IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : I : NEW DELHI
BEFORE SHRI R.S. SYAL, AM AND SHRI A.T. VARKEY, JM
ITA No.240/Del/2015
Assessment Year : 2010-11
Techbooks International Pvt. Ltd., Vs. DCIT,
A-37, Sector 60, Circle-3,
Noida. Noida.
PAN: AAACT6050A
(Appellant) (Respondent)
Assessee By : Shri C.S. Aggarwal, Sr. Advocate &
Shri R.P. Mall, Advocate
Department By : Shri R.K. Jha, Sr. DR &
Shri Vijay Choudhary, Sr. DR
Date of Hearing : 02.07.2015
Date of Pronouncement : 06.07.2015
ORDER
PER R.S. SYAL, AM:
This appeal by the assessee emanates from the final assessment
order passed by the Assessing Officer (AO) on 22.12.2014 under
section 143(3) read with section 144C of the Income-tax Act, 1961
ITA No.240/Del/2015
(hereinafter also called `the Act') in relation to the assessment year
2010-11.
2. The first major issue raised in this appeal is against the addition
made by the AO on account of transfer pricing adjustment to the tune of
Rs.20,48,76,996/- in the international transaction of `Provision of IT
Enabled data conversion services' (hereinafter also referred to as `the
ITES' for brevity). Succinctly, the assessee was incorporated as a
wholly owned subsidiary of Aptarausa. It is engaged in the development
of customized electronic data. It converts data from hard copy or files
into XML/SGML/HTML, creating electronic style files and modifying
the user interface for CD-ROM delivery. In the process, raw data
received from the customers in hard copy/electronically, is converted
into electronic form. Thereafter, the data is arranged and formatted.
Thus, it can be said that the assessee is primarily engaged in providing
ITES to its associated enterprise (AE). Apart from certain
reimbursement of expenses, the assessee reported an international
transaction of `Provision of IT enabled data conversion services' with
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the transacted value of Rs.129,58,11,907/-. The assessee adopted the
transactional net margin method (TNMM) as the most appropriate
method for demonstrating that this international transaction was at arm's
length price (ALP). On a reference made by the AO to the Transfer
Pricing Officer (TPO) for determining the ALP of the assessee's
international transactions, the latter accepted the TNMM as the most
appropriate method. However, the use of multiple-year data was
discarded. After considering the Transfer pricing study report along
with various objections raised by the assessee during the course of
proceedings before him, the TPO shortlisted nine comparable companies
with their arithmetic mean of the Profit level indicator (PLI) of
Operating Profit/Operating Costs (OP/OC) at 33.71%. By applying this
profit margin to the operating costs incurred by the assessee in
rendering the ITES, the TPO worked out a transfer pricing adjustment of
Rs.20,48,76,996/-. The assessee largely remained unsuccessful before
the Dispute Resolution Panel (DRP). That is how, the AO made
addition of Rs.20.48 crore on account of transfer pricing adjustment in
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the international transaction of `Provision of IT enabled data conversion
services.' The assessee is in appeal against this addition.
3. We have heard the rival submissions and perused the relevant
material on record. The assessee has agitated certain issues about
determination of the ALP of the international transaction of the
provision of ITES before us, which we will consider herein below.
I. FOREIGN EXCHANGE FLUCTUATION GAIN/LOSS
4.1. The first issue argued before us is against the exclusion of foreign
exchange fluctuation gain/loss from the operating revenue/cost of the
assessee as well as the comparables. We find merit in the contention
raised on behalf of the assessee about the inclusion of foreign exchange
gain/loss in the operating revenue/costs of the assessee as well as that of
the comparables. When we advert to the nature of such foreign exchange
gain earned by the assessee, it prima facie appears that the same is in
relation to the revenue earned from its AE in connection with the
provision of the ITES. When the foreign exchange gain directly results
from the consideration received for rendering ITES to AE, we fail to
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appreciate as to how such foreign exchange fluctuation gain can be
considered as non-operating. What is true for foreign exchange gain
from the transactions of the revenue nature being considered as part of
operating revenue is equally true for the foreign exchange loss being
considered as part of operating costs from the transactions of the revenue
nature.
4.2. The Special Bench of the Tribunal in ACIT Vs Prakash I.
Shah (2008) 115 ITD 167 (Mum)(SB) has held that the gain due to
fluctuations in the foreign exchange rate emanating from export is its
integral part and cannot be differentiated from the export proceeds
simply on the ground that the foreign currency rate has increased
subsequent to sale but prior to realization. It went on to add that when
goods are exported and invoice is raised in currency of the country
where such goods are sold and subsequently when the amount is realized
in that foreign currency and then converted into Indian rupees, the entire
amount is relatable to the exports. In fact, it is only the translation of
invoice value from the foreign currency to the Indian rupees. The
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Special bench held that the exchange rate gain or loss cannot have a
different character from the transaction to which it pertains. The Bench
found fallacy in the submission made on behalf of the Revenue that the
exchange rate difference should be detached from the exports and be
considered as an independent transaction. Eventually, the Special Bench
held that such exchange rate gain arising from exports cannot be viewed
differently from sale proceeds.
4.3. In the context of transfer pricing, the Bangalore Bench of the
Tribunal in SAP Labs India Pvt. Ltd. Vs ACIT (2011) 44 SOT 156
(Bangalore) has held that foreign exchange fluctuation gain is part of
operating profit of the company and should be included in the operating
revenue. Similar view has been taken in Trilogy E Business Software
India (P) Ltd. Vs DCIT (2011) 47 SOT 45 (URO) (Bangalore). The
Mumbai Bench of the Tribunal in S. Narendra Vs Addtl. CIT (2013) 32
taxman.com 196 has also laid down to this extent. In view of the
foregoing discussion, we are of the considered opinion that the amount
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of foreign exchange gain/loss arising out of revenue transactions is
required to be considered as an item of operating revenue/cost.
4.4. Since, the TPO has computed PLI of the assessee as well as
comparables by ignoring the amount of forex gain/loss, we set aside the
impugned order and remit the matter to the file of TPO/AO to recompute
the assessee's margin as well as that of the comparables by considering
foreign exchange gain/loss as an item of operating revenue/cost. We
want to make it clear that our finding in this regard is restricted to
considering forex gain/loss from the transactions of the revenue nature
as part of operating revenue/cost. If some part of forex gain/loss turns
out to be relatable to transactions on capital accounts, then that part
cannot be considered as part of operating revenue/cost. Similar view has
been taken by the Tribunal in the assessee's own case for the
immediately preceding assessment year, namely, 2009-10, a copy of
which order has been placed on page 908 of the paper book.
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II. BANK CHARGES
5.1. The ld. AR submitted that the bank charges incurred by it should
have been considered as non-operating expenses which have been taken
by the TPO as operating expenses. It was further submitted that the
TPO erred in making an effective comparison of the operating costs by
considering such bank charges as non-operating in the case of
comparables.
5.2. Having heard both the sides and perused the relevant material on
record, it is obvious that the assessee incurred bank interest which has
been treated as non-operating. There is, as such, no bifurcation available
of the bank interest and bank charges in the Annual accounts of the
assessee. It is noticed that the assessee is not aggrieved against the
treatment of bank interest as non-operating. We do not see much
difference between the nature of bank charges and bank interest. As the
amount of bank interest has been admitted as an item of non-operating
expense, the amount of bank charges also assumes the same character as
that of bank interest. In our considered opinion, both the bank charges
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as well as bank interest should have been considered as non-operating in
the case of the assessee as well as comparables. The TPO is directed to
verify whether the treatment of bank interest and bank charges in the
case of the assessee's computation of ALP and that of the comparables
is in accordance with our above observations. Needless to say, the
assessee will be afforded a reasonable opportunity of being heard.
III. PROVISION FOR DOUBTFUL ADVANCES
6.1. The ld. AR contended that the TPO erred in taking Provision for
doubtful advances amounting to Rs.17,11,167/- as operating in its case
and provision for doubtful debts as non-operating in the case of the
comparables. In the oppugnation, the ld. DR submitted that there is no
amount of provision for `doubtful debts' in the case of the assessee for
the year in question and the only provision appearing in its books is that
of `doubtful advances'.
6.2. Having heard both the sides and perused the relevant material on
record, we find that the assessee has not created any provision for
`doubtful debts'. The only provision made by it is of `doubtful
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advances'. Both the provision for bad debts as well as doubtful
advances are in the realm of the operations of the business. It is not the
case of the either side that the assessee made any excess provision. In
our considered opinion, the same has been rightly taken as an item of
operating expense of the assessee. The TPO is directed to treat the
amount of provisions for doubtful debts/advances as operating in the
case of the comparables as well.
IV. RISK ADJUSTMENT
7.1. The ld. AR vehemently argued that the TPO erred in not allowing
any risk adjustment. It was submitted that the assessee is a captive unit
providing ITES to its AE alone, thereby running no risk of any bad debts
etc. Per contra, the ld. DR opposed the grant of risk adjustment by
relying on the relevant parts of the order of the TPO.
7.2. We have heard the rival submissions and perused the relevant
material on record. The TPO has referred to several tribunal decisions in
which risk adjustment has been denied to the assessee. At the same
time, the ld. AR has also drawn our attention towards some of the
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tribunal decisions, in which such an adjustment has been allowed. In
fact, there cannot be a general rule of allowing or not allowing risk
adjustment. Risk is nothing but a possible adverse perception in the
given circumstances, which may or may not finally fructify. Generally,
risks and rewards go side by side. Higher the risk, more the profit; and
vice versa. Level of risk depends on the facts and circumstances of each
case. Where the assessee succeeds in ably demonstrating that the
comparables finally selected bore relatively more risks than it, then there
should be no denial of the risk adjustment. If, however, the assessee
fails in specifically pointing out the extra risks undertaken by the
comparables, then, of course, there cannot be any question of granting
risk adjustment. Under the transfer pricing regime, initial onus is always
on the assessee to show the reasons for claiming any specific adjustment
by pointing out differences between it and the comparables. Risk
adjustment can be allowed provided the assessee places on record some
appropriate material to demonstrate that the risks undertaken by the
comparable companies were relatively more than it, warranting
downward adjustment in their profit rates. Further, the variation in such
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risks, if any, should be capable of quantification on some reasonable and
logical basis.
7.3. The ld. AR stated before us that the assessee was not having any
risk at all inasmuch as its services were to be compensated by the AE
with an appropriate mark-up in comparison with the full-fledged risk
bearing comparable companies. We are not inclined to accept such a
generalized and bald statement. The mere fact that the assessee is a
captive unit rendering ITES to its AE alone, does not per se make it a
no-risk entity. There are several risks attached to such entities dealing
with a single customer. If such lone customer, on whom the enterprise's
entire survival depends, closes down its business either voluntarily or
due to reasons beyond his control, the possibility of realization of debts
for the services already rendered, becomes a potential risk. Further, the
fear of termination of agreement between such an enterprise and the
solitary customer also poses a grave threat to the existence of such an
enterprise. In that sense of the matter, an enterprise serving a single
customer, also assumes marked risks. As the assessee is wholly
dependent on its AE for securing business, its entire existence also
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depends on the same AE. If such AE runs out of business or its business
is reduced, the assessee is bound to bear severe jolts. The contention of
the ld. AR that the assessee did not have any risk is prima facie not
acceptable in view of Schedule 13 of its Profit & Loss Account
containing details of operating and other expenses. It transpires from
such Schedule that the assessee has claimed deduction for `Provision for
doubtful advances' amounting to Rs.17,11,167/-. On a pointed query,
the ld. AR submitted that this provision was created in respect of
expenses incurred by the assessee in rendering the services to the AE
and not on the realization of sale proceeds. We fail to appreciate the
rationale of this contention that the assessee assumes no risk of
realization of invoices from its AE, but there may be a risk of advances
given for expenses incurred during the course of rendering services.
Ultimately risk is risk, whether it is of realization of invoices or of
advances given for conducting operations. Since the aspects of incurring
expenses and earning revenue are two sides of the same coin, we find
that the existence of risk to the assessee cannot be denied. Be that as it
may, it is further found that though there is no Provision for doubtful
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debts (arising from realization of invoices) during the year, but, the
assessee did create provision for doubtful debts in the preceding year
amounting to Rs.10,79,665/-. This provision for bad debts is from the
revenue side. To contend that the assessee was not running any risk in
providing the services is, therefore, patently incapable of acceptance.
Since the ld. AR has failed to objectively demonstrate the relatively
higher risks undertaken by the comparables on an overall basis vis-à-vis
the assessee, we are disinclined to grant any risk adjustment.
V. SELECTION OF COMPARABLES
8. The assessee is aggrieved against the inclusion of five companies
in the list of comparables and the exclusion of six companies selected by
it. In order to analyze whether the disputed companies are comparable
or not, we need to concentrate on the nature of work performed by the
assessee. It is has been noted above that the assessee is engaged in
rendering ITES by converting data from hard copy or files into
XML/SGML/HTML, thereby processing raw data received from the
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customers in hard copy/electronically into electronic form, which is
then arranged and formatted.
A. Challenge to the inclusion of some companies.
9.1. Firstly, we will deal with the companies which have been included
by the TPO in the final set of comparables and the assessee claims them
to be incomparable. A submission common to some of such companies
was made by the ld. AR that certain Benches of the Tribunal in other
cases have held them to be not comparable. In that view of the matter, it
was urged that those companies, being ex facie incomparable, be
automatically excluded from the list of comparables drawn by the TPO.
9.2. We express our reservations in accepting such a broad proposition.
It is axiomatic that if company `A' is functionally different from
company `B', then, such company cannot be considered as comparable.
Two companies can be considered as comparable when both are
discharging the overall similar functions, though there may be some
minor differences in such functions, not marring the otherwise
comparability. Notwithstanding the functional similarity, many a times a
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company ceases to be comparable because of other reasons as well. To
cite an example, if company `A', though functionally similar to
company `B', but has related party transactions (RPTs) breaching a
particular level, then, such company cannot be considered as comparable
to company `A' in the year in which the RPTs breach such a level. If,
however, in the subsequent year, the related party transactions fall below
that barrier, then such company would again become comparable. To put
it simply, if company `A' has been held to be incomparable vis-a-vis
company `B', then it is not essential that company `A' would be
incomparable to company `C' also. What is relevant to consider is,
firstly, the functional profile of company `A' vis-a-vis company `C'. If
both are functionally similar, then notwithstanding the fact that company
`A' was held to be incomparable to company `B', it may still be
comparable to company `C'. Despite the fact that company `A' is
functionally similar to company `B', it may still have been declared as
incomparable to company `B' because of other relevant reasons. If
company `A' passes the same reasons vis-a-vis company `C', then
company `A' will find its place in the list of comparables of company
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`C', notwithstanding the fact that it was held to be incomparable to
company `B'. The crux of the matter is that the mere fact that company
`A' has been held to be not comparable in a judicial order passed in the
case of company `B', does not per se make it incomparable in all the
subsequent cases to follow. Not only company `A' held to be
incomparable to company `B' can be comparable to company `C', but
company `X' held to be comparable to company `Y' can also be
incomparable to company `Z', depending upon the functional profile and
the applicability or otherwise of the related factors. There can be no
hard and fast rule that if a particular company has been held to be not
comparable in the case of another company, then such former company
would also cease to be comparable to the assessee company also. The
comparability of each company needs to be ascertained only after
matching the functional profile and the relevant reasons of the other
company. Ergo, this contention raised on behalf of the assessee cannot
be accepted. With the above parameters and the factual matrix, we will
distinctly examine the companies chosen by the TPO to ascertain if they
are really comparable.
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i) Accentia Technologies Ltd.
10.1.1. The assessee objected to the inclusion of this company in the
list of comparables on several reasons including peculiar economic
circumstances owing to acquisition of Asscent Infoserve Pvt. Ltd. during
the financial year relevant to the assessment year under consideration.
The TPO discussed the functional comparability of this company and, in
the ultimate analysis, came to hold that it was functionally comparable
with the assessee company and hence includible.
10.1.2. We have heard the rival submissions and perused the relevant
material on record. We have also gone through the Annual report of this
company, a copy of which has been placed on page 435 onwards of the
paper book. Notes to Accounts of this company, which have been
placed on page 443 of the paper book, indicate about the amalgamation
of Asscent Infoserve Pvt. Ltd. with it as approved by the shareholders in
the court convened meeting held on 25.4.2009 and, subsequently,
sanctioned by the Hon'ble High Court on 21.8.2009. The Mumbai
Bench of the Tribunal in Petro Araldite (P) Ltd. Vs. DCIT (2013) 154
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TTJ (Mum) 176, has held that a company cannot be considered as
comparable because of exceptional financial results due to
mergers/demergers. Similar view has been bolstered by the Delhi Bench
of the Tribunal in several cases including Ciena India Pvt. Ltd. Vs. DCIT
(ITA No.3324/Del/2013) vide its order dated 23.4.2015. In view of the
fact that there was merger of Asscent Infoserve Pvt. Ltd. with Accentia
Technologies Ltd. by way of amalgamation during the year itself, we
hold that this company cannot be considered as comparable due to this
extra-ordinary financial event. Accordingly, the same is directed to be
excluded from the final list of comparables.
ii) TCS E-Serve International Ltd.
10.2.1. The assessee objected to the inclusion of this company on the
ground that it provided financial information processing and customer
contact services with high level of foreign expenditure and abnormal
profits. The TPO noticed that this company was also offering ITES. He
did not treat high turnover of this company as a relevant factor in
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considering the comparability. Eventually, this company was included in
the final set of comparables.
10.2.2. We have heard the rival submissions and perused the relevant
material on record. Relevant parts of the Annual report of this company
are available on pages 458 onwards of the paper book. Notes to
Accounts indicate that this company is engaged in the business of
providing IT enabled services/BPO services primarily to Citigroup
entities globally. The operations of this company : `broadly comprise of
transaction processing and technical services. Transaction processing
includes the broad spectrum of activities involving processing,
collections, customer care and payments in relation to the services
offered by Citigroup to its corporate and retail clients. Technical
services involve software testing, verification and validation of software
at the time of implementation and data centre management activities.'
It is manifest that this company is engaged in rendering BPO services to
the banking and financial services industry (BFSI) and Travel, Tourism
and Hospitality (TTH). It is providing services to BFSI and TTH and
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such services include `Transaction processing' and `Technical services'.
In other words, the remuneration of this company from the above
referred two segments includes compensation for rendering `Technical
services' and `Transaction processing'. Insofar as the `Transaction
processing' services are concerned, these are ITES, which are broadly
similar to those rendered by the assessee, though not specifically similar.
However, the `Technical services' involve software testing, verification
and validation of software item, implementation and data centre
management activities. The `Technical services' rendered by this
company are in the nature of servicing and maintenance of software. At
this stage, it is relevant to note that a company providing software
services may be of two types, viz., a company providing software
development services and a company providing software services other
than software development services (hereinafter also called `a company
providing non-development software services'). In order to properly
appreciate the vital difference between these two types of companies, it
is significant to note that a company which develops software is called a
company rendering software development services. Software
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development services also include maintenance of software and updation
of the software so as to suit the ever changing requirements of the users.
A company using, inter alia, a software for obtaining the desired results,
is called a company providing non-development software services. Thus,
it is crystal clear that there is a phenomenal difference between a
company providing software development services and a company
providing software non-development services in terms of expertise,
professional qualification and experience required for rendering such
services. A company providing software non-development services
performs a relatively low-end service. Thus the line of distinction is that
whereas a company providing software development services helps in
the creation, maintenance or updation of a software, on the other hand, a
company providing non-development software services obtains the
desired result with the use of an existing software. Further, whereas the
output of the former is a software in itself or a stage in the ultimate
creation of a software, the output of the later is the processed
information from the raw data obtained with the help, inter alia, of a
software. From the above discussion, it is overt that a company
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providing software development services is distinct from and
incomparable with a company providing non-development software
services.
10.2.3. We find that the assessee is a company providing non-
development software services, in the nature of conversion of data from
hard copy or files into electronic format. The assessee is not providing
any software development services to its AE. On the other hand, this
company is also providing `Technical services' to its AE involving
software testing, verification and validation of software, which are akin
to software maintenance services falling, within the overall category of
software development services. The TPO has taken entity level figures
of TCS E-Serve International Ltd. for comparison. There is no
bifurcation available in respect of the revenues of this company from
Transaction processing (which are in the nature of ITES, the same as
provided by the assessee) and Technical services (which are in the
nature of software development, absent in the assessee's case). In the
absence of the availability of any such segregation of the total revenue
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of this company, it is not possible to separately consider its profitability
from rendering of `Transaction processing services'. As such, the entity
level figures render this company as unfit for comparison. Ergo, we
order for the removal of this company from the final set of comparables.
iii) TCS e-Serve Ltd.
10.3.1. The TPO proposed to treat this company as comparable. The
assessee objected to its inclusion by contending that it was providing
financial information processing and customer contact services with
high operating revenue and peculiar economic circumstances leading to
abnormal profits. The TPO repelled the assessee's objections and
included it in the final set of comparables.
10.3.2. We have heard the rival submissions and perused the relevant
material on record. A copy of the Annual report of this company is
available on page 466 of the paper book. The company's overview has
been discussed on page 467 of the paper book, which divulges that this
company : "is in the business of providing business process management
services in the banking and financial services (BFSI), vertical ( i.e.
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industry vertical) to help its customers achieve their business objectives
by providing innovative best-in-class services." We find that this
company is also providing ITES. Unlike TCS e-Serve International
Ltd., this company is not providing any technical services involving
software testing, verification and validation of software etc. Since the
functional profile of this company on a broader basis is no different from
that of the assessee, both being involved in rendering ITES, we are not
inclined to treat this company as incomparable. The ld. AR argued that
the nature of the ITES provided by this company is different from that of
the assessee and hence the same be excluded. We are disinclined to
sustain this objection. Matching of the exact functional similarity is
dispensed with under the TNMM, which is not so under the Comparable
uncontrolled price method. The TNMM approves comparability on the
basis of broader overall similarity. When we consider the nature of
services provided by this company, being the ITES, which is similar to
that of those rendered by the assessee, again the ITES, we cannot order
its exclusion simply for the reason that the verticals of ITES are
somewhat different. If one goes to make a comparison in the way
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suggested by the ld. AR under the TNMM, then it will be very difficult,
if not impossible, to find out a ditto comparable. A company which
satisfies the broader parameters of comparability in the overall same
segment, cannot be excluded due to somewhat different nature of such
overall activity. An examination of the comparables chosen by the
assessee, which have been accepted by the TPO, also satisfy only the
test of overall similarity and not the peculiar similarity, as has been now
contrastly contended for the exclusion of this company. This argument,
therefore, fails.
10.3.3. In so far as the objection of the ld. AR about the high
profit/high turnover of this company is concerned, we find that the
Hon'ble Delhi High Court in ChrysCapital Investment Advisors (India)
P. Ltd. Vs. DCIT has held , vide its judgment dated 27.4.2015, that high
profit or high turnover is not a criteria to exclude an otherwise
comparable company. It is further noticed that the Hon'ble Delhi High
Court in CIT Vs. Agnity India Technologies (P.) Ltd. (2013 ) 219
Taxman 26 (Del) examined the comparability of Infosys Technologies
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from the angle of its inclusion or otherwise in the list of comparable of
Agnity India Technologies, a captive unit providing ITES to its AE
alone. In that case, the TPO treated three companies as comparable,
namely, Satyam Computer Service Ltd., L&T Infotech Ltd. and Infosys
Technologies. The DRP excluded Satyam Computer only. The Tribunal
excluded only Infosys Technologies Ltd., by impliedly retaining L&T
Infotech Ltd. as a good comparable. On appeal by the Revenue, the
Honourable High Court upheld the Tribunal order excluding Infosys on
the strength of certain relevant distinguishing features including its
giantness in terms of sales, nature of work and other factors. Thus it
follows that L&T Infotech Ltd., which is otherwise a vast company with
much higher turnover, finally found the status of a comparable with a
captive company providing ITES to its AE alone.
10.3.4. Coming back to the facts of our case, we find that since TCS e-
Serve Ltd. is functionally comparable with the assessee company on an
overall basis and no special reasons for its higher profit/turnover have
been brought to our notice. Consequently, we hold that the authorities
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below were justified in including this company in the list of
comparables.
iv) i-Gate Global Solutions Sdn. Bhd.
10.4.1. The TPO included this company in the list of comparables
despite the assessee's objections about such company offering both IT
and ITES services and the peculiar circumstance of amalgamation of i-
Gate Global Solutions Sdn. Bhd., with this company during the financial
year 2009-10.
10.4.2. We have gone through the Annual report of this company
which is available on page 446 onwards of the paper book. Notes to
accounts of this company indicate amalgamation of i-Gate Global
Solutions Sdn. Bhd. This amalgamation took place with the approval of
the members of the company on 12.8.2009 and subsequently sanctioned
by the Hon'ble High Court by its order dated 24.2.2010. As the
financial results of this company also include the results of
amalgamating company, in our considered opinion, this is an
extraordinary financial event, which renders it unfit for comparison with
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the assessee company. While discussing the comparability of Accentia
Technologies Ltd. (supra), we have referred to certain decisions in
which it has been held that a company loses the tag of comparability due
to amalgamations, mergers, etc., taking place during the year in
question. Adopting the same reasoning, we order for the exclusion of
this company from the list of comparables.
v) Infosys BPO
10.5.1. The TPO included this company in the list of comparables.
The assessee's objections against its inclusion were overturned.
10.5.2. After considering the rival submissions and perusing the
relevant material on record, we find from the Annual report of this
company, which is available on page 449 onwards of the paper book,
that there was acquisition by this company of McCamish Systems LLC.
Such information is available on page 456 of the paper book.
Acquisition of McCamish Systems LLC during the year, being an
extraordinary financial event, renders it incomparable. Following the
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reasons taken note of above, we order for the elimination of this
company from the final set of comparables.
B. Challenge to the exclusion of some companies.
11. The assessee is aggrieved against the exclusion of six companies
from the final set of comparables by the TPO. We will deal with these
companies hereinafter.
i) R. Systems International Ltd. (Seg.); Jindal Intelicom Pvt. Ltd.;
and Caliber Point Business Solutions Ltd.
12.1.1. The assessee included these three companies in its list of
comparables. However, the TPO eliminated R. Systems (Seg.) on the
ground that it was following different year ending, namely, 31st
December and, hence, was not comparable. Jindal Intelicom Pvt. Ltd.,
was excluded on the ground that March, 2010 ending financials of the
company were for 15 months. Since the annual figures for the financial
year ending 31.3.2010 were not available, this company was also
rejected. Caliber Point Business Solutions Ltd. was also rejected because
of different year ending. The ld. AR fairly accepted that the above
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referred three companies were either following calendar year for
maintaining their accounts or their figures were for more than 12 months
in contrast to the assessee following financial year ending 31st March. It
was, however, submitted that these three companies should not have
been excluded for this reason alone when they were otherwise
functionally similar, a fact which has not been disputed by the TPO.
The ld. DR opposed this contention by submitting that the data for the
year ending of these companies was not similar to that of assessee
company and hence such companies were rightly excluded.
12.1.2. After considering the rival submissions and perusing the
relevant material, it is noticed that the assessee company is having
financial year ending covering the period 1.4.2009 to 31.3.2010. In that
view of the matter, a valid comparison can be made only if the
comparable companies too have the same financial year. In this regard,
we consider it appropriate to note the relevant part of sub-rule (4) of
Rule 10B which provides that: "the data to be used in analyzing the
comparability of an uncontrolled transaction with an international
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transaction shall be the data relating to the financial year in which the
international transaction had been entered into." It is obvious from the
language of sub-rule (4) that the comparability of an uncontrolled
transaction can be analyzed only with the "data relating to the financial
year" in which the international transaction has been entered into. In
other words, if the tested party has March year ending, then, the
comparables must also have the data relating to the financial year ending
31st March itself. If such a data is not available, then, a company albeit
comparable, also disqualifies. Espousing the facts of the extant case, we
find that insofar as the functional comparability of these three companies
is concerned, the TPO has not disputed the same. The only reason given
for their exclusion is the non-availability of data for the relevant
financial year. The ld. AR contended that though the year ending of the
above referred three companies was either different or financial year
included results for 15 months, yet, the assessee was in a position to put
forward the data of these three companies for the financial year 1.4.2009
to 31.3.2010 from their Annual reports only. It was so stated on the
basis of the availability of the quarterly data from the Annual reports of
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these companies, which could be adjusted for the financial year ending
31.3.2010. If the contention of the assessee is correct, that the relevant
data for the concerned financial year can be deduced from the
information available from their annual reports, then, there can be no
objection to the inclusion of these companies in the list of comparables
with the adjusted data for the relevant financial year itself. Under such
circumstances, we set aside the impugned order and remit the matter to
the file of TPO/AO for examining this aspect of the matter. It is
clarified that only if the assessee succeeds in providing the relevant data
of these companies for the concerned financial year on the basis of the
information available from their Annual reports only, the TPO should
include these companies in the list of comparables by considering their
OP/OC on the basis of the financial year ending 31.3.2010. If however,
even though their quarterly data is available and can be compiled for the
relevant financial year, but the amounts of operating profit or operating
cost etc. for the relevant financial year are not directly available without
any apportionment or truncation, then these companies should not be
considered as comparable.
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ii) CG-VAK Software and Exports Ltd. (Seg.)
12.2.1. The assessee included the segmental figures of this company
in the list of comparables. The TPO eliminated this company on the
ground that it was providing software services and ITES and its turnover
from ITES was only 0.83 crore, which was less than the requisite
turnover.
12.2.2. Having heard both the sides on this issue, we find that the
TPO has accepted the functional comparability of this company on
segmental level. The ld. DR was also fair enough to candidly accept the
functional similarity of the relevant segment of this company. In such
circumstances, the question arises as to whether the relevant segment of
this company can be excluded from the list of comparables merely on
the ground that the revenue from this segment is only Rs.83 lacs? In
our considered opinion, the quantum of turnover can be no reason for the
exclusion of a company which is otherwise comparable. We have
noticed above the judgment of the Hon'ble jurisdictional High Court in
the case of ChrysCapital Investment Advisors (India) P. Ltd (supra) in
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which it has been held that high turnover or high profit can be no reason
to eliminate an otherwise comparable company. The same applies with
full force in the converse manner as well to a low turnover/low profit
company. We, therefore, hold that a company cannot be excluded from
the list of comparables on the ground of its low turnover. In principle,
we direct the inclusion of the relevant segment of this company in the
list of comparables. The TPO is directed to include the operating
profit/operating costs of the ITES segment of this company in the list of
comparables, after due verification of the necessary figures for
determination of the operating profit margin etc.
iii) Micro Genetics Systems Ltd.
12.3.1. The TPO excluded this company from the list of comparables
by observing that its turnover was only Rs.2.44 crore and, hence, it
failed the turnover filter.
12.3.2. We do not find any reason to exclude this company from the
list of comparables merely on the ground that its turnover is less. The
reasons given above while considering the comparability of CG-VAK
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Software and Exports apply to this company as well. We, therefore,
order for the inclusion of this company in the list of comparables.
However, the TPO is directed to verify the correctness of OP/OC of this
company before its inclusion in the set of comparables.
iv) Axis IT & T Ltd.
12.4.1. The TPO excluded this company by mentioning that it failed
export filter as the total exports of this company were only 43.16% of
the total operating revenue. Here again, we find that the only reason
given by the TPO for the exclusion of this company is its failing export
filter. Relevant details of the figures of this company have not been
made available. We, therefore, set aside the impugned order on this
score and remit the matter to the file of TPO/AO for examining the
functional comparability of this company. If this company is found to
be similar on entity or segment level, then, the entity or the relevant
segment should be included in the final set of comparables after due
verification of the rate of operating profit margin etc.
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12.5. In view of the foregoing discussion, we set aside the
impugned order and remit the matter of determination of ALP of the
international transaction of `Provision of IT enabled data conversion
services' to the file of TPO/AO for a fresh decision in accordance with
our above observations/directions and also the interest aspect as
discussed infra. Apart from the issues discussed in this order, the
decision of the TPO on all other aspects of the determination of the ALP
of this international transaction should be considered as final, as no other
issue has been agitated before us.
VI. INTEREST ON DELAYED/NON-REALIZATION OF EXPORT
PROCEEDS
13.1. On going through the Master Service Agreement between the
assessee company and its AE, it was observed by the TPO that the AE
was allowed much longer period for payment than was allowed normally
in an uncontrolled situation. The TPO considered the prescription of
clause 8.4 of the Agreement which provides that all amounts under this
Agreement should be paid within 150 days from the date of invoice. In
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his opinion, 60 days credit facility is ordinarily given without any
interest payment and any delay in payment thereafter was liable to be
compensated with interest @ 1.5% to 2% per month on the outstanding
amount. The assessee was required to give working of interest on late
realization or non-realization of export proceeds during the financial
year 2009-10. Such working given by the assessee has been made
Annexure-1 to the order of the TPO. On a perusal of the statement of
non/late realization of export invoices furnished by the assessee, the
TPO held that the assessee ought to have charged @ 15% p.a. on
receivables as on 1.4.2009 which were outstanding for more than 60
days; and export proceeds not realized within 60 days from the date of
invoice during the year. These two amounts were calculated at Rs.3.16
crore and Rs.2.69 crore, making total TP adjustment for interest at
Rs.5.86 crore. That is how, the TP adjustment on account of interest to
be charged on non-realisation of export proceeds to the tune of Rs.5.86
crore and odd was proposed and added by the AO in the final
assessment order. The assessee is aggrieved against this addition.
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13.2. The ld. AR contended that the Agreement between the assessee
and its AE does not provide for any charging of interest and, hence,
there can be no question of any notional/hypothetical interest income as
has been determined by the TPO. To support the non-charging of
interest, he relied on the judgment of the Hon'ble Bombay High Court in
the case of Vodafone India Services Pvt. Ltd. Vs. Union of India and
Others (2014) 368 ITR 1 (Bom.). He buttressed the same argument by
relying on the judgment of the Hon'ble jurisdictional High Court dated
27.3.2015 in CIT vs. Cotton Naturals (I) Pvt. Ltd. (Del.). The view
canvassed by the ld. AR against the not making addition on account of
interest was strongly countered by the ld. DR.
13.3. We are not persuaded to accept this argument. The argument
that the Agreement does not provide for charging any interest on late
realization of invoice value and hence no interest can be charged,
deserves the fate of dismissal under the transfer pricing provisions.
Chapter X of the Act has been enshrined to determine the income from
an international transaction at ALP, being in the same manner as is
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determined between two independent parties. It means that if an income
is not charged or under charged by an Indian entity from its foreign AE,
which ought to have been properly charged if the transaction had been
between two independent parties, then such under charged or uncharged
income needs to be brought to tax by determining the ALP of the
international transaction giving rise to such income.
13.4. Coming to other argument that no interest is chargeable under
the present circumstances on the strength of the judgment in the case of
Vodafone India Services Pvt. Ltd. (supra), we find that the point of
controversy in that case was quite distinct. Addition on account of the
excess share premium was made which, in the opinion of the TPO,
should have been received by that assessee from the issuance of shares.
It is on this excess share premium short received, that the amount of
interest was also charged. The Hon'ble Bombay High Court overturned
the opinion of the TPO by holding that the amount of less share
premium received over and above the actual premium received cannot
be added as TP adjustment because the receipt of premium itself, being a
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capital receipt, is not chargeable to tax. When the amount of premium is
a capital receipt, the Hon'ble High Court held that the so called short
premium charged also cannot assume the character of revenue. Apart
from the deletion of addition on account of share premium, the Hon'ble
Bombay High Court in Vodafone India Services Pvt. Ltd. Vs. Union of
India and Others (2014) 369 ITR 511 (Bom.) and Shell India Markets
P. Ltd. VS. ACIT (2014) 369 ITR 516 (Bom) has held that interest on
such short realized premium also cannot be construed as an item of
transfer pricing adjustment. It is obvious that the facts of the instant case
are absolutely different from those considered in the case of Vodafone
India Services Pvt. Ltd. (supra). The base amount on which interest was
calculated by the TPO in the case of Vodafone India (supra) was itself a
capital receipt not chargeable to tax and not a trading debt arising during
the course of business, which issue has been discussed in the
immediately succeeding paras. Instantly, we are concerned with the late
realization by the assessee of trading debt from its AE which is
otherwise a revenue receipt and has also been offered for taxation.
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13.5. At this juncture, it is apposite to note that the Finance Act, 2012
has inserted Explanation to section 92B with retrospective effect from
1.4.2002. Clause (i) of this Explanation, which is otherwise also for
removal of doubts, gives meaning to the expression `international
transaction' in an inclusive manner. Sub-clause (c) of clause (i) of this
Explanation, which is relevant for our purpose, provides as under:-
` Explanation.--For the removal of doubts, it is hereby clarified that--
(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 or
receivable or any other debt arising during the course of business;....'
13.6. On circumspection of the relevant part of the Explanation
inserted with retrospective effect from 1.4.2002, thereby also covering
the assessment year under consideration, there remains no doubt that
apart from any long-term or short-term lending or borrowing, etc., or
any type of advance payments or deferred payments, `any other debt
arising during the course of business' has also been expressly
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recognized as an international transaction. That being so, the payment
of interest or receipt of interest on the loans accepted or allowed in the
circumstances as mentioned in this clause of the Explanation, also
become international transactions, requiring the determination of their
ALP. If the payment of interest is excessive or there is no or low receipt
of interest, then such interest expense/income needs to be brought to
ALP. The expression `debt arising during the course of business' in
common parlance encompasses, inter alia, any trading debt arising from
the sale of goods or services rendered in the course of carrying on the
business. Once any debt arising during the course of business has been
ordained by the legislature as an international transaction, it is, but,
natural that if there is any delay in the realization of such debt arising
during the course of business, it is liable to be visited with the TP
adjustment on account of interest income short charged or uncharged.
13.7. The Hon'ble Bombay High Court in the case of CIT vs. Patni
Computer Systems Ltd., (2013) 215 Taxmann 108 (Bom.) dealt, inter
alia, with the following question of law:-
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"(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 having a bearing on the profits, income,
losses or assets of such enterprises?"
13.8. 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.
13.9. The foregoing discussion divulges 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.
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ITA No.240/Del/2015
13.10. In so far as the reliance of the ld. AR on the judgment in
Cotton Naturals (I) Pvt. Ltd. (supra) is concerned, we find the facts of
that case to be distinguishable. In that case, a loan was advanced by that
assessee to a wholly owned subsidiary in the USA. The assessee
selected the Comparable Uncontrolled Price (CUP) method to
benchmark the interest received on the loan and claimed that the interest
received @ 4% was comparable. The TPO held that the arm's length
interest rate should be taken at 14% per annum. This was reduced to
12.20% by the DRP by adopting the prime lending rate fixed by the RBI.
The Tribunal relying on certain decisions upheld the assessee's claim.
When the matter finally came up before the Hon'ble High Court, it held
that the amount in question was given in foreign currency, i.e., in US
Dollars and was also to be repaid in the same currency, i.e., US Dollars.
In that view of the matter, it was held that the currency in which the loan
is to be repaid normally determines the rate of return on the money lent
and the interest rate applicable to loans granted and to be returned in
Indian rupee would not be a relevant comparable. The prime lending
rate was, therefore, held to be not applicable. From the above narration
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of facts, it is clear that, firstly, in the case of Cotton Naturals (I) Pvt. Ltd.
(supra), that assessee charged interest on loans given to its AE. The
controversy was only about the rate of interest, which ought to have
been charged. In the case under consideration, the assessee did not
charge any interest on the amounts remaining parked with its foreign AE
due to late or non-realization of invoices in time. As the assessee before
us did not charge any interest, the judgment in Cotton Naturals (I) Pvt.
Ltd.(supra) rather supports the view canvassed by the Revenue on the
basic issue of chargeability of interest. Be that as it may, the amendment
to section 92B made with retrospective effect from 1.4.2002 sets the
controversy to rest inasmuch as it provides in unambiguous terms that
any other debt arising during the course of business is an international
transaction. Ex consequenti, transfer pricing adjustment on account of
interest income is mandated in case of late/non realization of invoice
value from AE. The view canvassed by the ld. AR on this issue is,
therefore, found to be devoid of merit and hence jettisoned.
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13.11. Now, we come to the computation of the ALP of the
international transaction of `debt arising during the course of business.'
This has two ingredients, viz., the amount on which interest should be
charged and the arm's length rate at which the interest should be
charged.
13.12. In so far as the first aspect is concerned, we find that the TPO
has taken normal credit period of 60 days and accordingly made addition
on account of transfer pricing adjustment for the period in excess of 60
days. In our considered opinion, transfer pricing adjustment on account
of interest for the entire period of delay beyond 60 days cannot be
treated as a separate international transaction of trading debt arising
during the course of business. It is noticed that the assessee entered into
an agreement with its AE for realization of invoices within a period of
150 days. This implies that the interest amount on non-realization of
invoices up to 150 days was factored in the price charged for the
services rendered. Annexure-1 to the TPO's order gives details of the
instances of late realization or non-realization of advances up to the year
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ending. First three and a half pages of this Annexure indicate number of
days for which there was delayed realization. Such delay ranges from
175 days to 217 days. The remaining pages disclose no realization of
invoices up to 31st March, 2010. When we consider the dates of
invoices in the remaining pages, it is manifested that in certain cases
these invoices have been raised on 31st August, 30th or September or
31st October, 2009. In all such cases, the period of 150 days already
stood expired as on 31st March, 2010 and the assessee ought to have
charged interest on the delay in realizing such invoices along with the
first three and a half pages in which there is an absolute and identified
delay in realization of invoices beyond the stipulated period. When the
interest for realization of trade advances up to 150 days is part and
parcel of the price charged from the AE, then the delay up to this extent
cannot give rise to a separate international transaction of interest
uncharged. Rather interest for the period in excess of normally realizable
period in an uncontrolled situation upto 150 days needs to be considered
in the determining the ALP of the international transaction of the
`Provision of IT Enabled data conversion services'. This can be done by
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increasing the revenue charged by the comparable companies with the
amount of interest for the period between that allowed by them in
realization of invoices and 150 days as allowed by the assessee, so as to
bring such comparables at par with the assessee's international
transaction of provision of the ITES. To illustrate, if the comparables
have allowed credit period of, say, 60 days and the assessee has
realized its invoices in 180 days, then interest for 90 days (150 days
minus 60 days) should be added to the price charged by the comparables
and the amount of their resultant adjusted operating profit be computed.
Rule 10B permits making such an adjustment. Sub-rule (2) to rule 10B
stipulates that for the purposes of sub-rule (1), the comparability of an
international transaction with an uncontrolled transaction shall be
judged, inter alia, with reference to the : `(c) the contractual terms
(whether or not such terms are formal or in writing) of the transactions
...' . Then sub-rule (3) mandates that an uncontrolled transaction shall
be comparable to an international transaction if `reasonably accurate
adjustments can be made to eliminate the material effects of such
differences'. Applying the prescription of rule 10, it becomes vivid that
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difference on account of the `contractual terms of the transactions',
which also include the credit period allowed, needs to be adjusted in the
profit of comparables. As the TPO has taken the entire delay beyond
that normally allowed as a separate international transaction, which
position is not correct, we hold that the effect of delay on interest up to
150 days over and above the normal period of realization in an
uncontrolled situation, should be considered in the determination of the
ALP of the international transaction of `Provision of IT Enabled data
conversion services' and the period of delay above 150 days, namely,
30 days in our above illustration (180 days minus 150 days) should be
considered as a separate international transaction in terms of clause (c)
of Explanation to section 92B.
13.13. In so far as the question of rate of interest is concerned, we find
that this issue is no more res integra in view of the judgment of the
Hon'ble jurisdictional High Court in the case of Cotton Naturals (I) Pvt.
Ltd. (supra), in which it has been held that it is the currency in which
the loan is to be repaid which determines the rate of interest and hence
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ITA No.240/Del/2015
the prime lending rate should not be considered for determining the
interest rate. Under such circumstances, we set aside the impugned
order and remit the matter to the file of TPO/AO for a fresh
determination of addition on account of transfer pricing adjustment
towards interest not realized from its AE on the debts arising during the
course of business in line with our above observations.
14. In the result, the appeal is allowed for statistical purposes.
The order pronounced in the open court on 06.07.2015.
Sd/- Sd/-
[A.T. VARKEY] [R.S. SYAL]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated, 06th July, 2015.
dk
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.
51
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