IN THE ITAT BANGALORE BENCH ‘A’
24/7 Customer.Com (P.) Ltd.
Deputy Commissioner of Income-tax
IT APPEAL NO. 227 (BANG.) OF 2010
[ASSESSMENT YEAR 2004-05]
NOVEMBER 9, 2012
Jason P. Boaz, Accountant Member – This appeal by the assessee is directed against the order of the Commissioner of Income Tax (Appeals)-IV, Bangalore dt.30.11.2009 for Assessment Year 2004-05.
2. The facts of the case, in brief, are as under :
2.1 The assessee, an Indian Company engaged in the business of providing call centre services exclusively to its Associated Enterprise (A.E.), 24/7 Customer.Com.Inc., USA (24/7 USA), filed its return of income for Assessment Year 2004-05 on 22.11.2004 declaring a total loss of Rs. 40,84,968. The case was processed under section 143(1) of the Income Tax Act, 1961 (herein after referred to as ‘the Act’) and the case was taken up for scrutiny by issue of notice under section 143(2) of the Act. A reference under section 92CA(1) of the Act was made by the Assessing Officer to the Transfer Pricing Officer (TPO) in respect of the following international transactions entered into by the assessee with it’s A.Es.
|Nature of International Transactions||Value Rs.|
|Call Centre Services||66,00,46,029|
|Import of Capital Equipment||45,43,167|
|Reimbursement of Expenses||1,78,60,545|
|Cross Charge of Expenses||33,56,693|
The TPO passed an order under section 92C r.w.s. 92CA(1) of the Act dt.15.12.2006 making an upward adjustment of Rs. 15,23,42,536 to the international transactions of the assessee in respect to call centre services.
2.2 After receipt of the order of the TPO under section 92CA(1) r.w.s. 92C of the Act, the Assessing Officer completed the assessment by an order under section 143(3) of the Act on 28.12.2006 determining the income of the assessee at Rs. 15,40,92,002. In the order of assessment, the Assessing Officer made the following additions/disallowances :
|(i)||Exclusion of telecommunication charges incurred in foreign exchange from ‘export turnover’ but not from ‘total turnover’ while computing deduction under section 10A||Rs. 64,34,198|
|(ii)||Exclusion of leased hire charges incurred in foreign exchange from ‘export turnover’ but not from ‘total turnover’ while computing deduction under section 10A||Rs. 3,23,02,116|
|(iii)||Transfer Pricing adjustment||Rs. 15,23,42,536|
2.3 Aggrieved by the order of Assessing Officer dt.28.12.2006, the assessee went in appeal before the CIT (Appeals). The CIT (Appeals) disposed off the assessee’s appeal by order dt.30.11.2009 allowing the assessee partial relief. The learned CIT (Appeals) allowed relief to the assessee on the first two issues at (i) and (ii) (supra) directing the Assessing Officer to recompute the deduction under section 10A of the Act after reducing the communication and leased hire expenses from both ‘export turnover’ and ‘total turnover’. The learned CIT (Appeals) has however upheld the Transfer Pricing adjustment of Rs. 15,23,42,536 proposed by the TPO and carried out by the Assessing Officer.
3. Aggrieved by the order of the learned CIT(Appeals) dt.30.11.2009 for the Assessment Year 2004-05, the assessee is now in appeal before us. The assessee initially filed elaborate grounds that were narrative and argumentative. It subsequently filed concise grounds of appeals which are extracted and reproduced hereunder :
“Ground 1 : Adjustment to the arm’s length margin
– The learned CIT (Appeals) erred in upholding the adjustments made by the learned TPO to the arm’s length margins computed by the appellant in respect of rendering of call centre services to its associated enterprise.
– The learned CIT (Appeals) erred in accepting comparable companies having related party transactions, as proposed by the TPO.
– The learned CIT (Appeals) erred in accepting comparable companies having economies of scale, as proposed by the TPO.
– The learned CIT (Appeals) erred in accepting comparable companies owning intangibles, as proposed by the TPO.
– The learned CIT (Appeals) erred in rejecting the comparable companies selected by the appellant on the account of use of non-contemporaneous data.
Ground 2 : Revised benchmarking
– The learned CIT (Appeals) erred in not taking into consideration the fresh bench marking analysis conducted after adopting the criteria postulated by the learned TPO.
Ground 3 : Applicability of multiple year data
– The learned CIT (Appeals) ought to have accepted the use of multiple year data for computing the final margin of the comparable.
– The learned CIT (Appeals) ought to have accepted the fact that current year data were not available in the public domain to calculate the margins of comparable companies.
Ground 4 : Adjustments for various risks
– The learned CIT (Appeals) has erred in concluding that the business risk is borne by the appellant and therefore did not warrant a market risk adjustment.
Ground 5 : Safe harbour
– The learned CIT (Appeals) should have allowed the benefit of safe harbor provisions of / – 5% as set out under the proviso to section 92C(2) of the Income Tax Act, 1961.
Ground 6 : Parent Company Loss
– The learned CIT (Appeals) ought to have appreciated the fact that the parent company of the appellant has incurred loss during the year and the assessee cannot be expected to earn margins beyond the global profit of the group as a whole.”
4. Before proceeding to deal with the above grounds of appeal, the approach of the TPO vis-à-vis that of the assessee in its Transfer Pricing Study submitted before the TPO is briefly summarized as under.
5.1 The assessee’s approach : The assessee treated itself as engaged in customer relationship management services OR call centre services and aggregated all the international transactions applying the Transactional Net Margin Method (TNMM). The assessee; adopted “Operating Profit to Operating Cost” as the Profit Level Indicator (PLI) and has used two widely available public data bases; i.e. Prowess and Capitaline. The assessee used earlier periods/years data i.e. data pertaining to the earlier financial years, 2001-02 and 2002-03.
(i) Companies engaged in BPO, Software Services, business services and miscellaneous services.
(ii) Companies data available for March 31, 2002 or later were considered.
(iii) Companies with turnover of less than Rs. 1 Crore were excluded.
(iv) Companies providing Business Process Outsourcing services were considered.
(v) Companies with foreign shareholding > 26% were excluded.
(vi) Indian companies having subsidiaries/holding companies abroad were excluded.
(vii) Companies making profits and not making abnormal growth were considered.
5.2 The above search yielded 7 companies as comparables. The operating profit margin of the assessee is computed at 10.60% on cost, whereas the arithmetical mean of the same for the set of seven comparable companies considered by the assessee works out to 9.5% on cost. As the margin of the assessee was above the arithmetical mean margin of the comparables, the assessee held that its international transactions were at arm’s length.
5.3-5.4 The TPO’s approach : The TPO analysed the Transfer Pricing report submitted by the assessee and the export and domestic sector of IT Enabled Services (ITES) and applied the following additional criteria.
(i) Companies with data available for 31.3.2004 were considered as mandated by Rule 10B(4) of IT Rules, 1962.
(ii) Companies providing ITES (As call centre services are ITES) wholly or mainly to export markets were considered as the assessee is rendering 100% of its services to the export market.
(iii) Companies with significant related party transactions were excluded.
(iv) Companies providing ITES were considered.
5.5 Accordingly, the following 8 comparables were identified by the TPO as the final set of comparable companies.
|S.No.||Name of the comparable||Operating Revenue||Operating cost (OC)||Operating Profit (OP)||OP/OC|
|1.||Nucleus Netsoft & G.S. India Ltd.||1.66||1.94||0.28||16.81 %|
|2.||Vishal Information Technologies Ltd.||9.37||13.88||4.51||48.13 %|
|3.||Wipro BPO Ltd.||322.3||430.31||108.01||33.51 %|
|4.||Tricom India Ltd||6.34||9.24||2.90||45.74 %|
|5.||Fortune Infotech Ltd||8.08||11.38||3.30||40.84 %|
|6.||Sparco Telesystems & Solutions Ltd.||10.32||15.44||4.57||40.10 %|
|7.||Ultramarine Pigments Ltd.||6.18||10.99||3.91||63.27 %|
|8.||Allsec Technologies Ltd.||24.10||24.94||0.83||3.44 %|
5.6 As per the calculation above, the TPO arrived at the arithmetical mean margin of 36.45% on cost. After considering the objections raised by the assessee, the TPO used the above 8 companies as the final comparables with the arithmetical mean PLI of 34.49%, after allowing 2% deduction towards working capital adjustment. Based on the above, arithmetical mean margin, the arms length price of the call centre services rendered by the assessee was arrived at Rs.81,23,88,565 as against the price shown at Rs. 66,00,46,029 resulting in a transfer pricing adjustment of Rs. 15,23,42,536.
6. We have heard both parties, carefully perused and considered the order of the TPO under section 92CA of the Act, the order of assessment, the order of the learned CIT (Appeals), the submissions of the assessee/learned counsel for the assessee and the judicial decisions relied on by the assessee. We now proceed to examine the various issues raised by the assessee.
Adjustments to Arms Length Margin
7. At the outset the learned counsel for the assessee stated that the sub-ground in Ground No. 1 : Adjustment to arms length margin challenging the learned CIT (Appeals)’s action in rejecting the comparable companies selected by the assessee on account of use of non-contemporaneous data (supra) is not pressed in this appeal. In this view of the matter, we dismiss this ground as infructuous.
8. Applicability of Multiple Year Data
8.1 The learned counsel for the assessee also submitted that the ground raised at S.No. 3 – Applicability of Multiple Year data was also not being pressed in this appeal. Consequently, we therefore dismiss this ground as infructuous.
8.2 Even otherwise, this ground of the assessee is liable to be dismissed. Rule 10B (4) of the IT Rules, 1962 specifies the requirement regarding data to be used for analyzing the comparability of an uncontrolled transaction with an international transaction which reads as under :
“Rule 10B(4) 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 :
Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”
8.3 The use of the word “shall” in the main provision of the Rule makes it abundantly clear that the use of data of the current financial year (i.e. of the financial year in which the international transaction was actually entered into) is a mandatory requirement of law in the comparability analysis to be undertaken as as per Indian T.P. Regulations. It is only the proviso to Rule 10B(4) that makes an exception in allowing the use of data of the two preceding years, if and only, if it is established that the data reveals facts which could have an influence on the determination of transfer price. The mandatory requirement of law for the use of data of the current financial year cannot be dispensed with even if the relevant data was not available to the assessee in the public data base at the time of preparation of the T.P. Report. Non-availability of information in the public data base can at best be relevant to explain the discharge of the assessee’s obligation of maintaining the prescribed documentation under section 92D(i) of the Act r.w. Rule 10D of the IT Rules, 1962. However, such non-availability will not dispense with the mandatory requirement of Rule 10B(4) for using current financial year data in conducting comparability analysis and in determining the ALP in accordance with section 92C (1) and 92C(2) of the Act.
8.4 As it is mandatory requirement of law to utilize data of the current financial year to conduct the comparability analysis at the time of transfer pricing proceedings, the TPO is not only empowered but is also duty bound to determine the ALP using such contemporaneous data for this purpose even if such data was not available to the assessee in the public data bases at the time of preparation of its report on the T.P. Study. Further, we are also of the view that the TPO rightly rejected the use of earlier year’s data by the assessee, as the assessee failed to establish before the TPO, CIT (Appeals) or the Tribunal how such earlier year’s data had an influence on the prices of the current financial years.
Use of data by the TPO after the cut off date
8.5 As regards the data used by the TPO while determining the ALP, we find that it is to be as per the provisions of section 92D of the Act that every person who has entered into international transactions is required to maintain information and documentation thereof. Rule 10B(4) provides that the information and documents as specified under Rule 10B(1) and 10B(2) should as far as possible be contemporaneous and should exist latest by the “specified date” referred to in section 92F(4) which has the same meaning as ‘due date’ in Explanation 2 to section 139(1) of the Act. In the assessee’s case, this would be ’30th day of September’ as it is a company. It is clear, after going through the relevant provisions of law, that the Act has not provided for any cutoff date up to which only the information in the public domain has to be taken into consideration by the TPO while arriving at the ALP or making TP adjustments. Both the assessee and Revenue being bound by the provision of the Act and Rules are required to take into consideration contemporaneous data relevant to the previous year in which the international transaction has taken place. The assessee is obliged to maintain the information and documentation as required relating to international transactions as per the specified date so that it can be made available to the TPO or the Assessing Officer or any other authority in any proceedings under the Act. We are, therefore, of the view that there is no infirmity in the action of the TPO in using contemporaneous data at the time of transfer pricing audit, though the same may not have been available to the assessee at the time of preparation of statutory transfer pricing study/documentation.
9.1 In the ground No.5 on Safe Harbour – the assessee has sought the benefit of + / – 5% as set out under the proviso to section 92C(2) of the Act citing several judicial decisions in support of this proposition. Prior to the amendment made by Finance (No.2) Act, 2009 and the Finance Act, 2012, the proviso to section 92C(2) of the Act provided that the ALP would be taken to be the Arithmetical Mean (AM) or at the option of the assessee, a price which may vary from the A.M. by an amount not exceeding 5% of such A.M. Thus, the ALP was + / – 5% of such A.M. Thus, the ALP was + / – 5% from the A.M. This issue is more of an academic nature and case laws cited by the assessee are not applicable to the facts of the case, as the IT Act, 1961 has been amended with retrospective effect from 1.4.2002 by the introduction of a clarificatory amendment in which the section 92C (2A) was inserted, which as per the Finance Act, 2012 reads as follows :
“(2A) Where the first proviso to sub-section (2) as it stood before its amendment by Finance (No. 2) Act, 2009 (33 of 2009), is applicable in respect of international transactions from an assessment year and the variation between the arithmetical mean referred to in the said proviso and the price at which such transaction has actually been undertaken exceeds five per cent of the arithmetical mean, then, the assessee shall not be entitled to exercise the option as referred to in the said proviso.”
9.2 The new section 92C(2A) mandates that if the arithmetical mean price falls beyond + / – 5% from the price charged in the international transactions, then the assessee does not have any option referred to in section 92C(2). Thus, as per the above amendment, it is clear that the + / – 5% variation is allowed only to justify the price charged in the international transactions and not for adjustment purposes. The aforesaid amendment has settled the issue and accordingly the 5% benefit is not allowable in the assessee’s case. The various judicial decisions cited pertain to the period prior to the retrospective amendment in section 92C(2A) of the Act and are not applicable to the facts of the assessee’s case. In view of the amendment brought about therein by Finance Act, 2012, this ground raised by the assessee is not maintainable and is accordingly dismissed.
Ground No. 2 Revised Benchmarking
10. This ground challenging the benchmarking is general in nature and was not agitated before us in the course of appellate proceedings. In this view of the matter, the ground raised being general in nature, no adjudication is called for thereon and the ground is therefore dismissed as infructuous.
11. Rejection of T.P. Study
11.1 The learned counsel for the assessee vehemently argued that the TPO erroneously rejected the procedure adopted by the assessee in identifying the list of comparable companies. In this appeal, it is seen that the TPO rejected the transfer pricing documentation prepared and maintained by the assessee mainly due to three defects, namely,
(i) the assessee did not use data of the relevant year i.e. Financial Year 2003-04,
(ii) Inadequate search of comparables and
(iii) the assessee considered comparables catering to the domestic sector whereas the assessee is catering to the export sector.
11.2 We have carefully considered the submissions of the learned counsel for the assessee. The use of current year data is mandated by the relevant IT Rules, 1962 and by not adhering thereto, the assessee has rendered into T.P. Study unreliable. In this view of the matter, we are of the opinion that the TPO was right in rejecting the T.P. Study submitted by the assessee.
12. Ground No.1 : Adjustment to arms length margin
12.1 The ground raised by the assessee that the learned CIT (Appeals) erred in upholding the adjustments made by the TPO in respect of rendering call centre services to its AE is general in nature and therefore no adjudication is called for thereon.
Related Party Transactions
13. In respect of the ground raised at S.No.1 regarding acceptance of comparable companies having related party transactions as proposed by the TPO, the learned counsel for the assessee argued that the transfer pricing regulations do not stipulate any minimum limit of related party transactions which form the threshold for exclusion as a comparable. In this regard, the learned counsel for the assessee objected to the TPO’s setting a limit of 25% on related party transactions. He objected to the inclusion of comparables being related party transactions in excess of 15% of sales/revenue. In support of this proposition, the learned counsel for the assessee placed reliance on the decision of the Hon’ble Bench of the ITAT, Delhi in the case of Sony India (P) Ltd. v. Dy. CIT  114 ITD 448. The learned counsel for the assessee drew our attention to para 115.3 of the order wherein the Tribunal has held that -
“………We are further of the view that an entity can be taken as uncontrolled if its related party transactions do not exceed 10 to 15% of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of the comparables. For the purpose of comparison what is to be judged is the impact of the related party transactions vis-à-vis sales and not profit since profit of an enterprise is influenced by large number of other factors ….”
Respectfully following the decision of the Tribunal in the case of Sony India (P) Ltd. (supra), the Assessing Officer/TPO are directed to exclude after due verification those comparables from the list with related party transactions or controlled transactions in excess of 15% of total revenues for the financial year 2003-04.
14. Economies of Scale
14.1 In ground No. 1 : The assessee has contended that the learned CIT (Appeals) erred in accepting comparable companies having economies of scale as proposed by the TPO.
The learned counsel for the assessee argued that size is an important facet of an enterprise – level difference. He submitted that size as one of the selection criteria has been approved by various benches of the ITAT in many cases. It was further submitted that size as a criterion for selection of comparables is also recommended by the OECD in its T.P. Guidelines. Hence, the learned counsel for the assessee contended that an appropriate turnover range should be applied in selecting a comparable of uncontrolled companies. In this regard, he drew our attention to the decision of the co-ordinate bench of this Tribunal in the case of Genisys Integrating Systems (India) (P.) Ltd. v. Dy. CIT  53 SOT 159/20 taxmann.com 715 (Bang.), wherein the bench was of the view that size matters in business and at para 9 on page 32 thereof held that :
“….We hold that the turnover filter is very important and the companies having a turnover of Rs. 1 Crore to Rs. 200 Crores have to be taken as a particular and the assessee being in that range having a turnover of Rs. 8.15 Crores, the companies which also have a turnover of Rs. 1 to Rs. 200 Crores only should be taken into account for consideration for the purpose of making T.P. Study.”
In these circumstances, the learned counsel for the assessee pleaded that Wipro BPO Ltd., one of the comparables taken by the TPO and having a turnover of Rs. 322.3 Crores be excluded as it falls outside the range ofRs.1 Crore to Rs.200 Crores laid down in the cited case.
14.2 Per Contra, the learned Departmental Representative supported the orders of the authorities below.
14.3 We have heard both parties, carefully considered the submissions made, judicial decision relied on and the material on record. The Tribunal in the case of Genisys Integrating Systems (India) (P.) Ltd. (supra) held that only companies within the turnover range of Rs. 1 Crore to Rs. 200 Crores should be taken into consideration for the T.P. Study. We are of the considered view that the cited case squarely applies to the assessee’s case as the turnover of the assessee being approximately Rs. 66 Crores falls within the range of Rs. 1 Crore to Rs. 200 Crores. Therefore, respectfully following the decision of the co-ordinate bench of this Tribunal in the case of Genisys Integrating Systems (India) (P.) Ltd. (supra), we direct the Assessing Officer/TPO that only those companies having a turnover of Rs. 1 Crore to Rs. 200 Crores be taken as comparable companies and to consequently exclude Wipro BPO Ltd. which has a turnover of Rs. 322 Crores in the relevant period.
15. Comparables Companies Owning Intangiables
15.1 In Ground No. 1, the assessee has contended that the learned CIT (Appeals) erred in accepting comparable companies owning intangibles as proposed by the TPO. The learned counsel for the assessee submitted that the assessee is a captive service provider engaged in the business of providing call centre services and would fall under the IT Enabled service sector. It is argued that while the assessee does not own brand intangibles some of the comparables chosen by the TPO have their own, software products and hence own intangibles. It is submitted that such companies, having the ability to deliver services, penetrate the market and provide faster delivery, ought not to have been taken as comparable companies as has been done in the case of Wipro BPO Ltd., Tricom India Ltd. and Fortune Infotech Ltd. It is urged that these companies ought to be excluded from the list of comparables. The learned counsel for the assessee argued that intangible assets, in the normal commercial sense, are those which have intrinsic productive value, even though they may not have any intangible form and substance such as Research & Development, Patents and Software. He quoted from the synthesis report of the OECD, which forms part of the paper books, to stress that intangible assets play an important role in value creation and enabling productivity and efficiency to reap economic gains. It was contended that in the service industry, service providers who have better brand or other intangible assets get better premium for their services, as in the case of some of the comparable companies selected by the TPO. Whereas, it is submitted that, the assessee is only rendering call centre services and does not possess any intangibles nor does it derive any benefit from intangibles in providing these services.
15.2 The learned Departmental Representative on his part supported the orders of the learned CIT (Appeals) which he contended was well explained. It was submitted by the learned Departmental Representative that the assessee had not pointed out any provisions in the Act or Rules or OECD guidelines which imposes any prohibition in taking comparables with intangibles so long as there is functional similarity of comparables vis-à-vis the tested party. The learned Departmental Representative argued that Brands can give business but not profits. The learned Departmental Representative pointed out the assessee itself does not have any consistent stand in the matter as in its own T.P. Study the assessee has taken companies like Tata Share Registry and Max Health – which had their own intangibles. The learned Departmental Representative submitted that the arguments put forth by the assessee shifted to suite its own purpose. In these circumstances, the learned Departmental Representative contended that the findings of the learned CIT (Appeals) be upheld.
15.3.1 We have heard both parties and have carefully perused and considered the submissions made, details filed and material on record. It is a well accepted principle that only those companies which are on similar standards need to be considered for comparability. In this context, a co-ordinate bench of this Tribunal in the case of Genisys Integrating Systems (India) (P.) Ltd. (supra) has reiterated that all the comparables have to be compared on similar standards. Therefore, companies which possess their own unique software intangibles cannot be compared with the assessee, as the former would derive significant advantage from unique software compared with the assessee, which is performing call centre services for it’s A.E. in the USA.
15.3.2 In the case of M/s. Wipro BPO Ltd., this comparable is under consideration for exclusion as a comparable, in this case for this Assessment Year 2004-05, on account of the application of the turnover filter of Rs. 1 Crore to Rs. 200 Crores. (refer para 14.3 supra)
15.3.3 In respect of M/s. Tricom India Ltd., the learned counsel for the assessee contended that it has registered an abnormal growth of 33% increase in PAT in the relevant period due to the fact that it has developed its unique software to provide BPO services to its customers. The learned counsel for the assessee referred to the Annual Report of this comparable, wherein it is mentioned that it does specialized services such as Title Plant maintenance and Electronic Data discovery which gives it an edge over other Indian Company competition thereby enabling it to generate higher revenues and margins. It was also submitted by the learned counsel for the assessee that it has a process of continuous in house R & D process for upgradation of software and training its professionals to develop its own software to cater to the needs of its clients.
On appraisal of the submissions and the material on record, it would certainly stand to reason that a company having unique software developed in house which also renders specialized services in its area of specialization gets that sort of competitive edge that gives it an advantage. Applying the principle that companies which are on similar standards only should be taken as comparables, we hold that this company which has unique intangibles cannot be taken as a comparable for the assessee and accordingly direct the Assessing Officer / TPO to exclude it from the list of comparables in this case.
M/s. Fortune Infotech Ltd.
15.3.4 The learned counsel for the assessee contended that this company was using web based software, unique technology and technical know how imported from its business partner for providing BPO services and submitted letter dt.11.9.2012, enclosing web site extracts detailing the intangibles developed by this company.
On perusal of the details furnished and submissions made, it is seen that this company has developed its own software called “Finetran” and “image index” for performing specialized services in medical transcription and patient record management. On appraisal of the same, we are of the opinion that this comparable company has developed unique software from which it would derive substantial benefits/advantages when compared with the assessee which is undertaking pure call centre services. Applying the principle that companies which are on similar standards only should be taken as comparables, we hold that this company which has unique intangibles cannot be taken as a comparable for the assessee and accordingly direct the Assessing Officer/TPO to exclude it from the list of comparables in this case.
16. Parent Company Losses
16.1 In the ground raised at S. No. 6, the assessee argued that the parent company is under losses and thus there is no situation where profits are shifted outside India.
16.2 The learned Departmental Representative supported the orders of authorities below.
16.3 Both parties have been heard and the submissions made considered. In respect of the issue of parent company losses, it is to be stated that clearly the assessee is compared as if it is a separate entity. When a separate entity deals with its customers, it would not see whether such dealing would result into profit or loss for him. While dealing at arm’s length, the parties to the transaction would not see the impact of the same on the profitability of others. What is important is the arms length nature of such transactions and the profit that could have resulted in similar circumstances when dealt with at arm’s length. It would not be correct to assume that merely because a group was making a loss, then the assessee company should attract its ‘fair share’ of losses. Each case would have to be looked at on the basis of its own facts.
16.4 The issue of parent company under losses was considered and examined by the Delhi ITAT in the case of Dy. CIT v. Carraro India Ltd.  28 SOT 53 (URO) and it held as under :
“Where a business is carried on between a resident and a non-resident and it appears to the Assessing Officer that, owing to the close connection between them, the course of business is so arranged that business transacted between them produces to the resident either no profits or less than ordinary profits which might be expected to arise in that business, the Assessing Officer shall determine the amount of profits which may reasonably be deemed to have been derived therefrom and include such amount in the total income of the resident.”
In the same decision at para 17 thereof, it was held that ‘the burden was on the appellant to show that this case of ‘no profit’ is not on account of any arrangement between the parties. Similar transactions carried on between unrelated parties were to be seen.
16.5 The above decision is based on the decision of the Hon’ble Apex Court in the case of Mazagaon Dock Ltd. v. CIT & Excess Profits Tax  34 ITR 368, wherein it was held that the question of the parent company under losses is irrelevant while computing the profits of a resident. This principle was upheld as under :
“(iii) the fact that the non-resident companies carried on their business in such a manner that no profits could accrue to them was irrelevant.”
In this case, the finding was given as under :
“Where a non-resident person carries on business with a resident and owing to the close connection between them the course of the business is so arranged that the business produces either no profits or less than the ordinary profits to the resident, the subject of the charge under section 42(2) of the Act in the business of the resident and not of the non-resident, and what the court has to decide is not whether the non-resident made profits in his dealing with the resident but whether, having regard to the course of dealings between the non-resident and resident, it can be said of the non-resident that he carried on business with the resident; and for that purpose it is immaterial that the business was carried on in such a manner that no profit could accrue to the non-resident therefrom.”
16.6 As per a plain reading of the language of the provisions of section 92 of the Act, it is clear that the income arising from an international transaction shall be computed having regard to the arms length price. Similar transactions carried on between unrelated parties were to be seen to come to a conclusion whether the profits earned by the assessee is justified. Thus, the arguments that the profits earned by the assessee is justified because the parent company is under losses is against the principle of arms length price. To sum up, the assessee’s arguments that it has not shifted profits outside India based on the loss incurred by the parent company is not acceptable.
16.7 The learned counsel for the assessee argued that T.P. regulations is not a deeming provision but a fact working provision and the entire exercise of T.P. Audit is to prevent shifting of profits out of the country by manipulating international transactions. It is contended that the basic intention underlying the T.P. Regulations is to prevent shifting out of the profits by manipulating prices charged or paid in international transaction, thereby eroding the country’s tax base. Thus, the assessee mainly states that the T.P. regulations being anti avoidance legislation, the TPO has to prove that tax avoidances had in fact taken place before making any T.P. adjustment. In fact on this issue, the Special Bench of the ITAT, Bangalore in the case of Aztec Software Technology Services Ltd v. Asstt. CIT  107 ITD 141/15 SOT 49/162 Taxman 119 (Mag.) (Bang) (SB) has held that it is not necessary to prove that profits are shifted out of India for making a transfer pricing adjustment. In this view of the matter, respectfully following the decision of Aztech SoftwareTechnology Service Ltd. (supra), we hold that it is not necessary for the TPO to demonstrate tax avoidance and diversion of tax/income before invoking the provisions of section 92C and 92CA of the Act.
16.8 In the case of Coca Cola India Inc. v. Asstt. CIT  309 ITR 194/177 Taxman 103, the Punjab and Haryana High Court dealt with the matter of anti-avoidance and transfer pricing in detail and held that it was not necessary for the Assessing Officer/TPO to show that the profits were shifted out of India to determine the arms length nature of any international transactions. Consequently, it is wrong in attaching importance to the fact that the assessee Associated Enterprise (A.E.) is earning losses. The theory of shifting of profits can be tested only when the tax payer’s profits are compared with that of a company acting under uncontrolled conditions and situated in India; operating in similar markets as that of the assessee, performing similar functions as that of the assessee. Shifting profits out of India is one of the reasons for introducing the Transfer Pricing provisions in the Act. However, the relevant T.P. provisions do not require the TPO to establish such a motive independently and distinct from the determination of ALP. As per law, the TPO is required to examine and find out whether the assessee’s international transactions are at arm’s length or not. Law warrants an adjustment to the assessee’s income if the international transactions are not at arm’s length. The mechanism for determining the ALP is provided in the Act and the relevant rules framed in this regard. To sum up, the assessee’s argument that it has not shifted profits out of India based on the reasoning that the AE is under losses is rejected.
17. Individual Companies for Comparability
17.1 Having held that there was no infirmity in the action of the TPO in rejecting the TP Study of the assessee and having decided the principles as discussed in the preceding paragraphs, we now proceed to examine the individual companies chosen as comparables. As mentioned earlier, the assessee had selected a list of 7 companies in the TP Study. During the transfer pricing audit proceedings, the assessee updated the comparability analysis based on current year’s data and submitted a list of seven comparable companies. The TPO considered the updated set of comparables submitted by the assessee and come up with a final set of eight comparable companies, which are as under :
|S.No.||Name of the comparable||Operating Revenue||Operating cost (OC)||Operating Profit (OP)||OP/OC|
|1.||Nucleus Netsoft & G.S. India Ltd.||1.66||1.94||0.28||16.87 %|
|2.||Vishal Information Technologies Ltd.||9.37||13.88||4.51||48.13 %|
|3.||Wipro BPO Ltd.||322.3||430.31||108.01||33.51 %|
|4.||Tricom India Ltd||6.34||9.24||2.90||45.74 %|
|5.||Fortune Infotech Ltd||8.08||11.28||3.30||40.84 %|
|6.||Spares Telesystems & Solutions Ltd.||10.32||15.44||4.57||40.10 %|
|7.||Ultramarine Pigments Ltd.||6.18||10.99||3.91||63.27 %|
|8.||Allsec Technologies Ltd.||24.10||24.94||0.83||3.44 %|
From the record, it is seen that the TPO rejected the transfer pricing documentation mentioned by the assessee mainly on three parameters/defects namely :
(i) The assessee did not use data of the relevant financial year i.e. 2003-04
(ii) The assessee rejected certain companies as comparables even though they are functionally comparable.
(iii) The assessee considered certain companies catering to the domestic sector, whereas the assessee is catering to the export sector.
17.2 Nucleus Netsoft GIS India : In respect of this comparable, both the assessee and the TPO agree that there is no dispute as this is a comparable company.
17.3 Vishal Information Technologies Ltd. (VIT) – In the case of this comparable, we find that the Mumbai Tribunal in the case of Asstt. CIT v. Maersk Global Service Center (India) (P.) Ltd.  133 ITD 543/16 taxmann.com 47 has held that since Vishal Information Technologies Ltd is outsourcing most of its work it has to be excluded from the list whereas the assessee in the cited case was carrying out the work by itself. In the instant case of the assessee also the assessee was carrying out its work by itself whereas in the case of VITL, it is outsourcing most of its work. We are therefore of the considered opinion that the decision of the ITAT, Mumbai in the cited case on the issue of excluding VITL as a comparable squarely applies. This decision was followed by the decision of the co-ordinate bench of this Tribunal in the case of Netlinx India (P.) Ltd in ITA No.454/Bang/2011 dt.19.10.2012] wherein it was held that Vishal Information Technologies Ltd cannot be considered as a comparable. We, therefore, respectfully following the decision of the Mumbai Tribunal in the case of Maersk Global Service Centre (India) (P.) Ltd. case (supra) direct the Assessing Officer/TPO to exclude Vishal Information Technologies Ltd. from the list of comparables.
Wipro BPO Ltd.
17.4 As per the details on record, the turnover/Revenue of Wipro BPO Ltd. in the period relevant to Assessment Year 2004-05 is Rs. 322 Crores. Further, this company having the influence of “Wipro” brand may be seen as having its unique intangibles. Following the decision of the co-ordinate bench of this Tribunal in the case of Genisys Integrating Systems (India) (P.) Ltd. (supra), we have already held that companies whose turnover is outside the range of Rs. 1 Crore to Rs. 200 Crores are to be excluded from the set of comparables and accordingly direct the Assessing Officer/TPO to exclude Wipro BPO Ltd from the list/set of comparable companies for the assessee’s case in Assessment Year 2004-05.
Tricom India Ltd.
17.5 This comparable has already been considered and dealt with by us in para 15.3.3 of this order (supra) wherein we have directed the Assessing Officer/TPO to exclude it from the list of comparables for the assessee’s case in Assessment Year 2004-05.
Fortune Infotech Ltd.
17.6 This comparable has also been considered and dealt with by us in para 15.3.4 of this order (supra) wherein we have directed the Assessing Officer/TPO to exclude it from the list of comparables for the assessee’s case for Assessment Year 2004-05.
Spanco Telesystems & Solutions Ltd.
17.7 The assessee’s main contention was that this company should be rejected as a comparable at the segmental level (call centre activity) and as it had related party transactions of about 12% of total sales. The learned counsel for the assessee relied on the decision of the ITAT, Mumbai in the case of DHL Express (I) (P.) Ltd. v. ACIT [ITA No. 2423/Mum/2006] in which case the Tribunal was of the view that segmental results of comparable company engaged in multiple activities need not be considered when direct comparables are available.
From an appraisal of the details on record, we find that this company has a clearly demarcated call centre segment and segmental results are available in the audited financial statements of the company and therefore see no reason why this company should not be considered as a comparable. Further, as already held by us in this order above, that related party transactions to the extent of 15% of sales would not distort the comparability, this company having related party transactions to the extent of 12% of its sales in the period relevant to Assessment Year 2004-05, the assessee’s grounds seeking its exclusion is rejected. This company is, therefore, to be retained as a comparable for the assessee’s case for Assessment Year 2004-05.
M/s. Ultra Marine Pigments Ltd.
17.8 The assessee contended that this company has earned abnormal profits of 63.27% and had also been rejected by the TPO as a comparable for Assessment Year 2005-06. It was also submitted that the assessee is engaged in a host of services like laundry and allied products, packaging products and others besides IT enabled services (ITES) and hence ought not to be taken as a comparable citing a catena of decisions and the OECD guidelines.
We have carefully considered the submissions made seeking the exclusion of this company as a comparable for the reason that it has high profits of 63.27% and that it has various segmental apart from ITES and that there were a catena of decisions in support of the assessee’s proposition. A similar matter of ‘Super Profits’ was considered by a co-ordinate bench of this Tribunal in the case of Netlinx India (P.) Ltd. case (supra) to which both of us were a party. In that order, it was held that the word ‘super’ is a superlative word which denotes something extraordinary and noted that in all the cases/decisions where these super profit making companies were directed to be excluded, the TPO was comparing cases like Infosys, Wipro, etc. where the turnover was more than 10 times that of the assessee or the profit margin was abnormally high.
In the case of Exxon Mobil Company India (P.) Ltd. v. Dy. CIT  46 SOT 294 (URO)/12 taxmann.com 84, the ITAT, Mumbai held that :
“A comparable cannot be eliminated just because it is a loss making unit. Similarly, a higher profit making unit cannot also be automatically eliminated just because the comparable company earned higher profits than the average. In other words, as a general principle, both loss making unit and high profit making unit cannot be eliminated from the comparables unless, there are specific reasons for eliminating the same which is other than the general reason that the comparable has incurred loss or made abnormal profits.”
Further, India TP Rules specifically deviate from OECD guidelines in this aspect and specify the Arithmetic Mean for determining ALP. In the Quartile Method, the companies that fall in the extreme quartiles get excluded and only those that fall in the middle quartile are retained for comparability thereby automatically eliminating outliners whereas in the Arithmetic Mean Method all companies that are in the sample are considered, without exception, and the average of all the companies are considered as ALP. Therefore as a general rule that companies with abnormal profits should be excluded may be in line with the principles enumerated in the OECD guidelines, but cannot be said to be in tune with Indian TP regulations. The assessee has not been able to establish or demonstrate with any evidence any reason to support the proposition that the profit of the comparable company was abnormally high. It must not be overlooked that high profits reflect better business sense and practices also. The net Arithmetic Mean margin of 36.49% was arrived at after taking into account both 63.27% and also 3.44% which is the lowest in the relevant ITES industry. We also find from the material on record that this company has a clearly demarcated call centre segment and segmental results are available in the audited financial statements of the company. We, therefore, see no reason why the M/s. Ultra Marine Pigments Ltd should not be considered as a comparable and therefore reject the assessee’s grounds seeking its exclusion. This company is, therefore, directed to be retained as a comparable for the assessee for Assessment Year 2004-05.
18.1 We shall now deal with the objections raised by the assessee for excluding certain companies from the set of comparable companies by the TPO. From the details on record, it is seen that the TPO’s set of comparables excluded the following 4 companies selected by the assessee.
(i) Ace Software Ltd.
(ii) Apollo Health Street Ltd.
(iii) MCS Ltd
(iv) Tata Share Registry.
18.2 Ace Software Ltd.
The learned counsel for the assessee contended that the company is engaged in CAD/CAM services, which are in the nature of ITES and therefore it ought to be accepted as a comparable. The TPO on examination of the annual report noted that it had an agreement with Apex Data Services Inc. USA on buyback of 100% of its production. The TPO rejected this company as a comparable for the reason that it supplies 100% of its services to a single enterprise. It is an A E as per the provisions of section 92B of the Act and thus its transactions with the A E are controlled transactions.
We have perused and considered the submissions made and are in agreement with the finding of the TPO that since the entire services of the company are rendered to a single enterprise, it becomes an AE and as such all its transactions assume the character of controlled transactions. We, therefore, held that the TPO was correct in rejecting this as a comparable company.
Apollo Health Street Ltd.
18.3 The TPO had rejected this company as a comparable for the reason that it had related party transactions in excess of 40% of its turnover. The learned counsel for the assessee submitted before us that as per the annual report of this company for F.Y. 2003-04, there are no related party transactions at all and therefore this company should be accepted as a comparable.
We have perused and considered the material on record. It is seen that the TPO in her order has mentioned ‘related party transactions amounting to more than 40% of turnover’ as the reason for rejection as a comparable. From a perusal of its annual report for F.Y. 2003-04 though it does not appear to have any related party transactions, it is seen that out of its total revenues of Rs. 12.2 Crores, only Rs. 6.50 Crores i.e. about 54% of its revenue was received from ITES. This shows that significant Revenue earning of about 46% is not from IT enabled services which will render it functionally different and not comparable to the assessee We, therefore, direct the TPO to verify the claim of the assessee in respect of related party transactions and also our observation as to whether the company is functionally comparable to the assessee in view of 46% of its revenue being from non-ITES business.
MCS Ltd & Tata Share Registry
18.4 In respect of these two companies, in the business of share transfer agents, the assessee contends that they are engaged in data processing activities which are akin to ITES and therefore should be included as comparables. The TPO, however, noted that these companies handle share registry activities, mutual fund operations etc and are functionally different from a BPO. Further, the TPO held that there are no forex earnings and hence it would not pass the export filter. In this view of the matter, the TPO rejected both these companies as comparables.
We have heard both parties and perused the material on record. It is a fact that the assessee caters to the export market, whereas these two companies cater to the domestic market. We find that the TPO has given elaborate reasoning as to why companies catering significantly to domestic market would not be apt comparables for those assessees catering to the export market. We agree with the TPO that pricing and profitability in export and domestic market in ITES sector are not likely to be the same for the following reasons :
(a) Conditions prevailing in the export and domestic market in which the respective parties to the transactions operate are different.
(b) Geographical locations (domestic and export) are different.
(c) Size of the markets (domestic and export) to which companies cater to are different.
(d) Cost of labour and capital in the markets (domestic and export) are different.
(e) Overall economic development and level of competition is different.
(f) Government incentives like tax incentives etc are available only for exporters.
(g) As the pricing for services differs in the domestic market vis-à-vis the export market, the level of competition, size of the market etc are different in the domestic and export sectors.
In view of the facts of the matter as discussed above, we uphold the action of the TPO in rejecting these two companies as comparables or the assessee on the ground of both functional dis-similarity and also for failing the export filter.
Allsec Technologies Ltd.
18.5 Both the assessee and the TPO agree that this company is to be considered as a comparable. The assessee, however, has disputed the computation of the margin taken by the TPO. The TPO while examining the concerned details, noted that two items of abnormal expenditure, namely, connectivity cost and data base cost, amounting to more than 60% of the revenue cannot be treated as regular operating costs and hence averaged the costs incurred on these items for the earlier years for comparability. The assessee contends that these are normal reasonable expenses and were incurred as the company was in an expansion mode which has been misconstrued as extraordinary expenses and therefore the adjustments made by the TPO are not called for.
We have considered the material on record. We find that the TPO in her order has not explained as to why these expenses cannot be taken as regular operating expenses for comparability or the basis for making the adjustments worked out by averaging the costs on the basis of the previous two years. We, therefore, direct the Assessing Officer/TPO to examine the issue, based on the assessee’s submissions and then decide on the adjustment, if any, that would be required to be made for comparability.
Additional ground of appeal
19.1 The assessee vide letter dt.10.9.2012 filed an application seeking leave to urge additional grounds under Rule 11 of the Income Tax (Appellate Tribunal) Rules, 1963 which are as under :
“Ground 1 : Transfer Pricing
It is most humbly prayed that this Hon’ble Tribunal to permit the appellant to raise the following additional ground in continuation of the existing grounds of appeal and be read as Ground No.1.7 after Ground No. 1.6
Ground No. 1.7 Depreciation adjustment
– The depreciation cost as a percentage of the gross block of the appellant during the financial year 2004 was 25% and the comparables reported an average depreciation cost as a percentage of the gross block of 10%.
– The difference in the depreciation cost arises due to differences in the accounting treatment across the comparables and the appellant.
– Considering the above fact, to achieve reliable comparability, the margins of the comparable companies post the adjustment of the depreciation should be considered.”
19.2 The assessee in the grounds raised sought adjustment towards depreciation on the ground that the depreciation cost as a percentage of the gross block of the assessee was 25% as against 10% for the comparable and hence this difference needs to be adjusted for comparability. During the proceedings, on being specifically asked, the learned counsel for the assessee stated that this ground was not raised before the TPO and CIT (Appeals) but prayed that the same be admitted for adjudication as it was a legal issue.
19.3 The learned Departmental Representative submitted that he has, prima facie, no objection to admission of this additional ground. He, however, pointed out that the additional ground raised was very general, put in a bland manner, was not clear or specific and appeared to be an afterthought after the CIT (Appeals) has confirmed the adjustments made by the TPO. The learned Departmental Representative submitted that the assessee has not explained as to why this claim of depreciation is being submitted now; why it is necessary to accept the same; why this claim was not raised earlier; computation of quantum, etc. In the absence of these details, such an additional ground would have no meaning and not being maintainable ought to be dismissed summarily.
19.4 We have heard both parties and considered the rival submissions. We find force in the submissions of the learned Departmental Representative. Whether an adjustment towards depreciation is warranted or not may be, issue of principle. But whether the principle needs to be applied to a particular case or not would depend on the peculiar facts of that case. It cannot be anybody’s case that an adjustment has to be necessarily granted whenever and wherever there is difference in depreciation between the tested party and the comparables. An adjustment for difference in depreciation is a valid principle for comparability, but whether this case entails such an adjustment has to be examined in the light of the particular facts of the case. Hence, the additional ground raised by the assessee is as much as issue of fact as it is of principle.
19.5 Before us, the assessee has not been able to adduce any reason as to why this issue was not raised before the authorities below. It gives credence to the view of the learned Departmental Representative that this claim is only an afterthought, pursuant to the learned CIT (Appeals) confirming the adjustments proposed by the TPO.
19.6 Besides this, the adjustment for depreciation, sought for by the assessee, does not appear to be tenable even on merits. It has been stated in the additional grounds raised that while the depreciation of the assessee is 25% of its gross block, it is 10% of the gross block for the comparables. It is interesting to note that the assessee has compared the depreciation as a percentage of the gross block of the individual cases and not as a percentage to operating cost.
19.7 No case has been made out by the assessee that the difference in depreciation is due to any reason like capacity utilization, etc. The difference in depreciation could be due to many reasons as different companies have their own accounting problems in the matter of fixed assets and depreciation on the basis of technical estimates made of useful life of the assets. Depreciation provided under the Income Tax Rules or the minimum depreciation provided under the Companies Act may not be really exhibiting the actual position. Over a period of time, the difference of depreciation provided under different methods would almost be the same except for marginal difference. In the written down value (WDV) method, the depreciation for the initial year would be more, whereas in straight line method, depreciation in the initial years would be less. However, at the end of the day, the depreciation off sets each by itself.
19.8 In the interest of equity and natural justice, we feel constrained to admit the additional ground raised by the assessee on the issue of depreciation. However, mere claim for an adjustment will serve no purpose unless it is backed by proper details. The additional ground states that the depreciation of the assessee is a ratio of its gross block of 25% as against 10% of the comparable companies. The assessee has not stated the depreciation as a percentage of operational cost nor has any evidence been placed on record to show that the difference in depreciation is due to any operational reasons. As discussed (supra), there could be several reasons for difference in depreciation between companies like, rates of depreciation, age of the assets, etc. and therefore adjustment towards depreciation can be granted only if there are operational differences that affect comparability. We remit the issue of depreciation as raised by the assessee in the additional grounds (supra) to the file of the Assessing Officer/TPO with direction to examine and consider the claim for adjustment towards depreciation in the light of our observations from paras 19.3 to 19.8 of this order and to dispose the matter expeditiously after affording adequate opportunity of being heard to the assessee. It is ordered accordingly.
20. In the result, the assessee’s appeal is partly allowed.