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Income Tax Appellate Tribunal, “C” BENCH : KOLKATA
Before: Hon’ble Sri N.V.Vasudevan, JM & Dr.Arjun Lal Saini, AM]
M/s. Philips India Ltd. -vs.- D.C.I.T., Circle-11(2) Kolkata Kolkata [PAN : AABCP 9487 A] (Respondent) (Appellant) For the Appellant : Shri Arvind Sonde, Advocate & Shri M.S.Gunjam, AR For the Respondent : Shri G.Mallikarjuna, CIT(DR) Date of Hearing : 30.01.2017. Date of Pronouncement : 08.02.2017. ORDER Per N.V.Vasudevan, JM
This is an appeal by the Assessee against the order dated 22.05.2015 D.C.I.T., Circle-11(2), Kolkata passed u/s 143(3) r.w.s. 144C of the Act.
2. The only issue for consideration in this appeal by the assessee is with regard to the determination of arms length (ALT) of an International Transaction carried out by the assessee with its Associated Enterprises (AE) under the provision of section 92 of the Act.
3. The Assessee, amongst other lines of business, is also engaged in the business of software development and it provides software development services to its various group companies. During the previous year relevant to AY 2006-07, the Assessee had a turn over of Rs.381.3 crores in respect of software development services rendered to its AE. The assessee justified its transactions with its AE as one at an arm’s length on the 2 M/s. Philips India Ltd. A.Yr.2006-07 basis of Transaction Net Margin Method (TNMM). For this, operating margin data in respect of comparable Indian companies were identified by the assessee. Hence, TNMM, using operating margin on operating cost as the PLI (Profit Level Indicator) was selected as the most appropriate method.
Based on the above analysis, 20 companies were selected by the assessee and their net margin was analysed. It was seen that the average operating margin on operating costs percentage of these companies was between (-) 61.5% to 46.4%. The arithmetic mean of the above mentioned companies was 9.6%. This margin was taken as the benchmark for comparison of the operating margin over operating cost earned by the Assessee from its software development services rendered to its AE. During the year the Assessee had earned an operating margin of 12% on transactions with the AE. Hence, it was concluded by the assessee that the provision of software development and software services to its overseas AEs were at an arm’s length.
5. The AO on consideration of the above transfer pricing study conducted by the Assessee was of the view that the assessee had included loss making companies in the list of comparable companies. The assessee in reply submitted that industry represents all kinds of companies new or old loss, profit making or incurring loss and therefore it would be inappropriate to ignore functionally similar companies only for the reason that they are loss making companies. The Transfer Pricing Officer (TPO) however was of the view that the loss making companies should be excluded from the list of comparable companies. Another query raised by the TPO was as to why companies having very low turnover were chosen as comparable companies. The TPO in this regard found that the turnover of the Assessee from rendering software services to its AE was Rs.381.3 crores whereas the companies having turnover as low as Rs.1.5 crores has been included in the list of comparable companies. Similarly companies having very huge turn over ranging from Rs.9449 crores and Rs.4792 crores were also included 2
3 M/s. Philips India Ltd. A.Yr.2006-07 in the list of comparable companies by the Assessee. According to the TPO companies having such huge turn over ought not to have been chosen as comparable companies by the assessee. The assessee submitted before the AO that functional comparability would be material even if the turnover is considered as basis for including or excluding a company. The TPO had not spelt out any basis on which the principle of lower limits of the turnover had to be fixed for the purpose of comparability. The TPO however was of the view that the companies having very low turnover compared to that of the assessee and very high turnover compared to that of the Assessee ought to be excluded from the list of comparable companies.
6. The TPO accepted six out of 20 comparables chosen by the Assessee. In addition to the above the TPO added three more companies namely M/s. Mphasis BFL Ltd., M/s. Visual Soft Technologies Ltd and M/s Blue Star Infotech Ltd., as comparable companies. Thus the TPO arrived at the list of nine comparable companies having the following average arithmetic mean of profit to the total cost as follows :- “After such filtration, it is found out that the following companies can be selected for the purposes of comparison out of the list 20 companies submitted by the assessee : Sl. Name of the company 2004 2005 2006 Total Average No. OP/TC% OP/TC% OP/TC% OP/TC% 1. M/s. Mphasis BFL 53.78 17.39 23.27 94.44 31.48 Ltd. 2. M/s. Visual Soft 26.92 14.37 10.06 51.35 17.11 Technologies Ltd. 3. M/s. Blue Star 21.31 13.10 5.16 39.57 13.19 Infotech Ltd. 4. M/s. Infotech Ltd. Loss 4.02 7.83 11.85 5.92 5. M/s Ftech Infosys 51.08. 43.25 NA 94.33 47.16 Ltd. 6. M/s Aztec Software Loss 19.40 22.79 42.19 21.09 & Technology Services Ltd 7. M/s K P I T Cummins 13.29 12.87 12.15 38.31 12.77 Infosystems Limited 8. M/s Prithvi 8.30 10.53 NA 18.83 9.41 Information Solutions Ltd. 3
The arithmetic mean of the operating profit on operating cost comes to 18.41% as compared to the operating margin on operating cost of the software division of the assessee company. which is 12%. Hence. by taking the operating profit on operating cost percentage as 18.41 % as the benchmark, the arm's length price of international transactions representing provision of software development services by the assessee company to its AEs during the year 2004- 05 are re-determined as under ;- Operating margin declared by the assessee At 12% operating martin percentage- Rs.40.80 crores Operating profit margin taking the operating margin percentage at 18.41 % Rs.62.S9 crores Arm's Length Price Adjustment - Rs.21.79 crores Hence, an addition of 1.79 crores has to be made to the total income of the assessee company.”
7. The AO proposed to make the above suggestions by the TPO in his order dated 30.10.2009 passed u/s 92CA(3) of the Act and ultimately accepted the TPO’s proposal in the draft assessment order dated 14.12.2009. The assessee filed objections to the draft assessment order before the DRP in terms of section 144C of the Act. The primary contention of the assessee was exclusion of certain comparable companies chosen by the TPO. The assessee also prayed for adjustment to the margins determined by the TPO by allowing risk adjustment and working capital adjustments. The DRP by its directions dated 17.06.2010 accepted the stand of the assessee in so far as it relates to exclusion of three comparable companies namely M/s. Mphasis BFL Ltd., M/s. Visual Soft Technologies Ltd and M/s. Blue Star Infotech Ltd. The DRP however refused to allow any adjustment towards working capital adjustment and risk adjustment. The relevant observations of the DRP in this regard are as follows :-
“14. The Panel reviewed the two samples - one by the assessee of 20 companies and the other by the TPO having 9 companies. Close scrutiny of the two samples showed that 4
5 M/s. Philips India Ltd. A.Yr.2006-07 within the sample there were still a number of companies which had lower turnover than the assessee company. The turnover, it was felt, by the Panel was an important criteria to consider a particular sample. So after due consideration, it was decided to apply a filter on the basis of the' turnover. It was decided to filter out all those companies which had turnover ·of less than Rs. 150 Crores. This resulted in a sample of just 6 companies. In this sample, there were 5 companies, namely, M/s 31 Infotech, Aftek Infosys, Aztec Software & Technology Services, KPIT Cummins Infosystems, Prithvi Information Solutions which were part of the assessee's TP study and one company, namely, M/s Visual soft Technologies, which was as per the TPO's order. Based oh the above, the average operating margin came to be 17.77%. This margin is beyond 5% of the price as provided for in Section 92C(2) of the IT Act, and so can be used for the arm's length price adjustments.
15. The assessee in its submission dated 02.06.2010 to the Panel also stated it had submitted before the TPO requesting to make adjustments to the comparable companies' margins on account of the various' differences. These adjustments are on account of the following: • Risk. Adjustment: This adjustment, according to the assessee, was sought on account of the difference in the risk profile of a captive service provider (assuming less than the normal risks) and full-fledged entrepreneurs (bearing business and operational risks). The assessee stated that where a risk-insulated captive service provider would earn low returns, a full-fledged 'entrepreneur would earn higher returns, on the basis of higher the risk higher the returns. The assessee sought the above adjustment to be calculated on the basis of the difference between prime 'lending rate (PLR) and the bank rate, and determined the same at 4.75% (PLR, 10.75% - Bank Rate, 6.00%). It was also contended by the assessee that the above computation of risk adjustment was upheld by the ITAT, Bangalore Bench in the assessee's own case for AY 2003-04. .• Working Capital Adjustments: The assessee stated that since it is a captive contract service provider, rendering software services to its AEs, the collection cycle of receivables from its customers is shorter as compared to those having third party service providers. Accordingly, the assessee stated, working capital adjustments should be allowed as held in the case of Mentor Graphics by the ITAT, Delhi Bench. The assessee based on the above logic demanded a suitable adjustment for the differences in the working capital position. • Other Adjustments: For this, the assessee sought adjustments for R&D expenses, marketing expenditure and accounting policies, but did not provide any logic for the above adjustments.
The demand for risk adjustments was sought, as. stated above, on the basis of the difference between the PLR and the bank rate. The Prime Lending Rate is a benchmark interest rate to which all loans 'are linked. It is a term applied as a reference interest rate used by banks. Bank rates, also referred to as the discount rate, is the rate of interest which a central bank charges on the loans .and advances that it extends to commercial banks and other financial intermediaries. Both these rates for calculation of risk adjustments, it was felt by the Panel, are more appropriate for the bank lending and borrowing, and the way was sought by the assessee to be used. here is more theoretical than real: The Panel further felt. that the methodology as proposed by the assessee did not show how it really 5 6 M/s. Philips India Ltd. A.Yr.2006-07 measured the risk of the assessee. Since there was no force in the arguments of the assessee and the measure sought was more global than specific, the same cannot be allowed, the Panel felt.
17. Similarly for the working capital adjustments. The assessee did not provide any specific number. It just provided a methodology without being specific. It was not obvious to the Panel what type of risk adjustments should be made to convert the risk-bearing comparable into one that is highly customized and that is such that it reduces the risks. No doubt the principle of providing reasonable and accurate adjustments cannot be argued against as it is required, and the IT Act does provide for that, but in the absence of limited guidance on the methodology to be adopted, and no such methodology being provided by the assessee which could be considered reasonable and accurate, the adjustments cannot be allowed. It would be beyond this Panel to come up with a specific number for adjustments. Hence in view of the same, the adjustments as requested by the assessee are denied. In fact, there. was no force in the submission of the assessee and the demand by them was neither specific nor accurate.”
After the order of DRP the TPO passed the order of assessment u/s 143(3) r.w.s. 144C of the Act dated 30.07.2010. Against the aforesaid fair order of the assessment the assessee preferred appeal before the Tribunal in ITA No.1887/Kol/2010. The Tribunal vide its order dated 07.03.2010 had not allowed any relief to the assessee. The assessee filed an appeal before the Hon’ble Calcutta High Court and the Hon’ble Calcutta High Court vide its order dated 13.10.2012 in its G.A.No.2012 held that the entire matter should be remanded for fresh hearing by the Tribunal. Accordingly the appeal was restored to the file of the tribunal for fresh hearing.
The Tribunal by an order dated 19.06.2013 remanded certain issue to the DRP for fresh consideration. The following are the relevant observations of the ITAT :
“6. We have considered the rival submissions. At the outset a perusal of the order of the DRP clearly shows that the DRP has rejected the assessee’s application in Form No.35A in respect of the draft assessment order without giving any specific valid reasons as has been rightly pointed out by the ld. AR. The Co-ordinate Bench of this Tribunal has given the decision in favour of the assessee in respect of working capital adjustments as also risk profile adjustments. Adjustments on this account have not been granted to the assessee nor has any valid reasons been given in denying the adjustments. Admittedly in respect of the risk adjustment the DRP itself admits that an adjustment is to be given and it is permissible under the Income Tax Act. Once it is accepted that an adjustment must be 6 7 M/s. Philips India Ltd. A.Yr.2006-07 given and it is permissible under the Income Tax Act there is no reason for not giving the adjustment. An adjustment liable to be given as per the provision of the Act must be given, in the failure of which the order itself would become erroneous. Further, the DRP has not given any finding in respect of the claim of the assessee that working capital adjustment is to be given especially when the assessee itself has provided the calculation for the same. The DRP has also not answered the issue raised by the assessee that M/s. Aftech Infosys Ltd. must be removed as its intellectual properties constitute 81% of the total assets. The DRP has also not answered the issue as to why the company M/s. Sasken Technologies Ltd. was not included as comparable for A.Yr. 2006-07 when for the immediately earlier assessment year and subsequent assessment years the said company was considered. In this circumstances we are of the view that the issue of the TP adjustments is liable to be restored to the file of the DRP for re-adjudication after taking into consideration and answering the issue as raised by the assessee in its objections and we do so.
In the result the issue of the Transfer pricing adjustment is restored to the file of the DRP for re-adjudication after granting the assessee adequate opportunity.”
The DRP adjudicated the issue afresh and identified four issues arising for consideration pursuant to the order of the Tribunal dated 19.06.2013 in I. Claim of Risk Adjustment II. Claim of Working Capital adjustment III. Removal of Comparable (Aftek Infosys Ltd.) sought by assessee IV. Inclusion of Comparable (Sasken Technologies Ltd.) sought by the assessee.
As far as the claim of the assessee for risk adjustment and workiing capital adjustments is concerned the DRP held as follows :- “ 10.0 Finding: 10.1 DRP has carefully considered the facts of the case and the submissions of the taxpayer. The panel is not inclined to accept the assessee's claim of risk adjustment. Risk adjustment as a general rule cannot be allowed unless it is clearly shown that the comparables had actually undertaken such risk and how the same materially affected their margins. Unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustment, no adjustment can be allowed to the taxpayer. ln the present case, except pointing out various risks, the taxpayer has not shown with evidence as to whether each of the risk was actually undertaken or not by the comparables 7
10.2 Further, the panel is of the view that a purpose specific captive agency like the assessee is not entirely risk free. The assessee is in a business which requires skilled manpower. Skilled manpower is the human capital related intangible assets. The judgment of Appellate Tax Court, USA in the case of lthaca Industries Inc. v. CIR 97 TC 253, highlights that in a knowledge organization, there is a little machinery other than the employees, because only people can act, employees become both the mind of the machines and machines themselves. Therefore, retention of skilled work force is an issue due to the globalization of trade and consequently many new opportunities are available to skilled staff. The assessee has developed its own human capital intangible at its own cost and all the risks related in creation and maintenance of human intangible are borne by the assessee. Thus, it is not correct on the part of the assessee to say that it does not assume any risk and it is a risk free entity. The risk analysis may be summarized as under: + The taxpayer is totally dependent on the AE for business. Thus, the taxpayer takes the risks associated with heavy dependence on a single customer. In common business parlance it is known as single customer risk. • The compensation model with the AE does not guarantee volume of business nor the period. The agreement can be terminated by any party at any time after giving a stipulated period notice. Thus the taxpayer is not free from the risk of losing business entirely or losing volume of business. + The taxpayer is not compensated any amount for termination of agreement even if it is terminated without any cause. No independent enterprise would like to agree for a termination clause without compensation if it is terminated without any cause. • The AE is exposed to the market risk and any fluctuation in the business conditions of the AE affect the taxpayer. Thus, even if independent comparables undertake some risk, the taxpayer also had to undertake risks. + The independent entrepreneur has to incur expenditure on marketing, etc. which is debited to the P&L ale. But, it is always not necessary that these risks reflected in the marketing, sales promotion expenses will automatically be compensated by increase in sales or higher margins. For example, increased marketing efforts in some segments of export market may not yield results for a software development company and thereby there may be a loss on this marketing effort which may bring down the overall profitability rather than increase the profitability. Thus if undertaking the market risk etc. helps in earning any extra margin, the benefit is more than set off by the corresponding expenditure. The same applies to credit risk undertaken. • It is incorrect to say that higher the risk, the higher is the margin though it is true that higher risk expects a higher margin. Thus realization of risk is different from expected return based on risk undertaken. Finally selected cornparables had almost similar risks but margins varied. • The taxpayer's single customer risk more than offsets any other risk differential between the taxpayer and the comparable companies.
• Different comparables can have different risk profiles and different profit margins. The proviso to s. 92C(2) of the Act provides for adopting arithmetical mean of the different 8
9 M/s. Philips India Ltd. A.Yr.2006-07 prices. This provision neutralizes the effect of difference in the risk profile, if any between the taxpayer and the comparables as realized risk may pull down the profitability below the risk free return. •• It is not sufficient to merely spell out risks, it has to be shown which risk was actually undertaken by the comparables and to what extent it affected the profitability. The taxpayer has not done so.
10.3 The computation of risk adjustment has to be based on robust data, which is not shown herein. The taxpayer in the instant case has set up a business in India and therefore it has to be compared with independent business entrepreneurs and not with passive investors.
10.4 In case of Motorola Solutions emphatically referred to by the Ld AR (ITA No 5637/DeI/2011), the Hon'ble bench has not acceded to the request for risk adjustment of accepted CAPM, they have merely restored the matter back for examination. The citation would therefore not help the case of the assessee in seeking the adjustment in absence of clear and precise data to justify the risk adjustment.
10.5 In view of discussion above, the panel is of considered view that objection of the assessee deserves to be rejected. “
12. With regard to the claim of the assessee for working capital adjustment the DRP gave the following conclusion :- “7.1. DRP has duly considered the issue. It has been noted that as mentioned in para 17 of DRP Kolkata's order, even during hearing before DRP Kolkata, no reliable data was furnished by the assessee regarding need for any working capital adjustment. Even now, the assessee has not established its claim by placing on record any reliable data to show that there is significant difference in working capital requirement of the comparables and that of the assessee which has bearing on profit margin and therefore needs to be adjusted. Working capital adjustments are difficult to apply due to the lack of accurate and reliable data. Apart from the issue of unreliable data for the tested party, adequate financial data is not available for the comparable companies. Working capital adjustment needs to be given on the basis of daily or at least monthly average of payables, receivables and inventory and not on the basis of yearend figures. While these daily and monthly figures may be available in the taxpayer's case, the same are not available in the case of comparable companies. Hence, calculation of reasonably accurate adjustments is not possible. Further, the issue of working capital would be relevant only when there is a situation of inventory remaining tied up or receivables being held up. These situations may not be so relevant to the service industry. 7.2 Further, this adjustment is not generic to be allowed as a routine. The assessee has to demonstrate unambiguously for the relevant period that variations in Working Capital profile would indeed have impact on the margins of the comparables. The factum of working capital adjustment having been allowed in other years would have no binding 9
10 M/s. Philips India Ltd. A.Yr.2006-07 proposition unless it is demonstrated that the capital profiles were identical to such periods. In view of above discussion, the panel is of the considered view that this objection deserves to be rejected.”
On excluding Aftek Infosys Ltd. As comparable the DRP took the following view :- “DRP has duly considered submissions of the assessee. There is no evidence furnished to DRP about functional differentiation of the comparable. The functional profile of Aftek as per first page of the annual report does not give any indications of its functionality so as to enable us to specify the differences in functionality of the comparable and the assessee. Though the comparable has shown significant IPRs, in absence of any details about the nature and profile of such intangibles, it would be inappropriate to allow its exclusion just on this basis. It would also be pertinent to point out that such plea was not taken before the earlier DRP hearing. Further, the assessee seeks exclusion relying on the case of Qualcomm India Pvt Ltd. in 147 ITD 17 (Delhi) where Aftek was directed to be excluded from comparables list due to different functional profiles of Aftek and Qualcomm. DRP has carefully gone through said the case law and it was seen that Hon'ble ITAT have given functional profile of Qualcomm as being engaged in the business of software development and providing marketing services and being a captive service provider to its AEs. In present case, the assessee company is engaged in business of software development. This clearly demonstrates the functional differentiation between the two and as a result we cannot apply mutatis mutandis the finding given in case of Qualcomm to the facts of the assessee. Therefore, the assessee, in our considered view is not entitled for exclusion of this comparable especially when functional profile differences could not be demonstrated and the assessee is totally silent on its own IRP issues which are bound to be there as it is extending services to group companies and it is mandatory in such situations to create templates to standardise services across the board & the nature of IPRs enjoyed by the comparable are too vague and unspecified. The onus is on the assessee to substantiate its claim. The assessee has also not demonstrated how change in financial year from June to March has affected the profit in of the comparable. In view of discussion above, the objection of the assessee is rejected.”
As far as including a comparable Sasken Technologies Ltd which was excluded by the TPO the DRP accepted the contention of the assessee and held as follows :- “14.0 Sasken Technologies Ltd. 14.1. The assessee has submitted that this comparable has been accepted by the TPO 14.2. In view of the fact that the functionality of the assessee is identical for all these periods, this contention is accepted by this DRP. The TPO/AO is directed to take this comparable in final list and re-compute the profit margin and consequent adjustment, if any thereafter. The objection is according allowed.”
11 M/s. Philips India Ltd. A.Yr.2006-07 14. Pursuant to the aforesaid directions of the DRP the AO proposed an adjustment of Rs.32.81 crores by his order dated 21.05.2015 giving effect to the directions of the DRP dated 16.03.2015as follows :- “ 4. The Hon'ble DRP, Delhi in its order dated 16.03.2015 has rejected the all the claims of the assessee except for claim 4 i.e. inclusion of Sasken Technologies Ltd as among the comparable.
The assessee in its original transfer pricing study has rejected the company as functionally not comparable. However, this office has consistently taken a view that the M/s Sasken Communication Technologies Ltd as a comparable in subsequent years for the same assessee and as no difference in functionality of the above comparable is observed the decision of the DRP, Delhi accepted and no further appeal is suggested. It is also seen that after giving effect to the directions of DRP the adjustment is 32.81 Crores in place of Rs 21.79 crores as is calculated in the order u/s 92CA (3) dated 30.10.2009.
The company Sasken Communication Technologies Ltd has two segment viz Software services and Software product segment. The segment Software services segment is considered as comparable to the functions of the assessee. The calculation of operating profit/operating Cost of the Software services segment of the comparable M/s Sasken communication Technologies Ltd are as under :
Segment Software services Particulars 2004 2005 2006 Average PLI Segment 12378.43 18905.47 24003.42 Revenue 53.94% Segment Result 4430.89 6916.49 7829.54 Segment Cost 7947.54 11988.98 16173.88 OP/TC(%) 55.75% 57.69% 48.40% Average PLI after including the above as comparable are calculated as under :
S.No. Name of the 2004 2005 2006 Avg- Company OP/TC OP/TC OP/TC OP/TC 1. M/s. Mphasis BPL 53.78 17.39 23.27 31.48 Ltd. 2. M/s. Visual Soft 26.92 14.37 10.06 17.11 Technologies Ltd. 3. M/s. Bluestar 21.31 13.10 5.16 13.19 Infotech Ltd 4. M/s. 31 Infotech Ltd. Loss 4.02 7.83 5.92 5. M/s Aftek Infosys 51.08 43.25 N.A. 47.16 11
12 M/s. Philips India Ltd. A.Yr.2006-07 Ltd. 6. M/s. Aztec Software Loss 19.40 22.79 21.09 Technology Ltd. 7. M/s. Kpit Cummins 13.29 12.87 12.15 12.77 Infosystems Ltd. 8. M/s. Prithvi 8.30 10.53 N.A. 9.41 Information Solutions Ltd. 9. M/s. R.S.Software Loss 7.57 N.A. 7.57 Ltd. 10 M/s. Sasken 55.75 57.69 48.40 53.94 Communication Technologies Ltd. Average 21.96
The arithmetic mean of the operating profit on operating cost comes to 21.96% as corn pared to the operating profit on operating cost of the software division of the assessee company which is 12%. Hence by taking the operating profit on operating cost percentage at Rs 21.96% as the benchmark, the Arm's length price of international transaction representing provision of software development services by the assessee company to its A.E during the year 2004-05 are determined as under Operating margin declared by the assessee at 12% operating margin percentage- Rs 40.80 Crores Operating margin taking the operating margin percentage at 21.96%- Rs 73.61 Crores Arm's Length Price adjustment Rs 32.81 Crores
Hence an adjustment of Rs.32.81 Crores has to be made following the Hon’ble DRP, Delhi order.
It can be seen from the aforesaid proposal of the AO that the original adjustment by the TPO at the first instance was Rs.19,61,43,994/- which was increased to Rs.32,81,00,000/-. The proposal as above was incorporated by the AO in his fair order dated 22.05.2015. Aggrieved by the aforesaid order of the AO dated 22.05.2015giving effect to the directions of the DRP u/s 144C of the Act dated 16.03.2015, the assessee has preferred the present appeal before the Tribunal.
1.1. That on the facts and circumstances of the case and in law, the Ld. AO erred in enhancing the figure of transfer pricing adjustment in respect of Software services to Rs. 32,81,00,000 as against Rs. 19,61,43,994 determined in the final assessment order dated 30 July 2010 passed u/s.143(3) r.w.s. 144C of the Income Tax Act ("the Act"). 1.2. That on the facts and circumstances of the case and in law, the Ld. AO erred in not appreciating that where the Appellate Tribunal remands the matter to the lower authorities, the enhancement of income cannot be made.
Erroneous inclusion of the companies as comparable in respect of Software services which are already rejected by DRP vide its Order dated 17 June 2010 2.1 The Ld. AO, and the TPO while passing the comments giving effect to DRP directions dated 16 March 2015 has erroneously considered the same set of comparables as given in the TPO order dated 30 October 2009.
2.2 The Ld. AO, and the TPO has erred in law and on facts in considering three comparable companies namely M/s Mphasis BFL Ltd., M/s Blue Star Infotech Ltd., and M/s R S Software Ltd which had already been rejected by the Hon'ble DRP vide its order dated 17 June 2010 and accepted by Ld. AO in the Final Assessment Order dated 30 July 2010 passed u/s. 143(3) r.w.s. 144C of the Act.
2.3 The Ld. AO, and the TPO had failed to acknowledge that a set of 6 comparable companies was arrived having an arm's length margin of 17.77% vide DRP directions dated 17 June 2010.
2.4 The Ld. AO, and the TPO had failed to acknowledge that the IT AT vide order dated 19 June 2013 had remanded the matter back to DRP for fresh adjudication only on four issues - 1) Allowance of working capital adjustment 2) Allowance of Risk adjustment 3) Removal of Aftek as a comparable and 4) Inclusion of Sasken as a comparable, thus the TPO/ AO should have confined themselves to the issues restored for adjudication. The Ld. AO, and the TPO had no authority to dispute the matters already settled before the appellate authorities during the previous proceedings.
Erroneous consideration of segmental margin of Sasken for computing transfer pricing adjustment on Software services 3.1 The Ld. AO, and the TPO while passing the comments giving effect to DRP directions dated 16 March 2015 has erroneously considered the segmental results of Sas ken for computing transfer pricing adjustment on Software services as against the results at entity level consistently considered by him for other assessment years.
14 M/s. Philips India Ltd. A.Yr.2006-07 3.2 The Ld. AO, and the TPO erred in not appreciating that the TPO in its own orders for preceding years i.e. AY 2005-06 as well as in subsequent years i.e. AY 2007-08 to AY 2011-12 has considered the margin of Sasken at overall entity level. Thus, following the principle of consistency, entity level margin of Sasken should be considered. 3.3 Without prejudice, the Ld. AO, and the TPO erred in not considering the unallocated expenses provided in the segment reporting of the Annual Report of Sasken while doing the segmental margin computation, as a result of which the margin so computed by TPO is significantly skewed and distorted.
4. Non- Rejection of Aftek as a comparable
4.1 The Learned AO, DRP and the TPO erred in not considering the claim of the Appellant for rejecting Aftek as a comparable company.
4.2 The Learned AO, DRP and the TPO erred in not considering that Aftek is functionally dissimilar to the Appellant.
4.3 The learned AO, DRP and the TPO erred in not considering that Aftek should be rejected as it enjoys significant benefits on account of intellectual property rights ('IPR'), which constitutes nearly 81 % of the total net fixed assets of the Company.
4.4 The Learned AO, DRP and the TPO erred in not considering that Aftek underwent a financial reorganization, has changed its financial year from June to March and thus the financial statements of Aftek is not comparable to the Appellant.
5. Variation of 5% from the arithmetic mean
5.1. The Ld. AO, DRP and TPO erred in law in not granting the benefits of +/-5% variance as per proviso to section 92C(2) of the Act to the Appellant.
6. Non-allowance of appropriate adjustments as per Rule 10B
6.1. The Ld. AO, DRP and TPO erred in law and on facts in not granting the adjustment on account of the differences in the working capital adjustments between the appellant and the comparable companies.
6.2. The Ld. AO, DRP and the TPO erred in law and on facts in not granting the adjustment on account of, differences in the risk profile between the appellant and the comparable companies.
6.3. The Ld. AO, DRP and TPO erred in making erroneous observation in denying the working capital/risk adjustment and failed to follow the observation made by Hon 'ble ITAT wherein ITAT in its order dated 19 June 2013 had mentioned that in respect of risk adjustment, if the DRP itself (page no. 8 of the DRP directions dated 17 June 2010) had in 15 M/s. Philips India Ltd. A.Yr.2006-07 principle admitted that an adjustment is to be given and it is permissible under the IT Act, there is no reason for not giving the adjustment. . 6.4. That on the facts and circumstances of the case, adjustments for working capital and risk adjustment should be allowed as the same have been allowed by DRP in appellant's own case in subsequent year.
7. Non grant of deduction under section 80G of the Act That on the facts and circumstances of the case and in law, the Ld. AO erred in not granting the benefit of deduction under section 80G of the Act amounting to Rs. 46,65,128 without appreciating the fact that the same was allowed by the Ld. AO in the final assessment order dated 30 July 20 I 0 passed under section 143(3) r.w.s. 144C of the Act.
8. Erroneous levy of interest under section 220(2) of the Act That on the facts and circumstances of the case and in law, the Ld. AO erred in levying interest of Rs. 2,75,32,130 under section 220(2) of the Act.
9. Interest under section 234B 9.1. That on the facts and circumstances of the case and in law, the Ld. AO erred in levying interest of Rs.3,25,49,736 under section 234B of the Act.”
We have heard the submissions of the ld. Counsel for the assessee and the ld. DR. The first and foremost submissions of the ld. Counsel for the assessee was on exclusion of companies listed in ground no.2.2 from the list of comparables. In this regard we have already seen that the DRP when it passed order dated 17.06.2010 excluded these three companies from the list of nine comparable companies chosen by the TPO. In the order giving effect to the directions of the DRP dated 16.03.2015 these companies were never sought to be included. In other words, the DRP’s directions dated 17.06.2010 was accepted by the revenue and the assessee and had become final. Therefore the AO was not justified in adding these three companies as comparable companies while giving direction to the DRP in its order dated 16.03.2005. Therefore these three companies have to be excluded from the list of comparable companies. We are of the view that the stand taken by the assessee in this regards deserves to be accepted. We have already seen in the narration of facts that these three companies chosen by the TPO in its first order dated 30.10.2009 was held to be erroneous by the DRP in its directions dated 17.06.2010 and these directions have become final having been accepted by the revenue 15
16 M/s. Philips India Ltd. A.Yr.2006-07 and the Assessee. Therefore it was open to the AO while passing the order giving effect to the DRP dated 16.03.2015 to consider these companies as comparable companies. We therefore direct the TPO/AO to exclude these three companies from the list of comparable companies.
The next issue that needs to be addressed is as to whether Aftek InInfosys Ltd., should be considered as comparable company or not. In this regard we find that the objections by the assessee before the DRP after remand by the Tribunal was that this company had IPR in the Schedule of fixed assets and therefore its business model was completely different which rendered this company as not comparable with the assessee for the reason that the assessee does not have any IPR in the schedule of its fixed assets. On this issue we find that the DRP in paragraph -13 of its order 16.03.2015 has accepted that this company namely Aftek Infosys Ltd had shown significant IPRs but since the details of the nature and profile of the IPR was not available this company need not be excluded. In our view when the fact that this company had significant IPR s is accepted and the fact that the Assessee does not have any IPR is also accepted then that distinguishing feature itself is enough to exclude this company from the list of comparable companies. In fact it was brought to our notice by the ld. Counsel for the assessee that in A.Y.2009-10 the DRP in its directions dated 15.03.2016 has accepted this aspect and excluded Aftek Infosys Ltd as not comparable with that of the assessee company. The DRP held that Aftek Infosys Ltd was not comparable with the assessee because it was functionally not a comparable entity nor on FAR in view of the details filed before the panel. The functional comparability was also challenged by the assessee on the ground that this comparable company owned substantial IPRs and this was accepted by the Tribunal. In the light of the above discussion we are of the view that Aftek Infosys Ltd., should excluded from the list of comparable companies. We hold and direct accordingly.
17 M/s. Philips India Ltd. A.Yr.2006-07 19. The next grievance of the assessee in this appeal is projected in ground no.3 of its appeal. We have also seen that DRP in its direction dated 16.03.2015 has held that Sasken Communication Technologies Ltd has to be included as a comparable. The TPO has excluded this company chosen by the assessee from the list of comparables. The only limited prayer of the ld. Counsel for the assessee is that the DRP had given direction to take a profit margin at the segmental level whereas it should be taken at the entity level. In this regard it was pointed out by the ld. Counsel for the assessee that the TPO himself has taken the entity level margins in A.Y.2007-08 to 2009-10 as follows :
Assessment year Margin as per TPO Order Paper Book Page Reference 2007-08 13.37% 171 2008-09 16.88% 201 2009-10 17.51% 204 2010-11 19.95% 207 2011-12 20.91% 210 Thus going by the above, it was submitted that the corrected computation of profit margins of Sasken at an entity level should be taken as given below :-
Sasken Technologies Annual Report (AR) Annual Report Mar Annual Report Mar Ltd. Mar 2004 12 months 2005 12 mmonths Pg 2006 12 months Pg Amt in Lakhs Pg No.60 of AR No.60 of AR No.71 of AR/288 of PB Revenue 16,613.01 22,299.04 26,754.43 Total Revenue 16,613.01 22,299.04 26,754.43 Total Operating Cost Cost of Revenues, 9662.66 13181.43 19349.30 including Research and Development Exp. Product Engineering 1553.71 2061.68 Expense Selling Expenses 1890.87 2146.69 2094.97 Administrative and 1903.43 2856.21 3313.59 General Expenses Employee stock 15.63 73.70 53.59 17 Total Operating 1,586.71 1,979.33 1,942.98 Profit NCP%(on cost) 10.56% 9.74% 7.83%
It was submitted that the computation for the relevant year, i.e. AY 2006-07 was also submitted before DRP and forms part of the Paper Book (‘PB ‘). It was further submitted that the TPO while computing the segmental margin in the order has not allocated the ‘Corporate expenses ‘and that has resulted in adopting margins that are skewed. It was prayed that the corrected segmental margin of Sasken as under should be taken :
Sasken Technologies Annual Report (AR) Annual Report Mar Annual Report Mar Ltd. Mar 2004 12 months 2005 12 months Pg 2006 12 months Pg Amt in Lakhs Pg No.86 of AR No.85 of AR No.101 of AR/318 of PB Segment Revenue Software 12,378.43 18,905.47 24,003.42 Development and Services Software Products 4,234.58 3,393.55 2,751.01 Profit Before Interest and Tax (‘ PBIT ‘ ) Software 4,430.89 6,916.49 7,829.54 Development and Services Software Products 1,159.55 411.20 (424.41) Total PBIT 5,590.44 7,327.69 7,405.13 Segment Software 15.63 73.70 53.59 Development and Services Segment Revenue 12,378.43 18,905.47 4,003.42 Segment PBIT 4,430.89 6,916.49 7,829.54 Net Allocated 2,994.67 4,534.55 4,900.51 Expenditure Segmental Net 1,436.22 2,381.94 2,929.03 Profit 18
After considering the submission of the learned counsel of the Assessee, we are of the view that the profit margin at the entity level of this comparable company Sasken ought to be taken and not at the segmental level. We are of the view that the claim of the Assessee that without allocating ‘Corporate expenses‘ the margins have been computed needs verification by the TPO/AO and the TPO/AO is directed to verify this claim as given in the chart above and allow the same, if the figures are found to be correct.
The last and final submission of the ld. Counsel for the assessee is with regard to the adjustment towards working capital and risk adjustment. In this regard it was pointed out by the ld. Counsel for the assessee that the TPO again in A.Y.2004-05 in its order dated 15.05.2006 has himself allowed working capital and risk adjustment at 2% and similar allowance of such adjustments in the present assessment year should be done. The following are the relevant observations of the TPO in A.Y.2004-05 :-
“Taking all these into account, the computation provided by the tax payer cannot be accepted as reliable. However it is not fair to deny the benefit of adjustment altogether. Hence, an overall adjustment of (-2%) is given towards working capital level differences and also towards risk level differences. “
After considering the submissions of the learned counsel for the Assessee, we are of the view that similar adjustments should also be allowed in the present assessment year. We hold and direct accordingly. We also observe that the principle reasons assigned by the DRP in the present assessment year was lack of details furnished by the assessee. In this regard we find that all the details have been given by the assessee in its transfer pricing study and we find that the observations of the DRP in this regard cannot be sustained. We accordingly direct that adjustment of 2% towards working capital
Ground no.5 raised by the assessee will not survive because of the retrospective amendment to the statutory provision of section 92C(2) of the Act and hence dismissed.
As far as ground no.7 is concerned it will be just and appropriate to direct the AO to verify the claim of the assessee in this regard and allow appropriate relief if the stand taken by the assessee is found to be correct. Ground Nos. 8 and 9 regarding levy of interest is purely consequential and the AO is directed to give consequential relief.
In the result the appeal of the assessee is partly allowed. Order pronounced in the Court on 08.02.2017.