TMI Blog2015 (8) TMI 225X X X X Extracts X X X X X X X X Extracts X X X X ..... ftware Solutions Ltd. were held to be functionally different from a company rendering software development services thus directed to be excluded as relying on case of Sunquest Information Systems (I) Pvt.Ltd [2015 (6) TMI 723 - ITAT BANGALORE] M/S.Exensys Software Solutions Ltd company has to be excluded for the reason that it is functionally different from a software development service provider such as the Assessee because it operates three business segments viz., provision of software services, BPO services and software products. Sankhya Infotech Limited (‘Sankhya’) company activities set out as compared 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. Bodhtree Consulting Ltd is directed to be excluded from the list of comparable companies as this company has erratic margins and growth over the years. The margins of Bodhtree are consistently changing. This reflects that the revenue recognition policy followed by Bodhtree is not proper and is resulting in consistent change in margins. Further, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... support of the assessee s claim that the price charged by it for services rendered to its AE was at arms length, the assessee filed a report as required by the provisions of section 92E of the Act in Form 3EB together with detailed analysis. The assessee adopted Transaction Net Margin Method (TNMM) as the most appropriate method for determining the ALP. Operating profits to cost was adopted as the Profit Level Indicator ( PLI ). The PLI of the assessee was arrived at as follows: Revenue Rs.16,23,64,188 PBIT Operating Profit (Op.Income Op.Expenses) ₹ 1,48,73,837 PBIT on cost Op.Profit/Total cost (OP/TC) 10.08% 5. The Assessee selected a set of 45 comparable companies and arrived at an arithmetic profit mean margin of 9.97% of those comparables and compared the same with the Assessee s profit margin of 10.08% and claimed that the price paid in the international transaction with AE was at Arm s length. The Transfer Pricing Officer ( TPO ) rejected the TP study as above done by the As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 17 companies chosen by the TPO as the final set of comparable companies, the CIT(A) excluded 2 companies for the reason that these companies had related party transaction of more than 10%. 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 related party transaction of more than 10% of its turnover. By doing so, the CIT(A) excluded Geometric Software solutions co. Ltd., and Foursoft Ltd. From the final list of 17 comparable companies chosen by the TPO as the RPT in these two companies according to the CIT(A) was more than 10% of its turnover. In coming to the above conclusion, the CIT(A) followed the decisions of this Hon ble Tribunal in the case of Sony India Pvt. Ltd. VS. DCIT ITA No.1189/Del/2005, 819/Del/2007 820/Del/2007 Mentor Graphics (Noida) (P.) Ltd. vs DCIT (2007] 109 lTD 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 ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en accepted by the CIT(A). 10. The Revenue is in appeal on the following grounds (relevant grounds relating to TP adjustment) 1. The order of the Learned CIT (Appeals), in so far as it is prejudicial to the interest of revenue, is opposed to law and the facts and circumstances of the case. 2. The learned CIT(A) erred in holding that the size and turnover of the company are deciding factors for treating a company as a comparable and accordingly erred in excluding M/s. Satyam Computer Services Ltd , M/s. Flextronics Software Services Ltd, iGate Global Solutions Ltd, Infosys Technologies Ltd. M/s. L T Infotech Ltd, as comparables. 3. The Ld. CIT(A) erred in rejecting the diminishing revenue filter used by the TPO to exclude companies that do not reflect the normal industry trend. 4. The Ld. CIT(A), in facts and circumstances of the case, erred in holding that M/s. Exensys Software Solutions Ltd. cannot be taken as a comparable being functionally different. 5. The Ld. CIT(A), in facts and circumstances of the case, erred in holding that M/s. Exensys Software Solutions Ltd. and M/s Thirdware Solutions Ltd. cannot be taken as a comparables, being functionally differe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection 133(6) without giving an opportunity to comment on such replies or cross examine the parties involved, thus violating the principles of natural justice; and c. Not appreciating that the charging or computation provision relating to income under the head Profits Gains of Business or Profession do not refer to or include the amounts computed under Chapter X and therefore the addition made under Chapter X is bad in law. 4. The learned CIT(Appeals) has erred in confirming the action of the Assessing officer and Transfer Pricing Officer in: a. Rejecting the transfer pricing analysis undertaken by the Respondent on unjustifiable grounds; b. Rejecting the comparables selected by the Respondent under TNMM on unjustifiable grounds; c. Rejecting Orient Information Technology Ltd., Goldstone Technologies Ltd and Akshay Software Technologies Ltd on the ground that they are predominantly onsite software development companies; and d. Rejecting VJIL Consulting Ltd on the ground that it is functionally different. 5. The learned CIT(Appeals) has erred in confirming the action of the Assessing officer and Transfer Pricing Officer in: a. Conducting a fresh transfer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to sales as given in the order of the TPO in the chart Annexed to this order is wrong. To support his contention, the learned counsel for the Assessee has filed profit and loss account of and schedules forming part of the Profit Loss Account to substantiate his contention as above. We are of the view that this aspect was never raised or considered by the TPO/DRP and therefore the claim made by the Assessee has to be examined by the TPO/AO. Accordingly the issue to determine the correct RPT percentage to sales of this company is remanded to the AO/TPO. If the RPT is found to be more than 15% of sales than this company has to be excluded from the list of comparable companies. It is held that the CIT(A) ought to have adopted a threshold limit of 15% of the total revenue attributable to related party transaction as ground for rejecting comparable companies. Consequently it is held that comparable companies having RPT upto 15% of the total revenues can be excluded. 14. As regards ground No.1 raised by the Revenue the same is general and calls for no specific adjudication. As regards ground No.2 raised by the revenue is concerned, the CIT(A) followed the decision of the ITAT Bangalo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een 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 the buyer and seller and therefore comparability. 12. The ICAI TP Guidelines note on this aspect lay down in para 15.4 that 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 under which they operate. The fact that they operate in the same market may not make them comparable enterprises. The relevant extract 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 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). 16. It was finally submitted that companies having turnover more than ₹ 200 crores ought to be rejected as not comparable with the Assessee. 17. The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than Q 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard. 18. We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en shall be deemed to be the arm s length price. (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that- ( a ) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or ( b ) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in 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 material or information or document available with him: Rule 10B of the IT Rul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g in the markets in which the respective parties to the transactions 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 materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or ( ii)r easonably accurate adjustments can be made to eliminate the material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urnover filter and excluding companies whose turnover was beyond ₹ 200 Crores. 16. As far as ground No.3 is concerned there is no company which was included by the CIT(A) on the basis of the filter of diminishing revenue and therefore the grievance projected by the Revenue in ground No.3 is found to be without any basis and hence dismissed. 17. As regards ground No.9, 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. 18. As regards ground No.7, TATA Elxsi Ltd., has to be excluded as this company was held to be not com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er 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 to examine and in case, the segmental profits of a particular service is not available, then, to exclude the TATA Elxsi Limited from the 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. 19. In view of the aforesaid decision rendered on identic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ftware 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 wherever the segmental details are not available, then the said companies should n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we do not find any infirmity in the action of the CIT(A) in excluding the aforesaid two companies from the list of comparable companies for determining ALP. 25. As far as the comparable company M/Snsys Software Solutions Ltd., is concerned, this tribunal in the case of M/S.Vendio Technologies (I) Pvt.Ltd. IT (TP) A.No.1374/Bang/2011 for AY 05-06 vide para 11.8 of its order dated 19.9.2014 held that this company has to be excluded for the reason that it is functionally different from a software development service provider such as the Assessee because it operates three business segments viz., provision of software services, BPO services and software products. 26. For the reasons given above, we do not find any merit in grounds No.4 to 6 raised by the revenue in its appeal. 27. As far ground No.10 to 12 are concerned, we are of the view that the ground is vague and does not project any real grievance. Neither the TPO or the CIT(A) have carried out any new analysis and the exercise is restricted only to the correctness of the claim of the Assessee and the TPO. The ground of appeal is a general statement with no reference to any particular aspect which changes and results in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee therein which was also in the business of software development. 31. 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. 32. In the C.O. the Assessee has also prayed for exclusion of Bodhtree Consulting Ltd., which was considered as a comparable company by the TPO/DRP. Bodhtree Consulting Ltd. was chosen as a comparable company by the assessee in its TP study and same was accepted as a comparable by the TPO also. Even before the DRP, the assessee did not challenge the inclusion of this company as a comparable. However, in the CO filed before the Tribunal, the assessee has sought to challenge the inclusion of this company as a comparable in ground No.5(d). The law by now is well settled that assessee is entitled to raise an objection regarding comparability at any stage of proceedings and even in a case where the assessee has not raised objection for in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be excluded. Our attention was drawn to the DRP's observation in its order on the issue which is as follows : Bodhtree : The assessee has objected to selection of this entity on the basis of following objections: The entity has fluctuating margins The company is more of a product company rather than software service company. The Panel has considered the objections of the assessee. Insofar as the contention regarding the rejection of this entity on the basis of fluctuating margin is concerned, in order to appreciate the compatibility or otherwise of this entity, it is important to first note that the Indian software industry uses two different models for revenue recognition. The first is the Time and Material (T M) Contracts model in which Customer are billed on the basis of hours worked by the employees of supplier software companies. Hourly rates are agreed on by both parties and are applied to the total hours worked to arrive at the revenue that is to be recognized. The second is the Fixed Price Project Model (FPP). Under the Fixed Price Project Model, the total contract price is agreed upon between the parties. Billing may be done either at the end of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in view of the admitted position that the assessee follows Fixed Price Project model where revenues from software development is recognized based on software developed and billed to clients, there is a possibility of the expenditure in relation to the revenue being booked in the earlier year. The results of Bodhtree from FY 2003 to 2008 excluding FY 2007 as given by the learned counsel for the assessee were also perused. Perusal of the same shows, that there has been a consistent change in the operating margins. The chart filed by the assessee in this regard is given as an annexure to this order. It appears to us that the revenue recognition method followed by the assessee is the reason for the drastic variation in the profit margins of this company. In the given circumstances, we are of the view that it would be safe to exclude Bodhtree Consulting from the final list of comparables chosen by the assessee. We hold and direct accordingly. 33. The ld. counsel for the assessee filed before us a chart showing the fluctuation margins of Bodhtree Consulting Ltd., which are as follows:- 34. As can be seen from the above analysis, this company has erratic margins and growth ..... X X X X Extracts X X X X X X X X Extracts X X X X
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