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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI INTURI RAMA RAO & SHRI LALIET KUMAR
O R D E R Per Laliet Kumar, Judicial Member The appellant is a company engaged in the business of development of software. During the previous year 2011-12 relevant to the assessment year the appellant’s international transactions are as per details below.
2. The appellant filed its return of income on 27.09.2012 for the assessment year declaring the total income of Rs. 2,81,61,719/-.
The case of the appellant is selected for scrutiny and therefore a notice u/s. 143(2) was issued to the appellant. Since the assessment proceedings involves international transactions therefore after taking due permissions the matter was referred for computation of arms length price in relevant to international transaction u/s. 92CA(1) of the Act. Before the ld. DCIT(TPO) the assessee vide letter dated 31.03.2012 filed the transfer pricing report. The ld.
IT(TP)A No. 1747/Bang/2016 Page 3 of 21 DCIT(TPO) vide order dated 22.01.2016 passed order u/s. 92CA called for an adjustment.
3. The assessee was asked to submit the documents maintained in terms of section 92D along with the financial, annual report and copies of the agreement. The assessee furnished the same. The TP document contained the eleven comparables in respect of software development activities selected by the Tax payer. By applying certain filters and TNMM was applied as most appropriate method.
The tax payer has selected the comparable engaged in the same nature vertical as tax payer. The assessee was given a show cause notice on 06.11.2015 with proceedings u/s. 92CA of the Act for the year 2011-12 and 2012-13. In the said notice it is mentioned as under.
4.Software segment: you have selected 11 companies as comparables on the basis of the search conducted in the public data bases. Prowess & Capitaline. The search criteria and the acceptance / rejection matrix applied by the company for screening the initially identified cases for arriving at a final comparable set are as under: Sl.no Particulars Remark of the TPO Companies for which Only current year data has sufficient financial or been used as mandated under 1 descriptive information is not 10(B)(4) of the Income Tax available to undertake Rules and as held by various
IT(TP)A No. 1747/Bang/2016 Page 4 of 21 analysis. courts. The TPO has used the filter of persistent losses for the last three years including the current year. The TPO has also not considered companies which have been declared sick. Companies that have been This is because; no company 2 declared sick or have would like to sustain losses persistent negative net worth beyond reasonable period. A company whose performance is extremely divergent from the normal industry trend cannot be considered as a normal comparable. Companies that have ceased The TPO has also not 3 business operations or are considered such companies. currently inactive Companies undertaking significantly different The TPO has also not 4 functions compared to considered such companies. taxpayer. The TPO has modified this filter and applied export earnings of Companies that do not have more than 75% on total 5 significant (less than 25%) revenues since the taxpayer is foreign exchange earnings. a hundred percent export oriented company. Appropriate filter. TPO applied 25% as the threshold limit Companies that have following the provisions of substantial (excess of 25%) section 92A (2)(a) which 6 transactions with related provides a limit of 26% of the parties equity capital carrying voting rights for treating an enterprise as Associated Enterprise. The TPO has also applied this filter to eliminate companies Companies which have been with losses for continuous 3 7 incurring persistent operating years to give it sufficient time to losses reverse the trend and show growth. The TPO has applied a more Companies that have appropriate filter of rejecting 8 exceptional year(s) of companies which have had operation exceptional economic activity
IT(TP)A No. 1747/Bang/2016 Page 5 of 21 that has a bearing on the profits. Companies that are duplicated in the databases 9 with different names or This is an appropriate filter. merged to form another company
4. The assessee filed the reply to the show cause notice on 08.01.2016.
The ld. DCIT vide order dated 22.01.2016 has passed an order u/s. 92CA(3) and thereby called for adjustment to the value of international transaction to the extent of Rs. 1,99,61,449/-. Based on the order passed u/s. 92CA(3) by the TPO, the AO has also passed a draft assessment order on 10.02.2016.
The assessee feeling aggrieved by the draft assessment order filed its objection before the DRP on 10.03.2016 and also filed additional grounds of objections on 07.06.2016 however the DRP has partly accepted certain objections and has rejected the remaining. The AO passed the assessment order u/s. 143 r.w.s. 144C on 26.07.2016 giving effect to the directions of the DRP. Feeling aggrieved by the assessment order passed u/s. 143(3) r.w.s. 144C, the assessee has filed the present appeal on various grounds as mentioned in the petition.
IT(TP)A No. 1747/Bang/2016 Page 6 of 21
During the course of argument, the assessee has not pressed ground nos. 1 to 3 and therefore the said grounds are dismissed being not pressed.
The assessee has raised various other grounds in the grounds appeal. However in respect of ground no. 4, the assessee has relied upon the judgment of the Hon’ble Delhi High Court in the matter of Valvoline Cummins Ltd. Vs DCIT (307 ITR 103) more particularly paragraph 29 and 30. The same are reproduced herein below.
“29. It appears to us quite clearly that there is a distinction between concurrent exercise of power and joint exercise of power. When power has been conferred upon two authorities concurrently, either one of them can exercise that power and once a decision is taken to exercise the power by any one of those authorities, that exercise must be terminated by that authority only. It is not that one authority can start exercising a power and the other authority having concurrent jurisdiction can conclude the exercise of that power. This perhaps may be permissible in a situation where both the authorities jointly exercise power but it certainly is not permissible where both the authorities concurrently exercise power. One example that immediately comes to the mind is that of grant of anticipatory bail. Both the Sessions Judge and the High Court have concurrent power. It is not as if a part of that power can be exercised by the High Court and the balance power can be exercised by the Sessions Judge. If the High Court is seized of an application for anticipatory bail it must deal with it and similarly if the Sessions Judge is seized of an anticipatory bail, he must deal with it. There can be no joint exercise of power both by the High Court as well as by the Sessions Judge in respect of the same application for anticipatory bail.
IT(TP)A No. 1747/Bang/2016 Page 7 of 21
In the facts of the present case, since the Additional Commissioner had exercised the power of an Assessing Officer, he was required to continue to exercise that power till his jurisdiction in the matter was over. His jurisdiction in the matter was not over merely on the passing of the assessment order but it continued in terms of section 220(6) of the Act in dealing with the petition for stay. What has happened in the present case is that after having passed the assessment order, the Additional Commis- sioner seems to have washed his hands of the matter and left it to the Deputy Commissioner to decide the stay petition filed under section 220(6) of the Act. We are of the opinion that this was not permissible in law.”
On the basis of the above said judgment it was contented that the initial reference was made to ACIT transfer pricing (2)(2), Bangalore. However the order has been passed by the DCIT transfer pricing (2)(2) u/s. 92CA. It was submitted that DCIT, has subsequently assumed the office, therefore the order passed by the DCIT was not in accordance with law. On this issue the ld. DR has submitted that the order passed by the DCIT is in accordance with law and there is no error in passing the order.
We have heard the rival contention of the parties and perused the record. It is not disputed that the ACIT transfer pricing (2)(2) as well as the DCIT transfer pricing (2)(2) have concurrent jurisdiction to decide the issue after receiving the reference issued by the AO.
IT(TP)A No. 1747/Bang/2016 Page 8 of 21 In the case referred by the assessee the facts were different in the said case i.e. Valvoline Cummins Ltd. Vs DCIT (supra). The assessment order was passed by the Additional Commissioner and thereafter he washed his hand and left the matter to the Deputy Commissioner to decide the issue. In the present case the show cause notice dated 06.11.2015 was issued by DCIT Transfer Pricing (2)(2) Mr. Smarak Swain and the said officer, after issuing the show cause notice had given the hearing to the assessee and the said officer thereafter passed the order u/s. 92CA of the IT Act, 1961, therefore to say that the person who had initiated the proceedings or the person to whom the reference was made, should only decide the matter in our view is factually incorrect as in the present case though initial reference was made to the Additional Commissioner Transfer Pricing (2)(2). However, the DCIT is having the current powers and therefore had issued the show cause notice and thereafter passed order u/s. 92CA of the Act. The present case is not of delegation of authority by Additional Commissioner to DCIT rather the present case is of concurrent jurisdiction and therefore in view of the above discussion we do not find any merit in the IT(TP)A No. 1747/Bang/2016 Page 9 of 21 grounds raised by the assessee in respect of ground no. 4 and therefore we dismiss the same.
The next ground which the preliminary ground is taken by the assessee with respect to rejection of the TP study by the Transfer Pricing Officer.
The ground nos. 5 and 6 which deals with this issue are reproduced herein below for the sake of brevity.
IT(TP)A No. 1747/Bang/2016 Page 10 of 21
It was submitted that the ld. DCIT(A) in the show cause notice has mentioned as under.
4.Software segment: you have selected 11 companies as comparables on the basis of the search conducted in the public data bases. Prowess & Capitaline.
The search criteria and the acceptance / rejection matrix applied by the company for screening the initially identified cases for arriving at a final comparable set are as under:
Sl.no Particulars Remark of the TPO Companies for which Only current year data has sufficient financial or been used as mandated under 1 descriptive information is not 10(B)(4) of the Income Tax available to undertake Rules and as held by various analysis. courts. The TPO has used the filter of persistent losses for the last three years including the current year. The TPO has also not considered companies which have been declared sick. Companies that have been This is because; no company 2 declared sick or have would like to sustain losses persistent negative net worth beyond reasonable period. A company whose performance is extremely divergent from the normal industry trend cannot be considered as a normal comparable. Companies that have ceased The TPO has also not 3 business operations or are considered such companies. currently inactive Companies undertaking significantly different The TPO has also not 4 functions compared to considered such companies. taxpayer. The TPO has modified this filter Companies that do not have and applied export earnings of 5 significant (less than 25%) more than 75% on total foreign exchange earnings. revenues since the taxpayer is a hundred percent export
IT(TP)A No. 1747/Bang/2016 Page 11 of 21 oriented company. Appropriate filter. TPO applied 25% as the threshold limit Companies that have following the provisions of substantial (excess of 25%) section 92A (2)(a) which 6 transactions with related provides a limit of 26% of the parties equity capital carrying voting rights for treating an enterprise as Associated Enterprise. The TPO has also applied this filter to eliminate companies Companies which have been with losses for continuous 3 7 incurring persistent operating years to give it sufficient time to losses reverse the trend and show growth. The TPO has applied a more appropriate filter of rejecting Companies that have companies which have had 8 exceptional year(s) of exceptional economic activity operation that has a bearing on the profits. Companies that are duplicated in the databases 9 with different names or This is an appropriate filter. merged to form another company
In this regard, the ld. AR for the assessee has submitted that the assessee has in fact submitted the TP study after using the contemporary current year data and has also used the filter of more than 75% of the foreign exchange and also have used the turnover filter of employee cost with less than 25% of the turnover employees in software cases were excluded. It was submitted by the assessee that in the TP study at page 220 the assessee has used the current year data and have also used the filter of foreign
IT(TP)A No. 1747/Bang/2016 Page 12 of 21 exchange earning to turnover ratio less than 75% and employee cost turnover less than 25%. On the basis of the above it was submitted that as per provisions of section 92CA(3) the TPO was also required to follow the same methodology and approach as was incumbent upon the AO u/s. 92C(3) of the Act. It was submitted that the material on the basis of which the opinion was formed by the TPO was incorrect as the basis of rejecting the TPO study of the assessee was that the assessee is not using the current financial year data and has relied upon the three year average of the data for the last three years and has applied qualitative filter of companies that has substantial transaction with excess of 75%. In this regard, the ld. AR has relied upon the judgment of Hon’ble Delhi High Court in the matter of CIT Vs. Mentor Graphics (Noida) (P.) Ltd. (354 ITR 586) more particularly paragraph 8 and 9 of the said judgment held as under.
”8. Having said so, we may now notice the provisions of sub- section (3) of section 92C which we have already extracted above. A reading of the said provision makes it clear that if the assessing officer in the course of any proceeding of assessment, on the basis of material or information or documents in his possession, is of the opinion that any of the 4 conditions (a) to (d) stipulated in sub-section (3) are satisfied then, the assessing officer may proceed to determine the arm's length price in relation to the international transaction in accordance with the provisions of sub-section (1) and sub-section (2) of section 92C on the basis of such material or information or documents
IT(TP)A No. 1747/Bang/2016 Page 13 of 21 available with him. Provided, of course, that an opportunity is given by the assessing officer to the assessee to show cause as to why the arm's length price should not be so determined on the basis of material or information or document in the possession of the assessing officer. In other words, in the aforesaid circumstances the assessing officer may himself embark upon the determination of the arm's length price. However, where the assessing officer considers it necessary to do so, he may with the previous approval of the commissioner, refer the computation of the arm's length price to the Transfer Pricing Officer. This is provided in section 92CA of the said Act which, to the extent relevant, reads as under:- "92CA. (1) Where any person, being the assessee, has entered into an international transaction [or specified domestic transaction] in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Commissioner, refer the computation of the arm's length price in relation to the said international transaction [or specified domestic transaction] under section 92C to the Transfer Pricing Officer. ** ** ** (3) On the date specified in the notice under sub-section (2), or as soon thereafter as may be, after hearing such evidence as the assessee may produce, including any information or documents referred to in sub-section (3) of section 92D and after considering such evidence as the Transfer Pricing Officer may require on any specified points and after taking into account all relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the arm's length price in relation to the international transaction [or specified domestic transaction] in accordance with sub-section (3) of section 92C and send a copy of his order to the Assessing Officer and to the assessee."
9. Coming back to the facts of the present case, the assessing officer while considering the assessment of income of the respondent/assessee had, in terms of section 92CA(1) of the said Act referred the computation of arm's length price to the Transfer Pricing Officer. That being the position, it is clear that the Transfer Pricing Officer, in view of the provisions of section 92CA(3), was also required to follow the same methodology and approach as was incumbent upon the assessing officer under section 92C(3) of the said Act. In other words, the Transfer Pricing Officer would have to, first, form an opinion that any of the four conditions (a) to (d) set out in sub-section (3) of section IT(TP)A No. 1747/Bang/2016 Page 14 of 21
92C existed and then he could proceed to determine the arm's length price in relation to the international transactions in question in accordance with sub-sections (1) and (2) of section 92C on the basis of such material or information or document available with him. After the Transfer Pricing Officer determines the arm's length price, it is incumbent upon him to send a copy of the order to the assessing officer and to the assessee. In the present case what has happened is that the Transfer Pricing Officer has generally rejected the comparables submitted by the respondent/assessee in his transfer pricing report and has rejected the suggested arm's length price based on a profit level indicator of 6.99% as determined by the respondent/assessee and, in place thereof, the Transfer Pricing Officer adopted a profit level indicator of 24.53% and determined the arm's length price of the international transactions at Rs. 10,34,40,177/- as against Rs.. 8,88,66,320/- returned by the respondent/assessee. This resulted in an adjustment of Rs. 1,45,73,857/- in the income of the assessee being the difference between the arm's length price and the price charged by the assessee from its associated enterprise (IKOS System Inc.) for rendering services to them. Thereafter, the assessing officer passed the assessment order on 28.03.2005, inter alia, after making the aforesaid addition. We are not concerned with the other aspects of the assessment order.”
On the other hand, the ld. DR has drawn our attention to paragraph 6 of the TP order to the following effect.
“6. REJECTIONOF THE TAXPAYER'S TP STUDY In the case of tax payer, the TPO is mainly concerned about whether the information or data used in the computation of the arm's length price is reliable and correct. It is clear from the provisions of Sec. 92C(3)(c) read with Sec. 92CA that on the basis of material or information or documents in the possession of TPO, if he is of the opinion that the information or data used in computation of the arm's length price is not reliable or correct, the TPO may proceed to determine the arm's length price in relation to the international transactions in accordance with Sec. 92C(1) and 92C(2) on the basis of such material or information or document available with him.
IT(TP)A No. 1747/Bang/2016 Page 15 of 21 The following pertinent defects have been found in the TP analysis carried on by the tax payer.
1. As per Rule 10B (4), it is mandatory to the use the current financial year data i.e. the financial year in which the international transactions took place (FY 2011-12) but the taxpayer has computed the 3-year average of the data for the last three years. The taxpayer has selected cases even where no current year data is available and has based its analysis on earlier year's data.
2. The taxpayer has used the earlier year data pertaining to the FYs 2009-10,2010-11 besides the current year ending 2012 wherever available but no reasons are given as to how the earlier year data has influence over the price either of the taxpayer or of the comparable so to attract the proviso to Rule 10B (4).
The assessee has not used export revenue> 75% of sales as a filter. The assessee is engaged in the provision of SWD services to its Associated Enterprises situated outside India. Since, the revenue is arising out of export sales, comparing the assessee company with a company providing services primarily within India will not be appropriate. The profit margins of companies engaged in domestic sales and those engaged in export sales would be different. The level of competition within the country and those prevailing in international market are different. Therefore, it is important to have a filter to eliminate companies which are predominantly engaged in the provision of services within India.
The assessee company has not applied employee cost filter (ratio of employee cost to sales >25%). SWD industry is primarily engaged in provision of services through personnel implying that the industry is manpower intensive. Therefore, it is appropriate to have employee cost filter to eliminate those companies which are not directly providing SWD services but are outsourcing the same. Due to the rejection of certain filters used by the taxpayer and inclusion of certain other appropriate filters, there is a change in the set of uncontrolled comparables identified by the taxpayer. The ALP as per the Transfer Pricing regulations in India is arithmetic average of the prices of the uncontrolled comparables. In view of the same, due to IT(TP)A No. 1747/Bang/2016 Page 16 of 21
rejection of filters, if some or all uncontrolled comparables are rejected, the consequent Arm's Length price would also stand rejected. Therefore, in view of section 92C(3)(c), it is relevant to hold that the data used in computation of the arm's length price is not reliable or correct. The TP document is proposed to be rejected and the TPO proceeds to determine arm's length price by conducting an independent search for comparables considering the functions of the taxpayer, the assets employed and the risks taken and the results of the search is given in the following paras.:”
It was submitted by the ld. DR that the TPO has correctly rejected the TP study of the assessee and has rightly proceeded in determination of the ALP in accordance with the procedure provided u/s. 92CA. In the alternate it was submitted if this Hon’ble Tribunal comes to the conclusion that the TPO has wrongly rejected the study, in that eventuality the matter should be remanded back to the file of the TPO for the purposes of examining the TP study of the assessee and thereafter computing the arm’s length price of the international transactions of the assessee.
We have heard the rival contentions of the parties and perused the record. The TPO in para 7 of the show cause notice at page 337 has mentioned as under:-
IT(TP)A No. 1747/Bang/2016 Page 17 of 21
“7. Comparables selected by taxpayer
Before proceeding to discuss the search strategy adopted by the TPO, the comparables selected by the taxpayer are discussed as under. a. The tax payer has selected 11 comparable companies in respect of Software development Services the details of which are as under:
Sl. Name of the company Remarks No. Acropetal Technologies Qualifies all the filters. Hence 1 6.13% Ltd accepted. Akshay Software Functionally different. Hence, 2 7.22% Technologies Ltd. rejected. C G – VAK Software & Excluded as different function. 3 - 15.21% Exports Ltd. Hence rejected. 4 R S Software India P. Ltd. 15.30% Qualifies all filters. Accepted. Sasken Communication 5 7.31% Qualifies all filters. Accepted. Technologies Ltd. Thinksoft Global Services 6 6.43% Fails the Forex Filter. Rejected. Ltd. Consolidated financials are not 7 Sonatta Software Ltd. - 9.54% available for the A.Y 2012-13 ICRA Techno Analytics Qualifies all the filters. Hence 8 17.21% Ltd Accepted. Forex to sale < 75%, Hence 9 Ajel Ltd 2.88% rejected. Goldstone Technologies Fails forex earning filter. Hence, 10 9.96% Ltd. rejected. KALS Information Company is functionally different. 11 6.64% Systems Ltd. Hence rejected. Average 4.94% Rejection of TP document In the case of tax payer, the TPO is mainly concerned regarding whether the information or data used in the computation of the arm’s length price is reliable or correct. It is clear from the provisions of Sec.92C(3)(c) read with Sec. 92CA that on the basis of material or information or documents in the possession of TPO, if he is of the opinion that the information or data used in computation of the arm’s length price is not reliable or correct, the TPO may proceed to determine the arm’s length price in relation to the IT(TP)A No. 1747/Bang/2016 Page 18 of 21 international transactions in accordance with Sec.92C(1) and 92C(2) on the basis of such material or information or document available with him. The following pertinent defects have been found in TP analysis carried on by the tax payer.
As per Rule 10B(4), it is mandatory to use the current year data i.e. the financial year in which the international transactions took place (FY 2011-12) but the tax payer has computed the 3 year average of the data for the last three years. The taxpayer has selected cases even where no current year data is available and has based its analysis on earlier year’s data.
The taxpayer has used the earlier year data pertaining to the FYs 2008- 09, 2009-10 & 2010-11 besides the current year ending 2012 wherever available but no reasons are given as to how the earlier year data has influence over the price either of the taxpayer or of the comparables so to attract the proviso to Rule 10B(4).
3. The taxpayer has applied quantitative filter of companies that have substantial transactions with related parties excess of 25%.
4. The taxpayer has also applied filter of companies undertaking significantly different functions compared to SSSDI.
Because of rejection of filters used by the taxpayer, there is a change in the set of uncontrolled comparables identified by the taxpayer. The ALP as per the Transfer pricing regulations in India is arithmetic average of the prices of the uncontrolled comparables. IN view of the same, due to rejection of filters, if some or all uncontrolled comparables are rejected, the consequent Arm’s Length price would also stand rejected. Therefore, in view of section 92C(3)(c), it is relevant to hold that the data used in computation of the arms length price is not reliable or correct. The TP document is proposed to be rejected and the TPO proceeds to determine the arm’s length price by conducting an independent search for comparables considering the functions of the taxpayer, the assets employed and the risks taken and the results of the search is given in the following paras:”
If we look into the table reproduced hereinabove, it is clear that the assessee has selected Akshay Software Technologies Ltd and CG- VAK Software & Exports Ltd as comparable despite these
IT(TP)A No. 1747/Bang/2016 Page 19 of 21 companies were functionally different. Similarly assessee has selected Thinksoft Global Services Ltd., Ajel Ltd. and Goldstone Technologies Ltd as comparable , despite these companies fails on forex filter or forex sale less than 75%. And selected Sonatta Software Ltd.as comparable despite it fails as the consolidated financials are not available for FY 2012-13. The submission of the ld. AR at Bar was that the assessee had adopted the filters where the foxex sale was more than 75% and the consolidated financials were used for the year under consideration. If we examine the table and more particularly the reason mentioned hereinabove, while rejecting the comparables by the TPO, we notice the contradictions in the submissions made by the assessee, as two companies were selected which were functionally dissimilar to the assessee, further three companies failed on forex filter and one companies failed on consolidated financial were not Available.
In our view, though the TPO has rejected the TP study on the four grounds stated hereinabove, but as discernible from the table tabulated hereinabove, it is clear that the rejection of TP study was for a cogent reason failing within the parameters laid down in paragraph stated hereinabove more particularly the information and IT(TP)A No. 1747/Bang/2016 Page 20 of 21 data used for computation of ALP was not reliable and correct. In view thereof, the TPO has satisfied himself about the methodology adopted by the assessee vis-à-vis parameter/filter applied in view of the provisions as mentioned hereinabove, more particularly, section 92C(3)(c) r.w.s. 92CA and Rule 10B(4). Accordingly, these grounds are decided against the assessee.
Since we have decided the preliminary grounds raised before us against the assessee, therefore, the matter is directed to be listed before the Bench for deciding this issue on merits and accordingly the case is directed to be fixed on 06th July, 2017.
Pronounced in the open court on this 12th day of April, 2017.