M/S TATA MCGRAW HILL EDUCATION PVT. LTD.,NOIDA vs. ACIT, NEW DELHI

During the year under consideration the assessee company had entered into following international transactions:

The assessee used TNM method with operating profit over the total cost as the PLI for TP analysis.

Ld. TPO noticed that the results as submitted by the taxpayer in the segments of software and software activities were as under:

The assessee in its TP document computed the average PLI of the comparables at 12.38% and, accordingly, claimed that the international transaction in regard to provision of IT support services was at arm’s length. The comparables as selected by assessee in the TP report in regard to IT support segment were as under:

Mindtree Consulting Ltd. 16.98

Quintegra Solutions Ltd. 15.18

VJIL Consulting Ltd.

85 Mean 12.38

Ld. TPO noticed that assessee had used multiple year data to determine the margin of the comparables in the TP study and, therefore, on the basis of current year data, he required the assessee to furnish update margins of the comparables. The assessee, accordingly, submitted the following update margins of comparable sin regard to IT support service segment:

Quintegra Solutions Ltd. 21.48 20 Softsol India Ltd.

95 Mean 7.14

Following comparable was not found comparable by the assessee while providing the updated margins:

After examining the search process adopted by the assessee and various information furnished by the assessee relating to the functional analysis of comparables, their margin computation and their annual reports, all the comparables and the accept/ reject matrix of the assessee, ld. TPO issued a detailed show cause notice to assessee which has been reproduced from pages 9 to 15 of his order. The reply of assessee has been considered in para 8 of the order and after considering the various case laws and the comparability criteria and after detailed analysis of various risk adjustment asked for by assessee, ld. TPO finally selected following comparables, the average margin of which was 20.15%.

95 Average 20.15

He, accordingly, computed the ALP and corresponding adjustments as under:

Ld. TPO denied the working capital adjustment sought for by assessee.

Before ld. DRP the assessee had taken various objections, after considering which, ld. DRP confirmed the findings of ld. TPO and further enhanced the margin in respect of Softsol India Ltd. to 25.58% as against 14.95% adopted by ld. TPO. Being aggrieved the assessee is in appeal before us and has taken following grounds of appeal: “On the facts and circumstances of the case and in law, the learned Assessing Officer ("AO") has. erred in passing the assessment order under section 143(3) read with section 144C of the Income-tax Act, 1961 ("the Act") after considering the adjustments proposed by the learned Transfer Pricing Officer ("TPO") in her order passed under section 92CA(3) of the Act

the learned AO/TPO has erred by rejecting certain comparable companies identified by the Appellant using 'Employee cost greater than 25 percent of total cost' as a comparability criterion. 6. the learned AO/TPO has erred, by wrongly rejecting certain companies from and adding certain companies to the final set of com parables for the impugned transaction on an ad-hoc basis, thereby resorting to cherry picking of comparables for benchmarking the impugned transaction. 7. the learned AO/TPO has erred by passing an order under section 92CA(3) which has computational error in the margin of certain comparable companies used in determination of ALP. 8. the learned AO/TPO has erred by not making appropriate adjustments to account for differences in working capital employed by the Appellant vis-a-vis the com parables. 9. the learned AO/TPO has erred by not making suitable adjustments to account for differences in the risk profile of the Appellant vis-a-vis the com parables. 10. the learned AO/TPO has erred in not providing the benefit of the arm's length range as provided under proviso to Section 92C of Act for the purposes of computing the ALP under section 92F of the Act. 11. the learned AO has erred while giving credit of the taxes paid and computing the interest payable under section 2348 of the Act.”

Ld. counsel for the assessee submitted that primarily there are two issues – first being working capital adjustment denied to assessee and second regarding exclusion of certain comparables and inclusion of certain

As regards the working capital adjustment denied to assessee and confirmed by ld. DRP, ld. counsel referred to page 36 of TPO’s order where ld. TPO has discussed the issue regarding working capital adjustment. The main objection of ld. TPO, with reference to the working capital adjustment submitted vide letter dated 28.9.2011 by assessee, was that the assessee had a consolidated P&L a/c and the segmental reporting of software development and back office support services segment had been made only for the purposes of TP study of international transactions. Ld. TPO observed that since financials of the company showed consolidated income from both the segments, it could not be ascertained that the creditors and debtors pertained to which segment. Moreover, segmental financials of some of the comparables viz. Mindtree Consulting Ltd. etc. had been considered for computation of the operating margin and it could not be ascertained as to which segment the creditors and debtors pertained . Therefore, working capital analysis could not be accepted.

Ld. counsel further referred to ld. DRP’s directions with reference to objection taken before ld. DRP vide ground no. 7 and pointed out that ld. DRP observed that to carry out the adjustment the availability of relevant information to accurately identify the difference and then quantify impact of such difference is a pre-requisite. Ld. DRP observed that the margins of tested party could not be adjusted to bring at par with each of the comparables because degree of difference in functions, assets and risk of each of the comparables with that of the assessee differs in case of each comparables. Ld. DRP pointed out that in the present case only the amount of working capital deployed by the comparables on the first and last day of the accounting year is available and there are no means to ascertain the working capital deployed by the comparables throughout the year.

The main reason given by ld. DRP for rejecting the adjustment in regard to working capital adjustment, as sought by assessee, was that working capital adjustment should be computed on the basis of daily average of working capital deployed by the tested party and each of comparables respectively, which details were not available.

Ld. counsel referred to page 117 of the PB and pointed out that separate details in regard to sundry creditors and sundry debtors are available. Ld. counsel referred to page 237 of the PB wherein the segmental details in regard to IT services and R&D services have been given. He referred to page 238 of the PB, wherein the working submitted before ld. TPO in regard to working capital adjustment is given to demonstrate that all the relevant details were furnished before TPO. He referred to page 165 of the PB, wherein the TPO’s order for AY 2007-08 is contained to demonstrate that necessary adjustment had been allowed in regard to capital working adjustment. He further pointed out that in AY 2009-10 the ld. DRP in para 9.4 of its directions has, inter alia, observed that since the balances of inventories, trade debtors/ receivables and trade creditors/ payables were not available on daily basis for the comparables, therefore TPO was directed to take following into consideration: “a) compute the average of opening and closing balances of lnventories, trade debtors/receivables, trade creditors/payables of both the tested party and the com parables b) work out the net working capital ratio (in percentage) after dividing the net working capital by operating cost/sales or such denominator (as is used in the PU) both for the tested party and the comparables,

He, therefore, submitted that assessee be allowed working capital adjustment.

Ld. CIT(DR) submitted that ld. TPO had duly considered the workability of working capital adjustment claimed by assessee. He submitted that matter can go back to ld. TPO to identify the trade creditors and trade debtors relating to this segment and then compute the working capital adjustment.

We have considered the submissions of both the parties. Ld. TPO’s main objection was that since assessee was maintaining consolidated accounts, therefore, the trade creditors/ debtors in regard to IT support service segments were not available separately. Ld. counsel has pointed out that as noted earlier that segmental details are available and, therefore, this objection does not survive. As regards the objections of ld. DRP that average day to day working capital deployment cannot be computed, we are of the opinion that this objection cannot be accepted because, as rightly observed by ld. DRP in AY 2009-10 that it is the average working capital deployment which is to be considered, which can be computed with referene

Now coming to the issue regarding comparables, the main dispute raised by assessee is in regard to following three comparables: - CG VAK Software & Exports Ltd. - Ancent Software International Ltd. - Softsol India Ltd.

As regards CG VAK Software & Exports Ltd., the objections of ld. TPO were that this comparable was functionally not comparable to the tested party as it had employee compensation less than 25% and hence it failed employee cost filter.

Before ld. DRP the assessee pointed out that the employee cost (cost of services) as percentage of total revenue of the company was 75.55%. Ld. DRP did not accept the assessee’s contention that cost of services should be taken as remuneration to employees by observing that in the annual report of the company there was no expense such as ‘salary cost’ or ‘remuneration to employees’ in its P&L A/c. Ld. DRP observed that assessee was drawing conclusions on the basis of unsubstantiated presumptions and whenever there is doubt about the functional comparability, it is better to drop such comparable rather than indulging in presumptions. Ld. DRP did not accept the assessee’s contention that some companies may include employee cost as a separate item in their financial statements while others may aggregate it under the expenses such as administrative expenses, sales

Ld. counsel submitted that this comparable has been accepted in the case of Kenexa Technologies Pvt. Ltd. (page 254 of the PB). Ld. counsel submitted that this comparable passes the employee cost filter of more than 25% as adopted by ld. TPO. He submitted that the employee cost is 46% of the total cost. In this regard ld. counsel referred to page 56 & 57 of the PB, wherein the objections raised before ld. DRP are contained in which it was pointed out that ld. TPO nowhere cited any instances of functional dissimilarity of this company vis a vis the assessee. Further, at per page 21 of the annual report of this company, schedule 15 to accounts, cost of services has been shown as under: Cost of services Amount (Rs.) Cost of services- Overseas 2,46,69,456 Cost of services- domestic 1,78,34,926 Transcription charges 11,63,991 Web designing charges 97,333 Staff welfare 8,29,092 Staff training 3,74,302 Contribution to PF & ESI 12,04,280 Gratuity 38,270 Ex Gratia 1,28,951 HRD expenses 8,66,766 Total 4,72,07,367

We have considered the submissions of both the parties. We are in agreement with the ld. counsel for the assessee that since there was no separate expenditure shown under the head ‘salary/ remuneration’, the sub-

As regards Ancent Software International Ltd., the main contention of ld. TPO was that this comparable was not functionally comparable to the tested party as it had turn over less than Rs. 1 crores and hence it failed the turn over filter.

Ld. counsel submitted that in the case of Chryscapital Investment Advisors (India) Pvt. Ltd. (ITA no. 417/2014), the Hon’ble Delhi High Court has held that turn over filter is not an appropriate filter.

Ld. counsel pointed out that ld. TPO has nowhere cited any instances of functional dissimilarity of this company. On the contrary he submitted that as is evident from the P&L A/c of this comparable as contained at page 275 of the PB, the company has derived income from software services. He further pointed out that in the case of Ameriprise India Pvt. Ltd. ITA no. 2010/Del/2014, it has been held that the turnover filter is not an appropriate filter. Further, he pointed out that this company is functionally similar to the assessee.

We have considered the submissions of both the parties. We find that ld. DRP has confirmed the findings of ld. TPO solely on the ground that sales were less than Rs. 1 crore. No adverse comments have been made on the functional analysis by both the lower revenue authorities. Under such circumstances in view of the decision of Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt. Ltd. (supra), this comparable has to be included in the list of comparables selected by ld. TPO. We direct accordingly.

As regards Softsol India Ltd. the main contention of ld. counsel for the assessee is that since no opportunity was provided by ld. DRP while increasing the margin from 14.95% to 25.58%, therefore, this comparable should be excluded. He further submitted that computation provided by ld. DRP does not tally with the financials of Softsol India Ltd.

Ld. counsel referred to page 316 of the PB, wherein the financial statements of Softsol India Ltd. are contained and pointed out that in the fixed asset schedule the figures of depreciation in regard to building is Rs. 68,30,762/-, whereas ld. DRP has wrongly taken the figures at Rs. 85,10,646/-. In this regard Ld. counsel referred to page 20 of the appeal set wherein the computation made by JCIT (Transfer Pricing), Hyderabad in regard to operating margin of M/s softsol India Ltd. is contained, which is as under: “Rental income : Rs. 4,48,40,012/- (ii) Expenses attributable to let out property Rs. 54,14,483/- (iii) Depreciation on let out property Rs. 85,10,646/- Revised operating margin is as under:

He submitted that there is nothing on record to suggest that depreciation on building was in respect of let out building. Ld. DRP has considered this on assumption. He submitted that if data is insufficient to make necessary adjustment, then comparable is to be rejected. In this regard ld. counsel referred to Rule 10B(3) which mandates that an uncontrolled transaction shall be comparable to an international transaction if reasonably accurate adjustments can be made to eliminate the material effects of such differences. In the alternative ld. counsel submitted that only direct expenses attributable to earning of rental income being rent, rates and taxes aggregating to Rs. 23,37,991/- being as per P&L A/c at page 319 of PB should be reduced.

We have considered the submissions of both the parties and have perused the record of the case. The very basis for enhancing the margin from 14.95% to 25.58% was the computation made by JCIT (Transfer Pricing), Hyderabad, as noted earlier. Ld. counsel has pointed out that figures adopted in regard to depreciation are not correct. Further, there is no basis pointed out by ld. JCIT in regard to expenses being attributed to let out property.

Ld. DRP has accepted the TPO’s findings that rental income had to be excluded from the operating income. However, ld. DRP was of the opinion and rightly so that the expenses attributable to the rental income should also be reduced from the operating expenditure to compute correct margin for software development segment. Ld. DRP had given direction to JCIT(Transfer Pricing), Hyderabad to identify the expenses attributable to the rental income and recomptue the margins of the software development segment. As noted earlier, ld. JCIT has not given any basis for attribution of expenses to the earning of rental income and the figure of depreciation also has not been correctly adopted.

Under such circumstances, in our opinion, only the direct expenses attributable to the earning of rental income viz. 23,37,991/- is to be excluded and the margins to be recomputed. We are not inclined to accept the submission of ld. counsel for the assessee that this comparable should be excluded entirely from the list of comparables because it is not in dispute that this comparable is functionally comparable with the tested party and reasonably the necessary adjustment as contemplated in Rule 10B(3) can be made. We, accordingly, direct the ld. TPO to recomptue the margin of this comparable and determine the average margins accordingly.

In the result, assessee’s appeal is partly allowed for statistical purpose.