LGS Global Ltd, Hyderabad V. ACIT, Circle-16(1), Hyderabad

ITA 1885/HYD/2011

• Counselvise Citation: [2014] 140 COUNSELVISE.COM (IT) 77973 (ITAT-HYDERABAD)
• Duration Of Justice: 2 year(s) 7 month(s) 23 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 27-06-2014
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: A
• Assessment Year: 2007-2008
• Appeal Filed On: 04-11-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: P SOMASEKHAR REDDY
• Assessee Lawyers: P MURALI MOHAN RAO
• Keywords: Business income; Transfer pricing; International transaction
• Section: 143(3)

Judgement Text

1 ITA NO. 1885/H/2011 LGS GLOBAL LTD. IN THE INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCH A, HYDERABAD BEFORE SHRI B. RAMAKOTAIAH, ACCOUNTANT MEMBER AND SHRI SAKTIJIT DEY, JUDICIAL MEMBER ITA NO. 1885/HYD/2011 ASSESSMENT YEAR : 2007-08 LGS GLOBAL LTD., HYDERABAD. PAN AAACL5827B. VS. ASST. COMMISSIONER OF INCOME- TAX, CIRCLE 16(1), HYDERABAD. (APPELLANT) (RESPONDENT) ASSESSEE BY : SHRI P. MURALI MOHAN RAO REVENUE BY : SHRI P. SOMA SEKHAR REDDY DATE OF HEARING 15-05-2014 DATE OF PRONOUNCEMENT 27-06-2014 O R D E R PER SAKTIJIT DEY, J.M.: THIS APPEAL OF THE ASSESSEE IS DIRECTED AGAINST TH E ASSESSMENT ORDER PASSED U/S 143(3) READ WITH SECTION 144C OF T HE ACT IN PURSUANCE TO THE DIRECTIONS OF THE DISPUTE RESOLUTION PANEL (DRP ), HYDERABAD, PERTAINING TO THE AY 2007-08. 2. BRIEFLY THE FACTS ARE, THE ASSESSEE COMPANY EARL IER KNOWN AS LANCO GLOBAL SYSTEMS LTD., WAS INCORPORATED UNDER THE COM PANIES ACT, 1956. THE ASSESSEE IS REGISTERED WITH SOFTWARE TECHNOLOGY PARK OF INDIA (STPI) AS 100% EOU. ASSESSEE PROVIDES SOFTWARE DEV ELOPMENT SERVICES TO ITS CLIENTS IN VARIOUS COUNTRIES INCLUDING ITS A SSOCIATED ENTERPRISES (AE) OVERSEAS. FOR THE AY UNDER DISPUTE ASSESSEE FILED I TS RETURN OF INCOME ON 27/10/2007 DECLARING TOTAL INCOME OF RS. 41,08,995/ - AFTER CLAIMING DEDUCTION U/S 10A OF THE ACT. THE FINANCIAL RESULT S OF THE ASSESSEE FOR THE FY 2006-07 AS PER THE ANNUAL REPORT IS AS UNDER : 2 ITA NO. 1885/H/2011 LGS GLOBAL LTD. DISCRETION AMOUNT OPERATING REVENUE RS. 45,38,93,898 OPERATING COST RS. 39,19,54,735 OPERATING PROFIT (PBIT) RS. 6,19,39,163 OPERATING PROFIT TO COST RATIO 15.8 0% TO BENCHMARK THE PRICE CHARGED BY THE ASSESSEE FOR THE INTERNATIONAL TRANSACTION ENTERED WITH ITS AE WHICH AMOUNTED TO R S. 18,29,92,020/-, ASSESSEE UNDERTOOK A TP STUDY THROUGH AN EXTERNAL C ONSULTANT. TRANSACTION NET MARGIN METHOD (TNMM) WAS SELECTED A S THE MOST APPROPRIATE METHOD FOR DETERMINING THE ALP. ASSESSE E BY UNDERTAKING A SEARCH IN THE DATA BASES SELECTED 11 COMPANIES AS C OMPARABLES HAVING AVERAGE PLI OF 11%. AS ASSESSEES NET PROFIT MARGIN ON SALES WAS 14% AND ON COST WAS 17% THE PRICE CHARGED WAS FOUND TO BE AT ARMS LENGTH. DURING THE SCRUTINY ASSESSMENT PROCEEDINGS, THE ASS ESSING OFFICER NOTICING THAT THE ASSESSEE HAS ENTERED INTO INTERNA TIONAL TRANSACTIONS WITH ITS AE MADE A REFERENCE U/S 92CA OF THE ACT TO THE TPO FOR DETERMINING THE ALP. IN COURSE OF THE PROCEEDING BEFORE HIM, T HOUGH THE TPO ACCEPTED TNMM AS THE MOST APPROPRIATE METHOD, HOWEV ER, ULTIMATELY HE REJECTED THE TP STUDY OF THE ASSESSEE BY POINTING O UT VARIOUS DEFECTS AND DEFICIENCIES. THE TPO BY APPLYING SOME FILTERS ADOP TED BY THE ASSESSEE AS WELL AS CERTAIN ADDITIONAL FILTERS SELECTED BY H IM SEARCHED THE DATA BASES WHICH YIELDED 25 COMPANIES AS COMPARABLES HAV ING AVERAGE PLI OF 25.51%. WITH A NEGATIVE WORKING CAPITAL ADJUSTMENT OF (-) 0.05% , THE ADJUSTED ARITHMETIC MEAN PLI WAS WORKED OUT TO 25.5 7%. BY APPLYING THIS ADJUSTED ARITHMETIC MEAN PLI TO THE TOTAL OPERATING COST OF RS. 39,19,54,735/-, THE TPO WORKED OUT THE ADJUSTMENT U /S 92CA AS UNDER: SL.NO. ITEM CODE REMARKS 1 TOTAL OPERATING COSTS A 39,19,54,735 2 ARMS LENGTH MEANING MARGIN (OP)/COST B 125.57% 3 ARMS LENGTH TOTAL SALES (AXB/100) C 49,21,77,561 4 TOTAL OPERATING REVENUES D 45,38,93,898 5 SALES WITH RELATED PARTIES E 18,29,92,020 6 SALES WITH UNRELATED PARTIES F 27,09,01,878 3 ITA NO. 1885/H/2011 LGS GLOBAL LTD. (D-E) 7 ARMS LENGTH PRICE OF SALES MADE TO AES (C-F) G 22,12,75,683 8 ADJUSTMENT (G-E) H 3,82,83,663 2.1 AFTER RECEIVING THE ORDER OF THE TPO, THE ASSES SING OFFICER FRAMED THE DRAFT ASSESSMENT ORDER BY ADDING THE AMOUNT OF RS. 3,82,83,663/- BEING TP ADJUSTMENT U/S 92CA OF THE ACT. THE ASSESS ING OFFICER ALSO MODIFIED THE DEDUCTION CLAIMED U/S 10A OF THE ACT B Y REDUCING THE COMMUNICATION AND FREIGHT EXPENSES AMOUNTING TO RS. 1,47,17,752/- FROM THE EXPORT TURNOVER. BEING AGGRIEVED OF THE DRAFT A SSESSMENT ORDER, THE ASSESSEE RAISED OBJECTIONS BEFORE THE DRP. 3. THE DRP, HOWEVER, VIDE ORDER DATED 25/08/2011 RE JECTED ALL THE OBJECTIONS RAISED BY THE ASSESSEE AND DIRECTED THE ASSESSING OFFICER TO FINALIZE THE ASSESSMENT ACCORDINGLY. IN ACCORDANCE WITH THE DIRECTION OF THE DRP, THE ASSESSING OFFICER PASSED THE IMPUGNED ASSESSMENT ORDER, WHICH IS UNDER CHALLENGE IN THE PRESENT APPEAL BEFO RE US. 4. GROUND NOS. 1 TO 15 RELATE TO VARIOUS TRANSFER P RICING ISSUES. HOWEVER, AT THE TIME OF HEARING THE LEARNED AR CON FINED HIS ARGUMENT ONLY TO THE ISSUE OF SELECTION OF CERTAIN COMPARABL ES BY THE TPO AND SUSTAINED BY THE DRP. OUT OF THE 25 COMPARABLES SEL ECTED BY THE TPO, THE ASSESSEE HAS OBJECTIONS IN RESPECT OF 5 COMPARA BLES. HEREINAFTER WE WILL DEAL WITH EACH OF THE COMPARABLE OBJECTED TO B Y THE ASSESSEE. 1. AVANI CIMCON TECHNOLOGIES LTD. I) THE LEARNED AR OBJECTING TO THIS COMPANY SUBMITT ED THAT IT HAS PRODUCT SALES ALONG WITH SOFTWARE DEVELOPMENT SERVI CES AND SEGMENT WISE DATA IS NOT AVAILABLE. FURTHER, IT WAS CONTEND ED THAT THE COMPANY HAS DISCLOSED SUPER NORMAL PROFIT DURING THIS YEAR AS AGAINST THE AVERAGE 4 ITA NO. 1885/H/2011 LGS GLOBAL LTD. PROFIT MARGIN OF OTHER COMPARABLES. THE LEARNED AR SUBMITTED THAT FOR THESE REASONS THIS COMPANY CANNOT BE TREATED AS A C OMPARABLE. IN SUPPORT OF SUCH CONTENTION, THE LEARNED AR RELIED U PON THE FOLLOWING DECISIONS: 1. M/S SUMTOTAL SYSTEMS INDIA LTD. , HYDERABAD V/S . ITO, ITA NO. 1710/HYD/2011, DT. 09/05/14. 2. LOGICA PVT. LTD., 1129/BANG/11 3. TRIOLOGY E BUSINESS SOFTWARE INDIA LTD., 1054/BA NG/11 4. BEARING POINT BUSINESS CONSULTING PVT. LTD., 112 4/BAG/11 5. SOFTWARE INDIA P. LTD., 1196/H/10 6. VIRTUSA (INDIA) P. LTD., 1962/H/11 II) THE LEARNED DEPARTMENTAL REPRESENTATIVE ON THE OTHER HAND SUPPORTED THE ORDER OF THE TPO/DRP. III) WE HAVE HEARD THE PARTIES AND PERUSED THE MATE RIALS ON RECORD. ASSESSEES CONTENTION THAT AFORESAID COMPANY IS HAV ING REVENUE FROM BOTH PRODUCT AND SERVICES AND SEGMENT WISE DATA IS NOT AVAILABLE COULD NOT BE CONTROVERTED BY THE DEPARTMENT. FURTHER IT I S SEEN THAT THE COORDINATE BENCH OF THIS TRIBUNAL IN CASE OF M/S SU MTOTAL SYSTEMS INDIA P. LTD. (SUPRA) FOLLOWING ANOTHER DECISION OF THE C OORDINATE BENCH IN CASE OF VIRTUSA INDIA PVT. LTD. AS WELL AS SOME OTHER RU LINGS OF THE DIFFERENT BENCHES OF THE TRIBUNAL EXCLUDED THIS COMPANY FROM THE LIST OF COMPARABLES BY HOLDING AS UNDER: IT IS VERY MUCH EVIDENT FROM THE TP ORDER THAT THE ASSESSEE HAS BEEN CATEGORISED AS A SOFTWARE DEVELOPMENT SERVICE PROVIDER. COORDINATE BENCH OF THIS TRIBUNAL IN THE CASE OF VI RTUSA (INDIA) PVT. LTD. (ITA NO. 1962/HYD/2011 DATED 30/08/2013) AFTER FOLLOWING SOME OTHER DECISIONS OF THE TRIBUNAL HAS HELD THIS COMPANY CANNOT BE TREATED AS COMPARABLE AS THIS COM PANY IS ALSO INTO PRODUCT DEVELOPMENT. AS SEGMENTAL DETAILS OF OPERATING INCOME OF SOFTWARE DEVELOPMENT SERVICES A ND SALE OF SOFTWARE PRODUCTS ARE NOT AVAILABLE, IT COULD NOT B E ASCERTAINED WHETHER THE PROFIT RATIO OF THIS COMPANY CAN BE TAK EN INTO CONSIDERATION FOR COMPARING WITH THE ASSESSEE. AS T HE AFORESAID DECISION OF THE COORDINATE BENCH PERTAINED TO THE S AME 5 ITA NO. 1885/H/2011 LGS GLOBAL LTD. ASSESSMENT YEAR I.E. A.Y. 2007-08, FOLLOWING THE SA ME, WE HOLD THAT THIS COMPANY CANNOT BE TREATED AS COMPARABLE T O THE ASSESSEE. IV) IN THE CASE BEFORE US ALSO ASSESSEE IS ENGAGED IN PROVIDING SOFTWARE DEVELOPMENT SERVICES, THEREFORE, FOLLOWING THE AFORESAID DECISIONS OF THE COORDINATE BENCH WHICH PERTAIN TO THE SAME ASSESSMENT YEAR, WE DIRECT THE ASSESSING OFFICER/TPO NOT TO CO NSIDER THIS COMPANY AS COMPARABLE. 2. CELESTIAL LABS LTD. I) OBJECTING TO SELECTION OF THIS COMPANY, THE LEAR NED AR SUBMITTED THAT THE COMPANY IS INVOLVED IN RESEARCH AND DEVELO PMENT ACTIVITY, HENCE, IT IS FUNCTIONALLY DIFFERENT FROM THE ASSESSEE. IT WAS SUBMITTED THAT THOUGH THE PANEL ACCEPTING ASSESSEES CONTENTION FOUND THI S COMPANY IS NOT TO BE A COMPARABLE, BUT, ULTIMATELY THEY HAVE RETAINED THE SAME. II) THE LEARNED DEPARTMENTAL REPRESENTATIVE SUPPORT ED THE ORDER OF THE TPO/DRP. III) WE HAVE CONSIDERED THE SUBMISSIONS OF THE PART IES AND PERUSED THE MATERIALS ON RECORD AS WELL AS THE ORDERS OF THE TP O AND DRP. FROM THE MATERIALS ON RECORD, IT IS QUITE EVIDENT THAT THE A FORESAID COMPANY IS NOT COMPARABLE TO THE ASSESSEE AS THE FUNCTIONS ARE NOT SIMILAR. FURTHER, ON A PERUSAL OF THE ORDER OF THE DRP, IT IS TO BE SEEN T HAT TWO OF THE MEMBERS OF THE PANEL ON CONSIDERING THE FACT THAT IN MANY O THER CASES CELESTIAL LABS LTD., WAS NOT TREATED AS COMPARABLE ON THE G ROUND THAT IT IS NOT INVOLVED IN DEVELOPMENT OF SOFTWARE SERVICES HAVE D IFFERED FROM THE FINAL ORDER PASSED BY THE PANEL. IN THE AFORESAID FACTS A ND CIRCUMSTANCES, WE ARE OF THE VIEW THAT CELESTIAL LABS CANNOT BE TREAT ED AS COMPARABLE TO THE ASSESSEE. 6 ITA NO. 1885/H/2011 LGS GLOBAL LTD. 3. INFOSYS TECHNOLOGIES LTD. AND WIPRO LTD. I) OBJECTING TO THE AFORESAID COMPANIES, LEARNED AR SUBMITTED THAT BOTH THESE COMPANIES CANNOT BE CONSIDERED TO B E COMPARABLE TO THE ASSESSEE AS THEY ARE INDUSTRIAL GIANTS NOT O NLY ON ACCOUNT OF QUANTUM OF REVENUE EARNED BY THEM BUT DUE TO VARIOU S OTHER FACTORS LIKE REPUTATION, BRAND VALUE, GOODWILL ETC. IT WAS SUBMITTED THAT DUE TO THE AFORESAID FACTORS NOT ONLY THESE CO MPANIES COMMAND PREMIUM IN THE PRICING OF THEIR PRODUCTS A ND SERVICES, BUT, DUE TO SCALE OF OPERATION ALSO THEY ENJOY ECON OMIES OF SCALE IN THE LOWER COST OF INFRASTRUCTURE FACILITIES AND EMP LOYEES AND AS WELL AS IN EARNING PROFIT. APART FROM THIS, IT WAS SUBM ITTED THAT THESE COMPANIES HAVE DIVERSIFIED ACTIVITIES INCLUDING PRO DUCTS, CONSULTANCY AND SOLUTION. THEY NOT ONLY OWN INTANGI BLES BUT ALSO ASSUME CONSIDERABLE RISK WHICH RESULTS IN EARNING H IGHER PROFITS. IN SUPPORT OF SUCH CONTENTION, LEARNED AR RELIED ON TH E FOLLOWING DECISIONS: 1. M/S SUMTOTAL SYSTEMS INDIA P. LTD., ITA NO. 1710/HYD/2011, ORDER DATED 09/05/2014. 2. VIRTUSA (INDIA) P. LTD., 1962/H/11 3. CES PVT. LTD., 1445/H/10 4. CAPITAL IQ INFORMATION SYSTEMS INDIA LTD. II) THE LEARNED DEPARTMENTAL REPRESENTATIVE ON THE OTHER HAND SUPPORTED THE ORDERS OF THE TPO AND DRP. III) HAVING CONSIDERED THE SUBMISSIONS OF THE PARTI ES IN THE LIGHT OF THE ORDERS OF THE COORDINATE BENCH CITED BEFORE US BY THE LEARNED AR, WE ARE OF THE VIEW THAT BOTH THESE COMPANIES CA NNOT BE CONSIDERED AS COMPARABLES TO THE ASSESSEE FOR THE R EASONS STATED BY THE COORDINATE BENCH IN THE CITED RULINGS. RESPE CTFULLY FOLLOWING THE VIEW EXPRESSED BY THE COORDINATE BENCH AS AFORE SAID, WE DIRECT 7 ITA NO. 1885/H/2011 LGS GLOBAL LTD. THE ASSESSING OFFICER/TPO TO EXCLUDE THE AFORESAID COMPANIES FROM THE LIST OF COMPARABLES. 4. MEGA SOFT LTD. I) OBJECTING TO THE AFORESAID COMPANY, THE LEARNED AR SUBMITTED THAT THIS COMPANY CANNOT BE CONSIDERED AS COMPARABLE TO THE ASSESSEE, AS IT IS PREDOMINANTLY A PRODUCT D EVELOPMENT COMPANY AND THE MARGIN FROM SOFTWARE DEVELOPMENT SE RVICES IS ONLY 23.11%. FURTHER, THE LEARNED AR SUBMITTED THA T DURING THE YEAR THERE IS AMALGAMATION IN THE COMPANY WHICH HAS IMPACTED ITS PROFITS. THE LEARNED AR SUBMITTED THAT IF AT ALL TH IS COMPANY HAS TO BE SELECTED AS COMPARABLE THEN ONLY SEGMENTAL PROFI T CAN BE CONSIDERED FOR COMPARABILITY ANALYSIS. IN SUPPORT O F SUCH CONTENTION, HE RELIED UPON THE FOLLOWING DECISIONS: 1. INTOTO SOFTWARE INDIA P. LTD., 1196/H/10. 2. M/S SUMTOTAL SYSTEMS INDIA P. LTD., ITA NO. 1710/HYD/2011, ORDER DATED 09/05/2014. II) THE LEARNED DEPARTMENTAL REPRESENTATIVE, HOWEVE R, SUPPORTED THE ORDERS OF THE TPO/DRP. III) WE HAVE CONSIDERED THE SUBMISSIONS OF THE PAR TIES AND PERUSED THE MATERIALS ON RECORD. AS CAN BE SEEN FRO M THE ORDER PASSED IN CASE OF M/S SUMTOTAL SYSTEMS INDIA PVT. L TD. (SUPRA) THE COORDINATE BENCH OF THIS TRIBUNAL FOLLOWING ANOTHE R DECISION OF THE SAME BENCH IN CASE OF M/S VIRTUSA INDIA PVT. LTD. D IRECTED THE TPO TO TAKE ONLY THE SEGMENTAL MARGIN OF THIS COMPANY F OR COMPUTING ALP. FACTS BEING MATERIALLY SAME, FOLLOWING THE VI EW EXPRESSED BY THE COORDINATE BENCH AS AFORESAID, WE DIRECT ASSESS ING OFFICER/TPO TO CONSIDER ONLY SEGMENTAL MARGIN OF THIS COMPANY F OR THE RELEVANT AY FOR COMPUTING ALP. 8 ITA NO. 1885/H/2011 LGS GLOBAL LTD. 6. IN VIEW OF THE AFORESAID, WE DIRECT THE ASSESSIN G OFFICER/TPO TO COMPUTE THE ALP AFRESH KEEPING IN VIEW OUR DIREC TIONS GIVEN HEREINABOVE AND AFTER AFFORDING REASONABLE OPPORTUN ITY OF BEING HEARD TO THE ASSESSEE. 7. IN VIEW OF THE ABOVE, ALL OTHER GROUNDS RAISED B Y THE ASSESSEE RELATING TO TP ISSUES ARE CONSIDERED TO BE DISMISSED AS NOT PRESSED. 8. THE ONLY OTHER SURVIVING ISSUE IN THIS APPEAL RE LATES TO THE ACTION OF THE ASSESSING OFFICER IN REDUCING COMMUNI CATION AND FREIGHT EXPENSES AMOUNTING TO RS. 1,47,17,752/- FRO M THE EXPORT TURNOVER ONLY WHILE COMPUTING DEDUCTION U/S 10A OF THE ACT. 9. WE HAVE CONSIDERED THE SUBMISSIONS OF THE PARTIE S AND PERUSED THE MATERIALS ON RECORD. THIS ISSUE IS SQUARELY COVERED BY THE DECISION OF THE HONBLE BOMBAY HIGH COURT IN CA SE OF CIT VS. GEMPLUS JEWELLERY, 330 ITR 175 AND ITO VS SAKSOFT LTD (313 ITR AT 353 (CHENNAI) (SB). FOLLOWING THE RATIO LAID DOWN IN T HE AFORESAID JUDGMENTS, WE DIRECT THE AO TO EXCLUDE TH E COMMUNICATION EXPENSES FROM EXPORT TURNOVER AS WELL AS TOTAL TURNOVER WHILE COMPUTING DEDUCTION U/S 10A OF THE A CT. 10. IN THE RESULT, APPEAL OF THE ASSESSEE IS PARTLY ALLOWED. ORDER PRONOUNCED IN THE COURT ON 27/06/2014. SD/- SD/- (B. RAMAKOTAIAH) (SAKTIJIT DEY) ACCOUNTANT MEMBER JU DICIAL MEMBER HYDERABAD, DATED: 27 TH JUNE, 2014 KV 9 ITA NO. 1885/H/2011 LGS GLOBAL LTD. COPY TO:- 1) LGS GLOBAL LTD., C/O P. MURALI & CO., CAS., 6-3- 655/2/3, SOMAJIGUDA, HYDERABAD 500 082 2) ACIT, CIRCLE 16(1), HYDERABAD. 3)DRP, HYDERABAD. 4) THE ADDL. CIT(TP), HYDERABAD 5)THE DEPARTMENTAL REPRESENTATIVE, I.T.A.T., HYDER ABAD. DESCRIPTION DATE INTLS 1. DRAFT DICTATED ON SR.P.S. 2. DRAFT PLACED BEFORE AUTHOR SR.P.S 3 DRAFT PROPOSED & PLACED BEFORE THE SECOND MEMBER AM 4 DRAFT DISCUSSED/APPROVED BY SECOND MEMBER VP 5 APPROVED DRAFT COMES TO THE SR.P.S./PS SR.P.S. 6. KEPT FOR PRONOUNCEMENT ON SR.P S. 7. FILE SENT TO THE BENCH CLERK SR.P.S. 8 DATE ON WHICH FILE GOES TO THE HEAD CLERK 9 DATE OF DISPATCH OF ORDER