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Income Tax Appellate Tribunal, “C” BENCH : BANGALORE
Before: SHRI ARUN KUMAR GARODIA & SHRI PAVAN KUMAR GADALE
O R D E R
Per Shri A.K. Garodia, Accountant Member
This appeal is filed by the assessee which is directed against the order of ld. CIT(A)-6, Bangalore dated 29.11.2017 for Assessment Year 2008-09.
The grounds raised
by the assessee are as under. “The grounds hereinafter taken by the Appellant are without prejudice to one another.
1. That the order passed by the learned Commissioner of Income Tax (Appeals) - IV, Bangalore NIT (Appeals)'), under section 250 of the Income Tax Act, 1961 (`Act') to the extent prejudicial to the Appellant, is bad in law and liable to be quashed. Transfer Pricing
2. That on the facts and circumstances of the case, the learned AO and the learned CIT (Appeals)erred in upholding the approach of the learned Transfer Pricing Officer ("the learned TPO") and the adjustment of INR 486,177,068 made to the transfer price of the Appellant in respect of its software development services provided to its Associated Enterprises (`AEs')
3. Upholding the learned TPO's approach of not excluding the foreign exchange gain/loss from comparable M/s. Sasken Communication Technologies Limited even though company has realised the income from hedging activity.”
It was submitted by ld. AR of assessee that the copy of written submissions filed by the assessee before ld. CIT(A) on 17.09.2014 is available on pages 217 to 223 of the paper book and in particular, our attention was drawn to page no. 222 of the paper book and it was pointed out that this was the submission made by assessee before ld. CIT(A) that the assessee realizes foreign exchange gain / loss directly as a result of conversion of sales proceeds from export of services whereas the comparable companies realize foreign exchange gain / loss from an additional function of treasury activity in the nature of hedging i.e. entering into forward contracts which they perform to mitigate their risk arising on account of foreign exchange fluctuation and therefore, this was the request of the assessee that any income arising on account of such additional hedging activity should not be considered in the computation of mark-up on total cost of comparable companies for the purpose of determination of the arm’s length price. He submitted that on this aspect, there is no decision of ld. CIT(A) and in this regard, our attention was drawn to page no. 9 of the order of ld. CIT(A) and it was pointed out that this submission was reproduced by ld. CIT(A) but while deciding the issue, no finding is given in this regard and hence, the matter may be restored back to the file of ld. CIT(A) for fresh decision. The ld. DR of revenue supported the order of ld. CIT(A).
We have considered the rival submissions. First of all, we reproduce para no. 6 from the order of ld. CIT(A) because in this para, ld. CIT(A) has reproduced the written submissions filed by assessee before him. This para reads as under. “6. During appellate proceedings, appellant filed written submission, against additions made by AO. A portion of the same is reproduced as under:- “The Appellant refers to the captioned report submitted by the learned TPO to your goodselfs office, wherein the learned TPO has provided his response of considering foreign exchange gain/loss earned by comparable companies (Persistent Systems Limited and Sasken Communication Technologies Limited (Segment) as operating income even though the same has been earned on account of hedging activity. The Appellant in this regard would like to file its submission against the findings of the learned TPO in the aforementioned remand report.
The learned TPO in his report has mentioned that the comparable companies are engaged in the business line similar to that of the Appellant, i.e. software development services and does not carry out separate business activity of hedging. In the regard, the Appellant would like to submit that the comparable companies no doubt are not engaged in the business of financing activity as a separate segment, i.e. speculation, hedging, etc. However, in order to mitigate the risk arising on account of foreign exchange fluctuation, comparable companies enter into forward contracts in order to mitigate or hedge risks from foreign exchange fluctuations. Hence, as a result of carrying out this hedging activity, comparable companies realize exchange gain/loss. On the contrary, as acknowledged by the learned TPO himself, the Appellant did not have a policy of hedging during the relevant year and realised foreign exchange fluctuations was on account of conversion of sale proceeds earned by the Appellant from the Associated Enterprises ("AEs"). Based on the above, your goodself would appreciate that the comparable company realizes foreign exchange gain/loss from an additional function of treasury activity in the nature of hedging i.e. entering into forward contracts which they perform to mitigate their risk arising on account of foreign exchange fluctuation and not from fluctuations on account of business operation. Further, in this regard, the Appellant would like to draw your goodself s attention towards the remand report wherein the learned TPO, himself has acknowledged that the comparable companies enters into forward contract in order to manage its foreign exchange exposures in line with its hedging policy. Based on above, your goodself would appreciate that comparable companies carry out additional function of entering into forward contract as compared to the Appellant. Additionally, it is submitted that it is not necessary that a function is recognized as activity/function only if the same is reported/carried out as a separate segment in the financial statement. The mere fact that the comparable companies have mentioned in the financial statement that they carry out hedging activity by way of entering into forward contract in itself entails that the company carry out hedging function. Further, the learned TPO in his report has mentioned that the policy undertaken by these comparable companies is not to make profit from currency movement but to ensure the foreign exchange exposures on exports and imports are managed through the hedging policy. In this regard, the Appellant would like to submit that the intention or motive to carry out the activity would not be criteria to determine whether the function/activity is carried out. Based on the perusal of annual report of the comparable companies it is Page 4 of 8 evident that the comparable companies have carried out additional hedging activity as comparable to that of the Appellant. The Appellant would also like to submit that while the intention of the comparable companies may not be to earn profit but to mitigate the foreign exchange exposure, on perusal of the annual report, it is clearly evident that the comparable companies have earned profit dciring the relevant years from this hedging activity. The relevant extract of the annual report in reproduced below, for your goodself's ready reference. Persistent systems Limited Other income increased to Rs. 269.35 Million during the year as compared to Rs. 20.87 Million in the previous year mainly due to exchange gain of Rs. 221.54 Million derived by the Company from forward currency contract as per its hedging policy. Following table shows details of significant changes in other income under different heads. (In Rs. Million) Financial year Financial year Particulars 2007-08 2006-07 Income from investment of funds 26.44 8.56 Foreign exchange gain (net) 221.54 - Profit on sale of assets 1.05 4.12 Provision written back 14.87 7.26 Miscellaneous income 5.45 0.93 Total 269.35 20.87 Sasken Communication Technologies Limited Other Income and Exchange Gain Other income and exchange gain amounted to Rs.542.73 Lakhs and Rs. 1,799.93 Lakhs respectively, constituting 1% and 3.2% of total revenues during the year ended March 31, 2008. The average investments in FY 06-07 were higher as the Company had invested the IPO proceeds in mutual funds, until August 2006, when the proceeds were utilized for acquisition of Sasken Finland. The Company manages its foreign exchange exposures in line with its hedging policy. The policy is not so much to make profit from currency movements but to ensure that foreign exchange exposures on exports and imports are properly monitored, limiting risks to tolerable levels. Thus, risk limitation/reduction is the prime objective. The exchange gain is primarily on account of exchange differences on forward Page 5 of 8 contracts. The FY 07-08 witnessed a rupee appreciation of around 11.5% as compared to FY 06-07. Further, the Appellant has also enclosed relevant page of the annual report, i.e. Page no – 58 of the annual report of Persistent Systems Limited (Annexure A) and Page no – 164 of the annual report of Sasken Communication Technologies Limited (Segment) (Annexure B), for your goodself's reference. Based on the above, your goodself would appreciate that the comparable companies realizes foreign exchange gain/loss from hedging activity i.e. entering into forward contracts and not from business activity, i.e. software development services as in the case of the Appellant."”
The issue in dispute was decided by ld. CIT(A) as per para nos. 7 to 19 of its order which are also reproduced hereinbelow for ready reference. “7. During appellate proceedings, a remand report was received from TPO on 11/03/2015. The same has been considered.
The grounds of appeal
, appellant's statement of facts, written submission, AO's observations / explanations, remand report of TPO, appellant's rejoinder to TPO's remand report and legal position have been duly considered.
9. The solitary issue to be adjudicated in the appeal concern appellant's grievance that AO computed arm's length price without considering mark up on total cost of the final set of comparable companies.
10. Perusal of records reveal that the Ld CIT(A) had directed AO to treat foreign exchange gain/loss as forming part of operating revenue/cost relying on the decision of the Tribunal in the case of Trilogy E Business where the Hon'ble ITAT had directed that foreign exchange gain or loss should be considered as operating revenue or cost while computing the operating margin of the assessee as well as the comparable
11. In this context, it is noted that TPO had passed an Order Giving Effect consequent to CIT (A) 's order dated 23/4/2013. In the Order Giving Effect, the appellant was allowed a relief to the extent of Rs. 52,37,09,285/- from an Arms Length Price addition of Rs. 100,98,86,353/-.
12. The appellant in its ground had raised the issue that AO computed arm's length price without considering mark up on total cost of the final set of comparable companies.
13. It may be noted that the appellant is engaged in the business of providing software development and related services to SAP AG and its subsidiaries. As per TP document. the appellant is Page 6 of 8 remunerated on a cost plus 6 percent basis for software development services provided to SAP group companies. The appellant is registered under Software Technology Parks India scheme and is claiming tax holiday benefit in respect of profits earned by it from software development and related services SAP labs India has a Research & Development (R&D) services agreement with SAP AG dated 01/04/2001 with an amendment on 01/04/2005 as per which SAP labs India is remunerated at cost plus basis for services provided.
14. In this context, it may be noted that a Remand Report was received from TPO dated 02/03/2015 wherein it was stated that Foreign Exchange gain or loss is attributable to operating business of rendering software development services but this cannot be held as derived from operating business Software Development. Accordingly, though there is no denying the fact that foreign exchange gain or loss is related to operating business, it is revenue in nature and hence taken into consideration while computing net profit of the appellant but it is not derived from operating activity and therefore, while computing profit from operating business it must be excluded. Foreign exchange gain or loss can be compared with the contribution in profit of working capital. While computing the operating profit the element of gain or loss due to working capital employed is excluded from profit margin as it is not derived from operating business activity.
15. Further, TPO has also brought out the fact that the comparable companies' principal business was to provide software development and related services. For providing such services, the invoices of its AEs in foreign currency on remittance is converted into Indian currency as per requirement. Therefore, foreign exchange gain/loss realized by the appellant is a consequence of contractual arrangement and not from any other separate activity. The appellant's PLI is worked out at 7.40% by the TPO which includes foreign exchange gain, which was shown as other income by appellant. Hence, the same procedure was followed for computation of PLI of the comparables PLI also, i.e., taking foreign exchange gain as operating income. Due to above reasons the contentions of the appellant was not accepted. If the foreign exchange gain has to be treated to be non operating in nature the same should also be applicable in the case of appellant also 16. In this context, it may be noted that while passing Order Giving Effect to CIT(A)'s order, the TPO had verified Annual Reports, of Mis Persistent Systems Limited and Sasken Communications Technologies Ltd. The TPO noted that these companies are in comparable business activity in line with that of appellant and does not carry out separate business activity of hedging as claimed by appellant company. The contention of the appellant that the comparable company Persistent Systems Limited is making profit Page 7 of 8 from hedging activity was found to be incorrect and as per the Annual reports of the comparable company, its functions have been clearly stated. It was also stated that it manages its foreign exchange exposures in line with its hedging policy. This policy, it states was not to make profit from currency movements but to ensure that foreign exchange exposures on exports and imports are properly monitored by a hedging policy. In the case of M/s Sasken Communication Technologies Limited (segment), the claim that the said comparable was making profit from hedging activity is incorrect and as per the Annual reports of the comparable company, it's functions have been clearly stated to be that of a company which derived income mainly due to exchange gain derived from forward contract as per hedging policy and not from separate hedging activity. Hence the contention of the appellant company was found to be incorrect by TPO.
17. In its rejoinder to TPO's remand report, appellant company states that comparable companies 'in order to mitigate the risk arising on account of foreign exchange fluctuation, enter into forward contracts in order to mitigate or hedge risks from foreign currency fluctuation'.
18. The rejoinder of appellant company to TPO's remand report has been considered. However, it is noted that appellant company has not rebutted the fact that Annual Reports of comparable companies (Persistent Systems Limited and Sasken Communication Technologies Ltd show that these are in comparable business activity in line with that of appellant company and does not carry out separate business activity of hedging as claimed by appellant company.
19. It is noted that appellant company's PLI was worked out at 7.40% by TPO which included foreign exchange gain shown as other income by appellant. It is also noted that the same procedure was followed for computation of PLI of comparable companies. In view of these facts, and based on remand report of TPO, contentions of appellant are found to be untenable and hence the same are rejected. Hence, no interference in TPO/ AO's order is called for since no infirmity arose.”
6. In para no. 15 of his order, ld. CIT(A) has stated that the assessee’s PLI is worked out at 7.40% by the TPO which includes foreign exchange gain, which was shown as other income by assessee and hence, the same procedure was followed for computation of PLI of the comparable’s PLI also i.e. taking foreign exchange gain as operating income and due to above reasons, the contentions of the assessee was not accepted. He has also held that if the foreign exchange gain should be treated as non-operating in nature in the case of comparables, then the same should also be applicable in the case of assessee also but he has not given any finding on this aspect of the assessee’s claim that the receipt of foreign exchange gain by assessee is on Page 8 of 8 account of conversion of sales proceeds from export of services whereas the foreign exchange gain in the case of comparable is on account of foreign exchange gain / loss from an additional function of treasury activity in the nature of hedging i.e. entering into forward contracts which they perform to mitigate their risk arising on account of foreign exchange fluctuation. This argument of the assessee should have been addressed by ld. CIT(A) in his order after examining the relevant facts even if this argument is not finding his favour. Hence we feel that in the facts of present case and in view of above discussion, the matter should go back to the file of ld. CIT(A) for fresh decision by way of a speaking and reasoned order on all aspects of the matter and hence, we set aside the order of ld. CIT(A) and restore the matter back to his file for fresh decision with the direction that the ld. CIT(A) should pass a speaking and reasoned order considering all the arguments of ld. AR of assessee. Needless to say, adequate opportunity of being heard should be provided by ld. CIT(A) to both sides.
In the result, the appeal filed by the assessee is allowed for statistical purposes. Order pronounced in the open court on the date mentioned on the caption page.