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2015 (7) TMI 124 - ITAT DELHI

2015 (7) TMI 124 - ITAT DELHI - TMI - Transfer pricing adjustmeent - arm's length price of the international transactions representing software development services provided to the associated enterprises (AE) is determined by applying transactional net margin method (TNMM) - selection of comparable - Held that:- Since the assessee company is engaged in software development services; whereas M/s. Bodhtree Consulting Ltd. was engaged into software product development, we find force in the argument .....

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ch, M/s. Infosys Ltd. is not a valid comparable with the appellant.

M/S THIRDWARE SOLUTIONS assessee is not having any license sale of its products and, the annual report of the Thirdware does not reveal the bifurcation of sale of ₹ 47 crores and ₹ 16 cores from SEZ of STPI Unit. Therefore we direct the exclusion of this company from the list of comparables.

SONATA SOFTWARE - In the instant case, aggregate related party transactions are roughly around 95 crores .....

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rned counsel for the assessee may be taken into account before the TPO decides whether to include the company as comparable or not.

Kals Information System should not be regarded as a comparable as this company was developing software products and not purely or mainly software development service provider.

Treatment of foreign exchange fluctuation gain/loss as operating item - Held that:- As relying on Westfalia Separator India Pvt. Ltd. vs. ACIT [2015 (3) TMI 140 - ITAT D .....

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we read the ratio of the case of Sutlej Cotton (1978 (9) TMI 1 - SUPREME Court) in juxtaposition to that of the Special Bench in case of Prakash I Shah (2008 (8) TMI 387 - ITAT BOMBAY-K ), there remains no doubt that forex gain or loss from a trading transaction is not only an item of revenue nature, but is, in fact, a part of the price of import or value of export transaction, as the case may be. Thus we direct the AO/TPO to treat the foreign exchange gain/loss as an operating item - Decided in .....

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d 20.12.2013 for the Assessment Year 2009-10. 2 In this appeal, the following grounds have been raised by the appellants: 1. That on facts and circumstances of the case and in law, the Assessing Officer ("AO") erred in assessing the total income of the Appellant at ₹ 19,14,56,510/- as against income of ₹ 9,90,640/- returned by the Appellant after making transfer pricing addition of ₹ 19,04,65,871/- in respect of international transaction of software development and ma .....

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3. That on facts and in circumstances of the case and in law, the AO and Dispute Resolution Panel ("DRP") erred in partly confirming the action of the Transfer Pricing Officer ("TPO") in making an addition to the extent of ₹ 19,04,65,871/- to the income of the Appellant without appreciating that the Appellant had computed arm's length price in respect of international transaction entered into by the Appellant with its Associated Enterprise ("AE") using the .....

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iedly rejecting the Transfer Pricing Study of the Appellant and in conducting a fresh benchmarking analysis on the basis of conjectures and surmises. 5. That on facts and circumstances of the case and in law, the AO and DRP erred in confirming the action of the TPO in applying the following filters:- A. Use of only current year (i.e. FY 2008-09) data for comparability despite the fact that at the time of comparison done by the Appellant, the complete data for the FY 2008-09 was not available in .....

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exceeds 25% of the total revenue without appreciating that companies with any related party transactions should have been excluded or else companies with revenue from RPT of more than 10-15% to sales should have been excluded, F. Rejecting companies with employee cost less than 25% of total operating cost, without appreciating that such a filter is not decisive for tracing out service companies since there is no compulsion on companies to necessarily keep personnel on their rolls, G. Rejecting c .....

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operating as entrepreneur companies without appreciating the true nature of services provided by the Appellant and other material facts related to the functional and risk profile of the Appellant. 8. That the AO and DRP erred in confirming the action of the TPO in selecting the following companies which were not functionally comparable to the Appellant for the purposes of benchmarking the international transaction entered into by the Appellant: a) Bodhtree Consulting b) Comp-U-Tech Indian Ltd. c .....

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in confirming and not setting aside the action of the TPO in applying -c. flawed and inconsistent search process for its benchmarking analysis by selecting Bodhtree Consulting Ltd as a comparable company without appreciating the fact that the said company was deleted as a comparable by the Hon‟ble DRP in the case of the Appellant's group company viz Open Solutions Software Services Pvt. Ltd. on the ground of abnormal growth during the relevant previous year. 11. That the DRP erred in n .....

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without appreciating that since the Appellant was eligible to claim deduction under Section IDA of the Act in respect of income from the international transaction entered into between the Appellant and its AE, there was no motive to shift profits outside India by manipulating the prices charged in international transactions, which is a pre-requisite to make any adjustment under the provisions of Chapter X of the Act. 14. That the AO/TPO erred in law in mechanically initiating penalty proceeding .....

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pment and maintenance services to its AE vis. Fiserv Global Services Inc., USA. For this it was compensated based on the terms of the Master Service Agreement entered between both the entities on cost plus 15%. As per the transfer pricing (TP) document furnished for the AY 2009-10, the taxpayer company has entered into the following international transactions with its associated enterprises (AEs) Nature of transaction Value of international Software Development services 204,03,31,108 Liability w .....

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is taken as the profit level indicator (PLI) in the TNMM analysis. The PLI of the company is arrived at 15.00% on cost; whereas the average PLI of the comparables is arrived at 9.54% as per the analysis in the TP document. It is further seen that average Profit Level Indicator (PLI) was directed on the basis of 29 comparables selected by the tax payers. The mean margin of the comparables selected by the assessee as stated above was 9.54% and since the profit margin of the assessee was within +/ .....

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tituted a fresh process and modified the filters and comparable selected by the assessee. Thereafter the TPO selected a list of 13 comparables and proposed an adjustment of ₹ 19,69,44,637/- by computing the mean Profit Level Indicator (PLI) of the comparable companies at 25.78% as against PLI of 15% of the assessee. Thereafter Dispute Resolution Panel (DRP) vide order dated 20.12.2013, upheld the adjustment made by the TPO, subject to the claim of working capital adjustment as per the OECD .....

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ys Ltd. 44.34% 7. Kals Information Systems Ltd. 48.11% 8. LG. G Global Ltd. 14.17% 9. Mindtree Limited 27.27% 10. RS Software India Ltd. 11.67% 11. Sasken Communication Ltd. 16.30% 12. Sonata Software Ltd. 32.07% 13. Thirdware Solution 28.03% 14. Zylog Systems Ltd. 6.52% Average 22.25% 7. As a result of the above, the final assessment was completed vide order dated 24.02.2014, passed u/s 143(3) r.w.s. 144C of the IT Act, 1961 (the Act) assessing the total income of the assessee at ₹ 19,14, .....

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e following comparables from the list which was finally selected by the DRP: a) Bodhtree Consulting Ltd. b) Infosys Ltd. c) Thirdware Solutions d) Sonata Software e) Mindtree Ltd. f) Kals Information Systems; and treatment of foreign exchange fluctuation gain/loss as operating item 9. We have considered the rival submissions and perused the material on record. Taking up the each of the comparables contested and disputed by the appellant in this appeal. BODHTREE CONSULTING LTD: 10. The learned AR .....

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A consulting, CRM consulting, data warehousing and product engineering. It was submitted that merely because one segment of the company is of software development, the same does not entail the company to be used as a comparable. Further it was submitted that M/s Bodhtree collaborates with reputed software vendors of the Silicon Valley for implementation and development of solutions and does not carry out the development themselves. It was submitted that Bodhtree is functionally not comparable an .....

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base) Base Year 195% 100 155% 141% 94% PBIT (increase in % taking FY 2005-06 as the base) Base Year 4998% 35% 441% 71% -8% 10.1 On the basis of above, it was stated that increase in PBIT is 441% for FY 2008-09 whereas the increase in sales is 155%, which indicates that there is a disproportionate increase in the profit of the company, hence the same ought to be rejected.: 10.2 The Ld. AR also draw attention to annual report of Bodhtree for subsequent year where it has categorically mentioned tha .....

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Q. Logic India Pvt. Ltd. vs. DCIT dated 21.10.2014 in ITA No. 27/PN/2014 wherein the said company was excluded as comparable on account of fluctuating margin. Apart from the above, reference was also made to another decision in the case of Mindteck in ITA No. 17/Bangalore/2014 dated 21.10.2014 wherein ITAT has excluded Bodhtree Consulting Ltd. from the list of final comparables on account of fluctuations in margins over the years. 10.3 The ld AR also relied on the decision of the ITAT Bangalore .....

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a coordinate bench of this Tribunal in the case of M/s. Softek India Pvt. Ltd. vs. ITO, ITA No. 222/Bang/2014 for assessment year 2009-10 wherein in an order dated 31.10.2014 it was held as under: 4.3 Having regard to the contentions of the rival parties and also the material on record, we find that the assessee is only a software services company whereas M/s. Bodhtree Consulting Ltd. is also into the business of software product development and segmented data is not available in the public dom .....

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as it is functionally different. 10.6 Also another coordinate bench in the case of Cisco Systems (India) (P) Ltd. vs. DCIT 66 SOT 82 (Bang) has held as under: 26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute that in the list of comparables chosen by the assessee, this company was also included by the assessee. The assessee, however, submits before us that later on it came to the assessee's notice that this company is not being considered as a comparab .....

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e aforesaid decisions, the Tribunal has taken the view that Bodhtree Consulting Ltd. is in the business of software products and was engaged in providing open & end to end web solutions software consultancy and design & development of software using latest technology. The decision rendered by the Mumbai Bench of the Tribunal in the case of Nethawk Networks (P.) Ltd. (supra) is in relation to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumst .....

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actually it is shown that the said company is a software product company and not a software development services company. 10.7 Having considered the above, we hold that since the assessee company is engaged in software development services; whereas M/s. Bodhtree Consulting Ltd. was engaged into software product development, we find force in the argument of the ld counsel for the assessee that M/s. Bodhtree Consulting Ltd. is functionally different from assessee company. 10.8 Accordingly, we dire .....

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P at Page. 150 as under: The objection of the assessee was verified from the Annual report and it is observed that the revenues from software products are only ₹ 848 crores out of its operating revenues of ₹ 20,297/- crores in this regard the following portion of the annual report of the company is relevant Income: (Rs. In crore) % Software Services 19416 95.8 Products 848 4.2 Total 20264 100 Thus, the revenue from software products constitutes only 4.18% of operating revenues for th .....

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. Therefore, this objection of the taxpayer is not acceptable. 11.1 The Ld counsel referred to following distinguishing parameters to submit that M/s. Infosys Ltd. is not comparable with the appellant: Diversified business v. Contract software development Turnover of ₹ 20,264 crores v. ₹ 209.83 crores Significant intangibles of ₹ 1,34,478 crores v. NIL Onsite (49.3) and offshore (50.7) v. Only services from India Sales, advertisement and brand building expenses of ₹ 80 cr .....

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the field of software development services having considerable brand value and assumed all risks related to business. Further, appeal of Revenue against this order has been dismissed by the Hon‟ble Andhra Pradesh High Court vide an Order dated 18.06.2014 in ITA No. 371/2014. 11.3 On the other hand the ld DR relied on findings of DRP. 11.4 We have considered rival submissions, perused the material on the record. In the case of Agnity Technologies, ITA No.3856/Del/2010, a coordinate Bench ha .....

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s seen from the financial data etc. of the two companies mentioned earlier in this order. Therefore, we are of the view that this case is required to be excluded 11.5 The aforesaid order was upheld by the Hon‟ble Delhi High Court after taking note of the chart as given below: Basic Particular Infosys Technologies Ltd. Assessee Risk Profile Operate as full-fledged risk taking entrepreneurs Operate at minimal risks as the 100 percent services are provided to AEs Nature of services Diversifie .....

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(including its flagship banking product suite Finacle ) Onsite vs. Offishore As much as half of the software development services rendered by Infosys are onsite (i.e. services performed at the customer s location overseas). And offshore (50.20 per cent) Refer p. 117 of the Paper Book) than half of its service, income from onsite services The appellant provides only offshore services (i.e. remotely from India) Expenditure on advertising/sales promotion and brand building ₹ 80 crores Rs. Ni .....

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and therefore, do not warrant any different conclusion. The appellant is also captive service provider to its AE and as such, M/s. Infosys Ltd. is not a valid comparable with the appellant M/S THIRDWARE SOLUTIONS: 12. The DRP repelled the objection of the assessee by holding as under: On the perusal of annual report, its clear that this entity is in exports are software services exports. Further, when details of purchase are analyzed, it is seen that majority of expenses are in the form of softw .....

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vices company: As per page 9 of annual report: The company‟s earning are a significant extent export oriented and the company constantly reviewing and augmenting its efforts to increase export of software services and applications to existing and new markets and for this purpose has also drawn long term strategy to strengthen its overseas marketing infrastructure. As per Page 10 of annual report Technology Absorption Adaption and Innovation: Your company will focus on latest development te .....

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23; 1956 As per Page 54 of Annual report 23) Segment reporting The company‟s operation comprises of software development implemention and support services. Software development, implementation and support services are various sub-segments of support services are various sub-segments of software development services only and require employment of software engineers. Hence, this company is valid comparable. 12.1 The ld. counsel for the assessee submitted that Thirdware Solutions Ltd. is func .....

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Reliance was placed on the decision in the case of Carlyl India Advisors vs. DCIT ITA No. 717/Mum/2011 dated 4.4.2012 (pages 940-949 of Paper Book Vol 3) wherein it was held that if reliable segmental data is not available a company cannot taken as comparable. 12.2 It was also submitted that during the year, Thirdware set up a subsidiary in China, which is an unusual event, (page 106 of Appeal documents) and as such it should be excluded from comparables. Reliance was placed on the decision in t .....

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(pages 458 & 474 (Tab 1 of Vol. 4) b) ITA vs. CRM Services : ITA No. 4068/Del/2009 (para 12 (Tab2 of Vol.) c) Delmia Solutions (P) Ltd. vs. DCIT ITA NO. 845/Bang/2011 (para 3.5.2 (Tab 3 of Vol 4) d) LG Soft India Pvt. Ltd. vs. DCIT: ITA ON. 1121/Bang/2011 (para 3.8.2 (Tab 4 of Vol. 4) 12.4 Having considered the rival submission we find that assessee is not having any license sale of its products and, the annual report of the Thirdware does not reveal the bifurcation of sale of ₹ 47 cro .....

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y 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 .....

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e 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 excluded from the list of compar .....

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ctions, 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 the development of software products .....

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jection to include this company was dealt by the TPO as under:- Assessee objected on the use of this comparable on the ground that this comparable fails RPT filter since it is having RPT/sale of>10% and calculated the RPT of 16.20. It has also referred to investment in setting up a company in Dubai which has been taken as an extraordinary event. TPO‟s remarks: The RPT filter has been discussed in the preceding paras. As far investment in the company in Dubai is concerned, the assessee h .....

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er annual report of the company RPT of this company is 14.65% and is within the overall limit of 25%. As per the taxpayer‟s argument of taking the receivable into the calculation of RPT, it is seen that it is balance sheet item. The sonata Software limited has 4 related parties it is seen that the service charge credited in the P&L account of Sonata Software Ltd. is ₹ 243.57 crores. The only related party with which this comparable is having transaction in services is Sonata Info .....

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r receivables or payables have been excluded from the calculation of RPT. This approach of the TPO was well justified in view of the accounting norms. Therefore, the taxpayer‟s contention to exclude Sonata Software Ltd. is rejected. 13.2 The ld. counsel submitted that M/s Sonata Software majorly deals into product, sale, offshore development services and significant related party transactions. The company is also engaged in research and development. It was submitted as under: As per segmen .....

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s it an unviable comparable. It is seen from the annual report that the RPT to sales ratio is more than 40% during the relevant previous year. Therefore, it fails the 25% filter applied by the TPO. 13.3 Having considered the rival submissions, we find that in the instant case, aggregate related party transactions are roughly around 95 crores which is approximately about 40% of the total service income of ₹ 243.57 crores.As such, the said comparable is not a valid comparable and hence is di .....

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Report for FY 2008-09 (Tab 5 of Vol. 4). Refer Capital IQ v. DCIT: (pg 891-916 of paper-book vol.3 @ pg. 907) wherein it is held that extraordinary events will have impact on profitability. Toluna India Pvt. Ltd. (formerly Greenfield Online Pvt. Ltd.) [TS-247-ITAT-2014(DEL)-TP]- Para 27.1, Pg 32 14.1 Having considered the rival submissions, we find that annual report of M/s Mindtree provides as under: 3 Acquisition and amalgamations of TES PV Electronics Solutions Private Limited. On December 17 .....

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tal consideration of ₹ 25,99,25,675 (including direct transactions costs of ₹ 17,62,093/-) were allocated to net assets of ₹ 3,66,89,086 resulting in goodwill of ₹ 22,32,36,589 14.2 It is evident from the annual report that subsequent to the acquisition the company vide a scheme of amalgamation ( the scheme ) approved by the shareholders of the Company in June 2008 proposed to merge MTPL with itself. Approval of Hon‟ble High Court of Karnataka was received in Januar .....

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scheme. b) All the assets and liabilities of MindTree Technologies Private Limited are recorded in the books of the company at their carrying amounts as on April 1, 2008. c) Pursuant to the scheme of amalgamation approved by the Hon‟ble High Court of Karnataka, the goodwill of ₹ 22,32,36,589/- resulting from the amalgamation was set off against the securities premium account of the company. If the treatment specified by AS-14 had been followed, the goodwill balance of ₹ 22,32, .....

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ormation System 15. The DRP repelled the objection of the assessee as under: Annual report of this company is verified, it is seen that schedule 12 of AR shows that main income is from software development services sales, services & training Income from software Development Export 20533880 Translation and Interpretation 166123 Training Receipt 704683 It can be seen from the above, main income is from software development services and the segmental data for the same is available in the annual .....

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CIT: (pg.698-715 of paper-book vol.3 @ pg.704-705 & 713) Witness Systems Software v. DCIT: (pg.716-734 of paper-book vol.3 @ pg.729-730) Trilogy E-Business Software v. DCIT: (pg.735-795 of paper-book vol.3 @ pg.767-768) PTC Software (India) Pvt. Ltd. v. DCIT I.T.A. No.336/PN/2014 dated 31.10.2014 Toluna India Pvt. Ltd. (formerly Greenfield Online Pvt. Ltd.) (TS-247-ITAT-2014(DEL)-TP]- Para 27.1, Pg 32 Planet Online Pvt. Ltd. v. ACIT: ITA Nos. 464 and 608/Hyd/2014 dated 30.01.2015 ITO v. Pran .....

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any 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 report, 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 .....

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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, etc. All these aspects have not been factually rebu .....

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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 service provider. We therefore accept the plea of the As .....

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Labs India Pvt. Ltd. v. ACIT (2010) 6 ITR (Trib) 81 dated 30.08.2010 wherein ITAT held that foreign exchange fluctuations are an integral part of the sale proceeds of the assessee carrying on export business and thus could not be excluded from the computation of the operating margin of the assessee. b) Four Soft v. DCIT (2012) 16 ITR (Trib) 73 (Hyd): c) Capital IQ Information Systems (I) P. Ltd. v. DCIT 25 ITR (Trib) 185 (Hyd) dated 23.11.2012: relied on SAP Labs decision, that foreign exchange .....

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import of diamonds with AEs had nexus with export and import activity e) Curam Software International (P) Ltd. v. ITO: [2014] 149 ITD 458 f) CISCO Systems (India) Pvt. Ltd. v. DCIT (TS-246-ITAT-2014(Bang)-TP] 17. Having considered the rival submissions, we find that the issue is no longer res-integra and stands concluded by the decision of the Coordinate Bench in the case of Westfalia Separator India Pvt. Ltd. vs. ACIT ITA No. 4446/D/02 for Assessment year 2003-04 wherein it has been held as un .....

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akes of the same character as that of the transaction to which it relates. The Special Bench of the Tribunal in the case of ACIT vs. Prakash I. Shah (2008) 115 ITD 167 (Mum) (SB) has held that foreign exchange fluctuation gain is a part of export turnover. Though such decision was rendered in the context of section 80HHC, but the same logic applies generally as well. The essence of the matter is that any gain or loss arising out of change in foreign currency rate in respect of transaction for im .....

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