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

DCIT Mentor Graphics, (Noida) Pvt, Cent. Circle- Ltd.Logix Technopark, 6(1),Room No- Vs Building- A, 413.C R Building plot No-5, Sec-127 Noida, New Delhi Pan No.AABCM5494Q Appellant Respondent

Appellant by : Sh. Bhaskar Goswami, Sr. DR Respondent by : ShRohit Tiwari, CA

Date of Hearing 25.06.2015 Date of pronouncement 30.06.2015

ORDER PER A.T. VARKEY, JUDICIAL MEMBER:

This appeal filed by the Revenue is directed against the order dated 14.1.2011 passed by the Ld. CIT(A)-XX, New Delhi pertaining to assessment year 2005-06.

2. The Revenue has raised the following grounds in its Appeal:-

"1. The order of the Ld. CIT(A) is erroneous and contrary to facts and law.

2. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in directing the AO to allow depreciation on computer accessories and peripherals @60% as against 25% allowed by the AO.

2.1 The Ld. CIT(A) ignored the finding recorded by the AO and the fact that the depreciation on computer accessories and peripherals is correctly allowed @25%.

ITA NO.2634/Del/2011

3. On the facts and in the circumstances of the case in the law, the Ld. CIT(A) has erred in deleting the addition of Rs. 2,31,97,273/- made by the AO u/s. 92CA(4) on account of TP adjustment.

3.1 The Ld. CIT(A) ignored the finding recorded by the TPO & AO and the fact that the comparable adopted by the assessee are not in accordance with the prevailing market trends.

4. The appellant craves leave to add, to alter, or amend any grounds of the appeal raised above at the time of the hearing."

3. The brief facts of the case are that the assessee filed its return of income on 27.10.2005 declaring a total income of Rs. 6,41,476/- which was processed u/s. 143(1) of the Income Tax Act, 1961 (hereinafter called "the Act") on 22.3.2007 wherein a refund of Rs. 1,63,000/- was determined. Later on the case was selected for scrutiny.

4. The assessee company is a domestic company incorporated on 27.2.1998 under the Companies Act, 1956. The assessee is a subsidiary of IKOS Systems Inc., a company incorporated in USA. Later on, the company was merged with Mentor Graphics (India) Pvt. Ltd. The assessee company provides software development and related services to Mentor Graphics, Ireland that manufactures and distributes the products of the ultimate parent company to the markets outside America. In addition to above, it is also engaged in providing marketing support services to IKOS Systems Inc., USA to secure clients for it for maintenance services.

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5. A reference to the TPO was made u/s. 92CA(1) of the Act and the TPO passed the order u/s. 92CA(3) of the Act on 19.9.2008 proposing an addition of Rs. 2,31,97,273/- on account of difference in arm‟s length price determined by the TPO and that adopted by the assessee. The TPO‟s order dated 19.9.2008 reads as under:-

"The Arm's length price of international transactions relating to software development services, referred by AO is determined at Rs. 28,69,50,838/-. The book value of these international transactions is Rs. 26,37,53,585/-. Therefore, the book value of international transactions is understated by Rs. 2,31,97,273/-. In view of above, AO shall enhance the total income of the assessee by Rs. 2,31,97,273/- for the AY 2005-06 for the international transactions undertaken by the assessee during the FY 2004-05 to bring the international transactions at arm's length price."

6. Pursuant to the TPO direction, Assessing Officer made the addition of Rs.2,31,97,273/- to the total income of the assessee; and also added the addition of Rs. 25,97,918/- on account of depreciation on computer accessories and peripherals by reducing the same from 60% to 25% and thus the AO completed the assessment u/s. 143(3) vide his order dated 17.11.2008 on total income of Rs. 2,38,38,750/-.

7. Against the aforesaid order of the Assessing Officer, assessee appealed before the Ld. CIT(A), who vide his order dated 14.1.2011 was pleased to allow the claim of the assessee in respect to claim for depreciation on computers @ 60% ; And in respect to ALP, the ld. CIT (A) after excluding two companies from seven (7) comparable companies i.e. M/s Infosys Technologies Ltd. and M/s Satyam Computer Service Ltd. found that the arms length margin of finally

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selected comparable is 15.95% as against assessee‟s margin of 12% for contract of software development services, which falls within ± 5% range allowed by Proviso to Section 92C(2) of the Act. So he held that the assessee‟s international transactions are at arm‟s length; and thereafter ld. CIT (A) observed that other grounds raised are academic since relief has been granted to the assessee. Thus, he partly allowed the appeal of the assessee.

8. Aggrieved by the order of the Ld. CIT(A), now the Revenue is in appeal before the Tribunal.

9. Ld. DR relied upon the order of the AO and reiterated the contention raised in the grounds of appeal raised by the Revenue. With regard to disallowance of Rs. 2,597,918/- on account of depreciation on computer accessories and peripherals is concerned, he submitted that there was enough rationale in the intent of legislature to provide for depreciation for computers @60%. The rate of obsolescence is very high as technological changes in this field are extremely fast and rapidity of change is enormous. Hence what is bought today becomes obsolete or technologically outdated within a very short time. This is specially too for computers and this obvious fact needs no elaboration. Therefore, he submitted that the rate of depreciation provided for computers is exceptionally high i.e. 60% whereas the same does not hold good for plant and machinery. He also submitted that the networking equipments are just cables inter connecting or joining instruments that facilitate connectivity across computers. They do not get obsolete and rather endure for a very long

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time. In fact, it‟s role can be taken as akin to that of electrical installations whereby they are like pillars which provide back support to a system and their question of obsolescence does not arise. Ld. DR further pointed out that the Projectors can work independently of computer and have different role in running of business operation than a computer. Therefore, the rate of depreciation on Projectors and Networking equipment is correspondingly needed to be reduced from 60% to 25% and addition of Rs. 25,97,918/- on this account was rightly been made by the AO. Therefore, he pleaded that the action of the AO may be upheld and thus the order of the ld. CIT (A) may be reversed.

10. On the other hand, the ld. AR relied on the order of the ld. CIT (A) and does not want us to interfere

11. We have heard both the parties and perused the records. With regard to ground no. 2 to 2.1 relating to disallowance of Rs. 2,597,918/- on account of depreciation on computer accessories and peripherals is concerned, we find that Ld. CIT(A) after going through the facts of the case, and considering the nature of the items being switches, back-up storage devices, servers, projectors and other items held that they are integral part of the computer systems. We find that the issue is no longer res integra and the ground no. 2 to 2.1 is squarely covered by the decision of the Hon‟ble Delhi High Court in the case of CIT vs. BSES Rajdhani Powers Limited wherein the Hon‟ble Jurisdictional High Court has held that computer accessories form an integral part of the computer system and thus depreciation on

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them is allowable @60%. We find that Ld. CIT(A) was quite right in observing that the items for which assessee claimed depreciation appear to be integral to the computer systems. Therefore, he was opinion that with regard to these items the higher rate of deprecation at 60% should be allowed. In the background of the aforesaid discussions and the precedent, we do not find any infirmity in the impugned order of the Ld. CIT(A) on the aforesaid additions, which does not need any interference on our part, hence, we uphold the same. Therefore, the issue involved in ground no. 2 to 2.1 is dismissed.

12. With regard to disallowance of Rs. 23,197,273/- on account of adjustment under section 92CA(3) of the Act on provision of contract software development services, ld. DR submitted that the assessee gave a list of 87 companies as comparables before the TPO. However, TPO applied the filter of wages to sales between 30% to 60%. Having done so, the TPO brought down the comparables to twenty five companies from eighty seven companies originally selected by the assessee. From these twenty five companies, the TPO further rejected fifteen companies citing reasons, such as, low foreign exchange revenue, declining sales/negatives net wealth, different financial year ending, related party transactions, functionally different companies etc. Thereafter, TPO arrived at a set of ten companies and after taking the objections of the assessee, three more companies were removed from the list of comparables and the TPO finally arrived at a set of seven companies with an OP/TC of 21.60% for comparison

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computing an addition of Rs.23,197,273/- to the taxable income of the assessee. Therefore, the TPO ordered as follows :-

"The Arm's length price of international transactions relating to software development services, referred by AO is determined at Rs. 28,69,50,838/-. The book value of these international transactions is Rs. 26,37,53,585/-. Therefore, the book value of international transactions is understated by Rs. 2,31,97,273/-. In view of above, AO shall enhance the total income of the assessee by Rs. 2,31,97,273/- for the AY 2005-06 for the international transactions undertaken by the assessee during the FY 2004-05 to bring the international transactions at arm's length price."

13. Accordingly, the ld. DR contended that the Assessing Officer has rightly made the addition of Rs. 2,31,97,273/-. However, on appeal, the ld. CIT (A) has ordered exclusion of Infosys Technologies Ltd. and Satyam Computer Service Ltd. which, according to the ld. DR, are functionally similar to that of the assessee company and the ld. CIT (A) erred in directing exclusion of both companies. So he wants us to reverse the order of the ld. CIT (A) and restore the order of Assessing Officer.

14. On the contrary, Ld. Counsel of the assessee has relied upon the order of the Ld. CIT(A) and defended the same and does not want us to interfere in the same.

15. We find that Ld. CIT(A) after considering the facts of the case and the submission of the AR observed that with regard to Infosys Technologies Ltd. it was evident from the Annual Report of the company that Infosys Technologies provides much wider range of

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services, performs extensive functions, undertakes diversified business activities and assumes significant risks as compared to routine software development service providers like the assessee. Further, the company undertakes substantial R&D activities and derives majority of its revenues the sale of proprietary products unlike the assessee. Also, the turnover of the company is significantly higher than that of the appellant and in no manner is comparable to the size/ operations of the assessee.

16. We note that all the above facts highlight that Infosys Technologies Ltd. is a product owner, undertakes substantial advertising/ sales promotion and brand-building activities and is engaged in significant R&D activities, and is very huge in size/volume as compared to the assessee. Hence, it cannot be said to be comparable with the assessee. The said proposition has also been confirmed by Delhi Tribunal in Agnity India Technologies vs. ITO (supra) (ITA No.3856/Del/2010) wherein the Coordinate Bench held as follows :

"Various arguments, as stated earlier, were taken before the DRP which inter-alia included rejection of comparable cases; application of arbitrary filter of wage to sales ratio; ignoring that the assessee is a limited risk company; inclusion of Infosys Technologies Ltd.; and inclusion of Sat yam Computers Services Ltd. in spite of the fact that its data is not reliable as publicly known. On the basis of these arguments, the DRP excluded the case of Sat yam Computers Services Ltd., thereby reducing the arm's length margin to 25.6%. It is argued that the case of the assessee is not comparable with Infosys Technologies Ltd., the reason being that the latter is 8 ITA NO.2634/Del/2011

giant in the area of development of software and it assumes all risks, leading to higher profit. On the other hand, the assessee is a captive unit of its parent company in the USA and it assumes only limited currency risk. Having considered these points, we are of the view that the case of aforesaid Infosys and the assessee are not comparable at all as seen from the financial data etc. of the two companies mentioned earlier in this order. Therefore, we are of the view that this case is required to be excluded. Once that is done, it is the accepted position of both the parties that the results of the assessee are in line with the mean margin of comparable cases even if no adjustment is made on account of capital etc. Therefore, it is held that no adjustment was required to be made to the results declared by the assessee company."

11.5 The aforesaid order was upheld by the Hon'ble Delhi High Court after taking note of the chart as given below:

Basic Particular Infosys Technologies Ltd. Assessee Risk Profile Operate as full-fledged risk Operate at minimal risks as taking entrepreneurs the 100 percent services are provided to AEs Nature of services Diversified-consulting, Contract software application design, development services development, re-

engineering and maintenance system integration, package evaluation and implementation and business process management, etc. (refer page 117 of the Paper Book) Turnover 20,264 crores 209.83 crores Ownership Develops/owns proprietary branded/proprieta products like Finacle, ry products Infosys Actice Desk, Infosys iProwe, Infosys mConnect. Also the company derives substantial portion of its proprietary products (including its flagship banking product

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suite „Finacle‟) Onsite vs. As much as half of the The appellant provides only Offishore software development offshore services (i.e.

services rendered by Infosys remotely from India) are onsite (i.e. services performed at the customer‟s location overseas). And offshore (50.20 per cent) Refer p. 117 of the Paper Book) than half of its service, income from onsite services Expenditure on Rs. 80 crores Rs. Nil (as the 1-percent advertising/sales services are provided to promotion and AEs) brand building Expenditure on Rs. 236 crores Rs. Nil Research and Development Other 100 per cent offshore (from India)

11.6 On the basis of the above chart, the Hon'ble High Court affirmed the conclusion that a captive unit of a comparable company which assumed only a limited risk cannot be compared with a giant company in the area of development of software who assumes all types of risks leading to higher profits. The facts of the appellant are akin and therefore, do not warrant any different conclusion. The assessee is also captive service provider to its AE and as such, M/s. Infosys Ltd. is not a valid comparable with the assesse

Accordingly, Ld. CIT(A) proposed to exclude this company from comparable set of companies. . Therefore, the ld. CIT (A) has rightly ordered exclusion of the Infosys Technologies Ltd. from the comparable and this impugned order is upheld.

Satyam Computer Services Ltd.

18. On a perusal of the Annual Report of the company for FY 2004- 05, it is evident from the Annual Report of the company that Sat yam Computer Services Ltd. provides a much wider range of

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services, performs extensive functions, undertakes diversified business activities and assumes significant risks as compared to routine software development service providers like the appellant. Further, the company undertakes substantial R&D on its own account leading to creation of valuable non-routine IPRs and has also incurred significant advertisement and marketing expenses.

19. Further, the ld. AR has also submitted that it is common knowledge that the annual accounts of this company are not reliable and the company's auditors have themselves admitted this fact; and the criminal proceedings have been initiated for serious fraud committed by the directors of the company.

20. So we take note that M/s. Satyam Computer Services Ltd. is a diversified company, undertakes substantial advertising/ sales promotion and brand-building activities and carries out significant R&D activities, and is very huge in size/ volume as compared to the assessee and on the top of it, has unreliable financial statements and accordingly, it cannot be said to be comparable with the assessee. The said proposition also find support by the decision of Delhi Tribunal in the case of Agnity Technologies vs. ITO passed in ITA No. 3856/Del/2010) wherein the Tribunal agreed with the DRP decision to exclude Satyam Computers Services Ltd. that since data of Sat yam is not reliable is a common knowledge . Accordingly, Ld. CIT(A) directed exclusion of M/s. Satyam Computer Service Ltd. from the comparable set of companies, which, according to us, is a correct

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decision which does not need any interference and we affirm exclusion of M/s. Satyam Computer Service Ltd. from the list of comparables.

21. Thus, finally, after rightly excluding the above mentioned two companies the following list of comparable companies emerges :

S.NO. Name of the Company OP/TC 1. Sonata Software Ltd. 14.94% 2. Aztec Software & Technology Services 17.54% Ltd. 3. Geometric Software Solutions Co. Ltd. 20.32% 4. Hewlett-Packard Globalsoft Ltd. 16.63% 5. Larsen & Toubro Infotech Ltd. 10.30% Mean 15.95%

22. The ld. CIT (A) had taken note that the arm's length margin of finally selected comparable companies is 15.95% against the assessee's margin of 12% for provision of contract software development services. The ld. CIT (A) found that the OP/TC of 12% earned by the appellant falls within the range allowed by Proviso to Section 92C(2) of the Act. Accordingly, the ld. CIT (A) rightly found that the assessee‟s international transactions with its AE's with respect to provision of contract software development services during the FY 2004-05 is at arm's length.

23. In view of the above, we find that Ld. CIT(A) has rightly held that the assessee‟s international transaction was at arm‟s length and thus no addition as directed by the TPO was warranted. In the background of the aforesaid discussions and respectfully following

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the precedent as aforesaid as laid in Agnity India Technologies (supra), we do not find any infirmity in the impugned order of the Ld. CIT(A) on the ALP issue, which does not need any interference on our part, hence, we uphold the same. Therefore, the issue involved in ground No. 3 to 3.1 of the revenue are dismissed.

24. In the result, the appeal of the Revenue stands dismissed.

Order pronounced in the Open Court on 30/06/2015.

-Sd/- -Sd/- [R.S.SYAL] [A.T. VARKEY] ACCOUNTANT MEMBER JUDICIAL MEMBER

Date:30/06/2015 "AK KEOT'' Copy forwarded to: - 1. Appellant - 2. Respondent - 3. CIT 4. CIT (A) 5. DR, ITA TRUE COPY By Order, Assistant Registrar, ITAT, Delhi Benches

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