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TMI Blog2015 (1) TMI 868X X X X Extracts X X X X X X X X Extracts X X X X ..... s associated enterprises are as follows: Nature of transactionsValue in Rs. (i) Provision of software development services 23,46,16,590 (ii) Reimbursement of expenses to AE 9,19,228 (iii) Reimbursement of expenses by AE 65,80,319 Total 24,21,16,137 3. With respect to international transactions of reimbursement of expenses to AE of Rs. 9,19,228/- and Rs. 65,80,319/-, the same was accepted by the Department and no TP adjustment was made. With reference to software development services, the bench marking analysis conducted by the assessee is as follows: Particulars Software Development Services Most appropriate method Transactional Net Margin Method ('TNMM') Profit Level Indicator (PLI) used Operating Profit ('OP)/Total cost ('OC)) No of comparable 21 Comparable mean mark-up 9.30% Assessee's mark-up 14% 4. The TPO issued a show-cause notice to the assessee proposing to modify the results of assesee's economic analysis with the results of a search undertaken by himself by applying his own set of quantitative and qualitative filters and rejecting/modifying the filters applied by the assessee. The following filters were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the assessee for the immediately preceding assessment year, namely, AY 2008-09 which were elaborately analysed and decided by the earlier Bench of this Tribunal vide its order in ITA No.5329/Del/2012 dated 31.5.2013. On the other ground, the learned DR submitted that the issues raised by the assessee have since been deliberated by the TPO, AO and DRP in great detailand arrived at a correct conclusion and, therefore, the same require to be sustained in full. 9. We have carefully considered the rival submissions, perused the relevant materials on record, the findings of the earlier Bench of this Tribunal in the assessee's own case (supra). Taking all the facts into consideration, we shall dispose of this appeal, ground-wise as under: Ground No.1: The assessment order passed by the AO pursuant to the directions of DRP was bad in law and void ab-initio. Ground No.2: Both the DPO and the AO erred on facts and in law in confirming the addition to the extent of Rs. 3,18,73,338/- to the income of the assessee as proposed by the TPO/AO in the assessment order u/s 143(3) r.w.s. 144C of the Act by holding that its international transactions do not satisfy the arm's length principle envis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a (i.e., FY 2008-09 data) from sources other than the electronic data-bases, when in fact practically no such other sources were available in case of most companies 13. Similar issue was also before the earlier Bench for adjudication in the assessee's own case for the AY 2008-09. After due consideration of the assessee's submission, the Bench had dismissed the assessee's ground for the following reasons, namely: "13...........we find that as per Rule 10B(4), the data to be utilised and analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into. As per proviso to rule 10D earlier year data can be used in addition to the data pertaining to the relevant financial year only for taking a decision on how much of the factors in earlier years have impact on the profit of the current year for both the tax payer and the comparable. Therefore, it has to be demonstrated as to how the earlier year conditions have influenced the profit of the relevant financial year. Since assessee had not given details in this regard, therefore, the TPO's action was j ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ery small, it is more than likely that the margins well be erratic. The TPO was of the opinion that a company which is very small in size does not have sufficient economic significance that it be used as a bench mark. The assessee objected to the filter on the ground that turnover filter should not be used and if it is used then the high turnover filter should also be used. Ast the time of hearing, ld. Counsel for the assessee did not press for exclusion of companies on the ground of high turnover filter. As far as the assessee's claim for inclusion of comparables where turnover is less than 1 crore is concerned, we do not find any substance in the same because in service sector turnover has no relevance particularly when TNMM method has been selected as the most appropriate method. In the case of companies with low level of sales/operating income, the companies may be operating with altogether different management model including lack of human resources. Therefore, the margin of companies having turnover of less than 1 crore fluctuate to extreme because of the narrow base." 16. Following the findings of the earlier Bench of the Tribunal in the cases of (i) M/s. Haworth India (P) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ich were having turnover of less than Rs. 1 crore instead of Rs. 5 crores. It is ordered accordingly. (ii) With regard to applying of a filter of excluding companies with employee cost of less than 25% of the total cost: "20...........The TPO applied this filter on the ground that the companies which are engaged in software development require a minimum level of expenditure on personnel expenses. He referred to certain judicial pronouncements in support of his contention that expense on personnel being extremely low may lead to the conclusion that company is not engaged in software development. The TPO observed that extremely low expenditure on salary/employee cost is an indication that the company is either into further outsourcing of the work or is a software product developer or a software trading company. The assessee's contention was that there are no general accounting norms that govern the disclosure of employee cost in the profit and loss account. It was, further, contended that some companies may choose to outsource their software development. The claim of the assessee was that there was no comprehensive and exhaustive way in which these expenses can be tracked. The TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ground of appeal." 19. It was submitted by the learned AR that the above issue of excluding companies as comparable on the basis of diminishing revenue/persistent losses etc., though identical to the last years, the assessee had filed an appeal to the Hon'ble High Court u/s 260A of the Act and the Hon'ble Court admitted the plea of the assessee as substantial question of law is involved. However, in order to maintain consistency, we follow the findings of the earlier Bench of this Tribunal in the assessee's own case for the AY 2008-09 and decide the issue against the assessee. Therefore, ground No.3.4.1 is partly allowed since the TPO has been directed to exclude only those companies from the comparable list having turnover of less than Rs. 1 crore instead of Rs. 5 Crores. However, ground Nos.3.4.2 and 3.4.4 are decided against the assessee. Ground No.3.5: Exclusion of companies with export earnings of less than 75% of the operating revenues including certain companies which have earned supernormal profits as compared to the assessee and including volatile/ high profit making companies in the final comparable set for bench-marking a low risk captive unit such as the assessee, thu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xsi 24. The earlier Bench of this Tribunal, for the AY 2008-09 in the assessee's own case, restored the issue of inclusion of these companies to the TPO for de novo consideration. The relevant findings of the Tribunal read as follows: "59. Ground No.3.6 & 3.7 primarily assails the inclusion/exclusion of certain companies on the basis of functions performed, assets employed and risks assumed. In this regard, main contention of ld. Counsel for the assessee is that ld. TPO / DRP have not correctly appreciated the difference in functional profile of companies. He submitted that the distinction has to be kept between the software development service provider and software Product Company. 60. Ld. Counsel vehemently submitted that a software product company cannot be compared with a pure software service provider. He explained that a software product company undertakes all the steps involved in creating software from domain analysis to testing. In this case, intellectual property belongs to the company. The products are sold generally on license basis wherein right to use the software is transferred without giving the source code. However, a pure software development service provider i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th software service provider. This is evident from the fact that TPO while applying the filters had accepted the assessee's filter of rejecting companies undertaking significantly different functions compared to assessee. In para 8(3) o his show-cause notice ld. TPO applied following filter stating as under: '8. However, these are curable defects. This leads us to the next question as to what will be the correct set of filters to be used in your case. Companies in your set were subjected to following filters: (iii) Select companies where the ratio of service income to total income is at least 75%: The use of this filter is to ensure that we choose companies that are primarily in the service sector. The application of this filter will ensure that companies with significant income from manufacturing and trading are not selected. You have argued for placing this threshold at 50%. This will be an inappropriate limit as this will allow companies that have significant incomes from manufacturing and trading activities to be used as comparable. In your case, your entire income is from provision of services. It would not be right to allow you to be benchmarked against a company that has 5 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Persistent Systems Limited: 26. This company was included by the assessee itself as a comparable. However, in view of the order of the Special Bench in the case of DCIT v. Quark Systems (P) Ltd reported in (2010) 132 TTJ (Chd) (SB) 1, the assessee can rescind from its earlier admission provided the assessee is able to point out any material difference with the assessee and comparable companies and suitable adjustment could not be made to iron out the differences. In case of Persistent Systems Limited, the assessee objects to its inclusion for the reasoning that (i) the company derive its income from the sale of software services as well as products, (ii) since the annual report does not provide any further break-up of income into products and services; and (iii) high turnover and also abnormal high profit margin. It was, therefore, contended that Persistent Systems Limited cannot be treated as functionally comparable to the assessee. 27. We have carefully considered the contentions put-forth by the assessee. High turnover and abnormal high profit margin per se cannot be a reason for rejecting a company as comparable, unless, there are other cumulatedreasons which do not satisfy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mplementation and support services are various sub-segments of software development services only and require employment of software engineers."[Source: Page 13 of DRP's directions]. 29. We have carefully considered the contentions of the assessee and also perused the TPO's reasoning and the directions of DRP in rejecting the assessee's claim. In the absence of any documentary materials, the claim of the assessee that the functioning of Thirdware solutions Limited was different from that of the assessee is rejected. We are in agreement with the DRP's observation that'Software development, implementation and support services are various sub-segments of software development services only and require employment of software engineers'.In view of the above, the TPO is directed to include this company as comparable with a rider to exclude the figure of sale and purchase of license. For this limited purpose, this issue is restored on the file of the TPO to carry out the above direction. It is ordered accordingly. (3) TCS: 30. The assessee's objection for the inclusion of this company is that the service and offerings of TCS is wide encompassing IT Solutions and services which includes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see. The service and offerings of TCS was wide encompassing IT solutions and services which included assurance (testing) and systems integrations services, enterprise solutions, IT Infracture services, business process outsourcing, IT enabled services, engineering and industrial services etc. Further TCS was engaged in significant R & D activities which had enabled it to influence customers and facilitate business wins in several verticals. Also TCS had significant intellectual property [IP] which was evident from the annual report, according to which, FY 2008-09 was a watershed year with respect to IP creation in TCS. TCS was also amongst the top reputed software companies in the globe which enabled it to enjoy a greater position in the software market. It had a significant brand value and market leadership position which enabled it to charge premium fee from the clients as against other software service providers. 33. Taking into account the above features, we are of the view that TCS cannot be considered as comparable and, accordingly, the TPO is directed to exclude TCS from the list of comparable. It is ordered accordingly. (4) L & T Infotech& (5) Mindtree: 34. The stand of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e judgment of Hon'ble jurisdictional High Court in the case of CIT v. Agnity India Technologies (P) Ltd reported in (2013) 219 Taxman 26 (Del). In that case, the assessee was a captive Unit providing software services to its associated enterprises. After analysing the issue at length, the Hon'ble Court directed the exclusion of Infosys Limited from the list of comparable which list otherwise included several companies with huge turnovers [including L & T Infotech]. The exclusion of Infosys was ordered by the Hon'ble Court on account of its giant-ness which was, in turn, determined by seeing the cumulative effect of several factors including risk profile, nature of services, turnover, ownership of branded/proprietary products, onsite vs. off-shore services, expenditure on advertisement and R & D etc. The higher turnover was only one of the criterion stand not the sole criteria for the exclusion of Infosys. Therefore, no potentially comparable company can be excluded from the list of comparable simply because of its high turnover. 36. In view of the above facts, we are of the view that the TPO was justified in including L & T Infotech and Mindtree Limited as comparable. It is ordere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s own case for the preceding AY for adjudication. After analysing the issue at length and also taking into account the rival submissions, the earlier Bench had restored the matter to the file of TPO for making the working capital adjustment to the profit margins of comparable subject, of course, to assessee demonstrating that there was difference in the levels of working capital employed viz-a-viz the comparable [Refer: Para 73 on page 54 of Tribunal's order]. 42. In conformity with the findings of the earlier Bench on a similar issue in the assessee's own case (supra), the matter is restored on the file of the TPO for a similar action as directed by the earlier Bench. It is ordered accordingly. Ground No.3.12: Disregarding judicial pronouncements in India in undertaking the TP Adjustment: 43. However, during the course of hearing, no specific argument was put-forth in respect of disregarding of judicial pronouncements in India in undertaking the TP Adjustment. Therefore, this ground was not taken up for adjudication. Ground No.4: DRP and the AO erred in adding FBT paid for computing the book profit u/s 115 JB of the Act: 44. An identical ground to that of the present one was r ..... X X X X Extracts X X X X X X X X Extracts X X X X
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