TMI Blog2015 (11) TMI 1719X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee is application software designed to perform various business processes. The application software enables the assessee to carry out its business operations efficiently and smoothly and does not provide any enduring benefit. Such software enhances the efficiency of the operations. It is an aid in the manufacturing process. Considering the above facts and the judicial precedents relied upon by the assessee company, we hold that the said license fees and maintenance fees is to be allowed as revenue expenditure. Since we have allowed the assessee’s claim of software expenditure to be treated as revenue expenditure, the alternate ground for non-grant of additional deduction u/s. 10B on account of capitalisation of software expenditure is not considered for adjudication. - IT(TP)A No.551/Bang/2015 - - - Dated:- 27-11-2015 - SMT. ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER AND SHRI ABRAHAM P. GEORGE, ACCOUNTANT MEMBER Appellant by : Shri K.R. Vasudevan, Advocate Respondent by : Shri Sunil Kumar Agarwala, Jt. CIT(DR) O R D E R Per Asha Vijayaraghavan, Judicial Member This appeal is by the assessee company directed against the order dated 27.01.2015 of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a of comparable companies while determining arm s length price. 5. The learned AO, TPO and Hon ble CIT(A) erred in using data as at the time of assessment proceedings, instead of that available as on the date of preparing the TP documentation for comparable companies while determining arm s length price. 6. The learned AO, TPO and Hon ble CIT(A) have erred in rejecting companies selected as comparable by the Appellant in the TP documentation and have erred in selecting/introducing companies which are not comparable to the Appellant on conducting a fresh comparability analysis and on introduction of additional filters in determination of arm s length price. 7. The learned AO, TPO and Hon ble CIT(A) have erred in rejecting Thinksoft Global Services Ltd. and FCS Software Solutions Ltd. on the ground that the working capital adjustment for these companies are substantial. 8. The learned AO, TPO and Hon ble CIT(A) have erred in not rejecting Bodhtree Consulting Ltd. and Kals Information Systems Ltd. being functionally dissimilar to the Appellant. 9. The learned AO, TPO and Hon ble CIT(A) have erred in ignoring the limited risk nature of the contractual services provided b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9. With respect to Sl.Nos.5, 6, 7, 8, 9, 10 11 of the final list of comparables selected by the TPO, the ld. counsel for the assessee pleaded that these comparables have to be rejected since the turnover filter is more than ₹ 200 crores. 10. It has been held by this Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd. in ITA No.1054/Bang/2011 dated 23.11.2012 that companies with a turnover of more than ₹ 200 crores cannot be taken as comparables while determining the ALP in the case of companies having turnover of less than ₹ 200 crores. The following are the relevant observations of the Tribunal in this regard:- (1) Turnover Filter 11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of ₹ 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially af ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rate. 13. It was further submitted that the TPO s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of ₹ 13,149 crores as compared to ₹ 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 14. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet s analysis, the turnover of ₹ 1 crore to ₹ 200 crores was held to be proper. The following relevant observations were brought to our notice:- 9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on shall be computed having regard to the arm s length price. Sec.92-B provides that international transaction means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92- A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm s length price in an international transaction and it provides:- (1) that the arm s length price in relation to an international transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection 92C:- 10B. (1) For the purposes of sub-section (2) of section 92C, the arm s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) . to (d) .. (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in subclause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red. 19. A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. 20. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee s turnover is ₹ 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es company by the Bangalore Bench of the Tribunal in the case of M/s. Trilogy e-business Software India Pvt. Ltd. (supra). The following were the relevant observations of the Tribunal:- (d) KALS Information Systems Ltd. 46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was ₹ 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal s decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows: 16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparables unless the assessee demonstrates and establishes that some abnormal event took place which led to abnormal results. Hence, the CIT(A) rejected the contentions of the assessee for exclusion of Bodhtree Consulting Ltd. as a comparable. 15. The assessee has now raised grounds before us stating that the same is functionally dissimilar which is into development of software products. The ld. counsel for the assessee also stated that there is mismatch on the revenue-cost. Reliance was placed on the decision of the Bangalore Bench of the Tribunal in the case of CISCO Systems (India) Pvt. Ltd. (supra) and Delhi Bench of the Tribunal s decision in Ciena India Pvt. Ltd., ITA No.1453/Del/2014 respectively. 16. We have heard both the parties and perused the material on record. In the case of CISCO Systems (India) Pvt. Ltd. (supra), the coordinate Bench of this Tribunal held that Bodhtree Consulting Ltd. is not to be treated as a comparable company. In this regard, the relevant observations of the Tribunal on the functional dissimilarity are as under:- 26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute that in the list of comparables ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch software development may be capitalized, which appears to be a more rational manner of depicting the true and fair view of the profitability of the enterprise; and the second, in which such expenses may be straightway taken as revenue cost for the year of its incurring itself, which may not reflect a true and fair view of the profits on year to year basis. The contention of the ld. AR is that whereas Bodhtree fell into the second situation, the assessee was in the first situation. Though this contention about Bodhtree accounting for expenses in the year of incurring but considering income only on the conclusion of the project in the subsequent year sounded a little awkward, we attempted to find out the amount of capitalized expenses in respect of incomplete projects at the end of the year. Apparently, we could not find out any such capitalized value of work-inprogress in the balance sheet of the company on standalone basis. We directed the ld. DR to examine the Annual report of this company and point out the amount of expenses capitalized in respect of incomplete work at the end of the year. On the next date of hearing, the ld. DR failed to specifically point out any amount of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... borne by a captive service provider is only an anticipated risk vis-a-vis the existing market risk borne by independent comparables. and has allowed market risk adjustment. 22. In the case of lntellinet Technologies India Private Ltd., the coordinate Bench of this Tribunal held as under:- 7. Having heard both the parties and having considered the rival contentions, we find that the assessee has claimed the risk adjustment which is not allowed by the TPO on the ground that the assessee also has the risk of having a single customer. The question before us is as to whether the risk of having a single customer is equivalent to the marketing and technical risk attached to the comparables. According to the TPO, the assessee has the single customer risk meaning, if the single customer refuses to have any dealings with the assessee, the assessee would lose all of its business and there would be no profit at all. But, as we see it, the risk of having a single customer is anticipated risk which may or may not happen. What we have to see is the position in the relevant period whether the assessee had encountered such a risk during the relevant period. 7.1 As seen from the rec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the arithmetical average of net profit margins computed in the case of uncontrolled comparables is considered as arm s length profit margin in transfer pricing that arise from operating business, then the average cost of capital computed in the case of uncontrolled comparables should also be considered as arm s length price of the cost of capital in transfer pricing exercise. Accordingly, the average cost of capital computed in the case of the uncontrolled comparables should be an upper cap for the purpose of allowing working capital adjustment. 26. It was submitted that the TPO in the order has advocated limiting the working capital adjustment contending that the adjustment would be negative for the assessee/tested party, since it does not have significant debtors/inventory and generally, the assessee/tested party receives the money in advance for the services from the AEs. Whereas, the entrepreneurial companies selected as comparable will have debtors, inventory and the creditors. 27. The ld. counsel for the assessee submitted that in advocating this principle the TPO has ignored the characterisation of the assessee as a low risk captive services provider that does not per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uard against possible injustice and arbitrariness and affords protection to the person adversely affected. Reasons are the links between the material on which certain conclusions are based and the actual conclusions. They disclose how the mind is applied to the subject-matter for a decision, whether it is purely administrative or quasi-judicial. They should reveal rational nexus between the facts considered and the conclusion reached. Only in this way can opinions or decisions recorded be shown to be manifestly just and reasonable. 29. In view of the decision in the case of Dresser-Rand India Pvt. Ltd. (supra) rendered by the Mumbai Bench of the Tribunal, the restriction placed by the TPO in providing the working capital adjustment was not justified. The AO/TPO is directed to allow the actual adjustment towards the differences in the working capital position between the assessee and the entrepreneurial companies selected as comparable. 30. The next ground of appeal is with respect to disallowance of software expenses. The facts with regard to this issue are that the assessee has incurred expenses towards purchase of application software (i.e. obtaining or renewing the license ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or ownership in any of the assets upon payment of such allocation charges. 35. The AO has disallowed the above software expenditure on the ground that the same is capital in nature and hence provided depreciation on the same at a rate of 30% (Assuming that the software has been put to use for less than 180 days). 36. Before us, it was submitted that In this regard, the entire software expenditure amounting to ₹ 11,951,844 is allowable as deduction under section 37(1) of the Act on the following grounds:- a. The above referred expenditure has been incurred on obtaining or renewing the licenses for use, of certain application software and as this expenditure was incurred with the prime objective of carrying on the business activities more effectively and profitably leaving the capital base untouched. b. The test of enduring benefit is more prone to failure in the case of computer software where the pace of advancement is so rapid that whatever technology is installed today becomes obsolete within a short time. c. No portion of the application software was custom made software and all of them had been purchased off the shelf . Further, the assessee was merely a l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing income chargeable under the head profits and gains from business or profession . 39. Thus for an expenditure to be deductible in terms of section 37(1) of the Act, the following conditions are to be satisfied - a. The expenditure should not be of the nature described in sections 30 to 36 of the Act; b. It should not be in the nature of personal expenses; c. It should have been laid out or expended wholly and exclusively for the purpose of the business; and d. It should not be in the nature of capital expenditure. 40. The ld. counsel for the assessee submitted that in the instant case, all the above conditions are satisfied and thus the application software expenditure including maintenance expenses is revenue in nature and is eligible for deduction under section 37(1) of the Act. Attention was invited to the fact that the assessee has only acquired the requisite licenses to use the application software and hence the ownership and the intellectual properties of the software c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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