KOBELCO CRANES INDIA PVT. LTD.,NEW DELHI vs. ITO, NEW DELHI

ORDER

PER R.S. SYAL, AM:

2.1. The only issue raised in this appeal is against the addition on account of transfer pricing adjustment amounting to Rs.72,51,258/-.

Briefly stated, the facts of the case are that the assessee is a closely held company with its 99.78% share capital held by Kobelco Cranes Company Ltd., Japan and the remaining 0.22% held by Kobelco Cranes Trading Company, Japan. The assessee got incorporated in India on 4.8.2010 to carry on the business of buying, selling, importing, exporting, developing, designing, manufacturing, assembling or otherwise dealing in all kinds of cranes including used cranes and material handling equipments with other related components. This is the first year of the assessee’s business operations. The assessee filed its return declaring total income of Rs.29,88,565/- accompanied by audit report in Form No.3CEB detailing nine international transactions. The assessee used Transactional Net Margin Method (TNMM) as the most appropriate method for demonstrating that its international transactions were at arm’s length price (ALP). It used Profit level indicator (PLI) of Operating Profit/Operating Cost (OP/OC). The assessee computed its OP/OC at 8.7% with the weighted average margin of nine comparable companies chosen by it, at 13.44%. That is how, it was shown that the international transactions entered into by the assessee with its AEs were within the permissible +/- 5% range and, hence, at arm’s length price (ALP). The AO made a reference to the Transfer Pricing Officer (TPO) for determining the ALP of these international transactions. The TPO observed that in the year in question the assessee rendered Marketing and sales support services to its parent company. Such support services have been summarized in the order passed by the TPO, as under:-

- Customer support services in relation to the business dealings with existing clients and potential clients in India;

- Administrative/facilitation assistance such as inventory of spare parts, arranging facilities, customs clearance and product support

(both parts and service) and training to dealers and customers;

- Assistance in relation to marketing/new business development;

- Compilation of customer/market data, identification and evaluation of potential business opportunities in India, etc.

2.2. The TPO disputed the calculation of the assessee’s own profit margin at 8.70%. He noticed that the assessee’s revenue was to the tune of Rs.4.24 crore, whereas the assessee had calculated its operating profit margin with the figure of gross revenue at Rs.2.23 crore, which was shown as net of commission expenses amounting to Rs.2.00 crore. In support of its argument for taking such a reduced figure of revenue, the assessee submitted that it paid commission to Voltas India Ltd. amounting to Rs.2.00 crore, which was a pass through cost and hence reduced from the gross revenue earned from its AE rather than showing it separately as an item of operating cost. Not convinced with the assessee’s submissions, the TPO re-worked out the assessee’s profit margin at 6.34% by taking income from operation at a gross figure of Rs.4.24 crore. Out of nine companies chosen by the assessee, the TPO considered only one company as comparable, namely, ICRA Management Consulting Services Ltd. He carried out his own search process to expand the list of comparable companies. In the ultimate analysis, a list of 12 comparable companies was drawn with their average OP/TC at 26.80%. By treating this profit margin of 26.80% as arm’s length profit margin, the TPO recommended transfer pricing adjustment amounting to Rs.81,63,332/-, which was included by the AO in his draft order. The assessee objected to such addition before the Dispute Resolution Panel (DRP) and remained partly successful. After considering the directions given by the DRP, the AO finally worked out the addition on account of transfer pricing adjustment amounting to Rs.72,51,258/-, against which the assessee has come up in appeal before us.

I. DETERMINATION OF ASSESSEE’S PROFIT MARGIN.

4.1. The assessee computed its profit margin of OP/OC at 8.70%, the working of which has been incorporated on page 4 of the TPO’s order.

In calculating its operating profit margin, the assessee adopted the amount of its gross revenue, being ‘Income from sales commission’ at Rs.2,23,72,709/-, by mentioning that such figure was deduced after reducing commission expenses of Rs.2,00,76,132/-. The TPO took the gross amount of income from operations as operating revenue at Rs.4,24,48,841/-. There is no dispute on any aspect of the determination of the assessee’s profit margin at 6.34% except for the consideration of commission payment of Rs.2.00 crore to Voltas India Ltd. as deductible or not from the gross revenue earned by the assessee from its AE.

4.2. The facts leading to this controversy are that the assessee entered into an Agreement dated 10.3.2011, effective from 1.10.2010, with its associated enterprise (AE) for rendering Market support/customer support services, a copy of which is available on page 1382 of the paper book. As per this agreement, the assessee agreed to render the following services to its AE:-

• Providing customer support services to KCL (i.e. its AE) in relation to their business dealings with existing clients and potential clients in India; • Providing administrative/facilitation assistance such as inventory of spare parts, arranging facilities, customs clearance, etc., to KCL; • Providing product support (both parts and service) and training to dealers and customers, assistance in relation to marketing/new business development, compilation of customer/market data, identification and evaluation of potential business opportunities; • KCI (i.e. the assessee) shall communicate any new business opportunity, post evaluation, to KCL in the form of a business proposal;

• KCL shall be solely responsible to scrutinize such business proposals recommended by KCI and will independently take decision to accept or reject the same; • It is expressly agreed upon by the Parties to the Agreement that KCI’s role shall be limited to finding business opportunities in India and it shall not have any authority to execute any contracts for or on behalf of KCL nor bind KCL in any other manner whatsoever in India. • Liasoning with the technical department of KCL’s affiliates (located outside India) to provide assistance to KCL’s customers in India. • Providing assistance to KCL in negotiating the prices of the products/terms of the contract with the customer. However, KCL shall be the ultimate decision-making authority in this respect and KCI shall not have any authority to finalise the prices or execute any contracts for or on behalf of KCL in India.”

4.3. As per clause 4 of the Agreement, it was agreed between the parties that the assessee shall be paid sales commission on the products (i.e. Cranes and Spare parts) sold by its AE to customers in India.

Pursuant to this Agreement, the assessee was paid commission to the tune of Rs.4,24,48,841/-. The assessee entered into a Sub-contract service agreement with Voltas Ltd. on 1.10.2010, a copy of which is available on page 1372 onwards of the paper book. Clause 2 of this Agreement provides that the assessee agreed to sub-contract the market support/customer support services to Voltas Ltd. in relation to its business dealings with its AEs. Pursuant to this Agreement, Voltas Ltd. agreed to provide the following services:-

• “Providing customer support services to KCI in relation to the business dealings of KCI’s associated enterprises in respect of existing clients and potential clients in India; • Providing assistance in product support (both parts and service), training to dealers and customers, assistance in relation to marketing/compilation of customer/market data;

• Providing administrative/facilitation assistance to the dealers/customers of KCI/KCL. • Communicating any potential business opportunity to KCI for its evaluation and scrutiny. • It is expressly agreed upon by the Parties to the Agreement that Voltas India’s role shall be limited to providing assistance in marketing and customer support services opportunities in India and it shall not have any authority to execute any contracts for or on behalf of KCI nor bind KCI in any other manner whatsoever in India.”

4.4. Clause 4 of this Agreement provides that in performance of the Services under this Agreement, Voltas Ltd. shall be paid commission by the assessee, which may be mutually decided by both the parties. It is pursuant to this Agreement, that the assessee paid a commission of Rs.2,00,76,132/- to Voltas Ltd. It is such payment of commission, which is the subject matter of dispute in the calculation of the assessee’s operating profit margin. Whereas the assessee computed its profit by excluding the amount of commission paid to Voltas from its gross revenue, being commission earned from its AE, the TPO held that such commission to Voltas Ltd. was to be considered as an operating expense and was not liable to be reduced from the gross revenue. The reason behind this difference of opinion is the impact of such treatment on the computation of profit margin rate of the assessee, albeit the ultimate amount of operating profit remains the same in both the situations. If the revenue is taken at Rs.2.23 crore because of the shifting of commission payment to Voltas Ltd. from the operating costs, as adopted by the assessee, the percentage of operating profit shoots up to 8.70%. If, on the contrary, this amount of commission is retained as an operating expense, the percentage of operating profit slides to 6.34%.

4.5. It is simple and plain that higher the assessee’s operating profit rate, lower is the amount of the transfer pricing adjustment and vice versa. Under such circumstances, we are required to decide as to whether the amount of commission paid to Voltas Ltd. should be rightly considered as part of operating expenses or be reduced from the gross operating revenue earned by the assessee from its AE. The ld. AR supported his view by arguing that the payment of this commission is a pass through cost and, hence, was correctly excluded by the assessee from its gross revenue. We are unable to countenance this contention put forth on behalf of the assessee. The argument that the expenditure of Rs.2.00 crore and odd incurred in paying commission to Voltas Ltd. is a pass through costs, pre-supposes that such expense was incurred by the assessee for and on behalf of its foreign AE, which was recoverable as such from its AE. If the cost is not recoverable from the AE, then such cost sheds the character of pass through costs. We find that the entire amount of Rs.2.00 crore and odd represents the costs incurred by the assessee in its role as a principal for carrying out the market and support services and not as an agent of its foreign AE inasmuch as this is not a sum recoverable per se from its AE. The assessee received revenue of Rs.4.24 crore as commission for rendering marketing support services to its AE. There is no agreement with the AE for outsourcing of such services from Voltas Ltd. It was only between the assessee and Voltas Ltd. that the assessee sub-contracted the provision of services to Voltas 12 Ltd. Further, it is not the case that the assessee simply sub-contracted the services and enjoyed revenue from its AE without making any further effort. It can be seen from the assessee’s Profit & Loss Account that as against the total operating expenses of Rs.4.06 crore, the assessee incurred other operating expenses at Rs.2.06 crore and paid only a sum of Rs.2.00 crore to Voltas Ltd. The assessee is not involved in any other business activity except rendering services to its AE. Thus, all the costs incurred by it, including payment of commission to Voltas Ltd., are directed towards rendering of marketing support services to its AE.

Neither there was any agreement between the assessee and its AE for outsourcing of the services from Voltas Ltd., nor the assessee’s AE attributed any particular sum in respect of service rendered by Voltas Ltd. On a pointed query, the ld. AR candidly admitted that the assessee was paid commission at a specified rate on the sales of cranes and spare parts. This manifests that the revenue earned by the assessee amounting to Rs.4.24 crore was a one composite amount received against the services outsourced from Voltas Ltd., for which it paid Rs.2.06 crore and the in-house services, for which it incurred Rs.2.06 crore. Thus, it is 13 clear that the payment of Rs.2.00 crore to Voltas Ltd. is not a pass through cost, but, a value added cost. We fail to appreciate any difference between the payment made by the assessee to Voltas Ltd. and to its own employees in the context of the so called pass through costs.

If the contention of ld. AR that payment to Voltas India Ltd. made exclusively for rendering services by the assessee to its AE is a pass through cost, is taken to a logical conclusion, then the payment to assessee’s own employees, which was also made for the same purpose, should also get a similar tag of a pass through cost. Going a step ahead with the same logic, all other expenses including rent and depreciation should also become pass through costs as these were also incurred in rendering services to the AE. Obviously, it is an absurd proposition.

We, therefore, approve the view taken by the TPO in adopting the gross figure of revenue at Rs.4.24 crore and payment of commission to Voltas Ltd., as a part of operating cost for the purpose of calculating the operating profit margin of the assessee.

II. COMPARABLES

6.1. This company was chosen by the TPO as comparable. However, there is no discussion whatsoever in his order about this company. The DRP has discussed this company on page 27 of its order by noticing that the assessee mainly objected to high profit margin earned by it, which, in the opinion of the DRP, was not significant. That is how, the DRP approved the inclusion of this company in the final list of comparables.

6.2. We have heard the rival submissions and perused the relevant material on record. Though the DRP has recorded in its order that the assessee simply objected to high profit margin earned by this company, 15 but, when we peruse a copy of objections filed before the DRP, it transpires that the assessee objected to the inclusion of this company on the basis of its Related Party Transactions (RPTs). This is apparent from page 66 of the objections filed before the DRP, wherein it has been mentioned that Apar Chematek Lubricants Ltd., taken by the TPO as comparable, is a subsidiary of Apar Industries Ltd., and it fails the RPT filter proposed by the TPO as the entire revenue of the former was earned from the latter, holding 50% of the share capital in the former.

Even the relevant extracts showing this position have also been reproduced in the objections taken before the DRP. We have also perused the Annual accounts of this company, a copy of which is available on pages 388 onwards of the paper book. When we go through the financials of Apar Chematek Lubricants Ltd., it is seen that its gross revenue is `Marketing fees’ amounting to Rs.22,79,57,211/-, which was paid by Apar Industries Ltd. Schedule 17 on page 474 contains, ‘Operating and other expenses’ incurred by Apar Industries Ltd. In this Schedule, there is an item of expenditure of Rs.22,79,57,210/-, with the narration of ‘Marketing fees.’ It has also been mentioned in the Annual 16 accounts of this company that this Marketing fees was paid by Apar Industries Ltd. to Apar Chematek Lubricants Ltd. This manifests that the total revenue of Apar Chematek Lubricants Ltd., taken by the TPO as comparable, is from its AE alone, thereby making it a related party transaction and, hence, a controlled transaction.

6.3. Rule 10B(1)(e)(ii) and (iii) talk of comparing the net profit margin realized by the enterprise from international transaction with the similar net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction. An uncontrolled transaction has been defined in Rule 10A(a) to mean: ‘a transaction between enterprises other than associated enterprises, whether resident or non-resident.’ On going through the mandate of Rule 10B(1)(e) in juxtaposition to Rule 10A(a), it is manifested that the controlled transactions are not contemplated for comparison with the international transaction undertaken by an enterprise. Reverting to the factual position before us, we find that the only source of revenue of Apar Chematek Lubricants Ltd. is from its AE, which makes it a controlled transaction, thereby justifying its exclusion from the list of comparables.

We, therefore, direct to remove this company from the list of comparables.

(ii) Info Edge (India) Ltd. 7.1. The TPO included this company in the list of comparables. The assessee objected to its inclusion by arguing that it was functionally different. Not convinced, the TPO considered it as comparable, which viewpoint was upheld by the DRP. The assessee is assailing the inclusion of this company in the set of comparables.

7.2. We have heard the rival submissions and perused the relevant material on record. We have also gone through the Annual report of this company, which is available on page 208 onwards of the paper book. It can be seen that this company owns several websites that serve as online search portals catering to different needs of its customers, as under:-

“Recruitment – This comprises online recruitment classifieds www.naukri.com, India’s leading job site and www.naukrigulf.com a job site focused at the Middle East job market and offline executive search www.quadranglesearch.com Related sites in this business are a professional networking site www.brijj.com and a fresher hiring site www.firstnaukri.com.

Matrimony – This comprises online matrimony classifieds www.jeevansathi.com and 14 offline Jeevansathi Match Points. Real Estate – this comprises online real estate classifieds www.99acres.com a real estate brokerage business www.allcheckdeals.com, housed in a subsidiary named Allcheckdeals.com India Private Limited. Education – This comprises online education classifieds www.shiksha.com.

The sites provides tools that enable its users make a well informed decision by interacting with other Shiksha users, domain experts and college/school alumni. For e.g., a Shiksha user can start a discussion at “Shiksha Cafe”, an ask & answer section, in order to seek opinion of other Shiksha users and domain experts including alumni and fellow students or the Institute itself.”

7.3. A careful perusal of several websites which are owned by this company delineates that it is primarily in the business of internet based services. Anyone can have access to these websites on payment. For example, through www.naukri.com, interested candidates can apply for jobs. Through www.jeevansathi.com, the persons interested in looking for matrimonial alliance get registered on this website. Similarly, www.99acres.com serves as a real estate agent between the prospective buyers and sellers. As against this, the assessee company is engaged in providing marketing support services to its AE, which are in the nature of providing administrative /facilitation assistance, providing product support and training to dealers and customers; assistance in relation to marketing/new business developments; communicating new business opportunities to AE; and providing assistance in negotiating the price of the products/terms of the contract with the customers. When we see the nature of activities carried out by Info Edge (India) Ltd. on one hand and that carried out by the assessee on the other, we find no difficulty in holding that there is complete mismatch between the two. By no standard, the services rendered by Info Edge (India) Ltd. can be considered as comparable with the services provided by the assessee.

We, therefore, direct to exclude this company from the list of comparables. 20 (iii) Apitco Ltd. 8.1. The TPO proposed the inclusion of this company which was objected to by the assessee. It was stated that this company was primarily engaged in providing high end consultancy services by preparing project feasibility reports and carrying out market/other service and, hence, functionally different. The TPO refused to accept the assessee’s contention and eventually included it in the list of comparables. No relief was allowed by the DRP.

8.2. We have heard the parties and perused the relevant material available on record. We have analyzed the Annual report of this company which is available at page 573 of the paper book. From this report, it can be seen that its `Income from operations' stands at Rs.15,41,75,273/-, break-up of which has been given as per Schedule 11, as under :-

“INCOME FROM OPERATIONS - Micro Enterprises Development Rs.5,729,192 Skill Development Rs.33,00,091 Entrepreneurship Development Rs.1,02,55,558 Tourism & Research Studies Rs.41,86,253 Project related Services, Infrastructure Planning &

Development Rs.3,65,66,465 Environment Management Rs.15,38,346 Energy related Services Rs.23,20,885 Cluster Development Rs.4,94,85,525 Asset Reconstruction & Management Services Rs.60,50,759.”

8.3. A careful perusal of the operations carried out by Apitco Limited deciphers that this company is providing services in the nature of Project report preparation, Technical and economic studies, Feasibility studies, Micro enterprise development, Skill development, Project management consulting, Industrial cluster development, Environmental management consulting, Energy management consulting, Market and social research and Asset reconstruction management services. No segment-wise profitability data of these services is available. The TPO has considered this company as comparable on entity level. We find that there is a tiny resemblance of some of the functions performed by this company with the overall activities undertaken by the assessee. Under such circumstances, we fail to appreciate as to how all the above listed services taken together as one unit can be considered as comparable with the services provided by the assessee as listed above.

8.4. The ld. DR strenuously argued that all the activities done by this company are basically `Business services' and the assessee is also rendering business services. He submitted that differentiation of functions in the overall `Business services' umbrella is taken care of under the TNMM. He harped on the contention that there is no requirement to have identical services for the purpose of making comparison under the TNMM.

8.5. We are unable to accept this argument in view of the judgment of the Hon'ble jurisdictional High Court in the case of Rampgreen Sales Pvt. Ltd. vs. CIT (2015) 377 ITR 533 (Del) in which it has been held that the comparables are to be selected on the basis of similarity even under TNMM. The Hon'ble High Court has laid down that selection of comparables does not differ with the method adopted. Ex consequenti, it is no more open to argue that the functional dissimilarity of the companies under the overall broader category can be ignored under the TNMM.

8.6. In view of the foregoing discussion, we find the functional similarity of Apitco Limited lacking on entity level with the assessee company. As such, we order for its exclusion from the final set of comparables.

(iv) Global Procurement Consultants Limited 9.1. The TPO included this company in the list of comparables despite the assessee's objection that it was engaged in providing consultancy services and review of procurement processes for various projects funded by the World Bank. The assessee failed to convince even the DRP for its exclusion.

9.2. After considering the rival submissions and perusing the relevant material on record, we consider it expedient to first discuss the nature of activities carried out by Global Procurement Consultants Ltd. A copy of Annual report of this company for the relevant year is available on record. As per this Report, this company is promoted by Export-Import Bank of India in association with leading Indian Public Sector and Private Sector consultancy organisations on the basis of Public-private partnership model that offers collective Indian experience and expertise through the provision of a range of advisory services with particular focus on `Procurement'. This company provides technical assistance in enhancing quality, transparency, efficiency and effectiveness of procurement and implementation service to help attain desired institutional and corporate objectives. The expertise of this company is available to various sectors including power, water resources, transportation, industries, etc. Its services have been outlined in the Annual report. From such services, it can be noticed that it is conducting Independent Procurement Review of multilaterally funded projects spread across the globe. It also undertakes Procurement audits. This company is providing full time advice on procurement and contract related aspects to several agencies across the globe. For example, in Georgia, the World Bank directly approached it for conducting any independent procurement review of contracts selected from two projects in transportation and municipal infrastructure sector. In Moldova, this company was assigned the task of conducting an independent 25 procurement review of 75 contracts including asset verification. That apart, this company also undertook Valuation Assignments as listed on page 25 of its Annual report in addition to rendering Financial Advisory services as discussed on 26 of its Report. When we go through the nature of services provided by this company, which basically aims at providing advice on procurement and also carrying out procurement audit, it becomes palpable that there is an absolute mismatch with the services provided by the assessee. The services provided by Global Procurement Consultants Ltd. are miles apart from those rendered by the assessee. By no standard, Global Procurement Consultants Ltd. can be considered as comparable with the assessee company. We, therefore, order for the elimination of this company from the list of comparables.

(v) TSR Darashaw Limited.

10.1. The TPO selected this company as comparable. There is no discussion whatsoever about this company in the order of the TPO. The DRP approved the inclusion of this company.

10.2. Having heard the rival submissions and perused the relevant material on record, we find that this company is a broking and investment banking house. As per its website, TSRDL is one of India's leading Business Process Outsourcing (BPO) organizations certified under ISO 9001:2008 guidelines having a total industry experience of over 35 years. TSRDL has state-of-the-Art IT capabilities and well trained HR which are the key requirements for handling BPO activities.

TSRDL's strength, capabilities and infrastructure enables it to handle any large, voluminous, time bound processing activities requiring meeting of stringent quality and service standards in a regulatory environment. Details of products and services provided by this company, as disclosed on its website, are as under : -

"Payroll & Employees' Trust Fund Administration & Management - All the activities normally handled by "Payroll and Retirement Funds" Section in the Organization, including interface with Regulatory Authorities, are taken over by us. Record Management - • Storage. Retention & Retrieval of Physical and/or Electronic Records Registrar & Transfer Agents for-

• Equity and Preference shares. • Debenture Instruments and Bonds • Commercial Paper and Private Placements • Transfer Processing • Customer/Query Handling and Correspondence . • Split/Consolidation/Renewal of Certificates • Processing and Distribution of Interest/Dividend Warrants • Payments by Physical Warrants/through ECS/Direct Credit Depository Related Services • Electronic Connectivity with NSDL/CDSL and transmission • Information to Client Companies through preferable electronic media • Dematerialization/Rematerialization • Inter-Depository Transfers Registrar to Fixed Deposit schemes • Acceptance and Processing of Applications • Renewals & Repayments • Processing & Distribution of Interest Payments through ECS or Physical Warrants. • Reconciliation of Payment of Interest

Registry Related Services: • Registrar to Issues • Public/Rights/Bonus Issues • Special Projects Buy-back of Shares Open Offers Mergers & De-mergers Sub-division & Exchange Redemption of Debt Instruments Bulk Processing & Printing Customer/Investor Analytical Surveys Assisting Client Companies in conducting meetings AGM/EGM/Court Convened Meetings Postal Ballot Handling Poll related activities”

10.3. A narration of the activities undertaken by this company abundantly shows that there are striking dissimilarities with the assessee’s activities. We, therefore, order for the exclusion of this company from the final set of comparables.

11.1. Apart from disputing the inclusion of the above five companies by the TPO, the assessee has also challenged non-inclusion of one company, namely, M/s Kirloskar Consultants Ltd., in the list of comparables. The ld. AR submitted that this company chosen as comparable was wrongly rejected by the TPO on the ground that it failed 29 its RPT to Sales filter. The ld. AR submitted that, but for that, there is no discussion in the order passed by the TPO about the functional similarities or dissimilarities. No relief was allowed by the DRP.

11.2. After considering the rival submissions and perusing relevant material on record, it is found that the TPO has worked out the RPT to Sales ratio of this company at 25.30%, whose correctness has been assailed before us by the ld. AR. The ld. DR also could not point out as to how this percentage was calculated. Under such circumstances, we deem it appropriate to remit the matter to the file of the TPO/AO for confronting the assessee with the calculation of RPT to Sales filter of 25.30%. Apart from that, the TPO will be fully competent to consider the functional similarities/dissimilarities of this company before considering its inclusion or otherwise in the final tally of comparables.

The order pronounced in the open court on 11.05.2015.