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Income Tax Appellate Tribunal, DELHI BENCH ‘I-2’ : NEW DELHI
Before: SHRI N.K. BILLAIYA & SHRI KULDIP SINGH
(PAN : AABCE4540P) (APPELLANT) (RESPONDENT) ASSESSEE BY : Shri Ravi Sharma, Advocate REVENUE BY : Shri Shashi Bhushan Shukla, CIT DR Date of Hearing : 10.06.2021 Date of Order : 15.07.2021 O R D E R PER KULDIP SINGH, JUDICIAL MEMBER : Hon’ble Punjab & Haryana High Court in of 2016 (O&M) & ITA No.405 of 2016 (O&M) vide order dated 30.10.2019 set aside the order passed by the Tribunal dated 15.02.2018 with direction to examine the issue, “whether the assessee is engaged in the activities of software development after considering the additional evidence placed before this Court, namely, Annexure A-6 to A-13 and any other evidence which should be produced after hearing both the parties and allowing sufficient opportunity to the Revenue to verify the same” by returning following findings :-
“31. The brief facts leading to the present appeal are that the Appellant is a company engaged in IT Services and IT Enabled Services which has been accepted by the assessing officers and the Transfer Pricing Officer vide orders for A.Y. 2010-11 and 2011-12, however, for the present year i.e. A.Y. 2013-14, the Transfer Pricing Officer characterized the Appellant as ITES Service Provider only rejecting its claim of providing IT Services in the nature of Software Development which had been accepted for all preceding years. The claim of the assessee before the Dispute Resolution Panel that it had two distinct segments of IT i.e. Software Development and ITES were also rejected and the findings of the TPO were upheld. The Assessee appellant filed an appeal before the ITAT and during the course of hearing on 8th February, 2018, the Appellant was directed by the ITAT to submit additional evidence demonstrating that the appellant was engaged in IT services including software development activity. The hearing on 8th February, 2018 being a Thursday was adjourned to 12th February, 2018, thus, the Appellant was provided one working day before the final hearing on 12 February, 2018 which was a Monday. The present appeal has been filed alongwith an application for additional evidence wherein voluminous evidence has been filed by way of Annexure A-6 to A-13 indicating that the assessee was engaged in software development.
Keeping in view the fact that the Transfer Pricing Officer had in the preceding years accepted that the assessee was engaged in IT Services (i.e. including software development and ITES) as is evident from the assessment order, which are part of the ITAs 419 of 2016 and 405 of 2016 and considering the fact that due to paucity of time, the assessee could not produce evidence before the ITAT. The order of the ITAT dated 15th February, 2018 is set aside and the ITAT is directed to examine the issue whether the assessee is engaged in the activity of software development after considering the additional evidence placed before this Court namely Annexures A-6 to A-13 and any other evidence which may be produced after hearing both the parties and allowing sufficient opportunity to the revenue to verify the same.”
Briefly stated the facts necessary for adjudication of the controversy at hand are : Orange S.A., formerly known as France Telecom S.A., is a French multinational telecommunication corporation, serving more than 225 customers in nearly 35 countries. Orange S.A. is a leading European wireless operator and broadband service provider, with nearly 175 million mobile customers and more than 15 million broadband subscribers.
Orange S.A. is a recognised leader in global, integrated and customized communication infrastructure solutions that enable the key business processes of its customers. Currently, 8 out of every 10 companies extend or renew their outsourcing contracts with the Group and no contract with the customer has ever been prematurely ended. Building on an extensive experience in data communications, Orange S.A. serves over 3,750 large business customer including two-thirds of the world’s largest companies.
Orange S.A. network consists of switches, routers, hosted servers and nodes, leased and owned capacity to link switches and network intelligence and control to prove full resilience on each route. The taxpayer does not in general, build any of its transmission structure, rather it controls the “intelligent” part of the network and the switching and routing, as opposed to owning the physical network fiber and the optronics required to light such network fibre. The taxpayer has the industry’s most extensive portfolio of communication services and network solutions, including more than 323,000 marketing leading IP VPN access points in 172 countries.
The taxpayer, an Indian entity and a part of Orange Group is a subsidiary of EGN BV, Netherlands, which is into providing information technology enabled network management / technical support and other back office support services to its group companies. It also undertakes software developments services for developing software applications which are used within the Orange Group.
4. The IT enabled network management/technical support and other back office support services performed by the taxpayer primarily include remote monitoring and maintenance of Orange’s Global network platforms and services, coordination, remote configuration and implementation of quality customer networking solutions. Further, under the category of software development services, the taxpayer is engaged in providing routine Contract Software Development Services (CSDS) relating to development and maintenance of applications used within the Group like Human Resource, Accounting etc.
5. The taxpayer filed its return of income at Rs.32,82,84,980/- declaring three international transactions in Form 3CEB. Matter was referred to ld. TPO for benchmarking of international transactions. Taxpayer’s international transactions as per Form 3CEB with its AEs are as under :-
S. Nature of Value Ld. TPO approach No. Transactions (Rs.) 1. Provision of IT 241,63,07,817 Transfer Price (‘TP’) Services Adjustments Provision of IT services amounting to INR 13,67,86,810 (The Ld. TPO merged the CSD and ITeS segment); and Interest on outstanding receivables amounting to INR 8,05,59,981 2. Cost Recharges 1,25,52,121 Accepted to be arm’s length 3. Payment of interest on 49,18,007 Accepted to be arm’s loan length
6. The taxpayer in order to benchmark its international transactions applied Transactional Net Margin Method (TNMM) with Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) as the Most Appropriate Method (MAM) for determining the arm’s length nature of its international transactions pertaining to ITES & IT segments summarized as under :-
Nature of Most PLI OBSISPL’s Comparables International appropriate operating working capital Transaction method mark-up/ adjusted Price OP/TC Provision of IT enabled 13.54% Services Contract TNMM OP/OC 17.30% software 13.04% development services Consequently, the taxpayer found its international transactions at arm’s length.
However, ld. TPO rejected Contract Software Development Services (CSDS) segment as claimed by the taxpayer and characterized the taxpayer as ITES provider only. Consequently, ld. TPO proceeded to consider the total amount of revenue pertaining to ITES segment and benchmarked the transactions considering the comparables of that business segment. Ld. TPO introduced some new filters and selected different set of comparables to benchmark the international transactions. Ld. TPO finally selected 12 comparables having average of 23.94% as against 17.30% computed by the taxpayer and proceeded to propose ALP of the transaction relating to provisions of ITES as under :-
Particulars Amount (INR) Operating Cost 2,059,944,026 Arm’s length margin (%) 23.94% Arm’s length margin (Rs.) 493,150,600 Arm’s length Price 2,553,094,626 Price charged by the assessee 2,416,307,816 Difference between ALP and price 13,67,86,810 charged by assessee
Consequently, ld. TPO proposed an amount of Rs.13,67,86,810/- as adjustment u/s 92CA of the Act.
The taxpayer carried the matter by way of filing objections before the ld. DRP who have not accepted the same and upheld the order passed by the ld. TPO. In compliance with the orders passed by the ld. TPO/DRP, AO made adjustment in the final assessment order. The Tribunal vide order dated 15.02.2018 also upheld the aggregation of IT and ITES segment and remanded the matter back to ld. TPO for selection of comparables operating in both IT and ITES segment. The taxpayer carried the matter before the Hon’ble High Court challenging the segmentation of rejection of CSDS and ITES segment by the TPO/DRP and the Tribunal. 10. Hon’ble High Court set aside the matter and remanded the case back to the Tribunal to examine the issue, “whether the assessee is engaged in the activities of software development after considering the additional evidence placed before this court, namely, Annexure A-6 to A-13 and any other evidence which may be produced after hearing both the parties to the 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.
Undisputedly, the taxpayer company has been held to be engaged in IT services and ITES by the AO as well as TPO vide their orders passed in AYs 2010-11 and 2011-12. It is also not in dispute that there is not an iota of material in the TP order as well as DRP order if there is any change in the business model of the taxpayer during the year under assessment i.e. AY 2013-14.
However, TPO/DRP/Tribunal in first round of litigation have characterized the taxpayer as ITES provider by rejecting the taxpayer’s claim of providing IT services in the nature of software development. Since AY 2010-11 it has been providing services in two distinct segments i.e. IT & ITES segments.
When we peruse the order passed by the Tribunal particularly para 10, it is a matter of fact that the taxpayer had failed to present before the Tribunal authenticated data in respect of ITES and CSDS. Thus, the taxpayer had failed to prove its claim that highly qualified persons were used for CSDS and lowly qualified persons were used for ITES services and had also failed to substantiate its segregated revenue in respect of IT and ITES segments.
Before Hon’ble High Court, the taxpayer has candidly admitted that it could not produce evidence before the Tribunal due to paucity of time as only one working day was granted by the Tribunal to file any additional evidence. Now, the taxpayer has produced additional evidence in the form of Annexures A-6 to A-13 before the Hon’ble High Curt/Tribunal, to prove the fact that the taxpayer is engaged in two distinct activities i.e. CSDS and ITES services.
The ld. AR for the taxpayer drew our attention towards pages 227 to 284 of the convenience compilation which is complete details and resumes qua the educational and professional experience of the key employees of the taxpayer working in IT segment. Evidence brought on record in the tabulated form under the head “details as per head count for FY 2012-13” shows that the taxpayer has engaged a team for software development of highly qualified engineers to perform software development activities.
The taxpayer has also brought on record job description of Project Manager IT and Lead Programme Manager of the taxpayer company having Bachelor Degree of Software Engineering or Computer Science, BS Technology Management or equivalent and Project Manager IT having experience of 7 – 10 years including development and implementation of product methodologies and standards. It is also proved on record that Project Managers IT are having knowledge in WEB development environments (LAMP, WAMP), on OS such as Windows 2008 and UNIX (Workstation) and in Oracle database management and design.
15.1 The taxpayer also employed Lead Programme Manager having experience of 15 years in software application programming and development in telecommunications in multicultural and international environment. The taxpayer has brought on record screenshots of application that are developed by the taxpayer, functional specification documents, internal e-mails regarding deliverables etc., which are available in the convenience compilation at pages 285 to 345.
All these facts substantiate the claim of the taxpayer that it has a full-fledged team of software development engineers to carry out its software development activities and they are carrying out software development activities independently. The taxpayer has also brought on record list of employees working in contracts of contract software development services /ITES services along with the monthly cost of each employee available at pages 285 to 345 of the convenience compilation.
When we examine this evidence in the light of the order passed by the AO/TPO in AYs 2010-11 & 2011-12, there is no change in the functional profile of the taxpayer company and likewise, there is no change in the international transactions as well as functions performed by the taxpayer. The TPO/DRP/Tribunal have reached the conclusion that because of paucity of evidence the taxpayer has failed to substantiate that it is carrying out activities in two segments viz. CSDS and ITES.
So, when Revenue has been accepting and benchmarking such international transactions in segregated manner in earlier years in taxpayer’s own case and there is no change in the nature of international transactions as well as functional profile of the taxpayer during the year under assessment vis-à-vis earlier assessment years, following the “rule of consistency” as has been held by Hon’ble Supreme Court in Radhaswami Satsang vs. CIT (1992) 193 ITR 321 (S.C.), we are of the considered view that both the segments viz. CSDS and ITES are required to be benchmarked independently/in segregated manner.
Now, the next question arises is as to how to allocate certain common expenses incurred by the taxpayer in various segments for the purpose of calculation of the gross profit margin. Ld. AR for the taxpayer while replying upon the decision rendered by Hon’ble High Court of Delhi in case of Fujitsu India Private Ltd. vs. DCIT in ITA 604/2017 order dated 13.02.2019 contended that in such situation, “head count” method for allocation of such common expenses needs to be applied.
Hon’ble High Court in the case of Fujitsu India Private Ltd. (supra) upheld the head count principle by returning following findings :-
3. As far as the first question is concerned, while arriving at the transfer pricing adjustment by the ALP, the Assessing Officer/TPO had to allocate certain common expenditure. The tax authority applied the first principle of apportionment, which resulted in proportionate allocation of expenditure attributable to the concerned segments. After completion of this step, a sum of ₹9.79 crores, remained as un-allocable costs. For this, the assessee sought to use the “headcount method for allocation as the allocation principle to ascribe the segment to which the expenses were to be considered. The assessee’s arguments with respect to application of the “headcount” basis was rejected by the TPO, DRP and later by the ITAT in the impugned order.
Mr. Srivastava, learned counsel appearing on behalf of the assessee relied upon the judgment of the this Court in Commissioner of Income Tax vs. EHTP India Pvt. Ltd. (2013) 350 ITR 41(Del.). In that decision, the Court indicated broadly that if headcount had been the basis for proportionate allocation of costs, there was no objection or illegality attached to it. The Court of course in that case was cognizant of the circumstances that the principle of headcount had been applied consistently in the past by the assessee. Learned counsel for the Revenue relied upon the Tribunal’s order and submitted that the rejection of the headcount principle was justified. The Tribunal’s reasoning was that the headcount principle was irrational given the disparity of salaries of the employees of the different segments.
It is apparent that the headcount basis is an acceptable principle and known to law. EHTP India Pvt. Ltd. (supra) recognized it; although the Court took note of the previous practice of the assessee, at the same time it did not in any manner frown upon the application of that principle.
This Court notices that the principle of applying the headcount method has not been universally accepted and was in fact rejected in M/S Continental Carriers vs. Commissioner of Income Tax, New Delhi (2016) 384 ITR 102. At the same time, the Court did say so on the basis that the assessee had not followed the consistent method; and that the issue of allocation of such expenditure was in the context of deduction claimed under Section 80(4). This Court is of the opinion that the two possible choices, i.e. turnover method as well as the headcount method in the present case was not justified. Concededly, the expenditure incurred by the assessee was common for two different segments. The tax authorities broadly agreed that expenditure could be allocated on the basis of proportionate turnover of the concerned segment. Having done so, the alternative was open to accept one or the other principle. Therefore, the choice of the assessee in relying upon the headcount principle per se could not have been rejected. The question of law, therefore, is answered against the Revenue and in favour of the assessee.”
So, keeping in view the evidence brought on record by the taxpayer and following the reasons rendered by Hon’ble High Court of Delhi in case of Fujitsu India Private Ltd. (supra), we are of the considered view that ld. TPO should allocate common expenditure incurred by the taxpayer in two segments i.e. ITES & IT segment for the purpose of benchmarking the two separate transactions for calculation of the gross profit margin by applying the “head count” method.
In the first round of litigation, ld. TPO in this case had proceeded to benchmark international transactions qua CSDS and ITES segment by adopting aggregated approach. Now, as per our findings returned in the preceding paras, both the segments i.e. CSDS and ITES are required to be benchmarked independently.
Ld. AR for the taxpayer as well as ld. DR for the Revenue have contended in one voice that the issue of benchmarking both the segments independently is required to be remanded back to the ld. TPO as the entire exercise of benchmarking international transactions are to be redone.
Since the issue of benchmarking the international transactions is required to be examined qua both the segments i.e. CSDS and ITES separately and independently for factual analysis of taxpayer’s TP study, the case is remanded back to ld. TPO who shall determine the ALP of international transactions of both the segments independently afresh after providing an opportunity of being heard to the parties. Consequently, the appeal filed by the taxpayer is allowed for statistical purposes. Order pronounced in open court on this 15th day of July, 2021.