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Income Tax Appellate Tribunal, “C” BENCH : BANGALORE
Before: SHRI N. V. VASUDEVAN & SHRI B. R. BASKARAN
Per N. V. Vasudevan, Vice President:
This is an appeal by the assessee against the final order of assessment dated 05.12.2016 passed under section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (Act) in relation to Assessment Year 2012-13 by the DCIT, Circle - 1(1)(2), Bengaluru. Though the assessee has raised as many as 14 grounds of appeals, the issues that have to be adjudicated in this appeal are as follows:
1. Transfer pricing adjustment ("TP adjustment") of Rs.1,49,79,297/- made by the Transfer Pricing Officer ('the TPO' for short) towards the International transactions of provision of Information Technology Enabled services to the Appellant's Associated Enterprises ('AE' for short), which was IT(TP)A No. 352/Bang/2017 Page 2 of 14
reduced to 1,31,74,095/- upon giving effect to the DRP's directions; 2. Disallowance of deduction claimed under Section 10AA of the Act upon reducing telecommunication expenses only from the export turnover without corresponding reduction from total turnover; 3. Disallowance of employees' contribution made under the Employee State Insurance Act, 1948; and 4. Short-grant of credit of taxes deducted at source.
The assessee is a company incorporated under the provisions of Companies Act, 1956 and is engaged in providing contract software development services (SWD services) and contract information technology enabled services (ITES) to its Associated Enterprises (AE) as a captive service provider. The first issue that needs to be decided in this appeal is as to whether the consideration received by the assessee for providing IT enabled services (ITES) to its AE is at arms length as laid down under the provisions of section 92 of the Act. The assessee received a sum of Rs.13,60,48,189/- for providing ITES to its AE. To justify the price paid in the international transaction as at arms length, the assessee filed the TP study in which it had chosen Transaction Net Margin Method (TNMM) as the most appropriate method for determining arms length price (ALP). The profit level indicator (PLI) chosen for the purpose of comparison was operating profit on total cost (OP/TC). The OP/TC as computed by the assessee was at 14.60%. The assessee had chosen 6 comparable companies and compared their average arithmetic mean profit margin which was 13.65% with the profit margin of the assessee and claimed that since the profit margin of the assessee was more than the arithmetic mean of the profit margin of the comparable companies, the price charged in the international transaction was at arms length.
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The Transfer Pricing Officer (TPO) to whom the AO referred the question for determination of ALP agreed with the choice of PLI as well as method adopted by the assessee for determination of ALP i.e., TNMM. The TPO accepted 2 out of the 5 comparable companies chosen by the assessee in its TP analysis and on his own the TPO selected 8 other comparable companies and determined the ALP and the addition to be made to the total income on account of determination of ALP as follows:-
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The sum as suggested by the TPO as shortfall in the price charged in the international transaction was added to the total income of the Assessee by the AO in the draft order of assessment.
The Assessee filed objections to the determination of ALP by the TPO before the DRP. The DRP excluded 2 out of 10 comparable companies chosen by the TPO based on the objections raised by the Assessee before it. The DRP on its own excluded another comparable companies chosen by the TPO. The resultant comparable companies, after the order of the DRP that remained for comparison and the ultimate determination of ALP and the addition to be made to the total income was as follows:-
Upon giving effect to the directions issued by the DRP, the Respondent passed an order dated 05.12.2016 inter alia reworking the TP adjustment at Rs. 1,31,74.095/-.
The AO passed the final assessment order making addition of a sum of Rs.1,31,74,095/-. Against the aforesaid addition, the assessee is in appeal before the Tribunal.
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At the time of hearing of the appeal, the learned Counsel for the assessee pleaded for exclusion of 3 out of 7 comparable companies that remain after the order of the DRP viz., Infosys BPO Ltd., TCS E-Service Ltd., and BNR Udyog Ltd. As far as Infosys BPO Ltd., is concerned, the learned Counsel for the assessee brought to our notice a decision of the ITAT, Bangalore Bench, in the case of Zyme Solutions Pvt. Ltd., Vs. ACIT in IT(TP)A No.1661/Bang/2016 dated 16.11.2018 and another order in the same case dated 28.06.2019. In the aforesaid order dated 28.06.2019, the Tribunal considered exclusion of Infosys BPO Limited, an assessee who is also engaged in rendering ITES such as the assessee. The Tribunal held that the aforesaid 2 companies should be excluded from the list of comparable companies as they were not functionally comparable with ITES. The following were the relevant observations of the Tribunal:-
“5. We have heard the rival submissions on the comparability of Infosys BPO as a comparable company. The Delhi ITAT in the case of Baxter India Pvt. Ltd. Vs. ALIT for AY 2012-13 in the case of a company rendering ITES such as the Assessee, vide order dated 24.8.2017 Paragraph 23 held that Infosys BPO is not comparable with a company rendering ITES for the following reasons:- "23. In so far as exclusion of Infosys BPO Ltd. is concerned, we find from the submissions made by the assessee before the Assessing Officer/TPO/DRP is that Infosys BPO Ltd. is predominantly into areas like Insurance, Banking, Financial Services, Manufacturing and Telecom which are in the niche areas, unlike the assessee. Further it was also submitted that the Infosys BPQ Ltd. comprises brand value which will tend to influence its business operation and the pricing policy thereby directly impacting the margins earned by the Infosys BPO Ltd.. We find the submissions of the Id. counsel for the assessee before TPO/DRP that in order to maintain the brand image of Infosys BPQ Ltd. in the market, the company incurs substantial selling and marketing expenditure whereas the assessee being a contract service provider does not incur such expenses to maintain its brand has not been controverted by them. Further, Infosys BPO Ltd. being a subsidiary of Infosys has an element
IT(TP)A No. 352/Bang/2017 Page 6 of 14 of brand value associated with it. This can be further confirmed by the presence of brand related expenses incurred by Infosys BPO Ltd. Further, Infosys BPO Ltd. has acquired Australian based company M/s Portland Group Pty Ltd. during financial year 2011-12. They provide sourcing and category management services in Sydney, Australia. Therefore, this company also failed the TPO's own filter of rejecting companies with peculiar circumstances. In view of the above i.e. functionally not comparable, presence of brand and extraordinary event that has taken place during the year on account of acquisition of Australian based company, we are of the considered opinion that Infosys BPO Ltd. should not be included in the list of comparables. We accordingly direct the Assessing Officer/TPO to exclude Infosys BPO Ltd. from the list of comparables for the purpose of computing the average margin." It was also brought to our notice that the Hon'ble Delhi High 6. Court in in the appeal filed by the Revenue against the aforesaid order dismissed the appeal at the admission stage observing that rationale given by the ITAT for exclusion was correct. In view of the aforesaid decision, we direct exclusion of Infosys BPO from the list of comparable companies chosen by the TPO. The next company that is sought to be excluded by the assessee 7. from the list of comparable companies chosen by the TPO is BNR Udyog Ltd. In original order passed by the Tribunal this company was retained as a comparable company. In the M.P. filed by the Assessee it was pointed out that the chart filed at the time of hearing before the Tribunal, the assessee company sought to exclude this company on the ground that the turnover of this company was only 1.7 cores and it cannot be compared with turnover of assessee which was 30.6 crores. It was also submitted on behalf of the assessee that this company has related party transaction (RPT) over and above the threshold limit of 15% and is also functionally different. The assessee in this regard at the time of hearing placed reliance on the decision of ITAT Bangalore Bench in the case of Indegne Pvt. Ltd., Vs. ACDIT in IT(TP)A No.591/Bang2017 for asst. year 2012-13 order dated 2/8/2017 wherein at page 10 of this order in para 10.3.2 the Tribunal remanded the matter of comparability of this company with ITES company. Decision in the case of M/s e4e Business Solution India Pvt. Ltd., Vs. ITO in IT(TP)TP No.451/Bang/2017 was also filed in support of assessee's claim for remand on functional comparability. The Tribunal in the impugned order however in IT(TP)A No. 352/Bang/2017 Page 7 of 14 paragaraph 13 to 13.2 followed the decision rendered in the case of CGI Information Systems and Management Consultation Ltd., Vs. ACTT-TS- 320—ITAT-2018(Bang) wherein this company was considered as comparable with ITeS company. The Tribunal however did not render any decision on functional comparability of this company. On the above objections in the MP, the Tribunal recalled the original order for analysis the comparability of this company afresh, with the following observations: "7. We have considered the submissions of the Ld. counsel for the assessee and are of the view that the contention in the MA that this company was sought to be excluded by the assessee on functional comparability and that the tribunal's order in the case of CGI Information Systems (supra) did not consider functional comparability or application of RPT filter of this company is correct. Therefore there is error in the order of the Tribunal in as much as functional comparability of this company with ITeS company has not been considered by the Tribunal. We, therefore recall the order of the Tribunal for the limited purpose of examining the functional comparability of this company with the assessee company." We have heard the rival submissions on the comparability of the 8. aforesaid company. The Delhi ITAT in the case of BT e-Service (India) Ltd. Vs. ITO for AY 2012-13 order dated 19.6.2018 considered the comparability of this company and came to the conclusion that this company was carrying out medical transcription, medical billing and coding whereas the Assessee was a captive service provider. The Tribunal followed its own ruling in the same Assessee's case in AY 201112 in ITA No.99/Del/2016 reported in (2017) 87 taxmann.com 251 (Del) in BT e-Serve (India) Pvt.Ltd. Vs. ITO giving identical reasons for excluding BNR Udyog Limited from the list of comparable companies in the field of companies rendering ITES such as the Assessee. Respectfully following the aforesaid decision, we direct exclusion of the aforesaid company from the list of comparable companies chosen by the TPO.”
In view of the aforesaid decision of the Tribunal which is also in relation to Assessment Year 2012-13, we hold that the aforesaid 2 companies should be excluded from the list of comparable companies.
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As far as TCS E Service Ltd., is concerned, the comparability of this company was considered by this Tribunal in the case of Zyme Solutions Ltd., in its order dated 16.11.2018 as follows:-
“11. TCS E Service Ltd.: This company was selected by the TPO and objected by the assessee for inclusion in the list of comparables on the ground that it is functionally different as it is engaged in the business of BPO, banking, finance, insurance domain. This contention was rejected by the TPO by holding that it is engaged in BPO, business of banking, finance, insurance domain, which are purely in the nature of ITES. Even the Hon'ble DRP confirmed the findings of the TPO. 11.1 Being aggrieved, the assessee is before us contending that this company is functionally different as it is engaged in diversified business activities of BPO such as banking, finance, insurance. Learned AR of the assessee has also drawn our attention to the Annual Report placed at pages 563 to 563 of the paper book and reliance in this regard was placed on the following decisions:
Turnover Filter: i. McAfee Software (India) Pvt Ltd US-136-ITAT-2016(Bang)-TP] ii. Swiss Re Global Business Solutions India (P.) Ltd. FS-307-ITAT- 2017(Bang) Functionally different filter: i. XL Health Corporation India (P.) Ltd. (supra) ii. Baxter India (P.) Ltd. v. ACIT12017185 taxmann.com 285 (Delhi - Trib.) iii. CGI Information Systems and Management Consultants (P.) Ltd. (supra)
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11.2 On the other hand, ld. CIT(DR) opposed its exclusion. He submitted that this company is engaged in KPO services and there is no difference between KPO and ITES. 11.3 We have heard rival submissions and perused material on record. The issue of comparability of this company was considered by the co-ordinate bench of Tribunal in the case of XLHealth Corpn. India (P.) Dd. (supra). The relevant findings of the Tribunal are as under: ‘. . . We have heard the rival submissions and perused the material on record. From the perusal of the Annual Report of this entity placed at page Nos. 583 to 678 of paper book, at page No. 604 it is stated as under. "2. COMPANY OVERVIEW Your Company, along with its subsidiary companies - TCS e-Serve International Limited and TCS e-Serve America Inc., is primarily engaged in the business of providing Business Process Services (BPO) for its customers in Banking, Financial Services and Insurance domain. The Company's operations include delivering core business processing services, analytics & insights (KPO) and support services for both data and voice processes. Your Company is an integral part of the Tata Consultancy Services' (TCS) strategy to build on its 'Full Services Offerings' that offer global customers an integrated portfolio of services ranging from IT services to BPO services. The Company provides its services from various processing facilities, backed by a robust and scalable infrastructure network tailored to meet clients' needs. A detailed Business Continuity Plan has also been put in place to ensure the services are provided to the customers without any disruptions." Thus, this company is also stated to be a Knowledge Process Outsourcing and therefore for the reasons stated by us while dealing with this issue of comparability of the company Infosys BPO Ltd. shall equally hold good and therefore we direct the AO/TPO to exclude this company from the list of comparables. Since the appellant company is into low end BPO, it cannot be compared with KPO service provider.
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11.4 Respectfully following the decision of the co-ordinate bench of Tribunal, we direct for exclusion of this company from the list of comparable.”
Respectfully following the aforesaid decision, we hold that TCS E Service Ltd., should be excluded from the list of comparable companies.
The next issue that needs to be adjudicated is as to whether foreign exchange fluctuation gain or loss should be considered as part of the operating profit while computing the profit margin of the assessee as well as the comparable companies. The main reason why the DRP considered foreign exchange gain should not be treated as a part of the operating profit was due to the fact that the assessee in the preceding Assessment year did not consider foreign exchange loss as operating in nature. The DRP was of the view that the assessee has to be consistent in the approach in this regard.
At the time of hearing, however, the learned Counsel for the assessee brought to our notice the decision of the ITAT Bangalore Bench in the case of Finastra Software Solutions (India) Pvt. Ltd., Vs. ACIT (2018) 93 taxmann.com 460 (Bangalore – Trib.) wherein this Tribunal considered the very same issue and held as follows:-
“38. As far the issue treating foreign exchange gain as operating revenue is concerned, it has been held a several decisions of various Benches of ITAT that foreign exchange gain, to the extent it relates to or connected with the business for which ALP is determined, is to be regarded as operating revenue or loss as the case may be. In the case of SAP Labs India (P.) Ltd. v. Asstt. CIT [2010] 8 taxmann.com 207/[2011] 44 SOT 156 (Bang.) and Trilogy E Business Software India (P.) Ltd. v. Dy. CIT [2011] 12 taxmann.com 464/47 SOT 45 (Bang)(URO), which decisions have subsequently been consistervs followed by this Tribunal, lays down the proposition that foreign exchange gain or loss has to be regarded as IT(TP)A No. 352/Bang/2017 Page 11 of 14 operating revenue or loss. The learned DR however brought to our notice a decision of the ITAT Bangalore Bench in the case of Commonscope Networks (India) (P.) Ltd. v. ITO IT(TP: A.No.166 & 181/Bang/2016 order dated 22.2.2017 wherein it was the foreign exchange gain or loss that arises should relate to the concerned AY because what is compared is the profit margin of a particular AY. According to him therefore the TPO/AO should examine the nature of foreign exchange gain or loss in the case of the Assessee and the comparable companies and to the extent it relates to turnover of the relevant AY and the segment for which ALP is being determined, the same should alone be considered as part of the operating revenue or loss. The learned counsel for the Assessee pointed out that it is impossible to carry out such an exercise. The Assessee might be willing to carry out such an exercise but the same cannot be expected from the comparable companies who have to furnish the relevant data. He also pointed out that under rule 10B(3) of the criteria for comparability is the effect of profit on account of differences. Rule 10B(3) reads thus: "(3) An uncontrolled transaction shall be comparable to an international transaction if— none of the differences, if any, between the transactions being (i) compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or reasonably accurate adjustments can be made to eliminate the (ii) material effects of such differences." The learned counsel for the Assessee therefore submitted that profit arising from comparable transaction will not be materially affected by adopting the foreign exchange gain as reflected in the accounts of the comparable companies because the terms of credit are almost identical in the line of business of SWD Services and ITES.
We have considered the rival submissions and are of the view that in the light of Rule 10B(3) of the Rules and the business cycle in the relevant business, the comparability will not be materially affected if the foreign exchange gain is considered as reflected in the accounts of the comparable companies as available in public domain. To this extent the decision rendered by the Bangalore Bench of ITAT in the case of Commonscope Networks (India) Pvt.Ltd. (supra) is distinguishable. Therefore respectfully following the decision of the ITAT Bangalore in the case of SAP Labs India (P.) Ltd. (supra), we hold that the DRP was justified in directing the AO to IT(TP)A No. 352/Bang/2017 Page 12 of 14
consider the foreign exchange gain or loss as operating in nature. Therefore, in light of the above, this ground of the Revenue is liable to be dismissed.”
In view of the aforesaid decision, we are of the view that the foreign exchange gain has to be treated as part of the operating profit while computing the profit margin of the assessee as well of the comparable companies. The TPO is directed to compute the ALP in the light of the directions given above, after affording opportunity of being heard to the assessee. All other issues arising on account of TP adjustments were not argued and therefore treated as not pressed for adjudication.
The next issue that needs to be adjudicated is as to whether the Revenue authorities were justified in disallowing a sum of Rs.1,19,694/- u/s.43B of the Act, being employees’ contribution under the Employees’ State Insurance Act, 1948, on the ground that the same were paid beyond the due date as per the relevant law relating to employees’ state insurance even though the said contributions were remitted on or before the due date for filing return of income under section 139(1) of the Act. As far as the aforesaid addition is concerned, it is not in dispute before us that it has been held by the Hon’ble Karnataka High Court in the case of CIT Vs. Spectrum Consultants India (P) Ltd., (2014) 49 taxmann.com 29 (Karn.) that employees’ contribution if it is paid on or before the due date prescribed under section 139(1) of the Act should be allowed as a deduction. In view of the above, we direct the AO to allow the claim for deduction.
The next issue that arises for consideration is as to whether the Revenue authorities were justified in reducing the telecommunication charges from the export turnover without reducing the same from the total turnover while allowing deduction to the assessee under section 10AA of the Act. It is not in dispute
IT(TP)A No. 352/Bang/2017 Page 13 of 14 before us that the Hon’ble Karnataka High Court in the case of CIT Vs. Tata Elxsi Ltd., 349 ITR 98 (Karnataka) has held that whatever is excluded from the export turnover should also be excluded from the total turnover while computing deduction under section 10AA of the Act. This view of the Hon’ble Karnataka High Court has been upheld by the Hon’ble Supreme Court in the case of CIT Vs. HCL Technologies Ltd., (2018) 93 taxmann.com 33 (SC). In view of the above, we hold that telecommunication charges should be excluded both from the export turnover as well as from the total turnover and deduction under section 10AA computed accordingly.
The last issue that needs to be adjudicated is the assessee’s grievance regarding short-grant of credit of taxes deducted at source. The DRP has in its direction directed the AO to allow credit as per law. In the order giving effect passed by the AO, after the order of the DRP, the AO did not give credit for taxes deducted at source. We are of the view that it would be just appropriate to direct the AO to consider the grievance in this regard and allow credit to TDS in accordance with law.
In the result, appeal of the assessee is partly allowed.
Order pronounced in the open court on this 15th day of October, 2019.