Case Law Details

Case Name : Global Logic India (P.) Ltd. Vs Deputy Commissioner of Income-tax, Circle 12(1), New Delhi (ITAT Delhi)
Appeal Number : IT Appeal No. 5110 ( Delhi) of 2010
Date of Judgement/Order : 21/12/2012
Related Assessment Year : 2006-07
Courts : All ITAT (4266) ITAT Delhi (937)

ITAT DELHI BENCH ‘I’

Global Logic India (P.) Ltd.

versus

Deputy Commissioner of Income-tax, Circle 12(1), New Delhi

IT Appeal No. 5110 ( Delhi) of 2010
[ASSESSMENT YEAR 2006-07]

DECEMBER 21, 2012

ORDER

Shamim Yahya, Accountant Member

This appeal by the assessee is directed against the order of the Assessing Officer u/s. 143(3) read with section 144C of the I.T. Act for the assessment year 2006-07.

2. The grounds raised read as under:-

1. That the assessing officer erred on facts and in law in completing assessment under Section 143(3) read with Section 144C of the Income-tax Act, 1961 (“the Act”) at an income of Rs. 8,20,86,272 as against the returned income of Rs. 14,78,675.

2. That the assessing officer erred on facts and in law in making an addition of Rs. 7,87,94,571 on account of the alleged difference in the arm’s length price of the ‘international transactions’ of provision of software design and development services on the basis of the order passed under section 92CA(3) of the Act by the Transfer Pricing Officer (“the TPO”).

3. That the assessing officer/the TPO erred on facts and in law in considering the current year data only of the comparable companies disregarding the multiple year data used by the appellant.

3.1 That the assessing officer/the TPO erred on facts and in law in not appreciating that use of single year data of the comparable companies may not adequately capture the market and business cycle reflected in the industry.

4. That the assessing officer/the TPO erred on facts and in law in applying additional filters of percentage of wages to sale, declining sales, NFA/Sales ratio, without appreciating that the selection’ or rejection’ should be based on FAR analysis and not merely on financial results.

4.1 That the assessing officer/the TPO erred on facts and in law in considering (i) Saksoft Limited, (ii) Datamatics Technologies Ltd. and (iii) 3D PLM Software Ltd. having abnormally high profit margin as comparable companies for undertaking benchmarking analysis applying TNMM.

4.2 That the assessing officer/TPO erred on facts and in law in not appreciating that M/s. Saksoft Ltd. cannot be considered as comparable company in as much as (i) the said company was not engaged in business activities comparable to that of the appellant, (ii) the said company has significant related party transaction in excess of 25% of total revenue and (iii) the wages/sales ratio of the company is 40.85% and the NFA/sales ratio is 6.96% which are not comparable to those of the appellant at 60.25% and 19.42%.

4.3 That the assessing officer/TPO erred on facts and in law in not appreciating that Datamatics Technologies Ltd. was engaged in rendering BPO services and cannot be considered as comparable company of the appellant which is engaged in rendering software development services.

4.4 That the assessing officer/TPO erred on facts and in law in considering 3D PLM Software Solutions Ltd. as comparable company not appreciating that the said company has significant related party transactions and also wages/sales ratio of the said company is 41.70% which is not comparable to that of the appellant at 60.25%.

5. That the assessing officer/the TPO erred in rejecting Goldstone Technologies Ltd. and Blue Star Infotech Limited as comparables allegedly on the ground that there has been decline in the sales of such companies.

5.1 That the assessing officer/the TPO erred on facts and in law in rejecting PSI Data Systems Ltd. as comparable company allegedly on the ground of being functionally different without appreciating that the company provides information technology services similar to that of the appellant.

6. Without prejudice the learned assessing officer/the TPO erred on facts and in law in not appreciating that the appellant is a low-risk-bearing contract service provider and a risk adjustment to the extent of 5% over the cost ought to be provided, as risk and reward to this extent vest with the overseas associated enterprises to which the appellant renders off-shore software services.

7. That the assessing officer/the TPO erred on facts and in law in not appreciating that the income of the appellant is exempt under section 10A of the Income Tax Act and hence, there could not be any motive for the transfer of profits outside India.

8. Without prejudice that the assessing officer/the TPO erred on facts and in law in not allowing the working capital adjustment in respect of the companies proposed to be selected as comparable by the TPO.

9. Without prejudice the assessing officer/the TPO erred on facts in considering the total operating cost of the appellant at Rs. 49,40,57,000 as against the actual operating cost of Rs.48,26,77,000.

10. Without prejudice, that the assessing officer/the TPO erred in law in not allowing variation to the extent of (+/-) 5%, while determining the arm’s length price of the ‘international transactions’, in terms of proviso to section 92CA(2) of the Act.

11. That the assessing officer erred on facts and in law in reducing the communication expenses to the extent of Rs. 1,79,10,869 from the export turnover for computation in terms of clause (iv) of Explanation 2 of section 10A of the Act while computing deduction under that section.

11.1 That the assessing officer erred on facts and in law in not appreciating that only 5% internet charges of the communication expenses is attributable to the export of software outside India.

11.2 Without prejudice that the assessing officer erred on facts and in law in making the adjustment of communication expenses, viz., link charges of Rs. 1,79,10,869 attributable to delivery of computer software outside India from “the export turnover” in terms of clause (iv) of Explanation 2 of Section 10A of the Act without making the similar adjustment from” the total turnover” resulting into absurd and unintended results.

The appellant craves leave to add, alter, amend or vary from the aforesaid grounds of appeal before or at the time of hearing.

3. Transfer Pricing Issue

The assessee is a private limited company, is affiliated to Global Logic USA and is engaged in the business of provision of software development services. The assessee in the relevant previous year entered into the international transaction of rendering the software development services to its associated enterprise.

3.1 For the purpose of benchmarking the international transactions, the assessee has considered TNMM as the most appropriate method and considered itself to be the tested party with operating profit/operating cost (OP/OC%) as the Profit Level Indicator (PLI). In the search process, the assessee has considered following 8 comparable companies in the transfer pricing documentation with OP/OC of 11.70% as under:

S. No.

Name of the company

OP/OC%

1

Goldstone Technologies Ltd.

0.79%

2

California Software Co. Ltd.

22.36%

3

Neilsoft Ltd.

14.69%

4

N.S.E.I.T. Ltd.

13.66%

5

Applabs Technologies Pvt. Ltd.

18.17%

6

PSI Data Systems Ltd.

0.12%

7

Kale Consultants Ltd.

13.15%

8

Blue Star Infotech Ltd.

10.66%

Average

11.70%

3.2 Since the operating profit margin (OP/OC%) of the appellant at 14.36% was higher than 11.70% of the comparable companies, the international transaction was considered to be at arm’s length and no adjustment was required to be made.

3.3 The TPO, however, rejected the filter of OP/OC(%) less than (-) 40% and greater than 40% considered in the search process and included 3 companies in the final set of comparables, as under:

(i) Saksoft Ltd.

(ii) Datamatics Technologies Ltd.

(iii) 3D PLM Software Ltd.

3.4 The TPO, further applied additional filter of declining sales for rejection of the comparable companies and rejected following companies on various grounds, as under:

S. No.

Name Reasons for rejection

1

Goldstone Technologies Ltd. Declining sales and functionally different

2

PSI Data Systems Ltd. NFA/Sales and functionally different

3

Blue Star Infotech Ltd. Declining sales and functionally different

3.5 The TPO, accordingly, benchmarked the operating profit margin (OP/OC%) of the appellant company with the margin of the remaining comparable companies as follows:

S. No.

Name of the company

Financial Year

OP/TC

1

California Software Co. Ltd.

2006-07

22.36%

2

Neilsoft Ltd.

2006-07

14.69%

3

NSEIT Ltd.

2006-07

13.66%

4

Applabs Technologies Pvt. Ltd.

2006-07

18.17%

5

Kale Consultants Ltd.

2006-07

13.15%

6

Saksoft Ltd.

2006-07

51.10%

7

Datamatics Technologies Ltd.

2006-07

39.83%

8

3D PLM Software Ltd.

2006-07

48.46%

Average Mean

27.67%

3.6 Accordingly, the TPO in the order passed under section 92CA(3) of the Act had computed an adjustment of Rs. 78,794,571/- on account of the difference in the margin of the comparable companies and the appellant company, as under:

Total cost incurred by assessee

494,058,000

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630,762,571

Revenue shown

551,968,000

Difference

78,794,571

3.7 The Dispute Resolution Panel (‘DRP’) upheld the order of the TPO and accordingly, the assessing officer on the basis the order of the DRP passed the final order.

4. We have heard the rival contentions and perused the records. At the outset, ld. Counsel of the assessee submitted that in the transfer pricing analysis in this case companies having significant related party transactions should be rejected. Ld. Counsel of the assessee submitted in this regard, that an unrelated enterprise having controlled transactions cannot be considered as comparable to the assessee, while applying TNM Method, as a company having substantial related party transactions may influence the profits of the company.

4.1 Ld. Counsel of the assessee submitted that Rule 10B(1)(e) of the Income Tax Rules, 1962, too, provides that net margin of the assessee requires to be compared to an unrelated enterprise form a comparable uncontrolled transactions.

4.2 Ld. Counsel of the assessee has further placed reliance in this regard on the decision of Delhi Bench of Tribunal in the case of Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448.

4.3 Ld. Counsel of the assessee also invited attention on the decision of Delhi Bench of Tribunal in the assessee’s own case for the assessment year 2005-06 [ITA No. 6082/Del/2010], wherein the Tribunal excluded 3DPLM Software considered by the appellant, having a very high ratio of related party transaction.

4.4 In view of the aforesaid provisions of the Act and decisions, it was submitted that following companies considered by the TPO in his order, having significant related party transactions should be rejected from the final set of comparable companies:

S. No.

Company Name

Related party transaction/Total income

1

California Software Co. Ltd.

71.53%

2

Saksoft Ltd.

67.81%

3

Datamatics Technologies Ltd.

44.86%

4

3D PLM Software Ltd.

118.04%

4.5 It was further submitted that after excluding the above companies, the operating profit margin (OP/OC) of the remaining companies works out to 14.92%, as under:

S. No. Name of the company

OP/OC%

1

Neilsoft Ltd.

14.69%

2

N.S.E.I.T. Ltd.

13.66%

3

Applabs Technologies Pvt. Ltd.

18.17%

4

Kale Consultants Ltd.

13.15%

Average

14.92%

Global Logic India Pvt. Ltd.

14.36%

4.6 Ld. Counsel of the assessee submitted that since, the operating profit margin (OP/OC%) of the appellant at 14.36% is within safe harbur range of +/- 5% of the average of (OP/OC%) of comparable companies at 14.92%, the international transaction undertaken by the assessee should be considered at arm’s length and the adjustment proposed by the TPO should be deleted for this reason alone.

5. On the other hand Ld. Departmental Representative principally did not have any serious objection to the proposition as above.

5.1 Ld. Departmental Representative referred to the decision of the Tribunal in the case of American Express India (P) Lt. [IT Appeal No. 4240/D/2009, A.Y. 2003-04, dated 18-05-2012]. The relevant para of the tribunal’s order is as under:-

“16. From the above, it is evident that learned CIT(A) has totalled up the amount received from the related parties for rendering of services together with the payments made to related parties which became Rs. 323.23 lakhs. He compared the same with the total operating expenses which were Rs. 4448.71 lakhs. If the total operating expenses are being compared, then they can be compared only with the total operating expenses paid to the related parties. The amount received from related parties for rendering services can be compared only with the total receipt of Hinduja TMT from rendering of services. Therefore, apparently, the working of learned CIT(A) is incorrect.”

5.2 Referring to the above order, Ld. Departmental Representative submitted that capital inflow and capital outflow do not enter into working of related party transactions. Revenue items (includes sales) need to be compared upon a base of Revenue, and expenditure or purchase items need to be compared upon a base of total expenditure.

5.3 Ld. Counsel of the assessee in his rejoinder submitted that under the Transfer Pricing regulations, an international transaction is to be benchmarked by applying one of the five prescribed methods in section 92C(1) of the Act being the most appropriate method. In the Transfer Pricing documentation, the appellant applied the Transactions Net Margin Method (TNMM) as the most appropriate method. The TNMM was also applied by the Transfer Pricing Officer in his order.

5.4 Ld. Counsel of the assessee submitted that in terms of rule 10B(1)(e) of the Rules for application of TNMM 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. Further, 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 to be computed having regard to the same base. In the converse for applying TNMM in terms of clause (ii) of rule 10B(1)(e) of the Rules, the net profit margin realized by an unrelated enterprise from a controlled transactions is not to be considered. In other words, in case the net profit margin of the comparable companies is distorted by controlled or related party transactions the same is to be excluded. Therefore it is net profit margin, which is not influenced or distorted by the presence of controlled transactions, only is to be taken into account for the purpose of applying the TNMM.

5.5 Ld. Counsel of the assessee submitted that the OECD guidelines regarding adoption of enterprise level profits in TNMM and treatment of partial controlled transactions are reproduced below:

“3.42 An analysis under the transactional net margin method should consider only the profits of the associated enterprise that are attributable to particular controlled transactions. Therefore. it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly. when analysing the transactions between the independent enterprises to the extent they are needed. profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally. when profit margins of an independent enterprise are used. the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise.”

5.6 It was further submitted that the OECD Transfer Pricing guidelines further in para 2.79 provides in this regard as under:

“2.79 Similarly, when analysing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally. when net profit indicators of an independent enterprise are used. the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise.”

5.7 Ld. Counsel of the assessee submitted that that any controlled transaction with related parties (i.e. Related party transaction or RPT), whether undertaken by way revenue or expense (whether capital or revenue expense) which, having a bearing on the net profit of such enterprise, should not distort the net profit margin of the comparable uncontrolled enterprise which may be taken into consideration for the purpose of applying TNMM. In other words, the following controlled transactions or the related party transactions (RPT) which may have bearing and would have distorted or influenced the net profit margin of the comparable uncontrolled enterprise is to be considered as the relevant related party transactions for applying TNMM:

(i) Transactions involving issue of share capital not having bearing on the net profit margin of the comparable uncontrolled enterprise, is not to be considered as the relevant related party transactions.

(ii) The transactions of purchase or sale on revenue account, having bearing on the net profit margin of the comparable uncontrolled enterprise, is to be considered as the relevant related party transactions.

(iii) The transaction of purchase of fixed/capital asset having bearing on the net profit margin of the comparable uncontrolled enterprise, by way of charge of depreciation or amortization is to be considered as the relevant related party transactions.

5.8 Ld. Counsel of the assessee submitted that the Delhi Bench of the Tribunal in the case of Sony India (P.) Ltd. (supra) held that companies having related party transactions in excess of 10-15% of the sales have to be rejected and cannot be considered as comparable for the purpose of comparability analysis.

5.9 Ld. Counsel of the assessee referred the decision of the Tribunal in the case of Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226 (Bang.).

5.10 He also referred the Delhi Bench Tribunal decision in the case of Actis Advisors (P.) Ltd. v. Dy. CIT [ITA No 5277/De1/2011, dated 12-10-2012].

5.11 It was further submitted that the decision of the Hon,ble Tribunal in the case of Dy. CIT v. American Express India (P.) Ltd. [2012] 19 taxmann.com 23 (Delhi – Trib), it was rendered on its own facts wherein the aforesaid contentions were not canvassed and the ratio of the aforesaid decisions were not brought to the notice of the Hon’ble Tribunal.

5.12 Ld. Counsel of the assessee accordingly submitted that an enterprise is to be considered as uncontrolled for the purpose of benchmarking analysis, if the ratio of related party transactions (i.e. transactions of sales and purchase on revenue as well as capital account having a bearing on profitability of the enterprise) to relevant base, i.e. sales or cost does not exceed the limit of 25%. Hence, he submitted that Saksoft limited, Datamatics Technologies Limited, 3DPLM Software Solutions Ltd. and California Software Limited, considered as the comparable companies by the TPO in the assessee’s case have related party transactions exceeding 25% the same are to be excluded from the set of comparable companies for applying TNMM.

5.13 We have carefully considered the submission and perused the records. In this case for benchmarking the international transaction the assessee has considered TNMM as the most appropriate method and considered itself to be the tested party with operating profit/operating cost (OP/OC%) as the profit level indicated. In the search process the assessee has considered 8 comparables companies in the transfer pricing documentation with OP/OC of 11.70%. Since the operating profit margin (OP/OC%) of the assessee at 14.36% was higher than 11.70% of the comparable companies, the international transaction was considered to be at arms length and no adjustment was required to be made.

5.14 The TPO accepted TNMM as the most appropriate method. However, he rejected the filter OP/OC% less than (-)40% and greater that 40% considered in the search process and included 3 companies in the final set of comparables. The TPO further applied additional filter of declining sales for rejection of 3 comparables and rejected three more companies. TPO accordingly benchmarked the operating profit (OP/OC%) of the assessee company with the margin of remaining 8 comparable companies. The resultant average mean came to 27.67%. Accordingly, the TPO in the final order passed under section 92CA(3) of the Act computed an adjustment of Rs. 78,794,571/- on account of the difference in margin of the comparables companies and the assessee company.

5.15 We agree with the contention of the assessee that an unrelated enterprise having controlled transaction can not be considered as comparable to the assessee while applying TNMM. As a company having substantiated related party transaction, may influence the profits of the company. In this regard, we can gainfully refer to the 10B(1)(e) of the Income Tax Rules as under:-

“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.”

5.16 A reading of the above clearly shows that under the said Rules the net margin of the assessee required to be compared to an unrelated enterprise from a comparable uncontrolled transaction. Thus it follows that comparables having high ratio of related party transaction cannot be taken a comparable. This proposition is also supported by the following case laws:

(i) Sony India (P.) Ltd.’s case (supra) wherein the tribunal has held as under:-

“We are further of view that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15% of total revenue, Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purposes of comparison, what is to be judged is the impact of the related party transaction vis-a-vis sales and not profit since profit of an enterprise is influenced by large number of other factors.

The TPO and on appeal, the learned CIT (Appeals) did not substantiate the allegation by furnishing figures of controlled transactions to show that such transaction had significant impact on the profits of these companies. The taxpayer, on the other hand, has given percentage of transaction with related parties and we are of view that they are not so high as to exclude them from the list of comparables. We are further of view that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15% of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purposes of comparison, what is to be judged is the impact of the related party transaction vis-a-vis sales and not profit since profit of an enterprise is influenced by large number of other factors. No dispute having been raised by TPO or the ld. CIT(A) that the other filters of functions, economic activities, product profiles etc are satisfied, we are of view that these three entities should also be taken in the list of comparables for working average/mean operating profit. Even as per OECD Guidelines, it is emphasized that large number of similar entities should be taken to make comparison broad based.”

(ii) Assessee’s own case for A.Y. 2005-06 (I.T.A. No. 6082/Del/2010) wherein it was held as under:-

“Still, if it is found that RPT is 97% as has been claimed by the appellant before us, it has to be accepted that this comparable is not un-controlled and therefore, the same has to be excluded from the list of comparables adopted by the TPO. Even if the percentage of RPT to total revenue is not 97% but is more than 25%, even then, this comparable cannot be considered as un-controlled comparable and the same has to be excluded from the list of comparables finally selected by the TPO.

As per the Tribunal decision rendered in the case of Sony India Ltd. (supra), it was held by the Tribunal that comparables having RPT in the range of 10 to 15% of total revenue cannot be taken or considered as controlled. No specific percentage of RPT had been pointed out by the Tribunal in this case which will render the comparable as controlled comparable. Still, if it is found that RPT is 97% as has been claimed by the assessee before us, it has to be accepted that this comparable is not un-controlled and therefore, the same has to be excluded from the list of comparables adopted by the TPO. Even if the percentage of RPT to total revenue is not 97% but is more than 25%, even then, this comparable cannot be considered as un-controlled comparable and the same has to be excluded from the list of comparables finally selected by the TPO. But for the same, the factual aspect has to be examined as to how much percentage of RPT to total revenue is there in the case of this comparable i.e. 3D PLM Software Ltd. Hence, we set aside the assessment order and restore the entire matter to the file of the Assessing Officer for a fresh decision after examining the factual aspect of this claim of the assessee and after obtaining fresh directions from DRP. If it is found that the percentage of RPT to total revenue in the case of this comparable i.e. 3 DPLM Software is more than 25% then this comparable should be excluded from the list of comparables selected by the TPO and the average mean should be worked out after excluding this comparable and if the same is within plus minus 5% of the profit margin declared by the assessee then no transfer pricing adjustment is required to be made.”

(iii) Tribunal decision in the case of Philips Software (P.) Ltd. (supra) wherein it was held as under:-

“The filter of 25% related party transactions have been adopted because transactions with related parties exceeding 25% of total turnover may distort the overall profit margins of that company. While calculating the 25%, the transactions on account of sales as well as purchases have been combined and percentage on the overall sales of the comparable company worked out.”

(iv) Tribunal decision in the case of Actis Advisors (P.) Ltd. (supra) wherein it was held as under:-

“On the basis of the scheme, one can safely say that an entity can be taken as uncontrolled, if its related party transaction do not exceed 25% of the total revenue. Thus, we do not find any fault in the conclusion of the learned TPO for applying this filter to the extent of 25% transaction with related party of the total revenue. The contentions raised by the learned counsel for the assessee in this regard are rejected. Accordingly, the ratio of total related party transactions (i.e. sales and purchase) as a percentage of sales is to be taken into account while judging as to whether a company can be considered as uncontrolled for the purpose of benchmarking analysis.”

5.17 In the background of the aforesaid discussion and precedents, we hold that an enterprise is to be considered as uncontrolled for the purpose of benchmarking analysis of the ratio of related party transaction to the relevant base i.e. sales or cost does not exceed the limit of 25%. The related party transaction referred here are those which have a bearing on the net profit of the enterprise.

5.18 Thus, we agree with the assessee’s submission that following companies considered by the TPO in his order, having significant related party transaction should be rejected from the final set of comparables.

S. No.

Company Name

Related party transaction/Total income

1

California Software Co. Ltd.

71.53%

2

Saksoft Ltd.

67.81%

3

Datamatics Technologies Ltd.

44.86%

4

3D PLM Software Ltd.

118.04%

5.19 After exclusion of the above companies the operating profit margin (OP/OC) of the remaining companies works out to 14.92% as under:-

S. No.

Name of the company

OP/OC%

1

Neilsoft Ltd.

14.69%

2

N.S.E.I.T. Ltd.

13.66%

3

Applabs Technologies Pvt. Ltd.

18.17%

4

Kale Consultants Ltd.

13.15%

Average

14.92%

Global Logic India Pvt. Ltd.

14.36%

5.20 From the above, we hold that since the operating profit margin (OP/OC%) of the assessee at 14.36% is within the safe harbur range of +/-5% of the average of (OP/OC) of comparable companies at 14.92% the international transaction undertaken by the assessee should be considered at arm’s length, and the adjustment proposed by the TPO is unwarranted.

6. Ground No. 11 to 11.2

On these issues Assessing Officer referred to the definition of export turnover as per explanation 2(iv) of section 10A. Export turnover means that the’ consideration in respect of export by the undertaking of articles or things -or computer software received in, or bought into, India by the assessee in convertible foreign exchange in accordance with sub-section (3), but does not include freight, tele-communication charges or insurance attributable to the delivery of the article or thing or computer software outside India or expenses, if any, incurred in foreign exchange in providing the technical services outside India.

6.1 Considering the above, definition the Assessing Officer asked the assessee to give the details of any freight, telecommunication charges and insurance attributable to the delivery of the goods and details of expenses incurred in foreign exchange in providing the technical services outside India.

6.2 Assessee responded that it had not incurred any freight expenses in this regard. It was further stated that the persons employed for a software product are divided on onshore team and offshore team. One of the teams gets in touch with the clients to understand customer’s need through site visit, video/voice conferencing and emails. They also get in touch with the clients, when the software is developed and transmitted to the customers. It was further stated that only 5% of the Internet Charges are attributable to the delivery of software to client, hence full amount of the above expenses should not be taken into consideration for calculating Export turnover as per explanation 2(iv) to the section 10A of the Income-tax Act.

6.3 However, Assessing Officer was not satisfied with the above explanation. He observed that use of telephone and internet continuously is necessary in this line of business and it cannot be said that only 5% of internet expenses is related to the delivery of the software. Therefore, Assessing Officer held that the communication expenses of Rs. 17910869/- should be reduced from export turnover for calculation of deduction u/s. 10A.

6.4 The Disputes Resolution Panel (DRP) on this issue has rejected the assessee’s contention and held that communication expenses related to export of software and hence, the order of the Assessing Officer is not interfered.

7. Against the above order the assessee is in appeal before us.

8. The submissions of the ld. Counsel of the assessee in this regard was as under:-

“During the year, the assessee has incurred Rs. 1,79,10,869 as communication expenses and the same were debited to the P&L account as part of operating expenses. The break-up of these expenses are as follows:

Description

Amount

Telephone expense

1,31,48,431

Internet expenses

43,97,525

Postage and courier charges

3,64,913

Total Communication Expenses

1,79,10,869

In relation to said communication expenses, it is submitted that 5% of the total life cycle of software is used for transmission of software to clients on estimated basis. Further, it is also submitted that the persons employed for a software product are divided as onshore team and offshore team. One of the team gets in touch with the client to understand customer’s need through site visit, video/voice conferencing and emails. They also get in touch with the clients, when the software is developed and transmitted to the customers. Therefore, admittedly, only 5% of the internet charges i.e. Rs. 2,19,867 (5% of 43,97,525) is attributable to the delivery of software outside India. Further, it is also submitted that no insurance expense are attributable to the delivery of software as seen from the above table.”

8.1 Ld. Counsel of the assessee submitted that that even if any freight, telecommunication or insurance expense during the year, are reduced from the export turnover, such sums will also have to be reduced from the total turnover of the company for the purpose of computation of deduction u/s. 10A.

8.2 Ld. Counsel of the assessee further placed reliance on the decision of Supreme Court in the case of CIT v. Lakshmi Machine Works [2007] 290 ITR 667, rendered in the context of section 80HHC of the Act, wherein, the formula for calculation of deduction is similar to that of section 10A of the Act. The Apex Court, in that case held that excise duty and sales tax etc. which are not included in ‘Export Turnover’ would also be excluded from ‘Total Turnover’ for the purpose of computation of deduction under section 80HHC of the Act.

8.3 He further placed reliance on the following decisions of the Tribunal, wherein it is held that for computation of deduction under section 10A of the Act, total turnover in the denominator and export turnover in the numerator have to be read in the same manner and accordingly that the expenses incurred in foreign exchange are to be excluded from export turnover in the numerator then the same are even excluded in the total turnover in the denominator.

Microchip Technology Designs (India) Pvt. Ltd. [I.T.A. No. 1161/Bang/2007] (Bang.)

Alternative Food Process (P.) Ltd. v. ITO [I.T.A. No. 52/Bang/2008] (Bang.)

– Goodrich Aerospace Services (P.) Ltd. v. DCIT [I.T.A. No. 58/Bang/2008] (Bang.)

Hewlett Packard Global Soft Ltd. [I.T.A. No. 33/Bang/208] (Bang).

Asstt. CIT v. Infosys Technologies Ltd. [2008] 172 Taxman 134 (Chennai) (Mag.).

ITO v. Servion Global Solutions Ltd. [2008] 115 ITD 95 (Chennai)

I-Gate Global Solutions Ltd. v. Asstt. CIT [2008] 24 SOT 3 (Bang.) (URO)

Tata Elxsi Ltd. v. Asstt CIT [2008] 115 TTJ 423 (Bang.)

Nous Infosystems (P) Ltd. v. ITO [IT Appeal No. 1042/Bang./07] (Bang.)

Mphasis Ltd. v. Asstt. CIT [I.T.A. No. 884/Bang/07 (Bang.)]

Patni Telecom (P) Ltd. v. ITO [2008] 22 SOT 26 (Hyd.)

Dy. CIT v. Softsol India Ltd. [2008] 22 SOT 271 (Hyd.)

Dy. CIT v. Binary Semantics Ltd. [I.T.A. No. 293/Del/2005].

8.4 Ld. Counsel of the assessee further invited attention to the recent decision from the Special Bench of the Tribunal in the case of ITO v. SakSoft Limited (ITA Nos. 691 & 1953/MDS/2007) upholding the aforesaid position.

8.5 It was submitted that it would further be appreciated that the Assessing Officer has accepted the contentions of the appellant in the AY 2007-08 and had accordingly reduced freight, telecommunication or insurance expense from total turnover of the assessee while reducing such sum from export turnover.

8.6 Ld. Counsel of the assessee submitted that Delhi Bench of ITAT in the assessee’s own case for the assessment year 2005-06, relying on the aforesaid decision of Special Bench of Tribunal in the case of Saksoft India Limited, has allowed the appeal of the appellant and directed the assessing officer to re-compute deduction under section 10A after reducing communication expense from export turnover as well as total turnover.

9. Ld. Departmental Representative relied upon the order of the Assessing Officer in this regard.

10. We have carefully considered the submissions and perused the records. We note that it is the contention of the assessee company that only 5% of the internet charges are attributable to the delivery of software to client, hence, full amount of the above expenses should not be taken into consideration for calculating the export turnover as per Explanation 2(iv) of Section 10A of the I.T. Act. However, we note that there is no cogent basis in the above assertions made by the assessee. However, we agree with the contention that freight telecommunication or insurance expenses during the year are reduced from the export turnover, then such sum will also have to be reduced from the total turnover of the company for the purpose of computation of deduction u/s. 10A.

10.1 Analogy in this regard can be drawn from Hon’ble Apex Court decision in the case of Lakshmi Machine Works (supra).

Though this decision was rendered in the context of section 80HHC, this formula for calculation of deduction is similar to that of section 10A of the Act. The Apex Court in that case has held that excise duty and sales tax etc. which are not included in the export turnover would also be excluded from the total turnover for the purpose of computation of deduction u/s. 80HHC of the Act.

10.2 Furthermore, we note that in a catena of decisions of the tribunal, it was held that for computation of deduction u/s. 10A of the Act total turnover in the denominator and export turnover in the numerator have to be read in the same manner and accordingly when the expenses incurred in foreign exchange are to be excluded from the export turnover in the numerator, then the same treatment have to be given in the total turnover in the denominator. We further note that ITAT, Delhi Bench in assessee’s own case for assessment year 2005-06 relying upon the decision of the ITAT, Special Bench in the case of ITO v. Sak Soft Ltd. [2009] 30 SOT 55 (Chennai) has allowed the appeal of the assessee and directed the Assessing Officer to recomputed the deduction u/s. 10A after reducing communication expenses from the export turnover as well as total turnover.

10.3 Accordingly, in the background of the aforesaid discussions and precedents, we hold that freight telecommunication or insurance charges during the year that are reduced from the export turnover, then such sum will also have to be reduced from the total turnover of the company for the purpose of computation of deduction u/s. 10A.

11. In the result, the appeal filed by the assessee is partly allowed.

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