The Hyderabad Bench of the Income-Tax Appellate Tribunal [the Tribunal] has in the case of M/S Convergys Information Management (India) (F) Ltd. Vs. DCIT [ITA No. 299/Hl/2009] , held that in a cost plus arrangement expenses incurred post the date of entering into agreement has to be marked up, as no customer would pay mark up before entering into agreement.
Facts of the Case
• Convergys Information Management (India) (P) Ltd. (Convergys/ Taxpayer), a 100 percent subsidiary of Convergys Information Management Inc. USA (Convergys USA/AE), is engaged in providing software development and product support service to its AE.
• The Taxpayer entered into a R&D agreement with its AE on 1 January 2004 which provided remuneration for services at a mark¬up of 10 percent on the costs incurred.
• The Taxpayer raised invoices on the AE for the period 15 March 2004 to 31 March 2004 being the period of commercial operation for the FY 2003-04.
• Taxpayer filed the return of Income for FY 2003-04 declaring a loss of INR 15,623,690.
Transfer Pricing Officer (TPO’s) allegations
• The TPO alleged that the expenses incurred by Taxpayer prior to commencement of commercial operations are required to be paid by the AE along with the mark-up. Considering the fact that the Taxpayer had incurred such expenses towards hiring technically skilled manpower, administrative support staff prior to the date of entering into agreement was incurred towards rendering R&D services.
• Accordingly, TPO computed expenditure incurred for the period July 2003 to 15 March 2004 at INR 38,902,467. After applying a 10 percent mark-up, the TPO made a Transfer Pricing adjustment of INR 3,890,247.
• On appeal, the CIT (A) held that as the agreement for services was entered on 1 January 2004, all the expenses incurred during 1 January 2004 and 14 March 2004 is to be treated as expenses incurred for the R&D services and a markup should be charged on these costs.
Issues before the Tribunal
• Against the order of the CIT (A), the Revenue raised the issue whether the date of execution of inter company agreement can be a criterion to ascertain what all costs are liable to be charged with a mark-up.
• The Tribunal agreed to the CIT (A) view that the expenses incurred post agreement is to be considered for the mark-up at 10 percent since no customer would pay mark-up before entering into the service agreement.
• The Tribunal bifurcated the expenses incurred up to 15 March 2004 as follows:
? Incurred up to 31 December 2003 – prior to commencement of commercial operations – INR 13,484,885.
? Incurred between 1 January 2004 and 31 March 2004 – post commencement of commercial operations – INR 25,417,576.
• Accordingly, the Tribunal upheld the decision of the CIT (A) of considering 10 percent mark-up on the expenditure incurred from 1 January 2004 to 14 March 2004.
• However, the Tribunal also noted that the Revenue had not brought any material on record to show that the Taxpayer had incurred any expenditure before entering into Inter company service agreement, which may be considered for the purposes of provision of services.
Our Comments/ Key observations
• Under a cost plus arrangement, typically all costs incurred towards rendering of services are to be charged with a mark-up and this would be typically be post the commencement of commercial operations.
• The ascertainment of date of commencement of commercial operations is by and large an exercise driven by fact and would have to be substantiated with the underlying material/ details.