IN THE ITAT BANGALORE BENCH ‘A’
Centillium India (P.) Ltd.
v.
Deputy Commissioner of Income-tax
IT APPEAL NO. 1354 (BANG.) OF 2010
[ASSESSMENT YEAR 2006-07]
FEBRUARY 29, 2012
ORDER
George George K., Judicial Member–
This appeal instituted by the assessee is directed against the assessment concluded u/s 143(3) r.w.s 144C of the I T Act, 1961. The relevant assessment year is 2006-07. The assessee is aggrieved by the direction issued by the Dispute Resolution Panel (DRP) dated 17/09/2010. The DRP had approved but for minor modification, the draft order of assessment, making transfer price adjustment as suggested by the Transfer Pricing Officer (TPO) u/s 92CA of the Act.
2. The assessee has raised the following grounds in an exhaustive and narrative manner. For the sake of clarity, they are reformulated as under.-
(1) As directed by the DRP, the AO has erred in holding that the communication expenses attributable to the delivery of computer software outside India should be reduced from export turnover while computing the deduction u/s 10A of the Act;
(2) On the facts and in the circumstances of the case and in law, the learned AO has erred in law by not considering that, if the communication expenses (i.e. lease line charges) attributable to the delivery of computer software outside India are reduced from export turnover, an equal amount should also be reduced from total turnover for computing the deduction u/s 10A of the Act.
The lower authorities (the AO, TPO and DRP) have erred in –
(3) making an addition of Rs. 2.82 crores to the total income on account of adjustment in Arm’s Length Price (ALP) of the software development services transaction entered with its Associate Enterprise (AE);
(4) conducting afresh economic analysis for determination of ALP with regard to international transaction disowning the analysis under taken by the assessee;
(5) ignoring the fact that the assessee has been availing tax holiday u/s 10A of the Act and there was no intention to shift the profit base out of India which was one of the basic intentions of introduction of transfer pricing provisions;
(6) determining the arm’s length margin/price using only FY 2005-06 data which was not available to the assessee at the time of complying with the transfer pricing documentation requirements;
(7) rejecting certain comparables considered by the assessee in the comparability analysis by applying different quantitative/qualitative filters:
AO/TOP erred by rejecting certain comparable companies identified by the assessee:
– where consolidated results have been used for analysis; that the assessee had considered the consolidated results in only those cases where the software services related income of the Indian operations constituted more than 75% of the consolidated company-wide/segmental revenue;
– using turnover < Rs. 1 crore as a comparability criterion;
– as having economic performance contrary to the industry behaviour (e.g. companies showed diminishing revenue trends);
– in the comparability analysis as the comparables were having different accounting year (other than 31st March or companies whose financial statements were for a period other than 12 months);
– in the comparability analysis using ‘onsite revenues greater than 75 per cent of the export revenues as a comparability criteria; &
– in the comparability analysis using ’employee cost greater than 25 per cent of the total revenues’ as a comparability criteria;
(8) by accepting certain companies using unreasonable comparability criteria;
(9) obtaining information which was not available in public domain by exercising powers u/s 133(6) of the Act and relying on the information for comparability analysis;
(10) not considering the foreign exchange fluctuation gain (loss) as part of the operating income while computing the operating margin;
(11) not considering the provisions written back as part of he operating income while computing the operating margin;
(12) not making suitable adjustments on account of difference in the risk profile of the assessee vis-à-vis the comparables while conducting comparability analysis;
(13) computing the ALP without giving benefit of +/- 5% under the proviso to s. 92C of the Act;
(14) charging of interest 234B and 234D of the Act; &
(15) initiation of penal proceedings u/s 271(1)(c) of the Act.
Brief facts of the case are as follows:
3. The assessee is engaged in the business of providing software development service of its AE in USA. The return of income for concerned asst. year was filed on 15/11/2006 declaring an income of Rs. 8,45,107/-. During the course of hearing, the AO observed that for the period of relevant financial year, the assessee had international transaction to the extent of Rs. 27 crores. With the approval of the jurisdictional CIT, a reference was made to the TPO to determine the ALP as per the provisions of s. 92CA of the Act. For the reasons recoded, the ALP of the international transaction pertaining to providing software development was determined by the TPO at Rs. 29.91 crores instead of Rs. 27.07crores, resulting in an adjustment to the extent of Rs. 2.83 crores and the excess claim of deduction u/s 10A of the Act at Rs. 3.1 lakhs.
3.1 Aggrieved by the said order, the assessee had approached the DRP for relief. However, the DRP in its directions dated 17.9.2010 had almost ratified the TPO’s stand, except a marginal relief of Rs. 1.5 lakhs.
4. Agitated, the assessee is in appeal before us. The assessee’s appeal is largely confined to the following counts:
(i) determination of ALP in respect of international transactions;
(ii) the authorities below erred by holding that the communication software attributable to the delivery of computer software outside India were not to be reduced from export turnover while computing deduction u/s 10A of the Act; or alternatively if the expenditure is reduced from the export turnover, the same should be reduced also from the total turnover while computing deduction under section 10A of the Act; and
(iii) charging of interest u/s 234B and 234D of the Act and also initiation of penal proceedings u/s 271(1)(c) of the Act.
4.1 During the course of hearing the Ld. A R had submitted his submission in an exhaustive manner narrating various contentions put forth before the TPO as well as before the DRP. The submissions of the Ld. A R are summarized as under:
(1) the international transactions of the assessee with its AEs during the relevant AY for the provision of software development services at Rs. 27.07 crores; that for the purpose of establishing the ALP of its international transaction with its AE, the assessee had undertaken a transfer pricing study in accordance with the provisions of the Act. Based on a detailed analysis with regard to the functions performed, risks assumed and assets utilized by the assessee and its AEs in respect of international transactions between them and, accordingly, concluded that the price received by the assessee in respect of its transactions with AEs was at arm’s length;
(2) that the key features of the TP study undertaken for software development services were that –
– as per the functional analysis, the assessee was categorized as a risk mitigated contract service provider and selected as the tested party;
– that the TNMM was determined as the most appropriate method to determine the ALP; that a search was conducted on prowess database and Capitoline database up-dated till 25.8.2006 to select comparable companies;
– that given the nature of the international transaction under review, economic conditions, differences in business or product life cycles and other similar factors and also the fact that financial date for the FY 2005-06 was not available in all cases, financial data of FY 2003-04 was also considered along with date for FY 2004-05 wherever available;
(3) however, the TPO had not accepted the economic analysis undertaken by the assessee and conducted a fresh economic analysis; that the TPO failed to appreciate that such data was not available in the public domain at the time of complying with the mandatory TP documentation rules by the prescribed due data; that the TPO applied certain filters and did not undertake an objective comparative analysis for selection of comparable companies; that while arriving at the ALP, the TPO rejected certain comparables identified by the assessee on the following filters:
– in the case of companies where consolidated results has been used for analysis;
– companies with turnover less than Rs. 1 crore;
– companies having economic performance contrary to the industry behaviour (e.g., companies which showed a diminishing revenue trend);
– companies having different accounting year (other than March 31 or companies whose financial statements were for a period other than 12 months);
– in the case of companies where on site revenues were greater than 75 per cent of the export revenues; that in the case of companies where employee cost was less than 25 per cent of the total revenues; &
(a) the TPO had excluded the foreign exchange gain or loss in computing the operating margin of the comparable companies;
(b) the TPO provided an adjustment towards working capital 1.72 per cent; that the adjusted net margin of comparable companies after providing the working capital adjustment was determined at 18.96 per cent on operating cost;
(c) the TPO did not make suitable adjustments to account for differences in the risk profile of the assessee vis-à-vis the comparable companies;
(d) that the TPO did not consider that the adjustment to the ALP, if any, should be limited to the lower end of 5% range as the assessee had the right to exercise this potion under the proviso to s.92C(2) of the Act; and
(e) the TPO initiated penalty proceedings under Explanation 7 to s. 271(1)(c) of the Act.
(4) that the AO had issued draft assessment order proposing to make an addition of Rs. 2.83 crores on account of TP adjustment and recomputed the deduction u/s 10A of the Act by reducing the communication charges (i.e.; lease line charges of Rs. 25.31 lakhs from the export turnover without simultaneously reducing the same from the total turnover) hence, reducing the deduction u/s 10A of the Act to the extent of Rs. 3.1 lakhs;
(5) Even the DRP agreed with the stand of the AO/TPO and rejected the assessee’s reasonable contentions with a marginal relief of Rs. 1.5 lakhs on account of re-computation of operating margin of Megasoft Limited whereby re-determining the ALP at Rs. 2.82 crores.
(6) Corporate tax: Disputing the AO’s stand by holding that the communication expenses attributable to the delivery of computer software outside India should be reduced from export turnover while computing the deduction u/s 10A of the Act, it was claimed, among others, that for the purpose of adjustment specified u/s 10A of the Act, only the expenditure incurred in foreign currency in providing technical services outside India alone needs to be excluded from export turnover. In this context, it was pertinent to note that the assessee was engaged in the business of development and export of software and, thus, as the assessee was not engaged in rendering any ‘technical services’ outside India, the question of excluding expenditure incurred in foreign currency did not arise;
Relies on case laws:
(i) Infosys Technologies Ltd v. Jt. CIT [2008] 19 SOT 7 (Bang.)
(ii) Patni Telecom (P) Ltd v. ITO [2008] 22 SOT 26 (Hyd.)
(iii) Mphasis Ltd – (2008
(7) Communication expenses:
That even if communication expenses were reduced from ‘export turnover’ an equal amount should be reduced from the ‘total turnover’ for computing the profits eligible for deduction u/s 10A of the Act.
Relies on case laws:
(i) ITO v. Sak Soft Ltd. [2009] 30 SOT 55 (Chennai) (SB);
(ii) ITO v. Motorola India (P.) Ltd [IT Appeal No. 645 (Bang.) of 2008, dated 1-5-2009]
(iii) Asstt. CIT v. Khoday India Ltd. [2009] 33 SOT 178 (Bang.)
That the communication expenses should not be reduced from the ‘export turnover’ while computing the eligible deduction u/s 10A of the Act and prays that the deduction u/s 10A of the Act be recomputed on this basis; &
Without prejudice, if communication expenses were to be reduced for computing the export turnover, the expenses should also be reduced from the total turnover for the purpose of computation of deduction u/s 10A of the Act;
(8) Transfer pricing matters:
That the assessee conducted a comparable search analysis using data from the two recognized databases and had determined the ALP of the international transaction by using the financial information of the comparable companies pertaining to FYs 2003-04 to 2005-06 as was available to the assessee at the time of complying with the transfer pricing documentation requirements;
– with regard to provisions of s.92C(3) of the Act, the AO could determine the price only under the circumstances enumerated in clauses (a) to (d), for which, it was submitted that –
(a) the ALP in the case of the international transaction has been determined by applying the prescribed method in accordance with sub-sec. (1) and (2) of s. 92C;
(b) all the relevant information and documents relating to the international transaction has been maintained as prescribed and provided to the TPO;
(c) the data used in computation of ALP was taken from the two databases for obtaining publicly available financial information in India, namely, prowess (a database compiled and managed by The Centre for Monitoring Indian Economy) and Capitoline (a corporate database compiled and managed by Capital Market Publishers); that the assessee had used the contemporaneous data for computation of ALP as on the date of filing of return of income in accordance with rule 10D(4), as such, the data used for computation of the ALP was reliable and correct; &
(d) the TP documentation, detailed workings of the economic analysis and all the other documents requested by the TPO have been provided during the course of assessment;
– that the assessee had under taken the comparability analysis based on well accepted TP principles and in the absence of any information to the contrary, that it was inappropriate on the part of the Revenue to reject the comparability analysis which was undertaken in accordance with the provisions of the Act read with rules;
– taking cue from the Board’s Circulars 12 of 23.8.2001 and 14 of 2001 and also placing reliance on the judicial views in the cases of (i) Mentor Graphics (Noida) (P.) Ltd. v. CIT [2007] 109 ITD 101 (Delhi); (ii) Sony India (P) Ltd v. CBDT [2007] 288 ITR 52/[2006] 157 Taxman 125 (Delhi); (iii) Dy. CIT v. Indo American Jewellery Ltd. [2010] 41 SOT 1 (Mum) and (iv) Sony India (P.) Ltd (supra), it was argued that the TPO was required to accept the assessee’s analysis on account of the reasons that (i) analysis undertaken in accordance with law; (ii) analysis undertaken by an external agency; & (iii) the AO/TPO had no reasons to believe that the transactions were not at arm’s length.
(9) Availing tax holiday u/s 10A of the Act:
The assessee has been availing tax exemption u/s 10A and there was no reason or motive for avoidance of tax in India through reduced payments by the parent company outside India to the assessee which enjoys tax holiday in India and thereby erode the Indian tax base.
Relies on case laws:
(i) Philips Software Centre (P.) Ltd v. Asstt. CIT [2008] 26 SOT 226 (Bang);
(ii) Indo American Jwellery (supra);
(iii) Zydus Atlana Healthcare (P.) Ltd v. ITO [2011] 44 SOT 132 (Mum);
(iv) ITO v. Panasonic India (P.) Ltd [2011] 43 SOT 68/[2010] 7 taxmann.com 117 (Delhi)
(10) Determining the ALP using only FY 2005-06 data:
That it was submitted before the TPO that conducting a search in the databases after the specified date for determining the arm’s length nature of the international transaction based on the financial information of the comparable companies for the FY 05-06, the data pertaining to which was not available to the assessee at the time of complying with the transfer pricing documentation requirements and was not in accordance with the provisions of the law;
– that the assessee was a subsidiary of Centillium Communications Inc., USA which was acquired by Transwitch Corporation in Oct. 08; that Transwitch has been incurring losses at the net level over the years from 2005 to 2010; that in spite of the parent company incurring operating losses, the assessee had earned income on cost plus margin consistently over the said period; and that the assessee earned a consistent margin irrespective of the losses incurred by the parent company reiterates that the assessee is a limited risk service provider and, thus, it was argued, an adjustment to the ALP proposed by the TPO was not warranted;
(11) that the comparable data for the FY 2005-06 was not available in most cases at the time of complying with the TP documentation requirements under the provisions of the Act; that the rejection of the comparability data used by the assessee on the above ground would be contrary to what was prescribed under the Act and the relevant rules;
– that extensively quoting the provisions of s. 92(1) of the Act read with Rule 10B and also s. 92B read with rule 10D, it was submitted that-
In compliance with the regulations the assessee maintained the documentation as per Rule 10D based on the data that was available on the public databases before the prescribed date. Further, rule 10D(4) provides that transfer pricing documentation should, as far as possible, be contemporaneous and should exist latest by the due date for filing of income-tax return i.e., 31.10.2006 for the FY 2005-06; that all the companies do not publish the financial results by the due date and, hence, use of financial data only for the FY 2005-06 was practically not possible and that even the press note dated 22.8.2001 had clarified that multiple year data pertaining to comparable transactions can be considered for determining the arm’s length price.
Relies on case laws:
(i) Philips Software Centre (P.) Ltd (supra)
(ii) Spud of Taxes, Dhubri (1975 CTR (SC) 172
4.1.1 In conclusion it was claimed that the use of multiple year and contemporaneous data available by the prescribed date be allowed to the assessee.
4.2 On the other hand, the Ld. D R also came up with equally exhaustive submission running into forty six pages. The submission of the Ld. D R is summarized in caption-wise as below:
Corporate tax matters:
Quoting a number of judicial pronouncements, among others, on a similar issue, the Ld. D R, relying on the findings of the Hon’ble Chennai Tribunal (SB) in the case ofSak Soft Ltd (supra) had submitted that “From the facts available (sic) on record, it is not clear whether export turnover include communication charges. In view of the observation above, the Hon’ble ITAT is requested to remand back to the matter to the AO for re-examination the issue in the interest of justice.’
Transfer pricing matters:
After commenting on the assessee’s contentions coupled with various case-laws, the Ld. D R, extensively explaining the provisions of s. 92 and also quoting the findings in the case of M/s. Aztec Software & Technology Service Ltd v. Asstt. CIT [2007] 107 ITD 141 (SB) (Bang), submitted that there is no merit in the assessee’s objection which deserves to be rejected. He had also submitted that out of the comparables selected by the assessee, the TPO accepted Accel Transmatic Ltd (Seg), Aztec Software & Technology Service Ltd. (supra) and Mega Soft Ltd. and, thus, comparables eliminated as comparable after detailed analysis and, hence, this ground of the assessee requires to be rejected.
Transfer pricing documentation:
Placing reliance on the findings in the case of M/s. Aztec Software & Technology Services Ltd. (supra), the Ld. D R opined that the assessee’s ground is not sustainable.
Determination of the arm’s length margin/price:
Contesting the assessee’s arguments, the Ld. D R, by illustrating the provisions of rule 10B (4), s. 92B read with rule 10D, 10D (3) and also 10D (4), maintained that the aspect raised by the assessee has been discussed by the TPO in his impugned order; that the DRP was also in agreement with the TPO’s view and held that ordinarily only the data pertaining to the FY of the transaction can be considered. It was, further, explained that the proviso to rule 10B (4) which permits the use of data relating to other than financial year in which the international transactions have been entered into being not more than two years prior to such FY data but it has a limited role only when the data of earlier years reveals facts which could have influenced on determination on the transfer pricing in relation to the transactions being compared. It was, further, argued that the assessee had not made out a case that taking data for only the current FY will not present the concept and fair financial result of the comparables, the claim for multi-year data has been rejected.
Relies on the case laws:
(i) Symantec Software Solution (P.) Ltd. v. Asstt. CIT [2011] 46 SOT 48/11 taxmann.com 264 (Mum.)
(ii) Avaya India (P) Ltd v. ACIT ITA No. 5150 (Delhi) 2010;
(iii) TNT India (P) Ltd v. Asstt. CIT [2011] 45 SOT 411/10 taxmann.com 161 (Bang.)
(iv) Exxon Mobile Co. India (P.) Ltd v. Dy. CIT [2011] 46 SOT 294/12 taxmann.com 84 (Mum.) (URO)
It was the case of the Ld. D R that, as the TPO and the DRP have rightly held, the contemporaneous data of relevant FY was to be used for making the comparable analysis for arriving at the ALP as the assessee unable to prove that the pricing pattern of the assessee for the relevant FY has been influenced by the market conditions, business cycle/product life cycle of the earlier years
Rejection of certain comparables considered by the assessee in the comparability analysis by applying different quantitative and qualitative filters:
The Ld. D R has detailed the following reasons for eliminating the companies as comparables by the TPO:
The companies having in business of IT enable services –
(i) the accounting periods were different from the financial year;
(ii) the companies having diminishing revenue as the trend of the software services sector is increasing;
(iii) Use of multiple year data instead of relevant financial year data;
(iv) the companies having onsite revenue is more than 75% of export revenue;
(v) the companies have employee cost is less 25% of export revenue.
It was the contention of the Ld. D R that these were the certain filter criterion for non-inclusion as comparable. There were other factors, the TPO had eliminated despite of the facts that high margins, for instance:
