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Income Tax Appellate Tribunal, PUNE BENCH “C”, PUNE
Before: SHRI INTURI RAMA RAO & SHRI S. S. VISWANETHRA RAVI
ORDER
PER INTURI RAMA RAO, AM:
This is an appeal filed by the assessee directed against the final assessment order dated 25.11.2010 passed u/s 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (‘the Act’) for the assessment year 2006-07.
Briefly, the facts of the case are that the appellant is a company incorporated under the provisions of the Companies Act, 1956. The assessee company is a wholly owned subsidiary of T- Systems International GmbH, a German Company, is a part of the Deutsche Telekom Group. It is registered as a 100% Export Oriented Unit (‘EOU’) under the Software Technology Park (‘STP’) Scheme at Pune. It is engaged in the business of development and export of computer software. The return of income for the assessment year 2006-07 was filed on 30.11.2006 disclosing loss of Rs.11,09,536/-. The assessee company also reported the following international transactions in Form No.3CEB :- Sr. Nature of Transaction Amount Method No. 1 Purchase and Development Software 1,503,955 TNMM 2 Development and sale of computer software services 281,520,840 CUP 3 Providing Application Life Cycle Management Services 141,717,090 TNMM and Testing Validation service (IT and related Software Services) 4 Services received for implementation SAP – HR Modules 1,461,800 TNMM 5 Services received for hosting of SAP Users 380,574 TNMM 6 Services received for Server Usage 976,572 TNMM 7 Reimbursement of lease line charges 5,880,079 TNMM 8 Expenses incurred by way of Damages 57,902,756 - 9 Reimbursement of professional costs incurred on SAP 10,607,181 - Implementation 10 Apartment charges for employees of employees of T- 19,719 TNMM Systems India 11 Services received for hotel stay expenses of ENPS team 635,077 TNMM during Germany tour 12 Services received for Visa, Insurance, accommodation 3,665,841 TNMM and personal support costs 13 Reimbursement of rent, recruitment and training charges 4,858,468 - Total 511,129,952
The assessee company sought to justify the consideration received for the above international transactions entered with its AE to be at arm’s length price (ALP). The assessee company also submitted Transfer Pricing (TP) study report adopting the Comparable Uncontrolled Price (CUP) as the most appropriate method. It is also applied internal CUP method whereby the assessee company compared the rates charged by its AEs with that charged by third party to Non-AE and accordingly, concluded that the international transactions in the software development segment are at arm’s length.
On noticing the above international transactions, the Assessing Officer referred the matter to the Transfer Pricing Officer (TPO) for the purpose of benchmarking the above international transactions. The TPO by an order dated 30.10.2009 passed u/s 92CA(3) suggested the upward TP adjustments of Rs.9,84,10,304/-. While doing so, the TPO had rejected the CUP as the most appropriate method and clubbed the transactions under the provisions of software development services with international transactions and adopted the TNMM as the most appropriate method at entity level. The TPO also adopted OP/OC as PLI, but rejected the TP study report submitted by the assessee company and proceeded to identify ALP of the international transactions. While doing so, the TPO applied the filters and finally selected the following 9 comparables :- Sr. Name of the company PLI (Operating No. Profit/Operating Cost) 1 Goldstone Technologies Ltd. 2.82% 2 Maars Software International Limited 12.66% 3 Melstar Information Technologies Limited 3.46% 4 Quintegra Solutions Limited 14.23% 5 R S Software (India) Limited 15.26% 6 Compucom Software Limited 33.44% 7 SIP Technologies & Exports Limited 21.71% 8 ICSA (India) Ltd. (Seg) 31.88% 9 Megasoft Limited 50.50% Arithmetic Mean 20.66% 5. The TPO computed the average profit margin of the comparables finally selected by him at 20.66%. On the above basis, the TPO computed the upward TP adjustments of Rs.9,84,10,304/- vide order dated 30.10.2009 passed u/s 92CA(3) of the Act. 6. Pursuant to receipt of the TPO’s order, the Assessing Officer passed the draft assessment order dated Nil passed u/s 143(3) of the Act incorporating the above TP adjustments of Rs.9,84,10,304/-. 7. On receipt of the draft assessment order, the appellant filed objections before the ld. DRP objecting the TP adjustment of Rs.9,84,10,304/- on the ground that the provisions of section 92CA of the Act have no application to the entity of the assessee as the 10A of the Act. During the course of proceedings before the ld. DRP, the Assessing Officer submitted remand report dated 23.08.2010 wherein the TPO rejected the 4 comparables out of 9 comparables identified in the TPO’s order and arrived final set of comparables whose average OP/OC margin was computed at 22.62% and suggested upward TP adjustment of Rs.10,77,00,742/-.
On receipt of the direction from the ld. DRP, the final assessment order was passed by the Assessing Officer vide order dated 25.11.2010 passed u/s 143(3) r.w.s. 144C(13) of the Act after making the addition of Rs.10,77,00,742/- on account of TP adjustments.
Being aggrieved by the above final assessment order, the appellant is in appeal before in the present appeal.
During the course of hearing of appeal before us, the ld. Senior Counsel submitted that if the ground of appeal
no.8 seeking exclusion of the damages incurred by the appellant relating to the EPCOS project form part of the operating cost for the purpose of computing the PLI and the ground of appeal no.7 seeking exclusion of Megasoft Limited as comparable is allowed in favour of the assessee, the other grounds of appeal filed by the assessee become academic in nature, since the price received by the assessee shall be at arm’s length price. Thus, it was submitted that this ground of appeal no.7 and 8 be decided at first instance. Accordingly, we take up the ground of appeal no.8 for adjudication.
11. Ground of appeal no.8 reads as under :- “8. Erred in treating damages pertaining to EPCOS project incurred by Appellant as operating expenses Erred on facts and in circumstances of the case by rejecting the contention of the Appellant that the damages incurred by the Appellant relating to the EPCOS project are not in the nature of an operating expense and hence should not be included in the calculation of operating profit.”
12. In this regard, the appellant explained that the damages incurred by the appellant relating to CPCOS project are not in the nature of operating expenses and, therefore, should not form part of the operating cost for the purpose of computation of PLI for the year under consideration. The factual background of this claim is explained as under :- The assessee had entered into an agreement with its associated enterprise viz. T-Systems Germany (‘TSES’) as a sub-contractor for providing “application management” and help desk services to EPCOS (a client of TSES) and the assessee provided services to TSES from November 2004 onwards. However, the services provided by the assessee during F.Y. 2004-05 were not in EPCOS. TSES being the primary contractor was responsible to EPCOS for the damages caused due to inefficiency of the assessee and had to incur incremental costs for providing services to EPCOS. The assessee mentioned that the said expenses are exceptional in nature and had been crystallized during the financial year ended 31 March 2006. Above facts are mentioned in the transfer pricing study prepared by the assessee (refer Page 60 of the Paper Book-I) The assessee was responsible for the consequences resulting from deficiencies in its performance as evident from agreement between the assessee and TSES (refer Para 5.1.2 on Page 202 of Paperbook-1). During the financial year ended 31 March 2006, part of the additional costs incurred by TSES which was attributable to the assessee was charged by TSES to the assessee as contractual damages on account of deficient services provided by the assessee (refer Para 5.4 of Page 204 of Paper Book-I). These expenses are exceptional/ non-recurring expenses incurred in the start-up phase, where the assessee was establishing its credentials. Accordingly, since the EPCOS damages paid were non-recurring and extra-ordinary in nature, same were treated as non-operating item of expenditure while computing the operating margins by the assessee. Further, inclusion of EPCOS damages in the operating cost would have led to an inappropriate conclusion. The assessee pointed out the fact that the item is an exceptional item, is evident from Point 5 of Schedule 13 of the notes forming part of the audited accounts for the financial year ended 31 March 2006, wherein such expenditure in profit and loss account has been disclosed separately (refer Pages 2 and 11 of the Paper Book-I). The assessee also pointed out that EPCOS damages was an extra-ordinary item is further evident from the fact that the same required specific approval from the Board of Directors as is evident from the extracts of the minutes of the meeting of Board of Directors (refer Page 207 of the Paper Book-I). The assessee vide submission dated 7 July 2009, inter alia submitted the steps taken and costs incurred by T-Systems Germany to overcome the EPCOS damages, the persons involved in the project for overcoming the damages. The assessee also provided the sample copies of invoices raised by third parties on T-Systems Germany and also the proofs of the cost incurred by T-Systems Germany for damage rectification vis-a-vis the cost charged to the Assessee (refer Pages 207 to 217 of the Paper Book-I). Further, the break-up of the amount charged by TSES to the assessee on the EPCOS project on account of the damages is also provided by the assessee along with logical basis for charging such damages (refer Page 224 and 229 of Paper Book - I). Further, the assessee mentioned that since inception till latest available financials i.e. from F.Y. 2004- 05 to FY 2008-09, the assessee had allocated cost of such damages only once i.e. in FY 2005-06 and that too for the deficient services rendered in initial years of operation. This clearly demonstrates that this cost is of exceptional and non-recurring in nature.
Thus, it was pleaded that the expenditure incurred on the reimbursement of damages should not be formed part of the operating cost for the purpose of computing the PLI for the year under conisation. The ld. Senior Counsel also placed reliance plethora of following decisions :- (i) Grupo Antolin India Private Limited vs. DCIT (ITA No.299/PUN/2013 dated 17.10.2018). (ii) ACIT vs. Chemtex Global Engineering P. Ltd. (ITA No.3590/Mum/2010 dated 12.06.2013) (iii) M/s. Igarashi Motors India Ltd. vs. ACIT (ITA No.2257(Mds)/2012 dated 17.06.2013) (iv) Capgemini India Private Limited vs. ACIT (ITA No.7861/Mum/2011 dated 28.02.2013)
(v) CIT vs. Transwitch India Pvt. Ltd. (ITA No.678/2012 and CM 20555/2012) (Delhi High Court). (vi) Transwitch India Pvt. Ltd. vs. DCIT (ITA No.6083/Del/2010 dated 30.03.2012) (vii) Demag Cranes and Components (I) Pvt. Ltd. vs. DCIT (ITA No.120/PN/2011 dated 04.01.2012) (viii) Symphony Services India (P.) Ltd. vs. ACIT (ITA No.623 & 624/Bang/2008 dated 28.04.2017) 14. On the other hand, ld. CIT-DR opposed the above submissions and submitted that this expenditure should form part of the operating cost for the purpose of computing the PLI for the year under consideration.
We heard the rival submissions and perused the material on record. The issue in the present ground of appeal no.8 relates to the adjustment in the computation of operating cost of the appellant company. The adjustment was sought by the assessee on the ground that during the year under consideration it had incurred extraordinary cost in the form of damages incurred in the deficiency of services rendered during the financial year 2004-05 in respect of providing the “application management” helpdesk services to EPCOS (a cline of T-Systems Germany). It was claimed that this expenditure was extraordinary exceptional expenses, therefore, cannot be treated as part of the operating cost for the purpose of computing the operative margins of the appellant company. It is further pointed out that the expenditure was incurred in relation to the income of earlier years, therefore, cannot form part of the operating cost for the year under consideration. These factual submissions are undisputed. It is settled position of law that the operating profit of the assessee is required to be adjusted by excluding items of abnormal costs to determine the normal profit that could have been earned by it for the purpose of benchmarking with other comparables. Therefore, while calculating the operating cost, the abnormal cost incurred on account of damages paid by it in relation to the income earned in the earlier years should be excluded. Therefore, we direct the Assessing Officer/TPO to adjust the operating cost of the appellant by excluding the abnormal cost incurred by the appellant in the form of damages. We are supported in taking this view by the decision of the Hon’ble Delhi High Court in the case of Transwitch India Pvt. Ltd. (supra), decision of the Hon’ble Punjab & Haryana High Court in the case of Honda Motorcycle & Scooters India (P.) Ltd. vs. ACIT, 77 taxmann.com 119 (P&H), decision of the Hon’ble Gujarat High Court in the case of PCIT vs. Sabic Research & Technology (P.) Ltd., 94 taxmann.com 338 (Guj.). Therefore, this ground of appeal no.8 stands allowed in favour of the assessee.
Ground of appeal
no.7 reads as under :- “7 Erred in acceptance of additional companies as comparable Erred on the facts and in circumstances of the case by considering additional companies as comparable in the TP order which were not considered as comparable by Appellant in transfer pricing report.”
17. Vide this ground of appeal no.7, the appellant company seeks exclusion of Megasoft Limited as a comparable on the grounds of functionality difference as the financial year of this company is ending with 31st December. Referring to page no.5 of the annual report of the said company enclosed at 508 of the Paper Book, it is submitted that this company is also product development company. It is further submitted that a company whose financial year is different from the assessee company, cannot be chosen as a comparable as the Megasoft Limited adopted financial year ending with 31st December. In this regard, reliance was placed on the following decisions :- (i) Bindview India P. Ltd. vs. DCIT (ITA No.1386/PN/2010 dated 30.11.2011). (ii) PTC Software (India) Pvt. Ltd. vs. ACIT (ITA No.1605/PN/2011 dated 30.04.2013).
18. On the other hand, ld. CIT-DR placed reliance on the orders of the lower authorities.
We heard the rival submissions and perused the material on record. The issue in the present ground of appeal
no.7 relates to the comparability of the company “Megasoft Limited” with that of the the appellant company which is characterized as software company by the TPO. We find in the directors’ report enclosed with the annual report forming part of the annual report of the appellant company in overview of the company is mentioned as follows :- “Overview During the current financial year, your Company made a strategic transition from being a mid-sized generic software services provider into a domain led IP driven Product Development company. Your Company has identified Telecom and Life Sciences as thrust areas for building strong foundation given their strong management and delivery capabilities in these industry domains. During the year your Company also acquired 64% stake in a German IT Services Company beam AG, Germany (“Beam”). This acquisition gives your Company a strategic base for the expansion of its operations in Europe. Your company has also entered new geographies and the overall overseas revenues have gone up from Rs.754.23 million in 2004 to Rs.981.09 million in 2005, a growth of 30%. Your Company during the financial year ended 31 December 2005 recorded consolidated revenues of Rs.1154.26 million compared to Rs.849.15 million for the financial year ended 31st December 2004, registering a growth of 36%. The Operating Profit at Rs.206.38 million as against Rs.61.64 million in the previous year, represent a growth of 235%.”
20. We also find that the financial year of the company ends with 31st December which is different from the assessee company. In the Balance Sheet enclosed at page no.504 of the Paper Book, it is clearly mentioned that this company is into business of development and maintenance of computer software and also imported capital goods which clearly indicates that the company is into development of software product and no segmental results of development of software product and software services are furnished. In the absence of segmental results, this company cannot be considered as comparable with that of the assessee company which is purely characterized as software development company.
Now, it is settled position in law to the extent that where the assessee company was rendering software development services to its AEs cannot compared to the company which is into the production development as well as software development in the absence of segmental information qua the software services alone. Reliance in this regard can be placed on the following decisions :- (i) Steria India Ltd. vs. DCIT, 92 taxmann.com 120 (Delhi). (ii) CIT vs. PTC Software (I) (P.) Ltd., 395 ITR 176 (Bom.).
In the light of the above discussions, we are of the considered view that the company “Megasoft Limited” cannot be compared with that of the assessee company which is purely software development company. Hence, we direct the Assessing Officer/TPO to exclude this company from the list of the comparables. Thus, this ground of appeal no.7 stands allowed.