2014 (9) TMI 192 - AT - Income Tax

Transfer pricing adjustment - Understatement of ALP of international transaction - Selection of comparables - Functionally different unit Different business model Held that - The TPO observed that the functions performed by Vishal are similar to the assessee; that wages to cost ratio cannot be adopted to accept/reject the comparables; that the assessee has itself chosen Vishal in its TP study - The assessee objected before the DRP that execution of contracts was outsourced by the assessee to external vendors - the company does not perform comparable functions; that work in progress is significant part of operating cost clearly demonstrating that the company is following a very different model of business - The DRP s findings are that the company is rendering ITES services using its own assets and human resources (may not be on the roll of the company) and is functionally similar to the taxpayer; and that RPT more than 25% as corporate guarantee is not acceptable, as this transaction does not have effect on profit & loss - M/s Vishal Information Technologies Limited has a different business model than that of the assessee, as it outsources execution of contracts to external vendors to save cost on employees which is also evident from the fact that employee cost for Vishal is 3% to the total cost, whereas in case of assessee, it is 60% to the total cost - the assessee was involved in the business of Information Technology Enabled Services, and revenue sought to include M/s Vishal Information Technologies as comparable to compute the mean margin of the comparables, it was held by the ITAT that such comparable is functionally not comparable. Relying upon First Advantage Offshore Services (P.) Ltd. Versus Deputy Commissioner of Income-tax, Circle - 11(3), Bangalore 2012 (6) TMI 572 - ITAT BANGALORE - in the case of an ITES company, employee cost should definitely be more than 25% of the total expenses as in the ITES segment, the entire work is to be done by the employees and companies whose employee cost is less than 25% must be excluded - since the employee cost/operating sales of M/s Vishal Information Technologies Ltd. is a mere 3%, whereas the threshold limit for acceptance as a comparable on the basis of employee cost to sales should be at least 25%, the same is liable to be excluded. Over 20% of operating costs of M/s Vishal Information Technologies Ltd. consist of Work in Progress and such a significant part of operating costs being work in progress clearly signifies that the company is following a very different operating model from that of the assessee also in Dy. CIT v. Quark Systems (P.) Ltd. 2009 (10) TMI 591 - ITAT, CHANDIGARH - while preparing the TP report by an oversight the business model of M/s Vishal was not properly taken into account and hence, merely because it is chosen by the assessee in its TP study, the same cannot be held to be comparable and the taxpayer is entitled to point out that the said enterprise has wrongly been taken as a comparable. Merely because M/s Vishal Information Technologies Ltd. has been selected as comparable in the transfer pricing study, this does not ipso facto establish that the same is an inappropriate comparable - even if the taxpayer or its counsel had taken Datamatics as comparable in its TP audit, the taxpayer is entitled to point out to the Tribunal that the above enterprise has wrongly been taken as a comparable, and as such, the assessee is entitled to contend that the aforesaid comparable is not comparable, as being functionally dissimilar. Revenue has not been able to refute the above position - finding the same to be perfectly reasonable, the exclusion of M/s Vishal Information Technologies Ltd. is directed as a comparable - the exclusion of M/s Vishal Information Technologies Ltd. from the set of comparables, brings the assessee within the prescribed range of /- 5%, the merits of the comparability of the other comparables need not be gone into Decided in favour of Assessee.

Issues Involved:
1. Computation of income by the Assistant Commissioner of Income Tax.
2. Addition on account of alleged understatement of arm's length price (ALP) in international transactions.
3. Reference to the Transfer Pricing Officer (TPO) under section 92CA of the Income Tax Act.
4. Dispute Resolution Panel's (DRP) adjustment proposal.
5. Determination of ALP by the TPO and DRP.
6. Use of multiple year data for computing ALP.
7. Rejection of comparable companies.
8. Adjustment to the ALP within the permissible range.
9. Violation of natural justice principles.
10. Levy of interest under sections 234B and 234C of the Income Tax Act.

Detailed Analysis:

1. Computation of Income:
The assessee challenged the computation of income at Rs. 5,97,19,420/- as against the declared income of Rs. 59,93,597/-. The Tribunal noted the facts, including the assessee's business activities and the filing of the return, claiming deduction under section 10B of the Income Tax Act.

2. Addition on Account of ALP:
The assessee contested the addition of Rs. 5,37,25,821/- for alleged understatement of ALP in transactions with its associated enterprises (AE). The Tribunal examined the transfer pricing study and the methods used by the assessee to determine the ALP, including the Transactional Net Margin Method (TNMM) and the comparables selected.

3. Reference to TPO:
The assessee argued that the reference to the TPO was not in accordance with the provisions of Section 92CA(1) and that no opportunity of being heard was granted. The Tribunal referred to the Special Bench decision in Aztec Software & Technology Services v. Asstt. CIT, which held that there is no requirement for the AO to hear the assessee or record reasons before making a reference to the TPO.

4. DRP's Adjustment Proposal:
The DRP's adjustment proposal of Rs. 7,68,20,717/- was challenged by the assessee. The Tribunal noted that the DRP allowed working capital adjustment but did not allow the benefit of -5% under the Proviso to section 92C(2).

5. Determination of ALP:
The Tribunal analyzed the TPO's rejection of certain comparables and the inclusion of others, such as CG Vak Software & Exports Ltd. and Vishal Information Technologies Ltd. The Tribunal found that Vishal Information Technologies Ltd. had a different business model and was not functionally comparable to the assessee.

6. Use of Multiple Year Data:
The assessee argued for the use of multiple year data for computing the ALP, which was rejected by the DRP. The Tribunal upheld the DRP's decision, citing that multiple year data is not permitted under the rules.

7. Rejection of Comparable Companies:
The assessee contested the rejection of CG Vak Software & Exports Ltd. and Ace Software Exports Ltd. as comparables. The Tribunal agreed with the assessee, noting that CG Vak had no related party transactions in its consolidated financial statements and that the rejection of Ace Software for declining revenues was arbitrary.

8. Adjustment to ALP:
The Tribunal found that if Vishal Information Technologies Ltd. was excluded, the arithmetic mean would fall within the range of +/- 5%, making the margin of profit declared at arm's length. Consequently, no adjustment would be required.

9. Violation of Natural Justice:
The assessee claimed that the DRP violated natural justice principles by relying on information not available in the public domain. The Tribunal did not find it necessary to address this issue separately as the exclusion of Vishal Information Technologies Ltd. resolved the main contention.

10. Levy of Interest:
The Tribunal noted that the issue of interest under sections 234B and 234C was consequential and did not require separate adjudication.

Conclusion:
The Tribunal allowed the assessee's appeal, directing the exclusion of Vishal Information Technologies Ltd. as a comparable. This brought the assessee's transactions within the arm's length range, negating the need for any adjustment. The grounds related to other comparables and procedural issues were rendered academic or consequential.

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