Income Tax Appellate Tribunal - Delhi
M/S. Opera Solutions Management ... vs Ito, New Delhi on 27 April, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH: 'I-2', NEW DELHI
BEFORE SH. AMIT SHUKLA, JUDICIAL MEMBER
AND
SH. O.P. KANT, ACCOUNTANT MEMBER
ITA No.5761/Del/2014
Assessment Year: 2009-10
M/s. Opera Solutions Vs. Income Tax Officer,
Management Consulting Ward -13(4), New Delhi
Services Pvt. Ltd.,
6th Floor, Express Trade
Tower-1, Wing B, Plot No. 15-
16, Sector -16A, Noida
PAN : AABFO4383R
(Appellant) (Respondent)
Appellant by Sh. Anil Bhalla, CA
Respondent by Sh. Sanjay Kumar Yadav, Sr.DR
Date of hearing 27.03.2018
Date of pronouncement 27.04.2018
ORDER
PER O.P. KANT, A.M.:
This appeal has been preferred by the assessee against the order dated 19/08/2014 passed by the Ld. Commissioner of Income-tax (Appeals)-XX, New Delhi [in short 'the Ld. CIT(A)' ] for assessment year 2009-10 raising following grounds:
1) The learned commissioner of Income Tax (Appeals) has erred both on facts and in law in making an addition of Rs.
2,27,84,888/- (being 29.96% of the total cost of the international transactions amounting to Rs.13,93,90,892/- as the mean arm's length margin of comparables) in respect of software development services representing the alleged 2 ITA No. 5761/Del/2014 AY: 2009-10 difference in Arm's Length Price (ALP) of the international transactions as returned by appellant company.
1.1.The learned Commissioner of Income Tax (Appeals) has erred both on facts and in law in enhancing the income of appellant company without providing sufficient opportunity of being heard as provided in sub section (2) of section 251 of the Income tax Act, 1961 which is against the principal of natural justice.
2) The learned Commissioner of Income Tax (Appeals) has erred both on facts and in law in upholding the action of Ld Transfer Pricing officer in rejecting the quantitative and qualitative filters applied by the appellant company for the purpose of selecting comparables in its Transfer Pricing study and arbitrarily selecting the quantitative and qualitative filter for selecting comparables which were functionally different from the appellant company.
3) The learned commissioner of Income Tax (Appeal) has erred both on facts and in law in not correctly analyzing the characteristic of the functions performed, assets employed and risk assumed (herein after referred to as FAR analysis) while making exclusions out of final set of comparables for determining means of Arm's length price of comparables.
4) The learned Commissioner of Income Tax (Appeals) has erred both on facts and in law in rejecting the entitlement of assessee for downward adjustment in margins on the basis of risk adjustments.
5) The learned Commissioner of Income Tax (Appeals) has erred both on facts and in law in confirming the action of the learned Transfer Pricing Officer in excluding foreign exchange gain from operating profit while calculating the margin of comparables allegedly on the ground that the same is not operating income.
6) The learned Commissioner of Income Tax (Appeals) has erred both on facts and in law in confirming the action of the learned Transfer Pricing Officer in selecting consolidated 3 ITA No. 5761/Del/2014 AY: 2009-10 financial results as against stand alone financials of the comparables for computing the margins of the comparable companies.
7) The appellant craves leave to add, alter or amend the ground of appeal at a later stage.
2. Briefly stated facts of the case are that the assessee company was engaged in business of software development and Information Technology enables services (ITes). For the year under consideration, the assessee filed return of income on 30/09/2009, declaring total income of Rs.2,97,078/-. The case was selected for scrutiny and notice under section 143(2) of the Income-tax Act, 1961 ( in short the 'Act') was issued and complied with. In scrutiny proceedings, the Assessing Officer noted the International transactions of providing software development and information technology enabled services to its Associated Enterprises (AEs), which being more than threshold of Rs. 15 crores, he referred determination of arm's length price of the International transaction to the Ld. Transfer Pricing Officer (TPO). The Ld. TPO in his order under section 92CA of the Act dated 24/01/2013 proposed adjustment of Rs.2,21,71,569/- to the transaction. The Assessing Officer after incorporating the transfer pricing adjustment and other disallowances i.e. disallowance of deduction under section 10A and excess claim of depreciation of UPS, issued draft assessment order dated 18/03/2013, assessing total income at Rs.4,28,60,350/-. As the assessee did not either file acceptance of the variations proposed by the Assessing Officer or file objections, if any, to such variations before the Ld. Dispute Resolution Panel (DRP) and, thus, the Assessing Officer passed 4 ITA No. 5761/Del/2014 AY: 2009-10 final assessment order under section 143(3) read with section 144C of the Act on 21/05/2013 assessing the total income at Rs.4,28,60,350/-. Aggrieved, the assessee filed appeal before the Ld. CIT(A) who partly allowed the appeal of the assessee. Aggrieved, the assessee is in appeal before the Tribunal raising the grounds as reproduced above.
3. In the grounds raised, the assessee has challenged Transfer Pricing Adjustment of Rs.2,27,84,888/- sustained by the Ld. CIT(A).
3.1 The brief facts leading to the transfer pricing adjustment are that in its transfer pricing study the assessee claimed it to be a captive service provider and provided services of software development and information technology enabled services to its Associated Enterprises (AEs). The assessee reported international transaction as under:
S. No. Nature of Transaction Method used Amount by assessee
1. Provision of Software TNMM 18,02,79,259 Development and IT enabled Services Total 18,02,79,259 3.2 For benchmarking the International transaction, the assessee chosen Transactional Net Margin Method (TNMM) as the most appropriate method, taking Operating Profit/Total Cost (OP/TC) as Profit Level Indicator (PLI) . The assessee selected 14 comparables and worked out arithmetic mean of the PLI of the comparables at 13.92% using multiple year data. The PLI of the assessee company was worked out at 14.89% , which being more 5 ITA No. 5761/Del/2014 AY: 2009-10 than the average PLI of the comparables, the assessee treated the price charged to International transaction at arm's length. The list of comparables selected by the assessee is reproduced as under:
SI. No Name of comparable OP/TC
Akshay Software Technology 8.95
1.
Ltd.
2. Apex Knowledge 12.93
3. Bodhtree Consulting 21.45
4. CAT Tech 12.69
5. Sagar Soft 17.12
6. Softsole 18.06
7. Synetalros Technology 17.16
8. Tutis Technology 16.27
9. VMF Softtech 5.03
10. Zylog Systems India ltd- 2.34
11. Bells Soft 22.73
12. eZest Solutions 29.61
13. Maars Software 0.41
14. FSL Software 10.18
Arithmetic Mean 13.92%
3.3 According to Ld. TPO, the operating profit margin or the PLI of the assessee was not correctly computed. The assessee considered a sum of Rs.17,74,591/- being difference in foreign exchange fluctuation as part of operating income. According to the Ld. TPO, the receipts/expenditure in foreign currency are booked at the time of transaction at prevalent foreign exchange rate, whereas at the time of actual receipt or payment the foreign-
exchange received/paid is converted into Indian currency, which may result into forex gain/loss due to variation in that exchange rate as compared to the exchange rate on the date of transaction. The Ld. TPO observed that forex loss/gain and cost incurred for 6 ITA No. 5761/Del/2014 AY: 2009-10 hedging the same would depend on the risk management policy of each company and, therefore, it was advisable to exclude forex gain/loss and hedging cost/premium from operating cost/income of the tested party as well as comparables while computing the PLI for the purpose of determination of arm's length price, which would lead to a consistent and reliable basis for comparison, based purely on operational consideration. In view of the observation, the Ld. TPO excluded foreign-exchange fluctuation from the operating income and computed the operating profit margin (OP/TC) of the assessee company at 13.61% as under:
Particulars Amount (Rs.)
Income:-
Income from services rendered 18,02,79,259 Less:- Reimbursement on actual (2,19,11,744) included in income Total Operating Income 15,83,67,515 Expenses:-
Total Expenses 16,39,25,173 Less:- Reimbursement included (2,19,11,744) in cost Less:- Assets W/o (25,48,738) Less:- Interest Expenses (73,799) (Grouped under other expenses) Total operating cost 13,93,90,892 Operating profit 1,89,76,623 OP/OC 13.61% 3.4 The Ld. TPO issued show cause proposing other comparables and after considering the submission of the assessee, he finally selected 12 comparables and worked out their 7 ITA No. 5761/Del/2014 AY: 2009-10 operating margin excluding for exchange gain/loss. The average margin of the comparables was worked out it 29.52%. The list of comparables finally selected by the Ld. TPO is as under:
Sl. No. Company Name OP/TC
(W/o Fx)
1. Aricent Tech 25.76
2. Bodhtree Consul. 69.80
3. Cat Tech. 34.43
4. KPIT Infosys. 21.56
5. L & T Infortech 21.33
6. Mindtree 27.36
7. Persistent Sys 37.77
8. R S Software (I) 10.15
9. Tata Elxsi 16.88
10. Tech Mahindra 35.35
11. Thinksoft Global 16.56
12. Tirdware Sol 37.27
29.52
3.5 The Ld. TPO, computed adjustment of Rs.2,21,71, 569/-as under:
Operating Cost 13,93,90,892
OP/TC 29.52%
Margin 4,11,48,192
Arm's Length Price 18,05,39,084
Price Charged by the assessee 15,83,67,515
?Difference 2,21,71,569
% of difference with the International 14.00%
Transaction
3.6 The Ld. CIT(A) directed the Ld. TPO to exclude M/s Persistent Systems Ltd and M/s Tata Elexi Ltd (seg.) from the final set of comparables and compute the adjustment after reworking the average margin of comparables.
8 ITA No. 5761/Del/2014AY: 2009-10 3.7 Before us, the Ld. counsel of the assessee submitted that the comparables M/s Aricent Technologies (holding) Ltd, M/s Bodhtree Consulting Ltd., M/s CAT Technologies Ltd., M/s KPIT Cumins Infosystems Ltd., M/s TechMahindra Ltd. and M/s Thirdware Solutions Ltd. are not comparables due to different reasons and excluding those comparables, would bring the PLI of the assessee in the plus minus range of 5% of the average PLI of the remaining comparables and in that situation, no adjustment would be required in the case of the assessee. In view of the arguments of the Ld. counsel, Accordingly, the issue of excluding or retaining above companies in the final set of comparables is adjudicated as under:
Aricent Technologies (holding) Ltd:
4. Before us, the Ld. Counsel submitted that the Ld. TPO has applied the Related Party Transactions (RPT) filter of more than 25% for excluding the companies from the set of comparables and the company is having RPT more than 27.06 % as per page 27 to 30 of the Paper Book, Volume-II. He submitted that this fact has been noted by the Ld. TPO himself, on page 49 of his order. The Ld. counsel, accordingly prayed for excluding the above company on the ground of RPT filter. He further referred to page 6 of the Paper Book, Volume- II and submitted that the company was engaged in diversified business activities including LTE (Long Term Evolution), multimedia applications, broadband networks, wireless technologies with packaged software sale. He further submitted that no separate segment for software development 9 ITA No. 5761/Del/2014 AY: 2009-10 services is available in Annual Report of the company. He also submitted that during the year under consideration there is an extraordinary event of amalgamation with Flextronics Software System Ltd. and future software and due to which margin of the company has tripled. The Ld. counsel submitted that the Ld. TPO has relied upon the consolidated results including subsidiaries with different geographical location and functional activity for comparison with the assessee.
4.1 The Ld. DR, on the other hand, submitted that related party transactions in the case of the company are approximately 24%, which is less than the RPT filter of 25% applied by the Ld. TPO. He also submitted that amalgamation occurred in the earlier year and not in the year under consideration and, therefore, there is no extra ordinary event in the year under consideration affecting the margin of the company.
4.2 We have heard the rival submissions and perused the relevant material on record. On perusal of page 18 of the Annual Report of the company, we find that sales of the company consist of software product amounting to Rs.127,38,34,261/- and software services of Rs.11,50,88,79,710/-. Thus, it is evident that company is engaged in the sale of software products as well as sale of software services, but no separate segment result for software services are available and, thus, the company cannot be compared with the assessee at the entity level. In our opinion, the company is liable to be excluded only on this reason 10 ITA No. 5761/Del/2014 AY: 2009-10 alone. Accordingly, we direct the Ld. AO/TPO to exclude this company from set of the comparables.
Bodhtree Consulting Ltd.
5. The Ld. counsel submitted that the company was engaged in providing other solutions in addition to the software development and due to those activities, the company was functionally dissimilar. Further, he referred to page 25 of the Annual Report and submitted that revenue recognized from software development is recognized based on software developed and billed to client. Accordingly, the Ld. counsel submitted that profitability results do not properly match expenses with revenue and thus it loses creditability for making logical comparison. The Ld. counsel also referred to the volatility in the profit of the company in earlier years ranging from 13.91% in March ending 2006 to 69.80% in March ending 2009. The Ld. counsel also relied on the decision of Tribunal Delhi Bench in the case of Ciena India (P) Ltd. (2015) 59 taxmann.com 92 .
5.1 The DR, on the other hand, submitted that the company is having revenue earning only from the export and domestic sales of the software services, as evident from the profit and loss account of the company for the year ending March, 2009. He referred to the Director's report available on page 12 of the Annual Report and submitted that it is clearly mentioned that the company has only one segment, namely, software development and being a software solution company, it is engaged in providing open and end-to-end web solutions, 11 ITA No. 5761/Del/2014 AY: 2009-10 off-shoring data management, data warehousing, software consultancy, and design and development solutions, using the latest technologies. According to him, these are the different product categories, in which the assessee is engaged in software development and, therefore, company is comparable at entity level with the assessee. He submitted that assessee is also characterized as software development and ITes, and, thus, it is fully comparable with the company. As far as the impact of revenue recognition from software development services on the profit margin is concerned, the Ld. DR submitted that the Ld. counsel of the assessee has not demonstrated, whether the work in progress expenses on software development are included in financial statements or not and, therefore, he requested that this issue may be restored to the Ld. TPO/AO for verification of the facts. 5.2 We have heard the rival submission and perused the relevant material on record. On perusal of profit and loss account and Director's report of the company, as available on page 19 and page 12 of the Annual Report, we find that the company is engaged only in the software development and, thus, it is functionally similar to the assessee company. On the issue of accounting entries of revenue recognition from the software development and consequent impact on profit margin of the company is concerned, we are of the opinion that this issue need verification by the Ld. TPO/AO and thus, we restore this matter to the file of Ld.TPO/AO for verification of impact of revenue recognition accounting entries on profit margin of the company and decide the comparability 12 ITA No. 5761/Del/2014 AY: 2009-10 accordingly after providing due opportunity of being heard to the assessee.
CAT Technologies Ltd.
6. The Ld. counsel submitted that the company was engaged in diversified business activities of information technology infrastructure, IT staffing services, 3-D animation, game development, Web development. H also referred to page 112 of the paper book, Volume II, and submitted that company was engaged in software development as well as consulting services and there being no separate segment of software development, the company is liable to be excluded from the set of comparables. He further submitted that company has been excluded by the Tribunal from the set of the comparable in the case of Agilis Information Technologies International (P) Ltd (2007) 88 taxmann.com 6. 6.1 On the other hand, the Ld. DR opposed exclusion of the above company and submitted that primarily the company is engaged in software development only and, thus, it is functionally similar to the assessee. 6.2 We have heard the rival submission and perused the relevant material on record. On perusal of the page 36 of the Annual Report of the company (available on page 108 of the PB II), we find that income from operations consist of 3 streams as under:
13 ITA No. 5761/Del/2014AY: 2009-10 training income Rs.2,44,107 software development and Rs.8,49,39,375 consulting services Medical transcription receipts Rs.83,74,194 6.3 From the above streams of revenue, it is manifested that the assessee is having revenue earnings from consulting services along with software development. The consulting services are functionally different from software development services and, therefore, the company cannot be compared at entity level with the assessee. In view of the non-availability of segment result of software development, the company is held to be functionally dissimilar at entity level and, accordingly, we direct the Ld. TPO/AO to exclude the company from the set of comparable.
KPIT Cummins Infosystems Ltd.
7. The Ld. counsel referred to page 49 of the order of the Ld. TPO and submitted that the company is having Related Party Transactions (RPT) of around 98.87% and, thus, in view of the RPT filters applied by the Assessing Officer, the company needs to be excluded from the set of the comparables.
7.1 The Ld. counsel, on the other hand, relied on the finding of the Ld. TPO and the Ld. CIT(A).
7.2 We have heard the rival submission and perused the relevant material on record. There is no dispute on the fact that related party transactions in the case of company are 98.87 %. In view of this fact alone, the financial results of the 14 ITA No. 5761/Del/2014 AY: 2009-10 company cannot be compared with the assessee. Accordingly we direct the Ld. TPO/AO to exclude this company from the set of the comparables.
TechMahindra Ltd.
8. The Ld. Counsel of the assessee submitted that the company is having 74.23% of the transactions as Related Party Transactions (RPT) and, thus, alone on this ground, the company is liable to be excluded from the set of comparable. 8.1 The Ld. DR, on the other hand, relied on the order of the law authorities.
8.2 We have heard the rival submission and used the relevant material on record. We have already excluded the company KPIT Cummins Infosystems Ltd. on the ground of RPT more than 25% i.e. a filter deployed by the Ld. TPO and, thus, to have the consistency in decision, we direct the Ld. TPO/AO to exclude the company M/s TechMahindra from the set of comparable.
Thirdware Solutions Ltd
9. The Ld. counsel referred to page 297 of the paper-book and submitted that the company also sells software products and license along with export of services and, therefore, in absence of any segmental result for software development services, the company cannot be compared with the assessee at entity level.
9.1 The Ld. DR relied on the finding of the lower authorities.
15 ITA No. 5761/Del/2014AY: 2009-10 9.2 We have heard the submission of the rival parties and perused relevant material on record. The detail of the sales of the company in the year under consideration are available on page 285 of the Paper Book, Volume II, which are reproduced as under:
Schedule 12: Sales As on 31.03.09 As on 31.03.08 Total Sale of Licence 23,237,588 3,916,427 Software Services 89,177,023 76,724,371 Export from SEZ Unit 478,572,420 263,971,033 Export from STPI Unit 162,900,630 168,863,049 Revenue from Subscription 16,433,714 9,293,874 770,321,375 522,768,754 9.3 It is evident from the above detail that the revenue streams of the company consist from sale of license and revenue from subscription along with software services and export of services. The activity of sale of license and subscription are functionally different from the activity of software development or software services. We find that no segment result for software development/services are available in the case of company, and, therefore, it cannot be compared with the assessee at entity level. Accordingly, we direct, the Ld. TPO/AO to exclude this company from the set of comparable.
10. No other comparables were argued for exclusion or inclusion to the set of comparable. The issue of excluding foreign exchange gain from the operating profit was also not argued specifically.16 ITA No. 5761/Del/2014
AY: 2009-10
11. In view of above direction for excluding the comparables, the learned TPO/AO is directed to re-compute the average margin of comparable finally selected and make the adjustment to the International Transaction, if required so.
12. Accordingly, the grounds raised by the assessee challenging the transfer pricing adjustment are allowed partly for statistical purposes.
13. In the result, the appeal of the assessee is allowed partly for statistical purposes.
The decision is pronounced in the open court on 27th April, 2018.
Sd/- Sd/-
(AMIT SHUKLA) (O.P. KANT)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated: 27th April, 2018.
RK/-(D.T.D)
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(A)
5. DR
Asst. Registrar, ITAT, New Delhi