STANLEY CONSULTANTS INDIA PVT. LTD.,,NEW DELHI vs. DCIT, NEW DELHI

By way of this appeal, the assessee appellant has challenge correctness of the order dated 30th April 2012 passed by the CIT(A) in the matter of assessment under section 143(3) of the Income Tax Act, 1961, for the assessment year 2007-08.

Grievances of the assessee, in substance, are that the learned CIT(A) erred in upholding (i) the impugned arm’s length price adjustment of Rs 2,96,58,519; and (ii) the disallowance of reimbursement of recruitment expenses to the tune of Rs 6,53,850. Assessment year: 2007-08 Page 2 of 7 3. So far the arm’s length price adjustment of Rs 2,96,58,519 is concerned, one of the fundamental issues that the learned counsel has raised is against rejection of segmental results by the TPO. It is contended that “the learned CIT(A) erred by not taking cognizance of the basic business model, functional responsibilities and risk profile of the appellant and its AE, and erred in rejecting the segmental approach followed by the appellant in benchmarking its international transactions”. We will deal with this issue first.

In order to adjudicate on this plea, some basic facts will have to be taken note of. The assessee before us is a company incorporated in 2003, is a fully owned subsidiary of Stanley Consultants Inc. USA, and is a part of Stanley Group engaged in the business of providing engineering, environmental and construction services- mainly transmission and distribution engineering, including planning and feasibility studies, design and construction management. Stanley Group also renders specialized services such as load forecasting, rate design, financial analysis, contract and economic evaluations. Stanley Group has two entities in India- first, the project office as a PE, and – second, the assessee company before us. It is stated that the purpose of the assessee company being incorporated in India was to provide support services to Indian projects of the Stanley Group, but, in addition to this support function, develop as an entrepreneur in its own right i.e. to develop business with other independent entities requiring such services. This is second year of assessee’s operations in India. During this year, the assessee’s AE (i.e. project office of the assessee group company in India) had services agreements with certain customers, such as National Highway Authority of India and MP Road Development Corporation Ltd. The AE undertaken five such major projects in association with the assessee as also in association with the independent enterprises. The business model adopted by the AE was is to be this. The customer opens a tender in the market and invites quotes from various service providers. The quotes for the services to be rendered are prepared by the AE, for their part of services, and the assessee, for its part of services- which are confined to the technical support services. Once these inputs are in place, a consolidated proposal is sent to the customer. It is in this background, according to the assessee, that there is no fixed Assessment year: 2007-08 Page 3 of 7 overhead charged by the assessee and that the prices quoted by the assessee are as per their assessment of the market conditions. It is also stated that the quotes are issued on man month basis. Once the tender is awarded, the assessee and the AE enter into an agreement specifying the work to be performed by the assessee. So far as the year before us is concerned, the nature of work performed by the assessee was ‘supervision of project’. As for the billing arrangement, the AE raises a consolidated bill on the customer even though such a bill contains complete breakup of the work done by different parties to the contract, and, with the consent of the AE, the customer makes direct payments to the assessee. In this transaction structure, the crucial entrepreneurial and market risks and functions are with the AE, while idle capacity risk, since billing is on man month basis, and other routine risks and functions are with the assessee.

Coming to the segmental approach adopted by the assessee, what the assessee has done is this. The assessee has bifurcated the profit and loss account, in substance, into two parts- project expenses and non-project expenses. While the former head accounts for all the expenses directly relatable to the technical support service, i.e. international transactions in questions, the latter accounts for business development and administrative expenses. The case of the assessee is that the business is still in its infancy inasmuch as its only second year of operation and that a substantial portion of expenses being incurred at this stage are for long term business development and securing independent contracts as an entrepreneur. Allocating all these expenses to the project revenues will give a distorted picture of business results, rendering it inherently incomparable with other independent entities engaged in business as independent service providers. This approach, however, did not find favour with the Transfer Pricing Officer. He was of the view that “there was no fundamental accounting basis for segregation of expenses into project expenses and overhead expenses (i.e. no project expenses) and calculation of adjusted OP/TC margin of the assessee”. He also noted that “no income stream had been shown with respect to non-invoice expenses (overhead expenses)”. As for the basis of allocation, it was explained by the assessee that “segregation of expenses into two segments was on actual basis”. The TPO was of the view that as Assessment year: 2007-08 Page 4 of 7 per transfer pricing report “main business of SCIPL (i.e. the assessee before us) is to act as advisors and/or consulting engineers”. The TPO further relied upon the transfer pricing study which is said to have inter alia stated that the assessee company was set up to support operations of Stanley USA in India and throughout Asia. A reference was also made to the Memorandum of Association which states that main object of the company is “to act as advisors and/or consultants, consulting engineers for engineering, environmental, constructions and other infrastructure projects of all kinds”. The TPO concluded that “the assessee is a 100% subsidiary and has been set up in India to provide and act as consultant to parent Stanley Consultants US” and “it is nowhere stated in any contract or document that the assessee is acting as an independent entrepreneur which will be operating for the purpose of seeking independent business”. He further noted that “the segregation and treatment of certain expenses as administrative and non- operational is not borne out of any agreement between the assessee and its AE, nor from the terms of Memorandum of Association and Articles of Association of the assessee” and that “this is also not borne out of functional analysis submitted by the assessee”. He further noted that “as per no accounting standard or legal provisions can the above expenses be treated as non operating expenses” and that “if the AE of the assessee were to procure the above services from an independent third party, the cost of billing by the third party would include all costs, including administrative and overhead costs for the purpose of rendering such services”. The TPO also noted that “The assessee has not furnished any evidence to prove that the so called ‘non-invoice expenses’ were not incurred to support logistic services provided to AE as per agreement” and that “no income stream gas been shown with respect to the non-invoice expenses” It was in this backdrop that the TPO rejected the segmental results and proceeded to take entire costs incurred by the company as operating cost, and compute operating profits accordingly. Aggrieved, assessee carried the matter in appeal before the CIT(A) but without any success. The assessee is not satisfied and is in second appeal before us. Assessment year: 2007-08 Page 5 of 7 6. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.

We have noted, as rightly pointed out by the learned counsel, that in the immediately preceding assessment year as also in immediately succeeding assessment year, the TPO himself has accepted the segmental results, as shown by the assessee on the same lines as in this assessment year, without any adjustments. No doubt, there is no res judicata in the income tax proceedings, but there has to consistency in approach about such a fundamental aspect which permeates from year to year. We have also noted that the basic reason for rejecting the segmental results in this year is that there were no separate streams of revenues so far as non -project expenses are concerned. However, it is important to bear in mind the fact that whether or not there are existing separate streams of revenue for non-project expenses is wholly irrelevant because what is material is whether the expenses is incurred for a distinct purposes, other than the that of project in question, or not. Once we come to the conclusion that the apart from doing the project work in question, the assessee was also making efforts to develop its separate business, as an entrepreneur, and whole or a significant part of the non- project expenses are incurred for such a purpose, the exclusion of whole of, or such significant part of, non-project expenses is fully justified. In case the assessee has to bear the expenses incurred by it, as an entrepreneur, for business development expenses, taking into account such business development expenses, for the purpose of computing operating profits from the business activity of providing these technical services in question, will make the assessee inherently incomparable. It is not even the case of the revenue that the assessee is a captive service provider forbidden from rendering such services to other entities. If that be the case, the idle capacity risk must also go to the AE, but then that is not the case here. It is also elementary that nobody can be expected to prove a negative. The TPO was, therefore, clearly in error in observing that the assessee could not prove that the expenses incurred by the assessee, under the head non-project expenses, were not incurred for the proposes of the project work. There is no, and cannot be any, straight jacket formula to segregate the costs, on a fixed ratio basis, between the Assessment year: 2007-08 Page 6 of 7 project costs and non project costs- save and except for the identification on item to item, i.e. actual, basis. That is precisely what the assessee has done. The detailed basis of allocation in respect of each item has been set out, and the TPO has not dealt with these specific allocation basis. Similarly, the basis of allocation cannot be found in the agreement and the Memorandum of Association or Articles of Association either. The observations made by the TPO are thus wholly unsustainable in law and inappropriate to the facts of the case. As a matter of fact, as subsequent results (set out at page 206 of the paper-book) would show, the assessee was indeed able to develop substantial business from non AEs. In the subsequent assessment years, the percentage of business with non AEs vis-à-vis total business increased to 31% (AY 208-09), 53% (AY 2009-10) and 59% (AY 2010- 11). The inferences drawn by the TPO are incorrect and quite clearly the assessee was not doing a simple support service per se for the project work undertaken by its AEs. The assessee did act as an entrepreneur and developed this field quite substantially, and the segmental approach of the assessee has been accepting in preceding and succeeding assessment year as well. On these peculiar facts, the approach of the assessee, in treating project work as separate profit centre, is justified. The plea of the assessee was, therefore, indeed well taken and we approve the same. With these observations, the matter goes back to the TPO for re- examination of the matter. As the matter is going back to the file of the TPO, and as it is uncontroverted stand of the assessee that in the event of this basic plea being accepted, all other issues, with respect to ALP determination, will be rendered infructuous and academic, we see no need to deal with other issues, on ALP determination, raised by the assessee.

That takes us to the second issue with respect to disallowance under section 40(a)(i). There is no dispute that this amount of 6,53,850 on account of recruitment charges reimbursed to the Stanley Consultancy Inc. The Assessing Officer has disallowed the payment on the ground that no tax was deducted at source from this reimbursement which was clearly taxable in India under section 9(1). In appeal, learned CIT(A) has confirmed the same. The assessee is aggrieved and is in further appeal before us. Assessment year: 2007-08 Page 7 of 7 9. Having heard the rival contentions, and having perused the material on record, we find that the disallowance is wholly uncalled for. The requirements of tax deduction at source under section 195 do not come into play simply because an amount is being remitted abroad. The income embedded in such a payment must also be taxable in nature, and unless that is established, the tax deduction at source requirements do not come into play. Here is a case in which the payment is in the nature of reimbursement to a US resident, but even if we go by nature of expenses, recruitment fees, by the virtue of Article 12(4)(b) of India US tax treaty, is not taxable in the source country since it does “make available’ technical knowledge, experience, skill, know-how, or processes or consist of the development and transfer of a technical plan or technical design”. Since the income embedded in the payment was not taxable in India under the treaty provisions, and since treaty provisions override the provisions of the Income Tax Act- unless the latter was beneficial to the assessee, the tax withholding requirements of Section 195 were not triggered on the facts of this case. Since the assessee did not have any tax withholding obligations, non-deduction of tax at source by the assessee cannot lead to any disallowance under section 40(a)(i). We, therefore, delete the impugned disallowance.

The assessee thus succeeds on the second issue.

In the result, the appeal is allowed in the terms indicated above. Pronounced in the open court today on 25th day of July, 2016.