TMI Blog2015 (10) TMI 2645X X X X Extracts X X X X X X X X Extracts X X X X ..... ld not be excluded from the export turnover, we are unable to appreciate in view of the definition of ‘export turnover’ given in Explanation 2 (iv) to Section 10A does not warrant such an interpretation. However in respect of parity between the export turnover and total turnover, in view of the decision of the Hon’ble jurisdictional High Court in the case of CIT v. Tata Elxsi Ltd [2011 (8) TMI 782 - KARNATAKA HIGH COURT], assessee has to succeed. We direct the AO / TPO to exclude what has been excluded from the export turnover from the total turnover also while computing deduction u/s.10A of the Act Direct that assessee be given deduction u/s.10A of the Act without setting off brought forward loss and unabsorbed depreciation of non-eligible units. - I.T(TP).A No.1231/Bang/2011 - - - Dated:- 16-10-2015 - SHRI. ABRAHAM P. GEORGE, ACCOUNTANT MEMBER AND SHRI. VIJAYPAL RAO, JUDICIAL MEMBER For The Assessee : Shri. Amit B. Jain, CA For The Revenue : Shri. J. P. S. Bindra, CIT - DR ORDER PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER : In this appeal filed by assessee directed against an assessment order passed u/s.143(3) r.w.s.144C of the Income-tax Act, 1961 ( the Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee s own work-out of its PLI read as under : Comparables : Assessee : Particulars Amount in Rs. Operating Revenue 237,833,871 Operating cost 218,418,222 Margin (PBIT) 19,415,649 Margin/Operating cost (%) 8.89% 06. As per the assessee, its net margin was well within the + / - 5% of the average PLI of the comparables and therefore there was no requirement for any adjustment on the pricing of the international transactions in the software development services segment. Assessee had followed the TNM method for its TP study. However, TPO did not accept the comparables selected by the assessee but for R. S. Software (India) Ltd and iGate Global Solutions. He rejected others citing various reasons. There after he made his own analysis and arrived at a list of 26 comparables which according to him was functionally close to that of the assessee. The list of the comparables selected by the TPO and their average PLI were as under : Sl No ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 112.01 15.07% 22 Sasken Communication Technologies Ltd (seg) 343.57 22.17% 23 SIP Technologies Exports Ltd 3.80 13.90% 24 Tata Elxsi Ltd (seg) 262.58 26.51% 25 Thirdware Solutions Ltd 36.08 25.12% 26 Wipro Ltd (seg) 9616.09 33.65% Average PLI 25.14% 07. Though the assessee argued for a risk adjustment this was not accepted by the TPO. Nevertheless he made a negative working capital adjustment of -2.77% on the average PLI of 25.14 % of the comparables and arrived at an adjusted mean margin of 22.87 %. He thereafter worked out the short-fall on account of deficit in the international transactions relating to the software development services segment as under : Adjusted mean margin of the comparables ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Thirdware Solutions Ltd 25.12% 16 Wipro Ltd (seg) 33.65% 10. According to him none of the above comparables selected by the TPO were part of list of the assessee. They were all functionally different and not comparable to a software development services provider. Ld. AR placed reliance on the decision of coordinate bench in the case of Hewlett- Packard (India) Globalsoft P. Ltd, v. DCIT [ IT(TP)A1031/Bang/2011, dt.23/09/2015]. Vis-a-vis the issue of risk adjustment, Ld. AR submitted that its risk analysis and work out of risk adjustment was unfairly rejected by the TPO. As per the Ld. AR, marketing expenditure was taken as the bench mark for deciding on the market risk, and relation of the profitability to the market risk by the TPO. Ld. AR submitted that assessee was not bearing a significant market risk since its services were only to the AE. According to him, the same situation was not present in so far as the comparables selected by the TPO is concerned. Hence it was necessary that a proper adjustment was made for the risk element for a meaningful comparison. 11. Per contra, Ld. D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed. An amount of ₹ 11,692,020/- has been debited to the Profit and Loss Account as Deferred Revenue Expenditure (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R D activities is bad in law. 43. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT ITA No.6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment. The relevant extract of discussion regarding this company is as follows: The learned D.R. however drew our attention to page-389 of the paper book which is an extract from the Directors report which reads as follows: The Company has developed a de novo drug design tool CELSUITE to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Technology New Delhi) based on our insil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der this company as a comparable in clinical trial segment, for the reason that this company has diverse business. It was submitted that, however, from the above extracts it is clear that this company is not into software development activities, accordingly, this company should be rejected as a comparable being functionally different. 45.From the material available on record, it transpires that the TPO has accepted that up to AY 06-07 this company was classified as a Research and Development company. According to the TPO in AY 07-08 this company has been classified as software development service provider in the Capitaline/Prowess database as well as in the annual report of this company. The TPO has relied on the response from this company to a notice u/s.133(6) of the Act in which it has said that it is in the business of providing software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the segmental data for each activity is not available and therefore this company should not be treated as comparable. Besides the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company ought to be excluded from the list of comparables on the ground that it is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in e-Business Consulting Services , consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised Representative contends, are high end ITES normally categorised as knowledge process Outsourcing ( KPO ) services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that since the Annual Report of the company does not contain detailed descriptive information on the business of the company, the assessee places reliance on the details available on the company s website which should be considered while evaluating the company s functional profile. It is also submitted by the learn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12.2 Before us, the assessee contended that this company is not functionally comparable to the assessee and in this context has cited various portions of the Annual Report of this company to this effect which is as under :- (i) The company has an Intellectual Property (IP) Cell to guide its employees to leverage the power of IP for their growth. In 2008, this company generated over 102 invention disclosures and filed an aggregate 10 patents in India and the USA. Till date this company has filed an aggregate of 119 patent applications (pending) in India and USA out of which 2 have been granted in the US. (ii) This company has substantial revenues from software products and the break-up of the software product revenues is not available. (iii) This company has incurred huge research and development expenditure to the tune of approximately ₹ 200 Crores. (iv) This company has a revenue sharing agreement towards acquisition of IPR in AUTOLAY, a commercial software product used in designing high performance structural systems. (v) The assessee also placed reliance on the following judicial decisions :- (a) ITAT, Delhi Bench decision in the case of Agnity India ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds. Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable. 47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not av ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd. company is also involved in the development of software as compared to the assessee, which is only into software services. Similarly, as regards Ishir Infotech Ltd., the Tribunal has considered the decision of the Tribunal in the case of 24/7 Co. Pvt. Ltd to hold that Ishir Infotech is also out-sourcing its work and, therefore, has not satisfied the 25% employee cost filter and thus has to be excluded from the list of comparables. As the facts of the case before us are similar, respectfully following the decision of the co-ordinate bench, we hold that these two companies are also to be excluded. 21. Respectfully following the decision of the Tribunal referred to above, we direct the AO/TPO to exclude the aforesaid companies from the final list of comparable companies for the purpose of determining ALP. 7) Wipro Limited 13.1 This company was selected as a comparable by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables or several grounds like functional dis-similarity, brand value, size, etc. The TPO, however, brushed aside the objections of the assessee and included this company in the set of comparabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he set of comparable companies in the case on hand for the year under consideration. 8 ) Accel Transmatic Ltd. 48. With regard to this company, the complaint of the assessee is that this company is not a pure software development service company. It is further submitted that in a Mumbai Tribunal Decision of Capgemini India (F) Ltd v Ad. CIT 12 Taxman.com 51, the DRP accepted the contention of the assessee that Accel Transmatic should be rejected as comparable. The relevant observations of DRP as extracted by the ITAT in its order are as follows: In regard to Accel Transmatics Ltd. the assessee submitted the company profile and its annual report for financial year 2005-06 from which the DRP noted that the business activities of the company were as under. (i) Transmatic system - design, development and manufacture of multi function kiosks Queue management system, ticket vending system (ii) Ushus Technologies - offshore development centre for embedded software, net work system, imaging technologies, outsourced product development (iii) Accel IT Academy (the net stop for engineers)- training services in hardware and networking, enterprise system management, embe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT ITA No.7821/Mum/2011 wherein the Tribunal accepted the assessee s contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:- 7.8 Avani Cincom Technologies Ltd. ( Avani Cincom ): Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis. It was also highlighted that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h is primarily only to supplement the information already available on record, but not, as rightly submitted by ld. Counsel for the assessee, to replace the information. If there is a complete contradiction between the information obtained u/s 133(6) and annual report then the said information cannot be substituted for the information contained in annual report. We, therefore, are in ITA No. 5637/D/2011 149 agreement with ld. counsel for the assessee that this company cannot be included as a comparable in the set of comparables selected by ld. TPO on account of clear contradiction between contents of annual report and information obtained u/s 133(6). 27. Rule 10D(3) specifies the information and documents that are to be maintained by a person who is entering into international transactions. These are official publications, published accounts or those which are in public domain except for agreements and contracts to which assessee is privy. Once the annual report of a company is for a year different from the financial year ending 31st March, then without doubt, it will cease to be a good comparable, unless the information received in pursuance to a notice u/s.133(6) of the Act fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is engaged in the business of sale of software products and software services. The assessee pointed out this to the TPO in its written submissions, copy of which is placed in the Paper book at page 420.3 to 420.4. The assessee further pointed out that there was no bifurcation available between the business of sale of software products and the business of software services, and therefore, it was not appropriate to adopt the application software segment of the said concern for the purposes of comparability with the assessee s IT-Services Segment. The TPO however, noticed that though the application software segment of the said concern may be engaged in selling of some of the software products which are developed by it, however, the said concern was not into trading of software products as there were no cost of purchases debited in the Profit Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessee s segment of IT-Services. 18. Before us, apart ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (Seg), in the instant case also for A.Y. 2006-07 the said concern was found functionally incomparable by the assessee in its Transfer pricing study and the said position was not disturbed by the TPO. The relevant portion of the Transfer pricing study, placed at page 432 of the Paper book has been pointed out in support. Considered in the aforesaid light, on the basis of the discussion in relation to KALS Information Solutions Ltd. (Seg), in the instant case also we find that the said concern is liable to be excluded from the list of comparables. 12) Persistent Systems Ltd. 17.1.1 This company was selected by the TPO as a comparable. The assessee objected to the inclusion of this company as a comparable for the reasons that this company being engaged in software product designing and analytic services, it is functionally different and further that segmental results are not available. The TPO rejected the assessee's objections on the ground that as per the Annual Report for the company for Financial Year 2007-08, it is mainly a software development company and as per the details furnished in reply to the notice under section 133(6) of the Act, software development cons ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a) that in the absence of segmental details / information a company cannot be taken into account for comparability analysis, we hold that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. It is ordered accordingly. 13) Sasken Communication Technologies Ltd.: 109. Ld TPO noticed that the company was rejected in the TP document on the ground that the company fails its filter of business review and R D to sales was more than 3%. However, no reasons were given for the business review. 109.1 Ld. TPO pointed out that R D to sales being more than 3% is not acceptable for which detailed discussion has already been made earlier. He further noticed that the company has software services segment and segmental results are available for software services. He further pointed out that on the basis of information obtained u/s 133(6), the company qualifies onsite revenue filter (onsite revenues were to the extent 27.27% of its export revenues). After considering the assessee s reply, ld. TPO included this company in the list of comparables. Ld. counsel pointed out that this company has incurred significant expend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of comparables. 14.2 Before us, it was reiterated that this company is not functionally comparable to the assessee as it performs a variety of functions under the software development and services segment namely (a) Product design services (b) Innovation design engineering and (c) visual computing labs. In the submissions made the assessee had quoted relevant portions from the Annual Report of the company to this effect. In view of this, the learned Authorised Representative pleaded that this company be excluded from the list of comparables. 14.3 Per contra, the learned Departmental Representative supported the stand o the TPO in including this company in the list of comparables. 14.4.1 We have heard both parties and carefully perused and considered the material on record. From the details on record, we find that this company is predominantly engaged in product designing services and not purely software development services. The details in the Annual Report show that the segment software development services relates to design ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss account for software development services and product development services. (ii) In the case of E-Gain communications Pvt. Ltd. (2008-TII-04- ITAT-PUNE-TP), the Tribunal has directed that this company be omitted as a comparable for software service providers, as its income includes income from sale of licences which has increased the margins of the company. The learned A.R. prayed that in the light of the above facts and in view of the afore cited decision of the Tribunal (supra), this company ought to be omitted from the list of comparables. 15.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 15.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the case of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparable satisfied TPO s filter of more than 75% of revenues from software development services. The basis on which the TPO arrived at the PLI of 60.23% is given at page-115 and 116 of the order of the TPO. It is clear from the perusal of the same that the TPO has proceeded to determine the PLI at the entity level and not on the basis of segmental data. 25. In the order of the TPO, operating margin was computed for this company at 60.23%. It is the complaint of the assessee that the operating margins have been computed at entity level combining software services and software product segments. It was submitted that the product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions on page 381 to 383 of the PB-I). It was further submitted that Megasoft Limited has provided ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rvices segment. Ordered accordingly. 15. In so far as risk adjustment sought by the assessee is concerned, we find that TPO had considered the risk analysis done by the assessee in its TP study and came to a conclusion that the risk borne by the various comparables were more or less similar in nature to that of the assessee. He had cited the following reasons for not giving any adjustment for the perceived risk : The taxpayer is totally dependent oil AE for business. Thus the taxpayer takes the risks associated with heavy dependence oil single customer. In common business parlance it is known as 'single customer risk'. The taxpayer is not compensated any amount for termination of agreement even if it is terminated without any cause. No independent enterprise would like to agree for a termination clause without compensation if it is terminated without any cause. The AE is exposed to the market risk and any fluctuation in the business conditions of the AE affect the contractual terms between the AE and the taxpayer. Thus even if independent comparables undertake some risk, the taxpayer also had to undertake risks like single customer risk, political r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yer submitted some method for computation of the risk, which is discussed above and rejected. The taxpayer's single customer risk and political / country risk more than offsets any other risk differential between the taxpayer and the comparable companies. Different comparables can have different risk profiles and different profit margins. The proviso to Sec. 92C(2) of the Act provides for adopting arithmetical mean of the different prices. This provision neutralizes the effect of difference in the risk profile, if any between the tax payer and the comparables as realized risk may pull down the profitability below the risk free return. It is not sufficient to merely spell out risks. But, it has to be shown which risk was actually undertaken by the comparables and to what extent it affected the profitability. The taxpayer has not done so. 16. Nothing was brought before us by the Ld. AR to show that findings of the TPO was incorrect. We are of the opinion that the risk borne by the comparables as well as the assesee were of the very same nature and therefore the effect of the risk on the profitability already stood discounted in the operational results ..... X X X X Extracts X X X X X X X X Extracts X X X X
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