NDS LIMITED - INDIA BRANCH OFFICE,BANGALORE vs. DDIT INTERNATIONAL TAXATION, BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCH “ A ” BEFORE SHRI N.V. VASUDEVAN, JUDICIAL MEMBER AND SHRI JASON P. BOAZ, ACCOUNTANT MEMBER I.T(T.P) A. No.1515/Bang/2010 (Assessment Year : 2006-07) NDS Limited – India Branch Office, Vs. Dy. Director of Income Tax, No.9, Ashford Park View, (International Taxation), 80 ft Road, Koramangala III Block, Circle 1 (1), Bangalore. Bangalore-560 034 PAN AABCN 2524L Appellant Respondent.

Appellant By : Smt. Shreya Loyalka, C.A. Respondent By : Shri C.H. Sundar Rao, CIT (D.R) Date of Hearing : 24.2.2015. Date of Pronouncement : 20.3.2015. O R D E R Per Shri Jason P. Boaz, A.M. : This appeal by the assessee is directed against the order of assessment under Section 143(3) rws 144C(5), 144C(8) of the Income Tax Act, 1961 (in short 'the Act') dt.25.10.2010, passed in pursuance and in conformity with the directions of the Dispute Resolution Panel (‘DRP’),Bangalore; order dt.21.9.2012 passed under Section 144C(5) rws 144C(8) of the Act. 2. The facts of the case, briefly, are as under :- 2.1 The assessee, set up as a R&D Unit to develop software for its head office, NDS, UK, filed its return of income for Assessment Year 2006-07 on 30.10.2005 declaring

2 IT(T.P)A No.1515/Bang/2010 income of Rs.2,26,400 after claiming deduction of Rs.7,44,47,321 under Section 10A of the Act. The return was processed under Section 143(1) of the Act and the case was subsequently taken up for scrutiny. In the course of assessment proceedings, it was noticed that the assessee had entered into international transactions in excess of Rs.5 Crores. In view of this, a reference under Section 92CA of the Act was made by the Assessing Officer to the Transfer Pricing Officer (‘TPO’) for the determination of the correct Arm’s Length Price (‘ALP’) of the international transactions that the assessee had entered into with its Associated Enterprises (‘AEs’) The international transactions entered into by the assessee were as under :-

(i) Software Development Services : Rs.56,21,89,699. (ii) Reimbursement of expenses (paid) : Rs.3,64,50,712. (iii) Reimbursement of expenses (Received) : Rs.25,36,521. (iv) Purchase of fixed assets : Rs.3,03,28,911. The TPO passed the order under Section 92CA of the Act dt.28.10.2009, determining the ALP of the international transactions with respect to software development service at Rs.61,87,56,230 as against Rs.56,21,89,699 declared by the assessee, and therefore requiring T.P. Adjustment of Rs.5,65,66,531 to be made under Section 92CA of the Act. 2.2 The Assessing Officer then passed a draft assessment order on 29.10.2009 determining the income of the assessee at Rs.6,14,54,553. Apart from the T.P. Adjustment of Rs.5,65,66,531 made as per the TPO’s order under Section 92CA; the

3 IT(T.P)A No.1515/Bang/2010 Assessing Officer recomputed the deduction under Section 10A of the Act to Rs.7,07,81,419 as against Rs.7,44,47,321 claimed by the assessee. 2.3 Aggrieved with the draft order of assessment for Assessment Year 2006-07 dt.29.10.2009, the assessee filed its objections thereto before the DRP, Bangalore. The DRP issued its directions on the objections put forth by the assessee under Section 144C(5) rws 144C(8) of the Act dt.21.9.2010. It is in pursuance of and conformity with the order of DRP that the Assessing Officer passed the impugned final order of assessment under Section 143(3) rws 144C(5) & 144C(8) of the Act wherein the income of the assessee was determined at Rs.6,11,40,278 in view of – (i) T.P. Adjustment u/s.92CA : Rs.5,65,66,531. and (ii) Disallowance of excess deduction claimed u/s.10A : Rs.36,65,902.

“ 1. The assessment order dated October 25, 2010 passed by the learned Assessing Officer under section 143(3) read with section 144C of the Income-tax Act, 1961 is not in accordance with the law and is contrary to the facts and circumstances of the present case and in any case violation of principle of equity and natural justice. 2. Relief under section 10A of the Act 2.1 The learned AO and the Honorable DRP have erred in law and on facts in re- computing relief under section 10A of the Act at Rs 70,781,419 as against Rs 74,447,321 claimed by the Assessee in the return of income. 2.2 The learned AO and the Honorable DRP have erred in law and on facts in re- computing relief under section 10A of the Act by excluding the foreign currency expenses of Rs 27,683,096 from the export turnover.

4 IT(T.P)A No.1515/Bang/2010 2.3 The learned AO and the Honorable DRP have erred in law and on facts in re- computing relief under section 10A of the Act by excluding the foreign currency expenses of Rs 27,683,096 only from the export turnover and not reducing the same from the total turnover. 2.4 The Learned AO and the Honorable DRP have erred in law and on facts in disregarding the decisions of the Jurisdictional Tribunal, binding on the Learned AO, in the case of Tata Elxsi Ltd Vs DCIT (ITA No 315/Bang/2006) and i Gate Global Solutions Ltd Vs ACIT (112 TTJ 1002) which had held that whatever is reduced from the export turnover, needs to be reduced from the total turnover as well. 3. Transfer Pricing Transfer Pricing – lack of jurisdiction / Against principles of natural justice 3.1 The Learned AO has erred in passing the order under section 143(3) read with section 144C of the Act, following the directions of the Dispute Resolution Panel (“DRP”), when the order of the DRP was not in accordance with section 144C(5) of the Act. The DRP in the case of the Appellant was comprised of a Director of Income-tax (“DIT”) and two Commissioners of Income-tax (“CIT”). As per section 144C(15) of the Act, DRP means a collegium of three CITs constituted by a Central Board of Direct Taxes (“CBDT”) for this purpose. Rule 3(2) of the (Dispute Resolution Panel) Rules, 2009 (“DRP Rules”) also authorises the CBDT to name three CITs to the panel. The term ‘CIT’ is defined under section 2(16) of the Act, while ‘DIT’ is defined as a separate authority as per section 2(21) of the Act. Hence, the order dated September 21, 2010 passed by the DRP cannot be considered to be a direction issued under section 144C(5) of the Act. 3.2 The Honourable DRP and the Ld AO have erred, in law and on facts in upholding the adjustment to the arm’s length price made by the learned TPO to the income of the Appellant, based on the order, purportedly under section 92CA of the Act, passed by the learned Joint Director of Income- tax (Transfer Pricing-II). The Honourable DRP and the Ld AO have erred in merely adopting the observations of the TPO without detailed reasons. 3.3 The Honourable DRP/Ld AO have erred in law and on facts, in holding that the TPO’s order is correct, which are based on incorrect interpretation of law and contrary to facts of the case. Other transfer pricing adjustment related grounds 3.4 The Ld AO/TPO and the Honourable DRP have erred, in law and on facts in holding that the transactions between the Appellant and its Associated Enterprise (“AE”) were not at Arm’s Length Price (“ALP”) as defined under section 92F(ii) of the Act. 3.5. The Learned AO/TPO and the Honorable DRP have erred in law and on facts by not appreciating the bonafide Transfer Pricing (“TP”) study undertaken by the Assessee, in accordance with the provisions of the Act and the Income‐tax Rules, 1962 (“Rules”) and on the contrary commenting that the Appellant had not done the correct Functions Assets and Risks (“FAR”) analysis of the comparable companies and the search carried out by the Appellant was not based on objective criteria and accordingly rejecting the TP report. 3.6 The Learned TPO and the Honorable DRP have erred in law and on facts in holding that the TP study/report of the Appellant is not based on Rule 10B of the Rules and accordingly, rejecting the TP study.

5 IT(T.P)A No.1515/Bang/2010 3.7 The Learned TPO and the Honorable DRP have erred in law and on facts in holding that there are some pertinent defects in the determination of ALP and thereby holding that the TP study undertaken by the Assessee as defective and unreliable. 3.8 The Learned AO and the Honorable DRP have has erred in law and on facts in upholding the adjustment of Rs 56,566,531 to the income of the Appellant, consequent to incorrectly computing the ALP in respect of the international transactions undertaken by the Appellant with its associated enterprises. 3.9 The Learned AO/TPO and the Honorable DRP have erred in law, by restricting the available size of the comparables by applying the following additional filters which are unwarranted: • Use of relevant FY data - Contemporaneous Data [therefore rejection of use of multiple year data (data for FY 2003-04 , FY 2004-05 and FY 2005-06) by NDS India]; • Companies having different FY ending and data not available for 12 months; • Minimum turnover of Rs 1 crore; • Ratio of employee cost to revenue of atleast 25 percent; • Ratio of software development services to operating revenues of atleast 75 percent; • Ratio of onsite revenues to operating revenues of atleast 75 percent; • Rejection of companies having diminishing revenues; and • Rejection of certain comparables on functional differences that were accepted by NDS India 3.10 The Learned AO/TPO and the Honorable DRP have erred in applying a minimum turnover filter and not applying the maximum turnover filter to reject the companies like Infosys Ltd, Flextronics Software Systems Ltd, iGate Global Solutions Ltd Mindtree Consulting Ltd etc, which have extremely high levels of turnover and size as against the Assessee and hence not comparable. 3.11 The Learned AO/TPO and the Honorable DRP have erred in not eliminating companies with large turnover, whereas companies with turnover less than Rs one crore were eliminated on the basis of lack of comparability. 3.12 The Learned AO/TPO and the Honorable DRP have erred in rejecting comparables selected by the Appellant on the ground that they did not qualify the related party filter, without appreciating the manner in which the filter was applied by the Appellant 3.13 The Honorable DRP and the Ld AO have erred in law and on facts by adopting the financial data for a single year [ie the Financial Year (“FY”) 2005-06 of the comparables] as against the multiple year data considered by the Appellant.

6 IT(T.P)A No.1515/Bang/2010

3.14 The Learned AO/TPO and the Honorable DRP have erred in law and on facts by using data pertaining to the FY 2005‐06 in respect of certain comparables when the same was not available to the Appellant at the time of compilation of the TP documentation and in doing so, the Learned TPO and the Ld AO have erred in not appreciating that only the financial information available on or before October 31, 2006 [as specified by section 92F(iv) of the Act] could be used in compiling the TP documentation and not information that was available after that period as per the provisions of Rule 10E(4) of the Rules. 3.15 The Learned AO/TPO and the Honorable DRP have erred in law by gathering the following information under section 133(6) of the Act, which were otherwise not available in public domain at the time of conducting the TP study: • Determining the functions performed by the comparables, which are not clear from the Annual Report; • The quantum of related party transactions; • Obtaining the Annual Reports of the companies not available in public domain for FY 2005-06; • Obtaining the financials for the 12 months ending on March 31, 2006 if financials available in the public domain had a different accounting year ending; • Obtaining segment details of the comparables; and • Obtaining the employee cost debited to other heads of expenses in the financial statements of the comparables available in public domain or the annual reports obtained from various companies. 3.16 The Learned AO/TPO and the Honorable DRP have erred in law and on facts in rejecting the filters applied by the Appellant and in proposing new filters, in selecting comparables. 3.17 The Learned AO/TPO and the Honorable DRP have erred in law by rejecting the objections raised by the Appellant in relation to inclusion of additional companies as comparables by the Learned TPO. 3.18 The Learned AO/TPO and the Honorable DRP have failed to appreciate that the Assessee bears limited market risk as it renders services only to the associated enterprise. 3.19 The Learned AO/TPO and the Honorable DRP have erred in law by not making the risk adjustment from the arithmetic mean margin computed. They have failed to

7 IT(T.P)A No.1515/Bang/2010 appreciate the fact that the Assessee bears minimal risk compared to the independent parties. 3.20 The Learned AO/TPO and the Honorable DRP have erred in law by holding that the Appellant bears ‘single customer risk’ which offsets the benefit of the absence of other risks. 3.21 The learned TPO has erred in law and on facts in rejecting the risk adjustment submissions proposed to be filed by the Appellant citing lack of time to examine the submissions. 3.22 The Honourable DRP and the Ld AO have erred in stating that the foreign exchange loss/gain is not dependent upon the operations carried out by the assessee and is a result of various extraneous factors and therefore have erred in considering foreign exchange loss to be in the nature of a non operating expense and in excluding the same from “Operating profit” for the purpose of the analysis. 3.23 The Ld AO/TPO and the Honorable DRP have erred in law and on facts by concluding that the economic principle “higher returns assume higher risks” as observed in Mentor Graphics case is incorrect. 3.24 The Ld AO/TPO and the Honorable DRP have erred in law and on facts by excluding the foreign exchange loss and interest expense from the operating expenses in computing the Profit Level Indicator (“PLI”) without appreciating that foreign exchange gain/loss and similar items were not excluded in the computation of operating profit of the Appellant. 3.25 The Ld AO/TPO and the Honouable DRP have erred in law by not providing the Appellant the benefit of +/- 5 percent range as prescribed under the Act. 3.26 Without prejudice to all of the above, the learned DRP, TPO and AO have erred in not accepting the argument that the transfer pricing provisions will not apply when tax payer’s income is exempt as provided vide paragraph 55.5 of Circular no 14/2000 of the CBDT and the principles of the Bangalore Tribunal in the case of Philips Software Centre Private Limited (26 SOT 226). 3.27 The impugned order of assessment dated December 29, 2009 was made based on an order dated October 28, 2009, purportedly under section 92CA made by the JDIT, TPO II, Bangalore. However, the said transfer pricing order is made without jurisdiction and hence invalid. In view of the provisions of the Act and the notifications, it is evident that the JDIT, TPO II, Bangalore, who made the order purportedly under section 92CA of the Act on October 28, 2009 acted without proper jurisdiction. Hence, the said order is invalid and void ab initio. 3.28 Without prejudice, the Ld AO/Honourable DRP have erred in law and on facts in upholding the arm’s length margin (subject to the revision by the DRP to the margin of Megasoft Limited) as proposed by the learned TPO to the software development segment of the Appellant.

8 IT(T.P)A No.1515/Bang/2010 3.29 The Ld AO and the Honourable DRP have erred in law and on facts, by upholding the adjustment of Rs 56,252,256 (i.e. after considering the revision of the margin of Megasoft Limited) to the income of the Appellant in respect of the international transactions in connection with software development segment undertaken by the Appellant with its associated enterprise. 4. Others. 4.1 The Ld AO has erred in law and on facts by proposing to raise a demand of Rs 36,273,959 for the AY 2006-07. 4.2 The Ld AO has erred in law and on facts in levying interest under section 234B of the Act amounting to Rs 11,257,425. 4.3 The Ld AO has erred in law and on facts in initiating penalty proceedings on the Appellant. 5. The Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds, at any time before or at the time of hearing of the appeal. Each of the above objections is independent and without prejudice to the other grounds preferred by the Appellant. “ 4.1 At the outset, the learned Authorised Representative brought to the notice of the Bench that the assessee has filed a letter dt.20.2.2013 submitting that it is withdrawing the grounds raised in this appeal at S.Nos.3.1 to 3.29 in respect of Transfer Pricing issues, since the assessee had gone in for Mutual Agreement Procedure (MAP) proceedings and as per resolution thereof the T.P. Adjustment has been reduced to Rs.5,32,66,637 as against Rs.5,65,66,531 determined in the order of assessment. The contents of the assessee's letter dt.20.2.2013 are extracted hereunder for the sake of clarity.

“ February 20, 2013 The Members of the Bench Income Tax Appelalte Tribunal, Bangalore Benches, Santosh Complex, 3rd & 4th Floors, Kempegowda Road, Bangalore-560 001

9 IT(T.P)A No.1515/Bang/2010 PAN : AABCN 2524L Dear Sirs, Sub : NDS Limited – India Branch Office – Mutual Agreement Procedure of Article 27 of India – UK Double Taxation Avoidance Agreement – Resolution between India and UK for Assessment Year 2006-07 – Withdrawal of Grounds of Appeal. We refer to the appeal preferred by NDS Limited – India Branch Office (‘NDS India’) against the assessment order passed under Section 143(3) read with section 144C of the Income Tax Act, 1961 (‘Act’) dated October 25, 2010 for the Assessment Year 2006-07 (ie ITA 1515 of 2010) (copy of acknowledgement for filing the appeal is enclosed as Annexure 1). Subsequent to filing of above appeal, with respect to the transfer pricing adjustment carried out as per above orders, NDS India’s Head Office ie, (NDS Limited, UK (‘NDS UK’) filed an application with the UK Competent Authority invoking the mutual agreement procedure under Article 27 of the India-United Kingdom Double Taxation Avoidance Agreement (‘DTAA’). In this regard, the Assessing Officer has issued a letter dated December 21, 2012 (copy enclosed as Annexure 2) and a copy of the resolution passed under Section 90 of the Act read with Article 27 of the India – UK DTAA also was enclosed, requiring NDS India to submit its reply either accepting or rejecting the mutual agreement procedure resolution in accordance with the provisions of Rule 44H of the Income Tax Rules, 1962 n(‘Rules’). As per the said resolution, the transfer pricing adjustment ahs been proposed to be reduced to Rs.53,266,637 as against Rs.56,566,531 determined in the assessment order. In this regard, NDS India has filed its reply with the Assessing Officer vide letter dated January 30, 2013 intimating the Assessing Officer, NDS India’s acceptance to the above resolution arrived at under the mutual agreement procedure in respect of the subject assessment year and hence proposes to withdraw the grounds of appeal numbered 3.1 to 3.29 pertaining of the transfer pricing adjustment in the subject appeal preferred by NDS India (copy of grounds of appeal enclosed as Annexure 3) in so far as the same applies to the transfer pricing adjustment of Rs.56,566,531. However, NDS India reserves its right to contest any other proceedings (including rectification proceedings) that may arise in relation to the assessment. Further, we wish to clarify / confirm that the above withdrawal only pertains to the grounds of appeal pertaining to the transfer pricing adjustment and NDS India shall continue to contest the grounds of appeal numbered 1, 2.1 to 2.4 (under main ground of appeal number 2), and 4.1 to 4.3 (under main ground of appeal number 4) of the subject

10 IT(T.P)A No.1515/Bang/2010 appeal pertaining to the adjustments regarding 10A of the Act and consequent proceedings. We hereby request you to accept the modification of the grounds of appeal in the manner detailed above. We request you to take the above on record. If you require any further information or details on the above, please do contact us. Yours faithfully, (Sd/-) Yogish Acharya (Power of Attorney Holder).” 4.2 In view of the above letter of the assessee, the grounds raised at S.Nos.3 (3.1 to 3.29) in this appeal, being withdrawn are rendered infructuous and are accordingly dismissed as withdrawn.

11 IT(T.P)A No.1515/Bang/2010 that are reduced from export turnover should also be reduced from total turnover, placing reliance on the decision of the Hon'ble Karnataka High Court in the case of CIT V Tata Elxsi Ltd. (2012) 349 ITR 98 (Kar). 6.2 We have heard both the learned Authorised Representative and the learned Departmental Representative in the matter. Taking into consideration the decision rendered by the Hon'ble High Court of Karnataka in the case of Tata Elxsi Ltd. (supra), we are of the view that it would be just and appropriate to direct the Assessing Officer that the expenses incurred in foreign currency are to be excluded from both export turnover as well as total turnover while computing the deduction under Section 10A of the Act, as has been prayed by the assessee in its alternate plea at Ground raised at 2.4. In view of the acceptance of the alternate plea of the assessee, we are of the view that no adjudication is called for on Ground No.2.2 as to whether the aforesaid expenditure are required to be excluded from export turnover. 7. In the Ground at S.No.4.2, the assessee denies itself liable to be charged interest of Rs.1,12,57,425 under Section 234B of the Act. The charging of interest is consequential and mandatory and the Assessing Officer has no discretion in the matter. This proposition has been upheld by Hon'ble Apex Court in the case of Anjum H Ghaswala (252 ITR 1). In this view of the matter, we uphold the action of the Assessing Officer in charging the assessee the said interest in the case on hand. The Assessing Officer is, however, directed to recompute the interest chargeable under Section 234B of the Act, if any, while giving effect to this order.

12 IT(T.P)A No.1515/Bang/2010 8. In the Ground at S.No.4.3, the assessee challenges the action of the Assessing Officer in initiating penalty proceedings under Section 271(1)(c) of the Act in the assessee's case. This ground is not maintainable as no penalty under Section 271(1)(c) of the Act has been levied on the assessee for any cause of grievance to arise in the impugned order. Since there is no cause of grievance to the assessee by the mere action of the Assessing Officer in initiating penalty proceedings under Section 271(1)(c) of the Act, this ground is not maintainable and we therefore dismiss this ground as infructuous. 9. In the result, the assessee's appeal for Assessment Year 2006-07 is partly allowed. Order pronounced in the open court on 20th March, 2015.

Sd/- Sd/- (N.V.VASUDEVAN) (JASON P BOAZ) Judicial Member Accountant Member *Reddy gp Copy to : 1. Appellant 2. Respondent 3. C.I.T. 4. CIT(A) 5. DR, - A Bench. 6. Guard File. (True copy) By Order

Asst. Registrar, ITAT, Bangalore