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Income Tax Appellate Tribunal, “C” BENCH : BANGALORE
Before: SHRI N. V. VASUDEVAN & SHRI CHANDRA POOJARI
Per N. V. Vasudevan, Vice President are appeals by the Assessee and Revenue respectively against the order of CIT(A)-7, Bengaluru, dated
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 2 of 38 21.11.2017, relating to Assessment Year 2010-11. & ITA No. 418/Bang/2018 are appeals by the Assessee and Revenue respectively against the order of CIT(A)-7, Bengaluru, dated 21.11.2017, relating to Assessment Year 2011-12. The issues in these appeals are common and arise out of identical facts and circumstances. We therefore deem it convenient to pass a common order.
We shall first take up for consideration the cross appeals for AY 2010-11. The assessee is a subsidiary of VMware International Unlimited Company, Ireland (formerly known as VMware International Limited), which is an affiliate of VMware Inc., USA. It provides software development services [‘SWD services’ for short], Information Technology Enabled Services [‘ITES’ for short] and marketing support services [‘MSS services’ for short] to VMware group companies, as a captive service provider. For all the above services, the Assessee is compensated by the Associate Enterprise (AE) on a cost plus mark up basis. In terms of section 92B of the Income Tax Act, 1961 (Act), the above transactions were international transactions. In terms of section 92 of the Act, any income arising out of an international transaction has to be determined having regard to Arm’s Length Price (ALP). The revenue from the international transactions are as follows:
Details of international transactions entered into by the Assessee with its AE, as reflected in the TP order are as follows: International Amount Outcome of TP Order Transactions (in Rs) Accepted as being at Purchase of fixed assets 3,75,35,500/- arm’s length. Receipts for software TP adjustment of 1,23,00,29,957/- development services Rs. 16,23,38,959/- TP adjustment of Receipts for ITES 28,96,12,078/- Rs. 2,62,90,745/- Receipts for Marketing TP adjustment of 16,55,05,334/- Support services Rs. 2,55,86,449/- Reimbursement of 22,42,607/- Accepted as being at expenses arm’s length. Reimbursement of ESPP 1,26,20,227/- Accepted as being at charges paid arm’s length.
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 3 of 38 The manner in which ALP was computed by the TPO and the CIT(A) for each of the three segments and the issues that arise in these appeals with regard to computation of ALP are discussed in the subsequent paragraphs.
SOFTWARE DEVELOPMENT SERVICES SEGMENT As far as SWD services segment is concerned, both the assessee and Transfer Pricing Officer (TPO) to whom the determination of ALP was referred by the AO in terms of Sec.92CA of the Act, adopted Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for determining ALP.
Analysis of transfer pricing study of the Assessee and the TPO for software development services segment:
Mark-up on Total Cost (OP/ OC) earned by the Assessee (as reflected in the TP order vis-à-vis TP study):
Particulars As per TP order As per TP study Operating Income Rs.1,22,09,69,922/- Rs.1,32,56,71,807/- Operating Expenses Rs. 1,14,57,87,196/- Rs.1,17,26,67,316/- Operating Profit (Op. Income – Op. Rs.7,51,82,726/- Rs.15,30,04,491/- Expenses) OP/OC 6.56% 13%
Comparison of TP study done by the Assessee and the TPO:
The Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator (PLI) OP/TC OP/OC Database used PROWESS & PROWESS CAPITALINE Comparables selected 16 11
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 4 of 38
Comparables selected by TPO and their arithmetic mean as per TPO order:
Mark-up on Sl. Comparables Selected by TPO Total Costs No. (Unadj) 1. ICRA Techno Analytics Ltd. 24.94 2. Infosys Ltd. 44.98 3. Kals Information Systems Ltd. 34.41 4. Larsen & Toubro Infotech Ltd. 19.33 5. Mindtree Ltd. 14.83 6. Persistent Systems & Solutions Ltd. 15.38 7. Persistent Systems Ltd. 30.35 8. RS Software (India) Ltd. 10.29 9. Sasken Communication Technologies 17.36 10. Tata Elxsi 20.93 11. Thinksoft Global Services Ltd. 17.05 Arithmetic Mean 22.71%
Computation of arm’s length price by TPO and the adjustment made: Arm’s Length Mean Margin 22.71% Less: WC Adjustment (restricted to 1.98%) 1.98% Adjusted margin 20.73% Operating cost Rs.1,14,57,87,196/- Arm’s Length Price (ALP): 120.73% of Operating Cost Rs.1,38,33,08,881/- Price Received Rs.1,22,09,69,922/- Short fall being adjustment u/s. 92CA Rs.16,23,38,959/-
The adjustment suggested by the TPO was incorporated by the TPO in the draft Order of Assessment. The assessee did not file any objection to the draft Assessment Order before Dispute Resolution Panel (DRP) but filed appeal against the final Assessment Order in which the addition suggested by the TPO was incorporated by the AO.
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 5 of 38 5. The CIT(A) passed an order dated 21.11.2017 granting partial relief to the Assessee. The CIT(A) accepted the contention of the Assessee and directed exclusion of the following companies:
1. ICRA Techno Analytics Ltd.; 2. Infosys Ltd.; 3. Kals Information Systems Ltd.; 4. Persistent Systems Ltd.; 5. Sasken Communication Technologies Ltd.; and 6. Tata Elxsi However, the CIT(A) did not agree with the contentions of the Assessee and upheld the inclusion of L&T Infotech Ltdand Persistent Systems and Solutions Ltd. Further, the CIT(A) agreed with the contention of the Assessee and directed the AO/TPO to (i) treat gain/loss arising on account of fluctuation of foreign currency as being operating in nature and rework the margins of the Assessee and also the comparable companies; and (ii) grant working capital adjustment on actual basis without any restriction. Aggrieved by the reliefs allowed by the CIT(A) the Revenue has raised the following grounds of appeal before Tribunal:
1. The order of the learned CIT(A) is opposed to law and facts of the case.
2. The C1T(Appeals) ought to have considered that that the expenditure incurred in foreign currency, towards telecom charges and other expenses in connection with rendering technical services outside India, to be excluded only from export turnover and not from total turnover for the purpose of computation of deduction u/ s 10A of the Act, since such exclusion is permitted to arrive at the export turnover only as per the definitions given in Sec. 10A and total turnover has not been defined in the same. 3. "Whether the C1T(A) is correct in law in following the judgements of jurisdictional High Court in the case of CIT vs. Tata Elxsi Ltd., which has not become final since the same has not been accepted by the Department and SLPs are pending before the Hon'ble Apex Court"? 4. "The C1T(A) erred in excluding 2 companies in SWD segment as comparables on functional dissimilarity"? 5. "Whether the C1T(A) is right in not appreciating in fact that transfer pricing is not an exact science and no two entities can be exact replicas"?
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 6 of 38
6. "Whether the C1T(A) is right in trying to find out exact replica of the assessee for determining the ALP based on such replicas, even when the law and the international jurisprudence itself recognise that there cannot be an exact comparable to a given situation, especially with TNMM as the most appropriate method"? 7. "Whether the CIT(A) is right in law in demanding comparability standards that may itself defeat the purpose of law relating to determination of ALP under the IT Act"? 8. "Whether the order of the C1T(A) in imposing conditions is beyond the scope of law and business reality by rejecting all close comparables on the other ground, without appreciating that not two companies can ever be the same"? 9. "The C1T(A) erred in holding that the size and turnover of the company are deciding factors for treating a company as a comparable and accordingly erred in excluding ICRA Techno Analytics Ltd., (seg.) as comparable". 10.'The C1T(A) has erred in not appreciating that economies of scale is not relevant in the software industry". 11."Whether the C1T(Appeals) was right in removing the comparables on functional similarity"? 12."Whether the C1T(A) was right in seeking exact comparability while searching comparable companies of the assessee under TNMM method whereas requirements of and international jurisprudence require seeking similar comparable companies"? 13.`Whether the C1T(A) has erred in judging the nature and vast arena of the segment Marketing and sales support services"? 14.For these and other grounds that may be urged at the time of hearing, it is prayed that the order of the C1T(A) in so far as it relates to the above grounds may be reversed and that of the Assessing Officer may be restored. 15.The appellant craves leave to add, alter, amend and/or delete any of the grounds mentioned above.
We have heard the submissions of the learned Counsel for Assessee and the learned DR. Out of the above grounds Gr.No.4 to 12 are in relation to the TP adjustment in the SWD services segment. Vide these grounds, the Revenue is presumably challenging the action of the CIT(A) in directing the exclusion of (i) ICRA Techno Analytics Ltd., (ii) Infosys Ltd., (iii) Kals Information Systems Ltd., (iv) Persistent
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 7 of 38 Systems Ltd., (v) Sasken Communication Technologies Ltd.; and (vi) Tata Elxsi. We find that the grounds of appeal of the revenue are vague and therefore we presume that the grounds of appeal 4 to 12 are in relation to SWD services Segment and therefore proceed to decide the correctness of the CIT(A) in excluding the 6 comparable companies out of the 11 comparable companies chosen by the TPO.
7. ICRA Techno Analytics Ltd: We find that this company was excluded by the CIT(A) for the reason that it is functionally dissimilar to that of the Assessee (pages 17-18 of the CIT(A)’s order). It has been held that this company is engaged in a diverse range of IT Solution Services. The company is not a full-fledged software development company and provides such services among its other wide array of IT solution services like Business Analytics, IT Engineering and Business Process Outsourcing. Thus, functionally, the company is different from the Assessee. The learned Counsel for Assessee has placed reliance on the decision of this Hon’ble Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)], ACIT v. Broadcom India Research (P.) Ltd [2016] 72 taxmann.com 77 (Bangalore - Trib.) and ITO v. Interwoven Software Services (India) (P.) Ltd. [2016] 74 taxmann.com 103 (Bangalore - Trib.) wherein this company was directed to be excluded as a comparable in the case of assessees similar to the Assessee herein. Therefore, this company, in our view, was rightly excluded.
8. Infosys Ltd: This company was excluded by the CIT(A) for the reason that it was functionally dissimilar to the Assessee, by placing reliance of the decision of this Hon’ble Tribunal in Assessee’s own case for the Assessment year 2009-10. This company has high brand value and focuses on brand-building which occasions the high profits. The company incurs sales and marketing expenses amounting to 4.6% of its sales and thus acts as an entrepreneur as against the Assessee which is a captive unit. It also focuses heavily on R & D, having its own applied research division, and thus the company is thus not comparable to the Assessee. The turnover of this IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 8 of 38 company for the year ended 31st March 2010 was Rs. 21,140 crores which is far higher than the turnover of the Assessee. Infosys is a giant in the software development space while the Assessee is a captive unit. This company is being consistently excluded from the list of comparables in similar cases. Since the circumstances leading to it being excluded as being functionally dissimilar in the previous assessment continue to remain same, the company ought to remain excluded in the current assessment year. Further this Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)], ACIT v. Broadcom India Research (P.) Ltd [2016] 72 taxmann.com 77 (Bangalore - Trib.) and ITO v. Interwoven Software Services (India) (P.) Ltd. [2016] 74 taxmann.com 103 (Bangalore - Trib.) directed that this company should be excluded. We thus find no infirmity in the order of the CIT(A) in excluding this company.
9. Kals Information Systems Ltd.: This company was excluded by the CIT(A) for the reason that it was functionally dissimilar to the Assessee, by placing reliance of the decision of this Hon’ble Tribunal in Assessee’s own case for the Assessment year 2009-10. The company is engaged in the development of software products and providing related services. It also provides implementation and maintenance of software products. It has developed a range of products such as Shine ERP software, Docuflo, Dac4Cast, CMSS, La Vision, Virtual Insure and Aldon. The annual report also confirms that the company is engaged in development of software and software products. The company holds significant inventories which account for 27% of the total current assets which demonstrates that it is a product development company as against a pure software service provider like the assessee. The functions carried out by the two companies being substantially different, this company ought to stand rejected as a comparable. The company is being consistently excluded from the list of comparables in similar cases. Since the circumstances leading to it being excluded as being functionally dissimilar in the previous assessment continue to remain same, the company ought to remain excluded in the current assessment year. This Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 9 of 38 – Trib.)], ACIT v. Broadcom India Research (P.) Ltd [2016] 72 taxmann.com 77 (Bangalore - Trib.) and ITO v. Interwoven Software Services (India) (P.) Ltd.[2016] 74 taxmann.com 103 (Bangalore - Trib.), directed this company to be excluded in the case of assessees similar to the Assessee herein. We, therefore, find no ground to interfere with the order of CIT(A).
Persistent Systems Ltd.: This company was excluded by the CIT(A) for the reason that it was functionally dissimilar to the Assessee, by placing reliance of the decision of this Hon’ble Tribunal in Assessee’s own case for the Assessment year 2009-10. This company is engaged in rendering outsourced product development as against software development services and is thus not comparable to the assessee. Further, as per the annual report of the company, income is shown as “sale of software services and products” and no break-up is available between sale of software services and sale of products. The company is thus functionally dissimilar.The company is being consistently excluded from the list of comparables in similar cases, and also in the case of the Assessee for the assessment year 2009-10. Since the circumstances leading to it being excluded as being functionally dissimilar in the previous assessment continue to remain same, the company ought to remain excluded in the current assessment year. This Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)] ACIT v. Broadcom India Research (P.) Ltd [2016] 72 taxmann.com 77 (Bangalore - Trib.) and ITO v. Interwoven Software Services (India) (P.) Ltd.[2016] 74 taxmann.com 103 (Bangalore - Trib.), where the said company was directed to be excluded/exclusion upheld in the case of assessees similar to the Assessee herein. We, therefore, uphold the order of CIT(A).
Sasken Communication Technologies Ltd.: This company was excluded suo moto by the CIT(A) for the reason that it was excluded by this Hon’ble Tribunal in assessee’s own case for the assessment year 2009-10. The company is engaged in high-end software products and services that are not similar to the services rendered by the Assessee. It develops and owns several patents and earns returns on the same
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 10 of 38 while the Assessee neither develops nor owns any patents. Moreover the company incurs significant expenditure on research and development activities. However, the Assessee is a captive software development service provider and does not undertake development or sale of software products and in turn does not own intangible assets. The company is therefore not comparable to the Assessee. Reliance is placed on the decision of this Hon’ble Tribunal Assessee’s own case for the assessment year 2009- 10. This Tribunal in in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)], ACIT v. Broadcom India Research (P.) Ltd [2016] 72 taxmann.com 77 (Bangalore - Trib.) and ITO v. Interwoven Software Services (India) (P.) Ltd. [2016] 74 taxmann.com 103 (Bangalore - Trib.), upheld exclusion of this company in a case similar to the Assessee herein. We thus uphold the exclusion of this company.
Tata Elxsi Ltd.: This company was excluded by the CIT(A) for the reason that it was functionally dissimilar, by placing reliance on the decision of this Hon’ble Tribunal in assessee’s own case for the assessment year 2009-10. For FY 2009-10, the company operated under two segments – (1) software development services and (2) systems integration and support. The business segment relating to software development and services considered by the TPO as being comparable to the assessee comprises of services such as graphics, imaging & image processing, signal processing, routing and switching, VOIP, network management, product design services, innovation design services and visual computing labs which are related to high-end hardware and software product and development activities, which differ from routine software development activities undertaken by the Assessee. The company provides niche services which is not comparable to the low-end software development services rendered by the Assessee. Tata Elxsi has also invested heavily in R & D activities and has expenses amounting to nearly 3% of its sales which demonstrates that the company is engaged in innovation of products and services such as animation, content creation for advertisements as well as hardware related activities such as network management, engineering services capabilities for IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 11 of 38 broadcast technology players, products for wireless communication etc. The company is being consistently excluded from the list of comparables in similar cases, and also in the case of the Assessee for the assessment year 2009-10. Since the circumstances leading to it being excluded as being functionally dissimilar in the previous assessment continue to remain same, the company ought to remain excluded in the current assessment year. Further, this Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)] and ITO v. Interwoven Software Services (India) (P.) Ltd. [2016] 74 taxmann.com 103 (Bangalore - Trib.) excluded this company in the case of an Assessee similar to the Assessee herein. Following the same, we uphold exclusion of this company.
As far as ground No.9 raised by the Revenue is concerned, vide this ground, the Revenue is challenging the action of the CIT(A) in excluding ICRA Techno Analytics Ltd. upon taking its turnover into consideration. In this regard, it is seen that while the Assessee had sought for its exclusion inter alia on the ground that the turnover of this company was not comparable with that of the Assessee, the CIT(A) had directed its exclusion by placing reliance on the decisions of Bangalore Bench of ITAT for the reason that the company was functionally dissimilar to the assessee (pages 17-18 of the CIT(A)’s order). Therefore, it is clear that the company was not directed by the CIT(A) for the reason that it failed the turnover filter. Therefore, the Revenue’s ground to this extent is misconceived. Further, since the Revenue has not challenged the exclusion of this company for reasons assigned by the CIT(A), its exclusion on the said reasons has been accepted by the Revenue and therefore the company ought to remain excluded.
The learned counsel for the Assessee submitted that in the event the Revenue’s appeal is dismissed by upholding the exclusion of the above mentioned companies, the Assessee’s appeal to the extent it challenges the order of the CIT(A) with respect to the SWD service segment would not have to be adjudicated as no adjustment would survive and consequently the same would become academic in nature. We accept
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 12 of 38 the said submission and dismiss the relevant grounds of appeal of the assessee as infructuous.
The TPO/AO is directed to compute ALP of the SWD services segment in accordance with the directions contained int his order after affording opportunity of being heard to the assessee.
INFORMATION TECHNOLOGY ENABLED SERVICES SEGMENT While the Revenue has raised ground No. 11, in terms of which it is challenging the action of the CIT(A) in excluding companies which are allegedly functionally similar, specific comparable whose exclusion in challenged by the Revenue is not specified. The grounds of appeal are vague and hence, we are of the view that Revenue has not challenged the order of CIT(A) in so far as this segment is concerned. Since we have held that the Revenue’s appeal does not challenge the order of CIT(A) in the ITES segment, the grounds raised by the assessee in this segment would not have to be adjudicated as no adjustment would survive and consequently the same would become academic in nature.
MARKETING SUPPORT SERVICES SEGMENT As far as this segment is concerned, the financial results like operating revenue, operating cost etc., and the manner of computation of ALP in this segment by the TPO are as follows:
Mark-up on Total Cost (OP/ OC) earned by the Assessee (as reflected in the TP order):
Particulars As per TP order Operating Income Rs.16,55,05,334/- Operating Expenses Rs.15,31,18,416/- Operating Profit (Op. Income – Op. Expenses) Rs.1,23,86,918/-
OP/OC 8% IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 13 of 38 Comparison of TP study done by the Assessee and the TPO:
Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator (PLI) OP/TC OP/OC Database used PROWESS & PROWESS CAPITALINE Comparables selected 6 7 Comparables selected by TPO and their arithmetic mean as per TPO order:
Sl. Name of the Company Mark up No. WC Unadj. (%) 1. Asian Business Exhibition & Conference Ltd. 60.13 2. Cyber Media Research Ltd. 13.68 3. HCCA Business Services Pvt. Ltd. 19.09 4. Hindustan Housing Co. Ltd. 38.12 5. ICC International Agencies Ltd. 13.72 6. Killick Agencies & Mktg. Ltd. 17.36 7. Priya International Ltd. 11.47 ARITHMETIC MEAN 24.80
Computation of arm’s length price by TPO and the adjustment made: Arm’s Length Mean Margin 24.80% Operating cost Rs.15,31,18,416/- Arm’s Length Price (ALP): 124.80% of Operating Cost Rs.19,10,91,783/- Price Received Rs.16,55,05,334/- Short fall being adjustment u/s. 92CA Rs.2,55,86,449/- 18. The Addition suggested by the TPO was incorporated in the draft order of Assessment by the AO. The Assessee did not file any objection to the draft assessment order before the Dispute Resolution Panel (DRP) but filed appeal against the final assessment order before the CIT(A). The CIT(A) passed an order dated 21.11.2017 partly allowing the Assessee’s appeal. Pertinently, the CIT(A) accepted the contention of the Assessee and directed exclusion of the following companies:
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 14 of 38 1. Asian Business Exhibition & Conference Ltd. 2. HCCA Business Services Pvt. Ltd. 3. Killick Agencies & Mktg. Ltd.
However, the CIT(A) rejected the contention of the Assessee that Hindustan Housing Co. Ltd. is functionally dissimilar to the Assessee, and consequently, upheld its inclusion. Further, the CIT(A) agreed with the contention of the Assessee and directed the AO/TPO to treat gain/loss arising on account of fluctuation of foreign currency as being operating in nature and rework the margins of the Assessee and also the comparable companies.
While the Revenue has raised ground Nos. 11 and13, in terms of which it is challenging the action of the CIT(A) in excluding companies which are allegedly functionally similar, specific comparable whose exclusion in challenged by the Revenue is not specified. The grounds of appeal of the Revenue in this regard are vague. We however proceed to adjudicate the correctness of exclusion of the aforesaid three companies by the CIT(A).
20. Asian Business Exhibition & Conferences Ltd: The CIT(A) excluded Asian Business Exhibition & Conferences Ltd., for the reason that it is functionally dissimilar to the Assessee. This company is an event management company engaged in organizing exhibitions and events. Revenue is derived from sale of stall spaces, through sponsors by displaying names of exhibitors in signages, hoardings and banners, income from entry charges and income from delegates attending conferences/ events. This is in no way comparable to the Assessee’s MSS services segment under which it assists its AEs in marketing and sales of their products in India. This Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)] and ITO v. Interwoven Software Services (India) (P.) [2016] 74 taxmann.com 103 (Bangalore - Trib.) directed this company to be excluded as a comparable in the case of assessees similar to the Assessee herein. We find no grounds to interfere with the findings of the CIT(A).
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 15 of 38
HCCA Business Services P. Ltd: This company was excluded by the CIT(A) for the reason that it is functionally dissimilar to the Assessee. This company is a service provider and provides services in the gamut of HR operations and administration. It provides HR operations and administration services, offering payroll processing and compensation restructuring, management of labour and legal compliances, employee reimbursement processing and accounting services. It is thus clear that the activities of HCCA are not similar to marketing support services provided by the Assessee. This Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)] and ITO v. Interwoven Software Services (India) (P.) [2016] 74 taxmann.com 103 (Bangalore - Trib.) directed this company to be excluded as a comparable in the case of assessees similar to the Assessee herein. Therefore, this company ought to remain excluded from the final list of comparables for the MSS segment.
Killick Agencies & Mktg. Ltd.: This company was excluded by the CIT(A) for the reason that it is functionally dissimilar to the Assessee, and therefore does not warrant any interference by this Hon’ble Tribunal. This Tribunal in DCIT v. Electronics for Imaging India P. Ltd [(2016) 70 taxmann.com 299 (Bang – Trib.)] and ITO v. Interwoven Software Services (India) (P.) [2016] 74 taxmann.com 103 (Bangalore - Trib.) directed this company to be excluded as a comparable in the case of assessees similar to the Assessee herein.
The learned Counsel for Assessee submitted that in the event the Revenue’s appeal is dismissed by upholding the exclusion of the above companies, the Assessee’s appeal to the extent it challenges the order of the CIT(A) with respect to the MS service segment would not have to be adjudicated as no adjustment would
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 16 of 38 survive and consequently the same would become academic in nature. Hence, the relevant grounds of appeal of Assessee in the MSS segment are dismissed.
24. The other grounds that require adjudication in Revenue’s appeal is ground Nos.2 and 3 which is in connection with the computation of deduction under section 10A of the Act. As far as Grd.No.2 raised by the Revenue is concerned, the same is with regard to exclusion of telecommunication expenses and expenses incurred in foreign currency for rending technical servies outside India, both from the export turnover and total turnover for the purpose of computation of deduction u/s. 10A of the Act. It is not in dispute before us that the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn) has held that charges/expenses relating to telecommunication, and expeses in connection with rendering technical services outside India, should be excluded both from export turnover and total turnover while computing deduction u/s.10A of the Act i.e., whatever is removed from the numerator should also be excluded from the denominator while working total turnover and export turnover for allowing deduction u/s.10A of the Act. In ground No.3 the grievance of the revenue is that a Special Leave Petition (SLP) is pending before Hon’ble Supreme Court. The aforesaid decision of the jurisdictional High Court has been upheld by the Hon’ble Supreme Court in the case of CIT v. HCL Technologies Ltd. in Civil Appeal No.8489-98490 of 2013 &Ors. dated 24.04.2018. In view of the above, we are of the view that the telecommunication charges should be excluded both from the export turnover as well as total turnover while computing deduction u/s.10A of the Act. The order of the CIT(A) is therefore upheld. In view of the ground Nos.2 and 3 raised by the Revenue are without merit, the same are dismissed.
25. Ground Nos.1, 14 and 15 are general and require no specific adjudication.
26. What now remains for consideration in the appeal relating to AY 2010-11 is ground Nos.2.1, 2.2, 3 and 4 raised by the assessee in its appeal. We may add that the ground Nos.5 to 17 raised by the assessee in its appeal has already been dismissed
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 17 of 38 as infructuous and ground No.18 raised by the assessee being levy of interest under section 234B of the Act being purely consequential in nature and a direction to the AO give consequential effect would be sufficient to dispose off the said ground.
Ground Nos.2.1 and 2.2 raised by the assessee reads as follows:
2.1 The learned CIT(A) erred in law and facts by upholding the action of the Deputy Commissioner of Income Tax, Circle – 12(5), Bangalore (“learned AO”) in not providing an allowance for expenditure amounting to INR 1,37,875 which was disallowed during the assessment proceedings for the Assessment Year (“AY”) 2009-10, despite the fact that the Tax Deducted at Source (“TDS”) on such expenditure was deducted and paid in January 2010 i.e., during the AY 2010-11. 2.2 The learned CIT(A) has erred in not apricating the fact that the Appellant has submitted requisite evidence on deduction and payment of TDS on the expenses amounting to INR 1,37,875, which was disallowed during the assessment proceedings for the AY 2009-10, and thereby erred in holding that no details and documentary evidence are filed establishing its claim.
As far as the above grounds are concerned, the AO disallowed the claim for deduction made by the assessee while computing income from business, legal and professional charges incurred for certification purposes on the ground that the assessee did not deduct tax at source on the aforesaid payments and by invoking the provisions of section 40(a)(ia) of the Act. The CIT(A) confirmed the action of the AO by holding that the necessary evidence of having deducted tax at source had not been produced by the assessee. Learned Counsel for the assessee brought to our notice Form No.27A which is a statement of deduction of tax at source for the period 01.10.2009 to 31.12.2009. It was brought to our notice that the necessary evidence was filed before the CIT(A) but the CIT(A) has overlooked the same. We are of the view that it would be just and appropriate to direct the AO to verify the claim of the assessee regarding tax deduction at source, in the light of the evidence produced before the CIT(A) after affording the assessee opportunity of being heard. Ground No.2.1 & 2.2 are decided accordingly.
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 18 of 38 29. Ground No.3 raised by the assessee reads as follows:
3. The learned CIT(A) has erred in law and facts in disallowing the expenses grouped by the Appellant under ‘Repairs and maintenance’ towards purchase of application software on the premise that it constitutes “royalty” under the provisions of the Act and is thus to be disallowed under section 40(a)(ia) of the Act for non-deduction of taxes at source when making such payments.
As far as the aforesaid ground of appeal raised by the assessee is concerned, the issue is with regard to deduction of tax at source on purchase of application software from non-resident. It was the case of the Revenue that the aforesaid payment made to the non-resident constitutes royalty and the assessee was under obligation to deduct tax at source on the aforesaid payment in terms of section 195 of the Act. Since the assessee did not deduct tax at source, the AO invoked the provisions of section 40(a)(ia) of the Act and disallowed the claim of the assessee for deduction of a sum of Rs.3,63,397/-. The CIT(A) confirmed the order of the AO.
The learned Counsel for the assessee made submission that even assuming that the payment in question is in the nature of royalty as laid down by the Hon’ble Karnataka High Court in the case of CIT Vs. Samsung Electronics Ltd., 16 taxmann.com 141 which was passed on 15.10.2011, the assessee in the present case had made payments to the non-resident during the period 01.04.2009 to 31.03.2010. It is the submission of the learned Counsel for the assessee that prior to the decision of Hon’ble Karnataka High Court referred to above, payments made for purchase of software were not considered as in the nature of royalty and therefore the assessee cannot be held as an assessee in default for the period prior to the pronouncement of the decision of the Hon’ble Karnataka High Court in the case of Samsung Electronics Ltd., (supra) dated 15.10.2011. In this regard, learned Counsel for the assessee placed reliance on the following decisions:
ITO Vs. Clear Water Technology Services (P) Ltd., (52 taxmann.com 115)
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 19 of 38 2. ACIT Vs. Aurigene Discovery Technologies Ltd., (decision of the ITAT — Bangalore Bench dated 23.11.2016 in
3. CIT Vs. NGC Networks (India) Pvt. Ltd (decision of the Bombay High Court dated 29.01.2018 in ITA No. 397/2015) 4. M/s. Herbalife International India Pvt. Ltd [IT(TP)A Nos.1679/Bang/2012 & 184/Bang/2013
We have considered the submissions of the learned Counsel for the assessee and we find that on an identical issue for Assessment Year 2010-11, this Tribunal in the case of ACIT Vs. Aurigene Discovery Technologies Ltd., in dated 23.11.2016 held as follows:
“03. We heard the rival submissions and gone through the relevant orders. The assessee resubmitted the plea taken before the lower authorities and placed on the ruling of the Hon'ble Bangalore ITAT in Sonata Information Technology Ltd v. ACIT (103 ITD 324) which had held that payments for software licenses do not constitute royalty under the provisions of the Act and hence disallowance under section 40(a) (ia) of the Act would not be applicable. The change in the legal position on taxation of computer software was on account of the ruling of the Karnataka High Court in CIT v. Samsung Electronics Co. Ltd. (320ITR 209), which was pronounced on 15.10.11 that is much later than the closure of the FY 2010-11. Subsequently, the Finance Act 2012 also introduced, retrospectively, Explanation 4 to section 9(1 (vi) of the Act to clarify that payments for, inter alia. license to use computer software would qualify as royalty. During the FY 10-11, the assessee did not have the benefit of clarification brought by the respective amendment. As such, for the FY 2010- 11, in light of the provisions of section 9(1)(vi) of the Act read with judicial guidance on the taxation of computer software payments, tax was not required to be deducted at source. Given the practice in prior assessment years, the assessee was of the bona fide view that the payment of software license fee was not subject to tax deduction at source under section 194J/195 of the Act. It is submitted that liability to deduct tax at source cannot be fastened on the assessee on the basis of retrospective amendment to the Act (Finance Act 2012 amendment the definition of royalty with retrospective effect from 01.04.1976) or a subsequent ruling of a court (the Karnataka HC in CIT v Samsung Electronics Co. Ltd. (16 taxmann.com 141) was passed on October 15, 2011). Courts have consistently upheld this principle as seen in: • ITO v. Clear Water Technology Services (P.) Ltd. (52 taxmann.com 115)
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 20 of 38 • Kerala Vision Ltd v. ACIT (46 taxmann.com 50) • Sonic Biochem Extractions (P.) Ltd v. ITO (35 taxmann.com 463) • Channel Guide India Ltd v. ACIT (25 taxmann.com 25) • DCIv. Virola International (20 14(2) TMI 653) • CIT v. Kotak Securities Ltd. (20 taxmann.com 846).
4. The relevant portion of the CIT(A) order is extracted as under : “ Disallowance of expenses under 40(a)(i) / 40(a)(ia) : 5.1. As regards disallowance of expenses under 40(a)(i)/40(a)(ia), it has been submitted that the company had determined the rate of tax to be deducted and following the judgments that were prevalent at the time of tax deduction, Supreme Court in the case of Tata Consultancy Services and jurisdictional Tribunal in the case of Samsung Electronics Co. Ltd, the appellant submitted that the said judgment shall not be applicable since it was pronounced on 15/10/2011 and Velankani Mauritius Ltd., whereas the liability to deduct tax for the appellant was the F.Y. 2010-11. The appellant has relied on the judgment of Cochin Tribunal in the case of Kerala Vision Ltd and Agra Tribunal in the case of Virola International, wherein it was held that - "The law amended was undoubtedly retrospective in nature but so far as tax withholding liability is concerned, it depends on the law as it existed at the point of time when payments, from which taxes ought to have been withheld, were made. The tax-deductor cannot be expected to have clairvoyance of knowing how the law will change in future." Further, software payment was included in definition of royalty only vide Explanation to section 9(1)(vi)inserted retrospectively vide Finance Act, 2012 and when the purchase was made, the appellant did not have the benefit of clarification brought by the retrospective amendment. It is impossible to fasten liability for deducting tax at source retrospectively as tax is to be deducted at source at the time when the payment is credited or made. This view has been upheld by the Bangalore Tribunal in the case of DCIT vs M/s WS Atkins India Pvt Ltd (ITA No 14671Bang12014 and the Mumbai Tribunal in the case of Channel Guide India Ltd. vs ACIT ([2012] 25 taxmann.com 25). 5.2 The ITAT 'C' Bench in the case M/s WS Atkins India Pvt. Ltd and in the case of Infotech Enterprises Ltd of the Hyderabad Bench of the Tribunal wherein it has been held that section 40(a)(ia) would not apply to disallow payments when TDS was not done and subsequently becomes taxable on account of a retrospective legislation. It has also referred to in the case of Sonic Biochem Extractions Pvt.Ltd. (supra), identical issue IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 21 of 38 was considered and decided by the Mumbai Tribunal. Following were the relevant observations:- "The assessee purchased software, capitalized the payment to the computers account as the software came along with the hardware of computers and claimed depreciation. On the ground that purchase of software is essentially purchase of copyright which attracts tax deduction at source under section 194J, the Assessing Officer involved the provisions of section 40(a)(ia) and disallowed the depreciation claimed. The Commissioner (Appeals), confirmed the action of the Assessing Officer on the ground that the purchase of software amounted to acquisition of intangible asset and therefore, the payment was royalty and disallowable. On appeal: Held, (i) that mere purchase of software, a copyrighted article, for utilisation of computers cannot be considered as purchase of copyright and royalty. The assessee did not acquire any rights for making copies, selling or acquiring which generally could be considered within the definition of "royalty". Explanation 2 to section 9(1)(vi) cannot be applied to purchase of a copyrighted software, which does not involve any commercial exploitation thereof. The assessee simply purchased software delivered along with computer hardware for utilization in the day-to-day business." 5.3. Relying on the above deci sion, the I T A T ' C ' B e nc h , Bangalore upheld the order of the CIT(A) who had observed that the Assessee did not have the benefit of the clarification brought about by the retrospective amendment that the payments tantamount to payment for royalty and consequently tax was to be de ducted u/ s 194J. T he law as it existed on the date when the payment for obtaining the software was made, has not categorically laid down that tax is required to be deducted. It is impossible to fasten liability for deducting tax at source retrospectively. 5.4 In view of the above decisions, it is correct to say that it is not possible to faste n liability for de ducting tax at source retrospectively as tax is to be deducted at source at the time when the payment is credited or made. When purchase of software was made the assessee did not have the benefit of t h e c l a r i f i c a t i o n b r o u g h t a b o u t b y t h e retrospective amendment. The contention of the appellant is correct that the software payment disallowed by the AO did not warrant withholding of the tax u/s40(a)(ia) and 40(a)(ia) (by an order of corrigendum dt 20.11.2015) of the Act. Therefore disallowance made by the AO on account of software payment want of withholding of tax is hereby deleted."
The CIT(A) followed the decision of this Tribunal in M/s WS Atkins India Pvt. Ltd, supra, which referred the decisions of Hyderabad Bench of the IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 22 of 38 Tribunal in Infotech Enterprises Ltd in ITA 115/HYD/2011 wherein it has been held that section 40(a)(ia) would not apply to disallow payments when TDS was not done and subsequently becomes taxable on account of a retrospective legislation. It has also referred to the decisions of the Delhi & Mumbai Tribunal in SMS Demag Pvt Ltd , 132 ITJ 498 & Sonic Biochem Extractions Pvt. Ltd. 23 ITR (Trib) 447, respectively. We uphold the decision of the CIT(A) and dismiss the grounds raised
by the Revenue.”
33. The crux of the decisions referred to above is that prior to the decision in the case of Samsung Electronics (supra) rendered by the Hon’ble Karnataka High Court on 15.10.2011, the law as interpreted by various judicial forums was that payments for purchase of software were not in the nature of royalty but were in the nature of business profits and if the recipient non-resident did not have a Permanent Establishment in India, there was no obligation to deduct tax at source. Therefore payments to non-resident for purchase of software prior to 15.10.2011 cannot be disallowed u/s.40(a)(ia) of the Act for non deduction of tax at source as on the date of payment to non-resident, there was no such obligation. In view of the above said decisions, we hold that the disallowance under section 40(a)(ia) of the Act has to be deleted. We hold and direct accordingly.
Ground No.4 raised by the Assessee reads as follows:
4. The CIT(A) erred in upholding the action of the larned AO by rejecting the audit adjustments made in the Appellant’s financial statements amounting to INR 8,34,62,981 and adding back the same to the taxable income by alleging that the same is suppressed income of the Appellant. 35. As far as ground No.4 is concerned, the facts are that during the assessment proceedings, the AO issued a notice seeking details of the Foreign Inward Remittances Certificate (FIRC) statement regarding receipt of export of services. In response to the notice, the Assessee filed the FIRCs and reconciliation of FIRCs with sales invoices for the FY 2009-10. There was a difference in the total revenue as recorded in the financial statements and the total of the FIRCs. The AO sought reasons for difference between the revenue recorded in the financial statements
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 23 of 38 amounting to INR 1,68,51,47,369 vis-à-vis revenue as per the invoices raised amounting to INR 1,76,86,10,350.
In response to the same, it was submitted by the Assessee that it works on cost plus model, wherein the invoices are raised based on an estimated cost after adding the agreed percentage of mark-up on the same on a monthly basis. However, at the year-end, the actual costs were lesser than the estimated cost and therefore the excess amount invoices had to be reversed on account of audit adjustments. Such audit adjustment was made to reverse the excess revenue, to the extent overstated. A reconciliation of revenue as per invoices with the financial statements was also submitted during the assessment proceedings and the same is given below:
Particulars Amount (INR) Amount (INR) Total invoice value 1,76,86,10,350 Less: Audit adjustments - I/C Revenue - Call centre 44,28,283 - I/C Revenue - Marketing subs (6,01,653) - I/C Revenue - R&D (8,70,87,364) (8,32,60,734) Less: Forex adjustment (2,02,247) Revenue as per financial statements 1,68,51,47,369 37. The learned AO was not satisfied with the aforesaid explanation and made an adjustment of INR 8,34,62,981 as suppression of income being differential revenue as per invoices(Rs.1,76,86,10,350) vis-à-vis financial statements(Rs.1,68,51,47,369). The CIT(A) confirmed the order of the AO by following the decision of the DRP in Assessee’s case on similar addition in AY 2012-13.
Before the Tribunal, the learned counsel for the Assessee submitted that the Assessee is engaged in the business of providing software research and development services, IT enabled services and marketing support services to its group companies. Towards the same, the Assessee has entered into Master Service Agreements with its group companies for rendering such services. A brief description of the services is mentioned below:
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 24 of 38 Software research and development services - for development and improvement of computer products. A mark-up of 13% on cost is charged for the services as provided in the agreement IT enabled services – for assisting the overseas group company in telephonic support services, to include advising its customers with respect to installation and configuration of software products, resolving problems and resolving availability and stability issues. A mark-up of 16% on cost is charged for the services as provided in the agreement Marketing support services – for providing the overseas company general, administrative, marketing, liaising and promotional services and developing and expanding the customer base. A mark-up of 8% on cost is charged for the services as provided in the agreement The revenue earned from such services are recognized in accordance with Accounting Standard (‘AS’) – 9. According to AS - 9, revenue is recognized based on the percentage completion method which is on the basis of associated costs incurred towards rendering the services. In this regard, the revenue recognition policy of the Assessee as mentioned in Note L (iv) of the financials which is reproduced below was brought to our notice :
“(vi) Revenue recognition- Revenue from Research and development is recognised as services are rendered, on cost plus basis, and billed as per the terms of the Master Services Agreement dated November 01, 2007 between the Company and VMware Bermuda Limited, Bermuda.
Revenue from Marketing support services is recognised as services are rendered, on a cost plus basis, based on services rendered and billed as per the terms of the Master Services Agreement dated November 01, 2007 between the Company and VMware International Ltd, Ireland.
Revenue from IT Enabled services is recognised as services are rendered, on a cost plus basis, based on services rendered and billed as per the terms of the Master Services Agreement dated November 01, 2007 between the Company and VMware International Ltd, Ireland.”
The learned counsel submitted that the invoices raised by the Assessee are based on the cost incurred after adding the above-mentioned percentage of mark-up on the IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 25 of 38 same. Our attention was drawn to the details of the cost incurred by the Assessee based on which the revenue as per financials was arrived at as mentioned below:
(Amounts in INR) Particulars Software IT enabled Marketing Total Developmen services support t Services services Income from 1,23,00,29,95 28,96,12,078 16,55,05,33 1,68,51,47,36 services 7 4 9 Add: Foreign gain 9,56,41,850 9,56,41,850 1,32,56,71,80 28,96,12,078 16,55,05,33 1,78,07,89,21 7 4 9 Operating cost Employee Cost 67,70,60,614 13,84,31,457 10,41,25,58 91,96,17,651 0 Administrative cost 28,83,74,507 8,37,92,832 4,81,81,316 42,03,49,445 Depreciation 21,62,92,230 2,71,46,427 8,11,520 24,42,50,177 Less: Liability no (90,60,035) - - (90,60,035) longer required written back 1,17,26,67,31 24,93,70,716 15,31,18,41 1,57,51,57,23 6 6 8 Operating profit 15,30,04,491 4,02,41,362 1,23,86,918 20,56,31,982 Less: Provision for 1,78,20,085 advances Profit before taxes 18,78,11,897 Operating profit on 13% 16% 8% total cost
It was submitted by the learned counsel for the Assessee that the reasons for difference in revenue recorded in the financial statements vis-à-vis revenue as per the invoices raised are on account of the following: a) True up/down of cost b) Foreign exchange fluctuation a) True-up/down of costs The Assessee follows a cost-plus model and the invoices are raised based on costs after adding the agreed mark-up to such costs. Such costs initially considered at the IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 26 of 38 time of raising invoices may be subsequently trued up/down on the basis of AS at the time of audit. Similarly, there may be cases where certain items are recorded as cost at the time of raising invoices, but subsequently removed from the cost base in accordance with the AS. For instance, at the time of raising the invoices on monthly basis, service tax credit/ VAT refund receivable from revenue authorities was recorded as an expense in the books. The invoices were raised by applying the agreed mark-up on the cost including service tax credit /VAT refund receivable. Given that the service tax is recoverable, the same was reclassified as an asset in the balance sheet at the time of statutory audit in accordance with the AS ( see Note F of the financial statements). To the extent the service tax was recorded as an asset, the corresponding cost was reduced. Given that the Assessee follows cost plus model wherein the revenue is a function of cost, the corresponding revenue would also be reduced. The excess amount as invoiced to the customer due to the above was recorded under ‘current liability’ in the balance sheet of the Assessee as advance received from VMware Bermuda Limited (note G to the financial statements). The above facts are explained by way of the following illustration:
Particulars Revenue as per Revenue post true- invoice up/down of costs Salary cost 100 100 Rental expenses 150 150 Service tax/ VAT refund 30 - Total cost (A) 280 250 Margin on cost at 15% (B) 42 37.5 Total value of revenue (A+B) 322 287.5 Excess revenue recorded 34.5 subsequently adjusted at the time of audit It was submitted that the AO and CIT(A) failed to appreciate the fact that the Assessee follows cost plus model and the revenue is a function of cost. The revenue as per financials has been arrived by applying the agreed mark-up on the revised cost. The IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 27 of 38 learned AO failed to appreciate that due to change in cost, the revenue of the Assessee would undergo a change. The increase/decrease in revenue is contingent upon increase/decrease in cost under a cost plus model. In other words, the revenue cannot be reduced on a standalone basis, without corresponding reduction in cost. Accordingly, it was submitted that the reduction of revenue is due to reduction in cost and the Assessee had not suppressed any income. It was also submitted that the learned TPO has accepted the cost excluding the costs which are reclassified as asset at the time of statutory audit in accordance with ASs and no adjustment has been made on the cost base. This also substantiate the fact the cost as determined by the Assessee post audit adjustments is in accordance with the Transfer pricing methodology. b) Foreign exchange fluctuation It was submitted that due to different exchange rates followed at the time of raising the invoice and recording of revenue in the financial statements, the revenue recorded in the financial statements was lower than the amount of revenue as per the invoices raised. It was pointed out that during the year under consideration, the Assessee had received certain advance from its overseas group Company in USD against services. At the time of receiving such advances in USD, it was converted in INR currency based on the exchange rate prevailing at that point in time. Subsequently, during the said year, the Assessee raised its invoices in USD based on the exchange rate prevailing at the time of raising such invoices. As per the AS, the Assessee is required to record revenue in its financial statements based on the exchange rate that prevailed at the time of receiving the advance and not at the time of raising the invoice. Accordingly, the amount of revenue recorded in the financial statements was lower than the amount of revenue as per the invoices raised. The above facts were explained by way of the following illustration:
Particulars Amount Exchange Amount (USD) rate (INR)
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 28 of 38 Advance received on 1 April 2009 100 55 5,500
Invoice raised on 1 May 2009 100 60 6,000 Recognition of revenue in the financial 100 55 5,500 statements at the year-end based on AS Excess revenue recognized at the time 500 of raising invoice
Without prejudice to the above, it was submitted that if any portion of the adjustment made by the TPO is sustained in the Revenue’s appeal before this Hon’ble Tribunal, since the above amount would form part of the said adjustment, no further adjustment can be made by the AO in this regard. It was submitted that when any transaction is a subject matter of the transfer pricing provisions, then the other general provisions of the Act cannot be applied simultaneously. In this regard, the learned counsel brought to our notice a decision of ITAT Bangalore rendered in the case of M/s. Herbalife International India Pvt. Ltd [IT(TP)A Nos.1679/Bang/2012 & 184/Bang/2013] wherein the Tribunal held as follows:
“We have considered the rival submissions as well as the relevant material on record. This transaction of payment of administrative service fee has been declared by the assessee as international transaction and is also subjected to TP provisions of sec.92CA, however, the AO made an alternative addition by invoking the provisions of sec.40A(2) of the Act. The AO allowed only 2% of the turnover amounting to Rs.1,02,62,530/- and the balance of Rs.4,81,97,802/- has been disallowed under section 40A(2) of the Act. There is no dispute that the transaction has been reported by the assessee as international transaction which was also accepted by the AO and the TPO as an international transaction. Thus, once a particular transaction is admitted as international transaction then the same falls in the ambit of the provisions of X chapter of the Act which are specific provisions to deal with such transactions between the assessee and its AE. Therefore, once the transaction is undisputedly subject matter of Chapter X of the IT Act, then the other general provisions of the Act cannot be applied simultaneously. The AO, having considered the transaction being international transaction and making a reference to the TPO for determination of the ALP cannot go back to the provisions of sec.40A(2) for determining the reasonableness of the price paid by the assessee” . (Emphasis added)
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 29 of 38
It was thus submitted that the revenue authorities erred in adding the revenue to the taxable income as suppression of income when the same has been adjudicated by the learned TPO. It was also submitted that similar explanation given by the Assessee during the course of assessment proceedings for AY 2013-14 on similar matter was examined by the AO and no addition was made in the final assessment order in respect of the aforesaid issue for the said year. The learned DR relied on the order of the CIT(A).
After hearing the rival submissions, we are of the view that the issue has to be remanded to the AO for fresh consideration. The assessee works on a cost + mark-up as its margin. The revenue that the assessee shows in the financial statements is dependent on cost and if due to an incorrect estimation of cost or other reasons as submitted by the learned counsel for the Assessee before us, there is change in the revenue shown by the assessee then the corresponding cost which was wrongly estimated also needs to be identified. It is only when there is reconciliation of the incorrect estimate of the cost can it be said that the audit adjustment suggested would be correct. In other words, the restatement of revenue has to be matched by corresponding reduction in the estimated cost only then can it be said that the audit adjustment suggested will not have any effect on the income of the assessee. The submissions made before us as well as the revenue authorities are general and do not give one to one tally or reconciliation of the differences and the reasons for such differences. The assessee is, therefore, directed to give a complete breakup of the difference between the revenue recorded in financial statements and as per the invoices and correlate the same with the cost estimates and as to how both are reflected in the financial statements. The AO will afford opportunity of being heard to the assessee before deciding the issue.
In the result, the appeal by the Revenue is dismissed while appeal by the assessee is partly allowed.
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 30 of 38 45. Now we will take up cross appeals of assessee and Revenue for Assessment Year 2011-12 against the order of CIT(A)-7, Bangalore, dated 21.11.2017. The facts of the case for Assessment Year 2011-12 are identical to the facts as it prevailed in Assessment Year 2010-11. The grounds of appeal of the Revenue are identical rather verbatim the same as in Assessment Year 2010-11. We construe the grounds of appeal of Revenue as one relating to determination of ALP in SWD services and MSS segment only and not in relation to ITES segment.
SOFTWARE DEVELOPMENT SERVICES SEGMENT : The details of financials and profit margins in SWD services segment and the computation of ALP as done by the AO/TPO are as follows:
Net mark-up on cost earned by the Assessee as reflected by the TPO in the TP Order: Operating Income Rs. 1,75,03,90,732/- Operating Cost Rs.1,54,58,77,571/- Operating Profit (Op. Income – Op. Cost) Rs. 20,45,13,161/- Operating/Net mark-up (OP/TC) 13.23%
Comparison of the TP studies done by the Assessee and TPO: Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator OP/TC OP/TC (PLI) Database used PROWESS & PROWESS & CAPITALINE PLUS CAPITALINE PLUS Comparables selected 16 13 Comparables selected by TPO and their arithmetic mean:
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 31 of 38 Sl. Mark-up on No. Total Costs Name of the Company (WC–Unadj) (in %) 1 Acropetal Technologies Ltd. (seg) 31.98 2 e-Zest Solutions Ltd. 21.03 3 E-Infochips Ltd. 56.44 4 Evoke Technologies Pvt. Ltd. 8.11 5 ICRA Techno Analytics Ltd. 24.83 6 Infosys Ltd. 43.39 7 Larsen & Toubro Infotech Ltd. 19.83 8 Mindtree Ltd. (seg) 10.66 9 Persistent Systems & Solutions Ltd. 22.12 10 Persistent Systems Ltd. 22.84 11 R S Software (India) Ltd. 16.37 12 Sasken Communication Technologies 24.13 Ltd. 13 Tata Elxsi Ltd. (seg) 20.91 AVERAGE MARK-UP 24.82
Computation of arm’s length price by the TPO and the adjustment made: Arm’s Length Mean Mark-up 24.82% Less: Working Capital Adjustment (restricted) 1.63% Adjusted mean mark-up of the comparables 23.19% Operating Cost Rs. 1,54,58,77,571/- Arm’s Length Price – 123.19% of Operating Cost Rs1,90,43,66,580/- Price Received Rs.1,75,03,90,732/- Shortfall being adjustment u/s. 92CA Rs.15,39,75,848/-
The AO passed an assessment order inter alia incorporating the aforesaid adjustment. On appeal by the assessee, the CIT(A), accepting the contentions of the IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 32 of 38 Assessee, the CIT(A) directed the exclusion of (i) Acropetal Technologies Ltd.; (ii) E-Infochips Ltd.; (iii) ICRA Techno Analytics Ltd.; (iv) Infosys Ltd.; (v) Tata Elxsi Ltd. However, the contentions of the Assessee seeking exclusion of certain other companies and inclusion of certain companies came to be rejected by the CIT(A).Following the order passed by this Hon’ble Tribunal in the Assessee’s own case for the assessment year 2009-10, the CIT(A) directed the TPO to grant working capital adjustment on actual basis without any restriction. The CIT(A) agreed with the contention of the Assessee as regards the inclusion of gains arising on account of foreign exchange fluctuation while computing the margin of the Assesseeand the comparable companies as the same is operating in nature. In view of the reliefs granted by the CIT(A), the TP adjustment made to the SWD services segment would stand deleted.
The learned Counsel for Assessee submitted that if Revenue’s appeal in SWD services segment are decided against the Revenue then he would not press for adjudication the grounds raised by the assessee on SWD services segment in its appeal. As far as Revenue’s appeal is concerned, the first aspect which we notice is that the grounds of appeal are general and vague with no reference to any particular company that was excluded by the CIT(A) as not comparable with assessee. In ground No.4, there is a reference to 2 companies in SWD service segment but there is no name of any company specified therein. In ground No.9, there is a reference to ICRA Technoanalytics Ltd., have been excluded by applying turnover filter which is factually incorrect. This company was excluded on the ground that income from SWD service segment was less than 75% of the total revenue. Since the grounds of appeal of the Revenue with reference to SWD segments being ground Nos. 4 to 12 are dismissed. In view of the dismissal of Revenue’s grounds of appeal in the SWD segment, the grounds of appeal of the assessee in its appeal with regard to SWD services segment are dismissed as infructuous.
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 33 of 38 MARKETING SUPPORT SERVICES SEGMENT: The details of the TP 49. adjustment in this segment are as follows:
Net margin on cost earned by the Assessee for marketing support services (as reflected in the TP Order): Operating Income Rs.31,41,76,777/- Operating Cost Rs.29,05,98,930/- Operating Profit (Op. Income – Op. Cost) Rs.2,35,77,847/- Operating/Net margin (OP/TC) 8.11% Comparison of the TP studies done by the Assessee and TPO: Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator (PLI) OP/TC OP/TC Database used PROWESS & PROWESS CAPITALINE PLUS Comparables selected for 5 3 marketing support services
Comparables selected by TPO and their arithmetic mean: Sl. Mark-up on No. Name of the Company Total Costs (in %) 1. Asian Business Exhibition & 19.51 Conferences Ltd. 2. Cyber Media Research Ltd. 10.59 3. ICC International Agencies Ltd. 24.66 AVERAGE MARGIN 18.25
Computation of arm’s length price by the TPO and the adjustment made:
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 34 of 38
Arm’s Length Mean Margin 18.25% Operating Cost Rs.29,05,98,930/- Arm’s Length Price – 118.25% of Operating Cost Rs.34,36,33,235/- Price Received Rs.31,41,76,777/- Shortfall being adjustment u/S. 92CA Rs.2,94,56,458/-
The AO passed an assessment order inter alia incorporating the aforesaid adjustment. On appeal by the assessee, the CIT(A) accepted the contention of the Assessee and directed the exclusion of Asian Business Exhibition & Conferences Ltd. However, the CIT(A) rejected the contention of the Assessee seeking exclusion of ICC International Agencies Ltd. and consequently upheld its inclusion. The CIT(A) agreed with the contention of the Assessee as regards the inclusion of gains arising on account of foreign exchange fluctuation while computing the margin of the Assessee and the comparable companies as the same is operating in nature. In view of the reliefs granted by the CIT(A), the TP adjustment made to the MSS segment would stand deleted. Revenue has appealed against the relief granted by the CIT(A) by challenging certain independent comparable companies rejected by the CIT(A). The Revenue has specifically challenged the exclusion of ICRA Techno Analytics Ltd. vide ground No. 9 and exclusion of 2 companies as being functionally dissimilar vide ground No. 4. However, the specific 2 comparables whose exclusion is challenged by the Revenue is not specified. Ground No.13 with regard to this segment is also vague. Hence, the appeal of the Revenue with regard to this segment is dismissed. Since the Revenue’s appeal is dismissed by upholding the order of the CIT(A) directing exclusion of the companies the learned Counsel for Assessee submitted that the Assessee’s appeal to the extent it challenges the order of the CIT(A) upholding the action of the TPO would not have to be adjudicated as no adjustment would survive and consequently the same would become academic in nature. Hence, the assessee’s appeal challenging CIT(A)’s order in this segment are dismissed as infructuous.
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 35 of 38 51. The other grounds in Revenue’s appeal that require adjudication is ground Nos.2 to 3 relating to computation of deduction under section 10A of the Act. As far as Grd.No.2 raised by the Revenue is concerned, the same is with regard to exclusion of telecommunication expenses and expenses incurred in foreign currency for rending technical servies outside India, both from the export turnover and total turnover for the purpose of computation of deduction u/s. 10A of the Act. It is not in dispute before us that the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn) has held that charges/expenses relating to telecommunication, and expeses in connection with rendering technical services outside India, should be excluded both from export turnover and total turnover while computing deduction u/s.10A of the Act i.e., whatever is removed from the numerator should also be excluded from the denominator while working total turnover and export turnover for allowing deduction u/s.10A of the Act. In ground No.3 the grievance of the revenue is that a Special Leave Petition (SLP) is pending before Hon’ble Supreme Court. The aforesaid decision of the jurisdictional High Court has been upheld by the Hon’ble Supreme Court in the case of CIT v. HCL Technologies Ltd. in Civil Appeal No.8489-98490 of 2013 &Ors. dated 24.04.2018. In view of the above, we are of the view that the telecommunication charges should be excluded both from the export turnover as well as total turnover while computing deduction u/s.10A of the Act. The order of the CIT(A) is therefore upheld. In view of the ground Nos.2 and 3 raised by the Revenue are without merit, the same are dismissed.
We shall now take up for consideration corporate tax grounds in assessee’s appeal. Ground No.1 is general and calls for no specific adjudication.Ground No.2 was not pressed for adjudication. Hence, dismissed. Ground 3 raised by the Assessee is with regard to disallowance of expenses on purchase of application software for non-deduction of taxes under section 40a(ia) of the Act. The issue is identical to the issue raised by the assessee in Assessment Year 2010-11. The payment to the non- resident in this Assessment Year is also prior to the decision of Hon’ble Karnataka
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 36 of 38 High Court in the case of Samsung Electronics Ltd., (supra). For the reasons stated in the order for Assessment Year 2010-11 is deleted and ground No.3 is allowed.
In Ground No. 4, the assessee has challenged the order of CIT(A) upholding the order of AO in not granting allowance for depreciation on the expenses considered as capital expenditure for the Assessment Years 2009-10 and 2010-11 and in holding that no details and documentary evidence were filed establishing its claim. In the assessment order passed for AY 2009-10 and AY 2010-11, certain expenses were disallowed by holding the same to be capital in nature. The details of the same are mentioned below:
AY 2010-11 AY 2009-10 Particulars Amount (in Amount (in INR ) INR)
Computers and software 96,16,777 1,77,97,245 Office Equipment 9,90,797 71,45,092 Total 1,06,07,574 2,49,42,337 The AO granted depreciation as per the applicable rates in the AYs 2009-10 and 2010-11. The AO did not allow depreciation on such expenses treated as capital in nature in AY 2009-10 & 2010-11 during the year under consideration i.e., AY 2011- 12. In our view, allowance of depreciation on expenses considered as capital expenditure in AYs 2009-10 and 2010-11 is consequential in nature and accordingly, should be allowed in Assessment Year 2011-12. The written down value of the earlier year cannot be tampered with by the AO in subsequent year. We therefore hold that the disallowance of depreciation should be deleted. We hold and direct accordingly and allow ground No.4.
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 37 of 38 54. In ground No.5, the assessee has challenged the order of CIT(A) in upholding the action of the AO by rejecting the audit adjustments made in the Appellant’s financial statements amounting to INR 7,38,48,502 and thereby adding back the same to the taxable income by alleging that the same is suppressed income of the assessee. The facts and circumstances under which this issue arises for consideration are identical to the facts and circumstances as it prevailed in AY 2010- 11. The difference on account of audit adjustment in this year was also between the revenue recorded in the financial statements amounting to INR 258,65,27,304 vis-à-vis revenue as per the invoices raised amounting to INR 266,03,75,806. The explanation of the Assessee with regard to the said audit adjustment was that Assessee works on cost plus model, wherein the invoices are raised based on an estimated cost after adding the agreed percentage of mark-up on the same on a monthly basis. However, at the year-end, the actual costs were lesser than the estimated cost and therefore the excess amount invoices had to be reversed on account of audit adjustments. Such audit adjustment was made to reverse the excess revenue, to the extent overstated. A reconciliation of revenue as per invoices with the financial statements was also submitted during the assessment proceedings and the same is produced below:
Particulars Amount (INR) Amount (INR) Total invoice value 266,03,75,806 Add: Reversal of previous year adjustment 8,32,60,734 Less: Current year audit adjustment (10,46,27,639) (2,13,66,905) Less: Forex adjustment (5,24,81,597) Revenue as per financial statements 258,65,27,304 The AO made an adjustment of INR 7,38,48,502 as additions to revenue being differential revenue as per invoices(Rs.266,03,75,806) vis-à-vis financial statements(Rs.258,65,27,304).
The submissions made before the Tribunal are identical to the submissions
IT(TP)A Nos.322, 323, 417 and 418/Bang/2018 Page 38 of 38 made as in AY 2010-11 and are therefore not being repeated. We are of the view that the facts and circumstances under which the issue arises being identical, it would be just and appropriate to remand the issue to the AO for fresh consideration on the lines indicated in the order for AY 2010-11 incorporated in the earlier part of this order. We hold and direct accordingly.
Ground No.6 to 17 with regard to Transfer Pricing adjustment in the SWD services segment, ITES segment and MSS segment have already been dismissed as infructuous in the earlier part of this order. Ground No.18 raised by the Assessee is with regard to levy of interest under section 234B of the Act which is purely consequential in nature and the AO should give consequential relief.
In the result, appeals of the Revenue are dismissed while the appeals of the assessee are partly allowed.
Pronounced in the open court on the date mentioned on the caption page.