Mentor Graphics (Noida) (P) Ltd., New ... vs Department Of Income Tax

Mentor Graphics (Noida) P. Ltd., Vs. Dy. Commissioner of Income Building-A, Logix Techno Park Tax, Ciccle-6(1), New Delhi Plot no. 5, Sector 127, Noida (PAN:AABCM5494Q) (Appellant) (Respondent)

And

ITA No. 2847/Del/2010 Assessment Year: 2003-04

Dy. Commissioner of Income Vs. Mentor Graphics (Noida) P. Ltd., Tax, Ciccle-6(1), New Delhi Building-A, Logix Techno Park, Plot no. 5, Sector 127, Noida (PAN:AABCM5494Q) (Appellant) (Respondent)

Assessee by : S/sh. Rohit Tiwari & Ravi Sharma, CAs Department by: Sh. Judy James, Standing Counsel for DR

ORDER

PER R.S. SYAL, AM :

These two cross appeals, one by the assessee and other by the Revenue,

arise out of the order passed by the CIT(A) on 22.04.2010 in relation to the

assessment year 2003-04.

2

ITA Nos. 2423 & 2847/Del/2010

2. The only issue pressed by the learned AR from the assessee's appeal is

against the inclusion of certain companies in the list of comparables.

3. Briefly stated the facts of the case are that the assessee Mentor Graphics

(NOIDA) P. Ltd., formerly known as IKOS India Pvt. Ltd., is a wholly owned

subsidiary of IKOS Systems Inc. USA, which, in turn, was acquired by Mentor

Graphics Corporation, USA during the year relevant to the assessment year

under consideration. The assessee reported two international transactions,

namely, "Software Development Services Rendered" with value of Rs.

11,17,29,489/- and "Marketing Support Services Rendered" with value of Rs.

1,33,72,483/-. Insofar as the segment of `Software development services' is

concerned, the assessee provided software development services only to its AEs

and not to the third parties. Such software development services were utilized by

its parent company, which is engaged in the development of software products

for chip designing. Apart from this, the assessee also rendered `Marketing

Support Services' to IKOS, USA by securing clients in India for its foreign

entity. The assessee is a contract service provider who was remunerated by its

AEs at cost plus 13% in respect of both the above types of services. The

Transactional Net Margin Method (TNMM) was used by the assessee as a most

appropriate method with the Profit Level Indicator (PLI) of Operating profit to

Sales. Four companies were chosen by it as comparables which have been listed

on page 3 of the order of the Transfer Pricing Officer (TPO). The arithmetic 3 ITA Nos. 2423 & 2847/Del/2010

mean of the Profit ratio of these four companies was computed at 5.50% against

the assessee's PLI of 9.75%. That is how, the assessee demonstrated that its

international transactions were at Arm's Length Price (ALP). The TPO changed

the PLI to Operating profit/ Total cost (OP/TC) by accepting the TNMM as the

most appropriate method. Not satisfied with assessee's selection of comparables

and the use of multiple year data, the TPO searched a new set of comparables

with current year's data alone. After entertaining objections from the side of the

assessee, the TPO shortlisted 16 companies as comparable which have been

tabulated on page 9 of his order. The arithmetic mean of their OP/TC at 22.30%

was found to be breaching + 5% margin of the assessee's OP/TC. This resulted

into transfer pricing adjustment of Rs. 1,34,64,448/-. The Assessing Officer

made this addition. The learned CIT(A) accepted the TPO's version in entirely

except treating Genesys International Corporation Ltd. as not comparable. Both

the sides are in appeal on their respective stands.

4. We have heard the rival submissions and perused the relevant material on

record. It is noticed that the only dispute pressed before us from the assessee's

appeal is the inclusion of four companies in the list of comparables by the TPO.

No other aspect, such as the application of OP/TC as PLI or the exclusion of

some of the companies chosen by the assessee in its Transfer Pricing Study

report or consideration of current year's data alone etc. has been challenged 4 ITA Nos. 2423 & 2847/Del/2010

before us. As such, we will confine ourselves only to examining the inclusion of

certain companies in the list of comparables which have been agitated before us.

5. Before considering the comparability or otherwise of the companies

assailed before us, it is paramount to consider the functional profile of the

assessee company. We have noticed above that the assessee rendered not only

Software development services but also Marketing support services to its AEs.

The TPO has clubbed both the sets of international transactions and proceeded

to determine their ALP by treating both of them as Software development

services rendered in a combined manner. As the assessee has not challenged

this aspect, we will also consider both these services in a combined manner as

software development services, albeit we feel that these two ought to have been

benchmarked separately.

6. The assessee entered into an Agreement with Mentor Graphics (Ireland)

Ltd effective from 08.05.2002 under which it undertook to render `Development

services' to its AEs. A copy of the Agreement is available at pages 127 onwards

of the paper book. "Development Services" in this Agreement have been defined

to mean "all development activities concerning any of the Products, including

but not limited to (i) development of new Products; and (ii) creation of

improvements, updates, adaptations, translations or other modifications to

existing Products or Products under development". The expression "Products"

has been defined in this Agreement to mean and include "all software products 5 ITA Nos. 2423 & 2847/Del/2010

which any Party or any Affiliate markets or intends to market and updates,

enhancements, new versions and new releases thereof, other than "Specifically

Excluded Products", if any, set forth in Exhibit A". From the above description

of the work to be carried out by the assessee, it clearly emerges that the assessee

is providing software development services to its AEs as a captive unit. With

the above understanding of the functional profile of the assessee company, let

us examine if the four companies under challenge are, in fact, comparable.

(i) Aftex Infosys Ltd.

7.1. The TPO included this company in the list of comparables with profit

rate of 86.45%. The assessee objected to the inclusion of this company by

contending through its letter dated 23.01.2006, a copy of which is available on

pages 266 onwards of the paper book, that this company is a software-driven

and internet product company that produces Personal Data Assistant (PDA)

machine for Para-banking and Smart Card Machines which are used in public

transportation. The assessee also contended that this company deals in software

products having its own Intellectual Property Rights of the software products

developed by it and hence is not comparable. The TPO in a generalized and

sweeping manner brushed aside the assesee's objections given for this company

and others without separately discussing as to how a particular company was not

incomparable as per the assessee's version. The learned CIT(A) upheld the

assessment order.

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ITA Nos. 2423 & 2847/Del/2010

7.2. After considering the rival submissions and perusing the relevant material

on record, we find from the Annual Report of Aftek Infosys Ltd., a copy of

which is available on record, that this company is, in fact, engaged in the

software products by owning Intellectual Property Rights to the software

products. Apart from that, it can be seen from its Annual report that it

undertook acquisition of 49% of stake in Arexera for its products business.

7.3. The Mumbai Bench of the Tribunal in Petro-Aroldite (P) Ltd Vs. DCIT,

(2013) 154 TTJ (Mum.) 176 has held that a company cannot be considered as

comparable because of exceptional financial results due to mergers/demergers

etc. Similar view has been taken by the Delhi Benches of the Tribunal in several

cases including Toluna India Pvt. Ltd. Vs. ACIT (ITA No. 564/D/2013). It is

patent that the mergers/demergers largely influence the profitability of a

company during the year of happening of such event, which makes it

incomparable. As there have been acquisitions by Aftek Infosys Ltd. in the year

in question and the financial results of the erstwhile company stand included in

the overall profitability of this company, we hold that the same cannot be

considered as a comparable.

7.4. Be that as it may, it is seen that Aftek Infosys Ltd. is not only engaged in

providing software development services but is also in the business of software

products by holding Intellectual Property Rights in some software products

developed by it. No segmental data of the `Software development services' of 7 ITA Nos. 2423 & 2847/Del/2010

this company is available. Thus, it cannot be considered as comparable to the

assessee on an entity level because the assessee is engaged only in the provision

of contract software development services. We, therefore, order for the

exclusion of this company from the list of comparables.

(ii) Blue Star Infotech Ltd.

8.1. The TPO included this company in the final set of comparables with the

profit ratio of 37.27%. The learned AR was fair enough to concede before us

about the similarity of the functional profile of this company with the assessee.

It was, however, claimed that the Related Party Transactions of this company

were quite substantial.

8.2. After considering the rival submissions and perusing the relevant material

on record, we find that the predominant view of the Tribunal across the country

in several cases is that the transactions of a company having more than 25% of

Related Party Transactions (RPTs) are considered as controlled, thereby failing

the test of comparability. This view has been taken in several decisions

including by the Delhi Bench in Toluna India Pvt. Ltd. (supra) and Actis

Advisers Pvt. Ltd. Vs. DCIT, (2012) 20 ITR 138 (Del.)(Trib.). and Mumbai

Bench in Stream International Services Pvt. Ltd. Vs. ACIT (IT) (2013) 141 ITD

492 (Mum.). The mechanism for calculating the percentage of Related Party

Transactions has been broadly laid down in Nokia India Private Ltd. Vs. DCIT,

2014-TII- 224-ITAT- DEL-TP. Since the authorities below have not examined 8 ITA Nos. 2423 & 2847/Del/2010

the extent of the RPT percentage of this company, which the learned AR is

claiming to be in excess of 25%, we set aside the impugned order and remit the

matter to the file of AO/TPO for fresh determination of the percentage of

Related Party Transactions of this company in consonance with the broader

principles laid down in the case of Nokia India Private Ltd (supra), to the extent

these are applicable. If the Related Party Transactions of this company are

found to be more than 25%, then this company should be excluded from the set

of comparables and in the otherwise situation, it should continue in the list of

comparables.

(iii) Sark Systems India Ltd.

9.1. The TPO included this company in the list of comparables with profit rate

of 23.51%. The assessee challenged the inclusion of this company before the

TPO as well as the learned CIT(A), but without any success.

9.2. After considering the rival submissions and perusing the relevant material

on record, it is noticed that this company is a Software products company having

Intellectual Property Rights of the software products developed by it. This fact

emerges from the Annual report of this company, a copy of which is available in

the paper book. It can be observed from page 486 of the paper book, being page

no. 23 of the Annual report of this company, that it is engaged in the business of

production and sale of software products. As the assessee is engaged in

rendering contract software development services, it cannot be considered as 9 ITA Nos. 2423 & 2847/Del/2010

comparable with Sark Systems India Ltd. We, therefore, direct to eliminate this

company from the list of comparables.

(iv) Zylog Systems Ltd.

10.1. The TPO made this company as a part of the list of comparables with

the profit margin of 24.93%. The assessee is contesting against the inclusion of

this company in the final set of comparables.

10.2. Having heard the rival submissions and perused the relevant material

available on record, it is noticed as an admitted position that this company is

functionally comparable with the assessee company. The learned AR candidly

accepted this position. He, however, urged to exclude this company on the basis

of fresh Acquisitions undertaken by it during the financial year relevant to the

assessment year under consideration. We find from its Annual report, which is

available in the paper book, that the business acquisitions of three firms in USA

were undertaken by this company giving a substantial boost to its operations.

When we come to the Schedule of fixed assets of this company, which is

available on page 523 of the paper book, it can be seen that there is an entry with

the narration "Business acquisitions", during the year with the value of Rs.

8,47,18,999/-. These facts abundantly show that this company undertook

acquisitions in the relevant year making it incomparable in the light of the

reasoning given above while dealing with Aftek Infosys Ltd. We, therefore,

order to delete this company from the list of comparables. 10

ITA Nos. 2423 & 2847/Del/2010

11. The first issue taken by the ld. DR from the Revenue's appeal is against

the exclusion from the list of comparables by the ld. CIT(A) of Genesys

International Corporation Ltd. with a profit margin of 45%. There is not much

discussion in the TPO' s order about this company. Similarly, we find from page

16 of the impugned order that although there is some reference to the exclusion

of companies with higher percentage of Related Party Transactions, but there is

no specific discussion about Genesys International Corporation Ltd. or the

percentage of its RPTs. As such, we set aside the impugned order and remit the

matter to the file of AO/TPO for considering the percentage of Related Party

Transactions of this company in consonance with our decision above while

considering the case of Blue Star Infotech Ltd. If the percentage of the RPTs of

this company turns out to be more than 25%, then this company should be

excluded from the list of comparables. In the otherwise situation, the TPOs

inclusion of this company should be upheld. Needless to say, the assessee will

be allowed a reasonable opportunity of hearing in such fresh proceedings.

12.1. The only other issue which survives in the appeal of the Revenue is

against the deletion of addition of Rs.1,33,96,258/- made by the Assessing

Officer by disallowing deduction claimed by the assessee under Section 10A of

the Act.

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ITA Nos. 2423 & 2847/Del/2010

12.2. Briefly stated the facts apropos this ground are that the assesee claimed

deduction of Rs. 1.33 crores under Section 10A of the Act. On being called upon

to explain about the eligibility of deduction, the assessee stated that it was

entitled to deduction in view of fulfillment of all the requisite conditions as

prescribed under Section 10A. The Assessing Officer held the assessee to be not

qualifying for deduction under this section because the registration was granted

by the Software Technology Park of India (STPI) and not the Inter-ministerial

Standing Committee (IMSC) . He held that the IMSC was entrusted with the

obligation to examine the proposals for STP units and there was no provision

under which it could delegate this power to Software Technology Park of India.

He further held that STPI society has mechanically approved all the units

without examining anything except export commitments. Further, there was no

evidence that Press Note 5 and Green Card were issued with the concurrence of

the Department of Revenue or the CBDT. The learned CIT(A) overturned the

assessment order on this point by relying on the order dated 06.06.2008 passed

by the Delhi Bench of Tribunal in the case of ACIT Vs. Sanjay Bhalla.

12.3. We have heard the rival submissions and perused the relevant material

available on record. The only objection taken by the Assessing Officer for

refusing deduction under Section 10A is that the registration was granted by the

STPI Society and not the Inter-ministerial Standing Committee. We find that

this issue is no more res integra in view of the judgment dated 26.2.2013 of the 12 ITA Nos. 2423 & 2847/Del/2010

Hon'ble Delhi High Court in CIT Vs. Technovate E Solution Pvt. Ltd., a copy

of which has been placed on record by the ld. AR. In this judgment, it has been

held that the approvals given by the Directors of Software Technology Parks of

India are valid having the authority of the Inter-ministerial Standing Committee.

This position was fairly accepted by the ld. DR also. In view of the binding

precedent of the Hon'ble jurisdictional High Court, the facts of which are on all

fours with those of the assessee company, we are of the considered opinion that

no exception can be taken to the view canvassed by the learned CIT(A) on this

score. This ground fails.

13. In the result, both the cross appeals filed by the assessee as well as the

Revenue are partly allowed for statistical purposes.

The decision is pronounced in the open court on 18th February, 2015.

Sd/- Sd/- (A.T. VARKEY) (R.S. SYAL) JUDICIAL MEMBER ACCOUNTANT MEMBER

Dated: 18th February, 2015. RK/- Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR Asst. Registrar, ITAT, New Delhi

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