M/S GLOBAL E-BUSINESS OPERATIONS PRIVATE LIMITED ,BANGALORE vs. JOINT COMMISSIONER OF INCOME TAX SPECIAL RANGE-3 , BANGALORE

The assessee is engaged in the business of providing back office operations and customs support services to its various Associate Enterprises (AE). The services so rendered are in the nature of Information Technology

As far as rendering of ITeS by the assessee to its AE is concerned, the most appropriate method chosen for the purpose of comparison of the assessee’s profit margin with that of comparable companies was Transaction Net Margin Method (TNMM) and Profit Level Indicator (PLI) chosen for comparison was Operating Profit / Operating Cost (OP/OC). The assessee’s OP/OC was 17.73%. The assessee had chosen 7 comparable companies and their average arithmetic mean profit margin was 6.81% and assessee considered the transaction as at arm’s length as its margin was higher. The TPO did not accept the plea of the assessee and he chose 5 comparable companies whose average profit margins were 22.34% as per the following chart:- Average ITES Segment Amounts in Rs.Lakh Sl OP/OC No. OR/Sales OC OP (in %) Company Name 1 Infosys B P O Ltd. 2,30,900.00 1,81,200.00 49,700.00 27.43% 2 Microgenetic Systems Ltd. 225.97 191.41 18.06% 34.56 3 Microland Ltd. 28,709.00 5,762.00 20.07% 34,471.00 4 B N R Udyog Ltd. (Seg) 142.59 114.00 28.59 25.08% Crossdomain Solutions 5 6,164.00 1,298.76 21.07% 7,462.75 Pvt Ltd..

The TPO ultimately computed the ALP as follows:- ITES Segment Arm's Length Mean Margin on cost 22.34% Operating Cost 13,17,09,81,000 Arm's Length Price(ALP) @ 122.34% 15,11,33,78,155 of Operating Cost) Price Received 15,50,67,84,000 Variation in Price 60,65,94,155 3% of price received 46,52,03,520 Shortfall being adjustment 60,65,94,155

The Transfer Pricing Adjustment and consequent addition to the total income as determined by the TPO at Rs.60,65,94,155 was incorporated by the AO in the draft order of assessment passed by the AO. The Assessee preferred objections to the determination of ALP by the TPO before the Dispute Resolution Panel (DRP). The DRP excluded only one company from the list of comparable companies viz., BMR Udyog Ltd. After the directions of the DRP, the AO gave effect to the directions of the DRP in his final order of Assessment, in which the addition suggested by the TPO, to the extent it was sustained by the DRP was made to the total income of the Assessee. Aggrieved by the aforesaid addition on account of determination of ALP, and the consequent addition to the total income of the Assessee, the Assessee is in appeal before the Tribunal.

Before the Tribunal, the assessee seeks exclusion of 2 comparable companies out of remaining 4 comparables viz., (i) Infosys BPO Ltd., (ii) and (ii) Cross Domain Solutions P. Ltd. As far as comparability of the IT(TP)A No. 3379/Bang/2018 Page 4 of 17 aforesaid 2 companies in the ITeS segment are concerned, the learned Counsel for the assessee relied on a decision of the Hyderabad Bench of the Tribunal in the case of Infor (I) Pvt. Ltd. v. DCIT [2019] 109 taxmann.com 435 [Hyd. Trib.]wherein the Tribunal in the case of assessee who is also in the business of ITeS such as the assessee in this appeal, held that these two companies are not comparable with an ITeS company with the following observations:

The learned DR however relied on a decision of ITAT Hyderabad Bench for Assessment Year 2014-15 in the case of Hyundai Motor India Engg. Pvt. vs. Dy. Commissioner of Income- Tax Ltd., Hyderabad (2018) 110 taxmann.com 483 (Hyd.-ITAT) wherein the Tribunal held Cross Domain Solutions Pvt. Ltd., as a comparable company with the following observations:

We have considered the rival submissions. As far as exclusion of Infosys Ltd., is concerned, the decision of the ITAT Hyderabad Bench cited by the learned Counsel for assessee supports the pela for exclusion. Hence, we direct exclusion of Infosys Ltd., as a comparable company. As far as exclusion of Cross Domain Solutions Pvt. Ltd., is concerned, we notice that this company renders diversified Knowledge Process Outsourcing (KPO) providing services in insurance, health care, HR and accounting domains. In the decision cited by the learned DR, the assessee was also in KPO services of providing engineering design services. The assessee in this appeal is a Business Processing Outsourcing Services which are routine in nature and not in the nature of a knowledge process outsourcing. Therefore we prefer to follow the decision cited by the learned Counsel for assessee and direct exclusion of Cross Domain Solutions Pvt. Ltd.

The other issue that remains for consideration is the issue with regard to non-grant of working capital adjustment while arriving at the average arithmetic profit margin of comparable companies. As far as the aforesaid issue is concerned, the DRP refused to allow the working capital adjustment for the following reasons:- “2.8.1 Having considered the submissions, we note that Rule 10B provides for making reasonably accurate adjustment to the uncontrolled comparable transaction to eliminate the material effects of differences on the price, cost or profits. The assessee has argued for working capital adjustment contending that there exist differences in the payable and receivable position between the assessee and the comparables. However, it was not demonstrated with any data or information as to the impact of such difference on the price, cost or profits, and as to whether such difference materially affect the price, cost or profits. The ‘Accounts payables' and 'Receivables' shown in the balance sheet only reflects the position as at the end of the financial year, and as such it would not enable to measure the impact of working capital on the costs, price or profits. The working capital requirements and impact depends on various factors such as business cycle, the nature of business activity with its correlation on the general economic trends, the fund and capital position of the company, its marketing strategies, its market share etc. all of which cannot be captured in the year end Receivable or Payable position. Besides, the 'Payable' and 'Receivable' position stated in the Balance Sheet may not exactly reflect as to whether it arises from transaction elating to Revenue Account or Capital Account as there is no uniformity in the accounting or reporting requirements, and an intermixing is generally possible. The cost ascribable to the working capital would be different to different enterprises depending on the cost of fund to the enterprise, the cost of money in the economy it operates etc. In view of these, a reasonable accurate adjustment is not possible, as the differences in working capital requirements itself is based on various assumptions. Besides, we also note that the assessee had failed to demonstrate such material differences so as to warrant an adjustment. In these circumstances, we are inclined to uphold the IT(TP)A No. 3379/Bang/2018 Page 8 of 17 TPO's reasoning and reject the assessee's claim for working capital adjustment.”

The ld. counsel for the assessee submitted that a co-ordinate Bench of ITAT Bangalore in the case of Huawei Technologies India Pvt. Ltd. IT(TP)A No.1939/Bang/2017 has dealt with the issue of granting of working capital adjustment. The Tribunal held that a reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly show that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. The Tribunal also referred to Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) which contains extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of those guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that:  None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or IT(TP)A No. 3379/Bang/2018 Page 9 of 17  Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments.

The Tribunal analysed Paragraph 13 to 16 of the aforesaid OECD guidelines, which highlights the need for working capital adjustment as follows:- “13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing effect.

A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory)

The CIT(A) in the decision cited by the learned counsel for the assessee also placed reliance on a decision of Chennai ITAT in the case of Mobis India (2013) 38 taxmann.com. The Tribunal held that the said decision was based on the factual aspect that the assessee was not able to demonstrate how working capital adjustment was arrived at by the assessee.

The Tribunal further held that in the matter of determination of Arm’s Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm’s Length Price. The data available with the assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the assessee to produce the correct information about the comparable companies. The Revenue has, on the other hand powers, to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing

In the case of the Assessee in this appeal, neither the TPO nor the DRP have gone into the quantum of adjustment that is to be given towards

The assessee has filed application for raising the following additional grounds: Ground No.15: Claim towards payment of leave encashment of INR 2,35,95,073 15.1 The Assessing Officer ("Learned AO") and Honourable Dispute Resolution Panel ("Hon'ble DRP") have erred in law and on facts, in not granting deduction in respect of amount paid towards leave encashment INR 2,35,95,073 during the Assessment Year ("AY") 2014-15 under the provisions of section 43B(f) of the Income Tax Act,1961 ("the Act"), after having denied the Appellant's claim of provision for leave encashment on accrual basis for AY 2007-08 and AY 2013-14. 15.2 The Learned AO and Hon'ble DRP, have erred in law and on facts, in not appreciating the fact that the Appellant was eligible for the deduction towards leave encashment although the same was not claimed in the return of income filed by the Company for the AY 2014-15, owing to its claim of deduction of provision for leave encashment made in AY 2007-08 and AY 2013-14 based on the decision of Hon'ble Calcutta High Court decision in the case of Exide Industries Limited v. Union of India [2007] [164 taxman 9], which was subsequently rejected.

The Assessing Officer ("AO") during the assessment proceedings did not accept the claim in FY 2006-07 and FY 2012-13 relevant to Assessment Year ("AY") 2007-08 and AY 201314. Accordingly, the AO made an adjustment of INR 6,83,81,220 and INR 11,66,67,733 -respectively, to the total income in the assessment order under section 143(3) of the Act, for the said AY's. The Hon'ble Income Tax Appellate Tribunal, Bangalore ("ITAT") in case of assessee for AY 2007-08 and AY 2013-14, has remitted the issue back to the file of the AO through order dated 16 January 2017 in I.T(TP).A No. 1092/Bang/2011 and order dated 25 October 2019 in respectively to decide the issue based on the outcome of the Hon'ble Supreme Court's decision in the case of Exide Industries.

Subsequently on 24 April 2020, the Hon'ble Supreme Court vide Civil Appeal 3545/2009 overruled the decision of Calcutta High Court in the case of Exide Industries and upheld the constitutional validity for deduction of leave encashment on payment basis under section 43B(f) of the Act. In view of the Hon’ble Supreme Court decision, the deduction on account of IT(TP)A No. 3379/Bang/2018 Page 16 of 17 provision for leave encashment cannot be sustained. However, the assessee wants to raise additional grounds of appeal for allowing the deduction under section 43B(f) of the Act on the payments made towards leave encashment in AY 2014-15 which has not been claimed in the Return of Income for the year.

We have considered the submissions of the parties and are of the view that in the light of the decision of the Hon’ble Supreme Court in the case of Exide Industries (supra), the assessee will not be entitled to claim deduction on leave encashment on the basis of the provision. Taking into consideration the circumstances under which the assessee did not claim a sum of Rs.4,50,79,000/- being leave encashment actually being paid during the previous year relevant to Assessment Year 2014-15 we are of the view that the assessee should be allowed leave encashment actually paid as per provisions of section 43B(f) of the Act. We remit the issue to the AO to verify the claim of the assessee and allow deduction to the assessee as per law after affording assessee opportunity of being heard.

As far as ground No.16 raised by the assessee is concerned, the same is with regard to deduction in respect of Education Cess on Income Tax and Secondary and High Education Cess on Income Tax. The learned Counsel submitted that in the case of Sesagoa Ltd., Vs. JCIT (supra), the Hon’ble Bombay High Court held that Education Cess and Secondary and High Education Cess are not in the nature of tax and are deductible expenditure. We have considered the submissions and we find that the Hon’ble Bombay High Court in the case of Sesagoa Ltd., (supra) held the expression 'cess' used in section 40(a)(ii) of the Act ought not to be read or included in IT(TP)A No. 3379/Bang/2018 Page 17 of 17 expression 'any rate or tax levied' as appearing in section 40(a)(ii) and consequently, 'cess' whenever paid in relation to business, is allowable as deductible expenditure. Following the aforesaid decision, we uphold the claim of the assessee for deduction of the aforesaid sum.

In the result, appeal by the assessee is partly allowed.