TMI Blog2014 (12) TMI 894X X X X Extracts X X X X X X X X Extracts X X X X ..... such provision for determining the ALP of an international transaction for more than one year by considering a few years as one unit during which an asset is put to use - Not only is this exercise impermissible under the law, but is also impractical of application. Various assets will have varying useful life spans due to different rates of depreciation and their useful life will not terminate at one common point of time, so as to facilitate the making of adjustment at such point of time - the method of charging depreciation, both by the assessee and its comparables, is by and large the same that is SLM - The assessee is seeking adjustment only due to higher rates of depreciation charged by it under SLM with the lower rates of depreciation charged by four comparable companies, other than Mapro Industries Ltd. and Karvy Consultants Ltd. - the operating profit margins of these four comparable companies should be recomputed by the TPO/AO in line with the rates of depreciation charged by the assessee under SLM. The amount of depreciation of the four comparable companies on their assets shall also be recomputed under the SLM alone as per the rates at which the assessee has provided ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ptance - The other part of the argument about the comparables undertaking much more risks, is not substantiated with any worthwhile evidence - any risk adjustment in the operating profit margins of the comparables on this score cannot be accepted. Allowability of treansfer pricing adjustment – Group Suffering losses –Held that:- Some of the associated enterprises of the overall group may suffer loss due to their own inefficiencies and wrong business decisions and the consequences of such wrong decisions taken by them cannot be allowed to affect the ALP of the international transaction undertaken by the assessee in India - the overall loss incurred by group companies as a whole can never be a criteria to desist from making any TP adjustment, which is otherwise called for as per the statutory provisions under the Act. Exclusion of Fortune Infotech Ltd from the list of comparables – Held that:- There can be no fetters on the assessee in claiming before the authorities that a particular company was inadvertently included in the list of comparables - mere making of a claim of incomparability does not automatically lead to exclusion - If a company, which is actually not comparable, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and voice based customer care services worth ₹ 9,78,563,935/-. To demonstrate that this international transaction was at Arm s Length Price (ALP), the assessee selected Transactional Net Margin Method (TNMM) as the most appropriate method with the Profit Level Indicator (PLI) of Operating Profit to Total cost (OP/TC). As against its PLI at 5.62%, the assessee showed weighted PLI of seven comparable companies at 9.18%. The Transfer Pricing Officer (TPO) did not treat two companies as comparable, namely, Mapro Industries Ltd. and Nucleus Netsoft and GIS India Ltd., for the reasons given in his order. He worked out OP/TC of the remaining five companies at 18.46%, which resulted into eventual addition on account of Transfer pricing adjustment amounting to ₹ 13,40,26,353/-. 3. The assessee challenged the said addition of ₹ 13.40 crore before the ld. CIT(A). After considering various objections raised by the assessee, the ld. CIT(A) held that the only current year s data was to be used; the two companies excluded by the TPO were liable to be included in the list of comparables; one company, namely, Giltedge Infotech Services Ltd., was not comparable; arithmetic mea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll. 5.3. As this issue has been taken up before us for the first time, we consider it expedient to verify the veracity of the assessee s contention about it charging depreciation at higher rates in comparison with its comparables. The question of adjudicating such issue would arise only if there, in fact, exists some difference in the rates at which the assessee charged depreciation vis-a-vis its comparables. In this regard, it is noticed that the assessee charged depreciation in its Profit Loss account to the tune of ₹ 19,49,90297/-. Schedule of Fixed assets is available on page 115 of the paper book, indicating Opening balance of the assets, Additions, Disposals/ adjustments and Closing balance. Similarly, the amount of Opening depreciation, Disposal/adjustments and Depreciation for the year under consideration have also been given. It can be seen from Note 2(a) of Notes to the Financial statements , a copy of which is available on page 112 of the paper book, that: Depreciation on fixed assets is provided pro-rata to the period of use, based on the straight-line method at the rates specified in Schedule XIV of the Companies Act, 1956, or based on the management s ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eas the assessee charged depreciation at an enhanced SLM rate of 33.33%. In like manner, Motor vehicles have been depreciated by the assessee at 33.33% on SLM, as against the SLM rate of depreciation on Motor vehicles under the Schedule at 9.50%. This shows that the assessee charged depreciation in its Profit Loss account at the SLM rates higher than those provided in the Schedule XIV to the Companies Act. 5.6. Now let examine the rates at which the comparable companies provided depreciation in their respective P L accounts. The ld. AR submitted that the rates of depreciation charged by Mapro Industries Ltd. and Karvy Consultants Ltd. in comparison with the rates prescribed under Schedule XIV of the Companies Act may be taken as correct, without any further need for adjustment. Taking us through the Annual report of Apex Logical Data Conversion Pvt. Ltd., it was shown that this company provided depreciation on their fixed assets at the SLM rates given at page 813 of the paper book. On a perusal of the rates on which depreciation has been charged by this company under SLM, it can be seen that albeit some of the depreciation rates accord with those prescribed in Schedule XIV, bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or the initial years gets neutralized with the resultant lower amount of depreciation for the later years, thereby ultimately having no impact on the overall profitability in long run. He relied on certain decisions, which we will shortly advert to, for bolstering his submission in this regard. 5.10. The primary question which falls for our consideration is whether any adjustment to the operating profits can be made on account of the difference in the rates of depreciation on various assets. In order to find an answer to this question, it is relevant to note the mandate of Rule 10B(1)(e), which embodies the modus operandi for determining the ALP of an international transaction under TNMM, as under : - (e) transactional net margin method, by which, (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uired to be adjusted in such a manner so as to bring both the international transaction and comparable cases at the same pedestal. In other words, if there are no differences in these two, then the net operating profit margin of the comparable companies should be considered as a benchmark, but in case there is some difference, then such difference should be ironed out by making suitable adjustment to the operating profit margin of the comparables. That is the way for bringing both the transactions, namely, the international transaction and the comparable uncontrolled transaction, on the same platform for making a meaningful and effective comparison. 5.12. Now the moot question is as to whether variation in the rates of depreciation can be considered as a relevant factor necessitating adjustment in the operating profit margin of the comparables. The ld. DR relied on DCIT VS. Sumi Motherson Innovative Engineering Ltd. (2014) 150 ITD 195 (Delhi) and some other decisions to bring home his point of view of not carrying out any adjustment on account of difference in depreciation. 5.13. There can be no dispute on the principle that calculation of Operating profit as envisaged unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the need for making any adjustment on account of higher or lower amount of individual items of expenses and incomes. Merely because the amount of depreciation of one enterprise is more or less than the other, can never be a reason to seek adjustment. Such higher amount of depreciation may be due to large scale of the company and host of other factors. By considering percentage of operating profit margin under the TNMM of the assessee as well as comparables, the higher or lower volume of two companies becomes immaterial and so is the quantum of depreciation. The nitty-gritty of the matter is that no adjustment can be allowed simply for the reason that one company has charged higher amount of depreciation vis-a-vis its comparable companies. Not only no adjustment on this score is permissible, the assessee cannot also seek an exclusion or inclusion of a company on the ground that the ratio of its depreciation to total expenses is more or less in comparison with comparables. It is so for the reason that such higher percentage of depreciation to total expenses is marginalized by the lower percentage of repairs and other incidental costs of the assets and vice versa. 5.14. Howev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing aside other related and consequential items, such as repair costs etc., then the results are likely to be distorted. It was further observed that to ask for adjustment, it is essential that there should be some independent and substantial reason. It was held that : In the context of depreciation, one can rightly appreciate the need to make adjustment, if rate of depreciation charged by the assessee vis-a-vis its comparables is different. But the simplicitor difference in the amount of depreciation is inconsequential. 5.16. Almost similar proposition has been laid down by the Delhi Bench of the tribunal in Nokia India (P) Ltd. VS. DCIT 2014-TII-224-ITAT-DEL-TP by disapproving the exclusion of some companies on the strength of the filter of lower or higher depreciation as a percentage of total costs. In so holding, it observed that the higher amount of depreciation is usually coupled with the lower repair cost etc., and vice versa. That is how, it held that : there can be no justification in applying the filter of rejecting the companies with depreciation higher or lower than a particular percentage of total costs. . It is, thus, overt that these two cases relied by the ld. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s more not due to higher value of the assets employed by one company but due to higher rates of depreciation. Whereas, the first situation would not call for any adjustment, the second one would warrant adjustment in the operating profit of the comparable company. That is where Rule 10B(1)(e) (ii) (iii) read with Rules 10B(2) (3) come into play for neutralising the difference in the operating profits of the two otherwise comparable companies by making a reasonably accurate adjustment ... to eliminate the material effects of such differences . 5.19. Now the next question is as to in whose hands the above adjustment should be allowed. The ld. AR argued that the excessive rate of depreciation charged by the assessee should be lowered to the rates as prescribed under Schedule XIV to the Companies Act so as to bring a parity between the rates of depreciation charged by the assessee vis-a-vis its comparables. This contention in our considered opinion, is not tenable. It has been noticed above that Rule 10B(1)(e)(iii) contemplates the making of adjustment to the net profit margin of the comparables determined under sub-clause (ii) to Rule 10B(1)(e). Even Rule 10B(3) also requires ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iding depreciation on SLM in the hands of comparables at the higher rates, at par with the assessee s, would distort the comparison. He explained his point of view by stating that no doubt with the increase in the rates of depreciation of the comparables for the current year at par with the assessee, would achieve comparability, but this would adversely affect the calculation of operating profit of the comparables because of the inclusion of proportionate depreciation also on the assets which still appear in their books but actually depreciated fully due to parity with the assessee s higher rates of depreciation. It was explained with the help of an example in which the assessee is charging depreciation under SLM at the rate of 33.33% on a particular asset considering the useful life of three years, as against the comparables providing depreciation on similar asset under SLM at the rate of 16.21% by impliedly considering its useful life a little over six years. He explained that the comparable company providing depreciation at 16.66% on SLM would continue to hold assets in 4th, 5th and 6th year as well and the amount of depreciation in these three years will also be at 16.21% despi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ii) the actual cost of any asset falling within the block of assets acquired during the previous year. It is this excess which is deemed to be the capital gains arising from the transfer of short-term capital assets. Second is the situation in which any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year. In such a situation, the cost of acquisition of the block of assets is taken as the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year. The income received or accruing as a result of such transfer or transfers is deemed to be the capital gains arising from the transfer of short-term capital assets. A careful perusal of the above provisions deciphers that the individual assets on their purchase merge with other assets of that block, thereby losing their separate identity. Depreciation is provided on the basis of the written down value of such block and not the w.d.v. of such individual assets. Even the event of their transfer also does not lead ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... including any excess referred to in the proviso to section 350 of the written-down value of any asset which is sold, discarded, demolished or destroyed over its sale proceeds or its scrap value. Proviso to section 350 provides that: if any asset is sold, discarded, demolished or destroyed for any reason before depreciation of such asset has been provided for in full, the excess, if any, of the written-down value of such asset over its sale proceeds or, as the case may be, its scrap value, shall be written off in the financial year in which the asset is sold, discarded, demolished or destroyed. 5.22.4. On a reading of sections 349 in conjunction with section 350 of the Companies Act, it emerges that depreciation on each asset is separately provided at the rates specified in Schedule XIV for the purposes of the determination of profit. If an asset is sold or discarded before providing full depreciation on it, then the excess of the w.d.v. of such asset over its sale price/scrap value, to the extent provided, shall be written off in the financial year in which the asset is sold or discarded. In the converse situation, where the amount for which any fixed asset is sold exceeds th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rded. Ordinarily, no company would continue to hold obsolete assets. Once an asset is sold after its useful life, the company will write off the unamortized depreciation in the year of its sale or discarding, by considering its sale price and w.d.v. and hence it would cease to appear in the books of account. Once it does not appear in the books of account, there can be no question of any depreciation on it in the later years as has been put forth on behalf of the Revenue. Continuing with the example given by the ld. DR, we find that the particular asset on the completion of its useful life of three years would become obsolete in fourth year and sold/discarded by the company and the short-fall in the amount and depreciation charged over its cost would be accordingly written off in its accounts. In such a situation, that particular asset with useful life of three years would cease to appear in the Schedule of fixed assets of the comparable company at the end of fourth, fifth and sixth years respectively, As such, no value of such assets will be available for depreciation in the next year(s). 5.23. Turning to the facts of the instant case, we find that the method of charging deprec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... make suitable adjustment to the profits of the comparables. II. RISK ADJUSTMENT 6.1. The ld. Counsel contended that the assessee undertook no risks or minimal risks while rendering services to its AEs under this segment, in contrast to the risks undertaken by the comparables finally selected. Taking us through the Transfer pricing study report conducted by the assessee, the ld. AR submitted that the assessee is a captive BPO service provider immune to any risks. It was put forth that its foreign AE undertakes all the risks relating to marketing in identifying the prospective customers in the US; entering into contracts with the clients for the provision of the agreed services; undertaking responsibility for the quality of the services provided by the assessee; and for the accuracy of the information conveyed to customers. In contrast to minimal or no risks undertaken by the assessee in providing such services, the ld. AR submitted that the comparable companies are full risk bearing entities and accordingly risk adjustment was required to be allowed. On the other hand, the ld. DR opposed this contention. 6.2. After considering the rival submissions and perusing the relevant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of the assessee, which contention came to be rejected by the ld. CIT(A), the ld. AR has placed no material on record worth the name to indicate the level of risks undertaken by the comparable companies. There is hardly any need to accentuate that it is for the assessee to place on record material indicating differences in its international transaction and comparables, if it seeks any adjustment on such account. Only when such differences are pointed out, that the authorities can proceed to calculate the effect of such differences on the operating profit margins of the comparables. Reverting to the facts of the instant case, we find that the submission made by the ld. AR that the assessee is a captive unit not undertaking any risks vis-a-vis its comparables, is partly incorrect and partly unsubstantiated. As we have noticed above that the assessee has also undertaken business/capacity/foreign exchange fluctuation risks, the contention that the assessee did not bear any/minimal risks, does not merit acceptance. The other part of the argument about the comparables undertaking much more risks, is not substantiated with any worthwhile evidence. In such circumstances, we are unable to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome methods have been prescribed for this purpose. All the methods provide mechanism for the determination of ALP of an international transaction. There is no reference whatsoever in the entire transfer pricing legislation for restricting the arm s length price of an international transaction or the amount of transfer pricing adjustment by viewing the overall profitability of all the entities of the group taken together. Such a contention put forth on behalf of the assessee does not stand to any logic because Chapter-X of the Act provides for computation of income from an international transaction having regard to its ALP. Neither any section of Chapter-X nor any Rule prescribes an upper limit for restricting the TP adjustment as determined in the manner laid down in Rule 10B, to the level of the overall profitability or loss of the group as a whole. In the absence of any such provision set out in Chapter-X for limiting the TP adjustment to the loss at the group level, we are constrained to accept this argument. 7.3. Further, we find logic in the legislature not providing such a provision capping the ALP/TP adjustment. It is quite possible that some of the associated enterprises ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n. 8.2. After considering the rival submissions and perusing the relevant material on record, we hold in principle, that there can be no fetters on the assessee in claiming before the authorities that a particular company was inadvertently included in the list of comparables. Eventually, it is for the TPO to consider the argument and then decide whether it is comparable or not. The mere making of a claim of incomparability does not automatically lead to exclusion. If a company, which is actually not comparable, but was inadvertently included by the assessee in the list of comparables, the same is liable to be excluded. 8.3. Turning to the facts of this company, we find that the ld. AR has harped on higher OP/OC margin of this company for the year under consideration at 108%, in contrast to 67% for the preceding year and 39% for the succeeding year to contend for its exclusion due to abnormal profits. In our considered opinion, the year in question cannot be considered as abnormal when viewed in the light of the fact that its profit rate has progressed from the preceding year. The decline in the profit rate for the succeeding year is due to the reasons given by the company in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing interquartile range, which is also called middle fifty, the Indian legislation stipulates for calculating arithmetic mean of price/profit of all the otherwise comparable companies. Simply because the profit rate of a company is higher or it has a higher turnover, can be no reason to seek exclusion. This has been held by the Delhi bench of the tribunal in the case of Nokia India (supra). 8.5. In view of above discussion, we are of the considered opinion that Fortune Infotech Ltd. is a comparable company warranting its inclusion in the list of comparables. The contrary contention of the ld. AR in this regard is rejected. 9. Having dealt with all the issues raised by the ld. AR on the addition towards transfer pricing adjustment, we set aside the impugned order on this issue and send the matter back to the TPO/AO for making a fresh determination of the ALP under this segment in conformity with our above observations and conclusions, after allowing a reasonable opportunity of hearing to the assessee. 10.1. Ground Nos. 16 and 17 of the assessee s appeal are against the sustenance of disallowance of provision of expenses amounting to ₹ 32,08,612/-. 10.2. Briefly sta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his ground of appeal is allowed. 11. The last ground about charging of interest is consequential. 12.1. The only issue raised by the Revenue in its appeal is against the deletion of addition of ₹ 40,50,472/-, being rent equalization reserve included in the provision for expenses amounting to ₹ 5.18 crore. The claim of the Revenue is that this amount is not in the nature of expense. 12.2. After considering the rival submissions and perusing the relevant material on record, we find that this issue is no more res integra in view of the judgment of the Hon ble jurisdictional High Court in CIT vs. Virtual Soft Systems Ltd. (2012) 205 Taxman 257 (Del), in which it has been held that the lease equalization charges debited to the Profit Loss Account cannot be disallowed. Similar view has been taken by the Hon ble Karnataka High Court in Prakash Leasing Ltd. Vs. DCIT (2012) 208 Taxman 464 (Kar). In view of the above judicial precedents, we uphold the view taken by the ld. CIT(A) in deleting this addition. This ground fails. 13. In the result, the appeal of the assessee is partly allowed and that of the Revenue is dismissed. Order pronounced in the open Court on ..... X X X X Extracts X X X X X X X X Extracts X X X X
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