Income Tax Appellate Tribunal - Bangalore
M/S Lsi India Research & Development ... vs Deputy Commissioner Of Income Tax ... on 7 October, 2020
IN THE INCOME TAX APPELLATE TRIBUNAL
"C" BENCH : BANGALORE
BEFORE SHRI N.V. VASUDEVAN, VICE PRESIDENT
AND SHRI B R BASKARAN, ACCOUNTANT MEMBER
IT(TP)A No.3170/Bang/2018
Assessment year : 2014-15
M/s. LSI India Research & Vs. The Deputy
Development Pvt. Ltd., Commissioner of
S1, Wipro Electronic City Income Tax,
Special Economic Zone, Circle 4(1)(1),
Doddathogur Village, Bangalore.
Begur Hobli, Electronic City,
Bangalore - 560 100.
PAN: AAECM 1677N
APPELLANT RESPONDENT
Appellant by : Shri T. Suryanarayana, Advocate
Respondent by : Shri Pradeep Kumar, CIT(DR)(ITAT), Bengaluru.
Date of hearing : 01.10.2020
Date of Pronouncement : 07.10.2020
ORDER
Per N.V. Vasudevan, Vice President This is an appeal by the assessee against the final order of assessment dated 28.9.2018 passed by the DCIT, Circle 4(1)(1), Bangalore u/s. 143(3) r.w.s. 92CA & 144C of the Income-tax Act, 1961 [the Act] relating to assessment year 2014-15.
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2. The grounds of appeal raised by the assessee reads as follows:-
"The grounds stated hereunder are independent of, and without prejudice to one another. The Appellant submits as under:
1. Order/ Directions bad in law and on facts
a) The order issued by the Deputy Commissioner of Income Tax, Circle 4(1)(1), Bangalore [(`Assessing Officer') or ('AO')], under section 143(3) read with section 144C (1 ), pursuant to the directions issued by the Hon'ble Dispute Resolution Panel ['DRP' / Panel'], is bad in law and on facts and is in violation of the principles of natural justice.
b) The AO has erred in law in making a reference to the learned Assistant Commissioner of Income Tax [Transfer Pricing (2)(1)(1)] ['TPO']. The Ld. Panel erred in upholding the actions of the Ld. AO/ TPO.
c) The directions issued by the Ld. Panel did not take cognizance of the objections raised by the Appellant in relation to the transfer pricing matters while issuing the directions under Section 144C(5).
d) The directions issued by the Ld. Panel and the order passed by the Ld. AO is without jurisdiction, inter alia, in so far as it purports to give effect to an invalid order of the Ld. TPO
e) On the facts and in the circumstances of the case and in law, Ld. AO/ TPO erred in not demonstrating that the motive of the Appellant was to shift profits outside India by manipulating the prices charged in the international transaction, which is a pre-requisite condition to make any adjustment under the provision of Chapter X of the Act. The Ld. Panel also erred in confirming the same."
2. Comparability Analysis adopted by the TPO for determination of arm's length price for the Software Development Services.
IT(TP)A No.3170/Bang/2018 Page 3 of 32
a) The Ld. Panel and the Ld. AO/ TPO erred in rejecting the value of international transactions pertaining to rendering of software development services, as recorded in the books of accounts, as the arm's length price. The Ld. Panel and Ld. AO/ TPO erred in determining a new arm's length price in substitution of the arm's length price as determined by the Appellant.
b) The Ld. AO/ TPO erred on facts in arbitrarily rejecting the comparable companies selected by the Appellant in the transfer pricing documentation without considering the functional and risk analysis of the Appellant such as (i) Akshay Technologies Limited, (ii) Sasken Communication Technologies Limited and
(iii) Goldstone Technologies Limited. The Ld. Panel also erred in confirming the same.
c) The Ld. AO/ TPO grossly erred on facts in benchmarking the transactions of the software development 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-à-vis comparable companies. The Ld. Panel erred in upholding the actions of the Ld. AO/ TPO.
d) The Ld. Panel and 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, such as, (i) companies whose data for financial year ('FY') 2013-14 was not available, (ii) companies with software development service revenue less than 75% of total operating revenue, (iii) companies with related party transactions greater than 25% of sales (iv) companies with export service income less than 75% of total operating revenues,
(v) companies with employee cost less than 25% of turnover, and (vi) companies with different financial year ending (i.e. other than 31 March 2014) (vii) companies with persistent losses.
e) The Ld. AO / TPO erred in law in applying an arbitrary filter to reject companies having related party transactions IT(TP)A No.3170/Bang/2018 Page 4 of 32 greater than 25% of sales. Further, the Ld. Panel also erred in upholding the related party transaction filter of 25%, disregarding the Appellant's ground for application of the related party transaction filter at a threshold of 10% or 15% of sales.
f) The Ld. AO/ TPO erred in including Infosys Limited, Larsen & Toubro Infotech Limited, Mindtree Limited, Persistent Systems Ltd, R S Software (India) Limited, Cigniti Technologies Ltd and Thirdware Solutions Ltd as comparable, despite these companies being functionally dissimilar to the Appellant. The Ld. Panel also erred in confirming the same.
g) The Ld. AO/ TPO erred in rejecting following companies from its own search which are otherwise functionally comparable and pass all the filters applied in the transfer pricing order:
• Infomile Technologies Limited;
• Sagarsoft India Limited; and • Maveric Systems Ltd.
The Ld. Panel failed to adjudicate the aforesaid contentions of the Appellant.
h) The Ld. AO/TPO erred in considering data obtained u/s 133(6). The Ld. Panel erred in confirming the same.
i) The Ld. AO/ TPO also erred in treating provisions for doubtful debts as non-operating in nature while calculating the net margins of the comparable companies. The Ld. Panel also erred in confirming the same.
j) The Ld. AO/ TPO erred in treating gain on account of foreign exchange fluctuation as non-operating in nature and thereby computing the tested party margin at 15.56% instead of 16.10%. The Ld. Panel erred in upholding the aforesaid treatment of gain on account of foreign exchange fluctuation thereby re-computing the margin at 13.11%.
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3. Erroneous data used by the Ld. TPO
a) The Ld. Panel and the Ld. AO / TPO 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.
b) The Ld. Panel and the Ld. AO / TPO erred in law and on facts in disregarding the application of multiple-year data while computing the margins of comparable companies.
4. Non-allowance of appropriate adjustments to the comparable companies, by the Ld. AO/ TPO The Ld. AO/TPO erred in law and on facts in not allowing appropriate adjustments under Rule 10B of the Income Tax Rules, 1962 to account for, inter alia, differences in (a) accounting practices, (b) depreciation adjustment, (c) marketing expenditure, (d) research and development expenditure and (e) risk profile between the Appellant and the comparable companies. The Ld. Panel erred in confirming the same.
5. Variation of 3% from the arithmetic mean The Ld. AO/TPO erred in law in not granting the benefits of proviso to Section 92C(2) of the Act available to the Appellant.
6. Determination of arm's length price in relation to trade receivables
a) The Ld. AO/TPO erred in considering outstanding receivables as international transactions without acknowledging that outstanding receivables pertains to provision of services and are not in the nature of any loans/advances. The Ld. Panel erred in confirming the same.
b) The Ld. AO/TPO erred in calculating the rate of interest in computing the TP adjustment on account of interest on the delayed trade receivables.
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7. Disallowance of the principal payment towards financial lease
a) The Ld. AO has erred in facts and law and the Hon'ble DRP has erred in confirming the disallowance of the principal payment towards financial lease of Rs. 67,328,039 and capitalized the same as leasehold improvements after allowing the depreciation ic4 10% thereby leading to the net disallowance of Rs. 60,595,235.
b) On facts and circumstances of the case, though the Appellant has erroneously conceded and misconceived the issue as covered matter, wherein it in fact meant to submit that the same issue in pending before Hon'ble 1TAT for earlier years, the DRP has erred in dismissing the same and not adjudicating on merit basis.
c) Without prejudice to the above, the Ld. AO and the Hon'ble DRP has failed to take cognizance of the fact that the assets taken on lease do not include only leasehold improvements but also include furniture and office equipments which are depreciable at 10% and 15% respectively. However, the Ld. AO has erred in providing depreciation at the rate of 10% only considering that all the assets taken on lease are lease hold improvements.
8. Non grant of TDS Credit The learned DCIT erred in granting TDS credit of Rs. 2,160,691 as against Rs. 2,162,489 as claimed in the return of income, resulting in a short grant of TDS credit to the tune of Rs. 1,798.
9. Non grant of MAT credit entitlement The Ld. AO has erred in law and facts in not considering the carried forward Minimum Alternate Tax ('MAT') credit balance against the taxes determined as payable under the normal provision of the Act in the assessment order.
IT(TP)A No.3170/Bang/2018 Page 7 of 32
10. Excess levy of interest under section 234B of the Act The Ld. AO has erred in levying interest under section 23413 of the Act amounting to Rs. 201,744,702.
Further, the Ld. AO has also erred in not considering the MAT credit balance and appropriate TDS credit while computing interest under section 234B of the Act amounting to Rs. 201,744,702.
11. Relief The Appellant prays that directions be given to grant all such relief arising from the above grounds and also all relief consequential thereto.
The Appellant submits that the above grounds are independent of and without prejudice to one another."
3. The assessee has filed an application seeking leave to urge the following additional grounds of appeal:-
"2(k) That I2T2 India Limited and Evoke Technologies Private Limited ought to be included in the final list of comparables to the software development services segment as the functions performed, assets employed and risks assumed by the said companies are similar to that of the Appellant."
4. It has been mentioned in the application for admission of additional ground that the companies that are sought to be included as comparable companies in Gr.No.2(k) were so included by the Tribunal in the case of similarly placed assessee and that on legal advise, the assessee filed its application for admission of additional ground.
5. We have considered the request for admission of additional ground and are of the view that the same has to be admitted. In this regard, we also notice that Evoke Technologies Pvt. Ltd. which is sought to be included as a IT(TP)A No.3170/Bang/2018 Page 8 of 32 comparable company was a comparable chosen by the assessee in its TP study. The Special Bench of the ITAT Chandigarh Bench in the case of DCIT v. Quark Systems Pvt. Ltd. 38 SOT 207(SB)(Chd.) has taken the view that it is open to the parties in Transfer Pricing cases to take a stand contrary to their TP study, if they contend that the stand taken in the TP study is contrary to facts or was erroneous. Such a claim cannot be disregarded only on the basis that it is contrary to Assessee's own stand in the TP study. We are also of the view that in the case of companies providing software development services such as the assessee, inclusion of the aforesaid company as a comparable has always been an issue. In these circumstances, we admit the additional ground for adjudication.
6. Ground Nos.1 to 5 raised by the assessee in the grounds of appeal are with regard to determination of Arm's Length Price (ALP) in respect of an international transaction of rendering software development [SWD] services by the assessee to LSI Corporation, USA which is an Associate Enterprise [AE]. On the issue of determination of ALP, the Assessee mainly reiterated its stand as put forth before the revenue authorities and the learned DR relied on the order of the AO/TPO and the DRP.
7. The assessee rendered SWD services to its AE for which assessee received a sum of Rs.624,64,83,200. It is not in dispute that the transaction of rendering SWD services to its AE was an international transaction and the arm's length price [ALP] in respect of such transaction has to be determined having regard to the arm's length test as laid down in section 92 of the Act.
8. The assessee in support of its claim that the consideration received in the international transaction was at arm's length, filed a TP analysis in which it adopted Transaction Net Margin Method (TNMM) as the Most Appropriate IT(TP)A No.3170/Bang/2018 Page 9 of 32 Method (MAM) for determination of ALP. The Assessee adopted Operating Cost to Total Cost (OP/OC) as Profit Level Indicator [PLI] for the purpose of comparison of assessee's operating margin with profit margin of comparable companies. The assessee computed the PLI as follows:-
Net mark-up on cost earned by the Assessee (as reflected in the TP study):
Operating Income Rs. 6,24,64,83,200/-
Operating Cost Rs.5,38,02,02,798/-
Operating Profit (Op. Income - Op. Cost) Rs.86,62,80,402/-
Operating/Net mark-up (OP/TC) 16.10%
As per the agreement between the Assessee and its AE for providing SWD services, the Assessee was to be paid on the basis of mark up on cost i.e., a percentage on costs incurred for rendering SWD services. In terms of the amendment to the intercompany agreement, for the purposes of charging mark-up, the relevant cost should be considered post increase due to foreign exchange loss and reduction due to foreign exchange gain. Accordingly, in the year under consideration the gains realised by the Assessee on account of fluctuation of foreign currency of Rs. 14,02,81,103/- was reduced from the operating cost base. Corresponding reduction was also made in the operating income to arrive at the above margin.
9. The Transfer Pricing Officer (TPO) to whom the AO referred the question of determination of ALP in terms of Sec.92CA of the Act, accepted TNMM as the MAM and also adopted OP/OC as the PLI. The TPO however included foreign exchange gain as part of the operating income and also included the same in the operating cost while computing PLI as a result, the PLI was computed by the TPO as follows:-
IT(TP)A No.3170/Bang/2018 Page 10 of 32 Net mark-up on cost earned by the Assessee (as reflected in the TP order):
Operating Income Rs. 6,38,14,21,153/-
Operating Cost Rs.5,52,23,74,800/-
Operating Profit (Op. Income - Op. Cost) Rs.85,90,46,353/-
Operating/Net mark-up (OP/TC) 15.56%
As already stated in computing the margin, the TPO excluded the foreign exchange gains only from the operating revenue, not treating it as a operating income and also did not reduce the said sum from the operating cost as expense and this was one of the reason for the difference in the PLI as computed by the Assessee and as computed by the TPO.
10. The assessee chose 6 comparable companies and the average arithmetic mean profit margin of those 6 companies were 13.32%. Since the profit margin of the comparable companies was less than the profit margin earned by the assessee from the international transaction, the assessee claimed that the price receive in the international transaction was at arm's length. The TPO accepted 2 out of 6 comparable companies chosen by the assessee, viz., Mindtree Ltd. and R S Software India Ltd.
11. The TPO on his own chose 6 other comparables and computed the ALP of the international transaction and the consequent addition to be made to total income as follows:-
Comparables selected by TPO and their arithmetic mean Sl. Name of the Company OP/OC No. (WC-unadj) (in %) 1 Infosys Ltd. 36.13 2 Larsen & Toubro Infotech Ltd. 24.61 3 Mindtree Ltd. 20.43 4 Persistent Systems Ltd. 35.10 IT(TP)A No.3170/Bang/2018 Page 11 of 32 5 R S Software (India) Ltd. 24.25 6 Cigniti Technologies Ltd. 27.62 7 SQS India BFSI Ltd. 22.37 8 Thirdware Solution Ltd. 44.68 AVERAGE MARK-UP 29.40 Computation of arm's length price by the TPO and the adjustment made Arm's Length Mean Mark-up 29.40% Operating Cost Rs. 552,23,74,800/-
Arm's Length Price @129.40% of cost Rs. 714,59,52,991/-
Price Received Rs. 638,14,21,153/-
Shortfall being adjustment u/s. 92CA Rs. 76,45,31,838/-
12. Thus, a sum of Rs.76,45,31,838 was suggested as addition to total income of assessee on determination of ALP by the TPO. The addition suggested by the TPO in the order passed u/s. 92CA(4) of the Act was incorporated by the AO in the draft order of assessment dated 6.12.2017. Against the addition proposed in the draft order of assessment, the assessee filed objection before the Dispute Resolution Panel (DRP) u/s. 144C of the Act. The DRP excluded SQS India BFSI Ltd. from the list of comparable companies and retained the remaining 7 comparables chosen by the TPO.
13. Before the DRP, one of the issues raised by the assessee was with regard to computation of PLI of the assessee i.e., OP/OC by the TPO. The TPO treated the gains arising from fluctuation of foreign exchange as not operating in nature and did not exclude the said sum from the expenses. According to the Assessee, the TPO ought to have treated foreign exchange gain as part of the operating income and excluded the said gain from operating cost while computing the profit margin of the Assessee because as per the agreement between the Assessee and its AE, the profit margin of the IT(TP)A No.3170/Bang/2018 Page 12 of 32 Assessee was on cost and foreign exchange gain would go to reduce the cost of the Assessee for the purpose of computing Assessee's profit margin. The DRP however did not agree with the contention of the Assessee and concurred with the view of TPO in this regard. The relevant observations of the DRP were as follows:-
"10. Ground of objection: The Ld. TPO erred in computing the margin earned by the Assessee as 15.56% instead of 16.10%. The Ld. AO erred in upholding the. actions of the TPO.
Panel: The assessee has made the following arguments in respect of its contention that the TPO has not computed the margins correctly.
"The Assessee submits that LSI India is compensated on a cost plus markup of 1S% for rendering of IT services to its AEs. The Assessee has submitted the margin computation with the IA. TPO vide its submission filed on 9 Oct 2017. The same is reproduced below:
Particulars Amount in Rupees
(as per TP Study)
Revenue from Operations 6,241,140,050
Other income 167,456,407
Less: Interest Income 21,832,154
Less: Foreign Exchange Gain 140,281,103
Total Income (A) 6,246,483,200
Employee Benefit Expenses 3,710,843,964
Depreciation & Amortisation 609,928,724
Other expenses 1,203.414,977
Less: Provision for doubtful advances 1,812,865
Less: Advances written off 1,890,899
Less: Foreign Exchange gain 140,281,103
Total Expenditure (B) 5,380,202,798
Operating Profit (C = A - B) 866,280,402
NCP (%) 16.10%
Facts, if any, modified by the Assessing Officer Further, the Ld. TPO without taking the cognizance of the detailed submission filed on 9 October 2017, has passed the order and computed the margin of the Assessee as below:
IT(TP)A No.3170/Bang/2018 Page 13 of 32 Particulars Amount in Rupees (as per TP Study) Revenue from Operations 6,408,596,457 Other income 167,456,407 Less: Interest Income -
Less: Foreign Exchange Gain 140,281,103
Total Income (A) 6,381,421,153
Employee Benefit Expenses 3,710,843,964
Depreciation & Amortisation 609,928,724
Other expenses 1,203,414,977
Less: Provision for doubtful advances 1,812,865
Less: Advances written off -
Less: Foreign Exchange gain -
Total Expenditure (B) 5,522,374,800
Operating Profit (C = A - B) 859,046,353
NCP (%) 15.56%
The Ld. TPO computed the NCP of LSI India as 15.56% on account of following erroneous adjustments:
• Other income being doubly included in the operating income (i.e. first as part of the revenue from operations thereby considering revenue from operations to be Rs.6,408,596,457/- instead of Rs. 6,241,140,0501-; and second as a separate line item in the total income).
• Exclusion of foreign exchange gain from the total income without excluding the same as part of the total income.
• Treatment of advances written --off as operating in nature"
The contentions of the assessee are carefully considered. With reference to taking other income twice it is a clear error and needs to be rectified. Further it is noticed that the interest income of Rs. 2,1832,154/- is not reduced from the operating income.
However, with reference to the claim of the assessee that Forex gain should be reduced from the operating cost, the Panel is not inclined to accept the same as it is not part of the expenditure of the assessee as seen from the financials. The Audited financial results have to be IT(TP)A No.3170/Bang/2018 Page 14 of 32 taken and necessary adjustments are to be made as per law. It is contended that the AE compensates the assessee for forex loss or gain so that the assessee remains neutral to forex risk. However, it is not clear that the AE adjustments affect the financials of the current year. Hence such argument cannot be accepted. With reference to provision for doubtful advances and advances written off, the Panel conforms the view taken by the TPO. Accordingly, the computation of the profit margin is reworked as under:
Particulars Amount in Rupees
(as per TP Study)
Revenue from Operations 6,241,140,050
Other income 167,456,407
Less: Interest Income 21,832,154
Less: Foreign Exchange Gain 140,281,103
Total Income (A) 6,246,483,200
Employee Benefit Expenses 3,710,843,964
Depreciation & Amortisation 609,928,724
Other expenses 1,203.414,977
Less: Provision for doubtful advances 1,812,865
Less: Advances written off -
Less: Foreign Exchange gain -
Total Expenditure (B) 5,522,374,800
Operating Profit (C = A - B) 724,108,400
NCP (%) 13.11%
As per the above computation the margin of the assessee comes to 13.11%. This is mainly due to the error is taking other income twice. This results in enhancement of the adjustment. Since the assessee voluntarily admitted this error of the TPO in its grounds and sought amendment the same is conceded and opportunity for enhancement is deemed to have been given. Accordingly, the AO/TPO is directed to adopt the revised margin of the assessee as above. Ground rejected."
14. The AO passed final order of assessment incorporating the directions of DRP. Aggrieved, the assessee has preferred the present appeal before the Tribunal.
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15. In this appeal, the assessee seeks exclusion of 5 out of 7 comparable companies that remain after the order of DRP viz., (1)Infosys Ltd. (2) Larsen & Toubro Infotech Ltd. (3) Persistent Systems Ltd. (4) Cigniti Technologies Ltd. & (5) Thirdware Solutions Ltd.
16. As far as the challenge by the assessee on exclusion of aforesaid 5 companies in ground No.2(f), the ld. counsel for the assessee has brought to our notice a decision of Bangalore Bench of ITAT for the very same Assessment Year 2014-15 in the case of LG Soft India Pvt. Ltd. in IT(TP)A No.3122/Bang/2018 for AY 2014-15, order dated 28.5.2019. In this order rendered in a case of assessee rendering SWD services such as the assessee, the Tribunal excluded 3 out of 5 companies referred to in the earlier paragraph and remanded 1 company for fresh consideration with the following observations:-
"5. The Ld A.R submitted that M/s Infosys Ltd, M/s Persistent Systems Ltd and M/s Thirdware Solutions Ltd have been excluded by the co-ordinate bench in the assessee's own case in AY 2008-09 in IT(TP)A No.1673/Bang/2012.
6. We notice that the co-ordinate bench has excluded M/s Infosys Ltd in AY 2008-09 by following the decision rendered by another co-ordinate bench in the case of 3DPLM Software Solutions Ltd (IT(TP)A No.1303/Bang/2012 dated 28.11.2013, wherein the decision rendered in the case of Triology E Business Software India P Ltd (ITA No.1054/Bang/2011) was followed and it was held that M/s Infosys Technologies Ltd is not functionally comparable since it owns significant intangible and has huge revenues from software products. It was further observed that the break-up of revenue from software services and software product is not available.
6.1 It was stated that there is no change in facts. Accordingly, following the decision rendered in the assessee's own case in AY 2008-09, we direct exclusion of M/s Infosys Ltd.
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7. In AY 2008-09, the co-ordinate bench has excluded M/s Persistent Systems Ltd also by following the decision rendered in the case of 3DPLM Software Solutions Ltd (supra), where in it was held that M/s Persistent Systems Ltd is engaged in product development and product design services while the assessee is a software development service provider. Further, the segmental details were not available.
7.1 It was stated that there is no change in facts. Accordingly, following the decision rendered in the assessee's own case in AY 2008-09, we direct exclusion of M/s Persistent Systems Ltd.
8. We also notice that in AY 2008-09, the co-ordinate bench has excluded M/s Thirdware Solutions Ltd also by following the decision rendered in the case of 3DPLM Software Solutions Ltd (supra), where in it was held that M/s Thirdware solutions Ltd is engaged in product development and earns revenue from sale of licenses and subscription. Further, the segmental details were not available.
8.1 It was stated that there is no change in facts. Accordingly, following the decision rendered in the assessee's own case in AY 2008-09, we direct exclusion of M/s Thirdware Solutions Ltd.
9. We have noticed that the assessee seeks exclusion of M/s Cigniti Technologies Ltd. It is pertinent to note that the assessee itself had selected this company as a comparable and it has urged for exclusion of the same only before Ld DRP. The Ld A.R submitted that the Ld DRP did not address the same. The Ld A.R submitted that M/s Cigniti Technologies Ltd is a Testing company and hence it cannot be considered as a comparable. However, we notice that this contention has been raised by the assessee for the first time before Ld DRP and there was no occasion for the TPO to examine the same. Accordingly we restore this comparable to the file of AO/TPO for examining it afresh."
17. As far as exclusion of Larsen & Toubro Infotech Ltd., is concerned, the Tribunal in the very same case of M/s. LG Soft Pvt. Ltd. (supra) in another order dated 27.9.2019 in MP No.95/Bang/2019 held that exclusion of Larsen & IT(TP)A No.3170/Bang/2018 Page 17 of 32 Toubro Infotech Ltd., was omitted to be adjudicated in the original order dated 28.5.2019 passed by the Tribunal referred in the earlier paragraph and held that Larsen & Toubro Infotech Ltd., is also not a comparable company because there were extraordinary events that occurred in the relevant previous year and that it possessed brand and intangibles and there was no segmental information of sub-contracting expenses.
18. Respectfully following the aforesaid decision, we direct exclusion of (1) Infosys Ltd. (2) Larsen & Toubro Infotech Ltd. (3) Persistent Systems Ltd. & (4) Thirdware Solutions Ltd. from the list of comparable companies and restore the question of deciding the comparability of Cigniti Technologies Ltd. to the AO for fresh consideration as directed by the Tribunal in the decision referred to above.
19. We shall now take up the plea for inclusion of certain comparable companies. The assessee is seeking inclusion of Akshay Software Technologies Ltd., Infomile Technologies Ltd., Sagarsoft India Ltd., Maverick Systems Ltd., I2T2 India Ltd. & Evoke Technologies Ltd. The grievance in this regard is projected in grounds 2(b), 2(g) & 2(k) of grounds of appeal.
20. As far as inclusion of Akshay Software Technologies Ltd. is concerned, it was selected by the assessee as a comparable company in its TP study, but was rejected by the TPO for the reason that this company was engaged in providing professional services, procurement, installation, implementation, support & maintenance of ERP products and services and incurrent significant foreign branch expenses indicating a different operating model from that of assessee.
21. It is the plea of assessee that assessee's function is comparable with this company and that the TPO had chosen companies with significant foreign IT(TP)A No.3170/Bang/2018 Page 18 of 32 branch expenses as comparable companies. The ld. counsel for the assessee brought to our notice a decision of ITAT Bangalore in the case of EMC Software & Services India P. Ltd. v. JCIT in IT(TP)A No.3375/Bang/2018, order dated 18.12.2019 for AY 2014-15, wherein in the comparability of this company was remanded to the TPO for consideration afresh.
22. The ld. DR relied on the order of the DRP. After considering the rival submissions, we find that comparability of this company was remanded to the TPO for consideration afresh in the case cited by the ld. counsel for the assessee. Following were the relevant observations of the Tribunal:-
"(i) Akshay Software Ltd. which has a margin of 8.13%. The income from commission on sale of software license constitute meager 0.5% of total revenue and TPO has not applied transfer development filter. The said company was rejected by the TPO for the reason that the company is engaged in providing provisional services, procurement installation, employment support of ERP products. The DRP has rejected the comparable without applying the filter and there is no difference in the business model adopted by the company and the assessee. We on perusal of the Annual Report at Page 1373 of Paper Book, found that major revenues are from operations as per Note 19 being income from software services and commission received on sale of software licenses. The earnings as per Note 28 as per the financial statements, the company has earning from export of software and in the F.Y. 2013-14 which constitute more than 95% of income. Therefore we found these facts are not considered by the TPO or DRP and accordingly we restore this issue to the file of TPO for examination and verification."
23. We are of the view that the issue of comparability of Akshay Software Ltd. should be examined afresh by the TPO as per the directions of the Tribunal in the order referred to above. We hold and direct accordingly.
IT(TP)A No.3170/Bang/2018 Page 19 of 32
24. As far as inclusion of Infomile Technologies Ltd., Sagarsoft India Ltd. and Maveric Systems Ltd. are concerned, we find that inclusion of Maveric Systems Ltd. was remanded by the Tribunal to the TPO for consideration afresh in the case of EMC Software & Services India P. Ltd. (supra) with the following observations:-
"(iii) Maveric Systems Limited : This comparable was rejected by the TPO and it was sought for inclusion by the assessee and whereas TPO has rejected without any basis and was excluded on the ground that the company was engaged in R & D activity and expenditure is 6% of total turnover. Similarly, the DRP has upheld the exclusion of the company. The learned Authorised Representative submitted that company's functional profile is comparable and applied the TPO filters. Whereas the DRP has observed that the company has incurred substantial expenses to the tune of 6% of turnover towards R & D and the tolerable limit is 3%. We found the observations of the DRP are without any basis. Accordingly we restore this issue to the file of TPO to give a logical conclusion and findings."
25. Following the aforesaid decision, we remand the issue of inclusion of this company i.e., Maveric Systems Ltd. to the TPO for fresh consideration on the lines directed in the order of the Tribunal referred to above.
26. As far as inclusion of Infomile Technologies Ltd. and Sagarsoft India Ltd. are concerned, it is seen that the DRP, despite objections by the assessee for inclusion of these two companies, did not adjudicate the same. Since some of the issue are being remanded to the TPO for fresh consideration. We deem it fit and proper to restore the question of inclusion of these two companies also to the TPO.
27. As far as inclusion of I2T2 India Ltd. is concerned, we find that in the case of LG Soft India Pvt. Ltd. (supra) this company was directed to be included. The Tribunal in para 11 of its order held that the TPO excluded this IT(TP)A No.3170/Bang/2018 Page 20 of 32 company for the reason that the Related Party Transaction (RPT) had not been disclosed in the annual report. The Tribunal held that if there is no disclosure of RPT in the annual report, it has to be concluded that there was no RPT and therefore this company should be included as a comparable company. Following the aforesaid decision, we direct inclusion of I2T2 India Ltd. as comparable company.
28. As far as inclusion of Evoke Technologies Ltd. is concerned, the reasons given for non-inclusion was that data relating to this company was not available in the public domain. The ld. counsel for the assessee brought to our notice that the data is now available in the public domain, therefore the TPO may be directed to consider the comparability of this company afresh in the light of data available in the public domain. We accept the request made in this regard and direct the TPO to consider the data available in the public domain and consider the comparability of this company for inclusion, after affording opportunity of being heard to the assessee.
29. In ground No.2(j), the limited challenge by the assessee is in respect of the action of the revenue authorities in not treating the gain on account of foreign exchange fluctuation as operating income. As far as the issue with regard to treatment of foreign exchange gain as part of operating profit is concerned,, this issue is no longer res integra and has been settled by the decision of the Bangalore Bench of ITAT in the case of e4e Business Solutions P. Ltd. v. DCIT [2016] 67 taxmann.com 68 [Bang. Trib.]. It has been held therein that the gains arising from fluctuation of foreign exchange having nexus with international transaction should be treated as operating income and taken into consideration while computing the operating profit of the assessee. Following the aforesaid decision, we direct the computation of PLI IT(TP)A No.3170/Bang/2018 Page 21 of 32 by treating the gains arising from fluctuation of foreign exchange having nexus with international transaction as part of operating income.
30. No other arguments were advanced on grounds No.1 to 5. Accordingly these grounds are decided as above.
31. The TPO is directed to determine the ALP in accordance with the directions given above, after affording opportunity of being heard to the assessee.
32. As far as ground No.6 raised by the assessee is concerned, the facts are that the TPO, in the order passed under Section 92CA of the Act determined a TP adjustment of Rs. 7,08,83,288/- in respect of delayed receivables on a notional manner. The TPO has observed in this regard in his order that the Assessee did not furnish the trade receivable and details of realization and in the absence of such details, he has no other option but to determine the interest attributable to delayed realization of trade receivables by applying 6 months LIBOR plus 400 basis points with a mark-up of 100 basis points (which works out to 4.836%) on the average of opening and closing receivable. The DRP confirmed the action of the TPO.
33. Before the Tribunal the learned counsel for the Assessee submitted that it is a fully funded entity of the AE, and the amounts outstanding from the AE will be settled with the AE on an ongoing basis in the normal course of business, having regard to commercial and economic factors. The arm's length price determination for the said receivables is subsumed within the arm's length price determination of the principal transaction itself. The outstanding receivables are in respect of the provision of software development services by the Assessee and hence arise out of the primary transaction of rendering SWD services. Since the receivables are integral to IT(TP)A No.3170/Bang/2018 Page 22 of 32 the main transaction, the same ought to be aggregated with the said transaction and adjustment ought to be computed accordingly. Reliance in this regard was placed on the decision of this Hon'ble Tribunal in the case of Avnet India (P.) Ltd. v. DCIT (reported in [2016] 65 taxmann.com 187 [Bangalore - Trib.)] which was upheld by the Hon'ble High Court of Karnataka in ITA No. 358/2016. In any event, it was submitted that the Assessee has substantial own funds and has not incurred any additional cost on account of the delayed receivables, warranting a TP Adjustment. It was pointed out that the Assessee has not taken any loans to fund its working capital requirement, and therefore an adjustment towards outstanding receivables is not warranted. Further, it was submitted that the receivables have remained outstanding for less than 180 days, and therefore no adjustment is warranted. Detailed submissions in this regard are at pages 526-530 and 879-888 of the paperbook. He placed reliance on the decision of the ITAT Bangalore Bench, in the case of Avnet India (P.) Ltd. v. DCIT (reported in [2016] 65 taxmann.com 187 (Bangalore- Trib), wherein it was held that transaction of providing extended period of credit to an AE constitutes an international transaction u/s 92B of the Act. However, this transaction is not an independent transaction. It is an integral part of transaction of sale made to the AE and therefore, it has to be considered along with the main transaction.
34. It was further contended that that the Delhi Bench of ITAT in the case of Kusum Healthcare Pvt. Ltd. v. ACIT (Order dated 31.03.2015 passed by the Delhi Bench of the Hon'ble Tribunal in ITA No. 6814/Del/2014) held that if the working capital investment of the assessee and the comparables rather are considered than looking at the receivable independently is not necessary as the working capital adjustment takes into account the impact of outstanding receivables on the profitability. It was pointed out that this decision came to be upheld by the Hon'ble Delhi Court in PCIT v. Kusum Healthcare Pvt. Ltd.
IT(TP)A No.3170/Bang/2018 Page 23 of 32 (Order dated 25.04.2017 passed in ITA No. 765/2016) (refer paras 10 and
11):-
"10. The Court is unable to agree with the above submissions. The inclusion in the Explanation to Section 92B of the Act of the expression "receivables" does not mean that de hors the context every item of "receivables" appearing in the accounts of an entity, which may have dealings with foreign AEs would automatically be characterised as an international transaction. There may be a delay in collection of monies for supplies made, even beyond the agreed limit, due to a variety of factors which will have to be investigated on a case to case basis. Importantly, the impact this would have on the working capital of the Assessee will have to be studied. In other words, there has to be a proper inquiry by the TPO by analysing the statistics over a period of time to discern a pattern which would indicate that vis-à-vis the receivables for the supplies made to an AE, the arrangement reflects an international transaction intended to benefit the AE in some way. 11. The Court finds that the entire focus of the AO was on just one AY and the figure of receivables in relation to that AY can hardly reflect a pattern that would justify a TPO concluding that the figure of receivables beyond 180 days constitutes an international transaction by itself. With the Assessee having already factored in the impact of the receivables on the working capital and thereby on its pricing/profitability vis-à-vis that of its comparables, any further adjustment only on the basis of the outstanding receivables would have distorted the picture and re- characterised the transaction."
35. It was argued that the above principles have been followed consistently by this Hon'ble Tribunal inter alia in the following cases:
(i) ACIT v. Information Systems Resource Centre (P.) Ltd. (2015) 59 taxmann.com 147 (Mumbai-Trib.) (refer paras 11-13)
(ii) Bechtel India Pvt. Ltd. v. DCIT (Order dated 21.12.2015 passed by the Delhi Bench of the Hon'ble Tribunal in ITA No. 1478/Del/2015) (refer para 16) IT(TP)A No.3170/Bang/2018 Page 24 of 32
(iii) Tally Solutions (P.) Ltd. v. ACIT (2016) 73 taxmann.com 70 (Bangalore-Trib) (refer para 5 9)
(iv) Xchanging Solutions Ltd. v. DCIT [2017] 78 taxmann.com 54 (Bangalore-Trib) (refer para 23)
(v) ACIT v. Millipore (India) Ltd. [2017] 80 taxmann.com 12 (Bangalore-Trib) (refer para 13)
(vi) Och-Ziff Real Estate India (P.) Ltd. v. DCIT [2017] 86 taxmann.com 190 (Bangalore-Trib) (refer para 12)
(vii)Sunquest Information Systems India (P.) Ltd. v. DCIT [2019] 101 taxmann.com 315 (Bangalore-Trib) (refer para 24) In view of the above, it is submitted that the delayed receivables cannot be treated as an independent international transaction
36. Without prejudice to the above submissions, it was contended that even assuming that delayed realization of trade receivables is an international transaction, the delay in realization of the trade receivables in this case is not inordinate so as to warrant any benefit provided to the AE warranting determination of ALP. Our attention was drawn to the fact that the average realization period of the trade receivables is 66.77 days as per the calculation given to the DRP which is given as an Annexure-1 to this order. It was contended that since the period of credit is not unusually high, no addition is warranted. The ld. DR relied on the order of the DRP.
37. We have carefully considered the rival submissions. On the question whether delayed realization of trade receivables from the AE constitutes an international transaction or not, there are conflicting decisions of various benches of the Tribunal, which we shall point out. Sec.92B of the Act defining what is an international transaction was amended by Finance Act, 2012, by IT(TP)A No.3170/Bang/2018 Page 25 of 32 way of insertion of an Explanation to sec.92B with retrospective effect from 1- 4-2002 and the same reads thus:-
"Explanation- For the removed of doubts, it is hereby clarified then-
(i) the expression "international transaction" shall include--
(a) .............
(b) ..............
(c) capital financing, including any type of long-term or short-
term borrowing. lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment of receivable or any other debt arising during the course of business:
............"
38. The amendment is to the effect that "international transaction" would specifically include within its ambit. 'deferred payment or receivable or any other debt arising during the course of business' and hence non-charging or under-charging of interest on the excess period of credit allowed to the AE for the realization of invoices would amount to an international transaction. It was so held by the ITAT Delhi Bench in the case of Bechtel India Pvt Ltd (in ITA No.6530/De1/2016 dated 16 May 2017). It is important to note that the Bench while arriving at the said conclusion distinguished its earlier order in the case of Kusum Healthcare Pvt. Ltd. (supra) and rejected the contention that interest gets subsumed in the working capital adjustment. The Hon`ble Bombay High court in the case of CIT vs. Patni Computer Systems Ltd, (2013) 215 Taxman 108 (Bom) dealt, inter alia, with the following question of law:-
"(c) Whether on the facts and circumstances of the case and in law, the Tribunal did not err in holding that the loss suffered by the assessee by allowing excess period of credit to the associated enterprises without charging an interest during such credit period would not amount to international transaction whereas section 92B(1) of the Income-tax Act, 1961 refers to any Other transaction IT(TP)A No.3170/Bang/2018 Page 26 of 32 having a bearing on the profits, income, losses or assets of such enterprises?"
While answering the above question, the Hon'ble High Court noticed that an amendment to section 92B has been carried out by the Finance Act, 2012 with retrospective effect from 1.4.2002. Setting aside the view taken by the Tribunal, the Hon'ble High Court restored this issue to the file of the Tribunal for fresh decision in the light of the legislative amendment.
39. In the case of BT e Serv (TS-849-ITAT-2017(DEL)-TP) the ITAT Delhi Bench held that undoubtedly the receivable or any other debt arising during the course of the business is included in the definition of 'capital financing' as an 'international transaction' as per explanation 2 to section 92B of the Act w.e.f. 01.04.2002 inserted by the Finance Act 2012. Therefore, even the outstanding receivable partake the character of capital financing and consequently, overdue outstanding is an "international transaction". The natural corollary would be of imputing interest on such "capital financing" if same is not charged at arm's length. The ITAT concluded that if outstanding receivables are within the terms of agreement, then it may be argued that interest on such outstanding is already covered in the sale price of the goods. However, if the agreement does not specify the term of the payment, even then assessee must be given benefit of credit period which is accepted business practice in the trade. The ITAT confirmed 30 days as the normal credit period adopted by the TPO.
40. The foregoing discussion discloses that non-charging or under- charging of interest on the excess period of credit allowed to the AE, for the realization of invoices amounts to an international transaction and the ALP of such an international transaction is required to be determined. In view of the above observations. the reliance placed by the ld. counsel for the assessee on IT(TP)A No.3170/Bang/2018 Page 27 of 32 earlier decisions cannot be accepted. Similarly, Considering the above discussion, it is held that deferred trade receivable constitutes international transaction.
41. Having concluded that deferred trade receivables constitute international transaction, we now proceed to deal with the argument of the Assessee that the credit period allowed to the AE is not unreasonable so as to warrant an inference of any benefit to the AE and consequent determination of ALP of such delayed receivables. From the details brought to our notice i.e., page 526 of PB Vol.II and page 18 of PB which is the annual report of the assessee, it is clear that the average credit period is about 66 days for realization of trade receivables from the AE. As to whether this period can be construed as reasonable or not has not been examined by the DRP despite submissions by the Assessee in this regard. If there has been no unreasonable delay in realizing the trade receivables from the AE, then the addition is not warranted. In our opinion, the issue requires to be decided afresh and hence the same is remanded to the AO/TPO to give a factual finding on the aspect what constitutes normal credit period and what is extended credit period that warrants conclusion that there has been a separate international transaction of providing deferred payment facility to the AE. Consequently, the issue is remanded to the AO/TPO for consideration afresh in the light of the above discussion after affording opportunity of being heard to the Assessee.
42. We shall now take up for consideration the other corporate tax issues. Ground No.7 raised by the assessee is with regard to disallowance of finance lease purchase. The facts in this regard are during the financial year under consideration, the Assessee had made some payments towards certain assets taken on lease from Rentworks India Pvt. Ltd. In order to comply with IT(TP)A No.3170/Bang/2018 Page 28 of 32 the Accounting Standards AS-19 in its books of accounts, the Assessee had capitalised the payments made towards principal component of the rent and claimed depreciation on the same. However, since the assets were taken only on rent under the rental agreement and the Assessee did not have any title/ownership to the same, while computing its income for tax purposes, the Assessee claimed deduction of the entire amount paid towards the rent. Depreciation claimed in the books was disallowed while computing the taxable income. The Assessing Officer disallowed the amount paid towards the principal and capitalised the same. Consequent depreciation at the rate of 10% was allowed. The DRP rejected the objections of the Assessee and upheld the order of the Assessing Officer on the ground that the risk of the assets falls entirely on the Assessee and the Assessee is permitted to sell the same with the consent of the lessor.
43. Before the Tribunal, the learned counsel for the Assessee submitted that the orders of the lower authorities are erroneous. It was submitted that in order to determine whether the Assessee is the owner of the assets, it is pertinent to examine the relevant clauses in the agreement under which the assets were taken on rent by the Assessee. The relevant features/clauses in the agreement are as follows:-
(a) The agreement is titled 'rental agreement' and the charges payable are 'rent';
(b) The arrangement is for a specified period only;
(c) The rent is payable monthly;
(d) The Appellant does not have any title to the assets;
(e) There is no agreement/representation by the lessor which will entitle the Appellant to acquire the assets at any later date;
IT(TP)A No.3170/Bang/2018 Page 29 of 32
(f) The lessor will have the authority to inspect the assets;
(g) The assets will remain the property of the lessor and the Appellant has the right only to use the assets;
(h) The Appellant is required to take insurance of the assets in the name of the lessor as owner and its own name as renter. The lessor shall be entitled to claim and receive all monies under the insurance policies;
(i) If any asset is lost, stolen or damaged beyond economic repairs which is caused directly by the Appellant's negligence, the Appellant is bound to replace the asset with the asset if like nature, age and condition as approved by the lessor;
(j) The leases are renewable only on mutually agreeable terms; and
(k) At the end of the lease term, the Appellant will make the assets available for collection in good working order.
It was submitted that the above clauses in the Agreement make it clear that the Assessee did not have any title to the assets and as it was not the owner of the asset, it is entitled to claim deduction of the rental amount. It was submitted that the bifurcation of the payment for treatment in terms of Accounting Standards-19 cannot be the sole factor to determine whether the Assessee is the owner of the asset and consequently not eligible to claim deduction of the rental payments. Reliance in this regard was placed on the decision of the Delhi Bench of the Tribunal in the case of Bharti Hexacom Ltd. v. ACIT (reported in [2016] 68 taxmann.com 357 (Delhi - Trib.). Further reliance was also placed on the decision of the Hon'ble Supreme Court in the case of ICDS Ltd. v. CIT (reported in [2013] 350 ITR 527 (SC). Reliance is also placed on the decisions of the Hon'ble Supreme Court in the case of Taparia Tools Ltd. v. JCIT ([2015] 55 taxmann.com 361 (SC) and Hon'ble Karnataka High Court in the case of Karnataka Bank Ltd. v. ACIT ([2013] 34 taxmann.com 150 (Karnataka), wherein the Courts have held that entries in IT(TP)A No.3170/Bang/2018 Page 30 of 32 the books of account are not determinative or conclusive and the matter is to be examined on the touchstone of provisions contained in the Act. Therefore, it was submitted that since the Assessee does not have any title to the assets, deduction of the rent paid by it ought to be allowed. Without prejudice, it was submitted that the assets taken on rent by the Assessee were in the nature of leasehold improvement, furniture and office equipments, which are eligible for depreciation at the rate of 10% and 15% respectively. However, the Assessing Officer has granted depreciation at the rate of 10% only. Therefore, it was submitted that the Assessing Officer may be directed to grant depreciation at the applicable rates. The ld. DR relied on the order of DRP.
44. We have heard the rival submissions. It is clear from the facts that the assessee claimed depreciation in the financial statement on the assets taken on lease only because of requirement of AS-19 of Institute of Chartered Accountants of India (ICAI). In the income tax return, the assessee has not claimed any depreciation. Since it is a payment of lease rent, the claim for deduction has to be allowed. In this regard, the decision of the ITAT Delhi Bench in the case of Bharati Hexacom Ltd. (supra) supports the plea of assessee that rental payments have to be allowed as a deduction. We therefore direct that deduction claimed by the assessee should be allowed.
45. Ground Nos. 8 & 9 are with regard to non-grant of TDS credit and MAT credit. The AO is directed to verify the claim of assessee and give credit in accordance with the law, after affording opportunity of being heard to the assessee.
46. The grounds relating to levy of interest are consequential and the AO is directed to give consequential relief.
IT(TP)A No.3170/Bang/2018 Page 31 of 32
47. In the result, the appeal by the assessee is partly allowed.
Pronounced in the open court on this 7th day of October, 2020.
Sd/- Sd/-
( B R BASKARAN ) ( N V VASUDEVAN )
ACCOUNTANT MEMBER VICE PRESIDENT
Bangalore,
Dated, the 7th October, 2020.
/Desai S Murthy /
Copy to:
1. Appellant 2. Respondent 3. CIT 4. CIT(A)
5. DR, ITAT, Bangalore.
By order
Assistant Registrar
ITAT, Bangalore.
IT(TP)A No.3170/Bang/2018
Page 32 of 32
ANNEXURE-I