IN INCOME TAX APPELLATE TRIBUNAL C BENCH BANGALORE BEFORE SHRI ARUN KUMAR GARODIA, ACCOUNTANT MEMBER AND SHRI PAVAN KUMAR GADALE, JUDICIAL MEMBER ITA No. 2883/Bang/2018 Assessment Year 2008-09 M/s. SAP Labs India Pvt. Deputy Ltd., Commissioner of No. 138, Export Promotion Vs. Income Tax, Industrial Park, Whitefield, Range 12 (3), Bangalore 560 066. Bangalore. PAN: AAFCS3649P APPELLANT RESPONDENT Assessee by Shri Sumeet Khurana, CA Revenue by Shri Pradeep Kumar, CIT (DR) Date of hearing 23.07.2019 Date of Pronouncement 28.08.2019 ORDER Per Shri A.K. Garodia, Accountant Member This appeal is filed by assessee which is directed against order of ld. CIT(A)-6, Bangalore dated 29.11.2017 for Assessment Year 2008-09. 2. grounds raised by assessee are as under. grounds hereinafter taken by Appellant are without prejudice to one another. 1. That order passed by learned Commissioner of Income Tax (Appeals) - IV, Bangalore NIT (Appeals)'), under section 250 of Income Tax Act, 1961 (Act) to extent prejudicial to Appellant, is bad in law and liable to be quashed. Transfer Pricing 2. That on facts and circumstances of case, learned AO and learned CIT (Appeals)erred in upholding approach of learned Transfer Pricing Officer ("the learned TPO") and adjustment of INR 486,177,068 made to transfer price of Appellant in respect of its software development services provided to its Associated Enterprises (`AEs') 3. Upholding learned TPO's approach of not excluding foreign exchange gain/loss from comparable M/s. Sasken Communication Technologies Limited even though company has realised income from hedging activity. ITA No. 2883/Bang/2018 Page 2 of 8 3. It was submitted by ld. AR of assessee that copy of written submissions filed by assessee before ld. CIT(A) on 17.09.2014 is available on pages 217 to 223 of paper book and in particular, our attention was drawn to page no. 222 of paper book and it was pointed out that this was submission made by assessee before ld. CIT(A) that assessee realizes foreign exchange gain / loss directly as result of conversion of sales proceeds from export of services whereas comparable companies realize foreign exchange gain / loss from additional function of treasury activity in nature of hedging i.e. entering into forward contracts which they perform to mitigate their risk arising on account of foreign exchange fluctuation and therefore, this was request of assessee that any income arising on account of such additional hedging activity should not be considered in computation of mark-up on total cost of comparable companies for purpose of determination of arm s length price. He submitted that on this aspect, there is no decision of ld. CIT(A) and in this regard, our attention was drawn to page no. 9 of order of ld. CIT(A) and it was pointed out that this submission was reproduced by ld. CIT(A) but while deciding issue, no finding is given in this regard and hence, matter may be restored back to file of ld. CIT(A) for fresh decision. ld. DR of revenue supported order of ld. CIT(A). 4. We have considered rival submissions. First of all, we reproduce para no. 6 from order of ld. CIT(A) because in this para, ld. CIT(A) has reproduced written submissions filed by assessee before him. This para reads as under. 6. During appellate proceedings, appellant filed written submission, against additions made by AO. portion of same is reproduced as under:- Appellant refers to captioned report submitted by learned TPO to your goodselfs office, wherein learned TPO has provided his response of considering foreign exchange gain/loss earned by comparable companies (Persistent Systems Limited and Sasken Communication Technologies Limited (Segment) as operating income even though same has been earned on account of hedging activity. Appellant in this regard would like to file its submission against findings of learned TPO in aforementioned remand report. ITA No. 2883/Bang/2018 Page 3 of 8 learned TPO in his report has mentioned that comparable companies are engaged in business line similar to that of Appellant, i.e. software development services and does not carry out separate business activity of hedging. In regard, Appellant would like to submit that comparable companies no doubt are not engaged in business of financing activity as separate segment, i.e. speculation, hedging, etc. However, in order to mitigate risk arising on account of foreign exchange fluctuation, comparable companies enter into forward contracts in order to mitigate or hedge risks from foreign exchange fluctuations. Hence, as result of carrying out this hedging activity, comparable companies realize exchange gain/loss. On contrary, as acknowledged by learned TPO himself, Appellant did not have policy of hedging during relevant year and realised foreign exchange fluctuations was on account of conversion of sale proceeds earned by Appellant from Associated Enterprises ("AEs"). Based on above, your goodself would appreciate that comparable company realizes foreign exchange gain/loss from additional function of treasury activity in nature of hedging i.e. entering into forward contracts which they perform to mitigate their risk arising on account of foreign exchange fluctuation and not from fluctuations on account of business operation. Further, in this regard, Appellant would like to draw your goodself s attention towards remand report wherein learned TPO, himself has acknowledged that comparable companies enters into forward contract in order to manage its foreign exchange exposures in line with its hedging policy. Based on above, your goodself would appreciate that comparable companies carry out additional function of entering into forward contract as compared to Appellant. Additionally, it is submitted that it is not necessary that function is recognized as activity/function only if same is reported/carried out as separate segment in financial statement. mere fact that comparable companies have mentioned in financial statement that they carry out hedging activity by way of entering into forward contract in itself entails that company carry out hedging function. Further, learned TPO in his report has mentioned that policy undertaken by these comparable companies is not to make profit from currency movement but to ensure foreign exchange exposures on exports and imports are managed through hedging policy. In this regard, Appellant would like to submit that intention or motive to carry out activity would not be criteria to determine whether function/activity is carried out. Based on perusal of annual report of comparable companies it is ITA No. 2883/Bang/2018 Page 4 of 8 evident that comparable companies have carried out additional hedging activity as comparable to that of Appellant. Appellant would also like to submit that while intention of comparable companies may not be to earn profit but to mitigate foreign exchange exposure, on perusal of annual report, it is clearly evident that comparable companies have earned profit dciring relevant years from this hedging activity. relevant extract of annual report in reproduced below, for your goodself's ready reference. Persistent systems Limited Other income increased to Rs. 269.35 Million during year as compared to Rs. 20.87 Million in previous year mainly due to exchange gain of Rs. 221.54 Million derived by Company from forward currency contract as per its hedging policy. Following table shows details of significant changes in other income under different heads. (In Rs. Million) Financial year Financial year Particulars 2007-08 2006-07 Income from investment of funds 26.44 8.56 Foreign exchange gain (net) 221.54 - Profit on sale of assets 1.05 4.12 Provision written back 14.87 7.26 Miscellaneous income 5.45 0.93 Total 269.35 20.87 Sasken Communication Technologies Limited Other Income and Exchange Gain Other income and exchange gain amounted to Rs.542.73 Lakhs and Rs. 1,799.93 Lakhs respectively, constituting 1% and 3.2% of total revenues during year ended March 31, 2008. average investments in FY 06-07 were higher as Company had invested IPO proceeds in mutual funds, until August 2006, when proceeds were utilized for acquisition of Sasken Finland. Company manages its foreign exchange exposures in line with its hedging policy. policy is not so much to make profit from currency movements but to ensure that foreign exchange exposures on exports and imports are properly monitored, limiting risks to tolerable levels. Thus, risk limitation/reduction is prime objective. exchange gain is primarily on account of exchange differences on forward ITA No. 2883/Bang/2018 Page 5 of 8 contracts. FY 07-08 witnessed rupee appreciation of around 11.5% as compared to FY 06-07. Further, Appellant has also enclosed relevant page of annual report, i.e. Page no 58 of annual report of Persistent Systems Limited (Annexure A) and Page no 164 of annual report of Sasken Communication Technologies Limited (Segment) (Annexure B), for your goodself's reference. Based on above, your goodself would appreciate that comparable companies realizes foreign exchange gain/loss from hedging activity i.e. entering into forward contracts and not from business activity, i.e. software development services as in case of Appellant." 5. issue in dispute was decided by ld. CIT(A) as per para nos. 7 to 19 of its order which are also reproduced hereinbelow for ready reference. 7. During appellate proceedings, remand report was received from TPO on 11/03/2015. same has been considered. 8. grounds of appeal, appellant's statement of facts, written submission, AO's observations / explanations, remand report of TPO, appellant's rejoinder to TPO's remand report and legal position have been duly considered. 9. solitary issue to be adjudicated in appeal concern appellant's grievance that AO computed arm's length price without considering mark up on total cost of final set of comparable companies. 10. Perusal of records reveal that Ld CIT(A) had directed AO to treat foreign exchange gain/loss as forming part of operating revenue/cost relying on decision of Tribunal in case of Trilogy E Business where Hon'ble ITAT had directed that foreign exchange gain or loss should be considered as operating revenue or cost while computing operating margin of assessee as well as comparable 11. In this context, it is noted that TPO had passed Order Giving Effect consequent to CIT (A) 's order dated 23/4/2013. In Order Giving Effect, appellant was allowed relief to extent of Rs. 52,37,09,285/- from Arms Length Price addition of Rs. 100,98,86,353/-. 12. appellant in its ground had raised issue that AO computed arm's length price without considering mark up on total cost of final set of comparable companies. 13. It may be noted that appellant is engaged in business of providing software development and related services to SAP AG and its subsidiaries. As per TP document. appellant is ITA No. 2883/Bang/2018 Page 6 of 8 remunerated on cost plus 6 percent basis for software development services provided to SAP group companies. appellant is registered under Software Technology Parks India scheme and is claiming tax holiday benefit in respect of profits earned by it from software development and related services SAP labs India has Research & Development (R&D) services agreement with SAP AG dated 01/04/2001 with amendment on 01/04/2005 as per which SAP labs India is remunerated at cost plus basis for services provided. 14. In this context, it may be noted that Remand Report was received from TPO dated 02/03/2015 wherein it was stated that Foreign Exchange gain or loss is attributable to operating business of rendering software development services but this cannot be held as derived from operating business Software Development. Accordingly, though there is no denying fact that foreign exchange gain or loss is related to operating business, it is revenue in nature and hence taken into consideration while computing net profit of appellant but it is not derived from operating activity and therefore, while computing profit from operating business it must be excluded. Foreign exchange gain or loss can be compared with contribution in profit of working capital. While computing operating profit element of gain or loss due to working capital employed is excluded from profit margin as it is not derived from operating business activity. 15. Further, TPO has also brought out fact that comparable companies' principal business was to provide software development and related services. For providing such services, invoices of its AEs in foreign currency on remittance is converted into Indian currency as per requirement. Therefore, foreign exchange gain/loss realized by appellant is consequence of contractual arrangement and not from any other separate activity. appellant's PLI is worked out at 7.40% by TPO which includes foreign exchange gain, which was shown as other income by appellant. Hence, same procedure was followed for computation of PLI of comparables PLI also, i.e., taking foreign exchange gain as operating income. Due to above reasons contentions of appellant was not accepted. If foreign exchange gain has to be treated to be non operating in nature same should also be applicable in case of appellant also 16. In this context, it may be noted that while passing Order Giving Effect to CIT(A)'s order, TPO had verified Annual Reports, of Mis Persistent Systems Limited and Sasken Communications Technologies Ltd. TPO noted that these companies are in comparable business activity in line with that of appellant and does not carry out separate business activity of hedging as claimed by appellant company. contention of appellant that comparable company Persistent Systems Limited is making profit ITA No. 2883/Bang/2018 Page 7 of 8 from hedging activity was found to be incorrect and as per Annual reports of comparable company, its functions have been clearly stated. It was also stated that it manages its foreign exchange exposures in line with its hedging policy. This policy, it states was not to make profit from currency movements but to ensure that foreign exchange exposures on exports and imports are properly monitored by hedging policy. In case of M/s Sasken Communication Technologies Limited (segment), claim that said comparable was making profit from hedging activity is incorrect and as per Annual reports of comparable company, it's functions have been clearly stated to be that of company which derived income mainly due to exchange gain derived from forward contract as per hedging policy and not from separate hedging activity. Hence contention of appellant company was found to be incorrect by TPO. 17. In its rejoinder to TPO's remand report, appellant company states that comparable companies 'in order to mitigate risk arising on account of foreign exchange fluctuation, enter into forward contracts in order to mitigate or hedge risks from foreign currency fluctuation'. 18. rejoinder of appellant company to TPO's remand report has been considered. However, it is noted that appellant company has not rebutted fact that Annual Reports of comparable companies (Persistent Systems Limited and Sasken Communication Technologies Ltd show that these are in comparable business activity in line with that of appellant company and does not carry out separate business activity of hedging as claimed by appellant company. 19. It is noted that appellant company's PLI was worked out at 7.40% by TPO which included foreign exchange gain shown as other income by appellant. It is also noted that same procedure was followed for computation of PLI of comparable companies. In view of these facts, and based on remand report of TPO, contentions of appellant are found to be untenable and hence same are rejected. Hence, no interference in TPO/ AO's order is called for since no infirmity arose. 6. In para no. 15 of his order, ld. CIT(A) has stated that assessee s PLI is worked out at 7.40% by TPO which includes foreign exchange gain, which was shown as other income by assessee and hence, same procedure was followed for computation of PLI of comparable s PLI also i.e. taking foreign exchange gain as operating income and due to above reasons, contentions of assessee was not accepted. He has also held that if foreign exchange gain should be treated as non-operating in nature in case of comparables, then same should also be applicable in case of assessee also but he has not given any finding on this aspect of assessee s claim that receipt of foreign exchange gain by assessee is on ITA No. 2883/Bang/2018 Page 8 of 8 account of conversion of sales proceeds from export of services whereas foreign exchange gain in case of comparable is on account of foreign exchange gain / loss from additional function of treasury activity in nature of hedging i.e. entering into forward contracts which they perform to mitigate their risk arising on account of foreign exchange fluctuation. This argument of assessee should have been addressed by ld. CIT(A) in his order after examining relevant facts even if this argument is not finding his favour. Hence we feel that in facts of present case and in view of above discussion, matter should go back to file of ld. CIT(A) for fresh decision by way of speaking and reasoned order on all aspects of matter and hence, we set aside order of ld. CIT(A) and restore matter back to his file for fresh decision with direction that ld. CIT(A) should pass speaking and reasoned order considering all arguments of ld. AR of assessee. Needless to say, adequate opportunity of being heard should be provided by ld. CIT(A) to both sides. 7. In result, appeal filed by assessee is allowed for statistical purposes. Order pronounced in open court on date mentioned on caption page. Sd/- Sd/- (PAVAN KUMAR GADALE) (ARUN KUMAR GARODIA) Judicial Member Accountant Member Bangalore, Dated, 28th August, 2019. Copy to 1. Appellant 4. CIT(A) 2. Respondent 5. DR, ITAT, Bangalore 3. CIT 6. Guard file By order Assistant Registrar, Income Tax Appellate Tribunal, Bangalore. SAP Labs India Pvt. Ltd. v. Deputy Commissioner of Income-tax, Range-12(3), Bangalore