ACIT, NEW DELHI vs. M/S. TECH BOOKS ELECTRONICS PVT. LTD., NEW DELHI

ORDER PER R.S. SYAL, AM: This appeal by the Revenue and Cross Objection by the assessee arise out of the order passed by the CIT(A) on 3.10.2012 in relation to the assessment years 2007-08.

3.1. Briefly stated, the facts of the case as recorded in the TPO’s order are that the assessee is a wholly owned subsidiary of Aptara. Its primary functions include the provision of electronic publishing services, such as, computerized data conversion, web-page construction, data entry/key 2

CO No.15/Del/2013 boarding, copyediting, and CAD/CAM/GIM mapping services to its AE.

The assessee undertook one international transaction of: ‘Provision of IT-Enabled data Conversion services’ valued at Rs.4,38,06,911/-. It used the Transactional Net Margin Method (TNMM) as the most appropriate method for determining the ALP of its international transaction. Profit level indicator (PLI) of Operating profit/Total cost (OP/TC) was used. The assessee reported its OP/TC at 15.50% and 15 comparable companies with their weighted average margin of three financial year endings 2005 to 2007 at 21.51%. The AO referred the matter of determination of the ALP of this international transaction to the Transfer Pricing Officer (TPO). The TPO required the assessee to furnish margin of comparables using current year data alone, which was calculated by the assessee at 14.61%. The TPO examined the list of comparable companies given by the assessee. After making certain alterations, he shortlisted 11 companies as comparable which have been tabulated on pages 16 and 17 of his order with their respective OP/TC, as under :-

S.No. Company Name OP/TC 1. Ace Software Exports Ltd. 2.03% 2. Allsec Technologies Limited 27.21% 3. Apex Advanced Technology Pvt. Ltd. 39.73% 4. Cosmic Global Limited 11.31% 5. CG-VAK 4.97% 6. Genesys International Corporation Limited 12.52% 7. Maple E-Solutions Limited 33.96% 8. R. Systems International Ltd. 13.54% 9. Spanco Ltd. 24.82% 10. Triton Corp. Limited 34.49% 11. Vishal Information Technologies Limited 51.64% Average 23.29% 3.2. The TPO accepted the assessee’s computation of OP/TC at 15.50%, as under :-

Particulars Amount (Rs.) IT Enabled Services 4,38,06,911 Scrap Sales 1,62,019 Miscellaneous Income 62,150 Total Operating Income 4,40,31,080 Expenditure Total Operating Expenses 3,81,22,147 OP 59,08,933 OP/TC 15.50%

CO No.15/Del/2013 3.3. By considering the arm’s length margin of comparables at 23.29%, the TPO worked out transfer pricing adjustment to the tune of Rs.29,69,715/-. The AO made this addition vide his order dated 28.1.2011 passed u/s 143(3) of the Income-tax Act, 1961 (hereinafter also called `the Act’). The assessee challenged the assessment order before the ld. CIT(A), who deleted the entire addition by excluding Vishal Information Technologies Limited from the comparables selected by the TPO; altering the figure of profit margin of Ace Software Exports Ltd.; and including Ask Me Info Hubs Ltd. in the list of comparables which was excluded by the TPO. Both the sides are in appeal on their respective stands.

CO No.15/Del/2013 average of multiple years data that was initially considered by the assessee in its transfer pricing study report. The area of dispute is only in respect of three comparable companies, viz., Vishal Information Technologies Ltd., Ace Software Exports Ltd and Ask Me Infor Hubs Ltd. 5.1. In order to precisely ascertain the comparability or otherwise of the companies in disagreement, we first need to find out the exact nature of services rendered by the assessee. The transfer pricing study report of the assessee is available on record which gives the profile of the assessee exactly on the same lines as has been incorporated above from the relevant part of the TPO’s order. We have gone through the Master Services Agreement (hereinafter the `Agreement’) dated 1.10.2003, between the assessee and its AE, namely, Tech Enterprises Inc., a Fairfax based incorporation having its registered office at Fairfax, Virginia, USA. This Agreement is valid for the year under consideration as well, whose copy is available at page 263 onwards of the paper book.

As per this Agreement, the assessee specializes in provision of technical

CO No.15/Del/2013 services, such as, data conversion, web-page construction, data entry/key boarding and software development. The assessee under this Agreement has undertaken to render ‘Included services’ which have been described in Exhibit-A. This Exhibit is `Statement of work’ which embodies the terms of the relationship between the assessee and Tech Enterprises Inc.

Para 2 of the Exhibit divulges that the assessee is responsible for providing the services defined in para 3 below, which is as under:-

“3.1 Nature of services: The nature of work that TechBooks International Pvt. Ltd. performs is electronic publishing and pre press services including print ready files to printers and electronic deliverables for on-line publishing, in addition to serving the publishers, Techbooks also works with Corporate and information aggregators to covert data from one file format to another which include conversion of legacy material to electronic formats, conversion from one electronic to another for various needs of information processing, data management, storage, archival and re-purposing of information for various end uses as required by the customers.” 5.2. The services so availed by the assessee’s AE are ultimately given to end-customers whose list has been given in para 3.2 of the Agreement which includes: Blackwell Publishing, John Wiley and Sons Ltd., Elsevier Science, Cambridge University Press, Springer SBM, i Archives and Pearson Education. Para 5 of the Agreement outlines the CO No.15/Del/2013 manner of remuneration to be paid to the assessee, which is 100% of the actual costs and expenses incurred in the provision of such services plus an appropriate mark-up. The above narration of the relevant clauses of the Agreement delineates the nature of work carried out by the assessee, which precisely is electronic publishing and pre-press services including print ready files to printers and electronic deliverables for on-line publishing by converting data from one file format to another, managing and storing such data for the ultimate use as required by the customers.

With this background of the functional profile of the assessee in mind, we will examine the comparability of the companies under challenge.

6.1. The assessee has resisted the inclusion of this company as comparable by contending that it is engaged in four primary areas of data digitization; e-publishing; digital library solutions; and print on demand conversion. It was also submitted that this company incurred more than 65% of its total costs on outsourcing of contracts to external vendors and its own employees cost was only 3% of its total cost, in CO No.15/Del/2013 contrast to the assessee adopting an altogether different business model of rendering in-house services. The TPO held this company to be functionally similar and, accordingly, included it in the list of comparables with its OP/TC at 51.64%. The ld. CIT(A) echoed the assessment order on this point. The assessee is aggrieved against the treatment of this company as comparable.

6.2. After considering the rival submissions and perusing the relevant material on record, we find that this company is, inter alia, engaged in e- publishing, which is an activity similar to the one done by the assessee.

Even the activities of ‘data digitisation’ and ‘print on demand conversion’ are also similar to those undertaken by the assessee.

However, despite having functionally similarity to a greater extent, this company cannot be considered as comparable because of a different business model adopted by it. Its Annual accounts for the year ending 31.3.2007 are available on record. It can be seen that its `Operating expenses’ are to the tune of Rs.17.35 crore out of which a sum of Rs.13.12 crore is on account of ‘Data entry charges & Vendor

CO No.15/Del/2013 Payments.’ This shows that 75% of the Operating expenses of this company are on outsourcing. As against this, the assessee’s job work to total cost ratio is only 5%. This demonstrates that Vishal Information Technologies Ltd., though in almost similar line of business functionally, ceases to be comparable, because of the adoption of a different business model as per which the activities are mostly outsourced. In contrast, the assessee is providing majority of its activities in-house. It goes without saying that there is a marked difference in profitability when the services are outsourced or provided in-house. Similar view has been taken by the Tribunal in several cases removing Vishal Information Technologies Ltd. on the basis of such business model. Under such circumstances, we consider Vishal Information Technologies Ltd., as not comparable and direct to eliminate it from the list of comparables. The view taken by the ld. CIT(A) in continuing to include this company in the final set of comparables is, therefore, overturned and the assessee’s sole effective ground in cross objection is allowed.

CO No.15/Del/2013 ii) Ace Software Exports Ltd.

7.1. The assessee considered this company as comparable in its transfer pricing study report by computing its OP/TC for the year at 8.24%. The TPO continued to include this company in the list of comparables, but, re-worked out its OP/TC at 2.03%. The ld. CIT(A) concurred with the submissions advanced on behalf of the assessee and restored the assessee’s stand. The Revenue is aggrieved against the computation of OP/TC of this company at a lower level.

7.2. The ld. DR raised a preliminary objection to the effect that Ace Software Exports Ltd. is functionally different and, hence, the same should be excluded in totality. On a specific question as to whether the TPO disputed the functional similarity of this company with the assessee, the ld. DR submitted that though the TPO accepted it as comparable, but, in reality, this company is not comparable. That being so, he contested the inclusion of this company in the final list of comparables. The ld. AR opposed the departmental stand of excluding a company which was considered by the TPO himself as comparable.

CO No.15/Del/2013 7.3. A brief question which falls for our consideration is whether the ld.

DR can legally challenge the action of the AO in considering a particular company as comparable at his own without any external interference by some Income-tax authority. In this regard, it is noted that the Revenue has preferred appeal against the deletion of addition on account of transfer pricing adjustment. Accordingly, what has been challenged is the decision given by the ld. CIT(A) on issues decided against the Revenue, which in relation to Ace Software Ltd., is the calculation of its profit ratio. When the TPO himself considered this company as comparable, in our considered opinion, there can be no reason for the ld. DR to be aggrieved against its inclusion in the appeal filed before the tribunal. The Department can take recourse to the other legal remedies, if any, available as per law in so far as its grievance against the decision of the AO/TPO is concerned.

7.4. Even rule 27 of the ITAT Rules, 1963, does not come to the rescue of the ld. DR for assailing the correctness of the order of the AO/TPO in appeal before the tribunal.

CO No.15/Del/2013 7.5. This rule provides that : “The respondent, though he may not have appealed, may support the order appealed against on any of the grounds decided against him.” This rule manifests that the respondent, with or without having filed any cross appeal or cross objection can support the impugned order on any of the grounds decided against him. Two essential elements of the rule 27 come to the fore. First is the condition precedent for invoking this rule and the second is scope of interference by the respondent. Insofar as the first element is concerned, we find that this Rule has been enshrined with a view to dispense justice to a respondent who is otherwise legally entitled to assail the correctness of the impugned order by filing appeal or cross objection, whether or not actually filed. This is borne out from the expression `though he may not have appealed’ used in the context of a respondent. This amply indicates the existence of a pre-right of the respondent to appeal, which may have remained unavailed. This Rule cannot help the respondent in a situation where he is otherwise debarred from filing cross appeal or cross objection on a particular point. If no CO No.15/Del/2013 right to file an appeal or cross objection statutorily vests in the respondent on a particular point, then it cannot be inferred indirectly by taking recourse to Rule 27. We have noticed above that though the Revenue has a right to file cross appeal or cross objection against the adverse order of the CIT(A), but it has no right to file appeal against the view taken by the AO/TPO himself, which was not disturbed in the first appeal. Since the condition precedent for seeking relief in terms of the second element of rule 27 is wanting, the very right of taking recourse to rule 27 is lost. As such, we are not inclined to accept the argument of the ld. DR to treat Ace Software Export Ltd. as functionally dissimilar and delete it from the list of comparables, as the same has been treated by the TPO as comparable and the ld. CIT(A) has not tinkered with this conclusion of the AO/TPO.

7.6. On merits, the controversy rotates around the computation of OP/TC of this company. The TPO computed it profit margin on page 15 of his order in the following manner:-

CO No.15/Del/2013 “Operating Income: 4.53 Crs. Operating Expenses: 4.44 Crs. Operating Profit: 0.09 Crs OP/OE: 2.03%”

7.7. The assessee contended before the ld. CIT(A) that a sum of Rs.42,44,736/- has been debited by this company towards ‘Cost variance’ and shown under the head ‘Income’ as a negative figure which the TPO omitted to consider in computing OP/TC of this company. The ld. CIT(A) agreed that stock variance of Rs.42.44 lac was liable to be considered for calculating its OP/TC. He accepted the assessee’s calculation of OP/TC of this company at (-) 6.98% as under:-

Operating Income 4.53 Cr. Operating Expenses (OE) inclusive of 4.87 Cr. Stock Variance Operating Profit (OP) (0.34) Cr. OP/OE (6.98%)

CO No.15/Del/2013 7.8. Now, the question is whether the calculation of OP/TC of Ace Software Exports Ltd. as done by the CIT(A) is correct ? Profit level indicator has been taken as Operating Profit to Total Cost.

`Operating profit’ refers to Net Profit as increased by non-operating expenses, such as, Interest expense and as reduced by non-operating incomes, such as, Gain on sale of assets. The calculation of Operating income at Rs.4.53 crore of this company as determined by the ld. CIT(A) remains at the same level as found by the TPO. Difference has arisen in the calculation of the figure of `Total Operating cost’, which refers to Cost of goods sold (COGS) plus other operating expenses, such as, selling expenses and depreciation. Cost of goods sold is equal to Opening stock plus Purchases and other direct expenses debited to the Trading account as reduced by the amount of Closing stock. This shows that COGS cannot be computed without considering the figures of opening and closing stocks. If we adopt the figure of direct expenses debited to the Trading account without adjusting it with Opening and closing stock values, the resultant figure cannot be termed as COGS.

CO No.15/Del/2013 7.9. Coming back to the facts of the instant case, we find that the ld.

CIT(A) has computed `Total costs’ by considering COGS, that also incorporates the effect of the amount of opening and closing stocks, which was omitted by the TPO. As such, we countenance the view taken by the ld. first appellate authority in adding the amount of opening stock of this company to the other operating expenses and then reducing the amount of its closing stock, to find out the amount of `Total operating costs’ at Rs.4.87 crore. Consequently, the objection taken by the Department is repelled.

8.1. The assessee considered this company as comparable. The TPO refused to acknowledge it as comparable by noticing that there was a declining turnover and declining profitability of this company which indicated that it was in a negative phase of economic cycle. The ld. CIT(A) found the TPO’s observations as factually unfounded and restored the inclusion of this company in the final list of comparables.

The Revenue is aggrieved against the inclusion of this company.

CO No.15/Del/2013 8.2. We have heard the rival submissions and perused the relevant material on record. It can be seen from page 15 of the TPO’s order that the otherwise functional similarity of this company with the assessee was not disputed by the Officer. The exclusion has been made simply on the ground that: ‘this company has declining turnover, declining profitability and it is in the negative phase of economic cycle.’ This viewpoint of the TPO is contrary to the factual position stated before him about this company which is as under:-

Year Sales Operating Margins FY 2003-04 Rs.9,917,965 1.34% FY 2004-05 Rs.23,963,134 (-) 13.92% FY 2005-06 Rs.47,065,140 5.05% FY 2006-07 Rs.29,776,679 0.67% 8.3. If we peruse the above Table, it becomes evident that there is no negative phase of this company either in terms of turnover or operating profit margin. Whereas its turnover for the financial year 2004-05 stood at Rs.2.39 crore, it increased to Rs.4.70 crore in the CO No.15/Del/2013 Financial year 2005-06 and came down to Rs.2.97 crore in the previous year relevant to the assessment year under consideration. Similar is the position regarding operating margins of this company which was at a loss of 13.92% for the financial year 2004-05; such loss got converted into profit at 5.04% during the Financial year 2005-06 and to 0.67% for the year under consideration. We are unable to find any negative phase of economic cycle of this company which is, in fact, in sync with the increase and decrease of the assessee’s turnover and profitability in the earlier two years vis-à-vis the year under consideration as has been noticed by the ld. CIT(A) on page 8 of the impugned order. Under these circumstances, we are of the opinion that the view taken by the ld. CIT(A) in ordering the inclusion of this company cannot be interfered with. We, therefore, uphold the same and dismiss the ground taken by the Revenue.

The order pronounced in the open court on 02.12.2015.