TMI Blog2014 (4) TMI 285X X X X Extracts X X X X X X X X Extracts X X X X ..... f transfer pricing, only the cost related to the transaction with the Associated Enterprises has to be considered - segmental financials is to be considered for the purpose of arriving at the net margin on the international transaction with the assessee's enterprise in respect of software development services - In that process, bad debts/reimbursements has to be excluded and segmental profitability has to be adopted - the TPO should have determined the Arm’s Length Price for the international transactions with associated enterprises considering only the operating cost allocable to the Associated Enterprises segment – the AO had no occasion to verify the veracity of the segmental financials prepared by the assessee company – thus, the matter is remitted back to the AO/TPO to determine the ALP only considering the receivables and payables in respect of transactions with AEs only. Selection of comparables - Avani Cimcon Technologies Limited – Held that:- The assessee has been categorised as a software development service provider – the company cannot be treated as comparable as the company is also into product development - As segmental details of operating income of software devel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... soft BV, Netherlands – Held that:- The decision in M/s. Four Soft Ltd. Hyderabad Versus The Dy. Commissioner of Income-tax, Circle 1(3), Hyderabad [2011 (9) TMI 634 - ITAT, Mumbai] followed - The ALP is to be determined for the international transaction, on international loan and not for the domestic loan - Hence, the comparable, in respect of foreign currency loan in the international market, is to be LIBOR based which is internationally recognised and adopted - the DRP rightly directed the assessing officer to adopt the LIBOR plus for the purpose of TP adjustment – arm’s length price of loan transaction with AE should be on the basis of LIBOR + percentage point - the AO/TPO is directed to determine the arm’s length interest on loan advanced by assessee to its AE by applying LIBOR + percentage points. Re-characterisation of equity into loan – Held that:- Assessee contended that the loan was extended in view of FEMA regulations - It is also a fact acknowledged by the TPO that the assessee has obtained approval of the RBI for converting the loan into equity - neither the TPO nor DRP have considered the issue at depth – thus, the matter is remitted back to the AO / TPO for fresh cons ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3/Hyd/11 - - - Dated:- 28-3-2014 - Shri B. Ramakotaiah And Shri Saktijit Dey,JJ. For the Petitioner : Shri Deepak Chopra Ravi Bharadwaj For the Respondent : Sri P. Somasekhar Reddy (DR) ORDER Per Saktijit Dey, J. M: This appeal by the assessee is directed against the assessment order passed u/s 143(3) read with sec. 144C of the Act pertaining to the assessment year 2007-08. 2. Briefly stated, assessee is a private limited company. The assessee has following wholly owned subsidiaries overseas which are its Associated Enterprises(AE):- 1. Four soft Denmark A/s 2. Four soft Singapore Pte Ltd 3. Four soft BV Netherland 4. Four Soft Malaysia Sdn Bhd 3. Besides, the assessee company also exercises control over four subsidiaries in USA, Netherland, Germany and U.K. through its wholly owned subsidiary in Netherlands. The assessee company basically is engaged in providing services in enterprise solutions by operating software products and services in ITES sector for the logistics and supply chain management market place. As stated by the assessee, as a result of global acquisitions and expansions the assessee and its route companies have esta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erage arithmetic mean of 14.2%. Since assessee s operating margin is shown at 14.76% as against 14.2% of the comparable companies, the price charged for the international transactions with AEs was considered to be within arm s length range. 5. During the scrutiny assessment proceedings, the Assessing Officer noticing that the assessee had entered into international transactions, made a reference to the transfer pricing Officer (TPO) for determining the arm s length price. In course of the TP proceedings, the TPO called for various information from the assessee as well as from outside sources u/s 133(6) of the Act and on considering the material available on record rejected the TP study done by the assessee by observing that the same is not reliable due to various defects and deficiencies as noted by the TPO in his order. The TPO rejecting the CUP method adopted by the assessee selected TNMM as the most appropriate method for determining ALP. The primary reason for rejecting the TP study is, use of multiple year data and not confining to the financial data of the current financial year. The TPO further observed that the assessee while selecting/rejecting comparables has not consi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erefore felt that CUP method cannot be considered to be most appropriate method due to non availability of reliable data in the public domain. Having rejected the TP study submitted by the assessee and selected TNMM as the most appropriate method, the TPO by applying certain filters proceeded to search data bases for selecting comparables. In this regard, the TPO also exercised his powers under section 133(6) of the Act for obtaining information from certain companies. In the process the TPO selected 26 companies as comparables with an average margin of 26.36%. While doing so the TPO included reimbursement transactions also in operating cost and arrived at the arm s length price of international transactions with its AE from software services at Rs.27,44,96,144/- which resulted in a transfer pricing adjustment of Rs.3,78,08,058/-. Apart from the aforesaid TP adjustment on account of provision for software development services to AEs, the TPO also made TP adjustment of Rs.17,72,097/- with regard to interest on loans provided to AEs. While arriving at aforesaid TP adjustment, the TPO considered BBB rated bonds in India as comparable transactions and determined the bench mark rate o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ined his submissions to the following issues with regard to the transfer pricing adjustment in respect of software development services. i) Non application of CUP/TNMM to internal uncontrolled transactions of the assessee for determining ALP. ii) Bad debts, reimbursements should not be included in the operating cost. iii) Selection of incomparable as comparables by TPO So far as the first and second issues are concerned, the learned AR submitted that the TP provisions require testing the arms length nature of a transaction with AE by comparing the price/margins of the controlled transactions with price/margin of comparable transactions under comparable circumstances engaged by uncontrolled enterprises, in other words, uncontrolled transactions. It was submitted that comparability exists if the uncontrolled transactions and circumstances sufficiently resembles the assessee s transaction to provide a reliable measure of an arm s length price/margin. He further submitted that Rule 10B provides the comparability criteria for an international transaction with an uncontrolled transaction. In terms with the aforesaid Rules the assessee has furnished enough evidence and data to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... On perusal of the TP order it is to be seen that in para 2.4.1 the TPO has admitted that the assessee has submitted segmental financials separately in respect of AE and non-AE transactions. As per the aforesaid segmental financials (reproduced at page 4 of TP order), the margin in respect of transactions with AEs is 39.26% as against margin of 6.30% in respect of non AE transactions. Therefore, when segmental details have been furnished by the assessee the TPO should have considered them properly instead of rejecting them with broad and sweeping allegations. It seems, the TPO has not properly allocated the segmental expenditures. If the bad debts etc. are not related to AE transactions they cannot be considered as part of operating cost for determining ALP of the transactions with AE. Similarly, reimbursement on cost to cost basis also cannot be included in the operating cost. Unfortunately, the DRP without dealing with this issue at depth has finished its job by simply commenting that TPO has dealt with the issue appropriately. In this context, it is to be noted that when identical issue was agitated by the assessee before the Tribunal for the assessment year 2006-07, a coordinat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the assessing officer had no occasion to verify the veracity of the segmental financials prepared by the assessee company, for limited purpose, we direct the assessing officer to verify the segmental financials prepared by the assessee company and adopt the same for arriving at the net margin on the international transaction with AEs in respect of software development services. We direct accordingly. Respectfully following the aforesaid observation of the coordinate bench in assessee s own case, we remit this issue back to the file of the Assessing Officer/TPO to determine the ALP in terms with the direction of the coordinate bench extracted hereinabove. Another contention of the ld. AR is while making TP adjustment and computing working capital adjustment under TNMM, the TPO has considered margins at the entity level. It was therefore contended that the TP adjustment has to be restricted only to transactions with AE. We find force in the contentions of the ld. AR. The Assessing Officer/TPO is directed to determine the ALP only considering the receivables and payables in respect of transactions with AEs only. 11. The next issue is wi th regard to selection of certain compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n be taken into consideration for comparing with the assessee. As the aforesaid decision of the coordinate bench pertained to the same assessment year i.e. AY 2007-08, following the same we hold that this company cannot be treated as comparable to the assessee. Infosys Technologies Ltd. Wipro Limited 11.4 Objecting to the aforesaid companies being treated as comparables, the learned AR submitted that these two companies cannot be considered to be comparable to a captive service provider like the assessee , not only because of the quantum of revenue earned by them but also on account of various other factors. It was submitted that these companies command a premium in the pricing of their products and services due to the goodwill, reputation and brand value. It was submitted that due to scale of operation they not only enjoy economies of scale in the lower cost of infrastructure facilities and employees but also earning profit. It was submitted that both the companies have diversified activities including products, consultancy and solutions. Both these companies own intangibles and assume considerable risk which results in earning higher profits. In support of such contention ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... current year data also needs to be appreciated. Therefore, considering the enormity of turnover of these two companies as well as other relevant factors, the aforesaid companies cannot be treated as comparable to the assessee in any manner. This view of ours is also in tune with the view expressed by different Benches of this Tribunal as well as that of the Hon ble Delhi High Court in the case of CIT Vs. Agnity India Technologies Pvt. Ltd.,[2013] 85 CCH 146. We therefore direct the Assessing Officer /TPO to exclude them while computing ALP. ISHIR INFOTECH LTD 11.8 Objecting to this company being treated as comparable, the learned AR submitted that this company cannot be a comparable to the assessee as the said company does not satisfy the employee cost filter threshold limit of 25% applied by TPO. It was submitted that as per the information available from the Annual Report of the said company employee cost as a percentage of operating revenue is only 3.96%. In support of such contention, the learned AR relied upon the decision of co-ordinate bench of this Tribunal in case of Virtusa (India) Pvt. Ltd. V/s. DCIT (supra) and various other decisions. 11.9 The learned DR, on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r only the segmental margin of this company for the relevant assessment year for computing ALP. Tata Elxsi Limited 11.13 We have heard the parties and perused the materials on record. The assessee has sought exclusion of the aforesaid company by placing reliance upon the information furnished by said company u/s 133(6) wherein the said company has admitted that it cannot be treated as comparable with any other software service provider due to complex nature of its business. Considering the submissions of the parties we remit the issue of comparability of this company back to the file of Assessing Officer/TPO for considering afresh. The Assessing Officer/TPO shall duly consider assessee s objection with regard to functional differences between assessee and Tata Elixi Ltd. before deciding the issue of comparability. Accordingly, we direct the Assessing Officer/TPO to determine the ALP of the price charged by the assessee to its AE towards provision of software development services in terms with our direction in the preceding paragraphs. If on such determination of ALP the price charged by the assessee for the international transactions with its AE is found to be within arm s le ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... international loan and not for the domestic loan. Hence, the comparable, in respect of foreign currency loan in the international market, is to be LIBOR based which is internationally recognised and adopted. In our considered view, the DRP rightly directed the assessing officer to adopt the LIBOR plus for the purpose of TP adjustment. Our view is fortified by the decision of the Madras Bench in the case of Siva Industries [supra]. We do not find any merit in the arguments of the learned counsel for the assessee that the DRP should have adopted the EURIBOR for the purpose of the TP adjustments, as we find that the mostly used and recognised benchmark rate for international loan is LIBOR based. Hence, the DRP rightly directed the assessing officer to adopt the LIBOR rates. We confirm the directions of the DRP. However, by considering the contentions of the learned counsel for the assessee that the actual LIBOR was 4.42% as against the 5.78% approved by the DRP, we find it proper to restore this issue to the file of the assessing officer, to verify the correctness of the claim made by the assessee company. In view of this mat ter, we remit this matter to the file of the assessing offi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere issued and the amount of loan was converted into share premium in relation to the existing shares, 100% of which is held by Foursoft India. It was submitted, though fresh shares could have been issued but as assessee is holding 100% of equity, it does not have any impact on the shareholding interest of assessee in its subsidiary in Netherlands. Since 100% of the equity is held by assessee, the entire dividends declared by the subsidiary in Netherlands would be received by assessee. The Ld. A.R. referring to Chapter VII of OECD guidelines submitted that an activity performed by a group member solely because of its ownership interest in the capacity of a shareholder is a shareholder activity and would not justify a charge to the recipient company. The Ld. A.R. submitted that the decision in Perot Systems TSI (India) Ltd. vs. DCIT (supra) will not be applicable to the assessee firstly because it is not a case of interest free loan but equity capital contribution and secondly, unlike in assessee s case the loan was not converted into equity. The Ld. A.R. relied upon a decision of ITAT, Mumbai Bench in case of Besix Kier Dabhol, SA vs. DCIT (ITA.No.4249/Mum/2007) wherein it is hel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... objection on the issue. 25. We have heard the parties and perused the material on record. The sum and substance of the submissions made by the learned AR is, the corporate guarantee provided by the assessee cannot be equated to bank guarantee and resultantly the commission rate for bank guarantee cannot be applied to the corporate guarantee. It was submitted that the corporate guarantee is nothing but an additional guarantee provided by the parent company and it does not involve any cost or risk to the shareholders. It was submitted that since the corporate guarantee was given keeping in view paramount business interest of the parent company it has to be allowed as business expenditure. It is the further submissions of the learned AR that the retrospective amendment effected to section 92B of the Act, by Finance Act, 2012 by insertion of Explanation (i)(c) to section 92B also has not enlarged the scope of the international transaction to include the corporate guarantee in the nature provided by the assessee. The learned AR further contended that the issue is covered in favour of the assessee by virtue of the order passed by the Tribunal in assessee s own case for AY 2006-07 ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the ITAT Hyderabad. In case section 92B is not amended with retrospective effect, he should grant relief to the appellant. 25.4 In the aforesaid view of the matter, we agree with the TPO that ALP of the corporate guarantee has to be determined as it falls within the scope and ambit of an international transaction after the retrospective amendment to section 92B. However, it appears that the TPO has applied the rate of 3.75%, which is applicable to bank guarantee issued by the bank. As the corporate guarantee is not in the nature of bank guarantee, the rate applicable to bank guarantee provided by the bank cannot be applied to corporate guarantee which is provided by a group company. In case of Glenmark Pharmaceuticals Vs. ACIT in ITA No. 5031/Mum/2012, dated 13/11/2013, the Mumbai Bench of the Tribunal after analysing the facts in that case had held that 0.53% corporate guarantee rate in that case was appropriate. The ITAT Hyderabad Bench in case of Infotech Enterprises Ltd. in ITA No. 115/Hyd/2011 and in ITA No. 2184/Hyd/2011, dated 16/01/2014 while considering identical issue of determining ALP of corporate guarantee provided by the assessee to its AE followed the ratio la ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urpose . 30. Respectfully following the aforesaid order of the Coordinate Bench, we remit the matter back to the file of the A.O. for deciding afresh in terms with the direction of the Tribunal extracted hereinabove. This ground is allowed for statistical purposes. 31. Ground No.20 relates to disallowance of expenditure incurred of Rs.43,92,874/- towards purchase of software for third parties. 32. During the assessment proceedings the A.O. noticing that the assessee has claimed expenditure of Rs.43,92,874/- towards purchase of software for third parties, disallowed the same by treating it as capital expenditure. The DRP though endorsed the view of the A.O. with regard to the nature of expenditure, but nevertheless directed the A.O. to examine admissibility of depreciation on such capital expenditure. 33. The Ld. A.R. submitted before us that the assessee has purchased software such as Oracle, progress etc., from third parties sold to its customers. Accordingly, cost of purchase and sales are routed through profit and loss account. It was therefore submitted that the expenditure is allowable. In support of such contention, he relied upon the following decisions : 1. A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore us, the said software helps in compression of size of e-mails sent through the Lotus Notes Mailing System and it includes licenses for 150 users who are using Lotus Notes Mailing System and software license for running on its server. If use of this software in the business of the assessee is limited to facilitate merely an effective and fast communication in order to increase its organizational efficiency, the same cannot be treated as forming part of the profit making apparatus of the assessee. On the other hand, if such software is being used by an assessee engaged in the business of placement agency where the applications from persons seeking jobs are invited through e-mail and are also forwarded to the concerned clients through e-mail, the same may form part of profit making apparatus of the assessee s business of placement agency and can be treated as a capital asset. (ii) As a general rule it may be stated that the more expensive the computer software the more it is likely to be a central tool of the business and the more enduring is likely to be its effect adding to the profit earning apparatus. If there are associated capital expenditure like purchase of new comput ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er words, the functional test becomes more important and relevant because of the peculiar nature of the computer software and its possible use in different areas of business touching either capital, or revenue field or its utility to a businessman which may touch either capital or revenue field. 60. Having laid down the criteria for determining the nature of expenditure incurred on acquisition of software, whether capital or revenue, we are of the view that these criteria need to be applied to determine the exact nature of expenditure incurred by the assessees in the present cases for acquiring different softwares. Since this exercise is required to be done in respect of each and every software independently having regard to the criteria laid down above, we are of the view that the matter needs to be restored back to the file of the AO for doing such exercise. The AO shall examine the question whether expenditure on computer software is capital or revenue in the light of the criteria laid down above after giving an opportunity of being heard to the assessees. If on such examination, the AO comes to the conclusion that the expenditure is capital expenditure, then the question reg ..... X X X X Extracts X X X X X X X X Extracts X X X X
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