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2015 (5) TMI 365 - ITAT BANGALORE

2015 (5) TMI 365 - ITAT BANGALORE - TMI - Transfer pricing adjustment - determination of Armís Length Price (ALP) in respect of international transaction entered into by the Assessee with itís Associated Enterprises (AE) - improper application of the Related Party Transaction (RPT) filter by the CIT(A) as submitted by AO - Held that:- In the cases of 24/7 Customer Pvt. Ltd. (2013 (1) TMI 45 - ITAT BANGALORE ), and Sony India Private Ltd. (2008 (9) TMI 420 - ITAT DELHI-H) and various other cases .....

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Excluding companies with abnormal profits - Held that:- CIT(A) rejected some of the comparable companies chosen by the TPO by applying related party transaction filter. The filter of companies dealing in software products and abnormal profits owing to amalgamation of the companies during the relevant period thereby showing abnormal profits was applied to exclude Exensys Software solutions Ltd., was excluded for reasons of high turnover and high risk profile. Satyam Computer Services .....

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e which were rejected on the basis of RPT being more than zero percent, one comparable viz., Four Soft Ltd., will have to be excluded since the RPT is at 19.89% and thus in excess of 15%. Sathyam Computers Ltd., will get excluded for the reason that the financial results are not reliable. The remaining 10 comparable companies which were excluded by the CIT(A) by applying the Related Party Transaction filter of 0% related party transaction will now have to be included.

Foursoft Ltd., .....

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ed by the TPO.] and Infosys Technologies Ltd.[being a big company in all respects including the range of turnover] be excluded from the list of comparable companies for the purpose of determining the ALP.

Geometric Software Solutions Ltd. - remand the question of excluding this company as a comparable to the TPO. If the RPT is more than 15% of the total revenues than this company should be excluded from the list of comparable companies.

Working capital adjustment - Held th .....

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ored the submissions made by the Assessee regarding non utilization of the advances received for acquiring fixed capital. n our view the submissions made by the Assessee that the advance received from the AE should be considered while working out the working capital adjustment deserves to be accepted, if the Assessee demonstrates that such advances were not utilized for acquisition of fixed assets. If it is so demonstrated, these advances need to be included for working out the working capital o .....

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in Tata Elxsi Ltd. (2011 (8) TMI 782 - KARNATAKA HIGH COURT) held that while computing the deduction under section 10A of the Act, if the export turnover in the numerator is to be arrived at after excluding certain expenditure, then the same expenditure should also be excluded from the total turnover also. Respectfully following the same, we dismiss this ground of revenue and of the view that the CIT(A) has rightly directed the AO to exclude telecommunication charges and travel expenses incurre .....

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dated 5.1.2012 of CIT(Appeals)-IV, Bangalore, relating to assessment year 2005-06. 2. The main issue that arises for consideration in the appeal by the Revenue and by the Assessee are relating to the addition made to the total income consequent to determination of Arm s Length Price (ALP) in respect of international transaction entered into by the Assessee with it s Associated Enterprises (AE) u/s.92 of the Income Tax Act, 1961 (Act). The addition made consequent to determination of ALP by the T .....

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o exclude telecommunication expenses and travel expenses both from the total turnover and export turnover while computing deduction u/s.10A of the Act. The revenue has challenged the said action of the CIT(A) also. Aggrieved by the order of CIT(A) in not applying certain filters while choosing comparable companies the Assessee has filed appeal before the Tribunal. 3. The assessee is a company incorporated on 12th May, 2000 under the Companies Act, 1956. The Assessee is a wholly owned subsidiary .....

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ed by it for services rendered to its AE was at arms length, the assessee filed a report as required by the provisions of section 92E of the Act in Form 3EB together with detailed analysis. The assessee adopted Transaction Net Margin Method (TNMM) as the most appropriate method for determining the ALP. Operating profits to cost was adopted as the Profit Level Indicator ( PLI ). The PLI of the assessee was arrived at as follows: Operating Revenue Rs.21,61,03,704 Operating Cost Rs.19,48,13,252 Ope .....

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nies set out in Annexure-I to this order, arrived at arithmetic mean of 23.45% after working capital adjustment and 26.59% before working capital adjustment. The computation of the ALP by the TPO in this regard was as 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 .....

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as under: Arms Length Price (ALP) At 123.45% of operating cost Rs.24,04,96,960 Price charged in the international transactions Rs.21,61,03,704 Shortfall being adjustment u/s.92CA ₹ 2,43,93,255 The above shortfall of ₹ 2,43,93,255/- is treated as transfer pricing adjustment u/s 92CA. 8. On appeal by the Assessee, the CIT(A) partly allowed the appeal of the Assessee. The following were the key findings of the CIT(A):- (i) Out of the 17 companies chosen by the TPO as the final set of co .....

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17 comparable companies chosen by the TPO, viz., Bodhtree Consulting Ltd., Lanco Global System Ltd., Sankhya Infotech Ltd., Exensys Software Solution Ltd., and Visual Soft Technology Ltd. In coming to the above conclusion, the CIT(A) followed the decisions of this Hon ble Tribunal in the case of Mentor Graphics (Noida) (P.) Ltd. vs DCIT (2007] 109 lTD 101 (Del). (ii) One company, Exensys Software Solutions Ltd., was excluded because it was in multiple activities including software products, sof .....

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ded from comparable companies for non-reliability of financial data. In doing so, the CIT(A) followed the decision of this Hon ble Tribunal in Agnity India Technologies v. ITO (ITA 3856/DeI/2010) and SAP India Pvt. Ltd v. ITO [ITA No. 398/8/2008]. Likewise lnfosys Technologies selected by the TPO, was rejected as a comparable based on high turnover and high risk. In doing so, the CIT(A) followed the decision of this Hon ble Tribunal in Agnity India Technologies v. ITO and Genisys Integrated Syst .....

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ee submitted should be applied in choosing some comparable companies have not been accepted by the CIT(A). 11. The Revenue is in appeal on the following grounds:- (1) the decision of the Hon ble High Court of Karnataka in the case of TATA Elxsi 349 ITR 98 (Karn) wherein it was held that whatever is reduced from the export turnover should also be reduced from the total turnover, has been challenged by the Revenue in higher forums; (2) the learned CIT(A) erred in holding that the TPO erred in not .....

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-tax Act, 1961. 12. The grounds raised by the Assessee in its grounds of appeal are:- (a) Arbitrarily rejecting filters applied by the Respondent while undertaking the TP Study. (b) Modifying filters applied by the learned TPO in the TP order, without providing an opportunity of being heard to the appellant. (c) Disregarding application of multiple year/prior year data for comparability. (d) Upholding the learned TPO s approach of using data available at the time of assessment proceedings. (e) U .....

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with regard to improper application of the Related Party Transaction (RPT) filter by the CIT(A), it is not in dispute before us that this Tribunal, in the cases of 24/7 Customer Pvt. Ltd. (ITA No.227/Bang/2010), and Sony India Private Ltd. reported in (2009) 315 ITR (80) 150 (Del.) and various other cases has taken a view that comparables having RPT of upto 15% of total revenues can be considered. In view thereof, the Revenue s grievance on this issue as projected in the relevant ground has to .....

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the CIT(A). As we have already seen the CIT(A) rejected some of the comparable companies chosen by the TPO by applying related party transaction filter. The filter of companies dealing in software products and abnormal profits owing to amalgamation of the companies during the relevant period thereby showing abnormal profits was applied to exclude Exensys Software solutions Ltd., was excluded for reasons of high turnover and high risk profile. Satyam Computer Services Ltd., has to be excluded fr .....

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puters Ltd., from the list of comparable companies. 15. As regards the standard deduction of 5% of the arm s length price allowed to the Appellant by the CIT(A), which is challenged in ground No.5 by the Revenue before the Tribunal, it is not in dispute before us that in view of the substitution of the Second proviso to Section 92C(2) of the Income-tax Act by the Finance (No.2) Act, 2009, the second ground of appeal (Ground No.3 in the appeal filed by the Revenue) may have to be allowed. Consequ .....

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ed by the CIT(A) on the basis of the said filter will have to be included along with the four comparable retained by the CIT(A). Although 12 comparable which were rejected on the basis of RPT being more than zero percent, one comparable viz., Four Soft Ltd., will have to be excluded since the RPT is at 19.89% and thus in excess of 15%. Sathyam Computers Ltd., will get excluded for the reason that the financial results are not reliable. The remaining 10 comparable companies which were excluded by .....

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d in the business of development of software products & services and training. The company focuses on the development of niche products for the transport and aviation industry. However, segmental information in relation to the above mentioned activities is not available in public domain. Therefore, as Sankhya engages itself in products and services as well as software training, it cannot be considered as a comparable of the Appellant. The products developed and owned by Sankhya are listed be .....

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-toend solution for all Flight Operations. - Sakai CLE : This is a widely used and popular open source LMS used in many leading educational institutions and corporate. The relevant extract from the Annual report substantiating that the company also engages in different activities is reproduced below: 2. Activities The company as engaged in the business of development of Software Products & Services and training. The production of software is not capable of being expressed in any generic unit .....

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nsel for the Assessee are considered. The activities set out above and the decision of the Delhi ITAT rendered in the context of a software development company such as the Assessee makes it amply clear that this company Sankhya cannot be regarded as a comparable. The same is directed to be excluded from the list of comparable companies. 21. The learned counsel for the Assessee submitted before us that two of the comparable companies out of the 12 excluded by the CIT(A) by applying RPT filter and .....

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services by the ITAT Hyderabad Bench in the case of CNO IT Services (India) Pvt. Ltd. (Formerly known as Conseco Data Services (India) Pvt. Ltd.) Hyderabad vs. DCIT, Circle 1(2) Hyderabad, in ITA.No.1280/Hyd/2010 Assessment Year 2005-2006 order dated 12.2.2014. 22. We have considered his submission and find that the ITAT Hyderabad Bench on identical facts, held that the aforesaid two companies viz., Four Soft Ltd., and Thirdware Solutions Ltd., are not comparable companies in Software Developmen .....

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DWARE SOFTWARE SOLUTIONS LIMITED : This company is objected to by the assessee on the reason that the said Thirdware Software Solutions Ltd. is engaged in sale of software licence and related services and not a service provider. Referring to the annual report, it was submitted that this comparable was rejected by the ITAT, Pune in the case of Egain Communications Ltd. This company having revenue from product license and earning extraordinary profit due to intangible owns. 15.6. These three compa .....

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e 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 associa .....

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ve comparable companies before adopting them as comparable companies and before taking the operating margin for arriving at the arms length price. He submitted that wherever the segmental details are not available, then the said companies should not be taken as comparables. For this purpose, he placed reliance upon the decision of the Bangalore Tribunal in the case of First Advantage Offshore Services Pvt. Ltd. vs. The DCIT in ITA.No.1252/Bang/2010 wherein these companies were directed to be exc .....

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f 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 t .....

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Order, the said company has derived income from software licence also and AMCs. 26. As far as Thirdware Software Solution Limited is concerned, we find from the information furnished by the said company that though the said company is also into product development, there are no software products that the company invoiced during the relevant financial year and the financial results are in respect of services only. Thus, it is clear that there is no sale of software products during the year but th .....

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stment 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 compa .....

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rom the list of comparable companies. 24. The learned counsel for the Assessee submitted before us that TATA Elxsi Ltd., a comparable company out of the 12 excluded by the CIT(A) by applying RPT filter and which gets included in the comparable companies because of 15% RPT being adopted as threshold limit for excluding companies for the purpose of comparability. It was his submission that this company will however, have to be excluded as this company was held to be not comparable with an Assessee .....

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I LIMITED : The objection of the assessee is that TATA Elxsi operating two segments -system communication services and software development services. The TPO accepted the software development services segment in his T.P. analysis and assessee s objection is that the software development services segment itself comprises of three subservices namely (a) product design services (b)design engineering services and (c) visual computing labs. It was submitted that these services are not akin to assesse .....

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, the learned Counsel appearing on behalf of the assessee, filed before us the reply of Tata Elxsi Limited to the Addl. CIT (Transfer Pricing), Hyderabad, wherein the concerned Officer has been informed that Tata Elxsi Limited is specialised Embedded Software Development Service Provider and that it cannot be compared with any other software development company. It was submitted that because of the specialisation and also because of diverse nature of its business, it is very difficult to scale-u .....

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his company to the TPO in the case of another assessee. In the result, the Assessing Officer/TPO is directed to reconsider the issue in accordance with law, after affording a reasonable opportunity of being heard to the assessee. Keeping the assessee s objections and the decisions of the Coordinate Bench, prima facie, we are of the view that TATA Elxsi Limited is functionally different and has incomparable size to that of the assessee. Further, we are unable to verify whether the segmental profi .....

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fording reasonable opportunity of being heard to assessee. 26. Though the issue has been set aside to the AO in the aforesaid decision, the ITAT Hyderabad in the case of NTT Data India Enterprise Application Services Pvt.Ltd., ITA No.1612/Hyd/2010 order dated 23.10.2013 and in a subsequent ruling in the case of Invensys Development Centre (India) Pvt.Ltd., ITA No.1256/Hyd/2010 order dated 28.2.2014, held that TATA Elxsi is not functionally comparable with that of a software development service p .....

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engaged in development of niche products, owns brands, intangibles and has huge scale of operations etc., In this regard, the learned counsel for the Assessee relied on the following observations of the Hyderabad ITAT Bench in the case of IVY Computech P.Ltd. Vs. ACIT ITA No.1558/hyd/2010 for AY 05-06:- (f) Bodhtree Consulting Ltd.: The learned AR objecting to the aforesaid company being treated as a comparable submitted that the related party transaction of the aforesaid company being more than .....

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ed AR seeks for exclusion of the aforesaid company is, its related party transaction as a percentage to the total revenue is 34% which is more than the accept/reject matrix of more than 25% fixed by the TPO. It is to be noted that in final filters adopted by the TPO in para 8.7 of his order he himself has excluded companies having RPT of more than 25%. We, therefore, direct the AO to examine this aspect and exclude it from the list of comparables if the assessee's contention is found to be c .....

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extraordinary high turnover of about ₹ 6,859 crores compared to the total turnover of about ₹ 66 crores of the assessee from both the segments and it was contended by the learned AR that under no circumstances Infosys Technologies Ltd. and WIPRO can be treated as comparable to the assessee as it is a giant in the sector of software development and ITES having considerable brand value. The learned DR, on the other hand, while strongly opposing contention of the assessee, submitted tha .....

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the assessee. In support of such contention, the learned AR relied upon the decision of the ITAT Special Bench in the case of Quark Systems (38 SOT 207). We have heard submissions of the parties and perused the materials on record. So far as Infosys Technologies Ltd. is concerned the issue of comparability of the aforesaid company has been considered by different Benches of the Tribunal including the Hyderabad Benches. It is to be noted that the consistent view of different Benches of the Tribun .....

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Infosys Technologies Ltd. as a comparable. However, as held by ITAT Special Bench in the case of Quark Systems Ltd. (supra) merely because the assessee had selected it as a comparable it cannot operate as an estoppel in raising objections with regard to comparability of the aforesaid company. Therefore, keeping in tune with the consistent view of different Benches of the Tribunal in respect of the aforesaid company, we direct the AO/TPO to exclude the aforesaid company from the list of comparab .....

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Data Storage Systems (India) Pvt. Ltd. IT(TP)A.No.1274/Bang/2010 for AY 06-07. It is seen that the aforesaid decision relates to AY 06-07 and we do not know the details of the RPT in AY 05-06. We therefore deem it fit and proper to remand the question of excluding this company as a comparable to the TPO. If the RPT is more than 15% of the total revenues than this company should be excluded from the list of comparable companies. We hold and direct accordingly. 31. According to the learned counsel .....

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this regard is accepted. WORKING CAPITAL ADJUSTMENT : [Ground 2 (g)] 32. The Assessee has pointed out that while working out the adjustment to be made to the profit margins on account of working capital adjustment, the TPO did not take into account the advance received by the Assessee from its Associated Enterprise on the ground that these advances were utilized for acquiring fixed assets. The Assessee pointed out before DRP that the advances were provided to the Assessee by the AE to meet its c .....

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quired out of the business operations and not out of the advances given by the AE. The TPO as well as the DRP did not consider this claim by examining the details furnished by the Assessee but held that the advances received from the AE were utilized for acquiring fixed assets. 33. Before us, the learned counsel for the Assessee reiterated submissions made before DRP. The learned counsel therefore prayed for inclusion of advances received from AE while computing working capital for arriving at t .....

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come to this wrong conclusion without any basis, the TPO has proceeded to ignore the advances received from AE while computing working capital adjustment. In our view such an approach cannot be sustained. Besides the above, the DRP has ignored the submissions made by the Assessee regarding non utilization of the advances received for acquiring fixed capital. Before us the Assessee did not demonstrate regarding the utilization of advances from the AE. In our view the submissions made by the Asse .....

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details to demonstrate its case regarding advances not having been utilized for acquiring fixed assets. The AO/TPO will afford opportunity of being heard to the Assessee and decide the issue in accordance with law. 35. The AO/TPO is accordingly directed to work out the profit margins and working capital adjustment in the light of the directions given above. 36. The Revenue in the grounds of appeal before the Tribunal (Ground No.2 & 3) has also projected its grievance regarding the action of .....

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