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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI ARUN KUMAR GARODIA
O R D E R
Per Shri A.K. Garodia, Accountant Member
This appeal is filed by the assessee which is directed against the assessment order dated 11.09.2017 passed by the AO u/s. 143(3) r.w.s. 144C of IT Act as per the directions of DRP.
The grounds raised
by the assessee are as under.
1. The Assessment Order dated September 11, 2017 (served on September 15, 2017), issued by the learned Assistant Commissioner of Income-tax, Circle -4(1)(2), Bangalore ("learned AO") under Section 143(3) read with Section 144C(13) of the Income-tax Act, 1961 ("the Act"), the Directions issued by the Hon'ble Dispute Resolution Panel ("Hon'ble DRP") and the Order of the learned Transfer Pricing Officer ("learned TPO") issued under Section 92CA of the Act are not in accordance with the law, made in violation of the principles of equity and natural justice and are contrary to the facts and circumstances of the present case.
2. Transfer pricing adjustment of INR 73,919,904 The Hon'ble DRP and learned AO / TPO have erred in law and on facts in making Transfer Pricing ("TP") adjustment of INR 73,919,904 to the returned income of the Appellant and in holding that the international transactions between the Appellant and its associated enterprises ("AEs") were not at arm's length.
3. Rejection of transfer pricing documentation of the Appellant 3.1 The Hon'ble DRP and the learned AO / TPO have erred in law and on facts in rejecting the TP documentation which had been prepared by the Appellant, in the manner contemplated under the relevant provisions of the Act and the Income-tax Rules, 1962 ("the Rules"). 3.2 The Hon'ble DRP has erred in law and facts in upholding the learned TPO's finding that the information or data used in computation of arm's length price is "unreliable or incorrect", under Section 92C(3) of the Act. 4. Use of multiple year data 4.1 The Hon'ble DRP and the learned AO / TPO have erred in law and on facts in rejecting the use of multiple year data, without considering that the past year's data had an influence on the determination of arm's length price and that the Appellant had considered contemporaneous data available at the time when it carried out the benchmarking study having regard to the statutory requirement to maintain the TP documentation by the specified date. 4.2 The Hon'ble DRP and the learned AO / TPO have erred in law, on facts and circumstances of the case by ignoring the provision of the Rule 10B(4) of the Rules, international commentaries and judicial pronouncements, which advocate usage of multiple year data of comparable companies for the purpose of determination of the arm's length price. 5. Computation of operating profit margins of comparable companies The Hon'ble DRP and the learned AO / TPO have erred in law and on facts in considering provision for doubtful debts to be non-operating in nature while computing the operating profit margins of the comparable companies overlooking the fact that the same resulted from company's normal business operations. 6. Comparable companies 6.1 The Hon'ble DRP and the learned AO / TPO have erred in law by conducting a fresh search for comparable companies and by rejecting the search process carried out by the Appellant, without giving justifiable reasons under the law including Section 92C(3) for the rejection. 6.2 The Hon'ble DRP and the learned AO / TPO have erred in law and on facts in adopting additional filters and modifying the filters adopted by the Appellant for conducting TP analysis, without appreciating the TP documentation prepared by the Appellant. 6.3 The Hon'ble DRP and the learned AO / TPO have erred in selecting following companies which are not comparable to the Appellant for reason including functional dissimilarity, non-availability of segmental information, diverse set of activities, presence of intangibles etc.: Persistent Systems Limited Larsen & Toubro Infotech Limited Tech Mahindra Limited CG — VAK Software & Exports Limited 6.4 Without prejudice to the above, while adjudicating on Persistent Systems Limited, theHon'ble DRP did not take cognizance of the order of Hon'ble Bangalore ITAT for AY 2007-08 in Appellant's own case [IT(TP)A No. 536/Bang/2015] wherein Persistent Systems Limited was rejected. 6.5 The Hon'ble DRP and the learned AO / TPO have erred in law and on facts in rejecting the following Appellant's TP documentation companies which are comparable to the Appellant: Helios & Matheson Information Technologies Limited R Systems International Limited Bells Softech Limited 6.6 The Hon'ble DRP and the learned AO / TPO have erred in law and on facts in rejecting the following additional comparable companies proposed by the Appellant during the course of TP proceedings, without considering the detailed submissions of the Appellant: Evoke Technologies Limited Spry Resources India Private Limited 7. Information gathered under Section 133(6) of the Act is inappropriate for the purposes of disturbing the TP documentation undertaken by the Appellant 7.1 The Hon'ble DRP and the learned AO / TPO have erred in law and in facts by gathering information from various companies under Section 133(6) of the Act, which were not available with the Appellant at the time of preparing its TP documentation.
7.2 The Hon'ble DRP and the learned AO / TPO have erred in law by relying upon the information not available in public domain while carrying out the bench marking analysis under the Act. 8. Comparability adjustments 8.1 The Hon'ble DRP and the learned AO / TPO have erred in not making a risk adjustment reducing the arm's length margin determined by the Appellant, disregarding the judicial precedents on the said aspect.
8.2 The Hon'ble DRP and the learned AO / TPO have erred in not appreciating that the Appellant, being a captive service provider operates at lower risk levels as compared to comparable companies, which carry higher risks and accordingly, erred in not granting appropriate risk adjustments.
9. Other transfer pricing related grounds 9.1 The Hon'ble DRP and the learned AO / TPO have failed to appreciate Appellant's commercial judgment about the application of arm's length principle which is tied to the business realities.
9.2 The Hon'ble DRP and the learned AO / TPO have erred in law and on facts, in making several observations and findings which are based on incorrect interpretations of law and contrary to facts of the case.
9.3 The Hon'ble DRP and the learned AO / TPO have erred in not carrying out the determination of arm's length price as required under Section 92C of the Act read with Rule 10D of the Rules.
9.4 The Hon'ble DRP and the learned AO / TPO have erred in not following the process specified under Section 92C(3) of the Act, for rejection of TP analysis of the Appellant and for independent determination of arm's length price.
9.5 The learned AO has erred in law and on facts in initiating penalty proceedings under section 271(1)(c) of the Act. 9.6 The learned AO has erred in computing interest under Section 234B on the assessed income. Each of the above objections is independent and without prejudice to the other grounds of objections preferred by the Appellant. The Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds, at any time before or at the time of hearing of the appeal. Each of the above objections is independent and without prejudice to the other grounds preferred by the appellant.”
At the very outset, it was submitted by ld. AR of the assessee that only ground nos. 5 and 6 are to be decided and the remaining grounds are not pressed. Accordingly all grounds except ground nos. 5 and 6 are rejected as not pressed.
Regarding ground no. 5, the ld. AR of assessee placed reliance on a Tribunal order rendered in the case of Sony India (P.) Ltd. Vs. DCIT as reported in 114 ITD 448 (Delhi), copy available on pages 291 to 344 of paper book. He also placed reliance on another Tribunal order rendered in the case of Kenexa Technologies Pvt. Ltd. Vs. DCIT as reported in 51 taxmann.com 282 (Hyderabad), copy available on pages 345 to 357 of paper book. The ld. DR of revenue submitted that these two Tribunal orders are not applicable in the present case. He supported the assessment order and DRP order.
We have considered the rival submissions. First of all, we examine the applicability of Tribunal order rendered in the case of Sony India (P.) Ltd. Vs. DCIT (supra). This is a long Tribunal order and in course of arguments before us, reference was made only to para 106.2 available on page 324 of paper book and therefore, the same is reproduced hereinbelow for the sake of ready reference. “106.2 After considering facts and circumstances of the case, we do not see any good ground for not permitting the taxpayer to raise the ground before the Income-tax Appellate Tribunal which is clearly arising out of the impugned order. As noted earlier, the revenue has not challenged relevant part of the order of the CIT(A). Therefore, the objection now being taken by the ld. D.R. is not justified. On merit, we see no good reason to exclude provisions written back as not forming part of computing operating profit of the taxpayer. In our considered opinion, exclusion of above provision is based upon misconception of real nature of the entry generating income. It is not practically possible for a businessman to actually disburse all expenses incurred by it in the financial year and, therefore, a large number of business liabilities (manufacturing included) are provided in the accounts of a given year. It is elementary that there is no difference between actual disbursement of an expenditure or provision thereof. However, recovery of liability provided may become barred by limitation or for some other reasons, liability gets unenforceable or is reduced or ceases to exist with the passage of time. Therefore it may be necessary to write back such a liability. But it cannot follow that the liability was not expenditure of business or operating expense. Cessation of a liability is a taxable income Under Section 41 of the Income Tax Act. The underlying principle behind above provision is that revenue takes back a benefit which it granted earlier, but which, due to subsequent events or changed circumstances should be charged to tax as "income". Statutory provision overrides general understanding that mere creation of a benefit to a taxpayer by admission or cessation of a debt or a liability should not result in an income. Thus, creation of unpaid liability and its write back is a normal incident of a business operation which is carried everywhere in accounts to have true picture of profits of the relevant period. If a liability has ceased to exist and is required to be accounted for and shown as income by the taxpayer and, in case it is not so shown the taxpayer can be subjected to a penal action under Indian regulations. In this connection, we can refer to decision of Supreme Court in the case of CIT v. Teja Singh 35 ITR 408. Having regard to statutory provisions, it cannot be said that provisions or writing back of liability is not part of operating profit or would not be taken into consideration for computing the same. The aspect of liabilities written off was ignored without considering nature and character of such liabilities. It would have been different if a finding was recorded that provision written back did not relate to business operations of the taxpayer. There is no suggestion on the above lines. Further it is not the case of the revenue that liabilities written back were wrongly provided for. It is a settled and well-accepted proposition that adjustment can be made only on account of differences. It is not possible to believe that other comparable entities taken into consideration are not making and writing back provision of liabilities no more required. There is no material nor there is any finding to support action of the revenue authorities. We can therefore make a general observation that all business enterprises are making and writing back liabilities as a normal incident of operating business. The expenses for which provisions were originally made were considered operating in nature and allowed in assessment. These provisions no longer required by the taxpayer during the year under review were reversed in the books of account as per mercantile system of accounting and shown as income. Therefore on facts we do not see any justification for excluding provisions written back in the profit and loss account as not forming part of the operating profit of the taxpayer. Accordingly claim of the taxpayer is accepted.”
From the above Para of this Tribunal order, it comes out that in that case, the issue involved was regarding writing back of the provision by the assessee in the present year. The Tribunal order in this case is on this basis that certain liabilities are provided on estimate basis because exact quantification is not possible in the same year for some expenses and when in future year, the actual amount of liability is known then any excess provision made in the earlier year has to be written back and the same has to be considered as operating income for the purpose of computing ALP also. In our considered opinion, this Tribunal order is not applicable in the present case because in the present case, the issue involved is regarding provision for bad and doubtful debts and not writing back of excess provision in earlier years. There is major difference in the nature of these two items. Writing back of excess provision is on this basis that provision is made on estimate basis in a given year because exact quantification is not possible in the same year for some expenses and when exact amount of liability is determined in a future year in which actual amount is known then excess provision if any is written back and more provision is made if the provision made earlier is short. But in that year also, similar provisions are made on estimate basis in respect of liability incurred in that year and it is an ongoing process and therefore, neither the provision made can be excluded nor the excess provision written back can be excluded. But in the present case, the issue in dispute is regarding provision for bad and doubtful debts made in the present year. This is not the case of the assessee that sale were accounted for in earlier year on estimate basis and now the exact amount of sales is known and therefore, the excess amount of debts created in earlier year on estimate basis is to be reduced now to make at par with actual debt. In the present case, actual sales were accounted for in earlier years and debts were created in earlier years on the basis of actual sales and invoices and now, the provision is made when it is seen that the recovery of such debt is doubtful.
We would like to observe that the whole purpose of TP study and TP exercise is to compare the price charged by the assessee for its income or prices paid by the assessee for its expenses from or to its AE and for that purpose, we use various methods including TNMM as per which, the profits of tested party and uncontrolled comparables are compared to come to conclusion that prices are at arms length or not. If the sale is made in an earlier year and provision for doubtful debts is made in a later year and in such a later year, such provision for doubtful debts made is reduced from the profit of the tested party or of the comparables, such provision for doubtful debts cannot be considered for reduction from the profit because for the purpose of transfer pricing analysis after determining the profit of the tested party or comparable, profit percentage is worked out by dividing such profit of the tested party/comparable by its turnover. If the provision for doubtful debts is reduced from profit, the numerator is reduced but the denominator is not reduced because the turnover has been considered in earlier year and cannot be considered in the present year. Hence such provision for doubtful debts has to be ignored and added back in the profit of the tested party or of the comparable as the case may be while making the TP analysis. Hence on this issue, we find no reason to interfere in the order of AO and DRP and we hold that this Tribunal order is not applicable in the present case but we will also examine the applicability of the second tribunal order cited before us by the learned AR of the assessee.
Now we examine the applicability of the second Tribunal order on which reliance has been placed by the ld. AR of assessee i.e. Tribunal order rendered in the case of Kenexa Technologies Pvt. Ltd. vs. DCIT (supra). In this case, there is no such issue regarding provision of bad and doubtful debts. No particular para was referred to by ld. AR of assessee. When we go through this entire Tribunal order, we find that ground nos. 2 and 3 raised in this appeal is similar to the assessee’s claim. As per this ground nos. 2 and 3, the issue in dispute was regarding considering foreign exchange loss as operating loss. The Tribunal in that case followed another Tribunal order rendered in the case of Capital IQ Information Systems India (P.) Ltd. vs. DCIT (International Taxation) as reported in 57 SOT 14 (Hyd. – Trib.). In that case, the issue in dispute was regarding foreign exchange fluctuation gain and it was held that foreign exchange fluctuation income is forming part of the sales proceeds of the assessee. There cannot be any dispute on this aspect but for such issue also, it has to be seen as to whether foreign exchange fluctuation gain is on sale of the present year or of an earlier year. If such foreign exchange fluctuation gain is in respect of sale of the same year then such foreign exchange gain has to be considered for the purpose of TP analysis and computation of ALP but if such gain is in respect of sale of an earlier year then the same cannot be considered for the purpose of ALP because in that situation also, the numerator will increase i.e. the profit but not the denominator i.e. the turnover because the turnover was considered in the earlier year. In this Tribunal order, there is no discussion on this aspect of the matter and therefore, for the purpose of deciding this aspect, this Tribunal order is also not applicable and the assessee does not get any help from this Tribunal order. This ground is rejected.
Regarding ground no. 6 which is regarding the assessee’s request for exclusion of four comparables i.e. 1) Persistent Systems Ltd., 2) Larsen & Toubro Infotech Ltd., 3) Tech Mahindra Limited and 4) CG-VAK Software & Exports Limited and inclusion of 3 comparables i.e. 1) R Systems International Ltd., 2) Evoke Technologies Ltd. and 3) Spry Resources India Pvt. Ltd., the ld. AR of assessee has submitted a chart as per which this is the submission of the ld. AR of assessee that out of 7 comparables for which the assessee is requesting for exclusion, 5 comparables are to be excluded because of turnover filter. It was submitted that the assessee company’s turnover is Rs. 93.59 Crores and therefore, any comparable company having turnover in excess of Rs. 935.91 Crores or less than Rs. 9.35 Crores should be excluded because it fails the tolerance range of 10 times or 1/10th of assessee company’s turnover. At this juncture, the bench pointed out that as per judgment of Hon’ble Delhi High Court rendered in the case of Chryscapital Investment Advisors (India) (P.)Ltd. Vs. DCIT as reported in 376 ITR 183, it was held that huge profit or huge turnover, ipso facto does not lead to the exclusion of a comparable and the TPO, first, has to be satisfied that such differences do not materially affect the price or cost and secondly, an attempt is to be made for making reasonable adjustment to eliminate the material effect of such differences. The bench pointed out that in view of this finding of Hon’ble Delhi High Court, the matter should go back to the file of AO/TPO for fresh decision in the light of this judgment of Hon’ble Delhi High Court. In reply, it was submitted by ld. AR of assessee that apart from turnover filter, the assessee is also arguing about the functional comparability. The bench observed that even if it is found that a comparable company is functionally comparable then also turnover filter has to be applied as requested by the assessee and in that situation, this judgment of Hon’ble Delhi High Court has to be considered and those aspects as noted above are to be examined and decided and therefore, this will be proper if entire TP matter in respect of list of comparables is restored back to the file of AO/TPO for fresh decision. In reply, both sides agreed to this proposition put forward by the bench. Hence we set aside the order of AO/TPO/DRP on this aspect i.e. the final list of comparables and the matter is restored back to the file of AO/TPO for fresh decision with the direction that the AO/TPO should examine and decide afresh this aspect i.e. list of final comparables by deciding the functionality aspect as well as turnover filter aspect and while doing so this, judgment of Hon’ble Delhi High Court rendered in the case of Chryscapital Investment Advisors (India) (P.)Ltd. Vs. DCIT(supra) should also be considered. Needless to say, adequate opportunity of being heard to assessee should be provided. Ground no. 6 is allowed for statistical purposes.
In the result, the appeal filed by the assessee is partly allowed for statistical purposes. Order pronounced in the open court on the date mentioned on the caption page.