Loading judgment…
No AI summary yet for this case.
Income Tax Appellate Tribunal, BANGALORE BENCH ‘ B ’
Before: SHRI VIJAY PAL RAO & SHRI INTURI RAMA RAO
Per Shri Vijay Pal Rao, J.M. :
These cross appeals are directed against the order dt.02.07.2012 of
Commissioner of Income Tax (Appeals) for the Assessment Year 2005-06.
The assessee has raised the following grounds :
2 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
GROUNDS RELATING TO LEGAL ISSUES
The Order of the learned Commissioner of Income Tax (Appeals) - IV to the extent prejudicial to the appellant is bad in law.
The learned Assessing Officer has erred in making a reference to Transfer Pricing Officer for determining arm's length price without appreciating that under section 92CA(I), a reference could be made to the Transfer Pricing Officer only in circumstances where the assessing officer considers it necessary or expedient so to do and also without specifying the relevant clause under section 92C(3) which necessitated the reference. The learned Commissioner of Income Tax (Appeals) - IV has erred in confirming the action of the Assessing officer.
The learned Assessing Officer, learned Transfer Pricing Officer and Commissioner of lncome Tax (Appeals) - IV have erred in, a. passing the order without demonstrating that appellant had motive of shifting profits outside India by manipulating prices charged in its international transactions; and b. not appreciating that the charging or computation provision relating to income under the head "Profits & Gains of Business or Profession" do not refer to or include the amounts computed under Chapter X and therefore the addition made under Chapter X is bad in law.
GROUNDS ON COMPARABLES AND REJECTION OF TP ANALYSIS OF THE APPELLANT 4. The learned Assessing Officer and learned Transfer Pricing Officer have erred in
3 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited a. rejecting the transfer pricing analysis undertaken by the appellant without specifying the relevant clause under section 92C(3) which necessitated such rejection; and b. rejecting the comparables selected by the appellant on unjustifiable grounds.
GROUNDS RELATING TO TP ANALYSIS OF THE TPO: 5. The learned Assessing Officer and learned Transfer Pricing Officer have erred in: a. performing fresh transfer pricing analysis and adopting inappropriate filters in doing fresh transfer pricing analysis; and, b. adopting companies as comparables even though they are not comparable to the appellant.
GROUNDS RELATING TO DETERMINATION OF ARM'S LENGTH PRICE BY THE CIT (A)-IV:
i. Selection of TP Analysis 6. The learned Commissioner of lncome Tax (Appeals) - IV has erred in a. rejecting the TP Analysis of both the appellant and TPO on unjustifiable grounds and without giving an opportunity of being heard to the appellant; b. rejecting TNMM method adopted by the appellant and confirmed by the TPO as the most appropriate method; and, c. doing separate analysis of commission paid to AE and onsite services rendered by AE by unilaterally adopting CUP Method and CPM as the most appropriate method respectively without giving an opportunity of being heard to the appellant.
4 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
ii. TP Analysis of Selling Commission paid to AE 7. The learned Commissioner of Income Tax (Appeals) - IV has erred in: a. adopting CUP as the most appropriate method for evaluating the selling commission paid to AE without justifying how the same was most appropriate method; b. concluding that arm's length price of selling commission is NIL without bringing on record any comparable; c. concluding that arm's length price of selling commission is NIL without appreciating that the services had been actually rendered by the associated enterprises and the evidences supporting the same are on record; d. concluding that the AE has a mark up of 27% on cost without appreciating the underlying facts and reality. e. oncluding that the appellant has not produced any evidence to justify commission paid without appreciating that the basis of computation of commission is explained in the TP Report and also explained and submitted the workings during the appellate proceeding.
iii. TP Analysis of Onsite Services Rendered by AE 8. The learned Commissioner of Income Tax (Appeals) - IV has erred in a. adopting CPM as the most appropriate method for evaluating the software development services received by the appellant without justifying how the same was most appropriate method; b. adopting inappropriate methodology and process in arriving at the arm's length price;
5 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited c. selecting Indian companies having onsite revenues as comparable after selecting AE(a company based in USA) as the tested party. Without prejudice, CIT(A) has erred in rejecting similarly placed Indian companies as comparable on unjustifiable reason; d. not appreciating that appellant has onsite revenue of more than 75% of total revenue and ought to be compared with other Indian companies having more than 75% on site revenues. On such a comparison, the appellant's international transaction relating to receipt of services from AE are at arm's length; and, e. adopting net margin of the comparable in computing the arm's length price without appreciating that under CPM gross margin are to be considered.
GROUNDS ON ADJUSTMENT FOR DIFFERENCES 9. The learned Assessing Officer, learned Transfer Pricing Officer and Commissioner of Income Tax (Appeals) - IV have erred in not making proper adjustment for enterprise level and transactional level differences between the appellant and the comparable companies.
GROUND RELATING TO RESTRICTING TP ADJUSTMENT TO AE TRANSACTIONS 10. Without prejudice to all the above, the learned Assessing Officer and learned Transfer Pricing Officer have erred in not restricting the TP adjustment to AE transactions only and thereby making an adjustment in respect of transactions with non-associated enterprise also.
GROUND ON BENEFIT OF 5% RANGE 11. Assuming without admitting that the adjustment is to be made, the learned Assessing Officer, learned Transfer Pricing Officer and Commissioner of Income Tax (Appeals) -
6 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited IV have erred in not allowing the benefit of the +/-5% range mentioned in the proviso to section 92C(2).
REDUCTION IN DEDUCTION UNDER SECTION 10B OF THE ACT IN RESPECT OF EXPENDITURE INCURRED IN FOREIGN CURRENCY 12. In the facts and in the circumstances ofthe case, the learned CIT(A) has erred in reducing the foreign currency expenses from both the export turnover and the total turnover of units while computing the deduction under section 10B of the Act, without considering the applicant's submission that it is engaged in the business of software development and not in rendering technical services.
REDUCTION IN DEDUCTION UNDER SECTION lOB OF THE ACT IN RESPECT OF ON-SITE SOFTFWARE DEVELOPMENT WORK PERFORMED BY THE ASSOCIATED ENTERPRISES ("AE'S") OF THE APPELLANT OUTSIDE INDIA 13. The learned CIT(A) has erred in disallowing the deduction under sections 10B of the Act in respect 0f on-site software development work being sub-contracted to and performed by the Associated Enterprises CAE') overseas without appreciating the fact that: i. The entire risk & rewards and functions & responsibilities of executing the work lies with the Appellant; and, ii. The entire on-site software development work was performed under the control and supervision of the Appellant.
The learned CIT(A) has erred in reducing the interest income and profit on sale of assets from the profits of the business while computing the deduction under section l0B of the Act with respect to Unit - 6 of the Company without considering the provisions of section I0B(4) of the Act.
7 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
Without prejudice to the above, on the facts and in the circumstances of the case, the learned CIT(A) has erred in: i. computing the disallowance in respect of on-site software development work based on the ratio of software development charges paid to AEs to the total software development expenses; ii. not considering the submissions of the Appellant with respect to the ratio to be adopted for computing the disallowance, i.e. the ratio of software development charges paid to AEs to the total expenses incurred by the unit for developing the software; iii. not appreciating the fact that the aforesaid ratio has been accepted by the assessing officer during the assessment proceedings for AY 2008-09; and, iv. The CIT(A) has erred in reducing the deduction under section l0B of the Act by an amount of Rs. 69,853,035.
DISALLOWANCE UNDER SECTION 40(A)(l) IN RESPECT OF COMMISSION PAYMENTS
Without prejudice to ground no. I, the learned CIT(A) erred in holding that the services rendered by Mphasis Corporation outside India are in the nature of managerial services and commission paid to MphasiS Corporation in consideration of such services is chargeable to tax in India under section 9(i)(vii) of the Act and under Article 12 of the India-US treaty.
The learned CIT(A) erred in disallowing the commission payment to MphasiS Corporation under section 40( a)(i) of the Act in the absence of tax deducted at source without considering the Circular issued by the Central Board of Direct Taxes.
8 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
INTEREST UNDER SECTION 234B OF THE ACT The learned CIT(A) has erred in confirming the levy of interest under section 234B of the Act amounting to Rs. 59,554,625.
INTEREST UNDER SECTION 234C OF THE ACT The learned CIT(A) has erred in confirming the levy of interest under section 234C of the Act amounting to Rs. 50,564.
PENALTY UNDER SECTION 27 I(J)(C) The learned CIT(A) has erred in directing the AO to re-compute the penalty in view of the enhanced total income of the Company.
RELIEF a. The Appellant prays that directions be given to grant all such relief arising from the above grounds and also all relief consequential thereto. b. The Appellant craves leave to add to or alter, by deletion, substitution, modification or otherwise, the above grounds of appeal, either before or during the hearing of the appeal. c. Further, the Appellant prays that all the above adjustments / additions / disallowances made by the learned Assessing Officer / TPO and upheld by the CIT(A) are bad in law and liable to be deleted.”
Ground No.1 is general in nature and does not require any specific
adjudication.
Ground No.2 is regarding validity of reference made by the
Assessing Officer to Transfer Pricing Officer (TPO). At the time of
9 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited hearing, the learned Authorised Representative has stated at Bar that the
assessee does not press this ground of appeal and the same may be
dismissed as not pressed. The learned Departmental Representative has
raised no objection for the same. Accordingly, we dismiss this ground as
not pressed.
Ground Nos.3 to 11 are regarding the Most Appropriate Method for
determination of ALP and consequential TP Adjustment.
The assessee is a company engaged in the business of
development of computer software and providing other related services.
During the year under consideration, the assessee has reported its
financial results as well as international transactions as reproduced by
the Transfer Pricing Officer in paras 2.3 and 2.4 as under :
10 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
11 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
Thus it is clear from the international transactions reported by the
assessee that there are diversified activity constituting the international
transactions. To benchmark its international transactions, the assessee
adopted the Transactional Net Margin Method (TNMM) as Most
Appropriate Method (MAM) and compared its entity level PLI with
comparable prices. The TPO accepted the entire international
transactions at arm’s length however the CIT (Appeals) held that cost
plus method is MAM in the case of the assessee to determine the ALP
12 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited and accordingly adopted the cost plus method. The CIT (Appeals) then
compared the assessee price with the comparable companies and
directed the TP Adjustment. Aggrieved by the order of the CIT (Appeals)
the assessee raised this issue in this appeal.
Before us, the learned Authorised Representative of the assessee
has submitted that when the assessee is engaged in the diversified
activity of international transactions then TNMM would be the MAM for
the purpose of determining the ALP. He has further contended that the
CIT (Appeals) not only adopted cost plus method but also took the
Associated Enterprise (AE) of the assessee as a tested party. Thus the
learned Authorised Representative has submitted that a foreign
company was taken by the CIT (Appeals) as tested party instead of the
assessee's price. Therefore it was submitted that the impugned order of
the CIT (Appeals) is not sustainable and liable to be set aside. In support
of his contention, he has relied upon the decision dt.22.4.2016 of this
Tribunal in the case of M/s. Kshema Technologies Ltd. Vs. ACIT in
IT(TP)A No.1105/Bang/2012.
On the other hand, the learned Departmental Representative has
relied upon the orders of the authorities below.
13 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited 9. Having considered the rival submissions as well as the relevant
material on record, we find that in order to determine whether the
international transactions carried out by the assessee are at arm’s length,
the price/cost of international transactions is compared with the
uncontrolled independent price as per the method and procedure
prescribed under Chapter X of the Income Tax Act, 1961 (in short 'the
Act'). Therefore only the price/the PLI of international transactions of
the assessee has to be compared with the uncontrolled comparable
price. The assessee took its entity level margin for the purpose of bench
marking its international transactions which is not permissible under the
T.P. provisions of IT Act as envisaged in Chapter X of the Act. We further
note that the CIT (Appeals) rejected the TNMM as MAM and adopted
cost plus method as MAM. However, the CIT (Appeals) has proceeded to
consider the AE of the assessee as tested party to compare the margin
with the comparable price. We find that this exercise of the CIT
(Appeals) is also contrary to the provisions of Transfer Pricing. The co-
ordinate bench of this Tribunal in the case of M/s. Kshema Technologies
Ltd. Vs. ACIT (supra) while dealing with an identical issue has held in para
11.3 as under :
14 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited “ 11.3 We have heard the rival submissions and considered the relevant material on record. We find that the assessee took its operating margin at entity level and then compared the same with the mean margins of the selected comparables. The TPO has not objected to its methodology of the assessee but rejected certain comparables selected by the assessee and included the some more comparables in the set of comparables for determining the ALP. It is pertinent to note that as per the provisions of Transfer Pricing, the entity level margin of the assessee cannot be considered for the purpose of bench marking the international transactions when the assessee is having both international as well as third party transactions. Though there is a strength in the contention of the learned Authorised Representative that in view of the complexity of the transactions between the assessee and its AEs as well as the third party transactions in which the assessee has to pay the selling commission to the AE, the assessee adopted entity level operating margin for the purpose of bench marking its international transactions. However, this method is not permitted as per the provisions and rules of the transfer pricing under Income Tax Act and I.T. Rules and therefore to that extent, we find that the learned CIT (Appeals) was justified in rejecting the methodology applied by the assessee as well as by the TPO. Once the CIT (Appeals) has rejected the entity level profit margin of the assessee for the purpose of bench marking the international transactions with ALP, the CIT (Appeals) was required to redo exercise of determination of ALP as per the provisions of transfer pricing. Instead of following the proper procedure stipulated under Chapter X of the I.T. Act as well as Rule 10 of I.T. Rules, the CIT (Appeals) has proceeded to take the AEs of the assessee as tested party and further recomputed their profit margin by excluding certain expenses which we find is not permitted under the provisions of transfer pricing. Not only changing the tested party from the assessee to its AE, the CIT (Appeals) has also selected a domestic company as a comparable to the AE of the assessee. Therefore the entire exercise of determining the ALP by the CIT (Appeals) is contrary
15 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited to the provisions of transfer pricing under the I.T. Act. Hence in view of the facts and circumstances of the case, we set aside the impugned order of the authorities below and remit the issue to the record of the Assessing Officer / TPO for deciding the matter afresh by considering the segment-wise data of the assessee and then compare the same with the comparable companies in the light of various decisions relied upon by the assessee. We find that in the series of decisions, this Tribunal has come to a conclusion that the threshold limit of the RPT should not be more than 15% in normal circumstances where there is no difficulty in selecting the comparable companies. Therefore we direct the TPO to apply the RPT filter at 15% instead of 25% and then consider the comparability of the companies. Since the assessee did not fully co-operate with the authorities below in the first round of the proceedings therefore we direct the assessee to co-operate in the proceedings before the A.O./TPO and furnish the relevant and requisite details in order determining the ALP. Needless to say that the Assessing Officer/TPO also consider the benefit of tolerance range of + / - 5% as per the proviso to Section 92C(2) as well as working capital adjustment.”
Accordingly, the TP Analysis of the assessee as well as the CIT (Appeals)
are not in accordance with the provisions of Transfer Pricing and
therefore, the impugned order of the CIT (Appeals) is set aside and the
TP issue is remitted to the record of the TPO for deciding the matter
afresh by comparing the margins of the international transactions with
the uncontrolled comparable price. Needless to say the assessee be
given an appropriate opportunity of hearing.
16 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited 10. Ground No.12 is regarding reduction of deduction under Section
10B in respect of expenditure incurred in foreign currency.
We have heard the learned Authorised Representative as well as
learned Departmental Representative and considered the relevant
material on record. The Assessing Officer while working out deduction
under Section 10B has reduced the expenditure incurred in foreign
currency from the export turnover. The learned Authorised
Representative of the assessee has submitted that expenditure in
question though incurred in foreign currency but it was not in respect of
providing technical services. He has further contended that this
expenditure was incurred regarding work done by the AE and therefore it
is not an expenditure incurred by the assessee for providing technical
services. In support of his contention, he has relied upon the decision
of Hon'ble jurisdictional High Court in assessee's own case for the
Assessment Year 2003-04 and submitted that vide order dt.1.8.2014 in
ITA No.1075 of 2008 and 196 of 2009 the Hon'ble High Court has decided
this issue in favour of the assessee.
On the other hand, the learned Departmental Representative has
relied upon the orders of the authorities below.
17 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited 13. Having considered the rival submissions as well as the relevant
material on record, at the outset we note that an identical issue has been
decided by the Hon'ble jurisdictional High Court in assessee's own case
for the Assessment Year 2003-04 (supra) in paras 2 & 3 as under :
18 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
19 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
20 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
21 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
In view of the decision of Hon'ble jurisdictional High Court in assessee's
own case, we decide this issue in favour of the assessee.
Ground Nos.13 & 15 are regarding disallowance of deduction
under Section 10B in respect of on site development work sub-
contracted to and income derived by the AE.
We have heard the learned Authorised Representative as well as
learned Departmental Representative and considered the relevant
material on record. At the outset, we note that an identical issue has
been considered by the Hon'ble jurisdictional High Court in assessee's
own case for the Assessment Year 2002-03 vide order dt.29.7.2015 in ITA
Nos.263 & 264 of 2014 as under :
“ From the record it is not borne out that the entire ‘on-site’ work has been sub-contracted to the AE. The MSA provides for the AE to work under total supervision and control of the assessee. The software to be produced by the assessee during its ‘on-site’ development has to be as per the specifications given by the assessee. The AE has no concern or direct dealing with the end customer. The assessee provides all relevant information and inputs to the AE on behalf of the end customer. The AE is admittedly answerable to the assessee and not the end customer. In such nature of the work which is
22 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited carried on by the AE on behalf of the assessee, it cannot be said that there is no nexus between ‘off-shore’ development and ‘on-site’ development.
In view of the above discussion, we are of the opinion that in the facts of the present case, the income earned by the assessee through ‘on-site’ development of software by the AE on behalf of the assessee would be eligible for deduction under Section 10A of the Act.”
Therefore prima facie this issue is covered in favour of the assessee
however, to verify certain facts regarding quantum of work sub-
contracted to the AE and whether the assessee was having total
supervision and control over the work executed by the AE this issue is
remitted to the record of TPO / A.O. The Assessing Officer is directed to
examine the relevant fact and then decide this issue in the light of
decision of Hon'ble jurisdictional High Court (supra).
Ground No.14 is regarding disallowance of deduction under
Section 10B in respect of interest income and profit on sale of assets.
We have heard the learned Authorised Representative as well as
learned Departmental Representative and considered the relevant
material on record. We find that the interest income from the deposits
in the bank has no direct first degree nexus with the business activity of
the undertaking therefore the same is not eligible for deduction under
23 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited Section 10B of the Act. Similarly the profit on sale of asset is not an
income derived from the business activity of the assessee-undertaking.
Hence we do not find any error or illegality in the order of the Assessing
Officer in denying the claim of deduction under Section 10B in respect of
interest income and profit o sale of asset.
Ground Nos.16 & 17 are regarding disallowance made under
Section 40(a)(i) of the Act.
The Assessing Officer has disallowed commission payment under
Section 40(a)(i) of the Act by holding that the same is Fees for Technical
Services and therefore in the absence of deduction of tax at source it is
not allowable.
On appeal, the CIT (Appeals) though upheld the orders of the
Assessing Officer that the payment in question is in the nature of Fees for
Technical Services however it was also held by the CIT (Appeals) that no
service has been rendered by the AE for which the alleged payment has
been made.
Before us, the learned Authorised Representative of the assessee
has submitted that even if this payment of commission is disallowed
under Section 40(a)(i), it will enhance the income of the undertaking
24 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited which is eligible for deduction under Section 10B of the Act. Thus he has
submitted that the deduction under Section 10B has to be allowed on
this amount.
On the other hand, the learned Departmental Representative has
relied upon the orders of the authorities below.
We have considered the rival submissions as well as the relevant
material on record. We are of the view that the disallowance of
expenditure under Section 40(a)(i) would result enhancement of the
income of the assessee. Since the income of the assessee is eligible for
deduction under Section 10B therefore, the said disallowance made
under Section 40(a)(i) is also eligible for deduction under Section 10B of
the Act. Accordingly, the alternate plea of the assessee is allowed.
Ground Nos.18 & 19 are regarding levy of interest under Sections
234B & 234C of the Act which is mandatory and consequential in nature.
Revenue’s Appeal (ITA No.1258/Bang/2012)
The revenue has raised the following grounds :
25 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited
The only issue arises in the appeal of the revenue is regarding
reduction of the expenditure incurred in foreign currency from export
turnover as well as total turnover while computing the deduction under
Section 10B of the Act.
Having considered the rival submissions as well as the material on
record, we find that the issue of expenditure incurred towards
telecommunication charges in foreign currency attributable to the
delivery of computer software abroad is reduced from export turnover
26 IT(TP)A Nos.1104 & 1258/Bang/2012 Mphasis Limited an equal amount should also be reduced from total turnover while
computing the deduction under section 10B of the Act, is covered in
favour of the assessee by the decision of the Hon’ble Karnataka High
Court in the case of CIT Vs. Tata Elxsi Ltd. 349 ITR 98 (Kar). The decision
of Hon'ble jurisdictional High Court has been followed in a number of
cases in co-ordinate benches of ITAT. Hence, this issue is decided
against the revenue and in favour of assessee.
In the result the assessee's appeal is partly allowed and the
revenue’s appeal is dismissed.
Order pronounced in the open court on the 7th day of June, 2017.
Sd/- Sd/- (INTURI RAMA RAO) (VIJAY PAL RAO) Accountant Member Judicial Member Bangalore, Dt. 07.06.2017. *Reddy gp Copy to : 1 Appellant 4 CIT(A) 2 Respondent 5 DR. ITAT, Bangalore 3 CIT 6 Guard File
Assistant Registrar Income Tax Appellate Tribunal Bangalore.