Hewlett Packard (India) Software Operation Pvt. Ltd. Vs DCIT (ITAT Bangalore)
ITAT Bangalore held that expenditure of ESOP cross-charge is wholly and exclusively for the purpose of business, said amount remitted by the assessee to ultimate holding company, and hence allowable expenditure u/s 37(1) of the Income Tax Act.
Facts-
The appellant company is engaged in providing Application Maintenance and Development, Enterprise Resource Planning and specialized services like Data Warehousing and Business Intelligence, Testing Services and Infrastructure Management Services.
It was submitted that the ESOP cross-charges represents the actual expenditure incurred by the Company in respect of its employees, who form part of the Company’s business and are involved in carrying out day-to-day business operations/management. The said expenses are incurred wholly and exclusively for the business of the Company and therefore, eligible for deduction under section 37 of the Act.
Conclusion-
Held that the ESOP expenditure incurred is a compensation/incentive to the employee and has direct nexus with his/her employment. Such compensation to the employees in the form of ESOP are included in salary of the employees under Section 17 of the Income Tax Act, 1961. Therefore, such expenses are incurred for the purposes of business and hence allowable expenditure under section 37 of the Income Tax Act in the hands of the employer i.e. the Company.
The expenditure of ESOP cross-charge amounting to INR 18,18,00,000 by the Ultimate Holding Company to HPISO are actual expenses incurred and remitted by HPISO and not notional in nature.
FULL TEXT OF THE ORDER OF ITAT BANGALORE
This appeal by the assessee is directed against the final assessment order passed by the Deputy Commissioner of Income-tax, Circle-3(1)(1) dated 31.3.2021 u/s 143(3) r.w.s. 144C(13) and 144C(13) r.w.s.143(3A) & 143(3B) of the Income-tax Act,1961 [‘the Act’ for short]. The assessee has raised following grounds of appeal:-
Transfer Pricing
The grounds mentioned hereinafter are without prejudice to one another.
1.1. The learned Assessing Officer (‘learned AO’), learned Transfer Pricing Officer (‘learned TPO’) and the Honourable Dispute Resolution Panel (‘Hon’ble DRP’) grossly erred in adjusting the transfer price by INR 1,18,75,36,269/- with respect to the international transactions undertaken by the Appellant, under section 92CA of the Income Tax Act, 1961 (“the Act”).
1.2. The learned AO/ learned TPO/ Hon’ble DRP erred in rejecting the Transfer Pricing (“TP”) documentation maintained by the Appellant by invoking provisions of sub-section (3) of section 92C of the Act.
1.3. The learned AO/ learned TPO/ Hon’ble DRP erred in rejecting the economic and comparability analysis undertaken in the TP documentation and in conducting a fresh comparability analysis by introducing various filters for the purpose of determining the Arm’s Length Price (‘ALP’) of the international transactions thereby following a non-transparent approach.
1.4. The learned AO/ learned TPO/ Hon’ble DRP erred in selecting the companies only if the data pertaining to Financial Year (“FY”) 2015-16 is available in the public databases.
1.5. The learned AO/ learned TPO/ Hon’ble DRP erred in applying different financial year ending filter while selecting the comparable companies thereby not considering the fact that the relevant data for the concerned financial year could be deduced from the corresponding financials.
1.6 The Learned AO/learned TPO/Hon’ble DRP erred in rejecting companies having employee cost filter less than 25% of total sales.
1.7 The learned AO/learned TPO/Hon’ble DRP erred in applying export earning filter of 75% of the total sales, leading to a narrower set of comparable companies.
1.8. The learned AO/ learned TPO/ Hon’ble DRP erred in considering bad and doubtful debts as non-operating in nature.
1.9. The learned AO/ learned TPO/ Hon’ble DRP erred in collating the information that are not publicly available using powers under section 133(6) of the Act.
1.10. The learned AO/ learned TPO/ Hon’ble DRP erred in law and facts in the methodology applied for computing Related Party Transactions (“RPT”) filter.
1.11. The learned AO/ learned TPO/ Hon’ble DRP have erred in not allowing appropriate adjustments towards working capital differential existing between the Appellant vis-a-vis independent comparable companies.
1.12. The learned AO/ learned TPO/ Hon’ble DRP have erred in not allowing appropriate adjustment towards the risk difference between the Appellant vis-a-vis the comparable companies.
1.13. The Hon’ble DRP have erred in not accepting the fresh search submitted during TP proceedings for inclusion of additional comparable companies.
Software Development Segment (“SWD”)
1.14.The learned AO/ learned TPO/ Hon’ble DRP have grossly erred in not rejecting the following companies:
Inteq Software Private Limited;
Larsen & Toubro Infotech Limited;
Nihilent Limited;
Persistent Systems Limited;
Infobeans Technologies Limited;
Aspire Systems (India) Private Limited;
Infosys Limited
Thirdware Solution Limited; and
Cybage Software Private Limited.
1.15 The learned AO/learned TPO/Hon’ble DRP have grossly erred in rejecting following companies that ought to have been accepted as comparable:
Sasken Communication technologies Limited;
Minvesta Infotech Limited
Agilisys IT Services India Pvt. Ltd.;
Batchmaster Software Private Ltd.;
DCIS Dot Com Solutions India Pvt. Ltd.;
Evoke Technologies Private Limited;
Eluminous Technologies Private Limited;
Sagarsoft (India) Limited;
Ace Software Exports Limited;
Synfosys Business Solutions Limited;
ksummation Technologies Private Limited;
frifoMile Technologies Limited; and
Mildunuru Limited.
1.16, The learned AO/ learned TPO/ Hon’ble DRP has grossly erred in computing the margin of the following companies:
CG-Vak Software & Exports Ltd;
kals Information Systems Ltd;
Cybage Software Pvt. Ltd;
Harbinger Systems Pvt. Ltd; and
Orion India Systems Pvt. Ltd.
INTEREST ON RECEIVABLES
1.17. The learned AO/ learned TPO/ Hon’ble DRP erred in treating a delay in receivables or deferred receivables as an international transaction.
1.18. The learned AO/ learned TPO/ Hon’ble DRP erred in not appreciating the fact that TP adjustment cannot be made on hypothetical and notional basis until and unless there is some material on record that there has been under charging of real income.
1.19. The learned AO/ learned TPO/ Hon’ble DRP erred in disregarding the fact that the receivables are arising out of transactions that are being determined to –be at arm’s length by application of Transactional Net Margin Method (“TNMM”) and in separately adjusting the –receivables on account of excess credit period.
1.20. The learned AO/ learned TPO/ Hon’ble DRP erred in not4considering the fact that the outstanding amount from the money advanced by the Appellant would get adjusted in the working capital adjustment and hence no separate adjustment is required.
1.21 The learned AO/learned TPO/Hon’ble DRP erred in computing interest on the outstanding balance from the AE by evaluating on invoice by invoice basis even though the weighted average period period of receivables of the Appellant is only 24 days, which is less than 30 days as accepted by the Ld. TPO.
1.22 The learned AO/ learned TPO/ Hon ‘ble DRP erred in imputing interest on the outstanding receivables from AEs ignoring the fact that the Appellant followed the same policy of not charging any interest on trade receivables from both AEs as well as Non-AEs.
1.23. Without prejudice, the learned AO/ learned TPO/ Hon’ble DRP erred in computing notional interest by considering entire year after providing 30 days grace period rather than limiting it to the delay beyond the average credit cycle of the comparable companies selected by the TPO while proposing the TP adjustment. Further without prejudice, the learned TPO has committed arithmetical mistakes in computation of interest.
1.24. Without prejudice, the Honorable DRP has erroneously directed the learned TPO to adopt State Bank of India (“SBI”) short term deposit interest rate instead of adopting London Inter-Bank Offered Rate (“LIBOR”). In this regard, the Honorable DRP have erred in law by not giving an opportunity to the Appellant as per Section 144C(11) of the Act and passing direction which is prejudicial to the interest of the Appellant.
B. Corporate Tax
2. Incorrect disallowance with respect to expenditure on Employee Stock Option Plan (“ESOP”) under section 37 of the Act — INR 18,18,00,000
2.1. The Learned AO and Honorable DRP has erred in law and on facts, in disallowing the expenditure on ESOP of INR 18,18,00,000 under section 37 of the Act without appreciating the submissions furnished by the Appellant.
2.2. The Learned AO and Honorable DRP has erred in law, in disregarding the decision of Jurisdictional Karnataka High Court in the case of Biocon Limited, [2020] 121 taxmann.com 351 (Kar.) and Bangalore Tribunal in the case of Novo Nordisk, [2014] 42 taxmann.com 168 wherein it was held that discount on issuance of ESOP is an allowable business expenditure under section 37 of the Act
2.3. The learned AO and Honorable DRP has erred in law and on facts by stating that there is no outflow of money resulting in an expense whereas the fact is that there is a clear outflow of economic resources/cash in the hands of the appellant, which is wholly and exclusively used for the purpose of business in India.
2.4 The learned AO and Honorable DRP has erred in law and on facts by not appreciating that the difference between the market value and the purchase price of shares is being taxed as perquisite in the hands of the employees.
2.5. The Learned AO and Honorable DRP has erred in law and on facts, in disregarding the sample debit note/invoices, Employee listing, sample Form 16 copies, cost reimbursement agreement, sample RSU agreement and scheme document submitted during the DRP proceedings by the Appellant.
2.6. The Learned AO and Honorable DRP has erred in law and on facts, in considering the ESOP expenditure as fictitious expenditure and making false allegation that the ESOP expenditure is a colorable device adopted for avoidance of tax which is totally inappropriate and misdirected. Further, Learned AO/Honorable DRP has considered the ESOP cross charge by the Ultimate holding company as fictional and notional in nature which is totally misplaced.
2.7. The Honorable DRP has erred in law and on facts by placing reliance on the case laws decided in different context and not applicable to the facts of the Appellant.
2.8. The Honorable DRP has erred in law and on facts by stating that the ESOP is uncertain by not appreciating the fact that the ESOP expenses are actual expenses claimed by the Appellant, based on actual invoices issued and actual payments made.
Non-Applicability of section 195 of the Act
2.9. The learned AO has erred in law and on facts by disregarding that the ESOP expense is liable to TDS under section 192 of the Act as perquisite in the hands of the employees and appropriate taxes are deducted and remitted by the Appellant, which is evidenced by sample Form 16 copies.
2.10. The learned AO has erred in law and on facts by stating that the provisions of section 195 of the Act shall be applicable on the remittance of reimbursement towards ESOP without taking cognizance of the fact that there was no income element arising to the recipient of such remittances.
2.11. The learned AO has erred in law and on facts by stating that the provisions of section 195 of the Act has not been complied with and consequently reimbursement towards ESOP shall suffer disallowance under section 40(a)(i) of the Act without evaluating the fact that the provision of section 195 of the Act is prima facie not applicable on such remittances.
2.12 The learned AO has erred in law and on facts by relying on decision of Danfoss Industries P Ltd (2004) 268 ITR 1 pronounced by the Hon’ble Authority for Advance Ruling (“AAR”) as the same is very specific to the given transaction of that Appellant. The transaction covered by the said decision is very different on facts as compared to the Appellant and the same cannot be applied here.
2.13. The learned AO has erred in law and on facts, in disregarding that the remittance towards recovery of ESOP charges is not taxable under the provisions of India-USA Double Taxation Avoidance Agreement
2.14. The learned AO has erred in law and on facts by contending that the said ESOP cross charge is liable to TDS under section 192 of the Act as perquisite in the hands of the employees and same is also liable to TDS under section 195 of the Act on the reimbursement to the Ultimate Holding Company thereby resulting in double taxation of same amount.
2.15. The learned AO has erred in law and on facts by contradicting his own statement by stating that in one hand there is an element of income included in the reimbursement made to the Ultimate Holding Company for the expenditure on ESOP whereas on the other hand the learned AO states that the said expenditure is notional/fictitious in nature.
3. Other Corporate Tax related grounds
3.1. The Learned AO, while assessing the total income of the Appellant for the year under consideration, have erred in not allowing a deduction for education cess and secondary & higher education cess (collectively known as “education cess”) for the year under consideration, although not claimed as a deduction by the Appellant in the return of income.
3.2. The Learned AO, while assessing the total income of the Appellant for the year under consideration, have erred in not considering the depreciation claim on written down value of software which was purchased in preceding previous years and claimed as revenue expenditure, which the erstwhile AO had disallowed in the said years and allowed a claim towards depreciation. Thus, consequential depreciation of the said software ought to be provided in the year under consideration.
4. Other Matters:
4.1 The learned AO has erred, in law and on facts, in initiating penalty proceedings under section 271(1)(c) of the Act.
4.2 The learned AO has erred in law and on facts in levying interest under section 234B and section 234C of the Act.
2. Ground Nos.1.1 to 1.13 are general in nature, which do not require any adjudication. Ground No.1.14 is as follows:-
Software Development Segment (“SWD”)
1.14.The learned AO/ learned TPO/ Hon’ble DRP have grossly erred in not rejecting the following companies:
Inteq Software Private Limited;
Larsen & Toubro Infotech Limited;
Nihilent Limited;
Persistent Systems Limited;
Infobeans Technologies Limited;
Aspire Systems (India) Private Limited;
Infosys Limited
Thirdware Solution Limited; and
Cybage Software Private Limited.
2.1 Out of above comparables, the assessee seeks exclusion of 3 comparables namely (1) Larsen & Toubro Infotech Limited (2) Persistent Systems Ltd. (3) Infosys Limited.
Larsen & Toubro Infotech Limited:-
4. The Ld. A.R. submitted that there is no information in AR as to any IPR developed or licensed or owned by this company. The amalgamation has not impacted in increasing the profitability. Selling and marketing by this company constitutes only 0.24% of total expenses. In this regard, Ld. A.R. relied on the following decisions of the coordinate benches of ITAT Bangalore & Hyderabad as mentioned below:-
1) M/s. Advice America Software Development Centre Private Limited, AY 2013-14; ITA (TP) No. 2531/Bang/2017 dated 23.05.2018
2) Oracle Solution Services v DCIT, (IT (TP) A No.880/Bang/2013-14.
3) EIT Services India Pvt. Ltd., AY 2016-17; Bangalore ITAT, IT(TP)A No.210/Bang/2021
4) LG Soft India Pvt. Ltd, AY 2016-17; Bangalore ITAT IT(TP)A No.266/Bang/2021
5) ADP Pvt. Ltd., AY 2016-17; Hyderabad ITAT ITA Nos. 227 & 228 /H/2021
6) Yahoo Software Development India Private Limited, AY 2017-18; IT(TP)A No. 178/Bang/2022
7) Yahoo Software Development India Private Limited, AY 2015-16; IT(TP)ANo.2657/Bang/2018 & IT(TP)ANo.2365/Bang/2019
8) Goldman Sachs Services Private Limited, AY 2015-16; IT(TP)A No. 2355/Bang/2019
9) LG Soft India Pvt. Ltd, AY 2015-16; Bangalore ITAT IT(TP)A No.2412/Bang/2019
10) Hewlett Packard India Software Operation Pvt. Ltd., AY 2014-15 Bangalore ITAT, IT(TP)A No. 3400/Bang/2018
11) Hewlett Packard India Software Operation Pvt. Ltd., AY 2013-14 Bangalore ITAT, IT(TP)A No. 2866/Bang/2017
4. Ld. D.R. submitted that the company is engaged in providing Application Maintenance and Development, Enterprise Resource Planning and specialized services like Data Warehousing and Business Intelligence, Testing Services and Infrastructure Management Services. The services offerings are focussed mainly towards four verticals namely manufacturing, utilities, financial services and telecom, For the period ended March 31, 2016, March 31, 2015 and March 31, 2014, as per the information in the annual reports, 100 percent of the operating revenues respectively were derived from software development services. The activities- Application maintenance and Development, Enterprise Resource Planning and Testing are all software development activities and fall within the umbrella IT services, as per NASSCOM. These activities are also functionally comparable to the assessee company, as evident from the nature of services rendered by it as stated in its TP study report. Taking into account the nature of industries, to which these services were rendered, the assessee has classified its business into Service Cluster and Industry Cluster. This is clearly stated in pages 113-114 of the annual report. Therefore, the plea that this company performs different functions has no basis. The nature of activity performed by this company is given at page 62 of the annual report, as follows:-
“We offer an extensive ranee of IT services to our clients in diverse industries such as banking and financial services, insurance, energy and process, consumer packaged goods, retail and pharmaceuticals, media and entertainment, hi-tech and consumer electronics and automotive and aerospace. Our range of services includes application development, maintenance and outsourcing, enterprise solutions, infrastructure management services, testing, digital solutions and platform-based solutions”
The nature of activities and the nature of its revenue, is also discussed at page-68 of the annual report as under:
“We generate revenue from our continuing operations through time-and-materials contracts and fixed-price contracts by providing IT services and solutions to our clients in our industrials and services clusters”
4.1 In view of the above information, Ld. D.R. submitted that it is very clear that this company is engaged in software development services only and hence functionally comparable. The plea that it has diversified activities has no basis, as could be seen from the above information and discussion in the annual report of this company. Further, we also note that as per Note 3, regarding Accounting principle on Revenue Recognition, it is stated that revenue is recognised when services are rendered and related costs incurred; and there is no reference to sale of products. The financial statements do not mention about any product sale or inventory. As there is no revenue stream on account of product sales, there is no merit in the argument that the company is engaged in product sales. Accordingly, Ld. DRP hold that this company is functionally comparable to the assessee.
4.2 On the pleas as to presence of brand, Ld. DR stated that Ld. DRP in his order noted that, there is no specific information in the financial statements to indicate that the brand has contributed to revenue growth of the company. On the other hand, the company has recognized client relationships and employee relationships as significant factor that has contributed to the revenue growth of the company. As to the significant factors contributing to the revenue growth, the annual report recognizes, “Client relationships are at the core of our business. We have a history of high client retention and derive a significant proportion of our revenue from repeat business built on our successful execution of prior engagements”; and further states, “A principal component of our ability to compete effectively is our ability to attract and retain qualified employees: our employee benefit expenses constituted 57.5% and 57.7% for the year ended 31-3-2016 and 31-3-2015.” (Ref: page 63-64 of the annual report). It is pertinent to note that brand was not recognized as the significant factor for revenue from operations. In other words, its operational efficiency has contributed to its revenue growth and brand name and not the other way. There is no information to indicate that the brand has impacted the revenue or profit of the company. Besides, the assessee has failed to establish that such differences have material effect on the margin of the above company, in terms of clause (i) of sub-rule (3) of Rule 10B. Hence, these pleas are rejected by Ld. DRP.
4.3 It was argued before Ld. DRP that this company owns intangible assets in the form of Intellectual property rights worth Rs.741.07 million, and which constitutes 21.85% unlike the assessee which does not own any intangibles and hence this company has to be excluded.
4.4 Having examined the pleas, Ld. DRP noted that the details of intangible assets are given at page 96 of the annual report. As per that information, the company has reported intangible assets worth Rs.741.07 million as at 31-3-2016, which comprises computer software of value Rs.553.51 million and intangible assets under development of Rs.187.56 million. There is no information as to any intellectual property rights developed or license owned by the company. The computer software referred to were normal software used by any software company and hence it cannot be construed as a unique or non-routine asset. The reference to intangibles under development also indicates that as at the end of the year, it does not possess its own intellectual property rights; and does not have any revenue stream on account of IPR. Thus, Ld. DRP did not find any material difference as to the intangibles owned by the assessee company and the comparable company. The assessee also failed to demonstrate as to any material effect on the profits of the enterprise. In view of the above discussion, Ld. DRP did not find any merit in these pleas and are accordingly rejected.
4.5 Ld. D.R. stated that it was argued before Ld. DRP that the amalgamation of M/s. Information Systems Resources Centre Private Limited, is an extraordinary event and will have an impact on the profit of the company. The assessee has not furnished any information to demonstrate the said plea. Having examined the plea, Ld. DRP noted that with the acquisition of M/s. Information Systems Resources Centre Private Limited, it had become wholly owned subsidiary in the earlier year operating in the same field of rendering software services. The Scheme of amalgamation was approved by the Hon’ble High Court of Bombay, vide its order dated 4 Sept 2015 with effect from 17th Oct 2014. The method of accounting to give effect to the amalgamation into the accounts is discussed at pages 115-116 of the annual report. As per the said information, net assets to the tune of Rs.192.41 million has been transferred to the comparable company as on 31.3.2015; the profit of the transferor company for the period 17th Oct 2014 to 31.3.2015 was given to be Rs.27.35 million. For the current year, there is no impact as such, as the transferor company is also in the same line of business activity- namely software development services. Thus, there is no functional difference so as to affect comparability on account of the said acquisition. On further perusal of the financial reports for the three years, Ld. DRP noted that there is no impact on the profitability of the transferee company on account of such acquisition, as could be seen from the following information extracted from the annual report:
