TMI Blog2018 (12) TMI 1563X X X X Extracts X X X X X X X X Extracts X X X X ..... sshra, Accountant Member For the Assessee : Sh. H.P. Aggarwal, FCA, and Ms. Prashuka Jain, CA For the Revenue : Sh. Sanjay I. Bara, CIT (DR) ORDER PER: ANADEE NATH MISSHRA, AM This appeal by the Assessee is filed directed against the Assessment Order dated 04-12-2014 passed by the Assessing Officer U/s 154/143(3) r.w.s. 144C of the Income Tax Act, 1961 (for short the Act ). The grounds of appeal are as under:- i. The learned DCIT(after incorporating Ld. DRP s order) has erred on facts and in law in making addition of ₹ 3,20,93,274/- on account of adjustment in value of international transaction, on account of following: a) Selecting 2 new comparable companies b) Rejecting 4 comparable companies selected by the assessee c) Rejecting adjustment in margin due to different risk profit of comparable companies ii. The learned DCIT (after incorporating Ld. DRP s order) has erred on facts and in law in initiating penalty proceedings u/s 271(1)(c) iii. The appellant craves leave to add to or modify the above grounds of appeal at or before the hearing of the appeal. (1.1) The Assessee has also filed an Additional Ground of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee s TP Report, the assessee selected eight comparables, and summary of the results as submitted by the assessee are as under: Particulars Amount Operating Revenues 250,055,514.60 Operating Expenses 223,767,775.99 Operating Profit 26,287,738.61 OP/OC 11.75% Method used TNMM PLI OP/OC No of Comparables 8 Mean Margin of Comparables 14.45% (2.3) The arm's length price of the international transactions representing Provision of Technical Support services provided to the associated enterprises (AE) was determined by the assessee by applying Transactional Net Margin Method (TNMM), which was stated by the assessee to be the most appropriate method in the facts and circumstances of the case. The operating profit to total cost (OP/TC) ratio was taken as the profit level indicator (PLI) in the TNMM analysis. The PLI of the company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty transactions, Rejected An appropriate fitler. In the aforesaid show cause notice, the TPO proposed the following filters: Companies whose Technical Support service income Companies whose revenue from Technical Support service is less than 75% of the total operating revenues are excluded. The companies whose revenues from Technical Support service and related services are more than 75% of their operating revenues are selected as comparables. According to the TPO, this was an appropriate filter as this is the stage which will determine the correct comparability. As per TPO, In respect of enterprises whose main source of income is from service segment, the companies whose income from TECHNICAL SUPPORT SERVICES comes to more than 75% of the operating revenues have been considered for the study as the other segment may not materially affect the financial results of the company. Companies having different financial year ending (i.e. not March 31, 2009) or data of the company does not fall within 12 month period i.e. 01-04-2009 to 31-03-2010, are rejected. As per TPO, If a tested party ends its financial year in March, then tak ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Hence, not a suitable comparable. Rejected 2 Mukund Engineers Limited This company is functionally different from the taxpayer. Hence, not a suitable comparable. Rejected 3 Petron Engineering Constructions Limited This company is engaged in 'Construction contract/projects' which are functionally different from the taxpayer. Hence, not a suitable comparable. Rejected 4 Project and Development India Limited This company is having controlled by the government Hence, can't be considered as a suitable comparable. Rejected 5 Simon India Limited This company is engaged in 'Construction contract which are functionally different from the taxpayer and fails service filter also. Hence, not a suitable comparable. Accepted 6 TCE Consulting Engineers Limited The company passes all the filters proposed by the TPO. Accept ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2 TCE Consulting Engineers Limited 25.88 3 Engineers India 67.77 4 Mukand Engineers Limited 12.87 5 Project and Development India Limited 23.09 6 UB Engineering Limited 9.71 AVERAGE 26.33 (2.9) Proposed Computation of ALP, and proposed Transfer pricing adjustments , as per aforesaid show cause notice of TPO are as under : Operating Cost 223,767,776 Arm's Length Price at a Margin of 26.33% 282,685,831 Price Received 250,055,515 105% of International Transaction 262,558,290 Proposed Adfustment u/s 92CA 32,630,317 (2.10) The assessee made a reply to the show cause notice. The reply was considered by the TPO and discussed with assessee s Authorised Rep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bench in the case of Deloitte Consulting India Pvt. Ltd in which it was held that no two comparable companies can be replicas of each other. The application of Rule 10B should be carried out and judged not with technical rigor, but on a broader prospective. Considering these facts and the fact that the taxpayer itself has not gone into the verticals or high end or low end distinction while selecting the comparables and for this very reason selected TNMM as the most appropriate method, the TPO held that it cannot now argue against some of the comparables on this ground. The TPO mentioned that the taxpayer has selected companies operating in various verticals and that TPO has also selected comparables which are broadly engaged in the field of Technical Consultancy engineering services. The TPO observed that out of 08 comparables selected in its TP report, 04 comparables were accepted by TPO and even the other 2 comparables further selected are from the search matrix of the assessee. (2.10.2) Regarding filters selected by the assessee but rejected by the TPO Filters of marketing expenses 3% of total sales: The taxpayer applied this filter whereby companies with t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... % on R D were necessarily creating IP products. The TPO was of the view that there were other quantitative filters which would more appropriately segregate companies which were rendering comparable services as that of the assessee. In the absence of any supporting data, R D expenditure @ 3% of the turnover cannot be considered as creating any significant economic intangibles; the TPO held and observed that rejection of this filter does not have material impact in the case of the assessee. (2.10.4) Regarding Comparables selected by the assessee but rejected by the TPO. The TPO started with a general discussion, stating that it is seen that taxpayers argue against or for a company based on the certain keywords rather than seeing the main activity of the company; that every company tries to put its best face both in its website as well as in annual report; that any person can pickup certain keywords from the website and annual report and may argue that it is providing a sophisticated service, has certain patents, has specialized in certain areas, has obtained excellence in certain area; that, however, what needs to be seen is whether that is the substantial activity of that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l Institutes (RI) located at Asansol/Dhanbad, Ranchi, Nagpur, Bilaspur, Singrauli Bhubaneswar and its headquarters at Ranchi. Seven Regional Institutes designated as RI-I to RI-VII rendered consultancy services to seven corresponding subsidiaries of CIL viz. ECL (RI- 1), BCCL (RI-Il), CCL (RI-111), WCL (RI-IV), SECL (RI-V), NCL (RI-VI), MCL (Rl- Vll). As per AR, the company is a subsidiary of Coal India Limited and is also providing services to seven other subsidiaries of Coal India Ltd; the TPO noted. Hence, the TPO held that all the transactions are related party transactions. (2.10.6) Petron Enqineerinq Construction Limited Assessee objected to the rejection of this comparable and submitted that this company is functionally similar to assessee as it is providing similar services as that of assessee. In this regard, as snap shot of P L Account was taken which is produced below:- As per TPO, the above data shows that the sources of revenue of this comparable company for the relevant year makes it evident that none of the work performed by this company like construction contracts is similar to assessee. Hence, this company can't be considered as suit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nover than that of taxpayer. Relying on his earlier general discussion; the TPO further r noted that M/s. Project and Development India Limited, a comparable selected by the assessee, is also a government company. As per TPO, Related Party Transactions (RPT) of the company is checked and it is within threshold limit. The TPO contended that all government contracts are being bid both by government and private companies on competitive basis and therefore there is no advantage to EIL on this account and that news items regarding the contracts of NTPC being bid competitively by BHEL, L T, BGR Energy make this point abundantly clear. On the issue of High turnover the TPO observed that the taxpayer's hypothesis that there is a direct corelation between turnover and profit margins of the company is not acceptable; that the Transfer pricing rules or the OECD guidelines do not prescribe any specific range of turnover for comparability corresponding to size and scale of operations; that once functional similarity is accepted, companies can be compared irrespective of the turnover, size or scope of operation particularly in the service industry where not much of infrastructure is needed t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he ITATs have accepted so called high margin comparables. For instance, the ITAT, Bangalore in the case of Sap Labs(2010-TII- 44-ITAT-Bang-TP), ITAT, Hyderabad in the case of Deloitte Consulting Pvt. Ltd. confirmed selection of high margin comparables for service industry. These decisions pertain to the service sector viz. Software development and ITES. In the case of Exxon mobil the ITAT upheld Alpha Geo India Ltd having margin of 47.79% and Vimta Lab having margin of 57.68%. In any case, as per TPO in comparability analysis loss or so called higher margin is not a determining factor unless there are any peculiar economic circumstances in such a case. As per TPO, in favour of loss making companies it is generally argued that such companies should not be rejected simply because they have incurred losses in a single year as loss making companies are as much part of industry as are profit making companies. As per TPO, the same logic is required to be applied to the cases having supernormal profit . Just like loss making companies, 'super* normal profit making companies are also part of the industry and hence cannot be rejected merely because they have earned such profits, unl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le and also not satisfying the requirement of Rule 10B read with Rule 10A as uncontrolled transactions. These are the reasons in support of their exclusion from the list of comparable cases and not because there was high loss in such cases. This elimination by itself would not support the omission of HT and DT, being the cases with extreme profit rate. The exclusion by the CIT(A) of these cases on the sole reason of high profits, is not sustainable. Before eliminating such cases from the count, it was incumbent upon him to show that such cases were incomparable on the basis Of relevant considerations and not the higher or lower profit rates. It is imperative to note that the list of 12 comparable cases was provided by the assessee and not something created by the TPO as per his own whims and fancies. When the list of comparable cases was furnished by the assessee, it was the turn of the TPO to find out whether such cases were, in fact, comparable or not and if not, then to exclude them after showing how these were not comparable; the decisive factors for determining inclusion or exclusion of any case in/from the list of comparables are the specific characteristics of services provi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liable data. The TPO referred to Paragraph 1.33 of the OECD guidelines, 2010 , in which it is stated : [.....] To be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or that reasonably accurate [emphasis added] adjustments can be made to eliminate the effect of any such differences. [....]. For Transactional Net margin method, the TPO also referred to paragraph 3.2 of the Guidelines which state: [....] the reliability of a method should be assessed taking into account the principles discussed in this Report, including the extent and the reliability [emphasis added] of adjustments to the data used. The TPO also referred to article of Shri. Jamal Hefazi, a transfer pricing expert of Canada in his article (at pages 356 to 358 of International transfer pricing journal November/December 2008 issue) to highlight that Growth in transfer pricing informant will form analysis to rely more heavily on Asian Financial statement; that in Asia working capital adjustments are difficult to apply due quality considerations in data; es that accurate financial ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s an appropriate one. A major issue in making Working Capital Adjustments is the question of which interest rate to use. The rate to be used is determined by the tested party. In most cases a borrowing rate will be appropriate. In cases where the tested party's working capital balance is negative (that Is Payables Receivables * Inventory) a lending rate may be considered in some cases. The example uses an interest rate based on what TestCo is able to borrow at in the local market. This example also assumes that the same interest rate is applied to payables, receivables and inventory. The purpose of Working Capital Adjustments is to improve the reliability of the comparables. There is a question whether Working Capital Adjustments should be made when the results of some comparables can be reliably adjusted while the results of some others cannot . The TPO expressed the opinion that the underlying assumption is that all companies are efficient profit maximizers but poor manager may be the simple reality. Rather than embarking on adjustments, the question should really be asked at this stage as to why the assessee or suggested comparables have material deviation in the wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital deployed is actually making a difference to the margins earned by the assessee and the comparables. This is actually at the heart of every comparability adjustment. The assessee has not been able to demonstrate that the difference in the working capital deployed is making a difference in the margin earned by the assessee and the comparables. The TPO held that there was no case for working capital adjustment. (2.10.11) Regarding Risk Adjustment The TPO declined to make Risk adjustment. According to TPO, risk adjustment as a general rule cannot be allowed unless it is clearly shown that the comparables had actually undertaken such risk and how the same materially affected their margins. The TPO quoted To quote him, revised OECD guidelines of 2010 Ensuring the needed level of transparency of comparability adjustments may depend upon the availability of an explanation of any adjustments performed, the reasons for the adjustments being considered appropriate, how they were calculated, how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urrency fluctuations; (v) extraordinary expenses; (vi) loss on transfer of assets or investments; (vii) expense on account of income tax; and (viii) other expenses not relating to normal operations of the assessee; (k) operating revenue means the revenue earned by the assessee in the previous year in relation to the international transaction during the course of its normal operations hut not including the following, namely: (i) interest income; (ii) income arising on account of foreign currency fluctuations; (iii) income on transfer of assets or investments; (iv) refunds relating to income-tax; (v) provisions written back; (vi) extraordinary incomes; and (vii) other incomes not relating to normal operations of the assessee (2.10.12) Regarding Provision for doubtful debts As per TPO, provision for doubtful debts was considered part of operating expenses only when the same expenses are incurred every year for the last three years upto and including the FY 2009-10 and these expenses are incurred at almost consistent level in terms of its ratio with the turnover; and otherwise, the same is excluded from operating expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... E, Haldor Topsoe International A/S, Denmark. The taxpayer claims to provide engineering and technical assistance services to its parent company for their global projects (including projects in India) and thereby serves to augment the total strength of the Topsoe Group. The international transactions entered into are tabulated below:- Sr. No. Nature of transaction Arm s length price as per taxpayer (i) Engineering and Technical Assitance Service rendered Rs.25,00,55,515 ( ) Purchase.pf fixed assets ₹ 11,87,625 (iii) Reimbursement of expenses (Received ₹ 81,0000 (iv) Reimbursement expenses (paid) ₹ 13,31,078 3. The taxpayer furnished the TP Study and selected TNMM as the most appropriate method to benchmark its international transaction namely engineering and technical assistance service rendered. The taxpayer selected a set of 8 companies w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred in not granting 100% of the eligible profit as deduction u/s 10A(1A), and confirming the deduction at 90%, which was so claimed by the Company inadvertently. 5. From the above grounds of objections relating to transfer pricing following issues emerge which requires consideration of the DRP for issue of direction under section 144C of the Act. Issue I Whether AO/TPO s action by applying various filters, is right in rejecting few of taxpayer s comparables and including new comparables without going into the functionally aspect. Issue II Whether AO/TPO is right in denying any adjustment on account of working capital, risk etc. while working out the average margins of the comparables. Issue III Whether AO/TPO is right in denying any adjustment on account of risk while working out the average margins of the comparables. Each of the issue is discussed hereinafter. 6. Issue I Whether AO/TPO s action by applying various filters, is right in rejecting few of taxpayer s comparables and including new comparables. 6.1 With regard to the above issue the taxpayer's has made the detailed submission contended that TPO was wrong in using following filters ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the above discussion this DRP has no hesitation in upholding this turnover filter used by the TPO instead of filter of ₹ 1 crore used by the taxpayer. Rejecting companies having RPT of 25% and more For the purpose of comparability analysis, the international transaction should be compared with uncontrolled transaction. Therefore, the comparables companies having more than 25% related party transactions could not be treated as operating in uncontrolled environment and RPT could have substantial impact on margins of such companies. The taxpayer has argued that there is no rational basis for applying the threshold limit of 25% of sales. The AR has referred to the number of ITAT decision in this regard. This panel has carefully considered the above objections of the taxpayer, but are not inclined to interfere in the TPO's action in this regard. Cases having some RPT can be taken as comparable as they do not materially affect the price/margins. This view has been upheld by various ITAT s including ITAT, Delhi. In the case of Sony India Ltd. ITAT, Delhi did not lay down any threshold limit for applying RPT filter. This was clarified by ITAT, Delhi in their ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccounts other than in terms of the financial year, following adjustments are required to be carried out in order to bring the data at par with that of the taxpayer: (i) Apportion the data from preceding or subsequent period so as to make data equivalent to the financial year available for comparison with the international transaction. (ii) While apportioning such data, adequate care needs to be taken so that the Profit Level Indicators are computed comparably. Further, for the determination of profit level indicators, certain entries having bearing on the cost and income are- interest, provisions, losses/ gains on account of foreign exchange, etc, which normally as per the business practice are accounted for at the end of the accounting year. Under both the situations, whether the data pertaining to the period prior to the accounting year or subsequent to the accounting year are integrated with the relevant portion of the accounting year of the comparable, the same gives a lopsided picture of the accounts so far as the financial year data is concerned. Since, there is no requirement as per company law or as per accounting standards that the da'ta pertaining to a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dered view that TPO is right in rejecting those comparable companies who are maintaining accounts in terms of period other than the financial year, for the purpose of determination of ALP. Not rejecting the companies having high turnover filter/super profit The taxpayer has objected to inclusion of high turnover/high margin companies in the set of comparables. We have carefully considered the arguments of the taxpayer. For the purpose of transfer pricing analysis, the comparables are selected which has similar functional profile. The profit margin of any company is not an indicator of its functional profile. Unless, the taxpayer is able to point out any functional differences, there is no reason to exclude a high profit margin company from the set of comparables. Further, high turnover is no criteria to determine the functional comparability. Bigger size may result into higher revenue and not necessarily higher margins. In this highly competitive environment, customer is very demanding and refuses to pay higher rates if he can obtain similar services from other smaller vendors having no brand and small turnover. What matters most in the service sector is the functi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exceptional conditions met by an otherwise comparable third party. An extreme result may be excluded on the basis that a previously overlooked significant comparability defect has been brought to light, not on the sole basis that the results arising from the proposed comparable merely appear to be very different from the results observed in other proposed comparables . 3.64 An independent enterprise would not continue loss-generating activities unless it had reasonable expectations of future profits. See paragraphs 1.70 to 1.72. Simple or low risk functions in particular are not expected to generate losses for a long period of time. This does not mean however that loss- making transactions can never be comparable. In general, all *relevant information should be used and there should not be any overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result. 3.65 Generally speaking, a loss-making uncontrolled transaction should trigger further investigation in order to establish whether or not it can be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty or showing any exceptional circumstances. Moreover, if high profit making case is to be excluded then logically loss/low profit margin cases are also required to be excluded. This would mean introducing the concept of inter-quartile range which is not provided under the Indian law. Without prejudice to above, in the case of SAPLabs India Ltd [2010-TII-44- ITAT-BANG-TP], the Hon'ble ITAT has held that if cases of abnormal margin on the high side are to be removed then those on the lower side (having margin lower than the taxpayer) also should be removed. The taxpayer has relied on the decision of Hon'ble Delhi High Court in the case of Agnity India Technologies Pvt. Ltd. to derive support on its claim that since their turnover is ₹ 25 crores, therefore, the comparables which are having high turnover viz. EIL, should not be considered as comparable. The decision of Hon ble Delhi High Court in the case of Agnity India Technologies P, Ltd. has been based on the decision of Delhi Bench of the ITAT in the same case in ITA No. 3856/Del/2010 wherein on page 5, para 3.3 of the order, the AR of the taxpayer had submitted a table differentiating the risk profil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he taxpayer's argument that some of the comparables included by FPO have high turnover and some others have high profitability, it is stated that as per proviso to section 92C(2) when more than one price is determined then the arithmetic-a/ mean of such prices shah' be the arm's length price. Therefore, when there is a robust set of severa/ comparables, such set: obviously contains comparables having low margin, norma/ margin and a/so high margin cases. The arithmetica/ mean of such prices takes care of a// kinds of cases including loss or high profit making, low turnover, high turnover, low end-high or end activity, etc. Thus, removing a comparable from such a set simply on the ground of high profit making would neither be as per the Act and nor would it result in a representative set. Without prejudice to the above, if high profit making comparables are to be removed then consequently loss or low profit making companies are also required to be excluded. This view has been upheld by the ITAT, Bangalore in the case of Sap Labs (supra). This would, however, mean the implied application of inter-quartile range concept which is not permissible under the Act, The Act m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s or profit cannot be a criterion for acceptance/ rejection of a comparable. These decisions have been given after duly considering Quark's decision. It may also be mentioned that the taxpayer s margin is not being compared with the margins of these high-margin comparables alone These comparables are only which contains even low margin cases. The margin of the taxpayer is being finally compared with the average margin of the comparables finally selected in this order. Hence, from the above discussions, it is more the amply clear that high turnover and profitability in a service industry has no correlation at all, therefore the taxpayer's reliance on Agnity Technologies (supra) and thereby arguing that the high turnover comparables should be removed does not cut much ice, Ergo, no comparable can be rejected merely on the basis of margins and turnover for the purpose of comparability analysis and Panel declines to interfere with the stand taken by the TPO in this regard. Rejecting companies where export revenues is less than 75% of total income The taxpayer is providing engineering and technical services, therefore in order to select similar comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eement with the TPO that this filter in the present case does not substantially help in comparability analysis. 6.3 Further, apart from the above discussion it is seen that among others, taxpayer is aggrieved from the exclusion of Petron Engineering Construction Ltd. It is seen that this company is engaged in installation, construction and commissioning of projects as against the taxpayer s business of providing engineering and consulting services, therefore this company is functionally different from that of the taxpayer. Hence, Panel feels that the said company has rightly been excluded for the purpose of comparability analysis. 6.4 As regards taxpayer's objection to the inclusion of 2 companies namely EIL and Mahindra Consultancy Engineers Ltd. is concerned, it is seen that every company tries to put its best face both in its website as well as in annual report. Any person can pickup certain keywords from the website and annual report and may argue that it is providing a sophisticated service, has certain patents, has specialized in certain areas, has obtained excellence in certain areas. However, what needs to be seen whether that is the substantial activity of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccompanied by the annual report, directors report etc., therefore, about the functionality no comments can be offered, hence, in the view of this Panel, this company cannot be taken as a valid comparable. However, taxpayer is directed to provide the complete annual report, director s report and financials and TPO then is directed to take a call accordingly about the inclusion/exclusion of this company as a comparable. Engineers India The taxpayer primarily wants this comparable to be excluded on account of RPT more than 25% Functionally different Predominantly rendering service to government companies This Panel has gone through the TPO's comments on the above grounds and also during the proceedings the taxpayer was requested to bring the data relating to RPT but inspite of the opportunity the data relating to RPT was not made available showing that it is more than 25%. As regards the arguments relating to catering to government sector/PSU, this Panel is of the view that in today s economic world the government companies/PSU s work as per the market forces and EIL has no advantage on this score and further as mentioned above that in a servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re, this DRP is of the opinion that in view of the Rule 10B(3) and in order, to improve the comparability, in the-facts of the present case, while comparing the margins of tested party with that of the comparables, adjustment be made for working capital for which the reliable data is to be provided by the taxpayer. 7.2.2 The TPO has stated that the taxpayer has not demonstrated that there is a difference in the levels of working capital employed by it vis-3-vis the comparables which affect prices and consequently profits. With regard to this objection, as discussed above that holding of inventories, trade debtor/ creditors, trade receivable/payable has always an interest cost. Therefore there is definitely a connection in the level of working capital and the price at which one is willing to offer its services/goods. Hence, this ground of rejecting taxpayer's claim of working capital adjustment by the TPO is not tenable. 7.2.3 TPO has also referred to OECD guidelines which state that only reasonably accurate adjustments can be made. In. this respect, TPO has raised the issue of unreliable data and has pointed out that monthly data of comparables as well as se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e directions of this Panel. 7.2.5 In allowing the working, capital adjustment, this DRP carries strength from the following judicial decisions. Mentor Graphics (109 ITD 101) Sony India (288 ITR 52 (Delhi- ITAT) Philips Software (26 SOT 226) (Bangalore- ITAT) 8. Issue III Whether AO/TPO is right in denying any adjustment on account of risk, while working out the average margins of the comparables. 8.2 Having gone through the taxpayer's submission in this regard and having considered the facts and evidences on records and case laws relied upon both by the TPO and taxpayer in this regard, this DRP agrees that for the purpose of meaningful comparison, Transfer Pricing provisions do prescribe that the reasonable and accurate adjustments be made only if they enhance comparability. But at the same time such data must be reliable and robust and there should be no scope for mechanical adjustments. As regards adjustment sought, it is seen that no claim for working capital has been made before the TPO and therefore no such claim can be entertained now. With regard to the risk adjustment, TPO has discussed in detail in his order as to why this adj ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er and the comparables in the absence of which risk adjustments cannot be considered for enhancing comparability. Thus the objection is rejected. In the various judicial pronouncements the risk adjustment has not been allowed by the ITATs. Some of these decisions are discussed below: (a) Vedaris Technology 2010-TII-10-ITAT-Del-TP: No risk adjustment to be allowed even on ad hoc basis particularly when the same has not been quantified; (b) Marubeni India Private Ltd (2011-TII-36-ITAT-Del-TP) in which it was held that as the taxpayer failed to bring any evidence on record to show that there was any difference in risk profiles of comparable companies and since the taxpayer failed to file the details exhibiting risk borne by comparables, no risk adjustment can be given, even on ad hoc basis. (c) ADP Private Limited (2011-TII-44-ITAT-Hyd-TP) wherein the ITAT held that there is no thumb rule for allowance of risk adjustment (d) Symantec Software Solutions Pvt. Ltd. (2011-TII-60-ITATMum-TP): The ITAT held that; (i) Until and unless it is shown that the difference in function and risk results in deflation or inflation of financial results of the comparables, i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he taxpayer has submitted that the provision was made in the month of March 2010. The AO misunderstood the accounting entry for booking of expenses on accrual basis. Attention is drawn to the reply dated 31.1.2014 addressed to the assessing officer where it has been explained that the provision was made in respect of the following invoices relating to the month of March 2010: (i) Canon India P. Limited ₹ 46,757/- (i) SS Stationers ₹ 32,005/- Referring to the account of printing and stationary for April 2010 (i.e. the subsequent period) it is brought out that the provision was reversed on 9.4.2010 and only net amount remained to be claimed in the financial year 2010-11. It is therefore, requested to delete the proposed addition. 10.4 The Panel has examined the matter. From the submissions of the taxpayer it is evident that provision of ₹ 75,000/- made on 31.03.2010 is with reference to the bills of SS Stationers and Canon India P. Limited. As against the total of such bills at ₹ 78,762/-, the taxpayer made a provision of ₹ 75,000/- on estimate basis. Thus, it cannot be said the provision so made of ₹ 75,000/- during FY 2009-10 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngwith letter dated 31.01.2010 (PB 149). The AO: has, by mistake, included the income of ₹ 29,74,264 twice while computing the total income (firstly, the taxpayer has itself offered the same as taxable in its return of income and secondly, the AO has made the addition again). The taxpayer never claimed benefit of exemption u/s 10A in respect of the said interest income. It is therefore, submitted that the disallowance made by the AO may be deleted. 11.4 The Panel has examined the matter. The allegation of the AO has been that the taxpayer has claimed deduction u/s 10A of ₹ 2,65,60,262/- but while doing so interest of ₹ 29,74,264/- was added thereby claiming excess deduction. The Panel has perused the taxpayer's letter dated 31.1:.2014 submitted to the AO where reconciliation of taxable income between STPI and others has been made (PB 148-149). A perusal of the reconciliation shows that interest on bank deposits of ₹ 29,74,264/- has been credited under the column for others and the no income from bank deposit is taken to the STPI unit. Accordingly, the Panel observes that the taxpayer itself has excluded the said interest from bank deposits for com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of section 40A(2)(b) of the Act. After considering all the facts of the case, no basis for charging rental expenses, and also mark-up charged by the taxpayer company. The expenses on account of rent expenses claimed by the taxpayer to the extent of 15% of ₹ 24,01,433/- is hereby disallowed u/s 40A(2)(b) of the Act. 12.3 The Ld. AR of the taxpayer has submitted that the provisions of section of 40A(2)(b) under which addition has been made by AO are not applicable in the present case, as no payment in respect of rent has been made by the taxpayer to any related person as specified u/s 40A(2)(b). Moreover, the observation of the AO that no margin has been charged on the said payment from the parent company is also irrelevant. This issue relates to calculation of margin which has already been dealt with in Transfer Pricing order by the TPO. 12.4 The Panel has examined the matter. On perusal of the details of office rent expenses (PB 150) it is seen that the taxpayer has taken office premises of STPI from M/s BHL Forex and Finlease Limited whereas other area has been taken from Ms Naseema Lone, Wasim Ahmed Bhatt, Vinay Nagrath and Neera Vinay Nagrath. None of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mitted that the taxpayer has in its Return of income inadvertently claimed 90% of the profits relating to STPI unit as deduction u/s 10A instead of 100% allowable to it. The AO accordingly allowed the same at 90%. Before the DRP, the taxpayer by way of this objection has claimed the deduction at higher amount being @ 100%. It is submitted that the taxpayer has made a legal mistake in claiming deduction @90% instead of 100%. For this legal claim, the taxpayer relied on the following cases: CIT v. Pruthvi Brokers and Shareholders P. Ltd [2012] 349 ITR 336 (Bombay) CIT v. Jai Parabolic Springs Ltd. [2008] 306 ITR 42 (Delhi) 14.4.1 The Panel has considered the matter. From the facts mentioned above it is clear that the taxpayer has claimed deduction to the extent of 90% of admissible deduction u/s 10A in the computation of total income. No action has been taken by the taxpayer to make any amendment to the total income by filing a revised computation of income within the time permitted u/s 139(4) of the Act. Even no claim was made before the AO during the course of assessment proceedings. The taxpayer has made the claim that it is entitled for 100% of deduction u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f Pruthvi Brokers and Share P. Limited held that the jurisdiction of appellate authority to entertain a fresh claim has not been negated by the Supreme Court in the case Goetze India. Further, the Supreme Court held that the issue in the case was limited to the power of the AO and that the judgment does not nor impinge upon the power of the ITAT u/s 254 of the Act. Liikewise, the Delhi High Court in the case of Jai Parabolic (supra) has commented upon the powers of the appellate authorities as against the assessing officer. As mentioned above, the present proceedings before the Panel are under Chapter XIV of the Act and therefore, the decision of Hon'ble Supreme Court in the case of Goetze (India) (supra) would be squarely applicable. 14.4.3 Considering the facts and circumstances of the case in totality, the claim of the taxpayer cannot be accepted by the Panel. 14.5 The ground of objection is disposed off accordingly. 15. The taxpayer has cited in its submission various judicial pronouncements which have been considered by this Panel. These are distinguishable from the factual matrix in the case of the taxpayer. Accordingly, a detailed description of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cumentation of comparability adjustments are discussed in Chaper V. From the above guidelines it can be seen that unless it is shown that how the risk adjustment would change the result of each comparable and how the same would improve the comparability and unless adequate reasons are given for such adjustment, no adjustment can be allowed to the taxpayer. In the present case, except giving proportion of various risks borne, the taxpayer has not shown with evidence as to whether each of the risk was actually undertaken or not by the comparables and if so, how these risks affected each of them and whether such adjustment would improve the comparability. Mechanical adjustment cannot be made to the margins of the comparables without knowing which risk was taken by the entity concerned and hot its profitability was affected. Profitability of risk and certainty of risk are two different aspects and cannot be equated for the purpose of adjustment. In my view assessee cannot be compared to a risk free security. Even other methodology, whether adhoc adjustment as in case of Sony India, CAPM or Sharpe Ratio ( which is a measure of excess return on risk undertaken by an entity in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herwise, the same is excluded from operating expenses treating the same expense as extraordinary or restricted to the extent of reasonable based on the three year figures. Thus provision for doubtful debts are allowed provided a company follows a consistent approach to make provisions every year. Otherwise, such expenses becomes extra ordinary and thus is excluded from operating expenses. 8. Following the discussions in the preceding paras the final set of comparables going to be used in the case of assessee are listed below:- SI. No. Name OP/OC 1. Mahindra Consulting Engineers Limited 23.50 2. TCE Consulting Engineers Limited 25.88 3. Engineers India 67.77 4. Mukand Engineers Limited 12.87 5. Project and Development India Limited 23 09 6. UB Engineering Limited ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion made by TPO as discussed above ₹ 3,26,30,317/- Total Income ₹ 3,69,89,217/- Rounded off ₹ 3,69,89,220/- Assessed as above at total income of ₹ 3,69,89,220/-. Issue necessary forms. Charge interest u/s 234B and 234D as applicable under Income tax Act, 1961. Penalty proceedings u/s 271(l)(c) have been initiated separately. (5) Aggrieved, the Assessee is now in appeal before us against the aforesaid Assessment Order dated 04.12.2014. During the appellate proceedings the Assessee filed application for admission of additional ground vide letter dated 14.06.2018. The additional ground is as under: The learned DCIT (after incorporating Ld. DRP s order) has erred in not granting 100% of the eligible profit as deduction u/s 10A(1A), and confining the deduction at 90% only. (5.1) During the appellate proceedings the Assessee also filed Paper Book containing the following particulars: S.No. Particulars 1 Copy of Order u/s 92CA dated 17.01.2014 passed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [2015] 60 taxmann.com 355 (Delhi High Court) 21 Copy of Thyssenkrupp Industries India (P.) Ltd. V. Addl. CIT. [2013] 33 taxmann.com 107 (Mumbai - Trib.) 22 Copy of Bechtel India (P.) Ltd. v. DCIT [2016] 66 taxmann.com 6 (Delhi - Trib.) 23 Copy of AT T Communication Services India (P.) Ltd. v. ACIT [2018] 91 taxmann.com 58 (Delhi - Trib.) 24 Copy of CIT v. Agnity India Technologies (P.) Ltd. [2013] 36 taxmann.com 289 (Delhi High court) 25 Copy ofPr. CIT v. New River Software Services (P.) Ltd. [2017] 85 taxmann.com 302 (Delhi High court) 26 Copy of Blackrock Services India (P.) Ltd. v. ACIT [2018] 93 taxmann.com 251 (Delhi - Trib.) 27 Copy of KOB Medical Textiles (P.) Ltd. v. DCIT [2017] 81 taxmann.com 223 (Chennai - Trib.) 28 Copy of Nokia India (P.) Ltd. v. DCIT [2018] 91 taxmann.com 288 (Delhi - Trib.) 29 Copy of Finastra Software Solutions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ld. TPO has selected following 2 and added the same to the list of final comparable companies : M/s Engineers India Ltd. (Margin - 67.77%) M/s Mahindra Consulting Engineers Ltd. (Margin - 23.50%) The detailed factual arguments were submitted to the Hon ble DRP (refer page 49 to 55 of PB). Our submissions regarding the comparable companies are as follows: Regarding Engineers India Ltd. [ EIL ]: Observations of Ld. TPO / Hon ble DRP The Ld. TPO has included this company in the final list of comparables and discussed about it at para 5 (7internal page 11 to 13 of the order) (refer page 11 to 13 of the PB). The Ld. DRP has discussed this issue at page 16 of its order (refer page 71 of the PB). Appellant s submission First Ground - Govt Entity Related Party Transactions 25% : The first ground for exclusion is that EIL is rendering services to other government companies and had executed most of the projects in the Consulting Engg. Division with govt. entities and therefore, its related party transactions are more than 25%. The assessee is rendering engineering services to industries operating in (1) Fertilizer, (2) Petr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ses) following Thyssenkrupp (supra) has discussed the comparable - Engineers India Ltd. and has given the various reasons for rejection of EIL as a comparable company. Second Ground - Scale Size of the company : The total turnover of EIL was 1984.10 crores, as against the appellant turnover of 25 crores . Thus EIL s turnover is 80 times the turnover of appellant company. Even if turnover of Consulting and Engineering segment is considered, the same is 1055.33 crores, i.e. appx 42 times the turnover of appellant company (refer page 202 of the PB). The appellant did not own any intangibles, has not incurred any expenditure ofn R D etc. In support of the proposition that company with very high turnover should not be considered as comparable, we place reliance on the following cases: ❖ CIT v. Agnity India Technologies (P.) Ltd. [2013] 36 taxmann.com 289 (Delhi HC) (para 5 6 at page 59 60 of the Compilation of cases) ❖ Pr. CIT v. New River Software Services (P.) Ltd. [2017] 85 taxmann.com 302 (Delhi HC) (para 12 at page 63 of the Compilation of cases) ❖ Sony Mobile Communications International AB v. DDIT [2016] 69 taxmann. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it loss account and balance sheet. Therefore, it is not possible to compute the Working capital adjustment in case of EIL. It may also be noted that the Ld. TPO, while giving effect to the Hon ble DRP s order has made the wrong calculation of WCA. He has computed the WCA adjustment using the segmental profits but the figures of debtors, creditors and inventory were taken from the consolidated balance sheet (refer page 89 and 194 of the PB). Since segmental accounts are not available, therefore, EIL cannot be taken as a suitable comparable company. In support of this proposition, reliance is placed on the following cases: ❖ Blackrock Services India (P.) Ltd. v. ACIT [2018] 93 taxmann.com 251 (Delhi -Trib.) (refer para 28 at page 74 of compilation of cases) ❖ Messe Dusseldorf India (P.) Ltd. v. DCIT [2018] 90 taxmann.com 159 (Delhi -Trib.) In view of the above, it is humbly prayed that EIL cannot be taken as a comparable company and, therefore, should be excluded from the list of comparable companies. Regarding Mahindra Consulting Engineers Ltd. [ Mahindra ! ; Observations of Ld. TPO /Hon bleDRP The Ld. TPO has included this company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e company. In support of the above proposition, reliance is placed on Hon ble Delhi High Court judgement in the case of Rampgreen Solutions Pvt. Ltd. v CIT. [2015] 60 taxmann.com 355 (at para 38 - refer page 16 of Compilation of cases) on account of different business model, namely, more of outsourcing than in-house services. Without prejudice to above, it is submitted that Mahindra has been specifically excluded by the Hon ble Delhi tribunal as the comparable company in view of highly technical capabilities of executing infrastructure development projects in the following cases: Rolls-Royce India (P.) Ltd. v. DCIT [2016] 69 taxmann.com 426 (Delhi - Trib.) Alcatel-Lucent India Ltd. v. DCIT [2017] 88 taxmann.com 157 (Delhi - Trib.) Ground 1(b) The learned DCIT (after incorporating Ld. DRP s order) has erred on facts and in law in making addition of ₹ 3,20,93,274 on account of adjustment in value of international transaction on account of following: (b) Rejecting 4 comparable companies selected by the assessee Brief facts The Ld. TPO of rejecting following comparable companies selected by the appellant: Central Mine Planning ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t risk, Service liability risk, Research development risk, Credit risk, Manpower risk, Technological obsolescence risk, etc. Accordingly, an adjustment for difference in risk profile (i.e. captive service provider vs. entrepreneur) is called for (refer page 101 to 102 of the PB). The Appellant claimed risk adjustment of 5.25%. The adjustment on account of a difference in risk profile was computed by subtracting the risk-free bank rate from the prime lending rate. During the previous year relevant to assessment year 2010-11, such difference worked out to appx. 5.25% (i.e. 11.75% less 6.50%) [refer page 102 of the PB], The appellant has submitted the brief note on the risk adjustment to the Ld. TPO (refer page 106 to 108 of the PB). TPO s observation The Ld. TPO has discussed this issue in para 6 (internal page 16 to 17) of its order dated 17.01.2014 (refer page 16 to 17 of the PB). DRP s Observation The Ld. DRP has discussed this matter in para 8 (internal page 19 to 21) of its order dated 29.09.2014 (refer page 74 to 76 of the PB). The Hon ble DRP has held that mechanical adjustment cannot be made to the margins of the comparables without knowing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e -Trib.) ❖ Starent Networks (India) (P.) Ltd. v. ACIT [2018] 90 taxmann.com 367 (Pune -Trib.) ❖ MSC Software Corporation India (P.) Ltd. v. ACIT [2017] 80 taxmann.com 55 (Pune - Trib.) Further reliance is placed on the following latest judicial decisions of various Tribunals where an adhoc risk adjustment has been granted: ❖ Sony India (P.) Ltd. v. DCIT [2008] 114 ITD 448 (Delhi-Trib) : 20% adhoc adjustment of profit i.e., appx. 2% -3% (refer para 132 at page 113 of Compilation of cases) KOB Medical Textiles (P.) Ltd. v. DCIT [2017] 81 taxmann.com 223 (Chennai -Trib.) : 2% adhoc adjustment (refer para 6 at page 81 of Compilation of cases) ❖ Finastra Software Solutions (India) (P.) Ltd. v. ACIT [2018] 93 taxmann.com 460 (Bangalore - Trib.) - 1 % adoc (refer para 40 at page 104 of Compilation of cases) The Ld. TPO has relied on the following cases in support of non-allowance of risk adjustment: ❖ ADP Private Limited (200-TII-44-ITAT-HYD TP) ❖ Symantec Software Solutions Pvt. Ltd. (201 l-TII-60-ITAT-MUM TP) ❖ ST Micro Electronics (201 l-TII-60-ITAT-DEL TP) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or computer software during the previous year relevant to any assessment year commencing on or after the 1st day of April, 2003, in any special economic zone, shall be - (i) hundred per cent of profits and gains derived from the export of such articles or things or computer software for a period of five consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce such articles or things or computer software, as the case may be, and thereafter, fifty per cent of such profits and gains for further two consecutive assessment years, and thereafter; The assessee raised an objection before the Hon ble DRP-1 as follows The learned Assessing Officer has erred in not granting 100% of the eligible profit as deduction u/s 10A(1A), and confirming the deduction at 90%, which was so claimed by the Company inadvertently. The Hon ble DRP-1 has discussed this objection at para 14.4. lto 14.4.2 of its order dated 25.09.2014. The Hon ble DRP has rejected the claim of the appellant in light of the decision of the Hon ble Supreme Court in the case of Goetze (India) Ltd. 157 Taxmann 1 and stated th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... igh Court in [2016] 68 taxmann.com 248 (Bombay), has held: The second reason is that Engineers India Limited earned income from turkey project by successfully completing the project of IOCL and other Public Sector Undertakings. In that sense of the matter, the related party transactions are much more than the filter of 25%. We, therefore, order for the exclusion of this case from the list of comparables. The Ld. Counsel for Assessee further submitted that this decision of Mumbai Bench of ITAT has been followed by Co-ordinate Benches of ITAT, Delhi in the cases of Bechtel India (P.) Ltd vs. DCIT [2016] 66 taxmann.com 6 (Delhi-Trib.), AT T Communication Sevices India (P.) Ltd. vs. ACIT [2018] 91 taxmann.com 58 (Delhi-Trib.) and Honda Trading Corp. (India) (P.) Ltd. vs. DCIT [2014] 44 taxmann.com 333 (Delhi-Trib.). The Ld. Counsel also relied on the decision of Co-ordinate Benches of ITAT, Delhi in the case of Eli Lily Co. (India) Ltd. vs. ACIT [2018] 98 taxmann.com 380 (Delhi-Trib.) giving the various reasons for rejection of EIL as a comparable company. Moreover, the Ld. Counsel for Assessee submitted that the scale and size of EIL was not comparable with the scale and size ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... IL, a Public Sector Undertaking, had rendered services to other Government companies and to Government entities; and in that sense had a substantially high ratio of Related Party Transactions, yet EIL had to compete with other private sector companies and entities to remain in business. Therefore, he contended that the fact that EIL had substantially high Related Party Transactions, was not relevant. Further, he submitted that merely because EIL had high profitability or because its scale and size was large; EIL cannot be rejected as a comparable. (7.2.1) However, the Ld. CIT(DR) failed to bring any distinguishable facts to our notice in respect of the Assessee in appeal before us, to make us consider any departure from view already taken by Co-ordinate Benches of ITAT, Delhi in respect of EIL as a comparable, in the aforesaid precedents, namely Bechtel India (P.) Ltd vs. DCIT (supra), AT T Communication Sevices India (P.) Ltd. vs. ACIT (supra), Honda Trading Corp. (India) (P.) Ltd. vs. DCIT (supra), Eli Lily Co. (India) Ltd. vs. ACIT (supra),Blackrock Services India (P.) Ltd. vs. ACIT (supra), and Messe Dusseldorf India (P.) ltd. vs. DCIT (supra). As no material differences ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AY 2009-10 and set aside this issue regarding comparable of Mahindra to the file of TPO/AO for fresh order, with the direction to exclude Mahindra as a comparable if the assessee is also to substantiate its claim that most of the work carried out by Mahindra was outsourced whereas the assessee had not or minimal outsourcing. (8) In ground 1(b) of appeal the Assessee objected to rejection of four comparables selected by the Assessee, namely Central Mine Planning Design Institute Ltd., IOT Design Engg. Ltd., Simon India Ltd. and Petron Engineering Construction Ltd. (8.1) At the time of hearing before us Ld. Counsel for the Assessee submitted that in respect of the first three of these four comparables, the appeal was not pressed. He informed that the appeal was being pressed only in respect of Petron Engineering Construction Ltd. He submitted that the disputed issue regarding selection of Petron Engineering Construction Ltd. as a comparable is covered in favour of the Assessee by order of Co-ordinate Bench of ITAT, Delhi in Assessee s own case for AY 2009-10. He referred to the following relevant portion of order dated 02.05.2017 of Co-ordinate Bench of ITAT, Delhi in As ..... X X X X Extracts X X X X X X X X Extracts X X X X
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