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2015 (6) TMI 723

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..... d that:- 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. Infosys Technologies Ltd., was excluded for reasons of high turnover and high risk profile. Satyam Computer Services Ltd., has to be excluded from the comparable companies for non-reliability of financial data as it was involved in financial scam as relying on Agnity India Technologies v. ITO [2010 (11) TMI 852 - ITAT DELHI ] . Thus CIT(A) rightly excluded Exensys Software Solutions Ltd., Infosys Technologies Ltd., and Satyam Computers Ltd., from the list of comparable companies. - Decided against revenue. Standard deduction of 5% of the arm’s length price allowed to the Appellant by the CIT(A) - Held 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 t is held that if the difference between the arithmetic mean of the profit margins comparable companies ultimately retained and the profit margin of the Assessee is more than 5% than no deduction under the proviso to Sec. .....

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..... an by excluding the aforesaid companies from the list of comparable. According to the learned counsel for the Assessee, if the submissions of the assessee are accepted, then the arithmetic mean of the comparables retained would be within the range of +/- 5% of the Assessee’s Net Margin Method of computation of deduction u/s.10A - Held that:- Taking into consideration the decision rendered by the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2011 (8) TMI 782 - KARNATAKA HIGH COURT] it is held whatever is excluded from the export turnover should also be excluded from the total turnover for the purpose of computing deduction u/s.10A of the Act. - Decided in favour of assessee. - IT(TP) A No.1302/Bang/2011,C.O.No.92/Bang/2012 - - - Dated:- 11-6-2015 - Shri N.V. Vasudevan and Shri Abraham P. George, JJ. For the Petitioner: Shri C.H.Sundar Rao, CIT-I (DR) For the Respondent: Shri T. Suryanarayana, Advocate ORDER Per N.V. Vasudevan, Judicial Member IT(TP)A.No.1302/Bang/2011 is an appeal by the Revenue against the order dated 14.12.2011 of CIT(A)-IV, Bangalore, relating to AY 2005- 06. The Assessee has filed Cross-Objection, C.O.No.92/Ba .....

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..... st (OP/TC) 12.78% 6. The Transfer Pricing Officer (TPO) arrived at a final set of 17 comparable companies. The set of 17 comparable companies is given as Annexure-I to this order. 7. The assessee raised various objections to the methodology adopted and the reasons assigned by the TPO for rejecting the comparable chosen by the assessee in its TP study. The TPO finally passed an order u/s. 92CA of the Act and on the basis of the profit margins of comparable companies set out in Annexure-I to this order , arrived at arithmetic mean of 24.85% 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:- 19.6 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 26.59% Less: Working capital Adj .....

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..... se of SAP India Pvt. Ltd v. ITO [ITA No. 398/8/2008 and E-gain Communications (P) Ltd. Vs. ITO Ward 1(4), Pune (2008) (23) SOT- 385 (Pune-Trib.). Thirdware Solutions Ltd. also gets excluded by applying RPT filter. (iii) The CIT(A) held that Satyam Computer Services Ltd., has to be excluded 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 Systems (India) Pvt Ltd v. ITO (supra). Infosys Technologies Ltd., get excluded by applying the related party transaction filter also. 9. The CIT(A) also held that the Assessee would be entitled to 5% standard deduction under the proviso to Sec.92CA(2) of the Act. After giving effect to the findings given above, the Arithmetic mean of the profit margins of the four remaining comparable companies viz., Bodhtr .....

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..... the TP Order. (b) Modifying some of the filters applied by the learned TPO in the TP order, without providing an opportunity of being heard to the appellant. (c) Arbitrarily arriving at a set of companies as comparable to the Respondent. (d) Disregarding application of multiple year/prior year data and holding that current year (i.e. Financial Year 2005-06) data for companies should be used for comparability. (e) Upholding the learned TPO s approach of using data as at the time of assessment proceedings. (f) Upholding the approach adopted by the learned TPO of collecting selecting information of the companies exercising power granted to him under Section 133(6) of the Income Tax Act, 1961 ( Act ) that was not available to the Respondent in the public domain. (g) Not providing appropriate adjustment towards the risk differential between the Respondent and the entrepreneurial companies selected as comparables, while determining the arm s length price. 13. We have heard the rival submissions. As far as the grounds of appeal of the Revenue are concerned, ground No.2 with regard to improper application of the RPT filter by the CIT(A), it is not .....

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..... s without any merit. 16. 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. Consequently it is held that if the difference between the arithmetic mean of the profit margins comparable companies ultimately retained and the profit margin of the Assessee is more than 5% than no deduction under the proviso to Sec.92C(2) of the Act could be allowed to an Assessee. 17. In view of the conclusion above that exclusion of comparable companies with RPT of less than zero percent is not valid, and that companies where RPT is less than 15% alone can be considered, then the comparable rejected 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 10 comparable which were rejected on the basis of RPT being more than zero percent, one .....

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..... of software is not capable of being expressed in any generic unit and hence 11 is riot possible to give the information as required by certain clauses of paragraphs 3.4C and 4 D of Part II of Schedule VI of the Companies Act, 1956. The Delhi Tribunal in ITO v. Colt Technology Services India Pvt. Ltd. (judgment dated 23.10.2012 in ITA No. 609I/Del/2011 for the assessment year 2005-06) has held that the said company is not a comparable to the assessee therein which was also in the business of software development. 20. The submissions made by the learned counsel 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 10 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 f .....

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..... el appearing on behalf of the 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 associated enterprise. He submitted that the TPO has allocated the expenditure in the proportion of the revenue of these companies from software services and software products and has adopted the figure as segmental margin of the company and has taken these companies as comparables. He submitted that by taking the proportionate expenditure, the correct financial results would not emerge. He submitted that nothing prevented the Assessing Officer/TPO from obtaining the segmental details from the respective comparable companies before adopting them as comparable companies and before taking the operating margin for arriving at the arms length price. He submitted that whereve .....

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..... velopment of the software products. 26. As far as Flextronics Software Limited is concerned, we find that at page 90 of his Order, the TPO has also observed that the said company has incurred expenditure for selling of products and has incurred R D expenditure for development of the products. The above facts clearly demonstrate that there is functional dissimilarity between the assessee and these companies and without making adjustment 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 companies are to be excluded from the list of comparables. Therefore, we direct the Assessing Officer/TPO to exclude these three companies from the list of comparables. 27. The learned counsel for the Assessee submitted before us that TATA Elxsi Ltd., a comparable .....

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..... a Elxsi Limited. In view of this, Tata Elxsi Limited has informed that it is not fair to use its financial numbers to compare it with any other company. The communication dated 25th August, 2009 to the TPO is placed before us. As this communication was not before the TPO at the time of transfer pricing adjustment we deem it fit and proper to remand this issue also to the file of the TPO to reconsider adopting this company as the comparable in the light of observations of this 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 profits adopted by the TPO pertain to entire software development services or pertain to limited service akin to assessee services. Since, these aspects are not clear from the data furnished before us, we direct the TPO t .....

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..... 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 that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not 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 o .....

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..... e size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able 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 Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of ₹ 1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken i .....

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..... ropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :- (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in subsection (1) shall be applied, for determination of arm s length price, in the manner as may be prescribed: Provided that where more than one price is determined 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 the .....

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..... mount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the 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; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions .....

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..... e 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., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores. 33. Respectfully following the aforesaid decision of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. (supra), we hold that the following companies should be excluded from the list of comparable companies I gate Global Solutions Ltd., Flextronics Software Systems .....

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