CASE LAW

2017-TII-86-ITAT-PUNE-TP

TIETO SOFTWARE TECHNOLOGIES LTD Vs DCIT: PUNE ITAT (Dated: March 3, 2017)

Income Tax - Sections 143(3), 144C - rule 10B(2) & 10B(1)(e)(iii)

Keywords: AE - software development - functional adjustment - risk adjustment - segmental results - repayment of loan & DEPB

The assessee company had filed return of income declaring total income at Nil. The assessee was engaged in the business of software development wherein the assessee had received the approval from STPI. The assessee claims that it was a 100% export oriented unit which was engaged in designing, developing quality assured documentation at its unit located in Pune. Reference under section 92CA was made to the Transfer Pricing Officer to determine ALP of the international transaction undertaken by the assessee. TPO noted various international transactions undertaken by the assessee regarding development and sale of software, reimbursement of expenses. TPO observed that assessee was a 100% subsidiary of Tieto Enator Oyj which belong to the TE group headquartered in Finland. The assessee was a dedicated in-house software developer for the TE group handling and the entire export billing was made on TE group and not on any outside parties. The assessee had selected CPM as the most appropriate method to benchmark the international transaction relating to rendering of Software Development Services. However, the TPO rejected the same and during the course of hearing itself TNMM was considered as most appropriate method. During the course of hearing the assessee selected some of the listed companies as functionally comparable and the average margin of the said 4 companies, i.e. (a) KPIT Cummins, (b) Satyam Computers Ltd., (c) Tata Consultancy Services Ltd. and (d) Patni Computer Systems Ltd. worked out to 14.17%. The assessee pointed out that ALP of its international transaction with 14.03% markup was considered to be most reasonable. However, the Transfer Pricing Officer did not accept the contention of the assessee and a show cause notice was issued to the assessee. After considering the filters applied by assessee, TPO from the accept reject matrix filed by assessee considered certain companies as comparable. On appeal, CIT(A) held that TNMM was to be applied to benchmark the international transaction undertaken by assessee.

Having heard the matter, the Tribunal held that,

Whether a company not meeting the minimum criteria set for export filter and far exceeded the domestic sales quantum, can it still be compared with a captive unit - NO: ITAT

+ the first issue which arises for adjudication is against exclusion of concern Compucom Software Limited from the final list of comparables. As pointed out in the paras hereinabove, the assessee was engaged in providing Software Development Services to its AEs. The unit of the assessee was 100% EOU wherein the assessee had received the recognition under the STPI scheme. The assessee while benchmarking its international transaction had initially applied CPM as the most appropriate method; however, TPO applied TNMM as most appropriate. AR during the course of hearing pointed out that there was no dispute on the application of method and also on the application of filter, however, the issues were against various adjustments not allowed to the assessee. Appeal of revenue is against exclusion of Compucom Software Limited on the ground that it does not fail the export filter and its export sales at Rs. 10.96 crores far exceeded the domestic sales of Rs.37.76 lakhs. We have perused the financial statements of said concern. We find as per the annual report, the assessee for the year under consideration, had declared its income under the head "Software Development and Services" wherein for the year under consideration the income from Overseas operation was declared at Rs.10.96 crores and the domestic sales services were to the tune of Rs.37.76 lakhs. We find error in order of CIT(A); though the income reported by the said company in its annual report is reproduced in Para 2.3.3.5.1 at page 10 of the appellate order, however, the CIT(A) directed its exclusion failing to satisfy the filter of minimum 75% of export earnings. We reverse the order of CIT(A) in this regard since the said concern fulfils the filter of minimum 75% of the export earnings. Hence, Ground of appeal raised by revenue is allowed;

Whether adjustment is possible in the hands of tested party, when depreciation has been admitted as a part of cost for determining the operating margins - NO: ITAT

+ the assessee before us is a captive service provider to its AE is 100% export oriented unit wherein services are provided to AE. Assessee has sought depreciation adjustment on the ground that it is providing higher depreciation on certain assets on a different basis while the other comparables are providing depreciation as per the Companies Act. The issue of claim of depreciation while working out the operating margins arose before Bombay High Court in CIT Vs. M/s. Welspun Zucchi Textiles Ltd. 2017-TII-03-HC-MUM-TP. HC held that the depreciation is to be included as operating expenses to determine the operating cost of the assessee and the comparables. The question before the HC was the comparability between profit margins of assessee and the comparables in view of the parameters of comparability under Rule 10B(2) of IT Rules. In view thereof we hold that while determining the operating margins of the assessee, depreciation is to be considered as part of cost and there is no merit in the claim of the assessee in this regard. It may further be clarified that as per Rule 10B(1)(e)(iii) of the Rules, adjustment if any has to be made in the hands of the comparables and not in the hands of the tested party. So we dismiss the plea of the assessee in this regard. However, in case the assessee is able to establish that there is material difference in the claim of depreciation by the assessee vis-à-vis comparables, then suitable adjustment may be allowed in the hands of comparables after due verification by AO / TPO;

Whether a company can still be considered as a valid comparable even if its accounting period adopted does not relate to the financial year in which the international transaction had been undertaken by the assessee - NO: ITAT

+ the assessee has raised other grounds of appeal against exclusion or inclusion of the concerns as comparables but AR has not made any submission in this regard and the said grounds of appeal are dismissed. Even in the written submissions filed the assessee in its appeal has agitated Grounds of appeal No.2 which is against the adjustment claimed on account of depreciation which we have already adjudicated in the paras herein above. However, the additional Ground of appeal No.2 raised by the assessee is against the inclusion of Sterling International Enterprise Ltd. on the ground that the financial years are different. AR pointed out that the Pune Bench of the Tribunal in PTC Software (India) Pvt. Ltd. Vs. ACIT for the very same AY, i.e. 2007-08 had held that the said company could not be considered as comparable as the accounting period adopted does not relate to the financial year in which the international transaction had been undertaken by the assessee. We find merit in the claim of the assessee in this regard and applying ratio laid down in PTC Software (India) Pvt. Ltd. Vs. ACIT we hold that Sterling International Enterprise Ltd. now known as Transworld Infotech Ltd. is to be excluded from the final set of comparables in order to benchmark the ALP of the international transaction undertaken by the assessee, as it has different year ending. AO/TPO is directed to recompute ALP in relation to our directions in the paras hereinabove. The additional Grounds of appeal No.2 raised by the assessee is this allowed. In the result, the appeal of the assessee is partly allowed and appeal of the revenue is allowed.

Assessee's appeal partly allowed