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Income Tax Appellate Tribunal, ‘C’ BENCH: BENGALURU
Before: SHRI SUNIL KUMAR YADAV & SHRI INTURI RAMA RAO
O R D E R Per INTURI RAMA RAO, AM :
This is an appeal filed by the assessee-company directed against the final assessment order passed u/s 143(3) r.w.s. 144C of the Income-tax Act, 1961 [hereinafter referred to as 'the Act' for short] dated 31/10/2011 for the assessment year 2007-08.
Briefly, facts of the case are that the assessee is a company incorporated under the provisions of the Companies Act,
IT(TP)A No.13/Bang/2012 Page 2 of 12 1956. It is 100% subsidiary of Msource Mauritus Ltd., which in term is a 100% subsidiary of Mphasis Europe BV. It is rendering services both voice and non-voice Information Technology enabled Services (ITeS) within India and outside India. For rendering ITeS assessee utilizes and deploys call processing and telecom systems. The clients of the assessee are engaged in financial services, insurance, telecom and web business. The assessee provides ITeS services to other AE as well as non- entities. Return of income for the assessment year 2007-08 was filed on 31/10/2007 declaring total income of Rs.30,42,47,023/-. The assessee-company also reported the following international transactions in Form 3CEB:
The assessee-company sought to justify the consideration received for the international transaction entered with its AE to be at arm’s length price [ALP]. The assessee-company had also submitted transfer pricing study report adopting the operating
IT(TP)A No.13/Bang/2012 Page 3 of 12 profit to total cost (OP/TC) as a profit level indicator for the transfer pricing study. The assessee-company applied Transactional Net Margin Method [TNMM] which was considered to be the most appropriate method for purposes of bench marking the international transactions.
The call Centre services rendered by the Appellant, can be split into the following two categories: i) United States of America ('US') operations; and ii)United Kingdom ('UK') operations. US Operations Mphasis Corp (Mcorp), AE of the Appellant, does the marketing and secures contracts from the customer. For clients based in US, Mcorp enters into contracts with ultimate customers. ITeS services are provided directly to the ultimate customers by the Appellant, under back to back arrangement with Mcorp. The entire revenue collected by Mcorp in US from ultimate customers is passed on to the Appellant. As return for the marketing activity carried on by the AE, the Appellant pays selling commission at the rate of 7% of the revenue to Mcorp. For US operations, the telecom equipment ownership and maintenance thereof are with Mcrop, the cost of which is reimbursed to Mcrop by the Appellant at actual cost.
UK Operations With respect to operations in Europe, Mphasis UK does the marketing function and secures the contracts. The Appellant itself
IT(TP)A No.13/Bang/2012 Page 4 of 12 enters into contracts directly with the ultimate customers. The entire services are provided by the Appellant directly to the end customers. In return for the marketing activity carried on, Mphasis UK is paid selling commission at the rate of 4% of the revenue. For Europe operations, the telecom equipment ownership and maintenance thereof are with Mphasis Holding BV, the cost of which is reimbursed by the Appellant at actual cost.
TP Analysis of the Appellant In the transfer pricing study, the Appellant analyzed international transaction of payment of selling commission and selected foreign AE's as the tested party. As selling commission payment was being evaluated, the Appellant selected foreign AE's as tested parties since they provide only marketing services. The AE's being least complex, were selected as the tested party. The Appellant selected TNMM as the most appropriate method. The Appellant carried out a methodical search process on One Sourcerm Global Business Browser database to identify potential comparable companies for both US and European regions. Various qualitative and quantitative filters were adopted by the Appellant to eliminate companies which were not comparable with it. The Appellant considered ratio of operating profit to operating cost as the profit level indicator (PIA). The following table summarizes the results of the search:
IT(TP)A No.13/Bang/2012 Page 5 of 12 Transaction Tested party No. of PLI of Arithmetic with comparables tested mean of associated party PLI of enterprise (%) comparable (%) Mcorp, USA Mcorp,USA 9 9.90% 13.06% companies Mphasis, UK Mphasis, UK 12 - 8.43% companies 47.99% Since the operating margin of AE's was below the average margin of comparables, it was concluded that the international transactions relating to payment of selling commission to AE were at arm's length. This was for the reason that the lower margin of the AE would reflect that the payment of selling commission made by the Appellant is not sufficient to absorb their expenses and give arm's length return. The Appellant had made reimbursement towards telecom cost, establishment cost and other expenses. With respect of reimbursements made to AE's, the Appellant concluded that the 'cost only' reimbursement by the Appellant to its AEs could be regarded as the arm's length price for such expenses. With respect to rendering of IT enabled services to Mcorp, USA, since the entire end customers revenue is passed on to the Appellant, the transactions were considered to be at arm's length. With respect to rendering of IT enabled services to Eldorado Inc, since the price charged by the Appellant to the AE was more than the price charged by the AE to the end customers, the transaction was considered to be at arm's length.
IT(TP)A No.13/Bang/2012 Page 6 of 12 TP Analysis of the TPO With respect to rendering of IT enabled services, the TPO on page 4 of his order has accepted the transaction to be at arm's length on the ground that the sales are pass through and the entire revenue is passed on to the Appellant. However the TPO proceeded to evaluate the arm's-length price of payment made towards selling commission, telecom cost, establishment charges and reimbursement of expenses paid. After discussing various aspects of the issue involved, the TPO has made a Transfer Pricing adjustment of Rs. 15,89,96,077/-. Breakup of the same along with brief observation of TPO is provided below:
The assessing officer incorporated the TP adjustment and passed the draft assessment order. Further, during the year
IT(TP)A No.13/Bang/2012 Page 7 of 12 consideration the Appellant had claimed deduction u/s 10A of the Act. While computing the deduction under section 10A, the AO reduced telecommunication expenses of Rs.9,74,64,618/- (Bangalore Unit Rs.5,05,68,550/-, Pune Unit Rs.4,17,87,463/- and Mangalore Unit Rs.51,06,606/-) only from the export turnover and not from the total turnover. Therefore, corporate Tax adjustment Rs.97,77,106/- is made by disallowing excess claim of deduction u/s 10A of the Act. The Appellant filed objections before the DRP, which confirmed the additions made by the TPO and the AO and rejected the objections filed by the Appellant.
Aggrieved by the order of the lower authorities, the appellant is in appeal before us in the present appeal.
Before us, the assessee-company has filed petition for admitting additional evidence to demonstrate that payment towards establishment charges and reimbursement of expenses, reimbursement towards establishment charges and reimbursement towards telecom cost. It is further submitted that in respect of selling commission paid to AE, the AE acts as marketing office and does front ending activities for the assessee- company. The AE does the marketing and secure contracts for assessee-company whereas the contracts are executed by the assessee-company. The assessee-company acts as an entrepreneur company performing all the functions undertaking
IT(TP)A No.13/Bang/2012 Page 8 of 12 all the risks and rewards and all intangibles rests with the assessee-company. Therefore, AE are least complex as they perform minimal functions and bear minimal risks. On the other hand, it was submitted that the assessee-company performs al risks and performs all functions. In the circumstances, it is submitted that it is appropriate to select overseas AEs as the tested party considering the limited functions performed, risks assumed and assets utilized by these entities as compared to the assessee-company. In support of this contention, assessee- company has relied on the decision in the case of General Motors India Pvt. Ltd. vs. ACIT (37 Taxmann.com 403)
The learned AR of the assessee also submitted that the entire revenue from the end customers is passed on to the Appellant by the AR This aspect has been accepted by the TPO in the TP order. Therefore, e AE's need to be remunerated for the marketing efforts and front ending activity done by them. No independent party would pass on the entire revenue without being remunerated for its efforts. The Appellant therefore submits that the addition made by the TPO with respect to selling commission is incorrect. With respect to reimbursement of expenses towards Telecom cost, establishment charges and reimbursement of other expenses, the Appellant submits that it has provided various additional documents which demonstrate that the reimbursements are actually at cost. The AEs incurred these
IT(TP)A No.13/Bang/2012 Page 9 of 12 expenses on behalf of the Appellant and later the Appellant reimbursed the same at cost to the AE's. For e.g., the Appellant relies on page 125 of Additional Evidence, which contains the ledger of telecom reimbursement. On a simple basis, the following may be seen: the AE has charged the Appellant USD 4,721.94 for communication expenses (payment voucher at page 856). The third party AT & T has charged the same amount to the AE and that invoice is at page 857. The Appellant submits that the evidence as filed is substantial in content. The evidence demonstrates that the foreign AE have not added any markup. As the payments to AE represent reimbursements, there is no income embedded therein and hence the transfer pricing provisions do not apply. Even otherwise, as the payments to AE are equal to third party invoices, the same is to be regarded as at arm's length.
After considering the above submissions of the assessee- company, we are of the considered opinion that since the assessee has filed additional evidence to substantiate that reimbursement towards telecom cost, establishment charges and other expenses are only on cost basis. In the interest of justice, matter requires fresh adjudication/remand to the AO/TPO to examine additional evidence whether reimbursement of expenses towards telecom cost and establishment charges are actually on cost. As regards selling commission paid, submission of the assessee that AE should be selected as tested party considering
IT(TP)A No.13/Bang/2012 Page 10 of 12 the evidence risk assumed, excess utilised may also be considered afresh by the TPO in light of submissions made by the assessee. Thus, the entire TP study of the issues on the TP adjustment are restored to the file of the AO/TPO for fresh adjudication in accordance with law after affording due opportunity to the assessee.
The next ground of appeal, the Appellant submits that telecommunication expenses of Rs.9,74,64,6 18/- must not to be reduced from export turnover in the light of decision of Karnataka High Court in the case of CIT/ACIT vs. MIs. Mphasis Ltd.— & ITA No.196/2009 and CIT/ACIT vs. M/s. Kshema Technologies Ltd.- ITA No.703/2009 (Group company of the Appellant), wherein the High Court held that freight, telecommunication charges or insurance attributable to the delivery of computer software outside India or expenses if any incurred in foreign exchange should not be reduced from export or total turnover when the business of the taxpayer is in the nature of export out of India of computer software or its transmission from India to a place outside India by any means as it is not rendering technical services for the purpose of the section. In the instant case, the Appellant is rendering IT enabled services it is not rendering technical services and therefore it is submitted that telecommunication and other expenses should not be reduced from both export turnover and total turnover.
IT(TP)A No.13/Bang/2012 Page 11 of 12 Alternatively, the learned AR of the assessee submitted that telecommunication charges and other expenses reduced from export turnover should also be reduced from total turnover of units while computing deduction u/s 10A, relying on decision of Karnataka High Court in the case of CIT v Tata Elxsi Ltd [2012] (349 ITR 98).
We heard rival submissions and perused material on record. The jurisdictional High Court in the case of CIT vs. Tata Elxsi (349 ITR 98) held that that the expenses excluded from the export turnover should also be excluded from the total turnover for computation of deduction u/s 10A of the Act. Respectfully following the ratio of the abovementioned decision, we direct that Telecommunication charges and other expenses should be reduced both from export turnover as well as the total turnover while computing deduction u/s 10A.
In the result, the appeal filed by assessee is partly allowed.