July Systems & Technologies Pvt. Ltd., Bangalore V. ITO, Bangalore

ITA 1203/BANG/2011

• Counselvise Citation: 120321114 RSA 2011
• Duration Of Justice: 2 year(s) 7 month(s) 6 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 11-07-2014
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: A
• Next Hearing Date: 08-07-2014
• Assessment Year: 2007-2008
• Appeal Filed On: 05-12-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: C H SUNDAR RAO CITI
• Assessee Lawyers: VISHNU BAGRA
• Keywords: Related party transaction; Transfer pricing; International transaction; Revenue expenditure
• Section: 92C; 143(3); 92D; 92E; 133(6); 10B

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL A BENCH : BANGALORE BEFORE SHRI N.V. VASUDEVAN, JUDICIAL MEMBER AND SHRI RAJENDRA, ACCOUNTANT MEMBER IT( TP )A NO.1203/BANG/2011 ASSESSMENT YEAR : 2007-08 JULY SYSTEMS & TECHNOLOGIES PVT. LTD., NO.17/9C, 17/4C, 4 TH FLOOR, MARUTHI CHAMBERS, RUPENA AGRAHARA, NEAR CENTRAL SILK BOARD, HOSUR ROAD, BANGALORE 560 068. PAN : AABCB 6543M VS. THE INCOME TAX OFFICER, WARD 11(2), BANGALORE. APPELLANT RESPONDENT APPELLANT BY : SHRI VISHNU BAGRA, C.A. RESPONDENT BY : SHRI C.H. SUNDAR RAO, CIT-I (DR) DATE OF HEARING : 08.07.2014 DATE OF PRONOUNCEMENT : 11.07.2014 O R D E R PER N.V. VASUDEVAN, JUDICIAL MEMBER THIS APPEAL BY THE ASSESSEE IS AGAINST THE ORDER DATED 4.10.2011 OF THE ITO, WARD 11(2), BANGALORE PASSED U/S. 143(3) R .W.S. 144C OF THE ACT. 2. GROUND NO. 1 IS GENERAL AND CALLS FOR NO SPECI FIC ADJUDICATION. GROUND NO.2 (A) TO (N) RAISED BY THE ASSESSEE IS W ITH REGARD TO THE ADDITION TO THE TOTAL INCOME BY WAY OF ADJUSTMENT TO THE ARM S LENGTH PRICE ( ALP ) TO AN INTERNATIONAL TRANSACTION CARRIED OUT BY THE ASSESSEE U/S. 92CA OF THE ACT. AT THE TIME OF HEARING OF THE APPEAL IT WAS S UBMITTED THAT THE COMPARABLE COMPANIES CHOSEN BY THE TPO AND THE ADDI TION MADE BY THE AO IN THE DRAFT ASSESSMENT ORDER WHICH WAS CONFIRME D BY THE DRP ARE IDENTICAL TO THE CASE DECIDED BY THE TRIBUNAL IN ITA NO.1054/BANG/2011 FOR AY 07-08 IN M/S. TRILOGY E-BUSINESS SOFTWARE INDIA PVT. LTD . VS. DCIT, CIRCLE 12(4), BANGALORE . IT WAS ALSO SUBMITTED THAT THE BUSINESS PROFILE OF THE ASSESSEE AND THAT OF THE ASSESSEE IN THE CASE OF M/S. TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. (SUPRA) ARE ALSO IDENTICAL. THIS SUBMISSION WAS FOUND TO BE CORRECT AT THE TIME OF H EARING. WITH THIS BACKGROUND, WE WILL NOW CONSIDER THE FACTUAL BASIS OF THE PRESENT CASE AND THE DECISION RENDERED IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. (SUPRA). 3. THE ASSESSEE IS A COMPANY. IT IS A WHOLLY OWNE D SUBSIDIARY OF M/S. JULY SYSTEMS INC. U.S.A. IT RENDERED SOFTWARE DEVE LOPMENT RESEARCH AND DEVELOPMENT SERVICES TO ITS HOLDING COMPANY. IT WA S REMUNERATED ON A COST PLUS 15% MARK UP FOR SERVICES RENDERED TO ITS HOLDING COMPANY. IT IS NOT IN DISPUTE BEFORE US THAT THE TRANSACTION OF PR OVIDING SOFTWARE RESEARCH & DEVELOPMENT SUPPORT SERVICES BY THE ASSESSEE TO I TS HOLDING COMPANY WAS AN INTERNATIONAL TRANSACTION WITH THE ASSOCIATE D ENTERPRISE ( AE ) AND THEREFORE THE PRICE AT WHICH THE ASSESSEE RENDERS S ERVICES TO ITS AE HAS TO PASS THE ARMS LENGTH PRICE (ALP) TEST AS LAID DOWN BY SECTION 92C OF THE ACT. DURING THE FINANCIAL YEAR 2006-07, THE ASSES SEE PROVIDED SOFTWARE RESEARCH & DEVELOPMENT SUPPORT SERVICES TO ITS AE A ND WAS REMUNERATED ON A COST PLUS BASIS. THE TOTAL VALUE OF INTERNA TIONAL TRANSACTION WITH RESPECT TO THE PROVISION OF SOFTWARE RESEARCH & DEV ELOPMENT SUPPORT SERVICES BY THE ASSESSEE TO ITS AE WAS RS. 18,61,98 ,727. 4. IN SUPPORT OF THE ASSESSEES CLAIM THAT THE PRI CE CHARGED BY IT FOR SERVICES RENDERED TO ITS AE WAS AT ARMS LENGTH, TH E ASSESSEE FILED A REPORT AS REQUIRED BY THE PROVISIONS OF SECTION 92E OF THE ACT IN FORM 3EB TOGETHER WITH DETAILED ANALYSIS. THE ASSESSEE ADOP TED COST PLUS METHOD IN ITS TRANSFER PRICING STUDY (TP STUDY) TO JUSTIFY THE PRICE RECEIVED AS ONE AT ARMS LENGTH BUT THE SAME WAS REJECTED BY THE TP O TO WHOM THE AO REFERRED TO QUESTION OF DETERMINATION OF ALP IN RES PECT OF THE INTERNATIONAL TRANSACTION WITH THE AE IN QUESTION. THE TPO ADOPT ED TRANSACTIONAL NET MARGIN METHOD ( TNMM ) AS THE MOST APPROPRIATE METHOD FOR DETERMINING THE ALP. OPERATING PROFITS TO COST WAS ADOPTED AS THE PROFIT LEVEL INDICATOR ( PLI ). THE PLI OF THE ASSESSEE WAS ARRIVED AT AFTER SEGMENTAL ANALYSIS AND AFTER DEDUCTING FOREX LOSS FROM THE COST, AS FO LLOWS:- OPERATING REVENUE RS.18,61,98,727 OPERATING COST RS.15,89,78,468 OPERATING PROFIT RS.2,72,79,259 OP.PR/COST% 17.12% 5. THE TPO ARRIVED AT A FINAL SET OF 26 COMPARABLES . THE SET OF 26 COMPARABLES IS GIVEN AS ANNEXURE-I TO THIS ORDER . 6. THE ASSESSEE RAISED VARIOUS OBJECTIONS TO THE M ETHODOLOGY ADOPTED AND THE REASONS ASSIGNED BY THE TPO FOR REJ ECTING THE COMPARABLES CHOSEN BY THE ASSESSEE IN ITS TP STUDY. IN THE COURSE OF PROCEEDINGS BEFORE THE TPO, NOTICE U/S. 133(6) HAS BEEN ISSUED TO THE COMPANIES THAT WERE CHOSEN AS COMPARABLE BY THE ASS ESSEE AS WELL AS THE TPO AND ON THE BASIS OF THE REPLIES RECEIVED IN RES PONSE TO SUCH NOTICES, CERTAIN INFERENCES WERE DRAWN BY THE TPO. THE ACTI ON OF THE TPO IN RELYING ON SOME OF THOSE INFORMATION WAS ALSO CHALL ENGED BY THE ASSESSEE. THE TPO FINALLY PASSED AN ORDER U/S. 92CA OF THE AC T AND ON THE BASIS OF THE COMPARABLES SET OUT IN ANNEXURE-I , ARRIVED AT ARITHMETIC MEAN OF 25.14%. AFTER FACTORING THE WORKING CAPITAL ADJUST MENT OF 1.78%, THE ADJUSTED ARITHMETIC MEAN WAS DETERMINED AT 23.36%. 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 DETAILS O F COMPUTATION OF PLI OF THE COMPARABLES). BASED ON THIS, THE ARMS LE NGTH PRICE OF THE SOFTWARE DEVELOPMENT SERVICES RENDERED BY THE TAXPA YER TO ITS AE(S) IS COMPUTED AS UNDER: ARITHMETIC MEAN PLI 25.14% LESS: WORKING CAPITAL ADJUSTMENT (ANNEXURE-C) 1.78% ADJ.ARITHMETIC MEAN PLU 23.36% ARMS LENGTH PRICE: OPERATING COST RS.15,89,78,468 ARMS LENGTH MARGIN 23.36% OF THE OPERATING COST ARMS LENGTH PRICE (ALP) AT 123.36% OF OPERATING COST RS.19,61,15,838 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 123.36% OF OPERATING COST RS.19,61,15,838 PRICE CHARGED IN THE INTERNATIONAL TRANSACTIONS RS.18,61,15,838 SHORTFALL BEING ADJUSTMENT U/S.92CA RS.99,17,111 THE ABOVE SHORTFALL OF RS.99,17,111/- IS TREATED AS TRANSFER PRICING ADJUSTMENT U/S 92CA. 7. 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 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. 8. THE LD. COUNSEL FOR THE ASSESSEE BROUGHT TO OUR NOTICE THAT OUT OF THE 26 COMPARABLE COMPANIES CHOSEN BY THE TPO, THE FOLLOWING COMPANIES WILL HAVE TO BE EXCLUDED AS THE TURNOVER OF THESE COMPANIES ARE MORE THAN RS.200 CRORES AND CANNOT BE COMPARED WITH THE ASSESSEE WHOSE TURNOVER IS LESS THAN RS.20 CRORES: (1) FLEXTRONICS SOFTWARE SYSTEMS LTD. 848.66 CRO RES (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 C RORES (6) TATA ELXSI LTD. 262.58 CRORES (7) WIPRO LTD. 961.09 CRORES (8) INFOSYS TECHNOLOGIES LTD. 13149 CRORES. OUR ATTENTION WAS DRAWN TO THE OBSERVATIONS OF THE TRIBUNAL IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. (SUPRA) ON THE APPLICATION OF TURNOVER FILTER AND IT WAS SUBMITTED THAT THE AF ORESAID COMPARABLE COMPANIES HAVE TO BE EXCLUDED FROM THE FINAL LIST O F COMPARABLES SELECTED BY THE TPO. 9. WE HAVE CONSIDERED THE SUBMISSION OF THE LEARNED COUNSEL FOR THE ASSESSEE AND THE LEARNED DR. IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA (P) LTD. (SUPRA), THIS TRIBUNAL ON APPLICATION OF THE TURNOVER FILTER WHILE SELECTING COMPARABLE COMPANIE S FOR COMPARABILITY ANALYSIS HELD AS FOLLOWS: (1) TURNOVER FILTER 11. THE LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT THE 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 SUBMITTED BY HIM THAT UNDER RULE 10B(3) TO THE INCOME-TAX RULES, IT WAS NECESSARY FOR COMPARING AN UNCONTROLLED TRANSACTION WITH AN INTERNATIONAL TRANSACTION THAT THERE SHOULD NOT BE ANY DIFFERENCE BETWEEN THE TRANSACTIONS COMPARED OR THE ENTERPRISE S ENTERING INTO SUCH TRANSACTION, WHICH ARE LIKELY TO MATERIALLY AF FECT THE PRICE OR COST CHARGED OR PAID OR PROFIT ARISING FROM SUCH TR ANSACTION IN THE OPEN MARKET. FURTHER IT IS ALSO NECESSARY TO SEE T HAT WHEREVER THERE ARE SOME DIFFERENCES SUCH DIFFERENCES SHOULD BE CAPABLE OF REASONABLE ACCURATE ADJUSTMENT IN MONETARY TERMS TO ELIMINATE THE EFFECT OF SUCH DIFFERENCES. IT WAS HIS SUBMISSION THAT SIZE WAS AN IMPORTANT FACET OF THE COMPARABILITY EXERCISE. IT WAS SUBMITTED THAT SIGNIFICANT DIFFERENCES IN SIZE OF THE COMPANIES WO ULD IMPACT COMPARABILITY. IN THIS REGARD OUR ATTENTION WAS DR AWN TO THE DECISION OF THE SPECIAL BENCH OF THE ITAT CHANDIGAR H BENCH IN THE CASE OF DCIT V. QUARK SYSTEMS PVT. LTD. 38 SOT 207 , WHEREIN THE SPECIAL BENCH HAD LAID DOWN THAT IT IS IMPROPER TO PROCEED ON THE BASIS OF LOWER LIMIT OF 1 CRORE TURNOVER WITH NO HI GHER LIMIT ON TURNOVER, AS THE SAME WAS NOT REASONABLE CLASSIFICA TION. 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 PAR TIES MIGHT AFFECT THE RELATIVE COMPETITIVE POSITIONS OF THE BUYER AND SELLER AND THEREFORE COMPARABILITY. 12. 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 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 DIFFERENCES COULD EITHER BE WITH REFERENCE TO THE TRANSACTION OR WITH REFERENCE TO THE ENTERPRISE . FOR INSTANCE, A TRANSACTION 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 UNDER WHICH THEY OPERATE. 13. 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 W AS SUBMITTED THAT AN APPROPRIATE TURNOVER RANGE SHOULD BE APPLI ED IN SELECTING COMPARABLE UNCONTROLLED COMPANIES. 14. REFERENCE WAS MADE TO THE DECISION OF THE ITAT BANGALORE 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 RS. 1 CRORE TO RS. 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 CONSIDERED THE RIVAL CONTENTIONS AND ALSO THE JUDIC IAL PRECEDENTS ON THE ISSUE, WE FIND THAT THE TPO HIMSE LF HAS REJECTED THE COMPANIES WHICH .IRE (SIC) MAKING LOSSES AS COMPARABLES. THIS SHOWS THAT THERE IS A LIMIT FOR THE LOWER END FOR IDENTIFYING THE COMPARABLES. IN SUCH A SITUATION, WE ARE UNABLE TO UNDERSTAND AS TO WHY THERE SHOULD NOT BE AN UPPER LIMIT ALSO. WHAT SHOULD BE UPPER LIMIT IS ANOTHER FACTOR TO BE CONSIDERED. WE AGREE WITH THE CONTENTI ON OF THE LEARNED COUNSEL FOR THE ASSESSEE THAT THE SI ZE MATTERS IN BUSINESS. A BIG COMPANY WOULD BE IN A POSITION TO BARGAIN THE PRICE AND ALSO ATTRACT MORE CUSTOMERS. IT WOULD ALSO HAVE A BROAD BASE OF SKILL ED EMPLOYEES WHO ARE ABLE TO GIVE BETTER OUTPUT. A SMA LL COMPANY MAY NOT HAVE THESE BENEFITS AND THEREFORE, THE TURNOVER ALSO WOULD COME DOWN REDUCING PROFIT MARGIN. THUS, AS HELD BY THE VARIOUS BENCHES OF THE TRIBUNAL, WHEN COMPANIES WHICH ARC LOSS MAKING ARE EXCLUDED FROM COMPARABLES, THEN THE SUPER PROFIT MAKING COMPANIES SHOULD ALSO BE EXCLUDED. FOR THE PURPOSE OF CLASSIFICATION OF COMPANIES ON THE BASIS OF NET SALES OR TURNOVER, WE FIND THAT A REASONABLE CLASSIFICATION HAS TO BE MADE. DUN & BRADSTREET & BRADSTREET AND NASSCOM HAVE GIVEN DIFFERENT RANGES. TAKING THE INDIAN SCENARIO INTO CONSIDERATION, WE FEEL THAT THE CLASSIFICATION MADE BY DUN & BRADSTREET IS MORE SUITABLE AND REASONABLE. I N VIEW OF THE SAME, WE HOLD THAT THE TURNOVER FILTER IS VERY IMPORTANT AND THE COMPANIES HAVING A TURNOVER OF RS.1.00 CRORE TO 200 CRORES HAVE TO BE TAKEN AS A PARTICULAR RANGE AND THE ASSESSEE BEING IN THAT RAN GE HAVING TURNOVER OF 8.15 CRORES, THE COMPANIES WHICH ALSO HAVE TURNOVER OF 1.00 TO 200.00 CRORES ONLY SHOULD BE TAKEN INTO CONSIDERATION FOR THE PURPOSE OF MAKING TP STUDY. 15. IT WAS BROUGHT TO OUR NOTICE THAT THE ABOVE PRO POSITION HAS ALSO BEEN FOLLOWED BY THE HONOURABLE BANGALORE ITAT IN THE 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. 16. THE LD. DR, ON THE OTHER HAND POINTED OUT THAT EVEN THE ASSESSEE IN ITS OWN TP STUDY HAS TAKEN COMPANIES HA VING TURNOVER OF MORE THAN RS. 200 CRORES AS COMPARABLES . IN THESE CIRCUMSTANCES, IT WAS SUBMITTED BY HIM THAT THE ASS ESSEE CANNOT HAVE ANY GRIEVANCE IN THIS REGARD. 17. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS. THE PROVISIONS OF THE ACT AND THE RULES THAT ARE RELEVANT FOR DECI DING THE 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 PROVIDES THAT INTERNATIONAL TRANSACTION MEANS A TRANSACTION BET WEEN TWO OR MORE ASSOCIATED ENTERPRISES, EITHER OR BOTH OF WHOM ARE NON- 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 INTERNATIONAL TRANSACTION SHALL BE DETERMINED BY AN Y OF THE FOLLOWING METHODS, BEING THE MOST APPROPRIATE METHOD, HAVING REGARD TO THE NATURE OF TRANSACTION OR CLASS OF TRANSACTION OR CLASS OF ASSOCIATED PERSONS OR FUNCTIONS PERFORMED BY SUCH PERSONS OR SUCH OTHER RELEVANT FACTORS AS THE BOARD MAY PRESCRIBE, 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 SUB- SECTION (1) SHALL BE APPLIED, FOR DETERMINATION OF ARMS LENGTH PRICE, IN THE MANNER AS MAY BE PRESCRIBED: PROVIDED 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: 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 PR ICE AT WHICH THE INTERNATIONAL TRANSACTION HAS ACTUALLY BE EN UNDERTAKEN SHALL BE DEEMED TO BE THE ARMS LENGTH P RICE. (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 POSSESSION, OF THE OPINION THAT ( A ) THE PRICE CHARGED OR PAID IN AN INTERNATIONAL TRANSACTION HAS NOT BEEN DETERMINED IN ACCORDANCE WITH 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 HE WAS REQUIRED TO FURNISH BY A NOTICE ISSUED UNDER SUB-SECTION (3) OF SECTION 92D, THE ASSESSING OFFICER MAY PROCEED TO DETERMINE THE ARMS LENGTH PRICE IN RELATION TO THE SAID INTERNAT IONAL TRANSACTION IN ACCORDANCE WITH SUB-SECTIONS (1) AND (2), ON THE BASIS OF SUCH MATERIAL OR INFORMATION OR DOC UMENT AVAILABLE WITH HIM: 18. RULE 10B OF THE IT RULES, 1962 PRESCRIBES RULE S 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 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 COSTS 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 TRANSACTIONS 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, BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSACTIONS, OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACTIONS, WHICH COULD MATERIALLY AFFECT THE AMOUNT 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-CLAUSE ( III ); ( V ) THE NET PROFIT MARGIN THUS ESTABLISHED IS THEN TAKEN INTO ACCOUNT TO ARRIVE AT AN ARMS LENGTH PRICE 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 TRANSACTION; ( B ) THE FUNCTIONS PERFORMED, TAKING INTO ACCOUNT ASSETS EMPLOYED OR TO BE EMPLOYED AND THE RISKS ASSUMED, 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 PARTIES TO THE TRANSACTIONS; ( D ) CONDITIONS PREVAILING IN THE MARKETS IN WHICH THE RESPECTIVE PARTIES TO THE TRANSACTIONS OPERATE, INCLUDING THE GEOGRAPHICAL LOCATION AND SIZE OF THE MARKETS, THE LAWS AND GOVERNMENT ORDERS IN FORCE, COSTS OF LABOUR AND CAPITAL IN THE MARKETS, OVERALL ECONOMIC DEVELOPMENT AND LEVEL OF COMPETITION AND WHETHER THE MARKETS ARE WHOLESALE OR RETAIL. (3) AN UNCONTROLLED TRANSACTION SHALL BE COMPARAB LE TO AN INTERNATIONAL TRANSACTION IF ( I ) NONE OF THE DIFFERENCES, IF ANY, BETWEEN THE TRANSACTIONS BEING COMPARED, OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACTIONS ARE LIKELY TO MATERIALLY 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 COMPARABI LITY 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 CONS IDERED IF SUCH DATA REVEALS FACTS WHICH COULD HAVE AN INFLUENCE ON THE DETERMINATION OF TRANSFER PRICES IN RELATION TO THE TRANSACTIONS BEING COMPARED. 19. A READING OF THE PROVISIONS OF RULE 10B(2) OF THE RULES SHOWS THAT UNCONTROLLED TRANSACTION HAS TO BE COMPA RED WITH 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 I NTERNATIONAL TRANSACTION. THE DISPUTES ARE WITH REGARD TO THE C OMPARABILITY OF THE COMPARABLE RELIED UPON BY THE TPO. 20. 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 IMPORTANT CRITERIA IN CHOOSING THE COMPARABLES. THE ASSESSEES TURNOVER I S RS. 47,46,66,638. IT WOULD THEREFORE FALL WITHIN THE C ATEGORY 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 H AVE TO BE ELIMINATED FROM THE LIST OF COMPARABLES AS LAID DOW N IN SEVERAL DECISIONS REFERRED TO BY THE LD. COUNSEL FOR THE AS SESSEE. APPLYING THOSE TESTS, THE FOLLOWING COMPANIES WILL HAVE TO BE EXCLUDED FROM THE LIST OF 26 COMPARABLES DRAWN BY T HE 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. . 10. 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 AFORESAID COMPANIES SHOULD BE EXCLUDED FRO M THE LIST OF COMPARABLE COMPANIES. THE AO IS DIRECTED TO COMPUT E THE ARITHMETIC MEAN BY EXCLUDING THE AFORESAID COMPANIES FROM THE LIST OF COMPARABLE. 11. IMPROPER SELECTION OF COMPARABLES: IT WAS SUBMITTED BY THE LEARNED COUNSEL FOR THE ASSESSEE THAT THE FOLLOWING 4 COMPANIES ARE NOT FUNCTIONALLY COMPARABLE WITH THAT OF THE ASSESSEE. A) AVANI CINCOM TECHNOLOGIES LTD. B) KALS INFORMATION SYSTEMS LIMITED C) CELESTIAL LABS LIMITED D) ACCEL TRANSMISSION LIMITED. IN THIS REGARD OUR ATTENTION WAS DRAWN TO THE DECIS ION OF THE HONBLE ITAT BANGALORE BENCH IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. (SUPRA) WHEREIN THESE COMPANIES WERE HELD TO BE NO T FUNCTIONALLY COMPARABLE WITH THAT OF A PURE SOFTWARE DEVELOPER L IKE THE ASSESSEE. 12. THE FOLLOWING WERE THE RELEVANT OBSERVATIONS OF THE TRIBUNAL ON THE AFORESAID COMPARABLE COMPANIES IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. (SUPRA): (B) AVANI CIMCON TECHNOLOGIES LTD. 39. AS FAR AS THIS COMPANY IS CONCERNED, THE PLEA OF THE ASSESSEE HAS BEEN THAT THIS COMPANY IS FUNCTIONALLY DIFFERENT FROM THE ASSESSEE. BASED ON THE INFORMATION AVAILA BLE IN THE COMPANYS WEBSITE, WHICH REVEALS THAT THIS COMPANY HAS DEVELOPED A SOFTWARE PRODUCT BY NAME DXCHANGE, IT WAS SUBMITTED THAT THIS COMPANY WOULD HAVE REVENUE FROM SOFTWARE PRODUCT SALES APART FROM RENDERING OF SOFTWARE SERV ICES AND THEREFORE IS FUNCTIONALLY DIFFERENT FROM THE ASSESS EE. IT WAS FURTHER SUBMITTED THAT THE MUMBAI BENCH OF THE TRIB UNAL TO THE DECISION IN THE CASE OF TELCORDIA TECHNOLOGIES PVT. LTD. V. ACIT ITA NO.7821/MUM/2011 WHEREIN THE TRIBUNAL ACCEPTED THE ASSESSEES CONTENTION THAT THIS COMPANY HAS REVENUE FROM SOFTWARE PRODUCT AND OBSERVED THAT IN THE ABSENCE O F SEGMENTAL DETAILS, AVANI CINCOM CANNOT BE CONSIDERED AS COMPA RABLE TO THE ASSESSEE WHO WAS RENDERING SOFTWARE DEVELOPMENT SERVICES ONLY AND IT WAS HELD AS FOLLOWS:- 7.8 AVANI CINCOM TECHNOLOGIES LTD. (AVANI CINCOM ) : HERE IN THIS CASE ALSO THE SEGMENTAL DETAILS OF OPE RATING INCOME OF IT SERVICES AND SALE OF SOFTWARE PRODUCTS HAVE NOT BEEN PROVIDED SO AS TO SEE WHETHER THE PROFIT R ATIO OF THIS COMPANY CAN BE TAKEN INTO CONSIDERATION FOR COMPARING THE CASE THAT OF ASSESSEE. IN ABSENCE OF ANY KIND OF DETAILS PROVIDED BY THE TPO, WE ARE UNABLE TO PERSUADE OURSELVES TO INCLUDE IT AS COMPARABLE PART Y. LEARNED CIT DR HAS PROVIDED A COPY OF PROFIT LOSS ACCOUNT WHICH SHOWS THAT MAINLY ITS EARNING IS FROM SOFTWARE EXPORTS, HOWEVER, THE DETAILS OF PERCENTAG E OF EXPORT OF PRODUCTS OR SERVICES HAVE NOT BEEN GIVEN. WE, THEREFORE, REJECT THIS COMPANY ALSO FROM TAKING INT O CONSIDERATION FOR COMPARABILITY ANALYSIS. IT WAS ALSO HIGHLIGHTED THAT THE MARGIN OF THIS COM PANY AT 52.59% WHICH REPRESENTS ABNORMAL CIRCUMSTANCES AND PROFITS. THE FOLLOWING FIGURES WERE PLACED BEFORE US:- PARTICULARS FYS 05-06 06-07 07-0 8 08-09 OPERATING REVENUE 21761611 35477523 29342809 280398 51 OPERATING EXPNS. 16417661 23249646 23359186 3110894 9 OPERATING PROFIT 5343950 12227877 5983623 (306909 8) OPERATING MARGIN 32.55% 52.59% 25.62% - 9.87% 40. IT WAS SUBMITTED THAT THIS COMPANY HAS MADE UN USUALLY HIGH PROFIT DURING THE FINANCIAL YEAR 06-07. THE O PERATING REVENUES INCREASED 63.03% WHICH INDICATES THAT IT W AS AN EXTRAORDINARY YEAR FOR THIS COMPANY. EVEN THE GROW TH OF SOFTWARE INDUSTRY FOR THE PREVIOUS YEAR AS PER NASS COM WAS 32%. THE GROWTH RATE OF THIS COMPANY WAS DOUBLE TH E INDUSTRY AVERAGE. IN VIEW OF THE ABOVE, IT WAS ARGUED THAT THIS COMPANY OUGHT TO HAVE BEEN REJECTED AS A COMPARABLE. 41. WE HAVE GIVEN A CAREFUL CONSIDERATION TO THE S UBMISSIONS MADE ON BEHALF OF THE ASSESSEE AND ARE OF THE VIEW THAT THE SAME DESERVES TO BE ACCEPTED. THE REASONS GIVEN BY THE ASSESSEE FOR EXCLUDING THIS COMPANY AS COMPARABLE A RE FOUND TO BE ACCEPTABLE. THE DECISION OF ITAT (MUMBAI) IN THE CASE OF TELCORDIA TECHNOLOGIES PVT. LTD. V. ACIT (SUPRA) ALSO SUPPORTS THE PLEA OF THE ASSESSEE. WE THEREFORE ACCEPT THE PLEA OF THE ASSESSEE TO REJECT THIS COMPANY AS A COMPARABLE. (D) KALS INFORMATION SYSTEMS LTD. 46. AS FAR AS THIS COMPANY IS CONCERNED, THE CONTE NTION 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 ENGAGED IN PROVIDING TRAINING. IT WAS ALSO SUBMITTED THAT AS PER THE ANNUAL REPOT, THE SALARY COST DEBITED UNDER THE SOFTWARE D EVELOPMENT EXPENDITURE WAS RS. 45,93,351. THE SAME WAS LESS T HAN 25% OF THE SOFTWARE SERVICES REVENUE AND THEREFORE THE SALARY COST FILTER TEST FAILS IN THIS CASE. REFERENCE WAS MADE TO THE PUNE BENCH TRIBUNALS DECISION OF THE ITAT IN THE CASE O F BINDVIEW INDIA PRIVATE LIMITED VS. DCI, ITA NO. ITA NO 1386/PN/1O WHEREIN KALS AS COMPARABLE WAS REJECTED FOR AY 2006-07 ON ACCOUNT OF IT BEING FUNCTIONALLY DIFF ERENT FROM SOFTWARE COMPANIES. THE RELEVANT EXTRACT ARE AS FOL LOWS: 16. ANOTHER ISSUE RELATING TO SELECTION OF COMPARABLES BY THE TPO IS REGARDING INCLUSION OF KALS INFORMATION SYSTEM LTD. THE ASSESSEE HAS OBJECTED TO ITS INCLUSION ON THE BASIS THAT FUNCTIO NALLY THE COMPANY IS NOT COMPARABLE. WITH REFERENCE TO PAGES 185-186 OF THE PAPER BOOK, IT IS EXPLAINED TH AT THE SAID COMPANY IS ENGAGED IN DEVELOPMENT OF SOFTWARE PRODUCTS AND SERVICES AND IS NOT COMPARABL E TO SOFTWARE DEVELOPMENT SERVICES PROVIDED BY THE ASSESSEE. THE APPELLANT HAS SUBMITTED AN EXTRACT ON PAGES 185-186 OF THE PAPER BOOK FROM THE WEBSITE OF THE COMPANY TO ESTABLISH THAT IT IS ENGAGED IN PROVIDING OF I T ENABLED SERVICES AND THAT THE SAID COMPANY IS INTO DEVELOPMENT OF SOFTWARE PRODUCTS, ETC. ALL THESE ASPECTS HAVE NOT BEEN FACTUALLY REBU TTED AND, IN OUR VIEW, THE SAID CONCERN IS LIABLE TO BE EXCLUDED FROM THE FINAL SET OF COMPARABLES, AND THU S ON THIS ASPECT, ASSESSEE SUCCEEDS. 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. 47. WE HAVE GIVEN A CAREFUL CONSIDERATION TO THE S UBMISSION MADE ON BEHALF OF THE ASSESSEE. WE FIND THAT THE T PO HAS DRAWN CONCLUSIONS ON THE BASIS OF INFORMATION OBTAINED BY ISSUE OF NOTICE U/S.133(6) OF THE ACT. THIS INFORMATION WHICH WAS NOT AVAILABLE IN PUBLIC DOMAIN COULD NOT HAVE BEEN USED BY THE TPO, WHEN THE SAME IS CONTRARY TO THE ANNUAL REPORT OF THIS COMPA NY 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 N OT PURELY OR MAINLY SOFTWARE DEVELOPMENT SERVICE PROVIDER. WE T HEREFORE ACCEPT THE PLEA OF THE ASSESSEE THAT THIS COMPANY I S NOT COMPARABLE. (C) CELESTIAL LABS LTD. 42. AS FAR AS THIS COMPANY IS CONCERNED, THE STAN D OF THE ASSESSEE IS THAT IT IS ABSOLUTELY A RESEARCH & DEVE LOPMENT COMPANY. IN THIS REGARD, THE FOLLOWING SUBMISSIONS WERE MADE:- I. IN THE DIRECTORS REPORT (PAGE 20 OF PB-IL), IT IS STATED THAT THE COMPANY HAS APPLIED FOR INCOME TAX CONCESSION FOR IN-HOUSE R&D CENTRE EXPENDITURE AT HYDERABAD UNDER SECTION 35(2AB) OF THE INCOME TAX ACT. II. AS PER THE NOTES TO ACCOUNTS - SCHEDULE 15, UNDER DEFERRED REVENUE EXPENDITURE (PAGE 31 OF PB-II), IT IS MENTIONED THAT, EXPENDITURE INCURRED ON RESEARCH AND DEVELOPMENT OF NEW PRODUCTS HAS BEEN TREATED AS DEFERRED REVENUE EXPENDITURE AND THE SAME HAS BEEN WRITTEN OFF IN 10 YEARS EQUALLY YEARLY INSTALLMENTS FROM THE YEAR IN WHICH IT IS INCURRED. III. AN AMOUNT OF RS. 11,692,020/- HAS BEEN DEBITED TO THE PROFIT AND LOSS ACCOUNT AS DEFERRED REVENUE EXPENDITURE (PAGE 30 OF PB-II). THIS AMOUNTS TO NEARLY 8.28 PERCENT OF THE SALES OF THIS COMPANY. IT WAS THEREFORE SUBMITTED THAT THE ACCEPTANCE OF T HIS COMPANY AS A COMPARABLE FOR THE REASON THAT IT IS INTO PURE SOFT WARE DEVELOPMENT ACTIVITIES AND IS NOT ENGAGED IN R&D ACTIVITIES IS BAD IN LAW. 43. FURTHER REFERENCE WAS ALSO MADE TO THE DECISIO N OF THE MUMBAI BENCH OF THE TRIBUNAL IN THE CASE OF TEVA PHARMA PRIVATE LTD. V. ADDL. CIT ITA NO.6623/MUM/2011 (F OR AY 2007-08) IN WHICH THE COMPARABILITY OF THIS COMPANY FOR CLI NICAL TRIAL RESEARCH SEGMENT. THE RELEVANT EXTRACT OF DISCUSSIO N REGARDING THIS COMPANY IS AS FOLLOWS: THE LEARNED D.R. HOWEVER DREW OUR ATTENTION TO PAGE-389 OF THE PAPER BOOK WHICH IS AN EXTRACT FROM THE DIRECTORS REPORT WHICH READS AS FOLLOWS: THE COMPANY HAS DEVELOPED A DE NOVO DRUG DESIGN TOOL CELSUITE TO DRUG DISCOVERY IN, FINDING THE LEAD MOLECULES FOR DRUG DISCOVERY AND PROTECTED THE IPR BY FILING UNDER THE COPY IF SIC (OF) RIGHT/PATENT ACT. (APPRISED AND FUNDED BY DEPARTMENT OF SCIENCE AND TECHNOLOGY NEW DELHI) BASED ON OUR INSILICO EXPERTISE (APPLYING BIO-INFORMATICS TOOLS). THE COMPANY HAS DEVELOPED A MOLECULE TO TREAT LEUCODERMA AND MULTIPLE CANCER AND PROTECTED THE IPR BY FILING THE PATENT. THE PATENT DETAILS HAVE BEEN DISCUSSED WITH PATENT OFFICIALS AND THE RESPONSE IS VERY FAVORABLE. THE CLONING AND PURIFICATION UNDER WET LAB PROCEDURES ARE UNDER PROGRESS WITH OUR COLLABORATIVE INSTITUTE, DEPARTMENT OF MICROBIOLOGY, OSMANIA UNIVERSITY, HYDERABAD. IN THE INDUSTRIAL BIOTECHNOLOGY AREA, THE COMPANY HAS SIGNED THE TECHNOLOGY TRANSFER AGREEMENT WITH IMTECH CHANDIGARH (A VERY REPUTED CSIR ORGANIZATION) TO MANUFACTURE AND MARKET INITIALLY TWO ENZYMES, ALPHA AMYLASE AND ALKALINE PROTEASE IN INDIA AND OVERSEAS. THE COMPANY IS PLANNING TO SET UP A BIOTECHNOLOGY FACILITY TO MANUFACTURE INDUSTRIAL ENZYMES. THIS FACILITY WOULD ALSO INCLUDE THE RESEARCH LABORATORIES FOR CARRYING OUT FURTHER R & D ACTIVITIES TO DEVELOP NEW CANDIDATES DRUG MOLECULES AND LICENSE THEM TO INTERESTED PHARMA AND BIO COMPANIES ACROSS THE GLOBE. THE PROPOSED FACILITY WILL BE SET UP IN GENOME VALLEY AT HYDERABAD IN ANDHRA PRADESH. ACCORDING TO THE LEARNED D.R. CELESTIAL LABS IS ALS O IN THE FIELD OF RESEARCH IN PHARMACEUTICAL PRODUCTS AN D SHOULD BE CONSIDERED AS COMPARABLE. AS RIGHTLY SUBMITTED BY THE LEARNED COUNSEL FOR THE ASSESSEE, THE DISCOVERY IS IN RELATION TO A SOFTWARE DISCOVER Y OF NEW DRUGS. MOREOVER THE COMPANY ALSO IS OWNER OF THE IPR. THERE IS HOWEVER A REFERENCE TO DEVELOPMENT OF A MOLECULE TO TREAT CANCER USING BIO - INFORMATICS TOOLS FOR WHICH PATENTING PROCESS WAS ALSO BEING PURSUED. AS EXPLAINED EARLIER IT IS A DIVERSIFIED COMPANY AND THEREFORE CANNOT BE CONSIDE RED AS COMPARABLE FUNCTIONALLY WITH THAT OF THE ASSESSE E. THERE HAS BEEN NO ATTEMPT MADE TO IDENTIFY AND ELIM INATE AND MAKE ADJUSTMENT OF THE PROFIT MARGINS SO THAT T HE DIFFERENCE IN FUNCTIONAL COMPARABILITY CAN BE ELIMI NATED. BY NOT RESORTING TO SUCH A PROCESS OF MAKING ADJUST MENT, THE TPO HAS RENDERED THIS COMPANY AS NOT QUALIFYING FOR COMPARABILITY. WE THEREFORE ACCEPT THE PLEA OF THE ASSESSEE IN THIS REGARD. 44. IT WAS SUBMITTED THAT THE LEARNED DR IN THE ABO VE CASE VEHEMENTLY ARGUED THAT THIS COMPANY IS INTO RESEARC H IN PHARMACEUTICAL PRODUCTS. THE ITAT CONCLUDED THAT TH IS COMPANY IS OWNER OF IPR, IT HAS SOFTWARE FOR DISCOVERY OF NEW DRUGS AND HAS DEVELOPED MOLECULE TO TREAT CANCER. IN THE ULTIMATE ANALYSIS, THE ITAT DID NOT CONSIDER THIS COMPANY AS A COMPARABLE IN CLINICAL TRIAL SEGMENT, FOR THE REASON THAT THIS COMPANY HAS DIVER SE BUSINESS. IT WAS SUBMITTED THAT, HOWEVER, FROM THE ABOVE EXTRACT S IT IS CLEAR THAT THIS COMPANY IS NOT INTO SOFTWARE DEVELOPMENT ACTIV ITIES, ACCORDINGLY, THIS COMPANY SHOULD BE REJECTED AS A C OMPARABLE BEING FUNCTIONALLY DIFFERENT. 45. FROM THE MATERIAL AVAILABLE ON RECORD, IT TRANS PIRES THAT THE TPO HAS ACCEPTED THAT UP TO AY 06-07 THIS COMPANY W AS CLASSIFIED AS A RESEARCH AND DEVELOPMENT COMPANY. ACCORDING T O THE TPO IN AY 07-08 THIS COMPANY HAS BEEN CLASSIFIED AS SOFTWA RE DEVELOPMENT SERVICE PROVIDER IN THE CAPITALINE/PROW ESS DATABASE AS WELL AS IN THE ANNUAL REPORT OF THIS COMPANY. THE TPO HAS RELIED ON THE RESPONSE FROM THIS COMPANY TO A NOTICE U/S.133( 6) OF THE ACT IN WHICH IT HAS SAID THAT IT IS IN THE BUSINESS OF PRO VIDING SOFTWARE DEVELOPMENT SERVICES. THE ASSESSEE IN REPLY TO THE PROPOSAL OF THE AO TO TREAT THIS AS A COMPARABLE HAS POINTED OUT TH AT THIS COMPANY PROVIDES SOFTWARE PRODUCTS/SERVICES AS WELL AS BIOI NFORMATICS SERVICES AND THAT THE SEGMENTAL DATA FOR EACH ACTIV ITY IS NOT AVAILABLE AND THEREFORE THIS COMPANY SHOULD NOT BE TREATED AS COMPARABLE. BESIDES THE ABOVE, THE ASSESSEE HAS PO INT OUT TO SEVERAL REFERENCES IN THE ANNUAL REPORT FOR 31.3.20 07 HIGHLIGHTING THE FACT THAT THIS COMPANY WAS DEVELOPS BIOTECHNOLOGY P RODUCTS AND PROVIDES RELATED SOFTWARE DEVELOPMENT SERVICES. TH E TPO CALLED FOR SEGMENTAL DATA AT THE ENTITY LEVEL FROM THIS COMPAN Y. THE TPO ALSO CALLED FOR DESCRIPTION OF SOFTWARE DEVELOPMENT PROC ESS. IN RESPONSE TO THE REQUEST OF THE TPO THIS COMPANY IN ITS REPLY DATED 29.3.2010 HAS GIVEN DETAILS OF EMPLOYEES WORKING IN SOFTWARE DEVELOPMENT BUT IT IS NOT CLEAR AS TO WHETHER ANY SEGMENTAL DATA WA S GIVEN OR NOT. BESIDES THE ABOVE THERE IS NO OTHER DETAIL IN THE T POS ORDER AS TO THE NATURE OF SOFTWARE DEVELOPMENT SERVICES PERFORM ED BY THE ASSESSEE. CELESTIAL LABS HAD COME OUT WITH A PUBLI C ISSUE OF SHARES AND IN THAT CONNECTION ISSUED DRAFT RED HERRING PRO SPECTUS (DRHP) IN WHICH THE BUSINESS OF THIS COMPANY WAS EXPLAINED AS TO CLINICAL RESEARCH. THE TPO WANTED TO KNOW AS TO WHETHER TH E PRIMARY BUSINESS OF THIS COMPANY IS SOFTWARE DEVELOPMENT SE RVICES AS INDICATED IN THE ANNUAL REPORT FOR FY 06-07 OR CLIN ICAL RESEARCH AND MANUFACTURE OF BIO PRODUCTS AND OTHER PRODUCTS AS S TATED IN THE DRHP. THERE IS NO REFERENCE TO ANY REPLY BY CELEST IAL LABS TO THE ABOVE CLARIFICATION OF THE TPO. THE TPO WITHOUT A NY BASIS HAS HOWEVER CONCLUDED THAT THE BUSINESS MENTIONED IN TH E DRHP ARE THE SERVICES OR BUSINESSES THAT WOULD BE STARTED BY UTILIZING THE FUNDS GARNERED THOUGH THE INITIAL PUBLIC OFFER (IPO ) AND THUS IN NO WAY CONNECTED WITH BUSINESS OPERATIONS OF THE COMPA NY DURING FY 06-07. WE ARE OF THE VIEW THAT IN THE LIGHT OF THE SUBMISSIONS MADE BY THE ASSESSEE AND THE FACT THAT THIS COMPANY WAS BASICALLY/ADMITTEDLY IN CLINICAL RESEARCH AND MANUF ACTURE OF BIO PRODUCTS AND OTHER PRODUCTS, THERE IS NO CLEAR BASI S ON WHICH THE TPO CONCLUDED THAT THIS COMPANY WAS MAINLY IN THE B USINESS OF PROVIDING SOFTWARE DEVELOPMENT SERVICES. WE THEREF ORE ACCEPT THE PLEA OF THE ASSESSEE THAT THIS COMPANY OUGHT NOT TO HAVE BEEN CONSIDERED AS COMPARABLE. (E) ACCEL TRANSMATIC LTD. 48. WITH REGARD TO THIS COMPANY, THE COMPLAINT OF THE ASSESSEE IS THAT THIS COMPANY IS NOT A PURE SOFTWARE DEVELOP MENT 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 THA T 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 FINANCIAL YEAR 2005-06 FROM WHICH THE DRP NOTED THA T 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 TECHNOLOGIES, OUTSOURCED PRODUCT DEVELOPMENT (III) ACCEL IT ACADEMY (THE NET STOP FOR ENGINEERS) - TRAINING SERVICES IN HARDWARE AND NETWORKING, ENTER PRISE SYSTEM MANAGEMENT, EMBEDDED SYSTEM, VLSI DESIGNS, CAD/CAM/BPO (IV) ACCEL ANIMATION STUDIES SOFTWARE SERVICES FOR 2D/3D ANIMATION, SPECIAL EFFECT, ERECTION, GAME ASSET DEVELOPMENT. 4.3 ON CAREFUL PERUSAL OF THE BUSINESS ACTIVITIES OF ACCEL TRANSMATIC LTD. DRP AGREED WITH THE ASSESSEE THAT THE COMPANY WAS FUNCTIONALLY DIFFERENT FROM THE ASS ESSEE 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. DR P THEREFORE DIRECTED THE ASSESSING OFFICER TO EXCLUDE ACCEL TRANSMATIC LTD. FROM THE FINAL LIST OF COMPAR ABLES FOR THE PURPOSE OF DETERMINING TNMM MARGIN. 49. BESIDES THE ABOVE, IT WAS POINTED OUT THAT THIS COMPANY HAS RELATED PARTY TRANSACTIONS WHICH IS MORE THAN THE P ERMITTED LEVEL AND THEREFORE SHOULD NOT BE TAKEN FOR COMPARABILITY PUR POSES. THE SUBMISSION OF THE LD. COUNSEL FOR THE ASSESSEE WAS THAT IF THE ABOVE COMPANY SHOULD NOT BE CONSIDERED AS COMPARABLE. TH E LD. DR, ON THE OTHER HAND, RELIED ON THE ORDER OF THE TPO. 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 THIS CO MPANY 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 AFORESAI D COMPANY SHOULD BE EXCLUDED AS COMPARABLES. 13. 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 TRILOGY E-BUSINESS SOFTWARE 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 THE FOLLOWING COMPANIES BE EXCLUDED FROM THE L IST OF 26 COMPARABLE ARRIVED AT BY THE TPO. A) AVANI CINCOM TECHNOLOGIES LTD. B) KALS INFORMATION SYSTEMS LIMITED C) CELESTIAL LABS LIMITED D) ACCEL TRANSMISSION LIMITED. 14. THE LEARNED COUNSEL FOR THE ASSESSEE SUBMITTED BEFORE US THAT IF THE AFORESAID 12 COMPARABLE COMPANIES ARE EXCLUDED FROM THE LIST OF 26 COMPARABLE COMPANIES CHOSEN BY THE TPO AND SEGMENTA L RESULTS (SOFTWARE DEVELOPMENT SEGMENT) ALONE OF COMPARABLE COMPANY CHOSEN BY THE TPO M/S. MEGASOFT LTD., IS TAKEN FOR COMPARABIL ITY, THEN THE PROFIT MARGIN OF THE ASSESSEE WOULD BE WELL WITHIN THE (+) / (-) 5% RANGE OF THE ARITHMETIC MEAN OF THE REMAINING COMPARABLE COMPANI ES AND THEREFORE THE PRICE RECEIVED BY THE ASSESSEE WOULD BE CONSIDERED AS AT ARMS LENGTH. HE PRAYED FOR A LIMITED DIRECTION TO THE TPO ON THE LINES SET OUT ABOVE AND DETERMINE THE ALP. IT ALSO SUBMITTED THAT THE OTHE R ISSUES RAISED BY THE ASSESSEE IN THE GROUNDS OF APPEAL NO.2 NEED NOT BE GONE INTO. 15. WE ARE OF THE VIEW THAT THE PRAYER SOUGHT FOR B Y THE LEARNED COUNSEL FOR THE ASSESSEE IS ACCEPTABLE AND ACCORDINGLY, THE TPO IS DIRECTED TO COMPUTE ALP AFTER EXCLUDING THE 12 COMPARABLE COMPA NIES DEALT WITH IN THIS ORDER. THE TPO IS ALSO DIRECTED TO TAKE ONLY THE SOFTWARE DEVELOPMENT SEGMENT MARGIN OF THE COMPARABLE COMPANY M/S.MEGASO FT LTD., AS WAS DIRECTED AND HELD IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT.LTD. (SUPRA). 16. GROUNDS NO.3 AND 4 RAISED BY THE ASSESSEE PROJE CT THE GRIEVANCE OF THE ASSESSEE REGARDING THE ACTION OF THE LEARNED AS SESSING OFFICER AND HONORABLE DISPUTE RESOLUTION PANEL EXCLUDING A SUM OF RS. 32,29,985/- INCURRED ON TELECOMMUNICATION CHARGES AND ANOTHER S UM OF RS.71,35,610/- INCURRED IN FOREIGN CURRENCY FROM EXPORT TURNOVER O N THE GROUND THAT THESE EXPENSES ARE INCURRED IN RENDERING TECHNICAL SERVIC ES RENDERED TO CLIENTS OUTSIDE INDIA WHILE COMPUTING DEDUCTION UNDER SECTI ON 10A. IT IS THE PLEA OF THE ASSESSEE THAT AT ALL TIMES DURING THE RELEVANT PREVIOUS YEAR, IT WAS ENGAGED IN DEVELOPMENT OF COMPUTER SOFTWARE AND NOT IN RENDERING ANY TECHNICAL SERVICES. WITHOUT PREJUDICE TO ITS CONTE NTION THAT THE AFORESAID SUMS SHOULD NOT BE EXCLUDED FROM THE EXPORT TURNOVE R WHILE COMPUTING DEDUCTION U/S.10A OF THE ACT, THE ASSESSEE HAS ALSO MADE AN ALTERNATE PRAYER THAT EXPENSES THAT ARE REDUCED FROM THE EXPO RT TURNOVER SHOULD ALSO BE REDUCED FROM THE TOTAL TURNOVER AND IN THIS REGA RD 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) . 17. WE HAVE HEARD THE LD. COUNSEL FOR THE ASSESSEE AND THE LD. DR ON THE ISSUES RAISED IN GROUND NOS.3 & 4. TAKING INTO CONSIDERATION THE DECISION RENDERED BY THE HONBLE HIGH COURT OF KARN ATAKA 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 A SUM OF RS. 32,29,985/- INCURRED ON TELECO MMUNICATION CHARGES AND ANOTHER SUM OF RS.71,35,610/- INCURRED IN FOREI GN CURRENCY BOTH FROM EXPORT TURNOVER AND TOTAL TURNOVER, AS HAS BEEN PRA YED FOR BY THE ASSESSEE IN GROUND NO.4. IN VIEW OF THE ACCEPTANCE OF THE A LTERNATIVE PRAYER IN GROUND NO.2, WE ARE OF THE VIEW THAT NO ADJUDICATIO N IS REQUIRED ON GROUND NO.3. 18. IN THE RESULT, THE APPEAL BY THE ASSESSEE IS PA RTLY ALLOWED. PRONOUNCED IN THE OPEN COURT ON THIS 11 TH DAY OF JULY, 2014 . SD/- SD/- ( RAJENDRA) ( N.V. VASUDEVAN ) ACCOUNTANT MEMBER JUDI CIAL MEMBER BANGALORE, DATED, THE 11 TH JULY , 2014 . /D S/ COPY TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT(A) 5. DR, ITAT, BANGALORE. 6. GUARD FILE BY ORDER ASSISTANT REGISTRAR / SENIOR PRIVATE SECRETARY ITAT, BANGALORE.