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Income Tax Appellate Tribunal, DELHI BENCHES : BENCH “I-2” : NEW DELHI
Before: SRI R.K.PANDA & SMT. BEENA A PILLAI
ORDER PER BEENA A PILLAI, JUDICIAL MEMBER
Present appeal has been filed by assessee against final assessment order dated 21/11/2013 passed by Ld. ITO, Ward 11(1), New Delhi for assessment year 2009-10 on following grounds of appeal: “1. The assessment order passed by the Learned Assessing Officer (‘Ld. AO’) pursuant to the directions of Learned Dispute Resolution Panel (‘Ld. DRP’) is bad in facts and law.
2. The Ld. AO (following the directions of the Ld. DRP), erred both (Element K India Pvt. Ltd.) on facts and in law in confirming the addition of Rs. 18,118,716 to the income of the appellant proposed by the Transfer Pricing Officer (‘Ld. TPO’) by holding that the related party international transactions pertaining to provision of content development support services do not satisfy the arm’s length principle envisaged under the Income-tax Act, 1961 ('the Act').
3. In doing so, the Ld. DRP and the Ld. AO has grossly erred in agreeing with and upholding the Ld. TPO’s action of disregarding the arm’s length price (‘ALP’), as determined by the appellant in the Transfer Pricing (‘TP’) documentation maintained by it in terms of section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 (‘Rules’) as well as fresh comparables study submitted in course of assessment proceedings; and in particular modifying and rejecting the economic analysis and benchmarking analysis undertaken by the appellant through: 3.1 disregarding the fact that appellant is engaged in content development services and only selecting software development service providers as comparables without providing any cogent reasoning thereof; 3.2 Exclusion of companies whose data for FY 2008-09 was not available; 3.3 Exclusion of companies having different financial year ending (i.e. not March 31,2009); 3.4 Exclusion of companies having service income to sales less than 75% (as against other operating to sales less than 50% applied by the appellant);
(Element K India Pvt. Ltd.) 3.5 Exclusion of companies with export sales that are less than 25% of their total revenue; 3.6 Exclusion of companies with diminishing revenues/ persistent losses for last three years upto and including FY 2008-09; 3.7 Adopting employee cost/ revenues filter greater than 25% of their total revenues as a search criteria for evaluating comparables; 3.8 Applying sales filter of Rs. 5 crore for selecting comparable companies, thereby rejecting the turnover filter of Rs. 1 crore, applied by Assessee; 3.9 Ignoring the appellant's approach and plea of rejecting companies with negative net worth; 3.10 Ignoring the appellant's approach and plea of rejecting companies having research & development costs to sales more than 3%; 3.11 Ignoring the appellant's approach and plea of rejecting companies having advertising, marketing and distribution costs to sales more than 3%; 3.12 Including companies having high margin / volatile operating profit margins in the final comparables’ set for benchmarking a low risk captive unit such as the appellant; 3.13 Including certain companies that are not comparable to the appellant in terms of functions performed, assets employed and risks assumed; 4. The Ld. AO (following the directions of the Ld. DRP), erred in (Element K India Pvt. Ltd.) ignoring the fact that the appellant is entitled to tax holiday under section 10A of the Act on its profits and whereas its Associated Enterprise (AE) is subject to normal taxes in USA, therefore it would not have any untoward motive of deriving a tax advantage by manipulating transfer prices of its international transactions; 5. The Ld. AO (following the directions of the Ld. DRP), erred in excluding certain cost such as provision for doubtful debts from the cost base in computation of mark-up of certain comparable companies; 6. The Ld. AO (following the directions of the Ld. DRP), erred in not verifying the factual errors in computation of the operating margins of the comparables.
7. The Ld. AO has grossly erred by initiating penalty under sections 271(i)(c) of the Act mechanically and without recording any satisfaction for its initiation.
8. That the Ld. AO erred on facts and in law in charging interest under sections 234B of the Act; The above grounds are without prejudice to each other.”
Brief Facts of the case are as under: 2. Original return of Income for year under consideration was filed by assessee on 29/09/2009 declaring total income of Rs.Nil. Return was processed u/s 143(1) of the Income Tax Act, 1961 (the Act) and case was selected for scrutiny. Representatives of assessee attended hearings from time to time and case was discussed.
(Element K India Pvt. Ltd.) 3. Ld.AO observed that for year under consideration, assessee entered into international transactions, value of which was more than Rs.15 crores. Ld.AO with approval of Ld. CIT, Delhi-IV, New Delhi referred the case to Transfer Pricing Officer.
Ld.TPO observed that Element K India Pvt. Ltd. (‘assessee’ or ‘EK India’) is wholly owned subsidiary of Element K Corporation, USA (‘EK USA’). It was observed that assessee provides content design and development support services for online courseware under Service Agreement entered with EK USA (an associated enterprise “AE”). Assessee was remunerated on cost plus mark-up basis for services rendered. Based on functional analysis in TP study for AY 2009-10, assessee characterized itself as low risk captive service provider. Ld.TPO observed that for year under consideration, assessee was entitled to avail benefits under section 10A of the Act, and made necessary statutory filings with Software Technology Park of India (‘STPI’) in this regard. Ld.TPO observed that assessee entered into following international transactions with its AEs: S.N Particul Amount of Methodolog Outcome TP o. ars the y used of the Adjustmen transactio Transfer t Amount n (in INR) Pricing (in INR) (‘TP’) order / DRP Direction s 1 Provisio 16,04,44, Transaction Adjustme 1,81,18,71 n of 535/- al Net nt 6/- in the contract Margin TP Order content Method [Please
(Element K India Pvt. Ltd.) / online (“TNMM”) refer to TP coursew Order Page are 177 of the develop merit ment appeal set] services & 1,81,18,71 6 after DRP Directions [Please refer Final AO order on page 6 of the merit appeal set]
For benchmarking international transaction of ‘Provision of contract content/ online courseware development services’, assessee selected TNMM as Most Appropriate Method by applying OP/TC as PLI. Assessee selected following 5 comparables having average margin of OP/TC at 9.61% as against assessee’s margin of 14.98 %. Accordingly transaction was held to be at arm’s length price by assessee. S. No. Company Name Average Operating Margin (OP/TC) 1 Datamatics -6.91% 2 Isoft Technologies Ltd. 17.72% 3 Tutis Technologies Ltd. 11.95% 4 Shree Tulsi Online.Com Ltd. 15.98% 5 SQL Star International Ltd. (E-governance 9.31% segment) Average 9.61%
Dissatisfied with Assessee’s search results of comparables Ld.TPO adopted fresh search and selected following 8
(Element K India Pvt. Ltd.) comparables having average margin at 25.71% using OP/OC as PLI. Sl.No. Comparable’s name OP/OC 1. Bodhtree Consulting Ltd. 68.63 2. Comp-U-Learn Tech India Ltd. 28.00 3. Sasken Communication 15.99 Technologies Ltd. 4. Sonata Software Ltd. 32.73 5. Akshay Software Technologies Ltd. 12.41 6. L G S Global Ltd. 21.26 7. Evoke Technoloiges Ltd. 20.68 8. Mindtree Ltd. (Seg.) 5.98 AVERAGE 25.71% Ld.TPO thus made adjustment of Rs.1,81,18,716.
Aggrieved by order of Ld. TPO, assessee preferred objections before Ld.DRP. Apart from objecting for comparables selected/rejected by Ld.TPO before DRP, assessee raised objections regarding computation errors in final TP adjustment that had crept in margins computed in case of assessee as well as two comparables selected by Ld.TPO. It has been submitted that despite objections, DRP upheld approach of Ld.TPO and issued directions to Ld.A.O.
Ld. AO passed impugned final assessment order as per directions of DRP.
Aggrieved by adjustment made by Ld. TPO, on the basis of comparables disputed by assessee as well as tcomputational (Element K India Pvt. Ltd.) errors, which was disregarded, assessee is in appeal before us now.
At the outset Ld.Counsel submitted that apart from assessee’s detailed contentions against the adjustment and selection/rejection of comparables, he highlighted certain errors in computation of adjustment. Ld.Counsel submitted that there are certain factual errors in computation of operating profit of assessee by Ld. TPO. It was submitted that while computing adjustment, Ld.TPO treated penalty charges paid to RBI amounting to Rs.25 lacs and loss on sale of fixed assets of Rs.6,811/-, as a part of operating cost, and accordingly mark- up was charged on total cost of Rs.14,20,43,792/- instead of Rs.13,95,36,981/-.
Particulars Computations as per the Ld. TPO Correct computations as per the Appellant Operating Cost INR 14,20,43,792 INR 13,95,36,981 (‘OC’) Arm’s Length 25.71% 25.71% Margin (as determined by the Ld. AO/TPO) Arm’s Length INR 17,85,63,251 INR 17,54,11,939 Price (25.71% of the OC)
Further Ld.Counsel submitted that final TP adjustment of Rs.1,81,18,716/- has been computed on wrong operating cost base of Rs.14,20,43,742/- instead of Rs.13,95,36,981/-.
(Element K India Pvt. Ltd.) Ld.Counsel submitted that certain factual errors have crept in while computing operating margin of certain comparables selected by Ld.TPO. The comparable specific factual errors submitted by Ld.Counsel are as under: S. No. Company Name Appellant’s Contentions/Disposition against the factual/ computation errors • The Correct OP/TC margin of 1. Sasken Communications Technologies Ltd. (Seg) the company is 15.87% instead of 15.99% as computed by Ld. AO/TPO on account of treatment of provision for doubtful debts as non-operating in nature. • The correct OP/TC margin of 2. Sonata Software Ltd. the company is 30.77% instead of 32.73% as computed by Ld. AO/TPO on account of treatment of decrease in stock as non- operating in nature.
It was submitted that after incorporating correct operating margins of above companies, the revised / correct mean of OP/TC of comparables works out to 25.45%.
Ld. Counsel thereafter submitted that comparables selected by Ld. TPO does not satisfy certain filters like some companies are with abnormally high margin and high turnover.
(Element K India Pvt. Ltd.) Ld.Counsel submitted that as computation of adjustment is being set aside back to Ld.AO, the comparability analysis of comparables selected by assessee/Ld.TPO may also be set aside.
Ld. DR did not object to request advanced by Ld.Counsel as there are computational errors which is apparent from record.
We have perused the submissions advanced by both the sides in the light of the records placed before us.
The grounds raised by assessee are basically in respect of acceptance and/or rejection of comparables selected by Ld.AO/TPO. However considering computational errors pointed out by Ld. Counsel, we are of considered opinion that Ld.TPO shall verify the items alleged to have been wrongly included in computing operational expenses in case of assessee.
As regards computation of wrong margin of Sasken Communication Technologies Ltd (Seg.) and Sonata software Ltd., we are inclined to set aside all comparables finally selected by Ld. TPO/AO in terms of FAR analysis of assessee. Ld. AO shall decide comparability of comparables on the basis of functions performed by these companies, risks assumed and assets owned by the comparables vis-a-vis that of assessee. Ld.TPO/AO shall verify
(Element K India Pvt. Ltd.) computation of margins and grant relief to assessee as per law.
Needless to say that assessee shall be granted proper opportunity to represent its case.
Accordingly all the grounds raised by the assessee stands allowed for statistical purposes.
In the result appeal filed by assessee stands allowed for statistical purposes.
Order pronounced in the Open Court on 06th September, 2018.