Witness Systems Software India Private Limited, Bangalore V. DCIT, Bangalore

ITA 1366/BANG/2011

• Counselvise Citation: [2013] 120 COUNSELVISE.COM (IT) 0652 (ITAT-BANGALORE)
• Duration Of Justice: 1 year(s) 1 month(s) 23 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 22-02-2013
• Appeal Filed By: Assessee
• Bench Allotted: B
• Assessment Year: 2007-2008
• Appeal Filed On: 29-12-2011
• Court: TRIBUNAL
• Assessee Lawyers: T SURYANARAYANA
• Keywords: Related party transaction; Transfer pricing; International transaction; Revenue expenditure
• Section: 143(3); 92D; 92A; 80HHC; 10B

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL B BENCH : BANGALORE BEFORE SHRI N. BARATHVAJA SANKAR, VICE PRESIDENT AND SHRI N.V. VASUDEVAN, JUDICIAL MEMBER IT(TP)A NO.1366/BANG/2011 ASSESSMENT YEAR : 2007-08 WITNESS SYSTEMS SOFTWARE INDIA PRIVATE LTD., 58, 6 TH FLOOR, BRIGADE ROAD, BANGALORE 560 001. PAN : AAACW 5507F VS. THE DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE 11(1), BANGALORE. APPELLANT RESPONDENT APPELLANT BY : SHRI T. SURYANARAYANA, ADVOCATE RESPONDENT BY : SHRI FARAHAT HUSSAIN QURESHI, CIT-II(DR) DATE OF HEARING : 31.01.2013 DATE OF PRONOUNCEMENT : 22.02.2013 O R D E R PER N.V. VASUDEVAN, JUDICIAL MEMBER THIS APPEAL BY THE ASSESSEE IS AGAINST THE ORDER D ATED 11.10.2011 PASSED U/S. 143(3) R.W.S. 144C OF THE INCOME-TAX AC T, 1961 [HEREINAFTER REFERRED TO AS THE ACT IN SHORT]. 2. GROUNDS 1 TO 6 RAISED BY THE ASSESSEE IN ITS GRO UNDS OF APPEAL ARE WITH REGARD TO THE ADDITION MADE BY THE AO BY WAY O F ADJUSTMENT TO ARMS LENGTH PRICE (ALP) IN RESPECT OF AN INTERNATIONAL T RANSACTION CARRIED OUT BY IT(TP)A NO.1366/BANG/2011 PAGE 2 OF 30 THE ASSESSEE WITH ITS ASSOCIATED ENTERPRISE (AE) IN TERMS OF SECTION 92A OF THE ACT. 3. THE FACTS WITH REGARD TO THE AFORESAID ADDITION ARE AS FOLLOWS. THE ASSESSEE IS A COMPANY. IT IS A WHOLLY OWNED SUBSID IARY OF WITNESS SYSTEMS INC. OF AMERICA. THE ASSESSEE IS A CAPTI VE SERVICE PROVIDER TO ITS HOLDING COMPANY, WITNESS SYSTEMS INC. [WSI]. THE ASSESSEE CARRIED OUT SOFTWARE DESIGNING RESEARCH AND DEVELOPMENT ACTIVIT IES FOR DEVELOPMENT OF SOFTWARE, SOFTWARE QUALITY ASSISTANCE, TESTING, SOF TWARE MAINTENANCE AND SUPPORT FUNCTION (WHICH INCLUDES TECHNICAL SUPPORT, DOCUMENTATION, IT INTEGRATION, CONFIGURATION MANAGEMENT) FOR WSI. D URING THE PREVIOUS YEAR, THE ASSESSEE RECEIVED THE FOLLOWING AMOUNTS FROM IT S AE FOR THE VARIOUS SERVICES THAT IT PROVIDED TO THE AE. 4. IN THIS APPEAL, WE ARE CONCERNED ONLY WITH TRANS FER PRICING ADJUSTMENT MADE BY THE TPO IN RESPECT OF THE RECEIP TS BY THE ASSESSEE FOR PROVIDING SOFTWARE DESIGNING AND DEVELOPMENT SERVIC ES. THE ASSESSEE FILED TRANSFER PRICING ANALYSIS JUSTIFYING THE PAYM ENT THAT IT HAD RECEIVED FROM ITS AE AS AT ARMS LENGTH. IT IS NOT IN DISPU TE THAT THE MOST APPROPRIATE METHOD FOR COMPUTATION OF ALP IS THE TRANSACTIONAL NET MARGIN METHOD (TNMM). THE NET MARGIN TO COST WAS CHOSEN AS THE P ROFIT LEVEL INDICATOR IT(TP)A NO.1366/BANG/2011 PAGE 3 OF 30 (PLI) FOR THE PURPOSE OF COMPARISON. THE ASSESSEE S PLI WAS COMPUTED AS FOLLOWS:- 5. THE ASSESSEE CHOSE 11 COMPARABLE COMPANIES AND T HE ARITHMETIC MEAN OF THOSE COMPARABLES WAS AS FOLLOWS:- 6. THE ASSESSEE ADOPTED THE FOLLOWING FILTERS WHILE CONDUCTING ITS TP STUDY:- IT(TP)A NO.1366/BANG/2011 PAGE 4 OF 30 7. THE TPO TO WHOM THE COMPUTATION OF ALP WAS REFER RED TO BY THE AO U/S. 92CA OF THE ACT, REJECTED 4 COMPARABLES ON THE GROUND THAT THE RELATED PARTY TRANSACTIONS IN THOSE COMPARABLES WER E MORE THAN 25%. ONE COMPARABLE WAS REJECTED ON THE GROUND THAT IT HAD D IMINISHING REVENUES AND PREDOMINANTLY ON-SITE ACTIVITIES GENERATED 85% OF ITS REVENUE. ONE MORE COMPANY WAS REJECTED FOR THE REASON THAT IT WA S FUNCTIONALLY NOT COMPARABLE. THUS, OUT OF 11 COMPARABLES CHOSEN BY THE ASSESSEE, ONLY TWO COMPARABLES WERE ACCEPTED BY THE TPO AS COMPARA BLE WITH THAT OF THE ASSESSEE VIZ., M/S. QUINTEGRA SOLUTIONS LTD. AND S I P TECHNOLOGIES & EXPORTS LTD. THE TPO ADOPTED HIS OWN FILTERS AND W HILE DOING SO, ARRIVED AT 26 COMPARABLES INCLUDING THE TWO COMPARABLES CHO SEN BY THE ASSESSEE. THE 26 COMPARABLES CHOSEN BY THE TPO WERE AS FOLLOW S:- IT(TP)A NO.1366/BANG/2011 PAGE 5 OF 30 8. AFTER REJECTING THE VARIOUS OBJECTIONS RAISED BY THE ASSESSEE, THE TPO COMPUTED THE ALP AND SUGGESTED AN ADDITION OF R S.2,05,82,039 AS FOLLOWS:- IT(TP)A NO.1366/BANG/2011 PAGE 6 OF 30 9. ON APPEAL BY THE ASSESSEE, THE DRP CONFIRMED THE ORDER OF THE TPO GIVING RISE TO THE PRESENT APPEAL BY THE ASSESS EE BEFORE THE TRIBUNAL. 10. AT THE OUTSET, IT WAS SUBMITTED BY THE PARTIES BEFORE US THAT THE VERY SAME 26 COMPARABLES HAD BEEN CHOSEN BY THE TPO FOR DETERMINING THE ALP IN THE CASE OF SOFTWARE SERVICES PROVIDING COMP ANY VIZ., TRILOGY E- BUSINESS SOFTWARE INDIA PVT. LTD. IT WAS ALSO ACCEPTED BY THE PARTIES THAT THAT IN THE CASE OF THAT COMPANY, THIS TRIBUNA L IN ITA NO.1054/BANG/2011 BY ITS ORDER DATED 23.11.2012 CONSIDERED THE COMPARABILITY OF THE COMPARABLES CHOSEN BY THE TPO. IT WAS AGREED BY THE PARTIES THAT THE AFORESAID DECISION, WHICH INCIDENT ALLY IS ALSO FOR THE A.Y. 2007-08, WILL APPLY TO THE CASE OF THE ASSESSEE IN THIS APPEAL ALSO. IT WAS ALSO ACCEPTED BY THE PARTIES THAT SOME OF THE COMPA RABLES CHOSEN BY THE TPO HAVE ALSO BEEN CONSIDERED BY THE MUMBAI BENCH O F THE TRIBUNAL IN THE CASE OF TELCORDIA TECHNOLOGIES INDIA PVT. LTD., ITA NO.7821/MUM/2011 ; AND BY THE BANGALORE BENCH OF THE TRIBUNAL IN THE CASE OF 24/7 CUSTOMER COM PVT. LTD., ITA NO.227/BANG/2010 . IN THIS BACKGROUND, WE SHALL NOW EXAMINE THE 26 COMPAR ABLES CHOSEN BY THE IT(TP)A NO.1366/BANG/2011 PAGE 7 OF 30 TPO AND ALSO CONSIDER AS TO WHAT WILL BE THE COMPAR ABLES THAT CAN BE CONSIDERED FOR THE PURPOSE OF DETERMINING THE ALP. 11. AS FAR AS THE COMPARABLES CHOSEN BY THE TPO AT SL.NOS. 6,9,10,17,18, 22, 24 & 26 ARE CONCERNED, IT IS NOT IN DISPUTE THAT THE TURNOVER OF THESE COMPANIES ARE MORE THAN RS.200 CR ORES. THE TURNOVER OF THE ASSESSEE IN THE PRESENT CASE IS RS.22.08 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 DETERMI NING THE ALP IN THE CASE OF COMPANIES HAVING TURNOVER OF LESS THAN RS.2 00 CRORES. THE FOLLOWING ARE THE RELEVANT OBSERVATIONS OF THE TRIB UNAL IN THIS REGARD:- (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 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 IT(TP)A NO.1366/BANG/2011 PAGE 8 OF 30 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 PARTIES M IGHT 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 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 N OT MATERIAL, THE TRANSACTIONS WOULD BE COMPARABLE. THE SE DIFFERENCES COULD EITHER BE WITH REFERENCE TO THE TRANSACTION OR WITH REFERENCE TO THE ENTERPRISE. FO R 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 A ND 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:- IT(TP)A NO.1366/BANG/2011 PAGE 9 OF 30 9. HAVING HEARD BOTH THE PARTIES AND HAVING CONSI DERED THE RIVAL CONTENTIONS AND ALSO THE JUDICIAL PRECEDE NTS ON THE ISSUE, WE FIND THAT THE TPO HIMSELF HAS REJECTE D THE COMPANIES WHICH .IRE (SIC) MAKING LOSSES AS COMPARABLES. THIS SHOWS THAT THERE IS A LIMIT FOR T HE LOWER END FOR IDENTIFYING THE COMPARABLES. IN SUCH A SITU ATION, 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 B E IN A POSITION TO BARGAIN THE PRICE AND ALSO ATTRACT MO RE 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 MARGI N. THUS, AS HELD BY THE VARIOUS BENCHES OF THE TRIBUNA L, 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 SAL ES OR TURNOVER, WE FIND THAT A REASONABLE CLASSIFICATION HAS TO BE MADE. DUN & BRADSTREET & BRADSTREET AND NASSCOM HAVE GIVEN DIFFERENT RANGES. TAKING THE INDIAN SCEN ARIO 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 PR OPOSITION 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(TP)A NO.1366/BANG/2011 PAGE 10 OF 30 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; IT(TP)A NO.1366/BANG/2011 PAGE 11 OF 30 ( 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 ARMS LENGTH PR ICE 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.1366/BANG/2011 PAGE 12 OF 30 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 TRANSACTION SHALL BE JUDGED WITH REFERENCE TO THE FOLLOWING, NAMELY: ( 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; IT(TP)A NO.1366/BANG/2011 PAGE 13 OF 30 ( 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 COMPARABL E 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 CHARG ED 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 TRANSACTION SHALL BE THE DATA RELATING TO THE FINAN CIAL YEAR IN WHICH THE INTERNATIONAL TRANSACTION HAS BEEN ENT ERED INTO : 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 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. IT(TP)A NO.1366/BANG/2011 PAGE 14 OF 30 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 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. 12. RESPECTFULLY FOLLOWING THE DECISION OF THE TRIB UNAL REFERRED TO ABOVE, WE HOLD THAT THE COMPARABLES CHOSEN BY THE TPO AT S L.NOS. 6,9,10,17,18, 22, 24 & 26 HAVE TO BE EXCLUDED AS COMPARABLES FOR THE PURPOSE OF DETERMINING THE ALP OF THE IMPUGNED TRANSACTION IN THIS APPEAL. 13. AS FAR AS COMPARABLES AT SL.NOS.1, 2 & 3 OF THE LIST OF COMPARABLES CHOSEN BY THE TPO ARE CONCERNED, THIS TRIBUNAL IN T HE CASE OF TRILOGY E- BUSINESS SOFTWARE INDIA PVT. LTD. ( SUPRA) HAS TAKEN A VIEW THAT THESE COMPANIES ARE NOT COMPARABLE TO THE SOFTWARE SERVIC E PROVIDER COMPANIES. THE FOLLOWING ARE THE RELEVANT OBSERVATIONS OF THE TRIBUNAL IN THIS REGARD:- IT(TP)A NO.1366/BANG/2011 PAGE 15 OF 30 (B) AVANI CIMCON TECHNOLOGIES LTD. AS FAR AS THIS COMPANY IS CONCERNED, THE PLEA OF T HE ASSESSEE HAS BEEN THAT THIS COMPANY IS FUNCTIONALLY DIFFERENT FR OM THE ASSESSEE. BASED ON THE INFORMATION AVAILABLE IN TH E COMPANYS WEBSITE, WHICH REVEALS THAT THIS COMPANY HAS DEVELO PED A SOFTWARE PRODUCT BY NAME DXCHANGE, IT WAS SUBMITT ED THAT THIS COMPANY WOULD HAVE REVENUE FROM SOFTWARE PRODUCT SA LES APART FROM RENDERING OF SOFTWARE SERVICES AND THEREFORE I S FUNCTIONALLY DIFFERENT FROM THE ASSESSEE. IT WAS FURTHER SUBMIT TED THAT THE MUMBAI BENCH OF THE TRIBUNAL TO THE DECISION IN THE CASE OF TELCORDIA TECHNOLOGIES PVT. LTD. V. ACIT ITA NO.7821/MUM/2011 WHEREIN THE TRIBUNAL ACCEPTED THE 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 SER VICES 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% IT(TP)A NO.1366/BANG/2011 PAGE 16 OF 30 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 SUBMISSIONS 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 ARE FOUND TO B E ACCEPTABLE. THE DECISION OF ITAT (MUMBAI) IN THE C ASE 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 . (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:- 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. AS PER THE NOTES TO ACCOUNTS - SCHEDULE 15, UNDER DEFERRED REVENUE EXPENDITURE (PAGE 31 OF PB-II), IT IS MENTIONED THAT, EXPENDITURE INCURRED ON RESEARC H AND DEVELOPMENT OF NEW PRODUCTS HAS BEEN TREATED AS DEFERRED REVENUE EXPENDITURE AND THE SAME HAS BEEN WRITTEN OFF IN 10 YEARS EQUALLY YEARLY INSTALL MENTS FROM THE YEAR IN WHICH IT IS INCURRED. AN AMOUNT OF RS. 11,692,020/- HAS BEEN DEBITED TO THE PROFIT AND LOSS ACCOUNT AS DEFERRED REVENUE EXPENDITURE (PAGE 30 OF PB-II). THIS AMOUNTS TO NEARLY 8.28 PERCENT OF THE SALES OF THIS COMPANY. IT WAS THEREFORE SUBMITTED THAT THE ACCEPTANCE OF T HIS COMPANY AS A COMPARABLE FOR THE REASON THAT IT IS INTO PURE SO FTWARE DEVELOPMENT ACTIVITIES AND IS NOT ENGAGED IN R&D AC TIVITIES IS BAD IN LAW. IT(TP)A NO.1366/BANG/2011 PAGE 17 OF 30 43. FURTHER REFERENCE WAS ALSO MADE TO THE DECISION 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 DIS CUSSION 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 (APPLYIN G 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 PURIFIC ATION UNDER WET LAB PROCEDURES ARE UNDER PROGRESS WITH OU R 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 FA CILITY WOULD ALSO INCLUDE THE RESEARCH LABORATORIES FOR CA RRYING OUT FURTHER R & D ACTIVITIES TO DEVELOP NEW CANDIDA TES DRUG MOLECULES AND LICENSE THEM TO INTERESTED PHARM A AND BIO COMPANIES ACROSS THE GLOBE. THE PROPOSED FACILITY WILL BE SET UP IN GENOME VALLEY AT HYDERAB AD 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 IT(TP)A NO.1366/BANG/2011 PAGE 18 OF 30 AS COMPARABLE FUNCTIONALLY WITH THAT OF THE ASSESSE E. THERE HAS BEEN NO ATTEMPT MADE TO IDENTIFY AND ELIMINATE AND MAKE ADJUSTMENT OF THE PROFIT MARGINS SO THAT THE DIFFERENCE IN FUNCTIONAL COMPARABILITY CAN BE ELIMINATED. BY NOT RESORTING TO SUCH A PROCESS OF M AKING ADJUSTMENT, THE TPO HAS RENDERED THIS COMPANY AS NO T QUALIFYING FOR COMPARABILITY. WE THEREFORE ACCEPT T HE 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 N EW DRUGS AND HAS DEVELOPED MOLECULE TO TREAT CANCER. IN THE ULTI MATE ANALYSIS, THE ITAT DID NOT CONSIDER THIS COMPANY AS A COMPARA BLE IN CLINICAL TRIAL SEGMENT, FOR THE REASON THAT THIS CO MPANY HAS DIVERSE BUSINESS. IT WAS SUBMITTED THAT, HOWEVER, FROM THE ABOVE EXTRACTS IT IS CLEAR THAT THIS COMPANY IS NOT INTO SOFTWARE DEVELOPMENT ACTIVITIES, ACCORDINGLY, THIS COMPANY S HOULD BE REJECTED AS A COMPARABLE BEING FUNCTIONALLY DIFFERE NT. 45. FROM THE MATERIAL AVAILABLE ON RECORD, IT TRAN SPIRES THAT THE TPO HAS ACCEPTED THAT UP TO AY 06-07 THIS COMPANY W AS CLASSIFIED AS A RESEARCH AND DEVELOPMENT COMPANY. ACCORDING TO THE TPO IN AY 07-08 THIS COMPANY HAS BEEN CLASSI FIED AS SOFTWARE DEVELOPMENT SERVICE PROVIDER IN THE CAPITA LINE/PROWESS DATABASE AS WELL AS IN THE ANNUAL REPORT OF THIS CO MPANY. 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 PROVIDING SOFTWARE DEVELOPMENT SERVICES. THE AS SESSEE IN REPLY TO THE PROPOSAL OF THE AO TO TREAT THIS AS A COMPARABLE HAS POINTED OUT THAT THIS COMPANY PROVIDES SOFTWARE PRODUCTS/SERVICES AS WELL AS BIOINFORMATICS SERVICE S AND THAT THE SEGMENTAL DATA FOR EACH ACTIVITY IS NOT AVAILABLE A ND THEREFORE THIS COMPANY SHOULD NOT BE TREATED AS COMPARABLE. BESID ES THE ABOVE, THE ASSESSEE HAS POINT OUT TO SEVERAL REFERE NCES IN THE ANNUAL REPORT FOR 31.3.2007 HIGHLIGHTING THE FACT T HAT THIS COMPANY WAS DEVELOPS BIOTECHNOLOGY PRODUCTS AND PRO VIDES RELATED SOFTWARE DEVELOPMENT SERVICES. THE TPO CAL LED FOR SEGMENTAL DATA AT THE ENTITY LEVEL FROM THIS COMPAN Y. THE TPO ALSO CALLED FOR DESCRIPTION OF SOFTWARE DEVELOPMENT PROCESS. 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 S EGMENTAL DATA WAS GIVEN OR NOT. BESIDES THE ABOVE THERE IS NO OT HER DETAIL IN THE TPOS ORDER AS TO THE NATURE OF SOFTWARE DEVELOPMEN T SERVICES PERFORMED BY THE ASSESSEE. CELESTIAL LABS HAD COME OUT WITH A IT(TP)A NO.1366/BANG/2011 PAGE 19 OF 30 PUBLIC ISSUE OF SHARES AND IN THAT CONNECTION ISSUE D DRAFT RED HERRING PROSPECTUS (DRHP) IN WHICH THE BUSINESS OF THIS COMPANY WAS EXPLAINED AS TO CLINICAL RESEARCH. TH E TPO WANTED TO KNOW AS TO WHETHER THE PRIMARY BUSINESS OF THIS COMPANY IS SOFTWARE DEVELOPMENT SERVICES AS INDICATED IN THE A NNUAL REPORT FOR FY 06-07 OR CLINICAL RESEARCH AND MANUFACTURE O F BIO PRODUCTS AND OTHER PRODUCTS AS STATED IN THE DRHP. THERE IS NO REFERENCE TO ANY REPLY BY CELESTIAL LABS TO THE ABOVE CLARIFI CATION OF THE TPO. THE TPO WITHOUT ANY BASIS HAS HOWEVER CONCLU DED THAT THE BUSINESS MENTIONED IN THE DRHP ARE THE SERVICES OR BUSINESSES THAT WOULD BE STARTED BY UTILIZING THE F UNDS GARNERED THOUGH THE INITIAL PUBLIC OFFER (IPO) AND THUS IN N O WAY CONNECTED WITH BUSINESS OPERATIONS OF THE COMPANY D URING 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 NO T TO HAVE BEEN CONSIDERED AS 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 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 RS.45,93,351. THE SAME WAS LESS THAN 25% OF TH E 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 A CCOUNT OF IT BEING FUNCTIONALLY DIFFERENT FROM SOFTWARE COMPA NIES. THE RELEVANT EXTRACT ARE AS FOLLOWS: 16. ANOTHER ISSUE RELATING TO SELECTION OF COMPARA BLES BY THE TPO IS REGARDING INCLUSION OF KALS INFORMATI ON 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 IT(TP)A NO.1366/BANG/2011 PAGE 20 OF 30 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 EN ABLED SERVICES AND THAT THE SAID COMPANY IS INTO DEVELOPM ENT OF SOFTWARE PRODUCTS, ETC. ALL THESE ASPECTS HAVE N OT BEEN FACTUALLY REBUTTED AND, IN OUR VIEW, THE SAID CONCERN IS LIABLE TO BE EXCLUDED FROM THE FINAL SET OF COMPARABLES, AND THUS ON THIS ASPECT, ASSESSEE SUCCEEDS. 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 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 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 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 IT(TP)A NO.1366/BANG/2011 PAGE 21 OF 30 (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 TH E ASSESSEE COMPANY AS IT WAS ENGAGED IN THE SERVICES IN THE FORM OF ACCEL IT AND ACCEL ANIMATION SERVICES F OR 2D AND 3D ANIMATION AND THEREFORE ASSESSEES CLAIM THAT THIS COMPANY WAS FUNCTIONALLY DIFFERENT WAS ACCEPTE D. DRP THEREFORE DIRECTED THE ASSESSING OFFICER TO EXC LUDE 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 COM PANY 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 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. 14. IN VIEW OF THE AFORESAID DECISION OF THE TRIBUN AL, COMPARABLES AT SL.NOS.1, 2 & 3 OF THE LIST OF COMPARABLES CHOSEN B Y THE TPO HAVE TO BE IT(TP)A NO.1366/BANG/2011 PAGE 22 OF 30 EXCLUDED FOR THE PURPOSE OF COMPARISON WHILE DETERM INING THE ALP OF THE IMPUGNED TRANSACTION IN THIS APPEAL. 15. AS FAR AS COMPARABLE AT SL.NO.14 VIZ., LUCID SO FTWARE LTD. FROM THE LIST OF COMPARABLES CHOSEN BY THE TPO IS CONCERNED, WE FIND THAT THE MUMBAI BENCH OF THE TRIBUNAL IN THE CASE OF TELCORDIA TECHNOLOGIES INDIA PVT. LTD. (SUPRA) WHILE DEALING WITH THE CASE OF SOFTWARE SERVICES PROVIDER LIKE THE ASSESSEE, CONSIDERED THE COMPARAB ILITY OF LUCID SOFTWARE LTD. WITH SIMILAR SOFTWARE SERVICES PROVIDER AND TH E 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, IT(TP)A NO.1366/BANG/2011 PAGE 23 OF 30 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 S ALE OF PRODUCT AND HOW MUCH IS FROM THE SERVICES, THEREFORE, THIS ENTITY CANNOT BE TAKEN INTO ACCOUNT FOR COMPARABILITY ANALYSIS FO R DETERMINING ARMS LENGTH PRICE IN THE CASE OF THE ASSESSEE. 16. IN VIEW OF THE AFORESAID DECISION OF THE MUMBAI BENCH OF THE TRIBUNAL, WHICH IS ALSO IN RELATION TO A.Y. 2007-08 , WE ARE OF THE VIEW THAT THE SAID COMPANY IS TO BE EXCLUDED AS A COMPARABLE WHILE DETERMINING THE ALP OF THE INTERNATIONAL TRANSACTION IMPUGNED IN TH IS APPEAL. 17. AS FAR AS COMPANIES AT SL.NO.7 & 11 OF THE LIST OF COMPARABLES CHOSEN BY THE TPO ARE CONCERNED, IT IS NOT IN DISPU TE THAT THE RELATED PARTY TRANSACTION OF THESE COMPARABLE COMPANIES WAS MORE THAN 15%. THIS TRIBUNAL IN THE CASE OF 24/7 CUSTOMER COM PVT. LTD., ITA NO.227/BANG/2010 (SUPRA) , HAD HELD THAT WHERE COMPARABLES HAVE RELATED PARTY TRANSACTIONS WHICH ARE IN EXCESS OF 1 5% OF ITS TOTAL RECEIPTS, THEN SUCH COMPANIES CANNOT BE CHOSEN FOR THE PURPOS E OF COMPARISON. FOLLOWING ARE THE RELEVANT OBSERVATIONS OF THE TRIB UNAL:- 13.0 RELATED PARTY TRANSACTIONS IN RESPECT OF THE GROUND RAISED AT S.NO.1 REGARDING ACCEPTANCE OF COMPARABLE COMPANIES HAVING RELATED PARTY TRANSACTI ONS AS PROPOSED BY THE TPO, THE LEARNED COUNSEL FOR THE AS SESSEE ARGUED THAT THE TRANSFER PRICING REGULATIONS DO NOT STIPUL ATE ANY MINIMUM LIMIT OF RELATED PARTY TRANSACTIONS WHICH FORM THE THRESHOLD FOR EXCLUSION AS A COMPARABLE. IN THIS REGARD, THE LEAR NED COUNSEL FOR THE ASSESSEE OBJECTED TO THE TPOS SETTING A LIMIT OF 25% ON RELATED PARTY TRANSACTIONS. HE OBJECTED TO THE INCL USION OF COMPARABLES BEING RELATED PARTY TRANSACTIONS IN EXC ESS OF 15% OF SALES / REVENUE. IN SUPPORT OF THIS PROPOSITION, TH E LEARNED COUNSEL IT(TP)A NO.1366/BANG/2011 PAGE 24 OF 30 FOR THE ASSESSEE PLACED RELIANCE ON THE DECISION OF THE HON'BLE BENCH OF THE ITAT, DELHI IN THE CASE OF SONY INDIA (P) LTD. REPORTED IN 2008-TIOL-439-ITAT-DELHI DT.23.12.2008. THE LEARNED COUNSEL FOR THE ASSESSEE DREW OUR ATTENTION TO PARA 115.3 OF THE ORDER 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 D O NOT EXCEED 10 TO 15% OF TOTAL REVENUE. WITHIN THE ABOVE LIMIT, TRANSACTIONS CANNOT BE HELD TO BE SIGNIFICANT TO IN FLUENCE THE PROFITABILITY OF THE COMPARABLES. FOR THE PURPOSE O F COMPARISON WHAT IS TO BE JUDGED IS THE IMPACT OF TH E RELATED PARTY TRANSACTIONS VIS--VIS SALES AND NOT PROFIT S INCE PROFIT OF AN ENTERPRISE IS INFLUENCED BY LARGE NUMBER OF OTHE R FACTORS ...... RESPECTFULLY FOLLOWING THE DECISION OF THE TRIBUNAL IN THE CASE OF SONY INDIA (P) LTD (SUPRA), THE ASSESSING OFFICER / TPO ARE DIRECTED TO EXCLUDE AFTER DUE VERIFICATION THOSE CO MPARABLES FROM THE LIST WITH RELATED PARTY TRANSACTIONS OR CONTROL LED TRANSACTIONS IN EXCESS OF 15% OF TOTAL REVENUES FOR THE FINANCIA L YEAR 2003- 04. 18. IN VIEW OF THE ABOVE, THE AFORESAID TWO COMPARA BLES SHOULD ALSO BE EXCLUDED FOR THE PURPOSE OF COMPARISON WHILE DETERM INING THE ALP OF THE INTERNATIONAL TRANSACTION IN QUESTION. 19. AS FAR AS SL.NO.16 VIZ., MEGASOFT LTD. OF THE L IST OF COMPARABLES CHOSEN BY THE TPO IS CONCERNED, THIS TRIBUNAL IN TH E CASE OF TRILOGY E- BUSINESS SOFTWARE INDIA PVT. LTD. (SUPRA) HAD HELD THAT ONLY SEGMENTAL DATA SHOULD BE TAKEN FOR THE PURPOSE OF C OMPARISON. FOLLOWING ARE THE RELEVANT OBSERVATIONS OF THE TRIBUNAL:- 37. THE NEXT PLEA OF THE ASSESSEE IS THAT IF AT AL L THIS COMPANY IS CONSIDERED AS A COMPARABLE THEN THE SEGMENTAL MA RGIN OF 23.11% (WHICH IS THE MARGIN FOR SOFTWARE SERVICE SE GMENT) ALONE SHOULD BE CONSIDERED FOR COMPARABILITY. ON THE ABO VE SUBMISSION, WE FIND THAT THE TPO CONSIDERED THE SEG MENTAL IT(TP)A NO.1366/BANG/2011 PAGE 25 OF 30 MARGIN (SOFTWARE SERVICE SEGMENT) IN THE CASE OF GE OMETRIC, KALS INFO SYSTEMS, R SYSTEMS, SASKEN COMMUNICATION AND T ATA ELXSI. BEFORE DRP THE ASSESSEE POINTED OUT THAT THE SEGMEN TAL MARGIN OF 23.11% ALONE SHOULD BE TAKEN FOR COMPARABILITY. THE DRP HAS NOT GIVEN ANY SPECIFIC FINDING ON THE ABOVE PLEA OF THE ASSESSEE. PERUSAL OF THE ORDER OF THE TPO SHOWS THAT THE TPO RELIED ON INFORMATION WHICH WAS GIVEN BY THIS COMPANY IN WHIC H THIS COMPANY HAD EXPLAINED THAT IT HAS TWO DIVISIONS VIZ ., BLUEALLY DIVISION AND XIUS-BCGI DIVISION. XIUS- BCGI DIVISION DOES THE BUSINESS OF PRODUCT SOFTWARE (DEVELOPING SOFTWARE). THIS COMPANY DEVELOPS PACKAGED PRODUCTS FOR THE WIRELESS AND CONVERGENT TELECOM INDUSTRY. THESE PR ODUCTS ARE SOLD AS PACKAGED PRODUCTS TO CUSTOMERS. WHILE IMPL EMENTING THESE STANDARDIZED PRODUCTS, CUSTOMERS MAY REQUEST THE COMPANY TO CUSTOMIZE PRODUCTS OR RECONFIGURE PRODUCTS TO FI T INTO THEIR BUSINESS ENVIRONMENT. THEREUPON THE COMPANY TAKES UP THE JOB OF CUSTOMIZING THE PACKAGED SOFTWARE. THE COMPANY ALSO EXPLAINED THAT 30 TO 40% OF THE PRODUCT SOFTWARE (S OFTWARE DEVELOPED) WOULD CONSTITUTE PACKAGED PRODUCT AND AR OUND 50% TO 60% WOULD CONSTITUTE CUSTOMIZED CAPABILITIES AND EXPENSES RELATED TO TRAVELLING, BOARDING AND LODGING EXPENSE . BASED ON THE ABOVE REPLY, THE TPO PROCEEDED TO HOLD THAT THE COM PARABLE COMPANY WAS MAINLY INTO CUSTOMIZATION OF SOFTWARE P RODUCTS DEVELOPED (WHICH WAS AKIN TO SOFTWARE DEVELOPMENT) INTERNALLY AND THAT THE PORTION OF THE REVENUE FROM DEVELOPMEN T OF SOFTWARE SOLD AND USED FOR CUSTOMIZATION WAS LESS THAN 25% O F THE OVERALL REVENUES. THE TPO THEREFORE HELD THAT LESS THAN 25 % OF THE REVENUES OF THE COMPARABLE ARE FROM SOFTWARE PRODUC TS AND THEREFORE THE COMPARABLE SATISFIED TPOS FILTER OF MORE THAN 75% OF REVENUES FROM SOFTWARE DEVELOPMENT SERVICES. HA VING DRAWN THE ABOVE CONCLUSION, THE TPO DID NOT BOTHER TO QUA NTIFY THE REVENUES WHICH CAN BE ATTRIBUTED TO SOFTWARE PRODUC T DEVELOPMENT AND SOFTWARE DEVELOPMENT SERVICE BUT AD OPTED THE MARGIN OF THIS COMPANY AT THE ENTITY LEVEL. IN TER MS OF RULE 10B(3)(B) OF THE RULES, 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 LIK ELY TO MATERIALLY AFFECT THE PRICE OR COST CHARGED OR P AID IN, OR THE PROFIT ARISING FROM, SUCH TRANSACTIONS I N THE OPEN MARKET; OR ( II ) REASONABLY ACCURATE ADJUSTMENTS CAN BE MADE TO ELIMINATE THE MATERIAL EFFECTS OF SUCH DIFFERENCES. IT(TP)A NO.1366/BANG/2011 PAGE 26 OF 30 38. NEITHER THE TPO NOR THE DRP HAVE NOTICED THAT THERE IS BOUND TO BE A DIFFERENCE BETWEEN THE ASSESSEE AND M EGASOFT AND THE PROFIT ARISING TO THE MEGASOFT AS A RESULT OF T HE EXISTENCE OF THE SOFTWARE PRODUCT SEGMENT AND NO FINDING HAS BEE N GIVEN THAT REASONABLY ACCURATE ADJUSTMENTS CAN BE MADE TO ELIM INATE THE MATERIAL EFFECTS OF SUCH DIFFERENCES. FOR THIS RE ASON, WE ARE INCLINED TO HOLD THAT THE PROFIT MARGIN OF 23.11% W HICH IS THE MARGIN OF THE SOFTWARE SERVICE SEGMENT BE TAKEN FOR COMPARABILITY. IN VIEW OF THE ABOVE CONCLUSION, WE DO NOT WISH TO GO INTO THE QUESTION AS TO WHETHER LESS THAN 25% OF THE REVENUES OF THE COMPARABLE ARE FROM SOFTWARE PRODUC TS AND THEREFORE THE COMPARABLE SATISFIED TPOS FILTER OF MORE THAN 75% OF REVENUES FROM SOFTWARE DEVELOPMENT SERVICES. 20. IN VIEW OF THE AFORESAID DECISION OF THE TRIBUN AL, SEGMENTAL MARGINS IN SO FAR AS IT RELATES TO PROVIDING SOFTWARE SERVI CES BY MEGASOFT ALONE BE TAKEN FOR THE PURPOSE OF COMPARISON. 21. OUT OF THE 26 COMPARABLES CHOSEN BY THE TPO AND AFTER EXCLUDING THE COMPARABLES REFERRED TO IN THE EARLIER PARAGRAP HS, THE COMPARABLE COMPANIES THAT WOULD REMAIN FOR COMPARISON AND THE ARITHMETIC MEAN OF THE REMAINING COMPARABLES WOULD BE AS FOLLOWS:- IT(TP)A NO.1366/BANG/2011 PAGE 27 OF 30 22. AFTER GIVING DUE ADJUSTMENT TO THE +/- 5% NET M ARGIN UNDER SECOND PROVISO TO SECTION 92C(2) OF THE ACT, THE UPPER AND LOWER MARGIN WOULD BE AS FOLLOWS:- 23. AS WE HAVE ALREADY SEEN, THE NET PROFIT TO COST EARNED BY THE ASSESSEE IS 12.21%, WHICH IS WELL WITHIN THE +/- 5% RANGE OF THE ARITHMETIC MEAN OF THE COMPARABLES VIZ., 15.01% AND THEREFORE NO TP ADJUSTMENT CAN BE MADE, AS THE PRICE RECEIVED BY THE ASSESSEE HAS TO BE CONSIDERED AS AT ARMS LENGTH. WE ARE THEREFORE OF THE VIEW T HAT THE ADDITION MADE BY THE AO BY WAY OF TP ADJUSTMENT CANNOT BE SUSTAINED AND ACCORDINGLY THE SAME IS DIRECTED TO BE DELETED. 24. IN VIEW OF THE ABOVE CONCLUSION, WE HAVE NOT GO NE INTO THE SPECIFIC ISSUES RAISED BY THE ASSESSEE IN GROUND NOS. 1, 2, 2.1 TO 2.14, 3 TO 6 OF THE GROUNDS OF APPEAL. IT(TP)A NO.1366/BANG/2011 PAGE 28 OF 30 25. THE REMAINING GROUNDS VIZ., GROUNDS NO. 7 TO 10 RAISED BY THE ASSESSEE ARE WITH REGARD TO THE COMPUTATION OF DEDU CTION U/S. 10A OF THE ACT. THE ASSESSEE CLAIMED A DEDUCTION OF RS.2,67,5 9,354/- UNDER SECTION 10A OF THE ACT. IN COMPUTING THE DEDUCTION, THE ASS ESSEE HAD NOT REDUCED TELECOMMUNICATION EXPENSES OF RS.62,35,424/- AND TR AVELLING EXPENSES OF RS.40,17,354/- FROM THE EXPORT TURNOVER AS NO PART OF THE EXPENDITURE WAS ATTRIBUTABLE TO THE DELIVERY OF SOFTWARE OUTSIDE IN DIA. THE ASSESSING OFFICER, HOWEVER, PROCEEDED TO RECOMPUTE THE DEDUCTION BY ON CE AGAIN REDUCING THE SAID AMOUNT OF RS.1,02,52,778/- FROM EXPORT TUR NOVER BUT NOT FROM TOTAL TURNOVER AND THEREBY DISALLOWED THE 10A DEDUCTION T O THE EXTENT OF RS.12,42,705/-. THE ASSESSEES SUBMISSION IS THAT N O PART OF THE ABOVE EXPENDITURE WAS ATTRIBUTABLE TO THE DELIVERY OF SOF TWARE OUTSIDE INDIA AND IN THE ALTERNATIVE, IF THE SAME IS REDUCED FROM EXPORT TURNOVER, IT SHOULD ALSO BE REDUCED FROM TOTAL TURNOVER. THE ALTERNATIVE SUB MISSION IS SUPPORTED BY THE DECISION OF THE HONBLE HIGH COURT OF KARNATAKA IN CIT V. TATA EIXSI LTD [2012] 349 ITR 98 (KARN). 26. AS FAR AS THE ALTERNATIVE CLAIM IS CONCERNED, WE FIND THAT THE HONBLE HIGH COURT OF KARNATAKA IN THE CASE OF TATA EIXSI LTD (SUPRA) HAS HELD THAT WHILE COMPUTING DEDUCTION UNDER SECTION 10A OF THE INCOME TAX ACT, 1961 (THE ACT), EXPENDITURE INCURRED BY THE ASSES SEE, IF EXCLUDED FROM THE EXPORT TURNOVER (ET), SHOULD ALSO BE EXCLUDED FRO M THE TOTAL TURNOVER (TT). IT HAS BEEN HELD THAT, THE TT WOULD HAVE TWO COMPONENTS ET AND DOMESTIC TURNOVER. THEREFORE, IF THE ET IN THE NUMERATOR IS TO BE ARR IVED AT AFTER IT(TP)A NO.1366/BANG/2011 PAGE 29 OF 30 EXCLUDING CERTAIN EXPENSES THESE SHOULD ALSO BE EXC LUDED IN COMPUTING ET AS A COMPONENT OF TT IN THE DENOMINATO R. THOUGH THERE IS NO DEFINITION OF TT IN SECTION 10A OF THE ACT, THERE IS NOTHING IN THE SAID SECTION TO MANDATE THAT WHAT IS EXCLUDED FROM THE NUMERATOR AND WOULD NEVERTHELESS FORM PART OF THE D ENOMINATOR. THE PRINCIPLE LAID OUT IN JUDGEMENTS RENDERED IN CO NTEXT OF SECTION 80HHC OF THE ACT WILL EQUALLY APPLY WHILE INTERPRET ING SECTION 10A OF THE ACT SINCE THE PRINCIPLE UNDERLYING BOTH THESE P ROVISIONS IS THE SAME. 27. IN VIEW OF THE AFORESAID DECISION OF THE HONBL E HIGH COURT OF KARNATAKA, WE ARE OF THE VIEW THAT THE GRIEVANCE OF THE ASSESSEE PROJECTED IN THE AFORESAID GROUNDS WOULD GET REDRESSED, IF TH E AO IS DIRECTED TO REDUCE THE COMMUNICATION AND TRAVEL EXPENSES FROM T HE EXPORT TURNOVER AS WELL AS THE TOTAL TURNOVER, WHILE COMPUTING DEDUCTI ON U/S. 10A OF THE ACT. WE HOLD AND DIRECT ACCORDINGLY. GROUNDS NO.7 TO10 ARE THUS PARTLY ALLOWED. 28. IN THE RESULT, THE APPEAL OF THE ASSESSEE IS PA RTLY ALLOWED. PRONOUNCED IN THE OPEN COURT ON THIS 22 ND DAY OF FEBRUARY, 2013. SD/- SD/- ( N. BARATHVAJA SANKAR ) ( N.V. VASU DEVAN ) VICE PRESIDENT JUDIC IAL MEMBER BANGALORE, DATED, THE 22 ND FEBRUARY, 2013. DS/- IT(TP)A NO.1366/BANG/2011 PAGE 30 OF 30 COPY TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT(A) 5. DR, ITAT, BANGALORE. 6. GUARD FILE BY ORDER SENIOR PRIVATE SECRETARY ITAT, BANGALORE.