ORDER

B. Ramakotaiah, Accountant Member - This appeal by assessee is against the order of A.O. under section 143(3) read with section 144C(1) of the Income Tax Act, 1961 consequent to the directions of the DRP, Hyderabad dated 27.11.2013.

2. Assessee has raised 11 grounds out of which ground Nos. 1 to 4, on various issues of T.P. documentation, use of multiple year data, use of additional filters, information obtained under section 133(6) are not pressed, therefore, ground Nos. 1 to 4 need not be adjudicated. Ground No.5 pertains to selection of comparables by TPO in which assessee is objecting to 6 comparables selected by the TPO. Ground No.6 pertain to rejection of assessee's comparables of four companies and this ground is not pressed in the course of arguments. Ground Nos. 7 and 8 pertains to adjustment for risk difference and negative working capital adjustment. Ground No.9 is legal issue with reference to application of proviso to section 92C(2). Ground No.10 pertains to interest under section 234B which is mandatory and consequential in nature and no adjudication is required. Ground No.11 pertains to initiation of penalty proceedings which is premature in nature.

3. We have heard the Ld. Counsel and learned D.R. Ld. Counsel fairly admitted that if ground Nos. 5, 7 and 8 are decided other grounds need not be considered.

4. Briefly stated, assessee company is engaged in the business of software, design and development and testing in the field of storage solutions. It filed its return of income declaring income of Rs. 89,51,330. Since assessee is functioning as ITES provider to it's A.E. on cost + 10% margin basis, its international transactions are referred to the TPO and after adopting various filters and analysing the data available in the domain, selected 17 companies as comparable companies, thereby arriving at an arithmetic mean of 25.26% and proposed a sum of Rs. 63,53,365 as an adjustment under section 92C(3) of the I.T. Act. Assessee has turnover of Rs. 5.88 crores and its operating cost was at Rs. 5.21 crores. Assessee has raised various objections before the DRP on the proposed addition which were rejected by the DRP in its order.

5. Before us, Ld. Counsel submitted detailed arguments with reference to selection of various companies which are not comparable to the assessee's business operations. Ld. Counsel also made reference to Coordinate Bench decision in the case of Cisco Systems India (P.) Ltd. v. Dy. CIT [2014] 50 taxmann.com 280/66 SOT 82 (URO) (Bang.) for A.Y. 2009-2010 and the decision of Kenexa Technologies (P.) Ltd. v. Dy. CIT [2014] 51 taxmann.com 282/[2015] 67 SOT 195 (Hyd.) for proposition of various comparables. He also made submissions with reference to negative working capital adjustments and relied on the decisions of the DRP in the case of Market Tools Research P. Ltd., for A.Y. 2010-2011 dated 26.09.2014 and M/s. Mega Systems Worldwide India P. Ltd., for A.Y. 2010-2011 dated 26.09.2014. The Ld. Counsel also further submitted that if contention of negative working capital adjustments is accepted, the issue of risk analysis will become academic. In reply, learned D.R. relied on the detailed order of the TPO and DRP for inclusion of various companies which are objected to by the assessee.

6. We have considered the issue and examined the documents placed on record. There is no dispute with reference to the fact that assessee can be categorised as ITES company and its turnover is only Rs. 5.88 crores. The TPO after adopting various filters, which were not objected by the assessee in these proceedings, selected following 17 companies as comparables.

7. Assessee has no objection for adoption of companies Sl. No. 1 to 11. Assessee has objection for the following six companies (Sl No 12 to 17) and its objections and findings are as under :

1. Bodhtree Consulting Ltd.,

"26.1 Bodhtree Consulting Ltd.:- As far as this company is concerned, it is not in dispute that in the list of comparables chosen by the assessee, this company was also included by the assessee. The assessee, however, submits before us that later on it came to the assessee's notice that this company is not being considered as a comparable company in the case of companies rendering software development services. In this regard, the ld. counsel for the assessee has brought to our notice the decision of the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. v. ITO, ITA No.7633/Mum/2012, order dated 6.11.2013. In this case, the Tribunal followed the decision rendered by the Mumbai Bench of the Tribunal in the case of Wills Processing Services (I) P. Ltd., ITA No.4547/Mum/2012. In the aforesaid decisions, the Tribunal has taken the view that Bodhtree Consulting Ltd. is in the business of software products and was engaged in providing open & end to end web solutions software consultancy and design & development of software using latest technology. The decision rendered by the Mumbai Bench of the Tribunal in the case of Nethawk Networks Pvt. Ltd. (supra) is in relation to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in AY 08-09 as far as this comparable company is concerned. Following the aforesaid decision of the Mumbai Bench of the Tribunal, we hold that Bodhtree Consulting Ltd. cannot be regarded as a comparable. In this regards, the fact that the assessee had itself proposed this company as comparable, in our opinion, should not be the basis on which the said company should be retained as a comparable, when factually it is shown that the said company is a software product company and not a software development services company."

Respectfully following the coordinate bench decision, we hold that this company cannot be regarded as a comparable. AO is directed to exclude the same.

2. Comp-U-Learn Tech India Ltd.,

"38. With respect to Comp-U-Learn Tech India Ltd., the assessee submitted that this company is functionally dissimilar and diversified in services. Further it was submitted by learned counsel that the software development expenditure is only 25% of the total expenditure. It was submitted that the TPO relied on the information obtained from the company under section 133(6) notice and held it to be predominantly engaged in software development services.

39. The assessee submitted before the DRP that Comp-U-Learn Tech India Ltd., was engaged in the development of new software (product development) (page 7 of the annual report) in information technology enabled services call center and business process outsourcing services (page 11 of annual report). It was further submitted that Schedule XIII of the annual report shows software development expenditure at only 25% of the total expenditure. The TPO extracted the 133(6) notice and held that the company has nil onside revenue and satisfied all the filters applied by the TPO. We are of the opinion that some more analysis has to be done and we direct the TPO to look into the financial statement of the company and also provide an opportunity to the assessee to submit relevant details to substantiate its claim that Comp-U-Learn Tech India Ltd., is not a comparable company."

Respectfully following the Coordinate Bench decision cited (supra), we restore analysis of this company to the file of TPO who should look into the financial statements of the company and re-examine whether the company can be considered as a comparable company. Assessee should be given due opportunity to submit relevant details to substantiate its claim. With these directions, analysis of this company is restored to the file of TPO.

3. I-Gate Global Solutions Ltd.,

A. TPO selected this company as per response to notice u/s.133(6), the company's income from software works out to 90% of total revenue.

B. Assessee's objections are that this company is functionally different. The company has 3 segments viz., IT, ITES and contract centre services. The segmental information is not available in the public domain. The company in the annual report has classified itself as an ITES company. It is further submitted that learned TPO has not provided the copy of 133(6) response obtained.

C. We have examined the contention of the assessee and noticed that this company has not been objected to by any other assessee's so far analysed by the ITAT in any of the orders so far issued for this assessment year. Ld. Counsel also could not bring anything on record that this company was rejected in any of the orders on the issue for this assessment year. As seen from the part of the balance sheet placed on record, company has three different segments. Details of segmental information adopted by TPO are not available. Even though the company itself classified that ITES company, being similar to assessee company, assessee's objection is that the information obtained by the TPO was not provided to the assessee. In view of this, we, in the interest of justice restore the matter to the file of the A.O. to examine afresh. The segmental information pertaining to ITES obtained by the TPO should be provided to the assessee for its objections and then re-consider the issue whether the same is comparable or not. With these directions, the issue is restored to the file of TPO for fresh examination, by giving due opportunity to the assessee.

4. Infosys Technologies Ltd.,

A. TPO selected this company stating that assessee itself considered this company as comparable in the T.P. study. The assessee has not furnished any economic rationale to say higher turnover companies or companies with brand value have earned better margins than low turnover companies. For example, ST Micro Electronics; and Symantee Software Solutons P. Ltd., The TPO further pointed out that Infosys itself is not sure of the computation of brand value and wants to use these only to initiate academic discussions. Further brand may bring more revenues but not necessarily higher margins.

B. Assessee's objections are that Infosys Limited has brand value. Infosys commands a premium in the pricing of its products and services due to its goodwill, reputation and brand value and hence cannot be considered as comparable to risk mitigated contract service providers. Due to scale of operations, Infosys enjoys economies of scale in lower cost of infrastructural facilities and employees. It is further submitted that these companies are engaged in diversified activities including products, consultancy and solutions unlike Adaptec India. Infosys derives more than 49.30% of its revenue from onsite operations. In support of its contention, assessee relied on the decision of Bangalore Tribunal order in the case of Cisco Systems (India) P. Ltd., (supra) for A.Y. 2009-2010 wherein this company has been analysed and rejected as a comparable by the Bangalore Tribunal. The relevant observations of the Bangalore Tribunal in the case of Cisco Systems (India) (P.) Ltd. (supra) are as under :

'26.2 Infosys Ltd.:- As far as this company is concerned, it is not in dispute before us that this company has been considered to be functionally different from a company providing simple software development services, as this company owns significant intangibles and has huge revenues from software products. In this regard, we find that the Bangalore Bench of the Tribunal in the case of M/s. TDPLM Software Solutions Ltd. v. DCIT, ITA No.1303/Bang/2012, by order dated 28.11.2013 with regard to this comparable has held as follows:-

"11.0 Infosys Technologies Ltd.

11.1 This was a comparable selected by the TPO. Before the TPO, the assessee objected to the inclusion of the company in the set of comparables, on the grounds of turnover and brand attributable profit margin. The TPO, however, rejected these objections raised by the assessee on the grounds that turnover and brand aspects were not materially relevant in the software development segment.

11.2 Before us, the learned Authorised Representative contended that this company is not functionally comparable to the assessee in the case on hand. The learned Authorised Representative drew our attention to various parts of the Annual Report of this company to submit that this company commands substantial brand value, owns intellectual property rights and is a market leader in software development activities, whereas the assessee is merely a software service provider operating its business in India and does not possess either any brand value or own any intangible or intellectual property rights (IPRs). It was also submitted by the learned Authorised Representative that :-

11.3 Per contra, opposing the contentions of the assessee, the learned Departmental Representative submitted that comparability cannot be decided merely on the basis of scale of operations and the brand attributable profit margins of this company have not been extraordinary. In view of this, the learned Departmental Representative supported the decision of the TPO to include this company in the list of comparable companies.

11.4 We have heard the rival submissions and perused and carefully considered the material on record. We find that the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable and the finding rendered in the case of Trilogy E-Business Software India Pvt. Ltd. (supra) for Assessment Year 2007-08 is applicable to this year also. We are inclined to concur with the argument put forth by the assessee that Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It is also seen that the break up of revenue from software services and software products is not available. In this view of the matter, we hold that this company ought to be omitted from the set of comparable companies. It is ordered accordingly."

The decision rendered as aforesaid pertains to A.Y. 2008-09. It was affirmed by the learned counsel for the Assessee that the facts and circumstances in the present year also remains identical to the facts and circumstances as it prevailed in AY 08-09 as far as this comparable company is concerned. Respectfully following the decision of the Tribunal referred to above, we hold that Infosys Ltd. be excluded from the list of comparable companies.'

Respectfully following the coordinate bench decision, we hold that this company cannot be regarded as a comparable. AO is directed to exclude the same.

5. Kals Information Systems (Segmental)

A. TPO selected this company stating that this company in its response to 133(6) notice clearly stated that their business may be classified as a pure software development service provider. In many cases, the company uses its own library of products and prepares customized software.

B. Assessee's objections are that this company is engaged in development of software and software products and no break-up of revenue is provided. Further, the company has inventory of -34% of revenue, clearly evidencing that the company has significant revenue from products (i.e., in excess of 25%). This company is functionally different as it is engaged in two segments (i) development of software and software products (ii) training services. In support of its contention, the Ld. Counsel relied on the following decisions :

C. From the perusal of the above decisions of Coordinate Benches of the Tribunal, we find that this company (Kals Information Systems Ltd.,) has been analysed and rejected as a comparable. Bangalore bench of Tribunal in the case of Cisco Systems (India) (P.) Ltd.(supra) A.Y. 2009-2010 has analysed as under :

'26.3 KALS Information Systems Ltd.:- As far as this company is concerned, it is not in dispute before us that this company has been considered as not comparable to a pure software development services company by the Bangalore Bench of the Tribunal in the case of M/s. Trilogy e-business Software India Pvt. Ltd. (supra). The following were the relevant observations of the Tribunal:-

"(d) KALS Information Systems Ltd.

46. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual repot, the salary cost debited under the software development expenditure was Rs. 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal's decision of the ITAT in the case of Bindview India Private Limited v. DCI, ITA No. ITA No. 1386/PN/1O wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. The relevant extract are as follows:

"16. Another issue relating to selection of comparables by the TPO is regarding inclusion of Kals Information System Ltd. The assessee has objected to its inclusion on the basis that functionally the company is not comparable. With reference to pages 185-186 of the Paper Book, it is explained that the said company is engaged in development of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds."

Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable.

47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the learned counsel for the Assessee, the Mumbai Bench of ITAT has held that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable."

Following the aforesaid decision of the Tribunal, we hold that KALS Information Systems Ltd. should not be regarded as a comparable.'

Respectfully following the coordinate bench decision, we hold that this company cannot be regarded as a comparable. AO is directed to exclude the same.

6. Tata Elxsi Ltd., (Segmental)

A. TPO selected this company stating that the company's revenue from software development segment is 90.42% of the total turnover.

B. Assessee's objections are that this company is functionally different. In the response to notice issued under section 133(6) of the Act for earlier year, this company has clearly stated that it cannot be considered as comparable to any other software services company, due to its complex nature of its business. This company has been analysed and rejected as a comparable by the Bangalore Tribunal in the case of Cisco Systems (India) (P.) Ltd. (supra) A.Y. 2009-2010. Assessee further relied on the following decisions in support of its contention.

C. From the perusal of the above decisions of Coordinate Benches of the Tribunal, we find that this company (Tata Elxsi Ltd.,) has been analysed and rejected as a comparable. Bangalore bench of Tribunal in the case of Cisco Systems (India) (P.) Ltd. (supra) A.Y. 2009-2010 has analysed as under :

"26.4 Tata Elxsi Ltd.:- As far as this company is concerned, it is not in dispute before us that in assessee's own case for the A.Y. 2007-08, this company was not regarded as a comparable in its software development services segment in ITA No.1076/Bang/2011, order dated 29.3.2013. Following were the relevant observations of the Tribunal:-

II. UNREASONABLE COMPARABILITY CRITERIA :

19. The learned Chartered Accountant pleaded that out of the six comparables shortlisted above as comparables based on the turnover filter, the following two companies, namely (i) Tata Elxsi Ltd; and (ii) M/s. Flextronics Software Systems Ltd., deserve to be eliminated for the following reasons :

20. On the other hand, the learned DR supported the order of the lower authorities regarding the inclusion of Tata Elxsi and Flextronics Software Systems Ltd., in the list of comparables. He reiterated the contents of para 14.2.25 of the TPO's order. He also read out the following portion from the TPO's order :

"Thus as stated above by the company, the following facts emerge :

Regarding Flextronics Software Systems, the following extract from page 143 of TPO's order was read out by him as his submissions :

"It is very pertinent to mention here that the company was considered by the taxpayer as a comparable for the preceding assessment year i.e., AY 2006-07. When the same was accepted by the TPO as a comparable, the same was not objected to it by the taxpayer. As the facts mentioned by the taxpayer are the same and these were there in the earlier FY 2005-06, there is no reason why the taxpayer is objecting to it. How the company is functionally similar in the earlier FY 2005-06 but the same is not functionally similar for the subsequent FY 2006-07 even when no facts have been changed from the preceding year. Thus the taxpayer is arguing against this comparable as the company was not considered as a comparable by the taxpayer for the present FY 2006-07."

21. We have heard the rival submissions and considered the facts and materials on record. After considering the submissions, we find that Tata Elxsi and Flextronics are functionally different from that of the assessee and hence they deserve to be deleted from the list of six comparables and hence there remains only four companies as comparables, as listed below:"

26.5. Following the aforesaid decision of the Tribunal, we hold that M/S. Tata Elxsi Ltd. should not be regarded as a comparable."

Respectfully following the coordinate bench decision, we hold that this company cannot be regarded as a comparable. AO is directed to exclude the same.

8. Ground No.7 pertain to risk analysis. Even though it was submitted that this ground becomes academic, we are of the opinion that the finding is required on this ground. In the case of Kenexa Technologies (P.) Ltd. (supra), the issue was analysed vide placitum 47 at page 331 (supra) which is as under :

"47. With respect to ground No.2.8, the assessee has sought for risk adjustment due to difference in risk profile of the assessee and the comparable cases selected. We rely on the decision in the case of Excellence Data Research v. ITO (ITA.No.159/Hyd/2014) for the A.Y. 2009-10 wherein it has been held as follows :

21. With reference to ground No.2.5 on risk profile, learned counsel for the assessee contended that the A.O./DRP have not considered the risk profile of the assessee and necessary adjustments have not been made in order to mitigate the differences between the assessee's risk profile and the comparables selected by the TPO. The assessee contends that adjustment of 1%, which was granted by the coordinate Bench in the case of DCIT v. Hellosoft India P. Ltd., ITA.No.645/Hyd/2009 (2013) 23 ITR (Trib.) 1 (Hyd.) , should have been allowed. Even though it was contended that the Coordinate Bench order in that behalf is binding on the A.O., we are not inclined to agree with that contention, as risk profile of each assessee differs depending on its own business activity when compared to that of the comparable company, and in each case separate risk profile has to be analysed in FAR analysis. Therefore, allowing deduction of 1% towards risk profile uniformly cannot be adopted as a norm. Further, this aspect requires to be re-examined by the TPO. Therefore, after excluding the above companies, if any adjustment is required to be made, the A.O. is directed to consider the risk profile and allow necessary deduction, based on the facts of each comparable case."

9. Following the decision in the case of Kenexa Technologies (P.) Ltd., (supra), we remit the issue to the TPO to consider the risk profile of the assessee. We direct the TPO to allow necessary deductions for risk adjustment, after finalising the list of comparables as directed by us.

10. Ground No.8 pertains to the issue of negative working capital. As briefly stated above, after arriving at the arithmetic mean of all comparables at 22.03%, the A.O. worked out negative working capital adjustment of 3.22% thereby, making arms length price at 25.25%. Even though, DRP refused to interfere with the objections of the assessee in its order, we were informed that DRP has directed the TPO/A.O. not to make any negative working capital adjustment in some of the cases in the next assessment year, in the cases of Market Tools Research P. Ltd., and Mega Systems Worldwide India P. Ltd., assessee placed on record copies of orders of DRP. In that DRP considered the issue and directed the TPO as under :

'14. Ground No. 11 : Negative Working Capital adjustment - Making a negative working capital adjustment without appreciating the fact that the company does not bear any working capital risks. On this issue, the assessee submitted as under :

"The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the differences in working capital between the assessee and the companies considered as comparables. The assessee does not agree with the learned TPO as :

We have gone through the submissions and the order of the TPO. The assessee pleaded that the DRP has acceded such a plea in some other case. On examination, we find that the DRP, Hyderabad in the case of Cordys Software India P. ltd., for A.Y. 2008-09 in its directions dated 03.08.2012 has given a finding as under :

"7.7. 4 Thus, working capital adjustment is made for the time value of money lost when credit time is provided to the customers. The applicant is not an entrepreneur but a captive service provider. Its entire funding needs are provided by the A.E. This being so, the applicant does not stand to lose anything as it is compensated on a total cost plus basis. The TPO probably was carried away by the large amount of receivables appearing in the books of the applicant. But the applicant is running its business without any working capital risk while comparable companies have such a risk for them. If at all any working capital adjustment is to be made to t his situation, only a positive adjustment has to be made to the comparables so that they are brought on par with the applicant. In view of the same, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made."

In view of the above, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made.'

11. In view of the above, we are of the opinion that assessee's case being similar, there is no need for making any negative working capital adjustment when assessee does not carry any working capital risk. In fact, TPO should have done necessary working capital adjustment to the profits of the selected comparables so as to make them comparable to the assessee. In view of this, we direct the TPO not to make negative working capital adjustment.

12. TPO is directed to examine the comparability of the two companies directed above and delete rest of the companies as objected by the assessee and re-workout the arithmetic mean. He should also consider the proviso to section 92C(2) as per law. For this purpose the orders to that extent are set aside for re-doing the same as per facts and provisions of law.

13. With these directions, assessee's appeal is considered as partly allowed for statistical purposes.

POOJA