Trilogy EBusiness Software v. Dy. CIT

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The Tax Publishers2013 TaxPub(DT) 0580 (Bang-Trib) : (2013) 140 ITD 0540 : (2013) 023 ITR (Trib) 0464 INCOME TAX ACT, 1961 --Transfer pricing--Computation of ALP Turnover filter--Assessee-company was incorporated in June, 2000. M/s 'V' USA holds the entire share capital of the assessee except two shares. The assessee provides software research and development services for 'V' on a contract basis as requested by 'V'. Thus the said transaction has an international transaction and was with AE. Assessee was remunerated on a 'cost plus' basis the total value of international transaction with respect to provision of software research and development support services by the assessee to its AE was 47,46,66,638. The assessee contended that TPO applied a lower turnover filter of Rs. 1 Crore, but has not choosen assessing officer apply any upper turnover limit. *Held:* Turnover filter is an important criterian in choosing the comparables. The assessees is 47,46,66,638 it would, therefore, full within the category of companies in the range of turnover between 1 Crore to 200 crores and as such companies having more than 200 Crores have to be excluded from the list of comparables. Income Tax Act, 1961 Section 92C Income Tax Act, 1961 Section 92CA INCOME TAX ACT, 1961 --Transfer pricing--Computation of ALP Selection of comparables--TPO rejected 20 out 28 comparables given by the assessee in its TP report. The assessee before the TPO had also given some other additional comparables which was also rejected by the TPO. The TPO on his own arrived at a set of 18 comparable over and above the 8 comparable relied upon by the assessee in its TP study, which the TPO accepted as comparables. Thus, the TPO arrived at a set of 26 comparables. *Held:* There are extraordinary profits and those companies are considered by the TPO for comparability but making companies are not considered as comparables that would be improper. In the present case, factors for abnormal profits have not be highlighted by the assessee, in such circumstances, it is not possible to accept the submission of assessee to exclude this company for the purpose of comparison. Further, profit margin of 23.11 per cent which is the margin of software service segment, would be taken for comparability. Where there are extraordinary profits and those companies are considered by the TPO for comparability but loss making companies are not considered as comparable, that would improper. Such contradiction in approach should not be permitted. [Para 32] When the margins of comparable companies are either extremely low or high, the approach should be to eliminate both and not consider only the high or low margin comparables as it suits either the TPO or the assessee. [Para 33] As far as the provisions of the Act are concerned, they lay down that the comparable companies should be functionally comparable to the tested party. There are no specific standards of comparability on the basis of abnormal profits or loss. Rule 10B(2) provides that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following namely: (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. [Para 34] There is, therefore, no bar to considering companies with either abnormal profits or abnormal losses as comparable to the tested party, as long as they are functionally comparable. A general rule that companies with abnormal profits should be excluded may be in tune with the principles enunciated in OECD guidelines but cannot be said to be in tune with Indian TP regulations. However, if there are specific reasons for abnormal profits or losses or other general reasons as to why they should not be regarded as comparables, then they can be excluded for comparability. It is for the assessee to demonstrate existence of abnormal factors. [Para 35] In the present case factors for abnormal profits have not been highlighted by the assessee. In such circumstances it is not possible to accept the submission of the assessee to exclude this company for the purpose of comparison. [Para 36] The next plea of the assessee is that if at all this company is considered as a comparable then the segmental margin of 23.11% (which is the margin for software service segment) alone should be considered for comparability. On the above submission, the TPO considered the segmental margin (Software service segment) in the case of G, K Info Systems, R Systems, S Communication and T. Before DRP the assessee pointed out that the segmental margin of 23.11% alone should be taken for comparability. The DRP has not given any specific finding on the above plea of the assessee. Perusal of the order of the TPO shows that the TPO relied on information which was given by this company. The TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to software development) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO, therefore, held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO's filter of more than 75% of revenues from software development services. Having drawn the above conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. [Para 37] Neither the TPO nor the DRP have noticed that there is bound to be a difference between the assessee and Megasoft and the profit arising to the Megasoft as a result of the existence of the software product segment and no finding has been given that reasonably accurate adjustments can be made to eliminate the material effects of such differences. For this reason, profit margin of 23.11% which is the margin of the software service segment be taken for comparability. In view of the above conclusion, Tribunal does not wish to go into the question as to whether less than 25% of the revenues of the comparable are from software products and therefore, the comparable satisfied TPO's filter of more than 75% of revenues from software development services. [Para 38] SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2013 TaxPub(DT) 0580 (Bang-Trib) : (2013) 140 ITD 0540 : (2013) 023 ITR (Trib) 0464

INCOME TAX ACT, 1961

--Transfer pricing--Computation of ALP Turnover filter--Assessee-company was incorporated in June, 2000. M/s 'V' USA holds the entire share capital of the assessee except two shares. The assessee provides software research and development services for 'V' on a contract basis as requested by 'V'. Thus the said transaction has an international transaction and was with AE. Assessee was remunerated on a 'cost plus' basis the total value of international transaction with respect to provision of software research and development support services by the assessee to its AE was 47,46,66,638. The assessee contended that TPO applied a lower turnover filter of Rs. 1 Crore, but has not choosen assessing officer apply any upper turnover limit. Held: Turnover filter is an important criterian in choosing the comparables. The assessees is 47,46,66,638 it would, therefore, full within the category of companies in the range of turnover between 1 Crore to 200 crores and as such companies having more than 200 Crores have to be excluded from the list of comparables.

Income Tax Act, 1961 Section 92C

Income Tax Act, 1961 Section 92CA

INCOME TAX ACT, 1961

--Transfer pricing--Computation of ALP Selection of comparables--TPO rejected 20 out 28 comparables given by the assessee in its TP report. The assessee before the TPO had also given some other additional comparables which was also rejected by the TPO. The TPO on his own arrived at a set of 18 comparable over and above the 8 comparable relied upon by the assessee in its TP study, which the TPO accepted as comparables. Thus, the TPO arrived at a set of 26 comparables. Held: There are extraordinary profits and those companies are considered by the TPO for comparability but making companies are not considered as comparables that would be improper. In the present case, factors for abnormal profits have not be highlighted by the assessee, in such circumstances, it is not possible to accept the submission of assessee to exclude this company for the purpose of comparison. Further, profit margin of 23.11 per cent which is the margin of software service segment, would be taken for comparability.

Where there are extraordinary profits and those companies are considered by the TPO for comparability but loss making companies are not considered as comparable, that would improper. Such contradiction in approach should not be permitted. [Para 32] When the margins of comparable companies are either extremely low or high, the approach should be to eliminate both and not consider only the high or low margin comparables as it suits either the TPO or the assessee. [Para 33] As far as the provisions of the Act are concerned, they lay down that the comparable companies should be functionally comparable to the tested party. There are no specific standards of comparability on the basis of abnormal profits or loss. Rule 10B(2) provides that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following namely: (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. [Para 34] There is, therefore, no bar to considering companies with either abnormal profits or abnormal losses as comparable to the tested party, as long as they are functionally comparable. A general rule that companies with abnormal profits should be excluded may be in tune with the principles enunciated in OECD guidelines but cannot be said to be in tune with Indian TP regulations. However, if there are specific reasons for abnormal profits or losses or other general reasons as to why they should not be regarded as comparables, then they can be excluded for comparability. It is for the assessee to demonstrate existence of abnormal factors. [Para 35] In the present case factors for abnormal profits have not been highlighted by the assessee. In such circumstances it is not possible to accept the submission of the assessee to exclude this company for the purpose of comparison. [Para 36] The next plea of the assessee is that if at all this company is considered as a comparable then the segmental margin of 23.11% (which is the margin for software service segment) alone should be considered for comparability. On the above submission, the TPO considered the segmental margin (Software service segment) in the case of G, K Info Systems, R Systems, S Communication and T. Before DRP the assessee pointed out that the segmental margin of 23.11% alone should be taken for comparability. The DRP has not given any specific finding on the above plea of the assessee. Perusal of the order of the TPO shows that the TPO relied on information which was given by this company. The TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to software development) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO, therefore, held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO's filter of more than 75% of revenues from software development services. Having drawn the above conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. [Para 37] Neither the TPO nor the DRP have noticed that there is bound to be a difference between the assessee and Megasoft and the profit arising to the Megasoft as a result of the existence of the software product segment and no finding has been given that reasonably accurate adjustments can be made to eliminate the material effects of such differences. For this reason, profit margin of 23.11% which is the margin of the software service segment be taken for comparability. In view of the above conclusion, Tribunal does not wish to go into the question as to whether less than 25% of the revenues of the comparable are from software products and therefore, the comparable satisfied TPO's filter of more than 75% of revenues from software development services. [Para 38]