LG CHEMICAL INDIA PVT. LTD.,GURGAON vs. ACIT, NEW DELHI

O R D E R PER PRASHANT MAHARISHI, A. M. 1. This is appeal filed by the assessee against the order u/s 143(3) rws 144C of the Act dated 30.01.2015 passed by ACIT, Circle-15(1), New Delhi in pursuance of direction of Dispute Resolution panel u/s 144C(5) dated 12.11.2014 for the Assessment Year 2010-11.

Page 2 of 15 2. The assessee has raised the following grounds of appeal:- 1. the Learned Assessing Officer ("the Ld. AO")/ Hon'ble Dispute Resolution Panel ("DRP") has erred in assessing the income of the Appellant at Rs. 16,026,230 as against the returned income of Rs. 3,967,748. 2. the Ld. AO grossly erred in law by referring the case to the Ld. Transfer Pricing Officer ('TPO') for determination of arm's length price contrary to the instruction issued by the Central Board of Direct Taxes ('CBDT) and therefore the transfer pricing order is void. 3. the Ld. AO/Ld. TPO erred on facts and in law by making a transfer pricing addition of Rs. 57,41,9837- to the income of the Appellant and holding that the international transactions pertaining to provision of marketing support services do not satisfy the arm's length principle envisaged under the Act and in doing so have grossly erred by: 3.1. rejecting comparability analysis undertaken by the Appellant in the TP documentation for determining the Arm's Length Price ('ALP') and modifying comparability analysis based on application of the following additional revised filters: a. excluding companies whose data is not available for the FY 2009- 10; b. excluding companies who have employee cost less than 25% of the sales; c. excluding companies whose revenue from service activity is less than 75% of the total operating revenues; and rejecting, in particular, the following filters applied by the Appellant: d. accepting companies having ratio of other operating income (i.e. income other than manufacturing and trading income) to sales greater than 50%; Page 3 of 15 e. accepting companies in prowess having data for at least two out of the three financial years under consideration 3.2. including certain companies that are not comparable to the Appellant in terms of functions performed, assets employed and risks assumed; 3.3. excluding certain companies on arbitrary/ frivolous grounds even though they are comparable to the Appellant in terms of functions performed, assets employed and risks assumed; 3.4. not providing appropriate economic adjustments as provided under Rule 10B of the Income-tax Rules, 1962 in respect of the difference in the risk profile of the comparable companies and the Appellant 3.5. disregarding multiple year/prior years' data used by the Appellant in the TP documentation and holding that current year (i.e. FY 2009- 10) data for comparable companies should be used despite the fact that the same was not necessarily available to the Appellant at the time of preparing its TP documentation; 4. the Ld. AO/TPO has grossly erred in making an illusionary disallowance on the pretext of expenditure to have been incurred for earning exempt income and on the other hand considering all expenses to have been incurred for earning taxable income while determining arm's length price of the international transactions. The Appellant has filed a rectification application u/s 154 of the Act with the Hon'ble DRP for adjudicating this contention of the Appellant. 5. the Ld. AO has erred in disallowing Rs. 6316,500 under section 14A of the Act read with Rule 8D of Income tax Rules, 1962 ("Rules") as he failed to appreciate:- (a) that no investments have been made by appellant out of borrowed funds; (b) that no new investments have been made during the subject year; Page 4 of 15 (c) that appellant has not earned any exempt income on its investments during the subject year; (d) that investments have been made in the financial year 2006-07 for controlling stake in Group concern and not for earning any dividend income; (e) that no administrative cost, directly/indirectly have been incurred by appellant during the year in connection with its investment 3.3. excluding certain companies on arbitrary/ frivolous grounds even though they are comparable to the Appellant in terms of functions performed, assets employed and risks assumed; 3.4. not providing appropriate economic adjustments as provided under Rule 10B of the Income-tax Rules, 1962 in respect of the difference in the risk profile of the comparable companies and the Appellant 3.5. disregarding multiple year/prior years' data used by the Appellant in the TP documentation and holding that current year (i.e. FY 2009- 10) data for comparable companies should be used despite the fact that the same was not necessarily available to the Appellant at the time of preparing its TP documentation; 4. the Ld. AO/TPO has grossly erred in making an illusionary disallowance on the pretext of expenditure to have been incurred for earning exempt income and on the other hand considering all expenses to have been incurred for earning taxable income while determining arm's length price of the international transactions. The Appellant has filed a rectification application u/s 154 of the Act with the Hon'ble DRP for adjudicating this contention of the Appellant. 5. the Ld. AO has erred in disallowing Rs. 6316,500 under section 14A of the Act read with Rule 8D of Income tax Rules, 1962 ("Rules") as he failed to appreciate:-

Page 5 of 15 (a) that no investments have been made by appellant out of borrowed funds; (b) that no new investments have been made during the subject year; (c) that appellant has not earned any exempt income on its investments during the subject year; (d) that investments have been made in the financial year 2006-07 for controlling stake in Group concern and not for earning any dividend income; (e) that no administrative cost, directly/indirectly have been incurred by appellant during the year in connection with its investment.”

Page 7 of 15 “4.3. Functions performed 4.3.1. Functions performed by LGCI As per the agreement, LGCI provides the requisite marketing support services to LG Chem, Korea. In this respect, the functions performed by LGCI are as follows: a) Study of petrochemical industry LGCI undertakes market research in the petrochemical industry in India with the objective of understanding the prevalent demands, competitive environment and trends in the industry. LGCI provides advice to LG Chem, Korea with respect to economic, financial, political and business environments and business practices in this industry. b) Identification of new customers LGCI explores new market opportunities for LG Chem, Korea by identifying new reliable customers and understanding requirements of these customers. LGCI studies and identifies the opportunities for sale of LG Chem, Korea's products in the Indian market. c) Imparting Product Information to potential customers LGCI provides information about the product portfolio of LG Chem, Korea to the potential customers in India. However, the functions are limited to providing information. LGCI does not secure orders, negotiate prices or enters into contract with the customers. In the case of advance technical queries, these are directed to the AE's technical people. LGCI merely acts as a facilitator for its AE while performing these marketing activities. d) Providing information on potential customers LGCI conducts surveys/studies on potential customers with due consideration to market standing, past performance and profitability, foreign collaborations, proposed business plans etc. LGCI sends periodical reports to LG Chem, Korea on any available market information with respect to customers. It follows up the correspondence between the AE and customers in the territory.

Page 8 of 15 e) Forwarding the inquiries/sales order LGCI forwards the inquiries received by it relating to the products and all the sales orders solicited by LGCI from identified customers to LG Chem, Korea for its evaluation. f) Contacting the customers to obtain feedback on behalf of AE LGCI contacts the customers of its AE on a regular basis to obtain their inputs on the quality and efficiency of products as supplied by the AE vis-a- vis the competitors in India and gives the resultant feedback to its AE. g) Providing marketing assistance 1 LGCI provides marketing assistance to LG Chem, Korea based on the instructions received by the AE. The marketing assistance is provided with an objective to promote the products of LG Chem, Korea in India. LGCI acts as a communication channel for AE's customers for all commercial and technical problems and does not carry out any repairs or supply of goods. As explained above, the marketing activities undertaken by LGCI for promoting LG Chem Korea's products are limited to co-ordination between its AE and the customers. LGCI acts as a facilitator for its AE and does not undertake significant functions (e.g. confirming orders, negotiation of prices/terms of agreements etc.) while performing these activities. 4.3.1.1. Other management functions The functions addressed below are common functions that are carried out by any business irrespective of their size and type. These functions are drivers of every business and are indispensable in the economic environment. a) Corporate Strategy Determination: Generally, all policies within LGCI are determined by its own management which continuously monitors the economic environment surrounding the Indian entity, assesses their Page 9 of 15 strategic position within the industry and targets to achieve its corporate objectives with guidance from the Group. b) Finance, Accounting, Treasury and Legal: The management in LGCI is responsible for managing the finance, treasury, legal and accounting functions. In certain areas, wherever necessary, LGCI is guided by the Group. c) Human Resource Management ("HR"): The HR function at LGCI is co-ordinated by its management which is responsible for recruitment, development and training of the personnel including the emolument structure. In this respect, where appropriate, it is guided by the Group's policies.”

Page 10 of 15 Sl. Comparable As per PLI of As per PLI of Remarks No. assessee of TPO of OP/TC PBIT/cost IDC India Ltd. 12.79 14.85 Assessee as 1. well as TPO both accepted this comparable Hansa Vision Pvt. Ltd. 3.63 NA Rejected by 2. TPO Empire Industries Ltd. 11.60 NA Rejected by 3. TPO Entertainment Network 0.22 NA Rejected by 4. India Ltd. TPO Cameo Corp. Serv. NA 8.26 Included by 5. TPO HCCA Business NA 20.05 Included by 6. Services Pvt. Ltd. TPO TSR Darashaw Ltd NA 41.15 Included by 7. TPO Average 7.06 21.08 Assessee’s PLI 8.14 International transaction 48843515 48843515 ( INR) ALP determined by 48843515 51285690 Assessee and TPO (INR) Adjustment (INR) Nil 5741983 Page 11 of 15 16. Before us ld AR of the assessee contested two comparables selected by TPO which are at Sl. NOs. 6 and 7 of above table which are considered as under:- a. TSR Darashaw Ltd:- The above comparable was contested by the assessee submitting that it is functionally dissimilar as it is engaged in the business of registrar and transfer agent activity, record management activity and pay roll trust fund etc. It was further submitted that it is BPO organization and therefore, it is not comparable. The ld TPO rejected stating that as the comparable is also a service provider it is functionally similar. Regarding abnormally high margins of the comparable ld TPO rejected this ground. Ld DRP considered the argument of the assessee and rejected them holding that the TPO has given adequate reasons for selecting the aforesaid comparables and they are functionally similar. Regarding the contention of the LD DR that assessee has selected this comparable in its T P study Analysis. We are not inclined to uphold the objection taken by the ld. DR on the inclusion of this company as comparable merely on the fact that the assessee treated it as comparable in its TP study analysis. If the assessee inadvertently includes a company in its accept reject Matrix, which is, in fact, not comparable, he has a right to agitate before the authorities that such comparable may be excluded. It is for revenue to counter the claim of the assessee and prove otherwise. If, however, the comparable turns out to be functionally dissimilar, then, there can be no rationale in continuing to treat it as comparable despite the functional dissimilarities. Matter of prime importance is comparability analysis The Special Bench of the Tribunal in the case of DCIT vs. Quark Systems (P) Ltd. (2010) 132 TTJ (Chd) (SB) 1, has held that an assessee is entitled to raise a claim for the first time before the tribunal even through an additional ground that a company was wrongly included in the list of comparables. Therefore we are of the considered opinion that the objection taken by the ld. DR is unacceptable. Before us the assessee has placed annual report of this comparable which is at Page 57-98 of the paper book filed by the Page 12 of 15 assessee. According to the Director’s report assessee is engaged in payroll process outsourcing business and also earned revenue from registry business as well as record management business. At page no. 80 which provides segmental information it has major revenue of Rs.1194 lacs from registry and transfer business and Rs.144.18 from record management business and balance from payroll outsourcing out of total revenue of Rs. 2007 lacs. Assessee has submitted that this comparable is a business process outsourcing organization and is primarily engaged in the handling of BPO services. We do not find any observation of ld TPO, ld DRP and ld DR before us which says that BPO industry comparable can be taken as functionally comparable with the limited risk market support service provider. Further, ld AR has relied upon decision in the case of Microsoft Corporation India Pvt. Ltd. Vs. DCIT in for AY 2007-08 of the coordinate bench where it has been held that TSR Darashaw Ltd. was held to be not comparable with market support service provider as under:- “18. Coming to the merits of comparability, we find that this company has three segments, which inter alia include: 'Pay Roll and Trust Fund activity (Pay Roll).' It is this segment which has been considered by the assessee as comparable. This company on an overview is a broking and investment banking house. Its other segments are : 'Registrar and Transfer Agent activity (R&D)' and 'Records management activity (Records).' The segment of 'Pay Roll' was considered by the assessee as comparable in its TP study report and the same is now assailed. Under the 'Pay Roll' segment, this company undertakes pay roll and employee trust fund administration and management. When we compare the nature of pay roll activity undertaken by this company with the marketing support services rendered by the assessee to its AEs, we find that both are way apart from each other. There can be no logical comparison between a specific pay roll services rendered by a company to its clients with the marketing support ITA No.5766/Del/2011 services rendered by the Page 13 of 15 assessee to its AEs. This company is, therefore, directed to be excluded from the final set of comparables.” In view of the above decision as well as our own perusal of the balance sheet of the comparable with specific reference to its director’s report at Page No. 57, segment reporting as per accounting standard 17 at page Nos. 80 to 82 also, we hold that this comparable is functionally dissimilar and therefore directed to excluded. b. HCCA Business Services Pvt. Ltd. The ld TPO has included this comparable holding it functionally similar. Assessee objected it that it is part of BPO industry, which requires significant employee skill and also own significant intangible assets which contributes to 52.91% of its block of assets. Ld TPO rejected holding that this comparable offers a wide range of service such as payroll processing, compensation structuring etc. and therefore it is comparable. Regarding the employee skill ld TPO was of the view that this contention has not been substantiated and further regarding intangibles he submitted that it constitutes only 11.67% of its sales. Ld DRP upheld the contention of the ld TPO. Before us ld AR reiterated the same contentions raised before the lower authorities and ld DR gave the same reasoning which was given by the ld TPO. Ld. DR also submitted that this comparable was included by the assessee in its initial T P Analysis we reject this submission for our reasons given in discussing earlier comparable. It is very significant to note that as per the balance sheet submitted by the assessee of the comparable at Page No.99 onwards it shows that according to schedule D of the balance sheet the comparable posses business and commercial rights of Rs. 37533159/- and further the nature of services produced by the assessee before ld TPO shows that it is engaged in pay roll processing and compensation structure. In the decision cited before us of the coordinate bench in case of Microsoft Corporation India Pvt. Ltd. Vs. DC IT (Supra) at para No. 18 it is held that marketing support services and Page 14 of 15 payroll activity are way apart from each other. In view of this we direct the exclusion of this comparable.