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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI CHANDRA POOJARI
O R D E R Per N.V. Vasudevan, Vice President
This is an appeal by the assessee against the final order of assessment dated 29.10.2018 passed by the JCIT, Special Range – 3, Bangalore u/s. 143(3) r.w.s. 144C of the Income-tax Act, 1961 [the Act], in relation to Assessment Year 2014-15..
The assessee is engaged in the business of providing back office operations and customs support services to its various Associate Enterprises (AE). The services so rendered are in the nature of Information Technology
IT(TP)A No. 3379/Bang/2018 Page 2 of 17 enabled Services [ITES]. In terms of section 92 of the Act, income arising from an international transaction has to be determined having regard to Arm’s Length Price [ALP]. In this appeal, we are concerned with determination of ALP in respect of international transaction of rendering ITeS by the assessee to its AE.
As far as rendering of ITeS by the assessee to its AE is concerned, the most appropriate method chosen for the purpose of comparison of the assessee’s profit margin with that of comparable companies was Transaction Net Margin Method (TNMM) and Profit Level Indicator (PLI) chosen for comparison was Operating Profit / Operating Cost (OP/OC). The assessee’s OP/OC was 17.73%. The assessee had chosen 7 comparable companies and their average arithmetic mean profit margin was 6.81% and assessee considered the transaction as at arm’s length as its margin was higher. The TPO did not accept the plea of the assessee and he chose 5 comparable companies whose average profit margins were 22.34% as per the following chart:- Average ITES Segment Amounts in Rs.Lakh Sl OP/OC No. OR/Sales OC OP (in %) Company Name 1 Infosys B P O Ltd. 2,30,900.00 1,81,200.00 49,700.00 27.43% 2 Microgenetic Systems Ltd. 225.97 191.41 18.06% 34.56 3 Microland Ltd. 28,709.00 5,762.00 20.07% 34,471.00 4 B N R Udyog Ltd. (Seg) 142.59 114.00 28.59 25.08% Crossdomain Solutions 5 6,164.00 1,298.76 21.07% 7,462.75 Pvt Ltd..
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The TPO ultimately computed the ALP as follows:- ITES Segment Arm's Length Mean Margin on cost 22.34% Operating Cost 13,17,09,81,000 Arm's Length Price(ALP) @ 122.34% 15,11,33,78,155 of Operating Cost) Price Received 15,50,67,84,000 Variation in Price 60,65,94,155 3% of price received 46,52,03,520 Shortfall being adjustment 60,65,94,155
The Transfer Pricing Adjustment and consequent addition to the total income as determined by the TPO at Rs.60,65,94,155 was incorporated by the AO in the draft order of assessment passed by the AO. The Assessee preferred objections to the determination of ALP by the TPO before the Dispute Resolution Panel (DRP). The DRP excluded only one company from the list of comparable companies viz., BMR Udyog Ltd. After the directions of the DRP, the AO gave effect to the directions of the DRP in his final order of Assessment, in which the addition suggested by the TPO, to the extent it was sustained by the DRP was made to the total income of the Assessee. Aggrieved by the aforesaid addition on account of determination of ALP, and the consequent addition to the total income of the Assessee, the Assessee is in appeal before the Tribunal.
Before the Tribunal, the assessee seeks exclusion of 2 comparable companies out of remaining 4 comparables viz., (i) Infosys BPO Ltd., (ii) and (ii) Cross Domain Solutions P. Ltd. As far as comparability of the IT(TP)A No. 3379/Bang/2018 Page 4 of 17 aforesaid 2 companies in the ITeS segment are concerned, the learned Counsel for the assessee relied on a decision of the Hyderabad Bench of the Tribunal in the case of Infor (I) Pvt. Ltd. v. DCIT [2019] 109 taxmann.com 435 [Hyd. Trib.]wherein the Tribunal in the case of assessee who is also in the business of ITeS such as the assessee in this appeal, held that these two companies are not comparable with an ITeS company with the following observations:
Infosys BPO Ltd. “51. As regards the comparability of Infosys BPO Services Ltd is concerned, the learned Counsel for the assessee submitted that it is a large company operating at high economies of scale with turnover of INR 2023 crores compared to the assessee having turnover of Rs.26.25 crores only. Further, it is submitted that it has a brand value and it employs substantial portion of its fixed assets in intangible assets. He submitted that the comparability of the said company had come up for consideration in the assessee's own case for the earlier A.Y 2011-12 and also in 2013-14. In A.Y 2011-12, the Tribunal had directed its exclusion while in 2013- 14, the DRP itself had directed its exclusion and the Revenue has not filed any appeal as against the same. He placed reliance upon the decision of the Hon'ble Delhi High Court in the case of Aginity India Ltd. (supra) wherein the said company has been directed to be excluded.”
Cross Domain Solutions P. Ltd. “57. As regards Cross Domain Solutions Ltd is concerned, the case of the assessee is that it is functionally dissimilar as it renders KPO services. The learned DR, however, supported the orders of the TPO & DRP. 58. As regards the services rendered by this company, we find that at Page 172 of the Paper Book which is the Website printout,
IT(TP)A No. 3379/Bang/2018 Page 5 of 17 it is shown as a "knowledge center". The learned DR had submitted that if the contents of a Website given by a company is taken into consideration, then even the assessee would be falling in the same category i.e. Knowledge Process Outsourcing. The learned DR, except for relying upon his argument that the assessee is also into high-end BPO services, has not been able to point out that Cross Domain Solutions Ltd is not a BPO. Therefore, we direct exclusion of this company also from the final list of comparables.”
The learned DR however relied on a decision of ITAT Hyderabad Bench for Assessment Year 2014-15 in the case of Hyundai Motor India Engg. Pvt. vs. Dy. Commissioner of Income- Tax Ltd., Hyderabad (2018) 110 taxmann.com 483 (Hyd.-ITAT) wherein the Tribunal held Cross Domain Solutions Pvt. Ltd., as a comparable company with the following observations:
“6.10 Crossdomain Solutions Pvt. Ltd. - Ld. AR submitted that this company cannot be a comparable to the assessee company as this company is functionally dissimilar as it has a diversified Knowledge Process Outsourcing Company providing services in insurance, health care, HR and accounting domains. Company also offers business excellence market research and data analytics and IT services. It was also submitted that the company is engaged in software development activities. It was also submitted that in assessee's own case in AY. 2008-09, this company was rejected by the ITAT due to the fact that it has diversified activity and further, segmental information was not available. It was also contended that the margin calculated by the TPO is incorrect and furnished a revised computation. The issue was whether the bad debts were non-operating expenses and TPO has not followed the guidelines on the issue. 6.11. Ld. DR, on the other hand, relied on the orders of revenue authorities. 6.12 Considered the rival submissions and perused the material on record. In assessee's own case for AY 2011-12, the coordinate bench held as under: "9.11. We have considered the rival contentions and perused the documents placed on record. Assessee has raised the same objections before DRP which gave a finding that the engineering
IT(TP)A No. 3379/Bang/2018 Page 6 of 17 design services being rendered by assessee are akin to KPO services of the above company. It further considered that functional comparability need to be decided on the basis of the information available in the annual report and not based on the website information which may vary and may not be reliable. It was further noted that in the case of M/s. Excellence Data Research Pvt. Ltd., in the ITAT rejected the objection of assessee for exclusion of above company noting that the annual report refers only service and is in the pay roll service activity. Thus, stating DRP rejected assessee's objections. We do not find any reason to interfere with the said objections as the very basis of the contentions are based on the website information but not on the annual report. However, the DRP has directed the TPO to verify the margin which assessee submits that has not been considered. Therefore, while retaining the company as a comparable one, we direct the AO/TPO to examine the contentions with reference to margin computation of the above said company after giving due opportunity to assessee to make submissions. This issue is considered partly allowed." Following the said decision, we reject the contention of the assessee and retain this company as comparable.
We have considered the rival submissions. As far as exclusion of Infosys Ltd., is concerned, the decision of the ITAT Hyderabad Bench cited by the learned Counsel for assessee supports the pela for exclusion. Hence, we direct exclusion of Infosys Ltd., as a comparable company. As far as exclusion of Cross Domain Solutions Pvt. Ltd., is concerned, we notice that this company renders diversified Knowledge Process Outsourcing (KPO) providing services in insurance, health care, HR and accounting domains. In the decision cited by the learned DR, the assessee was also in KPO services of providing engineering design services. The assessee in this appeal is a Business Processing Outsourcing Services which are routine in nature and not in the nature of a knowledge process outsourcing. Therefore we prefer to follow the decision cited by the learned Counsel for assessee and direct exclusion of Cross Domain Solutions Pvt. Ltd.
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The other issue that remains for consideration is the issue with regard to non-grant of working capital adjustment while arriving at the average arithmetic profit margin of comparable companies. As far as the aforesaid issue is concerned, the DRP refused to allow the working capital adjustment for the following reasons:- “2.8.1 Having considered the submissions, we note that Rule 10B provides for making reasonably accurate adjustment to the uncontrolled comparable transaction to eliminate the material effects of differences on the price, cost or profits. The assessee has argued for working capital adjustment contending that there exist differences in the payable and receivable position between the assessee and the comparables. However, it was not demonstrated with any data or information as to the impact of such difference on the price, cost or profits, and as to whether such difference materially affect the price, cost or profits. The ‘Accounts payables' and 'Receivables' shown in the balance sheet only reflects the position as at the end of the financial year, and as such it would not enable to measure the impact of working capital on the costs, price or profits. The working capital requirements and impact depends on various factors such as business cycle, the nature of business activity with its correlation on the general economic trends, the fund and capital position of the company, its marketing strategies, its market share etc. all of which cannot be captured in the year end Receivable or Payable position. Besides, the 'Payable' and 'Receivable' position stated in the Balance Sheet may not exactly reflect as to whether it arises from transaction elating to Revenue Account or Capital Account as there is no uniformity in the accounting or reporting requirements, and an intermixing is generally possible. The cost ascribable to the working capital would be different to different enterprises depending on the cost of fund to the enterprise, the cost of money in the economy it operates etc. In view of these, a reasonable accurate adjustment is not possible, as the differences in working capital requirements itself is based on various assumptions. Besides, we also note that the assessee had failed to demonstrate such material differences so as to warrant an adjustment. In these circumstances, we are inclined to uphold the IT(TP)A No. 3379/Bang/2018 Page 8 of 17 TPO's reasoning and reject the assessee's claim for working capital adjustment.”
The ld. counsel for the assessee submitted that a co-ordinate Bench of ITAT Bangalore in the case of Huawei Technologies India Pvt. Ltd. IT(TP)A No.1939/Bang/2017 has dealt with the issue of granting of working capital adjustment. The Tribunal held that a reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly show that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. The Tribunal also referred to Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) which contains extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of those guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that: None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or IT(TP)A No. 3379/Bang/2018 Page 9 of 17 Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments.
The Tribunal analysed Paragraph 13 to 16 of the aforesaid OECD guidelines, which highlights the need for working capital adjustment as follows:- “13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing effect.
14. The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect.
A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory)
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16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers – (less) the period granted to pay debts to suppliers. 12. In the aforesaid decision, the reasons for not allowing adjustment to the profit margins on account of working capital differences between the tested party and the comparable companies for the very same reasons for which CIT(A) refused to allow working capital adjustment in the case of the Assessee in this appeal and those reasons were as follows: (i) The daily working capital levels of the tested party and the comparables was the only reliable basis of determining adjustment to be made on account of working capital because that would be on the basis of working capital deployed throughout the year. (ii) Segmental working capital is not disclosed in the annual reports of companies engaged in different segments and therefore proper comparison cannot be made. (iii) Disclose in the balance sheet does not contain break up of trade and non-trade debtors and creditors and therefore working capital adjustment done without such break up would result in computation being skewed.
IT(TP)A No. 3379/Bang/2018 Page 11 of 17 (iv) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results.
The CIT(A) in the decision cited by the learned counsel for the assessee also placed reliance on a decision of Chennai ITAT in the case of Mobis India (2013) 38 taxmann.com. The Tribunal held that the said decision was based on the factual aspect that the assessee was not able to demonstrate how working capital adjustment was arrived at by the assessee.
The Tribunal further held that in the matter of determination of Arm’s Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm’s Length Price. The data available with the assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the assessee to produce the correct information about the comparable companies. The Revenue has, on the other hand powers, to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing
IT(TP)A No. 3379/Bang/2018 Page 12 of 17 working capital adjustment, the Tribunal in the decision cited by the learned counsel for the Assessee before us, relied on the decision of the Delhi Bench of ITAT in the case of ITO Vs. E Value Serve.com (2016) 75 taxmann.com 195 (Del-Trib) wherein it was held that insisting on daily balances of working capital requirements to compute working capital adjustment is not proper as it will be impossible to carry out such exercise and that working capital adjustment has to be based on the opening and closing working capital deployed. The Bench has also observed that in Transfer Pricing Analysis there is always an element of estimation because it is not an exact science. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. The Tribunal held that there is little merit in CIT(A)’s objection on working adjustment based on unavailable daily working capital requirements data. The Tribunal also held that there is also no merit in the objection of the CIT(A) regarding absence of segmental details available of working capital requirements of comparable companies chosen and absence of details of trade and non-trade debtors of comparable companies as these details are beyond the power of the Assessee to obtain, unless these details are available in public domain. Regarding absence of cost of working capital funds, the OECD guidelines clearly advocates adopting rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party.
15. The Tribunal finally concluded that the CIT(A) was not justified in denying adjustment on account of working capital adjustment.
In the case of the Assessee in this appeal, neither the TPO nor the DRP have gone into the quantum of adjustment that is to be given towards
IT(TP)A No. 3379/Bang/2018 Page 13 of 17 working of working capital adjustment, we are of the view that it would be just and appropriate to remand the issue of granting of working capital adjustment to the TPO/AO for fresh consideration in accordance with law after due opportunity of being afforded to the Assessee. We hold and direct accordingly.
The assessee has filed application for raising the following additional grounds: Ground No.15: Claim towards payment of leave encashment of INR 2,35,95,073 15.1 The Assessing Officer ("Learned AO") and Honourable Dispute Resolution Panel ("Hon'ble DRP") have erred in law and on facts, in not granting deduction in respect of amount paid towards leave encashment INR 2,35,95,073 during the Assessment Year ("AY") 2014-15 under the provisions of section 43B(f) of the Income Tax Act,1961 ("the Act"), after having denied the Appellant's claim of provision for leave encashment on accrual basis for AY 2007-08 and AY 2013-14. 15.2 The Learned AO and Hon'ble DRP, have erred in law and on facts, in not appreciating the fact that the Appellant was eligible for the deduction towards leave encashment although the same was not claimed in the return of income filed by the Company for the AY 2014-15, owing to its claim of deduction of provision for leave encashment made in AY 2007-08 and AY 2013-14 based on the decision of Hon'ble Calcutta High Court decision in the case of Exide Industries Limited v. Union of India [2007] [164 taxman 9], which was subsequently rejected.
Ground no. 16: Deduction in respect of 'education cess on income-tax' and secondary and higher education cess on income-tax' while assessing the total income of the Appellant The Assessing Officer ("Learned AO") and Dispute Resolution Panel ("DRP"), while assessing the total income of the Appellant for the IT(TP)A No. 3379/Bang/2018 Page 14 of 17 year under consideration, have erred in not allowing a deduction for education cess and secondary & higher education cess (collectively known as "education cess") for the year under consideration, although not claimed as a deduction by the Appellant in the return of income filed for the year under consideration. The said grounds are independent and without prejudice to the other grounds of appeal preferred by the Appellant. The Appellant craves leave to add, alter, vary, omit, substitute or amend the above ground of appeal, at any time before or at the time of hearing, of the appeal, so as to enable the Honorable Income Tax Appellate Tribunal to decide this appeal according to law and facts of the case.
18. Both the additional grounds have been stated to have been raised in view of the subsequent decision of the Hon’ble Supreme Court rendered on 24.04.2020 in the case of Exide Industries (supra) Civil Appeal No.3545/2009 on ground Nos.15 and 16 of the Hon’ble Bombay High Court in the case of Sesagoa Ltd., Vs. JCIT (2020) 117 taxmann.com 96 on addition ground No.16.
19. Ground No.15 is with regard to the claim for deduction on account of leave encashment. Both the aforesaid grounds are legal grounds and can be decided on the basis of the facts already on records and hence they are admitted for adjudication.
20. As far as ground No.15 is concerned, the facts are that during the Financial Year ("FY") 2013-14 the assessee had made payment towards leave encashment of INR 4,50,79,000 and the same was disclosed as part of Clause 26 of Tax Audit Report ("TAR") filed in Form 3CD for the said FY. Though the assessee was eligible to claim INR 4,50,79,000 under section 43B of the Act, the assessee had not claimed the payment towards leave
IT(TP)A No. 3379/Bang/2018 Page 15 of 17 encashment in the return of income by the assessee for the reason that during the FY 2006-07 to FY 2012-13, the assessee, placing reliance on the decision of Calcutta High Court in case of Exide Industries v. Union of India [2007] [164 taxman 9], had claimed deduction towards provision of leave encashment on accrual basis despite specific provisions of section 43B(f) of the Act which provides for deduction only on the basis of actual payment. Accordingly, the payments made in subsequent years were not claimed since the claim of accrual was already made d the litigations were pending, as detailed below.
The Assessing Officer ("AO") during the assessment proceedings did not accept the claim in FY 2006-07 and FY 2012-13 relevant to Assessment Year ("AY") 2007-08 and AY 201314. Accordingly, the AO made an adjustment of INR 6,83,81,220 and INR 11,66,67,733 -respectively, to the total income in the assessment order under section 143(3) of the Act, for the said AY's. The Hon'ble Income Tax Appellate Tribunal, Bangalore ("ITAT") in case of assessee for AY 2007-08 and AY 2013-14, has remitted the issue back to the file of the AO through order dated 16 January 2017 in I.T(TP).A No. 1092/Bang/2011 and order dated 25 October 2019 in respectively to decide the issue based on the outcome of the Hon'ble Supreme Court's decision in the case of Exide Industries.
Subsequently on 24 April 2020, the Hon'ble Supreme Court vide Civil Appeal 3545/2009 overruled the decision of Calcutta High Court in the case of Exide Industries and upheld the constitutional validity for deduction of leave encashment on payment basis under section 43B(f) of the Act. In view of the Hon’ble Supreme Court decision, the deduction on account of IT(TP)A No. 3379/Bang/2018 Page 16 of 17 provision for leave encashment cannot be sustained. However, the assessee wants to raise additional grounds of appeal for allowing the deduction under section 43B(f) of the Act on the payments made towards leave encashment in AY 2014-15 which has not been claimed in the Return of Income for the year.
We have considered the submissions of the parties and are of the view that in the light of the decision of the Hon’ble Supreme Court in the case of Exide Industries (supra), the assessee will not be entitled to claim deduction on leave encashment on the basis of the provision. Taking into consideration the circumstances under which the assessee did not claim a sum of Rs.4,50,79,000/- being leave encashment actually being paid during the previous year relevant to Assessment Year 2014-15 we are of the view that the assessee should be allowed leave encashment actually paid as per provisions of section 43B(f) of the Act. We remit the issue to the AO to verify the claim of the assessee and allow deduction to the assessee as per law after affording assessee opportunity of being heard.
As far as ground No.16 raised by the assessee is concerned, the same is with regard to deduction in respect of Education Cess on Income Tax and Secondary and High Education Cess on Income Tax. The learned Counsel submitted that in the case of Sesagoa Ltd., Vs. JCIT (supra), the Hon’ble Bombay High Court held that Education Cess and Secondary and High Education Cess are not in the nature of tax and are deductible expenditure. We have considered the submissions and we find that the Hon’ble Bombay High Court in the case of Sesagoa Ltd., (supra) held the expression 'cess' used in section 40(a)(ii) of the Act ought not to be read or included in IT(TP)A No. 3379/Bang/2018 Page 17 of 17 expression 'any rate or tax levied' as appearing in section 40(a)(ii) and consequently, 'cess' whenever paid in relation to business, is allowable as deductible expenditure. Following the aforesaid decision, we uphold the claim of the assessee for deduction of the aforesaid sum.
In the result, appeal by the assessee is partly allowed.
Pronounced in the open court on the date mentioned on the caption page.