web hosting co. isn’t comparable with co. rendering software development services

By | September 21, 2016

Radisys India (P.) Ltd.


Income-tax Officer, Ward- 5 (1), Bangalore


IT (TP) APPEAL NOS. 345 & 371 (BANG.) OF 2015

SEPTEMBER  4, 2015

Smt. Mahaveer C. Jain, CA for the Appellant. Sunil Kumar Agarwal, CIT-DR-I for the Respondent.


Abraham P. George, Accountant Member – These are appeals filed by assessee and Revenue respectively directed against an assessment order dt. 23-1-2015 passed u/s 143(3) r.w.s. 144C of the Income-tax Act, 1961 (‘the Act’ in short Appeal of the Revenue is taken up first for disposal.

2. Revenue has altogether taken three grounds. Ground 1 assails direction of DRP for reducing expenditure in foreign currency on telecommunication and travel, both from export turn over as well as total turnover for computation of deduction u/s. 10A of the Act.

3. We find that DRP had followed the judgment of Hon’ble jurisdictional High Court in the case of CIT v. Tata Elxsi Ltd.[2012] 349 ITR 98 . Just because the judgment has not been accepted by the Revenue and it has moved an SLP before the Hon’ble Apex Court would not be a reason for not following the judgment. We find no error in the order of AO in this regard. Ground. 1 is dismissed.

4. Vide its ground 2, grievance of the Revenue is that DRP directed exclusion of comparables having turnover of more than Rs.200 crores from the list of comparables selected by the TPO for making ALP analysis of the international transactions undertaken by the assessee.

5. Ld. DR submitted that there was no correlation between the turnover and profits and therefore application of turnover limit rule was not proper.

6. Ld. AR on the other hand supported the order of DRP.

7. We have perused the orders and heard the rival contentions. Appropriateness of the application of turnover filter had come up before this Tribunal in the case of Genisys Integrating Systems (India) (P.) Ltd. v. Dy. CIT [2012] 53 SOT 159  (Bang.). The Tribunal held as under :

‘8. According to learned counsel of for the assessee size is an important facet of an enterprise level difference. He Submitted that comparables should have something similar or equivalent and should possess same or almost the same or almost the same characteristics. To use a simile, he submitted that a Maruti 800 car cannot be compared to Benz car, even though both are cars only. He submitted that unusual pattern, stray cases, wide disparities have to be eliminated as they do not satisfy the test of comparability. Companies operating on large scale benefit from economies of scale, higher risk taking capabilities, robust delivery and business models as opposed to the smaller or medium sized companies and therefore, size matters. Two companies of dissimilar size therefore, cannot be assumed to earn comparable margins and this impact of difference in size could be removed by a quantitative adjustment to the margins or price being compared if it is possible to do so reasonably accurately. He submitted that size as one of the selection criteria has also been approved by various Benches of the Tribunal, in the following cases:
1. Dy. CIT v. Quark Systems (P.) Ltd. (2010) 132 TTJ (Chd)(SB) 1 : (2010) 42 DTR (Chd)(SB)(Trib) 414 : (2010) 38 SOT 307 (Chd)(SB), wherein it was held that even the filter of lower turnover of Rs. 1 crore is without any reasonable basis and there is no filter for higher turnover also. The application of turnover filter also leaves much to be desired and has to no rationale basis. In our considered view, it is improper to proceed on the basis that the turnover of Rs. 1 crore to infinite is a reasonable classification as turnover base.
2. E-Gain Communication (P.) Ltd. v. ITO (2008) 118 TTJ (Pune) 354 : (2008) 13 DTR (Pune) (Trib)65;
3. Sony India (P) Ltd. v. Dy. CIT (2008) 118 TTJ (Del) 865 : (2008) 14 DTR (Del)(Trib) 228 : (2008) 114 ITD 448 (Del);
4. Dy. CIT v. Indo American Jewellery Ltd., ITA No. 6194/Mum/2008 [reported at (2010) 131 TTJ (Mumbai) 163 : (2010) 40 DTR (Mumbai)(Trib) 386—Ed.];
5. Philips Software Centre (P.) Ltd. v. Asstt. CIT (2008) 119 TTJ (Bang) 721 : (2008) 15 DTR (Bang)(Trib) 505 : (2008) 26 SOT 226 (Bang);
6. Asstt. CIT v. NIT (2011) 57 DTR (Del)(Trib) 334
8.1 He further submitted that size as a criteria for selection of comparables is also recommended by OCED in its TP guidelines. The observation of OCED in para 3.43 of the chapter guidelines reads 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.”
8.2 The learned counsel for the assessee submitted that similar observations were also made by ICAI in para 15.4 of TP guidance note. He submitted that TPO’s range of Rs. 1 crore to infinity has resulted in selection of companies like M/s Infosys which is having a turnover of Rs. 9,028 crores which is 1,1007 times bigger than the assessee company which has a turnover of Rs. 8.15 crores. He further submitted that NASSCOM has also categorized the companies based on the turnover as follows :
1. Greater than USD 1 billion (approx. Rs. 50,000 crores)
2. Between USD 100 million to USD 1 billion (Rs. 500 crores to Rs. 5,000 crores) and
3. Others having less than USD 100 million (Rs. 500 crores).
Thus, the learned counsel for the assessee submitted that an appropriate turnover range should be applied in selecting a comparable of uncontrolled companies and the assessee has accordingly, applied the turnover range of Rs. 1 crore to Rs. 200 crores based on Dun and Bradstreet’s analysis. He submitted that in the alternative, the categories recognized by NASSCOM may also be applied in selecting comparables.
8.3 The learned Departmental Representative rebutted this argument and submitted that the Act or Rules does not provide for the turnover filter. He submitted that as rightly pointed out by the TPO in the case of service sector, the size of the company does not matter because, the infrastructure layout is very less and it will not affect the profit ratio in any way. He drew our attention to the particular portion of TPO’s order wherein the TPO has the reasoning given for rejecting the turnover filter.
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 are 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 consider. We agree with the contention of the learned counsel for the assessee that the size matter in business. A big company would be in a position to bargain the price and also attract more customers 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 are 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 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 crore to Rs. 200 crores have to be taken as a particular range and the assessee being in that range having turnover of Rs. 8.15 crores, the companies which also have turnover of Rs. 1 to Rs. 200 crores only should be taken into consideration for the purpose of making TP study.’

8. Accordingly we are of the opinion that DRP was justified in directing exclusion of comparables having turnover in excess of Rs.200 crores. We do not find any reason to interfere. Ground 2 is dismissed.

9. Vide its ground 3 (erroneously mentioned as no.2), grievance raised by the Revenue is that DRP directed the TPO to exclude Larsen & Toubro Infotech Ltd. Persistent Systems Ltd. R S Software (India) Ltd, on a premise that companies having any RPV transactions could not be considered as proper comparables.

10. Ld. DR submitted that this Tribunal in the case of 24/7 Customer.com (P.) Ltd. v. Dy. CIT [2013] 140 ITD 344 (Bang.), had given a clear finding that RPT filter had to be applied at 15% and only those comparable which had RPT in excess of 15% should be excluded.

11. Ld. AR fairly admitted that RPT @ 15% could be applied.

12. We have perused the orders and heard the rival contentions. In the case of 24/7 Customer.com (P.) Ltd. (supra), it was held as under :

‘In respect of the ground raised at S.No. l regarding acceptance of comparable companies having related party transactions as proposed by the TPO, the learned counsel for the assessee argued that the transfer pricing regulations do not stipulate any minimum limit of related party transactions which form the threshold for exclusion as a comparable. In this regard, the learned counsel for the assessee objected to the TPO’s setting a limit of 25 percent on related party transactions. He objected to the inclusion of comparables being related party transactions in excess of 15 percent of sales / revenue. In support of this proposition, the learned counsel 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 entity can be taken as uncontrolled if its related party transactions do not exceed 10 to 15 percent of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of the comparables. For the purpose of comparison what is to be judged is the impact of the related party transactions vis-a-vis sales and not profit since profit of an enterprise is influenced by large number of other 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 comparables from the list with related party transactions or controlled transactions in excess of 15 percent of total revenues for the financial year 2003-04.’

13. There is a clear finding given by the Tribunal in the case of selecting comparables, 15% is the threshould limit of RPTS. Accordingly, we set aside the order of DRP and direct the AO/TPO to consider 15% as threshold limit for RP transactions and consider all the comparables in the list of comparables which do not have RPT exceeding 15%, for the analysis of international transactions of the assessee for the impugned assessment year, provided other conditions for comparability are satisfied. Ordered accordingly. Ground 3 of the Revenue is treated as allowed for statistical purpose.

14. Now we take up appeal of the assessee. Assessee has altogether taken five grounds of which, ground 1 is general and Ground 5 is consequential in nature. Ld. Counsel for the assessee at the outset submitted that he was not pressing ground 4. Ground 4 is dismissed as not pressed. This leave us with grounds 2 and 3. Ground 2 of the assessee is reproduced hereunder:

“The learned Transfer Pricing Officer has grossly erred by arbitrarily rejecting the companies selected by the Appellant as comparables on unjustifiable grounds and the Hon’ble Dispute Resolution Panel has erred in confirming the same.”

15. Though in the above ground assessee assails rejection of comparables selected by it, Ld. AR submitted that he was particularly peeved by exclusion of Akshay Software Technologies Ltd. As per Ld. AR, this was one of the eight companies considered by the assessee in its TP study. Ld. AR submitted that Akshay Software Technologies Ltd. was rejected by the TPO for the sole reason that RPT data was not available in the public domain. As per the Ld. AR it was not disputed that Akshay Software Technologies Ltd. was having the same functional profile as that of the assessee. Ld. AR submitted that though it had brought this to the notice of the DRP the DRP also was of the opinion that RPT details being not available, Akshay Software Technologies Ltd. could not be considered.

16. Ld. AR submitted that audited annual report of Akshay Software Technologies Ltd for F. Y. 2010-11 was available in public domain. According to him such results for F. Y. 2010-11 also reflected the financial results for the financial year ending 31.03.2010. Relying on Annexure -F placed at page 25 of the paper book, Ld. AR submitted that RPT of the said company was clearly shown as a part of its Schedule 14, being notes to the audited financial statement. As per the Ld. AR, related party transactions for F. Y. 31.03.2010 was Rs.47,05,640/- against which the actual income from software service for the said year was Rs. 10,86,57,547/-. This as per the Ld. AR worked out to 4.33% only. Such figures being available in public domain, according to the Ld. AR, it was not appropriate to reject Akshay Software Technologies Ltd from the list of comparables.

17. Per contra, Ld. DR submitted that the figures submitted by the assessee, though stated as available in public domain, still required verification.

18. We have perused the orders and heard the rival contentions. TPO had rejected Akshay Software Technologies as a comparable for the reason that RPT data for the relevant previous year was not available. As per the assessee, such details were available in public domain and could have been easily culled out from the 24th annual report of the said companies placed at Annexure-F of the paper book. We have verified the 24th Annual report placed by the assessee in the paper book. It is true that said Annual report is for F.Y. 2010-11. However, figures for F. Y. 2009-10 are also available in the said financial statement. Nevertheless, it is required to verify the authenticity of the figures for earlier year shown in the said financial statement for for F.Y. 2010-11, for the reason that financial statement of F. Y. 2009-10 as such was not available in the public domain. No doubt the income under the head “services” on related party transaction, from the RPT for F. Y. 2009-10 is shown in para 9 (b) of Schedule 14 at Rs.47,05,640/- against which the total revenues for the said year of the said company came to Rs. 10,86,57,547/-. This works out to 4.33%. In our opinion the matter requires a fresh look by the AO. Since these details have not been verified by AO/TPO, we set aside the orders of the authorities in this regard and remit this issue of comparability of Akshay Software Technologies back to the file of the AO/TPO for fresh consideration in accordance with law, after considering the correct RPT of the said company. Ground 2 of the assessee is therefore treated as partly allowed.

19. Assessee’s ground 3 is reproduced hereunder :

“The learned Transfer Pricing Officer has grossly erred by disregarding the functional and risk profile of the Appellant and comparing it with companies, which have an entirely different functional and risk profile and the Hon’ble Dispute Resolution Panel has erred in confirming the same.”

20. Ld. Counsel for the assessee submitted that though the ground was generic in nature, he was aggrieved by inclusion of two companies, namely, Kals Information Systems Ltd, and ICRA Techno Analytics Ltd (seg) in the list of comparables. As per the Ld. AR, Kals Information System Ltd. and ICRA Techno Analytics Ltd. (seg), would come back into the list of comparable once RPT filter of 15% was applied. Vis-a-vis, Kals Information System, Ld. AR.submitted that assessee had specifically objected before the TPO dissimilarity. As per the Ld. AR, Delhi Bench in the case of Qualcom India (P.) Ltd. v.ACIT [IT Appeal 5239 (Delhi) of 2010, dt.10.06.2013] had held that Kals Information Systems Ltd was into development of software products and services and was not comparable with a software development services concern. As per the Ld. AR the same view was taken by a coordinate bench of this Tribunal in the case of Trilogy E Business Software India (P.) Ltd. v.Dy. CIT [2013] 140 ITD 540  (Bang. – Trib.) Ld. AR submitted that the audited final accounts and annual report of Kals Information Systems Ltd, for F. Y. 2009-10 was available in public domain and placed as Annexure-A of the paper book. Placing reliance on Schedule 14, Ld. AR submitted that income of the said company was from software services, software products and training and it had inventories which would go to show that the said company was engaged more in software product development than in software development services. Thus according to him, Kals Information Systems Ltd was not a proper comparable. In any case, according to him, when segmental results were not available in public domain, a company could not be considered for comparability.

21. Vis-a-vis, ICRA Techno Analytics Ltd. (seg), Ld. AR submitted that the said concern was functionally not comparable and segmental results were also not available. As per the Ld. AR, TPO had considered it as a proper comparable only for a reason that it was providing software solutions as per its Director’s Report. Ld. AR also pointed out that the said company was more into ITES segment and for this reliance was placed on its audited annual report placed at Appendix-D. As per Ld. AR its revenue from services consisted of software development, consultancy, engineering services, web development and hosting. Relying on safe harbor Rules notified by CBDT, on 18th September, 2013, Ld. AR submitted that web hosting services fell in the category of ITES. According to him, P&L account of ICRA Techno Analytics Ltd. did not show segmentwise reporting results. Therefore according to him considering ICRA Techno Analytics Ltd. as a proper comparable was incorrect.

22. Per contra, Ld. DR and submitted that Kals Information Systems and ICRA Techno Analytics Ltd, were correctly considered as proper comparables.

23. We have perused the orders and heard the rival contentions. First, taking up the case of Kals Information Systems Ltd., argument of the assessee is that Kals Information Systems was functionally dissimilar. Profile of the assessee as it appears at page 2 of TPO reads as under :

“As per the TP Document, the taxpayer company is a wholly owned subsidiary of Continuous Computing Corporation, USA (CCPU) and the taxpayer company is engaged in the development and support of software for CCPU. It is also stated that the taxpayer company is a captive service provider to CCPU and renders all its services to CCPU.”

From the above profile it is clear that the assessee was doing development and support of software falling within the category of software development services. The question before us is whether for the relevant previous year ending 31.03.2010 Kals Information System was also engaged in similar software development services or not. Concern of the assessee is that audited annual report of the said company had not bifurcated its revenue into different streams. Assessee is relying on the following notes appearing in Schedule 14 of the said company, for the year ending 31.03.2010 of the said company :

“1. Background
The company was incorporated under the Companies Act, 1956 as a Private Limited Company in the year 1993. Subsequently the company was converted into a public limited company in the year 2000. The company is engaged in development of Software and Software products since its inception. The company consisting of STPI unit engaged in Development of Software and Software products and a Training Centre engaged in training of Software professionals on online projects.
2. Summary of Significant Accounting Policies
(a) Basis of Accounting: The financial statements are prepared under the historical cost convention on accrual basis of accounting to comply with the accounting standards prescribed in the Companies (Accounting Standards) Rules, 2006 and with relevant provisions of the Companies Act, 1956.
(b) Revenue Recognition: The Company derives its revenues primarily from software services and software products. Revenue from time and material contract is recognized on the basis of software developed and billed in accordance with the terms of the contract. Revenue from the fixed price contract is recognized on the completion of milestones in contracts, under the percentage of completion method. Income from training is recognized on time proportion basis.
f. Inventories : Computer spares are charged to consumption in the year of purchase.”

24. Just for a reason that a company held inventories, we cannot say it is in the nature of a software product company. Computer spares could be held as inventory both by a software development company or a software product development company. The notes appearing in Schedule 14, does show that Kals Information Systems Ltd, had software product development and training centre. Therefore, unless segmental results are available, Kals Information cannot be considered for comparison. We are of the opinion that proper analysis of Kals Information Systems Ltd has not been done and proper inputs required from the said company has not been taken. A fresh look in this regard is required. No doubt in the case ofTrilogy E-Business Solutions Ltd. (supra) and Qualcom India (P.) Ltd. (supra), it was held that Kals Information Systems was not a proper comparable to a software development services company. However, these decisions were for A. Ys. 2007-08 and 2006-07 respectively and cannot be considered as a precedence. Considering all these, we are of the opinion that the issue requires a fresh look by the AO/TPO.

25. Vis-a-vis, ICRA Techno Analytics Ltd. contention of the Ld. AR is that the said concern was also into ITES segment and its results did not give a proper segmentation. Copy of its audited final accounts for the year ending 31.03.2010 has been placed at Annexure-D. Profit and Loss account of the said company shows total income from service of Rs. 1,18,98,000/-. Segmental results are not coming out from any of the schedules, forming integral part of the profit and loss account. Only mention regarding the nature of income appears at schedule 14, being significant accounting policies. Relevant paras read as under:

“BACK GROUND:- The Company was incorporated on July 27, 1992 as Computer Exchange Private Limited (CEPL) and subsequently became wholly owned subsidiary of ICRA Limited on August 25, 2005 and was renamed as ICRA Techno Analytics Limited (ICTEAS). The company is engaged in the software development & consultancy, engineering services, web development & hosting and subsequently diversified itself into the domain of business analytics and business process outsourcing.

(c) Revenue Recognition:-

(i) Revenue from services consists of revenue earned from services performed for software development & consultancy, licensing & sub-licensing fee web development and hosting which is recognized to the extent services are performed.
(ii) Revenue from Sales is recognized as and when delivery of the branded software’s is made and is booked net of trade discount.”

26. Ld. AR has also relied on Safe Harbour Rules notified by CBDT, dt.l8.09.2013. Said Safe-Harbour Rules has given definition of what could be considered as ITES. This is reproduced hereunder:

(e) “information technology enabled services” means the following business process outsourcing services provided mainly with the assistance or use of information technology, namely:-

(i) back office operations;
(ii) call centres or contact centre services;
(iii) data processing and data mining;
(iv) insurance claim processing;
(v) legal databases;
(vi) creation and maintenance of medical transcription excluding medical advice;
(vii) translation services;
(viii) payroll;
(ix) remote maintenance;
(x) revenue accounting;
(xi) support centres;
(xii) website services;
(xiii) data search integration and analysis;
(xiv) remote education excluding education content development; or
(xv) clinical database management services excluding clinical trials.

27. It is clear from the above that web site services is generally considered as falling within ITES segment. That ICRA Techno Analytics was also involved in web-development and hosting is clear from the background information mentioned in its significant accounting policies reproduced supra. Hence, in our opinion before considering ICRA Techno analytics as a proper comparable, it is necessary for a segmental analysis of its results. This issue, in our opinion, requires a fresh look by the AO/TPO so that necessary inputs are taken from the said company for proper analysis of its segmental results and deciding the comparability with that of the assessee.

28. As a result of our discussions at paras 23 to 27, Ld. AO/TPO is directed to consider both Kals Information Systems Ltd and ICRA Techno Analytics Ltd, for comparability after ensuring that they pass the RPT filter, and if required segmental data can be obtained. We, therefore, set aside the orders of lower authorities with regard to Kals Information Systems Ltd (seg) and ICRA Techno Analytics (seg) back to the file of AO/TPO for consideration afresh. In the result, ground 3 of the assessee is partly allowed for statistical purposes.

29. In the result, both the appeals of the Revenue and the assessee are partly allowed for statistical purpose.

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