BAIN CAPABILITY CENTRE INDIA PVT. LTD.,GURGAON vs. DCIT, GURGAON

final assessment order passed u/s 143(3) r/w section 144C of the Income Tax Act, 1961 (hereinafter referred to as "the Act") passed subsequent to the directions of the Hon’ble Dispute Resolution Panel - 1, New Delhi for assessment year 2012-13.

2.0 Brief facts of the case are that the assessee is a 99.99% subsidiary of Bain USA. The assessee company was set up in the year 2006 and during the year under consideration, the assessee was engaged in the following two segments:- i) Provision of IT-enabled back-office services (ITeS Segment)

Under this segment, the assessee provides Information

Technology enabled back-office services such as industry, company and financial analysis which comprise business information, data gathering, analysis and delivery etc. to Bain USA’s global operations through customized remote research and information support services. ii) Software development services – Under this segment the assessee provides contract research development services to BAIN USA for internal uses.

2.1 The return of income was filed declaring income of Rs. 7,75,29,795/- which was initially processed u/s 143(1) of the Act and was later selected for scrutiny. A reference u/s 92CA(1) of the Act was made to the Transfer Pricing Officer (TPO) for determining the Arm’s Length price (ALP) u/s 92CA(3) of the Act in respect of international transactions entered into by the assessee during the year under consideration. The TPO determined the adjustment/difference on account of ALP in respect of international transaction with Associated Enterprises (AE) in respect of ‘intra group services’ and ‘payment of royalty’ under ‘Provisions of IT enabled services at Rs. 2,49,28,004/- and ‘Receivables’ at Rs. 91,09,407/- respectively. As far as the software development segment of the assessee was concerned, the same was accepted by the department and no adjustment was proposed in the same.

2.2 Aggrieved, the assessee approached the Hon’ble DRP and filed its objections to the proposed adjustments. The Hon’ble DRP vide directions dated 16.11.2016 directed as under:- i) The Assessing Officer/TPO was directed to give an opportunity to the assessee to establish the arithmetical errors made and make necessary corrections. ii) The Assessing Officer/TPO was directed to compute working capital adjustments; iii) The Assessing Officer /TPO was directed to compute the adjustment using rate six months LIBOR plus 400 basis points and the period for which interest was to be calculated was to be limited to the year under consideration.

2.3 Subsequent to the directions of the Hon’ble DRP, the adjustment to the ALP was revised to Rs. 2,01,87,414/- as under:-

Assessment Year 2012-13 1. On account of ITES Rs. 1,86,38,499/-

2. On account of Receivables Rs. 15,48,913/- 2.4 The final assessment was completed at a total income of Rs. 9,77,17,210/-.

2.5 Now, the assessee has approached the ITAT and has raised the following grounds appeal:-

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

That the Learned Assessing Officer (‘Ld. AO’) erred in proposing to assess the income of the Assessee at Rs. 9,77,17,210/- as against the returned income declared by the Assessee at Rs. 1,15,29,195 by making an addition of Rs. 2,01,87,414(Rs. 1,86,38,499 for the transaction pertaining to provision of Information Technologies Enabled Services (‘ITES’) and Rs. 15,48,913 on account of interest on receivable outstanding) by holding that the Assessee’s international transaction does not satisfy the arm’s length principle envisaged under the Act.

1. The Ld. AO/ Hon’ble DRP erred on facts and in law in enhancing the income of the Assessee by Rs. 1,86,38,499 by holding that the Assessee’s international transaction pertaining to provision of ITES does not satisfy the arm’s length principle envisaged under the Act and in doing so, have grossly erred in: 2.1 disregarding multiple year/ prior years’ data as used by the Assessee in the TP documentation and holding that current year (i.e. FY 2011-12) data for comparable companies should be used despite the fact that the same was not necessarily available to the Assessee at the time of preparing its TP documentation; 2.2 rejecting comparability analysis in the TP documentation and in conducting a fresh comparability analysis based on application of the additional/ revised

filters in determining the Arm’s Length Price and while doing so, erred in: 2.2.1 rejecting companies whose accounting year does not end with March 31, 2012 on the basis that the transactions taking place in a different period cannot be compared; 2.2.2 rejecting companies having sales turnover from ITeS segment is less than 5 crore; 2.2.3 rejecting companies having export sales less than equal to 75% of the sales from ITES thereby modifying the Assessee’s filter of rejecting companies whose export sales is less than equal to 25%; 2.2.4 erroneously including functionally different and high profit making entrepreneurial companies in the final comparables’ set for benchmarking the IT enabled services segment (a low risk captive unit) of the Assessee (disregarding judicial pronouncements on the issue) and thereby resorting to cherry picking of comparables with a prejudicial mind set for making an upward adjustment; 2.3 excluding certain comparable companies submitted by the Appellant on arbitrary grounds even though they are comparable to the Appellant in terms of functions performed, assets employed and risks assumed; 2. The Ld. AO/ Hon’ble DRP ignored the business/ commercial reality that since the Assessee is remunerated on an arm’s length cost plus basis, i.e. it is compensated for all its operating costs plus a pre-agreed mark-up based on a benchmarking analysis, the Assessee undertakes minimal business risks as against comparable companies that are full-fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the Assessee on account of this fact.

3. The Ld. AO/ Hon’ble DRP erroneously imputed an interest of Rs. 15,48,913 for the receivables outstanding beyond 30 days and while doing so, has grossly erred in: 3.1 recharacterising the overdue receivables amount as deemed loan and that it constitutes as an international transaction separate from the main transaction; 3.2 Treatment of outstanding receivables from AEs as separate international transaction i.e. Unsecured loan; 3.3 not appreciating that in relation to the overdue receivables, the conduct of the Appellant with its AEs and non AEs was exactly the same; 3.4 not appreciating that the arm’s length price determination for outstanding receivables is subsumed within the arm’s length price determination of the principal international transaction itself; 3.5 not appreciating the fact that working capital adjustment adjusts the mark-up of comparable companies on account of variation in the working capital of the Assessee; and 3.6 determining an interest rate of LIBOR plus 400 basis points without giving regard to various factors responsible for determination of interest rate.

6. The Ld. AO has grossly erred in proposing to initiate penalty proceedings under section 271(1)(c) of the Act.

The above grounds are without prejudice to each other. The Appellant craves leave to add, amend, alter, delete, rescind, forgo or withdraw any of the above grounds of appeal either before or during the course of the proceedings before the Hon'ble Income Tax Appellate Tribunal in the interest of the natural justice. The aforesaid grounds are mutually exclusive and without prejudice to each other.”

3.0 The Ld. AR submitted that although the assessee is aggrieved with the inclusion/exclusion of several comparables, he will be arguing for the exclusion of Eclerx Services Limited and TCS E-Serve Ltd. and for inclusion of R Systems International Ltd. The arguments of the ld. AR in respect of the three comparables are as under:-

i) Delhi High Court in Pr. CIT vs Actis Global Services

Pvt. Ltd. In ITA No. 94/2017 ii) ITAT Delhi in Bechtel India Pvt. Ltd. Vs DCIT in ITA

1478/Del/2015 iii) ITAT Delhi in Equant Solutions India Pvt. Ltd. Vs DCIT in ITA No. 1202/Del/2015 3.1 It was further submitted that if TCS E-Serve is excluded from the list of comparables, the assessee would be at arm’s length and, as a consequence, the issue relating to inclusion/exclusion of R Systems International Ltd. and Eclerx Services Limited will become academic. It was further submitted that upper margin of arm’s length mark up after the exclusion of TCS E-Serve will work out at 24.85%.

The Ld. AR submitted that TCS E-Serve Ltd. was not a comparable as it followed an outsourcing model of business while the assessee was a captive service provider performing back office support functions. It was submitted that the two models are entirely different and have a significant impact on the FAR of the companies and, therefore, companies following the outsourcing model cannot be compared with the assessee who performs its own functions. The Ld. AR further submitted that the issue of comparability of Eclerx Services Limited to captive back office service providers is covered in favour of the assessee for the relevant assessment year by the order of the ITAT Delhi Bench in the case of B.C. Management Services Pvt. Ltd. vs DCIT (supra).

It was submitted that the facts in the instant case were similar to the facts in B.C. Management Services Pvt. Ltd. vs DCIT (supra) and hence Eclerx Services Limited should be excluded on this ground only. It was further submitted that Eclerx Services Limited was not comparable to the assessee because Eclerx Services Limited was a high-end KPO engaged in providing data analytics, data solutions, services etc. whereas the assessee is engaged in rendering IT enabled back-office support services in the nature of extraction of company snapshots/details, industry data and other market information from public databases and shares the same with its group companies for research. It was further submitted that that if Eclerx Services Limited was excluded from the list of comparables the assessee would be at arm’s length having an upper margin of 24.85% and as a consequence the issue relating to inclusion/exclusion of R Systems International Ltd. and TCS E-Serve Ltd. will become academic. It was further submitted that if both Eclerx Services Limited and TCS E-Serve Ltd. are excluded, the assessee would be at arm’s length as the margin of the assessee will be 18.9% while the margins of the comparables would be 16.18% and as a consequence, the issue relating to inclusion/exclusion of R Systems International Ltd. would become academic.

The Ld. AR submitted that R Systems International Ltd. has been excluded by the TPO as well as the Hon’ble DRP only for the reason that it had a separate year ending. It was submitted that the exclusion of a comparable on the ground of separate year ending has been set aside by the jurisdictional High Court in Mckinsey Knowledge Centre India Pvt. Ltd. in ITA 217/2014.

Reliance was also placed on the order of the ITAT Delhi Bench in the case of Mercer Consulting India Pvt. Ltd. in ITA No. 966/Del/2014. The Ld. AR submitted that the assessee had used the audited segmental financials of the comparable company available in the public domain and accordingly have computed its margin based on the quarterly results. It was submitted that in view of the factual as well as legal position, R Systems International Ltd. should be included as a comparable. Ld. AR also submitted that if only R Systems International Ltd. is included in the list of comparables, the assessee would be at arm’s length after getting the benefit of ± 5% band and as a consequence the issue relating to inclusion/exclusion of TCS E- Serve Ltd. and Eclerx Services Limited will become academic. It was submitted that then the upper margin of the assessee would be 24.85%.

3.2 On the second issue being challenged by the assessee pertaining to interest of Rs. 15,48,913/- for receivables outstanding beyond 30 days, the Ld. AR submitted that the interest component is embedded in the sale price and commercial considerations need to be appreciated and such compensation or charging of interest are commonly ignored by businesses. It was submitted that working capital adjustment takes into account the impact of outstanding receivables on the profitability and accordingly no separate adjustment is warranted on account of outstanding receivables. The Ld. AR submitted that the Assessing Officer/Hon’ble DRP were patently wrong in re- characterizing the overdue amounts as deemed loan. It was further submitted that the Delhi Bench of ITAT in the case of Kusum Healthcare Pvt. Ltd. in had held that if the impact of the credit period was duly factored in as “working capital adjustment” while determining the ALP, then no separate or further adjustment for interest on the receivables was warranted in the hands of the tested party. The Ld. AR further submitted that this order of the ITAT was upheld by the Hon’ble Delhi High Court vide order dated 25.4.2017 in ITA No. 765/2016 wherein the Hon’ble Delhi High Court has held that when the assessee has already factored in the impact of the receivables on the working capital and thereby on its pricing and profitability vis-à-vis that of the comparables, any further adjustment only on the basis of outstanding receivables would distort the picture and re-characterize the transactions. It was also submitted that the assessee is a debt free company where it has neither received any interest from its creditors nor paid any interest to any debtors, and, therefore, it could not inferred that the assessee had given any benefit to the AE by blocking its interest bearing funds by extending credit period to the AE. Reliance was also placed on another order of the ITAT Delhi Bench in the case of B.C.

Management Services Pvt. Ltd. vs DCIT (supra) wherein ITAT Delhi Bench had deleted transfer pricing adjustment made by the TPO by imputing interest on delay in receipt of payment.

4.0 In response, on the issue of exclusion of Eclerx Services Limited, Ld. CIT DR submitted that the outsourcing did not invalidate the functional profile and, therefore, the same should not be excluded. On exclusion of TCS, it was submitted that both the assessee company as well as TCS were service providers and neither does the turnover affect the profit level indicator (PLI) nor does the brand value change the functional profile. It was also submitted that intangible assets had relevance only in the case of public limited companies and not in the case of private limited companies and, therefore, this comparable was also a good comparable for the assessee company. On the issue of assessee’s plea for including R systems in the set of comparables, the Ld. CIT DR placed reliance on the observations of the TPO and submitted that when other comparables were available, then there was no justification introducing a new comparable.

4.1 On the second issue pertaining to receivables, the Ld. CIT DR submitted that adjustment has to be made irrespective of working capital adjustment. Ld. CIT DR also submitted that the Hon’ble DRP had duly considered the objections of the assessee in this regard and has given its directions thereafter. It was submitted that that working capital adjustment takes into account only trade creditors and not credits received towards capital items, loans etc. The Ld. CIT DR also read out from the relevant paragraphs as contained in the directions of the Hon’ble DRP and also submitted that ITAT Delhi Bench in the case of Ameriprise India P. Ltd. vs. ACIT reported in 2015-TII-347-ITAT- DEL-TP had held receivables do not have any impact on working capital adjustment in any manner. It was also submitted that the Hon’ble Delhi High Court in the case of CIT vs. Cotton Naturals India Pvt. Ltd. reported in 2015-TII-09-HC-DEL-TP had held that interest on receivables was a separate international transaction in terms of Explanation (i)(c) to Section 92B.

5.0 We have heard the rival submissions and have also perused the material on record. As far as the assessee’s plea for inclusion of R Systems International Limited is concerned, it is seen that the TPO/Hon’ble DRP had rejected this company on account of different financial year ending. However, the assessee has re-cast the profit and loss account of the company as per the quarterly audited results and has derived the updated operating margin.

The Hon'ble High Court has held in Mckinsey Knowledge Centre India Pvt. Ltd. in that if from the available data on record, the results for financial year can reasonably be extrapolated, then the comparable cannot be excluded solely on the ground that the comparables have different financial year endings. Therefore, we deem it appropriate to restore this comparable to the file of the TPO/Assessing Officer for verifying the computation, as recast by the assessee, and include this comparable in the final set of comparables.

5.1 As the Ld. AR has submitted that if R Systems was directed to be included in the final set of comparables, the assessee’s challenge against the inclusion of E Clerx Services Ltd and TCS E-serve Ltd would become academic in nature. Accordingly, as we have directed that R Systems be included in the final set of comparables, we dismiss as the assessee’s contentions challenging their inclusion as having become academic. We, however, note that the right of the assessee to challenge these comparables in succeeding assessment years, if it is so required, remains protected.

5.2 The second issue relates to treating the delay in receipt of payments from the AE to be in the nature of unsecured loan advanced to the AE and thereby charging interest. Before us, the main contention of the assessee is that since no interest has been charged on the delayed payment made by the third parties, therefore, no interest should be imputed in respect of receivables outstanding from the AE also. Apart from this, it has also been submitted that the assessee is a completely debt free company and, therefore, it cannot be held that its interest-bearing funds have been locked with the AE for a long period. The Ld. AR has also relied on the order of the Tribunal in the case of BC Management Services Ltd versus DCIT in and connected appeals wherein the Delhi Bench of the ITAT has, under identical circumstances, directed that the transfer pricing adjustment made by the TPO by imputing the interest on delay in receipt of payment be deleted. The relevant observations of the ITAT Delhi Bench in the aforesaid order are contained in paragraph 29 which reads as under –

“29. After considering the rival submissions and on perusal of the relevant material placed on record, we find that first of all, 16 the assessee is a debt free company as it has neither received any interest from any creditors nor paid interest to any debtor. A perusal of profit and loss account shows that interest and finance charges are only Rs. 73; and interest on corporate tax is Rs. 1,27,798/-. Apart from that there is no debt or loan with the assessee on which it has to pay any interest. Once it is an accepted fact that assessee does not have any interest bearing borrowed funds for extending any kind of loan to its AE, then it cannot be reckoned that assessee has given any benefit to the AE by blocking its interest-bearing funds to the AE by extending the credit period. This has been so held by this Tribunal in the case of Bechtel India Private Limited (supra). Moreover as pointed out by the Ld. Counsel, the assessee has also given similar credit period to the third parties which are extending up to 181 days. If a similar credit period is given to the AE as is given to third parties, then under the arms length scenario in looking into the similar conditions prevailing between controlled transaction and comparable uncontrolled transaction, then there cannot be any adjustment, because in a situation like this, there is a direct CUP to analyse such transaction. Accordingly, the transfer pricing adjustment as made by the TPO by imputing interest on delay in receipt of payment is uncalled for and on the facts of the present case and same is directed to be deleted.”

5.3 Similarly, the ITAT Delhi Bench in another case of Kusum Healthcare Private Limited versus ACIT, in has held as under –

“7.… An uncontrolled entity will expect to earn a market rate of return on its working capital investment independent of the functions it confirms or products it provides. However, the amount of capital required to support these functions varies greatly, because the level of inventories, debtors and creditors varies. High levels of working capital costs either in the form of incurred interest or in the form of opportunity costs. Working capital yields a return resulting from (a) higher sales price or (b) lower cost of goods sold which would have a 17 positive impact on the operational result. Higher sales prices acts as a return for the longer credit period granted to customers. Similarly in return for longer credit period granted, a firm should be willing to pay higher purchase price which adds to the cost of goods sold. Therefore, high levels accounts receivable and inventory tend to overstate the operating results while high levels of accounts payable tend to underestimate them thereby necessitating appropriate adjustment. The appropriate adjustments need to be considered to bring parity in the working capital investment of the assessee and the comparables rather than looking at the receivable independently. Such working capital adjustment takes into account the impact of outstanding receivables on the profitability.…

5.4 This order of the ITAT Delhi Bench in the case of Kusum Healthcare Private Limited (supra) was upheld by the Hon’ble Delhi High Court in the case of Principal Commissioner of Income Tax versus Kusum Healthcare Private Limited in ITA No. 765/2016.

5.5 The Ld. CIT DR was specifically asked by the Bench to point out to us if there was any distinguishable fact in the case of the assessee as compared to the facts in the cases of BC Management Services (P) Ltd (supra) and Kusum Health Care Pvt. Ltd (supra) with respect to the issue of interest on receivables. However, the Ld. CIT DR only placed reliance on the general principles of International Taxation and could not demonstrate with evidence that the case of the assessee was on a different footing as compared to the facts in the cases of BC Management Services (P)

Ltd (supra) and Kusum Health Care Pvt. Ltd (supra). Therefore, after considering the rival submissions and also the relevant material, we find force in the contention of the assessee that since the assessee is a debt free company and since it has neither received any interest from its creditors nor paid any interest to any of its debtors, it cannot be inferred that interest-bearing borrowed funds were utilised for extending any kind of loan to its AE and it cannot be reckoned that assessee has given any benefit to the AE by blocking its interest-bearing funds to the AE by extending the credit period. Accordingly, the transfer pricing adjustment, as made by the TPO, by imputing the interest on delay in receipt of payment is uncalled for on the facts of the present case and we direct that the same to be deleted.