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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SMT. ASHA VIJAYARAGHAVAN & SHRI ABRAHAM P. GEORGE
Per Asha Vijayaraghavan, Judicial Member
This appeal by the assessee is against the order dated 22.3.2013 of the CIT(Appeals)-III, Bangalore for the assessment year 2008-09.
2. The assessee company is a wholly owned subsidiary of Apigee Corporation, USA (‘Apigee Corp’ or ‘Apigee’) [formerly known as Sonoa Systems Inc. (“Sonoa mc”)]. The assessee is a captive offshore development centre of Apigee Corp, which is a development centre providing services to Apigee Corp in building products in the technology that Apigee is into. It filed the return of income on 01.102008 declaring total income of NIL after claiming the deduction u/s. 10A of Rs.1,69,53,978.
3. The return was selected for scrutiny and notices us/. 142(1) and 143(2) were issued. The Assessing Officer called for the various details and referred the case to the Transfer Pricing Officer [TPO] u/s. 92CA of the Income-tax Act, 1961 [“the Act”] for the determination of the arm’s length price (ALP) in respect of international transactions entered into by the assessee.
4. The TPO in her transfer pricing order dated 31.10.2011 passed u/s. 92CA of the Act, made a transfer pricing adjustment of Rs. 21,131,649 to the ALP adopted by the assessee. The AO subsequently passed the final assessment order dated 30.01.2012 u/s. 143(3) r.w.s 144C(3) r.w.s.
144C(4) of the Act assessing the total income at Rs. 2,11,31,649 after allowing deduction of Rs.1,80,54,350 u/s. 10A of the Act, resulting in a . demand of Rs.86,55,052.
During the relevant financial year 2007-08, international transactions that took place between the assessee and its associated enterprises (AEs) was provision of SWD services to them at a price of Rs. 170,844,091, for which a TP adjustment was made by the TPO to an extent of Rs.21,131,649.
It is stated that assessee was not in receipt of notice for hearing issued by the Ld. CIT(Appeals), on account of change in its registered office address. The ld. CIT(A) passed an ex-parte order.
The assessee entered into international transaction by providing software development services amounting to Rs.170,844,091 and towards purchase of capital goods, instrument etc. amounting to Rs.61,935. The margin (OP/TC) was at 10.04% on software development services segment. The assessee selected the following comparables:-
The TPO selected the following comparables:-
The arithmetic mean of the comparables selected by the assessee was at 9.01%, whereas that of the TPO was at 23.65%. The ld. counsel for the assessee before us objected to the following comparables selected by the TPO on the ground of functional dissimilarity:-
1. Avani Cimcon Technologies Ltd.
2. Celestial Biolabs Ltd. 3. E-Zest Solutions Ltd. 4. Infosys Technologies Ltd. 5. Kals Info Systems Ltd. (Seg) 6. Persistent Systems Ltd. 7. Quintegra Solutions Ltd. 8. Tata Elxsi Ltd. 9. Thirdware Solutions Ltd. 10. Wipro Ltd. (Seg) 11. Lucid Software Ltd.
In short, out of the 20 comparables selected by the TPO, the assessee objected to 11 comparables listed above as functionally dissimilar and not to be included in the TP study.
With respect Avani Cimcon Technologies Ltd., it was the assessee’s submission that the assessee offers diversified operations such as software solutions, software development, consulting and information technology services to various clients. The assessee was also a products development company and has developed innovative product lines such as Dxchange, CARMA etc. Reliance was placed on the decision of 3DPLM Software Solutions Ltd. in IT(TP)A No.1303/Bang/2012 for AY 2008-09 and Trilogy E-Business Software India (P) Ltd. in for AY 2007-08.
We find that there is merit in the objection of the ld. counsel for the assessee and hence we direct that Avani Cimcon Technologies Ltd. be excluded from the list of comparables selected by the TPO.
With regard to the other 8 comparables selected by the TPO, the ld. counsel for the assessee submitted that these companies were functionally different from the assessee for the following reasons:-
Celestial Biolabs Ltd. The company is into bio-informatics software product/services and in the development of products in the field of bio-technology and pharmaceuticals.
2. E-Zest Solutions Ltd. The company rendered product development services and high-end technical services which came under the category of KPO services.
3. Kals Info Systems It is engaged in the development of software products Ltd. and providing related services. As per the website of KALS, it is evident that the company is a full-fledged software product development company and also provides implementation and maintenance of software products. It also has a training centre engaged in training of software professionals for online projects.
Persistent Systems It is a product company. Persistent Systems’ product Ltd. lifecycle offering covers the entire product lifecycle from product concept to product support. 5. Quintegra Solutions It is into niche area of Information Technology. The Ltd. company’s operations consist of CRM, Telecom, Financial Services and other emerging verticals. It is engaged in providing High end IT solutions like development, testing, maintenance, SAP, product engineering and infrastructure management services, proprietary software products and consultancy services in IT on various platforms and technologies. 6. Tata Elxsi Ltd. AS seen from the annual report, it has business units divided into Embedded product Design Services, Industrial Design Services, Animation and Visual Effects ,Systems Integration services which are related to high-end hardware and software development activities. 7. Thirdware Solutions As seen from the annual report, it earns revenue by Ltd. rendering software development services, sale of user licences for software applications and also from sale of investments. 8. Lucid Software Ltd. It is a product company focusing on Advanced Non destructive Testing (NDT) technologies. As per the website, it is actively involved in R&D activities with leading scientific and educational institutions.
The assessee placed reliance on the following decisions in support of its contentions:-
- 3DPLM Software Solutions Ltd. IT(TP)A No.1303/Bang/2012 (AY 2008-09)
- Trilogy E-Business Software India P. Ltd. (ITA No.1054/Bang/2011 (AY 2007-08) - Systech Integrators India Pvt. Ltd., (AY 2008-09) - Telcordia Technologies India Pvt. Ltd., ITA No.7821/Mum/2011 (AY 2007-08)
With regard to the other three comparables, the ld. counsel for the assessee submitted that these companies are also to be excluded from the list of comparables selected by the TPO for the following reasons:-
Avani Cimcon Functionally different, diversified operations: 1. Technologies Ltd. The company offers software solutions, software development consulting and information technology services to various clients. Product development company The company has developed innovative product lines such as Dxchange, CARMA etc. It was submitted that the website of this company substantiates the same.
Infosys Technologies Full-fledged risk assuming entrepreneur Ltd. It is a giant company in the area of software development and assumed all risks leading to higher profits and is therefore not comparable with to the assessee which is a captive unit of the parent company and assumes only limited risks. Holds technology and marketing intangible It is actively engaged in research & development activities and also owns intellectual property. It also partakes in activities and advertising for brand building. Infosys was ranked as the top IT services company in that year and therefore has significant brand value. Functionally different It provides end-to-end solutions encompassing technical consulting, design, development, re- engineering, maintenance, systems integration and implementation.
Wipro Ltd. (Seg) Functionally different It is a product development company. The annual report for FY 2007-08 shows that it has income from both sale of software products and software development services. Full-fledged risk assuming entrepreneur It is a giant company and assumed all risks leading to higher profits and is therefore not comparable to the assessee company which is a captive unit of the parent company and assumes only limited risks. Holds technology and marketing intangible It is actively engaged in research & development activities and also owns intellectual property.
In support of his contentions, the ld. counsel for the assessee placed reliance on the following decisions:-
- 3DPLM Software Solutions Ltd. IT(TP)A No.1303/Bang/2012 (AY 2008-09) - Trilogy E-Business Software India P. Ltd. (ITA No.1054/Bang/2011 (AY 2007-08) - Systech Integrators India Pvt. Ltd., (AY 2008-09) - Telcordia Technologies India Pvt. Ltd., ITA No.7821/Mum/2011 (AY 2007-08) - Adaptec (India) Pvt. Ltd., ITA 1758/Hyd/2012 (AY 2008-09) - App Labs Technologies Pvt. Ltd., ITA No.94/Hyd/2013 (AY 2008-09) - CIT v. Agnity India Technologies Pvt. Ltd., ITA No.1204/2011, Delhi High Court.
The assessee’s reliance on 3DPLM Software Solutions Ltd. IT(TP)A No.1303/Bang/2012 (AY 2008-09) is well taken and hence the 11 companies identified by the assessee referred to in paras 12 and 14 hereinabove are functionally different. We therefore direct the TPO to exclude the aforementioned 11 comparables from the list of comparables for the TP study.
The next ground raised by the assessee is on the working capital adjustment. It was contended by the assessee before the AO that working capital adjustment has to be provided in accordance with Rule 10B(1) on account of risk profile of the assessee. The ld. counsel for the assessee submitted as follows:-
“iii. Working capital adjustment is essentially an adjustment for the opportunity cost of making investments in working capital (i.e., inventories, accounts receivable/debtors and accounts payable/creditors) which require capital and operating assets. At arm’s length, an uncontrolled entity will expect to earn a market rate of return on that capital, independent of its operations. However, the amount of capital required varies greatly, because the level of inventories, debtors and creditors measured as a percentage of the total cost varies. There is an effect on profits from investing in different levels of working capital due to differences reflected in cash collection cycle. Such differences in collection cycle imply differences in credits granted to customers and such a credit function is akin to an additional service for which markets are willing to pay. iv. High levels of working capital create costs either in the form of incurred interest or in the form of opportunity costs. Therefore, no profit maximizing/ entrepreneurial firm would hold working capital without a return. v. A working capital adjustment analysis seeks to adjust the profitability of each comparable company based on the working capital position of the Appellant to reflect the differences in working capital investment. Thus, the adjustment tries to isolate the interest effects (taking into account the time value of money) that result from the opportunity costs of holding working capital. The interest effects in the comparable company’s data are not completely eliminated but rather adjusted to the Appellant’s level of interest effects. Prime-lending rate (‘PLR’) is used as the appropriate cost of capital because it can be determined with reasonable accuracy and is the best available estimate of the cost of capital. For this purpose, the PLR is secured from CMIE (i.e. Center for Monitoring Indian Economy) and Reserve Bank of India publications. vi. At this point, a quote from the OECD Draft Notes is relevant, which is provided as below: “The purpose of Working Capital Adjustment is to improve the reliability of the comparables.” vii. It is also worthwhile to mention that working capital adjustment is necessary as well as mandated as a comparability adjustment under Rule l0B(3) of the Rules. In this context, emphasis is also placed on the Mentor Ruling, para 36.3 of which states: “The transactional net margin method may afford a practical solution to otherwise insoluble transfer pricing problems if it is used sensibly and with appropriate adjustments to account for differences of the type referred to above.” viii. Further, Para 27 of the Ruling states: “The risk assumed by respective parties is a very important consideration. Depending on facts of the case, final set of comparables may need to eliminate differences by making adjustments for the following: …………… working capital” ix. In this regard, the Appellant would also like to place reliance on the decision of the Hon’ble Pune Bench of the ITAT in the E-gain Ruling, which discusses at length, the necessity and importance of making adjustments (such as on account of working capital) for a robust comparable search analysis, while applying the TNMM. The E-Gain Ruling has drawn references from the India TP Regulations as well as the US TP provisions for pointing out the need for making adjustments. Para 35 of the E-Gain Ruling quotes the following from the US TP provisions: “(iv) Adjustments for the differences between the tested party and the uncontrolled taxpayers. If there are differences between the tested party and an uncontrolled comparable that would materially affect the profits determined under the relevant profit level indicator, adjustments should be made according to the comparability provisions of 1.482-1(d)(2). In some cases, the assets of an uncontrolled comparable may need to be adjusted to achieve greater comparability between the tested party and the uncontrolled comparable. In such cases, the uncontrolled comparable’s operating income attributable to those assets must also be adjusted before computing a profit level indicator in order to reflect the income and expense attributable to the adjusted assets. In certain cases it may also be appropriate to adjust the operating profit of the tested party and comparable parties. For example, where there are material differences in accounts payable among the comparable parties and the tested party, it will generally be appropriate to adjust the operating profit of each party by increasing it to reflect an imputed interest charge on each party’s accounts payable.” x. Making a working capital adjustment is an attempt to adjust for the differences between the tested party and potential comparables with an assumption that the difference should be reflected in profits. The grounds for using the working capital adjustment approach in TP have been provided in the Chapter - “Comparability Adjustments in Transfer Pricing” authored by Charles R Larson, Marios Karayannis and John Burgess in the “Transfer Pricing Handbook” by Robert Feinschreiber. xi. In this regard, the Appellant wishes to highlight that it had carried out a working capital adjustment in its TP report and had claimed the benefit of the same from time-to-time during the assessment proceedings. xii. In this regard, Appellant’s arguments are as follows:
(i) OECD view on working capital adjustment OECD Guidelines unequivocally emphasize the importance of appropriate adjustments including working capital adjustment for determining the ALP. This is evident from the following extracts from the OECD Guidelines: “In all cases adjustments must be made to account for differences between the controlled and uncontrolled situations that would significantly affect the price charged or return required by independent enterprises. Therefore, in no event can unadjusted industry average returns themselves establish arm’s length conditions.” (Para 1.16 of the OEC’D Guidelines) “Adjustments should be made for any material differences from the functions undertaken by any independent enterprises with which that party is being compared.” (Para 1.21 of the OECD Guidelines) “The transactional net margin method may afford a practical solution to otherwise insoluble transfer pricing problems if it is used sensibly and with appropriate adjustments to account for differences of the type referred to above.” (Para 3.39 of the OECD Guidelines) “Where differences in the characteristics of the enterprises being compared have a material effect on the net margin being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences” (Para 3.39 of the OECD Guidelines) (Emphasis Supplied) (ii) Availability of accurate data and the assumption of profit maximisation.
Decisions of various Tribunals relied upon by the assessee :
a. Nokia India Pvt Ltd - AY 2006-07, ITAT Delhi (page 295 to 299 of Case Law Compendium, para 5 to 6.1) b. Demag Cranes & Components (India) Private Limited — 2006-07) (page 179-189 of Case Law Compendium, para 18 - 33) c. TNT India Private Limited — ITA No. 1442(BNG)/o8 (Page 281 of the Case Law Compendium, para 13.2) d. Sony India Private Limited- 1731/Del/2009 e. Mentor Graphics (Noida) Pvt. Ltd. Vs. DCIT (112 TTJ 408) (ITA No. 1969/D/2006) (AY: 2002- 03) (page 337 of Case Law Compendium, para 27) f. E-Gain Communications (P) Ltd. vs. ITO (118 ITD 243) (ITA No. 1685/Pn/2007) (AY: 2004-05) (page 247 - 249 of Case Law Compendium, para 36).
We find that the claim of the assessee for providing working capital adjustment is to be upheld and hence we direct the AO/TPO to work out the same.
The ld. counsel for the assessee also brought to our notice the grounds of appeal at paras 5 and 6 of the appeal memo. Para 5(a) reads as follows:-
“That the CIT(A) based on mere surmise and conjecture had concluded that the assessee is not interested in pursuing the grounds raised in the appeal and accordingly erred in upholding the order of AO.”
Ground No.5(b) states that the AO erred in treating an amount of Rs.5,85,777 being expenditure incurred on computer spare parts and consumables as capital expenditure. The ld. counsel for the assessee contended that it was only RAM of the computer, which was a spare part which had to be replaced and is in the revenue field. The ld. DR opposed the contention of the ld. counsel for the assessee and relied on the decision of the Hon’ble Supreme Court in the case of CIT v. Sharavana Spinning Mills, 293 ITR 201.
We have heard both the parties. Firstly, we are of the opinion that the CIT(Appeals) has passed an ex parte order and had no opportunity to go through the cost of computer consumables disallowed by the AO. Relying on the decision of Southern Roadways, 304 ITR 84 and APL India v. ACIT, we are of the opinion that RAM is a frequently replaceable part of the computer and does not have any enduring benefit to assume the character of a capital expenditure and hence we allow the same.
At ground 6(b), similar to ground No.5(a), the CIT(A) had passed an ex parte order merely concluding that the assessee is not interested in pursuing the grounds raised in the appeal and upheld the order passed by the AO with respect to disallowance of payment made to Club Cabana and Golden palms amounting to Rs.58,925 and Rs.455,670 for business training and conference expenses u/s. 40(a)(ia) of the Act.
The ld. counsel for the assessee produced CBDT Circular No.715 dated 8.8.1995 wherein clarifications on various provisions relating to tax deduction at source regarding changes introduced through Finance Act, 1995 had been listed. Question 11 of the Circular is, whether a contract for catering would include serving food in a restaurant/sale of eatables; and the answer to it is: TDS is not required to be made when payment is made for serving food in a restaurant in the normal course of running of the restaurant/café. The ld. counsel for the assessee also relied on the judgment dated 6.3.2009 of the Hon’ble Bombay High Court in the case of East India Hotels Ltd. v. CBDT, WP No.2014 of 1994, wherein it was held that services rendered by hotel to its customers by making available certain facilities/amenities like providing multilingual staff, 24 hour service for reception, telephones, select restaurants, bank counter, beauty saloon, barber shop, car rental, shopping centre, laundry/valet, health club, business centre services, etc. do not involve carrying out any work which results into production of the desired object and, therefore, would be outside the purview of section 194C of the Act.
We are of the opinion that payment made to Club Cabana and Golden Palms are outside the purview of section 194C of the act. The appeal on this issue is allowed.
Ground Nos.7, 8 & 9 with respect to not allowing credit in respect of advance tax, charging of interest u/s. 234A & 234B respectively are consequential in nature and the AO shall work out the same.
In the result, the appeal is partly allowed.
Pronounced in the open court on this 23rd day of September, 2015.