ORDER

Chandra Poojari, Accountant Member - This appeal by the assessee is directed against the order of the CIT(A)-III, Hyderabad dated 25.3.2011.

2. The assessee raised the following grounds:

3. Before us, the learned AR has not pressed ground Nos. 1, 2, 3, 4, 5, 6, 8, 9, 12, 13, 14, 15, 17 and 18 and argued only in respect of ground Nos. 7, 10, 11 and 16 of the grounds of appeal and accordingly, Ground Nos. 1, 2, 3, 4, 5, 6, 8, 9, 12, 13, 14, 15,17 and 18 are dismissed as not pressed.

4. Ground No. 7 reads as follows:

7. On the facts and in the circumstances of the case and in law, the Ld. TPO erred and the Ld. CIT(A) further erred, in upholding/confirming the action of the Ld. TPO in selecting high profit margin companies on one hand and rejecting loss making or low profit margin companies on the other hand to arrive at the Arm's Length Price (ALP). Thus the approach adopted by the Ld. TPO lacks consistency and contains inherent contradictions.

5. The learned AR submitted that by applying this filter, the TPO has rejected companies without considering whether the companies are functionally comparable or not. The TPO as well as the CIT(A) failed to appreciate that the companies incurring losses should also be considered in the comparable companies set, to arrive at a margin which is reasonable, rational and which takes into account a variety of commercial and financial conditions. A company, which is otherwise a comparable company, should not be rejected only on the ground of diminishing revenue or on the ground that it has incurred losses. The TPO had rejected all the loss making comparables selected by the assessee-company in its TP study for various reasons which amounted to cherry picking of the comparables. The TPO rejected FI Sofex, Mapro Industries, BNKe Solutions P. Ltd. and Suprawin Technologies Limited based on the filter of diminishing revenue/persistent loss for the period under consideration. He objected rejection of companies on grounds of diminishing business or persistent losses as both profitable companies and loss makers are part and parcel of every industry. Further, he submitted that the Indian transfer pricing provisions provide for the comparability of the 'arithmetical mean' of the set of comparables with that of the tested party. As per statistical methodology, the arithmetical mean considers a sample of companies. The arithmetical mean represents an average of the given set, which represent the industry. An industry represents all kinds of companies, new or old, loss or profit making. Thus, the sample of companies would generally include both profit making as well as loss making companies. A compilation of both profit as well as loss making companies would constitute a normal distribution of the sample.

6. The AR submitted that a loss making company is part of the market and an entity's ability to make profits and losses is contingent upon market conditions. The profits and losses are contingent upon various economic factors and are subject to various influences in a free market economy. In a free market situation, one cannot ever perceive that all players would be making profits, with no one making losses. The rationale behind off-shoring services to India has been to curtail costs in a free global market, as against revenue maximisation. A profit or loss does not have any bearing on the comparability of a company. Accordingly, any company, which is functionally comparable, must be included in the set of comparables, irrespective of its profitability.

7. In view of the above, the AR submitted that in a transfer pricing documentation, for conducting a fair economic analysis, one need to follow a scientific methodology to eliminate companies on standard and economically viable filters. Thus, merely because the company has incurred losses, it should not be eliminated from the set of comparable. However, the CIT(A)/TPO has not taken due cognisance of the above mentioned submissions and rejected companies that fail to pass this filter.

8. He relied on the following precedents:

9. The AR submitted that in case loss making companies are excluded to arrive at the ALP, then in that case even extraordinary high profit margin companies should also be excluded for arriving at the ALP. In view of the same, the AR requested to reject/exclude the following companies from the final list of comparables as the margin earned by them is abnormally high:

10. The AR submitted that the comparable companies earning extraordinary margin should be excluded. This proposition is supported by the decision of the coordinate Bench of the Tribunal in the case of Dy. CIT v. Hellosoft India (P.) Ltd. [2013] 32 taxmann.com 101 (Hyd.) , where in it was held as under:

"33. Similarly, companies having extraordinarily high profits also cannot be considered as comparables. In this category comes Infosys Limited (40.38%), KALS Infosystems Ltd. (39.75%), Megasoft Limited (52.74%) and Accel Transmitting Ltd. (44.07%)."

11. He also relied on the following case law:

12. The learned DR relied on the orders of the lower authorities.

13. We have heard both the parties and perused the material on record. In our opinion, this issue was considered by the Tribunal in the case of Hellosoft India (P.) Ltd. (supra) wherein it was held that companies having extraordinarily high profit/loss cannot be considered as comparables. Being so, the companies having extraordinarily high profit or loss are to be excluded as comparables. Accordingly, the Assessing Officer is directed to re-calculate the ALP. This ground is partly allowed.

14. The next ground for our adjudication is ground No. 10 which is as follows:

10. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in upholding/confirming the action of the Ld. TPO in selecting Maple e-Solutions Limited as comparable despite the fact that the data of the company was not available for the full 12 months period. Thus the ld. TPO has adopted inconsistent and selective approach for the selection of the comparable companies.

15. Facts of the issue are that the TPO selected Maple e-solutions Ltd. as one of the new comparable company. The AR contended that Maple was in operation only for a period of 4 months during the FY 2004-05 and, therefore, the same does not qualify the filter adopted by the TPO. However, the CIT(A) did not consider the submission made by the assessee-company.

16. The AR submitted that one of the filters adopted by the TP for the purpose of selecting the final list of comparable companies to determine the ALP is "Companies having different financial year ending (i.e., not March 31, 2005) or data is not available for 12 months, were to be rejected. The AR submitted that Maple e-Solutions commenced its business of providing ITES services from 29th November, 2004 by setting up a 100% EOU unit and was operational only for a period of 4 months during the FY 2004-05. In view of the above mentioned facts, Maple e-Solutions merits rejection as the same was operational for less than 12 months period. The AR further submitted that the Directors of Maple e-Solutions are found to be involved in fraud and accordingly, its financial statements cannot be trusted and are not reliable. The AR relied on the following cases:

17. The DR relied on the order of the lower authorities and submitted that the services provided by Maple e-Solutions being foreign under ITES/GPO Sector and the TPO is justified in considering the above company. Further, this company commenced its business operation under ITES during the FY 2004-05 and the company was operational only for four month. The above company's financial data has satisfied all those filters adopted by the TPO for selection of comparables. Accordingly, he relied on the orders of the lower authorities.

18. We have heard both the parties and perused the material on record. Admittedly, the financial data of Maple e-Solution is not available for full financial year, it is available only for four months during the FY 2004-05. Being so, the part period data cannot be considered as a comparable to determine the ALP. The AO considered the financial data of partial period of operation of Maple e-Solutions. We are inclined to allow this ground taken by the assessee as the financial data of Maple e-Solutions cannot be considered as comparable to determine the ALP since it is part period data. This ground of the assessee is allowed.

19. The next ground of our consideration is ground No. 11 which is as under:

11. On the facts and in the circumstances of the case and in law, the Id. CIT(A) erred in upholding confirming the action of the ld. TPO in not rejecting VishaI Information Technologies Limited (Vishal) in spite of the fact that its salary cost as percentage of the total cost is very abnormal indicating difference in the functional profile of the Appellant and Vishal. Thus the TPO has adopted inconsistent and selective approach for the selection of the comparable companies

20. Brief facts of the issue are that the TPO in his SCN proposed to introduce Vishal Information Technologies Ltd. (Vishal for short) as a comparable in respect of the ITES service being rendered by the assessee company. It was also selected by the assessee company in the TP study. In response to the said SCN, the assessee-company furnished a detailed submission, wherein the assessee-company informed the TPO that the business model of Vishal is different from that of the assessee-company. On perusal of the annual report, the assessee-company observed that Vishal has significant amount of vendor payments. However, the TPO did not consider the submission made by the assessee-company and selected Vishal in the final list of comparables to arrive at the ALP. The AR argued that the salary cost of Vishal as a percentage of total cost is very low and therefore it is not functionally similar to the assessee-company. The CIT(A) did not consider the above submission made by the assessee- company and simply relied on the order of the TPO and stated that the TPO has not adopted any filter with respect to salary cost. Further, since the comparable is satisfying all the filters adopted by the TPO, the said comparable cannot be rejected.

21. The AR submitted that in view of the above mentioned facts, Vishal provides agency services by way of outsourcing the services to third party vendors and acting as an intermediary between the final customer and the vendor as against the assessee-company which provides ITES service on his own. The assessee-company's wages to total cost ratio is 45%, whereas wages to total cost ratio of Vishal is mere 1% as compared to industry average of 30-40%. The following table provides the information of vendor payment charges as a percentage of sales and also the personal cost as a percentage of sales of Vishal for a period of three years:

22. The AR submitted that the intermediary functions of Vishal can only be compared to that of a distributor which takes title to service/product for resale to the customer. On the contrary, the assessee-company is a provider of ITES service on his own. Therefore, the business model of Vishal is distinct and different from the business model and nature of activities of the Appellant Company. Based on the above mentioned facts, the AR submitted that Vishal is not functionally comparable as Vishal is not providing ITES services themselves but rather outsourcing it to another entity, thereby not qualifying as a comparable, due to its peculiar business model. Thus, based on the said analysis, the AR submitted that Vishal should be excluded from the final list of comparables selected by the TPO. The AR relied on the following decisions which squarely covers the ground of the assessee-company:

23. Further, he relied on the following case-law:

24. The DR submitted that the TPO has not adopted any filter with reference to salary cost. Thus, the 5 filters adopted by the TPO are as follows:

25. The DR submitted that Vishal Information Technologies has satisfied those filters adopted by the TPO. He relied on the order of the TPO.

26. We have heard both the parties and perused the material on record. In our opinion, M/s. Vishal Information Technologies can not be considered as a comparable case as this company was rejected by co-ordinate Bench while deciding similar issue in the case of Brigade Global Services (P.) Ltd. (supra) wherein held that ...

"Regarding Vishal Information Technologies Ltd., the employee's cost to total cost ratio is worked out at 2% as compared to the industry average of 30 to 40%. The assessee's employee's cost to total cost ratio is worked out at 47%. Since the employee's cost form major cost base in ITES service industries, the low ratio of comparables implies that it would not be providing services by employing its own sources. Being so, the assessee is not alike to M/s. Vishal Information Technologies Ltd. Accordingly, M/s. Vishal Information Technologies Ltd., cannot be considered as comparables and it is to be excluded from comparables."

27. Being so, considering the decision of the co-ordinate Bench, we decide the issue in favour of the assessee and directing the AO not to consider M/s. Vishal Information Technologies as comparable while determining the ALP.

28. The next issue for our consideration is ground No. 16, which is as under:

16. On the facts and in the circumstances of the case and in law, the Ld, TPO erred and the Ld. CIT(A) further erred in upholding confirming the action of the Id. TPO in not granting an adjustment for the difference in rate of depreciation charged by the comparables and the Appellant and not considering the Profit Before Depreciation and Tax to total cost as Profit Level Indicator for determining the ALP on his own conjectures and surmises.

29. At the outset, the AR submitted that the TPO has himself acknowledged the fact that in case where rate of depreciation has an impact on the profit margin of the assessee company, then the assessee company should be allowed depreciation adjustment or can opt for PLI as PBDIT/TC. In view of the above, the Ld. TPO in his order calculated the revised margin of the assessee company and also the comparables by taking the PLI as PBDIT/TC and concluded that the margin of the Assessee Company even after considering the PLI as PBDIT/TC is lesser than the arithmetic mean of the comparables. The TPO did not consider the fact that the margin of the Assessee Company falls within the ± 5% range of the arithmetic mean of the comparables. Also, the TPO while passing the rectification petition under section 154 of the Act failed to consider that once the PLI is taken as PBDIT/TC, the (-) 5% range from the arithmetic mean of 33.01% (34.60% less 1.59% working capital adjustment) of comparable companies as computed by the TPO himself comes to 26.36% and thus the margin of 26.80% of the assessee company as computed by the TPO falls within the said (-) 5% range. Therefore, the margin of the assessee company can be treated at ALP.

30. The AR further submitted that the TPO while passing the rectification order under section 154 of the Act, made calculation errors/mistakes in arriving at the margin of the assessee company as well as of the comparables. The TPO while calculating the PLI in the said rectification order, considered profit before depreciation (i.e. depreciation was not considered as cost while computing profits, but failed to exclude the same in the denominator (i.e. operating cost/total cost) which resulted in erroneous computation of PLI of the assessee company as well as that of the comparable companies. Once the correct calculation is considered, the revised margin of the assessee company will be 30.26% and the arithmetic mean of the comparables will be 38.74% (without working capital adjustment). Further, the working capital adjustment will increase from 1.59% to 1.74%. Thus, with the correct working capital adjustment, the revised arithmetic mean of the comparables will come to 37%. A detailed revised working of the margin of the assessee company, arithmetic mean of the comparables and working capital adjustment is on record vide Annexure A. The AR relied on the following case-law:

31. On the other hand, the learned DR relied on the orders of the lower authorities.

32. We have heard both the parties and perused the material on record. In our opinion, the depreciation has impact on the profit margin of the assessee. Being so, depreciation adjustment is to be made. Accordingly, considering the various judicial precedents as cited by the AR, we direct the AO to use the PLI as PBDIT. Accordingly, the AO is directed to recompute the ALP.

33. In the result, appeal of the assessee is partly allowed.

SB