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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI B R BASKARAN&
IN THE INCOME TAX APPELLATE TRIBUNAL “B” BENCH : BANGALORE BEFORE SHRI N.V. VASUDEVAN, VICE PRESIDENT AND SHRI B R BASKARAN, ACCOUNTANT MEMBER IT(TP)A No.453/Bang/2015 & IT(TP)A No.186/Bang/2016 Assessment years : 2010-11 & 2011-12
IZMO Ltd. Vs. The Deputy Commissioner [formerly Logix Microsystems Ltd.], of Income Tax, 177/2C, Bilekahalli Industrial Area, Circle 3(1)(1), Bannerghatta Road, Bangalore. Bangalore – 560 076. PAN: AAACL 3000E APPELLANT RESPONDENT
Appellant by : Shri L. Bharath, CA Respondent by : Shri Muzaffar Hussain, CIT(DR)(ITAT), Bengaluru.
Date of hearing : 09.01.2020 Date of Pronouncement : 29.01.2020 O R D E R Per N.V. Vasudevan, Vice President IT(TP)A No.453/Bang/2015 This is an appeal by the assessee against the final order of assessment dated 30.1.2015 passed by the DCIT, Circle 3(1)(1), Bangalore u/s. 143(3) r.w.s. 144C of the Income-tax Act, 1961 [the Act] in relation to assessment year 2010-11.
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 2 of 28 2. Ground No.1 raised by the assessee is general in nature and calls for no adjudication. Ground Nos. 2 to 4 by the assessee reads as follows:-
“2. In relation to the share application money remitted by the Appellant to its subsidiary companies, the Hon'ble DRP and the LAO erred in confirming the order of the Learned TPO. which held that, a. Share application money remitted by the Appellant to its associated enterprises ('AEs'), IZMO Inc., US, and IZMO Europe BVBA constitutes an international transaction involving provision of an interest free loan. b. The Appellant should have earned an interest on the funds remitted towards the share application money. 3. The Hon'ble DRP and the LAO erred in confirming the order of the Learned TPO which had held that receivables due to it from its AE, Homestar LLC, US, and outstanding beyond 6 months constitutes a loan and a notional interest has to be charged on the same. 4. Without prejudice to the above grounds, the Hon'ble DRP and the LAO erred in confirming the order of the Learned TPO, which has wrongly computed the arm's length interest amount on the receivables due to it from its AE and outstanding beyond 6 months: a. By computing the interest at the rate of 14.74% as satisfying the arm's length principle instead of adopting the LIBOR rate. b. Computing the interest on the impugned advances by applying the rate of interest on the amount of aggregate of funds for the year, without appreciating that the funds have been remitted or are due during the course of the year and interest should be computed from the day of its remittance to AE. c. By considering the amount remitted assumes the characteristic of a loan from the day of remittance.”
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 3 of 28 3. The assessee is engaged in the business of rendering software development services to its Associated Enterprise (AE) in the United States of America (US). During the previous year, the assessee paid a sum of Rs.27,44,91,560 towards share application money pending allotment to its foreign subsidiaries Logix America Inc. US and IZMO Europe BVBA. According to assessee, the aforesaid payment towards share application money was not an international transaction and the assessee therefore did not undertake any transfer pricing (TP) analysis u/s. 92 of the Act. As per the provisions of Sec.92 of the Act, income from an international transaction has to be determined having regard to the Arm’s Length Price (ALP). The AO was of the view that it was an international transaction and made a reference to the Transfer Pricing Officer (TPO) u/s.92CA of the Act, for determination of ALP. According to the TPO, the share application money pending allotment was nothing but in the character of an interest- free loan by the assessee to its AE.
Similarly there were trade receivables from the AE to the extent of Rs.11,62,16,761 for more than six months. The AO was of the view that giving a long period of credit on trade receivables was also in the nature of an interest-free loan transaction which are subject to provisions of section 92 of the Act. Accordingly a reference was made to the TPO for determination of ALP u/s.92CA of the Act. The AO was also of the view that this transaction was also an international transaction.
The TPO ultimately determined the ALP of the aforesaid international transactions by applying the PLR rate of banks in India and determined the ALP and the addition to be made to the total income as follows:-
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 4 of 28
4.1.13 Computation of Arms Length Price:
14.74% p.a. Arms Length Interest Rate Arms Length Price @ 14.74% p.a. on the outstanding receivables exceeding six months of Rs. 39,07,08,330/- Rs.5,75,90,408/-
4.1.2 TP Adjustment for share application pending allotment outstanding AE debts exceeding 6 months: Arms Length Interest Rate Rs.5,75,90,408 Price Charged Rs. NIL Rs.5,75,90,408 Adjustment u/s. 92CA
On Appeal by the assessee, the CIT(Appeals) confirmed the order of AO.
At the time of hearing, it was brought to our notice by the ld. counsel for the assessee that identical issue had come up for consideration in assessee’s own case in AY 2009-10 before this Tribunal in IT(TP)A Nos. 280 & 243/Bang/2014, and by order dated 22.2.2017 it was held that the transactions in question were in the nature of international transactions, but however directed the TPO to apply LIBOR rate of interest.
In so far as the transaction of payment of money as share application money to the AE, the following were the observations of the Tribunal in this regard:-
“34. We have considered the rival submissions as well as the relevant material on record. As regards the question of treating the share application money as international transactions, there is no dispute that in ordinary circumstances if the remittance is made as share application money for allotment of shares and shares are allotted within a reasonable period of time then the
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 5 of 28 said payment of money to the AE cannot be considered as loan or advance for the purpose of international transaction under Section 92B of the Act. However, it is pertinent to note that the share application money does not belong to the allotting company till the shares are actually allotted against the said remittance. Thus till the allotment of shares the allotting company cannot have any right to use the share application money rather the share application money has to be kept in a separate bank account under share application money account, it is also the case of the assessee that remittance of money for subscription of equity share is not a transaction of purchase and sale of share and therefore the money remitted by the assessee remains the money of the assessee till the shares are allotted. Therefore, allotting company has no access or right to use the said money till the allotment of shares. In this case the assessee has remitted this amount during the year under consideration as per the details given at page 707 of the paper book. It is also undisputed fact that no shares were allotted to the assessee till the end of the financial year as on 31.3.2009. thus when this money was available with the AE of the assessee for utilization then it loses the character of share application money and therefore the rule as laid down by the various decisions of this Tribunal relied upon by the learned Authorised Representative will not be applicable in a case where the money is available to the AE and there is an extraordinary delay in allotment of shares. Hence we are of the view that when this money was paid by the assessee to the AE and it was very much available to the assessee for utilization for business purpose of the AE then this transaction of payment of money to the AE against which no shares were allotted till the end of the financial year relevant to the assessment year under consideration will constitute an international transaction as per the provisions of Section 92B of the Act as it has a direct bearing on the profit and loss as well as the assets of the enterprises. Further as per the Explanation to Section 92B(1) of the Act till the date of allotment it will constitute as capital financing/advance to the AE. We hold accordingly. 35. As regards the alternative plea of the assessee, we find substance so far as the applicability of LIBOR because the remittance has been made in foreign currency and therefore it is appropriate to apply the LIBOR rate for determining the arm's
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 6 of 28
length interest. Further the computation of the interest has to be from the date of remittance till the end of the financial year. Accordingly, we direct the TPO/A.O. to recompute the arm's length interest in respect of this transaction by taking into consideration LIBOR and the period from the date of remittance till 31.3.2009. As regards allowing the time period of 180 days, since this is not a case of an ordinary time period of allotment and therefore when this money was available with the AE for use then we do not find any merit or substance in this contention of the learned Authorised Representative.” 9. Insofar as question regarding allowing extended period in respect of trade receivables beyond six months and attributing income on account of interest on account of such extended credit period, in assessee’s own case for the AY 2009-10 vide order dated 22.2.2017 (supra) reported in [2011] 8 ITR (Trib.) 525 Bang., this Tribunal has held that giving a long credit period beyond six months on trade receivables constitutes an international transaction and ALP on such transaction has to be determined.
The ld. counsel for the assessee, however, made submission that the assessee is in appeal against the order of Tribunal before the Hon’ble Karnataka High Court and further submitted that in respect of share application money which was treated as loans, the Hon’ble Bombay High Court in the case of CIT v. Sterling Oil Resources (ITA No.341/2017) vide judgment dated 1.7.2019 has upheld the view of the Tribunal that such transactions cannot be regarded as international transactions. He also brought to our notice that similar ruling of Hon’ble Bombay High Court in ITA No.1248/2014 dated 28.1.2019 in Pr. CIT v. Aegis Ltd.
We have perused the aforesaid decision and find that in both the cases, the Hon’ble Bombay High Court held that no question of law arises for consideration and hence did not admit appeal of revenue. We are therefore of the view that it would be appropriate to follow the decision of the Tribunal in assessee’s own case. Therefore, we hold that the two
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 7 of 28 transactions which were subject matter of grounds No. 2 to 4 are international transactions. However, the income attributable should be by adopting LIBOR as held by the Tribunal in the aforesaid decision and not by adopting the rate of 14.75%. Thus, these grounds are partly allowed.
Ground No.5 is with regard to Transfer Pricing (TP) adjustment in software development services segments. As we have already seen, the assessee is in the business of rendering software development services to its AE. There is no dispute that the transaction of providing software development services by the assessee to its AE is an international transaction and that ALP of such transaction has to be determined in accordance with the provisions of section 92 of the Act. It is also not in dispute that the most appropriate method for determining the ALP was Transaction Net Margin Method (TNMM). The Profit Level Indicator (PLI) chosen for the purpose of comparison of the Assessee’s profit margin with the profit margin of comparable companies was Operating Profit/Operating Cost (OP/OC). The TPO finally arrived at a set of 10 comparable companies and the average arithmetic mean profit of those companies was as follows:-
SI.No. Name PLI 1 . 45.01% Infosys Ltd 2 Kals Information Systems Ltd.(seg) 38.37% 3 Larsen & Toubro Infotech Ltd. 19.33% 4 Mindtree Ltd.(seg) 14.83% 5 Persistent Systems Ltd. 30.35% 6 R S Software (India) Ltd. 10.29% 7 Sasken Communication Technologies 17.36% 8 Tata Elxsi (seg) 21.88% 9 Thinksoft Global Services Ltd. 17.05% 10 Zylog Systems (India) Ltd 19.06% 11 Evoke Technologies Pvt. Ltd. 18.75% AVERAGE MARGIN 22.93%
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 8 of 28
On the basis of the above arithmetic mean of profit margin of the above comparable companies, the TPO computed the ALP in the software development services segment as follows:-
“SOFTWARE DEVELOPMENT SERVICES
Arm's Length Mean Margin on cost 22.93% Less: Working Capital Adjustment (Annex. B) . -6.75% Adjusted margin 29.68% Operating Cost 16,09,64,911 20,87,23,200 Arms Length Price(ALP) @ 129.68% of Operating Cost Price Received 18,36,62,314 Shortfall being adjustment u/s 92CA 2,50,60,886
The above shortfall of Rs.2,50,60,886/- is treated as transfer pricing adjustment u/s 92CA in respect of software development segment of the taxpayer's international transactions.”
The addition suggested by the TPO in his order was incorporated by the AO in his draft assessment order. Against the draft assessment order of the AO, the Assessee filed objections before the Dispute Resolution Panel (DR), who confirmed the order of AO/TPO. Hence ground No.5 by the assessee before the Tribunal.
The assessee did not press for adjudication of ground No.5 (b), (c) & (e). Ground No.5(a) is general in nature and calls for no specific adjudication. Ground No.5(d) reads as follows:-
“d. The LAO, based on the directions of the Hon'ble DRP, erred in confirming the order of the Learned TPO which has considered companies that are functionally different vis-à-vis the functions of the Appellant, including, by considering giant turnover companies, product focus companies etc. namely, Infosys Limited, Persistent Systems Limited, Sasken
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 9 of 28 Communication Technologies Limited, Tata Elxsi Limited and KALS Information Systems Limited.” 16. Ground No.5(d) is with reference to excluding 5 comparable companies viz., Infosys Ltd., KALS Information Systems Ltd., Tata Elxsi Ltd., Persistent Systems Ltd. & Sasken Communication Technologies Ltd. from the list of comparable companies. It is not in dispute before us that in case of a company rendering software development services such as the assessee, for the very same AY 2010-11, the aforesaid 5 companies were chosen as comparable companies by the revenue authorities in determining the ALP and the correctness of inclusion of those companies as comparable companies was considered by this Tribunal in the case of Cerner Healthcare Solutions P. Ltd. v. ITO, 79 taxmann.com 64 (Bangalore Trib.). This Tribunal held that the aforesaid companies are not to be regarded as comparable companies with the software development service provider such as the assessee. The following were the relevant observations of the Tribunal:-
“(2) Infosys Ltd. 2. The assessee objected against the selection of this company on the ground that this company has a big name and brand value and therefore it has a bargaining power. It also contended that the turnover of this company is Rs.21,140 crores, which is 442 times higher than the assessee. 3. The DRP accepted the objections of the assessee and by following the decision of the Delhi Benches of the Tribunal in the case of Agnity India Pvt. Ltd. v. ITO [2015] 58 taxmann.com 167 (Delhi - Trib), directed the TPO to exclude this company from the list of comparables. 4. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. We note that in the case of Agnity India Pvt. Ltd. (supra), the Delhi Bench of the Tribunal has considered the comparability of this company and the findings of
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 10 of 28 the Delhi Bench of the Tribunal has been confirmed by the Hon'ble Delhi High Court. The Hon'ble Delhi High Court has observed that this company having brand value as well as intangible assets cannot be compared with an ordinary entity provide captive service. We further note that this company provides end to end business solutions that leverage cutting edge technology thereby enabling clients to enhance business performance. This company also provides solutions that span the entire software lifecycle encompassing technical consulting, design, development, re-engineering, maintenance, systems integration, package evaluation and implementation, testing and infrastructure management service. In addition, the company offers software product for banking industry. Thus, this company is engaged in diversified services including design as well as technical consultancy, consulting, re-engineering, maintenance, systems integration as well as products for banking industry. 5. In view of the above facts that Infosys Ltd. having a huge brand value and intangibles as well as having bargaining power, the same cannot be compared with the assessee who is providing services to its AE. (3) KALS Information Systems Ltd. 6. The assessee raised objections against this company on the ground that this company is engaged in the development of software and software products. Further, this company consists of STPI unit and also having a training centre engaged in training of software professionals on online products. Thus, when this company is having revenue from software services as well as software product, the same cannot be considered as comparable with software development service providing company. 7. The DRP has directed the AO to exclude this company from the list of comparables by taking note of the fact that there were inventories in the books of accounts of this company which shows that this company is in the software product business. Further, by following the decision of this Tribunal in the case of Trilogy e-business Software India Ltd. v. DCIT, ITA No.1054/Bang/2011 dated 23.11.2012, this company was found to be not comparable with that of the assessee.
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 11 of 28 8. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. The ld. DR has not disputed the fact that comparability of this company has been examined by this Tribunal in a series of decisions including in the case of Trilogy e-business Software India Ltd. (supra). We further note that in the balance sheet of this company as on 31.3.2010, there are inventories of Rs.60,47,977. Therefore, when this company is in the business of software products, the same cannot be compared with a pure software development services provider. Accordingly, we do not find any error or illegality in the impugned findings of the DRP. (4) Persistent Systems Ltd. 9. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. The assessee raised objections against selection of this company on the ground that this company is functionally not comparable as engaged in the product development. The segmental information for services and product is not available. Further, the assessee has also pointed out that there was an acquisition and restructuring during the year under consideration. 10. The DRP has noted the fact that this company has reported the entire receipt from sales and software services and product. Therefore, no segmental information was found to be available for sale of software services and product. Further, the DRP has noted that as per Note 1 of Schedule 15, this company is predominantly engaged in outsource software development service. Apart from the revenue from software services, it also earns income from licence of products, royalty on sale of products, income from maintenance contract, etc. These facts recorded by the DRP has not been disputed before us. 11. Therefore, when this company is engaged in diversified activities and earning revenue from various activities including licencing of products, royalty on sale of products as well as income from maintenance contract, etc., the same cannot be considered as functionally comparable with the assessee. Further, this company also earns income from outsource product development. In the absence of any segmental data of this
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 12 of 28 company, we do not find any error or illegality in the findings of the DRP that this company cannot be compared with the assessee and the same is directed to be excluded from the set of comparables. (5) Sasken Communication Technologies Ltd. 12. The assessee raised objection that this company has revenue from software services, software products and other services. The DRP has come to the conclusion that this company earned revenue from 3 segments. However, no segmental information is available. Accordingly, the DRP directed the AO to exclude this company from the comparables. 13. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. The DRP has reproduced the break-up of revenue in the impugned order as under:- Amount in Rs. lakhs
Year ended Year ended March 31, 2010 March 31, 2019
Software Services 37,736.22 40,531.20 Software products 2,041.00 6,146.43 Other services 372.77 1,297.05 Total revenues 40,150.89 47,974.68 14. Thus, there is no dispute that this company earns revenue from 3 segments. However, the segmental operating margins are not available. Therefore, in the absence of segmental relevant data and particularly operating margins, this composite data cannot be considered as comparable with the assessee for software development services segment. Accordingly, we do not find any error or illegality in the findings of the DRP. (6) Tata Elxsi Ltd. 15. The assessee has raised objections against this company on the ground that the company is functionally different from the assessee. Though the TPO has considered the software
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 13 of 28 development and services segment of this company as comparable to that of assessee, however, the assessee contended that even within the software segment, this company is engaged in diverse activities. The assessee placed reliance on the information in the annual report under the Directors Report and submitted before the DRP that even under the software development services segment, this company is engaged in various diversified activities including product design service, innovation design, engineering service, visual computing labs, etc. The assessee also placed reliance on the decision of Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. v. ACIT, 137 ITD 1 (Mum). 16. The DRP found that this company is not functionally comparable with assessee company as it is engaged in diversified activities even in the software development services. The DRP has followed the decision of the Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. (supra). 17. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. We find that this company even in the software development segment is engaged in diversified activities of product design services, innovation design, engineering services, visual computing labs, etc. We further note that in the case of Telcordia Technologies Pvt. Ltd. (supra), the Mumbai Bench of the Tribunal vide its order dated 11.5.2012 in para 9.7 has held as under:- "7.7 From the facts and material on record and submissions made by the learned AR, it is seen that the Tata Elxsi is engaged in development of niche product and development services which is entirely different from the assessee company. We agree with the contention of the learned AR that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company as fit for comparability analysis for determining the arm's length price for the assessee, hence, should be excluded from the list of comparable parties."
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 14 of 28 18. No contrary view has been brought to our notice regarding comparability of this company with that of a pure software development service provider. Accordingly, in view of the decision of the Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. (supra), we do not find any reason to interfere with the finding of the DRP.” 17. Following the decision of the Tribunal, we direct the aforesaid five companies be excluded from the list of comparable companies.
The next ground pressed for adjudication is ground 5(f) which reads as follows:-
f. The Hon'ble DRP and the LAO erred in confirming the order of the Learned TPO which had undertaken a working capital adjustment: i. without providing an opportunity of being heard; ii. without providing computation and manner of computation of working capital adjustment; and iii. without appreciating the business model of the Appellant and the economic circumstances in which the Appellant operated.” 19. With regard to ground No.5(f), the submissions made by the assessee before the DRP were that the negative working capital adjustment should not have been made by the revenue authorities. It was further submitted that the TPO has already considered the extended credit period allowed to the AE in respect of trade receivables as an international transaction and therefore the negative working capital adjustment ought not to have been resorted to.
According to him, doing so would result in a double addition. It was pointed out by the ld. counsel for the assessee that the DRP despite elaborate submissions in this regard, has not chosen to address the issue and has
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 15 of 28 merely upheld the order of the TPO. He relied on the decision of the Hon’ble ITAT Bangalore in the case of FNF India Pvt. Ltd. (infra). On the other hand, the ld. DR relied upon the order of DRP.
We have considered the rival submissions and are of the view that the negative working capital adjustment ought not to have been made by the TPO. The Bangalore Bench of ITAT in IT(TP)A Nos.195/Bang/2016 & 459/Bang/2017 for Assessment years: 2011-12 & 2012-13 in the case of FNF India Private Limited Vs. ACIT order dated 3.7.2019 had an occasion to deal with identical issue and the Tribunal held as follows:
“14. In Gr.No.11 the Assessee has contended that the TPO and the DRP erred in adding to the average arithmetic profit margin of the comparable companies chosen by the TPO, negative working capital adjustment. On the above ground, it is undisputed that the Hyderabad Bench of the ITAT in ITA.No. 206/Hyd/2014 for Assessment Year 2009-2010 in the case of Adaptec (India) P. Ltd. Vs. The ACIT, Circle 1(1), order dated 25.3.2015 held that no such addition can be made for the following reasons:- "Ground No.8 pertains to the issue of negative working capital. As briefly stated above, after arriving at the arithmetic mean of all comparables at 22.03%, the A.O. worked out negative working capital adjustment of 3.22% thereby, making arms length price at 25.25%. Even though, DRP refused to interfere with the objections of the assessee in its order, we were informed that DRP has directed the TPO/A.O. not to make any negative working capital adjustment in some of the cases in the next assessment year, in the cases of Market Tools Research P. Ltd., and Mega Systems Worldwide India P. Ltd., assessee placed on record copies of orders of DRP. In that DRP considered the issue and directed the TPO as under : "14. Ground No.11 : Negative Working Capital adjustment - Making a negative working capital adjustment without appreciating the fact that the company does
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 16 of 28 not bear any working capital risks. On this issue, the assessee submitted as under : "The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the differences in working capital between the assessee and the companies considered as comparables. The assessee does not agree with the learned TPO as the company does not bear any working capital risk since it is been fully funded by it's A.E. from its inception and has no working capital contingencies. The company has never taken any loans till date from the date of incorporation nor has incurred any expense for meeting the working capital requirement." We have gone through the submissions and the order of the TPO. The assessee pleaded that the DRP has acceded such a plea in some other case. On examination, we find that the DRP, Hyderabad in the case of Cordys Software India P. ltd., for A.Y. 2008-09 in its directions dated 03.08.2012 has given a finding as under : "7.7. 4 Thus, working capital adjustment is made for the time value of money lost when credit time is provided to the customers. The applicant is not an entrepreneur but a captive service provider. Its entire funding needs are provided by the A.E. This being so, the applicant does not stand to lose anything as it is compensated on a total cost plus basis. The TPO probably was carried away by the large amount of receivables appearing in the books of the applicant. But the applicant is running its business without any working capital risk while comparable companies have such a risk for them. If at all any working capital adjustment is to be made to this situation, only a positive adjustment has to be made to the comparables so that they are brought IT(TP)A No. 195/Bang/2016 & 459/Bang/2017 on par with the applicant. In view of the same, the Panel directs that negative working capital adjustment to
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 17 of 28 the arithmetic mean margin of the comparables shall not be made." In view of the above, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made." 15. In view of the above, we are of the opinion that assessee's case being similar, there is no need for making any negative working capital adjustment when assessee does not carry any working capital risk. In fact, TPO should have done necessary working capital adjustment to the profits of the selected comparables so as to make them comparable to the assessee. In view of this, we direct the TPO not to make negative working capital adjustment.” 16. It is undisputed that the Assessee is also a captive service provider such as the Assessee in the case decided by the ITAT Hyderabad Bench and therefore making a negative working capital adjustment without appreciating the fact that the company does not bear any working capital risks, was not correct. Following the aforesaid decision, we allow Gr.No.11 raised by the Assessee. All other grounds relating to Transfer Pricing were not pressed. The grounds with regard to Charging of interest u/s.234A and 234 B of the Act has been challenged on the ground of improper computation. The AO is directed to verify the correctness of the claim of the Assessee and if found correct compute correct liability of interest u/s.234A and 234 B of the Act.” 21. Respectfully following the aforesaid decision of the Tribunal, we hold that the action of the revenue authorities in making negative working capital adjustment and increasing the profit margin of the average arithmetic profit margin of comparable companies chosen, is not sustainable in the facts and circumstances of the present case which is identical to the case decided by the Tribunal in the case of FNF India Private Limited (supra). The relevant ground of appeal of the Assessee is allowed.
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 18 of 28 22. In Ground No.5(g) the Assessee seeks to question the very basis of the provisions of Sec.92 of the Act by contending that the transfer pricing adjustment and consequent addition to the total income would result in the profits of the Indian entity to be more than the global profits of the group and therefore the addition should be deleted. Such arguments which are against the very basis of Transfer Pricing provisions incorporated in Sec.92 of the Act, deserves to be rejected as without merit. Similarly in Grd.No.5(h) the Assessee seeks to contend that the foreign AE must be regarded as tested party. The contention is devoid of merits and is flawed for the reason that the geographical and other economic circumstances of the comparable companies outside India would be different and cannot reflect the correct ALP. In our view the aforesaid grounds are contrary to the statutory provisions of the Indian TP regulations and hence rejected.
Ground No.5 is accordingly partly allowed to the extent indicated above.
Ground No.6 raised by the assessee is with regard to the action of the revenue authorities in treating the purchase cost of computers as capital expenditure, but not allowing depreciation on capitalised value of computers. We are of the view that it would be just and appropriate to direct the AO to verify the claim of assessee in this regard and allow the claim in accordance with law, after due opportunity to the assessee.
Ground No.7 raised by the assessee is with regard to disallowance of expenses u/s. 14A of the Act. As far as disallowance u/s. 14A of the Act is concerned, we find that the amount of exempt income is Rs.9,64,943 and in the given facts and circumstances of the case, it would be just and appropriate to hold that disallowance u/s. 14A of the Act cannot exceed the exempt income. The Hon’ble Delhi High Court in the case of Joint Investments (P) Ltd. v. CIT, 372 ITR 694 has taken the view that
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 19 of 28 disallowance u/s. 14A of the Act cannot exceed the exempt income. Similar view was expressed by the Hon’ble Delhi High Court in the case of CIT v. Holcim India Pvt. Ltd., 272 CTR 282 (Del). These decisions were considered by the Mumbai Bench of the Tribunal in the case of Future Corporate Resources Ltd v. ACIT, ITA No.4658/Mum/2015 dated 26.07.2017 relating to AY 2011-12 and it was held by the Tribunal Mumbai Bench that disallowance u/s. 14A of the Act cannot exceed the exempt income. Following the aforesaid decisions, we hold that disallowance u/s. 14A of the Act in the present case should be restricted to the exempt income earned by the assessee. Accordingly, the AO is directed to restrict the disallowance u/s. 14A to the exempt income earned by the assessee.
As far as ground No.8 raised by the assessee is concerned, the issue is with regard to the set off of losses of the non-10A unit against the eligible profits of the 10A unit while allowing deduction u/s.10A of the Income Tax Act, 1961 (Act). The assessee had claimed deduction u/s 10A of the Act before setting of losses of the non-10A unit. The AO was of the view that deduction u/s 10A of the Act was not in the nature of exemption provision and, therefore, the business loss and unabsorbed depreciation of the earlier years has to be first set off against the income of the eligible unit and only on the reminder deduction u/s 10A of the Act has to be allowed. The view of the AO was confirmed by the CIT(A), hence this ground of appeal by the Assessee before the Tribunal.
At the time of hearing it was agreed by the parties before us that this issue is no longer res integra and has been concluded by the Hon’ble Supreme Court in the case of Yokogawa India Ltd., 391 ITR 274 by its order dated 16.12.2016 and in the aforesaid decision the Hon’ble Supreme Court took the following view :- • That from a reading of the relevant provisions of section 10A it is more than clear that the deductions contemplated therein is qua the
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 20 of 28 eligible undertaking of an assessee standing on its own and without reference to the other eligible or non-eligible units or undertakings of the assessee. The benefit of deduction is given by the Act to the individual undertaking and resultantly flows to the assessee. • This is also more than clear from the contemporaneous Circular No. 794, dated 9-8-2000. • If the specific provisions of the Act provide [first proviso to sections 10A(1); 10A(1A) and 10A(4)] that the unit that is contemplated for grant of benefit of deduction is the eligible undertaking and that is also how the contemporaneous Circular of the department (No.794 dated 9-8-2000) understood the situation, it is only logical and natural that the stage of deduction of the profits and gains of the business of an eligible undertaking has to be made independently and, therefore, "immediately after the stage of determination of its profits and gains. • At that stage the aggregate of the incomes under other heads and the provisions for set off and carry forward contained in sections 70, 72 and 74 would be premature for application. The deductions under section 10A therefore would be prior to the commencement of the exercise to be undertaken under Chapter VI for arriving at the total income of the assessee from the gross total income. The somewhat discordant use of the expression 'total income of the assessee' in section 10A has already been dealt with earlier and in the overall scenario unfolded by the provisions of section 10A the aforesaid discord can be reconciled by understanding the expression "total income of the assessee" in section 10A as 'total income of the undertaking'. • For the aforesaid reasons it is held that though section 10A, as amended, is a provision for deduction, the stage of deduction would be while computing the gross total income of the eligible undertaking under Chapter IV and' not at the stage of computation of the total income under Chapter VI. ” 28. The effect of the aforesaid decision would be that the provision of set off and carry forward as contemplated under Chapter-VI of the Act would not be attracted and therefore intra head set off sought by seeking to
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 21 of 28 rely on the provision of section 70(1) of the Act and seeking to restrict the deduction u/s 10A and 10AA of the Act to the extent of gross total income as contemplated u/s 80A(2) of the Act, cannot be sustained. We therefore hold that deduction u/s.10A of the Act has to be allowed without setting off losses of non-10A unit before allowing the deduction under section 10A of the Act. In view of the aforesaid decision of the Hon’ble Supreme Court, the AO is directed not to set off the losses of non-10A units against profits of 10A units before allowing deduction u/s. 10A of the Act.
As far as ground Nos. 9 & 10 is concerned, the issue is with regard to computation of capital gain and rate of tax at which short term capital gain is to be brought to tax. It is the plea of assessee that the AO did not allow expenditure in connection with transfer of shares and also erred in not applying the rate of tax @ 15% on short term capital gain. In our view, it would be just and appropriate to direct the AO to verify the claim of assessee in this regard and decide the issue afresh in accordance with law, after due opportunity to the assessee.
Ground Nos.11 & 12 raised by the assessee are with regard to not allowing credit for TDS and also adding a sum of Rs.25,60,632 to the tax payable as interest on distributed profits. In our view, the above issues need a fresh look by the AO as was directed by the DRP and we direct the AO to consider the claim of assessee in this regard afresh, after affording opportunity of being heard to the assessee.
The TPO is directed to compute the ALP in the light of the directions given above after affording Assessee opportunity of being heard. In the result, the appeal by the assessee is partly allowed.
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 22 of 28 IT(TP)A No.186/Bang/2016
This appeal is also by the assessee and is filed against the final order of assessment dated 15.12.2015 passed by the ITO, Ward 4(1)(1), Bangalore relating to assessment year 2011-12. The grounds of appeal in the present assessment year are also identical to grounds of appeal for AY 2010-11.
As far as ground Nos.2 to 4 are concerned, the same relates to attribution of notional income on share application money which was treated as interest-free loan by the assessee to its subsidiary. We have already held while deciding ground No.2 in the appeal of assessee for AY 2010-11 that the transaction in question is an international transaction and that ALP of the same has to be determined in accordance with the provisions of section 92 of the Act. We have also held that rate of interest to be attributed is not 13.64% as done by the revenue authorities, but LIBOR rate of interest. Similar direction and decision in this assessment year, in our view, would be just and proper and we hold and direct accordingly.
Similarly ground Nos. 3 to 5 raised by the assessee are with regard to extended credit period on trade receivables allowed by the assessee. In respect of this issue, while deciding ground No. 4 raised by the assessee in AY 2010-11, we have already held allowing extended period on trade receivables was an international transaction and that income attributable on such extended period should be the LIBOR rate of interest and not 13.64%. Similar direction in the present assessment year would be just and appropriate and we hold and direct accordingly.
As far as ground No.6 raised by the assessee is concerned, the same is with regard to determination of ALP in respect of transaction of
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 23 of 28
rendering of software development services by the assessee to its AE. There is no dispute that the transaction in question is an international transaction and that TNMM is the most appropriate method for determining the ALP of the international transaction. The TPO chose 13 comparable companies which were as follows:-
PLI Sl.No Name Sales Cost 1 Acropetal Technologies Ltd.(seg) 814,016,893 616,754,876 31.98% 2 e zest solutions (from Capitaline) 112866098 93255341 21.03% 3 E-infochips Ltd 260384251 166447527 56.44% 4 Evoke (from Capitaline) 144869912 133996568 8.11% S I C R A Techno Analytics Ltd. (in 158401000 126894000 24.83% 000) 6 Infosys Ltd 253850000000 177,030,000,000 43.39% 23318122096 19,764,861,289 19.83% 7 Larsen & Toubro Infotech Ltd. 8 Mindtree Ltd.(seg) 8,783,000,000 7,937,143,242 10.66% 189,490,457 155,172,089 22.12% 9 Persistent Systems & Solutions Ltd. 10 Persistent Systems Ltd. 6,101,270,000 4,971,860,000 22.84% 11 R S Software (India) Ltd. 1,882,638,471 1,617,804,170 16.37% 12 Sasken Communication 3,941,962,000 3,175,616,000 24.13% Technologies Ltd 3,581,985,000 2,962,533,352 20.91% 13 Tata Elxsi Ltd (seg) AVERAGE MEAN 24.82%
After working capital adjustment, the TPO determined the ALP of international transactions as follows:-
“14.4. Computation of Arms Length Price:
The arithmetic mean of the Profit Level indicators is taken as the arms length margin. Please see Annexure B for details of computation of PLI of the comparables. Based on this, the arms
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 24 of 28 length price of the services rendered by the taxpayer to its AE(s) is computed as under: SOFTWARE DEVELOPMENT SERVICES 24.82% Arm's Length Mean Margin on cost Less: Working Capital Adjustment 1.63% (As per Annex. C) 23.19% Adjusted margin 135,611,357 Operating Cost 167,059,631 Arms Length Price(ALP) 123.19% of Operating Cost) 153,308,512 Price Received 13,751,119 Shortfall being adjustment u/s 92CA: The above shortfall of Rs.1,37,51,119 /--is treated as transfer pricing adjustment u/s 92CA in respect of software development segment of the taxpayer's international transactions.” 37. The DRP confirmed the action of the TPO and hence ground No.6 by the assessee before the Tribunal. Ground 6(a) is general in nature and requires no adjudication. Ground No.6(b) reads as follows:-
“6(b) The Hon'ble DRP and the LAO erred in confirming the order of the Learned TPO which had rejected a comparable company, namely CG VAK Software and Exports Limited, selected by the Appellant by holding that this company was not found in the public domain / information was not available for the same despite the Appellant furnishing details of the same.” 38. As far as ground No.6(b) is concerned, we find that the assessee had given the annual report of CG VAK Software & Exports Ltd., but the TPO took the view that the financial details of this company was not available in the public domain and rejected this company as a comparable company. The DRP upheld the action of the TPO without noticing that the assessee has specifically pointed out before the DRP that the information regarding this company in the form of annual reports was very much available. Since the comparability of this company has not been examined
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 25 of 28 in the light of financial statements of this company already available on record, it would be just and proper to direct the TPO to consider the comparability of this company afresh in the light of the annual report of the company which is already available on record. We hold and direct accordingly.
Ground No.6(c) was not pressed for adjudication. As far as ground No.6(d) is concerned, the same reads as follows:-
“6(d) The Learned Assessing Officer, based on the directions of the Honorable Dispute Resolution Panel, erred in confirming the order of the Learned Transfer Pricing Officer which has considered companies that are functionally different vis-a-vis the functions of the Appellant, including, by considering giant / high turnover companies, product focus companies etc., namely E-zest Solutions Limited, E-Infochips Limited, ICRA Techno Analytics Limited, Infosys Limited, Larsen & Toubro Infotech Limited, Mindtree Limited, Persistent Systems Limited, Sasken Communication Technologies Limited and Tata Elxsi Limited.” In the aforesaid ground, the assessee seeks to exclude the 8 companies from the list of comparable companies viz., (1) Infosys Ltd. (2) Tata Elxsi Ltd. (3) Persistent Systems Ltd. (4) Sasken Communication Technologies Ltd. (5) E-Zest Solutions (6) E-Infochips Ltd. (7) ICRA Techno Analytics Ltd. (8) L&T Infotech Ltd.
At the time of hearing, it was pointed out by the ld. Counsel for the assessee that the comparability of the aforesaid 8 companies was subject matter of consideration by the ITAT Bangalore Bench in the case of assessee rendering software development services such as the present assessee in the case of Applied Materials (India) Pvt. Ltd. in IT(TP)A No.17/Bang/2016 for the AY 2011-12 and in whose case also the TPO had chosen same comparable companies as was chosen by the TPO in the
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 26 of 28 case of the Assessee. In the aforesaid decision, the Tribunal excluded Infosys Ltd. from the list of comparables on the ground that Infosys Ltd. was not functionally comparable vide para 18 of the order on the ground that it had very huge turnover and had brand value and considering the size of turnover, this company cannot be compared functionally to the assessee. As far as Tata Elxsi Ltd. is concerned, vide para 20 of the aforesaid order of Tribunal, it was held that this company was a software product company and not a pure software development services provider such as the assessee and hence not comparable functionally. As far as Persistent Systems Ltd. is concerned, vide para 9.2.4 in the aforesaid order, the Tribunal held that this company was also engaged in software product development and not software development services provider such as assessee and hence not comparable functionally. As regards Sasken Communication Technologies Ltd. is concerned, the Tribunal vide para 9.3.1 of the aforesaid order held that this company was into the software products, software development services and other services and therefore cannot be compared with the assessee functionally. Regarding E-Zest Solutions, the Tribunal in the aforesaid order vide para 9.1.1 to 9.1.3 held that the issue with regard to comparability of this company should be remanded to the TPO for fresh consideration. We accordingly remand the comparability of this company for fresh adjudication by the TPO.As regards E-Infochips Ltd. is concerned, the Mumbai Tribunal in the case of Ness Technologies Pvt. Ltd. in ITA No.696/Mum/2016 for AY 2011-12, order dated 11.11.2016, vide para 6 of the order, held that this company was not comparable as it was providing varied services and not purely software development services provider and hence functionally not comparable with a SWD service provider such as the Assessee. As far as ICRA Techno Analytics Ltd. is concerned, we find that this company was considered as not comparable company with software development services provider in the case of Applied Materials (India) Pvt. Ltd. (supra). Vide para 19 of this
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 27 of 28 decision of the Tribunal, it was held that L&T Infotech Ltd. had Related Party Transactions (RPT) transactions beyond the threshold limit and therefore cannot be regarded as a comparable. In the light of the decisions, we direct exclusion of the aforesaid 8 companies from the list of comparable companies.
Ground No.6(e) was not pressed and grounds 6(f) & (g) are identical to ground 6(g) & (h) raised by the Assessee in AY 2010-11. For the reasons stated in the AY 2010-11, these grounds are dismissed.
The AO is directed to compute the ALP in the light of directions given above, after affording due opportunity of being heard to the assessee.
Ground No.7 is with regard to disallowance section 14A of the Act. For the same reasons as already held in AY 2010-11, we direct the AO to restrict the disallowance u/s. 14A to the exempt income earned by the assessee.
Ground No.8 is with regard to disallowance of club expenses of Rs.5,72,231/-. The AO disallowed the claim of the Assessee for deduction on the ground that the expenditure cannot be regarded as having been incurred for the purpose of the business of the assessee. It was the claim of the Assessee that the expenditure enabled its executes to meet business associates, collaborators, customers etc., and was incurred owing to commercial expediency and benefit the business of the Assessee. The AO did not agree with the stand of the Assessee. The DRP also confirmed the action of the AO. We are of the view that the expenditure in question has to be allowed as deduction. The Hon’ble Bombay High Court in the case of Otis Elevators Co (I) Ltd. Vs. CIT 195 ITR 682 (Bom) has also held the expenditure to be business expenditure. Therefore there is no case for
IT(TP)A No.453/B/2015 & IT(TP)A No.186/B/2016 Page 28 of 28 disallowing any part of the club expenditure as owing to non-business purposes. This issue is no longer res integra and has been settled by the Hon’ble Supreme Court in the case of CIT v. United Glass Mfg. Co. Ltd. [Civil Appeal Nos. 6447 to 6449 of 2012, dated 12-9-2012] wherein it was held that club membership fee paid by the company is an admissible business expenditure and cannot be regarded as capital expenditure. In view of the aforesaid decision of the Hon’ble Supreme Court, we are of the view that there is merit in ground No.8 raised by the Assessee and the same is allowed.
In the result, the appeal is partly allowed.
In the result, both the appeals are partly allowed.
Pronounced in the open court on this 29th day of January, 2020.
Sd/- Sd/-
( B R BASKARAN ) ( N V VASUDEVAN ) ACCOUNTANT MEMBER VICE PRESIDENT
Bangalore, Dated, the 29th January, 2020. /Desai S Murthy /
Copy to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard file
By order
Assistant Registrar ITAT, Bangalore.