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2015 (8) TMI 225 - ITAT BANGALORE

2015 (8) TMI 225 - ITAT BANGALORE - TMI - Transfer pricing adjustment - Computation of Arms Length Price - selection of comparable - Held that:- CIT(A) was justified in applying the turnover filter and excluding companies whose turnover was beyond ₹ 200 Crores.

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 is found to be without any basis and hence dismissed.

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at it cannot be compared with any other software development company.

Thirdware Solutions Ltd., and Geometric Software 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 soft .....

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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 growth rate over the years is also fluctuating to extremes. Further, growth in revenues is not supported by growth in expenses.

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SHRI ABRAHAM P. GEORGE, JJ. For The Revenue : Shri Dr. Shankar Prasad, K., JCIT(DR) For The Assessee : Shri Padamchand Khincha, C.A. Per N.V. Vasudevan, Judicial Member IT(TP)A.No.532/Bang/2013 is an appeal by the Revenue against the order dated 09.01.2009 of CIT(A)-LTU, Bangalore, relating to AY 2005-06. The Assessee has filed Cross-Objection, C.O.No.119/Bang/2015, against the very same order of the CIT(A). 2. The issue that arises for consideration in the appeal by the Revenue and the C.O. by .....

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lowed by the CIT(A), the revenue is in appeal before the Tribunal. Aggrieved by the order of CIT(A) in not applying certain filters while choosing comparable companies the Assessee has filed C.O. 3. The assessee is a wholly owned subsidiary of Kodiak, US. and it provides software development and support services to its AE. The Assessee is a routine service provider for the group. works as a contract software development service provider. During the financial year 2004-05 relevant to the assessme .....

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(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 A .....

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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 24.51% 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:- 17.6 Computation of Arms Length Price: The arithmetic mean of th .....

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ice (ALP) At 125.53% of operating cost Rs.18,36,40,236/- *after excluding the advances written off. 17.7 Price received vis-à-vis the Arms Length Price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length Price as under: Arms Length Price (ALP) At 124.51% of operating cost Rs.18,36,40,236 Price charged in the international transactions Rs.16,23,64,188 Shortfall being adjustment u/s.92CA ₹ 2,12,76,048 …………&hellip .....

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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 .....

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Pune-Trib.). (iii) The CIT(A) held that Satyam Computer Services Ltd.,, L & T Infotech Ltd., Infosys Ltd., Flexotronics Software System (seg) and I gate Global Solutions (Seg.) have to be excluded from comparable companies because these companies had turnover of more than ₹ 200 crores and cannot be compared with the Assessee whose turnover is only ₹ 16.24 Crores (Approx.). In coming to the above conclusion, the CIT(A) placed reliance on the decision of the ITAT Bangalore in the c .....

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In coming to the above conclusion, the CIT(A) placed reliance on the decision of the ITAT Mumbai in the case Telcordia Technologies Pvt.Ltd. Vs. ACIT ITA No.7821/Mum/2011. 8. 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 seven remaining comparable companies viz., Bodhtree Consulting Ltd., Lanco Global Solutions Ltd., Sa .....

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before against the order of the CIT(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). 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 .....

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anies 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 different. 6. The Ld. CIT(A), in facts and circumstances of the .....

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related party transactions on sales. 9. The learned CIT(A) erred in holding that the assessee is eligible for a standard deduction of 5% from the Arm s Length Price (ALP) under the proviso of Section 92C(2) of the Incometax Act. 10. The CIT(A) erred in not appreciating that if any filter or criteria applied by the taxpayer for search of comparables is accepted or any filter or criteria applied by the TPO is relaxed, the entire accept / reject matrix changes resulting in a new comparable set inc .....

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omparables needed to considered in toto. 11. The grounds raised by the Assessee in the cross objection are as follows: 1. The Order of the learned Commissioner of Income Tax (Appeals) - Large Tax Payers Unit, Bangalore [CIT (Appeals)], to the extent prejudicial to the Respondent is bad in law. 2. The learned CIT (Appeals) has erred in confirming the action of the Assessing officer in making a reference to Transfer Pricing Officer for determining the arm s length price without demonstrating as to .....

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ging 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 .....

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spite absence of any defects in the transfer pricing analysis submitted by the Respondent; b. Computing the arm s length price based on the data for the Financial Year 2004-05 of the comparables, which was not available when the Respondent undertook transfer pricing documentation and reporting obligations; c. Adopting onsite in the process of selecting comparables; and d. Adopting companies like Bodhtree Consulting Ltd., Sankhya Infotech Ltd. as comparables even though they are not comparable in .....

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to be credited with a risk premium on this account. 12. We have heard the rival submissions. As far as the grounds of appeal of the Revenue are concerned, ground No.8 with regard to improper application of the RPT filter by the CIT(A), it is not 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 comparable companies having RPT of u .....

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1.49% of sales and therefore it would get included in the list of comparable companies. 13. The learned counsel for the Assessee filed before us a chart showing the percent of RPT to sales in the case of Geometric Software Solutions Co. Ltd. According to him the RPT transactions to sales in the case of this company was 22.52% and the percentage of RPT 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 Asse .....

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ded 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 concerne .....

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ded comparable companies from the final list of comparable selected by the TPO. In the case of Trilogy E-Business Software India (P) Ltd. (supra), this Tribunal on application of the turnover-filter while selecting comparable companies for comparability analysis held as follows: (1) Turnover Filter 11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Q 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by .....

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ld 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 .....

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ts 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 compa .....

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mpared 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. 13. It was further submitted that the TPO s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of ₹ 13,149 crores as compared to ₹ 47.47 crores of Assessee). It was submitted that an appropriate turnover .....

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e 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 is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big comp .....

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cation 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 .....

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T (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 gri .....

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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 profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any .....

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s, being the most appropriate 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 sub-sec .....

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e 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 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 transac .....

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termine 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 Rules, 1962 prescribes rules for Determination of arm s length price under section 92C:- 10B. (1) For the purposes of sub-section (2) of section 92C, the arm s length price in relation to an international transaction shall be determined by any of the following methods, being th .....

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or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount .....

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dged 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 d .....

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)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)reasonably 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 shal .....

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onal transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the t .....

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unsel 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 Q (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 15. .....

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out 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. Consequentl .....

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abad Bench in the case of CNO IT Services (India) Pvt. Ltd. (Formerly known as Conseco Data Services (India) Pvt. Ltd.) Hyderabad vs. DCIT, Circle 1(2) Hyderabad, in ITA.No.1280/Hyd/2010 Assessment Year 2005-2006 order dated 12.2.2014. 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. .....

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software development service. Since company s operations are functionally different as such, the same is not comparable. Further, assessee is also objecting on the basis of intangible scale of operations. 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), Hyder .....

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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 wi .....

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re 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 identical facts and circumstances, we ar .....

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elevant observations of the Tribunal. 22. We have considered his submission and find that the ITAT Hyderabad Bench on identical facts, held that the aforesaid two companies viz., Four Soft Ltd., and Thirdware Solutions Ltd., are not comparable companies in Software Development 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 eTra .....

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s and not a service provider. Referring to the annual report, it was submitted that this comparable was rejected by the ITAT, Pune in the case of Egain Communications Ltd. This company having revenue from product license and earning extraordinary profit due to intangible owns. 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. .....

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lected 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 .....

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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 comparables. 21. The learned D.R. however, supported the Orders of the authorities below. 22. Having heard both the parties and having gone through the material on record, we f .....

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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 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 .....

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any 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 software products. 24. In view of the aforesaid decision, we do not find any infirmity in the action of the CIT(A) in exc .....

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rates 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 an .....

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ed by the learned counsel for the Assessee that Sankhya is engaged in the business of development of software products & services and training. The company focuses on the development of niche products for the transport and aviation industry. However, segmental information in relation to the above mentioned activities is not available in public domain. Therefore, as Sankhya engages itself in products and services as well as software training, it cannot be considered as a comparable of the App .....

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ystem exclusively developed for Airline operations. It is an end-to-end solution for all Flight Operations. - Sakai CLE : This is a widely used and popular open source LMS used in many leading educational institutions and corporate. The relevant extract from the Annual report substantiating that the company also engages in different activities is reproduced below: 2. Activities The company as engaged in the business of development of Software Products & Services and training. The production .....

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rein 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 exclusio .....

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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 including the same as a comparable before the lower authorities, or the assessee had chosen in its TP study a company which it seeks to exclude as a comparable. The Special Bench of Chandigarh Tribunal in DCIT v. Quark Systems P. Ltd. (2010) 38 SOT 307 has held that the Tribunal is a fact finding body and therefore .....

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onsulting Ltd. should not be regarded as a comparable in the case of software development service provider. The ld. counsel for the assessee also brought to our notice that comparability of this company with software development provider was considered by this Tribunal in Mindtech India Ltd. v. DCIT, ITA No.70/B/2014 for AY 2009-10, order dated 21.8.2014 and it was held as under:- 14. The next aspect that was canvassed by the learned counsel for the assessee was with regard to the exclusion of t .....

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in FY 2011-12 and finally touched (-) 9% in FY 2012-13. Our attention was drawn to the fact that the Special Bench of the Tribunal, Mumbai, in the case of Maersk Global Centres (India) P. Ltd., in ITA.7466/Mum/2012, dt 07.03.2014 for AY 2008-09 had an occasion to consider the question as to whether companies having abnormal profits should be excluded as a comparable. The Special Bench took the view that it has to be shown that the high profit margin does not reflect the normal business condition .....

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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 .....

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Revenue from software development is recognised based on software developed and billed to clients. From perusal of the above, it is seen that this entity is engaged in building revenues through Fixed Price Project model. As is a natural corollary in such type of revenue recognition, some part of the expenditure may be booked in one year, for which the revenue may have been recognised in the earlier or subsequent year. Therefore, it is but natural that there is some fluctuation in the profitabil .....

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oftware would be billed in an earlier year but the revenue would be recognized in a subsequent year. It was his submission that this fact is recognized by the DRP in its order. According to him this circumstance would be sufficient to show that the margin reflected of this company does not reflect the normal business condition. 15. The learned DR placed reliance on the reason given by the DRP in its order. 16. We have considered the rival submissions. The Special Bench of the ITAT in the case of .....

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er to establish whether the entities with such high profits can be taken as comparable or not. In the light of the aforesaid decision of the Special Bench and 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 ex .....

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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 over the years. The margins of Bodhtree are consistently changing. This reflects that the revenue recognition policy followed by Bodhtree is not proper and .....

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to exclude Bodhtree Consulting Ltd. in this year is acceptable and accordingly Bodhtree Consulting Ltd. is directed to be excluded from the list of comparable companies. We hold accordingly. 36. The AO is directed to compute the Arithmetic mean 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% .....

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