M/S. FIBERLINK SOFTWARE PRIVATE LIMITED,BENGALURU vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-3(1)(1), BENGALURU

IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCHES “B” BENCH: BANGALORE

BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SHRI GEORGE GEORGE K, JUDICIAL MEMBER

IT(TP)A. No. 2703/Bang/2017 Assessment Year: 2013-14 M/s. Fiberlink Software Pvt. Ltd., The Deputy C/o. IBM India Pvt. Ltd., Commissioner of Level 3, Subramanya Income Tax, Arcade -1, Circle – 3 (1)(1), 12, Bannerghatta Road, vs. Bangalore. Bangalore – 560029. PAN: AAACF8942P (Appellant) (Respondent)

Assessee by : Shri K. Nageswar Rao, Advocate Revenue by : Dr. Manjunath Karkaihalli, CIT (DR)

Date of Hearing : 23.11.2021 Date of Pronouncement : 20.12.2021 ORDER PER SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER

This appeal by assessee is directed against the order of DCIT, Circle 3(1)(1), Bangalore dated 16.10.2017 for Assessment Year 2013-14. The assessee raised grounds as follows: “Based on the facts and circumstances of the case and in law, Fiberlink Software Private Limited (hereinafter referred to as the 'Appellant') respectfully craves leave to prefer an appeal against the order passed by the Deputy Commissioner of Income-tax — Circle 3(1)(1) (Assessing Officer' or 'AO') dated October 16, 2017 in pursuance of the directions issued by the Dispute Resolution Panel ('DRP'), Bengaluru dated September 13, 2017, under section 253 of the Income-tax Act, 1961 ('the Act') on the following grounds:

Page 2 of 15 IT(TP)A No. 2703/Bang/2017 That on the facts and in the circumstances of the case and in law and based on the directions of the DRP: A. General 1. The order of the learned AO and directions of the Hon'ble DRP are based on incorrect interpretation of law and therefore are bad in law. 2. On the facts and in the circumstances of the case and in law and based on the directions of DRP, the learned AO erred in assessing the total income of the Appellant at INR 6,95,28,295 as against returned income of INR 5,12,80,580 computed by the Appellant. 3. The learned AO has erred, in law and facts, by considering an incorrect amount of interest under Section 234B of the Act and Section 234C of the Act in the assessment order. 4. The learned AO erred, in law and in facts, in initiating penalty proceedings u/s 271(1)(c) of the Act. B. Grounds of appeal relating to Corporate tax matters 5. The learned AO has erred, in law and facts, by disallowing rent expense of INR 7,97,793 credited by the Assessee to the rent equalisation reserve 6. The learned AO has erred, in law and facts, by disallowing INR 6,55,171 in respect of reversal of provisions pertaining to bonus, gratuity and leave encashment 7. The learned AO has erred, in law and facts, by disallowing gross repairs and maintenance expenses of INR 20,29,320 considering the same to be capital expenditure and only allowing a deduction of depreciation instead for INR 1,11,764 on such expenditure. 8. The learned AO has erred, in law and facts, by considering a lower amount of credit under Minimum Alternate Tax ("MAT") provisions of the Act i.e. INR 21,68,578 than the MAT credit claimed in the return of income. C. Grounds of appeal relating to transfer pricing matters 9. The learned AO / TPO erred in making an addition of INR 1,48,77,237 to the total income of the Appellant on account of adjustment in the arm's length price with respect to the software development services transaction entered into by the Appellant with its associated enterprise. 10. The learned TPO/ AO have erred, in law and in fact, by erroneously allocating the entire expenditure incurred (both direct as well as indirect expenses) by the Assessee during the FY 2012-13, on

Page 3 of 15 IT(TP)A No. 2703/Bang/2017 revenue basis towards all the segments of Fiberlink India for the purpose of computing operating margins without appreciating the fact that all direct expenses were booked by the Assessee on actuals and indirect expenses were allocated on appropriate basis by the Assessee, while computing the operating margins in the TP documentation report. 11. The learned TPO/ AO have erred, in law and in fact, by not appreciating the economic analysis undertaken by the Assessee in accordance with the provisions of the Act read with the Rules, rejecting the transfer pricing approach and the comparables identified by the Assessee in its transfer pricing documentation report maintained, conducting a fresh economic analysis for the determination of the ALP in connection with the impugned international transaction and holding that the Assessee's international transaction is not at arm's length. 12. The learned TPO/ AO have erred, in law and in fact, by including/rejecting certain companies based on unreasonable comparability criteria. Appellant craves leave to contest selection of all comparables (whether or not mentioned specifically herein above) included by TPO or Hon'ble DRP in comparable set and upheld by Honble DRP at the time of hearing. Although some of the companies were chosen as comparables in transfer pricing study, upon consideration of more details some of these comparables in case found to be not comparable for different reasons, appellant craves leave to urge the same at the time of hearing. 13. The learned TPO/ learned AO have erred, in law and in fact, by rejecting certain comparable companies identified by the Appellant using the employee cost less than 25% of the total revenues as a comparability criterion. 14. The learned TPO/ learned AO have erred, in law and in fact, by not applying a higher threshold while applying the turnover filter. 15. The learned TPO/ learned AO have erred, in law and in facts, by applying the filter of companies having different accounting year for rejecting the comparable companies (i.e., companies having accounting year other than March 31 or companies whose financial statements were for a period other than 12 months); 16. The learned TPO/A0 have erred in law and in fact, by erroneously computing the margins of the comparable companies for the purpose of margin calculation of the comparables.

Page 4 of 15 IT(TP)A No. 2703/Bang/2017 17. The learned TPO/ AO have erred, in law and in fact, by rejecting/ including certain companies on the basis of information obtained by the tax office by exercising powers under section 133(6) of the Act. 18. The learned AO/TPO have erred in law and in fact, by providing the negative working capital adjustment of -1.17% in relation to the software development services transaction without appreciating the fact that the Appellant does not bear any working capital risk. 19. The learned TPO/ learned AO have erred, in law and in facts, in computing the arm's length price without giving the benefit of 3 percent under the proviso to section 92C of the Act; 20. The learned TPO/ learned AO have erred, in law and in facts, by not making suitable adjustments to account for differences in the risk profile of the Appellant vis-a-vis the comparables. 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. Additional Grounds of Appeal:- 21. "The learned AO/ TPO and DRP erred in including CG-VAK Software and Exports Ltd., Larsen and Toubro Infotech Limited and Persistent Systems Limited in the final set of comparable companies by applying unreasonable comparability criteria." 22. "The learned AO/ TPO and DRP erred in rejecting Helios and Matheson Information Technology Ltd., Acropetal Technologies Limited and Blue Star Infotech Limited from the final set of comparable companies by applying unreasonable comparability criteria." 2. The assessee filed petition of additional grounds and submitted that these additional grounds arise out of the order of the lower authorities. The Ld.AR submitted that there is no necessity of investigating any facts relating to these issues which are already on record and non-adjudication of these additional grounds would result in incomplete appreciation and adjudication of matter. It was submitted that assessee failed to raise these grounds at an earlier stage is neither wilful nor wanton but raised by way of abundant caution.

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4.1 Ground nos. 9 to 17, 19 and 20 and additional ground no. 22 are also not pressed.

Ground no. 5:- 5. The facts of this issue are that the company created rent equalisation reserve of Rs. 7,97,793/- during the year. This is only a provision, the assessee company was requested to showcase why the provision should not be disallowed by the AO. The contention of the Ld.AR is that this was provided in the books of accounts on the basis of AS-19 and this issue was considered by Hon’ble Delhi High Court in the case of CIT vs. Virtual Soft Systems Ltd. reported in 341 ITR 593 wherein held as under: “14.3 Lease rental in monetary terms is a sum total of: the financing charge and the amount embedded in it in the form of the capital sum. What the assessee needs to do, while offering for tax income derived from lease is, to separate the financing charge from the amount recovered towards capital, that is, the capital recovery amount. The financing change is determined by applying the IRR to the net investment made in the asset. The assessee also needs to provide for depreciation, on the capital value embedded in the lease rental. The fourth element which is the lease equalization charge is the result of the adjustment, which the assessee has to make whenever, the amount

Page 6 of 15 IT(TP)A No. 2703/Bang/2017 put aside towards capital recovery is not equivalent to the depreciation claimed by the assessee. The assessee, may claim depreciation based on the provisions of the IT Act or, may even adopt the method of depreciation provided under the Companies Act. In the event, the depreciation claimed is less than the capital recovery, the difference is debited in the profit and loss account in the form of lease equalization charge, and similarly if, for any reason the depreciation claimed is more than capital recovery then, the difference is credited, once again, in the form of lease equalization charge to the profit and loss account. Therefore, the assessee in effect debits or credits its profit and loss account with a lease equalization charge depending on whether or not the depreciation claimed is, less or more than the capital recovery. The capital recovery can be known, as is evident, on deduction of financing charges from the lease rentals. In sum and substance, lease equalization charges is a method of re-calibrating the depreciation claimed by the assessee in a given accounting period. The method employed by the assessee, therefore, over the full term of the lease period would result in the lease equalization amount being reduced to a naught, as the debit and credits in the profit and loss account would square off with each other. Hence, the contention of the revenue that it is a claim in the form of a deduction which cannot be allowed, as there is no provision under the I.T. Act is, in our view, a complete misappreciation of what constitutes a lease equalization charge. In our opinion, as long as the method employed for accounting of income meets with the rudimentary principles of accountancy, one of which, includes offering only revenue income for tax, we cannot find fault with the assessee debiting lease equalization charges in the AYs in issue, in its profit and loss account. This represents true and fair view of the accounts; a statutory requirement under Section 211(2) of the Companies Act. As explained by us above, the rationale is that over the entirety of the lease period the said debit would work itself out.”

Page 7 of 15 IT(TP)A No. 2703/Bang/2017 Assessment Years which will result in total disallowance which cannot be permitted. We find force in this submission of Ld.AR. In our opinion, on actual payment of rent of enhanced in subsequent AY allowed this provision made in this AY as rent equalisation reserve cannot be allowed. Accordingly, this issue remitted to the AO to examine whether actual rent has been allowed in subsequent AYs or not and decide accordingly.

Ground no. 6:- 8. The assessee in the Assessment Year under consideration claimed an amount of Rs. 6,55,171/- in respect of reversal of provision pertained to bonus, gratuity and leave encashment. This was disallowed by the Assessing Officer on the reason by observing that this expenditure could be allowed only in the year of payment in view of provision section 43B of the IT Act. According to this, claim of the assessee was not allowed when the assessee made actual provisions in earlier Assessment Years and that provision was reversed in this AY and on this account of reversal, it should be allowed otherwise it would amount to double disallowance. The Ld.DR relied on the orders of lower authorities.

Ground no. 7:- 10. In the AY under consideration, assessee claimed expenditure of Rs.20,29,320/- as revenue expenditure on the reason that such expenditure

Page 8 of 15 IT(TP)A No. 2703/Bang/2017 is not a capital expenditure and it was in regard to setting up of workstations and interior work on leased premises and does not resulted in any creation of any capital asset and it should be allowed as revenue expenditure and instead of treating as capital expenditure. The Ld.DR submitted that expenditure is capital in nature which resulted in enduring benefit.

Page 9 of 15 IT(TP)A No. 2703/Bang/2017 carried on in a building not owned by him but in respect of which the assessee holds a lease or other right of occupancy and any capital expenditure is incurred by the assessee for the purposes of the business or profession on the construction of any structure or doing any work in or relation to, and by way of renovation or extension of, or improvement to, the building, then, the provisions of this claim shall apply as if the said structure or work is a building owned by the assessee." This Explanation to Section 32 of the Act was introduced by the Taxation Laws (Amendment and Miscellaneous Provisions) Act, 1986 w.e.f. 1.4.1988. By introduction of this Explanation, the Legislature intended to allow depreciation on the capital expenditure incurred by the assessee in relation to renovation, extension or improvement to the building in which the assessee carried on business as lessee. 7.4.4 It may be useful to examine the Legislative history of the introduction of Explanation 1 to Section 32 of the Act. The taxation Laws (Amendment) Act,1970 w.e.f. 1.4.1971 introduced sub- section 1A to grant some benefit to the assessee on the capital expenditure incurred by a tenant in leased premises'. Therefore, it is obvious that prior to the introduction of sub-section 1A to Section 32 of the Act w.e.f. 1.4.1971 by the Taxation Laws (Amendment) Act, 1970, the assessee who takes the business premises on lease was not entitled to any depreciation on capital expenditure incurred thereon. In other words, prior to 1.4.1971, assessees who incurred capital expenditure on leased premises were not entitled to any benefit at all in this regard. Therefore, by removing the legal restrictions in respect of capital expenditure incurred by the assessees who take business premises on lease, Parliament intended to grant / allow depreciation on the capital expenditure incurred on such leased premises. On a careful perusal of the provisions of section 32(1A) of the Act and the circumstances in which it was introduced in the statute, it is clear that in case revenue expenditure was incurred by the assessee on the premises taken on lease, the question of allowing any depreciation u. 32(1A) of the Act would not arise for consideration. In other words, section 32(1A) of the Act introduced w.e.f. 1.4.1971 by Taxation Laws (Amendment) Act, 1970 would not be applicable in case the assessee incurred revenue expenditure on the leased premises. 7.4.5 However, sub-section 1A of Section 32 of the Act introduced by Taxation Laws (Amendment) Act, 1970 was omitted and Explanation 1 to Section 32 was introduced by Taxation Laws (Amendment and Miscellaneous Provisions) Act, 1986 w.e.f. 1.4.1988. This was done when the concept of depreciation on individual asset was changed to depreciation on the block of assets. When Parliament introduced depreciation on block of assets, sub-section (1A) of Section 32 of the Act was deleted, an identical provision was incorporated in Explanation 1 to Section 32 of the Act. Therefore, the position of law as it remains after the introduction of sub-section 1A of Section 32 of the Act w.e.f. 1.4.1971 continued to be the same in respect of revenue expenditure incurred by the assessee on premises taken on lease. In

Page 10 of 15 IT(TP)A No. 2703/Bang/2017 other words, the concept of allowing depreciation on the capital expenditure in relation to renovation, extension or improvement of the premises taken on lease continued to be the same w.e.f. 1.4.1971. Therefore, whenever the assessee incurred the expenditure, in the process of earning profit while carrying on the business in the leased premises, the expenditure has to be treated as revenue expenditure and neither sub-section (1A) to Section 32 OR Explanation 1 to Section 32 of the Act would come in the way of allowing the same as revenue expenditure. However, when the assessee incurred expenditure which is of capital nature, then the Parliament allows the benefit to the assessee for claiming depreciation on such capital expenditure in relation to renovation, extension or improvement w.e.f. 1.4.1971 u/s. 32(1A) and in accordance with the provisions of Explanation 1 to Section 32 of the Act w.e.f. 1.4.1988. Hence, this is a benefit allowed to the assessees who have taken premises on lease and incurred expenditure in the capital field. However, as explained earlier, if the expenditure incurred falls in the revenue field, the assessee is entitled to claim it as revenue expenditure irrespective of Section 32(1A) or Explanation 1 of Section 32 of the Act. In our considered view, this being the correct position of law, the conclusions of both the Assessing Officer and the learned CIT(A) in the impugned orders that the expenses incurred on leased premises have to be capitalised and only depreciation can be allowed thereon is not in tune with the provisions of law and is therefore incorrect. 7.4.6 To fall within the ambit of the provisions of Explanation 1 to Section 32 of the Act, the question to be answered is, whether the assessee has incurred any capital expenditure for the purposes of business on the construction of any structure or doing of any work in or in relation to and by way of renovation or extension or improvement in the building. 7.4.7 In the case on hand, on an appreciation of the facts of the case and details on record, we find that after incurring the expenditure on the leased premises, the assessee has neither obtained any enduring benefit nor has any new capital asset has come into existence. The assessee continued to run the hotel in the very same leased premises. It is not anybody's case that the seating capacity was not increased after the expenditure. The expenditure incurred was only for carrying on the business and was an integral part of the profit earning process. Therefore, we find that no case has been made out to say that the assessee has obtained any enduring benefit by virtue of this expenditure. The nature of the work undertaken by the assessee is to carry on the business and not obtain any asset. Further, as already observed, no capital asset of an enduring nature came into existence. In other words, the assessee has not acquired any asset / income earning apparatus. It is well settled principle of law that the expenditure incurred for acquisition of an asset is a capital expenditure and expenditure incurred in the process of earning profit is revenue expenditure. In the case on hand, we are of the view that the assessee incurred the expenditure for efficient running of the business and therefore the expenditure incurred is revenue in nature.

Page 11 of 15 IT(TP)A No. 2703/Bang/2017 7.4.8 It is settled principle that the test of enduring benefit is neither certain nor conclusive. Even if this fact is applied, the expenditure incurred by the assessee is only in the process of earning profit and not to acquire any capital asset. As a result of the expenditure incurred by the assessee, the hotel remains a hotel and the capacity does not increase. At the most, the assessee might have carried on the business in a profitable manner. The assessee has not obtained any enduring advantage in the capital field. Therefore, the expenditure incurred facilitated the assessee to carry on its business effectively and more profitably. In this factual matrix of the case on hand, we are of the considered opinion that the expenditure incurred by the assessee has to be treated as revenue in nature. 7.4.9 In view of the judicial decisions cited by the assessee (supra), it is obvious that whenever an expenditure was incurred in the process of earning profits it has to be allowed as revenue expenditure. In such a case the expenditure incurred by the assessee would be out of the ambit and purview of the provisions of Explanation 1 to Section 32 of the Act of the Act. In the case on hand, it is not in dispute that the expenditure was incurred for renovation. These expenses were incurred only for the purpose of carrying on day to day business and earn profits and do not result in the bringing into existence of any capital asset. Therefore, in the light of the discussion from paras 7.1 to 7.4.9 of this order and the facts and circumstances of the case, in our view, the learned CIT (Appeals) was not right in upholding the disallowance of the expenditure by holding it as capital in nature. We, accordingly, reverse the findings of the authorities below on this issue and allow the assessee's claim for deduction of expenditure incurred towards renovation of plant design system, computer cabling, fire detection and alarm system, plumbing, air conditioning work, electrical works, interior work etc. on the hotel / building taken on lease. Accordingly the assessee's grounds raised at S.Nos.6 & 7 are allowed for Assessment Years 2005-06 to 2008-09.”

Ground no. 8:- 13. We have heard both the parties and perused the material available on record. The contention of the Ld.AR is that correct MAT credit benefit to be given to assessee. We direct the AO to give correct MAT credit to assessee. This issue is after verification of records remitted to the file of AO for fresh decision.

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TP Issues:- Ground No. 21:- 14. The assessee want exclusion of following comparables. i. CG-VAK Software and Exports Ltd. ii. Larsen and Toubro Infotech Ltd. iii. Persistent Systems Ltd.

Larsen & Toubro Infotech Ltd.- 16. The CIT(A) observed as under on this: “Having considered the submissions, and on perusal of the Annual Report, for the financial year 2012-2013, from the Directors Report it is evident that the IT services have been recognized in three clusters, i.e., service cluster, industrial cluster and telecom cluster. Product engineering services does not mean the engineering services but as per page-1 of the Directors Report, "Product engineering service business unit (PESBU) of the company has been serving the telecom/Entertainment Original Equipment Manufacturer (OEM) and semi-conductors market with several unique and cutting edge offerings." It is further evident from Note 'U', forming part of the accounts that entire revenue from overseas of Rs.3401.58 crores is from export of software. It is also noted that the TPO in his order has correctly founded out that the product UNITRAX, Accrusi, Service First are only platforms through which the software development services were rendered. Therefore, we do not find merit in the contentions that the company is a product development company. With regard to the contentions of substantial onsite expenses, we are in agreement with the reasoning of the TPO in the TP order that these expenses would not adversely impact the comparable. On the issue of huge turnover, we note this issue is discussed in detail in para 2.8 of this order. With regard to IPR, brand and other differences, the assessee has failed to establish that such differences have material effect on the margin of the above company, in terms of clause (i) of sub-rule (3) of Rule 10B, which provides that an uncontrolled transaction shall be

Page 13 of 15 IT(TP)A No. 2703/Bang/2017 comparable to an international transaction if none of the differences, if any, between enterprises entering into business transactions or likely to materially affect the profit arising from such transactions in the open market. Accordingly, the selection of the above company, as a comparable, is upheld.”

Persistent Systems Ltd.:- 19. As this was not considered as a comparable in the case of MetricStream Infotech (India) Pvt. Ltd. vs. DCIT (supra), we direct the TPO to exclude this from the list of comparables while determining the ALP of international transactions.

Page 14 of 15 IT(TP)A No. 2703/Bang/2017 Ground no. 18 with regard to negative working capital adjustment 20. We have heard both the parties and perused the record. This issue was considered by the Tribunal in the case of MetricStream Infotech (India) Pvt. Ltd. vs. DCIT(supra) as follows. “20. The last submission of the ld. Counsel for the assessee was that the TPO while concluding his order u/s.92CA of the Act, allowed adjustment on account of working capital at 1.85% but the DRP in its order held that working capital adjustment need not be given. On this aspect, the ld. Counsel for the assessee drew our attention to a decision of ITAT Bangalore Bench in the case of Microsoft Research Cable P. Ltd. v. DCIT, IT(TP)A No.1276/Bang/2017 for AY 2013-14, order dated 3.11.2017, wherein on identical reasoning of DRP, this Tribunal held as follows:- "8.2 We have heard the rival contentions, perused and carefully considered the material on record. It is settled principle by a plethora of judicial pronouncements by various benches of the Tribunals that the taxpayer shall be granted working capital adjustment in order to bring the assessee on par with the comparable companies selected. After perusal of the DRP's order, ITA Nos. IT(TP)A Nos.1418 & 2735/Bang/2017 we are of the view that the statement of the DRP in its order that the Tribunals have not examined the issues highlighted in its order is a general sweeping statement bereft of any basis. How to compute the working capital adjustment and the extent of adjustment to be granted to a particular assessee would depend on the facts of each individual case. We, however, observe that the factors mentioned by the DRP in its order could be of relevance only in deciding the quantum of working capital adjustment. We, therefore, set aside the finding of the DRP that the assessee is not to be granted working capital adjustment and in the interest of justice, we direct the TPO to examine, recompute and grant the assessee's working capital adjustment as per law after affording the assessee adequate opportunity of being heard in the matter and to file details / submissions required. Consequently Ground No.8 of assessee's appeal is allowed for statistical purposes."”

In view of the order of Tribunal, we inclined to allow the above grounds taken by the assessee.

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Sd/- Sd/- (GEORGE GEORGE K) (CHANDRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated: 20th December, 2021. /MS/

Copy to 1. The Appellant 2. The Respondent 3. CIT(A) 4. Pr. CIT 5. DR, ITAT, Bangalore. 6. Guard File By order

Assistant Registrar Income-tax Appellate Tribunal Bangalore