TMI Blog2015 (11) TMI 1308X X X X Extracts X X X X X X X X Extracts X X X X ..... ech Ltd.the related party transaction in the case of companies exceeds 15% ( 19.98 % in the case of Geometric Software Ltd. and 21.97% in the case of Ishir Infotech Ltd.) and in view of the decision of the Tribunal in the case of 24 X 7 Customer.Com Pvt. Ltd. [2013 (1) TMI 45 - ITAT BANGALORE] followed by this Tribunal in the case of Logica Private Ltd.[2015 (3) TMI 401 - ITAT BANGALORE] wherein it was held that where the RPT exceeds 15%, such companies should not be taken as comparable companies. Avani Cimcon Technologies Ltd. and Celestial Labs Ltd. not comparable to the software service provider companies. E-Zest Solutions Ltd. - With regard to the objection of the leaned DR that the functional profile of the company E-Zest Solutions Ltd. in AY 07-08 has to be compared with that in AY 08-09 decided by the Tribunal, we accept the said prayer and for this limited purpose direct the TPO/AO to examine as to whether there is any change in the profile of the said company so that it can be regarded as comparable with an Assessee rendering software development service such as the Assessee. Computing deduction under section 10A - Taking into consideration the decision rendered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ort turnover/total turnover. Ground No.5 is with regard to the Revenue authorities in not allowing set-off of current year unabsorbed depreciation against the adjustment made to the business income. 3. Grounds 2.5 to 7 and ground No.3 raised by the Assessee are with regard to the addition to the total income by way of adjustment to the Arms Length Price ( ALP ) to an international transaction carried out by the assessee u/s. 92CA of the Act. At the time of hearing of the appeal it was submitted that the comparable companies chosen by the TPO and the addition made by the AO in the draft assessment order which was confirmed by the DRP are identical to the case decided by the Tribunal in. July Sytstems Technologies (P) Ltd., Vs. ITO (2014) 33 ITR (TRIB) 643 (ITAT Bang)., 3DPLM Software Solutions Ltd. Vs. DCIT 2014 12 TMI 612- ITAT Bangalore, Element K.India Private Ltd. Vs. ITO, Ward 11(1), New Delhi (2014) 36 ITR (Trib) 604 (ITAT-Del), CSR India Pvt. Ltd. Vs. ITO IT(TP) A.No.1119/Bang/2011 AY 07-08 order dated 29.1.2013 Toluna India Pvt.Ltd. Vs. ACIT (2014) 35 ITR (Trib.) 388 (ITAT-Del.), ITA No.1054/Bang/2011 for AY 07-08 in M/S.Trilogy E-Business Software India Pvt.Ltd. V ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Op.pr/cost% 5.09% 7. The TPO arrived at a final set of 26 comparables. The set of 20 comparables is as follows: Sl. No Name of company OP/TC Turnover Rs. in Crores 1 Accel Transmatic Ltd (Seg.) 21.11% 9.68 2 Avani Cimcon Technologies Ltd 52.59% 3.55 3 Celestial Labs Ltd 58.35% 14.13 4 Datamatics Ltd 1.38% 54.51 5 E-Zest Solutions Ltd 36.12% 6.26 6 Flextronics Software Systems Ltd (Seg.) 25.31% 848.66 7 Geometric Ltd (Seg.) 10.71% 158.38 8 Helios Matheson Information Technology Ltd 36.63% 178.63 9 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the TPO in this regard was as follows:- 12.6 Computation of Arms Length Price: The arithmetic mean of the Profit Level indicators is taken as the arms length margin. (Please see Annexure B For details of computation of PLI of the comparables). Based on this, the arms length price of the software development services rendered by the taxpayer to its AE(s) is computed below. It needs to be pointed out that allocation of cost in respect of AE transactions taken in this computation is the same as intimated to the taxpayer vide notice dated 11.6.2010. The taxpayer has not given any comments in this regard. Arms Length mean margin on cost Operating Cost 25.14% ₹ 17,68,70,698 Arms Length Margin 25.14% of the operating cost Arms Length Price (ALP) At 125.14% of operating cost Price received Short fall being adjustment u/s. 92CA ₹ 22,13,35,991 ₹ 18,58,84,791 ₹ 3,54,51,200 12.7 Price received vis- -vis the Arms Length Price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length Price as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ter 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 ₹ 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, 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 would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bradstreet 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 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 company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come 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 compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... portionment 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 one or more of such enterprises. Sec.92- A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the 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 ) 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 of net profit margin in the open market; ( iv ) the net profit margin realised by the enterprise and referred to in sub-clause ( i ) is established to be the same as the net profit margin referred to in sub-clause ( iii ); ( v ) the net profit margin thus 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 referenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 turnover filter is an important criteria in choosing the comparables. The assessee s turnover is ₹ 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid 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 Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Comm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he relevant extract are as follows: 16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually 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. Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable. 4. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has dr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omparables for the purpose of determining TNMM margin. 49. Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as comparable. The ld. DR, on the other hand, relied on the order of the TPO. 50. We have considered the submissions and are of the view that the plea of the assessee that the aforesaid company should not be treated as comparables was considered by the Tribunal in Capgemini India Ltd (supra) where the assessee was software developer. The Tribunal, in the said decision referred to by the ld. counsel for the assessee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables. 16. The facts and circumstances under which the aforesaid companies were considered as comparable is identical in the case of the Assessee as well as in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ainly into customization of software products developed (which was akin to software development) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO s filter of more than 75% of revenues from software development services. Having drawn the above conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. In terms of Rule 10B(3)(b) of the Rules, 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) reasonably accurate adjustments can be made to eliminate the material effects of such di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oking to the fact that it has developed a software product named as Muulam which is used for civil engineering structures and the product development expenditure itself is substantial vis-a-vis the capital employed by the said company, this criteria for being taken as comparable party, gets vitiated. For the purpose of comparability analysis, it is essential that the characteristics and the functions are by and large similar as that of the assessee company and T.P. analysis/study can be made with fewest and most reliable adjustment. If a company has employed heavy capital in development of a product then profitability in the sale of product would be entirely different from the company, who is involved in service sector. Therefore, this company cannot be treated as having same function and profitability ratio. In our view, due to non-availability of full information about the segmental details as to how much is the sale of product and how much is from the services, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case of the assessee. 20. The facts and circumstances under which the aforesaid company were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Tribunal accepted the assessee s contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- 7.8 Avani Cincom Technologies Ltd. ( Avani Cincom ): Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis. It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which it is incurred. iii. An amount of ₹ 11,692,020/- has been debited to the Profit and Loss Account as Deferred Revenue Expenditure (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: The learned D.R. however drew our attention to page- 389 of the paper book which is an extract from the Directors report which reads as follows: The Company has developed a de novo drug design tool CELSUITE to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Tech ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e ultimate analysis, the ITAT did not consider this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a comparable being functionally different. 45. From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the segmental data for each activity is not available and therefore this company shou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he ITAT Delhi in the case of Toluna India Pvt. Ltd., (supra) has held in para 23.1 23.2 of its order that this company cannot be regarded as a comparable company in the case of Software Development Service Provider such as the Assessee. In view of the above, the said company is directed to be excluded from the list of comparable companies. 25. As far as comparable at Sl.No.5 of the list of comparable chosen by the TPO listed in the chart given at para-4 of this order viz., E-Zest Solutions Ltd., is concerned, the comparability of the aforesaid company with that of the software service provider was considered by the Bangalore Bench of ITAT in the case of 3DPLM Software Solutions Vs. DCIT IT(TP)A No.1303/Bang/2012 , wherein on the comparability of the aforesaid company with a software development service provider, the Tribunal held as follows:- 14. E-Zest Solutions Ltd. 14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erformed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I-Q Information Systems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O. / TPO is accordingly directed. 26. The learned DR however submitted that the comparability of this company with a software development service provider was not objected to by Assessee s who are in similar business in several cases like the case of Telecordia (supra), Logica (supra) and Trilogy E-Business(supra). According to him the Assessee in the present appeal should not be permitted to take a plea that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... margin of the comparable company M/S.Megasoft Ltd., as was directed and held in the case of Trilogy EBusiness Software India Pvt.Ltd. (supra). The ground relating to Transfer pricing are decided accordingly. 30. Ground No.4 raised by the Assessee project the grievance of the Assessee regarding the action of the learned Assessing Officer and Honorable Dispute Resolution Panel excluding expenses incurred on travel expenses in foreign currency and expenses incurred towards communication expenses from export turnover on the ground that these expenses are incurred in rendering technical services rendered to clients outside India, while computing deduction under section 10A. It is the plea of the Assessee that at all times during the relevant previous year, it was engaged in development of computer software and not in rendering any technical services. Without prejudice to its contention that the aforesaid sums should not be excluded from the export turnover while computing deduction u/s.10A of the Act, the Assessee has also made an alternate prayer that expenses that are reduced from the export turnover should also be reduced from the total turnover and in this regard has placed relia ..... 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