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TMI Blog2016 (7) TMI 1318X X X X Extracts X X X X X X X X Extracts X X X X ..... he international related party transaction of the Appellant with respect to the provision of software development services do not satisfy the arm's length principle envisaged under the Act. In doing so the Ld.CIT(A) has erred:- ............................... 2.7. by including certain companies in the final set of comparables which are not comparable to the Appellant in terms of functions performed, assets employed and risks assumed; 2.9 by denying the benefit of a working capital adjustment while computing the ALP and thereby disregarding the law, international guidance and judicial precedents in this regard; 2.10 by ignoring the business/commercial reality that since the Appellant (vis-a-vis its software development services) is remunerated on an arm's length cost plus basis, undertakes minimal business risks as against comparable companies that are full-fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the Appellant on account of this fact." 2. The assessee in the year under consideration returned an income of Rs. 47,11,359/-. In computing such income, a sum of Rs. 1,54,91,436/- was claimed as a deduction u/s 10A of the Income Tax Act, 1961. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he software development activity. 2.6. As per its reporting in Form No.3CEB the assessee in the year under consideration undertook the following international transactions with its AE's:- Name of International Transaction Value of International Transaction (INR) Provision of software development services 180,582,716 2.7. For the purposes of comparability analysis the assessee in its TP study selected TNMM as the most appropriate method and operating profit / total cost (OP/TC) as the Profit Level Indicator (PLI). Benchmarking analysis was made using multiple year data and 13 comparables were selected. The transaction was claimed to be at arm's length as the average OP/TC of the 13 comparables at 4.07% was lower than 6.95% OP/TC margin of the assessee. 3. The use of multiple year data resorted to by the assessee was objected to by the TPO. He was of the view that in the absence of any justification for multiple year data the resort to the same was in violation of Rule 10B(4) of the Income Tax Rules, 1962. The filters selected by the assessee also did not meet with the approval of the TPO for reasons set out in his order. Since these are not an issue in the present proceedings ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... functionally different. The said company it was submitted derives its income from the sale of software services as well as products. The annual report of the said company it was submitted does not provide any further break-up of income into products and services. Accordingly referring to pages 154, 200, 204, 218 & 226 of the annual report compendium it was submitted that the Company cannot be treated as functionally comparable to the assessee. 5.2. During the year under consideration it was further submitted that there had been several significant events namely Persistent System Ltd. formed a wholly owned subsidiary in Singapore; acquired physical assets and human resources of another company. The company had also converted itself into a public company (evident from pages 156, 166, 168 of Annual Report). All these facts it was submitted have been consistently argued before the tax authorities. By way of the synopsis, we find reliance has been placed on the following judicial precedent however, how these decisions were relevant has not been argued:- (i) FCG Software Services India P. Ltd. vs ITO [2014] 51 taxmann.com 75 (Bang-Trib.); (ii) LG Soft India P.Ltd. vs Dy.CIT [2014] 4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... formation Systems (Seg.) 5.4. The exclusion of KALS Information Systems (Seg.) was sought on the ground that it was functionally different. Referring to the information provided in the Annual Report it was submitted that the company is engaged in the business of software services and software products which were functionally different. The absence of segmental data, it was submitted takes the said comparable outside the purview of acceptable comparables. Bindview India P.Ltd. vs DCIT [2013] 145 ITD 436/34 taxmann.com 164 (Pune.-Trib) was relied upon for the proposition that the said comparable has been held to be different from a software development company. Income from software developed it was submitted has been accounted for on the basis of software developed and billed to its clients on acceptance thus financial information was stated to be unreliable. Reliance was placed on Cienna India pvt. Ltd. vs ITO (ITA No.1453/Del/2014) and Mindteck India Ltd. vs ITO [2015] 63 taxmann.com 105 (Banglore-Trib.). I Gate Global Solutions Ltd. 5.5. The exclusion of I Gate Global Solutions Ltd. was sought on the ground that it is functionally different. The company's operations it was st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ). 5.6.1. Reliance was placed on the Telcordia Technologies India Private Limited (page 99 of the Paper Book) wherein the Mumbai Bench of the Tribunal has rejected the said comparable for benchmarking software development services. Lucid Software Ltd 5.7. The exclusion of Lucid Software Ltd was sought on the ground that the said company was a product company focusing on Advanced Non-destructive Testing (NDT) Technologies. The company it was submitted was actively involved in the Research & Development activities with leading scientific and educational institutions as such it could not be considering to be a comparable. Reliance was placed upon ITO, Bangalore vs Infinera India Ltd [2016] 67 taxmann.com 8 (Banglore-Trib.) wherein Lucid Software ltd. has been held to be non-comparable to a company providing software development services. Acropetal Technologies Ltd 5.8. The exclusion of Acropetal Technologies Ltd was sought on the ground that it failed employee cost filter as its ratio of 8.33% was less than the 25% adopted by the TPO himself. The exclusion of this comparable it was submitted is supported by the decision of BP India services Private Ltd vs ACIT, Circle-8(1), Mu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nal pages 21 to 23 it was submitted that the very same arguments have been considered and rejected these giving specific reasons which remain unassailed. Heavy reliance was placed on the same. For ready-reference, the same are reproduced hereunder:- 4. "The assessee has raised objections against certain comparables. These specific objections are discussed below. 4.1. Persistent System Ltd. The assessee has claimed that the company is engaged in sale of software products. The assessee has also claimed that the company owns various IP rights. The annual report of the company shows there is no expense on account of software product development. The conclusion that one can reach is that either the revenue form software product is too less or absent completely. If it would have been substantial, the company would have maintained segmental accounts. Therefore, on this account this company cannot be rejected IP rights, no such matter is evident from the annual report. That apart, during the course of these proceedings, it was brought to the notice of the AR, that one patent that had been registered by the parent company in USA had originated from India. Therefore, there is no case to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed profitability may result in. revisions and corresponding revenues and costs are recognized in the period in which the changes are identified. (iii) Other Contracts Revenue from contracts with amounts to be billed on monthly basis is recognized on rendering of services as per the terms of the contracts. Revenue from unit priced contracts is recognized on rendering of the services as per the terms of the contracts. Unbilled receivables represent amounts recognized as revenues for the periods presented based on services performed in accordance with the terms of contracts that will be billed in subsequent periods. Deferred revenue represents amounts billed in excess of revenue earned for which related services are expected to be performed in the next operation cycle. It can be seen that the assessee is engaged in contracts that are in the nature of development contracts, Therefore, there is no problem in the use of this company as a comparable. Whatever be the 'plethora of activities' that the assesses claims that this company is carrying out, they are all in the domain of software development. That is absolutely clear from the annual report. This company can be used as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submitted was considered by the TPO and rejected. It was his submission that it was for the assessee to show the so-called difference in accounting which was stated to be causing any abnormality and despite an opportunity nothing has been shown by the assessee. Heavy reliance was placed on the para 4.2 of the TPO's order and page 23 para H (ii) of the CIT(A)'s order and page 136 of the Paper Book of Annual Report compendium filed by the assessee. 6.8. Accropetal Technologies Ltd. it was submitted deserves to be retained as a comparables as the argument of the assessee that it failed the employee cost filter is incorrect on facts as discussed by the TPO in para 4.5 of his order, it was his submission that the Annual Report of the said comparable disclosed that the expenditure under the head "employee head expenditure" considering the on-site development expenses was 80.22% of the total expenses. This finding of fact it was submitted is available on record and has not been assailed or distinguished by the assessee. 6.9. BodhTree Consulting Ltd.:-the prayer for exclusion was objected to on the ground that no such prayer had been made before the TPO or the CIT(A). It was also his su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as long as their respective stand appears to be reflected. The selection when challenged at the appellate stage often results in a situation where the entire edifice crumbles despite a valiant patch work attempt to uphold the edifice and the entire selection process offered and considered stands wiped out. Though, we note that the tax payer at the stage of the TP study no doubt may be handicapped by the insufficiency of data in the public domain as it may not be sufficiently robust and readily available completely. Reverting to the facts of the present case, we note that the year under consideration is 2008-09 AY and an argument may be capable of being advanced that due to lack of exposure, expertise and experience of the litigants on the issue there may be justifiable reasons for the inadequacies in the TP study and the TP Report. Addressing the departmental stand, we agree that in a TNMM methodology identical FAR analysis cannot be insisted upon and the method is infact resorted to when the complete data is not available. In that case the impact on the net profitability of the minor variations in the comparable companies so selected is considered capable of tolerating minor vari ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if the facts come to light subsequently. The comparable cannot be allowed to remain included on account of a mistake of the parties. If challenged its justification has to be demonstrated. Accordingly the argument that filters not having been challenged act as an estoppel to the assessee cannot be accepted. We see no bar to the prayer of the assessee to argue for the exclusion of a comparable if facts warranting such a prayer can be demonstrated by the tax payer. The Tribunal being the final fact finding body as conceived by the Statute permits the tax payer to demonstrate if so considered fit by the tax payer to plead for the exclusion of a comparable on the basis of robust facts and evidences which may demonstrate that the comparable was wrongly offered or accepted at the initial stages. Thus, we find no bar to the tax payer for pleading for exclusion of a comparable without challenging the filters. Even otherwise selection of comparable is one of the steps for identifying a comparable to tailor the search for the purposes of determining whether adjustment in Arm's length price of the international transaction undertaken by the assessee is warranted. 7.2. The next step is to es ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ors responsible for the high volatility in the margins of the said comparable and make necessary adjustments, if so warranted. We find that in the absence of discussion on the issue by the tax authorities as the issue was not agitated by the assessee and considering the request of the Ld.CIT DR that the issue may in the circumstance be restored, we direct accordingly. The issue is restored the TPO afresh following the precedent cited. (c) KALS Information Systems Ltd. We find that the arguments of the assessee that the said comparable was distinguishable as the said company apart from software services also had software products cannot be accepted. The assessee has failed to address/rebut the consistent finding on record that segmental data has been used. No arguments controverting this fact have been advanced. No fact contrary to this finding has been referred to. The Ld.AR inviting attention to copy of Schedule 16 of the said company from the copy of its Annual accounts so as to submit that its revenue recognition system is different and following legal precedent the comparable should be excluded. We find that nothing has been placed on record to demonstrate how the impact on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... set out in the Directors Report impacted the net profitability of the said comparable has to be established and has not been addressed on facts. We further find that the Revenue has also argued that even existence of extra ordinary events itself was not canvassed before the tax authorities. Accordingly, in view of this factual deficiency the issue is restored back to the TPO. The assessee's directed to support its claim for exclusion of the said comparable on the grounds of extra ordinary event impacting the net profitability of the said company so as to justify its exclusion. (e) TATA ELxsi We find that as per judicial precedent laid down by a Coordinate Bench in the case of Telecordia Technologies Pvt.Ltd. vs ACIT [2012] 22 taxmann.com 96 (Mum) qua the software development related services segment Tata Elxsi has been held to be engaged in development of a niche product justifying its capacity to bargain for higher price. On a perusal of the copy of Annual Reports of this company placed at pages 286 to 353 of the Annual Report Compendium, we find that the facts justifying its exclusion continue to remain on record as the very nature of its activities and customers towards which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee is rejected as in the facts as they stand, we find no impediment to the retention of this comparable. 8. Addressing Ground Nos. 2.9 and 2.10, the Ld. AR has submitted that since these were the initial years when the issues were being developed, considered and understood accordingly for working capital adjustments and risk adjustments in the comparables the issues may be restored to the TPO. Inviting attention to page 19 of the impugned order para 9.10.1, it was submitted that it is not a case where the issues had been given up by the assessee as the following submissions qua working capital were advanced on behalf of the assessee:- 9.10. (J) Denying the Appellant the benefit of working capital adjustment 9.10.1. The appellant submitted that working capital adjustment is an adjustment for the opportunity cost of capital for investments made in working capital. Investments in working capital (i.e. inventories, accounts receivable/debtors and accounts payable/creditors) require capital and operating assets, and an uncontrolled entity is expected to earn a market rate of return on the required capital independent of the services that it provides. However, the amount of capita ..... X X X X Extracts X X X X X X X X Extracts X X X X
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