Tata Mcgraw Hill Education Pvt. Ltd., ... vs Assessee

Assessee By : Shri G.C. Srivastava, Advocate & Shri Saurabh Srivastava, FCA Department By : Shri Judy James, Standing Counsel

ORDER PER R.S. SYAL, AM:

This appeal by the assessee is directed against the final order

passed by the Assessing Officer (AO) u/s 143(3) of the Income-tax Act,

1961 (hereinafter also called `the Act') on 31.10.2011 in relation to the

assessment year 2007-08.

ITA No.5857/Del/2011

2. Briefly stated, the facts of the case are that the assessee is a joint

venture between MH, USA and the Tata Group of India. Its activities

encompass publishing original books and selling McGraw Hill products

in India. The company publishes books for schools, colleges and

professional markets. The assessee's publishing activity comprises

sourcing authors and developing books to suit readers in various

disciplines. The assessee is also providing back office support services

in the nature of IT enabled services, transaction processing and data

processing services to its associated enterprises (AEs). The assessee

reported certain international transactions in Form No.3CEB. In the

present appeal, we are concerned only with the international transaction

of rendering IT support services to McGraw Hill Education (Asia),

Singapore with a value of Rs.4,07,64,433/-. The assessee's gross

revenue from the `Publishing segment' amounted to Rs.108.94 crore

with operating profit of Rs.18.75 crore. In the `Back office support

services' segment, the assessee earned a gross revenue amounting to

Rs.4.07 crore with operating profit of Rs.37.05 lac. Though the assessee

maintained books of account on aggregate basis combining the 2 ITA No.5857/Del/2011

transactions of these two major segments, however, for the purposes of

transfer pricing analysis, it splitted its combined results into Publishing

business segment and Back office support services segment. The

assessee adopted the Transactional Net Margin Method (TNMM) as the

most appropriate method for the international transactions under both the

above segments. It disclosed the Profit Level Indicator (PLI) as ratio of

Operating profit to Operating cost at 22.67% under the `Publishing

business segment' and 10.00% in the `Back office support services

segment'.

3. We have noticed above that in the present appeal, the major dispute

is about the international transactions in the `Back office support

services segment'. The assessee selected certain companies as

comparable under this segment to demonstrate that its international

transactions were at arm's length price (ALP). The Transfer Pricing

Officer (TPO) was not satisfied with the companies selected by the

assessee as comparables. He short-listed 26 companies with the average

OP/TC at 25%. After considering working capital adjustment of 0.96%,

3 ITA No.5857/Del/2011

the TPO worked out the revised arithmetic mean of the comparables at

25.96%. By considering this profit rate as benchmark, the TPO worked

out transfer pricing adjustment amounting to Rs.59,14,548/-. The AO

made the addition for the equivalent sum against which the assessee has

come up in appeal before us.

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

material on record. At the outset, we want to make it clear that the

assessee has mainly contested the selection of certain companies as

comparable. Before evaluating the comparability or otherwise of the

companies which have been assailed in the present appeal, it is sine qua

non to consider the functional profile of the assessee company. For

determining the nature of work done by the assessee under this segment,

we would go through the relevant clauses of the Agreement dated

01.01.2005 entered into between the assessee and its AEs, a copy of

which is available on pages 419 onwards of the paper book. It is

apparent from this Agreement that the AEs engaged the assessee: "to

provide administrative and other similar services for the Business Units

4 ITA No.5857/Del/2011

as included in Schedule A in TMH's "Territory." Such services shall

include, but not be limited to, general accounting services, accounts

payable services, payroll processing services, any other administrative

and accounting services and all other assistance as requested by MHCI

(herein referred to as the "Services")." As a compensation for the above

services, the AEs agreed to reimburse all the expenses directly or

indirectly incurred by the assessee in the performance of the services

with 10% mark-up. The assessee, vide its letter dated 13.09.2010

addressed to the TPO, narrated the nature of services rendered by it to

the AEs, the relevant part of which is as under:- "Back office support

services provided by TMH India are in the nature of routine IT

administration and support and software support type of services related

to data and transactions." A perusal of the Agreement between the

assessee and its AEs divulges that the assessee rendered 'general

accounting services, accounts payable services, payroll processing

services, any other administrative and accounting services' to its AEs.

The TPO has designated such services as `software development

5 ITA No.5857/Del/2011

services', whereas the assessee is contending that the services rendered

by it do not fall in the realm of `software development services'.

5. At this stage, it is relevant to understand the difference between a

software service company and a software product company. A Software

service company may again be of two types, viz., a company providing

software development services and a company providing software

services other than software development services (hereinafter also

called 'a company providing non-development software services'),

though both render software related services. In order to properly

appreciate the vital difference between these three types of companies, it

is significant to note that the ultimate thing is a software product, with

which the desired results are obtained. For example, if a person wants to

maintain accounts on computer or wants some specific types of accounts

reporting, then he needs to have a software, capable of delivering the

desired results. A software catering to such requirements is called a

software product. A company which develops software products, in

entirety or in parts, for another, is called a company rendering software

6 ITA No.5857/Del/2011

development services. Software development services also include

timely updation of the software products so as to suit the ever changing

requirements of the users. A company using, inter alia, a software

product for obtaining the desired accounting results, is called a company

providing non-development software services. This can be seen in a

cycle. First step is the development of software, which can be done in-

house by the owner himself or outsourced in entirety or in parts from

different companies providing software development services. Once a

software is fully developed, it becomes a software product, which can

either be self-used or sold off-the-shelf by giving licenses to various

customers, unless it is customized for a particular customer. This is the

second stage. When the software product goes into the hands of a user, it

is he who uses the software for getting the desired results from the raw

data. This is the third stage. Coming back to our context, a company

providing software development services is in the first stage and a

company providing non-development software services is in the third

stage. The second stage is the case of a software product company. It is

manifest that there is a phenomenal difference between a company 7 ITA No.5857/Del/2011

providing software development services and a company providing

software non-development services in terms of expertise, professional

qualification and experience required for rendering such services. A

company providing software non-development services performs a

relatively low-end service. From the above, it is amply clear that

whereas a company providing software development services helps in

the creation of a software, on the other hand, a company providing non-

development software services obtains the desired services with the use

of a software. Further, whereas the output of the former is a software in

itself or a stage in the ultimate creation of a software, the output of the

later is the processed information from the raw data obtained with the

help, inter alia, of a software. The later company does not create or

develop any software but simply uses an already existing software. From

the above discussion, it is overt that as a software product company

cannot be compared with a company providing software development

services, similarly, a company providing software development services

is as different from a company providing non-development software

services as is chalk and cheese.

8 ITA No.5857/Del/2011

6. Before embarking upon making a comparison of the nature of

services rendered by the companies, which the assessee is agitating in

the present appeal, we would like to mention that the TPO identified 26

companies as comparable. When we turn to the facts of the instant case,

it is found that the TPO categorized the assessee as a software

development services provider. However, we have noticed supra from

the nature of services actually rendered by the assessee to its AEs, that it

is a provider of software non-development services. With this

background in mind, we will proceed to examine the comparability or

otherwise of the companies challenged before us, one by one.

(i) Accel Transmatic Ltd. (Seg.)

7.1. The TPO treated this company as comparable with the profit

margin of 20.90% despite the assessee's contention that it is functionally

different. However, the TPO confined himself only to the software

segment which, in his opinion, qualified all the filters. The assessee is

agitating against the inclusion of this company.

9 ITA No.5857/Del/2011

7.2. We have heard both the sides and perused the relevant material

on record. It can be seen from the Annual report of this company, a

copy of which is available in the paper book, that this company has three

divisions, namely, Systems and Services Division, Technologies

Division and Animation Division. From the segmental reporting of this

company, which is available on page 48 of the paper book, it can be seen

that the management of the company identified four business segments,

namely, hardware products/services, software services, education &

training and animation. When we consider the 'software services'

segment of this company, the same is found to be comprising of research

and development, marketing, manufacturing and services of automated

payment collection terminals, uninterrupted power supply systems,

railway platform vending machines, etc. The focus of this division is on

products and solutions at the customer interface for utilities, banking &

finance and e-governance. It has also been mentioned in the Annual

report that this segment comprises of the following categories, namely,

manned and unmanned payment collection terminals, multi functions

kiosks, queue management systems, ticked issuing machines and 10 ITA No.5857/Del/2011

uninterrupted power supply systems. A bare perusal of the nature of

activities done by this company under this segment divulges that it is

into software development services and also the sale of software

products. On the other hand, the assessee in question is involved into

rendering software non-development services, which are far away

different from software development services. We, therefore, order for

the exclusion of this company from the list of comparables.

(ii) Avani Cimcon Technologies Ltd.

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

by observing that: "As per the information available in the public

domain, it is a software development and consulting company." After

seeking information from this company u/s 133(6) of the Act, the TPO

found it to be qualifying all the filters. That is how this company was

held to be comparable. The assessee is aggrieved against the inclusion

of this company in the final set of comparables.

8.2. After considering the rival submissions and perusing the relevant

material on record, it can be noticed from the TPO's observations that

11 ITA No.5857/Del/2011

this company is into software development. From the Annual report of

this company, a copy of which is available in the paper book, it can be

seen that this company is engaged in providing software development

services. In view of the fact that the assessee is not providing any

software development services, this company cannot be considered as

comparable. We, therefore, order to eliminate this company from the

list of comparables.

(iii) Celestial Labs Ltd.

9.1. The TPO observed that this company is engaged in the provision

of software development services. Notice u/s 133(6) of the Act was

issued. As per the reply received from the company, the TPO noted that:

"It is mainly a software development company" qualifying all the filters.

He, therefore, included this company in the list of comparables.

9.2. Having heard the rival submissions and perused the relevant

material on record, it is observed that this company is not only engaged

in providing software development services, but also into the software

products. It is noticeable from the TPO's order page 73 that the assessee

12 ITA No.5857/Del/2011

objected to the inclusion of this company by stating that it developed a

new drug design tool 'Çelsuite' to drug discovery in finding the lead

molecules for drug discovery and protected the IPR by filing under the

Copyright/Patent Act. It can be noticed from the Annual report of the

company, which is available in the paper book, that there is a reference

to the development of a denovo drug design tool 'Celsuite', which is a

revenue generating activity. When we examine the turnover of this

company with the narration given on page 24 of the Annual report, it can

be seen that the same comprises: "Bio-informatics services, data

warehousing and manning, software development, products and

services." It is manifest from the Annual report of this company that the

same cannot be considered as comparable on entity level when it has

dealt not only with software products, but has also engaged itself into

software development and also rendering services. In comparison with

that, the assessee company is simply providing software non-

development services to its AEs. As such, this company cannot be

considered as comparable. We, therefore, direct to remove the name of

this company from the list of comparables.

13 ITA No.5857/Del/2011

(iv) Flextronics Software Systems Ltd. (Seg.)

10.1. The TPO included this company with operating profit ratio of

25.31%, in the list of comparables despite the assessee's contention that

it is a software products company as well as a service provider.

10.2. After considering the rival submissions and perusing the relevant

material on record, it can be seen from the Annual report of this

company that it is an end-to-end provider of communication products,

services and solutions to network equipment providers, handset

manufacturers, service providers and business process outsourcing

sectors. From the Notes to the financial statements of this company, it

can be observed that: "The activities of the company include

development of package software, providing software consulting

services and other ancillary products and services, primarily for use in

the telecommunications industry." In view of the fact that it is a

software products company and is also providing software development

services, even the segmental results of software development services

cannot be equated with the activities undertaken by the assessee for its

14 ITA No.5857/Del/2011

AEs. We, therefore, order to exclude this company from the list of

comparables.

(v) Helios & Matheson Information Technology Ltd.

11.1. The TPO included this company in the final set of

comparables by noticing that it was engaged in the similar business

activity.

11.2. After hearing the rival submissions and perusing the relevant

material on record, we find from the Annual accounts of this company, a

copy of which is available on record, that it is engaged into similar

business activity as is done by the assessee. After going through some

pages of the Annual report, giving details about the nature of business

activity done by this company, the ld. AR also candidly accepted that

functional profile of this company is comparable with the assessee

company. We, therefore, uphold the impugned order on the inclusion of

this company in the list of comparables.

15 ITA No.5857/Del/2011

(vi) Infosys Technologies Ltd.

12.1. The TPO included this company despite the assessee's

objections that it was a very high turnover company with several other

functional dissimilarities.

12.2. It is an undisputed fact that the assessee rendered services to its

AEs as a captive unit without retaining any rights in intellectual property

in the work done by it. In contrast to that, Infosys Ltd. is a giant

company in terms of risk profile, scale, nature of services, revenue

ownership of branded/proprietary products, on site and offshore

services, etc. This company cannot be considered a comparable. Our

view is fortified by the judgment of the Hon'ble jurisdictional High

Court in CIT vs. Agnity India Technologies Pvt. Ltd. (2013) 219

Taxmann 29 (Del) in which Infosys Technologies Ltd., has been held to

be not comparable with a company engaged in the business of

development of software for its parent company. Similar view has been

taken by the Tribunal in the case of Toluna India Pvt. Ltd. As the

16 ITA No.5857/Del/2011

assessee's nature of business is of no match with Infosys Ltd., we direct

not to consider this company as a comparable.

(vii) KALS Information Systems Ltd. (Seg.)

13.1. The TPO included this company in the list of comparables by

observing that its operations were in software products, software

services and training. Information u/s 133(6) of the Act was called from

this company, which has been reproduced on page 94 of the TPO's

order. From such submissions, the TPO inferred that the software

products constituted only 3% of its revenues and training constituted

only 8.56%, thereby leaving around 88% of the total revenues to the

software services. That is how, the assessee's objections were repelled

and this company was considered as comparable.

13.2. After considering the rival submissions and perusing the relevant

material on record, we find that the entire premise of the TPO's

inclusion of this company in the list of comparables is that the software

products constitute only 3% of its revenue. This inference has been

drawn on the basis of the information supplied by this company stating:

17 ITA No.5857/Del/2011

"the use of readymade object laboratories is only to the tune of about

(0.33 to 3) % in the year 2005-06 and 2006-07. " We fail to comprehend

as to how the above line conveys that the software products' revenue

stands at 3%. What has been written is that the company's use the

readymade object laboratories is only to the tune of maximum 3%. By

no imagination this can be construed as revenues from software

products. When we peruse the Annual report of this company, which is

available in the paper book, it can be seen that there is no such mention

of software product's revenue limited to 3%. On the contrary, it has

been mentioned in the Notes to the financial statement that: "the

company is engaged in development of software and software products

since its inception." The company consisting of STPI unit engaged

software products and in development of software is also undertaking

training activity of software professionals on online projects. Not only

the revenues of the segment considered by the TPO also include the

revenue from software products, but also from training imparted on

commercial basis. When we consider the assessee's functional profile,

the only irresistible conclusion which can be drawn is that it is not a 18 ITA No.5857/Del/2011

comparable company. Accordingly, this company is ordered to be

expunged from the set of comparables.

(viii) Lucid Software Ltd.

14.1. The TPO included this company in the list of comparables on

entity level despite the assessee's objections.

14.2. Having heard the rival submissions and perused the relevant

material on record, we find that this company has been rightly included

in the list of comparables. The whole thrust of the submissions of the ld.

AR for the exclusion of this company was on the fact that this company

developed software products in-house and, hence, it was a software

product company. We are unable to accept this proposition for the

reason that this company developed software products for its internal use

for rendering software services to its customers. The fact that the in-

house software developed by it were used in rendering software services

is borne out from the debit of an account to its Profit & Loss Account

with the narration: "Amortization of product development expenses."

From Note 1.4.1 on accounts of this company, it can be observed that:

19 ITA No.5857/Del/2011

"the total expenditure incurred on in-house development of softwares

gets amortised over a period of 36 months from the launch date. The

unamortized product development expenditure is shown under 'Assets'

till it is fully written off. During the year, there is no such expenditure

incurred." When we consider this Note along with the Profit & Loss

Account and the Balance sheet of this company, it becomes palpable that

it spent a particular amount on in-house software development for

internal use and wrote off 1/3rd in its Profit & Loss Account for the year

in question and retaining the balance unamortised amount in its balance

sheet. If this expenditure had been incurred for software development

on behalf of its customers, then, the expenditure would not have found

its place in the balance sheet as Unamortized amount, because the

amount spent on the software development would have been received

with relevant mark-up. When we consider the assessee's balance sheet,

which is available in the paper book, it turns out that the assessee has

also shown a particular amount under the head 'Software' in its

Schedule of fixed assets, and, thereafter, it also claimed deduction on

account of amortization during the year, leaving the balance 20 ITA No.5857/Del/2011

unamortized amount under the head 'Software.' It shows that the

assessee is also using its software for rendering the services in the

similar manner as is done by Lucid Software Ltd. Apart from that, the

ld. AR could not point out any functional difference with Lucid

Software Ltd. We, therefore, approve the inclusion of this company in

the list of comparables.

(ix) Megasoft Ltd. (Seg.)

15.1. The TPO included this company in the list of comparables. The

ld. AR argued for its removal on the basis of certain acquisitions done

by this company during the year.

15.2. After considering the rival submissions and perusing the relevant

material on record, we find from the Notes to Accounts in the Annual

report of this company that there was, in fact, amalgamation of

Visualsoft Technologies Ltd. Note no. 25 with the caption

'Amalgamation of Visualsoft Technologies Ltd. with the Company'

reads that: "The prior year comparatives include effect of amalgamation

of Visualsoft Technologies Ltd. ('Visualsoft') with the company w.e.f.

21 ITA No.5857/Del/2011

1st October, 2006. The assets, liabilities, rights and obligations of

Visualsoft have been recorded at their respective fair values under the

purchase method of accounting for amalgamation."

15.3. 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 Megasoft Ltd., during

the year in question and the financial results of the erstwhile company

stand included in the overall profitability of this company, respectfully

following the precedents, we hold that this company cannot be

considered as a comparable.

22 ITA No.5857/Del/2011

(x) Persistent Systems.

16.1. Here again, we find that there have been certain acquisitions

which is evident from the Annual report of this company, that is

available on page 781 of the paper book. Note no. 6 states that : `The

company received sanction from the Bombay High Court, Mumbai and

Bombay High Court, Goa Bench for amalgamation of ControlNet

(India) Pvt. Ltd. (ControlNet) effective from April 1, 2006. Pursuant to

this, all assets, liabilities and losses of ControlNet are merged with the

assets, liabilities and reserves of the Company with effect from April 1,

2006 by following "pooling of interest method" as prescribed in

Accounting Standard 14 (AS-14) as issued by the Institute of Chartered

Accountants of India.' Thus, the acquisition took place in this company

during the relevant to the assessment year under consideration.

Following the reasons given above while discussing the case of

Megasoft Ltd., we order for the exclusion of this company from the list

of comparables.

23 ITA No.5857/Del/2011

(xi) Sasken Communication Technologies Ltd.

17.1. Here again, we find that the financial results of this company

stand distorted due to certain acquisitions made by it during the relevant

year. It is evident from the Annual report of this company, which is

available on page 868 and 924 of the paper book. It has been

categorically mentioned in its Annual report that during the year this

company acquired Botnia Hitech Oy, Finland and its two wholly owned

subsidiaries. It has also been stated in the same para that during the year

the company also successfully completed three mergers, namely, Sasken

Network Systems Ltd., and Integrated Softtech Solutions Pvt. Ltd., the

two Indian based wholly owned subsidiaries which merged with the

assessee. It also transpires from this Annual report that the companies

getting merged with the assessee company also provided software

services focused on telecom operating systems. Thus, it is abundantly

patent that the segmental results taken by the TPO of this company have

been influenced by the mergers and acquisitions taken place during the

year, thereby making such financial results as incomparable. Following

24 ITA No.5857/Del/2011

the reason given above, we order for the exclusion of this company from

the list of comparables.

(xii) Tata Elxsi Ltd. (Seg.)

18.1. The TPO included this company in the list of comparables

notwithstanding the assessee's objections about its incomparability.

18.2. Having heard both the sides on this issue and perused the

relevant material on record, it is noticed that the TPO has taken

'software development services' segment of this company for the

purposes of inclusion in the list of comparables. This segment

comprises of three sub-segments, namely, i) product design services, ii)

engineering design services and iii) visual computing labs. This

information is given on page 118 of the TPO's order. It is this 'Software

development and services' segment in entirety, comprising the above

three sub-segments, which has been considered as comparable. When

we consider the description of the three sub-segments, namely, product

design services, engineering design services and visual computing labs,

it turns out that the same falls into the software development services

25 ITA No.5857/Del/2011

segment and not the software non-development services segment. Since

the assessee is engaged in providing software non-development services

to its AEs, this segment of Tata Elxsi Ltd., being that of software

development services' cannot be considered as comparable. It is,

therefore, directed to be eliminated from the list of comparables.

(xiii) Wipro Ltd. (Seg.)

19.1. The TPO included segment of Wipro Ltd. in the list of

comparables by rejecting the assessee's contention that it was

functionally different.

19.2. After considering the rival submissions and perusing the

relevant material on record, we find that the TPO has himself mentioned

on page 123 of his order that: "the IT services segment of the company

is into software development services and segmental details are

available, the company is considered as comparable at segmental level."

As the TPO has himself noticed that this company is engaged in

providing software development services as against the assessee's

26 ITA No.5857/Del/2011

provision of software non-development services, we hold that this

company cannot be considered as comparable.

20. Having considered the comparability or otherwise of the

companies disputed by the assessee in the present appeal, we set aside

the impugned order and remit the matter to the file of AO/TPO for

determining the ALP of the international transactions under this segment

afresh, in accordance with our above observations. Needless to say, the

assessee will be allowed a reasonable opportunity of being heard.

21. The next issue argued by the ld. AR is about not approving the use

of multiple year data of comparables. The assessee adopted multiple

year data of comparable companies, which the TPO modified only to the

current year's data. Rule 10B(4) provides that : `The data to be used in

analysing the comparability of an uncontrolled transaction with an

international transaction shall be the data relating to the financial year in

which the international transaction has been entered into'. Nothing has

been placed on record by the ld. AR to demonstrate that the case falls

under proviso to rule 10B(4), which provides that the data relating to a

27 ITA No.5857/Del/2011

period not being more than two years prior to such financial year may

also be considered if such data reveals facts which could have an

influence on the determination of transfer prices in relation to the

transactions being compared. In view of a plethora of decisions

including the Special Bench decision in the case of Aztech Software

Technologies Ltd. (2007) 107 ITD 141 (Bang.) (SB), we approve the

view taken by the authorities below in considering only the current

year's data. This ground is not allowed.

22. Another issue raised by the assessee is against the seeking of

information u/s 133(6) of the Act by the TPO from the companies

considered as comparable. Here again, we do not find any embargo on

the powers of the TPO in seeking the relevant information from the

companies. Unless germane information is obtained, we fail to see as to

how the TPO can be sure about the comparability or otherwise of a

particular company with the assessee. However, the rider is that such

information obtained from the companies must be confronted to the

assessee before using against it. As the needful has been done by the

28 ITA No.5857/Del/2011

TPO, we see no reason to disturb the view taken by the TPO in

collecting information u/s 133(6) of the Act.

23. No specific argument was advanced in respect of the last issue

about the risk adjustment. We, therefore, uphold the impugned order on

this issue.

24. In the result, the appeal is partly allowed for statistical purposes.

The order pronounced in the open court on 20.02.2015.

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

Dated, 20th February, 2015. dk Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT (A) 5. DR, ITAT

AR, ITAT, NEW DELHI.

29