DCIT, NEW DELHI vs. M/S. EXL SERVICE COM INDIA PVT. LTD., NEW DELHI

This appeal has been preferred by the department against the final assessment order passed u/s 144C of the Income Tax C.O. No. 165/D/2014 Act, 1961 (hereinafter referred to as "the Act") read with 143(3) passed subsequent to the directions of the Ld. Dispute Resolution Panel (DRP) for assessment year 2009-10. The Cross Objection (CO) has been preferred by the assessee.

The return was subsequently revised declaring a total income of Rs. 19,89,23,287/-. The international transaction entered into by the assessee pertained to provision of IT enabled services. The assessee had selected TNMM for computation of Arm’s Length Price (ALP) and the ALP computed by the taxpayer was Rs. 50,96,699,481/-. In respect of these services, the assessee had selected seven comparables whose average margin was 19.24% as against the assessee’s margin of 15%. Since the margin fell within ±5% range, the assessee was of the view that the transaction was at arm’s length. C.O. No. 165/D/2014 2.1 A reference was made to the Transfer Pricing Officer (TPO) who did not agree with the various filters used by the assessee for the transfer pricing study and he used certain more filters and required the assessee to submit the comparables on the basis of new filters. The assessee selected a set of 14 comparables and the TPO, out of the fourteen, accepted nine comparables. The TPO also included two more comparables out of the accepted/rejected matrix. Thus, the TPO selected a final set of 11 comparables whose average margin was 22.26% as against the assessee’s margin of 7.14%. The TPO proposed the adjustment of Rs. 72,36,07,916/- to the income of the assessee.

Apart from this, the Assessing Officer also made a disallowance of Rs. 16,58,079/- u/s 14A of the Act. The Assessing Officer also made an addition of Rs. 2,60,20,875/- with respect to income of BPRS on the ground that the assessee had failed to take this income in the final computation of income.

2.2 Aggrieved, the assessee approached the Ld. DRP and raised its objections. Ld. DRP directed that the adjustment relating to transfer pricing was to be deleted. Ld. DRP also directed deletion of addition with respect to income from BPRS. However, the Ld. C.O. No. 165/D/2014 DRP upheld the disallowance u/s 14A to the tune of Rs. 14,34,861/-.

2.3 Now, the department is in appeal before the ITAT and has challenged the action of the Ld. DRP in deleting the addition of Rs. 72,36,07,916/- being transfer pricing adjustment. The grounds raised by the department are as under:-

“On the facts and the circumstances of the case and in law, Hon'ble DRP has erred in deleting the addition of Rs. 72,36,07,916/- being adjustment on account of Arm's length price by directing to remove one comparable case of M/s Genesys International Ltd. from the final list of comparables on the ground of functional differences, without appreciating the fact that this comparable was selected by assessee itself in its Transfer Pricing Documents.”

2.4 The assessee has preferred cross objection and is challenging the upholding of disallowance u/s 14A of the Income Tax Act, 1961 (hereinafter referred to as "the Act"). The grounds raised by the assessee in the C.O. are as under:-

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

2. the Ld. AO./ Ld. TPO erred in following an inconsistent and erroneous approach while allowing adjustment on account of differences in working capital in the case of certain comparables;

4. The Ld. DRP erred in confirming the Ld. AO/ Ld. TPO’s approach of determining the arm’s length price (‘ALP’) of the international transactions pertaining to provision of Information Technology (‘IT’) enabled services. In doing so, the Ld. DRP has grossly erred in:

4.1 disregarding the ALP as determined by the Respondent in the 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 search and in particular modifying/ rejecting the filters applied by the Respondent; 4.2 agreeing with the Ld. TPO’s action of holding that only current year (i.e FY 2008- 09) data for comparable companies should be used for comparability analysis despite the fact that the same was not necessarily available to the Respondent at the time of preparing its TP documentation; 4.3 not appropriately considering the functions, assets and risk profile of the companies used for comparison with the Respondent, thereby including in the final comparable set certain companies with completely different functional profile; ITA No. 2559/D/2014 C.O. No. 165/D/2014

4.4 agreeing with the Ld. TPO’s action of resorting to arbitrary rejection of low-profit/ loss making companies based on erroneous and inconsistent reasons;

4.5 upholding exclusion of certain companies considered by the Respondent in its TP documentation/ fresh search on arbitrary/ frivolous grounds even though they are comparable to the Respondent in terms of functions performed, assets employed and risks assumed;

4.6 erroneously retaining companies having abnormal margins/ volatile operating margins in the final comparables’ set, that signify high element of entrepreneurial risk as opposed to the Respondent who is a captive service provider bearing limited risk;

4.7 upholding the contradictory approach followed by the Ld. TPO in considering companies demonstrating supernormal growth/ profit while rejecting companies with persistent losses;

4.8 denying the adjustment on account of differences in the risk profile of the Respondent and the comparables;

4.9 not appreciating the fact that in the relevant assessment year the Respondent was entitled to a tax holiday on its profits from provision of IT enabled services and therefore did not have any motive of deriving any tax advantage by manipulating the transfer prices of its international related party transactions; without prejudice to the above, not appreciating 4.10 that in the instant case the profits already booked by the Respondent at consolidated level (including its subsidiaries in India) are in effect more than loss earned by the Associated Enterprises (‘AEs’) and any adjustment would lead to an increase in losses on a worldwide basis;

6. The Ld. DRP /AO has erred in law and on the facts and circumstances of the case by ignoring detailed submission filed by the Respondent and making an addition of Rs. 14,34,861, being 0.5% of the average investment, per provisions of section 14A of the Act read with rule 8D of the Rules.

6.1 The Ld. AO has erred in law and on the facts and circumstances of the case while mentioning that the Respondent has not kept separate books of accounts in respect of expenditure incurred for earning the exempt income; although there is no requirement as such in the Act for the same.

6.2 The Ld. DRP / AO has erred in law' and on the facts and circumstances of the case in ignoring the fact that substantial dividend income is earned from investment in subsidiaries for which no funds has been borrowed by the company and further no management or administration cost is incurred to monitor the same.

6.3 Without prejudice to the above, the Ld. AO has erred in disregarding the fact that the disallowance of Rs 14,34,861 pertains to the STPI / EOU units of the Respondent and addition made to the income of the Respondent of Rs. 14,34,861 should be entitled for enhanced deduction under Section 10A /1OB of the Act.

7. The Ld. AO has erred in law and on the facts and circumstances of the case in adding notional expenditure of Rs. 14,34,861 per provisions of section 14A of the Act while calculating book profit per section 115JB of the Act and the DRP failed to give directions to the Ld. AO in this regard. 8. the Ld. AO has erred in law and on the facts of the case by charging and computing interest under section 234B, 234C and 234D of the Income tax Act, 1961. 9. the Ld. AO has grossly erred by initiating penalty under section 271 (1 )(C) of the Act mechanically and without recording any satisfaction for its initiation. 7 ITA No. 2559/D/2014 C.O. No. 165/D/2014

The Respondent craves leave to add, amend, alter, delete, rescind, forgo or withdraw any of the above grounds of cross-objections either before or during the hearing before the Hon’ble Tribunal.

The aforesaid cross-objections are mutually exclusive and without prejudice to each other.” 3. The Ld. CIT DR submitted that the department was challenging exclusion of one comparable i.e. Genesys International Corporation Ltd. by the Ld. DRP. The Ld. CIT DR submitted that from the profile of the assessee, it was evident that the assessee was also an IT enabled service provider company. It was further submitted that this company was selected as a comparable initially by the assessee itself and, subsequently, the assessee had pleaded for exclusion of this comparable. It was also submitted that the assessee had not objected to inclusion of this company before the TPO as this company fell squarely within the parameters/filters being applied by the TPO and now the assessee should not be allowed to plead exclusion of this company. It was also submitted that there cannot be an exact replica of a comparable under the TNMM and what was required under the statute was a general comparability.

Reliance was placed on the findings of the TPO in this regard.

ITA No. 2559/D/2014 C.O. No. 165/D/2014

Our attention was drawn to the annual report of this company wherein these activities had been enumerated. It was further submitted that the assessee, on the other hand, is engaged in providing back office IT enabled services to its AE and is also engaged in rendering transaction processing services, internet, consulting and voice based customer care services and, therefore, Genesys cannot be cannot be taken as a comparable to the assessee company. It was also submitted that Genesys was engaged in doing pioneering research in the area of image intelligence and recognition, mobile mapping as well as LIDAR whereas the assessee was not involved in any research and development activity. The Ld. AR also submitted that Genesys operated as a full-fledged risk taking entrepreneur whereas the assessee was a limited risk provider as it rendered services to the customers of the Exl group only and is assured of a specified C.O. No. 165/D/2014 return on its costs. The Ld. AR also submitted that Genesys had a super normal growth of 77% in terms of total income by sales and 107% in terms of net profit with respect to the preceding assessment year which was evident from the annual report whereas the assessee had only a normal year of operation. It was further submitted that Genesys had significant intangibles in the form of computer software and GIS data base which was evident from the annual report whereas the assessee did not own any significant intangibles and placed leverage only on the valuable intellectual property rights owned by the holding company. It was also submitted that Genesys staff consisted of specialized personnel including rocket scientists whereas the assessee did not have specialized skill task force. The Ld. AR also submitted that this company was not included as a comparable in the subsequent assessment year 2010-11. It was submitted that this comparable had been rightly excluded by the Ld. DRP.

5. Coming to the assessee’s C.O. challenging the upholding of disallowance u/s 14A of the Act, it was submitted that during the relevant assessment year, the assessee had earned dividend income of Rs. 32,61,15,948/- from investments held in the mutual funds and subsidiary and the same had been claimed as C.O. No. 165/D/2014 exempt u/s 10(35)/10(34) of the Act. It was further submitted that the assessee had not incurred any expenditure in relation to the earning of this exempt income. It was further submitted that investment made in mutual funds like ICICI Prudential Institutional Liquid Plan and Birla Sunlife Cash Plus Institutional Plan handed out dividends on a daily basis and since these were dividend plans, the amount of dividend was automatically reinvested in the same mutual funds and hence no expense can be said to have been incurred for earning dividend income. It was also submitted that the provision of Section 14A read with Rule 8D of the Income Tax Rules, 1962 was arbitrarily invoked as the provision requires incurrence of expenditure having a proximate nexus with the income earned and not some notional expenditure for the purpose of disallowance. It was also submitted that the disallowance made u/s 14A had been made in a mechanical manner by applying the formula without bringing out any actual incurrence of expenditure. It was further submitted that the assessee had incurred an expenditure of Rs. 1,049,687/- by way of interest on loan taken from M/s Orix Auto Infrastructure Services Limited which was specifically taken for the purpose of financing the vehicles and, therefore, the ITA No. 2559/D/2014 C.O. No. 165/D/2014 disallowance with respect to this interest under Rule 8D(2)(ii) could not be invoked. It was also submitted that the long term investments of the assessee were in the wholly owned subsidiaries which were old investments existing from earlier years and, therefore, disallowance could not be made in respect of these investments also. It was also submitted that the Ld. DRP had deleted a similar disallowance in assessee’s own case for assessment year 2006-07 and 2007-08 and the issue had been restored to the file of the TPO/Assessing Officer for fresh adjudication by the ITAT in assessment year 2010-11.

5.1 It was also submitted that deduction u/s 10A/10B of the Act should be allowed on recomputed profits and gains from business and profession if disallowance u/s 14A is upheld.

5.2 The Ld. AR also submitted that in the final assessment order, the Assessing Officer, while computing book profits u/s 115JB of the Act, had made an adjustment of Rs. 14,34,861/- computed u/s 14A of the Act which was not legally tenable.

Reliance was placed on the judgment of the Hon’ble Delhi High Court in the case of Pr. CIT vs. Bhushan Steel Ltd. in dated 29.09.2015 wherein the Hon’ble Delhi High ITA No. 2559/D/2014 C.O. No. 165/D/2014 Court had held that disallowance u/s 14A r/w Rule 8D cannot be added while computing book profits u/s 115JB of the Act.

5.3 Ld. AR also submitted that in case the department’s ground challenging exclusion of Genesys International Corporation Ltd. was dismissed, ground nos. 1 to 5 of the assessee’s C.O. will become academic in nature and need not be adjudicated upon.

7.1 We also note that Genesys is engaged in doing pioneering research in the area of image intelligence and recognition, mobile mapping as well as LIDAR whereas the assessee is not involved in any research and development activity and, therefore, this company cannot be considered a comparable on this account also.

7.2 We further note that Genesys operates as a full-fledged risk taking entrepreneur whereas the assessee is a limited risk provider as it renders services to the customers of the Exl group only and is assured of a specified return on its costs. The comparability fails on this count also. Further, from the Annual Report, it is also seen that Genesys has significant intangibles in the form of computer software and GIS data base whereas the assessee does not own any significant intangibles and banks only on the valuable intellectual property rights owned by the holding company. Therefore, the comparability cannot be made for this reason also. We also note that this company was not included as a comparable in the subsequent assessment year 2010-11. C.O. No. 165/D/2014 7.3 Therefore, in view of our above observations we find no reason to interfere with the directions of the Ld. DRP in directing exclusion of this company from the final set of comparables and we uphold the same.

9.1 Ground Nos. 6, 7 and 8 challenge the disallowance u/s 14A of the Act and also the addition of disallowance u/s 14A while computing the book profit u/s 115JB of the Act. In the appeal before us it is not clear as to whether the AO has considered only the investment which yielded the exempt income or the entire investment made by the assessee while computing the disallowance. It has also been submitted that the assessee had incurred an expenditure of Rs. 1,049,687/- by way of interest on loan taken from M/s Orix Auto Infrastructure Services Limited which was specifically taken for the purpose of financing the C.O. No. 165/D/2014 vehicles and, therefore, the disallowance with respect to this interest under Rule 8D(2)(ii) could not be invoked. We find that this aspect has not been considered by the AO. It is also not clear as to whether the investment in shares of the subsidiary company was out of commercial expediency or for some other reason. Therefore, in absence of a clear finding by the AO, it is our considered opinion that this issue needs to be adjudicated afresh by the AO/TPO in accordance with law after providing due opportunity to the assessee. It is directed so accordingly.

9.2 As far as the assessee’s ground relating to the addition of disallowance u/s 14A to the book profits u/s 115JB is concerned, this issue is covered in favour of the assessee by the judgment of the Hon’ble Delhi High Court in the case of Pr. CIT vs. Bhushan Steel Ltd. (supra) wherein it was held that disallowance u/s 14A r/w Rule 8D cannot be added while computing book profits u/s 115JB of the Act. Respectfully following the same, we direct the AO/TPO to exclude the amount of disallowance made u/s 14A while computing the book profits u/s 115JB of the Act.

ITA No. 2559/D/2014 C.O. No. 165/D/2014

The order is pronounced in the open court on 18th June, 2018.