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Income Tax Appellate Tribunal, DELHI BENCH ‘I-2’ : NEW DELHI
Before: SHRI R.K. PANDA & SHRI KULDIP SINGH
(PAN : AAJCS9528D) (APPELLANT) (RESPONDENT) ASSESSEE BY : Shri Ravi Sharma, Advocate Ms. Shruti Khimta, Advocate Shri Ravi G. Gupta, Advocate REVENUE BY : Shri H.K. Choudhary, CIT DR Date of Hearing : 13.09.2017 Date of Order : 13.10.2017 O R D E R
PER KULDIP SINGH, JUDICIAL MEMBER :
The Appellant, M/s. Stryker Global Technology Center Pvt. Ltd. (hereinafter referred to as ‘the taxpayer’) by filing the present appeal sought to set aside the impugned order dated 16.10.2014, passed by the AO in consonance with the directions issued 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 :-
“1. The Learned Dispute Resolution Panel ('Ld. DRP') and the Ld. Deputy Commissioner of Income- tax ('Ld. AO') (following the directions of the Ld. DRP) have erred on facts and in law in enhancing the income of the Appellant by INR 1,00,97,208 under section 143(3) of the Income-tax Act 1961 ('Act') and INR 5,99,003 under section 115JB of the Act.
2. The Ld. DRP and Ld. AO have erred on facts and in law in enhancing the income of the Appellant by INR 1,00,97,208 by holding that the Appellant's international transactions pertaining to provision of contract software development services and Information Technology ("IT") enabled back office support services does not satisfy the arm's length principle envisaged under the Act and in doing so have grossly erred in:
2.1 disregarding the ALP as determined by the Appellant in the Transfer Pricing ("TP") documentation maintained by it in terms of section 92D of the Act read with Rule 100 of the Income-tax Rules, 1962 (‘Rules') as well as fresh search;
2.2 disregarding multiple year and prior years' data as used by the Appellant in its TP documentation and holding that current year (i.e. FY 2009-10) data for comparable companies should be used despite the fact that the same was not necessarily available to the Appellant at the time of preparing its TP documentation;
2.3 rejecting the economic and comparability analysis undertaken by the Appellant in its TP documentation/ fresh search entailing a detailed and robust search methodology, while proceeding to apply certain erroneous additional! modified filters in determining the ALP such as rejecting comparable companies based on sales less than INR 5 Crores, while disregarding the fact that the Appellant itself had earned a revenue of less than INR 5 Crores in the IT enabled back office support service segment;
2.4 erroneously including certain functionally dissimilar companies that are full-fledged risk taking entrepreneurs and high-profit making companies for benchmarking a low risk captive service provider like the Appellant and excluding certain comparable companies on arbitrary/ frivolous grounds;
2.5 not considering the correct computation of operating profit margins of certain companies used as comparable in the IT enabled back office support services segment of the Appellant;
2.6 disregarding judicial pronouncements in India in undertaking the TP adjustment.
3. The Ld. DRP/ Ld. AO erred in ignoring the fact that the Appellant is entitled to tax holiday under section 10A of the Act on its profits and therefore would not have any untoward motive of deriving a tax advantage by manipulating transfer prices of its international transactions;
4. The Ld. DRP and Ld. AO have erred on facts and in law in adding back the amount of rent equalisation reserve of INR 5,99,003 to the book profits of the Appellant, declared under section 115JB of the Act, and in doing so has grossly erred in:
4.1 proposing that the amount of rent equalisation reserve charged to profit and loss account is covered under clause (b) or (c) of Explanation 1 to Section 115JB of the Act, and thus needed to be added in Book profits.
5. The Ld. AO erred in initiating penalty proceedings under section 271(l)(C) of the Act.
6. The Ld. AO erred in charging interest under section 234D of the Act.”
Briefly stated the facts necessary for adjudication of the controversy at hand are : Stryker Technology started its business from October 1, 2006 as a global technology centre for the Stryker Group in India. The taxpayer operates as a technology support centre for the group and provides Computer Aided Designing (CAD) / engineering, contract software development, and IT Enabled back office support services to the Stryker Group.
According to TP report, Stryker Technology has been characterized as a routine CAD / engineering contract software development and IT enabled back office support services provider and stated to use all the valuable intellectual property rights (know-how, copyrights etc.) and other commercial or marketing intangibles (brand names, trademarks etc.) owned by the Group.
During the year under assessment, the taxpayer entered into international transactions with its Associated Enterprises (AE) as under :-
S.No. Type of International Method selected Total value of transaction transaction (Rs.) i. Purchase of fixed assets TNMM OP/OC 904,667 ii. Provision of CAD / TNMM OP/OC 150,956,456 Engineering services iii. Provision of contract TNMM OP/OC 158,083,256 software development services iv. Provision of IT enabled TNMM OP/OC 38,037,799 back office services v. Cost recharge from group TNMM OP/OC 58,521,893 companies vi. Cost recharge to group CUP NA 28,298,733 companies
Assessee in its TP study has computed its margin at 17.03% as tested party and after selecting 16 comparables and by taking OP/TC computed the mean margin at 13.18% and found its international transactions qua software maintenance services of Rs.15,80,83,256/- at arms length.
Assessee in its TP study benchmarked its international transactions pertaining to IT Enabled Services (ITES) by adopting TNMM as the most appropriate method with OP/TC as PLI having tested party margin at 21.47% as against average OP/TC margin of 14.27% of 15 comparables chosen by the assessee. However, on the basis of show-cause notice and filters proposed to be used by TPO, the taxpayer given fresh search conducted during TP proceedings and selected 11 comparables having OP/TC as PLI at 7.69% for software development and maintenance services transactions. Similarly, the taxpayer has given fresh search conducted during TP proceedings for ITES on the basis of show- cause notice and filters adopted to be applied and computed the OP/TC margin of 10 comparables at 15.83%.
6. TPO then chosen 15 comparables having OP/OC at 27.64% and worked capital adjustment of OP/OC at 25.95% relating to software development services and proposed the adjustment of Arms Length Price (ALP) of international transaction at Rs.1,20,55,936/-.
7. TPO finally chosen 9 comparables having OP/OC at 32.72% and working capital adjustment OP/OC at 32.72% and working capital adjustment OP/OC at 32.62% and thereby proposed an adjustment of Rs.34,90,402/- relating to ITES. TPO accordingly proposed the total adjustment of Rs.1,55,46,338/- to the income of the assessee.
8. AO added an amount of Rs.5,99,003/- to the book profit of the assessee debited by the taxpayer towards rent acquisition reserve by applying Explanation 1 to section 115JB of the Act.
Pursuant to the directions issued by ld. DRP, AO passed assessment order by assessing total income of the assessee at Rs.1,00,97,208/-.
9. The taxpayer carried the matter by way of filing objections before the ld. DRP who has dismissed the same. 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.
GROUND NO.1
7. Ground No.1 is general in nature, hence does not require any adjudication.
GROUND NOS.2, 2.1, 2.2, 2.3, 2.4, 2.5 & 2.6
8. Transactional Net Margin Method (TNMM) used by the assessee for benchmarking its international transaction as most appropriate method has been accepted by the TPO/DRP. TPO/ DRP have also provided working capital adjustment to the assessee for benchmarking its international transactions.
9. TPO has finally selected 15 comparables for benchmarking its international transactions qua software development services, which are to the following effect :-
No. Name of the Company OP/OC Working (%) Capital adjusted OP/OC i. Akshay Software Tech Ltd. -1.04 -0.53 ii. E-Infochips Bangalore Ltd. 72.69 66.03 iii. Evoke Technologies Ltd. 19.02 19.56 iv. E-Zest Solutions Ltd. 18.66 14.71 v. Infinite Data Systems Pvt. Ltd. 88.25 84.63 (merged) vi. Infosys Ltd. 45.08 46.29 vii. Larsen & Toubro Infotech Ltd. 20.48 20.87 viii. LGS Global Ltd. 12.79 8.35 ix. Mindtree Ltd. 16.62 15.39 x. Persistent Systems & Solutions Ltd. 15.38 12.74 (merged) xi. R S Software India Ltd. 10.29 11.07 xii. Sasken Communication Technologies 17.54 18.75 Ltd. xiii. Tata Elexi Ld. 19.82 17.93 xiv. Thinksoft Global Services Ltd. 17.35 14.51 xv. Thirdware Solutions Ltd. 41.63 38.94 Average 27.64 25.95
10. On the basis of mean margin of 27.60% of comparable companies after giving working capital adjustment of OP/OC at 25.95%, TPO computed the arms length price of international transaction relating to software development services as under :-
Particulars Amount INR Operating Cost (Adjusted as discussed supra) 135,084,710 Arm’s Length Margin (%) 25.95% Arm’s Length Margin (Rs.) 35,054,482 Arm’s Length Price 170,139,192 Price charged by the assessee 158,083,256 105% of price charged in international 165,987,419 transaction Difference for which adjustment is proposed 12,055,936 to be made
11. Similarly, TPO has finally selected 9 comparables for benchmarking the international transactions qua ITES, which are as under :-
S.No. Company Name OP/OC WCA (%) OP/OC (%) i. Accentia Technologies Ltd. 43.07 39.86 ii. Cosmtic Global Ltd. 18.28 19.95 iii. e4e Healthcare 31.03 31.21 iv. I-gate Global Ltd. 24.54 23.75 v. Infosys BPO Ltd. 31.46 29.83 vi. Jindal Intellicom Ltd. 13.62 14.61 vii. Omega Healthcare 15.31 14.40 viii. TCS E-Serve International Ltd. 53.80 55.09 ix. TCS E-Serve Ltd. 63.38 64.93 Average 32.72 32.62
12. On the basis of average OP/OC of 32.72% and working capital adjustment of OP/OC at 32.62% of the comparable companies, the ld. TPO computed the arms length price of international transaction relating to ITES as under :-
Particulars Amount INR Operating Cost 31313679 Arm’s Length Margin (%) 32.62% Arm’s Length Margin (Rs.) 10214522 Arm’s Length Price 41528201 Price charged by the assessee 38037799 105% of price charged in international 39939689 transaction Difference between ALP and price charge by 3,490,402 assessee % of difference with ALP 9.18%
Ld. AR for the assessee in order to cut short the controversy sought to exclude two comparables viz. E-Infochips Bangalore Ltd. and Infinite Data Systems Pvt. Ltd. (merged) for benchmarking international transactions relating to software development and maintenance services and TCS E-Serve Company for benchmarking international transactions relating to ITES. So, we will examine all the three comparable companies finally selected by TPO for benchmarking the international transactions one by one.
COMPARABLE FOR BENCHMARKING INTERNATIONAL TRANSCTIONS QUA SOFTWARE DEVELOPMENT SERVICES E-INFOCHIPS BANGALORE LTD. (E-INFOCHIPS)
The taxpayer sought to exclude E-Infochips from the final list of comparables on the grounds inter alia that it is functionally dissimilar; it is engaged in product and semiconductor 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; it is a Member of Indian Electronics and Semiconductor Association (IESA). Ld. TPO as well as DRP have dismissed the objections raised by the assessee by recording the findings that this comparable company is functionally comparable; engaged in maintenance and development of software and its income from software services is Rs.7,43,04,66,481/- and thus retained this company as a comparable.
Appraisal of the annual report, available at pages 1 to 85 of the paper book and Schedule VII, available at pages 1 to 41 make it clear that E-Infochips had income from software services to the tune of Rs.37,13,88,107/-. From Schedule XI, available at pages 42 to 46 of the paper book, it is clear from para 9 of Schedule XI “that E-Infochips is engaged in development and maintenance of computer software , the production and sales of software cannot be expressed in any generic unit, hence, it is not possible to give quantitative details of sale and certain other information as required under Paragraph 3, 4C and 4D of Part II of Schedule VI to the Companies Act, 1956”.
However, the ld. DR drew our attention to para 16 of Schedule XI of the Annual Report wherein it is mentioned that the company is primarily engaged in software development and ITES which is considered the only reportable business segment as per Accounting Standard – AS 17 “Segment Reporting” issued by mandatory Accounting Standards prescribed in Companies (Accounting Standards) Rules, 2006 and relevant provisions of Companies Act, 1956.
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.
Suitability of E-Infochips has been examined by coordinate Bench of the Tribunal vis-à-vis Sun Life India Service Centre (P.)
Ltd. vs. DCIT – (2016) 71 taxmann.com 189 (Delhi – Trib.). E- Infochips has been ordered to be excluded as a comparable with Sun Life India Service Centre (P.) Ltd. which is a routine service provider like the taxpayer on the grounds inter alia that E-Infochips engaged in both software development as well as ITES and its segmental information is not available. Moreover, E-Infochips is having volatile margin trend for a period of five years which is detailed as under :-
OP/TC Company Name Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 E-Infochips 91.83% 38.48% 97.29% 72.69% 27.31%
Moreover, E-Infochips is a product and semiconductor engineering services company and has designed 500 products for key verticals like aerospace, defence, semiconductor, security and surveillance, etc., thus functionally incomparable. So, we are of the considered view that E-Infochips is not a suitable comparable vis-à-vis assessee company, hence ordered to be excluded.
INFINITE DATA SYSTEMS PRIVATE LIMITED (INFINITE) 20. Assessee sought to exclude Infinite from the final list of comparables for benchmarking international transactions on the grounds inter alia that it is functionally dissimilar; primarily it derives revenue from technical support and infrastructure management services; that it is having abnormally high margin and having exceptional growth in business operation over the last four years i.e. 908% in sales over previous year.
However, TPO/DRP have retained Infinite as comparable by holding that this company provides IT services, application services, IT infrastructure services, project engineering solutions and mobility & messaging solutions & platforms.
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 (Crores) 43.31 52.75 38.31 4.74 % Growth in Sales 182% 238% 908% - OP/TC 124.40% 153.97% 88.25% 31.48%
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.
COMPARABLE FOR BENCHMARKING INTERNATIONAL TRANSACTIONS QUA ITES SEGMENT TCS E-SERVE INTERNATIONAL LTD. (TCS E-SERVE) 25. Assessee sought to exclude TCS E-Serve from the final list of comparables for benchmarking international transactions qua ITES on the ground that it is functionally dissimilar – BPO services along with technical services. However, TPO/DRP have retained TCS E-Serve as a comparable by merely recording the findings that the company is functionally comparable to the assessee and it satisfies all the filters.
Ld. AR for the assessee in order to point out functional dissimilarity of TCS E-Serve vis-à-vis assessee drew our attention towards page 927 of Paper book (Annual Report Compendium II) wherein it is categorically mentioned that TCS E-Serve is engaged in business of providing Information Technology – Enabled Services (ITES) / Business Processing Outsourcing (BPO) services primarily to Citi Group entities globally. It is further mentioned in the Notes to Account that company’s operations broadly comprise of transaction processing and technical services which includes broad spectrum of activities involving the processing, collections, customer care and payments in relation to the services offered by Citi Group to is corporate and retail client. Technical services involve software testing, verification and validation of software at the time of implementation and data centre management activities.
So, the functions being performed by TCS E-Serve are diametrically dissimilar to the assessee company.
Furthermore segmental information of TCS E-Serve is not available to bifurcate ITES and CSD Services as is evident from page 916 of the Annual Report Compendium II, which is profit and loss account, because income from transaction processing and other services is jointly given. Furthermore because of acquisition by TCS E-Serve from Citi Group effective from January 2009, the brand value of TCS E-Serve has impacted the profitability and revenue of business. Moreover, TCS E-Serve is having volatile profit margin as is evident from the table reproduced below :-
Company Name FY 2007-08 FY 2008-09 FY 2009-10 TCS E serve -100% -27.50% 51.51%
Furthermore TCS E-Serve is having super-normal growth of 173% in revenue and is an industry giant as against the assessee which is a captive service provider rendering back-end support services to its AE.
So, in view of what has been discussed above, we are of the considered view that TCS E-Serve is not a suitable comparable vis- à-vis assessee for benchmarking international transaction qua ITES. Hence, we ordered to exclude the same.
GROUND NO.3 30. Ground No.3 is general in nature and does not require any adjudication.
GROUND NOS.4 & 4.1 31. Ld. DRP / AO by invoking Clause B & C of Explanation 1 to section 115JB of the Act added the amount of Rs.5,99,003/- on account of rent acquisition reserve charged to profit & loss account and added the same in book profits. The ld. AR for the assessee fairly conceded that this issue has been decided against the assessee in its own case for AY 2008-09 in vide order dated 24.01.2017. Ld. DR also relied upon the aforesaid order passed by the Tribunal.
Undisputedly, the issue in controversy has come up before the coordinate Bench of the Tribunal in assessee’s own case for AY 2008-09 (supra) by way of raising following round :-
“9. The Ld. AO has grossly erred in adding back the amount of Rent equalization reserve of Rs.18,45,875/- to the book profits of the Appellant, declared under section 115JB of the Act, erroneously proposing that the amount of rent equalization reserve charged to profit and loss account is covered under clause (b) or (c) of Explanation 1 to section 115JB of the Act, and thus needs to be added in Book profits.”
It is also not in dispute that the assessee has claimed rent acquisition reserve of Rs.5,99,003/- in accordance with the lease deed dated 06.09.2006 entered into between M/s. Vatika Landbase Pvt. Ltd. and the assessee. The coordinate Bench of the Tribunal has determined the issue against the assessee by returning the following findings :-
10. We have considered the rival submissions and have perused the record of the case. The scope of AS 19 does not extend, inter-alia, to lease agreements to use lands. Para 2 of scope reads as under :- “2. This Standard applies to agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. On the other hand, this Standard does not apply to agreements that are contracts for services that do not transfer the right to use assets from one contracting party to the other.
The classification of leases for the purposes of AS 19 are as under :- “Classification of Leases 5. The classification of leases adopted in this Standard is based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic
conditions. Rewards may be represented by the expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realisation of residual value.
6. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. Title may or may not eventually be transferred. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incident to ownership.
Since the transaction between a lessor and a lessee is based on a lease agreement common to both parties, it is appropriate to use consistent definitions. The application of these definitions to the differing circumstances of the two parties may sometimes result in the same lease being classified differently by the lessor and the lessee.
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than its form. Examples of situations which would normally lead to a lease being classified as a finance lease are: (a) the lease transfers ownership of the asset to the lessee by the end of the lease term;
(b) the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised;
(c) the lease term is for the major part of the economic life of the asset even if title is not transferred;
(d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and (e) the leased asset is of a specialised nature such that only the lessee can use it without major modifications being made.
Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are:
(a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;
(b) gains or losses from the fluctuation in the fair value of the residual fall to the lessee (for example in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and (c) the lessee can continue the lease for a secondary period at a rent which is substantially lower than market rent.
Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree to change the provisions of the lease, other than by renewing the lease, in a manner that would have resulted in a different classification of the lease under the criteria in paragraphs 5 to 9 had the changed terms been in effect at the inception of the lease, the revised agreement is considered as a new agreement over its revised term. Changes in estimates (for example, changes in estimates of the economic life or of the residual value of the leased asset) or changes in circumstances (for example, default by the lessee), however, do not give rise to a new classification of a lease for accounting purposes.”
Now, if, we examine various definitions contained in paragraph 3, we find that the same deals primarily with defining of finance lease, operating lease, non-cancellable lease, lease term, fair value of asset, economic life, useful life, residual value, guaranteed residual value of lease assets. It clearly shows that the main object of the AS 19 is to deal with the leases concerning movable assets and it specifically excludes lease agreements to use lands. We find considerable force in the submissions of ld. CIT-DR that AS 19 is not applicable to lease of immovable property. Therefore, the Assessing Officer rightly added back the rent equalization reserve debited to Profit & Loss Account while computing the book profit for the purposes of section 115JB of the Act. Moreover, the assessee itself has added back this reserve for the purposes of computation of total income under the normal provisions of the Act. Therefore, in any view of the matter, the stand of the assessee is contradictory. Accordingly, this ground is dismissed.”
So, in view of what has been discussed above, AO has rightly added back the rent acquisition reserve debited to profit & loss account while computing the book profit for the purpose of section 115JB of the Act. So, we hereby determine grounds no.4 & 4.1 against the assessee.
GROUND NO.5 35. Ground No.5 is premature.
GROUND NO.6 36. Ground No.6 is consequential.
Resultantly, the appeal filed by the assessee is partly allowed for statistical purpose. Order pronounced in open court on this 13th day of October, 2017.