Income Tax Appellate Tribunal - Delhi
Navisite India Pvt. Ltd., Gurgaon vs Assessee
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH 'I': NEW DELHI
BEFORE SHRI S.V. MEHROTRA, ACCOUNTANT MEMBER
&
SHRI I.C. SUDHIR, JUDICIAL MEMBER
ITA No. 5329/Del/2012
Assessment Year: 2008-09
Navisite India Pvt. Ltd., ITO,
Vipul Orchid Plaza, First Ward 13(1),
Floor, Golf Course Road, Vs. New Delhi.
Suncity, Sector-53, Gurgaon.
PAN No. AACCN0289R
(Appellant) (Respondent)
Appellant by: Sh. Kanchan Kaushal, Sh. Rohit Tiwari & Ms. Mahima Jain, CAs
Respondent by: Sh. Peeyush Jain, CIT(DR)
ORDER
PER S.V. MEHROTRA, A.M.
This appeal filed by the assessee is directed against the order of ld. CIT(A) dated 21/08/2012 for A.Y. 2008-09.
2. Brief facts of the case are that the assessee is a wholly owned subsidiary of Navisite Inc. USA. It had been set up for the purpose of providing software services to clients of Navisite. The range of services included services such as design and development of custom and e- commerce solutions, application management, problem resolution management and deployment and management of IT networks, customer specific infrastructure and data centre infrastructure. The international ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 2 transactions undertaken by the assessee company with its associated enterprises were as under:
S.No. Nature of transaction Method Value of transaction
1. Provision of TNMM 207,868,050 Software services
2. Reimb. of traveling BNR 10,220,308 and mis emp. Exp by AE
3. Reimb. of traveling 454,438 and mis emp. Exp to AE
3. The main issue in the present appeal is determination of arm's length price of the international transactions representing Software Services provided to the associated enterprise. The arm's length price was determined by applying transactional net margin method (TNMM) considered to be the most appropriate method in the facts and circumstances of the case. The operating profit to total cost (OP/OC) ratio was taken as the profit level indicator (PLI) in the TNMM analysis. The PLI of the company was arrived at 9.51% on cost. Considering the functions performed by assessee, the TPO was of the opinion that the mark up of 9.51% on cost was inadequate. After considering the various filters applied by the assessee and after detailed analysis of the comparables selected by the assessee, the TPO finally selected 36 comparables and arrived at average PLI of 38.13% and, accordingly, concluded that an addition of Rs. 5,43,25,482/- was required as under:
Price received : Rs. 207,868,050/-
Total cost : Rs. 189,816,500
ALP at a margin of 38.13% : Rs. 262,193,532/-
ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 3
Price received : Rs. 207,868,050/-
Difference : Rs. 54,325,482/-
4. After considering the assessee's reply the TPO finally arrived at arithmetic mean PLI at 28.16% and, accordingly, made an adjustment of Rs. 3,40,26,578/- by taking into consideration 25 comparables as against 36 mentioned in the show cause notice to the assessee. On the basis of order u/s 92CA(3) of the TPO, the AO issued draft assessment order against which the assessee had filed objections before DRP which issued directions u/s 144C(5) on 20/07/2012 on the basis of which arm's length price of the international transactions undertaken by the assessee in respect of software development segment had been computed by taking PLI at 22.34% of the operating cost. Accordingly, an adjustment of Rs. 2,30,41,663/- was made as under:
1. Operating Cost Rs. 18,87,44,248/-
2. Arms length margin 23.34% of the OC
3. Arms length price (ALP Rs. 23,09,09,713/-
4. Price received by the assessee Rs. 20,78,68,050/-
5. Adjustment to be made (3-4) Rs. 2,30,41,663/-
5. Being aggrieved with the assessment order, the assessee is in appeal before us and has taken following grounds of appeal:
That on the facts and circumstances of the case, and in law;
1. The assessment order passed by the ld. Assessing Officer ('ld. AO') pursuant to the directions of ld.
Dispute Resolution Panel ('ld. DRP') is bad in law and void ab-initio.
ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 4
2. The ld. DRP and the ld. AO (following the directions of the ld. DRP), erred both on facts and in law in confirming the addition to the extent of Rs.
2,30,41,663/- to the income of the appellant out of the total addition of Rs. 3,40,26,578/- as proposed by the ld. TPO/AO in its draft assessment order u/s 143(3) read with section 144C by holding that its international transactions do not satisfy the arm's length principle envisaged under the Act. In doing so, the ld. DRP and the ld. AO has grossly erred in agreeing with and upholding the ld. TPO's action of:
3.1not appreciating that none of the conditions set out in sec. 92C(3) of the Act are satisfied in the present case; 3.2disregarding the ALP, as determined by the appellant in the TP documentation maintained by it in terms of sec. 92D of the Act read with Rule 10D of the Rules as well as while submitting the updated comparables analysis; and in particularly conducting a fresh economic analysis, by applying additional filters than those applied by the appellant, for the determination of the Arm's Length Price ("ALP") of the assessee's international transaction and holding that the international transactions are not at arm's length; 3.3 disregarding multiple year/ prior years' data as sued by the appellant in the TP documentation and holding that current year (i.e. FY 2007-08) data for comparable companies should be used despite the fact that the same was not necessarily available to the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 5 appellant at the time of preparing its TP documentation, and in doing so have grossly erred in; 3.3.1interpreting the requirement of 'contemporaneous' data in the Rules to necessarily imply current/single year (i.e. FY 2007-08) data; and 3.3.2 holding that at the time of creating/maintaining the TP documentation, the appellant could have procured current/single year data (i.e. FY 2007-08 data) from sources other than the electronic database, when in fact practically no such other sources were available in case of most companies; 3.4 rejecting comparability analysis in the TP documentation/ appellant's updated comparables analysis and in conducting a fresh comparability analysis based on application of the following additional/revised filters in determining the comparable companies:
3.4.1 exclusion of companies having turnover Rs. 1 crore;
3.4.2 exclusion of companies with employee cost less than 25% of the total cost;
3.4.3 exclusion of companies having economic performance contrary to the industry behavior/witnessing peculiar economic circumstances (eg. Companies having diminishing revenues/persistent losses for last three years upto and including FY 2007-08);ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 6
3.5 Including FCS Software Solutions Ltd. which was earned supernormal profits as compared to the Appellant and including volatile/high-profit making companies in the final comparables' set for benchmarking a low risk captive unit such as the appellant (disregarding judicial pronouncements on the issue), thus demonstrating an intention to arrive at a pre-formulated opinion without complete and adequate application of mind with the single-minded intention of making an addition to the returned income of the appellant;
3.6 including certain companies that are not comparable to the appellant in terms of functions performed, assets employed and risks assumed; 3.7 excluding certain companies on arbitrary/frivolous grounds even though they are comparable to the appellant in terms of functions performed, assets employed and risks assumed;
3.8 ignoring the business/commercial reality that since the appellant is remunerated on an arm's length cost plus basis i.e. it is compensated for all its operating costs plus a pre-agreed mark-up based on a benchmarking analysis, the appellant undertakes minimal business risks as against comparable companies that are full fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the appellant on account of this fact;ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 7
3.9 denying a working capital adjustment to the operating profit margins of the comparables; 3.10 disregarding judicial pronouncements in India in undertaking the TP adjustment.
4. The ld. DRP and the ld. AO, erred both on facts and in law, in adding Fringe Benefit Tax paid by the appellant for computing the book profit u/s 115JB of the Act.
5. That the ld. AO erred on facts and in law in charging interest u/s 234A and 234B of the Act;
6. The ld. AO has grossly erred in initiating penalty u/s 271(1)(c) of the Act mechanically and without recording any satisfaction for its initiation."
6. As far as ground no. 1 is concerned, no arguments have been advanced by ld. Counsel for the assessee as to how the assessment order passed by AO pursuant to the directions of ld. Dispute Resolution Panel is bad in law and void-ab-initio. Accordingly, this ground is dismissed.
7. As far as ground no. 2 is concerned, the same is general and needs no specific adjudication.
8. Ground no. 3.1 is with reference to sec. 92C(3) which deals with AO's power to determine the arm's length price in relation to the international transactions if, in his opinion, the price charged in regard to international transaction has not been determined as per sec. 92C(1) & (2). The assessee has not demonstrated as to how the AO was not justified in determining the arm's length price in relation to the international ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 8 transaction. The reference made by AO to TPO itself shows that in his opinion the international transaction had not been determined as per sec.
92C(1) & (2).We, therefore, dismiss this ground.
9. As far as ground no. 3.2 is concerned, the same relates to rejection of arm's length price as determined by the assessee in the TP documentation maintained by it and also challenging the fresh economical analysis undertaken by the TPO by applying additional filters.
10. Having heard both the parties, we find that TPO has given detailed reasoning for rejecting the TP document maintained u/s 92D read with Rule 10D of the Income tax Rules. We, therefore, do not find any substance in this ground particularly because the TPO's order has been assailed on various counts in ground no. 3.4 to 3.10. Therefore, this ground is dismissed.
11. Apropos ground no. 3.3, the TPO in its show cause notice dated 14th October, 2011 had, inter-alia, stated as under:
3. "As per the TP report submitted, you are engaged in providing development services to your AE. You have earned a margin of 9.51% on cost. For the benchmarking of this transaction, you have conducted a search on the Prowess and Capitaline databases and arrived at a set of 20 comparables. The average margin of these comparables is 14.84% by using multiple year data. The use of multiple year data is inappropriate given the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 9 contents of Rule 10D(4). The Rule stipulates that primarily current year data should be used.
Multiple year data can be allowed only if the assessee demonstrates that there are certain factors in the earlier years that have affected only if the assessee demonstrates that there are certain factors in the earlier years that have affected the transfer prices in the current year. All the arguments made by you in this regard, especially the one made on in your submission dated 15.06.2011 have been carefully perused. You have not been able to provide any data/facts that would demonstrate that factors pertaining to earlier years have affected the transfer prices in the current year. In any case, you have set your transfer price pre-ante. There is nothing on record to show that any study, analysis was available that justified the transfer price agreed upon by you and your AE."
12. Ld. Counsel for the assessee submitted that multiple year data was to be used because the current year data was not available at the time of preparation of T.P. Study Report. He further submitted that multiple year data gives correct indicator of the margin of comparables.
13. Having heard both the parties, we find that as per Rule 10B(4), the data to be utilized and analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into. ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 10 As per proviso to Rule 10D earlier year data can be used in addition to the data pertaining to the relevant financial year only for taking a decision on how much of the factors in earlier years have impact on the profit of the current year for both the tax payer and the comparable. Therefore, it has to be demonstrated as to how the earlier year conditions have influenced the profit of the relevant financial year. Since assessee had not given details in this regard, therefore, the TPO's action was justified on this count. Further in para 5.6 of his order, the TPO has given a detailed list of cases, wherein it has been held that the current year data is to be utilized for the purpose of comparability. In view of above discussion, we do not find any reason to interfere with the order of AO/TPO on this count.
14. In the result, this ground is dismissed.
15. Apropos ground no. 3.4, the assessee has assailed the TPO's order in selecting comparables by applying various filters. The assessee has filed a brief synopsis of the case in which comparable wise contentions of the assessee have been given. The assessee has assailed the inclusion/exclusion of the companies by TPO/DRP on various counts which will be considered in subsequent grounds. Therefore, this ground does not require any specific adjudication.
16. Vide ground no. 3.4.1 the assessee has assailed the TPO's action excluding companies having turnover less than Rs. 1 crore. ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 11
17. We have considered the submissions of both the parties. This filter was applied by TPO on the ground that where the turnover and cost base is very small, it is more than likely that the margins will be erratic. The TPO was of the opinion that a company which is very small in size does not have sufficient economic significance that it be used as a bench mark. The assessee objected to the filter on the ground that turnover filter should not be used and if it is used then the high turnover filter should also be used. At the time of hearing, ld. Counsel for the assesee did not press for exclusion of companies on the ground of high turnover filter. As far as assessee's claim for inclusion of comparables where turnover is less than 1 crore is concerned, we do not find any substance in the same because in service sector turnover has no relevance particularly when TNMM method has been selected as the most appropriate method. In the case of companies with low level of sales/operating income, the companies may be operating with altogether different management model including lack of human resources. Therefore, the margin of companies having turnover of less than 1 crore fluctuate to extreme because of the narrow base.
18. Ld. DR has pointed out that in the case of M/s Haworth India (P) Ltd. (2011-TII-64-ITAT-Del-TP) Tribunal has impliedly approved this filter. Similarly ITAT, Delhi in the case of M/s CRM Services India Ltd. (2001-TII- 86-ITAT-Del-TP) rejected comparable as its turnover was less than Rs. 1 ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 12 crore. We, therefore, do not find any reason to interfere with the order of ld. DRP on this count.
19. In the result, this ground is dismissed.
20. Ground no. 3.4.2 is regarding applying of a filter of excluding companies with employee cost less than 25% of the total cost. The TPO applied this filter on the ground that the companies which are engaged in software development require a minimum level of expenditure on personnel expenses. He referred to certain judicial pronouncements in support of his contention that expense on personnel being extremely low may lead to the conclusion that company is not engaged in software development. The TPO observed that extremely low expenditure on salary/employee cost is an indication that the company is either into further outsourcing of the work or is a software product developer or a software trading company. The assessee's contention was that there are no general accounting norms that govern the disclosure of employee cost in the profit and loss account. It was further contended that some companies may choose to outsource their software development. The claim of the assessee was that there was no comprehensive and exhaustive way in which these expenses can be tracked. The TPO after considering these submissions observed that this filter is just a trigger to see the functionality of the comparable company. He pointed out that he had not out rightly applied this filter. He referred to the decision in the case of Vidaris Technologies Ltd. by the ITAT, Delhi, ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 13 wherein it was held that companies that have lower levels of employee cost may not be software developers. They may be involved in other activities like trade of software product etc. He pointed out that this filter may be described as diagnostic tool only. The object of such tool is to arrive at a set of comparables i.e. closest to the tax payer in functions. His contention was that this quantitative filter essentially controls the subjective element in the qualitative analysis. Ld. DRP confirmed the TPO's action, inter-alia, observing that very low employee cost, viz., less than 25% of total cost, indicates that company is either engaged in some other business or it has outsourced the service functions to a third party, i.e., it is not rendering services on its own.
21. Having heard both the parties, we do not find any reason to interfere with the findings of ld. DRP on this count because in order to consider the functional similarity of two comparables, it is necessary that such quantitative filters are applied to reach a reasonable conclusion regarding functional similarity. As rightly pointed out by ld. TPO, this filter essentially works as a diagnostic tool in deciding the functional similarity of two comparables.
22. In view of above discussion, this ground is dismissed.
23. In ground no. 3.4.3 the assessee has assailed the TPO's action in applying the filter in selection of comparable by excluding companies having diminishing revenues/persistent losses for last three years upto and ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 14 including FY 2007-08. In the show cause notice dated 14th October, 2011 in para 6 the TPO had examined the filter applied by assessee in TP Study and had, inter-alia, pointed out with reference to filter applied by assessee of rejecting companies having persistent operating losses by observing as under:
"This is an appropriate filter. However, only companies which are incurring losses persistently are to be rejected as against companies which have made loss once in a while. This is an appropriate filter because of the reason that software industry has been growing at a rate of more than 20% and in such an environment a company making persistent losses does not reflect the industry conditions and is in persistent losses because of company specific issues."
24. The TPO had excluded the companies with diminishing revenue because in an environment where software sector is growing at a CAGR (Compounded Annual Growth Rate) of more than 30% during the last 30 years or at least the diminishing revenue for the last three years is not a true indicator of the performance of the company. This filter was applied on the ground that such companies have some peculiar problems because of which the revenue's were declining and not in line with the growth of software industry. Ld. DRP confirmed the TPO's action, inter-alia, observing that the average growth rate incorporates top line bottom line ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 15 has consistently been in positive territory during last decade. Therefore, declining turnover and persistent loss is not a usual phenomenon in the Indian economic time.
25. Having heard both the parties, we do not find any reason to interfere with the order of ld. DRP/AO because the diminishing revenue/persistent losses are not inconformity with the normal operational results in this line of activity. They may be indicator of the company on the verge of closer on account of under utilization of assets or human resources which had been created/ recruited earlier. These exceptional circumstances are not quantifiable and, therefore, these companies cannot be taken as comparable. We, therefore, reject this ground of appeal.
26. In the result, this ground is dismissed.
27. In ground no. 3.5 the assessee has challenged the inclusion of FCS Software Solutions Ltd. on the ground that the said company had earned super normal profit. The assessee has also challenged the inclusion of companies in the final comparable set for bench marking which had volatile/high profit making companies on the ground that the assessee is a captive service provider and, therefore, its risk element stands considerably been mitigated.
27.1 First we will consider the assessee's objection regarding inclusion of FCS Software Solutions Ltd. in the final set of comparables. Brief facts in this regard are that while making qualitative analysis in the TP Study, the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 16 assessee had rejected this company on the ground that it was providing customized software solutions to its clients and the revenue was divided into four broad heads viz. E-learning and Digital Consulting (ELDS), IT Consulting Services Product Engineering Services.
28. Ld. Counsel for the assessee referred to page 697 & 698 of paper book to demonstrate the functional profile of the company. He also referred to page 670 of paper book, wherein the website extracts are contained which reads as under:
"FCS Software Solutions is a leading provider of IT services in the past one decade of its existence, FCS has carved out a niche for itself in core IT areas like e- learning, digital content services, IT consultancy and product engineering services.
We have a huge offshore center in India that caters to a global clientele. Our development center prides in a state of the art facilities and a competent workforce consisting of programmers. IDs, visualizers, e-learning experts, writers and editors who have worked extensively in the areas of e-learning, product training, sales training, support services, performance and collaboration for several Fortune 500 companies."
29. Thus, first contention of assessee is that since the functional profile of FCS Software Solutions is different in-as-much as the same is, inter-alia, engaged in infrastructure management services, therefore, the same cannot be taken as comparable. The assessee also submitted that the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 17 segmental information was also not available. The TPO however, observed that since the FCS Software Solutions was engaged in software services, therefore, the objection of assessee on functional dissimilarity was not acceptable. We find that ld. DRP in this regard has observed at page 21 as under:
"It is clear from the annual report that the company is providing software services/solutions to its clients. It is seen that all the segments pertain to software development and are various sub-segments of the software development industry. It is nowhere indicated in the report that the assessee is providing e-learning, digital content services and product engineering services on its own to its clients. The annual report clearly states that the income is from software development and main expenditure is on software development. In fact it is clearly mentioned in the annual report that the company is deriving more that 70% of the revenues on the basis of time & material model while the rest are charged on the basis of fixed price and fixed time frame model. The relevant part of the annual report is extracted below this table."
30. The assessee has also assailed the inclusion of this comparable on the ground that this company was earning abnormally high profit in comparison to the assessee. The assessee has also submitted that its profit margins were highly volatile. In support of its contention the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 18 assessee has referred to the profit margins of last three years and also for subsequent two years:
Name of the FY FY FY FY FY FY
Comparable 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
FCS Software 14.40% 14.32% 22.64% 57.05% 15.61% 47.79%
Solutions Limited
A further challenge is on the ground that FCS Software Solutions has brand value. The assessee also submitted that as per the annual report of the company, the company is positioned in top 50 companies of India, for the IT Services Export, data quest. Dalal street rated FCS in top 250 companies in its midcap, 2008. The company under takes branded efforts by participating in the media and industrialist event, etc., whereas the assessee does not undertake any branded activities.
31. We find that in para 4 of the show cause notice dated 14/10/2011 the TPO has referred to article 2 of the agreement which elaborates the services rendered by assessee. This reads as under:
"Services in the field of information technology services, including software programming services, monitoring and database management services, database and application maintenance services, customer support services, establishment of data centres, infrastructure management services, services related to servers, network connectivity, security, networking, storage, web and application development, collocation hosting, bandwidth options, disaster recovery, digital storage systems, electronic software distribution, online customer information, ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 19 backup, recovery, archive, offsite vault storage for all data on servers, anti-spam, anti-virus, reporting, enhanced monitoring and value added services, message archiving and retrieval services, end-to-end archiving solution and other customer end-to-end information technology services."
32. From the above, it is evident that the assessee is rendering almost all kinds of comprehendible software services. The assessee is carrying out services that are not merely routine software development services but a whole range of services to carry out the main work of AE. Functions include providing the services in its entirety to AE. Therefore, the assessee's contention on the basis of functional dissimilarity cannot be accepted from the extracts of annual report contained at page 670 of paper book. It is evident that assessee was mainly an IT service provider. This could be in areas like e-learning, digital content services, product engineering services, IT engineering consultant, etc. which are primarily the areas where the assessee was providing software services. It does not in any manner bring the FCS software solutions on a different platform. The company essentially was a software service provider only. We, therefore, do not find any reason to exclude FCS software solutions from the list of comparables on the ground of functional dissimilarity.
33. The assessee's next objection is that FCS software solution was earning abnormally high margin. On this issue ld. DR submitted that primarily functional comparability is to be established and if the same is ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 20 there then there is no need to go to margins. Ld. DR submitted that the fallacy in the argument of ld. Counsel for the assessee lies in the fact that first higher margins have been considered and then functions are examined. On the contrary it should be other way round. He submitted that in comparability analysis loss or higher margin is not a determining factor unless there are any peculiar circumstances in a case making it functionally not comparable. He submitted that comparable has to be selected on the touch stone of FAR analysis and not on the basis of margins.
34. We have considered the submission of both the parties and find considerable force in the arguments of ld. DR on this issue. The very object of TP Study is to find out comparable uncontrolled cases performing similar functions in order to find out the reasonableness of price at which international transaction has actually been undertaken by assessee. If the functional profile of the comparable is same as that of assessee then the same cannot be rejected merely because of high margins of profit being earned by it unless it is established that the high margins were on account of exceptional economic factors for which necessary adjustment may be required to bring the profit of comparable on the same footing and at the same level at which the tested party is operating in the same economic synario. If comparables carrying out similar functions are excluded on the ground of earning high profit then the very object of TP Study would be ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 21 frustrated. That is the reason that under rule 10B, dealing with various most appropriate methods, it is contemplated that the normal gross profit mark up is adjusted to take into the account the functional and other differences which could materially affect such profit mark up in the open market.
35. Ld. DRP has rightly observed that while taking arithmetic mean, the differences on account of low margins as well as high margin ultimately average out. If the assessee is able to demonstrate that there are peculiar economic circumstances which warrant the exclusion of comparable on account of earning high profit then only the comparable can be excluded. In this regard ld. DRP has reproduced the revised 2010 guidelines of OECD which were taken note of by TPO.
36. Ld. Counsel has referred to the decision of Tribunal in the case of Actis Advisers Pvt. Ltd. (ITA No. 5277/Del/2011) & ITA No. 958/Del/2012), wherein the Tribunal has, inter-alia, observed as under:
22. "Profit and loss are two incidence of business and merely on account of low profit or loss would not make a functional comparables company as uncomparable, but if the ultimate result is of such a nature which demonstrates that such company is not comparable then that company deserves to be excluded e.g. a company may be functionally comparable but if it is showing persistent losses then it is always adviseable to exclude such a ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 22 company from the list of comparable. Similarly, if the result of a company over a period shows fluctuation disproportionate to other concern, then that would not be an indicator for the profit or loss resulting from the operation of the company rather some extra reasons would be responsible for the losses or the profit. Therefore, such comparable deserves to be excluded."
37. In our opinion this decision does not in any manner advance the assessee's case. In this decision also it has been clearly stated that low profit or loss would not make a functional comparable company as uncomparable. Further it was pointed out that if the result of a company over a period shows fluctuations disproportionate to other concern, then that would be an indicator for the profit or loss resulting from extra reasons and not merely from operations. This is for assesee to demonstrate that on account of certain extra economic factors the assessee had earned high profits. However, if the high profit is merely the consequence of operations carried out by the assessee in its regular course of business then the same cannot be rejected because of high margins earned by assessee. On the contrary, it depicts the operational efficiency of the concern which is achievable in that particular sector. Moreover, as noted by ld. DRP, since arithmetic mean is being considered, therefore, the extra profits reflecting extra operational efficiency of the concern gets ironed out and the profit margin determined reflects the representative of the whole lot. In this ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 23 regard we find that TPO has referred to the following decisions which hold the aforementioned view:
1) Exxon Moibel Company India Pvt. Ltd. (2011-TII-68-ITAT-Mum.-TP;
2) M/s B.P. India Services Pvt. Ltd. (ITA No. 4425/Mum./2010).
38. Further, as per the requirements of law, in order to find out the arm's length price, FAR analysis is to be carried out which requires the study of assets employed to carry out the specified functions as per risk undertaken by the assessee as well as the comparable. Once the functional similarity has been established then comparable selected cannot be rejected unless it is established that the assets employed by it and the risk undertaken by it is not in conformity with that of assessee.
39. In the case of M/s Extreme International Services Pvt. Limited vs. Asstt. Director of Income-tax (Int. Taxation) -7(2)/Mumbai the inclusion of Maple E-solutions Ltd. in the list of comparables was assailed by ld. AR. The Tribunal noticed that the TPO excluded the case of Satya Computers services on the ground of unreliability of data "although that case satisfied all the relevant criteria chosen by the TPO". It was contended before the Tribunal that Maple E-solutions Ltd., which was included by the TPO in the list of comparables, suffered from the same disability. It was argued that the reputation of Rastogi Group, owning Maple E-solutions Ltd. was under
serious indictment. Before the Tribunal the decision of Delhi Bench of the Tribunal in CRM Services India Pvt. Ltd. (ITA No. 4068/Del/2009) for AY 2006-07 was placed vide which the case of Maple E-solutions Ltd. had ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 24 been directed to be excluded for this reason alone. It was also brought to the notice of Tribunal that the Hyderabad Bench of the Tribunal in the case of Capital IQ Systems (India) Pvt. Ltd. (ITA No. 1961/Hyd./2011) that the decision of Delhi Bench of Tribunal in the case of CRM Services (I) Pvt.
Ltd. had been followed and the case of Maple E-solutions was excluded from the list of comparables. With reference to this decision ld. DR submitted that it was on account of reputation of Rastogi Group Maple E-
solutions was directed to be excluded and not because of high profit or low profit. He submitted that extra ordinary economic circumstances only warranted exclusion of Maple E-solutions and not the high/low profits.
40. In view of above discussion, we reject the assessee's contention that a comparable is to be rejected merely on the ground of earning abnormally high margin.
41. The third objection of assessee is regarding non-availability of segmented financials. In principle, we are in agreement with ld. Counsel for the assessee that if a comparable is operating in different lines of activities and thus, performing different functions including the functions performed by tested party then the segmental details have to be available so that the results of assessee could be compared with the relevant segmental detail of comparables. This only can make the functional comparability possible. However, as far as FCS Software Solutions Ltd. is concerned, we are of the opinion that the entire range of activity is in the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 25 field of software services and, therefore, this contention of assessee cannot be entertained in this case.
42. The next contention of assessee is that FCS Software Solutions Ltd. has brand value as it undertakes branding efforts by participating in media and industry and event.
43. Ld. DR has objected to this submission on two counts-firstly his submission is that brand/intangible per se does not make any difference and secondly that this claim had not been made in T.P. Study. As regards the first objection, he has relied on the following decision:
• DCIT vs. M/s Deloitte Consulting India Pvt. Ltd., Hyderabad vide ITA No. 1082/Hyd./2010 order dated 22/07/2011 in which in para 36 Tribunal has, inter-alia, observed that the intangibles do not materially affect the profit margin.
44. Similarly in the case of M/s Willis Processing Services (I) Pvt. Ltd. vs. DCIT vide ITA No. 4547/Mum./2012 vide order dated 01/03/2013, the Tribunal had held that where marketing expenditure did not influence the profit margin significantly then on that basis the comparable cannot be excluded. The Tribunal observed in para 45.1 & 45.2 as under:
45.1 "On the objection of the marketing expenditure, we note that marketing expenditure has been shown by this company at Rs. 61,11,240/- which is otherwise not giving material effect on the price or cost charged or paid or profit arising from the operation of that company. Therefore, in the absence of any such factor or criteria provided ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 26 under Rule 10B(2), a comparable cannot be excluded on the ground of marketing expenditure, which is not so material as to influence the profit margin significantly. Further, such a factor, if at all, may be considered for an appropriate adjustment as per Sub Rule 3 of Rule 10B subject to the fulfillment of the conditions provided therein. 45.2 Further, the Delhi Benches of the Tribunal in the case of Actis Advisors P. Ltd. (supra) has considered and decided an identical issue in para 26 as under:
"26. We have heard the rival contentions and gone through the record carefully. On page 24 to 26, ld. TPO has considered this aspect. According to the ld. TPO, the filters applied by the assessee in the TP Study report for eliminating the companies who had incurred expenses of more than 3% of the sales on advertisement and marketing is not an appropriate filter. According to the ld. TPO independent enterprises has to incur marketing expenditure. In a service industries like I.T. enabled services, the assessee did not provide the basis on which such expenses resulted in any intangible unlike in manufacturing industries where substantial marketing expenditure create an intangible. Ld. TPO invited the explanation of the assesseeas to why this filter be not ignored. The assessee has filed a reply to the query of the TPO which has duly been noted by the ld. TPO on pages 24 & 25 of the impugned order. On due consideration of assessee's objections, ld. TPO has observed that the operative force of the assessee's contention is that marketing and advertisement activities carried out ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 27 by the comparable companies result in creation of marketing intangible, which would give return on such investment. In other words, the expenses incurred on advertisement and marketing creates a marketing intangible. Ld. TPO rejected this contention on the ground that such an argument is not based on any substantial analysis. The assessee made reference to WIPRO & Flex Tronic Software System and submitted that these companies have created marketing intangible, therefore, they are earning more profit then any other captive entity. Ld. TPO rejected the contention of the assessee on the ground that 95% of the revenue of Infosys is from repeat business. The marketing intangible did not help Infosys to get any better business according to the ld. TPO. On an analysis of the ld. TPO's order coupled with the contentions of the assessee, we are of the view that ld. TPO has rightly observed that in the case of manufacturing or distribution companies marketing expenses over a period of time may create marketing intangible which will helpful to them for getting better business but it may not be applicable with equal force on service industries like I.T. Enabled Services. The instances of Infosys referred by the assessee has been specifically dealt with by the ld. TPO, he has reproduced relevant portion of the annual report of Infosys on page 25. For buttressing this plea, ld. Counsel for the assessee mainly gave two explanations. In his first reasoning he pointed out that profit ratio of the companies who have incurred expenses less than 3% of the sales is 22.26%. The companies who have incurred expense more than 3% but less than ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 28 5% of the sales on AMP, their profit is 45.52%. Similarly, the companies who have incurred expense on AMP at 5% to 7% of sales, the profit is between 67.46%. These figure have been put from the result of comparable. We have extracted such comparable in para 24 on page 32 of this order. Contrary to this, ld. DR also pointed out that HCL Commet System Services incurred 0.65% of sales on AMP but shown profit at 45.91%. Similarly, Maple E-solution incurred 0.16% and shown profit at 32.06%. Visual Infra-tech did not incur any expenditure but shown profit at 44.15%. Thus, the details referred by the ld. Counsel for the assessee do not advance the case of the assessee. What is the actual impact on the earning of income could not be demonstrated on the basis of these comparative details, graph etc. The next reasoning is that such companies are functionally different. Creation of marketing intangible is brand by incurring such expenses may be helpful in future. But how their FAR is substantially so different could not be explained. Ld. TPO has looked into this aspect. He observed that material showing impact on Information & Technology Industry by such expenses had not been produced by the assessee. After taking into consideration the discussion made by the ld. TPO as well as the DRP on this issue, we do not find any merit in the contentions of ld. Counsel for the assessee for exclusion of eight companies, extracted supra from the list of comparables."
45. As regards second objection ld. DR submitted that this claim had not been made by assessee in its TP Study and, therefore, it cannot be ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 29 made at this stage of proceeding. In this regard, ld. Counsel relied on the decision in the case of M/s Interra Information Technologies India (P) Ltd. vs. DCIT, wherein in para 79 reproduced as under:
79. "On the claim of adjustment of low capacity utilization or in other words, for the idle capacity, we find that in the Transfer Pricing Study the assessee has not made any such adjustment. The assessee follows cost plus method of billing it's AE. It is not known as to how the costs are arrived at. On the utilization of man power, the fact whether there was assured volumes and the decision as to who bears the cost of idle capacity etc. are not stated. In the absence of such details and data, the question of granting adjustment on the ground of idle utilization of capacity does not arise. The findings of the TPO on this issue based on broad parameter are upheld. The assessee is required to support its claim for any adjustment with robust data and full details and evidences so as to enable the TPO to examine the claim. The burden is on the assessee whenever it makes a claim and in this case, it has not discharged the burden of proof. These adjustments are being claimed only when adjustments are proposed by the TPO in an Ad-hoc manner. If the claim was correct, then it should have been made in the T.P. Study itself and not, only to meet the goal of ALP."
46. We have considered the submissions of both the parties and have perused the record of the case.
47. We would first deal with the second objection of ld. DR. In principle, we are not in agreement with the ld. DR on this count. In Transfer Pricing matters the assessee invariably provides current updated margins which were not available at the time of its T.P. Study. ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 30 The entire thrust in such matters is on finding the arm's length price which may as far as possible near to the real price of the transaction. If assessee has not taken note of an important economic factor at the time of T.P. Study, and accordingly, either included/excluded the comparable then it cannot be estopped from furnishing the correct position regarding comparable at any stage of proceedings. However, the assessee will have to substantiate its claim with robust data in this regard. In the case of M/s Stream International Services P. Ltd. (supra) Tribunal in para 16 of its order has observed as under:
16. "Having heard the rival submissions and perused the relevant material on record, we find that the purpose of income tax assessment is to determine correct income of the assessee. As the Revenue cannot allow an assessee to depress his income, in the same manner, it is not permissible to the Revenue to take advantage of the ignorance or mistake of the assessee in offering more than due income. It is trite that no tax can be collected except as per law. Circular No. 14(XI-35) of 1955 dated 1.4.1955 cautions the Officers of the Department from taking advantage of ignorance of an assessee as to his rights. The Hon'ble Bombay High Court in the case of Mirmala L. Mehta vs. A. Balasubramaniam, CIT [2004] 269 ITR 1 has held that there cannot be any estoppel against the statute. Article 265 of the Constitution of India ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 31 clearly provides that no tax shall be levied or collected except by authority of law. Similar view has been taken recently by the Hon'ble Jurisdictional High Court in Sancheti Software and Solutions P. Ltd. vs. CIT (2012) 349 ITR 404 (Bom.). In our considered opinion there can be no escape from the proposition that the assessee is entitled to argue at least before the appellate authorities that a wrong stand taken at the time of filing the return of income should be allowed to be modified. The ld. AR has rightly relied on order passed by the Mumbai Bench of the Tribunal in the case of M/s A.M. Tod Company India Pvt. Ltd. vs. ITO (ITA No. 492/Mum./2006). Vide order dated 24.06.2009, the Tribunal accepted the assessee's contention for exclusion of certain cases which were wrongly included in the Transfer Pricing study but were actually not comparable. It is observed that the Special Bench of the Tribunal in the case of DCIT vs. Quark Systems (P) Ltd.
[(2010 132 TTJ (Chd.) (SB) 1] also allowed the assessee to claim exclusion of certain cases from the list of comparables which were inadvertently included by it in its transfer pricing study. In view of the afore-noted discussion and the ratio of these precedents, we direct the AO/TPO to examine the correctness of the figures placed on record by the assessee in support of its contention that the case of Goldstone Teleservices Limited was wrongly ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 32 included by it in the list of comparables, which is actually not comparable. We want to make it clear that the above discussion made by us considering the figures given by the ld. AR is only for a prima facie ascertainment as to whether this case is passing through the filter chosen by the TPO. The AO/TPO in the fresh proceedings will decide the question of inclusion or exclusion of this case afresh independent of our above observations, albeit keeping in mind the afore-quoted filter of 'Companies whose export revenues are more than 25% of the revenues'."
48. Further in the case of Deputy CIT vs. M/s Quark Systems Pvt. Ltd., the Special Bench of Tribunal observed as under:
30. "Ld. Special counsel for the revenue Shri Kapila has vehemently argued that "Datamatics" was taken as one of the comparables by the taxpayer and no objection to its inclusion was raised before the TPO or before the ld. CIT(Appeals) in appeal.
Therefore, the taxpayer should not be permitted to raise additional ground and ask for exclusion of the above enterprise in the determination of the average margins. We are unable to accept above contention. In the first place, these are initial years of implementation of Transfer Pricing Legislation in India and taxpayers as well as tax consultants were not fully conversant, with this new branch of law when proceedings were initiated or even at appellate stage. Besides, ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 33 Revenue authorities, including TPO were required to apply statutory provisions and consider for purposes of comparison functions, assets and risks (turnover), profit and technology employed by the tested party and other enterprises taken as comparable Statutory duty is cast on them to undertake above exercise. This has not been done in this case. We would only say that prima facie, as per the material, to which reference has been drawn by Shri Aggarwal, Datamatics does not appear to be comparable. Even if the taxpayer or its counsel had taken Datamatics as comparable in its I.P. audit, the taxpayer is entitled to point out to the Tribunal that above enterprise has wrongly been taken as comparable. In fact there are vast differences between tested party and the Datamatics. The case of Datamatics is like that of "Imercius Technologies" representing extreme positions. If Imercius Technologies, has suffered heavy losses and, therefore, it is not treated as comparable by the tax authorities, they also have to consider that the Datamatics has earned extraordinary profit and has a huge turnover.
Besides differences in assets and other characteristics referred to by Shri Aggarwal. The Income Tax Appellate Tribunal is a fact finding body and, therefore, has to take into account all the relevant material and determine the question as per the statutory regulations.
ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 34
3. In the case of CIT vs. Bharat General Reinsurance Co. Ltd. 81 ITR 303, the Hon'ble Delhi High Court, observed as under:
"It is true that the assessee itself had included that dividend income is in return for the year in question but there is no estoppel in the Income Tax Act and the assessee having itself challenged the validity of taxing 'he dividend during the year of assessment in question it must be taken that it had resiled from the position which it had wrongly taken while filing the return. Quit apart from it, it is incumbent on the income tax department to find out whether a particular income was assessable in the particular year or not. Merely because the assessee wrongly included the income in its return for a particular year, it cannot confer jurisdiction on the department to tax that income in that year even though legally such income did not pertain to that year."
32. In the case of R.B. Jessa Ram Fateh Chand vs. CIT 81 ITR 409, it has been found and observed as under:
"Mr. Brijal Gupta appearing for the department pointed out that the assessee itself filed separate returns for the two parts of a single accounting period. The assessee ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 35 applied for registration for the first period only. The assessment for the second period proceeded as against an unregistered firm. It was, therefore, urged by Mr. Gupta that it is not open to the assessee to urge now that a single assessment under section 26(1) ought to have been made. Now, there cannot be an estoppel against statute. If in fact the procedure adopted by the Income-tax Officer was incorrect, the defect is not cured by the attitude taken up by the assessee."
33. In the case of CIT vs. C.Parakh & Co. (India) Ltd. 29 ITR 661, their Lordship of Supreme Court made the following observations:
"On the question of the admissibility of the deduction of Rs. 1,23,719, the contention of the appellant is that as the respondent had itself split up the commission of Rs. 3,12,699/- paid to the managing agents, and appropriated Rs. 1,23,719/- thereof to the profits earned at Karachi and had debited the same with it, it was not entitled to go back upon it, and claim the amount as a deduction against the Indian profits. We do not see any force in this ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 36 contention. Whether the respondent is entitled to a particular deduction or not will depend on the provision of law relating thereto, and not on the view which it might take of its rights, and consequently, if the whole of the commission is under the law liableto be deducted against the Indian profits, the respondent cannot be estopped from claiming the benefit of such deduction, by reason of the fact that it erroneously allocated a part of it towards the profits earned in Karachi. What has therefore to be determined is whether, notwithstanding the apportionment made by the respondent in the profit and loss statements, the deduction is admissible under the law."
34. In the case of CIT vs. V.M.R.P. Firm, Muar (SC) 56 ITR 67, the following observations of their Lordship of Supreme Court are as under:
"The decision in Amarendra Narayan Roy vs. CIT AIR 1954 Cal. 271 has no bearing on the question raised before us. There the concessional scheme tempted the assessee to disclose voluntarily ail his concealed income and he agreed to pay the proper tax upon it. The agreement there related to ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 37 the quantification of taxable income but in the present case what is sought to be taxed is not a taxable income. The assessee in such a case can certainly raise the plea that his income is not taxable under the Act. We, therefore, reject this plea."
35. In para 4.16 of latest report, the OECD provides the following guidelines:
"In practice, neither countries nor taxpayers should misuse the burden of proof in the manner described above because of the difficulties with transfer pricing analysis, it would be appropriate for both taxpayers and tax administrations to take special care and to use restraint in relying on the burden of proof in the course of the examination of a transfer pricing case. More particularly, as a matter of good practice the burden of proof should not be misused by tax administrations or taxpayers as a justification for making groundless or unverifiable assertions about transfer pricing. A tax administration should be prepared to make good faith showing that its determination of transfer pricing is consistent with the arm's length ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 38 principle even where the burden of proof is on the taxpayer, and the taxpayers similarly should be prepared to make good faith showing that their transfer pricing is consistent with the arm's length principal regardless of where the burden of proof lies."
36. The aforesaid decisions and guidelines may not be exactly on identical facts before us but they emphatically show that taxpayer is not estopped from pointing out a mistake in the assessment though such mistake is the result of evidence adduced by the taxpayer.
37. When substantial justice and technical considerations are pitted against each other, the cause of substantial justice deserves to be preferred. For the other side cannot claim to have a vested right in injustice being done due to some mistakes on its part.
38. Accordingly on facts and circumstances of the case, we hold that taxpayer is not estopped from pointing out that Datamatics has wrongly been taken as comparable. While admitting additional ground of appeal raised by the assessee to require us to consider whether or not Datamatics should be included in the comparable, we make no comments on merit except observing that assessee from record has shown it's prima-facie case.
Further claim may be examined by the Assessing ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 39 Officer. This course we adopt as objection to the inclusion of Datamatics as comparable has been raised now and not before revenue authorities.
Therefore, we deem it fit and proper to remit the matter to the file of the Assessing Officer for consideration of claim of the taxpayer and made a denovo adjudication of the arm's length price after providing reasonable opportunity of being heard to the assessee. We order accordingly.
39. We have, however, also noted that the very basis of selection of comparables and application of filters leaves lot to be desired. As we have noted earlier as well, the transfer pricing was in the initial stages in this year and we are inclined to take a rather liberal approach by giving assessee an opportunity to make out its case properly and place all the relevant facts before the tax authorities so that proper arm's length price can be determined in accordance with the law the proceedings before the tax authorities are not adversarial proceedings and the assessee should not therefore be placed at under advantage because of his inadvertent and bonafide mistakes. With this objective in sight, and having no led inconsistencies in selection of compatibles, while we uphold the exclusion of Imercious from comparables, we also deem it fit and proper to remit the matter to the file of the Assessing Officer for adjudication denovo in the light of the above ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 40 observations and in accordance with the law. We direct the assessee to place all the relevant material before the Assessing Officer and/or Transfer Pricing Officer and fully cooperate in expeditious disposal of the matter in accordance with the law. The matter stands restored to the file of the Assessing Officer as such."
49. These decisions clearly fortify the view which we have taken. However, before concluding discussion on this issue, it is necessary to deal with the elaborate submissions advanced by ld. DR with reference to M/s Quark Systems Pvt. Ltd. (Special Bench) decision. In regard to the decision of Spl. Bench in the case of M/s Quark Systems Pvt. Ltd., Ld. DR submitted that in the case of Quark Systems a comparable M/s Data Matrix Technologies Ltd. was chosen by assessee as its own comparable in TP study. No challenge was made before the ld. CIT(A). Before the ITAT, it was pointed out that owing to mathematical mistake, the assessee had taken data matrix as a comparable even when it had 37% related party transactions. It was before the ITAT, that the assessee had noticed the mathematical calculation mistake and had desired that if the mistake was rectified, then this entity, (i.e. M/s Data Matrix) was no more a comparable. Under these circumstances, ITAT had sent the matter back to the TPO for examination of mathematical errors. Therefore, ld. DR submitted that it was never laid down that the assessee can be allowed to take a plea ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 41 that the comparable chosen by it can be treated as a non-comparable even at ITAT's stage. Ld. Counsel submitted that in the case of Quark Systems, the TP report prepared by the assessee was accepted, as against the case of the assessee where it was rejected. Ld. Counsel pointed out that in the TP study, the assessee had taken a comparable Data Matrix Technologies Ltd. while trying to justify its international transactions to be at arm's length. No arguments in this connection were taken before the lower authorities. Before the Spl. Bench for the first time, the assessee by way of an additional ground made a claim that the comparable data matrix was inadvertently considered as a comparable and so requested/prayed that it may now be excluded.
50. Ld. Counsel took us through various paras of ruling to demonstrate that it was not only on account of mathematical mistake but for other reasons also that Tribunal had accepted the assessee's claim of excluding Datamatics from the list of comparables. In this regard ld. Counsel had submitted a note in which it is, inter-alia, stated as under:
Para 9 of the Ruling - As per the para 9 of the Ruling, the Appellant submitted that Datamatics has been wrongly included in the comparables set for "more reasons than one". Thus the Appellant had more than one reason for raising an additional ground before the Hon'ble Special Bench to adjudicate the issue of ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 42 exclusion of Datamatics from the list of comparables accepted by the Appellant and the ld.TPO. The two reasons for the exclusion of the comparable as submitted were:
1) Firstly, there were related party transactions to the extent of 31.27% and so the comparable ought to be excluded;
2) There was an arithmetical error in the computation of profits of Datamatics and the operating expenses of Rs. 579 had not been taken into account while aggregating total expenditure.
Post the correction of such an error, the OP/TC comes out to 138.46% and hence the comparable now deserves to be excluded on the ground of having abnormally high margins.
The above mentioned two reasons were independent and thus, it will not be correct to state the case as has been put forth by the ld. DR in our case that only "owing to the mathematical mistake"; the Appellant had held that Datamatics deserves to be excluded from the final set of comparables.
Further, in the last line of Para 9 the Special Bench held, "In effect, thus, we are also called upon to adjudicate, subject to the admission of this additional ground so raised by the assessee as to whether or not Datamatics should be excluded from comparables."
Further in para 27 also there is an indication that there is more than one mistake which should be ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 43 corrected and should not be allowed to be carried forward.
Para 18 of the Ruling - Reading of the said para of the Hon'ble Special Bench's Order, it is highlighted that the ld. Counsel for Quark pointed out that there were three reasons for the exclusion of Datamatics and they were:
1) Abnormally high margin of 138.46%;
2) Related party transactions of around 31.27%; and
3) Without prejudice to the grounds of the high profitability and RPT, there has been arithmetical inaccuracy.
Para 21 of the Ruling- Para 21 reckons the DR's arguments on the additional ground relating to the exclusion of Datamatics as a comparable. The ld. Counsel for the revenue besides vehemently objecting to the admission of the additional ground also emphatically urged as to why the comparable should not be excluded. The summary of the arguments for non-inclusion are given below:
1) Datamatics was considered as a comparable by the Appellant in the TP study;
2) Tinkering with the comparables at this stage would lead to revisiting and revising the TP study;
3) Arguments/pleas taken by the Appellant now were not taken before the lower authorities.ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 44
Without prejudice to the opposition, the ld. Counsel for the revenue pleaded that the matter should be remitted to the TPO, if Datamatics is not to be considered as comparable."
51. Having heard both the parties, we find that the submissions advanced by the ld. Counsel for the assessee makes it very clear that Spl. Bench in the case of Quark Systems did not merely exclude Datamatics on the ground of arithmetical mistakes but for other reasons also.
52. In view of above discussion, we reject the plea of ld. DR that once in the TP study the assessee has taken a comparable then in subsequent appellate proceedings it cannot relegate from its claim even when it is able to substantiate its claim with robus data for wrongly taking/excluding a particular comparable.
53. Now coming to the first plea of ld. DR in this regard, we find considerable force in the same because unless assessee demonstrates that the revenue's of a comparable were affected by the brand value, the comparable cannot be excluded on that count. This issue is covered by various decisions relied upon by ld. CIT(DR) as noted above.
54. In view of above discussion, we are not inclined to accept the assessee's plea of excluding FCS Software Solutions Ltd. from the list of final comparables.
ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 45
55. The second part of the ground raised by assessee is that TPO erred in including volatile/high profit making companies in the final comparables set for bench marking a low risk captive service provider unit such as the assessee. We have already considered earlier that merely on the ground of high profit margins a comparable cannot be excluded. The assessee's plea is primarily that since it is a low risk captive service provider unit, therefore, it's profit margins are low and it cannot be compared to companies which operate as full fledged risk taking enterprises. The contention of assessee is that it is not taking entrepreneurd risks as it is a captive service provider.
56. Ld. DR submitted that a captive service provider has much more risk to encounter as compared to other entrepreneur who operates in open market.
57. Ld. DR submitted that assessee bears a much bigger market risk with single customer risk as it is wholly dependent on its AE. He submitted that if AE runs out of its business or if AE's business gets reduced substantially the tax payer business will also get adversely affected.
58. We have considered the submissions of both the parties. The TPO has rightly pointed out that in the present case except pointing out various risks, the tax payer has not shown with evidence as to whether each of the risk was actually undertaken by the comparables or not ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 46 and, if so, how these risks affected the profit margins of comparables and whether such adjustment would improve the comparability. In the backdrop of above discussion, this ground is dismissed.
59. Ground no. 3.6 & 3.7 primarily assail the inclusion/exclusion of certain companies on the basis of functions performed, assets employed and risks assumed. In this regard main contention of ld. Counsel for the assessee is that ld. TPO/ DRP have not correctly appreciated the difference in functional profile of companies. He submitted that the distinction has to be kept between the software development service provider and software product company.
60. Ld. Counsel vehemently submitted that a software product company cannot be compared with a pure software service provider. He explained that a software product company undertakes all the steps involved in creating software from domain analysis to testing. In this case, intellectual property belongs to the company. The products are sold generally on license basis, wherein right to use the software is transferred without giving the source code. However, a pure software development service provider imparts a part of the entire software development process. It does not generate any intellectual property for its own. The intellectual property generated belongs to the customer and not to the service provider. With reference to this distinction ld. Counsel submitted that in the case of tested party i.e. the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 47 assessee, a comparable can be selected which is primarily carrying out the functions of a software service provider. He, therefore, submitted that if a comparable is both software product as well as software development service provider then unless the segmental details are available, the company has to be excluded from the list of comparables.
61. We have considered the submissions of both the parties on this count and find considerable force in the argument of ld. Counsel for the assessee because unless there is functional comparability between tested party and the comparable selected, the same cannot be taken as a comparable for bench marking the arm's length price. The arguments of ld. Counsel for the assessee in regard to software product company do not require detailed elaboration. The intellectual property in this case belongs to the company. The company primarily deals in software products per se. Whenever it sells its product it will only grant license to use the software but will not part with the source code. The payment received by this company are the payments for the use of its copyright and, accordingly, taxed as royalty. However, as far as software development service provider is concerned, in our opinion, it imparts twin services- firstly as software developer and secondly as software service provider. As far as software developer companies are concerned they primarily develop the software ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 48 depending upon the need of its clients, which is primarily a customized service. However, a service provider mainly imparts consultancy regarding software. In common parlance, however, this distinction often gets blurred and both are taken as performing similar functions and, therefore, categorized in one category only. Therefore, at least the segmental details in the case of a company which is both software product as well as software development service provider have to be available in respect of both these segments. While selecting the comparables ld. TPO/Ld. DRP in principle were agreeable that software product company cannot be compared with software service provider. This is evident from the fact that TPO while applying the filters had accepted the assessee's filter of rejecting companies undertaking significantly different functions compared to assessee. In para 8(3) of his show cause notice ld. TPO applied following filter stating as under:
"8. However, these are curable defects. This leads us to the next question as to what will be the correct set of filters to be used in your case. Companies in your set were subjected to following filters:
(iii) Select companies where the ratio of service income to total income is at least 75%: The use of this filter is to ensure that we choose companies that are primarily in the service sector. The application of this filter will ensure that companies with significant ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 49 income from manufacturing and trading are not selected. You have argued for placing this threshold at 50%. This will be an inappropriate limit as this will allow companies that have significant incomes from manufacturing and trading activities to be used as comparables. In your case your entire income is from provision of services. It would not be right to allow you to be benchmarked against a company that has 50% of its income from manufacturing or trading activities.
This will ensure integrity of all comparable data."
62. From the above, it is evident that though assessee was claiming the threshold of revenue from service sector at 50% but ld. TPO took it at 75%. This demonstrates that TPO was giving more weightage to functional profile. Therefore, the segmental information about revenue from software services was sine qua non before considering a particular company in the set of comparables. We find that ld. TPO/Ld. DRP have primarily relied upon the information contained in the annual report but the financial statements have not been examined in this regard. The assessee has assailed the inclusion of following comparables on this count:
1) E-Infochips Bangalore Ltd.;
2) E-Infochips Ltd.;
3) Kals Information Systems Ltd. (Seg);
4) Bodhtree ConsultingLtd.;
5) Softsol India Ltd.;
6) Cat Technologies Ltd.;ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 50
7) Goldstone Technologies Ltd.;
8) Infosys Technologies Ltd.;
9) Tata Elxsi Ltd. (Seg).
63. The information contained in Annual Report cannot be taken as sacrosanct unless the same is duly corroborated with the financial statements.
64. We, therefore, restore this issue to the file of AO/TPO for verification of details with reference to financial statements and other relevant documents/information. While examining the aforementioned issue ld. TPO will also examine the abnormal factors, if any, brought to his notice by assesse which was the real cause of high volatility of margins for making necessary adjustments. In view of above discussion, ground nos. 3.6 and 3.7 are allowed for statistical purposes.
65. As far as ground no. 3.8 is concerned regarding risk adjustment, we find that assessee has not quantified the same and, therefore, it has not claimed any risk adjustment. Therefore, this ground is misconceived and, accordingly, dismissed.
66. Vide ground no. 3.9 the assessee has assailed the order of ld. TPO/ld. DRP in denying the working capital adjustment to the operating profit margins of the comparables.
67. Before the ld. TPO it was submitted by assessee that in computing the margins earned by comparable companies, differences on account of working capital employed by comparable viz-a-viz the assessee ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 51 should be factored in order to improve the reliability of the comparable. Therefore, it was submitted that the adjustment is to be made for different levels of accounts receivables, inventory and accounts payable between assessee and the comparable companies.
68. Ld. TPO rejected the assessee's claim observing that the tax payer had not demonstrated that there was a difference in the levels of working capital employed by it viz-a-viz the comparables. Ld. TPO further pointed out that the audited accounts of the tax payer did not show that it had received any advances from its AE's. He further pointed out that the OECD guidelines also mentioned that no adjustment can be allowed in the absence of reliable data. Ld. TPO further pointed out that the issue of adjustment of working capital will be relevant when there is a situation of inventory remaining tied up or receivables been held up. He pointed out that the situation may not be so relevant to the service industry. He further pointed out that the tax payer will launch into a project only when they have been awarded a contract. It is not as if these parties have manufactured goods that await buyers. Thus, ld. TPO concluded that practically there will be no funds logged up in current assets. He, therefore, concluded that no working capital adjustment was required in the case of service industry. Further he pointed out that the tax payer had not been able to demonstrate that the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 52 difference in the working capital employed was making a difference in the margin earned by the tax payer and the comparables.
69. Ld. DRP in principle accepted that for allowing any adjustment for differences in respect of functions, assets and risks etc., as a general rule, the margins of comparables are adjusted to eliminate the effect of such differences on the margins of each comparable rather than adjusting the margins of tested party that is the assessee. Ld. DRP further observed that to carry out the adjustment, the availability of relevant information to accurately identify the difference and then quantify the impact of such difference is a pre-requisite. Ld. DRP further observed that in the present case only the amount of working capital deployed by the comparables on the first and last day of the accounting period was known but there are no means of ascertaining the working capital deployed by the comparable through out the year. Ld. DRP pointed out that the working capital adjustment should be computed on the basis of daily average of working capital deployed by the tested party and each of comparables respectively. Ld. DRP further noticed as under:
"The assessee has taken the average of the amount of working capital deployed by the comparables on the first and last day of the accounting period to compute the working capital adjustment. It is quite probable that daily average is substantially different from the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 53 average of the amount of working capital deployed by the comparables on the first and last day of the accounting period. The adjustment for functional differences etc. is to be allowed only if it can be ascertained with reasonable accuracy which is impossible in this case because of unavailability of relevant data. Therefore, this panel endorses the proposal of the AO to disallow the working capital adjustment claimed by the assessee."
70. Ld. Counsel for the assessee vehemently assailed the findings of ld. DRP in holding that working capital adjustment is to be made on the basis of daily average of working capital deployed by the assessee as well as comparable. He submitted that working capital deployment is to be considered on the first and last day of accounting period and not for through out the year. He submitted that if ld. DRP's observations are accepted then it would become impossible to arrive at any working capital adjustment. Ld. Counsel referred to page 282 and 283 of paper book, wherein arithmetic mean has been computed for making adjustment to the profit margin. Ld. Counsel further submitted that in earlier year adjustment had been allowed.
71. We have considered the submissions of both the parties and have perused the record of the case.
72. Ld. DRP in principle has agreed that working capital adjustment is required to eliminate the influence of working capital differences on the ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 54 margins of each comparable. However, the mode of computation suggested by ld. DRP for computing the working capital difference cannot be sustained. We are in agreement with ld. Counsel for the assessee that the reasoning given by ld. DRP that working capital deployed on daily basis is to be considered, cannot be accepted. The opening working capital deployed and the closing working capital deployed has to be taken into consideration for making any adjustment to the working capital deployed in the case of a comparable. Ld. Counsel pointed out that working capital adjustment was allowed in earlier year.
73. In view of above discussion, we consider it in the interest of justice that the matter be restored back to the file of ld. TPO for making the working capital adjustment to the profit margins of comparables subject, of course, to assessee demonstrating that there was difference in the levels of working capital employed viz-a-viz the comparable.
74. In the result, this ground is allowed for statistical purposes.
75. Ground no. 3.10 is general and, therefore, does not call for any adjudication.
76. Vide ground no. 4 the assessee has assailed the action of ld. DRP and the ld. AO in adding fringe benefit tax paid by the assessee for computing the book profit u/s 115JB of the Act. The AO had disallowed the deduction of fringe benefit tax for the computation of book profit as per sec. 115JB. The assessee relied on the circular no. 8/2005 dated 29th August, ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 55 2005 issued by CBDT clarifying that FBT is an allowable deduction in computation of book profit u/s 115JB of the Act. The AO observed that there is no provision in any of the clause, proviso or explanation of sec. 115JB of the Act to exclude FBT from the profit for the purpose of computing book profit. The assessee's contention was that while computing net profit FBT is to be deducted and in none of the clauses of Explanation 2 to sec. 115JB contemplate for adding back of FBT.
77. We have considered the submissions of both the parties and have perused the record of the case.
78. Ld. DRP has observed in para 15 as under:
15. "Ground No. 12 - the assessee has objected that no opportunity of being heard and to support his claim was provided to it before proposing to add fringe benefit tax ('FBT') to compute book profit under provision of sec. 115JB of the Act. However, this panel has heard the assessee and gone through its submissions on this issue very carefully. Therefore, the grievance of the assessee, i.e., it was not provided an opportunity of being heard by the AO, stands redressed.
Now, coming to the merits of the issue, the clause (a) of the Explanation 1 below sub-section (2) of sec. 115JB clearly states that the amount of income tax paid or payable and the provision therefore, shall be added to the net profit as shown in P&L A/c to arrive at the amount of 'Book profits' for the purpose of sec. 115JB. The term 'tax' is defined in sub-section (43) of sec. 2 of ITA No. 5329/D/2012 - Navisite India Pvt. Ltd. 56 the Act. As per the definition, tax includes Fringe Benefit Tax (FBT) payable u/s 115WA of the Act. It leaves no doubt that book profits for the purpose of sec. 115JB has to be computed after adding the amount of FBT to the profit shown in the P&L A/c prepared by the assessee. Therefore, the panel declines to interfere with the action of the AO in this regard."
79. We do not find any reason to interfere with the order of ld. DRP because as per sec. 115WA Fringe Benefit Tax is an additional income tax and, therefore, it is to be treated at par with Income-tax for computing book profits.
80. In the result, this ground is dismissed.
81. In the result, the assessee's appeal is partly allowed for statistical purposes.
Order pronounced in the open court on 31/05/2013 Sd/- Sd/-
(I.C. SUDHIR) (S.V. MEHROTRA)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated: 31/05/2013
*Kavita
Copy to:
1. Appellant
2. Respondent
3. CIT
4. CIT(A)
5. DR, ITAT, New Delhi.
TRUE COPY
By Order
ASSISTANT REGISTRAR