TMI Blog2015 (1) TMI 466X X X X Extracts X X X X X X X X Extracts X X X X ..... ded and rejected some comparables without even examining as to whether they are functionally comparable or not. If at all the TPO was to reject the same, it was imperative for him to examine all the comparables in the light of the FAR analysis and only thereafter reject the same after passing a speaking order. In the absence of such an approach by the TPO, in our view, the comparability analysis carried out by him is vitiated. In the entirety of the facts and circumstances, we deem it fit to restore this aspect of the issue back to the file of the AO / TPO, who shall consider the aforesaid companies picked up by way of fresh search carried out in ITES segments. Reasonable opportunity of being heard to the assessee should be given in this regard. The said issue with respect to determination of arm’s length price in ITES segment is thus, set aside to the file of AO / TPO and the ground of appeal raised by the assessee in this regard is thus, allowed for statistical purposes. - ITA No.336/PN/2014 - - - Dated:- 31-10-2014 - SHRI G.S. PANNU AND Ms. SUSHMA CHOWLA, JJ. For The Appellant : Shri Ashwini Taneja For The Respondent : Shri B.C. Malakar ORDER PER SUSHMA CHO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business operations from final set of comparables which were accepted in past assessment years (and also identified based on the fresh search conducted by the appellant on a without prejudice basis) without providing any reasons. 3. The Ld. DRP/AO erred in considering the single year data for the comparables i.e. data for FY 2008-09 only and disregarding multiple year data which was considered by the appellant in accordance with the provisions of Rule 10B(4) of the Income-tax Rule, 1962 ( Rules' ) 4. The Ld. DRP / AO erred in not allowing an adjustment for the difference between the level of risk borne/assets employed by the comparables and the appellant as provided by the appellant, without providing any cogent reasons, and disregarding the provisions of Rules 10B (3) read with Rule 10C of the Rules. In doing so, the Ld DRP / AO erred by: i. failing to capture that the appellant is a routine captive service provider as against the comparable companies selected by the Ld TPO which include entrepreneurial companies and hence an adjustment is necessary; ii. disregarding the provisions of Rules 10B(3) read with Rule 10C of the Rules. 5. The Ld. AO while passing the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f. Companies with Peculiar Economic Circumstances are rejected g. Companies whose data is not available for the FY 2008-09 has not been considered. h. Companies with IT and IT enabled service income 1 Cr and 200 Cr were excluded and having turnover between ₹ 1 Cr to ₹ 200 Cr has been retained. i. Companies whose IT enabled service revenue is less than 50% of the total operating revenue or segmental revenue were excluded j. Companies who have more than 25% related party transactions were excluded k. Companies who have less than 75% of the operating revenue as export sales were excluded. l. Companies who have diminishing revenues/persistent losses for the period under consideration were excluded m. Companies that are functionally different from you or working in peculiar economic circumstances, after giving valid reasons, were excluded. 5. In view of the search criteria applied by the TPO, certain companies which were selected by the assessee as comparables were found to be not comparables and hence were rejected. The following comparables were selected by the TPO for the purposes of benchmarking the international transactions. The TPO selected ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of rejection of comparables having similar functional profile, especially while applying the TNMM. It was further pointed by the assessee that both levels of turnover mentioned above were significantly higher than the turnover of the assessee, and on consideration of the turnover filter as the primary reason for rejection, both levels would stand a similar chance for rejection. The assessee further submitted that the turnover filter of sales greater than ₹ 1 Crore was applied in the TP study conducted by the assessee. 8. The TPO rejecting the plea of the assessee observed that in the previous year, the TPO had applied higher turnover criteria of ₹ 200 crores and the same fact was confirmed by the DRP in its own case. Therefore, in order to maintain consistency, the same criteria was adopted and company such as LT Infotech, Mindtree and Persistent Systems were rejected on this account. 9. The assessee further raised objections on the following criteria applied by the TPO. a. Foreign exchange loss / gain non-operating in nature b. consideration of other income / miscellaneous income as operating income c. Companies with less than 75% earning from exportsex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection to the introduction of the additional companies by the TPO without providing any cogent reasons. However, the TPO rejected the plea of the assessee and selected the final set of comparables in IT segments as under: S.No. Name of the Company PLI PLI After WC Adj 1 FCS Software Solutions Ltd 15.49 14.41 2 Akshay Software Technology 8.19 10.56 3 KALS Information Systems Ltd. (seg) 41.91 43.20 4 Bodhtree Consulting Ltd 68.35 69.25 5 LGS Global Ltd 18.03 15.03 6 Goldstone Technologies Ltd 4.15 7.07 Average 26.25 13. The PLI of the comparable companies thus worked out at 26.25 as against 17.19 of the assessee. 14. The ALP of the software ser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PLI of the comparable companies thus worked out at 31.71 as against 15.04 of the assessee. 18. The ALP of the software services rendered by the assessee was worked out as under:- Rs. Operating revenue of the assessee R 101,596,764 Operating Cost (OC) 100,244,536 PLI of comparables P 31.71 Arm's Length Price (ALP) of the international transaction (ALP=OC*(1+P/100) A 132,032,078 Adjustment over operating income (Shortfall being adjustment u/s 92CA) A-R 30,435,314 19. In view of the above, an adjustment of ₹ 30,435,314/- was made to the international transaction relating to ITES segment to arrive at the arm s length value of the international transaction and as a consequence of this adjustment, income of the assessee was increased by ₹ 30,435,314/-. 20. The report by the TPO was submitted to the Assessing Officer which was show cause ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thorized Representative for the assessee that the said comparables picked up by the TPO i.e. KALS Information System Ltd. was primarily engaged in the business of software services and software products, whereas the assessee does not sell any software products and was a capital service provider. The learned Authorized Representative for the assessee made reference to the financial statement of KALS Information System Ltd. placed at pages 479 to 489 of the Paper Book and our attention was drawn to the notes to the financial statement and also the profit loss account for the year ending 31.03.2009, under which the said company had declared the receipts from sales, services and training at ₹ 2.14 crores. The learned Authorized Representative for the assessee further referred to the notes on account at page 481 of the Paper Book and pointed out that it was reported that the company was engaged in the development of computer software and other related services. Further at pages 482 to 489 attached to the list of products dealt in by KALS Information Systems Ltd. In respect of the other comparables selected i.e. Bodhtree Consulting Ltd., it was pointed out that the TPO had select ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee pointed out that last year the said company Bodhtree Consulting Ltd. was functionally comparable but since comparable was declaring fluctuating profits, the same cannot be used a comparable and was not picked up by the assessee in its TP study. The assessee further was aggrieved by the selection of the FCS Software Solutions Ltd. and it was pointed out by the learned Authorized Representative that the said company was rendering diverse services and no segmental data was available. Even before the TPO, it was pointed out that segmental data was not available. The TPO had selected the said company as the software development was more than 50%. However, the said company does not fit into the said filter as it has software development only to the extent of 40% of the revenue and hence fails the filter. The learned Authorized Representative for the assessee pointed out that certain companies i.e. Mindtree Ltd. (5.52%), e-Infochips Ltd. (- 12.69%) should be taken as comparable. The learned Authorized Representative for the assessee further pointed out that it had carried out a fresh search during the proceedings before the TPO and the TPO rejected the fresh search conducted by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able with the assessee. The relevant finding of the Tribunal vide para 19 is as under: 19. In our considered opinion, the point raised by the assessee is potent in as much as it is quite evident that the said concern (KALS Information Systems Ltd.) has not been found to be functionally comparable with the assessee in the immediately preceding assessment year and in the present year also, on the basis of the Annual Report, referred to in the written submissions addressed to the lower authorities, the assessee has correctly asserted out that the said concern was inter alia engaged in sale of software products, which was quite distinct from the activity undertaken by the assessee in the IT Services segment. At the time of hearing, neither is there any argument put forth by the Revenue and nor is there any discussion emerging from the orders of the lower authorities as to in what manner the functional profile of the said concern has undergone a change from that in the immediately preceding year. Therefore, having regard to the factual aspects brought out by the assessee, it is correctly asserted that the application software segment of the said concern is not comparable to the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... companies should be excluded as a comparable. The Special Bench after considering several aspects held in para 88 of its order that the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special bench held that in such cases it would require further investigation to ascertain the reasons for unusually high profit and in order to establish whether the entities with such high profits can be taken as comparable or not. In the light of the aforesaid decision of the Special Bench and in view of the admitted position that the assessee follows Fixed Price Project model where revenues from software development is recognized based on software developed and billed to clients, there is a possibility of the expenditure in relation to the revenue being booked in the earlier year. The results of Bodhtree from FY 2003 to 2008 excluding FY 2007 as given by the learned counsel for the assessee were also perused. Perusal of the same shows, that there has been a consistent change in the operating margins. The chart filed by the assessee in this regard is given as an annexure to this order. It appears to us that the revenue recognition met ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Special Bench, it is quite clear that the concerns earning abnormal high profit margins cannot be excluded from the list of comparables unless appropriate investigations are made. It would be necessary to ascertain as to whether the high profit margins reflect a normal business phenomena or whether it is the result of certain abnormal conditions prevailing in a particular year. In order to determine so, profit margins earned by such concern in the proximate preceding and succeeding years would be required to be considered in order to establish whether the high profit margins reflect a normal business trend or otherwise. In this background of the matter, the appellant has furnished before us the operating margin trends of the said concern over the five financial years i.e. for the three preceding years and one succeeding financial year. Notably, for the financial year under consideration, the margin of the said concern is 34.71% whereas for the preceding three financial years of 2003-04, 2004-05 and 2005-06 it is -6.47%, -69.07% and -44.21% respectively and for the subsequent financial year of 2007-08, the margin is 3.67%. The aforesaid clearly suggests a wide fluctuation in the m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e an influence on the determination of transfer prices in relation to the tested transaction. We are only pointing out the aforesaid to say that the proposition being canvassed by the Revenue that data of the financial year in which the international transaction has been entered into, alone and alone, is to be used is not an absolute proposition. Needless to say, the objective of carrying out the comparability analysis is to determine the arm's length price of an international transaction by means of examining similarly placed uncontrolled transactions. Therefore, if on facts, it can be established that adoption of a certain comparable would lead to skewed results or that the financial data of a particular comparable is otherwise devoid of credibility, such comparables would deserve to be excluded from the list of comparables even if such an exercise involved examination of data of the comparables for more than one financial year. In the present case, as our discussion in the earlier paras reveal, the profit margin of 34.71% for the year under consideration is an abnormal business trend, and, accordingly the said concern is liable to be excluded. Therefore, we do not find any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of KALS Information System Ltd. and Bodhtree Consulting Ltd. from the final set of comparables. We accordingly, direct the Assessing Officer to re-compute the arm s length price of the transactions of assessee company with its AEs applying the average profit margin of remaining comparables and if the difference between the arm s price length so recomputed and the price actually charged is within the limit of +/- 5%, then no Transfer Pricing adjustment is to be made. The grounds of appeal raised by assessee are thus, allowed for statistical purposes. 36. The other issue remaining for adjudication is the adjustment made in IT enables serviced segment at ₹ 3,04,35,314/-. 37. The assessee was also aggrieved by the selection of certain comparables by the TPO in the ITES segments. The first objection raised by the assessee is against the inclusion of M/s. Coral Hubs Ltd (formerly known as Vishal Information Technologies Ltd.). The plea of the assessee was that the said company, besides providing IT enabled services, also provides diversified activities like data capture and digitalization, data conversion, e-publishing, digital library solutions, fund accounting services, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bunal held that extra-ordinary event like merger and de-merger will have an effect on the profitability of the company in the financial year in which such event takes place. The learned Authorized Representative for the assessee further drew our attention to the list of services provided by the said company and the nature of the activities and the list of products as per the financial statements of the said company placed at pages 505 to 507 of the Paper Book. 41. The learned Authorized Representative for the assessee is also aggrieved by the inclusion of Eclerx Services Ltd. as a comparable. The grievance of the assessee was that the TPO had observed that both BPO and KPO services were similar in nature and hence the said companies were functionally comparable to the assessee. The learned Authorized Representative for the assessee pointed out that the said company was rejected by the TPO in its study relating to assessment year 2008-09 on account of having super profits and the same was also not part of the final set of companies accepted by DRP in assessment year 2008-09. The learned Authorized Representative for the assessee further pointed out that the said company was a Kno ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee were picked up in the TP study and the margins of the said comparables were applied to determine the arm s length price of the transactions of the assessee in ITES segments. The assessee was aggrieved by the selection of the said comparables and the plea of the assessee was that in case said comparables were not included in the TP study, the margins shown by the assessee would be at arm s length. The first comparable referred to by the learned Authorized Representative for the assessee was M/s. Vishal Information Technologies Ltd. The said company was providing IT enabled services and was also engaged in other diversified activities. Further, it has outsourced its services to third party vendor and acted as intermediary between the final customer and the vendor. The assessee on the other hand was engaged in the running of a call centre and was providing technical support to its AEs. We find that the Tribunal in assessee s own case relating to assessment year 2006-07 in ITA No.1346/PN/2010 and in assessment year 2007-08 in ITA No.1605/PN/2011 had excluded the said comparables observing as under: 30. The next point raised by the assessee is against the inclusion of Vishal In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hich breaches the RPT filter. Furthermore, the functional profile of the said concern brought out by the assessee also reveals differentiation in the activity profile. The TPO, in our view, has not appreciated the qualitative difference in the functions performed by the said concern as sought out to be brought out by the assessee. Considering the aforesaid, we therefore, find that the assessee was justified in ascertaining that the said concern be excluded from the list of comparables for the reasons canvassed. Thus, on this aspect assessee succeeds. 46. The Tribunal in the assessee s own case had held that the said concern was found to be operating in different functional environment and the same was excluded for the purpose of comparability analysis. Following the ratio laid down by the Tribunal in assessee s own case in assessment years 2006-07 and 2007-08 (supra), we uphold the plea of the assessee in excluding the margins of the said concern M/s. Vishal Technologies Ltd. 47. The next objection of the learned Authorized Representative for the assessee was with regard to the inclusion of M/s. Accentia Technologies Ltd. which admittedly was engaged in developing its own so ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if the assessee had not challenged the inclusion of the comparable before the authorities below, the same could be challenged before the Tribunal for the first time. Accordingly, we hold that the assessee at this point can raise the said issue. Now, the second part of the objection was that the company had outsourced its vendor and was making high vendor payments as compared to the sales and hence was not comparable. While adjudicating the exclusion of M/s. Vishal Information Technologies Ltd., we have in paras hereinabove already considered this aspect of the companies outsourcing to vendors and held M/s. Vishal Information Technologies Ltd. to be not functionally comparable. Following the same parity of reasoning, we hold that M/s. Cosmic Global Ltd. is not functionally comparable. 52. An ominous objection was raised by the assessee with regard to non-consideration of the following comparables by the TPO:- Sr. No. Company Adjusted OP/TC of comparables considered by Ld. TPO OP/TC of comparables considered by the Assessee 8 Informed Technologies Ltd - ..... X X X X Extracts X X X X X X X X Extracts X X X X
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