ITO, NEW DELHI vs. M/S. E VALUE SERVE.COM, NEW DELHI

Brief facts of the case are that as per TP report of assessee, in the relevant assessment year, the assessee was engaged in the business of providing high end IT enabled services to its Associated Enterprise. The company was registered with Software technology Park of the Government of India. The assessee conducted research activities and provided knowledge management services to its associated enterprise. The assessee derived business from following major segments:

In the Market Research (Primary) segment, the assessee acted as back office research centre (mainly a captive unit) and did not have any direct competition in India as it provided services mainly to its AE.

Further the assessee had no direct interaction with the market due to the fact that work was outsourced to the Indian entity from its AE. The assessee had entered into the following international transactions:

The assessee had selected TNMM as the most appropriate method for bench marking this transaction. It had also selected OP/TC as the most appropriate profit level indicator for the bench marking of the international transactions. In the TP report the assessee had selected following seven comparable companies:

The assessee had adopted upper filter of Rs. 50 crores turnover for selection, which resulted into the above seven comparables. The average operating margin of these comparables was 7.22% whereas that of the assessee was 6.50% and, accordingly, assessee concluded that the international transaction entered into with AE was at arm’s length.

Ld. TPO increased the upper sales filter to Rs. 150 crores and also directed for using current year data on the basis of which the assessee found 21 comparables. Since 12 comparables were having RPT more than 15%, therefore, they were rejected by assessee and only 9 were lifted, which were as under:

Out of the above nine comparables, TPO rejected two comparables on the ground of different year endings:

M/s BT TechNet Ltd. was also rejected on the ground that it had no foreign exchange earnings. Ld. TPO also scrutinized the comparables rejected by assessee on the ground that related party transactions were more than 15% and pointed out that following two comparables were to be included as they performed similar functions:

Before ld. TPO the assessee had, inter alia, submitted that the margin of these two additional comparables had to be recomputed. Ld. TPO accepted the assessee’s contention as per his finding on pages 47 & 48 of his order in regard to Tech Mahindra (R&D Services Ltd.) and also in regard to ICRA Techno Analytics Ltd., the findings of which are contained at pages 49 & 50 of his order. He further pointed out that the margins of the remaining seven comparables, on the lines of the computation of these two comparables, is to be done again. He, accordingly, recomputed the margins of all the other seven comparables, the details of which are contained from pages 51 to 55 of his order and, accordingly, final selection of comparables was done as under:

Ld. TPO also rejected the working capital adjustment as claimed by the assessee observing at page 50 of his order that assessee had not demonstrated that there was a need for extra working capital to carry out the international transaction during FY 2004-05. He pointed out that in the last two years assessee had carried out substantial expansion activity within India and outside India. This company also opened a centre in Chile. He pointed out that it was not clear whether the working capital adjustment sought by the assessee was for the expansion activity or for the execution of the international transaction carried out by the assessee. He observed that the working capital adjustment could only be provided if the assessee could demonstrate that the working capital was not adequate for the normal business activities relating to international transactions. He, accordingly, rejected the assessee’s claim for working capital adjustment.

Ld. TPO determined the ALP as under:

Ld. CIT(A) upheld the ld. TPO’s finding regarding applying upper limit of sales filter of Rs. 150 crores. However, he rejected following four comparables out of nine selected by ld. TPO:

Ld. CIT(A) further examined the TPO’s computation of operating profit and held that stock adjustment and misc. income is to be treated as operating income and finance charges and misc. expenses were to be treated as operating expenses for both the tested party as well as the comparables.

Ld. CIT(A) computed the ALP on the basis of recomputed margins as under:

Accordingly, he held that since the OP/TC margin earned by the assessee was within ±5% range permissible under proviso to section 92C(2) of the Arm’s length margin, therefore, the international transactions of the assessee were held to be at arm’s length. After adjudicating the corporate issues, ld. CIT(A) finally partly allowed the assessee’s appeal. Being aggrieved with the order of ld. CIT(A), the department is in appeal before us and the assessee has filed cross objection.

The department has filed additional ground of appeal, which is reproduced hereunder:

We have considered the submissions of both the parties and have perused the record of the case. We are not in agreement with the findings of ld. CIT(A) that working capital adjustment cannot be computed on the basis of year end figures. We find that in the case of Navisite India Pvt. Ltd. (supra), it has been held that the opening working capital deployed and the closing working capital deployed has to be taken into consideration for meeting any adjustment to the working capital deployed in the case of a comparable. If we accept the contention of ld. CIT(A), then it will become impossible to allow any working capital adjustment to assessee, because it is impossible to arrive at working capital requirement on day to day basis. In TP analysis there is always an element of estimation because it is not an exact science. One has to see that reasonable adjustment is being made so as to bring both comparable and tested party on same footing. Accordingly, the additional ground raised by the department is rejected.

Ld. DR submitted that assessee is KPO. In this regard he referred to para 2.3 of TPO’s order and also referred to page 66 of TPO’s order, wherein ld. TPO has observed as under:

He submitted that assessee was the first KPO established in the country and was high-end service provider. Ld. DR further submitted that ld. CIT(A) has taken into consideration all comparables which were BPO. He further pointed out that margins were recomputed for all comparables without affording any opportunity to assessee. He submitted that no reason has been given by ld. CIT(A) for rejecting three comparables on the ground that foreign exchange earnings was less than 50%. Further, he rejected Tech Mahindra n(R&D), on the ground that the same was functionally not comparable to assessee. He referred to page 57 of CIT(A)’s order where ld. CIT(A) has given findings on various items in regard to determination of operating profit. He pointed out that ld. TPO had never opportunity for considering adjustments allowed by ld. CIT(A). He pointed out that ld. CIT(A) had arrived at margins lesser than arrived at by assessee after working capital adjustment. He pointed out that the margins arrived at by ld. CIT(A) were 14.22% a against margins arrived at 21.88% by assessee itself after allowing working capital adjustment. Ld. DR further referred to page 6 of CIT(A)’s order wherein the ground raised before ld. CIT(A) are concerned, in which ground no. 4.1 reads as under:

Ld. DR submitted that ld. CIT(A) has not adjudicated this ground and there is no challenge in CO on this count. Therefore, the fact that assessee is KPO, rendering high end services, is not disputed.

Ld. counsel for the assessee submitted that Tech Mahindra (R&D) has been rejected by ld. CIT(A), which was an ITES and, therefore, now this ground cannot be taken by the department. He further pointed out that none of the companies selected by ld. TPO were engaged in any KPO activities and, therefore, now this issue cannot be agitated. He pointed out that assessee was primarily rendering a call centre.

Ld. counsel further pointed out that at page 47 of TPO’s order, wherein he has considered the issue regarding BT TechNet Ltd. and had rejected this company because it had almost nil foreign exchange revenue earned in FY 2004-05, whereas in the case of assessee the entire revenue was in foreign exchange. On the same footing ld. CIT(A) rejected other three comparables noted earlier.

As regards Tech Mahindra (R&D) is concerned, ld. counsel referred to page 40 of ld. CIT(A)’s order, wherein he has observed, how this comparable was functionally different from assessee as it was providing software development services. He submitted that nothing has been brought on record by revenue to dislodge this finding of ld. CIT(A).

As regards ld. DR’s submission regarding computation of operating margins by ld. CIT(A), he submitted that the main issue was whether certain expenses were operating or non-operating in nature. He referred to page 268 of PB, wherein computation of operating profit margins wss filed before AO on 7.7.2008. Ld. counsel submitted that Rule 46A is not applicable because no fresh evidence was filed before ld. CIT(A). He further submitted that ld. DR has not pointed out any fresh evidence being filed before ld. CIT(A). As there was no additional evidence filed before ld. CIT(A) there is no question of applicability of rule 46A.

Ld. counsel referred to PB II, filed on 22.8.2016, wherein show cause notice received from TPO dated 25.7.2008 is contained from pages 1 to 26. Ld. counsel referred to page 285 of PB, wherein assessee’s reply dated 11.8.2008 is contained wherein at page 289, chart was filed for determining the operating profit margins. Ld. counsel referred to page 55 of TPO’s order and pointed out that after considering these mistakes, ld. TPO determined the PLI at 17.53% as against 15.83% in show cause notice. Ld. counsel referred to PB II, filed on 22.8.2016 and referred to page 72 of the same wherein in regard to ground no. 4.6 raised before ld. CIT(A) in regard to computation of operating profit/ total cost earned by the comparable company for making TP additions was mentioned.

Ld. CIT(A) considered these submissions and, thereafter, arrived at profit margin of 11.38% for which details were furnished at pages 122 to 122A of the submissions. He, therefore, submitted that only the computational errors were corrected by ld. CIT(A).

As regards the issue raised by ld. DR regarding KPO/BPO, ld. counsel submitted that ld. CIT(A) rightly treated the assessee as ITES. He pointed out that on this count there was no show cause issued by ld. TPO and there is no ground of appeal. He further pointed out that the concept of BPO and KPO is always overlapping. He referred to page 43 of PB-II dated 22.8.2016, wherein the submissions made before ld. CIT(A) are contained and pointed out that specific ground was taken before ld. CIT(A) that ld. AO/ TPO erred in interpreting that the IT enabled service activities of the assessee could be categorized as high end service and could be placed high in the value chain of the ITES industry. He pointed out that in this regard assessee had referred to TP documentation and had pointed out that assessee derived business from 4 major segments, which included business information and market research (primary). This aspect has been referred to earlier also.

It was further held that where the controlled transactions were clearly in the nature of low-end ITES such as call centres etc., for rendering data processing not involving domain knowledge, inclusion of any KPO service provider as a comparable would not be warranted.

We have considered the submissions of both the parties and have perused the record of the case. We may point out that department has not specifically objected to rejection/ inclusion of comparables by ld. CIT(A). However, since the selection of comparables has a bearing on the determination of ALP, therefore, we proceed to consider the inclusion/ exclusions of comparables done by ld. CIT(A).

Now coming to the issue of comparables, we find that as far as rejection of three comparables viz. Ace Software Exp., C S S Technergy Ltd. and KLG Systel is concerned, ld. CIT(A) has rejected these comparables for the reason that it had no foreign exchange earnings. This has been done because BT TechNet Ltd. was rejected by ld. TPO on the ground that it had no foreign exchange earnings. We do not find any reason to interfere with the order of ld. CIT(A) on this count because ld. TPO was required to be consistent in his approach in rejection/ selection of comparables.

As far as this comparable is concerned, we find that ld. CIT(A) has observed at page 40 as under:

Nothing has been brought on record to controvert the findings recorded by ld. CIT(A). It is not disputed that assessee is not in software development services and is primarily providing IT enabled services to its AEs. In the TP study it has been described as high end IT enabled service because the assessee conducts research activity and provide knowledge management services to its AEs. But this could not be compared with a company which was engaged in software development services. The assessee’s essential service were IT enabled services only. We, accordingly, confirm the order of ld. CIT(A) on this count.

Ground nos. 4 & 5: Now coming to the issue regarding computation of operating profit margin of comparables: In this regard the department in ground no. 4 has assailed the findings of ld. CIT(A) for accepting the assessee’s contention that stock adjustment should be treated as part of operating expense whereas the TPO had treated the same as part of operating income. We find that ld. CIT(A) has observed in this regard as under:

The aforementioned reasoning given by ld. CIT(A) cannot be disputed because change in stock has been considered as an expenditure since this essentially refers to the cost of goods sold. It is not disputed that consistent method has been adopted for all the comparables under consideration in this regard. We do not find any reason to interfere with these findings of ld. CIT(A) ground no. 4 is dismissed.

As regards ground no. 5, seeking invocation of rule 46A, we find that computation of operating profit margin was considered by ld. TPO also and before ld. CIT(A) the assessee had given the correct mode of computation, but no additional evidence was filed. Therefore, there was no violation of Rule 46A. Accordingly, we do not find any reason to interfere with the order of ld. CIT(A) ground no. 5 is dismissed.

Ground no. 6: The main contention of department is that ld. CIT(A) had concluded that misc. income and misc. expenses were operating profits without verifying their nature. We find that ld. CIT(A) has observed in regard to misc. income that the same pertained to income from other sources and the misc. income was included as part of operating profit in the case of comparable company. Therefore, there could not be any prejudice to revenue on this count. As regards misc. expenses, ld. CIT(A) has observed that the same included a multitude of expenses that were too small in value. But since they pertained to the operations of the company, they were treated as operating expenses for both the tested party as well as the comparable companies. The TP analysis, as we have earlier observed, is not an exact science and we have to arrive at reasonable conclusions which would not materially affect the profit margins. Therefore, we do not find any reason to interfere with the finding of ld. CIT(A) on this count. In the result ground no. 6 is dismissed.

Ground no. 7: The department has assailed the finding of ld. CIT(A) in considering the finance charges for computation of operating profits and in not quantifying the finance charges brought in as operating expense and providing a line by line calculation of the operating margin. We find that ld. CIT(A) has observed that finance charges were in the nature of bank charges which pertained to the business operations of a company. He further referred to this observation in regard to working capital adjustment wherein he had held that the interest on loans taken by both the comparables as well as the assessee should be treated as part of operating expense. These findings have not at all been controverted. Therefore, we do not find any reason to interfere with the finding of ld. CIT(A). Ground no. 7 is dismissed.

In the result department’s appeal is dismissed.

As we have dismissed the revenue’s appeal by upholding the ld. CIT(A)’s order, the cross-objection filed by assessee has become infructuous because after the CIT(A)’s order there is no adjustment left to be made.

In the result, departmental appeal as well as the assessee’s cross objection are dismissed.