TMI Blog2023 (8) TMI 1170X X X X Extracts X X X X X X X X Extracts X X X X ..... [ 2022 (7) TMI 1349 - ITAT BANGALORE] in respect of Larsen Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd. and Infosys Ltd direct exclusion from the final list. Exclusion of Nihilent Ltd. and OFS Technologies Ltd. from the final list as not functionally similar to that of assessee. Case followed SUBEX LIMITED [ 2023 (4) TMI 224 - ITAT BANGALORE] Assessee seeking inclusion of only two comparables Maveric Systems Ltd. and Evoke Technologies Pvt. Ltd. - We note that the authorities below has not verified the annual reports to come to a conclusion that the export revenue filter is not satisfied. In the interest of justice, we direct these comparables back to the Ld.AO/TPO to verify the FAR analysis of these comparables with that of assessee and to consider its inclusion in case it satisfies all the relevant filters. Margins of Harbinger Systems Pvt. Ltd. and CG-Vak Software and Exports Limited has been wrongly computed - We direct the Ld.AO/TPO to recompute the margins of these comparables in accordance with law. Considering bad debts and provision for bad debts as non-operating expenses while computing the operating margin of comparable companies - H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e arm's length price for international transactions entered by the Appellant with its associated enterprise. 4. Adjustment on account of re-determination of arm's length price for the services rendered by the Appellant to its Associated Enterprises ( AEs ) 4.1 The Ld. AO/TPO/DRP erred, in law and in facts. by not accepting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Income-tax Rules, 1962 ( the Rules ) and in conducting a fresh economic analysis for the determination of ALP in connection with the impugned international transactions and holding that the Appellant's international transactions are not at arm's length. 4.2 The Ld. AO/TPO/DRP erred, in law and in facts, by incorrectly applying the following quantitative and qualitative filters: a) Rejecting comparables companies having different accounting year/ financial year (i.e. companies having accounting year/ financial year other than March 31 or companies whose financial statements were for a period other than 12 months). b) Applying only the lower turnover filter of less than INR 1 crore as a comparability criterion an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e or at the time of hearing of the appeal, so as to enable the Hon'ble Tribunal to decide on the appeal in accordance with the law. 2. At the outset, the Ld. AR submitted that the assessee has filed applications seeking admission of additional grounds on 19.08.2022 and 17.02.2023. He submitted that specific comparables have been sought for inclusion / exclusion by way of these additional grounds and no new records need to be considered / verified in order to adjudicate them. The Ld.AR submitted that, the assessee while filing the original ground of appeal had not categorically mentioned the comparables, seeking inclusion/exclusion. He submitted that, these additional grounds may be admitted to render complete justice to the assessee. Following are the issues raised by the assessee in the applications dated 19.08.2022 and 17.02.2023 Addl. Grounds of appeal dated 19.08.2022 Addl. Grounds of appeal dated 17.02.2023 2.1 It has been submitted that no new facts needs to be considered in order to dispose of the additional grounds raised by the assessee. It is submitted that, the additional grounds raised do not require verification of any new facts. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l Zeiss products in India. The company caters to both domestic and international market. In addition Carl Zeiss India also provides software development services to its Group Companies. The Ld.TPO noted that the international transactions as disclosed by the assessee in Form 3CEB are as under: Particulars Amount (Paid) Amount (Recd) Purchase of Raw Materials 52,68,67,776 Sale of Finished /Manufactured Goods 53,84,08,441 Sale of Traded Goods / Manufactured Goods 9,65,384 Sale of Traded Goods 85,78,786 Purchase of Traded Goods 168,45,93,438 Purchase of Fixed Assets 1,55,74,868 Royalty 2,35,06,551 Income from Services 48,92,09,994 Commission Income 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14 Larsen Toubro Infotech Limited 21.50% 15 R Systems International Limited (Segmental) 22.44% 16 Tata Elxsi Limited 23.88% Data place Range OP/OC (%) 6 35 th percentile 6.55% 8 and 9 Median 8.51% 11 65th percentile 12.38% B. Manufacturing segment: The Ld.TPO noted that assessee had selected 8 comparables with a median of 8.30%, the details of which are as under: C. Distribution and sales support services segment: The Ld.TPO noted that assessee had selected 8 comparables with a margin of 6.03% and thus treated its transaction to be at arms length, the details of which are as under: 4.4 Disagreeing with the search process carried out by the assessee under all 3 segments, the Ld.AO conducted fresh search and shortlisted the following set of comparables under all the 3 segments as under: A. SWD ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 26.47 67.57 29.93 15 Cygnet Infotech Pvt. Ltd. 25.24 30.45 36.61 30.19 17 Infosys Ltd. 38.79 38.30 41.40 39.50 18 Threesixty Logica Testing Services Pvt. Ltd. 36.63 48.46 42.02 41.94 19 Cybage Software Pvt. Ltd. 41.89 62.90 68.68 57.82 20 Consilient Technologies Pvt. Ltd. 54.85 71.82 69.51 65.14 35 th Percentile 21.24 Median 26.18 65 th Percentile 26.46 B. Manufacturing segment C. Distribution and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... raised in application dated 17.02.2023. It is the submission of the Ld.AR that the remaining grounds becomes either general in nature or academic at this stage and may be left open to be contested in an appropriate circumstances. 7.1. Before we carry out the comparability analysis, it is sinequa non to understand the functions performed, assets owned and risks assumed by assessee. 7.2. Thus the assessee has been characterised to be a contract service provider to its AE with absolutely minimal risk undertaken in the rendering of services. 8. We note that Ground nos. 4.1-4.4 are to be disposed of along with Additional Ground nos. 1(a) and 1(b ) in the application dated 19.08.2022. He submitted that assessee is seeking exclusion of only six comparables in Additional Ground no.1(a) which are as under: a) Larsen Toubro Infotech Ltd. b) Mindtree Ltd. c) Persistent Systems Ltd. d) Nihilent Ltd. e) OFS Technologies Ltd. f) Infosys Ltd. 8.1. The Ld.AR submitted that these comparables do not satisfy the turnover filter of 1 to 200 crores as for the year under consideration as the turnover exceeds Rs. 200 crores. The Ld.AR h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e perused the submissions advanced by both sides in the light of records placed before us. 8.4 Admittedly, the assessee is a captive service provider to its AE. The FAR analysis of assessee establishes that it does not undertake any risk in terms of projects undertaken or services rendered. The functions carried out by the assessee are strictly on the basis of directions from its AE and the payment by the AE to the assessee is on cost+markup. The comparables sought by assessee herein for exclusion carry out diverse activities and has significant brand values. These companies are owning huge intangibles and also undertakes its own R D which is not the case of the assessee before us. The decisions herein above relied by the assessee on functional dissimilarities goes to establish that these are functionally not similar with that of the assessee. The relevant extract of the observation by Coordinate Bench of this Tribunal in case of Yahoo Software Development India Pvt. Ltd. vs. JCIT (supra) in respect of Larsen Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd. and Infosys Ltd . is as under: 4. The Ld.AR submitted that Coordinate Bench of this Tribunal in assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies who have more than 25% related parry transactions of the sales were excluded. Companies having related party transactions of more than 25% are proposed to be excluded. A threshold of 25% is being applied following the provisions of Section 92A(2)(a) which provides a limit of 26% of the equity capital carrying voting rights for treating an enterprise as Associated Enterprise. if the limit is reduced further it would only result in eliminating more and more companies, on the other hand if the limit is relaxed then companies with predominantly related party transactions would get included which would not represent uncontrolled transactions. Therefore, on a balancing note, 25% is a proper threshold limit for related party transactions. The companies having more than 25% related party transactions should therefore be rejected as comparables. The Hon'ble IT.AT has upheld the application of this filter by the TPO in its order in the case of M/s. Supporisoft India Pvt. Ltd for AY 2005-G6 in IT (TP)A 1372/B/11 20/2012 dated 28.03.2013 following its own decision in the case of M/s. Actis Advertisers Pvt. Ltd vide ITA No. 5277/De1/2011 dated 12.10.2012. On perusal of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 64. The next objection of the Assessee is that when the most appropriate method selected for determining ALP is the TNMM there is no reason as to why one should look at price difference in offshore software development and onsite software development. It is no doubt true that in TNMM it is only the margins in an uncontrolled transaction that is tested with reference to the controlled transaction but it is not possible to ignore the fact that pricing will have an effect on the margins obtained in a transaction. The argument that if pricing structure were to be considered as criteria, then it will have to be seen as to what is the pricing structure of all the comparable for various projects cannot be accepted because the TPO has not chosen any other onsite software service provider with a revenue composition of more than 75% from onsite software services as comparable. As rightly observed by the TPO, the pricing is different in onsite when compared to offshore operations. The further observations of the TPO that the reasons for the same lie in the fact that while in the case of OFFSHORE projects most of the costs are incurred in India; an ONSITE project has to be carried out abroad s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y applied by the TPO. 68. Admittedly the onsite revenue in the case of the following comparable companies identified by the Assessee was more than 75% of its export revenues viz., a) Visu International Ltd. b) Maars Software International Ltd. c) Akshay Software Technologies Ltd. d) VJIL Consulting Ltd. e) Synfosys Business Solutions Ltd. The above companies were therefore rightly not considered as comparable by the TPO. We hold accordingly. 36. It is seen that the TPO in coming to the conclusion that the onsite revenue filter is not applicable has placed reliance on the decision of the ITAT Mumbai Bench in the case of Capegemini as quoted in para 16 in para 14 of the TPO's order, but that decision does not deal with a case of onsite revenue filter and the decision was rendered on the facts of its own case. 37. On the issue of RPT filter, we notice that the TPO in para 16 has accepted that the RPT filter should be @ 25%. In the case of Persistent Systems Ltd., the RPT is at 31.32% as extracted in the earlier part of this order and therefore this company should be excluded by application of RPT filter. In view of the above, we do not wish to go into other grou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - Involved in development of software products in addition to software services. - Owns intellectual property rights. - Incurs significant research and development costs. - Carries out significant activities based on onsite business. - Owns products such as Finacle, Edge Verve and other product based solutions. Extra-ordinary event of merger with Infosys Consulting India Ltd. Segmental profit loss account not available. Commands substantial brand value. 40. The DRP, however, has not thought it fit to exclude this company by observing that this company has substantial pre-dominant revenue from software services and the growth was not attributable to any brand value. Presence of onsite activity and the expenses on R D have all been brushed aside. In our view, the difference pointed out by the ld. counsel for the assessee before us show that this company cannot be compared with that of the assessee basically because of its business model, presence of onsite revenue generation and other reasons cited before us. Besides, the reason that turnover of this company is huge and more than 10 times that of the assessee. 41. The next company sou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ord contrary to the above observations. Further admittedly the functions, assets owned and risks assumed by the assessee under the segment is similar with A.Ys. 2014-15 2015-16 (supra). Respectfully following the above view, we direct the Ld.AO to exclude Infosys Ltd., Persistent Systems Ltd., Mindtree Ltd. and L T Infotech Ltd. from the final list. Respectfully following the above, we direct exclusion of Larsen Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd. and Infosys Ltd. from the final list. 8.5 The decision of Coordinate Bench of this Tribunal in case of Subex Ltd. vs. DCIT (supra) for A.Y. 2017-18 by order dated 30.11.2022 has considered Nihilent Ltd. and OFS Technologies Ltd. Nihilent Ltd. 10. The ld AR for the assessee submitted that this company Nihilent Ltd. is predominantly engaged in rendering of software services, business consulting in the area of enterprise transformation, change and performance management and providing related IT services. Nihilent in engaged in rendering diverse services. The Company intends to diversify and expand into various other areas such as analytics, big data, internet of things, etc. In this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t this company is engaged in product development or to indicate that it has revenue stream from product sales. The assessee also could not point to any such information in the annual report. The ld DRP also noted at page 73 of the annual report, the independent auditor has certified, 'the company does not have any purchase of inventories or sales of goods since it is a service company primarily rendering software services'. In view of these, the ld DRP held that this company is functionally comparable to the assessee and the pleas raised in this regard were rejected by him. As the company is primarily engaged in software development services and earns the revenue from this activity there is no need of providing segmental information as per AS 17. 11.1 The ld DR further stated that the assessee has argued before the ld DRP that the Company acquired G Net Group LLC in the US and Intellect Bizware Services Pvt Ltd, which are engaged and specialised in ERP and SAP. On careful perusal of the information in the annual report, the ld DRP noted that during the year, Gnet Group LLC, USA ( Gnet ) has merged with its holding Company Nihilent Technologies Inc.. USA ( NTI ), wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f this comparable. 12. We have heard the rival submissions and perused the materials available on record. This comparable fails the functionality test and this company Nihilent Ltd. is not functionally similar to assessee s case as held by the coordinate bench of the Tribunal in the case of M/s. SanDisk India Device Design Centre Pvt. Ltd. in IT(TP)A No.288/Bang/2021 dated 30.6.2022, wherein held as under: 17.9 In respect of Nihilent Ltd., Infobeans Technologies Ltd. and Aspire Systems (India) Pvt. Ltd., Hon ble Mumbai Tribunal in case of Red Hat India Pvt. Ltd. vs. Addl. CIT (supra) observed as under: Comparable Sought to be excluded by the assessee Aspire System India Pvt. Ltd. (Aspire ) 40. The assessee sought exclusion of Aspire from the final set of comparables for benchmarking SDS segment on the ground that it fails Related Party Transaction (RPT) filters as its RPT/ sales ratio is more than 25%. The assessee computed the significant related party transactions at 37.58% whereas the Ld. TPO computed it at 23.55%. The TPO is directed to recalculate the RPT/sales ratio by providingof the Income-tax Act,1961 ['the Act' for short]of the Income- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o be excluded as a comparable being not a comparable to the assessee. 17.10 Perusal of the annual report, filed before us in respect of the above two comparables, we note that the segmental financials are not available in respect of Nihilent and Infobeans and the RPT in respect of Aspire Systems India Pvt. Ltd. is more than 25% being the threshold limit considered by the Ld.TPO. Nothing has been placed before us by the Ld.DR in order to take a different view. Respectfully following the Hon ble Mumbai Tribunal, we direct the Ld.TPO to exclude Nihilent, Infobeans and Aspire Systems from the final set. 12.1 Keeping in view of the above order of the Tribunal, we direct the AO/TPO to exclude this company Nihilent Ltd. from the list of comparables. OFS Technologies Ltd. 13. The ld AR for the assessee submitted that this company OFS Technologies Ltd. is engaged in diversified activities. OFS is a software development and information technology outsourcing company, enriched its core expertise over the last financial year in Enterprise Application Development, Mobile Applications Development, Cloud Enablement, UI Development, DevOps Implementation and Data Anal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lso passes the employment cost filter. Therefore, the company has to be included in the list of comparables and the Panel upholds the inclusion of this comparable. However, considering the plea of the assessee that the company fails the employment cost filter for the F.Y. 2014-15, the ld DRP directed the TPO to verify the plea of the assessee. If it fails the employment cost filter for the above year, the TPO was directed to consider the margin only for the F.Ys. 2015-16 and 2016-17. 14.2 The ld. DR further stated that the assessee argued before the ld DRP that the company fails export turnover filter for the F.Y. 2014-15 and hence if the company is considered as comparable the margins pertaining to F.Y. 2015-16 and F.Y. 2016-17 are only to be considered. On verification of the annual reports, it was seen that the company's export turnover is below the threshold limit of 75% adopted by the TPO. The TPO, was therefore directed by the ld DRP to verify and if the export turnover is below 75% for the F.Y. 2014-15 the margins pertaining to financial years 2015-16 and 2016- 17 should be considered for determining the ALP. 14.3 The ld DR stated that a plea was also raised ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f assessee and passes through all the relevant filters. The Ld.AR thus prayed for inclusion of both these comparables. The Ld.DR on the contrary relying on the observations of the DRP submitted that these comparables do not satisfy the export revenue filter and therefore deserves to be excluded. We have perused the submissions advanced by both sides in the light of records placed before us. 9.3. We note that the authorities below has not verified the annual reports to come to a conclusion that the export revenue filter is not satisfied. In the interest of justice, we direct these comparables back to the Ld.AO/TPO to verify the FAR analysis of these comparables with that of assessee and to consider its inclusion in case it satisfies all the relevant filters. Accordingly, Additional Ground no. 1(b) stands partly allowed. 10. Additional Ground no. 2 raised in application dated 19.08.2022, the Ld.AR submitted that margins of Harbinger Systems Pvt. Ltd. and CG-Vak Software and Exports Limited has been wrongly computed. He thus seeks a direction for correction of the margins of the two comparables mentioned hereinabove. We direct the Ld.AO/TPO to recompute the margins ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on for doubtful debts is to be considered as non-operating in nature because it is only a provision. While working out the operating profit, only items of receipts and expenditure, which have direct relation for determining the profit have to be taken into account. In the case of Four Soft Ltd. v. Dy. CIT [2011] 142 TTJ 358/[2012] 16 ITR (Trib.) 73 (Hyd.), it was held that for computing the net margin of the assessee for the purposes of transfer pricing, only the cost related to the transaction with the AEs has to be considered and that bad debts/reimbursements have to be excluded. Thus the expenses excluded by the TPO were in the nature of non-operating expenses. Therefore, we do not find any infirmity in the approach of the TPO. Hence, the objection is not found acceptable. Accordingly, we do not find merit in the plea that the margin computation of M/s CG VAK, ICRA Techno Analytics Ltd, L T Info tech, Persistent Systems Tech Mahindra are erroneous. 7. Learned Counsel for the assessee brought to our notice the decision of the ITAT, Bengaluru Bench, in the case of Maxim India Integrated Circuit Design Pvt. Ltd., Vs. DCIT in IT(TP)A No.1573/Bang/2017 order dated 02.11.2020 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 51. As regards provision for doubtful debts, ld. counsel submitted that provision for doubtful debts are a part of the operating activities of a business. The accounting standards issued by the ICAI require that accounting policies must be governed by the principles of prudence . Provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only the basic estimate in the light of available information. Para 6 of Accounting Standard-l defines accrual as the assumption that revenues and costs are accrued, i.e., recognized as they are earned or incurred and recorded in the financial statements of the period to which they relate. 52. Thus, going with the abovementioned facts and statutory provisions, when the making of provisions is very much in the interest of business to show the true and fair view and statutorily required, it cannot be said that such provisions are of non-operating nature. Such provisions are made to comply with the requirements of statute. 53. The learned TPO treated provision for doubtful debts as non-operating referring to the Safe Harbour Rules notified by CBDT, which a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g profit of the comparable party and accordingly the operating profit ratio of the said entity has been rightly taken by the TPO. Thus, we notice that the above said decision was also rendered in a different context. However, there should not be any dispute that if the provision for doubtful debts is taken as operating expenses in the hands of the assessee, then the said expenditure has to be taken so in the case of comparable companies also. 16. Accordingly, following the decision rendered by the co-ordinate bench in the case of Brocade Systems (P) Ltd (supra) and Rolls Royce India (P) Ltd (supra), we direct the AO/TPO to consider Provision for doubtful debts as an operating expense. 8. Learned Counsel brought to our notice the decision of the Tribunal rendered in the case of ACI Worldwide Solutions Pvt. Ltd., Vs. DCIT in IT(TP)A No.1893/Bang/2017 order dated 27.09.2019 wherein this Tribunal decided identical issue in favour of the assessee by following the decision of the Hon ble Karnataka High Court in the case of Pr.CIT Vs. Business Process Outsourcing India Pvt. Ltd., (2018) taxcorp (DT) 73195 (HC Karnataka). The following were the relevant observations of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd., (supra) that provision for bad and doubtful debts should be taken as operating expenses while computing profit level indicator of the comparable companies. In the light of the aforesaid decisions which have been cited at the time of hearing of the appeal, we are of the view that the claim of the assessee deserves to be accepted. Accordingly, ground No.4(h) raised by the assessee has to be allowed and is hereby allowed. Respectfully following the above view, we direct the Ld.AO to consider the bad and doubtful debts and provision for bad debts to be operating in nature while computing the PLI of the comparable companies. Accordingly, Additional Ground no. 2 raised by assessee in application dated 17.02.2023 stands allowed. 12. Apart from the above grounds and selected comparables, the Ld.AR has not argued any other grounds or comparables raised either in the grounds of appeal or in the additional grounds of appeal. These issues that are not being argued are left open for assessee to be contested in an appropriate circumstances. In the result, the appeal filed by the assessee stands partly allowed as indicated hereinabove. Order pronounced in the open co ..... X X X X Extracts X X X X X X X X Extracts X X X X
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