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TMI Blog2015 (5) TMI 1129X X X X Extracts X X X X X X X X Extracts X X X X ..... ormation Technology Enabled Services (ITES) as well as Software Development Services (IT services). ITES rendered by the Assessee include customer services, stores help desk, Financial services, one stop processes, pension service, property services and online advertising services. IT services include software development, quality deployment, testing and support services. All the above transactions were international transactions with an Associated Enterprise (AE) and have to pass the Arm's Length Price (ALP) test as provided u/s.92 of the Income Tax Act, 1961 (Act). In this appeal the dispute is with regard to addition made consequent to determination of ALP and consequent upward revision and adjustment made to the price at which international transactions were carried out by the Assessee with its AE in respect of (1) Software development Services and (2) IT enabled Services. 3. Financial Results of EMC India for the F Y 2005-06 Description Amount Operating Revenue Rs. 101,79,12,068 Operating Profit (PBIT) Rs. 1,07,04,828 Operating Profit to Cost Ratio 11.76 % The segmental details pertaining to software development Services, IT enabled services are as under (as per t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... justment u/s 92CA." 5. Against the said adjustment proposed by the TPO which was incorporated in the draft assessment order by the AO, the assessee filed objections before the DRP. The DRP rejected those objections and confirmed the transfer pricing adjustment suggested by the TPO. The adjustment confirmed by the DRP was added to the total income of the assessee by the AO in the fair order of assessment. Against the said order of the Assessing Officer, the assessee has preferred the present appeal before the Tribunal. 6. The assessee filed a chart showing how the TPO has not given working capital adjustment as prayed for by the Assessee, the turnover and the margins of the 22 comparable companies finally chosen by the TPO after giving effect to adjustment towards working capital as allowed by the TPO and also as claimed by the Assessee. The Chart also explains as to how some of the comparable companies chosen by the TPO are not comparable (a) for the reason that the turnover of those companies were beyond Rs. 200 crores and therefore cannot be compared with the Assessee whose turnover is less than 75 Crores, (b) for the reason that these companies were not functionally comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:- "Size criteria in terms of Sales, Assets or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs. 1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :- (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in subsection (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm's length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm's length price. (3) Where during the course of any proceeding for the assessment of income, the Assessing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction. (2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores." 10. Respectfully following the aforesaid decision of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. (supra) and Assessee's case for AY 06-07, we hold that the aforesaid companies should be excluded from the list of comparable companies. The AO is directed to compute the Arithmetic mean by excluding the aforesaid companies from the list of comparable. 11. Improper selection of comparables: It was submitted by the learned counsel for the Assessee that the following 2 companies are not functionally comparable with that of the Assessee. a) KALS Information Systems Limited b) Accel Transmission Limited. In this regard our attention was drawn to the decision of the Hon'ble ITAT Bangalore Bench in the case of Trilogy E-Business Software India Pvt.Ltd. (supra) wherein these companie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mission 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 available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable." "(e) 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... entical in the case of the Assessee as well as in the case of Trilogy E-Business Software India Pvt.Ltd. (supra). Respectfully following the decision of the Tribunal referred to above in the case of Trilogy E-Business Software India Pvt.Ltd.(supra), we direct that the said companies be excluded from the list of 22 comparable arrived at by the TPO. 14. As far as comparable company viz., Geometric Software Ltd. (Seg.) & Aztech Software Ltd., are concerned, it is not in dispute before us that the related party transaction in the case of this company exceeds 15% (19.98 % in the case of Geometric Software Ltd. & 17.78% in the case of Aztech Software Ltd.) and in view of the decision of the Tribunal in the case of 24 X 7 Customer.Com Pvt. Ltd. in ITA No.227/Bang/2010, followed by this Tribunal in the case of Logica Private Ltd. (supra) wherein it was held that where the RPT exceeds 15%, such companies should not be taken as comparable companies. Following the said decision, we hold that said companies referred to above be excluded from the list of comparable companies while working out the ALP. 15. As far as Megasoft Ltd., a comparable chosen by the TPO is concerned, this Tribunal in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. In terms of Rule 10B(3)(b) of the Rules, an uncontrolled transaction shall be comparable to an international transaction if - (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. 38. Neither the TPO nor the DRP have noticed that there is bound to be a difference between the Assessee and Megasoft and the profit arising to the Megasoft as a result of the existence of the software product segment and no finding has been given that reasonably accurate adjustments can be made to eliminate the material effects of such differences. For this reason, we are inclined to hold that the profit margin of 23.11% which is the margin of the software service segment b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... utation done by the TPO with RPT and other details are given as Annexure-II to this order which is at page-217 of the TPO's order. The TPO finally passed an order u/s. 92CA of the Act and on the basis of the comparables set out above, arrived at arithmetic mean of 24.00%. After factoring the working capital adjustment of 2.06%, the adjusted arithmetic mean was determined at 21.94%. the computation of the ALP by the TPO in this regard was as follows:- "39.5 Computation of Arms Length Price: The arithmetic mean of the Profit Level indicators is taken as the arms length margin. (Please see Annexure E For details of computation of PLI of the comparables). Based on this, the arms length price of the software development services rendered by you is computed as under: Arithmetic mean PLI 24.00% Less: Working capital Adjustment(Annexure-F) 2.06% Adj.Arithmetic mean PLI 21.94% Arm's Length Price: Operating Cost (Rs.29,61,56,385 +reimbursement of expenses Received Rs. 75,59,949 Rs.30,37,16,334 Arms Length Margin 21.94% of the operating cost Arms Length Price (ALP) At 121.94% of operating cost Rs.37,03,51,698 *excluding exchange loss, donation, loss on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the filters such as employee cost and on-site revenue filter. It was submitted that employee cost forms a major portion of the total cost of BPO services and in the assessee's case employee cost is 62% of the total cost, whereas in the selected company the employee cost is less than 2%, which indicates that most of the work was outsourced and the outsourcing cost was at 88.64% of the operating cost. It was further submitted that the ITAT Bangalore in the case of First Advantage Off-shore Services (ITA No.1252/Bang/2010) has directed to use employee turnover filter in a consistent manner for selection of comparables and in the case of Maersk Global Services Centre (India) Pvt. Ltd. (14 ITR(Trib) 541) the Mumbai Bench of the Tribunal has analysed and rejected this company as comparable for the reason that it has outsourced a considerable portion of it's business and is functionally different. Moreover, it was also submitted that the DRP in the later year of 2008-09 vide its order dated 3.8.2012 has rejected this company as a comparable (name changed to Coral Hub Ltd.), vide para 18 of the order, wherein ultimately, it was decided that there is major difference in functionality and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at of Goldstone Infratech Limited (Seg) (earlier known as Goldstone Teleservices Limited). Here it is relevant to note that the TPO, inter alia, applied filter of 'Companies with export revenues more than 25% of the revenues'. Annual accounts of Goldstone Teleservices Limited indicate total revenue of the company at Rs. 30.89 crore from three segments, viz., Telecommunication at Rs. 13.63 crore, BPO at Rs. 5.02 crore and Insulator at Rs. 12.23 crore. The break up of such revenue of Goldstone Teleservices Limited has been provided at page 236 of the paper book. Schedule forming part of the annual accounts of Goldstone Teleservices Limited divulges earnings in foreign currency at Rs. 4.24 lakh. Such detail is available at page 239 of the paper book. When we compare earning in foreign currency at Rs. 4.24 lakh with the earnings of BPO at Rs. 5.02 crore or for that purpose of the entity as a whole at Rs. 30.89 crore, it becomes manifest that this case does not pass through the filter adopted by the TPO, being, the 'companies whose export revenues are more than 25% of the revenues'. Therefore, we are of the opinion, that this company cannot be considered as a comparable for the purpos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsactions entered into by Datamatics Financial Services Ltd. with its AEs. Section 92F(v) defines 'transaction' in the context of transfer pricing provisions to include an arrangement, understanding or action in concert whether or not it is formal or in writing or whether or not it is intended to be enforceable by legal proceeding. There is no reference to any transaction having necessarily including profit element or mark-up so as to fall within the definition of 'transaction' under Chapter X of the Income-tax Act. Since the TPO applied filter of having companies with less than 25% related party transactions, it is not open to argue that the transactions of reimbursement of expenses duly reported by Datamatics Financial Services Limited as an 'international transaction' within the meaning of section 92B should be ignored simply because they represent reimbursement of expenses. If the contention of the Id. DR that the reimbursement of expenses not involving profit element should not be construed as a transaction, is taken to a logical conclusion, it would mean that all such dealings will cease to be transactions for the purposes of ChapterX of the Act. Once these dealings are not c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions Limited from the list of comparables, we are unable to accept the contention of the Id. DR in this regard. It is more so because no contrary view has been brought by the Ld. DR to our notice. Respectfully following the precedents, we direct the exclusion of this case from the final list of comparables." Since the DRP in assessee's own case for assessment year 2007-08 also considered and excluded this company, we uphold the assessee's objection in this regard and direct the Assessing Officer to exclude this company from the comparables adopted. Nucleus Netsoft & GIS(India) Ltd. 13. The last objection was with reference to the above company, which is on similar facts as that of Vishal Information Technologies, discussed above. It was submitted that this company is functionally different and fails under the employee cost filter. It was further submitted that there is a scheme of amalgamation of earlier company by the orders of the Hon'ble High Court of Judicature of Bombay, on 22.2.2006 and in view of amalgamation, the financials have changed and the business model also changed. Referring to the annual report placed on record, it was submitted that as against Rs. 24.02 lakh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the purpose of determining the ALP. 27. The learned counsel for the Assessee submitted that after excluding the aforesaid 6 companies from the list of comparable and if the (-) (+) 5% adjustment under proviso to Sec.92C is considered than the Assessee's margin would be held to be at Arm's Length. The AO/TPO is accordingly directed to work out the profits margins after excluding the aforesaid companies and determine the ALP. 28. In ground No.36 the Assessee has projected the following grievance: "36. Reimbursement of Expenses are not related to services rendered but are pure cost reimbursements and hence should not be marked up. - The appellant wishes to reiterate the fact that the Honourable DRP ought to have appreciated that reimbursements received are not in respect of any services rendered but in fact constitute payments made for administrative convenience. - The Honourable DRP has not accepted the reimbursement of expenses at cost and erroneously added it back to the cost base for the purpose of a mark-up. 29. We have already seen that the Assessee received a sum of Rs. 2,32,47,077 from its AE and the same has been shown as an international transaction with AE by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rged by the assessee to Tesco Stores Limited, UK who reimbursed the same at cost, without any mark up. The details of expat tax and interest paid on delay in the payment of TDS were also provided as given below:- Expat Tax Details for the financial year 2005-2006 Sl. No. Name of the Expat Tax (Rs) Interest (Rs) Total Income Tax (Rs) 1 Tim Sea 2,240,802 145,652 2,386,454 2 Sangenu Park 2,101,111 136,572 2,237,683 3 Henry Kang 2,395,230 155,690 2,550,920 4 Philip Greenwood 4,806,569 312,247 5,118,996 5 Ushir Bhatt 2,572,258 67,197 2,739,45 6 David Briggs 3,911,924 254,275 4,166,199 7 Peter Hanlon 1,654,880 107,567 1,762,447 8 Roger Morgan 1,360,427 88,428 1,448,855 9 Sarah Morgan 878,935 57,131 936,066 Total 21,922,137 1,424,939 23,347,076 31. The ledger entries pertaining to the abovementioned transactions were provided as Appendix 25A to the objections filed before the DRP. The challans in support of the payment of the abovementioned expat tax and the interest on delayed payment of TDS were also provided as Annexure to the objections before the DRP. Sample invoice copies of the reimbursements received were al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The DRP however did not agree with the submissions of the Assessee and held as follows: "The reason why the TPO has considered a mark up is that arm's length service suppliers would usually expect to recover their cots plus element of profit. Therefore, in determining arm's length charge for service one must also take into account the economic alternatives available to the recipient of the service. We agree with the reasoning of the TPO." 34. Aggrieved by the order of the DRP, the Assessee has raised Ground No.36 before the Tribunal. We have heard the rival submissions. The learned counsel for the Assessee reiterated submissions made before the DRP. The learned DR relied on the order of the DRP. 35. We have considered the rival submissions. As observed in the OECD commentaries referred to in the Circular of the Canada Customs and Revenue Agency, it is important to distinguish between the situation of a taxpayer who renders services for the other members of a group; and a taxpayer who acts solely as an agent on behalf of the group to acquire services from an arm's length party. In the latter situation, the arm's length compensation would be limited to rewarding the agency role. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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