Loading judgment…
No AI summary yet for this case.
Income Tax Appellate Tribunal, DELHI BENCH ‘I-2’ : NEW DELHI
Before: SHRI N.S. SAINI & SHRI KULDIP SINGH
(PAN : AABCM5494Q) (APPELLANT) (RESPONDENT) ASSESSEE BY : Shri Himanshu Sinha, Advocate Shri Bhuwan Dooper, Advocate REVENUE BY : Shri Anupam Kant, Senior DR Date of Hearing : 20.12.2018 Date of Order : 26.02.2019 O R D E R
PER KULDIP SINGH, JUDICIAL MEMBER :
The Appellant, M/s. Mentor Graphics (India) Pvt.Ltd.
(hereinafter referred to as ‘the taxpayer’) by filing the present appeal sought to set aside the impugned order dated 29.01.2015 passed by the AO in consonance with the orders passed by the ld. DRP/TPO under section 143 (3) read with section 144C of the Income-tax Act, 1961 (for short ‘the Act’) qua the assessment year 2010-11 on the grounds inter alia that :-
“Transfer Pricing
1. On the facts and in law, the learned Transfer Pricing Officer (hereinafter referred to as 'Ld. TPO'), the learned Assessing Officer (hereinafter referred to as 'Ld. AO') and the Hon'ble Dispute Resolution Panel ('DRP') have erred in making an adjustment of Rs.64,734,446 to the value of international transactions pertaining to provision of software development services by the Appellant under Section 92CA(3) of the Income-Tax Act, 1961 ('the Act').
2. On the facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by selecting certain alleged comparable companies without considering the differences in the functions performed, assets employed and risks assumed by the Appellant vis-a-vis these companies, thereby resorting to cherry picking of comparables.
3. On the facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by alleging E-Infochips Bangalore Ltd. as a comparable to the Appellant.
4. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in contravening the provisions of Rule 10B(1)(e)(ii) by alleging Infinite Data System Pvt. Ltd. as a comparable to the Appellant.
5. On the facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP violated the provisions of Rule 10B(2) by alleging Sonata Software Ltd as a comparable to the Appellant.
6. On the facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by alleging Zylog Systems Limited as a comparable to the Appellant.
7. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by rejecting certain comparable companies identified by the Appellant in its TP documentation.
8. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by rejecting CG-Vak Software & Exports Limited. from the set of comparables selected by the Appellant.
9. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by rejecting Powers of Global Solutions Limited from the set of comparables selected by the Appellant.
10. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by rejecting Helios & Matheson Information Technology Ltd. from the set of comparables selected by the Appellant.
11. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in erred in violating the provisions of Rule 10B(2) by rejecting Eforce India Private Limited from the set of comparables selected by the Appellant, on the basis of data non-availability for FY 2009-10, ignoring the financial statements of the said year submitted before the Ld. TPO.
12. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) by rejecting Varna Industries Limited from the set of comparables selected by the Appellant.
On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in proposing an adjustment of Rs.23,633,050 to the income of the Assessee on account of overdue receivables from its AEs.
Without prejudice to the above ground, on facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in applying an ad-hoc interest rate of 14.88% for computing the interest on overdue receivables from its AEs.
On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in grossly misinterpreting the requirement of 'contemporaneous' data in the Rule 10B(4) by necessarily using current year data (i.e. financial year 2009-10), thereby breaching the principles of natural justice and impossibility of performance.
16. On facts and in law, the Ld. TPO, the Ld. AO and the Hon'ble DRP erred in law and on the facts in not allowing appropriate adjustments under 10B(1)(e)(iii) and Rule 10B(3) to III account for differences in risk profile of the comparables vis-a-vis the Appellant.
17. On facts and in law, the Ld. AO/ Ld. TPO erred in not granting the benefit of reduction/ variation of 5 percent from the arithmetic mean while determining the arm's length price to the Appellant as per the proviso to section 92C(2) of the Act.
18. On facts and in law, the Ld. AO / Ld. TPO and the Hon'ble DRP has erred in proposing to initiate penalty proceedings under Section 271 (1) (c) of the Act.
Corporate Tax 19. That on facts and in law the Ld. AO and Hon'ble DRP has erred in not considering the Appellant's plea for providing allowance of 'Severance Cost' of Rs.66,762,386 incurred by the Appellant during the Financial Year 2008-09.”
Briefly stated the facts necessary for adjudication of the controversy at hand are : Mentor Graphics (India) Pvt. Ltd. (Mentor India), the taxpayer provides software product development support and quality analysis support services to Mentor Graphics (Ireland) Ltd. (Mentor Ireland) has entered into an agreement with the taxpayer for purchase of the aforesaid services. The taxpayer invoices Mentor Ireland for the software development services provided for both the units located in Noida and Hyderabad. During the year under assessment, the taxpayer entered into international transactions as under :-
S.NO. International Transaction Amount (in Rs.) 1 Purchase of Fixed Assets 93,70,761 2 Sales of Assets 29,31,345 3 Provision of software development and 90,83,58,259 quality analysis services 4 Payment towards communication 3,75,07,526 expenses 5 Reimbursement of Expenses - Payable 66,30,259 6 Reimbursement of Expenses – 29,88,273 Receivable
The taxpayer in order to benchmark its international transaction used Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) and Net Operating Profit Margin based on Costs (NCP Margin) as the Profit Level Indicator (PLI). The taxpayer chosen 16 companies with average margin of 14.26% by using multiple years data as against taxpayer’s own margin of 15.03% qua software development services and found its international transactions at arm’s length.
However, TPO in his TP analysis rejected 7 comparables of the taxpayer and introduced 10 new comparables having average of 24.40% as against taxpayer’s own margin of 15.03% and thereby determined the ALP of international transactions at Rs.98,25,23,396/- as against Rs.90,85,48,175/- determined by the taxpayer. TPO also made adjustment of Rs.2,36,33,050/- on account of receivables due from the Associated Enterprises (AEs) by the taxpayer and proposed the total adjustment of Rs.9,76,08,271/- on account of transfer pricing adjustment.
The taxpayer carried the matter before the ld. DRP by way of filing objections who has ordered to exclude one comparable, namely, Infosys Limited, from the final set of comparables, by partly allowing the objections made by the ld. TPO.
In compliance to the order passed by the TPO/DRP, AO framed the assessment u/s 143 (3) read with section 144 of the Act at an income of Rs.21,41,72,020/- by making addition on account of transfer pricing adjustment of Rs.8,83,67,496/- and by making addition of Rs.135/- and Rs.9,336/- on account of find & penalty and business expenditure respectively.
Feeling aggrieved, the taxpayer has come up before the Tribunal by way of filing the present appeal.
We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case. Our ground-wise findings are as under.
Undisputedly, the TNMM with OP/OC as MAM applied by the taxpayer has not been disputed by the TPO. It is also not in dispute that the TPO has also not disputed the functional profile and margin of the taxpayer of 15.03% for software development services. Ld. TPO on the basis of its TP analysis in order to determine the transfer pricing adjustment of international transactions entered into by the taxpayer with its AEs, chosen 19 comparables having average of 24.04% and proposed TP adjustment of Rs.7,39,75,221/-, which are as under :-
S.NO. Name of the Company OP/OC 1. Akshay Software Technologies Ltd. -1.07% 2. C T I L Ltd. 18.11% 3. E-Infochips Bangalore Ltd. 71.38% 4. Evoke Tech 18.56% 5. E-Zest Solutions 18.66% 6. Infinite Data System Private Limited 88.25% 7. Infosys Limited 45.47%
8. Larsen & Toubro Infotech Ltd. 19.06% 9. Mindtree Ltd. (Segment) 13.92% 10. Persistent Systems Limited 29.02% 11. Persistent Systems & Solutions Ltd. 11.37% (Merged) 12. Quintegra Solutions Ltd. -8.20% 13. R S Software (India) Ltd. 10.18% 14. Sasken Communication Technologies 17.54% Ltd. 15. Sonata Software 35.87% 16. Tata Elxsi (segment) 20.29% 17. Thinksoft Global Services Ltd. 17.35% 18. Zylog Systems Limited 25.07% 19. LGS Global 12.78% AVERAGE 24.40%
Out of 19 comparables, the ld. DRP excluded “Infosys Limited”. TPO also proposed adjustment of Rs.2,36,33,050/- on account of receivables due from the AEs by the taxpayer which has not been disturbed by the ld. DRP.
The ld. AR for the taxpayer in order to compress the controversy had sought exclusion of 5 comparables viz. (i)
Persistent Systems Ltd., (ii) Tata Elxsi Ltd., (iii) E-Infochips Bangalore Ltd., (iv) Infinite Data Systems Pvt. Ltd. & (v) Zylog Systems Ltd. and also disputed ALP determined by ld. TPO/DRP on receivables. We would dispose of the issues ground-wise as under.
GROUND NO.1
Ground No.1 being general in nature needs no adjudication.
GROUNDS NO.5, 8, 9, 10, 11, 12, 15, 16, 17 13. Grounds No.5, 8, 9, 10, 11, 12, 15, 16 & 17 are dismissed having not been pressed during the course of arguments.
GROUND NO.18 14. Ground No.18 being premature needs no specific findings TRANSFER PRICING GROUNDS GROUNDS NO.2, 3, 4, 6 & 7 Comparability of aforesaid companies viz. (i) Persistent 15.
Systems Ltd., (ii) Tata Elxsi Ltd., (iii) E-Infochips Bangalore Ltd., (iv) Infinite Data Systems Pvt. Ltd. & (v) Zylog Systems Ltd., vis-à-vis taxpayer for benchmarking the international transaction is being examined one by one as under.
PERSISTENT SYSTEMS LTD. (PERSISTENT)
Persistent is taxpayer’s own comparable which it has now sought to be excluded on the ground that its segmental financials are not available. Perusal of the profit & loss account for the year under assessment, available at page 388 of the paper book (Annual Reports), shows that the income of Persistent is from sale of software services and products to the tune of Rs.5196.91 millions as on 31.03.2009 and Rs.5044.13 as on 31.03.2010 with no segmental financials.
Persistent has already been rejected by the coordinate Bench of the Tribunal in taxpayer’s own case for AY 2008-09, available at pages 63 to 79 of the paper book, on ground of non-availability of segmental data. So, we are of the considered view that Persistent is not a valid comparable, hence ordered to be excluded.
TATA ELXSI LTD. (TATA ELXSI)
Tata Elxsi is again taxpayer’s own comparable which the taxpayer has sought to be excluded on ground of functional dissimilarity. Perusal of annual report, available at pages 482, 483, 484 & 485 of the paper book, goes to prove that business units of “Tata Elxsi” consist of Product Design Services (PDS) to provide full service embedded software, hardware and system design programmes for a variety of technology products. PDS has core domain and technology expertise in VLSI design, embedded software, multimedia, networking and wireless communications; Industrial Design and Engineering (IDE) supporting global corporations in the area of new brand/product introduction from concept to market its expertise lies in the areas of consumer insights, product/service innovation, industrial design, functional prototyping and mechanical engineering; it also engages in brand development and retail design; Visual Computing Labs (VCL) is an award winning production studio, offering 3D Animation and Visual Effects (VFX) services; with a blend of creativity and leading-edge technology, VCL offers pre and post production services for feature films, television series, television commercials and custom content development; and System Integration (SI) to implement complete systems and solutions in the entertainment, manufacturing, government and education sectors. This is backed by a network of offices, a team of specialists in design tools, visualization, high performance computing, storage and strategic partnerships with world-leading technology providers.
Perusal of the Director’s Report, available at pages 490 & 491 of the paper book, shows that Tata Elxsi’s IP related sale saw good traction during the year especially in the broadband wireless area and the company has developed IP related to Wimax and is already working on development of IP and reference designs for LTE, which is an upcoming standard for 4G wireless.
Software development and services segment constitutes Product Design Services (Design & Development of Hardware and Software), Innovation Design Engineering (Mechanical Design with a focus on Industrial Design) and Visual Computing Labs Division (Animation and Special Effects).
Ld. DR for the Revenue, to retain Tata Elxsi as a valid comparable, contended that in the earlier year, Tata Elxsi was excluded on the ground that it was into product but there is no sale of product. It is also contended that taxpayer is also designing IP.
However, we are of the considered view that the taxpayer is not the owner of IP which is a captive software development service provider whereas, on the other hand, Tata Elxsi is the owner of IP design of it. Moreover, business unit of taxpayer is very diverse having four business segments as discussed in the preceding paras, whereas only segmental of two of its unit are available. Moreover, there are un-allocable expenses (Net) of Rs.937.66 lakhs, as is evident from Schedule to the Financial Statements from the year ending March 31, 2010, available at page 526 of the paper book. So far as segmental reporting given at page 526 of the paper book (Annual Report) is concerned, it shows that the company’s operations predominantly relate to providing systems integration and software development services in the information technology field. So, all these facts go to prove that Tata Elxsi is functionally dissimilar vis-à-vis the taxpayer being engaged in the development of specialized/niche product, hence ordered to be excluded being not a valid comparable.
E-INFOCHIPS BANGALORE LTD. (E-INFOCHIPS)
23. This is TPO’s comparable which the taxpayer has sought to exclude on grounds of functional dissimilarity, it being engaged in product and semi-conductor engineering services; its segmental information is not available; it has abnormal deviation in profit margin indicating significant difference in risk profile which is unlike a software development company.
Perusal of page 18 of the annual report shows that E- Infochip is primarily engaged in software development and IT Enabled Services (ITES) which is considered as the only reportable business segment as per Accounting Standard -17. E-Infochip is also engaged in product and semi-conductor engineering services having 500 products for key verticals like aerospace and defence, security and surveillance, consumer devises, medical devices, retail and e-commerce and software technology. E-Infochip in its research and development activities is also engaged in development of software as per the specific requirement of the clients as is evident from annexure to Director’s Report, available at page 5 of the paper book. The segmental information of E- Infochip bifurcating software development and ITES and products is not available as is evident from page 63 of the paper book.
The taxpayer has brought on record data as to abnormal high margin in FY 2009-10 in E-Infochip, available at page 289 of the paper book, which is extracted as under :-
E-Infochips 31-Mar-08 31-Mar-09 31-Mar-10 31-Mar-11 Bangalore Ltd. Annual Report Income Income from 240,278,099 148,676,474 430,466,481 451,181,724 Software Services Variation in Stock 1,790,766 604,113 - - of Finished Goods Other Income 27,878 643 23,323 - Total Income 242,096,743 149,281,230 430,489,804 451,181,724 Expenditure Software 122,517,471 130,050,892 206,674,788 297,136,212 Development Expenses Raw Material 4,683,651 1,464,005 - - Consumed Administrative 44,184,354 39,801,604 38,404,671 47,529,955 Expenses Depreciation 14,184,354 10,713,079 7,870,005 9,732,818 Total Expenses 186,167,157 182,029,580 252,949,464 354,398,985 Net Profit 55,929,586 (32,748,350) 177,540,340 96,782,739 NCP% 30.04 -17.99 70.19 27.31
So, in the light of the decision rendered by the Special Bench of the Tribunal in Maersk Global Centers (India) Private Ltd. vs. ACIT, we are of the considered view that trend of profits needs to be investigated into to ascertain whether earning of high profits reflects normal business condition or whether it is a resale of abnormal business conditions.
E-Infochip has been ordered to be excluded by the coordinate Bench of the Tribunal in Stryker Global Technology Center Private Limited vs. DCIT – [TS-863-ITAT-2017 (DEL)- TP](AY2010-11) vis-à-vis routine software development service provider by returning following findings :-
“17. However, we are of the considered view that the entire reserves are to be examined in totality. Moreover, from Schedule III, depicting fixed assets, available at page 39 of the annual report, shows that the comparable company has huge intangibles which increases the brand value of the comparable company.”
So, in view of what has been discussed above, we are of the considered view that E-Infochips being a product and semi- conductor engineering services having 500 products for key verticals like aerospace and defence, security and surveillance, etc., having huge intangibles which increases its brand value and its segmental financials are not available, is not a suitable comparable vis-à-vis the taxpayer, hence ordered to be excluded.
INFINITE DATA SYSTEMS PVT. LTD. (INFINITE) 29. The taxpayer sought to exclude Infinite on grounds of functional dissimilarity that it drives revenue from technical support and infrastructure services; that it has abnormally high margin having exceptional growth in business operation over the last four years i.e. 908% in sales over the previous year; that “Infinite” signed an agreement (Built, Operate and Transfer mode) with Fujitsu Services Limited to set up Global Delivery Centers in India to provide offshore delivery capabilities to Fujitsu and Fujitsu’s associated companies. Perusal of the functional profile of Infinite, available at page 13 of the paper book, shows that it provides solutions that encompass technical consulting, design & development of software, maintenance, systems integration, implementation, testing and infrastructure management services.
This objection was taken by the taxpayer before the ld. DRP, as is evident from page 293 of the paper book, but it has not controverted the functional dissimilarity pointed out by the taxpayer.
As per revenue recognition given in annual report at page 82 of the annual report paper book, it is mentioned that Infinite primarily derived its revenue from technical support and infrastructure management services. Moreover, it is a single customer company operating on Build, Operate and Transfer business model.
Infinite has already been ordered to be excluded from the final set of comparables by the coordinate Bench of the Tribunal vis-à-vis the routine software development service provider in case cited as Stryker Global Technology Center Private Limited vs. DCIT (supra) by returning following findings :-
“22. The ld. AR for the assessee in order to point out functional dissimilarity of Infinite drew our attention to pages 98 to 102 of Annual Report. In para 17 at page 98 of Schedules to Financial Statements in Company Overview, it is categorically mentioned that Infinite provides solutions that encompass technical consulting, design and development of software, maintenance, systems integration, implementation, testing and infrastructure management services, whereas assessee company is a routine service provider. Furthermore when we examine para 17.1.3. at page 98 of the Annual Report undisputedly Infinite derives its revenue primarily from technical support and infrastructure management services which makes Infinite functionally dissimilar to the assessee.
Furthermore Infinite has exceptional growth in business operation over the last four years i.e. 908% growth rate in sales over previous year as is evident form auditing tabulated as under:- Particulars Mar-12 Mar-11 Mar-10 Mar- 09 Sales (in INR 43.31 52.75 38.31 4.74 (Crores) % Growth in 182% 238% 908% - Sales OP/TC 124.40% 153.97 88.25% 31.48 % % 24. The comparability of Infinite was also examined in Sun Life India Service Centre (P.) Ltd. (supra) with Sun Life India Service Centre (P.) Ltd. which is a routine software development and service provider and held to be not a suitable comparable as it is a full-fledged IT consulting organisation and provides services in the nature of technical consulting, design and development of software, maintenance, system irrigation, implementation, testing and infrastructure management services. So, in view of the matter, we are of the considered view that Infinite is not a suitable comparable vis-à-vis assessee company, hence ordered to be excluded.”
So, in view of what has been discussed above, we are of the considered view that Infinite is functionally dissimilar vis-à-vis taxpayer having been into providing solutions that encompass technical consulting, design and development of software maintenance, systems integration, implementation, testing and infrastructure management services. Furthermore, Infinite has entered into Build, Operate and Transfer (BOT) agreement with Fujitsu Services Limited to set up global delivery centers in India to provide offshore capabilities to Fujitsu and Fujitsu’s associated companies. It has also shown exceptional growth in business operation in the last four years i.e. 908% growth rate over the previous year. So, Infinite cannot be a valid comparable vis-à-vis the taxpayer, hence ordered to be excluded.
ZYLOG SYSTEMS LTD. (ZYLOG)
The taxpayer sought to exclude Zylog on ground of its diversified operation; having substantial brand value and intangible assets; having significant AMP spent; it incurred R & D expenses.
When we examine annual report of the Zylog under the head “Our Strengths” it shows that Zylog offered a value to their customers and marked place through value added Research & Development, Product Engineering, and end-to-end Product Lifecycle Management solutions from conceptualization, prototyping, development, integration with Enterprise applications, Migration, Porting, Performance Tuning, Application Upgrade, testing and maintenance. Zylog business applications are created with leading industry experts and experienced developers to help propel legacy systems and processes to fully leverage the current market technology. Zylog goal is to help to migrate in the direction of its goal, greater profitability, market prosperity and its operation is E- waste & compliance framework (manufacturing); Vesalius – HIS (Pharma); Phoenix, M-Banking, M-Wallet (BFSI); Smart Card Solutions (RTO, Healthcare, Agriculture), E-Police system (E- Governance), Wi54, Field Force automation (Telecom) and E- Enablement (Retail).
Furthermore, perusal of the intangible assets owned by Zylog, detail available at page 229 of the paper book, shows that it has huge intangibles. Furthermore, Zylog has incurred Rs.8,885 lakhs i.e. 9.1% of operating revenue on AMP expenses. Similarly, research and development expenses are incurred by Zylog as per Schedule 15, available at page 278 of the paper book, which are charged off to profit & loss account, so in-house R&D activities carried out by Zylog certainly delivered high value services.
In view of what has been discussed above, on account of diversified operation, substantial brand value and huge intangible assets having significant AMP spent and R & D expenses, Zylog cannot be a valid comparable vis-à-vis taxpayer which is a captive software development service provider to its AE only, so we order to exclude the same.
GROUNDS NO.13 & 14 36. TPO/AO/DRP have made adjustment of Rs.2,36,33,050/- to the income of the taxpayer on account of overdue receivables from its AE by applying the ad hoc interest rate of 14.88%. It is the case of the taxpayer that as per para 5.7 of the Agreement, interest, if any, is to be charged on receivables which has been followed in the earlier years and subsequent years. So, TPO/AO is directed to compute the interest, if any, following the rule of consistency, in view of para 5.7 of the Agreement by taking into account the findings returned in earlier years and subsequent years. So, this issue is remanded back to TPO/AO to decide afresh after providing an opportunity of being heard to the taxpayer.
CORPORATE TAX GROUND NO.19 37. AO/DRP had disallowed severance cost of Rs.6,67,62,386/- incurred by the taxpayer during the financial year 2008-09 also.
Identical issue has undisputedly been set aside to AO by the coordinate Bench of the Tribunal qua AY 2008-09by returning following findings :-
“11. We have heard both the parties and perused all the relevant documents. It is pertinent to note that the assessee company made payment of the severance cost during the Financial Year 2008-09. However, as per the letter dated 06.03.2009 produced by the Assessee it was seen that the employee's were to be relieved from service on 30.04.2009. Therefore, the liability to pay the severance/ notice pay etc. accrued to the assessee company in A.Y. 2010-11 as per the version of the Assessing Officer. From the records and from the Assessment Order it is not clear as to when the severance cost has been crystallized. Therefore, it will be appropriate to remand back this issue to the file of the Assessing Officer. Needless to say, the assessee be given opportunity of hearing by following principles of natural justice. Thus, Ground No. 18 of assessee's appeal for A.Y. 2009-10 is partly allowed for statistical purpose.”
So, in view of the matter, this issue being of subsequent year is required to be decided by the AO along with AY 2009-10.
Consequently, this issue is set aside to AO to decide afresh after providing an opportunity of being heard to the taxpayer.
Resultantly, the appeal filed by the taxpayer is allowed for statistical purposes. Order pronounced in open court on this 26th day of February, 2019.