Income Tax Appellate Tribunal - Delhi
Dcit, New Delhi vs M/S Microfoft India (R&D) Pvt. Ltd, New ... on 14 September, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : I-1 : NEW DELHI
BEFORE SHRI R.S. SYAL, VICE PRESIDENT
AND
SHRI K. NARASIMHA CHARY, JUDICIAL MEMBER
ITA No.1479/Del/2016
Assessment Year : 2011-12
Microsoft India (R&D) Pvt. Ltd., Vs. DCIT,
807, New Delhi House, Circle-16(2),
Barakhamba Road, New Delhi.
New Delhi.
PAN: AABCM6358F
ITA No.691/Del/2016
Assessment Year : 2011-12
DCIT, Vs. Microsoft India (R&D) Pvt. Ltd.,
Circle-16(2), 807, New Delhi House,
New Delhi. Barakhamba Road,
New Delhi.
PAN: AABCM6358F
(Appellant) (Respondent)
Assessee By : Shri Nageshwar Rao,
Shri Sandeep S. Karhail &
Parth, Advocates
Department By : Shri Sanjay I Bara, CIT, DR
ITA Nos.1479 & 691/Del/2016
Date of Hearing : 10.09.2018
Date of Pronouncement : 14.09.2018
ORDER
PER R.S. SYAL, VP:
These cross appeals - one filed by the assessee and the other by the Revenue arise out of the final assessment order passed by the Assessing Officer (A.O.) u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called 'the Act') in relation to the assessment year 2011-12.
2. At the outset, it is relevant to mention that when the appeal of the assessee came up for hearing before the Tribunal on 05.06.2018, it raised an additional ground contending that the transfer pricing adjustments made by the TPO are bad in law, inter alia, for the raison d'etre that the TP documentation prepared by the assessee was not rejected by the Officer. Vide interim order dated 23.07.2018, a copy placed on record, the Tribunal rejected the assessee's contention by chiefly observing that the TP study made available by the assessee was found to be not fully in compliance with the provisions of the Act and Rules and further the exclusion of some 2 ITA Nos.1479 & 691/Del/2016 comparables and other adjustments made by the TPO tantamount to its implied rejection. This is how, the appeal is now being taken up for final disposal on all other grounds.
PROVISION OF SOFTWARE DEVELOPMENT SERVICES (Hyderabad Unit)
3. The first issue raised by the assessee in its appeal is against the addition on account of transfer pricing adjustment amounting to Rs.197,23,68,765/- made by the Assessing Officer (AO) in the international transaction of ` Provision of Software Development services'.
4. Briefly stated, the facts of the case are that the assessee was set up in India in May, 1998 and is a subsidiary of Microsoft Ireland Research Ltd., Ireland (99.99% shareholding) with the ultimate parent company, Microsoft Corporation, USA. The assessee is engaged, inter alia, in rendering Software development services and Information Technology Enabled Services (ITES). The assessee filed Audit Report in Form no. 3CEB declaring six international transactions. The AO referred the matter of determination of the arm's length price (ALP) of the international transactions to the Transfer Pricing Officer (TPO). The international 3 ITA Nos.1479 & 691/Del/2016 transaction instantly under consideration is 'Provision of software development services (Hyderabad Unit)' with transacted value of Rs.1072,06,63,928/-. The assessee was compensated by its AE for such services at cost plus 15%. The assessee employed the Transactional Net Margin Method (TNMM) with the Profit level indicator (PLI) of Operating profit to Operating cost (OP/OC) for demonstrating that the international transaction was at ALP. As the assessee's PLI at 14.34% was shown to be better than 9.50% of comparables, on the basis of multiple year data, the assessee claimed that this international transaction was at ALP.
5. The assessee contended during the course of proceedings before the TPO that its international transaction of Software development services primarily included two things, viz., Contract software development services and Internal information technology support. The assessee explained that it was engaged in writing and testing codes under the direction of MS Corporation, USA requiring comparatively low level of expertise and skills. It was further explained that such services were rendered only for certain functions or modules within a product and not for the whole product, which activity, in turn, was done by MS Corporation in US. The 4 ITA Nos.1479 & 691/Del/2016 assessee still further stated that there were a couple of minor products, like BizTalk and Data Protection Manager (DPM), for which it provided significantly more Product engineering and design work services. In performing such Product engineering services, the assessee claimed that it did not deal with any other aspect of product development, such as, market research nor did it make any decision regarding which products were to be developed. It was explained that the ultimate holding company, namely, MS Corporation, USA, generates revenue by developing, manufacturing and supporting a wide range of software products and services for different types of computing devices and in order to make such products, the assessee and other MS affiliates perform R&D activity in a very limited way around the world under the overall guidance of MS Corporation, USA. The assessee explained the Software product life cycle comprising of three phases, namely, Product Definition, Product Engineering and Servicing. Under the Product Definition (Conceptualization Phase), a value proposition and a product prototypes are developed based on customer feedback etc. Then, marketing research is performed to test the value proposition and the marketing feasibility of a product prototype, which 5 ITA Nos.1479 & 691/Del/2016 closes the first phase. This phase was stated to be performed entirely in US by MS Corp except for a very limited role being played by the assessee in India. In the second phase of Project engineering which is a five-step process involving determination of the requirements, design, implementation, verification and release, the assessee submitted that the bulk of this activity takes place in the US at MS Corp. and the assessee has a limited input into the design of the product. The final phase of Servicing was stated to be performed in the US by MS Corp. In the entire software product lifecycle, the assessee submitted that it provided limited services to MS Corporation and that too under their directions. The assessee also stated to have provided software development services to Microsoft, USA, by developing software applications exclusively for MS Corp. group's internal use. The TPO analyzed the assessee's contentions in the hue of material before him and opined that the assessee was not a routine software developer, but, was engaged in rendering high quality software engineering services to MS Corp. and thus contributed positively to ultimate products developed and released by the latter. He further held that even though the overall work was to be supervised by foreign AE, but, the work assigned to 6 ITA Nos.1479 & 691/Del/2016 the assessee was to be done on its own by its team of experts having 1376 persons. Considering the fact that the assessee was remunerated on cost plus 15%, the TPO held that the same was not at ALP as the Microsoft USA, to whom services were rendered and were in the nature of contributions to the products being integrated there, earned margin ranging between 60 to 70% of the cost. He further did not approve the assessee's application of weighted margin of comparables. Out of 27 companies chosen by the assessee as comparable listed on pages 56 onwards of the TPO's order, he retained only one company, namely, M/s Persistent Systems Ltd. and chose three new companies, namely, Infosys Technologies, E-Infochips Bangalore and Wipro Technology Services Ltd. After finding out the current year's margin of these comparables, the TPO proposed transfer pricing adjustment of Rs.201,21,96,582/-. The assessee assailed the correctness of the draft order passed by the A.O., incorporating the TPO's view point, before the Dispute Resolution Panel (DRP) which directed to recompute the profit margin of the comparables. On giving effect to the directions of the DRP, the TPO proposed fresh transfer pricing adjustment of Rs.197,23,68,765/- in the international transaction of 7 ITA Nos.1479 & 691/Del/2016 provision of Software development services, for which the addition came to be made in the final assessment order. The assessee is aggrieved by the addition.
6. We have heard both the sides and perused the relevant material on record. The assessee employed the TNMM as the most appropriate method with the PLI of OP/OC for benchmarking the international transaction of rendering software development services. Unlike some earlier years, the TPO did not dispute the application of the TNMM as the most appropriate method, nor did he dispute the PLI. The assessee has primarily challenged the inclusion of all the companies and also the exclusion of some of its selected companies by the TPO in/from the final list of comparables.
7. Comparability of companies can be gauged only after fully ascertaining the functional profile of the assessee in respect of the international transaction under challenge. Thus, the first and the foremost task at our end is to identify the nature of actual services rendered by the assessee to Microsoft, USA under this international transaction. The assessee's main plank of submissions before the TPO was that it provided limited services 8 ITA Nos.1479 & 691/Del/2016 to MS Corp., USA in the product development cycle, which activity was wholly supervised by MS Corp., USA and done in different countries and the assessee was simply involved in creating some features within the overall product, which made it an ordinary captive low profile software developer. On the other hand, the case of the Revenue is that the assessee is engaged in providing high end software development services involving innovations and the same are in the context of products to be launched in future and such services result in creation of intangibles, which are distinct from a routine software development.
8. In this regard, we first advert to the version of the assessee on its nature of services rendered, as recorded in the TP documentation and stated before the TPO. The TPO on page 43 of his order has reproduced parts of the assessee's TP Study report describing the functions carried out by it as : (i) doing the contract software development services referring to the software development phase of the software development lifecycle, which primarily involves writing and testing codes under the direction of MS Corp.; (ii) doing only such functions or modules within a product as desired and not for the whole product, which, in turn, was assembled by 9 ITA Nos.1479 & 691/Del/2016 MS Corp. in USA; (iii) performing software development services for Microsoft IT including development of software applications exclusively for MS Corp. group's internal use, that is CSS Business Intelligence - Application to help CSS business worldwide to collect and report the information for decision making; VL FY11 MS Corp Quote - Applications to help manage customer queries for quotes/pricing for MS Corp products; OPS FY11 order management - Applications to help manage customer orders for MS-Corp products; Incentive Comp - Applications to manage Sales and Marketing teams incentives for the targets achieved; OPS FY11 OS PRSS - PIDNext - Applications to build next generation product key series for MS Corp products; Global Sales Experience (GSX) - CRM application for MS Corp Sales and marketing efforts; Headcount - Applications for maintaining headcount details for Full Time Employees (FTEs) and vendor resources; EAS - Enhancement - Portfolio of applications for enhancements on SAP customization for Microsoft (MS Corp) Business requirements; VL FY11 Volume Licensing software (VLSC) - Licensing application for MS Corp product sales. Thereafter, the TPO has noted in para 2.4 on page 45 of his order that the TP study 10 ITA Nos.1479 & 691/Del/2016 acknowledged that the assessee participated in the product definition process for subsequent versions of minor products like BizTalk for which the initial product definition was produced by MS Corp. (page 13 of TP study report); the assessee is responsible for design, implementation and verification of code for minor products like BizTalk and DPM (Data Protection Manager) (page 14 of the TP study report); Product definition is performed outside India with the exception of some incubation projects targeting emerging markets (page 15 of the TP study report); the assessee is creating ten inch language tools which are available for free for download from Microsoft (page 15 footnote of the TP study). The TPO has recorded in para 2.8 on page 46 of his order that the patents were created by the assessee in India in respect of the work done by it, which were registered in USA. This fact, in the opinion of the TPO, abundantly established that the assessee is rendering high-end software development services, which are unique and quite different from normal software activities.
9. The ld. AR heavily relied on interviews of certain employees of the assessee-company conducted by the Advance Pricing Agreement (APA) 11 ITA Nos.1479 & 691/Del/2016 Authorities in September, 2013 to buttress his point that the assessee was providing routine software development services of coding and testing and that too, under the direct supervision of Microsoft, USA, and further such services were of little consequence in the overall MS products. It was submitted that in these interviews all the officials categorically stated that the direction for doing the work came from MS, USA and the execution was done strictly according to such directions. A view was canvassed that these statements graphically divulged that the assessee is not involved in any R&D activity.
10. Having gone through the relevant parts of some of the interviews, whose copies have been placed on record by the assessee, it can be seen that the first interview was of Shri Rajiv Kumar, with the designation of General Manager - Office Group, IDC, Hyderabad. In response to Question no.1, he submitted to be responsible for four engineering teams at India Development Centre (IDC), Hyderabad, working on some features of Word web App e.g., Page Numbers and Annotations (Header and footer). As regards Visio, he stated that his team is supporting new features for the next office version of Office. For Graphics, he submitted that his team was 12 ITA Nos.1479 & 691/Del/2016 supporting picture, table, smart art used in various office products for the next release. Next is the interview of Shri Tanuj Vohra with designation of General Manager, Development, MSIT, Hyderabad. In response to Question no.1, he submitted that as a General Manager, Development Division, he is responsible for engineering delivery of IT solutions and services used by MS for internal consumption, which include packaged and custom applications developed using Microsoft and third party software such as SAP, Infragistics etc. In response to Question no.6, he admitted to be working closely with other engineering leaders in Redmond, USA. For the work assigned to the assessee, he stated to be writing the functional specifications documents. Next is the interview of Shri Amit Chatterjee with designation of Managing Director and General Manager - Developer Tools and Windows Azure. In response to question no. 1, he stated to be involved, along with his team, in two feature areas in engineering organization, the first one, being, the Visual Studio Product line of Microsoft which is a part of Developer Division at Microsoft and the second, being, Azure product line. Azure is a distributed operating system for the Microsoft Cloud offering, similar to the dedicated operating system 13 ITA Nos.1479 & 691/Del/2016 for Windows desktop. Next is the interview of Shri Anil Bhansali with designation of General Manager, Windows Server and System Centre, IDC, Hyderabad. He, along with his team, stated to be involved in WinSE Charter, Windows Engineering Group Server. In response to question no. 2 about the work flow in respect of each area of its activity, he stated that the same would be submitted later. There is nothing on record to substantiate that anything was submitted later. In response to question no. 6, he stated that the IDC team works on different features in different Windows versions e.g., Windows Store work going back to Redmond and the IDC team working on something totally different for the next version of Windows. In response to question no. 8 about the degree of functional autonomy, he stated that: "Once I have the feature or sub-feature task assigned to me, I would have autonomy to engineer/execute on this (as long as it is independent)." Next is the interview of Mr. Nitin Chandel with the designation of Partner Engineering Manager, Bing Ads Team, Bangalore. In response to question no.1, he stated that as a Partner Engineering Manager, Bing Ads team have carried out three functions, namely, Development, Test and PM. In response to Question no.3(e), he stated that 14 ITA Nos.1479 & 691/Del/2016 they sometimes use vendors (such as Infosys) to do some work. A common thread running through all the interviews is that they admitted that the work was assigned to them by MS, USA which is only a feature of the overall product and not the product in itself and further that the work was done by them for MS, USA and the same was performed as per the instructions of Microsoft, USA. A further common feature emerging from all the interviews conducted by the APA Authorities is that they were using Process tools (customised software, readymade templates and guidelines, etc.) provided by Microsoft USA, in the execution of work, albeit at no cost. It is palpable from the above interviews that the General Manager, Development, MSIT, Hyderabad agreed that he was responsible for engineering delivery of IT solutions; the General Manager, Windows Server and System Centre, IDC, Hyderabad failed to submit the work flow in respect of each area of its activity and also admitted that Once a feature or sub-feature task is assigned to him, he would have autonomy to engineer/execute it; and the Partner Engineering Manager, Bing Ads Team, Bangalore admitted that Bing Ads team have carried out three functions, namely, Development, Test and PM. We further find that the above 15 ITA Nos.1479 & 691/Del/2016 statements, on which the ld. AR has heavily banked upon, are inconclusive of their fate at this stage inasmuch as these were recorded by the APA Authorities in September, 2013 and, on a specific query, the ld. AR submitted that no decision of APA has come so far. Thus, it is patent that it is only one side of the story and till date, the consequences of these statements in the overall scenario, are yet not available by way of any order by the APA as to whether these were accepted or any further investigation was carried out which either corroborated the same or transpired anything else.
11. When we consider the version given in the interviews by these people that they were not at all involved in conceptualization, we find the same to be running contrary to the submissions made by the assessee before the TPO, which have been captured on page 42 of his order by means of a table in which the assessee has categorically admitted that it is involved in conceptualization and scoping of project work including defining functions specifications though in a very limited way. Despite specific requisition made by the TPO to give data as to how its role was limited or very limited 16 ITA Nos.1479 & 691/Del/2016 in product conceptualization, the assessee did not submit any material/evidence. A finding to this effect has been recorded on page 44 of TPO's order. Again, it has been recorded on page 45 of the order that though the assessee claimed in Parent-Subsidiary Agreement (PSA) dated 01.07.2003 that it undertook the activity of research and development work as requested and approved in writing by MS Corporation from time to time, but, no such evidence was furnished by the assessee despite being specifically asked to do so vide letter no.543 dated 15.12.2014. Thereafter, it has been noted by the TPO in para 2.5 of the show cause notice, which has been reproduced in his order, that though the assessee admitted in its TP Study report that it had a varying role to play in all the three phases, namely, Product Definition, Product Development and Product Servicing, but no elaboration of the degree of role played was done by the assessee.
12. Notwithstanding the above interviews, the assessee itself summarized its role before the TPO in different stages of the Software Product Lifecycle by means of a Table, which has been reproduced on page 42 of the TPO's order, reading as under :-
17
ITA Nos.1479 & 691/Del/2016 Type of functions MIRPL MS Corp.
Conceptualisation and Very Limited Yes
scoping of project work
including defining
functional specifications
Project execution Yes subject to Yes
supervision by MS
Corp.
Coding, testing and Yes, as per the Yes
documentation directions of MS
Corp.
Quality assurance Yes, but no economic Yes
burden of quality
failure
Sales and Marketing No Yes (in respect of
integrated final
product)
13. This Table enumerates five functions, out of which first four relate to software development, whilst the last one is concerned with marketing.
Admittedly, the sales and marketing activity of the MS Products has no relevance with the rendering of software development services. Out of the remaining four relevant functions, the first one is 'Conceptualization and scoping of project work including defining functional specifications.' Against the assessee's role in this function, it has been mentioned as 'Very limited.' In the second and third functions of 'Project execution' and 18 ITA Nos.1479 & 691/Del/2016 'Coding, testing and documentation', the assessee's role has been mentioned as 'Yes, subject to supervision/directions by/of MS Corp.' In the fourth function, namely, `Quality assurance', the assessee's role has been given as 'Yes (but, no economic burden of quality failure)'. From the above Table, it is manifest that the assessee has categorically admitted before the TPO that it was involved, to some extent, in Conceptualization of project work, Project execution, Coding, testing & documentation and Quality assurance. The TPO has repeatedly noted that though the assessee admitted in its Transfer pricing study report to be involved in development of software etc., : `but it does not give any data as to how it is construed that the role in product conceptualization is limited or very limited'. Similar is the position regarding the other functions, such as, Project execution and Coding, testing and documentation, in which, again, the assessee admitted to have a limited role to play, but did not spell out such role before the TPO.
14. The assessee also acknowledged in its TP Study report, as has been extracted in para 2.8 on page 46 of the TPO's order, that it is involved in the development of various products and `is responsible for design 19 ITA Nos.1479 & 691/Del/2016 implementation and verification of some products like BIZTALK and DPM'; is `also involved in product definition phase of some incubation project, like development of various indic language translators'; and is `also involved in the creation of window vista'. Despite the above averments in the Transfer Pricing Study Report, the assessee not only took a contrary stand before the TPO by trivializing its role as restricted only to coding and testing of some features of the Microsoft products but also failed to substantiate the same.
15. With a view to give one more chance to the assessee to substantiate its version about the nature of work carried out in this international transaction, the Bench required the ld. AR to produce primary evidence of the work actually done with the help of Requisition and disposal registers etc. divulging the date when a particular work was assigned to it, how many days it took in doing the same, how many man-hours went into its doing, what was the final output and when was it sent to the AE. The ld. AR refused to share any such primary data and harped on the interviews conducted by the APA Authorities, whose relevance at this juncture has been discussed supra. It is apparent that the assessee was not only obliged 20 ITA Nos.1479 & 691/Del/2016 to but has, in fact, maintained such complete records. We have extracted infra the relevant parts of the PSA between the assessee and Microsoft, USA, which clearly provide that the `Subsidiary (i.e. the assessee) hereby agrees to undertake such research and development work as requested and approved in writing by MSFT ( i.e. Microsoft, USA) from time to time'. This shows that not only the request for the work has to come from Microsoft, USA in writing, but the work done has also to be approved in writing, which automatically implies the maintenance of all such primary records. The fact that the assessee has, in fact, maintained such primary records is fairly borne out from its own submission before the TPO as reproduced on page 42 of his order that :`Furthermore, MIRPL (i.e. the assessee) is responsible for generating and maintaining appropriate documentation in connection with the services rendered to MS Corp.' The Managing Director of the assessee-company, Shri Amit Chatterjee, also admitted in his interview to the APA Authorities in response to question no.8 that : "my reports go to Redmond twice a year and there is regular interaction with the Redmond team at several levels and along the way review of IDC work and cross correction by Redmond" is done. It is thus 21 ITA Nos.1479 & 691/Del/2016 clear beyond any shadow of doubt that the assessee maintained all the relevant primary records, but did not produce the same before the authorities. The assessee is simply trying to marginalize its role to a bare minimum by a lip service contrary to what has been stated in the TP study and submitted before the TPO by way of a chart, as has been discussed above.
16. Admittedly, the assessee did not carry out the entire work of the MS Products at its own. Out of the work assigned, it sub-contracted some of the work to the Indian parties, for which it made a payment of Rs.158 crore during the year. Such payment is divided into two parts, viz., Rs.126.75 crore towards Application & Development and Rs.31.70 crore towards Product Development. The ld. AR was directed to produce contracts entered into with all the third parties for which such a sum of Rs.158 crore was paid so as to judge the overall nature of the work done by the assessee. Out of 12 contracts under `Application & Development', the assessee has filed copy of Agreements only with one party, that is, Accenture Services Private Limited. Out of 33 contracts under `Product Development', the assessee has filed copies with three parties only. Thus our attempt to find 22 ITA Nos.1479 & 691/Del/2016 out the overall nature of work done by the assessee with the aid of sub- contractors has also not fructified.
17. The ld. AR tried to justify his stand of not sharing the primary evidence by stating that the examination of such an evidence was not warranted as the interviews done by the APA Authorities gave enough hints about the work done. Such a submission that the authorities should decide the nature of work done without looking into primary evidence of the actual work done is not only strange but totally out of place. How an assessment is to be done falls in the exclusive domain of the authorities. The assessee cannot be allowed to dictate to the authorities as to the nature of evidence to be examined and the extent of such an examination for determining the issues which are of immense importance in the assessment. It is the sole prerogative of the authorities to decide the course of action and the nature of evidence to be examined for enabling them to complete the assessment, as long as their requirements do not breach the level of reasonableness and relevance.
23
ITA Nos.1479 & 691/Del/2016
18. Reverting to the point, the issue is the examination of comparables, which can't be decided unless the assessee's functional profile is fully understood. Examination of primary evidence of the work done by the assessee for this purpose is critical, without which the exercise of comparability cannot be undertaken properly. In normal circumstances, we would have upheld the drawing of an adverse inference against the assessee because of its unwillingness to share the desired primary information. Since the issue before us is crucial and has an impact in other years as well, we, with the help of both the parties, delved into other material available on record to extract the true nature of work done by the assessee. In this course of action, we first examined the PSA dated 1.7.2003 entered into by the assessee with Microsoft Corporation, USA, for rendering Research and Development services, a copy of which has been placed on record. Clause 2 of the Agreement, with the caption Research and Development, reads as under : -
`2. RESEARCH AND DEVELOPMENT Subsidiary (i.e. the assessee) hereby agrees to undertake such research and development work as requested and approved in writing by MSFT ( i.e. Microsoft, USA) from time to time.24
ITA Nos.1479 & 691/Del/2016 Subsidiary may subcontract with third parties to perform some or all of such work upon MSFT approval. In the event that MSFT contracts directly with vendors in country, MSFT may request the subsidiary to provide assistance with regard to such contracts.'
19. Clause 4 of the Agreement with the caption `Fees: Payment terms' states that: `In consideration of Subsidiary's research and development activities under Article 2 of the Agreement, MSFT shall pay Subsidiary a fee equal to one hundred and fifteen percent (115%) of Subsidiary's actual expenses...'.
20. Clause 5 of the PSA, which is central for our purpose, states that the intellectual property in respect of research work done by the assessee shall vest in Microsoft, USA, relevant parts of which read as under : -
5. INTELLECTUAL PROPERTY MATTERS 5.1 Research and Development. Subsidiary agrees that any and all developments made by it or under Subsidiary's direction, in connection with the performing of research and development work for MSFT shall be owned by MSFT in their entirety. Such developments shall (to the extent possible) be deemed "works made for hire" created by Subsidiary for MSFT pursuant to 17 USC Section 102(b). All copyrights (to the extent (if at all) not already owned by MSFT as "works made for hire), patents and other proprietary rights in such developments shall be and are hereby transferred, sold, conveyed and assigned to MSFT. To 25 ITA Nos.1479 & 691/Del/2016 the maximum extent permitted by law, Subsidiary hereby assigns to MSFT and waives and agrees never to assert any and all moral rights, including neighboring rights, in such developments.
Subsidiary shall itself, and shall require all individuals or entities working with Subsidiary in connection with the performing of research and development work for MSFT to execute and deliver such instruments and take such other action as may be required to carry out the transfer, sale, assignment or waiver of copyright, patent and other proprietary rights contemplated by this Section 5.1. Any documents, magnetically, optically or otherwise encoded media, or other materials created by Subsidiary, or under Subsidiary's direction, in performing research and development work for MSFT shall be owned by MSFT in their entirety.
5.2 Other Research and Development, including Without Limitation, Localization, Consulting and Training. As further consideration for the rights granted to Subsidiary by MSFT pursuant to this Agreement, Subsidiary hereby acknowledges MSFT ownership of all copyrights, patents and other proprietary rights in:
(i) any development work performed by Subsidiary whether or not it relates to MSFT Products and Services, irrespective of whether such work was approved and paid for by MSFT pursuant to the foregoing....... ; and
(ii) any work, materials or information acquired by Subsidiary irrespective of whether the acquisition of such work, materials or information was approved by MSFT.' 26 ITA Nos.1479 & 691/Del/2016
21. A close reading of clause 2 in juxtaposition to clause 5 of the PSA divulges three things, viz., first, that the assessee agreed to undertake research and development work, two, it is such research and development work which is requested and also approved in writing by Microsoft, USA and three, that the intellectual property rights in respect of such R&D work done by the assessee or outsourced to sub-contractors in India, shall be owned by Microsoft, USA.
22. The PSA continued as such. It appears that some income-tax assessments of the assessee were done taking an unfavourable view by the Department. To get rid of such a view, the assessee entered into an Amendment and Restated PSA on 1.1.2009 w.r.e.f 1.7.2003. The preamble clause of such an Agreement acknowledges that : `WHEREAS, As a result of misinterpretation by the Indian tax authorities of the Parent Subsidiary Agreement, the parties wish to expressly make their original intent known'.
Through this Agreement, clauses 2 and 5 of the original PSA stood substituted as under : -
`2. RESEARCH AND DEVELOPMENT Subsidiary hereby agrees to undertake such research and development work as requested and approved in writing by MSFT 27 ITA Nos.1479 & 691/Del/2016 from time to time. Subsidiary may subcontract with third parties to perform some or all of such work upon MSFT's approval. In the event that MSFT contracts directly with vendors in country, MSFT may request the subsidiary to provide assistance with regard to such contracts. Subsidiary's responsibilities are limited to best efforts to develop code or otherwise complete the project, not use IP not owned by MSFT, and deliver per project specifications as provided by MSFT.'
5. INTELLECTUAL PROPERTY MATTERS Research and Development. Subsidiary agrees that any and all developments made by it or under Subsidiary's direction, in connection with the performing of research and development work for MSFT shall be owned by MSFT in their entirety. Such developments shall (to the extent possible) be deemed "works made for hire" created by Subsidiary for MSFT pursuant to 17 U.S.C. Section 102(b). All copyrights (to the extent (if at all) not already owned by MSFT as "works made for hire), patents and other proprietary rights in such developments shall be and are hereby transferred, sold, conveyed and assigned to MSFT. To the maximum extent permitted by law, Subsidiary hereby assigns to MSFT and waives and agrees never to assert any and all moral rights, including neighboring rights, in such developments.
Subsidiary shall itself, and shall require all individuals or entities working with Subsidiary in connection with the performing of research and development work for MSFT to execute and deliver such instruments and take such other action as may be required to carry out the transfer, sale, assignment or waiver of copyright, patent and other proprietary rights contemplated by this Section 5.1. Any documents, magnetically, optically or otherwise encoded media, or other materials created by Subsidiary, or under 28 ITA Nos.1479 & 691/Del/2016 Subsidiary's direction, in performing research and development work for MSFT shall be owned by MSFT in their entirety. MSFT owns all rights to Covered Intangibles, takes all risk of successfully marketing such Covered Intangibles, and takes all risks not otherwise herein expressly taken by Subsidiary.'
23. A conjoint reading of the revised clauses 2 and 5 of the Amended PSA also acknowledges three things, that is, the assessee agreed to undertake research and development work; R&D is of such a work which is requested and approved in writing by Microsoft, USA; and the assessee agreed that the output of the performance of R&D work done by the assessee or under its direction, shall be owned by Microsoft, USA. The intention behind the Amended and Restated PSA is to clarify that the assessee shall work as per the specifications provided by Microsoft, USA. However, the scope of the assessee's R&D activities, even under the Amended PSA, is not restricted to developing codes only, but also to complete the project assigned to it by Microsoft, USA, as is clearly borne out from the language of clause 2 of the Amended PSA, which stipulates that the assesse's responsibilities are limited to best efforts to develop code or otherwise complete the project.... It is, therefore, utterly clear that the assessee undertook to do research and development work and the 29 ITA Nos.1479 & 691/Del/2016 unsubstantiated contention of the assessee that it was only engaged in testing and coding at a lower level, stands nowhere. It is more so in the light of the Amended PSA, which categorically sets out that its work will not be confined to developing code but also otherwise completing the project assigned to it by Microsoft, USA.
24. The assessee continued to carry on full-fledged research work albeit in respect of a part of the overall Microsoft product, which is further established from the fact that the patents registered in USA for work done in India amounted to 113 in number over a period of five years with 6 patents in 2008, 16 in 2009, 22 in 2010, 33 in 2011 and 36 in 2012. We have randomly gone through abstracts of some inventions done by the assessee in India which were registered in the USA for patents. The first one is dated 11.06.2013 which is 'extracting topically related key words from related documents.' Abstract of this work has been given as:-
"Keyword extraction technique embodiments are presented which extract topically related keywords from a set of topically related documents. In one general embodiment, this keyword extraction involves first accessing a set of topically related documents. A number of candidate keywords are then identified from the set of related documents. A weighted keyword candidate-document matrix is formed using these candidate keywords, and it is partitioned into multiple groups of keyword candidates. Dense clusters of keyword candidates whose density exceeds a prescribed density threshold are then identified in each of the groups of keyword candidates.30
ITA Nos.1479 & 691/Del/2016 Finally, the keyword candidates associated with each dense cluster are designated as topically related keywords."
25. Another creation of intellectual property by the assessee in India which has been patented in USA on 08.01.2013 is 'resource allocation framework for wireless or wired network.' Abstract of this work is as under:-
A resource allocation framework for wireless/wired networks is described. In an embodiment, methods of end host based traffic management are described which operate separately from the underlying access control protocol within the network (e.g. wireless MAC protocol or TCP). The rate limits for each flow are set based on per-flow weights, which may be user specified, and based on an estimate of the utilization of the shared resource and the rate limits are adjusted periodically so that the resource is not underutilized or saturated. Some embodiments compute a virtual capacity of the resource which is adjusted to optimize the value of the utilization and then the virtual capacity is shared between flows according to the per-flow weights. Methods for estimating the utilization of a wireless network and the capacity of a broadband access link are also described.
26. Still another intellectual property developed by the assessee, which got patented in USA on 18.02.2014 is `identifying topically related phrases in a browsing sequence'. Abstract of this work is as under:-
"Browsing sequence phrase identification technique embodiments are presented that generally extract topically-related phrases from the pages visited by a user in a browsing session. The topically-related phrases can be used for a variety of purposes, including aiding a user in re- finding previously visited sites. This phrase identification task is performed by considering not just the pages of a user's browsing sequence individually, but also pages visited immediately before and immediately after each page. In this way, phrases found in a page can be 31 ITA Nos.1479 & 691/Del/2016 analyzed in the context in which the page was viewed, rather than in isolation. The identified phrases are further filtered by picking those that appear on a pre-populated topic list, and then clustering to find the most informative ones."
27. In the same way, there are total 113 inventions carried out by the assessee, which were registered in the USA. This speaks volumes of the level of work done by the assessee in India culminating into the creation of intellectual properties at its end. It is simple and plain that in order to be eligible for patent, there has to be first some invention and further such invention must meet several criteria to get patent protection, such as, the invention must consist of patentable subject matter; it must be new (novel); it must involve inventive steps. A simple testing and coding does not result into an invention, much less its patentability. The fact that 113 patentable inventions were done by the assessee in India by its software development work, which were registered in the USA, leaves no room for doubt that it is undoubtedly engaged in research activities and is significantly different from a routine software developer.
28. The assessee has harped on its role as limited to providing services in relation to certain functions or modules within a product and not for the whole product itself which, in turn, is assembled by MS Corporation in 32 ITA Nos.1479 & 691/Del/2016 Redmond, USA. The ultimate products made by Microsoft, USA, involve several software, some of which are developed by its AEs in different parts of the world including the assessee. Even though integration of all the software developed in several countries is done in the USA, that does not mean that the research work done by the assessee or for that matter by AEs in the other countries, ceases to be a research work in itself. In such circumstances, it cannot be said that research work is done exclusively by Microsoft, USA, which is bringing together the research work done by several entities. In fact, all the entities contributing to the bringing out of a new product or a new version of the existing product by means of inventions, are doing research work. The assessee cannot be compared with a run-of-the-mill software developer as has been unsuccessfully attempted by the ld. AR. Au contraire, it is involved in the development of Microsoft products, though as an organ and in a limited way, but, within the scope of work assigned, it is undertaking research and development and creating intangibles, which are even patented.
29. A great deal of emphasis was laid by the ld. AR on the fact that the assessee was compensated at cost plus 15% irrespective of its success or 33 ITA Nos.1479 & 691/Del/2016 failure in the work assigned. In our considered opinion, this manner of quantification of remuneration simply shows the degree of low risk which the assesee is bearing and does not in any way, undermine the nature of work carried on. What is crucial at this juncture is to find out the nature of work done by the assessee and not the mode of compensation.
30. We have noticed above that the Parent-subsidiary agreement and the Restated PSA clearly indicate that the nature of work done by the assessee is that of research and development in the overall Microsoft products albeit to a limited extent. It is further clear from the same Agreements that the work done by the assessee would result into creation of intangibles, which would vest in Microsoft, USA. The fact that the assessee carried out research of sizeable nature in rendering software development services also gets established, inter alia, by the creation of intellectual properties in India which have been registered as patents in the USA. These two significant factors, viz., clauses of the PSA requiring the assessee to undertake research and development and actual creation of intellectual property in India patented in the USA, coupled with the shyness of the assessee in furnishing the primary evidence of the requisition 34 ITA Nos.1479 & 691/Del/2016 of work by Microsoft USA and the final output etc. before the TPO and also the Tribunal amply prove that the submissions made by some of the company's Officers before APA Authorities of not being involved in any research work, do not merit acceptance. Taking a holistic view of the matter, we have absolutely no doubt in our mind that the assessee is providing research and development software services to Microsoft, USA.
31. At this stage, it is imperative to note Circular no. 3/2013 dated 26.03.2013 which lays down certain guidelines for identifying if a Development centre in India is a contract R&D service provider with insignificant risk. It sets out the following guidelines for taking a decision on the point : -
"The CBDT has carefully considered the matter and lays down the following guidelines for identifying the Development Centre as a contract R&D service provider with insignificant risk.
1. Foreign principal performs most of the economically significant functions involved in research or product development cycle either through its own employees or through its associated enterprises while the Indian Development Centre carries out the work assigned to it by the foreign principal. Economically significant functions would include critical functions such as conceptualization and design of the product and providing the strategic direction and framework;
2. The foreign principal or its associated enterprise(s) provides 35 ITA Nos.1479 & 691/Del/2016 funds/capital and other economically significant assets including intangibles for research or product development. The foreign principal or its associated enterprise(s) also provides a remuneration to the Indian Development Centre for the work carried out by the latter;
3. The Indian Development Centre works under the direct supervision of the foreign principal or its associated enterprise which has not only the capability to control or supervise but also actually controls or supervises research or product development through its strategic decisions to perform core functions as well as monitor activities on regular basis;
4. The Indian Development Centre does not assume or has no economically significant realized risks. If a contract shows that the foreign principal is obligated to control the risk but the conduct shows that the Indian Development Centre is doing so, then the contractual terms are not the final determinant of actual activities;
5. In the case of a foreign principal being located in a country/territory widely perceived as a low or no tax jurisdiction, it will be presumed that the foreign principal is not controlling the risk. However, the Indian Development Centre may rebut this presumption to the satisfaction of the revenue authorities. Low tax jurisdiction shall mean any country or territory notified in this behalf under section 94A of the Act or any other country or territory that may be notified for the purpose of Chapter X of the Act;
6. Indian Development Centre has no ownership right (legal or economic) on the outcome of the research which vests with the foreign principal and that this is evident from the contract as well as from the conduct of the parties.
The Assessing Officer or the Transfer Pricing Officer, as the case may be, shall have regard to the guidelines above and shall take a decision based on the totality of the facts and circumstances of the case. In doing so, the Assessing Officer or the Transfer Pricing Officer, as the case may be, shall be guided by the conduct of the parties and not merely by the terms of the contract."36
ITA Nos.1479 & 691/Del/2016
32. The ld. AR contended that the guidelines laid down in the Circular are not final inasmuch as it is further provided therein that the above guidelines should be seen on the totality of facts and circumstances and the TPO shall be guided by the conduct of the parties and not merely by the terms of the contract. The ld. AR also referred to first, second and fourth reports of the Rangachary Committee dated 14.09.2012, 13.10.2012 and 05.12.2012 respectively, constituted to review taxation of Development Centres and IT Sector for accentuating the features of captive R&D Development Centres in India.
33. We have gone through the salient features given in these reports of the Committee. It is pursuant to such reports that the CBDT came out with the above Circular specifying the guidelines for identifying if a Development Centre in India can be termed as a contract R&D service provider. The recommendations of the Committee, to the extent of incorporation in the Circular, should be considered to have been accepted by the Government. In that view of the matter, it is vivid that guidelines laid down in the Circular, though not conclusive, but are of some relevance in deciding if a particular Development Centre in India is a contract R&D 37 ITA Nos.1479 & 691/Del/2016 service provider. On testing the facts of the case on the touchstone of the Circular, it is manifested that the assessee is satisfying all the ingredients except the one given at Sl. no. 5 which is not applicable to the facts of the instant case since Microsoft, USA is not located in a country perceived as a low tax or no tax jurisdiction. It can be seen that Microsoft, USA is performing most of the economically significant functions involved in research or product development cycle, while the assessee as an Indian Development Centre carries out the work assigned to it by the foreign principal (Sr. no. 1). Microsoft, USA is remunerating the assessee with cost plus 15% for the work carried out by it and is also providing its intangibles in the shape of Process tools (customised software, readymade templates and guidelines, etc.) to the assessee for doing the work (Sr. no.
2). The assessee is working under the direct supervision of Microsoft, USA, which is actually controlling or supervising research or product development through its strategic decisions and also monitoring activities on regular basis (Sr. no. 3). The assessee in India does not assume or has no economically significant realized risks (Sr. no. 4). The assessee has no ownership right (legal or economic) on the outcome of the research which 38 ITA Nos.1479 & 691/Del/2016 vests with Microsoft, USA, and that this is evident from the contract as well as from the conduct of the parties (Sr. no. 6).
34. We agree with the contention of the ld. AR that actual conduct of the assessee is also significant in taking a decision on the point, rather than going wholly with the terms of the Agreement which, in the extant case, provide that the assessee shall work as a R&D service provider. We have fairly noticed supra that it is not only the terms of the PSA, but also the actual conduct of the assessee, which proves, without an iota of doubt, that it is a contract R&D service provider inasmuch as economically significant functions involved in research or product development cycle are taken care of by Microsoft USA which also supplies other intangibles for research or product development and the assessee works under the direct supervision of MS, USA without having any economically significant risk and further having no ownership right on the outcome of the research, which vest with the MS, USA.
35. It is further interesting to note that the assessee vide its letter dated 12.01.2015, copy placed on page 664 onwards of the paper book, impressed 39 ITA Nos.1479 & 691/Del/2016 upon the TPO that it: "must be characterized as a contract R&D service provider bearing insignificant risks.................... we re-confirm that the functional profile of the assessee has remained unchanged from past year and the assessee continues to be a development centre undertaking contract R&D activities with insignificant risk as per Circular 6/2013." The above discussion brings us to an irresistible conclusion that the assessee is a contract R&D service provider.
36. Having seen the nature of work done by the assessee, we now proceed to examine the companies challenged before us. First of all, we take up the exclusions sought by the assessee from the list of comparables finalized by the TPO. In fact, the TPO shortlisted four companies, including Persistent Systems Ltd., which was assessee's comparable. The assessee has assailed the inclusion of all the four including its own comparable. We will deal with all of them in seriatim.
(i) E-Infochips Bangalore Limited.
37. The TPO proposed to include this company. The assessee objected to the same by contending that it was functionally different and failed the 40 ITA Nos.1479 & 691/Del/2016 service income filter along with diversified operations and non-availability of segmental data. The TPO rejected such contentions by noticing that the assessee as well as E-Infochips Bangalore Ltd., were engaged in the development of software. He, therefore, included it in the list of comparables, against which the assessee has come up in appeal before us.
38. Having heard both the sides and perused the relevant material on record, it is observed from the Annual report of this company for the year ending 31.03.2011, a copy of which has been placed on record, that its income from Software services as recorded in the Profit & Loss Account is Rs.45.11 crore. A detail of such income is given as per Annexure-7 which reveals Income from software services at Rs.27.98 crore and Consultancy charges at Rs.17.12 crore. Segmental information has been given in the Note no. 11 which states that: "the company is primarily engaged in software development and IT enabled services." Except for separate revenues, there is no segmental information of E-Infochips Bangalore Ltd., in respect of Software development services and IT enabled services. The segment of the assessee under consideration is Software development 41 ITA Nos.1479 & 691/Del/2016 services. It has got a separate segment of "IT enabled services", which is international transaction no. 3 given in Form no.3CEB with transacted value of Rs.323.46 crore, apart from the value of international transaction of 'Provision of software development services' under consideration at Rs.1072.06 crore. In this view of the matter, it becomes clear that E- Infochips Bangalore Ltd., having revenues from software services and IT enabled services in a common pool, cannot be compared with the assessee's only revenues from software development services under consideration. We, therefore, order to exclude this company from the list of comparables.
(ii) Infosys Technology Ltd.
39. The second company under challenge is Infosys Technology Ltd., which was included by the TPO in the final tally of comparables. The assessee objected to such inclusion by contending, inter alia, that it is engaged in noteworthy R&D activities apart from having significant intangible assets and exceptionally high turnover. The assessee also submitted that this company is functionally not comparable as it is also having revenues from software products. The assessee's objections have been recorded on pages 80-82 of the TPO's order. Not convinced, the TPO 42 ITA Nos.1479 & 691/Del/2016 held this company to be comparable, which has been assailed in the impugned order.
40. Having heard both the sides and perused the relevant material on record, we find from the Annual report of this company, a copy of which is available on pages 1653 onwards of the paper book, that this company is also engaged in earning revenue from Licensing of software products. This fact has also been recorded in the TPO's order noting that the revenue from software products stands at Rs.1,285/- crore. This revenue has been generated from its product 'Finacle', reference to which has been made on page 8 of the Director's Report. The extent of profit from software services, in the overall kitty of profits from software services and software products, cannot be separated because of the merged expenses. In view of the fact that the total profit of this company includes profit from software development services as well as software products and there is no separate profit available of the software development services, we are unable to countenance the comparability of this company as the assessee is not engaged in licensing of any software products. We, therefore, order to exclude Infosys Technologies Ltd. from the list of comparables. 43
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(iii) Persistent Systems Ltd.
41. Though this company was included by the assessee in its list of comparables, the same has still been challenged before us. The ld. AR contended that this company was erroneously included in the list of comparables as it is also a product company which is apparent from the Annual report of this company.
42. The ld. DR raised a preliminary objection to the effect that once a company has been considered by the assessee as comparable in its TP documentation and the same has been accepted by the TPO, the same cannot be challenged in the further appellate proceedings. He relied on the impugned order to contend that this company was rightly offered by the assessee in the list of comparables and, hence, the same should not be excluded.
43. We are disinclined to sustain the preliminary objection taken by the ld. DR that the assessee should be estopped from taking a stand contrary to the one which was taken at the stage of the TP study or during the course of proceedings before the TPO. It goes without saying that the object of 44 ITA Nos.1479 & 691/Del/2016 assessment is to determine the income in respect of which an assessee is rightly chargeable to tax. As an income not originally offered for taxation, if otherwise chargeable, is required to be included in the total income, in the same breath, any income wrongly included in the total income, which is otherwise not chargeable, should be excluded. There can be no estoppel against the provisions of the Act. Extending this proposition further in the context of the transfer pricing, it transpires that if an assessee fails to report an otherwise comparable company, then the TPO is obliged to include the same in the list of comparables, and in the same manner, if the assessee wrongly reported an incomparable company as comparable in its TP study and then later on realizes and claims that it should be excluded, there should be nothing to prohibit it from claiming so, provided the company so originally reported as comparable is, in fact, not comparable. Simply because a company was wrongly chosen by the assessee as comparable, cannot tie its hands from contending before the Tribunal that such a company was wrongly considered as comparable which is, in fact, not. There is no qualitative difference between a situation where an assessee claims that a wrong company inadvertently included for the purpose of 45 ITA Nos.1479 & 691/Del/2016 comparison should be excluded and the situation in which the Revenue does not accept a particular company chosen by the assessee as comparable. The underlying object of the entire exercise is to determine the arm's length price of an international transaction. Simply because a company was wrongly considered by the assessee as comparable, cannot, act as a deterrent from challenging before the Tribunal the fact that this company is, in fact, not comparable. The Special Bench of the Tribunal in DCIT vs. Quark Systems Pvt. Ltd. (2010) 132 TTJ (Chd) (SB) 1 has held that a company which was included by the assessee and also by the TPO in the list of comparables at the time of computing ALP, can be excluded by the Tribunal, if the assessee proves that the same was wrongly included. Similar view has been upheld by the Hon'ble Delhi High Court in Xchanging Technology Services India Pvt Ltd [TS-446-HC-2016(DEL)- TP]. The Hon'ble Bombay High Court in Tata Power Solar Systems Ltd [TS-1007-HC-2016(BOM)-TP] and the Hon'ble Punjab & Haryana High Court in CIT VS. Mercer Consulting (India) P. Ltd. (2017) 390 ITR 615 (P&H) have also approved similar view. In view of the foregoing 46 ITA Nos.1479 & 691/Del/2016 discussion, we do not find any substance in the preliminary objection taken by the ld. DR.
44. Coming to the comparability or otherwise of this company, we find from its Profit & Loss Account that its income from 'Sale of software services and products' stands at Rs.6,101.27 millions. Product revenue is 7.2% of the total revenue. Thus, it is established that this company is engaged in rendering software development services as well as sale of software products. Even though the percentage of software products in the total revenue is less, yet, the same ceases to be comparable as there is no precise information about the contribution made by the income from sale of software to the total income of the company. In the absence of any segmental information provided by the company in respect of software services, we cannot approve the inclusion of this company in the list of comparables. The same is directed to be excluded.
(iv) Wipro Technology Services Ltd.
45. The TPO proposed to include this company in the list of comparables despite the assessee's objection that it has more related party transactions. After going through the Annual report of this company, it is 47 ITA Nos.1479 & 691/Del/2016 noticed that it was earlier Citi Technologies Ltd. On 21.1.2009, Wipro Ltd. signed a master agreement with Citi Group Inc., for delivery of technology Infrastructure Services and application development and maintenance services for a period of six years, which also includes the year under consideration. This shows that income from software development support and maintenance services was earned by Wipro Technology Services Ltd., from Citi Group Inc., by means of master service agreement entered into between Wipro Ltd., its parent company and Citi Group Inc., a third person.
46. Rule 10B(1)(e)(ii) provides that it is the net profit margin realized from a comparable uncontrolled transaction, which is considered for the purposes of benchmarking. The epitome of `comparable uncontrolled transaction' is that the companies or transactions, in order to fall within the ambit of sub-clause (ii) of rule 10B(1)(e), should be both comparable as well as uncontrolled. `Uncontrolled transaction' has been defined in Rule 10A(a) to mean: 'a transaction between enterprises other than associated enterprises, whether resident or non-resident.' This shows that in order to be called as an uncontrolled transaction, it is essential that the 48 ITA Nos.1479 & 691/Del/2016 same should be between the enterprises other than the associated enterprises. Section 92B(2) provides that: `A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise'. On going through the prescription of sub-section (2) of section 92B, it is clearly borne out that a transaction with a non-AE shall be deemed to be a transaction entered into between two AEs if there exists a prior agreement in relation to the relevant transaction between the third person and the AE or the terms of the relevant transaction are determined in substance between the third person and the AE. When we consider section 92B(2) in combination with Rule 10A(a), it follows that the transaction between non-AEs shall be construed as a transaction between two AEs, if there exists a prior agreement in relation to the relevant transaction between third person and the AE. If such an agreement exists, the third person is 49 ITA Nos.1479 & 691/Del/2016 also considered as an AE and the transaction with such third person becomes international transaction within the meaning of section 92B. Once there is a transaction between two associated enterprises, it ceases to be an 'uncontrolled transaction' and, thereby, goes out of reckoning under Rule 10B(1)(e)(ii).
47. Coming back to the facts of this company, we find that Wipro Technology Services Ltd. earned a revenue from Master services agreement with Citigroup Inc. for the delivery of technology infrastructure services. This agreement was, in fact, executed between the assessee's AE, Wipro Ltd., and Citigroup Inc., a third person. This unfolds that the transaction of earning revenue from software development support and maintenance services by Wipro Technology Services Ltd., is an international transaction because of the application of section 92B(2) i.e., there exists a prior agreement in relation to such transaction between Citigroup Inc. (third person) and Wipro Ltd. (associated enterprise). In the light of this structure of transaction, it ceases to be uncontrolled transaction and, hence, Wipro Technology Services Ltd., disqualifies to become a comparable uncontrolled transaction for the purposes of inclusion in the final list of 50 ITA Nos.1479 & 691/Del/2016 comparables under Rule 10B(1)(e)(ii). We, therefore, direct removal of this company from the list of comparables. Similar view has been taken by the Delhi Bench of the Tribunal in the case of Saxo India (P) Ltd. (2016) 67 taxmann.com 155 (Delhi-Trib.). This order of the Tribunal stands affirmed by the Hon'ble Delhi High Court vide its judgment dated 28.09.2016 in ITA no.682/2016, C.M. APPL.35744-35746/2016 by holding that no substantial question of law arises from the Tribunal order.
48. Now, we take up the companies assailed before us which were included by the assessee in the list of comparables, but, excluded by the TPO. In all, the assessee selected 27 companies including M/s Persistent Systems & Solutions Ltd., which got accepted at the hands of the TPO but excluded by us hereinabove, on a challenge made by the assessee. Out of the remaining 26 companies, the assessee has challenged the exclusion of 12 companies by the TPO from the list of comparables, which we will take up one by one for consideration and decision.
51
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(i) Akshay Software Technologies Ltd.
49. The assessee included this company in the list of comparables which was excluded by the TPO by noting on page 56 of his order that it was not involved in rendering high-end software services. He further noticed on page 68 that it was a routine software trader and was not engaged in rendering any high-end software services or contract research and development, as the assessee was doing. No relief was allowed by the DRP.
50. Having heard both the sides and perused the relevant material on record, we find from the Directors' report of this company, whose copy has been placed on record by the ld. AR, that it is also engaged in sale of Products, which fact gets reflected from the first item, being `Income from Software Services and Products' under point 1(i), that is, `Financial Results'. Page 5 of the Annual report, being, Annexure to the report of Board of Directors records that: "The company is a service provider and therefore has not set up a formal Research and Development unit." Page 15 of the Annual report is a copy of its Profit & Loss Account, which shows income from operations as 'Income from software services and products' at 52 ITA Nos.1479 & 691/Del/2016 Rs.11,47,22,327/-. Thus it becomes apparent that this company, unlike the assessee, is not only not engaged in rendering Research and development services, but is also in the sale of Products, thus losing the comparability. The reasoning given above for exclusion of Infosys Technology Ltd. and Persistent Systems Ltd., as those also being Product companies, applies with full force to the exclusion of this company as well.
51. The ld. AR submitted that income from Products of this company was separable inasmuch as the figures of opening stock, purchases and sale of products were separately given in the Annual report. He, however, could not point out the amount of other operating expenses separately, included in the overall operating expenses, connected with sale of such products, so as to enable the computation of operating profit from the sale of Products. Admittedly, this company has no separate segment for its Products business. Figure of other operating expenses in relation to Products, naturally, cannot be deduced in the absence of any segmental information available in the financials of this company. In view of the foregoing reasons, it becomes lucid that neither the amount of other operating expenses of the `software development services' is available nor it can be 53 ITA Nos.1479 & 691/Del/2016 separately computed, thereby making it impossible to compute the amount of operating profits from such software development services, which is a necessary ingredient under the TNMM. We, therefore, uphold the exclusion of this company from the list of comparables.
(ii) Blue Star Infotech Ltd. (Consolidated)
52. The TPO excluded this company by observing on page 56 of his order that it was not involved in rendering high-end services and, further, it was not into research and development as recorded on page 69 of his order.
53. We have gone through the Annual report of this company, a copy of which has been placed on record by the ld. AR. Profit & Loss Account of this company is placed at page 91 of the paper book, which shows 'Sales and software services income' on the Income side. Schedule-J, being, Significant Accounting Policies and Notes to the Financial Statements provides under the head 'Revenue recognition' that: "Revenue from sale of traded software licences and traded hardware is recognized on delivery to the customer." This makes it apparent that, apart from rendering software services, this company is also into software products and hardware. The Director's Report of this company clearly sets out under the heading 54 ITA Nos.1479 & 691/Del/2016 'Research and Development' that: "The company is predominantly a service provider and, therefore, has not set up a formal research and development unit". It thus transpires that this company cannot be considered as comparable as apart from being a product company and dealing in hardware also, it is also not providing any R&D services. The view taken by the authorities is, thus upheld.
(iii) Caliber Point Business Solutions Ltd. (Others segment).
54. The TPO held this company to be not comparable by noting on page 56 of his order that it was not rendering any high-end software services. He further held on page 69 that this company was carrying BPO services.
55. After considering the rival submissions and going through the Annual report of this company, a copy of which has been placed by the ld. AR on record, it can be seen from Schedule-12, being, Significant Accounting Policies and Notes Forming Part of Accounts that under the head 'Revenue recognition', it has been mentioned that: "The company's revenue from process outsourcing and software support and related activities arise from unit priced contracts, time based contracts and fixed price projects." Unlike the assessee, this company is not rendering any 55 ITA Nos.1479 & 691/Del/2016 research and development software services to its AEs. On the contrary, it is also providing BPO services, which make it non-comparable with the segment of the assessee-company under consideration. We, therefore, approve the view taken by the authorities on the exclusion of this company.
(iv) Cat Technologies Ltd.
56. The TPO excluded this company by observing on page 57 of his order that it was not providing any high-end software services. He noticed from the Annual report of this company that its exclusive business was Medical transcription, training, software development and consulting services and both were considered as a single segment. He, therefore, held this company as not comparable.
57. We have examined the Annual report of this company which is available in the paper book. A copy of its Income statement on stand-alone basis is available on page 177 of the paper book, which shows operating revenue at Rs.7.34 crore. Break-up of such revenue is given on page 178. Revenue from software development stands at Rs.3.04 crore, while the revenue from IT Consultancy is to the tune of Rs.4.29 crore. Both the streams of revenue are pooled. It has been mentioned under the head 56 ITA Nos.1479 & 691/Del/2016 `Segment reporting' that : `The Company's exclusive business is Medical Transcription, Training Software Development and Consulting services as such this is the only reportable segment as per Accounting Standard - 17 on Segment Reporting issued by the ICAI'. Medical transcription is obviously a part of BPO services, falling within the ambit of IT enabled services. As the assessee under this segment is rendering only software development services, which are exclusive of ITES, following the view taken above for the exclusion of E-Infochips Bangalore above, we hold that this company was rightly excluded.
(v) CG-VAK Software & Exports Ltd.
58. The TPO excluded this company by noting on page 57 of his order that it was not involved in rendering any high-end software services and, further, recorded on page 70 of his order that it was a persistent loss making company, against which the assessee has come up in appeal before the Tribunal.
59. We have heard the rival submissions and perused the relevant material on record. It is observed from page 70 of the TPO's order that as per Prowess data base, profit before interest and taxes of the software 57 ITA Nos.1479 & 691/Del/2016 segment of this company is in negative for the financial years 2007-08 to 2010-11. For the financial year 2007-08, there is loss of (-) 0.10%, for the F.Y. 2008-09, there is loss of (-) 0.15%, for the F.Y. 2009-10, there is loss of (-) 0.73% and for the F.Y. 2010-11, there is loss of (-) 0.21%. The assessee tried to make out a case before the TPO that his calculation of margin was not correct by advancing its own calculation which has been set out at page 71 of the TPO's order. It is apparent even from such calculation that from the year ending 31.03.2008 to year ending 31.03.2011, there are persistent losses at (-) 2.01%, (-)2.35%, (-) 14.36% and (-) 3.70% respectively. In view of the fact that this company is a persistent loss making company in the relevant segment, the same ceases to be comparable. Even otherwise also, this company is not functionally similar as has been noted by the TPO on page 57 of his order that it is not engaged in rendering high-end services. The ld. AR could not draw our attention towards anything from the Annual report that this company under the relevant segment was also rendering any software research and development services. We, therefore, uphold the impugned order in removing this company from the list of comparables.
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(vi) Evoke Technologies Pvt. Ltd.
60. The assessee included this company, which got excluded by the TPO by observing on page 57 of his order that it was not engaged into any research and development, as was the assessee doing. The ld. AR fairly admitted that this company is not into rendering research and development services. He, however, maintained that rendering or not rendering of research and development software services cannot be a criterion to determine the comparability of a software company. In our considered opinion, this argument is far-fetched inasmuch as a company which is providing research and development software services cannot be compared with a routine software development service provider not rendering such R&D services because of glaring differences in the nature of work, type of skill required along with several other factors. As this company is, admittedly, not engaged in rendering any research and development services, the same cannot be considered as comparable with the assessee company. We, therefore, affirm the view taken by the lower authorities on this score.
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(vii) LGS Global Ltd.
61. The TPO held this company to be not comparable by noting on page 58 of his order that it was not rendering any high-end software services. The TPO further noticed on page 75 of his order that this company was providing routine IT enabled services and not any research and development services.
62. Having gone through the Annual report of this company, we find from its Director's Report that it is talking of certain research and development to be undertaken in future, which is merely a goal or vision. As, admittedly, this company is not rendering any research and development services and is a simple software service provider, we approve the exclusion of this company from the tally of comparables.
(viii) Maveric Systems Ltd.
63. The TPO excluded this company by mainly observing on page 58 of his order that it was not involved in rendering high-end software services, against which the assessee has approached the Tribunal. 60
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64. We have examined the Annual report of this company, a copy of which is available on record. It can be seen from such Annual report that it is engaged in rendering routine software development services and not research and development software services. Though this company carried out some research and development, as is apparent from its Directors' Report, but, the research and development was done for "creation of tools and frameworks that help 'Design Better TEST Umbrella' and 'execute faster (automate) umbrella.'' There is no income from rendering Research and development services as against its operating income of Rs.56.90 crore. On the other hand, there is only a spend of Rs.45.63 lac on research and development. Since R&D activity done by this company is meant for its own use and it has not earned any revenue from rendering R&D services, we hold that this company cannot be considered as comparable with the assessee, which is engaged in providing R&D software services to its AE under the current segment. Following the view taken hereinabove on similar lines, we approve the impugned order on excluding this company from the list of comparables.
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(ix) Mindtree Ltd. (IT Service Segment)
65. The TPO held this company to be not comparable by observing on page 58 of his order that it was not involved in rendering any high-end software services.
66. We have examined the Annual report of this company, a copy of which has been placed on record. Annexure to the Directors' Report provides under the head 'Research and Development' that this: "Company has a dedicated business unit for research and development which offers innovative solutions to clients and also fosters R&D within all business units to create intellectual property in the form of re-usable components, frameworks, etc., which help drive correct productivity." On next page of the Annexure to the Directors' Report, a list of patents registered either in India or the USA has been appended, which are 19 in number. Profit & Loss of this company shows 'Income from software development' at Rs.15,090 million. This company has three sub-segments which are covered within the overall 'Income from software development.' Details of such sub-segments are given on page 32 of the Annual report, which 62 ITA Nos.1479 & 691/Del/2016 mainly comprise revenue from IT services at Rs.8,783 million; from Product engineering services at Rs.5653 million; and from Wireless services at Rs.654 million. Obviously, `Wireless services' cannot be considered as a part of Research and development software services provided by this company. The assessee has also considered only IT service segment of this company as comparable with the exclusion of `Wireless services'. All the parameters, namely, rendering of research and development software services and also Product engineering services to its customers leading to the creation of patents, make this company fully comparable to the extent it earned revenues from IT services and Product engineering services, for which segmental information is available. We, therefore, direct the TPO to examine the PLI of this company from the IT services and Product engineering services and then treat the same as comparable with the segment of the assessee under consideration for the purposes of benchmarking. The impugned order is overturned to this extent.
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(x) R.S. Software (India) Ltd.
67. The TPO excluded this company by noting on page 58 of his order that it was not involved in any high-end software services and, further, on page 76 that it was not into any research and development.
68. We have examined the Annual report of this company. Income from software development has been shown in the Profit & Loss Account, whose copy is available on page 823 of the paper book. The ld. AR could not point out anywhere from the Annual report that this company is engaged in rendering R&D software services. Since it was a comparable chosen by the assessee, the onus is on it to show the comparability. The same being not involved in rendering any R&D software development services becomes functionally different and hence cannot be considered as comparable. It is therefore, held to have been rightly excluded.
(xi) R. Systems International Ltd. (Segment)
69. The assessee included the `Software Development & Customisation Services Segment' of the company in the list of comparables. The TPO excluded the same by noticing on page 58 of his order that it was not involved in high-end software services. Then, on page 76, the TPO also 64 ITA Nos.1479 & 691/Del/2016 noticed that the financial data of this company was available for a period of 12 months ending 31.12.2010. That is how, he held this company to be not includible in the list of comparables. The assessee is aggrieved by this exclusion.
70. We have heard both the sides and perused the relevant material on record. First of all, we take up the functional difference as noticed by the TPO on page 58 of his order. We have gone through the Annual report of this company, a copy of which has been provided in the paper book. It can be seen from the message of the company's Chairman, which is there on page 13 of the Annual report that under the heading `Our business', it has been narrated that its : `core service offerings include Product Engineering, sold under our brand of iPLM Services; IT enabled Business Process Outsourcing (BPO) services and consulting services for Enterprise Applications such as Business Intelligence and Analytics, ERP and Mobility'. It has further been mentioned on the same page that: "R Systems products group consists of two units. Indus® which address the retail lending, telecommunication and insurance industry and ECnet® which addresses supply chain, warehousing and inventory management." 65
ITA Nos.1479 & 691/Del/2016 A copy of the Profit & Loss Account of this company is available on internal page no. 81, which shows `Income' into three parts, namely 'Sales and service income'; 'Sale of third party hardware and software'; and 'Other income.' Page 97 contains information about the segments. For the year ending 31.12.2011, there are only two segments, namely 'Software development & Customization services' and 'Business process outsourcing'. It is, therefore, overt that income from the relevant segment of 'Software development & Customization services' taken by the assessee for the purposes of comparison includes Sale of products not only of its own but also those of third parties. Since the sale of Products is also included in this segment, and the assessee is not into sale of its own hardware or software and also the software of third parties, this company on segmental level becomes functionally different and ceases to be comparable with the assessee engaged in providing only research and development services under this international transaction. We, thus, hold that this company is not comparable to the assessee company.
71. In view of the above functional differences, there is no need to look for data relevant to the period 01.04.2010 to 31.03.2011. We, therefore, 66 ITA Nos.1479 & 691/Del/2016 approve the exclusion of this company on segmental level from the list of comparables on account of functional dissimilarity as noted by the TPO.
(xii) Silverline Technologies Ltd.
72. The TPO excluded this company by assigning two reasons. One has been given on page 58 of his order to the effect that this company is not involved in high-end software services and the second reason is given on page 76, being, the non-availability of data for the relevant financial year ending.
73. We have gone through the Annual report of the company whose copy has been provided in the paper book. It can be seen from internal page 3 of the Annual report, which is a message from the Chairman that the : `Company's Service Management team has announced that its Software-as-a-Service 'SaaS' based ITIL incident management software, iCare, is now available on Research in Motion's Playbook platform as well as on website'. This graphically demonstrates that the company is also engaged in sale of Products like iCare, which fact becomes more glaring from its Profit & Loss Account which has the first item under the head income as 'Sales and services.' It is further pertinent to note that though 67 ITA Nos.1479 & 691/Del/2016 this company is also engaged in Research and development as is apparent from page 9 of its Annual report, but, the : "R&D activities include tools development with the object of devising efficient methods of pre- production phase." Thus, the R&D activity carried out by this company is meant for creating tools for its internal use and is not done as a service to its customers, as the assessee in question is doing. In view of the fact that this company has also income from software products and is not engaged in rendering research and development software services, we hold that this company was rightly excluded.
74. Having dealt with the inclusions or exclusions challenged by the assessee in the international transaction of 'Provision of software development services', we, now take up other points urged by the assessee in its appeal.
75. The ld. AR argued that the authorities below erred in not granting working capital adjustment.
76. It can be seen from page 37 of the TPO's order that the assessee's claim for working capital adjustment has been denied primarily on the 68 ITA Nos.1479 & 691/Del/2016 ground that a working capital adjustment cannot be made as a matter of practice and routine. No relief was allowed by the DRP.
77. We are not inclined to accept the view canvassed by the authorities that the working capital adjustment cannot be allowed as the assessee is in service industry. Such an adjustment is restricted to inventory, trade receivables and trade payables. If a company carries high trade receivables, it would mean that it is allowing its customers relatively longer period to pay their dues, which will result into higher interest cost and the resultant low net profit. Similarly, by carrying high trade payables, a company benefits from a relatively longer period available to it for paying back the dues to its suppliers, which reduces the interest cost and increases profits. In order to neutralize the differences on account of carrying high or low inventory, trade payables and trade receivables, as the case may be, it becomes eminent to allow working capital adjustment so as to bring the case of the assessee at par with the other functionally comparable entities. We, therefore, agree in principle with the grant of working capital adjustment. Since the necessary details qua the grant of such an adjustment have not been examined because of refusal to grant such adjustment at the 69 ITA Nos.1479 & 691/Del/2016 threshold, we are of the considered opinion that it would be fit and proper to set aside the impugned order on this issue and send the matter back to the file of the AO/TPO to carry out the working capital adjustment in the light of our above discussion. Once it is held that such an adjustment is permissible, then it should be carried out whether it favours or disfavors the assessee. It goes without saying that the assessee will be allowed an opportunity of hearing in such fresh determination of the working capital adjustment, if any.
78. The only other point urged by the ld. AR under this international transaction is with reference to the computation of the assessee's own PLI. In this regard, it was submitted that rental income earned by it to the tune of Rs.17,22,16,198/- was considered as non-operating income. However, the assessee inadvertently did not exclude the corresponding expenses relating to such rental income from the total operating expenses. It was shown that the TPO himself, for the assessment year 2014-15, allowed deduction of such expenses from total operating expenses for the purpose of computation of the ALP. It was further pointed out that the DRP directed the TPO in relation to the assessment year 2012-13 for allowing 70 ITA Nos.1479 & 691/Del/2016 deduction of expenses concerning the rental income from total operating expenses.
79. Having heard both the sides and perused the relevant material on record, it is seen that the assessee did earn rental income amounting to Rs.17,22,16,198/- apart from income from operations as charges towards Software development and IT enabled services. Once rental income has been treated as non-operating qua the international transactions, as a sequitur, the corresponding expenses incurred in relation to earning of such rental income are also required to be removed from total operating expenses for the purposes of computation of ALP of the international transactions. We, therefore, direct the TPO/A.O. to examine the amount of expenses incurred in relation to earning of rental income and reduce such amount from the total amount of operating expenses to be bifurcated in all sources of revenues from operations.
PROVISION OF I.T. ENABLED SERVICES (Bangalore unit)]
80. The next international transaction under challenge is 'Provision of IT enabled services' with the transacted value of Rs.323,46,26,948/-. The assessee adopted TNMM as the most appropriate method with the PLI of 71 ITA Nos.1479 & 691/Del/2016 OP/OC for benchmarking this international transaction. It selected 17 companies as comparable with average PLI, on multiple year basis, at 4.63%. The assessee computed its own PLI at 15.39%. On this basis, it was claimed that the international transaction was at ALP. The TPO made certain exclusions and inclusions from/to the list of comparables drawn by the assessee. In all, 8 companies were shortlisted with average PLI of 29.57%. This led to proposing transfer pricing adjustment of Rs.39,67,65,085/-. The A.O. passed the draft order accordingly. The assessee carried the matter before the DRP, which directed to exclude e- Clerx Services Pvt. Ltd. from the list of comparables. Giving effect to the direction given by the DRP, the TPO recomputed revised transfer pricing adjustment at Rs.28,73,66,004/-. The Assessing Officer passed the final order making transfer pricing addition at this level. The assessee has assailed the transfer pricing addition before the Tribunal.
81. We have heard both the sides and perused the relevant material on record. The assessee has challenged the inclusion/exclusion of certain companies from/to the final tally drawn by the TPO. Before adverting to the comparability analysis, it is sine qua non to examine the functional 72 ITA Nos.1479 & 691/Del/2016 profile of the assessee under the international transaction of 'Provision of IT enabled services.' It is seen from the TPO's order that the assessee entered into a Product Support Services Agreement dated 01.07.2002 with MS Corporation to provide IT enabled services and such services were rendered through the establishment of Global Support Centre (India GSC) in Bangalore. It is further noticed from the TPO's order that ITES rendered by the assessee are a part of the 'Customer Support Services' arm of the Microsoft group, which supports a wide array of customer segments, from individual home users to corporate users. We have also gone through the assessee's Transfer pricing study report, which also throws some light on the nature of services provided under this international transaction. It is borne out from page 59 of the TP Study Report that the assessee's team in India tracks the calls made by the customers and routes them to the relevant support team. These teams, on receiving calls from the customers, understand their requirements, verify the service contracts of the customers and prepare the support requests and forward the same to the right support teams. The support requests prepared is serviced by India GSC's support engineer as a part of its product support services. In case any specific 73 ITA Nos.1479 & 691/Del/2016 support request is not resolved by the support engineers at India GSC, the same is escalated to specific escalation queues and handled by the escalation teams based elsewhere in the world. In certain cases, the team at India GSC acts as escalation team and handles the cases escalated by other teams. We have also gone through the Product Support Service Agreement (PSSA) effective from 01.07.2002 between the assessee and Microsoft Corporation, USA. This Agreement provides that the assessee shall provide 'Product support services', which term has been defined in clause II of the Agreement as under :-
"'II. PRODUCT SUPPORT SERVICES MSFT hereby engages Subsidiary (i.e. the assessee) to render product support services specified below throughout the term of this Agreement. The product support services shall include standard MSFT product support services for products which are generally made available to end users in the Territory and shall include requests for support originating from within the Territory. Product support services include phone, email, web-based and onsite support for all MSFT products. Product support services include all retail product warranty support in the areas of installations, set up and usage functionalities and excludes planning, design and programming."
82. We have also gone through the interview of Shri Thomas Payyapalli with designation General Manager, India Global Technical Support Centre (I-GTSC), conducted by the APA Authorities, a copy of which has been placed in the Paper book. In response to query about the nature of work 74 ITA Nos.1479 & 691/Del/2016 undertaken, he submitted that his team was resolving technical problems of customers and also providing technical assistance to MPN (Microsoft Partner Network) Partner Ecosystem. In answer to question no. 2, he stated that the support calls are routed through Microsoft and the systems of various support centres including India GTSC. Once the call ends here, the engineers interact with the customer, understand the root cause of the problem and provide a resolution. He further answered to question no.12 that MS Corporation provides process tools with the help of which the assessee renders services to its customers. From the above discussion, it is clear that unlike the international transaction of 'Provision of software development services', there is no conflict in the version of nature of services as given in TP documentation, PSSA Agreement and the interviews done by APA Authorities. There is complete unison in all of them about the nature of services rendered under this international transaction, being that of receiving calls and resolving technical problems of the customers of Microsoft Corporation. With the above understanding of the nature of work done by the assessee in this segment, we now proceed to examine the comparability of the companies challenged before us. 75
ITA Nos.1479 & 691/Del/2016 First of all, we take companies included by the TPO, which the assessee has contested as not comparable.
(i) Accentia Technologies Ltd.
83. The TPO treated this company as comparable despite the assessee's initial inclusion and later exclusion, by observing that it is engaged in Medical transcription and income from coding and billing and collection, which falls under the overall umbrella of IT enabled sector. The assessee is aggrieved by the inclusion of this company.
84. Having heard both the sides and gone through the relevant material on record, we find from the Annual report of this company, whose copy is available on page 2153 onwards of the paper book, that it is engaged in rendering KPO services. The Managing Director of this company has said in his message to the shareholders on page 6 of the Annual report that the company decided to develop its own EMR (Electronic Medical Records) software rather than depending on third party offering and market the same all over the US. It has further been mentioned that due to these developments, the company invested large amount of funds in the development of EMR software and SaaS model marketing of the same in 76 ITA Nos.1479 & 691/Del/2016 the US. It has still further been mentioned on page 2175 of the paper book that this company supported a Product Division under the name of Iridium and with a focused approach. The product team was able to come up with end-to-end global work flow automation system that help in the day-to-day work flow. The products like Iridium Medical Transcription Automation software, Iridium certified home based medical transcription, Iridium certified medical transcription, Falcon-2000, etc., are few of the products which have been accepted by customers. It has also been mentioned on page 2177 of the Annual report that: "since August, 2010 Accentia's products development team, along with their functional experts and development partners have been involved in the mission of designing and developing a world class fully integrated multi-disciplined cloud based host.......... Application which integrates all services from electronic medical record (EMR) Practices...... Management System (PMS) - Code Mapping/Scrubbing - Medical Billing and Receivables Management System (RCM......) - Electronic Data Interchange with insurance companies. The above seamlessly integrated (SaaS) system functions as a one stop shop for a clinical provider that manages all their healthcare 77 ITA Nos.1479 & 691/Del/2016 documentation needs, receivables managements needs..........". Profit & Loss Account of this company is available on page no. 2195, from which it can be seen that under the head 'Income', there is a first item of 'Sales and services.' Under the head 'Segment information' in 'Notes to Accounts', it has been mentioned that: 'Company has only one segment of activity, namely, 'healthcare receivable management', therefore, segment reporting as defined in AS-17 does not apply.' From the above discussion, it transpires that this company is not only earning income from sale of software Products as well, but is having a common pool of income both from products and services and there is no bifurcation of income available from sale of products and rendering of services. In this view of the matter, it becomes clear that this company is nowhere close to the exclusive ITES segment of the assessee company. The Hon'ble Delhi High Court in Principal CIT vs. B.C. Management Services Pvt. Ltd. (2018) 403 ITR 45 (Del), has held that Accentia Technologies Pvt. Ltd. is engaged in KPO services and is, hence, not comparable with a company providing ITES. This decision has also been rendered for the assessment year 2011-12, 78 ITA Nos.1479 & 691/Del/2016 which is under consideration in this appeal. We, therefore, order to exclude this company from the list of comparables.
(ii) ICRA Techno Analytics (Seg)
85. The TPO included this company in the list of comparables despite the assessee's objection of functional non-comparability etc., against which the assessee has come up before the Tribunal.
86. We have gone through the Annual report of this company, a copy of which is available on page 2237 of the paper book. Internal page 27 of this Annual report divulges that: 'the company is engaged in the software development and consultancy, engineering services, web development and hosting and subsequently diversifying itself into the domain of business analytics and business process outsourcing.' Under the head 'Revenue recognition', this company has recorded that: 'Revenue from services consists of revenue earned from services performed for software development and consultancy, licensing and sub-licensing fee, annual maintenance charges for software support, web development and hosting which is recognized to the extent services are performed.' Page 2284 is a copy of the Profit & Loss Account of this company which shows operating 79 ITA Nos.1479 & 691/Del/2016 revenue of Rs.1,58,401/- (in thousands of Indian rupees), bifurcation of which is available at page 2285. It shows revenues from sale of goods and revenue from other services separately at Rs.949/- (in thousands of Indian rupees) and 1,57,452/- (in thousands of Indian rupees) respectively. Since this company is, admittedly, engaged in software products, apart from rendering ITES and software development services and there is no separate segmental information, it cannot be considered as comparable with the assessee's IT enabled services segment under consideration. The Hon'ble jurisdictional High Court in B.C. Management Services (P) Ltd. (supra) has also held this company to be not comparable with a company providing IT enabled services only. We, therefore, direct to exclude this company from the list of comparables.
(iii) TCS E-Serve Ltd.
87. The TPO included this company in the list of comparables despite the assessee's several objections on functional non-comparability, ownership of intangibles and payment of brand equity. 80
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88. Having gone through the Annual report of this company, it is seen that this company is engaged in the business of providing ITES/BPO services, primarily to Citi group entities globally. It has been recorded on page 88 of its Annual report that the company's operations broadly comprise transaction processing and technical services. `Transaction processing includes the broad spectrum of activities involving the processing, collections, customer care and payments in relation to the services offered by the Citi group to its corporate and retail clients. Technical services involve software testing, verification and validation of software at the time of implementation and data centre management activities'. Thus, it is evident that the income of this company also includes the income from software development services, which are covered under 'Technical services' involving software testing, verification and validation of software. Pages 90/97 of the Annual report depict that the company has only one segment named as BPO (transcription processing services). Since the assessee in the instant international transaction is not rendering any software development services and the activities are confined to resolving problems of the enterprise customers in the software products, being 81 ITA Nos.1479 & 691/Del/2016 categorized as ITES, this company ceases to be comparable. We, therefore, order to exclude it from the list of comparables.
89. Now, we take up the companies challenged by the assessee, which were included by it, but, excluded by the TPO from the list of comparables.
(i) Microland Ltd. (Seg.)
90. The TPO excluded this company from the list of comparables drawn by the assessee on the ground that it was incurring persistent operating losses under the relevant segment considered by the assessee. The TPO has drawn a table on page 25 of his order which shows that the concerned segment is showing OP/TC at (-) 12.94%, (-) 3.79% and (-) 19.51% in respect of year ending 2011, 2010 and 2009 respectively. The assessee is aggrieved by this exclusion.
91. We have heard both the sides and perused the relevant material on record. The ld. AR contended that the TPO erred in considering persistent losses in the relevant segment by ignoring that this company was not into consistent losses on entity level. We have gone through the Annual report of this company, whose copy has been made available. On page 2524 of the 82 ITA Nos.1479 & 691/Del/2016 paper book, there is a mention of operating revenue of this company at Rs.16,20,426/- (in Thousands of Indian Rs.), described as 'Revenue information technology consultancy.' Segmental reporting of this company has been given on pages 2509/2510, which divulges that it has revenues from `Infrastructure management services' and `IT enabled services'. Note to accounts no. 16 clearly mentions that: "The company renders software services comprising of networking and infrastructure management services and IT enabled services which comprise the primary basis of segmental information set out in these financial statements." It is, thus, seen that the company has revenues from two streams. Though there is a positive income from rendering of `Software services', there is negative OP/TC from the relevant segment of `IT enabled services'. Since the assessee's `IT enabled services' segment is under consideration and the assessee has also considered Microland Ltd. as comparable on segmental basis, this segment, fetching persistent losses, sheds the character of comparability notwithstanding the fact that the other segment of software development services is not showing losses. Had there been comparison between the company's software development services segment and the assessee's 83 ITA Nos.1479 & 691/Del/2016 software development segment, the question of persistent losses would have paled into insignificance. As Microland Ltd. (Seg.) is persistently in losses, the same cannot be considered as comparable. We, therefore, uphold the exclusion of this company from the list of comparables.
ii) R. Systems International Ltd. (Seg.);
92. The assessee included this company on segmental level in its list of comparables. However, the TPO eliminated the same by noting that it was following different year ending, namely, 31st December and, hence, was not comparable. The ld. AR fairly accepted that the above company was following calendar year for maintaining its accounts in contrast to the assessee following financial year ending 31st March. It was, however, submitted that this company should not have been excluded for this reason alone when it was otherwise functionally similar, a fact which has not been denied by the TPO. The ld. DR opposed this contention by submitting that the data for the year ending of this company was not similar to that of assessee company and hence it was rightly excluded.
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93. We have heard both the sides on the issue. Unlike the international transaction of `Provision of Software development services', the TPO has not disputed functional similarity of the relevant segment of this company with the assessee's international transaction of `Provision of IT enabled services' under consideration. However, it is noticed that the assessee company is having financial year covering the period 1.4.2010 to 31.3.2011. In that view of the matter, a valid comparison can be made only if the potential comparable company has also the same financial year. In this regard, we consider it appropriate to note the relevant part of sub-rule (4) of Rule 10B which provides that: "the data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction had been entered into." It is obvious from the language of sub-rule (4) that the comparability of an uncontrolled transaction can be analyzed only with the "data relating to the financial year" in which the international transaction has been entered into. In other words, if the tested party has March year ending, then, the comparables must also have the data relating to the financial year ending 31st March 85 ITA Nos.1479 & 691/Del/2016 itself. If such a data is not available, then, a company albeit functionally comparable, disqualifies. Espousing the facts of the extant case, we find that insofar as the functional comparability of this company on segmental level is concerned, the TPO has not disputed the same. The only reason assigned for its exclusion is non-availability of data for the relevant financial year. The ld. AR contended that though the year ending of the above company was different, yet, the assessee was in a position to put forward the data of the relevant segment of this company for the financial year 1.4.2010 to 31.3.2011 from their Annual reports only. It was so stated on the basis of the availability of the quarterly data from the Annual reports of this company, which could, as per his opinion, be adjusted for the financial year ending 31.3.2011. If the contention of the assessee is correct, that the relevant data for the concerned financial year can be deduced from the information available from its Annual reports, then, there can be no objection to the inclusion of the relevant segment of this company in the list of comparables with the adjusted data for the relevant financial year itself. Under such circumstances, we set aside the impugned order and remit the matter to the file of TPO/AO for examining this aspect of the matter. It is 86 ITA Nos.1479 & 691/Del/2016 clarified that only if the assessee succeeds in providing the relevant data of this company for the concerned financial year on the basis of the information available from the Annual reports only, the TPO should include the appropriate segment of this company in the list of comparables by considering its OP/TC for the financial year ending on 31.3.2011. If, even though its quarterly data is available and can be compiled for the relevant financial year, but the amounts of operating profit or operating costs etc. for the relevant financial year are not directly available without any apportionment or truncation, then this company should not be considered as comparable. The Hon'ble Punjab & Haryana High Court in CIT vs. Mercer Consuling (India) P. Ltd. (2017) 390 ITR 615 (P&H) has approved the similar view of the Tribunal by holding : `that if the data relating to the financial year in which the international transaction has been entered into is directly available from the annual accounts of that comparable, then it cannot be held as not passing the test of sub-rule(4) of rule 10B.' We direct accordingly.
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(ii) Calibre Point Business Solutions Ltd. (Seg.)
94. The TPO held this company to be not comparable on the ground that it was having a different financial year ending i.e., December. But for that, the functional similarity under the instant segment is not disputed.
95. We have gone through the Annual report of this company, a copy of which is placed in the paper book. Its income from operation has been divided into two segments, namely, 'Business process outsourcing (BPO)' and 'Others'. Only the BPO segment of this company has been considered by the assessee as comparable. The only reason assigned by the TPO for excluding the BPO segment of this company is that its figures for the year ending 31st March, 2011 are not available. But for that, the functional comparability has not been challenged. We have discussed above the case of M/s R. Systems in which the TPO made exclusion only on the ground that its year ending was different from that of the assessee. The same has been disposed with some directions. Our observations made above in the context of M/s R. Systems apply to this company on segmental level as well. The TPO is directed to decide the inclusion or otherwise of this company in the light of the discussion made while dealing with M/s R. 88 ITA Nos.1479 & 691/Del/2016 Systems Ltd. under the instant international transaction of rendering IT enabled services.
(iii) Informed Technology; (v) Micro Genetics Systems Ltd.; and (vi) CG- Vak Software and Exports Ltd. (Seg.)
96. The TPO excluded these companies on the basis of turnover filter inasmuch the first two companies were having turnover less than Rs.5 crore and CG-Vak Software and Exports Ltd. (Seg.) was having income from BPO business at less than Rs.1 crore. This is the sole reason given by the TPO for their exclusion, without controverting the functional similarity of the above companies or the relevant segment. No change was made by the DRP in the views taken by the AO/TPO.
97. After considering the rival submissions and perusing the relevant material on record, we find that the assessee's turnover under this segment is to the tune of Rs.323.46 crore. The TPO excluded the companies with the turnover of less than Rs.5 crore. The preliminary question which looms large before us is whether the application of this filter is correct? In this regard, it is pertinent to note that the computation of arm's length price 89 ITA Nos.1479 & 691/Del/2016 under the Indian transfer pricing provisions is embodied in section 92C of the Act. Sub-section (1) of this section provides that the arm's length price in relation to an international transaction shall be determined by any of the given methods, being the most appropriate method, having regard to certain factors. Proviso to sub-section (2), which assumes significance for the present purpose, states that : 'where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices'. In contrast, some countries have adopted the inter-quartile range, which is also called the mid-spread or middle-fifty, instead of arithmetic mean of all, as used in India. When arithmetic mean is taken of the all the otherwise comparables companies, it tends to iron out the differences due to higher or lower size of a company or vacillating profitability rates. A company otherwise found to be functionally comparable cannot be excluded either on the ground of higher or lower profit rate or higher or lower turnover. There is no mention in the language of the provision for the exclusion of potential comparable companies simply on account of high or low turnover or profit rate. The Special bench of the tribunal in Maersk Global Centres (India) (P.) Ltd. VS. 90
ITA Nos.1479 & 691/Del/2016 ACIT (2014) 147 ITD 83 (Mum)(SB) has also held that potential comparables cannot be excluded merely on the ground that their profit is abnormally higher. There can be no justifiable reason to exclude such high or low profit companies unless it is shown that such high or low profit was due to abnormal factors. Same logic applies to the high or low turnover companies also. The mere fact that a company has a high or low turnover can be no reason to justify its exclusion if it is otherwise functionally comparable. The exclusion of companies on such a rationale runs contrary to the express provisions of the Act. The Hon'ble jurisdictional High Court in ChrysCapital Investment Advisors (India) P. Ltd. VS. DCIT (2015) 376 ITR 183 (Del) has also laid down to the same effect. We, therefore, direct to include Informed Technology; Micro Genetics Systems Ltd.; and CG-Vak Software and Exports Ltd. (Seg.) in the list of comparables.
98. Having considered the companies challenged by the assessee from the angle of comparability, we now take up the assessee's contention for grant of working capital adjustment and also allowing reduction of expenses in relation to rental income from total operating expenses in the computation of its PLI. The arguments advanced by both the sides on these 91 ITA Nos.1479 & 691/Del/2016 issues remain the same as were qua the international transaction of 'Provision of software development services.' In fact, the arguments given earlier were adopted for this international transaction as well. Following the view taken hereinabove, we direct the A.O./TPO to allow working capital adjustment after due verification of the claim, whether it goes for or against it, and also recompute the assessee's PLI from this international transaction by reducing operating expenses in relation to the earning of rental income from the overall operating expenses to be bifurcated amongst all the sources of the revenues of the assessee from operations including the instant international transaction.
99. The only issue raised by the Revenue in its appeal, as argued by the ld. DR, is against the exclusion of E-Clerx Services Ltd. on the direction of the DRP. The TPO included this company in the list of comparables, which was objected to by the assessee before the DRP by contending that it was functionally not comparable and was engaged in KPO activities. Apart from that, it was also submitted that it was outsourcing substantial amount of its work to outsiders. The DRP did not approve the view canvassed by the TPO. Relying on the judgment of the Hon'ble Delhi High Court in the 92 ITA Nos.1479 & 691/Del/2016 case of Rampgreen Solutions Pvt. Ltd. vs. CIT (2015) 279 CTR 441 (Del), the DRP directed to exclude this company from the list of comparables. The Revenue is aggrieved by such exclusion.
100. We have heard both the sides and gone through the relevant material on record. The ld. DR contended that this company ought to have been retained in the list of comparables as the assessee was also providing KPO services, which was countered by the ld. AR.
101. We are unable to approve the view taken by the ld. DR for the reason that under the international transaction of Provision of ITES, instantly under consideration, the assessee company is not rendering any KPO services. As noticed above, the nature of work carried on by the assessee under this international transaction is that of receiving complaints from the customers of Microsoft Corporation and then resolving their technical problems. Thus, this activity cannot be described as KPO. The Hon'ble Delhi High Court in Rampgreen Solutions (supra), has held that E- Clerx, being engaged in KPO, cannot be compared with a company providing BPO services. Recently, the Hon'ble Delhi High Court in B.C. Management Services (supra), has also reiterated that E-Clerx is not 93 ITA Nos.1479 & 691/Del/2016 comparable to an assessee providing IT enabled services. In view of the foregoing discussion, we are satisfied that the DRP was justified in ordering the exclusion of E-Clerx from the list of comparables drawn by the TPO under this segment.
102. To sum up, we set aside the impugned order on the issue of transfer pricing additions in the above referred two international transactions of `Provision of Software development services' and `Provision of IT Enabled services' and remit the matter to the file of AO/TPO for fresh determination of their ALP in consonance with our above observations/directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings.
103. Now, we take up corporate tax grounds raised by the assessee.
104. Ground no. 16 is against the addition towards realized foreign exchange fluctuation gain/loss and ground no. 17 is against the adjustment of Rs.13,40,482/- against the opening written down value of computers towards unrealized foreign exchange fluctuation gain arising out of re- statement of liability u/s 43A of the Act. Ground no.18 is against denial of 94 ITA Nos.1479 & 691/Del/2016 deduction u/s 10A of the Act in respect of specific additions amounting to Rs.8,73,11,096/-. Ground no. 20 is against the taxability of rental income under the head 'Income from house property.'
105. The Assessing Officer decided the above issues against the assessee. The ld. DRP also upheld the view taken by the Assessing Officer in the draft order by noticing that similar view was taken by it on the above issues in the immediately preceding year.
106. Having heard both the sides, it is observed that the immediately preceding year came up for consideration before the Tribunal. Vide order dated 28.06.2016, the Tribunal in ITA no.2058/Del/2015, has restored the above issues to the Assessing Officer for a fresh decision. Since the issues in the instant appeal are admittedly of the similar nature as in the preceding year, respectfully following the precedent, we set aside the impugned order on the above scores and remit the matter to the file of Assessing Officer for deciding them afresh in accordance with the view taken in such immediately preceding year, after allowing a reasonable opportunity of being heard to the assessee.
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107. Ground no. 19 is against not treating interest income of Rs.3,13,60,627/- earned on fixed deposits by the Bangalore undertaking as eligible for benefit u/s 10A of the Act. The ld. AR candidly admitted that this issue was neither raised before the Assessing Officer or DRP and the same being a legal issue, should be admitted by the Tribunal. The ld. DR objected to the admission of this ground.
108. Having gone through the nature of issue raised through this ground, we find that this is a legal issue and can be raised before the Tribunal for the first time. We, ergo, admit this issue for consideration.
109. In support of its contention, the assessee has filed additional evidence to bring home its point about the availability of benefit u/s 10A in respect of interest income. Since this issue has not been examined by the authorities below and the assessee has filed additional evidence, we are of the considered opinion that it would be in the fitness of things if the Assessing Officer is directed to decide this issue afresh as per law, after allowing an opportunity of being heard to the assessee. The assessee will be at liberty to file any fresh evidence before the AO in support of its claim on this issue.
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110. Ground no. 21 is against not allowing MAT tax credit. The Assessing Officer is directed to verify the assessee's contention and allow the necessary MAT credit as per law, if available.
111. Ground no. 23 about not granting credit for TDS to the extent of Rs.1,71,729/- was not pressed by the ld. AR. The same is, therefore, dismissed as not pressed.
112. Ground nos. 23 and 24 about charging of interest are consequential and are disposed off accordingly.
113. In the result, the appeal of the Revenue is dismissed and that of the assessee is partly allowed for statistical purposes.
The order pronounced in the open court on 14.09.2018.
Sd/- Sd/-
[K. NARASIMHA CHARY] [R.S. SYAL]
JUDICIAL MEMBER VICE PRESIDENT
Dated, 14th September, 2018.
dk
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Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.
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