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Income Tax Appellate Tribunal, DELHI BENCHES : I-1 : NEW DELHI
Before: SHRI R.S. SYAL, AM & SMT. BEENA A. PILLAI, JM
ORDER
PER R.S. SYAL, AM:
This appeal by the assessee arises out of the final order dated 27.2.2014 passed by the Assessing Officer (AO) u/s 144C(13) of the Income-tax Act, 1961 (hereinafter also called ‘the Act’) in relation to the assessment year 2009-10.
The first issue raised in this appeal is against the addition made by the AO on account of transfer pricing adjustment.
Briefly stated, the facts of the case are that the assessee is an Indian company, a part of Sun Life Group, which has diversified financial services organization providing savings, retirement and pension products and life and health insurance in Canada, US, UK and Asia. This group also operates mutual funds and investment management businesses. The assessee provided software development and maintenance support services, advisory and also back office support services to its associated enterprises (AEs) for assistance in their projects. The assessee, inter alia, reported four international transactions in Form no. 3CEB consisting of `Provision of software development and maintenance support services’ with the transacted value of Rs.39.45 crore-; `Provision of back office support services’ with the transacted value of Rs.6.52 Crore; `Provision of F&A support services’ with the transacted value of Rs.1.51 Crore and ‘Provision of advisory services’ with the transacted value of Rs.1.75 crore. In order to demonstrate that its international transactions were at arm’s length price (ALP), the assessee applied the transactional net margin method (TNMM) with the Profit level indicator (PLI) of Operating Profit to Total Cost (OP/TC). On a reference made by the AO, the Transfer Pricing Officer (TPO) noticed that the segment of `Provision of back office support services’ was no different from the segment of `Provision of financial and accounts support services’. He, therefore, merged these two segments into one for conducting the benchmarking analysis. Though the assessee initially used multiple-year data of comparables, however, during the course of the TP proceedings, such data was restricted to a single year, at the TPO’s instance. The ALP of these international transactions was determined by the TPO. On raising certain disputes before the Dispute Resolution Panel (DPO), the assessee got certain reliefs. In the final order, the TPO made an addition in respect of these three segments totaling Rs.6,47,47,465, which has been assailed by the assessee in the present appeal. 3 A. PROVISION OF SOFTWARE DEVELOPMENT AND MAINTENANCE SUPPORT SERVICES.
The TPO first took up software development services segment in which the assessee had computed its OP/TC at 12.56%. The assessee chose 22 companies as comparable. By employing the current year’s data, the assessee reduced number of comparables. The TPO finally shortlisted 16 companies as comparables, which have been listed on page 66 of his order. The average of OP/TC of these 16 companies was determined at 28.74% By applying this PLI as benchmark, the TPO worked out TP adjustment of Rs.6,38,46,198/-. The DRP allowed certain relief which reduced the transfer pricing adjustment under software development service segment to Rs.4,82,48,394. The assessee is aggrieved against the sustenance of addition to this extent.
We have heard the rival submissions and perused the relevant material on record. It is observed that the TPO has changed composition of comparables by excluding some companies from the assessee’s list and including fresh comparables in his final tally. The grievance of the assessee under this segment is confined against the inclusion of five companies and non-inclusion of two companies. We will take up these companies one by one for ascertaining whether or not they are comparables.
The comparability or otherwise of the disputed companies can be judged only after ascertaining the nature of services provided by the assessee under this segment which has two sub-classifications, namely, Software Development Services and Maintenance Support Services.
Software Development Services refer to the development of modules by the assessee and also parts of modules for the software being used by its overseas group entities. Maintenance Support Services refer to the services including bug fixing, carrying out maintenance and support services with software used by its overseas group entities. The assessee entered into Services Agreement dated 1.4.2006 with Sun Life Ireland, under which it undertook to provide software development and maintenance services to its overseas group entities. These services have been provided under the directions of Sun Life Ireland. The assessee has been compensated with cost plus mark up by Sun Life Ireland. The assessee provided software development and maintenance services during the year under consideration in pursuance of the same agreement dated 1.4.2006 under which services were provided in the preceding year as well.
Now, we proceed to examine the comparability of the companies included by the TPO in the final set of comparables, as under:-
8.1. The TPO considered this company as comparable. The assessee’s objections against the incomparable functional profile of this company were rejected. The TPO noticed that this company launched a job portal viz., Logtalent.com, which was quite successful with job aspirants. The assessee’s objection about the incomparability of this function adopted by CAT Technologies Ltd., was held by the TPO to be irrelevant in view of insignificant contribution of such a portal to the assessee’s income.
The TPO observed that majority of the income of this company was from `Software development & consulting services’. Income of this company from `Training’ and `Medical transcription’ was found to be minimal. He, therefore, considered this company as predominantly a software development provider. The assessee’s request before the DRP for the exclusion of this company met with the fate of dismissal. Now, the assessee is before us assailing the inclusion of this company.
8.2. After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company, a copy of which is available on pages 1 onwards of the paper book, that its total income from operations is Rs.9,35,57,676/-, with the following break-up :-
Training Income - Rs.2,44,107/- Software Development and Consulting Services - Rs.8,49,39,375/- Medical Transcription Receipts - Rs.83,74,194/- 8.3. It is this total figure of Rs.9.36 crore which has been taken by the TPO. It shows that the TPO has included CAT Technologies Ltd. as comparable on entity level. On a perusal of the above detail of income of this company, it is apparent that it not only includes revenues from Medical transcription and Training, but the major component of Rs.8.49 crore is income from ‘Software Development and Consulting Services.’ It is reiterated that the segment under consideration is `Software development and maintenance support services’ and the assessee has a separate international transaction of ‘Provision of advisory services’ with the transacted value at Rs.1.75 crore, whose ALP has been disjointedly determined by the TPO. When we come back to the revenues of CAT Technologies Ltd., it is seen that the major component of Rs.8.49 crore is on account of `Software development and consulting services’. Since the segment of the assessee under consideration is only `Software development and maintenance support services’ independent of `Advisory services’, it becomes manifest that a company rendering both the software development and also advisory services, cannot be considered as comparable on entity level with the assessee’s separate segment of software development maintenance support services. Be that as it may, CAT Technologies Ltd., has also earned Medical transcription receipts of Rs.83.74 lac and Training income of Rs.2.44 lac, both of which have been combined with the income from Software development and consulting services. One cannot ascertain with precision the 8 contribution made by the income from Medical transcription and Training to the overall profitability of CAT Technologies Ltd., so that the other income may be segregated. As such, we fail to comprehend as to how the entity level comparison of this company with the assessee’s `Software development and maintenance services’ segment can be construed as valid. This company is, therefore, directed to be excluded from the list of comparables.
9.1. 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.
9.2. 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 which was 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 such an assessee from claiming so, provided the TPO is satisfied that the company so originally reported as comparable is, in fact, not 10 comparable. The 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.
9.3. 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 with a limited number of employees at its disposal and also not owning any branded products with no expenditure 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 incomparable 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. Here it is pertinent to mention that the Tribunal in the assesse’s own case for immediately preceding assessment year in vide its order dated 27.5.2015, has also removed this company from the final set of comparables. This company is, therefore, directed to be excluded from the list of comparables. iii) Tata Elxsi.
10.1. The TPO included this company in the tally of comparables. The assessee objected to the proposed inclusion of this company by arguing that it was engaged in sale of equipment and software licenses also. The TPO refused to accept the assessee’s objections. No relief was allowed by the DRP and finally this company came to be included in the final set of comparables.
10.2. After considering the rival submissions and perusing the relevant material on record, we find that the total revenue of this company for the year in question stands at Rs.41851 lac, consisting of revenue of Rs.2352.41 lac from ‘Sales and suport’ and Rs.39499.19 lac from ‘Services.’ Segmental reporting done by this company indicates the split of total revenue of Rs.41851.60 lac into two segments, namely, Rs.4008.75 lac under the segment ‘Systems integration and support’ and Rs.37843.03 lac under the ‘Software development and services’ segment. The description of ‘Systems integration and support’ segment has been given on page 13 of the Annual report which indicates that this segment refers to: `a wide range of technical computing solutions spanning high end computing platforms, networking, mechanical design automation tools, enterprise storage solutions, digital media and life sciences solutions…’. This description of the ‘Systems integration and support’ segment indicates the nature of revenues, being from sales/licensing of solutions catering to the requirements of different industries. Our finding is fortified by annexure to Director’s report which also gives narration of ‘Systems integration and support.’ It has been mentioned that: ‘this segment offers turnkey solutions comprising of integration of hardware and software products sourced from global principals for domestic customers. The solutions are offered in the area of technical computing used in a wide range of industries such as automotive, pharmacy, defence, meteorology. Your company’s technical solutions involve supply of different products sourced from different global principals based on a set of the customers engineering IT requirements.’ Further, when we peruse the Schedule of fixed assets of this company, it can be found that there is a mention of an asset ‘Intangibles – Software’ with its closing written down value at 14 Rs.1423.16.’ Schedule to the Financial statements further indicate particulars in respect of Sales, purchases, stocks, etc. From the above narration of factual position extracted from the Annual report of this company, it can be seen that this company is also engaged in sale of software products/solutions and has its own intangibles. The revenues under ‘Systems integration and support’ segment of this company stand at Rs.4008.75 crore, out of its total revenue of Rs.41851.60. For comparison, the TPO has taken the figures of this company at entity level, starting with a revenue at Rs.41851.60 crore. Since the overall profit of this company includes the effect of profit from sale/licensing of software products/solutions and there is no measure to isolate such profit from the overall profit of software development segment, we hold that this company at an entity level cannot be considered as comparable with the assessee’s `Software development and maintenance’ segment. This company is, therefore, directed to be excluded.
11.1. This company was chosen by the TPO as comparable. The assessee’s objections about this company’s incomparability were turned down.
11.2. 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 purposes of making comparison. When we peruse the segmental reporting given by this company, it is found that the same has been done on the basis of geographical locations and there are no functional segments. It has been 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’s `Software and maintenance support services segment’ under consideration.
11.3. 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 bolstered 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 17 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 referred decisions, we hold that TCS Ltd. cannot be considered as comparable with the assessee’s software development and maintenance segment on this count as well. The same is directed to be excluded.
12.1. This company was directly chosen by the TPO as comparable.
The DRP refused to intervene in the TPO’s selection. The assessee is now assailing the inclusion of this company in the final set of comparables.
12.2. We have heard both the sides and perused the relevant material on record. It is observed from the Annual report of this company that apart from revenue from ‘Software services’, this company has also earned revenue from ‘Sales.’ The TPO has considered entity level figures of this company for comparison. In view of the joining of the revenue from sales with the revenue from software services, this company ceases to be comparable with the assessee’s `Software development and maintenance services’ segment. Here, it is pertinent to mention that this company was considered by the TPO as comparable in the immediately preceding year as well. The Tribunal vide its aforenoted order, has held it to be incomparable. Since no distinguishing features of the functional profile of this company and the assessee for the current year vis-à-vis the preceding year have been brought to our notice, following the precedent, we order for the removal of this company from the list of comparables.
Apart from challenging the inclusion of the above referred five companies in the final set of comparables by the TPO, the assessee has also assailed the non-inclusion of two companies, namely, Quintegra Solutions Ltd., and Zylog Systems Ltd. We will separately deal with these companies.
14.1. The assessee treated this company as comparable. The TPO refused to accept the comparability by observing that this company has Copyrights included in its fixed assets and was also having several products customized for its clients.
14.2. Having heard the rival submissions and perused the relevant material on record, we find from the Annual report of this company that it has ‘Copyrights’ included in its Schedule of fixed assets with the closing written down value at Rs.2.17 crore. Apart from that, it is seen that this company is regularly incurring expenses on Research and development. This company is also earning revenue from sale of software products apart from rendering software services. Following the view taken for the exclusion of Thirdware Solutions Ltd. etc. above, we hold that this company has been rightly excluded from the list of comparables by the TPO because of the joining of its income from sale of products with the income from rendering of software development services. The TPO’s action is, therefore, approved.
This company was considered by the assessee as comparable. The TPO refused to accept it as comparable on the ground that its revenues were segmented into onshore and offshore services. Certain other reasons for exclusion have also been given by the TPO. Though the ld. AR initially argued for recognizing this company as comparable, but after noting the differences in the functional profile of this company with the `Software development and maintenance service segment’ of the assessee, it was fairly conceded that this company was not comparable. Under such circumstances, we approve the view taken by the TPO in excluding it from the list of comparables.
B. BACK OFFICE SUPPORT SERVICES AND F & A SUPPORT SERVICES.
The assessee separately reported the international transactions of `Provision of back office support services’ and `Provision of F&A support services’. Separate OP/TC was computed and it was claimed that these international transactions were at arm’s length price (ALP).
The TPO merged these international transactions for benchmarking.
The assessee had chosen certain companies as comparables. The TPO made alterations in comparables. Finally, ten companies were chosen as comparable of this merged segment, which have been listed on page 88 of the TPO’s order. Average OP/TC of these companies was computed at 37.15%. By applying this profit rate as benchmark, the TPO recommended transfer pricing adjustment to the tune of Rs.1.89 crore.
The DRP allowed some relief by reducing the adjustment to Rs.1.48 crore. The assessee is aggrieved against the sustenance of balance addition under this merged segment.
The ld. AR did not seriously raise any dispute against the merger of the two segments by the TPO. As such, we are proceeding to determine the ALP of these merged segments into one.
Back office support service provided by the assessee include Policy administration and maintenance and also Contract generation.
Generating insurance contracts for the customers of overseas group entities and sending them to the respective overseas of Sun Life group entities is one of the activities performed by the assessee for its AEs. It also encompasses updating the financial and personnel data of clients of overseas group entities. Finance and Accounts support services are in the nature of financial and accounting support services rendered by the assessee under the directions issued by Sun Life, Canada. The assessee was compensated at cost plus mark-up in relation to both the Back office support and F&A support services. With the above background of the nature of activities carried out by the assessee under this merged segment of provision of services, we will now explore as to whether the companies assailed before us are, in fact, comparable or not.
The assessee has disputed inclusion of five companies in the final set of comparables with which we will deal hereinafter.
20.1. The TPO considered this company as comparable. The assessee’s objections about its functional incomparability were repelled. That is how, this company came to be included in the final set of comparables.
20.2. After considering the rival submissions and going through the Annual report of this company, we find that during the year in question certain acquisitions and mergers were undertaken by this company, which is apparent from page 29 of the Annual report. It has been mentioned that this company: ‘Completed the acquisition of Oak Technologies Inc., USA and has rapidly increased its customer base from New Jersey and neighboring areas.’ This shows that extraordinary financial event happened during the year in this company by means of acquisition, thereby rendering it as unfit for comparison with the assessee’s profitability under this segment. Following the view taken hereinabove while discussing the exclusion of TCS Ltd. from the `Software Development and Maintenance’ segment of the assessee, we direct the elimination of this company also from the final list of comparables.
21.1. This company was included by the assessee in its list of comparables. However, it was argued that the same be eliminated as it was wrongly chosen.
21.2. After hearing the rival submissions and perusing the relevant material on record, we find that this company was subject matter of consideration by the Tribunal in its order for the immediately preceding assessment year as well. After making a detailed analysis, the Tribunal has approved the view taken by the TPO in considering this company as a fit comparable. Following such a view taken in the immediately preceding assessment year, we uphold the TPO’s order rejecting the assessee’s contention for exclusion. iii. Coral Hub (Vishal Information Technology Ltd.)
22.1. The assessee chose this company as comparable. As such, no objection was taken before the TPO against its inclusion. However, the assessee argued before the DRP that this company was wrongly included. The DRP refused to accept the assessee’s contention. That is how the assessee is aggrieved before us.
22.2. In view of discussion made supra, we are not inclined to accept the preliminary objection raised by the ld. DR against the inclusion of this company on the premise that the assessee had itself chosen it as comparable.
22.3. Coming to the functional comparability of this company, we observe from its Annual report that it is outsourcing its major activities.
Such outsourcing charges constitute around 90.57% of the total operating cost. As against this, the assessee is engaged in providing the services under this segment at its own without any outsourcing. This crucial difference between the manner of performing services has an important bearing on the ultimate profitability. The Delhi Bench of the Tribunal in the case of Mercer Consulting (India) Pvt. Ltd. Vs. DCIT in from the list of comparables by, in turn, relying on the two Tribunal orders passed by the Mumbai Benches in Hapag Lloyd Global Services and ACIT vs. Mersk Global Services Centre (India) Pvt. Ltd. We note that the tribunal has also excluded this company from the list of comparables for the immediately preceding year. In view of the above reasons and respectfully following the above precedents, we direct to unload this company from the list of comparables. iv) e-Clerx Services Ltd. 23.1. The TPO considered this company as comparable. The assessee’s objection that e-Clerx Services Ltd., is a Knowledge Process Outsourcing (KPO) company and was engaged in rendering high end services, was rejected. The assessee is assailing the inclusion of this company in the list of comparables.
23.2. We have heard the rival submissions and perused the relevant material on record. Without going into the further details, it is observed that the Hon’ble jurisdictional High Court in the case of Rampgreen Solutions Pvt. Ltd. vs. CIT vide its judgment dated 10.8.2015 has observed that e-Clerx is engaged in KPO services which cannot be compared with a company providing low-end BPO services. Turning to the facts of the instant case, we find that the segment of the assessee under consideration is `Back office support plus F&A services’. By no standard, a KPO company like e-Clerx can be considered as comparable with the `Back office support plus F&A services’ segment of the assessee. We, therefore, order for the removal of this company from the list of comparables.
24.1. The TPO included this company in the list of comparables.
The assessee’s objections about its functional dissimilarity were jettisoned.
24.2. Having heard the rival submissions and perused the relevant material on record, we find that this company is engaged in rendering full range of geospatial services to its customers. These services, in simple terms, mean the services relating to the positioning of things on the earth’s surface. These include 3-D mapping, Navigation maps, Image processing, Cadastral mapping, etc. When we consider the nature of services provided by this company and then compare them with the combined back office, financial and accounting support services rendered by the assessee under consideration, it turns out that both are poles apart from each other. This company is totally incomparable with this segment of the assessee. At this stage, it is further pertinent to mention that the TPO has himself excluded this company from the list of comparables for the immediately succeeding year by noticing it to be a functionally different company. As such, we are not inclined to accept the comparability of this company with the assessee’s merged `Back office support and F&A support services’ segment. This company is directed to be taken away from the tally of comparables under this segment.
C. ADVISORY SERVICES SEGMENT
The TPO recommended a transfer pricing adjustment under this segment for a sum of Rs.17,08,751. The assessee assailed the draft order on this issue before the DRP. Pursuant to the directions given by the DRP, the AO made an addition of Rs.16,04,147 in his final order. This addition is in challenge before us. During the course of hearing, certain queries were raised from the Bench, but the ld. AR did not have the requisite material to answer them. In view of the non-availability of the relevant material and evidence, we dismiss this ground subject to the plus minus allowability of the working capital adjustment and adjustment on account of FOREX gain/loss as discussed infra.
D. WORKING CAPITAL ADJUSTMENT.
This claim of the assessee is common to all the three segments finally considered by the TPO. The assessee requested for grant of working capital adjustment. The TPO refused to allow such adjustment by noticing that the assessee had not demonstrated that there was any difference in the levels of working capital employed by it vis-à-vis the comparables. He, further noticed that the issue of working capital would be relevant only when there is a situation of inventory remaining tied up or receivables being held up, which can’t be relevant in a service industry, as is the assessee engaged in. He, therefore, refused to allow any working capital adjustment. No relief was allowed by the DRP.
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 in respect of all the three segments, namely, Provision of software development and maintenance services; Merged segment of provision of back office support and F&A services; and Advisory services. The TPO refused to allow such adjustment, inter alia, by opining that the financials of the company showed consolidated income from all the three segments and, hence, it was not possible to ascertain creditors and debtors pertaining to each segment. 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.
We are not inclined to accept the view canvassed by the authorities below 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, 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.
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.
Notwithstanding the otherwise availability of the working capital adjustment, we are unable to countenance the calculation given by the assessee at its face value because of an important factor. It is an undisputed position that the assessee made up its accounts on an entity level. It was only with a view to show that its international transactions were at ALP, that it bifurcated the consolidated accounts into different segments. Such bifurcation of accounts into different segments has not been disputed by the TPO inasmuch as he has not challenged the correctness of the figures so deduced in respect of operating profits etc. of each segment. But, when it comes to the computation of working capital adjustment, one needs to look only at the figures of inventory, trade receivables and trade payables. These figures can be culled out from balance sheet without any reference to the segregated income statement of each segment. On a pointed query from the Bench, the ld. AR conceded that there may be some trade receivables or payables common to the `Software development segment’, `Merged segment’ and ‘Advisory services segment’. In such a situation, it becomes relevant to see as to how the figures of such trade receivables or payables have been placed in the computation of working capital adjustment under each segment. The ld. AR argued that the calculation of the working capital adjustment has not been challenged by the TPO and, hence, the same should be accepted as such. We are not convinced with this proposition for the obvious reason that when the TPO rejected the assessee’s claim for the grant of any working capital adjustment at the threshold itself, there was no occasion for him to examine the 34 veracity of the computation of working capital adjustment as put forth on behalf of the assessee. Under such circumstances, we direct the AO/TPO to compute and allow working capital adjustment, if any, available under all these segments, namely, `Provision of software development and maintenance services’, `Provision of back office support services and F&A support services’ and ‘Advisory services’ distinctly in the light of our above discussion. It is noticed that similar adjustment has been allowed by the Tribunal in the assessee’s case for the immediately preceding assessment year, a copy of which order has been placed on record. 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.
E. FOREIGN EXCHANGE GAIN/LOSS.
The next issue raised in this appeal is against the treatment of foreign exchange (FOREX) gain/loss as an item of non-operating nature.
On a pertinent query, it was admitted by the ld. AR that the FOREX gain/loss in the hands of the assessee relates to its revenue transactions alone. The ld. DR relied on the orders passed by the authorities below.
We find merit in the contention raised on behalf of the assessee about the treatment of foreign exchange gain/loss as an item of operating nature. As regards the nature of such foreign exchange gain earned by the assessee, the ld. AR put forth that the same is in relation to the trading items emanating from the international transactions. No contrary material has been placed on record by the ld. DR. If the foreign exchange gain/loss resulted from the trading items only, we fail to appreciate as to how it can be treated as non-operating.
The Special Bench of the Tribunal in ACIT Vs Prakash I. Shah (2008) 115 ITD 167 (Mum)(SB) has held that the gain due to fluctuations in the foreign exchange rate emanating from export is its integral part and cannot be differentiated from the export proceeds simply on the ground that the foreign currency rate has increased subsequent to sale but prior to realization. It went on to add that when goods are exported and invoice is raised in currency of the country where such goods are sold and subsequently when the amount is realized in that foreign currency and then converted into Indian rupees, the entire amount is relatable to the exports. In fact, it is only the translation of invoice value from the foreign currency to the Indian rupees. The Special bench held that the exchange rate gain or loss cannot have a different character from the transaction to which it pertains. The Bench found fallacy in the submission made on behalf of the Revenue that the exchange rate difference should be detached from the exports and be considered as an independent transaction. Eventually, the Special Bench held that such an exchange rate fluctuation gain/loss arising from exports cannot be viewed differently from the sale proceeds.
In the context of transfer pricing, the Bangalore Bench of the Tribunal in SAP Labs India Pvt. Ltd. Vs ACIT (2011) 44 SOT 156 (Bangalore) has held that foreign exchange fluctuation gain is part of operating profit of the company and should be included in the operating revenue. Similar view has been taken in Trilogy E Business Software India (P) Ltd. Vs DCIT (2011) 47 SOT 45 (URO) (Bangalore). The Mumbai Bench of the Tribunal in S. Narendra Vs Addl. CIT (2013) 32 taxman.com 196 has also laid down to this extent. In view of the foregoing discussion, we are of the considered opinion that the amount of foreign exchange gain/loss arising out of revenue transactions is required to be considered as an item of operating revenue/cost.
However, it is made clear that it should be dealt with identically both in the calculation of the PLI of the assessee as well as the comparables under all the three segments.
In view of the foregoing discussion, we set aside the impugned order on the question of addition on account of transfer pricing adjustment under all the three segments made by the TPO and remit the matter to the file of AO/TPO for re-determination of the ALP afresh in consonance with our directions given in the earlier parts of this order.
Needless to say, the assessee will be allowed a reasonable opportunity of being heard.
The only other ground which survives for our consideration in this appeal is against not reducing lease line charges from `total turnover’, after excluding it from `export turnover’. The assessee claimed the benefit of section 10A. Considering the mandate of Explanation 2 (iv) to section 10A of the Act, the AO opined that lease line charges were in the nature of telecommunication charges incurred in foreign currency attributable to delivery of computer software outside India. He, therefore, reduced this amount from `export turnover’. The assessee’s contention for giving a similar treatment to this amount in the computation of `total turnover’, was rejected.
After considering the rival submissions and perusing the relevant material on record, we find force in the contention advanced by the ld. AR, requiring the exclusion of this amount from `total turnover’ as well.
The obvious reason is that when a particular item does not form part of export turnover, which, in turn, is a necessary ingredient of the total turnover, the same has to be necessarily excluded from the computation of latter. It has been brought to our notice that the Tribunal in assessee’s own case for the A.Ys. 2007-08 and 2008-09 has decided this issue in assessee’s favour. The ld. AR also invited our attention to the judgment of the Hon’ble High Court rendered in the case of the assessee approving the view taken by the tribunal for the earlier year.
Respectfully following the precedents, we allow this ground of appeal.
In the result, the appeal is partly allowed.
The order pronounced in the open court on 28.09.2015.