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TMI Blog2016 (3) TMI 1184X X X X Extracts X X X X X X X X Extracts X X X X ..... nt services and IT Enabled Services (ITES). The assessee reported five international transactions in its audit report in Form no. 3CEB, including "Provision of software development services" with transacted value of Rs. 134,37,46,752/-. The assessee used the Transactional Net Margin Method (TNMM) as the most appropriate method. Profit Level Indicator (PLI) of Operating Profit / Total Cost (OP/TC) was applied. The assessee calculated its PLI at 11.79%. Certain companies were selected as comparable for this international transaction with their average margin at 11.43%. That is how, the assessee tried to demonstrate that this international transaction was at arm's length price (ALP). Unconvinced, the Transfer Pricing Officer (TPO) recast the financials of the assessee for the international transaction of `Software development services', as under: Operating Income Income from Operations 176,06,48,375 Misc. Income 864,634 Total Operating Income 1,761,513,009 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 d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pparent from the TPO's order, that the transfer pricing adjustment has been made by considering the total costs incurred by the assessee in respect of transactions with the associated enterprises (AE) and non-AEs. It can be seen that the TPO has taken the figure of revenue at Rs. 1.76 crore while calculating the ALP of the international transaction from `Provision of software development services'. As against that, when we see page 2 of the TPO's order detailing the international transactions, it comes to the fore that the amount of revenue from `Provision of software development services' is only Rs. 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 ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Operating costs in relation to Provision of software development services at Rs. 1,60,05,39,757. As the figure of Rs. 166.69 crore consists of certain expenses, we will take up such expenses one by one for the purposes of distribution between the two segments. 7.3. First item of costs is `Personnel expenses' amounting to Rs. 1,23,85,27,756. We find that the assessee has been remunerated in the other international transaction of rendering ITES at cost 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 Rs. 7,30,47,418, we hold that the employee cost for rendering ITES be taken at Rs. 4,86,98,278 (Rs.7,30,47,418 *100/150). The remaining employee cost is relatable to software development services. We have also go ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able to software development services segment between the AE and non-AE transactions on the basis of their respective gross revenue. The proportionate part relatable to the AE transactions be considered in the calculation of OP/OC of the international transaction of rendering software development services. As regards Depreciation, we find that the assessee, inter alia, earned Rent of Rs. 88,90,195 and credited it to Profit and Loss account. 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e considered as comparable. Two companies can be considered as comparable when both are discharging the overall similar functions, though there may be some minor differences in such functions, not marring the otherwise comparability. Notwithstanding the functional similarity, many a times a company ceases to be comparable because of other reasons as well. To cite an example, if company 'A', though functionally similar to company '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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... crore and "Consultancy Charges" at Rs. 5.90 crore. Segmental information of this company is available on page 66 of its Annual Report which states that : "The Company is primarily engaged in Software Development and I.T. enabled services which is considered the only reportable business segment". This indicates that the revenue from Software Development and ITES has been clubbed by this company which also 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the overall six or seven parts of the software development, it cannot be said that the assessee is not into software development. Activities of the asessee, which admittedly constitute a major chunk of the overall software development, cannot be considered as different from the software development. We, therefore, refuse to accept this contention urged on behalf of the assessee. 13.3. Thereafter 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 Rs. 31.38 lakh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gh Court held Infosys Ltd. to be incomparable to Agnity India Technologies Pvt. Ltd. The facts of the instant case are more or less similar inasmuch as the extant assessee is also a service provider with a limited number of employees at its disposal and also not owning any branded products with no expenditure on R&D etc. When we consider all the above factors in a holistic manner, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rusal of the details of this segment, it comes to our notice from page 13 of the Annual report that Design and development of Hardware is also included in it. Since revenue from `hardware' is also included in the `Software Development and Services' segment of this company, we fail to see as to how it can be treated as comparable with the assessee company, which 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 in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... year" in which the international transaction has been entered into. In other words, if the tested party has March year ending, then, the comparables must also have the data relating to the financial year ending 31st March itself. If such a data is not available, then, a company albeit functionally comparable, disqualifies. Espousing the facts 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 ob ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... NMM as the most appropriate method with OP/TC as its PLI. Eight companies were chosen as comparable with their average margin of profit at 11.79%. The assessee computed its own profit margin at 14.27%. That is how, it was shown that this international transaction was at Arm's Length price. The TPO changed composition 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 63,680,056 Operating Profit 9,403,235 OP/OC 14.77% Operational Cost 63,680,056 Arm's Length Price at a Margin of 36.08% 86,655,820 Price Received 73,083,291 10 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore 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 acquisition of Asscent Infoserve Pvt. Ltd. during the financial year relevant to the assessment year under consideration. The TPO discussed the functional comparability of this company and, in the ultimate analysis, came to hold that it was functionally comparable with the assessee company and hence includible. 27.2. We have heard the rival submissions and perused the relevant material on record. We have also gone through the Annual report of this company, a copy of which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 words, the remuneration of this company from the above referred two segments includes compensation for rendering `Technical services' and `Transaction processing'. Insofar as the `Transaction processing' services are concerned, these are ITES, which are broadly similar to those rendered by the assessee, though not specifically similar. However, the `Technical services' involve software testing, verification and validation of software item, implementation and data centre management activ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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 processing services'. As such, the entity level figures render this company unfit for comparison. Ergo, we order for the removal of this company from the final set of comparables. (iv) TCS E-Serve Ltd. 30.1. The TPO proposed to treat this company as comparable. The assessee objected to its inclusion by contending that it was providing financial information processing and customer contact services with high operating revenue and peculiar economic circumstances leading to abnormal profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Tribunal excluded only Infosys Technologies Ltd., by impliedly retaining L&T Infotech Ltd. as a good comparable. On appeal by the Revenue, the Honourable High Court upheld the Tribunal order excluding Infosys on the strength of certain relevant distinguishing features including its giantness in terms of sales, nature of work and other factors. Thus it follows that L&T Infotech Ltd., which is otherwise a vast company with much higher turnover, finally found the status of a comparable with a captive com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng outsourced from third parties. Whereas, its salaries are Rs. 89.15 lac, Medical transcription charges paid stand at Rs. 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 rightly excluded by the TPO. (iv) R Systems International Transaction Ltd. (segmental) 35.1. The TPO excluded this company on the ground of different year ending. The assessee is aggrieved with this decision of the TPO. 35.2. While dealing with certain companies, such as, Caliber Point Business Solutions Ltd. etc. under the international transaction of `Software Development Services', we have given certain directions to the TPO for examining if those companies could be considered as comparable. Similar directions are directe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 separate unit-wise accounts were maintained. It was only during the course of assessment proceeding that the assessee split up combined accounts in three parts as per its convenience and that too, on the instructions of the AO. We find that if separate accounts are maintained then there can be no difficulty in examining indirect costs incurred in respect of such units separately. However, if consolidated accounts are maintained and allocation is made thereafter for determining the profit/loss from three units separately, then the question arises about the basis of appo ..... X X X X Extracts X X X X X X X X Extracts X X X X
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