Income Tax Appellate Tribunal - Delhi
Rampgreen Solutions Pvt. Ltd., Delhi vs Assessee on 4 November, 2015
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ITA no. 1066/Del/2015
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH "I-2" NEW DELHI
BEFORE SHRI S.V. MEHROTRA : ACCOUNTANT MEMBER
AND
SHRI A.T. VARKEY: JUDICIAL MEMBER
ITA no. 1066/Del/2015
Asstt. Yr: 2010-11
M/s Rampgreen solutions Pvt. Ltd. Vs. DCIT Circle 20(2),
(Erstwhile vCustomer Services New Delhi.
India Pvt. Ltd.),
C-95, Lower Ground Floor,
Lajpat Nagar-I,
Delhi-110024.
PAN: AABCV 0770 E
( Appellant ) (Respondent)
Appellant by : Sh. S.D. Kapila Adv. &
Shri R.R. Maurya Adv.
Respondent by : Sh. Syed Nasir Ali CIT (DR)
Date of hearing : 28/08/2015.
Date of order : 04/11/2015.
ORDER
PER S.V. MEHROTRA, A.M..:
This appeal has been preferred by the revenue against the assessment order dated 12-01-2015 passed by the DCIT, Circle-26(1), New Delhi pursuant to DRP directions u/s 143(3)/144C of the Income-tax Act, 1961. Originally, following grounds were raised:
"1. That on the facts and in the circumstances of the case, Order passed by the Ld. DRP/TPO/Ld. AO is without jurisdiction and bad in law and void ab initio.2
ITA no. 1066/Del/2015 The Ld.AO/DRP erred in sustaining the addition made by the Ld. TPO/AO by way of adjustment of Arm length Price of Rs 13.63 crore u/s 92CA and thus assessing total income of Rs. 1 12.39 crore as against total income of Rs. 98.75 crore declared by the assessee.
3. The Ld. TPO erred in rejecting the comparability analysis conducted by the appellant for determining the impugned arm Length price on the basis of wrong and subjective assumptions.
4. That on the facts and circumstances of the case and in law the Ld. DRP erred in upholding the action the TPO in rejecting the search process carried out by the assessee on the ground that it is flawed.
5. The Ld. AO/DRP erred in law by arbitrary rejecting certain com parables by applying lower turnover filter of Rs. 5 crores against Rs. 1 crores applied by the assessee.
6. The Ld. AO/DRP erred in not applying upper filter of turnover.
7. The Ld. AOI DRP erred in arbitrary qualitative filters on ad hoc basis resulting in exclusion of functionally appropriate comparables.
8. That on the facts and circumstances of the case Ld. DRP erred in upholding the employee cost filter more than 25% of total cost instead of applying range of ± 15% of the said ratio in the assessee's own case.
9. The Ld.TPO/DRP erred in selecting certain entities in the final set of comparables, which are inappropriately functionally dis-similar.
10. The Ld. TPO/DRP erred in excluding some of the entities selected by the assessee, which are functionally appropriate.3
ITA no. 1066/Del/2015
11. The Ld. AO/DRP erred in law not making adjustment to the net margin of the comparables on account of 'risk' analysis.
12. The Ld. AO/DRP erred in not treating foreign Exchange fluctuation loss in the revenue account for the purpose of computing the operating margin of the assessee as also of the comparables.
13. That Ld. DRP/TPO have made computational errors while making working capital adjustment.
14. The Ld. AO/DRP erred in not providing appropriate adjustments to account for difference in Working Capital requirement.
15. The Ld. AO I DRP have erred in law and on facts, by initiating penalty proceedings under section 271 (I )(c) of the Act.
1.1. Subsequently vide application dated 11-8-2015 following modified grounds of Appeal were raised:-
Amended Grounds No.2:
"The Ld. A O/DRP have erred in sustaining the addition of Rs. 12,69,65,687 (Rs. 12.70 crores) by valuing the arm's length price of services rendered to it U.S. holding company at Rs. 111.45 crores as against aggregate price of Rs. 98.75 crores declared by the assessee"
Amended Grounds No. 12:
"The Ld. AD/DRP erred in not treating foreign exchange fluctuation gain/loss incurred in the revenue account for the purpose of computing the operating margin of the assessee as also of the comparables"4
ITA no. 1066/Del/2015
2. Brief facts of the case are that assessee is a wholly owned subsidiary of vCustomer US. In the relevant assessment year it was primarily engaged in providing IT enabled services to its parent company. The company has the expertise in providing process driven, quality centric BPO services, contract centre and technology enabled services through its state of art facilities located in two cities in India, namely, New Delhi and Pune. The assessee had filed its return of income declaring income of Rs. 12,07,29,128/-. During the year assessee had entered into following international transactions:
Nature of international Method Value of international transaction selected transaction (INR) Provision of IT TNMM 987,546,863 Enabled services
3. Accordingly, reference was made to TPO for determination of ALP of the international transaction. Ld. TPO noticed that remuneration model of tested party was cost plus model which envisaged a mark up of 15% in the year under consideration. Assessee had earned a net margin of 17.43% as compared to the average margin of comparables mentioned in the TP report of 9.66%. He examined the filters used by assessee in search process and rejected the assessee's filters. As regards selection of companies based on financial information for FY 2007-08 to 2009-10 observing that as per Rule 5 ITA no. 1066/Del/2015 10B(4) only current year data could be used. He also did not accept the asessee's filters, which resulted into selection of certain companies that had been declared sick or had persistent negative net growth. Ld. TPO also applied certain new filters in order to arrive at comparables having maximum proximity with the tested party.
4. Ld. TPO, inter alia, applied following filters:
- Reject companies with different financial year
- Reject companies where turnover is less than Rs. 5 crores
- Select companies where the ratio of service income to total income is at least 75%
- Select companies where income from exports is at least 75% of total income
- Reject companies where related party transactions exceed 25% of sales.
- Reject companies that have employee cost less than 25% of total cost.
- Companies that are affected by some peculiar economic circumstances.
5. TPO also pointed out that operating margin in these cases had been calculated taking foreign exchange fluctuations as non-operating and by excluding forex gain/ loss and hedging cost/ premium from operating cost/ income of the tested party as well as the comparables while calculating the PLI for the purpose of determination of Arm's length price. 6
ITA no. 1066/Del/2015
6. Ld. TPO did not dispute that TNMM method was the most appropriate method with assessee as the tested party and percentage of operational profit/ operational cost as profit margin index. On the basis of the search carried out by assessee and after considering the assessee's submissions ld. TPO selected the following comparables to be used for benchmarking international transactions:
S. No. Company name Adjusted OP/OC (%)
1. Accentia Technologies Ltd. 45.14
2. Cosmic Global Ltd. 25.23
3. E4e Healthcare 36.49
4. Fortune Infotech Ltd. 26.32
5. I-gate Global Ltd. 29.03
6. Infosys BPO Ltd. 35.11
7. Jindal Intellicom Ltd. 19.86
8. Microland Ltd. 2.65
9. Omega Healthcare 19.67
10. TCS E-Serve International Ltd. 60.38
11. TCS E-Serve Ltd. 70.21
Average 33.65
7. He, accordingly, made adjustment of Rs. 13,63,84,339/-, as under:
Total cost : Rs. 84,09,51,143
ALP at a margin of 33.65% : Rs. 1,12,39,31,202
Price received : Rs. 98,75,46,863
Adjustment u/s 92CA : Rs. 13,63,84,339
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ITA no. 1066/Del/2015
8. Ld. DRP rejected all the objections raised before him, except directing the TPO, while disposing of objection no. 11, to rectify errors in computing margins. It observed that if miscellaneous income and other income are not related to the operation, the same should not be taken for calculation of profit, margin. In the same way, bad debts, loans and advances written off, should be taken as non operating in nature. The AO, accordingly, rectified the addition and reduced it to Rs. 12,69,65,687/- by applying margin of 32.53% after making working capital adjustment as under:
S. No. Company Name Adjusted
OP/OC (%)
1. Accential Technologies 44.34
2. Cosmic Global Ltd. 23.97
3. 34e Healthcare 36.64
4. Fortune Infotech Ltd. 25.15
5. I-gate Global Ltd. 27.77
6. Infosys BPO Ltd. 38.96
7. Jindal Intellicom Ltd. 11.86
8. Microland Ltd. 1.46
9. Omega Healthcare 19.31
10. TCSE serve International Ltd. 59.13
11. TCSE Serve Ltd. 69.23
Average 32.53
9. At the time of hearing, ld. counsel for the assessee did not press ground nos. 1,3,4,6,7,8,11. Accordingly, they are dismissed as not pressed. Ground no. 15 is premature and, therefore, does not require any adjudication.
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ITA no. 1066/Del/2015
10. Apropos ground no. 5, ld. counsel submitted that turnover filter of Rs. 5 crore applied by TPO as against Rs. 1 crore applied by assessee, for inclusion/ exclusion of any comparable, is not correct in view of the decision of Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) (P) Ltd. Vs. DCIT (2015) 277 CTR 137 (Del), wherein it has been held that mere fact that entity makes high/ extremelyhigh profits/ losses does not, ipso facto, lead to its exclusion from the list of comparables for the purposes of determination of ALP; in such circumstances, an enquiry under rule 10B(3) ought to be carried out, to determine as to whether the material differences between the assessee and the said entity can be eliminated; unless such differences cannot be eliminated, the entity should be included as a comparable. Accordingly, ld. counsel submitted that high turnover or low turnover cannot be the basis for accepting/ rejecting any comparable.
11. We have heard both the parties. We are of the opinion that in view of the decision of Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) (P) Ltd. (supra), the limit of turnover of Rs. 5 crores, as applied by ld. TPO, for selection of comparables cannot be accepted.
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ITA no. 1066/Del/2015
12. Ld. TPO had observed that the filter to reject companies, where turnover was less than Rs. 5 crores, was applied because where the turnover and cost base is very small, it is more than likely that the margins will be erratic. That apart, a company that is very small in size does not have sufficient economic significance that it be used as a benchmark.
13. This finding was confirmed by ld. DRP, observing that the reliability of the financial data for companies with low levels of sales/operating income can be significantly reduced because the same persons are often both major shareholders and also the key employees, thereby obliterating the economic distinction between profits and salaries. Ld. DRP further observed that such companies lack competitive strength, lack operational efficiencies and also lack human resources and so give skewed results.
14. From the observations of both ld. TPO and DRP, it is evident that they have not examined the comparables having regard to the functions performed by them and in the light of Rule 10B(3). Both the lower authorities have made general observations without pointing out any material differences between the assessee and the comparables. If the functional comparability is there, then a comparable can be rejected, if it is demonstrated that the assets employed and risk assumed are significantly different from the tested party. This exercise has not been carried out by 10 ITA no. 1066/Del/2015 both the lower revenue authorities. Therefore, this filter has not correctly been applied. This filter could be applied only after detailed analysis, as directed by Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) (P) Ltd. (supra). Ld. counsel pointed out that in the present assessment year, only one comparable viz. C.G. Vak Software Export Ltd., has been excluded by applying this filter by TPO, which, in any case, is covered by the decision of the Tribunal in the case of Techbook International Pvt. Ltd. Therefore, in the present assessment year, matter need not to be restored. This ground is disposed off accordingly.
15. Ground nos. 9 & 10: These grounds are in regard to selection of comparables. Ld. counsel pointed out that essentially assessee is aggrieved by the inclusion of following comparables:
i. Accentia Technologies Ltd.
ii. I-gate Global Ltd.
iii. Infosys BPO Ltd.
iv. TCS E-serve International Ltd.
v. TCS E-Serve Ltd.
16. As regards Accentia Technologies Ltd., ld. counsel referred to pages 350 & 351 of the PB-II, wherein the annual report of this company is contained. He pointed out that in the year under consideration Asscent Infoserve Ltd. amalgamated with this company w.e.f. 1-4-2008. He pointed 11 ITA no. 1066/Del/2015 out that Accentia Technologies Ltd. was engaged in the business of medical transcription and coding and had softwares which were being used by the Accential Technologies Ltd. in serving the end to end results. Thus, functionally amalgamating company and amalgamated companies were different as performing different functions.
17. The effect of amalgamation has been pointed out in the annual accounts and it is merely stated therein that in view of the amalgamation being effective the figures for the year ended 31-3-2010 were inclusive of the figures relating to the amalgamating company and, thus, were not comparable with those of the previous year.
18. Ld. counsel further referred to page 355 of the PB, wherein fixed asset schedule of the said company is contained in which, in the block goodwill/ brand/ IPR an addition of Rs. 19,651,057/- has been shown. Thus, he pointed out that the asset base had substantially increased in the year under consideration and, therefore, this could not be taken as comparable because of the extraordinary event. Ld. counsel further referred to the decision of the ITAT dated 6-7-2015 in the case of Techbook International Pvt. Ltd. for AY 2010-11, contained at pages 649 to 699 of the PB, wherein this comparable has been excluded on account of this event, observing as under: 12
ITA no. 1066/Del/2015 "10. 1.2 . We have heard the rival submissions and perused the relevant material on record. We have also gone through the Annual report of this company, a copy of which has been placed .on page 435 onwards of the paper book. Notes to Accounts of this company, which have been placed on page 443 of the paper book, indicate about the amalgamation or Asscent Infoserve Pvt. Ltd. with it as approved by the shareholders in the court convened meeting held on 25.4.2009 and, subsequently, sanctioned by the Hon'ble High Court on 21.8.2009. The Mumbai Bench of the Tribunal in Petro Araldite (P) Ltd. Vs. D'Cl'T (2013) 154 TTJ (Mum) 176, has held that a company cannot be considered as comparable because of exceptional financial results due to mergers/demergers. Similar view has been bolstered by the Delhi Bench of the Tribunal 'in several cases including Ciena India Pvt. Ltd. Vs. DCIT (ITA No.3324/Del/2013) vide its order dated 23.4.2015. In view of the fact that there was merger of Asscent Infoserve Pvt. Ltd.
with Accentia Technologies Ltd. by way of amalgamation during the year itself, we hold that this company cannot be considered as comparable due to this extra-ordinary financial event. Accordingly, the same is directed to be excluded from the final list of comparables."
19. Having gone through the annual report and keeping in view the extraordinary event in the year under consideration, we are in agreement with ld. counsel that this comparable cannot be taken into consideration while determining the average margin earned by the comparables. Ld. counsel has submitted that in the case of Techbook International Pvt. Ltd. (supra), this company has been excluded and, accordingly, in the present 13 ITA no. 1066/Del/2015 case also this should be excluded, because the functional profile of Techbook International Pvt. Ltd. (supra) and that of assessee is similar. We find that Tribunal in the case of Techbook International Pvt. Ltd. (supra), in regard to the business profile of Techbook International Pvt. Ltd. (supra), has observed as under:
"Succinctly, the assessee was incorporated as a wholly owned subsidiary of Aptarausa. It is engaged in the development of customized electronic data. It converts data from hard copy or files into XML/SGML/HTML, creating electronic style files and modifying the user interface for CD-ROM delivery. In the process, raw data received from the customers in hard copy/ electronically, is converted into electronic form. Thereafter, the data is arranged and formatted. Thus, it can be said that the assessee is primarily engaged in providing ITES to its associated enterprise (AE)."
20. The assessee's business profile has been considered in para 2 of this order and a comparison of the business profile of Techbook International Pvt. Ltd. (supra) with assessee clearly shows that both are providing ITES services to its AEs. Therefore, the finding in Techbook International Pvt. Ltd. (supra), regarding various comparables is applicable to the present set of facts. Therefore, respectfully following the order of the ITAT in the case of Techbooks International Pvt. Ltd. (supra), we direct this comparable to be excluded from the final list of comparables.
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ITA no. 1066/Del/2015
21. TCS e-Serve International Ltd.: Ld. counsel referred to page 434 of the PB, wherein the annual report of this comparable for the year ending 31- 3-2010 is contained and pointed out that FY 2009-10 was the second year of operations for the company and first full year as a step down subsidiary of Tata Consultancy Services Ltd. (TCS). He pointed out that in the annual report itself it has been noticed by the company that as it became a part of the TCS/ Tata Group, this company, backed by TCS scale and large client base, had enhanced its services offering and had also started service new clients during the year under review.
22. Ld. counsel further pointed out that TPO included this comparable observing that the comparable was functionally same. Ld. counsel submitted that it is the company's first year of operation and, therefore, functionality is to be tested on the touch stone of the decision of Hon'ble High Court in the case of Chryscapital Investment Advisors (India) (P) Ltd. (supra) and the reasons for low/ high profit; low/high turnover should have triggered an inquiry. He further referred to page 458 of the PB, wherein the schedules 'M' 'Operation and other expenses' is contained and pointed out that Tata Brand Equity contribution was Rs. 37,38,000. Ld. counsel further referred to 15 ITA no. 1066/Del/2015 "Notes to accounts", contained at page 459 of the PB and pointed out that it has been observed in the notes as under:
"Background and principal activities.
TCS e-Serve International Limited is engaged in the business of providing information Technology- Enabled Services (ITES)/ Business Processing Outsourcing (BPO) services, primarily to Citigroup entities globally.
The Company's operations broadly comprise of transaction processing and technical services. Transaction processing includes the broad spectrum of activities involving the processing, collections, customer care and payments in relation to the services offered by Citigroup to its corporate and retail clients. Technical services involve software testing, verification and validation of software at the time of implementation and data centre management activities."
23. Ld. counsel referred to page 467 and pointed out that in the notes forming part of the financial statements, it has been observed as under:
"Segment information:
Consequent to reorganization of its global organization with the objective of making industry practice its focal point for performance evaluation and internal financial report and decision making, the Company has reviewed and revised the manner in which it views the business risks and returns and monitors its operations. Accordingly, as required under Accounting Standard 17 "Segment Reporting" (AS-17), the format of reporting primary segment information has been changed to Business Segments and secondary segment information has been changed to geography.16
ITA no. 1066/Del/2015 The Company is engaged in business process outsourcing (transaction processing) services to the Banking & financial services industry (BFSI) and Travel, Tourism and Hospitality (TTH), which are considered as industry segment. Geographic segments of the company are Americas, Europe and others."
24. He, therefore, submitted that no segment has been recognized for technical services though assessee was rendering technical services also. Ld. counsel submitted that technical services are not part of BPO's operation and, therefore, the TPO's conclusion that comparable was functionally similar to assessee, was not correct. He pointed out that assessee buy readymade software and is not maintaining of its own. Ld. counsel referred to page 669 of the PB, wherein the decision in the case of Techbook International Pvt. Ltd. (supra) is contained, in which the Tribunal has observed as under:
"10.2.2. ........ In order to properly appreciate the vital difference between these two types of companies, it is significant to note that a company which develops software is called a company rendering software development services. Software development services also include maintenance of software and updation of the software so as to suit the ever changing requirements of the users. A company using, inter alia, a software for obtaining the desired results, is called a company providing non-development software services. Thus, it is crystal clear that there is a phenomenal difference between a company providing software development services and a company providing software non-development services in terms of expertise, professional qualification and experience 17 ITA no. 1066/Del/2015 required for rendering such services. A company providing software non-development services performs a relatively low- end service. Thus the line of distinction is that whereas a company providing software development services helps in the creation, maintenance or updation of a software, on the other hand, a company providing non-development software services obtains the desired result with the use of an existing software. Further, whereas the output of the former is a software in itself or a stage in the ultimate creation of a software, the output of the later is the processed in format ion from the raw data obtained with the help, inter alia, of a software. From the above discussion, it is overt that a company providing software development services IS distinct from and incomparable with a company providing non-development software services.
10.2.3. We find that the assessee is a. company providing non- development software services, in the nature of conversion of data from hard copy or files into electronic format. The assessee is not providing any software development services to its AE. On the other hand, this company IS also providing 'Technical services' to its AE involving software testing, verification and validation of software, which are akin to software maintenance services falling, within the overall category of software development services. The TPO has taken entity level figures of TCS E-Serve International Ltd. for comparison, There is no bifurcation available in respect of the revenues of this company from Transaction processing (which are in the nature of ITES, the same as provided by the assessee) and Technical services (which are in the nature or software developn1ent, absent in the assessee's case). In the absence of the availability of any such segregation of the total revenue of this company, it is not possible to separately consider its profitability from rendering of 'Transaction processing services'. As such, the entity level figures render this company as unfit for comparison. Ergo, we 18 ITA no. 1066/Del/2015 order for the removal of this company from the final set of_comparables."
25. Ld. counsel submitted that in view of above submissions, this comparable has to be excluded.
26. Having heard both the parties, we are of the considered opinion that since assessee company is providing non-development software services by resorting to the software purchased by it, therefore, it cannot be compared at par with TCS e-Serve International Ltd, a company, which was providing software development services.
27. TCS e-Serve Ltd.: Ld. counsel referred to para 10 of Tribunal's decision in the case of Techbook International Pvt. Ltd. (supra) and pointed out that this comparable was directed not to be excluded, inter alia, observing that unlike TCS e-Serve International Ltd., this company was not providing any technical service involving software testing, verification and validation of software etc. It was further observed that since the functional profile of this company on a boarder basis was not different from that of the assessee, both being involved in rendering ITES, this company was to be retained as comparable.
28. Ld. counsel referred to page 503 of the PB, wherein the annual report of this company is contained and pointed out that both the background and 19 ITA no. 1066/Del/2015 principal activity of this company were identical as that in the case of TCS e-Serve International Ltd., reproduced earlier, which was as under:
"TCS e-Serve Limited is engaged in the business of providing information Technology- Enabled Services (ITES)/ Business Processing Outsourcing (BPO) services, primarily to Citigroup entities globally."
29. Ld. counsel further referred to page 515 of the PB, wherein the notes forming part of the financial statements are contained and in regard to the segmental information it has been observed that the company was engaged in business process outsourcing (transaction processing ) services to the Banking & financial services industry (BFSI), which was considered as a single segment. He, therefore, pointed out that the segmental information was also identical to TCS e-Serve International Ltd. and, thus, no separate segmental information in regard to technical services carried out by the comparable, was given. He pointed out that on the same reasoning, as in TCS e-Serve International Ltd., this should also be excluded.
30. Having heard both the parties, we find that in the case of Techbook International Pvt. Ltd. (supra), the Tribunal has declined to exclude this comparable, inter alia, on the ground that this company was not providing 20 ITA no. 1066/Del/2015 any technical service involving software testing, verification and validation of software. We find that the Tribunal has observed as under:
"10.3.2. We have heard the rival submissions and perused the relevant material on record. A copy of the Annual report of this company is available on page 466 of the paper book. The company's overview has been discussed on page 467 of the paper book, which divulges that this company : "is in the business of providing business process management services in the banking and financial services (BFSI), vertical ( i.e. industry vertical) to help its customers achieve their business objectives by providing innovative best-in-class services." We find that this company is also providing ITES. Unlike TCS e- Serve International Ltd. this company is not providing any technical services involving software testing, verification and validation of software etc. Since the functional profile of this company on a broader basis is no different from that of the assessee, both being involved in rendering ITES, we are not inclined to treat this company as incomparable. The Id.AR argued that the nature of the ITES provided by this company is different from that of the assessee and hence the same be excluded. We are disinclined to sustain this objection. Matching of the exact functional similarity is dispensed with under the TNMM, which is not so under the Comparable uncontrolled price method. The TNMM approves comparability on the basis of broader overall similarity. When we consider the nature of services provided by this company, being the ITES, which is similar to that of those rendered by the assessee, again the ITES, we cannot order its exclusion simply for the reason that the verticals of ITES are somewhat different. If one goes to make a comparison in the way suggested by the id. AR under the TNMM, then it will be very difficult, if not impossible, to find out a ditto comparable. A company which satisfies the 21 ITA no. 1066/Del/2015 broader parameters of comparability in the overall same segment, cannot be excluded Due to somewhat different nature of such overall activity. An examination of the cornparables chosen by the assessee, which have been accepted by the TPO, also satisfy only the Lest of overall similarity and not the peculiar similarity, as has been now contrastly contended for the exclusion of this company. This argument, therefore, fails.
10.3.3 . In so far as the objection of the ld. AR• about the high profit/high turnover of this company is concerned, we find that the Hon'ble Delhi High Court in Chrys Capital Investment Advisors (India) P. Ltd. Vs. DCIT has held, vide its judgment dated 27.4.2015, that high profit or high turnover is not a criteria to exclude an otherwise . comparable company. It is further noticed that the Hon'ble Delhi High Court in CIT Vs. Agnity India Technologies (P.) Ltd. (2013 ) 219 Tasman 26 (Del) examined the comparability of Infosys Technologies from the angle of its inclusion or otherwise in the list of comparable of Agnity India Technologies, a captive unit providing ITES to its AE alone. In that case, the TPO treated three companies as comparable, namely, Sat yam Computer Service Ltd., L&T Infotech Ltd. and Infosys Technologies. The DRP excluded Sat yam Computer only. The Tribunal eluded only Infosys Technologies Ltd., by impliedly retaining L&T Infotech Ltd. as a good comparable. On appeal by the Revenue, the Honourable High Court upheld the Tribunal order excluding Infosys on the strength of certain relevant distinguishing features including its giantncss in terms of sales, nature of work and other factors.
Thus it follows that L&T Infotech Ltd., which is otherwise a vast company with much higher turnover, finally found the status of a comparable with a captive company providing ITES to its AE alone.
10.3.4. Coming back to the facts of our case, we find that since TCS e- Serve Ltd. is functionally comparable with the assessee 22 ITA no. 1066/Del/2015 company on an overall basis and no special reasons for its higher profit/ turnover have been brought to our notice. Consequently, we hold that the authorities were justified in including this company in the list of comparables".
31. However, the main contention of ld. counsel for the assessee is that the assessee in Techbook International Pvt. Ltd. (supra), did not bring to the notice of the Tribunal, certain business characteristics, which were reported in the annual report of Tata e-Serve Ltd. for F.Y. 2009-10. Therefore, the matter is restored back to the file of AO to examine the assessee's contention in the light of observations of the ITAT in the case of Techbook International Pvt. Ltd. (supra), while considering the TCS e-Serve International Ltd. We order accordingly.
32. i-Gate Global Solutions:- In the case of Techbook International Pvt. Ltd. (supra), the Tribunal has excluded this company from the list of comparables by observing as under:
"10.4.2: We have gone through the Annual report of this Company, which is available on page 446 onwards of the paper book. Notes to accounts or this company indicate amalgamation of i-Gate Global Solutions Sdn. Bhd. This amalgamation took place with the approval of the members of the company on 12.8.2009 and subsequently sanctioned by the Hon'ble High Court by its order dated 24.2.2010. As the financial results of this company also include the results of amalgamating 23 ITA no. 1066/Del/2015 company, in our considered opinion, this is an extraordinary financial event, which renders it unfit for comparison with the assessee company. While discussing the comparability of Accentia Technologies Ltd. (supra), we have referred to certain decisions in which it has been held that a company loses the tag of comparability due to amalgamations, mergers, etc., taking place during the year in question. Adopting the same reasoning, we order for the exclusion of this company from the list of comparables".
33. Respectfully following the Tribunal's decision in the case of Techbook International Pvt. Ltd. (supra), this company is excluded from the list of comparables.
34. Infosys BPO: In the case of Techbook International Pvt. Ltd. (supra), the Tribunal has excluded this company from the list of comparables by observing as under:
10.5.2. After considering the rival submissions and perusing the relevant material on record, we find from the Annual report of this company, which .is available on page 449 onwards of the paper book, that there was acquisition by this company of McCamish Systems LLC. Such information is available on page 456 of the paper book. Acquisition of Mcf.amish Systems LLC during the year, being an extraordinary financial event, renders it incomparable. Following the reasons taken note of above, we order for the elimination of this company from the final set of comparables."24
ITA no. 1066/Del/2015
35. Respectfully following the Tribunal's decision in the case of Techbook International Pvt. Ltd. (supra), this company is excluded from the list of comparables.
36. Ld. counsel submitted that following entities have wrongly been excluded by ld. TPO/ DRP:
- CG VAK Software and Exports Ltd.
- Microgenetics Systems Ltd.
37. As regards CG VAK Software and Exports Ltd., brief facts are that TPO had rejected this company on the ground that it did not qualify the sales filter. He observed that the sales from the ITES segment was less than 5 crores, therefore, this company could not be considered as a suitable comparable.
38. We have heard rival contentions and perused the relevant material available on record. While deciding ground no. 5, we have held that in view of the decision of Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) (P) Ltd. (supra), high or low turnover cannot be the criteria for acceptance/ rejection of any comparable. Ld. TPO has not disputed that this comparable is carrying on the same functions as that of assessee. Further, we find that this 25 ITA no. 1066/Del/2015 comparable has been accepted by the ITAT in the case of Techbook International Pvt. Ltd. (supra), observing as under:
12.2.2. Having heard both the sides on this issue, we find that the TPO has accepted the functional comparability of this company on segmental level. The Id. DR was also fair enough to candidly accept the functional similarity of the relevant segment of this company. In such . circumstances, the question arises as to whether the relevant segment of this company can be excluded from the list of comparables merely on the ground that the revenue from this segment is only Rs.83 lacs? In our considered opinion, the quantum of turnover can be no reason for the exclusion of a company which is otherwise comparable.
We have noticed above the judgment of the Hon'ble jurisdictional High Court in the case of ChrysCapital Investment Advisors (India) P. Ltd (supra) in which it has been held that high turnover or high profit can be no reason to eliminate an otherwise comparable company. The same applies with full force in the converse manner as well to a low turnover/low profit company. We, therefore, hold that a company cannot be excluded from the list of comparables on the ground of its low turnover. In principle, we direct the inclusion of the relevant segment of this company in the list of comparables. The TPO is directed to include the operating profit/operating costs of the ITES segment of this company in the list of comparables, after due verification of the necessary figures for determination of the operating profit margin etc.
39. We, therefore, direct for inclusion of this company in the list of comparables.
26
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40. Micro Genetics Systems Ltd.: Brief facts are that ld. TPO on examination of annual report observed that the same did not contain data regarding related party transactions. He observed that as per the website of the company, this company was affiliate of CBay Systems Ltd., USA for medical transcriptions business. He, therefore, did not consider this as a comparable.
41. Ld. counsel submitted that the observations of ld. TPO are not correct. He referred to pages 309 to 323 of the PB, wherein the annual report of this company is contained and referred to page 322 where several details in regard to transactions with related parties are contained. He pointed out that the total of all payments is only less than Rs. 13 lacs. Turnover is Rs. 2.44 crores and, therefore, the related party transactions are not even 5%. He pointed out that on functional aspect there is no dispute that tested party as well as this company are performing the same functions. He further pointed out that in the case of Techbook International Pvt. Ltd. (supra), this comparable has been accepted, on the same footing on which CG VAK Software and Exports Ltd has been accepted, observing as under:
"12.3.2. We do not find any reason to exclude this company from the list of comparables merely on the ground that its turnover is less. The reasons given above while considering the comparability of CG- VAK Software and Exports apply to this 27 ITA no. 1066/Del/2015 company as well. We, therefore, order for the inclusion of this company in the list of comparables. However, the TPO is directed to verify the correctness of OP/OC of this company before its inclusion in the set of comparables.
42. In view of above discussion, we direct ld. TPO to include this company in the set of comparable.
43. As regards exclusion of Informed Technologies Ltd., ld. counsel did not dispute the same.
44. In view of above discussion, ground nos. 9 & 10 stand partly allowed for statistical puroses.
45. Ground no. 12: Brief facts of the case are that ld. TPO did not consider the foreign exchange gain/ loss as operating income/loss, following the decision in the case of M/s DHL Express (India) Ltd. (ITA no.
7360/Mum/2010), wherein it was held that forex gain/loss was non-
operating income/loss and needed to be excluded for the purpose of benchmarking international transaction under TNMM. He, therefore, excluded forex gain/ loss operating cost/ income of the tested party as well as comparables while calculating PLI for the purpose of determination of ALP. Main contention of ld. TPO was that forex gain/loss occurs in following two situations:28
ITA no. 1066/Del/2015 "(i) Receipt/ expenditures are booked at the time of transaction while payment of foreign exchange is received at a later point of time and foreign exchange is converted to Indian currency at that time resulting into Forex gain/loss due to variation in the exchange rate from the date of transaction to that of conversion of Foreign exchange into Indian currency.
An exporter/importer of goods/services enters into forward contract for sale/purchase of Forex to hedge itself from the fluctuation in exchange rates."
46. He observed that the amount of forex loss/ gain and hedging cost/premium in each case would depend upon the risk management policy of each company and, therefore, the profit margin at the end of the year may vary substantially from the expected profit margin at the time of entering into project because of fluctuation in the exchange rate and its risk management policy i.e. the extent of which its Forex transactions were hedged.
47. Before ld. TPO the assessee had submitted as under:
"Remuneration model of the Assessee 4.1.1 As per the inter-company agreement entered into by the Assessee with its AE, the Assessee passes on the foreign exchange gain or loss to the AE and docs not bear the risk associated with such fluctuations. Therefore, in case of any foreign exchange loss is incurred by the Assessee, the same forms part of cost while getting reimbursed from AE on a cost plus mark up basis. The relevant extract of the inter-company agreement has been provided below:29
ITA no. 1066/Del/2015 Section 4.3. cost: For the purposes of this Section, Cost shall include all operating expenses including but not limited to normal recurring costs such as office rent, communication charges, salaries, employee benefits, depreciation on assets used, amortization prior period normal business expenses, net foreign exchange loss, fringe benefit tax etc. and appropriate share of the common expenses apportioned.
The learned TPO has in her order, considered foreign exchange gain or loss as a non-operating item. It is respectfully submitted that treatment of foreign exchange gain or loss as operating or non operating items depends upon the cornparability of the terms of conditions of the agreement of the Assessee with the terms of the business operations of the Assessee. As compared to tile Assessee the comparable selected by the learned TPO undertakes foreign exchange risk and the price charged by such comparables for undertaking such risk is in built in the sales remuneration model. Therefore, by treating foreign exchange gain or loss as a non-operating item, the comparability terms and conditions of business of the Assessee is not aligned to the comparables. Thus, in order to make a suitable comparison of the margin earned by the Assessee vis-a-vis that of the comparable companies, either of the following approaches needs to be followed:
Consider foreign exchange gain or loss as operating item and benchmark the net margin earned by the Assessee with that of the comparables; or Consider foreign exchange gain or loss as non-operating item and provide the Assessee a benefit of risk adjustment on account of not undertaking any risk on account of foreign exchange movement. This adjustment is required to adjust the profit downwards of the comparable companies which have an inbuilt premium of foreign exchange risk in the sales revenue 30 ITA no. 1066/Del/2015 due to which their profit margins are higher than that of the comparable companies.
However, the learned TPO in her order has neither given the benefit of risk adjustment to the Assessee nor has she taken foreign exchange gain as operating item while computing the operating margin of the comparable companies and the tested party. "
48. Ld. DRP, however, relied on the CBDT Notification dated 18-9-2013, which was issued pursuant to Rule 10TA(j)(k), laying down Safe Harbour Rules. Ld. DRP pointed out that as per this Rule, loss or income arising on account of foreign currency fluctuations are to be excluded from the calculation of operating expenses and operating income respectively. Ld. DRP, accordingly, upheld the TPO's action.
49. Ld. counsel for the assessee submitted that during the year the assessee earned forex gain of Rs. 7.44 crores on sale proceeds of export service to the US AE which was received in US dollars. Ld. counsel further submitted that on the other hand ld. TPO included forex gain of Rs. 28.35 crores on sale proceeds in the case of TCS e-Serve Ltd. He pointed out that because of exclusion of forex gain in the revenue account in th caes of the assessee, its PLI (OP/OC) was reduced by TPO from 26.29% to 17.43%. Ld. counsel pointed out that the decision in thecase of DHL Express (India) Ltd., 31 ITA no. 1066/Del/2015 relied by ld. TPO has been distinguished in subsequent decision in Westfalia Separator India P. Ltd. 108 ITD 376.
50. As regards ld. DRP's reliance on Rule TA to Rule TU notified in 2013, ld. counsel submitted that the said rules are applicable from 18-9-2013 and prior to that the said rule has no application.
51. Ld. counsel further pointed out that in any case Safe Harbour Rule can be applied only when assessee opts for the same, but in the present case assessee did not opt for applicability of Safe Harbour Rules.
52. Ld. counsel further pointed out that, in any case, DHL Express (India) Ltd. (supra), is distinguishable. He submitted that firstly there is no separate consideration of this aspect in that decision. He pointed out that perusal of the decision shows that forex loss/ gain, which had been considered by the Tribunal, was linked to other non-operational receipts. It was in this context that it was held that forex gain/ loss was non-operational. He pointed out that nature of foreign exchange fluctuation was not clear as to whether on capital account or on revenue account.
53. Ld. counsel relied on the decisions in the cases of :
- Woodward Governor's 312 ITR 254 (SC);
- CIT Vs. Priyanka Gems 367 ITR 575 (Guj);32
ITA no. 1066/Del/2015
- Cordys R & D (India) (P) Ltd. Vs. DCIT (2014) 43 Taxmann.com 64 (Hyd. Trib) wherein the Tribunal has, inter alia, observed that the foreign exchange fluctuation gains is nothing but an integral part of the sale proceeds of an assessee, carrying on export business and, therefore, it could not be excluded from the computation of the operating margin of the assessee company.
54. Ld. CIT(DR) relied on the TPO's order.
55. We have considered the rival submissions and have perused the record of the case. We find considerable force in the submission of ld. counsel for the assessee that ld. DRP wrongly invoked Safe Harbour Rule for coming to the conclusion that forex gain/ loss was not to be treated as operating income/ loss for current assessment year because the Safe Harbour Rules, in any case, were applicable from 18-9-2013 and prior to that the said Rules could not be applied. That apart, it is not disputed that in the case of assessee forex gain/ loss was related to sale price of export, which was in US dollar. Therefore, the entire receipts were on revenue account. This issue is squarely covered by the decision of the Hon'ble Supreme Court in the case of Woodward Governor's (supra), wherein it has been held that forex gain/ loss in the revenue account is a trading receipt, or, as the case may be, business expenditure, allowable u/s 37(1) of the Act. We, accordingly, direct that the forex gain/ loss be treated as operating income/ loss both in the case of 33 ITA no. 1066/Del/2015 tested party as well as comparable and the PLI should be determined accordingly. Ground no. 12 is allowed accordingly.
56. Ground nos. 13 & 14: These grounds relate to adjustments made on account of working capital adjustment by ld. TPO. Ld. TPO had made the working capital adjustment by using the OECD methodology given in Annexure to Chapter 3 of OECD guidelines on transfer pricing and applied SBI Prime Lending Rate as on 30th June of the relevant financial year, as the interest rate. He computed the working capital adjustment as under:
"a) Compute the average of opening and closing balance of inventories, trade debtors/ receivables, trade creditors/ payable of both the tested party and the comparables on revenue account.
b) Work out the net working capital ratio (in pecentage) after dividing the net working capital by operating cost/ sales of such denominator (as is used in the PLI) both for the tested party and the comparables.
c) Determine the difference between the tested party's rate with that of each comparables.
d) Thereafter multiply the above difference by interest rate i.e. SBASR as on 30.06.2009 i.e. 11.75%
e) Lastly, these adjustments are to be added to the profit margin of comparable companies.34
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57. Ld. counsel pointed out that assessee is receiving only in US dollar and, therefore, the interest rate is to be as per the US currency. He relied on the decision of Hon'ble Delhi High Court in the case of Cotton Natural (P) Ltd. (2015) 276 CTR 445, wherein it is observed as under:
"Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party, Interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/deposits are significantly universal and globally applicable. The currency in which the loan is to be repaid normally determines the rate of return on the money lent, i.e. the rate of interest. The loan in question was given in foreign currency i.e. US $ and was also to be repaid in the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign currency are different and dependent upon the currency in question. They are not dependent upon the PLR, which is applicable to loans in Indian rupee. The PLR, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR is not applicable to loans to be repaid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply. - Cotton Natureals (I) (P) Ltd. Vs. CIT (2015) 169 TTJ (Del) 685 (P) Ltd. VS. CIT (2015) 169 TTJ (Del) 685 affirmed."35
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58. Therefore, interest has to be determined as per US currency and not as per the prime lending rate, as applied by TPO. Under such circumstance, we set aside the impugned order and remit the matter to the file of TPO for fresh determination on account of TP adjustment towards interest not realized from its AE on the debts arising during the course of business. Ground is allowed for statistical purposes.
59. In the result, assessee's appeal stands partly allowed for statistical purposes.
Order pronounced in open court on 04/11/2015..
Sd/- Sd/-
(A.T. VARKEY) (S.V. MEHROTRA)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated: 04/11/2015.
*MP*
Copy of order to:
1. Assessee
2. AO
3. CIT
4. CIT(A)
5. DR, ITAT, New Delhi.
36
ITA no. 1066/Del/2015
-+ Date
Initial
1. Draft dictated on 13-10.2015 PS
2. Draft placed before author 19.10.2015 PS
3. Draft proposed & placed before the second JM/AM
member
4. Draft discussed/approved by Second JM/AM
Member.
5. Approved Draft comes to the Sr.PS/PS PS/PS
6. Kept for pronouncement on PS
7. File sent to the Bench Clerk PS
8. Date on which file goes to the AR
9. Date on which file goes to the Head Clerk.
10. Date of dispatch of Order.