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Income Tax Appellate Tribunal, BENCH- A, BANGALORE
Before: SMT. ASHA VIJAYARAGHAVANSHRI S JAYARAMAN
PER ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER:
This appeal by the Revenue is directed against the order of
Dy. Commissioner of Income-tax, Circle – 5(1)(2) dated 29/1/2015
and it pertains to the assessment year 2010-11.
The Assessee, Novell Software Development (India) Private
Limited, is a subsidiary of Novell Inc., USA (‘Novell US’), and is a
captive service provider. It is engaged in the business of providing
software development and support services to its Associated
Enterprise, namely, Novell US.
During the relevant previous year, the Assessee provided
software development and support services to the Novell US. The
transfer pricing study done by the Assessee concluded that the said
transaction was at arm’s length. Also, during the year the assessee
IT(TP)A No.281/B/15 CO No.101/B/15
3 had incurred an expenditure of Rs. 7,61,738/- towards the purchase
of software, which was capitalized and depreciation claimed thereon.
The TPO, however, made a total adjustment for Rs.
8,50,32,504/- towards the aforesaid international transaction. The
Assessing Officer (‘the AO’ for short) passed a draft assessment
order dated 28.03.2014 after incorporating the aforesaid TP
adjustment. Apart from the said TP adjustment, the AO also made a
disallowance under Section 40(a)(ia) of the Act of the depreciation
claimed on the ground that no tax had been deducted at source by the
assessee on payments made towards the purchase of software. The
AO also made a disallowance under Section 14A of Rs.15,26,315/-
as expenditure incurred in relation to exempt income, despite there
being no exempt income having been earned by the Assessee in the
previous year.
The Assessee filed its objections before the DRP which, vide
its directions dated 23.12.2014, reduced the TP adjustment made by
the TPO by granting an adjustment towards depreciation as prayed
for by the Assessee. The disallowance made under Section 40(a)(ia)
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4 was confirmed while the disallowance under Section 14A was
deleted.
Pursuant to the directions of the DRP, the TPO reworked the
TP adjustment at ‘NIL’. The AO passed the final assessment order
dated 29.01.2015 incorporating the same and also retained the
disallowance made under Section 40(a)(ia) of the Act.
To the extent that the DRP’s directions granted an adjustment
towards depreciation in computing the arm’s length price of the
transaction and to the extent the disallowance under Section 14A was
deleted, the Revenue has filed the above appeal. Since, upon giving
effect to the TP order, there was no transfer pricing adjustment, the
Assessee did not file a separate appeal before this Hon’ble Tribunal.
However on receipt of notice of the above Revenue’s appeal, it filed
cross-objections to the Revenue’s appeal, urging grounds to the
extent that the TPO’s order stands confirmed and also as regards the
disallowance made under Section 40(a)(ia).
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5 8. Aggrieved, the Department has filed the following grounds :
“The DRP erred in directing the AO in deleting the addition made without appreciating the provisions of section 14A r.w.r.8D and the clarification given by the Board in Circular NO.5/2014 dated 11.02.2014 which emphasizes that only expenditure allowable is which is relatable to earning of income and therefore the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective of the fact whether any such income has been earned during the financial year or not.
The learned DRP member erred in directing to exclude the depreciation from the cost of the taxpayer as well as the comparables.”
We find that the Hon’ble High Court of Delhi in ITA 749/2014
in the case of ITA 749/2014 in the case of Chem Investment Ltd., Vs
CIT has held that section 14A will not apply if no exempt income is
received or receivable during the relevant previous year.
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6 10. Respectfully following the above said decision of Hon’ble Delhi
High Court, we dismiss ground No.1 raised by the department.
With respect to Ground No.2 the assessee’s submissions on the
revenue’s appeal are as under:
“Re. ground 2 in the Revenue’s appeal: The DRP rightly directed allowance of a depreciation adjustment, following the order of the CIT(A) dated 16.9.2014 in the assessee’s own case for assessment year 2009-10 [para 14.5 at pages 63 and 64 of the CIT(A)’s order], and hence no interference is called for. The assessee makes the following submissions in support of its claim for depreciation adjustment.
* Rationale for making depreciation adjustment Rule 10B of the Income-tax Rules, 1962 (‘the Rules’ for short),provides the method in which the comparability analysis is to be conducted under the Transactional Net Margin Method. Under sub clause (i) of Rule 10B(1)(e), the net profit margin realized by the taxpayer from an international transaction is computed having regard to a relevant base e.g costs incurred, sales effected, etc. Under sub-clause (ii) of Rule 10BH(1)(e), the net profit margin realized by an unrelated enterprise/comparable company is computed having
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7 regard to the same relevant base as was selected in sub clause (i).
Sub-clause (iii) of the said Rule specifies that before a comparison of the net margins realized under sub-clauses (i) and (ii) is done, the net margin realized under sub-clause (ii) must be adjusted to take into account the differences which could materially affect the net profit margin in the open market. Relevant extract of Rule 10B(1)(e)(iii) is reproduced as under:-
“(iii) the net profit margin referred to in sub- clause (ii) arising in comparable uncontrolled transaction is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;”
Based on the above, there is a need for making an adjustment on account of difference between the net margin of the assessee and that of the comparable companies.
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8 It would also be relevant to note that Rule 10B(3) of the Rules provides that an uncontrolled transaction shall be considered as a comparable if: a) None of the differences between the comparable company and the controlled transaction are likely to materially affect the profit arising from such transactions in the open market; or b) Reasonably accurate adjustments can be made to eliminate the material effect of such differences.
• Assessee’s depreciation policy vis-avis depreciation policies of the comparables selected by the TPO:
The assessee has a policy of charging a higher rate of depreciation as compared tot eh companies selected by the TPO. It is, therefore, submitted t6hat there is a need for making an adjustment to eliminate the differences in the accounting policies of the assessee and the comparable companies. The assessee’s depreciation policy for the year is as below:
(iii) Depreciation Depreciation is provided from the date of capitalization on Straight Line method at the rates mentioned below, based on management’s estimate of the useful lives of assets concerned, which are higher than the
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9 corresponding rates prescribed in Schedule XIV of the companies Act, 1956:
The useful life of fixed assets are as follows:
Asset Rate of Depreciation Computer Systems Servers 33.33% Computer System Other than 50.00% servers Computer Software 33.33% Plant and Machinery 20.00% Office Equipment 33.33% Furniture and Fixtures 20.00% Vehicles 33.33%
Leasehold improvements are depreciated over the primary period of lease or their estimated useful life, whichever is shorter.
Individual assets other than Software, costing less than Rs.90,000/- are fully depreciated in the year of purchase. Software individually costing less than Rs.90,000/- is fully charged to the profit and loss account. Most other companies provide for depreciation at the rates specified in the Companies Act, 1956.
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• Decisions of this Hon’ble Tribunal Reliance is placed on the decision of the Bangalore Bench of this Hon’ble Tribunal in the Assessee’s own case for the assessment year 2005-06 in ITA No.1047/Bang/2011. However, unlike in the aforesaid case for AY 2005-06 when this Hon’ble Tribunal had remanded the matter to the TPO for consideration of the assessee’s request for a deprecation adjustment, it is submitted that there is no requirement fro4r such an order of remand by this Hon’ble Tribunal as the TPO has already looked into the detailed workings and submissions of eh assessee filed before the DRP and granted the deprecation adjustment pursuant to which the final assessment order too has been passed.
Also, in the assessee’s own case for the assessment year 2002-03, the CIT(A) in his order dated 9.8.2012, allowed the adjustment for depreciation (Para 4.7 at pages 27 and 28 of the order). Likewise, in the assessee’s own case for AY 2011-12, the DRP vide its directions dated 27.11.2015 directed that an adjustment for depreciation be allowed (Para 7.1.2. at page 11 of the directions).
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11 The assessee also places reliance on the judgments of this Hon’ble Tribunal in E-gain Communication Pvt. Ltd. Vs. ITO reported in [2008] 23 SOT 385 (Pune) (at page 36) and Honeywell Technology Solutions Lab P. Ltd., in IT(TP)A No.1344/Bang/2011 at para 5.71.”
The decision of Hyderabad Bench ’B’ in the case of Market Tools
Research Pvt. Ltd., in ITA No.2066/2011 is to be followed, wherein
the Hon’ble JM is a party to the order. The relevant portion is
extracted below:
All facts which impact the financial result of comparable companies should be taken into account and reasonable accurate adjustment should be made for the same. In this connection the rates of depreciation adopted by the assessee are significantly different from (straight line as compared with WTP; higher rate than that prescribed in schedule VI) those adopted by the comparable companies suitable adjustment for the different has to be made or the profit before depreciation may be considered.
Following the ratio of the above said decision in the case of
Market Tools Research Pvt. Ltd., (Supra), we hold that DRP erred in
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12 directing to exclude depreciation from the cost of the Tax Payer as
well as comparables. Hence, we direct the AO to rework depreciation
following decision in the case of Market Tools Research Pvt. Ltd.,
(Supra).
In the result, the department appeal is dismissed.
CO No./101/Bang/2015
The ld counsel for the assessee pressed only following grounds
among the grounds filed before the tribunal against the Departmental
appeal.
“1 (a) The learned TPO and the DRP erred in fact and law in including (a) Infosys Ltd. (b) Kals Information Systems Ltd., (Seg), c) Larsen & Toubro Infotech Ltd. d) Mindtree Ltd. (Seg) e) Persistent System Ltd., f) Sasken Communication Technologies, (Seg) g) Tata Elxsi Ltd. (Seg) as comparable companies , without considering the functional differences of the said companies vis-à-vis the Respondent.
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13 1 (b) The DRP erred in accepting the action of the Learned. AO/Learned. TPO in rejecting the comparable companies arrived at in the Respondent’s Transfer Pricing Study as mentioned below a) Akshay Software Technologies Ltd b) Evoke Technologies Pvt. Ltd.
The DRP/The DCIT, 12(2), Bangalore [DCIT or AO] erred I not holding that the amount of Rs.688,872 claimed as depreciation on software expenses should not be disallowed u/s 40(a)(ia) of the Act.”
The ld counsel submitted that regarding ground 1 in the
assessee’s cross-objection, the DRP did not adjudicate upon the
assessee’s grounds to exclude certain companies chosen by the TPO as
comparables and include certain companies from its TP study as
comparables. The accept-reject matrix of the TPO’s 11 comparables
based on the assessee’s submissions would be as follows:
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IT(TP)A No.281/B/15 CO No.101/B/15
SN Name of the Sales Mark- Mark-up on Mark-up on Assessee’s Grounds Company (Rs. In up on costs costs remarks for crores) costs (depreciation (WC and Rejection (unadj) Adj) depreciation % % – adj % Functionally dissimilar 1 LGC Global 240.74 11.95 13.70 9.10 Accept Ltd. 2 Infosys Ltd.,* 21140 45.01 53.51% 52.51% Reject 3 Kals 2.17 38.37 47.69 43.13 Reject Information Systems Ltd. (Seg)* 4 Larsen & 1176.76 19.33 23.33 23.22 Reject Toubro Infotech Ltd. 5 Mindtree Ltd. 698.02 14.83 21.75 19.04 Accept (seg) 6 Persistent 6.67 15.38 20.35 16.78 Accept Systems & Solutions Ltd. 7 Persistent 504.41 30.35 42.30 41.26 Reject System Ltd.** 8 RS Software 161.83 10.29 15.92 15.55 Accept (Ind) Ltd. 9 Sasken 401.50 17.36 25.14 25.12 Reject Communication Technologies 10 Tata Elxsi 336.94 21.88 28.80 26.21 Reject (seg)* 11 Thinksoft 74.55 17.05 19.44 17.99 Accept Global Services Ltd.
IT(TP)A No.281/B/15 CO No.101/B/15
15 16. The six comparables companies 1) Infosys Ltd., 2) Kals
Information Systems Ltd., (Seg), 3) Persistent System Ltd., 4) Sasken
Communication Technologies, 5) Tata Elxsi 6) Larsen & Toubro
Infotech Ltd., are covered by the decision of co-ordinate bench in
IT(TP) No.212/Bang/2015 in the case of M/s Electronics for Imaging
India Pvt. Ltd., and rejected since these are functionally dissimilar
to that of the assessee company.
The learned counsel for the assessee submitted as follows:
Additionally, the Assessee seeks inclusion of the following
two companies, which were part of its TP study, in the final list of
comparables:
• Akshay Software Technologies Ltd: The company is
functionally comparable to the assessee. Originally, the TPO proposed to reject the said company as a
comparable on the ground that there was no related party
disclosure for FY 2009-10(Page 269 of the paperbook).
The assessee had objected to the same stating that on the
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16 basis of the annual report of the company, the related
party transactions would only be 4.33% and that
therefore, it ought to be included in the list of final
comparables (Page 307 of the paperbook). However, in
the TP order, the TPO rejected the said company on the
basis that 90% of its export revenues for the year were
from Dubai operations, whereas the assessee earns 100%
of its revenues from India. On the basis that the
company and the assessee operated in different
geographical areas, the TPO excluded the said company.
The assessee submits that the company passes all the
filters applied by the TPO and, therefore, the exclusion of
the company solely on the basis that its operations lie in
different geographical areas, which was not at all a filter
applied by the TPO, is wholly arbitrary and thus the
company ought to be included in final list of
comparables.
IT(TP)A No.281/B/15 CO No.101/B/15
17 In fact, in the assessee’s own case for the immediately
preceding assessment year, Akshay Software
Technologies Ltd. (‘Akshay’ for short) has been accepted
by the TPO and confirmed by the CIT(A) as being
comparable to the Assessee.
In addition, Akshay is consistently figuring in the final
list of comparables in the cases of several other similarly
placed assesses for the same assessment year in question.
Further, in Arowana Consulting Ltd. v.ITO in IT(TP)A
No.235/Bang/2015, this Hon’ble Tribunal vide its order
dated 29.06.2015 for AY 2010-11 directed that Akshay
be included in the final list of comparables.
We find that the Coordinating Bench of the Tribunal in the case
of Arowana Consulting Ltd., Vs ITO in IT(TP)A No.235/ Bang2015
has directed that Akshay Software Technologies Ltd is to be included
as comparable.
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18 20. Hence we direct the TPO to include the same in the list of
comparables.
• Evoke technologies Pvt. Ltd.: The TPO in his notice
dated 19.11.2013 proposed to reject the company on the
ground that its data for FY 2009-10 was unavailable
(Page 269 of the paper book). However, in its
submissions dated 18.12.2013 (at page 307 of the
paperbook) the assessee submitted that the annual report
of the company was available in the public domain. In
the order passed by the TPO (at page 8 thereof), he, in
fact, noted that it qualifies all the filters applied by him
and accepted the company as a comparable. The
company, however, did not figure in the final list of
comparables selected by the TPO presumably due to an
oversight on the part of the TPO. The assessee submits that the TPO having accepted the company as a
comparable, the DRP ought to have given necessary
directions for its inclusion in the final list of
comparables.
IT(TP)A No.281/B/15 CO No.101/B/15
19 Further, the company is consistently figuring in the final
list of comparables in the cases of several other similarly
placed assesses for the same assessment year in question
and its inclusion has neither been challenged by the
assessees nor by the Revenue.
It qualifies all dependents applied by the TPO are accepted.
Hence, Evoke Technologies Pvt. Ltd., to be included in the
list of comparables.
COMPUTATION OF ARITHMETIC MEAN OF 7 COMPARABLES:
The final list of 7 comparables and the arithmetical mean of
their margins would be as follows:
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IT(TP)A No.281/B/15 CO No.101/B/15
SN Name of the Company Mark-up Mark-up on Mark-up on on costs costs costs (unadj) (depreciation (WC and % Adj) depreciation – % adj % 1 Persistent Systems & Solutions 15.38 20.35 16.78 Ltd. 2 LGS Global Ltd. 11.95 13.70 9.10 3 RS Software (Ind) Ltd. 10.29 15.92 15.55 4 Thinksoft Global Services Ltd. 17.05 19.44 17.99 5 Mindtree Ltd. (seg) 14.83 21.75 19.04 6 Akshay Software Technologies -1.04 -0.53 -1.09 Ltd., 7 Evoke Technologies P Ltd 19.35 21.41 20.70 ARITHMETIC MEAN 12.54 16.01 14.01
The Assessee’s NCP Margin for FY 2009-10, after excluding
the depreciation charged by it from its operating cost, is 26.12%.
Thus, since the Assessee’s margin of 26.12% is higher than
the arithmetical mean of the margins of the comparables, that is
14.01%, the international transaction of provision of software
development services by the Assessee to its AE in FY 2009-10 can
be concluded as being at arm’s length.
IT(TP)A No.281/B/15 CO No.101/B/15
21 With respect to ground no.3 in the assessee’s cross-bjections 25.
the assessee submits :
The DRP erred in confirming the disallowance of
Rs.6,88,872/- made under Section 4D(a)(ia). It is submitted that
during the relevant previous year, the assessee incurred a total
expenditure of Rs.7,61,738/- on software. Out of the said
expenditure, the assessee had written off Rs.6,88,872/- was treated
as an inadmissible expenditure and book depreciation on capitalized
software expenses of Rs.72,866/- was added back. For income tax
purposes, the assessee had capitalized software expenses of
Rs.7,61,738/- and appropriate income tax depreciation of
Rs.3,69,858/- was claimed under Section 32.
The Assessing Officer, however, held that the payment for
purchase of software was in the nature of ‘royalty’ in terms of
Explanation 2 to Section 9(1)(vi) of the Act and held that the
assessee ought to have deducted tax at source under Section 194J of
the Act. Since such deduction was not made, a disallowance of
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22 Rs.6,88,872/- under Section 40(a)(ia) was made, although the
depreciation claimed was Rs.3,69,858/-.
The assessee submits that the provisions of Section 40(a)(ia)
do not apply to depreciation allowance under Section 32 of the Act.
The disallowance under the said provision applies to amounts in the
nature of interest, commission, brokerage, rent, royalty etc. A plain
reading of the provision shows that the disallowance under the
provision is only in relation to expenditure incurred which would be
deductible while computing the total income and would therefore
apply only to revenue expenditure. Depreciation is in the nature of
an allowance, that is, a statutory deduction under Section 32 of the
Act, and does not represent an outgo/ expenditure to attract the
provisions of Section 40(a)(ia).
In support of this proposition, reliance is placed on the
following decisions:
(i) Crane Software International Ltd. v. ACIT (judgment dated 08.02.2011 in ITA No.741/Bang/2010).
IT(TP)A No.281/B/15 CO No.101/B/15
23 (ii) SKOL Breweries Ltd. v. ACIT (2013) 29 taxmann.com 111/ITAT Mum) (iii) SMS Demag P.Ltd v. DCIT (2010) 132 TTJ 498 (ITAT Del) (iv) Kawasaki Microelectronics Inc. v. DDIT (2015) 60 taxmann.com 256 (Bangalore – Trb.)
We are of the opinion that the issue is squarely covered by the
decision in the case of Kawasaki Microelectronics Inc. Vs DICT
(International Taxation) in IT(TP) No.1512/Bang/2010 dated
26,6,2015, where it has been held that once the assessee has
capitalized payment in question though the assessee has not deducted
tax at source on such payment, section 40 (a) (1) cannot be invoked
for disallowance of depreciation.
The Cross-objection filed by the assessee is allowed.
In the result, the appeal of the Department is dismissed and the
Cross-objection of the assessee is allowed.
Order pronounced in the open court on 30th September, 2016.
IT(TP)A No.281/B/15 CO No.101/B/15
24 Sd/- Sd/- (S JAYARAMAN) (ASHA VIJAYARAGHAVAN) ACCOUNTANT MEMBER JUDICIAL MEMBER Bangalore Dated : 30/09/2016 Vms Copy to :1. The Assessee 2. The Revenue 3.The CIT concerned 4.The CIT(A) concerned 5.DR 6.GF By order
Asst. Registrar, ITAT, Bangalore.
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