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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI N. V. VASUDEVAN & MS. PADMAVATHY S
IN THE INCOME TAX APPELLATE TRIBUNAL “B” BENCH : BANGALORE BEFORE SHRI N. V. VASUDEVAN, VICE PRESIDENT AND MS. PADMAVATHY S, ACCOUNTANT MEMBER IT(TP)A No.49/Bang/2019 Assessment Year : 2014-15 M/s. Harman Connected Services Vs. Deputy Commissioner of Corporation India Private Limited, Income Tax, 4A, Jupiter, Prestige Technology Park, Circle - 3(1)(2), Sarjapur, Marathahalli Road, Bengaluru. Kadubeesanahalli Village, Bengaluru – 560 103. PAN: AACCH 1585 J APPELLANT RESPONDENT Assessee by : Shri. T. Suryanarayana, Senior Advocate Revenue by : Dr. Manjunath Karkihalli, CIT(DR)(ITAT), Bengaluru. Date of hearing : 27.06.2022 Date of Pronouncement : 30.06.2022 O R D E R Per N V Vasudevan, Vice President
This is an appeal by the assessee against the final Order of Assessment dated 10.10.2018 passed by the DCIT, Circle – 3(1)(2), Bengaluru, under section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (hereinafter called ‘the Act’), relating to Assessment Year 2014-15. 2. The assessee is a subsidiary of Harman International Industries Inc., USA and is engaged in rendering services in the nature of SWD services and related professional services to Harman Group companies. The SWD services rendered by the assessee include software coding, testing,
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integration, release and post release support. The assessee is also engaged in trading of the infotainment systems, where the assessee purchases professional loudspeakers, audio special effect equipment, audio mixing consolers, consumer electronics and microphones and headphones from its Associate Enterprises (AEs) to be sold to domestic third-party customers. 3. During the previous year relevant to Assessment Year 2014-15, the assessee, inter alia, provided SWD services to its AEs for a consideration of Rs. 102,38,70,343/- and earned a net cost-plus mark-up of 19.64%. The assessee also purchased goods from its AEs for a consideration of Rs. 64,41,74,821/- for trading segment. In the trading segment, the assessee earned a gross profit margin of Rs. 24.94%. 4. On a reference made by the Assessing Officer (‘AO’) to the TPO, the TPO passed an order dated 31.10.2017 under Section 92CA of the Income-tax Act, 1961 (‘the Act’) determining a TP adjustment of Rs.8,34,81,655/- in respect of the SWD services segment and Rs.11,36,10,183/- in the trading segment, aggregating to total TP adjustment of Rs.19,70,91,838/-. 5. Initially, a draft assessment order dated 15.12.2017 came to be passed by the AO in which, inter alia, the aforesaid TP adjustment was incorporated. The AO also proposed to restrict the depreciation claimed on computer software at 25% as opposed to 60% claimed by the assessee and proposed to disallow the provision for warranty in excess of the utilization. 6. Aggrieved, the assessee filed its objections before the DRP which, vide its directions dated 24.09.2018, rejected the assessee’s objections to a large extent while granting marginal relief.
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Pursuant to the directions of the DRP, the AO passed the final assessment order dated 30.10.2018 in which the TP adjustment was reworked to Rs. 16,75,21,761/-. The other additions made on corporate tax were sustained. 8. Aggrieved by the final assessment order, the assessee has filed the appeal before this Hon’ble Tribunal. We will deal with the addition made on account of determination of Arm’s Length Price (ALP) in the SWD services segment, trading segment and thereafter the Corporate Tax issues raised by the assessee in its appeal, in that order.
SWD SERVICES SEGMENT OF THE ASSESSEE The Net mark-up on cost earned by the assessee (as reflected in the TP Order):
Operating Income Rs. 1,02,38,70,343/- Operating Cost Rs.85,57,58,886/- Operating Profit (Op. Income – Op. Cost) Rs.16,80,84,457/- Operating/Net cost plus mark-up (‘OP/OC’) 19.64%
Both the assessee and the TPO chose Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for determining ALP. The profit level indicator chosen for the purpose of comparing assessee’s margin with that of comparable companies was OP/OC. The assessee’s OP/OC was 19.64%. The assessee chose 9 comparable companies whose average arithmetic mean profit margin was 14.22%. The assessee therefore claimed that the price received from the AE was to be treated as at arm’s length under section 92 of the Act. The TOP accepted 2 out of 9 comparable companies chosen by the assessee and he on his own
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identified 6 other comparable companies. The TPO determined ALP as follows: Comparables selected by the TPO and their arithmetic mean:
Sl. No. Name of the Company OP/OC (WC-unadj) (in %) 1 Infosys Ltd. 36.13 2 Larsen & Toubro Infotech Ltd. 24.61 3 Mindtree Ltd. 20.43 4 Persistent Systems Ltd. 35.10 5 R S Software (India) Ltd. 24.25 6 Cigniti Technologies Ltd. 27.62 7 SQS India Ltd. 22.37 8 Thirdware Solution Ltd. 44.68 Arithmetic mean 29.40 Computation of arm’s length price by the TPO and the adjustment made: Arm’s length mean Mark-up 29.40% Operating Cost Rs. 85,57,58,886/- Arm’s Length Price @129.40% of cost Rs.1,10,73,51,998/- Price Received Rs.1,02,38,70,343/- Shortfall being adjustment u/s. 92CA of the Act Rs.8,34,81,655/- 11. The addition of Rs.8,34,81,655/- suggested by the TPO as short fall in the ALP was added to the total income by the AO in the Draft Order of Assessment. The assessee filed objections before the Dispute Resolution Panel (DRP) against the Draft Order of Assessment under section 144C of the Act.
The DRP issued the following directions to the TPO:
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The following companies were directed by the DRP to be excluded from the list of comparables by accepting the contentions of the assessee:
(i) Cigniti Technologies Ltd.; and (ii) SQS India Ltd.
The DRP, on holding that Sagarsoft India Ltd. is functionally comparable to the assessee, directed the TPO to verify if the company passes other filters applied by him, and if so, to include it in the final list of comparables. The other contentions of the assessee seeking the exclusion of incomparable companies and inclusion of comparable companies came to be rejected.
The DRP upheld the action of the TPO in not granting any adjustment towards the differences in working capital (“WC Adjustment”) of the assessee and the comparable companies. The AO passed the impugned final assessment order in line with the directions of the DRP in which the SWD services TP adjustment was reworked to Rs.5,49,84,884/-. Aggrieved by the aforesaid addition, the assessee is in appeal before the Tribunal. Briefly, the grounds in the appeal which are being pressed are as follows:
(i) That the DRP erred in upholding the inclusion of:
(a) Infosys Ltd.; (Ground No. 1(f)) (b) Larsen and Toubro Infotech Ltd.; (Ground No. 1(g)); (c) Persistent Systems Ltd.; (Ground No. 1(i)); and (d) Thirdware Solutions Ltd. (Ground No. 1(k))
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(ii) That the DRP erred in upholding the exclusion Akshay Software Technologies Ltd., and Maveric Systems Ltd. (Ground Nos. 1(l) and (n)).
(iii) That the lower authorities erred in not granting WC Adjustment (Ground No. 1(e)).
As far as ground Nos. 1(f), (g), (i) and (k) and Ground No. 8 in the appeal are concerned, the assessee in these grounds seeks exclusion of Infosys Ltd., Larsen and Toubro Infotech Ltd., Persistent Systems Ltd. and Thirdware Solutions Ltd. from the list of comparables.
(a) Infosys Ltd. (‘Infosys’):
This company earns income from both rendering software services and development of products. Despite rendering diverse services, there are no segmental details in respect of the services rendered. The company provides end-to-end business solutions like business consulting, technology, engineering and outsourcing services. In addition, the company offers software products and platforms for banking industry. The company also invests in products which helped the company establish itself as a credible IP Owner. The company owns seven Edge products/platforms and six other product based solutions. The company leverages on its premium banking solution ‘Finnacle ®’. The company owns significant brand value and focuses on immense brand building. For this purpose, it incurs significant brand building expenses, which goes to help the company have a premium pricing for its services. The company also heavily focuses on research and development activity and incurs significant expenditure for this account.
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Further, the company operates in diversified markets. Thus, the services rendered by the company are not functionally comparable to the routine SWD services rendered by the assessee.
We find that it is submitted that this company is consistently excluded from the final list of comparables in cases of other assessees who are placed similar to the assessee. Reliance in this regard is placed on the decisions of this Hon’ble Tribunal in the cases of LG Soft India Pvt. Ltd. v. DCIT (Order dated 28.05.2019 passed by this Hon’ble Tribunal in IT(TP)A No. 3122/Bang/2018 for the assessment year 2014-15), EMC Software and Services India Pvt. Ltd. v. JCIT (Order dated 18.12.2019 passed in IT(TP)A No. 3375/Bang/2018) and Brocade Communications Systems Pvt. Ltd. v. DCIT (Order dated 19.02.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 79/Bang/2019), wherein in the cases of the assessee which is similar to the assessee, the company was directed to be excluded from the final set of comparables. In view of the above, we direct exclusion of this company from the final list of comparables.
(b) Larsen and Toubro Infotech Ltd. (‘L&T’) –
This company deals with software products and renders aftermarket service management services, integrated Information Technology (‘IT’) service management Software as a Solution, business process management implementation services, cloud computing, consulting, enterprise integration, geographical information system and infrastructure management services. Despite rendering these diverse services, the segmental details of the various services and products are not available. The company’s business segments are divided into service cluster, industrial cluster and telecom
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business. In the absence of segmental data being made available as regards the diverse services, it is not possible to determine whether the company passes the filters applied by the TPO. Therefore, the company ought to be excluded. Further, the company is a market leader and thus enjoys significant benefits on account of ownership of marketing intangibles, intellectual property rights and business rights. Also, in addition to the above, the company owns proprietary software products which are developed in-house. Accordingly, it was submitted that L&T is a product company having significant intangibles and is thus not comparable to captive software development service providers such as the assessee who does not own any significant or non-routine intangibles. Further, L&T enjoys significant brand value. As a result of this high brand value, the company enjoys a high bargaining power in the market.
We find that this company is consistently excluded from the final list of comparables in cases of assessees which are placed similar to the assessee. Reliance in this regard is placed on the decisions of this Hon’ble Tribunal in the cases of LG Soft India Pvt. Ltd. v. DCIT (Order dated 27.09.2019 passed by this Hon’ble Tribunal in M.P. No. 95/Bang/2019 in IT(TP)A No. 3122/Bang/2018 for the assessment year 2014-15), EMC Software and Services India Pvt. Ltd. v. JCIT (Order dated 18.12.2019 passed in IT(TP)A No. 3375/Bang/2018) and Brocade Communications Systems Pvt. Ltd. v. DCIT (Order dated 19.02.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 79/Bang/2019), wherein in the cases of the assessee which is similar to the assessee, the company was directed to be excluded. We therefore direct that this company should be excluded from the final list of comparables.
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(c) Persistent Systems Ltd. (‘Persistent’) –
As far as exclusion of this company as a comparable company is concerned, it is submitted that this company is functionally dissimilar as it is engaged in rendering IT services and in the development of software products without there being separate segmental information disclosed in its Annual Report for such activities. In the absence of segmental data being made available as regards the IT services and products offered by it, it is not possible to determine whether the company passes the filters applied by the TPO. The operations of the company predominantly relate to providing software products, services and technology innovation covering full life cycle of product to its customers, which is completely different from the services rendered by the assessee. The company also made significant investment in intellectual property led solutions and also had a dedicated team for research and Intellectual Property (‘IP’) developments. The company also owns several IP solutions, and during the year under consideration, it acquired four products. Further, it is submitted that Persistent undertakes significant Research and Development (‘R&D’) activities and has an in-house R&D centre approved by the Department of Scientific and Industrial Research. The company also made significant investments towards R&D activities in the relevant previous year. Persistent Systems, Inc. which is a subsidiary of the company acquired CloudSquads, Inc during the year under consideration. There acquisitions constitute peculiar economic circumstances for which no adjustment can be made to Persistent’s mark-up to eliminate the material effects thereof.
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We find that this Tribunal in the cases of LG Soft India Pvt. Ltd. v. DCIT (Order dated 28.05.2019 passed by this Hon’ble Tribunal in IT(TP)A No. 3122/Bang/2018 for the assessment year 2014-15), EMC Software and Services India Pvt. Ltd. v. JCIT (Order dated 18.12.2019 passed in IT(TP)A No. 3375/Bang/2018) and Brocade Communications Systems Pvt. Ltd. v. DCIT (Order dated 19.02.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 79/Bang/2019), wherein in the cases of assessee which is placed similar to the assessee, this company was directed to be excluded. Consequently, we direct submitted that this company is not comparable to the assessee and ought to be excluded from the list of comparables for the above reasons.
(d) Thirdware Solutions Ltd. (‘Thirdware’):
As far as exclusion of this company as a comparable company is concerned, it is submitted that this company is an IT consulting firm engaged in consulting, design, implementing and support of enterprise applications. The company has significant capabilities in the transaction, analytics and cloud layers of enterprise application. The company also renders industry-specific solutions spanning business applications consulting, design, implementation and support. The said services are in the nature of knowledge process outsourcing services and are entirely different from the routine SWD services rendered by the assessee. The company is also engaged in development of software products and earns revenues from sale of user licenses for software applications. These diverse services are reported under one segment without any details being available as regards these services.
We find that this company is consistently excluded from the final list of comparables in cases of assessees placed similar to that of the assessee.
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Reliance in this regard is placed on the decisions of this Hon’ble Tribunal in the cases of LG Soft India Pvt. Ltd. v. DCIT (Order dated 28.05.2019 passed by this Hon’ble Tribunal in IT(TP)A No. 3122/Bang/2018 for the assessment year 2014-15), EMC Software and Services India Pvt. Ltd. v. JCIT (Order dated 18.12.2019 passed in IT(TP)A No. 3375/Bang/2018) and Brocade Communications Systems Pvt. Ltd. v. DCIT (Order dated 19.02.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 79/Bang/2019), wherein in the cases of assessee which is placed similar to the assessee, the company was directed to be excluded. Therefore, this company is directed to be excluded from the final list of comparables.
Ground Nos. 1(l), and (n) in the appeal:
Vide these grounds, the assessee is seeking inclusion of Akshay Software Technologies Ltd., and Maveric Systems Ltd.
(a) Akshay Software Technologies Ltd. (‘Akshay’):
This company was selected by the assessee as a comparable company in its TP study but came to be rejected by the TPO for the reason that the company is engaged in providing professional services, procurement, installation, implementation, support and maintenance of ERP products and services, and that the company incurred expenditure to the tune of 85% on foreign branches, which suggested that the business model adopted by the company was different from that of the assessee. The exclusion of this company came to be upheld by the DRP on the latter basis.
In this regard, it was submitted that firstly, perusal of the functions of the company listed in its annual report shows that the company is
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functionally similar to the assessee. The website of the company states that the company is engaged in rendering IT services, which are in the nature of SWD and caters to the needs of corporate bodies, banks and financial institutions. Further, it is submitted that the income from commission and sale of software licenses constitutes a meagre 0.5% of the total revenue and therefore, the same would not have any impact on the profitability of the company.
It was submitted that the action of the DRP in upholding the exclusion of this company on the basis that it incurs foreign branch expenses indicating that the business model adopted by it is different is erroneous as the TPO did not apply the onsite development filter. Therefore, the action of the DRP is arbitrarily rejecting Akshay on this count, without applying the filter at a uniform threshold across all companies is erroneous and unsustainable. In any event, it is submitted that foreign branch expenses per se do not indicate onsite development. There is no difference in the business model adopted by the company and the assessee, and without prejudice, it was submitted that the difference if any, would not have any impact on the profitability of the company.
We find that this Tribunal in the cases of EMC Software and Services India Pvt. Ltd. v. JCIT (Order dated 18.12.2019 passed in IT(TP)A No. 3375/Bang/2018) and Brocade Communications Systems Pvt. Ltd. v. DCIT (Order dated 19.02.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 79/Bang/2019), wherein in the case of an assessee which placed similar to the assessee, the comparability of this company was remanded to the
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TPO. We accordingly remand the comparability of this company with the assessee to the AO/TPO for a decision afresh.
(b) Maveric Systems Ltd. (“Maveric”):
As far as exclusion of this company is concerned, the TPO without any specific reason being assigned did not include this company as a comparable company. The DRP rejected the contention of the assessee seeking its inclusion on the basis that generally, companies with R&D expenditure of less than 3% alone were considered. In this regard, it is submitted that the action of the DRP is wholly erroneous in as much as the TPO did not apply a filter to exclude companies incurring R&D expenses. In the absence of application of a filter, rejecting a company on an arbitrary basis, more so when it is otherwise functionally comparable, is erroneous. Therefore, this company ought to be included in the final list of comparables.
We find that this Tribunal in the cases of EMC Software and Services India Pvt. Ltd. v. JCIT (Order dated 18.12.2019 passed in IT(TP)A No. 3375/Bang/2018) and Brocade Communications Systems Pvt. Ltd. v. DCIT (Order dated 19.02.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 79/Bang/2019), wherein in the case of an assessee which is placed similar to the assessee, the company was remanded to the TPO. We therefore remand the question of comparability of this company to the TPO/AO for consideration afresh.
Ground No. 1(e) projects the grievance of the assessee regarding non- granting of working capital adjustment. The assessee submits that that Rule 10B(3) of the Income-tax Rules, 1962, itself categorically provides that an
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adjustment ought to be provided for any differences in the economic factors between the tested party and the comparables. A working capital adjustment is one such adjustment which is to be applied in order to adjust for the differences between the working capital positions of the tested party and of the comparable. The learned Counsel for the assessee placed reliance on the decision of this Hon’ble Tribunal in the case of Brocade Communications Systems Pvt. Ltd. v. DCIT (Order dated 19.02.2020 passed by this Hon’ble Tribunal in IT(TP)A No. 79/Bang/2019), wherein working capital adjustment was directed to be granted.
Therefore, in the light of the settled proposition of law that necessary adjustments are to be made to the margins of comparables to give effect to the differences in the working capital positions of the tested party and of the comparables, the TPO ought to have given the assessee the benefit of the same. We direct the TPO/AO to give working capital adjustment in accordance with law.
The TPO/AO is directed to determine ALP in the SWD services segment in accordance with the directions contained in this order after affording assessee opportunity of being heard.
TRADING SEGMENT OF THE ASSESSEE 28. As far as the determination of ALP in the trading segment is concerned, the first dispute is with regard for the MAM to determine ALP. While the assessee chose Resale Price Method (RPM) as MAM in its TP study, the TPO chose TNMM as MAM.
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Gross profit earned by the assessee in the Trading Segment (as reflected in the TP study):
Revenue from operations Rs. 2,68,32,64,288/- Cost of goods consumed Rs. 2,01,39,27,787/- Gross profit Rs. 66,93,36,501/- Gross profit margin (GP/Sales) 24.94% The assessee chose the following companies as comparable companies and their arithmetic mean of profit margin was as follows:
Sl. No. Name of the company Weighted average 1. Phillips Electronics India Ltd. 35.73 2. Redington (India) Ltd. 1.21 3. Salora International Ltd. 12.41 4. Sony India Pvt. Ltd. 6.80 Arithmetic mean 14.04 Since the profit margin of the assessee was higher than that of the comparable companies, the assessee claimed that the price received from the AE should be regarded as at Arm’s Length.
The TPO did not accept assessee’s choice of MAM and he chose TNMM as MAM for the reason that data for comparability under RPM required many details that may not be available in public domain. Apart from the abve, the TPO also held that the assessee performs more functions than a normal distributor and therefore RPM is not MAM. The TPO thereafter chose the following comparable companies under TNMM.
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Sl. Name of the Company OP/Sales (in No. %) 1 Hi-Tech Systems & Services Ltd. 22.75 2 Sagittarians International Ltd. 9.73 3 Yamato Scale India Pvt. Ltd. 14.50 4 Shiv Pad Engineers Pvt. Ltd. 12.89 5 Adtech Systems Ltd. 11.82 6 Airox Technologies Pvt. Ltd. 12.57 7 Ankit Air Systems Pvt. Ltd. 11.28 8 United Telelinks (Bangalore) Pvt. Ltd. 9.30 9 Asian Feb Tec Ltd. 10.35 10 Intec Infonet Pvt. Ltd. 8.61 11 B N A Technology Consulting Ltd. 9.19 12 Micromax Informatics Ltd. 5.38 13 Keith Electronics Pvt. Ltd. 7.87 14 Usart Technologies India Pvt. Ltd. 7.08 15 I B D Electronics Pvt. Ltd. 6.27 AVERAGE MARK-UP 10.82
The TPO computed ALP as follows: Arm’s Length Mean Mark-up 10.82% Operating revenue Rs. 2,68,32,64,288/- Arm’s Length Price @89.18% of revenue Rs.2,39,29,35,092/- Price paid Rs.2,50,65,45,275/- Shortfall being adjustment u/s. 92CA Rs.11,36,10,183/-
The assessee filed objections before the DRP against the aforesaid addition suggested by the TPO which was incorporated by the AO in the Draft Order of Assessment. The DRP summarily rejected the contention of the assessee challenging the application of TNMM as opposed to RPM
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adopted by it. The DRP rejected the contentions of the assessee seeking exclusion of incomparable companies and inclusion of comparable companies, while granting marginal relief by directing exclusion of Intec Infonet Pvt. Ltd. While determining the adjustment to the trading segment, the TPO had taken into consideration the revenue of the assessee at entity level as opposed to transaction level, which the assessee objected to before the DRP. The DRP rejected the assessee’s contention and upheld the action of the TPO is determining the adjustment at entity level.
The AO passed the impugned final assessment order in line with the directions of the DRP in which the TP adjustment was reworked at Rs. 11,25,36,877/-. Aggrieved by the said addition, the assessee is in appeal before the Tribunal.
The grounds in the appeal which are being pressed are as follows:
(i) That the lower authorities erred in characterizing the assessee as a full-fledged risk bearing distributor. (Ground No. 2(a)).
(ii) That the lower authorities erred in rejecting the transfer pricing methodology adopted by the assessee in its TP study viz. RPM and erred in adopting TNMM. (Ground No. 7).
(iii) That the lower authorities erred in including:
(i) Hi-Tech Systems & Services Ltd. (Ground No. 2(b)); (ii) Sagittarians International Ltd. (Ground No. 2(c)); (iii) Yamato Scale India Pvt. Ltd. (Ground No. 2(d));
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(iv) Shiv Pad Engineers Pvt. Ltd. (Ground No. 2(e)); (v) Adtech Systems Ltd. (Ground No. 2(f)); (vi) Airox Technologies Pvt. Ltd. (Ground No. 2(g)); (vii) Ankit Air Systems Pvt. Ltd. (Ground No. 2(h)); (viii) Asian Feb Tec Ltd. (Ground No. 2(i)); (ix) B N A Technology Consulting Ltd. (Ground No. 2(j)); (x) Keith Electronics Pvt. Ltd. (Ground No. 2(k)); (xi) Usart Technologies India Pvt. Ltd. (Ground No. 2(l)); and (xii) I B D Electronics Pvt. Ltd. (Ground No. 2(m))
(iv) That the lower authorities erred in not including:
(i) Redington (India) Ltd. (Ground No. 2(n)); and
(ii) Salora International Ltd. (Ground No. 2(o)) (v) The lower authorities erred in determining the TP adjustment on the entire trading segment including transactions undertaken with unrelated enterprises (Ground No. 2(p)).
We shall take up for consideration ground No. 2(a) in the appeal re. characterization and Ground No. 7 re. application of MAM. In this regard, we find the following are the functions performed, assets employed and risks assumed by the assessee (as available in the TP study at page 586 of the paperbook) :
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(a) Functions performed: During the year, the assessee carried on trading activities for its Professional and Lifestyle verticals. A brief background of the trading activities is as under:
Professional vertical- The segment is engaged in trading of large infotainment systems and devices, which are meant for professional usage for example in cricket stadiums, movie theatres, arenas, airports etc. Examples of products sold under the PRO vertical include amplifiers. Loudspeakers, mixers, microphones, etc.
Lifestyle- The segment mostly caters to needs of small consumers involved in trading in audio system, home infotainment and multimedia devices. The assessee is engaged in trading of consumer products in its lifestyle segment through authorized distributors and channel partners.
Sales and pricing: In respect of the trading operations, the assessee purchases products mostly from its AEs for resale to domestic customers in India. The assessee does not add value to the products procured from ground companies and merely resells the same to domestic customers in India.
The assessee is responsible for determining the price at which the goods are sold to customers in India. The pricing structure is mainly dependent on the product margin. The assessee fixes its prices in accordance with a published price list. The prices may be changed to meet specific customer demands. The assessee is responsible for negotiating sales contracts.
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Product marketing and advertising: The assessee has established both direct distribution networks and network of dealers for marketing its products. The assessee also bears sales and support costs for marketing its products in India.
Inventory management:
Inventory management is performed by the assessee. The assessee reviews inventories on hand and records a provision for excess, slow moving and obsolete inventory; inventory not meeting quality standards. The assessee bears inventory cost of stocking products, which are held by its authorized dealers prior to sale.
Credit/payment terms: The assessee manages its own outstanding receivables with respect to products imported from AEs and sold in the local market. The payment terms are decided by the assessee.
Order processing: The assessee is responsible for processing orders based on requirement from distributors. The assessee is also responsible for invoicing and collecting the amount due from its distributors for the products sold.
(b) Risks assumed:
Contract Risk: In respect of the sales made to third party customers, the assessee enters into contracts with third-party customers and hence, bears the contract risk, However, in relation to import of traded goods from its AEs, the assessee does not bear any contract risk.
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Market Risk: The products imported by the assessee are sold to third party customers in India and thus, it would bear normal market risks associated with the trading of cables in the domestic market.
Price Risk: The assessee bears the price risk in relation to sale of goods to third-party customers. The AEs are not exposed to this risk.
Foreign Exchange Risk: The assessee is invoiced in foreign currency for import of finished goods. The assessee bears the foreign exchange fluctuation risk in respect of import of finished goods due to fluctuation in the foreign exchange currency rates.
Inventory Risk: The assessee bears inventory risk in relation to the products imported from AEs.
Credit Risk: The assessee bears the credit risk in respect of its sales to third party customers as it enters into contracts in its own name. The AEs are not exposed to this risk.
From a reading of the above, it is clear that the assessee undertakes routine distributor functions. However, the TPO, erroneously held that the assessee cannot be ascribed as a routine trader who merely purchases and sells goods. The TPO arrived at this erroneous conclusion by referring to so called page 13 of the TP study, wherein it is stated that the company is also responsible for installation, training services to independent third party customer and also renders additional services like after sales support and warranty services. However, it is pertinent to note that page 13 of the assessee’s TP study nowhere lists out the above contents, and more importantly, the assessee does not render any such additional services.
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Therefore, this finding of the TPO is clearly contrary to the material placed on record and is wholly baseless. In any case, even if such services were to be provided, that does not alter the function of the assessee being a distributor of products.
The laws by now are well settled that in the case of a routine distributor who does not perform any value-added services to the product. RPM is the MAM. The additional functions performed by the assessee as stated by the TPO/DRP will not make the assessee as not a trader. The true test is value addition to the product that is sold by the assessee as a trader. These is no such value addition to the product and therefore the assessee has to be regarded as a pure trade only. Since the assessee is merely a routine trader of services, without any value addition, RPM is the MAM.
As already stated, the law is well settled that MAM in the case of trader is RPM, reliance in this regard is placed on the following decisions:
(i) Textronix India (P.) Ltd. v. DCIT ([2013] 29 taxmann.com 288 (Bangalore-Trib.) at para 5); (ii) ACIT v. Akzo Nobel Car Refinishes India (P.) Ltd. ([2017] 84 taxmann.com 199 (Delhi-Trib.) at paras 6 and 7); (iii) ITO v. L’oreal India P. Ltd. (Order dated 25.04.2012 passed in ITA No. 5423/Mum/2009 at paras 18 and 19) which was upheld by the Hon’ble High Court of Bombay (reported in [2015] 53 taxmann.com 432 (Bombay)); (iv) DCIT v. A. O. Smith India Water Heating (P.) Ltd. ([2018] 97 taxmann.com 218 (Bangalore - Trib.) at paras 16-20;
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(v) PCIT v. Matrix Cellular International Services (P.) Ltd. ([2018] 90 taxmann.com 54 (Delhi) at para 12); (vi) Horiba India (P.) Ltd. v. DCIT ([2017] 81 taxmann.com 209 (Delhi - Trib.) at para 12)
Further, reliance is placed on the decision of the Hon’ble Mumbai Bench of the Tribunal in the case of Bristol Myers Squibb India Private Limited v. DCIT (Order dated 28.08.2019 passed in ITA No. 1969/Mum/2014), wherein it was held that, “Thus, if the ALP of a transaction can be determined by applying any of the direct methods like CUP, RPM, CPM then they should be given a preference, and it is only where the said traditional methods have been rendered inapplicable that under such circumstances TNMM should be resorted to”.
The TPO’s conclusion that complete information as regards comparable distribution is unavailable in public domain is also baseless and all information required for application of RPM is available in the public domain. Therefore, we hold that the assessee is a mere distributor and the method applied by it ought to be adopted. Pertinently, in the assessee’s own case for assessment years 2015-16 and 2016-17, the TPO accepted the method applied by the assessee in the trading segment. Since the facts and circumstances involved in the year under consideration remain the same in the assessment years 2015-16 and 2016-17, the assessee’s method ought to be accepted and is directed to be accepted. We remand the question of determination of ALP to the TPO/AO for fresh consideration and opting RPM as MAM. In view of the above conclusion the other issues raised by
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the assessee on determination of ALP under TNMM becomes academic and hence not decided.
Corporate tax issues arising in the appeal: Ground No. 11 re. restriction of depreciation claimed on computer software: In this ground, the assessee is challenging the action of the Revenue in restricting the depreciation claimed on computer software at 25% instead of 60%, by holding that ‘computer software’ is license eligible for depreciation at the rate of 25%. The Respondent arrived at this conclusion by holding that under Appendix-1 to the Income-tax Rules, 1962 (“the Rules”), what is eligible for depreciation at the rate of 60% is ‘computer including computer software’ indicating that the computer software which is eligible for depreciation at 60% is the software which is embedded in the computer. The DRP upheld the action of the AO.
It was submitted before us that the interpretation adopted by the lower authorities is contrary to the provisions of the Rules. It was submitted that Note No. 7 to Appendix-1 defines the term ‘computer software’, in terms of which, a computer software means any computer program recorded on any disc, tape, perforated media or other information storage device. The definition does not make any distinction between a software embedded in a computer or otherwise. In fact, the medium of storage of the software not being restricted to a computer itself demonstrates that any computer software is eligible for depreciation at 60%. Further, a computer software cannot be used in isolation and independent of a computer. Reliance in this regard was placed on the following decisions:
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- Computer Age Management Services Pvt. Ltd. v. The DCIT (Order dated 14.12.2018 passed by the Chennai Bench of this Hon’ble Tribunal in ITA Nos. 1140-1142/Chny/2018.; - ACIT v. Voltamp Transformers Ltd. (Order dated 22.03.2013 passed by the Delhi Bench of this Hon’ble Tribunal in ITA No. 1676/Ahd/2012; - ACIT v. i-Flex Solutions Ltd. ([2010] 42 SOT 7 (MUM.)(URO)), which came to be affirmed by the Hon’ble High Court of Bombay in CIT v. i-Flex Solutions Ltd. ([2014] 46 taxmann.com 88 (Bombay)); and - ACIT v. Zydus Infrastructure (P.) Ltd. ([2016] 72 taxmann.com 199 (Ahmedabad - Trib.)).
We have considered the submission and we find that the ITAT, Chennai, in the case of Computer Age Management Services (supra) dealt with identical issue and has held as follows:
“18. Arguing on fourth common ground, which is on restriction of the claim of depreciation on software, ld. Authorised Representative submitted that ld. Assessing Officer had restricted the depreciation to 25% against 60% available for computer systems. According to ld. Authorised Representative, what was acquired were only software license which enabled the assessee to use the applications. According to him, by virtue of definition of software given in New Appendix I of Income Tax Rules, computers including computer software were eligible for 60% depreciation. 19. Per contra, ld. Departmental Representative submitted that what were acquired by the assessee was only a licence and could at the best be considered as an intangible asset. Thus, according to him, lower authorities were justified in restricting the depreciation claim to 25%.
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We have considered the rival contentions and perused the orders of the authorities below. Nature of items on which assessee had claimed depreciation @60% are listed hereunder:- Sl. No Description of the Asset 1 Sco Unix 6.0 Enterprise User License 2 Server Licenses and customization charges for insurance process. 3 Server Licenses and customization charges for insurance process. 4 PI Sql Developer/ Single User license 5 PI Sql Developer/ Single User license 6 Vfox Pro 9.0 Office Std 2010 licence 7 Dynamics Nav Final Milestone license 8 Server licenses and customization charges for insurance process 9 Server licenses and customization charges for insurance process 10 Citrus software license basic server licenses 1 11 Server licenses and customization charges for insurance process 12 Server License 13 Server License 14 Server License 15 Server License 16 Cisco-firewall license 17 Window 2008 R2 standard license
What we find from the above description is that all these were nothing but items in the nature software or software applications. Entry No.5 coming in III of Part A in New Appendix I clearly says that computer included computer software. Note 7 of the Appendix, defines computer software as any computer programme recorded in any information storage device. We are therefore of the opinion that assessee was eligible to claim depreciation at the rate of 60% on the above items. Orders of the lower authorities on this issue are set aside and the claim is allowed. Ground No.4 of the assessee stands allowed.”
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In view of the above, depreciation at 60% is directed to be granted.
Ground No. 12 re. disallowance of provision for warranty: During the year under consideration, the assessee created a provision for warranty for an amount of Rs. 2,16,40,265/- by debiting the Profit and Loss account and crediting the Provision for Warranty account in the Balance Sheet. The assessee reduces/debits the provision account in the Balance Sheet with the amount of warranty actually utilized by the customers. For the year under consideration the assessee has a brought forward provision from previous year of Rs. 50,45,729/- and the current year provision when aggregated resulted in the total provision of Rs. 2,66,85,994/- The assessee utilized Rs. 74,30,802/- out of this provision and the closing balance of the provision is reflected in the Balance Sheet of the assessee as of 31.03.2014. The assessee creates the provision at 0.6% of sales, which is based on past trend and historical evidence. For the purpose of arriving at this 0.6%, the assessee has considered the actual warranty utilized by the customers during the entire warranty period which may vary depending on the product from 1 year to 6 years. The assessee submitted the details of provision created and utilized year on year as per the Balance Sheet before the AO which is produced as under:
(Amounts in Rs.)
Particulars FY 2012-13 FY 2013- FY 2014-15 FY 2015-16 14 Details of Covered Sales Covered Sales % increase as compared 303% 50% 12% to previous year Details of Warranty
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Provisions Opening as on April 1 Additions during the year - 5,045,729 19,255,192 39,213,342 Utilization during the 5,475,988 21,640,265 32,362,936 47,191,482 year Reversals during the year (430,259) (7,430,802) (12,404,786) (25,231,299)
- - - - Closing as on March 31 5,045,729 19,255,192 39,213,342 61,173,525 As per financials Under short-term - 12,677,212 17,696,144 29,487,216 provisions Under long-term 5,045,729 6,577,980 21,517,198 31,686,309 provisions Total 5,045,729 19,255,192 39,213,342 61,173,525 Breakup of Warranty Utilization made during the year Year Pertaining to sales for FY 2011-12 430,259 442,661 1,740,162 957,098 Pertaining to sales for FY 2012-13 - 1,070,053 2,209,813 2,645,128 Pertaining to sales for FY 2013-14 - 5,918,088 5,255,053 6,613,275 Pertaining to sales for FY 2014-15 - - 3,199,759 8,141,808 Pertaining to sales for FY 2015-16 - - - 6,873,988 Total 430,259 7,430,801 12,404,786 25,231,299 45. The AO disallowed the provision created in excess of the utilization, for the reason that the provision created by the assessee at a fixed percentage
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of sales does not conform to the tenets of a scientific, empirical and statistically consistent method as conceived by the Hon’ble Supreme Court in the case of Rotork Controls India (P.) Ltd. (180 Taxman 422 (SC)). The DRP upheld the action of the Respondent.
The learned Counsel for the assessee submitted that the entire basis on which the Revenue authorities proceeded to make the impugned addition i.e., on the basis that the provision created was much more than what was utilized, is erroneous. In this regard, the learned Counsel for assessee drew our attention to a letter dated 28.05.2018 filed before the DRP on 28.05.2019, wherein the assessee has explained that it sells amplifiers, loud speakers, microphones, soundcraft, Studer and signal processing equipment and these products / equipment are subject to a warranty for periods ranging upto 6 years. The provision is created on past experience and on a scientific basis at 0.6% for amplifiers loud speakers and signal processors and of 0.3% for microphones, 0.2% for sound craft and at 1.3% for Studer. The learned counsel therefore submitted that the provision created at a fixed percentage of sales is based on historical trends and empirical evidence.
The DRP had confirmed the disallowance on the basis of the chart above by stating that the amount of utilization is much less than the provision created. The panel took FY 2012-13 data where the utilization of Rs.4,30,259 was compared with the provision created for the year Rs.54,75,988 to conclude that the % of utilization is at 7.8% which does not justify the amount of provision created as a % of sales. In this regard the learned counsel submitted that the warranty provision is created for the entire period of warranty which would depend on the nature of product.
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Drawing reference from the letter submitted before the DRP, the learned counsel demonstrated for example that Amplifier has warrant of 5 years and 3 years whereas Studer has a warranty of 1 year only. Therefore the utilization of warranty for 1 year cannot be compared with provision for warranty which is created for the entire period of 6 years warranty period. The annexures to the letter submitted to the DRP give a complete break up for all the items sold by the assessee like loudspeaker, microphones etc.
The learned counsel submitted that provision of Rs.54,75,988/- for Assessment Year 2013-14 is for sales made in Assessment Year 2013-14 and that cannot be compared with actual utilization in Assessment Year 2013-14. In the table above the assessee had shown utilization against the year to which the same pertains to i.e. The sum of Rs.4,30,259 is utilized out of the provision created in the year 2011-12. This supports that contention that the amount shown as utilization will consists of utilization, which is in relation to warranty of that sales that may be for a period 1 to 6 years prior to previous year relevant to Assessment Year 2013-14. Applying the same analogy the utilization against the provision created for FY 2012-13 of Rs.54,75,988 during the course of the warranty period is Rs.10,70,053 in FY 2013-14,, Rs.22,09,813 during FY 2014-15 and Rs.26,45,128 for FY 2015- 16. The total utilization therefore amounts to Rs. 59,24,994 which is more than the provision created of Rs.54,75,988. The conclusion of the DRP that the provision created and actual utilization was less is therefore incorrect. It is thus clear from the facts of the case that the warranty provision was provided by the assessee on a scientific basis based on past experience, historical trend and satisfies the tests laid down by the Hon’ble Supreme Court in the case of Rotork Controls India (P) Ltd. 314 ITR 62 (SC) and
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therefore the disallowance of warranty provision cannot be sustained and the same is directed to be deleted.
In the result, the appeal by the assessee is partly allowed.
Pronounced in the open court on the date mentioned on the caption page.
Sd/- Sd/- (PADMAVATHY S) (N.V. VASUDEVAN) Accountant Member Vice President Bangalore, Dated: 30.06.2022. /NS/*
Copy to: 1. Assessees 2. Respondent 3. CIT 4. CIT(A) 5. DR 6. Guard file By order
Assistant Registrar, ITAT, Bangalore.