TMI Blog2016 (6) TMI 1259X X X X Extracts X X X X X X X X Extracts X X X X ..... see is a subsidiary of Avaya International LLC, a Delaware Corporation. The assessee, in the relevant assessment year, was engaged in providing software development services (SDS), IT enabled services (ITES) and market support services (MSS) to its AEs. The company is primarily engaged in the business of software development for export, more specifically, the assessee is involved in development of switching integration and comer stone modules for Janus release, a next generation messaging products. The assessee had filed its return of income declaring an income of ₹ 13,53,49,060/-. During the year under consideration the assessee had reported following international transactions in form 3CEB: Nature of transaction Value of international Transaction Software Services rendered (SDS) 1,508,656,740 Marketing Support Services provided (MSS) 16,158,264 Back office support services function (ITES) 71,907,052 Purchase of fixed assets 62,293,945 Reimbursement of Expenses paid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... les, computed the ALP in regard to provision of software development services, as under: 20.5 Computation of Arms Length Price: The arithmetic mean of the profit level indicators is taken as arms length margin. (Please see Annexure B for details of PLI of the comparables). Based on this, the arms length price of the software development services segment rendered by the taxpayer to its AE(s) is computed as under: Arithmetic mean PLI : 26.20% Adj. Arithmetic mean PLI : 26.20% Arm's Length price: Operating cost ₹ 1,300,738,569 Arms Length margin 26.20% of the operating cost Arms length price ₹ 1,641,532,074 20.6 Price received vis- -vis the Arm s Length price: The price charged by the tax payer to its Associated Enterprises is compared to the Arms Length price as under: Arms Length price @ 126.20% of operating cost ₹ 1,641,532,074 Price charged in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rms Length price ₹ 29,906,378 Price charged in the international transactions ₹ 26,158,256 Shortfall being adjustment u/s 92CA ₹ 3,748,122 10. Being aggrieved with the draft order of AO, passed in pursuance to directions of ld. TPO, the assessee filed its objections before ld. DRP. Ld. DRP issued following directions: a. Provision of Software Development Services : directed for exclusion of Celestial Biolabs for the following reasons: The Annual report in the case of Celestial Biolabs has been examined. We find that this company fails the employee cost filter. Besides that, this company is constantly receiving loans from Department of Science and Industrial Research and hence the economic circumstances of this company are at absolute divergence from the tested party. In view of these reasons, we find that Celestial Biolabs is not a suitable comparable for analysis. TPO is directed to exclude it. 11. As regards Softsol India Ltd., Ld. DRP directed as under: The company is functionally comparable. However, see that the operat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9;), IT Enabled Services ('ITES') Marketing Support Services ('MSS') do not satisfy the arm's length principle envisaged under the Act In doing so, the Hon'ble DRP has grossly erred in agreeing with the Learned Transfer Pricing Officer's ('Ld. TPO's) action of: 2.1. not appreciating that none of the conditions set out in section 92C(3) of the Act are satisfied in the present case; 2.2. disregarding the ALP as determined by the Appellant in the Transfer Pricing ('TP') documentation maintained by it in terms of section 920 of the Act read with Rule 100 of the Income-tax Rules, 1962 ('Rules'); and in particular modifying/ rejecting the filters applied by the Appellant; 2.3. disregarding multiple year/ prior years' data as used by the Appellant in the TP documentation and holding that current year (i.e. FY 2007-08) data for comparable companies should be used despite the fact that the same was not necessarily available to the Appellant at the time of preparing its TP documentation; at 2.4. collecting information of the companies by exercising power granted to him under section 133(6) of the Act that was n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... +/-5% range to the Appellant; 2.14. disregarding judicial pronouncements in India in undertaking the TP adjustment; and 2.15. ignoring the fact that the Appellant is entitled to tax holiday under section 10A of the Act on its profits in relation to provision of IT and ITES, and therefore would not have any untoward motive of deriving a tax advantage by manipulating transfer prices of its international transactions. 3. Without prejudice to the above grounds, the Ld. AO grossly erred, while following the direction of Hon'ble DRP of computing the operating margin of Softsol India Limited, in excluding depreciation and expenses attributable to let-out property, without any basis and rationale. 4. On the facts and circumstances of the case and in law, the Ld. AO has grossly erred in initiating penalty proceedings under Section 271 (1) (c) of the Act . 16. Ld. counsel pointed out that as far as software development services and IT enabled service segments are concerned, the same were there in AY 2007-08 and the Tribunal vide its order dated 18.9.2015 has directed for exclusion of comparables as detailed below: Software Development Segment: (x) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the contentions of the AR, held as under :- 27.1. The TPO observed that this company was engaged in Software development and training. As the software products constituted only 3% of its revenue and training revenue constituted 8.56%, the TPO held that this segment of KALS Information Systems Limited was rightly includible. 27.2. After considering the rival submissions and perusing the relevant material on record, it is an admitted position that the TPO adopted Software development segment of this company by noticing that this segment also included revenues from software products and training. In view of the fact that the assessee is not engaged in imparting any training on commercial basis or selling its software products, we hold that the financials of this company under this segment cannot be compared with the assessee. The contribution by the sale of software products or training to the overall revenue of this segment cannot be precisely ascertained to determine the question of its comparability. As such, this case is directed to be excluded. The assessee succeeds. In the light of the co-ordinate Bench finding, as afore-stated, we direct the exclusion of this comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble, despite the fact that the company admitting in writing that it is into medical transcription service. According to ld. AR, the TPO erred in comparing the medical transcription segment of Accentia to ITES segment of assessee. The Ld. AR submitted that Accentia provides high end functions such as Knowledge Process Outsourcing, Legal Process Outsourcing, Data Process Outsourcing, high end software services delivery besides offering Software As A Service ( SaaS ) Model in the healthcare outsourcing area. He further submitted that it also developed software products such as Business Process Outsourcing Management ('BPOM') solutions and HealthDox (HRCM Solution), apart from IT enabled services. Our attention was also brought to the pertinent fact that TPO has himself admitted that Annual Report of this company is not available so assumption is that segmental information for Accentia was unavailable before the TPO. We have considered the rival submission and have gone through the material available on record and the case-laws cited by both the parties. We find that a perusal of page 279 of appeal set of TPO order dealing with Accentia, the TPO has stated that annual rep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eservations as to the Tribunal's aforesaid view in Maersk Global Centers (India) Pvt. Ltd. (supra). As indicated above, the expression 'BPO' and 'KPO' are, plainly, understood in the sense that whereas, BPO does not necessarily involve advanced skills and knowledge; KPO, on the other hand, would involve employment of advanced skills and knowledge for providing services. Thus, the expression 'KPO' in common parlance is used to indicate an ITeS provider providing a completely different nature of service than any other BPO service provider. A KPO service provider would also be functionally different from other BPO service providers, inasmuch as the responsibilities undertaken, the activities performed, the quality of resources employed would be materially different. In the circumstances, we are unable to agree that broadly ITeS sector can be used for selecting comparables without making a conscious selection as to the quality and nature of the content of services. Rule lOB(2)(a) of the Income Tax Rules, 1962 mandates that the comparability of controlled and uncontrolled transactions be judged with reference to service/product characteristics. This factor ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... into high end service (KPO), which cannot be compared with the assessee. So, we direct its exclusion from the list of comparables. 20. Consistent with the view taken in AY 2007-08, we exclude this comparable from the list of comparables. Assessee succeeds. (viii ) Coral Hub (Vishal Information Technologies Ltd.) (vii) Eclerx Services Ltd. As regards the aforesaid two comparables [mentioned at sl.nos.(vii) (viii)], The ld. AR at the outset itself pointed out that Eclerx and Vishal are into KPO services. According to him, although KPO services were ITES but the nature of these services were materially different than the services rendered by the assessee. It was asserted that eClerx is engaged in financial services in the nature of account reconciliation, trade order management services and has been rated as a leading KPO by Nelso Hall. It was contended that similarly Vishal was engaged in the services of data analytics and providing data processing solutions to some of the largest brands in the world. Vishal too had been rated as a leading KPO by Nelso Hall. In addition, it was pointed out that whilst the employee costs incurred by Vishal was relatively lo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed eClerx as a comparable. It is further observed that the comparability of eClerx had also been examined by the Hyderabad Bench of the Tribunal in M/s Capital Iq Information Systems(India) (P.) Ltd. v. Additional Commissioner of Income- tax (supra), wherein, the Tribunal directed the exclusion of eClerx as a comparable for the reason that it was engaged in providing KPO Services and further that it had also returned supernormal profits. 38. In our view, even Vishal could not be considered as a comparable, as admittedly, its business model was completely different. Admittedly, Vishal's expenditure on employment cost during the relevant period was a small fraction of the proportionate cost incurred by the Assessee, apparently, for the reason that most of its work was outsourced to other vendors/service providers. The DRP and the Tribunal erred in brushing aside this vital difference by observing that outsourcing was common in ITeS industry and the same would not have a bearing on profitability. Plainly, a business model where services are rendered by employing own employees and using one's own infrastructure would have a different cost structure as compared to a busine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any judicial consensus on the numerical limit nor the section so prescribes. However, there is consensus on the effect of RPT i.e. it should not materially affect the international transaction. Therefore, considering the submissions of both the sides, we are of the opinion that if by applying the threshold limit of 15% of related party transaction, sufficient comparables are available then there is no reason to further extend the limit to 25%. Therefore, we direct the TPO to take into consideration only those comparables where related party transactions are to the extent of 15% because it is not the case of revenue that by applying the threshold limit of 15%, it will not get sufficient number of comparables. It was pointed out by the ld. AR that the aforesaid companies related party transactions are more than 15%. We find force in the said contention of the ld. AR and we find that in this list of comparables considered by the TPO, the assessee itself had accepted eleven (11) comparables as comparable with that of the assessee. In such a scenano, we are of the opinion that the TPO may take into consideration only those comparables where related party transactions are to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the customers on various promotional initiatives and new product launches of the Avaya Group entities. Assessee advices Avaya Group entities of the local law and business, political and regulatory practices and policies. 28. Ld. counsel has relied on the order of the ITAT in the case of Ciena India Pvt. Ltd. (supra) and, therefore, it is necessary to examine the functional profile of Ciena India Pvt. Ltd. (supra) also in regard to marketing support segment. In this regard we find that the Tribunal in paras 13 14 of its order has observed as under: 13. We have heard the rival submissions and perused the relevant material on record. Before examining the comparability or otherwise of the companies challenged before us, it is of utmost importance to consider the nature of activity carried out by the assessee in the provision of marketing support services. There is no elaboration of the nature of services in the Agreement between the assessee and Ciena Corporation, USA, except for mentioning in Schedule 2: 'Provision of other such services to Ciena, USA as Ciena, USA may reasonably request from time to time.' The TPO has also not discussed the nature of services under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n and Management Services (Rs. 201.93 lakhs) - Project related services (Rs. 201.64 Lakhs) - Micro Enterprises Development (Rs. 150.09 lakhs) - Infrastructure Planning Development (Rs. 136.15 lakhs) - Research Studies Tourism (Rs. 126.22 lakhs) - Spill Development (Rs. 112.88 lakhs); - Environment Management (Rs. 42.08 lakhs); - Entrepreneurship Development Training (Rs. 34.79 lakhs); - Cluster Development (Rs. 24.08 lakhs); - Energy related services (Rs./ 16.24 lakhs); - Emerging areas (Rs. 5.30 lakhs) 31. Thus, he submitted that this company was engaged in provision of high end technical consultancy services. He further pointed out that new areas covered by this company were trunkey implementation of wire rope suspension foot bridge at Lakhnavaram lake in Warangal district, Andhra Pradesh . 32. Ld. counsel referred to the TPO s comments at page 145 of his order, wherein the ld. TPO has observed as under: 8.1. Apitco Ltd.: In respect of this comparable the assessee has objected on the functional difference ground. However, a perusal of the annual report of the comparable in question reveals that its carried out functions akin to that o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from research studies which is akin to the nature of services provided by the assessee company. This contention has not been controverted by the ld. DR with any clinching evidence. When we consider the operations of this company as enumerated above and the fact that this company has maintained accounts on entity level and there is no bifurcation available in respect of the services similar to those provided by the assessee under this segment, this company on entity level cannot be considered as comparable. We, therefore, hold that the ld. CIT(A) was justified in considering this company as not comparable. 36. We, therefore, following the decision in the case of Ciena India Pvt. Ltd. (supra), direct for exclusion of this company from the list of comparables. 37. Choksi Laboratories Ltd. Ld. counsel referred to page 320 of the PB, wherein as regards segmental reporting it is stated as under in Schedule 14:- 08. Segmental Reporting: The Company treats Analytical Charges Consultancy Receipts as a single segment and therefore details of segments are not separately shown. The company is a Commercial Testing House engaged in testing of various products and also offers ser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 43. Having heard both the parties, we find that this company is mainly imparting technical consultancy services and there is no separate marketing support segment. In the case of Ciena India Pvt. Ltd., supra, the Tribunal has observed in para 16.2 as under: After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company that it has two segments, namely, 'Consultancy and engineering projects' and 'Lumpsum turnkey projects.' The TPO has taken 'Consultancy and engineering project segment' for the purposes of comparison with the assessee company. This company is engaged in infrastructure development projects. This company is also working as independent review and monitoring agency for projects in some States. It is also providing supervision and quality control consultancy for construction/ upgradation of rural roads under PMGSY. It also secured projects for development and hygiene education, development of dry pit latrines, designs for local conditions for household and schools and solid waste management. It also secured projects for transmission line Kirti Irti to Sta, Treng, Cambodia ..... 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