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TMI Blog2017 (3) TMI 1963X X X X Extracts X X X X X X X X Extracts X X X X ..... ance with law and are therefore, bad in law. 2. On the facts and circumstances of the case and in law, the Transfer Pricing order/ Assessment order/ directions passed by the TPO/ AO/ DRP are invalid and bad in law as the said order/ directions violate judicial discipline. GROUNDS ON TRANSFER PRICING ISSUES 3. The impugned order passed by ignoring the directions issued by the DRP is contrary to provisions of section 144C of the Act. 4. The TPO/ DRP and consequently the AO have erred, in law and on facts and circumstances of the case, by not accepting the economic analysis undertaken by the appellant in accordance with the provisions of the Act read with the Rules. 5. Without prejudice to above, the TPO has committed certain arithmetical inaccuracies while computing the net margins of comparable companies and the DRP has failed to adjudicate on the objection raised by the Appellant in this regard. 6. The TPO/ DRP and consequently the AO have erred in law and on facts and circumstances of the case, by rejecting the quantitative / qualitative filters applied by the appellant and substituting incorrect filters for the selection / rejection of comparables. 7. The TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e is contrary to law including provisions of Special Economic Zones Act, 2005 which have an overriding effect. 17. That the AO has erred in incorrectly computing the tax demand payable by the Appellant under the impugned order. 18. That on the facts and circumstances of the case and in law, the AO erred in holding that the Appellant has furnished inaccurate particulars of income in respect of each item of disallowance/ additions and in initiating penalty proceedings under section 274 read with section 271 of the Act." 2. Out of above grounds, the assessee has not pressed ground No. 1 & 2 , ground No. 17 is consequential and ground No. 18 is premature. Grounds in Department's Appeal: "1. Whether on the facts and in circumstances of the case, the Hon'ble Dispute Resolution Panel (DRP) has erred in directing the Assessing Officer/Transfer Pricing Officer (AO/TPO) to exclude M/s Infosys Technologies Ltd from the list of comparables for the purpose of benchmarking the international Transaction and computation of Arm's Length Price in relation to software development services. 2.1 Whether the direction of the Hon'ble DRP to exclude M/s Infosys Technologies Ltd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reckoned from the date of order u/s. 154 dated 09.12.2014, the appeal has to be treated as filed within the period of limitation. We observe that the reasons assigned by the revenue for filing the appeal with a short delay, are genuine, as nothing contrary is laid on record by the assessee. Accordingly, the delay is condoned. 4. The first major issue raised by the assessee in his appeal is against the addition of Rs.6,23,15,808/- made by the AO on account of transfer pricing adjustment, which was reduced to Rs.5,57,09,134/- vide rectification order u/s. 154 dated 09.12.2014. 5. Briefly stated, the facts of the case are that the assessee is an Indian branch office of Sony Mobile Communications International AB (hereinafter referred to as `SMCI') (formerly called Sony Ericsson Mobile Communications International AB), a company incorporated under the laws of Sweden. The assessee's Head office is a wholly owned subsidiary of Sony Ericson Mobile Communications AB (hereinafter referred to as `SEMC'). SMCI set up a branch office (R&D Centre) in a Special Economic Zone (SEZ) in Chennai with the objective of entering into research and development activity in the information technology ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any other additional rights to use or exploit the intangibles owned by AEs. AEs, on the other hand, are complex entities that are engaged in fullfledged manufacturing and marketing / product development / product selling etc. covering a wide range of activities and other commercial or marketing intangibles (brand names, trademarks etc.) AEs are the developers, owners and licensors of virtually all valuable intellectual property rights including proprietary products and processes. They bear all significant business and entrepreneurial risks, including product development, performance in the market, financial risks etc. All returns / risks attributable to the intangibles should accrue / vest in the entity that owns the intangibles (i.e. AEs). SEMCI has undertaken the below mentioned international transactions with its AEs during FY 2009-10 (Please refer to Appendix D for details): a) Rendering of services; b) Purchase of Fixed Assets; c) Recharges paid to AEs; d) Sale of Fixed Assets; and e) Recharges received from AEs. Transactions mentioned from (a) to (c) above are interlinked and have been aggregated for the purposes of this analysis as "software development service ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es the most reliable measure of an arm's length result. In determining the reliability of a method, the two most important factors to be taken into account are (i) the degree of comparability between the controlled and uncontrolled transactions and (ii) the coverage and reliability of the available data. As per the Indian Regulations24, other factors such as nature and class of international transactions, conditions prevailing in the markets, extent and reliability of adjustments that can be made, and extent and reliability of assumptions that may be required in applying the method, shall also be taken into account. Because the selection of the "Most Appropriate Method" involves a test of relative merit, a method that may not be perfect is not rejected unless some other method can be shown to be more reliable or provide a better estimate of an arm's length result. 5.2.3. Selection of most appropriate method: Comparable Uncontrolled Price Method The Comparable Uncontrolled Price {"CUP") Method compares the price charged for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ossible to estimate, with reasonable reliability and accuracy, the combined effect of such factors on per unit prices. *Abstract factors such as the use of intangibles make it difficult to use the CUP method for benchmarking purposes. Accordingly, in the absence of reliable data for application of the CUP method, this method was not considered as the most appropriate method for software development services. Recharges received from AEs Internal CUPs In case of transactions in the nature of reimbursement of expenses like Recharges received from AEs from Group Companies to SEMCI, the third party cost reimbursed is a CUP for the reimbursement. Accordingly, keeping in view the nature of transaction and the degree of comparability, CUP was considered as the most appropriate method for these transactions. Consequently other methods were not considered Resale Price Method The Resale Price Method ("RPM") evaluates the arm's length nature of a controlled transaction by reference to the gross profit margin realised in a comparable uncontrolled transaction. The RPM measures the value of functions performed and is ordinarily appropriate in cases involving ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... highly integrated and cannot be evaluated on a separate basis. Although the Indian transfer pricing rules list only one PSM, they provide guidance that the PSM can be applied by i) relying entirely on a contribution analysis; or ii) splitting the profits based on a residual analysis. Under the contribution analysis, the total profit earned by the parties to a controlled transaction is divided, based upon the relative contributions of the parties. The residual analysis allocates the combined operating profit or loss from the relevant business activity between the parties to the controlled transaction in two steps. First, a market return is provided to each party's routine contributions. Second, any "residual" profit attributable to intangibles is divided among the parties to the controlled transaction under evaluation based upon the relative value of their non-routine contributions of intangible property. SEMCl does not own any non-routine intangibles and the low risk operations of SEMCl can be independently evaluated. Therefore, the PSM is not considered as an appropriate method to determine the arm's length operating results in the case of SEMCl, which is a routine con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n. We primarily relied on Prowess and extracted additional companies from Capitaline Plus, i.e., companies for which data was not available in Prowess. For details about these databases and their limitations please refer Appendix E. To comply with the requirements of contemporaneous documentation to exist by the due date of filing the return of income as per the Indian Regulations, the Branch has conducted a benchmarking analysis using information in databases updated till February 19, 2010 focusing on the financial results of companies having financial years ended during the period April 1, 2007 and February 19, 2010. The companies from both databases have been extracted only if they had relevant financial data for at least two out of the three financial years ending during the period April 1, 2007 and February 19, 2010 to account for factors such as changes in economic conditions and leveling of industry and business cycles. For details regarding selection of time period please refer Appendix F. The search for comparables was undertaken, keeping in mind, that SEMCI, in respect to services segment was primarily engaged in providing contract software development services. Acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Lower Quartile 4.24% The details of search for uncontrolled comparables and determination of arm's length price has been given in Appendix G. Our analysis shows that the arithmetic mean OP/TC of comparable companies is 13.18%. Hence, prices of international transactions of SEMCI that achieve an OP/TC of 13.18% or more would meet the arm's length standard required under the Indian Regulations. The financial results of SEMCI provided to us (summarised in Appendix I) indicate that the Branch has an OP/TC of 17.44% during the year ended March 31, 2010. This provides evidence that both the pricing basis itself of international transactions of SEMCI and the outcome of the pricing i.e. the profitability, support our view that the international transactions of SEMCI were in accordance with the 'Arm's Length' standard required under the Indian Regulations. 5.3. Other international Transactions Cost Recharges paid by AEs As mentioned above, the operations of the branch have been to closed and thus, the fixed assets have been sold to the group companies (amounting to Rs. 148,258,176) and remaining fixed assets have been discarded/scrapped. On account of such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cing provisions lay down that primarily current year data should be use. The proviso to Rule 10D(4) allows the use of multiple year data only if the assessee is able to demonstrate through relevant data that certain factors of earlier years has affected the transfer prices for the current year. There are sufficient judicial pronouncements that support the use of current year data. ii. Different financial year: If a company is having an accounting year different from financial year for which financial of your company are being considered, the same has been excluded as the profits and revenues/expenses pertain to different period other than current year which is FY 2009-10. iii. Reject companies where turnover is less than Rs.5 Crore: This filter is applied because as it will eliminate start-up companies and also where the turnover and cost base is very small, there would be little differentiation between profits and remuneration. That apart, a company that is very small in size does not have sufficient economic significance, that it be used for benchmarking. iv. Select companies where the ratio of service income to tatal income is at least 75%: The use of this filter is to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffected by factors like persistent losses, declining sales, extraordinary income or expense, mergers and acquisitions or other such factors which affect the operations of the company substantially should not be used as comparables as they will not prove to be good benchmarks." 10. Based on the above observations, the ld. TPO applying certain filters, accepted the following companies as comparables: (i). Akshya Software Technologies Ltd. (ii). LGS Global Limited (iii). Larson & Toubro Infotech Ltd. (iv). Mind Tree Ltd. (v). Saskin Communication Technologies Ltd. (vi). Think Software Global Services Ltd. 11. Following companies were rejected by the TPO observing as under : No Name of the Company TPO's Observation i. Compulink Systems Ltd. Data for FY 2009-10 is not available in public domain/prowess and capitaline databases. It cannot be taken as comparable. ii. FCS Software Solutions Ltd. As per P-28/AR- "FCS business is organized into three strategic business units (SBUs): 1. IT Consulting 2. E-Learning Division-37% 3. Infrastructure Management- " There is significant % of business other than IT consulting. Further, from the follo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itya Birla Minacs IT Services Ltd. The company does not qualify net worth filter as its net worth is (3.86) which is less than zero. It cannot be taken as comparable. v. Polaris Software Lab Ltd. The name of the company has been changed to Polaris Financial Technology Ltd. This company is failing the RPT filter as RPT to sales in this case is 84.72% as per prowess database. It cannot be taken as a comparable. vi. Reliance infosolutions Pvt. Ltd. The company does not qualify export filter as its export sales to total sales are 3.71% which is less than 75% of sales. It cannot be taken as comparable vii. Syunetairos Technologies Ltd The company does not qualify export filter as its export sales are nil. It cannot be taken as comparable viii ZensarObt Technologies Ltd. The Company does not qualify RPT filter as its RPT to sales are 70.74% which is greater than 25% of sales. It cannot be taken as comparable. ix Crazy Infotech Ltd. The company has 3 segments - computer hardware, software development and IT training with segmental revenues at 2.46 crores Rs.2.67 crores and Rs.0.88 crores respectively. The relevant segment of this company has revenues less than Rs.5 crores a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase laws. The TPO has also made working capital adjustment which works out to 30.17%. Finally, the TPO has determined the ALP of the International transactions by giving effect of the working capital adjustment as under : S.No Company Name OP/OC(%) Working Capital adjusted OP/ OC (%) i Akshay Software Technologies Ltd. -1.04 3.52 ii. E-Infochips Bangalore Ltd. 72.69 70.08 iii. Evoke Technologies Pvt. Ltd 19.02 23.61 iv. E-Zest Solutions Ltd. 18.66 18.75 V, Infinite Data Systems Pvt. Ltd. 88.25 88.67 vi. Infosys Ltd. 45.08 50.34 vii. Larsen & Toubro Infotech Ltd. 20.48. 24.91 viii. LGS Global Ltd. 12.79 12.39 ix. Mindtree Ltd. 16.62 19.43 x. Persistent Systems Ltd. 30.50 32.79 xi. Persistent Systems & Solutions Ltd. [Merged] 15.38 16.78 xii. R S Software (India) Ltd. 10.29 15.11 xiii. Sasken Communication 17.54 22.80 xiv. Tata Elxsi Ltd. 19.82 21.97 xv. Thinksoft Global Services Ltd. 17.35 18.56 xvi. Thirdware Solution Ltd. 41.63 42.98 Average 27.82% 30.17% 17. Accordingly, the ld. TPO calculated the ALP of the international transactions related to Software Development Services as under : Particulars A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to decide their inclusion/exclusion in the final list of comparables. 21. Before deciding the comparability or otherwise of these six companies under challenge, it is of paramount importance to first ascertain the functional profile of the assessee. It has been noticed above that the assessee is providing research and development services relating to Contract software development maintenance and up gradation and Contract design, development, testing and any similar activities in relation to mobile phones, their accessories, communication devices or communication systems. Such services were provided pursuant to an Agreement entered into between the assessee through its head office, namely, SMCI on the one hand and SEMC on the other. A copy of this Agreement dated 19.9.2008 is available on page 133 onwards of the paper book-2. The nature of services provided by the assessee pursuant to this Agreement are contained in Annexure-A, which are verbatim reproduction of what has been mentioned above. This Agreement provides that the assessee will be compensated by its AE on all Costs incurred in providing such software services with a certain mark up and that the arm's length compensation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tware Development & ITES services. The ld. AR submitted that segmental information was not available in respect of this comparable. It was also objected before the TPO that this company earns supernormal profit. It was also submitted that the learned TPO itself has rejected similar comparable, viz., Goldstone, on the ground of insufficient segmental information. The ld. TPO did not accept the contention of the assessee and retained this company as comparable for the reason that many companies treat IT and ITES as one industry and therefore, report them as one segment even though they are not performing any IT enabled services. He further noted that the annual report does not have any reference to ITES services, BPO, Call centre, transcriptions or any other words related to ITES services. 23. The ld. DR, however, referring to the observations made by the ld. TPO in the order, submitted that E-Infochips Bangalore Ltd. is a comparable company with that of the assessee on the premise that the above comparable is into software development services; that as per TPO's analysis of the functions performed by the assessee, the assessee is also providing many other services apart from softwa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmation; that there was abnormal growth in operations and the said company earns supernormal profits; that the company is engaged in providing primary infrastructure management services which are very different from software development services and that the said company renders services to a single customer, i.e., Fujitsu Services Ltd. The ld. TPO rejected the all the objections of the assessee observing that the company is providing only SWD services and is engaged primarily in Software development services. 27. The ld. DR, however, referring to the observations made by the ld. TPO in the order, submitted that this company is a comparable company with that of the assessee. 28. After hearing both the sides and perusing the materials available on record, we are of the opinion that this company has no sufficient segmental information and functionally dissimilar. We rely on the judgment of ITAT in the case of Sun Life India Service (supra) wherein while dealing with this company on the comparability test, it has been observed as under : "10.8. After considering the rival contentions and perusing the annual reports placed on record, we are of the opinion that this company cannot b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecord. It can be seen from the information supplied by this company u/s 133(6) of the Act, a part of which has been reproduced in the TPO's order, that this company 'has developed a few of its own products in the area of identity management connectors.' Revenue from product licences stands at Rs.288.93 million as against the revenue from software development services at Rs.4829.57 millions. Though this company is more engaged in software development services, but, is also a software product company, which is evident from the information supplied by it to the TPO. Thus, the total profits of the company on entity level also, inter alia, include revenue from product licences. As there is no separate segmental information and it has been considered as comparable on entity level, it implies that the total revenue considered also consist of some part from product licences. In such circumstances, it is not possible to ascertain the impact of such revenue on the total revenue of this company. Further, there is no information available from the Annual report of this company or the data collected by the TPO u/s 133(6) of the Act to divulge the amount of revenue from software deve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Transfer Pricing Rules under Rule 10(b) to 10(e) of the Income Tax Rules, the data of the said firm, i.e., Persistent Systems Ltd. could not have been included." Respectfully following this decision of Tribunal and the Hon'ble jurisdictional High Court who have considered the functional dissimilarity of this comparable, we direct the AO/TPO to exclude this comparable from the final set of comparables. (iv). Thirdware Solutions: 33. This company was selected by the ld. TPO (page 206 & 207 of TPO's order). The assessee has objected that this company is functionally different as the company was engaged in implementation, application, management and development services and only 9% revenue is from software services. There is insufficient segmental information and only geographical segmental details are there. This company has earned supernormal profits. Reliance is placed on the decision of ITAT Delhi in Sun Life India Service Centre Pvt. Ltd. (supra) and of ITAT Bangalore Bench I M/s. 3DPLM Software (ITA No. 1303/bang/2012). 34. Having considered the submissions of both the parties, we find that the comparability test of this company has been well examined by ITAT Delhi Bench ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has been that turnover filter of less than 5 crores is not an appropriate filter for the comparability test. The ld. DR also submitted that there is no any foreign exchange revenue. All the turnovers from three segments of the company's operations are generated around Chennai city and some districts places in Tamilnadu and neighbouring places of Andhra Pradesh. Even during the year under consideration, the company had received only 2.68 crores from software developments. Therefore, it cannot be taken as a comparable. The case law relied by assessee in Chryscapital Investment Advisors (India) Pvt. Ltd. of Hon'ble Delhi High court in ITA No. 417/2014 does not support the case of assessee. 39. The ld. DR, on the other hand, submitted that this company fails service income filter and has less than 75% of its revenue from services. It also fails export filter as it is a pure domestic company operating only in and around Chennai city and some districts, places in Tamil Nadu and neighboring places in Andhara Pradesh. 40. Having considered the rival submissions, we find that the assessee company is engaged in 100% export of software development services to its holding company. The total ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) (iii). Ciena India Pvt. Ltd. (ITA No. 1453/Del./2014) ITAT, Delhi Bench (iv). Cash Edge India Pvt. Ltd. (ITA No. 5848/Del./2012 A.Y. 2008-09). 44. Having considered the rival submissions of both the parties, we find that in the case of assessee itself for A.Y. 2009-10, the coordinate bench of ITAT, Delhi has excluded this company from the set of comparables vide order dated 29.04.2016 observing as under : "6.3. Turning to the functional comparability, we find that the assessee is simply a captive unit rendering services to its AE alone without acquiring any intellectual property rights in the work done by it in the development of software. The Hon'ble Delhi High Court in CIT vs. Agnity India Technologies (P) Ltd. (2013) 219 Taxmann 26 (Del) considered the giantness of Infosys Ltd., in terms of risk profile, nature of services, number of employees, ownership of branded products and brand related profits, etc. in comparison with the factors prevailing in the case of Agnity India Technologies Pvt. Ltd., being, a captive unit providing software development services without having any IP rights in the work done by it. After making comparison of various factors as enumerated abo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 's appeal is dismissed. 48. In respect of ground No. 10 regarding working capital adjustment margins of the comparable companies, the advances have not been considered for calculating working capital adjustment. The case of the assessee is that working capital does have an impact on the profitability of the company and more accounts receivable in case of a company would mean relatively lower profit. Therefore, the companies could be considered as fully comparable if they hold the same level of account receivable and account payable . The Transfer Pricing Officer has, however, rejected the claim of working capital adjustment on advances which has been upheld by the Dispute Resolution Panel and additional evidence filed before the DRP have not been adjudicated. The ld. TPO has calculated the working capital adjustments and dealt with this issue on para no. 32 of TPO order. The main objection of the assessee is that advance has not been considered while calculating the working capital adjustment. The assessee has relied on para 76 of the judgement of ITAT, Bangalore Bench in ITA No. 1112/ Bang /2010 & 1161/Bang/2011 in case of ARM Embedded Technologies Pvt. Ltd. Respectfully followin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a case where certain services are rendered by the Branch Office to Holding Company on cost plus basis. The assessee tried to establish that the transaction between branch office and head office is basically a transaction between two separate taxable entities and such transaction should not be considered as dealing with self. However, this is not the truth as the subject dealing is essentially a transaction with self. The assessee has also taken an t argument that if the transaction between head office and branch office is transaction with self and if it is not an export then no income would accrue or arise in hand of branch office. The argument of the assessee is not acceptable in view of the fact that by deeming fiction, the branch office is treated as a separate taxable entity for determining the income which accrues or arises in respect of the activities undertaken by it. But the scope of deeming fiction cannot be extended beyond, to treat both the entities as separate legal entities. Therefore, even if the subject dealings represent transactions with self, the profit attributable to the permanent establishment for the activities undertaken by it, is taxable in India. (b) The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cost plus basis. We do not find this view point of the AO as correct for the obvious reason that the assessee did not render these services to its head office, but, to SEMC, which is the holding company of the assessee's head office. We have discussed in detail about the international transaction of rendering of Software services to its AE, on which transfer pricing adjustment was made. Under such circumstances, the point of view of the AO that the services were rendered by the assessee to its holding company, is wholly incorrect. As regards the other point considered by the AO for denial of deduction about the assessee rendering services to its head office alone, thereby leading to transaction with self, in our considered opinion, is again devoid of merits. Once the law requires an Indian branch of a foreign enterprise to be considered independent of its head office for taxation purpose, the AO cannot make out a case that there is no difference between head office and branch office in India and, hence, no deduction, which is otherwise available, should be given. If the principle of mutuality as invoked by the AO for denial of deduction u/s 10AA is taken to its logical conclusion, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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