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2015 (4) TMI 373 - ITAT BANGALORE

2015 (4) TMI 373 - ITAT BANGALORE - [2015] 39 ITR (Trib) 468 (ITAT [Bang]) - Transfer pricing adjustment - improper selection of comparable - Held that:- Respectfully following the decision of Trilogy E-Business Software India Pvt.Ltd.(2013 (1) TMI 672 - ITAT BANGALORE) we direct that KALS Information Systems Limited and Accel Transmatics Ltd., be excluded from the list of 20 comparable arrived at by the TPO.

Tata Elxsi and Infosys Limited has to be excluded from the list of comparabl .....

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n it was held that where the RPT exceeds 15%, such companies should not be taken as comparable companies. Following the said decision, we hold that said companies should be excluded from the list of the comparable companies chosen by the TPO while working out the ALP.

After excluding the aforesaid comparable from the list of comparable chosen by the TPO, the arithmetic mean of profit margin of the remaining 7 comparable would be 11.30% (unadjusted) and 9.87% after working capital adju .....

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isting unit or the business of the new unit had not commenced prior to registration with the STPI and therefore deduction u/s.10A of the Act ought not to have been denied on the profits of the Bangalore unit. The deduction claimed by the Assessee is directed to be allowed - Decided in favour of assessee.

Exclude telecommunication charges and insurance charges incurred both from export turnover and total turnover - Held that:- Taking into consideration the decision rendered by the Honí .....

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P. Boaz JJ. For the Appellant : Shri T. Suryanarayan, Advocate For the Respondent : Shri Farahat Hussain Qureshi, CIT-II(DR) ORDER Per N.V. Vasudevan, Judicial Member This appeal by the assessee is against the order dated 12.10.2010 of the Deputy Commissioner of Income Tax, Circle 11(2), Bangalore passed u/s. 143(3) r.w.s. 144C of the Act relating to AY 06-07. 2. The Assessee is a leading supplier of high-performance solutions for personal, network access, enterprise, metro switch and corecommun .....

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with an Associated Enterprise (AE) and have to pass the Arm s Length Price (ALP) test as provided u/s.92 of the Income Tax Act, 1961 (Act). In this appeal the dispute is with regard to addition made consequent to determination of ALP and consequent upward revision and adjustment made to the price at which international transactions were carried out by the Assessee with its AE in respect of Software development Services. 3. Financial Results of Cyprus India for the F Y 2005-06 Description Amount .....

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Ltd. 24.67 209.18 7 R.Systems International Ltd. (Seg.) 22.20 79.42 8 Sasken Communications Ltd. (Seg.) 13.90 240.03 9 Tata Elxsi Ltd (Seg.) 27.65 188.81 10 Lucid Software Ltd 8.92 1.02 11 Mediasoft Solutions Ltd 6.29 1.76 12 R S Software (India) Ltd 15.69 91.57 13 S I P Technologies & Exports Ltd 3.06 6.53 14 Bodhtree Consulting Ltd. 15.99 5.32 15 Accel Transmatic Ltd. (Seg.) 44.07 8.02 16 Synfosys Business solutions Ltd. 10.61 4.49 17 Flextronics Software Systems Ltd. 27.24 595.12 18 Lanc .....

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follows:- Computation of Arms Length Price: The arithmetic mean of the Profit Level indicators is taken as the arms length margin. (Please see Annexure B for details of computation of PLI of the comparables). Based on this, the arms length price of the software development services rendered by you is computed as under: Arithmetic mean PLI 20.68% Less: Working capital Adjustment(Annexure-C) 1.31% Adj.Arithmetic mean PLI 19.37% Arm s Length Price: Operating Cost Rs.42,36,90,759 Arms Length Margin .....

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eated as transfer pricing adjustment u/s 92CA. 6. Against the said adjustment proposed by the TPO which was incorporated in the draft assessment order by the AO, the assessee filed objections before the DRP. The DRP rejected those objections and confirmed the transfer pricing adjustment suggested by the TPO. The adjustment confirmed by the DRP was added to the total income of the assessee by the AO in the fair order of assessment. Against the said order of the Assessing Officer, the assessee has .....

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these companies were not functionally comparable. The Chart also gives the cases decided by various Benches of the ITAT where the comparable companies have been held to be not comparable with that of an Assessee providing IT Software development Services. The learned DR placed reliance on the order of the TPO/DRP. We will proceed to consider the comparability of companies chosen by the TPO and listed in para- 4 of this order. 8. The ld. counsel for the assessee brought to our notice that out of .....

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relevant observations of the Tribunal on the aforesaid comparable companies in the case of Trilogy E-Business Software India Pvt.Ltd.(supra): 9. Improper selection of comparables: It was submitted by the learned counsel for the Assessee that the following companies are not functionally comparable with that of the Assessee. a) KALS Information Systems Limited b) Accel Transmission Limited. 10. In this regard our attention was drawn to the decision of the Hon ble ITAT Bangalore Bench in the case .....

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oth software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal s decision of the ITAT in the case of Bindview India .....

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lained 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 conc .....

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in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comp .....

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atics Ltd. the assessee submitted the company profile and its annual report for financial year 2005-06 from which the DRP noted that the business activities of the company were as under. (i) Transmatic system - design, development and manufacture of multi function kiosks Queue management system, ticket vending system (ii) Ushus Technologies - offshore development centre for embedded software, net work system, imaging technologies, outsourced product development (iii) Accel IT Academy (the net st .....

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imation services 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. 49. Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of th .....

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ssee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables. 12. The facts and circumstances under which the aforesaid companies were considered as comparable are identical in the case of the Assessee as well as in the case of Trilogy E-Business Software India Pvt.Ltd. (supra). Respectfully fol .....

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(AY 07-08) wherein on the aforesaid company, the Tribunal held as follows:- 14. As far as comparable at Sl.No.6 & 24 are concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of the Tribunal in the case of Telcordia Technologies India Private Ltd. (supra) wherein on the aforesaid two companies, the Tribunal held as follows:- 7.6 Flextronics Software Systems Ltd. ……….. 7.7.Tata Elxsi Limi .....

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d by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties. 15. In view of the above, the ld. counsel for the assessee fairly admitted that comparable company at Sl.No.6 viz., Flextronics Software Systems Pvt. Ltd. should be taken as a co .....

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holds technology and marketing intangible and is functionally different providing end-to-end solutions encompassing technical consulting, design, development, re-engineering, maintenance, systems integration and package evaluation and implementation. The company generates around 3.96% of its revenue from software products. The relevant observations of the Tribunal in the case of Logical Pvt. Ltd. (supra) were as follows: 13. So also, the comparables listed at Sl.Nos. 10, 14 and 26 have to be re .....

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revenue, stage of business cycle and company s growth cycle. In the case of Infosys, there are huge intangible assets which as per the information provided by the learned AR are valued at ₹ 69,522 crores, which comprises of brand value itself at ₹ 22,915 crores. Based on such fund valuation, the profit of Infosys is predominantly due to its premium branding. It is India s No.2 software service exporter and Third in the World as an IT Service company. It is a giant company which is ev .....

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ity analysis miserably fails in this case. The comparison of function and profile as has been reproduced in para 6(iv) above, mostly shows that the profit level indicators in relation to return of cost, return of sales and return of assets are huge between Infosys and the assessee company and therefore, the Infosys cannot be treated as comparable entity for making comparability analysis with the assessee company. The comparability of lnfosys Technology of the company as that of an assessee has b .....

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the case of the assessee. 16. Respectfully following the decision of the Tribunal referred to above, we direct Infosys Limited should be excluded from the list of comparable companies chosen by the TPO. We order accordingly. 17. As far as comparable companies chosen by the TPO viz., iGate Global Solutions Ltd., Mindtree Consulting Ltd., Sasken Communications Ltd., and Flextronics Software Systems Ltd., are concerned, this Tribunal in the case of Trilogy E-Business (supra) has by applying turnove .....

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transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission .....

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reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:- Size criteria in terms of Sales, Assets or Number of Employees: The size of the transaction in absolute value or in proportion to the activities of the parties might affe .....

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able enterprises. The relevant extract is as follows [on Rule 10B(3)]: Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a ₹ 1,000 crore company cannot be compared with the transaction entered into by a ₹ 10 crore company. The two most obvious reasons are the size of the two companies an .....

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case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet s analysis, the turnover of Q 1 crore to Q 200 crores was held to be proper. The following relevant observations were brought to our notice:- 9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This s .....

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e 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 arc loss making are excluded from comparables, 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 & Br .....

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crores only should be taken into consideration for the purpose of making TP study. It was brought to our notice that the above proposition has also been followed by the Honourable Bangalore ITAT in the following cases: 1. M/s Kodiak Networks (India) Private Limited Vs. ACIT (ITA No.1413/Bang/2010) 2. M/s Genesis Microchip (I) Private Limited Vs. DCIT (ITA No.1254/Bang/20l0). 3. Electronic for Imaging India Private Limited (ITA No. 1171/Bang/2010). It was finally submitted that companies having t .....

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first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm s length price. Sec.92-B provides that international transaction means a transaction between two or more associated enterprises, either or both of whom are nonITA residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the pr .....

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Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm s length price in an international transaction and it provides:- (1) that the arm s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performe .....

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mined by the most appropriate method, the arm s length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm s length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm s length price. (3) Where during the course of any proceeding for .....

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in this behalf; or (c) the information or data used in computation of the arm s length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm s length price in relation to the said international transaction in accordance with sub-sections (1) and (2), on the basis of such mater .....

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h,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (i .....

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e same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm s length price in relation to the international transaction. (2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; .....

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operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to mat .....

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t being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared. A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determin .....

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egory of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., .....

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ollowing companies should be excluded from the list of comparable companies. (1) Flextronics Software Systems Ltd. 595.12 crores (2) iGate Global Solutions Ltd. 527.91 crores (3) Mindtree Ltd. 448.79 crores (4) Sasken Communication Technologies Ltd.(Seg.) 240.03 crores (5) Persistent Systems Limited 209.18 crores. 19. The AO is directed to compute the Arithmetic mean by excluding the aforesaid companies from the list of comparable. 20. The learned counsel for the Assessee brought to our notice t .....

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that this company, besides doing software development services, is also involved in development of software product. The learned AR has tried to distinguish by pointing out that product development expenditure in this case is around 39% of the capital employed by the said company, and, therefore, such a company cannot be considered as tested party. Even as per the information received in response to notice under Section 133(6), the company has described its business as software development comp .....

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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 service sect .....

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tical in the case of the Assessee as well as in the case of Logica Private Ltd., (supra). Respectfully following the decision of the Tribunal referred to above in the case of Logica Pvt.Ltd..(supra), we direct that the said company be excluded from the list of 20 comparable arrived at by the TPO. 22. As far as comparable companies chosen by the TPO viz., Aztec Software Limited and Geometric Software Ltd. (Seg.) and Megasoft Ltd., are concerned, it is not in dispute before us that the related par .....

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the ALP. 23. After excluding the aforesaid comparable from the list of comparable chosen by the TPO, the arithmetic mean of profit margin of the remaining 7 comparable would be 11.30% (unadjusted) and 9.87% after working capital adjustment. The Assessee s profit margin operating profit on cost is 10.15% which is within the + / - 5% range permitted under second proviso to Sec.92CA(2) of the Act and therefore the addition made by the TPO and confirmed by the DRP needs to be deleted. Accordingly t .....

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angalore, which was taken over from Lara Networks, it claimed a deduction of ₹ 2,35,44,629/- u/s.10A of the Act. The said deduction was however disallowed by the AO on the ground that the said unit was formed by reconstruction of an existing unit and that the business of the said unit had commenced prior to registration with the STPI. In doing so, he relied on the assessment orders for the Assessment years 2002-03 to 2004-05. The said assessment orders for AY 02-03 to 04-05 was subject mat .....

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igh Court in ITA Nos.1013 to 1015/2008 dated 7.11.2014. Copies of the order of the Tribunal and the Hon ble High Court were filed before us. In view of the said decision of the Tribunal on identical facts, we are of the view that the Bangalore unit was not formed by reconstruction of an existing unit or the business of the new unit had not commenced prior to registration with the STPI and therefore deduction u/s.10A of the Act ought not to have been denied on the profits of the Bangalore unit. T .....

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