M/S SUNQUEST INFORMATION SYSTEMS (INDIA) PRVATE LIMITED,BANGALORE vs. DCIT, BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL, BANGALORE BENCH “A” BEFORE SHRI N.V VASUDEVAN, VICE PRESIDENT SHRI JASON P BOAZ, ACCOUNTANT MEMBER IT(TP)A No.552/Bang/2015

Assessment year : 2010-11

M/s Sunquest Information Vs. The Dy. Commissioner Systems (India) Pvt. Ltd., of Income-tax, 3rd Floor, Indraprastha Circle-6(1)(1), Equinox, No.23, Bengaluru. 100 Ft. Inner Ring Road, Ejipura, Bengaluru. PAN – AAEC S 2754 E APPLICANT RESPONDENT

Applicant by : Shri Sharath Rao, C.A Respondent by : Shri C.H Sundar Rao, CIT

Date of hearing : 28.11.2018 Date of : 21.12.2018 Pronouncement O R D E R PER SHRI N.V.VASUDEVAN, JUDICIAL MEMBER : This appeal by the assessee is against the final order of assessment dated 30/1/2015 passed u/s 143(3) r.w.s 144C(13) of the Income-tax Act, 1961 (in short ‘the Act’) by DCIT, Circle- 6(1)(1), Bangalore relating to asst. year 2010-11.

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15.2 In computing the notional interest on the outstanding balances from the AE by adopting an adhoc threshold of 3 months as the arm's length benchmark for making the transfer pricing adjustment. 15.3 Without prejudice, by not computing notional interest only for the period exceeding the threshold interest free period of 3 months considered by the learned TPO. 15.4 By adopting an interest rate of 11.25% (being the prime lending rate) without giving any cogent reason for adopting the same.”

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development services. The assessee is compensated on a cost plus basis.

* Excluding other income, for forex plus markup

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** Excluding interest & forex loss 7. In support of assessee’s claim that the price received in the international transaction is at arms length. The assessee filed Trasnfer Pricing Analysis selecting 21 companies as comparable with the assessee in terms of Functions performed, Assets employed and Risks Assumed (FAR) and the arithmetic mean of profit margin of those companies was within the profit margins earned by the assessee in the international transaction.

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“10.4 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 length price of the services rendered by the taxpayer to its AE(s) is computed as under:

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RPT Filter and therefore by exclusion of the aforesaid 3 companies should be applied in that event, the 3 companies will get excluded.

“In Ground No.4 (e) of the grounds of appeal, the Assessee seeks exclusion of Geometric Software solutions Co. Ltd; and Foursoft Ltd. from the list of comparable companies as these companies have Related Party Transaction (RPT) of more than 15%. learned DR drew our attention to the decision of the Hon'ble ITAT Bangalore ‘B’ Bench in the case of Robert Bosch Engineering and Business Solutions Ltd. (supra) wherein the Tribunal in paragraph 8 has observed 25% to 15% RPT filter has to be applied depending on availability of comparables. His submission was therefore that companies with RPT of 25% or more alone should be excluded from the list of comparable companies chosen by the TPO and the action of the CIT(A) in excluding comparable companies even in a case where there are single and insignificant RPT was not correct. The learned counsel for the Assessee, on the other hand, pointed out that this Tribunal, in the eases of 2417 Customer (P.) Ltd. v. Dy. CIT [2012] 28 taxrnann.com 258/[2013] 140 ITD 344 (Punj.) Sony India (F) Ltd. v. Dv. CIT [2008]114 LTD 448 (Delhi) and various other cases, has taken a view that comparables having RPT of upto 15% of total revenues can be considered as comparable

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company. We have considered the rival submission. It is no doubt true that in the case of Robert Bosch (supra) this Tribunal has held that RPT filter can be in the range of 25% to 15% of the total receipts from software development services, depending on availability of comparable companies. It is no body's ease that there is dearth of comparable companies in software development services industry. Therefore it would be safe to follow the ruling of this Tribunal in the cases of 2417 Customer (P.) Ltd. (supra), Sony India (P.) Ltd. (supra) wherein a view has been taken that comparable companies having RPT of upto 15% of total revenues can be considered as comparable companies. In view thereof, the plea of the Assessee requires to be accepted. The TPO/AO are directed to adopt a threshold limit of 15% of the total revenue attributable to related party transaction as ground for rejecting comparable companies. Consequently, it is held that companies having RPT upto 15% of the total revenues can be included.”

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Systems Ltd., from the list of comparable companies on the grounds that this company was not functionally comparable as it was engaged in developing software products and was not a pure software development services company. On comparability of this company, the TPO has given the following finding in his order.

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“9.2 The taxpayer's principal objection regarding this comparable is that it is engaged in software development and also sale of products for which no segmental information is available and, therefore, needs to be excluded from the comparables. To support this contention, reliance was placed on various judicial pronouncements, including the decision of the Hon'ble ITAT, Bangalore in the case of Trilogy E Business Software India Pvt. Ltd Vs. DCIT (ITA NBo.1201/Bang/2010) which has been cited in the later judgments of the Bangalore ITAT in the case of Curam Software International Pvt. Ltd. Vs. ITO (ITA no.1280/Bang/2012) as well as in the appellant's own matter in ITA No.1538/Bang/2012. Additionally, the discussion around this company in the case of NettHawk Networks India Private Ltd. Vs. ITO (ITA no.7633/M/2012) was also cited. 9.3 The objections and arguments of the taxpayer have been considered and the order of the Hon'ble ITAT Bangalore in the case of M/s Trilogy E Business Software India Pvt. Ltd (supra) perused. At Para-46 of this order, the Hon'ble ITAT considered the decision in the case of Bindview India Private Limited and in Para-47 held as follows

"we have given a careful consideration to the submission made on behalf of the assessee, we find that the TPO has drawn conclusions on the basis of the information obtained by issue of notice u/s 133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same

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is contrary to the annual report of the company as highlighted by the assessee in its letter dated 21-06-2010 to the TPO. We also find that the decision referred by the Learned Counsel for the assessee, the Mumbai Bench of ITAT has held that the company was developing software product and not purely or mainly software development service provider. We therefore, accept the plea of the assessee that this company is not comparable".

9.4 It is clear from the order of the Hon'ble ITAT in the case of Trilogy (supra) that relief was allowed on the ground that the information gathered u/s 133(6) by the TPO was not in conformity with the Annual Report according to which the company was not purely or mainly a software development service provider in that particular assessment year. For the assessment year under consideration, it is evident from the Profit and Loss account and Balance Sheet of the company that it was engaged only in the software development service segment. In view of the statutory mandate for conducting comparability analysis taking into account only contemporaneous evidence (Rule 10D(4) the judicial decisions as above which pertain to AY 2006 are not applicable here. During the AY 2010-11 it is clear that there is no other activity other than the software development. Therefore, the TPO's inclusion of this company as a comparable is found to be in order. The taxpayer's objections are not acceptable.”

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product manufacturing company is found. Schedule-XIV to the annual accounts is also being referred to by the Assessee, wherein it is mentioned that this company is engaged in development of software and software products. Another circumstances pointed out by the assessee is that this company has significant inventory. On the above circumstances, the assessee wants to say that this company is software product company. We are of the view that these are the inferences which are drawn by the assessee and cannot be the basis to conclude that this company is a software product company. We are of the view that in the given facts and circumstances of the case, it is just an appropriate to set aside the matter to the TPO on the question regarding this company as comparable company and directing the TPO to exercise his power u/s 133(6) of the Act to find out whether this company is product company and also segmental margin, if it is a product company as well as software development services company. After affording opportunity of being herd to the assesee, the TPO will consider the comparability of this company with that of the assessee.

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treating the extended credit period given by the assessee to AE as international transaction. Following were relevant observations of the TPO in the order of assessment. Interest on Sundry debtors outstanding for more than 3 months: The taxpayer has shown receivables of Rs.16,82 Crore from its AE. A notice was issued to the taxpayer to show cause why interest should not be charged on amount outstanding for more than 3 months as being in the nature of extended credit period. The taxpayer filed its response vide letter dated 31/10/13 the taxpayer has submitted that debts are outstanding with the AE purely because of business reasons and that this was a common business practice prevailing in the industry. The taxpayer has submitted that there was no intention to extend credit period to its AE. However, once the normal period of credit that is extended to a debtor lapses, then the extended period of credit allowed to the debtors takes on the hue of a financial transaction and can no longer be stated to be a debtor transaction. The transaction will now have to be considered as a loan given and not an outstanding debt. In view of this, it is concluded in normal market conditions, no third party would be willing to extend credit for more than the accepted period. In the event of extended credit period, an independent party would expect to be compensated in return. Accordingly, the TPO is of the view that for debts outstanding for more than 3 months which is the accepted normal waiting period for any credit In the open market, interest at market rate should be charged on the debts outstanding amounting to Rs.7,15,52,695/- for more than 3 months in the books of the taxpayer. For this purpose, the Prime Lending rate of SBI for the year being 11.25% is being adopted for calculating the interest ought to

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be charged ,using CUP method and the SBI PLR is taken as the Arms Length Rate. The calculation is given below:

The interest chargeable of Rs.52,73,325/- is adjustment under section 92CA of the IT Act in respect of extended credit terms to the debtors.

The assessee had submitted the details of the receivables from its AE before the TPO as follow:

7.2 It was submitted that the debtors outstanding with the AE were pure1y because of business and commercial expediency and there was no malafide intention to extend indirect credit period to the AE. The TPO, however, computed notional interest at the rate of 11.25% (being the SBI Prime Lending Rate) for the outstanding receivables from AE beyond 3 The taxpayer has grieved this treatment and cited the decision of the Hon'ble Mumbai ITAT in case of Evonik Degussa India P. Ltd.v/s Asstt. Commissioner of Income Tax-OSD Circle-3(1) (ITA No. 7653/Mum./2011) where it was held that the T.P.

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adjustment cannot be made on hypothetical and notional basis until and unless there is some material on record that there has been under charging of real income, it was also pointed out by the taxpayer that the TPO had not given any basis for arriving at a threshold of three month for computing the notional interest. 7.3 The taxpayer's objections as above have been considered along with the judicial decision cited. The decision was given in the context of the case where the taxpayer had no interest liability and no external borrowing. In the case of Mastek Ltd vs Addl. CIT (2012) 21 taxmann.com 173 the Hon'ble ITAT Ahmadabad required verification of whether the AEs are recovering interest from third parties for late recoveries before considering any levy of interest by the taxpayer for delayed payment. The TPO's rationale for the addition in her order as elaborated as page 29 is that once the normal period of credit of three months extended to a debtor lapses, then the extended period of credit takes on the color of a financial transaction and can no longer be treated as a mere debtor transaction. We are in agreement with the logic of TPO which has been adopted by specifically citing the CUP method. However, the TPO is directed to verify whether the AE is recovering interest from third parties for late recovery and if this is found to exist the interest on extended credit period can reasonable. On contrary facts the TPO's adjustment cannot be sustained.”

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taxmann.com 187 (Bangalore – Trib.), wherein the Tribunal held as follows:- “We have heard the rival submissions. The assessee company reported international transactions in its TP report. On a reference by the AO, the learned TPO accepted that the price charged by the assessee company on these transactions are at arm's length. However, the TPO made adjustments on account of notional interest for the excess period allowed by the assessee- company to its AE for realization of its dues. The TPO applied 14% of interest on the outstanding amount of Rs. The learned DRP also had also concurred with the finding of learned TPO. There is no dispute that the transaction in question falls within the ambit of international transactions u/s 92B of the IT Act. However, this transaction is not an independent transaction. It is an integral part of transaction of sale made to the AE and therefore, it has to be considered alongwith the main transaction. The similar issue had come up for consideration before the Co-ordinate Bench of Mumbai in the case of Goldstar Jewellery Ltd. (supra), wherein it was observed as under;

“However, this transaction of allowing the credit period to AE on realization of sale proceeds is not an independent international transaction but it is closely linked or continuous transaction along with sale transaction to the AE. The credit period allowed to the arty depends upon various factors which also includes the price charged by the assessee from purchaser. Therefore, the credit period extended by the assessee to the AE cannot be examined independently but has to be considered along with the main international transaction being sale to the AE. As per Rule 1 OA(d) if a number of transactions are closely linked or continuous in nature and arising from a continuous transactions

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of supply of amenity or services the transactions is treated as closely linked transactions for the purpose of transfer pricing and, therefore, the aggregate and clubbing of closely linked transaction are permitted under said rule. This concept of aggregation of the transaction which is closely liked is also supported by OCED transfer pricing guidelines. In order to examine whether the number of transactions are closely linked or continuous so as to aggregate for the purpose of evaluation what is to be considered is that one transaction is follow-on of the earlier transaction and then the subsequent transaction is carried out and dependent wholly or substantially on the earlier transaction. In other words, if two transactions are so closely liked that determination of price of one transaction is dependent on the other transaction then for the purpose of determining the ALP, the closely linked transaction should be aggregated and clubbed together. When the transaction are influenced by each other and particularly in determining the price and profit involved in the transaction then those transactions can safely be regarded as closely lined transactions. In the case in hand, the credit period extended to the AE is a direct result of sale transaction. Therefore, no question of credit period allowed to the AE for realization of sale proceeds without having sale to AE. The credit period extended to the AE cannot be treated as a transaction stand alone without considering the main transaction of sale. The sale price of the product or service determined between the parties is always influenced by the credit period allowed by the seller. Therefore, the transaction of sale to the AE and credit period allowed in realization of sale proceeds are closely linked as they are inter linked and the terms and conditions of sale as well as the

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price are determined based on the totality of the transaction and not on individual and separate transaction. The approach of the TPO and DRP in analyzing the credit period allowed by the assessee to the AE without considering the main international transaction being sale to the AE will give distorted result by disregarding the price charged by the assessee from AE. Though extra period allowed for realization of sale proceeds from the AE is an international transaction, however, for the purpose of determining the ALP, the same has to be clubbed or aggregated with the sale transactions with the AE. Even by considering it as an independent transaction the same has to be compared with the internal CUP available in the shape of the credit allowed by the assessee to non- AE. When the assessee is not making any difference for not charging the interest from AE as well as non- AE then the only difference between the two can be considered is the average period allowed along with outstanding amount. If the average period multiplied by the outstanding amount of the AE is at arm's length in comparison to the average period of realization and multiplied by the outstanding from non-AEs then no adjustment can be made being the transaction is at arm's length. The third aspect of the issue is that the arm's length interest for making the adjustment. Both the TPO and the DRP has taken into consideration the lending rates, however, this is not a transaction of loan or advance to the AE but it is only an excess period allowed for realization of sales proceeds from the AE. Therefore, the arm's length interest in any case would be the average cost of the total fund available to the assessee and not the rate at which a loan is available. Accordingly, we direct the AO/TPO to re-do the exercise of determination of the ALP in terms of above observation".

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Respectfully following the above decision, we hold that there can be no separate international transaction of 'interest' in the international transaction of sale. Early or late realization of sale proceeds is only incidental to transaction of sale, but not a separate transaction in nature. Since we hold that the impugned transaction of interest on delayed realization of sale proceeds is not international transaction, it is not necessary to adjudicate upon the additional gr9inds raised by the assessee company. Hence, the appeal is treated as partly allowed for statistical purposes.”

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by the DRP cannot be sustained and the same is directed to be deleted.

16.2 The learned AO has erred in not appreciating the fact that the vendors providing the software to the Assessee have levied Value Added Tax ('VAT') considering the software as a 'good'

16.3 The learned AO has erred in holding that the payment towards purchase of off the shelf computer software comes within the purview of royalty' as defined in Explanation 2 to section 9(1)(vi) of the Act and are liable to tax deduction at source.

16.4 Without prejudice to the above, the learned AO has erred in holding that the Assessee has capitalized such expenditure and therefore depreciation claimed on the same to be disallowed.”

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account under the head ‘computer & software’. The assessee claimed the depreciation at 60% on computer software. The AO noticed that while making payment for the purchase of software and licence, the assessee did not deducted tax at source. According to the AO, assessee ought to have been deducted tax at source u/s 194J of the Act in respect of such purchases since the assessee has not deducted tax at source, the AO was view that provision of sec. 40a(ia) of the Act will be attracted. He was of the view that depreciation claimed on purchase of software and license by the assessee should be disallowed u/s 40a(ia) of the Act. The AO accordingly disallowed the depreciation to the extent of Rs.1,039,590/- and the DRP confirmed the action of the AO.

“7. As it is clear from the above decision that the Tribunal has discussed and analysed the provisions of section 40(a)(i) in detail in the context of disallowance of depreciation. The learned D.R. has submitted that once the assessee has violated the provisions of section

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195, then, even the expenditure is capitalized by the assessee, the provisions of section 40(a)(i) are applicable for disallowance of depreciation on such capitalized expenditure. We do not agree with the contention of the learned D.R, because a remedy for violation of provisions of section 195 is available with the Assessing Officer under Section 201 & 201A of the Act. The provisions of section 40(a) is only an additional measure to enforce the compliance of Chapter XVIJB of the Act, by disallowing an expenditure which is otherwise allowable under the provisions of the Act. Therefore, the question of disallowance under Section 40(a) arises only when an expenditure is claimed by the assessee without deducting the tax at source as per the provisions of Chapter-XVIIB of the Act, 1961. In the case on hand, when the assessee has not claimed, the said payment as an expenditure then the question of disallowance under Section 40(a)(i) does not arise. The only remedy which might have been resorted to by the Assessing Officer is the action under Section 201 and 201A of 12 IT(I.T)A No.1512/Bang/2010 ITA No.834/Bang/2016 the Act. A similar view has been taken by the Delhi Bench of the Tribunal in the case of SMS Demang (P) Ltd. (supra) in Para 8 as under :- "8. As regards the claim of assessee for depreciation on assets capitalized, depreciation cannot be disallowed on the ground that at the time of remittance, no tax was deducted at source. Provisions of section 40(a)(i) are not applicable for claim for deduction under section 32 of the Act. Accordingly, in our considered opinion, the AU was not justified in disallowing 50 percent of depreciation on the ground that provisions of section 40(a)(i) were applicable. However, the AU will verify the fact whether the assets in respect of which expenditure has been

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capitalized have been used in business for period more than 180 days. If the assets have been used for more than 180 days, the AU will allow full depreciation, as claimed by the assessee. The AU is directed accordingly".

Therefore, in the facts and circumstances of the case as well as by following the decisions of the co-ordinate benches of the ITAT, we are of the opinion that once the assessee has capitalized the payment in question though the assessee has not deducted the tax at source on such payment, Section 40(a)(i) cannot be invoked for disallowance of depreciation. Accordingly, we set aside the orders of the authorities below and the addition made by the Assessing Officer is deleted.”

Order pronounced in the open court on 21st December, 2018.

Sd/- Sd/- (JASON P BOAZ) (N.V VASUDEVAN) ACCOUNTANT MEMBER VICE PRESIDENT Bangalore Dated : 21/12/2018

Vms

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Copy to :1. The Assessee 2. The Revenue 3.The CIT concerned. 4.The CIT(A) concerned. 5.DR 6.GF By order

Asst. Registrar, ITAT, Bangalore.

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