Etisalat Software Solutions Pvt. Ltd. Vs DCIT (ITAT Bangalore)
The appeal arose from the final assessment order for Assessment Year 2018-19 making transfer pricing adjustments in respect of software development services rendered by the assessee, a subsidiary of Emirates Telecommunications Group Company PJSC engaged in software development and telecom support services for its associated enterprise. The Transfer Pricing Officer (TPO) rejected the assessee’s set of comparables, selected a new set of comparables with a higher average margin, proposed a transfer pricing adjustment on software development services, and also made a separate adjustment towards notional interest on outstanding receivables by applying the SBI short-term deposit rate. The Dispute Resolution Panel partly accepted and partly rejected the assessee’s objections, following which the final assessment order was passed.
Before the Tribunal, the assessee primarily challenged the adjustment relating to notional interest on outstanding receivables and the inclusion and exclusion of various comparable companies. Regarding outstanding receivables, the assessee contended that the receivables were part of the principal international transaction, stood subsumed in the arm’s length price of software development services, and that it was a debt-free company funded by its associated enterprise, thereby incurring no working capital cost. The Tribunal referred to judicial precedents dealing with outstanding receivables and working capital adjustments and held that the issue required fresh examination. It directed the Assessing Officer/TPO to verify whether the working capital adjustment already subsumed the outstanding receivables. If so, no separate transfer pricing adjustment should be made. For receivables not covered by the working capital adjustment, the Tribunal directed that interest, if chargeable, should be computed at LIBOR plus 300 basis points after allowing a credit period of 90 days. The issue was accordingly remanded for fresh adjudication.
With respect to comparability analysis, the Tribunal remanded the question of inclusion of Rheal Software Ltd. and Evoke Technologies Pvt. Ltd. to the Assessing Officer/TPO for verification of the assessee’s contentions based on their annual reports. It directed that these companies should be included if the factual claims regarding the persistent loss filter and export revenue filter were found to be correct.
The Tribunal accepted the assessee’s contention that an upper turnover filter should be applied while selecting comparable companies. Observing that significant differences in turnover affect profitability because of economies of scale, it held that companies having turnover exceeding ₹200 crore could not be compared with the assessee, whose software development services turnover was about ₹54.30 crore. Consequently, it directed exclusion of Exilant Technologies Pvt. Ltd., Tech Mahindra Ltd., Larsen & Toubro Infotech Ltd., Mindtree Ltd., Nihilent Ltd., Persistent Systems Ltd., Wipro Ltd., Tata Elxsi Ltd., Thirdware Solution Ltd., Infosys Ltd. and Cybage Software Pvt. Ltd. from the final set of comparables.
The Tribunal further directed exclusion of Threesixty Logica Testing Services Pvt. Ltd. because of functional dissimilarity and absence of appropriate segmental information. Elveego Circuits Pvt. Ltd. was excluded as it was engaged in chip and semiconductor design services and was not functionally comparable to the assessee’s captive software development services. Great Software Laboratory Pvt. Ltd. was excluded since it rendered diverse software-related services without segmental information. Acewin Agriteck Ltd. (formerly OFS Technologies Ltd.) was also excluded after the Tribunal found it engaged in outsourced product development, enterprise application development, testing services and other diversified activities which were functionally different from the assessee’s software development services. Accordingly, the appeal was partly allowed.
FULL TEXT OF THE ORDER OF ITAT BANGALORE
Present appeal arises out of order dated 31.01.2023 passed by the Ld.DCIT, Circle – 2(1)(1), Bangalore for A.Y. 2018-19 on following grounds of appeal:
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2. Brief facts of the case are as under:
2.1 Assessee is a subsidiary of Emirates Telecommunications Group Company PJSC. It is stated to be engaged in provision of software development services, Operations Supports Systems (OSS), Business Support Services (BSS) domain of telecom space with focus on products, custom software development, consultancy and enterprise resource planning solutions.
2.2 For the year under consideration, assessee filed its return of income on 29.11.2018 declaring gross total income of Rs.82,22,645/-. It is submitted that the assessee provides software development services to its AE and sold hardware and software products to its AE. As the Ld.AO noted that the transaction with AE exceeded the threshold limit, a reference was made to the transfer pricing officer u/s. 92CA.
2.3 On receipt of the reference, the Ld.TPO called upon assessee to furnish the economic details of the international transaction in form 3CEB. The Ld.TPO observed that assessee had carried out following functions during the year.
“Etisalat is engaged in the business of providing telecommunication services in United Arab Emirates since 1976 and having established a modern telecom infrastructure, is one of the leading companies in the region. ESSPL was set up in Bangalore, India as a wholly owned subsidiary of Etisalat to take care of the information technology of Etisalat and is desirous of carrying on software development and managed services (IT and managed services) for Etisalat.”
2.4 He noted that the international transaction undertaken by assessee was as under:
| Particulars | Value |
| Software Development Services | 385,553,406 |
| Reimbursement of expenses | 5,610,392 |
| Sale of hardware and software products | 148,565,238 |
2.5 Assessee used TNMM as the most appropriate method and PLI was calculated by using OP/OC at 7.08%.
The Ld.TPO noted that assessee selected following 12 comparables with an average margin of 6.02% and thus treated the SWD transaction to be at arms length.
| Sl.No. | Name of the Company | Operating Margin (%) |
| 1 | Rheal software Limited | (4.39) |
| 2 | Isummation Technologies Private Limited | 3.69 |
| 3 | DCIS Dot Com Solutions India Pvt Ltd | 3.90 |
| 4 | Maveric systems Limited | 4.31 |
| 5 | Sagarsoft India Ltd | 6.02 |
| 6 | Evoke Technologies Pvt Ltd | 4.49 |
| 7 | Harbinger Systems Pvt Ltd | 6.70 |
| 8 | Microland Ltd | 7.32 |
| 9 | ASM Technologies Ltd | 7.44 |
| 10 | 8K Miles Software Services Pvt Ltd | 13.08 |
| 11 | R Systems International Ltd (Seg) | 21.32 |
| 12 | Infobeans Technologies Ltd | 25.91 |
2.6 Dissatisfied with the comparables selected by the assessee, the Ld.TPO shortlisted set of 20 comparables with average margin of 23.60%, and thus proposed adjustment being shortfall at Rs.5,94,88,380/-.
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2.7 The Ld.TPO further noticed that, there were outstanding receivables and thus computed notional interest by adopting SBI short term deposit interest rate and proposed an adjustment of Rs.2,88,63,948/-.
2.8 On receipt of the order u/s. 92CA, the Ld.AO passed the draft assessment order on 30.12.2022 by proposing addition in the hands of the assessee being the transfer pricing adjustment at Rs.7,94,94,700/-.
2.9 On receipt of the draft assessment order, assessee preferred objections before the DRP. Before the DRP, assessee raised objections in respect of certain comparables seeking exclusion by applying turnover filter which was rejected.
2.9.1 Certain comparables that assessee sought inclusion was also rejected by the DRP, however certain other comparables like Isummation Technologies Pvt. Ltd., DCIS Dot Com Solutions India Pvt. Ltd., Maveric Systems Ltd., Sagarsoft India Ltd., ASM Technologies Ltd. were accepted by the DRP for inclusion.
2.10 On receipt of the DRP directions, the Ld.AO passed the final assessment order by making an addition on the transfer pricing issue at Rs.7,94,94,700/-.
Aggrieved by the order of the Ld.AO, the assessee is in appeal before this Tribunal.
3. At the outset, the Ld.AR submitted that the assessee wish to press Ground nos. 4-5 being notional interest computed on outstanding receivables.
He submitted that in Ground nos. 9.1, 9.2 assessee is seeking inclusion of two comparables and Ground no. 10 the assessee is seeking exclusion of 11 comparables by applying the turnover filter and two comparables being functionally not similar with that of the assessee.
3.1 It is submitted that the assessee is also seeking exclusion of two comparables for failing RPT filter.
3.2 It is submitted that Ground nos. 1,3,6,7,14 are general in nature and therefore do not require any adjudication.
3.3 The Ld.AR also submitted that Ground nos. 2, 9.3, 11 and 12 are not pressed by assessee.
Accordingly these grounds are dismissed as not pressed.
4. Ground nos. 4-5 raised by assessee against the notional interest computed by applying the SBI short term deposit rate.
4.1 It is submitted that, the amounts outstanding have been settled by the AE on an on-going basis in the normal course of business having regard to economic and commercial factors. Since the outstanding receivables related to the primary services rendered, the assessee submits that, the determination of ALP of the outstanding receivables is not warranted as the same is subsumed in the ALP of the principal transaction. The Assessee also contends the outstanding receivables could not be made subject matter of TP adjustment as the same is not covered under the provisions of Section 92B of the Act. Also, it is submitted that the Assessee is a debt free company and does not bear any working capital risk since it is fully funded by its AEs. The Assessee has not incurred any interest expenses for its working capital requirement. Hence, the Assessee does not have any interest cost in the funds blocked on deferred receivables from AEs as it is entirely funded by its AEs for its working capital requirements.
4.2 The Ld.DR relied on the orders passed by authorities below. We have perused the submissions advanced by both sides in the light of records placed before us.
4.3 We referred to decision of Special Bench of this Tribunal in case Instrumentation Corpn. Ltd. v. Asstt. DIT in ITA No. 1548 and 1549 (Kol.) of 2009, dated 15/07/2016, held that outstanding sum of invoices is akin to loan advanced by assessee to foreign AE., hence it is an international transaction as per explanation to section 92 B of the Act.
4.3.1 Alternatively, it has been argued that working capital adjustment subsumes sundry creditors. In such situation computing interest on outstanding receivables and lones and advances to international transaction would amount to double taxation. Hon’ble Delhi Tribunal in case of Orange Business Services India Solutions Pvt. Ltd. vs. DCIT in ITA No. 6570/Del/2016 vide its order dated 15.2.2018 observed that:
“There may be a delay in collection of monies for supplies made, even beyond the agreed limit, due to a variety of factors which would have to be investigated on a case to case basis. Importantly, the impact this would have on the working capital of the assessee would have to be studied. It went on to hold that, there has to be a proper inquiry by the TPO by analysing the statistics over a period of time to discern a pattern which would indicate that vis-à-vis the receivables for the supplies made to an AE, the arrangement reflected an international transaction intended to benefit the AE in some way. Similar matter once again came up for consideration before the Hon’ble Delhi High Court in Avenue Asia Advisors Pvt. Ltd. vs. DCIT (2017) 398 ITR 120 (Del). Following the earlier decision in Kusum Healthcare (supra), it was observed that there are several factors which need to be considered before holding that every receivable is an international transaction and it requires an assessment on the working capital of the assessee. Applying the decision in Kusum Health Care (supra), the Hon’ble High Court directed the TPO to study the impact of the receivables appearing in the accounts of the assessee; looking into the various factors as to the reasons why the same are shown as receivables and also as to whether the said transactions can be characterized as international transactions.”
4.4 In view of the above, we deem it appropriate to set aside the impugned order on this issue and remit the matter to the file of the Ld.AO/TPO for deciding it in conformity with the above referred judgment. We also direct the Ld.TPO that in the event the WCA subsumes the outstanding receivables, no separate characterisation is to be made. However for those receivables that fall out of the WCA pertaining to year under consideration, then, the rate of interest to be charged must be LIBOR + 300 basis points which is in accordance with the principles laid down by Hon’ble Delhi High Court in case of CIT vs. Cotton Naturals (I) Pvt. Ltd., reported in (2015) 276 CTR 445 by considering a credit of 90 days.
Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings.
Accordingly, this ground raised by assessee stands partly allowed for statistical purposes.
The remaining grounds are regarding exclusion / inclusion of comparables by the assessee.
Before we undertake the comparability analysis, it is sinequa non to understand the FAR of the assessee before us.
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5. In Ground nos. 9.1 & 9.2 assessee is seeking inclusion of Rheal Software Ltd. and Evoke Technologies Pvt. Ltd.
The Ld.AR submitted that these two comparables have been included by Coordinate Bench of this Tribunal in case of Meritor
5.1 He submitted that Rheal Software Ltd. is rejected by the Ld.TPO on the ground that it satisfies persistent loss filter. However the Ld.AR submitted that this Tribunal has held in a large number of cases that, in order for a comparable to be held to satisfy this filter, the comparable must have incurred losses consequently, for three years and that if it has incurred profit in event one of the three years, it cannot be held that this comparable has to be rejected by applying persistent loss filter. 5.2 In respect of Evoke Technologies Pvt. Ltd., the Ld.AR submitted that the Ld.TPO held that it fails the export service income filter. The Ld.AR referring to the annual reports submitted that this observation needs to be verified as the income export turnover earned by this comparable is more than 75%.
5.3 On the contrary, the Ld.DR placed reliance on orders passed by authorities below.
5.4 We have perused the submissions advanced by both sides in the light of records placed before us.
5.4.1 We note that all the above submissions by the assessee needs to be reverified by the Ld.AO/TPO. As the authorities have not disputed these comparables are functionally not similar, it is directed that the objections of the assessee may be verified having regards to their annual reports and then to consider the claim for inclusion of these comparables in accordance with law.
5.4.2 In the event, the contentions of the assessee are found to be true, the two comparables are directed for inclusion. Assessee is directed to file all the relevant documents in support of the claim. Needless to say that proper opportunity of being heard must be granted to assessee.
Accordingly, ground nos. 9.1 & 9.2 raised by assessee stands partly allowed for statistical purposes.
6. Ground no. 10 is in respect of exclusion of comparables.
The Ld.AR submitted that following 11 comparables deserves to be excluded on application of upper turnover filter.
| Sl. No. |
Name of the Company | Turnover (in crores) |
| 1 | Exilant Technologies Pvt. Ltd. | 332 |
| 2 | Tech Mahindra Ltd. | 23,661 |
| 3 | Larsen & Toubro Infotech Ltd. | 6,906 |
| 4 | Mindtree Ltd. | 5,325 |
| 5 | Nihilent Ltd. | 280 |
| 6 | Persistent Systems Ltd. | 1,733 |
| 7 | Wipro Ltd. | 44,710 |
| 8 | Tata Elxsi Ltd. | 1,386 |
| 9 | Thirdware Solution Ltd. | 204 |
| 10 | Infosys Ltd. | 61,941 |
| 11 | Cybage Software Pvt. Ltd. | 737 |
6.1 On the contrary, the Ld.DR placed reliance on orders passed by authorities below.
6.2 We have perused the submissions advanced by both sides in the light of records placed before us.
6.2.1 We note that the Ld.TPO erred in not applying a cap on upper limit on the turnover while selecting the companies comparable. In this regard, we note that, application of turnover filter is a relevant criterion in choosing comparable companies. The difference in the scale of operations has a direct impact on the profitability. The concept of economies of scale wherein, an increase in the size and scale of the operations leads to a decrease in the long run average cost of each unit or each service project delivered. Therefore, the per unit fixed cost of a small-scale company would be much higher than that of a medium/large size organisation.
6.2.2 Further, it is submitted that medium/large size organisation operating in a particular industry also enjoys benefits of certain other market drivers and cost arbitrages. It is submitted that the turnover of the assessee under SWD services is Rs. 54.30 crores. This being so, the Ld.TPO ought to have applied upper turnover filter while selecting comparable in the present case.
6.2.3 We draw support from the decision of this Tribunal in case of Autodesk India (P) Ltd. V. DCIT [Reported in (2018) 96 taxmann.com 263 (Bang Trib)]. On application of the turnover filter on 1-200 crores, the above 11 companies are to be excluded. Further reliance is placed on the decision of this Hon’ble Tribunal in ACI Worldwide Solutions Pvt. Ltd. v. ACIT (order dated 13.05.2022 passed in IT(TP)A No. 106/Bang/2022). Considering the facts and respectfully following the decision of the Coordinate Bench of the Tribunal in the case of Autodesk India Pvt Ltd., (supra), we hold that the above listed companies whose turnover in the current year is more than Rs.200 crores should be excluded from the list of comparable companies.
Accordingly all the above comparables stands rejected.
7. Threesixty Logica Testing Services Pvt. Ltd.
7.1 The Ld.AR submitted that, this comparable fails RPT filter as its RPT is 30.42%. It is also submitted that, this comparable is functionally not similar with that of assessee as it owns certain brand names “SAQAMA” & “STAQK”. He referred to pages 1075 to 1252 of paper book in support, wherein the annual reports of this comparable is placed. Referring to page 1129, the Ld.AR submitted that the income has been declared by this company under the head “Revenue from operations”. Referring to the company overview mentioned at page 1135, the Ld.AR submitted that, this company is primarily engaged in providing information technology services viz. software testing and QA services.
7.2 The Ld.AR submitted that, this company also earns revenue from sale of third party software product and hardware for which there is no segmental data available.
7.3 He placed reliance on the decision of Coordinate Bench of this Tribunal in case of NTS Technology Services Pvt. Ltd. vs. DCIT in IT(TP)A No.940/Bang/2022 where this comparable was excluded for the above reason.
7.4 On the contrary, the Ld.DR placed reliance on orders passed by authorities below.
7.5 We have perused the submissions advanced by both sides in the light of records placed before us.
7.6 We note that this Tribunal in case of NTS Technology Services Pvt. Ltd. vs. DCIT (supra) directed the exclusion of this comparable by observing as under:
“11.7.5 From the annual reports filed by the Ld.AR in the paper book, we note that this company derives 100% income from writing, modifying, testing of computer program to meet the needs of a particular client excluding webgage and designing. In the annual report, the revenue recognition by this company is stated to be primarily from software testing, QA and related services which is also supported from the notes to account being note 1 wherein the company overview also states that it is primarily engaged in providing information technology services being software testing and QA services and it also stated in the segmental report and operating segmental details that there are no other reportable segments. We therefore see merit in the arguments of the Ld.AR that this company is not comparable functionally since the assessee is a contract service provider rendering limited services to its AE alone.
Accordingly, this comparable is directed to be excluded.”
7.7 Revenue has not been able to bring on record any distinguishing facts. The assessee before us is a captive service provider.
Respectfully following the above view, we direct exclusion of this comparable from the final list for lack of segmental information and functional dissimilarities with assessee.
8. Elveego Circuits Pvt. Ltd.
8.1 The Ld.AR submitted that this comparable has abnormally high margin for the year under consideration. He also contended that this company was considered by the Ld.TPO without furnishing the annual report. He also submitted that this company is engaged in the business of electronics and semiconductor design services, which is not similar to the SWD services rendered by the assessee. He submitted that this company is into chip and semiconductor designing services where as the assessee before this Tribunal is a captive service provider rendering limited SWD services to its AE. The Ld.AR thus submitted that this company is functionally not at all similar with that of the assessee.
8.2 On the contrary, the Ld.DR relied on the observations of the authorities below.
We have perused the submission advanced by both sides in light of records placed before us.
8.3 We note that this company is in the business of Chip and semiconductor design services where as the assessee before us is into basic SWD services of coding an documentation, Testing and quality assurance, software patches and maintenance. There is no similarity between the functions performed by the assessee vis-à-vis that of this company. We therefore at the threshold reject this company being functionally not similar with that of the assessee.
Accordingly, the Ld.TPO is directed to exclude this company from the final list of comparables.
9. Great Software Laboratory Pvt. Ltd.
9.1 The Ld.AR submitted that this company is engaged in the business of design and development services of software applications including customisation and packaged software. She further submitted that the primary service of the Company are cloud products and operations management, IDM and connected experience practice, big data analytics and support services. The Company has also earned revenue from sale of products. The company is engaged in diverse activities for which no segmental details is available. It is further submitted that the company owns significant intangibles and that this company earned significant onsite revenue which demonstrates that it operates on a different model and therefore functionally not comparable with the assessee. 9.2 The Ld.AR placed reliance on the decision of Coordinate Bench of this Tribunal in case of Sprinklr India Pvt. Ltd. in IT(TP)A No. 713/Bang/2022 by order dated 11.01.2023.
9.3 The Ld.DR on the contrary, relied on the observations of the authorities below.
We have perused the submissions advanced by both sides in the light of records placed before us.
9.4 We note that in case of Sprinklr India Pvt. Ltd. (supra), this comparable was remanded for want of complete annual reports. However in the present case, the Ld.AR has filed the necessary details and complete annual report to verify the arguments advanced. On perusal of the detailed submissions, filed by the assessee at pages 141-145 of the appeal set as well as 820-822 of the paper book, we note that admittedly the TPO accepts that this comparable provides various services using the same platform of SWD. It is also an admitted fact that this company works in a different horizontal and this company has been retained by the Ld.TPO only because it renders services under the category SWD. It is also noted by the Ld.TPO that the operations of this comparable is from SWD segment without there being any segmental details, which according to the Ld.TPO is irrelevant. In our considered opinion, this Tribunal has been consistently rejecting the comparables whether there are no segmental information available in order to compare “an apple with an apple”. Therefore the services rendered by the assessee under a contract with its AE cannot be compared with a company that renders various services under SWD segment. We do not find any reason to include this comparable in the final list.
Accordingly we direct the Ld.AO/TPO to exclude Great software Laboratory Pvt. Ltd.
10. Acewin Agriteck Ltd. (formerly known as OFS Technologies)
10.1 Acewin Agriteck Ltd. was formerly known as OFS Technologies Ltd. It is not functionally comparable to a simple software development services provider like the assessee.
“13. The ld AR for the assessee submitted that this company OFS Technologies Ltd. is engaged in diversified activities. OFS is a software development and information technology outsourcing company, enriched its core expertise over the last financial year in Enterprise Application Development, Mobile Applications Development, Cloud Enab lement, UI Development, DevOps Implementation and Data Analytics solutions. He submitted that OFS is engaged in outsourced product development which is different from software development activity carried out by the assessee. The Company is also engaged in independent testing. The assessee further submitted that OFS is into diverse activities and there is no segmental data available in the financial statements. Accordingly, based on the above, the assessee submitted that OFS should be rejected as a comparable. Additionally,
a. the assessee placed reliance on the following ruling wherein exclusion of the comparables engaged in outsourced product development was upheld:
– SAP Labs India (P.) Ltd. (supra)
– The assessee placed reliance on the following ruling wherein it was upheld that testing services are distinct from the software development life cycle and cannot be considered to be akin to software development services and comparables engaged in testing services have been excluded:
– Advice America Software Development Center (P.) Ltd. v. ITO [2018] 94 taxmann.com 179 (Bang. – Trib.)
Extracts from the annual report are provided below:
Service Offerings
BUSINESS STRATEGY:
Product Strategy – Enterprise Resource Planning (ERP) Our ERP product development vertical is focused on addressing the specific needs of the supply chain and manufacturing industries. This focused approach would enable the company to research more on adding new features to Enterprise Resource Planning tools that help companies overcome their challenges in manufacturing and supply chain management.
(Page 46 of Annual Report – FY 2016-17) Services Strategy – Outsourced Product Development
In the software services outsourcing business, the company ha; positioned itself as an Outsourced Product Development (OPD) specialty Company, helping to design, build, test and maintain commercial products and digital solutions. Also position as extended software engineering development partner providing digital innovation center to create software possess with the multidisciplinary, multidimensional skills.
(Page 46 of Annual report – FY 2016-17) Outsourced Commercial Product Development
We develop commercial-grade software for leading ISVs and global companies in Healthcare, Media and Insurance service domains. We create software with single code-base that is,
– Scalable-to handle both small and large clients.
– Configurable-to handle different customer operating scenarios.
– Compelling -Ul must attract buyer’s eye and have features that differentiate client’s products from competition
– ‘Multi’-enabled:
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- Multi-country- to handle different currencies and date formats
- Multi-lingual-to present the Ul in different languages, including the ideographic ones, such as Chinese and Japanese that use double-byte representation and storage
- Multi platform-to be able to run on Unix, Windows, Apple and Android deployment environments
(Page 47 of Annual report – FY 2016-17)
Independent Testing OFS helps clients to take control of the testing process. All features, both new and existing, can be thoroughly tested. It helps make sure that the test cases cover virtually 100% of user cases and can even help build a complete library of unit test cases that the client’s developers can extend as they change the code. Having such a large percentage of the code covered by the test cases can shrink the client’s software release cycle by as much as 35% since the end-of-cycle testing period can be dramatically reduced due to the higher quality of code that is turned over for QA. We have experienced quality Assurance professionals that provide a number of different types of testing.
OFS helps in building test plans, test cases, and test scripts to thoroughly examine the software and make sure it meets requirements and design goals. Also, platform certification is provided to make sure that the current release of software works with latest upgrades to windows, Oracle, SQL server, hardware Devices, Mobile Phones, and other platforms.
The Company has QA resources trained in several of the major automated testing tools such as: Selenium, UFT (Formerly QTP), Bad boy, LoadRunner, LoadComplete, Appium and Calaba.sh
14. The Ld. D.R. submitted that the ld DRP on perusal of the annual report, he noted that the company is into software development activities. The company as per the Note 14 to financial statements give at page 72 of the annual report derives income from software development only. As regards employment cost filter, the company passes the employment cost filter. On perusal of the profit and loss account of the company an amount of Rs. 3,81,28,529/- is debited towards employment cost as against total sales of Rs. 9,37,54,000/- which comes to 40.66%. The assessee argued that it fails the employment cost filter for the F.Y. 2014-15. The assessee also argued before the ld DRP that if the OFS included in the final list of comparable the margin pertaining to only F.Y. 2015-16 and 2016-17 ought to be considered.
14.1 The ld D.R stated that at the outset, the company is functionally comparable to the assessee and also passes the employment cost filter. Therefore, the company has to be included in the list of comparables and the Panel upholds the inclusion of this comparable. However, considering the plea of the assessee that the company fails the employment cost filter for the F.Y. 2014-15, the ld DRP directed the TPO to verify the plea of the assessee. If it fails the employment cost filter for the above year, the TPO was directed to consider the margin only for the F.Ys. 2015-16 and 2016-17.
14.2 The ld. DR further stated that the assessee argued before the ld DRP that the company fails export turnover filter for the F.Y. 2014-15 and hence if the company is considered as comparable the margins pertaining to F.Y. 2015-16 and F.Y. 2016-17 are only to be considered. On verification of the annual reports, it was seen that the company’s export turnover is below the threshold limit of 75% adopted by the TPO. The TPO, was therefore directed by the ld DRP to verify and if the export turnover is below 75% for the F.Y. 2014-15 the margins pertaining to financial years 2015-16 and 2016-17 should be considered for determining the ALP.
14.3 The ld DR stated that a plea was also raised before the ld DRP that this company has incurred substantial expenditure towards R&D and hence not to be taken as comparable. However, perusal of the information in the annual report shown that there is no separate expenditure item under the head R&D in the profit and loss account statement. There is no indication in the annual report to show that the R&D had resulted in any distinct product development giving rise to source of separate revenue stream. The information on technology absorption on which the assessee relied states that R&D activities are integrated with software development process with objective of ensuring efficiency and quality. Therefore, they are to be taken as routine activities in enhancing the quality of delivery of services. In view of the above these pleas were rejected by the ld DRP. Subjected to the above discussion, the selection of this company was upheld by the ld DRP.
15. We have heard the rival submissions and perused the materials available on record. In our opinion, this comparable fails the functionality test and this company OFS Technologies Ltd. is not functionally similar and deserves to be excluded.”
Accordingly, Ground no. 10 raised by the assessee stands allowed.
In the result, the appeal filed by assessee stands partly allowed.
Order pronounced in the open court on 18th July, 2023.
