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Income Tax Appellate Tribunal, DELHI BENCHES : I-2 : NEW DELHI
Before: SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM
ORDER
PER R.S. SYAL, AM:
This appeal filed by the assessee is directed against the final assessment order passed by the Assessing Officer (AO) u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called ‘the Act’) on 30.12.2013 in relation to the assessment year 2009-10.
The first major issue raised by the assessee in this appeal is against the addition of Rs.3,84,30,722/- made by the AO on account of transfer pricing adjustment.
Briefly stated, the facts of the case are that the assessee is an Indian branch office of Sony Mobile Communications International AB (hereinafter referred to as `SMCI’) (formerly called Sony Ericsson Mobile Communications International AB), a company incorporated under the laws of Sweden. The assessee’s Head office is a wholly owned subsidiary of Sony Ericson Mobile Communications AB (hereinafter referred to as `SEMC’). SMCI set up a branch office (R&D Centre) in a Special Economic Zone (SEZ) in Chennai with the objective of entering into research and development activity in the information technology industry. The assessee filed its return along with the audit report in Form No. 3CEB showing four international transactions. On a reference made by the AO to the Transfer Pricing Officer (TPO) for determining the arm’s length price (ALP) of these international transactions, the TPO took up for consideration the international transaction of ‘Rendering services’ with the transacted value of Rs.58,93,09,326/-. The TPO noticed that the assessee entered into an agreement with Sony Ericson Mobile Communications (SEMC) for carrying out R&D services relating to Contract software development maintenance and up gradation and Contract design, development, testing and any similar activities in relation to mobile phones, their accessories, communication devices or communication systems. The nature of business carried on by the assessee was characterized by the TPO as that of providing software services to its AE. The assessee adopted Transactional net margin method (TNMM) as the most appropriate method with the Profit Level Indicator (PLI) of Operating profit/Operating cost for demonstrating that the international transaction of ‘Rendering of services’ was at ALP. Seventeen companies were selected by the assessee as comparable with their average PLI of 13.28%. After applying certain filters, the updated margin of the finally selected nine companies was worked out at 13.21%. The TPO analysed 3 the functions performed by the assessee and the other relevant details furnished before him. After doing all this, he shortlisted 19 companies (shown as 21 in the Table with duplication of two companies), as tabulated on pages 55 and 56 of his order, as comparable with their average OP/TC at 26.37%. By applying this profit rate as benchmark, the TPO proposed a transfer pricing adjustment of Rs.10,68,36,646/-.
The assessee assailed the draft order of the AO containing such addition before the Dispute Resolution Panel (DRP). After certain rectification order passed by the TPO pursuant to the directions of the DRP, a final addition of Rs.3.84 crore was made by the AO, against which the assessee has come up in appeal before us.
We have heard the rival submissions and perused the relevant material on record. There is no dispute on the determination of ALP of any transaction other than that of `Rendering of services’ with the declared value at Rs.58,93,09,326/-. Further, there is no dispute on the application of the TNMM as the most appropriate method with PLI of OP/TC. The assessee is aggrieved only against inclusion of three companies in the final set of comparables, namely, Infosys Ltd., Tata Consultancy Services Ltd. (Consolidated) and Bodhtree Consulting Ltd. (Standalone). We will take up these three companies in seriatim to decide their inclusion in the final list of comparables.
Before deciding the comparability or otherwise of the three companies under challenge, it is of paramount importance to first ascertain the functional profile of the assessee. It has been noticed above that the assessee is providing research and development services relating to Contract software development maintenance and up gradation and Contract design, development, testing and any similar activities in relation to mobile phones, their accessories, communication devices or communication systems. Such services were provided pursuant to an Agreement entered into between the assessee through its head office, namely, SMCI on the one hand and SEMC on the other. A copy of this Agreement dated 19.9.2008 is available on page 102 onwards. The nature of services provided by the assessee pursuant to this Agreement are contained in Annexure, which are verbatim reproduction of what has been mentioned above. This Agreement provides that the assessee will be compensated by its AE on all Costs incurred in providing such software services with a certain mark up. The term ‘Costs’ has been defined to mean all variable and fixed operating expenses including normal recurring costs, such as, lease rent, communication and linkage charges, salaries, employee benefits, depreciation, amortization and net loss of foreign exchange transactions. It has been provided that the term ‘Costs’ shall not include interest paid, loss in sale of fixed assets and any prior period or extraordinary expenses. As per this Agreement, the assessee, Indian Branch of SMCI, has undertaken to perform research and development services for the benefit of SEMC. Clause 6 of the Agreement is important, as per which SEMC shall, at all times, be the sole owner of all rights relating to or emanating from any information or material including intangibles supplied by it to the assessee. It has further been agreed that the assessee will not acquire any ownership or economic interest in the intangibles. We have gone through certain invoices raised by the assessee on SEMC, copies of which are available on page 118 onwards of the paper book. For example, invoice dated 6 7.1.2009 has been raised on SEMC by giving total expenses incurred during the month of December, 2008 to which a markup of 15% has been added. Similar is the position about 15% markup on the costs incurred by the assessee in providing these software services to its AE in other months. With the above background in mind about the functional profile of the assessee, we will now try to ascertain as to whether or not the above referred three companies are comparable.
6.1. The TPO noticed that this company was finding place in the accept/reject matrix. He found it to be engaged into software development services qualifying all the filters applied by him. The assessee raised certain objections before the DRP against the inclusion of this company, but without any success. The TPO computed operating profit margin of this company at 40.74% and considered it accordingly.
The assessee is aggrieved against the inclusion of this company in the eventual set of comparables.
6.2. We are disinclined to sustain the preliminary objection taken by the ld. DR that the assessee should be prohibited from adopting a stand contrary to the one taken at the stage of the TP study or during the course of proceedings before the TPO. It goes without saying that the object of an assessment is to determine the income in respect of which the assessee is rightly chargeable to tax. As the income not originally offered for taxation, if otherwise chargeable, is required to be included in the total income, in the same breath, any income wrongly included in the total income, which is otherwise not chargeable, should also be excluded. There can be no estoppel against the provisions of the Act.
Extending this proposition further to the context of the transfer pricing, we find that if an assessee fails to report an otherwise comparable company, then the TPO is obliged to include it in the list of comparables, and in the same manner, if an assessee wrongly reports an incomparable case as comparable in its TP study and then later on claims that it should be excluded, then, there should be nothing to forbid from claiming so, provided the TPO is satisfied that the company so originally reported as comparable is, in fact, not comparable. The 8 Special Bench of the Tribunal in DCIT vs. Quark Systems Pvt. Ltd. (2010) 132 TTJ (Chd) (SB) 1 has also held that a company which was included by the assessee and also by the TPO in the list of comparables at the time of computing ALP, can be excluded by the Tribunal, if the assessee proves that the same was wrongly included.
6.3. Turning to the functional comparability, we find that the assessee is simply a captive unit rendering services to its AE alone without acquiring any intellectual property rights in the work done by it in the development of software. The Hon’ble Delhi High Court in CIT vs. Agnity India Technologies (P) Ltd. (2013) 219 Taxmann 26 (Del) considered the giantness of Infosys Ltd., in terms of risk profile, nature of services, number of employees, ownership of branded products and brand related profits, etc. in comparison with the factors prevailing in the case of Agnity India Technologies Pvt. Ltd., being, a captive unit providing software development services without having any IP rights in the work done by it. After making comparison of various factors as enumerated above, the Hon’ble Delhi High Court held Infosys Ltd. to be incomparable with Agnity India Technologies Pvt. Ltd. The facts of the instant case are more or less similar inasmuch as the extant assessee is also a captive service provider and also not owning any branded products with no expenditure of its own on R&D etc. When we consider the above factors in a holistic manner, there remains absolutely no doubt in our minds that Infosys Technologies Ltd. is non-comparable with the assessee company. Respectfully following the judgment of the Hon’ble jurisdictional High Court in Agnity India (supra), we hold that Infosys Technologies Ltd., cannot be treated as comparable with the assessee company. This company is, therefore, directed to be excluded from the list of comparables.
7.1. This company was chosen by the TPO as comparable. The assessee’s objections about this company’s incomparability were turned down.
7.2. Having heard the rival submissions and perused the relevant material on record, we find from the Annual report of this company that its total income comprises of revenues from `IT and Consultancy services’ at Rs.21535.75 crore and `Sale of equipment and software licenses’ at Rs.868.25 crore. The TPO has taken entity level figures of this company for the purpose of making comparison. When we peruse the segmental reporting given by this company, it turns out that the same has been done on the basis of geographical locations and there are no functional segments. It is further noticed above that total revenue of this company includes a larger chunk from the sale of equipment and software licenses, which renders it incomparable with the assessee, which is solely engaged in rendering software services to its AE.
7.3. Significantly, page 23 of the Annual report of this company divulges that: ‘During the year 2008-09, the company has acquired Citigroup Inc.’s (Citi) 96.26% interest in TCS e-Serve Ltd. (formerly known as Citigroup Global Services Ltd.), the India-based capital BPO, for a total consideration of USD 504.54 million.’ This indicates that this company made acquisition during the year in question which is an extraordinary financial event. The Mumbai Bench of the Tribunal in Petro Araldite (P) Ltd. Vs. DCIT (2013) 154 TTJ (Mum) 176, has held that a company cannot be considered as comparable because of exceptional financial results due to mergers/demergers. Similar view has been adopted by the Delhi Bench of the Tribunal in several cases including Ciena India Pvt. Ltd. Vs. DCIT (ITA No.3324/Del/2013) vide its order dated 23.4.2015. The ld. DR contended that the mere fact of acquisition and merger should not be considered as a decisive test for exclusion of a company unless it has affected the profitability due to such merger etc. We are not inclined to accept this contention for the obvious reason that once acquisition and merger etc. has taken place, it is always likely to affect the profitability of such a company in the year of acquisition etc. There cannot be any standard yardstick to measure the impact of such a factor on the overall profitability of such a company. It is relevant to highlight that we are considering the exclusion of a company on this score. In our considered opinion, when other comparables are available, the exclusion of a probable comparable company cannot have much significance in contrast to a situation of inclusion of a probable incomparable. Respectfully following the above 12 referred decisions, we hold that TCS Ltd. cannot be considered as comparable with the assessee. The same is directed to be excluded.
(iii) Bodhtree Consulting Ltd. 8.1. This company was chosen by the TPO as comparable. The assessee’s objections to the functional dissimilarity of this company were jettisoned. That is how the TPO finally included this company in the list of comparables. The assessee is aggrieved against the inclusion of this company.
8.2. The TPO treated Bodhtree Consulting Ltd. as one of the comparables. The assessee objected to the inclusion of this company on the ground of functional dissimilarity and its fluctuating profit margins.
The TPO rejected the assessee’s contention about the super normal profits earned by this company during the year and also held the same to be functionally similar inasmuch as it was having only one identifiable reporting segment, i.e., software development services. The assessee is aggrieved with the inclusion of this company in the final list of comparables.
8.3. After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company, that it has only one segment, namely, Software development. It is engaged in providing open and end-to-end web solutions, off-shoring data management, design and development of solutions. When we consider the nature of services provided by the assessee under this segment, namely, Software development, there remains no doubt that functionally Bodhtree Consulting Ltd. is a comparable entity.
8.4. The ld. AR submitted that Bodhtree Consulting Ltd. cannot be considered as comparable because of a different model of revenue recognition. He invited our attention towards the Annual report of this company, in which it has been reported that revenue from software development is recognized based on software developed and billed to clients. He submitted that the costs incurred by this company in respect of the projects pending completion at the end of the year are booked at the time of incurring, but, the income is recognized on the raising of bills in subsequent year, thereby distorting the comparability with the assessee company.
8.5. We find that the assessee is raising invoices on month to month basis. From the dates of invoices raised by the assessee, it is found that such invoices are raised in succeeding month of doing the work. For example, total expenses incurred by the assessee in rendering the services in the month of June, 2008 will be billed in the month of July, 2008. This shows that expenses incurred in rendering services between April 2008 to February, 2009 and debited to the Profit and loss account match with the corresponding invoices raised during the months of May 2008 to March 2009. However, difficulty arises qua the expenses incurred in rendering the services during the month of March, 2008, for which bill is raised in the month of April, 2008 and the expenses incurred in rendering the services during the month of March, 2009, for which the bill is raised in the month of April, 2000. The assessee follows the financial year closing, namely, March ending every year. The revenue for the year ending 31.3.2009 thus includes the invoice raised during the month of April, 2008 for which expenses were incurred and booked in the preceding year and accordingly the expenses incurred during the year include expenses incurred and booked during the month of March, 2009, for which income got recognized in succeeding year.
This distorts the matching principle in the same way as is being done by Bodhtree, a position contrary to what has been argued by the ld. AR.
The assessee raised invoice in April, 2008 for Pounds 3,22,465.01 and in April, 2009 for Pounds 3,40,153.46. Difference in these two amounts, translated into Indian rupees, as per the ld. AR would be roughly to the tune of Rs. 18.00 lac. This shows that both the assessee and Bodhtree Consulting Ltd. are not following any different pattern of income recognition, namely, Bodhtree Consulting is recognizing income at the completion of project and the assessee at the end of month. In such circumstances, we find it difficult to order the exclusion of this company from the list of comparables on this sole ground, when this company is otherwise functionally similar.
8.6. The ld. AR relied on an order passed by the Delhi tribunal in Ciena India (P.) Ltd. vs. ITO (2015) 59 taxmann.com 92 (Del -Trib), in which Bodhtree has been held to be not comparable. It was therefore, urged that the same view be taken here also. We are not inclined to accept this proposition. It has been repeatedly laid down in several decisions that a particular company treated as comparable in one case does not per se become comparable in all other cases and vice versa.
What is required to be seen is the basis/factor on which such company was held as comparable or non-comparable in the first case. If the same basis/factor exists in other cases as well then, no different view can be taken. But if the relevant basis/factor for decision in the first case does not exist in the other cases, it is but natural that different view will have to be taken. In Ciena (supra), the tribunal found Bodhtree as otherwise functionally comparable, except Ciena accounting for expenses matching with the revenue as against the otherwise position in Bodhtree, which led to treating it as non-comparable on the basis of such income recognition methodology. Adverting to the facts of the instant case, we find such distinguishing factor to be absent here. We, therefore, hold that 17 the authorities below were justified in including this company in the final list of comparables.
9.1. The next issue raised by the ld. AR is about not granting of working capital adjustment. The assessee requested for allowing working capital adjustment which the TPO refused to allow on the ground that such adjustment would be relevant only when some inventory remains tied up or receivables are held up which cannot be a criteria in a service industry as the assessee is engaged in. He, therefore, refused to allow any working capital adjustment.
9.2. We have heard the rival submissions and perused the relevant material on record. It is observed that the assessee lodged a claim for grant of working capital adjustment. The TPO refused to allow such adjustment. The DRP strengthened the case of the TPO by adding one more reason, being the necessity and non-availability of daily average of working capital deployed as against the use by the assessee of the average of such figures of working capital on the first and the last days of the accounting period.
9.3. We are not inclined to accept the view canvassed by the authorities that the working capital adjustment cannot be allowed as the assessee is in service industry. Such an adjustment is restricted to inventory, trade receivables and trade payables. If a company carries high trade receivables, it would mean that it is allowing its customers relatively longer period to pay their dues, which will result into higher interest cost and the resultant low net profit. Similarly, by carrying high trade payables, a company benefits from a relatively longer period available to it for paying back the dues to its suppliers, which reduces the interest cost and increases profits. In order to neutralize the differences on account of carrying high or low inventory, trade payables and trade receivables, as the case may be, it becomes eminent to allow working capital adjustment so as to bring the case of the assessee at par with the other functionally comparable entities. We, therefore, agree in principle with the grant of working capital adjustment.
9.4. The view taken by the Dispute Resolution Panel (DRP) for computing such adjustment on the basis of daily average of working capital deployed by the tested party and also each of the comparables, is not tenable because of the order passed by the Delhi Bench of the Tribunal in the case of Navisite India Pvt. Ltd. Vs. ITO (ITA No.5329/Del/2012). Vide its order dated 31.5.2013, the Tribunal has held that the components of the working capital deployed should be considered on annual basis with the average of opening and closing figures. We, therefore, hold that the entitlement of the assessee to the working capital adjustment, cannot be denied. Since the necessary details qua the grant of such an adjustment have not been examined because of refusal to grant such adjustment at the threshold, we are of the considered opinion that it would be fit and proper to set aside the impugned order on this issue and send the matter back to the file of the AO/TPO to compute and allow working capital adjustment, if any, available to the assessee in the light of our above discussion. Once it is held that such an adjustment is allowable, then it should be carried out whether it favours or disfavors the assessee. It goes without saying that the assessee will be allowed an opportunity of hearing in such fresh determination of the working capital adjustment, if any. 20
To sum up, we set aside the impugned order on the issue of addition towards transfer pricing adjustment and remit the matter to the file of AO/TPO for fresh determination of the ALP of the international transaction of rendering of software services in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings.
The only other ground which survives for our consideration is the disallowance of deduction u/s 10AA of the Act amounting to Rs.5,42,10,177/-
The facts apropos this issue are that the assessee claimed this deduction u/s 10AA. The AO refused it giving three major reasons as recorded on pages 6 and 7 of his order, namely, first, that the services were rendered by the Indian branch office to its holding company at cost plus basis and the branch office cannot be treated as separate taxable entity different from its head office for determining the income which accrues in respect of activities undertaken by it. The second reason given by the AO was that even if exports were made, but, sale proceeds in foreign currency were not received in or brought into India inasmuch as what was received in India was only remuneration determined on cost plus basis for development of computer software. And third reason was that the assessee cannot claim benefit of deduction u/s 10AA from the transfer of software services to its holding company. In view of the above reasons, the TPO refused to allow deduction u/s 10AA. No relief was allowed by the DRP, which resulted into disallowance of Rs.5,42,10,177/- made by the AO. The assessee is aggrieved against the denial of benefit of deduction u/s 10AA of the Act.
We have heard the rival submission and perused the relevant material on record. We find that the assessee furnished complete details about the fulfillment of all the relevant conditions for the eligibility of deduction u/s 10AA before the AO as well as the DRP. Copies of such letters addressed to these authorities are available on pages 138, 166, 167, 173, 184, 193, etc. of the paper book. The AO has denied the deduction, inter alia, by holding that in the instant case there were no exports inasmuch as certain services were rendered by the branch office to its head office on cost plus basis. We do not find this view point of the AO as correct for the obvious reason that the assessee did not render these services to its head office, but, to SEMC, which is the holding company of the assessee’s head office. We have discussed in detail about the international transaction of rendering of Software services to its AE, on which transfer pricing adjustment was made. Under such circumstances, the point of view of the AO that the services were rendered by the assessee to its holding company, is wholly incorrect. As regards the other point considered by the AO for denial of deduction about the assessee rendering services to its head office alone, thereby leading to transaction with self, in our considered opinion, is again devoid of merits. Once the law requires an Indian branch of a foreign enterprise to be considered independent of its head office for taxation purpose, the AO cannot make out a case that there is no difference between head office and branch office in India and, hence, no deduction, which is otherwise available, should be given. If the principle of mutuality as invoked by the AO for denial of deduction u/s 10AA is taken to its logical conclusion, then, it would also mean that the assessee 23 did not earn any income at all from its head office again on the principle of mutuality. Obviously, this position is not sustainable. Be that as it may, we are confronted with a situation in which the assessee has rendered software services to its AE and not head office.
The other reason of the AO for denial of deduction u/s 10AA is that the assessee did not receive any income at all in foreign currency and what was received was simply the cost incurred plus a certain mark up and the same cannot be considered as sale proceeds of the software sold by the assessee. Again, we are unable to countenance this view of the AO because the assessee brought in India sale proceeds from rendering of services to its AE. The remuneration model has been decided by the parties inter se with a cost plus mark-up, which in the instant case, is 15% of costs. What the assessee has realized in India is nothing, but, sale proceeds of software service provided by it to its foreign AE, which include not only the costs incurred by it in providing software services but also such mark-up. This, in our considered opinion, satisfies the requirement of receipt of foreign currency in India.
Since the assessee has satisfied all the requisite conditions for availing of the benefit of deduction u/s 10AA, we are of the considered opinion that the authorities below erred in refusing to grant such deduction. We, therefore, overturn the impugned order on this issue and direct the grant of deduction u/s 10AA of the Act.
In the result, the appeal is partly allowed.
The order pronounced in the open court on 29.04.2015.