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The Deputy Commissioner of Income Tax, Circle 12 (3) , Bangalore Versus M/s. Software AG Bangalore Technologies Pvt. Ltd. and Vica-Versa

2015 (10) TMI 484 - ITAT BANGALORE

Determination of armís length price (ALP) in respect of an international transaction entered into with its Associated Enterprise (AE) - accepting/rejecting certain comparables - Held that:- Bodhtree Consulting Ltd. and KALS Information Systems Ltd. should be excluded from the list of comparable companies for the purpose of determining the ALP. It is also relevant to point out that in the case of CISCO Systems India Pvt. Ltd. (2014 (11) TMI 849 - ITAT BANGALORE) the very same 11 companies had bee .....

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of the CIT(Appeals) shows that none of these contentions have been considered by him. We are, therefore, of the view that the order of CIT(Appeals) on this issue should be set aside and the AO/TPO should be directed to examine the details and arrive at the correct working capital adjustment. We hold and direct accordingly.

Treating foreign exchange gain or loss and provision for bad debts as non-operating in nature and fringe benefit tax as part of operating cost - Held that:- Exchan .....

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e are of the view that the Assessee should be afforded opportunity to explain its position on the above and the AO is directed to consider the same in accordance with law. As far as Fringe Benefit Tax (FBT) is concerned, the same was not considered by the TPO as part of operating cost in the case of comparables and therefore the same should also not be considered as part of operating cost of the Assessee. We hold accordingly and direct the AO to compute the operating cost of the Assessee

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ive of the fact, whether such adjustment is negative or positive. To this extent, we are of the view that the observations of the CIT(Appeals) are incorrect. We have already directed the AO/TPO to work out the proper working capital adjustment. This ground of appeal is therefore treated as allowed for statistical purposes. - IT(TP)A No.1343/Bang/2014, IT(TP)A No.1291/Bang/2014 - Dated:- 4-9-2015 - SHRI N.V. VASUDEVAN, JUDICIAL MEMBER AND SHRI S. RIFAUR RAHMAN, ACCOUNTANT MEMBER For The Appellant .....

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ssee in the matter of determination of arm s length price (ALP) in respect of an international transaction entered into with its Associated Enterprise (AE) under the provisions of section 92 of the Income-tax Act, 1961 [ the Act ]. The Revenue also in its appeal in grounds No.3 to 6 has challenged the order of the CIT(Appeals) insofar it is against the Revenue in the matter of determination of ALP of an international transaction entered into with its AE under the provisions of section 92 of the .....

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he working capital adjustment performed by the learned TPO. 4. The assessee has also filed an application seeking adjudication of an additional ground, which reads as follows:- The learned TPO and the learned AO have erred, in law and in facts, by applying only the lower turnover filter as a comparability criterion and accepting companies having turnover greater than ₹ 200 crores. 5. It has been submitted in the application for admission of additional ground that the application of turnove .....

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ermination of ALP u/s. 92 of the Act, the assessee is entitled to raise any objection. In this regard, reliance was placed on the decision of the Hon ble Supreme Court in the case of NTPC v. CIT, 229 ITR 383 (SC) and Special Bench of ITAT Chandigarh in the case of DCIT v. Quark Systems (P) Ltd., ITA No.100(CHD) OF 2009). 6. We have considered the submissions of the assessee for admission of additional ground of appeal. We are of the view that the question as to whether the aforesaid companies ar .....

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ision of the Special Bench, Chandigarh in the case of Quark Systems (supra) clearly supports the plea of the Assessee. The Special Bench in the aforesaid decision in the case of Quark Systems (supra) has after considering the OECD Commentaries observed as follows:- 35. In para 4.16 of latest report, the OECD provides the following guidelines : "In practice, neither countries nor taxpayers should misuse the burden of proof in the manner described above. Because of the difficulties with trans .....

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th showing that its determination of transfer pricing is consistent with the arm s length principle even where the burden of proof is on the taxpayer, and the taxpayers similarly should be prepared to make good faith showing that their transfer pricing is consistent with the arm s length principle regardless of where the burden of proof lies." 36. The aforesaid decisions and guidelines may not be exactly on identical facts before us but they emphatically show that taxpayer is not estopped f .....

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atics has wrongly been taken as comparable. While admitting additional ground of appeal raised by the assessee to require us to consider whether or not Datamatics should be included in the comparable, we make no comments on merit except observing that assessee from record has shown its prima facie case. Further claim may be examined by the Assessing Officer. This course we adopt as objection to the inclusion of Datamatics as comparable has been raised now and not before revenue authorities. Ther .....

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action between the assessee and its AE are as follows. 9. WebMethods India i.e., the erstwhile name of the Assessee, was incorporated in the year 2004. It provides software development and implementation services to SAG Group, which includes research & development services of all traditional aspects of enterprise application software development such as architecture, design and coding, testing and maintenance. It also provides deliverables covering the entire webMethods suite such as core co .....

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the tested party. 2. In the FAR analysis, the taxpayer company has been characterized as provider of routine software support services to its AE. 3. TNMM was selected as the most appropriate method. 4. The search and databases yielded a set of 21 comparables with an average profit margin @ 14.13% on cost. Hence the margin earned by the taxpayer (as arrived at by the taxpayer) at 14.72% on the total cost was treated as being at arm s length. 11. Out of 21 comparables chosen by the assessee in it .....

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.) Margin 1 KALS Information Systems Ltd. 2,14,04,686 1,87,93813 13.89% 2 Akshay Software Technologies Ltd. 12,23,21,483 11,31,49,350 8.11% 3 Bodhtree Consulting Ltd. 16,05,75,212 9,89,56,821 62.27% 4 R S Software (India) Ltd. 1,49,57,12,634 1,36,01,02,589 9.97% 5 Tata Elxsi Ltd. (segmental) 3,78,43,03,000 3,14,63,15,000 27.91% 6 Sasken Communication Technologies Ltd. (seg) 4,05,31,20,000 3,18,69,97,000 27.91% 7 Persistent Systems Ltd. 5,19,69,10,000 3,67,52,70,000 27.91% 8 Zylog Systems Ltd. 7, .....

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of PLI of the comparables. Based on this, the arms length price of the services rendered by the taxpayer to its AE is computed as under:- Software Development Services Arm s Length mean Margin on cost 24.32% Less: Working Capital Adjustment (Annex c) - 0.02% Adjusted margin 24.34% Operating Cost 28,95,80,735 Arms Length Price (ALP) 124.34% of Operating Cost 36,00,64,686 Price Received 32,84,37,059 Shortfall being adjustment u/s 92CA 3,16,27,627 The above shortfall of Rs.3,16,27,627/- is treated .....

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fosys Ltd., KALS Information Systems Ltd. and Tata Elxsi Ltd. The assessee also challenged the order of the TPO insofar as it relates to action of the TPO in not treating the foreign exchange gain as part of the operating revenue of the assessee and the comparable companies while working out the profit margins of the assessee and the comparable companies. The assessee also challenged the order of TPO in working out the negative working capital adjustment. 15. The CIT(Appeals) upheld the order of .....

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ant observations of the CIT(Appeals):- 10.5.3 Thus, the fundamental principle, emerging is that if an expense has direct nexus with the revenues, it has to be taken as operating cost. Moereover, if foreign exchange gain is considered as a part of operating revenue, it naturally follows that foreign exchange losses have to be considered a part of operating costs. On applying the principles emerging from the orders of the Delhi & Bangalore Benches of the Hon ble Tribunal, the TPO is directed t .....

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ibunal in Exxon Mobil Company India P. Ltd. v. Deputy Commissioner of Income-tax (15 ITR (Trib) 353) has observed :- The other issue is grant of adjustments, i.e, working capital adjustment and risk adjustment while arriving at the arm length price. In this case, the assessee in his transfer pricing study, has not made any working capital adjustment or risk adjustment. The Assessing Officer has, in fact, granted working capital adjustment. When the assessee is confronted with the possible transf .....

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hat no further adjustment is necessary. 104.2. On the basis of the aforesaid line of reasoning, I am of the view that once the AO / TPO has granted working capital adjustment, there is no necessity of providing any further adjustments. But however, in the instant case, it cannot be said that the TPO has provided working capital adjustment. As a matter of fact, he has provided it at (-)3.18% which has increased the arm s length mean margin on cost from 25.05% to 28.22%. Before me, it was argued t .....

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d circumstances of the case and find that the working capital adjustment provided by the TPO has a negative impact on adjusted margin and therefore, it cannot be said that a working capital adjustment has been provided in the positive sense. Hence, the Hon ble Tribunal s ruling will not apply in the instant case. Therefore, in my view, the appellant is entitled to risk adjustment as per prevailing norms which shall be worked out by the TPO and granted to the appellant. It is ordered accordingly. .....

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iven by the assessee, the Revenue has preferred the present appeal before the Tribunal. 19. As far as appeal of the assessee is concerned, it would be appropriate to adjudicate only the additional ground of appeal. It has been the stand of the assessee that turnover filter is an accepted filter and in this regard drew our attention to the decision of the Tribunal in the case of Trilogy e-business Software India Pvt. Ltd. (supra). In the aforesaid decision, this Tribunal has taken the following v .....

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, 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 comparability exercise. It was submitted that significant differences in size of the companies .....

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ing 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 the buyer and seller and therefore comparability. 12. The ICAI TP Guidelines note on this aspe .....

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l, 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 under which they operate. 13. It was further submitted that the TPO s range (Rs. 1 crore to infin .....

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t 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 is a limit for the lower end for identifying the comparables. In such a situation, we are unabl .....

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e down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that t .....

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tice 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 than ₹ 200 crores ought to be rejected as not comparable with the Assessee. 16. The ld. .....

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tion 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 profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arra .....

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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 by such persons or such other relevant factors as the Board may prescribe, namely :- (a) compar .....

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l mean of such prices: Provided further that if the variation between the arm s length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm s length price. (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or d .....

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ot 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: 18. Rule 10B of the IT Rules, 1962 prescribes .....

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tered 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; (iii) the net profit margin referred to in subclause (ii) arising in comparable uncontrolled tr .....

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s established is then taken into account to arrive at an arm s length price in relation to the international transaction. (2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the ris .....

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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 transact .....

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eveals 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 determining the ALP of the international transaction. The disputes are with regard to the comparab .....

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aid 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 the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Globa .....

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viz., Tata Elxsi Ltd., Sasken Communication Technologies Ltd., Persistent Systems Ltd., Larsen & Toubro Infotech Ltd. & Infosys Ltd. 21. We have considered the submissions of the ld. counsel for the assessee and are of the view that in the light of judicial precedent cited by the ld. counsel for the assessee, turnover filter has to be applied in the present case. The assessee s turnover is ₹ 32.84 crores and the assessee cannot be compared with a company whose turnover is more than .....

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on to the ITAT Bangalore Bench decision in the case of CISCO Systems India Pvt. Ltd., IT(TP)A No.271/Bang/2014, order dated 14.8.2014. In this case for the AY 2009-10, the Tribunal considered the comparability of Bodhtree Consulting Ltd. as well as KALS Information Systems Ltd. with a company engaged in the business of software development services. Following were the relevant observations of the Tribunal:- 26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute .....

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TA No.7633/Mum/2012, order dated 6.11.2013. In this case, the Tribunal followed the decision rendered by the Mumbai Bench of the Tribunal in the case of Wills Processing Services (I) P. Ltd., ITA No.4547/Mum/2012. In the 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 .....

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ded as a comparable. In this regards, the fact that the assessee had itself proposed this company as comparable, in our opinion, should not be the basis on which the said company should be retained as a comparable, when factually it is shown that the said company is a software product company and not a software development services company. 26.3 KALS Information Systems Ltd.:- As far as this company is concerned, it is not in dispute before us that this company has been considered as not compara .....

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d in providing training. It was also submitted that as per the annual repot, 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 ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on acc .....

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o 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 rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds. Base .....

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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 Assessee that this company is not comparable. 23. Following the aforesaid decision of the Tribunal in the case of an assessee similarly placed wit .....

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ness profile. 24. The ld. counsel for the assessee further contended before us that the working capital adjustment worked out by the TPO was incorrect and in this regard submitted as follows:- 34. The Appellant wish to submit before your Hon ble member that, we had provided the learned TPO with the detailed updated margin computation along with working capital adjustment for some of the identified companies. 35. The learned TPO has erred, in law and facts, in computing the benefit on account of .....

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pital requirement nor paid any interest. 37. The Appellant wishes to submit that in the circumstances and facts of the case no negative working capital adjustment is warranted as Appellant functions in a risk mitigated environment and is reimbursed on cost plus model by the AEs and is fully funded by the AEs for its working capital requirements. 25. The detailed working capital adjustment is annexed as Annexure-I to this order. It is the limited prayer of the ld. counsel for the assessee that th .....

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the CIT(Appeals), the assessee has also given the details which are enclosed to this order. Perusal of the order of the CIT(Appeals) shows that none of these contentions have been considered by him. We are, therefore, of the view that the order of CIT(Appeals) on this issue should be set aside and the AO/TPO should be directed to examine the details and arrive at the correct working capital adjustment. We hold and direct accordingly. 27. As far as grievance of the Revenue in its appeal is concer .....

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de for exclusion of such expenditure from total turnover. In the absence of a definition for total turnover in section 10A, the normal definition of total turnover has to be adopted and as such the expenses which are reduced from the export turnover in accordance with the specific definition cannot be reduced from the total turnover. 29. On appeal by the assessee, the CIT(Appeals) following the decision of the Hon ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd., 349 ITR 98 (Kar .....

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relating to treating the gain on account of foreign exchange fluctuation as part of the operating revenue for the purpose of working the profit margins, this Tribunal in the case of Trilogy e-business Software India Pvt. Ltd. (supra) has held as follows:- (B) Treating foreign exchange gain or loss and provision for bad debts as non-operating in nature and fringe benefit tax as part of operating cost: As far as foreign exchange gain/loss being considered as not forming part of the operating cost .....

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wing the same, the AO is directed to accept the claim of the Assessee in this regard. As far as provision for bad debts are concerned, the TPO has accepted that the same would be part of operating expenses provided the same is incurred every year for at least three years and the manner in which provision is made is consistent. The Assessee in reply to the query of the TPO on the above aspect has not furnished any details. We are of the view that the Assessee should be afforded opportunity to exp .....

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