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Income Tax Appellate Tribunal, ‘B’ BENCH : BANGALORE
Before: SHRI. CHANDRA POOJARI & SMT. BEENA PILLAI
ORDER
PER BEENA PILLAI, JUDICIAL MEMBER Present appeal filed by assessee against the final assessment order dated 26.09.2017 for A.Y. 2013-14 by Ld.DCIT, Circle – 7(1)(1), Bangalore on following grounds of appeal: “Based on the facts and circumstances of the case and in law. Talisma Corporation Private Limited (hereinafter referred to as "Appellant"), respectfully craves leave to prefer an appeal against the appeal order passed by the learned Assessing Officer [hereinafter referred to as the learned A01 under section 143(3) read with section 144C(13) of the Income-tax Act. 1961 (the Act") on the following grounds: That on the facts and circumstances of the case and in law:
1. The learned AO/ Transfer Pricing Officer (.TPO') erred. in law and in facts. in making an addition of INR 1,44.13,409 Page 2 of 14 IT(TP)A No. 2499/Bang/2017 to the total income of the Appellant on account of adjustment in the arms length price for international transactions entered by the Appellant with its associated enterprise.
The learned AO/ TPO erred. in law and in facts. by not accepting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Rules. and conducting a fresh economic analysis for the determination of the ALP in connection with the impugned international transaction and holding that the Appellant's international transaction is not at arms length: 3. The learned AO/ TPO erred. in law and facts. in not accepting Other Method as the most appropriate method for benchmarking the payment of royalty transaction: 4. The learned AO/ TPO erred. in law and facts. in not accepting Transactional Net Margin Method ('TNMM') as the most appropriate method for benchmarking the payment of royalty transaction: 5. The learned AO/ TPO erred. in law and in facts. in the rejection of the external comparable uncontrolled transaction ('CUT*) search conducted for benchmarking the payment of royalty transaction.
6. The learned AO / TPO erred. in law and facts, has failed to understand the business model of the Appellant and accordingly. erred in considering the Appellant as a distributor of software product: 7. The learned AO / TPO erred, in law and facts. in considering the entire Non-AE sale of Appellant's AE's product. instead of sale of effected by way of payments of royalty: 8. Without prejudice to our contentions in ground numbers 1 to 8 mentioned above. on the facts and circumstances of the case, the learned AO / TPO erred in law and in facts: a. by determining the arm's length margin/ price using only FY 2012-13 data which was not available to the Appellant at the time of complying with the transfer pricing documentation requirements: b. by rejecting certain comparable companies identified by the Appellant for having different accounting year (i e. companies having accounting year other than March 31 or companies whose financial statements were for a period other than 12 months): c. by rejecting certain comparable companies identified by the Appellant using employee cost greater than 25% of the total revenues as a comparability criterion. d. by rejecting companies having IT income less than 75% of total operating revenue as a comparability criterion; Page 3 of 14 IT(TP)A No. 2499/Bang/2017 e. by applying only the lower turnover filter of less than I NR 1 crore as a comparability criterion and not applying an appropriate upper turnover filter: f. by exercising his powers under section 133(6) of the Act to obtain information which was not available in public domain and relying on the same for comparability purposes: g. in selecting companies which are functionally not comparable to the Appellant: h. in rejecting certain companies which are functionally comparable to the Appellant based on unreasonable comparable criteria; 9. The learned has AO erred, in law and in facts, in initiating penalty proceedings u/s 271(1)(c) of the Act. The Appellant submits that each of the above grounds is independent and without prejudice to one another. The Appellant craves leave to add, alter. amend. vary, omit or substitute any of the aforesaid grounds of appeal
at any time before or at the time of hearing of the appeal, so as to enable the Hon'ble Tribunal to decide on the appeal in accordance with the law.”
2. Brief facts of the case are as under: At the outset, the Ld.AR submitted that the main issue in these two appeals is regarding the characterisation carried out by the Ld.TPO of the assessee’s business. The assessee is a manufacturer of software products, it owns and develop IP of the software product by the name CRM software. The assessee also sells this software product in America and in Asia-pacific region. The Ld.AR submitted that in the TP study by assessee for the assessment years under consideration, assessee has been characterised as manufacturer of software products, based on the functional analysis.
3. It is submitted that the Ld.TPO for A.Y. 2011-12 accepted the activity of assessee to be a manufacturer of software products, however, characterised the business of assessee as software development service provider. The Ld.TPO then applied the filters applicable to SWD service provider bench mark the transaction Page 4 of 14 IT(TP)A No. 2499/Bang/2017 by applying comparables who are in the software development services. 3.1 The Ld. AR further submitted that for year under consideration, the Ld.TPO held that the business of assessee involves three segments viz., i) software development service segment, ii) software product segment and iii) software distribution segment. The Ld. Counsel opposed the different characterisation by the Ld.TPO for identical activity carried on by the assessee in preceding and the year under consideration.
He thus submitted that the Ld.TPO characterised assessee differently in both the years. At this juncture, he brought to our attention the characterisation carried out by the Ld.TPO for A.Y. 2010-11, wherein no adjustment was made u/s. 92CA to the arms length price determined by the taxpayer in respect of the identical international transactions entered into with the associated enterprises. It is submitted by the Ld.AR that the DRP even after noting business of assessee upheld the characterisation of receipts from sale of software products by the Ld.TPO, no decision has been rendered in respect of the same.
He submitted that the transfer pricing issues for similar reasons has been remanded by Coordinate Bench of this Tribunal for A.Y. 2012-13 in IT(TP)A No. 458/Bang/2017 by order dated 15.02.2022 in order to appreciate the functions performed by assessee in right perspective.
Page 5 of 14 IT(TP)A No. 2499/Bang/2017 The Ld.CIT DR did not particularly object to the issue being remanded for de novo verification. We have perused the submissions advanced by both sides in the light of records placed before us.
Admittedly, for both the years under consideration, assessee has been noted to be manufacturer of software product. It is an admitted fact that assessee owns the development of IP of software product being CRM software. Assessee entered into agreement with its AE for being an exclusive distributor for its software product in North America, for which the AE shall pay to assessee a licence fee equal to 30% of gross revenue. This receipt by assessee has been shown as royalty income by assessee. Apart from this, the assessee sells this software directly to third party customers in Asia-pacific region. It is noted that assessee also provides software support services for the CRM software product sold to both AE as well as non-AE. Thus the segments of income generated by assessee are : 1) income from licence fee 2) payment of licence fee 3) income from software services.
It has been submitted that for A.Y. 2010-11, assessee was identically characterised in the TP study which has not been disturbed by the transfer pricing officer therein. Subsequently, assessee has been characterised in different ways in the subsequent assessment years which needs to be verified at the end of Ld.TPO. In the interest of justice and to remain consistent in the approach of characterisation of assessee’s business module, we Page 6 of 14 IT(TP)A No. 2499/Bang/2017 remand the transfer pricing issues to the Ld.AO/TPO for de novo verification. Assessee is directed to file complete details regarding FAR analysis before the authorities in order to substantiate its arguments regarding the characterisation in the TP study. The Ld.TPO is directed to analyse the details so filed by assessee and to consider the international transactions in accordance with various principles laid down by this Tribunal as well as various High Courts on this issue. Needless to say that proper opportunity of being heard is to be granted to assessee. Accordingly, ground nos. 1 to 9 stands allowed for statistical purposes.
The Ld. Counsel submitted that assessee has raised additional grounds for year under consideration as under: Additional grounds of appeal: “
Based on the facts and circumstances of the case and in law, Talisma Corporation Private Limited (hereinafter referred to as "Appellant"), respectfully craves leave to prefer an appeal against the appeal order passed by the learned Assessing Officer [hereinafter referred to as the "learned AO"] under section 143(3) read with section 144C(13) of the Income-tax Act, 1961 ("the Act") on the following grounds: That on the facts and circumstances of the case and in law:
1. The learned AO/ Transfer Pricing Officer ('TPO') erred, in law and in facts, in making an addition of INR 1,44,13,409 to the total income of the Appellant on account of adjustment in the arm's length price for international transactions entered by the Appellant with its associated enterprise;
2. The learned AO/ TPO erred, in law and in facts, by not accepting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Rules, and conducting a fresh economic analysis for the determination of the ALP in connection with the impugned international transaction and holding that the Appellant's international transaction is not at arm's length; Page 7 of 14 IT(TP)A No. 2499/Bang/2017 3. The learned AO/ TPO erred, in law and facts, in not accepting Other Method as the most appropriate method for benchmarking the payment of royalty transaction; 4. The learned AO/ TPO erred, in law and facts, in not accepting Transactional Net Margin Method ('TNMM') as the most appropriate method for benchmarking the payment of royalty transaction; 5. The learned AO/ TPO erred, in law and in facts, in the rejection of the external comparable uncontrolled transaction ('CUT') search conducted for benchmarking the payment of royalty transaction; 6. The learned AO / TPO erred, in law and facts, has failed to understand the business model of the Appellant and accordingly, erred in considering the Appellant as a distributor of software product; 7. The learned AO / TPO erred, in law and facts, in considering the entire Non-AE sale of Appellant's AE's product, instead of sale of effected by way of payments of royalty; 8. Without prejudice to our contentions in ground numbers 1 to 8 mentioned above, on the facts and circumstances of the case, the learned AO / TPO erred in law and in facts: a. by determining the arm's length margin/ price using only FY 2012-13 data which was not available to the Appellant at the time of complying wit the transfer pricing documentation requirements; b. by rejecting certain comparable companies identified by the Appellant for having different accounting year (i.e. companies having accounting year other than March 31 or companies whose financial statements were for a period other than 12 months); c. by rejecting certain comparable companies identified by the Appellant using employee cost greater than 25% of the total revenues as a comparability criterion; d. by rejecting companies having IT income less than 75% of total operating revenue as a comparability criterion; e. by applying only the lower turnover filter of less than INR 1 crore as a comparability criterion and not applying an appropriate upper turnover filter; f. by exercising his powers under section 133(6) of the Act to obtain information which was not available in public domain and relying on the same for comparability purposes; g. in selecting companies such as Ducon Infra Technologies Ltd., Birla Shloka Edutech Ltd., Sonata Information Technology Ltd., Ontrack Systems Ltd., Vama Industries Ltd., and Accel Frontline Ltd. which are functionally not comparable to the Appellant; Page 8 of 14 IT(TP)A No. 2499/Bang/2017 h. in rejecting certain companies such as Edulink, cMeRun Corp., Siboney Learning Group, Online Education College of Renmin University of China, AlphaSmart Inc., Baan Development BV which are functionally comparable to the Appellant based on unreasonable comparable criteria; 9. The learned has AO erred, in law and in facts, in initiating penalty proceedings u/s 271(1)(c) of the Act. The Appellant submits that each of the above grounds is independent and without prejudice to one another. The Appellant craves leave to add, alter, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal, so as to enable the Hon'ble Tribunal to decide on the appeal in accordance with the law.” The Ld.DR did not object for the additional grounds being admitted.
9. We note that the additional grounds are directly connected with the main issue of disallowance and no new facts needs to be investigated for adjudicating the same. 9.1 Considering the submissions and respectfully following the decisions of Hon’ble Supreme Court in case of National Thermal Power Co. Ltd. Vs. CIT reported in (1998) 229 ITR 383 and Jute Corporation of India Ltd. Vs. CIT reported in 187 ITR 688, we are admitting the additional ground raised by the assessee. Accordingly, we admit the additional grounds raised by assessee. The Ld.CIT.DR submitted that this issue needs to be verified in detail. The Ld. Counsel submitted that outstanding receivables are only in respect of the provision of software development services by the assessee, and therefore the determination of ALP is not warranted, as the same is subsumed in the ALP of the transaction. The Ld. Counsel submitted that the Ld.TPO considered the interest chargeable at 1.5% p.m. by applying the internal CUP Page 9 of 14 IT(TP)A No. 2499/Bang/2017 method as per the agreement with the non-AE. He thus comuted the adjustment on receivables at Rs. 95,80,429/-. The Ld. Counsel placed reliance on the order passed by the Coordinate Bench in case of Swiss Re Global Business Solutions India Pvt. Ltd. vs. Addl. CIT in IT(TP)A No. 397/Bang/2021 by order dated 21.01.2022 for A.Y. 2016-17 wherein an identical issue has been dealt with as under. “35. The only other issue that remains for adjudication is ground No.15 with regard to re-characterizing certain trade receivables as unsecured loans and computing notional interest on such trade receivables. The main contention of the ld. AR is that deferred receivables would not constitute a separate international transaction and need not be benchmarked while determining the ALP of the international transaction. In our opinion, this issue was considered by the Tribunal in assessee’s own case for AY 2014-15 and in para 23 to 23.9 of the order dated 21.5.2020 this Tribunal held as under:- “23. Ground No. 14-17 alleged by assessee against adjustment of notional interest on outstanding receivables. From TP study, it is observed that payments to assessee are not contingent upon payment received by AEs from their respective customers. Further Ld.AR submitted that working capital adjustment undertaken by assessee includes the adjustment regarding the receivables and thus receivables arising out of such transaction have already been accounted for. Alternatively, he submitted that working capital subsumes sundry creditors and therefore separate addition is not called for. 23.1. Ld.TPO computed interest on outstanding receivables under weighted average method using LIBOR + 300 basis points applicable for year under consideration that worked out to 3.3758% on receivables that exceeded 30 days. It has been argued by Ld.AR that authorities below disregarded business/commercial arrangement between the assessee and its AE's, by holding outstanding receivables to be an independent international transaction. 23.2. Ld.AR placed reliance on decision of Delhi Tribunal in Kusum Healthcare (P.) Ltd. v. Asstt. CIT [2015] 62 taxmann.com 79, deleted addition by considering the above principle, and subsequently Hon'ble Delhi High Court in Pr. CIT v. Kusum Health Care (P.) Ltd. [2018] 99 taxmann.com 431/[2017] 398 ITR 66, held that no interest could have been charged as it cannot be considered as Page 10 of 14 IT(TP)A No. 2499/Bang/2017 international transaction. He also placed reliance upon decision of Delhi Tribunal in case of Bechtel India (P.) Ltd. v. Dy. CIT [2016] 66 taxman.com 6 which subsequently upheld by Hon'ble Delhi High Court vide order in Pr. CIT v. Bechtel India (P.) Ltd. [IT Appeal No. 379 of 2016, dated 21-7-16] also upheld by Hon'ble Supreme Court vide order, in CC No. 4956/2017. 23.3. It has been submitted by Ld.AR that outstanding receivables are closely linked to main transaction and so the same cannot be considered as separate international transaction. He also submitted that into company agreements provides for extending credit period with mutual consent and it does not provide any interest clause in case of delay. He also argued that the working capital adjustment takes into account the factors related to delayed receivables and no separate adjustment is required in such circumstances. 23.4. On the contrary Ld.CIT.DR submitted that interest on receivables is an international transaction and Ld.TPO rightly determined its ALP. In support of the contentions, he placed reliance on decision of Delhi Tribunal order in Ameriprise India (P.) Ltd. v. Asstt. CIT [2015] 62 taxmann.com 237 wherein it is held that, interest on receivables is an international transaction and the transfer pricing adjustment is warranted. He stated that Finance Act, 2012 inserted Explanation to section 92B, with retrospective effect from 1.4.2002 and sub-clause (c) of clause (i) of this Explanation provides that: (i) the expression "international transaction" shall include— . . . . . (c) capital financing, including any type of longterm or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;. . . . ' 23.5. Ld.CIT.DR submitted that expression 'debt arising during the course of business' refers to trading debt arising from sale of goods or services rendered in course of carrying on business. Once any debt arising during course of business is an international transaction, he submitted that any delay in realization of same needs to be considered within transfer pricing adjustment, on account of interest income short charged or uncharged. It was argued that insertion of Explanation with retrospective effect covers assessment year under consideration and hence under/non-payment of interest by AEs on debt arising during course of business becomes international transactions, calling for computing its ALP. He referred to decision of Delhi Tribunal in Ameriprise (supra), in which Page 11 of 14 IT(TP)A No. 2499/Bang/2017 this issue has been discussed at length and eventually interest on trade receivables has been held to be an international transaction. Referring to discussion in said order, it was stated that Hon'ble Delhi Bench in this case noted a decision of the Hon'ble Bombay High Court in the case of CIT v. Patni Computer Systems Ltd. [2013] 33 taxmann.com 3/215 Taxman 108 (Bom.), which dealt with 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?" 23.6. Ld.CIT.DR submitted that, while answering above question, Hon'ble Bombay High Court referred to amendment to section 92B by Finance Act, 2012 with retrospective effect from 1.4.2002. Setting aside view taken by Tribunal, Hon'ble Bombay High Court restored the issue to file of Tribunal for fresh decision in light of legislative amendment. It was thus argued that non/under-charging of interest on excess period of credit allowed to AEs for realization of invoices, amounts to an international transaction and ALP of such international transaction has to be determined by Ld.TPO. Insofar as charging of rate of interest is concerned, he relied on decision of the Hon'ble Delhi High Court in CIT v. Cotton Naturals (I) (P.) Ltd. [2015] 55 taxmann.com 523/231 Taxman 401 holding that currency in which such amount is to be re-paid, determines rate of interest. He, therefore, concluded by summing-up that interest on outstanding trade receivables is an international transaction and its ALP has been correctly determined. 23.7. We have perused the submissions advanced by both the sides in the light of the records placed before us. This Bench referred to decision of Special Bench of this Tribunal in case of Special Bench of ITAT in case of Instrumentation Corpn. Ltd. v. Asstt. DIT (IT) [2016] 71 taxmann.com 193/160 ITD 1 (Kol. - Trib.), held that outstanding sum of invoices is akin to loan advanced by assessee to foreign AE., hence it is an international transaction as per Explanation to section 92B of the Act. We also perused decision relied upon by Ld.AR. In our considered opinion, these are factually distinguishable and thus, we reject argument advanced by Ld.AR.
Page 12 of 14 IT(TP)A No. 2499/Bang/2017 23.8. Alternatively, it has been argued that in TNMM, working capital adjustment subsumes sundry creditors. In such situation computing interest on outstanding receivables and loans and advances to associated enterprise would amount to double taxation. Hon'ble Delhi Tribunal in case of Orange Business Services India Solutions (P.) Ltd. v. Dy. CIT [2018] 91 taxmann.com 286 has observed that: "There may be a delay in collection of monies for supplies made, even beyond the agreed limit, due to a variety of factors which would have to be investigated on a case to case basis. Importantly, the impact this would have on the working capital of the assessee would have to be studied. It went on to hold that, 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-a-vis the receivables for the supplies made to an AE, the arrangement reflected an international transaction intended to benefit the AE in some way. Similar matter once again came up for consideration before the Hon'ble Delhi High Court in Avenue Asia Advisors Pvt. Ltd v. DCIT [2017] 398 ITR 120 (Del). Following the earlier decision in Kusum Healthcare (supra), it was observed that there are several factors which need to be considered before holding that every receivable is an international transaction and it requires an assessment on the working capital of the assessee. Applying the decision in Kusum Health Care (supra), the Hon'ble High Court directed the TPO to study the impact of the receivables appearing in the accounts of the assessee; looking into the various factors as to the reasons why the same are shown as receivables and also as to whether the said transactions can be characterised as international transactions." 23.9. In view of the above, we deem it appropriate to set aside this issue to Ld.AO/TPO for deciding it in conformity with the above referred judgment. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in accordance with law.”
Accordingly, we are of the opinion that deferred receivables would constitute an independent international transaction and the same is required to be benchmarked independently as held by the Hon’ble Karnataka High Court in PCIT v. AMD (India) Pl. Ltd., dated 31.8.2018.
Once we have held that the transaction between the assessee and AE was in foreign currency with regard to receivables and transaction was international transaction, then transaction would have to be looked upon by applying the commercial principles with regard to Page 13 of 14 IT(TP)A No. 2499/Bang/2017 international transactions and accordingly proceeded to take into account interest rate in terms of London Inter Bank Offer Rate [LIBOR] and it would be appropriate to take the LIBOR rate + 2%. For this purpose, we place reliance on the judgment of the Bombay High Court in the case of CIT v. Aurionpro Solutions Ltd., 99 CCH 0070 (Mum HC). It is ordered accordingly.” The Ld. Counsel agreed for the interest on receivables to be computed at LIBOR rate + 2%. He also admitted that the transaction has to be treated as an independent international transaction and deserved to be bench marked. Accordingly, the Ld.CIT.DR placed reliance on orders passed by authorities below. We have perused the submissions advanced by both sides in the light of records placed before us. As the Ld. Counsel has considered for the rate on receivables to be applied at LIBOR + 2%, respectfully following the view taken by the Coordinate Bench in case of Swiss Re Global Business Solutions India Pvt. Ltd. vs. Addl. CIT (supra), we direct the Ld.AO/TPO to compute the ALP of the transaction accordingly. Accordingly, the additional grounds raised by assessee stands allowed as indicated above. Accordingly, all the grounds stands allowed as indicated hereinabove. In the result, the appeal filed by the assessee stands allowed. Order pronounced in the open court on 21st March, 2022.