M/S. SMART CUBE INDIA PVT. LTD.,NEW DELHI vs. ITO, NEW DELHI

I.T.A .No.-631/Del/2014 b) Cosmic Global Ltd c) Cross domain solutions Pvt Ltd d) Eclerx Services Ltd e) Infosys BPO f) Jeevan Softech 2.13 The DRP/TPO erred on facts and in law in selecting, Cosmic Global Ltd without appreciating the fact that it has outsourced significant part of its ITES operations to outside vendors making it to be functionally dissimilar to the assessee. 2.14 That the DRP/TPO erred on facts and in law in selecting Cosmic Global Ltd. and Crossdomain Solutions Pvt. Ltd. as comparable companies not appreciating that the companies are not satisfying the filter of related party transactions applied by the TPO himself. 2.15 That the DRP/TPO erred on facts and in law in considering eClerx Ltd and Infosys BPO Ltd having significantly higher turnover as compared to the appellant and are also not functionally comparable to the appellant. 2.16 That the DRP/TPO erred on facts and in law in applying inconsistent approach by eliminating loss making companies or companies with declining revenue without eliminating the companies having significantly high margins or high turnover. 2 17 That the DRP/TPO erred on facts and in law in selecting following super normal profit companies as comparable to the appellant being a captive service provider: S.No. Name of the OP/OC(%) company 1. Accentia Technolgoeis Ltd. 52.52 2. Cosmic Global Ltd. 50.70 3. Eclerx Limited 66.01 4. Jeevan Softech 44.32 2.18 Without prejudice to the ground that Jeevan Softech is functionally different, the DRP/TPO erred in facts and in law in incorrectly computing the operating profit margin of the company at 44.32% as against the correct profit margin of 20.07%.

3. That the assessing officer erred on facts and in law in levying interest under Section 234B and Section 234D of the Act, 4. That the assessing officer erred on facts and in law in initiating penalty proceedings under Section 271(1)(c) of the Act. The appellant craves leave to add, alter, amend or vary from the aforesaid ground of appeal before or at the time of hearing.”

1.1. However, at the time of argument the Ld. AR submitted that the assessee would like to first address only Ground No. 2.3 and 2.4 in the present proceedings.

I.T.A .No.-631/Del/2014 that the said issues have been taken into consideration by the ITAT in the immediately preceding assessment year in the case of the assessee itself. Relying on the judicial precedent available on the issues addressed by these two grounds it was submitted the matter will need to be remanded back to the TPO. Relying on the directions given in 2008- 09 by the ITAT it was submitted the other issues raised by the assessee in the present appeal may be left open for consideration before the TPO/AO to be decided on facts and law. Thus as far as the present proceedings before the ITAT are concerned the issues would become academic.

Relying on the same it was submitted that the issue which has been addressed in the present proceedings vide Ground No.2.3 namely under utilization of capacity was remanded by the ITAT. In the said year i.e. 2008-09AY the issue inadvertently had not been raised by the assessee in the grounds filed originally, accordingly an additional ground was raised. Accepting the prayer of the assessee it was submitted the ITAT admitted the additional ground. The only difference in the facts of the earlier year and the present year was that in the facts of that year the under utilization of capacity was to the extent of 75% whereas the under utilization of capacity in the year under consideration is to the extent of 72%.

I.T.A .No.-631/Del/2014 the evidences had remanded the matter to the TPO/AO. Accordingly it was his submission that in the facts of the present case also similar prayer for admission of fresh evidences has been moved and considering the judicial precedent it may be allowed.

6. The Ld. CIT DR, Mr. Amit Mohan Govil submitted that it is not possible to say that the issues are covered by the order of the ITAT as the matter is entirely factual and requires a reconsideration of facts. Carrying the argument, further it was his submission that he failed to understand how the assessee can argue that relocation expenses on account of sealing by the MCD in a particular year can be stated to be a continuous expenditure in the subsequent years also which is the prayer of the assessee in terms of Ground No. 2.4. Addressing ground No. 2.3, it was a stand that the issue may be considered by the TPO.

7. The Ld. AR addressing the specific grievance of the Revenue submitted that the expenses pertain to sealing and de-sealing of the specific premises of the assessee and have been specifically addressed before the DRP. In support of the said submission, reliance was placed on the petition dated 09.09.2013 Rule 7(4) of the income Tax (Dispute Resolution Panel) Rules 2009, copy of the said prayer is moved before the DRP it was submitted is placed at pages 189 to 195 where the specific evidences have been described as under:-

I.T.A .No.-631/Del/2014

BEFORE THE DISPTUE RESOLUTION PANEL II NEW DELHI

In the matter of : Smart Cube India Pvt.Ltd. Assessment Year : 2009-10 Re: Request for admission of additional evidence-Rule 7(4) of the Income Tax (Dispute Resolution Panel) Rules 2009 The assessee seeks to place on record the following by way of additional evidence:- S.No. Particulars Page No. Annexure 1. Copy of application filed before the Municipal Corporation of 1-8 1 Delhi 2. Copy of lease agreement of office premises at Chandiwala 9-19 1(a) Estate dated 28.12.2004 enclosed as Annexure to the representation made before the MCD for de-sealing of premise 3. Copy of letter issued by the trust dated 23.03.2004 giving 20-29 2 details of Chandiwala Estate property 4. Copy of correspondence made by the trust with regard to visit 30 3 of monitoring committee dated 02.08.2007 5. Copy of notice for de-sealing of Chandiwala Estate property for 31-32 4 20 days 6. Copy of application made before the Supreme Court of India 33-42 5 for a grant of 24 weeks for relocation from Chandiwala Estate.

8. Details of additional extraordinary expenses incurred on 65-66 7 account of shifting of office from Chandiwala office 9. Details of extra cost incurred by the assessee in Regus office 67 8 as compared to Noida office 10. Copy of order of Delhi High Court in the case of CIT vs Text 68-73 9 Hundred India Pvt. Ltd. 239 CTR 263 7.1. The DRP in its order dated 31.10.2013 does not refer to it and merely observes that following the precedent in 2008-09 AY the objections are rejected.

The relevant facts of the case are that the assessee is a private limited company incorporated on 8th January 2004. The assessee is a subsidiary company of Smart Cube Ltd. UK and is engaged in providing information Technology Enabled Services (ITES) in I.T.A .No.-631/Del/2014 the field of data processing in the domain of research and analysis related services to its group companies. The TPO has described the assessee as being “engaged in providing research and analyst services. It is a private limited company managed by team of professional that are specialized in delivering high value and customized research and analysis to its associated enterprises, it is resident in India and subject to India tax laws.

Its associated enterprises are The Smart Cube ltd, UK its holding company. The Smart Cube Inc. USA a fellow subsidiary.” The TPO noticed that “The Smart Cube Limited UK is engaged in conducting business development work to generate sales of research & analytics services from clients in the UK and Europe. The Company contracts with the Smart Cube India Pvt. Ltd. for execution of this work.” The Smart Cube Inc. US it has been noticed by the TPO is “engaged in conducting business development work to generate sales of research and analytics services from clients in the North America. The company contracts with the Smart Cube India Pvt.Ltd. for execution of this work. The entire share capital of company as on 31st March 2009 was held by the holding company- the Smart Cube UK. The company is registered with Software Technology Park of India (STPI).”

8.1. The following International transaction was disclosed by the assessee in the year under consideration:-

NS.No.. Nature of Transaction Value of transactions 1 Research and Analyst 13,36,26,646/- Services 8.2. Addressing the transfer pricing approach of the assessee the TPO noticed that “In order to benchmark the international transactions of the assessee for provision of Research and Analyst Services, the assessee has chosen TNMM as the most appropriate method. Page 7 of 18

I.T.A .No.-631/Del/2014 The margin of the tested party i.e. the assessee has been computed at 5.01%. In order to benchmark the international transactions the assessee has chosen 5 comparables whose mean margin using three years data has been computed at 3.94%.”

From the case records of A.Y. 2008-09 it was noticed that the assessee was operating from Ground Floor Building No.3, Chandiwala Estate which was sealed on 6th August 2007 by MCD on the orders of Monitoring Committee and the assessee shifted its premise to A 4-5, Sector 16, Noida, U.P. owned by IT Infrastructure Pvt. Ltd. (Logix Group) for the period 13.08.2007 to 14.09.2007 and shifted back to its old Premise at Building No.3, Chandiwala Estate on 17.09.2007. Again in September 2008 the TPO noticed that the assessee shifted

I.T.A .No.-631/Del/2014 its premises to Regus the shift accordingly to the TPO was not due to sealing. Accordingly he was of the view that additional cost incurred was due to shifting and was not due to sealing. He was of the view that an office could be shifted at any time and rent could also be revised thus he was of the view that it could not be said that the increase in expenses was due to the sealing effect. He was further of the view that such risks were normal business risks. Thus costs like this, he was of the view could be embedded in the total cost of the comparables also. Further, he was also of the view that this fact was not relevant as the assessee was charging its AEs on ‘man and material basis’ rather than ‘cost plus’ model which was generally the preferred business model for captive service providers. He was of the view that had the assessee followed ‘cost plus’ Model, it would have recovered its entire cost including the additional rent for new premises from its AEs along with a mark- up. He was of the view that while charging on ‘man and material basis’ an independent service provider would factor in such usual risks, viz., disruption of work etc. for fixing the prices i.e. keep sufficient margin for such situations. The TPO further was of the view that while furnishing the TP report the assessee had already considered this expenditure as operative and calculated the PLI accordingly at 5.01%. These findings and conclusions, we find are discussed in paras 7 to 7.3 of the TPO’s order.

S.No. Comparables OP/OC 1. Accentilia Technologies Ltd. 52.52% 2. Axis IT & T Ltd. 8.16% 3. Aditya Birla Minacs Worldwide Ltd. 11.95% 4. Cosmic Global Ltd. 50.70% 5. Crossdomain Solution Pvt.Ltd. 25.63%

I.T.A .No.-631/Del/2014

6. “Assessee has raised the following objection on the basis extraordinary expenditure incurred on account of shifting of premises as operating expenses. (v) That the assessing officer / TPO erred on facts and in law in treating the extraordinary expenditures incurred by the assesses on account of shifting of premises as operating expenses for the purpose of computation of tested pony margin. (x) The assessing officer/TPO erred on facts and in low in rejecting the claim of the assessee towards adjustment on account of extra-ordinary costs incurred by the appellant on account of shifting of officer premises. DRP observation 6.1. The assessee has raised the grounds of objections on incurred extraordinary cost of Rs. 10,978,227/- on account of shifting of office due to sealing drive by the MCD. Further, extraordinary expenditure was on account of force majeure and not operating expenditure incurred in relation to international transaction for rendering services. 6.2. During the course of Transfer Pricing proceedings the observation of the TPO on this matter is reproduce as under:- "7.5. The assesses is emphasizing on the issue that the above mentioned expenses are extra ordinary in nature and therefore deserve to be exclude while comparing the margins with that of comparables. This argument does not have force in it/as theses expenses mainly relate to the difference in rent of old premise and new premise and therefore, are normal in the course of a business and it may happen in case of any business concern, further, there could be such cost embedded in the total cost of the comparables also." 7.6. The rent paid on account of shifting of office has been incurred to earn the operative income of the assessee. The expense has direct nexus with the revenue generation. The expenditure resulting due to sealing is very much associated with the business of the assesses as without access to proprietary systems the assessee could not work. Nor Is the seating drive of the MCD illegal. By conducting its business in area not authorized for commercial activity the assessee had taken a calculated business risk hence this expenditure is not extraordinary but resulting from business activities and risk taken by the assessee. A Page 10 of 18

I.T.A .No.-631/Del/2014 reference can be made to the case of M/s Haworth (India) Pvt. Ltd. AY 206-7 (ITA No. 5341/Del/2010), wherein it was decided that operational expense is the expense which is incurred to earn operational income, thus expense which has nexus with the revenue has to be considered as operational expense and cannot be excluded, 7.7. in view of these findings I am of the considered view that the rent paid by the assessee company I to protect its revenue and is paid to earn operational income and hence it has to be treated as operative expenditure. Therefore, it is held that these expenses or Rs.1,09,78,227/- are operative in nature and cannot be excluded while computing the operating margins of the assessee * 6.3. DRP has considered submission of the assessee and view of the TPO. This issue was also litigated in the AY 2008-09. DRP has decided the issue by treating this expenditure as operative as the rent paid on account of shifting of office has been incurred to earn the operative income and the expense has direct nexus with the revenue generation. The expenditure resulting due to sealing is very much associated with the business of the assessee and it was the calculated business risk of the assessee. In view of this, DRP holds that the same should be taken as operating expenditure in this case.” 12.1. Since the grievance of the assessee still persists the assessee has filed the present appeal before the ITAT.

2.2. “That the assessing officer/TPO erred on facts and in law in not allowing comparability adjustment to the extent of Rs.29,46,865/- on account of extraordinary expense (loss) incurred by the appellant for relocation to a new business premises due to the sealing drive undertaken by Municipal Corporation of Delhi (‘MCD’).” 14. The said issue it is seen has been considered at internal page 12 to 15 by the ITAT in the aforesaid order in para 15. The same is extracted hereunder for ready-reference:-

I.T.A .No.-631/Del/2014

Ltd. (supra). In that case before the Hon'ble High Court, the assessee had claimed that they had incurred relocation expenses of Rs.32,88,224 including brokerage for moving/shifting to a new premises and had paid additional rent of Rs.39,72,626 for two months and had to pay salary for unproductive/idle hours amounting to Rs.45,78,633. The assessee had had to shift their office to Safdarjung Enclave ( a residential area ) Co Mohan Co-Op Ind. Estates at a very short notice in view of the sealing drive undertaken by the Municipal Corporation on account of non-confirming usages. It was submitted that the assessee had supplied software to its parent company and, therefore, the parent company should have also shares burden of Rs.1,11,73,078. The expenditure of Rs.1,11,73,078 was not disputed or doubted nor was there any debate that this expense was incurred. It was also not disputed that the assessee has shifted their operations from Safdarjung Enclave to Mohan Co-op Ind. Estates, It was also not denied that the assessee had paid two months extra rent amounting to Rs.39,72,626 because of shifting. The ITAT recorded that there was dip in turnover/supply of software during the last quarter from 01.01.2006 till 31.3.2006. In the last quarter, the capacity utilization failed to 72% from normal capacity utilization of 87% to 94% during the financial year ending 31.12.2005. Hon'ble High Court agreed with the submissions of the assessee that even though the assessee had leased the new premises and paid rent for the months of February and March, it could not have commenced its commercial operations from such premises, till the time necessary infrastructure in the form of fixture, power supply etc., was established. Further, before the operations of the assessee could be shifted from one premises of another, the necessary equipment and devices had to be installed at the new premises. The entire process and activities require considerable time and the assessee therefore, had to pay rent for the period during which the aforesaid infra- structure was established at the new premises. The Hon'ble High Conn held that the claim of assessee firm relocation expenses of Rs.32,88,224 ought to be allowed in full under the provisions of sec. 37(1) of the Act. The Hon'ble Court observed further that if the figure of Rs.1,11,73,078 is duly accounted for and taken into consideration, then, the operating margin of the assessee comes to 17.80% which is higher than the comparable operating margin of 17.09% taken as a benchmark by the TPO. The Hon'ble High Court observed further that the abnormality and difficulty resulting in an extra expenditure was not created or called by the associated enterprises, hence, they were not responsible or liable for the said payment/expenditure. The associated enterprise did not have legal or contractual obligation to make extra or additional payment beyond the true and correct value of the transaction. We thus find substance in the claim of the assessee regarding comparability adjustment on account of abnormal expenses incurred by the assessee. We thus set aside the matter to the file of the Assessing Officer to examine as to whether the adjusted operating margin of the assessee is higher than the operating margin earned by the comparable companies selected by the TPO and if it is find that the adjusted operating margin of the assessee is higher then hold that international transaction undertaken by the assessee satisfy the arm's length criteria. Of course, while deciding the issue, the Assessing Officer will afford opportunity of being heard to the assessee. Ground NO.2.2 is thus allowed for statistical purposes.

I.T.A .No.-631/Del/2014

15. We find that in the facts of the present case apart from stating that de-sealing cannot be a covered issue in every year, no further argument has been raised by the Revenue. We find that the objection of the Revenue to treat it as a covered issue may have a point inasmuch as the issue is to be decided after considering the evidences relied upon. We find that the prayer for admission of fresh evidences has not been opposed by the Revenue and only argument has been that following the precedent the same may be remanded. We find that the general argument that the extraordinary expenses on account of the sealing drive undertaken by the Municipal Corporation of Delhi cannot be a recurring issue for every year, cannot be addressed without first considering the facts. Generally speaking it can be argued that sealing activity was undertaken at a point of time.

However, if evidence shows that a sealing drive was followed by a de-sealing activity followed again by a sealing drive then the issue may become recurring in nature for the said duration. Thus though the argument cannot be outrightly rejected but it has to be considered on the basis of facts and evidences. We find that nothing has been placed on record by the Revenue so as to rebut the evidence that the sealing was final and contrary to assessee’s submissions there was no de-sealing followed by sealing activity once again.

We further find that on record, the assessee seeks to place evidence in support of arguments already recorded in the TPO’s order namely shifting from one premise to the other and then back to Chandiwala Estate and shifting out again therefrom. Thus the claim of expenses incurred for de-sealing and for functioning in the interregnum period from a specific address temporarily followed by shifting back to the original premises which again were sealed resulting in temporary functioning from another address and setting up premises permanently at some other premises are all facts which have been argued before

I.T.A .No.-631/Del/2014 the TPO. The veracity of the claims can be considered only after following the precedent the evidences are admitted. The evidences we find, are necessary and crucial for determining the issue and considering the judicial precedent as considered by the Hon’ble Delhi High Court in of CIT vs Text Hundered India Pvt. Ltd.(cited supra), we hold that it deserves to be admitted. It goes without saying that admission of fresh evidences is not a comment either way on its veracity or correctness as these claims and issues are to be examined by the TPO/AO. The remuneration model of the assessee as considered by the TPO has been addressed in the earlier part of this order, according to which the Revenue’s case is that the assessee was charging on the basis of “man on material” basis wherein it was concluded that costs would be necessarily embedded therein. The issue as observed has been remanded by the Co-ordinate Bench on similar facts and circumstances to the TPO/AO. Accordingly considering the judicial precedent we set aside this issue back to the file of the AO/TPO with a direction to pass a speaking order in accordance with law after giving the assessee a reasonable opportunity of being heard.

16. Addressing Ground No.2.4 it is seen that the issue had been raised before the Co- ordinate Bench by way of an additional ground supported by a prayer for admission of additional evidences. The Co-ordinate Bench it is seen has admitted the additional ground in para 4.1 and the fresh evidences in para 5 and restored the issue to the TPO/AO vide para No. 16 holding as under:-

I.T.A .No.-631/Del/2014 software during the last quarter from 01.01.2006 till 31.3.2006. In the last quarter, the capacity utilization failed to 72% from normal capacity utilization of 87% to 94% during the financial year ending 31.12.2005. In that case, the assessee had claimed that sealing price reduced its revenue and in support the assessee had placed on record its quarterly capacity utilization statement demonstrating the fall in its capacity utilization during the quarter January to March 2006. The ITAT noted this fact as well that assessee had to shift its office premises at a very short notice and agreed with the claim of the assessee regarding low capacity utilization during the last quarter of financial year 2005- 06. Respectfully following the cited decisions of the Hon'ble High Court upholding the order of the ITAT, we find substance on the issue raised in additional ground No.1 and thus set aside the matter to the file of the Assessing Officer to decide the issue in view of the ratios laid down in the cited decision in the case of Transwitch India Pvt. Ltd. (supra) and on the basis of evidence made available on record i.e. details of capacity utilization of the assessee during financial year 2007-08, 2008-09 and 2009-10 and that on account of closure of office from 06th August to 13th August, the assessee had incurred additional cost of Rs.14,68,460. It is needless to mention over here that while deciding the issue the Assessing Officer will afford opportunity of being heard to the assessee. The additional ground No.1 is accordingly allowed for statistical purposes.” 16.1. We find that in the facts of the present case the assessee has moved a petition dated 18.03.2015 seeking admission of additional evidence invoking Rule 29 addressing the details of capacity utilisation of the assessee during 2007–08; 2008–09 and 2009–10 financial years praying as under:-

capacity. After considering the above adjustment, the operating margin of the appellant works out to 29.50%. Details of capacity utilization of the applicant during financial years 2007-08, 2008-09 and 2009-10 are enclosed herewith. The applicant could obtain complete details of capacity utilization only now, which is being placed by way of additional evidence before your Honours.” 16.2. Reliance has been placed upon CIT(A) vs Text Hundred India Private Limited 239 CTR 263 decision of the Hon’ble Delhi High Court highlighting the following observation of the Hon’ble court :-

"13. The aforesaid case law clearly lays down a neat principle of taw that discretion lies with the Tribunal to admit additional evidence in the interest of justice once the Tribunal affirms the opinion that doing so would be necessary for proper adjudication of the matter. This can be done even when application is filed by one of the parties to the appeal and it need not to be a suo motto action of the Tribunal, The aforesaid rule is made enabling the Tribunal to admit the additional evidence in its discretion if the Tribunal holds the view that such additional evidence would be necessary to do substantial justice in the matter. It is well settled that the procedure is handmade of justice and justice should not be allowed to be choked only because of some inadvertent error or omission on the part of one of the parties to lead evidence at the appropriate stage. Once it is found that the party intending to lead evidence before the Tribunal for the first time was prevented by sufficient cause to lead such an evidence and that this evidence would have material bearing on the issue which needs to be decided by the Tribunal and ends of justice demand admission of such an evidence, the Tribunal can pass an order to that effect.”(emphasis supplied)

16.3. Reliance is also been placed upon Bentley Systems India Private Ltd vs ACIT (ITA No. 6160/Del/2013) for the proposition that the ITAT on considering more or less similar issue involving transfer pricing adjustment on account of intra-group services admitted the additional evidence raised on record by the assessee for the purpose of substantial the receipt of management services holding that the evidence placed on record goes to the root of the matter. It was his submission that the matter of additional evidence may be admitted. The said prayer has not been objected to by the Revenue. The judicial precedent available in assessee’s own case shows that the additional evidence for deciding

I.T.A .No.-631/Del/2014 the issue has been admitted in similar facts and circumstances. Considering the overall factual matrix on the issue and considering the judicial precedent available thereon, we find no good reason to deviate from the view taken. The fresh evidence sought to be admitted are not only relevant and crucial to determine the issue but also supported by judicial precedent respectfully following the same it is admitted.

16.4. The issues are accordingly restored back to the file of the TPO with a direction to pass a speaking order in accordance with law after giving the assessee a reasonable opportunity of being heard.

17. The remaining issues agitated in the present proceedings following the judicial precedent are left open and restored to the TPO for consideration afresh. The relevant extract from the order of the Co-ordinate bench is reproduced hereunder:-

18. So far as ground No. 2.3 is concerned, the issue raised therein is non- aliowance of appropriate risk adjustment to establish comparability on account of the assessee being a low risk bearing contract service provider as opposed to the comparable companies who were independent ITES Service Provider, is concerned, we find that this aspect has not been considered by the Learned DRP. We thus set aside the issue to the Assessing Officer/TPO to consider it afresh after affording opportunity of being heard to the assessee. The ground is thus allowed for statistical purposes.”