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TMI Blog2016 (5) TMI 402X X X X Extracts X X X X X X X X Extracts X X X X ..... im of the assessee in this regard. As far as the provision for bad debts are concerned, the Transfer Pricing Officer has accepted that the same would be part of operating expenses provided the same is incurred every year for at least three years and the manner in which provision is made is consistent. The assessee in reply to the query of the Transfer Pricing Officer on the above aspect has not furnished any details. We are of the view that the assessee should be afforded opportunity to explain its position on the above and the Assessing Officer is directed to consider the same in accordance with law. As far as fringe benefit tax (FBT) is concerned, the same was not considered by the Transfer Pricing Officer as part of operating cost in the case of comparables and therefore the same should also not be considered as part of operating cost of the asses see. We hold, accordingly, and direct the Assessing Officer to compute the operating cost of the assessee Computation of arithmetic mean - Held that:- We find that the detailed submissions as made by the assessee before the Dispute Resolution Panel and before us, were not made before the Transfer Pricing Officer. It was the stand of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a For the Respondent : Padamchand Khincha ORDER N. V. Vasudevan (Judicial Member) 1. These are the appeals filed by the Revenue as well as the assessee against the order dated January 27, 2015, of the Deputy Commissioner of Income-tax, Circle 5(1)(2), Bengaluru, passed under section 143(3) read with section 144C of the Income-tax Act, 1961 ( the Act ), relating to the assessment year 2010-11. 2. The issue that arises for consideration in these appeals are relating to the addition made to the total income consequent to the determination of the arm's length price (ALP) in respect of the international transaction entered into by the assessee with its associated enterprises (AE) under section 92 of the Income-tax Act, 1961 ( the Act ). The addition made consequent to the determination of the arm's length price by the Transfer Pricing Officer and the addition on account of the transfer pricing adjustment was a sum of ₹ 27,88,16,211 which was reduced pursuant to the directions of the Dispute Resolution Panel ( the DRP ) pursuant to the objections filed against the order of the Transfer Pricing Officer ( the TPO ) under section 92CA of the Act to ₹ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee in respect of its business segment of establishing, deploying and maintaining a platform for making mobile payments and facilitating related services for users in India. The break-up of the sum so claimed to be reimbursement were as follows : Nature of expense Amount (Rs.) Cost of imported capital asset 48,52,957 Professional fees 1,25,23,209 Communication expenses 1,70,292 Travel 30,10,220 Salaries 1,79,89,055 Royalty 80 Miscellaneous expenses 3,17,457 Total 3,88,63,270 5. The Transfer Pricing Officer (TPO) in his order under section 92CA of the Act treated the payment of ₹ 3,88,63,270 also as an international transaction carried out by the assessee with its associated enterprise. The following were the relevant observations of the Transfer Pricing Officer in this regard : The taxpayer did not appear to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... marketing the product of its associated enterprise without any compensation. Not only is it not getting compensated, it is also bearing the salary cost and other costs of its top employees without being reimbursed in the guise of secondment. The Transfer Pricing Officer, therefore, concludes that the taxpayer has reimbursed ₹ 3,88,63,270, the expenses which are not attributable to its business. The reimbursement is an international transaction and, hence, the taxpayer's submission that this has little or no connection with the associated enterprise, and, hence, no further study has been carried out is not accepted and the Transfer Pricing Officer proceeds with the determination of the international transactions conducted by the taxpayer by aggregating them. 6. The assessee adopted the transactional net margin method (TNMM) as the most appropriate method for determining the arm's length price. Operating profits to cost was adopted as the profit level indicator ( the PLI ). The segmental profit and loss of the assessee was shown as follows : Segmental profit and loss of the appellant Particulars Software segment (Rs.) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... % Adjusted mean margin after working capital adjustment 20.73% Operating cost (A) 39,24,10,489 Arm s length price-120.73% of operating cost (B) 47,37,57,183 Total operating revenue (C) 19,49,40,972 Shortfall being adjustment under section 92CA (B-C) 27,88,16,211 11. As can be seen from the aforesaid computation of the arm's length price by the Transfer Pricing Officer, he has taken the operating cost at ₹ 39,24,10,489. The operating expenses claimed in the software development segment by the assessee was ₹ 17,40,41,219. The operating expenses claimed in the mobile payment platform activity was ₹ 21,83,69,270. Since the Transfer Pricing Officer has already taken the view that the determination of the arm's length price has to be done by aggregating both the activities of development and delivery of domain specific software for Obapay Inc., U.S.A, and establishing, deploying and maintaining a platform for making mobile payments and facilitating related se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sistent Systems Ltd., Mindtree Ltd., L T Infotech and Infosys Ltd. as comparables. (ii) The learned Dispute Resolution Panel member erred in excluding uncontrolled comparables having turnover more than ₹ 200 crores in the absence of turnover criterion prescribed in rule 10B of the Income-tax Rules, 1962 and also there being no correlation between turnover and profit margin. 2. Foreign exchange loss/gain The hon'ble Dispute Resolution Panel has erred in directing to include forex gain/loss as operating in nature without ascertaining the nexus with the business activity of the taxpayer. 3. Risk adjustment (i) In so far as the issue of working capital adjustment is concerned, whether the learned Dispute Resolution Panel is justified in holding that capital adjustment has not been provided as it has negative impact. This is because working capital adjustment is given to increase comparability on the uncontrolled comparable with tested party and not to provide benefit to the assessee. Incidentally, the adjustment may or may not lead to a benefit for the assessee. In the instant case, wrong capital adjustment made by the Transfer Pricing Officer. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for comparing an uncontrolled transaction with an international transaction that there should not be any difference between the transactions compared or the enterprises entering into such transaction, which are likely to materially affect the price or cost charged or paid or profit arising from such transaction in the open market. Further, it is also necessary to see that wherever there are some differences such differences should be capable of reasonable accurate adjustment in monetary terms to eliminate the effect of such differences. It was his submission that size was an important facet of the comparability exercise. It was submitted that significant differences in size of the companies would impact comparability. In this regard our attention was drawn to the decision of the Special Bench of the Income-tax Appellate Tribunal, Chandigarh Bench, in the case of Deputy CIT v. Quark Systems Pvt. Ltd. [2010] 4 ITR (Trib) 606 (Chandigarh) [SB] ; [2010] 38 SOT 207, wherein the Special Bench had laid down that it is improper to proceed on the basis of lower limit of ₹ 1 crore tur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... et's analysis, the turnover of ₹ 1 crore to ₹ 200 crores was held to be proper. The following relevant observations were brought to our notice : '9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the Transfer Pricing Officer himself has rejected the companies which are making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various Benches of the Tribunal, when companies which are loss making are excluded from comparables, then the super profi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Section 92A defines what is an associated enterprise. In the present case, there is no dispute that the transaction between the assessee and its associated enterprise was an international transaction attracting the provisions of section 92 of the Act. Section 92C provides the manner of computation of arm's length price in an international transaction and it provides : '92C.(1) The arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :- (a) comparable uncontrolled price method ; (b) resale price method ; (c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base ; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base ; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market ; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii) ; (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ning the arm's length price of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the Transfer Pricing Officer. 20. In this regard we find that the provisions of law pointed out by the learned counsel for the assessee as well as the decisions referred to by the learned counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing comparables. The assessee's turnover is ₹ 47,46,66,638. It would, therefore, fall within the category of companies in the range of turn over between ₹ 1 crore and ₹ 200 crores (as laid down in the case of Genisys Integrating Systems (India) P. Ltd. v. Deputy CIT (I.T.A. No. 1231/Bang/2010) [2012] 15 ITR (Trib) 475 (Bang). Thus, compa nies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the learned counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the Transfer Pricing Officer, viz., ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the assessee in transfer pricing analysis. Therefore, as rightly submitted by learned counsel for the assessee the observations of the hon'ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdictional High Court, even though the said decision is of a non-jurisdictional High Court. We, however, find that the hon'ble Bombay High Court in the case of CIT v. Pentair Water India Pvt. Ltd. [2016] 381 ITR 216 (Bom) ; (Tax Appeal No. 18 of 2015 judgment dated September 16, 2015) has taken the view that turnover is a relevant criteria for choosing companies as comparable companies in determination of arm's length price in transfer pricing cases. In doing so the hon'ble Bombay High Court has followed the decision of the hon'ble Delhi High Court in the case of Agnity India Technologies P. Ltd. (supra). There is no decision of the jurisdictional High Court on this issue. In the circumstance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Pricing Officer as part of operating cost in the case of comparables and therefore the same should also not be considered as part of operating cost of the asses see. We hold, accordingly, and direct the Assessing Officer to compute the operating cost of the assessee. 20. In view of the aforesaid decision, we do not find any merit in ground No. 2 raised by the Revenue and the same is dismissed as such. 21. As far as ground No. 3 raised by the Revenue is concerned, the same reads as follows : (i) In so far as the issue of working capital adjustment is concerned, whether the learned Dispute Resolution Panel is justified in holding that working capital adjustment has not been provided as it has negative impact. This is because working capital adjustment is given to increase comparability on the uncontrolled comparables with tested party and not to provide benefit to the assessee. Incidentally, the adjustment may or may not lead to a benefit for the assessee. In the instant case wrong capital adjustment made by the Transfer Pricing Officer. (ii) Whether the learned Dispute Resolution Panel is justified in directing the Transfer Pricing Officer to grant risk adjustment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of this company and adopt a threshold limit of 15 per cent. of the total revenue attributable to related party transaction as ground for rejecting comparable companies. Consequently it is held that comparable companies having related party transaction up to 15 per cent. of the total revenues can be excluded. 25. As far as the exclusion of M/s. Kals Information Systems Ltd. is concerned, we find that for the assessment year 2010-11, in the case of a software development service provider, the Income-tax Appellate Tribunal, Hyderabad Bench, in the case of Pegasystems Worldwide India Pvt. Ltd. v. Asst. CIT (TS 488-ITAT-2015 (Hyd)) has taken the following view on adopting this company as a comparable company in software development segment : Kals Information Systems Ltd : 10. The assessee objected to the above company before the Transfer Pricing Officer stating that the abovesaid company is functionally different as it is engaged in the development of software and software products. It has inventories equivalent to 27 per cent. of the revenue. The Transfer Pricing Officer however rejected the assessee's contentions stating that company classified itself as pure software ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt is engaged in the marketing of the products of the associated enterprise ; and (d) Adopting entity wide operating cost and operating revenue of the appellant without giving an opportunity of hearing to the appellant. 27. A ground similar to ground No. 9 was raised by the assessee before the Dispute Resolution Panel but the same was not adjudicated by the Dispute Resolution Panel. The submission of learned counsel for the assessee before us which was also the submission before the Dispute Resolution Panel was that during the year under consideration, the assessee operated in two segments, viz., software development segment and mobile payment platform segment. Under the software development segment, the assessee rendered services to its associated enterprise. Under the mobile payment platform segment, the assessee rendered services to non-associated enterprise. However, expenses which were reimbursed to the associated enterprise were incurred in connection with the mobile payment platform segment of the assessee. The reimbursements were on back to back basis and, hence, were considered at arm's length. The mobile payment platform segment had no other connection with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . It is only such flight of profits that needs correction. It was contended that the Transfer Pricing Officer concluded that the reimbursements of ₹ 3,88,63,270 is not attributable to assessee's business and proceeded with the determination of arm's length price of the international transactions conducted by taxpayer by aggregating both the segments. The relevant extract from the transfer pricing order is already given in the earlier part of this order (vide paragraph 5 of this order) and is not being repeated. It is the stand of the assessee that the above queries were raised for the first time in the final order. These queries were not raised during the proceedings under section 92CA. The action of the Transfer Pricing Officer is, therefore, bad in law. 30. It was submitted that with respect to above queries of the Transfer Pricing Officer, the assessee had entered into an agreement with the associated enterprise to perform software development services for associated enterprise. These services involve requirement analysis, coding and testing. Even in the transfer pricing documentation, on page 14 under the head functional analysis it is clearly stated that onl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... correct. The assessee submitted that associated enterprise renders mobile payment platform services in the U.S.A. and Kenya whereas the assessee renders such services in India. The assessee submitted that in December, 2008, it signed an agreement with Yes Bank Ltd. to provide mobile payment services in India and agreed for revenue structure that would be effective post launch. The Revenue comprised of integration fee, set-up fee and transaction based fees, the assessee had projection of getting substantial revenue in future as this was new product and had growth prospects. In the financial year 2008-09, the assessee received ₹ 2,00,000 as integration fees from Yes Bank. A copy of the Yes Bank agreement and commercials was also filed before the Dispute Resolution Panel. 33. As part of above agreement, the assessee hired new employees in departments like treasury, operation., IT operation, BD, marketing, etc., to manage the above non-associated enterprise business. The associated enterprise also seconded two employees to India to manage legal and marketing activity for India operations. A copy of secondment agreement was filed before the Dispute Resolution Panel. It was poin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nue from the mobile payment platform segment. The year under consideration was first year of operation for mobile payment platform segment. The product itself was launched in February 2010. Therefore, the revenue earned during the year under consideration was not much. The assessee was carrying on the business activity independently for the third parties. These activities have generated revenues in the subsequent years. Therefore, the Transfer Pricing Officer's contention that the assessee is having huge costs against the revenue earned in mobile payment platform segment because it is bearing the marketing burden of the associated enterprise is incorrect. The learned Transfer Pricing Officer has not appreciated the business and commercial realities and has unilaterally rejected the segmental profit and loss account. 37. Learned counsel also filed before us a copy of the Transfer Pricing Officer's order for the subsequent assessment year, i.e., 2011-12 wherein the Transfer Pricing Officer has accepted the stand of the assessee and has considered the mobile payment platform services segment as independent of segment of rendering software development services to the associa ..... X X X X Extracts X X X X X X X X Extracts X X X X
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