2025 (6) TMI 1906 - AT - Income Tax

TP Adjustment - recharacterization of the services rendered by the assessee as knowledge process outsource or KPO services - HELD THAT - Appellant is providing engineering design services to its AEs on the basis of concept provided by the AE as per requirement of the customers. The services include in-depth understanding of the clients business process existing systems etc. However on careful examination of various design services provided by the assessee which includes 3D modelling and 2D Drawings from 3D modelling clean room technical specification 3D visualization (for Architecture) 3D Modelling and 2D Drawings from 3D Modelling of process plant equipment (pipes ducts cable tray pipe racks etc., ) Staad analysis connections design for (civil/structural) etc. For rendering the above services the appellant company has employed various categories of technical staff including Diploma Holders Engineering Graduates PG Graduates and from the above it is undisputedly clear that the services rendered by the appellant to its AEs in EDS segment is not a simple design services in the category of BPO services but it is a highly technical work in the category of Knowledge Process Outsourcing (KPO) and therefore there is no error in the reasons given by the TPO to recharacterize the services of the appellant company as KPO services and thus we reject the ground taken by the assessee. Comparable selection - exclusion of Mahindra Consulting Engineers Ltd. - Services rendered by the assessee to the AE are comparable to services rendered by Mahindra Consulting Engineers Ltd. Further although the appellant contended that it fails the RPT filter but in our considered view the method of computation of related party transaction by the assessee is contrary because related party transactions should be computed to revenue or expenses separately but there is no question of aggregating both the transactions and computing the percentage. Since related party transaction of the appellant company with related party is less than 25% in respect of income and expenditure separately in our considered view it passes the RPT filter applied by the TPO. Standing in the business of number of years does not matter for the margin earned by the company but all depends upon the nature of services rendered by the company. Therefore the argument of the learned Counsel for the assessee that Mahindra Consulting Engineers Ltd is in the business of almost 37 years and cannot be compared with the appellant company being in the first year operation does not hold water. Thus we reject the argument of the assessee and upholds the inclusion of Mahindra Consulting Engineers Ltd. M/s Genesys International Corporation Ltd is predominantly into the services of geographical information system services comprising of photogrammetry remote sensing car topography data conversion state of the art terrestrial and 3D geo-content including location and other computer related services whereas the assessee is into simple activities of engineering design services of EPC contractors and cannot be compared to each other. TPO/DRP without considering the relevant facts simply included the above company in the list of final set of comparables. Thus we direct the TPO/Assessing Officer to exclude it. L T Technologies Services Ltd is not a comparable company to the appellant company which is providing engineering design services to its AEs for EPC Contractor. Inclusion of exceptional item being consultancy charges paid as part of operating cost - Since the assessee itself has taken over the agreement in a slump sale and further the entire amount of consultancy charges has been paid by the assessee in our considered view unless the assessee derived benefit from the agreement it may not have taken over agreement and agreed to make payment to Cyient Ltd. Therefore from the above it is undisputedly clear that the benefits of agreement from Cyient Ltd is furthering the business of the assessee in subsequent years and for this purpose the assessee agreed to make payment. Therefore once the expenditure is related to the business operations of the assessee then it should be definitely part of the business expenditure do the assessee and partakes the nature of operating cost. The TPO/DRP has rightly considered exceptional item being service charges paid to Cyient Ltd as operating in nature. Thus we are inclined to uphold the findings of the TPO/DRP and reject the ground taken by the assessee. Considering Amortization of Good Will as part of operating cost - The excess of liabilities over assets has been treated as goodwill. Since it is one time extra ordinary expenses arise on account of acquisition of global design services division from another company and a difference between the asset and liabilities of the transferor company in our considered view said asset being goodwill cannot be included as asset employed in the business of the assessee to be considered as operating in nature. Further the learned DRP has itself given a finding that goodwill acquired on account of amalgamation or business transfer agreement is not eligible for depreciation. Once the assessee is not eligible for depreciation on goodwill then the same cannot be considered as operating in nature for the purpose of computing margin. Therefore we are of the considered view that the TPO is erred in including amortization of goodwill as part of operating cost. Thus we direct the TPO to exclude amortization of goodwill from operating cost. Considering management fee and value fee as part of operating cost - The assessee has considered the very same expenditure in Ground No.10 and seeks to exclude the amount as part of operating cost. Since we have already held that consultancy/management fees paid to Cyient Ltd is part of operating cost in our considered view Ground No.10 taken by the assessee challenging the exclusion of management fee and value fee is devoid of any merit and thus we reject the ground No.10 taken by the assessee. Rejecting capacity utilization adjustment sought by the assessee - There is no basis for adopting the total available hours and further the assessee has not submitted any details for the number of hours utilized for the under utilization and therefore on this ground itself capacity utilization computed by the assessee should be rejected. However the case of the assessee is that it has utilized 86.87% whereas the comparables which utilized 100% of their capacity. In our considered view once again the assessee is making a claim without there being any evidence. We do not know whether the comparables are operating with full capacity to say that they are operating with 100% capacity. In absence of any evidence it cannot be said that the comparables are operating at 100% capacity. Since the appellant has failed to file any evidences to support its claim in our considered view there is no reason to deviate from the reasons given by the DRP to reject allow adjustment towards capacity utilization. Thus we reject ground No.11 taken by the assessee. Inclusion of Code Ploy Engg. Ltd and E2G Engineering Design Services (P) Ltd in the list of comparables - There is no dispute with regard to the fact that the assessee has not taken any ground before the TPO raising inclusion of above 2 companies in the list of final set of comparables. Further the assessee has also not taken any ground before the DRP on this issue. Therefore the argument that the TPO/DRP not allowing the assessee to take an additional ground for inclusion of the above two companies is devoid of any merit and cannot be accepted. Further the assessee has not placed relevant material before the TPO to examine the FAR analysis of the 2 companies to consider for inclusion or exclusion for the purpose of computing the ALP. Appeal filed by the assessee is partly allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal include:

• Whether the Assessing Officer (AO) and Transfer Pricing Officer (TPO) erred in making transfer pricing (TP) adjustments under section 92CA(3) of the Income Tax Act, 1961 ("the Act") by selecting inappropriate comparables and applying incorrect profit level indicators (PLI).
• Whether the recharacterization of the appellant's engineering design services as Knowledge Process Outsourcing (KPO) services under Rule 10TA(g) of the Income Tax Rules, 1962 was justified.
• Whether the exclusion or inclusion of certain comparable companies (notably Mahindra Consulting Engineers Ltd., Genesys International Corporation Ltd., and L&T Technology Services Ltd.) in the TP study was appropriate, considering functional and financial comparability.
• Whether exceptional items such as consultancy charges paid to Cyient Ltd. and amortization of goodwill should be included as part of operating cost for TP analysis.
• Whether management and value fees should be included as part of operating cost.
• Whether capacity utilization adjustment claimed by the appellant was admissible.
• Whether the appellant should have been permitted to file additional grounds and include additional comparables not considered earlier in the proceedings.

2. ISSUE-WISE DETAILED ANALYSIS

Recharacterization of Services as KPO (Ground No.3)

Legal Framework and Precedents: The definition of KPO services under Rule 10TA(g) of the Income Tax Rules, 1962 was pivotal. The rule includes engineering and design services as KPO services.

Court's Interpretation and Reasoning: The Tribunal examined the nature of services rendered by the appellant, including 3D modelling, 2D drawings, clean room technical specifications, 3D visualization, Staad analysis, and structural design. The appellant argued that these services were simple design services provided by low-skilled employees and distinct from KPO services, which generally require highly skilled technical graduates.

The Tribunal found that the services were highly technical and involved skilled personnel including diploma holders, engineering graduates, and postgraduates. It held that these services fall within the ambit of KPO services as per Rule 10TA(g). The Tribunal rejected the appellant's contention that the services were simple design services and upheld the recharacterization.

Application of Law to Facts: The Tribunal applied the statutory definition of KPO services and found the appellant's services aligned with it. The functional analysis supported this conclusion.

Treatment of Competing Arguments: The appellant's argument based on employee skill level and nature of design was considered but found insufficient to override the statutory definition and functional realities.

Conclusion: The recharacterization of services as KPO was upheld.

Selection and Exclusion of Comparable Companies (Grounds No.4, 5, 6 & 7)

Legal Framework and Precedents: Transfer pricing requires selection of comparables based on functional analysis, financial comparability, and filters such as Related Party Transaction (RPT) percentage and turnover limits. Precedents emphasize that comparables must be functionally similar and financially comparable.

Mahindra Consulting Engineers Ltd. (Ground No.5): The appellant contended that this company was functionally different, failed the RPT filter, and had long business standing, making it non-comparable. The Tribunal found that the company's services-multidisciplinary engineering consultancy including design-were substantially similar to the appellant's engineering design services. The RPT filter was correctly applied by computing income and expenses separately rather than aggregating. The long business standing was irrelevant to comparability. The Tribunal upheld inclusion of this company.

Genesys International Corporation Ltd. (Ground No.6): The appellant argued this company was functionally different, engaged primarily in geographical information services, and lacked segmental information. The Tribunal found that the services of Genesys were distinct from the appellant's EPC contractor-related engineering design services and thus not functionally comparable. The Tribunal directed exclusion of this company from the comparables.

L&T Technology Services Ltd. (Ground No.7): The appellant submitted that this company was a large conglomerate with turnover over 115 times that of the appellant, had brand value, and was functionally different. The Tribunal noted that turnover filters are a recognized criterion for exclusion, typically applying a 10 times upper limit. The company's turnover exceeded this limit, and its services were broader, including research and development and AI, unlike the appellant's focused engineering design services. The Tribunal directed exclusion of this company.

Other Comparables (Ground No.4): The appellant did not press the ground challenging exclusion of six other comparables, leading to dismissal of that ground.

Application of Law to Facts: The Tribunal applied functional and financial comparability criteria strictly, respecting established turnover and RPT filters.

Treatment of Competing Arguments: The appellant's arguments based on business standing and aggregation of related party transactions were rejected in favor of standard TP principles.

Conclusion: Inclusion of Mahindra Consulting Engineers Ltd. was upheld; Genesys International Corporation Ltd. and L&T Technology Services Ltd. were excluded.

Inclusion of Exceptional Item (Consultancy Charges to Cyient Ltd.) in Operating Cost (Ground No.8)

Legal Framework: Operating cost for TP purposes includes expenses incurred in the ordinary course of business. Exceptional items are generally excluded unless they relate to ongoing business operations.

Court's Interpretation and Reasoning: The consultancy agreement with Cyient Ltd. covered a three-year period, part of which overlapped with the appellant's business transfer agreement (BTA) acquisition of the global engineering design services division. The appellant allocated part of the consultancy charges as exceptional (pre-BTA period) and part as operating expenses (post-BTA period).

The Tribunal held that since the appellant took over the agreement and agreed to pay consultancy charges, the benefits of the agreement accrued to the appellant in the relevant assessment year. The services provided by Cyient Ltd. (drawing, design, recruitment, operational management) were integral to the appellant's business operations. Therefore, the entire consultancy charges, including the portion treated as exceptional, were rightly included as operating cost.

Application of Law to Facts: The Tribunal applied the principle that expenses benefiting the business in the relevant year must be included in operating cost, regardless of accounting classification as exceptional.

Treatment of Competing Arguments: The appellant's contention that exceptional items should not be included was rejected as inconsistent with the commercial reality and the BTA terms.

Conclusion: Inclusion of consultancy charges paid to Cyient Ltd. as operating cost was upheld.

Inclusion of Amortization of Goodwill in Operating Cost (Ground No.9)

Legal Framework: Goodwill arising from acquisitions is an intangible asset. Whether amortization of goodwill is an operating expense depends on whether goodwill is considered an asset employed in the business for TP purposes.

Court's Interpretation and Reasoning: The goodwill arose from the acquisition of the global engineering design services division. The appellant treated amortization as an operating cost in its financial statements but did not raise any objection before the TPO. The Tribunal noted that goodwill was not self-generated and was a one-time extraordinary expense arising on acquisition.

The Tribunal held that goodwill acquired via business transfer is not an asset employed in the business for computing operating cost and is not eligible for depreciation under the relevant tax provisions. Therefore, amortization of goodwill should not be included in operating cost for TP purposes.

Application of Law to Facts: The Tribunal applied the principle that only expenses relating to assets used in the business operations are operating costs.

Treatment of Competing Arguments: The appellant's late objection before the DRP was rejected, and the Tribunal agreed with the DRP's view that amortization of goodwill is not operating cost.

Conclusion: Amortization of goodwill was to be excluded from operating cost.

Inclusion of Management Fee and Value Fee in Operating Cost (Ground No.10)

Legal Framework and Reasoning: Since the Tribunal upheld inclusion of consultancy/management fees paid to Cyient Ltd. as operating cost, it similarly rejected the appellant's contention to exclude management and value fees from operating cost.

Conclusion: Inclusion of management fee and value fee as operating cost was upheld.

Capacity Utilization Adjustment (Ground No.11)

Legal Framework: Adjustments for capacity utilization are permissible if supported by documentary evidence and relevant for comparability.

Court's Interpretation and Reasoning: The appellant claimed under-utilization of capacity (86.87%) compared to comparables (assumed 100%), seeking adjustment. The Tribunal noted that the appellant did not raise this claim before the TPO, and failed to provide documentary evidence supporting under-utilization or comparables' full capacity usage.

Further, the appellant's business transfer of an existing division negated the claim that it was a first-year operation. The Tribunal found no basis to accept the capacity utilization adjustment.

Conclusion: Capacity utilization adjustment was rejected.

Filing Additional Grounds and Inclusion of Additional Comparables (Ground No.12)

Legal Framework: Grounds and comparables not raised before the TPO or DRP are generally not admitted at the appellate stage unless justified.

Court's Interpretation and Reasoning: The appellant sought to include two additional comparables, Code Ploy Engg. Ltd and E2G Engineering & Design Services (P) Ltd, citing data base issues. The Tribunal noted that the appellant did not raise these grounds or provide FAR analysis before the TPO or DRP.

The Tribunal held that without prior examination and relevant material, allowing additional grounds or comparables at this stage was not justified.

Conclusion: The request to file additional grounds and include additional comparables was rejected.

3. SIGNIFICANT HOLDINGS

"The services rendered by the appellant to its AEs in EDS segment is not a simple design services in the category of BPO services but it is a highly technical work in the category of Knowledge Process Outsourcing (KPO) and therefore, in our considered view, there is no error in the reasons given by the TPO to recharacterize the services of the appellant company as KPO services."

"The method of computation of related party transaction by the assessee is contrary, because related party transactions should be computed to revenue or expenses separately but there is no question of aggregating both the transactions and computing the percentage. Since related party transaction of the appellant company with related party is less than 25% in respect of income and expenditure separately, in our considered view, it passes the RPT filter applied by the TPO."

"It is a well established principle of law that, the turnover filter is one of the criteria for exclusion of any company from the list of comparables. The various Courts and Tribunals have consistently held that the lower and upper limit of 10 times of the turnover filter should be applied to any company, for the purpose of computing FAR analysis."

"Once the expenditure is related to the business operations of the assessee, then it should be definitely part of the business expenditure of the assessee and partakes the nature of operating cost. The TPO/DRP has rightly considered exceptional item, being service charges paid to Cyient Ltd as operating in nature."

"Goodwill acquired on account of amalgamation or business transfer agreement is not eligible for depreciation. Once the assessee is not eligible for depreciation on goodwill, then the same cannot be considered as operating in nature for the purpose of computing margin."

"In absence of any evidence, it cannot be said that the comparables are operating at 100% capacity. Since the appellant has failed to file any evidences to support its claim, in our considered view, there is no reason to deviate from the reasons given by the DRP to reject allow adjustment towards capacity utilization."

"Since the assessee has not taken any ground before the TPO raising inclusion of above 2 companies in the list of final set of comparables and has not placed relevant material before the TPO to examine the FAR analysis of the 2 companies, there is no merit in the argument of the assessee and therefore, the Ground No.12 taken by the assessee is rejected."

The Tribunal partly allowed the appeal by excluding two companies (Genesys International Corporation Ltd. and L&T Technology Services Ltd.) from the list of comparables and excluding amortization of goodwill from operating cost, while upholding the recharacterization of services as KPO, inclusion of Mahindra Consulting Engineers Ltd. as comparable, inclusion of consultancy and management fees as operating cost, and rejecting capacity utilization adjustment and additional grounds for comparables.