Income Tax Appellate Tribunal - Delhi
Sapient Corporation Pvt. Ltd., Gurgaon vs Assessee on 12 October, 2010
ITA NO. 5263/Del/2010
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH "E" NEW DELHI
BEFORE SHRI RAJPAL YADAV, JUDICIAL MEMBER
AND
SHRI SHAMIM YAHYA, ACCOUNTANT MEMBER
I.T.A. No. 5263/Del/2010
A.Y. : 2006-07
Sapient Corporation Pvt. Ltd., vs. Dy. Commissioner of Income Tax,
C/o Pankaj Vasani, Circle 7(1),
Sapient Tower, DLF Cyber Greens, New Delhi
DLF, Phase-III, Sector-25A, (PAN : AAECS6286M)
Gurgaon - 122 022
(Appellant ) (Respondent )
Asseessee by : Sh. Ajay Vohra, Adv., Sh. Neeraj
Jain, Sh. Abhishek Aggrawal and
Sh. Pallav, CAs.
Department by : Sh. Sanjay Suri, C.I.T. (D.R.)
ORDER
PER SHAMIM YAHYA: AM This appeal by the assessee is directed against the order of the Assessing Officer dated 12.10.2010 and pertains to assessment year 2006-07.
2. The first issue raised is that Assessing Officer has erred in making addition of ` 14,79,00,000/- on account alleged difference in arms' length price of the international transactions of software development services on the basis of the order passed u/s 92CA(3) of the Act by the Transfer Pricing Officer.
3. The assessee in this case is a subsidiary of M/s Sapient Corporation, USA. The company was incorporated on March, 9, 2000 1 ITA NO. 5263/Del/2010 and was set up under the Software Technology Park Scheme of the Government of India. The assessee renders customized software development services to associated enterprises and also renders post sales support services. The assessee in the relevant assessment previous year has entered into international transactions with associated enterprises. In the Transfer Pricing documentation the assessee determined the arms' length price of the international transactions of software development and related services by applying TNMM as most appropriate method. The assessee had benchmarked its international transactions with 10 comparable companies with an average operating profit ratio (OP/TC) of 9.31%.
3.1 The final list of comparable companies is as under:-
S.No. Name of the company FY OP/TC
1. Birlasoft Ltd. 200503 -0.06%
2. Datamatics Ltd. 200409 -6.09%
3. Goldstone Technologies 200503 -1.50%
Ltd.
4. Maaars Software 200603 3.18%
International Ltd.
5. Melstar Infotech 200503 -9.17%
International ltd.
6. Prithvi Information 200603 12.48%
Solutions Ltd.
7. Quintegra Solutions Ltd. 200603 13.51%
8. RS Software India Ltd. 200603 15.29%
9. Visualsoft Technologies Ltd. 200503 15.99%
10. Zenith Infotech Ltd. 200603 49.47%
Mean 9.31%
2
ITA NO. 5263/Del/2010
The operating profit margin (OP/OC) of the assessee was computed at 12.49%.
Since the (OP/TC) earned by the assessee on transactions with the associated enterprise at 12.49% was higher than the average operating profit margin earned on similar transactions with unrelated third parties at 9.31% the international transaction of provision of software design and development services was considered to be at arms' length price.
The TPO in the course of the Transfer Pricing assessment proceedings required the assessee to submit current year data of all comparable companies considered in transfer pricing study report. Since at that time, financials of Datamatics Limited was not available, the appellant submitted current year operating results of the remaining 9 companies with an OP/TC ratio of 12.05% as follows:-
S.No. Name of the company FY OP/TC
1. Birlasoft Ltd. 200503 -2.59%
2. Goldstone Technologies 200603 0.95%
Ltd.
3. Maaars Software 200603 4.50%
International Ltd.
4. Melstar Infotech 200503 1.79%
International ltd.
5. Prithvi Information 200603 12.65%
Solutions Ltd.
6. Quintegra Solutions Ltd. 200603 13.71%
7. RS Software India Ltd. 200603 15.10%
8. Visualsoft Technologies Ltd. 200603 12.67%
9. Zenith Infotech Ltd. 200603 49.73%
Mean 12.05%
3
ITA NO. 5263/Del/2010
The TPO in his transfer pricing order has further rejected 5
comparable companies identified by the assessee on the following ground:
S.No. Name of company Reasons for rejection
1. Birlasoft Ltd. Decreasing profitability trend and sales since 3 years.
2. Goldstone Technologies Ltd. Decreasing profitability trend and sales since 3 years.
3. Maars Software International Not comparable as wages to Ltd. cost ratio only 0.24% as against 65% of the assessee.
4. Melstar Information Segmental data not Technologies Ltd. available, FOREX earring only 30%.
5. RS Software (India) Ltd. Negative net worth.
The TPO benchmarked the operating profit margin (OP/TC%) of the appellant company with the margin of the following 4 high profit making companies:
S.No. Name of the company FY OP/TC
1. Prithvi Information 200603 12.65%
Solutions Ltd.
2. Visualsoft Technologies Ltd. 200603 12.67%
3. Zenith Infotech Ltd. 200603 49.73%
4. Quintegra Solutions Ltd. 200603 13.71%
Arithmetic Mean 22.19%
Accordingly, the Transfer Pricing Officer in the order passed under
section 92CA(3) of the Act computed an adjustment of ` 14,79,00,000/-
4ITA NO. 5263/Del/2010 on account of the difference in the margin of the comparable companies and the appellant company.
4. Against the above order, the assessee is in appeal before us.
5. Assessee's submissions in this regard are summarized as under:-
"(i) The TPO has considered Zenith Infotech even though when it earning supernormal profits and does not satisfy his own additional filters:
Zenith Infotech has remarked an abnormal high profit margin of 49.73% during the financial year 2005-06 and there has been sharp increase in profitability and sales. The OP/TC during the year is summarized as follows:-
Year Mar-
Mar-04 Mar-
Mar-05 Mar-
Mar-06 Mar-
Mar-07
Sales in crores 18.28 21.90 35.37 66.97
% sales in increase
over base year Mar 04 120% 193% 366%
OP/TC 3.10% 22.27% 49.73% 87.88%
% margins increase 719% 1605% 2835%
Over base year Mar 04
It may be pointed out that Zenith Infotech is pre-dominantly software product company, while the appellant is engaged in rendering software development services. It is a matter of common knowledge that a software product company ends up earning higher margin as they are engaged in selling software products owned by them. The aforesaid is also corroborated from the facts that wages to cost ratio of Zenith Infotech is only 37.5% (which is usual case in the case of software product company) as opposed to 65% in the case of the appellant a 5 ITA NO. 5263/Del/2010 software service company. (refer page 852-855 of the supplementary paper book for brief product profile of Zenith taken from the website www.zenithinfotech.com) The DRP rejected the contention of the appellant of excluding the above company from the set of comparable companies on the ground that the said company was included in the list of comparable companies in the transfer pricing report.
Reliance in this regard is placed on the ruling of the Hon'ble Chandigarh ITA T, [ Special Bench in the case of Quark Systems Private Limited v. DCIT: 2010 38 SOT 307 while reviewing the comparability analysis of super profit compal1les provides as under:
" ..... Even if the taxpayer or its counsel had taken Datamatics as comparable in its IP audit, the taxpayer is entitled to point out to the Tribunal that above enterprise has wrongly been taken as comparable. In fact there are vast differences between tested party and Datamatics. The case of Datamatics is like that of Imercius Technologies" representing extreme positions. If Imercious Technologies has suffered heavy losses and, therefore, it is not treated as a comparable by the tax authorities, they also have to consider that Datamatics has earned extraordinary profit and has a huge turnover." (emphasis supplied) Reliance in this regard is also placed on the following decisions wherein a super profit margin company has been directed to be excluded:
Adobe Systems India (P) Ltd. v. ACIT: LT.A. No. 5043/De1/2010 Mentor Graphics (Noida) Pvt. Ltd : 109 ITD 101 E-Gain Communication Pvt. Ltd. v. DCIT: 118 ITD 243 Philips Software Centre (P) Ltd. v. ACIT: 119TTJ721 ITO v. Sunay Jewels Pvt. Ltd: ITA No. 5758/Mum/2007 6 ITA NO. 5263/Del/2010 Further, Zenith Infotech cannot be taken as comparable also for the reason that, (i) the wages to cost ratio of Zenith Infotech is 37.50% as against the wage to cost ratio of the applicant at 65% and (ii) forex earning of said company is _only 39% of the total revenue. It may be noted that the TPO has himself had rejected Melstar Information Technologies, inter alia, on the basis of low forex earnings without applying the same selection criteria while considering Zenith Infotech Ltd. as comparable company.
Computation of margin of comparable after eliminating Zenith Infotech The average of operating profit over cost of the remaining three companies after eliminating Zenith Infotech Software is as follows:
S. No. Name of the company FY OP/TC
1. Prithvi Information Solutions 200603 12.65%
Ltd.
2. Visualsoft Technologies Ltd. 200603 12.67%
3. Quintegra Solutions Ltd. 200603 13.71%
Arithmetic Mean 13.01 %
Since the OP/TC of the appellant at 12.49% is within the safe harbor range of (+/-)5% as per the proviso to section 92C(2) of OP/TC margin of 3 comparable companies at 13.01%, no adjustment is warranted on account of difference in arm's length price of the international transaction.
(ii) Rejection on the basis of additional filters In addition to the filter of wages/cost ratio, the TPO in his order has applied the following additional filters:7
ITA NO. 5263/Del/2010 a. Forex earning b. Declining operating results and sales c. Negative networth It is submitted that that the additional filters have been used by the TPO to suit his requirement and to arrive at predetermined results. It would be appreciated that rejection of the companies on the basis of the profit margin, rather than functional or asset profile, would not meet the comparability standard required in application of the "TNMM' method, which is selected by the appellant as the most appropriate method for benchmarking. It is a settled position that under the transfer pricing regulation, the comparability is to be judged with reference to functions performed, assets utilized and risk assumed (FAR) and the aforesaid functions parameters such as declining operating results and sales, etc., are not the relevant consideration.
Reliance in this regard is placed on the following decisions:
a. Mentor Graphics (Noida) Private Limited: 109 ITD 101 b. E-Gain Communication Pvt. Ltd. 118 ITD 234 c. Aztec Software India Pvt. Limited: 107 ITD 141 d. Sony India Pvt. Limited: 114 ITD 448 e. Philips Software: 26 SOT 226 f. Quark Systems Pvt. Limited v. DCIT: ITA NO.1 00 & 115/CHD/2009 g. DCIT vs Indo American Jewellery Ltd.: 131 TTJ 163" '
6. Alternatively the assessee had made fresh data base to identify comparables companies. According to which the average PLI is 12.60%. Assessee has claimed that since the operating profit ratio of the assessee at 12.49% is within the safe harbor of (+/-) 5% provided in section 92(2) of the Act with respect to the average of operating profit margin of the above comparable companies, i.e. 12.49%, the 8 ITA NO. 5263/Del/2010 international transaction entered into by the assessee with associated enterprises, are, therefore, considered being at arms length price on the applying TNMM. The DRP however, did not deal with the aforesaid fresh set of comparable placed on record by the assessee.
7, Ld. Departmental Representative on the other hand has submitted that Zenith Infotech was chosen by assessee itself in the list of comparables. Hence, the assessee cannot agitate against its inclusion. The Ld. Departmental Representative further claimed that assessee has raised perfunctory objection before the authorities below regarding exclusion of Zenith Infotech in the comparable. Hence the matter was not dealt with in detail by the TPO or the DRP. In the rejoinder, ld. counsel of the assessee has submitted that all the necessary documentation in this regard were before the TPO and the DRP. Ld. counsel of the claimed that if loss making companies were taken out by the TPO from the comparables, Zenith Infotech Ltd.
which had shown super normal profits should also be excluded. Ld. counsel of the assessee further claimed that there is no estoppels against the assessee. Now assessee has claimed that Zenith Infotech is not comparable. Ld. counsel further claimed that there cannot be any motive to the assessee as the entire income is exempt u/s 10A.
8. We have heard the rival contentions in light of the material produced and precedents relied upon. We find that TPO in his order 9 ITA NO. 5263/Del/2010 has rejected the five comparables companies identified by the assessee. the TPO benchmarked the operating profit margin by the assessee company with four profit making companies, which excluded Zenith Infotech Ltd. The margin of these companies are as under:-
S.No. Name of the company FY OP/TC
1. Prithvi Information 200603 12.65%
Solutions Ltd.
2. Visualsoft Technologies Ltd. 200603 12.67%
3. Zenith Infotech Ltd. 200603 49.73%
4. Quintegra Solutions Ltd. 200603 13.71%
Arithmetic Mean 22.19%
8.1 Now it is the contention of the assessee that when loss making companies were taken out from the comparables by the TPO, the super profit earning company, Zenith Infotech Ltd. should also be removed from the comparables. Ld. counsel of the assessee further claimed that this company does not satisfy TPO's own additional filters. It has been submitted that Zenith Infotech Ltd. has shown abnormal high profit margin. It has been submitted that Zenith Infotech Ltd. is predominantly software product company, while the assessee is engaged in rendering software development services. It has been submitted that software product company ends up earning higher margin as they are engaged in the selling of software products owned by them. Upon careful consideration, we find ourselves in agreement with the assessee's contention that when the loss making companies 10 ITA NO. 5263/Del/2010 have been taken out from the list of comparables by the TPO, Zenith Infotech Ltd. which showed super profits should also be excluded. The fact that assessee has himself included in the list of comparables, initially cannot act of estoppel particularly in light of the fact that Assessing Officer has only chosen the companies which are showing profits and has rejected the other companies which showed loss. In this regard reliance can be placed upon ITAT Special Bench decision in the case of Quark System vs. DCIT (2010) 38 SOT 307, which supports assessee contention of removal of Zenith Infotech from comparables, as it showed super profits. Furthermore, it is noted that Zenith Infotech is predominately software product company, while the assessee is engaged in rendering software development services. It is found that software product company shows higher margin. This is also corroborated by the fact that wages to cost ratio of Zenith Infotech is only 37.5% as opposed to 65% of assessee company. Hence, we are of the considered opinion that when loss making companies have been removed from comparables by the TPO, assessee is right in contending that Zenith Infotech should also be removed as it showed super profits. As submitted in the chart in preceding paragraph the average of operating profit over cost of the remaining three companies after eliminating Zenith Infotech Software is as follows:
S. No. Name of the company FY OP/TC
1. Prithvi Information Solutions 200603 12.65%
Ltd.
2. Visualsoft Technologies Ltd. 200603 12.67%
3. Quintegra Solutions Ltd. 200603 13.71%
Arithmetic Mean 13.01 %
11
ITA NO. 5263/Del/2010
Since the OP/TC of the appellant at 12.49% is within the safe harbor range of (+/-)5% as per the proviso to section 92C(2) of OP/TC margin of 3 comparable companies at 13.01%, no adjustment is warranted on account of difference in arm's length price of the international transaction.
8.2 The contention of the Ld. Departmental Representative that assessee has not vigorously agitated the issue of inclusion of Zenith Infotech before the authorities below is not acceptable, as all the necessary documents for assessee's contention in this regard were before the authorities below.
8.3 In the background of the aforesaid discussion, we delete the addition made by the Assessing Officer with regard to arms' length price.
9. The next issue raised is that Assessing Officer has erred in making disallowance of 1,18,31,549/- out of expenditure on advertisement and sale promotion and recruitment and training expenses. aggregating to ` 1,57,75,411/- holding that such expenses were incurred for better sales and turnover and contribution to the profits of the business and hence benefit of which expenditure accrued to the assessee over the years.
10. On this issue the Assessing Officer noted that as per the profit and loss account the assessee company has claimed expenditure of ` 1,29,25,617/- on account of recruitment and training expenditure and ` 28,49,794/- on account of advertisement and sales promotion expenses.
12ITA NO. 5263/Del/2010
11. Assessing Officer was of the opinion that these expenditures has given the assessee benefit spread over a certain number of years. In this regard, assessee has contended that Income Tax Law does not provide 'concept of deferred revenue expenditure'. Assessing Officer did not accept this proposition and he held that the above said expenditure leads to an enduring benefit to the assessee company. Accordingly, only 25% of the expenditure of ` 39,43,852/- was allowed and the balance amount of ` 1,18,31,559/- was disallowed and added to the total income of the assessee company.
12. Against the above order the assessee is in appeal before us.
13. Assessee has submitted that the aforesaid expenditures are incurred on revenue account and did not result in any enduring benefit in the capital field. Further, there is no concept of deferred revenue expenditure under the Income Tax Act and expenses are to be allowed deduction in full in the order in which they are incurred. In this regard, assessee placed reliance of catena of case laws. It has further been submitted that the Ld. Commissioner of Income Tax (Appeals) in assessee case for A.Y. 04-05 vide order dated 8.11.2007, deleted the similar disallowance made by the Assessing Officer in that year. It has been claimed that department has accepted the findings of the Ld. Commissioner of Income Tax (Appeals) with respect to disallowance of recruitment and training expenses and advertisement expenses and did not appeal to the Tribunal on this account.
14. Ld. Departmental Representative relied upon the orders of the Assessing Officer .
15. We have heard the rival contentions in light of the material produced and precedents relied upon. We find that it is not the case 13 ITA NO. 5263/Del/2010 here that the expenses are bogus and not incurred. It has also not the case that the entire expenses falls under the realm of capital expenses. The Assessing Officer is of the opinion that only 25% of the expenditure should be allowed during the year and the rest has to be added to the income of the assessee. We find ourselves in agreement with the contention of the ld. counsel of the assessee that there is no concept of deferred revenue expenditure under the IT law. The expenditure of account of recruitment and training expenses and advertisement and sales promotion expenses cannot be said to be capital expenditure. Under these circumstances, Assessing Officer's action in this regard is not sustainable. Moreover, we note that similar disallowance were deleted by the Ld. Commissioner of Income Tax (Appeals) in the assessment year 2004-05 against which the department did not file appeal before the Tribunal.
16. In the background of the aforesaid discussion and precedent, we delete the disallowance made in this regard.
17. In the result, the appeal filed by the assessee is allowed.
Order pronounced in the open court on 06/05/2011.
Sd/- Sd/-
[RAJPAL YADAV]
YADAV] [SHAMIM YAHYA]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Date 06/05/2011
SRB
Copy forwarded to: -
1. Appellant 2. Respondent 3. CIT 4. CIT (A)
5. DR, ITAT
TRUE COPY
By Order,
14
ITA NO. 5263/Del/2010
Deputy Registrar,
ITAT, Delhi Benches
15