Transfer pricing – Current year data can be used for comparability of international & uncontrolled transactions

IN THE ITAT MUMBAI BENCH ‘B’

Lionbridge Technologies (P.) Ltd.

V/s.

Deputy Commissioner of Income-tax

IT Appeal No. 9032 (Mum.) of 2010

[Assessment Year 2006-07]

JUNE 20, 2012

ORDER

R.S. Syal, Accountant Member – This appeal by the assessee is directed against the order passed by the DCIT u/s 143(3) read with section 144C(13) of the Income-tax Act, 1961 (hereinafter called the ‘Act’) on 07.10.2010 in relation to the assessment year 2006-07.

2. The major issue in this appeal is against the confirmation of addition of Rs. 8,86,68,683 on account of transfer pricing adjustment u/s 92CA(3) of the Act. Briefly stated the facts of the case are that the assessee is a company engaged in the development and sale of computer software and providing other related services. It filed its return on 21.10.2006 declaring total income of Rs. 87,64,611. Thereafter, the assessee e-filed revised return on 24.10.2006 declaring total income of Rs. 87,64,536. From the Form No.3CEB submitted by the assessee along with the return of income, the A.O. observed that the assessee entered into various international transactions with its Associated Enterprises (hereinafter called “AEs”). The A.O. made a reference u/s 92CA(1) to the Transfer Pricing Officer (hereinafter called “TPO”) for the determination of Arm’s Length Price (hereinafter called “ALP”) in relation to the international transactions. The TPO noticed that the assessee entered into 10 types of international transactions with its AEs. The entire dispute in the present appeal revolves around the first type of transactions being “Receipt of fees towards Information Technology (IT)/Information Technology Enabled Services (ITES)” reported by the assessee at Rs. 31,53,20,904. The assessee used Transactional Net Margin Method (hereinafter called “TNMM”) for the purposes of determination of ALP. In support of its ALP, the assessee furnished transfer pricing report. All international transactions with its AEs were put in one basket with respect to IT services, IT enabled services (hereinafter called ‘ITES’) and marketing & support services. The TPO observed that the main transactions were of the nature of IT and ITES. On the basis of search from Prowess and Capitaline Databases, the assessee identified 43 companies as comparables which have been tabulated on pages 3 and 4 of the TPO’s order. After considering the two years’ weighted average profit of such comparable cases, the assessee determined Profit Level Indicator (Operating Profit/Total Cost) margin in respect of such comparable cases at 17.20%. As against this benchmarked profit percentage, the assessee had disclosed its actual margin as per the books of account at 12.53% on overall basis, divided into 16.77% from the international transactions with the AEs and 10.80% from the transactions with Non-AEs. After exercising option u/s 92C(2), it was declared that the price charged by the assessee from its AEs was at arm’s length.

3. The TPO observed that the assessee adopted two years’ data to work out weighted average for computing PLI of Operating profit/Total cost of comparable companies, which was not in accordance with rule 10D(4). In his opinion, the requirement was to adopt the relevant year’s financials alone. During the course of proceedings before the TPO, it was stated on behalf of the assessee that even going by the internal comparables, it earned OP/TC margin of 16.77% from its AEs, which was higher than its OP/TP margin of 10.80% from its non-AEs, warranting no adjustment. The assessee also furnished its updated margin of comparable companies on the basis of Transfer Pricing report for financial year 2005-2006 alone at 17.36%. The TPO observed that the price charged by the assessee for providing IT/ITES was not determined in accordance with the provisions of section 92C(1) and (2). He noticed that the type of services offered to AEs were not the same as those offered to non-AEs and hence the comparison of margins between AEs and non-AEs was irrelevant. The assessee was specifically asked to clarify whether all the services rendered by it were in the nature of software development or in the nature of ITES. The assessee submitted that its service to AEs as well as non-AEs were ITES as it was not engaged in any high-end application software development. Considering the assessee’s submissions and taking into account the nature of services rendered by the assessee, the TPO categorized the services rendered by the assessee as IT/ITES. Thereafter, he took up the task of finding comparable cases in the category of IT/ITES. From the Prowess and Capitaline Databases, the TPO, after eliminating certain cases initially chosen, finally short-listed 33 companies which were declared as comparable. The list of such 33 companies with the amount of Turnover and PLI (OP to TC) in percentage has been tabulated on pages 12 and 13 of the TPO’s order. From such tabulation, the TPO worked out average OP/TC margin of the combined IT/ITES comparable companies at 21.99%. This PLI was used by the TPO as arm’s length margin to work out the amount of the proposed adjustment on account of transfer pricing in assessee’s case. Here it is important to mention that the assessee raised various objections to some of the cases chosen by the TPO as comparables. Such objections of the assessee and the remarks of the TPO have been incorporated on pages 13 to 17 of his order. After rejecting the assessee’s objections in this regard, the TPO concluded that the comparable companies finally selected by the him, represented the IT/ITES industry in a true sense. In this way, the TPO proceeded to compute the amount of adjustment at Rs. 8.86 crore as under:-

TABLE – A

4. From the above table it can be seen that the TPO applied arm’s length margin at 21.99%, worked out by him on the basis of 33 comparable cases as finally chosen by him. That is how arm’s length service fee was determined at Rs. 114,28,32,830 as against Rs. 105,41,64,147 declared by the assessee. Resultantly adjustment of Rs. 8.86 crore was proposed. The A.O. passed draft order u/s 143(3) read with section 144C(1) on 29.12.2009, making addition of Rs. 8.86 crore u/s 92CA(3). When the matter came up before the Dispute Resolution Panel (hereinafter called ‘DRP’), the assessee raised various objections. Not convinced with the assessee’s submissions/objections, the DRP vide its order dated 28.09.2010 confirmed the adjustment of Rs. 8.86 crore. The A.O. in his final order passed on 07.10.2010, made the addition for Rs. 8.86 crore accordingly. The assessee is aggrieved against this addition made by the AO in his order passed u/s 143(3) r.w.s. 144C(13).

5. We have heard the rival submissions and perused the relevant material on record. From the facts recorded above it is discernible that the assessee entered into international transactions with its AEs and also non-AEs. It earned revenue totaling Rs. 105.41 crore from IT/ITES split into two parts viz. Rs. 31.59 crore from AEs and Rs. 73.81 crore from non-AEs. From Table-A above, reproduced from the TPO’s order, it can be seen that the assessee incurred total cost of Rs. 93.68 crore, the detail of which is available on page 147 of the paper book. The total cost in relation to international transactions with the AEs comes to Rs. 27.06 crore as against with the non-AEs at Rs. 66.62 crore. The total operating profit of Rs. 11.73 crore consists of operating profit from international transactions with AEs at Rs. 4.53 crore and from transactions with the non-AEs at Rs. 7.19 crore. The ratio of operating profit to total cost from AEs is at 16.77%; from non-AEs at 10.80%; and aggregate at 12.53%. At this stage it is relevant to mention that the detail at page 147 of the paper book showing the allocation of revenues, cost and profitability between AEs and Non-AEs was available before TPO as well as DRP. Both the authorities have referred to such details in their respective orders. The figures as so given have not been controverted by any of these authorities. Thus it can be seen that margin in the case of international transactions with AEs stands at 16.77% as against the transactions with non-AEs at 10.80%. The assessee declared arm’s length margin on the basis of two years’ data at 17.20%, with which the TPO did not agree. In his opinion, and rightly so, the data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction can be the data relating to the financial year in which the international transaction is entered into. This is the prescription of rule 10B(4). If we exclude the other year’s profit margin from average of the 43 comparable cases taken note of by the assessee in its transfer pricing study, the average profit margin comes to 17.36%. This fact is verifiable from page 5 of the TPO’s order. The TPO chose three cases from the assessee’s list of 43 comparable cases and found out 30 cases at his own, which in his opinion were comparable. On the basis of final list of such 33 comparables cases, he worked out margin of 21.99%.

6. Various objections have been raised before us and were also raised before the authorities below on the cases selected by the TPO. For the time being, we are not dealing with such objections and proceeding with the presumption that the TPO rightly excluded 40 comparable cases given by the assessee and inducted 30 cases at his own. The average profit margin from such 33 cases has been determined by the TPO at 21.99%. A look at the Table-A divulges that the TPO considered total revenues from international transactions with AEs and also non-AEs at Rs. 105.41 crore. In the same breath, he considered OP/TC margin at 12.53% declared by the assessee in total, which again comprises of 16.77% from its international transactions with AEs and 10.80% from the transactions with non-AEs. That is how the TPO considered the transactions both with AEs and Non-AEs for the purpose of recommending adjustment of Rs. 8.86 crore.

7. It is axiomatic that the transfer pricing adjustment can be made only with reference to the international transactions with the AEs and not non-AEs. Special provisions relating to the computation of income from international transactions were introduced through sections 92 to 92F by the Finance Act, 2001 with a view to provide a statutory frame work which can lead to the computation of reasonable profits and taxes in India in case of international transactions between enterprises of a multi-national group. The object of these provisions is to ensure that the transactions between two AEs are not arranged in such a manner so as to reduce the incidence of tax due in India. Such object is achieved by determining ALP as per the relevant provisions of the Act, which is then compared with the price at which international transactions are actually entered into and recorded in the books of account. The difference between the ALP and the actual price, if leading to the lowering of income due in India, is added by way of transfer pricing adjustment. From the scheme of Chapter X of the Act, containing the sections as afore-referred, it is manifest that the addition on account of transfer pricing adjustment can be made only in respect of international transactions with the AEs and not the non-AEs. It is quite natural also because there can be no scope for arranging the transactions with non-AEs so as to reduce the due tax in India. That is the reason for which the transactions with non-AEs have been excluded from the ambit of Chapter X of the Act.

8. Coming back to the facts of the instant case it is observed that the addition of Rs. 8.86 crore has been made by the AO on the basis of the adjustment proposed by the TPO on the international transactions not only with AEs but non-AEs as well. This course of action has no force of law. When we concentrate on the international transactions of the assessee with its AEs, it can be observed that the margin from OP/TC comes to 16.77%. On the other hand, the TPO determined the average ratio of OP/TC at 21.99% from his chosen 33 comparable cases. If 5% plus minus margin is allowed in terms of section 92C(2), the arm’s length service fee will come at Rs.115.90 (Rs.100 + Rs. 21.99 = Rs.121.99 minus Rs. 6.09 [5% of Rs. 121.99] ). As against this, the service fee charged by the assessee is Rs.116.77 (Rs.100 + Rs. 16.77 [16.77% of Rs.100] ). Thus it can be seen that the arm’s length service fee at Rs. 115.90 is less than that charged by the assessee at Rs. 116.77. The above percentages when applied to the actual figures, give the following results:-

TABLE – B

9. The learned Departmental Representative vehemently supported the view canvassed by the TPO by stating that the statement showing allocation of revenue, cost and profitability between third parties and AEs giving ratio of operating profit total cost at 12.53% in aggregate and 16.77% on international transactions with AEs and 10.80% on transactions with non-AEs, was not available before the TPO. He also raised another objection by arguing that the final list of 33 comparable cases drawn by the TPO comprised of two sets of comparable cases, viz., one set of entity level cases and the other set of segment level cases. He argued that the profit margin of 21.99% was determined by the TPO by considering not only the revenues from IT/ITES in relation to some of these comparable companies but also from the figures of entity in relation to other comparable cases. It was accentuated that there was a dire need to restore the matter to the file of TPO for a fresh determination of PLI by considering only those comparable cases which involve IT/ITES, thereby excluding the non-ITES revenues from the other set of comparables.

10. We are not convinced with the submissions put forth on behalf of the Revenue. Insofar as the first contention, regarding non-availability of statement showing separate profit margins from transactions with AEs and non-AEs before the authorities below, is concerned, it is found that the TPO has taken note of this fact on page 5 of his order. It has been categorically recorded by him that the assessee submitted before him the OP/TC margin of 16.77% which was earned by it from the AEs segment and such margin was higher than OP/TC margin of 10.80% from the non-AEs segment. This indicates that the entire detail about the allocation of cost and revenue between AEs and non-AEs was very much available before the TPO. It is still further noted that the assessee submitted a Note on allocation of revenues and cost between AEs and non-AEs segment before DRP as well vide its letter dated 15th September, 2010, a copy of which is available on page 268 onwards of the paper book. These facts indicate that the allocation of total revenues and total cost between AEs and non-AEs, was very much available before the TPO as well as DRP. None of these authorities have adversely commented on such allocation. It, therefore, implies that they accepted these figures as correct.

11. The other contention of the learned Departmental Representative is again devoid of any force. The TPO finally chose 33 uncontrolled comparable cases on the basis of their revenues from IT/ITES. If we peruse Table-A, it can be seen that such 33 comparable cases have been broadly classified in two classes viz., Segment and Total. For example, the comparable case given by TPO at Sr.nos.5, 6, 7, 8 etc. have been marked with “Seg.” which represents the segmental results from IT/ITES. The other cases are those in which there is no separate identification. These cases include Ace Software Limited at sr.no.1, Allsec Technologies Ltd. at sr.no.2, Infosys Limited at sr.no.17, Aztec Software Limited at sr.no.14 etc. These are the companies which are exclusively engaged in rendering IT/ITES. To contend that the TPO wrongly recorded the figures of turnover and ratio of OP to TC in the case of such later category of comparable cases on the entity level, which also comprises non-IT/ITES services, is without any bedrock. In fact, the companies in second category are those which appear to be exclusively engaged in rendering IT/ITES. The TPO has recorded Turnover and OP/TC ratio of such companies on entity level because of their being solely involved in IT/ITES and in respect of the other category, where such comparable companies are involved not only in IT/ITES, the figures of turnover and OP /TC margin have been adopted in respect of IT/ITES segment alone. It can be observed from the earlier parts of the TPO’s order that he confined himself only to IT/ITES for the purposes of bench marking. In such a case, there could have been no question of the TPO embarking upon the figures in relation to non-IT/ITES segments of some of the comparable cases as chosen by him. Apart from making a general statement that the TPO also considered the figures from non-IT/ITES segments in some of the comparable cases, no material has been placed on record to substantiate this argument. If the ld. DR was confident of his viewpoint canvassed by him, then he should have brought on record the figures of some of such companies to demonstrate that the TPO committed mistake, which warranted fresh appraisal. We, therefore, do not find any force in the submission advanced by the learned Departmental Representative on this issue.

12. From the above Table-B, it is manifest that the service fee charged by the assessee from international transactions with its AEs is more than the ALP determined by applying the PLI as found out by the TPO and hence no addition/adjustment is called for. It is imperative to note that the above working is without prejudice to the view point of the assessee that the TPO wrongly chose 30 cases and rejected 40 cases rightly chosen by it. We, therefore, order for the deletion of addition of Rs. 8.86 crore.

13. The next ground of the assessee’s appeal is against the charging of interest u/s 234A. Interest u/s 234A is charged when there is a default in furnishing the return of income. This section, inter alia, provides that where the return of income for any assessment year is furnished after the due date or is not furnished, the assessee becomes liable to pay interest at the prescribed rate for every month or a part of month comprised in the period commencing on the date immediately following due date up to the date of furnishing of the return. Adverting to the facts of the instant case it is observed that the assessee furnished its return of income on 21.10.2006 and thereafter revised return was e-filed on 24.10.2006. The assessment year under consideration is 2006-2007. The due date for furnishing the return of income in the case of assessee for such year was 31.10.2006. When admittedly the return has been filed by the assessee before the due date, there could have been no question of charging any interest u/s 234A. We order accordingly.

14. The last ground about the charging of interest of interest u/s 234B is consequential and accordingly disposed off.

15. In the result, the appeal is allowed.