TMI Blog2013 (10) TMI 599X X X X Extracts X X X X X X X X Extracts X X X X ..... A HIGH COURT] - Decided in favour of assessee. Rejection of comparable - Held that:- TPO in his order has brought out the differences between a product company and a software development services provider. Thus, it is clear that he is aware of the functional dissimilarity between a product company and a software development service provider. Having taken note of the difference between the two functions, the Assessing Officer ought not to have taken the companies which are into both the product development as well as software development service provider as comparables unless the segmental details are available. Even if he has adopted the filter of more than 75% of the revenue from the software services for selecting a comparable company, he ought to have taken the segmental results of the software services only. The percentage of expenditure towards the development of software products may differ from company to company and also it may not be proportionate to the sales from the sale of software products. Under section 133(6) of the I.T. Act, the TPO has the power to call for the necessary details from the comparable companies. It is seen that the Assessing Officer/TPO has exerci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, the assessee filed its transfer pricing study and the details of the comparables adopted by it and justified with reasons the adoption of these companies as comparables. The TPO observed that the assessee has taken 40 companies as comparables with an average profit margin @ 15.96% on cost. The assessee had been compensated by the Associated Enterprise at cost plus method and therefore, the margin earned by the assessee at 16.06% on operating cost was treated as at arms length by the assessee. The TPO also asked the assessee to substantiate the cost plus method adopted by the assessee and to communicate the objections, if any, for adopting TNMM as Most Appropriate Method (hereinafter referred to as "MAM") to determine the ALP. In response to the same, the assessee filed reply dated 25.8.2007 stating that they have no objection to adopt TNMM as MAM for arriving at the ALP and that they have prepared the documentation accordingly. The TPO observed that the assessee has not applied various filters for selection of the comparables as is necessary for determining the ALP under the TNMM. He, therefore, rejected the comparable companies adopted by the assessee and made his own search fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , the TPO computed the arithmetic mean of operating profit to total cost at 26.59% and after giving the working capital adjustment of 0.81%, he arrived at the adjusted arithmetic mean of PLI at 25.78%. He, accordingly, made the adjustment of the short-fall under section 92CA at Rs. 1,44,00,953/-. 7. In consonance with the Order of the TPO, the Assessing Officer determined the taxable income of the assessee by making the suitable adjustments to the price received by the assessee for its services to the AE. Aggrieved by the additions made by the Assessing Officer, the assessee preferred an appeal before the CIT(A) who confirmed the Order of the Assessing Officer and the assessee is in second appeal before us. Though the assessee has raised as many as four grounds of appeal, its main objection is against the comparables adopted by the TPO to which the assessee has objected to before the TPO and also against the computation of relief under section 10A of the I.T. Act. 8. As far as the issue of computation of relief under section 10A is concerned, the learned Counsel appearing on behalf of the assessee, has submitted that the Assessing Officer has reduced the communication expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot be considered for the purpose of determination of the ALP. Therefore, we proceed to dispose of the assessee's appeal on the basis of this chart after hearing both the parties. 13. The assessee has mainly objected to the adoption of the following companies before us as comparables. 14. Exensys Software Solutions Limited: As regards this company, the learned Counsel appearing on behalf of the assessee submitted that the operating profit by operating cost of this company is 70.68%. He submitted that though the assessee has not objected to the adoption of this company as comparable before the TPO, it has come to its knowledge subsequently that there is an extraordinary event in the company which has effected the margins of the company for the relevant assessment year. He submitted that during the relevant previous year, the Exensys Software Limited was amalgamated with another company by name Holool India Limited and the operating margin of 70.68% is the combined result of the amalgamated company. Thus, according to him, the data collected by the TPO is not reliable and therefore, this company should be excluded from the list of comparables. 15. For this purpose, he has drawn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied upon by the learned Counsel for the assessee clearly denotes that there is an extraordinary event which has resulted in the high operating margin of the company, we deem it fit and proper to remand this issue to the file of the Assessing Officer/TPO for reconsideration. If it is found that there is an amalgamation of Exensys Software Limited and Holool India Limited and formed as one entity viz., Exensys Software Solutions Limited. during the relevant previous year and the financial result is the combined result of these two companies, then, we direct the Assessing Officer/TPO to exclude this company from the list of comparables. 18. Infosys Technologies Limited: According to the learned Counsel for the assessee the operating margin of this company is 42.83% and is a giant company which is into diversified activities of software development. He submitted that Infosys Technologies Limited is not only a giant company but is also into development of niche products and therefore, cannot be taken as comparable to any other software company, particularly, a small company like the assessee. He relied upon the decisions of the Tribunal in the case of Patni Telecom Solutions (P.) Ltd. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Software Solution Limited. As far as these three companies are concerned, the learned Counsel appearing on behalf of the assessee submitted that they are into both software as well as product development. He submitted that the TPO has taken note of the fact these companies are also into product development but has selected these companies as comparables by applying the filter of more than 70% of its revenue being from software development services. The learned Counsel submitted that the functions of these companies are different from the assessee who was into sole activity of software development for its associated enterprise. He submitted that the TPO has allocated the expenditure in the proportion of the revenue of these companies from software services and software products and has adopted the figure as segmental margin of the company and has taken these companies as comparables. He submitted that by taking the proportionate expenditure, the correct financial results would not emerge. He submitted that nothing prevented the Assessing Officer/TPO from obtaining the segmental details from the respective comparable companies before adopting them as comparable companies and before t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cts during the year but the said company might have incurred expenditure towards the development of the software products. 27. As far as Flexitronics Software Limited is concerned, we find that at page 90 of his Order, the TPO has also observed that the said company has incurred expenditure for selling of products and has incurred R D expenditure for development of the products. The above facts clearly demonstrate that there is functional dissimilarity between the assessee and these companies and without making adjustment for the dissimilarities brought out by the TPO himself, these companies cannot be taken as comparable companies. The method adopted by the TPO to allocate expenditure proportionately to the software development services and software product activity cannot be said to be correct and reasonable. Wherever, the Assessing Officer/TPO cannot make suitable adjustment to the financial results of the comparable companies with the assessee-company to bring them on par with the assessee, these companies are to be excluded from the list of comparables. Therefore, we direct the Assessing Officer/TPO to exclude these three companies from the list of comparables. 28. In th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied activities and for the detailed reasons given by us in the assessee's own case for the A.Y. 2005-2006 even dated, we direct that these two companies are to be excluded from the list of comparables. 33. As far as Tata Elxsi Limited is concerned, the learned Counsel appearing on behalf of the assessee has relied upon the communication of Tata Elxsi Limited to the Transfer Pricing Officer in the case of another assessee to say that it cannot be taken as a comparable company to enter software development services companies. For the A.Y. 2005-2006 we have directed the Assessing Officer/TPO to consider the contents of the said communication and take decision in accordance with law. Similar direction is given for this assessment year 2007-2008 also. 34. As far as Mega-Soft is concerned, the learned Counsel for the assessee has drawn our attention to the fact that the segmental margin of this company's software development services is only 23.11%. Whereas, the Assessing Officer/TPO has taken the combined result of 60.23%. He submitted that the Tribunal at Bangalore in the case of Trilogy E-Business Software India Private Limited vs. DCIT in ITA.No.1054/Bang/2011 at paras 24 to 26, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e case of Bindview India Private Limited v. 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 be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ratio of sale from software product and sale of software service and development. Looking to the fact that it has developed a software product named as "Muulam" which is used for civil engineering structures and the product development expenditure itself is substantial vis- -vis the capital employed by the said company, this criteria for being taken as comparable party, gets vitiated. For the purpose of comparability analysis, it is essential that the characteristics and the functions are by and large similar as that of the assessee company and T.P. analysis/study can be made with fewest and most reliable adjustment. If a company has employed heavy capital in development of a product then profitability in the sale of product would be entirely different from the company, who is involved in serve sector. Therefore, this company cannot be treated as having same function and profitability ratio. In our view, due to non-availability of full information about the segmental details as to how much is the sale of product and how much is from the services, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e", it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT - ITA No.7821/Mum/2011 wherein the Tribunal accepted the assessee's contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- 7.8 Avani Cincom Technologies Ltd. ('Avani Cincom'): Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vices for 2D and 3D animation and therefore assessee's claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from the final list of comparables for the purpose of determining TNMM margin." 38. Respectfully following the decision of the Coordinate Bench of the Tribunal, we direct that these companies should be excluded from the list of comparables. 39. As far as Ishir Infotech Ltd. is concerned, the learned Counsel for the assessee submitted that this company fails both employee cost filter of being less than 25% as well as RPT Filter of more than 15%. 40. The learned Counsel for the assessee has also relied upon the decision of the Coordinate Bench of the Tribunal in the case of HCL EAI Services Ltd. (supra) wherein taking note of the assessee's contention, has directed the Assessing Officer/TPO to exclude the said company from the list of comparables on the basis of the RPTG Filter of 15%. The relevant portion of the Tribunal's order is at pages 21 at paras 15 to 16 of its order is reproduced hereunder: "15. With regard to Sl.No.11 of the list of comparable chosen by the TPO viz., ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e case of 24/7 Customer Com Private Ltd. had held that if the related party transaction exceeded 15% of the total sales/revenue, the same cannot be taken as a comparable. The relevant contention that was raised and the finding of the Tribunal read as follows:- 13.0 RELATED PARTY TRANSACTIONS In respect of the ground raised at S. No.1 regarding acceptance of comparable companies having related party transactions as proposed by the TPO, the learned counsel for the assessee argued that the transfer pricing regulations do not stipulate any minimum limit of related party transactions which form the threshold for exclusion as a comparable. In this regard, the learned counsel for the assessee objected to the TPO's setting a limit of 25% on related party transactions. He objected to the inclusion of comparables being related party transactions in excess of 15% of sales/revenue. In support of this proposition, the learned counsel for the assessee placed reliance on the decision of the Hon'ble Bench of the ITAT, Delhi in the case of Sony India (P) Ltd. reported in 2008-TIOL-439-ITAT-Delhi dt.23.12.2008. The learned counsel for the assessee drew our attention to para 115.3 of t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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