HALDOR TOPSOE INDIA PVT. LTD.,NEW DELHI vs. DCIT, NEW DELHI

PER SUDHANSHU SRIVASTAVA, JM This appeal has been filed by the assessee against the order dated 31/01/2014 passed u/s 143(3) of the Income Tax Act, 1961 (the “Act”) read with section 144C of the Act pursuant to the order of the Hon’ble Dispute Resolution Panel-I, New Delhi vide order dated 20.12.2013 for assessment year 2009-10.

Refinery and Oil & Gas sector.

3.1 During the F.Y. 2008-09, the assessee got transfer pricing study done according to which the average margin of comparable companies was 10.20%. The actual margin of the assessee for 2 ASSESSMENT YEAR 2009-10 F.Y. 2008-09 was 12.99%. The assessee selected TNMM as the Most Appropriate Method to bench mark its international transaction namely engineering and technical assistance service.

The assessee had selected a set of nine comparables.

3.2 A reference was made to the TPO who did not agree with the assessee’s TP study. The Ld. TPO used certain filters and rejected assessee’s five comparables and introduced three new comparables. Thus, the Ld. TPO used a set of seven comparables in all (four from the assessee’s set and three new comparables) whose average margin was 23.44% and the addition proposed was Rs. 1,88,94,265/-. Aggrieved, the assessee approached the Hon’ble DRP and raised objections which were rejected and now the assessee is contesting the issues before the ITAT and challenging the inclusion of the following three companies to the list of comparable companies- Kirloskar Consultant Ltd (Margin

41.57%), Mitcon Consultancy Services Ltd (Margin 37.35%) and Mahindra Consultancy Engineers Ltd (Margin 22.24%). The assessee is also challenging the deletion of the following three companies selected by the assessee in the TP study- Chemtex

Gold Engineers Pvt. Ltd (Margin 1.32%), Simon India (Margin

6.52%) and Petron Engineering Consultants Ltd (Margin 6.89%).

ASSESSMENT YEAR 2009-10 The assessee is also challenging the assessee's claim regarding adjustment in margin due to different risk profile of comparable companies.

4.0 The Ld. AR submitted that three comparables included by the Ld. TPO were being challenged which were as under –

4.0.1 M/s. Kirloskar Consultants Ltd. (Kirloskar) – It was submitted that this comparable was added by the Ld. TPO to the list of comparable companies in view of his remarks appearing at internal pages 16 & 17 of his order, wherein the Ld. TPO has specifically stated that this company passed all the filters proposed by the TPO. The TPO's action was confirmed by Hon’ble DRP in Para 7.4 of its order (internal page 12-13). It was submitted that the Ld. TPO has applied a filter (Internal page 11) rejecting companies whose employee cost is less than 25% of engineering and technical services revenue. This has been upheld by DRP (Internal Pages 5-6). Now, in the case of Kirloskar, the employee cost is Rs. 1,48,25,884/-whereas consultancy fees is Rs. 8,53,10,642/- . Thus the employee cost is only 17.3% of the consultancy fees as against the filter of 25% adopted by Ld. TPO himself. It was submitted that it is evident from the facts that TPO grossly erred in including the case of ASSESSMENT YEAR 2009-10 Kirloskar in the list of comparable companies. It was further submitted that the profile of Kirloskar shows that it is functionally dissimilar from the assessee company. Kirloskar business continues in business development in Project

Management, Environment Engineering & Irrigation whereas the assessee operates in Fertilizer, Petro Chemical & Refinery & Oil

& Gas sectors. Further, without prejudice to the aforementioned submissions, it was further submitted that the income of Kirloskar is hugely bolstered by other income of Rs.

1,87,04,039/- and items No. 1-5 thereof aggregating to Rs.

1,86,09,786/- need to be ignored while working out consultancy profits of Kirloskar. The aforesaid other income works out to 18% of the total income of Kirloskar whereas the corresponding figure in the case of the assessee is only 0.64%. It was also submitted that the rent expenses in the case of Kirloskar are only 2.1% of the receipts whereas in the case of the assessee they are 23.3% and this without doubt shows functional dissimilarity between Kirloskar and the assessee. In this connection, reliance is placed on the decision of Hon'ble Delhi

High Court in Ramp Green Solutions Pvt. Ltd. V. CIT.

ASSESSMENT YEAR 2009-10 4.02 Mitcon Consultancy Pvt. Ltd. (Mitcon) – It was submitted that this comparable has been included by the Ld. TPO in the list of comparable companies in view of reasons recorded by him in his order (Internal page 17) and the Hon’ble DRP has confirmed the action of Ld. TPO vide Para 7.4 of its order (Internal page

12). It was submitted that on Internal page 3, the learned TPO has adopted the filter by which the companies whose revenue from engineering supplier services is less than 75% of the total operating revenue are excluded. This is also clear from their remarks of the TPO against the heading Mitcon in Para 3 of TPO's order (Internal page 4). It was submitted that a bare perusal of the Profit/Loss account of Mitcon will show that the percentage of consultancy fees operating income in the case of Mitcon is only 58.48% which is below the filter of 75% applied by the Ld. TPO. It is submitted that in view of this factual position, the TPO grossly erred in including the case of Mitcon in the list of comparable companies.It was further submitted that, without prejudice,Mitcon is functionally different from the assessee company. Mitcon provides corporate solutions in power, energy efficiency, renewable energy, climate change & environmental management sectors besides training courses & skill based ASSESSMENT YEAR 2009-10 training programmes and thus the sectors wherein Mitcon operates are totally different from the sectors in which the assessee operates. It was further submitted that the analysis to P&L A/c would show that the segmental profits in the consultancy business is only 8.3% as against 37.35% taken by the Ld. TPO.

4.03 Mahindra Consulting Engineers Ltd. (Mahindra) – It was submitted that this comparable has been included by the Ld. TPO in the list of comparable companies in view of the reasons recorded by him in his order (Internal page 17) and the Hon’ble DRP has confirmed the action of the TPO vide Para 7.4 of his order (Internal page 12). It was submitted that the business of Mahindra is functionally different from the assessee company and, therefore, TPO should not have included Mahindra in the list of comparable companies. A reference to paper book page 13 would show that Mahindra is providing consultancy in SEZ, industrial park and township, water and waste water, project managements, special projects, public private partnership and environment, transportation infrastructure, tourism infrastructure, social infrastructure etc. The industries in which consultancy is being provided by Mahindra are completely ASSESSMENT YEAR 2009-10 different from the industries in which the assessee is operating as the assessee is operating in Fertilizer, Petro-chemical, Refinery and Oil & Gas industries only. It was submitted that Mahindra cannot be taken as a functionally comparable company. Further a copy of the P&L A/c of Mahindra for the year ended 31.03.2009 and its Schedule J will show that there is substantial outsourcing in the case of Mahindra and, therefore, the business model of Mahindra is also different. In this connection, reliance is placed on the decision of Hon'ble ITAT Bangalore Bench-A in the case of 24/7 Customer.Com (P) Ltd. V. DCIT 28 taxmann.com 258 (Bang.). It was submitted that the Ld. TPO has erred in including the case of Mahindra in the list of comparable companies particularly in view of the decision of Hon'ble Delhi High Court in the case of Ramp Green Solutions Pvt. Ltd. V. CIT.

4.1.0 On the comparables excluded by the Ld. TPO, the Ld. AR submitted that the three comparables excluded by the Ld. TPO were being objected to as under – 4.1.1 Chemtex Gold Engineers (Pvt) Ltd. (Chemtex) – The Ld. AR submitted that the learned TPO has held that he would apply a filter according to which company whose engineering support service income is less than Rs. 5 crores need to be excluded. He ASSESSMENT YEAR 2009-10 has, therefore, excluded the case of Chemtex Gold Engineers Pvt. Ltd (Chemtex) by observing that "it is found that out of the total income of 41.75 crores, income from sales comprises Rs. 40.58 Crores, whereas income from services constitutes only 88 lakhs.

Therefore, the company does not qualify service income 5 Crores filter. Hence rejected" and rejecting the assessee’s submissions that the above observation was factually incorrect in view of Schedule 8 of the annual accounts of Chemtex according to which the service income of the company was Rs. 36.73 crores It was submitted that a bare perusal of Schedule 8 of the annual accounts of Chemtex will show that the Contract Revenue of Rs.40.58 Crores comprises of engineering service fees of Rs. 36.73 crores and Contract Revenue of Rs. 3.85 crores . It was submitted that it appears that the learned TPO has taken the figure from Prowess where detailed break - up of the figure of "Sales" amounting to Rs. 40.58 crores is not available. The figures are available in the Schedule 8 of the audited account of Chemtex. It was, submitted that the exclusion of the case of Chemtex from the list of comparable companies by the Ld. TPO is clearly erroneous and belies the facts.

ASSESSMENT YEAR 2009-10 4.1.2 Simon India Ltd. (Simon) – It was submitted that the learned TPO excluded the case of Simon India Ltd. (Simon) by observing that "The assessee contended that the TPO has incorrectly rejected the company on the ground that service income is less than 5 crores. The assessee argued that the gross receipts of the company are Rs. 142 crores towards supply and services. It relied on the fact that rendering of engineering services is the main business of the assessee therefore the income apportioned to this segment must be higher than 5 crores". The Ld. AR submitted that in coming to this conclusion, Ld. TPO rejected the following submissions of the assessee that "It is submitted that this observation is factually incorrect. The gross receipts of the company are Rs. 142 crores which includes substantial income towards services, which is evident from the profit and loss account which states that the receipt of Rs. 142 crore is towards supplies and services. It is submitted that it is not justifiable to say that since the company has not provided their segmental reporting, their service income out of total receipts of Rs. 142 crores is less than Rs. 5 crores, considering the fact that the main business of the company is to render engineering services. As mentioned on the company website (http)://www.simonindia.com/) SIL is a ASSESSMENT YEAR 2009-10 Global Engineering and-EPC Company". It was submitted that a copy of Form 23ACA in the case of Simon is placed in the Paper Book at pages 18-22 and a bare perusal of Page19 will show that whereas sale of goods trade is 8.8 crores, the supply of services (domestic & export) amounts to Rs. 142 crores. As such the finding of the Ld. TPO that the service income is less than Rs. 5 crores is factually incorrect.

4.1.3 Petron Engineering Consultants Ltd. (Petron) – It was submitted that this company has been excluded by the Ld. TPO by holding that "The assessee contended that the company is functionally similar as it operates on the fields like refinery, petrochemical & fertilizer plants, similar to assessee. However, on perusal of the Director's report it is observed that the company is into installation, construction and commissioning of projects.

Hence functionally different and rejected". It was submitted that a perusal of the profile of Petron would show that Petron is working in the same sector as the assessee i.e. in the field of refinery, petrochemical & fertilizer and, therefore, the learned

TPO was not justified in excluding the case of Petron from the list of comparable companies.

4.1.4 The Ld. AR submitted that even assuming for the sake of argument, though not conceding it, that the Ld. TPO was justified in excluding the case of Petron and including the case of Mahindra, the uncontroverted position which emerges regarding the comparable cases is as follows:-

SI. Comparable's Name OP/OC 1. Mukand Engineers Ltd. 14.97 2. Chemtex Gold Engineers 1.32 3. Simon India 6.52 4. Projects and 18.26 5. Mahindra Consulting 22.24 6. TCE Consulting 22.45 7. UB Engineers Ltd. 7.25 TOTAL 93.01 AVERAGE 13.29% 4.1.5 It was submitted that since the actual margin in the case of the assessee is 12.99%, Ld. TPO was not justified in making any addition.

ASSESSMENT YEAR 2009-10 4.2.1 Arguing on the ground relating to adjustment for risk profile, the Ld. AR submitted that in the submissions dated 04.01.2013 before the Ld. TPO (PB page 49) and in submissions before the Hon’ble DRP (PB pages 82-84), the assessee had submitted that it operates in a risk insulated environment since it operates on a cost - plus model and is compensated for all the costs borne by it. It was also submitted that the assessee being a 100% captive unit operates in risk free environment without incurring any marketing risk or any credit risk. It was also submitted that difference in risk profile of the assessee and the comparable companies are on account of the following factors: - a) Market risk b) Service liability risk c) Research & development risk d) Credit risk e) Manpower risk f) Technological obsolescence risk 4.2.2 The Ld. AR submitted that it was submitted before the Ld. TPO and the Hon’ble DRP that adjustment for difference in risk profile is called for and it was contended that "Although the actual risk adjustment may be much higher, it is submitted that an ASSESSMENT YEAR 2009-10 adjustment on account of a difference in risk profile may be derived by subtracting the risk-free bank rate from the prime lending rate. During the previous year relevant to assessment year 2009-10, such difference works out to appx. 5.50% (i.e. 12.25% less 6.75%)".

4.2.3 The Ld. AR submitted that the aforesaid claim of the assessee was disallowed by the Ld. TPO and the Hon’ble DRP did not allow any risk adjustment vide Para 8.3 (internal pages 15 &

16 of their order) by relying on Para 3.54 of the revised OECD guidelines of 2010 after observing that "From the above guidelines, it can be seen that unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustments, no adjustment can be allowed to the taxpayer. In the present case, except pointing out various risks, the taxpayer has not shown with evidence as to whether each of the risk was actually undertaken or not by the comparables and if so, how these risks affected each of them and whether such adjustment would improve the comparability". The Ld. AR submitted that this is factually incorrect in view of the fact that the assessee had filed a statement of bad debt of the ASSESSMENT YEAR 2009-10 comparable companies selected by the Ld. TPO placed in PB at Page 24 which indicates that the bad debts amounted to 1.19% of their turnover, a risk which was not faced by the assessee company. It was further submitted that the Hon’ble DRP has held that it was the onus of the taxpayer to show with the evidence as to whether each of the risk was actually undertaken or not by the comparables and if so how these risks effected each of that and where such adjustment would improve the incomparability. It was submitted that this onus placed by the Hon’ble DRP on the assessee is an onus which places impossibility on the shoulders of the assessee in as much as the assessee has no means to ascertain like risks actually undertaken by the various comparables. It was submitted that the Hon’ble DRP, thus, erred in law in placing the onus on the assessee in view of the celebrated maxim lex non legit impossibilia.

4.2.4 The Ld. AR further submitted that the reliance placed by Hon’ble DRP on the OECD guidelines is clearly misplaced in view of the observations in Para 37 of Hon'ble ITAT Delhi Bench-H contained in their decision dated 02.11.2007 in Mentor Graphics

(Noida) Pvt.Ltd. V. DCIT and that this issue is no longer res- 15 ASSESSMENT YEAR 2009-10 integra in view of Para 17 of the decision dated 15.01.2013 of Hon'ble ITAT Bench-A Hyderabad in DCIT V. Hellosoft India Pvt.

Ltd. where the facts are on all fours with the facts obtaining in the case of the assessee. Reliance was also placed on the following:-

Para 17.2 of the decision dated 28.06.2013 of Hon'ble i) ITAT Bench-B Hyderabad in HSBC Electronic Data Processing India Ltd. V. Addl. CIT . The observations of ITAT Bangalore Bench-B in Philips ii) Software Centre (P) Ltd. V. ACIT. Recent decision of Hon'ble ITAT Delhi Bench-I-2 in iii)

6.1.1 Kirloskar Consultants Ltd – It is the submission of the assessee that employee cost filter of 25% of the engineering and technical services revenue was applied by the Ld. TPO whereas in the case of Kirloskar, the employee cost was only 17.3%. It is also the argument of the Ld. authorised representative that this company was functionally dissimilar from the assessee company ASSESSMENT YEAR 2009-10 as Kirloskar was involved in project management, environmental engineering and irrigation whereas the assessee operated in fertiliser, petrochemicals, refinery, and oil and gas sectors. It is also contended by the assessee that Kirloskar has a huge amount of income from other sources which the assessee does not have and that this amount needs to be ignored while working out the consultancy profits of Kirloskar. We have perused the annual report of the Kirloskar company placed at page 7 of the paper book and we find that the employee cost in the case of the comparable is Rs. 14,825,884/- as against the consultancy fee of Rs. 85,310,642/-. Thus the employee cost works out to 17.378 % whereas the Ld. TPO has applied a filter of 25% but has included the same in the list of comparables. The Hon’ble DRP has upheld the application of the employee cost filter but the issue of error in calculation was not before the Hon’ble DRP. In such a circumstance, we deem it appropriate to restore this comparable to the file of the learner TPO/AO for reconsideration and direct that this comparable be excluded if the employee cost falls below 25% as demonstrated to us by the Ld. authorised representative.

We also direct that the assessee be afforded a proper opportunity of being heard on this issue.

ASSESSMENT YEAR 2009-10 6.1.2 Mitcon Consultancy Private Limited – The Ld. authorised representative has argued at length and has submitted that an analysis of the profit and loss account of this company will show that the percentage of consultancy fees in the case of this company is only 58.48% which was much below the filter of 75% applied by the Ld. TPO. On perusal of the profit and loss account, this contention of the assessee appears correct. However, it is seen that this issue was not raised before the Hon’ble DRP. In such a circumstance, we deem it fit to restore this comparable also to the file of the Ld. TPO/AO for re-examining the contention of the assessee regarding the error in calculation and direct him to exclude this comparable if the contention of the assessee is found correct. Due opportunity is to be given to the assessee to substantiate its claim.

6.1.3 Mahindra Consulting Engineers Ltd – In respect of this comparable, it is the contention of the assessee that the business of Mahindra was functionally different from that of the assessee company. A perusal of the profile of Mahindra Consulting Engineers placed at page 12 of the paper book shows that Mahindra is in the business of providing consultancy in SEZ, industrial park and township, water and wastewater, project ASSESSMENT YEAR 2009-10 management, special projects, public-private partnership and environment, transport infrastructure, tourism infrastructure, social infrastructure etc whereas the assessee is operating in the field of fertiliser, petrochemicals, refinery and oil and the gas industries only. However, it is our considered opinion that the comparable as well as the tested party, both, are providing services which are functionally similar and we find no reason for the exclusion on this ground. It is also the assessee’s contention that Mahindra has a substantial outsourcing which is not so in the case of the assessee company. The ITAT Bangalore Bench in the case of 24/7 Customer.com Private Limited versus DCIT in that where the assessee was carrying out its work by itself whereas in case of a comparable, it was outsourcing most of its work, the said company could not be a comparable. While we fully agree with the ratio laid down by the ITAT Bangalore Bench, we do find that the assessee could not substantiate its claim through evidences on this ground. However, we do feel that if such is the case, it would be inappropriate to include Mahindra in the list of comparables. Therefore, we deem it fit to restore this comparable also to the file of the Ld. TPO/AO with a direction ASSESSMENT YEAR 2009-10 that if the assessee is able to substantiate its claim that most of the work carried out by Mahindra Consulting Engineers Ltd was outsourced whereas the assessee had no or minimal outsourcing, this comparable be excluded. Needless to say, the assessee will be given due opportunity to present its case.

6.1.4 Thus, all the three comparables included by the Ld. TPO and upheld by the Hon’ble DRP are restored to the file of the Ld. TPO/AO for adjudication in terms of our directions contained in the preceding paragraphs. Thus, ground No. 1.1 (a) stands allowed for statistical purposes 6.2.0 As far as the assessee’s objections to exclusion of the three comparables are concerned, the same are being adjudicated as under – 6.2.1 Chemtex Gold Engineers (P) Ltd. – The Ld. authorised representative has submitted that the contract revenue in case of this comparable was Rs. 40.58 crores which comprises of engineering services fee of Rs. 36.73 crores and contract revenue of Rs. 3.85 crores. It is the submission of the Ld. AR that the Ld. TPO might have taken the figure from the software ‘Prowess’ where the detailed breakup of the sales figure of Rs. 40.58 crores was not available but the same was available in schedule 8 of the ASSESSMENT YEAR 2009-10 audited accounts of the comparable. It has been submitted that the service income of 5 crores filter was, therefore, wrongly applied. A perusal of page 65 of the paper book shows that the engineering service fees of Chemtex amounted to Rs. 367,304,215 during the year under consideration and thus it was above the 5 crore filter applied by the Ld. TPO. Thus, the observation of the Ld. TPO that the income from services constituted only Rs. 88 lakhs is incorrect and we deem it appropriate to direct that this comparable be included in the final set of comparables.

6.2.2 Simon India Ltd - This comparable was also excluded on the ground that it did not pass the service income of 5 crores filter. A perusal of pages 18 to 22 of the paper book shows that the value of goods traded by Simon India Ltd is 8.8 crores whereas the supply of services amounts to Rs. 142 crores. Thus, the finding of the Ld. TPO that the service income is less than 5 crores is factually incorrect and we have no hesitation in holding that this filter has been incorrectly applied. We, accordingly, direct that this company be also included in the final list of comparables.

ASSESSMENT YEAR 2009-10 6.2.3 Petron Engineering Consultants Ltd - It is the contention of the Ld. authorised representative that this company was functionally similar as it operated in fields like refinery, petrochemical and fertiliser plants similar to the assessee whereas the same has been excluded by the Ld. TPO on the ground that the company was into installation, construction and commissioning of projects. A perusal of the directors report, relied upon by the Ld. TPO and placed at page 16 of the paper book, shows that Petron is into fabrication, engineering, election, installation of plant, machinery and equipment for a number of business sectors in oil, gas and petrochemicals, power, cement, minerals and metals, chemicals and fertilisers etc. We are of the considered opinion that there is no functional dissimilarity between the tested party and the comparable as both of them are providing similar services although the sectors might be a little different and the Ld. TPO was wrong in excluding it. We direct the inclusion of this comparable in the final set of comparables.

6.2.4 In view of the above ground No. 1.1 (b) of the assessee’s appeal stands allowed in terms of our directions contained in the preceding paragraphs.

ASSESSMENT YEAR 2009-10 6.3 The next issue before us pertains to allowance of risk adjustment. The Hon’ble DRP, while rejecting the assessee’s claim for risk adjustment, has relied on the revised OECD guidelines and has observed that unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustments, no risk adjustment can be allowed to the taxpayer. The Hon’ble DRP has further observed that the assessee could not show with evidence as to whether each of the risk was actually undertaken by the comparables and, if so, how these risks affected each of them and whether such adjustment would improve the comparability. It has been further observed by the Hon’ble DRP that mechanical adjustment could not be made to the margins of the comparables without knowing which risks were taken by the entity concerned and how the profitability was affected.

6.3.1 Different benches of the ITAT have taken a divergent view on this issue. The ITAT Mumbai Bench in the case of Symantec has held that no separate adjustment is required on account of risk and functional differences whereas ITAT Delhi Bench in the case of Sony India Private Limited versus DCIT reported in 114 ASSESSMENT YEAR 2009-10 ITD 448 has held that deduction on account of ownership of intangibles, risk factors can be allowed. In view of the matter, we are inclined to accept the view favourable to the assessee.

6.3.2 ITAT Delhi Bench in the case of Avenue Asia Advisors Private Limited versus DCIT in has held that in the transfer pricing the study, the endeavour is to improve the comparability between the assessee and the comparable. The Bench opined that the risk taken by an independent entity and a captive service provider were different and since the remuneration of the captive advisor was not linked with the performance, it was not at a significant risk and therefore, suitable adjustments should be allowed.

6.3.3 ITAT Hyderabad Bench in the case of it is HSBC Electronic Data Processing India Ltd versus Additional CIT in has held that where the assessee operates in a risk mitigated environment vis-a-vis the comparable companies performing entrepreneurial risk-taking functions, adjustment for risk being taken by the comparable should be allowed.

6.3.4 ITAT Bangalore Bench in Philips Software Centre Private Ltd versus ACIT in has also held that adjustment needs to be made to the margins of the comparables 25 ASSESSMENT YEAR 2009-10 to eliminate differences on account of different functions, assets and risks. More specifically, adjustment needs to be made for differences in risk profile, difference in working capital position and differences in accounting policies.

6.3.5 Therefore, in view of the cited precedents and on the facts of the case, it is our considered opinion that the risk taken by an independent entity and the captive service provider are different and since the remuneration of the captive service provider is not linked with the performance, it is not a significant risk and, therefore, a suitable adjustment should be allowed. Accordingly, we restore the matter to the file of the Ld. TPO/AO for examination of the issue and provide suitable adjustment towards risk in accordance to the law. The assessee is directed to extend cooperation to the Ld. TPO in quantification of risk adjustment. Accordingly, this ground stands allowed for statistical purposes.

6.4 Ground No. 2 challenging initiation of penalty proceedings is dismissed as being premature.

Order pronounced in the open court on 2nd May, 2017.