TMI Blog2013 (11) TMI 967X X X X Extracts X X X X X X X X Extracts X X X X ..... nue authorities meaningfully - The TPO should have provided maximum limits too and he should not have pickup up the comparable such as Infosys and Wipro Ltd which are giants with huge turnovers - If these two companies with high turnover and margins are excluded, the assessee PLI is at arm's length and consequently, the TP adjustments are not required – The issue was remanded back for fresh adjudication. Functionally comparable companies – Held that:- The giant companies namely, Infosys Technologies and the Wipro Ltd are not good comparables on the grounds of the nature of services, risk profile, revenues, ownership of intangibles, onsite vs offshore works, expenditure on advertising, sales promotion and R& D developments etc - The onus is on the assessee to demonstrate that the turnover' factor has impact on the operating profits' of the company - The orders of AO/TPO/DRP do not contain reasoning for inclusions of these two comparable - They do not contain any reasoning rejecting the objections raised by the assessee - On the issue of giantness – It is a generic function and the turnover constitutes one of the factors contributing to the giantness - Assessee needs to demonstra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in the Transfer Pricing (TP) study of the assessee. Referring to ground no. 6 and 7, Ld Counsel mentioned that these two grounds are related and they have to be adjudicated together. Further, referring to ground no.9, Ld Counsel mentioned that the issue relating to the non-consideration of additional companies offered by the assessee as comparables was not adjudicated by the DRP. Therefore, the same is required to be remanded to the files of the DRP / TPO / AO for fresh adjudication with a direction to pass a speaking order. Considering the said prayer of the Ld Counsel and considering the no objection from the Ld DR, we remand the said ground 9 to the DRP/TPO/AO with a direction to adjudicate the same by passing a speaking order after giving requisite analysis / reasons for non-consideration or rejection, if any. Accordingly, ground no.9 is allowed for statistical purposes. Referring to ground no.13, Ld Counsel mentioned that the issues raised in this ground relate to levy of interest u/s 234B and 234D of the Act, which required to be allowed as consequential. Ld Counsel also mentioned that the issues raised relating to the initiation of penalty proceedings u/s 271(1)(c) of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 's Transfer Pricing study report and its comparables and rejected the same eventually. Otherwise, assessee applied Transactional Net Margin Method (TNMM) as most appropriate method with Operating Profit to Total Cost (OP/TC) as the Profit Level Indicator (PLI). Accordingly, assessee benchmarked the transactions at OP of 11.90% over the total cost. PLI at 11.90% is higher than the margins reported by the comparable companies considered in the TP study of the assessee. Thus, the impugned international transactions are at Arm's Length as per the assessee. This decision of the TPO is now final, since the assessee's representative has not pressed the ground no.1 and others before the Tribunal. Then, the TPO invoked the provisions of section 92C(3) of the Act and proceeded to determine the ALP. Accordingly, TPO conducted his search for suitable comparables on the data available in Prowess and Capitaline Databases and applied the following filters. Companies whose data is not available for AY 2007-2008 were excluded. Companies whose software development service's revenue is Rs. 1cr were excluded. Companies whose Software development service revenue is less than 75% of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly, the list of comparables proposed to the assessee and the related OP / TC as PLI are listed in the total as under: 6. From the above it is evident that the TPO shortlisted 23 comparables and arrived at the Arithmetic Mean Margin @ 24.99% against the assessee's margin of 11.90%. TPO issued a show cause notice and in reply, the assessee filed objections vide its letter dated 14.10.2011. In the said reply, the assessee justified the TP study report prepared by him which is a non issue now and further, assessee provided written explanation to the defects in the report picked up by the TPO. TPO rejected the objections raised by the assessee and proceeded to determine Arm's Length Mean Margin (ALM) as per the table given below. Operating cost Rs. 14,00,22,902/- Arm's Length Mean Margin 24.99% of the Operating cost Price charged Rs. 17,50,14,625/- Shortfall being adjustment u/s 92CA Rs.2,26,55,705/- 105% of International transaction Rs. 15,99,76,866/- 95% of international transaction Rs. 14,47,40,974/- Whether the shortfall falling within +/- 5% range No ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Department are comparables in the current year. These are examined as under..... 9. Before us, it is the argument of Sri Lohia, Ld Counsel for assessee that the TPO is under wrong impression that the assessee's return of income was processed for arriving at the ALP for the AY 2007-08 by the Department, where the said additional comparables pertaining to AY 07-08 were considered for the purpose of arriving at the ALP. In this regard, Ld counsel mentioned that the AY 2008-2009 is the relevant AY and happened to be the first assessment year of the assessee. Therefore the question of considering any companies as comparables for the AY 2007-2008 is patently wrong and therefore, the TPO's TP study suffers from fatal defects and therefore, self destructive. Therefore, it is the contention of the Ld Counsel that the said 5 additional comparable companies namely (1) Avani Cimeon Technologies Ltd (2) Celestial Labs Ltd (3) LGS Global Ltd (Lanco Global Solutions Ltd) (4) Tata Elxi Ltd (segment) and (5) Wipro Ltd (segment) should be excluded from the gross list of 23 final comparable companies short listed by the TPO for ALP purpose. 10. On the other hand, Sri Jain Ld CIT- DR accepted t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the list of filters and narrated that the filter relating to exclusion of comparables with turnover of Rs. 1 Cr or below is one such filter and as per Ld Counsel, the same should have also to exclude the cases of huge turnover on maximum side too. Referring to the data of the cases of Infosys Technologies Ltd and Wipro Ltd, Ld Counsel mentioned that these companies have turnovers of Rs. 15,653 Crs and Rs. 11,276 Crs respectively as against the assessee's turnover of Rs. 15 Crs, approximately. Prima facie, they are incomparable. By not filtering out these cases of extremely high turnovers, the TPO made an error in selection process of comparables. In this regard, Ld Counsel relied on the decision of Delhi High Court in the case of Agnity India Technologies P Ltd, supra and other orders of the Tribunal. The assessee also filed copies of other decisions of the Tribunal to suggest that Infosys Technologies Ltd and Wipro Ltd are not good comparable cases in view of the huge turnover with the diversified area of operations. Sri Lohia fairly submitted that the issue of turnover was referred to Special Bench but only to be withdrawn considering the judgment of the Hon'ble High court in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pro as the good comparables on one side and also on the appropriateness of the filters (ie (i) fixing turnover filter on maximum side; (ii) employee cost and (ii) onsite revenue filter) chosen by the TPO. On the filter relating to providing maximum turnover limit when the minimum turnover limit is proscribed, the comparables Infosys Technologies Ltd and Wipro Ltd are the target companies and we find the issue is not adjudicated by revenue authorities meaningfully. It is the objections of the assessee that the TPO should have provided maximum limits too and he should not have pickup up the comparable such as Infosys and Wipro Ltd which are giants with huge turnovers. Regarding these two companies with high turnovers, we find this issue is linked to the one specially being adjudicated while dealing with the ground 7 below relating to accepting of certain companies as good comparables. It is the submission of the assessee's counsel that the if these two companies with high turnover and margins are excluded, the assessee PLI is at arm's length and consequently, the TP adjustments are uncalled for. Since, the AR has raised these objections, the onus on the assessee to demonstrate before ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ifferent KALS. Information Systems Limited has been claimed to be functionally different being into business of provision of software development services as well as sale of software products. Likewise, Tata Elexi Limited has been distinguished on account of being functionally different being operating in software development services of different category. The comparables case of Wipro Limited has been disputed on account of high turnover and functional difference.‖ 17. From the above, it is evident that the assessee is critical of the fact that the some of the companies are functionally different in view of the fact that they are engaged in the products also. Further, it is the case of Acropetal Technologies Limited (Seg.), which has not met the filter relating to the employee cost as well as on-site revenue filters. Further, it is the assessee objected to the fact that certain companies information is not available on the public domain. In this regard, the direction of the DRP is that the TPO has undertaken FAR analysis by examining the Annual Reports and other documents before rejecting the incomparable cases. The assessee is aggrieved with such direction and raised t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d DR filed copies of the financial statements and mentioned that the said company is engaged in the software services. On considering the material available before us, we are of the opinion that this case is functionally different as this company is a product based and not of the development services. Therefore, we agree with the arguments of Sri Lohia, Ld Counsel's for the assessee. Therefore, considering the FAR analysis in favour of the assessee, we direct the TPO to exclude the same for the purpose of working out the Arithmetic Mean of the operating margins. C. Bodhtree Consulting Limited 21. On this comparable, case of the assessee is that the company is not a good comparable in view of the software products produced by the company. As such, no segmental data is adequately available too. 22. On the other hand, Ld DR filed a copy of the financial statement and argued vehemently stating that this company is not engaged in the software products. In this regard, Ld DR relied on the note no.3, relating to the relating to the revenue recommendation in Schedule 12, note no.5 relating to the segmental information etc to mention that the company is engaged in the software develop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion that Bodhtree Consulting Limited is not engaged in the software development services and there is no segmental data comparable. Therefore, the FAR analysis goes against the TPO/AO. Accordingly, we dismiss the argument of the Ld DR in this regard. Ex consequenti, the AO/TPO is directed to exclude the same from the list of final comparables for working out the arithmetic mean. D. E-infochip Limited 24. In this regard, it is the submission of the assessee that this company is not a good comparable as it is engaged in software services and IT enabled services. Accepting the fact that this is a IT product based company, Ld AR mentioned that the segmental information suggests that the revenues earned is below 25%, therefore, it fulfills the relevant filter specified by the TPO. In this regard, Ld DR filed a copy of the financial statement and read out the following. The company is engaged in the development and maintenance of computer software and also manufacturing EVM and VDB electronic Board (Hardware Division). The production and sales of software cannot be expressed in any generic unit. Hence, it is not possible to give the quantitative details of sales and certain other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n design and engineering services (i.e. Mechanical design with a focus on industrial design) and (C) Visual computing labs (i.e. animation and special effects). Further, based on the information available on the company's website, the company is engaged in provision of product engineering services which broadly falls under the ambit of ITES. Based on the above, it is submitted that the software development services‖ segment of the company comprises of design and development of hardware, software and IT enabled services/activities. Also, there is no sub services break up/ information provided in the annual report or the databases. Accordingly, the company cannot be taken as comparable to the Appellant. 29. On the other hand, Ld DR brought our attention to the segmental reporting data at page 374 and 375 of the paper book and mentioned that the segmental data relating to software development services was alone considered by the TPO. Therefore, the orders of the DRP / TPO do not call any change. 30. We have heard both the parties and perused the said pages 374 375 of the paper book and found that the order of the DRP is reasonable and does not call for any interference. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be compared to a risk mitigated captive unit such as the assessee. Further, argued that such giant companies should not be picked up for TNMM studies of the present company with Rs 15 cro or so. In this regard, on the issue of incomparability of the giant company like the Infosys Technologies, Satyam Computers, L T Infotech etc, he relied on a Delhi Bench judgment in the case of Agnity India Technologies P Ltd vide IT 1204/2011 for the AY 2006-07 to support his case. To support his line of arguments, Ld Counsel furnished copies of certain documents. Further, he also filed first time a chart showing how these two companies are functionally different vide the FAR analysis. 33. Per contra, Ld DR did not agree with the arguments of the Ld Counsel by stating that Infosys Technologies is a good comparable considering the availability of segmental data. He filed a copies of the financial statement and brought our attention to page 52 of the annual reports and demonstrated that the software services were 96.2% and the products is only 3.8% in the ratio of Rs. 15,051 Crs and Rs. 597 Crs respectively. The data on products segment of the company suggest that its segment is far below t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company cannot be treated as a comparable. 47 We have considered the rival submissions as well as the relevant material on record. The assessee has mainly emphasized the objection of high turnover of Infosys BPO Ltd in comparison to the assessee; therefore, this company cannot be treated as a comparable. The reliance was placed on the decision of the Hyderabad Benches of this Tribunal in case of Capital IQ Information (supra) as well as in the case of Agnity India Technologies (supra) 47.1 We note that in the case of Capital IQ Information (supra) the Tribunal has relied upon the decision in the case of Agnity India Technologies (supra) as well as in the case of Triniti Advanced Software Labs P Ltd (supra). We further note that all these decisions have primarily relied upon the decision of Bangalore Benches of this Tribunal in the case of Genesys Integrating Systems India P Ltd(supra) which has been relied upon by the Tribunal in case of Capital IQ Information in para 21 as under: 21. On considering the submissions of the assessee in relation to these three companies, we find that the TPO has excluded the companies whose turnover is less than Rs. One Crore, on the ground th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain for the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal when companies which are loss making are excluded from cam parables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun Bradstreet and NASSCOM has given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs. 1.00 crore to 200 crores have to be taken as a particular range and the assessee being in the range having t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of turnover.‖ 34. On hearing both parties, we find the case of the assessee is that the giant companies namely, Infosys Technologies and the Wipro Ltd are not good comparables on the grounds of the nature of services, risk profile, revenues, ownership of intangibles, onsite vs offshore works, expenditure on advertising, sales promotion and R D developments etc. He also mentioned that the turnover constitutes one of the contributors of the giantness of a company. Assessee relies on the judgment of the Delhi High court in the case of Agnity India Technologies P Ltd, supra. On the other hand, the case of the revenue is that the said judgment of the Delhi High court do not refers to the turnover function in the order. Further, Ld DR for the revenue is of the firm opinion that the turnover and intangibles do not contribute to the operating profits' of a company. It is the argument of the Ld DR that when assessee contends that a comparable is not good one for any reasons, the onus is on the assessee to demonstrate that the turnover' factor has impact on the operating profits' of the company and relies on various orders of the tribunal cited above. Regarding the delhi high court' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reputation and acceptability. After having arrived at the dataset, it is not open for the assessee to suggest inclusion of further concerns as comparables. If such a plea is allowed, there will be no end to the ALP computation and updation process. Hence, this Panel is of the opinion that the claim of the assessee for inclusion of certain comparable' entities handpicked by it is not feasible. So far as plea of taking correct updated margin is concerned, the AO/TPO is directed to verify the same corrected / updated margins be taken while re-computing ALP.‖ 36. From the above, it is evident that the DRP rejected the claim of the assessee stating that there will be no end to ALP computation and updation process, if the said comparables are accepted at this stage. 37. Before us, Ld Counsel is critical of the said directions of the DRP. Per contra, Ld DR mentioned that the DRP is correct in rejecting the same. Referring to the profit percentages of three companies of the list under consideration, Mr Jain mentioned that they are not the choices of the assessee initially. They are furnished by the assessee at the later stages of the assessment, considering the timing, the said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there are certain errors mistakes in the computation of the Assessee's operating margin done by the learned TPO/ Hon'ble DRP. While Hon'ble DRP has accepted the ground relating operating nature of service charges, it has not accepted the contention that foreign exchange loss pertaining to interest payments needs to be considered non-operating in nature while computing the operating margins of the Assessee. The revised margin of the Appellant as per the directions of the Hon‟ble DRP works out to be 9.23% as against 11.22% claimed by the Assessee before the Hon‟ble DRP. In the profit and loss account of the Appellant for FY 2007-08 (Schedule 12 --Other Income) the Exchange Gain' amounting to Rs 1,064,713 consists of foreign exchange gain on sales amounting to Rs 3,840,402 and foreign exchange loss on interest on loan payables amounting to Rs 2,775,689 (3,840,402 minus 2,775,689 equals to 1,064,713. The foreign exchange loss on interest on loan payables being non- operating in nature should be excluded from the computation of the operating margin of the Appellant. The learned TPO has rightly considered interest on term loan as a non-operating expense and the foreign exc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... direction of the DRP given in para 17.3 and the same reads as under: "17.3. Directions of the DRP: This Panel has considered the matter and is of the firm opinion that the arguments of the assessee are not very relevant because the assessee belonging to the renowned Nethawk group has a brand value and prestige in the global LT. market including India. The assessee or its Group is not a common LT. firm in the market due to its past reputation and global recognition and acceptability. Therefore, the loading of huge costs in terms of economic adjustments (Working capital adjustment of 1.56% and risk adjustment of 7.00%) as made by the assessee is unnatural and unacceptable. Further, this Panel holds that the claim of the assessee for working capital and risk adjustment for the difference between the comparables and tested party is not tenable since it has failed to produce any evidence supporting the workings of any such adjustment. We agree with the T.P.O. that the data used by the assessee in the workings are not reliable and therefore, liable to rejection. Also that, the assessee has made adjustments on its own will without collecting any information regarding comparables. H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cessing Services (I) P Ltd vs. DCIT vide ITA No.4547 4429/M/2012 (AY 2007- 2008), dated 1.3.2013 and para 57 to 58.3 of the said order of the Tribunal is relevant in this regard. Bringing our attention to the said paragraphs of the Tribunal's order (supra), Ld DR mentioned that assessee is required to demonstrate the existence of risk before the revenue authorities. As per these decisions, granting adjustments to WC and Risk factors is not an automatic process and like granting a standard deduction. There are no safe harbors specified on these adjustments. He relied on another order of the Tribunal in the case of decision of the Tribunal in the case of M/s. Premier Exploration Services Pvt. Ltd vs. ITO vide ITA No.4935/Del/2011 (AY: 2007-2008), order dated 31.5.2013 for the proposition that the risk adjustments cannot be allowed as a general rule and the assessee is under obligation to demonstrate the existence of risk with the help of data and they are materially affect their margins. The tax payer needs to demonstrate that the risk is translated into charging a higher margin in comparable companies. In these circumstances, the Tribunal has considered the fact of single customer ..... X X X X Extracts X X X X X X X X Extracts X X X X
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