TMI Blog2016 (7) TMI 1318X X X X Extracts X X X X X X X X Extracts X X X X ..... R For The Appellant : Shri Rohit Tiwari, CA For The Respondent : Shri A.M. Govil, CIT(DR) ORDER PER DIVA SINGH, JUDICIAL MEMBER The present appeal has been filed by the assessee assailing the correctness of the order dated 21.10.2014 of CIT(A)-XXIX, New Delhi pertaining to 2008-09 assessment year on various grounds. However at the time of hearing, the Ld. AR submitted that he is under instructions only to argue Ground Nos.-2.7, 2.9 and 2.10 and the remaining grounds may be dismissed as not pressed. In view thereof, we reproduce hereunder only the grounds which the assessee wants to agitate: 2. The Ld.CIT(A) erred on facts and in law in partially confirming the adjustment of ₹ 2,07,75,061/- computed by the Learned Assessing Officer ( Ld.AO ) in the assessment order passed under section 143(3) of the Income Tax Act, 1961 ( the Act ), by holding that the 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 comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ute our Memory Compilers of Logic libraries. - EDA views in TCL/Tk programming language. - Programming files in assessee's proprietary format that describes the physical, functional and timing behavior of the Memory or Logic elements. 2.3. These files it is claimed are developed on UNIX operating systems on Sun platforms or in the Windows NT environment and thereafter the created files are shipped overseas electronically via Internet. 2.4. The nature of activities that lead to the creating of the above-mentioned items have been characterized as: Software Development which includes, Electronic Design Automation. Engineering design services and other functions to support the above disciplines (IT. QA. documentation. etc). 2.5. It has been submitted that the Export invoices are raised at cost (including both direct and indirect costs) plus markup of 15% on the direct and indirect costs incurred by it for the 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 Transact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd. 7.37% 4. Quintegra Solutions Ltd. 19.33% 5. RS Software India Ltd. 6.30% 6. Acropetal Technolgies Ltd. 40.03% 7. Bodhtree Consulting Ltd. 19.14% 8. Sagarsoft India Ltd. 12.18% 9. I Gate Global Solutions Ltd. 14.77% 10. KALS Informtion Systems Ltd. (Segmental) 41.94% 11. Lucid Software Ltd. 16.50% 12. Mindtree Ltd. (Seg.) 16.41% 13. Persistent Systems Ltd. 27.70% 14. Sasken Communication Technologies Ltd. (Segmental) 13.44% 15. Tata Elxsi Ltd. (Software development and services Segment) 18.97% Mean ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .1. Accordingly relying upon the precedent laid down in the order dated 31.05.2013 in Navisite India Private Limited in ITA No.5329/Del/2012, it was submitted that the TPO may be directed to examine and address the abnormal factors that cause high volatility margin and make necessary adjustments. Financial Year Margin % age 2004-05 25.24% 2005-06 14.66% 2006-07 33.20% 2007-08 19.14% 2008-09 64.04% 2009-10 34.39% 2010-11 -4.10% 5.3.2. Without prejudice to the main argument, it was also submitted that the company had diverse operations as it provides open and end-to-end Web solutions, off shoring data management, data warehousing, software consultancy. Thus, when compared with the assessee s function Bodhtree Consulting Ltd. in contrast had diverse operation as the assessee was only engaged in contract software development services. Accordingly relying upon Nethawk Networ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ces. The company it was submitted had diversified businesses and this fact it was submitted would be evident from its Annual Report attached. 5.5.1. It was also submitted that its exclusion was also justified on the ground that in the year under consideration extraordinary circumstances prevailed in the case of this comparable on account of merger. This fact it was submitted would be evident from Paper Book page 38 and 46 of the Annual Report Compendium:- SUBSIDIARIES AND JOINT VENTURES I GATE Technology Services Pvt. Ltd. (ITS), an erstwhile wholly owned subsidiary of the company was merged with the Company following the approval of the scheme of amalgamation by the shareholders of both the companies and the Honorable High Court of Karnataka. The Honorable High Court of Karnataka passed its final order on July 27, 2007. Your company terminated its joint venture agreement with Software AG, Germany and sold its 49% holding of 7,84,000 shares in software AG (India) Private Limited to Software AG, Germany. 3. Merger of I Gate Technolgoy Services Pvt.Ltd. a. During the year the Scheme of Amalgamation of IGS and I Gate Technology Services Private Limited, whol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .) and Market Tools Research Private Limited (ITA No.1811/Hyd/2012, (TS)-294-ITAT-2013 (HYD)-TPq, ITAT, Hyderabad). 6. Before advancing specific arguments qua each of the comparables addressed by the assessee, the Ld.Sr.DR drew attention to the facts on record. Inviting attention to the material on record it was submitted that the assessee s margin was 6.95% as per its own TP study. TNMM has been selected as the most appropriate method by the assessee which has not been disputed by the Revenue. It was his submission that TNMM presupposes broad FAR comparability and it is an accepted position that it is impossible to find an exact identical or a near identical comparable. Thus as long as broad comparability is established then in a method like TNMM the exclusion of comparable s cannot be sought on the grounds of minor differences. Thus the assessee cannot now be allowed to selectively pick and choose from the list of comparable companies on the basis of minor difference. 6.1. The issues of comparability it was submitted cannot be decided summarily on the basis of precedent as the facts of each case on record need to be addressed. The issues it was submitted can be decided on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ems as a comparable. 4.2. Lucid Software The assessee has raised an objection that there is some deviation in the accounting policy followed by the company. I am afraid, that this is a rather lame excuse. There point raised by the assessee does not show that there is any functional difference between it and this company. The assessee had not even raised this issue while rejecting this company at the time of preparing its TP study. The assessee has not been able to show that the so-called difference in accounting is causing any abnormality in the results of this company. This shall be used as a comparable. 4.3. Kals Information Systems Ltd . The assessee has claimed that the company is engaged in software development and sale of software products. The assessee appears to have overlooked the fact that segmental results are being used in this case. On the issue of IP rights, the matter has been discussed earlier and it has been shown that the assessee is also the point of origin of patents registered in the USA. This company can be very well used as a comparable. 4.4. I-Gate Global Solutions Ltd The assessee has objected to this company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clear from the annual report. This company can be used as a comparable. 4.5. Acropetal Technologies Ltd. The assessee has objected to this company on the ground that the employee cost is less than 25%. The annual report shows that the expenditure under the head employee related and on site development expenses is 80.22% of the total expenses. The assessee must appreciate that onsite development expense is also a personnel cost and must be reckoned for the analysis. (emphasis provided) 6.3. Addressing first Persistent Systems Ltd., attention was invited to the reasons set out in para 4.2 of his order which were re-iterated by the CIT(A at page 23 of his order. It was his submission that the Annual Report of the said comparable relied upon by the assessee for exclusion of the said comparable has already been taken into consideration by the TPO and for the reason brought out in his order and the objection has been overruled by a speaking order. Accordingly it was his submission that the prayer of the assessee should not be accepted. 6.4. Addressing the arguments seeking the exclusion of KALS Information System Ltd. the reasons set out in para 4.3 of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the ground that no such prayer had been made before the TPO or the CIT(A). It was also his submission that if at all it was to be considered at this stage then it should be restored back. 7. We have heard the rival submissions and perused the material on record. Before, we address each of the comparables specifically, we propose to first address the broad principles addressed by the ld.CIT DR in regard to the selection of comparables in TNMM. Considering the same, we are of the view that the Ld.CIT DR is correct in his argument that the issue of comparability should be decided on the basis of facts on record and not on precedents as there cannot be an exact identical comparable and infact a perfect near identical comparable company is a rarity and generally can be said to be a virtually impossible condition incapable of being fully fulfilled. We are of the view that it is for this very purpose that TNMM as a method is often resorted to. The minor difference if any are addressed by comparing net profitability of the comparables. Thus broad comparability of a fairly large number of comparable companies can further ensure that minor variations if any are offset by taking a fairly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... variations in the comparable companies so selected is considered capable of tolerating minor variations in the FAR analysis of the comparables. The selection of this method is resorted to for this very purpose and the method is robust enough to tolerate the variations if any. The Rules moreover permit adjustments in the comparables selected if it can be demonstrated that these would impact the profitability of the comparable selected. 7.1. Examining the other argument advanced by the Ld.CIT DR who has objected that in the absence of challenge to the filter applied the assessee cannot object to the inclusion of a comparable thrown up applying the filter. We find that the argument is misplaced. The objection to the exclusion of a comparable cannot be ousted on the strength of the argument that filter has been accepted. We find that this simplistic argument of the Revenue cannot be accepted. We hold that the assessee having accepted the filters is fully within its right to insist upon the exclusion of a comparable which has remained in the list of comparables accepted if subsequent information/data available in the public domain shows that the said comparable on the basis of new co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the international transaction undertaken by the assessee is warranted. 7.2. The next step is to establish a functional comparability of the companies thrown up in the search. During this process the companies whose peculiar mix of FAR may directly impact its profitability may be excluded if they are seen to be considered incomparable. Thus wherever it can be shown that the functionality was not established or the necessary details qua its asset base or risk analysis or any extra ordinary event in the period under consideration created situations where the comparability of the company was tainted as impacting its net profitability then the exclusion of the comparable can be requested. Thereafter, if the facts are found supporting the prayer then the comparable can still be excluded for valid reasons justifying its exclusion based on evidence duly recorded and forming part of the reasoning despite the filters not having been challenged. We see no such bar for the assessee contemplated under law. 7.3. Addressing the specific comparables whose exclusion is sought, considering the facts, arguments and position of law, we hold:- (a) Persistent Systems We find that exclusio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecedent the comparable should be excluded. We find that nothing has been placed on record to demonstrate how the impact on the net profitability of the assessee s segment following the Revenue recognition stated to be different from the assessee. The exercise addressing the impact of the Revenue recognition system allegedly different from the assessee on the segmental net profitability of the comparable has to be established as mere reliance on precedent without addressing the facts is of no relevance. Reliance on precedent where segmental were either not used or available applied would be of no help. Without addressing and demonstrating an impact of revenue recognition policies vis-a-vis segmental details of a comparable will not per se take the said comparable out of the accepted list of comparables. The issue is restored to the TPO for this necessary exercise. The assessee may place necessary facts in support of its prayer. (d) I.Gate Global Solutions Ltd. We find that for exclusion of the said comparable the assessee has placed on record copy of Directors Report in support of the argument that extra-ordinary events prevailed justifying its exclusion. It has been argued ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... find that the facts justifying its exclusion continue to remain on record as the very nature of its activities and customers towards which it is focused shows that the said comparable cannot be said to be a comparable for the assessee who is not existing in a niche area engaged in development of niche products and services. Accordingly the prayer for the exclusion of this comparable on facts is justified. (f) Lucid Software Ltd. Considering the arguments and the facts alongwith the precedent relied upon, we find that the exclusion of the said comparable has been sought on the grounds of functional imcomparability as the said company is stated to be actively involved in leading scientific and educational institutions; is involved in R D activities. The said argument on facts has been faulted by the Revenue. The clear recital in the Notes on Accounts in Schedule M at Paper Book page 141 relied upon it is seen clearly shows that there is no software product expenditure. Further Paper Book page 136 Schedule G relied upon by the Revenue also does not support on facts the precedent relied upon by the assessee. The following clear recital heavily relied upon by the Ld.CIT DR ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing 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 capital required to support these services varies greatly, because the level of inventories, debtors and creditors measured as a percentage of the total cost varies. There is an effect on profits from investing in different levels of working capital due to differences reflected in cash collection cycle. Such differences in collection cycle imply differences in credits granted to customers and such a credit function is akin to an additional service for which markets are willing to pay. The Appellant receives payments for services in a stipulated period of time from its AE and hence enjoys a favourable working capital position. Accordingly, a working capital adjustment vis-a-vis the comparable is essential in the instant case. 8.1. Qua the benefit of risk adjustment, it was submitted that the assessee had advanced the following arguments before the CIT(A):- 9.11. (k) Denying the Appellant the benefit of risk adjustment The key arguments of the Appellant in relation to the risk adjustment are ..... X X X X Extracts X X X X X X X X Extracts X X X X
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