JJAA of the Act and has demonstrated the same in detail during the course of scrutiny assessment proceedings, we pray that the deduction not be disallowed in the hands of the Appellant. 35. Per contra, the learned DR reiterated the contents of the assessment order as his submissions. He also pleaded that this matter may be sent back to the Assessing Officer for passing a detailed order as many of the facts are to be referred to the Assessing Officer in the light of the submissions made by the learned AR. 36. We also find that the Tribunal in the case of Texas Instruments (P.) Ltd., in IT Appeal No.1/Bang/2011, dated 7.9.2012, for the assessment year 2005-06, at para no.10.7, has remitted the matter back to the Commissioner of Income-tax (Appeals) for fresh consideration. Hence, we are inclined to restore this issue back to the file of the Assessing Officer with a direction to redecide the issu ..... X X X X Extracts X X X X X X X X Extracts X X X X
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