2014 (10) TMI 504 - AT - Income Tax

Selection of comparables - Vishal Information Technology Ltd. functionally different unit - Held that - Assessee as well as TPO has not gone into verticals/horizontals of the ITES sector while selecting comparables - the employee cost of this company is abnormally low compared to the assessee, which presupposes that it has outsourced major portion of its work to third parties - Following the decision in M/s. HSBC Electronic Data Processing India Ltd. Versus Dy. Commissioner of Income-tax Circle 2(2), Hyderabad 2013 (9) TMI 485 - ITAT HYDERABAD this company is rejected as comparable, due to the reason that it has outsourced a considerable portion of its business and it is functionally different - the AO is directed to exclude this company from the list of comparables. Goldstone Infratech Ltd. Held that - Following the decision in M/s. HSBC Electronic Data Processing India Ltd. Versus Dy. Commissioner of Income-tax Circle 2(2), Hyderabad 2013 (9) TMI 485 - ITAT HYDERABAD business model of the above company is different from that of the assessee - the foreign exchange revenue is less than 1% of the total turnover - it fails the filter provided by the AO on the basis of the foreign exchange earnings - the Revenue from BPO is failing over a period of three years - the AO is directed to exclude this company from the list of comparables. Asit C Mehta Financial Services Ltd. - Employee cost filter Held that - Following the decision in M/s. HSBC Electronic Data Processing India Ltd. Versus Dy. Commissioner of Income-tax Circle 2(2), Hyderabad 2013 (9) TMI 485 - ITAT HYDERABAD - this company cannot be selected as a comparable not only on the reason of failing employee cost filter, but also due to amalgamation during the year, which has changed the business model of the company thus, the AO is directed to exclude this company from the list of comparables. Datamatics Financial Services Ltd. Held that - The assessee has objected to the inclusion of the aforesaid company for the reason that it fails RPT filter applied by the TPO himself as the RPT exceeds 25% of the sales - Following the decision in M/s. HSBC Electronic Data Processing India Ltd. Versus Dy. Commissioner of Income-tax Circle 2(2), Hyderabad 2013 (9) TMI 485 - ITAT HYDERABAD - once the dealings are not considered as transactions , these will also cease to be international transactions, going out of the purview of section 92 itself - a pure reimbursement of expenses by one AE to another AE is very much a transaction as per section 92F(v) and consequently is equally an international transaction as per section 92B requiring consideration as per section 92 of the Act it is liable to be excluded as it involves related party transactions at much higher level, as against the filter adopted by the TPO himself, being companies with less than 25% related party transactions the company fails in this filter adopted by the TPO - the TPO is directed to exclude this company from the list of comparables adopted. Maple E Solutions Ltd. Held that - Following the decision in Income-tax Officer, Ward 3(4), New Delhi Versus CRM Services India (P.) Ltd. 2011 (6) TMI 398 - ITAT DELHI the company cannot be treated as comparable as financials of the company are not reliable - the company selected by the TPO is not having the same business of voice based BPO as in the case of the assessee the AO is directed to exclude the company from the list of comparable. Rejection of comparables - Genesys International Corp. Ltd. (Seg) Goldstone Technologies Ltd. - Held that - Taxpayers have objected to the aforesaid company being treated as comparable to companies in ITES sector - so far as Goldstone Technologies Ltd. is concerned, the company being engaged in providing consultation services with various middle ware products is not functionally similar to the companies in the ITES sector - this company cannot be considered as comparable to the assessee. Visualsoft Technologies Ltd. and Quantum eservices Pvt. Ltd. Held that - So far as the Visual Soft Technologies Pvt Ltd. and Quantum e-solutions Services Pvt. Ltd., are concerned, it is seen that while the loss of Visual Soft Technologies Ltd. for the year under consideration is (-)57.63% that of Quantum e-solutions Services is (-) 14.11%. when the assessee is objecting to super normal profit making companies by applying same standard loss making companies also cannot be treated as comparable. Consideration of management fees disallowed in computation of operating margin Held that - Though the TPO has disallowed the payment of management fees by determining the ALP at Nil, but, at the same time, he has considered the same while computing operating margin of the assessee - when the TPO is disallowing the payment of management fees, it cannot be considered for the purpose of computation of operating margin, otherwise, it will amount to double addition - the matter is to be remitted back to the AO/TPO to look into this aspect and decide the issue after affording reasonable opportunity of being heard to the assessee. Computation of working capital adjustment Held that - Though the assessee has raised similar arguments before the DRP but the DRP has rejected the same by stating that the assessee has not maintained segmental accounts, allocation of cost to respective segments cannot be ascertained - DRP held that since the TPO has worked out the working capital adjustment on the business of a transparent method adopted in case of all taxpayers it cannot be questioned - if the assessee has maintained separate records and can substantiate allocation of expenditure to the international transactions with AE and non-AE there is no reason why working capital adjustment should not be made accordingly the matter is to be remitted back to the AO/TPO for fresh adjudication. Denial of exemption claimed u/s 10A Profit relating to offshore research services centre (ORSC) unit Held that - There is force in the contention of the assessee - ORSC unit is recognized as a STPI unit - the DRP has held that when ORSC unit is converted from domestic tariff area to STPI unit, it is eligible for deduction u/s 10A of the Act for the remaining period out of 10 consecutive assessment years starting from the year in which it was approved as STPI unit - the AO is directed to allow deduction u/s 10A of the Act for the AY also.

Summary

Issues Involved:
1. Selection of comparables.
2. Rejection of comparables.
3. Consideration of management fees disallowed in computation of operating margin.
4. Computation of working capital adjustment.
5. Denial of exemption claimed u/s 10A of the Act.
6. Levy of interest u/s 234B of the Act.
7. Initiation of penalty proceedings u/s 271(1)(c) of the Act.

Issue-wise Detailed Analysis:

I. Selection of Comparables:

1. Vishal Information Technologies Ltd.:
- The assessee objected to this company being a comparable due to its low employee cost (1.25% of turnover), implying major outsourcing. The Tribunal, following precedents like Maersk Global Service Centre and HSBC Electronic Data Processing India Ltd., directed its exclusion from the list of comparables due to functional dissimilarity and outsourcing.

2. Goldstone Infratech Ltd.:
- The assessee argued against this company due to low employee cost (9.38% of total cost), minimal forex earnings, and inclusion of lease income in BPO services. The Tribunal, citing cases like HSBC Electronic Data Processing India Ltd. and Stream International Services, directed its exclusion due to different business models and failing filters.

3. Asit C Mehta Financial Services Ltd. (Earlier known as Nucleus Netsoft & GIS (India) Ltd.):
- The company was excluded as a comparable due to failing the employee cost filter and undergoing amalgamation, which altered its business model, as per the Tribunal's decision in HSBC Electronic Data Processing India Ltd.

4. Datamatics Financial Services Ltd.:
- The company was excluded because its related party transactions exceeded 25% of sales, consistent with the Tribunal's decision in HSBC Electronic Data Processing India Ltd.

5. Mapple E Solutions Ltd.:
- The company was excluded due to unreliable financials stemming from fraud involvement by its directors, following decisions in cases like CRM Services India (P) Ltd. and Stream International Services.

II. Rejection of Comparables:

1. Genesys International Corp. Ltd. (Seg):
- The Tribunal upheld the rejection as the company was involved in geospatial and mapping activities, making it functionally different from the assessee.

2. Goldstone Technologies Ltd.:
- The Tribunal upheld the rejection as the company was engaged in providing consultation services with middleware products, which was not functionally similar to ITES sector companies.

3. Visualsoft Technologies Ltd. (SEG) and Quantum eservices Pvt. Ltd.:
- The Tribunal upheld the rejection due to persistent losses, aligning with the principle that both super normal profit-making and loss-making companies should be excluded.

III. Consideration of Management Fees Disallowed in Computation of Operating Margin:

- The Tribunal remitted the issue back to the AO/TPO to ensure that the disallowed management fees were not considered in the computation of the operating margin to avoid double addition.

IV. Computation of Working Capital Adjustment:

- The Tribunal remitted the issue back to the AO/TPO to reassess the working capital adjustment, ensuring proper allocation of receivables and payables between AE and non-AE transactions, potentially altering the adjustment from negative to positive.

V. Denial of Exemption Claimed u/s 10A of the Act:

- The Tribunal upheld the AO's finding that the ORSC unit was not a new unit but directed the AO to allow deduction u/s 10A for the remaining period as the unit was converted from a DTA to an STPI unit, following the DRP's decision for AY 2008-09.

VI. Levy of Interest u/s 234B of the Act:

- The Tribunal did not adjudicate this issue as it was consequential to the final determination of income.

VII. Initiation of Penalty Proceedings u/s 271(1)(c) of the Act:

- The Tribunal deemed this ground premature and did not adjudicate it at this stage.

Conclusion:
The appeal of the assessee was partly allowed for statistical purposes, with specific directions given for re-evaluation and reassessment on several issues.