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2016 (2) TMI 932 - ITAT PUNE

2016 (2) TMI 932 - ITAT PUNE - TMI - Transfer pricing adjustment - selection of comparables - Held that:- (i) KALS Information Systems Ltd., (ii) eZest Solutions Ltd. and (iii) Bodhtree Consulting Ltd. were engaged in ITES services and hence, the same being functionally dissimilar, should be excluded from the final set of comparables. - Genesys International Corporation Ltd as not functionally similar to the assessee, the said concern is to be excluded from the final list of comparables and .....

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ring the results of the said concern while benchmarking the international transaction of the assessee. Accordingly, we direct the Assessing Officer to exclude Goldstone Technologies Ltd. - Working capital adjustment - Held that:- We direct the Assessing Officer to re-compute the working capital adjustment in the hands of assessee in line with the directions given by the Tribunal in assessment year 2007-08 wherein have given directions for allowing working capital adjustment as per OECD guide .....

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ct'). 2. The assessee has raised the following grounds of appeal:- '1.1 The learned Assessing Officer erred in law and on facts in making an addition of ₹ 1,62,50,500 to the total income of the Appellant on account of adjustment to the arm's length price with respect to transaction of rendering services entered into by the Appellant with its associated enterprises. 1.2 The learned Assessing Officer erred in enhancing the value of the International Transactions of the Appellant .....

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and such companies should not be rejected for functional differences 2.3 The learned AO / DRP erred in rejecting some of the companies considered as com parable by the Appellant Company by applying the RPT criterion and by not appreciating that such companies did not have substantial transactions exceeding the threshold of 25% with the related parties during the relevant previous year and the RPT transactions were primarily in the nature of Investments. 3.1 The learned AO / DRP erred in conside .....

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f the said six companies were not comparable to the Appellant Company in terms of size and scale as the Turnover of such companies was substantially higher. 3.4 The learned AO / DRP erred in not appreciating that some of the six companies additionally included as comparable were engaged in totally different activities such as e-mapping activities, activities related to Media, TV, set-top boxes and Movie rights, designing and engineering activities etc and were not functionally comparable to the .....

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s additionally included in the list of comparables showed fluctuating operating margins in the earlier 2 - 3 years and therefore the operating results of such companies could not be relied upon and considered for the purposes of comparison. 3.7 The learned AO / DRP erred in not appreciating that some of the above six companies additionally included as comparable have shown more than ordinary profits (exceeding 30%) and it is not appropriate to compare such companies having higher than ordinary p .....

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ses of support staff, expenses incurred for training of employees while calculating operating profits from as well as operating costs related to the International transaction of export of services and erred in not appreciating that such expenses did not form part of the "Service Provider costs" as per the terms of the Inter-company services agreement. 5.1 The learned AO / DRP erred in holding that the Appellant Company had not discharged its onus to file requisite information pertainin .....

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securities and also had submitted the working of risk adjustment by applying the Capital Asset Pricing Model (CAPM). 5.3 The learned AO / DRP erred in holding that the Appellant Company had assumed more critical risks as compared to the Associated Enterprise and was entitled for higher remuneration. 5.4 The learned AO / DRP erred in not following the ratio of various judgements relied upon by the Appellant Company and erred in not granting suitable risk adjustment. 6.1 The learned AO erred in n .....

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of relevant working to the appellant company. 7.1 The learned AO / DRP erred in not granting the benefit of adjustment of + / - 5% as provided in Section 92C(2) of the Income Tax Act, 1961. 7.2 The learned AO / DRP erred in not following the ratio of various judgements relied upon by the Appellant company. 8. The learned AO / DRP erred in not appreciating that in the case of the Appellant Company, such a high margin was not at all comparable as the Appellant Company is engaged in rendering low- .....

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ot appreciating that for the purposes of bench-marking, profit after tax should have been considered and tax cost should have been considered as a part of operating costs as the Appellant Company was eligible to claim benefit of deduction u/s.10A and the basic nature of such benefits / incentives is to help the software companies compete globally. 10.1 The learned AO / DRP erred in not appreciating that the Appellant Company was eligible to claim tax holiday u / s.10A and had no reason to manipu .....

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er consideration. 11. The Ld. AO has erred in law and on facts in levying interest under section 234B of the Act. 12. The Ld. AO has erred in law and on facts in levying interest under section 234C of the Act given the fact that no interest is leviable as per returned income. 13. On the facts and in the circumstances of the case, the learned AO has erred in initiating penalty proceedings under section 271(1)(c) of the Act. 14. The Appellant submits that the above grounds are independent and with .....

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h its associate enterprises totaling ₹ 1,62,50,500/-. The assessee has also raised the consequential issue of charging of interest under section 234B and 234C of the Act vide grounds of appeal No.11 and 12. Further, the assessee is aggrieved by initiation of penalty proceedings under section 271(1)(c) of the Act vide ground of appeal No.13. The said issue is premature and hence, the ground of appeal No.13 raised by the assessee is dismissed. The ground of appeal No.14 raised by the assesse .....

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red into by the assessee with its associate enterprises. The TPO noted that the international transaction undertaken by the assessee during the year under consideration, as per TP report and Form No.3CEB was Automated Database creation and building Software Products to the tune of ₹ 20,85,85,805/-. For benchmarking the said international transaction, the assessee had adopted TNMM method as most appropriate method. For the purpose of analysis of international transaction, entity level Opera .....

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length. The TPO issued show cause notice to the assessee to provide search criteria on the details of functional comparability of the selected companies. In reply, the assessee furnished submissions from date to date. After considering the submissions of the assessee together with the facts of the case, the TPO was of the view that the companies selected by the assessee were not comparable and tabulated the details in respect of each of the companies as provided at pages 24 to 27 of the order of .....

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46% worked out by the assessee in respect of its international transaction. So in this regard, adjustment over operating income was proposed to be ₹ 2,29,68,091/-. Further, the assessee had asked for risk adjustment on account of various factors. However, after considering the details including the transfer pricing report of the assessee, the TPO vide para 15 observed that the assessee was risk bearing entity, which had borne most of the risks relevant to its business and it was wrongly co .....

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arables, hence, there was no requirement of any adjustment on account of risk adjustment. Further, the working capital adjustment asked for by the assessee was also not allowed to the assessee. Further, in addition, the assessee had requested that the safety harbor benefit of +/- 5% range as per section 92C(2) of the Act may be given to it, which was also rejected in view of various decisions of the Tribunal in this regard. Accordingly, the TPO proposed an adjustment of ₹ 2,29,68,091/- on .....

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n Ltd. from the final set of comparables and also allowed working capital adjustment. In this regard, reference again was made to the TPO, who in turn, furnished its reply and proposed an adjustment of ₹ 1,62,50,500/-. The said adjustment was adopted by the Assessing Officer while completing assessment in the hands of assessee, against which the assessee is in appeal. 5. The learned Authorized Representative for the assessee pointed out that in the final analysis, the margins of 11 compani .....

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ng its international transactions vis-à-vis the set of comparables picked up by it. In the first round, the assessee had selected 15 companies, which had margins of 5.81% on account of OP/OC. The TPO had rejected 9 companies out of 15 companies and hence, only considered 6 companies selected by the assessee, but included 7 new companies. The DRP had directed the TPO to exclude FCS Software Solutions Ltd. and DRP also confirmed the rejection of 9 companies as made by the TPO. Hence, the DR .....

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arned Authorized Representative for the assessee drew our attention that the final set of comparables selected by the TPO in the second round and the TPO had included certain companies, which were not engaged in software development. He further stressed that out of balance 11 companies, the assessee was objecting to inclusion of margins of 5 of the companies and in respect of balance, the learned Authorized Representative for the assessee pointed out that it had no objections if the margins of t .....

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copy of which is placed in Paper Book. The learned Authorized Representative for the assessee pointed out that the year under appeal was also assessment year 2008-09 and the Tribunal had also taken same view and the same may be adopted for excluding KALS Information Systems Ltd., then eZest Solutions Ltd. and Bodhtree Consluting Ltd. In respect of Genesys International Corporation Ltd., the learned Authorized Representative for the assessee pointed out that the functions were totally different .....

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the order of TPO in this regard. The learned Authorized Representative for the assessee made reference to various decisions of Hyderabad and Bangalore Benches of Tribunal and pointed out that the said comparable was rejected in view of the said company being functionally different. Similar proposition was raised in respect of Goldstone Technologies Ltd., wherein the said company was also selected on the basis of turnover. In respect of working capital adjustment, which was directed to be allowe .....

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iple grounds of appeal against the addition of ₹ 1,62,50,500/- made to the value of international transactions entered into by the assessee with its associate enterprises while providing software development services in the field of Automated Database creation and building Software Products to the tune of ₹ 20,85,85,805/-. The assessee was engaged in carrying out software development, support and maintenance, related documentation, and testing and relative services. The above said se .....

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s of the comparables and after selecting new set of comparables and after rejecting some of the comparables selected by the assessee, had computed the PLI of the comparables at 25.47% as against the PLI of the assessee at 13.46%. The TPO, thus, proposed an adjustment of ₹ 2,29,68,091/- on account of arm's length price of international transactions undertaken by the assessee with its associate enterprises. The DRP revised the determination of adjustment to be made under section 92CA(3) .....

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Valuemart Info Technologies Ltd. 26.13% 8 Bodhtree Consulting Ltd. 19.14% 9 eZest Solutions Ltd. 28.58% 10 FCS Software Solution Ltd. 57.02 11 Goldstone Technologies Ltd. 27.06% 12 KALS Information Systems Ltd. ((application software seg) 41.94% LGS Global Ltd. 26.33% Total 331.13 Arithmetic Mean 25.47 8. The DRP accepted the objection of the assessee in respect of FCS Software Solutions Ltd. and the same was not adopted as a comparable in the final determination of arithmetic mean of margins o .....

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ew of the Pune Bench of Tribunal in Barclays Technology Centre India (P.) Ltd.'s case (supra). 10. The assessee was providing software development services to its associate enterprises and the claim of the assessee before us was that the concern KALS Information Systems Ltd. was to be excluded from the list of comparables since the said concern was not only involved in the activity of providing software development services but was also engaged in selling of software products. 11. We find th .....

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on Systems Ltd. be excluded from the final set of comparables. On this aspect also, the case set up by the assessee is that the decision of the Pune Bench of the Tribunal in the case of Symphony Services Pune Pvt. Ltd. (supra) fully covers the controversy. In the case of Symphony Services (supra), M/s. Kals Information Systems Ltd. was excluded from the list of comparables on the ground that the said concern was involved not only in the activity of providing of software development services but .....

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ny Services Pune Pvt. Ltd. (supra) is similar. It is also quite clear that the nature of service being rendered by the assessee and Symphony Services Pune Pvt. Ltd. (supra) are similar, namely rendering of software development services to its affiliates. The following discussion in the order of the Tribunal in case of Symphony Services dated 30-04-2014 (supra) brings out the salient features of the controversy : "13. The second point raised by the assessee is with regard to the adoption of .....

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ERP "SHINE", etc., which are all specialised software products developed for the respective sectors. For the instance, Virtual Insure was said to be a web based solution that was useful in the insurance sector; La Vision was an e-commerce based application in the field of intra-organizational communications, etc.; and, CMSS was a software for consultants/agents to manage their customers pre and post sales. On this basis, it was sought to be made out that the assessee was functionally .....

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the learned counsel for the assessee has vehemently pointed out that the plea of the assessee has been rejected by the income-tax authorities without any justifiable reasons, as even on the basis of the information available in the public domain it is quite evident that Kals Information System Limited was a concern which was developing and selling software products, which was an activity quite distinct from the activity of software development undertaken by the assessee. In the course of hearing .....

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lso a concern engaged in rendering software development services for its parent company. The action of the TPO of selecting Kals Information Systems Limited as a comparable concern while applying the TNM method was rejected by the Tribunal on the basis that the said concern was engaged in development of software products and sale, which was functionally dissimilar to the software development services undertaken by the Bindview India Pvt. Ltd. (supra). The learned counsel pointed out that the sai .....

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Limited was not considered as a comparable on account of functional dissimilarities. The learned counsel pointed out that M/s 3DPLM Software Solutions Ltd. (supra) was also a concern engaged in the provision of software development and other related services, which is similar to the functions undertaken by the assessee. It was pointed out that the functions of Kals Information Systems Limited considered by the Bangalore Bench of the Tribunal is for the same assessment year as is in the present c .....

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) Ltd. (supra) and the decision of the Bangalore Bench of the Tribunal in the case of M/s 3DPLM Software Solutions Ltd. (supra) relied upon by the assessee squarely cover the controversy relating to Kals Information Systems Limited. In the aforesaid two precedents, the said concern has been sought to be excluded from the list of comparables on account of functional dissimilarities. The Bangalore Bench of the Tribunal in the case of M/s 3DPLM Software Solutions Ltd. (supra) has considered the fun .....

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h activity is quite distinct from the developing and selling of software products. The Pune Bench of the Tribunal in the case of Bindview India (P.) Ltd. (supra) has also found the said concern to be functionally dissimilar from a concern which was engaged in the business of software development services, which is the case before us. Though, the decision of the Tribunal in the case of Bindview India Pvt. Ltd. (supra) relates to the assessment year 2006-07 whereas the present case of the assessee .....

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transactions of provision of software development services. We hold so. Thus, on this aspect assessee succeeds.' 12. The second objection raised by the assessee was against inclusion of eZest Solutions Ltd. This concern was also excluded by the Tribunal in Barclays Technology Centre India (P.) Ltd.'s case (supra) for the proposition that the said concern was in the business of providing e-business services, which were in the nature of Information Technology enabled Services (ITES) and n .....

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nd not comparable to the functions performed by the assessee. Before the TPO, assessee had also pointed out that the said concern was also undertaking sale of software products which was quite distinct from the activity of the assessee which was merely providing software development services to its associated enterprises. It was also pointed out that there was no segmental data relating to the segment of software development service available in the context of the said concern. Thus, as per asse .....

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ssee and in this context, he relied upon the decision of the Pune Bench of the Tribunal in the case of Symphony Services Pune (P.) Ltd. vide ITA No.257/PN/2013 dated 30-04-2014 for A.Y. 2008-09. Relevant discussion in the order of Symphony Services Pune (P.) Ltd. (supra) with respect to E-Zest Solutions Ltd. reads as under : "19. The last point raised by the assessee is to exclude E-Zest Solutions Limited from the list of comparables for the purposes of benchmarking the international transa .....

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ultancy services being provided by the said concern do not pertain to software development services but are ITES services. Assessee also submitted before the TPO that the said concern does not provide any segmental data and being a highly diversified company, it is not possible to segregate data relating to the segment of software development services being undertaken by the said concern. 20. The TPO has considered the submissions of the assessee as per his discussion in para 16.3 of the order. .....

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n has been appreciated by the Bangalore Bench of the Tribunal in the case of 3DPLM Software Solutions Ltd. (supra) whereby the said concern has been held to be functionally dissimilar to a concern which was undertaking functions similar to those performed by the assessee. Accordingly, reliance has been placed on the decision of the Bangalore Bench of the Tribunal in order to justify the exclusion of the said concern from the list of comparables. 22. On the other hand, the learned CIT-DR has refe .....

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consultancy services including portal development services, etc.. It is sought to be explained that such kind of services are ITES services which are understood as KPO services. It was also pointed out that the said concern has not provided any segmental data in its Annual Report. Before us, it is sought to be contended that the KPO services are not comparable to the software development services being rendered by the assessee and therefore concerns which render KPO services cannot be considere .....

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with regard to the functions being performed by E-Zest Solutions Limited have not been controverted by the Revenue. Ostensibly, E-Zest Solutions Limited is rendering product development services and technology services, and the latter falls in the category of KPO services and the same have not been held by the Bangalore Bench of the Tribunal to be similar to a concern engaged in rendering of software development services, as is the assessee before us. Following the ratio of the decision of the B .....

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der dated 30-04-2014 (supra) considered the inclusion of E-Zest Solutions Ltd. for the purpose of comparability analysis of the transaction of development services for the very same assessment year, i.e. 2008-09, which is also the year before us. Following the aforesaid discussion which squarely covers the controversy in the present case, we direct that E-Zest Solutions be excluded from the final set of comparables.' 13. The third comparable which was directed to be excluded from the final s .....

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ulted in fluctuation of margins over the years. The relevant findings of the Tribunal are as under:- '20. The next point raised by the assessee is for exclusion of Bodhtree Consulting Ltd., from the final set of comparables. The main plea of the assessee is that the said concern is engaged in development and sale of software products and therefore it is not functionally comparable to the assessee. It is also pointed out that the said concern is engaged in product engineering and content engi .....

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e income would be recognized in a subsequent year. This business model results in fluctuation in margins over the years. The counsel for the assessee submitted that the Pune Bench of the Tribunal in the case of QLogic (India) (P.) Ltd. v. DCIT (ITA No.227/PN/2014) for assessment year 2009-10 dated 21.10.2014 has excluded the said concern from the list of comparables in a similar situation by following the decision of the Bangalore Bench of the Tribunal in the case of M/s. Mindteck (India) Ltd., .....

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he TPO, the material on record does not justify the assertions of the assessee that the said concern was engaged in development and sale of software products. The Ld. CIT-DR has opposed the plea of the assessee by referring to the stand of the TPO as contained in his order. 22. We have carefully considered the rival submissions with respect to Bodhtree Consulting Limited. The plea of the assessee is that the said concern is engaged in the sale of software products, apart from considering softwar .....

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sulting Limited 21. On this comparable, case of the assessee is that the company is not a good comparable in view of the Software Products produced by the company. As such, no segmental data is adequately available too. Accordingly, we dismiss the argument of the Ld. DR in this regard. Ex consequenti, the AO/TPO is directed to exclude the same from the list of final comparables for working out the arithmetic mean. 22. On the other hand, Ld DR filed a copy of the financial statement and argued ve .....

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product based company by the TPO in the TP study of other case and the TPO cannot take different stand in this case. In this regard, we have perused the para 29 of the order of the Tribunal in the case of M/s. Wills Processing Services (I) (P.) Ltd (supra) wherein it was mentioned that the TPO described this company is engaged in the business of software products, not the software development services. Relevant portions from the said para 29 of the order of the Tribunal is reproduced here under .....

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d end to end web solutions, software consultancy, design and development of software, using the latest technologies. Further, the company has identified only one segment i.e software development. Therefore, the Id AR has submitted that this company is functionally not comparable with the assessee and consequently should be excluded from the comparables. 29.2 On the other hand, the Id DR has filed the information collected u/s 133(6) of the I T Act and submitted that as per this information, this .....

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td to the TPO Hyderabad that the company is providing data cleaning services to clients for whom it had developed the software application" "23. Considering the above, we are of the opinion that Bodhtree Consulting Ltd. is not engaged in the software development services and there is no segmental data comparable. Therefore, the FAR analysis goes against the TPO/AO." 23. There is no material placed before us which would require us to deviate from the conclusion drawn by the Mumbai .....

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se of Mindteck India Ltd. (supra) is worthy of notice : "I. Bodhtree Consulting Ltd. : As far as this company is concerned, the submission of the learned counsel for the assessee was that this company made extraordinary profits during the previous year. Our attention was drawn to the fact that the operating profit/operating cost of this company jumped from 17% for F.Y. 2007 -08 to 56% in F.Y. 2008 -09. It dipped in F.Y.2009 -10 to 40% and in F.Y.2010 -11 it became (-) 2% and 5% in F.Y.2011 .....

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and only in such circumstances, high profit margin companies can be excluded. Our attention was drawn to the DRP's observation in its order on the issue which is as follows : "Bodhtree : The assessee has objected to selection of this entity on the basis of the following objections : The entity has fluctuating margins. The company is more of a product company rather than software service company. The Panel has considered the objections of the assessee. Insofar as the contention regarding .....

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tal hours worked to arrive at the revenue that is to be recognized. The second is the Fixed Price Project Model, the total contract price is agreed upon between the parties. Billing may be done either at the end of the contract or over the period of the contract on the basis of the agreed milestone for billing. In this respect, the basis of revenue recognition by this entity can be seen from the annual report as below : 3. Revenue Recognition : Revenue from software development is recognized bas .....

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tuation, an entity engaged in the development of software, being functionally comparable to the assessee, cannot be rejected only on this ground". 14. The learned counsel for the assessee drew our attention to the fact that Bodhtree Consulting admittedly follows a fixed price project model whereby revenues from software development is recognized based on software and billed to clients. In such business model expenditure for developing software would be billed in an earlier year but the reve .....

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with the question as to whether higher profit margin making companies should be excluded as a comparable. The Special Bench after considering several aspects held in para 88 of its order that the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special Bench held that in such cases it would require further investigation to ascertain the reason for unusually high profit and in order to establish whether the entities with such high pr .....

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the assessee were also perused. Perusal of the same shows, that there has been a consistent change in the operating margins. The chart filed by the assessee in this regard is given as an annexure to this order. It appears to us that the revenue recognitions method followed by the assessee is the reason for the drastic variation in the profit margins of this company. In the given circumstances, we are of the view that it would be safe to exclude Bodhtree Consulting from the final list of comparab .....

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services was being recognized based on the software developed and billed to the clients. In such a business model, the possibility of the expenditure not being booked on the basis of the matching principle cannot be ruled out, which would impart fluctuation in the margins over the years. In contrast, in the present case, the revenue is being recognized based on the cost plus markup basis. Clearly, the revenue recognition model of Bodhtree Consulting Ltd. is quite different from the model being .....

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both the assessee and Barclays Technology Centre India (P.) Ltd . were engaged in providing software development services. However, the TPO had selected the companies which were functionally dissimilar to the assessee before us i.e. all the three companies i.e. (i) KALS Information Systems Ltd., (ii) eZest Solutions Ltd. and (iii) Bodhtree Consulting Ltd. were engaged in ITES services and hence, the same being functionally dissimilar, should be excluded from the final set of comparables. Accord .....

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d the profile of the said concern and has giving a finding that the company was engaged in providing geographical information services comprising of photogrammetry, remote sensing cartography, data conversion related computed based services and other related services. Further, the business of the said concern required skilled manpower and scientists, civil engineers, etc. and the concern was also carrying out research and development services and owned intangibles. In view thereof, the Tribunal .....

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asoning, where the concern selected by the TPO was not functionally similar to the assessee, the said concern is to be excluded from the final list of comparables and accordingly, we direct so. 16. Now, coming to the objections raised by the assessee with regard to inclusion of concern Goldstone Technologies Ltd. 17. The learned Authorized Representative for the assessee pointed out that before the DRP, it was pointed out that the said concern Goldstone Technologies Ltd. was engaged in the activ .....

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tion of the assessee. Accordingly, we direct the Assessing Officer to exclude Goldstone Technologies Ltd. 18. Now, coming to the next plea of the assessee with regard to working capital adjustment. 19. The claim of the assessee before us was that though the DRP had directed the TPO to allow working capital adjustment, but the same was not allowed as per OECD guidelines. However, the learned Authorized Representative for the assessee pointed out that the Tribunal in assessee's own case relati .....

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on account of working capital, then such working capital adjustment is to be made in the hands of the companies, which are picked up as comparables to bring the same to the level of the assessee, while benchmarking the international transactions entered into by the assessee. Thus, an endeavour is to be made to bring the results of comparables at par with the results of the tested party as if the same are working in the same environment. In the case of the assessee, where it is benefitted on acc .....

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