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:
A.
Determination of arm's length price:
1.
On the facts and in the circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) erred in upholding/confirming an addition to the extent of Rs, 3,21,54,200 under section 92CA of the Income Tax Act, 1961 to the Information Technology Enabled Services rendered by Appellant to its Associated Enterprises without taking cognizance of the objections filed by the Appellant.
B.
Shifting of profits outside India not demonstrated:
2.
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 Learned Additional Commissioner of Income Tax (Ld. TPO) in not demonstrating that the motive of the Appellant was to shift profits outside of India by manipulating the prices charged in its international transactions which is a prerequisite condition to make any adjustment under the provision of Chapter X of the Act.
C.
Comparability analysis adopted for determination of arm's length price suffers from inherent defects:
3.
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 conducting fresh benchmarking analysis substituting the Appellant's analysis with fresh comparability analysis on his own conjectures and surmises,
4.
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 rejecting the following filters applied by the Appellant:
i.
Rejection of companies with Net Fixed Asset to Sales ratio greater 200%; and
ii.
Rejection of companies having Research and Development expense to Sales ratio in excess of 3%.
5.
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 adopting arbitrary quantitative criterion for selection of alleged comparable companies during the course of assessment proceedings. Thus the methodology adopted by the Ld. TPO lacks basic statistical principles and economic prudence.
6.
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 not sharing a detailed step by step search strategy adopted and the Functional, Assets and Risk (FAR) analysis conducted to reject the companies qualitatively including the manner of collection and disclosure of information called for under section 133(6) of the Act, in the search undertaken for selection of alleged comparable companies. Thus the search conducted by the Ld. TPO during the course of assessment proceedings lacks transparency and violates the principles of natural justice.
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.
8.
On the facts and in the circumstances of the case and in law, considering the limited business functions undertaken and risks assumed by the Appellant in the entire/end to end business value chain with respect to the international transactions entered with its AEs, the Ld. TPO erred and the Ld. CIT(A) further erred in upholding/confirming the companies selected by the Ld. TPO which undertake all the business value chain functions and assume all business risks as an appropriate comparables to the Appellant. Thus the ld. TPO/CIT(A) failed to conduct the arm's length analysis in accordance with the provisions of Rule 10B of the Income Tax Rules, 1902.
9.
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 benchmarking the transactions of the Appellant with companies having significant differences in the functions performed, turnover, research expenses and/or marketing expenses incurred and risk undertaken by the Appellant vis-a-vis the comparable companies.
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.
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
12.
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 not considering finance charges/miscellaneous expenses written off as part of operating expenses while computing the margins of the comparable companies.
D.
Use of non-contemporaneous data:
13.
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 of conducting a benchmarking analysis using non contemporaneous data.
14.
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 not allowing the use of multiple year data as prescribed under Rule 10B(4) of the Rules.
E.
Non-allowance of appropriate adjustments to the comparable companies:
15.
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 not allowing the adjustments on account of differences in the business functions performed and risks assumed by the Appellant vis-it-vis comparables selected by the ld. TPO while conducting the arm's length analysis of the international transactions of the Appellant entered with its AEs. Thus the Ld. TPO/CIT(A) failed to conduct the arms length analysis in accordance with the provisions of Rule 10B of the Rules.
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.
17.
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 TPO in not appreciating the difference in infrastructure cost of the Appellant and the comparables selected and erred in not giving a downward adjustment to the mark-up of comparables on account of difference in infrastructure cost.
F.
Variation of 5%. from the arithmetic mean:
18.
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 TPO in denying the benefit/reduction of 5 percent from the arithmetic mean as provided in proviso to Section 92C(2) of the Act. while computing the adjustment to the total income of the Appellant.
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:
(a)
The Chandigarh Bench of this Tribunal in the case of
Dy. CIT v.
Quark Systems (P.) Ltd. [2010] 38 SOT 307 (SB), held as under:
"25 While we agree that merely because a comparable is making loss, it cannot be excluded from the list or comparables (or the purposes of computation or arm's length price. lmercius is a case in which not only functional area is different. Imercius has a negative net worth but also because turnover of the Imercius has no comparison with the assessee companies"
(b)
The Mumbai Tribunal in the case of
Teva India (P.) Ltd. v.
Dy. CIT [2011] 44 SOT 105 (URO) made similar observations while rendering its decision. The Tribunal held that a comparable could not be excluded only on the ground of losses.
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:
(a)
Vishal Information Technologies Limited. [45.62%]
(b)
Nucleus Netsoft & Gis India [40.06%]
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:
(a)
Sapient Corporation (P.) Ltd. v.
Dy. CIT [2011] 11 taxmann.com 69/46 SOT 56 (Delhi) (URO) and
(b)
Syscom Corporation Ltd. v.
Asstt. CIT [2013] 35 taxmann.com 600 (Mum.).
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:
(a)
Cognizant Technology Services (P.) Ltd. v.
ACIT [IT Appeal Nos. 2106 & 1864 (Hyd) of 2011).
(b)
Market Tools Research (P.) Ltd. v.
Asstt. CIT [2013] 32 taxmann.com 358 (Hyd.)
(c)
Capital IQ Information Systems (India) (P) Ltd. v.
Dy. CIT (International Taxation) [2013] 32 Taxmann.com 21 (Hyd.)
(d)
HSBC Electronic Data Processing India Ltd. v.
Addl. CIT [2013] 38 taxmann.com 141 (Hyd.).
(e)
ITO v.
CRM Services India (P.) Ltd. [2011] 48 SOT 41 (URO) (Delhi)/14 taxmann.com 96 (Delhi)
(f)
Stream International Services (P) Ltd. v.
Asstt. DIT (International Taxation) [2013] 31 Taxmann. Com 227/141 ITD 492 (Mum).
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:
| Particulars |
FY 2003-04 |
FY 2004-05 |
FY 2005-06 |
| Data entry and vendor payments |
7,69,28,836 |
11,35,11,647 |
11,49,14,563 |
| Personnel costs |
19,15,371 |
19,70,458 |
32,01,756 |
| Sales |
13,88,22,227 |
20,82,33,000 |
25,64,28,476 |
| Vendor payment as a percentage of sale |
55.42% |
54.51% |
44.81% |
| Personnel cost as a percentage of sale |
1.38% |
0.94% |
1.25% |
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:
(a)
The Tribunal in the case of
HSBC Electronic Data Processing (I) (P.) Ltd. v.
Asstt. CIT [2013] 36 taxmann.com 388 (Hyd.) held as under:
"11. We have considered contentions of the parties and perused the material on record with regard 10 the aforesaid comparables. There is no dispute to the fact that the employees cost to total turnover of the aforesaid company works out to 1.42% as against the industry average of 30 to 40% and assessee's employees cost to turnover percentage o{ 43.76%. This fact implies that the aforesaid company has outsourced major portion of its work to third party vendors. Therefore, this company cannot be treated as a comparable by applying the ratio laid down by the co-ordinate bench in case of
Brigade Global Services (P.) Ltd v.
ITO [2013] 143 ITD 59/33 taxmann.com 618 (Hyd.) and
Capital IQ Information Systems (India) (P.) Ltd. v.
Dy. CIT [2013] 32 taxmann.com 21 (Hyd.) while directing exclusion of the aforesaid company. In this view of the matter, we direct the Assessing Officer to exclude this company from the list of comparables."
(b)
The Tribunal in the case of
Zavata India (P.) Ltd. v.
Dy. CIT [2013] 35 taxmann.com 423 (Hyd.) held as under:
"17. As could be seen from the findings of the co-ordinate bench, the aforesaid company unlike the assessee has outsourced considerable portion of its business to third party vendor. Hence, it cannot be considered as a comparable. That besides the DRP in assessee's own case for asst. year 2008-09 has held that this company cannot be treated as a comparable. Therefore, considering the aforesaid fact, we are of the view that M/s Vishal Information Technology Ltd., cannot be taken as a comparable and direct for excluding the same from the list o{comparables."
(c)
The Tribunal in the case of
Cognizant Technology Services (P.) Limited v.
ACIT [IT Appeal Nos. 2106 & 864 (Hyd) of 2011], held as under:
"17. .... the activities of the aforesaid company, as revealed from the annual report, is providing agency services by way of outsourcing the services to the third party vendor and acting as an intermediary between the final customer and vendor It was submitted that the company should be rejected as comparable as it has incurred 2.3% of the revenue during financial year 2006-07 towards employee expenditure and about 43% of revenue is expended towards payment to vendor, whereas, in case of the assessee payment to employees were 36% o{the revenue. The learned AR in support of such contention relied upon the decision of the coordinate bench of the Tribunal in the case of
Capital IQ Information Systems (India) (P.) Ltd. (
supra) and
Asstt. ACIT v.
Maersk Global Service Centre (India) (P.) Ltd. [2011] 133 ITD 543/16 taxman.com 47 (Mum.).
20. As facts are materially identical, we follow the order of the coordinate bench in case of
Capital IQ Information Systems (India) (P.) Ltd. (
supra) and hold that the aforesaid company i.e., Vishal Information Technology cannot be taken as a comparable and direct for excluding the same (or determining the ALP."
(d)
The Tribunal in the case of
Capital IQ Information Systems (India) (P.) Ltd. (
supra), held as under:
"17. After considering the submissions of the learned Authorised Representative for the assessee, we find that the DRP, in the proceedings for the assessment year 2008-09 in assessee's own case, after taking note of the composition of the vendor payments of Coral Hub for the last three years, and the fact that it has also commenced a new line of business of Printing on Demand (POD), wherein it prints upon clients request, concluded as follows-
"18.4. In view of this major difference in functionality and the business model, this Panel is of the view that 'Coral Hub' is not a suitable comparable to the taxpayer and hence needs to be dropped from the final list of comparables."
In case of
Maersk Global service Centre India (P.) Ltd. (
supra), the ITAT Mumbai Bench has also directed for exclusion of the aforesaid company, by observing in the following manner:
"Insofar as the cases of Tulsyan Technologies Limited and Vishal Information Technologies Limited are concerned, it is noticed from their annual accounts that these companies outsourced a considerable portion of their business. As the assessee carried out entire operations by itself in our considered opinion, these two cases were rightly excluded."
In view o(the observations made by the DRP as well as the decision of the ITAT Mumbai in the case of
Maersk Global Service Centre (
supra), we accept that this company cannot be taken as a comparable."
(e)
The Tribunal in the case of
Brigade Global Services (P.) Ltd. v.
ITO [2013] 143 ITD 59/33 taxman.com 618 (Hyd.) held as under:
"46. We have heard both the parties on the above two comparables. Regarding Vishal information Technologies M/s. BA Continuum India Pvt. 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."
(f)
The Mumbai Tribunal in the case of
Asstt. CIT v.
Maersk Global Service Center (India) (P.) Ltd. [2011] 16 taxmann.com 47/133 ITD 543 (Mum.) held as under:
"48. Insofar as the cases of Tulsyan Technologies Limited and Vishal Information Technologies Limited are concerned, it is noticed from their annual accounts that these companies outsourced a considerable portion of their business. As the assessee carried out entire operations by itself, in our considered opinion. these two cases were rightly excluded"
23. Further, he relied on the following case-law:
HSBC Electronic Data Processing India Ltd. (
supra).
Symphony Marketing Solutions India (P.) Ltd. v.
ITO [2013] 38 taxmann.com 55 (Bang.)
Google India (P.) Ltd. v.
Dy. CIT [2013] 29 taxmann.com 412/55 SOT 489 (Bang. - ITAT);
Nomura Fin Services (India) (P.) Ltd. v.
Asstt. CIT [2013] 33 taxmann.com 4 (Mum.);
Stream International Services (P.) Ltd. v. (
supra)
24/7 Customer.Com (P.) Ltd. v.
Dy. CIT [2012] 28 taxmann.com 258/[2013] 140 ITD 344 (Bang.);
HCL EAI Services Ltd., v.
Dy. CIT [2013] 35 taxmann.com 146 (Bang.)
Mercedes Benz Research & Development India (P.) Ltd. v.
Dy. CIT [IT(TP)A No. 1222 (Bang.) of 2011 (Bang. ITAT);
ITO v.
Nextlinx India (P.) Ltd. [IT Appeal No. 454 (Bang.) of 2011] (Bang. ITAT).
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:
(a)
Companies whose ITES income Rs. 1 crore were excluded.
(b)
Companies who have more than 25% related party transactions (sales as well as expenditure combined) of the sales were excluded.
(c)
Companies who less than 25% of the sales as export sales were excluded.
(d)
Companies who have diminishing revenues/persistent losses for the period under consideration were excluded.
(e)
Companies having different financial year ending (i.e., not March 31, 2005) or data is not available for 12 months, were rejected.
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:
(a)
The Tribunal in the case of
Market Tools Research (P.) Ltd. (
supra) held as under:
"11. ... c) All facts which impact the financial result of comparable companies should be taken into account and reasonable accurate adjustment should be made for the same. In this connection the rates of depreciation adopted by the assessee are significantly different from (straight line as compared with WTP; higher rate than that prescribed in schedule VI) those adopted by the comparable companies suitable adjustment for the different has to be made or the profit before depreciation may be considered.:"
(b)
The Tribunal in the case of
Qual Core Logic Ltd. v.
Dy. CIT [2012] 22 taxmann.com 4/52 SOT 574 (Hyd.), held as under:
"57. ... It is evident from statutory provisions that it is nowhere provided that deduction of depreciation is a must. Depreciation can be taken into account or disregarded in computing profit depending upon the context and purpose for which profit is to be computed. There is no formula which would be applicable universally and in all circumstances. "Net profit" used in Rule 10B can be taken to mean commercial profit. ... In the case in hand, Revenue authorities went wrong in disregarding the context and purpose for which the "net profit" was to be computed. Depreciation, which can have varied basis and is allowed at different rates, is not such an expenditure which must be deducted in all situations. ... Object and purpose of the transfer pricing to compare like with the like, and to eliminate differences. if any, by suitable adjustment is to be seen. Therefore, there was justification on the part of the assessee in pleading that profits be taken without deduction of depreciation as depreciation was leading to large differences in margins for various reasons. ... Thus, material differences needing suitable adjustment were ignored and a flawed analysis was carried even in appellate proceedings. Without considering obvious material differences, the contention of the assessee to take profit without depreciation was rejected. This rejection is not sound in law. This ground is allowed. Accordingly, we direct the Assessing Officer to re compute the ALP. "
(c)
The Delhi Tribunal in the case of
Schefenacker Motherson Ltd v.
ITO [2009] 123 TTJ 509, held as under:
"22 Taxpayer is seeking adjustment of differences on account of depreciation and no plausible reason has been given for not accepting this claim. There is no finding that there are no differences in claim of depreciation and, therefore, it should have been excluded in computing "operating profit" as warranted by rules. On the other hand, the differences as per the chart are accepted. The finding that cash profit cannot be considered is not legally correct. The taxpayer in order to get adjustment of difference in depreciation furnished arm's length working after excluding depreciation and by taking all other expenses into consideration and showed that such profit of the taxpayer was quite comparable to the mean margin of other comparables similarly computed. This demonstratively showed that deduction of depreciations was making huge difference and required suitable adjustment. This claim has not been challenged. It is clear that the best way to adjust difference on account of depreciation was to ignore depreciation both in case of the tested party and the comparables. ... If depreciation is not leading to any difference, its exclusion is immaterial. If it is leading to differences, then differences are required to be adjusted, as required by provisions of IT Regulations. There is no way to dislodge the claim of the taxpayer. The context and purpose of legislation and facts of case overwhelmingly approve adoption of cash profit only.
23. As the deduction of depreciation is leading to wide differences, the same should be excluded. The only reason given for rejecting taxpayer's analysis and for making adjustment in the two years is that use of ratio of cash profit without depreciation is not permitted under the law. This view in the light of above discussion cannot be accepted as correct and is disapproved."
(d)
The Mumbai Tribunal in the case of
Dy. CIT v.
Reuters India (P.) Ltd. [2013] 33 taxmann.com 481 (Mum.) held as under:
"4. ... It is further important to note that the claim of having higher rate of depreciation in assessee's case did not come to be considered for the first time. The assessee had reported this fact in Notes to its Financial Statement that the depreciation on equipments was charged on straight-line basis on the original cost in accordance with the policy of charging depreciation taking useful life of 2 to 5 rears ... respectfully following the Special Bench order in the case of Dy. CIT
v. Quark Systems (P) Ltd.
[2010] 38 SOT 307 (Chd.) (SB) 1], we find no infirmity in the order of the Id. CIT(A) in entertaining this claim for adjudication on merits."
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