2016 (5) TMI 198 - AT - Income Tax

Non granting of working capital adjustment - Held that - We are not inclined to accept the view canvassed by the authorities that the working capital adjustment cannot be allowed as the assessee is in service industry. Such an adjustment is restricted to inventory, trade receivables and trade payables. If a company carries high trade receivables, it would mean that it is allowing its customers relatively longer period to pay their dues, which will result into higher interest cost and the resultant low net profit. Similarly, by carrying high trade payables, a company benefits from a relatively longer period available to it for paying back the dues to its suppliers, which reduces the interest cost and increases profits. In order to neutralize the differences on account of carrying high or low inventory, trade payables and trade receivables, as the case may be, it becomes eminent to allow working capital adjustment so as to bring the case of the assessee at par with the other functionally comparable entities. We, therefore, agree in principle with the grant of working capital adjustment. To sum up, we set aside the impugned order on the issue of addition towards transfer pricing adjustment and remit the matter to the file of AO/TPO for fresh determination of the ALP of the international transaction of rendering of software services in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings. Grant of deduction u/s 10AA denied - Held that - As discussed in detail about the international transaction of rendering of Software services to its AE, on which transfer pricing adjustment was made. Under such circumstances, the point of view of the AO that the services were rendered by the assessee to its holding company, is wholly incorrect. As regards the other point considered by the AO for denial of deduction about the assessee rendering services to its head office alone, thereby leading to transaction with self, in our considered opinion, is again devoid of merits. Once the law requires an Indian branch of a foreign enterprise to be considered independent of its head office for taxation purpose, the AO cannot make out a case that there is no difference between head office and branch office in India and, hence, no deduction, which is otherwise available, should be given. If the principle of mutuality as invoked by the AO for denial of deduction u/s 10AA is taken to its logical conclusion, then, it would also mean that the assessee did not earn any income at all from its head office again on the principle of mutuality. Obviously, this position is not sustainable. Be that as it may, we are confronted with a situation in which the assessee has rendered software services to its AE and not head office. The other reason of the AO for denial of deduction u/s 10AA is that the assessee did not receive any income at all in foreign currency and what was received was simply the cost incurred plus a certain mark up and the same cannot be considered as sale proceeds of the software sold by the assessee. Again, we are unable to countenance this view of the AO because the assessee brought in India sale proceeds from rendering of services to its AE. The remuneration model has been decided by the parties inter se with a cost plus mark-up, which in the instant case, is 15% of costs. What the assessee has realized in India is nothing, but, sale proceeds of software service provided by it to its foreign AE, which include not only the costs incurred by it in providing software services but also such mark-up. This, in our considered opinion, satisfies the requirement of receipt of foreign currency in India. Since the assessee has satisfied all the requisite conditions for availing of the benefit of deduction u/s 10AA, we are of the considered opinion that the authorities below erred in refusing to grant such deduction. We, therefore, overturn the impugned order on this issue and direct the grant of deduction u/s 10AA of the Act. - Decided in favour of assessee

Summary

Issues Involved:
1. Transfer Pricing Adjustment
2. Inclusion of Comparable Companies
3. Working Capital Adjustment
4. Deduction under Section 10AA of the Income-tax Act, 1961

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment:
The primary issue raised by the assessee concerns the addition of ?3,84,30,722/- by the Assessing Officer (AO) due to transfer pricing adjustments. The assessee, an Indian branch office of Sony Mobile Communications International AB (SMCI), engaged in R&D services, adopted the Transactional Net Margin Method (TNMM) with a Profit Level Indicator (PLI) of Operating profit/Operating cost to demonstrate that its international transactions were at arm’s length. The Transfer Pricing Officer (TPO) initially proposed an adjustment of ?10,68,36,646/- but after the Dispute Resolution Panel (DRP) intervention, the final addition was reduced to ?3.84 crore.

2. Inclusion of Comparable Companies:
The assessee contested the inclusion of three companies—Infosys Ltd., Tata Consultancy Services Ltd. (TCS), and Bodhtree Consulting Ltd.—in the final set of comparables used by the TPO.

i) Infosys Technologies Ltd.:
The TPO included Infosys Ltd. based on its software development services. However, the Tribunal found Infosys Ltd. to be incomparable due to its giantness in terms of risk profile, nature of services, number of employees, and ownership of branded products. The Tribunal, following the Delhi High Court judgment in CIT vs. Agnity India Technologies (P) Ltd., directed the exclusion of Infosys Ltd. from the list of comparables.

ii) TCS Ltd.:
TCS Ltd. was included by the TPO, but the Tribunal found it incomparable due to its revenue from the sale of equipment and software licenses and an extraordinary financial event involving the acquisition of Citigroup Inc.'s interest in TCS e-Serve Ltd. The Tribunal, referencing decisions in similar cases, directed the exclusion of TCS Ltd. from the list of comparables.

iii) Bodhtree Consulting Ltd.:
The TPO included Bodhtree Consulting Ltd., which was contested by the assessee on the grounds of functional dissimilarity and fluctuating profit margins. The Tribunal found Bodhtree Consulting Ltd. functionally similar to the assessee and rejected the argument of different revenue recognition models, thereby upholding its inclusion in the list of comparables.

3. Working Capital Adjustment:
The assessee requested a working capital adjustment, which was initially denied by the TPO on the grounds that it was irrelevant for a service industry. The Tribunal disagreed, stating that working capital adjustments are necessary to neutralize differences in trade receivables, trade payables, and inventory. The Tribunal directed the AO/TPO to compute and allow the working capital adjustment based on annual figures, not daily averages, following the precedent set in Navisite India Pvt. Ltd. Vs. ITO.

4. Deduction under Section 10AA:
The assessee claimed a deduction of ?5,42,10,177/- under Section 10AA, which the AO denied for three reasons: services were rendered to the head office, no foreign currency was brought into India, and the branch office cannot claim such deductions. The Tribunal found that the services were rendered to SEMC, not the head office, and the remuneration model satisfied the requirement of foreign currency receipt. The Tribunal directed the grant of deduction under Section 10AA, overturning the AO's decision.

Conclusion:
The Tribunal set aside the impugned order on the issue of transfer pricing adjustment and remitted the matter to the AO/TPO for fresh determination of the ALP of the international transaction of rendering software services. The Tribunal also directed the exclusion of Infosys Ltd. and TCS Ltd. from the list of comparables while upholding the inclusion of Bodhtree Consulting Ltd. Additionally, the Tribunal mandated the computation and allowance of working capital adjustment and granted the deduction under Section 10AA of the Act. The appeal was partly allowed.