TMI Blog2015 (5) TMI 1138X X X X Extracts X X X X X X X X Extracts X X X X ..... aking into consideration the decision rendered by the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2011 (8) TMI 782 - KARNATAKA HIGH COURT] we are of the view that it would be just and appropriate to direct the Assessing Officer to exclude telecommunication charges and insurance charges incurred be excluded both from export turnover and total turnover, as has been prayed for by the assessee in the alternative. In view of the acceptance of the alternative prayer, we are of the view that no adjudication is required on the ground whether the aforesaid sums are required to be excluded from the export turnover. - I.T(TP).A No.1002/Bang/2011 - - - Dated:- 8-5-2015 - SHRI.N. V. VASUDEVAN, JUDICIAL MEMBER AND SHRI. ABRAHAM P.GEORGE, ACCOUNTANT MEMBER For The Appellant by : Shri. T.Suryanarayan, Advocate For The Respondent by : Shri.CH.Sundar Rao, CIT-D.R. ORDER PER N. V. VASUDEVAN, JUDICIAL MEMBER : This appeal by the assessee is against the order dated 19.09.2011 of the Deputy Commissioner of Income Tax, Circle11(2), Bangalore passed u/s. 143(3) r.w.s. 144C of the Act relating to AY 06-07. 2. The Assessee is a leading supplier of hi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Geometric Ltd. (Seg.) 10.71% New comparable 8 Helios Matheson Information Technology Ltd. 36.63% Common 9 iGate Global Solutions Ltd. 7.49% New comparable 10 Infosys Technologies Ltd. 40.30% Common 11 Ishir Infotech Ltd. 30.12% New comparable 12 KALS Information Systems Ltd. (Seg.) 30.55% New comparable 13 LGS Global Ltd. (Lanco Global Solutions Ltd.) 15.75% New comparable 14 Lucid Software Ltd. 19.37% New comparable 15 Mediasoft Solutions Ltd. 3.66% New comparable 16 Megasoft Ltd. 60.23% New comparable 17 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Length Price (ALP) at 123.82% of operating cost Rs.76,54,24,463 Price received vis- -vis the Arms 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 (ALP) At 123.82% of operating cost Rs.76,54,24,463 Price charged in the international transactions Rs.68,08.,49,606 Shortfall being adjustment u/s.92CA Rs.8,45,74,857 The above shortfall of ₹ 8,45,74,857/- is treated as transfer pricing adjustment u/s 92CA. 4. 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. Gr.No.1 to 5 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... were out of the same 26 set of comparable companies chosen in the present case as well as in the case of Logical Pvt.Ltd. (supra). 12. The next aspect which was highlighted by the ld. counsel for the assessee was that out of the 26 comparables, comparables at Sl.No.1, 2, 3 12 have to be rejected as they were held to be functionally not similar to a software services provider as held by this Tribunal in the case of Trilogy E-business Software India Pvt. Ltd., IT No.1054/Bang/2011 . The relevant paragraphs 39 to 50 of the aforesaid order of the Tribunal are as follows:- (b) Avani Cimcon Technologies Ltd. 39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company s website, which reveals that this company has developed a software product by name DXchange , it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Tec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... jected as a comparable. 41. We have given a careful consideration to the submissions made on behalf of the Assessee and are of the view that the same deserves to be accepted. The reasons given by the Assessee for excluding this company as comparable are found to be acceptable. The decision of ITAT (Mumbai) in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (supra) also supports the plea of the assessee. We therefore accept the plea of the Assessee to reject this company as a comparable. (c) Celestial Labs Ltd. 42. As far as this company is concerned, the stand of the assessee is that it is absolutely a research development company. In this regard, the following submissions were made:- In the Director s Report (page 20 of PB-Il), it is stated that the company has applied for Income Tax concession for in-house R D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act. As per the Notes to Accounts - Schedule 15, under Deferred Revenue Expenditure (page 31 of PB-II), it is mentioned that, Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arned D.R. celestial labs is also in the field of research in pharmaceutical products and should be considered as comparable. As rightly submitted by the learned counsel for the Assessee, the discovery is in relation to a software discovery of new drugs. Moreover the company also is owner of the IPR. There is however a reference to development of a molecule to treat cancer using bio-informatics tools for which patenting process was also being pursued. As explained earlier it is a diversified company and therefore cannot be considered as comparable functionally with that of the Assessee. There has been no attempt made to identify and eliminate and make adjustment of the profit margins so that the difference in functional comparability can be eliminated. By not resorting to such a process of making adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard. 44. It was submitted that the learned DR in the above case vehemently argued that this company is into research in pharmaceutical products. The ITAT concluded that this company is owner of IPR, it has software for discovery of new drugs an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bio products and other products as stated in the DRHP. There is no reference to any reply by Celestial labs to the above clarification of the TPO. The TPO without any basis has however concluded that the business mentioned in the DRHP are the services or businesses that would be started by utilizing the funds garnered though the Initial Public Offer (IPO) and thus in no way connected with business operations of the company during FY 06-07. We are of the view that in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable. (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 tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... el 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 to Accel Transmatics Ltd. the assessee submitted the company profile and its annual report for financial year 2005- 06 from which the DRP noted that the business activities of the company were as under. (i) Transmatic system - design, development and manufacture of multi function kiosks Queue management system, ticket vending system (ii) Ushus Technologies - offshore development centre for embedded software, net work system, imaging technologies, outsourced product development (iii) Accel IT Academy (the net stop for engineers)- training services in hardware and networking, enterprise system management, embedded system, VLSI designs, CAD/CAM/BPO (iv) Accel Animation Studies software services for 2D/3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ), the company has described its business as software development company or pure software development service provider. This information itself is very vague as the segmental details of operating revenue has not been made available to examine how much is the ratio of sale from software product and sale of software service and development. Looking to the fact that it has developed a software product named as Muulam which is used for civil engineering structures and the product development expenditure itself is substantial vis-a-vis the capital employed by the said company, this criteria for being taken as comparable party, gets vitiated. For the purpose of comparability analysis, it is essential that the characteristics and the functions are by and large similar as that of the assessee company and T.P. analysis/study can be made with fewest and most reliable adjustment. If a company has employed heavy capital in development of a product then profitability in the sale of product would be entirely different from the company, who is involved in service sector. Therefore, this company cannot be treated as having same function and profitability ratio. In our view, due to non-availa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fosys cannot be taken as a comparable for determining the arms length price in the case of the assessee. 7.5 Wipro Ltd.-IT Services Seqment( Wipro ): This company is also a global IT Company having varieties of service and products and looking to the magnitude of its operations, sales and expenses, the same cannot be taken into consideration for comparability analysis. Moreover, 67% of its sales relates to its product which are sold on premium resulting into higher profitability, therefore, cannot be compared with the assessee company at all. There are several judgments of ITAT which have been referred in para 6.5 above, that Wipro cannot be taken as comparable case for comparable case with the company like assessee. In view of these facts and the reasoning given in the case of lnfosys, we hold that Wipro also cannot be considered as a comparability analysis, hence, would not be included in the list of the comparable entities as identified by the TPO. 14. As far as comparable at Sl.No.6 24 are concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of the Tribunal in the case of Telcord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee, the ld. DR submitted that as far as functional comparability is concerned, it is not enough only to look at the fact that in the decisions relied upon by the ld. counsel for the assessee, also dealt with the case of software development and the assessee is also a software developer rendering software development services. It was his submission that the aforesaid companies even if they are engaged in providing software services, can be engaged in different sectors to which they cater, like software development in telecommunication, automobile manufacturing sector, etc. It was his submission that it was also necessary to consider as to whether the sectors in which the comparable chosen by the TPO belong and the sector to which the Assessee caters. 17. We have considered the submissions of the ld. counsel for the assessee and the ld. DR. We are of the view that the comparables which are sought to be excluded by the ld. counsel for the assessee have been held to be not comparable with the case of software service provider, in as much as these companies did not satisfy the functional similarity test. E.g., in the case of company at Sl.No.2 of the list of comparables chosen by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has to be excluded from the list of comparable companies. This filter is an accepted filter in the matter of choosing comparable companies. 9. In view of the above decision of the Tribunal, we direct that the aforesaid comparable companies in the list of comparables set out in Table given in para-4 of this order which is the final list of comparable companies chosen by the TPO, be excluded for the purpose of comparability. 10. As far as comparables at Sl.No.7 11 of the list of comparable chosen by the TPO listed at Para-4 of this order, are concerned, it is not in dispute before us that the related party transaction in the case of companies exceed 15% 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, that where the RPT exceeds 15%, such companies should not be taken as comparables, we hold that companies at Sl.Nos. 7 and 11 of the list of the comparables chosen by the TPO be excluded from the list of comparable companies while working out the ALP. 11. As far as comparable companies chosen by the TPO viz., iGate Global Solutions Ltd., Mindtree Consulting Ltd., Sasken Communications Ltd., Persistent Systems L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that a transaction entered into by a ₹ 1,000 crore company cannot be compared with the transaction entered into by a ₹ 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. The fact that they operate in the same market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a ₹ 1,000 crore company cannot be compared with the transaction entered into by a ₹ 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. 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 appropriat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndia) Private Limited Vs. ACIT (ITA No.1413/Bang/2010) 2. M/s Genesis Microchip (I) Private Limited Vs. DCIT (ITA No.1254/Bang/20l0). 3. Electronic for Imaging India Private Limited (ITA No. 1171/Bang/2010). It was finally submitted that companies having turnover more than ₹ 200 crores ought to be rejected as not comparable with the Assessee. The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than Q 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard. We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction 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 nonresidents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ( b ) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or ( c ) the information or data used in computation of the arm s length price is not reliable or correct; or ( d ) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm s length price in relation to the said international transaction in accordance with subsections (1) and (2), on the basis of such material or information or document available with him: Rule 10B of the IT Rules, 1962 prescribes rules for Determination of arm s length price under section 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 ) transact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o 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. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared. 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 f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sasken Communication Technologies Ltd. (Seg.) 240.03 crores (5) Persistent Systems Limited 209.18 crores. 13. After excluding the aforesaid comparable from the list of comparable chosen by the TPO, the arithmetic mean of profit margin of the remaining 9 comparable would be 15% (unadjusted) and 13.33% after working capital adjustment. The Assessee s profit margin operating profit on cost is 10.64% which is within the + / - 5% range permitted under second proviso to Sec.92CA(2) of the Act and therefore the addition made by the TPO and confirmed by the DRP needs to be deleted. Accordingly the same is deleted. The relevant grounds of appeal of the Assessee are allowed. The other issues raised on Transfer Pricing issues were not argued and hence does not require adjudication. 14. The next issue that arises for consideration in this appeal by the Assessee is with regard to disallowance of deduction claimed u/s.10A of the Act in respect of profits of the Assessee s Bangalore unit of ₹ 4,08,29,786/-. The Assessee has three units through which it conducts its business. Out of the three uni ..... 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