9911796707
TMI Blog2019 (6) TMI 588X X X X Extracts X X X X X X X X Extracts X X X X ..... s. 2. The assessee has raised the following grounds of appeal in ITA No. 1025/Del/2016 for the Assessment Year 2011-12:- "1. The learned TPO /AO/DRP have erred in making an addition of INR 13,129,292 to the total income of the Appellant in respect of international transaction pertaining to provision of content support services and back office support services by the Appellant to its Associated Enterprises ("AEs") 2. The learned TPO/AO/DRP has erred by not accepting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Income-tax Rules, 1962 ('the Rules'), and modifying the same for the determination of the Arm's Length Price ('ALP') of the impugned transaction to hold that the same are not at arm's length without returning a finding about existence of any of the circumstances specified in clauses (a) to (d) of sub-section (3) of section 92C of the Act. 3. The learned TPO/AO/DRP have erred in: a. Not accepting the use of multiple year data, as adopted by the Appellant in its Transfer Pricing ('TP') documentation; and b. Determining the arm's length margins / prices using data pertaining only to financial Year (' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The assessee benchmarked them adopting Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) and adopted profit level indicator ( PLI) of operating profit by total cost (OP/TC), selected 22 comparables, used multiple year data and found the average margin of those comparable at 10.72 %. The assessee's margins were 15% and therefore as per T P Study report the assessee contented that its international transactions are at arm's-length. 6. The ld TPO , While examining the provision of software development and support services international transactions amounting to INR 76362835/-, issued show cause notice stating that the filters, the comparable selected by the assessee found that they are not appropriate and therefore he carried out fresh search of the database and proposed 14 comparables. Subsequently, on comparable as well as their margins, assessee was given an opportunity to comment upon. After considering the same, learned transfer pricing officer reached a dataset of 16 comparables whose average profit level indicator of operating profit by operating cost was determined at 21.33 percentage, computed the arm's-length price at INR 80566111/- of the interna ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... all be comparable to an international transaction, if none of the differences, if any, between the transactions being compared or between the enterprise entering into such transactions are likely to materially affect the prices are cost, charges paid in or the profit arising from such transaction in the open market or reasonably accurate adjustment can be made to eliminate the material effects of such differences. He also submitted that when judicial precedents for the same AY for ITeS segment decided the exclusion or inclusion of any comparable, than one does not have to go to the functional comparability and on principle basis, they should be considered for exclusion/inclusion based on that judicial precedents. He therefore requested that in case if any of the comparables challenged by the assessee for inclusion/ exclusion, if there are judicial precedents available, then it should be excluded/included, without looking at the functional comparability of the assessee with those comparables. He further referred to the decision of the honourable Supreme Court in case of Berger paints Ltd vs Commissioner of income tax (2004) 12 Supreme Court cases (42) dated 17/02/2004 and submitted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arable will always be excluded from transfer pricing database, irrespective of its identity of functionality. No such judicial precedents are drawn to our notice by the ld AR. Such is not also the mandate of the law. Merely on the basis of some judicial precedents without satisfying the basic condition of the complete identity of the functionality between the assessee and those persons in whose case, the judicial precedents are relied upon, no comparable can be included or excluded. It is also important to note here that the provisions of rule 10 B (2) clearly provides that the comparability of an international transactions with in uncontrolled transactions shall be judged with reference to:- (1) Specific characteristic of the property transferred or services provided, (2) Functions performed taking into account the assets employed or to be employed and the risk assumed by the respective parties to the transaction, (3) contractual terms of the transactions which laid down explicitly or implicitly how the responsibilities, risk and benefits are to be divided between the respective parties to the transactions and, lastly (4) conditions prevailing in the markets in which t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... It is also responsible for training of employees with suitable inputs from the AE. ► Quality control In respect of the aforementioned services, KIPL is responsible for ensuring that requisite quality/ performance standards are met while rendering services. KIPL would also ensure that the services are rendered as per the requirements laid out in the statement of work issued by the AE. In case the services are not as per the standards laid down by the AE, KIPL would re-work on the deliverables to align them with the group's standards. Therefore, the responsibility to maintain quality is jointly of KIPL and the AE. Briefly tabulated are the functions performed by KIPL and its AE in relation to provision of content support services by KIPL to its AE 4.3.3. Risk analysis Briefly summarised below are some of the key risks, faced by KIPL and its AE, in relation to provision of content support services by KIPL to its AE. ► Business risk KIPL is not exposed to business risk since it provides back office support services only to its AE and is assured of a specified return on its costs. ► Market risk Since KIPL is a captive unit, therefore it is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ice support services by KIPL to its AE. ► Marketing and business development Being a captive unit, KIPL does not undertake any marketing or business development functions. All activities pertaining to solicitation of customers and development of business are performed by the AE itself. ► Project management KIPL is responsible for project management and the various services to be provided to the AE. Since it provides back office support services for internal use by the AE, therefore the ultimate responsibility of the work undertaken by KIPL rests with the AE. ► Human resources KIPL undertakes the recruitment/ hiring process and is responsible for day-to-day supervision and control of its employees. It is also responsible for training of employees with necessary inputs from the AE. ► Quality control In respect of the aforementioned services, KIPL is responsible for ensuring that requisite quality/ performance standards are met while rendering services. KIPL would also ensure that the services are rendered as per the requirements laid out in the statement of work issued by the AE. In case the services are not as per the standards laid do ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not exposed to foreign exchange risk in this transaction. Briefly tabulated below are the risks, which are faced by KIPL and its AE in relation to provision of back office support services by KIPL to its AE. Type of risks KIPL AE Market risk No Yes Capacity utilisation risk No Yes Service liability risk No Yes Credit and collection risk No Yes Foreign exchange risk v e s ^ . No 4.5 Assets employed The assets employed by KIPL after depreciation (as on 31 March 2011) are as under:- Type of Assets Amount (INR) Improvement to Leasehold property 8,380,014 Furniture and fixtures 5,106,861 Computer 18,837,666 Office equipment 3,771,913 Trademark 6,107,514 Goodwill 2,222,039 Total 44,426,007 4.6 Characterisation of entity Based on the results of the functional, risk and asset analysis documented in the preceding paragraphs, it is concluded that KIPL can be characterised as a routine service provider operating in a low-risk environment. These services are in the nature of software maintenance and support services, content support services and back office support services. 4.7 Budgets and Forecasts KIPL does not prepar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... referred to certain snapshots from the annual report of the company to show that it is an ITeS company which is in the same segment in which the assessee company is working. Such snapshots referred by the learned transfer pricing officer are with respect to the segment reporting and revenue recognition policy of that company. Accordingly, the learned transfer pricing officer held that the above company is retained as a suitable comparable. 17. The objections filed before the learned dispute resolution panel also did not meet any success. The learned dispute resolution panel as per para number 5.2.3 of the order held that the assessee is a high-end KPO as stated in para number 5.1 on discussion of the functional profile of the assessee, and considered that comparable company is also TPO in terms of the safe harbour rules and therefore it is a valid comparable. 18. The learned authorised representative placed at page number 1 - 128 of the paper book volume 2, wherein, he referred to page number 67 of annual report and drew our attention to the General And Administrative Expenses therein and referring to the 1st item the 'contract for services' amounting to INR 437.15 millions inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 33-HCDel- TP) and held that assessee failed to establish that the comparables with high profit margins are functionally very different so as to render them unsuitable even for TNMM comparison and that TPO had given valid reasons for his decision. Considering the above, DRP held that super profit companies can be taken as comparable (page 14 of DRP order). he submitted that It is trite law that the assessee should submit all the evidences and should take all the grounds at the first opportunity (before TPO, in this case) itself. Therefore, grounds/contention raised above, should not be considered at this stage of appellate proceedings. 20. Without prejudice to the above, submission on each of the contention of the assessee, he submitted a written note on this comparable as under- a. Functional Difference: Argument that E Clerx provides high end KPO services whereas assessee provides low end services do not hold in the light of the following: As per the TP Study of the assessee (page no 23 and 24 of the paper book), the assessee designs and develops educational content with appropriate media elements and graphics which are used for imparting online education at various levels ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... held that the assessee is risk-insulated entity. c. Supernormal profit: The entire exercise of determination of ALP by using TNMM seeks to determine the profit that comparable uncontrolled enterprises would make. Therefore, supernormal profit cannot be a criteria for elimination of any comparable as held by Hon'ble Delhi High Court in the case of in the case of Chryscapita! Investment Advisors and in the case of Rampgreen Solutions Pvt Ltd Vs CIT (2Q15-TI!-33-HC-Del-TP) unless the assessee, with tangible evidences demonstrates that the superprofit has been earned by a company owing to functional difference (or FAR differences). The assessee has abjectly failed to demonstrate the same not only before the lower authorities but also before this Hon'ble Tribunal. This issue has also been considered and rejected by Hon'ble DRP as stated above. d. High Turnover/Scale of Operations: Turnover doesn't impact profitability/profit margins which have been used as PLI for TNMM analysis it only means higher revenue and more often than not higher revenue comes at a lower profit margins. In service industry, due to absence of huge fixed cost (unlike manufacturing); profit mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9; broad-head despite availability of appropriate head. iv. There is nothing in the annual report to suggest that the subhead 'contract for services' was related to outsourcing of work in relation to services rendered to its AEs. The probability of outsourcing by e Clerx, which itself is a KPO and gets to do the work outsourced by its clients on the strength of its competent and professional employees, is close to zero. No client makes payment to e Clerx for getting work done by any employee of any company; rather they make payment to e-Clerx for obtaining the professional/technical/knowledge intense services of the employees of e- Clerx itself. v. E clerx had huge fixed assets (Page 62 of Paper Book Vol-1) in the nature of computers, computer software, office equipment and others which require maintenance. It is not uncommon to have Maintenance Contracts for maintenance of such assets. There is nothing to suggest that the subhead 'contract for services' was not for any such maintenance contract or for any other thing (and there can be several such things) totally unrelated to employee cost. vi. In any case this argument doesn't stand as the company had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d ITeS service provider and high-end ITeS service provider and it is quite difficult to analyse in such situations as to how much value additions are there in deliverables in rendering of such kind of host of services. At the outset, on a perusal of the Financials and annual report of E-clerx for the relevant financial year as pointed out to us during the course of the hearing, we find that the E-clerx has outsourced most of its services to outsiders which is evident from the fact that the expenses under the head 'contract for the services' is more than Rs. 43.71 Crores during the year out of total expenses debited to profit & loss account of Rs. 91.29 Crores. The major operations appears to be based on outsource model, which is evident from the quantum of expenditure and notes to the financial account (the copy of which is appearing at page 840 of the assessee's paper book). In an outsourcing model, the assets deployed in the form of human resources, infrastructure and other intangibles differ from an entity which operates from its own resources. Whence, in the case of E-clerx, substantial work has been outsourced to various parties, as compared to the assessee, where ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure of the comparable company. On careful analysis of the decision of the coordinate bench, it is apparent that it appeared to the bench that major operations of the comparable company are based on outsourcing model. We are also conscious of the fact that the decision of the coordinate bench has made an observation on the functionality of the comparable. It is also clear on reading para number 12 of the order of the coordinate bench as reproduced earlier that outsourcing model is not the only reason for which the comparable company was excluded in that particular decision. It is a fact that assessee has never contested before the lower authority that this comparable company has an outsourcing model and therefore it should be excluded. As this argument is raised before us for the 1st time and that too merely relying on the decision and not supporting it with the annual report of the comparable company, we are duty-bound to examine the annual report of the comparable company and 1st strive to decide the issue here itself to not to put either the assessee or the revenue in any inconvenience. No doubt in schedule 'L' In 'General And Administrative Expenses' grouping the comparable comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee and the revenue where assessee contends that company is carrying on business through outsourcing model and revenue refutes the above argument. The assessee is relying upon a judicial precedent of the coordinate bench of equal strength and very forcefully argues that this coordinate bench is bound to follow the above decision and cannot sit into the correctness of the judgment now, revenue relies upon the annual accounts placed before us. The facts are also telling us that this is altogether a new argument raised before the ITAT. We are very conscious about the decision of the coordinate bench which is cited before us and our duty to follow that. However, where on factual analysis, it is found that, the comparable company is not engaged in the outsourcing model as per the financial report of comparable company; we are also duty-bound to examine the correct facts as the coordinate bench is the final fact-finding authority. Therefore, On careful analysis of all these arguments, and respectfully following the decision of the coordinate bench, wherein a ratio has been laid down stating that a comparable company carrying on its services through outsourcing model substantially is n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee is contending that comparable is carrying on outsourcing model business which is not justified from the financial records and annual reports produced by the assessee before us. In view of these facts it is in the interest of the assessee that it may be examined by the learned assessing officer by issue of notice u/s 133 (6) of the act that whether the comparable company is carrying on an outsourcing business model or not. Therefore the reliance placed by the learned authorised representative on the above decision does not support the case of the assessee. 25. The next comparable contested is Infosys BPO Ltd. Assessee raised objection before the learned TPO about the inclusion of the above company stating that it is not functionally comparable, it has an incomparable scale of operation, and it has a brand value and the presence of intangibles. The learned TPO rejected the contention of the assessee stating that on the issue of brand profits, assessee has failed to demonstrate how the profit margin of 17.86%, which is less than the average of the comparable, is influenced by brand profits. The learned DRP has simply rejected the argument of the assessee stating that this com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparable is required to be excluded for the brand value of the TCS and functional the similarities. The assessee challenged its exclusion for the reason of the functional dissimilarity as the comparable companies engaged in transaction processing and technical services like software testing, verification and validation of the software. 30. The learned authorised representative also challenged it has it owns intangibles, pays for Tata brand equity and non availability of the segment information. He also submitted that it is also not comparable on the ground of incomparable scale of operations. 31. The ld DR vehemently supported the orders of the lower authorities. 32. We have carefully considered the contentions and find the annual account of the above comparable company placed in paper book. Apparently TCS E serve is a subsidiary of Tata consultancy services Ltd. Behind the above comparable company, there is a Tata brand. On the perusal of schedule to the profit and loss account there is a payment of towards the Tata brand equity contribution. For this reason that it belongs to Tata group and has also contributed to Tata brand which is one of the largest brand in the infor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... determination of a LP of this segment we find that the learned transfer pricing officer has not discussed at all why he is excluding the comparable selected by the assessee. The learned DRP vide para number 5.3 of his order has rejected the objection of the assessee with respect to inclusion of the comparables stating that all these comparable selected by the assessee and rejected by the learned TPO have been rejected because the file filter used by the learned transfer pricing officer. These filters have been discussed by the learned DRP and therefore the exclusion of the companies which fill these filters was justified and the appellant. We find it is not the reason for rejection of any of the comparable selected by the assessee without finding the functional dissimilarity is between them. 36. Further R system International Ltd is also rejected by the learned transfer pricing officer stating that it has a different financial year ending. 37. The ld AR submitted that it is functionally comparable and quarterly results are available in public domain. He also supported it with several judicial precedents. 38. The ld DR vehemently opposed its inclusion submitting that assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s the market risk, geographical risk, foreign exchange risk and human resource risk and the cost of providing the services are vastly different from the assessee. In the end he submitted that assessee is seeking inclusion of this comparable; therefore the primary onus was on him to establish its functional comparability by filing relevant documents to establish comparability, which he failed to do. He also submitted that there are enough number of comparables even without R Systems. Hence, there will be no improvement in the comparability exercise by including this comparable unless inclusion of the low PLI of this comparable so as to bring down the ALP itself is regarded as an improvement. In respect of case laws relied upon by the assessee it is submitted that none of the judgments being relied upon by the assessee have been given in assessee's own case. A judgment decides as per the facts of that case. Since assessee was not a party to any of the judgments being relied, assessee's FAR was not compared with any of the comparables discussed in these judgments. AS per the scheme of the Act and Rules relating to TP analysis as upheld by Hon'ble Delhi High Court, in the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rt of the relevant data from the database to the learned transfer pricing officer. Further there is also a fact that this comparable is found to be functionally dissimilar to assessee by assessee itself as per argument of the ld DR. Therefore The learned TPO is directed to include the above company in the comparability analysis if it is functionally similar and crosses all other filters. In view of above facts we also direct the ld TPO to examine this comparable. 44. Accordingly all 3 comparables which have been included by the assessee but rejected by the learned transfer pricing officer for comparability analysis are set aside to the file of the learned transfer pricing officer to consider them for the comparability analysis if they are found functionally comparable, passes all the filters applied by the TPO, and reliable information has furnished by the assessee in the form of quarterly results and annual reports. 45. In the result ground number 1 - 8 of the appeal of the assessee are allowed. 46. The ground number 9 of the appeal of the assessee is against the initiation of penalty proceedings u/s 271 (1) ( C ) of the act. The above ground of appeal is premature and there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e comparable companies selected by the Appellant and adding certain companies to the final set of comparable companies on an ad-hoc basis, thereby resorting to cherry picking of comparables to determine the ALP of the impugned transaction. 6. The learned TPO/AO/DRP have erred in selecting certain companies (which are earning super normal profits) as comparable to the Appellant to benchmark the impugned transaction. 7. The learned TPO/AO/DRP have erred in treatment of certain operating and non operating items while computing the margins of the Appellant and comparable companies in respect of the impugned transaction. 8. The learned TPO / AO / DRP have erred in not making suitable adjustments to account for differences in risk profile of the Appellant vis-a-vis the comparable companies in respect of the impugned transaction. 9. The learned AO has grossly erred in initiating penalty proceedings under section 271 (1 )(c) of the Act. 10. The learned AO has erred in not granting the relief available to the Appellant in view of directions passed by the Hon'ble DRP while passing the final assessment order. 11. The learned AO has erred in not granting the Minimum Alternate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g as it involves the identifying the generic name and trade name of the various drugs. That can be done only after reference to the pharmacology reference books which should always be a part of the library of a medical transcription profession. Further medical coding has also been explained by way of a flowchart. The company says that it has a sizeable number of certified coders which is assigning codes to diagnosis and procedures which help in financial reimbursement from insurance companies and government companies etc. It is further stated that medical coders are specialized in coding after thorough training program and certification. Further the assessee has contended that it has a significant amount of brands and software for providing IT services. For this proposition we look management discussion and analysis it is submitted that it is the one of first company to offer SaaS[ Software as s service ] model in MHRC service segment. There are also references to the various products at page number 28 - 42 of the annual accounts. It is also entering into the legal process outsourcing segment. It is also using Immaculate business process outsourcing management solutions for healthc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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