TMI Blog2016 (1) TMI 1359X X X X Extracts X X X X X X X X Extracts X X X X ..... ant : Shri. Vikram Vijayaraghavan, Advocate For The Respondent : Ms.Neeru Malhotra, CIT-(DR) ORDER PER N. V. VASUDEVAN, JUDICIAL MEMBER : This appeal by the assessee is against the order dated 18.10.2010 of the ITO, Ward 11(2), Bangalore, passed u/s. 143(3) r.w.s. 144C of the Act. 2. The Assessee is a subsidiary of FCG Software Service Inc., USA. The Assessee is engaged in providing software development services of its holding company. The said transaction was an international transactions with an Associated Enterprise (AE) and has 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 Software development Services. 3. Financial Results of the Assessee for the F Y 2005-06 Description Amount Operating Revenue Rs.52,03,85,342 Operating Cost . . . . Rs.45,11,93 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12 R S Software (India) Ltd 15.69 91.57 13 S I P Technologies Exports Ltd 3.06 6.53 14 Bodhtree Consulting Ltd. 15.99 5.32 15 Accel Transmatic Ltd. (Seg.) 44.07 8.02 16 Synfosys Business solutions Ltd. 10.61 4.49 17 Flextronics Software Systems Ltd. 27.24 595.12 18 Lanco Global Solutions Ltd 5.27 35.63 19 Megasoft Ltd 52.74 56.15 20 iGate Global solutions Ltd.(Seg.) 15.61 527.91 Arithmetic Mean 20.68% 5. The TPO finally passed an order u/s. 92CA of the Act and on the basis of the comparables set out above, arr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 92 CE report) Provision of software services ₹ 520,248,242/- Reimbursement Received ₹ 80,593,261/- The arm s length price has to be determined with reference to the above international transactions. The tax payer received an amount of ₹ 80,593,261/- in the form of reimbursement. In the 3CEB Report it was stated that with respect to reimbursements received, the assessee has certified that the actual costs incurred on behalf of the AE are recharged to the AE and are supported by relevant third party invoices. Consequently the amount received/receivable is deemed to be arms length price. In the TP report, the taxpayer did not mention anything about the reimbursement of expenses. Thus the taxpayer was asked vide this office letter dated 17-08- 2009 as under regarding the recovery of expenses or reimbursement of expenses received. Further, you are requested to submit the following:- 1 . 2. Details and nature of reimbursement of expenses. Also clarify whether such expenses are routed through the profit and loss account. If yes, please specify the head(s) under which it is shown. If no, please show why such expenditure sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, (b) for the reason that these companies were not functionally comparable; (c) for the reason that the related party transaction (RPT) carried out by the comparable companies during the previous year was beyond 15% of its revenue and hence ought not to be included as a comparable. The Chart also gives the cases decided by various Benches of the ITAT where the comparable companies have been held to be not comparable with that of an Assessee providing IT Software development Services. We will proceed to consider the comparability of companies chosen by the TPO and listed in para- 4 of this order. 9. The ld. counsel for the assessee brought to our notice that out of the 20 comparable companies chosen by the TPO, the following companies will have to be excluded as the turnover of these companies are more than ₹ 200 crores and cannot be compared with the Assessee whose turnover is less than ₹ 100 crores: (1) Flextronics Software Systems Ltd. 595.12 crores (2) iGate Global Solutions Ltd. 527.91 crores (3) Mindtree Ltd. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the question as to whether the aforesaid two companies are comparable or not with the Assessee company in terms of FAR analysis, has to be decided on the basis of data which is available in the public domain i. e., published annual report of these two companies. Therefore facts necessary to apply the filter sought to be relied upon by the Assessee in the additional ground of appeal are already available on record. Therefore there can be no valid objection to deciding the question of applying the aforesaid filter, if otherwise it is found to be a valid filter. We are of the view that the decision of the special Bench, chandigarh in the case of Quark Systems (supra) clearly supports the plea of the Assessee. The Special Bench in the aforesaid decision in the case of Quark Systems (supra) has after considering the OECD Commentaries observed as follows: 35. In para 4.16 of latest report, the OECD provides the following guidelines : In practice, neither countries nor taxpayers should misuse the burden of proof in the manner described above. Because of the difficulties with transfer pricing analysis, it would be appropriate for both taxpayers and tax administrations to take s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tribunal and Hon ble High Courts. In the light of the later judicial pronouncement, the Assessee is entitled to rely on the same and claim that the said filter should be applied to exclude a company chosen as a comparable company by the TPO. As held by the Special Bench in the case of Quark Systems(supra), there cannot be any tax liability on the basis of admission and the determination of tax liability has to be in accordance with law. In the light of the aforesaid judicial pronouncement, we are of the view that the additional ground of appeal deserves to be admitted for adjudication. Accordingly, the additional ground is admitted for adjudication. 15. We have considered the submission of the learned counsel for the Assessee. In the case of Triology E-Business Software India (P) Ltd. (supra), this Tribunal on application of the turnover filter while selecting comparable companies for comparability analysis held as follows: (1) Turnover Filter 11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Q 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 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 Q 1 crore to Q 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 ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ance in this regard. 18. 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid international transaction in accordance with sub-sections (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)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 sub-clause (ii) arising in comparable uncontrolled transac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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 for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. 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 Q 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... riteria in choosing comparable companies. 17. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon __________ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criteria for choosing companies as comparable companies in determination of ALP in transfer pricing cases. In doing so the Hon ble Bombay High Court has followed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Q 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 assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tem, VLSI designs, CAD/CAM/BPO (iv) Accel Animation Studies software services for 2D/3D animation, special effect, erection, game asset development. 4.3 On careful perusal of the business activities of Accel Transmatic Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee s claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from the final list of comparables for the purpose of determining TNMM margin. Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as comparable. The ld. DR, on the other hand, relied on the order of the TPO. 50. We have considered the submissions and are of the view that the plea of the assessee that the aforesaid company should not be trea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... llows:- 7.7.Tata Elxsi Limited.: From the facts and material on record and submissions made by the learned AR, it is seen that the Tata Elxsi is engaged in development of niche product and development services, which is entirely different from the assessee company. We agree with the contention of the learned AR that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties. 15. In view of the above, the ld. counsel for the assessee fairly admitted that comparable company at Sl.No.6 viz., Flextronics Software Systems Pvt. Ltd. should be taken as a comparable, while comparable at Sl.No.24 viz., Tata Elxsi Ltd. should be rejected as a comparable. 23. In view of the aforesaid decision, we hold that Tata El ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the light of the material now placed by the Assessee before the Tribunal. The TPO/AO shall consider the claim of the Assessee in this regard. The Assessee will provide the necessary supporting evidence to substantiate its claim. The TPO/AO will examine the claim of the Assessee after affording opportunity of being heard and in the light of the ruling of the ITAT in the case of LG Soft India (P) Ltd.(supra). We hold and direct accordingly. 28. The learned counsel for the Assessee has submitted before us that the TPO and the DRP have rejected the claim of the Assessee regarding risk adjustment. The Assessee has given detailed submissions in this regard in Ground No.12 raised before the DRP. The DRP has not given any findings in this regard. We are of the view that in the present case, the question of risk adjustment may not be required to be gone into in view of the fact that many of the comparable companies chosen by the TPO have been deleted from the list of comparable companies for determination of arithmetic mean of profit margin of comparable companies to determine ALP. We therefore deem it fit and proper to leave this issue open for the present, with liberty to the Asses ..... X X X X Extracts X X X X X X X X Extracts X X X X
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