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M/s. Kshema Technologies Limited (Merged with Mphasis Ltd.) Versus Asst. Commissioner of Income Tax, Circle 12 (1) , Bangalore

2016 (6) TMI 583 - ITAT BANGALORE

Transfer pricing adjustment - determination of ALP - bench marking technique - Held that:- There is a strength in the contention of the learned Authorised Representative that in view of the complexity of the transactions between the assessee and its AEs as well as the third party transactions in which the assessee has to pay the selling commission to the AE, the assessee adopted entity level operating margin for the purpose of bench marking its international transactions. However, this method is .....

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of ALP as per the provisions of transfer pricing. Instead of following the proper procedure stipulated under Chapter X of the I.T. Act as well as Rule 10 of I.T. Rules, the CIT (Appeals) has proceeded to take the AEs of the assessee as tested party and further recomputed their profit margin by excluding certain expenses which we find is not permitted under the provisions of transfer pricing.

Not only changing the tested party from the assessee to its AE, the CIT (Appeals) has also se .....

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me with the comparable companies in the light of various decisions relied upon by the assessee. We find that in the series of decisions, this Tribunal has come to a conclusion that the threshold limit of the RPT should not be more than 15% in normal circumstances where there is no difficulty in selecting the comparable companies. Therefore we direct the TPO to apply the RPT filter at 15% instead of 25% and then consider the comparability of the companies. Since the assessee did not fully co- ope .....

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- We direct the Assessing Officer/TPO not to reduce the expenses from the export turnover for computation of deduction under Section 10A

Foreign tax credit - Held that:- In the outcome of the remand proceedings if any tax liability is determined by the Assessing Officer, then the tax credit in respect of the foreign tax paid by the assessee is also required to be considered. We accordingly direct the Assessing Officer to consider the appropriate credit for foreign tax paid.

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I VIJAY PAL RAO, JUDICIAL MEMBER AND SHRI INTURI RAMA RAO, ACCOUNTANT MEMBER For The Appellant : Shri Padamchand Khincha, C.A. For The Respondent : Mrs. Neera Malhotra, CIT-II (D.R) ORDER Per Shri Vijay Pal Rao, J.M. : These cross appeals are directed against the order dt.2.7.2012 of Commissioner of Income Tax (Appeals)-IV, Bangalore for the Assessment Year 2005-06. 2. First we take up the assessee's appeal wherein the assessee has raised the following grounds : GROUNDS RELA TING TO LEGAL IS .....

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relevant- clause under section 92C(3) which necessitated the reference. The learned Commissioner of Income Tax (Appeals) - IV ['CIT(A) - IV'] has further erred in confirming the action of the Assessing officer. 3. The learned Assessing Officer, learned Transfer Pricing Officer and Commissioner of Income Tax (Appeals) IV have erred in a. passing the order without demonstrating that appellant had the motive of shifting profits outside India by manipulating prices charged in its internatio .....

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undertaken by the appellant without specifying the relevant-clause under section 92C(3) which necessitated such rejection; and b. rejecting the comparables selected by the appellant on unjustifiable grounds. GROUNDS RELATING TO TP ANALYSIS OF THE TPO: 5. The learned Assessing Officer and learned Transfer Pricing Officer have erred in: a. Performing fresh transfer pricing analysis and adopting inappropriate filters in doing fresh transfer pricing analysis. b. adopting companies as comparables ev .....

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arate analysis of selling commission paid to /,E and onsite services rendered by AE by unilaterally adopting CUP Method and CPM as the most appropriate method respectively without giving an opportunity of being heard to the appellant. ii. TP Analysis of Selling Commission paid to AE 7. The learned Commissioner of Income Tax (Appeals) - IV has erred in: a. adopting CUP as the most appropriate method for evaluating the selling commission paid to AE without justifying how the same was most appropri .....

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produced any evidence to justify commission paid without appreciating that the basis of computation of commission is explained in the TP Report and also explained and submitted the workings during the appellate proceeding; and, f. Combining the marketing expenses incurred by appellant and commission paid to AE to arrive at the ratio of 10.59 of such expenses on sales and accordingly concluding that it is very high without appreciating that marketing expenses of INR 64,76,000 were incurred for no .....

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AE (a company based in USA) as the tested party. Without prejudice, CIT(A) has erred in rejecting similarly placed Indian companies as comparable on unjustifiable reasons; and. d. adopting net margin of the comparable in computing the arm's length price without appreciating that under CPM gross margin are to be considered. GROUNDS ON ADJUSTMENT FOR DIFFERENCES 9. The learned Assessing Officer, learned Transfer Pricing Officer and Commissioner of Income Tax (Appeals) - IV have erred in not ma .....

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d learned Transfer Pricing Officer have erred in not restricting the TP adjustment to A E transactions only and thereby making an adjustment in respect of transactions with non-associated enterprise also. GROUND ON BENEFIT OF 5% RANGE 12. Assuming without admitting that the adjustment is to be made. the learned Assessing Officer. learned Transfer Pricing Officer and Commissioner of Income Tax (Appeals) - IV have erred in not allowing the benefit of the +/-5% range mentioned in the proviso to sec .....

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hat it is engaged in the business of software development and not in rendering technical services. 14. DISALLOWANCE UNDER SECTION 40(A)(1) IN RESPECT OF COMMISSION PAYMENTS a. Without prejudice to ground no. 2. the learned CIT(A) erred in holding that the services rendered by MphasiS Corporation outside India are in the nature of managerial services and commission paid to MphasiS Corporation in consideration of such services is chargeable to tax in India under section 9(i)(vii) of the Act and un .....

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b. The learned CIT(A) has erred in not directing the AO to grant appropriate credit for foreign taxes. 16. INTEREST UNDER SECTION 234B OF THE ACT The learned C IT(A) has erred in confirming the levy of interest under section 234B of the Act amounting to ₹ 10,928,569. 17. INTEREST UNDER SECTION 234D OF THE ACT The learned CIT(A) has erred in confirming the levy of interest under section 234D of the Act amounting to ₹ 128.352. 18. PENALTY UNDER SECTION 271(1)(C) The learned CIT(A) has .....

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justments / additions / disallowances made by the learned AO / TPO and upheld by the CIT(A) are bad in law and liable to be deleted. 3. The assessee company was incorporated in the year 1997 to provide software solutions and services to domestic and overseas customers. It has presence in the field of industrial automation and embedded solution, health care and life sciences, financial services and enterprise allocation. With effect from 1.6.2004 the assessee was acquired by Mphasis BFL Limited v .....

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deration as under : Financial Results of Kshema India, F.Y.2004-05 : The following are the brief financials of the tax payer as under : Operating Revenue 62,33,93,000/- Operating Expenses 55,54,82,000/- Operating Profit (PBIT) 6,79,11,000/- Operating Profit to Revenue 10.89% International transactions (as mentioned in the 92CE Report) The following are the international transactions entered into by the tax payer with its associated enterprises (as per the 3CEB Report and as per the reference rec .....

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ling commission to AEs. In fact the assessee is providing software development services to overseas third party through its AE and some part of the services were also sub-contracted to the AE. Accordingly, the assessee is making payment on selling commission to its AE on cost plus 12%. Similarly, the assessee is also receiving sub- contracts work of software development services from AE which was ultimately meant for the third party as per the contract between the AE and the third party. However .....

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les for bench marking its transactions, the details of comparables are as under :- Sl.No. Name of the company 1. Akshay Software Technologies Ltd. 2. Aztec Software and Technologies Services Ltd. 3. Geometric Softweare Solutions Company Ltd. 4. iGate Global Solutions Ltd. 5. Maars Software International Ltd. 6. Mascon Global Ltd. 7. Melstar InformationTEchnologies Ltd. 8. Mphasis BFL Ltd. 9. Orient Information Technologies Ltd. 10. PSI Data Systems Ltd. 11. R S Software (India) Ltd. 12. Sasken C .....

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e of the company Margins (OP/OR) % WC Adjusted Margins (OP/OR) % 1. Bodhtree Consulting Ltd. 19.91 19.31 2. Lanco Global Solutions Ltd. 12.01 9.86 3. Exensys Softwre Solutions Ltd. 41.41 39.35 4. Sankya Infotech Ltd. 21.50 18.51 5. Sasken Network Ltd. Systems 14.27 13.42 6. Foursoft Ltd. 18.69 18.65 7. Thirdware Solutions Ltd. 39.79 39.77 8. R S Software (India) Ltd. 7.47 7.56 9. Geometric Solutions Ltd. Software 16.90 16.15 10. Tata Elxsi Ltd. (Seg.) 19.58 19.59 11. Visualsoft Technologies Ltd. .....

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part of the assessee's TP analysis which are at Sl. Nos.8, 9, 11, 12 & 13 of the above table. Thus the TPO has proposed an adjustment of ₹ 4,97,23,259 under Section 92CA of the Act. The assessee challenged the action of the TPO before the learned CIT (Appeals). The CIT (Appeals) did not agree with the methodology applied by the assessee as well as by the TPO wherein the entity level result was taken into consideration for determining the ALP. The CIT (Appeals) selected Cost Plus M .....

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the assessee has tested party Thus the CIT (Appeals) selected MAARS Software International Ltd., an Indian Company as comparable to test the price at the hand of the various AEs of the assessee in different countries. The operating margin of the MAARS was computed at 9.61% whereas the operating margin of the AEs of the assessee was recomputed by the CIT (Appeals) by disallowing marketing / selling expenses and accordingly the CIT (Appeals) made a TP Adjustment of ₹ 2,54,18,865 on this acco .....

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rmissible. He has further pointed out that since there was an acquisition of the assessee by the Mphasis BFL Limited therefore, due to this event of acquisition a proper representation could not be made before the authorities below. No notice was given to the assessee by the CIT (Appeals) to adopt a different method and AE as a tested party. Even otherwise, the profit margin of the AE has not been properly computed by the CIT (Appeals) as it has excluded certain expenses while computing the prof .....

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e objections against various companies selected by the TPO and one company namely Geometric Software Solutions Ltd. which was though selected by the assessee also however, as it is found to be not comparable with the assessee, therefore the assessee is seeking exclusion of the same from the set of comparables. The learned Authorised Representative of the assessee has submitted that the assessee is seeking the exclusion of the following companies : (i) Bodhtree Consulting Ltd. (ii) Exensys Softwa .....

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ity of the company cannot be considered as good comparable. He has further submitted that even otherwise this company is having its revenue from sale of products, sale of services to subsidiaries and therefore in the absence of segmental results, this company cannot be considered as a good comparable for software development services of the assessee. 5. Exensys Software Solutions Ltd. : The learned Authorised Representative of the assessee has submitted that the comparability of this company has .....

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Pvt. Ltd. in ITA No.1374/Bang/2011 vide order dt.19.9.2014. 7.1 Foursoft Limited & Thirdware Solutions Ltd. : The functional comparability of these two companies are also examined by the Tribunal in the case of Kodiak Network India Ltd. (supra). 7.2 The learned Authorised Representative has pointed out that Related Party Transactions (RPT) in the case of Thirdware Solutions Ltd. is 19.89% and therefore in view of the consistent view taken by this Tribunal regarding the threshold limit of th .....

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nch of this company in the case of ITO Vs. Sunquest Information Systems (India) Pvt. Ltd. in ITA No.1302/Bang/2011 vide order dt.11.6.2015. This company is functionally not comparable with the assessee. 10.1 Geometric Software Solutions Ltd. : The learned Authorised Representative has submitted that though the company was selected by the assessee, however, in view of the RPT of this company at 22.52%, this company cannot be considered as a good comparable. 10.2 On the other hand, the learned Dep .....

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e details as well as the information so as to arrive at a proper decision. Thus the learned Departmental Representative has submitted that the CIT (Appeals) was compelled to take a decision on its own as the assessee has failed to furnish the relevant details. The learned Departmental Representative has submitted that the assessee cannot take the advantage of its own wrong. As regards the functional comparability of the various companies as described by the assessee, the learned Departmental Rep .....

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the TPO has applied a filter of 25% RPT which is acceptable. 11.1 Flextronics Software System Ltd. : The learned Departmental Representative has submitted that the Tribunal in the case of Sunquest Information System Ltd. (supra) has observed that this company is also in the software development product service. However, there was no sale of software product during the year. Further, the TPO has considered the segmental data of this company as computed in the Annexure B of the T P order. When the .....

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llocation of certain expenses. Therefore, the recomputation made by the TPO cannot be relied upon. 11.3 We have heard the rival submissions and considered the relevant material on record. We find that the assessee took its operating margin at entity level and then compared the same with the mean margins of the selected comparables. The TPO has not objected to its methodology of the assessee but rejected certain comparables selected by the assessee and included the some more comparables in the se .....

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as the third party transactions in which the assessee has to pay the selling commission to the AE, the assessee adopted entity level operating margin for the purpose of bench marking its international transactions. However, this method is not permitted as per the provisions and rules of the transfer pricing under Income Tax Act and I.T. Rules and therefore to that extent, we find that the learned CIT (Appeals) was justified in rejecting the methodology applied by the assessee as well as by the .....

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heir profit margin by excluding certain expenses which we find is not permitted under the provisions of transfer pricing. Not only changing the tested party from the assessee to its AE, the CIT (Appeals) has also selected a domestic company as a comparable to the AE of the assessee. Therefore the entire exercise of determining the ALP by the CIT (Appeals) is contrary to the provisions of transfer pricing under the I.T. Act. Hence in view of the facts and circumstances of the case, we set aside t .....

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ficulty in selecting the comparable companies. Therefore we direct the TPO to apply the RPT filter at 15% instead of 25% and then consider the comparability of the companies. Since the assessee did not fully co- operate with the authorities below in the first round of the proceedings therefore we direct the assessee to co-operate in the proceedings before the A.O./TPO and furnish the relevant and requisite details in order determining the ALP. Needless to say that the Assessing Officer/TPO also .....

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A No.703 of 2009 in paras 11 to 13 as under : 11. We have considered the rival submissions made by the parties and perused the material on record. 12. On substantial question No.1, the assessing authority has extensively considered whether the activity carried on by the assessee is software development or technical service. It is an admitted fact, as per the assessment order, the role of the assessee is of developer of software and not a consultant to any project. It is also categorically held b .....

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is forming an integral part as embedded in the process of on site development of software. This view is upheld by the Appellate Commissioner. 13. We have perused the relevant provisions of the Act i.e., export turnover as defined under explanation (2)(iv) to section 10A of the Act. The said export turnover as per explanation (2)(iv) to section 10A of the Act means the consideration in respect of export by the undertaking of articles or things or computer software received in, or brought into, I .....

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dia by the assessee in convertible foreign exchange is an export turnover and what is excluded from this clause is (a) freight, (b) telecommunication charges or insurance attributable to the delivery of the articles or things or computer software outside India (c) expenses, if any, incurred in foreign exchange in providing the technical services outside India. Explanation (3) inserted by Finance Act, 2001 with effect from 1.4.2001 explains that the profits and gains derived from on site developm .....

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software outside India. In other words, the services rendered by the assessee relating to the development of computer software is deemed to be part of export turnover of computer software outside India. Respectfully following the decision of the Hon'ble jurisdictional High Court in assessee's own case, we direct the Assessing Officer/TPO not to reduce the expenses from the export turnover for computation of deduction under Section 10A of the Act. 13.1 Ground No.15 is regarding foreign t .....

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ure. 15. Ground No.18 is regarding penalty under Section 271(1)(c) of the Act is premature to deal with the issue. Revenue s Appeal 16. The Revenue has raised the following grounds : 1. The order of the learned CIT (Appeals) is opposed to law and facts of the case. 2. On the facts and in the circumstances of the case the learned CIT (Appeals) erred in holding the telecommunication expenses amounting to ₹ 38,63,601 and foreign currency expenses incurred for providing software development ou .....

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the issue of computing deduction under Section 10A by excluding the above expenses from export turnover and total turnover as well, has not reached finality in view of the pending Department s SLP before the Hon'ble Supreme Court. 4. For these and other grounds that may be urged at the time of hearing, it is prayed that the order of the CIT (Appeals) in so far as it relates to the above grounds may be reversed and that of the Assessing Officer may be restored. 5. The appellant craves leave t .....

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tional High Court reads as follows:- ………..Section 10A is enacted as an incentive to exporters to enable their products to be competitive in the global market and consequently earn precious foreign exchange for the country. This aspect has to be borne in mind. While computing the consideration received from such export turnover, the expenses incurred towards freight, telecommunication charges, or insurance attributable to the delivery of the articles or things or computer sof .....

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e total turnover. However, while interpreting the provisions of section 80HHC, the courts have laid down various principles, which are independent of the statutory provisions. There should be uniformity in the ingredients of both the numerator and the denominator of the formula, since otherwise it would produce anomalies or absurd results. Section 10A is a beneficial section which intends to provide incentives to promote exports. In the case of combined business of an assessee, having export bus .....

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of the undertaking. Even in the case of business of an undertaking, it may include export business and domestic business, in other words, export turnover and domestic turnover. To the extent of export turnover, there would be a commonality between the numerator and the denominator of the formula. If the export turnover in the numerator is to be arrived at after excluding certain expenses, the same should also be excluded in computing the export turnover as a component of total turnover in the de .....

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fined, and when the total turnover includes export turnover, the very same meaning given to the export turnover by the legislature is to be adopted while understanding the meaning of the total turnover, when the total turnover includes export turnover. If what is excluded in computing the export turnover is included while arriving at the total turnover, when the export turnover is a component of total turnover, such an interpretation would run counter to the legislative intent and impermissible. .....

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otal turnover to maintain parity between numerator and denominator while calculating deduction u/s 10A of the Act. The relevant finding of the Hon ble Mumbai High Court reads as follows:- The total turnover of the business carried on by the undertaking would consist of the turnover from export and the turnover from local sales. The export turnover constitutes the numerator in the formula prescribed by sub-section (4). Export turnover also forms a constituent element of the denominator in as much .....

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in convertible foreign exchange but so as not to include inter alia freight, telecommunication charges or insurance attributable to the delivery of the articles, things or software outside India. Therefore in computing the export turnover the legislature has made a specific exclusion of freight and insurance charges. The submission which has been urged on behalf of the revenue is that while freight and insurance charges are liable to be excluded in computing export turnover, a similar exclusion .....

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rent meaning when it forms a constituent part of the total turnover for the purposes of the application of the formula. Undoubtedly, it was open to Parliament to make a provision which has been enunciated earlier must prevail as a matter of correct statutory interpretation. Any other interpretation would lead to an absurdity. If the contention of the Revenue were to be accepted, the same expression viz. export turnover would have a different connotation in the application of the same formula. Th .....

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