Income Tax Appellate Tribunal - Bangalore
Magma Design Automation I P Ltd, ... vs Deputy Commissioner Of Income Tax,, ... on 28 February, 2017
IT(TP)A.1279/Bang/2014 Page - 1
IN THE INCOME TAX APPELLATE TRIBUNAL
BENGALURU BENCH 'B', BENGALURU
BEFORE SHRI SUNIL KUMAR YADAV, JUDICIAL MEMBER
AND
SHRI. S. JAYARAMAN, ACCOUNTANT MEMBER
I.T(TP).A No.1279/Bang/2014
(Assessment Year : 2009-10)
Magma Design Automation India P. Ltd,
(Now merged with Synopsys (India) P. Ltd),
RMZ Infinity, Tower A, 5thfloor, Municipal No.3,
Old Madras Road, Benniganahalli,
Bengaluru .. Appellant
PAN : AADCM4542M
v.
Deputy Commissioner of Income Tax,
Circle - 12(1), Bengaluru .. Respondent
Assessee by : Shri. Nageshwar Rao, Advocate
Revenue by : Ms. Neera Malhotra, CIT-DR
Heard on : 26.12.2016
Pronounced on : 28.02.2017
ORDER
PER S. JAYARAMAN, ACCOUNTANT MEMBER :
This appeal is filed by the assessee against the order passed by the CIT (A) -IV, Bengaluru dt.12.08.2014, for the assessment year 2009-
10.
02. Magma Design Automation India Private Limited, the assessee , is a subsidiary of Magma Design Automation Inc, USA during a y 2009- 10 , engaged in providing software development -services, customer IT(TP)A.1279/Bang/2014 Page - 2 support services ("CSS") and sales support services to its Associated Enterprises for which it is remunerated on a cost plus basis. It operates from 3 units, Bangalore (STP unit claiming deduction u/s10(A), Noida (SW unit claiming deduction u/s 10A) and Mumbai (non STP unit).
03. The facts, in brief ,relevant to this appeal are that for the a y 2009-2010, the assessee filed its return on 30 September 2009, declaring a taxable income of Rs. 391,81,690 under the normal provisions . On a reference to the TPO, the, TPO passed an order dated 8th January 2013 determining an adjustment of Rs.5,46,76,721 & Rs. 1,15,99,315 in respect of the software development services & the CSS transactions, respectively. Thereafter, the AO has considered the ALP determined by the TPO and passed an order which resulted in an addition of Rs.6,62,76,036 to the total income of the assessee. The assessee challenged this order before the CIT (A), inter alia, on functional dissimilarity of comparables and on working capital adjustment on both segments but could not succeed. Aggrieved against the CIT (A) order, it filled this appeal with the following grounds :
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04. Additional grounds : Subsequently, the assessee filed additional grouds as under :
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04. The AR of the assessee submitted that there are two segments viz Software Services and ITEs or Customer Support Services having a turnover of Rs.49.34 & 9.89 Crores , respectively , and the corresponding operative net margin is 12.91% & 15.69% . With regard to the first segment, ie on Software Services, the AR submitted that out of 21 comparables chosen by the assessee, the TPO retained only 8 of them and introduced another 3 comparables. Out of which, the assessee is seeking exclusion of 5 comparables on functional dissimilarity and seeks correction in the margin computation of two comparable viz Sasken Communications Services Ltd & Larson and Toubro Infotech Ltd . It is further submitted that 4 comparables chosen by it were erroneously rejected by the TPO and hence pleaded to include them as comparables. The assessee placed reliance on its own case for a y 2007-08 in ITA No.1214/Bang/2011 dt 29.8.2016, Infinera India P. Ltd in IT(TP)A.No.977(Bang)2014 for ay 2009-10 dt 30.6.2016, NXP Semi Conductors in IT(TP)A.1634/Bang/2014 dt 22.7.2015 for ay 2009-10, Cisco systems India P Ltd in IT(TP)A.27/Bang/2014 dt 14.8.2014 etc.
05. We have heard the rival submissions, gone through relevant; orders, Charts, annual reports and material in the paper books. In its own case for a y 2007-08, this Tribunal in ITA No.1214/Bang/2011 dt 29.8.2016, inter alia, excluded M/s Infosys Tech. Ltd , M/s Persistent systems Ltd., M/ Tata Elxsi Ltd and M/s Kals Information Systems Ltd. Further, this Tribunal in the case of Infinera India P. Ltd, which was doing contract Software Development services to its AEs , in IT(TP)A.No.977(Bang)2014 for ay 2009-10 dt 30.6.2016, excluded 5 comparables on functional dissimilarity. The relevant portion of the order is extracted as under :
IT(TP)A.1279/Bang/2014 Page - 7
11.
..................................................................................................................
.............................................................................. He submitted a chart as per which the assessee is requesting for exclusion of certain comparables as noted hereunder;
Sl. No. Name of the Co. PLI %age Basis for seeking exclusion.
1.M/s Kals Information Systems Ltd., 13.89 Functional Dissimilarity
2. M/s Bodhtree Consulting Ltd., 62.27 "
3. M/ Tata Elxsi Ltd., 20.28 "
4. M/s Persistent systems Ltd., 41.40 "
5. M/s Infosys Tech. Ltd., 45.61 "
In addition to this, the assessee has also requested in the chart for consideration of correct operating margin in the case of M/s Sasken Communication Tech Ltd., and M/s Larsen & Toubro infotech Ltd.
12. Regarding the first aspect i.e. exclusion of some comparables on the basis of functional dissimilarity we deal this issue company wise as under;
1) M/s Kals Information Systems Ltd., For exclusion of this company, reliance has been placed on the Tribunal order rendered in the case of M/s Onward technologies Ltd., Vs DCIT as reported in 26 ITR (Trib) 734(ITAT, Mum.). It was pointed out that copy of the judgment is available on pages 1 to 19 of the Case Law Compendium and our attention was drawn to para no.23 of this Tribunal order. Ld. DR of the revenue supported the order of the authorities below.
13. We have considered rival submissions. We find that in para-23 of this Tribunal order, cited by the ld.AR of the assessee i.e. in the case M/s Onward technologies Ltd., Vs DCIT (Supra), it is noted by the Tribunal that this company i.e. M/s Kals information Systems Ltd., functions in the field of consultancy, information provider and general insurance sector. In the present case, the assessee company is providing software development services to its AE who is engaged in business of software products as well as of optical net working equipment to telecommunication provider and therefore, it has to be accepted that there is functional dissimilarity because, the assessee is not engaged in general insurance sector as Kals Information System. In the same chart, the assessee also placed reliance on the Tribunal order rendered in the case of M/s Cisco Systems (Ind.) Pvt.Ltd., in IT(TP)A No.271(Bang/2014. Copy of the order is available on pages 82 to 142 of Case Law Compendium. In particular, our attention was drawn to para-
26.3 of the order on pages 101 to 103. In this case, the Tribunal has followed another Tribunal order rendered in the case of M/s Trilogy e-business Software India Pvt. Ltd., [ITA No.1054(Bang)/2011]. Copy available on pages 20 to 81 of the paper book.
14. The ld. DR of the revenue could not point out any difference in facts in the present case and in these cases of the Tribunal orders and therefore, respectfully following these Tribunal orders, we direct the AO/TPO to exclude these companies from the final list of comparables.
IT(TP)A.1279/Bang/2014 Page - 8
2. M/s Bodhtree Consulting Ltd., For exclusion of this company also, reliance has been placed on the same Tribunal order rendered in the case of M/s Cisco Systems (Ind.) Pvt.Ltd.,(Supra) and in particular, our attention was drawn to para-26.1 available on page no.98 to 99 of Case Law Compendium. In this case, it is noted by the Tribunal that this company is in the business of software product and was engaged in providing open and end to end web solutions software consultancy and design and development of software using latest technology and therefore, the same cannot be considered as a comparable in the case of companies rendering software development services, as in the present case. Therefore, by respectfully following this Tribunal order, we hold that this company is also excluded from the list of final comparables.
3. M/s Tata Elxsi Ltd., For exclusion of this company also, reliance has been placed on the same Tribunal order rendered in the case of M/s Cisco Systems (Ind.) Pvt.Ltd.,(Supra) and our attention was drawn to para- 26.4 to 26.5 of the order available on pages 103 to 105 of the case law compendium. For the sake of ready reference these paras are reproduced hereunder;
"26.4 Tata Elxsi Ltd.:- As far as this company is concerned, it is not in dispute before us that in assessee's own case for the A.Y. 2007-08, this company was not regarded as a comparable in its software development services segment in ITA No.1076/Bang/2011, order dated 29.3.2013. Following were the relevant observations of the Tribunal:-
II. UNREASONABLE COMPARABILITY CRITERIA : The learned Chartered Accountant pleaded that out of the six comparables shortlisted above as comparables based on the turnover filter, the following two companies, namely (i) Tata Elxsi Ltd; and (ii) M/s. Flextronics Software Systems Ltd., deserve to be eliminated for the following reasons :
(i) Tata Elxsi Ltd., : The company operates in the segments of software development services which comprises of embedded product design services, industrial design and engineering services and visual computing labs and system integration services segment. There is no sub-services break up/information provided in the annual report or the databases based on which the margin from software services activity only could be computed. The company has also in its response to the notice u/s.133(6) stated that it cannot be considered as comparable to any other software services company because of its complex nature. Hence, Tata Elxsi Ltd., is to be excluded from the list of comparables.
(ii) Flextronics Software Systems Ltd. : The learned TPO has considered this company as a comparable based on 133(6) reply wherein this company reflected its software development services revenues to be more than 75% of the "software products and services" segment revenues. Flextronics has a hybrid revenue model and hence should be rejected as functionally different. Based on the information provided under "Revenue recognition" in its annual report, it can be inferred that the software services revenues are earned on a hybrid revenue model, and the same is not similar to the regular models adopted by other software service providers. The learned representative pleaded that a regular software services provider could not be compared to a company having such a unique revenue model, wherein the revenues of the company from software/product development services depends on the success of the products sold by its clients in the marketplace. Hence, it would be inappropriate to compare the business operations of the assessee with that of a company following hybrid business model comprising of royalty income as well as regular software services income, for which revenue break-up is not available. He finally submitted that this was a good reason to exclude this company also from the list of comparables.
IT(TP)A.1279/Bang/2014 Page - 9
20. On the other hand, the learned DR supported the order of the lower authorities regarding the inclusion of Tata Elxsi and Flextronics Software Systems Ltd., in the list of comparables. He reiterated the contents of para 14.2.25 of the TPO's order.
He also read out the following portion from the TPO's order :
"Thus as stated above by the company, the following facts emerge :
1. The company's software development and services segment constitutes three sub-segments i) product design services; ii) engineering design services and iii) visual computing labs.
2. The product design services sub-segment is into embedded software development. Thus this segment is into software development services.
3. The contribution of the embedded services segment is to the tune of Rs.230 crores in the total segment revenue of Rs.263 crores. Even if we consider the other two sub-segments pertain to IT enabled services, the 87.45% (›75%) of the segment's revenues is from software development services.
4. This segment qualifies all the filters applied by the TPO."
Regarding Flextronics Software Systems, the following extract from page 143 of TPO's order was read out by him as his submissions :
"It is very pertinent to mention here that the company was considered by the taxpayer as a comparable for the preceding assessment year i.e., AY 2006-07. When the same was accepted by the TPO as a comparable, the same was not objected to it by the taxpayer. As the facts mentioned by the taxpayer are the same and these were there in the earlier FY 2005-06, there is no reason why the taxpayer is objecting to it. How the company is functionally similar in the earlier FY 2005-06 but the same is not functionally similar for the subsequent FY 2006-07 even when no facts have been changed from the preceding year. Thus the taxpayer is arguing against this comparable as the company was not considered as a comparable by the taxpayer for the present FY 2006-07."
21.We have heard the rival submissions and considered the facts and materials on record. After considering the submissions, we find that Tata Elxsi and Flextronics are functionally different from that of the assessee and hence they deserve to be deleted from the list of six comparables and hence there remains only four companies as comparables, as listed below:"
26.5. Following the aforesaid decision of the Tribunal, we hold that M/S.Tata Elxsi Ltd. should not be regarded as a comparable".
15. Since ld. DR of the revenue could not point out any difference in facts, respectfully following these Tribunal orders, we direct the AO/TPO to exclude this company also from the list of final comparables.
4. Persistent Systems Ltd., For exclusion of this company, reliance has been placed on the Tribunal order rendered in the case of M/s Unisys India Pvt.Ltd., in IT(TP)A No.67(Bang)/2015, copy available on pages 210 to 246 of case law compendium and in particular, our attention was drawn to para 36 to 37 of the Tribunal order. These paras are reproduced as under:-
"36. As far as Persistent Systems Ltd. a comparable by the assessee in his TP study but was objected by the assessee before the TPO as not comparable, this Tribunal in the case of IT(TP)A No.108(Bang)/21014 order dated 12-12-2014 in the case of Yodlee Infotech Pvt. Ltd. Vs ITO held as follows:
"5.12............... This Tribunal in the case of 3DPLM Software Solutions Ltd., Vs DCIT (IT(TP)A No. 1303(Bang)/2012 dated 28-11-2013) has also held that Persistent IT(TP)A.1279/Bang/2014 Page - 10 Systems Pvt.Ltd., was in product designing services and into software product development. In the same decision it was also held that M/s Infosys Technologies Ltd., had considerable intangibles like IPR, and was also into software product development. It was also held that M/s Tata Elxsi Ltd., was developing niche products and into product designing services. Hence, these companies would in any case have to be excluded from the comparables being functionally different".
37. Following the said decision, we direct that Persistent Systems Ltd., be excluded from the final list of comparable companies chosen by the TPO".
The ld. DR of the revenue supported the orders of the authorities below.
16. We have considered the rival submissions. We find that in this case, the Tribunal has followed another Tribunal order rendered in the case of M/s Yodlee Infotech Ltd., Vs ITO in IT(TP)A No.108(Bang)/2014. The relevant portion of that Tribunal order is reproduced above and as per the same, this company i.e. M/s Persistent Systems Ltd., was in product designing services and into software product development. Since the present assessee company is only providing software development services to the AE, this company cannot be considered as a comparable in the present case. Since the ld. DR of the revenue could not point out any difference in facts, by respectfully following this Tribunal order, we direct the AO/TPO for exclusion of this company from the final list of comparable.
5. M/s Infosys Technologies Ltd., For exclusion of this company, reliance has been placed on the judgment of the Hon'ble Delhi High Court rendered in the case of M/s Aginity India Technologies Pvt.Ltd., in ITA No.1204/2011 dated 10-07-2013 and in particular, our attention was drawn to para-6 of the judgment as available inpage- 386 of the case law compendium and the same is reproduced hereunder:-
" 6. Learned counsel for the revenue has submitted that the Tribunal after recording the aforesaid table has not affirmed or given any finding on the differences. This is partly correct as the Tribunal has stated hat Infosys Technologies Ltd., should be exclude from the list of comparables for the reason latter was giant company in the area of development of software and it assumed all risks leading to higher profits, whereas the respondent assessee was a captive unit of the parent company and assumed only a limited risk. It has also stated that Infosys Technologies Ltd. cannot be compared with the respondent assessee as seen from the financial data etc. to the two companies mentioned earlier in the order i.e. the chart. In the grounds of appeal the Revenue has not been able to controvert or deny the data and differences mentioned in the tabulated form. The chart has not been controverted".
17. From the above para of the judgment of the Hon'ble Delhi High Court, it is seen that this company is a giant company in the area of software and it assumed all risks leading to higher profits, whereas the assessee company was a captive unit of the parent company and assumed only a limited risk. In the present case also, the assessee company is providing services to the parent company and therefore, assuming only limited risk and hence, respectfully following this judgment of the Hon'ble Delhi High Court, we direct the AO/TPO to exclude this company also from the list of final comparables. As per the TPO's order Annexure-B, 11 companies have been considered as final comparables with arms length mean margin of 24.32%. As per the above discussion, we have held that 5 companies should be excluded from the list of final comparables. i.e.............
1 M/s Kals Information Systems Ltd.,
2. M/s Bodhtree Consulting Ltd., IT(TP)A.1279/Bang/2014 Page - 11
3. M/ Tata Elxsi Ltd.,
4. M/s Persistent systems Ltd.,
5. M/s Infosys Tech. Ltd.,
18. The mean margin of these 5 companies is 36.69. After exclusion of these 5 companies, arithmetic mean of the remaining 6 companies (comparables) will be only 14.02% as against PLI of the tested party i.e. the assessee company 17.63% and as a result no, TP adjustment is called for after exclusion of these 5 comparables and therefore, we do not go into the claim of the assessee regarding adoption of correct operating profit of two companies i.e. M/s Sasken Communication and M/s Larsen & Toubro Ltd., because the same is of academic interest only."
Following the above order, we direct the TPO /AO to exclude the above 5 comparables on functional dissimilarity.
06. The next issue is seeking correction in the margin computation of two comparables viz Sasken Communications Services Ltd & Larson and Toubro Infotech Ltd . In this regard, the gist of the AR's submissions is extracted as under :
Sasken Communication Technologies Ltd : The TPO held that it is functionally comparable, satisfies all the filters and retained it as a comparable. However, the assessee submitted that this company has to be rejected for the reason that the margins are erroneously computed , took us through pages 282, 327& 328 of the paper book and furnished a working which shown the revised margin at 16.00% . Larsen & Toubro Infotech Ltd : The TPO held that this company is engaged in software development services, satisfies all the filters and retained it as a comparable. The sssessee submitted that this company has purchased Mutual fund units approx 170% of its revenue from operations and sold approx 169% of its revenue as found in page 1968 of paper book. It itself has categorised the closing balance under the current investments, showing intention to sell the said outstanding balance of securities as well as in page 1970. Though the activity of trading is not shown as a separate segment, the volume of the transactions clearly depict the intention of the company to trade in securities and earn profits in the said activity. Without prejudice to the above, it has to be rejected for the reason that the margins are erroneously computed and furnished a working which shown the revised margin at 16.96% and took us through pages 325& 328 of the paper book.
We heard the rival submissions and gone through relevant material. We deem it fit to remit these issues to the TPO/AO for a fresh re-adjudication. While IT(TP)A.1279/Bang/2014 Page - 12 doing so , the assessee shall have to be given due opportunity to present its case .
07. The next issue is seeking inclusion of 4 comparables chosen by the assessee , but claimed to have been erroneously rejected by the TPO . In this regard, the gist of the AR's submissions is extracted as under :
Azlecsoft Ltd : The TPO held that this company failed in export turnover filter which is less than 75% . Apart from that , the export earnings of that company is 86% as per page 2360 of paper book and took us through the Annual Report in pages 2352 to 2427 in the paper books. Hence , it is submitted that this company passes the filter applied by TPO . Further, it is pleaded that this company ; is functionally similar, qualifies all the filters and hence should be held as a comparable.
CG-VAK Software and Exports Ltd : The TPO held that it fails 25% employee cost filter while the assessee submitted that its employee cost is not disclosed separately in financials, however, it is included in the cost of services. Hence, it cannot be rejected . Further, it is pleaded that this company ; is functionally similar , qualifies all filters and hence should held as comparable. Placed reliance on the decision in Cisco systems India P Ltd in IT(TP)A.27/Bang/2014 dt 14.8.2014 .
Goldstone Technologies Ltd; The TPO held that it is functionally different and engaged in ITeS. The assessee submitted that this company is engaged in software development services. Further, it is pleaded that this company; is functionally similar, qualified all the filters and hence should be held as a comparable . Placed reliance on the decision in Cisco systems India P Ltd in IT(TP)A.27/Bang/2014 dt 14.8.2014 .
Quintegra Solutions Ltd : The TPO held that this company fails export turnover filter which is less than 75%. The assessee submitted that its export earnings is 95%, functionally similar and qualified all the filters applied by the TPO and hence it should be held as a comparable . Placed reliance on the decision in Cisco systems India P Ltd in IT(TP)A.27/Bang/2014 dt 14.8.2014 . The relevant portion of the order is extracted as under :
"
27.8 CG-Vak Software & Exports Ltd.
(D) (i) As far as this company is concerned, the TPO rejected the same by applying the 25% employee cost filter. According to the TPO, usually software development services are high-end services performed by skilled and professional employees and hence the cost of rendering such high-end services is also high as they comprise of high salaries and better welfare facilities, compared to low-end services. Therefore, the filter of employee cost of more than 25% of turnover was considered by the TPO while choosing the comparable.
(ii) The submission of the ld. counsel for the assessee was that in the case of assessee, this test is satisfied. In this regard, our attention was drawn to page IT(TP)A.1279/Bang/2014 Page - 13 818 to 824 of the assessee's paperbook wherein annual report of this company has been provided. Attention was drawn to the fact that in the profit & loss account of the audited accounts, the cost of services has been shown as an expenditure and in Schedule 15 to the Notes to Accounts, it has been elaborated as follows:-
Cost of services:
Cost of Services - Overseas 2,77,32,337
Cost of Services - Domestic 2,58,40,435
Transcription charges 3,97,389
Web Designing Charges 1,64,602
Staff Welfare 11,43,144
Staff Training 3,63,496
Contribution to PF & ESI 15,47,906
Gratuity 13,04,894
Ex Gratia 0
HRD Expenses 3,10,871
5,88,05,074
(iii) It was submitted by the ld. counsel for the assessee that the TPO ignored the contribution to PF & ESI, Gratuity and Ex Gratia payments and arrived at the employee cost. According to the ld. counsel for the assessee, doing so was not proper. If all the employee costs are properly considered, then this company can pass the filter applied by the TPO for excluding it. (iv) We have considered the submission of the ld. counsel for the assessee and are of the view that prima facie the submissions of the ld. counsel are acceptable. We, however, feel that it would be just and appropriate to direct the TPO to consider including this company as a comparable afresh in the light of the facts brought to our notice by the ld. counsel for the assessee. We hold and direct accordingly.
28. The ld. counsel for the assessee also submitted before us that the assessee had sought for risk adjustments, but the same has not been considered by the TPO. In this regard, our attention was drawn to the following submissions made before the revenue authorities:-
"17.1 The Appellant functions under a limited risk environment with most of the risk being assumed by its AE. The Appellant bears lesser limited business risks than independent comparable companies due to the nature of its revenue model as it is guaranteed profits by way of a mark-up on costs incurred, in provision of the software development services. However, the independent companies have to bear the vagaries of the economic and business factors that are prevailing in the industry and thus could either incur losses or earn profits based on market conditions.
17.2 Rule 10B(1)(e)(iii) of the Rules provides that an adjustment should be made to the profit margin of independent comparable companies to take into account the differences in functions and risks. The OECD Transfer Pricing guidelines also recognize adjustments to be made to account for differences between controlled and uncontrolled situations that would significantly affect the price charged or return required by independent enterprises. Accordingly, controlled and uncontrolled transactions are comparable only when IT(TP)A.1279/Bang/2014 Page - 14 adjustments with respect to significant differences between them in terms of risks assumed is made.
17.3 In the submissions made to the leaned TPO, the Appellant has computed the adjustment for the risk difference of the Appellant vis-à-vis of the comparable companies by placing reliance on the methodology of risk adjustment as stated in the decision of the Hon'ble Bangalore Tribunal in case of Philips Software Centre Private Limited vs. Asst. Commissioner of Income Tax (119 TTJ 721) (2008 26S0T226) as below.
Average prime lending rate during FY 2008-09 (A)¹ - 12.75 percent² Average bank rate during FY 2008-09 (B) - 6.00 percent³ Difference between the prime lending rate and bank rate C = (A - B) -6.75 percent Risk Adjustment (C) - 6.75 percent ¹ The rates have been considered as per the details as available in the Economic Survey analysis for 2008-09 ² Average Benchmark PLR for Public Sector banks was 12.25%- 12.75% ³The Average bank rate effective since April 30, 2003 has been 6% 17.4 Further, the Hon'ble Delhi Tribunal in the case of Sony India Pvt Ltd (315 ITR 150) has allowed 20% risk adjustment considering the fact that it may not be possible to quantify risk adjustments."
29. The limited request of the ld. counsel for the assessee is for a direction to the TPO to consider the aforesaid submissions in the light of judicial pronouncements referred to therein. On the above aspect, the TPO in his order has rejected the claim of the assessee observing as follows:-
"3.8. Risk Adjustment: Risk adjustment involves two vital preconditions. They are that difference in risk level exists between the tested party and the uncontrolled comparables; and that it is possible to calculate in terms of numbers the differences in risk so that adjustment can be made. But in case of the taxpayer, both the prerequisites are missing. Neither the difference in risk level of the tested parts and uncontrolled comparables has been established nor is it possible to convert the difference in risk level, if there is any. into numbers. If there is any difference. for a moment academically speaking, it rests in the realm of quality and not quantity. There is no reliable method to convert the qualitative difference into quantitative difference and to make adjustment on account of risk level. As per the provisions of Rule 10B(3), if any adjustment should be made, it should be reasonably accurate to eliminate the material effects of such differences. But in case of risk adjustment, neither reasonably accurate adjustment can be made for want of method to do so nor has it been established that there is a material effect that is affecting the comparisons due to risk level. If the taxpayer is suggesting that there exists a difference in the risk level assumed by the tested party and uncontrolled comparables, it is academic in nature and not based on any study whose results has been validated. It is not out of place to reiterate that single customer risk is a huge risk which the uncontrolled comparables are not assuming. By having more customers, the risk is shared or spread. In other words, if one customer goes out of business still there are others which will sustain the business of the tested party. But in case of the taxpayer there being only one client, the entire risk is concentrated on one client, and therefore. if the client is out of business the taxpayer will also be out of business. Earlier the argument given about the country risk was that EU & US are having better credit rating as compared to India. This argument is no IT(TP)A.1279/Bang/2014 Page - 15 longer valid as their credit rating is also on a downward trend. and moreover in case of uncontrolled comparables we are taking the filter of export sales >75%. Most of the exports of software services from India are primarily to EU & US and therefore in case of uncontrolled comparables also the risk level will he equated. So far as the methods suggested by taxpayers in this regard are concerned, they are statistical methods available in standard books of statistics and financial management. A careful study of these methods would show that in all of them a number of assumptions are made to draw the conclusions. Transfer pricing regulations in India is against any assumption in respect to any adjustment. In support, reference is made to Rule 10B discussed above which speaks of reasonably accurate adjustment. If accurate adjustment cannot he made, then alternative is no adjustment should be made. Therefore no risk adjustment is allowed. However TPO is not against adjustment if reasonable accurate adjustment can be made and there is a method to do so, as is evident in respect of working capital adjustment which the TPO has given, if it is possible. In the light of above discussion. no adjustment on account of risk is allowed to the taxpayer."
30. As can be seen from the aforesaid observations of the TPO, the risk adjustment was not allowed for the reason of absence of proper basis of quantification. Now that the assessee has given the basis of such quantification, the TPO is directed to consider the same.
31. The issue of computation of ALP is remanded to the TPO to be considered afresh in the light of directions given earlier. Thus, ground Nos.B 4 to 17 raised by the assessee are decided accordingly.
27.3 Quintegra Solutions Ltd 27.4 Goldstone Technologies Ltd As far as the other two companies viz., Quintegra Solutions Ltd. and Goldstone Technologies Ltd. are concerned, it is seen from page 825 to 827 and 828 to 833 of the assessee's paperbook that both these companies seem to have more than 75% export earnings. Since the facts have not been properly appreciated, we deem it fit and proper to restore the question of considering these two companies as comparable to the TPO/AO for fresh consideration. "
We heard the rival submissions and gone through relevant material. We deem it fit to remit these issues to the TPO/AO for a fresh re-adjudication. While doing so , the assessee shall have to be given due opportunity to present its case .
07. With regard to the second segment i.e. Customer Support Services, the AR of the assessee submitted that out of 8 comparables chosen by the assessee, the TPO retained 5 comparables only and introduced another 3 comparables . Out of IT(TP)A.1279/Bang/2014 Page - 16 which, the assessee is seeking exclusion of 5 comparables on functional dissimilarity and correction in the margin computation of two comparables viz Microland Ltd & Aditya Birla Minacs Worldwide Ltd . Further, it submitted that 2 comparables chosen by the assessee were erroneously rejected by the TPO and seeks to include them as comparables. In this regard, the gist of AR's submissions are as under:
Microland Ltd : The TPO held that this company is functionally comparable, satisfies all the filters and hence retained it as a comparable. The assessee submitted that it is engaged in IT Infrastructure Management services and ITeS services. The TPO has considered KPO services such IT Infrastructure management as well, while computing the margins. However, only ITeS operations has to be considered. Further , it submitted that the margins are erroneously computed and furnished a working. Relied on Lam Research (India) P Ltd v DCIT in IT(TP)A.1437/Bang/2014 dt 30.4.2015 Aditya Birla Minacs Worldwide Ltd : TPO held that it is functionally comparable, satisfies all the filters hence retained it as a comparable. Further, the assessee did not raise any objection when it is included. The assessee submitted that the margins are erroneously computed and furnished a working. Relied on Lam Research (India) P Ltd v DCIT in IT(TP)A.1437/Bang/2014 dt 30.4.2015.
08. The assessee also placed reliance on its own case for a y 2007-08 in ITA No.1214/Bang/2011 dt 29.8.2016 . For the above two issues, it placed reliance on Lam Research (India) P Ltd v DCIT in IT(TP)A.1437/Bang/2014 for ay 2009-10 dt 30.4.2015 and Maersk Global Centres India P. Ltd v. ACIT in ITA.7466/Mum/2012 for ay 2008-09, Capital IQ Information Systems India P. Ltd v ACIT , Hyderabad, for ay 2009-10 in ITA no 124/Hyd/2014 dt.07.03.2014 etc
09. We have heard the rival submissions, gone through relevant ;orders, Charts, annual reports and material in the paper books. In its own case for a y 2007-08, this Tribunal in ITA No.1214/Bang/2011 dt 29.8.2016 for ay 2007-08 , inter alia, excluded M/s Eclerx Services Ltd., M/s Infosys BPO Ltd., M/s Accentia IT(TP)A.1279/Bang/2014 Page - 17 Technologies Ltd., (Seg.) & M/s Informed Technologies Ltd. Further, this Tribunal in the case of Lam Research (India) P Ltd v DCIT in IT(TP)A.1437/Bang/2014 for ay 2009-10 dt 30.4.2015 which also had two segments viz software development services & ITE services, excluded 3 comparables viz Cosmic Global Ltd, M/s Eclerx Services Ltd and Accentia Technologies Ltd on functional dissimilarity and remitted the issue of computation of margins to the TPO/AO . The relevant portion of the order is extracted as under :
"30. We have perused the orders and considered the rival contentions.
With respect to Infosys BPO, we have already held at para 15 above that the said company was not an appropriate comparable in view of its huge turnover, far in excess of Rs.200 crores. In the case of Aditya Birla Minacs Worldwide Ltd., we find that Hyderabad Bench of this Tribunal in the case of Capital IQ Information Systems (India) P. Ltd., for the very same assessment year, had given the percentage margin on cost with respect to various comparables considered in that case as under, at para 5 of its order dt.31.07.2014 :
5. Even though there is no dispute with reference to the method adopted, the TPO rejected the documentation maintained by assessee on the reasons that multiple year data was used; has not applied export filters properly; and also selected some of the companies which are not functionally similar. After analyzing the reasons, vide para 7 of the TPO's order, the TPO undertook fresh search of comparables and after detailed analysis, gave a show cause notice to assessee for its objections to the selection of 14 comparables. Ultimately, the TPO determined the following twelve companies as comparables and arrived at the average Profit Level Indicator (PLI) of 27.42%, as per the details tabulated hereunder-
Sl. Company Name Operating Revenue PBIT/Cost%
1. Accentia Technologies Limited 78.73 49.40
2. Acropetal Technologies Ltd. (Seg.) 33.13 25.01
3. Aditya Birla Minacs Worldwide Ltd 231.57 0.53
4. Cosmic Global Ltd. 7.76 48.20
5. Crossdomain 33.76 29.38
6. Eclerx Services Ltd. 187.98 53.44
7. Infosys BPO Ltd. 101.62 16.90
8. Jeevan Softech Technology Ltd. 1.79 16.56
9. Microland Limited 144.05 2.35
10. Microgenetic Systems Ltd. 1.27 10.11
11. R.Systems International Ltd.(Seg.) 26.55 5.77
12. Genesys International Ltd. 83.18 71.50
The TPO has here considered the profit margin of M/s. Aditya Birla Minacs Worldwide Ltd., at 23.86%, against 0.53% given in the table above. There is IT(TP)A.1279/Bang/2014 Page - 18 an obvious contradiction which has to be resolved. We are therefore of the opinion that profit margin needs to be correctly worked out and the matter requires a fresh look by the AO / TPO. Though Aditya Birla Minacs Worldwide Ltd., is a good comparable, the profit margin needs to be correctly worked out after considering the submissions made by assessee in this behalf. Ordered accordingly.
31. With regard to M/s. Microland Ltd., assessee had submitted before CIT (A) that it was having two segments, namely, ITES and Infrastructure Management segment. Assessee has also given a working for its ITES segment, as under :
Particulars Amount
Total operating income (A) Rs.29,64,34,150.00
Operating expenditure (B) Rs.36,55,62.144.95
Operating profit (A-B) (Rs.6,91,27,994.95)
Operating profit margin -18.91%
(C/B*100)
We are of the opinion that the issue raised by assessee has to be looked into by the AO/TPO. While holding that Microland Ltd., is a proper comparable, we are of the opinion that only the results of the segment relatable to ITES can be considered for comparison while analysing the ALP of the ITES segment of the assessee. Ordered accordingly.
32. With respect of Accentia Technologies Ltd., it was held as under, in the case of Capital IQ Information Systems (India) P. Ltd., at para 21 to 22 of its order :
Accentia Technologies Limited.
21. This company was objected to by assessee on the reason of super profits as well as extra-ordinary events. It was submitted that acquisition of Oak Technologies & Trans Services has impact on the profits of the company and has taken inorganic growth as strategy to increase the profits because of the peculiar economic circumstances and brand value. The same in these circumstances cannot be selected. It was submitted that assessee was in medical transcription services.
21.1. The Departmental Representative however, objected to the pleas of assessee stating that the extraordinary events occurred in earlier year and therefore, the same cannot be considered as having any impact in the year under consideration.
21.2 We have considered the rival contentions and noticed that this company operates in a different business strategy of acquiring companies for inorganic growth as its strategy. In earlier years on the reason of acquisition of various companies, being an extraordinary event which had an impact on the profit, this company was excluded. As submitted by the learned counsel, this year also, the acquisition of some companies by that company may have impact on the profit. Considering the profit margins of the company and insufficient segmental data, we are of the opinion that this company cannot be selected as a comparable. Moreover, this is also not a comparable in the case of M/s.
Mercer Consulting (India) P. Ltd. (supra), which indicates that the TPO IT(TP)A.1279/Bang/2014 Page - 19 therein has excluded it at the outset. In view of this, we direct the Assessing Officer/TPO to exclude this comparable, from the list of comparables selected.
33. Capital IQ Information Systems (India) P. Ltd., was also into ITES and the decision given was also for the very same assessment year. Therefore, we are of the opinion that Accentia Technologies has to be excluded from the list of comparables. Ordered accordingly.
34. With respect to Cosmic Global Ltd., Hyderabad bench of ITAT in the case of Capital IQ Information Systems (India) P. Ltd., in para 19 of its order, had held as under :
Cosmic Global Ltd.
19. The main objection of assessee with reference to the inclusion of this company is with reference to outsourcing of its main activity. Even though this company is in assessee's TP study, it has raised objection before the TPO that this company's employee cost is less than 21.30% and most of the cost is with reference to the outsourcing charges or translation charges, and as such this is not a comparable company. The TPO, though considered these submissions, rejected the same, on the reason that this does not impact the profit margin of the company. Opposing the view taken by the TPO, it is submitted that this company cannot be selected as comparable, asM/s.
Capital IQ Information systems (India ) Pvt. Ltd., Hyderabad similar issue was discussed by the coordinate Bench of the Tribunal(Delhi) in the case of Mercer Consulting (India) P. Ltd. (supra), vide paras 13.2 to 13.3 which read as under-
"13.2. Now coming to the factual matrix of this case, we find from the material on record that outsourcing charges of this case constitute 57.31% of the total operating costs. This does not appear to us to be a valid reason for eliminating this case from the list of comparables. On going through the Annual accounts of Cosmic Global Limited, a copy of which has been placed on record, we find that its total revenue from operations are at Rs.7.37 crore divided into three segments, namely, Medical transcription and consultancy services at Rs.9.90 lacs, Translation charges at Rs.6.99 crore and Accounts BPO at Rs.27.76 lac. The ld. AR has made out a case that outsourcing activity carried out by this company constitutes 57% of total expenses. The reason for which we are not agreeable with the ld. AR is that we have to examine the revenue of this case only from Accounts BPO segment and not on the entity level, being also from Medical transcription and Translation charges. When we are examining the results of this company from the Accounts BPO segment alone, there is no need to examine the position under other segments. The entire outsourcing is confined to Translation charges paid at Rs.3.00 crore, which is strictly inthe realm of the Translation segment, revenues from which are to the tune of Rs.6.99 crore. If this segment of Translation is not under consideration for deciding as to whether this case is comparable or not, we cannot take recourse to the figures which are relevant for segments other than accounts BPO. Thus it is held that this case cannot be excluded on the strength of outsourcing activity, which is alien to the relevant segment. 13.3. However, we find this case to incomparable on the alternative argument advanced by the ld. AR to the effect that total revenue of the Accounts BPO segment of Cosmic Global Limited is very low at Rs.27.76 lacs. We have discussed this aspect above in the context of CG-VAK's case and held that a IT(TP)A.1279/Bang/2014 Page - 20 captive unit cannot be compared with a giant case and thus excluded CG-VAK with turnover from Accounts BPO segment at Rs.86.10 lacs. As the segmental revenue of BPO segment of Cosmic Global Limited at Rs.27.76 lac is still on much lower side, the reasons given above would fully apply to hold Cosmic Global Limited as incomparable. This case is, therefore, directed to be excluded from the list of comparables."
In view of the detailed analysis of the coordinate Bench of the Tribunal in the above referred case, in this case also we accept the contentions of assessee and direct the Assessing Officer/TPO to exclude this comparable for the same reasons.
Accordingly, we direct that Cosmic Global Ltd., also be excluded from the list of comparables.
35. With respect to Eclerx Services Ltd., Hyderabad bench of ITAT in the case of Capital IQ Information Systems (India) P. Ltd., in para 18 of its order, had held as under :
Eclerx Services Ltd.
18. The objection of assessee to this comparable is that this company is functionally dissimilar. It is in the business of consultancy and advisory service and provides only analytical data. It is also involved in quality monitoring. It is the stand of the assessee that this company offers solutions that include data analytics, operations management, audits and reconciliation and therefore has to be classified as high end KPO. In support of the stand of the assessee, extracts from the annual report of this company have been pointed out. Therefore, the functions of the above company are dissimilar to assessee, which is a captive service provider. On the principles laid down by the Hon'ble Special Bench of the ITAT (Mumbai) in the case of Maersk Global Centres (India) Pvt. Ltd. V/s. ACIT (ITA No.7466/Mum/2012 for assessment M/s. Capital IQ Information systems (India ) Pvt. Ltd., Hyderabad year 2008-09 dated 7.3.2014) and the principles laid down by the coordinate bench of the Tribunal(Delhi) in the case of M/s. Mercer Consulting (India) Pvt.
Ltd., (supra), assessee submits that this company cannot be selected as a comparable.
18.1 The Learned Departmental Representative, however, submitted that having accepted Aditya Birla Minacs Worldwide Ltd., as a comparable company, this company should also be included, as otherwise, both the companies should be excluded.
18.2 We have considered the issue and examined the Annual Report and the objections of assessee. As seen from the Annual Report, the above company is involved in diverse nature of services and there was no segmental data for diversified service port folio. Moreover this company can be considered as KPO and we are of the opinion that this company is not comparable to assessee's services. We therefore, direct the Assessing Officer/TPO to exclude this company.
We, therefore, hold that the said company also be excluded from the list of comparables".
IT(TP)A.1279/Bang/2014 Page - 21 Following the above order, we direct the TPO /AO to exclude the above 3 comparables on functional dissimilarity and re-adjudicate the issues in connection with correction of margin computation in Microland and Aditya Birla Minacs Worldwide Ltd , after giving due opportunity to the assessee.
10. In connection with exclusion of Infosys BPO Ltd & Informed Technologies India Ltd, the gist of the AR's submissions are as under :
Infosys BPO Ltd : The TPO held that this company is functionally comparable, satisfies all the filters hence retained it as a comparable. The assessee submitted that it has to be rejected for the following reasons :
1. Market Leader - Infosys is a giant company with different risk profile and nature of services, has brand value and owns IPs.
2. Global company - provides global delivery through 11 delivery locations (5 in India and 6 internationally) which sufficiently hints that the company fails onsite services filter, although the actual onsite revenue information is not available.
3. Brand building activity and the company incurs significant Marketing Expenses - 5.88% of sales.
4. Extraordinary events during the year - Amalgamation & re-organisation of various companies.
5 Rewards and recognition obtained by Infosys.
6 Significant brand value leading to the increase in revenue and brand profits.
In the assessee's case in a y 2007-08 , this Tribunal rejected it as a comparable in ITA No.1214/Bang/2011 and the assessee relied on the case laws of :
Logica P. Ltd IT(TP)A No 1621/Bang/ 2014 dt 18.03.2016 for ay 2009-10[TS -187
- ITAT -2016 (Bang)TP)] and Avineon India P. Ltd [TS-23-ITAT-2016(Hyd)-TP] Informed Technologies India Ltd : The TPO held that this company is functionally comparable, satisfies all the filters hence retained it as a comparable. Further , the assessee did not raise any objection for exclusion of it. The assessee submitted that it has to be rejected for the following reasons :
1. Referring to the business centre charges in page 3026 of paper book, the company has several other sources of income as equivalent to the revenue from operations. Earning of such huge stature of income apparently requires the utilization of resources, may it be in employee form or of investment form.
However, the segmental breakup of the same is not available. Hence the profits from each source of such incomes need to be bifurcated to adopt such margins.
IT(TP)A.1279/Bang/2014 Page - 22 2 The company has purchased Mutual fund units approx 165% of its revenue .
- The company itself has categorised the closing balance under the Current investments, showing intention to sell / trade the said outstanding balance of securities as well.
- Though the activity of trading is not shown as a separate segment, the volume of the transactions clearly depict the intention of the company to trade in securities and earn profits in the said activity.
In the assessee's case in ay 2007-08 [ITA No.1214/Bang/2011, this Tribunal rejected it as a comparable.
We heard the rival submissions and gone through relevant material. This Tribunal excluded these two comparables in the assessee's case in ay 2007-08 based on the decision of this Tribunal in AOL Online India P Ltd in IT(TP)A No 1036 /Bang/2011 dt 18.3.2016 which highlighted almost the above reasons , on which the assessee is seeking exclusion ,supra, and the allowed the appeal.
Since the facts are similar, following the above decisions, we direct the TPO/AO to exclude them as comparables.
11. The next issue is seeking inclusion of 2 comparables chosen by the assessee, but erroneously rejected by the TPO . In this regard, the gist of the AR's submissions is extracted as under :
Microgenetics Ltd : This company formed part of the TPO search. Since the RPT details are not available, the TPO rejected it as a comparable. The assessee stated that this company is engaged in BPO services, satisfies all the filters and hence the same should be included . It brought to the TPO's notice that is not required to report RPT filters as it qualifies to be 'Level I enterprise' as per Accounting Standards. In spite of powers available u/s 133(6), the TPO did not exercise it to get the RPT details. Hence this company should not be rejected.
Cepha Imaging : This TPO and the CIT (A) rejected this company without giving any reason. The assessee stated that it is engaged in provision of E- Publishing including Typesetting, composition, Artwork, proof editing management, XML conversion services servicing to publishers of books and journals. As the above services are in the nature of ITeS, accordingly the company should be accepted as comparable.
IT(TP)A.1279/Bang/2014 Page - 23 We heard the rival submissions and gone through relevant material. We deem it fit to remit these issues to the TPO/AO for a fresh re-adjudication. While doing so, the assessee shall have to be given due opportunity to present its case .
12. The next issue is that the assessee is seeking risk adjustments . In this regard, our attention was drawn to the decision of ; this Tribunal in case of Philips Software Centre Private Limited vs. Asst. Commissioner of Income Tax (119 TTJ 721) (2008 26 S0T226) , the Hon'ble Delhi Tribunal in the case of Sony India Pvt Ltd (315 ITR 150) wherein it has allowed 20% risk adjustment considering the fact that it may not be possible to quantify risk adjustments etc .
We heard the rival submissions and considered this tribunal decisions in various cases including the above cited cases . It is seen from the observations of the TPO that the TPO is not against risk adjustment but it was not allowed for the reason of absence of proper basis of quantification. Now , that the assessee has given the basis of such quantification, the TPO /AO is directed to consider them in the light of this Tribunal decisions.
13. In the result, the assessee's appeal is allowed / treated as allowed for statistical purpose.
Order pronounced in the open court on 28th day of February, 2017.
Sd/- Sd/-
(SUNIL KUMAR YADAV) (S. JAYARAMAN)
JUDICIAL MEMBER ACCOUNTANT MEMBER
MCN*
IT(TP)A.1279/Bang/2014 Page - 24
Copy to:
1. The assessee
2. The Assessing Officer
3. The Commissioner of Income Tax
4. The Commissioner of Income Tax (A)
5. DR
6. GF, ITAT, Bangalore
By Order
Assistant Registrar