EREVMAX TECHNOLOGIES PVT. LTD.,KOLKATA vs. D.C.I.T./A.C.I.T., TP-1, , KOLKATA

“For the addition in respect of issue of Bad debt for under reporting of income in consequence of mis-reporting - Rs.9,73,70,939/-: The matter has been considered. The TPOS order clearly brings out that the claimed bad debts were related to occurrence of an extraordinary event i.e. Covid Pandemic that led to settlement of debt transaction between assessee and its AE. The transaction led to complete erosion of profits of the assessee entity le. against a business turnover of Rs. 10.54 crores, bad debts written off were Rs. 9.73 crores. Being a related party transaction and that too a foreign AE, the rigour of provisions of the Income-tax Act for admissibility of claim of bad debt should have been scrupulously fulfilled by the assessee entity. Assessee has furnished documentary evidence of correspondence with the parent AE stating that it was in dire needs of business funds that were due to it. These indicate that there was no real need to write off the related party transaction when assessee was itself in critical stage of funds for business. Thereafter, vide Board Resolution, assessee decided to write off the pending debt. The minutes are extracted as under……… Thereafter, to improve the financial viability of the Parent AE during the time of COVID, assessee wrote-off the debtor balance for the period prior to March, 2020. Thus, write off exercise was made by the assessee not from its own business perspective but of the Parent AE. Under these circumstances, the AO has correctly proposed disallowance of claim of bad debt under section 36(1) (vii) of the Act. Accordingly, these objections are hereby rejected.” 2.0 Aggrieved with both these actions, the assessee has approached the ITAT with the following grounds of appeal:

“1. That the Assessment Order, passed u/s 143(3)/144C(13) incorporating, as well, the Transfer Pricing Order/TP Order, passed u/s 92CA(3), consequent to the endorsement of thereof, by the Ld. DRP. for being based on, misperceived, fallacious and also prejudiced reasonings and conclusions and equally significantly, after complete disregard of several crucial evidence and pertinent judicial pronouncements, would deserve total reversal and nullification, so as to render all the additions and disallowances, effected therein, fully repealed. Re: Transfer Pricing Issue-Addition of Rs.17678365.00 a) That in the light of the facts and the law, Ld. TPO/DRP has grossly erred in rejecting the Profit Split Method/PSM of benchmarking the Appellant's International Transactions entered into with US based AE, and arbitrarily substituting the same with Transactional Net Margin Method/TNMM as the MAM, after omitting to appreciate, from the Financials, including that of the AE as well as the TPSR, the integrated and complementary nature of activities of the Erevmax Technologies Pvt. Ltd. Appellant and the AE, the full applicability of PSM method of income attribution. b) That in the light of the facts and the law, Ld. TPO/DRP has grossly erred in effecting an addition of Rs. 17678365/- on the ground of the alleged deficiency in regard to the Mark up, determined an 16.85% of OC, based on TNMM Method applied to the data of some Companies viewed as Comparable, after failing to appreciate, in the light of duly produced Consolidated Financial Statement Tax Returns of the US based AE and Split Financials of the Appellant and the AE, that actual profit margin of the AE, derived from unrelated parties, had not only been significantly lower than the mark up allowed to the Appellant but also caused it to suffer loss. c) That in the light of the facts and the law, The Ld. TPO/DRP while effecting the addition of Rs.176788365/- on the alleged ground of deficiency as to profitability Mark-up, has totally disregarded the proven fact of actual cost based revenue sharing resulting in almost Nil Income Loss at the end of AE, the excess mark up to the Appellant and accordingly, by means of this addition, has caused in the assessment of grossly notional, fictional and never earned income, in violation of the fundamental principle of 'Real Income theory and its absolute applicability to Chapter X and thus, Transfer Pricing Mechanism. d) Even otherwise, without prejudice to the foregoing grounds, for the sake of justice and fairness. even if the TNMM Method is considered as the Most Appropriate Method, in view of availability of the complete Financials, Tax Returns of the Appellant and the AE, not ever disproved by the Ld. TPO/DRP, the TPO may be directed to re-work the ALP, solely based on Internal TNMM Method, in the light of the actual cost incurred and revenue, eventually derived from external/ unrelated entities. Grounds relating to disallowance of Bad Debt-Rs.97370939/- a) That the Ld. Faceless Assessment Unit/DRP, have grossly erred in disallowing and negating the claim of Bad Debt on the most arbitrary, superficial and unlawful reasonings, after not only adopting some contrary, erroneous, prejudiced stand with regard to such claim, but also evidently disregarding some of the most fundamental evidence and the Judicial and Administrative pronouncements. b) That the Ld. FAU/DRP, have fallen into grave error in not allowing the Bad Debt Claim of Rs. Rs.97370939/- which had, vide Sec. 36(1)(vii) read with Sec. 36(2), called for full admissibility as such, in view of the proven fulfillment by the Appellant, of three mandatory criteria, i.e., (a) the amount being a debt or part thereof, b) such debt having represented Income (Turnover in the present case) considered in some earlier year, vide Sec. 36(2) and lastly, c) being written off in the Books as irrecoverable. c) That the Ld. FAU/DRP have grossly erred and simply misdirected themselves by abruptly assuming that the Bad Debt claim had been effected to help out the AE Debtor facing COVID related hardships, after turning a blind eye to the evidence as to explicit and emphatic refusal of such debtor to pay such debt despite regular demands and insistence, the Resolution of the Board to treat the debt as bad, the compliance with rigours of FEMA regulations as regards such Write off, given the involvement of Foreign Exchange, the compliance with RBI prescribed norms and corresponding approval, granted in this regard. d) That on the facts and circumstances of the case and in law, the FAU/DRP was Erevmax Technologies Pvt. Ltd. not at all justified in negating the claim for Bad Debt in view of the proven compliance with Sec. 36(1)(vii)/Sec. 36(2) and also the according of Approval to the Write Off of such Debt involving FEMA by the Representative Bank of RBI, after due satisfaction with the above statute, credibility of the records, Auditor's Certificate and adherence to the existing RBI prescribed Regulations. e) That on the facts and circumstances of the case and in law, the FAU/DRP have grossly erred in arbitrarily requiring the Appellant to prove the debt becoming bad, after not appreciating that in the light of Amendment introduced in sec. 36(1)(vii)/36(2), vide the Amendment Act of 1987, read with various judicial pronouncements (including that of Supreme Court) and also CBDT Circular, only the write off of some debt originating from previously considered and accounted for income, had been the mandate, and as such, the onus of proving the fact of its becoming bad had been dispensed with. f) That the Appellant craves leave to go for additional grounds, modify and not press any one or more the aforementioned grounds, either before or during the Appeal Hearing.” 2.1 Before us the Ld. AR argued with the help of two detailed paper books containing various essential documents and several case laws. To properly comprehend the substance of the Ld. AR’s arguments, it is necessary to extract the relevant portions from his written submissions:

“As per the Service Agreement, executed in between the Appellant and the AE (Erevmax Inc, USA), vide Page 41, a mark-up of 5% on cost had been allowed by the AE for the purpose of billing. Accordingly, in the light of Cost and Billing Summary (Page 33 and 34), forming part of the Transfer Pricing Study Report (Page 1-50), the on the total cost of Rs.100261865.06, a mark-up @ 5% of Rs. 5013093.00 had been added, to as to constitute a Export value of Software Services of Rs.105274958.31 / 1420680.00 $ (Page 34 Cost, Mark-up and Billing Summary and Audited Accounts Page 177). The Appellant had followed the Profit Split Method / PSM of Pricing of such Export and accordingly, in Form 3CEB (Page 3) such method had been duly disclosed. Again in the Transfer Pricing Study Report (vide Page 29), due to availability of respective/standalone figures of Turnover, Cost and Profit as well as the consolidated figures thereof, vide Page 35, the reason for following Split Method had been restated. However, on the perusal of the Transfer Pricing Study Report (Page 6-32) and its Annexures, especially Cost and Billing Summary (Page 33-34) and Consolidated Turnover and Profitability Statement (Page 35), and also the Audited Financials of the Erevmax Inc., USA / AE providing consolidated figures, the Ld. TPO had raised the following queries. The DRP, vide Page 7 of its Order, endorsed the observation of the TPO, by echoing the observations of the Ld. TPO. Its observations are as under Proper Economic Analysis had not been made.

Erevmax Technologies Pvt. Ltd. The Appellant as a Captive Software Service Provider, had provided SDS/ITeS services to its AE, which after some value addition by AE had been sold to end customer. PSM is not applicable unless the service or transaction relates to Unique Intangibles or Transactions of Repeated Nature. Even the Group Profit had not been compared with any external comparable to verify the Profit Split. As a result, the adoption of TNMM Method, the comparison of the Profitability rate with eleven external comparable companies Transfer Pricing Order, and the consequent determination of ALP amount of Rs.17678365/- being 16.85% of the Turnover of the Appellant of Rs. 105274894/-, had been proper and thus, deserved endorsement and confirmation. The Appellant had furnished respected replies to both the TPO and the DRP, by means of separate submissions. A kind perusal of the said respective replies would highlight the fallacies in their stand.” The Ld. AR relied on a plethora of case laws to canvass the point that PSM was the best method to compute ALP and not TNMM, as adopted by the Ld. TPO.

2.2 Regarding the issue of bad debt, the Ld. AR has relied on the express provisions of section 36(i)(vii) and 36(2) of the Act to stress the point that receivables from the AE had to be written off as it was unable to pay amounts owed to it due to financial hardship. Some extracts from the submissions may be mentioned:

“During the relevant previous year a sum of Rs.97370939.37 (equivalent to US$ of 1290974 converted @ Rs.75.4244 / Dollar) that had remained unpaid since the earlier year, from the Assesses's customer i.e., M/s Erevmax Inc., of 37, North Orange Avenue, Suite 500, Orlando, Florida, 32801, USA, had been written off as Bad Debt in its Books of Account and accordingly, debited in the Profit and Loss Account as such. Given such Write-off, deduction under section 36(1)(vii) in relation to the same had been claimed in the Return in relation to current assessment year. The aforesaid grounds are concerned with such disallowance. So from above documentary evidence, filed with the Assessment Unit /DRP, the following facts would be absolutely clear. a) The amount of Rs.97370939/- had been factually and evidently written off as bad through Journal and Ledger entries. This apart because of this write off, the Debtors' Balance as on 31/03/2021 had declined to Rs. 116142773.72 (Page 110). b) The same had been given effect to in the Audited Profit and Loss Account (Page 177).

Erevmax Technologies Pvt. Ltd. c) RBI Approval had been obtained in compliance with FEMA (Page 105,106.107). d) So, in terms of sec. 36(1)(vii), subject to Sec. 36(2), for allowability of Bad Debt, the only and sole requirement under the Act is to write it the Accounts of the Assessee (and nothing more). e) Sec. 36(2) necessitates that Bad Debt so written off would be allowable u/s 36(1)(vii), provided the same has been previously considered as Income. In the above tabulation, with the help of prior year's revenue ledger (Page 111) and Audited Profit/Loss Account (177), it has been corroborated how the Bad Debt Amount written off of Rs.97370939/-had evidently formed part of prior year's Revenue from Export Services. So, the condition mandated by sec. 36(2) has been fulfilled, so as to warrant it it allowability. allowability" The Ld. AR also pointed out correspondence with the AE (pages 92- 99 and pages 100-103 of paper book). It was argued that the AE is the assessee’s only customer and hence the assessee was inclined to accept the writing off of bad debts instead of engaging in precipitate legal action with the AE. The Ld. AR also pointed out that huge losses were incurred by AE (page 133 of the paper book) on account of the COVID-19 pandemic.

4.1 Regarding the TP adjustment it is seen that the assessee’s contention is two-fold – that the PSM is the best suited method and the comparable entities considered and adopted by the Ld. TPO are not specifically related to tourism software development. On these two issues it deserves to be said that the assessee has not convincingly demonstrated how the transactions involve “unique intangibles” and “multiple inter-related international transactions” which cannot be evaluated separately, which could justify adoption of the PSM. Also, it is felt that the end use (tourism sector) of software developed may not be critical in determining whether a comparable selected by the Ld. TPO is appropriate or not, but it is the size and scale of operations, including the peculiar geographies involved, which may be more relevant. It is seen that the TP report prepared by the assessee (placed in the paper book) does not clearly rely on any comparable entities for demonstrating ALP. Rather reliance has been placed on the agreement signed between the assessee and the AE to indicate that the formula prescribed therein is supported by PSM and hence should be adopted. It is visible that while the TPO has given cogent reasons for adopting TNMM, while rejecting the PSM, the assessee has not clearly indicated as to why the revenue mechanism laid down in the contractual agreement between the assessee and the AE should be adopted as such. Since this is an exclusively factual issue, we deem it fit that this issue should be re- examined by the Ld. AO/TPO, whereby the assessee must give its own comparable entities and demonstrate conclusively why the TNMM should not be adopted. The Ld. TPO/AO would be expected to judicially consider such submissions.

4.2 Regarding the issue of bad debts, we are aware of the specific mandate provided to the assessee under the provisions of section 36(1)(vii)

Erevmax Technologies Pvt. Ltd. and 36(2) of the Act. However, the peculiar facts surrounding this issue leave us considering whether the bad debts written off are not clearly commercial transactions gone wrong, but a method to enrich the AE at the expense of the assessee, the losses being incurred by the AE notwithstanding. At this juncture, we need to mention that the payments (impugned) receivable pertaining to AY 2020-21, belonged to a period when the COVID pandemic had affected only the last one or two months of the relevant financial year (FY 2019-20). If the contract between the assessee and the AE, which appears to from the bedrock of the assessee’s attempt at justifying the ALP, was strictly adhered to then the payments for services rendered would have been duly remitted as per Articles 3 and 4 of the Contract (at pages 36-41 of the paper book), much before the full impact of the COVID Pandemic. This writing off of bad debts has effectively reduced the profits of the assessee and has left an adverse mark on the balance sheet for several future years as well. Thus, this issue along, with the TP adjustment issue, have to be considered holistically. We may draw strength from the case of Mcdowell and Co. Ltd. reported in 154 ITR 148 (SC), in which a Constitution Bench of the Hon’ble Apex Court has mandated lifting of the “Corporate Veil” to determine where legitimate tax planning ends and evasion begins.

4.3 Summing up the findings in paragraphs 4.1 and 4.2 (supra), it needs to be reiterated that the Ld. AO’s order is set aside and remanded back to the Ld. AO/TPO for determining a fair ALP, with the assessees cooperation, and to also for re-visiting the issue of bad debts in light of the extant provisions of the Act, as well as the contractual obligations between the two parties, especially when the impugned receivables pertain to a period when there was either no impact of COVID or there was, at best, negligible impact. Also, the Ld. AO/TPO must examine the impact of such write off on the ALP.