ORDER

A.T. Varkey, Judicial Member - The assessee and revenue have preferred the present appeals against the impugned order dated 30.1.2013 passed by the Commissioner of Income Tax (Appeals) XX, New Delhi for A.Y. 2009-10

2. The grounds raised by the assessee read as under :

'1 The learned Commissioner of Income Tax (Appeals) erred both on facts and in law in confirming the addition of Rs. 93,58,086/- to the income of the appellant out of an addition of Rs. 1,72,01,288 made by the learned Assessing Officer by holding that its international transactions pertaining to its contract software development services do not satisfy the arm's length principle envisaged under the Income Tax Act, 19661 ('the Act') and in doing so, the Ld. CIT(A) has grossly erred in confirming/upholding the ld. AO's action of:

1.1 Disregarding the Arms Length Price (''ALP"), as determined by the appellant in the Transfer Pricing ("TP") documentation maintained by it in terms of section 92D of the Act read with Rule 10D of the Income Tax Rules, 1962 ('the Rules') as well as fresh search;

1.2 Including companies having high margin/volatile operating profit margins in the final comparables' for benchmarking a low risk captive nit such as the appellant (disregarding judicial pronouncements on the issue);

1.3 Modifying the results of economic analysis carried out by the appellant in the TP documentation by conducting a further analysis on the 17 comparables given in the TP documentation based on application of the following additional/revised filters (applied by the TPO in the immediately preceding year) in determining the ALP :

1.3.1 Adopting employee cost to revenues filter greater than 25% of their total revenues as a search criteria for short listing and evaluating comparables for software development services;

1.3.2 Exclusion of companies with diminishing revenues for last three years upto and including FY 2008-09;

1.3.3 Exclusion of companies with export sales that are less than 25% of their total revenue;

1.3.4 Retaining companies with related party transactions ('RPT') up to 25% of their sales

1.4 Disregarding multiple year/prior years' data as used by the appellant in the TP documentation and holding that current year (i.e. FY 2008-09) data for comparable companies should be used despite the fact that the same was not necessarily available to the appellant at the time of preparing its TP documentation;

1.5 Ignoring the fact that the appellant is entitled to tax holiday under section 10B of the Act on its profits and therefore would not have any untoward motive of driving of tax advantage by manipulating transfer prices of its international transactions;

1.6 Including certain companies that are not comparable to the appellant in terms of functions performed, assets employed and risks assumed; and

1.7 Excluding certain companies on arbitrary/frivolous grounds even though they are comparable to the appellant in terms of functions performed, assets employed and risks assumed

2. The learned CIT(A) ought to have considered fresh search comparables in the final comparables' set, as provided by the appellant.

3. The learned CIT(A) has grossly erred both on facts and in law in not appreciating the business/commercial reality that since the appellant is remunerated on an arm's length cost plus basis, i.e. it is compensated for all its operating costs plus a pre-agreed mark-up based on a benchmarking analysis, the appellant undertakes minimal business risks as against comparable companies that are full-fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the appellant on account of this fact.

4. The Ld. CIT(A) has grossly erred both on facts and in law in confirming/upholding the Ld. AO's action of disallowing Rs. 30,946/- under section 14A of the Act.

5. The ld. CIT(A) erred on facts and in law in charging interest under section 234B of the Act.'

3. Further the grounds raised by the revenue read as under :

4. Brief facts are: The assessee is a wholly owned subsidiary of Aginity Inc., USA (hereinafter referred to as "Aginity, USA). It is engaged in providing software development services/information technology services to its overseas associated enterprises ('AEs') and operates as a limited risk bearing captive service provider. For the year under consideration, assessee company filed its return of income on 29.9.2009 declaring an income of Rs. 54,61,645/-. During the financial year 2008-09, the appellant undertook the following international transactions with its AEs which were duly reported in the accountant's report (Form No. 3CEB) filed alongwith the return of income :

5. The summary of the benchmarking analysis of the TP report, as stated in the CIT(A) order, is as under :

6. During the course of assessment proceedings the AO directed the assessee to produce the updated margin of the comparables selected in the TP study. The margins as provided by the assessee are reproduced below :

7. The AO employed export sales to sales, diminishing revenue, employee cost to sales ratio less than 25% and related party transactions (RPT) above 25% filters and rejected 11 comparables out of 17. The final set of comparables and the margin calculated against the assessee are as follows :

8. On appeal the CIT(A) rejected the objections of the assessee vis-à-vis the 4 filters by the AO namely export sales/sales, diminishing revenue, employee cost and RPT. However he accepted the contention of the appellant that high turnover companies should not be included in the list of comparables. He thus held that Larsen and Toubro Infotech Ltd., Persistent Systems Ltd. and Mindtree Ltd. are high turnover companies and therefore should be excluded from the list of comparables. He also held that M/s ICRA Techno Analytic Ltd. and E2E Infotech Ltd. should be included in the list of comparables. In light of the above the final list of comparables as upheld by the CIT(A) is as under :

9. Accordingly the ALP was computed as below :

10. In the aforesaid factual backdrop, we firstly take up the departmental appeal. The grounds raised by the department relate to exclusion of three comparables (Ground No. (b)) namely Larsen and Tourbo Infotech Ltd., Persistent Systems Ltd. and Mindtree Ltd. and inclusion of two comparables (Ground No. (c)) namely ICRA Techno Analytic Ltd. and E2E Infotech Ltd.

11. So far as exclusion of three comparables i.e. Larsen and Tourbo Infotech Ltd., Persistent Systems Ltd. and Mindtree Ltd., it is noted that before the CIT(A) the assessee contended that during the financial year 2008-09, it has a turnover of approx. Rs. 14.45 crores which cannot be compared with certain companies having turnover of more than 200 crores. Support was drawn from the following decisions :

12. Having regard to the above the CIT(A) held as under :

"5.6 I have carefully considered the submission of the appellant. The Ho'ble ITAT in the case of the appellant itself has held that high turnover companies should not be included in the list of comparables. Larsen & Toubro Infotech Ltd., Persistent Systems Ltd. and Mindtree Ltd. are certainly high turnover companies as can be seen from the above table. Respectfully following the order of the ITAT in the appellant's case, I hold that these three companies should be excluded from the list of comparables."

13. Having considered the rival submissions and perused the material on record. We find this issue is no longer res-integra. The Hon'ble High Court upholding the decision of Tribunal in the case of the appellant for A.Y. 2006-07 has held in an order dated 10.7.2013 in ITA No. 1204/2011 in [Cit v. Agnity India Technologies Pvt. Ltd…. [2013] 36 taxmann.com 289/219 Taxman 26 (Delhi) ] that a giant company in the area of development of software which assumed all risks leading to higher profits is not comparable with the assessee which was a captive unit of the parent company and assumed only a limited risk.

The Hon'ble High Curt has held as under :

"8. It is a common case that Satyam Computer Services Ltd. should not be taken into consideration. The Tribunal for valid and good reasons has pointed out that Infosys Tchnologies Ltd. cannot be taken as a comparable in the present case. This leaves L&T Infotech Ltd. which gives us the figure of 11.11%, which is less than the figure of 17% margin as declared by the respondent-assessee. This is the finding recorded by the Tribunal. The tribunal in the impugned order has also observed that the ae had furnished details of workables in respect of 23 companies and the mean of the comparables worked out to 10%, as against the margin of 17% shown by the assessee. Details of these companies are mentioned in para 5 of the impugned order. 9. In view of the aforesaid position, we do not think that any substantial question of law arises for consideration. The appeal is dismissed."

14. Larsen & Toubro Infotech Ltd. had an operational margin of 20% for the assessment year under consideration, and it was considered as a comparable in assessee's own case for assessment year 2006-2007 which was upheld by the Tribunal and the said order of the Tribunal had already been upheld by the Hon'ble High Court (supra) and so we direct the inclusion of the Larsen & Toubro infotech Ltd in the list of comparable.

15. Mind tree could not have been excluded simply because of high turnover only, if otherwise similar. There is no dispute that Mind tree is functionally similar. Ld AR could not place before us any material to persuade us from taking an opinion other than that of AO, where in operational margin is reflected as 27.6%, so we direct inclusion of the said comparable in the list of comparable.

16. When considering the exclusion of persistant system Ltd, we find no need to interfere in the order of the Ld CIT(A) because it is engaged in development of software product; and this company was excluded by the Tribunal in assessment year 2006-2007, which has been up held by the Hon'ble High Court, thus the issue about exclusion of persistent system Ltd, while making TP adjustments in it's case stands settled in view of these decisions in its own case. Therefore we do not find any necessity to interfere this company's exclusion.

17. Having regard to the factual position and respectfully following the judgment of the Hon'ble High Court we partly allow the ground raised by the revenue and uphold the exclusion of persistent system Ltd, and direct inclusion of Larsen & Toubro Infotech Ltd and Mind tree Ltd.

18. As regards inclusion of the comparables namely ICRA Techno Analytic Ltd. and E2E Infotech Ltd. are concerned it is noted that CIT(A) has included the same by observing as under :

"ICRA Techno Analytics Ltd.

This company was in the list of comparables selected by the appellant in the TP study. The appellant has stated that calculation of RPT is 23.88% and therefore this company should be included. On verification, I found that, the contention of the appellant is correct and therefore this company should be included in the set of comparables as the sole ground for rejection of this comparable was the calculation of RPT. The margin of this comparable was presented before the AO during the course of assessment proceedings which was at 10.94%.

E2E Infotech Ltd.

In this case, the AO has stated that there is no information about RPT and therefore this company should be rejected as a comparable. The turnover of the E2E Infotech Ltd. for the current year is Rs. 5.69 crores (appellant's turnover is Rs. 14.45 crores). As the disclosure requirement as per AS-18 is Rs. 50 crores turnover in case of RPT disclosure. As per the decision of the Hon'ble ITAT in the appellant's own case for the AY 2006-07 (supra), high turnover companies cannot be considered as comparables in this case. The factual matrix of the company being constant in all these years the decision of the Hon 'ble ITAT is applicable even for this year. Under such circumstances, unless the companies voluntarily disclose RPT even in the absence of legal requirement, then only such information will be available in a public database or in audited accounts. Absence of this data does not mean that this company fails RPT filter. Therefore, I am of the considered view that the AO was not right in rejecting E2E Infotech Ltd., as a comparable company. Therefore, this company should be brought back to the list of comparables. The margin of this comparable was presented before the AO during the course of assessment proceedings which was at 13.80%."

19. From the aforesaid finding it is evident that the CIT(A) has included ICRA Techno Analytic Ltd. on the ground that it does not breach the RPT filter of 25% applied by the AO. Likewise he has upheld the contention of the assessee to include E2E Infotech Ltd. on the ground that the said company does not fail the RPT filter. He has held that a company cannot be said to have failed the RPT filter solely on the ground that it has not disclosed RPT computation, where turnover is less than Rs. 50 crores.

20. Having considered the rival submissions, we agree in principle with the proposition laid down by the ld CIT(A), in excluding such companies from the list of comparables in which RPT are more than 25%. However we find no discussion in the assessment order about the determination of the percentage of RPT in the case of ICRA Techno Analytic Ltd. Under such circumstances we direct the AO to determine the RPT percentage of this company afresh as per law after giving opportunity to the assessee. In case if the RPT margin is less than 25%, the ICRA should be included and if it is more than 25% RPT it should be excluded.

21. Also, it is not disputed that turnover of E2E Infotech Ltd. was 5.69 crores which is less than 50 crores and therefore there was no disclosure requirement of RPT under AS-18.

22. Thus in light of the above we find no infirmity in the conclusion of the CIT(A) and reject the ground raised by the revenue.

23. Taking up assessee appeal in ITA No. 1780/D/2013, the ld. counsel contended vis-à-vis Ground Nos. 1, 2, 3 that out of the set of five comparables selected by the CIT(A) M/s Bodhtree Consulting Ltd. be excluded.

24. In this regard we notice that before the CIT(A) the appellant in this regard contended as under :

'Further, the appellant submits that during the FY 2008-09, Bodhtree Consulting Ltd. ("Bodhtree") had a high growth rate of 67% in its revenue as compared to the previous year.

It is humbly submitted that the abnormally high operating margin of 64.04% in case of Bodhtree May be an outcome of the high growth rate achieved by the company during the FY 2008-09. A relevant extract of the Annual report of Bodhtree is given below for your Honour's ready reference;

The total income increased to Rs. 1740.86 lakhs from 1042.52 lakhs in the previous year, at a growth rate of 67%. The operating profit amounted to Rs. 714.39 lakhs (41% of revenue) as against Rs. 162 lahs (15.5% of revenue) in the previous year. The net profit after tax was Rs. 583.52 lakh (33.5% of revenue) as against Rs. 140.74 (13.5% of revenue) in the previous year. The net profit for the year includes prior period adjustments of Rs. 24.61 lakhs (previous year Rs. 0.94 lakhs)

It is submitted that high profit companies such as Bodhtree deserve to be excluded from the final set of comparable companies particularly for benchmarking cost plus captive units that cannot be expected to earn such high profit margins as earned by independent risk taking entrepreneurs.

Further, it is observed that the ld. AO had excluded all the loss making companies such as Indus Networks Ltd. (OP/TC=4.25%), SIP Technologies & Exports Ltd. (OP/TC=54.71%) and Computech International Ltd. (seg) (OP/TC=74.31%) on arbitrary filtration criteria. On the same lines, extreme results (i.e. those which are significantly different from the majority of results obtained) might consist in losses or in unusually high profits.

Thus, to summarize, rejecting all loss-making companies on the basis of arbitrary/unsound inferences/presumptions and retaining high margin companies would tantamount to a travesty of the concept of arm's length principle. Therefore, Bodhtree (which is making supernormal growth and earning abnormally high profits during the FY 2008-09) is not an appropriate comparable and should be excluded from the final set of comparable companies.'

25. However the CIT(A) has rejected the contention of appellant by observing as under :

"The appellant has pleaded that Bodhtree consulting Ltd. is a comparable having 4.04% margin which is an extraordinary profitability company which should not be compared to the case of the appellant. The appellant has relied on various decisions of the ITAT. I have considered the argument of the appellant but cannot agree with the contention. Under the TNMM the arithmetical mean is used as against an intermediate/interquartile range. These two are separate average concepts commonly used in mathematics and statistics. The argument of the appellant confuses these two mathematical tools. The Indian Transfer Pricing Law does not recognize the intermediate/inter quartile range. The margin of the comparables is the end product and not the starting point of comparability. Therefore, the extreme profit or loss making companies can be rejected if the inter quartile range is being used instead of simple average. Only comparing the margins is like putting the cart before the horse. Therefore, this contention of the appellant is rejected."

26. Having considered the rival submission we notice that this company was a comparable in assessee's own case for Assessment Year 2008-09. At that time the assessee did not contest the inclusion of this company and allowed it to remain as a comparable. However this year, just because profit margin is higher, this company does not cease to become a comparable. Therefore we find no infirmity in the order of the ld CIT(A) and we uphold the same.

27. Ground No. 4 relates to disallowance of Rs. 30,946/- u/s 14A of the Act. The ld. Counsel for the assessee contends that assessee earned dividend of Rs. 5,75,850/- from mutual funds and the same is exempt u/s 10(23) of the Act. The AO made disallowance u/s 14A by applying Rule 8D. The appellant objected on the ground that no expenditure has been incurred during the year to earn dividend income.

28. The Ld. counsel reiterated the facts and contends that AO has not held that any borrowed funds were utilized for the investment in mutual funds. For earning dividend no administrative set up is required as it is a mechanical process by which dividend warrants are received by the assessee. Therefore, it cannot be held that any tangible administrative expenditure was incurred. In view of these facts application of Rule 8D is not justified.

29. Having regard to the rival submissions we find that in the instant year though Rule 8D is applicable, yet since the AO has not recorded any satisfaction in terms of section 14A(3) of the Act therefore disallowance is invalid. Mere general observations without examining the accounts of the appellant does not satisfy the test of section 14A(3) of the Act. The disallowance is thus deleted.

30. In the result the appeals of the revenue and the assessee are partly allowed.

POOJA