Income Tax Act, 1961 – Sections 92CA, 143(3) and 144C(13) – Software development Services – Transfer Pricing – Determination of Arm’s Length Price – Adjustment on account of negative working capital – Appellant/assessee is engaged in provision of software development services – On a reference made by Assessing Officer for determination of Arm’s Length Price in respect of international transaction of rendering software development services by assessee to its Associated Enterprises, TPO determined TP adjustment vide order passed under Section 92CA of the Act – AO passed draft assessment order by incorporating adjustment proposed by TPO and proposing to disallow provision for rent claimed by assessee – Pursuant to directions of Dispute Resolution Panel (DRP), AO passed final assessment order under Section 143(3) read with Section 144C(13) of the Act – Whether TPO has erroneously determined a negative working capital adjustment – HELD – Assessee is not an entrepreneur but a captive service provider which is entirely funded by its AE and has no working capital contingencies – Assessee has not incurred any expenses for meeting working capital requirement and is running business without any working capital risk as compared to comparables – Assessee does not bear any market risk, as services are provided only to its AE – On consideration of fact that assessee is a captive service provider entirely funded by its AE and has no working capital contingent, adjustment on account of negative working capital does not arise – Appeal is partly allowed

 

Issue 2: Transfer pricing adjustment – Selection of comparables – Whether TPO/AO/DRP has erred in accepting Persistent Systems & Solutions Ltd., Persistent Systems Ltd. and Sasken Communication Technologies Ltd. as comparables – HELD – Composite data of revenue as well as margins of Persistent Systems & Solutions Ltd. pertaining to sale of software services and products cannot be considered as comparable with software development services segment of assessee – When Persistent Systems Ltd. is engaged in diversified activities and earning revenue from various activities including licencing of products, royalty on sale of products as well as income from maintenance contract, same cannot be considered as functionally comparable with assessee – Sasken Communication Technologies Ltd. earns revenue from 3 segments, however, segmental operating margins are not available – AO is directed to exclude Persistent Systems and Solutions Ltd. and Persistent Systems Ltd. from list of comparable companies and remand question of comparability of Sasken Communication Technologies Ltd. to TPO for fresh consideration.

 

Issue 3: Exclusion of comparables – Whether TPO/AO/DRP has erred in rejecting LGS Global, Evoke Technologies Ltd., RS Software India Ltd. and Thinksoft Global Ltd. as comparables – HELD – TPO rejected LGS Global on ground that Annual Report did not give break up of employee cost and thus he could not compute its employee cost factor – Issue remanded to TPO/AO to verify relevant facts and decide comparability of this company – Since Evoke Technologies Ltd., RS Software India Ltd. and Thinksoft Global Ltd. were excluded by DRP suo moto, issue has to be remanded to TPO/AO for fresh consideration to decide comparability of these companies.

 

Issue 4: Computation of operating margin – Whether DRP has erred in rejecting objection raised by assessee in relation to computation of operating margin of assessee by stating that assessee had not made any submissions – HELD – DRP has merely observed that no submissions were made by assessee on above ground of appeal – Assessee has pointed out that in Annexure 1.26 of objections filed by assessee before DRP, submissions have been made with regard to computation of operating margin – Since issue has not been adjudicated by DRP, it would be just and appropriate to remand this issue to TPO/AO for consideration afresh with liberty to assessee to file additional evidence before AO/TPO – TPO/AO will decide issue after affording assessee opportunity of being heard.

 

Issue 5: Disallowance of rental expenditure – Whether DRP has erred in upholding action of AO in disallowing provision for rental expenditure – HELD – Deduction has been claimed by assessee towards provision for rental expenses based on possibility of increase in rental expenses and this was rightly treated as contingent in nature and not allowed as a deduction by Revenue authorities – Assessee has not given any basis for its anticipated liability towards rental expenses nor has he quantified basis of arriving at anticipated liability – Revenue authorities were justified in rejected claim of assessee

 

2022-VIL-1622-ITAT-BLR

 

IN THE INCOME TAX APPELLATE TRIBUNAL

“B” BENCH : BANGALORE

 

 

Date of hearing: 02.02.2022

Date of Pronouncement: 07.02.2022

 

Assessee by: Smt. Tanmayee Rajkumar, Advocate

Revenue by: Dr. Manjunath Karkihalli, CIT(DR)(ITAT), Bengaluru

 

BENCH

SHRI N. V. VASUDEVAN, VICE PRESIDENT

SHRI B. R. BASKARAN, ACCOUNTANT MEMBER

 

ORDER

 

Per N. V. Vasudevan, Vice President

 

IT(TP)A No.682/Bang/2016 is an appeal by the assessee while IT(TP)A No.632/Bang/2016 is an appeal by the Revenue. Both these appeals are directed against the final Order of Assessment dated 29.01.2016 passed under section 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (hereinafter called ‘the Act’) by the DCIT, Circle-3(1)(2), Bengaluru, in relation to Assessment Year 2010-11.

 

2. As far as the appeal of the Revenue is concerned, it is not in dispute before us that the tax effect in the appeal by the Revenue is less than Rs.50 lakhs and in view of the CBDT’s Circular No.17/2019, dt.08.08.2019, the appeal of the Revenue is liable to be dismissed as not maintainable and is dismissed as such.

 

3. As far as the appeal of the assessee is concerned, apart from one Corporate Tax issue, the main issue that arises for consideration is with regard to determination of Arm’s Length Price (ALP) in respect of an international transaction of rendering software development services by the assessee to its Associated Enterprises (AE).

 

4. The assessee is the subsidiary of Core Objects Software Inc., USA (“Core US”), which in turn is held by Symphony Services Corp., US. The assessee was incorporated under the provisions of the Companies Act, 1956 and is engaged in the provision of software development and related services. During the previous year relevant to the assessment year 2011-12, one of the international transactions that took place between the assessee and its AEs was the provision of software development services by the assessee for Rs. 15,83,77,318/-. On a reference being made by the Assessing Officer, the TPO passed an order dated 08.12.2014 u/s.92CA of the Act, determining TP adjustment of Rs. 10,44,44,180/-. The Assessing Officer passed a draft assessment order dated 30.03.2015, incorporating the above adjustment and proposing to disallow (i) provision for rent claimed by the assessee; and (ii) depreciation on computer software claimed by the assessee, for non deduction of tax at source. Aggrieved, the assessee filed its objections before the Dispute Resolution Panel (DRP), which, vide its directions dated 28.12.2015 granted marginal relief to the assessee in respect of the TP adjustment, while deleting the proposal to disallow depreciation claimed on computer software. The proposal to disallow provision for rent came to be upheld. Pursuant to the directions of the DRP, the AO passed the final assessment order dated 29.01.2016 in which the TP adjustment was reworked to Rs. 1,00,46,453/-. Aggrieved by the final assessment order to the extent the TP adjustment survived and to the extent the provision for rent was disallowed, the assessee has preferred the appeal before this Hon’ble Tribunal. To the extent that the DRP’s directions granted relief to the assessee, the Revenue has filed the above appeal before this Hon’ble Tribunal which we have already dismissed owing to low tax effect.

 

5. As far as determination of ALP in respect of the international transaction of rendering Software Development Services (SWD services) by the assessee to its AE is concerned, the net margin on cost earned by the assessee as computed by the TPO in the TP Order:

 

Operating Income*	Rs. 17,32,93,094/-
Operating Cost**	Rs. 22,13,75,159/-
Operating Profit (Op. Income – Op. Cost)	Rs. (4,80,82,065)/-
Operating/Net margin (OP/OC)	(21.71%)

 

*Excluding other income *

*Excluding exchange variation, loss on fixed assets sold.

 

The above net margin computed by the AO was against the following Net margin on cost earned by the assessee as per its TP study:

 

Operating Income	Rs. 16,35,19,442/
Operating Cost**	Rs. 14,80,35,862/-
Operating Profit (Op. Income – Op. Cost)	Rs. 1,54,83,580/
Operating/Net margin (OP/OC)	10.46%

 

It was the plea of the assessee that during the year under consideration, the assessee incurred certain extraordinary expenses amounting to Rs. 7,33,39,296/-. Since these expenses are in the nature of one time extraordinary expenses, the same were reduced from the operating cost while computing the operating margin. However, the TPO rejected the computation arrived at by the assessee.

 

6. A comparison of the TP studies done by the assessee and TPO would show that there is not much of a difference between the approach of the assessee as well as the TPO, except the choice of companies chosen for the purpose of comparison of profit margin. The following chart would show the position of the approach adopted by the assessee and the TPO:

 

	Assessee	TPO
Methodology adopted	TNMM	TNMM
Profit Level Indicator (PLI)	OP/TC	OP/OC
Database used	PROWESS & CAPITALINE PLUS	PROWESS & CAPITALINE PLUS
Comparables selected for software development services	9	13
Period for which data used	FYs ending during the period April 1, 2008 and March 31, 2011.	FY 2010-11 (i.e., April 1, 2010 to March 31, 2011)

 

7. The Filters applied by the TPO for the purpose of inclusion and exclusion of comparable companies was as follows:

 

Step	Description
1.	Companies whose data is not available for FY 2010-11 – excluded
2.	Companies whose software development income < Rs. 1 Cr – excluded
3.	Companies whose software development service and related services is less than 75% of the total operating revenue – excluded
4.	Companies which have related party transactions more than 25% of the sales – excluded
5.	Companies which have persistent losses for the last three years upto and including financial year 2010-11 – excluded
6.	Companies having different financial year ending (i.e. not March 31, 2011) or data of the company which does not fall within 12 month period i.e., 01.04.2010 to 31.03.2011 - excluded
7.	Companies that are functionally different – excluded
8.	Companies having peculiar economic circumstances – excluded
9.	Companies having export sales less than 75% of the sales– excluded
10.	Companies whose employee cost is less than 25% of their turnover – excluded

 

8. Comparables selected by TPO and their arithmetic mean was as follows:

 

Sl. No.	Name of the Company	Mark-up on Total Costs (WC–unadj) (in %)	Mark-up on Total Costs (WC – adj) (in %)
1	Acropetal Technologies Ltd. (seg)	31.98	30.14
2	e-Zest Solutions Ltd.	21.03	20.41
3	E-Infochips Ltd.	56.44	57.57
4	Evoke Technologies Pvt. Ltd.	8.11	9.44
5	ICRA Techno Analytics Ltd.	24.83	24.27
6	Infosys Ltd.	43.39	44.90
7	Larsen & Toubro Infotech Ltd.	19.83	21.32
8	Mindtree Ltd. (seg)	10.66	10.69
9	Persistent Systems & Solutions Ltd.	22.12	22.63
10	Persistent Systems Ltd.	22.84	23.07
11	R S Software (India) Ltd.	16.37	17.66
12	Sasken Communication Technologies Ltd.	24.13	25.97
13	Tata Elxsi Ltd. (seg)	20.91	20.39
	AVERAGE MARGIN	24.82	25.46

 

 

9. The Computation of arm’s length price by the TPO and the adjustment made was as follows:

 

Arm’s Length Mean Margin	24.82%
Less: Working Capital Adjustment	-0.64%
Adjusted mean margin of the comparables	25.46%
Operating Cost	Rs.22,13,75,159/-
Arm’s Length Price - 125.46% of Operating Cost	Rs.27,77,37,274/-
Price Received	Rs.17,32,93,094/-
Shortfall being adjustment u/S. 92CA	Rs.10,44,44,180/-

 

10. The addition suggested by the TPO was incorporated by the AO in the Draft Order of Assessment. The assessee filed objections against the Draft Order of Assessment before the Dispute Resolution Panel (DRP). Briefly, the directions issued by the DRP were as follows:

 

(a) The following companies were directed to be excluded by accepting the contentions of the assessee:

 

· Acropetal Technologies Ltd

· E-zest Solutions

· E-infochips Ltd

· ICRA Techno Analytics

· Infosys Limited

· Larsen and Toubro Infotech Limited

· Mindtree Limited

· Tata Elxsi Limited

 

(b) RS Software (India) Ltd and Evoke Technologies Ltd were suo moto directed to be excluded by the DRP.

 

(c) The DRP rejected the contentions of the Assessee seeking exclusion of Sasken Communication Technologies Ltd., Persistent Systems Ltd., and Persistent Systems and Solutions Ltd.

 

(d) The DRP also rejected the contentions of the Assessee seeking inclusion of comparables.

 

(e) Working capital adjustment was directed to be computed on actuals, without putting any restrictions.

 

11. On giving effect to the above directions issued by the DRP, the final list of comparables is as follows:

 

Sl. No.	Name of the Company
1	Persistent Systems & Solutions Ltd.
2	Persistent Systems Ltd.
3	Sasken Communication Technologies Ltd.

 

Pursuant to the directions of the DRP, the TP adjustment was reworked to Rs. 1,00,646,453/- in the final assessment order dated 28.12.2018.

 

12. Against the final Order of Assessment, assessee has preferred the present appeal before the Tribunal. The grounds that were pressed for adjudication before the Tribunal were ground No.9(a) of the grounds of appeal, with regard to working capital adjustment. Ground No.11 with regard to exclusion of certain comparables. Ground No12 with regard to inclusion of certain comparable companies. The assessee has filed 3 applications for admission of additional grounds 15 to 18. As far as ground No.15 is concerned, it seeks exclusion of 1 comparable company that remains after the order of the DRP. As far as ground No.16 is concerned, the said ground is nothing but an expanded version of the assessee’s grievances which has already been projected in ground No.13 viz., with regard to the computation of operating margin of the assessee for the purpose of comparison with a comparable company. Grounds 13 and 16 have to be therefore adjudicated together. As far as Grounds 17 and 18 is concerned, these grounds are with reference to taxation of same income in two Assessment Years. The assessee has also filed application for admission of addition evidence in so far as Grounds 13 and 16 and Grd. No. 17 and 18 are concerned.

 

13. The additional ground sought to be raised by the assessee arises out of the order of the CIT(A). In so far as additional ground Nos.17 and 18 raised by the assessee are concerned, the assessee should have ideally filed rectification application for Assessment Year 2010-11 but has chosen to raise additional ground in Assessment Year 2011-12. Keeping in mind the principles laid down by Hon’ble Supreme Court in the case of NTPC Ltd., 229 ITR 683 that any ground which has a bearing on tax liability on application of law, on facts already on record can be raised as additional ground, we admit the additional grounds for adjudication.

 

14. Ground No.9(a) raised by the assessee reads as follows:

 

9. The learned TPO/ learned AO/ Hon'ble DRP has erred in making the following errors in the computation of working capital adjustment by:

 

a) not considering the fact that the Appellant does not have any working capital risk, therefore, no negative working capital adjustment should be allowed.

 

15. As far as ground No.9(a) is concerned, it was submitted that the TPO has erroneously determined a negative working capital adjustment. It was submitted that working capital adjustment is made for the time value of money lost when credit time is given to the customers. The assessee however is not an entrepreneur but a captive service provider which is entirely funded by its AE and has no working capital contingencies. The assessee has not incurred any expenses for meeting the working capital requirement, and is running the business without any working capital risk as compared to the comparables. The assessee does not bear any market risk as the services are provided only to its AE. Therefore, requirement for adjustment of negative working capital does not arise. The learned counsel for the assessee has placed reliance the following decisions wherein consistently it has been held that negative working capital adjustment shall not be made in case of a captive service provider:

 

(i) Adaptec (India) (P.) Ltd. v. ACIT ([2015] 57 taxmann.com 307 (Hyderabad - Trib.));

 

(ii) Lam Research India Pvt. Ltd. (order dated 30.04.2015 passed by this Hon’ble Tribunal in ITA No. 1473 & 1385/2014)

 

(iii) DCIT v. Software AG Bangalore Technologies Pvt. Ltd. (order dated 31.03.2016 passed by this Hon’ble Tribunal in ITA No. 1628/2014)

 

(iv) iPass India Pvt. Ltd. v. DCIT (Order dated 19.07.2019 passed by this Hon’ble Tribunal in ITA Nos. 2093 and 2112/Bang/2017)

 

(v) CAPCO IT Services India (P.) Ltd. v. ITO ([2017] 79 taxmann.com 214 (Bangalore - Trib.)) which came to be upheld by the Hon’ble High Court of Karnataka in ITA No. 481/2017 vide order dated 05.07.2018;

 

(vi) FNF India (P.) Ltd. v. ACIT (Order dated 03.07.2019 passed by this Hon’ble Tribunal in IT(TP)A Nos. 195/Bang/2016 and 459/Bang/2017);

 

(vii) Tivo Tech Pvt. Ltd. v. DCIT (Order dated 12.06.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 1619/Bang/2017)

 

16. After considering the submissions, we are of the view that in the light of the judicial precedents brought to our notice and in the light of the fact that the assessee is a captive service provider entirely funded by its AE and has no working capital contingent, we accept the contention of the assessee and allow ground No.9(a) and hold that adjustment on account of negative working capital does not arise in the present case.

 

17. The next ground to be adjudicated is ground No.11 which reads as follows:

 

11. The learned TPO/ learned AO/ Hon'ble DRP erred in accepting companies that ought to have been rejected as comparable:

 

· Persistent Systems & Solutions Ltd.

· Persistent Systems Ltd.

· Sasken Communication Technologies Ltd.

 

18. As far as Ground 11 is concerned, the assessee seeks exclusion of 3 comparable companies which remain after the order of the DRP. Learned Counsel for the assessee brought to our notice decision of the ITAT, Bengaluru Bench rendered in the case of Applied Materials India Pvt. Ltd., Vs. ACIT IT(TP)A No.17 and 39/Bang/2016 order dated 21.09.2016. In the aforesaid case, which was in relation to a software development company such as the assessee and which was also in relation to Assessment Year 2011-12, the TPO had chosen 13 comparable companies which are one and the same as chosen by the TPO in the case of the assessee in this appeal.

 

The Tribunal had to consider the comparability of the aforesaid 3 companies and the Tribunal held that the Persistent Systems and Solutions Ltd., and Persistent Systems Ltd., are to be excluded from the list of comparable companies and that Sasken Communication Technologies Ltd., should be set aside to the AO for fresh consideration. The following were the relevant observations of the Tribunal in this regard :

 

“9.2.4 We have considered the rival submissions as well as the relevant material on record. At the outset we note that the functional comparability of these two companies have examined by the coordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra) in para 60 and 61 & paras 24 to 26 as under :

 

" Persistent Systems & Solutions Ltd.

 The assessee has the grievance against rejection of this company by the DRP. The Id. AR has submitted that assessee did not raise any objection against this company, however, the DRP has rejected the said company. Therefore, the said company should be retained in the list of comparables.

 

Having considered the rival submissions as well as relevant material on record, at the outset, we note that the DRP has examined the functional comparability of this company by considering the relevant details as given in the annual report of this company. The DRP has given the finding that the entire revenue has been earned by this company from the sale of software services and products and in the absence of segmental details, it cannot be considered as comparable with software services segment. We find that this company has shown the income from sale of software services and products to the tune of Rs.6.67 crores. We further note that as per Schedule 11, the entire revenue has been shown under one segment i.e., sale of software services and products. Therefore, no separate segment has been given in respect of software services. Accordingly, the composite data of revenue as well as margins of this company pertaining to the sale of software services and products cannot be considered as comparable with the software development services segment of the assessee. In view of the above facts and circumstances, we do not find any error or illegality in the directions of the DRP in excluding this company from the list of comparables. This ground of CO is dismissed.

 

(4) Persistent Systems Ltd.

 

24. We have heard the Id. DR as well as Id. AR and considered the relevant material on record. The assessee raised objections against selection of this company on the ground that this company is functionally not comparable as engaged in the product development. The segmental information for services and product is not available. Further, the assessee has also pointed out that there was an acquisition and restructuring during the year under consideration.

 

25. The DRP has noted the fact that this company has reported the entire receipt from sales and software services and product. Therefore, no segmental information was found to be available for sale of software services and product. Further, the DRP has noted that as per Note 1 of Schedule 15, this company is predominantly engaged in outsource software development service. Apart from the revenue from software services, it also earns income from licence of products, royalty on sale of products, income from maintenance contract, etc. These facts recorded by the DRP has not been disputed before us.

 

26. Therefore, when this company is engaged in diversified activities and earning revenue from various activities including licencing of products, royalty on sale of products as well as income from maintenance contract, etc., the same cannot be considered as functionally comparable with the assessee. Further, this company also earns income from outsource product development. In the absence of any segmental data of this company, we do not find any error or illegality in the findings of the DRP that this company cannot be compared with the assessee and the same is directed to be excluded from the set of comparables."

 

We further find from the Annual Report that there is no change in the activity and functions of these companies during the year under consideration in comparison to the Assessment Year 2010-11. Accordingly, following the decisions of the co-ordinate benches of this Tribunal (supra), we direct the A.O./TPO to exclude these two companies from the set of comparables.

 

(iv) Sasken Communication Technologies Ltd.

 

9.3.1 The Id. AR of the assessee has submitted that this company is engaged in the development of software products as it has inventories, intangible assets as well as high expenditure on R&D. Therefore this company is functionally not comparable to the assessee. The Id. AR has referred to the Annual Report of this company and submitted that it derives income from software products specifically new products launched called 'Vyaparaseva' during F.Y. 2010-11. Thus this company is engaged in product development cannot be compared with the assessee when segmental details are not available. He has relied upon the decision dt.24.2.2016 of the co-ordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra).

 

9.3.2 On the other hand, the learned Departmental Representative has submitted that the inventory shown at page 70 of the report is very negligible. The product launched is for future period and not generated any revenue during the year under consideration. He has relied upon the orders of authorities below.

 

9.3.3 We have considered the rival submissions as well as the relevant material on record. The co-ordinate bench of this Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra) has considered the comparability of this company in paras 27 to 29 as under :

 

" (5) Sasken Communication Technologies Ltd.

 

27. The assessee raised objection that this company has revenue from software services, software products and other services. The DRP has come to the conclusion that this company earned revenue from 3 segments. However, no segmental information is available. Accordingly, the DRP directed the AO to exclude this company from the comparables.

 

1.We have heard the Id. DR as well as Id. AR and considered the relevant material on record. The DRP has reproduced the break-up of revenue in the impugned order as under:-

                                                                                                     Amount in Rs. lakhs

 

	Year ended March 31, 2010	Year ended March 31, 2019
Software Services	37,736.22	40,531.20
Software products	2,041.00	6,146.43
Other services	372.77	1,297.05
Total revenues	40,150.89	47,974.68

 

29. Thus, there is no dispute that this company earns revenue from 3 segments. However, the segmental operating margins are not available. Therefore, in the absence of segmental relevant data and particularly operating margins, this composite data cannot be considered as comparable with the assessee for software development services segment. Accordingly, we do not find any error or illegality in the findings of the DRP."

 

We further note that the DRP has not adjudicated the objections of the assessee whereas for the Assessment Year 2010-11, the DRP rejected this company as comparable. Accordingly, we set aside this issue to record of the A.O./TPO to verify the relevant facts and compare with the facts recorded by the Tribunal in the case of DCIT Vs. Electronics for Imaging India Pvt. Ltd. (supra) for the Assessment Year 2010-11 and then decide the issue after giving an opportunity of hearing to the assessee.”

 

19. Respectfully following the aforesaid decision, we direct the AO to exclude Persistent Systems and Solutions Ltd., and Persistent Systems Ltd., from the list of the comparable companies and remand the question of comparability of Sasken Communication Technologies Ltd., to the TPO for fresh consideration in the lines indicated by the Tribunal in the order referred to above.

 

20. The next ground to be adjudicated is ground No.12 with regard to inclusion of certain comparable companies in the list of comparable companies that were excluded by the DRP. Ground No.12 reads as follows:

 

“12. The learned TPO/ learned AO/ Hon'ble DRP erred in rejecting companies that ought to have been accepted as comparable:

 

· Akshay Software Technologies Ltd.-/

· Comp-U-Learn Tech India Ltd.

· Helios & Matheson Information Technology Ltd.

· LGS Global Ltd.,"

· Maveric Software Ltd.

· Thinksoft Global Services Ltd.

· Silverline Technologies Ltd.

· Evoke Technologies Ltd

· R S Software India Ltd

 

21. At the time of hearing, learned Counsel for the assessee submitted that he wants to press for adjudication of inclusion of only 5 companies out of the companies set out in ground No.12 viz., Akshay Software Technologies Ltd., LGS Global Ltd., Thinksoft Global Services Ltd., Evoke Technologies and RS Software India Ltd.

 

22. As far as inclusion of Akshay Software Technologies Ltd., is concerned, it was the case of the DRP that this company was predominantly engaged in onsite development of software and therefore not comparable with a company like the assessee which was primarily engaged in offshore software development services. As far as the ground on which this company was excluded by the DRP is concerned, it is not in dispute that this Tribunal in the case of Applied Materials India Pvt. Ltd., (supra) for Assessment Year 2011-12 has excluded this company from the list of comparable companies on the ground that this company was predominantly engaged in onsite development of software. Learned Counsel for the assessee however submitted that in Assessment Year 2009-10 this company was retained as a comparable. We have perused the aforesaid order of the Tribunal which is at page 2218 of the assessee’s Paper Book and we find that the inclusion of this company was not challenged by either of the parties and therefore it cannot be said that this company has to be included on the basis of the decision in assessee’s own case for Assessment Year 2009-10. The plea of the assessee in this regard is accordingly rejected.

 

23. We will now consider the plea of the assessee for inclusion of LGS Global Ltd., Evoke Technologies Ltd., and R S Software India Ltd. as comparable companies. The DRP upheld exclusion of LGS Global Ltd., on the ground that it was not possible to ascertain whether this company passes the employee cost filter. The contention of the assessee for inclusion of this company was that under Schedule VI to the Companies Act, 1956, all categories of expenditure incurred on account of salary and wages are not required to be disclosed under the head ‘personnel expenditure’. Employee costs incurred by many companies are not separately clubbed as ‘Employee expenses’ in their financial statements. For instance, some companies club the employee costs under the head ‘Cost of Services’. Some others, like LGS Global Ltd., club the expenses under the head ‘Personnel and Purchase Cost’. The purchase and personnel cost are 83.91% of total sales. For a software company, major component of its expenses would be employee related expenses, and therefore the company passes the employee cost filter applied by the TPO. Foreign currency inflow is irrelevant, when otherwise the company is comparable.

 

24. As far as inclusion of Evoke Technologies Ltd., is concerned, the DRP suo moto excluded this company on the ground that this company has low margin indicating existence of peculiar economic circumstance. In this regard, the contention of the learned Counsel for the assessee was that the margin of this company cannot be termed as being abnormally low nor as a result of peculiar economic circumstances and in this regard, reliance was placed on the decision of the ITAT Bengaluru Bench in the case of Applied Materials India Pvt. Ltd., (supra).

 

25. As far as R S Software India Ltd., is concerned, the DRP excluded this company on the ground that this company renders onsite software development services. In this regard, it has been the contention of the learned Counsel for the assessee that the conclusion of the DRP that this company derives revenue from onsite is erroneous and is based only on the existence of foreign branch expenses which cannot be sustained. In this regard, reliance was placed by the learned in the decision of the ITAT, Bengaluru Bench, in the case of Applied Materials India Pvt. Ltd., (supra).

 

26. The learned DR submitted that these facts and contentions require examination by the TPO as these issues were not raise by the assessee before the DRP and therefore the question of comparability has to be set aside to the TPO/AO for fresh consideration.

 

27. We have considered the rival submissions. We find that the comparability of LGS Global Ltd., was contested by the assessee before the DRP whereas the companies Evoke Technologies and R S Software India Ltd., were not contested by the assessee before the DRP but the DRP suo moto excluded these 2 companies from the list of comparable companies. As far as inclusion of LGS Global Ltd., is concerned, this Tribunal in the case of Applied Materials India Pvt. Ltd., (supra) has remanded the issue to the TPO for fresh consideration with the following observations:

 

“(ii) LGS Global Ltd

 

13.1 The TPO rejected this company on the ground that the Annual Report did not give break up of employee cost and thus he could not compute its employee cost factor. The DRP upheld the rejection on the basis that the separate details of employee cost were not available.

 

13.2 Before us, the Id.AR of the assessee has submitted that this company has shown purchase and employee cost under a composite head which is 83.91% of the sale. Therefore this company satisfied the employee cost of 25% of total sales. The learned Authorised Representative has pointed out that in case of service provider the major component is employee cost and there is hardly any purchases therefore even if the employee cost is not separately reported, the composite of purchase and employee cost constitute 83.91% of sales. Thus he has submitted that this company should be included in the list of comparables.

 

13.3 On the other hand, the learned Departmental Representative has relied upon the orders of the authorities below and submitted that there is no dispute that this company has not reported employee cost separately and therefore it is not possible to ascertain the employee cost and to apply employee cost filter. Further this company has also shown its goodwill in its balance sheet and therefore the intangible assets renders this company non-comparable to the assessee.

 

13.4 We have considered the rival submissions as well as the relevant material on record. This company has shown the purchases and personnel cost at page 39 of the Annual Report as a combined expenditure as under:

 

Purchases & Personnel Cost: Rs.250,61,55,607.

 

Therefore the cost of employee is not separately reported by this company. Further it is not clear whether the goodwill is selfgenerated or acquired intangible asset. Accordingly, this issue is set aside to the record of the Assessing Officer/TPO to verify the relevant facts to ascertain the employee cost and then decide the functional comparability. Needless to say the information under Section 133(6) may be obtained for the purpose of ascertaining the annual employee cost of this company.”

 

28. We remand the issue to the TPO/AO to verify the facts as indicted in the order referred to above and the light of those facts decide the comparability of this company. We are of the view that since Evoke Technologies Ltd., and R S Software India Ltd., were excluded by the DRP suo moto, the issue has to be remanded to the TPO/AO for fresh consideration to decide the comparability of these 2 companies also. We hold and direct accordingly.

 

29. The other company which was sought to be included by the assessee is Thinksoft Global Ltd. The comparability of this company can be conveniently decided together with ground No.16 in which the assessee seeks inclusion of FCS Software Solutions Ltd., and this ground reads as follows:

 

16.The Hon'ble DRP has erred in rejecting the objection raised by the Petitioner in relation to computation of the operating margin of the Petitioner, by stating that no submissions were made.

 

30. This company was also excluded suo moto by the DRP on the ground of existence of onsite revenue and this Tribunal in the case of Finestra Software Solutions India Pvt. Ltd., (2018) 93 taxmann.com 460 (Bangalore – Tribunal) upheld the inclusion of this company. Similarly, even inclusion of FCS Software Ltd., was upheld in the aforesaid decision. The following were the relevant observations of the Tribunal in this regard:

 

“As far as the plea for including the other two companies viz., Thinksoft Global Ltd., and FCS Software Ltd., we find both these companies were excluded by the TPO for the reason that the ' working capital adjustment was very high. ITAT Bangalore Bench in the case of VMware Software India (P.) Ltd. v. DCIT in IT (TP) A.No.1311/Bang/2014 order dated 6.1.2017 has held that a company which is otherwise comparable cannot be excluded for the reason that the working capital adjustment to be done was very high. In view of the aforesaid decision, we are of the view that this company, which was otherwise found to be comparable, be included in the list of comparable companies.”

 

31. We have given a careful consideration to the submission and we find that exclusion of Thinksoft Global Ltd., was on the ground of onsite revenue and not on the ground of working capital adjustment to be done being very high. So also, in the case of FCS Software Solutions Ltd., inclusion was not challenged by the assessee before the DRP. In these circumstances, we are of the view that it would be just and appropriate to remand the question of comparability of these 2 companies also to the TPO/AO for consideration afresh leaving all contentions for exclusion and inclusion of these 2 comparable companies open.

 

32. The next ground that requires adjudication is ground Nos.13 and 16 which reads as follows:

 

“13. The learned TPO/ learned AO/Hon’ble DRP erred in considering certain extraordinary expenditure as operating in nature while computing the margin of the Appellant.”

 

 16. The Hon’ble DRP has erred in rejecting the objection raised by the Petitioner in relation to computation of the operating margin of the petitioner, by stating that no submissions were made.

 

33. As far as ground No.13 and additional ground No.16 are concerned, the submission of the learned Counsel for the assessee was as that during the year under consideration, the assessee incurred the following one-time extraordinary expenditure:

 

Sl. No.	Nature	Amount
(a)	Costs relating to Pune facility which was debonded post acquisition	Rs. 1,88,22,000/-
(b)	Costs relating to Bangalore facility which was debonded post acquisition	Rs. 2,70,00,000/-
(c)	Employee severance costs arising post-acquisition due to termination of the employees	Rs. 1,30,00,000/-
(d)	Costs relating to post-acquisition period (September 2010 to March 2011) in respect of which there were no corresponding revenues	Rs. 1,45,17,296/-
	Total	Rs. 7,33,39,296/-

 

Despite the assessee having filed submissions before the DRP, it erroneously rejected the objections on holding hat the assessee had not made any submissions. It was submitted that the above expenses were incurred by the assessee post-acquisition and are in the nature of one-time extraordinary expenses. Details in this regard were furnished vide the petition for additional evidence filed on 18.07.2018. It was submitted that while computing the operating margin for the purposes of determination of ALP of the transaction, extraordinary expenses ought not to be included, as they are not ‘operating’ in nature. The position is also recognized in Rule 10TA(j) of the Income-tax Rules, 1962 (“the Rules”), which while defining the term “operating expense” excludes from its purview extraordinary expenses. Reliance in this regard is placed on the following decisions:

 

- Grupo Antolin India (P.) Ltd. v. DCIT ([2019] 105 taxmann.com 31 (Pune - Trib.);

 

- HOV Services Ltd. v. JCIT [2016] 73 taxmann.com 311 (Pune - Trib.); and

 

- Marubeni India (P.) Ltd. v. DIT [2013] 354 ITR 638.

 

It was submitted that the above expenses ought to be excluded from the operating expenses while computing the operating margin. More importantly, it was submitted that the above costs have no impact on the international transaction entered into by the assessee and therefore they cannot be considered as a part of operating cost base. The following chart was also filed depicting the operating margins of the assessee, if extraordinary items of expenses are disregarded:

 

Operating income	Rs. 16,35,19,442/-
Expenditure before reduction of extraordinary expenses	Rs. 22,13,75,158/-
Operating expenditure after reducing extraordinary expenses	Rs. 14,80,35,862/-
Operating profit	Rs. 1,54,83,580/-
Net margin on cost	10.46%

 

34. As already stated, in this regard, the assessee has also filed application to file additional evidence before the Tribunal. We find that on this issue, the DRP in para 2.27 of its order at page 22 has merely observed that no submissions were made on the above ground of appeal. Learned Counsel for the assessee has however pointed out that in Annexure 1.26 of the objections filed by the assessee before the DRP, the submissions have been made with regard to the computation of operating margin. Since this issue has not been adjudicated by the DRP, we are of the view that it would be just and appropriate to remand this issue to the TPO/AO for consideration afresh with liberty to the assessee to file additional evidence before AO/TPO. The issue was not raised before the TPO in the assessment proceedings. Therefore, it would be appropriate if the TPO/AO are directed to consider the claim of the assessee in this regard. The TPO/AO will decide the issue after affording assessee opportunity of being heard.

 

35. As far as ground Nos.17 and 18 raised by the assessee are concerned, the same reads as follows:

 

17. The Learned Assessing Officer ["Learned AO] and Hon'ble Dispute Resolution Panel ["Hon'ble DRP"], while assessing the total income of the Appellant for the year under consideration, ought to have allowed deduction of ALP adjustment amounting to INR 1,20,30,164 inadvertently offered to tax by the Appellant twice i.e. in AY 2010-11 and AY 2011-12.

 

18. On the facts and circumstances of the case and in law, the Learned AO and Hon'ble DRP ought to have allowed deduction for the ALP adjustment offered to tax twice, though not claimed as a deduction by the Appellant while filing its return of income for AY 2011-12 under consideration.

36. As can be seen from the grounds of appeal, the issue arises owing to developments that took place after filing of return of income for AY 2011- 12 by the assessee. We are of the view that it would be just and appropriate that the AO/TPO should be directed to consider this issue after affording opportunity of being heard to the assessee and decide the same in accordance with law.

 

37. Corporate Tax issue raised by the assessee in the grounds of appeal reads as follows:

 

Corporate Tax

 

Disallowance of provision amounting to Rs. 1,364,146 towards rental expenses

 

· The Hon'ble DRP has erred in upholding the action of the learned AO in disallowing provision for rental expenditure.

 

· The learned AO and the Hon'ble DRP has failed to appreciate the fact that the amount payable by the Appellant represents only a best estimate on the basis of past experience.

 

· The Hon'ble DRP has failed to apply judicial precedents wherein it has been held that a liability can be allowed as deduction even though it is quantified and discharged at a future date.

 

· Notwithstanding and without prejudice, should the said amount be disallowed under section 37 of the Act e same has to be allowed in the subsequent year on reversal of the said amount.

 

38. As can be seen from the grounds of appeal of the assessee, the deduction has been claimed by the assessee towards provision for rental expenses based on the possibility of increase in rental expenses. This is purely on the basis of the estimate and was rightly treated as contingent in nature and not allowed as a deduction by the Revenue authorities. In this regard, we are of the view that the assessee has not given any basis for its anticipated liability towards rental expenses nor has he quantified the basis of arriving at the anticipated liability. In such circumstances, we are of the view that the Revenue authorities were justified in rejected the claim of the assessee. Accordingly, this ground of appeal raised by the assessee is dismissed. No other grounds were pressed for adjudication except the grounds adjudicated in this order.

 

39. In the result, appeal of the assessee is treated as partly allowed.

 

40. In the result, appeal by the Revenue is dismissed and the appeal by the assessee is treated as partly allowed for statistical purposes.

 

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