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Income Tax Appellate Tribunal, MUMBAI K BENCH, MUMBAI
Appearances by: M Subramanian for the appellant Mallikarjun Utture, for the respondent Date of concluding the hearing : January 12, 2016 Date of pronouncing the order : February 29, 2016 O R D E R Per Pramod Kumar, AM:
By way of this appeal, the assessee appellant has challenged correctness of the order 14th October 2013, passed by the learned CIT(A) in the matter of assessment under section 143(3) of the Income Tax Act, 1961, for the assessment year 2008-09.
In the first two grounds of appeal, which are interconnected and which we will take up together, the assessee has raised the following grievance:
1. The Learned Commissioner of Income Tax (Appeals) - 15 [CIT (A)] erred in conforming the adjustments made by the Assistant Director of Income Tax (International Taxation) - 1 (2) [ADIT (IT)] as proposed by the Assessment year: 2008-09 Page 2 of 11 Deputy Commissioner of Income Tax (TP) - 1(8) [TPO] amounting to Rs.95,04,121/- u/s. 92 CA(3) being 20% of the payments made under service level agreements amounting to Rs. 4,75,20,603/- to the head office of the appellant. The Learned CIT(A) erred in disregarding the contention of the appellant that the amount paid to its head office located at Norway should be considered at arm's length price under the provisions of the Income Tax Act, 1961 Your appellant submits that the expenses paid under the service level agreements to the head office of the appellant to the tune of Rs.4,75,20,603/- be considered at arm's length price and should not be subjected to any adjustment. Your appellant further submits that the CIT (A) erred in not considering the profits earned by the IT unit of head office and stating that the “appellant is comparing the global profit of the Norway company while the adjustment has been made by the TPO with reference to particular transaction relating to the appellant" Your appellant submits that the CIT(A) should have considered the profits earned by the IT Unit of the Head office while computing the arm's length price in respect of payments made under the service level agreements being software charges amounting to Rs.4,75,20,603/-.
2. The Learned CIT(A) erred in conforming the adjustment made by the ADIT (IT) as proposed by the deputy TPO amounting to Rs.16,31,771/- u/s 92 CA (3) being 20% of the regional head office expenses paid to head office of the appellant amounting to Rs.81,58,856/-. Your appellant submits that the expenses incurred and paid to the head office amounting to Rs.81,58,856/- of the appellant should be considered at arm's length price and should not be subjected to any adjustment. Your appellant further submits that the CIT(A) ought to have accepted the contention of the appellant that the adjustment in regional head office expenses should be made on net expenditure (regional head office expense less regional head office income) incurred by the appellant and not on the gross regional head office expenses incurred by the appellant.
So far as these grievances of the assessee are concerned, the relevant material facts are like this. The assessee before us is a non-resident company, incorporated in Norway, carrying on business in India through a branch office. The Assessment year: 2008-09 Page 3 of 11 assessee is engaged in the business of classification and survey of ships, classification, certification, verification and advisory services relating to offshore activities, and inspection and certification of non- marine products and services. In this case, the Assessing Officer referred ascertainment of arm’s length price, in respect of international transactions entered into with its associated enterprises, to the Transfer Pricing Officer. The Transfer Pricing Officer noted that “the assessee has adopted TNMM for showing its international transactions to be at an arm’e length” and that, as per transfer pricing study on the basis of inputs from Prowess database, “PLI (PBT/Income) for comparable companies have average of 19.65% whereas the same PLI (PBT/Income) for assessee is 19.77%”. It was also noted that “the assessee has selected four comparable companies based on its search on services, shipping, technical, certification and engineering services”.
The Transfer Pricing Officer did not point out in any fault in the ascertainment of arm’s length price, on the basis of transactional net margin method (TNMM) and by selecting comparables from the Prowess database, but yet he proceeded to make the adjustments in the arm’s length price.
The Transfer Pricing Officer made an adhoc adjustment @ 20%, in the arm’s length price, for the services received by the assessee under the Service Level Agreement, on the basis of following reasoning:
The submission of the assessee reflects that the annual accounts of the assessee is based on merely forecasting's. In this method the incomes as well as the expenses of the assessee are forecasted. Every year the budgeted expenses are being decided by the DNV group and being allocated to the assessee based on the method adopted by them. • No any instances was shown by the assessee in the submission or even during the course of hearing where it can be said that the assessee has arrived at the actual figure and the assessee has reconciled the differences between forecasted revenue/expenses and actual income/expenses. • The assessee has not even filed any details regarding any reconciliation made by it for previous years for forecasted and actual usage of the software.
Assessment year: 2008-09 Page 4 of 11 • The assessee has submitted that the charges for software usage are based on the number of the users • It is seen during the course hearing that the assessee has submitted that it has more user of software during the F.Y. 07-08 than the payment was made for usage. Accordingly the assessee is saying that it has paid actually less amount for the above services and accordingly no excess payment was made. • However it is seen that assessee was not able to prove that if the charges are based on the users using the software then the payment was how reconciled for the F.Y. 08-09. If the assessee has used more services than the payment made then in next year based on the method i.e. per user software charge, how the payment reconciliation was arrived at OR stilt no reconciliation has been prepared Likewise in the year specially, during previous years when the assessee has paid more amounts for software usage how it has adjusted with the actual uses has not been able to provide. • Accordingly the method as demonstrated by the assessee is itself contradictory. If the pricing model is per user charge for software use then it can be decided/ reconciled with the forecasted and actual usage vice versa. But the assessee has failed to demonstrate the same. • The assessee has tried to establish the basis of charging of the software charges/expenses but has totally failed to reconcile the differences arising out every year. It reflects that the annual accounts prepared by the assessee are not reflecting the true picture of its affairs. Accordingly the TPO has no option but to deny the some percentage of expenses to mitigate the differences arising out of the above abnormalities in the accounts of the taxpayers. In view of the above 25% of the total expense on account of software charges is being adjusted for the F.Y. 07-08 to the transaction of the assessee and thereby deciding the ALP of the transaction.
The Transfer Pricing Officer also made an adhoc adjustment @ 20% in the arm’s length price, in respect of the sharing of regional office expenses, on the basis of the following reasoning:
• In this segment the assessee pays to regional office @ 6.2% to its external revenue to Dubai for availing services in Maritime segment and 5% to Malaysia in Energy segment. But what is external revenue. What is the quantity of the external revenue? What was the budgeted figure earlier? What was the actual charge paid on this account in the previous year is not yet decided by the assessee. No reconciliation has been Assessment year: 2008-09 Page 5 of 11 prepared by the assessee so far for the budgeted and actual expenses between regional office expenses. • Likewise the same method has been followed this year the payment has been made on the %age of external revenue but what is external revenue is not yet decided. The external revenue how arrived has not been submitted by the assessee. What was the amount of the external revenue and how much was the contribution from India and other countries was not explained and submitted by the assessee. Accordingly the expenses as well as income on this head are also appearing to estimation only. The AR of the assessee has tried to explain the methodology of charging regional office expenses during the course of hearing which can be stated as under: .' “There is Dubai Regional office. Under it there are several other country who are availing services from this office. The total forecasted revenue of all country is taken by the DNV Group. Then the expense (estimated only) of the Dubai office is also taken Dubai office expenses are divided by the revenue of all the countries. The figure arrived at is allocated in equal rate amount ratio to all the country coming in the region This exercise is done every year in the month of June, July of the earlier year. The result arrived at is taken as effective for the next year from the month of January. The accounting year of the group entity starts from January across the world. For the tax purposes the annual accounts of this entity has been prepared taking Figure from April to March which includes 9 months for the 2007 and 3 month for the year 2008." • The pricing in terms of currency of the country concerned has been done this year for the 3 months January, 2008 to March, 2008). The assessee has not been able to explain that the same price was charge for these three months from all the country concerned. The assessee has not furnished any calculation of prices (through conversion of foreign currency in rupee) of the other country charged or through any other logical method to establish that the same price was charged from India as well as from other countries for the providing of the same services Accordingly the assessee's claim that the same price was charged from all the countries for regional expenses is difficult to prove. • Again the assessee has not been able to justify the expenses charged from India for regional office expenses. What was the services actually availed by the Indian entity has not been given by the taxpayer. Whether the charges paid by the India was lesser or higher in terms of services availed has not been quantified by the assessee.
Assessment year: 2008-09 Page 6 of 11 • The assessee has also not submitted as to how it has reconciled the differences between previous year's estimated/forecasted expenses and the actual expenses. • In view of the above it is apparently clear that the assessee has not been able to successfully explain that the prices paid by the India was for the actual services availed and there was no excess charges paid on this account. Accordingly TPO is of the view that the 20% of the expenses paid by the assessee should be adjusted to arrive at the logical end in absence of any data provided by the assessee.
It was in this backdrop that the Transfer Pricing Officer recommended, and the Assessing Officer made, ALP adjustments of Rs 95,04,121 in respect of payments under service level agreement for the software charges, and of R 16,31,771 in respect of sharing of regional office expenses. Aggrieved by the adjustments so made, assessee carried the matter in appeal before the CIT(A) but without any success. The assessee is not satisfied and is in further appeal before us.
We have heard the rival contentions, perused the material on record and duly considered the facts of the case in the light of the applicable legal position.
We have taken note of the fact that the assessee has benchmarked the international transactions on TNMM basis and the Transfer Pricing Officer has neither disputed the assessee’s claim that TNMM is the most appropriate method, on the facts of this case, nor the comparables selected by the assessee. In this view of the matter, it was not open to the Transfer Pricing Officer to even reject the benchmarking done by the assessee. In any case, what the TPO has done is to reject the benchmarking done by the assessee and make adhoc ALP additions in the value of international transactions. Such a course of action is not permissible under the scheme of transfer pricing law. Even when a method of ascertaining the ALP is, for good and sufficient reasons, rejected by the TPO, he has to select the most appropriate method, out of the recognised methods under rule 10AB and 10B, and then apply the same. Such an exercise has not been carried out on the facts of this case. The Transfer Pricing Officer has simply made adhoc adjustments, but then, as we have stated earlier, such adhoc adjustments are not permissible. Not only the Transfer Pricing Officer wrongly rejected the ascertainment of arm’s length price by Assessment year: 2008-09 Page 7 of 11 the assessee, the Transfer Pricing Officer ended up deciding the arm’s length price on the basis of a method, method if it can be said to be, not recognized under the scheme of transfer pricing envisaged by the statute. Learned CIT(A) was in error in not reversing the action of the Transfer Officer. In view of the above discussions, and bearing in mind entirety of the case, we vacate the orders of the authorities below on this point, and direct the Assessing Officer to delete the impugned ALP adjustments of Rs 95,04,121 and Rs 16,31,771
Ground nos, 1 and 2 are thus allowed.
In the third ground of appeal, the assessee has raised the following grievance:
3. The Learned CIT(A) erred in confirming the adjustment made by the ADIT (IT) as proposed by the TPO amounting to Rs.7,20,110/- being interest @14% p.a computed on the delayed realization of amounts of trade debts receivable on account of services rendered from various associated enterprises. Your appellant submits that no adjustment is warranted for any delay in realisation of debtors and the transactions with the associated enterprises should be considered at arm’s length under the Income Tax Act, 1961.
So far as this grievance of the assessee is concerned, the relevant material facts are like this. During the course of proceedings before the Transfer Pricing Officer, it was noticed that there is a delay in realization of debts recoverable from the AEs of the assessee. The assessee’s stand was that it is assessee’s standard policy not to charge interest in respect of delays in realization. It is not charged from anyone- AE or non AE. The TPO was of the view that “non recovery of outstanding dues from the AEs has resulted in business funds of the assessee being blocked with the related parties, thereby resulting in loss of revenue that could have been earned by utilizing it for the purpose of business which would have further improved the profit margin of the taxpayer”. He also noted that “had the taxpayer given this amount to an unrelated person, it would have charged interest thereon”. The TPO was of the view that the assessee should have charged interest in respect of delay
Assessment year: 2008-09 Page 8 of 11 on realization of these dues. The TPO was further of the view that an interest @ 14%, being equivalent to average yield on unrated bonds in the relevant financial period, should have been charged, as an arm’s length compensation on such delays. It was in this backdrop that the Transfer Pricing Officer recommended, and the Assessing Officer made, an ALP adjustment of Rs 7,20,110 on account of interest for delay in realization of receivables. The reasoning adopted by the TPO was as follows: 10.3 The explanation of the assessee was considered but not found acceptable. The assessee failed to get any satisfactory explanation for the delay and only submitted that generally payments are received in time and as per DNV policy and no interest are received or paid for occasional delays. The non recovery of outstanding dues from the AE has resulted in business funds of the taxpayer being blocked with the related parties thereby resulting in loss of revenue that could have been earned by utilizing it for the purpose of business which would have further improved the profit margin of the taxpayer. No independent business enterprise would allow funds to be blocked in any place, but would invest it prudently for earning revenue. Had the taxpayer given this amount to an unrelated person, it would have charged interest thereon. 10.4. Since the taxpayer has not recovered the dues from the AE within a reasonable time, it amounts to allowing the AE to use the taxpayer's money. In normal conditions such a transaction between two unrelated parties would have involved levy of interest on the delayed payments. In view of this fact, the international transaction representing outstanding debts without charging interest is not at arm's length price, within the meaning of section 92C (3) (a) of the Income Tax Act read with Rule 10B (1) (a) of the Income Tax Act. The arm's length interest on the outstanding debts is determined by following CUP method wherein the interest rate is determined under the circumstances in which the tax payer and its AEs are operating i.e. what is the interest that would have been earned if such debts had remained outstanding between two unrelated parties in similar situations. Since the tested party is tax payer, the prevalent interest that could have been earned by the tax payer on outstanding debts from an unrelated party in India with the same credit rating as that of the tax payer's AE is considered. 10.5. In view of the above, in view of the above discussion, the interest rate of 14% p.a. (average yield on unrated bonds for the FY 2007-08) was proposed to be adopted as the uncontrolled interest rate to arrive at the interest charged at arm's length. The taxpayer in its submission did not raise any specific objection on the interest rate except arguing that the delay was unintentional
Assessment year: 2008-09 Page 9 of 11 13. Aggrieved, assessee carried the matter in appeal before the CIT(A) but without any success. The assessee is not satisfied and is in further appeal before us.
We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.
When deciding the arm’s length price of an international transaction with the associated enterprises, the real issue for consideration is as to what would have been the situation in an arm’s length situation i.e. in respect of delay in realization of similar debt from an independent enterprises in this case. Once the assessee has contended that the interest is not being charged from anyone, including, of course, the non AEs, and that contention is not disputed to be factually incorrect, it cannot be open to the TPO to make adjustment in the case of delays in realization from the AEs. The treatment being accorded to the AEs and non AEs is the same, and, in such a situation, ALP adjustment cannot be made for delay in realization of monies from the AE. The consideration as to how the assessee would have received interest if money was given to an outsider is irrelevant because it is not a case of extending loan or placing deposit, rather it is a case of amount becoming due as a result of commercial transaction. In any event, when international transactions have been benchmarked on the basis of TNMM, and interest on delay in realization of amounts is only incidental to such transactions rather than a standalone transaction, such an adjustment cannot be made independently. For this proposition, we find support from a coordinate bench decision in the case of Micro Ink Vs ACIT [(2015) 63 taxmann 353 (Ahd)]. In the light of the above discussions, and bearing in mind entirety of the case, we deem it fit and proper to delete the impugned ALP adjustment of Rs 7,20,110. The assessee gets the relief accordingly.
Ground no. 3 is thus allowed.
In the fourth ground of appeal, the assessee has raised the following grievance:
Assessment year: 2008-09 Page 10 of 11 4. The Learned CIT(A) erred in confirming the addition made by the ADIT(IT) treating the expenditure incurred towards software charges amounting to Rs.34,59,517/- as capital in nature and thereby disallowing the same. Your appellant submits that the CIT(A) ought to have directed the Assessing Officer to treat the expenses incurred towards software charges amounting to Rs.34,59,517/- as revenue in nature. Without prejudice to the above that the software charges incurred should be treated as revenue in nature, your appellant submits that the CIT(A) should have allowed entire depreciation for the full year to the appellant as the software have been used for a period of more than 182 days during the relevant financial year.
So far as this grievance of the assessee is concerned, it is sufficient to take note of the fact that, during the course of scrutiny assessment proceedings, the Assessing Officer himself noted that the software expenses represent Microsoft licence fees which is “chargeable on annual basis”, yet he disallowed the expenses as capital expenses though he allowed depreciation thereon. In appeal, learned CIT(A) confirmed the disallowance. The assessee is aggrieved and is in appeal before us.
Having heard the rival contentions and having perused the material on record, we find that since it is an annual payment by the assessee and since the benefit of this payment does not go beyond the year, it is inherently a revenue expense in nature, and allowable, as such, to the assessee. The question of software expenses being in the nature of capital asset is relevant only when the payment is for acquiring the software. That is not the case here. It is a payment for the annual licence fees, and not the software itself. The expense is, therefore, clearly revenue in nature. We, accordingly, delete the impugned disallowance. As the relief has been allowed as revenue expenditure, the assessee will not be entitled to any depreciation on software. With this observation, grievance of the assessee is upheld.
Ground no. 4 is thus allowed.