SAIC INDIA PVT. LTD.,NOIDA vs. DCIT, NEW DELHI

The Ld. AO/Ld. TPO/Ld. DRP erred in-rejecting Appellant's plea that keeping in view the peculiar facts of the case this year, the Proviso to Rule 10B(4) of the Income Tax Rules, 1962 .

Briefly stated the facts of this case are : a reference has been made by the AO under section 92CA (3) of the Income-tax Act, 1961 (for short ‘the Act’) to the Transfer Pricing Officer (TPO) to determine the Arm’s Length Price (ALP) in respect of the international transactions entertained into by the assessee during the financial year 2007-08. Assessee company is a provider of engineering and technology application solution and concentrates on using its domain knowledge to provide solution to wide range of industries viz. energy, environment, financial services, health care, life sciences, national security, space, telecommunications, transport, etc.

Assessee company engaged in the profession of software development services to its group company during the financial year 2007-08. The assessee company formerly known as SCICOM Technologies Private Limited which was acquired by SAIC USA in September 2007 and consequently, the branch office of SAIC Ltd. w.e.f. December 2007. Prior to the acquisition of SAIC, the company acted as an entrepreneur and the transfer pricing arrangement between the company and its marketing subsidiary was based on a revenue split. During the year under assessment, assessee company entered into international transaction as under:-

Assessee company to benchmark its international transaction for provision of software development services adopted TNMM as the most appropriate method and computed the test party margin at 12.08%. Assessee selected 25 comparables, used three years data and computed their mean margin at 13.74% and claimed its international transaction at arm’s length.

TPO, when compared the tested party margin with profit & loss account of the assessee, noticed that a sum of Rs.1,70,00,000/- being the retention bonus paid to the employees has been treated as non-operating expenditure and consequently, reduced from total expenditure and similarly another sum of Rs.66,84,551/- being the foreign exchange fluctuation has been treated as non-operating whereas both these items are in the nature of operating expenses. Accordingly, assessee was called upon to treat retention bonus of Rs.1,70,00,000/- and foreign exchange fluctuation of Rs.66,84,551/- as operating expenses computed as under :-

Ld. TPO applied the filters viz. functional profile, companies having export sales of more than 25% of the total income, companies having employee cost to total cost of 25%; related party transaction is considered at 25% and used the data for financial year 2007-08 for benchmarking the international transaction.

By applying the aforesaid filters, the ld. TPO, out of 25 comparables chosen by the assessee for benchmarking its international transaction, accepted 5 comparables only and proposed to select 10 comparables having arithmetic mean at 27.02%. After considering the objections raised by the assessee, TPO has chosen 10 final comparable companies having mean margin of 26.79%. The ld. TPO also considered the segmental result of Kals Information System Ltd., R System International and Sasken Communication Technologies Ltd. and consequently made an adjustment of Rs.9,06,20,898/- between the difference in ALP and the price charged by the assessee from its Associated Enterprises (AEs) for export services.

Ld. DRP also directed the TPO to exclude foreign exchange fluctuation from operating income/loss of the assessee/comparables by accepting the contentions raised by the assessee. However, ld. DRP ratified the observation made by AO as to disallowing a sum of Rs.43,12,128/- out of staff recruitment expenses of Rs.53,90,160/- and training expenses of Rs.16,01,153/- after allowing 1/5th of these expenses and retention bonus expenses. Feeling aggrieved, the assessee company has come up before the Tribunal by way of filing the present appeal.

We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case.

At the very outset, ld. AR for the assessee by moving an application under Rule 11 of the Income Tax Appellate Tribunal Rules sought to raise the additional ground as under :- “That on the facts and in circumstances of the case the authorities below should have excluded following comparables:-

However, on the other hand, ld. DR opposed the application on the grounds inter alia that the assessee cannot be allowed to para-drop favourable comparables and exclude unfavourable ones at this stage as it has been granted full opportunity to choose the correct comparables before TPO; that except Bothtree Consulting Limited, none of the comparables now sought to be introduced by the assessee has been taken before the TPO; that taking new comparables at this stage would cause prejudice to the revenue as complete search of the new comparables is not possible at this stage.

Keeping in view the ratio of the judgments (supra) referred to in the preceding paras relied upon by the assessee that even if a particular plea factual or legal not taken by the assessee before the lower authorities out of ignorance or negligence, they cannot be estopped from taking a correct view later on before the appellate authority; that though admission is an admissible piece of evidence but it cannot be said to be conclusive as it is open to the person who made the admission to show that it is incorrect; that the assessee is entitled to argue before the appellate authorities that a wrong stand taken at the time of filing of return of income should be allowed to be modified; that in case, the assessee has not included correct comparable in its TP study nor sought to exclude the comparables chosen by the TPO, the assessee cannot be estopped from furnishing the correct position regarding comparables at any stage of the proceedings, we are of the considered view that to arrive at the logical conclusion as to benchmarking the international transaction undertaken by the assessee during the year under assessment, new set of comparables now sought to be excluded by way of additional evidence is necessary for complete adjudication of the controversy at hand. So far as question of causing prejudice to the revenue at this stage is concerned, it would amount to prejudging the issue sought to be raised by the assessee by way of additional ground, because question of comparability, if any, is ultimately to be determined by the TPO by providing an opportunity to be heard to the parties. So, we hereby allow the application under consideration without prejudice to the merits of the case.

Though corporate tax grounds as well as transfer pricing grounds are inter-linked but, for the sake of brevity, all the grounds under both the heads are being discussed separately.

Ld. AR for the assessee contended that recruitment and training expenses incurred by the assessee are revenue expenditure, hence allowable and relied upon judgment cited as Hindustan Aluminium Corporation Ltd. vs. CIT - (1986) 159 ITR 673 and CIT vs. Munjal Showa Ltd. - (2010) 329 ITR 449.

Hon’ble Supreme Court in judgment cited as Hindustan Aluminium Corporation Ltd. (supra) while deciding the identical issued held as under :- “CAPITAL OR REVENUE EXPENDITURE – ASSESSEE ESTABLISHING FACTOYR FOR MANUFACTURE OF ALUMINIUM – EXPENDITURE INCURRED IN SENDING SOME EMPLOYEES TO U.S.A. FOR PRACTICAL TRAINING AND EXPERIENCE IN RUNNING FACTORY – TRAINING GIVEN TO ACHIEVE EFFICIENT RUNNING OF FACTORY FOR GAINING OPTIMUM PRODUCTION – DIRECTLY LINKED TO PROFIT EARNING PROCESS – IS REVENUE EXPENDITURE – EXPENDITURE INCURRED FOR PRSPECTIVE AND SEARCHING BAUXITE MINES – BAUXITE RAW MATERIAL FOR PRODUCTION OF ALUMINIUM – EXPENDITURE WAS FOR EARNING PROFITS – IS REVENUE EXPENDITURE AND AN ALLOWABLE DEDUCTION – INCOME TAX ACT, 1961, S. 37.”

Similarly, Hon’ble jurisdictional High Court in judgment cited as CIT vs. Munjal Showa Ltd. (supra) while deciding the identical issue held as under :- “CAPITAL OR REVENUE EXPENDITURE – FEES PAID TO FOREIGN COMPANY FOR DESIGNS AND DRAWINGS AND EXPENSES ON FOREIGN TECHNICIANS FOR TRAINING ASSESSEE’S PERSONNEL – EXPENDITURE FOR FACILITATING PROCESS OF MANUFACTURE – EXPENSES INCURRED ARE REVENUE EXPENDITURE – INCOME TAX ACT, 1961.”

Now, adverting to the case at hand, when the assessee has come up with specific pleas that he has made payment of Rs.37,89.007/- to the third party recruitment agency, access fee to various job sites like naukari.com etc. and Rs.16,01,153/- for imparting training to the new employees who have recently joined and on job training to existing employees, which have otherwise been not disputed by the AO/DRP, recruitment of employees for efficient profit earning through a recruitment agency is recurring process and such expenditure cannot be avoided / deferred. At the same time, in the globalised set up, sudden upgradation of knowledge and skill of the IT engineers / technicians for providing IT Software Development Services particularly to foreign AE is also necessary for earning profit by a company. Moreover, when undisputedly there is no memorandum of understanding between the assessee company and its employees that the employee will work for specific period, as the attrition rate in software industry is highest, recruitment of employees and imparting of training to them cannot be considered as of enduring benefit. So, by following the law laid down by the Hon’ble Calcutta High Court Hindustan Aluminium Corporation Ltd. vs. CIT (supra) and Hon’ble jurisdictional High Court in CIT vs. Munjal Showa Ltd., we hereby decide ground no.1 in favour of the assessee.

Keeping in view the fact that the expenditure on account of quality audit incurred by the assessee even if treated to be of enduring nature, it is to be treated as expenditure in the nature of revenue field as the test of benefit of enduring nature breaks down in this case. Because quality audit creates positive image of the product of the assessee; it fulfills the requirement of certain clients which contracts with the assessee company only with such certification; that by making such expenditure, assets of the assessee company has not been enhanced in any manner. So, we are of the opinion that DRP has erred in deciding this issue against assessee. Consequently, ground no.2 is determined in favour of the assessee.

Ld. AR challenging the impugned order contended inter alia that provisions contained u/s 40(a)(i) are not applicable to depreciation; that depreciation is a statutory deduction and it is obligatory for the AO to allow the deduction of deprecation irrespective of the claim of the assessee.

Now the question arises for determination is “as to whether the AO/DRP have erred in treating the payment for acquisition of software as fee for technical services / royalty.”

Ld. DRP, while relying upon the decision rendered by ITAT, Delhi in the case of Grarcemac Corp. vs. ADIT (ITA No.1331 – 1336 of 2008) held that the consideration for acquiring such software was royalty which was taxable in India u/s 9(1)(vi) and Article 12 of DTAA, amended by Finance Act, 2012 with retrospective effect and it is provided therein that royalty includes payment for transfer of any right to use computer software and tax was required to be deducted at source and ratified the order passed by the AO in disallowing the deduction for such payment u/s 40(1)(i) on ground of the non-deduction of tax at source. 27. However, Hon’ble jurisdictional High Court in judgment cited as Director of Income Tax vs. Infrasoft Ltd. - (2013) 39 Taxman.com 88 made a distinction between royalty paid and consideration for transfer of copyrighted articles to decide the issue if royalty is to be paid in case of purchase of computer software by making following observations :-

The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process is necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said paragraph because it is only integral to the use of copyrighted product. Apart from such incidental facility, the licensee has no right to deal with the product just as the owner would be in a position to do 91. There is no transfer of any right in respect of copyright by the Assessee and it is a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article and cannot be considered as royalty either under the Income Tax Act or under the DTAA.”

Judgment cited as DIT vs. Infrasoft Ltd. (supra) is applicable to the facts and circumstances of the case in which undisputedly no licence has been issued by the AEs in favour of the assessee for transfer of copyrights but assessee has merely paid the consideration for transfer of copyrighted article in the form of PTC software and as such, exclusive right has not been transferred in favour of the assessee qua the software purchased by it rather assessee’s right was restricted to use the copyrighted product for internal business purpose.

Identical issue has been dealt with by the Tribunal in case cited as SMS Demag (P.) Ltd. vs. DCIT, 9 (1), New Delhi – (2010) 38 SOT 496 (Delhi), the operative part of the findings are as under:- "Section 40(a)(i) of the Income-tax Act, 1961, read with article 24 of the DTAA between India and Germany - Business disallowance - Interest, etc., payable outside India - Assessment year 2000-01 - Assessee paid certain amount to 'AG', its parent company in Germany for purchase of software 'SAP' - It claimed deduction on said payment - Assessing Officer disallowed assessee's claim on ground that said amount paid by assessee to its parent company was in nature of royalty/fees for technical services and was chargeable to tax in India - Whether payment made for purchase of software cannot be treated either as royalty or fees for technical services - Held, yes - Whether therefore, payment for SAP software could not be charged to tax in India as interest or royalty or fee for technical services - Held, yes - Whether even otherwise because of non-discriminatory clause 24(1) of DTAA with India and Germany, foreign national could not be subjected to provisions of section 40(a)(i) and, therefore, amount paid by assessee for acquisition of computers could not be taxed in India - Held, yes”

So, by following the judgments in case of DIT vs. Infrasoft Ltd. and SMS Demag (P.) Ltd. (supra), we are of the considered view that AO/DRP have erred in treating the acquisition of software under the head ‘fee for technical services/royalty’ requiring the assessee to pay the tax on the same.

Assessee debited an amount of Rs.2,10,21,984/- on account of retention bonus paid to its employees, out of which AO/DRP disallowed an amount of Rs.1,68,17,587/- being 4/5th of the total liability of Rs.2,10,21,984/- by treating the same as capital expenditure on the grounds that the said expenditure was incurred due to amalgamation of Bangalore branch of US company by the assessee which is to be amortized over a period of five successive years in equal proportion by invoking the provisions of section 35DD of the Act and that the retention bonus paid to the employees are not in the nature of normal business expenditure but expenditure which would result into enduring benefit.

Undisputedly, an amount of Rs.2,10,21,984/- on account of retention bonus was paid by the assessee company prior to filing of the income-tax return.

Ld. AR for the assessee contended that AO/DRP have erred in treating the “retention bonus” as amalgamation expenses because it was not a case of amalgamation rather it was a case of sale of Bangalore branch of US company by the assessee company.

In the backdrop of the aforesaid facts and circumstances, the first question arises for determination in this case is “as to whether transfer of business of one of the branch of SAIC Group of USA to the assessee company on November 30, 2007 amounts to amalgamation or sale of the branch of US branch?” 36. Bare perusal of the assessment order as well as order passed by the DRP and material brought on record by the parties go to prove that the business of the SAIC Group, USA branch has been transferred to the assessee and in consideration thereof, the assessee issued shares to SAIC Group, USA. Assessee company stated to have paid the bonus to the erstwhile employees of transferring company to ensure the smooth functioning of the business. So, there is no material on file to arrive at the conclusion that it was a case of amalgamation rather a case of sale on transfer of the shares by the assessee company to SAIC Group, USA. So, the findings of the AO/DRP that the retention bonus expenditure are amalgamation expenses are based upon surmises only.

DRP in order to ascertain whether the payment of retention bonus actually entail any extra expenditure by the assessee as compared to the earlier years and succeeding years called upon the assessee to provide the details of the employee cost and total opening cost for the financial year 2005-06 to financial year 2010- 11, which has been supplied by the assessee company, which is reproduced for ready reference as under :- “7.3 We have considered the submissions of the assessee. High rate of attrition of employees in software industry is a very common feature. As per the NASSCOM Report available on website http://www.dnb.co.in/TonIT 08/overview.asp, Major players in the Indian software industry - Tata Consultancy Services TCS), Infosys Technologies, and Wipro--- are currently witnessing high attrition rates. TCS reported an attrition rate of 11.5% - up from 10.6% a year ago; the attrition rate at Infosys was 13.17% in FY07 - higher than 11.2% recorded in FY06; the rate at Wipro witnessed a surge to 17.4% as against 14.6% during the previous fiscal, in its global IT services and product business That is why the payment of various incentives to retain the employees such as Employees Stock Option (ESOP) and payment of retention bonus is a very common HR strategy to ensure continuity and retention of talent in the company. By paying such incentives, the company saves a lot of expenditure which it would have otherwise required to spend on the training and recruitment of new employees. All software company have to give such incentives to its employees in order to retain them. In order to ascertain that whether the payment of retention bonus actually entailed any extra expenditure by the assessee as compared to the earlier years and subsequent years, the assessee was requested by this panel to provide the details of the employees cost and the total operating cost for the F.Y.2005-06 to F.Y.2010-11. The details filed by the assessee vide letter dated 23.08.2012 are as follow.

On the basis of material available on record, ld. DRP came to the conclusion that there is no substantial increase in the employee cost as a proportion of total operating cost as compared to the earlier years i.e. it has increased from 67.14% in the previous financial year to 68.12% in the financial year under assessment which is insignificant amount to have any substantial effect on the profit margin of the company.

Ld. DRP also noticed that retention bonus was payable over next three years and now in the year under assessment alone. Ld. DRP returned self contradictory findings that on the one hand, it is observed that the payment of retention bonus and allotment of ESOPs is very common feature in software industry and therefore such cost would be embedded in the employee cost of comparable also and on the other hand, ld. DRP observed that retention bonus paid to the employee in order to retain them for future is not in the nature of normal business expenditure but an expenditure resulting into enduring benefit to the company. 40. Ld. AR for the assessee also contended that the retention bonus paid to the employees of the erstwhile company falls under the definition of salaries u/s 15 of the Act. 41. For facility of reference, section 15 of the Act is reproduced as under :-

So, when the retention bonus has been paid by the assessee company to the erstwhile employees of SCICOM in order to ensure the smooth functioning of the business to arrest the attrition rate prevalent in the software industry, it would certainly enhance the profitability of the assessee company. So, we are of the considered view that payment of retention bonus made by the assessee company partakes character of salary payable to its employee for the business purposes and has to be treated as revenue expenditure.

Now, coming to TP grounds specifically raised by the assessee company, during the year under assessment, assessee company was engaged in the profession of software development services to its group company and has entered into international transactions with its AE to the following effect :-

Assessee company by applying Transactional Net Margin Method (TNMM) in order to benchmarking its international transaction computed its margin at 12.08% as against mean operating margin of the comparable selected by it at 13.74%.

However, TPO by making fresh search on the basis of current year data only i.e. financial year 2007-08 and by applying different sets of filters chosen 10 comparables arrived at arithmetic mean OP/OC margin of comparables at 26.79% and computed ALP of software development services provided by the assessee company to its AE as under :-

Undisputedly, TNMM is the most appropriate method applied by both the assessee company as well as TPO in this case for benchmarking the international transaction.

Ld. AR for the assessee to cut short the controversy as to the benchmarking the international transaction undertaken by the assessee restricted its argument for inclusion of two comparables, namely, M/s. Aarman Software Private Limited and CG-VAK Software & Exports Limited otherwise rejected by the TPO as well as ld. DRP and for exclusion of Kals Information System Ltd. otherwise accepted by the TPO/DRP, which are discussed as under:-

Ld. TPO rejected this company as a comparable on the ground that it fails employee cost filter; that employees cost should be more that 25% of the total cost whereas assessee for benchmarking international transaction applied the filter of employees cost more than 25% of the total sales. However, assessee company proved on record that employees cost (cost of service) as percentage of the total revenue of the company is 75.55%. During the course of argument, ld. AR for the assessee has fairly conceded that filter of employees cost more than 25% of total cost is to be applied in this case.

Assessee brought on record profit and loss account for the year ending 31.03.2008 lying at pages 771 to 775 wherein in column no.15 cost of services has been duly described. When the filter of employees cost more than 25% of total cost is to be applied of cost of services described in column no.15 at page 774 of Volume IV of paper book, all the cost of services are to be treated as salary and this comparable company qualifies for inclusion in the final list of comparables. So, we are of the considered view that this issue is again required to be reconsidered by the TPO by taking into account the cost of services while applying the filter of employees cost of more than 25% of total cost. So, we hereby restore the issue to the TPO to decide afresh by providing opportunity of being heard in the light of the observation made herein before.

This company has been accepted as a comparable by the TPO but the assessee has opposed its inclusion on the ground that its segmental margin having inconsistency in segmental information and P&L account for financial year 2007-08 has been used without providing an opportunity of being heard to the assessee. Ld. DRP by accepting the contention of the assessee recomputed the margin of this company at 13.92% after allocating in allocated operational expenses in proportion of revenues. But, undisputedly, the directions issued by the DRP have not been complied with. So, the mater is required to be determined afresh by the TPO in the light of the unchallenged observations made by the DRP by providing an opportunity of being heard to the assessee company.

However, ld. AR contended that identical issue has been decided by the Tribunal in case cited as Qualcom India Pvt. Ltd. vs. ACIT (ITA No.5239/De l/2010). Coordinate Bench in the judgment cited as Qualcom India 54. Pvt. Ltd. (supra) determined the issue of working capital adjustment to account for difference in working capital employed by assessee vis-à-vis comparable companies in favour of the assessee by making following observations :- “41. Considering the above submissions we concur with the submission of the Ld. DR that the issue raised in ground No. 6 & 7 on account of working capital adjustment and risk adjustment depend upon the fact and circumstances of each case. But at the same time we are of the view that these factors are equally important to consider while selecting comparable companies. In the present case the assessee is engaged in the business of software development and providing marketing services, hence there is no dispute that appropriate adjustment to account for difference in working capital employed by the assessee vis. a vis. the comparable companies for software development services is required to be considered. Similarly making of suitable adjustments to account for differences in the risk profile of the assessee vis. a vis. the comparable companies for software development services is also required to be considered. Of course these adjustments on account of working capital and risk is to be made after analyzing the case of the assessee since it depends upon the facts of the case of the assessee. The request for such adjustments cannot be summarily rejected unless some analysis of the case of the assessee is made vis-a-vis comparables companies. We thus set aside the matter to the file of the Ld. TPO/AO

Identical issue has also been dealt with by the ITAT, Delhi Bench ‘E’, New Delhi in case cited as M/s. Nokia India Pvt. Ltd. vs. Addl. CIT (ITA No.551/Del/2011) and determined the issue in favour of the assessee by returning the following findings :- “5.1 Thus it is the contention of the ld. counsel of the assessee that the TPO while determining the arm's length price of the subject international transaction during assessment year 2006-07 ignored the fact the assessee has been granted the benefit of the working capital adjustment during A.Y. 2005-06 by himself and the fact the same has also been allowed by his predecessors during the transfer pricing assessment proceeding for A.Y. 2002-03 till A.Y. 2004-05 despite the constraints mentioned in the transfer pricing order. Thus, it is the contention of the assessee that there is no change in the business model of the assessee with respect to the provision of contract software development services of the assessee vis-a-vis A.Y. 2005-06, the benefit of working capital adjustment should be allowed to the assessee in the subject year under appeal as well. 5.2 Ld. counsel of the assessee has further submitted that Rules 10B(1)(e) of the Rules prescribe that at the time of application of Transactional Net Margin Method,

We have carefully considered the submissions in light of the material produced and precedent relied upon. It is an undisputed fact that on the same set of facts and in the same business model the assessee has been provided the working capital adjustments in the preceding assessment years. Under the circumstances, in our considered opinion, it was incumbent upon the TPO to consider the same in the current year.”

Keeping in view the fact that the issue in question has been settled in the cases cited as Qualcom India Pvt. Ltd. and M/s. Nokia India Pvt. Ltd. (supra and the fact that assessee in this case is engaged in providing software development services to its group companies and to arrive at ALP of the international transactions, the ld. TPO / DRP resorted to comparability by selecting different sets of comparable companies and after applying the various filters, the ld. TPO selected 10 comparable companies as mentioned in para 8.7 of his order, the appropriate transfer pricing adjustment can only to be made qua the international transaction undertaken by the assessee company during the year under assessment on the basis of its comparability vis-à-vis comparable companies, by providing working capital adjustment to the assessee in view of the provisions contained under Rule 10B(1)(e) also. So, we are of the considered view that the matter is required to be restored to the TPO to provide the assessee company the benefit of working capital adjustment for transfer pricing adjustment.