ITO vs. M/S ACUSIS SOFTWARE INDIA PRIVATE LIMITED, BANGALORE

We shall first take up for consideration IT(TP)A No.842/Bang/2013, the appeal by revenue. Grounds No.5 to 13 raised by the revenue are with regard to determination of arm’s length price (ALP) in respect of international transaction of rendering Information Technology Enabled Services (ITeS) by the assessee to its Associated Enterprise (AE). Grounds 5 to 13 raised by the revenue read as follows:-

“5. The Ld. CIT(A) erred in rejecting the diminishing revenue filter used by the TPO to exclude companies that do not reflect the normal industry trend.

The additional grounds of appeal raised by the assessee in its appeal is with regard to comparability of certain companies excluded by the CIT(Appeals). It is the plea of the assessee in these additional grounds that these companies are required to be excluded on the basis of functional comparability, apart from its exclusion by the CIT(Appeals) on the ground that the profits shown by these companies were abnormal and did not reflect the normal profit margin in the concerned industry. The additional grounds being a ground on comparability is admitted for adjudication as the issue sought to be raised in the additional ground arises out of order of CIT(Appeals) and has been raised by the Assessee before the CIT(A).

As far as the question of determination of ALP of the international transaction is concerned, the facts are that the assessee is a company engaged in the business of development of software and rendering of ITeS. During the previous year, the assessee provided transcription services to its AE in USA. The assessee received a sum of Rs.26,24,05,361 for providing medical transcription services to its AE. The Operating Profit to Operating Cost (OP:OC) ratio in the matter of providing ITeS to AE was as follows:-

The price received in the international transaction has to satisfy the arm’s length test as laid down in section 92 of the Income-Tax Act, 1961 [“the Act”]. In support of its claim that the price received from the AE was at arm’s length, the assessee filed a TP study in which the assessee chose to Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for determining the ALP. The Profit Level Indicator (PLI) chosen for the purpose of comparison of the profit margin of the assessee with the comparable companies was OP to OC. The assessee in its TP study had applied a different criterion for accepting and rejecting the comparable companies. The TPO rejected some of the comparable companies chosen by the assessee in its TP study and on his own, did a selection of comparable companies and finally arrived at a set of 20 comparable companies and the average profit margin of these comparable companies was as follows:-

After providing for working capital adjustment, the TPO arrived at the ALP and addition to be made to the total income of the assessee at a sum of Rs.1,59,22,510 as follows:-

The additions suggested by the TPO was incorporated by the AO in the final order of assessment. Aggrieved by the aforesaid addition, the assessee preferred appeal before the CIT(Appeals).

The CIT(Appeals) excluded some of the comparable companies chosen by the TPO and consequent to the order of CIT(Appeals), the price charged by the assessee was to be regarded as at arm’s length. The revenue by its grounds of appeal sought to assail the findings of the CIT(Appeals).

As far as excluding the companies on the basis of turnover is concerned, the issue has been settled in several decisions of the Tribunal and has been elaborately discussed by this Tribunal in the case of Autodesk India Pvt. Ltd. v. DCIT in IT(TP)A No.540 & 541/Bang/2013, order dated 06.07.2018. The Tribunal in this decision after review of entire case laws on the subject, considered the question, whether companies having turnover more than 200 crores upto 500 crores has to be regarded as one category and those companies cannot be regarded as comparables with companies having turnover of less than 200 crores, the Tribunal held as follows:-

In view of the aforesaid decision of the Tribunal, we find no merit in ground No.6 raised by the revenue.

As far as ground No.7 raised by the revenue is concerned, grievance of the revenue is that the CIT(Appeals) excluded the following 6 companies on the ground that these companies reflected abnormal profits. They were; (1) Aditya Birla Minacs Worldwide Ltd. (2) Coral Hubs Ltd. (3) Eclerx Services Ltd. (4) Jindal Intellicom Pvt. Ltd. (5) Mold-Tek Technologies Ltd. & (6) Allsec Technologies Ltd. The decision of the CIT(Appeals) in excluding these companies is contained in para 165 of the CIT(A)’s order. There is, however, no discussion as to how abnormal profits would have impact on the comparability of a company. On a perusal of the order of CIT(A), we find that the discussion on turnover and abnormal profits and losses filter starts at para 156 and till para 164, there a discussion only about turnover filter and no discussion on abnormal profits & losses filter. However, in conclusion at para 165, the CIT(A) has held that abnormally high profits or losses making companies should be excluded. Therefore, the grievance projected by the revenue in ground No.6 needs to be accepted.

However, in additional grounds 6 & 7 raised by the assessee in its appeal, the assessee has pointed out that 3 out of 6 companies excluded by applying abnormal profit or loss filter are functionally not comparable viz., Mold-Tek Technologies Ltd., Eclerx Services Ltd. and Coral Hubs Ltd. In this regard, the ld. counsel for the assessee drew our attention to IT(TP)A No.697 & 842/ Bang/2013 Page 11 of 19 decision of the Tribunal rendered in the case of Flextronics Technologies India Pvt. Ltd. v. DCIT in IT(TP)A No.1559/Bang/2012 , order dated 23.10.2015 rendered for AY 2008-09 in the case of a similar company such as the assessee. In para 14 of this order, the Tribunal has considered the comparability of these companies and came to the conclusion that Coral Hubs Ltd. cannot be regarded as a comparable company, as the business model of this company was sub-contracting and outsourcing. As far as Mold-Tek Technologies Ltd. is concerned, in para 19 of this aforesaid order, this company was regarded as functionally not comparable as it provided engineering services like civil and structural engineering and GIS services. As far as Eclerx Services Ltd. is concerned, the Tribunal came to the conclusion that extra-ordinary events and peculiar circumstances prevailed in the relevant previous year of this company which had an impact on the profit margins and therefore this company had to be excluded from the list of comparable companies. Following the aforesaid decision, we hold that the aforesaid 3 companies i.e., Coral Hubs Ltd., Mold-Tek Technologies Ltd. and Eclerx Services Ltd. have to be removed from the final list of comparables chosen by the TPO on functional comparability.

As far as the remaining 3 companies i.e., Aditya Birla Minacs Worldwide Ltd., Jindal Intellicom Pvt. Ltd. and Allsec Technologies Ltd. are concerned, the issue; whether abnormal profit or loss should result in exclusion of a company; is remitted to the TPO for fresh consideration in the light of law that has evolved since the passing of the order of the TPO. Ground No.7 raised by the revenue is partly allowed for statistical purposes and additional grounds 6 & 7 of the assessee are allowed.

Ground No.8 raised by the revenue is academic because no company was excluded or included by applying different year ending filter.

As far as grounds 9 & 10 of the revenue are concerned, the same relates to excluding Accentia Technologies Ltd. and Genesys International Corporation Ltd. from the list of comparable companies chosen by the TPO by the order of CIT(Appeals). The CIT(Appeals) excluded Accentia Technologies Ltd. on the ground that abnormal features of this company did not represent the industry trend and therefore this company had to be regarded as not comparable. It is not in dispute before us that in the case of Flextronics Technologies India Pvt. Ltd. (supra), in para 12 this Tribunal held that this company was not to be regarded as comparable company rendering ITeS because of the extra-ordinary events like merger and de- merger which had impact on the profit margins of this company.

As far as Genesys International Corporation Ltd. is concerned, the CIT(A) in para 197 of his order excluded this company on the ground that this company was rendering geographical information systems services and cannot be compared with a company providing ITeS. It is not in dispute before us that the ITAT Bangalore Bench in the case of Flextronics Technologies India Pvt. Ltd. (supra) vide para 17 had excluded this company on the similar ground on which it was excluded by the CIT(A). In view of the aforesaid decision, we find no merits in ground Nos. 8, 9 & 10 raised by the revenue in its appeal.

Ground Nos.11 to 13 by the revenue are general in nature and call for no specific adjudication.

As far as ground Nos.1 to 4 by the revenue are concerned, the same reads as follows:-

The Ld.CIT(A) ought to have appreciated that there is no provision in section 10A which requires the concerned expenses, which are required to be reduced from the export turnover as per clause (iv) of the Explanation to Section 10A to be reduced from the total turnover also.

The issue raised in the above grounds is with regard to excluding internet charges of Rs.27,27,786 and expenditure incurred in foreign currency for travel amounting to Rs.4,80,079 from the export turnover as well as total turnover.

We have considered the rival submissions. Taking into consideration the decision rendered by the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2012] 349 ITR 98 (Karn), we are of the view that internet charges and expenditure incurred in foreign currency for travel should be excluded both from export turnover and total turnover. We are of the view that as of today, law declared by the Hon'ble High Court of Karnataka which is the jurisdictional High Court is IT(TP)A No.697 & 842/ Bang/2013 Page 14 of 19 binding on us. Moreover, the order of the Hon’ble Karnataka High Court has been upheld by the Hon’ble Supreme Court in the case of CIT v. HCL Technologies Ltd. in Civil Appeal No.8489-98490 of 2013 & Ors. dated 24.04.2018. Therefore, we find no merits in the grounds No.1 to 4 raised by the assessee and the same are dismissed.

In the result, the appeal by the revenue is treated as partly allowed for statistical purposes.

IT(TP)A No.697/Bang/2013 (Assessee’s appeal)

Ground No.1 raised by the assessee reads as follows:- “1. The learned CIT(A) has erred in law and facts, by holding that AO is justified in setting off the brought forward unabsorbed depreciation of Rs 240,221 before computing the deduction under section 10A. Further, the learned CIT(A) has erred by not relying on the decision of the jurisdictional High Court in the case of CIT vs Yokogawa India Ltd [ITA No. 248/2007] which is binding on the learned CIT(A).”

As far as this ground is concerned, the issue is with regard to the set off of brought forward unabsorbed depreciation in the earlier asst. years 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 unabsorbed depreciation of earlier years. 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.

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 :-

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 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 the brought forward business losses and unabsorbed depreciation of non- Sec.10A units 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 brought forward unabsorbed depreciation of non- 10A units against profits of 10A units before allowing deduction u/s. 10A of the Act.

Grounds 2 to 5 raised by the are with regard to disallowance made u/s. 40(a)(i) of the Act. As far as this issue raised by the assessee is concerned, it would be sufficient if ground No.5 is adjudicated, which reads as follows:- “5. The learned CIT(A) has erred in law and facts, by not considering the alternative plea that, if any disallowance is made under section 40(a)(i) of the Act, the same should be considered towards 'profits of the undertaking' in computing the eligible deduction under section 10A of the Act.”

The issue is with regard to disallowance of expenses u/s.40(a)(i) of the Act. The ld. counsel for the assessee has submitted that even assuming disallowance u/s. 40(a)(i) of the Act has to be sustained, the addition made consequent to such disallowance will go to increase the profits of the unit which is entitled to claim deduction on such profits u/s. 10A of the Act and therefore the impugned addition even if sustained, will be tax neutral. In other words, the assessee claims that even on the addition made consequent to disallowance u/s. 40(a)(i) of the Act, deduction u/s. 10A should be allowed.

In this regard, the dl. Counsel for the assessee has placed reliance on the decision of two High Courts viz., Hon’ble Bombay High Court in the case of CIT v. Gem Plus Jewellery India Ltd. (2010) 194 Taxman 192 (Bom) and Hon’ble Gujarat High Court in the case of ITO v. Kewal Construction, 354 ITR 13 (Guj). In the decision of the Hon’ble Gujarat High Court, it was held that when disallowance u/s. 40(a)(ia) of the Act goes to enhance the profits that are eligible for deduction under Chapter VIA of the Act, the deduction under Chapter VIA should be allowed on such increased profit. This position has also been now confirmed by the CBDT in its Circular No.37/2016 dated 02.11.2016 wherein the Board has observed as follows:-

In view of the above, we accept ground No.5 of the assessee and direct the AO to allow deduction u/s. 10A of the Act on the amount disallowed u/s. 40(a)(i) of the Act. Thus, ground No.5 raised by the assessee is allowed. In view of the decision on ground No.5, grounds above, the other grounds 2 to 4 raised by the assessee needs no adjudication.

In the result, the appeal by the assessee is allowed; while that of revenue is partly allowed for statistical purposes.