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M/s. Kodiak Networks India Private Ltd. Versus The Deputy Commissioner of Income Tax

2015 (5) TMI 367 - ITAT BANGALORE

Transfer pricing adjustment - Computation of Arms Length Price - wrong selection of comparables - Held that:- Kals Information Systems Ltd., Accel Transmatics Ltd., Lucid Software Ltd. and Tata Elxsi Ltd. held to be not comparable with a company engaged in the provision of software development services such as the assessee.

Megasoft Ltd. in the list of final comparables chosen by the TPO is concerned, this Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd.[2013 (1) TM .....

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he (+) (-) 5% range contemplated by the second proviso to Sec.92C(2) 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. - 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, .....

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bled 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 (ALP) in respect of the international transaction of rendering software development services to its Associated Enterprise (AE), the assessee, after making the search on the prowess and capitaline data bases, has selected 49 comparables for the softwa .....

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;s length price (ALP) as follows:- 18.6 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 the taxpayer to its AE(s) is computed as under: Arithmetic mean PLI 20.68% Less: Working capital Adjustment (Annexure-C) 1.55% Adj. Arithmetic mean PLI 19.13% Arm s Length Pri .....

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377; 1,74,97,967 The above shortfall of ₹ 1,74,97,967 is treated as transfer pricing adjustment u/s 92CA. 6. The above adjustment after the directions of the DRP was considered by this Tribunal in ITA No.1413/Bang/2010 in an order dated 27.1.2012. 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 re .....

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see; (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 of the order passed by the AO giving effect to the directions of the Tribunal in .....

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ording to the ld. counsel for the assessee, the provisions of second proviso to section 92C of the Act have not been properly applied by the TPO. 9. In the set aside proceedings, the TPO had chosen 14 comparables. The arithmetic mean of the profit margin of 14 comparables chosen after working the capital adjustment was 18.63%. Based on the above, the TPO computed the adjustment on account of ALP as follows:- Particulars Amount (Rs.) Operating Cost post capacity adjustment 21,67,21,274 Arm s Leng .....

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the transactions by the assessee with its Associated Enterprise (AE). As we have already seen, one of the directions in the order of Tribunal was that the TPO had obtained information while choosing the final set of comparable companies by seeking information u/s. 133(6) of the Act. The Tribunal, after noticing the argument of the ld. counsel for the assessee that the TPO did not confront the assessee with the information obtained by issue of notice u/s. 133(6), directed the TPO in the set aside .....

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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 oppo .....

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nvolves only collection of information. Collection of information cannot be equated with examination of parties. Therefore, no cross-examination is possible so long as examination of parties has not been done. 2. Further, the assessee is declaring the information collected u/s. 133(6) as not reliable on the basis of data available in electronic media such as PROWESS and CAPITALINE databases. It is relevant to submit that the data-base do not claim absolute authenticity. Therefore, how can assess .....

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es had to be sought from the third parties. The questions were forwarded to Kals Information Systems, Megasoft Pvt Ltd, Accel Transmatic Pvt Ltd. The reply sought for has not been provided by Megasoft Pvt Ltd till date. The other two parties Accel Transmatic Pvt Ltd and Kals Information Systems Pvt Ltd had replied which is enclosed as annexure-A to the order for the taxpayer s reference. I propose to pass the order subject to amendment to the Hon ble ITAT s order on the miscellaneous application .....

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ders in various decisions rendered by this Tribunal in the case of IT software development service providers 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 .....

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agraphs. 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 Act, in view of the subsequent decision of the Tribunal on functional comparability of the 5 comparables set out above. It is the further plea of the ld. counsel for the assessee that if the 4 comparables out of 5 ref .....

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ee has given up the assessee's right to agitate the issue with regard to the TPO not having afforded the opportunity to the assessee of cross-examining all the persons from whom TPO obtained information u/s. 133(6) of the Act. 15. The ld. DR, placing reliance on the order of the TPO, submitted that the comparability of 4 companies out of 5 companies pointed out by the ld. counsel for the assessee, has already been adjudicated by this Tribunal. The 5th company viz., Megasoft Ltd. was consider .....

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ut of the 5 comparable companies pointed out by the ld. counsel for the assessee before us, have already been held to be not comparable with a company engaged in the provision of software development services such as the assessee. Following were the relevant observations of the Tribunal in this regard (in respect of comparable companies viz., Kals Information Systems Ltd., Accel Transmatics Ltd., Lucid Software Ltd. and Tata Elxsi Ltd.) in the case of M/S. Sys Arris Software Pvt. Ltd. VS. DCIT I .....

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he 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 .....

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mpany is not comparable. With reference to pages 185-186 of the Paper Book, it is explained 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, et .....

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ained by issue of notice u/s.133(6) of the Act. This information which was not available 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 ser .....

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ns of DRP as extracted by the ITAT in its order are as follows: In regard to Accel Transmatics 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 .....

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e 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 company has related party transactions which is more than the permitted .....

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developer. The Tribunal, in the said decision referred to by the ld. counsel for the assessee, 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. In view of the aforesaid decision of the Tribunal, comparables at Sl.Nos.4 & 13 of the list of comparables chosen by the TPO have to be e .....

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rovider and the Tribunal held as follows:- 7.2 Lucid Software Limited It has been submitted before us 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 respons .....

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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 .....

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In view of the aforesaid decision of the Mumbai Bench of the Tribunal, which is in relation to A.Y. 2007-08, we are of the view that the said company Sl.No.9 of the list of comparable listed by the TPO is to be excluded as a comparable while determining the ALP of the international transaction impugned in this appeal. ………. 17. We are now left with only one comparable company chosen by the TPO viz., TATA Elxsi which is at Sl.No.8 of the list of comparable companies chosen by .....

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comparables for various reasons such as functional dis-similarity significant R & D activity, brand value, size, etc. The TPO, however, rejected the assessee's objections and included the company in the set of comparables. Before us, in this appeal the learned Authorised Representative reiterated that this company is not functionally comparable to the assessee as it performs a variety of activities and functions under the software development and services segment and has drawn our atten .....

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ee, the learned Authorised Representative submits that on perusal of the Annual Report of the company, it can be observed that the software development segment cannot be considered for analysis for the following reasons : (i) As per the Directors Report and the Management Discussion and Analysis, the software development and services segment comprises of three sub-services namely : a) Product Design Services i.e. design and development of hardware and software. b) Innovation Design Engineering i .....

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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 segmen .....

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development services, which is entirely different from the assessee company. We agree with the contention of the learned Authorised Representative that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided 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 .....

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comparable in the case on hand for the period under consideration and therefore direct the TPO to exclude this company from the final set of comparables for the period under consideration. 18. In view of the above, the aforesaid comparable at Sl.No.8 of the list of comparable chosen by the TPO should also be excluded for the purpose of comparison while determining the ALP of the international transaction in question. 17. In view of the aforesaid decisions, we are of the view that the following c .....

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mental 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 .....

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siness of product software (developing software). This company develops packaged products for the wireless and convergent telecom industry. These products are sold as packaged products to customers. While implementing these standardized products, customers may request the company to customize products or reconfigure products to fit into their business environment. Thereupon the company takes up the job of customizing the packaged software. The company also explained that 30 to 40% of the product .....

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% of the overall revenues. The TPO therefore held that 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. Having drawn the above conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. In terms of Rule 10B( .....

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