DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE- 6(1)(2), BENGALURU vs. M/S. SYMBOL TECHNOLOGIES INDIA PRIVATE LIMITED, BENGALURU

The learned Counsel for the assessee, at the time of hearing, submitted that he wishes to press for adjudication ground Nos.7 to 9. The relevant grounds raised by the assessee in its appeal reads as follows:

Ground Nos.7 and 8 raised by the assessee and grounds raised by the Revenue in its appeal are in relation to the determination of ALP in respect of an international transaction for rendering software development services by the assessee to its AE and therefore can be adjudicated together.

The assessee in engaged in the business of provision of Software Development Services (SWD services), to its wholly owned holding company. In terms of the provisions of Sec.92-A of the Act, the assessee and its wholly owned holding company were Associated Enterprises ("AEs"). In terms of Sec.92B(1) of the Act, the transaction of providing SWD Services was an “international transaction” i.e., a transaction between two or more associated enterprises, either or both of whom are non- residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. In terms of Sec.92(1) of the Act, the any income arising from an international transaction shall be computed having regard to the arm’s length price. In this appeal by the assessee, the dispute is with regard to determination of Arms’ Length Price (ALP) in respect of the international transaction of rendering SWD services to the AE.

As far as the provision of Software Development services are concerned, the assessee filed a Transfer Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The assessee selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) for the purpose of comparison. The OP/OC of the assessee was arrived at 12.05% by the assessee in its TP study. The operating income was Rs.66,88,41,798/- and the Operating Cost was Rs.59,69,34,645/-. The Operating profit (Operating income – Operating cost was Rs.7,19,07,153/-. Thus the OP/TC was arrived at 12.05%. The assessee chose companies who are engaged in providing similar services such as the assessee. The assessee identified 16 companies whose average arithmetic mean of profit margin was comparable with the Operating margin of the assessee. The assessee therefore claimed that the price it charged in the international transaction should be considered as at Arm’s Length.

The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO, accepted TNMM as the MAM and also used the same PLI for comparison i.e., OP/TC. He also selected comparable companies from database. The TPO accepted 2 companies chosen by the assessee as comparable companies. The TPO on his own identified 11 other companies as comparable with the assessee company and worked out the average arithmetic mean of the set of 13 companies profit margins as follows:

Ground No.7 raised by the Assessee and the grounds raised by the Revenue in its appeal deal with comparability of companies chosen by the TPO and that chosen by the CIT(A). The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows:

A reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market.

Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that:  None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or  Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments.

As far as comparability of the aforesaid 4 companies are concerned, the admitted factual position is that the turnover of these companies is more than Rs.200 Crores and the assessee’s turnover is only Rs. 66,88,41,798/-. The TPO excluded from the list of comparable companies chosen by the assessee in its TP study companies whose turnover was less than Rs.1 Crore. The contention of the assessee before the CIT(A) was that while the TPO excluded companies with low turnover, he failed to apply the same yardstick to exclude companies with high turnover compared to the assessee. The reason for excluding companies with low turnover was that such companies do not reflect the industry trend as their low cost to sales ratio made their results less reliable. The contention of the assessee was that there would be effect on profitability wherever there is high or low turnover and therefore companies with high turnover should also be excluded from the list of comparable companies. The CIT(A) in rejecting the contention of the Assessee primarily relied on the decision rendered by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors India Pvt.Ltd Vs. DCIT 82 Taxmann.com 167(Del), wherein it was held that high turnover ipso facto does not lead to the conclusion that a company which is otherwise comparable on FAR analysis can be excluded and that the effect of such high turnover on the margin should be seen. The CIT(A) therefore held that a company which is otherwise functionally comparable cannot be excluded only on the basis of high turnover.

On the issue of application of turnover filter, we have heard the rival submissions. The parties relied on several decisions rendered on the above issue by the various decisions of the ITAT Bangalore Benches in favour of the assessee and in favour of the Revenue, respectively. The ITAT Bangalore Bench in the case of Dell International Services India (P) Ltd. Vs. DCIT (2018) 89 Taxmann.com 44 (Bang-Trib) order dated 13.10.2017, took note of the decision of the ITAT Bangalore Bench in the case of Sysarris Software Pvt. Ltd. Vs. DCIT (2016) 67 Taxmann.com 243 (Bangalore-Trib) wherein the Tribunal after noticing the decision of the Hon’ble Delhi High Court in the case of Chryscapital (supra) and the decision to the contrary in the case of CIT Vs. Pentair Water India Pvt.Ltd., Tax Appeal No.18 of 2015 dated 16.9.2015 wherein it was held that high turnover is a ground to exclude a company from the list of comparable companies in determining ALP, held that there were contrary views on the issue and hence the view favourable to the assessee laid down in the case of Pentair Water (supra) should be adopted. The following were the conclusions of the Tribunal in the case of Dell International (supra):

The Assessee’s turnover was around Rs.110 Crores. Therefore the action of the CIT(A) in directing TPO to exclude companies having turnover of more than Rs.200 crores as not comparable with the Assessee was justified. As rightly pointed out by the learned counsel for the Assessee, there are two views expressed by two Hon’ble High Courts of Bombay and Delhi and both are non-

The only other company that remains for consideration in Ground No.7 is exclusion of Acropetal Technologies Ltd. As far as comparability of this company is concerned, the learned Counsel for the assessee brought to our notice the decision of the ITAT, Bengaluru Bench rendered in the case of ACIT Vs. M/s. Marvell India Pvt. Ltd., IT(TP)A No.384/Bang/2016 for Assessment Year 2011-12, order dated 28.06.2017. In the above case, the assessee was a SWD service provider such as the assessee. In the aforesaid case, the very same 13 comparable companies chosen by the TPO in the present case also was chosen as the comparable companies and therefore there can be no doubt that the functional profile of the Assessee and the company M/S.Marvell India Pvt.Ltd., are one and the same. The comparability of the company M/s. Acropetal Technologies Ltd., was considered by the Tribunal in the aforesaid decision and the Tribunal held that Acropetal Technologies Ltd., cannot be regarded as a comparable company because 75% of the Revenue was not from rendering software services and therefore this company cannot be considered as a comparable company. The following were the relevant observations of the Tribunal: “14. Acropetal Technologies Ltd:- 14.1 This company was selected by the TPO for inclusion in the final set of comparables. According to the Id. AR for the assessee, the total employee cost of this company is 11.51% of the total operating revenue

Respectfully following the aforesaid decision of the Tribunal, we direct exclusion of Acropetal Technologies Ltd., from the list of the comparable companies.

In Revenue’s appeal, the Revenue has challenged the action of the CIT(A) in including 2 comparable companies viz., M/s. FCS Software Solutions Ltd., and M/s. Akshay Technologies Ltd. As far as FCS Software Solutions Ltd., is concerned, it was a comparable chosen by the TPO on his own. The reasons given by the TPO for rejecting this company as a comparable company though it was proposed to be included as comparable company by the TPO in its show cause notice was as follows:

On appeal by the assessee, the CIT(A) held that FCS Software Solutions Ltd., is functionally comparable to the assessee. Aggrieved by the order of the CIT(A), Revenue is in appeal before the Tribunal.

Learned Counsel for the assessee brought to our notice decision of the Tribunal rendered in the case of Marvell India Pvt. Ltd., (supra) wherein comparability of this company was examined by the Tribunal. In that case also, the TPO refused to include this company as a comparable company for the very same reason that the working capital adjustment was very high and had an impact on the profits of that company. The Tribunal held that the reason given by the TPO cannot be the basis to exclude this company from the list of comparable companies as it is otherwise found to be functionally comparable. Following were the relevant observations of the Tribunal:

In view of the aforesaid decision of the Tribunal, we do not find any merits in the grounds raised by the Revenue regarding inclusion of this company from the list of comparable companies. As far as the comparable company M/s. Akshay Technologies Ltd., is concerned, learned Counsel for the assessee submitted that he accepts the stand of the Revenue and therefore inclusion of this comparable company is held to be incorrect on the basis of the concession given by the learned Counsel for the assessee and the relevant grounds of appeal of the Revenue is allowed.

The only other issue that remains for consideration in the determination of ALP in the SWD services segment is ground No.8 with regard to the action of the Revenue authorities in not providing working capital adjustment. In this regard, the grievance of the assessee as projectrd in the aforesaid ground of appeal is that no adjustment towards working capital has been allowed to the assessee by the TPO and the action of the TPO was confirmed by the CIT(A) contrary to well settled principle in transfer pricing. On the issue of non granting of working capital adjustment, the TPO/CIT(A) gave its decision by observing that (i) The assessee has not demonstrated with any data or information as to the impact of working capital on the costs, price or profit. (ii) working capital requirements and impact depends on various factors such as business cycle, the nature of business activity with its correlation on the general economic trends, the fund and capital position of the company, its marketing strategies, its market share etc., all of which cannot be captured in the year end receivable or payable position. (iii) the year end receivables and payable may not reflect as to whether it arises from transactions relating to revenue account or capital account as there is no uniformity in the accounting or reporting requirements and an intermixing is generally possible. (iv) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results.

The learned counsel for the assessee submitted that the conclusions of the DRP are identical to the conclusions arrived at by the revenue authorities in the case of Huawei Technologies India Pvt. Ltd. v. JCIT [2019] 101 taxmann.com 313 (Bang. Trib.). In the aforesaid decision on an identical issue, the Tribunal held that working capital adjustment has to be given. The tribunal reasoned in the aforesaid decision that a reading of Rule 10B(l)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly show that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. The tribunal referred to Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the "TPG") contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annexure to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. The Tribunal referred to Paragraphs 13 to 16 of the aforesaid OECD guidelines, wherein the need for working capital adjustment has been explained as follows: "13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing effect.

The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect.

A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: ♦ A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) ♦ This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers - (less) the period granted to pay debts to suppliers."

The tribunal observed that examples of how to work out adjustment on account of working capital adjustment is also given in the said guidelines. The guideline also expresses the difficulty in making working capital adjustment by concluding that the following factors have to be kept in mind (i) The point in time at which the Receivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these figures, (ii) the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The tribunal observed that the guidelines conclude by observing that the purpose of working capital adjustments is to improve the reliability of the comparables. The Tribunal further observed that the data available with the assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing.

We are therefore of the view that the issue with regard to the grant of working capital adjustment should be directed to be examined by the TPO/AO afresh in the light of the decision of the tribunal referred to above, after affording opportunity of being heard to the assessee.

The TPO/AO is directed to compute the ALP of the international transaction of rendering of SWD services by the assessee to AE in the light of the directions given above, after affording assessee opportunity of being heard.

The other issue that remains for consideration is ground No.9 raised by the assessee in its appeal and this relates to treating the delay in realizing receivables over and above the normal credit period, by the assessee from its AE, as a separate international transaction and in determining ALP of interest that the assessee ought to have charged. The AO computed the addition in this regard as follows:

On appeal by the assessee, the CIT(A) confirmed the order of the TPO. Aggrieved by the order of the CIT(A), the assessee is in appeal before the Tribunal. The learned Counsel for the assessee submitted that the TPO and the CIT(A) fell into an error in considering the delay in realizing the receivables by the assessee from its AE over and above the normal credit period agreed, was a separate international transaction. The learned Counsel for the assessee placed reliance on the decision of the ITAT, Mumbai Bench, rendered in the case of Vrushab Dia Vs. ACIT order dated 13.01.2016 wherein the Tribunal took the view that explanation to section 92B which was stated to be effective from 01.04.2002 has to be necessarily treated as effect from only Assessment Year 2013-14. On merits, it was submitted that the computation should be based on transaction to transaction applying libor rate and it should be restricted only to the transactions relating to the previous year relevant to Assessment Year 2010-11.

Before the Tribunal the learned counsel for the Assessee also submitted that the amounts outstanding from the AE will be settled with the AE on an ongoing basis in the normal course of business, having regard to commercial and economic factors. The arm’s length price determination for the said receivables is subsumed within the arm’s length price determination of the principal transaction itself. The outstanding receivables are in respect of the provision of software development services by the assessee and hence arise out of the primary transaction of rendering SWD services. Since the receivables are integral to the main transaction, the same ought to be aggregated with the said transaction and adjustment ought to be computed accordingly. Reliance in this regard was placed on the decision of this Hon’ble Tribunal in the case of Avnet India (P.) Ltd. v. DCIT (reported in [2016] 65 taxmann.com 187 [Bangalore - Trib.)] which was upheld by the Hon’ble High Court of Karnataka in ITA No. 358/2016. It was further contended that that the Delhi Bench of ITAT in the case of Kusum Healthcare Pvt. Ltd. v. ACIT (Order dated 31.03.2015 passed by the Delhi Bench of the Hon’ble Tribunal in held that if the working capital investment of the assessee and the comparables rather are considered than looking at the receivable independently is not necessary as the working capital adjustment takes into account the impact of outstanding receivables on the profitability. It was pointed out that this decision came to be upheld by the Hon’ble Delhi Court in PCIT v. Kusum Healthcare Pvt. Ltd. (Order dated 25.04.2017 passed in (refer paras 10 and 11):- “10. The Court is unable to agree with the above submissions. The inclusion in the Explanation to Section 92B of the Act of the expression “receivables” does not mean that de hors the context every item of “receivables” appearing in the accounts of an entity, which may have dealings with foreign AEs would automatically be characterised as an international transaction. There may be a delay in collection of monies for supplies made, even beyond the agreed limit, due to a variety of factors which will have to be investigated on a case to case basis. Importantly, the impact this would have on the working capital of the Assessee will have to be studied. In other words, there has to be a proper inquiry by the TPO by analysing the statistics over a period of time to discern a pattern which would indicate that vis-à-vis the receivables for the supplies made to an AE, the arrangement reflects an international transaction intended to benefit the AE in some way.

The Court finds that the entire focus of the AO was on just one AY and the figure of receivables in relation to that AY can hardly reflect a pattern that would justify a TPO concluding that the figure of receivables beyond 180 days constitutes an international transaction by itself. With the Assessee having already factored in the impact of the receivables on the working capital and thereby on its pricing/profitability vis- à-vis that of its comparables, any further adjustment only on the basis of the outstanding receivables would have distorted the picture and re-characterised the transaction.”

It was argued that the above principles have been followed consistently by the various Benches of the Tribunal. In view of the above, it is submitted that the delayed receivables cannot be treated as an independent international transaction.

Without prejudice to the above submissions, it was contended that even assuming that delayed realization of trade receivables is an international transaction, the delay in realization of the trade receivables in this case is not inordinate so as to warrant any benefit provided to the AE warranting determination of ALP. The ld. DR relied on the order of the DRP.

We have carefully considered the rival submissions. On the question whether delayed realization of trade receivables from the AE constitutes an international transaction or not, there are conflicting decisions of various benches of the Tribunal, which we shall point out. Sec.92B of the Act defining what is an international transaction was amended by Finance Act, 2012, way of insertion of an Explanation to sec.92B with retrospective effect from 1-4-2002 and the same reads thus:- “Explanation- For the removed of doubts, it is hereby clarified then-(i) the expression "international transaction" shall include— (a) …………. (b) ………….. (c) capital financing, including any type of long-term or short- term borrowing. lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment of receivable or any other debt arising during the course of business: …………”

The amendment is to the effect that “international transaction” would specifically include within its ambit. 'deferred payment or receivable or any other debt arising during the course of business’ and hence non-charging or under-charging of interest on the excess period of credit allowed to the AE for the realization of invoices would amount to an international transaction. It was so held by the ITAT Delhi Bench in the case of Bechtel India Pvt Ltd (in dated 16 May 2017). It is important to note that the Bench while arriving at the said conclusion distinguished its earlier order in the case of Kusum Healthcare Pvt. Ltd. (supra) and rejected the contention that interest gets subsumed in the working capital adjustment. The Hon`ble Bombay High court in the case of CIT vs. Patni Computer Systems Ltd, (2013) 215 Taxman 108 (Bom) dealt, inter alia, with the following question of law:- "(c) Whether on the facts and circumstances of the case and in law, the Tribunal did not err in holding that the loss suffered by the assessee by allowing excess period of credit to the associated enterprises without charging an interest during such credit period would not amount to international transaction whereas section 92B(1) of the Income-tax Act, 1961 refers to any Other transaction having a bearing on the profits, income, losses or assets of such enterprises?"

While answering the above question, the Hon'ble High Court noticed that an amendment to section 92B has been carried out by the Finance Act, 2012 with retrospective effect from 1.4.2002. Setting aside the view taken by the Tribunal, the Hon'ble High Court restored this issue to the file of the Tribunal for fresh decision in the light of the legislative amendment. In the case of BT e Serv (TS-849-ITAT-2017(DEL)-TP) the ITAT Delhi Bench held that undoubtedly the receivable or any other debt arising during the course of the business is included in the definition of 'capital financing' as an 'international transaction' as per explanation 2 to section 92B of the Act w.e.f. 01.04.2002 inserted by the Finance Act 2012. Therefore, even the outstanding receivable partake the character of capital financing and consequently, overdue outstanding is an "international transaction". The natural corollary would be of imputing interest on such "capital financing" if same is not charged at arm's length. The ITAT concluded that if outstanding receivables are within the terms of agreement, then it may be argued that interest on such outstanding is already covered in the sale price of the goods. However, if the agreement does not specify the term of the payment, even then assessee must be given benefit of credit period which is accepted business practice in the trade. The ITAT confirmed 30 days as the normal credit period adopted by the TPO.

The foregoing discussion discloses that non-charging or under- charging of interest on the excess period of credit allowed to the AE, for the realization of invoices amounts to an international transaction and the ALP of such an international transaction is required to be determined. In view of the above observations. the reliance placed by the ld. counsel for the assessee on earlier decisions cannot be accepted. Similarly, Considering the above discussion, it is held that deferred trade receivable constitutes international transaction.

As far as the manner of determination of ALP is concerned, we accept the prayer of the learned Counsel for the assessee to apply libor rate on transaction-to-transaction basis and restrict the addition only with reference to international transaction undertaken by the assessee where there is delay in receivables in the previous year relevant to Assessment Year 2010-11 only. Thus, the grounds of appeal raised by the assessee are partly accepted.

In the result, appeal by the assessee and that by the Revenue are treated as partly allowed.