High-End KPO Services Not Comparable with Captive ITeS: ITAT Bangalore

Swiss Re Global Business Solutions India Pvt. Ltd. Vs NFAC (ITAT Bangalore)

Summary: The Income Tax Appellate Tribunal, Bangalore Bench, comprising Shri N.V. Vasudevan, Vice President, and Shri Chandra Poojari, Accountant Member, partly allowed the appeal of Swiss Re Global Business Solutions India Pvt. Ltd. for Assessment Year 2016-17 against the final assessment order dated 29 June 2021 passed by the National Faceless Assessment Centre, Delhi. The dispute primarily concerned transfer pricing adjustments relating to information technology-enabled services (ITeS) and notional interest on outstanding receivables from associated enterprises. The assessee provided captive back-office support services to Swiss Re group entities, including contract administration, claims administration, technical reinsurance accounting and remote data processing in reinsurance activities. Under the functions, assets and risks analysis, the Transfer Pricing Officer characterised the company as a limited-risk captive service provider without significant non-routine intangible assets. The assessee originally challenged a transfer pricing adjustment of Rs.12,01,06,252, various comparable-company selection filters, recharacterisation of trade receivables as unsecured loans, interest under Section 234B and initiation of penalty proceedings under Section 271(1)(c). However, during the hearing, it pressed only specified grounds concerning comparable companies and outstanding receivables.

For the relevant year, the assessee reported international transactions involving provision of back-office support services of Rs.1,76,41,00,100, reimbursement of expenses to associated enterprises of Rs.2,65,95,152 and reimbursement of expenses by associated enterprises of Rs.54,21,424. Its transfer pricing study reported operating income of Rs.1,76,95,41,470, operating costs of Rs.1,56,72,61,983 and operating profit of Rs.20,22,79,487, producing an operating profit to operating cost ratio of 12.91%. The TPO recomputed the margin at 12.78% and selected nine final comparable companies, resulting in an adjustment of Rs.11,12,75,839 under Section 92CA of the Income-tax Act, 1961. Following directions of the Dispute Resolution Panel, the adjustment increased to Rs.12,01,06,252 in the final assessment order. The assessee also raised additional grounds regarding Hartron Communications Ltd. and Capgemini Solutions Ltd., contending that the TPO had not properly implemented the DRP’s directions. The Tribunal admitted these additional grounds by applying the Supreme Court judgment in National Thermal Power Co. Ltd. v. CIT, (1998) 229 ITR 383 (SC), which permits consideration of additional legal grounds arising from facts already on record.

The first substantive dispute concerned Infosys BPM Ltd., which the assessee sought to exclude from the list of ITeS comparables. It submitted that Infosys BPM operated a diversified outsourcing business involving sourcing and procurement, finance and accounting, legal process outsourcing, analytics, business platforms, technology optimisation, business transformation and human resources outsourcing. The assessee emphasised differences in functional activities, service delivery models, brand value, intangible assets, subcontracting expenses, marketing expenditure and turnover. The DRP had rejected these objections, reasoning that a broad ITeS classification was sufficient for comparability under the Transactional Net Margin Method and that the assessee had failed to establish any material profitability impact from the identified differences. However, the Tribunal examined its own earlier order in Swiss Re Global Business Solutions India Pvt. Ltd. v. DCIT, [2020] 116 taxmann.com 716 (ITAT Bangalore), relating to Assessment Year 2014-15, where the comparable had been excluded because the nature and breadth of its services differed materially from the assessee’s routine captive back-office operations. Following that decision, the Tribunal directed exclusion of Infosys BPM Ltd. from the final set of comparables.

The next dispute related to eClerx Services Ltd., which the assessee characterised as a high-end knowledge process outsourcing (KPO) service provider. The assessee argued that the company undertook specialised knowledge-intensive activities substantially different from its own routine reinsurance-related ITeS functions. The DRP had rejected the distinction between BPO and KPO activities and concluded that eClerx remained comparable under the broad ITeS category. The DRP also examined the amalgamation of Agilyst Consulting Pvt. Ltd. with effect from 1 April 2015, the acquisition of CLX Europe SPA through an overseas subsidiary, inorganic business growth, persistent profitability and business concentration risks. It found these matters insufficient to justify exclusion. The Tribunal, however, referred to its earlier decision in the assessee’s own case for Assessment Year 2014-15 and the Delhi High Court judgment in Rampgreen Solutions Pvt. Ltd. v. CIT, (2015) 377 ITR 533 (Delhi High Court), which recognised that high-end KPO services cannot automatically be compared with routine BPO services merely because both belong to the larger ITeS sector. Accordingly, eClerx Services Ltd. was also directed to be excluded.

Regarding the inclusion of Sundaram Business Services Ltd. and ACE Software Exports Ltd., the TPO and DRP had rejected the companies on the ground of persistent operating losses. The DRP relied on earlier decisions concerning loss-making comparable companies and considered losses in two out of three financial years sufficient for exclusion. The assessee submitted that neither company had incurred losses throughout all three immediately preceding years and that each had earned profits in at least one year. The Tribunal held that where a company earned profits in any one of the three relevant financial years, it could not automatically be treated as a persistent loss-making company merely because losses occurred in other years. The matter was therefore remitted to the AO/TPO to examine the financial results and determine comparability afresh. Regarding Hartron Communications Ltd., the Tribunal found that the DRP had already directed its inclusion subject to satisfaction of the TPO’s prescribed filters. The Tribunal consequently directed the AO/TPO to implement those directions in their entirety, rather than granting unconditional inclusion of the company.

The remaining substantive dispute concerned the treatment of outstanding trade receivables from associated enterprises. The assessee argued that deferred receivables were integrally connected with its underlying service transactions and that the working capital adjustment under TNMM already accounted for the financing effect of any delay. It submitted that the receivables should not be treated as a separate international transaction and that notional interest should not be charged independently. The Tribunal examined the extensive reasoning in its earlier decision for Assessment Year 2014-15, which considered the decisions in PCIT v. Kusum Health Care (P.) Ltd., (2017) 398 ITR 66 (Delhi High Court), PCIT v. Bechtel India (P.) Ltd., Ameriprise India (P.) Ltd. v. ACIT, CIT v. Patni Computer Systems Ltd., CIT v. Cotton Naturals (I) (P.) Ltd., Instrumentation Corporation Ltd. v. ADIT and Orange Business Services India Solutions (P.) Ltd. v. DCIT. The competing judicial views addressed whether the statutory definition of an international transaction under Section 92B, as amended retrospectively by the Finance Act, 2012, encompassed delayed receivables and how the financing component should be benchmarked.

Following the Karnataka High Court judgment in PCIT v. AMD (India) Pvt. Ltd., ITA No. 274/2018, dated 31 August 2018, the Tribunal concluded that deferred receivables constituted an independent international transaction requiring separate benchmarking. Since the underlying transactions and receivables were denominated in foreign currency, it held that the appropriate interest benchmark should reflect international commercial conditions rather than a domestic rupee interest rate. Relying on the Bombay High Court judgment in CIT v. Aurionpro Solutions Ltd., 99 CCH 0070 (Bombay High Court), the Tribunal directed application of LIBOR plus 2% for determining the appropriate interest rate. The assessee’s remaining grounds, which were not pressed during the hearing, were dismissed. Consequently, the appeal was partly allowed, with relief granted through exclusion of Infosys BPM Ltd. and eClerx Services Ltd., reconsideration of selected comparables and directions concerning the benchmarking of delayed receivables.

Cases Discussed

• Swiss Re Global Business Solutions India Pvt. Ltd. v. DCIT, [2020] 116 taxmann.com 716; IT(TP)A No. 3181/Bang/2018; 21/05/2020 (ITAT Bangalore). Earlier decision in the assessee’s own case for AY 2014-15, followed for exclusion of Infosys BPM and eClerx and extensively reproduced in the discussion of outstanding receivables.
• PCIT v. AMD (India) Pvt. Ltd., ITA No. 274/2018; 31/08/2018 (Karnataka High Court). Followed for treating deferred receivables as an independently benchmarkable international transaction.
• Orange Business Services India Solutions (P.) Ltd. v. DCIT, [2018] 91 taxmann.com 286 (ITAT Delhi). Discussed in the reproduced earlier order concerning delayed receivables, working-capital adjustments and the need to examine transaction-specific circumstances.
• PCIT v. Kusum Health Care (P.) Ltd., [2018] 99 taxmann.com 431 / [2017] 398 ITR 66 (Delhi High Court). Cited for examining whether the impact of outstanding receivables was already reflected in the working-capital adjustment.
• Avenue Asia Advisors Pvt. Ltd. v. DCIT, [2017] 398 ITR 120 (Delhi High Court). Discussed for the requirement to examine the reasons for outstanding receivables and their working-capital implications.
• Instrumentation Corporation Ltd. v. ADIT (IT), [2016] 71 taxmann.com 193 / 160 ITD 1 (ITAT Kolkata Special Bench). Considered for treating outstanding invoice amounts due from foreign associated enterprises as international transactions under the statutory explanation to Section 92B.
• Bechtel India (P.) Ltd. v. DCIT, [2016] 66 taxmann.com 6 (ITAT Delhi). Relied upon by the assessee concerning interest on outstanding associated-enterprise receivables.
• PCIT v. Bechtel India (P.) Ltd., ITA No. 379/2016; 21/07/2016 (Delhi High Court). Referred to as subsequent High Court proceedings concerning the treatment of associated-enterprise receivables.
• CIT v. Cotton Naturals (I) (P.) Ltd., [2015] 55 taxmann.com 523 / 231 Taxman 401 (Delhi High Court). Cited for the principle that the currency of the underlying financing transaction is relevant in determining the appropriate interest benchmark.
• Rampgreen Solutions (P.) Ltd. v. CIT, [2015] 60 taxmann.com 355 / 234 Taxman 573 / 377 ITR 533 (Delhi High Court). Relied upon for distinguishing high-end KPO companies from routine BPO service providers when selecting transfer pricing comparables.
• Ameriprise India (P.) Ltd. v. ACIT, [2015] 62 taxmann.com 237 (ITAT Delhi). Cited by the Revenue for the proposition that interest on delayed receivables can constitute a separately benchmarkable international transaction.
• Kusum Healthcare (P.) Ltd. v. ACIT, [2015] 62 taxmann.com 79 (ITAT Delhi). Relied upon by the assessee regarding delayed receivables and the impact of working-capital adjustments.
• CIT v. Patni Computer Systems Ltd., [2013] 33 taxmann.com 3 / 215 Taxman 108 (Bombay High Court). Discussed in connection with the retrospective amendment to Section 92B and the treatment of extended credit to associated enterprises.
• GE India Technology Centre (P.) Ltd. v. DDIT, ITA No. 789/Bang/2010 and connected appeals (ITAT Bangalore). Relied upon by the DRP concerning broad functional comparability under TNMM.
• National Thermal Power Co. Ltd. v. CIT, [1998] 229 ITR 383 (Supreme Court). Followed for admitting the assessee’s additional grounds of appeal.
• Jute Corporation of India Ltd. v. CIT, [1991] 187 ITR 688 (Supreme Court). Cited by the assessee concerning the admission of additional grounds at the appellate stage.
• Ahmedabad Electricity Co. Ltd. v. CIT, [1993] 199 ITR 351 (Bombay High Court, Full Bench). Cited in support of the Tribunal’s jurisdiction to consider additional grounds.
• CIT v. Aurionpro Solutions Ltd., 99 CCH 0070 (Bombay High Court). Relied upon for the application of an international benchmark interest rate to foreign-currency receivables; the Tribunal directed LIBOR plus 2%.
• Advance Power Display Systems Ltd. v. ACIT (ITAT Mumbai). Cited by the DRP in support of excluding persistent loss-making companies. The complete citation requires verification.
• Brigade Global Services Pvt. Ltd. v. ITO (ITAT Hyderabad). Cited by the DRP concerning exclusion of companies incurring continuous losses. The complete citation requires verification.
• CRM Services India Pvt. Ltd., 2011-TII-86-ITAT-DEL-TP (ITAT Delhi). Cited concerning companies reporting recurring losses and erosion of capital.
• Exxon Mobil Company India Pvt. Ltd., 2011-TII-68-ITAT-MUM-TP (ITAT Mumbai). Cited regarding rejection of comparable companies with declining revenue and losses.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

This appeal by the assessee is directed against the final assessment order of the Assessing Officer, National Faceless Assessment Centre (NFAC), Delhi, dated 29.06.2021 for the assessment year 2016-17 on the following grounds:-

“That on the facts and circumstances of the case and in law:

1. Final assessment order dated 29.06.2021 passed by NFAC is not in accordance with express provisions of the Act, bad in law and it is time barred.

2. Learned AO / TPO / DRP erred, in law and facts, in making addition of INR 12,01,06,252 to total income of Appellant on pretext that price charged was lower than arm’s length price determined for Information Technology Enabled Services (‘ITeS’) rendered by Appellant to its AE(s);

3. Learned AO / TPO / DRP erred, in law and facts, by not accepting economic analysis undertaken by Appellant in accordance with the provisions of the Act read with the Rules, and in conducting a fresh economic analysis for the determination of the ALP in connection with the impugned international transactions and holding that the Appellant’s international transactions are not at arm’s length;

4. Learned AO / TPO / DRP have erred, in law and facts, by rejecting certain comparable companies following different accounting year (i.e. companies following accounting year other than March 31);

5. Learned AO / TPO / DRP have erred in law and facts, by applying employee cost greater than 25% of the total operating cost as a comparability criterion;

6. Learned AO / TPO / DRP have erred, in law and facts, in application of filter i.e. by rejecting companies whose export services income is less than 75% of turnover for the purpose of selection of comparable companies;

7 Learned AO / TPO / DRP have erred, in law and facts, by applying only the lower turnover filter of less than INR 1 crore as a comparability criterion and not applying a higher threshold limit for turnover filter;

8. Learned AO / TPO / DRP have erred, in law and facts, by testing the proportion of revenue & expense transactions with related parties separately against total revenue & expenses respectively, instead of testing the proportion of all the transactions with related parties against the turnover, while applying the related party filter;

9. Learned AO / TPO / DRP have erred in law and facts, in application of persistent loss filter i.e., by rejecting certain comparable companies where there is loss for any two years out of three years under consideration, instead of excluding only such comparables which have incurred losses during all the three years under consideration;

10. Learned AO / TPO / DRP erred, in law and facts, by exercising his powers under section 133(6) of the Act to obtain information which was not available in public domain and relying on the same for comparability purposes;

11. Learned AO / TPO / DRP erred, in law and facts, by accepting/ rejecting the following companies based on unreasonable comparability criteria:

a) Accepting the following companies that should not be considered as comparable to the Appellant, on one or more grounds:

i. Infosys BPM Limited

ii. SPI Technologies India Private Limited

iii. Eclerx Services Limited

b) Rejecting the following comparable companies selected by the Appellant in its TP documentation:

i. ACE Software Exports Limited

ii. Sundaram Business Services Limited

iii. Informed Technologies India Limited, Allsec Technologies Limited

iv. Cosmic Global Limited

v. R Systems International Limited

vi. Jindal Intellicom Private Limited

c) Rejecting the following comparable companies additionally proposed by the Appellant:

i. Cyfuture India Private Limited

ii. ACE BPO Services Private Limited

iii. Microgenetic System Limited

Although some of the companies were chosen/ not chosen as comparables in the transfer pricing study, in case upon consideration of more details being available in public domain or subsequent decisions any of such companies if found to be comparable/not comparable for any reasons, appellant craves leave to urge the same at the time of hearing.

12. Learned AO / TPO erred, in law and facts, by wrongly computing operating margins of some of the comparable companies considered in the TP order;

13. Learned AO / TPO / DRP erred, in law and facts, by not making suitable adjustment to account for differences in working capital position of the Appellant vis-à-vis the comparables;

14. Learned AO / TPO / DRP erred, in law and facts, by not making suitable adjustments on account of differences in the risk profile of the Appellant vis-6-vis the comparables, while conducting comparability analysis;

15. Learned AO / TPO / DRP have erred, in law and facts, by re-characterizing certain trade receivables as unsecured loans, not appropriately considering the nature and characteristics of the transaction and computing notional interest on such trade receivables;

16. Learned AO / TPO / DRP have erred, in law and facts, by not appreciating that the working capital adjustment undertaken by the Appellant in its Transfer Pricing documentation would take into consideration impact of credit period extended to the customers, and therefore, a separate analysis would not be required in respect of trade receivables;

17. Without prejudice to our ground of appeal no.14 and 15 above, Learned DRP has erred, in law and facts, by arbitrarily directing the learned TPO to consider SBI short term fixed deposit interest rate for computing notional interest to be charged on the trade receivables recharacterized as unsecured loans for the period of delay in realization;

18. Learned AO / TPO have erred, in facts, by erroneously computing the amount of adjustment pursuant to the directions of Hon’ble DRP;

19. Learned AO erred, in law and facts; in levying interest of INR 2,80,52,437 under section 234B of the Income Tax Act, 1961;

20. Learned AO has erred in law and facts, in initiating penalty proceedings under section 271(1)(c) of the Act.

The Appellant submits that each of above grounds is independent and without prejudice to one another.

The Appellant craves leave to add, alter, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal, so as to enable the Hon’ble Tribunal to decide on the appeal in accordance with the law.”

2. The assessee has filed petition raising the following additional grounds explaining that the DRP has directed to include Hartron Communications Limited (Seg.) and exclude Capgemini Solutions Ltd. in the final set of comparables if it passes all the filters as applied by the TPO in the order u/s. 92CA dated 28.10.2019. However, the TPO in the said order has rejected the company for inclusion on the ground that it fails core function filter i.e., income from comparable service to sale ratio is less than 75% for AYs 2013-14, 2014-15 & 2015-16 disregarding that only segmental details were considered for comparability purpose. The AO/TPO has not given effect to the directions of DRP to exclude Capgemini Solutions Ltd. as it is not a part of search matrix as adopted by the TPO. Accordingly, these issues have arisen pursuant to the order of the TPO. Therefore, it is prayed that these grounds may be admitted for adjudication in the interest of justice. Reliance is placed on the following decisions:-

National Thermal Power Co. Ltd. Vs. CIT 229 ITR 383 (SC)

Jute Corporation of India Ltd. 187 ITR 688 (SC)

Ahmedabad Electricity Co. Ltd. 199 ITR 351 (Born) FB)

3. We have heard both the parties on the admission of additional grounds and following the Hon’ble Supreme Court judgment in the case of M/s National Thermal Power Co. Ltd. Vs. CIT, 229 ITR 383 (SC), the additional grounds are admitted for adjudication.

4. The assessee company renders contract IT enabled back office services to the Swiss Re Group entities across the globe. It provides IT enabled back office services such as contract administration, claims administration and technical reinsurance accounting support (for property and casualty reinsurance and life & health reinsurance). The assessee has also entered into agreements with Swiss Re companies for rendering remote data processing in the field of reinsurance. The functions performed by the taxpayer and its AE in relation the back office support services provided by the taxpayer to the AE are Strategic Management functions, Administrative Services , Contracting with customers, Specification/requirement analysis, Project Management and Performance/ Quality control uses the routine tangible assets for its business operations. The assessee does not own any non-routine intangibles such as trade secrets, patents, trademarks, etc. On the other hand, the AE, being the entrepreneurial entity, performs the necessary R&D function and owns intangible of products developed.

5. The FAR analysis serves as a foundation to characterize entities for the purpose of inter-company transfer pricing. Based on the analysis of the functions performed, assets employed and risks assumed, the TPO characterized the assessee as a captive service provider which assumes minimal risks associated with the business of providing Back Office Support Services, IT enabled services.

6. As per the Transfer Pricing (TP) document, the assessee company has entered into the following international transactions with its Associated Enterprises (AEs):

International Transactions	Amount Received/Receivable	Amount Paid/Payable	Method
Provision of back office support service	1,76,41,00,100		TNMM
Reimbursement of expenses to AE		2,65,95,152	Other Method
Reimbursement of expenses by AE	5421424		Other Method

7. The financials as submitted in TP study of assessee are as under:

PARTICULAR	ITeS Segment (Amount in INR)
Revenue from Operation	175,51,00,100
Forex Income	1,44,41,370
Operating Income	176,95,41,470
Employee Benefit	102,81,64,577
Other Expenses	47,97,19,587
Depredation and Amortization Expenses	6,11,63,395
Less: Interest Expenses	17,85,576
Total Operating Cost	156,72,61,983
Operating Profit	20,22,79,487
OP/OC	12.91%

8. The TPO worked out the financials as under:-

PARTICULAR	ITeS Segment (Amount in INR)
Revenue from Operation	175,51,00,100
Forex Income	1,44,41370
Operating Income	176,95,41,470
Total. Expenses	157,05,10,559
Less: CSR Expenses	14,63,000
Total Operating Cost	156[90,47,559
Operating Profit	20,04,93,911
OP/OC	12.78%

9. The TPO selected 9 final comparables and taking the median of the weighted average Profit Level Indicators as the arm’s length margin, he made a TP adjustment u/s. 92CA of the Act in respect of ITeS of Rs.11,12,75,839. After the directions of the DRP, the AO made a TP adjustment of Rs.12,01,06,252 in the final assessment order. Against this, the assessee is in appeal before us.

10. The ld. AR before us pressed only the grounds of appeal with regard to exclusion of the companies viz., Infosys BPM Ltd. and Eclerx Services Ltd. and inclusion of Sundaram Business Services Ltd., ACE Software Exports Ltd. & Hartron Communication Ltd. (addl. ground).

Exclusion of comparables

11. The ld. AR submitted that Infosys BPM Ltd. should be rejected as a comparable because it is functionally not comparable, has diversified activities and lack of segmental data, different business model, brand profits, various revenue models, presence of intangibles, outsourcing costs, marketing expenses and turnover. It offers business outsourcing solutions to several clients and span across multiple industry segments. The company’s catering to a variety of industries does not change the nature of functions carried out as it is committed to provide best in class services to both horizontal and vertical focus areas.

12. The DRP was of the view that just because the company is providing cloud based services over various mainframe computers, the company would not be functionally different as claimed by the assessee and rejected this plea of the assessee.

13. Regarding the plea of the assessee that this company is into high end ITES service provider, and hence not comparable, the DRP held that under TNMM, there is no requirement that the comparables should render the same or identical services. It would be sufficient, if the services fall under the broad industry segment ITES. In this regard the DRP relied on the Bangalore Tribunal decision in the case of GE India Technology Centre Private limited Vs. DDIT (ITA No. 789/Bang/2010 & ITA Nos 487 & 925/13ang/2011 and other decisions wherein it was observed that TNMM requires only broad comparability.

14. The contention of the assessee that Infosys BPO has various Revenue Models and its revenues are generated principally on time and material basis, transaction basis and fixed price contracts and therefore, it should not be compared with the assessee, the DRP observed that as the assessed failed to demonstrate as to how the different methods of billing would affect the Functional comparability or impact the profitability. Unless the same is demonstrated with credible evidence, it remains a theoretical argument without any backing with facts and figures and hence rejected it.

15. The assessee pointed out that this company has reported an amount of Rs. 136 crore as ‘cost of Technical sub-contractors’ which constitutes about 4.45% of total revenue of the company during the year. The DRP observed that the annual report mentions that these sub-contractors are used for operational activities. This is a common practice in almost all the companies to give a small portion of the work to some other sub-contractors for a variety of reasons. This may allow the company to focus on its core activities. Sometimes it may be to meet the mismatch in certain skill-sets that are required in various projects. These expenses are incurred in the routine course of business. This cannot be held to be a criteria to affect the functional comparability of a company and more so in the facts of this case, wherein the sub-contracting expenses are about 4.45% only. This objection was accordingly rejected.

16. Regarding the lack of segment data to reject it as a comparable, the DRP was of the view that when it has been held that all the services being done by this company falls in the category of ITeS, then the absence of segmental information remains a theoretical argument.

17. The assessee has also argued that this company has significant intangibles and brand and hence not functionally comparable. The DRP noted that the expenditure incurred towards brand was just Rs.19 crore which is meagre considering its operating revenue of Rs.3050 crores. Further, the assessee could not point to any information from the annual report to indicate brand has contributed to the revenue growth or profitability. Therefore, the presence of brand, as such, has not affected comparability. Further, there is no information in the annual report to indicate that the company has undertaken any major R&D initiatives & own intangibles. Therefore, the presence of intangible in the form of goodwill, which is also insignificant, as the value is only Rs.19 crore compared to the revenue from operations of Rs.3050 crores do not have any impact on the profits of the company. Hence, these pleas were rejected by the DRP.

18. The assessee’s contention that this comparable has incurred significant selling and marketing expense was also not accepted by the DRP, since from the perusal of the annual report, the DRP noted that the expenses on this count is only 4.56% of the total expenditure and which is not at all significant to affect the profitability of the comparable.

19. Thus, in view of the discussions held above, all the grounds raised by the assessee were rejected and the action of the AO/TPO was upheld by the DRP.

20. We have heard both the parties and perused the material on record. This comparable has been considered as not comparable in Swiss Re Global Business Solutions India P. Ltd. for AY 2014-15 in IT(TP)A No. 3181/Bang/2018 dated 21.5.2020 wherein it was observed as under:-

“We have perused submissions advanced by both sides in light of records placed before us. We note that this company is providing services in various areas of sourcing and procurement, customer services, finance and accounting legal process outsourcing, sales and fulfilment, analytics, business platforms, business transformation services, human resource outsourcing and technology solution optimisation. It is noted that this comparable also provides services in financial services and insurance, manufacturing, energy utilities communications and services and retail, consumer packaged foods, logistics and life services. Further in the annual report it has been mentioned that this comparable provides services that are different from routine back-office services. This noting itself makes this comparable not functionally similar with that of assessee.

Accordingly we direct this comparable to be excluded from finalist.”

21. In view of the above order of the Tribunal, we are inclined to hold that this company should be excluded from the list of comparables.

22. Regarding exclusion of Eclerx Services Ltd., the assessee argued that this company is a a KPO company and hence, it is not a good comparable. The DRP observed that there is a thin line of difference between BPO and KPO services. KPO is termed as an upward shift of the BPO industry in the value. chain. Thus, BPO trying to upgrade itself as KPO is likely to render both BPO as well as KPO services in the process of evolution and therefore, such an entity cannot be considered strictly as either BPO or KPO. In view of the above, ITeS service’s cannot be further classified as BPO and KPO services for the purpose of comparability analysis. Under the TNMM, functional similarity is more relevant than product similarity. The DRP noted that the functional profile of this company was similar to the assessee.

23. Regarding the amalgamation of wholly owned subsidiary Agilyst Consulting Pvt Limited has taken place with effect from 1.4.2015, the DRP observed that the assessee has not demonstrated any increase in profits due to this amalgamation. Therefore, this amalgamation has no impact on comparability. Accordingly, the plea was rejected.

24. With regard to acquisition resulting in inorganic growth, the DRP noted that the company has acquired entire shareholding of CLX Europe SPA, Italy, as on 22nd April 2015 and this acquisition was made by the company’s overseas subsidiary eClerx Investments (UK) Ltd. Therefore, there is no merit of the objection, as the stand alone financials of this company are considered for comparability.

25. The assessee also raised the objection that there is increase in revenue, but according to the DRP, it has failed to bring on record any evidence to suggest that this abnormal inorganic growth has impacted the profit margin of the company. It is observed that the profit margin of this company has been consistently at the same level during the last few years. The ALP margin is determined with reference the average profit margin of a comparable for three years and also taking into account the defined median value of the PLIs of the comparable. These will even out such differences. The DRP was of the opinion that it will not be proper to reject a comparable only on account of inorganic growth of top line, which otherwise. is functionally comparable.

26. The DRP further observed that it was consistently held that high profit margin as such cannot be reason for exclusion when it is otherwise functionally comparable. Accordingly, there is no need to reject a functionally comparable company on account of having super profits.

27. The Assessee submitted that Eclerx suffers business concentration risk unlike the Assessee, who operates as a risk-free entity. The DRP observed that as far as the limited risk in the case of captive service providers is concerned, if this argument is accepted then it cannot be compared to any company as most of the companies will be independent companies. Rather it should be compared to independent companies only as the price received for the services by them will be determined by market forces, which is not the case of the assessee. The assessee itself can be characterized as a contract service provider, which means that it operates on a cost plus model. Therefore, this argument was also rejected.

28. Thus, the DRP upheld the rejection of this company as a comparable.

29. We have heard both the parties on the issue. This company has also been considered as not comparable in assessee’s own case for AY 2014-15 in IT(TP)A No.3181/Bang/2018 dated 21.5.2020 wherein it was observed as under:-

“It is noted that this company is involved in high-end KPO services whereas assessee is providing IT enabled services by rendering remote data processing in the field of reinsurance. In our opinion functions performed by this company is not similar to that of assessee even though assessee before us also carries out certain services on contract basis. Ld.AR has placed reliance upon decision of Hon’ble Delhi High Court in case of Rampgreen Solutions (P.) Ltd. v. CIT [2015] 60 taxmann.com 355/234 Taxman 573/377 ITR 533 Hon’ble court had held that once a company falls into the category of high-end KPO, it cannot be functionally comparable with a BPO service provider like that of assessee.

Applying this reissue in the present case, we direct Ld.AO to eliminate this comparable from final list.”

30. In view of the above order of the Tribunal, we are inclined to direct that Eclerx Services Ltd. be excluded from the list of comparables.

Inclusion of comparables

31. Regarding inclusion of Sundaram Business Services Ltd., and Ace Software Exports Ltd., the DRP was of the view that the that the TPO is justified in excluding companies making persistent losses as comparable. The ITAT, Mumbai in the case of Advance Power Display Systems Limited vs. ACIT and Sumitomo chemicals held that persistent loss-making company cannot be considered as good comparable for the purpose of determining ALP. The ITAT, Hyderabad in the case of Brigade Global Services Private Limited vs. ITO held that in case there is continuous loss year by year, in such a situation, that company’s data cannot be considered as comparable. In the case of Sony India Private Limited, the Hon’ble ITAT in regard to the comparable Godrej Ltd noted that the huge losses suffered by the company over a period of several years would be a significant factor to justify exclusion of the said company as comparable. The ITAT, Delhi in the case of CRM Services India Private Limited (2011-TII-86-ITAT-Del-TP), observed that companies incurring losses year after year cannot be a valid comparable as their capital base has been completely eroded. In the case of Exxon Mobil Company India Pvt. Ltd. (2011-III-68-ITAT-Mum-TP) the ITAT Mumbai upheld the rejection of two comparables on the ground of declining revenue and losses. In view of these decisions, the DRP did not find any infirmity in the TPO’s approach in adopting this criteria for comparable analysis, as the above these companies have been making persistent losses for two out of three years.

32. The ld. AR submitted that these companies did not incur continuous loss in the last 3 preceding years and the assessee earned profit in one of the 3 immediate preceding years. Being so, it is to be considered as comparable.

33. In our opinion, if a company is making profit in any one of the 3 immediate preceding years, then it should be considered as a comparable. Accordingly, this issue is remitted to the AO/TPO to consider the financials of these companies and decide the issue of comparability of Sundaram Business Services Ltd., and Ace Software Exports Ltd. accordingly.

34. With regard to inclusion of Hartron Communications Ltd., according to the assessee, the TPO has not followed the directions of the DRP. We find no merit in this argument of the ld. AR. During the course of DRP proceedings the assessee has submitted that the company has earned profits for F.Y. 2015-16 F.Y. 2014-15 and 2013-14 on company wide basis. The DRP after perusing the annual reports of the company observed that the company is making profits for the three years and therefore directed the AO/TPO to consider this company as comparable if it passes all the filters chosen by the TPO. We accordingly direct the AO/TPO to follow the directions of the DRP in letter and spirt.

35. The only other issue that remains for adjudication is ground No.15 with regard to re-characterizing certain trade receivables as unsecured loans and computing notional interest on such trade receivables. The main contention of the ld. AR is that deferred receivables would not constitute a separate international transaction and need not be benchmarked while determining the ALP of the international transaction. In our opinion, this issue was considered by the Tribunal in assessee’s own case for AY 2014-15 and in para 23 to 23.9 of the order dated 21.5.2020 this Tribunal held as under:-

“23. Ground No. 14-17 alleged by assessee against adjustment of notional interest on outstanding receivables.

From TP study, it is observed that payments to assessee are not contingent upon payment received by AEs from their respective customers. Further Ld.AR submitted that working capital adjustment undertaken by assessee includes the adjustment regarding the receivables and thus receivables arising out of such transaction have already been accounted for. Alternatively, he submitted that working capital subsumes sundry creditors and therefore separate addition is not called for.

23.1. Ld.TPO computed interest on outstanding receivables under weighted average method using LIBOR + 300 basis points applicable for year under consideration that worked out to 3.3758% on receivables that exceeded 30 days. It has been argued by Ld.AR that authorities below disregarded business/commercial arrangement between the assessee and its AE’s, by holding outstanding receivables to be an independent international transaction.

23.2. Ld.AR placed reliance on decision of Delhi Tribunal in Kusum Healthcare (P.) Ltd. v. Asstt. CIT [2015] 62 taxmann.com 79, deleted addition by considering the above principle, and subsequently Hon’ble Delhi High Court in Pr. CIT v. Kusum Health Care (P.) Ltd. [2018] 99 taxmann.com 431/[2017] 398 ITR 66, held that no interest could have been charged as it cannot be considered as international transaction. He also placed reliance upon decision of Delhi Tribunal in case of Bechtel India (P.) Ltd. v. Dy. CIT [2016] 66 taxman.com 6 which subsequently upheld by Hon’ble Delhi High Court vide order in Pr. CIT v. Bechtel India (P.) Ltd. [IT Appeal No. 379 of 2016, dated 21-7-16] also upheld by Hon’ble Supreme Court vide order, in CC No. 4956/2017.

23.3. It has been submitted by Ld.AR that outstanding receivables are closely linked to main transaction and so the same cannot be considered as separate international transaction. He also submitted that into company agreements provides for extending credit period with mutual consent and it does not provide any interest clause in case of delay. He also argued that the working capital adjustment takes into account the factors related to delayed receivables and no separate adjustment is required in such circumstances.

23.4. On the contrary Ld.CIT.DR submitted that interest on receivables is an international transaction and Ld.TPO rightly determined its ALP. In support of the contentions, he placed reliance on decision of Delhi Tribunal order in Ameriprise India (P.) Ltd. v. Asstt. CIT [2015] 62 taxmann.com 237 wherein it is held that, interest on receivables is an international transaction and the transfer pricing adjustment is warranted. He stated that Finance Act, 2012 inserted Explanation to section 92B, with retrospective effect from 1.4.2002 and sub-clause (c) of clause (i) of this Explanation provides that:

(i) the expression “international transaction” shall include—

. . . . . (c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;. . . . ‘

23.5. Ld.CIT.DR submitted that expression ‘debt arising during the course of business’ refers to trading debt arising from sale of goods or services rendered in course of carrying on business. Once any debt arising during course of business is an international transaction, he submitted that any delay in realization of same needs to be considered within transfer pricing adjustment, on account of interest income short charged or uncharged. It was argued that insertion of Explanation with retrospective effect covers assessment year under consideration and hence under/non-payment of interest by AEs on debt arising during course of business becomes international transactions, calling for computing its ALP. He referred to decision of Delhi Tribunal in Ameriprise (supra), in which this issue has been discussed at length and eventually interest on trade receivables has been held to be an international transaction. Referring to discussion in said order, it was stated that Hon’ble Delhi Bench in this case noted a decision of the Hon’ble Bombay High Court in the case of CIT v. Patni Computer Systems Ltd. [2013] 33 taxmann.com 3/215 Taxman 108 (Bom.), which dealt with question of law:

“(c) ‘Whether on the facts and circumstances of the case and in law, the Tribunal did not err in holding that the loss suffered by the assessee by allowing excess period of credit to the associated enterprises without charging an interest during such credit period would not amount to international transaction whereas section 92B(1) of the Income-tax Act, 1961 refers to any other transaction having a bearing on the profits, income, losses or assets of such enterprises?”

23.6. Ld.CIT.DR submitted that, while answering above question, Hon’ble Bombay High Court referred to amendment to section 92B by Finance Act, 2012 with retrospective effect from 1.4.2002. Setting aside view taken by Tribunal, Hon’ble Bombay High Court restored the issue to file of Tribunal for fresh decision in light of legislative amendment. It was thus argued that non/under-charging of interest on excess period of credit allowed to AEs for realization of invoices, amounts to an international transaction and ALP of such international transaction has to be determined by Ld.TPO. Insofar as charging of rate of interest is concerned, he relied on decision of the Hon’ble Delhi High Court in CIT v. Cotton Naturals (I) (P.) Ltd. [2015] 55 taxmann.com 523/231 Taxman 401 holding that currency in which such amount is to be re-paid, determines rate of interest. He, therefore, concluded by summing-up that interest on outstanding trade receivables is an international transaction and its ALP has been correctly determined.

23.7. We have perused the submissions advanced by both the sides in the light of the records placed before us.

This Bench referred to decision of Special Bench of this Tribunal in case of Special Bench of ITAT in case of Instrumentation Corpn. Ltd. v. Asstt. DIT (IT) [2016] 71 taxmann.com 193/160 ITD 1 (Kol. – Trib.), held that outstanding sum of invoices is akin to loan advanced by assessee to foreign AE., hence it is an international transaction as per Explanation to section 92B of the Act. We also perused decision relied upon by Ld.AR. In our considered opinion, these are factually distinguishable and thus, we reject argument advanced by Ld.AR.

23.8. Alternatively, it has been argued that in TNMM, working capital adjustment subsumes sundry creditors. In such situation computing interest on outstanding receivables and loans and advances to associated enterprise would amount to double taxation. Hon’ble Delhi Tribunal in case of Orange Business Services India Solutions (P.) Ltd. v. Dy. CIT [2018] 91 taxmann.com 286 has observed that:

“There may be a delay in collection of monies for supplies made, even beyond the agreed limit, due to a variety of factors which would have to be investigated on a case to case basis. Importantly, the impact this would have on the working capital of the assessee would have to be studied. It went on to hold that, there has to be a proper inquiry by the TPO by analysing the statistics over a period of time to discern a pattern which would indicate that vis-a-vis the receivables for the supplies made to an AE, the arrangement reflected an international transaction intended to benefit the AE in some way. Similar matter once again came up for consideration before the Hon’ble Delhi High Court in Avenue Asia Advisors Pvt. Ltd v. DCIT [2017] 398 ITR 120 (Del). Following the earlier decision in Kusum Healthcare (supra), it was observed that there are several factors which need to be considered before holding that every receivable is an international transaction and it requires an assessment on the working capital of the assessee. Applying the decision in Kusum Health Care (supra), the Hon’ble High Court directed the TPO to study the impact of the receivables appearing in the accounts of the assessee; looking into the various factors as to the reasons why the same are shown as receivables and also as to whether the said transactions can be characterised as international transactions.”

23.9. In view of the above, we deem it appropriate to set aside this issue to Ld.AO/TPO for deciding it in conformity with the above referred judgment. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in accordance with law.”

36. Accordingly, we are of the opinion that deferred receivables would constitute an independent international transaction and the same is required to be benchmarked independently as held by the Hon’ble Karnataka High Court in PCIT v. AMD (India) Pl. Ltd., ITA No.274/2018 dated 31.8.2018.

37. Once we have held that the transaction between the assessee and AE was in foreign currency with regard to receivables and transaction was international transaction, then transaction would have to be looked upon by applying the commercial principles with regard to international transactions and accordingly proceeded to take into account interest rate in terms London Inter Bank Offer Rate [LIBOR] and it would be appropriate to take the LIBOR rate + 2%. For this purpose, we place reliance on the judgment of the Bombay High Court in the case of CIT v. Aurionpro Solutions Ltd., 99 CCH 0070 (Mum HC). It is ordered accordingly.

38. The other grounds of appeal were not pressed and dismissed accordingly.

39. In the result, the appeal of the assessee is partly allowed.

Pronounced in the open court on this 21st day of January, 2022.