TMI Blog2015 (5) TMI 367X X X X Extracts X X X X X X X X Extracts X X X X ..... no addition by way of adjustment to ALP can be made. We have already seen that the adjustment to ALP and consequent addition to the total income in ITES segment cannot be sustained. - Decided partly in favour of assessee. - IT(TP)A No.1348/Bang/2014 - - - Dated:- 10-4-2015 - Shri N.V. Vasudevan And Shri Jason P. Boaz JJ. For the Appellant : Shri H. Padamchand Khincha, C.A. For Respondent by : Dr. K. Shankar Prasad, Jt. CIT(DR) ORDER Per N.V. Vasudevan, Judicial Member This is an appeal by the assessee against the order dated 15.9.2014 of CIT(Appeals)-III, Bangalore passed against the order dated 28.2.2013 of DCIT, Circle 11(5), Bangalore u/s. 143(3) r.w.s. 144C r.w.s. 254 of the Act. 2. The brief background and facts circumstances under which this appeal arises for consideration are as follows. 3. The assessee is a company which is engaged in the business of providing software development and IT enabled services. The assessee extends software development services and also extends information technology enabled services (ITES) to M/s Kodiak Networks Inc. USA. 4. Software Development Services Segment: In order to arrive at the Arm s Length Price ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .1.2012. As far as software development services are concerned, the Tribunal set aside the order of the TPO/AO and gave the following directions to be carried out by the AO/TPO:- 7.8 In these circumstances, we are of the considered view that this issue requires to be remitted back to the file of the TPO for fresh consideration with the following directions:- (i) The operating revenue and the operating cost of the transactions relating to associated enterprises only shall be considered; (ii) the comparables having the turnover of morethan 1.00 crore but less than 200.00 crores only shall be taken into consideration; (iii) all the information relating to comparables which were sought to be used against the appellant shall be furnished to the assessee; (iv) the appellant shall also be extended an opportunity to cross examine the parties whose replies are sought to be used against the appellant; (v) to consider the objections of the appellant that relate to additional comparables sought to be adopted by the TPO and pass a detailed order and f) to give the standard deduction of 5% under the proviso to sec.92C(2) of the Act. 7. The present proceedings arise out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmation so obtained and also afford the assessee opportunity to cross-examine the parties, whose comparables were used against the assessee by the TPO. On the above directions, the TPO was of the view that the same is not capable of compliance for the following reasons:- 3. Furnishing of information Cross examination for u/s. 133(6) of the IT Act: The Hon ble tribunal has directed the TPO to furnish information collected u/s 133(6) to the taxpayer according to the principles of natural justice. The Tribunal has further directed that the taxpayer be provided an opportunity to cross examine the party from whom the information has been gathered and used against the assessee. Accordingly the taxpayer has been furnished with the information gathered by the TPO by exercising of powers u/s 133(6) once again. This information had already been given to the taxpayer along with time show cause notice issued. The directions of the Hon ble tribunal in respect of opportunity for cross examination to the taxpayer cannot be complied by the TPO for the following reasons. 1. The Hon ble ITAT in the above mentioned case has directed the AO/TPO to give an opportunity of cross examination ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ers and are therefore functionally dissimilar to an IT software service provider such as the assessee. In this regard, our attention was drawn to several decisions of the Tribunal on the comparable companies, in which the following 5 comparable companies were held to be functionally dissimilar to a company engaged in software development services viz., (1) KALS Infosystems Ltd. (2) Tata Elxsi Ltd. (3) Lucid Software Ltd. (4) Accel Transmatics Ltd. (5) Megasoft Ltd. 12. As far as Megasoft Ltd. is concerned, it was also pointed out that said company was accepted as a comparable for software service development companies, but only in respect of segmental operating margins of software development services rendered by such companies and not margins of the entity as a whole. The decisions relied on by the ld. counsel for the assessee in this regard will be dealt with in the subsequent paragraphs. 13. The ld. counsel for the assessee submitted before us that he does not want to press for adjudication before the Tribunal the issue with regard to the TPO not having afforded opportunity to the assessee to crossexamine the persons who have information u/s. 133(6) of the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nal in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) has taken a view that these companies are not comparable to the software service provider companies. The following are the relevant observations of the Tribunal in this regard:- (d) KALS Information Systems Ltd. 46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both 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 ₹ 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 Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: 16. Another issue relating to selection of comparables by the TPO is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 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 stop for engineers)- training services in hardware and networking, enterprise system management, embedded system, VLSI designs, CAD/CAM/BPO (iv) Accel Animation Studies software services for 2D/3D animation, special effect, erection, game asset development. 4.3 On careful perusal of the business activities of Accel Transmatic Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are product and sale of software service and development. Looking to the fact that it has developed a software product named as Muulam which is used for civil engineering structures and the product development expenditure itself is substantial visa- vis the capital employed by the said 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 sector. Therefore, this company cannot be treated as having same function and profitability ratio. In our view, due to non-availability of full information about the segmental details as to how much is the sale of product and how much is from the services, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case of the assessee. 14. In vie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Design Services i.e. design and development of hardware and software. b) Innovation Design Engineering i.e. Mechanical Design with a focus on Industrial Design; and c) Visual Computing Labs i.e. Animation and Special Effects for Movies and TV. ii) As the software development and services segment comprises of hardware, software and animation services, there is no sub-services break-up / information provided in the Annual Report OR the Databases, the learned Authorised Representative contends that this company should be rejected as a comparable as it is functionally different from the assessee. 15.2 Per contra, the learned Departmental Representative supported the orders of the authorities below on this issue. 15.3.1 We have heard both parties and perused and carefully considered the material on record including the judicial decisions relied upon. From the record, we find that this company is predominantly engaged in product designing services and not purely software development services. The references made to the Annual Report by the learned Authorised Representative show that the segment software development and services relates to design services and are not sim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12 has held had held that only segmental data of the said company should be taken for the purpose of comparison. Following are the relevant observations of the Tribunal:- 37. The next plea of the Assessee is that if at all this company is considered as a comparable then the segmental margin of 23.11% (which is the margin for software service segment) alone should be considered for comparability. On the above submission, we find that the TPO considered the segmental margin (Software service segment) in the case of Geometric, Kals Info systems, R Systems, Sasken Communication and Tata Elxsi. Before DRP the Assessee pointed out that the segmental margin of 23.11% alone should be taken for comparability. The DRP has not given any specific finding on the above plea of the Assessee. Perusal of the order of the TPO shows that the TPO relied on information which was given by this company in which this company had explained that it has two divisions viz., BLUEALLY DIVISION and XIUS-BCGI DIVISION. Xius- BCGI Division does the business of product software (developing software). This company develops packaged products for the wireless and convergent telecom industry. These products are sol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... question as to whether less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO s filter of more than 75% of revenues from software development services. 19. In view of the aforesaid decision of the Tribunal, segmental margins in so far as it relates to providing software services by Megasoft alone should be taken for the purpose of comparison. 20. In the light of discussion above, we are of the view that the adjustment on account of ALP and consequent addition made by the AO to the total income, both in the IT segment with the 10 remaining comparable companies (including segmental margin of Megasoft Ltd.) would be 10.89% after working capital adjustment. The same is given as ANNEXURE-II to this order. The said arithmetic mean of the comparables is within the (+) (-) 5% range contemplated by the second proviso to Sec.92C(2) of the Act and consequently no addition by way of adjustment to ALP can be made. We have already seen that the adjustment to ALP and consequent addition to the total income in ITES segment cannot be sustained. 21. The appeal of the assessee is accordingly partly allowed. Pronounced in the ..... 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