TMI Blog2013 (5) TMI 844X X X X Extracts X X X X X X X X Extracts X X X X ..... services included services such as design and development of custom and ecommerce solutions, application management, problem resolution management and deployment and management of IT networks, customer specific infrastructure and data centre infrastructure. The international transactions undertaken by the assessee company with its associated enterprises were as under: S. No. Nature of transaction Method Value of transaction 1. Provision of Software services TNMM 207,868,050 2. Reimb. of traveling and mis emp. Exp by AE BNR 10,220,308 3. Reimb. of traveling and mis emp. Exp to AE 454,438 3. The main issue in the present appeal is determination of arm s length price of the international transactions representing Software Services provided to the associated enterprise. The arm s length price was determined by applying transactional net margin method (TNMM) considered to be the most appropriate method in the facts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... following grounds of appeal: That on the facts and circumstances of the case, and in law; 1. The assessment order passed by the ld. Assessing Officer ( ld. AO ) pursuant to the directions of ld. Dispute Resolution Panel ( ld. DRP ) is bad in law and void ab-initio. 2. The ld. DRP and the ld. AO (following the directions of the ld. DRP), erred both on facts and in law in confirming the addition to the extent of ₹ 2,30,41,663/- to the income of the appellant out of the total addition of ₹ 3,40,26,578/- as proposed by the ld. TPO/AO in its draft assessment order u/s 143(3) read with section 144C by holding that its international transactions do not satisfy the arm s length principle envisaged under the Act. In doing so, the ld. DRP and the ld. AO has grossly erred in agreeing with and upholding the ld. TPO s action of: 3.1not appreciating that none of the conditions set out in sec. 92C(3) of the Act are satisfied in the present case; 3.2disregarding the ALP, as determined by the appellant in the TP documentation maintained by it in terms of sec. 92D of the Act read with Rule 10D of the Rules as well as while submitting the updated comparables analysis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ms of functions performed, assets employed and risks assumed; 3.7 excluding certain companies on arbitrary/frivolous grounds even though they are comparable to the appellant in terms of functions performed, assets employed and risks assumed; 3.8 ignoring the business/commercial reality that since the appellant is remunerated on an arm s length cost plus basis i.e. it is compensated for all its operating costs plus a pre-agreed mark-up based on a benchmarking analysis, the appellant undertakes minimal business risks as against comparable companies that are full fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the appellant on account of this fact; 3.9 denying a working capital adjustment to the operating profit margins of the comparables; 3.10 disregarding judicial pronouncements in India in undertaking the TP adjustment. 4. The ld. DRP and the ld. AO, erred both on facts and in law, in adding Fringe Benefit Tax paid by the appellant for computing the book profit u/s 115JB of the Act. 5. That the ld. AO erred on facts and in law in charging interest u/s 234A and 234B of the Act; 6. The ld. AO has grossly erred in i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hould be used. Multiple year data can be allowed only if the assessee demonstrates that there are certain factors in the earlier years that have affected only if the assessee demonstrates that there are certain factors in the earlier years that have affected the transfer prices in the current year. All the arguments made by you in this regard, especially the one made on in your submission dated 15.06.2011 have been carefully perused. You have not been able to provide any data/facts that would demonstrate that factors pertaining to earlier years have affected the transfer prices in the current year. In any case, you have set your transfer price pre-ante. There is nothing on record to show that any study, analysis was available that justified the transfer price agreed upon by you and your AE. 12. Ld. Counsel for the assessee submitted that multiple year data was to be used because the current year data was not available at the time of preparation of T.P. Study Report. He further submitted that multiple year data gives correct indicator of the margin of comparables. 13. Having heard both the parties, we find that as per Rule 10B(4), the data to be utilized and analyzing the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is concerned, we do not find any substance in the same because in service sector turnover has no relevance particularly when TNMM method has been selected as the most appropriate method. In the case of companies with low level of sales/operating income, the companies may be operating with altogether different management model including lack of human resources. Therefore, the margin of companies having turnover of less than 1 crore fluctuate to extreme because of the narrow base. 18. Ld. DR has pointed out that in the case of M/s Haworth India (P) Ltd. (2011-TII-64-ITAT-Del-TP) Tribunal has impliedly approved this filter. Similarly ITAT, Delhi in the case of M/s CRM Services India Ltd. (2001-TII- 86-ITAT-Del-TP) rejected comparable as its turnover was less than ₹ 1 crore. We, therefore, do not find any reason to interfere with the order of ld. DRP on this count. 19. In the result, this ground is dismissed. 20. Ground no. 3.4.2 is regarding applying of a filter of excluding companies with employee cost less than 25% of the total cost. The TPO applied this filter on the ground that the companies which are engaged in software development require a minimum level of expend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is dismissed. 23. In ground no. 3.4.3 the assessee has assailed the TPO s action in applying the filter in selection of comparable by excluding companies having diminishing revenues/persistent losses for last three years upto and including FY 2007-08. In the show cause notice dated 14th October, 2011 in para 6 the TPO had examined the filter applied by assessee in TP Study and had, inter-alia, pointed out with reference to filter applied by assessee of rejecting companies having persistent operating losses by observing as under: This is an appropriate filter. However, only companies which are incurring losses persistently are to be rejected as against companies which have made loss once in a while. This is an appropriate filter because of the reason that software industry has been growing at a rate of more than 20% and in such an environment a company making persistent losses does not reflect the industry conditions and is in persistent losses because of company specific issues. 24. The TPO had excluded the companies with diminishing revenue because in an environment where software sector is growing at a CAGR (Compounded Annual Growth Rate) of more than 30% during th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s as under: FCS Software Solutions is a leading provider of IT services in the past one decade of its existence, FCS has carved out a niche for itself in core IT areas like elearning, digital content services, IT consultancy and product engineering services. We have a huge offshore center in India that caters to a global clientele. Our development center prides in a state of the art facilities and a competent workforce consisting of programmers. IDs, visualizers, e-learning experts, writers and editors who have worked extensively in the areas of e-learning, product training, sales training, support services, performance and collaboration for several Fortune 500 companies. 29. Thus, first contention of assessee is that since the functional profile of FCS Software Solutions is different in-as-much as the same is, inter-alia, engaged in infrastructure management services, therefore, the same cannot be taken as comparable. The assessee also submitted that the segmental information was also not available. The TPO however, observed that since the FCS Software Solutions was engaged in software services, therefore, the objection of assessee on functional dissimilarity was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Services in the field of information technology services, including software programming services, monitoring and database management services, database and application maintenance services, customer support services, establishment of data centres, infrastructure management services, services related to servers, network connectivity, security, networking, storage, web and application development, collocation hosting, bandwidth options, disaster recovery, digital storage systems, electronic software distribution, online customer information, backup, recovery, archive, offsite vault storage for all data on servers, anti-spam, anti-virus, reporting, enhanced monitoring and value added services, message archiving and retrieval services, end-to-end archiving solution and other customer end-to-end information technology services. 32. From the above, it is evident that the assessee is rendering almost all kinds of comprehendible software services. The assessee is carrying out services that are not merely routine software development services but a whole range of services to carry out the main work of AE. Functions include providing the services in its entirety to AE. Therefore, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... high profit then the very object of TP Study would be frustrated. That is the reason that under rule 10B, dealing with various most appropriate methods, it is contemplated that the normal gross profit mark up is adjusted to take into the account the functional and other differences which could materially affect such profit mark up in the open market. 35. Ld. DRP has rightly observed that while taking arithmetic mean, the differences on account of low margins as well as high margin ultimately average out. If the assessee is able to demonstrate that there are peculiar economic circumstances which warrant the exclusion of comparable on account of earning high profit then only the comparable can be excluded. In this regard ld. DRP has reproduced the revised 2010 guidelines of OECD which were taken note of by TPO. 36. Ld. Counsel has referred to the decision of Tribunal in the case of Actis Advisers Pvt. Ltd. (ITA No. 5277/Del/2011) ITA No. 958/Del/2012), wherein the Tribunal has, inter-alia, observed as under: 22. Profit and loss are two incidence of business and merely on account of low profit or loss would not make a functional comparables company as uncomparable, but if ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... selected cannot be rejected unless it is established that the assets employed by it and the risk undertaken by it is not in conformity with that of assessee. 39. In the case of M/s Extreme International Services Pvt. Limited vs. Asstt. Director of Income-tax (Int. Taxation) -7(2)/Mumbai the inclusion of Maple E-solutions Ltd. in the list of comparables was assailed by ld. AR. The Tribunal noticed that the TPO excluded the case of Satya Computers services on the ground of unreliability of data although that case satisfied all the relevant criteria chosen by the TPO . It was contended before the Tribunal that Maple E-solutions Ltd., which was included by the TPO in the list of comparables, suffered from the same disability. It was argued that the reputation of Rastogi Group, owning Maple E-solutions Ltd. was under serious indictment. Before the Tribunal the decision of Delhi Bench of the Tribunal in CRM Services India Pvt. Ltd. (ITA No. 4068/Del/2009) for AY 2006-07 was placed vide which the case of Maple E-solutions Ltd. had been directed to be excluded for this reason alone. It was also brought to the notice of Tribunal that the Hyderabad Bench of the Tribunal in the case of C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nfluence the profit margin significantly then on that basis the comparable cannot be excluded. The Tribunal observed in para 45.1 45.2 as under: 45.1 On the objection of the marketing expenditure, we note that marketing expenditure has been shown by this company at ₹ 61,11,240/- which is otherwise not giving material effect on the price or cost charged or paid or profit arising from the operation of that company. Therefore, in the absence of any such factor or criteria provided under Rule 10B(2), a comparable cannot be excluded on the ground of marketing expenditure, which is not so material as to influence the profit margin significantly. Further, such a factor, if at all, may be considered for an appropriate adjustment as per Sub Rule 3 of Rule 10B subject to the fulfillment of the conditions provided therein. 45.2 Further, the Delhi Benches of the Tribunal in the case of Actis Advisors P. Ltd. (supra) has considered and decided an identical issue in para 26 as under: 26. We have heard the rival contentions and gone through the record carefully. On page 24 to 26, ld. TPO has considered this aspect. According to the ld. TPO, the filters applied by the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the companies who have incurred expenses less than 3% of the sales is 22.26%. The companies who have incurred expense more than 3% but less than 5% of the sales on AMP, their profit is 45.52%. Similarly, the companies who have incurred expense on AMP at 5% to 7% of sales, the profit is between 67.46%. These figure have been put from the result of comparable. We have extracted such comparable in para 24 on page 32 of this order. Contrary to this, ld. DR also pointed out that HCL Commet System Services incurred 0.65% of sales on AMP but shown profit at 45.91%. Similarly, Maple E-solution incurred 0.16% and shown profit at 32.06%. Visual Infra-tech did not incur any expenditure but shown profit at 44.15%. Thus, the details referred by the ld. Counsel for the assessee do not advance the case of the assessee. What is the actual impact on the earning of income could not be demonstrated on the basis of these comparative details, graph etc. The next reasoning is that such companies are functionally different. Creation of marketing intangible is brand by incurring such expenses may be helpful in future. But how their FAR is substantially so different could not be explained. Ld. TPO has loo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... far as possible near to the real price of the transaction. If assessee has not taken note of an important economic factor at the time of T.P. Study, and accordingly, either included/excluded the comparable then it cannot be estopped from furnishing the correct position regarding comparable at any stage of proceedings. However, the assessee will have to substantiate its claim with robust data in this regard. In the case of M/s Stream International Services P. Ltd. (supra) Tribunal in para 16 of its order has observed as under: 16. Having heard the rival submissions and perused the relevant material on record, we find that the purpose of income tax assessment is to determine correct income of the assessee. As the Revenue cannot allow an assessee to depress his income, in the same manner, it is not permissible to the Revenue to take advantage of the ignorance or mistake of the assessee in offering more than due income. It is trite that no tax can be collected except as per law. Circular No. 14(XI-35) of 1955 dated 1.4.1955 cautions the Officers of the Department from taking advantage of ignorance of an assessee as to his rights. The Hon ble Bombay High Court in the case of Mirmal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxpayer and no objection to its inclusion was raised before the TPO or before the ld. CIT(Appeals) in appeal. Therefore, the taxpayer should not be permitted to raise additional ground and ask for exclusion of the above enterprise in the determination of the average margins. We are unable to accept above contention. In the first place, these are initial years of implementation of Transfer Pricing Legislation in India and taxpayers as well as tax consultants were not fully conversant, with this new branch of law when proceedings were initiated or even at appellate stage. Besides, Revenue authorities, including TPO were required to apply statutory provisions and consider for purposes of comparison functions, assets and risks (turnover), profit and technology employed by the tested party and other enterprises taken as comparable Statutory duty is cast on them to undertake above exercise. This has not been done in this case. We would only say that prima facie, as per the material, to which reference has been drawn by Shri Aggarwal, Datamatics does not appear to be comparable. Even if the taxpayer or its counsel had taken Datamatics as comparable in its I.P. audit, the taxpayer is ent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... attitude taken up by the assessee. 33. In the case of CIT vs. C.Parakh Co. (India) Ltd. 29 ITR 661, their Lordship of Supreme Court made the following observations: On the question of the admissibility of the deduction of ₹ 1,23,719, the contention of the appellant is that as the respondent had itself split up the commission of ₹ 3,12,699/- paid to the managing agents, and appropriated ₹ 1,23,719/- thereof to the profits earned at Karachi and had debited the same with it, it was not entitled to go back upon it, and claim the amount as a deduction against the Indian profits. We do not see any force in this contention. Whether the respondent is entitled to a particular deduction or not will depend on the provision of law relating thereto, and not on the view which it might take of its rights, and consequently, if the whole of the commission is under the law liableto be deducted against the Indian profits, the respondent cannot be estopped from claiming the benefit of such deduction, by reason of the fact that it erroneously allocated a part of it towards the profits earned in Karachi. What has therefore to be determined is whether, notwithstan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... done due to some mistakes on its part. 38. Accordingly on facts and circumstances of the case, we hold that taxpayer is not estopped from pointing out that Datamatics 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 it s 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. Therefore, we deem it fit and proper to remit the matter to the file of the Assessing Officer for consideration of claim of the taxpayer and made a denovo adjudication of the arm s length price after providing reasonable opportunity of being heard to the assessee. We order accordingly. 39. We have, however, also noted that the very basis of selection of comparables and application of filters leaves lot to be desired. As we have noted earlier as well, the transfer pricing was in the initial stages in this year and we ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed, as against the case of the assessee where it was rejected. Ld. Counsel pointed out that in the TP study, the assessee had taken a comparable Data Matrix Technologies Ltd. while trying to justify its international transactions to be at arm s length. No arguments in this connection were taken before the lower authorities. Before the Spl. Bench for the first time, the assessee by way of an additional ground made a claim that the comparable data matrix was inadvertently considered as a comparable and so requested/prayed that it may now be excluded. 50. Ld. Counsel took us through various paras of ruling to demonstrate that it was not only on account of mathematical mistake but for other reasons also that Tribunal had accepted the assessee s claim of excluding Datamatics from the list of comparables. In this regard ld. Counsel had submitted a note in which it is, inter-alia, stated as under: Para 9 of the Ruling As per the para 9 of the Ruling, the Appellant submitted that Datamatics has been wrongly included in the comparables set for more reasons than one . Thus the Appellant had more than one reason for raising an additional ground before the Hon ble Special Bench to ad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... visiting and revising the TP study; 3) Arguments/pleas taken by the Appellant now were not taken before the lower authorities. Without prejudice to the opposition, the ld. Counsel for the revenue pleaded that the matter should be remitted to the TPO, if Datamatics is not to be considered as comparable. 51. Having heard both the parties, we find that the submissions advanced by the ld. Counsel for the assessee makes it very clear that Spl. Bench in the case of Quark Systems did not merely exclude Datamatics on the ground of arithmetical mistakes but for other reasons also. 52. In view of above discussion, we reject the plea of ld. DR that once in the TP study the assessee has taken a comparable then in subsequent appellate proceedings it cannot relegate from its claim even when it is able to substantiate its claim with robus data for wrongly taking/excluding a particular comparable. 53. Now coming to the first plea of ld. DR in this regard, we find considerable force in the same because unless assessee demonstrates that the revenue s of a comparable were affected by the brand value, the comparable cannot be excluded on that count. This issue is covered by various d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... explained that a software product company undertakes all the steps involved in creating software from domain analysis to testing. In this case, intellectual property belongs to the company. The products are sold generally on license basis, wherein right to use the software is transferred without giving the source code. However, a pure software development service provider imparts a part of the entire software development process. It does not generate any intellectual property for its own. The intellectual property generated belongs to the customer and not to the service provider. With reference to this distinction ld. Counsel submitted that in the case of tested party i.e. the assessee, a comparable can be selected which is primarily carrying out the functions of a software service provider. He, therefore, submitted that if a comparable is both software product as well as software development service provider then unless the segmental details are available, the company has to be excluded from the list of comparables. 61. We have considered the submissions of both the parties on this count and find considerable force in the argument of ld. Counsel for the assessee because unless ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing are not selected. You have argued for placing this threshold at 50%. This will be an inappropriate limit as this will allow companies that have significant incomes from manufacturing and trading activities to be used as comparables. In your case your entire income is from provision of services. It would not be right to allow you to be benchmarked against a company that has 50% of its income from manufacturing or trading activities. This will ensure integrity of all comparable data. 62. From the above, it is evident that though assessee was claiming the threshold of revenue from service sector at 50% but ld. TPO took it at 75%. This demonstrates that TPO was giving more weightage to functional profile. Therefore, the segmental information about revenue from software services was sine qua non before considering a particular company in the set of comparables. We find that ld. TPO/Ld. DRP have primarily relied upon the information contained in the annual report but the financial statements have not been examined in this regard. The assessee has assailed the inclusion of following comparables on this count: 1) E-Infochips Bangalore Ltd.; 2) E-Infochips Ltd.; 3) Kals I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion may not be so relevant to the service industry. He further pointed out that the tax payer will launch into a project only when they have been awarded a contract. It is not as if these parties have manufactured goods that await buyers. Thus, ld. TPO concluded that practically there will be no funds logged up in current assets. He, therefore, concluded that no working capital adjustment was required in the case of service industry. Further he pointed out that the tax payer had not been able to demonstrate that the difference in the working capital employed was making a difference in the margin earned by the tax payer and the comparables. 69. Ld. DRP in principle accepted that for allowing any adjustment for differences in respect of functions, assets and risks etc., as a general rule, the margins of comparables are adjusted to eliminate the effect of such differences on the margins of each comparable rather than adjusting the margins of tested party that is the assessee. Ld. DRP further observed that to carry out the adjustment, the availability of relevant information to accurately identify the difference and then quantify the impact of such difference is a pre-requisite. Ld ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee that the reasoning given by ld. DRP that working capital deployed on daily basis is to be considered, cannot be accepted. The opening working capital deployed and the closing working capital deployed has to be taken into consideration for making any adjustment to the working capital deployed in the case of a comparable. Ld. Counsel pointed out that working capital adjustment was allowed in earlier year. 73. In view of above discussion, we consider it in the interest of justice that the matter be restored back to the file of ld. TPO for making the working capital adjustment to the profit margins of comparables subject, of course, to assessee demonstrating that there was difference in the levels of working capital employed viz-a-viz the comparable. 74. In the result, this ground is allowed for statistical purposes. 75. Ground no. 3.10 is general and, therefore, does not call for any adjudication. 76. Vide ground no. 4 the assessee has assailed the action of ld. DRP and the ld. AO in adding fringe benefit tax paid by the assessee for computing the book profit u/s 115JB of the Act. The AO had disallowed the deduction of fringe benefit tax for the computation of book ..... X X X X Extracts X X X X X X X X Extracts X X X X
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