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Income Tax Appellate Tribunal, “C” BENCH : KOLKATA
Before: Hon’ble Shri S.S. Godara, JM & Shri M.Balaganesh, AM ]
ORDER Per M.Balaganesh, AM
This appeal by the Revenue arises out of the order of the Learned Commissioner of Income Tax(Appeals)-22, Kolkata [in short the ld CIT(A)] in Appeal No. 179&187/CIT(A)-22/KOL/14-15 dated 18.01.2016 against the order passed by the JCIT(OSD), Circle-2(1), Kolkata [ in short the ld AO] under section 143(3) of the Income Tax Act, 1961 (in short “the Act”) dated 31.03.2006 for the Assessment Year 2003-04.
At the outset, we find that there is a delay in filing of appeal by the revenue before us by two days. We have gone through the reasons adduced in the condonation petition and we are convinced of the same. Accordingly, we hereby condone the delay in filing of appeal by the revenue and admit the appeal for adjudication.
2 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 3. The only issue to be decided in this appeal is as to whether the ld CITA was justified in restricting the addition of Rs 3,71,40,235/- instead of Rs 20,56,13,879/- made by the Learned Transfer Pricing Officer (ld TPO in short) towards adjustment of Arm’s Length Price (ALP), in the facts and circumstances of the case.
The brief facts of this issue are that the assessee is engaged in the business of development of computer software. The assessee company (i/e IBM Business Consulting Service Pvt Ltd – IBM BCS in short) is a wholly owned subsidiary of IBM Global Services India Private Limited, the ultimate holding, being IBM Corporation. The company was renamed pursuant to a worldwide agreement between the consulting division of PricewaterhouseCoopers and IBM Corporation in October 2002. IBM BCS provides software and related serices to various IBM group companies. These companies are associated enterprises and are collectively referred to as IBM group. The assessee company filed its return of income for the Asst Year 2003-04 on 27.11.2003 declaring total loss of Rs 4,51,02,683/-. The return was accompanied with tax audit report in Form 3CA, 3CD, Audit report in Form 10CCAF and Form 3CEB. The case was referred to ld TPO for determination of ALP in respect of international transactions entered by the assessee company with its Associate Enterprises (AEs).
4.1. The ld TPO from the audit report in Form 3CEB observed that the assessee company had entered into several international transactions with many of its AEs across the world and the nature of transactions has been mentioned as ‘provision of software related services’ and the total value of such transactions was claimed at Rs 13,41,22,095/-. The assessee adopted Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) to benchmark its international transactions. During the year, the assessee had total operating income of Rs 80.76 crores from sale of software related services (including international transactions). Operating costs, on the other hand, amounted to Rs 83.70 crores (excluding financial expenses) resulting in 2
3 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 operating loss of Rs 2.94 crores. None appeared on behalf of the assessee before the ld TPO. Hence the ld TPO for want of details, proceeded to determine the ALP based on materials available on record. The ld TPO selected the following comparables and arrived at the mean operating profit as under:- Name of the Company Sales PBIT PBIT % Blue Star Info. 63.49 19.11 30.10 Eonour Technology 98.01 19.31 19.70 Geometric Soft 59.07 14.75 24.97 KPIT Cummins Info 72.51 9.20 12.69 Nucleus Software 60.37 7.88 13.05 Sonata Software 83.43 19.18 22.99 Subex Systems 70.01 12.42 17.74 Zensar Technologies 96.65 10.23 9.31
MEAN 18.82 The ld TPO applied the said OP margin and determined the ALP of the international transactions as under:-
Accordingly he made an adjustment to ALP at Rs 20,56,13,879/- in the order passed u/s 92CA(3) of the Act dated 21.3.2006. 3 PBIT stands for Profit before interest and tax
Before the ld CITA, the assessee submitted that there was an error in computation of adjustment of income to the international transactions as the ld TPO had erroneously attributed the entire alleged adjustment to the international transactions undertaken by the assessee with its AEs. It was submitted that the assessee had earned revenue from AEs and Non-AEs during the financial year 2002-03. The total income earned by the assesee was Rs 80,76,09,000/- out of which income from AEs was only Rs 13,41,22,095/-. The ld TPO had computed the ALP to be 18.82% on sales and 23.18% on cost. The ld TPO had concluded that the ALP as determined by him was higher than the revenue earned by the assessee from its AEs and hence the transactions thereon are not at ALP. However, while computing the adjusted value of international transactions, the ld TPO had erroneously attributed the entire adjusted revenue less the actual Non-AEs sales towards the AE segment, thereby arriving at an adjustment of Rs 20,56,13,879/- which is more than the value of the total international transactions undertaken with the AE of Rs 13,41,22,095/-, which results in absurdity. It was submitted that even for the sake of argument that the ld TPO’s margin of 22.42 is applied on the sales made to AEs, then the adjustment works out to be Rs 3,00,70,174/- which is far lesser than the adjustment undertaken by the ld TPO. Hence it was pleaded without prejudice, that the adjustment at any stretch of imagination cannot exceed Rs 3,00,70,174/-.
5.1. The assessee pleaded that the adjustment to ALP should be computed only for the sales made to AEs and not to the sales made to AEs and Non-AEs. The assessee gave the workings of adjustment to ALP to be made in the various scenarios :
5 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 “Scenario-1-Computation of adjustment based on sales Based on making an adjustment to the AE segment in the proportion of the revenue earned from the AEs during FY 2002-03 the adjustment works out to be Rs. 27,546,998. The working for the same is as under:
It is pertinent to note from the above that the adjustment value by both the methods of computation turnout to be the same (i.e. Rs. 27,546,998/-). Accordingly, we request 5 5.2. It was argued that even if the 5% adjustment were not to be given in both the situations above, then the adjustment could not have exceeded Rs 3,60,55,939/- above.
5.3. It was further brought to the notice of the ld CITA that the assessee company had debited certain expenses amounting to Rs 1,54,77,792/- which are extraordinary in nature and hence the same are to be excluded while computing the operating margins. It was stated that this expenditure even though debited in the profit and loss account, has been added back voluntarily in the return of income and the same has been accepted by the ld AO in the assessment framed on 31.3.2006. As they are abnormal expenditure, the same need to be excluded while computing the operating margins as the comparable companies may not have such abnormalities. The assessee also placed reliance in this regard on the special bench decision of Chandigarh Tribunal in the case of DCIT vs Quark Systems Private Ltd which has been later upheld by the Hon’ble Punjab & Haryana High Court reported in 200 Taxman 92 which emphasized the principle of substantial justice and pronounced that the assessee should not be estopped from pointing out a bonafide mistake in the assessment even though the mistake arose as a result of evidence adduced by the assessee. Based on the same, the rectified margin computation workings were provided before the ld CITA by the assessee.
5.4. The assessee further pleaded before the ld CITA that in its Transfer Pricing (TP) Study, it had claimed comparability adjustment in respect of employee cost. An employee cost adjustment should be granted to the assessee as the employee cost of the assessee had almost increased by 300% during the year from Rs 20,55,87,000/- to Rs 53,63,29,000/- while the revenue had remained fairly consistent. The assessee had increased employee strength during the year in anticipation of getting more business. However, due to unforeseeable market conditions, the assessee could not generate the 6
7 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 expected level of business and eventually the company also ended up selling its business by way of a slump sale on 31.12.2002. Further, the relative employee cost to sales of the assessee was 65.23% and that of the comparable companies as per the comparable companies of the TP study was 30.98% and that of the TPO’s comparable companies was 43.95%.
5.5. The revised margin after giving effect to the employee cost adjustment based on the average employee cost to total cost ratio of the comparable companies selected in the TP Study was 45.25% . The workings for the same were enclosed. Such adjustment partakes the character of utilization adjustment, especially because the assessee is working with excess employee cost. The assessee works on time and material model and the employee cost are in the nature of exceptional non-operating expenses. Further the revised margin after giving effect to the employee cost adjustment based on the average employee cost to total cost ratio of the comparable companies selected in the TP Order was 21.88%.
5.6. It was pointed out, that the ld TPO had not considered the comparability adjustment for the employee cost and computed the ALP based on actual numbers. The assessee gave the revised workings as under:-
8 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 6. The ld CITA in principle agreed to the arguments of the assessee that the adjustment made by the ALP by the ld TPO at Rs 20,56,13,879/- is much more than the total value of international transactions with the AEs itself at Rs 13,41,22,895/-, there by resulting in absurdity. It also leads to absurd results of earning 144% of operating margin which is not earned by any of the comparable companies in the industry. He observed that the entire exercise of conducting a transfer pricing analysis is to compute ALP of an international transaction alone. Section 92(1) of the Act prescribes that any income arising from an international transaction shall be computed having regard to the ALP. Therefore the objective of computing the ALP is to determine the income arising from an international transaction and accordingly, the adjustment that is required to be made is to be limited to the international transactions with the AEs only and not to the entity / segmental level transactions. This was held by the Co-ordinate Bench decision of Pune Tribunal in the case of Sandvik Asia (P) Ltd and by the decision of Hon’ble Bombay High Court in the case of Tara Jewels Exports Private Limited in ITA No. 1814 of 2013 dated 5.10.2015.
6.1. The ld CITA observed that assessee had worked out the adjustment value of sale of services to AEs by computing the adjustment based on sales and also on cost. In both the scenarios, the assessee had arrived at the adjustment value for sale of services to AEs at Rs 2,75,46,998/-. He observed that the assessee has however, while calculating the adjusted value, had taken the operating profit at 22.42% whereas the AO had taken the Arm’s Length Operating Profit / Cost ratio at 23.2%, which should be adopted. Accordingly, the ld CITA reworked the adjustment to ALP figure at Rs 3,71,40,235/- . With regard to exclusion of employee cost in the sum of Rs 1,54,77,792/- from the total operating costs , being extraordinary in nature, the ld CITA observed that the said argument cannot be accepted for the simple reason that the assessee had taken business decision to increase its employees strength in anticipation of generating increased business and once the assessee could not achieve its objective, it cannot isolate one 8
9 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 expense and call it extraordinary. Finally, the ld CITA deleted the total addition of Rs 16,84,73,644/- and sustained the adjustment to ALP in respect of sales to AEs at Rs 3,71,40,235/-. Aggrieved, the revenue is in appeal before us.
We have heard the rival submissions and perused the materials available on record. The facts stated hereinabove before the ld AO and ld CITA remain undisputed by both the parties and hence the same are not reiterated for the sake of brevity. The short point that arises for our consideration is as to whether for the purpose of computing the ALP of an international transaction, the entire transactions of both AEs and Non AEs are to be considered or not. We find that the issue under consideration is squarely answered by the Hon’ble Bombay High Court in the case of CIT vs Tara Jewels Exports Private Limited in of 2013 dated 5.10.2015, wherein the question raised before the Hon’ble High Court is as under:- “Whether in law and on the facts of the instant case, was the Tribunal justified in holding that while computing the ALP of international transactions the AO/TPO is precluded from taking into consideration transactions with Non Associate Enterprises, while arriving at the ALP using the Net Transactional Margin Method (TNMM) ; whereas Rule 10B(1)(e) mandates the consideration of profit margins with unrelated enterprises? ”
It was observed in the said order by the Hon’ble High Court as under:- “5. On appeal, the Tribunal by the impugned order recorded the fact that the only grievance of the respondent-assessee before it was the application of the margin of 4.79% computed by the TPO under the TMM across all it's sales and not restricted only to the international transactions entered into by it with it's AE. The Tribunal by the impugned order held that the entire exercise of determining the ALP is done in accordance with Chapter X of the Act and in particular to Section 92A and 92B of the Act require the transfer pricing adjustment to be done only in respect of the transaction entered into between the respondent-assessee with it's AEs and not with the non-AEs. In the above circumstances, the Tribunal set aside the order of the Assessing Officer/TPO and directed the Assessing Officer to compute the ALP by enhancing the consideration by 4.79% only in respect of the international transactions entered into between the respondent-assessee with it's AEs only.
The question as proposed by the revenue does not seems to arise from the impugned order of the Tribunal nor is the method of determination of ALP on application of TNMM arriving at the margin of 4.79% is disputed before Tribunal or before us. We 9 10 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 are unable to understand the grievance of the revenue as formulated in the proposed question. The respondent-assessee has not challenged the application of TNMM and arriving at the margin of 4.79% arrived at by the TPO to determine ALP. The grievance of the respondent-assessee before the Tribunal is only with the margin of 4.79% being applied in respect of all it's sales and not restricted to the international transactions entered into by the respondent- assessee with it's AEs. It is evident from the provisions of Chapter X of the Act that the adjustment which has to be done to arrive at ALP is only in respect of the transaction with it's AEs. Thus no fault can be found with the order of the Tribunal.
7. Mr. Pinto is unable to point out how the aforesaid finding of the Tribunal is incorrect in law in the face of the clear provisions in Chapter X of the Act. The question as framed by the revenue to our mind do not arise from the impugned order of the Tribunal as the issue raised in the proposed question is not disputed. Accordingly, we see no reason to entertain the proposed reframed question of law as it does not give rise to any substantial question of law”.
7.1. Similar view was taken by the Hon’ble Delhi High Court in the case of CIT vs Keihin Panalfa Ltd in of 2015 dated 9.9.2015 . Similar views were expressed by yet another decision of Hon’ble Bombay High Court in the case of Cit vs Alstom Projects India Limited in ITA No. 362 of 2014 dated 14.9.2016 wherein it was held as under:- “12. We are in respectful agreement with the view of the Delhi High Court in Keihin Panalfa Ltd. (supra). One must not loose sight of the fact that the transfer pricing adjustment is done under Chapter X of the Act. The mandate therein is only to redetermine the consideration received or given to arrive at income arising from for International Transactions with Associated Enterprises. This is particularly so as in respect of transaction with non Associated Enterprises, Chapter X of the Act is not triggered to make adjustment to considerations received or paid unless they are Specified Domestic Transactions. The transaction with non-Associated Enterprises are presumed to be at arms length as there is no relationship which is likely to influence the price. If the contention of the Revenue is accepted, it would lead to artificial increase in the profits of transactions entered into with non Associated Enterprises by applying the margin at entity level which is not the object of Chapter X of the Act. Absence of segmental accounting is not an insurmountable issue, as proportionate basis could be adopted as done by the Delhi High Court in Keihin Panalfa Ltd. (Supra).
In the above view, no substantial question of law arises. Therefore, we do not entertain the present appeal.
Accordingly, the appeal is dismissed. No order as to costs.”
11 M/s IBM Business Consulting Service Pvt. Ltd. A.Yr. 2003-04 7.2. We find that the veracity of the calculation of adjustment to ALP at Rs 3,71,40,235/- is not in dispute before us. Respectfully following the aforesaid judicial precedents on the impugned issue before us, we hold that the ld CITA had rightly held that the adjustment should be computed only for the sales made to AEs and not to the sales made to AEs and Non AEs. Accordingly, the grounds raised by the revenue are dismissed.
In the result, the appeal of the revenue is dismissed.
Order pronounced in the Court on 01.08.2018