$ 29 * IN HIGH COURT OF DELHI AT NEW DELHI Decided on : 27.03.2015 + ITA 217/2014 COMMISSIONER OF INCOME TAX-II Appellant Through: Sh. Kamal Sawhney, Sr. Standing Counsel. Versus MCKINSEY KNOWLEDGE CENTRE INDIA PVT. LTD. ..Respondent Through: Sh. Porus Kaka, Sr. Advocate with Sh. Divesh Chawla and Sh. N. Ganapathy, Advocates. CORAM: HON'BLE MR. JUSTICE S. RAVINDRA BHAT HON'BLE MR. JUSTICE R.K. GAUBA MR. JUSTICE S. RAVINDRA BHAT (OPEN COURT) % 1. This appeal under Section 260A of Income Tax Act, 1961 by Revenue, challenges order dated 13.09.2013 of Income Tax Appellate Tribunal ("ITAT") in ITA No.2195/Del/2011 for assessment year (AY) 2006-07. ITAT by impugned order confirmed order of Commissioner of Income Tax (Appeals) ( CIT(A) ) and allowed assessee s claim for certain deductions under Section 10A of Income Tax Act, 1961 (hereafter referred to as Act ). 2. Briefly, facts of case are that, Assessee Company was incorporated on 15.02.1999 under Companies Act, 1956. Assessee ITA 217/2014 Page 1 is wholly owned subsidiary of McKinsey Holdings Inc. which is in turn held by McKinsey & Co., Inc. Assessee was incorporated in India to provide various support services in area of export computer software, IT- enabled services including data processing, customization of data, back office operations and acting as support center to provide research analysis and information to various McKinsey entities/holdings across globe. Assessee is duly registered as unit exporting computer software under Software Technology Parks (STP) scheme of Ministry of Communication and Information Technology, by Government of India on 20.04.1999 and launched commercial operations on 01.03.2000. It filed its return of income declaring total income of ` 69,49,857/- which was processed under Section 143(1) of Act and selected for scrutiny. statutory notice under Section 143(2), dated 26.11.2007 was issued and served upon Assessee. Assessee filed objection against draft of proposed order dated 18.12.2009 before Dispute Resolution Panel ( DRP ) on 29.01.2010 and later withdrew same on 23.02.2010. After accepting withdrawal, Assessing Officer ( AO ) was allowed to pass order as per law. Assessing Officer computed Assessee s income at ` 27,21,57,968/- and completed assessment after disallowing deduction claimed u/s 10A and also, making additional revision of income by ` 59,09,890/- pertaining to transfer pricing (TP) adjustments. Assessee appealed against order of AO; CIT (A) by its order on 28.02.2011, deleted both additions. 3. Being aggrieved with said order, Revenue appealed to ITAT which concurred with findings of CIT (A), confirmed its order and dismissed appeal, by its impugned order dated 13.9.2013. ITAT ITA 217/2014 Page 2 held that appellant was entitled to claim enhanced deduction based on facts indicated, which reflect upon nature of service rendered as covered under Section 10A which is mentioned by CBDT notification. ITAT acknowledged role of these services which added value for customers generated through networked software. Further, applying principle of consistency, it was held that Assessee deserved deduction claimed by it under Section 10A as it had been granted in previous years. With regard to comparables, ones initially rejected by AO were admitted based on grounds that all of them were functionally similar and only varied in terms of certain common parameters considered for assessment. It is against this order that Revenue is in appeal before this Court. 4. Revenue challenges both deletions made to assessment made by AO. It argues that ITAT erred in deleting addition of ` 26,32,11,737/-, thereby allowing deduction under Section 10A of Act ignoring fact that Assessee is not fundamentally engaged in IT enabled services and therefore not entitled to deduction and further questioned deletion of additional ` 59,09,890/- made by Transfer Pricing Officer ( TPO ) u/s 92CA on account of Transfer Pricing Adjustment and acceptance of comparables that were initially rejected in AO s assessment. 5. question of law that arises before this Court for consideration is whether deduction should be allowed to Assessee under Section 10A, on ground that it is indeed entitled to benefit under particular provision. Revenue argues that for Assessee to be eligible for such deduction, services so rendered must be IT enabled and role of ITA 217/2014 Page 3 networked software within provision is seen as vital. Emphasis is drawn to nature of service and value added to customer is taken into account and assessment order reflects IT enabled services as being equal to solutions whose added value for customer is generated significantly through use of information and communication technologies that used networked software. It was contended that use of networked software in case of Assessee is limited to transmission of customized data to its parent company. 6. Assessee placed reliance upon several factors, i.e that it is duly established STP unit which is engaged in provision of IT-enabled services to parent company acting as its back office and thereby entitled to benefit under expanded definition of term computer software . Its activities are in nature of data processing, customization of data, acting as back office of parent company and acting as support center to parent company. AO in order questioned Assessee s eligibility for said deduction and relied upon decisions in Rao Bahadur Ravalu Subba Rao v. CIT1 and Karamchari Union v. Union of India2 where Supreme Court held that eligibility has to be seen within provisions of Act as it is self-contained code. 7. And as for purpose of applicability of Section 10A of Act, question in consideration was not nature of services provided by company in general but nature of services being exported or transmitted outside of India; and whether or not it falls within ambit of services of 1 [1956] 30 ITR 163 (SC) 2 [2000] 243 ITR 143 (SC) ITA 217/2014 Page 4 similar nature within meaning of Explanation 2, to Section 10A of Act. provision reads as follows: 10A. Special provision in respect of newly established undertakings in free trade zones, etc. (1) Subject to provisions of this section, deduction of such profits and gains as are derived by undertaking from export of articles or things or computer software for period of ten consecutive assessment years beginning with assessment year relevant to previous year in which undertaking begins to manufacture or produce such articles or things or computer software, as case may be, shall be. allowed from total income of assessee XXXXXX XXXXXX XXXXXX Explanation 2 - For purposes of this section, - (i) "computer software" means,-- (a) Any computer programme recorded on any disc, tape, perforated media or other information storage device; or (b) Any customized electronic data or any product or service of similar nature, as may be notified by Board, which is transmitted or exported from India to any place outside India by any means. 8. perusal of above provision and explanation implies that two conditions so mentioned must be cumulatively satisfied in order to be eligible for deduction. While Assessee claims itself to be covered under broader definition of Computer Software and more particularly under clause (b) of Explanation 2 under services of similar nature , Assessment Order was based on decisions in S. Gopal ITA 217/2014 Page 5 Reddy v. State of Andhra Pradesh3, K. P. Varghese v. ITO4 and Indian Hotels Co. Ltd. v. ITO5 and relying upon purposive approach to interpret Act reflects that services are being performed in India and end product, which is not software within meaning of Section 10A is being exported outside India and thus not making services of similar nature as such services can only be rendered on real time basis electronically to qualify for purpose of Section 10A. Also, TPO, by his order of 92CA(3) dated 09.10.2009 advised concerned officer to make upward adjustment of ` 59,09,890/- to total income declared and AO allowed adjustment. Apart from holding that Assessee company has furnished inaccurate particulars (the report of auditor considered non est) with view to evade tax, AO also initiated penalty proceedings under section 271(1) (e) of I.T. Act, 1961 for filing inaccurate particulars and concealment of income. 9. Aggrieved by Assessment Order, Assessee appealed against that to CIT (A) who thereby held that by making disallowance, AO erroneously concluded that appellant is engaged in business of analysis of financial and business information and not in business of data processing. CIT (A) in its findings, notes that it is evident that appellant is customizing data, what is accessed by appellant in databases and what is delivered to its parent company are two different products, i.e. data is customized to suit needs of requester and thereafter exported out of India. 3 [1996] 6 JT 268 4 [1981] 13 I ITR 597 (SC) 5 [2000] 245 ITR 538 (SC) ITA 217/2014 Page 6 10. This Court, while considering question involved in applicability of deduction under Section 10A notes that in CIT v. M.L. Outsourcing Services (P) Limited6 assessee s contention of entitlement to claim deduction u/s 10A of IT Act, 1961 read with Notification No. bearing SO 890 (E) dated 26th September, 2000 was upheld. In above mentioned case, it was observed that, Board has issued notification as per mandate and empowerment under Section 10A and this is not case of issue of circular under Section 119, which are issued for different purposes and have another purport. Notification is piece of delegated legislation and to that extent cannot be contrary to principal enactment nor can it whittle down effect of same. Albeit, clause (b) of Explanation 2 to Section 10A has been worded in manner which enforces view and opinion that Legislature, in their wisdom, has left it to Board to decide which product or services of similar nature would qualify and should be treated as falling under clause (b), in addition to customised data processing. intention of Legislature was not to constrain or restrict but to enable Board to include several services or products of similar nature in ambit of provision. This is what precisely Board has done when it used expression, information technology enabled products or services in notification. 11. court relied on circular issued by CBDT explaining provisions of Finance Act, 2000, and held that interpretation of term 'manufacture or produce of article or thing or computer software' by tax authorities should be guided by intention of legislature (including pronouncements of Central Government while notifying STP scheme) and directions/notifications of CBDT. Furthermore, deductions on same grounds were disallowed by 6 INCOME TAX APPEAL NO. 1255/2011 ITA 217/2014 Page 7 AO and later permitted by CIT (A) and upheld by ITAT for AY 2002-2003 and subsequently examined and allowed in preceding AYs 2003-04, 2004-05 and 2005-06 by AO himself and since there has been no change either in facts or circumstances of case of appellant accordingly, in view of foregoing appellant is eligible to claim deduction under section 10A of Act being sixth year of claim. Therefore, CIT (A) was of opinion that claim of assessee that all of its business income or profits from business or profession are exempt under section 10A of Act is correct and assessee is entitled to exemption and thereby reversed finding of AO and directed him to allow exemption to whole of assessee s profit as computed under said head 'profit and gains of business. In present case, ITAT held that, There is no dispute on services provided by Assessee. modus operandi of Assessee, as noted earlier while considering submissions made before ld. CIT(A), makes it very clear that assessee was acting as back office of its parent company by providing customized electronic data as per request received by it from parent company. It is clear from modus operandi that what was accessed by assessee at STP Unit and what was delivered to Mckinsey (Parent Company) after conversion took place were two different products/services which is described as customization of data/data processing. STP Unit undertook series of operations on data received from various data bases before it was finally delivered to customer. Thus, there was value addition made by STP Unit on data. We, therefore, are not in agreement with findings of AO that there was no value of addition on data obtained from various data base from parent company. Assessee acted as back office of parent company and provided support services to its parent company. Therefore, Id. CIT (A) rightly held that activities of ITA 217/2014 Page 8 assessee squarely fall within expanded definition of 'computer software'.. ITAT also relied on principle of consistency (Ref Assistant Commissioner of income-tax v. NGC Network (India) (P)Ltd7, Lenovo (India) P. Ltd v. Assistant Commissioner of Income-tax8, Deputy Commissioner of Income-tax v. Cheil Communication. India P.Ltd9 etc.) 12. CBDT circular relied upon by assessee in present case, reads as follows: "S.O.890(E) - In exercise of powers conferred by clause (b) of item (l) of Explanation 2 of section 10A. Clause (b) of item (l) of Explanation 2 to section 10B and clause (b) to Explanation to section 80HHC of Income-tax Act, 1961 (43 of 1961), Central Board of Direct Taxes hereby specifies following Information Technology enabled products or services as case may be for purpose of said clauses namely :- (l) Back-Office Operations (ii) Call Centres (iii) Content Development or animation (iv) Data Processing (v) Engineering and Design (vi) Geographic Information System Services (vii) Human Resources Services (viii) Insurance claim processing 7 [2010] taxmann.com 140 (Mum.) 8 46 SOT 289/21 taxmann.com 256 (Bang.) 9 140 ITD 127/11 taxmann.com 205 (Delhi) ITA 217/2014 Page 9 (ix) Legal Databases (x) Medical Transcription (Xl) Payroll (xii) Remote Maintenance (xiil) Revenue Accounting (xiv) Support Centres and (xv) Web-site Services. There is no dispute with respect to findings arrived at by lower authorities. assessee is involved in providing back office support and thereby entitled to benefit under definition of term computer software . Its activities are in nature of data processing, customization of data, acting as back office of parent company and acting as support center to parent company. Clearly it could not have been deprived of benefit of Section 10A, as is argued by revenue. This contention is accordingly rejected as unmerited. 13. So far as Arms Length Price (ALP) determination and Transfer Pricing upward adjustments, are concerned, in its TP documentation, assessee determined Transactional Net Margin Method (TNMM) as most appropriate method to determine ALP of international transaction pertaining to provision of IT support services. TPO in order accepted only 7 out of 11 comparable companies and rejected rest based on reasons that one of them, Fortune Infotech Ltd. ( FIL ) had different financial year ending, other two - Kirloskar Computer Services Ltd ( KCSL ) and Mercury Outsourcing Management Ltd. ( MOML ) had turnover of less than `1 Crore and finally, Genesis ITA 217/2014 Page 10 International Corporation Ltd ( GICL ) was rejected because it seemingly had negative growth graph. 14. Revenue is in appeal before this Court questioning admissibility of above mentioned comparables while computing Arm s Length Price regarding IT Support services after TPO and AO rejected above mentioned companies but was later allowed by CIT (A) and ITAT. While AO had confirmed findings of TPO, Ld. CIT(A) after considering Assessee's submissions accepted all four companies rejected by TPO. revenue submits that Fortune Infotech Ltd. was correctly rejected by TPO because company had different financial year ending on December, 2006, whereas Assessee s financial year ended on March, 2006. There is nothing shown to court that supports revenue s argument that ITAT fell into error in holding that if comparable is following different financial year then same cannot be included in list of comparables selected for benchmarking international transaction. Therefore, ITAT has held that if comparable is functionally same as that of tested party then same cannot be rejected merely on ground that data for entire financial year is not available. If from available data on record, results for financial year can reasonably be extrapolated then comparable cannot be excluded solely on ground that comparables have different financial year endings. 15. As far as KCSL and MOML are concerned, (again, rejected by TPO) typically filter of companies with less than turnover of `1 crore is applied for selecting comparables. According to available data, turnover of these two companies was less than Rupees one crore. However, ITA 217/2014 Page 11 if this filter is applied then, as submitted by Counsel for Assessee, companies with higher turnover also should have been rejected which was not case in said TP adjustments. Rule 10B (2) to (4) of Income Tax Rules are relevant for this purpose. They are extracted below: 10-B(2) For purposes of sub-rule (1), comparability of international transaction with uncontrolled transaction shall be judged with reference to following, namely :-- (a) specific characteristics of property transferred or services provided in either transaction; (b) functions performed, taking into account assets employed or to be employed and risks assumed, by respective parties to transactions ; (c) contractual terms (whether or not such terms are formal or in writing) of transactions which lay down explicitly or implicitly how responsibilities, risks and benefits are to be divided between respective parties to transactions ; (d) conditions prevailing in markets in which respective parties to transactions operate, including geographical location and size of markets, laws and Government orders in force, costs of labour and capital in markets, overall economic development and level of competition and whether markets are wholesale or retail. (e) extent to which reliable and accurate adjustments can be made to account for differences, if any, between international transaction or specified domestic transaction and comparable uncontrolled transaction or between enterprises entering into such transactions; (f) nature, extent and reliability of assumptions required to be made in application of method." ITA 217/2014 Page 12 Rule 10B (3) stipulates third step, and spells out when TPO is obliged to hold uncontrolled transaction as comparable with others. This provision reads as follows: (3) uncontrolled transaction shall be comparable to international transaction or specified domestic transaction if- (i) none of differences, if any, between transactions being compared, or between enterprises entering into such transactions are likely to materially affect price or cost charged or paid in, or profit arising from, such transactions in open market; or (ii) reasonably accurate adjustments can be made to eliminate material effects of such differences. Rule 10B (4) provides what should be basis of calculations in terms of data, its contemporaneity, etc. It stipulates that: (4) data to be used in analysing comparability of uncontrolled transaction with international transaction shall be data relating to financial year in which international transaction has been entered into: Provided that data relating to period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have influence on determination of transfer prices in relation to transactions being compared. It is evident, therefore, that functional similarity of comparable entity is emphasized; every effort must be made in ALP determination to ensure that material effects of differences between tested party and comparable must be eliminated. In our opinion, ITAT did not fall into ITA 217/2014 Page 13 error in holding that two comparables could not be rejected on ground relating to turnover threshold of `1 Crore. 16. In case of GICL, TPO in AY 2006-07 rejected this comparable on ground that company was in negative phase of growth which premise is strongly disputed by assessee and has not been refuted by Department. But based on Annual Report, 2006 available to Court, company exhibits considerable rise in income over past year. Under such circumstance, this Court finds that this company as comparable was wrongly rejected by TPO on grounds that it is currently in negative growth phase. 17. For aforesaid reasons, this Court finds that questions of law sought to be urged by Revenue do not arise in circumstances; appeal is accordingly dismissed without any order as to costs. S. RAVINDRA BHAT (JUDGE) R.K. GAUBA (JUDGE) MARCH 27, 2015 ITA 217/2014 Page 14 Commissioner of Income Tax-II v. Mckinsey Knowledge Centre India Pvt. Ltd