2020 (7) TMI 330 - AT - Income Tax

High Court allows EPF and ESI deductions in tax returns

The Karnataka High Court ruled that employees' contributions towards EPF and ESI, made before the due date for filing income tax returns, are deductible ... Addition 36(1)(va) read with Section 2(24)(x) - delayed PF and ESI payments - payments of employees contribution by the Assessee towards provident fund and Employees State Insurance which are not deposited on or before the due date to the respective organizations but which are deposited before the due date for filing return of income u/s.139(1) - HELD THAT:- The Hon’ble Karnataka High Court in the case of CIT Vs. Sabari Enterprises [2007 (7) TMI 169 - KARNATAKA HIGH COURT]has taken the view that contributions made by the Assessee to PF and ESI are allowable deductions even though made beyond stipulated period as contemplated under the mandatory provisions off Sec.36(1)(va) read with Section 2(24)(x) of the Act provided such contributions are paid by the Assessee on or before the due date for furnishing the return of income as per Sec.139(1) of the Act. Decided in favour of assessee. Determination of arm's length price (ALP) in respect of international transaction of rendering software development services by the assessee to its Associated Enterprise (AE) u/s. 92 - Comparable selection - HELD THAT:- Referring to software development services provided by the assessee we are of the view that Persistent Systems Ltd. should be excluded from the list of comparable companies as into software products and software solutions and no segmental details were available and therefore the profit margin in the software development services segment could not be compared with the assessee's profit margin. RPT filter applied by the TPO - Related Party Transaction - As far as Tech Mahindra Ltd. is concerned, the learned counsel made a prayer that the related party transaction (RPT) of this company was more than 25% - it would be just and proper to set aside the order of DRP on this issue and remand the issue to AO/TPO for consideration of the contention of the assessee with regard to the exclusion of this company by application of RPT filter. Adjustment on account of working capital at 5.23% - In keeping with the OECD guidelines, endeavor should be made to bring in comparable companies for the purpose of broad comparison. Therefore the working capital adjustment as claimed by the Assessee should be allowed. We hold and direct accordingly. Exclusion of Larsen & Toubro Infotech Ltd., is not considered because this company was chosen by the Assessee as a comparable company in its TP study. Though the Assessee is entitled to challenge the inclusion even though it was chosen by the Assessee as comparable company, in the present case we do not wish to go into this question for the reason that by reason of the relief allowed to the Assessee the profit margin of the Assessee after working capital adjustment would be within ALP. Similarly, inclusion of ICRA techno Analytics Ltd., and Mindteck (I) Ltd., is not considered because by reason of the relief allowed to the Assessee the profit margin of the Assessee after working capital adjustment would be within ALP. Issues Involved:1. Disallowance of employees' contribution towards EPF under Section 36(1)(va).2. Transfer pricing adjustments and determination of Arm's Length Price (ALP).Detailed Analysis:Issue 1: Disallowance of Employees' Contribution towards EPFThe first issue raised by the assessee is whether payments of employees' contribution towards provident fund (PF) and Employees State Insurance (ESI) made after the due date but before the filing of the income return can be disallowed under Section 36(1)(va) of the Income-tax Act, 1961. The Karnataka High Court in CIT Vs. Sabari Enterprises has ruled that such contributions are allowable deductions if paid before the due date for furnishing the return of income under Section 139(1). Consequently, the Tribunal found merit in the assessee's claim and allowed the deduction. This issue, although not raised before the Dispute Resolution Panel (DRP), was deemed permissible to be raised in the second appeal as per the precedent set by Avery Cycle Industries Ltd Vs. CIT.Issue 2: Transfer Pricing Adjustments and Determination of ALPThe remaining grounds of appeal pertain to the determination of the ALP for international transactions involving software development services rendered by the assessee to its Associated Enterprise (AE) under Section 92 of the Act. The Tribunal noted that the Transactional Net Margin Method (TNMM) was the most appropriate method for determining the ALP, with the Profit Level Indicator (PLI) being the Operating Profit (OP) to Operating Cost (OC) ratio.The assessee's OP/OC ratio was initially 15.83% but was revised to 12.15% by the Transfer Pricing Officer (TPO) after including foreign exchange loss as part of operating expenditure. The TPO's action was upheld by the DRP and found correct by the Tribunal.The TPO selected 7 comparable companies and determined the arithmetic mean of their profit margins to be 20.90%. After adjusting for working capital at 5.23%, the adjusted margin was 15.67%. The TPO's computation resulted in an addition of Rs. 74,69,142 to the assessee's income due to a shortfall in the price charged in the international transaction.The assessee contested the inclusion of certain comparables and the denial of working capital adjustments by the DRP. Specifically, the assessee sought the exclusion of Persistent Systems Ltd. and Tech Mahindra Ltd. and the inclusion of ICRA Techno Analytics and Mindteck (India) Ltd.Exclusion of Persistent Systems Ltd.The Tribunal referred to the ITAT Hyderabad Bench's decision in M/s. EPAM Systems (I) P. Ltd. v. ACIT, which excluded Persistent Systems Ltd. due to its involvement in software products and solutions without segmental details. The Tribunal agreed with this precedent and excluded Persistent Systems Ltd.Exclusion of Tech Mahindra Ltd.The Tribunal considered the assessee's argument that Tech Mahindra Ltd. had a Related Party Transaction (RPT) ratio of 42.88%, failing the RPT filter applied by the TPO. The Tribunal remanded this issue to the AO/TPO for reconsideration based on the RPT filter.Working Capital AdjustmentThe Tribunal addressed the DRP's denial of working capital adjustment, which the TPO had allowed at 5.23%. Citing the ITAT Bangalore's decision in Huawei Technologies (India) Pvt. Ltd. Vs. DCIT, the Tribunal emphasized the necessity of working capital adjustments to account for differences in time value of money between the tested party and comparables. The Tribunal directed the TPO to allow the working capital adjustment as claimed by the assessee.Other ComparablesThe Tribunal did not consider the exclusion of Larsen & Toubro Infotech Ltd. and the inclusion of ICRA Techno Analytics Ltd. and Mindteck (India) Ltd. because the relief granted regarding working capital adjustment rendered the assessee's profit margin within the ALP range.ConclusionThe appeal was partly allowed, with specific directions for the exclusion of Persistent Systems Ltd., reconsideration of Tech Mahindra Ltd. based on the RPT filter, and allowance of the working capital adjustment. The Tribunal's decision was pronounced on 3rd July 2020.