TMI Blog2016 (3) TMI 1184X X X X Extracts X X X X X X X X Extracts X X X X ..... ring ITES be taken at ₹ 4,86,98,278 (Rs.7,30,47,418 *100/150). The remaining employee cost is relatable to software development services. We have also gone through an Agreement with M/s Wells Fargo India Solutions Pvt. Ltd., which is a non-AE and the assessee has rendered software development services to this Indian company also. It is common submission that agreements with other non-AEs are on the same terms as with M/s Wells Fargo. No mechanism has been set out under this Agreement for determining the Personnel costs incurred by the assessee in rendering services to non- AE. In the absence of any mechanism for apportionment of employee cost between AE and non-AE transactions of software development services, we direct that the remaining personnel costs (after exclusion of ₹ 4,86,98,278) be apportioned between AE and non-AE transactions in the ratio of revenue. Operational and other expenses - TPO, in the first step, has bifurcated such expenses along with others in the ratio of revenue from software development and ITES segments. Then he reduced nonoperational expenses of Financial expenses, Forex loss, Provision of doubtful debts, Loss on sale/discarded of fixed a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany also. Comparability of each company needs to be ascertained only after matching the functional profile and the relevant factors of the other company. International transaction of `Software development’ of the assesseee need to be considered while selection comparable. Addition on account of re-allocation of indirect costs amongst eligible units (section 10A) and non eligible unit on the basis of gross revenue receipts - Held that:- It prima facie appears from the language of the assessment order that the assessee maintained consolidated accounts and apportionment of expenses was done at the instance of the AO alone. Be that as it may, we have to decide the basis of allocation of indirect expenses, for which the assessee also conceded to some extent before the DRP for apportionment on certain basis given in the paper book. We agree with the Ld. AR that all the expenses cannot be apportioned on the basis of gross receipts from each unit. There are certain expenses which have separate keys for allocations. In such circumstances, each expenditure needs to be viewed from the apportionment angle separately and there cannot be a strait jacket formula for apportioning them on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3,009 Operating Expenses Total Cost 1,60,05,39,757 Total Expenses 1,60,05,39,757 Less : Non-Operational Expenses Financial Expenses 15,40,275 Forex Loss 6,00,71,190 Provision for doubtful debts 96,526 Loss on sale/discard of fixed assets 19,21,957 Provision for doubtful advances 20,41,221 Total Operating Expenses 1,53,48,68,589 Operating Profit 22,66,44,420 OP/OC 14.77% 3. After making certain inclusions/exclusions in the list of comparables drawn by the assessee, the TPO worked out average profit margin of the finally selected comparables at 24.88%. Such profit rate of 24.88% was applied on total operating costs incurred by the assesseee at ₹ 153.48 crore to work out transfer pricing adjustment amoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the fore that the amount of revenue from `Provision of software development services is only ₹ 1.34 crore. This shows that the balance amount is revenue from non-AE transactions. An addition towards transfer pricing adjustment can be made by comparing the assessee s profit rate from the international transaction with that of comparable uncontrolled transactions. Under the TNMM, the process is simple in initially finding out the operating profit margin of the assessee and then the average adjusted operating profit margin of comparables. Such adjusted profit margin of the comparables constitutes benchmark margin, which is then matched with the operating profit margin from the assessee s international transaction (which is always with AE). It is not permissible to make transfer pricing adjustment, by applying the average operating profit margin of the comparables, on the assessee s universal transactions entered into with both the AEs and non-AEs. As the entire exercise under Chapter-X is confined to computing total income of the assessee from international transactions having regard to the arm s length price, there is no scope for computing income from noninternational transac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... plus 50% mark up. Definition of `Cost has been given in Exhibit B of the Agreement between the assessee at its US AE : `to mean all employees expenses . The term `employees expenses has been further defined to mean : `the actual payroll costs of the employees and does not include the employee expenses which are reimbursed separately without markup . This divulges that the assessee has been compensated under ITES at 50% over and above employees cost. Since the revenue from this international transaction representing 150% is ₹ 7,30,47,418, we hold that the employee cost for rendering ITES be taken at ₹ 4,86,98,278 (Rs.7,30,47,418 *100/150). The remaining employee cost is relatable to software development services. We have also gone through an Agreement with M/s Wells Fargo India Solutions Pvt. Ltd., which is a non-AE and the assessee has rendered software development services to this Indian company also. It is common submission that agreements with other non-AEs are on the same terms as with M/s Wells Fargo. No mechanism has been set out under this Agreement for determining the Personnel costs incurred by the assessee in rendering services to non- AE. In the absence of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount. This amount of rent has been taken as nonoperating income and rightly so. Once rent is non-operating, then the amount of depreciation on the assets yielding rent cannot also be treated as operating expenses. Accordingly, we direct that the above discussed exercise of bifurcating `Other Operating expenses be carried out in respect of Depreciation also, but after reducing such amount of depreciation as relates to the assets fetching rental income. c) Selection of Comparables 8. The assessee agitated inclusion of certain companies by the TPO in the final list of comparables and also sought intervention on certain companies which, in its opinion, ought to have been included in such list, which have been ignored by the TPO. 9. Before going into the question of comparability of the companies assailed before us, it is relevant to understand the nature of activity carried out by the assessee in rendering software development services to its AEs. As per Agreement dated 1.1.2009 between the assessee and Hedstrong UK Limited, a copy of which has been placed on record, there is an elaboration of `Services as per Exhibit A. This Exhibit stipulates that the assessee is `engaged ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any B , but has related party transactions (RPTs) breaching a particular level, then, such company cannot be considered as comparable to company A in the year in which the RPTs breach such a level. If, however, in the subsequent year, the related party transactions fall below that limit, then such company would again become comparable. To put it simply, if company A has been held to be incomparable vis-a-vis company B , then it is not essential that company A would be incomparable to company C also. What is relevant to consider is, firstly, the functional profile of company A vis-a-vis company C . If both are functionally similar, then notwithstanding the fact that company A was held to be incomparable to company B , it may still be comparable to company C . Despite the fact that company A is functionally similar to company B , it may still have been declared as incomparable to company B because of other relevant reasons. If company A passes the same reasons vis-a-vis company C , then company A will find its place in the list of comparables of company C , notwithstanding the fact that it was held to be incomparable to company B . The crux of the matter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... includes consultancy charges. No doubt Consultancy charges in relation to Software Development are part of overall Software Development, but the inclusion of ITES in the overall segment frustrates the comparability. We are currently dealing with the international transaction of `Provision of Software Development services and the international transaction of ITES is separate which has also been benchmarked distinctly. In our considered opinion, e- Infochips Bangalore Ltd. having a pool of both software developments and ITES segments into the overall segment designated as `Software development , cannot be considered as comparable on entity level with the international transaction of `Software development of the assesse. We, therefore, order for the exclusion of this company from the list of comparables. (ii) Infinite Data System Pvt. Ltd. 13.1. Rejecting the assessee s contention that the financial data of this company was not available in the public domain, the TPO included it by observing that it was engaged in providing software technical services to sole customer, viz., Fujitsu Services Ltd. The TPO has also narrated the services rendered by this company which were foun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reafter it was also argued that since Infinite Data System is providing Services to its sole customer and the terms of providing services to the sole customer are governed / controlled by the AE of this company and hence it should be treated as a controlled transaction. This submission is in the air. No relevant material worth the name has been placed on record to substantiate this contention of controlled transaction. 13.4. Last argument of the ld. AR about the different business model adopted by this company in the sense of receiving deficit charges arising on account of under utilization of its resources, again, fails to convince us in ordering the exclusion of this otherwise functionally comparable company. Our first reason for such decision is that such charges standing at ₹ 31.38 lakh are less than even 1% of the revenue from the customer. Once the functional comparability is accepted, at the most, this factor may require adjustment in the profit rate of this company taken as comparable, rather than excluding the company from the list of comparables. Further, such an adjustment can be made, if it is shown that the assessee s capacity also remained under-utilized with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ner, there remains absolutely no doubt that Infosys Technologies Ltd. is incomparable to the assessee company. Respectfully following the judgment of the Hon ble jurisdictional High Court in Agnity India (supra), we hold that Infosys Technologies Ltd. cannot be treated as comparable to the assessee company. This company is, therefore, directed to be excluded from the list of comparables. (iv) Sonata Software Limited 15.1. The TPO proposed this company as comparable which was objected to by the assessee on the ground that it has significant Related Party Transactions (RPTs). The TPO computed RPTs from the items of Profit Loss items of this company at 11.93%. The remaining items pertaining to the balance sheet was ignored. That is how, the TPO found this company to be comparable. The assessee has challenged the computation of the RPTs. 15.2. We have heard both the sides and gone through the relevant material on record. It is found that the predominant view of the Tribunal across the country in several cases is that the transactions of a company having more than 25% of Related Party Transactions (RPTs) are considered as controlled, thereby failing the test of comparabilit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch has not rendered any hardware services. We, therefore, eliminate this company from the list of comparables. 17. Now we will examine the companies refused by the TPO, which the assessee claims, as comparable. (i) CG-VAK Software Exports Limited 18.1. The assessee treated this company as comparable, which the TPO refused to accept. The assessee insists on the inclusion of this company in the list of comparables. 18.2. After going through the relevant material on record including the Annual report of this company, we find that its Profit loss account indicates `Income from Software Development, Services Products . It is further discernible that it is engaged in Research Development activity. This factor is traceable from page 6 of its Annual report which indicates: `The nature of business of software development involves inbuilt, constant Research and Development as a part of its process of manufacturing (development). The Company is developing application engines, re-usable codes and libraries as a part of its R D activities . A perusal of the above narration indicates that this company is also engaged in undertaking Research Development activities under t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts of the extant case, we find that insofar as the functional comparability of these companies is concerned, the TPO has not disputed the same. The only reason given for their exclusion is the non-availability of data for the relevant financial year. The ld. AR contended that though the year endings of the above company were different, yet, the assessee was in a position to put forward their data for the Financial year 1.4.2009 to 31.3.2010 from their Annual reports only. It was so stated on the basis of the availability of the quarterly data from the Annual reports of these companies, which could be adjusted for the financial year ending 31.3.2010. If the contention of the assessee is correct, that the relevant data for the concerned financial year can be deduced from the information available from their annual reports, then, there can be no objection to their inclusion in the list of comparables with the adjusted data for the relevant financial year itself. Under such circumstances, we set aside the impugned order and remit the matter to the file of TPO/AO for examining this aspect of the matter. It is clarified that only if the assessee succeeds in providing the relevant data of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of comparables by including some new companies and excluding some from the list of the assessee. Thereafter, he re-worked out the operating profit margin of the assessee from this international transaction and consequential transfer pricing adjustment, as under :- Operating Income Income from operations 73,047,418 Misc. Income 35,873 Total Operating Income 73,083,291 Operating Expenses Total Cost 66,404,683 Total Expenses 66,404,683 Less : Non-Operational Expenses Financial Expenses 6 3 ,904 Forex Loss 2,492,289 Provision for doubtful debts 4,005 Loss on sale/discared of fixed assets 79,740 Provision for doubtful advances 84,688 Total Operating Expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... penses are directed to be apportioned, as deduced after deduction of five items treated by the TPO as of nonoperating nature, in the ratio of revenue from the transactions of Software development with AEs, non-AEs and ITES. This working will give the figure of operating profit margin of the assessee from the international transaction of ITES. (b) Comparables 26. Here again the assessee has challenged certain inclusions and exclusions made by the TPO. Before taking up the comparability or otherwise of the companies disputed before us, it is sine qua non to consider the nature of services rendered by the assessee under this international transaction. Exhibit B of the Agreement with Headstrong US, divulges the nature of ITES provided by the assessee, which are - Accounting Services, Recruitment, Project Management, Human Resources and Quality and Assurance . Now, we will proceed to examine if the companies chosen by the TPO but challenged by the assessee, are really comparable. (i) Accentia Technologies Ltd 27.1. The assessee objected to the inclusion of this company in the list of comparables on several grounds including peculiar economic circumstances owing to acqui ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with high level of foreign expenditure and abnormal profits. The TPO noticed that this company was also offering ITES. 29.2. We have heard the rival submissions and perused the relevant material on record. The Annual report of this company is available in the paper book. Notes to Accounts indicate that this company is engaged in the business of providing IT enabled services/BPO services primarily to Citigroup entities globally. The operations of this company : broadly comprise of transaction processing and technical services. Transaction processing includes the broad spectrum of activities involving processing, collections, customer care and payments in relation to the services offered by Citigroup to its corporate and retail clients. Technical services involve software testing, verification and validation of software at the time of implementation and data centre management activities. It is manifest that this company is engaged in rendering BPO services to the banking and financial services industry (BFSI) and Travel, Tourism and Hospitality (TTH). It is providing services to BFSI and TTH and such services include `Transaction processing and `Technical services . In other w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion, it is overt that a company providing software development services is distinct from and incomparable with a company providing non-development software services. 29.3. We find that the assessee under this international transaction has provided only ITES or non-development software services, in the nature of Accounting, Recruitment and Project management etc. On the other hand, this company is also providing `Technical services to its AE involving software testing, verification and validation of software, which are akin to software maintenance services falling, within the overall category of `Software development services . The TPO has taken entity level figures of TCS E-Serve International Ltd. for comparison. There is no bifurcation available in respect of the revenues of this company from Transaction processing (which are in the nature of ITES, the same as provided by the assessee) and Technical services (which are in the nature of software development, absent in the assessee s case). In the absence of the availability of any such segregation of the total revenue of this company, it is not possible to separately consider its profitability from rendering of `Transaction pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent is, therefore, rejected. 30.3. In so far as the objection of the ld. AR about the high profit/high turnover of this company is concerned, we find that the Hon ble Delhi High Court in ChrysCapital Investment Advisors (India) P. Ltd. vs. DCIT (2015) 376 ITR 183 (Del) has held that the mere fact that an entity makes high/extremely high profits/losses does not, ipso facto, lead to its exclusion from the list of comparables for the purposes of determination of ALP. Similar view has been taken in Rampgreen Solutions Pvt. Ltd vs. CIT (2015) 377 ITR 533 (Del) to the effect that a potential comparable cannot be excluded merely on the ground of its abnormally higher profit. It is further noticed that the Hon ble Delhi High Court in CIT Vs. Agnity India Technologies (P.) Ltd. (2013 ) 219 Taxman 26 (Del) examined the comparability of Infosys Technologies from the angle of its inclusion or otherwise in the list of comparable of Agnity India Technologies, a captive unit providing ITES to its AE alone. In that case, the TPO treated three companies as comparable, namely, Satyam Computer Service Ltd., L T Infotech Ltd. and Infosys Technologies. The DRP excluded Satyam Computer only. The Trib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Account indicates revenue from operations from ITES. It can be seen from the further data available on the record that it is engaged in providing ITES. We, therefore, hold this company to be comparable. (iii) Microgenetics Systems Ltd. 34. The TPO excluded this company from the list of comparables. After going through the Annual accounts of this company, a copy of which is available on record, it can be seen that although it is engaged in providing ITES, yet the major part of the services rendered by it are being outsourced from third parties. Whereas, its salaries are ₹ 89.15 lac, Medical transcription charges paid stand at ₹ 95.48 lac. Such Medical transcription charges are in the nature of job work got done by this company from outside. There is hardly any need to emphasize that these two business models, viz., Outsourcing services from outside agencies and rendering in-house services, are completely different from each other. Since this company is providing ITES after outsourcing from third parties, the same cannot be considered as comparable to the assessee company which is rendering exclusively in-house services. We therefore, hold that this company was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee had shown a loss of ₹ 3.90 crore from the non-eligible unit, whereas profits of ₹ 20.76 crore and ₹ 5.66 crore were shown from the eligible units. The working of such profit/loss from eligible/non eligible units has been given on page 4 of the final assessment order. The dispute in the present appeal is only against the allocation of `Indirect costs amongst the three units. Whereas the assessee claims to have allocated indirect costs totaling ₹ 63.49 crore amongst the three units in a rational manner, the Assessing Officer apportioned such costs on the basis of unit-wise gross revenue. That is how, the amount of indirect costs in the non-eligible unit was reduced, which led to reduction in the claim of deduction u/s 10A of the Act. The DRP allowed some relief. The assessee is still unsatisfied. 38.2. We have heard the rival submissions and perused the relevant material on record. On a pertinent query, it was submitted by the ld. AR that the assessee was maintaining separate accounts in respect of three units, results from which were clubbed for drawing up the final accounts of the assessee-company. On the other hand, ld. DR contended that no such s ..... X X X X Extracts X X X X X X X X Extracts X X X X
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