Case Law Details
IN THE ITAT HYDERABAD BENCH ‘A’
Assistant Commissioner of Income-tax
Versus
Ckar Systems (P) Ltd.
IT Appeal No. 565 (Hyd.) of 2011
[Assessment year 2005-06]
OCTOBER 19, 2012
ORDER
Saktijit Dey, Judicial Member
This appeal by the Revenue is directed against the order of the CIT(A) III, Hyderabad dated 28.1.2011, for the assessment year 2005-06.
2. The Department has raised the following grounds-
“1. The order of the CIT(A) is erroneous on the facts and in the circumstances of the case.
2. The Ld. CIT(A) ought to have upheld the addition of Rs. 1,70,51,255 made u/s. 92CA which was determined by the TPO after careful and systematic study.
3. The Ld. CIT(A) erred in directing the Assessing Officer to exclude telecommunication charges of Rs. 15,23,721/- from the total turnover for the purpose of computation of deduction u/s.10A.
4. The Ld. CIT(A) ought to have noticed that on the issue of exclusion of communication charges form total turnover, the case-laws on which he relied upon have not become final and the matter is in appeal before the High Court.”
3. In ground No.2, which is the first effective ground in this appeal, the Department has challenged the decision of the CIT(A) in not sustaining the addition made on the basis of the Arm’s Length Price(ALP) determined by the Transfer Pricing Officer(TPO). The factual matrix of the case as emanate from the record are that the assessee, a private limited company, has set up a 100% export oriented unit under the software technology Park of India(STPI) at Hyderabad. The assessee is a wholly owned subsidiary of CBay Systems Ltd., USA, which is the holding company. The main object of the assessee company is to provide IT-enabled health care services to its parent company as well as to other overseas customers. The assessee commenced its trial operations in medical transcription from October, 2003. The assessee also has facility to train graduates and post graduates in medical transcription for inducting into their unit or in its associate units. For the impugned assessment year, the assessee filed return declaring its income at NIL. During the scrutiny assessment proceedings, the Assessing Officer noticing that the assessee entered into international transactions with its parent company CBay Systems Ltd., USA, which is an associated enterprises(AE), made a reference to the TPO under S.92CA(1) for determining the ALP. In the course of the proceedings before the TPO, the assessee submitted the Transfer Pricing Study accompanied by other documents. In the TP study report, the assessee adopted Comparable Uncontrolled Price (CUP) method as the most appropriate method for computing the Arms Length Price of the international transactions made with its AE. The assessee submitted before the TPO that the reason for adopting the CUP Method is due to the fact that during the period under consideration, there was internal comparables as the parent company CBay also outsourced the medical transcription to independent parties in India. The CBay USA pays a standard rate of 6 Cents per line (subject to the achievement of certain quality standards which are common for the outsourced company and the assessee) for the medical transcription activities carried on by the assessee and other outsourced companies. The assessee further submitted that the services received from third parties are similar to the services received by CBay USA from the assessee. The assessee has also entered into independent transactions with unrelated third parties during the year, viz. Ariel, Medscribe, Medwrite, and its transactions with these concerns are comparable or at lower rate. The assessee submitted that the five com parables selected by the assessee, which includes three internal com parables and two external com parables, and the price received being within the Arms Length standard as per the CUP method is similar to the rate charged by the AE to the assessee and the two independent Indian companies located at Hyderabad for rendering medical transcription services were similar. Similarly, the rates charged per line of medical transcription by the assessee to the three other independent overseas companies were also similar to the price charged by the assessee to its AE. The assessee therefore, submitted that the ALP computed by it by applying the CUP method is appropriate. In support of his contentions, the assessee submitted before the TPO various documents to show that it has received service charges at an average rate of 0.063 US$ per line of medical transcription from its AE during the previous year. In this regard, the assessee furnished the copy of the agreement entered into with its AE and also the copies of the bills issued to the AE during the relevant period. The assessee also submitted copies of the agreements entered into by its AE with two other Indian companies viz. M/s. ELICO Ltd, M/s. Shaster Technologies P. Ltd. showing rate of 0.063 US$ per line of medical transcription during the previous year. The assessee also submitted the copies of the agreement entered into between the assessee and the three other overseas companies, i.e. Ariel Ventures LLC, USA, Medscribe USA and Medwrite USA, as per which the assessee has charged them at 0.06 US$, 0.0575 US$ and 0.05US$ per line of medical transcription during the previous year. On the basis of the price indicated in the foresaid agreement, the assessee submitted before the TPO that the rate of Rs. 0.63 US$ per line of medical transcription received by it from its AE is within the Arms Length.
4. The TPO however, did not accept the submissions of the assessee By noting that though the assessee furnished copies of the agreements entered into by its AE with M/. Shaster Technologies Pvt. Ltd. ad MN/s. ELICO Ltd., showing rate of 0.05US$ per line of medical transcription, there is no basis on which it can be said that such price is an uncontrolled transaction. The TPO noted that the rate charged per line of transcription is dependent on the size of the transaction and the sophistication of the transcription work. The TPO noted that the income statement of those two companies does not give sufficient information to arrive at the conclusion that such rate of 0.05 US$ is an uncontrolled price per line of transcription. Further, the TPO referring to the Profit & Loss Account in the case of Shaster Technologies Pvt. Ltd. for the financial year ended 31.3.2005 noted that a sum of Rs. 61.17 lakhs was received by that company towards data processing (exports). However, in the absence of any break up of that amount, it was not known as to how much income was generated by that company from medical transcription work. The TPO noted that as per the report of the Directors of that company, during the year, total 14,600 lines of transcription work was received from CBay Systems Ltd. but in the last paragraph of that report, there is a mention that during the current year, the company has also taken up additional medical transcription work from M/s. Accurate Transcription Inc. USA. It is further mentioned that this work could not be continued since Accurate Transcription Inc. was not in a position to outsource its work to their company. On the basis of the aforesaid observations, the TPO noted that in the absence of required particulars and the details of revenue generated from the medical transcription work and also the total number of lines of transcription done by that AE, it cannot be said that such rate of 0.05US$ per line of medical transcription is an uncontrolled rate so as to use the same as a bench mark in the CUP method adopted by the assessee. So far as the other comparable, i.e. M/s. ELICO Ltd,. is concerned, the TPO referring to the Profit & Loss Account for the year ending 31.3.2005 noted that in the absence of break up of the amount of Rs. 20.13 crores shown towards total sales, it is not known as to how much income was generated from ITES or medical transcription services by that company. He further noted that ELICO Ltd. has got several divisions. The TPO noted that there is no segmental break up of revenue available. He further noted that in the absence of required particulars and the details of revenue generated from the medical transcription, it cannot be said that the rate of 10.05 US$ per line of medical transcription is an uncontrolled rate. So far as reliance made by the assessee with three other overseas companies, Ariel Ventures LLP, USA, Medscribe USA and Medwrite USA, the TPO noted that in the absence of annual reports and other details in respect of those companies furnished by the assessee, those companies cannot be accepted as comparables for the purposes of CUP method adopted by the assessee company. The TPO noted that in the CUP method adopted by the assessee, the data relating to rate charged per line of transcription and number of lines done were not available in public domain with respect to independent enterprises and as such the uncontrolled transaction rate per line of transcription is not available to benchmark the assessee’s actual rate. The TPO referring to para 2.9 of the OECD guidelines noted that the CUP method can be applied provided none of the differences between the transactions being compared affects the price in the open market, and reasonably accurate adjustment can be made to eliminate material effects of such differences. The TPO observed that the so called maximum rate is not an uncontrolled transaction to be compared with, as the industry average data from the competitive service providers and other MNC. Therefore, such method cannot be applied based on the industrial average maximum billing rate. The TPO held that the so called maximum rate of the average acceptable rate cannot be considered as an uncontrolled transaction as per Rule 10A(a). Another reason mentioned by the TPO for not accepting the method applied by the assessee is that there is no publicly available information on prices charged in independent transactions of similar nature that reflect the characteristics of the services rendered by the assessee. On the aforesaid reasoning, the TPO rejected the ALP computed by the assessee by adopting CUP method. The TPO held that the CUP method cannot be applied due to lack of information and comparables. The TPO held that Transfer Net Margin method(TNMM) is the most appropriate method for determining the ALP of the international transactions in the case of the assessee The TPO observed that the CUP method adopted by the assessee is not workable on the basis of the comparable rates per line with reference to independent comparable as the rate per line varies according to the quantity of work, i.e. number of lines of work done. Since the assessee has not provided the quantity, i.e. the number of lines billed with reference to any relative comparables, the ALP computed by the assessee cannot be accepted. The TPO for the purposes of determining the ALP of such international transactions made by the assessee with its AE, selected nine comparable companies, and on the basis of the profit margins in six of these companies, determined the average profit margin, i.e. Arithmetic Mean Profit Level Indicatro(PLI) at 24.65 per cent. After allowing deduction of 1.59% towards working capital adjustment, the Arithmetic Mean PLI was determined at 23.06 per cent and on that basis, determined the ALP at Rs. 12,02,19,332. The ALP determined by the TPO when compared to the ALP computed by the assessee at Rs. 10,31,68,077, exceeded by an amount of Rs. 1,70,51,255. The TPO recommended for adjusting the amount of Rs. 1,70,51,255 under S.92CA of the Act.
5. In conformity with the order passed by the TPO, the assessing officer passed the assessment order adding an amount of Rs. 1,70,51,255 to the income, on account of ALP difference.
6. The assessee aggrieved by such addition filed appeal before the CIT(A). In the course of hearing before the CIT(A), the assessee submitted that it has entered into international transaction with its holding company for rendering medical transcription services in terms with an agreement executed on 29.9.2003. Apart from providing services to the holding company, the assessee also provides ITES enabled health care services to other overseas customers as per the agreed terms and conditions. As per the terms of the agreement with the holding company, for the services rendered by it to the holding company, the holding company will pay consideration at the rate of 0.05 US$ per line typed. In addition to that, the assessee also gets enhanced payment depending upon the quality of service rendered. The assessee in its transfer pricing study, considering the nature of services rendered and availability of data has applied CUP method as the most appropriate method for computing the ALP for its international transactions. The assessee submitted that while computing the ALP, it has considered both internal com parables and also the external com parables. All the details regarding the com parables were also submitted before the TPO. It was submitted before the CIT(A) that the average price per line of transcription realised from the AE CBay USA at 0.063 US$ is almost same as the average price realized from the unrelated parties at 0.06 US$. The assessee objecting to the observations made by the TPO that in absence of proper data/information CUP method could not be applied, submitted that all the details pertaining to the external comparables relating to the companies, M/s. ELICO Ltd. and M/s. Shaster Technologies Ltd., such as the agreement entered into by the parent company CBay USA, financial statement and other details were produced before the TPO. TPO himself also obtained Balance Sheet and Profit & Loss Account of the aforesaid companies under S.133(6) of the Act. The assessee submitted that the rejection of CUP method by the TPO is not based on proper reasoning but on flimsy grounds. It was further submitted by the assessee that the OECD guidelines as well as the guidelines issued by the ICAI accept the CUP ,method as the best method for Transfer Pricing Study. Therefore, the TPO without pointing out any infirmity in the comparables selected by the assessee, was not justified in rejecting the method applied by the assessee for computing ALP. The assessee disputing the observation made by the TPO that it has accepted the TNMM method to evaluate the ALP, submitted that only where the data under the CUP method cannot be accepted then the other method can be explored to compute the ALP. The assessee has never accepted the TNMM method for computation of ALP. The assessee, objecting to the adoption of TNMM method by the TPO for computing the ALP, submitted that when information and data are available, the TPO should not have rejected the CUP method and adopted TNMM method, which should be adopted as a method of last resort, when all other methods fail.
7. The CIT(A), after considering the submissions of the assessee and examining the materials available before him, was of the view that as per the OECD guidelines, where it is possible to locate comparable uncontrolled transactions, the CUP method is the most direct and reliable one to apply for determining the ALP. The CIT(A) from the materials on the record found that the assessee has compared the price paid by their holding company CBay Systems Ltd USA to two other Indian companies, viz. ELICO Ltd. Hyderabad and M/s.Shaster Technology P. Ltd. Hyderabad for availing similar services from them, as have been rendered by the assessee to its AE during the financial year 2004-05. The assessee has further compared with the price charged by it to three other overseas companies, namely, Ariel Ventures LLC, USA, Medscribe USA and Medwrite USA for rendering similar services as rendered to its AE. From the documents submitted before him like the bills raised, agreements, etc. the CIT(A) found that the two Indian companies, namely, ELICO and Shaster Technologies Ltd. were also providing medical transcription services to the Cbay Systems USA at the same terms and conditions as applicable to the assessee, and at a price of 0.05 US$ per line of transcription. The CIT(A), after thoroughly examining the terms and conditions of the assessee with its AE and the AE with other companies in India, found that the international transactions relating to provision of medial transcription services made by the assessee with its AE CBay Systems USA during financial year 2004-005 are fully comparable with such transactions for providing similar services made by the two Indian companies namely, ELICO Ltd. and Shaster Technologies P. Ltd. with the assessee’s AE, CBay Systems Ltd. USA. The CIT(A) therefore, held that the most suitable method for determining the ALP of the international transactions is the CUP method. The CIT(A) further observed that though the TPO in his order, has mentioned that the Directors’ report in the case of Shaster Technologies P. Ltd. mentions that during the financial year 2004-05, a total of 14,600 lines of transcription work was received from CBay Systems Ltd. which is not correct, in view of the fact that the Directors” Report mentions that during the year 2004-05, the company on an aggregate produced 4,400 lines per day of medical transcription work in the first half of the year and 10,200 lines per day during the second half of the year with continuous improvement, which effectively means that the said company, i.e. Shaster Technologies produced on an average 4,400 lines per day of medical transcription during the first half and an average of 10,200 lines per day during the second half of the financial year 2004-05. So, on this basis and taking into account only the working days during the financial year 2004-05, the total number of lines transcribed by that company during the whole year exceeds 19 lakhs, which is not correct, as the actual number of lines of medical transcription work done by M/s. Sahster Technologies Ltd. was much more. Similarly, the CIT(A) also found that the observations made by the TPO in the case of ELICO Ltd., and the Directors’ Report in the case of that company does not mentions anything with regard to ITES or medical transcription activity carried on by that company is not correct. The CIT(A) observed that the TPO’s reasoning that the rate of 0.05US$ per line of medical transcription cannot be accepted, as the uncontrolled rate in the absence of segmental break of revenue, is without any basis. Since there is no denying the fact that M/s. ELICO Limited has received services charges from medical transcription rendered by them to CBay Systems USA at the rate of 0.05US$ per line of medical transcription as per the terms of the agreement. So far as the internal com parables considered by the assessee is concerned, the CIT(A) after going through the agreement entered into by the assessee with the three independent overseas companies found that the services rendered by the assessee for medical transcription to those companies are similar to those rendered by it to its AE and the price charged at the rate of US$0.06 per line of medical transcription in case of Ariel Venture LLC and at the rate of US$0.05 per line in the case of other two companies, Medscribe USA and Medwrite USA are similar to the price charged by the assessee from its AE, CBay Systems USA for similar medical transcription services rendered by the assessee during the financial year 2004-05. The CIT(A), after considering the agreement by the assessee with the AE and also with the overseas companies as well as the agreements by the AE with the Indian companies, the price charged by the assessee to its AE and the price charged by the other Indian companies to the AE and also the price charged by the assessee to the other overseas customers, held that they can be considered for the purposes of comparative analysis for determining the ALP of the international transactions made by the assessee with its AE. The CIT(A), after comparing the price charged by the assessee to its AE with the price charged by the assessee to the overseas customers and as well as the price charged by the other two Indian companies to CBAY Systems USA, found that the price charged by the assessee at the rate of 0.063 US$ per line of transcription work to its holding company is within the arms’ length range. The CIT(A) further found that the allegation of the TPO that the assessee has not provided the quantity of number of lines billed with reference to the unrelated comparables to be without any basis. After examining the materials on records, the CIT(A) was of the view that the assessee provided all the materials to the TPO with regard to the price charged by the internal com parables as well as external com parables. The CIT(A) finally came to a conclusion that the assessee was right in adopting the CUP method as the most suitable method for determining the ALP of international transactions made by it with its AE during the financial year 2004-05 relevant to assessment year 2005-06 and the amount of Rs. 84,840,538 received by it from its AE is within the Arms’ length range. The CIT(A), therefore, deleted the addition of Rs. 1,70,51,255.
8. Aggrieved by the order of the CIT(A), Revenue is in appeal before us.
9. The learned Departmental Representative, relying upon the reasoning of the TPO, submitted that the assessee is a contract service provider. Since the assessee did not provide the quantitative details in the case of com parables, the TPO was justified in rejecting the CUP method adopted by the assessee. The learned Departmental Representative, though agreed to the fact that the CUP method is the most appropriate method, submitted that in the absence of relevant data, the TPO was left with no other option but to adopt the TNMM method. He further submitted that the agreements between the AE and the assessee as well as the other two Indian companies were identically worded, which gives rise to a reasonable doubt that the com parables are not uncontrolled.
10. The learned Authorised Representative for the assessee, reiterating the contentions urged before the lower authorities, submitted that the observations made by the TPO that quantitative details were not furnished to the TPO is without any basis. All relevant data with regard to com parables were available before the TPO. The learned Authorized Representative for the assessee further submitted that the TPO himself has called for information under S.133(6) of the Act from the external com parables and therefore, the allegation that the relevant data is not submitted is without any basis. The learned Authorized Representative for the assessee referring to para 5.8 of the order of the CIT(A) submitted that all relevant materials with regard to the external as well as internal com parables were provided to the TPO. The learned Authorized Representative for the assessee ultimately submitted that when com parables in respect of uncontrolled transactions are available, the CIT(A) was justified in holding that the CUP method adopted by the assessee is correct and in accordance with he guidelines of the OECD and the IT Rules and the price charged by the assessee to its AE is within the Arms’ length.
11. We have heard the rival submissions and perused the materials on record. The facts of the case have been exhaustively dealt with by the CIT(A) in his order. It is a fact on record that the assessee has adopted the CUP method for computing the Arms’ Length Price for the international transaction entered into by it with its AE for the medical transcription service rendered by it to the AE. In this regard, the assessee has considered two external comparables and three internal com parables. The external comparables the two Indian companies, M/s. ELICO Limited and M/s. Shaster Technologies Ltd. have also entered into agreements with M/s. CBay Systems Ltd. USA for providing medical transcription services. Similarly, the assessee has also entered into agreement with three overseas customers (internal com-parables) for providing medical transcription services similar to the ones provided by assessee to its AE. As can be seen from the price charged by the assessee to its AE, in comparison with the price charged by the assessee to its other overseas customers, so also by the price charged by the other two Indian companies, viz. ELICO Ltd and Shaster Technologies P. Ltd. to M/s. CBay Systems, USA, it is clear that they are almost within similar range. The service rendered by the assessee to its AE as well as to the other overseas customers and the services rendered by the other two Indian companies to CBay systems is also same, i.e. medical transcription work. Therefore, the com parables adopted by the assessee are uncontrolled parties and can be considered for the purpose of determining the Arms’ Length Price as per CUP method. As can be seen from the order of the TPO, though the TPO accepts the fact that CUP method is the most direct and reliable one to apply for determining Arms’ Length Price, he rejects the CUP method adopted by the assessee in the present case on the ground that in the absence of information, the assessee’s statement that in medical transcription industry, in general, the price charged per line of transcription is around 00.6 US$ cannot be accepted and that apart, no publicly available information on prices charged in independent transactions of similar and identical nature that reflect the characteristics of the services rendered by the assessee, has been furnished. Therefore, the comparable for applying the CUP method cannot be accepted. The TPO has further observed that the assessee also accepts that the TNMM method is a useful method for computing the Arms Length Prices in its case. However, such finding of the TPO is not correct. It is seen from the order of the TPO itself that in response to his show-cause notice dated 22.10.2008, the assessee has strongly objected to the proposal for applying the TNMM method and has requested for accepting the CUP method applied by the assessee. The assessee has submitted before the TPO that it has applied the CUP method after comparing the functions performed and the risks undertaken by each entity involved in the inter-company transactions. The TPO has brushed aside the objections of the assessee by simply observing that the assessee has not provided quantitative details with reference to the unrelated comparables. However, such finding of the TPO is again not correct, considering the fact that the assessee has furnished all the relevant information/data, requisitioned by the TPO from time to time. This fact is very much evident from para 1.1 of the order of the TPO itself. Therefore, the finding of the TPO that the assessee has not given the quantitative details is without any basis. It is a matter of fact that the assessee has submitted the agreements between the assessee and its AE as well as the agreements entered into by the AE with the other Indian companies and the agreements between the assessee and its other overseas customers. The assessee has also submitted bills raised and the prices charged for each line of medical transcription work by the assessee to its AE and by the Indian companies for the services rendered to CBay Systems USA and also the services rendered by the assessee to the overseas customers. On perusing services rendered and price charged for all the aforesaid transactions, it is seen that the price charged by the assessee to its AE on each line of medical transcription work at 0.063 US$ is almost equal to the similar rate charged per line on medical transcription work by the other uncontrolled parties, considered as comparable by the assessee. The observation of the TPO that the com parables cannot be considered to be uncontrolled is without any basis, and it is based on mere presumptions and surmises. When the com parables considered by the assessee are in no way connected either with the assessee or with its holding company, and all the information/data relating to their transactions are available, the TPO was not justified in rejecting the computation of ALP made by the assessee by applying the CUP method. The CIT(A) has passed a well reasoned order, elaborately discussing the various issues raised by the TPO and ultimately came to a conclusion that the CUP method is the most appropriate method for computing the ALP for the international transactions entered into by the assessee with its AE. We fully agree with the order of the CIT(A) in this behalf. We accordingly uphold the same and reject the ground of the Revenue on this issue.
12. In grounds 3 and 4, the department has challenged the direction of the CIT(A) to exclude the communication charges of Rs. 15,23,721/- from the total turnover also while computing the exemption u/s. 10A of the Act.
13. Briefly stated, facts are that in the course of the assessment proceedings, the assessing officer found that the assessee has claimed exemption under S.10A of the Act, for an amount of Rs. 20,11,603. While verifying the details, the assessing officer noticed that the assessee has incurred expenses towards communication charges amounting to Rs. 15,23,721. The assessing officer asked the assessee to explain as to why the communication charges should not be excluded from the export turnover as per clause (iv) of Explanation 2 to S.10A, while computing the exemption under S.1.0A. The assessee in its reply submitted that it is neither possible nor practicable to segregate as to what amount of bandwidth charges paid is meant for delivery of product outside India. The assessee submitted that if the expenditure incurred towards communication charges is to be excluded from the export turnover, the same is also to be excluded from the total turnover for computing the exemption under S10 A of the Act. The assessing officer did not accept the contention of the assessee. The assessing officer interpreting the term ‘export turnover’ as defined in clause (iv) of Explanation (2) to S.10A, came to the conclusion that the communication charges amounting to Rs. 15,21,721 has to be excluded from the export turnover for working out the exemption under S.10A of the Act.
14. The assessee challenged the aforesaid action of the assessing officer in appeal before the CIT(A). In the course of hearing before the CIT(A), assessee contended that the assessing officer was not justified in deducting the communication charges from export turnover, while at the same time treating the same as part of total turnover for determining the exemption under S.10A. The CIT(A), considering the contentions of the assessee, though agreed with the view of the assessing officer that expenditure incurred towards communication charges, cannot form part of export turnover and as such communication charges have to be excluded from the export turnover, the CIT(A), however, following the orders of the Tribunal in similar matters, as in D-Block India Software P. Ltd. in ITA No. 983-984/Hyd/2006 dated 31.1.2007 and Patni Telecom (P.) Ltd. v. ITO [2008] 22 SOT 26 (Hyd.) held that communication charges which do not have element of profit, if excluded from the export turnover, at the same time has to be excluded from the total turnover also, for the purpose of computing deduction under S.10A.
15. We heard the submissions of the parties on the issue and also perused the materials on record. The issue involved in these grounds raised by the Revenue, could not detain us too long, in view of the consistent judicial pronouncements laying down the principles on the issue in dispute. The Hon’ble Karnataka High Court, while considering a similar issue, in the case of Tata Elexi Ltd. v. Asstt. CIT [2008] 115 TTJ 423 (Bang.) held that the expenditure incurred towards communication charges, if excluded from the export turnover, has also to be excluded from the total turnover. Following the aforesaid decision of the Hon’ble Karnataka High Court, and also the consistent view taken by the coordinate benches of this Tribunal in similar matters, we are of the view that the communication charges have to be excluded both from the export turnover as well as the total turnover, while computing exemption under S10A of the Act. In this view of the matter, we find no infirmity in the impugned order of the CIT(A) on this issue. We accordingly uphold the same, and reject the grounds of the Revenue on this issue.
16. In the result, Revenue’s appeal is dismissed.
