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Income Tax Appellate Tribunal, MUMBAI BENCH “K”, MUMBAI
Before: SHRI AMIT SHUKLA & SHRI MANOJ KUMAR AGGARWAL
O R D E R
Per Amit Shukla, Judicial Member:
The aforesaid cross appeals have been filed by the assessee as well as by the revenue against impugned final assessment order & 1958/M/2014 2 Pangea3 & Legal Database Systems Pvt. Ltd. dated 24.01.2014, for the quantum of assessment passed u/s. 143(3) r.w.s. 144C(3), in pursuance of directions given by the Dispute Resolution Panel-3, Mumbai (DRP), vide order dated 30.12.2013 u/s. 144C(5) for the AY 2009-10. Since issues involved in both the appeals are same, therefore same are taken up together.
2. In the assessee’s appeal, following grounds of appeal have been taken: “GROUND NO. 1:
The Ld. AO has erred in law and on facts and in circumstances of the case in assessing the total taxable income at Rs. 5,47,61,076 as against the returned income of Rs. 11,61,076 and making adjustment of Rs 5,36,00,000 in respect of the international transactions of the appellant based on the directions issued by the DRP.
GROUND NO. 2:
The Learned Additional Commissioner of Income-tax [TP-II(2)] ('the learned TPO') has erred in law and on facts and in circumstances of the case in pointing out various defects in the Transfer Pricing Study ('TP Study') of the appellant without appreciating the correct facts of the case. Further, DRP has also erred in rejecting the objection of the Appellant. The DRP overlooked the fact that the Appellant had not used earlier years' data and misdirected itself in erroneously alleging that the Appellant had used earlier years' data.
GROUND NO. 3:
The Ld. AO/TPO/DRP ought to have accepted the operating profit margin of the Appellant at 15% and the operating profit margin of the comparable cases at 5.04% as worked out by the Appellant as per TP Study.
4. GROUND NO. 4:
The Ld. AO/TPO/DRP erred in holding that the data which was not available as on the due date of filing return of income could be taken into account in determining the Arm's Length Price (' ALP').
5. GROUND NO. 5:
5.1 The Ld. AO/TPOIDRP has erred in law and on facts and in circumstances of the case in considering the foreign exchange loss & 1958/M/2014 3 Pangea3 & Legal Database Systems Pvt. Ltd. incurred by the appellant as operating expense for calculating the operating profit margin of the appellant.
5.2 The Ld. AO/TPO/DRP has erred in overlooking and ignoring the fact that the foreign exchange loss of Rs.3.41 crores included amount of Rs.2.23 crores on account of cancellation of forward Forex contracts which was an abnormal item.
5.3 The Ld. AO/TPO/DRP has erred and acted contrary to the evidence and material on record in alleging that the Appellant's Forex losses were not abnormal as compared to the comparables and as such were not required to be adjusted.
6. GROUND NO. 6:
The Ld. AO/TPO/DRP has erred in law and on facts and in circumstances of the case in rejecting the following companies as comparable companies:
6.1 IKF Technologies Ltd. ('IKF Technologies') 6.2 Lee & Nee Software (Exports) Ltd. ('Lee &: Nee Software') 6.3 Allsec Technologies Ltd ('Allsec') 6.4 Tata business Support Services Limited ('Tata Business') 6.5 R Systems International Ltd ('R Systems') 6.6 Jindal Intellicom Pvt. Ltd ('Jindal') 6.7 Optimus Global Service Ltd ('Optimus') 6.8 Sundaram Business Services Ltd ('Sundaram') 6.9 Galaxy Commercial Ltd. ('Galaxy Commercial') 6.10 Inhouse Productions Ltd.('lnhouse Productions') 6.11 Sparsh BPO Service Ltd ('Sparsh BPO')
7. GROUND NO. 7:
The learned AO/TPO/DRP have erred in law and on facts and in circumstances of the case in selecting following companies as comparables, which should not have been taken as comparable companies.
7.1 Acropetal Techologies Ltd. ('Acropetal')
7.2 Accentia Technologies Ltd. ('Accentia')
& 1958/M/2014 4 Pangea3 & Legal Database Systems Pvt. Ltd. 7.3 e-Clerx Services Ltd. ('eClerx')
8. GROUND NO. 8:
The learned AO/TPO/DRP have erred in law and on facts in not modifying the draft assessment order in respect of Datamatics Financial Services Limited ('Datamatics') as submitted by the Appellant.
9. GROUND NO. 9:
9.1 The learned AO/TPO/DRP have erred in law and on facts and in circumstances of the case in not allowing working capital adjustment while computing average operating profit margin of the comparables.
9.2 The learned AO/TPO/DRP have acted contrary to the record and erred in alleging that the Appellant had not demonstrated that working capital adjustment was essential in the facts of its case.
10. GROUND NO. 10:
The learned AO/TPO/DRP have erred in law and on facts and in circumstances of the case in making upward adjustment exceeding the difference between total revenue earned by the AE from independent third party clients and revenue booked by the appellant from AE.
11. GROUND NO. 11:
The learned AO/TPO/DRP have erred in law and on facts and in circumstances of the case in making the upward adjustment without considering inter alia the facts that during the year under consideration, the AE has incurred substantial operating loss and the assessee is STPI unit with 100% tax exemption and as such, there is no incentive to shift profit outside India.
12. GROUND NO. 12:
The learned AO has erred in law and on facts and in circumstances of the case in making the upward adjustment of Rs.5,36,00,000 in his final computation instead of Rs.5,35,52,000 as per the body of his assessment order.
13. GROUND NO. 13:
The orders of the Ld. AO/TPO/DRP are vitiated by errors in law and fact and on account of ignoring and thereby being contrary to the material and evidence on record and on account of internal contradiction and inconsistencies.”
& 1958/M/2014 5 Pangea3 & Legal Database Systems Pvt. Ltd.
3. The Department in its appeal has raised the following grounds: “1.Whether on the facts and circumstances of the case, did the DRP err in directing the TPO to re-compute the adjustment on account of arm's length price by rejecting the comparables selected by the TPO and consequently giving relief of Rs.3,27, 59,000/- to the assessee without appreciating the fact that the comparables were selected appropriately as per the provisions of the Act."
2. "Whether on the facts and circumstances of the case, did the DRP err in directing the TPO to include Micro land Ltd. as comparable without appreciating the fact that the comparable selected by the TPO was appropriate and as per the provisions of the Act."
3. "Whether on the facts and circumstances of the case, did the DRP err in directing the TPO to allocate administrative expenses and depreciation while computing the operative margin in respect of Acropetal Technologies included as comparable without appreciating the fact that the same was included accordingly as per the provisions of the Act."
4. "The appellant prays that the order of DRP on the above grounds be set aside and that of the Assessing Officer be restored." Thus, the whole issue revolves around transfer pricing adjustment of Rs.5,36,00,000/- made under the provisions of ITES support services.
The brief facts qua the issue of transfer pricing adjustment are that, the assessee company is registered as STPI unit with Software Technology Parks of India. The functions performed by the assessee includes rendering of ITES services in the nature of legal support services, data processing, legal database and other administrative support services to its AE. Further, ITES services provided by the assessee mainly includes document review services (i.e. identifying the documents into responsive or non-responsive document based on the procedure manual provided by the client), abstraction services & 1958/M/2014 6 Pangea3 & Legal Database Systems Pvt. Ltd. (i.e. punching the data from the contracts in predefined format like Excel or client provided template), drafting services (i.e. feeding of key contract data into contract template provided by the client) etc. In other words, the assessee company can be classified as mainly engaged in providing ‘Information Technology Enabled Services’ (ITES) to its associated enterprises. As per the agreement with the AE the remuneration for providing ITES to AE is Cost plus 15% mark up. To benchmark the international transaction of ITES with AE as well as margin of 15%, the assessee selected TNMM as the most appropriate method and the PLI was based on operating profit /operating cost. The working was given in the following manner: Particulars Amount (Rs. in lac) Operating Revenue (A) 3,324.40 Operating Cost (B) 2,890.78 Operating Profit (C=B-A) 433.62 Net Cost Plus % (C/B *100) 15.00% In its TP Study Report, the assessee had selected following five comparables: Name of company OP/Cost % i. Aditya Birla Mincas Worldwide Limited 21.43
ii. Allsec Technoligies Limited -16.44 iii. Sundaram Business Services Limited 2.54 iv. R Systems International Limited 16.91 v. Cross domain Solutions Private Limited 26.92
Arithmetic Mean 10.27 After claiming working capital adjustment of 5.23%, the adjusted arithmetic mean was arrived at 5.04% and hence, it was reported that the international transaction with the AE meets the arm’s length price. & 1958/M/2014 7 Pangea3 & Legal Database Systems Pvt. Ltd.
The Ld. TPO first of all held that, assessee’s working of PLI was erroneous as it had wrongly considered foreign exchange loss as non-operating item of expenses. He, therefore, re-casted the PLI in the following manner: Particulars Amount (Rs. in lac)
Operating Revenue (A) 3,324.40 Operating Cost (B) 3232.22 Operating Profit (C=B-A) 92.18
Net Cost Plus % (C/B*100) 2.85% Thereafter, he rejected three of assessee’s comparable companies, viz., i) Allsec Technologies Ltd., on the ground that it is consistently a loss making company; ii) Sundaram Business Services Ltd., on the ground of RPT Filter being less than 25%; and iii) R. Systems International Ltd., on the ground that the financial data is up to December, 2008. TPO then proceeded to carry out his own fresh search from comparables operating in ITES segment. He first selected nine comparable companies with an arithmetic mean arrived at 30.38%; and after inviting assessee’s objection on various comparable and detailed discussion, he finally selected following comparables with an arithmetic mean of 29.57%:-
Name of the company NCP 2008-09 (%) i. Accentia Technologies Ltd. 43.42 ii. Acropetal Technologies Ltd. 46.02 iii. Cosmic Global Ltd. 43.06 & 1958/M/2014 8 Pangea3 & Legal Database Systems Pvt. Ltd. iv. Datamatics Financial Services Ltd. 3.05 v. e4e Healthcare Business Services Pvt. Ltd. 31.68 vi. e-Clerx Services Limited 46.98 vii. Informed Technologies India Ltd. 23.13
Assessee’s Comparables viii. Aditya Birla Mincas Worldwide Ltd. 1.85 ix. Crossdomain Solutions Pvt. Ltd. 26.92
Arithmetical Mean 29.57% Accordingly, an adjustment of Rs.8,63,59,000/- was made on international transaction of ITS which was shown by the assessee at Rs.33,24,40,607/-.
From the stage of the DRP two of the comparable companies’ viz., Metro Land Ltd. and Omega Healthcare Management Services Pvt. Ltd. selected by the TPO were excluded from the comparable list. Certain comparables which were submitted by the assessee before the TPO in the transfer pricing proceedings were also rejected. The DRP also allowed certain corrections in the working of operating profit margin of Acropetal Technologies Ltd. Accordingly, after the direction of the DRP the adjustment was reduced to Rs.5,35,52,000/- against which both the parties are in appeals before us.
We will first take up the issue pertaining to treatment of Forex loss and whether any adjustment on account of Forex loss can be made vis-a-vis the comparables. This issue has been raised by the assessee in ground no. 5.1 to 5.3. As stated earlier, the assessee has been set up as a STPI unit which is providing ITE services to its AE and is captive service provider. Before us the Ld. Counsel for the & 1958/M/2014 9 Pangea3 & Legal Database Systems Pvt. Ltd. assessee, Mr. Rajan Vora submitted that the assessee had entered into a ‘Service Agreement’ dated 30.06.2006 for rendering back office local support services to its AE and for the year under consideration the assessee had received advance from its AE for meeting its operating cost requirement. During the year under consideration, the assessee had suffered Forex loss of Rs.3.41 crores in the following manner: Particulars: Amount (in Rs.)
Conversion of USD from EFC A/c to INR A/c: 62,80,115 Intercompany Receivables/Payables: 39,48,667 Cancellation of forward contracts: 2,22,52,796 Reinstatement of balances: 10,89,549 Open Contract: 6,96,633 Others: (1,22,986)
Total 3,41,44,774 Mr. Vora further pointed out that, under clause 3 of the ‘service agreement’, the compensation for services to the assessee includes for all services from its AE on actual total cost plus mark up of 15%. Since the AE had given advance towards compensation for services to be rendered, it was agreed and accepted that Forex loss is not an actual cost which is incurred for providing service to AE, hence the Assessee is not supposed to recover the amount of Forex loss along with mark-up as per the inter-company agreement. In fact, he contended that no independent service recipient would agree to compensate a captive service provider for the amount of Forex loss incurred by such service provider, since Forex loss is an expense incurred after the service is provided and it is not an expense incurred for rendering of the service. It is based on Forex & 1958/M/2014 10 Pangea3 & Legal Database Systems Pvt. Ltd. management of the assessee. In the TP Study report the assessee has worked out the operating profit margin at 15% considering foreign exchange loss of Rs.3.41 as non-operating in nature as the same has been considered to be abnormal. He submitted that the TPO has erroneously re-determined the operating profit margin of the assessee at 2.85% by considering the Forex loss as operating expenses on the ground that since it is a regular occurrence in a business and therefore, should form part of the total operating cost.
Mr. Vora, as an alternative argument submitted that, at least out of Forex loss of Rs.3.41 crores, the amount of Rs.2,22,52,796/- which was towards loss on cancellation of forward contracts should be adjusted, because this was an abnormal situation particularly in the case of the assessee, as it had entered into forward contract to minimize the risk on account of exchange rate fluctuation. This is more so in the current financial year, because the exchange rate was so volatile that the assessee had to cancel the forward contracts. Before the authorities below the assessee had provided the data pertaining to the movement in the exchange rates of INR vs. US $ during the FY 2008-09. It was specifically pointed out that in this financial year the fluctuation in the foreign exchange rate was 27.47% as compared to forex fluctuation of US $ of 2.87% in the preceding three financial years. He also pointed out to various factors nationally and internationally which had affected the sharp decline of Indian rupee vis-à-vis the US dollars during the FY 2008-09, which was so abnormal that Reserve Bank of India had to step in for sale of US $ 20.6 billion in foreign exchange market. The assessee had entered into majority of forward contracts during the FY 2007-08 when the value of INR was appreciating. However, the trend in exchange rate of INR vs. US $ completely turnaround in the FY 2008- 09 when the value of INR depreciated sharply particularly post September, 2008. In the notes to the accounts the assessee has ITA Nos.2128 & 1958/M/2014 11 Pangea3 & Legal Database Systems Pvt. Ltd. highlighted its accounting policy in the past which was that, the assessee recognized marked to marked loss and gains if any, were not recognized till settlement. There was change in said accounting policy pursuant to the ICAI announcement on 29.03.2008 which was adopted by the assessee during the year under consideration. In the preceding year the accounting policy followed as per ICAI guideline was as such that profit or loss arising on settlement of forward contracts was recognized as income or expenses for the year. Thus, due to the fact that the assessee had entered into majority of ‘forward exchange contracts’ in the preceding year, i.e., FY 2007-08 and on account of change in accounting policy, there was double impact during the year under consideration. In the light of this background, Mr. Rajan Vora, submitted that such a unprecedented loss on cancellation of forward contracts is an abnormal/extraordinary feature which is peculiar to the facts of the assessee’s case qua this year which has impacted its cost base and also the margin and hence, such a loss on account of cancellation of forward contract should be treated as non-operating in nature. In support he relied on following decisions: i) HOV Services Ltd. Vs. JCIT (OSD), dated 04.08.2016; ii) DCIT Vs. Federal Mogul Automotive Products (I) Pvt. Ltd., ITA No. 5769/Del/2011 dated. 25.03.2015; iii) SAP Labs India Pvt. Ltd. 44 SOT 156 (Bang) iv) Mylan Laboratories Ltd. Vs. ACIT, ITA lNo. 66/Hyd/2013 dated 10.01.2014 He pointed out that, once the loss on cancellation of forward contract is considered as non-operating, then the operating margin of the assessee will be 10.46% as against 2.85% determined by the TPO. & 1958/M/2014 12 Pangea3 & Legal Database Systems Pvt. Ltd.
By way of an alternative argument, Mr. Vora submitted that even if forex loss compared with the comparables, then also the forex loss in case of assessee was quite abnormal. The assessee has incurred Forex loss of Rs.3.41 crores which is 11.79% of its total cost, whereas in the case of comparables it is in the range of 0.52% to 7.27%, (if the case of Aditya Birla is removed which had an abnormal rate of forex loss of 27.04%), the arithmetic mean of forex loss/total cost of all the comparables would come to 2.7%, which is almost four times the cost of assessee, i.e., 11.79%. By way of a chart he demonstrated before us, if the adjustment is to be made by taking the total forex loss of comparables which is 2.71%, then the Forex loss which can be treated to be operating in nature would come to Rs.78.34 lakhs only and in that case the operating margin would come to 11.97% as compared to 15% taken by the assessee and not 2.85% as taken by the TPO. He further pointed out that if cancellation of forward contract of Rs.2,22,52,795/- alone is taken as non-operating item then the PLI of the assessee would come to 10.46%, which can be taken for the purpose of benchmarking. In support of his contention that foreign currency fluctuation can be taken into account for transfer pricing adjustment both for comparable companies as well as the tested parties, he relied on the following two judicial precedence of Delhi ITAT: (i) Schneider Electric India Pvt. Ltd. Vs. DCIT (ITA No. 937/DEL/2014) dated 29 September 2016:- wherein the Hon'ble Delhi Tribunal has held that foreign currency fluctuations need to be taken into account for TP adjustment both for comparable companies as well as tested party. The Delhi Tribunal also observed that effect of adverse foreign exchange movement should be considered determining the arms' length price.
(ii) Honda Trading Corp. India Pvt. Ltd. Vs. ACIT (ITA No. 5297/DEL/2011) dated 8 March 2013):- wherein the Hon'ble Delhi Tribunal has held that foreign exchange & 1958/M/2014 13 Pangea3 & Legal Database Systems Pvt. Ltd. fluctuation loss on account of abnormal fluctuation in exchange rates should be treated as non-operating in nature. Accordingly, the Delhi Tribunal deleted the TP adjustment after considering foreign exchange fluctuation loss as non-operating in nature.
Mr. Vora thus concluded that; firstly, either the Forex loss upto 2.7% of the assessee’s cost i.e. Rs.78.34 lakhs may be treated as operating in nature and balance Rs.2.63 crores out of Rs.3.41 crores should be treated as non-operating in nature, which will make the operating margin at 11.97%; or secondly, the cancellation of forward contract which is at abnormal feature in this year vis-à-vis the comparables, the same should be treated as non-operating in nature and if the sum of Rs.2,22,52,796/- is removed the PLI would be 10.46%.
On the other hand, the Ld. CIT DR, Ms. Malti Shridharan after explaining the relevant facts, submitted that the foreign exchange loss relates entirely to the services rendered to the AE in the international transaction. If the assessee has adopted the TNMM as MAM to determine the ALP of its international transaction, then methodology contained in Rule 10B(1)(e) should be followed. After drawing our attention to the said provision she pointed out that, sub- clause (i) of Rule 10B(1)(e) provides that the net profit margin realized by the assessee from the international transaction entered into with the AE should be computed in relation to costs incurred or sales effected. For the purpose of determining the profit realized on the international transaction, all operating costs incurred for the purpose of providing the services to the AE have to be taken into account. Therefore, no question arises whether the foreign exchange gain or loss is non-operating in nature or not. This aspect of the matter has come up for consideration before the Tribunal in series of cases wherein the Tribunal has consistently held that foreign exchange gain or loss arising out of international transaction is in the nature of ITA Nos.2128 & 1958/M/2014 14 Pangea3 & Legal Database Systems Pvt. Ltd. operating cost or revenues. She pointed out that, while coming to this conclusion, the Tribunal has considered that, when transactions are entered into foreign currency and assessee maintains its books of account in Indian currency, then such gain or loss is part and parcel of the relevant transaction and there is no basis to artificially segregate the loss or gain from the main transaction and give a different treatment. In support, she had relied on the following decisions: a) SAP Labs India Pvt. Ltd. -(2011) 44 SOT 156 (Bang.); b) Cisco Systems (India) Pvt. Ltd. - 50 taxmann.com 280 (Bang.); c) Rusabh Diamonds - 34 taxmann.com 160 (Mumbai ITAT); d) Westfalia Separator India Pvt. Ltd. 52 taxmann.com 381 (Delhi ITAT); e) Sumit Diamond (India) Pvt. Ltd. -32 taxmann.com 394 (Mumbai Tribunal); f) Techbooks International Pvt. Ltd.- dt. 28/04/2014; g) Mindteck (India) Ltd. - IT(TP)A No. 70/Bang/2014 dt. 21/8/2017; h) Amba Research India (P) Ltd - (2015) 58 taxmann.com 363 (Bang. ITAT); i) e4e Business Solutions India (P) Ltd - 67 taxmann.com 68 (Bang. ITAT).
In the case of Rushab Diamonds, (supra) she pointed out that, the issue whether or not hedging profits are non-operating in nature was specifically considered and the Tribunal held that hedging profits are in the nature of operating income only.
On the issue whether PLI of the assessee/tested party can be adjusted so as to increase the profit earned from the international transaction by excluding any part of the operating cost is abnormal or not, she submitted that it is not permissible to make any & 1958/M/2014 15 Pangea3 & Legal Database Systems Pvt. Ltd. comparable adjustment in the PLI of the tested party and adjustment if required to be made, can be only made in the case of comparables. After referring to the provisions contained in sub-clause (iii) of Rule 10B (1)(e), she submitted that the said clause provides that the net profit margin of the comparable uncontrolled transaction that is required to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions which would materially affect the amount of net profit margin in the open market. This suggests that adjustment if any can be made in case of comparable uncontrolled transaction; therefore, there is no warrant to adjust the profit margin of the assessee to take into account the differences. Under TNMM, the net profit margin earned from international transaction is determined and once an item of expenditure is concluded to be operating income, then the same has to be taken into account for arriving at the net profit margin. Whence the Forex loss is reckoned as operating cost and is taken into account for determining the PLI, there is no reason to exclude any part of the same in the garb of making comparability adjustment. Thus, she submitted that for determining the PLI of the ‘tested party’, the only question which is required to be seen is whether an item of expenditure is to be treated as operating in nature or not. The PLI so determined cannot be tinkered with by removing any part of the operating cost in the garb of comparability adjustment. In support, she strongly relied upon the following two decisions of the ITAT, Delhi Bench:- (i) Honda Motor Cycle & Scooters India Pvt. Ltd. (2015) 56 taxmann.com 237 (Del. Trib.); (ii) JCB India Ltd. (2015) 59 taxmann.com 211 (Del. Trib.)
Coming to the issue, whether the loss or gain from hedging transaction can be given a separate treatment from the loss or gain of the same underlined transactions, she submitted that the contention & 1958/M/2014 16 Pangea3 & Legal Database Systems Pvt. Ltd. of the assessee that loss on account of cancellation of forward contract amounting to Rs.2.22 crores is abnormal and, therefore, should be excluded from the operating cost, is not tenable, because the hedging loss or gain has to be necessarily be given same treatment as is given to the loss or gain on the underlined transactions. In support she also referred to OECD commentary on this aspect and drew our attention to para 2.82, which read as under: “2.82 Whether foreign exchange gains and losses should be included or excluded from the determination of the net profit indicator raises a number of difficult comparability issues. First, it needs to be considered whether the foreign exchange gains and losses are of a trading nature (e.g. exchange gain or loss on a trade receivable or payable) and whether or not the tested party is responsible for them. Second, any hedging of the foreign currency exposure on the underlying trade receivable or payable also needs to be considered and treated in the same way in determining the net profit. In effect, if a transactional net margin is applied to a transaction in which the foreign exchange risk is borne by the tested party, foreign exchange gains or losses should be consistently accounted for (either in the calculation of the net profit indicator or separately)".
Thus, she submitted that gain or loss on forward contract entered into for hedging of trade receivable or payable has to be given the same treatment, i.e., which is given to the loss or gain or trade receivable or payable. The reason being, the purpose of hedging is to compensate the loss or gain which is likely to arise on the realization of receivable or payable. If foreign exchange is likely to be received on realization of debtor at a future date, the hedging is done to sell foreign currency at the future date and if in the future date when the foreign currency is actually received and loss or gain is earned on the same, the reverse of the same transaction is done under the forward contract and if there is a profit earned on underlined transaction then & 1958/M/2014 17 Pangea3 & Legal Database Systems Pvt. Ltd. there could be a loss also on the hedging and vice versa. Thus, the object of the hedging transaction is to minimize the profit or loss on the exchange fluctuation. As a hedge operates in the reverse direction to the underlying transaction and in the process mitigates its impact, there is no mandate to segregate the hedging profits/loss from the profit/loss on the underlying transaction.
On the contention raised by the Ld. Counsel that even if the entire foreign exchange loss is considered as operating expense, a comparability adjustment will still have to be made in the margin of the comparables (i.e., the margin of the comparables should be reduced), in view of the fact that the assessee has incurred significant loss on cancellation of forward contracts, she submitted that Rule 10B(2) and 10B(3) provides for various comparability factors and the adjustments which are to be made are for the differences materially affecting the price or cost. She further submitted that Rule 10B (2) contains various comparability factors that should be employed for establishing the comparability between the international transaction and the uncontrolled transaction. The comparability of an uncontrolled transaction should be judged with reference to the factors mentioned in sub-clause (a), (b), (c) and (d) of Rule 10B (2). Sub-clause (b) of sub-rule (2) of Rule l0B provides that the functions performed taking into account assets employed and risks assumed by the respective parties to the transaction should be similar in the international transaction and the uncontrolled transaction. Thus, risk is one of the important comparability factors. Risk on account of foreign exchange fluctuation arises when a transaction is entered into with another party resulting in contractual obligations being denominated in a foreign currency as compared to the currency in which the accounts are maintained. In such an event, any difference in the rate of exchange between the rate prevailing on the date of entering into contract and the date of realization will result in a gain & 1958/M/2014 18 Pangea3 & Legal Database Systems Pvt. Ltd. or loss. Therefore, all the comparables that have been considered should also bear the foreign exchange loss, i.e., their sale proceeds should be realizable in foreign currency. Once this comparability factor is established to be similar, the transactions become comparable on account of foreign exchange risk. It is therefore, she submitted that, once all the comparables that are considered, invoice in foreign currency and recovery of the sale proceeds in foreign currency, the risk assumed by the assessee and the comparables have to be established to be similar. Having so established, there is no further requirement to ensure that actual loss or gain earned by the comparable should be matching with the actual loss or gain earned by the assessee. Therefore, she submitted that, once the comparables are also providing services and earning their receipts in foreign currency then there is no difference between the international transaction and the uncontrolled transaction that warrants an adjustment in terms of sub-rule (3). Further, once all the comparables are considered for the purpose of determining the ALP, then they also bear the same foreign exchange risk on account of fluctuation in the exchange rate, hence there would be no difference between the international transaction and the comparable uncontrolled transaction, because the loss figure would be more or less same and it does not imply that there is a difference in the risk borne by the assessee and not by the comparables. She contended that if the argument of the assessee’s counsel is to be accepted then every item of expenditure or income forming part of the assessee’s operating cost will have to be matched individually with the comparables and this is not the requirement under Rule 10B(2) read with Rule 10B(3). Once all the comparables are found to be earning in foreign exchange currency then they will also have the same risk of having foreign exchange gain or loss in their P&L Account. In other words, the risk on account of foreign exchange would be similar & 1958/M/2014 19 Pangea3 & Legal Database Systems Pvt. Ltd. between the assessee and the comparables and hence no adjustment is warranted.
Lastly, she contended that when there is a contractual arrangement between the assessee and the AE and they have agreed upon terms relating to compensation of services, then AE has to compensate the assessee for the total cost actually incurred by it for the provision of ITE services to the AE along with mark up of 15%. The forex loss pertains to the transaction of provision of services by the assessee to the AE and, therefore, it has to be concluded that the forex loss incurred in this case for the purpose of providing services to the AE is as per the contractual arrangement, the same is required to be compensated by the AE and hence, it is to be recovered from the AE by the assessee. She also referred to a judgment of Hon’ble Delhi High Court in the case of Morabeni India Pvt. Ltd. Vs. CIT (2013) 33 Taxmann.com 100.
By way of rejoinder, the Ld. Counsel for the assessee submitted that it is not the core contention of the assessee, that the forex loss should be considered as operating or non-operating. Forex loss may arise in the normal course of the business and can be reckoned as operating in nature, however the loss arising on account of abnormal fluctuation or on account of abnormal movement in forward exchange contracts has to be treated as non-operating in nature. In this regard, reliance placed on Honda Trading Corp. India Pvt. Ltd. Vs. ACIT; and SAP Labs India (P) Ltd vs. ACIT (supra) was reiterated. Further reliance was placed on the decision of CISCO Systems (India) Pvt. Ltd. vs. DCIT (66 SOT 82) (Bangalore) dated 14 August, 2014, wherein the Hon'ble Tribunal has distinguished the Forex loss between capital and revenue in nature and has categorically held that only the Forex gains arising on account of rendering of software development services is to be considering for & 1958/M/2014 20 Pangea3 & Legal Database Systems Pvt. Ltd. the purpose of computing operating margin of the Assessee. He submitted that in the assessee’s case, the loss has arisen on account of cancellation of forward exchange contracts on account of abnormal variation in Forex rates. The assessee has merely contested that suitable adjustment need to be granted for the Forex loss to the extent it is extraordinary or abnormal. Thus, the judicial precedents relied upon by Ld. CIT DR are distinguishable on facts and merits. He submitted, such a huge loss was a peculiar phenomenon for the year under consideration in the assessee’s case, because such abnormal event and abnormal loss has neither arisen to the assessee in the past or in subsequent years nor in case of comparable companies. Thus, it was submitted by him that forex loss though arising in the normal course of business is a non-recurring and extraordinary item qua the year under consideration and qua the comparables. Hence, the same should not be considered while determining the operating margin of the assessee.
Regarding adjustment to be made on the tested party’s margin, Ld. Counsel for the assessee placed reliance on following decisions where adjustment to the tested party has been allowed to be made: (i) Pune Tribunal in case of Ariston Thermo India Limited vs. DCIT (ITA No 1455/PN/2010); (ii) Egain Communication P. Limited vs ITO (118 TT J 354); (iii) Skoda Auto India Private Limited vs. ACIT (30 SOT 319) (Pune); (iv) Amdocs Business Services Pvt. Ltd. vs DCIT (ITA No. 1412/PN/11) (Pune), dated 23 July 2012; (v) ACIT vs Fiat India Private Limited (ITA No.1848/Mum/2009) (Mum) dated 30 April 2010; (vi) Transwitch India Private Limited Vs. DCIT ( / Del/ 2010) (Delhi) dated 30 March 2012; (vii) Global Vantedge (P) Ltd. vs DCIT (2010 37 SOT 1) (Delhi)
Without prejudice, Mr. Vora submitted that assuming if the adjustment is to be made on the margins of the comparables, then in & 1958/M/2014 21 Pangea3 & Legal Database Systems Pvt. Ltd. majority of the comparables (i.e., 10 comparables) it was not possible to identify the amount of forex loss/gain as it has not been specifically mentioned in the financials available in public domain or as collected/provided by the TPO, therefore, it is very difficult to make any reasonable adjustment in the operating margins of that comparables that is, in absence of reliable data. In such situation making adjustment of comparables’ margin with partial information is unscientific and will give absurd results. In any case, ld. counsel submitted that on the facts of the present case, it will not make substantial difference whether forex loss adjustment if made on the PLI of the tested party or on the comparable companies. A separate working on approximate basis in the cases of the comparables where forex gain/loss details were available (out of set of 18 comparables 9 comparables) was given before us to demonstrate that the arithmetic mean of the comparables would then come down to 4.28% and after working capital adjustment is given then it would come around the PLI of 2.85% of TPO which would be under the arm’s length consideration. Regarding the Ld. CIT, DR’s contention that hedging operates in the reverse direction to the underlined transaction and in the process it mitigates the impact and, therefore, there is no mandate to segregate the hedging profit or loss from the profit/loss of the underlined transaction, he submitted that in the case of the assessee there has been a peculiar feature this year which has been amply demonstrated that the cancellation of forward contracts was extraordinary and peculiar to the facts of the assessee’s case. On the issue of whether the PLI of the tested party (assessee) can be adjusted so as to increase the profit earned from the international transaction by excluding any part of the operating cost as normal, ld. counsel submitted that in the case of the assessee, forward contract was entered to minimize the risk on account of exchange rate fluctuation, however, the exchange rate became so volatile that assessee had to cancel the same and booked an abnormal/extraordinary exchange & 1958/M/2014 22 Pangea3 & Legal Database Systems Pvt. Ltd. loss. He also made distinction of decision of Delhi ITAT in the case of Honda Motor Cycles & Scooters India Pvt. Ltd., (supra) and JCB India Ltd., (supra) by submitting that they are distinguishable on facts. In the case of Honda Motor Cycles & Scooters India Pvt. Ltd., he pointed out that while computing the operating margin, the assessee had reduced the operating cost incurred during the period of strike and on the basis of ad-hoc calculation adjustment in the operating margin was made. Similarly, in the case of JCB India Ltd., the assessee had reduced the operating expenses on ad-hoc basis to account for the excessive operating cost incurred in the first year of operation. As compared to these cases, in the case of the assessee, the forex loss arising on account of cancellation of Forward contract is part of forex loss as appearing in financial statement, the break-up of which was filed before us. On the issue of contractual arrangement between the parties whether the forex loss is to be borne by the AE or not, he submitted that the assessee had given advance towards compensation for services to be rendered and it was agreed and accepted that Forex loss is not an actual cost which is incurred for providing services to AE. Thus, the assessee was never supposed to recover the amount of forex loss along with the mark up as per the inter-company agreement. The decision of Hon'ble Delhi High Court in the case of Morabeni India Pvt. Ltd., supra as relied on by the Ld. DR was also distinguished by him.
We have heard rival submissions and considered the entire gamut of facts with reference to material referred to before us. The core issues before us are, firstly, whether the Forex loss or gain is operating cost or non-operating in nature; secondly, if yes, then, whether the PLI of the assessee (i.e., the tested party) can be adjusted so as to increase the profits earned from the international transaction for the purpose of making the comparability adjustments or not; and lastly, whether the loss or gain on cancellation of forward contract & 1958/M/2014 23 Pangea3 & Legal Database Systems Pvt. Ltd. can be said to be abnormal factor materially affecting the cost/ margin in the case of the assessee so as to warrant any kind of adjustment. The assessee in its financials has worked out the PLI in the following manner:- Particulars Amount (Rs. in Lakhs) Operating Revenue Service Income 3,324.40 Total Operating Revenue 3,324.40
Operating Cost Personnel expenses 1806.48 Operating & Other Expenses 825.18 Bank charges 0.35 Depreciation 258.77 Total Operating Cost 2890.78 Operating Profit 433.62
Add: Non-operating income Other Income 1l.61 Less: Non-operating Expenses 341.44 Exchange Difference 4.28 Loss on sold / scrapped fixed assets 0.14 Finance Expenses 345.86 Total Non-operating Expenses 99.36
Net Profit before Tax (OP/OC) 15.00% From the above calculation, the assessee has excluded foreign exchange loss amounting to Rs. 3.41 crores from its operating cost base and accordingly, the profit margin of 15% has been shown. On the other hand, the TPO has treated the Forex loss as an operating cost and thereby re-casted the operating margin at 2.83%. The breakup of foreign exchange loss of Rs. 3.41 crores is as under:- & 1958/M/2014 24 Pangea3 & Legal Database Systems Pvt. Ltd. Particulars: Amount (in Rs.) Conversion of USD from EFC A/c to INR A/c: 62,80,115 Intercompany Receivables/Payables: 39,48,667 Cancellation of forward contracts: 2,22,52,796 Reinstatement of balances: 10,89,549 Open Contract: 6,96,633 Others: (1,22,986) Total 3,41,44,774 The assessee has adopted TNMM as the most appropriate method to determine the ALP of its international transaction of provision of legal process outsourcing services to the AE.
The relevant methodology of TNMM as contained in Rule 10 B (1)(e) for sake of ready reference is reproduced hereunder:- “10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction (or a specified domestic transaction) shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) …… (b)……. …….. (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction [ or a specified domestic 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 & 1958/M/2014 25 Pangea3 & Legal Database Systems Pvt. Ltd. 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 [or the specified domestic 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 [for the specified domestic transaction].”
Under the TNMM the focus is on transaction rather than business or the operating income of the company. The aforesaid rule refers to the net profit margin realized by an enterprise from an international transaction but not operational margin of enterprise as a whole. Here, the analysis is done only of the profits of the AE that are attributable to a particular controlled transaction. The arms length result under this method is determined by reference to the net profit margin of a comparable transaction under comparable circumstances. The profit level indicator (PLI) is computed in relation to a base, viz., either the costs incurred (i.e., direct cost of an output of product or services); or sales effected (i.e., amount of total receipts from sale of goods and provisions of services, less returns and allowances); or assets deployed (i.e., any tangible or intangible asset owned by the enterprise having economic value of its owner or source of wealth/income). Thus; & 1958/M/2014 26 Pangea3 & Legal Database Systems Pvt. Ltd. � Sub-clause (i) envisages that the net profit margin is to be computed on any one of the base as above. � Sub-clause (ii) envisages that comparability analysis of the net profit margin realized by the enterprise is to be done from a comparable uncontrolled transaction by an unrelated enterprise which is to be computed having regard to the same base, that is, the base adopted for determining the PLI of the enterprises entering into controlled transaction. � Sub-clause (iii) refers to the net profit margin under sub-clause (ii) which is the net profit margin realized by the enterprise vis- à-vis the unrelated enterprise from comparable uncontrolled transaction which is computed on the same base. Further, this clause envisages that the net profit margin arising in comparable uncontrolled transaction (that is, net profit margins of the independent comparables) is to be adjusted taking into account the differences, if any, either between the international transaction and the comparable uncontrolled transactions, (in other words, difference is to be adjusted in the net profit margins of the comparables); or between the enterprises entering into such transaction (that is, related party) which could materially affect the amount of net profit margin in the open market. Thus, sub-clause (iii) envisages that the adjustment on account of difference which could materially affect the amount of net profit margin in the open market can be made in two kinds of situations, firstly, either between the international transaction and the independent third party comparables; or secondly, amongst the transactions between the AEs, that is, controlled transactions between the enterprises (related parties) which are entering into such kind of transactions. & 1958/M/2014 27 Pangea3 & Legal Database Systems Pvt. Ltd.
Since, TNMM is one sided method and is applied to least complex party that does not contribute much to valuable or unique intangible assets, therefore, the determination of ALP is based on the amount of operating profits of that party to the controlled transaction. Such least complex party is referred to as ‘tested party’. Such a ‘tested party’ is reckoned to be an enterprise who is the participant in the controlled transaction and whose operating profit is attributable to the controlled transactions which is verified using the reliable data of incomparable transactions of independent party so that very few or reliable adjustment can be made. If any adjustment is required to be made so as to take into account the differences between the transactions being compared or between the enterprises entering into such transaction which is likely to materially affect the price or cost charged or paid, then rule envisages that reasonable accurate adjustment should be made. This has been so provided under sub-rule (3) of Rule 10B, which reads as under:- “(3) An uncontrolled transaction shall be comparable to an international transaction if - (i) none of the differences, if any, between the transaction being compared, or between the enterprises entering into such transaction are likely to materially affect the price or cost shared or paid in, or the profit arising from, such transaction in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.”
From the harmonious reading of sub-clause (iii) of clause (e) of Rule 10B and sub-rule (3) of 10B, it is quite ostensible that under a comparability analysis of an international transaction with the uncontrolled transaction, reasonable and accurate adjustment is permitted to weed out any difference which materially affects the & 1958/M/2014 28 Pangea3 & Legal Database Systems Pvt. Ltd. price or costs or the profit arising therefrom such transaction in the open market. Nowhere the rule suggests that the adjustment which materially affects the price or cost or profit should be made only to the uncontrolled transaction, that is, comparables and not to the ‘tested party’ whose transactions is being compared. This is apparently clear from the reading of sub clause (i) and (ii) which envisages that the net profit margin is to be computed and compared to in relation to or having regard to the same base, that is, of the ‘tested party’ or the comparables; and sub-rule (iii) provides that adjustment of net profit margin arising in comparable uncontrolled transaction, i.e., vis-à-vis the independent comparables is adjusted taking into account the difference both between the comparables or between the enterprises (related parties) entering into such international transaction. The adjustment can be made either in the case of the ‘tested party’, (i.e. controlled transaction) or the comparables (i.e. uncontrolled transactions) so that the difference which could materially affect the amount of net profit margin is removed. Further clause (iv) provides that the net profit realized by the enterprise as referred to in sub-clause (i) i.e., the ‘tested party’ or the enterprise entering into controlled international transaction is to be established at the same net profit margin which is determined under sub-clause (iii), that is, under the comparability analysis. Lastly, sub-clause (v) provides that the net profit arrived should be at ALP.
In view of our understanding and analysis of Rule 10B as above, we are unable to appreciate the contention raised by the Ld. CIT DR that any adjustment if required to weed out the difference materially affecting the price or cost or profit can be made only in the case of the comparables while determining the profit margin and not in the case of the tested party. More so, in practical situations there may be absence of reliable data in the case of the uncontrolled & 1958/M/2014 29 Pangea3 & Legal Database Systems Pvt. Ltd. transactions (comparables) for which such material difference is to be analysed or examined. Under the public domain at times in depth information of the financials or data of comparables are not available which renders the comparability analysis improper/impractical and so is the adjustments. The entire substratum of transfer pricing and determination of ALP is, thorough comparability analysis of controlled transactions with the comparable uncontrolled transactions which is needed to ensure that any adjustment if required to be made should achieve the results that would be realized by an independent enterprise in comparable circumstances. Without adequate comparability analysis, the third party data which is used to find out the transfer price or ALP of the international transaction might not represent true market price because of the difference in the circumstances of third party in relation to the assessee whose transaction is being benchmarked. In certain cases there may arise some difficulty when the reliable data for particular cost or profit may not be available, therefore, a reasonable accurate adjustment in the hands of the tested party may throw fruitful result. If we accept the proposition that no adjustment can be made either on the cost base or profit of the ‘tested party’ then there may arise a problem, that in case of the comparables such factors materially affecting the cost or profit may not be accurately available so that proper adjustment can be made in respect of all the comparables. Here in this case, it has been pointed out that in case of as many as ten comparables it was not possible to identify the correct amount of forex loss/gain from the financials/data available in the public domain. In such situations, it would be very difficult to fathom a proposition that adjustment should be made only in the case of comparables and not in the case of the tested party. Making adjustment of comparable margins with partial information would at times result into absurdity or unscientific analysis of the profit margin which can never be the intention of the law as contained in Rule 10B(1). & 1958/M/2014 30 Pangea3 & Legal Database Systems Pvt. Ltd.
One of the contention raised by the Ld. CIT, DR before us is that, for determining the net profit margin, all operating expenses should be taken into account and once any item is appearing as an operating cost which is taken into determining the PLI, then there cannot be any reason to exclude any part of the cost subsequently in the garb of making comparability adjustment; and while determining the PLI of the tested party the only information which is required to be seen is, whether the item of expenditure is operating or non- operating. We are unable to fully subscribe to such proposition because, even if an item is taken as an operating cost, however the rule as enshrined under 10B (1)(e)(iii) and 10B(3) clearly contemplates that any difference or abnormality or any extraordinary item which materially affects the cost base or profit, the same needs to be adjusted so as to eliminate the material effect of such difference. Because, the whole spirit of the transfer pricing exercise is to determine the appropriate arms length price. Such an adjustment definitely warrants at times the tinkering of PLI in the exercise of determination of arms length price. If any peculiar abnormality or extraordinary event which has arisen specific in the case of the ‘tested party’ then same needs to be analysed, firstly, by comparing it with uncontrolled transactions with independent entity; and secondly, if such peculiarity is not found in the case of the uncontrolled comparable transactions then the rule envisages that reasonable accurate adjustment should be made which materially affects the cost or profit. Hence, the contention put forth by Ld. CIT DR in our humble opinion is not acceptable.
Now coming to the issue, whether Forex loss is to be reckoned as operating cost or not. At the outset, we agree with the contention of the Ld. CIT, DR that foreign exchange gain or loss relatable to an international transaction is always part and parcel of such & 1958/M/2014 31 Pangea3 & Legal Database Systems Pvt. Ltd. underlined transaction and for this proposition there are catena of decisions which have been referred to by her on this point. Otherwise also when international transactions are entered into with the AE, one of whom is resident of other contracting state and the transactions are in foreign currency, then any gain or loss on account of forex is inherent item of cost or profit. To this extent the Ld. Counsel before us has also not made much dispute, though this issue was vehemently raised by the assessee before revenue authorities and also in the ground raised
before us. Thus, the proposition of the assessee that forex loss is not part of the operating cost is rejected. The only bone of contention of the parties, now before us is that, whether the loss or gain on hedging transaction, i.e., loss on account of cancellation of forward contracts is something of peculiar feature in the case of the assessee which requires any adjustment in the PLI. The main contention of the Ld. Counsel before us is that, out of the total forex loss of Rs.3.41 crores, loss on account of cancellation of forward contracts amounting to Rs.2.22 cr. is due to abnormal factors peculiar to the case of the assessee in this financial year and, therefore, should be excluded from the operating cost while computing the PLI. In principle, we agree with the contention of the Ld. CIT, DR that hedging loss or gain arising in the normal course of business has to be generally given the same treatment as is given to the loss or gain in the underlined transactions. It is imperative to see, firstly, whether the forex gain or loss are of trading nature that is, exchange gain or loss is on a trade receivable or payable and whether or not the tested party is responsible for them, that is, the foreign currency risk is that of the tested party or not; and secondly, whether the hedging of the foreign currency exposure on the underlined trade receivable or payable needs to be considered and treated in the same way in determining the net profit. If foreign exchange risk is borne by the tested party, then it needs to be accounted for by the tested party. This is the & 1958/M/2014
32. Pangea3 & Legal Database Systems Pvt. Ltd. explanation given by the OECD as referred to by the Ld. CIT, DR. In all such cases, if forex is directly to be received on realization of debtors at a future date, hedging is done to sell or buy foreign currency at the future date. In the case of the assessee, it has been explained that the assessee had entered into forward contracts to minimize the risk on account of exchange rate fluctuation. So far as entering into forward contracts to minimize such risks is absolutely no abnormal conduct on part of the assessee, because if the trade receivables or payables are in foreign currency, the parties generally resort to entering into forward contract and hence, it is to be reckoned as normal business transaction and any gain or loss in the normal course of business is to be accounted for in the accounts. However, if there is some hedging abnormality or any extraordinary event has occurred qua the tested party (assessee) which materially affects the cost or profit in the relevant financial year, which is not across the industry or is either absent or is of less magnitude in the case of comparable independent parties, then definitely such an abnormality or extraordinary event has to be factored in while computing the cost base or PLI. Before us, the assessee has demonstrated that in this particular financial year there was an extraordinary fluctuation in the Forex rate which was at 27.47% as compared to the average fluctuation of 2.87% in the earlier three financial years (as per the chart reproduced in our earlier part of the order). In the earlier financial year, i.e., in the FY 2007-08 like a normal transaction the assessee had entered into majority of forward contracts when the exchange rate of INR vs. US $ was steady or rather INR was appreciating; however, in the FY 2008-09 the value of INR depreciated so sharply that even the RBI had to intervene by pumping US $ 84 billion in the Forex market. In order to save itself from such huge loss, the assessee cancelled the forward contract so that loss can be mitigated and accordingly, in that process assessee had suffered a loss of Rs. 2.22 cr. Such a loss even due to untoward & 1958/M/2014
33. Pangea3 & Legal Database Systems Pvt. Ltd. incident generally would have gone into the operating cost, had it been demonstrated that it was the phenomenon across the industry or in the cases of comparable uncontrolled transactions, that is, independent comparable entities this was also the peculiar feature. If such a peculiarity is absent or its magnitude is less in the case of the comparables, then ostensibly such peculiarity or abnormality has to be treated as factors materially affecting the cost and consequently, the PLI of the tested party for which the reasonable accurate adjustment should be made to eliminate this effect, because it has to be reckoned as a difference between the international transaction and the comparable uncontrolled transactions.
Before us, the Ld. CIT, DR has also contended that comparability factors as contained in Rule 10B (2) also envisages risks assumed by the respective parties to the transactions and risk on account of forex fluctuation arises when a transaction is entered into with another party resulting in contractual obligations being denominated in foreign currency as compared to the currency in which accounts are maintained. In such an event, any difference in the rate of exchange between the rate prevailing on the date of entering into the contract and the date of realization will result any gain or loss. Therefore, all the comparables that have been considered should also bear the Forex loss. We agree with this contention of the Ld. CIT, DR that once a comparability factor of forex gain or loss is established to be similar then the transaction becomes comparable on account of Forex risk. However, here, in this case as stated earlier it has not been brought on record that such kind of an exposure of hedging loss on cancellation of forward contracts is there in every comparable uncontrolled transaction, that is, in the case of the other comparables. Risk assumed by the assessee as well as by the comparable entity may be similar but quantum and scale of a risk factor if undermines the computation of PLI of the assessee vis-à-vis & 1958/M/2014 34 Pangea3 & Legal Database Systems Pvt. Ltd. the comparables, then our rules under the Indian Transfer Pricing provisions also enshrines that any material difference affecting the cost or profitability between the international transaction and comparable uncontrolled transaction needs to be eliminated by making suitable adjustments. Here in this case, a material difference has arisen in the case of the assessee due to abnormal feature which is qua the assessee in this particular year, (which is abnormal loss on cancellation of forward contract) which admittedly is absent in the cases of comparables with whom the assessee’s transaction is being bench marked, therefore, a suitable adjustment has to be made to factor in the material difference in the PLI. Thus, in our opinion, the loss amounting to Rs.2,22,52,786/- on account of cancellation of forward contracts out of total forex loss of Rs.3,41,44,774/- needs to be eliminated from the operating cost and this adjustment is proposed to be made in the case of the assessee which is the tested party. We accordingly direct the TPO/AO to make the adjustment of this amount in the operating cost and rework the PLI.
In view of our this finding, we do not feel necessary to go into the other arguments of the Ld. Counsel that if adjustment is made in the case of the comparables then the assessee’s margin would be arrived at 11.97% as the Forex loss to the total cost in the case of comparables is only 2.71% which will work out to Rs. 78 lakhs and, therefore, only Rs.78 lakhs should be as operating cost to make it comparable and at par with the comparables and balance should be removed as non-operating. This argument has become purely academic; hence no opinion is expressed on this point.
Both the parties have also referred to various decisions in support of their contentions that how the adjustment should be made either in the case of the tested party or in the case of the comparable independent parties. Both the parties have cited their own set of & 1958/M/2014 35 Pangea3 & Legal Database Systems Pvt. Ltd. decisions and have also tried to distinguish the contrary decisions relied by the opposing parties. Since we have analysed the issue as per our understanding of relevant provisions of the rules and also its application on the facts of the present case, therefore, we are not inclined to deal and discuss in detail about the various judgments on which both the parties have given their submissions and counter submissions. Other submissions on this issue made by both the parties are also not dealt with because; we have already given our finding on the issue of adjustment.
28. The next main issues relates to inclusion and exclusion of certain comparables which has been contested before us. As discussed in our earlier part of the order that the Ld. TPO has rejected most of the comparables shortlisted by the assessee and has also introduced his own set of comparables. During the course of the transfer pricing proceedings, the assessee gave a list of certain more comparables for bench marking the assessee’s margin, which has been by and large rejected by the TPO. In all, out of the total set of 24 comparables which were subject matter of acceptance and rejection both by the revenue as well as by the assessee, some ten comparable companies have been seriously disputed before us, which are as under:-
Sr. no. Name of the Company OP/OC % Assessee’s stand i. Accentia Technologies 43.42 Disputed ii. Acropital Technologies 21.30 Disputed iii. eClerx Services Ltd. 46.92 Disputed iv. Datamatics Financial Services 3.05 Accepted v. e4E Healthcare Business Pvt. Ltd. 31.68 Accepted vi. Informed Technologies 23.13 Accepted vii. Aditya Birla Minacs Worldwide 1.85 Accepted viii. Cross Domain Solutions Pvt. Ltd. 26.92 Accepted ix. Microland Limited -19.51 Reinstated by & 1958/M/2014 36 Pangea3 & Legal Database Systems Pvt. Ltd. DRP Accepted by assessee. x. Omega Healthcare Management 15.43 Reinstated by DRP & Services Pvt. Ltd. accepted by assessee.
As per the assessee’s FAR analysis contained in TP study report, the various functions performed by the assessee have been described in the following manner:-
ITES, data processing, legal database and other administrative support services P3 LDS The functions performed by P3 LDS with resp3ect to rendering ITES in the nature of legal support services, data processing, legal databases and other administrative support services to P3 HC through its own-staffed lawyers are briefly enumerated as under: a. Patent Research & Prosecution Services: P3 LDS renders services relating to drafting patent applications and supporting client's patent application. Further, it also renders various other services in prosecution processing inter- alia including: prior art search, landscaping, invalidity and infringement studies, claims mapping studies, freedom to use studies, patent illustrations and conducting patent related studies. b. Contract Drafting & Management Services: P3 LDS provides a commercial contracting and licensing services, including drafting, reviewing and revising contracts. It also provides contract management and administration services. These services are further integrated with customized online contract managed databases. P3 LDS also provides legal terms database solutions. c. Document Review & Litigation Services:
& 1958/M/2014 37 Pangea3 & Legal Database Systems Pvt. Ltd. P3 LDS also provides services, which include organization, review and catalogue of documents. These services involve identification of data pertinent to litigation or corporate due diligence matters, populating databases and preparation of reports regarding such data. These services also involve compilation of lay witness background reports and betting of curriculum vitae. d. Legal Research & Competitive Intelligence Services: P3 LDS conducts and analyzes research including federal, state, international case law, federal, state and municipal regulatory codes and legislative history using industry-standard databases; and also conducts multi-jurisdictional surveys i.e., 50 states survey. e. Marketing/Business Development: P3 LDS does not carry out marketing functions, since it is a captive entity and secures business by way of outsourcing from its parent company, P3 LLC. f. Finance: P3 LDS makes arrangements for the funds required for meeting working capital and fixed capital requirements. The funds are mainly provided by P3 LLC. g. Technology: P3 LDS uses the appropriate technologies for executing various projects. The choice of technologies to be used is only by P3 LDS without any inputs from P3 LLC. 3.1 In consideration of PLDS's performance of its duties and obligations under the Agreement, Client agrees to compensate PLDS monthly for all services based on the actual total cost incurred by PLDS per month for the Client plus a markup of 15% subject to withholding tax, services tax and any other taxes, duties or levies as applicable in US and in India. & 1958/M/2014 38 Pangea3 & Legal Database Systems Pvt. Ltd.
29. Both the parties have made very elaborate submissions on all the ten comparables which we shall be discussed in brief hereinafter:-
(i) Acropetal Technologies Ltd.:-
29.1 The TPO has considered the “Engineering Design service segment” of Acropetal as similar to ITES service and has considered the operating margin of Engineering Design Service segment for comparison purpose. The DRP has accepted the TPO’s contention of considering the ‘Engineering Design Service’ segment for calculation of operating profit margin, however has accepted the assessee’s contention of allocation of administrative expenses and depreciation of this segment.
29.2 The Ld. Counsel before us submitted that this company is engaged in the business of development of computer software and hence, it is functionally incomparable. Apart from that, he pointed out that there was an extraordinary event of acquisition in this year which makes its results incomparable. From the Annual Report of the said company, he pointed out that this company has entered into the business of exporting software services and hence, 100% of its revenue comprises of export earnings. Referring to the business description as available in the public domain, he pointed out that ‘engineering design services’ of this company has a portfolio of services like concept design, product design and development, advanced analysis, reliability engineering and value engineering. Thus, this company is providing specialised engineering design services which is a nature of software services to its client and cannot be treated as similar to ITES services. In support of its contention and for exclusion of this company, the Ld. Counsel relied on the following decisions:- & 1958/M/2014 39 Pangea3 & Legal Database Systems Pvt. Ltd. a) Jardine Lloyd Thompson India P Ltd (ITA No. 779/Mum/2013) (Mumbai) dated 29 November 2016; b) HSBC Electronic Data Processing India Pvt. Limited (ITA No. 247 & 295/Hyd/2014 AY 2009-10 dated 18 February 2015 ; c) Excellence Data Research Pvt. Ltd v ITO (ITA No. 159/Hyd/20 14) AY 2009-10 dated 12 December 2014; d) M/s. Capital IQ Information Systems (India) Pvt. Ltd.[ITA No. 1961/Hyd/2011] AY 2009-10; e) Daksh Business Process Services Pvt. Ltd [ITA No. 2666/Del/2014], AY 2009-10, dated 5 July 2016; f) QAD India Pvt. Ltd [ITA no. 1685/Mum/2013], AY 2009- 10, dated 30 September 2016; g) Market Tools Research Pvt. Ltd. [ITA No.1811/Hyd/2012], AY 2008-09, dated 24 October 2013.
29.3 On the other hand, Ld. CIT, DR relying upon the order of the DRP submitted that DRP has already directed the TPO to consider only the relevant segment of TPO who has considered the margin of 21.3% in respect of engineering design services. The objection of the assessee has already been addressed by the DRP including the consideration of unallocated expenses and depreciation.
29.4 After considering the aforesaid submissions and on the perusal of the material available on record, we find that assessee is mostly into ITES relating to data processing of legal data base and other administrative support services. It has not been disputed that under the segment of ‘Engineering Design Services’, this company is providing broad spectrum of services which is mainly in the nature of software development. Its entire ‘Engineering Design Services’ is providing software services to its client and has portfolio of services which included concept design, product design and development and other reliable engineering services which is given through development of computer software. A computer software development & 1958/M/2014 40 Pangea3 & Legal Database Systems Pvt. Ltd. company cannot be said to be functionally similar with a company which is rendering purely ITES services, as it has a different FAR analysis. One other distinct factor which has been pointed out before us is that, there was an extraordinary event of acquisition in this year and such an acquisition definitely has an impact on the PLI. Moreover, in various decisions as cited by Ld. Counsel this company has been held to be incomparable with the company rendering purely ITES services. Thus, we agree with the contention of the Ld. Counsel that Acropetal Technologies Ltd. should be excluded from the list of the comparables.
(iii) Accentia Technologies Ltd.:-
29.5. During the course of the transfer pricing proceedings, the Ld. TPO based on his fresh bench marking exercise had selected this company. Before us, Ld. Counsel submitted that this company is into high end KPO service provider and thereby making it functionally incomparable to the assessee which is providing back office legal support services. That apart, there was an extraordinary event of merger which had taken place during the relevant financial year which is evident from the relevant extract of Annual Report, submitted before the authorities below to highlight this point. It was further pointed out that due to the merger the sales was boosted and there was a sharp/abnormal increase of 50% in the turnover of this company. Thus, this company cannot be held to be a good comparable. In support, heavy reliance was placed on the decision of Maersk Global Service Centre India Pvt. Ltd., 2014 for AY 2009-10 order dated 16.01.2015. That apart reliance was also placed on the following decisions:- a. Jardine Lloyd Thompson India P Ltd (ITA No. 779/Mum/2013) (Mumbai) dated 29 November 2016; & 1958/M/2014 41 Pangea3 & Legal Database Systems Pvt. Ltd. b. Xchanging Technology Services India Pvt. Ltd (ITA 813/2015) (Delhi High Court) dated 20 October 2015; c. Nett App India Pvt Ltd [IT(TP) A No. 1633/Bang/2014], AY 2009-10, dated 11 May 2016; d. Aegis Limited [ITA No. 1213/Mum/2014], AY 2009-10, dated 27 July 2015; e, HSBC Electronic Data Processing India Pvt. Limited (ITA No. 247 & 295/Hyd/2014 AY 2009-10 dated 18 February 2015; f. Excellence Data Research Pvt. Ltd v ITO (ITA No. 159/Hyd/2014) AY 2009-10 dated 12 December 2014; g. M/s. Capital IQ Information Systems (India) Pvt. Ltd.[ITA No. 1961/Hyd/2011] AY 2009-10 dated 31 July 2014; h. Hyundai Motors India [ITA No. 255/Hyd/2014, AY 2009- 10, dated 31 July 2014; i. M/s. Avineon India Pvt Ltd. [ITA No. 1989/Hyd/2011], AY 2007-08, dated 31 October 2013; 29.6 The Ld. CIT, DR objecting to the exclusion of this company submitted that the assessee is not low end BPO service provider albeit assessee is into high end service which is in the nature of legal process outsourcing. Assessee’s service agreement describes the scope of service at clause 3 of the said agreement, which reads as under: “PLDS SCOPE OF SERVICES
2.1 PLDS agreed to provide the Client various legal back office support services through its Resources. Each Project shall be performed by the Resources of the PLDS based on the, Client Data and Project Instructions and deliverable requirements of the Client as provided by the Client to PLDS from time to time. 2.2 Legal Support services and Project Deliverables shall be through Resources of PLDS. Service provision with respect to anyone Project will include: • receipt of the Project, review and acceptance of Project Instructions, • application of relevant Client Date and Client Resources; and • creation and delivery of Project Deliverables & 1958/M/2014 42 Pangea3 & Legal Database Systems Pvt. Ltd. This Agreement shall apply to all Services performed by PLDS and to all Project Deliverables supplied by the PLDS from the date hereof, whether or not an SOW specifically covers the services or Project Deliverables requested.”
Apart from that the assessee had used professional lawyers to provide these services and as per the industry analysis, the assessee has been described as the legal process outsourcing industry. Thus, assessee is also performing high end services and utilizing highly skilled man power in the form of professionally qualified lawyers. After referring to the decision of Hon'ble Delhi High Court in the case of Rampgreen Solutions Pvt. Ltd. (2015) 60 taxmann.com 355 (Del.), wherein the Hon'ble High Court held that comparables that used skilled manpower to provide services are not comparable to the low end service provided by a voice based call centre. Thus, Accentia Technologies Ltd. is comparable to the assessee as both the assessee as well as the Accentia is providing services by using highly skilled manpower. Regarding extraordinary event of merger, she submitted that same has not impacted the profitability of the said company and as a matter of fact, the operating profit margin to cost ratio was 40% for the year ending 31.03.2008 and the same was 43% during the previous year. Thus, the event of merger has not impacted the profit margin.
29.7 After considering the aforesaid submissions made by the parties, we at the outset agree with the contention of the Ld. CIT, DR that the assessee is rendering its ITES of legal data base and other administrative services through highly skilled and professionally qualified lawyers and hence this company cannot be reckoned as providing simply BPO services of low end. She has pointed out that for rendering ITES, skilled and professional Lawyers were engaged by the assessee company and that precludes the assessee being classified as low end service provider. As pointed out by her, in the T. & 1958/M/2014 43 Pangea3 & Legal Database Systems Pvt. Ltd. P. Study Report as stated, the assessee is providing the services mostly through its own staff which are qualified lawyers in Mumbai and has also outsourced its ITES services which is in the nature of legal support services, data processing and legal data services by engaging qualified lawyers from outside. If both the comparables are providing services by using skilled manpower then definitely it has to be reckoned that both are providing high end services and functionally can be held as comparable. Thus, comparability cannot be rejected simply on the ground that assessee is mainly a BPO or low end ITES service provider.
So far as the issue relating to impact on profitability on the margin involving significant merger and acquisitions, this definitely becomes a very crucial factor for carrying out the comparability analysis and its impact on sales/profit margin. Under such exceptional events of merger and acquisition, the accounts and the trading results does not reflect normal margin which are earned in the normal course of the business in a comparable uncontrolled scenario, because M & As generally have huge impact on the trading results and distort the profit margin. This factor mostly vitiates the comparability analysis at least qua the year in which such M & As are undertaken. But as pointed out by Ld. CIT DR there is no major impact in profit margin in the year of M & As, which aspect becomes very crucial and requires verification from the end of TPO/AO. Accordingly, we remit this issue to the file of the TPO to find out the impact of M & As on the trading results and the profit margin of Accentia Technologies Ltd by comparing its margin from the earlier financial years as pointed out by Ld. CIT DR. If there is no major impact, then this company can be taken for comparability analysis. Thus, this comparable is remitted back to the TPO for proper analysis in light of aforesaid observation. & 1958/M/2014 44 Pangea3 & Legal Database Systems Pvt. Ltd.
(iii) eClerx Services Ltd.:-
29.8 During the course of the fresh benchmarking exercise carried out by the ld. TPO, this comparable was selected by him. On this, the Ld. Counsel before us submitted that firstly, this company is functionally not comparable to the assessee as this company has reported exceptional performance during the year under consideration as it has been chosen as the best KPO Company by Forbes & Human Resources in the form of senior management and its strength was doubled in this year despite global recession. Apart from that, the revenue of this company increased by 51% and profits by 39%. In support, reliance has been placed on following decisions wherein this company was held to be incomparable with companies providing ITES/BPO services: i) Jardine Lloyd Thompson India P Ltd (ITA No. 779/Mum/2013) (Mumbai) dated 29 November 2016 ii) Copal Research India Pvt Ltd (ITA 894/2015)(Delhi High Court) dated 23 November 2015 iii) Nett App India Pvt. Ltd [IT(TP) A No. 1633/Bang/2014], AY 2009-10, dated 11 May 2016 iv) Daksh Business Process Services Pvt. Ltd [ITA No. 2666/DeI/2014], AY 2009-10, dated 5 July 2016 v) HSBC Electronic Data Processing India Pvt. Limited (ITA No. 247 & 295/Hyd/2014 AY 2009-10 dated 18 February 2015 vi) Maersk Global Service Centre India Pvt. Ltd. (ITA No. 2594/Mum/2014 AY 2009-10 dated 16 January 2015 vii) Excellence Data Research Pvt. Ltd v ITO (ITA No. 159/Hyd/2014) AY 2009-10 dated 12 December 2014 & 1958/M/2014 45 Pangea3 & Legal Database Systems Pvt. Ltd. viii) M/s. Capital IQ Information Systems (India) Pvt. Ltd.[ITA No. 1961/Hyd/2011] AY 2009-10 dated 31 July 2014 Apart from that it was pointed out that e-Clerx Services Ltd. has outsourced substantial work to third party during the year and the outsourcing charges to the total direct cost is approximately 32%. In support, the following chart was furnished before us: Particulars Rs. (in millions) Outsourcing charges (Contract for 266.59 services) 843.09 Total direct cost (outsourcing charges + employee benefit expenses) 31.59% Rate of outsourcing charges to total direct cost Further Ld. Counsel relied upon the decision of Hon'ble Delhi High Court in the case of Rampgreen Solutions Pvt. Ltd., (supra), wherein the Hon'ble High Court has directed the Assessing Officer to exclude one of the comparables on the ground that most of its work was outsourced to other service providers which affects the profitability.
29.9. On the other hand, the Ld. CIT DR submitted that the assessee too is providing high end legal outsourcing services which cannot be reckoned as low end ITES service provider, therefore, none of the decisions relied by the assessee are applicable to the facts of this case. Further, a comparable company cannot be rejected mainly for the reason that is showing high margin.
29.10. After considering the aforesaid submissions and on perusal of the relevant finding given in the impugned orders, we agree with the contention of the Ld. CIT, DR that assessee company cannot be regarded as low end ITES service provider because engagement of qualified and professional lawyers for providing legal outsourcing services is definitely high end services. We cannot reject this comparable simply on the ground that the comparable company is & 1958/M/2014 46 Pangea3 & Legal Database Systems Pvt. Ltd. providing high end KPO services, because as held in the foregoing paragraph the assessee too is into providing high end legal outsourcing services through qualified lawyers, hence this factor of distinction is unacceptable on the facts of the present case. So far as the issue of outsourcing the substantial work to third party during the year to indicate that eClerx operates in a different business model, we find that this contention be quite acceptable, because in outsourcing model, assets deployed in the form of human resource and other intangibles differ from an entity which operates on its own resources. However, there is no data regarding the assessee as to how much the assessee is outsourcing its activities or whether all its activities are in house. Therefore, we remit this issue to the file of the TPO/AO to examine the outsourcing activity of this comparable and analyse vis-à-vis the assessee. If TPO founds that there is a major difference in the outsourcing activity in the case of eClerx as compared to assessee’s outsourcing activity whether negligible or there is no outsourcing at all, then eClerx should be rejected for being considered as a comparable company. Because, as observed above the outsourcing activity indicates a different business model and assets employed, therefore, it has an impact on the cost and consequently profit margin. With this direction this comparable is too set aside to the file of the TPO.
(iv) R-Systems International Ltd. 29.11 The assessee had selected this comparable in its TP Study based on the financials for the accounting year ending 31.12.2008. The assessee had also submitted the copy of Annual Report of the company as at 31.12.2009 and results as on 31st March 2009 also. The TPO has rejected this comparable on the ground that it has reported financials for the year ending 31.12.2008, whereas the period for comparability analysis is 31.03.2009. Before us, the Ld. Counsel submitted that as per the supplementary details available, & 1958/M/2014 47 Pangea3 & Legal Database Systems Pvt. Ltd. R-Systems is engaged in BPO/ITES business and it is undisputed fact that it is functionally comparable to the assessee. The assessee had also submitted the operating profit margin of R-System for the year ending 31.12.2009 which was calculated from the audited financials for the year ending 31.12.2008 and also audited accounts for the quarter ending on 31st March, 2008-09. The working of which has been given in the following manner: Particulars For the year For the For the quarter For the year ended quarter ended ended ended 31-Dec-08 31-Mar-08 31-Mar-09 31-Mar-09 (Audited) (Audited) (Audited) (Audited) A B C D = (A+B+C) Revenue 2,606 566 576 2,616 Cost 2,229 520 466 2,175 (Revenue (-) PBIT) Unallocable 105 49 18 74 expense (Refer note-1) Total cost 2,334 569 484 2,249 Operating 272 (3) 92 367 profit OP/OC 11.65% 0.53% 19.06% 16.33% Note-1: Unallocable expenses calculated on the basis of proportion of revenue from BPO segment to total revenue.
Thus, it was pointed out that from the aforesaid figures which are from the audited accounts, it can be seen that operating margin of R- Systems for the year ending 31st March 2009 can be calculated and based on such audited figures this comparable company cannot be rejected simply on the ground that it is following financial year from January to December. In support of this contention and cases where R Systems has been accepted despite following calendar year, reliance was placed on the following decisions: � Maersk Global Service Centre India Pvt Ltd. (ITA No. 2594/Mum/2014 AY 2009-10 dated 16 January 2015; � Mercer Consulting India Pvt. Limited [ITA No. 9661De1/2014] AY 2009-10 dated 6 June 2014; & 1958/M/2014 48 Pangea3 & Legal Database Systems Pvt. Ltd. � Mercer Consulting India Pvt. Limited [ITA No. 101 of 2015 (O&M)] (Punjab & Haryana High Court) AY 2009-10 dated 24 August 2016 ; � M/s. CISCO Systems India Private Limited [ITA No. 271/Bang/2014, AY 2009-10], dated 30 July 2014; � Aegis Limited [ITA No. 1213/Mum/2014], AY 2009-10, dated 27 July 2015.
29.12. On the other hand, the Ld. CIT, DR has placed reliance on the decision of Hon'ble Bombay High Court in the case of ‘PTC Software India Pvt. Ltd’. (2016) 75 Taxmann.com 31, wherein the Hon'ble High Court has held that there is no basis to consider a comparable that does not have the data relating to financial year. In the rejoinder, the Ld. Counsel for the assessee submitted that the comparables under consideration before the Hon’ble High Court was following July to June financial year and quarterly results were not publicly available so as to compute the margin of the financial period April to March. Further, Hon'ble P&H High Court in the case of CIT Vs. M/s. Mercer Consulting India Pvt. Ltd., of 2015 dated 24.08.2016 had dealt the issue in connection with R-Systems International Ltd. only.
29.13. We have heard rival submissions and also perused the relevant finding given in the impugned orders. This comparable company has been rejected not on the ground of functionality but on the ground that it is following the financial year from January to December (i.e., calendar year). Though a comparable company following a different financial year may not be generally taken for comparability analysis, however, if financial data is available for all the quarters including January to March and it is otherwise possible to determine the value of the transaction as well as the profitability during the corresponding period, then it suffices the comparability criteria. Because, ultimately the core point in comparability analysis & 1958/M/2014 49 Pangea3 & Legal Database Systems Pvt. Ltd. is to benchmark the margin of a given period of a comparable uncontrolled transaction with controlled transaction. If the financials of the corresponding period is available then it cannot be rejected simply on the ground that it has a different financial year. As brought out on record by the Ld. Counsel before us that the audited accounts of R-Systems for the year ending 31.12.2008 and for the quarter starting from 31.01.2008 to 31.03.2009 is available and once such an audited statement is available, then the proportionate working for 31.03 2009 can easily be deduced. If there are no major incidents of factors disturbing the profit margin in that quarter, whose results are being worked out and the transactions of the Company are carried out in the normal course of business, then we do not find any reason to reject the comparable out rightly on the aforesaid ground. The working of PLI based on audited accounts as incorporated above clearly clinches the point. The Hon'ble P&H High Court in the context of R-Systems only had made a very important observation which reads as under: “27. The TPO excluded the case of R-Systems International Limited from the list of comparables. The ITAT included the same. The Transfer Pricing Officer excluded the case of R-Systems International Limited on the ground that it follows the calendar year i.e. 1st January to 31st December for maintaining its annual account whereas the accounting year of the assessee is 1st April to 31st March. The Transfer Pricing Officer followed an order passed by the Mumbai Bench of the Tribunal in ACIT v. Hapag Lloyd Global Services Ltd. 2013-TH-68-ITATMUM-TP in which it had been held that a company with a different financial year ending cannot be compared.
We are unable to agree with the decision of the Transfer Pricing Officer and of the DRP that affirmed it. The view taken by the Tribunal commends itself to us. It is not the financial year per se that is relevant. Even if the financial years of the assessee and of another enterprise are different it would make no difference. If it is possible to determine the value of the transactions during the corresponding period, the purpose of comparables would be served. The question in each case is whether despite the financial years of the assessee and of the other enterprise being different, & 1958/M/2014 50 Pangea3 & Legal Database Systems Pvt. Ltd. the financials of the corresponding period of each of them are available. If they are, the Transfer Pricing Officer must refer to the corresponding period of both the entities in determining whether the two are comparable or not for the purpose of determining the ALP.
As noted by the Tribunal, the audit accounts of R System International Ltd. for the year ending 31.12.2008 had been given under one column and the data for the quarter ending 31.03.2009 and 31.03.2008 (both audited) had been given in two other columns. Thus, as rightly held by the Tribunal, if from the yearly data ending 31.12.2008, the results of the quarter ending 31.03.2008 are excluded and if the results for the quarter ending 31.03.2009 are included, it is possible to obtain the data for the financial year 01.04.2008 to 31.03.2009.
30. This view is not contrary to Rule 10(B)(4) which reads as under:- "10B(4) The data to be used in analysing the comparability of an international transaction shall be the data relating to the financial year in which the international transaction has been entered into.
31. The Rule does not exclude from consideration the data of an entity merely because its financial year is different from the financial year of the assessee. What the Rule requires is that the data to be used in analyzing the financial results of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into. Thus, so long as the data relating to the financial year is available, it matters not, if the financial year followed is different. In the case before us the data relating to the relevant financial year of R-Systems International Limited is available.
We are, therefore, entirely in agreement with the decision of the Tribunal that if the data relating to the financial year in which the international transaction has been entered into is directly available from the annual accounts of that comparable, the same cannot be held as not passing the test of sub-rule (4) of Rule 108.”
29.14. So far as the decision of Hon'ble Bombay High Court as relied upon by Ld. CIT DR is concerned, in that case the revenue was contesting that the difference between two financial years was only of three months, therefore, same should be ignored. It was not brought before the Hon'ble High Court or anything was on record that the & 1958/M/2014 51 Pangea3 & Legal Database Systems Pvt. Ltd. data for relevant two months was available or can be worked out on the proportionate basis based on audited accounts; then in that case whether it can be ignored or not. Nothing is borne out that, whether the assessee has provided the audited accounts of the intervening period and the proportionate working of two consecutive calendars years in which the said quarter results fell, like in the present case. Here in this case, once the audited data is available for the quarter 01.01.2009 to 31.03.2009 then same is liable to be accepted. Accordingly, we hold that this company is to be accepted as comparable company for the purpose of benchmarking the assessee’s margin.
(v) Allsec Technoligies Ltd.:-
29.15 This comparable company has been rejected by the TPO on the ground that it was incurring loss. It is an undisputed fact that this company is also providing ITES services and was included in the set of comparables selected by the assessee. In the TP Study Report the profit margin of this comparable was reported at (-) 16.44%. Further, Ld. Counsel submitted that a comparable cannot be rejected simply because it had incurred loss in one or two years unless there are abnormal reasons for loss which in this case was none. It has incurred losses purely on account of downturn in the international market which has affected the entire industry. Further, this company had reduced its losses by 46% in this year as compared to the earlier years.
29.16. On the other hand, the Ld. CIT, DR in her written write up has submitted as under: “Allsecc Technologies Ltd. - This comparable was rejected by the TPO for the reason that it was incurring losses, which indicated that there were certain abnormal factors operating in its case. The exclusion was upheld by the DRP whereas the assessee has requested for its reinstatement before the ITAT. The Balance Sheet & 1958/M/2014 52 Pangea3 & Legal Database Systems Pvt. Ltd. of Allsec can be referred to at Page 381 of the Paper Book containing the Balance Sheet of the comparable. This company is operating call centre and is predominantly operating within India. Its foreign exchange earnings during the year were 74% and with further growth taking place within India, the same has reduced to 50% in the subsequent year. As explained by the Delhi High Court in the case of Rampgreen Solutions, a call centre is in the nature of low end BPO service and is not comparable to high end services that require skilled manpower. Further, this company is also going through merger and acquisition during the relevant previous year. The same is evident from Pg 392-393 of the Paper Book. Further, the financial highlights of the company as appearing in its Balance Sheet for 2010-11 can be referred to Sr. No. V(l) of Revenue's Paper Book. It can be observed from the same that right from the year 2008 to 2011; this company is incurring only losses. Further, the ratio of export earnings to total earnings is also coming down annually. The impact of merger can be observed from the data of net margins in last few years. Rs. in Millions Year Ending Dec-02 Mar-04 Mar-O5 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Total Income 199.43 249.61 575.64 933.32 1171.35 1040.26 1098.46 1327.87 1451.21 Net Profit 23.79 -150.95 118.54 216.65 284.58 -107.98 -66.42 -64.39 -34.74 Profit Margin 11.93% - 60.47% 20.59% 23.21% 24.30% -10.38% -6.05% -4.85% -2.39%
The fall of profits over a period of three years as compared to good margins in the year 2005, 2006 and 2007 (shows that the merger and acquisition undertaken by this company and significant expansion within India has impacted the profitability over a period of three years up to March 20 1l. Refer pages VI, V2 and V3 of Revenue's Paper Book. It is therefore submitted that Allsec Technologies has been correctly excluded by the TPO as it is neither functionally comparable nor is it complying with the extraordinary event filter or the export filter.
34. The case of Allsec Technologies has been rejected by the ITAT in a number of BPO cases and for this purpose reliance is placed on the following decisions:
S. Name of the Citation Revenue’s Relevant No. Ruling paper book para of Reference judgment & 1958/M/2014 53 Pangea3 & Legal Database Systems Pvt. Ltd. i) Macquarie (2015) 55 IV-1 Para 33 Global Taxmann.com Services Pvt. Ltd. 259 (Del. ITAT) ii) Sanmina SCI (2015) 60 V-4 Para 23 Pvt. taxmann.com 467 (Chn. Tribunal) iii) Schlumberger (2015) 64 V-5 Para Global Support taxmann.com 63,64 Centre Ltd. 322 (Pune ITAT) iv) Lason India Pvt. (2016) 70 V-6 Para 4.6.2 Ltd. taxmann.com 259 (Chn. ITAT)
29.17. We have heard the rival submissions and also perused the relevant material placed on record. One of the arguments placed by the Ld. CIT DR is that, the foreign exchange earnings of this comparable during the year was 74% which has reduced to 50% in the subsequent year, therefore, it is below the threshold (filter) applied by the parties. However, we are unable to accept this contention, because, if the export is quite approximate to 75% in this year, then same cannot be held to be a very relevant factor for rejecting such minor difference in export turnover filter. This has been held so by the Hon'ble P&H High Court in the case of Mercer Consulting India Pvt. Ltd., (supra). The Ld. CIT DR has also pointed out that this company had been going through merger and acquisition and right from the year 2008 to 2011 this company has been incurring loss. The merger and acquisition undertaken by this company has impacted the profitability over a period of three years upto March, 2011. If the loss is on account of merger and acquisition in this year, then definitely we agree with the proposition of Ld. CIT, DR that this would definitely impact the PLI and consequently the comparability analysis. However, if the loss is during the normal course of business and has nothing to do with merger and acquisition in this year, therefore, such a margin even if it is a loss, has to be & 1958/M/2014 54 Pangea3 & Legal Database Systems Pvt. Ltd. accepted and it would be a fit comparable for benchmarking the assessee’s margin. Accordingly, only for this exercise, that is, to examine the impact of merger and acquisition in this year, we are remitting the matter back to the file of the TPO. The assessee will also provide the relevant details in support of its case. Thus, this comparable is also set aside to the file of the TPO, for limited purpose.
(vi). Microland Ltd. (subject matter of Department’s appeal):-
29.18 This comparable was selected by the assessee which has been rejected by the TPO but reinstated by the DRP. Such an inclusion of this comparable has been challenged by the department in its appeal. The TPO rejected this company mainly on the ground that ITES activity is not its main activity and the said company is primarily engaged in infrastructure management function which generates 80% of its revenue. This company has been reinstated by the DRP for the reason that separate profitability of ITES segment was available. Ld. CIT, DR pointed out that margin of this company’s ITES segment is (-) 19.51% and this company has been consistent loss making company in the subsequent year, i.e., year ending 2010 and even prior to this year also this company was into loss. She pointed out that this comparable company has come up for consideration before ITAT, Hyderabad and Bangalore Benches in the following cases:
S. Name of the Rulling Citation Revenue’s Relevant No. paper book para of Reference judgment i) SA&P Capital IQ (2016) 72 III-1 Para 28.2 India Pvt. Ltd. taxmann.com 326 (Hyd. ITAT) ii) Interwoven Software (2016) 74 III-2 Para 26 Services (I) Pvt. Ltd. taxmann.com 103 (Bang. ITAT)
& 1958/M/2014 55 Pangea3 & Legal Database Systems Pvt. Ltd. 29.19. On the other hand, Ld. Counsel submitted that TPO has rejected the Microland on the ground that it was not selected by the assessee in its TP Study Report and income from ITES business is less than 75% of the total turnover. The DRP has upheld the selection of this company, because the supplementary data of ITES segment was available. Hence, this comparable company cannot be ignored for the reasons given by the TPO or by the Ld. CIT, DR.
29.20. After considering the aforesaid submissions and on perusal of the relevant finding given in the impugned order, we find that this company has been rejected by the TPO for the reason that firstly, it was not selected by the assessee in its original TP Study Report; and secondly, it has incurred loss during the year. The Ld. CIT, DR has also pointed out that the ITES segment was into loss in earlier year also. As regard the contention that the assessee has not selected the company in the T.P. Study Report, therefore, it is precluded from being considered as comparable by assessee at a later stage, we are unable to subscribe to the views of the TPO, because once the TPO has rejected most of the comparables and asked the assessee to furnish fresh comparables, then TPO is bound to consider the comparables as submitted by the assessee. Apart from that, once the separate segment of ITES services are available in public domain or made available, then such segment needs to be benchmarked with the assessee. Further, we are unable to subscribe to the view that, since this comparable company had incurred loss in this year as well as in the earlier year, the same should be excluded, because the loss making and profit is in the normal course of business and unless certain peculiar factors have not been pointed out for loss, a comparable company cannot be rejected simply on the ground that it is loss making company. Once a separate segment is available and the profitability of such a segment is determinable, then the same should be adopted for the comparability analysis. Hence, we uphold & 1958/M/2014 56 Pangea3 & Legal Database Systems Pvt. Ltd. the order of the DRP for accepting the said comparable in the final list of comparables. Accordingly, the revenue’s ground on this comparable is treated as dismissed.
(vii) Omega Healthcare Management Services Pvt. Ltd.:-
29.21 This comparable was rejected by the TPO for the reason that its P&L Account was not available in the public domain. However, before the DRP the assessee pointed out that the Balance Sheet and Profit & Loss account was available in the public domain and copy of the same was furnished. Accordingly, DRP directed the TPO to verify the financials and include the same in the list of the comparables.
29.30 After considering the submissions of both the parties and on perusal of DRP’s order, we do not find any reason to interfere on such a direction of the DRP, because if financials are available and profit margins are determinable along with functional profile, then the TPO should consider this comparable for comparability analysis. Accordingly, we direct that Omega Healthcare should be accepted subject to the availability of financial data.
29.30 Apart from the aforesaid comparables, the Ld. Counsel pointed out that there are three more comparables which assessee had submitted during the course of TP proceeding and TPO has erroneously rejected the same. These comparable companies are; (i) IKF Technologies Ltd.; (ii) Lee & Nee Software Exports Ltd.; and (iii) Jindal Intellicom Pvt. Ltd. During the course of the assessment proceedings, TPO had initiated fresh benchmarking process and search of fresh comparables were carried out and from the said search the assessee pointed out that these comparables were also engaged in providing ITES services and hence should be accepted for comparative analysis. The first two companies have been rejected by the TPO mainly on the ground that, these companies are not forming & 1958/M/2014 57 Pangea3 & Legal Database Systems Pvt. Ltd. part of the TP’s study report. The DRP too has rejected these comparables on the ground that, inclusion of such comparables would amount to cherry picking of the comparables. The assessee before the authorities below had submitted the relevant extracts of annual report of the companies to substantiate the claim that these companies were engaged in providing ITES and they were not part of the T.P. Study report, because their data and financials were not available on public domain, which were now available.
29.31 We are of the considered opinion that once the annual report of the companies are available along with the functional profile and are capable of being analysed on FAR analysis then, we do not see any reason as to why these comparable companies should not be considered for comparability analysis. The TPO cannot preclude the assessee from proposing inclusion or exclusion of comparables even it has been brought at later stage either by assessee or by TPO himself, if all material facts for comparative analysis are made available. The paramount aim of transfer pricing mechanism is determination of ALP of a transaction and any inclusion or exclusion of comparables should be based on proper FAR analysis as provided under the law. Accordingly, we direct the TPO to examine these two comparables and assessee will provide all the necessary data for considering the same. Thus, these two comparables are set aside to the file of the TPO for proper comparability analysis and if they are found to be comparable then same should be included in the comparable list for the purpose of benchmarking the profit margin.
29.32 As regards M/s. Jindal Intellicom Pvt. Ltd, it is seen that this company too was rejected by the TPO on the ground that financial data of the company was available only up to 31.03.2008. The assessee had submitted that the business description of this company is based on information available on website which shows that Assessee Company is into BPO/ITES services and assessee made & 1958/M/2014 58 Pangea3 & Legal Database Systems Pvt. Ltd. available the financial data for 31st December 2008. Here, in this case also, if audited financials after 31st December 2008 are available and based on the data for next year the turnover as well as proportionate margin can be worked out, then we do not find any reason as to why this comparable should not be included. However, this exercise has to be done by the assessee to make available the audited accounts/data for 1st January 2009 to 31st March, 2009 as has been done in the case of R-Systems. Our finding given in relation to the R- System will also apply here subject to the fulfillment of the aforesaid condition. Thus, this comparable is to set aside to the file of the TPO.
It has been admitted by both the parties that if the aforesaid comparables are decided then other comparables need not be adjudicated upon and accordingly, we are confining our finding qua the comparables which has been argued before us; and we are refraining ourselves in deciding the other comparables as the parties have not argued other comparables before us.
Regarding working capital adjustment as urged in ground no. 9 by the assessee, if assessee has provided the comparative analysis vis-à-vis the comparables and the data, then in that case, we direct the TPO to examine this issue in light of several decisions now available on this subject and the details submitted by the assessee. The assessee will provide the necessary details to substantiate its case, if required by the TPO/AO.
32. As regard the other grounds of appeal
and comparables as raised by the assessee, it has been stated by the Ld. Counsel that some of these grounds are general and some of them are not been urged as they may become academic. Since other grounds have not been argued before us, therefore, we are not adjudicating the remaining grounds. & 1958/M/2014 59 Pangea3 & Legal Database Systems Pvt. Ltd.
33. Lastly, in ground no. 3 the revenue had also challenged the direction of the DRP to the TPO to allocate administrative expenses and depreciation while computing the operative margin in respect of Acropetal Technologies Ltd, included as comparables. The TPO had accepted that the information technology segment is not similar to the functions performed by the assessee. However, he considered the engineering design service segment of Acropetal Technologies Ltd. is similar to ITES and considered the same for the operating margin of engineering service system. Once this comparable company has been rejected by us, then the grounds raised herein have become purely academic.
34. Accordingly, TPO is directed to benchmark the profit margin after giving effect to the various observation and direction contained in this order.
In the result, the appeal of the assessee is partly allowed for statistical purposes, whereas the appeal of the Revenue is dismissed.
Order pronounced in the open court on 06.03.2017.