I.T.(T.P) A. No.1465/Bang/2010

The order of the Bench was delivered by

Shri Jason P. Boaz, A.M. :-This appeal by the assessee is directed against the order of assessment passed by the Dy. Commissioner of Income Tax, Circle 12(4), Bangalore under Section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (in short 'the Act') dt.11.10.2010 for Assessment Year 2006- 07, in pursuance of the directions issued by the Dispute Resolution Panel (‘DRP’) vide order dt.27.9.2010 passed under Section 144C(5) r.w.s. 144C(8) of the Act.

2. The facts of the case, briefly, are as under :-

2.1 The assessee, a private limited company, is a wholly owned subsidiary of Tektronix Inc., USA. The assessee is engaged in providing engineering and software development services to its Associated Enterprises (‘AEs’). For Assessment Year 2006-07, the assessee filed its return of income on 30.11.2006 declaring total income of Rs. 48,54,821 after claiming deduction of Rs. 1,92,86,469 under Section 10A of the Act. The case was taken up for scrutiny. In the course of assessment proceedings, the Assessing Officer noticed that the assessee had, inter alia, received payments in excess of Rs. 15 Crores for providing software development services, the details of which are as under :-

i) Rendering of Engineering & Software Development Services : Rs. 19,67,38,380.
ii) Reimbursement of expenses (received) : Rs. 71,28,098.

In view of the above international transactions entered into by the assessee, the Assessing Officer made a reference under Section 92CA of the Act to the Transfer Pricing Officer (‘TPO’) for determining the Arm’s Length Price (‘ALP’) of these international transactions, after obtaining the approval of the CIT-III, Bangalore. The TPO vide order under Section 92CA of the Act, dt.30.10.2009 proposed a T.P. adjustment of Rs. 1,61,74,393 to the ALP of international transactions in respect of software development services rendered by the assessee. The Assessing Officer then issued a draft assessment order under Section 143(3) r.w.s. 144C of the Act proposing the incorporation of the T.P. Adjustment as determined by the TPO’s order under Section 92CA of the Act.

2.2 Aggrieved by the Draft Assessment Order for Assessment Year 2006-07, the assessee filed its objections thereto before the DRP, Bangalore. The DRP vide its order under Section 144C(5) r.w.s. 144C(8) of the Act dt.27.9.2010 agreed with the findings of the TPO / Assessing Officer and rejected the assessee's objections. In consequence thereof, the Assessing Officer passed the impugned final order of assessment for Assessment Year 2006-07 under Section 143(3) r.w.s. 144C of the Act vide order dt.11.10.2010.

3. Aggrieved by the final order of assessment for Assessment Year 2006-07 dt.;11.10.2010, the assessee is in appeal before this Tribunal raising various grounds of appeal. The assessee, in the course of appellate proceedings, has subsequently filed the following concise grounds of appeal :-
Concise Grounds of Appeal.

“ Transfer Pricing
1. The order passed by the Hon'ble Dispute Resolution Panel and the ld. Assessing Officer / Transfer Pricing Officer is not in accordance with the law and is contrary to the facts and circumstances of the present case and in any case in violation of the principle of equity and natural justice.

2. The Hon'ble DRP and the ld. Assessing Officer have erred in fact and in law in confirming the action of the TPO in rejecting the TP documentation maintained and the detailed bench marking analysis conducted by the appellant, and making an adjustment to the ALP of the international transactions of the appellant, and in doing so have grossly erred in :

2.1 Upholding the action of the TPO in rejecting the analysis of the appellant without any valid or cogent reasons, particularly when the analysis of the appellant was accepted in the preceding years;
2.2 Upholding the action of the TPO in using selective information, which was not available in public domain, obtained under Section 133(6) of the Act and relying on the same for comparability purposes.

2.3 Disregarding the multiple / prior year data considered by the appellant in determining the ALP and adopting the financial data for a single year (i.e. the financial year 2005-06) of the comparables despite the fact that the same was not available to the appellant at the time of preparing the TP documentation.

3. The Hon'ble DRP / the ld. Assessing Officer have erred in upholding the TPO’s action of determining the operating profit margin of the appellant at lower level at 10.72 percent and not accepting the computation of operating income and operating costs as carried out by the appellant.
4. The Hon'ble DRP / the ld. Assessing Officer have erred in law and in facts in upholding the TPO’s action of selecting companies as comparable to the appellant despite such companies failing the test of comparability on some or all of the factors such as having related party transactions, different scale of operations, functional dis-similarity, differing product led revenues, differing asset base, risk profile etc. and failure of his own filters.

5. The Hon'ble DRP / the ld. Assessing Officer have erred in upholding the TPO’s action of not providing appropriate working capital adjustment to the appellant and also ignoring the limited risk nature of the services provided by the appellant and upholding the conclusion of the ld. TPO that no adjustment on account of risk differential is required in determining the ALP.

6. The Hon'ble DRP and the ld. Assessing Officer have erred in law and on facts in upholding the arm’s length margin arrived at by the ld. TPO by not considering the lower range of 5 percent from the mean margin as allowed under the Act and this Income Tax Rules, 1962.

7. The Hon'ble DRP and the ld. A.O. / TPO have erred in fact and law in applying the provisions of transfer pricing to the appellant without appreciating the fact that appellant was entitled to 100 percent deduction of profits under Section 10A during the relevant year and therefore there would not be any motive to shift profits to the other country.

Adjustments under the Section 10A of the Act.
8. The Hon'ble DRP and the ld. Assessing Officer have erred in law and on facts in concluding that the freight, telecommunication expenses, insurance expenses, and certain other expenses incurred by the appellant including expenses incurred in foreign currency are to be excluded from the export turnover for the purpose of computation of relief under Section 10A of the Act.

9. The Hon'ble DRP and the ld. Assessing Officer has erred in law and on facts in upholding that the said expenses should not be reduced from the total turnover for the purpose of computation of relief under Section 10A of the Act even if these are reduced from the export turnover. Other Grounds
10. The Hon'ble DRP and the ld. A.O. / TPO have erred in law and on facts in levying interest under Section 234B, 234C and 234D of the Act.

11. The ld. Assessing Officer has made an arithmetical error in determining the total taxable income of the appellant as Rs. 28,525,919 by making a mistake in adding the adjustment to the returned income of the appellant.”

TRANSFER PRICING ISSUES
4.0 The Grounds at S.Nos.1 to 7 (supra) are issues raised for consideration with respect to the T.P. Adjustment made by the Assessing Officer pursuant to the TPO’s order under Section 92CA of the Act, as upheld by the directions of the DRP. In the course of proceedings before us, the learned Authorised Representative of the assessee submitted that the assessee does not wish to press the general grounds raised on T.P. matters and would restrict submissions only on the comparability of the individual companies selected by the TPO in the final set of comparables; which is raised at Ground No.4 (supra). In this view of the matter, the other grounds at S.Nos.1 to 3 and 5 to 7 are dismissed as infrctuous.

5.2 It is seen that the assessee in its T.P. Study, had adopted TNMM as the Most Appropriate Method (‘MAM’), using the search processes Prowess and Capitative, and after applying certain filters, the assessee selected the following eight companies as comparables to it; the details of which are extracted and reproduced hereunder :-

Since the assessee's net margin for transactions with its AEs computed at 14.00% was higher than the average net margin of the comparable companies, at 8.89%, the assessee concluded that its international transactions with its AEs was at Arm’s Length and that therefore no T.P. Adjustment was required.

5.2 The TPO, while accepting TNMM as the MAM, rejected the assessee's T.P. Study and carried out his own search using ‘Prowess’ and ‘Capitaline’, applying various filters. In this process the TPO rejected all 8 comparables selected by the assessee and selected the following 20 companies as his final set of comparables :-

5.3 The TPO finally passed the order under Section 92CA of the Act dt.30.10.2009 and on the basis of the margins set out above arrived at the arithmetic mean of 20.68%. After granting working capital adjustment of 0.86%, the adjusted arithmetic mean was determined at 19.82%. The computation of ALP by the TPO in this regard was as under :-
Computation of Arm’s Length Price.

Price Received vis-à-vis Arm’s Length Price.

The above short fall of Rs. 1,61,74,393 was treated as the T.P. Adjustment u/s.92CA of the Act.
5.4 Against the aforesaid T.P. Adjustment proposed by the TPO (supra), which was incorporated in the draft assessment order, the assessee filed objections before the DRP, Bangalore. The DRP rejected the assessee's objections and upheld the T.P. Adjustments proposed by the TPO. Accordingly, the T.P. Adjustment upheld by the DRP was incorporated in the impugned final order of assessment. The assessee is now in appeal before us against the final order of assessment for Assessment Year 2006-07 passed under Section 143(3) r.w.s. 144C of the Act dt.11.10.2010.

5.5 In the appellate proceedings before us, the learned Authorised Representative of the assessee filed a chart explaining as to how some of the comparable companies chosen by the TPO are not comparable to the assessee in the case on hand. These are broadly :-

i) for the reason that the turnover of those companies were beyond Rs. 200 Crores and therefore cannot be compared with the assessee, whose turnover is Rs. 19.67 Crores;
ii) for the reason that certain comparables were functionally dis-similar and therefore not functionally comparable to the assessee;
iii) for the reason that Related Party Transactions (‘RPT’) of some of the comparable companies during the period under consideration were in excess of 15% of its revenues and hence ought not to be included as comparables.

The chart also cites the judicial pronouncements of various benches of the ITAT where certain comparable companies have been held to be not comparable with that of a taxpayer providing IT Software Development Services. We will now proceed to consider the comparability of companies chosen by the TPO in his order under Section 92CA of the Act dt.30.10.2009.

6. Turnover Filter of Rs. 200 Crores.
6.1 The learned Authorised Representative of the assessee brought to our notice that out of the 20 comparable companies selected by the TPO (supra), the following 6 companies will have to be excluded as their turnover is in excess of Rs. 200 Crores and cannot be taken as comparable to the assessee whose turnover in the relevant period was only Rs. 19.67 Crores. These companies are :-

6.2 In support of the proposition that these six companies ought to be excluded from the list of comparables as their turnover was in excess of Rs. 200 Crores, whereas that of the assessee was only Rs. 19.67 Crores in the period under consideration, the learned Authorised Representative of the assessee referred to and placed reliance on the decisions of various benches of the ITAT. Our attention was specifically drawn to the observations of the co-ordinate bench of this Tribunal in the case of Triology E-business Software India Pvt. Ltd. in ITA No.1054/Bang/2011 dt.23.11.2012, on the application of the turnover filter at Rs. 200 Crores and it submitted that in view of this, the aforesaid six comparable companies have to be excluded from the final list of comparables selected by the TPO.

6.3.1 We have heard both the learned Authorised Representative of the assessee and the learned Departmental Representative for revenue and perused and carefully considered the material on record. In the case of Triology E-business Software India Pvt. Ltd. (supra), cited by the assessee, the co-ordinate bench of this Tribunal on the issue of the application of the turnover filter while selecting comparable companies for comparability analysis has held as follows :-

 “ Turnover Filter
11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Rs. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the 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 differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard 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 lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:-

“Size criteria in terms of Sales, Assets or Number of Employees: The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the buyer and seller and therefore comparability.”

12. The ICAI TP Guidelines note on this aspect lay down in para 15.4 that a transaction entered into by a Rs. 1,000 crore company cannot be compared with the transaction entered 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. The fact that they operate in the same market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: “Clause (i) lays down that if the differences are 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 TPO’s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 14. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet’s analysis, the turnover 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 judicial 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 also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these 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 proposition 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. DCIT (ITA No.1254/Bang/20l0).
3. Electronic for Imaging India Private Limited (ITA No. 1171/Bang/2010).

It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable 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 having turnover of more than Rs. 200 crores as comparables. In these circumstances, it was submitted by him that the assessee 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 deciding 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 arm’s length price. Sec.92-B provides that “international transaction” means a transaction between two or more associated enterprises, either or both of whom are nonresidents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92-A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the 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 Arm’s length price in an international transaction and it provides:- that the arm’s length price in relation to an international transaction shall be determined by any 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 arm’s length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm’s length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price. (3) Where during the course of any proceeding for the 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 subsection (1) of section 92D and the rules made in this behalf; or
(c) the information or data used in computation of the arm’s 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 arm’s length price in relation to the said international transaction in accordance with subsections (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 arm’s length price under section 92C:- “10B. (1) For the purposes of subsection (2) of section 92C, the arm’s length price in relation to an international transaction shall be determined by any of the following 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 arm’s length price in relation to the international transaction. (2) For the purposes of sub-rule (1), the comparability 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;
(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 comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.” 19. A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability 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 clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is Rs. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs.

(1) Flextronics Software Systems Ltd. 848.66 crores
(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.”

6.3.2 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Triology E-business Software India Pvt. Ltd.(supra), we hold the aforesaid 6 companies listed at para 6.1 of this order should be excluded from the list of comparable companies as their turnover is in excess of Rs. 200 Crores. The Assessing Officer is accordingly directed to re-compute the arithmetic mean of the comparable companies after excluding the aforesaid 6 companies from the list of comparables.

7. Related Party Transactions exceeding 15%.

7.1 In respect of the following 3 comparable companies selected by the TPO, the learned Authorised Representative of the assessee has objected to their inclusion in the list of comparables on the grounds of that their RPT is in excess of 15%. The three comparables are -

In support of their exclusion, the learned Authorised Representative has placed reliance on the decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. in IT(TP)A No.1172/Bang/2010 dt.26.9.2014; which is also for Assessment Year 2006-07; the period under consideration. The learned Authorised Representative prayed that in view of the above, these three comparables be excluded from the list of comparable companies to the assessee.
7.2 We have heard the rival contentions of both the learned Authorised Representative and learned Departmental Representative, perused and carefully considered the material on record; including the judicial decision cited and placed reliance upon by the assessee. The fact is that the RPT in the case of the above three comparable companies listed at para 7.1 (supra) exceed 15%. The co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (supra) for Assessment Year 2006-07, as in many other decisions of this Tribunal, has held that where the RPT exceeds 15%, such companies should not be taken as comparables. The operative portion of this order of the coordinate bench (supra) in paras 8.11 and 8.12 at pages 16 & 17 thereof is extracted hereunder :-

“ 8.11 Megasoft Ltd.
8.12 Aztech Software Ltd.
8.13 Geometric Software Ltd.

Ld. AR submitted that in each of the above companies the RPT filter exceeded 15%. According to him, RPT filter has been upheld by this Tribunal in a host of decisions including that of EMC Data (supra). Per contra, the ld. DR supported the orders of authorities below. We have perused the orders and heard the rival contentions. Application of RPT filter while selecting the comparables has been held to be an appropriate criteria by this Tribunal in a number of decisions. In the case of EMC Data (supra), it was held as under:-

“16. As far as comparable companies at Sl.No.1 & 2 &19 of the chart of comparable companies chosen by the TPO at page-4 of this order viz., Aztec Software Limited and Geometric Software Ltd. (Seg.) and Megasoft Ltd., is concerned, it is not in dispute before us that the related party transaction in the case of companies exceeds 15% and in view of the decision of the Tribunal in the case of 24 X 7 Customer.Com Pvt. Ltd. in ITA No.227/Bang/2010, followed by this Tribunal in the case of Logica Private Ltd. (supra) wherein it was held that where the RPT exceeds 15%, such companies should not be taken as comparable companies. Following the said decision, we hold that companies at Sl.Nos. 1 & 2 & 19 referred to above of the list of the comparable companies chosen by the TPO be excluded from the list of comparable companies while working out the ALP.” There is no dispute that RPT filter in the case of Megasoft Ltd. was 17.08%, that of Aztech Software Ltd. was 17.78% and that of Geometric Software Ltd. was 19.34%. Coordinate Benches of the Tribunal are consistently following 15% as cut off mark for applying the RPT filter. Accordingly, we direct exclusion of Megasoft Ltd., Aztech Software Ltd. and Geometric Software Ltd. from the comparables.”

7.3 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (supra), we hold that the aforesaid three companies listed at para 7.1 of this order be excluded from the list of comparables.

8. Improper Selection of Comparables - Functionally Different.
8.1 The learned Authorised Representative submitted that the following four companies be excluded from the list of comparables selected by the TPO as they are functionally different and not comparable to the assessee.

i) KALS Information Systems Ltd.
ii) Tata Elxsi Ltd. (Seg).
iii) Accel Transmatics Ltd. (Seg.) and
iv) R Systems International Ltd. (Seg.)

In this connection, the learned Authorised Representative drew the attention of the bench to the decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (Supra) for Assessment Year 2006-07, wherein the companies listed at S.Nos.(i), (ii) and (iii) supra were held to be not functionally comparable with that of a pure software developer like the assessee.

8.2.1 We have heard the rival contentions of both the learned Authorised Representative and the learned Departmental Representative, perused and carefully considered the material on record; including the judicial decision cited and placed reliance upon by the assessee. On a perusal of the decision of the co-ordinate bench of the Tribunal in the case of Agile Software Enterprises Pvt. Ltd. (supra) for Assessment Year 2006-07, relied upon by the assessee, we find that the following three companies were excluded from the TPO’s list of comparables as they were held to be functionally different from the assessee, who was into pure software development services :-

i) KALS Information Systems Ltd.
ii) Tata Elxsi Ltd. (Seg).
iii) Accel Transmatics Ltd. (Seg.) and

8.2.2 In this context, the relevant observations and findings of the co-ordinate bench in the case of Agile Software Enterprises Pvt. Ltd. (supra) at para 8.7 to 8.9.3 thereof are extracted hereunder :-
“ 8.7 KALS Information Systems Ltd: The ld. AR submitted that this company was a software product company and could not be compared with that of the assessee. The assessee was a software services company and not a software product company. Reliance was placed on the decision of Trilogy ebusiness Software (I) Pvt. Ltd. (supra). As per the ld. AR, same view was taken in EMC Data (supra) also.

8.7.1 Per contra, the ld. DR submitted that KALS Information Systems Ltd. could not be considered as a software product company.

8.7.2 We have perused the orders and heard the rival contentions. We find that KALS Information Systems Ltd. was considered as a software product company in both Trilogy e-business(supra) as well as EMC Data (supra). In these decisions, a host of companies, inter alia, including KALS Information Systems Ltd. were deliberated upon and held as under:-

“12. The following were the relevant observations of the Tribunal on the aforesaid comparable companies in the case of Triology E-Business Software India Pvt.Ltd.(supra):
“(d) KALS Information Systems Ltd.

As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Q 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal’s 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 of it being functionally different from software companies. The relevant extract are as follows:

“16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion 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 is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually 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 rejected as a comparable.

We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO 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 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 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 development 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 that Accel Transmatic should be rejected as comparable. The relevant 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 that the business activities of the company were as under.

(i) Transmatic system - design, development and manufacture of multi function kiosks Queue management system, ticket vending system
(ii) Ushus Technologies - offshore development centre 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,enterprise 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 assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee’s claim that this company was functionally different was accepted. DRP therefore directed the Assessing Officer to exclude ACCEL Transmatic Ltd. from the final list of comparables for the purpose of determining TNMM margin.” Besides the above, it was pointed out that this company has related party transactions which is more than the permitted level and therefore should not be taken for comparability purposes. The submission of the ld. counsel for the assessee was that if the above company should not be considered as 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 company 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 referred to by the ld. counsel for the assessee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables.”

13. The facts and circumstances under which the aforesaid companies were considered as comparable is identical in the case of the Assessee as well as in the case of Triology E-Business Software India Pvt.Ltd. (supra). Respectfully following the decision of the Tribunal referred to above in the case of Triology E-Business Software India Pvt.Ltd.(supra), we direct that the following companies (listed as Sl.No.4 & 15 of the list of comparable companies chosen by the TPO and listed in para-4 of this order) be excluded from the list of 20 comparable arrived at by the TPO.”

8.7.3 It might be true that a number of software development companies in their TP studies might have considered KALS Infosystems Ltd. as a comparable and not as a software product company. However this, in our opinion, will not dilute the findings in this regard given by the Tribunal. The assessee having relied on the decision of the Tribunal wherein it has been held that KALS is a software product company, unless the decision of a higher authority which is different from the one given by the coordinate Bench is shown by the revenue, it will not be possible to deviate from the view earlier taken by a coordinate Bench. Accordingly, we direct that KALS Information Systems Ltd. be excluded from the comparables.

8.8 Accel Transmatics Ltd.: Ld. AR raised similar contentions for exclusion of this company as was made in the case of KALS Information Systems Ltd. (supra). Ld. DR also raised similar objections. We find that Accel Transmatics Ltd. has also been considered as a software product company by this Tribunal in the decisions cited at para 8.7.2 above. Relevant part of the decision has been reproduced by us therein. Accordingly, we direct that Accel Transmatics Ltd. be excluded from the comparables.

8.9 Tata Elxsi Ltd.: Ld. AR submitted that this company was engaged in research & development which resulted in creation of Intellectual Property Rights and therefore was a software product company. Reliance was placed on the decision of coordinate Bench of the Tribunal in the case of EMC Data (supra).

8.9.1 Per contra, the ld. DR submitted that Tata Elxsi Ltd. was not a software product company, but was engaged only in development of software.

8.9.2 We have heard the rival contentions. Whether Tata Elxsi Ltd. could be considered as a software development company was one of the issues which came up for consideration before the this Tribunal in the case of EMC Data (supra), wherein it was held as under:-

 “17. As far as comparable at Sl.No.9 of the list of comparable chosen by the TPO listed in the chart given at para-4 of this order viz., Tata Elxsi Ltd., is concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of this Tribunal in the case of Logica Pvt.Ltd. IT (TP) 1129/Bang/2011 AY 07- 08) wherein on the aforesaid company, the Tribunal held as follows:-

“14. As far as comparable at Sl.No.6 & 24 are concerned, the comparability of the aforesaid two companies with that of the software service provider was considered by the Mumbai Bench of the Tribunal in the case of Telcordia Technologies India Private Ltd. (supra) wherein on the aforesaid two companies, the Tribunal held as follows:-

7.7. Tata Elxsi Limited.:

From the facts and material on record and submissions made by the learned AR, it is seen that the Tata Elxsi is engaged in development of niche product and development services, which is entirely different from the assessee company. We agree with the contention of the learned AR that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties.”

15. In view of the above, the ld. counsel for the assessee fairly admitted that comparable company at Sl.No.6 viz., Flextronics Software Systems Pvt. Ltd. should be taken as a comparable, while comparable at Sl.No.24 viz., Tata Elxsi Ltd. should be rejected as a comparable.”

18. In view of the aforesaid decision, we hold that Tata Elxsi has to be excluded from the list of comparable chosen by the TPO.”

8.9.3 The assessee before us is not developing any niche product. As held by the coordinate Bench of the Tribunal (supra), Tata Elxsi Ltd. could not be considered as a software development company simplicitor. That Tata Elxsi Ltd. was functionally different, has been held by the coordinate Bench of the Tribunal in the case of Yodlee Infotech Pvt. Ltd. (ITA No.1397/Bang/2010 dated 15.2.2013) as well. We therefore direct that Tata Elxsi Ltd. be excluded from the comparables.”

8.2.3 Following the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Agile Software Enterprises Pvt. Ltd. for Assessment Year 2006-07 (supra), we hold that the above mentioned three companies i.e. i) KALS Information Systems Ltd. ii) Tata Elxsi Ltd. (Seg). and iii) Accel Transmatics Ltd. (Seg.) should be excluded from the TPO’s final list of comparables. The Assessing Officer is directed to re-compute the ALP of the assessee's international transactions after excluding these three companies.

8.4 R. Systems International Ltd. (Segmental).

8.4.1 In the proceedings before us, the learned Authorised Representative submitted that this company should be excluded from the list of comparable companies as it is functionally different from the assessee and not comparable to it.

8.4.2 This company was selected as a comparable company by the TPO, based on information collected in response to requisition made under Section 133(6) of the Act and on the basis of statements made in this company’s Annual Report. As per the reply submitted by this company to the information called for under Section 133(6) of the Act, the revenue by way of software licenses / products constitute only 0.64% of the total revenues of Rs. 79.42 Crores and the balance revenue is earned form software development services. In view of this reply, the TPO considered this company to be a software development company and accordingly adopted this company as a comparable.

8.4.3 Before the DRP, Bangalore, the assessee contended that this company was adopted as a comparable company by the TPO without affording the assessee an opportunity of being heard, as this company was not included in the show cause notice issued by the TPO. In view of this, the DRP directed the TPO to examine this objection and furnish his comments thereon. After considering the TPO’s report in the matter and hearing the assessee's contentions, the DRP held that the TPO was justified in selecting this company as a comparable company to the assessee.

8.4.4 Before us, the learned Authorised Representative argued at length that this company is a product company and needs to be excluded from the list of comparable companies, referring to the Directors Report and the audited financial statements of the company. Attention of the Bench was drawn to the fixed asset schedule, wherein product development cost of Rs. 40,57,182 was capitalized and shown under the gross block of fixed assets. Our attention was also drawn to the company’s reply dt.16.1.2009, wherein it has referred to one particular Loan Organisation System (‘LOS’) product for retail lending for over 12 years consisting of three offerings that can be used independently interfaced with other banking and lending solutions or together and that the company has implemented the solutions in over 80 sites over the years. It also mentions that the license fee depends on the size of the customer’s lending business and the number of loan portfolios that the customer does business in. Laying emphasis on this reply of the company, the learned Authorised Representative argued that the revenue of this company is essentially license fees received by the assessee for selling the software products which has been described as ‘software development and customization services’ in its accounts. The learned Authorised Representative contended that, in view of this, R Systems International Ltd. is a product company and different from any software development services company like the assessee and pleaded for its exclusion from the list of comparable companies.

8.4.5 Per contra, the learned Departmental Representative pointed out that the product development cost of Rs. 45.07 lakhs shown in the fixed assets constitutes only a miniscule portion of the fixed assets which aggregate to about Rs. 14 Crores and it is inconceivable that such a product could have generated revenues of Rs. 79.41 Crores to the company. The learned Departmental Representative further pointed out that this company itself has categorized revenue of Rs. 79.41 Crores out of its total revenues of Rs. 88.59 Crores as ‘Software Development and Customisation Services’ in the segmental information furnished along with its final accounts. It was also pointed out that no revenue from product sale in the form of license fee was shown by this company and therefore it is factually incorrect to say that the entire revenue under this head is derived from license fee. Further, the description of transactions as reported in Annexure D to the accounts indicate that the company is primarily engaged in software development services. The learned Departmental Representative also referred to the company Chairman’s Message which contain elaborate narration of the company’s offerings under different sub-heads; the product group being the least of such offerings. At the outset itself, this company has described itself as one of the largest offshore based I.T. Services Company that focuses on the special needs of organizations and throughout the description of other offerings, the company has described itself as a software development services company. The learned Departmental Representative prayed that in view of the above, the orders of the authorities below in including this company in the list of comparables be upheld.

8.4.6 We have heard the rival contentions and perused and carefully considered the material on record. From an appreciation of the details furnished by this company, in reply to the requisition under Section 133(6) of the Act, it is seen that the revenues by way of software licenses / products constitute only 0.64% of the software development service segment revenues of Rs. 79.42 Crores, a fact that is not controverted by the assessee. This, therefore, satisfies the filter of revenue greater than 75% from software development services, applied by the TPO. In any case, a miniscule revenue of 0.64% cannot transform this company into a software product company; nor could it be excluded from the list of comparables by holding the revenue of 0.64% as a separate segment in itself. That the fixed assets include an amount of Rs. 40.57 lakhs towards product development cost, does not by itself, establish that the assessee generates revenue from product development. At best, in our view, it could simply be a tool, developed by the assessee for its software development activities. Anyway, as pointed out by the learned Departmental Representative, the amount of Rs. 40.57 lakhs on an asset base of about Rs. 14 Crores is too small a component to claim that it can generate revenue of the order of Rs. 79.42 Crores for it to be characterized as a software product company. We find that in the factual matrix of the case, the learned Authorised Representative of the assessee could not demonstrate that the revenue of Rs. 79.42 Crores is mainly from license fees or product development. In these factual circumstances, we find no reason to contradict the finding of the TPO that this company is mainly into software development services and therefore its inclusion by the TPO in the list of comparables cannot be faulted. This finding of ours is in tune with the decisions in transfer pricing appeals decided by the coordinate benches of this Tribunal, wherein the status of this company as being a software development services entity was not disputed. In this view of the matter, we uphold the inclusion of this company as a comparable company by the TPO and consequently dismiss the assessee's grounds raised in this appeal in this regard.

9. Accordingly, the grounds raised by the assessee at S. Nos. 1 to 7 in respect of transfer pricing issues stand disposed off as indicated above.

CORPORATE TAX ISSUES
10. Ground Nos. 8 & 9 : Deduction u/s. 10A of the Act.

10.1 The assessee challenges the action of the authorities below (i.e. the Assessing Officer and the DRP) in excluding expenses incurred in foreign currency towards freight, telecommunication, insurance, etc. from export turnover while computing the deduction under Section 10A of the Act. Without prejudice to its contention that the aforesaid sums should not be excluded from the export turnover, while computing the deduction under Section 10A of the Act, the assessee has also made an alternate plea that the expenses that are reduced from export turnover should also be reduced from total turnover, placing reliance on the decision of the Hon'ble Karnataka High Court in the case of CIT V Tata Elxsi Ltd. (2012) 349 ITR 98 (Kar).

10.2 We have heard both the learned Authorised Representative and the learned Departmental Representative in the matter. Taking into consideration the decision rendered by the Hon'ble High Court of Karnataka in the case of Tata Elxsi Ltd. (supra), we are of the view that it would be just and appropriate to direct the Assessing Officer that freight, telecommunication charges and insurance charges incurred in foreign currency are to be excluded from both export turnover as well as total turnover while computing the deduction under Section 10A of the Act, as has been prayed by the assessee in its alternate plea at Ground raised at No.9. In view of the acceptance of the alternate plea of the assessee, we are of the view that no adjudication is called for on Ground No.8 as to whether the aforesaid expenditure are required to be excluded from export turnover.

11. Ground No.11 - Charging of interest under Section 234B, 234C and 234D of the Act.

11.1 In this Ground, the assessee challenges the action of the Assessing Officer in charging the assessee interest under Section 234B, 234C and 234D of the Act. The charging of interest under the aforesaid sections is consequential and mandatory and the Assessing Officer has no discretion in the matter. In this view of the matter, we uphold the Assessing Officer’s action in charging the said interest. The Assessing Officer is, however, directed to re-compute the interest chargeable under Section 234B, 234C and 234D of the Act, if any, while giving effect to this order.

12. In Ground No.11, the assessee contends that there has been an arithmetical mistake while computing the taxable income as Rs. 2,85,25,919 while adding the adjustment to the returned income. In this regard, the Assessing Officer is directed to examine the veracity of the assessee's claim and make the computation of income as per law.

13. In the result, the assessee's appeal for Assessment Year 2006-07 is partly allowed.

The order pronounced in the open court on 20th Feb., 2015.