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The Income Tax Officer, Ward 12 (2) , Bangalore and others Versus M/s. Sunquest Information Systems (India) Private Limited and others

2015 (6) TMI 723 - ITAT BANGALORE

Transfer pricing adjustment - CIT(A) allowed partial relief to assessee - selection of comparables - improper application of the RPT filter by the CIT(A) as per revenue - Held that:- It is not in dispute before us that this Tribunal, in the cases of 24/7 Customer Pvt. Ltd. ( 2013 (1) TMI 45 - ITAT BANGALORE), Sony India Private Ltd. reported in (2008 (9) TMI 420 - ITAT DELHI-H ) and various other cases has taken a view that comparables having RPT of upto 15% of total revenues can be considered. .....

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rty transaction filter - Held 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 fin .....

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o.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.92C(2) of the Act could be allowed to an Assessee.

Selection of comparables - Held that:- Having taken note of the difference between the two functions, the Assessing Officer ought not to have taken the companies which are into both the product developm .....

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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 the said company might have incurred expenditure towards the development of the soft .....

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comparables. Therefore, we direct the Assessing Officer/TPO to exclude these three companies from the list of comparables.

TATA Elxsi Ltd.should be excluded from the list of comparable companies as not comparable with that of a software development service provider such as the Assessee.

Gate Global Solutions Ltd., Flextronics Software Systems Ltd., L & T Infotech Ltd. and Infosys Ltd., will have to be rejected applying the upper limit of ₹ 200 crores turnover in view .....

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ion 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 Shr .....

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y 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 TPO and addition on account of transfer pricing adjustment was a sum of ₹ 2,36,04,205. The CIT(A) gave partial relief to the Assessee. Aggrieved by the relief a .....

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s and medical practitioners to effectively manage the complexities in healthcare services. The Assessee is remunerated on a cost plus basis for the software development and support services it provides to its AEs. 4. During the financial year 2004-05 relevant to the assessment year 2005- 06, the only international transaction that took place between the Assessee and its AEs was provision of software development and support services at a price of ₹ 20,88,57,270/-. 5. In support of the asses .....

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erating Expenses Rs.18,51,84,000 Operating Profit (Op.Income - Op.Expenses) ₹ 2,36,73,270 Op.Profit/Total cost (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 .....

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parables). 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 Adjustment (Annexure-C) 1.06% Adj.Arithmetic mean PLU 25.53% Arm s Length Price: Operating Cost Rs.18,51,84,000/- Arms Length Margin 25.53% of the operating cost Arms Length Price (ALP) At 125.53% of operating cost Rs.23,24,61,475/- 19.7 Price received vis-à-vis the Arms Length Price: The price cha .....

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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 comparable companies, the CIT(A) excluded 10 companies for the reason that these companies had related party transaction. The CIT(A) applied the filter of related party transaction by holding that to be chosen as a comparable company, the comparable companies should not have any related party transaction. Therefore even if there is a single related par .....

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TD 101 (Del). (ii) Two companies, Exensys Software Solutions Ltd., and Thirdware Solutions Ltd., were excluded because they were functionally not comparable and were also having abnormal profits. In coming to the above conclusion, the CIT(A) followed the decision of the ITAT Bangalore Bench in the case 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 applyi .....

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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., Bodhtree Co .....

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(A). The Assessee has filed cross objection before the Tribunal to emphasis the stand of the Assessee that some of the filters which the Assessee 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 (ground No.1, 6 and 7 are general and hence not reproduced) as follows-: (2) The learned CIT(A) erred in holding that all companies having related party transactions ought to be excluded as compar .....

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erred in excluding M/S.Infosys Technologies Ltd., as a comparable. (5) The CIT(A) erred in holding that the Assessee is eligible for a standard deduction of 5% from the arm s length price under the proviso to Section 92C(2) of the Income-tax Act, 1961. 12. The grounds raised in the cross objection are as follows (Ground No.1 is general hence not reproduced):- (2) That the learned CIT(A) erred in not entirely deleting the adjustment to the arm s length price made by the learned Assessing Officer .....

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(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 Se .....

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in dispute before us that this Tribunal, in the cases of 24/7 Customer Pvt. Ltd. (ITA No.227/Bang/2010), 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 ground No.2 has to be allowed. It is held that the CIT(A) ought to have adopted a threshold limit of 15% of the total revenue attributable .....

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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. In doing so, the CIT(A) followed the decision of this Hon ble Tribunal in Agn .....

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n the case of Agnity India Technologies v. ITO (ITA 3856/DeI/2010) in coming to the conclusion that Infosys Technologies Ltd., is not comparable for the reason of its size, turnover and brand. The decision of the Tribunal in the case of Agnity India Technologies (supra) has since been confirmed by the Hon ble Delhi High Court. Therefore the grievance projected by the Revenue in this regard is without any merit. 16. As regards the standard deduction of 5% of the arm s length price allowed to the .....

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e 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 .....

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by the CIT(A) by applying the Related Party Transaction filter of 0% related party transaction will now have to be included. Their comparability with the Assessee in terms of other filters will be discussed in the following paragraphs. 18. The learned counsel for the Assessee also seeks exclusion of one comparable chosen by the TPO as a comparable viz., Sankhya lnfotech Limited. Sankhya Infotech Limited ( Sankhya ) 19. It was submitted by the learned counsel for the Assessee that Sankhya is eng .....

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below: (1) SILICONTM Training Suite of Products: The products are a comprehensive enterprise wide training platform that covers the entire spectrum of training in a paperless environment. It comprises of four products:- SILICONTM LMS (Training Management Information - SILICONTM QT (Online Assessment System) - SILICONTM LCMS (Learning Content Management System) - IRMAQTM : This is an integrated resource planning, management tracking system exclusively developed for Airline operations. It is an e .....

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it 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 couns .....

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hich gets included in the comparable companies because of 15% RPT being adopted as threshold limit for excluding companies for the purpose of comparability , viz., Four Soft Ltd., and Thirdware Solutions Ltd., will have to be excluded as these companies were considered as not comparable. These companies according to him, will however, have to be excluded as these two companies were held to be not comparable with an Assessee such as the Assessee in the present case providing software development .....

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t Services companies. The following were the relevant observations:- 15.4. FOURSOFT LIMITED : This comparable is objected on the same reason as this company is involved in product development and owns products namely 4S eTrans and 4S eLog. These products are used in Sun Microsystems Inc, in an Application Verification Kit Certified for Enterprises and assessee have been investing continuously on product developments. Since assessee is in the product development, having I.P. rights, the same is n .....

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. 15.6. These three comparable above Flextronics Software Limited, Foursoft Limited and Thirdware Software Solution Limited were analysed by the Coordinate Bench of the Tribunal in the case of Intoto Software Solutions Pvt. Ltd. (supra) wherein it has been held as under : "23. The other companies which are objected to by the assessee are Flextronics Software Limited, Foursoft Limited and Thirdware Software Solution Limited. As far as these three companies are concerned, the learned Counsel .....

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velopment 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 .....

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s were directed to be excluded from the list of comparables. 23. The learned D.R. however, supported the Orders of the authorities below. 24. Having heard both the parties and having gone through the material on record, we find that the TPO at page 37of his order has brought out the differences between a product company and a software development services provider. Thus, it is clear that he is aware of the functional dissimilarity between a product company and a software development service prov .....

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of expenditure towards the development of software products may differ from company to company and also it may not be proportionate to the sales from the sale of software products. Under section 133(6) of the I.T. Act, the TPO has the power to call for the necessary details from the comparable companies. It is seen that the Assessing Officer/TPO as exercised this power to call for details with regard to the various companies. As seen from the annual report of Foursoft Limited which is reproduce .....

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ts during the year but the said company might have incurred expenditure towards the development 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 companie .....

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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 company 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 for the purpose of .....

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nsidered his submission and find that the ITAT Hyderabad Bench on identical facts, held on comparability of TATA Elxsi Ltd. as follows: 15.7. TATA ELXSI 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 .....

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ons. The coordinate bench in the case of Intoto (supra) considered the issue as under in para 22: "22 Tata Elxsi Limited : As regards this company, 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 devel .....

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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 .....

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he list of comparables. Accordingly, this issue is restored to the file of TPO for examination and to decide in accordance with law and facts, after affording reasonable opportunity of being heard to assessee. 29. 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) .....

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Global Solutions Ltd., Flextronics Software Systems Ltd., L & T Infotech Ltd. and Infosys Ltd., will have to be rejected applying the upper limit of ₹ 200 crores turnover in view of the decision of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. ITA No.1054/Bang/2011. 32. We have considered the submission of the learned counsel for the Assessee and the learned DR. In the case of Trilogy E-Business Software India (P) Ltd. (supra), this Tribunal on application of t .....

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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 that size was an important facet of the .....

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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 affect the relative competitive positions of .....

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ct 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 and the relative economies of scale un .....

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Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet s analysis, the turnover of ₹ 1 crore to ₹ 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 shows that there .....

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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 NAS .....

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ld be taken into consideration for the purpose of making TP study. 15. 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 turnover more .....

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e 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 nonresidents, 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 prof .....

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ssessee 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 performed .....

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ned 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 t .....

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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 materia .....

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ich,- (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; .....

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he 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 ma .....

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ot 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. 19. 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 det .....

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within the category 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 .....

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hold that the following companies should be excluded from the list of comparable companies I gate Global Solutions Ltd., Flextronics Software Systems Ltd., L & T Infotech Ltd. and Infosys Ltd., will have to be rejected applying the upper limit of ₹ 200 crores turnover. Flextronics Software Systems Ltd., was also held to be functionally not comparable with a software development service provider such as the Assessee by the ITAT Hyderabad Bench in the case of CN O IT Services (India) P. .....

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he assessee are accepted, then the arithmetic mean of the comparables retained would be within the range of +/- 5% of the Assessee s Net Margin. Therefore, the other grounds raised in the cross objection not pressed at this stage. He has however sought liberty to urge the said grounds in any future proceeding, appellate or otherwise, and in these proceedings at a future point in time. The prayer sought by the learned counsel for the Assessee in this regard is accepted. 35. Ground No.6 raised by .....

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