FIRSTSOURCE SOLUTIONS LTD,MUMBAI vs. ASST CIT CIR 11(4), MUMBAI

Brief facts are, the assessee an Indian company filed its return of income for the impugned assessment year on 1st February 2003, declaring nil income after set–off of brought forward loss. The Assessing Officer noticing that in the relevant previous year, the assessee has entered into international transactions with its Associated Enterprises (A.E) made a reference to the Transfer Pricing Officer (Transfer Pricing Officer) under section 92CA of the Income-tax Act, 1961 (for short "the Act") to determine the arm’s length price (ALP). As stated by the Transfer Pricing Officer, the assessee is in the business of providing Business Process Outsourcing (BPO) services to independent overseas customers. He has further stated in the process of providing such service the assessee uses the services of its A.E. in the area of marketing support services. From the audit report of the assessee, the Transfer Pricing Officer found that in the relevant previous year, assessee has earned revenue of ` 47,57,71,446, out of which an amount of ` 4,98,20,772, was paid to ICICI One Source, U.S., and ` 7,87,62,366, were paid to ICICI One Source, U.K. towards provisions of market support service. While the Transfer Pricing Officer accepted the rest of the international transactions, he picked–up payment of marketing support service fee to the A.Es, as noted above, to find out whether they were at arm’s length. After issuing a show cause notice to the assessee and examining assessee’s objections / submissions, the Transfer Pricing Officer proceeded to determine the arm's length price of the marketing support service fees paid to the A.Es by selecting transactional net margin method (TNMM) as the most appropriate method. In fact, in this respect, the Transfer Pricing Officer agreed with the most appropriate method selected by the assessee itself. However, rejecting the profit level indicator (PLI) of the assessee of operating profit / total cost the Transfer Pricing Officer held that in case of operating profit of marketing support service the PLI should be net margin divided by marketing cost. While doing so, the Transfer Pricing Officer observed that since the total marketing service fee paid by the assessee works out to 28% of the total cost and 27% of the sales, net margin as a percentage of total cost of sales will not be a correct indicator fo the pricing of the marketing service. By adopting the PLI of net margin divided by marketing cost, the Assessing Officer short listed two comparables and by applying the PLI of net margin to marketing cost to both the assessee and the comparables he worked out the average margin of comparables at 1.32% as against the margin of 0.22% worked out in the same manner for the assessee. Accordingly, he determined the arm's length price of the marketing cost at 2,18,54,135. The assessee having debited marketing cost of ` 12,96,17,674 in its books, the differential amount of ` 10,77,63,539 was proposed as adjustment under section 92CA of the Act. The Assessing Officer while completing the assessment added the transfer pricing adjustment proposed by the Transfer Pricing Officer. Being aggrieved of the addition made on account of transfer pricing adjustment, the assessee preferred appeal before the learned Commissioner (Appeals), inter–alia, on the ground of adoption of net margin / marketing cost as the PLI.

The learned Commissioner (Appeals) having not found merit in any of the grounds raised by the assessee upheld the transfer pricing adjustment made by the Transfer Pricing Officer. Notably, with regard to selection of net profit / marketing cost as PLI by the Transfer Pricing Officer, the learned Commissioner (Appeals) agreed with the reasoning of the Transfer Pricing Officer. Being aggrieved with the aforesaid decision of the learned Commissioner (Appeals), the assessee is in appeal before the Tribunal.

Though, in the memorandum of appeal the assessee has raised a number of grounds on transfer pricing issues (grounds no.1 to 11), however, Shri Ajit Jain, learned Authorised Representative appearing for the assessee submitted at the time of hearing that the only issue the assessee will be contesting is, adoption of net margin / marketing cost as PLI by the Transfer Pricing Officer. Learned Authorised Representative submitted, international transaction of the assessee that is required to be bench marked is payment of marketing cost to the A.Es. He submitted, since the transaction in question is that of cost, by adopting PLI of net margin / marketing cost the Transfer Pricing Officer has divided the net margin by value of international transaction itself. He submitted, as per the principle of transfer pricing, while determining the PLI if transaction to be bench marked is that of cost then the denominator should be revenue / sales. If transaction to be bench marked is revenue / sales then the denominator should be cost. He submitted, requirement of selecting the denominator in the aforesaid manner is for the reason is, while determining the arm's length price of the cost transaction if the cost is the part of denominator the results reflected by the PLI would not be correct. Similarly, while determining the arm's length price of the sales if the sale value is taken as the denominator the result should be flawed. To support his aforesaid contention, the learned Authorised Representative put emphasis on the following observations from the book “Transfer Pricing demystified” by Ms. Pallavi Denodia and Shri Pradeep Dinodia.

The learned Authorised Representative submitted, PLI adopted by the Transfer Pricing Officer by dividing the net margin by value of international transaction itself is patently wrong. He submitted, considering the fact that the international transaction under consideration is the marketing cost the appropriate PLI which can be adopted is net margin / operating revenue. In this context, the learned Authorised Representative drew our attention to the computation of margin of the assessee as well as comparables by applying the aforesaid PLI as per which the margin of the assessee works out to 5.90%, whereas, the arithmetic mean margin of the two comparables works out to 6.54% thereby suggesting that margin of the marketing cost paid by the assessee is at arm’s length requiring no further adjustment. The aforesaid working computing the margin by adopting the PLI of net margin / operating revenue are at Page–182 and 183 of the paper book.

Shri Jayant Kumar learned Departmental Representative, though, relied upon the observations of the Transfer Pricing Officer and learned Commissioner (Appeals), however, he submitted that assessee’s submissions with regard to the appropriate PLI to be adopted can be re–considered along with the working of arithmetic mean of comparables as submitted by the assessee by adopting the PLI of net margin / operating revenue.

We have heard rival submissions and perused material on record. At the outset, it is necessary to observe, the limited issue which is contested before us is what should be the appropriate PLI in the context of the international transaction entered into by the assessee with its A.E. involving payment of marketing service fees. It is a fact on record that both the assessee as well as the Transfer Pricing Officer have no quarrel that TNMM is the most appropriate method to determine the arm's length price of the marketing cost. Rule–10B of the Income–tax Rules provides the methodology of computing the arm's length price of international transaction under different prescribed methods. Rule–10B(1)(e) prescribes the methodology for computation of arm's length price of international transaction under TNMM. As per clause (i) of rule–10(B)(1)(e), the net profit margin realised by the enterprise from an international transaction with the A.E. is to be computed in relation to either cost incurred or sales effected or assets employed. PLI is a measure of company’s profitability that is used to compare comparables with the tested party. Thus, a PLI may express profitability in relation to sales or costs or assets. Thus, a reading of the aforesaid rule makes it clear that while the numerator in PLI under TNMM is always net profit margin the denominator can either be cost incurred or sales effected or assets employed or any other relevant base. The denominator varies from case to case depending upon nature of transaction and host of other relevant factors. In the present case, undisputedly, the arm's length price to be determined is that of the marketing cost paid by the assessee to A.Es. That being the case, the marketing cost, or, for that matter cost itself, cannot be considered as the denominator. Therefore, in principle we agree with the submissions of the learned Authorised Representative that the PLI of net margin (operating profit) / marketing cost adopted by the Transfer Pricing Officer will not be proper to determine the arm's length price. It is also pertinent to observe that the working of margin of assessee and comparables by adopting the PLI of net margin / operating revenue as submitted in the working at Page–182 and 183 of the paper book, though, formed part of the submissions made before the Transfer Pricing Officer on 15th February 2006, as it appears, he has not at all considered either the submissions of the assessee or the working of the margin of the assessee and comparables. Though, detail submissions have been made before the learned Commissioner (Appeals), he has also completely ignored them and simply adopted the reasoning of the Transfer Pricing Officer without any deliberation on the issue. In view of the aforesaid, we are inclined to restore the issue to the file of the Assessing Officer for deciding afresh after considering assessee’s claim of adopting the PLI of net margin / operating revenue and also examining working of margins submitted by the assessee at Page–182 and 183 of the paper book. The Assessing Officer shall decide the issue keeping in view our observations hereinabove and only after extending reasonable opportunity of being heard to the assessee. Grounds raised by the assessee are partly allowed for statistical purposes.

In ground no.12, the assessee has challenged the disallowance of employer’s contribution to provident fund and ESI.

Brief facts are, at the time of assessment proceedings, the Assessing Officer noticing that employer’s contribution towards provident fund and ESI for the month of March 2003, paid beyond the date prescribed as per Explanation to section 36(1)(va) disallowed the deduction claimed in respect of such payment.

The learned Commissioner (Appeals) also confirmed the disallowance alleging lack of details furnished by the assessee.

We have heard rival submissions and perused material on record. As could be seen, the Assessing Officer disallowed the payment made towards employer’s contribution to provident fund and ESI on the ground that such payments were made beyond the date prescribed under Explanation to section 36(1)(va). However, by virtue of the amendment made to section 43B of the Act employer’s contribution to provident fund / ESI is allowable as deduction if they are paid before the due date of return of income to be filed for the relevant assessment year. The Hon'ble Jurisdictional High Court has expressed such view in case of Hindustan Organics Ltd., 366 ITR 001. In view of the aforesaid, we direct the Assessing Officer to allow assessee’s claim of deduction in respect of employer’s contribution to provident fund and ESI if they have been made before the due date of filing of return of income for the impugned assessment year. This ground is allowed for statistical purpose.

In ground no.13, the assessee has challenged levy of interest under section 234B and 234D of the Act.

Considering the fact that this ground was not specifically argued at the time of hearing and also levy of interest being consequential, the Assessing Officer is directed to give consequential effect while re– computing the income in view of our decision as aforesaid.

In the result, assessee’s appeal is partly allowed for statistical purposes. Order pronounced in the open Court on 01.06.2018