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HCL Technologies BPO Services Ltd. Versus ACIT, CC-2, New Delhi

2015 (7) TMI 477 - ITAT DELHI

Transfer Pricing Adjustment - CIT(A) restricted addition - selection of comprables - Held that:- CIT(A) had followed the ratio laid down in the case of Global Ventedge P. Ltd. (2009 (12) TMI 668 - ITAT DELHI ) wherein held that adjustment on account of arm's length price of international transactions cannot exceed the amount received by the associated enterprise from the customer and the actual value of international transactions, i.e., the amount received by the assessee in respect of internati .....

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e calculating operating cost, the abnormal cost incurred on account of start-up should be excluded. Following the same parity of reasoning in the cases cited by him and keeping in view that the judgement of ITAT co-ordinate Bench in the case of Transwitch India (2012 (5) TMI 314 - ITAT DELHI) affirmed by Hon'ble Delhi High Court. Therefore, respectfully following the decision of Hon'ble High Court, we direct TPO / A.O. to adjust operating cost by excluding abnormal cost incurred on account of st .....

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, Sr. DR ORDER PER INTURI RAMA RAO, AM: These are cross appeals filed by assessee company in I.T.A. No. 3547/Del/2010 as well as Revenue in I.T.A. No. 5071/Del/2010 for the Assessment Year 2003-04. These appeals involve the issue of Transfer Pricing Adjustment (TPA) for the Assessment Year 2003-04. The Revenue had come up with the present appeal challenging the order of Ld. CIT(A) that the TPA should be restricted to gross revenue receipt by the associate enterprises from its customers. 2. We fi .....

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facts as he has failed to appreciated the fact that when the com parables were making average profit @ 13.56% then the assessee would have earned the same profit in international transactions? 3. The brief facts of the case are that the appellant is a private limited company and is engaged in providing IT Enabled Services (ITES) e.g. voice/web based contact and front office services (hereinafter referred as business process outsourcing (BPO) services). For the relevant previous year, the return .....

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nt were computed as follows: Operating income 209,032,558 Less: Operating expenses Personnel expenses 13,38,59,484 Administration selling & other expenses 15,13,90,147 Finance charges 7,68,060 Depreciation 4,42,53,507 Miscellaneous expense written off 37,71,203 Total Operating Cost 33,40,42,401 Operating profit 12,50,09,843 Operating profit ratio (-)37.34% 4. The assessee had conducted transfer pricing analysis by using multiple year data of previous financial year in which data of the 3 yea .....

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Profit Level Indicator ("PLI"), i.e., Operating Profit /Total Cost of the comparable companies for the financial years 2001-02 and 2002-03, as under: S. No. Name of the Company Margins (OP/TC) Weighted average 2003 2002 1. Ace Software Exports 11.64% 17.63% 14.88% 2. Allsec Technologies Ltd 12.55% 9.53% 11.65% 3. Apex Logical Data 14.30% 22.26% 17.80% 4. Compudyne 0.18% Winfosystems Ltd. 52.78% 20.05% 5. Fortune Infotech Limited 107.46% 68.03% 96.87% 6. Nucleus Netsoft and GIS India Li .....

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years was computed as 14.09%. The weighted operating" profit on total cost margin of 14-.09% during the abovementioned financial ears, being higher than that of the comparable companies at 13.56%, the "international transactions" of rendering business process outsourcing services were considered being at arm's length. 7. On noting of above transactions, the A.O. made reference to transfer pricing officer. The Transfer Pricing Officer (TPO), however, in his order held that the .....

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h price Amount Total operating cost ₹ 33,40,42,401 Arm's length margin 13.56% Profit which the appellant would have earned ₹ 33,40,42,401 13.56% ₹ 4,52,96,150 Less: Operating loss posted by the appellant Rs. (-)12,50,09,843 Difference Rs.17,03,05,993 8. The TPO held in this regards as follows: "6.0 In the transfer pricing approach the assessee has used data for five financial years out of which data of three years is on actual basis and for two years on projected basis .....

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oraneous 'and drily in exceptional circumstances data for two prior years can be used along with data for the year under consideration. In fact all the provisions emphatically and with no ambiguity cast an obligation of benchmarking transaction on the basis of information as close as possible to the year in which the with the AE(s)' has been entered into international transaction. IT is understandable that since in. modern economics situations change so fast, use of non contemporaneous d .....

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shrined in proviso to the above said rule deserving use of financial data for the multiple year. Therefore, the approach of the assessee in respect of use of multiple year data of comparables is not disturbed. It is also not out of place to mention that the comparables used by the assessee company has functional and product differences with the assessee company but for the year under consideration these comparables are not being disturbed for the reasons that the assessee company has apparently .....

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the comparables the approach of the assessee for the year under reference is not disturbed being the start up phase. The eight comparables adopted by the assessee for Transactional Net Margin Method are accepted for year under consideration only for the specific reasons mentioned above. 9. The A.O. based on the report of TPO made addition of ₹ 17,03,05,993/- on account of transfer pricing adjustment. Aggrieved by the said order appeal was filed before Ld. CIT(A). However, Ld. cia accepted .....

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ed by AE Amount INR Net amount remitted to HCL-BPO HCL-AMERICA 71,073,269 15,507,867 431,660 7,107,327 - 28,650 10% 0% 7% 63,965,942 15,507,867 403,010 Sub Total 87,012,796 7,135,977 79,876,819 HCL T NI 23,280,234 2,328,023 10% 20,952,210 Infosystem America 5,412,892 541,289 10% 4,871,603 Infinet Acquisition Revenue 18,796,957 1,879,696 10% 16,917,261 HCLT Europe 7,547,211 75,472 1 % 7,471,739 Grand Total 142,050,089 11,960,457 130,089,632 11. Without prejudice to the assessee company s contenti .....

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32. The total revenue received by the associated enterprises in respect of BPO services rendered by the appellant amounting to ₹ 13,00,89,632 is ₹ 14,20,50,089. In other words, the associated enterprise has retained ₹ 1, 19,60,457 out of the total proceeds received from the customers. The adjustment computed by the TPO in the order passed under section 92CA(3) of the Act at best cannot exceed the net amount retained by the associated enterprises in respect 'of international .....

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edge P. Lid., wherein, the Tribunal held that adjustment on account of arm's length price of international transactions cannot exceed the maximum arm's length price, i.e., the amount received by the associated enterprise from the customer and the actual value of international transactions, i.e., the amount received by the assessee in respect of international transactions. 12.4 In view of the same I am of the considered view that the adjustment to the income of the appellant has to be res .....

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ppellant were to be obtain the contracts for services from the customers directly, i.e., without the involvement of the AEs of the appellant. Thus, at the most the consideration received by the appellant from the AEs may be replaced by the consideration received by the AEs from its customers, for the services provided by the appellant; the price charged by AEs to the customers being the CUP. Reliance is placed in this regard on the decision of the Hon'ble Delhi High Court in the case of Sony .....

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's length price as if is referred to in the present context) and in turn the subsidiary is able to avoid, partly or wholly, payment of the local tax, Alth9ugh the expression "transfer price" has not been defined in the Act,' it is 'understood to mean "that price which is arrived at when two associated or related' enterprises deal with each other". 14. Reference was made to the Finance Minister s Budget Speech for the year 2001 that the presence of multinationa .....

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id., (ITA No. 1432 & 2321/0ell2009 and 116/0eI/2011), wherein, the Hon'ble Tribunal held that adjustment on account of arm's length price of international transactions cannot exceed the amount received by the associated enterprise from the customer and the actual value of international transactions, i.e., the amount received by the assessee in respect of international transactions. The Hon'ble Jurisdictional High Court vide order dated 14-03-2013 (in ITA Nos. 1828/2010, 1829/2010 .....

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ourt recently vide order dated 16-12-2013 (in ITA No.306/2012), while adjudicating on the said decision of the Tribunal, held in paragraph 40 of the order that "the approach of the TPO arid the tax authorities in essence imputes notional adjustment / income in the assessee's hands on the basis of a fixed percentage of the free on board value of export made by unrelated party vendors. " ..... 18. Reliance in this regard is also placed on the recent decision of Delhi Bench of the Tri .....

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fit in the hands of the AE, there is no case of shifting of profits, practicable or probable. Invoking a higher ALP on the appellant is only anticipatory and complete ignorance of fact. The facts and figures produced before the Ld. TPO establish that there is no commercial profit available in the hands of the AE. In absence of profit availability, the any enhancement of the ALP results in artificial profit anticipated by the Ld. TPO and not earned by the Appellant. The order of the LD, TPO in en .....

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der: '77. As a concept and principle Chapter X does not artificially broaden, expand or deviate from the concept of "real income". "Real income", as held by the Supreme Court in Poona Electricity Supply Company Limited versus CIT, [1965J 57 ITR 521 (SC), means profits arrived at on commercial principles, subject to the provisions of the Act. Profits and gains should be true and correct profits and gains, neither under nor over stated. Arm's length price seeks to corre .....

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icing is an income allocating exercise to prevent artificial shifting of net incomes of controlled taxpayers and to place them on parity with uncontrolled, unrelated taxpayers. The exercise undertaken should not result in over or double taxation. Thus, the Assessing Officer/TPO can segregate AMP expenses as an independent international transaction, but only after elucidating grounds and reasons for not accepting the bunching adopted by the assessed, and examining and giving benefit of set off. S .....

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was followed in subsequent decisions as submitted earlier and, therefore, the order of Ld. CIT(A) on this issue is reasonable and we do not find any reason to interfere with this finding of Ld. CIT(A) and hence, the grounds of appeal filed by revenue are dismissed. Accordingly, appeal filed by revenue is dismissed. I.T.A.No. 3547/Del/2010: 22. Now, we deal with the appeal filed by assessee in I.T.A. No. 3547/Del/2010. The assessee has raised following grounds of appeal: 1. That the learned Comm .....

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of 5 years (including the impugned financial year) of business cycle and then comparing the same with the arithmetic mean of the companies selected as comparable companies for applying the TNMM as the most appropriate method is in conformity with the well established OECD guidelines in case of Start-up Companies. 3. That the learned Commissioner of Income-tax (Appeals) erred in failing to appreciate that since the appellant was a start up enterprise and the impugned financial year was effective .....

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art of the appellant to divert its profits outside India. 5. That, without prejudice, the learned Commissioner of Incometax (Appeals) erred in concluding that the TPA has correctly not allowed the variation to the extent of (+1-) 5%, while determining the arm's length price of the international transactions, in the case of the appellant. 23. The main grounds raised by the assessee in its appeal relate to the adjustment of operating profit as well as selection of comparables. During the cours .....

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relevant previous year, i.e. previous year 2002-03 was, thus, the first full year of operation of the BPO unit of the appellant. It is submitted that during the previous year 2002-03, the appellant was a start up enterprise, due adjustment ought to be made of the start-up/ one-time costs incurred, which inevitably lead to losses. It is submitted that operating profit/ loss of the appellant for the relevant previous year are required to be adjusted to exclude items of abnormal cost / short fall .....

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ct / Indirect 18,26,67,573 Infinet Acquisition 1,69,17,261 WIP 94,47,723 Total Sales 20,90,32,557 22,77,90,205 (1,87,57,647) Salary 13,38,59,483 10,45,16,279 2,93,43,204 64% 50% 14% Dep 4,42,53,507 2,29,93,581 2,12,59,926 21% 11% 10% OAG 15,13,90,147 8,49,41,671 6,64,48,476 72% 41% 32% Finance Charges 7,68,060 7,68,060 - 0% 0% 0% Misc. Exp. W /0 37,71,203 37,71,203 - 2% 2% 0% Total Cost 33,40,42,402 21,69,90,796 11,70,5t,606 160% 104% 56% Operating (12,50,09,844) 1,07,99,409 (13,58,09;254) Profi .....

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margins of the appellant. 28. Rule 10B(3) of the Rules provides that an appropriate adjustment is required to be made to account for the differences between the controlled and uncontrolled transactions: "An uncontrolled transaction shall be compara.ble to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in .....

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the assessee with respect to idle capacity adjustment during the relevant period while determining the ALP cost. The relevant extract of the decision reads as under: "We are of the considered view that under-utilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production. In view of the above, .....

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the Tribunal in the case of Amdocs Business Services Pvt. Ltd. vs. DCIT (ITA No. 14212/PN/11), wherein, the Tribunal allowed economic adjustment on account of under capacity utilization holding that the appellant was in start up phase during the assessment year consideration. The relevant extract of the decision is reproduced as under: "9. The next major point made out by the appellant is that this being the first full year of operation, the assessee had incurred certain expenditure which .....

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ase, is not something which is unreasonable and neither it is otiose to the mechanism of transfer pricing assessments. In fact, in principle, the plea of the assessee is in line with the decisions of the Tribunal in the, case of Global venttedge P. Ltd v. DCIT in ITA Nos. 1763-2764IDel/09 (Del); Brintons Carpets' Asia (P) Ltd v. DCIT 139 TT J -177; and, Skoda, Auto India P. Ltd. v. A CIT 122 TT J 699. In our view, the matter requiring factual appreciation, the same is remanded back to the fi .....

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on reads as under: "10. -We have heard the rival contentions and perused the material available on record. The suitable adjustment for non-utilisation of capacity is to be taken in to account after considering the ALP while working out TP adjustment, this proposition has been held by coordinate Bench in the case of the Amdocs Business Services (P.) Ltd. (supra) and various other cases as cited here in above . 11. In the given facts and circumstances it was required on the part of the lower .....

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king order will be passed deciding the issue in accordance with law." 32. Reliance in this regard is placed on the following observation of the Hon'ble Mumbai Bench of the Tribunal in the case of ACIT vs. Fiat India Pvt. Ltd (ITA no 1848/Mum/2009): "As rightly held by the Id. CIT(A), the said submission made by the appellant is sufficient to demonstrate that there was a material difference in the facts of the appellant's case and that of the comparable cases in terms of capacit .....

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e (iii) above to make the adjustments. Such adjustments are necessary only to remove or minimize the differences in the comparable or anomaly in' the said comparable. -Such adjustments are authenticated by the OECD guidelines too. In this regard, we have perused the important findings of the Tribunal in the case of the Fiat India P Ltd (supra) placed at page 191 of the paper book. For the sake completeness, the same is reproduced as under. …….as regards the adjustments made by .....

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Y 2002- 03, 2003-04 as well as in the immediate succeeding years i.e. 2005-06 and 2006-07 wherein the facts involved were similar to that of the year under consideration i.e. AY 2004-05; + accordingly, no infirmity is found in the impugned order of the CIT(A) as the adjustments made by the appellant in TNMM analysis were reasonable and accurate and as reflected in the said analysis, international transactions made by the appellant company with its associated concerns during the year under consid .....

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ores '(rounded off), fixed cost versus the variable cost etc as they' summarily rejected the external comparables in view of their preference to the operating profits of the domestic segment of the carpets. •Therefore and consequently, this key issue also has to be set aside to the files of the' TPO/AO for fresh examination of the issue. Prima facie we see the need for such economic adjustments to the total cost of the carpet of the export segment. We refuse to comment on the fa .....

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Also, in the case of E.I. Dupont India Pvt. Ltd. vs. DCIT (ITA No 5336/0/2010), the Hon'ble Delhi Bench of the Tribunal, while allowing the adjustment for capacity utilization held that ; "It is a matter of fact that fixed costs remain the same even when there is under utilization of capacity. Therefore, the case of the appellant and the comparable cases have to be examined in respect of capacity utilization so as to make the controlled and uncontrolled transactions comparable." Al .....

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ame time, it is a/so held that suitable adjustment has to be made to such PLI in respect of idle capacity." 35. Further, the Hon'ble Bangalore bench of the Tribunal in the case of Genisys Integrating Systems (India) Pvt. Ltd vs. DCIT (ITA No 1231/Bang/2010) the Hon'ble Tribunal held as under: "The appellant should also be given adjustment for under utilization of its infrastructure. The AO shall consider this fact also while determining the ALP find make the TP, adjustments. Wi .....

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demonstrating the fall in its capacity utilization during the quarter January to March, 2006. The capacity utilization, of the appellant during the quarter January to March, 2006 fell to i2% as' against the normal capacity utilization of 87% to 94% during the financial year ending December, 31, 2005. Further, the fact that the appellant had to shift its office premises at a very short notice, sufficiently substantiates the low capacity utilization of the appellant during the last quarter of .....

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o. 4620/0eI/2011), wherein the Hon'ble Bench has held that capacity underutilization is an important factor affecting net profit margin as lower capacity utilization results in higher per unit costs which in turn results in lower profits. The relevant finding of the decision reads as under: "5. Having heard the rival contentions and having perused the material on record, we see no reasons to interfere in very well reasoned findings and directions of the learned CIT (A). Rule 10B (1 )(e) .....

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