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2015 (10) TMI 1085 - ITAT DELHI

2015 (10) TMI 1085 - ITAT DELHI - TMI - Transfer pricing adjustment - selection of comparable - Held that:- Aftek Infosys Ltd. - TPO had included this company on account of it dealing in software activity after pointing out that assessee had not been able to establish how the company was functionally different. Thus, it is evident that the functional differences, as pointed out by ld. counsel for the assessee in synopsis, have not been critically examined with reference to the annual report and, .....

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ownership of branded/ proprietary products, it cannot be compared with the assessee because difference in functions performed, asset base and risk assumed by both the companies.

Satyam Computers Services Ltd.- we are in agreement with ld. counsel for the assessee that due to unreliable financial data of Satyam Computers Services Ltd., which is in public domain now, the company cannot be considered as a comparable to the assessee

Xansa India Ltd.- no plea was taken before ld .....

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before us needs to be examined by ld. TPO because assessee itself had taken into consideration this comparable.

Ecosoft Technologies Ltd. - this company was rejected since data for current year was not available. As now the current year’s data is available, so matter may be restored back to the file of ld. CIT(A).

Compudyne Winfosystems Ltd -CIT(A) has not considered the segmental results of the software development unit. The assessee has filed the annual report of this com .....

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y assessee and, therefore, the matter needs to be examined afresh by ld. CIT(A). Accordingly, we set aside this issue to the file of CIT(A) for decision afresh.

Adjustment on account of risk environment - CIT(A) held that TPO had committed an error by allowing downward adjustment of 20% in an ad hoc fashion - Held that:- No interference is called for in the order of ld. CIT(A) on this count because assessee failed to propose the necessary adjustment by filing a scientific methodology .....

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o be considered as part of export turnover. In the result, this ground is allowed.

Disallowance of leave encashment - Held that:- In view of clause (f) of section 43B, assessee’s claim will be disallowed as the same had actually not been paid by the assessee. The assessee had merely made a provision for payment of leave encashment. - Decided against assessee.

Disallowance of foreign exchange fluctuation loss - Held that:- In case of the revenue items falling under section 3 .....

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fore, an enterprise has to report the outstanding liability relating to import of raw materials using closing rate of exchange. Any difference, loss or gain arising on conversion of the said liability at the closing rate, should be recognized in the profit and loss account for the reporting period. See CIT Vs. Woodward Governor India (P) Ltd. [2009 (4) TMI 4 - SUPREME COURT] - Decided in favour of assessee. - ITA no. 2297 & 2298/Del/2008, ITA no. 2244 & 2245/Del/2008 - Dated:- 9-9-2015 - SHRI S. .....

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together and are being disposed of by this consolidated order, for the sake of convenience. ITA no. 2297/Del/08 (assessee s appeal for AY 2003-04): Following grounds are raised: 1. That on the facts and in the circumstances of the case and in law, the orders passed by the Ld. Deputy Commissioner of Income-tax ('Ld. AO') and the Ld. Commissioner of Income Tax (Appeals) [CIT(A)]. are bad in law and void ab- initio. 2. That the Ld. CIT(A) grossly erred on facts and in law by concluding tha .....

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al adjustment of ₹ 11,26,75,000 made by the ld. Transfer Pricing Officer (TPO) to the arm's length price on providing of software services and other services declared by the appellant in respect of the international transactions entered into by it with overseas associated enterprises (AEs). 4. That the Ld. CIT(A) grossly erred on facts and in law in: (a) rejecting the 'TNMM' analysis undertaken by the appellant using multiple year data to substantiate that its international tra .....

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appellant as com parables on erroneous and inconsistent reasons; (d) resorting to arbitrary addition of certain companies as comparables, without undertaking a detailed stepby- step scientific search, and further, without appreciating the fact that those companies were not only functionally incomparable but some were also characterized by presence of related party transactions; (e) failing to appreciate that the appellant (being a captive service provider) operates in a near risk-free environmen .....

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percent) is more than the operating profit margin earned by several com parables (forming part of the final set derived by the Ld. CIT(A) himself vide Annexure V of his impugned order), the appellant's 'international transactions' with its 'associated enterprises' are at arm's length. 5. That the Ld. CIT(A) grossly erred in law and on facts by confirming the action of the Ld. AO of not providing any reasons for not accepting the appellant's objections to the order of .....

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ction of the Ld. AO of reducing the deduction claimed by the appellant under section 10A of Act to ₹ 12,56,84,892 as against ₹ 12,60,73,272 thereby reducing the deduction by ₹ 3,88,340 on erroneous and untenable grounds. 8. That the Ld. CIT(A) erred in facts and in law in not appreciating that other incidental services are inextricably linked with IT-enabled services provided by the appellant to its customer, and are covered by notification SO/890(E) dated September 26, 2000, w .....

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2 ITR 470 wherein the Hon'ble High Court struck down the provision of section 43B(f) by holding it invalid and ultra vires. 2. For A.Y. 2003-04, the assessee had filed return declaring total income of ₹ 4,12,10,285/-. The AO determined the total income at ₹ 19,12,29,580/-, after making following additions: Under statement of value of transactions with AEs 11,26,75,000 Disallowance u/s 43B - Leave Encashment 53,08,491 Disallowance u/s 43B- PF Dues etc. 97,50,204 Disallowance on a/ .....

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rdware and software development and training). The assessee was primarily undertaking contract software designing and development for Lucent Group and, thus, functioning as a captive software development centre for its AEs. Brief facts as regards the addition of ₹ 11,26,75,000/- were like this: 3.1. The major international transactions reported in form 3CEB were as under: S. No. International transactions Method Value (in thousand rupees) 1 Purchase of fixed assets TNMM 146.45 2 Sale of so .....

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was taken at OP/TC. On these aspects there is no dispute between the assessee and the department. Ld. TPO noticed from the TP document that assessee prepared a list of comparables comprising of 43 companies, the OP/TC of which were arrived at 13.89% whereas the assessee s PLI was 8.80%, which was within ± 5% of the ALP. 3.3. Ld. TPO examined the comparables selected by assessee and noticed that some of them were not functionally comparable to the assessee and, therefore, issued a show ca .....

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ng the assessee s reply, ld. TPO rejected 7 companies from the comparables selected by the assessee in its TP report for the following reasons: S. No. Name of the company Reasons for Exclusion 1 Escosoft Technologies Ltd. The company has expertise in application development, facilities management, ERP, EMS, e-Business and IT outsourcing. The functions of the company are varied and not comparable to those of the assessee. 2 ORG Informatics Ltd. The object of the company is related to manufacture .....

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elematics Ltd. The company is a leading manufacturer of computer peripherals like keyboards, printers etc. The company also deals in embedded software. Accordingly, this cannot be compared with the assessee company. 5 Thermax Systems & Software Limited The assessee could not provide any details regarding the activities except a general comment about the business of software development. 6 Zenith Global Consultants Limited The company provides customized training software and is focused in th .....

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margin of 23.54%. After considering the assessee submission that it was a risk mitigated company, being captive service provider, allowed 20% deduction out of the mean OP/TC determined at 23.54% and thus arrived at a mean OP/TC at 18.83%, applying the same, the ALP was determined at ₹ 13,34,361,000 as against the declared value of ₹ 122,16,86,000/- and, therefore, there was upward revision of the income by ₹ 11,26,75,000/-. 3.7. All these additions were assailed before ld. CIT .....

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the ground that they had substantial related party transactions. 3.8. Ld. CIT(A) had retained only Aftek Infosys Ltd. 18 companies had been rejected by ld. CIT(A), though there was agreement between the assessee and the TPO regarding their comparability with the assessee. Ld. CIT(A) also confirmed the rejection of 7 companies which were considered by the assessee in its TP documentation but were rejected by ld. TPO in the TP order on the basis of final set of 18 companies, the OP/.TC margins of .....

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,,376/-. 3.9. As regards other additions made by AO on corporate issues, we will consider the same after disposing of the grounds raised by assessee in regard to TP issues. 4. The assessee has raised TP issues from ground no. 1 to 6 out of which ground no. 1 is general and, therefore, does not require any adjudication. Ground nos. 2,3 and 5 were not pressed at the time of hearing. Accordingly, the same are rejected. The assessee has, therefore, primarily assailed the finding of ld. CIT(A) in reg .....

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on of the functional and risk profile of the assessee vis a vis Aftek Infosys Ltd., as given in the synopsis, was as under: Basis/ Particular Aftec Infosys Ltd. Appellant Risk Profile Operate as full fledged risk taking entrepreneurs Operates at minimal risks as the 100% services as provided to its AE Nature of Services The company is engaged in development of software products Software Development Services only Revenue from products ₹ 30.79 crores NIL- As the company is a software develop .....

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itted that the matter can be restored back to the file of TPO for examination of factual aspects. 5.4. Ld. DR submitted that the matter may be restored to the file of ld. CIT(A) to find out correct position. 5.5. Having heard both the parties, we find that ld. TPO had included this company on account of it dealing in software activity after pointing out that assessee had not been able to establish how the company was functionally different. Thus, it is evident that the functional differences, as .....

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sys Technologies Ltd. - In the list of 41 comparables, finally selected by ld. CIT(A), Infosys Technologies Ltd. was included, inter alia, pointing out that there was agreement between TPO and the assessee on this comparable. 6.1. Ld. counsel pointed out that the comparison of the functional and risk profile of the assessee vis a vis Infosys Technologies Ltd., is as under: Basis/ Particular Infosys Technologies Ltd. Appellant Risk Profile Operate as full fledged risk taking entrepreneurs Operate .....

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erives substantial portion of its revenue from sale of its proprietary products (including its flagship banking product suite Finacle ). As per the annual report of the company, it ahs intangibles assets worth approx. ₹ 30,75 Crores for the period ended March 31,2003. No Intellectual property Rights ( IPR or IPRs ) Expenditure on Advertising/ Sales promotion and brand building ₹ 30.55 crores Nil (as all the software development services are rendered to the AEs only) Expenditure on Re .....

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nctions performed, asset base and risk assumed by both the companies. 6.4. We may observe that merely because the assessee in the TP study had included the comparable, which was accepted by TPO, it does not follow that the assessee cannot resile from its original claim at a later stage of proceeding , if it can demonstrate that a company has to be excluded because its FAR analysis clearly shows that it is not comparable to the listed party. Accordingly, we direct exclusion of this comparable. 7. .....

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the assessee that due to unreliable financial data of Satyam Computers Services Ltd., which is in public domain now, the company cannot be considered as a comparable to the assessee. 8. Xansa India Ltd. : Ld. counsel for the assessee submitted that this company could not be included in the final set of comparables because it has a significant RPT/ Sales ratio of 100.45%. 8.1. Ld. counsel very fairly contended that no plea was taken before ld. CIT(A) on the basis of RPT, but now this objection ha .....

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t between the TPO and the assessee. He submitted that this company is a software product development company, offering products such as its interoperable instant messaging platform known as Mundu to various customers across the world. In this regard he referred to the annual report for F.Y. 2002-03. He further pointed out that this company owns intellectual property rights for its products, which is also evident from the annual report. 9.1. Ld. counsel pointed out that apart from owning software .....

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ces Ownership proprietary products The company owns propriety products such -Mundu and Imaround Engaged in contract Software Development. 9.2. Ld. CIT(A) confirmed the TPO s action observing that the annual report for the FY 2002-03 submitted by the assessee clearly showed that the financial data of the company is available which confirmed that the OP/TC ratio was 74.55%. Since this comparable was chosen by assessee, therefore, ld. CIT(A) rejected the assessee s contention. 9.3. However, now ld. .....

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ision afresh in accordance with law. 10. Ld. counsel for the assessee submitted that the following comparables, which were selected by assessee, were not included by TPO and confirmed by ld. CIT(A): - Ecosoft Technologies Ltd. - Compudyne Winfosystems Ltd. - Orient Information Technology Ltd. 10.1. Ld. counsel pointed out that Ecosoft Technologies Ltd. was rejected since data for current year was not available. He submitted that now the current year s data is available, so matter may be restored .....

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jected on account of non-availability of financial data. 10.3. As far as observation of ld. CIT(A) confirming the TPO s action on the basis of functional profile are concerned, we find that the comparable Ecosoft Technologies Ltd. had expertise in application development, facilities management, ERP, EMS, e-Business and IT Outsourcing. The assessee was also engaged in the business of development of software, subcontracting and exports system engineering services, technical services including syst .....

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ble in annual report and the findings of ld. CIT(A) were not factually correct. 11.1. Having heard both the parties, we find that ld. CIT(A) has rejected this comparable, taking note of the fact that the details of related parties transactions are not available and has observed as under: There was agreement between the appellant and the TPO regarding inclusion of this company as a comparable. It has been submitted by the appellant that there is no information regarding related party transaction .....

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y is different from the appellant. Therefore, the company is to be rejected as a comparable. 11.2. From the above observation it is evident that ld. CIT(A) has not considered the segmental results of the software development unit. The assessee has filed the annual report of this comparable for FY 2002-03 in the paper book, wherein we find that in the entertainment division and analysis specific segmental details regarding software development, revenue earning and segment-wise results have been g .....

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itted that the details pertaining to related party transaction are not available. A perusal of the annual report for the FY 2002-03 submitted by the appellant, however reveals that the financial results bare available only on a consolidated basis including the results of its subsidiaries. Further, the profit before tax of ₹ 0.09 crores against the consolidated turnover of ₹ 69.27 crores do not reflect the profitability of the functionally similar company as consolidation of results t .....

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ing to RPT were also given in the annual report and, therefore, the matter should be restored to the file of CIT(A) for decision afresh in respect of this comparison. 12.2. Having heard both the parties, we find that the financial details as mentioned in the TPO s order are available in the annual report filed by assessee and, therefore, the matter needs to be examined afresh by ld. CIT(A). Accordingly, we set aside this issue to the file of CIT(A) for decision afresh. 13. Apropos ground no. 4(e .....

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hat TPO had committed an error by allowing downward adjustment of 20% in an ad hoc fashion, without following any scientific methodology, inter alia, observing as under: 9.4.2 The appellant had also made a passing reference in the TP report that the risks assumed by the uncontrolled comparable companies were Significantly higher than .the risks assumed by the appellant. Though the appellant had retained the option to make adjustment to reflect the risk differences, the option was neither exercis .....

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e up with any risk adjustment methodology, the TPO's adhoc adjustment is without any basis. 13.2. Having heard both the parties, we are of the opinion that no interference is called for in the order of ld. CIT(A) on this count because assessee failed to propose the necessary adjustment by filing a scientific methodology during TP proceedings or during appellate proceedings. The onus for quantification was on assessee on the risk assumed by comparables vis a vis tested party. Accordingly, thi .....

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; 127.41 crores in the P&L A/c. The reason for variance was that the service receipts aggregating to ₹ 9,99,34,000/- were not included in the total turnover. 17.1. After considering the assessee s submissions he concluded that service receipts would form part of the total turnover of the business as such income had been generated by carrying out the main business activity of the assessee company, even if it was not eligible for tax holiday. He, accordingly, recomputed allowable deducti .....

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ey were covered by the Notification dated 26-9-2000 issued by the CBDT for allowing deduction for certain IT enabled services. However, as far as services covered under category (b) were concerned, he observed that none of these services were either related to export or covered by the Notification as IT enabled services eligible for deduction u/s 10A. He observed that assessee failed to bring any evidence on record to prove that these services were related to export or could be categorized as IT .....

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tification no. 890(E) dated 26-9-2000, these services being part of back office operation and support services are eligible to be considered as part of export turnover. In the result, this ground is allowed. 17.6. Brief facts apropos ground no. 9 are that the assessee had claimed ₹ 53,08,491/- as leave encashment. However, in view of clause (f) of section 43B, the AO disallowed the assessee s claim as the same had actually not been paid by the assessee. The assessee had merely made a provi .....

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of law in clause (f) of section 43B of the Act. 17.9. Ld. DR filed before us the copy of order of Hon ble Supreme Court pointing out that the decision of the Hon ble Calcutta High Court in the case of Exide Industries Ltd. (supra) has been stayed by the Hon ble Supreme Court vide order dated 8-9-2008 in Special Leave to appeal (Civil) CC 12060/2008. 17.10. Ld. counsel for the assessee submitted that merely because the decision has been stayed does not mean that the same loses its precedential v .....

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section 43B. As far as the decision of Hon ble Calcutta High Court in the case of Pijush Kanti Chowdhury (supra) is concerned, the said decision was rendered with reference to the proceedings which took place in West Bengal. Once the decision of Hon ble Calcutta High Court has been stayed, the specific mandate of section has to be followed. In view of above discussion, this ground is dismissed. 18. In the result, assessee s appeal for AY 2003-04 is partly allowed. ITA no. 2244/Del/2008 (Revenue .....

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n account of foreign exchange fluctuation loss without considering the fact that the same is ambiguously a notional loss. 20. Ground no. 2: This ground has been taken by the department because of the relief provided by ld. CIT(A) on account of TP adjustment. 20.1. In view of our findings in the assessee s appeal, the AO will have to carry out fresh computation and will, accordingly, determine the ALP. Therefore, this ground at present does not require any adjudication. 21. Ground no. 3:Brief fac .....

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e date of the invoice. When the remittances are received, they are converted into rupees at the prevailing exchange rate on the date of realization. Out of the total forex loss ₹ 16,41,732/- pertains to services and ₹ 1,09,44,200/- pertains to software exports. 21.1. The AO, however, did not accept the assessee s contention, inter alia, observing as under: The claim of deduction on account of foreign exchange loss is in the nature of an anticipated loss and not actual loss suffered d .....

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deduction. Admittedly, there is no settlement of the outstanding contracts during the accounting year. Whether the outstanding contracts will result in a loss or not will be known only when the outstanding contracts are settled. The possibility that there may be a favourable fluctuation cannot be ruled out and perhaps when the liability is actually discharged assessee may actually earn a profit. Assessee has simply debited the P&L a/c based on a notional loss without actually incurring any .....

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rt of Delhi in the case of CIT Vs. Woodward Governor India (P) Ltd. (2007) 162 Taxman 60 (Delhi) which has been affirmed by the Hon ble Supreme Court in the case of CIT Vs. Woodward Governor India (P) Ltd. (2009) 179 Taxman 326 (SC), wherein it has been held as under: AS-11 deals with giving of accounting treatment for the effects of changes in foreign exchange rates. In case of the revenue items falling under section 37(1), para 9 of AS-11, which deals with recognition of exchange differences, .....

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t of raw materials using closing rate of exchange. Any difference, loss or gain arising on conversion of the said liability at the closing rate, should be recognized in the profit and loss account for the reporting period. [Para 18] In conclusion, it may be stated that in order to find out if an expenditure is deductible, the following factors have to be taken into account (i) whether the system of accounting followed by the assessee is mercantile system, which brings into debit the expenditure .....

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been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making entries in the books both in respect of losses and gains as per nationally accepted Accounting Standards; (vi ) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reduce the incidence of taxation. 21.3. Respectfully following the decision of Hon ble Supreme Court, this ground is dismissed. 2 .....

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to the ld. Transfer Pricing Officer (Ld. TPO), under section 92CA(3) of the Income Tax Act, 1961 ('Act') was validly made. The Ld. CIT(A) completely failed to appreciate that the Ld. AO had not recorded any reasons under section 92CA of the Act which made it expedient and necessary for him to make a reference under that provision. 3. That the ld. CIT(A) grossly erred on facts and in law in confirming an adjustment of ₹ 13,03,09,390 out of the total adjustment of ₹ 13,22,71,2 .....

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39;s length, and in inappropriately using data/ information not available at the time of documentation; (b) rejecting the final set of companies selected by the appellant as com parables without having material information in possession to prove that the analysis undertaken by the appellant is incorrect and hence warrants a fresh determination of the arm's length price by the Ld. TPO; (c) resorting to arbitrary rejection of certain companies selected by the appellant as comparables on errone .....

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ignificant risks, would typically be much lower); and (e) failing to appreciate that since the operating profit margin earned by the appellant (6.6 percent) is more than the operating profit margin earned by several comparables (forming part of the final set derived by the Ld. CIT(A) himself vide Annexure II of his impugned order), the appellant's 'international transactions' with its 'associated enterprises' are at arm's length. 5. That the Ld. CIT(A) grossly erred in la .....

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+/-) 5% mentioned in the proviso to section 92C(2) of the Act to the appellant. 7. That the Ld. CIT(A) erred in facts and in law in confirming the action of the Ld. AO of reducing the deduction claimed by the appellant under section 10A of Act to ₹ 17,30,35,950 as against ₹ 17,65,26,357 thereby reducing the deduction by ₹ 34,90,407 on erroneous and untenable grounds. 8. That the Ld. CIT(A) erred in facts and in law in not appreciating that other incidental services are inextric .....

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omparables selected by TPO: - Bangalore Softsell - Infosys Technologies Ltd. - Satyam Computer - Intertec Communications - Cherrysoft Technologies Ltd. - Future Software Ltd. - Mahindra Consulting Ltd. - Bristal.Com. India Ltd. ? - XcelVision Technologies Ltd. - Bangalore Softsl 27. We have considered the submissions of both the parties. 28. Bangalore Softsell: The assessee has objected to the inclusion of this comparable on the ground that company has a significant RPT of 34.94%, thereby failin .....

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o pointed out that this company has a significant AMP expenditure to sales of 6.17% as compared to the assessee, which does not incur any AMP expenditure. Ld. CIT(A) did not exclude this comparable observing that there was agreement between the TPO and assessee regarding this company being a comparable. He has further observed that the assessee had submitted that there was no related party transaction. However, now ld. counsel has submitted that it has significant party transaction. Therefore, w .....

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xcluded from the list of comparables 31. Intertec Communications: Ld. CIT(A) has observed that there was agreement between the assessee and TPO regarding exclusion of this company has a comparable. He further observed that assessee pointed out that there was no information regarding related party transaction available. 31.1. Ld. counsel pointed out that the revenue was derived from sale of software products as mentioned in the Revenue Recognition Policy of its annual report. 31.2. Having heard b .....

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