Mastek Ltd Vs DCIT (ITAT Ahmedabad)
ITAT Ahmedabad held that tax deduction at source doesn’t apply to service which are neither availed nor rendered and not even utilized in India. Accordingly, disallowance u/s 40(a)(ia) unjustified.
Facts- During the course of assessment, AO observed that the UK branch of the assessee made payment on certain professional and consultancy services to U.K. resident companies on which no tax was deducted. During the course of assessment proceedings, the assessee submitted that the U.K. branch of the assessee was a separate legal entity formed under the U.K. regulations. It was submitted that the services availed by the U.K. branch, non-residents had been rendered and utilised outside India. Accordingly, in view of the exception provided in sub-clause “C” of section 9(1)(vii) of the Act, no tax is required to be deducted on such payment. However the AO made disallowance u/s. 40(a)(ia) of the Act.
CIT(A) deleted the addition. Being aggrieved, revenue has preferred the present appeal.
Conclusion- ITAT in assessee’s own case has held that The UK branch of the assessee has availed services of non-resident consultants. These services were provided from outside India. And these services have also been utilized outside India. Since the services in question were neither “availed” nor “rendered” and even not “utilised” in India, therefore no tax was required to be deducted at source.
FULL TEXT OF THE ORDER OF ITAT AHMEDABAD
These four appeals, two filed by assessee and two filed by Department for assessment years 2011-12 & 2012-13 are against the order of the ld. Commissioner of Income Tax, CIT(A)-2, Ahmedabad, in proceeding u/s. 250 vide orders dated 27/10/2027 & 22-02-2018.
ITA No. 2931/Ahd/2011 filed by assessee for A.Y. 2011-12
2. The assessee has taken the following grounds of appeal:-
“GROUND NO. 1
a) The learned CIT (A) has erred in law and on facts in upholding the adjustment of Rs. 6,508,491 made by Transfer Pricing Officer (“TPO”) in relation to the financial guarantee given by the Appellant to its Associated Enterprise (“AE”).
In doing so, the learned CIT (A).-has erred in not appreciating the following:-
1. The financial guarantee-is in the nature of shareholder activity; as it was to enable the AE pay purchase consideration ‘of acquisition, decision in relation to which was made by the Appellant;
2. The financial guarantee is quasi-equity in nature as the loan availed through financial guarantee, has been repaid from time to time by equity infusion; and
3. Provision of guarantee is not an international transaction as per section 92B of the Act.
b) Without prejudice to the above, the1 learned CIT (A) has erred in the following:-
1. Not undertaking a credit rating analysis for the Appellant and the AE and not considering ratings for both Appellant and the AE and the spread between them on an adhoc basis;
2. Disregarding the comparable uncontrolled price details submitted by the Appellant
3. Not appreciating the fact that, no cost is incurred by the Appellant in relation to the financial guarantee, and .
4. Mot appreciating that the jurisdiction Tribunal in various rulings has levied a charge of approx. 0.3 to 0.5%.
GROUND NO. 2
a) The learned CIT(A) has erred in law and on facts by grossly rejecting the contentions of the Appellant and upholding the action of the TPO in determining the arm’s length price of the international transaction of provision of software services rendered by P&C Division of the Appellant to its AE at Rs. 4,22,04,828.
In doing so, the learned CIT (A) has erred in not appreciating the following:-
1. The CIT(A) have erred in disregarding the transfer pricing analysis carried out by the Appellant. In the case under consideration, none of the conditions set out in section 92C(3) of the Act get satisfied. The Appellant complied with the provisions of section 92C (1) and 92C (2) of the Act at the time of conducting the transfer pricing study.
2. In conducting a fresh search and selecting a final set of 20 comparable
b) Without prejudice to the above, the CIT(A) has erred in law and on facts in rejecting the use of multiple year data and insisting on the use of current year data for benchmarking the transaction. Thus, the CIT(A) have failed to appreciate the intent of the provisions of Rule 10D (4) of the income -tax Rules, 1962 (“the Rules”) which require that the data to be used for uncontrolled analysis should relate to the relevant financial year a.id be available as on the specified date. Both the above two conditions prescribed by the Rules are mutually inclusive end as such, if any one of these conditions is not satisfied, the relevant comparable ought not to be included in the comparability analysis.
c) Without prejudice to the above, the CIT(A) erred in not granting economic adjustments on arithmetic mean of comparables, more so when the TPO has himself carried out a risk adjustment on comparables considered for benchmarking the transaction with MUK.
GROUND NO. 3
a) The learned CIT(A) has erred in law and on facts by enhancing the adjustment of Rs. 3,800,000 made in relation to the performance guarantee given by the Appellant to the customers. In doing so, the learned CIT(A) has erred in not appreciating the following:-
1. The service liability risk is borne by the Appellant as the services are either provided by its delivery center in India (offshore) or branch in UK (onsite in case of Mastek (UK.) Ltd); and
2. The said performance guarantee is in the nature of shareholder activity.
b) Without prejudice to the above, the learned CIT(A) has erred in not appreciating the following:-
1. No cost is incurred by the Appellant in provision of these performance guarantees;
2. The said performance guarantees cannot be equated with financial guarantee;
Your Appellant craves leave to add to and/or to amend and/or to modify and/or to cancel any one or mere grounds of appeal at any time before or at the time of hearing.”
Ground No. 1 (Upward adjustment of Rs. 65 lakhs for financial guarantee given by assessee to AE)
3. The brief facts in relation to this ground of appeal are that the assessee is engaged in providing services in the life and annuity which is a vertical of the insurance sector. In order to expand its business in another vertical (property and casualty), the assessee decided to acquire STG (USA). Accordingly, it was decided to undertake the acquisition through Majesco Mastek, US (MMUS), a wholly owned US subsidiary of the assessee and acting as a distributor of software services capabilities of the assessee. The assessee issued a guarantee to ICICI bank, Canada, which in turn gave a loan to MMUS, which enabled the latter to pay the purchase consideration for the acquisition of STG (USA). Further, the assessee also decided to make an equity investment of USD 26 million in MMUS over a period of three years, which would interalia was to be used for repayment of loan, availed for payment of acquisition of STG (USA).
4. During the course of assessment proceedings, the TPO/Assessing Officer observed that the assessee has not benchmarked the provision for guarantee given by it on behalf of its AE. However, the Assessing Officer held that providing guarantee to another company represents a service rendered on behalf of the other company. It involves shifting a considerable burden/risk on the guarantee provider and such service would be required to be compensated on arms length basis. Accordingly, the Assessing Officer/TPO made an upward adjustment of Rs. 65.08 lakhs by adopting a rate of 2.12% (being the average difference in coupon rate in respect of AA rated bonds and BBB rated bond.
5. In appeal, the CIT(A) upheld the addition by following the order rendered by CIT(A) for assessment years 2008-09, 2009-10 and 2010-11, which were rendered on identical set of facts. While confirming the order passed by Assessing Officer/TPO, ld. CIT(A) has made the following observations:-
“9.9. Considering the above fact and the fact that the identical issue on similar facts has been dismissed by CIT(A)-4, Ahmedabad in its order for A. Y. 2010-11 and has confirmed the addition relying upon the order for A. Y. 2009-10, the ground of appeal for this year is also confirmed.
The ground of appeal is dismissed.”
6. Before us, the counsel for the assessee submitted that the financial guarantee is the nature of share holder activity as it was to enable the AE to pay purchase consideration of acquisition, the decision in relation to which was made by the assessee. It was further, submitted that financial guarantee is quasi equity in nature as the loan availed by the AE of the assessee company through financial guarantee has been repaid back to the assessee company through equity infusion made by the assessee company into its subsidiary. It was further submitted that provision of guarantee is not covered under transfer pricing regulations. The counsel for the assessee submitted the case of the assessee is covered in its favour by decision of ITAT for assessment year 2008-09, 2009-10 and 2011-12.
7. We have heard the rival contentions and perused the material on record. We observe that the ITAT in assessee’s own case for preceding assessment year have held that providing of corporate/financial guarantee does not tantamount to an international transaction, and hence there is no requirement for benchmarking the same. However, we observe that the Allahabad High Court in the case of Jubilant Pharmoba Ltd. 146 com 319 (Allahabad) held that transaction of furnishing corporate guarantee to overseas AEs constitute an international transaction. Further, the Hon’ble Supreme Court in the case of Jubilant Pharmoba Ltd. vs. Additional CIT 146 taxman.com 318 (SC) also dismissed the SLP filed by the assessee against the order of High Court. Further, the Madras High Court in the case of PCIT vs. Radington India Ltd. 122 taxman.com 136 held that inherent risk cannot be ruled out in providing guarantees and hence adjustments are required for carrying commissions. Further, in the case of Rubani Ltd. 131 taxman.com 344, Ahmedabad ITAT held that corporate guarantee extended by assessee to its AE is an international transaction and corporate adjustment guarantee addition has to be made to an extent of 0.5% only. Similarly, the Bombay High Court in the case of Siro Clinpharm 131 taxman.com 73 (Mumbai Tribunal) held that corporate guarantee constitutes international transaction u/s. 92B of the Act and further the ITAT directed the Assessing Officer to adopt 0.5% as an arms length consideration for the corporate guarantee issued by the assessee in favour of its AE.
8. In view of the aforesaid decisions, we are of the considered view that extending of corporate guarantee to AE constitutes an “international transaction” and the Assessing Officer is directed to adopt 0.5% as an arms length consideration for the corporate guarantee issued by the assessee in favour of its AE.
9. In the result, ground no. 1 of assessee’s appeal is partly allowed.
Ground No. 2 (upward adjustment of Rs. 4.22 crores for software services by P & C division of assessee to AE)
10. The brief facts in relation to this ground of appeal are that during the course of assessment, the TPO/Assessing Officer observed that the P & C Division of Mastek entered into international transaction relating to rendering of IT services during the impugned year under consideration with its associated enterprise. The TPO/Assessing Officer made an upward adjustment of Rs. 4.22 crores for the software services rendered by P & C division of the assessee to its associated enterprise. The assessee had selected 16 comparables with PLI of 7.66%, whereas the own PLI of the assessee was 15%. While making upward adjustment of Rs. 4.22 crores, the Assessing Officer/TPO took a list of 20 comparables with PLI of 25.75%.
11. In appeal, before ld. CIT(A), the assessee sought removal of 9 comparables for various reasons such as functional dissimilarity, significant RPT, high turnover, lack of availability of segmental data etc. The ld. CIT(A) confirmed the addition by following the order of ld. CIT(A) for assessment year 2010-11. Before us, the counsel for the assessee submitted that the facts and issues for consideration for assessment year 2010-11 are completely different and unconnected it was submitted before us, that in the instant case, it may be noted that order of ld. CIT(A) for assessment year 2010-11, on which reliance has been placed by ld. CIT(A) while confirming the adjustment has been reversed by ITAT subsequently. However, in the instant facts, the matter needs to be set aside to see whether the comparables which have been taken are correct or not. In the instant facts, the TPO would need to examine the comparables in light of earlier years’ orders.
12. On going through the facts of the instant case, in the interest of justice, the issue is being set aside to the file of TPO for carrying out afresh analysis of the comparables, after taking the submissions of the assessee on record. Further, ld. Departmental Representative also not objected to the matter being set aside to the file of TPO for de-novo consideration, in the interest of justice.
13. In the result, ground no. 2 of assessee’s appeal is allowed for statistical purposes.
Ground No. 3 (Upward adjustment of Rs. 38 lakhs for giving comparables carrying out by assessee to the customers of associated enterprise)
14. The brief facts in relation to this ground of appeal are that the assessee had given performance guarantee to customers of MUK, its associated enterprise based in U.K. As per the assessee, the performance guarantees are made to ensure that the services are provided towards customers as per the contract entered into by MUK with the customers. The services for which the performance guarantee is given are performed by the assessee either through its off shore facilities or on-site through its branch in U.K. MUK is a distributor of the assessee’s software capabilities and is not engaged in provision of services. However, the ld. CIT(A) made an upward adjustment of Rs. 38 lakhs for getting performance guarantee by the assessee to the customer of AE by following the decision rendered by his predecessor, CIT(A) for assessment year 2010-11.
15. Before us, the counsel for the assessee drew our attention to pages 177-222 of the paper book (para 6-8) and pages 126-163 of the paper book (para 6-7) and submitted that the ITAT has specifically adjudicated on this issue in favour of the assessee. Accordingly, it was submitted that this issue may be decided in favour of the assessee in light of order passed by the ITAT in assessee’s own case for the earlier assessment years.
16. We observe that the ITAT in assessee’s own case on identical set of facts for assessment years 2008-09 and 2009-10 and 2010-11 has decided the issue in favour of the assessee with the following observations:-
“The other contention which has been taken by the appellant is that performance guarantee and financial Guaranty are entirely different products and therefore, it would not be appropriate to adopt the rates given for financial Guaranty for evaluating the performance guarantee. The contention of the appellant is justified. The criteria for giving the performance guarantee for a particular product would be entirely different than that of the financial Guaranty for a particular loan or credit. The performance guarantee would depend on the technical expertise and the skills of the company and the historical performance data of the product which is being sold by the distributor. It has been observed that the performance guarantee is worked out by evaluating the historical data of similar claims made in the past and the value of the product for which the performance guarantee that have been claimed, it is noted from the facts that no such historical figure or any comparable data is available for deciding the issue. The appellant is giving a commission of 5.5% of the revenues generated through MUK. It is this commission which varies in absolute terms in accordance with the price fixed by MUK while selling a product, which is guaranteed by the appellant company. The appellant has furnished a copy of sample performance guarantee agreement entered by it with British Telecommunication and it is noted that it has guaranteed due and punctual performance by MUK of each and all of the obligations, warranties or representations due to it etc. It also had agreed to indemnify the British Telecom against all losses which may incur due to breach of contract by the MUK and also the losses which may incur due to certain guaranteed obligations being enforceable, invalid or illegal. It is an admitted fact that out of the total sale consideration received by the MUK, it is retaining only 5.5% of the sales value and balance is given to the appellant company. The performance guarantee component in this commission can be only certain Percentage of the 5.5% commission retained by MUK. It is also a fact that MUK is also undertaking other functions of selling and distribution. It is making efforts in marketing the product and undertaking activities so as to achieve the maximum possible sales. However, the contracts are signed by MUK and manage. the customer relationships until the point of final delivers of the product to the buyer. Therefore, the majority of the commission given by the appellant to UK is attributable to the activities as a distributor or the marketing agent of the appellant company and only a small component or certain percentage of that commission can be attributed due to performance guarantee given by the appellant. It is noted that the TPO has evaluated this commission at 2% of the total sales made by the appellant company. After considering overall facts and circumstances, it would be appropriate if the upward adjustment on account of performance guarantee is pegged at 2% of the sale consideration retained by the MUK. Since the MUK is retaining 5.67% of the sale consideration the amount would come to 2% of 5.67% i.e. 0.11% (rounded off) of the sales.
The appellant has objected that even if certain percentage is to be attributed to the performance guarantee, it can only be attributed to the sales made by the appellant company through MUK on which the performance guarantee was given by the appellant. The objection and argument of the appellant is justified as this can only be applied to those sales made through MUK on which to performance guarantee has been given by the appellant. Accordingly, the sales made through MUK on which the performance guarantee was given by the appellant should only be considered for applying the above rate. The appellant has submitted that it has given performance guarantee on the sales of Rs.260.35 crores made through MUK. The AO is directed to verify this figure and apply the above rate accordingly. The addition made by the AO, on without prejudice basis, is accordingly upheld to that extent.
The ground of appeal is partly allowed. “
17. Accordingly, arms length price in respect of performance guarantee may be decided in light of above observations made by the ITAT in assessee’s own case for assessment year 2008-09.
18. In the result, ground no. 3 of assessee’s appeal is partly allowed.
ITA No. 159/Ahd/2018 filed by Revenue for A.Y. 2011-12
19. The Department has taken the following grounds of appeal:-
“1. The Ld CIT(A) has erred in law and on facts in deleting the adjustment while computation of arms length price of the international transactions of software services distributed by MUK(Associated Enterprise) by making upward adjustment of Rs 17,48,63,595/-
2. The Ld CIT(A) has erred in law and on facts in deleting the adjustment made by way of Human Resource Management Services amounting to Rs 80,70,360/-
3. The appellant craves leave to amend or alter any ground or add a new ground, which may be necessary.”
Ground No. 1 (Ld. CIT(A) erred in deleting upward adjustment of software development of Rs. 17.48 crores)
20. The brief facts in relation to this ground of appeal are that during the course of assessment, the Assessing Officer/TPO made an upward assessment of Rs. 17.48 crores on account of benchmarking of transactions on sale of software to Mastek, USA primarily on the ground that while in the TP documentation, the assessee has categorized MUK, UK as a full-fledged distributor eligible for above normal margin of sales and the assessee tried to justify the margin allowed to MUK by submitting that significant functions are being performed by employees of MUK, and the same are not merely distribution functions, however, on a perusal of FAR analysis revealed that UK entity is merely performing pure distribution functions without carrying any financial, functional or inventory risks. Hence, this function is different from normal independent distributor which bears financial and inventory risk. Further, the Assessing Officer observed that though MUK has been presented as a risk bearing entity, it is seen that its profits have remained at 4.5% without any reference to the margin earned by the assessee company which has fallen significantly in the current year. Therefore, it is clear that all the risks are being taken by the Indian entity while there is an attempt to attribute higher risks to MUK. This clearly leads to the conclusion that in the TP documentation, the assessee has wrongly attributed higher risks to MUK whereas there are no such risk actually being taken by MUK. In view of the above observations, the Assessing Officer/TPO made an upward adjustment of Rs. 17.48 crores. In appeal, the CIT(A) deleted the addition by following the order passed by his predecessor, CIT(A) for assessment year 2008-09, assessment year 2009-10 and 2010-11.
21. The Department is in appeal before us against the aforesaid deletion made by ld. CIT(A). Before us, at the outset, the counsel for the assessee submitted that this issue has been conclusively decided in favour of the assessee by ITAT in assessee’s own case for assessment years 2006-07, 2007-08, 2009-10 and 2010-11. Accordingly, since this issue has been conclusively decided in favour of the assessee by the ITAT in assessee’s own case, the issue may be decided in favour of the assessee. It would be useful to reproduce the relevant extracts of the decision of ITAT in assessee’s own case for assessment years 2009-10 and 2010-11:
