M/s Cypress Semiconductor Technology India Private Limited, Bangalore V. DCIT, Bangalore

ITA 1167/BANG/2010

• Counselvise Citation: [2015] 120 COUNSELVISE.COM (IT) 8681 (ITAT-BANGALORE)
• Duration Of Justice: 4 year(s) 5 month(s) 6 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 27-03-2015
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: B
• Next Hearing Date: 19-03-2015
• Assessment Year: 2006-2007
• Appeal Filed On: 21-10-2010
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: T SURYANARAYAN
• Keywords: Related party transaction; Transfer pricing; International transaction
• Section: 143(3); 92D; 10B

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL B BENCH : BANGALORE BEFORE SHRI N.V. VASUDEVAN, JUDICIAL MEMBER AND SHRI JASON P. BOAZ, ACCOUNTANT MEMBER IT(TP)A NO.1167/BANG/2010 ASSESSMENT YEAR : 2006-07 M/S. CYPRESS SEMICONDUCTOR TECHNOLOGY INDIA PRIVATE LIMITED, # 65/2, LAUREL, BAGMANE TECH PARK, BLOCK C, C.V.RAMAN NAGAR, BANGALORE 560 093. PAN : AABCC 2470Q VS. THE DEPUTY COMMISSIONER OF INCOME-TAX, CIRCLE 11(2), BANGALORE. APPELLANT RESPONDENT APPELLANT BY : SHRI T. SURYANARAYAN, ADVOCATE RESPONDENT BY : SHRI FARAHAT HUSSAIN QURESHI, CIT-II(DR) DATE OF HEARING : 19.03.2015 DATE OF PRONOUNCEMENT : 27.03.2015 O R D E R PER N.V. VASUDEVAN, JUDICIAL MEMBER THIS APPEAL BY THE ASSESSEE IS AGAINST THE ORDER DATED 12.10.2010 OF THE DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE 11 (2), BANGALORE PASSED U/S. 143(3) R.W.S. 144C OF THE ACT RELATING TO AY 06-07. 2. THE ASSESSEE IS A LEADING SUPPLIER OF HIGH-PER FORMANCE SOLUTIONS FOR PERSONAL, NETWORK ACCESS, ENTERPRISE, METRO SWI TCH AND CORE- COMMUNICATIONS SYSTEM APPLICATIONS. IT DESIGNS, MA NUFACTURES AND ITA NO.1167/BANG/2010 PAGE 2 OF 26 MARKETS SILICON-BASED PRODUCTS AND SOLUTIONS FOR A RANGE OF MARKETS. THE ASSESSEE, IS A SUBSIDIARY OF CYPRESS SEMICONDUCTOR TECHNOLOGY LTD., CAYMAN ISLAND AND IS ENGAGED IN PROVIDING SOFTWARE DEVELOPMENT AND TESTING SERVICES TO ITS ASSOCIATED ENTERPRISES (AES ) AS A CAPTIVE SERVICE PROVIDER IN THE AREAS OF INTEGRATED CIRCUITS FOR ME MORY, INTERFACE AND DATA COMMUNICATION APPLICATIONS. THE ABOVE TRANSACTION WAS AN INTERNATIONAL TRANSACTIONS WITH AN ASSOCIATED ENTERPRISE (AE) AND HAVE TO PASS THE ARMS LENGTH PRICE (ALP) TEST AS PROVIDED U/S.92 OF THE INCOME TAX ACT, 1961 (ACT). IN THIS APPEAL THE DISPUTE IS WITH REG ARD TO ADDITION MADE CONSEQUENT TO DETERMINATION OF ALP AND CONSEQUENT U PWARD REVISION AND ADJUSTMENT MADE TO THE PRICE AT WHICH INTERNATIONAL TRANSACTIONS WERE CARRIED OUT BY THE ASSESSEE WITH ITS AE IN RESPECT OF SOFTWARE DEVELOPMENT SERVICES. 3. FINANCIAL RESULTS OF CYPRUS INDIA FOR THE F Y 20 05-06 DESCRIPTION AMOUNT OPERATING REVENUE RS.46,66,89,135 OPERATING COST . . . . RS.42,36,90,759/- OPERATING PROFIT (PBIT) RS. 4,29,98,376/- OPERATING PROFIT TO COST RATIO 10.15 % ITA NO.1167/BANG/2010 PAGE 3 OF 26 4. COMPARABLE ULTIMATELY SELECTED BY TPO AND THEIR ARITHMETIC MEAN : SL. NO NAME OF COMPANY OP / TC (FY 2006-07) SALES (RS.CR.) 1 AZTEC SOFTWARE LIMITED 18.09 128.61 2 GEOMETRIC SOFTWARE LIMITED (SEG.) 6.70 98.59 3 INFOSYS LTD 40.38 9028.00 4 KALS INFO SYSTEMS LIMITED 39.75 1.97 5 MINDTREE CONSULTING LTD 14.67 448.79 6 PERSISTENT SYSTEMS LTD. 24.67 209.18 7 R.SYSTEMS INTERNATIONAL LTD. (SEG.) 22.20 79.42 8 SASKEN COMMUNICATIONS LTD. (SEG.) 13.90 240.03 9 TATA ELXSI LTD (SEG.) 27.65 188.81 10 LUCID SOFTWARE LTD 8.92 1.02 11 MEDIASOFT SOLUTIONS LTD 6.29 1.76 12 R S SOFTWARE (INDIA) LTD 15.69 91.57 13 S I P TECHNOLOGIES & EXPORTS LTD 3.06 6.53 14 BODHTREE CONSULTING LTD. 15.99 5.32 15 ACCEL TRANSMATIC LTD. (SEG.) 44.07 8.02 16 SYNFOSYS BUSINESS SOLUTIONS LTD. 10.61 4.49 17 FLEXTRONICS SOFTWARE SYSTEMS LTD. 27.24 595.12 18 LANCO GLOBAL SOLUTIONS LTD 5.27 35.63 19 MEGASOFT LTD 52.74 56.15 20 IGATE GLOBAL SOLUTIONS LTD.(SEG.) 15.61 527.91 ARITHMETIC MEAN 20.68% APPELLANT'S OP / TC FOR FY 2006-07 10% 5. THE TPO FINALLY PASSED AN ORDER U/S. 92CA OF THE ACT AND ON THE BASIS OF THE COMPARABLES SET OUT ABOVE, ARRIVED AT ARITHMETIC MEAN OF 20.68%. AFTER FACTORING NEGATIVE WORKING CAPITAL A DJUSTMENT OF 1.31%, THE ADJUSTED ARITHMETIC MEAN WAS DETERMINED AT 19.37%. THE COMPUTATION OF THE ALP BY THE TPO IN THIS REGARD WAS AS FOLLOWS:- COMPUTATION OF ARMS LENGTH PRICE: THE ARITHMETIC MEAN OF THE PROFIT LEVEL INDICATORS IS TAKEN AS THE ARMS LENGTH MARGIN. (PLEASE SEE ANNEXURE B FOR DETA ILS OF ITA NO.1167/BANG/2010 PAGE 4 OF 26 COMPUTATION OF PLI OF THE COMPARABLES). BASED ON TH IS, THE ARMS LENGTH PRICE OF THE SOFTWARE DEVELOPMENT SERVICES R ENDERED BY YOU IS COMPUTED AS UNDER: ARITHMETIC MEAN PLI 20.68% LESS: WORKING CAPITAL ADJUSTMENT(ANNEXURE-C) 1.31% ADJ.ARITHMETIC MEAN PLI 19.37% ARMS LENGTH PRICE: OPERATING COST RS.42,36,90,759 ARMS LENGTH MARGIN 19.37% OF THE OPERATING COST ARMS LENGTH PRICE (ALP) AT 119.37% OF OPERATING COST RS.50,57,59,659/- PRICE RECEIVED VIS--VIS THE ARMS LENGTH PRICE: THE PRICE CHARGED BY THE TAX PAYER TO ITS ASSOCIATE D ENTERPRISES IS COMPARED TO THE ARMS LENGTH PRICE AS UNDER: ARMS LENGTH PRICE (ALP) AT 119.37% OF OPERATING COST RS.50,57,59,659 PRICE CHARGED IN THE INTERNATIONAL TRANSACTIONS RS.46,66,89,135 SHORTFALL BEING ADJUSTMENT U/S.92CA RS.3,90,70,524 THE ABOVE SHORTFALL OF RS.3,90,70,524/- IS TREATED AS TRANSFER PRICING ADJUSTMENT U/S 92CA. 6. AGAINST THE SAID ADJUSTMENT PROPOSED BY THE TPO WHICH WAS INCORPORATED IN THE DRAFT ASSESSMENT ORDER BY THE A O, THE ASSESSEE FILED OBJECTIONS BEFORE THE DRP. THE DRP REJECTED THOSE O BJECTIONS AND CONFIRMED THE TRANSFER PRICING ADJUSTMENT SUGGESTED BY THE TPO. THE ADJUSTMENT CONFIRMED BY THE DRP WAS ADDED TO THE TO TAL INCOME OF THE ITA NO.1167/BANG/2010 PAGE 5 OF 26 ASSESSEE BY THE AO IN THE FAIR ORDER OF ASSESSMENT. AGAINST THE SAID ORDER OF THE ASSESSING OFFICER, THE ASSESSEE HAS PREFERRE D THE PRESENT APPEAL BEFORE THE TRIBUNAL. 7. THE ASSESSEE FILED A CHART SHOWING HOW THE TPO H AS NOT GIVEN WORKING CAPITAL ADJUSTMENT AS PRAYED FOR BY THE ASS ESSEE, THE TURNOVER AND THE MARGINS OF THE 20 COMPARABLE COMPANIES FINA LLY CHOSEN BY THE TPO AFTER GIVING EFFECT TO ADJUSTMENT TOWARDS WORKI NG CAPITAL AS ALLOWED BY THE TPO AND ALSO AS CLAIMED BY THE ASSESSEE. THE CHART ALSO EXPLAINS AS TO HOW SOME OF THE COMPARABLE COMPANIES CHOSEN BY T HE TPO ARE NOT COMPARABLE FOR THE REASON THAT THESE COMPANIES WERE NOT FUNCTIONALLY COMPARABLE. THE CHART ALSO GIVES THE CASES DECIDED BY VARIOUS BENCHES OF THE ITAT WHERE THE COMPARABLE COMPANIES HAVE BEE N HELD TO BE NOT COMPARABLE WITH THAT OF AN ASSESSEE PROVIDING IT SO FTWARE DEVELOPMENT SERVICES. THE LEARNED DR PLACED RELIANCE ON THE O RDER OF THE TPO/DRP. WE WILL PROCEED TO CONSIDER THE COMPARABILITY OF CO MPANIES CHOSEN BY THE TPO AND LISTED IN PARA- 4 OF THIS ORDER. 8. THE LD. COUNSEL FOR THE ASSESSEE BROUGHT TO OUR NOTICE THAT OUT OF THE 20 COMPARABLE COMPANIES CHOSEN BY THE TPO, KALS INF ORMATION SYSTEMS LIMITED AND ACCEL TRANSMATIC LTD. ARE NOT FUNCTIONA LLY COMPARABLE WITH THAT OF THE ASSESSEE. IN THIS REGARD OUR ATTENTION WAS DRAWN TO THE DECISION OF THE HONBLE ITAT BANGALORE BENCH IN THE CASE OF TRI LOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. VS. DCIT ITA NO.1054/BANG/2 012 (AY 07-08) ITA NO.1167/BANG/2010 PAGE 6 OF 26 WHEREIN THIS COMPANY WAS HELD TO BE NOT FUNCTIONALL Y COMPARABLE WITH THAT OF A PURE SOFTWARE DEVELOPER LIKE THE ASSESSEE. TH E FOLLOWING WERE THE RELEVANT OBSERVATIONS OF THE TRIBUNAL ON THE AFORES AID COMPARABLE COMPANIES IN THE CASE OF TRILOGY E-BUSINESS SOFTWAR E INDIA PVT.LTD.(SUPRA): 9. IMPROPER SELECTION OF COMPARABLES: IT WAS SUBMITTED BY THE LEARNED COUNSEL FOR THE ASSESSEE THAT THE FOLLOWING COMPANIES ARE NOT FUNCTIONALLY COMPARABLE WITH THAT OF THE ASSESSEE. A) KALS INFORMATION SYSTEMS LIMITED B) ACCEL TRANSMISSION LIMITED. 10. IN THIS REGARD OUR ATTENTION WAS DRAWN TO THE D ECISION OF THE HONBLE ITAT BANGALORE BENCH IN THE CASE OF TRILOGY E-BUSIN ESS SOFTWARE INDIA PVT.LTD. (SUPRA) WHEREIN THESE COMPANIES WERE HELD TO BE NOT FUNCTIONALLY COMPARABLE WITH THAT OF A PURE SOFTWARE DEVELOPER L IKE THE ASSESSEE. 11. THE FOLLOWING WERE THE RELEVANT OBSERVATIONS OF THE TRIBUNAL ON THE AFORESAID COMPARABLE COMPANIES IN THE CASE OF TRILO GY E-BUSINESS SOFTWARE INDIA PVT.LTD.(SUPRA): (D) KALS INFORMATION SYSTEMS LTD. AS FAR AS THIS COMPANY IS CONCERNED, THE CONTENTION OF THE ASSESSEE IS THAT THE AFORESAID COMPANY HAS REVENUES FROM BOTH SOFTWARE DEVELOPMENT AND SOFTWARE PRODUCTS. BESIDE S THE ABOVE, IT WAS ALSO POINTED OUT THAT THIS COMPANY IS ENGAGE D IN PROVIDING ITA NO.1167/BANG/2010 PAGE 7 OF 26 TRAINING. IT WAS ALSO SUBMITTED THAT AS PER THE AN NUAL REPOT, THE SALARY COST DEBITED UNDER THE SOFTWARE DEVELOPMENT EXPENDITURE WAS Q 45,93,351. THE SAME WAS LESS THAN 25% OF THE SOFTWARE SERVICES REVENUE AND THEREFORE THE SALARY COST FILT ER TEST FAILS IN THIS CASE. REFERENCE WAS MADE TO THE PUNE BENCH TR IBUNALS DECISION OF THE ITAT IN THE CASE OF BINDVIEW INDIA PRIVATE LIMITED VS. DCI, ITA NO. ITA NO 1386/PN/1O WHEREIN KALS AS COMPARABLE WAS REJECTED FOR AY 2006-07 ON ACCOUNT O F IT BEING FUNCTIONALLY DIFFERENT FROM SOFTWARE COMPANIES. THE RELEVANT EXTRACT ARE AS FOLLOWS: 16. ANOTHER ISSUE RELATING TO SELECTION OF COMPARABLES BY THE TPO IS REGARDING INCLUSION OF KA LS INFORMATION SYSTEM LTD. THE ASSESSEE HAS OBJECTED T O ITS INCLUSION ON THE BASIS THAT FUNCTIONALLY THE COMPAN Y IS NOT COMPARABLE. WITH REFERENCE TO PAGES 185-186 OF THE PAPER BOOK, IT IS EXPLAINED THAT THE SAID COMPANY IS ENGA GED IN DEVELOPMENT OF SOFTWARE PRODUCTS AND SERVICES AND I S NOT COMPARABLE TO SOFTWARE DEVELOPMENT SERVICES PROVIDE D BY THE ASSESSEE. THE APPELLANT HAS SUBMITTED AN EXTRAC T ON PAGES 185-186 OF THE PAPER BOOK FROM THE WEBSITE OF THE COMPANY TO ESTABLISH THAT IT IS ENGAGED IN PROVIDIN G OF I T ENABLED SERVICES AND THAT THE SAID COMPANY IS INTO DEVELOPMENT OF SOFTWARE PRODUCTS, ETC. ALL THESE AS PECTS HAVE NOT BEEN FACTUALLY REBUTTED AND, IN OUR VIEW, THE SAID CONCERN IS LIABLE TO BE EXCLUDED FROM THE FINAL SET OF COMPARABLES, AND THUS ON THIS ASPECT, ASSESSEE SUCC EEDS. BASED ON ALL THE ABOVE, IT WAS SUBMITTED ON BEHALF OF THE ASSESSEE THAT KALS INFORMATION SYSTEMS LIMITED SHOULD BE REJ ECTED AS A COMPARABLE. WE HAVE GIVEN A CAREFUL CONSIDERATION TO THE SUBMI SSION MADE ON BEHALF OF THE ASSESSEE. WE FIND THAT THE TPO HA S DRAWN CONCLUSIONS ON THE BASIS OF INFORMATION OBTAINED BY ISSUE OF NOTICE U/S.133(6) OF THE ACT. THIS INFORMATION WHI CH WAS NOT AVAILABLE IN PUBLIC DOMAIN COULD NOT HAVE BEEN USED BY THE TPO, WHEN THE SAME IS CONTRARY TO THE ANNUAL REPORT OF T HIS COMPANY AS HIGHLIGHTED BY THE ASSESSEE IN ITS LETTER DATED 21. 6.2010 TO THE TPO. WE ALSO FIND THAT IN THE DECISION REFERRED TO BY THE LEARNED COUNSEL FOR THE ASSESSEE, THE MUMBAI BENCH OF ITAT HAS HELD THAT THIS COMPANY WAS DEVELOPING SOFTWARE PRODUCTS AND NOT PURELY OR MAINLY SOFTWARE DEVELOPMENT SERVICE PROVI DER. WE ITA NO.1167/BANG/2010 PAGE 8 OF 26 THEREFORE ACCEPT THE PLEA OF THE ASSESSEE THAT THIS COMPANY IS NOT COMPARABLE. (E) ACCEL TRANSMATIC LTD. 48. WITH REGARD TO THIS COMPANY, THE COMPLAINT OF T HE ASSESSEE IS THAT THIS COMPANY IS NOT A PURE SOFTWARE DEVELOPMEN T SERVICE COMPANY. IT IS FURTHER SUBMITTED THAT IN A MUMBAI TRIBUNAL DECISION OF CAPGEMINI INDIA (F) LTD V AD. CIT 12 TAXMAN.COM 51, THE DRP ACCEPTED THE CONTENTION OF THE ASSESSEE TH AT ACCEL TRANSMATIC SHOULD BE REJECTED AS COMPARABLE. THE RE LEVANT OBSERVATIONS OF DRP AS EXTRACTED BY THE ITAT IN ITS ORDER ARE AS FOLLOWS: IN REGARD TO ACCEL TRANSMATICS LTD. THE ASSESSEE SUBMITTED THE COMPANY PROFILE AND ITS ANNUAL REPORT FOR FINAN CIAL YEAR 2005-06 FROM WHICH THE DRP NOTED THAT THE BUSINESS ACTIVITIES OF THE COMPANY WERE AS UNDER. (I) TRANSMATIC SYSTEM - DESIGN, DEVELOPMENT AND MANUFACTURE OF MULTI FUNCTION KIOSKS QUEUE MANAGEME NT SYSTEM, TICKET VENDING SYSTEM (II) USHUS TECHNOLOGIES - OFFSHORE DEVELOPMENT CENT RE FOR EMBEDDED SOFTWARE, NET WORK SYSTEM, IMAGING TECHNOL OGIES, OUTSOURCED PRODUCT DEVELOPMENT (III) ACCEL IT ACADEMY (THE NET STOP FOR ENGINEERS) - TRAINING SERVICES IN HARDWARE AND NETWORKING, ENTERPRISE SYS TEM MANAGEMENT, EMBEDDED SYSTEM, VLSI DESIGNS, CAD/CAM/BPO (IV) ACCEL ANIMATION STUDIES SOFTWARE SERVICES FOR 2D/3D ANIMATION, SPECIAL EFFECT, ERECTION, GAME ASSET DEVELOPMENT. 4.3 ON CAREFUL PERUSAL OF THE BUSINESS ACTIVITIES O F ACCEL TRANSMATIC LTD. DRP AGREED WITH THE ASSESSEE THAT T HE COMPANY WAS FUNCTIONALLY DIFFERENT FROM THE ASSESSE E COMPANY AS IT WAS ENGAGED IN THE SERVICES IN THE FO RM OF ACCEL IT AND ACCEL ANIMATION SERVICES FOR 2D AND 3D ANIMATION AND THEREFORE ASSESSEES CLAIM THAT THIS COMPANY WAS FUNCTIONALLY DIFFERENT WAS ACCEPTED. DRP THEREF ORE ITA NO.1167/BANG/2010 PAGE 9 OF 26 DIRECTED THE ASSESSING OFFICER TO EXCLUDE ACCEL TRA NSMATIC LTD. FROM THE FINAL LIST OF COMPARABLES FOR THE PUR POSE OF DETERMINING TNMM MARGIN. 49. BESIDES THE ABOVE, IT WAS POINTED OUT THAT THI S COMPANY HAS RELATED PARTY TRANSACTIONS WHICH IS MORE THAN THE P ERMITTED LEVEL AND THEREFORE SHOULD NOT BE TAKEN FOR COMPARABILITY PURPOSES. THE SUBMISSION OF THE LD. COUNSEL FOR THE ASSESSEE WAS THAT IF THE ABOVE COMPANY SHOULD NOT BE CONSIDERED AS COMPARABL E. THE LD. DR, ON THE OTHER HAND, RELIED ON THE ORDER OF THE T PO. 50. WE HAVE CONSIDERED THE SUBMISSIONS AND ARE OF T HE VIEW THAT THE PLEA OF THE ASSESSEE THAT THE AFORESAID COMPANY SHOULD NOT BE TREATED AS COMPARABLES WAS CONSIDERED BY THE TRIBUN AL IN CAPGEMINI INDIA LTD (SUPRA) WHERE THE ASSESSEE WAS SOFTWARE DEVELOPER. THE TRIBUNAL, IN THE SAID DECISION REFE RRED TO BY THE LD. COUNSEL FOR THE ASSESSEE, HAS ACCEPTED THAT THI S COMPANY WAS NOT COMPARABLE IN THE CASE OF THE ASSESSEES ENGAGED IN SOFTWARE DEVELOPMENT SERVICES BUSINESS. ACCEPTING THE ARGU MENT OF THE LD. COUNSEL FOR THE ASSESSEE, WE HOLD THAT THE AFOR ESAID COMPANY SHOULD BE EXCLUDED AS COMPARABLES. 12. THE FACTS AND CIRCUMSTANCES UNDER WHICH THE AFO RESAID COMPANIES WERE CONSIDERED AS COMPARABLE ARE IDENTICAL IN THE CASE OF THE ASSESSEE AS WELL AS IN THE CASE OF TRILOGY E-BUSINESS SOFTWA RE INDIA PVT.LTD. (SUPRA). RESPECTFULLY FOLLOWING THE DECISION OF THE TRIBUNAL REFERRED TO ABOVE IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD.( SUPRA), WE DIRECT THAT KALS INFORMATION SYSTEMS LIMITED AND ACCEL TRANSMAT ICS LTD., BE EXCLUDED FROM THE LIST OF 20 COMPARABLE ARRIVED AT BY THE TPO. 13. AS FAR AS COMPARABLE TATA ELXSI LTD., IS CONCE RNED, THE COMPARABILITY OF THIS COMPANY WITH THAT OF THE SOFT WARE SERVICE PROVIDER WAS CONSIDERED BY THE MUMBAI BENCH OF THIS TRIBUNAL IN THE CASE OF LOGICA ITA NO.1167/BANG/2010 PAGE 10 OF 26 PVT.LTD. IT (TP) 1129/BANG/2011 (AY 07-08) WHEREIN ON THE AFORESAID COMPANY, THE TRIBUNAL HELD AS FOLLOWS:- 14. AS FAR AS COMPARABLE AT SL.NO.6 & 24 ARE CONCE RNED, THE COMPARABILITY OF THE AFORESAID TWO COMPANIES WITH T HAT OF THE SOFTWARE SERVICE PROVIDER WAS CONSIDERED BY THE MUM BAI BENCH OF THE TRIBUNAL IN THE CASE OF TELCORDIA TECHNOLOGIES INDIA PRIVATE LTD. (SUPRA) WHEREIN ON THE AFORESAID TWO COMPANIES, THE TRIBUNAL HELD AS FOLLOWS:- 7.6 FLEXTRONICS SOFTWARE SYSTEMS LTD. .. 7.7.TATA ELXSI LIMITED.: FROM THE FACTS AND MATERIAL ON RECORD AND SUBMISSIO NS MADE BY THE LEARNED AR, IT IS SEEN THAT THE TATA EL XSI IS ENGAGED IN DEVELOPMENT OF NICHE PRODUCT AND DEVELOP MENT SERVICES, WHICH IS ENTIRELY DIFFERENT FROM THE ASSE SSEE COMPANY. WE AGREE WITH THE CONTENTION OF THE LEARNE D AR THAT THE NATURE OF PRODUCT DEVELOPED AND SERVICES P ROVIDED BY THIS COMPANY ARE DIFFERENT FROM THE ASSESSEE AS HAVE BEEN NARRATED IN PARA 6.6 ABOVE. EVEN THE SEGMENTAL DETAILS FOR REVENUE SALES HAVE NOT BEEN PROVIDED BY THE TPO SO AS TO CONSIDER IT AS A COMPARABLE PARTY FOR COMPARING THE PROFIT RATIO FROM PRODUCT AND SERVICES. THUS, ON THESE FAC TS, WE ARE UNABLE TO TREAT THIS COMPANY FIT FOR COMPARABILITY ANALYSIS FOR DETERMINING THE ARMS LENGTH PRICE FOR THE ASSES SEE, HENCE, SHOULD BE EXCLUDED FROM THE LIST OF COMPARAB LE PARTIES. 15. IN VIEW OF THE ABOVE, THE LD. COUNSEL FOR THE A SSESSEE FAIRLY ADMITTED THAT COMPARABLE COMPANY AT SL.NO.6 VIZ., F LEXTRONICS SOFTWARE SYSTEMS PVT. LTD. SHOULD BE TAKEN AS A COM PARABLE, WHILE COMPARABLE AT SL.NO.24 VIZ., TATA ELXSI LTD. SHOULD BE REJECTED AS A COMPARABLE. 14. IN VIEW OF THE AFORESAID DECISION, WE HOLD THAT TATA ELXSI HAS TO BE EXCLUDED FROM THE LIST OF COMPARABLE CHOSEN BY THE TPO. ITA NO.1167/BANG/2010 PAGE 11 OF 26 15. AS FAR AS THE COMPARABLE CHOSEN BY TPO VIZ., IN FOSYS LIMITED IS CONCERNED, IT HAS BEEN HELD BY THE CO-ORDINATE BENC H OF ITAT BANGALORE IN THE CASE OF LOGICA PVT.LTD. VS. ACIT ITA NO.1129/BA NG/2011 (AY 07-08) THAT THIS COMPANY IS A FULL FLEDGE RISK ASSUMING EN TREPRENEUR, HOLDS TECHNOLOGY AND MARKETING INTANGIBLE AND IS FUNCTION ALLY DIFFERENT PROVIDING END-TO-END SOLUTIONS ENCOMPASSING TECHNICAL CONSULT ING, DESIGN, DEVELOPMENT, RE-ENGINEERING, MAINTENANCE, SYSTEMS I NTEGRATION AND PACKAGE EVALUATION AND IMPLEMENTATION. THE COMPANY GENERATES AROUND 3.96% OF ITS REVENUE FROM SOFTWARE PRODUCTS. THE R ELEVANT OBSERVATIONS OF THE TRIBUNAL IN THE CASE OF LOGICAL PVT. LTD. (SUPR A) WERE AS FOLLOWS: 13. SO ALSO, THE COMPARABLES LISTED AT SL.NOS. 10 , 14 AND 26 HAVE TO BE REJECTED AS FUNCTIONALLY NOT COMPARABLE WITH THAT OF THE ASSESSEE IN VIEW OF THE DECISION OF THE MUMBAI BENCH OF THE TRIBUNAL IN THE CASE OF TELCORDIA TECHNOLOGIES INDIA PRIVATE LTD. IN ITA NO.7821/MUM/2011 , WHEREIN IT WAS HELD AS UNDER:- 7.2 LUCID SOFTWARE LIMITED 7.4 INFOSYS TECHNOLOGIES LTD.: THE PARAMETER FOR IDENTIFYING COMPARABLE ENTITY HA S TO BE SEEN FROM THE ANGLE OF FUNCTIONS FORMED BY THE C OMPANY, SIZE OF THE COMPANY IN TERMS OF THE SALE REVENUE, S TAGE OF BUSINESS CYCLE AND COMPANYS GROWTH CYCLE. IN THE CASE OF INFOSYS, THERE ARE HUGE INTANGIBLE ASSETS WHICH AS PER THE INFORMATION PROVIDED BY THE LEARNED AR ARE VALUED A T RS.69,522 CRORES, WHICH COMPRISES OF BRAND VALUE IT SELF AT RS.22,915 CRORES. BASED ON SUCH FUND VALUATION, TH E PROFIT OF INFOSYS IS PREDOMINANTLY DUE TO ITS PREMIUM BRANDIN G. IT IS INDIAS NO.2 SOFTWARE SERVICE EXPORTER AND THIRD IN THE ITA NO.1167/BANG/2010 PAGE 12 OF 26 WORLD AS AN IT SERVICE COMPANY. IT IS A GIANT COM PANY WHICH IS EVIDENT FROM ITS REVENUE FUND FROM THE SAL ES WHICH ITSELF IS MORE THAN RS.13145 CRORES AND EXPENDITURE ON ADVERTISEMENT/SALES PROMOTION AND EXPENDITURE ON R& D IS AT RS.69 CRORES AND RS.167 CRORES RESPECTIVELY, WHE REAS IN THE CASE OF THE ASSESSEE THE REVENUE IS ONLY 10.7 C RORES WITH NO EXPENDITURE ON ADVERTISEMENT, SALES AND PROMOTIO N ETC., WHICH ARE BORNE BY THE ASSOCIATED ENTERPRISES. EVEN FROM THE TEST OF FAR IE. FUNCTION PERFORMED, ASSETS EM PLOYED AND RISK ASSUMED, COMPARABILITY ANALYSIS MISERABLY FAILS IN THIS CASE. THE COMPARISON OF FUNCTION AND PROFILE A S HAS BEEN REPRODUCED IN PARA 6(IV) ABOVE, MOSTLY SHOWS T HAT THE PROFIT LEVEL INDICATORS IN RELATION TO RETURN OF CO ST, RETURN OF SALES AND RETURN OF ASSETS ARE HUGE BETWEEN INFOSYS AND THE ASSESSEE COMPANY AND THEREFORE, THE INFOSYS CANNOT BE TREATED AS COMPARABLE ENTITY FOR MAKING COMPARABILI TY ANALYSIS WITH THE ASSESSEE COMPANY. THE COMPARABILI TY OF LNFOSYS TECHNOLOGY OF THE COMPANY AS THAT OF AN ASS ESSEE HAS BEEN DEALT WITH ITAT DELHI BENCH IN THE CASE OF AGNITY INDIA TECHNOLOGIES PRIVATE LIMITED (ITA NO.3856/DELHI/2010), WHEREIN IT WAS HELD THAT LNFOS YS IS A GIANT IN THE AREA OF DEVELOPMENT OF SOFTWARE AND IT ASSUMES ALL RISKS, LEADING TO HIGHER PROFIT AND CANNOT BE C OMPARED WITH THE COMPANY WHICH IS A CAPTIVE UNIT OF ITS PAR ENT COMPANY ASSUMING ONLY LIMITED CURRENCY RISK. IN VIE W OF THE ABOVE FINDING, WE HOLD THAT THE INFOSYS CANNOT BE T AKEN AS A COMPARABLE FOR DETERMINING THE ARMS LENGTH PRICE IN THE CASE OF THE ASSESSEE. 16. RESPECTFULLY FOLLOWING THE DECISION OF THE TRIB UNAL REFERRED TO ABOVE, WE DIRECT INFOSYS LIMITED SHOULD BE EXCLUDED FROM T HE LIST OF COMPARABLE COMPANIES CHOSEN BY THE TPO. WE ORDER ACCORDINGLY. 17. AS FAR AS COMPARABLE COMPANIES CHOSEN BY THE TP O VIZ., IGATE GLOBAL SOLUTIONS LTD., MINDTREE CONSULTING LTD., SA SKEN COMMUNICATIONS LTD., AND FLEXTRONICS SOFTWARE SYSTEMS LTD., ARE CO NCERNED, THIS TRIBUNAL IN ITA NO.1167/BANG/2010 PAGE 13 OF 26 THE CASE OF TRILOGY E-BUSINESS (SUPRA) HAS BY APPLY ING TURNOVER FILTER HELD THAT WHILE SELECTING COMPARABLE COMPANIES FOR COMPA RABILITY ANALYSIS TURNOVER WILL BE A RELEVANT CRITERIA AND HELD AS FO LLOWS: (1) TURNOVER FILTER 11. THE LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT TH E TPO HAS APPLIED A LOWER TURNOVER FILTER OF RS. 1 CRORE, BUT HAS NOT CHOSEN TO APPLY ANY UPPER TURNOVER LIMIT. IN THIS REGARD, IT WAS SUBMI TTED BY HIM THAT UNDER RULE 10B(3) TO THE INCOME-TAX RULES, IT WAS NECESSA RY FOR COMPARING AN UNCONTROLLED TRANSACTION WITH AN INTERNATIONAL TRAN SACTION THAT THERE SHOULD NOT BE ANY DIFFERENCE BETWEEN THE TRANSACTIONS COMP ARED OR THE ENTERPRISES ENTERING INTO SUCH TRANSACTION, WHICH A RE LIKELY TO MATERIALLY AFFECT THE PRICE OR COST CHARGED OR PAID OR PROFIT ARISING FROM SUCH TRANSACTION IN THE OPEN MARKET. FURTHER IT IS ALSO NECESSARY TO SEE THAT WHEREVER THERE ARE SOME DIFFERENCES SUCH DIFFERENCE S SHOULD BE CAPABLE OF REASONABLE ACCURATE ADJUSTMENT IN MONETARY TERMS TO ELIMINATE THE EFFECT OF SUCH DIFFERENCES. IT WAS HIS SUBMISSION THAT SI ZE WAS AN IMPORTANT FACET OF THE COMPARABILITY EXERCISE. IT WAS SUBMITTED TH AT SIGNIFICANT DIFFERENCES IN SIZE OF THE COMPANIES WOULD IMPACT C OMPARABILITY. IN THIS REGARD OUR ATTENTION WAS DRAWN TO THE DECISION OF T HE SPECIAL BENCH OF THE ITAT CHANDIGARH BENCH IN THE CASE OF DCIT V. QUARK SYSTEMS PVT. LTD. 38 SOT 207 , WHEREIN THE SPECIAL BENCH HAD LAID DOWN THAT IT I S IMPROPER TO PROCEED ON THE BASIS OF LOWER LIMIT OF 1 CRORE T URNOVER WITH NO HIGHER LIMIT ON TURNOVER, AS THE SAME WAS NOT REASONABLE C LASSIFICATION. SEVERAL OTHER DECISIONS WERE REFERRED TO IN THIS REGARD LAY ING DOWN IDENTICAL PROPOSITION. WE ARE NOT REFERRING TO THOSE DECISIO NS AS THE DECISION OF THE SPECIAL BENCH ON THIS ASPECT WOULD HOLD THE FIELD. REFERENCE WAS ALSO MADE TO THE OECD TP GUIDELINES, 2010 WHEREIN IT HAS BEEN OBSERVED AS FOLLOWS:- SIZE CRITERIA IN TERMS OF SALES, ASSETS OR NUMBER OF EMPLOYEES: THE SIZE OF THE TRANSACTION IN ABSOLUTE VALUE OR IN PROPORTION TO THE ACTIVITIES OF THE PARTIES MIGH T AFFECT THE RELATIVE COMPETITIVE POSITIONS OF THE BUYER AND SEL LER AND THEREFORE COMPARABILITY. THE ICAI TP GUIDELINES NOTE ON THIS ASPECT LAY DOWN IN PARA 15.4 THAT A TRANSACTION ENTERED INTO BY A RS. 1,000 CRORE COMPANY CANNOT BE COMPARED WITH THE TRANSACTION ENTERED INT O BY A RS. 10 CRORE COMPANY. THE TWO MOST OBVIOUS REASONS ARE THE SIZE OF THE TWO COMPANIES AND THE RELATIVE ECONOMIES OF SCALE U NDER WHICH THEY OPERATE. THE FACT THAT THEY OPERATE IN THE SA ME MARKET MAY ITA NO.1167/BANG/2010 PAGE 14 OF 26 NOT MAKE THEM COMPARABLE ENTERPRISES. THE RELEVANT EXTRACT IS AS FOLLOWS [ON RULE 10B(3)]: CLAUSE (I) LAYS DOWN THAT IF THE DIFFERENCES ARE N OT MATERIAL, THE TRANSACTIONS WOULD BE COMPARABLE. THESE DIFFERE NCES COULD EITHER BE WITH REFERENCE TO THE TRANSACTION O R WITH REFERENCE TO THE ENTERPRISE. FOR INSTANCE, A TRANSA CTION ENTERED INTO BY A RS 1,000 CRORE COMPANY CANNOT BE COMPARED WITH THE TRANSACTION ENTERED INTO BY A RS 10 CRORE COMPANY. THE TWO MOST OBVIOUS REASONS ARE THE SIZE OF THE TWO COMPANIES AND THE RELATIVE ECONOMIES OF SCALE U NDER WHICH THEY OPERATE. IT WAS FURTHER SUBMITTED THAT THE TPOS RANGE (RS. 1 CRORE TO INFINITY) HAS RESULTED IN SELECTION OF COMPANIES LI KE INFOSYS WHICH IS 277 TIMES BIGGER THAN THE ASSESSEE (TURNOVER OF RS. 13,149 CRORES AS COMPARED TO RS. 47.47 CRORES OF ASSESSEE) . IT WAS SUBMITTED THAT AN APPROPRIATE TURNOVER RANGE SHOUL D BE APPLIED IN SELECTING COMPARABLE UNCONTROLLED COMPANIES. REFERENCE WAS MADE TO THE DECISION OF THE ITAT BAN GALORE BENCH IN THE CASE OF GENESIS INTEGRATING SYSTEMS (INDIA) PVT. LTD. V. DCIT, ITA NO.1231/BANG/2010 , WHEREIN RELYING ON DUN AND BRADSTREETS ANALYSIS, THE TURNOVER OF Q 1 CRORE TO Q 200 CRORES WAS HELD TO BE PROPER. THE FOLLOWING RELEVANT OBSE RVATIONS WERE BROUGHT TO OUR NOTICE:- 9. HAVING HEARD BOTH THE PARTIES AND HAVING CONSI DERED THE RIVAL CONTENTIONS AND ALSO THE JUDICIAL PRECEDENTS ON THE ISSUE, WE FIND THAT THE TPO HIMSELF HAS REJECTED TH E COMPANIES WHICH .IRE (SIC) MAKING LOSSES AS COMPARA BLES. THIS SHOWS THAT THERE IS A LIMIT FOR THE LOWER END FOR IDENTIFYING THE COMPARABLES. IN SUCH A SITUATION, W E ARE UNABLE TO UNDERSTAND AS TO WHY THERE SHOULD NOT BE AN UPPER LIMIT ALSO. WHAT SHOULD BE UPPER LIMIT IS ANO THER FACTOR TO BE CONSIDERED. WE AGREE WITH THE CONTENTI ON OF THE LEARNED COUNSEL FOR THE ASSESSEE THAT THE SIZE MATTERS IN BUSINESS. A BIG COMPANY WOULD BE IN A POSITION TO B ARGAIN THE PRICE AND ALSO ATTRACT MORE CUSTOMERS. IT WOULD ALSO HAVE A BROAD BASE OF SKILLED EMPLOYEES WHO ARE ABLE TO GIVE BETTER OUTPUT. A SMALL COMPANY MAY NOT HAVE THESE B ENEFITS AND THEREFORE, THE TURNOVER ALSO WOULD COME DOWN RE DUCING PROFIT MARGIN. THUS, AS HELD BY THE VARIOUS BENCHES OF THE TRIBUNAL, WHEN COMPANIES WHICH ARC LOSS MAKING ARE ITA NO.1167/BANG/2010 PAGE 15 OF 26 EXCLUDED FROM COMPARABLES, THEN THE SUPER PROFIT MA KING COMPANIES SHOULD ALSO BE EXCLUDED. FOR THE PURPOSE OF CLASSIFICATION OF COMPANIES ON THE BASIS OF NET SAL ES OR TURNOVER, WE FIND THAT A REASONABLE CLASSIFICATION HAS TO BE MADE. DUN & BRADSTREET & BRADSTREET AND NASSCOM HAV E GIVEN DIFFERENT RANGES. TAKING THE INDIAN SCENARIO INTO CONSIDERATION, WE FEEL THAT THE CLASSIFICATION MADE BY DUN & BRADSTREET IS MORE SUITABLE AND REASONABLE. IN VIEW OF THE SAME, WE HOLD THAT THE TURNOVER FILTER IS VERY IMPO RTANT AND THE COMPANIES HAVING A TURNOVER OF RS.1.00 CRORE TO 200 CRORES HAVE TO BE TAKEN AS A PARTICULAR RANGE AND T HE ASSESSEE BEING IN THAT RANGE HAVING TURNOVER OF 8.1 5 CRORES, THE COMPANIES WHICH ALSO HAVE TURNOVER OF 1.00 TO 2 00.00 CRORES ONLY SHOULD BE TAKEN INTO CONSIDERATION FOR THE PURPOSE OF MAKING TP STUDY. IT WAS BROUGHT TO OUR NOTICE THAT THE ABOVE PROPOSI TION HAS ALSO BEEN FOLLOWED BY THE HONOURABLE BANGALORE ITAT IN T HE FOLLOWING CASES: 1. M/S KODIAK NETWORKS (INDIA) PRIVATE LIMITED VS. ACIT (ITA NO.1413/BANG/2010) 2. M/S GENESIS MICROCHIP (I) PRIVATE LIMITED VS. D CIT (ITA NO.1254/BANG/20L0). 3. ELECTRONIC FOR IMAGING INDIA PRIVATE LIMITED (I TA NO. 1171/BANG/2010). IT WAS FINALLY SUBMITTED THAT COMPANIES HAVING TURN OVER MORE THAN RS. 200 CRORES OUGHT TO BE REJECTED AS NOT COM PARABLE WITH THE ASSESSEE. THE LD. DR, ON THE OTHER HAND POINTED OUT THAT EVEN THE ASSESSEE IN ITS OWN TP STUDY HAS TAKEN COMPANIES HAVING TURN OVER OF MORE THAN Q 200 CRORES AS COMPARABLES. IN THESE CIRCUMS TANCES, IT WAS SUBMITTED BY HIM THAT THE ASSESSEE CANNOT HAVE ANY GRIEVANCE IN THIS REGARD. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS. THE PROV ISIONS OF THE ACT AND THE RULES THAT ARE RELEVANT FOR DECIDING TH E ISSUE HAVE TO BE FIRST SEEN. SEC.92. OF THE ACT PROVIDES THAT ANY INCOME ARISING FROM AN INTERNATIONAL TRANSACTION SHALL BE COMPUTED HAVING REGARD TO THE ARMS LENGTH PRICE. SEC.92-B PROVIDE S THAT INTERNATIONAL TRANSACTION MEANS A TRANSACTION BET WEEN TWO OR MORE ASSOCIATED ENTERPRISES, EITHER OR BOTH OF WHOM ARE NON- ITA NO.1167/BANG/2010 PAGE 16 OF 26 RESIDENTS, IN THE NATURE OF PURCHASE, SALE OR LEASE OF TANGIBLE OR INTANGIBLE PROPERTY, OR PROVISION OF SERVICES, OR L ENDING OR BORROWING MONEY, OR ANY OTHER TRANSACTION HAVING A BEARING ON THE PROFITS, INCOME, LOSSES OR ASSETS OF SUCH ENTER PRISES, AND SHALL INCLUDE A MUTUAL AGREEMENT OR ARRANGEMENT BETWEEN T WO OR MORE ASSOCIATED ENTERPRISES FOR THE ALLOCATION OR APPORT IONMENT OF, OR ANY CONTRIBUTION TO, ANY COST OR EXPENSE INCURRED O R TO BE INCURRED IN CONNECTION WITH A BENEFIT, SERVICE OR F ACILITY PROVIDED OR TO BE PROVIDED TO ANY ONE OR MORE OF SUCH ENTERP RISES. SEC.92- A DEFINES WHAT IS AN ASSOCIATED ENTERPRISE. IN THE PRESENT CASE THERE IS NO DISPUTE THAT THE TRANSACTION BETWEEN TH E ASSESSEE AND ITS AE WAS AN INTERNATIONAL TRANSACTION ATTRACTING THE PROVISIONS OF SEC.92 OF THE ACT. SEC.92C PROVIDES THE MANNER OF COMPUTATION OF ARMS LENGTH PRICE IN AN INTERNATION AL TRANSACTION AND IT PROVIDES:- (1) THAT THE ARMS LENGTH PRICE IN RELATION TO AN I NTERNATIONAL TRANSACTION SHALL BE DETERMINED BY ANY OF THE FOLLO WING METHODS, BEING THE MOST APPROPRIATE METHOD, HAVING REGARD TO THE NATURE OF TRANSACTION OR CLASS OF TRANSACTIO N OR CLASS OF ASSOCIATED PERSONS OR FUNCTIONS PERFORMED BY SUCH P ERSONS OR SUCH OTHER RELEVANT FACTORS AS THE BOARD MAY PRE SCRIBE, NAMELY : ( A ) COMPARABLE UNCONTROLLED PRICE METHOD; ( B ) RESALE PRICE METHOD; ( C ) COST PLUS METHOD; ( D ) PROFIT SPLIT METHOD; ( E ) TRANSACTIONAL NET MARGIN METHOD; ( F ) SUCH OTHER METHOD AS MAY BE PRESCRIBED BY THE BOARD. (2) THE MOST APPROPRIATE METHOD REFERRED TO IN SU B- SECTION (1) SHALL BE APPLIED, FOR DETERMINATION OF ARMS LENGTH PRICE, IN THE MANNER AS MAY BE PRESCRIBED: ITA NO.1167/BANG/2010 PAGE 17 OF 26 PROVIDED THAT WHERE MORE THAN ONE PRICE IS DETERMINED BY THE MOST APPROPRIATE METHOD, THE ARMS LENGTH PRICE SHALL BE TAKEN TO BE THE ARITHMETICAL MEAN OF SUCH PRICES : PROVIDED FURTHER THAT IF THE VARIATION BETWEEN THE ARMS LENGTH PRICE SO DETERMINED AND PRICE AT WHICH THE INTERNATIONAL TRANSACTION HAS ACTUALLY BEEN UNDERTA KEN DOES NOT EXCEED FIVE PER CENT OF THE LATTER, THE PRICE A T WHICH THE INTERNATIONAL TRANSACTION HAS ACTUALLY BEEN UNDERTA KEN SHALL BE DEEMED TO BE THE ARMS LENGTH PRICE. (3) WHERE DURING THE COURSE OF ANY PROCEEDING FOR T HE ASSESSMENT OF INCOME, THE ASSESSING OFFICER IS, ON THE BASIS OF MATERIAL OR INFORMATION OR DOCUMENT IN HIS POSSE SSION, OF THE OPINION THAT ( A ) THE PRICE CHARGED OR PAID IN AN INTERNATIONAL TRANSACTION HAS NOT BEEN DETERMINED IN ACCORDANCE W ITH SUB-SECTIONS (1) AND (2); OR ( B ) ANY INFORMATION AND DOCUMENT RELATING TO AN INTERNATIONAL TRANSACTION HAVE NOT BEEN KEPT AND MAINTAINED BY THE ASSESSEE IN ACCORDANCE WITH THE PROVISIONS CONTAINED IN SUB-SECTION (1) OF SECTION 92D AND THE RULES MADE IN THIS BEHALF; OR ( C ) THE INFORMATION OR DATA USED IN COMPUTATION OF THE ARMS LENGTH PRICE IS NOT RELIABLE OR CORRECT; OR ( D ) THE ASSESSEE HAS FAILED TO FURNISH, WITHIN THE SPECIFIED TIME, ANY INFORMATION OR DOCUMENT WHICH H E WAS REQUIRED TO FURNISH BY A NOTICE ISSUED UNDER SUB-SE CTION (3) OF SECTION 92D, THE ASSESSING OFFICER MAY PROCEED TO DETERMINE THE ARMS LENGTH PRICE IN RELATION TO THE SAID INTERNATIONAL TRANSACTION IN ACCORDANCE WITH SUB-SECTIONS (1) AND (2), ON THE BASIS OF SUCH MATERIAL OR INFORMATION OR DOCUMENT AVAILABLE WITH HIM: RULE 10B OF THE IT RULES, 1962 PRESCRIBES RULES FOR DETERMINATION OF ARMS LENGTH PRICE UNDER SECTION 9 2C:- 10B. (1) FOR THE PURPOSES OF SUB-SECTION (2) OF SE CTION 92C, THE ARMS LENGTH PRICE IN RELATION TO AN INTERNATIO NAL ITA NO.1167/BANG/2010 PAGE 18 OF 26 TRANSACTION SHALL BE DETERMINED BY ANY OF THE FOLLO WING METHODS, BEING THE MOST APPROPRIATE METHOD, IN THE FOLLOWING MANNER, NAMELY : (A). TO (D).. ( E ) TRANSACTIONAL NET MARGIN METHOD, BY WHICH, ( I ) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE FROM AN INTERNATIONAL TRANSACTION ENTERED INTO WITH AN ASSOCIATED ENTERPRISE IS COMPUTED IN RELATION TO CO STS INCURRED OR SALES EFFECTED OR ASSETS EMPLOYED OR TO BE EMPLOYED BY THE ENTERPRISE OR HAVING REGARD TO ANY OTHER RELEVANT BASE; ( II ) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE OR BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROLLED TRANSACTION OR A NUMBER OF SUCH TRANSA CTIONS IS COMPUTED HAVING REGARD TO THE SAME BASE; ( III ) THE NET PROFIT MARGIN REFERRED TO IN SUB-CLAUSE ( II ) ARISING IN COMPARABLE UNCONTROLLED TRANSACTIONS IS ADJUSTED TO TAKE INTO ACCOUNT THE DIFFERENCES, IF ANY, BETWE EN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONT ROLLED TRANSACTIONS, OR BETWEEN THE ENTERPRISES ENTERING I NTO SUCH TRANSACTIONS, WHICH COULD MATERIALLY AFFECT THE AMO UNT OF NET PROFIT MARGIN IN THE OPEN MARKET; ( IV ) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE AND REFERRED TO IN SUB-CLAUSE ( I ) IS ESTABLISHED TO BE THE SAME AS THE NET PROFIT MARGIN REFERRED TO IN SUB-CL AUSE ( III ); ( V ) THE NET PROFIT MARGIN THUS ESTABLISHED IS THEN TAKEN INTO ACCOUNT TO ARRIVE AT AN ARMS LENGTH PRI CE IN RELATION TO THE INTERNATIONAL TRANSACTION. (2) FOR THE PURPOSES OF SUB-RULE (1), THE COMPARABI LITY OF AN INTERNATIONAL TRANSACTION WITH AN UNCONTROLLED TRAN SACTION SHALL BE JUDGED WITH REFERENCE TO THE FOLLOWING, NA MELY: ( A ) THE SPECIFIC CHARACTERISTICS OF THE PROPERTY TRANSFERRED OR SERVICES PROVIDED IN EITHER TRANSACT ION; ITA NO.1167/BANG/2010 PAGE 19 OF 26 ( B ) THE FUNCTIONS PERFORMED, TAKING INTO ACCOUNT ASSETS EMPLOYED OR TO BE EMPLOYED AND THE RISKS ASS UMED, BY THE RESPECTIVE PARTIES TO THE TRANSACTIONS; ( C ) THE CONTRACTUAL TERMS (WHETHER OR NOT SUCH TERMS ARE FORMAL OR IN WRITING) OF THE TRANSACTIONS WHICH LAY DOWN EXPLICITLY OR IMPLICITLY HOW THE RESPONSIBILITIES, RISKS AND BENEFITS ARE TO BE DIVIDED BETWEEN THE RESPECTIVE P ARTIES TO THE TRANSACTIONS; ( D ) CONDITIONS PREVAILING IN THE MARKETS IN WHICH THE RESPECTIVE PARTIES TO THE TRANSACTIONS OPERATE, INC LUDING THE GEOGRAPHICAL LOCATION AND SIZE OF THE MARKETS, THE LAWS AND GOVERNMENT ORDERS IN FORCE, COSTS OF LABOUR AND CAP ITAL IN THE MARKETS, OVERALL ECONOMIC DEVELOPMENT AND LEVEL OF COMPETITION AND WHETHER THE MARKETS ARE WHOLESALE O R RETAIL. (3) AN UNCONTROLLED TRANSACTION SHALL BE COMPARABLE TO AN INTERNATIONAL TRANSACTION IF ( I ) NONE OF THE DIFFERENCES, IF ANY, BETWEEN THE TRANSACTIONS BEING COMPARED, OR BETWEEN THE ENTERPR ISES ENTERING INTO SUCH TRANSACTIONS ARE LIKELY TO MATER IALLY AFFECT THE PRICE OR COST CHARGED OR PAID IN, OR THE PROFIT ARISING FROM, SUCH TRANSACTIONS IN THE OPEN MARKET; OR ( II ) REASONABLY ACCURATE ADJUSTMENTS CAN BE MADE TO ELIMINATE THE MATERIAL EFFECTS OF SUCH DIFFERENCES. (4) THE DATA TO BE USED IN ANALYSING THE COMPARABIL ITY OF AN UNCONTROLLED TRANSACTION WITH AN INTERNATIONAL TRAN SACTION SHALL BE THE DATA RELATING TO THE FINANCIAL YEAR IN WHICH THE INTERNATIONAL TRANSACTION HAS BEEN ENTERED INTO : PROVIDED THAT DATA RELATING TO A PERIOD NOT BEING MORE THAN TWO YEARS PRIOR TO SUCH FINANCIAL YEAR MAY ALSO BE CONSIDERED IF SUCH DATA REVEALS FACTS WHICH COULD H AVE AN INFLUENCE ON THE DETERMINATION OF TRANSFER PRICES I N RELATION TO THE TRANSACTIONS BEING COMPARED. ITA NO.1167/BANG/2010 PAGE 20 OF 26 A READING OF THE PROVISIONS OF RULE 10B(2) OF THE R ULES SHOWS THAT UNCONTROLLED TRANSACTION HAS TO BE COMPARED WI TH INTERNATIONAL TRANSACTION HAVING REGARD TO THE FACT ORS SET OUT THEREIN. BEFORE US THERE IS NO DISPUTE THAT THE TN MM IS THE MOST APPROPRIATE METHOD FOR DETERMINING THE ALP OF THE INTERNATIONAL TRANSACTION. THE DISPUTES ARE WITH R EGARD TO THE COMPARABILITY OF THE COMPARABLE RELIED UPON BY THE TPO. IN THIS REGARD WE FIND THAT THE PROVISIONS OF LAW POINTED OUT BY THE LD. COUNSEL FOR THE ASSESSEE AS WELL AS THE DECISIONS REFERRED TO BY THE LD. COUNSEL FOR THE ASSESSEE CLE ARLY LAY DOWN THE PRINCIPLE THAT THE TURNOVER FILTER IS AN I MPORTANT CRITERIA IN CHOOSING THE COMPARABLES. THE ASSESSEE S TURNOVER IS Q 47,46,66,638. IT WOULD THEREFORE FAL L WITHIN THE CATEGORY OF COMPANIES IN THE RANGE OF TURNOVER BETWEEN 1 CRORE AND 200 CRORES (AS LAID DOWN IN THE CASE OF GENESIS INTEGRATING SYSTEMS (INDIA) PVT. LTD. V. DCIT, ITA NO.1231/BANG/2010) . THUS, COMPANIES HAVING TURNOVER OF MORE THAN 200 CRORES HAVE TO BE ELIMINATED FROM THE LIST OF COMPARABLES AS LAID DOWN IN SEVERAL DECISIONS REFER RED TO BY THE LD. COUNSEL FOR THE ASSESSEE. APPLYING THOSE T ESTS, THE FOLLOWING COMPANIES WILL HAVE TO BE EXCLUDED FROM T HE LIST OF 26 COMPARABLES DRAWN BY THE TPO VIZ., TURNOVER RS (1) FLEXTRONICS SOFTWARE SYSTEMS LTD. 848.66 CR ORES (2) IGATE GLOBAL SOLUTIONS LTD. 747.27 CRORES (3) MINDTREE LTD. 590.39 CRORES (4) PERSISTENT SYSTEMS LTD. 293.74 CRORES (5) SASKEN COMMUNICATION TECHNOLOGIES LTD. 343.57 CRORES (6) TATA ELXSI LTD. 262.58 CRORES (7) WIPRO LTD. 961.09 CRORES. (8) INFOSYS TECHNOLOGIES LTD. 13149 CRORES. . 18. RESPECTFULLY FOLLOWING THE AFORESAID DECISION O F THE TRIBUNAL IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. (SUPRA), WE HOLD THAT THE FOLLOWING COMPANIES SHOULD BE EXCLUDED FROM THE LIS T OF COMPARABLE COMPANIES. ITA NO.1167/BANG/2010 PAGE 21 OF 26 (1) FLEXTRONICS SOFTWARE SYSTEMS LTD. 595.12 CRO RES (2) IGATE GLOBAL SOLUTIONS LTD. 527.91 CRORES (3) MINDTREE LTD. 448.79 CRORES (4) SASKEN COMMUNICATION TECHNOLOGIES LTD. (SEG.) 240.03 CRORES (5) PERSISTENT SYSTEMS LIMITED 209.18 CRORES. 19. THE AO IS DIRECTED TO COMPUTE THE ARITHMETIC ME AN BY EXCLUDING THE AFORESAID COMPANIES FROM THE LIST OF COMPARABLE. 20. THE LEARNED COUNSEL FOR THE ASSESSEE BROUGHT TO OUR NOTICE THAT THE COMPARABLE COMPANY CHOSEN BY THE TPO VIZ., LUCID SO FTWARE LIMITED, HAS TO BE EXCLUDED AS FUNCTIONALLY NOT COMPARABLE WITH THAT OF THE ASSESSEE IN VIEW OF THE DECISION OF THE MUMBAI BENCH OF THE TRI BUNAL IN THE CASE OF TELCORDIA TECHNOLOGIES INDIA PRIVATE LTD. IN ITA NO .7821/MUM/2011 , WHICH WAS FOLLOWED BY THE ITAT BANGALORE BENCH IN THE CAS E OF LOGICA PRIVATE LTD. ITA NO.1129/BANG/2011 FOR AY 07-08, WHEREIN IT WAS HELD AS UNDER:- 7.2 LUCID SOFTWARE LIMITED IT HAS BEEN SUBMITTED BEFORE US THAT THIS COMPANY , BESIDES DOING SOFTWARE DEVELOPMENT SERVICES, IS ALSO INVOLV ED IN DEVELOPMENT OF SOFTWARE PRODUCT. THE LEARNED AR HAS TRIED TO DISTINGUISH BY POINTING OUT THAT PRODUCT DEVELOPMEN T EXPENDITURE IN THIS CASE IS AROUND 39% OF THE CAPITAL EMPLOYED BY THE SAID COMPANY, AND, THEREFORE, SUCH A COMPANY CANNOT BE C ONSIDERED AS TESTED PARTY. EVEN AS PER THE INFORMATION RECEIV ED IN RESPONSE TO NOTICE UNDER SECTION 133(6), THE COMPANY HAS DES CRIBED ITS BUSINESS AS SOFTWARE DEVELOPMENT COMPANY OR PURE SO FTWARE DEVELOPMENT SERVICE PROVIDER. THIS INFORMATION ITS ELF IS VERY VAGUE AS THE SEGMENTAL DETAILS OF OPERATING REVENUE HAS NOT BEEN MADE AVAILABLE TO EXAMINE HOW MUCH IS THE RATIO OF SALE FROM ITA NO.1167/BANG/2010 PAGE 22 OF 26 SOFTWARE PRODUCT AND SALE OF SOFTWARE SERVICE AND D EVELOPMENT. LOOKING TO THE FACT THAT IT HAS DEVELOPED A SOFTWAR E PRODUCT NAMED AS MUULAM WHICH IS USED FOR CIVIL ENGINEERI NG STRUCTURES AND THE PRODUCT DEVELOPMENT EXPENDITURE ITSELF IS SUBSTANTIAL VIS-A-VIS THE CAPITAL EMPLOYED BY THE S AID COMPANY, THIS CRITERIA FOR BEING TAKEN AS COMPARABLE PARTY, GETS VITIATED. FOR THE PURPOSE OF COMPARABILITY ANALYSIS, IT IS ESSENT IAL THAT THE CHARACTERISTICS AND THE FUNCTIONS ARE BY AND LARGE SIMILAR AS THAT OF THE ASSESSEE COMPANY AND T.P. ANALYSIS/STUDY CAN BE MADE WITH FEWEST AND MOST RELIABLE ADJUSTMENT. IF A COMP ANY HAS EMPLOYED HEAVY CAPITAL IN DEVELOPMENT OF A PRODUCT THEN PROFITABILITY IN THE SALE OF PRODUCT WOULD BE ENTIR ELY DIFFERENT FROM THE COMPANY, WHO IS INVOLVED IN SERVICE SECTOR . THEREFORE, THIS COMPANY CANNOT BE TREATED AS HAVING SAME FUNCT ION AND PROFITABILITY RATIO. IN OUR VIEW, DUE TO NON-AVAILABILITY OF FULL INFORM ATION ABOUT THE SEGMENTAL DETAILS AS TO HOW MUCH IS THE SALE OF PRO DUCT AND HOW MUCH IS FROM THE SERVICES, THEREFORE, THIS ENTITY C ANNOT BE TAKEN INTO ACCOUNT FOR COMPARABILITY ANALYSIS FOR DETERMI NING ARMS LENGTH PRICE IN THE CASE OF THE ASSESSEE. 21. THE FACTS AND CIRCUMSTANCES UNDER WHICH THE AFO RESAID COMPANIES WERE CONSIDERED AS COMPARABLE IS IDENTICAL IN THE C ASE OF THE ASSESSEE AS WELL AS IN THE CASE OF LOGICA PRIVATE LTD., (SUPRA) . RESPECTFULLY FOLLOWING THE DECISION OF THE TRIBUNAL REFERRED TO ABOVE IN T HE CASE OF LOGICA PVT.LTD..(SUPRA), WE DIRECT THAT THE SAID COMPANY B E EXCLUDED FROM THE LIST OF 20 COMPARABLE ARRIVED AT BY THE TPO. 22. AS FAR AS COMPARABLE COMPANIES CHOSEN BY THE TP O VIZ., AZTEC SOFTWARE LIMITED AND GEOMETRIC SOFTWARE LTD. (SEG.) AND MEGASOFT LTD., ARE CONCERNED, IT IS NOT IN DISPUTE BEFORE US THAT THE RELATED PARTY TRANSACTION IN THE CASE OF COMPANIES EXCEEDS 15% AN D IN VIEW OF THE ITA NO.1167/BANG/2010 PAGE 23 OF 26 DECISION OF THE TRIBUNAL IN THE CASE OF 24 X 7 CUST OMER.COM PVT. LTD. IN ITA NO.227/BANG/2010, FOLLOWED BY THIS TRIBUNAL IN THE CASE OF LOGICA PRIVATE LTD. (SUPRA) WHEREIN IT WAS HELD THAT WHERE THE RPT EXCEEDS 15%, SUCH COMPANIES SHOULD NOT BE TAKEN AS COMPARABLE CO MPANIES. FOLLOWING THE SAID DECISION, WE HOLD THAT SAID COMPANIES SHOU LD BE EXCLUDED FROM THE LIST OF THE COMPARABLE COMPANIES CHOSEN BY THE TPO WHILE WORKING OUT THE ALP. 23. AFTER EXCLUDING THE AFORESAID COMPARABLE FROM T HE LIST OF COMPARABLE CHOSEN BY THE TPO, THE ARITHMETIC MEAN OF PROFIT MA RGIN OF THE REMAINING 7 COMPARABLE WOULD BE 11.30% (UNADJUSTED) AND 9.87% A FTER WORKING CAPITAL ADJUSTMENT. THE ASSESSEES PROFIT MARGIN OPERATIN G PROFIT ON COST IS 10.15% WHICH IS WITHIN THE + / - 5% RANGE PERMITTED UNDER SECOND PROVISO TO SEC.92CA(2) OF THE ACT AND THEREFORE THE ADDITIO N MADE BY THE TPO AND CONFIRMED BY THE DRP NEEDS TO BE DELETED. ACCORDIN GLY THE SAME IS DELETED. THE RELEVANT GROUNDS OF APPEAL OF THE ASS ESSEE ARE ALLOWED. 24. THE NEXT ISSUE THAT ARISES FOR CONSIDERATION IN THIS APPEAL BY THE ASSESSEE IS WITH REGARD TO DISALLOWANCE OF DEDUCTIO N CLAIMED U/S.10A OF THE ACT IN RESPECT OF PROFITS OF THE ASSESSEES BAN GALORE UNIT OF RS.2,35,44,629/-. THE ASSESSEE HAS THREE UNITS THR OUGH WHICH IT CONDUCTS ITS BUSINESS. OUT OF THE THREE UNITS 2 ARE STP UNI TS ENTITLED TO DEDUCTION U/S.10A OF THE ACT. IN SO FAR AS ONE OF THE STP UN ITS AT BANGALORE, WHICH WAS TAKEN OVER FROM LARA NETWORKS, IT CLAIMED A DED UCTION OF ITA NO.1167/BANG/2010 PAGE 24 OF 26 RS.2,35,44,629/- U/S.10A OF THE ACT. THE SAID DEDU CTION WAS HOWEVER DISALLOWED BY THE AO ON THE GROUND THAT THE SAID UN IT WAS FORMED BY RECONSTRUCTION OF AN EXISTING UNIT AND THAT THE BUS INESS OF THE SAID UNIT HAD COMMENCED PRIOR TO REGISTRATION WITH THE STPI. IN DOING SO, HE RELIED ON THE ASSESSMENT ORDERS FOR THE ASSESSMENT YEARS 2002 -03 TO 2004-05. THE SAID ASSESSMENT ORDERS FOR AY 02-03 TO 04-05 WAS SU BJECT MATTER OF APPEAL BEFORE THIS TRIBUNAL IN ITA NOS. 748, 852 AND 819/B ANG/2007 AND THIS TRIBUNAL BY ITS ORDER DATED 21.6.2008 WAS PLEASED T O HOLD THAT THE BANGALORE UNIT WAS NOT FORMED BY RECONSTRUCTION OF AN EXISTING UNIT OR THE BUSINESS OF THE NEW UNIT HAD NOT COMMENCED PRIOR TO REGISTRATION WITH THE STPI AND THEREFORE DEDUCTION U/S.10A OF THE ACT OUG HT NOT TO HAVE BEEN DENIED ON THE PROFITS OF THE BANGALORE UNIT. THE S AID DECISION OF THE TRIBUNAL HAS SINCE BEEN CONFIRMED BY THE HONBLE KA RNATAKA HIGH COURT IN ITA NOS.1013 TO 1015/2008 DATED 7.11.2014. COPIES OF THE ORDER OF THE TRIBUNAL AND THE HONBLE HIGH COURT WERE FILED BEFO RE US. IN VIEW OF THE SAID DECISION OF THE TRIBUNAL ON IDENTICAL FACTS, W E ARE OF THE VIEW THAT THE BANGALORE UNIT WAS NOT FORMED BY RECONSTRUCTION OF AN EXISTING UNIT OR THE BUSINESS OF THE NEW UNIT HAD NOT COMMENCED PRIOR TO REGISTRATION WITH THE STPI AND THEREFORE DEDUCTION U/S.10A OF THE ACT OUG HT NOT TO HAVE BEEN DENIED ON THE PROFITS OF THE BANGALORE UNIT. THE D EDUCTION CLAIMED BY THE ASSESSEE IS DIRECTED TO BE ALLOWED. THE RELEVANT G ROUNDS OF APPEAL OF THE ASSESSEE ARE ALLOWED. ITA NO.1167/BANG/2010 PAGE 25 OF 26 25. THE ASSESSEE IN THE GROUNDS OF APPEAL BEFORE TH E TRIBUNAL HAS ALSO PROJECTED ITS GRIEVANCE REGARDING THE ACTION OF THE LEARNED ASSESSING OFFICER AND HONORABLE DISPUTE RESOLUTION PANEL IN E XCLUDING FROM THE EXPORT TURNOVER, WHILE COMPUTING DEDUCTION U/S.10A OF THE ACT LEASE LINE EXPENSES OF RS.5,40,722 BEING DATA LINK CHARGES ON THE GROUND THAT THESE EXPENSES ARE ATTRIBUTABLE TO DELIVERY OF SOFTWARE O UTSIDE INDIA. WITHOUT PREJUDICE TO ITS CONTENTION THAT THE AFORESAID SUMS SHOULD NOT BE EXCLUDED FROM THE EXPORT TURNOVER WHILE COMPUTING DEDUCTION U/S.10A OF THE ACT, THE ASSESSEE HAS ALSO MADE AN ALTERNATE PRAYER THAT EXP ENSES THAT ARE REDUCED FROM THE EXPORT TURNOVER SHOULD ALSO BE RED UCED FROM THE TOTAL TURNOVER AND IN THIS REGARD HAS PLACED RELIANCE ON THE DECISION OF THE HONBLE KARNATAKA HIGH COURT IN THE CASE OF CIT V. TATA ELXSI LTD [2012] 349 ITR 98 (KARN) . 26. WE HAVE HEARD THE LD. COUNSEL FOR THE ASSESSEE AND THE LD. DR ON THE ISSUES RAISED IN THIS REGARD. TAKING INTO CONS IDERATION THE DECISION RENDERED BY THE HONBLE HIGH COURT OF KARNATAKA IN THE CASE OF CIT V. TATA ELXSI LTD [2012] 349 ITR 98 (KARN) , WE ARE OF THE VIEW THAT IT WOULD BE JUST AND APPROPRIATE TO DIRECT THE ASSESSING OFFICER TO EXCLUDE TELECOMMUNICATION CHARGES AND INSURANCE CHARGES INC URRED BE EXCLUDED BOTH FROM EXPORT TURNOVER AND TOTAL TURNOVER, AS HA S BEEN PRAYED FOR BY THE ASSESSEE IN THE ALTERNATIVE. IN VIEW OF THE ACCEPT ANCE OF THE ALTERNATIVE PRAYER, WE ARE OF THE VIEW THAT NO ADJUDICATION IS REQUIRED ON THE GROUND ITA NO.1167/BANG/2010 PAGE 26 OF 26 WHETHER THE AFORESAID SUMS ARE REQUIRED TO BE EXCLU DED FROM THE EXPORT TURNOVER. 27. IN THE RESULT, THE APPEAL BY THE ASSESSEE IS ALLOWED . PRONOUNCED IN THE OPEN COURT ON THIS 27 TH DAY OF MARCH , 2015 . SD/- SD/- ( JASON P. BOAZ ) ( N.V. VASUDEVA N ) ACCOUNTANT MEMBER JUDICIAL MEMBE R BANGALORE, DATED, THE 27 TH MARCH , 2015 . /D S/ COPY TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT(A) 5. DR, ITAT, BANGALORE. 6. GUARD FILE BY ORDER ASSISTANT REGISTRAR ITAT, BANGALORE.