ITAT Partly Allows TP Appeal by Excluding Cybercom as Software Comparable

Velocity Tech-Sol India Pvt. Ltd. Vs ACIT (ITAT Pune)

The Income Tax Appellate Tribunal (ITAT) adjudicated the assessee’s appeal against the final assessment order passed under Sections 143(3) read with 144C(13) of the Income-tax Act, 1961 for Assessment Year 2014-15. The assessee, a wholly owned subsidiary of its US parent company, was engaged in providing software development services on a cost-plus mark-up basis. It benchmarked its international transaction of software development and IT enabled services using the Transactional Net Margin Method (TNMM), adopting Operating Profit to Total Cost (OP/TC) as the Profit Level Indicator. The assessee claimed its operating margin of 10.34% exceeded the average margin of its selected comparables.

The Transfer Pricing Officer (TPO) accepted TNMM and the Profit Level Indicator but rejected most of the assessee’s comparables, selected a fresh set of comparable companies, computed an average margin of 34.74%, and proposed an upward transfer pricing adjustment of ₹6,94,47,074. The Dispute Resolution Panel (DRP) upheld the TPO’s approach, leading to the present appeal.

Grounds challenging the transfer pricing adjustment generally were not separately adjudicated. The principal dispute before the Tribunal related to inclusion of three comparables, namely Cybercom Datamatics Information Solutions Ltd., Thirdware Solutions Ltd., and Infobeans Systems India Ltd. Grounds relating to other comparables were dismissed as not pressed.

Regarding Cybercom Datamatics Information Solutions Ltd., the assessee contended that the company carried on diversified activities, including consultancy, advisory, surveyor services, software products and technical services, and that no segmental information was available. It was also argued that the company earned abnormally high profits of 83.99%. The Revenue submitted that the company derived its revenue from software services and could not be excluded merely because of high profitability. After examining the annual report, the Tribunal observed that the company was engaged in both technical and software services without segmental information. It also noted the exceptionally high profit margin and the absence of any enquiry by the TPO to determine whether such profits arose under normal business conditions. Following an earlier Tribunal decision, the ITAT directed exclusion of Cybercom Datamatics Information Solutions Ltd. from the final set of comparables.

With respect to Thirdware Solutions Ltd., the assessee argued that the company earned revenue from sale of products and software licences and therefore could not be compared with a pure software development service provider. The Tribunal examined the annual report and found that revenue from software licence sales was insignificant compared with total operating revenue. It further observed that the balance sheet did not indicate the presence of intangible assets or closing stock suggesting software product development. Accordingly, it upheld inclusion of Thirdware Solutions Ltd. as a comparable.

The assessee also challenged inclusion of Infobeans Systems India Ltd., contending that it earned supernormal profits and was engaged in product development. The Tribunal examined the financial statements and found that revenue was derived solely from software exports. It observed that the absence of closing stock or work-in-progress did not support the contention that the company was engaged in software product development. The Tribunal further held that supernormal profits alone could not justify exclusion without establishing that they arose from abnormal business conditions. Consequently, it upheld inclusion of Infobeans Systems India Ltd. in the final set of comparables.

The assessee also sought admission of an additional ground contending that foreign exchange gains or losses should be treated as operating revenue while determining the Profit Level Indicator. The Tribunal held that the issue required factual examination of the financial statements of both the tested party and comparable companies and was therefore not a pure question of law. As the assessee had not produced the necessary financial records or computation supporting its claim, the Tribunal declined to admit the additional ground.

A second additional ground seeking inclusion of Cat Technologies Ltd. and Maverick Systems Ltd. as comparables was not pressed and was dismissed accordingly.

Accordingly, the Tribunal partly allowed the assessee’s appeal.

Cases Discussed

• M/s. Nethawk Networks India Private Limited vs. ACIT, ITA No.173/PUN/2017

• Synechron Technologies Private Limited Vs. ACIT, ITA No.1692/PUN/2018

• Symantec Software India Private Limited Vs. ACIT, ITA No.1824/PUN/2018

• FIS Solutions (India) Private Limited Vs. ACIT, ITA No.1695/PUN/2018

• Optiva India Technologies Private Limited Vs. DCIT, ITA No.15/PUN/2019

• Kony IT Services (P.) Ltd., ITA No.2304/HYD/2018

• PubMatic India Private Limited Vs. ACIT, ITA No.655/PUN/2017

• Emerson Electric Company (India) Private Limited Vs. ACIT, ITA No.6098/Mum/2018 & ITA No.531/Mum/2018

• Maersk Global Centres (India) (P.) Ltd. vs. ACIT, 31 ITR 1

• CIT vs. Quark Systems India (P.) Ltd. (Punjab & Haryana High Court), 11 taxmann.com 427 (P&H)

• National Thermal Power Co. Ltd. v. CIT (Supreme Court), 229 ITR 383

• Ultratech Cement Ltd. vs. Addl. CIT, 81 com 74 (Bom.)

FULL TEXT OF THE ORDER OF ITAT PUNE

This is an appeal filed by the assessee directed against the final assessment order dated 23.08.2018 passed u/s 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (‘the Act’) for the assessment year 2014-15.

2. Briefly, the facts of the case are as under :

The appellant is a company incorporated under the provisions of the Companies Act, 1956. It is fully owned subsidiary of TTP Technology USA company. It is engaged in the business of providing software development services to its parent company located in USA on Cost Plus Mark-up (CPM) basis. The return of income for the assessment year 2014-15 was filed on 26.11.2014 declaring total income of Rs.3,06,19,876/-. The assessee company also reported the following international transactions :-

3. The assessee company sought to justify the consideration received for the above international transactions entered with its AE to be at arm’s length price (ALP). The assessee company also submitted Transfer Pricing (TP) study report adopting the Operating Profit to Total Cost (OP/TC) as a Profit Level Indicator (PLI) for the transfer pricing study. The assessee company also applied Transactional Net Margin Method (TNMM) which is considered to be the most appropriate method for the purpose of benchmarking the international transactions. The assessee company’s profit margin was computed at 10.34% and the assessee company claimed that the same was comparable with other companies rendering software development services. For the purpose of TP study, the assessee company chosen 7 comparables entities and arithmetic average of operating profit margins of said comparables was computed at 8.93%. According to the assessee company, its PLI was much higher than the arithmetic mean of the comparable entities. Hence, it was claimed that the international transactions with its AE are at arm’s length. The assessee company had also chosen the following 7 entities as comparables whose average profit margin was computed at 8.93% using 3 years weighted data :-

4. On noticing the above international transactions, the Assessing Officer referred the matter to the Transfer Pricing Officer (TPO) for the purpose of benchmarking the above international transactions. The TPO by an order dated 27.10.2017 passed u/s 92CA(3) suggested the upward TP adjustments of Rs.6,94,47,074/-. While doing so, the TPO had accepted the TNMM adopted by the assessee company and also OP/TC as PLI, but rejected the TP study report submitted by the assessee company and proceeded to identify the different set of comparable entities for the purpose of determining the ALP of the international transactions. While doing so, the TPO applied the following filters :-

5. Applying the above filter, the TPO had rejected the 5 comparables selected by the assessee company in its TP study report and introduced 5 new companies and finally selected the following comparables :-

6. The TPO computed the average profit margin of the comparables finally selected by him at 34.74%. On the above basis, the TPO computed the upward TP adjustments of Rs.6,94,47,074/-vide order dated 27.10.2017 passed u/s 92CA(3) of the Act.

7. Pursuant to receipt of the TPO’s order, the Assessing Officer passed the draft assessment order dated 26.12.2017 passed u/s 143(3) r.w.s. 144C(1) of the Act incorporating the above TP adjustments of Rs.6,94,47,074/-.

8. On receipt of the draft assessment order, the appellant filed objections before the ld. DRP objecting the exclusion of Akshay Software Technologies Ltd. and inclusion of (i) Cybercom Datamatics Information Solutions Ltd., (ii) Thirdware Solutions Ltd. and (iii) Infobeans Systems India Ltd.. However, the ld. DRP on due consideration of the details/submissions made in support of exclusion/inclusion of the above companies, upheld the action of the TPO in exclusion of Akshay Software Technologies Ltd. and inclusion of inclusion of (i) Cybercom Datamatics Information Solutions Ltd., (ii) Thirdware Solutions Ltd. and (iii) Infobeans Systems India Ltd..

9. On receipt of the direction from the ld. DRP, the final assessment order was passed by the Assessing Officer vide order dated 23.08.2018 passed u/s 143(3) r.w.s. 144C(13) of the Act after making the addition of Rs.6,94,47,074/- on account of TP adjustments.

10. Being aggrieved by the above final assessment order, the appellant is in appeal before us with the following grounds of appeal :-

“1] The learned A.O. / DRP erred in recomputing the transfer price of the international transactions relating to software development services, despite the fact that none of the conditions as prescribed in Section 92C(3) of the Income Tax Act, 1961 (‘the Act’), had been violated by the appellant. Thus, the learned Assessing Officer (‘AO’) erred in making an addition of Rs.6,94,47,074/- u/s 92C on the basis of the order of the TPO u/s 92CA(3) dated 27.10.2017 in the case of the appellant company.

2] The learned A.O. / DRP erred in computing the Arm’s Length Price (ALP) of the software development services rendered by the assessee company to its AE by holding that the assessee should have earned operating margin of 34.74% as against 10.34% earned by the assessee company.

3] The learned A.O. / DRP erred in not appreciating that the transactions of software development services entered into by the assessee company with its AE were at Arm’s Length Price (ALP) and thus, there was no reason to make any addition in respect of the said segment.

4] The learned A.O. / DRP erred in confirming Thirdware Solutions Ltd, Cybercom Datamatics Information Solutions Ltd. and Infobeans Systems India Ltd as comparable entities for determining the ALP in respect of the International Transaction of provision of software development services without appreciating that all the said entities were not comparable on FAR basis with the assessee company and therefore, the same should have been excluded while working out the ALP.

5] The learned A.O. / DRP further erred in not appreciating that Thirdware Solutions Ltd, Cybercom Datamatics Information Solutions Ltd. and Infobeans Systems India Ltd had earned super normal profits during the year under consideration and accordingly, on this ground also, the above three companies should have been excluded while determining the ALP in respect of the provision of software development services.

6] The learned A.O. / DRP erred in rejecting Virinchi Technologies Ltd. as a comparable entity on the ground that the said company was also engaged in the business of software products and in the absence of segmental details, the said entity was to be excluded from the final list of comparables.

7] The learned A.O. / DRP erred in not appreciating that as per the Annual Report of Virinchi Technologies Ltd., the said entity was engaged only in providing software development services and therefore, there was no reason to reject the said company as a comparable entity.

8] The assessee submits that the learned A.O. erred in rejecting Evoke Technologies Pvt. Ltd. as a comparable entity on the ground that the Annual Report of the said entity was not available in the public domain.

9] The assessee submits that the Annual Report of Evoke Technologies Pvt. Ltd. is now available in public domain and therefore, the said company should be included as a comparable while determining the ALP of the software development services provided to AE.

10] Without prejudice to the above grounds, the assessee submits that the learned A.O. / DRP erred in not making adjustments to the ALP to account for various differences on account of intangibles, R & D, risk factors, etc. etc. between the assessee company and the comparables.

11] The appellant craves leave to add, alter, amend or delete any of the above grounds of appeal.”

11. Ground of appeal no.1 to 3 are general in nature do not require any adjudication.

12. Ground of appeal no.4 and 5 challenges the inclusion of these companies (i) Cybercom Datamatics Information Solutions Ltd., (ii) Thirdware Solutions Ltd. and (iii) Infobeans Systems India Ltd..

13. Ground of appeal no.6 to 10 are dismissed as not pressed during the course of hearing.

14. Now, we shall dealt with each of the comparables in the following manner :

15. Cybercom Datamatics Information Solutions Ltd. :-

This is a comparable selected by the TPO rejecting the contention of the appellant company that it is super abnormal profit making company and also it is into the diversified activities, apart from the software development services such as an advisor and consultant on IT/IT space as mentioned in the Note No.1A forming part of financial statement for the year ending on 31.03.2013. Even the DRP confirmed the inclusion of this company in the list of the comparables by holding that as long as the company functionally similar, it should be included in the set of comparables irrespective of fact that such company is making a super normal profits and potential company cannot be excluded merely on the ground that the company reported abnormal profits. Further analysis to ascertain whether such abnormal profit reflect a normal business condition or arise from some abnormal conditions during the year under consideration placing reliance on the decision of Special Bench of Mumbai Tribunal in the case of Maersk Global Centres (India) (P.) Ltd. vs. ACIT, 31 ITR 1, learned DRP rejected the objection of the appellant that there is difference in functionality placing reliance on the descriptive given in the annual report.

16. Being aggrieved, the appellant is in appeal before us challenging the inclusion of this company in the list of the comparables placing reliance on page no.239 of the Paper Book, wherein, it is stated that the principal object of Cybercom is that of an advisor and consultant on IT/IT space and act as a surveyor of information services. The company is also into manufacturing, marketing of software products for the telecom industry. Thus, it is submitted that Cybercom is engaged in different activities and hence, it is functionally different not comparable with that of the assessee company. It is also to be noted that there is no segmental information for the various activities carried out by Cybercom. In the absence of any segmental information, this company cannot be considered to be comparable with that of the software development companies. Reliance in this regard placed on the following decisions :-

(i) eGain Communications Pvt. Ltd Vs. ACIT (ITA No.544/PUN/2017).

(ii) PubMatic India Private Limited Vs. ACIT (ITA No. 655/PUN/2017).

(iii) Emerson Electric Company (India) Private Limited Vs. ACIT (ITA No.6098/Mum/2018 & ITA No.531/Mum/2018).

17. It is further submitted that the finding of the TPO that this company was considered as comparable in immediate preceding year is incorrect.

18. On the other hand, ld. Sr. DR submitted that from the website, information of this company is very clear that it is a pure software development company. He also placing reliance on the schedule to the income of operation submitted that the entire revenue is derived from the income from rendition of the software services. He further submitted that this company cannot be excluded from the list of the comparables merely on the ground that it is a super abnormal profit making company without investing whether it reflects normal business or arises from some abnormal conditions prevalent during the year under consideration.

19. We heard the rival submissions and perused the material on record including the financial statements of this comparable, Cybercom Datamatics Information Solutions Ltd., copy of which is placed at page no.232 to 250 of the Paper Book. At page no.239, Note- 1A forming part of the financial statements, it is stated as under :-

“About the Company

………….

The Principal object of the Company is to act as consultants and advisors on information/internet system and surveyors of information services, and to carry on the business of development, testing, implementation, migration of home grown and other applications, marketing and manufacturing of information technology products and services, software and hardware systems to enterprise and embedded technologies in the telecom and other industries.”

20. At page no.237 income from operations was shown from sale of software services alone and at page no.274 in Note- 23 forming part of the financial statements for the year ended 31.03.2014, it is stated that the principal business of the company is of providing of technical and software services. All other activities of the company revolve around its main business. A perusal of the annual report of the said company clearly shows that it was engaged in providing technical software services, contrary to the assessee company which is engaged purely in rendering software development services. The financial statements of the said company do not give any segmental information between the technical services and software services. Further, this company was chosen by the TPO in the list of the comparables, the onus of proving the comparability lies upon the TPO. We also find that this company had reported super profit of 83.99% which is abnormally high profits, the TPO should have caused enquiry to ascertain whether such abnormally profits reflected normal business conditions or arising from abnormal conditions. We also find that this company was excluded from the list of the comparables by the Co-ordinate Bench of the Tribunal in the case M/s. Nethawk Networks India Private Limited vs. ACIT in ITA No.173/PUN/2017 for A.Y. 2012-13 vide order dated 17.06.2021. In the circumstances, we direct the Assessing Officer/TPO to exclude this company from the list of comparables.

21. Thirdware Solutions Ltd.:- This company was selected by the TPO rejecting the contentions of the appellant that it is a product development company which is quite different from a software services provider. Even before the ld. DRP, the ld. DRP confirmed the exclusion of this company in the list of comparables taking into consideration that the employee cost is around 41% of the revenue from operations which indicate that it is a software company.

22. Being aggrieved, the appellant is in appeal before us challenging the inclusion of this company, Thirdware Solutions Ltd.. It is submitted before us that this company is engaged in the sale of products and also earns income from sale of license. The appellant also filed the balance sheet of this company at page no.79 to 200 of the Paper Book. Taking us through Note- 2 to the Profit & Loss Account at page no.175, he submits that there is revenue from sale of products of Rs.20.675 crores and page no.176, it clearly shows the bifurcation of the revenue on sale of license shown at 7.98 crores. It is submitted that in the absence of segmental information, this company cannot be compared with that of the assessee company which is pure software development. Reliance in this regard also placed on the following decisions :-

(i) Synechron Technologies Private Limited Vs. ACIT (ITA No. 1692/PUN/2018).

(ii) Symantec Software India Private Limited Vs. ACIT (ITA No. 1824/PUN/2018).

(iii) FIS Solutions (India) Private Limited Vs. ACIT (ITA No. 1695/PUN/2018).

(iv) Optiva India Technologies Private Limited Vs. DCIT (ITA No. 15/PUN/2019).

23. It is further submitted that in the immediate preceding assessment year, this Tribunal held it to be not comparable with that of the assessee company. Without prejudice to the above, it is also stated that Related Party Transactions (RPT) of this company on expenditure side more than 25% of the total expenses. Therefore, this company cannot be excluded from the list of the comparables.

24. On the other hand, ld. Sr. DR submitted that the revenue from sale of products is very nominal does not impact on the operation results of the software segment. Therefore, it is submitted that this company cannot be excluded from the list of the comparables on the ground that this company also engaged in the produce development. As regards to the exclusion of this company on the ground of RPT of expenditure is more than 25%, it is submitted that this plea was taken for the first time and cannot be entertained.

25. We heard the rival submissions and perused the material on record and also perused the annual report of this company placed before us at page no.79 to 200 of the Paper Book. At page no.176, the bifurcation of revenue from operations is furnished in the footnotes, which reads as under :-

“Export of Software Services : 20194.37 Software Services from local unit : 414.07 Revenue from Subscription & Training : 59.32 Sale of Licence : 7.98.”

26. On careful perusal of the annual report, it indicates that there is no segmental details are furnished. However, the revenue from sale of licence is only 7.98 crores which is very-very minimal compared to the total revenue of Rs.20,675.00 crores. Further, the balance sheet does not indicate the presence of any intangible assets or closing stock. Therefore, it cannot be said that this company cannot be compared with software development provider. Therefore, we do not find any merit in the contentions raised on behalf of the assessee company. Hence, we uphold the action of the Assessing Officer/TPO/DRP in inclusion of this company in the list of comparables.

27. Infobeans Systems India Ltd.:- This company was selected for inclusion in the list of the comparables by the TPO rejecting the contention of the appellant that it should be rejected on the ground of earning super normal profits. Even the ld. DRP had confirmed the action of the TPO.

28. Being aggrieved, the appellant is in appeal before us.

29. Before us, it is contended that this company should be excluded from the list of the comparables on the ground that it is earning super normal profits placing reliance on Note- 27 forming part of the financial statements at page no.222 of the Paper Book, it is submitted that this company has also exports of goods placing reliance on the following decisions :-

1. Kony IT Services (P.) Ltd. (ITA No. 2304/HYD/2018)

2. PubMatic India Private Limited Vs. ACIT (ITA No. 655/PUN/2017)

3. Emerson Electric Company (India) Private Limited Vs. ACIT (ITA No.6098/Mum/2018 & ITA No.531/Mum/2018)

4. ADP Private Ltd Vs. ACIT (ITA No.2233/Hyd/2018)

30. On the other hand, ld. Sr. DR submitted that no company can be excluded as comparable merely it is making a super normal profits and reliance in this regard is placed on the decision of the Special Bench of Mumbai Tribunal in the case of Maersk Global Centres (India) (P.) Ltd. vs. ACIT, 31 ITR 1. It is further submitted that this company is functionally comparable with that of the assessee company and no objection was taken up before the TPO/DRP on functionality differences.

31. We heard the rival submissions and perused the material on record. We also perused the financial statements of the company, Infobeans Systems India Ltd. placed at page no.201 to 229 of the Paper Book. The Note-20 giving the details of the revenue operations, it is clearly mentioned that the revenue from operations is solely derived from sale of software exports, which clearly indicates that it is engaged in the software development services. A company cannot be characterized as product development company merely based on the description that is given under clause the export of goods/services. We have carefully gone through financial statements of this company, we do not find presence of closing stock or working progress which indicates that it is into development of products. Thus, the contention of the appellant company that it is into product development company and, therefore, cannot be compared with that of the assessee company, cannot be accepted. However, merely because the company is earning super normal profits cannot be excluded without enquire into whether the profits are earned under normal business conditions or abnormal business conditions. Reliance can be placed on the decision of Chandigarh Bench of the Tribunal in the case of CIT vs. Quark Systems India (P.) Ltd. approved by the Hon’ble Punjab & Haryana High Court, 11 taxmann.com 427 (P&H). Thus, we uphold the action of the Assessing Officer/TPO/DRP in inclusion of this company in the final list of the comparables.

32. The appellant company also filed additional ground of appeal no.1 which reads as under :-

“1. The assessee submits foreign exchange gain or loss should be considered as part of operating revenue while determining PLI of the assessee and the comparable companies.

33. It is submitted that the exchange operations on account of foreign currency conversion should be considered as a part of the operating revenue for the purpose of determining the PLI of the assessee company. It is stated that it is purely a legal issue and requires no investigation into facts, therefore, this additional ground of appeal should be decided placing reliance on the decision of the Hon’ble Supreme Court in the case of National Thermal Power Co. Ltd. v. CIT, 229 ITR 383 (SC).

34. On the other hand, ld. Sr. DR opposed the admission of the above additional ground of appeal no.1 placing reliance on the decision of the Hon’ble Jurisdictional High Court in the case of Ultratech Cement Ltd. vs. Addl.CIT, 81 com 74 (Bom.).

35. We heard the rival submissions and perused the material on record. Admittedly, the issue whether gain or loss arising out of foreign currency conversion is forming part of the income or loss is not subject-matter of proceedings before the lower authorities. Further, whether gain or loss arising out of conversion of foreign currency form part of the operating income or not is indicated question of fact and law as the gain or loss arising out on trading alone can form part of the operating income. Therefore, it requires examination and verification of the financial statements of the tested party as well as the comparable entities to form an opinion whether gain or loss arising out of foreign exchange fluctuation shall form part of the operating income or not?. Therefore, it cannot be said that it is a pure question of law as canvassed by the ld. AR for the appellant company. Further, the appellant had not produced the financial statements of the comparables before us nor filed any record of working of the arm’s length price as required under clause (j) of sub-rule(1) of Rule 10(d) of the Rules to demonstrate in support of its claim. Thus, the appellant contention is not based on the material on record in support of the additional ground of appeal. He could not establish that it is a pure question of law. In the circumstances, the additional ground of appeal no.1 cannot be admitted for adjudication and hence, additional ground of appeal no.1 stands dismissed.

36. The appellant also filed additional ground of appeal no.2, which reads as under ;-

2. The assessee requests for inclusion of Cat Technologies Ltd and Maverick Systems Ltd. as comparable entities in final list of comparables while determining Arm’s length price under Transactional Net Margin Method (TNMM).”

37. This additional ground of appeal no.2 was not pressed during the course of hearing of appeal before us, hence, the additional ground of appeal no.2 stands dismissed as not pressed.

38. In the result, the appeal filed by the assessee stands partly allowed.

Order pronounced on this 30^th day of May, 2022.