Case Law Details
Tyco Fire and Security India Private Limited Vs ACIT (ITAT Bangalore)
As far as comparability of companies listed in Grd.No.4.3 raised by the Assessee is concerned, the admitted factual position is that the turnover of these companies is more than Rs.200 Crores and the Assessee’s turnover is only Rs. 40,39,51,067/-. The TPO excluded from the list of comparable companies chosen by the Assessee in its TP study companies whose turnover was less than Rs.1 Crore. The contention of the Assessee before the DRP was that while the TPO excluded companies with low turnover, he failed to apply the same yardstick to exclude companies with high turnover compared to the Assessee. The reason for excluding companies with low turnover was that such companies do not reflect the industry trend as their low cost to sales ratio made their results less reliable. The contention of the Assessee was that there would be effect on profitability wherever there is high or low turnover and therefore companies with high turnover should also be excluded from the list of comparable companies. The DRP primarily relied on the decision rendered by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors India Pvt.Ltd Vs. DCIT 82 Taxmann.com 167(Del), wherein it was held that high turnover ipso facto does not lead to the conclusion that a company which is otherwise comparable on FAR analysis can be excluded and that the effect of such high turnover on the margin should be seen. The DRP therefore held that a company which is otherwise functionally comparable cannot be excluded only on the basis of high turnover. The Assessee has raised Grd.No.4, 4.1 to 4.3 before the Tribunal challenging the aforesaid view of the DRP.
On the issue of application of turnover filter, we have heard the rival submissions. The parties relied on several decisions rendered on the above issue by the various decisions of the ITAT Bangalore Benches in favour of the Assessee and in favour of the Revenue, respectively. The ITAT Bangalore Bench in the case of Dell International Services India (P) Ltd. Vs. DCIT (2018) 89 Taxmann.com 44 (Bang-Trib) order dated 13.10.2017, took note of the decision of the ITAT Bangalore Bench in the case of Sysarris Software Pvt.Ltd. Vs. DCIT (2016) 67 Taxmann.com 243 (Bangalore-Trib) wherein the Tribunal after noticing the decision of the Hon’ble Delhi High Court in the case of Chryscapital (supra) and the decision to the contrary in the case of CIT Vs. Pentair Water India Pvt.Ltd., Tax Appeal No.18 of 2015 dated 16.9.2015 wherein it was held that high turnover is a ground to exclude a company from the list of comparable companies in determining ALP, held that there were contrary views on the issue and hence the view favourable to the Assessee laid down in the case of Pentair Water (supra) should be adopted.
The Tribunal in the case of Autodesk India Pvt.Ltd. Vs. DCIT (2018) 96 Taxmann.com 263 (Banglore-Tribunal), took note of all the conflicting decision on the issue and rendered its decision and in paragraph 17.7. of the decision held as that high turnover is a ground for excluding companies as not comparable with a company that has low turnover.
In view of the aforesaid decision, we hold that 7 companies listed in the earlier paragraph 7 of this order whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of comparable companies.
FULL TEXT OF THE ORDER OF ITAT BANGALORE
This appeal by the Assessee is directed against the final order of assessment dated 27.04.2021 of National e-Assessment Centre (NFAC), Delhi, (Assistant Commissioner of Income Tax, Circle-7(1)(1), Bangalore) (hereinafter referred to as the Assessing Officer, “AO” in short) passed u/s.143(3) read with Section 144C(13) of the Income Tax Act, 1961 (Act) in relation to AY 2016-2017.
2. The learned counsel for the Assessee submitted that the grounds of appeal filed along with Form No.36 on 23.6.2021 can be taken up for consideration. In ground No.1 to 16 of the grounds of appeal, the Assessee has challenged the order of the AO whereby the AO added a sum of Rs.4,63,62,735/- to the total income of the Assessee on account of determination of Arm’s Length Price in respect of an international transaction of rendering of Software Development Services by the Assessee to its Associated Enerprise. Though the Assessee has raised several grounds of appeal, at the time of hearing of the Appeal, the learned counsel for the Assessee restricted his arguments to exclusion of 7 comparable companies viz., and exclusion of margins for R.S.Software (India) Ltd., for FY 2014-15 & 201516) inclusion of one comparable company Akshay Software Technologies Ltd., besides grounds on working capital adjustment.
3. The Assessee in engaged in the business of provision of Software Development Services (SWD services), to its wholly owned holding company. In terms of the provisions of Sec.92-A of the Act, the Assessee and its wholly owned holding company were Associated Enterprises (“AEs”). In terms of Sec.92B(1) of the Act, the transaction of providing SWD Services was an “international transaction” i.e., a transaction between two or more associated enterprises, either or both of whom are nonresidents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. In terms of Sec.92(1) of the Act, the any income arising from an international transaction shall be computed having regard to the arm’s length price. In this appeal by the Assessee, the dispute is with regard to determination of Arms’ Length Price (ALP) in respect of the international transaction of rendering SWD services to the AE.
4. As far as the provision of Software Development services are concerned, the Assessee filed a Transfer Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The Assessee selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) for the purpose of comparison of the Assessee’s profit margin with that of the comparable companies. The OP/OC of the Assessee was arrived at 12.70% by the Assessee in its TP study. The operating income was Rs.40,39,51,067/- and the Operating Cost was Rs.35,84,15,952/-. The Operating profit (Operating income – Operating cost was Rs.4,55,35,115/-. Thus, the OP/TC was arrived at 12.70%. The Assessee chose companies who are engaged in providing similar services such as the Assessee. The Assessee identified 13 comparable companies with an arm’s length range of 9.83% to 15.49% and a median of 10.97%. The TPO however identified 17 companies whose average arithmetic mean of profit margin was in the range of 18.50% to 30.89% and a median of 25.64%. The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO, accepted TNMM as the MAM and also used the same PLI for comparison i.e., OP/OC.The TPO worked out the average arithmetic mean of their profit margins of the 13 comparable companies as follows:
| S.No. | Company Name | Financial Year wise OP/OC (%) | |||
| 2015-16 | 2014-15 | 2013-14 | Weighted Average |
||
| 1 | Kals Information Systems Pvt. Ltd. |
3.97% | 5.77% | 16.94% | 8.60% |
| 2 | E-Zest Solutions Limited | 7.65% | 11.80% | 14.88% | 10.87% |
| 3 | Rheal Software Pvt. Ltd. | 3.20% | 2.76% | 36.64% | 14.50% |
| 4 | Sybrant Technologies Private Limited | 16.10% | 13.88% | 15.26% | 14.74% |
| 5 | Harbinger Systems Pvt. Limited | 12.69% | 17.18% | No Data in Public Domain | 15.06% |
| 6 | C G-V A K Software & Exports Ltd. | 19.60% | 19.87% | 13.81% | 18.50% |
| 7 | R S Software (India) Ltd. | -2.09% | 32.75°/0 | 24.14% | 20.87% |
| 8 | Larsen & Toubro Infotech Ltd. | 26.29% | 24.22% | 23.54% | 24.83°- |
| 9 | Orion India Systems Private Limited | 26.08% | 25.14% | No Data in public | ‘ 25 64% |
| 10 | Nihilent Ltd. | 15.94% | 29.19% | 35.72% | 26.36% |
| 11 | lnteg Software Pvt. Ltd. | 7.53% | 32.14% | 45.00% | 28.20% |
| 12 | Persistent Systems Ltd. | 26.92% | 31.34% | 35.64% | 30.89% |
| 13 | Infobeans Technologies Ltd. | 34.98% | 20.78% | 41.95% | 32.42% |
| 14 | Thirdware Solution Ltd. | 23.89% | 44.39% | 44.68% | 36.90% |
| 15 | Infosys Ltd. | 38.22% | 41.30% | 36.28% | 38.61% |
| 16 | Aspire Systems (India) Pvt. Ltd. | 34.26% | 47.56% | 38.04% | 39.28% |
| 17 | Cybage Software Pvt. Ltd. | 62.90% | 68.68% | 68.82% | 66.45% |
| 35th Percentile | 18.50% | ||||
| Median | 25.64% | ||||
| 65th Percentile | 30.89% | ||||
5. The TPO did not give working capital adjustment to the margin of the comparable companies as claimed by the Assessee. TPO computed the Addition to total income on account of adjustment to ALP as follows:
“22.4. Computation of Arm’s Length Price:
22.4.1 The median of the weighted average Profit Level indicators is taken as the arm’s length margin. Please see Annexure A for details of computation of PLI of the comparables. Based on this, the arm’s length price. of the services rendered by the taxpayer to its AE(s) is computed as under:
| SWD SEGMENT | ||
| Particulars | Formula | Amount (in Rs.) |
| Taxpayers operating revenue | OR | 40,39,51,067 |
| Taxpayers operating cost | OC | 35,84,15,952 |
| Taxpayers operating profit | OP | 4,55,35,115 |
| Taxpayers PLI | PLI=OP/OC | 12.70% |
| 35th Percentile Margin of comaparable set | 18.50% | |
| Adjustment Required (if PLI< 35th Percentile) | Yes | |
| Median Margin of comparable set | M | 25.64% |
| Arm’s Length Price | ALP=(1+M)*OC | 45,03,13,802 |
| Price Received | OR | 40,39,51,067 |
| Shortfall being adjustment | ALP-OR | 4,63,62,735 |
22.4.2 The above shortfall of Rs.4,63,62,735/-is treated as transfer pricing adjustment u/s 92CA in respect ,-of software development segment of the taxpayer’s international transactions.
Thus a sum of Rs.4,63,62,735/- was added to the total income of the Assessee on account of determination of ALP for provision of SWD services by the Assessee to its AE.
6. The Assessee filed objections before the Disputes Resolution Panel (DRP) against the draft assessment order passed by the AO wherein the addition suggested by the TPO as adjustment consequent to determination of ALP was added to the total income of the Assessee by the AO. The DRP gave certain directions. Based on the directions of the DRP, the AO passed the final order of assessment. To the extent the Assessee did not get relief from the DRP, the Assessee has preferred appeal before the Tribunal.
7. The grievance of the Assessee projected in the grounds of appeal filed before the Tribunal which was pressed for adjudication and argued before us were:
(i) choice of comparable companies by the TPO which was affirmed by the DRP. It was the plea of the Assessee that the Ld. ITO/ Ld. TPO/ Ld. DRPanel, while applying the turnover filter rejected companies having turnovers less than INR 1 crore, however, erred in not applying an appropriate upper limit to reject high turnover companies and thereby, erred in accepting companies without considering the turnover and size of the Assessee and comparables. It was the plea that should an upper limit be applied, the following companies would be rejected:
| Sl.No | Company | Turnover | ||
| FY 2013-14 | FY 2014-15 | FY 2015-16 | ||
| 1 | R S Software (India) Ltd. | 351.88 | 345.51 | – |
| 2 | Persistent Systems Ltd. | 1,184.12 | 1,242.50 | 1,447.14 |
| 3 | Thirdware Solution Ltd. | 206.76 | 230.08 | – |
| 4 | Larsen & Toubro Infotech Ltd. | 4,643.94 | 4,744.40 | 5,569.52 |
| 5 | Infosys Ltd. | 44,341.00 | 47,300.00 | 53.983.00 |
| 6 | Nihilent Ltd. | 242.00 | 267.00 | |
| 7 | Aspire Systems (India) Pvt Ltd | 156.53 | – | |
| 8 | Cybage Software Pvt. Ltd. | 544.27 | 622.26 | 722.25 |
The further argument was that out of the 8 companies set out above, the Turnover of 7 companies except R.S.Software (India) Ltd., during AY 2016-17 was more than Rs.200 Crores and therefore those 7 companies have to be regarded not as comparable. As far as R.S.Software (India) Pvt. Ltd., is concerned, the turnover for FY 2015-`6 (AY 2016-17 was less than Rs.200 Crores hence cannot be excluded on application of turnover filter but the said companies turnover for r FY 2013-14 & 14-15 was more than Rs.200 crores and therefore the profit margin of this company for FY 13-14 & 14-15 has to be excluded. In these two financial years, the turnover of these companies was more than Rs.200 Crores and therefore is not a comparable company in those two Financial Years and therefore while computing the average profit margin of three financial years, the profit margins of these two Financial years 2013-14 & 2014-15 should be excluded and only margins for FY 16-17 should be taken for working out the average profit margin of this company. (Grd.No.9 and Addl.Grd.No.24 & 25)
(ii) The next prayer was for Inclusion of Akshay Software Technologies Ltd., on the ground that this company is functionally similar to the Assessee. (Grd.No.10)
(iii) Allow working Capital Adjustment as prayed for by the Assessee. The grievance in this regard is projected by the Assessee in Grd.No.15 of the grounds of appeal raised by the Assessee.
8. As far as the plea of the Assessee for exclusion of companies whose turnover was more than Rs.200 Crores is concerned, the 7 companies listed in paragraph 7 of this order (excluding R.S.Software (India) Ltd.), the relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows:
Determination of arm’s length price under section 92C .
10B . (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :—
(a) to (d) ….
(e) transactional net margin method, by which,—
(i) the net profit margin realised by the enterprise from an international transaction [or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;
(ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base;
(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
(iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii);
(v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction [or the specified domestic transaction];
(f)…..
(2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:—
(a) the specific characteristics of the property transferred or services provided in either transaction;
(b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;
(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;
(d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.
(3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if—
(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or
(ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
9. A reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market.
10. Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that:
- None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or
- Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments.
11. As far as comparability of companies listed in Grd.No.4.3 raised by the Assessee is concerned, the admitted factual position is that the turnover of these companies is more than Rs.200 Crores and the Assessee’s turnover is only Rs. 40,39,51,067/-. The TPO excluded from the list of comparable companies chosen by the Assessee in its TP study companies whose turnover was less than Rs.1 Crore. The contention of the Assessee before the DRP was that while the TPO excluded companies with low turnover, he failed to apply the same yardstick to exclude companies with high turnover compared to the Assessee. The reason for excluding companies with low turnover was that such companies do not reflect the industry trend as their low cost to sales ratio made their results less reliable. The contention of the Assessee was that there would be effect on profitability wherever there is high or low turnover and therefore companies with high turnover should also be excluded from the list of comparable companies. The DRP primarily relied on the decision rendered by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors India Pvt.Ltd Vs. DCIT 82 Taxmann.com 167(Del), wherein it was held that high turnover ipso facto does not lead to the conclusion that a company which is otherwise comparable on FAR analysis can be excluded and that the effect of such high turnover on the margin should be seen. The DRP therefore held that a company which is otherwise functionally comparable cannot be excluded only on the basis of high turnover. The Assessee has raised Grd.No.4, 4.1 to 4.3 before the Tribunal challenging the aforesaid view of the DRP.
12. On the issue of application of turnover filter, we have heard the rival submissions. The parties relied on several decisions rendered on the above issue by the various decisions of the ITAT Bangalore Benches in favour of the Assessee and in favour of the Revenue, respectively. The ITAT Bangalore Bench in the case of Dell International Services India (P) Ltd. Vs. DCIT (2018) 89 Taxmann.com 44 (Bang-Trib) order dated 13.10.2017, took note of the decision of the ITAT Bangalore Bench in the case of Sysarris Software Pvt.Ltd. Vs. DCIT (2016) 67 Taxmann.com 243 (Bangalore-Trib) wherein the Tribunal after noticing the decision of the Hon’ble Delhi High Court in the case of Chryscapital (supra) and the decision to the contrary in the case of CIT Vs. Pentair Water India Pvt.Ltd., Tax Appeal No.18 of 2015 dated 16.9.2015 wherein it was held that high turnover is a ground to exclude a company from the list of comparable companies in determining ALP, held that there were contrary views on the issue and hence the view favourable to the Assessee laid down in the case of Pentair Water (supra) should be adopted. The following were the conclusions of the Tribunal in the case of Dell International (supra):
“41. We have given a very careful consideration to the rival submissions. ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, relying on Dun and Bradstreet’s analysis, held grouping of companies having turnover of Rs. 1 crore to Rs.200 crores as comparable with each other was held to be proper. The following relevant observations were brought to our notice:-
“9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.”
42. The Assessee’s turnover was around Rs.110 Crores. Therefore the action of the CIT(A) in directing TPO to exclude companies having turnover of more than Rs.200 crores as not comparable with the Assessee was justified. As rightly pointed out by the learned counsel for the Assessee, there are two views expressed by two Hon’ble High Courts of Bombay and Delhi and both are non-jurisdictional High Courts. The view expressed by the Bombay High Court is in favour of the Assessee and therefore following the said view, the action of the CIT(A) excluding companies with turnover of above Rs.200 crores from the list of comparable companies is held to correct and such action does not call for any interference.”
13. The Tribunal in the case of Autodesk India Pvt.Ltd. Vs. DCIT (2018) 96 Taxmann.com 263 (Banglore-Tribunal), took note of all the conflicting decision on the issue and rendered its decision and in paragraph 17.7. of the decision held as that high turnover is a ground for excluding companies as not comparable with a company that has low turnover. The following were the relevant observations:
17.7. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon’ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon’ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon’ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee.
17.8. In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5.8.2011. The decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India Pvt.Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding co-ordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of M/S.NTT Data (supra), Societe Generale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon’ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon’ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).
14. In view of the aforesaid decision, we hold that 7 companies listed in the earlier paragraph 7 of this order whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of comparable companies.
15. As far as the company R.S. Software (India) Pvt.Ltd., listed at Sl.No.1 in Ground No.4.3 is concerned, the said company has admittedly a turnover of above Rs.200 crores in FY 2013-14 & 2014-15 and hence is not a comparable company in those two Financial Years and therefore while computing the average profit margin of three financial years, the profit margins of these two Financial years 2013-14 & 2014-15 should be excluded and only margins for FY 16-17 should be taken for working out the average profit margin of this company. In the case of M/S.BORQS Software Solutions Pvt.Ltd. Vs. ACIT IT(TP) A.No.310/Bang/2021 for AY 2016-17, the ITAT Bangalore Bench in it’s order dated 25.10.2021 has taken the view as canvassed by the Assessee. The following are the relevant observations of the Tribunal in this regard:
“A reading of Rule 10B(3) shows that comparison of an uncontrolled transaction to an international transaction can be done only if differences, if any, between the transactions that are compared or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market or reasonably accurate adjustments can be made to eliminate the material effects of such differences. A reading of Proviso to Rule 10B(4) would show that use of data relating to a period of two years prior to the current year may also be considered but with a rider that “if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared”. If by application of any filter an enterprise undertaking uncontrolled transaction similar to an international transaction is regarded as not being comparable in the earlier two years immediately preceding the current year and thereby attracting the provisions of Rule 10B(2) or 10B(3) then the data for those years will not have any influence on the determination of transfer prices in relation to the transactions being compared for the current year and hence have to be ignored. On a harmonious reading of the provisions of Rule 10CA, 10B(3) (4) of the Rules, we agree with the stand taken by the learned counsel for the Assessee. Therefore, if at all R.S.Software Ltd., is to be regarded as a comparable company, then the margins for AY 2014-15 and 2015-16 of the company have to be ignored because in those years they are to be regarded as not comparable. We hold accordingly.”
16. Following the same, we hold that R.S. Software (India) Pvt.Ltd., has admittedly a turnover of above Rs.200 crores in FY 2013-14 & 2014-15 and hence is not a comparable company in those two Financial Years and therefore while computing the average profit margin of three financial years, the profit margins of these two Financial years 2013-14 & 2014-15 should be excluded and only margins for FY 16-17 should be taken for working out the average profit margin of this company.
17. The next plea of the Assessee is for inclusion of Akshay Software Technologies Ltd., as a comparable company. As far as the plea of the Assessee for inclusion of the aforesaid companies is concerned, the DRP dealt with the plea of the Assessee and held that this company is not strictly speaking said to be engaged in software development services but was a mix of software services and professional services. It also held that segmental details were not available to ascertain the profit margins of the software services segment.
18. It was submitted that under the safe Harbour Rules under Rule 10TA of the Income Tax Rules, 1962 (Rules), software development services include support services like debugging of systems and services for maintenance of software products and hence the conclusion of the DRP is incorrect. It was submitted that SWD services forms 96.05% of the total ooperating revenue. Reliance was placed on decision of ITAT Bangalore in the case of Citrix R & D India Private Limited order dated 19.7.2022 in IT(TP) A.No.459/Bang/2017 wherein this company was held to be comparable company.
19. We have considered the submissions and are of the view that on identical facts and directions of the DRP, this tribunal in the case of M/s. Prism Network Pvt.Ltyd. Vs. ACIT IT(TP) A.No.349/Bang/2021 order dated 11.2.2022 for AY 2016-17 remanded the issue to the TPO/AO for fresh consideration with the following observations:
“18. We heard the rival submissions. It is clear from the order of the DRP that the DRP has not considered the plea of the Assessee in proper perspective. The fact that the TPO rejected the TP study of the Assessee cannot be the basis not to consider the claim of the Assessee for inclusion of comparable companies. The TPO excluded these companies only on the ground that information related to these companies was not available in the public domain and this fact was shown to be an incorrect assumption by the Assessee in the submissions before the DRP. In such circumstances, it was incumbent on the part of the DRP to have adjudicated the question of inclusion of these companies as comparable companies. The fact that these companies do not figure in the search matrix of the TPO is not and cannot be a ground not to consider inclusion of these companies as comparable companies. Since the DRP has failed to do so, we are of the view that the issue regarding inclusion of the aforesaid companies as comparable companies should be set aside to AO/TPO for fresh consideration in the light of the information available in public domain. Thus ground No.7 is treated as allowed for statistical purposes.”
20. We are of the view that a direction to consider the comparability of this company afresh in the light of the submission as made above and decisions cited would be just and sufficient in the present case. Hence the question regarding inclusion of this company as comparable company is hereby set aside to AO/TPO for fresh consideration.
21. The next ground that needs adjudication is the ground with regard to the grievance of the Assessee that no adjustment towards working capital has been allowed to the Assessee. In this regard though the ground of appeal raised by the Assessee is ground No.15. On the issue of non granting of working capital adjustment, the DRP gave its decision by observing that (i) The Assessee has not demonstrated with any data or information as to the impact of working capital on the costs, price or profit. (ii) working capital requirements and impact depends on various factors such as business cycle, the nature of business activity with its correlation on the general economic trends, the fund and capital position of the company, its marketing strategies, its market share etc., all of which cannot be captured in the year end receivable or payable position. (iii) the year end receivables and payable may not reflect as to whether it arises from transactions relating to revenue account or capital account as there is no uniformity in the accounting or reporting requirements and an intermixing is generally possible. (iv) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results.
22. The learned counsel for the Assessee submitted that the conclusions of the DRP are identical to the conclusions arrived at by the revenue authorities in the case of Huawei Technologies India Pvt. Ltd. v. JCIT [2019] 101 com 313 (Bang. Trib.). In the aforesaid decision on an identical issue, the Tribunal held that working capital adjustment has to be given. The tribunal reasoned in the aforesaid decision that a reading of Rule 10B(l)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly show that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. The tribunal referred to Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annexure to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. The Tribunal referred to Paragraphs 13 to 16 of the aforesaid OECD guidelines, wherein the need for working capital adjustment has been explained as follows:
“13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing effect.
14. The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect.
15. A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory)
16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that:
- A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers)
- This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers – (less) the period granted to pay debts to suppliers.”
23. The tribunal observed that examples of how to work out adjustment on account of working capital adjustment is also given in the said guidelines. The guideline also expresses the difficulty in making working capital adjustment by concluding that the following factors have to be kept in mind (i) The point in time at which the Receivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these figures, (ii) the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The tribunal observed that the guidelines conclude by observing that the purpose of working capital adjustments is to improve the reliability of the comparables. The Tribunal further observed that the data available with the Assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing.
24. We are therefore of the view that the issue with regard to the grant of working capital adjustment should be directed to be examined by the TPO/AO afresh in the light of the decision of the tribunal referred to above, after affording opportunity of being heard to the Assessee.
25. No other grounds with regard to determination of ALP in the SWD services segment was pressed for adjudication. The TPO/AO is directed to compute the ALP of the international transaction of rendering of SWD services by the Assessee to AE in the light of the directions given above, after affording Assessee opportunity of being heard.
26. Grounds No.17 to 22 raised by the Assessee reads as follows:
Disallowance of short term capital loss of INR 550,0891891 on transfer of investment and erroneous computation of the same at INR 146,900,010
17. erred in questioning the business rationale behind hiving off the sprinkler business by TFSIPL as opposed to shutting it down completely and transfer of CCDs to Aigua Sprinkler at nominal value by TFSIP in a short span of time post subscription
18. erred in asserting that the rationale and action of investment of INR 550,000.000 by TFSIPL in the CCDs of Aigua Sprinkler is contradictory in nature considering the continuous losses being incurred by the sprinkler business.
19. erred in concluding that the sale of investment in Aigua Sprinkler at nominal value is a pre-planned and arranged transaction and rejecting the short-term capital loss of INR 550.089.891 arising on the sale of investment in Aigua Sprinkler on account of projection of growth of revenue in the valuation report of the Sprinkler business without considering the historic negative EBITDA of the Sprinkler business
20. without prejudice to the above. erred in offering the capital gains on the enterprise value of Sprinkler business twice. on both sale of Sprinkler business to Aigua Sprinkler amounting to INR 12 crores and on considering INR 14.7 crores as full value of consideration of 9.999 equity shares sold to third party.
21. without prejudice to the above. erred in considering enterprise value of Sprinkler business amounting to be INR 14.7 crores instead of book value of INR 12 crores as prescribed under Rule 11 UA.
22. erred in considering the face value of CODs to be the sale consideration and reworking the short-term capital gain/ loss on transfer of the same to be Nil.
The learned counsel filed memo requested for withdrawing ground No.21 & 22 and for revising ground No.18 to 20 to read as follows:
Revised/Modified Ground No. 18 to 20:
18. The learned AO / DRP erred in estimating/ substituting/deeming sale consideration of equity shares and debentures of Aigua Sprinkler and Hydrant India Private Limited by ignoring the actual sale consideration received. while computing capital gain/ loss arising to the Assessee from the said transaction, and treating it as a sham / non-genuine transaction.
19. The learned AO / DRP erred in concluding that sale of equity shares and debentures of Aigua Sprinkler is pre-planned / arranged transaction and rejecting the short term capital loss of INR 89,991 on sale of equity shares and short term capital loss of INR 54,99,99,990 on sale of debentures.
20. Without prejudice to the above the learned AO / DRP erred in taxing the capital gain twice , once on transfer of Sprinkler business by way of slump sale (INR 12,00,00,000 — INR 9,99,82,170 = INR 2,00,17,830) and secondly by considering the cost of equity shares at INR 99,990 and deeming the sale consideration of the same at INR 14,69,00,010.
27. The facts with regard to ground No.17 and modified grounds No.18 to 20 are that the Assessee is engaged in the business of providing installation solutions for Tyco’s fire and security products in India. The operations of the Assessee included a business unit primarily engaged in the installation of water-based fire suppression solutions (“Sprinkler business”). The Assessee incurred loss in the Sprinkler business and wanted to hive off the same, i.e., wanted to sell its Sprinkler business as a going concern, identifying it’s assets and liabilities. The Assessee sold its sprinkler business on a slump sale basis. As per section 2(42C) of the Act, ‘slump sale’ means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. Section 50B of the Act, provides the mechanism for computation of capital gains arising on slump sale. Sec.50B of the Act is a special provision for computation of capital gain on slum sale and excludes other provisions of the Act, in so far as it relates to charge and computation of capital gain on slump sale. Capital gains arising on slump sale are calculated as the difference between sale consideration and the net worth of the Net worth is defined in Explanation 1 to section 50B as the difference between ‘the aggregate value of total assets of the undertaking or division’ and ‘the value of its liabilities as appearing in books of account’. The ‘aggregate value of total assets of the undertaking or division’ is the sum total of: WDV as determined u/s.43(6)(c)(i)(C) in case of depreciable assets, The book value in case of other assets. Net worth is deemed to be the cost of acquisition and cost of improvement for section 48 and section 49 of the Act. As per section 50B, no indexation benefit is available on cost of acquisition, i.e., net worth.
28. Before and after effecting slump sale, the Assessee entered into some ancillary transactions which had tax implications. The issue raised in Grd.No.18 to 20 of the modified grounds emanate from those ancillary transactions.
29. The sequence of events prior to slump sale of sprinkler business and ancillary transactions was as follows:
|
Date |
Events |
| 3 February 2015 |
|
| 24 April 2015 |
|
| 9 June 2015 |
|
| 12 June 2015 |
Reason for Selling at Nominal Value
|
30. There is no dispute with regard to the capital gain offered to tax by the Assessee on slump sale of its sprinkler business on 9.6.2015 to Aigua Sprinkler. The Full value of consideration received on slump sale was Rs.12 Crores. The networth of the sprinkler business was Rs.9,99,82,170/- The resultant capital gain of Rs.2,00,17,830/- declared by the Assessee was accepted by the AO. The Assessee sold its entire shareholding in Aigua Sprinkler to Gitendra G.Bahnot on 12.6.2015 worth Rs.99,999/- for a nominal sum of Rs.9,999/- and declared Short Term Capital Loss Rs.89,991/-. Likewise, the Debentures worth Rs.55 Crores were assigned to Gitendra G.Bhanot on 12.6.2015 for a nominal sum of Rs.100/-and the short term capital loss resulting from such transfer by way of assignment of the debentures of Rs.54,99,99,900. The aforesaid short term capital loss on sale of shares and assignment of debentures was sought to be carried forward for set off in future. Ground No.18 to 20 of the grounds of appeal is in relation to the aforesaid short term capital loss on sale of shares and assignment of debentures.
31. It can be seen from the above sequence of events that the valuation of the business for slump sale happened on 24.4.2015 and the slump sale took place on 9.6.2015 on the basis of the said valuation. By virtue of the Slump Sale, the Assessee hived off it’s sprinkler business to Aigua Sprinkler. Prior to the slump sale it funded Aigua Sprinkler by subscribing to its Debentures worth Rs.55 crores on 9.6.2015. The full value of consideration received on slump sale was Rs.20 Crores. Thus the Assessee funded Aigua Sprinkler for payment of consideration for slump sale by subscribing to its debentures. On 12.6.2015 the Assessee sold Debentures worth Rs.55 Crores for a nominal sum of Rs.100 to Mr.Gitendra G.Bhanot. Likewise the shares held by the Assessee in Aigua Sprinkler of the face value of Rs.99,999/- were sold on 12.6.2015 to Mr.Gitendra G.Bhanot for a paltry sum of Rs.999/-. Between 9.6.2015 and 12.6.2015 how could there be such a huge difference in valuation and the rationale for incurring loss on sale of shares and assignment of debentures by the Assessee. This is the basis on which the AO proceeded to analyse the transaction and the short term losses declared by the Assessee.
- If the Assessee had incurred continuous losses in its sprinkler business which motivated the business restructuring, then it had its own right to shut off the sprinkler business completely. However, instead the Assessee had decided to invest INR 55,00,00,000 in debentures of the Sprinkler business held by its subsidiary.
- The entire transaction of subscribing to the CCDs of Aigua Sprinkler and transfer of the same happening with a period of 4 days doesn’t substantiate any business expediency for sale of its investment at nominal value;
- The sale of asset worth INR 55,00,99,999 for INR 10,099 clearly establishes the motive of Assessee to avoid the tax liability and to provide undue favor to its related party;
32. On the above reasoning, the AO proceeded to determine the capital gain on sale of shares and assignment of debentures as follows:
- On short term capital loss on sale of equity shares of Aigua India by Assessee to Jitendra G.Bhanot, at nominal value, the AO relied on the valuation report of sprinkler business at the time of Slump Sale wherein the value of INR 14.7 crores was determined as the value of sprinkler business and substituted the full value of consideration received on transfer by the fair market value of the equity shares of Rs.14.7 crores as against a sum of Rs.999 actually received as consideration for transfer of shares. The AO accordingly, determined a short-term capital gain of INR 14,69,00,001 on sale of equity shares(Rs.14,70,00,000 – Rs.999= Rs.14,69,00,001/-);
- On the short term capital loss on assignment of CCDs of Aigua India held by the Assessee of the face value of Rs.55 Crores to Jitendra G.Bhanot, at nominal value of Rs.100, the AO held that the assignment/sale of CCDs at a nominal value of INR 100 was irrational and not acceptable as per the Act and accordingly, determined the sale consideration to be at face value of INR 55 Crores and the short-term capital gain / loss was reworked to be Nil.
33. The Assessee filed objections before the Dispute Resolution Panel (DRP) against the draft order of Assessment incorporating the above findings of the AO. The DRP upheld the AO’s findings and held that the series of transactions has been planned to avoid payment of capital gains and also for carrying forward capital losses for future set off.
34. The tax treatment of the business transfer as per the Assessee and per the AO as upheld by DRP are summarized below:
| Particulars | As per Assessee | As per learned AO upheld by Hon’ble DRP |
| Slump Sale of Sprinkler Business to Aigua Sprinkler | ||
| Sale Consideration | 12,00,00,000 | 12,00,00,000 |
| Less: Cost of Acquisition | 9,99,82,170 | 9,99,82,170 |
| Long Term Capital Gain | 2,00,17,830 | 2,00,17,830 |
| Sale of equity shares of Aigua Sprinkler to unrelated third party | ||
| Sale Consideration | 9,999 | 14,70,00,000 |
| Less: Cost of Acquisition | 99,990 | 99,990 |
| Short Term Capital Gain/(Loss) | (89,991) | 14,69,00,010 |
| Sale of CCDs of Aigua Sprinkler to unrelated third party | ||
| Sale Consideration | 100 | 55,00,00,000 |
| Less: Cost of Acquisition | 55,00,00,000 | 55,00,00,000 |
| Short Term Capital Gain/(Loss) | (54,99,99,900) | – |
| Total Capital Gains | ||
| Long Term Capital Gain | 2,00,17,830 | 2,00,17,830 |
| Short Term Capital Gain/(Loss) | (55,00,89,891) | 14,69,00,010 |
| Net Short-term Capital Gains (Loss) after set-off | (53,00,72,061) | 16,69,17,840 |
35. The learned counsel for the Assessee submitted that in so far as the loss on sale/assignment of debentures is concerned, the same has been determined at nil and therefore there are not tax implications. It was also submitted that there would no income, which could be set off within the time permitted in law of the short term capital loss that the Assessee incurred on sale/assignment of the debentures. In the circumstances, he submitted that that the said ground with regard to rejection by the revenue authorities of short term capital loss on sale/ assignment of debentures is not pressed. He however submitted that the Assessee reserves its right to contest the correctness of the findings and action of the revenue authorities on the issue and without prejudice to its rights in law to contest the said findings, on the issue in other proceedings. In view of the prayer of the learned counsel for the Assessee, the ground of appeal with regard to rejection of short term capital loss on sale/assignment of debentures raised by the Assessee in its appeal is dismissed. The learned counsel for Assessee also filed a memo requesting withdrawing original ground No.21 & 22 and hence these grounds are dismissed as withdrawn.
36. In so far as the issue with regard to short term capital loss on sale of shares by the Assessee, is concerned, the learned counsel for the Assessee explained the circumstances under which the sprinkler business was sold as a going concern and as to how losses were incurred by the sprinkler business resulting in a decision to sell sprinkler business. It was highlighted that the Assessee is engaged in the business of providing installation solutions for Tyco’s fire and security products in India. The operations of the Assessee included a business unit primarily engaged in the installation of sprinklers (‘Sprinkler business’). The sprinkler business was incurring huge losses and was not expected to make profits in the foreseeable future. In order to turnaround the business, the Assessee changed the business strategy in 2013. However, despite the same, the business was continuing to make losses. Therefore, the management envisaged shutting down this business unit to avoid future losses. However, this would have resulted in additional costs, efforts to close the open contracts and recover outstanding receivables, and could have possibly had legal repercussions on account of non-performance of obligations on contracts with customers, retrenchment of employees, etc. In order to mitigate future losses from the sprinkler business, the Assessee contemplated hiving off the same during FY 2015-16. This was executed by a sale of the sprinkler business to Assessee’s subsidiary, Aigua Sprinkler, as a going concern on a slump sale basis. Further, in order to identify the potential buyer, the Assessee had shared confidential information presentation pertaining to Sprinkler Business (Project Cricket) with 10 potential bidders. In response to which 4 potential bidders responded. Finally 2 offers were received by the Assessee, out of which the more beneficial offer from an unrelated third party, Mr. Jitendra Bahnot who had the necessary experience and expertise required to take over and operate the sprinkler business was finalized.
37. The learned counsel for the Assessee drew our attention to page 881 of Assessee’s paper book wherein a snapshot of the Sprinkler business as on April 24, 2015 is provided, which is as follows:
- Number of contracts – 118
- Total Value of Contracts – INR 414.90 Crore
- Order Backlog – INR 29.90 Crore
- Number of employees – 112
The same were transferred as part of the slump sale. Further the assets that were transferred comprised of fixed assets such as laptops and current assets such as trade receivables and work in progress for projects under process whereas the liabilities transferred included accrued expenses, accrued pension, income received in advance, and advance from customers. It was submitted that the sprinkler business unit was historically incurring significant gross losses and negative EBITDA y-o-y basis. This was adversely impacting the overall business of Assessee. The historical EBITDA margins is tabulated below for your reference:
(Amount in INR Crores)
| Particulars | 30-Sep-2013 (YE) |
30-Sep-2014 (YE) |
24 April 2015 (YTD) |
| Revenue (A) | 902 | 352 | 186 |
| Gross Profit (B) | -36 | -195 | 37 |
| Gross Margin | -4% | -55% | 20% |
| Employee Costs (C) | -22 | -22 | -17 |
| Other expenses (D) | -119 | -128 | -319 |
| EBITDA (E = B-C-D) | -176 | -345 | -300 |
| EBITDA margin (F = E/A) | -20% | -98% | -161% |
38. It was submitted that as provided in the aforementioned valuation report, the Sprinkler business registered losses at gross margin level during year ended September 30, 2013 and year ended September 30, 2014 since the direct cost of product installations (“Cost of product revenues”) have exceeded corresponding revenues during the said historical period. These losses were primarily attributable to six projects which had significant cost overruns due to one or more of project delays, redesigns, estimation issues, labor issues etc. Moreover, significant proportion of the losses were attributable to one project (MEAT airport) where the cost overruns have been significant as a combination of redesigns, re-installations (the costs of which could not be passed through to the customer) and labor issues. As the projects are fixed-price in nature, the Sprinkler business has not been able to secure pro-rata increases in the event of re-designs / re-installations and have also been impacted by adverse exchange rate movements, considering that a significant proportion of the materials are imported. Further, it is to be noted that the Sprinkler Business registered positive gross margins for the year to date April 24, 2015 only due to completion of certain projects for which the costs were already booked.
39. The reason given by the Assessee why the business for which the Aigua Sprinkler, subsidiary of the Assessee paid Rs.12 crores as lump sum consideration to the Assessee when the very same business on the very same period was valued at a paltry sum and sold by the Assessee in the form of sale of shares and assignment of debentures, is that separately, no purchaser would rank the projections of the Management over the historical performance of an undertaking while contemplating to go ahead with the purchase and negotiating on the terms of the same. The projections of the revenue of the Sprinkler business were based on a positive outlook. One should not consider only the projections of the management and disregard the negative EBITDA earned by the Sprinkler Business. The above reasoning of the Assessee is the basis for its claim that the loss on sale of shares and assignment of debentures was genuine. In support of the above, the learned counsel for the Assessee brought to our notice application seeking to produce some additional evidence vide application dated 10.8.2022. We need not consider the said application for admission of additional evidence because of the conclusions which we may ultimately arrive at on the issue in question, it may become unnecessary. We may also add that, if a third party would not be willing to pay the price which the Assessee received from its subsidiary, then the provisions of Sec.92 of the Act regarding specified domestic transactions or Sec.40A(2)(b) of the Act, would stand attracted. The Assessee’s plea as above, cannot therefore be accepted. The Assessee has neither reported the above transaction as specified domestic transaction nor qualified payment covered u/s.40A(2)(b) of the Act.
40. The learned counsel submitted that merely, because the transfer of investment in Aigua Sprinkler has taken place at a loss, it cannot be said that it is a colorable device to evade tax and provide undue favour to related party. In hindsight, there have been no tax benefits arising out of the transfer of investment in Aigua Sprinklers to the unrelated third party. If the sprinkler business was continued by the Assessee, it would have resulted in growing business losses in the future. The decision taken by the Assessee in the normal course of business to divest its sprinkler business has minimized any further losses on account of the performance of that business unit. The learned counsel drew our attention to the compilation of the Assessee’s EBITDA over the years.
| Financial Year | EBITDA (in INR) |
| FY 2012-13 | -25,34,11,126 |
| FY 2013-14 | -73,04,71,185 |
| FY 2014-15 | -34,83,31,363 |
| FY 2015-16 | -56,81,11,225 |
| FY 2016-17 | -10,28,37,197 |
| FY 2017-18 | 26,77,23,571 |
| FY 2018-19 | 38,02,13,725 |
| FY 2019-20 | 26,39,48,654 |
41. The learned counsel for the Assessee submitted that having regard to the future losses circumvented and the assurance, warranties and undertakings of the purchaser, it was agreed that the equity shares and CCDs of Aigua Sprinkler be transferred at a nominal value of INR 9,900 and INR 100 respectively. Since, the sale of equity shares / CCDs is to an unrelated third party, the sale consideration is driven by the market forces. Further, having regard to the underlying liabilities and obligations, it can be concluded that the current sale consideration is what a third party buyer would be willing to pay. Therefore the same cannot be questioned by the learned AO / Hon’ble DRP.
42. Our attention was drawn to the relevant extracts of the stock purchase agreement, debenture subscription agreement and business transfer agreement indicating the underlying liabilities and obligations:
As per para 2.13(b) of the stock purchase agreement provided
“the aggregate direct, out-of-pocket cash cost to be incurred by the Company after Closing for labor and materials to complete its obligations pursuant to Company Contracts covering Ongoing Projects and Completed Projects will not exceed INR 308,000,000 in the aggregate.”
(Emphasis supplied)
As per para B and C of the debenture subscription agreement provided
“B. It is the understanding of the Parties that the Sprinkler Business shall be continued in the Ordinary Course through Aigua and Aigua understands and acknowledges that TFS is interested in the continued and uninterrupted operations of the Sprinkler Business. The Parties further acknowledge that Aigua will require funds to purchase the Sprinkler Business from TFS and immediately after the purchase of the Sprinkler Business, to meet the working capital expenses of the Sprinkler Business and for the due discharge of all obligations and liabilities of the Sprinkler Business.
C. As consideration towards Aigua assuming the liabilities of the Sprinkler Business and continuing the Sprinkler Business in the manner contemplated in this Agreement and to fund the purchase of the Sprinkler Business and the immediate working capital needs of the Sprinkler Business, TFS has agreed to invest an amount of INR 550,000,000 (Subscription Consideration) in Aigua and subscribe to 55,000,000 compulsorily convertible debentures of Aigua (CCDs).”
(Emphasis supplied)
This is further substantiated in para 3.2 of the debenture subscription
3.2. Aigua agrees and covenants that the Subscription Consideration shall be used as follows:
(a) an amount of INR 120,000,000 shall be paid as consideration to TFS for purchase of the Sprinkler Business under the BTA;
(b) subject to and in accordance with the terms of Clause 4, an amount up to 13,000,000 shall be used to pay the retention amounts to the Employees as set out in Schedules 1 and 2 (Employee Retention Amounts) pursuant to the respective retention agreements listed in Schedule 3 (Retention Agreements) in the following manner:
| Within 7 days of the Transfer Date | INR 6,500,000 (First Installment) |
| Within 90 days of the Transfer Date (Second Installment Date) | INR 6,500,000 (Second Installment) |
(c) the balance Subscription Consideration shall be used only to meet the working capital expenses and run the operations of the Sprinkler Business and discharge the operational and corporate obligations of Aigua.
(Emphasis supplied)
The same is also substantiated in Para B of business transfer agreement
The Seller and the Purchaser have also entered into a debenture subscription agreement dated 9 June 2015, a copy whereof is attached as Annex 6 (DSA) pursuant to which the Seller has invested an amount of INR 550,000,000 in the Purchaser with the understanding that INR 120,000,000 out of such amount shall be paid by the Purchaser to the Seller as consideration for the Sprinkler Business under this Agreement
(Emphasis supplied)
43. It was submitted that the short-term capital loss of INR 55,00,89,891 arising on transfer of investment in Aigua Sprinkler has not been claimed as business loss. It was submitted that the short-term capital loss has been set off with the long-term capital gain of INR 2,00,17,830 arising on the slump sale of the sprinkler business. The resultant loss amounting to INR 53,00,72,061 was carried forward by the Assessee in the return of income filed by it for AY 2016-17 and has not been set off any eligible income till date. By way of the same, the Assessee has absolved its claim to the subject loss and shall not be bringing forward the same in its return of income for AY 2022-23. Therefore the transaction is no colorable device to evade tax.
44. Without prejudice to the above contentions, the learned counsel for Assessee submitted that the AO has determined full value of consideration of the equity shares of Aigua Sprinkler to be INR 14.7 crores which is as per the valuation report dated 24 April 2015. The Assessee had sold the Sprinkler business to Aigua Sprinkler at a consideration of INR 12 crores based on the valuation report where the enterprise value of the Sprinkler business as at April 24, 2015 was determined to be in the range of INR 11.6 crores and INR 14.7 crores. The Assessee had offered an amount of INR 2,00,17,830 to long term capital gain tax under this transaction. It was submitted that this action of the AO leads to double taxation of the enterprise value, first on valuing the slump sale transaction and second on valuing 9,999 equity shares of Aigua Sprinkler. It was submitted that the AO has recomputed the short term capital loss of INR 89,991 to a short term capital gain of INR 146,900,010 by notionally substituting the value of sale consideration which is ultra-vires the power of the AO. It was submitted that it is a settled position of law that the AO has no power to replace/substitute the value of consideration agreed between the parties for the year under consideration. In this regard, the learned counsel for Assessee has relied on the Hon’ble Supreme Court’s judgement in the case of George Henderson & Co. Ltd. (Civil Appeal No. 1618 of 1966) dated April 26, 1967 where the Hon’ble court held that the full value of consideration of a capital asset is different from its fair market value and that the former does not have any reference to the latter. Attention was drawn to the following observations of the Judgment:
It follows that the expression “full consideration” in the main part of s. 12B(2) cannot be construed as having a reference to the market value of the asset transferred but the expression only means the full value of the thing received by the transferor in exchange for the capital asset transferred by him.
If it is therefore held in the present case that the actual price received by the respondent was at the rate of Rs. 136 per share the full value of the consideration must be taken at the rate of Rs. 136 per share. This interpretation of the main part of s. 12B(2) is borne out by the fact that in the first proviso to s. 12B(2) the expression “full value of the consideration” is used in contradistinction with “fair market value of the capital asset” and there is an express power granted to the ITO to “take the fair market value of the capital asset transferred” as “the full value of the consideration” in specified circumstances.
(Emphasis supplied)
Reliance was placed on the decision of Hon’ble Bombay High Court in the case of Morarjee Textiles Ltd. (ITA No. 738 / 2014) dated January 24, 2017 wherein the Hon’ble High Court did not admit the Department’s appeal and upheld Hon’ble Mumbai Tribunal’s decision in relation to rejection of fair market value of the unlisted shares for working out long term capital gain. Our attention was drawn to the following extracts of the judgement:
As held by the Tribunal at the relevant time there was no power vested in the authorities under the Act to substitute a full value of consideration received for sale of shares by fair market value in respect of stocks a nd shares. The power to substitute full consideration with f air market value in respect of shares came into the statute only on introduction of Section 50D with effect from 1st April, 2013. Moreover, such a power under Section 50D of the Act is only to be exercised if the Assessing Officer comes to a finding that the consideration received is not ascertainable or cannot be determined.
(Emphasis supplied)
Further reliance was placed on the following judicial precedents:
- Hon’ble Supreme Court’s judgement in the case of K.P. Varghese (Civil Appeal No. 412 / 1973) for AY 1966-67 dated Sep 4, 1981
- Hon’ble Delhi High Court’s judgement in the case of Smt. Nilofer I. Singh (ITA No. 154 / 2008) dated August 27, 2008
- Hon’ble Delhi Tribunal’s judgement in the case of Venus Financial Services Ltd (ITA No. 5335 / Del / 2012) for AY 2009-10 dated September 28, 2015.
45. The learned DR reiterated the stand of the revenue that the valuation of the business for slump sale happened on 24.4.2015 and the slump sale took place on 9.6.2015 on the basis of the said valuation. By virtue of the Slump Sale, the Assessee hived off its sprinkler business to Aigua Sprinkler. Prior to the slump sale it funded Aigua Sprinkler by subscribing to its Debentures worth Rs.55 crores on 9.6.2015. The valuation of the sprinkler business was without considering the inflow of funds of Rs.55 Crores, in the form of debenture subscription by the Assessee. The full value of consideration received on slump sale was Rs.20 Crores. Thus the Assessee funded Aigua Sprinkler for payment of consideration for slump sale by subscribing to its debentures. On 12.6.2015 the slump sale was effected in favour of Aigua Sprinkler. On 12.6.2015 the Assessee sold Debentures worth Rs.55 Crores for a nominal sum of Rs.100 to Mr.Gitendra G.Bhanot.
Likewise the shares held by the Assessee in Aigua Sprinkler of the face value of Rs.99,999/- were sold on 12.6.2015 to Mr.Gitendra G.Bhanot for a paltry sum of Rs.999/-. Between 9.6.2015 and 12.6.2015 how could there be such a huge difference in valuation and the rationale for incurring loss on sale of shares and assignment of debentures by the Assessee. He questioned when was Aigua Sprinkler incorporated and what was the purpose. The Assessee could have directly sold the business to Mr.Gitendra G.Bhanot without the intervening medium of Aigua Sprinkler. In that event, even going by the logic of the Assessee, it would not have fetched price of Rs.12 crores from a third party, why did the Assessee invest Rs.55 Crores of his money in Aigua Sprinkler and then give Mr.Gitendra G.Bhanot the entire business of Aigua Sprinkler, which as per valuation of the valuers was worth Rs.14.7 Crores for a paltry sum of Rs.999/-. It was highlighted that effectively Mr.Gitendra G.Bhanot has been the beneficiary of a business worth Rs.14.7 Crores and debenture subscription money of Rs.55 Crores less Rs.12 Crores paid to the Assessee as consideration for slump sale. What is the business rationale for conferring such a benefit on Mr.Gitendra G.Bhanot at the cost of incurring loss. The purpose creating Aigua Sprinkler and transferring by way of slump sale the sprinkler business and immediately transferring to Mr.Gitendra G.Bhanot was nothing but a colorable device. The purpose was to set off the gain on slump sale against loss on sale of shares and debentures. The fact that the Assessee claimed set off loss which was denied and the fact that in future years he did not claim the loss cannot be the basis to say that there was no colorable device. He reiterated the fact that the transaction of slump sale and subscription to the debentures and shares was between related parties, i.e., holding company and subsidiary. He urged that the tribunal should look into the real nature of the transaction. If the real nature of the transaction is looked into, then the real gain on sale of shares should be brought to tax and the action of the revenue authorities in doing so should be upheld.
46. We have given a careful consideration to the rival submissions. To appreciate the rival contentions, the sequence of events leading to the ultimate sale of shares by the Assessee to Mr.Gitendra G.Bhanot, have to be seen. On 3.2.2015, the Assessee incorporated Aigua Sprinkler as its wholly owned subsidiary with a paid up share capital of Rs.99,990 comprising of 9,999 shares of the face value of Rs.10 each. It is undisputed that Aigua Sprinkler was incorporated by the Assessee as wholly owned subsidiary only with a view to transfer Sprinkler Business by way of slump sale. With this end in mind the Assessee got the Sprinkler business valued by a valuer who vide his valuation report dated 24.4.2015 valued the sprinkler business at Rs.14.70 Crores. On 9.6.2015, the Assessee subscribed to 5,50,00,000 compulsorily convertible debentures of Rs.10/- each of Aigua Sprinkler and paid a sum of Rs.55 Crores. On the very same day i.e., 9.6.2015 the Assessee sold way of slump sale Sprinkler Business to Aigua Sprinkler for a consideration of Rs.12 Crores. The capital gain on such slump sale in accordance with the provisions of Sec.50B of the Act, was determined at Rs.2,00,17,830/-computed by reducing from the purchase consideration of Rs.12 crores, the networth of the sprinkler business which was Rs.9,99,82,170/-. The capital gain on slum sale of the sprinkler business as declared by the Assessee was accepted by the AO and there is no dispute on this aspect.
47. On 13.6.2015, just one week after the slump sale of sprinkler business, the Assessee transferred his share holding of 9,990 of Rs.10 each in Aigua Sprinkler, for a consideration of Rs.9,999. It incurred Short Term Capital Loss Rs.89,991/-on sale of shares. Likewise, the Debentures worth Rs.55 Crores were assigned to Gitendra G.Bhanot on 13.6.2015 for a nominal sum of Rs.100/- and claimed short term capital loss resulting from such transfer by way of assignment of the debentures of Rs.54,99,99,900. The aforesaid short term capital loss on sale of shares and assignment of debentures was sought to be set off against the capital gain on slump sale and the remaining sum was sought to be carried forward for set off in future.
48. The short term capital loss on sale of shares and debentures was not accepted by the AO and the CIT(A). On short term capital loss on sale of equity shares of Aigua India by Assessee to Jitendra G.Bhanot, at nominal value, the AO relied on the valuation report of sprinkler business at the time of Slump Sale wherein the value of INR 14.7 crores was determined as the value of sprinkler business and substituted the full value of consideration received on transfer by the fair market value of the equity shares of Rs.14.7 crores as against a sum of Rs.999 actually received as consideration for transfer of shares. The AO accordingly, determined a short-term capital gain of INR 14,69,00,001 on sale of equity shares(Rs.14,70,00,000 – Rs.999= Rs.14,69,00,001/-). On the short term capital loss on assignment of CCDs of Aigua India held by the Assessee of the face value of Rs.55 Crores to Jitendra G.Bhanot, at nominal value of Rs.100, the AO held that the assignment/sale of CCDs at a nominal value of INR 100 was irrational and not acceptable as per the Act and accordingly, determined the sale consideration to be at face value of INR 55 Crores and the short-term capital gain / loss was reworked to be Nil.
49. In so far as the short term capital loss on sale of shares, with which we are called upon to adjudicate in this appeal, we find that the entire case of the revenue rests on the footing that when the value of the business as per the valuer’s report is Rs.14.7 Crores, the value of the shares should be Rs.14.7 Crores and there was no rationale for selling the same at a paltry sum of Rs.9,999/-. Doing so, was nothing but a devise to avoid legitimate taxes payable on sale of shares of Aigua Sprinkler. The short term capital loss on sale of equity shares of Aigua India by Assessee to Jitendra G.Bhanot, was determined by the AO at a sum of Rs.14,69,00,001/- by substituting the actual sale consideration on sale of shares of Rs.999/- by the value of the sprinkler business as per the valuation report of valuer which was a sum of Rs.14.7 crores. By substituting the full value of consideration received on transfer by the fair market value of the equity shares of Rs.14.7 crores, the AO determined a short term capital gain of INR 14,69,00,001 on sale of equity shares(Rs.14,70,00,000 – Rs.999= Rs.14,69,00,001/-).
50. Sec.45 of the Act lays down that profits and gains arising out of transfer of capital asset effected in the previous year shall be chargeable to income tax under the head “capital gains” and shall be deemed to be the income of the previous year in which the transfer took place. Section 48 of the Act provides that income chargeable under the head “Capital gains” shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely :— (i) expenditure incurred wholly and exclusively in connection with such transfer; (ii) the cost of acquisition of the asset and the cost of any improvement thereto: The expression “full value of consideration received on transfer”, has been explained in two judgments of the Supreme Court in the case of CIT v. George Henderson and Co. Ltd [1967] 66 ITR 622 and in the case of CTT v.Gillanders Arbuthnot and Co. [1973] 87 ITR 407 in which it has been held that the expression “full value of the consideration” does not mean the market value of the asset transferred, but it shall mean the price bargained for by the parties to the transaction. It has been further held that the consideration for the transfer of a capital asset is what the transferor receives in lieu of the assets he parts with, viz., money or money’s worth, and, therefore, the very asset transferred or parted with cannot be the consideration for the transfer and, therefore, the expression “full value of the consideration” cannot be construed as having a reference to the market value of the asset transferred and that the said expression only means the full value of the things received by the transferor in exchange for the capital asset transferred by him. Section 50C was introduced in the Act, by the Finance Act, 2002 with effect from 1st April 2003 for substituting the valuation done for the Stamp Valuation purposes as full value of the consideration in place of the apparent consideration shown by the transferor of the capital asset, being land or building and, accordingly, calculating the capital gains under Section 48. The said provision reads thus:
50C Provision for full value of consideration in certain cases
(1) Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being land or building or both, is less than the value adopted or assessed or assessable by any authority of a State Government (hereafter in this section referred to as the “stamp valuation authority”) for the purpose of payment of stamp duty in respect of such transfer, the value so adopted or assessed or assessable shall, for the purposes of section 48, be deemed to be the full value of the consideration received or accruing as a result of such transfer :
The aforesaid provisions are applicable only when the capital asset transferred is land or building or both and are not applicable to the sale of shares, with which we are concerned in this appeal.
51. Finance Act, 2017 inserted new section 50CA in the Act w.e.f 1st April, 2018 to provide that where consideration for transfer of unquoted equity share of a company is less than the Fair Market Value (FMV) of such share determined in accordance with the prescribed manner, the FMV shall be deemed to be the full value of consideration for the purposes of computing income under the head “Capital gains”. The aforesaid provisions reads thus:
“Special provision for full value of consideration for transfer of share other than quoted share.
50CA. Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being share of a company other than a quoted share, is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined shall, for the purposes of section 48, be deemed to be the full value of consideration received or accruing as a result of such transfer:
Provided that the provisions of this section shall not apply to any consideration received or accruing as a result of transfer by such class of persons and subject to such conditions as may be prescribed.
Explanation.—For the purposes of this section, “quoted share” means the share quoted on any recognised stock exchange with regularity from time to time, where the quotation of such share is based on current transaction made in the ordinary course of business.”
52. It is thus clear from the judicial pronouncements and the statutory provisions referred to above that prior to insertion of Sec.50CA of the Act, the AO could not substitute the full value of consideration received on transfer by the fair market value of unquoted shares. The provisions of Sec.50CA of the Act are applicable only from AY 2018-19 and not applicable for AY 2016-17 in which the transfer of shares took place during the previous year and the capital gain from transfer with which we are concerned in the present appeal.
53. We are of the view that the entire exercise of forming a subsidiary, selling the sprinkler business by way of slump sale, subscribing to the debentures and ultimately selling shares held in the subsidiary at a loss (much less than its value) and assigning debentures at virtually nil value, is well thought out and has been carried out with a view to gain tax advantage and to ultimately confer benefit to a third party. Interjecting Aigua Sprinkler in the transaction was only with a view to gain tax advantage and for no other purpose. It is a colorable device adopted by the Assessee. A method put in place to avoid a legal liability, involving an unacceptable form of avoidance that is not within the framework of the law. Whether the device should be accepted or not is a changing perception and Courts have been conservative in the present times than in the past in accepting such avoidance. The facts and circumstances of the present case shows that it would be a fit case to lift the corporate veil and by doing so, we will find the Assessee is the transferor and Mr.Gitendra Bhanot the transferee of the sprinkler business worth as per valuation a sum of Rs.14.7 Crores together with Rs.55 Crores of debenture money less Rs.12 Crores paid to Assessee by way of slump sale. The law is settled that if the Revenue finds that in an transaction an entity which has no commercial/business substance has been interposed only to avoid tax”, then in such cases the Revenue would be entitled to ignore the separate legal identity or interposition of that entity, to look at the holding company as having directly done the transaction. In so far as the Assessee is concerned, the statutory provisions do not provide for any tax implications. The affairs have been arranged in such a way that there is tax advantage to the Assessee. The transaction of sale of shares of Aigua Sprinkler to Mr.Gitendra Bhanot will be ignored, by lifting the corporate veil and by construing the sale of sprinkler business by the Assessee to Mr.Gitendra Bhanot. Loss on sale of shares to exploit a loophole in the law, has been plugged by way of amendment from AY 18-19 by introduction of Sec.50CA of the Act. We do not wish to go into the tax implications in the hands of Mr.Gitendra Bhanot and whatever is the observations in this appeal is restricted to the tax implications in the hands of the Assessee. Therefore the better course of action would be to ignore the transaction of sale of shares as superfluous and entered into with a view to gain tax advantage. In that view of the matter, the short term capital loss would be nil, in the facts and circumstances of the present case. In the light of the above discussion, we reject the prayer of the Assessee to allow the short term capital loss on sale of shares as claimed by the Assessee and hold that the transaction of sale of shares deserves to be ignored and no loss can be determined nor can any short term gain be taxed. Thus the grounds relating to short term loss/gain on sale of shares are treated as partly allowed.
54. Ground No.23 and 24 relate to disallowance under Section 40(a)(ia) of the Act of INR 18,723,021 on account of non-deduction of TDS on payment of management fees. These grounds read as follows:
23. erred in disallowing payment of management fees amounting to INR 17,691,705 to Tyco International Limited under section 40(a)(i) of the Act without appreciating the fact that the Applicant is not required to withhold taxes on these payments as per the provisions of the Act read with India-Switzerland Treaty read with India-US Treaty .
24. erred in disallowing payment of management fees amounting to INR 1,031,316 to Tyco International Asia, Inc. under section 40(a)(i) of the Act without appreciating the fact that the Applicant is not required to withhold taxes on these payments as per the provisions of the Act read with India-Singapore Treaty.
55. The Assessee entered into inter-company services agreement with Tyco International Management Company LLC, USA (“TIMCO”) ( pages 2870 to 2889 of supplementary paperbook dated July 18, 2022) and Tyco International Asia, Inc., Singapore to receive certain management services. In relation to the services rendered by TIMCO, the Assessee remunerates Tyco International Limited, Switzerland (“TIL, Switzerland”) which is appointed as a billing & collection agent by TIMCO, wherein TIMCO is beneficial owner of the income received from the Assessee for the management services rendered. 50% of the payment towards management support services received from TIMCO accrued in the books of the Assessee during FY 2014-15 and the balance 50% (i.e. INR 1,76,91,705) was considered in FY 2015-16 in the books of the Assessee. The Assessee made a similar payment for management services received from Tyco International Asia, Inc., Singapore of a sum of INR 1,031,316. The payments made by the Assessee to TIL, Switzerland and Tyco International Asia Inc., Singapore in all totaling a sum of Rs.1,87,23,021 was disallowed by the AO for the reason that the Assessee did not deduct tax at source on the aforesaid payments as required u/s.195 of the Act and therefore the said sum claimed as deduction was to be disallowed as per the provisions of Sec.40(a)(i) of the Act for non-deduction of tax at source. The AO has wrongly referred to Tyco Fire and Security GmbH instead of referring to TIL, Switzerland. According to the AO, the sums paid to the aforesaid non-residents were in the nature of Fees for Technical Services (FTS) and was chargeable to tax in India as per the provisions of Sec.9(1)(vii) of the Act.
56. Before the Dispute Resolution Panel (DRP), the Assessee gave a description of the nature of services rendered by the non-residents Tyco International Management Co. USA (TIMCO) and Tyco International Asia, Inc., Singapore Tyco Asia, Inc., Singapore. The same is given as an annexure to this order. It was contended by the Assessee that the payment to the non-residents was for services provided by the AEs which are in the nature of management services namely, marketing and product development advisory services; fire and security global account sales support services; information technology support services; financial support services; human resource services; six sigma services and supply chain & real-estate services. It was contended under the Act, tax withholding provisions are attracted in relation to payments to non-residents only if the income is chargeable to tax in India. Since the payees were tax residents of countries with which India has Treaty for Avoidance of Double Taxation (DTAA), the taxability of the payment in the hands of the non-residents in India has to be determined having regard to the provisions of section 90(2) of the Act, which lays down that tax incidence on a non-resident would be governed by the provisions of the Act or the relevant DTAA, whichever is more beneficial.
57. It was contended that having regard to the nature of services, these could at best be managerial or consultancy services and hence could be characterised as Fees for technical services (“FTS”) / Fees for included services (“FIS”) as per the provisions of the Act but cannot be taxed in India as per the applicable DTAA. In this regard, the Assessee pointed out that the sum of Rs.1,76,91,705/- paid to TIMCO had to be judged in the light of the provisions of the India-USA DTAA because TIMCO was a tax resident of USA. The payments were made for managerial services to TIL, Switzerland as they were appointed as a billing and collection agent by TIMCO for management services rendered to the Assessee. Accordingly, TIL, Switzerland was only a ‘flow through’ entity and would be deemed to be acting on behalf of TIMCO and accordingly the effect would be as if the Assessee has directly engaged with TIMCO.
58. In so far as the payment of management fee amounting to Rs.10,31,316/- to Tyco International Asia Inc., Singapore is concerned, the Assessee submitted that the said payee was tax resident of Singapore and therefore the taxability of the payment in India has to be determined having regard to the provisions of the DTAA between India and Singapore.
59. The non-residents to whom the Assessee paid management fees and the applicable DTAA’s with reference to them were thus as follows:
| Name of AE | Country of residence | Applicable DTAA |
| Tyco International Asia Inc. | Singapore | India – Singapore DTAA |
| TIMCO | US | India – US DTAA |
60. As per the provisions of India-Singapore and India-US DTAA, the term of fees for technical services / included services is defined as any consideration for rendering of any managerial, technical or consultancy service only where the services make available technical knowledge, experience, skill, know-how or processes, which enables the person acquiring the services to apply the technology contained therein. The relevant extracts of Article 12(4) of India–US DTAA and India–Singapore DTAA is as follows:
- Definition of fees for included services as provided under Article 12(4) of India – US DTAA
“4. For purposes of this Article, “fees for included services” means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services :
(a)………; or
(b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.”
(Emphasis supplied)
- Definition of fees for technical services as provided under Article 12(4) of India – Singapore DTAA
“4. The term “fees for technical services” as used in this Article means payments of any kind to any person in consideration for services of a managerial, technical or consultancy nature (including the provision of such services through technical or other personnel) if such services :
(a) ……. ; or
(b )make available technical knowledge, experience, skill, know-how or processes, which enables the person acquiring the services to apply the technology contained therein ; or”
(Emphasis supplied)
It was submitted that for the management services rendered by the AEs to be construed as FIS / FTS under India-US DTAA and of India-Singapore DTAA, respectively, the services should among others make available technical knowledge, experience, skill, know-how or processes, which enable the personnel of the Assessee acquiring the services to apply the technology contained therein. Hence, as the management services rendered by the AEs and do not “transfer” / “make available” any technical knowledge, skills, know-how, etc., to the Assessee, which could be independently applied by the Assessee, and such services would not qualify as “Fees for included services / Fees for technical services” as defined under Article 12(4) of India-US DTAA and Article 12(4) of India-Singapore DTAA, respectively.
61. Attention was drawn to the Memorandum of Understanding entered into between India and US explaining the term “make available” as follows:
- Technology will be considered as “made available” when the person acquiring the services is enabled to apply the technology.
- The fact that the provision of services may require technical input by the person does not per se mean that technical knowledge skill, etc. are “made available” to the person utilizing the service. Similarly, the use of a product that embodies technology shall not per se be considered to make the technology available.
62. It was submitted that in the assessment order passed by the Deputy Commissioner of Income Tax – 10(2), Mumbai under section 143(3) read with section 263 dated December 28, 2010 for AY 2005-06 in the Assessee’s own case wherein it was held that management fee is not subject to tax as per the provisions of India – Singapore DTAA. Further reliance was placed on the following judicial rulings:
- The Special Bench of the Hon’ble Mumbai Tribunal in the case of Mahindra & Mahindra Ltd (313 ITR 263) observed that “make available” means to provide something to one, which is capable of use by the other. Such use may be for once only or on a continuous basis. To make available means that such technical information or advice is transmitted to the recipient, which remains at his / its disposal for taking the benefit therefrom by use. Even the use of such technical services by the recipient for once will satisfy the test of “making available”.
- The Honorable jurisdictional Karnataka High Court in the case of CIT vs De Beers India Minerals Private Limited (ITA 549 of 2007) has also interpreted the meaning of the term “make available” and observed that:
“The service should be aimed at and result in transmitting technical knowledge etc. so that the payer of the service could derive an enduring benefit and utilize the knowledge or know how on his own in future without the aid of the service provider. In other words, to fit into the terminology “making available”, the technical knowledge, skills etc. must remain with the person receiving the services even after the particular contract comes to an end. It is not enough that the services offered are the product of intense technological effort and a lot of technical knowledge and experience of the service provider have gone into it. The technical knowledge or skills of the provider should be imparted to and absorbed by the receiver so that the receiver can deploy similar technology or techniques in the future without depending upon the service provider…payment of consideration would be regarded as FIS only if the twin test of rendering services and making technical knowledge available at the same time is satisfied.”
(Emphasis supplied)
- Relying on the above judgment, the Hon’ble Karnataka High Court in the case of Director of Income-tax (International taxation) vs Sun Micro Systems India Private Limited (ITA no. 35/2010) held that “it is clear that Sun Singapore has not made available to the assessee the technology or the technological services which is required to provide the distribution, management and logistic services. When once factually it is held that the technical services has not been made available, then in view of the law declared in the Judgment of De Beers India Minerals Pvt Ltd (supra), there is no liability to deduct tax at source.
- The AAR ruling of Intertek Testing Services India Private Ltd (307 ITR 418) in relation to ‘make available’ concept states that service should be aimed at and result in transmitting the technical knowledge, etc., so that the payer of service could derive an enduring benefit and utilize the knowledge or know-how in future on his own without the aid of the service provider.
- The Hon’ble Mumbai ITAT in case of Raymond Limited vs. DCIT (86 ITD 791) held that the requirement of “make available” in the tax treaty is met if the technology, knowledge or expertise can be applied independently by the person who obtained the services, without recourse to the service provider.
- The Hon’ble Bangalore ITAT in the case of IRunway India (P.) Ltd. (IT(TP) A NO. 229 / BANG / 2019) for AY 2015-16 dated April 27, 2022, having regard to the fact that the services provided by iRunaway Inc., did not make available any technical knowledge to the assessee, held that the same cannot be regarded as taxable in India. Consequently, there was no obligation on the part of the assessee to deduct tax at source at the time of making payment. Hence, the ITAT ordered that the disallowance made under section 40(a)(i) cannot be sustained and directed that the same be deleted.
63. It was submitted that given the nature of the management services provided by TIMCO and Tyco International Asia, Inc. to the Assessee, the services would not qualify as FTS / FIS as defined under Article 12(4) of India-US DTAA and India-Singapore DTAA respectively. Accordingly, such payments are not liable to tax in the hands of TIMCO / Tyco International Asia, Inc. in India and consequently the Assessee is not required to withhold any tax on these payments and no disallowance can be made u/s.40(a)(i) of the Act.
64. Alternatively, it was submitted that if payment made to TIMCO is regarded as payment made to TIL Switzerland, then the applicable DTAA would be India-Switzerland DTAA and in terms of the Most Favoured National Clause (MFN Clause) in the said DTAA, the restricted scope of taxation under more than one DTAA for definition of FTS is available to be adopted. Accordingly the restricted scope of FTS as provided in India-UK DTAA can be applied in India Switzerland DTAA by virtue of MFN clause. Thus, the payment made by the Assessee to TIL, Switzerland for management services rendered by TIMCO is not taxable as FTS in India as nothing was made available to the Assessee by virtue of those services.
65. The arguments advanced before the DRP did not find acceptance by the DRP. The DRP, in so far as payment to TIMCO is concerned, observed that the Assessee deducted TDS on similar payments from 17.11.2014 and therefore all arguments raised by the Assessee were rejected. It was the argument of the Assessee before DRP that the sum of Rs.1,76,91,705/- paid to TIMCO had to be judged in the light of the provisions of the India-USA DTAA because TIMCO was a tax resident of USA, though the payments were made for managerial services to TIL, Switzerland as they were appointed as a billing and collection agent by TIMCO for management services rendered to the Assessee. It was the contention of the Assessee that TIL, Switzerland was only a ‘flow through’ entity and it was only TIMCO which was the beneficial owner of the income from managerial fees received from the Assessee and therefore would be deemed to be acting on behalf of TIMCO and accordingly the effect would be as if the Assessee has directly engaged with TIMCO. On the above argument, the DRP held that the argument cannot be accepted but no reasons whatsoever was given by the DRP. The DRP thereafter held that the applicable DTAA would be India-Switzerland DTAA. The alternative argument of the Assessee was that if India-Switzerland DTAA is to be considered as applicable, then in terms of the Most Favoured National Clause (MFN Clause) in the said DTAA, the restricted scope of taxation under more than one DTAA for definition of FTS is available to be adopted. Accordingly the restricted scope of FTS as provided in India-UK DTAA can be applied in India Switzerland DTAA by virtue of MFN clause. On this alternate argument, the DRP held that by way of protocol dated 27.12.2011 MFN clause was introduced in the India-Switzerland DTAA and that protocol says that any convention entered into by India after 27.12.2011 containing a more restricted scope of the term FTS/FIS alone can be taken advantage of. The DRP held that the India-UK DTAA was entered into on 11.2.1994 much prior to the protocol to India-Switzerland DTAA and therefore the restricted scope of the term FTS/FIS as contained in India-UK DTAA cannot be adopted while interpreting India-Switzerland DTAA.
66. In so far as payments made to Tyco International Asia Inc. Singapore is concerned, the DRP held there is a description error of in the books of the Assessee and therefore the payment in question cannot be regarded as payment of management fee, hence the same was taxable in India.
67. Aggrieved by the order of the DRP, the Assessee has raised Grd.No.23 & 24 before the Tribunal. We have heard the rival submissions. The learned counsel for Assessee reiterated submissions made before the DRP. The learned DR relied on the order of the DRP.
68. We have carefully considered the rival submissions. The first aspect that needs to be clarified is on the question of applicable DTAA in so far as the payment made to TIMCO is concerned. TIMCO is the person with whom the Assessee entered into Agreement for providing managerial services. TIMCO nominated TIL Switzerland as billing and collecting agent and directed the payment to be made for management services to the agent. TIMCO is the beneficial owner of the payment and therefore taxability of the payment in India has to be considered in the hands of TIMCO and not TIL Switzerland. Therefore the applicable DTAA would only be India-USA DTAA and not India-Switzerland DTAA. The findings of the DRP on the MFN clause on India-Switzerland DTAA are therefore in our view superfluous. In so far as the payment made to Tyco International Asia, Inc. Singapore is concerned, it was not the case of the AO that the services rendered were not in the nature of managerial services. The DRP has given findings on its own without confronting to the Assessee as to the alleged discrepancy which it had noticed. The findings of the DRP in this regard is therefore held to be unsustainable. We have to therefore proceed to analyse the taxability of the payments towards management fees in the hands of the payee under the India-USA DTAA and India-Singapore DTAA.
69. We shall first take up for consideration argument of the assessee that the sum paid by the assessee to TIMCO and TIL Switzerland cannot be brought to tax in India even assuming that the nature of the payment was FTS within the meaning of the Act because under the Indo US Treaty and India-Singapore DTAA, FTS is taxable in India only when the recipient of the payment ‘makes available’ technical knowledge, experience, skill, know-how or processes, or consist of the development and transfer of a technical plan or technical design. The details of the services rendered by the non-residents are given in the annexure to this order. The services so provided were (a) legal & tax compliance services (b) Communication Support Services; (c) Information Technology support services; (d) internal audit services; (e) Marketing strategy and business development advisory services; (f) Human resource services; (g) Mergers and acquisition services; (h) Operation excellence servies and (i) Facility management services; In short it was in the nature of services of managerial in nature.
70. The relevant articles in the treaty between India and USA are is Article 12 which deals with taxability of Royalties and fees for included services. In terms of Article 12(1) . The same are the wordings in India-Singapore DTAA also. The discussion with regard to India-USA DTAA would therefore be applicable for payment made to Tyco International Asis Inc. Singapore. Royalties and fees for included services arising in a Contracting State (USA in this case) and paid to a resident of the other contracting State (India/Assessee in this case) may be taxed in that other state (i.e., USA). The relevant clause on which reliance was placed by the assessee for non taxability of the sum in question in India in the hands of iRunway Inc. USA was Article 12(4) which provides as follows:
“(4) For the purposes of this article ‘fees for included services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provisions of services of technical or other personnel) if such services :
(a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in para 3 is received; or
(b) make available technical knowledge, experience, skill, know-how or processes, or consist of the development and transfer of a technical plan or technical design.”
71. The case of the assessee is that in terms of Article 12(4)(b) of the Indo US treaty, which is applicable to the present case, only rendering of technical or consultancy services as ‘make available’ technical knowledge, experience, skill or know-how etc can be taxed in India in the hands of iRunway Inc. In other words, in order to attract the taxability of an income under Article 12(4)(b), not only the payment should be in consideration for rendering of technical or consultancy services, but in addition to the payment being consideration for rendering of technical services., the services so rendered should also be such that ‘make available’ technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.
72. These worlds are ‘which make available’. The meaning of the expression make available were considered by the Tribunal in the case of Raymond Ltd. Vs. DCIT (2003) 80 TTJ (Mum) 120. The Tribunal after elaborate analysis of all the related aspects observed that :-
“The words ‘making available’ in Article 13.4 refers to the stage subsequent to the ‘making use of’ stage. The qualifying words is ‘which’ the use of this relative pronoun as a conjunction is to denote some additional function the ‘rendering the services’ must fulfil. And that is that it should also ‘make available’ technical knowledge, experience, skill etc. The word which occurring in the article after the word ‘services’ and before the words ‘make available’ not only ITA No.229/Bang/2019 described or defines more clearly the antecedent noun ‘(services’) but also gives additional information about the same in the sense that it requires that the services should result in making available to the user technical knowledge, experience, skill, etc. Thus, the normal, plain and grammatical meaning of the language employed is that a mere rendering of services is not roped in unless the person utilizing the services is able to make use of the technical knowledge, etc. by himself in his business or for his own benefit and without recourse to the performer of the services in future. The technical knowledge, experience, skill etc. must remain with the person utilizing the services even after the rendering of the services has come to an end. A transmission of the technical knowledge, experience, skill, etc. from the person rendering services to the person utilizing the same is contemplated by the article. Some sort of durability or permanency of the result of the ‘rendering services’ is envisaged which will remain at the disposal of the person utilizing the services. The fruits of the services should remain available to the person utilizing the services in some concrete shape such as technical knowledge, experience skill etc.
73. In Raymond’s case (supra), the Tribunal also held that rendering of technical services cannot be equated with making available the technical services. In the case of CESC Ltd. Vs. DCIT (2003) 80 TTJ (Cal) (TM) 806: (2003) 87 ITD 653 (Cal)(TM) also the question regarding the scope of expression making available came up for the consideration of the Tribunal. In that case, the Tribunal was dealing with the scope of Article 13(4)(c) of the Indo-UK tax treaty which is admittedly in pari materia with Article 12(4) of the India-USA tax treaty with which we are presently concerned. The majority view was that in order to attract the provisions of the said article of the tax treaty, not only the services should be technical in nature but should be such as to result in making the technology available to person receiving the technical services in question. The Tribunal also referred to with approval the extracts from protocol to the Indo-US tax treaty to the effect that ‘generally speaking, technology will be considered made available, when the person acquiring the service is enabled to apply the technology.
74. Honorable jurisdictional Karnataka High Court in the case of CIT vs De Beers India Minerals Private Limited (ITA 549 of 2007) has also interpreted the meaning of the term “make available” and observed that:
“The service should be aimed at and result in transmitting technical knowledge etc. so that the payer of the service could derive an enduring benefit and utilize the knowledge or know how on his own in future without the aid of the service provider. In other words, to fit into the terminology “making available”, the technical knowledge, skills etc. must remain with the person receiving the services even after the particular contract comes to an end. It is not enough that the services offered are the product of intense technological effort and a lot of technical knowledge and experience of the service provider have gone into it. The technical knowledge or skills of the provider should be imparted to and absorbed by the receiver so that the receiver can deploy similar technology or techniques in the future without depending upon the service provider…payment of consideration would be regarded as FIS only if the twin test of rendering services and making technical knowledge available at the same time is satisfied.”
75. It is not even the allegation of the revenue that the non-residents had made available to the assessee, the knowledge generated in the course of rendering managerial services. In our view the services rendered were purely managerial services and by no stretch of imagination can be considered as making available any technical knowledge, experience, skill, know-how or processes, to the assessee. In view of the fact that the services provided by non-residents, did not make available any technical knowledge, experience, skill, know-how or processes to the assessee, the same cannot be regarded as taxable in India. Consequently, there was no obligation on the part of the assessee to deduct tax at source at the time of making payment. Hence, the disallowance made u/s 40(a)(ai) of the Act cannot be sustained and is directed to be deleted.
76. In the result, the appeal of the Assessee is partly allowed.
ANNEXURE:
Details of management services provided by TIL and TIP to TFSIPL during the FY 2015-16
Sl. No. |
Description of services |
Brief note on the type of services received |
Mode of receipt of services |
Benefits derived by TFSIPL from receipt of services |
Supporting evidence (submitted on a sample basis) |
1. |
Legal & Tax compliance services |
|
Emails & phone conferences |
TFSIPL obtained guidance on overall legal and tax framework and policy as formulated at a group level.TFSIPL also obtained assistance and inputs to enable it to adhere to the global approach to be followed by Tyco group in negotiating contracts with agents / distributors. |
|
2. |
Marketing strategy and business development advisory services |
|
Telecon-ferences & meetings |
TFSIPL has obtained guidance in relation to better servicing of existing clients, better unders-tanding of market trends.TFSIPL was also provided a platform for exchange of information with various industrial and trade associations. Apart from various meetings and discussions held throughout the year, TFSIPL was provided with useful insights on the market trends in India. |
|
3. |
Communication support services |
|
Emails & phone conferences |
Communication services has assisted TFSIPL in integrating the communication lines within the group as well as external communications which helps in ease of communication with the employees and external customers and vendors, and for public relations programs. |
|
4. |
Information technology support services |
|
Emails & phone conferences |
TFSIPL obtained assistance with formulating standard policies and processes in relation to IT information systems.TFSIPL also obtained assistance in the implementation and supervision of common IT applications. |
|
5. |
Internal audit services |
Develops and executes internal audit practice to be adopted by Tyco Group entities;
|
Emails, meetings & phone conferences |
TFSIPL obtained assistance with formulating internal audit control procedure. |
|
6. |
Human resource services |
|
Emails, presentations, meetings & phone conferences |
TFSIPL obtained assistance with formulating standard policies and processes in relation to compensation & benefits; minimum criteria for recruiting personnel; performance evaluation; training & development etc. |
advice, training, assistance from HR team via inperson meetings / teleconferences. |
7. |
Mergers and acquisition services |
|
Emails, meetings & phone conferences |
TFSIPL has benefitted from the review comments / inputs provided by TIL’s and TIP’s M&A team in the divesture of its Sprinkler business division during the year. |
|
8. |
Operational excellence services |
|
Emails, meetings & phone conferences |
TFSIPL was assisted in developing itsstrategies and growth plan in line with group strategies, master plans.For example: The group senior management provided various directions and advice on the running and general management of the business through emails and periodic calls. |
|
9. |
Facility management services |
|
Emails and teleconferenc es |
TFSIPL has benefitted from the negotiation inputs provided TIL’s and TIP’s team for finalising additional office space / lease renewal discussions |
|
