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Income Tax Appellate Tribunal, PUNE BENCH “B”, PUNE
आदेश / ORDER PER SUSHMA CHOWLA, JM:
The cross appeals filed by the assessee and the Revenue are against order of CIT(A)-IT/TP, Pune, dated 17.07.2014 relating to assessment year 2009-10 against order passed under section 143(3) of Income Tax Act 1961 (in short the ‘Act’).
The cross appeals filed by the assessee and the Revenue were heard together and are being disposed of by this consolidated order for the sake of convenience.
The assessee in ITA No.1788/PUN/2014 has raised the following grounds of appeal:- On the facts and in the circumstances of the case and in law, the Hon'ble CIT(A) has: I. In respect of transfer pricing grounds 1. General ground challenging the transfer pricing adjustment of Rs.9,77,11,928 consequential to non consideration / non-acceptance of analysis documented in the transfer pricing study report Erred on facts and in law by making the transfer pricing adjustment to its international transactions in connection with provision of call centre services and not considering/not accepting the comparability analysis documented in the transfer pricing study report for benchmarking purpose. Erred in facts and in law by changing the Profit Level Indicator ('PLI') of Ventura India by including expenses recovered by Ventura India from its AEs (ie recovery of expenses) as part of operating income and operating cost for the purpose of computation of the operating margin. 2. Non-applicability of transfer pricing provisions to the Appellant which is enjoying tax holiday under section 10A of the Act Erred on facts and in law by applying transfer pricing provisions to the Appellant which enjoys tax holiday under section 10A of the Act.
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Non-consideration of contemporaneous data Erred on facts and in law by conducting arm's length analysis based on information of comparable companies available at the time of transfer pricing assessment but not available at the time of compliance with the transfer pricing regulations by the Appellant. 4. Selection of inappropriate qualitative filters Erred on facts and in law by selecting following inappropriate qualitative filters: - Use of single year data for comparability analysis instead of multiple year data; - Rejection of companies with less than 75 earnings from exports; - Revision of comparable activity revenue filter from 75 to 50; and - Rejection of loss making companies. 5. Erroneous rejection of CG VAK Software and Exports Limited identified as comparable by the Appellant Erred on facts and in law by rejecting CG VAK Software and Exports Limited from the set of comparable companies identified by the Appellant by erroneously applying the filter of rejecting companies having turnover less than Rs.1 crore. 6. Accepting certain additional companies as comparable Erred on facts and in law by accepting following additional companies as comparable to the Appellant: i. Accentia Technologies Limited; and ii. E4e-Healthcare Solutions limited 7. Accepting companies having abnormal profits Erred on facts and in law by accepting companies earning abnormal profits under the circumstances of the case. 8. Computation of operating margin of comparable companies Erred on facts and in law by directing the learned TPO to compute the operating margins of comparable companies using Safe Harbour Rules recently introduced by the Central Board of Direct Taxes ('CBDT') on 18 September 2013 in case of any dispute on consideration of a particular item of income or expenditure as operating or non-operating. 9. Rejection of adjustment on account of lower utilisation capacity or higher fixed costs Erred on facts and in law by rejecting the adjustment for lower utilisation of capacity or higher fixed costs of the Appellant at the time of computing its operating margin. 10. Non-consideration of adjustment for companies identified as comparable to factor differences on account of risk undertaken by such companies
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Erred on facts and in law by comparing full-fledged risk bearing entities with the Appellant's operations without undertaking any risk adjustment. 11. Treating the recovery of expenses as part of operating income and operating cost Erred on facts and in law in treating the recovery of expenses from Club 24 and NEXT Plc in respect of payments made by the Appellant on their behalf as part of operating income and operating cost and re-computing the operating margin of the Appellant. II. Other Grounds 12. Erroneous levy of interest under section 234B of the Act Erred on facts and in law by levying interest under section 234B of the Act to the extent addition is made to the total income of the Appellant on account of transfer pricing adjustment without providing any cogent reasons for the same and disregarding the submissions of the Appellant. 13. Initiation of penalty proceedings under section 271(1)(c) of the Act Erred on facts and in law by not adjudicating the ground relating to initiation of penalty proceedings under section 271(1)(c) by considering the contention of the Appellant as premature.
The assessee has also filed additional ground of appeal which read as under:- Ground 14 – Acceptance of certain comparable companies identified by the Appellant as comparables in the transfer pricing study but subsequently considered as non-comparable Erred on facts and in circumstances of the case and in law, the learned Transfer Pricing Officer („TPO‟) and consequently the learned Assessing Officer („AO') have included Cosmic Global Limited and Vishal Information Technologies Limited as comparable to the Appellant, which were originally a part of the Transfer Pricing Study, but subsequently identified by the Appellant to be functionally non-comparable to the Appellant.
The Revenue in ITA No.1800/PUN/2014 has raised the following grounds of appeal:- 1. Whether on the facts and circumstances of the case, the ld. CIT(A)-IT/TP erred in Law in including Aditya Birla Minacs Worldwide Limited as comparable company on the ground that it is not a consistent loss making company. 2. Whether in the facts and circumstances of the case, the ld. CIT(A)-IT/TP erred in law in excluding Cross Domain Solution Limited & Eclrex Services Limited from comparables as higher profits cannot be a ground for exclusion.
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Whether on the facts and circumstances of the case, the ld. CIT(A)-IT/TP erred in law in directing the AO to consider „advances receivable‟ for computing net working capital of the appellant. 4. The order of the AO be restored and that of the Ld. CIT(A)-IT/TP be vacated on the issues.
First, we shall take up the appeal filed by the assessee. The learned Authorized Representative for the assessee at the outset pointed out that the first ground of appeal was against transfer pricing adjustment of Rs.9,77,11,928/-, wherein the Transfer Pricing Officer (TPO) had made the aforesaid adjustment to its international transactions in connection with provision of Call Centre Services by not accepting comparability analysis documented in the transfer pricing study report. The assessee is also aggrieved by the order of Assessing Officer / TPO in changing Profit Level Indicator by including expenses recovered by the assessee from its associated enterprises as part of operating income and operating cost, for the purpose of computing operating margins. The learned Authorized Representative for the assessee at the outset pointed out that certain grounds of appeal are not pressed by the assessee i.e. grounds of appeal No.2, 3, 5, 7 and 10. Hence these grounds of appeal are dismissed as not pressed. Further, the ground of appeal No.12 against levy of interest under section 234B of the Act is consequential, hence the same is dismissed. The issue in ground of appeal No.13 against initiation of penalty proceedings under section 271(1)(c) of the Act is premature and the same is also dismissed.
Vide additional ground of appeal, the assessee is aggrieved by inclusion of Cosmic Global Ltd. and Vishal Technologies Ltd. as functionally comparable to assessee, which were originally part of transfer pricing study report but were subsequently, identified to be not functionally comparable. The assessee by way
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of ground of appeal No.4 is aggrieved by the selection criteria applied by the TPO. The assessee is also aggrieved by the directions to the TPO to compute operating margins of comparable companies using Safe Harbor Rules. By way of ground of appeal No.9, the assessee has asked for adjustment on account of low capacity utilization. The ground of appeal No.11 is specific in treating the recovery of expenses from Club 24 and NEXT Plc as part of operating income and operating cost and thus, re-computing the operating margins of assessee company.
Briefly, in the facts of the case, the assessee for the year under consideration had furnished the return of income declaring Nil income. The Assessing Officer made reference under section 92CA(1) of the Act to the TPO for determination of arm's length price with reference to international transactions reported in Form No.3CEB filed by the assessee. The assessee was established as International Call Centre, which serves Non-Indian clients. Club 24 Ltd., a subsidiary of NEXT Group Plc had established the assessee company through Venture (UK) India Ltd. to provide Call Centre Services to the customers of Club 24 Ltd. During the year under consideration, the assessee provided services to The NEXT Retail Ltd. and British Midland Airways Ltd. and BCA through Club 24. The assessee had commenced its operations on 01.06.2005 and thus, the year under appeal was first year of operations. The assessee had unit in Pune registered under Software Technologies Parks Scheme (STP Scheme), which enjoyed tax holiday under the Act. The international transaction which we are concerned is the rendering of Call Centre and ITES services to Club 24 to the tune of Rs.27,45,98,473/- and NEXT Retail Ltd. to the tune of Rs.30,65,04,833/-. The assessee for benchmarking its international transactions pertaining to Call Centre Services had adopted TNMM method as the most appropriate method.
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The assessee had selected eight companies as functionally comparable in its TP study report. The said list of companies is enlisted at page 2 of the order of TPO and average margins of said concerns worked out to 14.26%. Since the assessee had projected its operating margins higher than the comparable companies, the assessee held its international transactions pertaining to Call Service Centre to be at arm's length price. The TPO noted that the assessee had failed to consider the contemporaneous financials of the companies and it was asked to furnish updated margins for the financial year 2008-09. The details were furnished by the assessee and the average margins of said comparables by adopting PLI of OP/OC worked out to 15.47%. The assessee after fresh search rejected two comparables earlier selected and proposed selection of three more comparables and the final set of comparables are enlisted under para 7 of the order of TPO. The TPO however, rejected submissions made by the assessee and drew up list of final set of comparables which is reproduced under para 20. The assessee filed objections to the final list of comparables prepared by the TPO on the ground that some of the concerns were showing super normal profits during the year and the same were not comparable. However, the plea of assessee for rejection of Cosmic Global Ltd. showing revised margins of 48.59% was not accepted by the TPO since the same concern was selected by the assessee in the original TP study report. The assessee further asked for capacity adjustment and other risk adjustments. The TPO in the final analysis drew up list of ten companies to be comparable to the assessee and worked out the mean margins of said comparables after working capital adjustment of 26.46%. The assessee had shown margins of 11.59% and accordingly, the TPO proposed an upward adjustment of ₹ 8,17,66,432/-. The TPO rejected adjustment on account of capacity and other risk adjustments to the assessee. The Assessing Officer passed draft assessment order and thereafter, passed
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final assessment order making the upward adjustment on account of transfer pricing at ₹ 8.17 crores.
The CIT(A) directed exclusion of certain concerns and confirmed the inclusion of certain concerns as proposed by the TPO.
Both the assessee and Revenue are in appeal before us. Other linked issue has also been raised, which we shall adjudicate as the grounds of appeal are raised.
We have heard the rival contentions and perused the record. In the facts of the case before us, the assessee was running an international call centre at Pune and was providing lower-end BPO services to its associated enterprises. This was the first year of operations of assessee. The learned Authorized Representative for the assessee by way of ground of appeal No.6 and linked to ground of appeal No.4 has raised the limited issue of exclusion of two concerns Accentia Technologies Ltd. and E4e Healthcare Solutions Ltd. The TPO in the final analysis had selected following concerns as comparable:-
1 Accentia Technologies Ltd. 49.40 2 Cross Domain Solutions Ltd. 24.71 3 E4e-health Solutions Ltd. (Formerly known as 30.67 Nittany Outsourcing Services Pvt. Ltd. 4 Eclerx Services Ltd. 48.43 5 Infosys B P O Ltd. 24.28 6 Cosmic Global Ltd. 48.12 7 Informed Technologies India Ltd. 23.13 8 Vishal Information Technologies Ltd. 36.93 9 Microgenetics 1.28 10 R System 16.94
The assessee pleads that both Accentia Technologies Ltd. and E4e Health Solutions Ltd. were providing high-end KPO services and hence were
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functionally not comparable. In this regard, the assessee placed reliance on following decisions:- i) The Hon‟ble High Court of Delhi in Rampgreen Solutions Pvt. Ltd. Vs. CIT in ITA No.102/2015, judgment dated 10.08.2015; ii) Vishay Components Pvt. Ltd. Vs. ACIT in ITA No.341/PUN/2013, relating to assessment year 2008-09, order dated 31.05.2017.
The issue of exclusion of the concern engaged in KPO services has been decided by the Hon’ble High Court of Delhi in Rampgreen Solutions Pvt. Ltd. CIT (supra) and it has been held that there are different factors which have to be judged with reference to service / product characterization and the same could not be undermined by using broad classification of ITES. The Hon’ble High Court of Delhi drew the distinction between BPO service provider and the KPO service provider and held that where the controlled transactions were in the nature of lower end ITeS such as Call Centres, etc. for rendering data processing not involving domain knowledge, in such circumstances inclusion of any KPO service provider as a comparable would not be warranted and the transfer pricing study must take that into account at the threshold. The Hon’ble High Court therefore, directed the exclusion of Vishal Information Technology Ltd., which is subsequently known as Coral Hubs Ltd. The concern Accentia Technologies Ltd. has been rejected to be not functionally comparable to the concern providing BPO services by Pune Bench of Tribunal in BNY Mellon International Operations (India) Pvt. Ltd. Vs. DCIT in ITA No.23/PN/2014, relating to assessment year 2009-10, order dated 11.02.2015, which is the year in appeal before us. Following the same parity of reasoning, we hold that Accentia Technologies Ltd. is to be excluded from final set of comparables.
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Similarly, E4e Healthcare Solutions Ltd. which is also engaged in providing KPO services, for the same parity of reasoning, is to be excluded from final set of comparables. Accordingly, we hold so.
Now, coming to another concern which the assessee has raised by way of additional ground of appeal for exclusion is Cosmic Global Limited and Vishal Information Technologies Limited (Coral Hubs Ltd.). The assessee in the TP study report had included the said concerns as comparable. However, when the TPO revised the filters and wanted to apply the contemporaneous data for the year under consideration, the assessee sought exclusion of two concerns. The additional ground of appeal raised by the assessee do not require any investigation of facts, hence the same is admitted.
Now, coming to the plea of assessee vis-à-vis rejection of companies which were originally selected in TP study by the assessee. The said issue has been decided by the Special Bench of Chandigarh Tribunal in DCIT Vs. Quark Systems India (P) Ltd. (2010) 38 SOT 207 (Chd) and it has been held that the assessee can exclude the concerns in case on a later date, certain factors come into his domain which make the said concern as functionally not comparable.
The said proposition has also been laid down by the Hon’ble Bombay High Court in CIT Vs. M/s. Tata Power Solar Systems Ltd. in Income Tax Appeal No.1120 of 2014, judgment dated 16.12.2016. The relevant findings of the Hon’ble High Court are as under:- “(d) We find that the impugned order of the Tribunal holding that a party is not barred in law from withdrawing from its list of comparables, a company, if the same is found to have been included on account of mistake as on facts, it is not comparable. The Transfer Pricing Mechanism requires comparability analysis to be done between like companies and controlled and un-controlled transactions.
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This comparison has to be done between like companies and requires carrying out of FAR analysis to find the same. Moreover, the Assessee‟s submission in arriving at the ALP is not final. It is for the TPO to examine and find out the companies listed as comparables which are, in fact comparable. The impugned order has on FAR analysis found that M/s. Indowind Energy Ltd. and B.F. Utilities Ltd. are not comparable. They are in a different area i.e. wind energy while the Respondent-Assessee is in the field of solar energy.”
Now, coming to the exclusion of Cosmic Global Limited and Vishal Information Technologies Limited. The financial statements of the said concerns reflect that Cosmic Global Ltd. is engaged in translation and prescription of data which is entirely different from the functions performed by the assessee. Further, the said concern has been rejected by the TPO himself in the TP assessment proceedings for assessment year 2012-13, in turn, relying on the ratio laid down by the Pune Bench of Tribunal in PTC Software (India) Private Limited Vs. DCIT in ITA No.336/PN/2014, relating to assessment year 2009-10, order dated 31.10.2014 and Principal Global Services Pvt. Ltd. for assessment year 2009-10. The assessee has placed on record the copy of order of TPO under section 92CA(3) of the Act for assessment year 2012-13 at pages 380 onwards of Paper Book with relevant reference at page 397 of Paper Book.
The Pune Bench of Tribunal in Eaton Industries Pvt. Ltd. Vs. ACIT in ITA No.2544/PUN/2012, relating to assessment year 2008-09, order dated 30.10.2017 has held that Cosmic Global Ltd. is not to be functionally comparable to a concern which is engaged in BPO services. The relevant findings of Tribunal are as under:- “30. The last concern which the assessee wants to be excluded from the final set of comparables prepared by the TPO is Cosmic Global, wherein the said concern had sub-contracted IT Enabled Services to third party vendors. The said concern had low employee cost to sales ratio and hence, had different business model from that of the assessee. We find that the said concern has been excluded as being not comparable to BPO service provider by the Pune Bench of Tribunal in Cummins Turbo Technologies Ltd. Vs. Dy.DIT(IT) (2016) 68 taxmann.com 273 (Pune - Trib.). We find that the said concern is not comparable to the assessee as the functions performed by it were quite
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dissimilar to the business model of the assessee while carrying out its ITES services to the associated enterprises. 31. The Hon‟ble High Court of Delhi in Rampgreen Solutions Pvt. Ltd. Vs. CIT in ITA No.102/2015, vide judgment dated 10.08.2015 had upheld the exclusion of Cosmic Global Ltd. because of its low expenditure on employment cost being functionally dissimilar. In view of the findings of Tribunal in the case of another IT enabled service provider and the ratio laid down by Hon‟ble Delhi High Court, we hold that where Cosmic Global Ltd. was operating in different business model than the assessee in the year under consideration, the same needs to be excluded from the final set of comparables.”
Similarly, such is the proposition in respect of Vishal Information Technologies Ltd. (Coral Hubs Ltd.). The Hon’ble High Court in Rampgreen Solutions Pvt. Ltd. Vs. CIT (supra) has held the said concern not to be functionally comparable to concern providing BPO services. Accordingly, we hold that both Cosmic Global Ltd. and Vishal Information Technologies Ltd. are to be excluded from final set of comparables.
Before parting, we also refer to one concern which the assessee wanted to be included i.e. CG VAK Software and Exports Ltd. The assessee pointed out that it is not a persistent loss making concern and hence, the same should not be excluded from final set of comparables. We have already decided similar issue of inclusion of CG VAK Software and Exports Ltd. on the same ground of not being persistent loss making in Starent Networks (India) Pvt. Ltd. Vs. ACIT in ITA No.164/PUN/2013, relating to assessment year 2008-09, order dated 09.02.2018 and have held as under:- “25. Now, coming to the concern CG VAK Software & Exports Ltd. and SIP Technologies & Exports Ltd. which were excluded on the ground that they were persistent loss making concerns. 26. The learned Authorized Representative for the assessee pointed out that CG VAK Software & Exports Ltd. was not persistent loss making concern. In this regard, he pointed out that the margins of said concern in the earlier two years was positive and only in the year under consideration, there was loss of 1.97%. He further stressed that segmental details were available in respect of revenue from software development and revenue from BPO service. The assessee pointed out that the Tribunal in TIBCO software India Pvt. Ltd. Vs. DCIT (2015) 56 taxmann.com 91 (Pune-Trib) at page 13 vide paras 26 and 29 had considered
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the plea of assessee and held the said concern to be included in the final list of comparables as it was not a consistent loss making company. He further placed reliance on the ratio laid down by the Hon‟ble Bombay High Court in CIT Vs. Welspun Zucchi Textiles (2017) 77 taxmann.com 137 (Bom). 27. The learned Departmental Representative for the Revenue placed reliance on the orders of authorities below. 28. We find no merit in the plea of Revenue in this regard. The reason for exclusion of CG VAK Software & Exports Ltd. was that the operating margin for the year under consideration was that the concern was showing loss. In the financial year 2005-06, the operating margin i.e. OP/OC was 2.54%, in financial year 2006-07 it was 5.69% and in financial year 2007-08, it was (-) 1.97%. The concern which has been thus, claimed to be persistent loss making by the TPO has only suffered losses in a particular year. Where the concern is not consistent loss making concern, then the same is not to be excluded from list of comparables, is the ratio laid down by the Hon‟ble Bombay High Court in CIT Vs. Welspun Zucchi Textiles Ltd. (supra). The Tribunal in TIBCO Software India Pvt. Ltd. Vs. DCIT (supra) had also similarly held vide para 29, which reads as under:- “29. We have carefully considered the rival submissions. In our considered opinion, the point sought to be made out by the TPO is quite mis-placed having regard to the purpose and import of the comparability analysis of the international transaction being undertaken for determining its arm's length price. Ostensibly, the whole objective of the transfer pricing proceeding is that the contours of an un-controlled transaction shall reflect a measure of arm's length price of the tested international transaction. The un-controlled transaction, if it reflects a loss, would not normally be excludible unless any peculiarity in such un-controlled transaction is brought out. For instance, the un-controlled transaction is of an entity which is consistently loss making or that the loss has arisen in the un-controlled transaction on account of an abnormal fact-situation, etc. In such situations, ostensibly, the un-controlled transaction would not reflect a normal business situation. In the present case, the comparable in question has incurred a loss; notably, incurrence of loss in business operations is a normal incident of business and there is nothing to suggest in the present case that it has been incurred in any abnormal situation. It is also not the case of the Revenue that the said concern is a consistently loss making concern. Therefore, the said concern cannot be excluded merely because of incurrence of loss in this year, especially when the said loss has not been established to be an abnormal business condition and more so in the context that the said concern is not denied to be functionally comparable to the assessee. Therefore, on this aspect, we uphold the plea of the assessee for including the said concern in the final set of comparables in order to determine the arm's length price of the international transaction. Thus, on this aspect, assessee succeeds.” 29. Accordingly, we allow the ground of appeal raised by the assessee and hold that CG VAK Software & Exports Ltd. is to be included in the final list of comparables.”
Accordingly, we hold that CG VAK Software & Exports Ltd. is to be included in final list of comparables.
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Now, coming to the ground of appeal No.8 raised by the assessee against certain mistakes in computing margins of comparables.
The learned Authorized Representative for the assessee pointed out that it had filed an application under section 154 of the Act, which was rectified by the Assessing Officer and certain margins were amended. The CIT(A) vide para 2.9.3 has referred to other margins and has given some directions to the Assessing Officer, which have not been carried out. Further, in para 2.9.3, the CIT(A) has referred to Safe Harbour Rules to be applied subsequently. The assessee is aggrieved by the said observations of CIT(A).
We find merit in the plea of assessee in this regard and delete the findings of CIT(A) vis-à-vis Safe Harbour Rules. However, in respect of rectification to be carried out in the margins of comparables, the Assessing Officer / TPO is directed to carry out the said rectification and give appeal effect to the assessee. The learned Authorized Representative for the assessee in this regard pointed out that in case the above said concerns are excluded, then the margins shown by the assessee would be within +/- 5% of mean margins of comparables and no other adjustment on account of comparables is to be made except the economic adjustments asked for. Accordingly, we direct the Assessing Officer to compute the margins of comparables and also to exclude the concern which we have so held in the paras hereinabove and compute the TP adjustment, if any, in the hands of assessee.
Now, coming to ground of appeal No.9, wherein the assessee has asked for adjustment on account of capacity utilization.
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The learned Authorized Representative for the assessee in this regard pointed out that this was the first year of operations and hence, the capacity to its full could not be utilized and hence the call for adjustment on account of capacity under utilization. We find merit in the plea of assessee and following the ratio laid down by the Pune Bench of Tribunal in Affinity Express India Pvt. Ltd. Vs. DCIT in ITA No.1467/PN/2010, relating to assessment year 2006-07, order dated 10.06.2016, we allow the adjustment on account of capacity under utilization to the assessee. The relevant findings of Tribunal are as under:- “10. The second issue raised by the assessee in ground no. 3 of the appeal relates to capacity utilization. We find that TPO has not accepted the adjustment made by the assessee on account of under utilization of its employees and under absorption of its overheads, primarily on the ground that the assessee company is a captive unit of its AE. The entire capacity increased by the assessee is for the purpose of business of its holding AE. Thus, there cannot be any possibility of under utilization of capacity. The DRP made a detailed discussion in its order in respect of under utilization of manpower and under absorption of overheads. However, after the elaborate discussion we find that DRP has not given any findings on this issue. The ld. AR of the assessee has placed on record a copy of the order of Tribunal in assessee‟s own case for the assessment year 2004-05, wherein the identical issue was considered. The relevant extract of the findings of the Tribunal are reproduced here-in-below: “7. We have heard the submissions made by the representatives of rival sides and have perused the orders of the authorities below. We have also considered the decisions on which the ld. AR of the assessee has placed reliance to support his submissions. The assessee in its appeal has raised 6 grounds. Ground Nos. 1, 5 and 6 are general in nature. Hence, require no adjudication. Thus, the effective grounds raised in the appeal are 2, 3 and 4 only. 8. In ground no. 2 the assessee has assailed the findings of Commissioner of Income Tax (Appeals) in upholding the order of Assessing Officer in rejecting functional (capacity utilization) adjustment. The contention of the assessee is that during the period relevant to the assessment year under consideration the assessee has expanded its output capacity by increasing manpower by anticipating new markets and increased volume of work from the existing customers. However, the volume of the work did not increase in commensurate with the expanded production capacity of the assessee company. While calculating operating margin the fixed cost have been adjusted to the extent of capacity under unitized in the „Documentation business‟ of the assessee. The assessee has given working of under utilization of the capacity and manpower for documentation business at page 181 of the paper book. The relevant extract of the same is reproduced here-in-under:
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Sr. No. Particulars Number I Under-absorption of Overheads Installed capacity - Jobs per day 413 Actual Jobs per day 294 Under-utilization of working facilities 119 - % Under-utilisation of working 29% facilities I Under-utilization of Manpower Average Number of Employees (employed during the 197 year) Average Number of Employees executing the jobs 118 (Considering 2.5 Jobs per employee per hour as standard) Under-utilization of man-power 79
% Under-utilization of man-power 40%
The ld. AR also furnished revised working of PLI of the comparables in support of employees cost and fixed expenses. 8.1 The TPO and Commissioner of Income Tax have denied the capacity utilization adjustment on the ground that the assessee company is a captive unit of its AE. It is presumed that the orders/business are assured because the entire capacity created is for the purpose of business of the holding AE. The under utilization of the capacity can only be possible if the holding AE is not performing well. The fact that the assessee has increased the working capacity during the year has not been examined by the authorities below. The TPO and the Commissioner of Income Tax (Appeals) rejected the contentions of the assessee merely on the ground that the assessee is a captive unit of holding AE, therefore, the entire production capacity will be monitored and utilized by the holding company alone. The TPO and the Commissioner of Income Tax (Appeals) have erred in not examining the factual aspect of increase in output capacity before rejecting functional adjustment made to the PLI. The contention of the assessee is that it had increased the capacity in anticipation of new vistas. We do not concur with the view of Commissioner of Income Tax (Appeals) that future business demands can be predicted with accuracy by using modern business management tools. If that would be the case, no business venture would fail. The future is uncertain, market forces play a vital role in providing buoyancy to new business ventures. The claim of the assessee can be rejected if the assertions made by the assessee are found to be incorrect. The Tribunal in various cases has granted under/low capacity utilization adjustments. 9. The Bangalore Bench of the Tribunal in the case of M/s. Genisys Integrating Systems (India) Pvt. Ltd. Vs. DCIT (supra) has held as under: “15. With regard to low capacity utilization, adjustments to be given in the determination of ALP in ITES sector, the learned
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counsel for the assessee submitted that during the year under consideration the assessee had under utilized its facilities to the extent of 51.89% and therefore, this adjustments also should be given while determining the ALP. After giving adjustments, according to him the net operating margin on cost would be 27.46%. He submitted that the learned TPO has rejected the adjustments on the ground that comparables have similar problem as they have idle bench strength. He submitted that the adjustments sought was for under utilization of infrastructure while in the case of comparables, it is the case of idle bench strength. He submitted that infrastructure certain fixed costs attached to it which would affect the operating margin of the assessee considerably. 15.1 In support of his contention, that adjustment has to be made for under utilization of the infrastructures he placed reliance upon the decision of the Tribunal at Delhi in the case of M/s Global Vantedge Pvt.Ltd., (2010-TIOL-24 ITAT- Delhi) and also the decision of ITAT in the case of M/s Fiat India Pvt.Ltd., Vs ACIT 2010-TII-30 ITAT-Mum-TP. He has also drawn our attention to the orders of the TPO in the case of other companies for the assessment year 2007-08, the extracts of which are reproduced at pages 199-200 of paper book-2, wherein the TPO has observed that the average under utilization of manpower in ITES industry is 20% as per information available in the public domain. The adjustment to the extent of difference is being allowed. He submitted that when the under utilization of manpower is allowed, similar adjustment for under utilization of infrastructure also has to be allowed.” 10. The Pune Bench of the Tribunal in the case of Tasty Bite Eatables Limited Vs. ACIT (supra) while dealing with the issue of capacity under utilization placed reliance on the decision of Mumbai Bench of the Tribunal in the case of ACIT Vs. M/s. Fiat India Pvt. Ltd. in ITA No. 1848/Mum/2009 decided on 30-04-2010 and in the case of Ariston Thermo India in ITA No. 1455/PN/2010 decided on 25-06-2013 and granted the benefit of low capacity utilization to the assessee. 11. The Delhi Bench of the Tribunal in the case of DCIT Vs. Claas India Pvt. Ltd. (supra) while dealing with the issue of capacity utilization in an elaborate manner bifurcated the issue in two parts i.e. capacity adjustment, allowable in whose hands and how to compute capacity adjustment under TNMM. The relevant extract of the order of Tribunal reads as under: “8. We have heard the rival submissions and perused the relevant material on record. Before embarking upon the question of allowability and extent of capacity adjustment under the TNMM, we want to make it clear that the assessee reduced its operating costs by considering its capacity utilization vis-à-vis that of comparables and resultantly claimed that its increased profit as a result of such reduced operating costs be compared with that of the comparables. The TPO has also agreed in principle with the otherwise availability of the capacity adjustment. The issue of allowing capacity adjustment before us can be divided into two sub-issues for consideration, viz., first, whether the adjustment should be allowed in the hands of the assessee as has been done
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by the authorities below or comparables and second, how to compute capacity utilization adjustment under the TNMM. We will deal with these aspects one by one. i. Capacity adjustment should be allowed in whose hands? 9.1. It has been noticed above that the assessee claimed idle capacity adjustment by reducing its own operating costs. It is further observed that the authorities below have reduced the amount of adjustment by excluding certain costs from the ambit of the costs qualifying for adjustment. However, the adjustment has been ultimately allowed from the operating costs incurred by the assessee. In such circumstances, the question arises as to whether the action of the authorities in allowing the reduction of the operating costs incurred by the assessee, is in accordance with law? In order to find answer to this question, we need to refer to the manner of computation of the arm‟s length price under TNMM, which has been set out in Rule 10B(1)(e) as under:- “(e) transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base ; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market ; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii) ; (v) the net profit margin thus established is then taken into account to arrive at an arm‟s length price in relation to the international transaction.” 9.2. Sub-clause (i) in the process of determination of the ALP under the TNMM talks of the computation of net operating profit margin realized by the assessee from an international transaction. Sub-clause (ii) is the computation of net operating profit margin realized by an unrelated enterprise from a comparable uncontrolled transaction. This refers to determining the operating profit margin of comparables with the same base as that of the assessee. Sub-clause (iii) provides that the net profit margin realized by a comparable company, determined as per sub-clause
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(ii) above, „is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, ..... which could materially affect the amount of net profit margin in the open market.‟ It is this adjusted net profit margin of the unrelated transactions or of the comparable companies, as determined under sub-clause (iii), which is used for the purposes of making comparison with the net profit margin realized by the assessee from its international transaction as per sub-clause (i). 9.3. Sub-rule (2) of Rule 10B provides that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to certain factors which have been enumerated therein. Rule 10B(3) states that an uncontrolled transaction shall be comparable to an international transaction, if either there are no differences between the two or a „reasonably accurate adjustment can be made to eliminate the material effects of such differences.‟ When we read sub-clauses (ii) & (iii) of Rule 10B(1)(e) in juxtaposition to sub-rules (2) & (3) of rule 10B, the position which emerges is that the net operating profit margin of comparable companies calls for adjustment in such a manner so as to bring both the international transaction and comparable cases at the same pedestal. In other words, if there are no differences in these two, then the average of the net operating profit margin of the comparable companies becomes a benchmark. However, in case there are some differences between the comparables and the assessee, then the effect of such differences should be ironed out by making suitable adjustment to the operating profit margin of comparables. That is the way for bringing both the transactions, namely, the international transaction and the comparable uncontrolled transactions, on the same platform for making a meaningful and effective comparison. The above analysis overtly transpires that the law provides for adjusting the profit margin of comparables on account of the material differences between the international transaction of the assessee and comparable uncontrolled transactions. It is not the other way around to adjust the profit margin of the assessee. In other words, the net operating profit margin realized by the assessee from its international transaction is to be computed as such, without adjusting it on account of differences with the comparable uncontrolled transactions. The adjustment, if any, is required to be made only in the profit margins of the comparables. 9.4. Reverting to the facts of the instant case, we find that the authorities below have adjusted the operating costs of the assessee in allowing the capacity adjustment. As against that, the correct course of action provided under the law is to adjust the operating costs of the comparable and their resultant operating profit. There is hardly need to accentuate that there can be no estoppel against the law. Once the law enjoins for doing a particular thing in a particular manner alone, it is not open to anyone to adopt a contrary or different approach. As the authorities below have adopted a course of action in allowing adjustment, which is not in consonance with law, we cannot approve the same. The impugned order is set aside and the matter is restored to the file of the TPO/AO for giving effect to the
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amount of idle capacity adjustment in the operating profit of the comparables and not the assessee. ii. How to compute capacity utilization adjustment under TNMM: - 10.1. Under the TNMM, the ALP of an international transaction is determined by computing and comparing the percentage of operating profit margin realized by the assessee with that of the comparables. We have noticed above that the difference in the capacity utilizations is an important factor, which needs to be adjusted. No mechanism has been given under the Act or the rules for computing the amount of capacity utilization adjustment. 10.2. On an overall understanding, we feel that under the TNMM, the first step in granting capacity utilization adjustment is to ascertain the percentage of capacity utilization by the assessee and comparables. There can be no difficulty in working out these percentages. The second step is to give effect (positive or negative) to the difference in the percentage of capacity utilizations of the assessee vis-à-vis comparables, one by one, in the operating profit of comparables by adjusting their respective operating costs. Operating costs can be either fixed or variable or semi-variable. One needs to split semi-variable costs into the fixed part and variable part. In so far as the variable costs and the variable part of the semi-variable costs are concerned, these remain unaffected due to any under or over utilization of capacity. Accordingly, such variable operating costs remain unchanged. The adjustment is called for only in respect of the fixed operating costs and fixed part of semi-variable costs. Such costs are scaled up or down by considering the percentage of capacity utilization by the assessee and such comparable. It can be illustrated with the help of a simple example. Suppose the fixed costs incurred by a comparable (say, A) are Rs. 100 and it has capacity utilization of 50% as against the capacity utilization of 25% by the assessee. The above percentages show that the assessee has incurred full fixed costs with 25% of the utilization of its capacity, as against A incurring full fixed costs with 50% of its capacity utilization. This divulges that the assessee has incurred relatively more fixed costs and A has incurred lower costs. In order to make an effective comparison, there arises a need to obliterate the effect of this difference in capacity utilizations. It can be done by proportionately scaling up the fixed costs incurred by A so as to make it fully comparable with the assessee. This we can do by increasing the fixed costs of A to Rs. 200 (Rs.100 into 50/25) as against the actually incurred fixed costs by it at Rs.100. When we compute operating profit of A by substituting the fixed costs at Rs.200 with the actually incurred at Rs.100, it would mean that the fixed costs incurred by the assessee and A are at the same capacity utilization. There can be converse situation as well. Suppose the fixed costs incurred by a comparable (say, B) are Rs. 100 and it has capacity utilization of 25% as against the capacity utilization of 50% by the assessee. The above percentages show that the assessee has incurred full fixed costs at 50% of the utilization of its capacity, as against B incurring full fixed costs at 25% of the capacity utilization. This deciphers that the assessee has incurred relatively lower fixed costs and B has incurred higher
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costs. This difference in capacity utilizations can be eliminated by proportionately scaling down the fixed costs incurred by B so as to make it fully comparable. This we can do by reducing the fixed costs of B to Rs. 50 (Rs.100 into 25/50) as against the actually incurred fixed cost by it at Rs.100. When we compute operating profit of B by substituting the fixed costs at Rs.50 with the actually incurred at Rs.100, it would mean that the fixed costs incurred by the assessee and B are at the same capacity utilization level. 10.3. Turning to the facts of the instant case, we find that both the TPO as well as the ld. CIT(A) have proceeded on a wrong premise not only by allowing capacity utilization adjustment in the assessee‟s profit, which is contrary to the legal position as discussed above, but also by considering all the comparables as one unit with the average percentage of their respective capacity utilizations. It is further observed that in the calculation of such capacity utilization adjustment, the ld. CIT(A) has considered four companies as comparable, which view has been modified by us supra inasmuch as we have held that M/s Eicher Motors and M/s. Force Motors are incomparable. Naturally, they would also go out of reckoning in the computation of idle capacity utilization adjustment. In the absence of the availability of financials of all the comparable companies, it is not possible at our end to work out the amount of capacity adjustment in the manner discussed above. Ergo, we set aside the impugned order and direct the TPO/AO to work out the amount of capacity utilization adjustment afresh in terms of our above observations. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings.” 12. Thus, in view of the decisions of the Tribunal discussed above, it is evident that the capacity utilization adjustment has to be granted where there has been under utilization or lower utilization of the capacity. In the facts of the present case, we deem it appropriate to remit the issue back to the file of Assessing Officer to decide this issue afresh after considering the submissions of the assessee, documents on record and decisions of the Tribunal. Accordingly, ground no. 2 raised in the appeal is allowed for statistical purpose.” 11. The ld. DR has not been able to controvert the findings of the Tribunal in asessee‟s own case. Thus, in view of the similarity of facts in the assessment year under appeal, we deem it appropriate to restore the file back to the Assessing Officer to decide this issue in same terms. Accordingly, ground no. 3 raised in the appeal is allowed for statistical purpose.”
Following the same parity of reasoning, the issue is restored back to the file of Assessing Officer to decide the same in line with the above directions of Tribunal. The ground of appeal No.9 is thus, allowed for statistical purposes.
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The ground of appeal No.10 raised by the assessee is not pressed, hence the same is dismissed as not pressed.
Now, coming to the ground of appeal No.11 raised by the assessee.
Brief facts relating to the issue are that the assessee claimed that expenses which are incurred by it also include the recovery of expenses incurred on behalf of Club 24 and NEXT Plc which are not routed through Profit and Loss Account. Accordingly, the said expenses which are recovered on cost without any mark up should not be considered as part of operating income and operating cost of Ventura India.
The assessee is aggrieved by the order of TPO in re-computing PLI of assessee by including expenses recovered as part of operating income and operating expenses; such re-working of PLI was in respect of margins of assessee and no such exercise was carried out in respect of margins of comparables finally selected. The assessee is aggrieved by such an approach of TPO in adopting different methodology for computing operating margins of assessee and hence, the ground of appeal No.11 raised by the assessee. While applying the transfer pricing adjustment, the endeavour is to compare like with like and hence, the said exercise should be carried out not only in spirit but in actual fact. In the facts of the present case before us, the assessee is aggrieved by the action of TPO in adopting different methodology for computing its operating margins. The assessee had pointed out that certain costs were recovered from other concerns and the same should be excluded from its operating income and operating cost as it does not have bearing on the margins of assessee. We find merit in the plea of assessee in this regard. The PLI
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adopted by the assessee and the TPO is operating income / operating cost and hence, only operating income and operating cost of assessee is to be considered for working the margins for the year under consideration. In case certain expenses have been incurred on behalf of related concerns, which in turn, have been reimbursed, then the same are to be excluded from both operating income and operating cost. Accordingly, we hold so and direct the Assessing Officer / TPO to re-work the margins of assessee in this regard and also of comparables.
Now, coming to the appeal of Revenue, wherein the ground of appeal No.2 raised by the Revenue is against exclusion of Cross Domain Solutions Ltd. as well as Eclerx Services Ltd. as comparable on the ground that the said concerns were making higher profits.
The learned Authorized Representative for the assessee in this regard pointed out that the two concerns Cross Domain Solutions Ltd. as well as Eclerx Services Ltd. were engaged in KPO services and hence, the same were excluded from final list of comparables by the CIT(A). We have already decided similar issue in the paras hereinabove and have directed the Assessing Officer / TPO to exclude the concerns which are engaged in KPO services being not functionally comparable to the assessee which are engaged in BPO services. Following the same parity of reasoning, we uphold the order of CIT(A) in excluding Cross Domain Solutions Ltd. as well as Eclerx Services Ltd. being engaged in KPO services.
Now, coming to ground of appeal No.1 raised by the Revenue which is against inclusion of Aditya Birla Minacs Worldwide Ltd. as comparable on the ground that it is not consistent loss making concern.
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The learned Departmental Representative for the Revenue in this regard pointed out that facts need confirmation. However, the learned Authorized Representative for the assessee relied on the findings of CIT(A) in this regard. We find merit in the plea of learned Departmental Representative for the Revenue that it needs to be confirmed whether the said concern was persistent loss making. In case it is so, then the same is to be excluded but in case it is not so, then the same is to be included. Accordingly, we direct the Assessing Officer/ TPO to carry out necessary verification in this regard. The ground of appeal No.1 raised by the Revenue is thus, allowed for statistical purposes.
The ground of appeal No.3 raised by Revenue is in respect of working capital adjustment.
The Revenue is aggrieved in this regard by directions of CIT(A) to the Assessing Officer / TPO to examine the working capital adjustment as computed by the assessee and re-work the adjustment by considering the advance receivable for computing net working capital of assessee as the same was considered in computation of working capital of comparable companies. The TPO had not taken into consideration the advance from customers while computing net current assets. The plea of assessee is that where the assessee had received advances from its customers which were reflected in the financial statements, hence the same needed to be considered while computing net current assets, which was not accepted by the TPO. The assessee had raised the contention before the CIT(A) of adopting same methodology for computation of working capital adjustment both for tested party as well as comparable concerns. The CIT(A) has accordingly, directed the Assessing Officer / TPO to examine the working and adopt the same methodology as adopted for the
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comparables. We find no error in the directions of CIT(A) in this regard, where in any case, for computing adjustments, if any, the same treatment to be given to both tested party and comparable concerns. Accordingly, we find no merit in the ground of appeal No.3 raised by Revenue and the same is rejected. The grounds of appeal raised by the Revenue are thus, partly allowed.
In the result, both the appeals of assessee and Revenue are partly allowed.
Order pronounced on this 9th day of March, 2018.
Sd/- Sd/- (ANIL CHATURVEDI) (SUSHMA CHOWLA) ऱेखा सदस्य / ACCOUNTANT MEMBER न्याययक सदस्य / JUDICIAL MEMBER ऩुणे / Pune; ददनाांक Dated : 9th March, 2018. GCVSR आदेश की प्रयतलऱपप अग्रेपषत/Copy of the Order is forwarded to : अऩीऱाथी / The Appellant; 1. प्रत्यथी / The Respondent; 2. आयकर आयुक्त(अऩीऱ) / The CIT(A)-IT/TP, Pune; 3. The CIT-IV / DIT(TP/IT), Pune; 4. ववबागीय प्रतततनधध, आयकर अऩीऱीय अधधकरण, ऩुणे “फी” / DR 5. ‘B’, ITAT, Pune; गार्ड पाईऱ / Guard file. 6. आदेशािुसार/ BY ORDER, सत्यावऩत प्रतत //True Copy// वररष्ठ तनजी सधिव / Sr. Private Secretary आयकर अऩीऱीय अधधकरण ,ऩुणे / ITAT, Pune