M/s. Support.com India Pvt. Ltd., Bangalore V. ITO, Bangalore

ITA 1340/BANG/2010

• Counselvise Citation: 134021114 RSA 2010
• Duration Of Justice: 4 year(s) 11 month(s) 5 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 04-11-2015
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: A
• Next Hearing Date: 06-10-2015
• Assessment Year: 2006-2007
• Appeal Filed On: 29-11-2010
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: G R REDDY CITIDR
• Assessee Lawyers: PADAMCHAND KHINCHA
• Keywords: Related party transaction; Transfer pricing; International transaction
• Section: 143(3); 92D; 234B; 10B

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL A BENCH : BANGALORE BEFORE SMT. ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER AND SHRI JASON P. BOAZ, ACCOUNTANT MEMBER IT(TP)A NO.1340/BANG/2010 ASSESSMENT YEAR : 2006-07 M/S. SUPPORT.COM INDIA PRIVATE LTD., (FORMERLY KNOWN AS SUPPORTSOFT INDIA PVT. LTD.), 3 RD FLOOR, SALARPURIA SENATE, 4 TH CROSS, 5 TH BLOCK, KORAMANGALA INDUSTRIAL LAYOUT, BANGALORE 560 095. PAN: AAHCS 3904R VS. THE INCOME TAX OFFICER, WARD 12(2), BANGALORE. APPELLANT RESPONDENT APPELLANT BY : SHRI PADAMCHAND KHINCHA, CA RESPONDENT BY : SHRI G.R. REDDY, CIT-I(DR) DATE OF HEARING : 06.10.2015 DATE OF PRONOUNCEMENT : 04.11.2015 O R D E R PER ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER THIS APPEAL BY THE ASSESSEE IS DIRECTED AGAINST T HE ORDER DATED 08.10.2010 PASSED U/S. 143(3) R.W.S. 144C OF THE IN COME-TAX ACT, 1961 [THE ACT] PURSUANT TO THE DIRECTIONS OF THE DRP. IT(TP)A NO.1340/BANG/2010 PAGE 2 OF 25 2. THE ASSESSEE COMPANY PROVIDES SOFTWARE DEVELOPM ENT AND MARKETING SUPPORT SERVICES FOR AND ON BEHALF OF ITS PARENT COMPANY, SUPPORTSOFT INC., USA. UNDER THE MASTER SERVICES AGREEMENT WITH ITS ASSOCIATED ENTERPRISE (AE), THE ASSESSEE IS REMUNER ATED AT COST PLUS 8% FOR SOFTWARE DEVELOPMENT SERVICES. UNDER ANOTHER S ERVICES AGREEMENT BETWEEN THE TAXPAYER AND ITS PARENT COMPANY SUPPORT SOFT INC., USA, THE ASSESSEE IS COMPENSATED AT COST PLUS 5% FOR MARKETI NG SUPPORT SERVICES. 3. THE TRANSFER PRICING (TP) PROCEEDINGS WERE TAKE N UP AND TP DOCUMENTATION CONTAINED THREE COMPARABLES SELECTED BY THE ASSESSEE BY APPLYING CERTAIN FILTER AND THE CPM METHOD WAS ADOP TED. THE TPO HELD AT PARA 18.7 AS FOLLOWS:- 18.7 PRICE RECEIVED VIS--VIS THE ARMS LENGTH PR ICE: THE PRICE CHARGED BY THE TAX PAYER TO ITS ASSOCIATE D ENTERPRISES IS COMPARED TO THE ARMS LENGTH PRICE AS UNDER: ARMS LENGTH PRICE @ 118.31% OF OPERATING COST RS.14,46,93,444 PRICE SHOWN IN THE INTERNATIONAL TRANSACTION RS.13 ,20,83,370 SHORTFALL BEING ADJUSTMENT U/S 92CA RS. 1,26,10,07 4 4. THE TPO FURTHER OBSERVED THAT NO ADVERSE CONCLUS IONS HAVE BEEN DRAWN IN RESPECT OF OTHER INTERNATIONAL TRANSACTION S. THE TPO HELD THAT TNMM IS THE MOST APPROPRIATE METHOD TAKING INTO ACC OUNT THE FACTS AND CIRCUMSTANCES OF THE CASE. THE TPO SELECTED THE FI NAL SET OF COMPARABLES AS FOLLOWS:- IT(TP)A NO.1340/BANG/2010 PAGE 3 OF 25 SL. NO NAME OF COMPANY SALES (RS. IN CRORES) OPERATING MARGIN ON COST 1 AZTEC SOFTWARE LTD. 128.61 18.09% 2 GEOMETRIC SOFTWARE LTD. (SEG) 98.60 6.70% 3 IGATE GLOBAL SOLUTIONS LTD. (SEG) 527.91 15.61% 4 INFOSYS LTD. 9,028.00 40.38% 5 KALS INFORMATION SYSTEMS LTD. 1.97 39.75% 6 MINDTREE CONSULTING LTD. 448.79 14.67% 7 PERSISTENT SYSTEMS LTD. 209.18 24.67% 8 R SYSTEMS INTERNATIONAL LTD. (SEG) 79.42 22.20% 9 SASKEN COMMUNICATION LTD. (SEG) 240.03 13.90% 10 TATA ELXSI LTD. (SEG) 188.81 27.65% 11 LUCID SOFTWARE 1.02 8.92% 12 MEDIA SOFT SOLUTIONS PVT. LTD. 1.76 6.29% 13 R S SOFTWARE (INDIA) LTD. 91.57 15,69% 14 SIP TECHNOLOGIES & EXPORTS LTD. 6.53 3.06% 15 BODHTREE CONSULTING LTD. 5.32 15.99% 16 ACCEL TRANSMATICS LTD. (SEG) 8.02 44.07% 17 SYNFOSYS BUSINESS SOLUTIONS LTD. 4.49 10.61% 18 MEGASOFT LTD. 56.15 51.74% 19 LANCO GLOBAL SOLUTIONS LTD. 35.63 5.27% 20 FLEXTRONICS SOFTWARE SYSTEMS LTD. 595.12 27.24% ARITHMETIC MEAN 20.63% 5. THE COMPARABLES SELECTED BY THE ASSESSEE IN THE TP STUDY WITH RESPECT TO SOFTWARE DEVELOPMENT SERVICES ARE AS FOL LOWS:- 1. VJIL CONSULTING LTD. 2. SANKHYA INFOTECH LTD. 3. FOURSOFT LTD. 6. AGGRIEVED, THE ASSESSEE PREFERRED APPEAL BEFORE THE DRP AGAINST THE ORDER PASSED BY THE TPO U/S. 92CA OF THE ACT. THE REVISED MARGIN OF MEGASOFT IS AS PER DIRECTION OF THE DRP AT PAGE 23 OF ITS ORDER. IT(TP)A NO.1340/BANG/2010 PAGE 4 OF 25 7. CONSEQUENT TO THE DIRECTIONS OF THE DRP, THE AO PASSED THE ORDER REVISING THE ALP WORKED OUT EARLIER BY THE TPO AS F OLLOWS:- THE PRICE CHARGED BY THE TAX PAYER TO ITS ASSOCIAT ED ENTERPRISES IS COMPARED TO THE ARMS LENGTH PRICE AS UNDER: ARMS LENGTH PRICE @ 118.25% OF OPERATION COST RS.14,46,20,063 PRICE SHOWN IN THE INTERNATIONAL TRANSACTIONS RS.13 ,20,83,370 SHORTFALL BEING ADJUSTMENT U/S. 92CA RS. 1,25,36,6 93 THE SHORTFALL OF RS.1,25,36,693/- IS TREATED AS T RANSFER PRICING ADJUSTMENT U/S. 92CA. HENCE THE ORIGINAL AD JUSTMENT OF RS.1,26,10,074/- STANDS REVISED TO RS.1,25,36,693/- . 8. AGGRIEVED, THE ASSESSEE IS IN APPEAL BEFORE US. 9. GROUND NOS. 1 TO 8 ARE GENERAL IN NATURE. 10. GROUND NO.9 IS WITH RESPECT TO THE TP ANALYSIS OF THE TPO. THE LD. COUNSEL FOR THE ASSESSEE POINTED OUT THAT THE COMPA RABLES VIZ., AZTECH SOFTWARE LTD., GEOMETRIC SOFTWARE LTD. (SEG) AND ME GASOFT LTD. CHOSEN BY THE TPO AND SUBMITTED THAT UNDISPUTEDLY THE RELATED PARTY TRANSACTIONS OF THESE COMPARABLES WAS MORE THAN 15%. HE RELIED ON THE DECISION OF THIS TRIBUNAL IN THE CASE OF M/S. HUAWEI TECHNOLOGIES INDIA PVT. LTD. V. ITO IN IT(TP)A NO.1338/BANG/2010 DATED 30.4.2013 , WHEREIN IT WAS HELD AS UNDER:- 16. AS FAR AS MEGASOFT LTD., AZTEC SOFTWARE LTD., AND GEOMETRIC SOFTWARE LTD., CHOSEN BY THE TPO AS COMPA RABLES ARE CONCERNED, IT IS NOT IN DISPUTE THAT THE RELATED PA RTY TRANSACTIONS OF THESE COMPARABLE COMPANIES WAS MORE THAN 15%. T HIS TRIBUNAL IN THE CASE OF 24/7 CUSTOMER COM PVT. LTD. , ITA IT(TP)A NO.1340/BANG/2010 PAGE 5 OF 25 NO.227/BANG/2010 (SUPRA), HAD HELD THAT WHERE COMPA RABLES HAVE RELATED PARTY TRANSACTIONS WHICH ARE IN EXCESS OF 15% OF ITS TOTAL RECEIPTS, THEN SUCH COMPANIES CANNOT BE CHOSE N FOR THE PURPOSE OF COMPARISON. FOLLOWING ARE THE RELEVANT OBSERVATIONS OF THIS TRIBUNAL:- 13.0 RELATED PARTY TRANSACTIONS IN RESPECT OF THE GROUND RAISED AT S.NO.1 REGARDING ACCEPTANCE OF COMPARABLE COMPANIES HAVING RELATED P ARTY TRANSACTIONS AS PROPOSED BY THE TPO, THE LEARNED CO UNSEL FOR THE ASSESSEE ARGUED THAT THE TRANSFER PRICING REGULATIONS DO NOT STIPULATE ANY MINIMUM LIMIT OF R ELATED PARTY TRANSACTIONS WHICH FORM THE THRESHOLD FOR EXC LUSION AS A COMPARABLE. IN THIS REGARD, THE LEARNED COUNSE L FOR THE ASSESSEE OBJECTED TO THE TPOS SETTING A LIMIT OF 25% ON RELATED PARTY TRANSACTIONS. HE OBJECTED TO THE I NCLUSION OF COMPARABLES BEING RELATED PARTY TRANSACTIONS IN EXCESS OF 15% OF SALES / REVENUE. IN SUPPORT OF THIS PROPO SITION, THE LEARNED COUNSEL FOR THE ASSESSEE PLACED RELIANC E ON THE DECISION OF THE HON'BLE BENCH OF THE ITAT, DELHI IN THE CASE OF SONY INDIA (P) LTD. REPORTED IN 2008-TIOL-4 39- ITAT-DELHI DT.23.12.2008. THE LEARNED COUNSEL FOR T HE ASSESSEE DREW OUR ATTENTION TO PARA 115.3 OF THE OR DER WHEREIN THE TRIBUNAL HAS HELD THAT - ...........WE ARE FURTHER OF THE VIEW THAT AN ENT ITY CAN BE TAKEN AS UNCONTROLLED IF ITS RELATED PARTY TRANSACTIONS DO NOT EXCEED 10 TO 15% OF TOTAL REVENUE. WITHIN THE ABOVE LIMIT, TRANSACTIONS CANNO T BE HELD TO BE SIGNIFICANT TO INFLUENCE THE PROFITAB ILITY OF THE COMPARABLES. FOR THE PURPOSE OF COMPARISON WHAT IS TO BE JUDGED IS THE IMPACT OF THE RELATED PARTY TRANSACTIONS VIS--VIS SALES AND NOT PROFIT S INCE PROFIT OF AN ENTERPRISE IS INFLUENCED BY LARGE NUMB ER OF OTHER FACTORS .... RESPECTFULLY FOLLOWING THE DECISION OF THE TRIBUNAL IN THE CASE OF SONY INDIA (P) LTD (SUPRA), THE ASSESSING O FFICER / TPO ARE DIRECTED TO EXCLUDE AFTER DUE VERIFICATION THOSE COMPARABLES FROM THE LIST WITH RELATED PARTY TRANSA CTIONS OR CONTROLLED TRANSACTIONS IN EXCESS OF 15% OF TOTA L REVENUES FOR THE FINANCIAL YEAR 2003-04. IT(TP)A NO.1340/BANG/2010 PAGE 6 OF 25 17. IN VIEW OF THE ABOVE, THE AFORESAID COMPARABLE SHOULD ALSO BE EXCLUDED FOR THE PURPOSE OF COMPARISON WHILE DET ERMINING THE ALP OF THE INTERNATIONAL TRANSACTION IN QUESTION. 11. RESPECTFULLY FOLLOWING THE DECISION OF THE COOR DINATE BENCH OF THIS TRIBUNAL IN M/S. HUAWEI TECHNOLOGIES INDIA PVT. LTD. (SUPRA) , WE HOLD THAT THE COMPANIES VIZ., AZTECH SOFTWARE LTD., GEOMETRIC SOFTWARE LTD. (SEG) AND MEGASOFT LTD. ARE TO BE EXCLUDED FROM THE LIST OF COMPARABLES CHOSEN BY THE TPO. 12. WITH RESPECT TO IGATE GLOBAL SOLUTIONS LTD. (SE G); INFOSYS LTD.; MINDTREE CONSULTING LTD.; PERSISTENT SYSTEMS LTD.; SASKEN COMMUNICATION LTD. (SEG); AND FLEXTRONICS SOFTWARE SYSTEMS LTD., THE LD. COUNSEL FOR THE ASSESSEE SUBMITTED THAT THESE COMPARABLES SELECTED BY THE TPO SHOULD BE REJECTED ON THE GROUND THAT THE TURNOVER IS MORE THAN RS.200 CRORES. THE LD. COUNSEL FOR THE ASSESSEE RELIED UPON THE DE CISION OF M/S. HUAWEI TECHNOLOGIES INDIA PVT. LTD. (SUPRA) , WHEREIN THE RELEVANT OBSERVATIONS AT PARAS 10 & 11 OF THE ORDER ARE AS FOLLOWS:- 10. INSOFAR AS INFOSYS LTD., FLEXTRONICS SOFTWARE SYSTEMS LTD., IGATE GLOBAL SOLUTIONS LTD., MINDTREE CONSULTING LT D., PERSISTENT SYSTEMS LTD., AND SASKEN COMMUNICATION LTD. CHOSEN BY THE TPO AS COMPARABLES, IT IS NOT IN DISPUTE THAT THE TURNOVER OF THESE COMPANIES IS MORE THAN RS.200 CRORES. THE TURNOVER OF THE AS SESSEE IN THE PRESENT CASE IS RS.114.13 CRORES (APPROX.). IT HAS BEEN HELD BY THIS TRIBUNAL IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT. LTD. (SUPRA) THAT COMPANIES WITH A TURNOVER OF MORE THAN RS.200 CRORES CANNOT BE TAKEN AS COMPARABLES WHILE DETERMINING TH E ALP IN THE CASE OF COMPANIES HAVING TURNOVER OF LESS THAN RS.200 CR ORES. THE FOLLOWING ARE THE RELEVANT OBSERVATIONS OF THE TRIB UNAL IN THIS REGARD:- IT(TP)A NO.1340/BANG/2010 PAGE 7 OF 25 (1) TURNOVER FILTER 11. THE LD. COUNSEL FOR THE ASSESSEE SUBMITTED THA T 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 INCO ME-TAX RULES, IT WAS NECESSARY FOR COMPARING AN UNCONTROLLED TRAN SACTION WITH AN INTERNATIONAL TRANSACTION THAT THERE SHOULD NOT BE ANY DIFFERENCE BETWEEN THE TRANSACTIONS COMPARED OR THE ENTERPRISES ENTERING INTO SUCH TRANSACTION, WHICH ARE 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 DIFFE RENCES SHOULD BE CAPABLE OF REASONABLE ACCURATE ADJUSTMENT IN MON ETARY TERMS TO ELIMINATE THE EFFECT OF SUCH DIFFERENCES. IT WA S HIS SUBMISSION THAT SIZE WAS AN IMPORTANT FACET OF THE COMPARABILI TY EXERCISE. IT WAS SUBMITTED THAT SIGNIFICANT DIFFERENCES IN SIZE OF THE COMPANIES WOULD IMPACT COMPARABILITY. IN THIS REGA RD OUR ATTENTION WAS DRAWN TO THE DECISION OF THE 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 IS IMPROPER TO PROCEED ON THE BASIS OF LOWE R LIMIT OF 1 CRORE TURNOVER WITH NO HIGHER LIMIT ON TURNOVER, AS THE SAME WAS NOT REASONABLE CLASSIFICATION. SEVERAL OTHER DECIS IONS WERE REFERRED TO IN THIS REGARD LAYING DOWN IDENTICAL PR OPOSITION. WE ARE NOT REFERRING TO THOSE DECISIONS AS THE DECISIO N OF THE SPECIAL BENCH ON THIS ASPECT WOULD HOLD THE FIELD. REFEREN CE 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 ENT ERED INTO BY A RS. 10 CRORE COMPANY. THE TWO MOST OBVIOUS REASON S ARE THE SIZE OF THE TWO COMPANIES AND THE RELATIVE ECONOMIE S OF SCALE UNDER WHICH THEY OPERATE. THE FACT THAT THEY OPERA TE IN THE SAME IT(TP)A NO.1340/BANG/2010 PAGE 8 OF 25 MARKET MAY NOT MAKE THEM COMPARABLE ENTERPRISES. T HE RELEVANT EXTRACT IS AS FOLLOWS [ON RULE 10B(3)]: CLAUSE (I) LAYS DOWN THAT IF THE DIFFERENCES ARE NOT 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 LIKE INFOSYS WHICH IS 277 TIMES BIGGER THAN THE ASSESSEE (TURNOV ER OF RS. 13,149 CRORES AS COMPARED TO RS. 47.47 CRORES OF AS SESSEE). IT WAS SUBMITTED THAT AN APPROPRIATE TURNOVER RANGE S HOULD BE APPLIED IN SELECTING COMPARABLE UNCONTROLLED COMPAN IES. 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 TURNO VER OF RS. 1 CRORE TO RS. 200 CRORES WAS HELD TO BE PROPER. THE FOLLOWING RELEVANT OBSERVATIONS 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 HIMSELF 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 CONTENTION OF THE LEARNED COUNSEL FOR THE ASSESSEE THAT THE SIZE MATTERS IN BUSINESS. A BIG COMPANY WOULD BE IN A POSITION TO BARGAIN THE PRICE AND ALS O 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 IT(TP)A NO.1340/BANG/2010 PAGE 9 OF 25 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. IN 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 RANGE 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. IT(TP)A NO.1340/BANG/2010 PAGE 10 OF 25 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: IT(TP)A NO.1340/BANG/2010 PAGE 11 OF 25 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 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 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 TH E 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 DOCUMENT AVAILABLE WITH HIM: 18. 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 INTER NATIONAL IT(TP)A NO.1340/BANG/2010 PAGE 12 OF 25 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, NAMELY: IT(TP)A NO.1340/BANG/2010 PAGE 13 OF 25 ( 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 COMPARABLE 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 COMPARABIL ITY OF AN UNCONTROLLED TRANSACTION WITH AN INTERNATIONAL TRAN SACTION SHALL BE THE DATA RELATING TO THE FINANCIAL YEAR IN WHICH TH E INTERNATIONAL TRANSACTION HAS BEEN ENTERED INTO : IT(TP)A NO.1340/BANG/2010 PAGE 14 OF 25 PROVIDED THAT DATA RELATING TO A PERIOD NOT BEING MORE THAN TWO YEARS PRIOR TO SUCH FINANCIAL YEAR MAY ALS O BE CONSIDERED IF SUCH DATA REVEALS FACTS WHICH COULD H AVE AN INFLUENCE ON THE DETERMINATION OF TRANSFER PRICE S IN RELATION TO THE TRANSACTIONS BEING COMPARED. 19. A READING OF THE PROVISIONS OF RULE 10B(2) OF T HE 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. 11. RESPECTFULLY FOLLOWING THE DECISION OF THE TRI BUNAL REFERRED TO ABOVE, WE DIRECT THAT INFOSYS LTD., FLEXTRONICS SOFTWARE SYSTEMS LTD., IGATE GLOBAL SOLUTIONS LTD., MINDTREE CONSULT ING LTD., PERSISTENT IT(TP)A NO.1340/BANG/2010 PAGE 15 OF 25 SYSTEMS LTD., AND SASKEN COMMUNICATION LTD., ARE TO BE EXCLUDED AS COMPARABLES FOR THE PURPOSE OF DETERMINING THE ALP OF THE IMPUGNED TRANSACTION IN THIS APPEAL. 13. RESPECTFULLY FOLLOWING THE DECISION OF THE TRIB UNAL CITED SUPRA, THE COMPANIES VIZ., IGATE GLOBAL SOLUTIONS LTD. (SEG); INFOSYS LTD.; M INDTREE CONSULTING LTD.; PERSISTENT SYSTEMS LTD.; SASKEN CO MMUNICATION LTD. (SEG); AND FLEXTRONICS SOFTWARE SYSTEMS LTD. ARE DI RECTED TO BE EXCLUDED FROM THE LIST OF COMPARABLES CHOSEN BY THE TPO. 14. WITH RESPECT TO KALS INFORMATION SYSTEMS LTD., AND ACCEL TRANSMATICS LTD. (SEG), IT WAS CONTENDED THAT THEY HAVE TO BE REJECTED AS FUNCTIONALLY DIFFERENT, FOLLOWING THE DECISION OF I TAT BANGALORE BENCH IN THE CASE OF M/S. HUAWEI TECHNOLOGIES INDIA PVT. LTD. (SUPRA) WHERE IT WAS HELD AS FOLLOWS:- 12. IN SO FAR KALS INFO SYSTEMS LTD., AND ACCEL TR ANSMATICS LTD. CHOSEN BY THE TPO AS COMPARABLES, THIS TRIBUNA L IN THE CASE OF TRILOGY E-BUSINESS SOFTWARE INDIA PVT. LTD. (SUPRA) HAS TAKEN A VIEW THAT THESE COMPANIES ARE NOT COMPARABLE TO THE SOFT WARE SERVICE PROVIDER COMPANIES AS THEY ARE FUNCTIONALLY DIFFERE NT. THE FOLLOWING ARE THE RELEVANT OBSERVATIONS OF THE TRIBUNAL IN TH IS REGARD:- (D) KALS INFORMATION SYSTEMS LTD. 46. AS FAR AS THIS COMPANY IS CONCERNED, THE CONTEN TION 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 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 IT(TP)A NO.1340/BANG/2010 PAGE 16 OF 25 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 COMPARA BLES BY THE TPO IS REGARDING INCLUSION OF KALS INFORMATION SYSTEM LTD. THE ASSESSEE HAS OBJECTED TO ITS INCLUS ION ON THE BASIS THAT FUNCTIONALLY THE COMPANY IS NOT COMPARABLE. WITH REFERENCE TO PAGES 185-186 OF THE PAPER BOOK, IT IS EXPLAINED THAT THE SAID COMPANY I S ENGAGED IN DEVELOPMENT OF SOFTWARE PRODUCTS AND SERVICES AND IS NOT COMPARABLE TO SOFTWARE DEVELOPM ENT SERVICES PROVIDED BY THE ASSESSEE. THE APPELLANT HA S SUBMITTED AN EXTRACT ON PAGES 185-186 OF THE PAPER BOOK FROM THE WEBSITE OF THE COMPANY TO ESTABLISH T HAT 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 FACT UALLY REBUTTED AND, IN OUR VIEW, THE SAID CONCERN IS LIAB LE 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 SU BMISSION 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 TH E TPO. WE ALSO FIND THAT IN THE DECISION REFERRED TO BY THE LEARNE D COUNSEL FOR THE ASSESSEE, THE MUMBAI BENCH OF ITAT HAS HELD THAT TH IS COMPANY WAS DEVELOPING SOFTWARE PRODUCTS AND NOT PURELY OR MAINLY SOFTWARE DEVELOPMENT SERVICE PROVIDER. WE 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 THE ASSESSEE IS THAT THIS COMPANY IS NOT A PURE SOFTWARE DEVELOP MENT SERVICE IT(TP)A NO.1340/BANG/2010 PAGE 17 OF 25 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 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 T HE PERMITTED LEVEL AND THEREFORE SHOULD NOT BE TAKEN FOR COMPARA BILITY PURPOSES. THE SUBMISSION OF THE LD. COUNSEL FOR TH E ASSESSEE WAS THAT IF THE ABOVE COMPANY SHOULD NOT BE CONSIDERED AS IT(TP)A NO.1340/BANG/2010 PAGE 18 OF 25 COMPARABLE. THE LD. DR, ON THE OTHER HAND, RELIED ON THE ORDER OF THE TPO. 50. WE HAVE CONSIDERED THE SUBMISSIONS AND ARE OF THE VIEW THAT THE PLEA OF THE ASSESSEE THAT THE AFORESAID CO MPANY SHOULD NOT BE TREATED AS COMPARABLES WAS CONSIDERED BY THE TRIBUNAL 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. 13. IN VIEW OF THE AFORESAID DECISION OF THE TRIBU NAL, KALS INFO SYSTEMS LTD., AND ACCEL TRANSMATICS LTD. ARE TO BE EXCLUDED FOR THE PURPOSE OF COMPARISON WHILE DETERMINING THE ALP OF THE IMPUGNED TRANSACTION IN THIS REGARD. IT IS ORDERED ACCORDIN GLY. 15. RESPECTFULLY FOLLOWING THE DECISION OF THE COOR DINATE BENCH OF THIS TRIBUNAL IN THE CASE OF M/S. HUAWEI TECHNOLOGIES INDIA PVT. LTD. (SUPRA), WE DIRECT THAT KALS INFORMATION SYSTEMS LTD., AND A CCEL TRANSMATICS LTD. (SEG) BE EXCLUDED FROM THE LIST OF COMPARABLES. 16. WITH RESPECT TO TATA ELXSI LTD. (SEG) AND LUCID SOFTWARE LTD., THE LD. COUNSEL FOR THE ASSESSEE PLEADED THAT THE SAME ARE TO BE REJECTED AS FUNCTIONALLY DIFFERENT IN VIEW OF THE DECISION OF T HE COORDINATE BENCH OF THIS TRIBUNAL IN THE CASE OF M/S. HUAWEI TECHNOLOGIES INDIA PVT. LTD. (SUPRA) WHEREIN IT WAS HELD AS FOLLOWS:- 14. AS FAR AS LUCID SOFTWARE LTD. AND TATA ELXSI L TD. CHOSEN BY THE TPO AS COMPARABLES, WE FIND THAT THE MUMBAI BEN CH OF THE IT(TP)A NO.1340/BANG/2010 PAGE 19 OF 25 TRIBUNAL IN THE CASE OF TELCORDIA TECHNOLOGIES INDI A PVT. LTD. (SUPRA) WHILE DEALING WITH THE CASE OF SOFTWARE SERVICES PR OVIDER LIKE THE ASSESSEE, CONSIDERED THE COMPARABILITY OF LUCID SOF TWARE LTD. WITH SIMILAR SOFTWARE SERVICE PROVIDER AND THE TRIBUNAL HELD AS FOLLOWS:- 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 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. 15. IN VIEW OF THE AFORESAID DECISION OF THE MUM BAI BENCH OF THE TRIBUNAL, WHICH IS IN RELATION TO A.Y. 2006-07, WE ARE OF THE VIEW THAT IT(TP)A NO.1340/BANG/2010 PAGE 20 OF 25 LUCID SOFTWARE LTD. AND TATA ELXSI LTD. ARE ALSO TO BE EXCLUDED AS COMPARABLES WHILE DETERMINING THE ALP OF THE INTERN ATIONAL TRANSACTION IMPUGNED IN THIS APPEAL. 17. RESPECTFULLY FOLLOWING THE DECISION OF THE COOR DINATE BENCH OF THIS TRIBUNAL IN THE CASE OF M/S. HUAWEI TECHNOLOGIES INDIA PVT. LTD. (SUPRA) , WE ARE OF THE VIEW THAT TATA ELXSI LTD. (SEG) AND L UCID SOFTWARE LTD. ARE TO BE EXCLUDED FROM THE LIST OF COMPARABLES. 18. THE LD. COUNSEL FOR THE ASSESSEE POINTED OUT TH AT BODHTREE CONSULTING LTD. WAS FUNCTIONALLY DIFFERENT TO BE SE LECTED AS COMPARABLE BY THE TPO. HE REFERRED TO THE DECISION OF ITAT BANG ALORE BENCH IN THE CASE OF MINDTECK (INDIA) LTD. IN IT(TP)A 70/BANG/2014, W HEREIN IT HAS BEEN HELD AS FOLLOWS:- 1. BODHTREE CONSULTING LTD : AS FAR AS THIS COMPANY IS CONCERNED, THE SUBMISSION OF THE LEARNED COUNSEL FOR THE ASSESSEE WAS THAT THIS COMP ANY MADE EXTRA ORDINARY PROFITS DURING THE PREVIOUS YEAR. O UR ATTENTION WAS DRAWN TO THE FACT THAT THE OPERATING PROFIT / OPERA TING COST OF THIS COMPANY JUMPED FROM 17% FOR F Y 2007-08 TO 56% IN F Y 2008- 09. IT DIPPED IN FY 2009-10 TO 40% AND IN FY 2010- 11 IT BECAME (-) 2% AND 5% IN FY 2011-12 AND FINALLY TOUC HED (-) 9% IN FY 2012-13. OUR ATTENTION WAS DRAWN TO THE FACT THAT THE SPECIAL BENCH OF THE TRIBUNAL, MUMBAI, IN THE CASE OF MAERSK GLOBAL CENTRES (INDIA) P. LTD., IN ITA.7466/MUM/201 2, DT 07.03.2014 FOR AY 2008-09 HAD AN OCCASION TO CONSID ER THE QUESTION AS TO WHETHER COMPANIES HAVING ABNORMAL PR OFITS SHOULD BE EXCLUDED AS A COMPARABLE. THE SPECIAL BENCH TOO K THE VIEW THAT IT HAS TO BE SHOWN THAT THE HIGH PROFIT MARGIN DOES NOT REFLECT THE NORMAL BUSINESS CONDITIONS AND ONLY IN SUCH CIR CUMSTANCES, HIGH PROFIT MARGIN COMPANIES CAN BE EXCLUDED. OUR ATTENTION WAS IT(TP)A NO.1340/BANG/2010 PAGE 21 OF 25 DRAWN TO THE DRP'S OBSERVATION IN ITS ORDER ON THE ISSUE WHICH IS AS FOLLOWS : 'BODHTREE : THE ASSESSEE HAS OBJECTED TO SELECTION OF THIS ENTI TY ON THE BASIS OF FOLLOWING OBJECTIONS: THE ENTITY HAS FLUCTUATING MARGINS THE COMPANY IS MORE OF A PRODUCT COMPANY RATHER THAN SOFTWARE SERVICE COMPANY. THE PANEL HAS CONSIDERED THE OBJECTIONS OF THE ASSE SSEE. INSOFAR AS THE CONTENTION REGARDING THE REJECTION O F THIS ENTITY ON THE BASIS OF FLUCTUATING MARGIN IS CONCER NED, IN ORDER TO APPRECIATE THE COMPATIBILITY OR OTHERWISE OF THIS ENTITY, IT IS IMPORTANT TO FIRST NOTE THAT THE INDI AN SOFTWARE INDUSTRY USES TWO DIFFERENT MODELS FOR REV ENUE RECOGNITION. THE FIRST IS THE TIME AND MATERIAL (T& M) CONTRACTS MODEL IN WHICH CUSTOMER ARE BILLED ON THE BASIS OF HOURS WORKED BY THE EMPLOYEES OF SUPPLIER SOFTWARE COMPANIES. HOURLY RATES ARE AGREED ON BY B OTH PARTIES AND ARE APPLIED TO THE TOTAL HOURS WORKED T O ARRIVE AT THE REVENUE THAT IS TO BE RECOGNIZED. THE SECOND IS THE FIXED PRICE PROJECT MODEL (FPP). UNDE R THE FIXED PRICE PROJECT MODEL, THE TOTAL CONTRACT P RICE IS AGREED UPON BETWEEN THE PARTIES. BILLING MAY BE DON E EITHER AT THE END OF THE CONTRACT OR OVER THE PERIO D OF THE CONTRACT ON THE BASIS OF THE AGREED MILESTONE FOR B ILLING. IN THIS RESPECT, THE BASIS OF REVENUE RECOGNITION B Y THIS ENTITY CAN BE SEEN FROM THE ANNUAL REPORT AS BELOW: 3. REVENUE RECOGNITION : REVENUE FROM SOFTWARE DEVELOPMENT IS RECOGNISED BAS ED ON SOFTWARE DEVELOPED AND BILLED TO CLIENTS. FROM PERUSAL OF THE ABOVE, IT IS SEEN THAT THIS ENT ITY IS ENGAGED IN BUILDING REVENUES THROUGH FIXED PRICE PROJECT MODEL. AS IS A NATURAL COROLLARY IN SUCH TY PE OF REVENUE RECOGNITION, SOME PART OF THE EXPENDITURE M AY BE BOOKED IN ONE YEAR, FOR WHICH THE REVENUE MAY HA VE IT(TP)A NO.1340/BANG/2010 PAGE 22 OF 25 BEEN RECOGNISED IN THE EARLIER OR SUBSEQUENT YEAR. THEREFORE, IT IS BUT NATURAL THAT THERE IS SOME FLU CTUATION IN THE PROFITABILITY MARGIN OF SUCH ENTITY. MERELY BECAUSE OF SUCH FLUCTUATIONS, AN ENTITY ENGAGED IN THE DEVELOPMENT OF SOFTWARE, BEING FUNCTIONALLY COMPARA BLE TO THE ASSESSEE, CANNOT BE REJECTED ONLY ON THIS GR OUND.' 14. THE LEARNED COUNSEL FOR THE ASSESSEE DREW OUR A TTENTION TO THE FACT THAT BODHTREE CONSULTING ADMITTEDLY FOLLOW S A FIXED PRICE PROJECT MODEL WHEREBY REVENUES FROM SOFTWARE DEVELO PMENT IS RECOGNIZED BASED ON SOFTWARE AND BILLED TO CLIENTS. IN SUCH BUSINESS MODEL EXPENDITURE FOR DEVELOPING SOFTWARE WOULD BE BILLED IN AN EARLIER YEAR BUT THE REVENUE WOULD BE RECOGNIZED IN A SUBSEQUENT YEAR. IT WAS HIS SUBMISSION THAT THIS F ACT IS RECOGNIZED BY THE DRP IN ITS ORDER. ACCORDING TO H IM THIS CIRCUMSTANCE WOULD BE SUFFICIENT TO SHOW THAT THE M ARGIN REFLECTED OF THIS COMPANY DOES NOT REFLECT THE NORM AL BUSINESS CONDITION. 15. THE LEARNED DR PLACED RELIANCE ON THE REASON GI VEN BY THE DRP IN ITS ORDER. 16. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS. THE SPECIAL BENCH OF THE ITAT IN THE CASE OF MAERSK GLOBAL CENT RES (SUPRA) HAD AN OCCASION TO DEAL WITH THE QUESTION AS TO WHE THER HIGH PROFIT MARGIN MAKING COMPANIES SHOULD BE EXCLUDED A S A COMPARABLE. THE SPECIAL BENCH AFTER CONSIDERING SE VERAL ASPECTS HELD IN PARA 88 OF ITS ORDER THAT THE POTENTIAL COM PARABLE COMPANIES CANNOT BE EXCLUDED MERELY ON THE GROUND T HAT THEIR PROFIT IS ABNORMALLY HIGH. THE SPECIAL BENCH HELD THAT IN SUCH CASES IT WOULD REQUIRE FURTHER INVESTIGATION TO ASC ERTAIN THE REASONS FOR UNUSUALLY HIGH PROFIT AND IN ORDER TO E STABLISH WHETHER THE ENTITIES WITH SUCH HIGH PROFITS CAN BE TAKEN AS COMPARABLE OR NOT. IN THE LIGHT OF THE AFORESAID DECISION OF THE SPECIAL BENCH AND IN VIEW OF THE ADMITTED POSITION THAT THE ASSES SEE FOLLOWS FIXED PRICE PROJECT MODEL WHERE REVENUES FROM SOFTW ARE DEVELOPMENT IS RECOGNIZED BASED ON SOFTWARE DEVELOP ED AND BILLED TO CLIENTS, THERE IS A POSSIBILITY OF THE EX PENDITURE IN RELATION TO THE REVENUE BEING BOOKED IN THE EARLIER YEAR. THE RESULTS OF BODHTREE FROM FY 2003 TO 2008 EXCLUDING FY 2007 AS GIVEN BY THE LEARNED COUNSEL FOR THE ASSESSEE WERE ALSO PERUSED. PERUSAL OF THE SAME SHOWS, THAT THERE HAS BEEN A CO NSISTENT IT(TP)A NO.1340/BANG/2010 PAGE 23 OF 25 CHANGE IN THE OPERATING MARGINS. THE CHART FILED B Y THE ASSESSEE IN THIS REGARD IS GIVEN AS AN ANNEXURE TO THIS ORDE R. IT APPEARS TO US THAT THE REVENUE RECOGNITION METHOD FOLLOWED BY THE ASSESSEE IS THE REASON FOR THE DRASTIC VARIATION IN THE PROF IT MARGINS OF THIS COMPANY. IN THE GIVEN CIRCUMSTANCES, WE ARE OF THE VIEW THAT IT WOULD BE SAFE TO EXCLUDE BODHTREE CONSULTING FROM T HE FINAL LIST OF COMPARABLES CHOSEN BY THE ASSESSEE. WE HOLD AND DIRECT ACCORDINGLY. 19. FOLLOWING THE AFORESAID DECISION OF THE COORDIN ATE BENCH OF THIS TRIBUNAL, WE THEREFORE HOLD THAT BODHTREE CONSULTIN G LTD. IS TO BE EXCLUDED FROM THE LIST OF COMPARABLES CHOSEN BY THE TPO. 20. THE ADDITIONAL GROUND RAISED BY THE ASSESSEE RE GARDING EXCLUSION OF HELIOS & MATHESON INFORMATION TECHNOLOGY LTD. AS A COMPARABLE WAS NOT PRESSED. 21. THUS, THE MARGINS OF THE FINAL COMPARABLES ARE AS FOLLOWS:- SL. NO. NAME OF THE COMPANY OPERATING MARGIN ON COST WORKING CAPITAL ADJUSTED MARGIN 1 R SYSTEMS INTERNATIONAL LTD. (SEG.) 22.20% 19.38% 2 MEDIA SOFT SOLUTIONS PVT. LTD. 6.29% 3.30% 3 R S SOFTWARE (INDIA) LTD. 15.69% 14.34% 4 SIP TECHNOLOGIES & EXPORTS LTD. 3.06% 0.20% 5 SYNFOSYS BUSINESS SOLUTIONS LTD. 10.61% 6.47% 6 LANCO GLOBAL SOLUTIONS LTD. 5.27% 3.97% ARITHMETIC MEAN 10.52% 7.94% COMPUTATION OF ALP SOFTWARE DEVELOPMENT SERVICES AVG. MARGIN OF FINAL COMPARABLES AFTER WORKING CAPITAL ADJUSTMENT 7.94% IT(TP)A NO.1340/BANG/2010 PAGE 24 OF 25 COMPUTATION OF OPERATING MARGIN OF THE ASSESSEE PARTICULARS AMOUNT IN INR (AS PER TPO) OPERATING INCOME 13,20,83,370 TOTAL OPERATING COST 12,23,00,265 OPERATING PROFIT 97,83,105 OPERATING PROFIT MARGIN 8.00% 22. SINCE THE ASSESSEES MARGIN OF 8.00% IS HIGHER THAN THE AVERAGE MEAN OF THE COMPARABLES, THE INTERNATIONAL TRANSACT ION RELATING TO SOFTWARE DEVELOPMENT SERVICES CAN BE CONCLUDED TO BE AT ARM S LENGTH PRICE. 23. IN VIEW OF THE ABOVE, GROUNDS NO.10, 11 AND 12 DO NOT SURVIVE FOR ADJUDICATION. 24. GROUND NO.13 IS ACADEMIC IN NATURE AND HENCE NO T ADJUDICATED. 25. GROUND NO.14 RELATING TO COMPUTATION OF DEDUCTI ON U/S. 10A READS AS FOLLOWS:- 14, THE LOWER AUTHORITIES HAVE ERRED IN NOT: A. EXCLUDING TELECOMMUNICATION CHARGES AND FOREIGN EXCHANGE LOSS FROM THE TOTAL TURNOVER IN THE PROC ESS OF COMPUTATION OF DEDUCTION U/S. 10A; B. APPRECIATING THAT, UNDER SIMILAR FACTS AND CIRCUMSTANCES OF THE CASE, THE BANGALORE BENCH OF THE ITAT AS WELL AS OTHER TRIBUNALS HAVE HELD THAT IF SOME EXPENSES, FOR ANY REASON, ARE EXCLUDED IN ARRIVING AT THE EXPORT TURNOVER, THE SAME SHOULD ALSO BE REDUCED FROM TOTAL TURNOVER. IT(TP)A NO.1340/BANG/2010 PAGE 25 OF 25 26. THE HONBLE HIGH COURT IN THE CASE OF TATA ELXSI LTD., 349 ITR 98 (KARN) , HAS HELD THAT WHATEVER IS EXCLUDED FROM THE EXPO RT TURNOVER, HAS ALSO TO BE EXCLUDED FROM THE TOTAL TURNOVER. RESPE CTFULLY FOLLOWING THIS DECISION, WE HOLD THAT THE EXPENDITURE OF TELECOMMU NICATION CHARGES AND FOREIGN EXCHANGE LOSS BE EXCLUDED FROM THE TOTAL TU RNOVER ALSO IN THE PROCESS OF COMPUTATION OF DEDUCTION U/S. 10A. 27. GROUND NO.15 WITH RESPECT TO LEVY OF INTEREST O F A SUM OF RS.23,41,075 U/S. 234B IS CONSEQUENTIAL. 28. IN THE RESULT, THE APPEAL FILED BY THE ASSESSEE IS PARTLY ALLOWED. PRONOUNCED IN THE OPEN COURT ON THIS 4 TH DAY OF NOVEMBER, 2015. SD/- SD/- ( JASON P. BOAZ ) (ASHA VIJAYARAGHAVAN ) ACCOUNTANT MEMBER JUDICIAL M EMBER BANGALORE, DATED, THE 4 TH NOVEMBER, 2015. /D S/ COPY TO: 1. APPELLANT 2. RESP ONDENT 3. CIT 4. CIT(A) 5. DR, ITAT, BANGALORE. 6. GUARD FILE BY ORDER ASSISTANT REGISTRAR, ITAT, BANGALORE.