Appeal details
Counselvise Citation
[2022] 102 COUNSELVISE.COM (IT) 9255 (ITAT-BANGALORE)
Assessee PAN
Bench
Appeal Number
Duration Of Justice
3 month(s) 11 day(s)
Appellant
Respondent
Appeal Type
Income Tax (Transfer Pricing) Appeal
Pronouncement Date
04-12-2022
Appeal Filed By
Assessee
Order Result
PartlyAllowed
Bench Allotted
C
Next Hearing Date
28-11-2022
Assessment Year
2018-2019
Appeal Filed On
23-08-2022
Judgement Text
IN THE INCOME TAX APPELLATE TRIBUNAL “C” BENCH : BANGALORE BEFORE SHRI GEORGE GEORGE K., JUDICIAL MEMBER AND Ms. PADMAVATHY S, ACCOUNTANT MEMBER IT(TP)A No.731/Bang/2022 Assessment year : 2018-19 Huawei Technologies India Private Ltd., Sy.No.37, 46, 45/3, 45/4, ETC., KNO 1540, Divyasree Technopark, Kundalahalli Village, Bengaluru – 560 037. PAN: AAACH 8599L Vs. The Assistant Commissioner of Income Tax, Circle 3(1)(1), Bengaluru. APPELLANT RESPONDENT Appellant by : Shri Chavali Narayan, CA Respondent by : Smt. Vandana Ramachandan, CIT(TP)(1)(DR)(ITAT), Bengaluru. Date of hearing : 29.11.2022 Date of Pronouncement : 05.12.2022 O R D E R Per Padmavathy S., Accountant Member This appeal is against the final assessment order passed by the Assistant Commissioner of Income Tax, Circle 3(1)(1), Bangalore dated 29.6.2022 passed u/s. 143(3) r.w.s. 144C(13) of the Income-tax Act, 1961 [the Act] for the assessment year 2018-19. IT(TP)A No.731/Bang/2022 Page 2 of 32 2. The assessee is subsidiary of Huawei Tech Investments Co. Ltd., Hong Kong, which in turn is a subsidiary of Huawei Investments & Holding Co. Ltd., China. The assessee is engaged in the business of software development [SWD] services and Information Technology enabled Services [ITeS]. For the AY 2018-19, the assessee filed the return of income on 30.11.2018 disclosing a total income of Rs.85,57,77,213. The case was selected for scrutiny under CASS and notice u/s. 143(2) was duly served on the assessee. Since the assessee had international transactions, the case was referred to the TPO for determination of arm’s length price (ALP) with respect to the international transaction the assessee had with its AE. The TPO ignored the segmental financials of the assessee and considered the entire operations as SWD services. Accordingly, the AO arrived at TP adjustment of Rs.82,58,40,327 in the SWD services segment. The TPO further calculated the notional interest on delayed receivables at LIBOR + 450 basis points to arrive at an adjustment of Rs.6,89,46,372. The AO passed the draft assessment based on the order passed by the TPO. Aggrieved the assessee filed its objections before the DRP. 3. The DRP gave partial relief to the assessee whereby the TP adjustment in SWD segment was reduced to Rs.55,69,83,890. With respect to interest on receivables, the DRP directed the TPO to use the short term deposit rate of SBI to recomputed the adjustment, according to which the interest was reworked at Rs.6,49,06,385. The assessee is in appeal before the Tribunal against the final assessment order passed by the AO. IT(TP)A No.731/Bang/2022 Page 3 of 32 4. It is not in dispute between the assessee and the TPO that the Transaction Net Margin Method is the most appropriate method for determination of ALP and the Profit Level Indicator (PLI) to be adopted for comparison of the assessee’s profits with that of the comparable companies was Operating Profit/Operating Cost (OP/OC). In the TP study, the assessee has worked out the margins as per Table below:- Particulars TP Study TPO Order SWD Segment ITeS Segment Total Total (considered as SWD Segment) Operating Revenue (OR) 4,937,139,539 3,982,080,444 8,919,219,983 8,919,219,983 Operating Cost (OC) 4,365,118,021 3,519,234,982 7,884,353,003 7,884,353,002 Operating Profit (OP=OR-OC) 572,021,518 462,845,462 1,034,866,981 1,034,866,981 Operating/Net margin (OP/OC) 13.10% 13.15% 13.13% 13.13% 5. The assessee chose the following comparables and accordingly concluded that the margins of 13.10% with respect to SWD services is within arm’s length:- Sl. No. Name of comparable company Weighted average unadjusted margin (OP/OC)(%) 1 CG-VAK Software & Exports Limited 8.19% 2 E-Zest Solutions Limited 9.29% 3 Infobeans Technologies Limited 25.85% 4 Isummation Technologies Private Limited 3.44% 5 Maveric Systems Limited 0.19% 6 Rheal Software Limited -4.26% 7 Sagarsoft (India) Limited 5.89% 8 Tata Elxsi Limited 27.19% IT(TP)A No.731/Bang/2022 Page 4 of 32 Sl. No. Name of comparable company Weighted average unadjusted margin (OP/OC)(%) 9 Yudiz Solutions Private Limited 4.18% 10 Bhilwara Infotechnology Limited (segmental) 26.45% 11 Mukand Engineers Limited (segmental) 21.18% 12 R Systems International Limited (segmental) 24.17% 13 Sasken Technologies Limited (segmental) 6.52% 35th Percentile 5.89% Median 8.19% 65th Percentile 21.18% 6. The TPO however considered the Operating Revenue and the Operating Cost at entity level and took the margin of the assessee at 13.13% (refer Total column in the above table). The TPO conducted a fresh search for comparables and the final set of comparables as arrived at by the TPO is as given below:- Sl. No. Name of comparable company Weighted average unadjusted margin (OP/OC)(%) 1 Infomile Technologies Ltd 9.89% 2 Harbinger Systems Private Limited 11.65% 3 Exilant Technologies Private Limited 17.17% 4 Tech Mahindra Limited 18.57% 5 Larsen & Toubro Infotech Limited 18.94% 6 Great Software Laboratory Private Limited 19.73% 7 Elveego Circuits Private Limited 20.19% 8 Black Pepper Technologies Private Limited 20.62% 9 Mindtree Limited 21.21% 10 Aptus Software Labs Private Limited 22.70% 11 Acewin Agriteck Limited 24.51% 12 Persistent Systems Limited 24.98% 13 Wipro Limited 26.83% 14 Tata Elxsi Limited 28.24% IT(TP)A No.731/Bang/2022 Page 5 of 32 Sl. No. Name of comparable company Weighted average unadjusted margin (OP/OC)(%) 15 Infobeans Technologies Limited 28.52% 16 Nihilent Limited 30.17% 17 Thirdware Solution Limited 30.94% 18 Threesixty Logica Testing Services Private Limited 36.58% 19 Infosys Limited 37.38% 20 Cybage Software Private Limited 56.81% 35th Percentile 20.19% Median 23.60% 65th Percentile 28.83% 7. Accordingly, the TPO arrived at the TP adjustment as per working below:- Particulars Amount (INR) Arm’s length median margin as per comparable set 23.60% Operating Cost (OC) 7,88,43,53,002 Arm’s Length Price (‘ALP’) = 123.60% of OC 9,74,50,60,310 Price Received 8,91,92,19,983 Short fall being adjustment u/s. 92CA 82,58,40,327 8. The DRP accepted the assessee’s contention for inclusion of certain comparables and accordingly the revised arm’s length margin as per DRP directions was arrived at 20.19%. The TPO in the order giving effect revised the TP adjustment to Rs.55,69,83,890. 9. The assessee raised 7 grounds and several sub-grounds contending the TP adjustment. Ground nos. 1 to 3 are general and Ground no.6 & 7 are consequential. These grounds therefore do not warrant separate adjudication. Ground no.4 is with regard to the TP IT(TP)A No.731/Bang/2022 Page 6 of 32 adjustment in SWD segment. Ground 5 pertains to levy of interest on delayed receivables. 10. During the course of hearing, the ld. AR submitted that of the various sub grounds of ground 4 if the exclusion of 2 of the comparables viz., Infosys Ltd. (Ground No.4.6(xv) and L&T Infotech Ltd (Ground No.4.6(iii). are adjudicated in favour of the assessee, then the rest of the grounds will not be pressed with regard to TP adjustment in the SWD segment. So we will adjudicate first the exclusion of Infosys ltd and L&T Infotech Ltd. Infosys Ltd. - (Ground No.4.6(xv) 11. The ld. AR submitted that this company is to be excluded from the list of comparables on the following grounds:- 1. Functionally different The company provides business consulting, technology, outsourcing, next generation services and software. The company also provides products business platforms and solutions to accelerate intellectual property-led innovation. Also, the company’s new service offerings cover area like digital, big data and analytics, cloud, data and mainframe modernization, cyber security, IoT engineering services and API and micro services (which have been classified as KPO services under the Act). (Page 1993 of Paperbook II - Annual report - Part 1). Accordingly, such high-end services cannot be compared to the routine software development services rendered by the Appellant. 2. Insufficient segmental information The varied nature of services rendered by Infosys has been clubbed and mentioned as IT services. The Segmental information is required due to diversified services rendered by Infosys and clubbed as IT services. The IT(TP)A No.731/Bang/2022 Page 7 of 32 overall nature of services which is varied cannot be compared with the routine software development services rendered by the Appellant. (Page 2032 of Paperbook II - Annual report - Part 1) 3. Brand value The brand name empowers better negotiation position for Infosys and accordingly helps in optimisation of cost and margins. The Appellant renders services exclusively to its AE and therefore the impact of the brand name of the parent (if any) will not have an impact on the sales of the Appellant as entire sales are made to the AE on a cost-plus basis. However, the operations/ sales undertaken by Infosys are impacted hugely by its brand name. The same has also been recognised by Infosys: “Infosys” brand is one of the most important intangible assets owned by the company. (Page 1882 of Paperbook II - Annual report - Part 1). 4. Engaged in research and development activities Expenditure in R&D will lead to increased productivity, modernization, operational synergies etc. (Page 1880, 1938 of Paperbook II - Annual report - Part 1) 5. Size and scale of operations The turnover of Infosys is more than 50 times of that of the Appellant. Accordingly, the size and scale of operations of Infosys are much significant than that of the Appellant. Thus, Infosys cannot be considered as comparable to the Appellant. Large scale of operations, high turnover. (Page 1875, 1872 of Paperbook II - Annual report - Part 1) 6. Market leader Infosys is a market leader and has won accolades in almost every industry in which it provides its services. (Page 1882 of Paperbook II - Annual report - Part 1) IT(TP)A No.731/Bang/2022 Page 8 of 32 7. Full-fledged risk bearing entity Infosys is a full-fledged risk bearing entity and cannot be considered as comparable for the Appellant, who is a captive service provider. (Page 1939 of Paperbook II - Annual report - Part 1) 8. Huge selling and marketing expenditure Infosys has made significant expenditure in relation to sales and marketing. However, the Appellant is a captive service provider who does not undertake any selling and marketing expenses. (Page 1933 of Paperbook II - Annual report - Part 1) 9. Significant foreign expenditure It has incurred significant foreign expenditure which works out to 68.09%, 49.06%, and 49.51% of total expenditure incurred for FY 2017- 18, FY 2016-17 and FY 2015-16 respectively. (Page 1920 of Paperbook II - Annual report - Part 1) 10. Mergers and acquisitions Board of Directors have approved to acquire WongDoody Holding Company Inc, a US based creative and consumer insights agency. (Page 1879 of Paperbook II - Annual report - Part 1) 12. The ld AR also submitted that the coordinate bench in assessee’s own case has been consistently holding Infosys Ltd., should be excluded from the comparables in AY 2010-11, 2012-13 and in 2014- 15. The ld AR also submitted that there has not been any change in the operations of both the assessee and Infosys Ltd., and therefore the exclusion is covered by the decisions of the coordinate bench for the year under consideration. IT(TP)A No.731/Bang/2022 Page 9 of 32 13. The ld. DR submitted that as regards the reliance of the appellant on the order of TPO for AY 2014-15, each year needs to be looked into separately and the comparables need to be selected after examining the issue of filters applied and the functionality of the company based on the financials or the other data available with the TPO. So this argument was rejected. 14. The ld DR submitted that the platforms/products and solutions of the company are not off the shelf products as argued by the assessee. The company had revenue from software services of RS.61,910 crores and that from software products was only Rs.31 cores. As such, the product revenue constituted a meagre 0.05% of total operating revenue. It passed the filter of ‘Revenue from Core services greater than 75% and functionally comparable to assessee. The meagre revenue from software products does not impact the margins of company from software development and segmental data is not required to be considered. 15. With regard to the contention that Infosys Ltd has a huge brand value, the ld DR submitted that the growth in revenue was on account of various business initiatives taken to accelerate the growth and not because of just the brand value. Further the ld DR submitted that on perusal of the annual report page 41, 98.5% of the revenue is from repeat business from the top clients and the brand building spends is meagre 0.39% of the total revenue. To counter the argument that Infosys Ltd has huge selling and marketing expenditure the Ld DR IT(TP)A No.731/Bang/2022 Page 10 of 32 submitted that expenditure as a percentage of total revenue works out Rs.4.46% only and therefore will have no effect on profit margin of the company. 16. On the contention of the assessee that Infosys Ltd. has a huge R&D expenditure, the ld. DR submitted that company has incurred R&D expenditure of Rs.374 crore which is a meagre 0.6% of its total operating revenue. From the Note 1.1 of the Annual Report at page 80, the development of intangibles and its impact on the revenue and profitability can be inferred as meagre. The assessee has failed to establish that differences, if any, on account of R&D, brand and intangibles have material effect on the margin of the said company. Further the assessee itself considered such companies as comparable which had R&D expenditure to sales ratio less than 3%. The reason given by assessee to apply such a filter was to select companies which do not own intangibles and are pure service providers. Thus this company cannot be rejected as a comparable because of R&D or intangibles.. 17. We heard the rival submissions and perused the material on record. We notice that the issue of exclusion of Infosys Ltd. has been considered by the coordinate Bench in assessee’s own case for the AY 2014-15 (ITA No.339/Bang/2019 dated 22.7.2021). We also notice that the assessee and the revenue had made similar submissions as above in AY 2014-15 also. The relevant extract of the decision of the Hon’ble Tribunal is given below – IT(TP)A No.731/Bang/2022 Page 11 of 32 “25. We have heard both the parties and perused the material on record. The issue of comparability of Infosys Ltd. came up for consideration before the Tribunal in the case of Microsoft Research Lab India (P.) Ltd. v. Dy. CIT [IT (TP) Appeal No. 3131 (Bang.) of 2018, dated 5-2-2020] the Tribunal excluded this company from the comparables holding as follows:— '(i) Infosys Limited : The turnover being Rs. 44,341 Crores and it is functionally not comparable as the turnover is more than 500 times of the assessee turnover of Rs. 84.09 Crores. The company is engaged in developing software products Pinnacle and was rejected by the DRP in assessee own case for the Assessment Year 2011-12. Further has high brand value and incurred huge expenditure in R & D with exceptional areas of operation and earned super natural profits and is engaged in diversified activities. We found that the comparable was excluded by the co-ordinate Bench decision of the Tribunal in the case of M/s. Marwell IndiaP. Ltd. v. DCIT in IT(TP)A No. 3082/Bang/2018 for the Assessment Year 2014- 15 Dt.23-10- 2019 at page 20 para 4.2 (b) which read as under: "4.2 (b). Infosys Ltd: It has been submitted by Ld. Counsel that this comparable has been included by Ld.TPO in finalist. It has been submitted that this comparable is not comparable due to high turnover and intangibles owned by this company. It has been submitted that Hon'ble Delhi High Court in case of CIT v. Agnity IndiaTechnologies reported in (2013) 36 Taxmann.com 289 has held this company to be bad comparable to a company which is captive service provider under the segment. It has been submitted that this company provides end to end business solutions that leverage technology to enable clients to enhance business performance. Ld. CIT DR placed reliance upon the order passed by authorities below. We have perused submissions advanced by both sides in the light of the records placed before us. IT(TP)A No.731/Bang/2022 Page 12 of 32 Admittedly this company owns huge intangibles and is an entrepreneur in the field of software service development service segment. At page-1100 of paper book, Vol. III it is observed that this company primarily derives revenue from software development and related services and from licensing of products. In segmental details at page-1110, it is observed that revenue generated from software services is Rs. 4253/- Crores which is much high and hence cannot be compared to a captive service provider like that of assessee. Respectfully following decision of orderable Delhi High Court (supra) we direct Ld. AO/TPO to exclude this comparable from the final list." We considering the facts, functional profile and the decision of the co-ordinate Bench, direct the TPO to exclude the comparable from the final list of comparables for determination of ALP.' 26. Since the facts of the case are similar relating to SWD segment to the case of Microsoft Research Lab India (P.) Ltd. (supra), we direct exclusion of Infosys Ltd. from the comparables.” 18. On perusal of the annual report of the Infosys ltd as on 31.03.2018, it is noticed that the revenue of the company from software development services is Rs.61,910 (page 1875 of paper book). Further that functional profile of the company as in the annual report (page 1993 of paper book II)) states that the company is rendering varied services under the umbrella of SWD services. It is also noticed that the company is having huge intangible assets being the brand value of the company. The assessee on the other hand is a captive service provider with no intangible asset as per the financials. Given the volume of revenue generated, different kinds of services within the SWD segment, brand value etc., of Infosys Ltd, it cannot be IT(TP)A No.731/Bang/2022 Page 13 of 32 compared with a captive service provider like assessee. Therefore the grounds on which the company was excluded in earlier years are applicable to the year under consideration also and therefore respectfully following the decision of the coordinate bench we direct the AO/TPO to exclude Infosys Ltd as a comparable. L&T Infotech- (Ground No.4.6(iii) 19. The ld. AR submitted that L&T Infotech was excludible from the comparables list on the following counts:- 1. Functionally dissimilar L&T Infotech offers extensive range of IT services like application development, maintenance and outsourcing, enterprise solutions, infrastructure management services, testing, digital solutions and platform-based solutions to the clients in diverse industries such as Banking, Financial services, Insurance, Media & Entertainment, Travel, Logistics and Healthcare. (Pg 3005 of Paperbook II - Annual report - Part 3). As evident for above, varied nature of services have been included and termed as ‘IT services’ which are not comparable to the routine software development services rendered by the Appellant. 2. Cost of Bought out items for resale The company is engaged in trading of goods/ products also and the same is apparent from its annual report. (Pg 3024 of Paperbook II - Annual report - Part 3) 3. Insufficient segmental information While L&T Infotech is engaged in providing host of services and also in sale of products (as discussed above), there is no segmental break-up for such services/ products and accordingly comparability cannot be IT(TP)A No.731/Bang/2022 Page 14 of 32 assessed relying on the overall services rendered by L&T Infotech. (Pg 3041 of Paperbook II - Annual report - Part 3) 4. Brand value L&T Infotech deals with third party customers enjoying market dominion and an enhanced brand image would allow it to command or negotiate better price deals with its customers thereby aiding in securing improved margins for the company. (Pg 2956 of Paperbook II - Annual report - Part 3) 5. Acquisitions and amalgamations L&T Infotech has undertaken several acquisitions, the synergy from which will impact the profitability of L&T Infotech. During the year, the scheme of Amalgamation for “AugmentIQ Data Sciences Private Limited” was sanctioned by the NCLT. Thus, the synergies obtained through this acquisition would have an impact on the overall margin of the company for the FY 2017-18. The company was amalgamated with L&T with effect from 01 April 2017 and entire assets were transferred with effect from 01 April 2017 (Pg 2981 of Paperbook II - Annual report - Part 3) 6. Investment in technology absorption and owns significant intangibles L&T Infotech has made great investment in technology absorption. It operates Centers of Excellence in emerging technologies such as Big Data, Analytics, Internet of Things, Cloud, User Experience. (Pg 2991, 3000 of Paperbook II - Annual report - Part 3) Any analytics’ related activities have been classified under KPO services under the Indian safe harbor rules. Hence, it can be said that the company provides high-end services which are classified as KPO under rule 10TA of safe harbor rules and are not comparable to the routine SWD services segment of the Appellant. 7. Engaged in research and development activities IT(TP)A No.731/Bang/2022 Page 15 of 32 Expenditure in R&D will lead to increased productivity, modernization, operational synergies etc., which in turn has an impact on revenue/ for achieving cost efficient structure and on the profit margins. Accordingly, it is evident that the same cannot be comparable to Appellant which is a low risk service provider to its AEs. (Pg 2992 of Paperbook II - Annual report - Part 3) 8. Market leader L&T Infotech is a market leader and has won accolades in almost every industry in which it provides its services. (Pg 2928 of Paperbook II - Annual report - Part 3) 9. Significant foreign expenditure L&T Infotech has incurred significant foreign expenditure which works out to 54.04%, 53.32% and 55.02% of total expenditure incurred for FY 2017-18, FY 2016-17 and FY 2015-16 respectively. Considering this, it is clearly evident that L&T Infotech has significant onsite activities outside India. Given that the Appellant predominantly carries out its operations within India and does not incur any significant foreign expenses, it is evident that L&T follows a different operating model (which also impacts the profitability) and hence, could not be compared with the Appellant. (Pg 2992 of Paperbook II - Annual report - Part 3) 20. The ld. AR relied on the following cases in this regard:- • Appellant's own case [ITA No.339/Bang/2019] and [IT(TP)A No.370/Bang/2019] - AY 2014-15 - Para 35, Page no. 3945 - Paperbook III – Caselaw • Appellant's own case [IT(TP)A No.1939/Bang/2017] - AY 2012- 13 - Para 30, Page no. 4016 - Paperbook III – Caselaw • Appellant's own case [IT(TP)A No.1940/Bang/2017] and [ITA Nos.2140, 2051/Bang/2017] - AY 2010-11 - Para 31, Page no. 3993 - Paperbook III - Caselaw IT(TP)A No.731/Bang/2022 Page 16 of 32 • M/s. Yahoo Software Development India Pvt. Ltd. [IT(TP)A No. 178/Bang/2022] - AY 2017-18 - Para 5, Page no. 4038 - Paperbook III - Caselaw • M/s. Mandiant Cyber Security Pvt. Ltd. [IT(TP)A No. 292/Bang/2021] - AY 2016-17 - Para 7.7, Page no. 4068 - Paperbook III – Caselaw 21. The ld. DR submitted that as per the information in the annual reports, 100 percent of the operating revenues respectively were derived from software development services. The activities- Application maintenance and development, Enterprise Resource Planning and Testing are all software development activities and fall within the umbrella IT services, as per NASSCOM. As per the annual report information for the year ended 31.03.2018, the main object of the assessee company is to carry on the business of designing software development, software maintenance and support services the areas of computer networks, computer software and hardware, data communication equipment, electronic equipment, radio and wireless communication product and equipment and wireless telecommunication equipment of every description. Thus the activities of L&T are functionally comparable to the assessee company, as evident from the nature of services rendered by it. The financial statements do not mention about any product sale or inventory. As there is no revenue stream on account of product sales, we do not find any merit in the argument that the company is engaged in product sales. IT(TP)A No.731/Bang/2022 Page 17 of 32 22. With regard to the plea of the assessee that L&T brand value is contribute to the revenue of the company, it is submitted by the ld DR that there is no specific information in the financial statements to indicate that the brand has contributed to revenue growth of the company. On the other hand, the company has recognized client relationships and employee relationships as significant factor that has contributed to the revenue growth of the company. As to the significant factors contributing to the revenue growth, the annual report recognizes, "Client relationships are at the core of our business. We have a history of high client retention and derive a significant proportion 4if our revenue from repeat business built on our successful execution of prior engagements"; and further states, "A principal component of our ability to compete effectively is our ability to attract and retain qualified employees; our employee benefit expenses constituted 56.0% and 55.6% of our total income in the year ended March 31, 2018 and March 31, 2017", respectively (Ref: page 22 of the annual report). It is pertinent to note that brand was not recognized as the significant factor for revenue from operations. In other words, its operational efficiency has contributed to its revenue growth and brand name and not the other way. There is no information to indicate that the brand has impacted the revenue or profit of the company. 23. The next contention of the assessee is that the company has invested huge amounts technology absorption and owns significant intangibles. In this regard the ld DR submitted that as per page 88 of the annual report, the intangible assets reported in the balance sheet IT(TP)A No.731/Bang/2022 Page 18 of 32 comprises of only computer software. There is no information as to any intellectual property rights developed or license owned by the company. The computer software referred to were normal software used by any software company and hence it cannot be construed as a unique or non-routine asset. The reference to intangibles under development also indicates that as at the end of the year, it does not possess its own intellectual property rights; and does not have any revenue stream on account of IPR. Thus, there is no material difference as to the intangibles owned by the assessee company and the comparable company. In connection with the submission that this company has incurred substantial expenditure of Rs,302 million towards R&D the ld DR submitted that on perusal of the information in the annual report show that the expenses incurred towards R&D was only 0.43% of total revenue, and which is quiet meagre considering the generally acceptable tolerable limit of 3%. There is no indication in the annual report to show that the R&D had resulted in any distinct product development giving rise to source of separate revenue stream, Therefore, they are to be taken as routine expenses incurred in enhancing the quality of delivery of services. 24. The ld DR submitted that since the company is primarily engaged in software development services and earns the revenue from this activity there is no need of providing segmental information as per AS 17 IT(TP)A No.731/Bang/2022 Page 19 of 32 25. The next plea taken by the assessee is that L&T Infotech has undertaken several acquisitions, the synergy from which will impact the profitability of the company. In this regard the ld DR submitted that on perusal of records it is noticed that the various amalgamation has not impacted in increasing the profitability of the transferee company. Besides, it is also seen that the company has not reported amalgamation as a significant factor affecting its revenue growth or profitability. 26. We have considered the rival submissions and perused the material on record. Exclusion of L&T Infotech Ltd. is considered by the Tribunal in assessee’s own case for AY 2014-15 (supra) wherein it is held that – “34. We have considered the rival submissions. Similar issue was decided by the Tribunal in the case of Microsoft Research Lab India (P.) Ltd. (supra) wherein it was observed as follows:— 'We have perused submissions advanced by both sides in the light of the records placed before us. It is observed that Delhi ITAT in case of Aginity IndiaTechnologiesIndia private limited (supra) has held as follows: "Larsen and Toubro Infotech Ltd was excluded from the list of comparable companies by relying on the decision of the Delhi bench ITAT in case of Saxo India d v. ACIT. The discussion is contained at para 4 .8 to 4.10 of tribunal's order. The tribunal held that LMT Infotech Ltd was software product company and segmental information on SWT services was not available. The tribunal also noticed that appeal filed by revenue against rivals order was dismissed by orderable Delhi High Court in ITA No. 682/2016. IT(TP)A No.731/Bang/2022 Page 20 of 32 Respectfully following the same we are of considered opinion that this company deserves to be excluded from the final list." We rely on the coordinate bench decision and direct the TPO/A.O. to exclude the comparable from the final list for determination of ALP.' 35. In view of the above decision, we direct exclusion of Larsen & Toubro Infotech Ltd. from the comparables.” 27. The nature of activity performed by this company is given at page 83 of the annual report, as under: "Larsen & Toubro Infotech Limited (`the Company') offers extensive range of IT services like application development, maintenance and outsourcing, enterprise solutions, infrastructure management services, testing, digital solutions and platform based solutions to the clients in diverse industries." 28. From the above it is clear that L&T is providing varied services under the umbrella of SWD services whereas the assessee is a captive service provider of routine software development. It is the submission of the ld AR that the L&T is engaged in trading of goods and there is no segmental break-up for such services/ products. We also notice that the company has made several acquisitions during the year under consideration. In view of these discussion and considering that there is no change to facts for the year under consideration also, we respectfully follow the decision of the co-ordinate bench and direct the AO/TPO to exclude L&T Infotech Limited from the list of comparables. IT(TP)A No.731/Bang/2022 Page 21 of 32 Interest on receivables – Ground no.5 (5.1 to 5.4) 29. The TPO computed the notional interest on outstanding receivables by applying LIBOR rate + 450 basis points to arrive at the interest rate of 6.724%. The TPO after allowing a credit period of 30 days computed the interest for 335 days to arrive at an adjustment of Rs.6,89,46,372. The DRP directed the TPO to apply SBI short term rate and recompute the amount of adjustment. Accordingly, the TPO recomputed the interest on delayed receivables at Rs.6,49,06,385. 30. The ld. AR submitted a detailed written submission in this regard which extracted below Outstanding receivables cannot be treated as a separate international transaction It was submitted that the assessee has provided SWD services and IT and technical support services to its AEs and amount outstanding as trade receivables merely represent the dues to be received by the Appellant against the services provided. As a business practice, the Appellant did not charge any interest on delayed realisation of invoice from AEs nor paid any interest on delayed payables. Early or late realization of service proceeds is incidental to the transaction of sale/ service, and not a separate transaction in itself. In other words, these represent the consequence of an international transaction and not an international transaction per-se. If the ALP in respect of an international transaction of service is determined, then there can be no question of treating non-receipt of interest in such transaction as separate international transaction warranting any further adjustment. Once ALP is determined in respect of the sale/ service transaction, it would be deemed to be covering all the elements and consequences of such transaction of sale/ service. IT(TP)A No.731/Bang/2022 Page 22 of 32 Aggregation approach - all service-related costs are embedded in the remuneration received from the AEs Without prejudice to above, it is to be appreciated that where companies are aware of the fact that customer will take longer than the agreed time to pay the outstanding dues, the same is factored in the price/ mark-up charged for the services rather than to levy of actual interest when the payment is eventually made by the customer. The principle of aggregation is well established rule in the transfer pricing analysis. This principle seeks to combine all functionally similar transactions wherein arm's length price can be conducted for a number of transactions taken together. The said principle is enshrined in the transfer pricing regulation itself. Fully funded by AEs with no working capital risk The Appellant wishes to highlight that the Company (being a captive service provider to group entities) does not bear any working capital risk since it has been fully funded by its AEs and has no working capital contingencies. There have been some instances where there has been delay in making the payments by the AEs beyond the agreed credit period; however, no interest has been charged for the reason that on account of alleged delayed payment in collection of receivables from AEs, the Appellant has no additional burden for managing its working capital life cycle. Outstanding receivables from AEs cannot be re-characterised as loan advanced to AEs It needs to be appreciated that in the instant case, since outstanding balances arise in the course of regular business with its AEs (and not from advancing of money, indicating an intent to lend), it would be improper to re-characterize outstanding receivables (arising in course of regular dealings of business) as advancing of money (in the nature of unsecured loan). Further, it may be noted that Appellant has not IT(TP)A No.731/Bang/2022 Page 23 of 32 obtained any third-party loan in connection with its business and accordingly does not have any expenses in the form of interest-payout on borrowed funds. Thus, it cannot be reckoned that the Appellant has given any benefit to its AEs by blocking its interest-bearing funds by extending the credit period to AEs. The ld. AR submitted that outstanding/ delayed receivables from AEs cannot be treated as unsecured loans advanced to AEs and interest cannot be imputed on the same. TPO’s jurisdiction to question the commercial wisdom of the Appellant Any prudent business entity will attempt to collect its outstanding receivables from their customers and charging of interest is not a routine case, as the same could result in loss of business from the customers in the future. The Appellant wishes to submit that not charging interest on overdue receivables is the commercial wisdom of the Appellant however, the learned TPO has proposed to impute interest on overdue receivables from AEs. (Page 668 of Paper Book I - Factual Document - Part 1) Working capital adjustment appropriately takes into account the delayed/ outstanding receivable; separate TP adjustment is unwarranted The Appellant requests that where working capital adjustment is granted, receivables amount gets adjusted in working capital adjustments and a separate addition is not required under the TP provisions. The difference in arm’s length margin and margin of the Appellant gives an impact of different working capital level by way of higher differential margin. Comparing the actual credit period allowed by the Appellant with the average receivable days of the comparable companies proposed by the Appellant IT(TP)A No.731/Bang/2022 Page 24 of 32 Without prejudice to all the above contentions, the Appellant wishes to submit that if receivables adjustment needs to be quantified, it should be done by comparing the actual credit period allowed by the Appellant with the average receivable days of the comparable (i.e.,) adjustment should be made only in cases where the actual credit period allowed is over and above the average receivable days of comparables and not in respect of cases where actual credit period allowed is less than the normal credit period extended in the similar industry. Account receivables arising from an international transaction are closely linked to the main transaction and should be benchmarked using a combined transaction approach Without prejudice to the contention that outstanding receivables is not an international transaction, it is submitted that if outstanding receivables is treated as a separate international transaction by the learned TPO, the same should be benchmarked using a combined transaction approach, by combining the outstanding receivables with the main international transaction of provision of services due to the fact that receivables are a result of the international transactions of the Appellant. LIBOR rate to be applied in case of delayed receivable collection The ld. AR submitted that while the TPO adopted LIBOR 6 months + 450 bps, the DRP on the other hand, directed TPO to adopt short term lending rate prescribed by SBI. Without prejudice to the fact that no interest should be computed, the ld. AR submitted to highlight that if interest needs to be computed on alleged delayed collection of receivables, then the applicable rate of interest would be LIBOR since the Appellant raises invoices on its AEs in foreign currency in respect of its inter-company transactions. Outstanding payables shall be netted off from the outstanding receivables IT(TP)A No.731/Bang/2022 Page 25 of 32 Without prejudice to our above, if outstanding receivables are considered as unsecured loans, then the same should be netted off from outstanding payables due from AE and the balance amount shall be considered for computing the interest. 31. The ld. AR relied on the following judicial Precedents:- 1. M/s. ON Semiconductor Technology India Private Limited – IT(TP)A No.291/Bang/2021 – AY 2016-17 - Para 24, Page no. 4284 - Paperbook III - Caselaw 2. M/s. Boston Scientific International BV India – [2010] 40 SOT 11 (MUM.) (URO) - Para 32, Page no. 4295 - Paperbook III - Caselaw 3. M/s. Kusum Healthcare Pvt. Ltd. – ITA No. 6814/Del/2014 – AY 2010-11 - Para 14, Page no. 4308 - Paperbook III - Caselaw 4. M/s. Bechtel India Pvt Ltd – CC No(s). 4956/2017 – AY 2014-15 - Para 4, Page no. 4313 - Paperbook III – Caselaw 5.M/s. Verifone India Technology Pvt. Ltd. – IT(TP)A No.290/Bang/2021 – AY 2016-17 - Para 4, Page no. 4316 - Paperbook III - Caselaw 32. We heard the rival submissions and perused the material on record. In our opinion, the impugned issues of whether the interest on receivable is a separate international transaction and the rate of interest to be considered has been considered in the decision of the coordinate Bench of the Tribunal in the case of Swiss Re Global Solutions India Pvt. Ltd. (Order dated 21.01.2022 passed in IT(TP)A No. 397/Bang/2021). wherein it was held as under:- “35. The only other issue that remains for adjudication is ground No.15 with regard to re-characterizing certain trade receivables as unsecured loans and computing notional interest on such trade IT(TP)A No.731/Bang/2022 Page 26 of 32 receivables. The main contention of the ld. AR is that deferred receivables would not constitute a separate international transaction and need not be benchmarked while determining the ALP of the international transaction. In our opinion, this issue was considered by the Tribunal in assessee’s own case for AY 2014-15 and in para 23 to 23.9 of the order dated 21.5.2020 this Tribunal held as under:- “23. Ground No. 14-17 alleged by assessee against adjustment of notional interest on outstanding receivables. From TP study, it is observed that payments to assessee are not contingent upon payment received by AEs from their respective customers. Further Ld.AR submitted that working capital adjustment undertaken by assessee includes the adjustment regarding the receivables and thus receivables arising out of such transaction have already been accounted for. Alternatively, he submitted that working capital subsumes sundry creditors and therefore separate addition is not called for. 23.1. Ld.TPO computed interest on outstanding receivables under weighted average method using LIBOR + 300 basis points applicable for year under consideration that worked out to 3.3758% on receivables that exceeded 30 days. It has been argued by Ld.AR that authorities below disregarded business/commercial arrangement between the assessee and its AE's, by holding outstanding receivables to be an independent international transaction. 23.2. Ld.AR placed reliance on decision of Delhi Tribunal in Kusum Healthcare (P.) Ltd. v. Asstt. CIT [2015] 62 taxmann.com 79, deleted addition by considering the above principle, and subsequently Hon'ble Delhi High Court in Pr. CIT v. Kusum Health Care (P.) Ltd. [2018] 99 taxmann.com 431/[2017] 398 ITR 66, held that no interest could have been charged as it cannot be considered as international transaction. He also placed reliance upon decision of Delhi Tribunal in case of Bechtel India (P.) Ltd. v. Dy. CIT [2016] 66 taxman.com 6 which subsequently upheld by Hon'ble Delhi High Court vide order in Pr. CIT v. Bechtel India (P.) Ltd. [IT Appeal No. 379 of 2016, dated IT(TP)A No.731/Bang/2022 Page 27 of 32 21-7-16] also upheld by Hon'ble Supreme Court vide order, in CC No. 4956/2017. 23.3. It has been submitted by Ld.AR that outstanding receivables are closely linked to main transaction and so the same cannot be considered as separate international transaction. He also submitted that into company agreements provides for extending credit period with mutual consent and it does not provide any interest clause in case of delay. He also argued that the working capital adjustment takes into account the factors related to delayed receivables and no separate adjustment is required in such circumstances. 23.4. On the contrary Ld.CIT.DR submitted that interest on receivables is an international transaction and Ld.TPO rightly determined its ALP. In support of the contentions, he placed reliance on decision of Delhi Tribunal order in Ameriprise India (P.) Ltd. v. Asstt. CIT [2015] 62 taxmann.com 237 wherein it is held that, interest on receivables is an international transaction and the transfer pricing adjustment is warranted. He stated that Finance Act, 2012 inserted Explanation to section 92B, with retrospective effect from 1.4.2002 and sub-clause (c) of clause (i) of this Explanation provides that: (i) the expression "international transaction" shall include— . . . . . (c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;. . . ' 23.5. Ld.CIT.DR submitted that expression 'debt arising during the course of business' refers to trading debt arising from sale of goods or services rendered in course of carrying on business. Once any debt arising during course of business is an international transaction, he submitted that any delay in realization of same needs to be considered within transfer pricing adjustment, on account of interest income short charged or uncharged. It was argued that insertion of IT(TP)A No.731/Bang/2022 Page 28 of 32 Explanation with retrospective effect covers assessment year under consideration and hence under/non-payment of interest by AEs on debt arising during course of business becomes international transactions, calling for computing its ALP. He referred to decision of Delhi Tribunal in Ameriprise (supra), in which this issue has been discussed at length and eventually interest on trade receivables has been held to be an international transaction. Referring to discussion in said order, it was stated that Hon'ble Delhi Bench in this case noted a decision of the Hon'ble Bombay High Court in the case of CIT v. Patni Computer Systems Ltd. [2013] 33 taxmann.com 3/215 Taxman 108 (Bom.), which dealt with question of law: "(c) 'Whether on the facts and circumstances of the case and in law, the Tribunal did not err in holding that the loss suffered by the assessee by allowing excess period of credit to the associated enterprises without charging an interest during such credit period would not amount to international transaction whereas section 92B(1) of the Income-tax Act, 1961 refers to any other transaction having a bearing on the profits, income, losses or assets of such enterprises?" 23.6. Ld.CIT.DR submitted that, while answering above question, Hon'ble Bombay High Court referred to amendment to section 92B by Finance Act, 2012 with retrospective effect from 1.4.2002. Setting aside view taken by Tribunal, Hon'ble Bombay High Court restored the issue to file of Tribunal for fresh decision in light of legislative amendment. It was thus argued that non/under-charging of interest on excess period of credit allowed to AEs for realization of invoices, amounts to an international transaction and ALP of such international transaction has to be determined by Ld.TPO. Insofar as charging of rate of interest is concerned, he relied on decision of the Hon'ble Delhi High Court in CIT v. Cotton Naturals (I) (P.) Ltd. [2015] 55 taxmann.com 523/231 Taxman 401 holding that currency in which such amount is to be re-paid, determines rate of interest. He, therefore, concluded by summing-up that interest on outstanding IT(TP)A No.731/Bang/2022 Page 29 of 32 trade receivables is an international transaction and its ALP has been correctly determined. 23.7. We have perused the submissions advanced by both the sides in the light of the records placed before us. This Bench referred to decision of Special Bench of this Tribunal in case of Special Bench of ITAT in case of Instrumentation Corpn. Ltd. v. Asstt. DIT (IT) [2016] 71 taxmann.com 193/160 ITD 1 (Kol. - Trib.), held that outstanding sum of invoices is akin to loan advanced by assessee to foreign AE., hence it is an international transaction as per Explanation to section 92B of the Act. We also perused decision relied upon by Ld.AR. In our considered opinion, these are factually distinguishable and thus, we reject argument advanced by Ld.AR. 23.8. Alternatively, it has been argued that in TNMM, working capital adjustment subsumes sundry creditors. In such situation computing interest on outstanding receivables and loans and advances to associated enterprise would amount to double taxation. Hon'ble Delhi Tribunal in case of Orange Business Services India Solutions (P.) Ltd. v. Dy. CIT [2018] 91 taxmann.com 286 has observed that: "There may be a delay in collection of monies for supplies made, even beyond the agreed limit, due to a variety of factors which would have to be investigated on a case to case basis. Importantly, the impact this would have on the working capital of the assessee would have to be studied. It went on to hold that, there has to be a proper inquiry by the TPO by analysing the statistics over a period of time to discern a pattern which would indicate that vis-a-vis the receivables for the supplies made to an AE, the arrangement reflected an international transaction intended to benefit the AE in some way. Similar matter once again came up for consideration before the Hon'ble Delhi High Court in Avenue Asia Advisors Pvt. Ltd v. DCIT [2017] 398 ITR 120 (Del). Following the earlier decision in Kusum Healthcare (supra), it was observed that there are several factors which need to be considered before holding that every receivable is an international transaction and it requires an IT(TP)A No.731/Bang/2022 Page 30 of 32 assessment on the working capital of the assessee. Applying the decision in Kusum Health Care (supra), the Hon'ble High Court directed the TPO to study the impact of the receivables appearing in the accounts of the assessee; looking into the various factors as to the reasons why the same are shown as receivables and also as to whether the said transactions can be characterised as international transactions." 23.9. In view of the above, we deem it appropriate to set aside this issue to Ld.AO/TPO for deciding it in conformity with the above referred judgment. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in accordance with law.” 36. Accordingly, we are of the opinion that deferred receivables would constitute an independent international transaction and the same is required to be benchmarked independently as held by the Hon’ble Karnataka High Court in PCIT v. AMD (India) Pl. Ltd., ITA No.274/2018 dated 31.8.2018. 33. In so far as the question of rate of interest is concerned, we find that this issue is no more res integra in view of the judgment of the Hon'ble Delhi High Court in the case of Cotton Naturals (I) (P.) Ltd (supra) in which it has been held that it is the currency in which the loan is to be repaid which determines the rate of interest and hence the prime lending rate should not be considered for determining the interest rate. 34. During the course of hearing the ld AR drew our attention to the the invoice-wise receivable collection of the assessee with with the average receivable days computed for the comparable companies proposed by the assessee where, it is observed that the weighted average number of days for which the invoices remained overdue IT(TP)A No.731/Bang/2022 Page 31 of 32 during the year worked out to 43 days (Page 1096 and 1097 of Paper Book I - Factual Document - Part 2) and that of the comparable companies average came to 51 days. (Internal Page 387 of the DRP submission/ Page 664 of Paper Book I - Factual Document - Part 1/ Page 494 to 495 of Appeal set). The ld AR without prejudice submitted that a similar analysis on the comparable set proposed by the learned TPO it is noticed that the average receivable days of the learned TPO’s set came up to 79 days and therefore it is the submission of the ld AR that that the comparable companies are allowing higher credit days than the assessee. (Internal Page 388 of the DRP submission/ Page 494 to 495). 35. We notice that the coordinate Bench of this Tribunal in the case of ON Semiconductor Technology India Private Limited (supra) while considering the issue of interest on receivable has held that:- 24. We have heard rival submissions and perused the material on record. The details with respect to the terms of the Master Service Agreement, credit period allowed thereunder, invoicing details, the realization data, and such other particulars as may be relevant to adjudicate on this issue, are not emanating from the DRP's directions/TPO's order. We accordingly direct the AO/TPO to examine the factual aspect. The AO/TPO is also directed to examine computation of debtors holding period of comparable vis-à-vis that of the assessee. If the debtors holding period of comparable is higher than that of the assessee, then prima facie, no TP adjustment is required on the amounts outstanding from the AEs. We, accordingly, allow the ground 6.1 to 6.6 for statistical purposes.” 36. In assessee case also the details with regard to Master Service Agreement, credit period allowed thereunder, invoicing details, the IT(TP)A No.731/Bang/2022 Page 32 of 32 realization data, and such other particulars as may be relevant to adjudicate on this issue need to be examines. Therefore we remit the issue back to the AO/TPO for verification of the details. The AO/TPO is also directed to keep in mind the ratio laid down in the case of ON Semiconductor Technology India Private Limited (supra) by the coordinate bench while deciding issue. Needless to say that the assessee may be given a reasonable opportunity of being heard. This ground of the assessee is allowed for statistical purposes. 37. In the result, the appeal by the assessee is partly allowed. Pronounced in the open court on this 5 th day of December, 2022. Sd/- Sd/- ( GEORGE GEORGE K. ) ( PADMAVATHY S. ) JUDICIAL MEMBER ACCOUNTANT MEMBER Bangalore, Dated, the 5 th December, 2022. /Desai S Murthy / Copy to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. By order Assistant Registrar ITAT, Bangalore.
