Saktijit Dey, Judicial Member - This appeal by the assessee is directed against the order dated 15-6-2010 of CIT (A)-III, Hyderabad pertaining to the assessment year 2004-05.
2. Briefly the facts are the assessee formerly known as Vanenburg R & D (India) Pvt. Limited, a wholly owned subsidiary of Vanenburg Group BV, Netherlands was incorporated on 3rd July, 1997. The assessee has its registered office at Hyderabad. It provides software development and support services to its group companies (Associated Enterprises (AE). For the services rendered to its AE, the assessee is remunerated on a cost plus mark-up basis. The assessee is also registered with Software Technology Parks of India (STPI) as 100% export oriented unit. For the assessment year under dispute, the assessee filed its return of income on 1-11-2004 declaring total income of Rs.15,27,145/- after claiming deduction u/s 10A of the Act. During the scrutiny assessment proceedings, the Assessing Officer noticing that the international transactions of the assessee with its AE exceeded turnover of Rs.5 crores referred the matter to the Transfer Pricing Officer u/s 92CA of the Act for determining the ALP. The TPO from the TP study submitted along with return filed by the assessee noticed that the assessee had shown reported revenue earned from international transaction with its AE as under:—
| (i) Software development services |
Rs.18,90,57,493/- |
(ii) Software development services |
Rs.13,26,28,711 |
(iii) Import of software for distribution |
Rs.18,74,557 |
3. On examining the TP study, the TPO noted that the assessee had adopted transactions net margin (TNMM) as most appropriate method and operating profit/total cost as profit level indicator. He further noticed that the assessee on the basis of information available in public data base has identified 24 comparable companies in the area of software development services and by taking the average of two years data as on March, 2003 and March, 2004 arrived average operating profit margin on cost at 11.71% of the comparable companies as against the assessee's operating profit margin of 6.83%. The TPO however did not accept the TP documentation of the assessee on the ground that the assessee has used multiple data for selecting the comparables. So far as selection of comparables are concerned, out of 24 comparables selected by the assessee, the TPO found 11 comparables to be functionally similar to the assessee and fulfilling all the selection criteria adopted by the department as well as by the assessee. The average arithmetic mean of the 11 comparable companies selected by the TPO is 28.80%, after allowing adjustment at 2% towards working capital the ALP of international transaction was determined at Rs.38,73,84,405/-. The assessee's operating cost being Rs.32,63,76,762/-, shortfall of Rs.6,10,07,643/- was treated as the adjustment u/s 92CA of the Act. On the basis of the order passed by the TPO, the Assessing Officer passed an assessment order making addition of TP adjustment worked out by the TPO. Being aggrieved of the assessment order passed, the assessee challenged the determination of the ALP made by the TPO inter alia on the ground that (i) selection/rejection of certain comparables were not correct (ii) margin of companies has been wrongly computed by the TPO because the TPO has excluded bad debts written off and provision of bad and doubtful debts/advances foreign exchange gain/loss, deferred revenue expenditure etc., while computing the operating cost. The CIT (A) after considering the submission of the assessee excluded three companies i.e, M/s. i Power Solutions India Limited, Satyam Computer Services Limited and Xcel Vision Technologies Limited out of 11 comparables selected by the TPO. Further, the CIT (A) also worked out the net margin of three comparables out of the remaining '8'. As a result of which the average net margin of 8 comparables finally retained by the CIT (A) worked out to 24.56% and accordingly the CIT (A) after allowing deduction at 2% towards working capital adjustment determined the ALP of international transaction at Rs.37,44,30,857/- as against the price of Rs.32,63,76,762/- shown by the assessee. This resulted in a shortfall of Rs.4,80,54,095/- which was directed to be treated as the income of the assessee. Being aggrieved of the aforesaid direction of the CIT (A), the assessee is in appeal before us.
4. At the very outset, the learned AR submitted that he does not want to press ground Nos. 1,2,7,8 and 9. In view of such submission, these grounds are dismissed as not pressed.
5. Ground No.3 reads as under:—
"On the facts and in the circumstances of the case and in law, the learned CIT (A) erred in confirming the use of following filters in undertaking the comparative analysis:
Different year ending filter; and
Application of one side turnover filter."
In so far as the aforesaid ground is concerned, the learned AR did not press the issue with regard to the application of different year ending filter. So far as the other issue of application of one side turnover filer is concerned, the learned AR objecting to the selection of Infosys Technologies Limited as a comparable, submitted that when the Assessing Officer has rejected companies having turnover of less than 1 crores as comparables, he should also have fixed an upper limit by rejecting the companies having extraordinarily high turnover like Infosys Technologies Limited. The learned AR submitted that while assessee's turnover is Rs.32 crores, Infosys's turnover during the year is about Rs.13000 crores. Hence, it cannot be considered as comparable to the assessee. In support of such contention, the learned AR relied upon various decisions of different benches of this Tribunal and pleaded for excluding the said company from the list of comparables.
6. The learned DR, on the other hand, submitted that the assessee itself in TP documentation has selected Infosys Limited as a comparable and hence the said company having been selected by the assessee being functionally similar, there is no mistake committed by the TPO in retaining the same as a comparable.
7. We have considered the submissions of the parties and perused the materials on record. Though the learned AR has contended before us that Infosys Technologies limited cannot be considered as comparable as it is not only functionally different but it is a giant company having a turnover of about Rs.13000 crores but as can be seen from the materials on record the assessee in its TP documentation has itself selected M/s. Infosys Technologies Limited as comparable company. Therefore, the assessee's contention that it is functionally different, cannot hold much water. Be that as it may, fact however remains that M/s Infosys Technologies Limited is a giant in the field of software development services having considerable brand value, it also assumes all the risks related to the business. Further, the turnover of Infosys Technologies during the year is about Rs.13000 crores as against Rs.32 crores of the assessee. This itself makes Infosys Technologies Limited uncomparable to the assessee. When the Assessing Officer is applying the turnover filter by adopting a lower limit of Rs.1 crore, he should also have fixed an upper limit while applying the turnover filter. In that view of the matter, Infosys Technologies Limited cannot be considered to be a comparable to the assessee. Different benches of the Tribunal have also expressed similar view. In fact, the Hon'ble Delhi High Court vide judgment dated 10-7-2013 in case of CIT v. Agnity India Technologies (P.) Ltd. [2013] 219 Taxman 26/36 taxmann.com 289 upheld the order of the Income-tax Appellate Tribunal, Delhi Bench holding that big companies like Infosys cannot be treated as comparable to small captive service providers like the assessee. In the aforesaid view of the matter, we direct the Assessing Officer/TPO to exclude M/s Infosys Technologies Limited from the list of comparables for determining the ALP. Hence, this ground of the assessee is partly allowed.
8. In ground No.4, the assessee has objected to rejection of the following companies selected as comparable by the assessee.
| (i) |
|
Bangalore Softsell Limited |
(ii) |
|
Cherrysoft Technologies Ltd., |
(iii) |
|
Future Software Ltd., and |
(iv) |
|
Mahindra Consulting Limited |
9. Briefly the facts relating to the issue are, the assessee in its TP documentation had selected the aforesaid four companies as comparables claiming them to be functionally similar to the assessee as they are in the similar line of business of software development and services. The TPO however rejected them to be treated as comparables which was also sustained by the CIT (A). The TPO rejected Bangalore Softsell Limited on the ground that it fails RPT filer of more than 25% of sales. Cherrysoft Technologies Limited was rejected on the ground that company's data is not available in public data base. The TPO has also rejected future software limited on the same ground. Mahindra consulting Limited was rejected as it failed the RPT filter of more than 25% of sales. Hereinafter, we will deal with the assessee's objection with regard to the finding of the TPO/CIT (A) in respect of each of comparable companies as under:—
| (i) |
|
Bangalore Softsell Limited- The learned AR submitted that the TPO has erroneously excluded Bangalore Softsell Limited by wrongly applying the RPT filter of more than 25% of the sales. It was submitted that while applying the aforesaid filter, the TPO has included the reimbursement transactions in computing the percentage of RPT to turnover. It was submitted that receipts on account of reimbursement should not be considered while computing the percentage of related party transactions since they are in the nature of cost to cost recharge and do not have impact on the profitability. The learned AR submitted that the assessee has raised invoices on cost to cost basis and the reimbursement of expenditure incurred on account of related party transactions and accommodation are excluded for applying the RPT filter. |
10. The learned DR, on the other hand, submitted that TPO as well as the CIT (A) after proper analysis of materials on record have excluded the aforesaid companies from the list of comparables, hence no interference is called for.
11. We have heard the submissions of the parties and perused the materials on record. It is the contention of the learned AR that the TPO has included the reimbursement transaction in computing the percentage of related party transaction to turnover while rejecting the aforesaid comparables. We find force in the contention of the learned AR that reimbursement of cost actually incurred cannot be considered to be part of the turnover while computing the percentage of RPT to turnover and they are purely in the nature of reimbursement. However, the assessee is required to establish by producing necessary evidences that they are in the nature of reimbursements only. In aforesaid view of the matter, we direct the TPO to consider afresh as to whether the aforesaid company can be treated as comparable to the assessee after taking into consideration all materials and after affording a due opportunity of being heard to the assessee.
Cherrysoft Technologies Limited and Future Software Limited-With regard to the aforesaid two companies, the learned AR submitted that the assessee in its TP documentation has selected the aforesaid two companies as comparables as they satisfy all the filters applied by the TPO and the annual reports are available in public domain which was provided to the TPO as well as CIT (A) during the proceedings before them. The learned AR relying upon the decision of Special Bench of the Income-tax Appellate Tribunal, Chandigarh in case of Dy. CIT v. Quark Systems (P.) Ltd. [2010] 38 SOT 307 submitted that every information has to be considered in the process of determination of ALP so that a fair view is adopted. It was thus submitted by the learned AR that the TPO should not have rejected the aforesaid companies as comparables on the ground of non availability of data in public domain when the annual reports of the comparable companies were submitted before the Assessing Officer/TPO.
12. The learned DR, on the other hand, supported the orders of the revenue authorities on the aforesaid issue.
13. Having considered the submissions of the parties in the light of the materials on record, we are of the view that when the assessee has placed the annual reports of the aforesaid two companies, the TPO should have considered the same and should not have rejected on the ground of non availability of data in public domain. If information relating to the companies are available with the TPO and if the companies satisfy the filter applied by the TPO then there is no justification for rejecting the aforesaid two companies as comparables. We therefore direct the TPO to examine this issue afresh after considering all the information available with him and after affording due opportunity of being heard to the assessee.
Mahindra Consulting Limited:- The learned AR contended before us that as per the annual report the company does not have any related party transaction. It was submitted that the CIT (A) on the basis of the annual report of the subsidiary company of the assessee viz., Mahindra Consulting (Singapore) Pte. Limited assumed that the assessee has got related party transactions in excess of 25% of turnover. The learned AR referring to the profit and loss of subsidiary company viz., Mahindra Consulting (Singapore) Pte. Limited, a copy of which is placed at pages 265 and 266 of the paper book submitted that the subsidiary company's annual report disclosed RPT with other group companies and not with the assessee, hence the assumption made by the TPO and CIT (A) was not correct. The learned AR relying upon a decision of Income-tax Appellate Tribunal, Delhi Bench in case of Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 109 ITD 101 submitted that the TPO is not authorised to make inferences by presumptions by ignoring the materials on record. The learned AR further submitted that even assuming that all related party transactions mentioned in the subsidiary's annual report are with the assessee, the same are 1.81% of the company's turnover which is less than 25% RPT to turnover filter adopted by the TPO.
14. The learned DR, on the other hand, supported the reasoning of the TPO and CIT (A) in this regard.
15. We have heard the submissions of the parties and perused the materials on record. It is the specific contention of the learned AR that as per the annual report of the assessee, there is no related party transactions and whatever related party transactions are there are between the subsidiary company and other companies and not with the assessee company. Therefore, considering the aforesaid submissions of the assessee, we are of the view that the matter requires to be examined afresh by the TPO to ascertain as to whether actually there is any related party transaction and if at all there is any related party transaction whether they exceeded 25% threshold limit of related party transaction to turnover filter adopted by the TPO. The issue is therefore remitted to the file of the Assessing Officer/TPO for examining the same afresh after affording a reasonable opportunity of being heard to the assessee. Hence, this ground is treated as allowed for statistical purposes.
16. Ground No.5 raised by the assessee reads as follows:—
"On the facts and in the circumstances of the case and in law, the learned CIT (A) erred in not accepting the submission of the appellant and the remand report of the TPO on the inclusion of bad debts in operating costs for computation of margin of the companies under TNMM."
17. The learned AR submitted before us that the TPO as well as the CIT (A) committed error in not accepting the assessee's contention for including the bad debts and provision of bad and doubtful debts in operating cost for computation of margin of the comparable companies. The learned AR submitted that bad debts are incurred in the normal course of business operations and it was submitted that the loss on account of and are therefore operating in nature. It is in connection with the revenues not being realised by the company from third party customers and takes its colour from such revenues which are considered as being operating in nature and the loss on account of bad debts is not unique and extra ordinary in nature. He further submitted that it is a common phenomenon for any independent service provider company who provide services to third party service recipients on a credit basis and in some cases are unable to realise the same from such customers, which result in having such unrealised amounts as bad debts. Therefore, disregarding such bad debts would not result in the disclosure of appropriate results and would to a large extent distort the margins. It was submitted that comparable companies have incurred certain bad debts and it bears credit and collection risks which are inherent for any company bearing entrepreneurial risks and it would be incorrect to disregard such expenses in computation of net margin. The learned AR further submitted that TPO in fact has admitted the error committed by him while computing the margin of VMF Softech Limited during the remand proceedings and therefore correctly computed the margin of the said company at 4.37% in the remand report submitted before the CIT (A). It was submitted that the CIT (A) was not correct in not accepting the computation of net margin of VMF Softech Limited in the remand report.
18. We have considered the submissions of the parties and perused the materials on record. The only grievance of the assessee in the aforesaid ground is with regard to the CIT (A) adopting the net profit margin of the comparable company VMF Softech Limited at 71.99%. As can be seen in the TP report, the TPO had computed the net profit margin of the aforesaid company at 72.38%. During the appeal proceedings before the CIT (A), the assessee specifically objected to the profit margin adopted at 72.38% of VMF Softech Limited by contending that bad debts and provision for bad debts and advances should be considered as part of the operating cost. On the basis of the aforesaid contention of the assessee, the CIT (A) called for remand report from the Assessing Officer. As can be seen from para-6 of the remand report submitted by the TPO a copy of which was placed before us, the TPO re-computed the net profit margin of VMF Softech Limited on the basis of annual report which worked out at 4.37%. However, the CIT (A) in the order passed by him did not accept the net profit margin worked out to 4.37% by the TPO by observing that the computation made by the TPO is erroneous and himself proceeded to compute the net profit margin at 71.99%. However, the CIT (A) has not given any reason why the computation made by the TPO in the remand report is erroneous. In such view of the matter, we remit the issue back to the file of the TPO for fresh determination after affording a reasonable opportunity of being heard to the assessee.
19. The issue in ground No.6 is with regard to exclusion of foreign exchange fluctuations from operating income. The learned AR submitted before us that the foreign exchange fluctuation in general would arise on account of number of factors which are as under:—
| (a) |
|
Export proceeds realised at a rate higher/lower than the rate at which they were booked |
(b) |
|
Import payables settled at a rate lower/higher than the rate at which they were booked |
(c) |
|
Adjustment of customer advances (received in foreign currency) against export invoices |
(d) |
|
Restatement in the financial statements of export receivables/import payables and advances received from customers in foreign currency as on the last day of the financial year. |
20. It was submitted that exchange gain/loss arises in the normal course of business and therefore should be considered in computing the net margins. In support of such contention, the learned AR relied upon the following orders of co-ordinate benches of the Tribunal:—
| (i) |
|
Capital IQ Information Systems (India) (P.) Ltd. v. Dy. CIT (International Taxation) [2013] 57 SOT 14 (URO)/32 taxmann.com 21 (Hyd. - Trib) |
(ii) |
|
Four Soft Ltd. v. Dy. CIT [IT Appeal No.1495 (Hyd.) of 2010, dated 9-9-2011] |
(iii) |
|
SAP Labs India (P.) Ltd. v. Asstt. CIT [2011] 44 SOT 156/[2010] 8 taxmann.com 207 (Bang.) |
(iv) |
|
Smt. Sujata Grover v. Dy. CIT [2002] 74 TTJ 347 (Delhi) |
(v) |
|
Deutsche Bank AG v. Dy. CIT [2003] 86 ITD 431 (Mum.) |
(vi) |
|
Bestobell (India) Ltd. v. CIT [1979] 117 ITR 789/2 Taxman 62 (Cal.) |
21. The learned DR supported the orders of the revenue authorities.
22. We have heard the submissions of the parties and perused materials on record. We find that the issue as raised in the aforesaid ground is no more res integra as the co-ordinate bench of this Tribunal in case of Capital IQ Information Systems (India) (P.) Ltd. (supra) where both present Members are the parties held as under:
'27. We have considered the submissions of the parties in this regard. The Bangalore Bench of the Tribunal in the case of SAP Labs India P. Ltd. (supra), while considering a dispute of similar nature, observed as follows—
"The foreign exchange fluctuation gains is nothing but an integral part of the sales proceeds of an assessee carrying on export business. The Courts and Tribunals have held that foreign exchange fluctuation gains form part of the sale proceeds of exporter-assessee. The foreign exchange fluctuations income cannot be excluded from the computation of the operating margin of the assessee company……."
Following the aforesaid decision of the Bangalore Bench of the Tribunal, the Hyderabad Bench of the Tribunal held in the case of Four Soft Ltd. (supra) in the following manner-
16. With regard to the exclusion of gain on account of foreign exchange fluctuation while computing the net margin, as claimed by the assessee, we find that the exchange fluctuation gains arise out of several factors, for instance, realisation of export proceeds at higher rate, import dues payable at lower rate. Since the gain or loss on account of exchange rate fluctuation arises in the normal course of business transaction, the same should be considered while computing the net margin for the international transactions with the associated enterprises of the assessee. Our view in this behalf is fortified by the decisions of the Bangalore Bench of the Tribunal in the case of SAP Labs India Ltd. supra and Bombay bench of the Tribunal in the case of Deutsche Bank A.G. v. Dy. CIT [2003] 86 ITD 431……
Respectfully following the aforesaid decisions of the Tribunal, and considering the contention of the assessee that for the assessment year 2008-09 foreign exchange fluctuation gain/loss has been considered as operating margin while computing the margin of comparable companies, we hold that even for the year under appeal also the same principle should be applied, and while computing the margin for determining the ALP for the assessment year under appeal, the foreign exchange gain/loss has to be taken as part of the operating margin. Consequently, we allow the ground of the assessee on this issue and direct the Assessing Officer to treat the foreign exchange fluctuation gain/loss as part of the operating margin of the comparable company.'
Respectfully following the aforesaid order of the co-ordinate bench of this Tribunal, we direct the Assessing Officer/TPO to treat the foreign exchange fluctuation gain/loss as part of operating income of the comparable companies for computing the net margin. The TPO shall determine the ALP keeping in view of our direction given hereinabove.
23. In the result, the appeal filed by the assessee is allowed in part.