FUJITSU CONSULTING INDIA P.LTD,NEW DELHI vs. ACIT, CIRCLE-9(2), NEW DELHI

the order of the Ld. Commissioner of Income Tax (Appeals)-44, New Delhi {CIT (A)} vide order dated 31.10.2018 pertaining to assessment year 2014-15.

2.0 The brief facts of the case are that the assessee is engaged in the business of providing computer software consulting, system design, enterprise application and computer programming services. Fujitsu India (assessee) is one of the global delivery centres of the Fujitsu group which renders software Assessment year 2014-15 consulting and back-office support services to its Associated Enterprises (AE). Fujitsu India renders its services to its associated enterprises using estimated cost plus pricing methodology in accordance with the intercompany agreement and Global Trading Model (GTM) of the Fujitsu group. The assessee had adopted Transactional Net Margin Method (TNMM) in order to justify the arms length price of its international transactions.

2.1 The return of income was filed declaring income of Rs. 74,37,01,710/-. Subsequently, the return of income was revised to an income of Rs. 75,04,24,590/-. The case of the assessee was selected for scrutiny and during the course of assessment proceedings it was noticed that the assessee had issued credit notes to the value of Rs. 39 crores to its associated enterprises.

2.2 As per the assessee, during the year under consideration, the assessee had raised invoices on its associated enterprises in terms of the intercompany agreements and the GTM of the group. Based on the turnover of the preceding financial years i.e. is Rs. 259 crores for financial year 2010–11, Rs. 356 crores for financial year 2011–12 and Rs. 423 crores for financial year 2012–13, the assessee company had determined its estimated cost for the year under consideration i.e. financial year Assessment year 2014-15 2013–14 (assessment year 2014–15) and at such cost applied the mark-up provided in the Global Trading Model. As per the assessee, due to lower-cost being incurred by the assessee and gain arising on account of foreign exchange, the revenue due to the assessee as per the agreement was lower than the revenue which the assessee had billed to the associated enterprises.

Accordingly, credit notes to the tune of Rs. 39 crores were issued by the assessee to the AEs. On being asked to show cause by the Assessing Officer (AO), it was submitted by the assessee that the assessee had issued these credit notes of Rs. 39 crores to its associated enterprises which was duly reflected in the books of accounts of the assessee in the service income Ledger and in the Ledger accounts of the four associated enterprises to which these credit notes were issued. It was also submitted that service charges received from the associated enterprises from time to time or any credit note returned out of such receipts related to the international transaction of provision of software consulting and support services which were shown on that basis in Form 3CEB. It was also submitted that even after giving these credit notes of Rs. 39 crores to the associated enterprises, the assessee had still earned a profit margin of 20.64% on its costs which was Assessment year 2014-15 more than the margin earned by the comparable companies i.e. 11.31% as shown in the Transfer Pricing (TP) documentation. It was also the assessee’s claim that the safe harbour margin prescribed under Rule 10TD of the Income Tax Rules, 1962 (hereinafter called ‘the Rules’) for software development companies was 20% on cost and, therefore, the margin earned by the assessee was more than the margin prescribed under the safe harbour rules and, thus, there was no erosion of tax base in India because of issue of these credit notes.

2.3 It was also submitted before the assessing officer that the objective behind the issue of these credit notes to the associated enterprises was that the associated enterprises were charged in accordance with the contracts while ensuring at the same time that the arms length income was retained in India and in line with the requirement of section 92 (1) of the Income Tax Act, 1961 (hereinafter called ‘the Act’) which mandated that income arising from international transaction was to be computed having regard to the arms length price. It was also submitted that section 92 (1) of the Act did not prohibit the assessee on issuing a credit note or giving discount to a customer as long as the resulting price charged was at arms’ length. Assessment year 2014-15 2.4 However, the assessing officer reached the conclusion that the real purpose of issuance of the said credit notes was to maintain a minimum level of operating profit which was acceptable to the Indian tax authorities and repatriate the balance to its associated enterprises. The amount of Rs. 39 crores was ascertained by the assessing officer to be the profits accrued to the assessee under section 5 (1) (b) of the Act which had been diverted with a view to evade taxes in India. Accordingly, the AO made an upward adjustment on account of credit notes issued to the group companies considering them as undisclosed income and completed the income tax assessment at an income of Rs. 1,14,04,24,590/-.

2.5 Aggrieved with the order of assessment, the assessee filed appeal before the Ld. first appellate authority. However, the Ld. CIT (Appeals) dismissed the assessee’s appeal.

2.6 Now the assessee is before this Tribunal (ITAT) and has raised the following grounds of appeal:

“On the facts and circumstances of the case and in law, Ld. Commissioner of Income Tax (Appeal) (“CIT(A)” vide Impugned order dated 31.10.2018 grossly erred in upholding addition made by Ld. Assessing Officer (“AO”) to income returned by Assessee company vide order dated 30.12.2016 passed under section 143(3) of the Income Tax Act, 1961 (“the Act”).

Assessment year 2014-15

Each of the ground is referred to separately, which may kindly be considered independent of each other and without prejudice to each other.

That on the facts and circumstances of the case and in law,

learned transfer pricing officer and in doing so has failed to follow CBDT Instruction No. 3/2016. Accordingly, the order passed by the learned AO is bad in law and should be quashed.

The Appellant craves leave to add, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal.

Assessment year 2014-15

The Appellant prays for appropriate relief based on the said grounds of appeal and the facts and circumstances of the case.”

3.0 The Ld. Authorised Representative (AR) submitted that the lower authorities had erred in not appreciating that even after the issuance of the said credit notes to the associated enterprises the assessee had still earned a profit margin of 20.64% on its costs which was more than the margin earned by the comparable companies which was 11.08% as shown in the transfer pricing documentation. Our attention was drawn to the transfer pricing documentation place in the paper book to buttress this point. It was further submitted that the safe harbour margin prescribed under Rule 10TD of the Rules for software development companies was 20% on costs and, therefore, the margin earned by the assessee was more even than the margin prescribed under the safe harbour rules and thus there was no evasion of tax in India because of issuance of these credit notes.

3.1 It was further submitted that the lower authorities had failed to appreciate the fact that the only objective behind the issuance of the said credit notes to the Assessment year 2014-15 associated enterprises was that the associated enterprises were charged in accordance with the contracts while ensuring at the same time that the arms length income was retained in India and was in line with the requirement of section 92 (1) of the Act which mandated that income arising from international transaction was to be computed having regard to the arms length price. It was argued that section 92 (1) of the Act did not prohibit the assessee on giving a credit note or discount to a customer as long as the resultant price charged was at arms’ length.

3.2 The Ld. authorised representative also drew our attention to instruction No. 03/2016 dated 10/03/2016 regarding guidelines for implementation of transfer pricing provisions which has been issued by the Central Board of Direct Taxes (CBDT) and submitted that the guidelines clearly mandate that when cases are selected for scrutiny on the basis of transfer pricing risk parameter, then the case has to be referred to the Transfer Pricing Officer (TPO).

He drew our attention to Para 3.7 of the said CBDT instruction and submitted that since the impugned proceedings pertained to adjustment made with respect to Assessment year 2014-15 intra-group transactions entered into between two group entities, it was very much evident that the case had transfer pricing implications and since no reference had been made to the TPO, the assessment itself was bad in law and deserved to be quashed.

3.3 The Ld. authorised representative further submitted that these pleadings were duly made before the assessing officer as well as the Ld. CIT (Appeals) but the Ld. first appellate authority had passed the appellate order in a routine manner without considering the detailed objections and evidences placed on record by the assessee. He drew our attention to the grounds of appeal raised before the Ld. first appellate authority and also to Para 6.5 of the impugned order and submitted that in this order the Ld. first appellate authority had proceeded on incorrect factual presumption that there was no mention of credit notes in the financial statements. It was further submitted that the order of the Ld. first appellate authority not only ignored to deal with the issue as to how the amount involved in credit notes was taxable under section 5. (1) (b) of the Act but also cited no reasons on how the adjustment of tentative billing Assessment year 2014-15 for actual expenditure, which was in consonance with terms of the agreement, amounted to correction of the arms length price.

3.4 The Ld. authorised representative submitted that the Ld. CIT (Appeals) had upheld the conclusions reached by the assessing officer without even referring to the contractual agreement and, therefore, the decision-making process in the impugned order was arbitrarily.

3.5 The Ld. authorised representative further submitted that the lower authorities had erred in not appreciating that the credit notes were required to be issued to ensure that the associated enterprises were charged in accordance with the contracts and not charged excessively only by reference to the budgeted expenditure.

Referring to the GTM, it was submitted that credit notes were issued and accounted for in the context of billing for the services rendered and this approach was not contrary to any provisions of the Act including section 92 of the Act.

It was submitted that correct charges for services and issuance of credit notes was required to arrive at contractual consideration of the international transaction Assessment year 2014-15 which was the first step before testing the same for the point of view of arms length price.

3.6 It was further submitted that section 5 (1) (b) of the Act cannot bring to tax notional income or by selectively ignoring parts of the contractual agreement. It was submitted that in the present case the contractual agreement provided that the consideration was to be determined/adjusted on the basis of agreed mark-up to the actual expenditure and the initial error of billing on the basis budgetary expenditure was necessarily to be corrected by issuance of credit notes.

3.7 The Ld. authorised representative referred to order of the ITAT in the case of Sony India (Private) Limited reported in (2008) 114 ITD 448 wherein it had been held that form and substance of a transaction should be respected as long as there is a written agreement in place.

It was submitted that the agreements which were very much in place and were on record had been completely ignored by the lower authorities. Placing reliance on this decision it was submitted that in absence of information to Assessment year 2014-15 the contrary, the business and commercial substance of a transaction should not be disputed.

3.8 It was further submitted that in the instant case since the credit notes were issued in the course of regular dealings with the associated enterprises, it was improper and beyond the jurisdiction of the assessing officer to assume that the issuance of such credit notes was with intent to evade taxes in India. Reliance was placed on Para 1.64 of the OECD guidelines wherein it has been provided that it is desirable for the income tax authorities to recognise and appreciate the actual transactions undertaken by a taxpayer and the same should not be disregarded barring exceptional circumstances. It was submitted that this position has also been accepted by several courts of law wherein it has been held that it is necessary for the income tax authorities to accept and recognise a transaction as such and not to dictate or determine the terms thereof.

3.9 The Ld. authorised representative referred extensively to the paper book wherein the detailed submissions before the assessing officer and the Ld. CIT Assessment year 2014-15 (Appeals) had been incorporated. It was prayed that since the lower authorities and not considered these arguments and submissions, the appeal of the assessee deserved to be allowed.

4.0 In response, the Ld. CIT Departmental Representative (DR) placed extensive reliance on the observations and findings of the assessing officer. The Ld. CIT DR submitted that reference was not required to be made to the transfer pricing officer because in this case the issue was not any dispute about the arms length price but it was shifting of profits or avoidance of tax to other group entities. The Ld. CIT DR submitted that the main issue was whether the profit, as determined from the books of accounts maintained in the normal course of business, could be artificially reduced to a level just above the net profit margin acceptable to the local tax authority by way of issuance of credit notes to the associated enterprises. It was further submitted that the other issue which needed consideration was whether or not the profit of Rs. 39 crores had accrued to the assessee and was, thereafter, diverted as an application of income. The Ld. CIT DR submitted that Assessment year 2014-15 it has been the contention of the assessee that the credit notes were issued in accordance with the guidelines provided under the Fujitsu Global Transfer Pricing Policy and, thus, it was apparent that the assessee’s justification for the transfer of funds through credit notes primarily relied more on the group transfer pricing policy rather than the provisions of law or the Income Tax Act which had a statutory binding on the assessee with regard to its assessable income in India.

4.1 The Ld. CIT DR reiterated that as per the provisions of the Act, the assessee company has to make international transactions with its group entities at arm’s length price and there is no provision in the relevant section pertaining to international transactions which legalises a negative transfer pricing of the companies operating above the arms length price. It was submitted that the issue of negative transfer pricing on cost or upward transfer pricing on sale of services would be justified to maintain the arms length price for its transactions as per the Income Tax Act but just by the mere fact that the operating margin of the company was more than the Assessment year 2014-15 average margin of comparable independent companies, the same did not justify the transfer of funds from the sale of services receivables by the assessee under the cover of group transfer pricing policy. It was submitted that any policy or regulation of an entity is to be read within the ambit and framework of the statutory provisions of the Income Tax Act.

4.2 The Ld. CIT DR referred to the observations of the assessing officer in paragraph 9 of the assessment order and submitted that this entire exercise of issuance of credit notes was an attempt to manipulate the accounts to adjust the taxable profits down words.. The Ld. CIT DR also submitted that this was an extraordinary transaction which affected the taxable profit of the assessee in India but the same was not disclosed in Form 3CEB by the assessee.

4.3 It was also submitted that the credit notes were issued at the end of the year i.e. on 31st March and not during the course of the assessment year and, therefore, it was apparent that the credit notes were issued after the assessee realised that it had earned profits over and above expected margins. Assessment year 2014-15 4.4 The Ld. CIT DR also made reference to the email exchange to which the assessing officer had made a reference to in Para 4.7 of the assessment order from which it was apparent that this adjustment was done to maintain only the minimum level of operating profit which was acceptable to the income tax authorities.

4.5 The Ld. CIT DR submitted that it was beyond conclusion that the impugned transactions were pure transfer of taxable profits out of India with the view to evade taxes. It was submitted that these adjustments certainly did not qualify as tax planning because the same was done as an arrangement by the group in Tokyo with a view to divert the accrued profit of 39 crores to other associated enterprises by leaving a minimum level of taxable profit in India.

4.6 The Ld. CIT DR submitted that in view of the observations of the assessing officer and further in view of the findings of the Ld. CIT (Appeals), the appeal of the assessee deserved to be dismissed.

5.0 We have heard the rival submissions and have also perused the material on record. We have also perused Assessment year 2014-15 the order of the assessing officer as well as that of the Ld. first appellate authority. A perusal of the order of the Ld. CIT (Appeals) shows that the Ld. first appellate authority has summarily rejected the contentions of the assessee.

The findings of the Ld. CIT (Appeals) are contained in Para 6.5 to 6.13 and while adjudicating all the grounds before her, the Ld. CIT (Appeals) has just mentioned that she has found force in the arguments of the assessing officer in view of the fact that the impugned transaction was not an international transaction and, therefore, there was no requirement for making any reference to the transfer pricing officer. Apart from this observation, the Ld. CIT (Appeals) has not undertaken to adjudicate the issue before her and, thus, it is very much apparent that there is no independent application of mind by the Ld. CIT (Appeals).

Although the assessee had challenged the action of the assessing officer on the ground that the assessing officer had incorrectly interpreted the provisions of the Act while making an addition under section 5 (1) (b) of the Act, the Ld. CIT (Appeals) has dismissed it simply by observing that the observation of the assessing officer that the impugned Assessment year 2014-15 transaction was not an international transaction was correct and, therefore, this ground is dismissed. Similarly while dismissing ground No. 4 of the assessee’s appeal pertaining to the assessee’s contention that the credit notes issued were in line with the contractual agreement between the assessee and the associated enterprises, the Ld. CIT (Appeals) has dismissed this ground by observing that in view of acceptance of the observations of the assessing officer that this was not an international transaction, the ground of appeal was being dismissed. Further, while dismissing the assessee’s contention in ground No. 5 of the assessee’s appeal that the credit notes issued were in line with the global trading model of the group which was consistent with the transfer pricing regulations in India and abroad, it was observed by the Ld. CIT (Appeals) that this contention is not accepted in view of the reasons given by the assessing officer in paragraph 6 of the assessment order. It is further seen that ground No. 6 of the assessee’s appeal also was dismissed wherein the assessee had contended that the assessing officer had erred in not accepting that the credit notes were issued on account of ITA No. 140/D/2019 Assessment year 2014-15 difference between budgeted and actual cost and foreign exchange fluctuations. The reason for dismissal of this ground is also that the assessing officer’s observation that the impugned transaction was not an international transaction has been accepted by the Ld. CIT (Appeals).

Further ground No. 7 pertaining to the assessee’s contention that the assessing officer had erred in concluding that the credit notes were part of software development services transactions and not international transactions and ground No. 8 pertaining to the contention of the assessee that the assessing officer had erred in not considering that even after the issuance of credit notes the profit margin earned by the assessee was more than the arms length margin of the comparable companies were also dismissed by making only one observation that these grounds required to be dismissed because the assessing officer had held that the adjustment of funds by way of credit notes did not fall under the meaning of international transactions according to the provisions of section 90(2)(b) of the Act. While dismissing the grounds raised by the assessee, the impugned order is woefully silent on the Assessment year 2014-15 reasons as to why the Ld. CIT (A) agrees to the observations of the assessing officer. Thus, it is very much evident that there has been a failure on the part of the Ld. first appellate authority to properly adjudicate the grounds before her.

There is no independent application of mind by the Ld. first appellate authority and she has failed to consider all of the contentions raised by the assessee in the appeal before her.

The Ld. first appellate authority has simply dittoed the observations of the assessing officer and has upheld the findings of the assessing officer without even examining the observations of the AO vis-a-vis the objections/contentions of the assessee. It is our considered opinion that it was incumbent upon Ld. first appellate authority to pass a speaking order after proper appreciation of the facts before her. It may not be out of place here to note that as held by the Hon'ble Apex Court in the case of Kapoorchand Shrimal [1981] 131 ITR 451 (SC) in connection with the appeal before the Ld. CIT (A) that it is the duty of appellate authority to remove the errors in the order of authorities below and remit the issue with or without direction for reconsideration unless prohibited by law. Accordingly, Assessment year 2014-15 since the Ld. CIT (A) has not passed a speaking order on this issue, we are of the considered opinion that the interest of justice will be served if this issue is remitted to the file of the Ld. CIT (A) with a direction to pass a speaking order after duly examining and considering all the contentions raised by the assessee. Accordingly, the appeal is restored to the file of the Ld. First Appellate Authority with a direction to re-adjudicate the issue after duly considering all the contentions of the assessee which it may raise in this regard and after giving proper opportunity to the assessee. Needless to say, passing of a speaking order is mandatory.

6.0 In the final result, the appeal of the assessee stands allowed for statistical purposes.

Order pronounced in the open court on 9th August, 2019.