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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI ABRAHAM P. GEOGE & SHRI VIJAY PAL RAO
Per Vijay Pal Rao, Judicial Member
This appeal by the Revenue is directed against the order dated 11.11.2011 of the CIT(Appeals)-IV, Bangalore for the assessment year 2005-06.
The Revenue has raised the following grounds:-
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The order of the Learned CIT(A) in so far as it relates to the following grounds is opposed to law and facts of the case.
2. On the facts and in the circumstances of the case, the learned CIT(A) erred in holding that the TPO erred in not excluding comparables having any related party transactions.
3. The Id. CIT(A) erred in holding that profit on cost of more than 50% of the comparable company(ies) is abnormal without giving reasons how functions discharged, assets deployed and risks assumed of such companies were different from that of the appellant company.
4. The learned CIT(A) erred in holding that the size, turnover and brand of the company are deciding factors for treating a company as a comparable, and accordingly erred in excluding M/s Infosys Technologies Ltd., M/s iGate Global Solutions Ltd., Flextronics Software System Ltd., L & T Infotech Ltd., Satyam Software Services Ltd., and Infosys Technologies Ltd., as comparables.
5. The Id. CIT(A) erred in holding that expenditure of Rs.11,44,740/- towards telecommunication expenses and other expenses of Rs.1,31,528/- incurred in foreign currency are to be excluded from total turnover as well whereas such exclusion is permitted to arrive at the export turnover only as per the definitions given in Sec.10A of the Act and total turnover has not been defined in the section.
6. For these and other grounds that may be urged at the time of hearing, it is prayed that the order of the CIT(A) in so far as it relates to the above grounds may be reversed and that of the Assessing Officer may be restored.
7. The appellant craves leave to add, alter, amend and/or delete any of the grounds mentioned above.
None has appeared on behalf of the assessee-respondent when this appeal was called repeatedly for hearing, nor any request of IT(TP)A No.28/Bang/2012 Page 3 of 12 adjournment has been filed on behalf of the assessee, therefore, we propose to hear and dispose of this appeal ex parte.
Ground No.1 is general in nature and does not require any specific adjudication.
Ground No.2 is regarding the direction of DRP in excluding the comparable companies having related party transaction.
We have heard the ld. DR and considered the relevant material on record. It has been pointed out by the ld. DR that the CIT(Appeals) has directed the TPO to exclude the companies which have Related Party Transactions (RPT) without specifying the exact percentage of RPT to be taken as threshold limit. We find that the TPO has not applied any filter of RPT for selection of comparable companies. The CIT(Appeals) while passing the impugned order held that there is no need for inclusion of the companies which have RPT and accordingly directed the AO to exclude the companies having RPT from the comparables. It is pertinent to note that in the normal circumstances the Tribunal has considered 15% as threshold limit of RPT, when there is no difficulty of finding the comparable companies. Therefore, in view of the fact that the CIT(Appeals) has not fixed any threshold limit of RPT, we modify the impugned order of the CIT(A) and direct the AO/TPO to apply 15% RPT as threshold limit for the purpose of selecting comparables. This ground of the Revenue’s appeal is partly allowed.
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Ground No.3 is that the CIT(Appeals) has directed the AO to exclude the comparable companies having abnormal/high profit margin.
We have heard the ld. DR and carefully perused the relevant material on record. At the outset, we note that an identical issue was considered by the Special Bench of the Mumbai Tribunal in the case of Maersk Global Centres (India) (P.) Ltd. V. ACIT, 147 ITD 83 (MUM)(SB) and the conclusion of the Special Bench recorded in paras 98 & 99 of the said order are as under:-
“98. As noted by the Division Benches of the Tribunal in the cases discussed above, the OECD guidelines suggest quartile method which excludes the companies that fall in the extreme quartiles for comparability and there is deviation in this respect in T.P. Regulations in India which specify the Arithmetic Mean for determining the ALP. Nevertheless, the OECD TP Guidelines have considered and dealt with the situation of extreme results in the context of comparability consideration in section A.7.3 of chapter III and it is suggested in para 2.63 that where one or more of potential comparables have extreme results consisting loss or unusual high profits, further examination would be needed to understand the reasons for extreme results. After taking into consideration this guidance provided in OECD Transfer Pricing Guidelines and on analyzing the decisions rendered by the Division benches of this Tribunal on this issue after taking into consideration inter alia the T.P. Regulations in India as discussed above, we are of the view that the potential comparables cannot be excluded merely on the ground that their profit is abnormally high. In our opinion, the matter in such case would require further investigation to ascertain the reasons for unusual high profit and in order to establish whether the entities with such high profit can be taken as comparables or not.
The question No. 2 referred to this Special Bench is as to whether, in the facts and circumstances of the case, companies earning abnormally high profit margin should be included in the IT(TP)A No.28/Bang/2012 Page 5 of 12
list of comparable cases for the purpose of determining arm’s length price of an international transaction. As already observed, the issue involved in this question has become infructuous in so far as the case of the assessee before the Special Bench is concerned and the same therefore no more survives for consideration in the present case. In generality, we are of the view that the answer to this question will depend on the facts and circumstances of each case inasmuch as potential comparable earning abnormally high profit margin should trigger further investigation in order to establish whether it can be taken as comparable or not. Such investigation should be to ascertain as to whether earning of high profit reflects a normal business condition or whether it is the result of some abnormal conditions prevailing in the relevant year. The profit margin earned by such entity in the immediately preceding year/s may also be taken into consideration to find out whether the high profit margin represents the normal business trend. The FAR analysis in such case may be reviewed to ensure that the potential comparable earning high profit satisfies the comparability conditions. If it is found on such investigation that the high margin profit making company does not satisfy the comparability analysis and or the high profit margin earned by it does not reflect the normal business condition, we are of the view that the high profit margin making entity should not be included in the list of comparable for the purpose of determining the arm’s length price of an international transaction. Otherwise, the entity satisfying the comparability analysis with its high profit margin reflecting normal business condition should not be rejected solely on the basis of such abnormal high profit margin. Question No. 2 referred to this special bench is answered accordingly.”
Thus, it is clear that merely a company or entity having a high profit margin or high loss cannot be a reason for exclusion or inclusion in the list of comparables. However, if the high profit or high loss is as a result of some abnormal event or circumstances in a particular comparable company, the same is to be investigated and examined, and if it is found that due to the said particular extra-ordinary or abnormal circumstances the IT(TP)A No.28/Bang/2012 Page 6 of 12 said company cannot be regarded as functionally comparable to that of assessee, then only it is to be excluded from the list of comparables.
Accordingly, we direct the AO/TPO to further verify and investigate the actual reason of the high profit margin of the company and then decide the issue in the light of the finding of the Special Bench in the case of Maersk Global Centres (India) (P.) Ltd. (supra).
Ground No.4 is regarding exclusion of certain comparable companies by the CIT(A) by applying the turnover filter.
11. We have heard the ld. DR and carefully considered the relevant material on record. The CIT(A) has directed the AO/TPO to exclude 5 comparable companies on the ground that their turnover exceeds Rs.200 crores. The details of the companies are as under:-
Sr No. Name of the company Turnover (Rs. in crores) 1 iGate Solutions Ltd. 406 2 Flextronics Software System Ltd. 457.45 3 L&T Infotech Ltd. 562.45 4 Satyam Computer Services Ltd. 3462.2 5 Infosys Technologies Ltd. 6859.7
It is pertinent to note that the CIT(A) has applied turnover slab of Rs.1 crore to Rs.200 crores for excluding these companies, whereas there is an inherent difficulty in applying such a turnover slab of Rs.1 crore to Rs.200 crores because the said classification on the basis of slab of the turnover gives unrealistic results, as an entity having Rs.1 crore turnover can be compared with any entity having Rs.200 crores turnover, but at the IT(TP)A No.28/Bang/2012 Page 7 of 12 same time an entity having Rs.200 crores turnover cannot be compared with an entity having Rs.201 crores turnover. Thus, as it is clear from the above illustration that it gives ambiguous result as two entities having difference of Rs.1 crore cannot be considered as comparable, whereas on the other hand difference of Rs.199 crores can be considered as comparable company. Therefore, such classification of comparables on the basis of companies selected on turnover basis is not appropriate and acceptable. The turnover, no doubt, is a relevant factor to be taken into account, but there should be some proper and reasonable parameter to apply the difference of turnover between the assessee and the comparable which may be a multiple in the range of 2 times, 3 times, X times or any other number of times which should be applied to all the comparable companies, instead of taking a slab from Rs.1 crore to Rs.200 crores.
Thus, if appropriate multiple to say 10 times is applied, then the assessee having turnover of Rs.8.15 crores can be compared with a company which is having a turnover of Rs.81.5 crores. Accordingly, in view of the above facts of the case, we set aside this issue to the record of the AO/TPO to apply appropriate multiple or differential factor regarding the turnover of the comparable and the assessee.
Ground No.5 is regarding exclusion of telecommunication expenses and other expenses in foreign currency from total turnover as well.
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We have heard the ld. DR and carefully considered the relevant material on record. At the outset, we note that this issue is covered by the Hon’ble jurisdictional High Court in the case of ACIT v. Tata Elxsi Ltd., 349 ITR 49 [Karn], wherein the Hon’ble High Court has held as under:-
“10. The Bombay High Court had an occasion to consider the meaning of the word 'total turnover' in the context of Section 10-A, in the case of CIT v. Gem Plus Jewellery India Ltd. [2011] 330 ITR 175 [2010] 194 Taxman 192 (Bom.). Interpreting sub-Section (4) of Section 10-A, it is held as under:
"Under sub-section (4) the proportion between the export turnover in respect of the articles or things, or, as the case may be, computer software exported, to the total turnover of the business carried over by the under-taking is applied to the profits of the business of the undertaking in computing the profits of the business of the undertaking in computing the profits derived from export. In other words, the profits of the business of the undertaking are multiplied by the export turnover in respect of the articles, things or, as the case may be, computer software and divided by the total turnover of the business carried or by the undertaking. The formula which is prescribed by sub-section (4) of section 10A is as follows:
Export turnover in Profits of the Profits derived from respect of the articles or business of the X export of articles or things or computer = undertaking things or Computer software software Total turnover of the business carried on by the undertaking
The total turnover of the business carried on by the undertaking would consist of the turnover from export and the turnover from local sales. The export turnover constitutes the numerator in the formula prescribed by sub-section (4). Export turnover also forms a constituent element of the denominator inasmuch as the export turnover is a part of the total turnover.
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The export turnover, in the numerator must have the same meaning as the export turnover which is a constituent element of the total turnover in the denominator. The legislature has provided a definition of the expression "export turnover" in Explanation 2 to section 10A by which the expression is defined to mean the consideration in respect of export by the undertaking of articles, things or computer software received in, or brought into India by the assessee in convertible foreign exchange but so as not to include inter alia freight, telecommunication charges or insurance attributable to the delivery of the articles things or software outside India. Therefore in computing the export turnover the Legislature has made a specific exclusion of freight and insurance charges. The submission which has been urged on behalf of the Revenue is that while freight and insurance charges are liable to be excluded in computing export turnover, a similar exclusion has not been provided in regard to total turnover. The submission of the Revenue, however, misses the point that the expression "total turnover" has not been defined at all by Parliament for the purposes of section 10A. However the expression "export turnover" has been defined. The definition of "export turnover" excludes freight and insurance. Since export turnover has been defined be Parliament and there is a specific exclusion of freight and insurance, the expression "export turnover" cannot have a different meaning when it forms a constituent part of the total turnover for the purposes of the application of the formula. Undoubtedly, it was open to Parliament to make a provision to the contrary. However, no such provision having been made, the principle which has been enunciated earlier must prevail as a matter of correct statutory interpretation. Any other interpretation would lead to an absurdity. If the contention of the Revenue were to be accepted, the same expression viz. "export turnover" would have a different connotation in the application of the same formula. The submission of the Revenue would lead to a situation where freight and insurance, though it has been specifically excluded from "export turnover" for the purposes of the numerator would be brought in as part of the "export turnover" when it forms an element of the total turnover as a denominator in the formula. A construction of a statutory provision which would lead to an absurdity must be avoided."
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The special bench of the Tribunal, in the case of ITO v. Sak Soft Ltd. [2009] 313 ITR (AT) 353/ 30 SOT 55 (Chennai) also had an occasion to consider the meaning of the word 'total turnover'. After referring to the various judgments of the High Court as well as the Supreme Court held as under: "53. For the above reasons, we hold that for the purpose of applying the formula under sub-section (4) of Section 10-B, the freight telecom charges or insurance attributable to the delivery of articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing the technical services outside India are to be excluded both from the export turnover and from the total turnover, which are the numerator and the denominator respectively in the formula." The formula for computation of the deduction under Section 10-A would be as under: Profits of the business X export turnover Total turnover
From the aforesaid judgments, what emerges is that, there should be uniformity in the ingredients of both the numerator and the denominator of the formula, since otherwise it would produce anomalies or absurd results. Section 10-A is a beneficial section. It is intended to provide incentives to promote exports. The incentive is to exempt profits relatable to exports. In the case of combined business of an assessee, having export business and domestic business, the legislature intended to have a formula to ascertain the profits from export business by apportioning the total profits of the business on the basis of turnovers. Apportionment of profits on the basis of turnover was accepted as a method of arriving at export profits. In the ease of Section 80HHC, the export profit is to be derived from the total business income of the assessee, whereas in Section 10-A, the export profit is to be derived from the total business of the undertaking. Even in the case of business of an undertaking, it may include export business and domestic business, in other words, export turnover and domestic turnover. The export turnover would be a component or part of a denominator, the other component being the domestic turnover. In other words, to the extent of export turnover, there would be a commonality between the numerator and the denominator of the formula. In view of the commonality, the understanding should also be the same. In other words, if the export
IT(TP)A No.28/Bang/2012 Page 11 of 12 turnover in the numerator is to be arrived at after excluding certain expenses, the same should also be excluded in computing the export turnover as a component of total turnover in the denominator. The reason being the total turnover includes export turnover. The components of the export turnover in the numerator and the denominator cannot be different. Therefore, though there is no definition of the term 'total turnover' in Section 10-A, there is nothing in the said Section to mandate that, what is excluded from the numerator that is export turnover would nevertheless form part of the denominator. Though when a particular word is not defined by the legislature and an ordinary meaning is to be attributed to the same, the said ordinary meaning to be attributed to such word is to be in conformity with the context in which it is used. When the statute prescribes a formula and in the said formula, 'export turnover' is defined, and when the 'total turnover' includes export turnover, the very same meaning given to the export turnover by the legislature is to be adopted while understanding the meaning of the total turnover, when the total turnover includes export turnover. If what is excluded in computing the export turnover is included while arriving at the total turnover, when the export turnover is a component of total turnover, such an interpretation would run counter to the legislative intent and impermissible. If that were the intention of the legislature, they would have expressly stated so. If they have not chosen to expressly define what the total turnover means, then, when the total turnover includes export turnover, the meaning assigned by the legislature to the export turnover is to be respected and given effect to, while interpreting the total turnover which is inclusive of the export turnover. Therefore, the formula for computation of the deduction under Section 10-A, would be as under: Export turn over Profits of the business of the X (Export turnover + domestic turn over) undertaking Total Turn Over
In that view of the matter, we do not see any error committed by the Tribunal in following the judgments rendered in the context of Section 80HHC in interpreting Section 10-A when the principle underlying both these provisions is one and the same. Therefore, we do not see any merit in these appeals. The substantial question of law framed is answered in favour of the assessee and against the revenue.”
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Following the judgment of Hon’ble jurisdictional High Court in the case of Tata Elxsi Ltd. (supra), we do not find any error or illegality in the impugned order of the CIT(A), qua decision.
In the result, the appeal by the Revenue is partly allowed.
Pronounced in the open court on this 31st day of March, 2016.