Chandra Poojari, Accountant Member - These cross appeals are directed against the order of the CIT(A)-V, Hyderabad, dated 15/02/2012 for assessment year 2007-08.
2. Briefly the facts of the case are that the assessee company engaged in the business of information technology enabled services, filed its return of income for the year under consideration on 03/11/2007 admitting total income of Rs. 1,50,72,101/- after claiming deduction u/s 10A amounting to Rs. 51,05,98,237/-. The Assessing Officer completed the assessment by determining the total income at Rs. 21,80,92,100/-.
3. Before the CIT(A), the assessee challenged the issue relating to reducing the bandwidth charges, leased line charges, internet charges etc. from export turnover while calculating deduction u/s 10A of the IT Act, should also be reduced from total turnover. The assessee also challenged the TP adjustment towards interest on funds given to subsidiaries and also interest on loans given to subsidiaries.
4. The Assessing Officer disallowed communication, internet, travelling and other expenditure from export turnover while calculating the deduction u/s 10 of the Act. The CIT(A) relying upon the decision in the case of Patni Telecom (P.) Ltd. v. ITO [2008] 22 SOT 26 (Hyd.), on which reliance placed by the assessee, held that the communication charges, internet charges and travelling expenditure should be reduced both from export turnover as well as from total turnover for the purpose of calculation of exemption u/s 10A of the Act.
5. As regards the addition with regard the interest on funds given to subsidiaries of Rs. 18,36,38,251/-, the CIT(A) deleted the addition on the ground that there is no evidence to show that the this amount was actually a loan given by the assessee.
6. As regards the addition with regard to the interest on loan given to subsidiaries of Rs. 2,31,66,591/-, the CIT(A) confirmed this addition by holding that the assessee could not substantiate its claim by showing evidence regarding the lower level of risk in its loans, therefore, there was no reason to interfere in the arm's length interest calculations at which Assessing Officer has calculated the notional interest.
7. Against the order of the CIT(A) both the revenue and the assessee are in appeal before us.
8. Ground No. 1 of revenue's appeal is that calculation of eligible exemption u/s 10A of the Act.
9. The Assessee had claimed exemption u/s 10A of the IT Act and it had not excluded communication and internet charges attributable to the delivery of computer software and expenses incurred in foreign exchange in providing the technical services outside India. The Assessing Officer excluded the said elements from export turnover. The Special Bench of this Tribunal at Chennai in the case of ITO v. Sak Soft Ltd. [2009] 30 SOT 55 (Chennai)(SB) held that the above elements are to be reduced both from export turnover as well as from total turnover for the purpose of calculation of exemption u/s 10A of the Act.
10. We have heard the arguments of both the parties and perused the record. The Special Bench in the case of Sak Soft Ltd. (supra) held "that for the purpose of applying the formula under sub-section (4), the freight, telecom charges or insurance attributable to the delivery of articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing the technical services outside India are to the excluded both from the export turnover and from the total turnover, which are the numerator and denominator respectively in the formula.". Therefore, we do not find any infirmity in the order of the CIT(A) and the order of the CIT(A) is hereby confirmed on this issue. Accordingly, the ground raised by the revenue is dismissed.
11. The next ground of the revenue is as follows:
"The CIT(A) ought to have appreciated the fact that the TPO has determined arm/s length interest @ 14% on Rs. 131,17,01,796/- amounting to Rs. 18,36,38,251/- i.e. interest on funds given to its subsidiaries in the form of share premium."
12. The facts relating to this ground are that the assessee made investments aggregating to Rs. 139,24,84,460/- in its subsidiaries consisting of share capital of Rs. 8,07,87,664/- and share premium of Rs. 131,17,01,796/-. In addition to this, the assessee also had given funds to its subsidiaries at Rs.16,54,75,651/-. The Assessing Officer observed that there was absolutely no justification with regard to payment of share premium and it is a deemed loan given without interest. According to the TPO it is not an arm's length transaction.
13. On appeal, the CIT(A) observed as follows:
"7.6 The first issue is whether the share premium paid was actually a disguised loan as has been held by the Transfer Pricing Officer. According to the order of the Transfer Pricing Officer, there is not a shred of evidence to prove that the share premium was actually a loan. The Transfer Pricing Officer has not even analyzed the accounts of the subsidiaries, nor has he calculated at any stage, the share value of the subsidiaries in question. He has merely stated that the 'taxpayer could not explain the economic rationale behind the payment of huge amounts of share premium in the subsidiaries in question with reference to recognized methods of share price valuation.'
With these conjectures the Transfer Pricing Officer concluded that the share premium was actually a loan.
7.6.1 From the above discussion, I do not find any evidence whatsoever which would give me any indication to conclude that the share premium was actually a loan. Even in the future no interest payments had been received nor is there any accounting treatment which shows that this amount was actually a debt. Therefore, I do not agree with the contention of the TPO or Assessing Officer that the share premium was a debt.
7.6.2 Having said that, it would be in the fitness of things to analyze the entire transaction and to get to the root of the matter.
7.6.3 Northgate India provides online advertisement solutions to advertisers and publishers. The Company generates audiences for advertiser's campaigns through networks of third party websites its own publishing web media and other online publishing partners. The company offers products and services that enable marketers to advertise and sell their products through most of the online marketing channels like display advertising, lead generation and marketing. The company also offers technology infrastructure tools and services that enable advertisers and advertising agencies to implement and manage their own online display advertising. This service facilitates the online management of website advertisement inventory by publishers.
Snapshot of company's financial performance during AY 2007-08 Table A
|
Particulars |
Amount in INR |
|
Operating income (excluding other income) |
805,721,743 |
|
Expenditure (excluding exchange loss and finance charges) (TC) |
300,844,253 |
|
Operating profit (OP) |
504,877,490 |
7.6.4 During the year in question, the appellant paid 8 crores as value for purchase of shares and Rs. 131 crores as share premium. I find that the appellant had valued the shares of the subsidiaries on the basis of discounted cash flow method and net asset value method. During the course of appeal proceedings, the Transfer Pricing Officer was asked to compute the accurate share prices of the various subsidiaries in question. The TPO expressed his inability to be able to do that. Accordingly, the appellant was asked to provide details of the projected earnings and the actual earnings for the various years so as to have an idea of the share prices. The discounted cash flow method takes into account the present value of the future cash flows.
7.6.5 From the above, it is clearly seen that there was vast variation in the actual earnings and what have been projected by the appellant in the DCS calculations. For example, for the FY 2006-07, in the case ofAxil1 Europe Limited the appellant had projected a profit which was 4229% or 42 times of the actual profits. Similarly, for Axilllnc for the FY 2006-07 the projection is 283% of the actual profits. Similar is the case with all the projections shown in the chart above. A simple perusal of the aforementioned chart will clearly show that when the discounted cash flow method is applied the share price projections will nowhere be close to the prices which the appellant has shown on which a huge share premium of 131 crores has been paid.
7.6.6 During the course of appeal proceedings, the appellant explained that there was a general downtrend in economy in the subsequent years and as such the projections of profits were proven to be inaccurate.
7.6.7 After having perused the considered the facts and arguments carefully, find that the share price calculations are not accurate and in fact there was absolutely no reason to give such a huge share premium. Clearly, the appellant has resorted to huge over projections of the future earnings in order to show an inflated share price relating to the subsidiaries. This has resulted in an absolutely wrong transfer of funds from the appellant to the subsidiaries. This needs to be considered for taxation in the hands of the subsidiaries. However, since the amounts have been drawn from the reserves of the appellant and there is no debit in the profit and loss account, there is no element of income in the hands of the appellant. Further, I have already held that there is no evidence to show that this amount was actually a loan given by the appellant. Therefore, in view of the above facts and circumstances, the addition of 18,36,38,251/- made on account of imaginary interest earnings is ordered to be deleted."
14. Against the order of the CIT(A), the revenue is in appeal before us.
15. The learned DR submitted that the funds given to subsidiaries without any interest is not proper, but, at least interest could have been charged @ 14% per annum and the fund has been given to the subsidiaries in the guise of share premium, which is nothing but interest free loan.
16. On the other hand, the learned counsel submitted that the CIT(A) has analysed the Discounted Cash Flow (DCF) method, based on the comparison of projected Earnings, before Interest and Tax as per the valuation report with the actual EBIT. He mentioned that the valuation report carried out by the valuer represents the revenues and the cash flows which would be additionally generated by the group as a whole through these subsidiaries located at U.S., U.K., and Hong Kong. He drew our attention to page 10 of the valuation report placed at pages 97,115,132 of the paper book wherein the Valuer has computed gross profit (revenue - cost of revenues) and cost of the revenue is defined to include the traffic acquisition cost, bandwidth cost, data center charges, traffic cost and software charges. Of the above, the data center charges, is the cost associated with running the data center by the assessee company. He submitted that profit earned through these subsidiaries were, based on the Function, Assets and Risk Analysis, stand allocated between the assessee and its subsidiaries in the manner provided in the transfer pricing report. According to him, margin of profit at the subsidiaries level revealed were only 2%, 1%, 2% and 1% while the margin without profits retained at the assessee level was 66%. In this connection, he drew our attention to the following comparison table:
INR (crore)
| Particulars |
March 2005* |
March 2006* |
March 2007 |
March 2008 |
Sales Turnover |
51.79 |
81.92 |
80.57 |
61.94 |
Operating Expenses ('OE') |
42.02 |
51.74 |
27.77 |
13.38 |
Operating Profits ('OP') |
9.77 |
30.18 |
52.80 |
48.56 |
% of OP/Sales Turnover |
19% |
37% |
66% |
78% |
% of OP/OE |
23% |
58% |
190% |
363% |
*The previous year (2005 & 266) immediately preceding the financial year 2006-07, in which the investments in subsidiaries were made.
17. We have heard the arguments of both the parties and perused the record. The main contention of the department is that the fund transferred to the subsidiaries on account of share premium without any interest and the assessee could not furnish any such analysis to show that the premium paid was at arm's length. The assessee has to prove the amounts advanced was actually towards premium and to substantiate that the shares of the subsidiaries actually command such premium in the open market in term of fair market value worked out as per the guidelines issued by the Controller of Capital Issues in the case of unquoted shares. The prescribed methods for determination of fair market value are either by net asset value (NAV) or by profit earning capacity value (PECV) methods. The taxpayer failed to furnish the valuation of the subsidiary companies in which shares were acquired as per these two methods. Unless the price paid as premium is justified in an arm's length situation, the same will be treated as NIL under CUP method as no independent party would like to pay such huge amounts in the form of premium without any basis. Therefore, the monies parked with its subsidiaries in the form of share premium have to be treated as loan transactions. Vide order sheet noting dated 28/06/2010 and 14/10/2010, the tax payer was asked to justify the funds given to its AEs in the form of share premium on the above lines. There is no compliance from the taxpayer. Being so, the TPO/Assessing Officer computed notional interest on that and disallowed the same. However, the CIT(A) considered certain datas furnished by the assessee and allowed the claim of the assessee. In our opinion, it is appropriate to remit the issue back to the file of the Assessing Officer for deciding the issue afresh. The assessee is directed to place all the necessary evidences before the Assessing Officer what was placed before the CIT(A) for considering the same by the Assessing Officer while adjudicating the issue.
18. The assessee's ground is against the action of the CIT(A) in confirming the addition on account of interest on loans given to subsidiaries of Rs. 2,31,66,591/-.
19. At the time of hearing, the learned counsel for the assessee has canvassed that the issue is squarely covered by the decision of the coordinate bench in case of M/s Four Soft Ltd. in ITA No. 1495/Hyd/2010 for AY 2006-07 vide order dated 9th September, 2011.
20. On the other hand, the learned DR has relied upon the order of the CIT(A).
21. We have heard both the parties and perused the record. We find that the issue is squarely covered by the decision of the coordinate bench in case of M/s Four Soft Ltd (supra) wherein the coordinate bench held as follows:
"19. We have considered the rival submissions and perused the materials available on record. We do not find any merit in the arguments of the learned departmental representative as we find that the ALP is to be determined for the international transaction, that is, on international loan and not for the domestic loan. Hence, the comparable, in respect of foreign currency loan in the international market, is to be LIBOR based which is internationally recognised and adopted. In our considered view, the DRP rightly directed the assessing officer to adopt the LIBOR plus for the purpose of TP adjustment. Our view is fortified by the decision of the Madras Bench in the case of Siva Industries (supra). We do not find any merit in the arguments of the learned counsel for the assessee that the DRP should have adopted the EURIBOR for the purpose of the TP adjustments, as we find that the mostly used and recognised benchmark rate for international loan is LIBOR based. Hence, the DRP rightly directed the assessing officer to adopt the LIBOR rates. We confirm the directions of the DRP. However, by considering the contentions of the learned counsel for the assessee that the actual LIBOR was 4.42% as against the 5.78% approved by the DRP, we find it proper to restore this issue to the file of the assessing officer, to verify the correctness of the claim made by the assessee company. In view of this matter, we remit this matter to the file of the assessing officer to verify the actual average LIBOR prevailed in the financial year relevant to the assessment year under consideration and adopt the interest rate 4.42% if the claim of the assessee is found correct. The ground raised by the assessee on this issue is partly allowed for statistical purpose."
22. Since the issue under consideration is identical to the case decided by the coordinate bench cited supra, we remit the issue back to the file of the Assessing Officer to consider the same in line with the material placed by the assessee before the CIT(A) and decide the issue in the light of the decision of the coordinate bench (supra). The assessee is directed to place all the material evidence before the Assessing Officer in support of its claim. This ground is allowed for statistical purposes.
23. In the result, appeal of the assessee being ITA No. 672/Hyd/12 is allowed for statistical purposes and the appeal of the revenue being ITA No. 634/Hyd/12 is partly allowed for statistical purposes.