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Income Tax Appellate Tribunal, AHMEDABAD ‘D’ BENCH, AHMEDABAD
By way of this appeal, the assessee-appellant has challenged correctness of the order dated 12th April 2017 passed by the CIT(A)-8, Ahmedabad in the matter of assessment under section 143(3) of the Income-tax Act, 1961, for the assessment year 2012-13.
In the first ground of appeal, the assessee has raised following grievances:-
“1. Ground No. 1 - Transfer Pricing Adjustment
1.1. On die facts and in the circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO / TPO of making upward adjustment of Rs 2,04,090 under Section 92CA(3) of the Act.
1.2. On the facts and circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO / TPO in considering the amount receivable from AE for more than 90 days as a separate international transaction.
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 2 of 9 The Appellant submits that the outstanding receivables are a result of the main international transaction of sale of software/services and hence are closely linked to the main international transaction of sales.
1.3. On the facts and circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO / TPO in not appreciating the fact that even after the delayed receivables, the working capital adjusted operating margins of the Appellant are higher than that of the comparable companies and hence no separate adjustment is warranted.
1.4. Without prejudice to the above, on the facts and circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO / TPO in rejecting Internal Comparable Uncontrolled Price ('CUP') method as the most appropriate method.
The Appellant submits that it has not charged any interest on the outstanding receivables from Non AEs beyond the credit period and hence Internal CUP should be applied as the most appropriate method.
1.5. Without prejudice to the above, on the facts and circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO / TPO in applying External CUP as the most appropriate method.
1.6. Without prejudice to the above, on the facts and circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO / TPO in making adhoc adjustment without any basis of 100 bps on account of foreign exchange risk.”
To adjudicate on this issue only a few material facts need to be taken note of. The assessee is engaged in the business of development of network security software product by the name of Cyberoam. During the relevant previous year, the assessee had entered into international transactions in respect of sale of its product to its Associated Enterprise (AE) abroad. These transactions were benchmarked using Transactional Net Margin Method (TNMM). In the course of proceedings before the Transfer Pricing Officer (TPO), while the TPO accepted the benchmarking of these sale transactions, he noted that in some of the cases the realization of bills was beyond 90 days. The TPO was of the view that realization of billing dues beyond 90 days constitutes an international transaction and accordingly made an adjustment of Rs.2,04,090/- in respect of delay in realization of sale invoices.
Aggrieved, the assessee carried the matter in appeal before the learned CIT(A) but without any success. Learned CIT(A) was of the view that “if the funds are repatriated to India, the assessee would have been in a position to earn better profit
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 3 of 9 from appropriate investment of those repatriated funds” and “this potential loss is definitely a factor to be considered while evaluating the financial impact of the international taxation concluded by the assessee”. Learned CIT(A) further relied upon the decision of Chennai Bench of this Tribunal in the case of Professional Access Software Development (P.) Ltd Vs. DCIT [(2017) 79 taxmann.com 25(Chennai-Trib)]. The ALP adjustment of Rs.2,04,090/- was thus confirmed. The assessee is not satisfied and is in further appeal before us.
We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.
As learned Counsel rightly points out, this issue is now covered, in favour of the assessee, by a decision of Ahmedabad Bench of this Tribunal in the case of Micro Inks Limited Vs. ACIT, [2016] 157 ITD 132 (Ahmedabad - Trib.), wherein, after taking into account Hon’ble jurisdictional High Court’s judgment in the case of Nirma Industries Ltd. Vs.. DCIT, [2006] 283 ITR 402 and the Hon’ble Delhi High Court’s judgement in the case of Sony Ericsson Mobile Corpn. (P.) Ltd. v. CIT, [2015] 374 ITR 118, the Co- ordinate bench has, inter alia, observed as under:-
“5. We find that this issue is covered, in favour of the assessee, by a decision of the coordinate bench in assessee's own case for the assessment year 2002-03 [reported as Micro Inks Ltd. v. Asstt. CIT [2013] 144 ITD 610/36 taxmann.com 50 (Ahd.), While deleting similar addition, the coordinate bench had observed as follows: "20. The only other ALP adjustment in appeal before us is with respect to, what the authorities below have treated as, excess credit period allowed to Micro USA. This adjustment must be deleted for the short reason that it was part of the arrangement that specified credit period was allowed and thus the cost of funds blocked in the credit period was inbuilt in the sale price. There is no dispute that similar products are not sold to any other concern, at same price or even any other price, and interest is levied on the similar credit period allowed to those independent parties but not to Micro USA. The question of excess credit period arises only when there is a standard credit period for the product sold at the same price and the credit period allowed to the associated enterprises is more than the credit period allowed to independent enterprises. That is not the case here. The credit period for finished goods cannot be compared with credit period for unfinished goods and raw materials, and in any case, when products are not the same, there cannot be any question of prices being the same. Unless the prices of the product and the product are the same, and yet extra credit period is allowed, there cannot be any occasion for making ALP adjustment on the basis of the excess credit period. None of the
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 4 of 9 authorities below have even disputed that the ingredients, raw materials and semi-finished goods sold to Micro USA are not sold to any other concern. The very foundation of impugned addition in arm's length price on account of excess credit period is thus devoid of any legally sustainable merits or factual basis. When all these factors were pointed out to the learned Departmental Representative, he did not have much to say except to place his bland but dutiful reliance on the orders of the authorities below. However, for the reasons set out above and in the absence of any comparative price and credit period figures on comparable product to support the case of the revenue, we uphold the grievance of the assessee and direct the Assessing Officer to delete this ALP adjustment. The assessee gets the relief accordingly." 6. Learned counsel for the assessee submits that the issue being squarely covered, in favour of the assessee and on admittedly similar set of facts, there is no occasion to reconsider the matter. We are urged to follow the said decision and delete the impugned adjustment. On the other hand, while learned Departmental Representative does not dispute that this issue is squarely covered by the aforesaid decision, he submits that the aforesaid decision is "severely flawed" as no matter what is the goods sold, "a credit period is a credit period". It is also submitted that "the credit period for sale of raw material to an independent manufacturer would be lower as the supplier does not have to factor the lead time for the sale of finished goods by the manufacturer" and that "the supplier is entitled to receipt of payment immediately on delivery irrespective of whether the finished goods is sold in the market, get spoiled in manufacturing or is damaged". He further submits that "it is by now acknowledged that granting of excess credit period is a service rendered to the AE and needs to be benchmarked". A reference is then made to Special Bench decision in the case of Aztec Software & Technology Services (P.) Ltd. v. Asstt. CIT [2007] 107 ITD 141/162 Taxman 119 (SB) (Bang.), in support of the proposition that merely by finding fault in the work done by the TPO, the adjustments cannot be deleted and that unless the ALP submitted by the taxpayer is specifically accepted, the appellate authorities, on the basis of material available on record have to determine ALP themselves. 7. We find that, as evident from audit report on form 3CEB (pages 39 to 52 of the paper-book), the arm's length price of exports to the AEs, including Micro USA, has been determined on the basis of the Transactional Net Margin Method (TNMM). By way of a note at page 51, it is specifically stated that "further, the said amount of Rs 2428.26 millions has also been determined/ computed by the assessee having regard to the arm's length price on application of Transactional Net Margin Method (TNMM), on aggregation of transactions, as prescribed under section 92C of the Income-tax Act, 1961". In this backdrop, we can usefully refer to the decision of Hon'ble Delhi High Court, in the case of Sony Ericsson Mobile Corpn. (P.) Ltd. v. CIT [2015] 374 ITR 118/231 Taxman 113/55 taxmann.com 240 (Delhi), wherein Their Lordships had, inter alia, observed as follows: "Where the Assessing Officer/TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 5 of 9 comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction," 8. By way of an example, this aspect of the matter was then explained by Hon'ble Delhi High Court as follows: "An example given below would make it clear: Particulars Case 1 Case 2 Sales 1000 1,000 Purchase Price 600 500 Gross Margin 400 (40%) 500 Marketing Sale promotion 50 150 Overhead expense 300 300 Net profit 50 (5%) 50 (5%) The above illustrations draw a distinction between two distributors having different marketing functions. In case 2, a distributor having significant marketing functions incurs substantial expenditure on AMP, three times more than in case 1, but the purchase price being lower, the Indian AE gets adequately compensated and, therefore, no transfer pricing adjustment is required. In case we treat the AMP expenses in case 2 as Rs.501-, i.e. identical as case 1 and AMP of Rs. 100 as a separate transaction, the position in case 2 would be: Particulars Case 2 Sales 1,000 Purchase Price 500 Gross Margin 500 (50%) Overhead expenses 300 Marketing expenses 50 Net profit 150 (15%) It is obvious that this would not be the correct way and method to compute the arm's length price. The purchase price adjustments/set off would be mandated to arrive at the arm's length price, if the AMP expenses are segregated as an independent international transaction....." 9. By the same logic, even making an adjustment for interest on excess credit allowed on sales to AEs will vitiate the picture, inasmuch as what has already been factored in the TNMM analysis, by taking operating profit figure which incorporate
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 6 of 9 financial impact of the excess credit period allowed, will be adjusted again separately as well. Of course, in the example used by Hon'ble Delhi High Court, the AMP expenses are deductibles in computation of operating profit but that does not make any material difference because the interest levy for late realization of debtors, being inextricably connected with the sales, is also part of operating income. In the case of Nirma Industries Ltd. v. Dy. CIT [2006] 283 ITR 402/155 Taxman 330 (Guj.), Hon'ble High Court has dealing with the nature of interest on debtors, held it to be integral to business income. The same is the principle for the transfer pricing cases to that extent interest is to be taken as integral to sale proceeds, and, as such, includible in operating income. When such an interest is includible in operating income and the operating income itself has been accepted as reasonable under the TNMM, there cannot be an occasion to make adjustment for notional interest on delayed realization of debtors. One can understand separate adjustment for excess credit period when the arm's length price for exports has been benchmarked on the CUP basis but not in a case when the arm's length price of the exports has been benchmarked on the basis of TNMM. The very conceptual foundation, for separate adjustment for delayed realization of debtors and on the facts of this case, is thus devoid of legally sustainable merits.”
In any case, as pointed out by the learned Counsel, the undisputed position is that the assessee had allowed credit period beyond 90 days in the case of Non- Associated Enterprises, i.e. independent enterprises as well. Once this fact is not disputed, the transactions with the non-AE constitute valid Internal CUP inputs and ALP adjustment on account of realisation of bills beyond 90 days from the Associated Enterprise cannot be justified.
In view of above discussions, and respectfully following the binding judicial precedents as referred to above, we uphold the plea of the assessee and direct the Assessing Officer to delete the impugned ALP adjustment of Rs.2,04,090/-.
Ground no. 1 is thus allowed.
In ground no.2, the assessee has raised following grievances:-
“2. Ground No. 2 - Disallowance of provision for royalty expenses of Rs 2.1. On the facts and in the circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO by upholding disallowance of gross provision of royalty expenses of Rs 91,97,594 under Section 40(a)(i) of the Act. 2.2. On the facts and in the circumstances of the case and in law, the learned CIT (A) has erred in confirming the action of the learned AO in not appreciating the fact that the vendors of anti-virus and anti-spam software have not got the vested right to receive the amount of royalty and hence, the amount credited by the Appellant is
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 7 of 9 towards a provision account and not to the respective parties' account. Accordingly, no tax is required to be deducted by the Appellant on such provision. 2.3. Without prejudice to above, the Appellant submits that tax has been appropriately deducted in the subsequent years when the actual liability of making the payment of royalty has occurred. Hence it is prayed that the appropriate deduction be granted to the Appellant in the subsequent year when taxes have been deducted.”
So far as this disallowance is concerned, the relevant material facts are like this. The assessee procures anti-virus (soured from Kasperkey, Russia) and anti-spam software (soured from Commtouh Software Ltd, Israel) and bundles these softwares with assessee’s own Unified Threat Management Software which is ultimately sold to the end customers as a bundled product. The royalty in respect of anti-virus and anti- spam software, referred to above, is paid only when the end customer, i.e. the ultimate user of the bundled software, activates the license key. However, the assessee recognizes the revenue from the sale of its software and at the point of time when the bundled software is sold to the distributor, and the assessee also makes a provision for the royalty that it may have to pay upon activation of key in respect of the outsourced component which is part of the bundled product. In other words, while the assessee makes the provision in respect of the possible liability for the anti-virus and anti-spam software which are bundled along with this product at the time of sale of product to the distributor, the actual liability to pay for this product crystallizes at a much later time when the product is eventually activated by the end customers and that is also the point of time when tax withholding obligations are discharged. On these facts, the Assessing Officer was of the view that the provision for the liability in respect of royalty payable for the bundled product is not admissible as a deduction because the assessee has failed to deduct the tax at source. The plea of the assessee is that the liability to pay tax arises only at the point of time when the end product activated by the end customer was rejected. The Assessing Officer was of the view that the provision for royalty is not a provision per se but an expense payable which had occurred but was not actually paid as on the year end date. The Assessing Officer accordingly held that the assessee is liable to deduct tax at source under section 195 and, on account of assessee’s inability to do so, the expense is disallowable under Section 40(a)(i).
Aggrieved, the assessee carried the matter in appeal before the learned CIT(A) but without any success. Learned CIT(A), relying upon the decision of Tribunal in the
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 8 of 9 case of IBM India (P.) Ltd. Vs. ITO, [2015] 154 ITD 497 (Bangalore - Trib.), upheld the stand of the Assessing Officer. The assessee is aggrieved and is in further appeal before us.
We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.
We find that the taxability of royalty income in terms of the provision in respect of treaties i.e. India Russia Double Taxation Avoidance Agreement [(1998) 233 ITR (Stat) 90] (“Indo-Russian Tax Treaty” in short) and India Israel Double Taxation Avoidance Agreement [(1996) 222 ITR (Stat) 10] (“Indo-Israel Tax Treaty” in short) arises only at the point of time when the royalties are paid to the resident of the other Contracting State. As a matter for fact, Article 12(1) of both of these treaties, which is identically worded, provides that “royalty arises in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State”. Clearly, therefore, the trigger for tax liability under the treaty is the point of time when the royalty income is paid to the resident of the other Contracting State. Incidentally, while dealing with an identically worded Article 13(1) of the Indo-Italian Tax Treaty, a Co-ordinate Bench of this Tribunal in the case of Saira Asia Interiors (P.) Ltd. Vs. ITO, [2017]164 ITD 687 (Ahmedabad- Trib.), has, inter alia, observed as follows:-
“8. As for the point of time of crediting the amount payable to non-resident, i.e. "at the time of credit of such income to the account of payee", the royalty so paid by the assessee was not taxable in the hands of the resident, for the simple reason that, in terms of article 13 of Indo Italian DTAA- which is reproduced above for the ready reference, taxability of royalty is dependent on the payment by the resident of a contracting state and receipt of the same by the resident of the other contracting state. Unless, therefore, the actual payment takes place, the taxability under article 13 of Indo Italian DTAA does not arise. In other words, the mere fact that an Indian resident credits the amount of royalty payable to an Italian resident does not trigger taxability under article 13 of the Indo Italian DTAA. Such is also the view taken by a series of decisions by the coordinate benches, including the decision in the case National Organic Chemical Industries Ltd. v. Dy. CIT [2006] 5 SOT 317 (Mum.), with which we are in respectful agreement. When the royalty so credited by the assessee is not taxable at the time of credit of such amount to the account of payee, in the light of law laid down by Hon'ble Supreme Court in the case of GE Information Technology Centre (P.) Ltd. (supra), it does not give rise to any tax withholding obligations under section 195 (1) either. ”
The liability to deduct tax at source arises only when the income embedded in the relevant payment is exigible to tax. Clearly, the sale of bundles software to the
I TA N o. 1 5 6 5/ Ah d /2 0 1 7 S op h os Tec h n ol og ie s Pv t L td Vs . DC I T Ass e ss me n t Y ea r : 2 0 12 - 1 3 Page 9 of 9 distributor is not a point of time when the royalty in respect of the bundled product becomes payable. That point of time is when the end product is activated. In these circumstances, the Assessing Officer’s approach of treating the entire provision as income exigible to tax in the hands of the supplier of the anti-virus/anti-spam product is fallacious.
In any event, as evident from the undisputed facts on records, the tax withholding liability has been discharged by the assessee as and when the activation of key has taken place. This approach is legally correct because activation of the end product is the trigger to royalty accruing to the vendors and as such to the income in the hands, if taxable, being brought to tax in India. The approach of the assessee thus cannot be faulted with. In view of the above discussions and bearing in mind entirety of the case, we see merits in the plea of the assessee. The impugned disallowance of under section 40(a)(i), as rightly contended by the learned Counsel, is devoid of legally sustainable merits and must be, therefore, deleted. Accordingly, we direct the Assessing Officer to delete the impugned disallowance made under section 40(a)(i) of the Act.
Ground no. 2 is also thus allowed.
In the result, the appeal of the assessee is allowed. Pronounced in the open court today on the 16th November, 2018
Sd/- Sd/-
Justice P P Bhatt Pramod Kumar (President) (Vice President) Ahmedabad, the 16th day of November, 2018 **bt
Copies to: (1) The appellant (2) The respondent (3) Commissioner (4) CIT(A) (5) Departmental Representative (6) Guard File
By order TRUE COPY Assistant Registrar Income Tax Appellate Tribunal Ahmedabad benches, Ahmedabad