TMI Blog2015 (12) TMI 517X X X X Extracts X X X X X X X X Extracts X X X X ..... its AE then there can be no claim on account of under utilization of capacity as it was AE who initiates such expansion. Hence, we reject the ground raised by the assessee. Risk adjustment under Rule 10B(1)(e)(iii) and Rule 10B(3) to account for differences in the risk profile of the comparable companies vis-ŕ-vis the Appellant - Held that:- Where the assessee succeeds in ably demonstrating that the comparables finally selected bore relatively more risk than it, then there should be no denial of the risk adjustment. If, however, the assessee fails in specifically pointing out the extra risks undertaken by the comparables, then, of course, there cannot be any question of granting risk adjustment. Under the transfer pricing regime, onus is always on the assessee to show the reasons for claiming any separate adjustment by pointing out the differences between it and the comparables. Risk adjustment can be allowed provided the assessee places on record some appropriate material to demonstrate that the risk undertaken by the comparable companies were relatively more than it, warranting downward adjustment in their profit rates. Further, the variation in such risks, if any, should be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... facts and in the circumstances of the case and in law, the Ld. TPO erred in not demonstrating that the motive of the Appellant was to shift profits outside India by manipulating the prices charged in its international transactions, which is a prerequisite condition to make any adjustment under the provisions of Chapter X of the Act. 4. On facts and in law, the Ld. TPO/Ld. AO erred in conducting and the Hon ble DRP further erred in allowing a fresh benchmarking analysis using non contemporaneous data and substituting the Appellant s analysis with the fresh benchmarking analysis on his own conjectures and surmises. 5. On facts and in law, the Ld. TPO/Ld. AO and Hon ble DRP erred in violating the provisions of Rule 10B(2) of Income Tax Rules, 1962 ( the Rules ) by introducing new companies without considering the differences in the functions performed, assets employed and risks assumed by such companies vis- -vis the Appellant, thereby resorting to unsubstantiated selection of comparables. 6. On the facts and in law, the Hon ble DRP violated the provisions of Rule 10B(2) of the Rules by rejecting CG-VAK Software Exports Limited, a comparable company selected by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 5 percent from the arithmetic mean while determining the arm s length price to the Appellant as per the proviso to section 92C(2) of the Act. 17. On the facts and in circumstances of the case, the Ld. AO erred in levying tax at the rate of 40% on the assessed income vis - vis applicable tax rate of 30%, given the fact that the Appellant is a domestic company incorporated under the Companies Act, 1956. 18. On the facts and in the circumstances of the case, the Ld. AO erred in computing interest under section 234B of the Act. 19. On the facts and in the circumstances of the case, Ld. AO erred in demanding an amount of ₹ 162,976 in relation to tax refunded earlier as this amount was never refunded and not received by the Appellant. 20. On the facts and in the circumstances of the case, the Ld. AO erred in levying interest under section 234A and 234D of the Act. 21. On the facts and in law, the Ld. AO erred in initiating penalty proceedings under section 271(1)(c) of the Act. 3. Grounds 1 to 15 relate to adjustment of ₹ 3,03,25,034/- to the arm's length price of the international transaction of provision of software development serv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pellant had computed the PLI of the comparables by selecting a set of 6 comparables and the margin of these was shown to be 6.48% using the current year data as under: Sr. No. Name of the company Margin for FY 2009-10 1 CG- Vak Software Exports Ltd. -12.48% 2 Quintegra Solutions Ltd. -9.42% 3 R S Software (India) Ltd. 9.29% 4 Tata Elxsi Ltd. 20.60% 5 Thinksoft Global services Ltd. 11.82% 6 Zylog Systems Limited 19.08% Average 6.48% 7. The TPO vide its order dated 22.01.2014, has observed that appellant has selected 6 companies as comparables on the basis of the search conducted in the public data base Prowess only. Further, TPO applied the following filters: i) Companies with RPT greater than 25% of revenue should have been excluded; ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch Ltd. 19.76% 12 Mindtree Limited (Segment) 20.47% 13 Persistent Systems Limited 30.15% 14 Persistent Systems Solutions Limited 11.37% 15 Quintegra Solutions Ltd. -8.83% 16 RS Software (India) Ltd. 9.07% 17 Sasken Communication Technologies Ltd. 22.65% 18 Sonata Software 32.16% 19 Tata Elxsi Ltd. 17.08% 20 Thinksoft Global services Ltd. 11.22% 21 Thirdware Solutions Limited 29.05% 22 Wipro Technology Services Limited (Formerly Citi Technologies) 63.27% 23 Zylog Systems Limited 19.08% Average ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14 Persistent Systems Solutions Limited 24.70% 15 Quintegra Solutions Ltd. -23.63% 16 RS Software (India) Ltd. 5.68% 17 Sasken Communication Technologies Ltd. 18.32% 18 Tata Elxsi Ltd. 12.66% 19 Thinksoft Global services Ltd. 4.53% 20 Thirdware Solutions Limited 22.88% 21 Wipro Technology Services Limited (Formerly Citi Technologies) 56.61% 22 Zylog Systems Limited 11.03% Average 17.22% 12. The Assessing Officer accordingly passed an order under section 144C(13)/143(3) of the Act determining the adjustment at ₹ 3,03,25,034/- and as such, income of the appellant was finally assessed at ₹ 3,06,78,474/-. The said adjustment ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has supported the orders of DRP/TPO/AO and contended that adjustment made should be sustained and, no interference is warranted. 14. We have considered the rival submissions and perused the material placed on record. The first and foremost substantive contention raised by the learned counsel vis-a-vis Ground 6 of Grounds of Appeal is that DRP violated the provisions of Rule 10B(2) of the Rules by rejecting CG-VAK Software Exports Limited, a comparable company selected by the appellant in the TP documentation by modifying the filter of employee cost being less than 25% of turnover as proposed by the ld. TPO to employee cost of less than 75% of turnover and further erred in incorrectly computing the filter ratio at less than 75% instead of correct ratio of 79.69% of turnover. The TPO had rejected the above comparable by holding as under: Rejection of CG-VAK as a comparable by the undersigned is valid for the reasons explained in the show cause notice. Further, the assessee has not submitted any detail to justify that each one of the identified filters are satisfied in this case. Since the assessee company has failed to discharge its onus, the undersigned is constrained, to r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O of employee cost less than 75% of turnover and therefore the same cannot be taken as comparable. In view of the above, action of the TPO is upheld. 18. Before us it was submitted that DRP incorrectly applied employee cost filter which was never proposed by the TPO. It was submitted in the profit and loss account, CG-VAK has reported certain Cost of Services , however, the breakup of the same is not known (to ascertain whether the same includes any employee cost or not). It was further submitted that from the annual report for financial year 2010-11 and financial year 2011-12, it is can be seen that the employee cost was disclosed as cost of services. The relevant extracts from the annual report is given below: PROFIT LOSS STATEMENT FOR THE YEAR ENDED 31ST MARCH 2012 Note No. 31.3.2012 (Rs.) 31.3.2011 (Rs.) III Expenditure: Employee Benefit Expenses 3.03 5,33,80,368 4,73,01,685 PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31.3.2011 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... P) Ltd. vs. DCIT [TS 203-ITAT-2015 (Bang)] - Yodlee Infotech (P) Ld. vs. ITO [TS-465-ITAT-2014 (Bang)] - Cisco System India (P) Ltd. vs. DCIT [TS-246-ITAT-2014 (Bang)] 21. We have considered the submission of the ld. counsel for the assessee and have considered the argument of the ld. DR that the assessee is not producing any product, however, we find that CGVak Software and Exports Limited is not only into computer software but it is a product manufacturer too. Since assessee is not into product manufacturing and the segmental details cannot be bifurcated from the financial details, we find that the assessee and the CG-Vak Software and Exports Limited are not comparables. Therefore, we are inclined to uphold the orders of the authorities below in rejecting this company as a comparable. We direct accordingly. 22. Now taking up Grounds No.7 to 13 of Grounds of Appeal, the learned counsel made his submission for exclusion of comparables selected by TPO. We will now consider the merits of the arguments of the parties with regard to selection of the these companies as comparables by TPO. 23. E-Infochips Bangalore Limited 24. The learned AR contended that DRP/T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch is placed on record before us. On the basis of the said contents, he has made an attempt to point out that M/s. E-Infochips Bangalore Ltd. is functionally different form the assessee company in as much as the said company is mainly into development of new products whereas the assessee company is mainly providing software development services. It is seen that reference to the website of company is not of much help as it may not have information which pertained to FY 2009-10. It is possible that these services were provided by E-Infochips Ltd. instead of EInfochips Bangalore Ltd. Also, it is possible that provision of these services is a subsequent development. Further, many of these services like software, FPGA, ASIC, QA Testing require software engineers only. Hence, the services and personnel required are not entirely different. The reference made by the taxpayer is in respect of website of E-Infochips Ltd. and not that of E-Infochips Bangalore Ltd. After having gone through the website www.einfochip.com., we however find that the same is in respect of the entire group of E-Infochips, of which M/s. E-Infochips Bangalore Ltd. is only a part. The functional profile given on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le in the public domain in as much as the TPO can obtain such information in the form of relevant schedules of the Profit Loss Account of the said entity as well as the segmental details, if any, directly from the said entity. 27. Following the above judgments, we therefore, set aside the impugned order of the Assessing Officer as well as the direction given by the DRP on this issue and restore the matter to the file of the Assessing Officer/TPO for deciding the same afresh after giving the assessee proper and sufficient opportunity of being heard. 28. Infinite Data System Private Limited 29. The learned counsel for the assessee further contended that the DRP, has completely ignored the submissions made by the assessee and upheld the action of the Assessing Officer/TPO to include Infinite Data System Private Limited in the list of final comparables. The appellant objected to the inclusion of the comparable before TPO on the following grounds: i) Functionally not comparable ii) Abnormal/Supernormal profits iii) Significant intangibles iv) Accepted as a non comparable in previous year by TPO 30. The DRP upheld the order of TPO as under: The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g comparison thereof with FY 2009010 i.e. 4 years prior to the current year is incorrect. (Refer page 70 of the Paper book for TPO s observation) 32. On the other hand, the learned DR supported the order of the lower authorities regarding the inclusion of the same in the list of comparables. He reiterated the contents of the TPO's order which states as under: It is seen that Infinite is providing following services:- technical consulting, design development of software, maintenance, systems integration, implementation, testing and infrastructure management services. These services except infrastructure management services have also been refereed as technical support services in Revenue Recognition portion and as software technical consultancy services in Segment Reporting portion of the annual report. All these services are in the nature of software development services. .It can be seen that all the services have been referred primarily as IT services. The objection of the assessee is mainly on verticals of the company. Under TNMM the standards of comparability are relatively relaxed and only broad similarity of functions is required. It is furthe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot be considered as a comparable as it is engaged in diversified activities as it has wide spectrum of services such as business services, technology services and outsourcing services. It was contended that Infosys Limited is engaged in significant Research Development (R D) that has led to creation of significant Intellectual property. It has been further pointed out that as per Annual Report of FY 2009-10, the company claims itself as the most reputed and admired company in India (Pg. 18 of Director s Report). Further assessee contended that Infosys Limited has a turnover of ₹ 21,140 crores, which is even more than 968 times of that of the assessee. The Ld. Counsel for the appellant has placed reliance upon the various decisions, in which Infosys Limited has been rejected as a comparable considering the same not only as a giant company but is also engaged in development of various niche products, which are as follows: i) 35 taxmann.com 421 (Hyd) Intoto Software India Pvt. Ltd. vs. Asst. CIT ii) 40 taxmann.com 173 (Hyd) NTT Data India Enterprise Application Services (P.) Ltd. vs. Asst. CIT iii) 38 taxmann.com 306 (Del) Agnity India Technologies (P.) Ltd. vs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... port of the company that Infosys Technologies provides much wider range of services, performs extensive functions, undertakes diversified business activities and assumes significant risks as compared to routine software development service providers like the assessee. Further, the company undertakes substantial R D activities and derives majority of its revenues the sale of proprietary products unlike the assessee. Also, the turnover of the company is significantly higher than that of the appellant and in no manner is comparable to the size/operations of the assessee. 16. We note that all the above facts highlight that Infosys Technologies Ltd. is a product owner, undertakes substantial advertising/sales promotion and brand-building activities and is engaged in significant R D activities, and is very huge in size/volume as compared to the assessee. Hence, it cannot be said to be comparable with the assessee. The said proposition has also been confirmed by Delhi Tribunal in Agnity India Technologies v. ITO [IT Appeal No.3856 (Delhi) of 2010] wherein the Coordinate Bench held as follows : Various arguments, as stated earlier, were taken before the DRP which inter-alia in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fosys Connect. Also the company derives substantial portion of its proprietary products (including its flagship banking product suite Finacle) Onsite v. Offishore As much as half of the software development services rendered by Infosys are onsite (i.e. services performed at the customer's location overseas). And offshore (50.20 per cent) Refer p. 117 of the Paper Book) than half of its service, income from onsite services The appellant provides only offshore services (i.e. remotely from India) Expenditure on advertising/sales promotion and brand building ₹ 80 crores Rs. Nil (as the 1- percent services are provided to AEs) Expenditure on Research and Development ₹ 236 crores Rs. Nil Other 100 per cent offshore (from India) 11.6 On the basis of the above chart, the Hon'ble High Court affirmed the conclusion that a captive unit of acomparable company which assumed only a limited risk can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he order and held that the company is providing software development services which is paramateria with the functions carried on by the assessee. Having considered the material placed on record we find that the company is mainly involved in software services. Therefore, we hold that TPO is right in including the same for the purpose of comparability analysis. 46. We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. A Coordinate Bench in the case of Agnity India Technologies (P) Ltd. vs. ITO 154 ITD 293 (Del) regarding the said comparable has held as under: 11. So far as exclusion of three comparables i.e. Larsen and Tourbo Infotech Ltd., Persistent Systems Ltd. and Mindtree Ltd., it is noted that before the CIT(A) the assessee contended that during the financial year 2008-09, it has a turnover of approx. ₹ 14.45 crores whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uded by the Tribunal in assessment year 2006-2007, which has been up held by the Hon'ble High Court, thus the issue about exclusion of persistent system Ltd, while making TP adjustments in it's case stands settled in view of these decisions in its own case. Therefore we do not find any necessity to interfere this company's exclusion. 17. Having regard to the factual position and respectfully following the judgment of the Hon'ble High Court we partly allow the ground raised by the revenue and uphold the exclusion of persistent system Ltd, and direct inclusion of Larsen Toubro Infotech Ltd and Mind tree Ltd. 47. Similar view has also been expressed in the case of Fiserv India (P) Ltd. vs. DCIT 60 taxmann.com 345 (Del), it was held as under: 12.2 We have considered the rival submission and perused the material on record. The counsel for the assessee has contended that Persistent Systems Ltd. is functionally different from the assessee as the company is into software development services as well as software products unlike the assessee who is a captive service provider. Moreover, no segmental details are available in the annual report. It can be thus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd 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 are 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 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 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200 crores only should be taken into consideration for the purpose of making TP Study. 3.3.2 The above view has been followed in the recent order of the Tribunal in the case of Trilogy E -Business (supra ). The relevant findings of the Tribunal are extracted as under: 20 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submitted that, as per Annual Report, the company derives revenue from software products, which suggests that the company is a product company unlike the assessee. It was further submitted that the company has inventories amounting to ₹ 166.55 lakhs and being a software service company, it was also provided that should not be holding any inventory in the books of accounts. The assessee also contended that company is also actively engaged in product development and earns revenue also from sale of software products, there were also peculiar economic circumstances as it underwent restructuring during the year which inflated its profit by ₹ 1,519.70 lakhs in addition to other factors affecting its sales and margins. Further, the turnover of the company is more than 19 times of the appellant. The TPO has held as under: It is seen that this cost (contract staff cost) is insignificant in comparison to employee cost of ₹ 213.46 cr. All software companies have software in their fixed assets. It is only when it is significant and developed by them and is being amortized on sale of software products exceeding 25% of total income, it can be said to be resulti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... laborative Solution Layers. This includes ERP, customer relationship management (CRM), SCM, BI/DW, BPM etc. Thirdware offers Application Implementation Services (AIS), Application Development Services (ADS) and Application Management-support Services (AMS). It was further submitted that it is engaged in development of own software-PAPA and has incurred expenses towards import of software service, evidencing outsourcing of software services unlike the Applicant company. The TPO has not provided any reason for holding Thirdware as a company comparable to the Appellant whereas, The DRP while upholding Thirdware as comparable to the Appellant company observed as under: The audited report of the company reveals that company is mainly engaged in software development. The majority of income is from software development. Having considered the material placed on record we find that the company is mainly involved in software services. Therefore, we hold that TPO is right in including the same for the purpose of comparability analysis. 56. We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the audited Financial that in RPT schedule it is not considered as an Associated Enterprise. The TPO has not provided any reason for holding Wipro as a company comparable to the Appellant whereas The DRP while upholding Wipro as comparable to the Appellant company observed as under: The audited report of the company reveals that company is mainly engaged in software development. The majority of income is from software development. Having considered the material placed on record we find that the company is mainly involved in software services. However, the assessee has brought to the notice that Wipro Technologies Service Ltd has RPT of more than 25%. The AO is directed to verify the computation provided by the assessee and if RPT is more than 25% than it should not be included for the purpose of comparability analysis. 59. We have considered the rival submissions, perused the material on record. In our view, Companies that are affected by factors like persistent losses, declining sales, extraordinary Income or expense, mergers and acquisitions or other such factors which affect the operations of the company substantially should not be used as comparables as they w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the hurry to get business by committing a sum of money in terms of rental and maintenance charges. c) The assessee is required to support its claim for any adjustment with robust data and full details and evidences so as to enable the TPO to examine the claim. The burden is on the assessee whenever it makes a claim and in this case, it has not discharged the burden of proof. These adjustments are being claimed in an adhoc manner. Further, according to assessee since fixed cost remain constant irrespective level of operation and therefore such costs could not be optimally utilized to low level of capacity utilization. In view of this office capacity adjustment in service industry is not applicable as the business model I s cost plus so there is no question of idle capacity in terms of fixed costs assets. d) If the taxpayer had seen a sudden spike in the volume o f its work during the year, it would have reaped the benefits of advance planning and foresight. This would have resulted in greater profits and better margins owing to its smart moves. However, when the volume of work did not grow as anticipated, it is seeking an adjustment due to the same smart business move. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tional transactions of the Assessee with the arm s length price. 67. The TPO in its order dated 22.01.2014 has held as under: The assessee hasn t claimed raised Risk Adjustment in its submission. However, it may claim at later stage on account of adjustment commensurate to the risk profile of the assessee. After carefully considering the facts of the case and the submissions of the taxpayer, I am not inclined to accept the assessee s future claim of risk adjustment. Risk adjustment as a general rule cannot be allowed unless it is clearly shown that the comparables had actually undertaken such risk and how the same materially affected their margins. The revised OECD guidelines of 2010 has also stated in Para 3.54 as under:- Ensuring the needed level of transparency of comparability adjustments may depend upon the availability of an explanation of any adjustments performed, the reasons for the adjustments being considered appropriate, how they were calculated, how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chapter V. From the above guidelines i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... considered appropriate, how they were calculated how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chapter V. Even the various judicial decisions on the issue of adjustments and even OECD guidelines, impresses upon time and again that the adjustment should be reasonable accurate adjustment . 13.10 From the above guidelines, it can be seen that unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustments, no adjustment can be allowed to the assessee. In the present case, except pointing out various risks, the assessee has not shown with evidence as to whether each of the risk was actually undertaken or not by the comparables and if so, how these risks affected each of them and whether such adjustment would improve the comparability. 13.11 Mechanical adjustment cannot be made to the margins of the comparables without knowing which risks were taken by the entity concerned and how its profitability was affected. Pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee succeeds in ably demonstrating that the comparables finally selected bore relatively more risk than it, then there should be no denial of the risk adjustment. If, however, the assessee fails in specifically pointing out the extra risks undertaken by the comparables, then, of course, there cannot be any question of granting risk adjustment. Under the transfer pricing regime, onus is always on the assessee to show the reasons for claiming any separate adjustment by pointing out the differences between it and the comparables. Risk adjustment can be allowed provided the assessee places on record some appropriate material to demonstrate that the risk undertaken by the comparable companies were relatively more than it, warranting downward adjustment in their profit rates. Further, the variation in such risks, if any, should be capable of quantification on some reasonable and logical basis. Since the ld. AR has failed to objectively demonstrate the relatively higher risks undertaken by the comparables on an overall basis, we are disinclined to grant any risk adjustment. 69.1 In view of the foregoing discussion, we set aside the impugned order and remit the matter of determ ..... X X X X Extracts X X X X X X X X Extracts X X X X
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