Income Tax Appellate Tribunal - Hyderabad
Kanexa Technologies Private Limited,, ... vs Assessee on 14 November, 2014
IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCH 'A', HYDERABAD
BEFORE SHRI B. RAMAKOTAIAH, ACCOUNTANT MEMBER and
SMT. ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER
I.T.A. No. 243/Hyd/2014
Assessment year 2009-10
M/s. Kenexa Technologies Pvt. vs. The Deputy Commissioner of
Ltd., Hyderabad Income-tax, Circle-2(1)
PAN: AACCK1647A Hyderabad
Appellant by: Sri H. Srinivasulu
Respondent by: Sri P. Soma Sekhar Reddy
Date of hearing: 28.08.2014
Date of pronouncement: 14.11.2014
ORDER
PER ASHA VIJAYARAGHAVAN, JM:
This appeal by the assessee is directed against the order of the Deputy Commissioner of Income-tax, Circle-2(1), Hyderabad dated 05.12.2013 for assessment year 2009-10.
2. Facts of the case are that M/s. Kenexa Technologies Pvt. Ltd., the assessee, provides software and services to its Associated Enterprise (AE) which includes software development, research, modification, reuse, re-engineering, maintenance, coding etc. The taxpayer is a wholly owned subsidiary of Kenexa Technologies Inc., USA. For the impugned assessment year i.e., 2009-10, the assessee filed its return of income on 29.9.2009 declaring income of Rs. 32,58,320 under normal provisions of Income-tax Act, 1961 after claiming deduction u/s. 10A of the Act. The case was referred to the Transfer Pricing Officer (TPO) u/s. 92C(1) with prior approval of CIT- II. The assessee submitted before the Assessing Officer/TPO that the assessee carried out the economic analysis and has summarised it as under:
2 ITA No. 243/Hyd/2014M/s. Kenexa Technologies Pvt. Ltd.
===========================
Margin Margin of
Sr. Nature of international
MAM PLI of compare-
No. transaction
taxpayer ables
1. Software development, TNMM OP/TC 25.34% 9.80%
software support and
related services.
3. It was submitted that after applying certain filters, the assessee has short-listed around 13 comparables, arithmetic mean PLI (OP/TC) was computed at 9.80% s against the PLI of the taxpayer at 25.34%. Accordingly, it was stated that the transactions pertaining to purchase and sale are at arm's length. Therefore, no adjustment is proposed to the transactions pertaining to operations.
4. Further it was submitted that as per the audited statement of accounts the financials of the assessee are as under:
Description Amount (Rs.)
Operating Revenue 42,69,56,940
Operating Cost 40,01,48,084
Operating Profit 2,68,08,856
OP/OR (%) 6.28
OP/OC (%) 6.70
5. The TPO rejected the Transfer Pricing (TP) Study of the assessee on the following grounds:
"In the case of tax payer, the TPO is mainly concerned regarding whether the information or data used in the computation of the arm's length price is reliable or correct. It is clear from the provisions of Sec. 92C(3)(C) read with Sec. 92CA that on the basis of material or information or documents in the possession of TPO, if he is of the opinion that the information or data used in computation of the arms length price is not reliable or correct, the TPO may proceed to determine the arm's length price in relation to the international transactions in accordance with Sec. 92C(1) and 92C(2) on the basis of such material or information or document available with him. To sum up, the following defects have been found in the TP analysis carried on by the tax payer:
1. As per Rule 10B(4), it is mandatory to the use the current financial year data i.e., the financial year in which the international transactions took place (FY 2008-09) but the taxpayer did not use data for the FY 2008-09 (i.e. ending with March 31, 2009).3 ITA No. 243/Hyd/2014
M/s. Kenexa Technologies Pvt. Ltd.
===========================
2. The taxpayer has used the earlier year data pertaining to the FYs 2006-07 and 2007-08 but no reasons were given as to how the earlier year data has influence over the price either of the taxpayer or of the comparable so to attract the proviso to Rule 10B(4).
3. The taxpayer selected companies such as Sagarsoft (India) Ltd and SIP Technologies & exports Ltd which have consistent decline in sales and are persistently loss making.
4. As discussed above, most of the taxpayer's comparables do not stand scrutiny of FAR analysis.
5. Some companies though qualify all the filters applied by the tax payer based on the data pertaining to the FY 2008-09, have not been selected.
In view of the above defects and others, the information as well as the data used in computation of the arms length price is not reliable and correct. The provisions of s. 92C(3)(C) are invoked and the TP document is rejected."
6. On rejecting the Transfer Pricing (TP) study of the assessee, a fresh TP study was carried out by the TPO with the following filters:
1. Companies whose data is not available for the FY 2008-09 were excluded.
2. Companies whose software development service income < Rs. l cr. were excluded.
3. Companies whose Software Development Service is less than 75% of the total operating revenues were excluded.
4. Companies who have export sales less than 75% of the safes were excluded.
5. Companies that are functionally different from the taxpayer were excluded.
6. Companies that are having peculiar economic circumstances were excluded.
7. The TPO shared information obtained u/s. 133(6) from the comparable companies with the assessee and on this basis rejected claim of the assessee that the comparable data used was not in 4 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== public domain. The TPO further rejected the claims of the assessee for working capital adjustment and risk adjustment. The TPO also rejected the segmental accounts (AE and Non-AE segments) of the assessee while computing margins. The TPO also held a number of items of income of the assessee to be non-operative in nature such as interest, dividend, provisions no longer written back, gain on sale of assets, income from investment, gain on re-valuation of assets, other incomes pertaining to operations and excluded the same from operating revenue as well as held a number of expenditures to be non-related to operations and excluded the same from operating expenses. The TPO also held that the foreign exchange loss which the assessee had claimed as non-operative to be related to operations and included it in the calculations of the assessee profit level indicator (PLI).
8. The TPO rejected the assessee's request to remove certain comparables and add new ones and also rejected the additional filters proposed by the assessee. The TPO arrived at a final list of comparables as under:
S. Company Name OP/OC No.
1. Akshay Software Technologies Ltd. 12.41
2. Bodhtree Consulting Ltd. 68.43
3. Comp-U-Learn Tech India Ltd. 28.00
4. Igate Global Solutions Ltd. 21.97
5. Infosys Ltd. 41.34
6. KALS Inf. Systems (seg) 23.11
7. LGS Global 20.51
8. Mindtree Ltd. (seg) 5.56
9. Neilsoft Ltd. 9.05
10. Persistent Sys 18.49
11. RS Software (India) Ltd. 9.99
12. R Systems International Ltd. (seg) 17.53
13. Sasken Communication Technologies Ltd. 17.30
14. Tata Elexi Ltd. (seg) 22.82
15. Thinksoft Global 20.80
16. Thirdware Solutions 22.28
17. Zylog Systems Ltd. 15.00
9. TNMM was chosen as the most appropriate method both by the assessee and the TPO. Further, the assessee was chosen as the tested party and contemporaneous data was used by the TPO i.e., 5 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== FY 2008-09 with the PLI being chosen as operating profit/operating cost (OP/OC). The TPO concluded by calculating the ALP of the assessee's transactions as follows:
Amount Description (Rs.) Operating Revenue 48,83,00,780 Operating Cost 40,01,48,144 Operating Profit 8,81,52,636 OP/OR (%) 18.05 OP/OC (%) 22.03 Arms's Length Price 48,83,00,780 Less: Price Received 42,69,56,940 Adjustments 6,13,43,840
10. Thus, the arm's length price of the assessee is Rs. 48,83,00,780 and the shortfall of Rs. 6,13,43,840 is treated as adjustment u/s. 92CA of the Act and the total income of the assessee will be enhanced accordingly u/s. 92CA(3) of the Act. Thus, the TPO passed the order u/s. 92CA(3) dated 22.1.2013 levying TP adjustments u/s. 92CA of the Act of Rs. 6,13,43,840.
11. Pursuant to TPO's order dated 22.1.2013 the Assessing Officer passed the order dated 19.3.2013 u/s. 143(3) r.w.s. 92CA(3) of the Act having arrived at a total income of Rs. 6,46,02,160. The Assessing Officer made adjustments as proposed by the TPO and accepted by the Assessing Officer at Rs. 6,13,43,840 towards adjustment of ALP.
12. The assessee-company strongly objected to the draft assessment order and filed objections to the draft assessment order passed u/s. 153(3) r.w.s. 144C(1) of the Act before the DRP. The DRP considered each of the grounds of the assessee consisting of 23 grounds and concluded as follows:
"Based on the above discussion, the directions of the Panel as per the provisions of s. 144C(5) of the Act is as follow:
All the objections of the assessee are rejected."
13. Aggrieved, the assessee filed the present appeal before this Tribunal by raising the following grounds of appeal:
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1. That the order of the Deputy Commissioner of Income Tax, Circle 2( I), Hyderabad (hereinafter referred to as 'AO') in pursuance of the directions of the Dispute Resolution Panel (hereinafter referred to as 'DRP'), Hyderabad in so far as it is prejudicial to the Appellant, is contrary to law, facts and circumstances of the case.
2. Transfer Pricing Adjustments 2.1. General Grounds 2.1.1 The assessment order passed by the AO under section 143(3) read with section 144C and read with the order passed by the Learned Transfer Pricing Officer (hereinafter referred to as 'TPO'), under section 92CA(3) of the Income Tax Act, 1961 (hereinafter referred to as 'the Act') is bad in law and void ab-
initio.
2.1.2 That the DRP / AO erred by not accepting the price of international transaction of software development services of Rs. 42,69,56,940 shown by the Appellant and determining the Arm's Length Price (hereinafter referred to as 'ALP') at Rs. 48,83,00,780 and thereby making transfer pricing adjustment of Rs. 6,13,43,840 to the Total Income of the Appellant.
2.1.3 That the DRP / AO erred in rejecting the economic analysis undertaken by the Appellant in accordance with the provisions of the Income Tax Act, 1961 (hereinafter referred to as 'the Act') read with the Income-tax Rules, 1962 (hereinafter referred to as 'the Rules') and consequently making adjustment under section 92CA of the Act to the total income of the Appellant.
2.2 Segmental information should be considered 2.2.1 Based on the facts and the circumstances of the case and in law, the DRP / AO / TPO erred in not considering the segmental details provided by the Appellant and rejecting the segmental data in relation to AE & Non-AE segments.
2.2.2 Based on the facts and the circumstances of the case and in law, the DRP / AO/ TPO erred in not considering the separate books of account maintained 2.2.3 Based on the facts and the circumstances of the case and in law, the DRP / AO/ TPO erred in adopting 7 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== the entity level approach without considering the functional dissimilarity among the business segments of the Appellant for the transfer pricing analysis.
2.2.4 Based on the facts and the circumstances of the case and in law, the DRP / AO / TPO erred in considering the total operating cost under the software development services segment by incorrectly assuming that the Non-AE segment did not entail any worthwhile or substantial expenditure.
2.3 Incorrect computation of margin of Appellant 2.3.1 Based on the facts and the circumstances of the case and in law, the DRP / AO erred in confirming the action of the TPO in considering the foreign exchange loss as operating though the loss is mainly due to the re-instatement of balances at the year end and did not pertain to the operations of the Appellant.
2.3.2 Without prejudice to Ground No. 2.3.1, based on the facts and the circumstances of the case and in law, the DRP / AO / TPO erred by treating the foreign exchange loss on re-instatement of the advances received from the AE as operating though the same is considered as an extraordinary event for granting the working capital adjustment.
2.4 Grant of Working Capital Adjustment 2.4.1 Based on the facts and the circumstances of the case and in law, the Learned AO/DRP/TPO erred in not granting the working capital adjustment to the net profit margins of the comparable companies as provided under Rule IOB(l)(e) read with Rule 10B(2)(b).
2.4.2 Based on the facts and the circumstances of the case and in law, the Learned DRP / AO / TPO erred in not allowing working capital adjustment to the margins of the comparable companies by ignoring the fact that the Appellant is a captive service provider and furnished the quantum of working capital adjustment.
2.5 Filters 2.5.1 The Learned AO/ DRP erred in confirming the TPO's stand in adopting the following filters for selection of comparable companies, which have been objected to by the Appellant:
8 ITA No. 243/Hyd/2014M/s. Kenexa Technologies Pvt. Ltd.
=========================== 2.5.1.1 Rejection of comparable companies which have onsite revenues greater than 75% of the export revenues.
2.5.1.2. Rejection of comparable companies which have more than 25% related party transactions of the total operating income.
2.5.1.3. Rejection of comparable companies which have diminishing revenue /persistent losses for the period under consideration.
2.5.2 The Learned AO/DRP erred in confirming the TPO's stand in not correctly applying the following filters for selection of comparable companies, which have been objected by the Appellant:
2.5.2.1 Rejection of companies with employee cost less than 25% of the total turnover.
2.5.2.2 Rejection of companies having export sales less than 75% of the total sales.
2.5.3 The Learned AO/DRP erred in confirming the TPO's stand of rejection of key filters applied by the Appellant.
2.6 Comparables 2.6.1 The Learned AO/DRP erred in confirming TPO's selection of Bodhtree Consulting Limited as a comparable company even though it fails the TPO's own filter of rejection of companies having software development service income less than 75% of the total operating revenues.
2.6.2 The Learned AO/DRP erred in confirming the TPO's selection of the following functionally dissimilar comparable companies without proper reasons:
2.6.2.1 Comp-u-Learn Tech India Limited 2.6.2.2 Infosys Technologies Limited 2.6.2.3 "Kals Information Systems Limited 2.6.3 The Learned AO/DRP erred in accepting the incorrect margins of the following comparable companies as computed by the TPO, while determining the ALP:
2.6.3.1 Igate Global Solutions Ltd 2.6.3.2 Persistent Systems Limited 2.6.3.3 Sasken Communication Technologies Ltd.9 ITA No. 243/Hyd/2014
M/s. Kenexa Technologies Pvt. Ltd.
=========================== 2.6.4 The Learned AO/DRP erred in confirming the TPO's stand in considering provision for bad and doubtful debts and bad debts as non-operating expenses for the purpose of margin computation of the comparable companies.
2.6.5 The Learned AO/ DRP erred in confirming the TPO's stand of rejecting the following comparable companies selected by the Appellant in its transfer pricing study by inadvertently applying the employee cost filter:
2.6.5.1 CG-VAK Software & Exports Ltd. 2.6.5.2 Prithvi Information Solutions Limited 2.7 Use of multiple year data 2.7.1 The Learned AO/DRP erred in rejecting the multiple year analysis for computing the operating margins earned by the alleged comparable companies.
2.8 Risk Profile for captive service provider 2.8.1 The Learned AO / DRP / TPO ought to have appreciated that margins earned by the Appellant (being a captive service provider) were reflective of the functions performed and proportionate with the risks assumed while determining the ALP of the international transactions of the Software Development Services business of the Appellant.
2.8.2 The Learned AO/DRP/TPO erred in disregarding the differences in risk profile of the Appellant and the alleged comparable companies selected by him, by not allowing the risk adjustment claimed by the Appellant 2.8.3 Without prejudice to ground no. 2.8.2, the Learned AO/DRP erred in not granting an adjustment of I per cent which was granted by the Jurisdictional Tribunal in case of Hellosoft India Private Limited (ITA No. 645/HYD/2009), which is binding on the Learned AO / DRP/TPO.
3. The Learned DRP erred in law and on facts by summarily rejecting the Appellant's objections and disregarding the material placed on record thereby not following the procedure laid down u/s 144C(5), 144C(6) & 144C(7) of the Act.10 ITA No. 243/Hyd/2014
M/s. Kenexa Technologies Pvt. Ltd.
===========================
4. The Learned AO erred in granting credit in respect of taxes deducted at source ('TDS') only to the extent of Rs. 18,66,654 as against Rs. 18,94,969 claimed in the Return of Income.
5. The Learned AO/ DRP erred in computation of interest liability under sections 234B and 234C.
14. We have heard both parties.
15. Ground No. 1 and 2.1 which consists of ground Nos. 2.1.1 up to 2.1.3 are general grounds and hence need not be adjudicated. Accordingly, these grounds are dismissed being general in nature.
16. Ground No. 2.2 is with regard to the issue of segmental information to be considered while computing margin of the assessee in its TP study. The assessee had provided services to both AEs and non AEs and stated that it maintained separate books in relation to these segments. Also the assessee provided segmental data of AE and non-AE segments for its TP study. The TPO rejected the segmental information with the following observations:
"The taxpayer has provided the segmental information in its TP study. However, such segmental information is not available in the published Annual Report. Therefore, the manner in which the costs have been allocated is not known. Unaudited information cannot be taken as a basis to compute the profitability of the segments for transfer price analysis as the same is unreliable. It is also not known whether the taxpayer has maintained cost audit report or not. Even otherwise, in the allocation of revenue and expenses, still a lot of assumptions and presumptions are made in addition to the cost records if any maintained. When we are unable to arrive at segmental financials without giving room for any ambiguity, then it is better to go with the enterprise level margins for the purpose of ALP determination under the TNMM method. At this juncture, it is also not possible for the department to go into the merits of allocation of each and every transaction and thereby evaluate whether the cost audit report if any, reflects accurate profit margins of the segments in the business of the assessee."11 ITA No. 243/Hyd/2014
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===========================
17. The TPO on rejecting assessee's segmental information has considered only software development services (SDS) income of the assessee while taking the entire expenditure of the assessee including non-AE segment for computing its margin. The assessee before the DRP raised ground No. 13 for considering its segmental data which the DRP dismissed as follows:
"We have gone through the submissions and order of the TPO. The grounds raised before us were the same grounds raised before the TPO. We find that the TPO had given valid reasons for countering the argument of the assessee in the TP order. The TPO has rightly taken the revenues pertaining to AE segment and since the segmental results are not available in the audited financials, the TPO considered the expenditure on the pro-rata basis. This Panel and the earlier Panel have upheld the action of the TPO in similar other cases and accordingly, we decline to interfere on this ground."
18. In 3i Infotech Ltd. vs. ITO in ITA No. 21/Mds/2013 dated 7.5.2013, the ITAT Chennai Bench held that segmental information provided must be taken and only the AE transactions ought to be considered, unless it was shown by the TPO/DRP that there were specific issues with the same. The ITAT Chennai Bench held as follows:
"29. We, thus, find that the lower authorities were not justified in not excluding profit or loss in respect of domestic transactions for determining the profit declared by the assessee in respect of AE transactions. They were not justified in adopting the profit level achieved by the assessee in respect of all its transactions including domestic transactions as the profit level declared in respect of AE transactions. Further, we find that the assessee had furnished separately its working of the profit declared by it in respect of its AE transactions before the TPO as well as before the DRP. The lower authorities could not point out any specific defect in the said working of the assessee. As per the said working of the assessee, the assessee claimed to have earned a profit level of 34.17% of the cost in respect of AE transactions. Before us also, the ld. CIT/DR could not point out any specific defect in this working of the assessee. The only argument of the Department is that the 12 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== segment-wise working made by the assessee is not audited. In our considered view, there is no legal requirement that the segment-wise working submitted before the TPO should be audited by the assessee's CA. Moreover, it is not open to the Revenue to reject the working prepared by the assessee without pointing out any error therein. In absence of any error being pointed out in the working shown by the assessee wherein it has claimed that it has achieved a profit level of 34.17% of the cost in respect of transactions with AE, we have no option but to accept the same. On the above facts, in view of the decision of the Delhi Bench of the Tribunal quoted above, we find that the rate of profit achieved in other comparable cases are to be compared with profit level declared by the assessee in respect of its AE transactions after excluding domestic transactions. Therefore, on comparing the same, we find that the profit level declared by the assessee in respect of its AE transactions is more than the profit level in respect of comparable cases found by the TPO. In the above circumstances, in our considered view, the lower authorities were not justified in making addition to the income of the assessee. We, therefore, delete the addition of Rs. 5,23,19,210/- and allow the ground of appeal of the assessee."
19. Further, the co-ordinate Bench in the case of Four Soft Ltd. vs. DCIT in ITA No. 1495/Hyd/2010 dated 9th September held that only AE segment transactions should be considered while computing the PLI. In that case bad debts incurred by the assessee were in respect of transactions with AE.
20. In the above case the Hyderabad Bench of the ITAT held as follows:
"15. We have considered the rival submissions and perused the material on record. First, we will take up the issue relating to the adjustments made by the assessing officer in respect of the international transactions with its associated enterprises in the software development services. It is the contention of the assessee that bad debts incurred by the assessee company are in respect of transactions, which are not related to associated enterprises. This contention of the 13 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== assessee has not been controverted by the Revenue by bringing any material on record before us. It is the contention of the learned counsel for the assessee that such bad debts cannot be taken into account for computing the margin of the assessee from the transactions with the associated enterprises in respect of software development services. The learned counsel for the assessee has also filed before us a comparative chart explaining the computation of Net Margin, excluding the bad debts and clearly demonstrated before us that if the bad debts/reimbursements are excluded for the purpose of computing the margins on the transactions relating to the associated enterprises, the net margin comes to 19.07%, which is well comparable with the Arms Length Margin of 19% determined by the Transfer Pricing Officer. In our considered view, for computing the net margin of the assessee for the purposes of transfer pricing, only the cost related to the transaction with the Associated Enterprises has to be considered and accordingly, we approve that segmental financials is to be considered for the purpose of arriving at the net margin on the international transaction with the assessee's enterprise in respect of software development services. In that process, bad debts/reimbursements has to be excluded and segmental profitability has to be adopted. We find support in this behalf from various decisions of the Tribunal relied upon by the learned counsel for the assessee duly filing copies thereof in the paper-book, which have been noted hereinabove. That being so, the TPO should have determined the Arms Length Price for the international transactions with associated enterprises considering only the operating cost allocable to the Associated Enterprises segment. Since the assessing officer had no occasion to verify the veracity of the segmental financials prepared by the assessee company, for limited purpose, we direct the assessing officer to verify the segmental financials prepared by the assessee company and adopt the same for arriving at the net margin on the international transaction with AEs in respect of software development services. We direct accordingly."
21. This ratio was approved in the order of Brigade Global Services Pvt. Ltd. in ITA No. 988/Hyd/2011 dated 26.11.2012.
22. In view of the decisions cited above, we send back this issue to the TPO to verify whether the assessee had maintained separate books of account which were audited by statutory auditors of the 14 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== Software Development Services and, if so, the TPO is directed to consider the audited segmental information and use only the AE segment for computing the assessee's PLI.
23. With respect to Ground No. 2.3, with regard to incorrect computation of margin of assessee, the facts are that foreign exchange loss has been considered as operating loss by the TPO and upheld by the DRP. It was submitted by the learned counsel that the loss has occurred as part and parcel of normal business operations of the assessee and the learned counsel relied on the decision of Teva India (P) Ltd. vs. DCIT, 44 SOT 105 (Mum).
24. We are of the opinion that the assessee's case is distinguishable as the decision relied on by the learned counsel viz., Teva India (P) Ltd. (supra) dealt with foreign exchange gain on loan relating to acquisition of capital asset in India which was treated as addition by the Assessing Officer and capital receipt by the CIT(A) and the facts in the instant case are different.
25. The co-ordinate Bench of the Tribunal in Capital IQ Information Systems India Pvt. Ltd. vs. DCIT, in ITA No. 1961/Hyd/2011 dated 23.11.2012 has held as follows:
"The Bangalore Bench of the Tribunal in the case of SAP Labs India P. Ltd. (supra), while considering a dispute of similar nature, observed as follows-
"The foreign exchange fluctuation gains is nothing but an integral part of the sales proceeds of an assessee carrying on export business. The Courts and Tribunals have held that foreign exchange fluctuation gains form part of the sale proceeds of exporter-assessee. The foreign exchange fluctuations income cannot be excluded from the computation of the operating margin of the assessee company......."
Following the aforesaid decision of the Bangalore Bench of the Tribunal, the Hyderabad Bench of the Tribunal held in the case of Four Soft Ltd. (supra) in the following manner-
15 ITA No. 243/Hyd/2014M/s. Kenexa Technologies Pvt. Ltd.
=========================== "16. With regard to the exclusion of gain on account of foreign exchange fluctuation while computing the net margin, as claimed by the assessee, we find that the exchange fluctuation gains arise out of several factors, for instance, realisation of export proceeds at higher rate, import dues payable at lower rate. Since the gain or loss on account of exchange rate fluctuation arises in the normal course of business transaction, the same should be considered while computing the net margin for the international transactions with the associated enterprises of the assessee. Our view in this behalf is fortified by the decisions of the Bangalore Bench of the Tribunal in the case of SAP Labs India Ltd. supra and Bombay bench of the Tribunal in the case of Deutsche Bank A.G. V/s. D. CIT reported in 86 ITD 431......"
Respectfully following the aforesaid decisions of the Tribunal, and considering the contention of the assessee that for the assessment year 2008-09 foreign exchange fluctuation gain/loss has been considered as operating margin while computing the margin of comparable companies, we hold that even for the year under appeal also the same principle should be applied, and while computing the margin for determining the ALP for the assessment year under appeal, the foreign exchange gain/loss has to be taken as part of the operating margin. ... "
26. We, therefore, are of the opinion that foreign exchange loss in case of providing services to AEs is to be considered as operative in nature and hence is to be included in the PLI calculation of the assessee. However, we note that before us the learned counsel submitted that a portion of the foreign exchange loss is attributable to non-AE transactions and furthermore, a portion of the said foreign exchange loss pertains to advances which are non-operative in nature. We, therefore, remit this issue back to the file of the TPO with a direction that only foreign exchange loss attributable to AE transaction should be considered and also that only that portion of loss which is operative in nature is to be included in the PLI calculation. The Assessing Officer shall re-work the same after providing sufficient opportunity to the assessee in substantiating its claim.16 ITA No. 243/Hyd/2014
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27. With respect to ground No. 2.4, with regard to grant of working capital adjustment, we rely on the decision of Demag Cranes & Components (India) Pvt. Ltd. vs. DCIT, ITA No. 120/PN/2011, dated 4.1.2012, wherein it has been held as follows:
"We have so far analysed Rule 10B(1)(e) on one side and other sub-rules in the context of TNMM and we have analysed the need for elimination of the difference, if any, in the comparable uncontrolled transactions which materially affect the profit margin in the open market."
28. Hence in the instant case, we are of the opinion that appropriate working capital adjustment is required to the margins of comparable uncontrolled transactions to generate credible comparable data on transactional net margins since the TNMM is applied. Hence we set aside this issue to the TPO with a direction to allow requisite adjustments on account of the impugned "working capital" while determining the margins of comparable.
29. With respect to ground No. 2.5, with regard to filters, the assessee has objected to the filters adopted by the TPO specifically the onsite revenues greater than 75% of the export revenues filter, 25% related party transactions filter and diminishing revenue persistent losses filter. The assessee has in ground No. 2.5.2 has raised the ground that the TPO has not correctly applied certain filters such as employees cost less than 25% of the total turnover and export sales less than 75% of the turnover. The assessee has also objected to the filters applied by the TPO.
30. We find that the TPO has discussed about the filters in details their applicability from page Nos. 29 to 41 of the TPO order. We further note that the DRP has also summarily accepted the filters applied by the TPO. Therefore, we do not find any reason to disturb the application of filters as carried out by the TPO. We, therefore, dismiss ground No. 2.5.1 of the assessee.
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31. With respect to ground No. 2.5.2, being the objection of incorrect application of certain filters, rejection of assessee's filters by the TPO and also the general ground of appeal against the order of the TPO with respect to filters are not adjudicated as they are general in nature, since we have dealt with ground relating to comparability analysis. We, therefore, dismiss ground No. 2.5.2 of the assessee hence ground No. 2.5 of the assessee is dismissed.
32. With respect to ground No. 2.6, this ground relates to comparability analysis carried out by the TPO and ground No. 2.6.1 relates to the use of Bodhtree Consulting Ltd., as a comparable company. For this purpose, we rely on the recent decision of Bangalore Bench of this Tribunal in the case of M/s. CISCO Systems (India) Pvt. Ltd. vs. DCIT, S.P. No. 130/Bang/2014 and IT(TP)A No. 271/Bang/2014 dated 14.08.2014 wherein it was held as under:
"In this regard, the Id. counsel for the assessee has brought to our notice the decision of the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. v. I TO, ITA No. 7633/Mum/2012, order dated 6.11.2013. In this case, the Tribunal followed the decision rendered by the Mumbai Bench of the Tribunal in the case of Wills Processing Services (I) P. Ltd., ITA No. 4547/Mum/2012. In the aforesaid decisions, the Tribunal has taken the view that Bodhtree Consulting Ltd. is in the business of software products and was engaged in providing open & end to end web solutions software consultancy and design & development of software using latest technology. The decision rendered by the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. (supra) is in relation to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in A.Y. 08-09 as far as this comparable company is concerned. Following the aforesaid decision of the Mumbai Bench of the Tribunal, we hold that Bodhtree Consulting Ltd. cannot be regarded as a comparable.
In this regards, the fact that the assessee had itself proposed this company as comparable, in our opinion, should not be the basis on which the said company should be retained as a comparable, when factually it is shown that the said company is a software product 18 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== company and not a software development services company."
33. Following the decision in the case of CISCO Systems (India) Pvt. Ltd. (supra), we reject the Bodhtree Consulting Ltd., as a comparable in the instant case. Hence ground No. 2.6.1 of the assessee is allowed.
34. Ground No. 2.6.2.. In this ground the assessee objected to TPO selection of three comparable companies viz., CompU-Learn Tech India Ltd., (2) Infosys Technologies Ltd. and (3) Kals Information Systems Ltd., on the ground that these are functionally different from the assessee-company.
35. The Bangalore Bench in the case of CISCO Systems (India) Pvt. Ltd. (supra) for A.Y. 2009-10 while rejecting Infosys Systems as comparable has stated as follows:
"26.2 Infosys Ltd.: As far as this company is concerned, it is not in dispute before us that this company has been considered to be functionally different from a company providing simple software development services, as this company owns significant intangibles and has huge revenues from software products. In this regard, we find that the Bangalore Bench of the Tribunal in the case of M/s. TDPLM Software Solutions Ltd. v. DCIT, ITA No. 1303/Bang/2012, by order dated 28.11.2013 with regard to this comparable has held as follows:-
"11.0 Infosys Technologies Ltd.
11.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment.
11.2 Before us, the learned Authorised Representative contended that this company is not functionally comparable to the assessee in the case on hand. The learned Authorised Representative drew our attention 19 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== to various parts of the Annual Report of this company to submit that this company commands substantial brand value, owns intellectual property rights and is a market leader in software development activities, whereas the assessee is merely a software service provider operating its business in India and does not possess either any brand value or own any intangible or intellectual property rights (IPRs). It was also submitted by the learned Authorised Representative that :-
(i) the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. in ITA No. 227/Bang/2010 has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any intangible and hence does not have an additional advantage in the market. It is submitted that this decision is applicable to the assessee's case, as the assessee does not own any intangibles and hence Infosys Technologies Ltd. cannot be comparable to the assessee;
(ii) the observation of the ITAT, Delhi Bench in the case of Agnity India Technologies Pvt. Ltd. in ITA No. 3856 (Del)/2010 at para 5.2 thereof, that Infosys Technologies Ltd. being a giant company and market leader assuming all risks leading to higher profits cannot be considered as comparable to captive service providers assuming limited risk;
(iii) the company has generated several inventions and filed for many patents in India and USA;
(iv) the company has substantial revenues from software products and the break up of such revenues is not available;
(v) the company has incurred huge expenditure for research and development;
(vi) the company has made arrangements towards acquisition of IPRs in 'AUTOLAY', a commercial application product used in designing high performance structural systems.
In view of the above reasons, the learned Authorised Representative pleaded that, this company i.e. Infosys Technologies Ltd., be excluded form the list of comparable companies.
11.3 Per contra, opposing the contentions of the assessee, the learned Departmental Representative 20 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== submitted that comparability cannot be decided merely on the basis of scale of operations and the brand attributable profit margins of this company have not been extraordinary. In view of this, the learned Departmental Representative supported the decision of the TPO to include this company in the list of comparable companies.
11.4 We have heard the rival submissions and perused and carefully considered the material on record. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) for Assessment Year 2007-08 is applicable to this year also. We are inclined to concur with the argument put forth by the assessee that Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the breakup of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly."
The decision rendered as aforesaid pertains to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in AY 08-09 as far as this comparable company is concerned. Respectfully following the decision of the Tribunal referred to above, we hold that Infosys Ltd. be excluded from the list of comparable companies."
36. Bangalore Bench in the case of CISCO Systems (India) Pvt. Ltd. (supra) in the case of KALS Information Systems Ltd., has held as follows:
"26.3. KALS Information Systems Ltd.: As far as this company is concerned, it is not in dispute before us that this company has been considered as not comparable to a pure software development services company by the Bangalore Bench of the Tribunal in the case of M/s. Trilogy e-business Software India Pvt. Ltd. (supra). The following were the relevant observations of the Tribunal:
"(d) KALS Information Systems Ltd.21 ITA No. 243/Hyd/2014
M/s. Kenexa Technologies Pvt. Ltd.
===========================
46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual report, the salary cost debited under the software development expenditure was Rs. 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. DCIT, ITA No. ITA No 1386/PN/10 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 from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds."
Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable.
47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s. 133(6) of the Act. This information which was 22 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We, therefore accept the plea of the Assessee that this company is not comparable."
Following the aforesaid decision of the Tribunal, we hold that KALS Information Systems Ltd. should not be regarded as a comparable."
37. Following the above decision in the CISCO Systems, we hold that KALS Information System should not be regarded as a comparable company.
38. With respect to Comp-U-Learn Tech India Ltd., the assessee submitted that this company is functionally dissimilar and diversified in services. Further it was submitted by the learned counsel that the software development expenditure is only 25% of the total expenditure. It was submitted that the TPO relied on the information obtained from the company u/s. 133(6) notice and held it to be predominantly engaged in software development services.
39. The assessee submitted before the DRP that Comp-U-Learn Tech India Ltd. was engaged in the development of new software (product development) (page 7 of the Annual Report) in ITES call centre and BPO services (page 11 of Annual Report). It was further submitted that schedule XIII of the Annual Report shows software development expenditure at only 25% of the total expenditure. The TPO extracted the 133(6) notice and held that the company has nil onsite revenue and satisfied all the filters applied by the TPO. We are of the opinion that some more analysis has to be done and we direct the TPO to look into the financial statement of the company and also provide an opportunity to the assessee to submit relevant 23 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== details to substantiate its claim that Comp-U-Learn Tech India Ltd. is not a comparable company.
40. With respect to ground No. 2.6.3 and 2.6.4, it was argued by the learned counsel that the TPO erred in computing the margins of comparable companies by considering the provision for bad and doubtful debts and bad debts as non-operative expenditure.
41. We place reliance on the decision of ITAT Delhi Bench in the case of Sony India Pvt. Ltd. vs. DCIT, ITA No. 1189/Del/2005, 819/Del/2007 and 820/Del/2007. The relevant portion is extracted below:
"106.2 Thus, creation of unpaid liability and its write back is a normal incident of a business operation which is carried everywhere in accounts to have true picture of profits of the relevant period.
Having regard to statutory provisions, it cannot be said that provisions or writing back of liability is not part of operating profit or would not be taken into consideration for computing the same.
We can therefore make a general observation that all business enterprises are making and writing back liabilities as a normal incident of operating business. Therefore on facts we do not see any justification for excluding provisions written back in the profit and loss account as not forming part of the operating profit of the taxpayer. Accordingly claim of the taxpayer is accepted.
107. The next item relates to balances written back. In our considered opinion, finding given in respect of provisions written back is equally applicable to balances written back more particularly when ld. CIT(A) has not given any separate finding and the Transfer Pricing Officer has said nothing specifically on this item. The balances written back should also be treated as part of operating profit. We direct accordingly."
42. We are of the view that in the instant case bad debts and provision for bad and doubtful debts are part of the operating expenses and we direct the TPO to re-compute the margins of 24 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== comparable companies by including bad debts and provision for bad and doubtful debts as operating expenses for the purpose of computing profit and loss of comparable companies.
43. In ground No. 2.6.5. the assessee has objected to the rejection of comparable companies by TPO in the course of applying employee cost filter. The ITAT Bangalore Bench in the case of CISCO Systems India Pvt. Ltd. has held with respect to CG-VaK Solutions & Exports Ltd. has held as under:
"(ii) The submission of the Id. counsel for the assessee was that in the case of assessee, this test is satisfied. In this regard our attention was drawn to page 818 to 824 of the assessee's paper book wherein annual report of this company has been provided. Attention was drawn to the fact that in the profit & loss account of the audited accounts, the cost of services has been shown as an expenditure and in Schedule 15 to the Notes to Accounts, it has been elaborated as follows:-
Cost of services Rs.
Cost of services - Overseas 2,77,32,337
Cost of services - Domestic 2,58,40,435
Transcription charges 3,97,389
Web Designing charges 1,64,602
Staff Welfare 11,43,144
Staff training 3,63,496
Contribution to PF & ESI 15,47,906
Gratuity 13,04,894
Ex Gratia 0
HRD expenses 3,10,87
5,88,05,074
(iii) It was submitted by the Id. counsel for the assessee that the TPO ignored the contribution to PF & ESI, Gratuity and Ex Gratia payments and arrived at the employee cost. According to the Id. counsel for the assessee, doing so was not proper. If all the employee costs are properly considered, then this company can pass the filter applied by the TPO for excluding it.
(iv) We have considered the submission of the Id.
counsel for the assessee and are of the view that prima facie the submissions of the Id. counsel are acceptable. We, however, feel that it would be just and appropriate to direct the TPO to consider including 25 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== this company as a comparable afresh in the light of the facts brought to our notice by the Id. counsel for the assessee. We hold and direct accordingly.:
44. Following the decision cited above, we set aside the issue of comparability of CG-Vak Solutions & Exports Ltd. to the TPO for correct application of employee cost filter.
45. With respect to Prithvi Information Solutions Ltd., we remit the issue back to the TPO for fresh application of employee cost filter and onsite revenue filter after giving opportunity for the to submit its claim that Prithvi Information Solutions Ltd., is a correct comparable which satisfied the filters of the TPO.
46. Ground No. 2.7 is not pressed by the assessee and the same is dismissed as not pressed.
47. With respect to ground NO. 2.8, the assessee has sought for risk adjustment due to difference in risk profile of the assessee and the comparable cases selected. We rely on the decision in the case of Excellence Data Research vs. ITO, ITA No. 159/Hyd/2014 for A.Y. 2009-10 wherein it has been held as follows:
"21. With reference to ground No. 2.5 on risk profile, learned counsel for the assessee contended that the Assessing Officer/DRP have not considered the risk profile of the assessee and necessary adjustments have not been made in order to mitigate the differences between the assessee's risk profile and the comparables selected by the TPO. Assessee contends that adjustment of 1%, which was granted by the coordinate bench in the case of Helloso]t India P. Ltd. in ITA 645/Hyd/2009, should have been allowed. Even though it was contended that the coordinate Bench order in that behalf is binding on the Assessing Officer, we are not inclined to agree with that contention, as risk profile of each assessee differs depending on its own business activity when compared to that of the comparable company, and in each case separate risk profile has to be analysed in FAR analysis. Therefore, allowing deduction of 1% towards risk profile uniformly cannot be adopted as a norm. Further, this aspect requires to be re-examined by the TPO. Therefore, 26 ITA No. 243/Hyd/2014 M/s. Kenexa Technologies Pvt. Ltd.
=========================== after excluding the above companies, if any adjustment is required to be made, Assessing Officer is directed to consider the risk profile and allow necessary deduction, based on the facts of each comparable case."
48. Following the decision in the case of Excellence Data Research (supra), we remit the issue to the TPO to consider the risk profile of the assessee. We direct the TPO to allow necessary deductions for risk adjustment after finalising the list of comparables as directed by us.
49. Ground No. 4. With respect to ground No. 4, we remit the issue back to the Assessing Officer to verify and grant credit in respect of tax deducted at source by the assessee.
50. Ground No. 5 is consequential and needs no adjudication.
51. In the result, appeal of the assessee is partly allowed for statistical purposes.
Order pronounced in open court on 14th November, 2014.
Sd/- Sd/-
(B. RAMAKOTAIAH) (ASHA VIJAYARAGHAVAN)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Hyderabad, dated the 14th November, 2014 tprao Copy forwarded to:
1. M/s. Kenexa Technologies Pvt. Ltd., 8-2-502/1/AG, 3rd Floor, Uma Aishwarya House, Road No. 7, Banjara Hills, Hyderabad- 500 034.
2. The Deputy CIT, Circle-2(1), Hyderabad.
3. The Dispute Resolution Panel (DRP), Hyderabad.
4. The Deputy CIT (Transfer Pricing-II), Hyderabad.
5. The DR - A Bench, ITAT, Hyderabad