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Income Tax Appellate Tribunal, ‘J‘ BENCH
Before: SHRI AMIT SHUKLA & SHRI, M.BALAGANESH
आदेश / O R D E R PER M. BALAGANESH (A.M):
This appeal in A.Y.2016-17 preferred by the order against the final assessment order passed by the Assessing Officer dated 26/03/2021 u/s.143(3) r.w.s. 144C(13) of the Income Tax Act, hereinafter referred to as Act, pursuant to the directions of the ld. Dispute Resolution Panel (DRP in short) u/s.144C(5) of the Act dated 29/10/2020 for the A.Y.2016-17.
The only effective issue to be decided in this appeal is as to whether the ld. AO was justified in making the transfer pricing adjustment in his final assessment order in the sum of Rs.1,14,91,999/- in respect of international transaction of provision of software development services by the assessee to the Associated Enterprises (AE) in the facts and circumstances of the instant case.
We have heard rival submissions and perused the materials available on record. Zedo (India) Pvt. Ltd was incorporated in September 2002 and registered under the Indian Companies Act 1956. Its software development centre is in Andheri, Mumbai. It is engaged in the development of software Zedo Inc and providing digital advertising related services to third party client in India. The assessee had rendered software development services to its AE and the said international transaction is benchmarked by the assessee using Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) by applying Operating Profit / Total Cost (OP/TC) as the Profit Level Indicator (PLI) in its Transfer Pricing Study Report (TPSR). The assessee used six comparables in its TPSR and compared its PLI of 15.04% with the comparable margins ranging from 9.01% to 15%. The assessee conducted search process and identified the following comparables together with its margins as under:-
S.No. Company Name 3 year weighted unadjusted Average 1. CG-VAK Software & Exports Ltd. 9.01 2 Otco International Ltd. 15.00 3. RS Software (India) Ltd. 20.26 4. Sasken Communications Technologies Ltd. 5.97 5. TVS Infotech 3.18 6. R Systems International Ltd. 25.51 Median 12.00 35th Percentile 9.01 65th Percentile 15.00 3.1. The assessee concluded that since NCP of assessee of 15.04% is higher than the median of the data set i.e. 12%, its transaction was concluded to be at arm’s length. Since the turn over of the assessee from provision of software development services was from export activity, the ld. TPO observed that assessee ought to have used a filter in respect of export revenue more than 75% of sales. He also observed that profit margins of companies engaged in domestic sales and those engaged in export sales would be different together with the level of computation prevailing thereon. The final set of comparables chosen by the Revenue pursuant to the directions of the ld. DRP are as under:-
Sr. No. Name of Comparable OP/OC (i) CG-VAK Software and Exports Ltd. 14.05% (ii) Nihilent Analytics Ltd. 31.60% (iii) R.S. Software India Ltd. 20.92% 3.2. Accordingly, the ld. TPO / ld. AO made an addition of Rs.1,14,91,999/- in the final assessment order as the adjustment to arm’s length price in respect of international transaction of provision of software development services by the assessee to its AE.
3.3. Being aggrieved, the assessee is in appeal before us seeking following prayers:-
(a) Correction of margins adopted by the ld. TPO in the case of CG-VAK Software and Exports Ltd. (b) Exclusion of Nihilent Anaytics Ltd. as functionally not comparable with that of assessee and also not comparable in the absence of segmental data. (c) Inclusion of Sasken Communications Technologies Ltd. and TVS Infotech Ltd by not applying export filter as was done by the ld. TPO.
3.4. At the outset, we find the comparable company R.S. Software India Ltd. had been included by the assessee as a good comparable in its TPSR and the same is also accepted by the ld. TPO. Hence, there is no dispute with regard to inclusion of this comparable.
3.5. With regard to correction of margin adopted by the ld. TPO with case of CG-VAK Software and Exports Ltd, the ld. TPO adopted the margin of this comparable at 14.05%. This was arrived by the Revenue by not considering provision for doubtful debts as operating expenses. The ld. AR before us pleaded that if provision for doubtful debts is considered as operating expenses then, the revised margin of this comparable would be 9.43%. Now, the question that arises for our consideration is as to whether provision for doubtful debts could be considered as operating expense. Admittedly, the provision for doubtful debts had arose in respect of sales made by the assessee. The audited financial statements for the year ended 31/03/2015 are enclosed in pages 108-123 of the paper book, Volume 2 filed before us. From the perusal of the same, we find that the said company had debited a sum of Rs.43,98,574/- on account of provision for doubtful debts under ‘operating expenses’ in its profit and loss account. We also find from the schedule of trade receivables in the balance sheet of this comparable, there is a note attached towards provision for doubtful debts as under:- iii.Provision for Doubtful Debts: The Company evaluates all customer dues for collectability. The need for provisions is assessed based on various factors including collectability, present market indicators pertaining to the relevant country which could affect the ability to settle. Provisions are made for debtor dues exceeding one year or longer from the date of invoice as at the date of the balance sheet. The company pursues all recovery of dues irrespective of provisions made.
3.6. Based on this note, the ld. DR vehemently argued that the said comparable had been making provision for doubtful debts only in respect of dues exceeding one year or longer from the date of invoice as on the date of balance sheet. Hence, it goes to prove that provision for doubtful debts has been made in respect of sales made in earlier years and accordingly, the said provision does not relate or pertain to the operating results of the year. Hence, the ld. TPO was justified in excluding the provision for doubtful debts as non-operational expenses while working out the margins of this comparable. He also placed reliance on the decision of Chennai Tribunal in the case of Doowon Automotive Systems India (P.) Ltd. vs. Asst. Commissioner of Income Tax (OSD) reported in 135 taxmann.com 197 (Chennai Tribunal). We have gone through the said judgement and we find that provision for doubtful debts has been considered as non-operating expenses on the premise that the said provision has been made for unascertained liabilities. In this regard, we hold that provision for doubtful debts can never be an unascertained liability. The management of any company would by its experience would be able to judge the probable irrecoverability of the dues in respect of sales made by it to its customers depending upon the situation in which customers of the company are placed and depending upon efforts taken by the company to recover the dues from such customers, the management of the company would decide to make the provision for doubtful debts by debiting its profit and loss account and reduce the same from the gross value of sundry debtors in the balance sheet. As admittedly, the said provision for doubtful debts had arose in respect of sales made by the assessee. In our considered opinion, the said provision could only fall under the ambit of operational expenses of any company and thereby would have to be included while computing the operating margins of the company. Hence, the said provision for doubtful debts would be clearly ascertained liability. In fact, the Hon’ble Supreme Court in the case of Vijaya Bank vs. CIT reported in 323 ITR 166 had indeed held that provision for doubtful debts once reduced from the gross value of the debtors would tantamount to actual write off of the debtors and hence, would be allowed as deduction. This conclusion goes to prove that the said provision for doubtful debts can always be only an ascertained liability arising in the normal course of business of any assessee. This proposition has not been considered in the decision of Chennai Tribunal referred to supra and hence, we are not inclined to follow the same. The issue as to whether the provision for doubtful debts could be considered as an operating expenses was subject matter of adjudication by the Co- ordinate Bench of the Pune Tribunal in the case of Extentia Information Technology (P) Ltd vs. Dy. Commissioner of Income Tax, Circle-1(2), Pune reported in 116 taxmann.com 567 wherein it was held as under:-
“34. Having discussed the inclusion or otherwise of the above referred three companies in the list of comparables, now we proceed to determine the correctness of the profit margin of two comparables, namely, CG-VAK Software and Exports Ltd. and Exilant Technologies Ltd.
The assessee has not disputed the per se inclusion of these two companies in the list of comparables. The only quarrel is on the computation of their OP/OC. To be precise, the question is about the treatment given by the authorities below to the Provision for bad and doubtful debts as non-operating. The TPO while calculating the profit margin of CG VAK Software and Exports Ltd., reduced the amount of Provision for bad debts at Rs.39,97,218/- from total expenses for working out the OP/OC at 18.40%. The view point of the assessee is that the Provision for bad and doubtful debts ought not have been reduced from operating expenses.
We have gone through the Annual report of this company whose copy has been provided on behalf of the assessee. It can be seen from the 'Expenditure' under the head "Operating and other expenses" at Rs.1.87 crore that there is an item of "Provision for doubtful debts" at Rs.39,97,218/- included in it. The provision for doubtful debts has a direct relation with the sales made by a company. In the same way in which the amount of sales is an item of operating revenue, the amount of provision for doubtful debts, having direct link with the sales, is also an item of operating expense. In our considered opinion, Provision for doubtful debts cannot be treated as a non-operating expense. We, therefore, direct to include the amount of Provision for doubtful debts in the expense side of this company for calculating the profit margin. Similar is the position regarding Exilant Technologies. Provision for bad and doubtful debts of this company stands at Rs.81,91,798/- which can be found in the detail of Other expenses. The TPO while calculating the profit margin of this company reduced such an amount. Following the reasoning given hereinabove, we direct to include Reserve for doubtful debts as an item of operating expenses in calculating the operating profit margin of this company.”
3.7. In any case, at the time of recovery of debts from the parties for whom provision for doubtful debts has already been made by the comparable, the same would be offered to tax by the said comparable as bad debts recovered and that would form part of the operating revenue of the said comparable in that year. Hence, in view of the aforesaid observations and respectfully following the Co-ordinate Bench of the Tribunal referred to supra, we direct the ld. TPO / ld. AO to re-work the operating margin of the comparable CG-VAK Software and Exports Ltd. by including provision for doubtful debts as operating expenses.
(b) Exclusion of Nihilent Anaytics Ltd. 3.8. We find from perusal of the financial statements of ICRA Techno Analytics Ltd (now known as Nihilent Analytics Ltd) for the year ended 31/03/2016, the said comparable company has got huge asset base of Rs.14.14 Crores. The company could be considered as a good comparable with that of the assessee company for the purpose of benchmarking its international transactions based on FAR analysis i.e. functions performed, assets employed and risks undertaken. In the instant case, the said comparable has got an asset base of Rs.14.14 Crores whereas the assessee company before us has got an asset base of only Rs.1.34 Crores. It is elementary that company having huge asset base would be able to command a better margin on the prices of goods or services rendered based on huge economies of scale and volume of operations. Hence, based on one of the parameters of FAR analysis i.e. assets employed, we hold that this comparable would not be a good comparable with that of the assessee company. Hence, the ld. TPO / AO is directed to exclude the same from the final set of comparables while re-working the ALP of the international transaction.
(c) Inclusion of Sasken Communications and Technologies Ltd. and TVS Infotech Ltd.
3.9. From the perusal of the financial statements of the assessee as on 31/03/2016, we find that assessee had shown receipts from software development charges (exports) in the sum of Rs.18,48,64,844/- in its profit and loss account. From the related party transactions disclosed by the assessee in the financial statements in accordance with Accounting Standard-18 issued by the Institute of Chartered Accountants of India (ICAI), we find that assessee had shown the very same software development service charges of Rs. 18,48,64,844/- to have received from its AE i.e. Zedo Inc. This goes to prove that the entire Revenue from software development services had arose to the assessee from exports. In this scenario, there is absolutely nothing wrong in ld. TPO applying a filter of export Revenue more than 75% of sales for accepting or rejecting a particular comparable. We find from the perusal of the financial statements of Sasken Communications and Technologies Ltd, its export turnover contributed 70.27% of its total turnover. Hence, the ld. TPO was justified in rejecting the same as a good comparable with that of the assessee company based on export filter application. Similarly, from the perusal of the financial statements of TVS Infotech Ltd as on 31/03/2016, its export turnover of Rs.1316,67,746/- worked out to 56.84% of total turnover of Rs.2316,46,376/-.
3.10. With regard to yet another argument advanced by the ld. AR before us that there is no sanctity of applying 75% is concerned, we find that the Hon’ble High Court in the case of Pr. Commissioner of Income Tax vs. Convergys India Services Pvt. Ltd., in 142 taxmann.com 276 (Delhi) has already approved the applicability of 75% export filter. Apparently this is done primarily to exclude predominantly domestic companies which cannot be compared with the companies having major earning from exports. This is because economic circumstances of such companies would be different which is also recognised by Rule 10B(2) of the Income Tax Rules 1962. In view of the above, we hold that the ld.TPO /ld. AO was justified in excluding TVS Infotech Ltd. from the list of comparables chosen by the assessee.
3.11. The ld.TPO is directed to re-work the arm’s length price of international transaction in view of the aforesaid observations. Accordingly, the ground No. 1 raised by the assessee is partly allowed for statistical purposes.
The ground No.2 raised by the assessee is challenging the levy of interest u/s.234B of the Act which is consequential in nature and does not require any specific adjudication.
In the result, appeal of the assessee is partly allowed for statistical purposes.
Order pronounced on 20/01/2023 by way of proper mentioning in the notice board.