Income Tax Appellate Tribunal - Bangalore
Teenotree Convergence Pvt Ltd, ... vs Deputy Commissioner Of Income Tax, ... on 27 June, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
"C" BENCH : BANGALORE
BEFORE SHRI ARUN KUMAR GARODIA, ACCOUNTANT MEMBER AND
SHRI LALIET KUMAR, JUDICIAL MEMBER
IT(TP)A No.1616/Bang/2017
Assessment Year :2013-14
M/s. Tecnotree Convergence Pvt. Ltd.,
No. 65/2, B-Block, 6th Floor, The Deputy
Level-7, BagmaneTridib, Commissioner of
Bagmane Tech Park, CV Raman Nagar, vs. Income Tax,
Byrasandra, Circle - 7 (1) (1),
Bangalore - 560 093. Bangalore.
PAN: AAACL7345L
APPELLANT RESPONDENT
Appellant by : Shri Bharadwaj Sheshadri, CA
Respondent by : Shri D. Sudhakara Rao, CIT (DR)
Date of hearing : 14.05.2018
Date of Pronouncement : 27.06.2018
ORDER
Per Shri A.K. Garodia, Accountant Member
This appeal is filed by the assessee and the same is directed against the assessment order dated 29.05.2017 for Assessment Year 2013-14 passed by the AO u/s. 143(3) r.w.s. 144C(13) of IT Act, 1961 as per the directions of DRP.
2. The grounds raised by the assessee are as under.
"1. General 1.1 The assessment order dated 29 May 2017 passed by the Ld. Deputy Commissioner of Income-tax Circle 7(1) (1) ['Ld. AO'] under section 143(3) read with section 144C (13) of the Income-tax Act, 1961 ( 'Act') is not in accordance with the law and is contrary to the facts and circumstances of the present case and is in any case violative of principles of equity and natural justice.
GROUNDS OF APPEAL ON TRANSFER PRICING ISSUES
2. Assessment and reference to Transfer Pricing Officer are bad in law 2.1 The Ld. AO has erred in law in making a reference to the IT (TP) A No. 1616/Bang/2017 Page 2 of 42 learned Deputy Commissioner of Income Tax (Transfer Pricing) - 2(2)(2) ['Ld. TPO'], inter alia, since he has not recorded an opinion that any of the conditions in section 92C(3) of the Act, were satisfied in the instant case.
3. The Ld. TPO has erred in justifying the motive of shifting of profits
3.1 On the facts and in the circumstances of the case and in law, the Ld. TPO / AO erred in not demonstrating that the motive of the Appellant was to shift profits outside of India by manipulating the prices charged in its international transactions which is a pre- requisite condition to make any adjustment under the provision of Chapter X of the Act.
4. Comparability Analysis and Determination of Arm's Length Price Grounds of Appeal for rejection of comparables selected by the Ld. TPO in the order issued u/s 92CA of the Act 4.1 The Ld. AO/ TPO grossly erred on facts in benchmarking the transactions of the captive information technology services ('IT services') of the Appellant with companies operating as full-fledged entrepreneurs without considering the differences in the functions performed, assets employed and risk undertaken by the Appellant vis- a-vis comparable companies.
4.2 The Ld. TPO erred in selecting CG-VAK Software Exports Limited as comparable in the order u/s 92CA of the Act, despite the business of the company being functionally not comparable to the IT services rendered by the Appellant. CG-VAK Software Exports Limited is involved in product development during the Financial Year ('FY') 2012-13. It is also involved in the business of providing Software Development and BPO services and there is no segmentation available in respect of revenue earned by the said company on account of rendering of software development and BPO services. Accordingly, the said company cannot be compared to the Appellant, being a risk insulated captive IT service provider.
4.3 The Ld. TPO erred in selecting Larsen & Toubro Infotech Limited, Mindtree Limited (Seg.) and Persistent Systems Limited as comparables in the order u/s 92CA of the Act, despite their turnover being more than ten times of the turnover of the Appellant for the FY 2012-13. The said companies are functionally not comparable to the IT services rendered by the Appellant. The said companies have significant profitability on account of their brands, own intangibles and incur significant onsite expenses. Larsen & Toubro Infotech Limited and Persistent Systems Limited have significant related party transactions for the FY 2012-13. Accordingly, the said companies cannot be compared to the Appellant, being a risk insulated captive IT service provider.
IT (TP) A No. 1616/Bang/2017 Page 3 of 42 4.4 The Ld. TPO erred in selecting ICRA Techno Analytics Limited as comparable in the order u/s 92CA of the Act, despite the said company having significant related party transactions for the FY 2012-13. Accordingly, the said company cannot be compared to the Appellant, being a risk insulated captive IT service provider.
Grounds of Appeal for inclusion of combarables selected by the Appellant in the Transfer Pricing Study, rejected by the Ld. TPO in the order issued u/s 92CA of the Act 4.5 The Ld. TPO erred on facts in rejecting the comparable companies arrived at in the Transfer Pricing Study without considering the functional and risk analysis of the Appellant.
4.6 The Ld. TPO erred on facts in rejecting Akshay Software Technologies Limited, selected by the Appellant as comparable in its transfer pricing study, despite the said company being functionally comparable and qualifying all the filters applied by the Ld. TPO in the order u/s 92CA of the Act. The Honorable Dispute Resolution Panel ('Honorable DRP') further erred in rejecting Akshay Software Technologies Limited in the absence of segmental information whereas the said company is engaged in rendering software development services and earns majority of its revenue from rendering such services.
4.7 The Ld. TPO erred on facts in rejecting Helios and Matheson Information Technology Limited and R Systems international Ltd., selected by the Appellant as comparable in its transfer pricing study, despite the said companies being functionally comparable.
Ld. AO/ TPO erred in computing a negative working capital adjustment on the margins of the comparable companies 4.8 The Ld. TPO/ AC) erred on facts and in law. and the Honorable DRP further erred in upholding / confirming the action of the Ld. TPO/ AO in computing a negative working capital adjustment on the margins of the comparable companies wherein the IT services segment of the Appellant operates as a captive service provider.
Non-allowance of appropriate adjustments to the comparable companies by the Ld. AO/TPO 4.9 The Ld. AO / TPO erred in law and on facts in not allowing appropriate adjustments under Rule 10B to account for, inter alia, differences in (a) accounting practices. (b) marketing expenditure, (c) research and development expenditure, and (d) risk profile between the Appellant and the comparable companies.
Variation of 3% from the arithmetic mean 4.10 Without prejudice to the other grounds of appeal, the Ld. AO/ IT (TP) A No. 1616/Bang/2017 Page 4 of 42 TPO erred in law in not granting the variation as per the proviso to Section 92C(2) of the Act.
Erroneous data used by the Ld. AO / TPO 4.11 The Ld. AO/ TPO has erred in law in using data, which was not contemporaneous and which was not available in the public domain at the time of conducting the transfer pricing study by the Appellant.
4.12 The Ld. AO/ TPO erred in law and on facts in disregarding the application of multiple-year data while computing the margins of alleged comparable companies as such data had an influence in determining the pricing policy of the Appellant.
5. Other General Grounds of Appeal 5.1 The Ld. TPO erred on facts and in law in conducting a fresh benchmarking analysis using non contemporaneous data and substituting the Appellant's analysis with fresh benchmarking analysis on his own conjectures and surmises. Thus the Appellant prays that the fresh benchmarking analysis conducted by the Ld. TPO is liable to be quashed.
5.2 The Ld. AO/ TPO erred in law in applying arbitrary filters to arrive at a fresh set of companies as comparables to the Appellant, without establishing functional comparability.
5.3 The Ld. AO/ TPO grossly erred in law in deviating from the uncontrolled party transaction definition as per the Income-tax Rules and arbitrarily applying a 25% related party criteria in accepting / rejecting comparables.
5.4 The Ld. AO/ TPO also erred on facts and in law in arbitrarily rejecting companies with different year ending (i.e. other than 31 March 2013) and applying the said filter inconsistently.
5.5 The Ld. AO/ TPO grossly erred on facts in arbitrarily rejecting companies having software development revenue less than 75% of total operating revenue and inconsistently applying such filter, without considering the specific segmental results.
5.6 The Ld. AO/ TPO also erred on facts in arbitrarily rejecting companies based on their financial results without considering the functional comparability.
5.7 The Ld. AO/ TPO erred on facts and in law in considering a set of 'secret data', i.e. data which was not available in public domain, in arriving at a fresh set of companies using his power under section 133(6), which is grossly unjustified.
5.8 The Ld. AO/TPO also erred on facts and in law in accepting IT (TP) A No. 1616/Bang/2017 Page 5 of 42 comparable companies without considering the turnover and size of the Appellant and the comparable companies.
GROUNDS OF APPEAL ON CORPORATE TAX ISSUES
6. Disallowance of commission expense on account of non- deduction of tax at source 6.1 On the facts and circumstances of the case and in law, the Ld. AO erred in disallowing the export commission expense amounting to Rs. 4,34,72,134 paid to non-resident parties under section 40(a)(i) of the Act without appreciating that such payments were not taxable in India and the Honorable DRP erred in confirming the same.
7. Non grant of set off of Minimum Alternate Tax ('MAT') credit 7.1 On the facts and circumstances of the case and in law, the Ld. AO erred in not granting set off of MAT credit while computing tax liability and the Honorable DRP erred in not adjudicating on the same.
8. Levy of interest under sections 234B of the Act 8.1 On the facts and circumstances of the case, the Ld. AO erred in levying interest under section 234B of the Act amounting to Rs. 1,58,63,950.
9. Initiation of proceedings under section 274 read with section 271 of the Act 9.1 On the facts and circumstances of the case, the Ld. AO erred in initiating penalty proceedings under section 274 read with section 271(1)(c) of the Act.
10. Directions issued by the Honorable DRP 10.1 That the directions issued by the Honorable DRP, to the extent they confirm the draft assessment order of the Ld. AO, are erroneous and liable to be set aside.
11. Relief 11.1 On the facts and circumstances of the case and in law, the Appellant prays that the Ld. AO be directed to grant all such relief arising from the preceding grounds as also all relief consequential thereto.
The Appellant craves leave to add to or alter, by deletion, substitution, modification or otherwise, the above grounds of appeal, either before or during the hearing of the appeal. Each of the above grounds of appeal is independent and without prejudice to the other grounds preferred by the Appellant."
3. The assessee has also filed one additional ground of appeal which is as under.
IT (TP) A No. 1616/Bang/2017 Page 6 of 42 "1. The learned DRP erred in affirming the wrong computations of margins made by the learned TPO in the cases of the following comparables:
(a) CG-VAK Software & Exports Ltd.; and
(b) ICRA Techno Analytics Ltd."
4. The ld. AR of assessee has filed the synopsis of arguments which are reproduced hereinbelow for ready reference:-
"SYNOPSIS OF THE APPELLANT'S ARGUMENTS Notes:
(i) Unless repugnant to the context, all sections and rules referred to herein are sections and rules of the Income Tax Act, 1961 and the Income Tax Rules, 1962 respectively.
(ii) All grounds taken and arguments urged are without prejudice to each other.
(iii) The following is not in derogation of the arguments advanced at the hearing.
The Appellant begs to submit the following synopsis of its arguments.
TRANSFER PRICING ISSUES
1. The accompanying chart shows a summary of the comparables as selected by both sides and their fate before the learned DRP.
NEGATIVE WORKING CAPITAL ADJUSTMENT
IMPERMISSIBLE
2. The Appellant submits that the learned TPO erred in making a negative working capital adjustment to artificially increase the margins of the comparables for the following reasons.
(a) The Appellant does not have any borrowings at all. It thus does not incur any expenditure whatsoever in the maintenance of its working capital.
(b) 99.83% of the Appellant's share capital is held by Lifetree Cyberworks Pvt. Ltd., the Appellant's holding company and TecnotreeOyj, Finland, the Appellants ultimate holding company.
Thus. the Appellant does not have any working capital risk at all.
3. A substantial portion of the Appellants working capital arises out of transactions with its related parties. For instance, out of the total trade receivables of Rs.163,35,09.966 as at 31.03.2013, more than 77%. i.e., Rs.126,40,42,576 is receivable from its holding and subsidiary companies. This reinforces the proposition that the Appellant bears no working capital risk.
IT (TP) A No. 1616/Bang/2017 Page 7 of 42
4. The following orders of co-ordinate benches of this Tribunal have held that where the Appellant bears no working capital risk and incurs no expenditure on working capital, the Revenue cannot make a negative working capital adjustment.
(a) Adaptec (India) Pvt. Ltd. v ACIT [2015] 57 taxmann.com 307 (Hyderabad-Trib.)
(b) Lam Research (India) Pvt. Ltd. v. DCIT (I.T(TP). A. No. 1437/Bang/2014)
(c) CAPCO IT Services India Pvt. Ltd. v ITO [2017] 79 taxmann.com 214 (Bangalore-Trib.)
(d) ITO V. Intoto Software (India) Pvt. Ltd [2017] 78 taxmann.com 260 (Hyderabad-Trib.)
(e) TNS India Pvt. Ltd. v. ACIT [2017] 77 taxmann.com 356 (Hyderabad-Trib.)
5. Having referred to the judgment in Adaptec's case (supra.) and dissented from it against all principles of judicial discipline, the learned TPO has argued that working capital position affects the pricing of any service and that risk and value are different concepts. It is humbly submitted that the basis of the working capital adjustment is the existence of a difference in the cost of working capital. This is relevant because the cost is stated to affect the margin In the Appellant's case, the Appellant has demonstrated that it holds its working capital at no cost, completely out of its own funds without any borrowings at all. Thus, if anything, the comparables' margin is to be reduced to the extent of the Appellant's cost-saving on account of free working capital. The learned TPO and the learned DRP have thus erred in upholding a negative working capital adjustment.
RISK AND OTHER ADJUSTMENTS
6. The Appellant contends that the learned TPO and the learned DRP erred in not allowing adjustments for risk and other factors such as size, brand value, and marketing expenditure. The necessity for such adjustments has been upheld by the Delhi High Court in Chryscapital Investments case as also by co-ordinate Bengaluru benches in numerous cases.
7. Option 1. This option is based on the decision of this Honourable Tribunal in Sony India where a co-ordinate bench of this Honourable Tribunal found that there are various differences between the assessee and the comparables. Holding that it was a difficult exercise to determine precisely the nature and extent of the differences, it held that a downward adjustment of 20% from the mean Profit Level Indicator (PLI) of the comparables was to he allowed.
8. Option 2: This option is based on the decision of a co-ordinate IT (TP) A No. 1616/Bang/2017 Page 8 of 42 bench in Philips Software Centre's cases. In that case, it was held that the risk premium (i e., the incremental rate of return to be attributed to additional risk) of the return of full-fledged entrepreneurs over the return of captive service providers such as the Appellant would be the difference between the bank rate and the Prime Lending Rate (PLR). The bank rate is considered the risk-free rate of return while the PLR is considered the normal risk-bearing rate. For the relevant previous year, this risk premium would be 2.94% (i.e., 294 basis points) (being 10.25% (PLR notified by RBI during the year ended 31.03.2013) - 7.31% (bank rate notified by RBI for that period).
9. Option 3: The third option is based on the decision of a coordinate bench of this Honourable Tribunal in Motorola's case. This provides for the use of the Capital Asset Pricing Model (CAPM) along with the WACC (Weighted Average Cost of Capital) mechanism. First, the cost of equity is determined using the CAPM. Second, the cost of debt is determined on actual basis. The WACC is then computed applying the equity and debt mix as the weight to the cost of equity and the cost of debt. The risk- adjustment is computed as the portion of the WACC that represents return attributable solely to risk This risk adjustment. as a percentage. is applied to the comparables' arithmetic mean to adjust it. The detailed method of computation is at Annexure 12 to Form 35A submitted before the learned DRP (at p. 76 thereof) read with the enclosures thereto which forms a part of the memorandum of appeal before this Tribunal. It is not reiterated here for the sake of brevity.
10. The Appellant submits that while all three options are reasonable, the second option is the most preferable. The third option is acceptable too. However, the sensitivity factor (beta) required to compute the return on equity as per the CAPIVI is not determinable in the case of unlisted securities. The first option is less scientific than the other two. However, the Appellant does not object to applying any of the options.
11. Marketing and Research and Development Expenses Adjustment: A co-ordinate Bench has. in Rolls Royce's case held that 5% of the profits of an entity are to be allocated to research and development while 35% are to be allocated to marketing. This allocation was accepted by a coordinate Bengaluru Bench in IBM India's case In IBM India's case, the co-ordinate Bench relied on Rolls Royce to direct the learned DRP to consider the question of the risk adjustment. Based on these allocations. a detailed computation was furnished in the present case before the DRP, in Annexure 12 to Form 35A at page 71 thereof. The learned DRP merely wrongly held that the Appellant had submitted no detailed computation. This is clearly incorrect. Considering the decisions of the co-ordinate benches, it is submitted that the adjustment IT (TP) A No. 1616/Bang/2017 Page 9 of 42 (reduction of comparables' margins by 7.13% (i.e., 713 basis points) for marketing and 424 basis points for R&D expenditure) deserves to be allowed.
12. The learned DRP also held that the Appellant only sought an ad hoc adjustment and that it did not provide a detailed computation. This is untrue. Annexure 12 to the reference to the DRP in Form 35A read with the enclosures thereto (all forming part of the memorandum of appeal before this Tribunal) contains detailed computations for this purpose.
13. The learned TPO has also held that the Appellant has "single customer risk" and that thus no risk adjustment was warranted. This reasoning has been expressly disapproved by this Honourable Tribunal in Intellinet Technologies India Pvt. Ltd. v. ITO [2012] 22 taxmann.com 28 (Bang.-Trib.).
14. The learned TPO relied on SAP Labs' casel°. Meritor LVS' case and Symantec's case. In both SAP Labs and Symantec's cases, the risk adjustment was denied as it was either brought up before the tribunal for the first time or that computations of the adjustment were not furnished before the lower authorities. Both these are not true in the present case. Additionally, the learned DRP relied on the decisions in Zyme Solutions", CDC Software', Stryker Global, and Aptara Technologies. In Zyme Solutions, the attending circumstances were that the DRP had directed the TPO to grant a risk adjustment of 1% without considering any of the material. In the Appellant's case, it is plainly evident that the learned DRP has denied the risk adjustment on non-existent grounds. In Aptara's case. the Tribunal held that where no Arm's Length Price adjustment was being made at all by virtue of the margin provided for in the second proviso to section 920(2), the ground relating to the risk adjustment was infructuous. The learned DRP has misrepresented this as meaning that the 5% ipso facto implied that no risk adjustment could be made. All the precedents are thus distinguished.
R SYSTEMS INTERNATIONAL. LTD. (SEGMENT)
15. This comparable was selected by the Appellant. It was rejected by both the learned TPO ant the learned DRP on the ground that it has a different financial year. i.e., year ending 31st December as opposed to the Appellant's 31st March.
16. The Appellant submits that this issue is covered in favour of the Appellant by the following precedents.
(a) CIT v. Mercer Consulting (India) Pvt Ltd. [2017] 390 ITR 615, 627 (P&H) - The Punjab & Haryana High Court held that different financial year would not itself entail the rejection of the company so long as the data for the relevant period is available.
IT (TP) A No. 1616/Bang/2017 Page 10 of 42
(b) e4e Business Solutions India Pvt. Ltd, v. ITO [2017] 87 taxmann.com 254 (Bangalore-Trib.)-A coordinate Bengaluru Bench of this Tribunal held that comparables with different financial years can be accepted if it is possible to reasonably extrapolate data for the relevant period from data available on the public domain.
(c) G.E. India Exports Pvt. Ltd. v DCIT [2017] 82 taxmann.com 464 (Bangalore-Trib.) coordinate Bengaluru Bench of the Tribunal has also adopted a view similar to that in e4e Business Solutions' case.
(d) Cadence Design Systems (India) Pvt Ltd. v. DCIT [2017] 86 taxmann.com 188 (Delhi-Trib.) -A coordinate Delhi Bench held that where proportionate workings for the relevant period can be easily deduced, there is no bar to selecting a comparable with a different financial year. This decision was followed by another co-ordinate bench in Cadence Design Systems (India) Pvt. Ltd. v. DCIT [2018] 89 taxmann.com 443 (Delhi-Trib.).
17. The Appellant submits that in its TP Study, it had not conducted the process of extrapolating the data for the relevant period. However, in view of the subsequent precedents cited above, the Appellant has recomputed the PLI by the following process of reasonable extrapolation. However, in order to do so, it has had to rely on the financial statements of R Systems for its financial year ended 31 03.2313 as well. An application for admitting the same as additional evidence has been filed. It is humbly prayed that that application be allowed for the reasons stated therein.
18. The twelve months constituting the Appellant's financial year consist of nine months from R Systems financial year ended 31.12.2012 and three months from R Systems' financial year ended 31.12.2013. The Appellant has thus considered 9/12th of R Systems' segmental figures from its year ended 31.12.2012 and 3/12th of its figures from its year ended 31.12.2013. It is submitted that this method, being a reasonable method of extrapolation ought to be accepted and thus, the rejection of the comparable on the ground of its different financial year deserves to be set aside in accordance with the binding precedents.
19. The PLI of R Systems, so computed, is 15.95%. This computation is as follows.
Amount (in Rs . )
Particulars FYE FYE
FYE
B=A*9/12 31.12.2013 D=C*3/12 31.03.2013
31.12.2012(A)
(C)
Segment Revenue (A) 1,99,04,50,611 1,49,28,37,958 2,35,64,00,658 58,91,00,164 2,08,19,38,123
Less: Segment Result 26,75,09,209 20,06,31,906 49,03,89,126 12,25,97,282 32,32,29,188
Segment Expenditure 1,72,29,41,402 1,29,22,06,052 1,86,60,11,532 46,65,02,883 1,75,87,08,935
IT (TP) A No. 1616/Bang/2017
Page 11 of 42
Add:Apportioned Operating 3,47,04,136 2,60,28,102 4,34,24,035 1,08,56,009 3,68,84,111
Expenditure
Total Segment Operating
1,75,76,45,538 1,31,82,34,154 1,90,94,35,567 47,73,58,892 1,79,55,93,046
Expenditure (B)
SEGMENT OPERATING
PROFIT (C = A - B) 23,28,05,073 17,46,03,804 44,69,65,091 11,17,41,273 28,63,45,077
PLI (D = C ÷ B) 13.25% 13.25% 23.41% 23.41% 15.95%
CG-VAK SOFTWARE AND EXPORTS LTD.
20. This comparable was selected by the TPO and has been upheld by the Id. DRP. The Appellant's only submission before this Honourable Tribunal is that the learned TPO/AO has wrongly computed the PLI of this comparable. The Appellant does not challenge the selection of this comparable and thus does not press the relevant grounds.
21. As regards the PLI, the learned TPO/AO has determined the PLI at 20.45% at p. 12 of his order. However, he has finally considered the PLI at 20.54%. The Appellant submits that the correct PLI is, in fact, 15.41%. The following table shows the differences (highlighted in yellow) between the computation of the learned TPO/AO and the Appellant on the other hand.
Amount (in Rs.)
Particulars As per As per
As per AO As per AO
Appellant Appellant
Revenue from Operations 8,69,20,713 8,69,20,713
Add: Foreign Exchange Gain 15,67,139 15,67,139
Add: Sundry Receipts - 58,600
Total Revenue (A) 8,84,87,852 8,85,46,452
5,23,79,214 5,23,79,214
Employee Benefits Expense
Operating & Other Expenses 1,87,38,171 1,87,38,171
Gross 39,97,218
Less: Provision for Doubtful Debts -
Less: Share Demat Expenses 1,28,661
Less: Bank Charges 55,000 5,54,004
Less: Donations 55,000
Depreciation and Amortization 1,46,85,953 1,80,00,506
63,45,039 63,45,039
Total Expenditure (B) 7,34,10,206 7,67,24,759
Operating Profit (C = A - B) 1,50,77,646 1,18,21,693
PLI 20.54% 15.41%
22. Submissions are separately addressed on each of the differences below.
(a) Sundry receipts: In computations, other income, to the extent it does not represent interest and non-operating incomes is excluded. The learned TPO/AO had no basis to exclude sundry receipts in the absence of a finding that it is non-operating in its nature. The learned TPO/AO had every occasion to determine the nature of the funds by making inquiries with the relevant entity but has omitted to do so.
(b) Provision for doubtful debts: The learned TPO/AO has IT (TP) A No. 1616/Bang/2017 Page 12 of 42 excluded provisions for doubtful debt on the ground that it is non- operating in its character. This runs against settled precedent, arising from the following precedents, that provisions for doubtful debts are in fact operating in their character.
i) Outsource Partners International Pvt. Ltd. v. DCIT [2017] 79 taxmann.com 74 (Bangalore-Trib.)
ii) Techbooks International (P.) Ltd. v. Dy CIT [2015] 63 taxmann.com 114 (Delhi-Trib.).
iii) Rolls Royce India Pvt. Ltd v. DCIT [2016] 69 taxmann.com 209 (Delhi-Trib.)
iv) Vestergaard Asia Pvt. Ltd. v. DCIT [2017] 88 taxmann.com 313 (Delhi-Trib.)
v) ITO v. Intoto Software (India) Pvt. Ltd. [2017] 78 taxmann.com 260 (Hyderabad-Trib.)
vi) Kenexa Technologies Pvt Ltd. v. [2014] 51 taxmann.com 282 (Hyderabad-Trib.)
vii) Sum Total Systems India Pvt. Ltd. v DCIT [2016] 74 taxmann.com 247 (Hyderabad-Trib.) It is thus prayed that, following binding precedent, this Tribunal hold hat provisions for doubtful debts is operating in character and that the same be considered as an expense in computing the PLI.
(c) Share demat expenses: This represents expenditure incurred on conversion of shares into dematerialised form. It is humbly submitted that this is clearly non-operating in nature. It has more to do with the financing of the company than the company's operations themselves. It is more akin to finance costs, which as a matter of routine, are excluded it computing the PLI both by the assessees and the revenue.
(d) Bank charges Bank charges. being in the nature of a finance cost, are to be excluded too.
23. It is thus prayed that the Tribunal hold that the margin is to be computed as the Appellant contends, to arrive at a PLI of 15.41% in respect of CG-VAK.
ICRA TECHNO ANALYTICS LTD.
24. This comparable was selected by the learned TPO and accepted by the learned DRP. The Appellant submits that this comparable deserves to be rejected as it fails even the learned TPO's own related party transactions (RPT) filter, adopted by him at 25%. This is demonstrated below, with two alternative computations both yielding the same result.
(Amounts are in thousands of Rs.)
Amount - Amount -
Particulars of RPT Nature of RPT
Option 1 Option 2
Professional services received Income 32,008 32,008
Interest Income 409 409
Reimbursement of expenses Other Income 6,862 6,862
IT (TP) A No. 1616/Bang/2017
Page 13 of 42
income Income 355 355
Numerator (A) 39,634 39,634
Expenditure 1,867 1,867
Professional services availed
Expenditure 5,281 5,281
Reimbursement of expenses Interest
Expenditure 479 479
Other expenses
Expenditure 71 71
NUMERATOR (B) 7,698 7,698
Operating Revenue (C) 1,80,737 1,80,737
Total Expenses (D) 1,59,007 1,59,007
RPT Percentage (Option 1)
E=A÷C 21.92% N/A
F=B÷D 4.84% N/A
G=E+F 26.76% N/A
RPT Percentage (Option 2)
N/A 26.19%
(H = (A+B) ÷ C)
25. So computed, the RPT percentage exceeds 25%, being the filter adopted by the learned TPO as upheld by the learned DRP. In any event the Appellant contends that the appropriate filter to be applied is 15% and not 25%.
26. The Appellant has applied the 15% filter while the learned TPO has applied a 25% filter. Therefore, it is common ground that an RPT filter is to be applied. The only question concerns the percentage to be considered. Firstly, there is no doubt that the 15% filter is being regularly applied by various benches of the Tribunal. Secondly, on the very question of how to choose between the 25% and the 15% filters, a co-ordinate Bengaluru Bench has held in Dell's case that the question turns on the availability of comparables. It has further held that since there is no dearth of comparables in the software development sector, the stricter 15% filter can be applied. Further, in Siemens BPO's case, a co-ordinate Bengaluru Bench has held that, under normal circumstances, the tolerance level must be 15%. Accordingly, it is submitted that the 15% filter must be applied. In whatever manner the RFT computations are made, ICRA fails the 15% filter.
27. Without prejudice, the Appellant submits that the question of the method of computing the RPT filter was considered at length by a co-ordinate bench of this Tribunal in Nokia s case. The Tribunal held that the percentage of numerator to denominator can be calculated only when the contents of a part of representing the RPT of a particular nature is seen with reference to the contents of whole of that nature. Accordingly, it is submitted that RP expenditure cannot be compared to total turnover, but must instead by total expenditure.
L&T INFOTECH LTD.
28. This comparable was selected by the learned IPO and upheld by the learned DRP. The Appellant submits that this comparable is to be rejected on the following two grounds.
(a) Brand Value,: The second page (numbered S-623) of L&T Infotech's director's report throws light on that company's IT (TP) A No. 1616/Bang/2017 Page 14 of 42 substantial brand value. Further, on the third page (S-624), the long list of awards and recognitions earned by that company further evidence the strength of its brand.
(b) Functionally Different: The segment reporting information at p. S-653 of the annual report shows the multifarious nature of this comparable's operations. It has been held by a co-ordinate Bengaluru Bench in Cisco Systems (India) Pvt. Ltd. v. DCIT [2014] 50 texmann.com 280 (Bangalore-Trib.) that L&T Infotech, being a global IT services and solutions provider, cannot be compared to a captive software development service provider.
(c) High Turnover: L&T Infotech has a turnover of X3,613.42 crore. This is more than 18 times the Appellant's turnover. In the following cases, co-ordinate Benches of this Honourable Tribunal have held that a turnover filter of one-tenth the turnover of the tested company up to ten times its turnover is appropriate.
i) ABB Industrial IT Development Centre Ltd. v. ACIT [2017] 83 taxmann.com 122 (Bangalore)
ii) AOL Online India Pvt. Ltd. v. DCIT [2016] 68 taxmann.com 235 (Bangalore)
iii) DCIT v. Sunquest Information Systems (India) Pvt. Ltd. [2016] 70 taxmann.com 273 (Bangalore)
iv) Lam Research (India) (P.) Ltd. v Dy. CIT [IT Appeal Nos.1437 & 1385 (Bang.) of 2014. dated 30-4-2015] (para 9) MINDTREE LTD. (SEGMENT)
29. This comparable was selected by the learned TPO and accepted by the learned DRP.
30. The Appellant submits that this comparable ought to be rejected as it is functionally different from the Appellant. This is evidenced by the following statements in Mindtree's annual report.
(a) Operations (page 28): "With delivery centers in India and overseas, we offer IT strategy consulting, application development and maintenance, data warehousing and business intelligence, package implementation, product architecture, design and engineering, embedded software, technical support, testing, infrastructure management services etc., to our customers."
(b) Substantial Research & Development (page 34): Paragraph C in the annexures to the Director's Report deals with "Technology and Innovation" and brings out the substantive and substantial nature of the company's R&D. There are two categories of laboratories set up by it, PES and ESP labs.
(c) Substantial Intellectual Property (page 35): In paragraph C(c) of the said annexures, there is a long list of patents which Mindtree IT (TP) A No. 1616/Bang/2017 Page 15 of 42 holds. This makes it clear that the operations of Mindtree extend much beyond just software development.
(d) Wide Range of Operations page 57) and Lack of Information from Segment Reporting (page 58):
i) The learned TPO has taken figures from the "IT services"
segment of Mindtree. Page 58 of the Annual Report shows two segments "IT services" and 'Product Engineering Servies (PES)''.
ii) The graphs on page 57 of the annual report show the distribution of Mindtree's revenue across service lines.
iii) On this graph, development represents only 25% of Mindtree's revenue. It is not clear whether this 'development" includes product development (i.e., development of products for its own exploitation and sale) or software development (i.e., development of software at the instructions of its customers where the intellectual property would eventually vest in such customers) or both.
iv) In the Appellant s case, software development falls in the latter of these categories. Even if the whole of Mindtree's 25% of development revenue was considered to be software development of the kind comparable with the Appellant, it is impossible to determine how much of the "IT Services" segment of Mindtree actually constitutes software development. Thus the information used by the TPO is unreliable.
v) Further, from the graphs on page 57. it emerges that as much as 22% of Mindtree's revenue is from maintenance. Maintenance would certainly be in the nature of "IT Services" and not "PES".
Thus, the ''IT Services" segment itself is heterogenous and not functionally comparable to the Appellant's homogenous software development activities.
vi) Further, in the segmental information at page 90 (identical to the segmental information at page 58) shows that IT Services Constitutes about 69.47% of Mindtree's revenue, but as seen above, development is only about 25% while maintenance is itself 22%. Thus it is clear that the segment "IT Services" is a heterogenous, multi-faceted and composite mixture of various kinds of activities.
vii) In the paragraph above the segment table on page 58/90, the company itself has stated that as segmental assets are used interchangeably between segments, meaningful disclosures in that regard are not possible.
viii) From all this, it is clear that Mindtree's operations are an indivisible blend of a variety of verticals, rendering any information IT (TP) A No. 1616/Bang/2017 Page 16 of 42 on specific aspects of its operations unreliable, being merely and conjectures.
(e) Product Company: Page 3 of its annual report shows that it offers a wide variety of products such as Match, MindTest etc. Thus, since Mindtree's IT Services includes maintenance, consulting. package implementation, etc., it is evident that these services are inextricably linked to their products.
(f) Brand: Page 5 of its annual report shows that a process of brand transformation was undertaken evidencing the existence of substantial brand value. Page 30 contains an analysis of its brand identity. Mentions of the comparable's brand are also to be found at pp. 10 and 28.
31. The above averments as regards the classification of Mindtree's segments also evidences that the information available from Mindtree's annual report as regards its software development operations (if any) is scanty and incomplete. This itself vitiates its reliability as a comparable.
PERSISTENT SYSTEMS
32. This comparable has been selected by the learned TPO and upheld by the learned DRP. The Appellant submits that this comparable ought to be rejected on the grounds that:
(a) The comparable is functionally different from the Appellant; and
(b) The comparable fails the related party transaction (RPT) filter set by the Appellant.
33. RPT Filter The Appellant submits that it fails the 15% RPT filter. By the TPO's own computation, the RPTs of Persistent is 19.62%, thus failing the filter. It has already been submitted above that a co-ordinate Bengaluru Bench of this Honourable Tribunal has held that in the software sector, since there is no dearth of comparables, the stricter 15% RPT filter is to be applied in preference to the more lenient 25% filter. It has also been shown above that various coordinate benches have shown a preference to the 15% filter in recent times.
34. Functionality
(a) Page 4 of the annual report shows that the company is in many lines of businesses such as product engineering, technology consulting, strategic partnership to build platforms, and 1P-led business. The activities are thus wide and multifarious.
(b) Page 19, 27 and 31 of the annual report show a focus on IP-led business and the acquisition of IP during the year.
IT (TP) A No. 1616/Bang/2017 Page 17 of 42
(c) Acquisitions: Page 27 shows
(d) The nature of Persistent's services is different too. Page 21 of the annual report shows the nature of services as being cloud computing, analytics. social enterprise and enterprise mobility.
(e) R&D: Pages 21 and 28 show that Persistent has an in-house research lab recognised by the Department of Scientific and Industrial Research (DSIR), Government of India.
35. Without prejudice, the learned TPO and the learned DRP have wrongly treated provision for doubtful debts as being non- operating in nature. If this is treated as operating, the margin will come to 27% as opposed to the 28.27% determined by him. Detailed arguments have been advanced in this respect in relation to the comparable CG-VAK.
OTHER ISSUES TDS ON COMMISSION
36. The Appellant paid commission of Rs. 4,34,72,134 to parties based abroad and having no permanent establishment (PE) in India for services rendered by them abroad. No tax was deducted at source.
The entire amount of Rs.4.34,72,134/- has beer disallowed under section 40(a)(i) on the ground that export commission is not exempt under the Act.
37. The DRP noted the factual position that the agents rendered services and solicited orders outside India and the commission was also remitted abroad. It, however, upheld the disallowance on the reasoning that as the order is executed by the assessee in India the right to receive the commission also arose in India. TDS under section 195 was applicable.
38. The Appellant submits that this reasoning is incorrect as the execution of the orders by the Appellant determines the situs of the source of the Appellant's income arid not that of the overseas commission agent.
39. The Appellant relies on the following precedents.
(a) CIT vs. Faizman Shoes (P) Limited [2014] 367 ITR 155 (Madras) where, on identical facts, the court held that TDS is not deductible.
(b) Zanav Home Collection vs. JCIT [2015] 55 Taxman.com 200 (Bangalore - Trib)
(c) Balmer Lawrie and Co. Limited vs. ITO [2016] 68 Taman.com 384 (Kolkata Trib)
(d) DCIT vs. SRM Agro Foods [2016] 75 Taxman.com 210 (Mumbai- Trib)
40. The learned AO erred it not giving the Appellant credit for set off IT (TP) A No. 1616/Bang/2017 Page 18 of 42 of taxes paid by the Appellant in foreign jurisdiction amounting to Rs. 1,18,23,711."
5. In the course of hearing before us, the ld. AR of assessee has submitted a big chart containing assessee's arguments in respect of assessee's claim regarding inclusion / exclusion of some comparables and it was submitted by ld. AR of assessee that appeal of the assessee may be decided on the basis of synopsis of the assessee's arguments and the big chart in respect of inclusion / exclusion of various comparables. The ld. DR of revenue supported the final assessment order and the order of DRP.
6. We have considered the rival submissions. We find that as per the synopsis of arguments filed by ld. AR of assessee and reproduced above, in transfer pricing issues, one matter to be decided is regarding negative working capital adjustment done by the AO and the second TP issue is regarding the assessee's claim for risk and other adjustments. In addition to this, the assessee is requesting for inclusion of one comparable i.e. R Systems International Ltd. (segment) and exclusion of five comparables i.e. 1) CG-VAK Software and Exports Ltd., 2) ICRA Techno Analytics Ltd., 3) L&T Infotech Ltd.,
4) Mindtree Ltd. (segment) and 5) Persistent Systems. In addition to TP issues, there is one issue on corporate taxation i.e. TDS on commission. We decide this appeal by deciding various issues one by one.
7. We first examine and decide the issue in respect of negative working capital adjustment. In this regard, this is the submission of the assessee that 99.83% of the assessee's share capital is held by Lifetree Cyberworks Pvt. Ltd., the assessee's holding company and TecnotreeOyj, Finland, the assessee's ultimate holding company and thus, the assessee does not have any working capital risk at all. This is also the assessee's submission that a substantial portion of the assessee's working capital arises out of transactions with its related parties and in support of this contention, it was submitted that out of total trade receivables of Rs. 163.35 Crores as on 31.03.2013, more than 77% i.e. Rs. 126,40,42,576/- is receivable from its holding and subsidiary companies and this is the claim of the assessee that this factual position reinforces the IT (TP) A No. 1616/Bang/2017 Page 19 of 42 proposition that the assessee bears no working capital risk. The assessee has placed reliance on several Tribunal orders as noted in para 4 of the synopsis of the assessee's arguments reproduced above and therefore, we have to consider and examine the applicability of these judgments. The first Tribunal order on which reliance is placed is the Tribunal order of Hyderabad Bench of the Tribunal rendered in the case of Adaptec (India) Pvt. Ltd. vs. ACIT as reported in [2015] 57 taxmann.com 307. Copy of this Tribunal order is available on pages 275 to 286 of compilation of case laws and in particular, our attention was drawn to paras 10 & 11 of this Tribunal order available on page nos. 285 and 286 of paper book. Hence, for the sake of ready reference, these paras are reproduced hereinbelow. The same are as under.
"10. Ground No.8 pertains to the issue of negative working capital. As briefly stated above, after arriving at the arithmetic mean of all comparables at 22.03%, the A.O. worked out negative working capital adjustment of 3.22% thereby, making arms length price at 25.25%. Even though, DRP refused to interfere with the objections of the assessee in its order, we were informed that DRP has directed the TPO/A.O. not to make any negative working capital adjustment in some of the cases in the next assessment year, in the cases of Market Tools Research P. Ltd., and Mega Systems Worldwide India P. Ltd., assessee placed on record copies of orders of DRP. In that DRP considered the issue and directed the TPO as under :
"14. Ground No.11 : Negative Working Capital adjustment - Making a negative working capital adjustment without appreciating the fact that the company does not bear any working capital risks. On this issue, the assessee submitted as under :
"The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the differences in working capital between the assessee and the companies considered as comparables. The assessee does not agree with the learned TPO as :
• The company does not bear any working capital risk since it is been fully funded by it's A.E. from its inception and has no working capital contingencies.
• The company has never taken any loans till date from the date of incorporation nor has incurred any expense for meeting the working capital requirement."
We have gone through the submissions and the order of the TPO. The assessee pleaded that the DRP has acceded such a plea in some other IT (TP) A No. 1616/Bang/2017 Page 20 of 42 case. On examination, we find that the DRP, Hyderabad in the case of Cordys Software India P. ltd., for A.Y. 2008-09 in its directions dated 03.08.2012 has given a finding as under :
"7.7. 4 Thus, working capital adjustment is made for the time value of money lost when credit time is provided to the customers. The applicant is not an entrepreneur but a captive service provider. Its entire funding needs are provided by the A.E. This being so, the applicant does not stand to lose anything as it is compensated on a total cost plus basis. The TPO probably was carried away by the large amount of receivables appearing in the books of the applicant. But the applicant is running its business without any working capital risk while comparable companies have such a risk for them. If at all any working capital adjustment is to be made to t his situation, only a positive adjustment has to be made to the comparables so that they are brought on par with the applicant. In view of the same, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made."
In view of the above, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made."
11. In view of the above, we are of the opinion that assessee's case being similar, there is no need for making any negative working capital adjustment when assessee does not carry any working capital risk. In fact, TPO should have done necessary working capital adjustment to the profits of the selected comparables so as to make them comparable to the assessee. In view of this, we direct the TPO not to make negative working capital adjustment."
8. From the above paras reproduced from this Tribunal order, it is seen that in that case, the Tribunal has reproduced the relevant para of the directions of DRP in a different case i.e. Market Tools Research P. Ltd. and Mega Systems Worldwide India P. Ltd. We find that in these paras of these directions of DRP, this is the basis of decision of DRP that assessee company does not bear any working capital risk since it has been fully funded by it's A.E. from its inception and has no working capital contingencies and the company has never taken any loans till date from the date of incorporation nor has incurred any expense for meeting the working capital requirement. In that case, the DRP has examined the direction of DRP, Hyderabad in some other case i.e. Cordys Software India P. Ltd. for Assessment Year 2008-09 dated 03.08.2012 and the direction in that case are also reproduced and as per the same, it is held by DRP in that case that working capital adjustment is made for the time IT (TP) A No. 1616/Bang/2017 Page 21 of 42 value of money lost when credit time is provided to the customers. In our considered opinion, this very basis adopted by DRP in those cases that working capital adjustment made is for the time value of money lost when credit time is provided to the customers is incorrect because in TP analysis, comparison is made of operating profit margin i.e. profit before interest and therefore, interest cost has no relevance for TP analysis. In fact, the working capital adjustment is made for this reason that if the sale is made on the terms of cash payment to one customer and to second customer the sale is made with the payment terms of one month outstanding and to third customer with payment terms of two months outstanding then the prices charged to the first customer having cash payment terms will be minimum and the prices charged for the second customer with the payment terms of one month credit will be more as compared to the prices charged to first customer and the prices charged to the third customer with the payment terms of two months credit will be more than the prices charged to the first customer also. Similar is the situation for creditors because if the assessee makes payment to its suppliers on cash basis, the assessee will get least price and if the assessee is making payment after one or two months then the prices charged to the assessee by the supplier will be extra. Such extra pricing depending on the payment terms is not for this reason that the supplier is making payment of interest because even if a supplier has its own money and has no interest burden then also he will charge extra if the payment terms is for two months credit as against payment terms of one month credit and payment terms of cash payment i.e. immediately on supply. Hence it is seen that the very basis adopted by DRP in those cases is wrong and the Tribunal has simply decided the issue on this basis that since the assessee does not carry any working capital risk, negative working capital adjustment is not called for. At this juncture, we feel it proper to reproduce the relevant Para from the order of TPO in the present case from page 31 of the order of TPO being Para 12.1 which reads as under.
"12.1 NEGATIVE WORKING CAPITAL ADJUSTMENT A question that few ITAT benches have deliberated over lately pertains to whether negative working capital adjustment should be given. Most ITATs have equivocated that positive working capital adjustment should be made on the comparables' margin. The adjusted margin is [PLI-WCA]. Hence positive WCA reduces the mean margin IT (TP) A No. 1616/Bang/2017 Page 22 of 42 of comparables, whereas negative WCA increases the mean margin of comparables. In the case of Adaptec (India) Private Limited (ITA.No. 206/Hyd/2014), the assesse argued in ITAT that it is a captive service provider and does not bear any working capital risk. Hon'ble ITAT ruled that negative working capital adjustment should not be made. This has been followed by few other judgments.
On analysis, it is seen that the case was not properly represented in front of Hon'ble ITAT. Risk and Value are different concepts. Working Capital Adjustment is given on the time value of working capital. Working capital position affects the pricing of any service in open market.* WCA basically calculates the difference in pricing of comparable and taxpayer. Whether positive or negative does not matter. WCA is done on each comparable, and it will be seen that for some comparables, WCA is positive while for others, WCA is negative. The end impact of WCA is that it increases comparability. The purpose of WCA is not to benefit the assessee, but to increase comparability and be just.
Working capital risk is a different concept. It is part of many risks that companies face. For a captive service provider, systematic risk is lower than comparables whereas unsystematic risk is higher than comparables. Working capital risk is one of the many risks. To account for working capital risk, the appropriate adjustment is risk adjustment. It cannot be confused with Working Capital Adjustment.
In the present case, net working capital adjustment is negative. WCA has increased comparability, and hence is justifiable."
* Emphasis supplied.
9. From the above Para from the order of TPO, it is seen that as per the TPO in the present case, working capital position affects the pricing of any service in open market as discussed above. The TPO also held that whether positive or negative working capital difference is not material and the purpose of the working capital adjustment is this that it increases comparability and the purpose of working capital adjustment is not to benefit the assessee but to increase comparability and be just. In our considered opinion, working capital risk and whether there is interest burden or not are not relevant factors for deciding working capital adjustment because in our considered opinion, working capital adjustment is done because working capital position affects the pricing of any service or goods in the open market. Since this aspect has not been considered by Tribunal in that case, in our considered opinion, this Tribunal order is not binding precedence for the purpose of deciding this aspect that working capital position affects the pricing of any service or goods in the open market because in the present case, this is the objection of the IT (TP) A No. 1616/Bang/2017 Page 23 of 42 TPO as per relevant paras reproduced above and this aspect is not discussed and decided by Tribunal in this case.
10. Now we examine the applicability of the second Tribunal order on which reliance is placed and this Tribunal order is rendered in the case of Lam Research (India) Pvt. Ltd. Vs. DCIT (supra), copy of this Tribunal order has not been provided by the assessee in the compilation of case laws and no citation is also provided and this is not a reported Tribunal order and therefore, we cannot examine and consider the applicability of this Tribunal order and hence, we hold that this Tribunal order is not applicable in the present case.
11. The third Tribunal order on which reliance is placed is the Tribunal order rendered in the case of CAPCO IT Services India Pvt. Ltd. Vs. ITO (supra), copy available on pages 287 to 295 of case law compilation and it was pointed out before us that paras 13 to 17 of this Tribunal order are relevant and the same are available on page no. 294 of paper book. These paras from this Tribunal order are reproduced hereinbelow.
"13. It was further submitted that for the purpose of the Economic Analysis, the cost plus mark-up of the Appellant is compared against that of uncontrolled companies engaged in similar services and that such independent comparable uncontrolled companies, who operate under uncontrolled conditions, bear risk during the course of its operations including market risk, research and development risk, technology risk credit risk, currency fluctuation risk, liquidity risk, default risk etc. As a result, the resultant profitability of such comparable uncontrolled companies is directly related to the level of risk borne, which is not so it the case of a captive service provider similar to the Appellant as it assumes minimal risks and being an entity with a fixed mark-up on the cost earn steady return year on year.
14. We heard both parties relying on the following Tribunal judgments, wherein comparability economic adjustments are also mandated by the Tribunal.
• Sony India (P.) Ltd v. Dy. CIT [2008] 114 ITD 448 (Delhi) • E-Gain Communication (P) Ltd v. ITO [2009] 118 ITD 243/[2008] 23 SOT 385 (Pune) • Mentor Ruling • Motorola Solutions India (P) Ltd v. Asstt. CIT [2014] 48 taxmann.com 248/[2015] 152 ITD 158 (Delhi - Trib.) IT (TP) A No. 1616/Bang/2017 Page 24 of 42
15. Further, in addition to the above rulings, the principle has also been upheld by the recent High Court ruling the case of Chryscapital Investment Advisors (India) (P) Ltd. v. Dy. CIT [2015] 376 ITR 183/232 Taxman 20/56 taxmann.com 417 (Delhi), wherein the Hon'ble Court has held that appropriate adjustments should be carried out in situations where there are differences between the tested parties and comparables and in case such differences perceptible in the comparables cannot be eliminated on account of adjustments or otherwise, then such comparables have to be rejected.
16. We direct the TPO to work out appropriate risk adjustment.
17. The learned AO/DRP erred in not providing appropriate working capital adjustment The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the differences in working capital between the assessee and the companies considered as comparables.
It is submitted that working capital adjustment is made for the time value of money lost when credit time is provided to the customers. It was submitted that the assessee is not an entrepreneur but a captive service provider and its entire funding needs are provided by the A.E. This being so, the assessee does not static to lose anything as it is compensated on a total cost plus basis. It was further submitted that the assessee is running its business without any working capital adjustment is to be made to this situation, only a positive adjustment has to be made to the comparables so that they are brought on par with the assessee."
12. We find that in this case also, the decision of Tribunal is on this basis that working capital adjustment is made for the time value of money lost when credit time is provided to the customers and there is no decision in this case also on this aspect that working capital position affects the pricing of any service or goods in open market as the case made out by TPO in the present case as per Para 12.1 of TPO's order reproduced hereinabove. Hence we hold that in the present case, this tribunal order is also not applicable.
13. Now we examine the applicability of the fourth Tribunal order on which reliance is placed having been rendered in the case of ITO Vs. Intoto Software (India) Pvt. Ltd. (supra), copy available on pages 61 to 73 of case law IT (TP) A No. 1616/Bang/2017 Page 25 of 42 compilation and it was pointed out before us that Para 14 on pages 71 and 72 are relevant and hence, the same is reproduced hereinbelow.
"14. Ground No.14 is raised as an additional ground stating that TPO/DRP has erred in making a negative working capital adjustment of (-)0.61% while computing the adjustment u/s. 92CA. It was the submission that negative working capital adjustment was not allowed in various decisions and relied on the decision of Adaptec (India) P. Ltd., Vs. ACIT in ITA No. 206/Hyd/2014, dt. 25- 03-2015, in the above referred case.
"10. Ground No.8 pertains to the issue of negative working capital. As briefly stated above, after arriving at the arithmetic mean of all comparables at 22.03%, the A.O. worked out negative working capital adjustment of 3.22% thereby, making arms length price at 25.25%. Even though, DRP refused to interfere with the objections of the assessee in its order, we were informed that DRP has directed the TPO/A.O. not to make any negative working capital adjustment in some of the cases in the next assessment year, in the cases of Market Tools Research P. Ltd., and Mega Systems Worldwide India P. Ltd., assessee placed on record copies of orders of DRP. In that DRP considered the issue and directed the TPO as under :
"14. Ground No.11 : Negative Working Capital adjustment - Making a negative working capital adjustment without appreciating the fact that the company does not bear any working capital risks. On this issue, the assessee submitted as under :
"The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the differences in working capital between the assessee and the companies considered as comparables. The assessee does not agree with the learned TPO as :
• The company does not bear any working capital risk since it is been fully funded by it's A.E. from its inception and has no working capital contingencies.
• The company has never taken any loans till date from the date of incorporation nor has incurred any expense for meeting the working capital requirement."
We have gone through the submissions and the order of the TPO. The assessee pleaded that the DRP has acceded such a plea in some other case. On examination, we find that the DRP, Hyderabad in the case of Cordys Software India P. ltd., for A.Y. 2008-09 in its directions dated 03.08.2012 has given a finding as under :
IT (TP) A No. 1616/Bang/2017 Page 26 of 42 "7.7. 4 Thus, working capital adjustment is made for the time value of money lost when credit time is provided to the customers. The applicant is not an entrepreneur but a captive service provider. Its entire funding needs are provided by the A.E. This being so, the applicant does not stand to lose anything as it is compensated on a total cost plus basis. The TPO probably was carried away by the large amount of receivables appearing in the books of the applicant. But the applicant is running its business without any working capital risk while comparable companies have such a risk for them. If at all any working capital adjustment is to be made to this situation, only a positive adjustment has to be made to the comparables so that they are brought on par with the applicant. In view of the same, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made."
In view of the above, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made."
11. In view of the above, we are of the opinion that assessee's case being similar, there is no need for making any negative working capital adjustment when assessee does not carry any working capital risk. In fact, TPO should have done necessary working capital adjustment to the profits of the selected comparables so as to make them comparable to the 21 ITA.No.206/Hyd/2014 Adaptec (India) P. Ltd., Hyderabad. assessee. In view of this, we direct the TPO not to make negative working capital adjustment"."
14. From the above Paras reproduced from this Tribunal order, it is seen that in this case also, the decision is on the basis of Tribunal order rendered in the case of Adaptec (India) Pvt. Ltd. vs. ACIT (supra). As we have already seen that the tribunal order rendered in the case of Adaptec (India) Pvt. Ltd. Vs. ACIT (supra) is not applicable in the present case because it was found that in that case, the Tribunal decision is not on this aspect that working capital position affects the pricing of any services or goods in open market as the case made out by the TPO in the present case. Hence we hold that this Tribunal order is also not relevant in the present case.
15. The last Tribunal order on which reliance is placed is the Tribunal order rendered in the case of TNS India Pvt. Ltd. Vs. ACIT (supra), copy available on pages 296 to 310 of case law compilationand before us, it was pointed out that para 8.1 on page nos. 298 & 299 is relevant and hence, we reproduce IT (TP) A No. 1616/Bang/2017 Page 27 of 42 para 8.1 from pages 298 & 299 of the compilation of case laws. The same is as under.
"8.1. This ground pertains to incorrect computation of working capital adjustment. It was submitted that working capital adjustment was wrongly considered by considering the total receivables and arrivals including third party transactions and making a negative working capital adjustment. AO/TPO is directed to examine this issue and work out the working capital adjustment afresh, as certain comparable companies are being considered separately. In case the working capital adjustment comes negative, AO/TPO is directed not to make any negative working capital adjustment as the same is not approved in various Co-ordinate Bench decisions. The Co-ordinate Bench of ITAT in the case of Adaptec (India) P. Ltd., Vs. ACIT in ITA. No. 206/Hyd/2014 (AY 2009-10) dt. 25-03-2015, has decided the issue of negative working capital as under:
"10. Ground No.8 pertains to the issue of negative working capital. As briefly stated above, after arriving at the arithmetic mean of all comparables at 22.03%, the A.O. worked out negative working capital adjustment of 3.22% thereby, making arms length price at 25.25%. Even though, DRP refused to interfere with the objections of the assessee in its order, we were informed that DRP has directed the TPO/A.O. not to make any negative working capital adjustment in some of the cases in the next assessment year, in the cases of Market Tools Research P. Ltd., and Mega Systems Worldwide India P. Ltd., assessee placed on record copies of orders of DRP. In that DRP considered the issue and directed the TPO as under :
"14. Ground No.11 : Negative Working Capital adjustment - Making a negative working capital adjustment without appreciating the fact that the company does not bear any working capital risks. On this issue, the assessee submitted as under :
"The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the differences in working capital between the assessee and the companies considered as comparables. The assessee does not agree with the learned TPO as :
• The company does not bear any working capital risk since it is been fully funded by it's A.E. from its inception and has no working capital contingencies.
• The company has never taken any loans till date from the date of incorporation nor has incurred any expense for meeting the working capital requirement."
We have gone through the submissions and the order of the TPO. The assessee pleaded that the DRP has acceded such a plea in some other IT (TP) A No. 1616/Bang/2017 Page 28 of 42 case. On examination, we find that the DRP, Hyderabad in the case of Cordys Software India P. ltd., for A.Y. 2008-09 in its directions dated 03.08.2012 has given a finding as under :
"7.7. 4 Thus, working capital adjustment is made for the time value of money lost when credit time is provided to the customers. The applicant is not an entrepreneur but a captive service provider. Its entire funding needs are provided by the A.E. This being so, the applicant does not stand to lose anything as it is compensated on a total cost plus basis. The TPO probably was carried away by the large amount of receivables appearing in the books of the applicant. But the applicant is running its business without any working capital risk while comparable companies have such a risk for them. If at all any working capital adjustment is to be made to t his situation, only a positive adjustment has to be made to the comparables so that they are brought on par with the applicant. In view of the same, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made."
In view of the above, the Panel directs that negative working capital adjustment to the arithmetic mean margin of the comparables shall not be made."
11. In view of the above, we are of the opinion that assessee's case being similar, there is no need for making any negative working capital adjustment when assessee does not carry any working capital risk. In fact, TPO should have done necessary working capital adjustment to the profits of the selected comparables so as to make them comparable to the assessee. In view of this, we direct the TPO not to make negative working capital adjustment"."
16. From the above paras, we find that in this case also, the issue is decided by Tribunal by following Tribunal order rendered in the case of Adaptec (India) Pvt. Ltd. Vs. ACIT (supra) and we have already seen that this Tribunal order is not relevant in the present for the reasons mentioned above and therefore, we hold that this Tribunal order is also not applicable in the present case. We also find that in para 5 of the synopsis of arguments reproduced above, this is the submission of the assessee that the basis of the working capital adjustment is the existence of a difference in the cost of working capital and it is also stated that this is relevant because the cost is stated to affect the margin and in the assessee's case, the assessee has demonstrated that it holds its working capital at no cost, completely out of its own funds without any borrowings at all. In our considered opinion, these factors are not relevant for IT (TP) A No. 1616/Bang/2017 Page 29 of 42 working capital adjustment because in TP analysis, operating profit is considered which is profit before interest and therefore, the interest cost has no relevance for TP analysis and the working capital adjustment is for this reason that working capital position affects the pricing of any services or goods in the open market and not because the working capital cost increases or decreases the profit margin. Hence we find no merit in this claim of the assessee and accordingly this issue is decided against the assessee.
17. Now we decide the assessee's claim regarding risk and other adjustments. We first reproduce Para no. 13 available on page nos. 31 & 32 of TPO order. The same is as under.
"13. RISK ADJUSTMENT:
Risk adjustment involves two vital preconditions. They are that difference in risk level exists between the tested party and the uncontrolled comparables; and that it is. possible to calculate in terms of numbers the differences in risk so that adjustment can be made. But in case of the taxpayer, both the prerequisites are missing. Neither the difference in risk level of the tested party and uncontrolled comparables has been established nor is it possible to convert the difference in risk level, if there is any, into numbers. If there is any difference, for a moment academically speaking, it. rests in the realm of quality and not quantity. There is no reliable method to convert the qualitative difference into quantitative difference and to make adjustment on account of risk level. As per the provisions of Rule 10B (3), if any adjustment should be made, it should be reasonably accurate to eliminate the material effects of such differences. But in case of risk adjustment, neither reasonably accurate adjustment can be made for want of method to do so nor has it been established that there is a material effect that is affecting the comparisons due to risk level. If the taxpayer is suggesting that there exists a difference in the risk level assumed by the tested party and uncontrolled comparables, it is academic in nature and not based on any study whose results has been validated.
Further, it is not out of place to reiterate that single customer risk is a huge risk which the uncontrolled comparables are not assuming. By having more customers, the risk is shared or spread. In other words, if one customer goes out of business still there are others which will sustain the business of the tested party. But in case of the taxpayer there being only one client, the entire risk is concentrated on one client, and therefore, if the client is out of business the taxpayer will also be out of business.
Moreover, the proviso to Sec. 92C (2) of the Act provides for adopting arithmetical mean of the different prices. This provision neutralizes the effect of difference in the risk profile, if any between the tax payer IT (TP) A No. 1616/Bang/2017 Page 30 of 42 and the comparables as realized risk may pull down the profitability below the risk free return. This stand is supported by the decision of the Hon'ble ITAT Bangalore bench in the case of M/s SAP Labs India (P.) Ltd. [2012] 17 taxmann.com 16 (Bang.) and M/s Meritor LVS India Pvt. Ltd. [2015] 64 taxmann.com 136 (Bangalore - Trib.) and also by the Hon'ble ITAT, Mumbai bench in the case of M/s. Symantec Software Solutions Pvt. Ltd. Vs ACIT (2011) 46 SOT 48 (Mumbai). Based on the above discussions, no risk adjustment is allowed."
18. We also reproduce Para no. 10 available on page no. 13 of DRP directions.
"10.0 Objection no 12 The Ld. TPO erred in not allowing appropriate adjustments on account of difference in functional, risk and operational profile. The Ld. AO erred in upholding the actions of the TPO.
10.1 In relation to the above objection, at the time of hearings before this Panel, the assessee submitted that it needs to be allowed a risk adjustment as it is a non-risk bearing entity. The submissions of the assessee have duly been considered. The assessee relied on various decisions of 1TAT to argue that such adjustment needs to be allowed to it. The issue has been discussed in detail by the TPO in para 13 of his order. During the proceedings before this Panel the assessee was asked to give detailed working of the risk adjustment it was seeking and the basis thereof. However, as discussed supra, the assessee just sought an adhoc adjustment on this account. The assessee argued that it can be provided such adjustment on basis of various decisions of IAT. Such a claim of the assessee does not have any scientific backing. The claim of the assessee is only a theoretical one. Further, from the financials of the assessee it is noted that the assessee is not a 100% export entity but it is operating in the domestic market also and thus is subject to normal risks in relation to revenue from such source. The TPO has rightly pointed out that if the assessee is subject to 'single customer risk', the same in itself is huge and the comparables are not bearing such a risk. Mumbai ITAT in the case of Symantec Software Solutions (P.) Ltd. v Asstt. CIT [2011] 216 SOT 48/11 taxmann.com 264 for AY 2006-07, held that (para 16) -
"As regards the difference in function and risk level adjustment; the assessee has raised this issue without quantification of such adjustment on this account. Even otherwise until and unless such difference results in deflation or inflation of financial result of the comparables, it is not general rule of standard adjustment. The assessee has not brought on record how such functional difference and risk has influenced the result of the comparables with quantified data to the satisfaction of the authorities. The assessee did not quantify the alleged adjustments on account of difference in risk. However, the assessee, first time filed certain calculation before the DRP in support of its claim. The said calculation is also not on the basis of any formula or principle rather it is general in IT (TP) A No. 1616/Bang/2017 Page 31 of 42 nature. In our opinion, second proviso to sub.sec. 2 of sec. 92C cover and take care of these aspects. Since it is impossible to have a perfect comparable without any difference or variation regarding turnover risk profile and functional differences; therefore, the legislature has provided a margin of + 5% while determining the ALP. Therefore, when the assessee is having benefit of choice/option as per the said provision as existed at the relevant point of time, no separate adjustment is required on account of risk and functional differences. Therefore, we do not find any merit and substance in the claim of the assessee for adjustment in respect of risk and functional differences.
10.2 In view of the decision in the case of Symantec Software Solutions (P.) Ltd. v. Asstt. (supra), no separate adjustment is required on account of risk functional difference. Further, the assessee has not provided any detailed working of the adjustment it was seeking. So in view of the decision of the Hon'ble ITAT Bangalore in Zyme Solutions AY 2010-11 in I.T(TP).A No. 465/ Bang/2015 order dt 22.01.2016, no such adjustment can now be provided to the assessee. That Risk Adjustment cannot not be granted as a general rule was also upheld in CDC Software India Pvt Ltd [TS- 839-ITAT-2016(Bang)-TP] and Stryker Global Technology Centre Pvt Ltd [TS-450-ITAT-2015(DEL)-TP] Assessee has failed to give any justification for non-application of this adjustment in its transfer pricing study. The assessese has not brought on record how lack of this adjustment has influenced the result of the comparables with quantified data. Second proviso to sec 92C (2) also covers and take care of these aspects. Since it is impossible to have a perfect comparable without any differences, the legislature has provided a margin of +/- 3% while determining ALP. Further, in following cases this was held that the margin of +/- 5 % (now 3%) takes care of the risk difference:
Symantec Software Solutions (P.) Ltd [2011] 11 taxmann.com 264 (Mumbai) Followed in SAP Labs India (P.) Ltd. [2012] 17 taxmann.com 16 (Bang.) Aptara Technologies Pvt Ltd [TS-309-1TAT-2016(PUN)-TP] 10.3 Considering above, the objection of the assessee is not accepted."
19. From the above Para no. 10 reproduced from the directions of DRP, it is seen that this is the basis of DRP directions that as per the Tribunal order rendered in the case of Symantec Software Solutions (P.) Ltd. Vs. ACIT (supra) in which the issue was decided against the assessee on this basis that the assessee did not quantify the alleged adjustments on account of difference in risk, the assessee, first time filed certain calculation before the DRP in support of its IT (TP) A No. 1616/Bang/2017 Page 32 of 42 claim and although the same calculation is also not on the basis of any formula or principle rather it is general in nature.This finding is also given by DRP that the DRP asked the assessee to give detailed working of the risk adjustment which the assessee was seeking and the basis thereof. But the assessee just sought of adhoc adjustments on this account based on various Tribunal decisions. The DRP has given a categorical finding that the assessee does not have any scientific backing and the assessee's claim is only a theoretical one. As per para 13 of the order of TPO also, a categorical finding has been given by TPO that the assessee has not established the difference in risk level of the tested party and uncontrolled comparables and this is also not established that it is possible to convert the difference in risk level, if there is any, into numbers. He has also given a finding that there is no reliable method to convert the qualitative difference into quantitative difference to make adjustment on account of risk level. The TPO has also referred to Rule 10B (3) of IT Rules which says that if any adjustment should be made, it should be reasonably accurate to eliminate the material effects of such differences. Before us also, as per the synopsis reproduced above, the assessee has pointed out three options for risk adjustment but these are general in nature and the assessee has not established that there is any risk difference between the tested party and the comparables. In the absence of any working having been provided by the assessee showing difference in risk between the tested party and comparables and in the absence of any working regarding the assessee's claim for risk adjustment, we find no reason to interfere in the order of DRP on this issue also. This issue is also decided against the assessee.
20. Now we examine the assessee's claim for inclusion of one comparable i.e. R Systems International Ltd. (segment). On this aspect, it is submitted that this comparable was excluded by the TPO and DRP on this basis that it has a different Financial Year i.e. year ending 31st December as opposed to the assessee's 31st March. Reliance was placed on the judgment of Punjab & Haryana High Court rendered in the case of CIT Vs. Mercer Consulting (India) IT (TP) A No. 1616/Bang/2017 Page 33 of 42 Pvt. Ltd. as reported in [2017] 390 ITR 615. Para nos. 27 to 32 of this judgment are relevant and hence these paras are reproduced hereinbelow.
"27. The Transfer Pricing Officer excluded the case of R. Systems International Limited from the list of comparables. The Income-tax Appellate Tribunal included the same. The Transfer Pricing Officer excluded the case of R. Systems International Limited on the ground that it follows the calendar year, i.e., 1st January to 31st December for maintaining its annual account whereas the accounting year of the assessee is 1st April to 31st March. The Transfer Pricing Officer followed an order passed by the Mumbai Bench of the Tribunal in Asst. CIT v. Hapag Lloyd Global Services P. Ltd. 2013-TII-68- ITATMUM- TP in which it had been held that a company with a dif- ferent financial year ending cannot be compared.
28. We are unable to agree with the decision of the Transfer Pricing Officer and of the Dispute Resolution Panel that affirmed it. The view taken by the Tribunal commends itself to us. It is not the financial year per se that is relevant. Even if the financial years of the assessee and of another enterprise are different, it would make no difference. If it is possible to determine the value of the transactions during the corresponding periods, the purpose of comparables would be served. The question in each case is whether despite the financial years of the assessee and of the other enterprise being different, the financials of the corresponding period of each of them are available. If they are, the Transfer Pricing Officer must refer to the corresponding period of both the entities in determining whether the two are comparable or not for the purpose of determining the arm's length price.
29. As noted by the Tribunal, the audit accounts of R System International Ltd. for the year ending December 31, 2008 had been given under one column and the data for the quarter ending March 31, 2009 and March 31, 2008 (both audited) had been given in two other columns. Thus, as rightly held by the Tribunal, if from the yearly data ending December 31, 2008, the results of the quarter ending March 31, 2008 are excluded and if the results for the quarter ending March 31, 2009 are included, it is possible to obtain the data for the financial year April 1, 2008 to March 31, 2009.
30. This View is not contrary to rule 10B(4) which reads as under :
"10B. (4) The data to be used in analyzing the comparability of any uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into."
31. The Rule does not exclude from consideration the data of an entity merely because its financial year is different from the financial year of the assessee. What the Rule requires is that the data to be used in analyzing the financial results of an uncontrolled transaction with an IT (TP) A No. 1616/Bang/2017 Page 34 of 42 international transaction shall be the data relating to the financial year in which the international transaction has been entered into. Thus so long as the data relating to the financial year is available, it matters not, if the financial year followed is different. In the case before us the data relating to the relevant financial year of R. Systems International Limited is available.
32. We are, therefore, entirely in agreement with the decision of the Tribunal that if the data relating to the financial year in which the international transaction has been entered into is directly available from the annual accounts of that comparable, then it cannot be held as not passing the test of sub-rule (4) of rule 10B."
21. We find that this was held by Hon'ble Punjab & Haryana High Court that if thedata relating to the financial year in which the international transaction has been entered into is directly available from the annual accounts of that comparable, then it cannot be held as not passing the test of sub-rule (4) of rule 10B. In para no. 29 this judgment, it is noted by Hon'ble High Court that it is noted by Tribunal in that case that the audited accounts of R System International Ltd. for the year ending December 31, 2008 had been given under one column and the data for the quarter ending March 31, 2009 and March 31, 2008 (both audited) had been given in two other columns. In the present case, the assessee has submitted annual report of R Systems International for the year ending 31.12.2013 by way of additional evidence containing 1 to 188 pages and we find that the P&L account is available and although statement of P&L account is for year ended 31.12.2013 in the said additional evidence paper book but it is not shown to us that the figures for 31.03.2012 and 31.03.2013 are also available on any page of this additional evidence as has been noted by Punjab & Haryana High Court in that case. But still we feel it proper to restore this matter back to the file of AO/TPO for fresh decision and we order accordingly. The AO/TPO is directed that if the assessee can establish that the figures for Financial Year ending on 31.03.2013 can be worked out from audited accounts of that company then it should be adopted and this comparable should be included in the list of comparables. If the assessee is not in a position to do so, then the TPO may again exclude the same.
IT (TP) A No. 1616/Bang/2017 Page 35 of 42
22. In addition to this, the assessee has also placed reliance on three Tribunal orders as per the synopsis reproduced above. But since, we are deciding the issue by following the judgment of Hon'ble Punjab & Haryana High Court; we feel that those Tribunal orders are not required to be considered separately. Hence on this issue, we restore the matter back to the file of TPO for fresh decision in the light of above discussion in the light of judgment of Hon'ble Punjab & Haryana High Court after providing reasonable opportunity of being heard to assessee.
23. Now we take up the issue in respect of CG-VAK Software and Exports Ltd.
Regarding this comparable, this is the case of the assessee that the assessee does not challenge the selection of this comparable and therefore, does not press the relevant ground. The assessee's case is only to determine the PLI of this company correctly. As per the assessee, the PLI of this company should be adopted at 15.41% as against 20.54% computed by the TPO/AO. In the synopsis reproduced above, the basis of difference in working of the PLI of this comparable is this that the AO has reduced the amount of 39,97,218 being the provision for doubtful debts from the operating and other expenses of this company and in the result, the profit of that company has been increased by AO by this amount resulting in increase of PLI. But as per the assessee, provision for doubtful debts is operating expenses and therefore, it should not be excluded from the operating and other expenses. In support of this contention that provision for doubtful debts is an operating expenditure, reliance has been placed by ld. AR of assessee on various judicial pronouncements as noted in para 22 of synopsis of arguments reproduced above. In our considered opinion, only this aspect is covered by these Tribunal orders that provision for doubtful debts is an operating expenditure but for the purpose of TP analysis, this alone is not enough. Even after holding that provision for doubtful debts is an operating expense, it has to be seen that as to whether the same can be considered as an expenditure for TP analysis. In TP analysis, percentage of profit of the tested party and the comparable is worked out by dividing the profit by the turnover. If a receipt or expenditure is not related to the turnover of the present year being the denominator to work IT (TP) A No. 1616/Bang/2017 Page 36 of 42 out the profit percentage then such receipt or expenditure also cannot be considered to compute the profit percentage of that tested party or comparable being numerator because if we reduce the numerator by the amount of provision for doubtful debts and the denominator is not reduced by the amount of related turnover then the result will be absurd. Hence it has to be found out from the annual report of the concerned company as to whether provision for doubtful debts is in relation to sale of the present year or of an earlier year. As per the annual report of this company available on pages 559 to 608 of paper book, this cannot be ascertained as to whether the provision for doubtful debts is against the turnover of the present year or of an earlier year. Generally the provision for doubtful debts is created in a later year when it is felt that the debt has become bad or doubtful and therefore, in the absence of any categorical reporting in the annual report that the provision for doubtful debts is against the turnover of the present year, it should be considered as provision against the turnover of an earlier year and therefore, the same cannot be considered as operating expenses for the current year in TP analysis. In this view of the matter, we find no infirmity in the order of authorities below on this aspect. Therefore, we decline to interfere in the orders of lower authorities on this aspect and various judgments cited by ld. AR of assessee in the synopsis are not rendering any help to assessee because these judgments are only on this aspect that provision for doubtful debts is an operating expenditure but in our considered opinion, even after accepting this contention that provision for doubtful debts is operating expenditure, the same has to be excluded in TP analysis for the reasons discussed above.
24. Now we examine and decide about the assessee's claim is for exclusion of four comparables i.e. ICRA Techno Analytics Ltd.,L&T Infotech Ltd.,Mindtree Ltd. (segment) andPersistent Systems.
25. Regarding ICRA Techno Analytics Ltd., this is the case of the assessee that RPT% of this company is either 26.76% or 26.19% and since it is more than 25%, this comparable should be excluded because of RPT filter of 25% IT (TP) A No. 1616/Bang/2017 Page 37 of 42 adopted by the TPO. This is also the claim of the assessee that in the present case, the RPT filter should be adopted at 15% and not 25%. In this regard, we feel it proper that regarding the working of RPT% of this comparable company, the issue should be restored back to the file of TPO for fresh decision after examining these contentions of ld. AR of assessee because we find that from page no. 12 of TPO order, the RPT% of this comparable has been worked out by the TPO at 0% as against the working of the assessee in the synopsis that it should be 26.76% or 26.19%. Hence we restore this matter back to the file of TPO for fresh decision after providing adequate opportunity of being heard to assessee. The TPO should examine the working of the assessee regarding RPT% of this comparable as provided in the synopsis reproduced above and such RPT% should be worked out by way of speaking and reasoned order after providing adequate opportunity of being heard to assessee.
26. Regarding this contention of ld. AR of assessee that permissible RPT% should be adopted at 15% and not 25% because there is no dearth of comparable in the present case, we find that as per page no. 32 of the order of TPO, 7 comparables have been selected and out of the same, the assessee is requesting for exclusion of four comparables i.e. ICRA Techno Analytics Ltd., L&T Infotech Ltd., Mindtree Ltd. (segment) and Persistent Systems Ltd. (Seg) and if these four comparables are excluded, the remaining comparables will be 3 only and hence, in our considered opinion, in the facts of the present case, 25% RPT filter is proper and not 15%.
27. Now we examine the assessee's claim in respect of exclusion of L&T InfoTech Ltd. This is the case of the assessee that this company should be excluded because this company has substantial brand value and this is functionally different. The assessee has placed reliance on Tribunal order rendered in the case of Cisco Systems (India) Pvt. Ltd. Vs. DCIT as reported in 50 taxmann.com 280 (Bangalore-Trib.), copy available on pages 181 to 211 of case law compilation. We find that this Tribunal order is for Assessment Year 2009-10 whereas in the present case, Assessment Year involved is Assessment Year 2013-14 and therefore, this Tribunal order is not relevant.
IT (TP) A No. 1616/Bang/2017 Page 38 of 42 One more argument is made by ld. AR of assessee that this company is having high turnover of Rs. 3,613.42 Crores which is 18 times of the turnover of the assessee company. Reliance has been placed on several Tribunal orders as noted in Para 28 of synopsis reproduced above. But on this aspect of the matter, we are following the judgement of Hon'ble Delhi High Court rendered in the case ofChryscapital Investment Advisors (India) (P.) Ltd. vs. DCIT as reported in 376 ITR 183in which it was held that huge profit or huge turnover, ipso facto does not lead to exclusion of a comparable and the TPO first, has to be satisfied that such differences do not "materially affect the price or cost" and secondly, an attempt should be made to make reasonable adjustment to eliminate the material effect of such differences. Hence on this issue, we restore the matter back to the file of AO/TPO for fresh decision in the light of this judgement of Hon'ble Delhi High Court.
28. The next company for which the assessee is requesting for exclusion is Mindtree Ltd. (seg.). The contentions raised by the assessee regarding exclusion of Mindtree Ltd. are contained in Para nos. 29 to 31 of the synopsis reproduced above. As per the same, this is the contention raised that Mindtree is offering various services such as IT Strategy consulting, application development and maintenance, data warehousing and business intelligence, package implementation, product architecture, design and engineering, embedded software, technical support, testing, infrastructure management services etc., to its customers. It is also pointed out that this company is having substantial research and development and have substantial intellectual property. This is also contended that this company is having wide range of operations and there is lack of information from segment reporting. This is also pointed out that the graphs on page 57 of the annual report of this company show the distribution of Mindtree's revenue across service lines and as per this graph, development represents only 25% of Mindtree's revenue but this is not clear whether this development includes product development i.e. development of products for its own exploitation and sale or software development i.e. development of software at the instructions of its customers where the intellectual property would eventually vest in such IT (TP) A No. 1616/Bang/2017 Page 39 of 42 customers or both where this activity is mixture of both type of activities. We find that the orders of TPO and DRP are not speaking orders on these aspects which are raised before us and therefore, we feel it proper to restore this matter also back to the TPO for fresh decision by way of a speaking order after considering all these aspects and after providing adequate opportunity of being heard to the assessee. We order accordingly.
29. The last company for which the assessee is requesting for exclusion is Persistent Systems Ltd. This is the claim of the assessee that this company is functionally different fromthe assessee and this company's RPT is 19.62% as per the TPO. On this aspect that this company is having RPT of 19.62%, we hold that since this company is having RPT% less than 25%, this company cannot be excluded by applying RPT filter. There is one more argument on account of this company that while working out the PLI of this company also, the AO has reduced the provision for doubtful debts from the operating expenses and as a consequence, the profit margin has been increased from 27% to 28.27%. This is the claim of the assessee that provision for doubtful debts should be part of operating expenditure. Hence it was submitted that for this issue, the same arguments should be considered which were advanced for the other company i.e. CG-VAK Software and Exports Ltd. While deciding the issue in respect of CG-VAK Software and Exports Ltd., we have held that provision for doubtful debts can be accepted as operating expenditure but the same cannot be considered for the purpose of TP analysis because it is not possible to find out whether such provision for doubtful debts is in relation to the turnover of the present year or earlier year. Hence it should be accepted that such provision is in relation to the turnover of earlier year and therefore, it cannot be considered in TP analysis. Accordingly, on the same line, this argument is rejected for this company also. The third contention of assessee regarding this comparable company is that this company is not functionally comparable.
30. Regarding functionality difference aspect of this company, it is submitted in synopsis that page no. 4 of annual report of that company shows that IT (TP) A No. 1616/Bang/2017 Page 40 of 42 company is in many lines of businesses such as product engineering, technology consulting, strategic partnership to build platforms and IP-led business and therefore, the activities of this company are wide and multifarious. We find that the orders of TPO and DRP are not speaking orders on these aspects which are raised before us and therefore, we feel it proper to restore this matter also back to the TPO for fresh decision by way of a speaking order after considering all these aspects and after providing adequate opportunity of being heard to the assessee. We order accordingly.
31. Regarding assessee's request for exclusion of Larsen & Toubro Infotech Ltd.
and Persistent Systems Ltd., we have come across a Tribunal order rendered in the case of W M Global Technology Services (India) (P.) Ltd. Vs. ACIT as reported in [2018] 91 taxmann.com 403(Bengaluru-Trib) in which one of us i.e. Ld. Judicial Member is the author. As per this Tribunal order, the issue regarding assessee's request for exclusion of L&T Infotech Ltd. and Persistent Systems Ltd. has been restored back to the file of TPO for fresh decision. Para nos. 8 to 11 of this Tribunal order are relevant and hence these paras are reproduced hereinbelow for ready reference.
"LARSEN & TOUBRO INFOTECH Ltd & PERSISTENT SYSTEMS Ltd :
08. In this regard the Ld. AR has submitted that L & T Infotech Ltd is engaged in software product development and is having substantial amount of intangibles assets. Further it also has a significant brand value and is engaged in diversities including IP Led business activities. It was also the case of the assessee that segmental information is not available and therefore cannot be compared with the assessee. Similar argument was submitted before us in respect of Persistent Systems Ltd, wherein the assessee has submitted that the comparable is engaged in software product development and further engaged in diversified business in IP Led and therefore the segmental information is not available and therefore has sought the exclusion of these two companies. Further it was submitted by the Ld. AR that the facts of the present case are similar to that of Microsoft Research Lab India P. Ltd [TS-994- ITAT-2017(Bang)], wherein the coordinate bench, in which one of us i.e., the Accountant Member was a party to the order, remanded the matter back to the file of the TPO for examining afresh the contention of the assessee as well as with respect to the functionality of these two comparables.
09. On the other hand the Ld. DR has submitted that in terms of the decision of the Tribunal in Microsoft Research Lab India P. Ltd IT (TP) A No. 1616/Bang/2017 Page 41 of 42 (supra), the matter may be remitted back to the file of the TPO for examining afresh in the light of the observations made by the Tribunal in the said matter.
10. We have heard the rival contention and perused the record. In the light of the reliance by both parties on Microsoft Research Lab India P. Ltd (supra), we would like to remand the matter to the file of TPO to the similar effect as done in the matter of Microsoft (supra) however we would like to add a word of caution that it will be unsafe to follow one decision passed by the Tribunal in any other case unless the assessee demonstrates that the profile of the assessee company as well as the assessee in other case are materially comparable with each other and there is no element of distinction between the profile of those two companies. However at this stage we do not wish to examine the profile of the assessee company as well as the profile of Microsoft Research Lab India P. Ltd(supra) as we are remitting back the matter and we leave it to the wisdom of the TPO to consider the facts of the present case (assessee) with that of Microsoft Research Lab India P. Ltd, and apply the decision of Microsoft Research Lab India Ltd (supra).
11. Following the above order of the coordinate bench, these two comparables namely LARSEN & TOUBRO INFOTECH Ltd & PERSISTENT SYSTEMS Ltd are restored back to the file of the TPO to decide afresh in terms of the observations made hereinabove."
32. From the above paras reproduced from this Tribunal order, it is seen that our decision regarding these two comparables to restore back the matter to the file of TPO is fortified by this Tribunal order also in which, the tribunal has considered one more Tribunal order rendered in the case of Microsoft Research Lab India (P.) Ltd. vs. ACIT as reported in [2017] 85 taxmann.com 352 (Bang.-Trib.).
33. Regarding corporate tax issues in respect of disallowance of Rs. 4,34,72,134/-
being payment of commission disallowed by the AO u/s. 40(a)(i), reliance has been placed on the judgement of Hon'ble Madras High Court rendered in the case of CIT Vs. Faizman Shoes (P) Ltd. as reported in 367 ITR 155. We find that this was held by Hon'bleMadras High Court in this casethat where the assessee paid commission to non-resident agent for procuring orders for leather business from overseas buyers wholesalers or retailers, as the case may be, the non-resident agent is paid 2.5% commission on FOB basis. That appears to be a commission simpliciter and did not provide any technical IT (TP) A No. 1616/Bang/2017 Page 42 of 42 services for purposes of running business in India. The assessee was not liable to deduct tax on such commission paid. As per the assessment order, this is not the case of the AO that the non-resident agent provided any technical services for the purposes of running business of the assessee in India. Hence in our considered opinion, this judgment of Hon'ble Madras High Court is squarely applicable in the present case. Respectfully following this judgment of Hon'ble Madras High Court, we hold that the TDS was not required to be deducted from this payment of commission of Rs. 4,34,72,134/- and therefore, disallowance made of this amount u/s. 40(a)(i) is not justified and hence we delete the same.
34. In the result, the appeal filed by the assessee is partly allowed in the terms indicated above.
Order pronounced in the open court on the date mentioned on the caption page.
Sd/- Sd/-
(LALIET KUMAR) (ARUN KUMAR GARODIA)
Judicial Member Accountant Member
Bangalore,
Dated, the 27th June, 2018.
/MS/
Copy to:
1. Appellant 4. CIT (A)
2. Respondent 5. DR, ITAT, Bangalore
3. CIT 6. Guard file
By order
Senior Private Secretary,
Income Tax Appellate Tribunal,
Bangalore.