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Judgment
PER M. BALAGANESH, A. M.:
The appeal in ITA No. 3198/Del/2017 for AY 2009-10, arises out of the order of the ld Commissioner of Income Tax (Appeals)-2, Gurgaon [hereinafter referred to as ‘ld. CIT(A)’, in short] dated 01.03.2017 against the order of assessment passed u/s 143(3) of the Income-tax Act, 1961 (hereinafter referred to as ‘the Act’) dated 28.03.2013 by the Assessing Officer, DCIT, Circle-1(1), Gurgaon (hereinafter referred to as ‘ld. AO’). As these are cross appeals, they are heard together and disposed of by this common order for the sake of convenience.
The assessee has raised the following grounds of appeal before us:-
“1.On facts and in law, the Hon'ble Commissioner of Income Tax (Appeals) - 2 ('Hon'ble CIT(A)') erred in confirming the action of the Assistant Commissioner of Income-tax, Circle-1(1) ("Ld. AO') and the Learned Additional Director of Income Tax, Transfer Pricing Officer-II(1) ('Ld. TPO') of rejecting the economic analysis carried out in the TP Documentation maintained by the Appellant. In doing so, the Hon'ble CIT(A) also erred in summarily rejecting several contentions of the Appellant on an adhoc and arbitrary basis.
2.On facts and in law, the Hon'ble CIT(A) erred in confirming the Ld. AO's/Ld. TPO's action of not rejecting Infosys Technologies Limited, Bodhtree Consulting Limited, CAT Technologies Limited and Tata Consultancy Services Limited as comparable companies despite differences in the functions performed, assets employed and risks assumed of these companies vis-à-vis the Appellant. Thereby, the Ld. AO/Ld. TPO erred in violating the provisions of Section 92C(3) of the Income Tax Act, 1962 ('the Act') read with Rule 10B(2) of the Income Tax Rules, 1962 ('the Rules').
3.On facts and in law, the Hon'ble CIT(A) erred in confirming the Ld. AO's/Ld. TPO's action of not rejecting Tata Consultancy Services Limited despite the fact that the company has transactions with its related parties exceeding 25% of its total sales.
4.On facts and in law, the Hon'ble CIT(A) erred in confirming the Ld. AO's/Ld. TPO's action of rejecting CG Vak Software & Exports Limited, Quintegra Solutions Limited and R Systems International Limited as comparable companies selected by the Appellant in its TP documentation. Thereby, the Ld. AO/Ld. TPO erred in violating the provisions of Section 92C(3) of the Act read with Rule 10B(2) of the Rules.
5.On facts and in law, the Hon'ble CIT(A) erred in confirming the Ld. AO's/Ld. TPO's action of computing incorrect Net Cost Plus margins of the comparable companies by incorrectly classifying operating/Non-operating items.
6.On facts and in law, the Hon'ble CIT(A), Ld. AO and Ld. TPO erred in not allowing a risk adjustment under Rule 10B(1)(e) of the Rules for determination of the ALP to account for the difference in the risk profile of the Appellant and of comparable companies. 7. On facts and in law, the Hon'ble CIT(A), Ld. AO and Ld. TPO erred in not allowing the benefit of (+/-) 5% as provided in the proviso to Section 92C(4) of the Act, while determining the arm's length price of the international transactions of the Appellant.
8.On facts and in law, the Hon'ble CIT(A) erred in summarily confirming the Ld. AO's/Ld. TPO's action of use of current year data and thereby, contravening the provisions of section 92C of the Act read with Rule 10B and Rule 10D(4) of the Rules.
9.On facts and in law, the Hon'ble CIT(A) erred in not discussing the ground raised by the Appellant for short allowing the credit of tax deducted at source of INR 13,54,493/- as against the claim of INR 13,62,070/-.”
The revenue has raised the following grounds of appeal before us:-
“1.Ld. CIT(A) has erred in fact and in law in deleting the addition of Rs. 32,12,38,545/- on account of TP adjustment, same was added in final assessment order passed by the Assessing Officer.
2.Ld. CIT(A) has erred in fact and in law by directing the TPO to modify the adjustment of value of international by adopting operating margin of 18.5% in place of 28.74% as per APA agreement, which was executive between CBDT and assessee company. As per this agreement, the assessee has entered into agreement with CBDT on 29th August, 2016 from A.Y. 2010-11 to 2013-14 with roll back years A.Y. 2014-15 and 2015-16. From the agreement it is clear that the A.Y. 2009-10 is not covered under APA agreement.
3.Ld. CIT(A) has erred in fact and in law by granting the relief to the assessee on the ground that the transaction has remained the same and there is no substantial change in FAR of the parties. It is pertinent to mention here that the Ld. CIT(A) misconstrued in deriving a concept which outside the scope of ambit of the APA.
4.That the appellant craves for the permission to add delete or amend grounds of appeal before or at the time of hearing of appeal.”
We have heard the rival submissions and perused the materials available on record. The assessee is a wholly owned Indian subsidiary of Churchill Management Ltd. The assessee provides routine software development and maintenance support services to its Associated Enterprise (AE) and is remunerated on a cost plus basis. During the year under consideration, the assessee had entered into international transactions related to provision of software support services of Rs. 359,34,83,099 and employed Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) with Operating Profit / Operating Cost (OP / OC) as the Profit Level Indicator (PLI). The margin of the assessee was 14.46 %. The assessee selected set of 22 comparable companies in their TP study report for benchmarking the international transaction of provision of software development services. The arithmetic mean margin of the 22 comparables was 14.18% and since the assessee's margin was 14.46%, the transaction carried out was considered to be at arm's length price.
The case of the assessee was referred to the Learned TPO by the Learned AO under section 92CA(1) of the Act. During the transfer pricing assessment proceedings, the Learned TPO accepted TNMM to be the MAM and PLI selected by the assessee for benchmarking the software development services transaction. However, the Learned TPO modified certain filters and the set of final comparables selected by the assessee. Further, the Learned TPO recomputed the assessee's margin at 14.57% while considering foreign exchange gain as non-operating in nature. The Learned TPO selected final set of 16 comparable companies and arrived at the arithmetical mean margin of 28.74% and proposed a transfer pricing adjustment under the software development segment of Rs 44,45,48,184 in the following manner:-
| Particulars | Amount (in INR) |
|---|---|
| Operational cost (A) | 3,137,095,195 |
| Arm’s length markup at NCP margin of 28.74% (B) | 901,601,159 |
| Arm’s Length Price (ALP) (C = A + B) | 4,038,696,354 |
| Price shown in international transaction (D) | 3,594,148,170 |
| Total adjustment (C-D) | 444,548,184 |
Aggrieved by the said order, the assessee filed an appeal before the Learned CITA. The assessee pleaded for allowance of working capital adjustment while working out the margins of the comparable companies selected by the Learned TPO. The assessee also pleaded foreign exchange gain to be considered as part of operating income while working out the margin of the assessee as well as the comparable companies selected by the Learned TPO. The Learned CITA allowed the working capital adjustment to the assessee and also treated the foreign exchange gain as operating income in nature. Aggrieved by this action, the revenue is in appeal before us. The Learned CITA adopted the Advance Pricing Arrangement (APA) margins agreed by the assessee for assessment years 2014-15 aand 2015-16 for provision of software development services and the rollback years for the same would be assessment years 2010-11 to 2013-14. Hence, the entire margins that got settled in the APA would be from assessment years 2010-11 to 2015-16. The Learned CITA observed that after allowing working capital adjustment ; after correcting the margins and after treating foreign exchange fluctuation as operating income, the arm’s length margin of comparable companies would be 18.35%. Further, the margin agreed under the APA dated 29-08-2016 was 18.50%. Accordingly, the Learned CITA adopted APA agreed margins for computing the transfer pricing adjustment for the year under consideration also even though the year under consideration does not fall under the rollback years period.
The Learned TPO vide order giving effect dated 15-05-2017 modified the adjustment by adopting arm's length margin at 18.50% in place of 28.74%. Consequently, the adjustment was reduced to Rs. 12,33,09,639. However, the Learned TPO erred in not treating the foreign exchange fluctuation as operating income in nature while computing the margins of the assessee, which is contrary to the directions of the Learned CITA. The assessee filed rectification application pursuant to which the Learned TPO vide rectification order dated 17-08-2017 accepted foreign exchange fluctuation as operating in nature and accordingly revised the margin of the assessee to 15.34%. The revised transfer pricing adjustment stood determined at Rs. 9,91,05,698 as under:-
| Particulars | Amount (in INR) |
|---|---|
| Operational cost (A) | 3,137,095,195 |
| Arm’s length markup atNCP margin of 18.50% (B) | 580,362,611 |
| Arm’s Length Price (ALP) (C = A + B) | 3,717,457,806 |
| Price shown in international transaction (D) | 3,618,352,108 |
| Total adjustment (C-D) | 99,105,698 |
Since the APA margin of 18.50% was applied by the Learned CITA for the year under consideration; due to inclusion and exclusion of certain comparables ; and since the Learned TPO erred in not allowing the benefit of + / - 5% tolerance range as per the proviso to section 92C(4) of the Act while determining the ALP, the assessee is in appeal before us.
We find that the Learned CITA had granted the benefit of working capital adjustment and had treated foreign exchange fluctuation as operating income in nature, which resulted in the arm's length margin of 20.51%, keeping all the comparables of the learned TPO intact. This margin when compared with the margin of the assessee after considering foreign exchange fluctuation to be part of operating income works out to 15.34%. This falls within the + / - 5% tolerance range provided in the proviso to section 92C(4) of the Act and hence no TP adjustment need to be made thereon. However, the working capital adjustment which was granted by the learned CITA requires to be verified by the learned TPO/AO. Hence we direct the learned TPO/ AO to verify the working capital adjustment of the comparable companies for the purpose of arriving at the arm's length margin. We find that the APA has been entered into only for assessment years 2014-15 and 2015-16 and the rollback years would be only from assessment years 2010-11 to 2013-14. Accordingly for assessment year 2009-10 i.e. for the year under consideration, the APA margin cannot be applied at all. Even if the said APA margin of 18.50% is to be adopted, still we find that assessee margin falls within the benefit of + / - 5% tolerance range as provided in the proviso to section 92C(4) of the Act and even on that count no transfer pricing adjustment would be warranted.
We hold that the foreign exchange fluctuation should be treated only as part of operating income as the said fluctuation is inextricably linked with the main transaction of provision of software development services. The law is now very well settled that once the workings of working capital are provided by the assessee, the adjustment on account of working capital is required to be granted while determining the arm’s length margins. However, as stated earlier, this working capital adjustment workings need to be verified by the Learned TPO for which limited purpose, we are restoring this issue to the file of Learned TPO / AO to verify the said workings. After such verification, if it is found that the working capital adjusted margins of the comparable companies fall within the + / - 5% tolerance range as provided in proviso to section 92C(4) of the Act, then no transfer pricing adjustment is to be made on account of provision of software development services, either with adoption of APA margin or without adopting APA margin.
In view of the aforesaid observations, the grounds raised by the assessee on the inclusion / exclusion of certain comparables need not be gone into as it would be academic in nature. Accordingly, the grounds raised by the revenue in this regard are partly allowed for statistical purposes and the grounds raised by the assessee in this regard are partly allowed.
The Ground No. 9 raised by the assessee is only seeking short credit of TDS which requires factual verification by the Learned AO. Hence we restore this issue to the file of the Learned AO for denovo adjudication in accordance with law.
In the result, the appeal of the assessee is partly allowed and appeal of the revenue is partly allowed for statistical purposes.