INGERSOLL-RAND(INDIA) LTD.,BANGALORE vs. DCIT CR11(4), BANGALORE

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“1) The learned Assessing Officer (“AO”), the learned Joint Commissioner of Income Tax (Transfer Pricing Officer — II), Bangalore (“Transfer Pricing officer” or “TPO”) and the Honorable Dispute Resolution Panel (“DRP”) have erred in law and facts of the case in proposing a transfer pricing adjustment under section 92CA of the Income-tax Act, 1961 (“the Act”) amounting to Rs. 1,53,40,000 on account of payment of cost contribution charges by the Appellant and while doing so: 1.1. The learned TPO, AO and the Hon’ble DRP erred in considering the arm’s length price to be with respect to the payments made by the assessee towards cost contribution charges to its Associated Enterprise (AE). 1.2. The learned TPO, AO and the Hon’ble DRP erred in holding that the international transactions cannot be aggregated in the application of Transactional Net Margin Method (‘TNMM’) for the transfer pricing analysis without appreciating the fact that the principle of aggregation of closely linked transactions is a well-established rule prescribed by the Organisation for Economic Co-Operation and Development guidelines (‘OECD Guidelines’) and referred to for guidance in various rulings of Income Tax Appellate Tribunals (‘ITAT’). 1.3. The learned TPO, AO and the Hon’ble DRP erred in selecting Comparable Uncontrolled Price Method (“CUP”) as the most appropriate method in determining the arm’s length price of payment towards management fees to AE despite the learned TPO not following the provisions prescribed in clause (a) of the sub-rule (1) of Rule l0B of the Rules for determination of ALP in relation to an international transaction under CUP. 1.4. The learned TPO, AO and the Hon’ble DRP erred in ignoring the evidences submitted by the assessee to prove that it was in need of services, services were actually rendered and the benefit was derived from the services obtained from the AE.

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2) The learned TPO, AO and the Hon’ble DRP have erred in imputing notional interest on the outstanding receivables amounting to Rs.. 11,04,290/- from the AEs and while doing so: 2.1. The learned TPO, AO and the Hon’ble DRP erred in imputing interest on the outstanding receivables from the AEs ignoring the fact that the assessee followed the same policy of not charging any interest on trade receivables from both AEs as well as Non-AEs. 2.2. Without prejudice, the learned TPO and AO ought to have been netted off the outstanding payables pertaining to the dues owed by the assessee from the outstanding receivables from AEs before proposing transfer pricing adjustment in connection with notional interest on outstanding receivables from AEs. 2.3. Without prejudice, the learned TPO, AO and the Hon’ble DRP has erred in not providing the reasonable period as interest free period for which no interest has to be determined by calculating the notional interest for the entire year (for 12 months) on outstanding receivables from AEs amounting to Rs. 74,91,793. 2.4. The learned TPO, AO and the Hon’ble DRP having accepted the Transactional Net Margin Method (‘TNMM’) as the most appropriate method had failed to appreciate that the operating margin of the assessee is higher than the arithmetic mean operating margin of comparable companies even after working capital adjustment which provides ample evidence that the additional compensation if any, required towards the credit period is already factored in the pricing of the goods sold/services rendered to its AEs. 2.5. The learned TPO, AO and the Hon’ble DRP erred in determining the credit rating of the AEs as ‘BB’ on adhoc basis and thereby imputing interest on the outstanding receivables from the AEs at a rate of 14.74% which was derived based on the annual average yield for ‘BB’ rated bond for 5 year or more term at 12.28% plus adhoc 20% premium which was obtained from CRISIL under section 133 (6) of the Act.

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Corporate Tax 3) Short Credit of Taxes deducted at source (TDS) - The learned AO has erred in granting a credit for TDS to the extent of Rs. 5,92,70,316 as against Rs. 6,05,12,937 claimed by the assessee in the revised return of income, thus resulting in a short credit of Rs. 12,42,621. 4) Interest under Section 234B - The learned AO has erred in levying interest under section 234B of the Act amounting to Rs. 2,31,864. The appellant craves to leave/to add to/to alter/to amend/to rescind/to modify the grounds herein above or produce further documents, facts and evidence before or at the time of hearing this appeal.”

- Pertaining to FY 2009-10 - Rs. 1,53,40,000 - Pertaining to FY 2008-09 - Rs. 1,04,02,489 (This payment is reflected as prior period item in the audited financial statements of FY 2009-10).

Cost contribution towards intra-group services (Ground No.1.1)

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IT(TP)A No.228/Bang/2015 Page 8 of 24 It was further submitted that the assessee received services from its AE in the area of Administration, Finance, Treasury, Tax and Strategy etc. and these services are utilized by assessee to undertake its business operations in India. It was stated that the lntra-group charges are incurred centrally by the AE and allocated to the various group affiliates including assessee on the basis of headcount and the annualized sales and the costs represent the actual costs incurred by the AE in the capacity of a centralized service provider and are allocated amongst the concerned affiliates on a rational, logical and systematic basis.

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“The allocation might be based on turnover, or staff employed, or some other basis. Whether the allocation method is appropriate may depend on the nature and usage of the service. For example, the usage or provision of payroll services may be more related to the number of staff than to turnover, while the allocation of the stand-by costs of priority computer back-up could be allocated in proportion to relative expenditure on computer equipment by the group members.”

“For example, in many cases, the services provided through intra- group arrangements are administrative or ancillary in nature, and the participants would only have been prepared to centralize the activity if they could share in the cost savings. Cost may represent an arm’s length charge in such situations’.

Aggregation approach with the application of TNMM and selection of most appropriate method (Ground Nos. 1.2 and 1.3)

IT(TP)A No.228/Bang/2015 Page 11 of 24 to payment of intra-group services. It was submitted that though the learned TPO has provided that CUP should be considered as the most appropriate method, he has failed to substantiate how CUP method can be applied in instance case, as he has not identified any uncontrolled comparable transactions to enable the application of CUP Method. It was submitted that considering the maturity of the databases, nature and type of information available as well as the nature of the international transactions, it would be extremely cumbersome, if not impossible to obtain comparable data on an independent basis. Hence conducting a benchmarking analysis to determine the ALP of the international transactions separately would be a difficult task.

Benefits derived by assessee from intra-group services (Ground No. 1.4)

IT(TP)A No.228/Bang/2015 Page 12 of 24 was derived from the services obtained from the AE. Further, the guidance, advice and support obtained from the experienced and knowledgeable team of the AE helped in management of the operational and corporate activities reducing significantly the level of senior personnel required locally, and provided for a higher degree of co-ordination of the activities among assessee and its foreign affiliates. It was submitted that the key benefits to the assessee by availing the Intra-Group services include, but are not limited to:-

• Access to high quality services on “as and when such a need arises” basis; • The staff providing the services have unequalled knowledge of the business and the issues, compared to third party providers; • Some of the services provided by the AE would not likely be obtainable from third party service providers, and it may not be prudent from a business as well as commercial perspective to avail some of the services provided by the AE’s, directly from third party service providers; • It is practically and financially not possible for the assessee to employ such experienced personnel on a stand-alone basis. Further, procuring such assistance from third party consultants would have proven to be extremely costly for the assessee: • Further, due to the direct involvement of administrative and executive management teams, the level of staff and management required at the recipient entity levels get reduced. This further provides for a higher degree of coordination of the activities among the foreign affiliates. This greater degree of coordination in turn facilitates increased sales and more efficient use of the resources; • Provide operational efficiencies (e.g. better training, staff recruitment and retention and IT platforms) and to promote opportunities of cross selling to maximise revenues;

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• Reduced costs - Many functions can be carried out centrally for the benefit of the entire Group, by reducing duplication, providing dedicated resources and the benefits of economies of scale. • Ingersoll Group has a brand name and reputation in the market because of the level and quality of the services provided to the clients. Therefore, lack of support from Ingersoll group may adversely impact the ability of IRIL to provide quality services to the client. Further, failure to have correct/appropriate policies could lead to control risks further arising leading to loss of revenue or unexpected rise in the cost of the business.

Evidence to demonstrate that the services are indeed rendered by the AE

• Detailed description of the intra-group services rendered by the AE (Page 99 of the paper book) • Cost Contribution Agreement entered between IRIL and Ingersoll Rand Company dated January 1, 2009 (Page 349 of the paper book) • Ledger extracts along with sample copy of invoice in connection with the Intra-group services (Page 355 of the paper book) • The detailed working providing the allocation of costs by Ingersoll Rand Company to various group affiliates of Ingersoll Group including IRIL (Page 358 of the paper book) • Evidence of communication in the form of electronic mails I meetings I presentations made to demonstrate services provided (Page 362 and 431 of the paper book).

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• It is only elementary that how an assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an assessee and what s not. • An assessee may have any number of qualified accountants and management experts on his rolls, and yet he may decide to engage services of outside experts for auditing and management consultancy; it is not for the revenue officers to question assessee’s wisdom in doing so. • Whether a particular expense on services received actually benefits an assessee in monetary terms or not is not even a consideration for its being allowed as a deduction in computation of income, and, by no stretch of logic, it can have any role in determining arm’s length price of that service. • The real question which is to be determined in such cases is whether the price of this service is what an independent enterprise would have paid for the same. • Similarly, whether the AE gave the same services to the assessee in the preceding years without any consideration or not is also not relevant. • The Assessee has filed a huge compilation of papers, including copies of reports, emails and other documents evidencing the rendering of services. • There is no infirmity in this contribution being taken as an arm’s length contribution to the costs. • There is no objective way in which use of services can be measured and as is the commercial practice even in market factors driven situation, the costs are shared in accordance with some objective criterion, including sales revenues and number of employees. • In any case, the assessee has adopted TNMM as most appropriate method, and the revenue authorities have neither made an effort to show as to how this method is not appropriate to the facts of this case, nor shown as to which other prescribed method of ascertaining arm’s length price of services received will be more appropriate to these facts.

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IT(TP)A No.228/Bang/2015 Page 17 of 24 exceeding 6 months take the characterisation of a loan transaction for which interest is chargeable. Further, he observed that if interest had been charged by the assessee on its AEs for the outstanding balance, it would have been included in the profit of the assessee.

IT(TP)A No.228/Bang/2015 Page 18 of 24 was submitted that in the absence of any specific provision in the Act which seeks to tax any hypothetical income, the assessee cannot be subject to tax in respect of ‘hypothetical income’, i.e., to say an income which ought to have been earned or that the assessee failed to earn. It was further submitted that in the present case, since no income has been earned or can be said to have been earned by the assessee in respect of interest chargeable from AEs, the question of applying the provisions of section 92 of the Act does not arise.

“For the purposes of this section and sections 92, 92C, 92D and 92E, “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 to mean the ALP in length price under section 92C” (emphasis supplied)

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“11.2.2 On the first issue of taxability of notional income, the assessee submitted that the TPO has tried to bring within the ambit of Section 92, a transaction that is non-existent and in the absence of any provision in the Act, the tax-payer cannot be subjected to tax in respect of ‘hypothetical income’. In the case on hand, since no income has been earned or can be said to have been earned by the assessee in respect of interest chargeable from AEs, the question of applying the provisions of Section 92 of the Act does not arise. In support of this proposition, the assessee placed reliance on the following judicial pronouncements :- 1) Vodafone India Services Pvt. Ltd. V UOI (W.P. No.871 of 2014) 2) Evonik Degussa P. Ltd. V ACIT – OSD, Circle 3(1) (ITA No.7653/Mum/2011) of ITAT, Mumbai Bench. 11.2.3 It was also submitted by the assessee that it had not charged any interest for delayed realisations even in the case of Non-AE transactions. It was submitted that the debts were outstanding with both the AEs and Non-AEs for a period exceeding the credit period purely because of business reasons and that this is a common business practice prevailing in the industry and the delay if any in the payment is not due to extension of credit period by the assessee to its AEs. In this regard, the assessee placed reliance on the decision of the Hon'ble

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High Court of Bombay in the case of CIT V Indo American Jewellery Ltd., in of 2012. 11.2.4 The assessee further made the following submissions :- (i) The TPO had mentioned, in his order under Section 92CA of the Act, that debts outstanding for more than 6 months is considered for making the T.P. Adjustment towards notional interest. However, the actual adjustment has been made on the total amount of receivables. In this regard, it was submitted by the learned Authorised Representative that there were no receivables from AEs outstanding for more than 6 months. (ii) It was submitted that if at all any adjustment had to be made, the notional interest is to be computed on the net receivables after netting off payables to all the AEs and not only to the holding company, as taken by the TPO. (iii) It was submitted that the TPO has erred in adopting an interest rate of 14% by stating that in terms of the financial health, the AEs of the assessee are not considered fit to be returned even as BBB (Moderate Safety) as per CRISIL rating. Having so stated, the TPO arbitrarily concluded that the interest rate for BBB rated corporate Bond rates at 11.45% and with an upward adjustment of 20% to arrive at the conclusion that the rate of interest of 14% is reasonable. 11.3 Per contra, the learned Departmental Representative supported the orders of the authorities below. 11.4.1 We have heard the rival contentions and perused and carefully considered the material on record, including the judicial decision cited and placed reliance upon. We find that the decision of the ITAT, Mumbai Bench, in the case of Evonik Degussa P. Ltd. V ACIT – OSD, Circle 3(1), Mumbai (ITA No.7653/Mum/2011, dt.21.11.2012) of ITAT, Mumbai Bench is squarely applicable to the facts of the case in the case on hand. In this decision the ITAT, Mumbai Bench at para 28 thereof has held as under :

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“28. After carefully considering the rival submissions and the orders of the TPO as well as the direction of the DRP, we find that the assessee has no interest liability and it does not have any external borrowings. Even if the payments have been made by the AE beyond the normal credit period, there is no interest cost to the assessee. Moreover, there is no such agreement whereby interest is to be charged on such a delayed payment. From the summary of payment submitted by the learned Counsel, it is seen that the billing is done on quarterly basis and, accordingly, the payment is being received. Therefore, the delay is not wholly on account of late payment by the AEs only. Moreover, the T.P. Adjustment cannot be made on hypothetical and notional basis until and unless there is some material on record that there has been under charging of real income. Thus, on the facts and circumstances of the case, we are of the opinion that addition an account of notional interest relating to alleged delayed payment in collection of receivables from the AEs is uncalled for on the facts of the present case and is, accordingly, deleted.” 11.4.2 Following the above decision of the ITAT, Mumbai Bench in the case of Evonik Degussa India P. Ltd. (supra), we also hold that the addition on account of notional interest relating to alleged delayed payment in collection of receivables from AEs is not called for. However, as can be seen from the extract of the decision reproduced above, the above decision has been rendered in the factual context that there has been no agreement for charging interest on delayed payment. We, therefore, deem it appropriate to remand this issue back o the file of the Assessing Officer / TPO for examination as to whether there was any agreement for charging interest on late payments or not and if it is found that there was no such agreement, then the T.P. Adjustment made in this regard requires to be deleted. As this issue has been decided, in principle, in favour of the assessee by placing reliance on the aforesaid decision of the ITAT, Mumbai Bench (supra), it is not necessary for us to adjudicate on the other grounds of appeal raised on this issue. Consequently, the grounds IT(TP)A No.228/Bang/2015 Page 23 of 24 raised at S.Nos.10 to 13 relating to the issue of interest on receivables are disposed off accordingly.”

36. Respectfully following the aforesaid decision of the coordinate Bench of this Tribunal cited supra in assessee’s own case for the AY 2006- 07, we are of the view that the lower authorities erred in making TP adjustment on account of notional interest on outstanding receivables from AEs and hence the assessee’s ground(s) of appeal on this issue is allowed.

38. With respect to ground No.4 regarding interest u/s. 234B of the Act, charging of interest is mandatory and there is no discretion in the matter as held by the Hon’ble Apex Court in the case of Anjum M.H. Ghaswala (252 ITR 1) (SC). We therefore uphold the action of the AO in charging of the interest. The AO is directed to recompute interest u/s. 234B after giving effect to this order.

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Pronounced in the open court on this 5th day of November, 2015.