Income Tax Appellate Tribunal - Mumbai
Vidafibe Ubdua Servces P.Ltd ( Formelry ... vs Department Of Income Tax
IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCH "F",
MUMBAI
BEFORE SHRI N.V.VASUDEVAN(J.M) & SHRI B. RAMAKOTAIAH (A.M)
ITA NO.5887/MUM/2010(A.Y.2005-06)
The DCIT, Cir. 3(3), M/s. Vodafone India Services
Room No.609, 6th Floor, P. Ltd., (Formerly known as
Aaykar Bhavan, MK Marg, Vs. M/s. 3 Global Services P. Ltd.)
Mumbai - 20. Spectrum Towers, Mindspace
(Appellant) Complex, Off. Link Road,
Malad (W), Mumbai - 400 064.
PAN:AAACZ 1849D
(Respondent)
ITA NO.7125/MUM/2010(A.Y. 2006-07)
M/s. Vodafone India Services P. Ltd., The DCIT, Cir. 3(3),
(Formerly known as M/s. 3 Global Room No.609, 6th Floor,
Services P. Ltd.) Aaykar Bhavan, MK Marg,
Spectrum Towers, Mindspace VS. Mumbai - 20.
Complex, Off. Link Road,
Malad (W), Mumbai - 400 064.
PAN:AAACZ 1849D (Respondent)
(Appellant)
Assessee by : Shri Yogesh Thar
Revenue by : Shri Subachan Ram
ORDER
PER N.V.VASUDEVAN, J.M,
ITA No.5887/M/10 is an appeal by the revenue against the order
dated 10/5/2010 of CIT(A),15 Mumbai relating to assessment year 2005-06.
ITA No.7125/M/10 is an appeal by the assessee against the order passedunder section 253(1)(d) of the Income Tax Act, 1961 (the Act) dated 2 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) 27/9/2010 of the DCIT, Circle (3)(3), Mumbai relating to assessment year 2006-07.
2. First we shall take up for consideration ITA No.5887/M/10. Ground No.1 raised by the revenue reads as follows.
"1. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in deleting the addition of Rs. 24.79 crores on account of the order of Transfer Pricing Officer u/s. 92CA(3) considering assessee company's transaction with its AE is at Arms Length Price and by holding that there is no scope for calling any adjustment."
3. The assessee is a company engaged in providing information technology services such as call center, back office operation etc. The assessee was incorporated in March, 1999 and commenced its business in April, 2003. The assessee is subsidiary of HTS Mauritius which in turn is subsidiary of M/s. Hutchinson Whampoa Ltd. Hongkong (HWL). It is a BPO center providing services to two other fellow subsidiaries of its parent company i.e. M/s. Hutchison 3 G Australia Pvt. Ltd. (H3GA), Australia and Hutchison 3G UK Ltd., UK (H3GUK). The assessee provided IT services to Hutchison Australia Pvt. Ltd. and Hutchson 3G UK Ltd., UK. The aforesaid two companies were associated enterprises and in terms of the provisions of section 92 CA of the Act the Arms Length Price (ALP) of the international transaction between the assessee and its associated enterprise had to be determined. The Assessing Officer referred to the TPO under section 92 CA(1) of the Act the computation of ALP in relation to international transaction referred to above.
4. During the relevant year the assessee has provided I.T. enabled services (ITES) to its AEs- H3GA, Australia at Rs. 50,59,00,694/- and H3GUK, UK at Rs. 83,16,10,735/-. As per the 3CEB report, the method used for 3 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) benchmarking this transaction by the assessee was Cost Plus Method. 3GS had charged H3G AEs on the basis of the following formula-
a) Operating Cost, depreciation and amortization for the period.
b) 7% mark up on (a) above.
5. During the F.Y 2003-04 (AY 04-05), the assessee had charged a mark up of 4% on the operating cost, depreciation and amortization. This was increased to 7% for the previous year. In A.Y. 2004-05, the assessee had selected CUP method as the most appropriate method for bench marking this transaction. In this method the assessee had relied for the purpose of benchmarking its transfer price on the rates published by NASSCOM. The then TPO had observed in its order for the A.Y 2004-05 that the rates relied upon by the assessee are "General Industry rates" and therefore cannot be considered as comparable to the assessee's transaction. He considered in the facts of the case and considering the data available, TNMM as the most appropriate method.
6. During the relevant year the assessee has itself considered TNMM as the most appropriate method for benchmarking this transaction. During the course of TP proceedings for the relevant year, the assessee was asked to why it has changed the most appropriate method from CUP being followed by it in A.Y 2004-05 to TNMM method this year. The assessee submitted vide letter dt. 5.2.2008 that in the absence of information about comparable rates for voice based services for the relevant year and particularly, for the comparables in the public domain, CUP was not considered for benchmarking. Therefore, it changed the most appropriate method from CUP to TNMM during the relevant year. It used operating profit/ operating cost as Profit Level Indicator.
4 ITA NO.5887/MUM/2010(A.Y.2005-06)ITA NO.7125/MUM/2010(A.Y. 2006-07)
7. Under the TNMM method, the assessee selected 13 comparables. The net margin on operating cost earned by the comparables was between - 41.87% to 62.25% with an arithmetic mean of 6.95% as under:
Sr. No. Comparable companies OP/TC (%)
1 Allsec Technologies Ltd. 28.07
2 WIPRO BPO Solutions Ltd. 28.43
3 Transworks Information Services Ltd. 5.69
4 Citigroup Global Services Ltd. 15.91
5 Firstsource Solutions Ltd. 4.84
6 Godrej Upstream Ltd - 17.57
7 NIIT Smartserve Ltd. -15.21
8 Nipuna Services Ltd. - 7.33
9 Rev IT Systems Pvt. Ltd. - 7.33
10 Transwork Information Services Ltd. 5.69
11 Wipro BPO Solutions Ltd. 28.43
12 Hinduja TMT Ltd. (Segment) 62.25
13 Mpphasis Ltd. (Segment) 38.26
Arithmetic mean 6.93
The net margin of Assessee worked out to 11.63% and thus the Assessee justified the price it charged the AEs as proper and calling for no adjustment by the TP.
8. The TPO (on a reference made by the AO to determine the ALP) was of the view that the comparables selected by the Assessee cannot be accepted as being comparable to Assessee due to following reasons:
Sr.No. Name of the company Reasons for rejection 1 M/s. Ask Me Info Hubs Ltd. Chronically loss making 2 B2K Corpn Pvt. Ltd. Chronically loss making 3 Citigroup Global Services Ltd. Related party transactions with foreign parent hence not uncontrolled transaction 4 Godrej Upstream Ltd. Chronically loss making 5 Nipuna Services Ltd. Chronically loss making & negative net worth 6 NIIT Smartserve Ltd. Chronically loss making & negative net worth 7 Rev IT Systems Pvt. Ltd Chronically loss making.5 ITA NO.5887/MUM/2010(A.Y.2005-06)
ITA NO.7125/MUM/2010(A.Y. 2006-07)
9. The TPO on his own obtained data available in public domain and was of the view that the following companies were operating at better margin than the assessee:
Sr.No. Comparable companies OP/TC (%)
1 Allsec Technologies Ltd 28.07
2 WIPRO BOPO Solutions Ltd. 28.43
3 Transworks Information Services Ltd. 5.69
4 Hinduja TMT Ltd. 62.25
5 Mphasis Ltd. 38.26
6 Firstsource Solutions Ltd 4.84
7 Tulsyan Technologies Ltd. (Cosmic Global) 19.08
8 Saffron Global 24.89
9 Vishal Information Technologies Ltd. 45.65
10 Ace Software Exports Ltd. 15.46
11 Nucleus Netsof& GIS India Ltd. 40.6
12 Asian Cerc Information Technology Ltd.(seg) 37.4
13. Airline Financial Support Services (I) Ltd. 26.54
14 Goldstone Teleservices Ltd. (Seg) 15.95
15 Cepha Imaging Pvt. Ltd. 47.7
Total 440.81
Average 29.38
10. In its reply the assessee submitted that the rejection of some of its
comparables on the ground that they were chronically loss making / negative net worth is not proper. The Assessee also pointed that eight of the nine comparables additionally selected by the TPO (other then M/s. Saffron Global Ltd.) should not be considered as these companies function in entirely different segments and not in voice based call services. The assessee pointed out that it was a call center catering to certain queries of subscribers / prospective subscribers of its AEs relating to the following:
a) Service related queries: Sales Queries: enquiry about the contractual plans, Handsets, network or all services in general; Add existing Services;
Change existing Services, problems with Existing Services, Problems with any of the services provided;
b) Billing related queries
c) Mobile Number Portability (MNP) related queries;
6 ITA NO.5887/MUM/2010(A.Y.2005-06)ITA NO.7125/MUM/2010(A.Y. 2006-07)
d) Handset Related Queries
e) Network Related queries
f) Price Plan related Queries
g) Dealer support/Demo & Staff provisioning support.
11. The TPO however examined the agreement between the assessee and the associated enterprises and drew conclusion to the effect that the Assessee is performing important functions, assuming risks etc. and therefore any price determined as ALP has to give due weightage to these factors:
a) The AEs operate mobile telecommunication network in Australia and U.K respectively. The assessee operates Contact Centre Services in India and is to provide a Contact Centre and Services the assessee is being paid certain charges in accordance with the agreement.
b) The TPO referred to clause 8.2 of the Agreement between the Assessee and deliverables which reads as under:
"8.2 As between GSPL and Hutchison, all Intellectual Property Rights in any Deliverable, and in any software or anything created or developed by GSPL or any third party acting on its behalf, in compliance or purported compliance with its obligations under this Agreement ( including GSPL Materials) solely for the benefit of Hutchison under this Agreement ( the "Works"), shall vest legally and beneficially in Hutchison. The parties further agree that all Intellectual Property Rights in any Deliverable, and in ant software or anything created or developed by GSPL or any third party acting on its behalf, in compliance or purported compliance with its obligation under this Agreement and the Related Agreement (including the GSPL Materials) for the joint benefit of Hutchison and Hutchison 3G UK Limited ("Joint Material") shall west legally and beneficially in Hutchison and Hutchison 3G UK Limited".
Based on the above clause, the TPO concluded that in the course of rendering services the Assessee delivers project software, design, report, document, specifications or other item or in combination 7 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) thereof, which may be developed or created or provided by the assessee arising out of the supply of services to these companies.
c) Referring to the definition of Management personnel, operating procedure, services and GSPL Infrastructure as contained in the agreement between the Assessee and AEs for rendering services, the ATPO held that the AEs could utilize the infrastructure consisting of its dedicated personnel, computer, network and electronic hardware and equipment, which will include hardware, network, communication and ancillary equipments alongwith embedded programmes and the contact centre of the Assessee. It will utilize management personnel including Contact Centre Manager, Director of Customer Services, head of Operations, Head of Operations Support, Head of HR of Finance, Head of IT and Operations and Planning Manager, each of whom shall report to the Steering Committee for supervision of the services.
d) The services will be provided ensuring quality customer services as set out in the services schedule including establishment of the Contact Centre, hiring training, recruitment and supervision of the personnel. It has also undertaken not to provide similar services to any other person other than the H3G companies without their written consent.
e) The assessee has to take necessary steps to provide the services levels as per the stated Services levels. The assessee need to have Disaster Recovery Plan and appropriately test the operationability of these plans. In case of any default or non-performance by the assessee, which substantially degrade, or delay the performance of the services in accordance with the services levels,, H3G companies may take control of that part of the services that impacts on the service levels. This shows that services being rendered by the assessee are of paramount importance for the core functions being performed by H3G companies and are not routine services.
8 ITA NO.5887/MUM/2010(A.Y.2005-06)ITA NO.7125/MUM/2010(A.Y. 2006-07)
f) The agreement also provides that the assessee has to provide a Professional Indemnity Insurance to H3G companies for an amount of US$ 10,000,000 per occurrence and also gave third party insurance covering the legal liability of the assessee to any injury to persons or loss or damage to property arising out of the performance of this agreement. This shows that the assessee is bearing the risks to a large extent arising from the performance of the contracts.
12. The TPO thereafter referred to the website of the Assessee "WWW.3globalservices.com" and found that the Assessee has described itself as providing the following services:
a) Post sales-Mobile Number Porting (MNP) /Activation / Provisioning.
b) Sales-Direct Selling/Campaign Management
c) Collections- Consumer / Commercial.
d) Value Added Service-Content Selling.
e) Customer Care-Queries / complaints / Billing requests/ Technical issues / Delivery Enquiries Services Change Request.
f) Customer Retention-Inbound /Handset upgrade
g) Channel Support Retail Support.
The TPO also held that the assessee company has over four million customers in Australia & U.K. That the Assessee provides end-to-end customer relationship management solutions to customers and the third generation mobile telephony - 3 which has pioneered revolutionary 3 G mobile technology. That the assessee's operations assumes importance since it is forms the back support system for the core functions performance by the H3G companies. The TPO was also of the view that 3G technology facilitates the convergence of communication, information and entertainment. Customers can make a video call, download and wach music videos, watch live sports action and live video messages. According to 9 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) the TPO the terms of the Agreement between the Assessee and the AEs clearly show that the quality of services assumes lot of importance and the agreement also showed the wide range of services being performed by the assessee for the H3G companies. The TPO was also of the view that certain service levels are to be maintained and achieved and the assessee is also to have to have a disaster recovery plan in place. According to the TPO in case the H3G companies find that the services are not upto mark they can take control of the activities themselves. The TPO also concluded that the services being provided by the assessee include the direct selling, campaign management, content selling, customer retention and retail support and that these services are important for theH3G companies since the mobile phone operations are basically customer driven. The TPO was also of the view that the importance of the functions being performed by the assessee was also visible from the experienced management team which was overlooking the operations.
13. For all the above reasons the TPO was of the view that the assessee was performing significant functions and assuming significant risks. The Assessee submitted before the TPO that due consideration should be given while fixing the ALP for the money received in advance from the AE for performing the services. Due consideration should also be given for the fact that the link charges and equipment charges installed at AEs premises have not been claimed by the assessee. The TPO however held that the said plea cannot be accepted because the Assessee was undertaking substantial risk in its business with the AEs. The TPO held that the interest cost would therefore, not affect the profit margin. The TPO also held that the assessee was not able to demonstrate that link charges and cost of assets installed at premises of the AEs were also not charged in comparable cases set out in the T.P report filed by the assessee.
10 ITA NO.5887/MUM/2010(A.Y.2005-06)ITA NO.7125/MUM/2010(A.Y. 2006-07)
14. Thereafter the TPO took up nine comparable cases and also 6 comparable cases given by the assessee. Thus the 15 comparables including 6 selected by the assessee and nine selected by the TPO are as under:-
Sr.No. Comparable companies OP/TC (%)
1 Allsec Technologies Ltd 28.07
2 WIPRO BOPO Solutions Ltd. 28.43
3 Transworks Information Services Ltd. 5.69
4 Hinduja TMT Ltd. 62.25
5 Mphasis Ltd. 38.26
6 Firstsource Solutions Ltd 4.84
7 Tulsyan Technologies Ltd. (Cosmic Global) 19.08
8 Saffron Global 24.89
9 Vishal Information Technologies Ltd. 45.65
10 Ace Software Exports Ltd. 15.46
11 Nucleus Netsof& GIS India Ltd. 40.6
12 Asian Cerc Information Technology Ltd.(seg) 37.4
13. Airline Financial Support Services (I) Ltd. 26.54
14 Goldstone Teleservices Ltd. (Seg) 15.95
15 Cepha Imaging Pvt. Ltd. 47.7
Total 440.81
Average 29.38
The arithmetic mean of the net margin (PBIT) on total costs for these 15 comparables was 29.38%.
15. The net margin of the assessee was calculated as under:
Total Expenditure as per P/L account 125,00,96,000/-
Less 1. Loss on sale of fixed assets 7000/-
2. Misc exp. w/o. 2000/-
Total cost 125,00,87,000/-
PBT as per P/L account 12,10,96,000/-
Less Bank interest 17,49,000/-
Add 1. Loss on sale of fixed assets 7000/-
2. Misc. exp w/o. 2000/-
PBIT 11,93,56,000/-
OP/TC 9.55%
The TPO held that the net margin on cost earned by the assessee was less then the net margin on cost earned by the comparables. The net margin on costs earned by the comparables at 29.38% was held to be the arm's length 11 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) margin. The amount of adjustment to the income of the assessee on account of provision of services to its AEs was calculated by the TPO as under:
Total cost 125,00,87,000/- PBIT(as per the assessee @ 9.55%) 11,93,56,000/- PBIT @ 29.38% 36,72,75,560/- Shortfall 24,79,19,550/- Amount received from AEs for ITES services by the assessee 133,75,11,429/- 5% of 133,75,11,429/- 6,68,75,571/- Arms length value of these services which should have been 158,54,30,979/- received by the assessee from its AEs Amount of Adjustment to the income of the assessee 24,79,19,550/-
In view of the above, the arm's length value of the transaction for provision of IT enabled services by the assessee to its AE's was calculated at Rs. 158,54,30,979/- is being made to the income of the assessee. Consequently an addition of Rs.24,79,19,550/- was made to the total income of the Assessee on account of adjustment of ALP by the AO.
16. As can be seen from the conclusions of the TPO in his order, it has been the stand of the TPO that the assessee was not peforming merely the services of a call center and was providing services which were much more than an ordinary call center. In this regard the TPO has referred to certain facts which emerge from the agreement between the assessee and the AE. According to the assessee these facts were not confronted to the assessee by the TPO and the assessee came to know about the observation of the TPO only after receipt of the order of the TPO. The assessee filed an application under section 154 of the Act before the TPO. In this application the assessee had specifically pointed out that the conclusions of the TPO that the assessee also provided and delivered project software design reports is not factually correct. In this regard the assessee submitted "Deliverables means any product, software, interface, design, report, document, specification or other item or any combination thereof to be developed, created or provided by GSPL in the course of or arising out of the supply of services under the 12 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) this agreement. It was submitted that the term "Deliverables" is used only in relation to any software etc. that may get developed in the course of rendering the 'Services", being the services of a call center as explained above. The assessee is not engaged in the business of supplying "Deliverables" as presumed by A.O. The work 'Deliverables is used only in Clause 8.2 which reads as under:
"8.2 As between GSPL and Hutchison, all Intellectual Property Rights in any Deliverable, and in any software or anything created or developed by GSPL or any third party acting on its behalf, in compliance or purported compliance with its obligations under this Agreement ( including GSPL Materials) solely for the benefit of Hutchison under this Agreement ( the"Works"), shall vest legally and beneficially in Hutchison. The parties further agree that all Intellectual Property Rights in any Deliverable, and in ant software or anything created or developed by GSPL or any third party acting on its behalf, in compliance or purported compliance with its obligation under this Agreement and the Related Agreement (including the GSPL Materials) for the joint benefit of Hutchison and Hutchison 3G UK Limited ("Joint Material") shall west legally and beneficially in Hutchison and Hutchison 3G UK Limited".
The Assessee submitted that the term "Deliverables" does not mean the services to be rendered by '3GS'. 3Gs is engaged in providing call centre related services. As per the Agreement, 3GS operates an international contact centre in India to provide contract centre services and has agreed to provide a Contact Centre and Services for Hutchison. The term Contact Centre means the contact centre that 3GS shall provide pursuant to this Agreement. The terms Service means the establishment of the Contact Centre, hiring and training of the Contact Centre Personnel, recruitment and supervision of 3GS Personnel, ensuring quality customer services and providing the services set out in the Service Schedule in accordance in particular, with the forecasts provided to 3GS from time to time which are to be agreed between the parties. The assessee, therefore, submitted that 3GS is not engaged in delivering project software, design, reports, documents, specifications or other items or in combination thereof. It was submitted 13 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) that the edifice on which the order rests is misconceived and is based on completely erroneous assumption of facts. It was submitted that the order of TPO suffers from serious glaring mistake of fact and ought to be rectified.
17. The assessee also pointed out that disaster recovery plan is nothing but a plan of action that has to be adopted in the course of performing services by the assessee. Thus disaster recovery does not involve providing any services which were beyond the scope of service rendered by a call center. The assessee also pointed out that by looking into the web site of the assessee the TPO had drawn some conclusions. The assessee pointed out that all these services were ordinarily performed by a call center. The assessee also pointed out that the assessee has no privity of contract with the customers of the AEs and only provides call center services, answering queries of subscribers or prospecting subscribers of the AEs. The assessee also invited the TPO to visit its office to find out the nature of services the assessee renders.
18. The TPO passed an order under section 154 wherein he expressed the opinion that the comparable selected by him are broadly similar to the functions performed by the assessee. Thus the TPO in his original order took the view that the services rendered by the Assessee were much sophisticated and technical than a mere call centre. In the order u/s.154 of the Act, he did not deny the plea of the Assessee as set out in the application u/s.154 of the Act but took a stand that the comparable cases relied by TPO, similar services were being rendered as the one claimed by the Assessee.
19. On appeal by the assessee the CIT(A) deleted the addition made by the AO for the following reasons:
14 ITA NO.5887/MUM/2010(A.Y.2005-06)ITA NO.7125/MUM/2010(A.Y. 2006-07)
a) The TPO has proceeded on an incorrect understanding of the Assessee's business and that such misconception has resulted from an erroneous reading of the various clauses of the relevant agreement with the A.E.
b) The Assessee was a mere call centre and not engaged in other high end ITES like software development etc. Copies of the approval from the Department of Telecommunications as also the approval from the Shop and Establishment authority, both mention the nature of activities approved as call centre activity.
c) As per the agreement between the Assessee and the services to be provided by the Assessee was to act as "Contact Centre" and the allied activity in relation thereto.
d) The TPO has relied on the word "Deliverables" to buttress his argument that the assessee is not a mere call centre. According to the CIT(A), the term was used only in para 8.2 of the agreement as per which all intellectual property rights in any "deliverable" shall vest with Hutchison (i.e. the A.E) and not the appellant. Apart from this clause, this term has not been referred in this agreement and certainly not while dealing with the scope of services to be rendered by the appellant. The inference of the TPO that the term "deliverable"
referred to delivering of software, design, reports etc. is clearly an erroneous and lop sided reading of the agreement.
e) The CIT(A) held that the status of the Assessee has in all assessment orders been described as "Call centre.
f) The CIT(A) held that the true import of "Disaster Recovery Plan refers to the commitment on the part of the Assessee to provide service to its AE and to take care of any emergency situation while providing its call centre services. It is a common business practice of service providers to provide its clients with a DRP however small or big it might be.
g) The CIT(A) held that the TPO erred in construing the customers of its AEs as customers of the Assessee. He held that the AEs were telecom service provider and were providing 3G technology to its customers. He also held that the TPO has used the data from the website of the assesseee's clients to content that the assessee is engaged in providing such 3G technology services to its 4 million customers.
h) On rejection of the loss making companies included in the list of companies selected by the assessee, the CIT(A) found that 5 out of 6 15 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) companies were all established in the year 2001/2002 which is around the same time as the incorporation of the Assessee. He also held that the 9 new companies added by the TPO in his list are the companies established during the period 1992 to 2000 i.e. period much prior to the incorporation of the Appellant Company. He was of the view that the companies which were at the start-up stage may make losses and, therefore, cannot be brushed aside from the sample of comparable companies. He held that these cannot be regarded as "chronically" loss making since they are just at the start-up stage. Balance one company, namely, Ask Me Info Hub Ltd. being a loss making company included in the list of comparable of the assessee but rejected by the TPO is, no doubt, established in the year 1962. However, on a perusal of its Profit and Loss Account, it cannot be labled as 'chronically" loss making since in the financial year 2005-06 and 2006-07 this company has turned around and has earned small profits. The companies selected by the assessee, though loss making during the relevant year, cannot be removed from the list of comparables in view of the fact that these are, like the Assessee itself, start-up companies and these companies are undoubtedly engaged in voice based call centre services.
i) With regard to the 9 new additional companies selected by the TPO (except Saffron Global) the CIT(A) held that these companies are not engaged in Plain Vanila Voice Based Call Centre and engaged in higher end ITES. Also since these are not start up companies, he held that the new 9 companies introduced by the TPO deserve to be rejected. Even if M/s. Saffron Global (being one of the 9 companies selected by the TPO but not included in the list of the Assessee) is included, the arithmetic mean would work out to 7.64% which is lower than the 9.55% margin charged in the case of the assessee.
j) With regard to the other adjustments (5 different adjustments) so as to bring about the comparability between the data selected and the assesseee having regard to the broad facts in the assessee's case, the CIT(A) held as follows: (Para 3.10 of CIT(A)'s order) "These are adjustments on account of working capital i.e. saving in Interest Cost, saving in IPLC Link Cost, saving in Asset Installation Cost resulting in lower depreciation, saving in Maintenance Cost and saving in Business Development and Ad spend. While most of the above adjustments are debatable, I am of the view that the adjustments in terms of saving in interest cost on account of the appellant having received trade advances from its customers is a justifiable claim made by the appellant and ought to have been entertained by the TPO. It is seen from the data of the companies selected not only by the appellant but also the companies selected by the TPO that the average 16 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) collection period appearing in the Balance Sheet of all these companies for Financial Year 2004-05 works out around 3 months. As against this, the Appellant has received trade advances from its customers and its Balance Sheet does not reflect any sundry debtors outstanding on account of its billing. The appellant has furnished a detailed working of the savings in interest cost accruing as a result of these advances. The interest has been calculated on conservative basis at Prime Lending Rate of the State Bank of India. If this adjustment is to be factored, the ratio of operating profit to the total operating cost works out to 29.87% and this is even higher than the ratio of 29.38 if all the comparables of the TPO are accepted blindly. It has to be borne in mind that Transfer Pricing cases typically require a more in depth analysis of the facts and underlying economic of a particular related party transactions. From the point of view of a trader, his pricing would differ if the customer pays him advance or cash payment as compared to the customer who pays him after a credit period. There can be no two views on the proposition that the pricing of the trader would differ in these situations, everything else remaining the same. It is also quite common to hear about cash discount being offered by traders to induce the customer to make early payments. In view of this common business understanding and practice it will be fair and reasonable in accepting the claim of the appellant since the companies selected by him or by the TPO provide an average credit period of 3 months as against the Appellant obtaining advances from its customers which are periodically adjusted against the billing."
k) The CIT(A) also held that in Assessee's case in the earlier year, being the first year of operations, the Assessee charged cost plus 4% mark up plus depreciation on actual basis to the AEs. That year's appeal was decided in favour of the assessee vide order dated 6th January 2009 and the Revenue's appeal there against has since been dismissed by the "L" Bench of the ITAT in ITA No.1812/Mum/2009 dated 18th February 2010. In the current year, the assessee has charged 7% mark up not only on all costs but also on depreciation which according to CIT(A) means that the mark up charged by the assessee in current year has doubled than the mark up of the preceding year.
20. For the above reasons and taking on overall view of the matter the CIT(A) held that assessee's transaction with its AE is at Arms Length Price 17 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) calling for no adjustments. The consequent addition of Rs.24.79 crores made by the AO was deleted by the CIT(A).
21. Aggrieved by the order of the CIT(A) the revenue has raised ground No.1 before the Tribunal.
22. We have heard rival submissions which was a reiteration by the learned D.R.of the stand of the AO as reflected in the order of AO/TPO and the order of CIT(A) and submissions before CIT(A) by the learned counsel for the Assessee.
23. We have considered the rival submissions. It will be useful to recapitulate the sequence of events. The assessee entered into international transaction with Hutchison 3 G UK Ltd. and Hutchison 3 G Australia Ltd., who were the AEs of the assessee. The assessee claimed that it was performing services of a call center catering to certain queries of subscribers/ prospective subscribers of the AEs. The AEs were in the business of providing 3G mobile telephone facilities to its subscribers. The AEs subscribers as and when they have queries relating to services, billing, mobile number portability, hand set related queries, net work related queries, price plan related queries and dealer support demo and staff provisioning support, contact the assessee who provides all the related information. Thus the claim of the assessee was that it was purely providing voice based call center service.
24. There is no dispute between the assessee and the AO that for determining the ALP of the international transaction between the assessee and its AE the most appropriate method is TNMM. We have already seen the manner in which the assessee substantiated the price which it charged its AE. The assessee while doing so had selected 13 comparable cases. The net 18 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) margin on operating cost earned by this comparables was between -41.87% to 62.25% with arithmetical mean of 6.95%. The assessee had claimed that the price it had charged gave a net margin on operating cost which at 11.63% and, therefore, justified the price that it charged to the AE. The TPO rejected 7 of the 13 comparables selected by the assessee in its TP Study. The AO had on his own collected the data of 9 companies and considered the 6 companies selected by the assessee and arrived at a data base of 15 comparable cases. The assessee had objected before the AO that 8 out of the 9 comparable cases cited by the AO cannot be considered at all because they were in a totally different business. The objections with regard to the 8 parties out of the 9 considered by the AO was as follows:
Sr. Name of the Reason for Non-comparison with Appellant's business as Remarks if No. company described in Company's own web-site any.
1. Cepha Imaging CEPHA is a complete service provider for all publishing Refer Private Limited needs in the contemporary electronic era. Our primary Profile markets are Scientific, Technical, Medical, Scholarly, from Web Reference, and College publishing. The core of business is site at Typesetting/ Composition and also provides Project Pg.223 of Management Service and extended value added products- PB Multimedia Solutions.
2. Vishal Vishal is in the business for the last 8 years and is well Information established in its four areas of operations, namely Data Technologies Ltd. Digitization & Conversion, E-publishing, Digital Library Solutions and Print and Demand Conversion.
3. Ace Software Ace provides Document Management, e-publishing and Data Refer Exports Limited. Conversion solutions using optimal process engineering, cost Profile effective and flexible conversion systems. from Web site at Pg.220 of PB
4. Nucleus Netsof & The company continue to delight its customers with its Refer GIS India Limited products & service offerings in location based services, web Profile mapping, supply chain management, remote sensing, digital from Web photogrammetry, AM/FM for utilities & telcos, GIS in local site at government, business geographics & GPS segments of the Pg.226 of spatial technologies market place. PB
5. Asian Cerc Asian CERC Information Technology Ltd. is a leading Refer information provider of IT services to clients globally. During two Profile Technology decades long period of its existence, Asian CERC has from Web Limited(Seg.) provided solutions for dynamic environments where site at business and technology strategies converge. In order to Pg.222 of service its clients more efficiently, it has split is strategic PB business units into 3 distinct focus area: 1) Knowledge Management Services 2) Financial Technology Solutions and
3) Offshore Services & Support.
6 Airline financial AFS offers a range of services extending from airline revenue Refer Support Services accounting services, traffic accounting and cargo revenue Profile (I) Limited. accounting to passenger interline billing, navigation support, from Web 19 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) Level 1 h/w support and frequent fiyer programme site at administration Pg.221 of PB 7 Goldstone GIL is pioneer in design and manufacturing Composite Refer Teleservices Insulators in the country for use in Transmission and Profile Limited (Seg) Distribution, Railway Traction net works. The company is from Web also setting up plant to manufacture corrosion protective site at sleeves for oil and gas pipelines. The company is having its Pg.225 of own R&D Center and manufacturing facility at Cherlapally. PB 8 Tulsyan CGL provides Business Process Outsourcing (BPO) and IT High-end Technologies enabled services (ITES) to a global clientele. We Technical Limited (Cosmic conceptualize and realize technology driven business Services, Global) transformation initiates. With a vast worldwide network, we Refer use a low-risk Global Delivery Model (GDM), to accelerate profile for schedules with a high degree of time and cost predictability. Description of nature of business at page No.224 of PB
25. It was the plea of the Assessee before the TPO that the Services rendered by IT Industry (ITES-BPO) are classified into various segments are as under:
- Customer care (Voice and non-voice) includes inbound and outbound calls, telemarketing, email support, market surveys, web sales, advertising & PR;
- HR includes benefits administration, recruiting, education and training payroll and records management;
- Finance and accounting includes accounting transactions, tax consulting and management, risk management, financial analysis and reporting;
- Payment services includes processing and collection of claims, credit/debit cards, loans and cheques and Electronic Data Interchange;
- Content Development includes Animation, Gaming, business and Corp Research (includes data processing, decision support, data mining, asset management and market research) Document Management , Geographic information Services, Medical Transcription, Legal/Litigation support etc. 20 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) It can be observed that there are various segments in ITES - BPO section with the billing rates varying for each service line having different functionality.
26. In this regard the assessee also furnished a copy of the NASSCOM, the apex national level body of all IT enabled entities providing billing rates by ITES BPO for various services:
Sr.No. Type of service Billing Rate per hour
1 Customer care 10-14$
2 Payment services 12-15$
3 Finance 12-15$
4 Admn 12-15$
5 Human Resource ("HR") 15-17$
6 Content Development 18-24$
7 Knowledge Process Outsourcing ("KPO") 30-45$
Source :NASSCOM Strategic Review 2005
The Assessee pointed out that as per the above table of NASSCOM, the assessee would be classified under Customer Care. The assessee has all along been contending that it was a call centre handling various customer queries. The Assessee submitted that it employs candidates who are graduates / under graduates with English speaking skills. The nature of work handled does not require a person to hold any specific skill set like those held by accountants, legal professionals, software professionals, executives, technical consultants, creative agents. The assessee gets classified under the lowest strata of ITES as per the NASSCOM list given above. The Assessee had reiterated that the ITES, however, is a very wide network of services wherein at higher strata one can get higher end services like Payment Services, HR, Payroll, Finance and Accounts which require personnel with specific skill sets like Accountants, HR professionals having post degree qualification in HR, etc. The higher one go in the list of NASSCO table given above, the more complex the jobs are and accordingly, the more are their billing rate per hour and the resultant margins charged for the services.21 ITA NO.5887/MUM/2010(A.Y.2005-06)
ITA NO.7125/MUM/2010(A.Y. 2006-07)
27. The TPO has not considered the above objections of the assessee at all. In para 16 of the TPOs order the TPO has merely observed that the 9 comparables selected by the TPO are broadly similar functioning to the functions and risk profile of the assessee company. In our view the TPO was not justified in ignoring the distinction pointed out by the assessee with regard to the characteristics of the services provided by it and the 8 comparable cases considered by the TPO.
28. It has been the stand of the TPO that the assessee was not performing merely the services of a call center and was providing services which were much more than an ordinary call center. In this regard the AO has pointed out certain facts which emerges from the agreement between the assessee and the AE. According to the assessee these facts were not confronted to the assessee by the TPO and the assessee came to know about the observation of the TPO only after receipt of the order of the TPO. The assessee filed an application under section 154 of the Act before the TPO. In this application the assessee had specifically pointed out that the conclusions of the TPO that the assessee also provided and delivered project software design reports is not factually correct. In this regard the assessee submitted "Deliverables means any product, software, interface, design, report, document, specification or other item or any combination thereof to be developed, created or provided by GSPL in the course of or arising out of the supply of services under the this agreement. It was submitted that the term "Deliverables" is used only in relation to any software etc. that may get developed in the course of rendering the 'Services", being the services of a call center as explained above. The assessee was not engaged in the business of supplying "Deliverables" as presumed by the TPO. It was submitted that the Assessee was engaged in providing call centre related services. As per the Agreement, 3GS operates an international contact 22 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) centre in India to provide contract centre services and has agreed to provide a Contact Centre and Services for Hutchison. The assessee also pointed out that disaster recovery plan is nothing but a plan of action that has to be adopted in the course of performing services by the assessee. Thus disaster recovery does not involve providing any services which were beyond the scope of service rendered by a call center. The assessee also pointed out that by looking into the web site of the assessee the TPO had drawn some conclusions. The assessee pointed out that all these services were ordinarily performed by a call center. The assessee also pointed out that the assessee has no privity of contract with the customers of the AEs and only provides call center services, answering queries of subscribers or prospecting subscribers of the AEs. The assessee also invited the TPO to visit its office to find out the nature of services the assessee renders.
29. The TPO passed an order under section 154 wherein he expressed the opinion that the comparable selected by him are broadly similar to the functions performed by the assessee.
30. It can be seen from above discussions that one of the areas of dispute is regarding the exact nature of services rendered by the assessee. In this regard we have examined the agreement between the assessee and its AEs. In this agreement (a copy of which is at page No.32 to 94 of the PB) the assessee has agreed to operate international contact center in India to provide contact centre services. Services has been defined in this agreement as follows:
"Services" means the establishment of the Contact Centre, hiring and training of the Contact Centre personnel, recruitment and supervision of GSPL Personnel, ensuring quality customer service and providing the services set out in the Service Schedule in accordance , in particular, with the forecasts provided to GSPL from time to time which are to be agreed between the parties."23 ITA NO.5887/MUM/2010(A.Y.2005-06)
ITA NO.7125/MUM/2010(A.Y. 2006-07) The service schedule has been defined as follows:
"Service Schedule" means the Schedule to be agreed between the parties setting out the Services to be provided by GSPL as amended or replaced by Hutchison from time to time and notified to GSPL."
On a careful perusal of the agreement we find that there is no exact description of the nature of services to be rendered. That can be verified only from the schedule agreed between the parties setting out the services to be provided. The ld. counsel for the assessee submitted before us that in the earlier assessment year the assessee has been accepted to be performing the services of a call centre. It was also pointed out that the registration certificate of the assessee under Bombay Shop and Establishment Act, 1948 the assessee has been described as a call centre. It has also been pointed out that the approval from Department of Telecommunication also supports the claim of the assessee that it is call centre.
31. We have, on a carefully consideration of the rival submissions, come to the conclusion that it is necessary to find out the exact nature of services rendered by the assessee. It is only after finding out exact nature of services rendered by the assessee can a comparative uncontrolled transaction can be brought to the picture. We, therefore, set aside the order of the CIT(A) and restore the issue to the TPO/AO for a fresh consideration. The steps involved in determination of the ALP would be to first identify the international transaction, i.e., the transaction between the Assessee and it's AE which is a non-resident. The next step is to identify comparable uncontrolled transaction, i.e., transaction between parties who are not related. Rule10A(a) of the IT Rules, 1962 (Rules)defines uncontrolled transaction. It lays down that 'uncontrolled transaction' means a transaction between enterprises other than associated enterprises, whether resident or non-resident. Rule 10B lays down the manner of determination of arm's length price under section 92C. It says that for the purposes of 24 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the five methods viz.,
(a)comparable uncontrolled price method; (b)resale price method; (c)cost plus method; (d)profit split method; (e)transactional net margin method; Rule 10-B (2) lays down that the manner in which comparison has to be made. It lays down that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely :--
(a) the specific characteristics of the property transferred or services provided in either transaction ;
(b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions ;
(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions ;
(d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.
Rule 10-B(3) lays down that an uncontrolled transaction shall be comparable to an international transaction if--
(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or th+profit arising from, such transactions in the open market ; or
(ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
In the set aside proceedings, the AO will consider the issue in the light of the rules set out above. The Assessee has set out in pages 337 to 340 of his paper book as to how working capital adjustments have to be made. In pages 183 to 186 and 191 to 202 of the paper book the Assessee has also highlighted the other adjustments that are required to be made to eliminate 25 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) material effects of the differences between the international transaction and the comparable uncontrolled transactions. These aspects will also be considered by the AO in the set aside proceedings. It was also submitted by the learned counsel for the Assessee that in terms of Rule 10-B(1)( e)(i) of the Rules under the TNMM, net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is to be computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant pase. In annexure 1 to the written note filed before us, the Assessee has pointed out that the Assessee's return on assets employed is higher than the comparable uncontrolled transactions considered by the AO. This requires verification and the AO will also consider this aspect in the set aside proceedings. Regarding rejection of the comparables given by the Assessee in its TP report on the ground that some of the companies were loss making companies, the Assessee has explained as to how in some cases there is actually profit and as to how despite losses those are comparable transactions. This aspect has however not been considered by the AO at all. In the set aside proceedings before the AO, the AO shall consider this aspect also.
32. It was the submission of the Assessee that ITES-BPO sector consists of various segments and each segment is functionally different from the other. It was the claim of the Assessee that it falls under the category of customer care which is at the lowest strata of ITES-BPO sector. The Assessee is a call centre answering various customer queries. The Assessee for carrying out its work has to employ candidates who are gradates/undergraduates with English speaking skills and need not hold any specific skill like accountants, legal professionals, software professionals, executives, technical consultants, creative agents. The ITES-BPO sector provides higher end services like payment services, HR, Payroll, Finance and Accounts which 26 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) require personnel with specific skills sets like Accountant, HR Professionals having post degree qualification in HR, etc. It has been the claim of the Assessee that as one goes higher in the ITES-BPO sector ladder, the job is more complex and therefore billing rate per hour and resultant margin charged for services is bound to be higher. Thus the Assessee claimed that the BPO sector selected by the TPO ( 9 companies) were not mere call centre but performing much more skilled jobs than that of a call centre. We have already extracted the explanation of the Assessee before the TPO in this regard. The TPO has ignored the plea of the Assessee and has not given any reasons for doing so. The TPO has merely said the comparable instances were performing identical job as performed by the Assessee. In our view such rejection of the Assessee without assigning any reason is arbitrary.
33. Another aspect which we notice in the TPO's order is that he had carried out FAR analysis and has alleged that the Assessee was performing services that are much more technical than what an ordinary call centre performs. The TPO has not spelt out as to how in the comparative uncontrolled transaction considered by the TPO, the nature of services rendered is similar to the one rendered by the Assessee.
34. One of the submission made by the learned counsel for the Assessee was that, if for any reason, the Tribunal remands the issue of determination of ALP to the AO, then , a direction should be given that the TPO will not look afresh into data that is available in the public domain. According to him, the TP study is required to be done on the basis of data available in the public domain at the point of time when the TP study is undertaken by the Assessee and any new data available should not be considered, since the Asssessee cannot foresee data which is not available in public domain when it determined ALP. According to him, if the TPO is permitted to do so, then it 27 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) will be an endless exercise, which will put the Assessee in a disadvantageous position.
35. We have considered this submission and are of the view that the same cannot be fully accepted. We are of the view that so long as the data available before the TPO in the course of proceedings pursuant to the order of the tribunal is contemporaneous in point of time and is otherwise comparable, we do not see why the TPO should be precluded from looking into such data. After all the exercise of determining the ALP involves approximation and is to some extent notional. The idea is to fix the ALP. Any uncontrolled comparable transaction which is available in public domain cannot therefore be ignored. We are of the view that the Assessee will not be prejudiced in any manner, if such data is looked into by the TPO. The Assessee can always have objections to such data being used. We would however emphasis that the data so used should be contemporaneous in point of time and should be comparable. Even Rule 10-B (4) of the Rules contemplate this and it lays down that the data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into. Thus there are adequate safeguards in the rules and the Assessee's apprehension is not well founded.
36. For statistical purposes, the ground of appeal is treated as allowed.
37. Connected Issue in ITA No.7125/M/2010: (Ground No.1 in Assessee's appeal for AY 06-07:
Ground No.1: Addition u/s.92CA(3)- Rs.32,56,85,911/-
1. On the facts and in the circumstances of the case and in law, the Deputy Commissioner of Income Tax, Range 3(3), Mumbai (the AO) erred in making an addition under Section 92 amounting to 28 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) Rs.32,56,85,911/- in respect of the Appellant's international transaction with its associated enterprises of rendering voice based call centre services. In doing so, the AO has, inter alia, erred in completely overlooking/ignoring the earlier year's order of the Appellate Authorities and all other submissions/arguments of the Appellant.
2. The appellant, therefore, humbly prays that the addition u/s.92 be deleted.
38. In this assessment year the assessee has challenged the adjustment made by the TPO to the ALP. In this assessment year the facts are almost identical. The TPO in his order under section 92C has determined the ALP in the following manner. The assessee had given 11 comparable instances. The assessee on his own only pressed for 7 of the comparables selected by it. The TPO rejected these comparables for the following reasons:
Sr.No. Name of the comparable Reasons for rejection.
1. Ask Me Info Hubs Ltd. The company is chronically loss making, hence rejected.
2. B 2K Corp. Pvt. Ltd. Company operates in the area of rendering business process outsourcing services. The company is chronically loss making with loss in FY 2005-06, hence rejected.
3 Godrej Upstream Ltd. Company is engaged in business of ITES services.
Main income from call centre operation. Chronically loss making company. Approx. 28% of total services to related parties.
4 Optimus Global Services Company is engaged in business of call centers Ltd. providing, customer care services. The company is chronically loss making. Hence Rejected.
5 Nipuna Services Ltd. The company offers services like contact centres for customer services, product support and help desk services. Additionally it also offers back office processes in area such as accounting and HR. Hence, rejected.
6 Transworks Information The company provides CRM services and also Services Ltd. operates in the area of rendering business process outsourcing services. Hence rejected.
7 Wipro Ltd. (Segment) Company is engaged in the business of providing IT and BPO services. Highly diversified company with main income being from software services. Company business also includes consumer care and lighting 29 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) products and sale of hydraulic cylinders and sale mini computer / micro computer based systems.
39. The AO on his own conducted a search and selected 13 comparable instances as follows:
Sr.No. Company name Sales OP to Total
(Rs.cr.) cost %
1 Ace Software Exports Ltd. 4.97 7.72
2 Allsec Technologies Ltd. 92.25 28.51
3 Apex Knowledge Solutions Pvt. Ltd. 4.92 20.48
4 Asit c Mehta financial Services Ltd. (Earlier known as 5.68 34.52
Nucleus Netsoft & GIS (India) Ltd.)
5 Cosmic Global Ltd (Seg) 3.11 16.03
6 Datamatics Financial Services Ltd. (Seg) 2.31 24.99
7 Flextronics Software Systems Ltd. (Seg) 21.41 14.54
8 Goldstone Infratch Ltd. (seg) (Earlier known as 5.03 29.01
Goldstone Teleservices Ltd.)
9 Maple e Solutions Ltd. 7.43 32.66
10. R Systems Internation Ltd. (Seg) 9.17 15.11
11 Spanco Ltd. (Seg) (Earlier known as Spanco 82.32 20.86
Telesystems & Solutions Ltd.)
12 Transworks Information Services Ltd. 163.3 19.56
13 Vishal Information Technologies Ltd. 25.64 48.03
Arithmetic mean 24.00%
40. The TPO held that the arm's length margins of comparable companies engaged in software development activities is 24% on cost. Accordingly the ALP was determined by adopting the above arithmetic mean of 24% and ALP determined. Consequently the impugned addition to the total income was made by the AO based on TPO's report.
41. It was the claim of the Assessee that out of the 13 companies selected by the TPO 11 companies are grossly non-comparable with the Assessee. The Assessee pointed out that the 10 out of the 11 companies were functionally not comparable at all and the other company viz., Spanco Ltd. earned export revenues of less than 25% of its total revenue. The Assessee pointed out that the 10 companies fell under the higher strata of services 30 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) with some getting calssified under content development and KPO. Thus they were functionally not comparable at all. The details in this regard are contained at page-204 of the Assessee paper book in the form of annexure-1 to the reply filed by the Assessee before the TPO vide its letter dated 21.10.2009 filed before the TPO. Apart from the above, the Assessee also submitted reconciliation of margin working, submission as to why the comparable transactions relied upon by the Assessee cannot be rejected, reasons as to why saving on account of link cost, recovery of reimbursement of expenses should be considered while working ALP. No valid reasons have been assigned by the TPO while ignoring these submissions. The TPO has merely observed at page-3 last two paras of his order that the comparables selected by the TPO are comparable. As regards the link cost, the TPO has merely observed that the saving of link cost because of its being borne by the AE cannot be considered for adjustment because had the Assessee incurred these costs, the Assessee would have got a mark-up on this cost also. In our view this reason assigned by the TPO cannot be sustained. The TPO has to give due adjustment on this account. Saving of cost is certainly a matter which would affect the price charged by the Assessee and it cannot be ignored. It is not the case of the TPO that in the comparable cases also there has been such saving of cost. The same reasons would also hold good for claim of the Assessee regarding saving on account of depreciation on equipment capitalization cost. Similarly with regard to saving on advertisement cost, the TPO has rejected the claim of the Assessee on the ground that the Assessee has incurred expenditure on account of advertisement to the tune of Rs.1.27 crores. The point that ought to have been addressed is only with regard to the saving of cost and its impact on the ALP. The TPO in our view is not justified in his approach in this regard. It is also noticed that the Assessee pointed out before the AO that its margin was at 7.29% as against 6.64% mentioned by the TPO in his show cause notice. On this the TPO has no answer and proceeds to observe that the 31 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) details regarding the same are kept on record. In our view the TPO has proceeded in an arbitrary manner while rejecting the claim of the Assessee. In the set aside proceedings he shall address all the above issues in the light of the observations made by us above and the earlier part of this order on identical issue for AY 05-06. In our view the DRP has also not considered all these objections, which are clearly set out in the statement of facts filed by the Assessee before the DRP. We therefore set aside the order of the AO and remand the question of determination of ALP by the AO afresh in the light of the directions given above. For statistical purposes, the ground of appeal of the Assessee is treated as allowed.
42. Ground No.2 raised by the Revenue in ITA No.5887/Mum/10 reads as follows:
"2. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in allowing the claim of the assessee u/s. 10A before setting off of unabsorbed depreciation."
43. The Assessee had filed a return of income for AY 05-06 on 28.10.2005 declaring total income of Rs.15,71,120 after claiming deduction u/s.10-A of the Act of Rs.11,29,06,385. The sum of Rs.15,71,120 was interest income which was offered to tax. On 9.2.2007, the Assessee filed a revised return of income of Rs. Nil. The Assessee had brought forward depreciation loss of Rs.3,85,20,781/-. In this revised return of income the Assessee set off against the interest income brought forward depreciation loss and claimed carry forward of the remaining depreciation loss of Rs.3,69,49,662/-. The AO however held that u/s.32 of the Act, as applicable to the Assessment year in question, unabsorbed brought forward depreciation has to be added to the current years depreciation and shall be deemed to be part of depreciation allowance and so on for succeeding previous years. Thus the 32 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) brought forward unabsorbed depreciation was added to the current year's depreciation and the AO held that the same can be allowed as deduction while computing business income i.e., under the head "profits and gains of business/profession". The AO held that since there was no unabsorbed depreciation or brought forward losses, no amount of business or depreciation could be carried forward
44. Before CIT(A), the Assessee submitted that unabsorbed brought forward depreciation should not be added to the current year's depreciation and that such unabsorbed brought forward depreciation is eligible for set off against profits under any head of income. It was argued that deduction u/s.10-A of the Act should be computed on profits for the year before setting of unabsorbed depreciation and that unabsorbed depreciation should be allowed to be set off against income under other heads and deduction u/s.10-A of the Act has to be allowed on profits before setting of unabsorbed depreciation.
45. The CIT(A) held as follows:
" 4.1 According to the AO, the unabsorbed brought forward depreciation is required to be added to the amount of depreciation for the next year and, therefore, he has taken a view that the entire depreciation of earlier years should be first adjusted against the profit of the undertaking before computing deduction u/s. 10A. This issue stand squarely covered by the decision of the Chennai Tribunal (22 SOT 220) wherein the Tribunal has held that the deduction should be computed without setting off brought forward losses. Section 72(2) clearly provides that where any allowance or part thereof under sub- section (2) of section 32 is to be carried forward, effect should first be given to the provisions of section 72(2). Now, since in view of the Tribunal, Sec. 10A is to be computed before setting off brought forward losses and since effect should be given first to brought forward losses and then unabsorbed losses, it is only logical that the deduction u/s. 10A should be allowed not only before setting off brought forward losses but also before setting off unabsorbed depreciation. The appellant's stand is also covered by the decision of 33 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) the Special Bench in the case of Scientific Atlanta India Technology Pvt. Ltd. Thus ground No.2 is allowed."
46. Aggrieved by the order of the CIT(A), the revenue has raised ground No.2 before the Tribunal. We have heard the rival submissions. Under the provisions of Sec.10-A of the Act, deduction of such profits and gains as are derived by an undertaking from the export of computer software or other notified business shall be allowed from the total income of such undertaking. Section 72(2) clearly and specifically provides that where any allowance or part thereof under sub-section (2) of section 32 is to be carried forward, effect shall first be given to the provisions of Section 72(2). Thus, there is no reference to the set-off of business losses and unabsorbed depreciation. The view is also supported by decision of Chennai Tribunal in the case of Changepond Technologies (P) Ltd. vs. ACIT (22 SOT 220) wherein it was held as under:
"The Commissioner (Appeals) was not correct in setting off of carried forward losses before giving the exemption under section 10A. There is no provision in the Act by which the deduction should be restricted to the total income of the assessee computed under the provisions of the Act before allowing such deduction. Wherever the Legislature intends so to restrict the deduction, the same is provided in the Act itself. Therefore, there is no scope for any interpretation that the profits and gains of the specified undertaking should be computed under the normal course as per the provisions of the Act and not under the special provisions of section 10A. Accordingly the deduction under section 10A is not to be restricted to the total income of the assessee computed before allowing the deduction under section 10A, since the deduction is given on the profit and gain derived from the export activity and not on the total income as computed under the provisions of the Act. Therefore, the only interpretation which is applicable in respect of section 10A is that the deduction of the unit qualifying for exemption is to be given to the extent of income computed in respect of the said unit. Therefore, the Commissioner (Appeals) was not justified in holding that the total income of the assessee for any relevant assessment year is required to be computed after taking into consideration the carried forward losses incurred after 1.4.2001 and after setting off the loss if there is any positive income is 34 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) left, the same is exempted under section 10A. Therefore, the assessee was entitled to deduction under section 10A without setting off the brought forward losses."
As per aforesaid decision, if unabsorbed business losses cannot be set off against profits of the undertaking before granting deduction u/s. 10A, then, indeed unabsorbed depreciation also cannot be set off in view of section 72(2) of the Act. The Special Bench of Chennai Tribunal in the case of M/s. Scientific Atlanta India Technology Pvt. Ltd. vs. ACIT (ITA No.229/Mds/2007) has also held that profits of 10A unit can't be adjusted against losses of a non-10A unit. In other words, deduction u/s. 10A ought to be granted solely on the profits of the business of the 10A undertaking and not on total income computed after giving effect to Section 72 / Section 32(2), etc. We are therefore of the view that deduction u/s. 10A has to be allowed on profits of the undertaking before set off of unabsorbed depreciation. Unabsorbed depreciation has therefore to be allowed to be adjusted against interest income. For the reasons given above, we confirm the order of CIT(A) and dismiss ground No.2 raised by the Revenue.
47. Ground No.3 raised by the Revenue in ITA No.5887/Mum/10 reads as follows:
"3. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in holding that exchange rate gain is integral part of the exports and hence part of "Business Income" and cannot be treated as "Income from other sources"
48. The Assessee had earned foreign exchange gain of Rs.3,19,32,434/- . The foreign exchange gain earned by the Assessee and its accounting was explained by the Assessee as follows:
The Assessee say receives an advance of 1000 US $ on 15.3.2004 from AE (Exchange rate difference on the date of receipt 1 US $ = Rs.44.00). This 35 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) advance will get adjusted against subsequent billing on AE. Entry passed at the time of receipt on 15.3.2004 will be:
Bank A/C. Dr. Rs.44,000 To AE Cr. Rs.44,000 On 31.3.2004, (1 US $ = Rs.47.00) revaluation of foreign currency liability, the entry passed will be:
Foreign Exchange loss A/c. Dr. Rs.3,000
To AE Cr. Rs.3,000
On 31.3.2004, the effect of the above transaction in the books of account will be:
Bank Balance (Asset side) Rs.44,000 AE Balance (liability) Rs.47,000 Foreign Exchange loss Rs. 3,000
In the next year i.e., FY 04-05 relevant to AY 05-06, the advance received will be adjusted against bill of US $ 1000. The exchange rate on the date of billing is 1 US $= Rs.41/-. The entry passed will be:
AE A/C. Dr. Rs.47,000
To sales Cr. Rs.41,000
To Foreign Exchange gain Cr. Rs.6,000
As on 31.3.2005 will be:
Sales Income Rs.41,000
Foreign Exchange Income Rs. 6,000
AE Balance Rs. Nil
The Assessee thus submitted that the Foreign Exchange gain is part of the business income of the Assessee and ought to be considered as Income from Business while working deduction u/s.10A of the Act. The Assessee also relied on the decision in the case of CIT Vs. Woodward Governor India Pvt.Ltd. 179 Taxman 326 (SC)wherein it was held that the loss suffered by an Assessee on account of exchange difference as on the date of the balance sheet is an item of expenditure u/s.37(1) of the Act.
49. The AO however held that the gain on foreign exchange rate difference received by the Assessee pertains to the sales mainly of preceding year and 36 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) partly of the current year. According to the AO the sales are recorded in the books as on the date of sales (in the earlier year) and the gain on exchange rate difference is booked on the date of realisation of the sales ( in the previous year) already booked in the books of account and therefore they cannot be regarded as income of the previous year. He also held that the gain in question can be said to be 'attributable to' income from business of eligible undertaking but cannot be said to be 'derived from' the eligible undertaking. The AO therefore excluded the foreign exchange gain from the profits of the business while working out deduction u/s.10-A of the Act.
50. On appeal by the Assessee, the CIT(A) held as follows:
"5.2. I have considered the submissions and I find that the issue is covered by the decision of the Tribunal in Changepond Technologies (P) Ltd. and it has been categorically held that where the gain from fluctuation of foreign exchange is directly related to the export activities, it should be considered as income derived from export activity and, therefore, such foreign exchange gain would be included in the profits for computation of deduction u/s. 10A. Moreover, the Special Bench in ACIT v/s. Prakash L. Shah (301 ITR) has also held that exchange rate gain difference pertaining to exports is an integral part of the exports and export turnover cannot be treated as income from other sources. Thus ground No.3 & 4 are allowed."
51. Before us the learned D.R. relied on the order of the AO. We are of the view that the order of the CIT(A) on this issue has to be upheld. In the case of Changepond Technologies (I) Pvt. Ltd.(2008) 22 SOT 220(Chennai) , the Chennai Bench of ITAT dealt with identical issue and held as follows:
" The gain from the fluctuation of foreign exchange was directly related to the export activities and should be considered as income derived from export activities. Such gain due to fluctuation of foreign exchange arose only due to the export and not due to other activities of the Assessee. If the Assessee has not exported any article, then the question of any gain or loss due to foreign exchange did not arise.37 ITA NO.5887/MUM/2010(A.Y.2005-06)
ITA NO.7125/MUM/2010(A.Y. 2006-07) Therefore, the gain on foreign exchange would be included in the total turnover while computing the deduction u/s.10A."
We are of the view that the CIT(A) has rightly decided the issue in line with the law on the issue. We therefore uphold the order of CIT(A) and dismiss ground No.3 raised by the Revenue.
52. In the result, ITA No.5887/Mum/10 is partly allowed for statistical purposes.
53. ITA No.7125/Mum/10 (For AY 06-07):
This is an appeal by the Assessee against the order of the DCIT, Circle-3(3), Mumbai, passed u/s/143(3) of the Act, read with Sec.144C of the Act.
54. Ground No.1 has already been decided while deciding identical issue in the appeal by the Revenue for AY 05-06.
55. Ground No.2 raised by the Assessee reads as follows:
"Ground II : Disallowance of Set off of Unabsorbed depreciation against other Income:
1) On the facts and in the circumstances of the case and in law, the DRP and the AO erred in not allowing set off of unabsorbed depreciation against income from other source.
2) The DRP/AO failed to appreciate and ought to have held that during the A.Y 2004-05, the Appellant had unabsorbed depreciation of Rs. 3,85,20,781/- and therefore, in compliance with the carry forward & set off of loss provisions contained in Chapter VI of the Act, the Appellant has carry forward and set off such unabsorbed depreciation loss against the Income from other sources."
56. This ground of appeal is identical to ground No.2 raised by the Revenue in AY 05-06. While deciding the ground of appeal of the revenue, we have 38 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) already held that the Assessee is entitled to set off unabsorbed depreciation against interest income. For the reasons stated therein the ground of appeal raised by the Assessee is allowed and the AO is directed to allow the set off as claimed by the Assessee.
57. Ground No.3 raised by the Assessee reads as follows:
"Ground III: Treating interest on L/C Margin & Bank Guarantee of Rs.3,36,697/- as 'Income From Other Sources:
1. On the facts in the circumstances of the case and in law, the AO erred in treating interest income on L/C Margin & Bank Guarantee as "Income from Other Sources" as against "Business Income" of the eligible 10A unit for the first time in his final assessment order without having considered so in his draft assessment order u/s. 144C and accordingly, erred in denying deduction u/s. 10A in respect of such interest income."
58. For deciding ground No.3 it is necessary to have a look at the provisions of Sec.144-C of the Act, which were introduced by the Finance Act , 2009, wef. 1-4-2009. The said provisions provide that in the case of eligible Assessee, the Assessing Officer shall, notwithstanding anything to the contrary contained in this Act, in the first instance, forward a draft of the proposed order of assessment (hereafter in this section referred to as the draft order) to the eligible assesse, if he proposes to make, on or after the 1st day of October, 2009, any variation in the income or loss returned which is prejudicial to the interest of such assessee. For the purpose of Sec.144C of the Act, Eligible Assessee has been defined under Sec.144-C (15) to (i) any person in whose case the variation referred to in sub-section (1) arises as a consequence of the order of the Transfer Pricing Officer passed under sub- section (3) of section 92CA ; and (ii) any foreign company. Admittedly in the case of the Assessee there was reference to the TPO u/s.92CA of the Act, for determination of ALP of international transaction between the Assessee and 39 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) its AE. Therefore the Assessee is an eligible Assesssee to whom the provisions of Sec.144C of the Act, will apply.
In the case of assessments in the case of eligible Assessee, Sec.144C of the Act prescribes procedure where the AO proposes variation to the income or loss returned by the eligible Assessee. The AO has to first pass a draft assessment order. The copy of the draft assessment order is served on the Assessee and if the Assessee objects to the variation, then he has to file his objections to the Dispute Resolution Panel (DRP) and the Assessing Officer. The Dispute Resolution Panel shall, in a case where any objection is received, issue such directions, as it thinks fit, for the guidance of the Assessing Officer to enable him to complete the assessment. The Dispute Resolution Panel may confirm, reduce or enhance the variations proposed in the draft order so, however, that it shall not set aside any proposed variation or issue any direction for further enquiry and passing of the assessment order. Every direction issued by the Dispute Resolution Panel shall be binding on the Assessing Officer. Upon receipt of the directions issued under by the DRP, the Assessing Officer shall, in conformity with the directions, complete, notwithstanding anything to the contrary contained in section 153, the assessment without providing any further opportunity of being heard to the assessee, within one month from the end of the month in which such direction is received. u/s.253(1) (d) of the Act, any assessee aggrieved by an order passed by an Assessing Officer under sub-section (3) of section 143 or section 147 in pursuance of the directions of the Dispute Resolution Panel or an order passed under section 154 in respect of such order may appeal to the Appellate Tribunal against such order. Thus it is clear from the provisions that whatever variation is proposed to be made to the loss or income returned by an eligible assesse has to be spelt out in the draft assessment order passed by the AO, so that the Assessee can project his grievance against such variation before the DRP. The fair order passed by the AO on receipt of directions from the DRP cannot be at 40 ITA NO.5887/MUM/2010(A.Y.2005-06) ITA NO.7125/MUM/2010(A.Y. 2006-07) variance with the directions issued by the DRP nor can the AO deal with issues not considered in the draft assessment order. If the AO is permitted to make any variation to the loss or income returned by the eligible assesse which is not spelt out in the draft assessment order, then the Assessee will have no opportunity to address his grievance before the DRP.
59. In the present case, the AO treated interest on L/C.Margin and Bank Gurantee earned by the Assessee of Rs.3,36,697/- as "Income from Other sources" in the fair order passed. The Assessee had claimed the same as "Income from Business" and had also claimed that the same is eligible for deduction u/s.10-A of the Act. In the draft assessment order he did not deal with this issue at all. The Assessee has therefore objected to the said action of the AO in ground No.3 raised above.
60. We are of the view that in the light of the statutory provisions of Sec.144-C of the Act, which have been discussed above, the AO had no jurisdiction to consider an issue which was not considered in the draft assessment order passed u/s.144C of the Act. On this ground the impugned action of the AO is held to be bad in law. The AO is therefore directed to consider the interest income in question as Income from business.
61. In the result, the appeal of the Assessee is partly allowed.
Order pronounced in the open court on the 22nd day of July, 2011.
Sd/- Sd/-
(B.RAMAKOTAIAH ) (N.V.VASUDEVAN)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Mumbai, Dated. 22nd July.2011
41 ITA NO.5887/MUM/2010(A.Y.2005-06)
ITA NO.7125/MUM/2010(A.Y. 2006-07)
Copy to: 1. The Appellant 2. The Respondent 3. The CIT City -concerned
4. The CIT(A)- concerned 5. The D.R"F" Bench.
(True copy) By Order
Asst. Registrar, ITAT, Mumbai Benches
MUMBAI.
Vm.
42 ITA NO.5887/MUM/2010(A.Y.2005-06)
ITA NO.7125/MUM/2010(A.Y. 2006-07)
Details Date Initials Designation
1 Draft dictated on 14&15/7/11 Sr.PS/PS
2 Draft Placed before author 19/7/11 Sr.PS/PS
3 Draft proposed & placed JM/AM
before the Second Member
4 Draft discussed/approved by JM/AM
Second Member
5. Approved Draft comes to the Sr.PS/PS
Sr.PS/PS
6. Kept for pronouncement on Sr.PS/PS
7. File sent to the Bench Clerk Sr.PS/PS
8 Date on which the file goes to
the Head clerk
9 Date of Dispatch of order