ITO, NEW DELHI vs. M/S. STYX BACK OFFICE SERVICES PVT. LTD., DELHI

PER R.S. SYAL, AM:

“1. The ld. CIT(A) erred in facts & law in rejecting seven comparables out of 11 selected by the AO.

2. The ld. CIT(A) has taken very narrow comparables where only four companies are there which have wide variations in OP/TC.

3. The Hon’ble Tribunal may restore the adjustment/addition made by the AO or without prejudice to this request offer, another opportunity to AO to determine the new OP/TC ratio by taking more companies as comparables.

4. The appellant craves leave or reserving the right to amend, modify alter, add or forego any ground(s) of appeal at any time before or during the hearing of this appeal.”

Direct Cost Salaries and Bonus 1,59,08,981 Contribution to Provident Fund 5,77,316 Internet Charges 8,61,916 Rent 22,13,992 Total Direct Costs 1,95,62,205 Add: Mark-up on Direct Cost 35% 68,26,318 Amount billed 2,63,88,523

Thereafter, he proceeded to determine the quantum of ‘Direct costs’ under the Cost Plus method. In doing so, he noticed that only a sum of Rs.1.95 crore was shown by the assessee as total `Direct costs’ incurred in rendering back office, accounting and management information system services to its AEs. He opined that amount of Personnel expenses and other Operating and Administrative expenses was liable to be considered in the base of ‘Direct costs.’ On a perusal of the assessee’s Profit & Loss Account, he observed that Personnel expenses, Operating and Administrative expenses totaled up to Rs.3,43,06,171/-, out of which a sum of Rs.95,37,970/- was towards reimbursement. He, therefore, determined total `Direct costs’ attributable to the business at Rs.2,47,68,201/- (Rs.3,43,06,171/- minus Rs.95,37,970/-). By applying 35% mark-up on such total direct costs determined by him at Rs.2,47,68,201/-, he worked out the ALP of the international transaction at Rs.3,34,37,071/-. By reducing the amount of revenue received from the 4 AEs at the transacted value of Rs.2,63,88,523/-, he worked out transfer pricing adjustment amounting to Rs.70,48,548/- (Rs.3,34,37,071/- minus Rs.2,63,88,523/-). Eventually, addition was made for Rs.70.48 lac to the returned income. The ld. CIT(A) reduced the addition to Rs.25,92,749/-.

Our attention has not been drawn towards any Cross appeal having been filed by the assessee against sustenance of the remaining addition. The Revenue is aggrieved against the reduction allowed by the ld. first appellate authority in the amount of addition made by the AO.

Since no comments were received, the ld. CIT(A) proceeded to decide the appeal on the basis the additional evidence furnished by the assessee. In doing so, he evaluated the assessment order by holding that the TNMM 6 was applied by the AO as the most appropriate method. From the list of eleven companies selected by the AO as comparable, he excluded five companies on the ground of higher Related party transactions (RPTs). He also excluded two more companies. Thus, out of eleven companies chosen by the AO, the list got shrinked to only four companies, whose average OP/OC was worked out by him at 17.01%. By applying it as benchmark, the ld. CIT(A) reduced the transfer pricing adjustment to Rs.25.92 lac.

I. TNMM OR COST PLUS METHOD ?

6.1. The first issue before us is to decide the most appropriate method in the facts and circumstances of the case. It can be observed from the assessment order that the AO show caused the assessee as to why the TNMM be not applied as against the CPM used by the assessee as the most appropriate method. He selected eleven companies as comparable with their mean margin of profit of OP/TC at 32.46%, which is specific to the TNMM alone. In the same breath, he also enhanced the amount of ‘Direct costs’, which is relevant to the CPM. Applying 35% profit rate, he worked out addition of Rs.70.48 lac. The ld. CIT(A) disposed of the appeal by considering the determination of the ALP under the TNMM alone.

6.2. The ld. DR argued that the ld. CIT(A) erred in computing the ALP under the TNMM, which ought to have been done on the basis of Cost plus method. Thus, selection of the most appropriate method in the given facts and circumstances of the case, assumes significance.

6.3. Section 92C(1) of the Income-tax Act, 1961 (hereinafter also called `the Act’) takes into account five specific and one general method for the computation of arm’s length price of an international transaction. One of such specific methods is ‘Cost Plus Method’ and another is TNMM.

Manner of computation of ALP under all the given specific methods is contained in Rule 10B(1). Clause (c) of Rule 10B(1) deals with the determination of ALP under ‘Cost Plus Method’, which runs as under:-

`(c) cost plus method, by which,—

(i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined ;

(ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined ; (iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market ; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii) ; (v) the sum so arrived at is taken to be an arm’s length price in relation to the supply of the property or provision of services by the enterprise;’ 6.4. On going through the mandate of Rule 10B(1)(c), it emerges that the direct and indirect costs incurred in providing services to an AE are determined under sub-clause (i). The second sub-clause stipulates that the amount of normal gross profit mark-up in a comparable uncontrolled transaction is determined. Under sub-clause (iii), such normal gross profit mark-up of comparables as determined under sub-clause (ii), is adjusted on account of differences between the international transaction and comparable uncontrolled transaction. As per sub-clause (iv), the adjusted profit mark-up arrived under sub-clause (iii) is applied to costs incurred by the assessee as per sub-clause (i). The sum so arrived at is taken as ALP of the international transaction as per sub-clause (v). On circumspection of the above sub-clauses of Rule 10B(1)(c), it emerges that not only the direct, but also the indirect costs incurred in providing services to an AE, are required to be taken into consideration, which are then increased by gross profit mark-up of comparables. Adverting to the facts of the instant case, we find that the AO has albeit rightly increased the costs base in consonance with sub-clause (i) of Rule 10B(1)(c), but, erred in applying the mark-up of 35%, impliedly under sub-clause (ii) and (iii) of Rule 10B(1)(c). It is clear from the mandate of the provision that the mark-up applied must be of comparable uncontrolled transactions.

Where from this 35% mark-up applied by the AO has come, is a mystery.

There is no discussion in the assessment order as to how this 35% was taken. List of eleven comparable companies chosen by the AO, on page 77 of the paper book, exhibits the calculation of their profit margin under TNMM with OP/TC at 32.46%. There is no calculation of gross profit mark-up on direct and indirect costs of these companies, which is relevant 10 under rule 10B(1)(c). On a specific query, the ld. DR also could not precisely point out as to where from the gross profit mark-up of 35% was taken by the AO, except for relying on page 2 of the assessment order, which extracted the assessee’s reply that: ‘the back office work done by the Indian subsidiary was of non-integral nature and, therefore, the method adopted has been Cost Plus Method. The mark-up added on a year to year basis has been in excess of 30-35% which is more than the industry average of 20-25%. The benchmarking has been done accordingly.’ On going through the assessee’s above reply, it crops up that the profit rate of industry (which may be akin to the comparables in general) is 20-25% and the assessee’s own profit rate ranges between 30- 35%. This does not help in any manner in finding out the origin of the gross profit rate of comparables taken by the AO at 35%. It prima facie appears that the AO might have been swayed by the profit rate of 35% on the basis of the stated profit rate of the assessee over the years ranging between 30%-35%, which course of action is wrong. Per contra, the profit rate to be taken is that of comparables in terms of sub-clauses (ii) and (iii) of rule 10B(1)(c) and not that of the assessee. 11 6.5. It is further found that having done this, the AO referred to the calculation of profit under TNMM as well. In this regard, he chose the following eleven companies as comparable which have been tabulated on page 77 of the paper book, giving their OP/TC at 32.46%, which percentage matches with that taken note of in last para on page 2 of his order:-

Mar-09 Mar-09 Company Name OP/Sales OP/TC 1. Aditya Birla Minacs Worldwide Ltd. -0.92 -1.12 2. Coral Hub Ltd. 27.25 35.07 3. Cosmic Global Ltd. 34.19 47.28 4. Eclerx Services Ltd. 34.29 51.12 5. Genpact India 36.14 49.2 6. Infosys BPO Ltd. 16.12 20.15 7. Microgenetic Systems Ltd. 1.6 1.71 8. Rev IT Systems Pvt. Ltd. 34.81 44.12 9. TCS E-Serve Ltd. 14.63 18.3111 10. Tricom India Ltd. 42.16 69.77 11. Tricom Infotech Solutions Ltd. 18.24 21.48 Average 23.50 32.46 6.6. The above analysis of the assessment order divulges that the AO has considered and discussed both the methods of computation of the ALP from the international transaction, viz., CPM and TNMM. However, while determining the amount of TP adjustment at Rs.70.48 lac, he applied Cost Plus Method with average gross profit margin at 35%, which we have noticed above is non-existent. The ld. CIT(A) took up the transfer pricing exercise only under the TNMM. When we peruse the specific grounds taken by the Revenue before us at sr. nos. 1 to 3, it clearly emerges that the entire focus is on various facets of the computation of ALP under TNMM. For instance, ground no. 1 is against removal of seven comparables by the ld. CIT(A) from the AO’s list of eleven, which were impliedly considered by him while applying the TNMM, as he has no where computed their ratio of gross profit to direct and indirect costs, which is germane to the CPM. Similarly ground no. 2 is against taking narrow comparables which have wide variations in OP/TC. Again it is apparent that OP/TC is relevant only under the TNMM and not the CPM. In the like manner, ground no. 3 is also aimed at either restoring the adjustment or giving another opportunity to the AO to determine the new OP/TC ratio by taking more companies as comparable.

This ground also talks of OP/TC, which is material only for the TNMM.

As such, it becomes vivid that through all the three specific grounds taken by the Revenue, the assail has been only to the computation of the ALP 13 under the TNMM. When we consider the fact that the AO applied both the TNMM and also the CPM and the ld. CIT(A) decided the case only under the TNMM and the further fact that all the specific grounds taken by the Revenue challenge the computation of the ALP under the TNMM, the inevitable conclusion which follows in the given facts and circumstances of the case is that it is the TNMM, which has been ultimately considered by the authorities as the most appropriate method.

As such, we hold that the TNMM has been accepted by the Revenue as the most appropriate method.

II. AMBIT OF GENERAL WIDE GROUND IN APPEAL MEMO 7.1. The ld. DR vehemently argued that the ld. CIT(A) was not justified in ignoring the CPM as the most appropriate method. When his attention was drawn towards the fact that there was no specific ground taken by the Revenue in its appeal in this regard, he pressed into service ground no. 4 by claiming it to be generally worded with widest amplitude covering any other aspect that may be taken up before the tribunal. He accentuated that this ground will cover the plea for adoption of the CPM as the most appropriate method.

7.2. We find that as against the first three specific grounds, there is one more last ground no. 4 which, inter alia, states that the appellant reserves the right to amend, modify, alter, add any ground of appeal at any time before or during the hearing of this appeal. This type of ground is permissible and can be normally taken in the appeal memo with a view to protect the interest of the appellant in taking up any fresh issue at the time of hearing of the appeal. Such a ground is given a very wide scope to encompass any other issue, which may have been omitted at the time of filing of appeal or which may arise during the course of hearing, or for that matter, any other relevant issue which may be taken up there and then. No exception can be taken to raising of such type of ground by the appellant. It enables the appellant to protect its interest in all possible manners. The appellant with the help of such a ground can support the specific grounds from any angle other than those specifically taken or raise an altogether new issue, which is not covered by any of the specific grounds. For example, if there was a comparable, say X, selected by the assessee, which got axed by the authorities on account of functional dissimilarity. When the assessee files appeal against the exclusion of X on the ground of functional similarity and there is a general ground of appeal also taken in the memorandum of appeal, then the assessee, in addition, can also challenge the exclusion of X from the angle of extra-ordinary financial events or excessive RPTs etc. Such a course of action of the assessee in raising fresh issues qua comparable X is perfectly in order as the general ground enables him to challenge its exclusion on other scores such as, extra-ordinary financial events or excessive RPTs etc. Similarly, if there was no issue of limitation/jurisdiction, the assessee can very well take up such an issue for the first time with the help of such a general ground. In our considered opinion, there is one inherent limitation on the ambit of such a general ground, howsoever widely worded it may be. The limitation is that it should not be invoked for arguing anything contrary to the subject matter of the specific grounds taken in the memo of appeal.

The obvious reason is that taking up of any such issue with the help of general ground, if allowed, would militate against the specific grounds 16 taken in appeal memo. This can be allowed only if the appellant first opts not to press the specific contrary ground and then take up a new issue with the help of general ground. Where the specific grounds are allowed to remain intact, then such a general ground cannot be invoked to help the appellant in taking up new issues which runs contrary to the subject matter of the specific grounds.

7.3. Reverting to the facts of the case, we find that though ground no. 4 is generally worded, taking within its sweep all possible issues, but the contention raised by the ld. DR for determining ALP under Cost Plus Method falls in the limitation clause as discussed above. It is manifest that the first three specific grounds challenge various aspects concerning the computation of ALP under the TNMM. If we accept the plea for the application of CPM, with the help of fourth ground, then it would make the earlier three grounds infructuous. As the ld. DR has also equally argued and pressed the first three specific grounds, we are unable to accept his argument for examining the applicability of the CPM as the most appropriate method with the help of general ground at sr. no. 4.

Consequently, his contention in this regard is repelled. In the ultimate analysis, we hold that the TNMM is the method accepted by the authorities below as the most appropriate method.

III. COMPARABLES 8.1. Now, we turn to the comparables excluded by the ld. CIT(A).

In all eleven companies were treated by the AO as comparable, which have been tabulated above. The ld. CIT(A) excluded five companies having significant RPTs, as under:-

S.No. Name of the Company RPT (%) 1. Rev IT Systems Pvt. Ltd. 62.70% 2. TCSE E-Serve Ltd. 53.39% 3. Tricom India Ltd. 87.49% 4. Tricom Infotech Solutions Ltd. 87.05% 5. Genpact India 114.16% 8.2. He, then, excluded Coral Hub Ltd. and E-clerx Services Ltd. also from the tally of comparables drawn by the AO. In excluding these seven companies, the ld. CIT(A) noticed that the assessee was not given adequate opportunity by the AO. That is how, he admitted additional evidence filed by the assessee before him for the first time and also sought remand report from the AO. In the absence of any remand report forthcoming, he decided on the exclusion of these seven companies unilaterally by considering the additional evidence filed on behalf of the assessee. The Revenue is aggrieved against the exclusion of such companies.

8.3. When we peruse the additional evidence in the shape of calculation of percentage of related party transactions qua the first five companies, we find that the ld. CIT(A) has accepted the same at face value without examining the correctness of the manner of computation of percentage of their RPTs. It is noticed that the assessee computed percentage of RPTs of Tricom India Ltd. at 87.49%, a copy of which has been placed at page 118 of the paper book. In such a calculation, the assessee included not only Sales to AEs but also Receipt and payment of interest on loan/advances as a percentage of turnover, which is an erroneous approach for the calculation of RPTs, but inadvertently got the seal of approval from the CIT(A) without any question. Similarly, while computing percentage of RPTs of Tricom Infotech Solutions Ltd. at page 122 of the Paper book, the assessee considered not only Export of services to the AEs, but also Leave and licence, Service charges and Other expenses, as a percentage of total turnover at 87.05%, which is, again, not correct. In so far as the calculation of percentage of RPTs of Genpact India, at page 127 of the paper book, is concerned, we find that the assessee has calculated the same at 114.16% of total turnover by considering Expenses, Reimbursement, Interest income on deposits, Allocations received/ made along with Income from IT enabled services as a percentage of Total turnover. This calculation leading to RPT at 114.16% is, again, flawed and has even crossed the maximum of 100%.

As regards the exclusion of other two companies, namely, Coral Hub Ltd. and E-clerx Services Ltd., we find that there is not much discussion about their incomparability to the assessee-company.

8.4. After examining the above position from the additional evidence filed before the ld. CIT(A), we required the ld. AR to place before us Annual reports of these seven companies, so that we could undertake comparability exercise at our own end. No such reports were available with the ld. AR. Given the fact that the ld. CIT(A) admitted additional evidence qua these seven companies and did not give adequate opportunity to the AO for sending remand report, we are of the considered opinion that the ends of justice would meet adequately if the impugned order on this score is set aside and the matter is restored to the file of AO.

We order accordingly and direct him to decide the comparability or otherwise of these seven companies afresh for the purposes of inclusion or otherwise in the final set of comparables drawn by him with a total of eleven companies. Needless to say, the assessee will be allowed an adequate opportunity of hearing in such fresh proceedings.

8.5. As regards the ld. DR’s contention for giving one more opportunity to the AO for including new companies in the fresh round of proceedings, we are not in agreement with the same. The ld. DR has not brought to our notice any company which is comparable and ought to have been included. When the AO himself shortlisted eleven companies as comparable, we cannot permit to undertake this exercise once again with a view to increase the list beyond such companies.

8.6. Here, we also want to make it clear that with the exclusion of seven companies, the ld. CIT(A) computed average profit of the remaining four companies at 17.01%. Since there is no appeal from the side of the assessee, the four companies finally selected by the CIT(A), namely, Cosmic Global Ltd., Infosys BPO Ltd., Microgenetic Systems Ltd. and Aditya Birla Minacs Worldwide Ltd., will continue to remain as such in the list of comparables to be drawn by the AO in the fresh round and the assessee will not be entitled to assail their comparability before the AO.

The order pronounced in the open court on 17.02.2016.