Income Tax Appellate Tribunal - Bangalore
Fcg Software Services (India) Private ... vs Ito, Bangalore on 21 April, 2017
IN THE INCOME TAX APPELLATE TRIBUNAL
"A" BENCH : BANGALORE
BEFORE SHRI SUNIL KUMAR YADAV, JUDICIAL MEMBER
AND
SHRI INTURI RAMA RAO, ACCOUNTANT MEMBER
IT(TP)A No. 994/Bang/2011
Assessment year : 2007-08
M/s. FCG Software Services Income Tax Officer,
(India) Pvt. Ltd., (Now merged Ward 11(2),
with Computer Sciences Vs. Bengaluru.
Corporation India Private Ltd.,)
2nd & 3rd Floors, 3, SJR IPark,
EPIP - Zone I,
Whitefield Road,
Bengaluru-560 066.
PAN : AABCP5094K
APPELLANT RESPONDENT
Assessee by : Shri. Vikram Vijayaraghavan, Advocate
Revenue by : Shri. Bijoy Kumar Panda, CIT-DR
Date of hearing : 24.01.2017
Date of Pronouncement : 21.04.2017
ORDER
Per Inturi Rama Rao, Accountant Member
This appeal filed by the assessee directed against the assessment order dated 12.09.2011 passed under section 143(3) r.w.s. 144C of the IT(TP)A No. 994/Bang/2011 Page 2 of 26 Income Tax Act, for the assessment year 2007-08. The appellant raised the following grounds:
IT(TP)A No. 994/Bang/2011 Page 3 of 26
9. The learned AO and Honorable DRP have erred, in law and in facts, by applying the turnover < Rs 1 Crore as a comparability criterion.
10. The learned AO and Honorable DRP have erred, in law and in facts, by rejecting certain comparable companies identified by the Assessee as having economic performance contrary to the industry behaviour (e.g. companies which showed a diminishing revenue trend).
11. The learned AO and Honorable DRP erred, in law and in facts, by rejecting certain comparable companies identified by the Assessee using employee cost greater than 25% of the total revenues as a comparability criterion.
12. The learned AO and Honorable DRP erred, in law and in facts, by rejecting certain comparable companies identified by the Assessee using onsite revenues greater than 75% of the export revenues as a comparability criterion.
13. The learned AO and Honorable DRP erred, in law and in facts, by not taking into consideration foreign exchange fluctuation gain/ loss in computing the operating margin of the Assessee as well as the comparable companies.
14. The learned AO and Honorable DRP erred, in law and facts, by not making suitable adjustments to account for differences in the risk profile of the Assessee vis-à-vis the comparables.
15. The learned AO and Honorable DRP erred, in law and facts, in computing the ALP without giving benefit of +/- 5 percent under the proviso to section 92C of the Act.
16. The learned AO and Honorable DRP have erred, in law and in facts, by wrongly computing the operating margins of some of the comparable companies identified in the TP order.
IT(TP)A No. 994/Bang/2011 Page 4 of 26
17. The learned AD and Honorable DRP have erred, in law and in facts, by ignoring the fact that since the Assessee is availing tax holiday u/s 10A of the Act, there is no motive or reason to shift profits out of India, curbing which is the basic intention of introducing the transfer pricing provisions
18. The learned AD and Honorable DRIP have erred in considering reimbursement received as operating income/ operating cost for the purpose of computing the value of Transfer pricing adjustment.
Grounds of objection relating to corporate tax matters
19. In computing the deduction under section 10A/10B of the Act, a The learned AO has erred in excluding telecommunication expenditure of INR1,02,13,858 incurred in connection with the delivery of computer software outside India from the export turnover of units claiming deduction under section 10A/10B when such items were not, in the first place, included in the export turnover of the said Units b. Without prejudice to ground (a) above, the learned AO has erred in excluding telecommunication expenditure incurred in connection with the delivery of computer software outside India from the export turnover of units claiming deduction under section 10A/10B to the extent of the expenditure incurred in Indian rupees. C Without prejudice to ground (a) and (b) above, the learned AO has erred in holding that while telecommunication expenditure incurred in connection with the delivery of computer software outside India should be excluded from export turnover of units claiming deduction under section 10A/ 10B, but not from total turnover of the said Units.
20. In computing the deduction under section 10A/10B of the Act, a . the learned AO has erred in excluding expenditure incurred in foreign currency amounting to INR 23,730 from the export turnover of units claiming deduction under section 10A/10B, when such items were not, in the first place. included in the export turnover of the said Units.
IT(TP)A No. 994/Bang/2011 Page 5 of 26 b . Without prejudice to ground (a) above, the learned AO has erred in treating expenditure in foreign currency as expenditure incurred for providing technical services" outside India without appreciating the fact that the Assessee is engaged in provision of software development services and not technical services.
C. Without prejudice to ground (a) and (b) above, the learned AO has erred in holding that expenses incurred in foreign currency should be excluded from export turnover of Units claiming deduction under section 10A/10B, but not from total turnover of the said Units.
21. The Learned AO has erred in computing Interest under section 234B of the Act on the assessed income since the addition to the returned income on account of Transfer Pricing adjustment is only a notional income and not actual earned income.
22. The Learned AO has erred in computing Interest under section 234C` on assessed income since the same is to be computed only on the returned income.
2. Briefly the facts of the case are that the appellant is a company duly incorporated under the Companies Act, 1956. It is a wholly owned subsidiary of FCG Software Services Inc., (USA). It is engaged in the software development and design activities for its AE company. The return of income for the AY 2007-08 was filed on 31.10.2007 declaring income of Rs.2,17,040/-. The assessee company also reported the following international transaction:
IT(TP)A No. 994/Bang/2011 Page 6 of 26
3. The assessee company sought to justify the consideration received for the international transaction entered with its AE to be at arm's length. The assessee company submitted the transfer pricing study report adopting operating profit/operating cost (OP/OC) as a profit level indicator for the transfer pricing study. The assessee company applied Transactional Net Margin Method (TNMM), which was considered as the most appropriate method for the purpose of bench marking the international transaction. The assessee company's profit margin was computed at 13.21% and the assessee company claimed that the same was comparable with other companies rendering software development activities. For the purpose of transfer pricing study, the assessee company had chosen 18 comparable entities and average operating margin of the said comparables was computed at 13%. According to the assessee company, its PLI is higher than the arithmetic mean of comparable entities. Hence it was claimed that the transaction with its AE are at arm's length. The assessee company had chosen the following 18 entities as comparables whose profit margin was computed at 13%:
1. Bodhtree Consulting Ltd.,
2. FCS Software Solutions Ltd.,
3. Goldstone Technologies Ltd.,
4. Larsen & Tourbro Infotech Ltd.,
5. Melstar Information Technology Ltd.,
6. Orient Information Techno Logy Ltd.,
7. Powersoft GlobalSolutions Ltd.,
8. SIP Technologies & Exports Ltd.,
9. Sonata Software Ltd.,
10. Synetairos Technologies Ltd.,
11. Trident Info-Tech Corpn Ltd., IT(TP)A No. 994/Bang/2011 Page 7 of 26
12. VJIL Consulting Ltd.,
13. Akshay Software Technologies Ltd.,
14. Cambridge Technology Enterprise Ltd.,
15. ICRA Techno Analytics Ltd.,
16. Mindtree Consulting Ltd.,
17. Computech International Ltd.,
18. Karturi Networks Ltd The AO referred the matter to TPO for the purpose of bench marking the international transactions entered by the assessee company with its AE. The TPO, by order dated 19.10.2010, computed the transfer pricing adjustment at Rs.7,98,19,873/-. The TPO rejected the bench marking analysis carried out by the appellant in its transfer pricing study report. However, the TPO adopted the TNMM and proceeded to identify the different set of comparable entities for the purpose of determining the ALP. While doing so, the learned TPO applied the following filters.
IT(TP)A No. 994/Bang/2011 Page 8 of 26
4. The TPO rejected 16 comparables selected by the assessee company and identified 24 new comparable entities thereby accepting 2 entities selected by the assessee company i.e., M/s. SIP Technologies and Exports Ltd., and M/s. Mindtree Consulting Ltd. The TPO finally selected the following companies:
1. Accel Transmatics Ltd., (Seg.)
2. Avani Cimcon Technologies Ltd.,
3. Celestial Labs Ltd.,
4. Datamatics Ltd.,
5. E-Zest Solutions Ltd.,
6. Flextronics Software Systems Ltd., (Seg.)
7. Geometric Ltd., (Seg.)
8. Helios & Matheson Information Technology Ltd.,
9. iGate Global Solutions Ltd., (Seg.)
10. Infosys Technologies Ltd.,
11. Ishir Infotech Ltd.,
12. KALS Infosystems Ltd.,
13. Lanco Global Systems Ltd.,
14. Lucid Software Ltd.,
15. Mediasoft Solutions (P) Ltd.,
16. Megasoft Ltd.,
17. Mindtree Consulting Ltd.,
18. Persistent Systems Ltd.,
19. Quintegra Solutions Ltd.,
20. R S Software (India) Ltd.,
21. R Systems International Ltd., (Seg.)
22. S I P Technoloiges and Exports Ltd.,
23. Sasken Communication Technologies Ltd.,
24. Tata Elxsi Ltd., (Seg.)
25. Thirdware Solutions Ltd.,
26. Wipro Ltd.,
5. The TPO computed average profit margin of the comparables finally at 25.154% after adjusting working capital adjustment at 0.08% and arithmetic mean of PLI of the comparable was determined at IT(TP)A No. 994/Bang/2011 Page 9 of 26 25.05%. On the above said basis, the TPO computed the transfer pricing adjustment as follows:
6. The AO passed the draft assessment order dated 27.12.2010.
The draft assessment order passed under section 143(3) r.w.s. 144C(1) of the Act incorporating the above TP adjustment and reducing the benefit under section 10A by reducing the total cost expenditure, travel expenditure from export turnover alone.
7. Being aggrieved, the assessee company filed objection before the DRP. The DRP has confirmed the order of the learned TPO without giving any relief to the assessee company. The AO passed the final assessment order under section 143(3) r.w.s. 144C(13), dated 12.09.2011 incorporating the TP adjustment of Rs.7,98,19,873/-. Being aggrieved, the appellant is in appeal before us.
8. Before us, the learned counsel for the assessee vehemently contended that the learned TPO has included 14 comparables which are functionally dissimilar with that of the assessee company. In this connection, he contended that the following companies are functionally dissimilar and placed reliance on the coordinate bench's IT(TP)A No. 994/Bang/2011 Page 10 of 26 decision in the case of M/s. Magma Design Automation India Pvt. Ltd., in ITA No. 1241(Bang)2011 and M/s.NXP Semiconductors India Pvt. Ltd. in IT(TP)A No.1174/Bang/2011.
1. Accel Transmatics Limited (Seg.)
2. Avani Cimcon Technologies Limited
3. Celestial Labs Ltd.,
4. E-Zest Solutions Limited
5. Flextronics Software Systems Limited (Seg.)
6. Helios & Matheson Information Technology Limited
7. Infosys Technologies Limited
8. Ishir Infotech Limited
9. KALS Infosystems Limited
10. Lucid Software Limited
11. Persistent Systems Limited
12. Tata Elxsi Limited (Seg.)
13. Thirdware Solutions Limited
14. Wipro Limited
9. On the other hand, the learned CIT-DR placed reliance on the orders of the TPO.
10. We have heard the rival submissions and perused the material on record. The issue of comparability of these companies had come up before the coordinate bench in the case of M/s.NXP Semiconductors India Pvt. Ltd., wherein it was held as under:
Accel Transmatic Ltd.
48. With regard to this company, the complaint of the assessee is that this company is not a pure software development service company. It is further submitted that in a Mumbai Tribunal Decision of Capgemini India (F) Ltd v Ad. CIT 12 Taxman.com 51, the DRP accepted the contention of the assessee that Accel Transmatic should be rejected as comparable. The relevant IT(TP)A No. 994/Bang/2011 Page 11 of 26 observations of DRP as extracted by the ITAT in its order are as follows:
"In regard to Accel Transmatics Ltd. the assessee submitted the company profile and its annual report for financial year 2005-06 from which the DRP noted that the business activities of the company were as under.
(i) Transmatic system - design, development and manufacture of multi function kiosks Queue management system, ticket vending system
(ii) Ushus Technologies - offshore development centre for embedded software, net work system, imaging technologies, outsourced product development
(iii) Accel IT Academy (the net stop for engineers)-
training services in hardware and networking, enterprise system management, embedded system, VLSI designs, CAD/CAM/BPO
(iv) Accel Animation Studies software services for 2D/3D animation, special effect, erection, game asset development.
4.3 On careful perusal of the business activities of Accel Transmatic Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee's claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from the final list of comparables for the purpose of determining TNMM margin."
Avani Cimcon Technologies Ltd.
39. As far as this company is concerned, the plea of the Assessee has been that this company is functionally different from the assessee. Based on the information available in the company's website, which reveals that this company has developed a software product by name "DXchange", it was submitted that this company would have revenue from software product sales apart from rendering of software services and therefore is functionally different from the assessee. It was further submitted that the Mumbai Bench of the Tribunal to the decision in the case of Telcordia Technologies Pvt. Ltd. v. ACIT - ITA No.7821/Mum/2011 wherein the Tribunal accepted the assessee's contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only and it was held as follows:-
IT(TP)A No. 994/Bang/2011 Page 12 of 26 "7.8 Avani Cincom Technologies Ltd. ('Avani Cincom'):
Here in this case also the segmental details of operating income of IT services and sale of software products have not been provided so as to see whether the profit ratio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis."
It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits.
The following figures were placed before us:-
Particulars FYs 05-06 06-07 07-08 08-09
Operating Revenue 21761611 35477523 29342809 28039851
Operating Expns. 16417661 23249646 23359186 31108949
Operating Profit 5343950 12227877 5983623 (3069098)
Operating Margin 32.55% 52.59% 25.62% - 9.87%
Celestial Labs Ltd.
42. As far as this company is concerned, the stand of the assessee is that it is absolutely a research & development company. In this regard, the following submissions were made:-
i. In the Director's Report (page 20 of PB-Il), it is stated that "the company has applied for Income Tax concession for in-house R&D centre expenditure at Hyderabad under section 35(2AB) of the Income Tax Act."
ii. As per the Notes to Accounts - Schedule 15, under "Deferred Revenue Expenditure" (page 31 of PB-II), it is mentioned that, "Expenditure incurred on research and development of new products has been treated as deferred revenue expenditure and the same has been written off in 10 years equally yearly installments from the year in which it is incurred." An amount of Rs. 11,692,020/- has been debited to the Profit and Loss Account as "Deferred Revenue Expenditure" (page 30 of PB-II). This amounts to nearly 8.28 percent of the sales of this company. It was therefore submitted that the acceptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R&D activities is bad in law.
IT(TP)A No. 994/Bang/2011 Page 13 of 26 E-Zest Solutions Ltd.
14.1 This company was selected by the TPO as a comparable. Before the TPO, the assessee had objected to the inclusion of this company as a comparable on the ground that it was functionally different from the assessee. The TPO had rejected the objections raised by the assessee on the ground that as per the information received in response to notice under section 133(6) of the Act, this company is engaged in software development services and satisfies all the filters. 14.2 Before us, the learned Authorised Representative contended that this company ought to be excluded from the list of comparables on the ground that it is functionally different to the assessee. It is submitted by the learned Authorised Representative that this company is engaged in 'e-Business Consulting Services', consisting of Web Strategy Services, I T design services and in Technology Consulting Services including product development consulting services. These services, the learned Authorised Representative contends, are high end ITES normally categorised as knowledge process Outsourcing ('KPO') services. It is further submitted that this company has not provided segmental data in its Annual Report. The learned Authorised Representative submits that since the Annual Report of the company does not contain detailed descriptive information on the business of the company, the assessee places reliance on the details available on the company's website which should be considered while evaluating the company's functional profile.
It is also submitted by the learned Authorised Representative that KPO services are not comparable to software development services and therefore companies rendering KPO services ought not to be considered as comparable to software development companies and relied on the decision of the co-ordinate bench in the case of Capital IQ Information Systems (India) (P) Ltd. in ITA No.1961(Hyd)/2011 dt.23.11.2012 and prayed that in view of the above reasons, this company i.e. e-Zest Solutions Ltd., ought to be omitted from the list of comparables.
14.3 Per contra, the learned Departmental Representative supported the inclusion of this company in the list of comparables by the TPO. 14.4 We have heard the rival submissions and perused and carefullyconsidered the material on record. It is seen from the record that the TPO has included this company in the list of comparbales only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act. It appears that the TPO has not examined the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, we find that while the assessee is into software development services, this company i.e. e-Zest Solutions Ltd., is rendering product development services and high end technical services which come under the category of KPO services. It has been held by the co-ordinate bench of this Tribunal in the case of Capital I-Q Information Systems (India) (P) Ltd. Supra) that KPO services are not comparable to software development services and are therefore not comparable. Following the aforesaid decision of the co-ordinate bench of the Hyderabad Tribunal in the aforesaid case, we hold that this company, i.e. e-Zest IT(TP)A No. 994/Bang/2011 Page 14 of 26 Solutions Ltd. be omitted from the set of comparables for the period under consideration in the case on hand. The A.O. /TPO is accordingly directed.
Flextronics Software Systems Ltd., ITA No : 7821/Mum/2011 M/s Telcordia Technologies India P. Ltd 6.6 Learned AR submitted that this company is also involved in development of software product and providing software consulting service for the use in telecommunication industries and also sales telecommunication equipments. Besides this, it is providing services of business outsourcing (BPO). Being product and service company, it cannot be taken as comparable.
On the other hand, learned CIT DR submitted a copy of profit and loss account of the company, obtained from the public domain, which revealed that services constitute almost 90% of its sales and product sales is only 10%, hence, TPO has rightly taken the said company for comparability analysis and the contention of the assessee should be rejected.
Helios & Matheson Information Technology Limited "16. The next point made out by the assessee is with regard to the inclusion of items at (9) and (11) namely Helios & Matheson Information Technology Ltd., and KALS Information Solutions Ltd. (Seg). The primary plea raised by the assessee to assail the inclusion of the aforesaid two companies from the list of comparables is to be effect that they are functionally incomparable and therefore, are liable to be excluded. In sum and substance, the plea set up by the assessee is that both the aforesaid concerns are engaged in development and sale of software products which is functionally different from the services undertaken by the assessee in its IT-services segment.
17. As per the discussion in para 6.3.2. of the order of the TPO, the reason advanced for including KALS Information Systems Ltd., is to the effect that the said concern's application software segment is engaged in the development of software which can be considered as comparable to the assessee company. The said concern is engaged in two segments namely application software segment and Training. As per the TPO, the application software segment is functionally comparable to the assessee as the said concern is engaged in software services. The stand of the assessee is that a perusal of the Annual Report of the said concern for F.Y. 2006-07 reveals that the application software segment is engaged in the business of sale of software products and software services. The assessee pointed out this to the TPO in its written submissions, copy of which is placed in the Paper book at page 420.3 to 420.4. The assessee further pointed out that there was no bifurcation available between the business of sale of software products and the business of software services, and therefore, it was not appropriate to adopt the application software segment of the said concern IT(TP)A No. 994/Bang/2011 Page 15 of 26 for the purposes of comparability with the assessee's IT-Services Segment. The TPO however, noticed that though the application software segment of the said concern may be engaged in selling of some of the software products which are developed by it, however, the said concern was not into trading of software products as there were no cost of purchases debited in the Profit & Loss Account. Though the TPO agreed that the quantum of revenue from sale of products was not available as per the financial statements of the said concern, but as the basic function of the said concern was software development, it was includible as it was functionally comparable to the assessee's segment of IT- Services.
18. Before us, apart from reiterating the points raised before the TPO and the DRP, the Ld. Counsel submitted that in the immediately preceeding assessment year of 2006-07, the said concern was evaluated by the assessee and was found functionally incomparable. For the said purpose, our reference has been invited to pages 421 to 542 of the Paper book, which is the copy of the Transfer Pricing study undertaken by the assessee for the A.Y. 2006-07, and in particular, attention was invited to page 454 where the accept reject matrix undertaken by the assessee reflected KALS Information Solutions Ltd. (Seg) as functionally incomparable. The Ld. Counsel pointed out that the aforesaid position has been accepted by the TPO in the earlier A.Y. 2006-07 and therefore, there was no justification for the TPO to consider the said concern as functionally comparable in the instant assessment year.
19. In our considered opinion, the point raised by the assessee is potent in as much as it is quite evident that the said concern has not been found to be functionally comparable with the assessee in the immediately preceding assessment year and in the present year also, on the basis of the Annual Report, referred to in the written submissions addressed to the lower authorities, the assessee has correctly asserted out that the said concern was inter alia engaged in sale of software products, which was quite distinct from the activity undertaken by the assessee in the IT Services segment. At the time of hearing, neither is there any argument put forth by the Revenue and nor is there any discussion emerging from the orders of the lower authorities as to in what manner the functional profile of the said concern has undergone a change from that in the immediately preceding year. Therefore, having regard to the factual aspects brought out by the assessee, it is correctly asserted that the application software segment of the said concern is not comparable to the assessee's segment of IT services.
20. With regard to the inclusion of Helios & Matheson Information Technology Ltd., the assessee has raised similar arguments as in the case of KALS Information Solutions Ltd. (Seg). We have perused the relevant para of the order of the TPO i.e., 6.3.21, in terms of which the said concern has been included as a comparable concern. The assessee pointed out that as in the case of KALS Information Solutions Ltd. (Seg), in the instant case also for A.Y. 2006- 07 the said concern was found functionally incomparable by the assessee in its Transfer pricing study and the said position was not disturbed by the TPO. The relevant portion of the Transfer pricing study, placed at page 432 of the Paper book has been pointed out in support. Considered in the aforesaid light, on the IT(TP)A No. 994/Bang/2011 Page 16 of 26 basis of the discussion in relation to KALS Information Solutions Ltd. (Seg), in the instant case also we find that the said concern is liable to be excluded from the list of comparables."
"12. (4) Infosys Technologies Ltd.
12.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment.
12.2 Before us, the assessee contended that this company is not functionally comparable to the assessee and in this context has cited various portions of the Annual Report of this company to this effect which is as under :-
(i) The company has an Intellectual Property (IP) Cell to guide its employees to leverage the power of IP for their growth. In 2008, this company generated over 102 invention disclosures and filed an aggregate 10 patents in India and the USA. Till date this company has filed an aggregate of 119 patent applications (pending) in India and USA out of which 2 have been granted in the US.
(ii) This company has substantial revenues from software products and the break-up of the software product revenues is not available.
(iii) This company has incurred huge research and development expenditure to the tune of approximately Rs.200 Crores.
(iv) This company has a revenue sharing agreement towards acquisition of IPR in AUTOLAY, a commercial software product used in designing high performance structural systems.
(v) The assessee also placed reliance on the following judicial decisions :-
(a) ITAT, Delhi Bench decision in the case of Agnity India Technologies India Pvt. Ltd.
(ITA No.3856/Del/2010) and
(b) Trilogy E-Business Software India Pvt. Ltd. (ITA No.1054/Bang/2011) 12.3 Per contra, opposing the contentions of the assessee, the learned Departmental Representative submitted that comparability cannot be decided merely on the basis of scale of operations and the operating margins of this company have not been extraordinary. In view of this, the learned Departmental Representative supported the decision of the TPO to include this company in the list of comparable companies.
12.4 We have heard the rival submissions and perused and carefully considered the material on record. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis- similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) for Assessment Year 2007-08 is applicable to this year also. The argument put forth by assessee's is that Infosys Technologies Ltd is not IT(TP)A No. 994/Bang/2011 Page 17 of 26 functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the break up of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly.
Ishir Infotech Limited "As regards Ishir Infotech Ltd., the Tribunal has considered the decision of the Tribunal in the case of 24/7 Co. Pvt. Ltd to hold that Ishir Infotech is also out-sourcing its work and, therefore, has not satisfied the 25% employee cost filter and thus has to be excluded from the list of comparables. As the facts of the case before us are similar, respectfully following the decision of the co-ordinate bench, we hold that these two companies are also to be excluded."
(d) KALS Information Systems Ltd.
46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal's decision of the ITAT in the case of Bindview India Private Limited Vs. DCI, ITA No. ITA No 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows:
"16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds."
IT(TP)A No. 994/Bang/2011 Page 18 of 26 Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable.
Lucid Software Limited ITA No : 7821/Mum/2011 M/s Telcordia Technologies India P. Ltd 6.2 The contention of the learned AR is that, the Lucid Software Company though described as Software Development Company, is mainly dealing in selling of software products, which is reflected in the website of the said company and develops a software product called "Muluam", which is used in civil engineering structures. He submitted that as per the details given, the company has employed the capital of `.1,18,57,145/-, out of which the product development expenditure itself was `.47,14,783/-, which comes to 39.76% of the capital. The said party is a product software company, different from assessee's nature of activities which is purely engaged in software services. The software product company is different from software development company as the margin of profit in sale of product is very high, hence, it cannot be taken as a comparable case. Alternatively, he submitted that the TPO has wrongly ignored, depreciation and amortisation of the software development expenses and excluded the interest from the operating profit. The analysis of the operating profit vis-à- vis the analysis of TPO was given as under :-
Particulars As per TPO As per
Appellant
Operating Revenue 16,992,078 16,992,078
Less :
Software services and 11,507,896 11,507,896
administrative expenses
Interest (3,99,799) -
Foreign exchange fluctuation (134, 783) (134, 783)
Depreciation Not considered 995,484
Amortisation of software Not considered 1,866,703
development expenses
Total Operating Expenses 1,09,73,224 14,235,300
Operating Profit 60,18,854 2,756,778
ITA No : 7821/Mum/2011
M/s Telcordia Technologies India P. Ltd
Operating mark up on cost 54.85% 19.37%
Thus, if these expenses are considered then operating profit will come down to 19.37%.
"17. Persistent Systems Ltd.
17.1.1 This company was selected by the TPO as a comparable. The assessee objected to the inclusion of this company as a comparable for the reasons that this company being engaged in software product designing and analytic IT(TP)A No. 994/Bang/2011 Page 19 of 26 services, it is functionally different and further that segmental results are not available. The TPO rejected the assessee's objections on the ground that as per the Annual Report for the company for Financial Year 2007-08, it is mainly a software development company and as per the details furnished in reply to the notice under section 133(6) of the Act, software development constitutes 96% of its revenues. In this view of the matter, the Assessing Officer included this company i.e. Persistent Systems Ltd., in the list of comparables as it qualified the functionality criterion.
17.1.2 Before us, the assessee objected to the inclusion of this company as a comparable submitting that this company is functionally different and also that there are several other factors on which this company cannot be taken as a comparable. In this regard, the learned Authorised Representative submitted that :
(i) This company is engaged in software designing services and analytic services and therefore it is not purely a software development service provider as is the assessee in the case on hand.
(ii) Page 60 of the Annual Report of the company for F.Y. 2007-08 indicates that this company, is predominantly engaged in 'Outsourced Software Product Development Services' for independent software vendors and enterprises.
(iii) Website extracts indicate that this company is in the business of product design services.
(iv) The ITAT, Mumbai Bench in the case of Telecordia Technologies India Pvt.
Ltd.(supra) while discussing the comparability of another company, namely Lucid Software Ltd. had rendered a finding that in the absence of segmental information, a company be taken into account for comparability analysis. This principle is squarely applicable to the company presently under consideration, which is into product development and product design services and for which the segmental data is not available.
The learned Authorised Representative prays that in view of the above, this company i.e. Persistent Systems Ltd. be omitted from the list of comparables. 17.2 Per contra, the learned Departmental Representative support the action of the TPO in including this company in the list of comparables. 17.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider. We find that, as submitted by the assessee, the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details / information a company cannot be taken into account for comparability analysis, we hold that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. It is ordered accordingly. 14.0 (6) Tata Elxsi Ltd.
14.1 This company was a comparable selected by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the set of comparables on several counts like, functional dis-similarity, significant R&D IT(TP)A No. 994/Bang/2011 Page 20 of 26 activity, brand value, size, etc. The TPO, however, rejected the contention put forth by the assessee and included this company in the set of comparables.
Thirdware Solutions Ltd. (Segment) 15.1 This company was proposed for inclusion in the list of comparables by the TPO. Before the TPO, the assessee objected to the inclusion of this company in the list of comparables on the ground that its turnover was in excess of Rs.500 Crores. Before us, the assessee has objected to the inclusion of this company as a comparable for the reason that apart from software development services, it is in the business of product development and trading in software and giving licenses for use of software. In this regard, the learned Authorised Representative submitted that :-
(i) This company is engaged in product development and earns revenue from sale of licences and subscription. It has been pointed out from the Annual Report that the company has not provided any separate segmental profit and loss account for software development services and product development services.
(ii) In the case of E-Gain communications Pvt. Ltd. (2008-TII-04-ITAT-PUNE- TP), the Tribunal has directed that this company be omitted as a comparable for software service providers, as its income includes income from sale of licences which has increased the margins of the company.
The learned A.R. prayed that in the light of the above facts and in view of the afore cited decision of the Tribunal (supra), this company ought to be omitted from the list of comparables.
15.2 Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the list of comparables. 15.3 We have heard the rival submissions and perused and carefully considered the material on record. It is seen from the material on record that the company is engaged in product development and earns revenue from sale of licenses and subscription. However, the segmental profit and loss accounts for software development services and product development are not given separately. Further, as pointed out by the learned Authorised Representative, the Pune Bench of the Tribunal in the case of E-Gain Communications Pvt. Ltd. (supra) has directed that since the income of this company includes income from sale of licenses, it ought to be rejected as a comparable for software development services.
In the case on hand, the assessee is rendering software development services. In this factual view of the matter and following the afore cited decision of the Pune Tribunal (supra), we direct that this company be omitted from the list of comparables for the period under consideration in the case on hand." Wipro Limited 13.1 This company was selected as a comparable by the TPO. Before the TPO, the assessee had objected to the inclusion of this company in the list of comparables or several grounds like functional dis-similarity, brand value, size, etc. The TPO, however, brushed aside the objections of the assessee and included this company in the set of comparables.
IT(TP)A No. 994/Bang/2011 Page 21 of 26 13.2 Before us, the assessee contended that this company is functionally not comparable to the assessee for several reasons, which are as under :
(i) This company owns significant intangibles in the nature of customer related intangibles and technology related intangibles and quoted extracts from the Annual Report of this company in the submissions made.
(ii) The TPO had adopted the consolidated financial statements for comparability purposes and for computing the margins, which contradicts the TPO's own filter of rejecting companies with consolidated financial statements.
13.3. Per contra, the learned Departmental Representative supported the action of the TPO in including this company in the set of comparables. 13.4.1 We have heard both parties and carefully perused and considered the material on record. We find merit in the contentions of the assessee for exclusion of this company from the set of comparables. It is seen that this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison.
13.4.2 We also find that this company owns intellectual property in the form of registered patents and several pending applications for grant of patents. In this regard, the co-ordinate bench of this Tribunal in the case of 24/7 Customer.Com Pvt. Ltd. (ITA No.227/Bang/2010) has held that a company owning intangibles cannot be compared to a low risk captive service provider who does not own any such intangible and hence does not have an additional advantage in the market. As the assessee in the case on hand does not own any intangibles, following the aforesaid decision of the co-ordinate bench of the Tribunal i.e. 24/7 Customer.Com Pvt. Ltd. (supra), we hold that this company cannot be considered as a comparable to the assessee. We, therefore, direct the Assessing Officer/TPO to omit this company from the set of comparable companies in the case on hand for the year under consideration.
11. The learned CIT-DR had not brought any evidence on record controverting the above findings of the Tribunal. In the circumstances, we hold that these companies cannot be included in the list of the comparables with that of the assessee company. Therefore, we direct the AO/TPO to exclude these companies from the list of comparables.
IT(TP)A No. 994/Bang/2011 Page 22 of 26
12. The assessee company also sought the inclusion of Indium Software (India) Limited. It is submitted that this company was rejected by TPO by holding that it fails the foreign exchange filter of more than 25% and it passes through all other filters applied by the TPO. It is submitted that the foreign exchange earning of the company is 31.74% and therefore it passes through the foreign exchange filter also. Therefore, this company also should be included in the list of the comparables and reliance was placed on the decision of M/s.NXP Semiconductors India Pvt. Ltd.
13. We heard the rival submission and perused the material on record. The issue of comparability of M/s. Indium Software (India) Limited had come up before the coordinate bench in the case of M/s. NXP Semiconductors India Pvt. Ltd., wherein the Hon'ble Tribunal has held as follows:
"32. Indium Software (India) Limited:-
Before the TPO the Assessee sought to include the aforesaid company as a comparable company. The TPO rejected the plea of the Assessee on the ground that as per Schedule 12 & 13 of the Profit and Loss account out of the total operating revenues of Rs.649,14.48,000 revenue from software testing and training services were Rs.539,39,82,000 and Rs.8,93,88,000 respectively. The TPO therefore concluded that this company was generating revenues mainly from testing services which are not in the nature of software development services as render by other software development companies. This company does not write any code. That this company tests the software products, generate bug reports and coordinate with software product develoers using testing tools. Such services are speciflised services in the nature of software quality assurance(QA)/testing. Such service provides merely ensure that the applications/products of third party vendors meet customer specifications and expected service levels. According to the TPO the above services were not in the nature of software development services and therefore the aforesaid company cannot be considered as a comparable company."
14. The learned counsel for the assessee company had not brought any evidence controverting the above findings. Therefore, respectfully IT(TP)A No. 994/Bang/2011 Page 23 of 26 following the decision of the coordinate bench, we direct the AO/TPO to include this company in the final list of comparables.
15. The next ground of appeal relates to the reimbursement of expenditure, not to be treated as part of operating cost as well operating revenue. It is the contention of the assessee company that the reimbursement of expenditure was routed through Balance Sheet and therefore cannot be routed through profit and loss account as there was no service or profit element involved and therefore the same should not be treated either as part of operating cost or part of operating revenue, he placed reliance on the decision of the Hon'ble coordinate bench in the assessee's own case for the assessment year 2006-07 and 2008-09. We have heard the rival submission and perused the material on record. Respectively following the decision in the earlier orders, we remand back this issue to the file of the AO to examine the issue whether any profit element is involved in the reimbursement of this transaction or not and is in the nature of pure reimbursement of expenditure.
16. The next ground of appeal challenges that the foreign exchange gain/loss should be treated as operating in nature for the purpose of computing the operating margin, as the same is in relation to the sale proceeds of the assessee company and reliance in this regard was placed on the decision of Hon'ble Delhi High Court in the case of CIT Vs. Fieserv India Pvt. Ltd., ITA No.17/2016. Now the law is settled that the exchange gain/loss arises on account of realizing of sales, payment to suppliers should be treated as part of operating revenue/operating cost. However, nothing is shown to us to IT(TP)A No. 994/Bang/2011 Page 24 of 26 demonstrate that the foreign exchange loss is on account of revenue items i.e., on account of purchase of revenue items and therefore, we remand this issue back to the file of AO/TPO to examine whether the loss is arising on account of revenue items, if so, to treat it as a part of the operating cost for the purpose of computing the operating margins of the company.
17. The other ground of appeal relates to not giving benefit of the risk adjustment. The learned DR submitted that in the light of the decision of the coordinate bench in the case of Gem Solutions Pvt. Ltd., the assessee is not entitled to any risk adjustment. The decision of the Hon'ble coordinate bench is as under:
IT(TP)A No. 994/Bang/2011 Page 25 of 26
18. In the light of the decision of the coordinate bench, the assessee is not entitled to any benefit of risk adjustment.
19. The next ground of appeal relates to the corporate tax deduction under section 10A & 10B. The issue raised in the above ground of appeal is covered in favour of the assessee company by the decision of the jurisdictional High Court in the case of Tata Elxsi 349 ITR 98.
20. In the result, the appeal filed by the assessee is partly allowed for statistical purposes.
Pronounced in the open court on this 21st day of April, 2017.
Sd/- Sd/-
(SUNIL KUMAR YADAV) (INTURI RAMA RAO)
Judicial Member Accountant Member
Bangalore.
Dated: 21st April, 2017.
/NShylu/
IT(TP)A No. 994/Bang/2011
Page 26 of 26
Copy to:
1. Appellants
2. Respondent
3. CIT
4. CIT(A)
5. DR, ITAT, Bangalore.
6. Guard file
By order
Assistant Registrar,
ITAT, Bangalore.