Income Tax Appellate Tribunal, Hyderabad Bench ‘A’
B. Ramakotaiah, Accountant Member
1. These cross-appeals by Assessee and Revenue are directed against the order of Ld. CIT(A)-III, Hyderabad dated 31.01.2007 with reference to T.P. adjustments made by AO/TPO in the assessment order dated 27.02.2006.
2. Briefly stated, assessee is a software company and 100% export oriented unit set-up to provide computer software/services to its parent company D.E. Shaw India Software P. Ltd., USA and acts as captive software development service provider to its AE. During financial year 2002-03, it provided various services to its AE for which an amount of Rs.11,73,72,986 was shown to have been received. Assessee selected TNMM method for its T.P. study and stated that its profit margin on cost was within arms length. While doing so, it excluded amount of Rs.29,44,130 representing irrecoverable amount of expenses receivable from M/s. Juno Online Services P. Ltd., for computing operating profit margin. Assessee arrived at the profit margin at 12% on total cost. TPO however, did not accept this contention. While re-determining the cost incurred by assessee, TPO also made a detailed analysis of various comparables and selected seven comparables whose arithmetic mean of profit came at 17.27%/ after giving 0.5% adjustment to take into account the differences, the average profit margin of 16.77 was adopted by the TPO to arrive at the ALP and proposed an amount of Rs.77,86,574 as an addition vide his order dated 20th February, 2006. Following the same, A.O. added the amount to the total income of the assessee. In view of provisions contained in section 92C(4) proviso, deduction at 10A was not allowed on this addition.
3. Being aggrieved, assessee has taken-up the matter before the Ld. CIT(A). Ld. CIT(A) while considering the risk adjustment, enhanced risk adjustment to 1% as against 0.5% given by A.O. and directed the A.O. to exclude three comparables namely M/s. SAARC Net and M/s. Zigma Software for having low profit margins. Even though assessee contended that M/s. e-Star Infotech and M/s. Zen Technologies Ltd., are not comparable, Ld. CIT(A) however, directed the A.O. to exclude only M/s. Zen Technologies Ltd., on the reason of abnormal high profit margin, beyond normal range of profit of software companies in financial year 2002-03. He accordingly, re-determined the profit margin at 15.40% sustained an addition of Rs.63,18,14.
4. Assessee is aggrieved on (a) risk adjustments (b) inclusion of operating expenses of June Online and not considering profit range of +/- 5%. During the present proceedings, it raised an additional ground on incorrect computation of margin of M/s. e-Star Infotech. Revenue is aggrieved on exclusion of Zen Technologies Ltd., and increasing the risk allowance from 0.5% to 1%.
5. We have heard the Ld. Counsel and Ld. D.R. and perused the paper book placed on record and case law paper book supporting various contentions. In the course of arguments, Ld. Counsel did not press ground No.2 pertaining to assessee's T.P. study and also grounds No. 6, 7 and 8 pertaining to not giving an opportunity by A.O. while accepting the order of TPO. Ground No. 10 is general in nature. The issues are decided as under.
Risk Adjustment :
6. As briefly stated above, A.O. has allowed 0.5% risk adjustment for various differences while taking the comparability analysis which the Ld. CIT(A) increased to 1%. On considering the rival contentions, we do not see any reason to differ from the finding of the Ld. CIT(A). In fact, the Coordinate Bench in assessee's case for A.Y. 2007-08 in ITA.No.2071/Hyd/2011 dated 27.11.2013 De Shaw India Software (P.) Ltd. v. Asstt. CIT  42 taxmann.com 74 (Hyd.) considered similar facts in that order and confirmed risk adjustment at 1%. Even though it was stated in that order that it should not act as a precedent to be applied uniformly, considering the facts of the case and the fact that Ld. CIT(A) has analysed the issue correctly, we uphold the risk adjustment at 1%. Accordingly, both assessee's ground No.3 and Revenue ground No.3 are rejected.
Inclusion Of Domestic Expenditure As Operating Expenditure :
7. As briefly stated earlier, assessee while arriving at the profit margin has excluded amount of Rs.29,44,130 representing irrecoverable amount of expenses receivable from M/s. June Online Services P. Ltd., It was the submission before the TPO that assessee had a Cost Reimbursement Agreement with M/s. June Online Service Development P. Ltd., who is sharing premises for which certain costs are commonly spent by assessee but being reimbursed by the said company. It has placed the agreement before the TPO. It was submitted by assessee that it has incurred total cost of Rs.38,78,574 towards electricity, generator expenses, repairs and maintenance, telephone, security, pest control and coffee, tea etc., expenses on behalf of M/s. Juno Online and has recovered only an amount of Rs.9,34,444. The balance amount of Rs.29,44,130 was not recovered and therefore, the operating cost incurred on behalf of Juno Online cannot be considered as operating cost for the services rendered to A.E., since it is a domestic expenditure not connected with assessee's activity. TPO, however, did not accept the contention on the reason that (a) that assessee has not taken any steps to recover the amount (b) that the amount has not been charged to P & L account and (c) on verification from statements of Juno Online Services, there is no such claim of expenses payable to assessee company. Accordingly, TPO did not allow the reduction of the expenses thereby, effecting assessee's profit margin. Ld. CIT(A) also vide para 7.2 of the order agreed that the A.O. had correctly excluded the amount and accordingly, rejected assessee's contentions.
8. On perusal of the ledger accounts placed in the paper book at page73 and recoveries at page 158 of paper book and perusing the nature of expenditure and the case law on the issue, we are of the opinion that both TPO and Ld. CIT(A) erred in not considering assessee's genuine claim. In fact, as seen from the P & L account assessee's total expenses were at Rs.9,34,58,220 against which, assessee has recovered Rs.9,34,444 stated to be from Juno Online, thereby, reducing the expenses to Rs.9,25,23,76. This is the amount which the TPO has taken for considering the operating expenses. Therefore, assessee's contention that part of the expenditure was recovered from M/s. Juno Online has to be accepted. Not only that in the previous year relevant for A.Y. 2001-02 assessee has recovered expenses to an extent of Rs.67,34,915 for the whole year from M/s. Juno Online. It is stated that during the year assessee has provided services only up to September, 2002. when the problems arose, assessee stopped incurring the expenditure. Therefore, assessee's contentions are prima facie acceptable, that this much of the expenditure cannot be considered as operating expenses while arriving at the PLI. The case law on the issue also supports assessee's contention that domestic transaction with non-AE cannot be considered as operating expenditure in relation to International transactions with AE, as decided by Coordinate Bench in the case of Four Soft Ltd. v. Dy. CIT  142 TTJ (Hyd.) 358 and HSBC Electronic Data Processing India Ltd. v. Dy. CIT  36 taxmann.com 382 (Hyd.). In principle, assessee's contentions are acceptable.
9. However, as seen from the ledger account, copies of which were placed from pages 74 to 90, entire cost incurred from April, 2002 to December/January, 2003 under various heads have been transferred to Juno Online recoveries. The ledger account indicates the total amount spent under various heads is equivalent to the amount transferred to Juno Online. What is the gross expenditure incurred by assessee could not be verified. For example, under the head 'Electricity and Generator' expenses, the ledger account of power expenses placed at page 79 indicates expenditure from 8th April, 2002 to 9th January, 2003 to the extent of Rs.29,93,214. The entire amount has been shown towards Juno Online recovery. Likewise, generator charges at page 80 from 11th April, 2002 to 16th January, 2003 were shown to have been paid to Sunil Service Station amounting to Rs.78,806 and the entire amount has been shown to be recovered from Juno Online. Total generator expenses/power charges were not placed before us so as to examine whether 50% of the expenditure was only charged to Juno recoveries and not 100%. Therefore, in order to examine the nature and extent of expenditure and the vouchers therein, the issue is restored to the file of A.O. who should examine the nature of expenditure and if this expenditure was spent on behalf of Juno Online, then the expenditure not recovered from the said company has to be excluded. Therefore, for actual verification of the expenditure involved therein, the matter is restored to the A.O. who should examine the expenditure and allow assessee's contentions accordingly. With these directions, ground No.4 of the assessee is allowed for statistical purposes.
OPTION OF +/- 5%:
10. Ground No.5 pertains to allowing the option of +/-5%. The Ld. CIT(A) rejected this contention on the reason that claim is not made before the TPO/A.O. We are of the opinion that there is no need to make any claim of the statutory provision. In case ALP determined after due analysis is within +/- 5% range as provided in the proviso to section 92C(2) of the I.T. Act. A.O./TPO is bound to give the benefit to the assessee. There is no need to make any separate claim. Since assessee has shown ALP within the range, there is no requirement of making a claim in its T.P. study, we are of the opinion that the Ld. CIT(A) erred in observing that assessee has not made the claim before the TPO. However, this aspect will come into consideration only after determining the ALP by A.O. consequent to the orders of the Ld. CIT(A)/ITAT in assessee's own case in this year. TPO/A.O. is directed to keep this statutory provision in mind while arriving at the addition, if any, required. However, we make it clear that this +/- 5% is not a standard deduction but if ALP so determined is within the range of this +/- 5% from assessee's margin, then the benefit as provided in proviso should be given to assessee. With these observations, Ground No.5 of the assessee is allowed.
Additional Ground :
11. Assessee has raised the following additional ground in the course of present proceedings.
"The Ld. CIT(A) erred in accepting the incorrect margin of the E.Star Infotech Limited, one of the comparable company, as computed by A.O./TPO's in determining the Arm's Length Price."
12. The relevant facts are already on record and hence, the ground is allowed to be raised before us after considering the Ld. D.R. objections. It was the contention that even though assessee has objected to the inclusion of E-Star Infotech Limited as one of the comparable company, the objection was rejected by the Ld. CIT(A). However, it is the objection of the assessee that the margin adopted by TPO at 32.82% is not correct. It was the submission that this objection was raised before the Ld. CIT(A) but has not been adjudicated, therefore, raised as an additional ground before us. After considering the orders of the TPO and the annual report of the said E.Star Infotech Limited placed on record by assessee, we are of the opinion that the margin computation requires re-examination by the TPO/A.O. In fact, in page 121 of the TPO order, learned TPO mentions margin on sales of E.Star at 27.24% and margin on cost at 32.82%. However, the basis for arriving at those figures are not available. As seen from the details filed by assessee, operating cost was arrived at Rs.19.04 crores and operating profit at Rs.4.81 crores thereby, OP/OC at 25.28%. Since, there is a substantial variation between the margin computed by assessee vis--vis computation by TPO, we are of the opinion that this aspect requires re-examination by TPO/A.O. The TPO/A.O. should examine how the margin on cost was arrived at and give an opportunity to assessee to file its objections and then arrive at the correct margin on cost, so as to include the same in arriving at the ALP. Needless to say, that assessee should be given an opportunity to explain the working. Accordingly, additional ground of the assessee is considered allowed for statistical purposes.
ITA.No.486/Hyd/2007 - Revenue Appeal
13. Revenue in its appeal in ground No.2 has objected to the exclusion of M/s. Zen Technologies Ltd., from the list of comparables considered
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by CIT(A). It was the assessee's objection before TPO/CIT(A) that the said company was a product company and not comparable and the objections were recorded by Ld. CIT(A) correctly in para 6 of the order. However, while considering the comparables in para 6.4 of his order, he has excluded the company on the reason of being abnormally high profit margin. Even though this is one of the valid reason, what we noticed, after considering the rival contentions is that the company is not functionally comparable as the said company is in manufacturing/product service and is also involved in research and development. Its employee cost was only 3%. It is also evidenced that company paid excise duty/VAT. In view of this, assessee's objection that it is functionally different is to be accepted. Whatever may be the reason, we are of the opinion that Ld. CIT(A) has correctly excluded the same from the list of comparables. Therefore, we do not see any reason to interfere with the said order even though for different reasons. Revenue ground No.2 is accordingly rejected. 14. Ground No.3 pertains to allowing risk adjustment at 1% as against 0.5% allowed by TPO and was already considered in assessee's appeal. Accordingly, ground No.3 of the Revenue is rejected. 15. In the result, ITA.No.434/Hyd/2007 of Assessee is allowed for statistical purposes and ITA.No.486/Hyd/2007 of the Revenue is dismissed.