TII Instant Update -2018-TII-INSTANT-ALL-560

CASE LAWS

2018-TII-197-ITAT-BANG-TP

SAP LABS INDIA PVT LTD Vs ADDL CIT: BANGALORE ITAT (Date of Decision: April 6, 2018)

Income tax - ALP - captive service provider - diminishing marginal revenue - employee cost filter - software development services - segmental report - TNMM

The Assessee company, a subsidiary of SAP AG, Germany, is engaged in the business of providing software development and other related support services to SAP AG and other Group companies. It is a captive service provider and conducts its operation from various undertakings registered with the STPI scheme at Bangalore, Gargaon and Chandigarh. It had filed the return reporting various international transactions in Form 3CEB, and sought to justify the consideration received for such international transactions to be at arm's length. The assessee company also submitted TP study report adopting TNMM which was considered to be the MAM and operating profit to operating cost as the PLI. The assessee-company's profit margin was computed at 7.62% and the same was claimed to be at arm's length with other companies rendering software development services. For the purpose of TP study, the assessee-company had chosen 16 comparables and the arithmetical average mean of the operating margin of the said comparable was computed less than 12%. According to the assessee company, its PLI was within +/-5% of the arithmetical mean of the comparable entities. Hence, it was claimed that transactions with its AEs to be at arm's length.

The TPO, though accepted TNMM adopted by assessee-company as the MAM, he however rejected the TP study report submitted by the assessee company for the reason that current year's financial data was not used by the assessee-company but average of three previous year's data was used. The assessee-company had not applied the filters of export revenue of more than 75% and employee-cost filter of more than 25% of the revenue. The TPO identified different set of comparable entities for the purpose of determining the arm's length price. He computed average profit margin of the comparables finally selected at 23.65% after giving working capital adjustment of 1.7%, adjusted margin of 21.95%. On such basis, the TPO suggested TP adjustment of Rs.100,98,86,353/-. The AO thereafter passed draft assessment order incorporating the TP adjustment suggested by the TPO. On appeal, the CIT(A) deleted fourteen companies by applying the turnover filter of range of Rs.200 cr. to Rs.2000 cr. The CIT(A) also held that the application of employee cost filter and diminishing revenue or persisting loss making or different year ending filters were not appropriate. He further held that gain on account of fluctuation of foreign exchange should be treated as operating nature.

On appeal, the ITAT held that,

Whether non-furnishing of information obtained u/s 133(6) by the TPO to the Assessee, vitiates selection of comparables - YES: ITAT

+ as far as selection of Avani Cimcom Technologies Ltd., Kals Information Systems Ltd. and E-Zest Solution Ltd. are concerned, it is seen that the comparability of these companies had came up for consideration before Co-ordinate bench of this Tribunal in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd., wherein it was observed that the TPO has included these companies in the final set of comparables only on the basis of information obtained u/s 133(6). In these circumstances, it was the duty of the TPO to have necessarily furnished the information so gathered to the assessee and taken its submissions thereon into consideration before deciding to include this company in its final list of comparables. Non-furnishing the information obtained u/s 133(6) to the assessee has vitiated the selection of this company as a comparable. Further, Kals Information Systems and E-Zest Solutions are engaged in both software products as well as software development services. Therefore, respectfully following the ratio of the Coordinate bench in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd., this Tribunal directs the TPO to exclude Avani Cimcon Technologies Ltd., Kals Information System Ltd and e-Zest Solutions Ltd, from the list of comparables;

Whether potential comparable companies can be excluded for purpose of comparison merely because they had shown abnormally high profit - NO: ITAT

+ as far as selection of Bodhtree Consulting Ltd is concerned, the comparability of this company had also came up for consideration before co-ordinate bench of this Tribunal in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd, wherein it was opined that: "....the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special bench held that in such cases it would require further investigation to ascertain the reasons for unusually high profit and in order to establish whether the entities with such high profits can be taken as comparable or not. In view of the admitted position that the assessee follows Fixed Price Project model where revenues from software development is recognized based on software developed and billed to clients, there is a possibility of the expenditure in relation to the revenue being booked in the earlier year. Perusal of the annual results of this company shows, that there has been a consistent change in the operating margins. It appears that the revenue recognition method followed by the assessee is the reason for the drastic variation in the profit margins of this company...." Therefore, respectfully following the ratio of the decision of the co-ordinate bench, the TPO is directed to exclude this company from the list of comparables;

Whether company having significant intangibles and huge revenues from software products, can be compared to a pure software developer which is captively engaged in rendering services only to its AE - NO: ITAT

+ as far as selection of Infosys Technologies Ltd is concerned, the assessee-company is challenging the inclusion of this company on the ground that this company provides end-to-end business solutions that leverage technology thereby enabling its client to enhance business performance including technical consulting, design, development, re-engineering, maintenance, systems integration, package evaluation and implementation, and testing and infrastructure management services. The Director Report states that Income is from software service and products. However, no segmental information is available as regards profits earned on account of software services and software products. It is seen that the comparability of Infosys Technologies Ltd. also came up for consideration before co-ordinate bench of this Tribunal in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd., wherein it was held that: "....the assessee has brought on record sufficient evidence to establish that this company is functionally dis-similar and different from the assessee and hence is not comparable, since it owns significant intangible and has huge revenues from software products. It is also seen that the break up of revenue from software services and software products is not available...." Therefore, respectfully following the ratio of the decision of the co-ordinate bench in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd, the TPO is directed to exclude Infosys Technologies Ltd. from the list of comparables;

+ as far as selection of Persistent Systems Ltd. is concerned, the assessee-company is challenging the inclusion of this company on the ground that this company on the ground that the company is engaged in providing 'Outsourced Product Development Services' to independent software vendors and enterprises. The company offers complete product life cycle services from end to end. No bifurcation is available between the two activities of the company, being sale of software services and products. It is seen that the comparability of Persistent Systems Ltd. had also came up for consideration before co-ordinate bench of this Tribunal in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd., wherein it was observed that this company is engaged in product development and product design services while the assessee is a software development services provider. As submitted by the assessee, the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. and M/s. Hewlett-Packard (India) Software Operation P.Ltd, that in the absence of segmental details / information a company cannot be taken into account for comparability analysis, the TPO is directed to exclude Persistent Systems Ltd. from the list of comparables;

Whether entity engaged in product engineering services and has substantial R&D activity which has resulted in creation of its IPRs, can be compared to a pure software developer - NO: ITAT

+ as far as selection of Quintegra Solutions Ltd. is concerned, the assessee-company is challenging the inclusion of this company on the ground that this company provides a full range of custom high end IT solutions such as development, testing, maintenance, SAP, product engineering and infrastructure management services), proprietary software products and consultancy services in IT on various platforms and technologies. During the year under consideration, the company has developed certain proprietary products portfolio and acquired copy rights for the same in Flexible Home Building (HBfx), Hospital Management and Information System (HMIS) in healthcare and EduCampus in Education verticals as products. The comparability of Quintegra Solutions Ltd. had come up for consideration before co-ordinate bench of this Tribunal in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd, wherein it was opined that this company is engaged in product engineering services and is not purely a software development service provider as is the assessee in the case on hand. It is also seen that this company is also engaged in proprietary software products and has substantial R&D activity which has resulted in creation of its IPRs. Having applied for trade mark registration of its products, it evidences the fact that this company owns intangible assets. Therefore, respectfully following the ratio of the decision of the co-ordinate bench in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd, this Tribunal directs TPO to exclude Quintegra Solutions Ltd. from the list of comparables;

Whether entity engaged in rendering both product development as well as software development services can be compared to a software developer, in the ansence of segmental bifurcation - NO: ITAT

+ as far as selection of Wipro Ltd is concerned, the assessee-company is challenging the inclusion of this company on the ground that this company on the ground that the company is engaged in Information Technology Services, R&D Services, Business Processing Outsourcing and other business. The company caters to various industries and is leading India based provider of IT services and Products. Wipro is a giant company and a market leader assuming all risks leading to higher profits. It is seen that the comparability of Wipro Ltd. (seg.) had come up for consideration before co-ordinate bench of this Tribunal in the case of M/s.Hewlett- Packard (India) Software Operation P.Ltd, wherein it was observed that: "....this company is engaged both in software development and product development services. There is no information on the segmental bifurcation of revenue from sale of product and software services. The TPO appears to have adopted this company as a comparable without demonstrating how the company satisfies the software development sales 75% of the total revenue filter adopted by him. Another major flaw in the comparability analysis carried out by the TPO is that he adopted comparison of the consolidated financial statements of Wipro with the stand alone financials of the assessee; which is not an appropriate comparison...." Therefore, respectfully following the ratio of the decision of the co-ordinate bench in the case of M/s. Hewlett-Packard (India) Software Operation P.Ltd., the TPO is directed to exclude Wipro Ltd., from the list of comparables.

Assessee's appeal partly allowed

2018-TII-27-HC-AHM-TP

VODAFONE INDIA SERVICE PVT LTD Vs ACIT: GUJARAT HIGH COURT (Dated: March 21, 2018)

Income tax - Sections 2(14), 2(47), 9(1)(ii) & 92B

Keywords - ALP - cost of acquisition - international transaction - indirect shareholding - subscription of AEs shares - relinquishment of option rights

The Assessee company preferred the present appeal challenging the action of Revenue Authorities in taxing the assignment of call options and controlling rights over different companies, so as to benefit one SMMS Investment Private Limited. The Revenue Authorities opined that instead of exercising such call options and acquiring shares of the said SMMS Private Limited at a very small pre-agreed sale consideration, the assessee paid a sum of Rs. 21.25 Crores to the shareholders. Eventually, there was increase in the share capital of SMMS and tile shares were alloted to TII. Revenue argues that the market value of SMMS at the relevant time was more than Rs. 1600 Crores. On the other hand, case of the assesses was that since the transaction was not exigible to capital gain tax, the transfer pricing provisions would not apply. When the matter reached before the Tribunal, it was held that a framework agreement made by foreign AEs, with option rights to buy entire equity of related parties at a nominal price, would be considered as an international transaction u/s 92B(2).

On appeal, the HC held that,

Whether where any action in concert included non-resident AEs, and de horse the question of their legal rights under such arrangement, then the said non-resident AE being a party to the arrangement, satisfies the definition of international transaction u/s 92B r.w. section 92F(v) - YES: ITAT

Whether a framework agreement made by foreign AEs, with option rights to buy entire equity of related parties at a nominal price, can be considered as an international transaction u/s 92B(2) - YES: ITAT

Whether the 'right to nominate the assignee of the option rights', if exercised during the relevant previous year, is to be treated as a 'capital asset' u/s 2(14) - YES: ITAT

+ in the case of Vodafone international Holdings B.V. v. Union of india & Anr - 2010-TII-13-HC-MUM-INTL, the Bombay High court had examined certain transactions of transfer of shares by a non-resident to anther non-resident company in the context of charging capital gain tax in india and upheld the Revenue's view point. This decision of bombay High Court was carried in appeal by international Holdings B.V. Vs Union of india & Anr - 2012-TII-01-SC-LB-INTL, while reversing the judgment of the bombay High court had held that the controlling interest in the company in an incident of ownership of shares in, something which flow out of the holding of shares. A controlling interest is, therefore, not an identifiable or distinct capital asset independent of the holding of shares. The control and management is a fact of the holding of shares. The Court held that the case on hand concerns straightforward share sale. The Court further observed that the Bombay High Court failed to notice that till the date call options had remained unencashed, and therefore, even if it is assumed that such options under frame work agreement could be considered to be property rights, there had been no transfer or assignment of options till the date. Even if, it is assumed that the High Court was right in holding that the options constitute capital assets, even then Section 9 [1](ii) of the Income-tax Act was not applicable, as these options had not been transferred till then;

+ as is well-known, this judgment of the Supreme Court gave rise to certain amendments in the Income-tax Act under the provisions of Section 2(14) & 2(47). These amendments came up for consideration before the Bombay High Court in the case of Vodafone India Services P. Ltd Vs Commissioner of Income-tax & Anr - 2015-TII-63-HC-MUM-TP wherein it was held that option to purchase or sell shares is not capital asset. In the context of controversy and the judicial pronouncements and statutory changes, the question of taxability in the present case would certainly arise. Before the Revenue can succeed, answers to some of the questions would have to be in the affirmative. Such as, whether the transaction in question would give rise to transfer of capital asset; whether the transaction involved any international transaction and whether the asset; even if considered to be capital asset, can be assigned any cost of acquisition and whether the Tribunal was correct in assigning its market value on the basis of what the Revenue would refer to as comparable sale instance. The tax liability arising out of the judgment of the Tribunal is in the vicinity of Rs. 507.74 Crores. This Tribunal is informed that the assessee has so far deposited Rs. 76.87 Crores. Under the circumstances, further coercive recovery arising out of the judgement of the Tribunal would be stayed on condition that the applicant deposits a further sum of Rs. 23.13 Crores with the Department.

Case disposed of