Income Tax Appellate Tribunal - Chennai
Scm Microsystems (India) Pvt Ltd., ... vs Assessee on 18 February, 2013
IN THE INCOME TAX APPELLATE TRIBUNAL
'A' BENCH, CHENNAI
BEFORE SHRI ABRAHAM P.GEORGE , ACCOUNTANT MEMBER
AND SHRI VIKAS AWASTHY, JUDICIAL MEMBER
ITA No.774/Mds/2011 & Cross Objection No.198/Mds/2012
(in ITA No.774/Mds/2011)
( Assessment Year : 2005-06)
The Assistant Commissioner of Vs. M/s. SCM Microsystems (India)
Income Tax, Company Circle-VI(1), Pvt.Ltd.
Aayakar Bhavan, New Block, Module No.506, Tidel Park, Module
121, M.G.Road, 7th floor, No.4, Canal Tank Road, Taramani,
Chennai-600 034. Chennai-600 113.
PAN: AABCS3064Q
(Appellant) (Respondent/Cross Objector)
Appellant by : Mr. Shaji P.Jacob, Addl. CIT
Respondent by : Mr. R.Vijayaraghavan, Advocate
Date of Hearing : 18th February, 2013
Date of Pronouncement : 15th April, 2013
ORDER
Per Vikas Awasthy, JM:
The appeal has been filed by the Revenue impugning the order of the CIT(A)-V, Chennai dated 24.01.2011 passed under section 143(3) read with section 92C(4) of the Income Tax Act, 1961. The assessee has filed Cross Objection in support of the order of the CIT(A). However, the Cross Objection has been filed with the delay of 550 days. An affidavit in support of application for condonation of delay in filing of Cross Objection citing reasons for the delay has also 2 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 been filed. We have perused the grounds for delay in filing of the Cross Objection and are satisfied that there is a reasonable cause for delay in filing of the cross objection. In the interest of justice, we condone the delay of 550 days in filing of the cross objection. The application for condonation of delay is thus, allowed and the Cross Objection is admitted to be heard on merits.
2. The brief facts of the case are that the assessee is a wholly owned subsidiary of M/s. SCM Microsystem Group UK Ltd. The assessee is engaged in prototype design development and related supported activities based on technical specifications and product ideas obtained from the affiliates. It also undertakes product development of smart card and bio-metric readers. The activities of the assessee include design, development and testing of ASICs, hardware and software. It also maintains the smart card and bio-metric products developed by third parties. The assessee filed its return of income for the assessment year 2005-06 on 29.10.2005 declaring its income as ` 12,89,760/-. The assessee in its return has also disclosed income of 3 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 `1,61,29,367/- from business and claimed the entire said amount as deduction under section 10B of the Act. The case of the assessee was selected for scrutiny and notice under section 143(2) was issued to the assessee on 30.10.2006. The Assessing Officer made addition to the income returned by the assessee on account of telecommunication charges, amount contributed by the assessee towards employees provident fund beyond due date and adjustment towards Arm's Length price.
As regards computation of Arm's Length price in relation to international transactions, the Assessing Officer referred the issue to the Transfer Pricing Officer. The TPO vide order dated 30.7.2008 made addition to the tune of `55,88,944/- in respect of international transactions. The assessee entered into a service agreement dated 1.4.2004 with Associated Enterprises in Singapore. As per the agreement compensation for the services rendered by the assessee company was to be calculated by adopting Cost Plus an appropriate mark-up. An addendum to service 4 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 agreement was signed between the parites on 1.8.2004 specifying appropriate mark-up at 17%.
The assessee for the assessment year 2005-06 arrived at operating profit /total cost of 15.5% to benchmark the international transaction by following Transactional Net Margin Method (hereinafter referred to as "TNMM"). Vide letter dated 28.5.2008, the assessee was required to show cause why the Cost plus agreed mark up of 17% not adopted to benchmark the international transactions with the Associated Enterprises based on the service agreement with SCM, Singapore. The assessee vide letter dated 15.7.2008 gave detailed reasons for adopting TNMM and also gave reasons for variations between agreed mark up of 17% and the final calculation at 15.5%. The TPO rejected the submissions of the assessee and made addition to the tune of `55,88,944/-. The Assessing Officer vide assessment order dated 22.12.2008 made addition of the aforesaid amount in accordance with TPO's order apart from the additions made by him.
5 ITA No.774/Mds/2011 &C.O No.198/Mds/2012
3. Aggrieved against the assessment order, the assessee preferred an appeal before the CIT(A). The CIT(A) vide impugned order partly allowed the appeal of the assessee. The CIT(A) while deciding the appeal of the assessee partly allowed the ground of exclusion of telecommunication charges from the export turnover while computing the deduction under section 10B of the Act. The CIT(A) relying on the decision of the Special Bench of the Tribunal in the case of M/s. SAK Soft Limited reported as 20 DTR 514 : 313 ITR (AT) 353 directed that `5.00 lakhs being estimated telecommunication charges should be excluded from export turnover as well as total turnover while computing deduction under section 10B of the Act. The second ground of appeal before the CIT(A) was with regard to disallowance of employees contribution to provident fund after due date. The CIT(A) following the decision of the Tribunal in the case of M/s. Atlas Cycles (Haryana) Ltd., reported as 2010-TIOL-140- ITAT-Del deleted the addition made by the Assessing Officer stating that even though the amount was remitted belatedly i.e. beyond the due date but before the due date for filing of 6 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 tax return of income is allowable as deduction. In respect of third ground i.e. Transfer Pricing adjustment, the CIT(A) accepted the submissions of the assessee and deleted the entire addition made by the TPO.
Aggrieved against the order of the CIT(A), the Revenue has come in second appeal before the Tribunal .
4. Shri Shaji P.Jacob appearing on behalf of the Revenue submitted that the CIT(A) has erred in directing the Assessing Officer to exclude ` 5.00 lakhs against ` 6,46,123/- from export turnover attributable to telecommunication charges for delivery of product outside India. The DR submitted that the invoice raised by the assessee includes the cost of product including all expenses and margin of profit irrespective of whether the expenses are mentioned in the invoice or not. Therefore, it would be incorrect to say that the assessee has not claimed and got reimbursed the internet expenses incurred for the delivery of products outside India. With regard to contribution of the assessee towards employees provident fund, the DR submitted that it has been admitted by the assessee that the amount has been deposited beyond the 7 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 due date. Therefore, it has to be disallowed under section 43B read with section 36(1)(va) of the Act. On the third ground of transfer pricing adjustment, the DR submitted that as per the service agreement, arm's length price was to be calculated on the basis of Cost plus 17% as a mark-up. However, the assessee deviated from the cost plus to TNM method without any justification. The assessee has achieved profit of 15.5% only. The explanation of the assessee that revenue recognition was postponed as per Accounting Standard-9 is not tenable. The DR pointed out that the TPO in his order has categorically stated that in the transfer pricing documents, it has been mentioned that SCM group companies generally pay in advance before the commencement of the project and since the SCM is based on a cost plus method as per the service agreement, it has an assured compensation so it is not exposed to any price risks. The DR further stated that the CIT(A) has erred in stating that TPO had not given reason as to why the cost plus method Is better than TNM method. The DR strongly relied on the order 8 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 of TPO as far as calculation of arm's length price is concerned.
5. On the other hand, Shri R.Vijayaraghavan appearing on behalf of the assessee submitted that the TPO has erred in making addition on account of arm's length price. Although in the service agreement cost plus method has been mentioned, but there is no bar in adopting TNM method, as TNM method is one of the approved methods under section 92C of the Act for determining arm's length pricing in relation to international transactions. He submitted that one of the methods provided under the mechanism is to be applied for benchmarking comparable uncontrolled transactions. One of the most appropriate methods provided under section 92C of the Act has to be applied for transfer pricing arrangement for international transactions. In the instant case, the assessee had given justification before the TPO for adopting TNMM for determining the arm's length pricing with Associated Enterprises. The counsel for the assessee contended that the assessee has taken financial data of 87 companies and the arithmetic mean profit level indicator for these companies 9 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 is 13.1% as against the assessee's margin of 15.5%. The learned counsel for the assessee further submitted that it is clearly evident from the transfer pricing documents that the assessee has done billing @ 15.5% over cost and not at the agreed rate of 17%, therefore, there is no question of taking mark up of 17%.
The learned counsel for the assessee contended that the assessee has filed cross objection in support of the order of CIT(A) and assailing the order of TPO. The order of TPO is not as per the well formulated transfer pricing system. The TPO has not done any transfer pricing study. The TPO has not undertaken detailed comparison of the arm's length price of international transaction by applying appropriate mark-up to the expenses incurred. The TPO accepted the percentage of profit mentioned in service agreement as the arm's length price.
6. The AR made an alternate plea that even though the arm's length price is determined at the value mentioned in the notice, +/- 5% adjustment on the same as provided under the provisions of section 92C of the Act would result in an 10 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 adjusted price of ` 11,72,38,713/-. As against this, the value of international transaction of the company is at ` 11,78,20,228/- which is within the range. The counsel for the assessee further contended that the assessee followed TNMM over Cost Plus method as most appropriate method for the reason Cost plus method requires comparison of gross margins earned by the company with that of the comparable companies and to determine the gross margins of comparable companies on a reliable manner it is difficulty as the accounting policies adopted by the comparable companies are inconsistent and entire details are not available in the public domain.
7. We have heard the submissions made by both the parties and have also perused the orders of the authorities below. The Revenue has assailed the order of the CIT(A) primarily on three grounds.
8. The first ground is with respect to exclusion of telecommunication charges from export turnover while computing deduction under section 10B of the Act. The assessee has claimed an amount of ` 6,46,123/- towards 11 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 telecommunication charges. The assessee had excluded the said amount from export turnover in computation of deduction under section 10B of the Act. The assessee has conceded before the CIT(A) that it is not in a position to furnish break up of expenses incurred for domestic and exports. The CIT(A) made estimation of telecommunication charges to the tune of ` 5.00 lakhs as attributable towards export of software. It is an admitted fact that the assessee is in the business of export of design, development and testing of hardware and software and it was also maintaining the smart card and bio-metric products developed by third parties. Therefore, it must have incurred a substantial amount of expenditure towards telecommunication and internet charges. The CIT(A) has made fair estimation of the same. Since the Revenue has not able to produce any cogent evidence to controvert the findings of the CIT(A), we do not deem it appropriate to interfere with the same. The Revenue has also assailed the order of the CIT(A) with regard to exclusion of telecommunication charges from export turnover as well as total turnover. We find that the Special Bench of the Tribunal 12 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 in the case of SAK Soft Ltd. (supra) has held that while applying the formula prescribed under section 10B(4) of the Act, where the freight, telecommunication charges or insurance attributable to the delivery of articles or things or computer software outside India, the expenses that are to be excluded from the export turnover, should also be excluded from the total turnover as well. In view of the well settled law, this ground of appeal of the Revenue is dismissed.
9. The second ground of appeal of the Revenue relates to disallowance of employees contribution towards provident fund beyond due date. It is an admitted fact that the assessee has made contribution towards employees provident fund beyond the due date prescribed under the Provident Fund Act, but the same has been made before the due date for filing of the tax return. The Tribunal in the case of Atlas Cycles (Haryana) Ltd.(supra) has held that employee's contribution which has been remitted belatedly beyond the due date prescribed in the Provident Fund Act but before the due date for filing of tax return of income is allowable as deduction. 13 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 Respectfully following the decision of the Tribunal, this ground of appeal of the Revenue is dismissed.
10. The third and last ground of appeal of the Revenue relates to transfer pricing adjustment. The objection of the DR is with regard to the method adopted by the assessee in determining the arm's length price. As per the service agreement it was agreed to determine arm's length price on the basis of cost plus mark up of 17%, whereas the assessee had followed TNM method for determining the arm's length price . A perusal of section 92C shows that arm's length price to any international transaction shall be determined by any of the methods specified therein being most appropriate method having regard to :
i) Nature of transaction; or
ii) Class of transaction; or
iii) Class of Associated persons; or
iv) Functions performed by such persons; or
v) such other relevant factors as may be prescribed
by the Board.
14 ITA No.774/Mds/2011 &
C.O No.198/Mds/2012
The methods prescribed under section 92C(1) for determining ALP are :
1. Comparable Uncontrolled Price Method (CUP);
2. Resale Price Method;
3. Cost Plus Method;
4. Profit Split Method; &
5. Transactional Net Margin Method (TNMM) or any other method prescribed by the Board.
11. The most appropriate method has to be applied for determining arm's length price in the manner as may be prescribed in Rule 10C of the Income Tax Rules. In the instant case, the assessee followed TNMM over Cost Plus method for the reason: Cost Plus method requires comparison of gross margins earned by the company with that of the comparable companies and to determine the gross margins of the comparable companies in a reliable manner is difficult as the accounting policies adopted by the comparable companies are not consistent and the details are not available in the public domain. An agreement between the parties cannot exclude the other approved method of determining the 15 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 arm's length price as provided under the law, for the reason margin mentioned therein are between related parties. Thus, assessee has shown reasonable cause for adopting TNMM as the most appropriate method. The method mentioned in the agreement cannot be followed for comparison being related party transaction. The assessee is at liberty to adopt any of the appropriate methods specified in Section 92C of the Act, as long as it can show it to be the most appropriate method for determining the arm's length price. Therefore, contention of the DR that the assessee has deviated from the method specified in agreement i.e. Cost Plus Method to TNMM has no force.
The DR has also raised an issue that as per the agreement bench marking was cost plus 17% mark-up whereas while determining arm's length price the assessee has determined at 15.5%. The A.R. pointed out that the assessee has taken data of 87 companies and the arithmetic mean profit level indicator for these companies works out at 13.1% as against the assessee's margin of 15.5%. However, TPO has adopted cost mark-up as the correct one without 16 ITA No.774/Mds/2011 & C.O No.198/Mds/2012 verifying the appropriateness of determination of arm's length price determination under TNM method.
12. We are of the considered opinion that the TPO has not conducted the pricing study as required under the statute. The TPO has not independently determined arm's length price by taking candid transactions of unrelated parties. The TPO has erred in simply accepting the percentage of profit indicated in the service agreement between the assessee and the PE. The TPO ought to have conducted detailed study for determining arm's length price between unrelated enterprises by applying the most appropriate method as provided under section 92C of the Act.
13. In view of the above, we remit this issue back to the TPO with a direction to pass a speaking order after conducting detailed transfer pricing study select comparables and determine arm's length price as per the provisions of law. This ground of appeal of the Revenue is allowed for statistical purposes.
17 ITA No.774/Mds/2011 &C.O No.198/Mds/2012
14. In the result, the appeal of the Revenue is partly allowed for statistical purposes and the cross objection of the assessee is allowed for statistical purposes. Order pronounced in the open court on Monday , the 15th day of April, 2013 at Chennai.
Sd/- Sd/-
(Abraham P.George ) (Vikas Awasthy)
Accountant Member Judicial Member
Chennai,
Dated the 15th April, 2013.
somu
Copy to: (1) Appellant (4) CIT(A)
(2) Respondent (5) D.R.
(3) CIT (6) G.F.