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IN THE INCOME TAX APPELLATE TRIBUNAL “B” BENCH : BANGALORE BEFORE SHRI N.V. VASUDEVAN, JUDICIAL MEMBER AND SHRI ABRAHAM P. GEORGE, ACCOUNTANT MEMBER IT(TP)A No.469/Bang/2015 Assessment year : 2010-11 M/S.Obopay Mobile Vs. The Deputy Commissioner Technology India Private of Income Tax, Circle 5 Limited, Enzyme JNC Business (1)(2), Bengaluru. Center, 2nd Floor, MPK Mansion, No.18, Guava Garden, 5th Block, Koramangala, Bengaluru-560 095. PAN NO. AAACO9074H APPELLANT RESPONDENT
IT(TP)A Nos.388/Bang/2015 Assessment year : 2010-11 Vs. M/S.Obopay Mobile Technology The Deputy Commissioner India Private Limited, Golden of Income Tax, Circle 5 Millenium, 2nd Floor, 69/1, (1)(2), Bengaluru. Millers road, Bengaluru-560 052. PAN NO. AAACO9074H APPELLANT RESPONDENT
: Shri Ms.Neera Malhotra, CIT (DR) Revenue by Assessee by : Shri Padamchand Khincha, CA
Date of hearing : 29.12.2015 Date of Pronouncement : 08.01.2016
ITA No.469/Bang/2015 & 388/Bang/2015 O R D E R Per N.V. Vasudevan, Judicial Member
These are appeals filed by the Revenue as well as the assessee against the order dated 27.1.2015 of the DCIT, Circle5(1)(2), Bengaluru, passed u/s.143(3) read with Section 144C of the Income Tax Act, 1961 (Act), relating to assessment year 2010-11.
The issue that arises for consideration in these appeals are relating to the addition made to the total income consequent to determination of Arm’s Length Price (ALP) in respect of international transaction entered into by the Assessee with it’s Associated Enterprises (AE) u/s.92 of the Income Tax Act, 1961 [the Act]. The addition made consequent to determination of ALP by the TPO and addition on account of transfer pricing adjustment was a sum of Rs.27,88,16,211 which was reduced pursuant to the directions of the Disputes Resolution Panel (DRP) pursuant to the objections filed against the order of the Transfer Pricing Officer (TPO) u/s.92CA of the Act, to Rs.26,58,66,665/-. To the extent the transfer pricing adjustment survives pursuant to the impugned directions of the DRP, the Assessee is in appeal before the Tribunal. The Revenue is in appeal before the Tribunal challenging the reliefs allowed pursuant to the directions of the DRP.
The assessee is a private limited company incorporated under the Companies Act, 1956. It is engaged in two distinct business segments- (1) Development and delivery of domain specific software for obapay Inc., 2
ITA No.469/Bang/2015 & 388/Bang/2015 USA and (2) Establishing, deploying and maintaining a platform for making mobile payments and facilitating related services for users in India. The Assessee has a single software development centre at Bangalore, India. The Assessee is a 100% subsidiary of Obopay Inc., Mauritius. M/S.Obopay Inc., Mauritius is a 100% subsidiary of Obopay Inc. The transaction of development and delivery of domain specific software by the Assessee for Obapay Inc., USA was therefore an international transaction entered into with an Associated Enterprise(AE) and therefore the income from such international transaction had to be determined having regard to Arm’s Length Price (ALP) as provided in Sec.92 & 92Cof the Act.
In support of the assessee’s claim that the price charged by it for services rendered to its AE was at arms’ length, the assessee filed a report as required by the provisions of section 92E of the Act in Form 3EB together with detailed analysis. In para 4.1.1. of its TP Study (Transfer Pricing Study) the Assessee explained that its TP study was confined only to the transaction of Development and delivery of domain specific software for Obapay Inc., USA. In para-4.1 at page-6 of the TP study the Assessee explained that its business segment of establishing, deploying and maintaining a platform for making mobile payments and facilitating related services for users in India was an activity which had nothing to do with its AE. The Assessee submitted that during the previous year it had paid a sum of Rs.3,88,63,270/- to its AE Obapay Inc., USA. This payment was explained by the Assessee as reimbursement of expenses incurred by AE on behalf of the Assessee in respect of its business segment of 3
ITA No.469/Bang/2015 & 388/Bang/2015 establishing, deploying and maintaining a platform for making mobile payments and facilitating related services for users in India. The break-up of the sum so claimed to be reimbursement were as follows:
Nature of expense Amount Cost of imported capital asset Rs.48,52,957 Professional fees Rs.1,25,23,209 Communication expenses Rs.1,70,292 Travel Rs.30,10,220 Salaries Rs.1,79,89,055 Royalty Rs.80 Miscelleneous expenses Rs.3,17,457 Total Rs.3,88,63,270
The Transfer Pricing Officer (TPO) in his order u/s.92CA of the Act treated the payment of Rs.3,88,63,270 also as an international transaction carried out by the Assessee with its AE. The following were the relevant observations of the TPO in this regard:
“The taxpayer did not appear to explain the submissions made before the undersigned on the dates given for hearing on 20/11/2013. Hence, in view of the same, the details available on record are examined. In respect of the seconded employees, it is seen that they have been seconded from Obopay Inc., USA. Their details are as under:
Name of employee Term Position Raj Aji 18 months VP Business development and legal affairs Gurpreet (Gary) Singh 18 months VP Channels and Global relationship
ITA No.469/Bang/2015 & 388/Bang/2015 The Vice President for business development & Legal affairs and the Vice President for channels and Global relationship have been appointed by the Chief Financial Officer of Obopay USA to work for Obopay USA. The offer letters are dated April 23, 2009 and May 6 2009 (revised agreement May 12, 2009). The secondment agreement is dated October 1" 2009. Other than these, the taxpayer has not furnished any information regarding the nature of functions performed by these two seconded employees. As reproduced above, all that the taxpayer has offered as an explanation is that these employees function in line with their designation." The market in which they were to perform was local market. The taxpayer is a 100% subsidiary of Obopay, Mauritius which in turn is a 100% subsidiary of Obopay, USA. Its main functions are rendering software services in the' nature of research and development to its AE. Hence, apparently these gentlemen are not seconded for the AE services. The other function of the taxpayer is said to be development of a platform for mobile payments. As already established by the TPO, these are products which the AE is already marketing. Hence, it is deduced that the functions of the taxpayer are more like marketing functions for the products of the AE. To facilitate this function, the taxpayer has taken employees at the level of Vice Presidents by way of secondment to market the products of the AE. The income from this segment is only Rs. 9584 as against the expense of Rs. 21,83,69,270/- . Thus the taxpayer is bearing the burden of marketing the product of its AE without any compensation. Not only is it not getting compensated, it is also bearing the salary cost and other costs of its top employees without being reimbursed in the guise of secondment. The TPO therefore concludes that the taxpayer has reimbursed Rs. 3,88,63,270.00/- , the expenses which are not attributable to its business. The reimbursement is an international transaction and hence the taxpayer's submission that this has little or no connection with the AE, and hence no further study has been carried out is not accepted and the TPO proceeds with the determination of the international transactions conducted by the taxpayer by aggregating them.”
The assessee adopted Transaction Net Margin Method (TNMM) as the most appropriate method for determining the ALP. Operating profits to
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ITA No.469/Bang/2015 & 388/Bang/2015 cost was adopted as the Profit Level Indicator (“PLI”). The segmental profit and Loss of the Assessee was shown as follows:
The Assessee chose 14 comparable companies in its TP study whose arithmetic mean of operating margin on cost was 6.63%. The Assessee claimed that its operating margin on cost was 12% (Page-28 of the TP study of the Assessee) and the same was arrived at by the Assessee as follows:
Operating Income Rs.19,49,40,972 Operating expenses claimed Rs.17,40,41,219 Operating Profit Rs. 2,08,90,169 OP/OC 12% The Assesse claimed that it’s Operating Profit to Operating Cost was within the permissible range of (+) or (-) variation to the arithmetic mean of operating margin on cost of comparable companies chosen by it, as provided in the second proviso to Sec.92CA of the Act. Therefore the same was at Arm’s Length hence there was no necessity for making any addition to the total income of the Assessee by way of adjustment to the ALP. 6
ITA No.469/Bang/2015 & 388/Bang/2015 7. The TPO accepted two of the comparable companies out of the 14 comparable companies proposed by the Assessee in its TP study viz., R.S.Software (India) Ltd., and Thinksoft Global Services Ltd., and rejected the other comparable companies chosen by the Assessee as not comparable. The TPO proposed 9 more comparable companies. The arithmetic mean operating margin on cost of the 11 companies chosen by the TPO was 22.71%.
The TPO computed the ALP and consequent addition to the total income as follows:
As can be seen from the aforesaid computation of ALP by the TPO, he has taken the operating cost at Rs.39,24,10,489. The operating expenses claimed in the Software Development segment by the Assessee was Rs.17,40,41,219. The operating expenses claimed in the Mobile Payment Platform activity was Rs.21,83,69,270/-. Since the TPO has already taken the view that the determination of the ALP has to be done by aggregating both the activities of Development and delivery of domain specific software for obapay Inc., USA and Establishing, deploying and 7
ITA No.469/Bang/2015 & 388/Bang/2015 maintaining a platform for making mobile payments and facilitating related services for users in India, the TPO considered Rs.39,24,10,489 (Rs.17,40,41,219 + Rs.21,83,69,270) as the operating cost on which he applied the adjusted margin of 20.73% to arrive at the shortfall being adjustment u/s.92CA of the Act of Rs.27,88,16,211/-.
Aggrieved by the aforesaid order of the TPO, the assessee filed objections before the Disputes Resolution Panel (DRP). appeal before the CIT(Appeals). The DRP held turnover and size was a relevant criteria in selecting comparable companies and was of the view that Infosys Ltd., Larsen & Toubro Infotech Limited, Mindtree Ltd., Persistent Systems Ltd., Sasken Communication Technologies Ltd., and Tata Elxsi Ltd., had to be excluded from the list of comparable companies as their turnover was in excess of Rs.200 crores whereas the turnover of the Assessee was less than Rs.20 Crores. The DRP also held that foreign exchange flotation gain had to be regarded as part of the operating profit of the Assessee and the profits margins of the Assessee had to be reckoned accordingly. The DRP also held that risk adjustment had to be provided to the Assessee and gave directions to the TPO in this regard. The other aspects with regard to determination of ALP by the TPO were held to be correct by the DRP. The 6 final comparable companies that remain after the order of the DRP are ICRA Techno Analytics Ltd., Kals Information systems Ltd., Persistent Systems & Solutions Ltd., R.S.Software (India) Ltd., and Thinksoft Global Services Ltd.
ITA No.469/Bang/2015 & 388/Bang/2015 11. The AO incorporated the directions of the DRP in his fair order of assessment. Aggrieved by the reliefs allowed by the DRP, the revenue has filed appeal before the Tribunal. The substantial grounds raised by the Revenue in this regard are as follows:
“1. Turnover filter i) The Honbie DRP erred in holding that the size and turnover of the company are deciding factors for treating a company as a comparable and accordingly erred in excluding M/s Tata Elxsi Limited, Sasken Communication Technologies Ltd., Persistent Systems Ltd. Mindtree Ltd., L & T Infotech and Infosys Limited as comparables.
ii) The learned DRP member erred in excluding uncontrolled comparables having turnover more than Rs.200 crores in the absence of Turnover criterion prescribed in Rule lOB of Income Tax Rules and also there being no correlation between turnover and profit margin. 2. Foreign Exchange Loss/Gain The Honble DRP has erred in directing to include forex gain/loss as operating in nature without ascertaining the nexus with the business activity of the taxpayer. 3. Risk Adjustment i) In so far as the issue of working capital adjustment is concerned, whether the learned DRP is justified in holding that capital adjustment has not been provided as it has negative impact. This is because working capital adjustment is given to increase comparability on the uncontrolled comparable with tested party and not to provide benefit to the assessee. Incidentally, the adjustment may or may not lead to a benefit for the assessee. In the instant case, wrong capital adjustment made by the TPO.
ii) Whether the learned DRP is justified in directing the TPO to grant risk adjustment without advising any reasonable accurate method in the absence of which the TPO had not provided the same. ”
ITA No.469/Bang/2015 & 388/Bang/2015 12. Aggrieved by the order of the DRP confirming the order of the TPO on several other aspects, the Assessee has preferred the present appeal before the Tribunal.
We have heard the rival submissions. The ld. counsel for the assessee filed before us a chart showing as to how companies excluded by the DRP was valid and as to how two of the companies retained by the DRP viz., ICRA Techno Analytics Ltd., and Kals Information Systems Ltd., had to be one of the companies, comparable companies chosen by the TPO which was retained by the DRP, had to be excluded. The learned DR relied on the order of the TPO. We shall deal with these argument by taking up individual companies chosen by the TPO and excluded by the DRP.
As far as Revenue’s grievance in its appeal are concerned, the first grievance of the Revenue as projected in ground no.1 of its appeal is that the CIT(A) was not right in applying turnover filter and excluding 6 companies chosen as comparable by the TPO. The Bangalore Bench of ITAT has been consistently following the decision rendered in the case of Trilogy e-business Software India Pvt. Ltd. v. DCIT, ITA No.1054/Bang/2011 dated 23.11.2012 wherein a view has been taken that huge turnover makes a company not comparable with a company having smaller turnover. For the sake of reference, we may refer to the decision of this Bench in the case of Trilogy e-business Software India Pvt. Ltd. v.
ITA No.469/Bang/2015 & 388/Bang/2015 DCIT, ITA No.1054/Bang/2011 dated 23.11.2012, the relevant observations therein are as follows:-
“(1) Turnover Filter
The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of RS. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not reasonable classification. Several other decisions were referred to in this regard laying down identical proposition. We are not referring to those decisions as the decision of the Special Bench on this aspect would hold the field. Reference was also made to the OECD TP Guidelines, 2010 wherein it has been observed as follows:- “Size criteria in terms of Sales, Assets or Number of Employees: The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the buyer and seller and therefore comparability.” 12. The ICAI TP Guidelines note on this aspect lay down in para 15.4 that a transaction entered into by a Rs. 1,000 crore 11
ITA No.469/Bang/2015 & 388/Bang/2015 company cannot be compared with the transaction entered into by a Rs. 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. The fact that they operate in the same market may not make them comparable enterprises. The relevant extract is as follows [on Rule 10B(3)]: “Clause (i) lays down that if the differences are not material, the transactions would be comparable. These differences could either be with reference to the transaction or with reference to the enterprise. For instance, a transaction entered into by a Rs 1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate.” 13. It was further submitted that the TPO’s range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 14. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, wherein relying on Dun and Bradstreet’s analysis, the turnover of RS. 1 crore to RS. 200 crores was held to be proper. The following relevant observations were brought to our notice:- “9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad 12
ITA No.469/Bang/2015 & 388/Bang/2015 base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.” 15. It was brought to our notice that the above proposition has also been followed by the Honourable Bangalore ITAT in the following cases: 1. M/s Kodiak Networks (India) Private Limited Vs. ACIT (ITA No.1413/Bang/2010) 2. M/s Genesis Microchip (I) Private Limited Vs. DCIT (ITA No.1254/Bang/20l0). 3. Electronic for Imaging India Private Limited (ITA No. 1171/Bang/2010). It was finally submitted that companies having turnover more than Rs. 200 crores ought to be rejected as not comparable with the Assessee. 16. The ld. DR, on the other hand pointed out that even the assessee in its own TP study has taken companies having turnover of more than RS. 200 crores as comparables. In these circumstances, it was submitted by him that the assessee cannot have any grievance in this regard.
ITA No.469/Bang/2015 & 388/Bang/2015 17. We have considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm’s length price. Sec.92-B provides that “international transaction” means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92-A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provisions of Sec.92 of the Act. Sec.92C provides the manner of computation of Arm’s length price in an international transaction and it provides:- (1) that the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :— (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board.
(2) The most appropriate method referred to in sub- section (1) shall be applied, for determination of arm’s length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm’s 14
ITA No.469/Bang/2015 & 388/Bang/2015 length price shall be taken to be the arithmetical mean of such prices:
Provided further that if the variation between the arm’s length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price.
(3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that— (a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm’s length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm’s length price in relation to the said international transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him:”
Rule 10B of the IT Rules, 1962 prescribes rules for Determination of arm’s length price under section 92C:- “10B. (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :— (a)……. 15
ITA No.469/Bang/2015 & 388/Bang/2015 to (d)…….. (e) transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub- clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction.
(2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:— (a) the specific characteristics of the property transferred or services provided in either transaction;
ITA No.469/Bang/2015 & 388/Bang/2015 (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.
(3) An uncontrolled transaction shall be comparable to an international transaction if—
(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
(4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into :
Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have
ITA No.469/Bang/2015 & 388/Bang/2015 an influence on the determination of transfer prices in relation to the transactions being compared.”
A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. 20. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is RS. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores (7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.”
The learned DR however relied on the decision of the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd. Vs. DCIT (2015) 56 Taxmann.com 417 (Del) wherein at para-3 of the said judgment the Hon’ble Delhi High Court held that the mere circumstance of
ITA No.469/Bang/2015 & 388/Bang/2015 a company otherwise conforming to the stipulations in Rule 10B(2) of the IT Rules, 1962 (Rules) in all details, presenting a peculiar feature, such as huge profit or a huge turnover, ipso facto does not leads to its exclusion. The TPO, first, has to be satisfied that such differences do not “materially affect the price… or cost”; secondly, an attempt to make reasonable adjustment to eliminate the material effect of such differences has to be made. The learned counsel for the Assessee however submitted that the Hon’ble Court was only by way of an obiter dictum and the Hon’ble Court was concerned only with the issue of excluding high profit making or abnormally loss making companies from being regarded as comparable companies. He pointed out that in any event the earlier decision of the Hon’ble Delhi High Court in the case of Agnity India Technologies Pvt.Ltd. ITA No.1204/2011 dated 10.7.2013 had taken the view that turnover was a relevant criteria in choosing comparable companies.
We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon’ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though 19
ITA No.469/Bang/2015 & 388/Bang/2015 the said decision is of a non-jurisdictional High Court. We however find that the Hon’ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criteria for choosing companies as comparable companies in determination of ALP in transfer pricing cases. In doing so the Hon’ble Bombay High Court has followed the decision of the Hon’ble Delhi High Court in the case of Agnity India Technologies Pvt.Ltd. (Supra). There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon’ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 6 companies from the list of comparable companies chosen by the TPO on the basis of turnover and size.
As far as grounds No.2 raised by the revenue is concerned, the same relates to treating the gain on account of foreign exchange fluctuation as part of the operating revenue for the purpose of working the profit margins, This Tribunal in the case of Trilogy e-business Software India Pvt. Ltd. (supra) has held as follows:-
“(B) Treating foreign exchange gain or loss and provision for bad debts as non-operating in nature and fringe benefit tax as part of operating cost: As far as foreign exchange gain/loss being considered as not forming part of the operating cost, the reasoning of the 20
ITA No.469/Bang/2015 & 388/Bang/2015 revenue is that such loss or gain cannot be said to be one realized from international transaction though they may form part of the gain/loss of the enterprise and therefore they should be excluded while determining operating cost. On the above issue we find that the Bangalore Bench of ITAT in the case of Sap Labs India (P) Ltd. Vs. ACIT (2011) 44 SOT 156 (Bang.) has taken the view that Foreign Exchange Fluctuation gains are required to be added to operating revenue. Following the same, the AO is directed to accept the claim of the Assessee in this regard. As far as provision for bad debts are concerned, the TPO has accepted that the same would be part of operating expenses provided the same is incurred every year for at least three years and the manner in which provision is made is consistent. The Assessee in reply to the query of the TPO on the above aspect has not furnished any details. We are of the view that the Assessee should be afforded opportunity to explain its position on the above and the AO is directed to consider the same in accordance with law. As far as Fringe Benefit Tax (FBT) is concerned, the same was not considered by the TPO as part of operating cost in the case of comparables and therefore the same should also not be considered as part of operating cost of the Assessee. We hold accordingly and direct the AO to compute the operating cost of the Assessee.” In view of the aforesaid decision, we do not find any merit in ground No. 2 raised by the Revenue and the same is dismissed as such.
As far as ground No.3 raised by the revenue is concerned, the same reads as follows:-
“i) In so far as the issue of working capital adjustment is concerned, whether the learned DRP is justified in holding that working capital adjustment has not been provided as it has negative impact. This is because working capital adjustment is given to increase comparability on the uncontrolled comparables with tested party and not to provide benefit to the assessee. Incidentally, the adjustment may or may not lead to a benefit for the assessee. In the instant case wrong capital adjustment made by the TPO. ii) Whether the learned DRP is justified in directing the TPO to grant risk adjustment without advising any reasonable accurate 21
ITA No.469/Bang/2015 & 388/Bang/2015 method in the absence of which the TPO had not provided the same.”
As far as ground No.3 (i) is concerned, it does not arise out of the order of the DRP as no such direction was given by the DRP. As far as Ground No.3(ii) is concerned, the DRP has given definite directions in its order at para 10.5 of its directions by quoting decided cases to be considered by the TPO/AO. These directions in our view are sufficient guidelines for the TPO to allow risk adjustment. The TPO/AO is also entitled to look into other circumstances that may be brought before it by the Assessee in the proceedings pursuant to the order of the DRP and this order.
In the result, the appeal by the Revenue is treated as partly allowed for statistical purposes.
We now take up the Assessee’s appeal for consideration. As far as the appeal of the Assessee is concerned, the first grievance is regarding choosing ICRA Techno Analystics Ltd., and Kals Information Systems Ltd., as comparable companies. As far as ICRA Techno Analystics Ltd., is concerned, the learned counsel for the Assessee has pointed out before us that the Related Party Transaction (RPT)of this company during the relevant period was in excess of 15%. Our attention was drawn to the submissions made by the Assessee before the DRP on this aspect at page 376 of Assessee’s paper book (Para 5.156) wherein the relevant details were given. The financials of this company are also placed at page 22
ITA No.469/Bang/2015 & 388/Bang/2015 619 to 622 of the Assessee’s paper book. We have considered the submissions. It is not in dispute before us that this Tribunal, in the cases of 24/7 Customer Pvt. Ltd. (ITA No.227/Bang/2010), Sony India Private Ltd. reported in (2009) 315 ITR (80) 150 (Del.) and various other cases has taken a view that comparables having RPT of upto 15% of total revenues can be considered. In view thereof, the Assessee’s grievance on this issue as projected in its grounds requires to be accepted. The TPO/AO are directed to examine the financials of this company and adopt a threshold limit of 15% of the total revenue attributable to related party transaction as ground for rejecting comparable companies. Consequently it is held that comparable companies having RPT upto 15% of the total revenues can be excluded.
As far as exclusion of M/S.Kals Information Systems Ltd., is concerned, we find that for AY 2010-11, in the case of a software development service provider, the ITAT Hyderabad Bench in the case of Pegasystems Worldwide India Pvt.Ltd. Vs. ACIT TS 488-ITAT-2015 (hyd) has taken the following view on adopting this company as a comparable company in software development segment:
“Kals Information Systems Ltd : 10. Assessee objected to the above company before TPO stating that the above said company is functionally different as it is engaged in the development of software and software products. It has inventories equivalent to 27% of the revenue. TPO however rejected Assessee’s contentions stating that company classified itself as pure software development service provider. Further, extracting page No. 22 of the annual report of the company, TPO opined that the segmental 23
ITA No.469/Bang/2015 & 388/Bang/2015 information indicates that revenue is shown to have been earned from application software and training. Accordingly, he rejected Assessee’s objections and included as the comparable company. DRP confirmed the same. 10.1. Assessee’s main objection before us is on functionality of the comparable company. As seen from the annual report of 2008-09 and 2009-10 and comparative statement placed by Assessee, the company classified itself as ‘the company engaged in development of software and software products since its inception’. The company consisting of STPI unit engaged in development of software and software products and a training centre engaged in training of software professionals on on-line projects. This indicates that company is engaged in development of software and products and its inventory also indicates that Assessee has been using its readymade libraries for sales. This company was rejected in earlier year on functional analysis by ITAT in the case of Planet Online Pvt. Ltd., in ITA No. 464/Hyd/2014 where in it was held that company is engaged in development of software products. Since its annual report states the same facts in this assessment year also, we are of the opinion that the company cannot be selected as a comparable as it was engaged in development of software and software products. Accordingly, Assessee’s objections are accepted and AO is directed to exclude the company.” 38. We now take up for consideration the grievance of the Assessee as projected in ground No.9 of its appeal which reads as follows:
“9. The lower authorities have erred in: a) Not restricting the TP adjustment to AE transactions only and thereby making an adjustment in respect of transactions with non-associated enterprise also; b) not appreciating that the appellant renders mobile payment platform services to third parties and the costs relating to mobile payment platform segment cannot be considered for computing the arm’s length price of the software development services rendered to AE; c) Concluding that appellant is engaged in the marketing of the products of the associated enterprise; and 24
ITA No.469/Bang/2015 & 388/Bang/2015
d) Adopting entity wide operating cost and operating revenue of the appellant without giving an opportunity of hearing to the Appellant. ”
A ground similar to ground No.9 was raised by the Assessee before DRP but the same was not adjudicated by the DRP. The submission of the learned counsel for the Assessee before us which was also the submission before the DRP was that during the year under consideration, the assessee operated in two segments viz software development segment and mobile payment platform segment. Under the software development segment, assessee rendered services to AE. Under mobile payment platform segment, the assessee rendered services to Non-AE. However, expenses which were reimbursed to AE were incurred in connection with mobile payment platform segment of the assessee. The reimbursements were on back to back basis and hence were considered at arm's length. Mobile payment platform segment had no other connection with the international transaction in the software development segment. Out of the total turnover of Rs. 19,49,40,972, turnover of the software segment was to the tune of Rs. 19,49,31,388/-. Turnover of the mobile payment platform activity was to the tune of Rs. 9,584/-. The assessee had performed the TP analysis on the basis of segmental results. The segmental P&L was part of the TP Study. The summary of segmental P&L account is tabulated below:-
ITA No.469/Bang/2015 & 388/Bang/2015 Particulars Software Mobile payment segment(Rs.) platform segment (Rs.) Operating revenue 19,49.31,388 9,584 Operating Cost 18,41,06,107 20,83,01,489 Operating profit 1.08,25,281 (20,82,91,905) Operating profit/cot 5.88% -99.99%
It is the contention of the Assessee that the segmental P&L for both the software and mobile payment platform segment was given to the TPO. In the show cause notice, no query was raised about the segmental profit and loss account. According to the Assessee, this indicates that the TPO accepted the segmental results as per the TP Study of the assessee. It is the stand of the Assessee that in the order passed, the learned TPO has not considered the segmental profit and loss while determining the TP adjustment. Instead the learned TPO has unilaterally considered cost and operating revenues of both Mobile Payment Platform service segment and Software Development segment for computing arm's length price. This has been done without providing any opportunity of hearing to the assessee.
It was further contended that while computing arm's length price only revenues and costs relating to AE segment need to be considered. The transactions with non-AE are not international transactions. It is only with reference to the transactions with related parties (AE) it could be alleged that the prices are manipulated" to result in a flight of profit from India. It is only such "flight" of profits 26
ITA No.469/Bang/2015 & 388/Bang/2015 that needs correction. It was contended that the TPO concluded that the reimbursements of Rs. 3,88,63,270/- is not attributable to assessee's business and proceeded with the determination of arm's length price of the international transactions conducted by taxpayer by aggregating both the segments. The relevant extract from the TP Order is already given in the earlier part of this order (vide Para-5 of this order) and is not being repeated. It is the stand of the Assessee that the above queries were raised for the first time in the Final Order. These queries were not raised during the proceedings under section 92CA. The action of the TPO is therefore bad in law.
It was submitted that with respect to above queries of the TPO, the assessee had entered into an agreement with the AE to perform software development services for AE. These services involve requirement analysis, coding and testing. Even in the TP documentation, on page 14 under the head Functional Analysis it is clearly stated that only software/system development activity is rendered by the assessee to the AE. The AE is offering the Mobile Payment Services outside India mostly in USA and Kenya. It has no such business activity in India. The assessee renders mobile payment platform services to third parties and services are provided in the domestic market(in India). The mobile payment services refer to deploying and maintaining a platform for making mobile payments and facilitating related services for users in India. It was submitted that the TPO has contended that AE is already rendering services related 27
ITA No.469/Bang/2015 & 388/Bang/2015 to mobile payment segment and therefore, where is the question of taxpayer doing independent research. In this regard, the assessee submitted that research and development is continuous activity. The software product of AE requires fine tuning for the domestic requirements. Lot of efforts are involved for installation/implementation of the product. Also in the Non-AE segment, lot of other activities like marketing, sales, legal, customer support, client management, data center, and IT support, project management etc are involved. The learned TPO has assumed that whole of Non-AE expenses is R&D. However, this is not correct. It involves various activities/expenses like marketing, sales, legal, customer support etc. The contention of the TPO is therefore without basis.
It was pointed out that even though assessee is 100% subsidiary, it is separate legal entity. There is no bar on it to carry on business in India with third party clients. The TPO assumption that the assessee cannot do any third party business because it is 100% subsidiary is bad in law.
It was argued that the TPO has contended that since AE is into development of mobile payment platform. The product developed by AE is just marketed by the assessee in India. Further, TPO has stated that the assessee has earned very less income as against the expenditure in
ITA No.469/Bang/2015 & 388/Bang/2015 mobile payment platform segment. It was submitted that this contention of the TPO is incorrect. The assessee submitted that AE renders mobile payment platform services in USA and Kenya whereas assessee renders such services in India. The assessee submitted that in December 2008 it signed an agreement with Yes Bank Ltd to provide mobile payment services in India and agreed for revenue structure that would be effective post launch. The revenue comprised of integration fee, set up fee and transaction based fees. Assessee had projection of getting substantial revenue in future as this was new product and had growth prospects. In FY 2008-09, assessee received Rs. 200,000/- as integration fees from Yes Bank. A copy of Yes bank agreement and commercials was also filed before the DRP.
As part of above Agreement, the assessee hired new employees in departments like Treasury, Operation. IT operation, BD, Marketing etc. to manage the above non AE business. AE also seconded two employees to India to manage Legal and Marketing Activity for India operations. A copy of secondment agreement was filed before the DRP. It was pointed out that as this was a new product and had regulatory compliance requirements from Reserve Bank of India (RBI), it took nearly one year to launch the product. In FY 2009-10, the team spent time on preparing the documents and analysing the market. Finally, the product was launched in February 2010. Since it was almost year end, 29
ITA No.469/Bang/2015 & 388/Bang/2015 assessee could not make much revenue in FY 2009-10.
In November 2010, assessee signed another deal with Union Bank of India (UBI), one of the top retail banks of India. However, post launch of this product in the market, the assessee realized that it needs more funds to execute it's business activity in India. Assessee being a startup Company had various limitations. Therefore assessee changed its strategy and sold this mobile payment platform business along with employees supporting this business to Nokia Mobile Payment Services India Pvt Ltd (Nokia Mobile) in January 2011. A copy of agreement was filed before the DRP. In FY 2010-11, the assessee received a part of revenue from the Nokia deal. The same has been reflected as income in the profit and loss account of FY 2010-11. A copy of financial statement for FY 2010-I I was filed before the DRP.
The summary of the revenue earned from Mobile Payment Platform segment in FY 2010-11 was as follows:-
Nature of Income Amount (Rs.) Assignment of UBI Contract 11,39,25,000 Assignment of Other Contracts 45,57,000 Transfer of employees 68,36,213 Managed Services Revenue 1,85,02,569 Professional services revenue 20,65,688 Total 14,58,86,470 47. Further, during FY 2011-12 assessee received Rs. 8.71,561/- as income from mobile payment services and Rs. 16,92,09,899/- as managed service revenue and professional service revenue from the 30
ITA No.469/Bang/2015 & 388/Bang/2015 Nokia deal. A copy of financial statement for FY 2011-12 was filed before DRP. It was pointed out that the assessee has subsequently earned revenue from the Mobile Payment Platform segment. The year under consideration was first year of operation for Mobile Payment Platform segment. The product itself was launched in February 2010. Therefore the revenue earned during the year under consideration was not much. The assessee was carrying on the business activity independently for the third parties. These activities have generated revenues in the subsequent years. Therefore the TPO's contention that assessee is having huge costs against the revenue earned in Mobile payment platfor m s egment bec aus e it is bearing the marketing burden of the AE is incorrect. The learned TPO has not appreciated the business and commercial realities and has unilaterally rejected the segmental profit and loss account. 48. The learned counsel also filed before us a copy of the TPO’s order for the subsequent AY i.e., 2011-12 wherein the TPO has accepted the stand of the Assessee and has considered the mobile payment platform services segment as independent of segment of rendering software development services to the AE. The learned DR relied on the order of the TPO.
We have given a careful consideration to the rival submissions. We find that the detailed submissions as made by the Assessee before DRP and before us, were not made before the TPO. It was the stand of 31
ITA No.469/Bang/2015 & 388/Bang/2015 the Assessee that the TPO did not confront the Assessee with the various queries that were raised in his order and therefore the answers to those queries were provided before the DRP. The DRP has not considered those submissions. We are of the view that there has been a complete failure on the part of the DRP to have considered these submission made by the Assessee before it. We are also of the view that the TPO should also have the benefit of going into the submissions made by the Assessee before us, as there was lack of opportunity of being heard afforded to the Assessee both by the TPO and the DRP. We therefore deem it fit and proper to remand this issue to the TPO/AO for fresh consideration in the light of the submissions made before us. The TPO/AO will decide the issue in accordance with law after giving the Assessee opportunity of being heard.
The TPO/AO is directed to compute the arithmetic mean of the remaining comparable companies and allow adjustment of + / - 5% of the net margin as contemplated by the provisions of Sec.92C of the Act, if the Assessee is entitled to such adjustment as a result of exclusion of the comparable companies. The TPO/AO will also rework the operating cost while determining ALP after considering the submissions of the Assessee.
In ground No.14 raised by the Assessee the Assessee has raised a ground challenging order of the DRP whereby the DRP did not give the benefit of set off of brought forward losses and unabsorbed depreciation allowances against the TP adjustment while computing total income of the
ITA No.469/Bang/2015 & 388/Bang/2015 Assessee. We find that the DRP has directed the AO to allow set off as permissible in law. We are of the view that the above direction will be sufficient as the AO is bound to give the benefit of set-off, if the other requirements of law are satisfied. We accordingly direct the AO to give effect to the directions of the DRP. The other ground relating to charging of interest u/s.234B and 234D are purely consequential and the AO is directed to give consequential relief, if any.
In the result the appeal by the Assessee is partly allowed while the appeal by the Revenue is dismissed.
Pronounced in the open court on this 08th day of January, 2016.
sd/- sd/- ( ABRAHAM P. GEORGE ) ( N.V. VASUDEVAN ) Accountant Member Judicial Member Bangalore, Dated: 8.1.2016 eks
Copy to: 1. Revenue 2. Assessee 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard file By order
Assistant Registrar, ITAT, Bangalore.