2021 (2) TMI 575 - AT - Income Tax

TP Adjustment - Comparable selection - functional dissimilarity - HELD THAT - Assessee is into rendering Information Technology Enabled Services (ITES) related to IP administration/renewal and data management services to its group companies including renewal support services, proof reading support, customer support services etc.. The taxpayer functions as a captive off-shore centre in India and supports its Associated Enterprises (AEs) in servicing customer contracts, thus companies functinally dissimilar with that of assessee need to be deselected from list of comparability. ECLERX SERVICES LIMITED (ECLERX) - Functional profile of Eclerx shows that it is a Knowledge Process Outsourcing (KPO) company and is providing domain specific reengineering expertise in partnership with financial services firms to increase control and execute ongoing functions.Thus is functionally dissimilar; that it is also outsourcing substantial amounts of work to outsider and that Eclerx has unreliable data. TCS E-SERVE LIMITED (TCS E-SERVE) - Keeping in view the functional dissimilarity, related party transactions, high turnover and payment for brand fee to Tata and abnormal profitability trend discussed in the preceding paras, we are of the considered view that TCS E-Serve is not a suitable comparable vis- -vis the taxpayer who is a BPO/ITES service provider, hence ordered to be excluded. EXCEL INFOWAYS LTD. (EXCEL) - Excel has been rejected by the Tribunal in taxpayer's own case of earlier years. So, in these circumstances, we are of the considered view that Excel is not a suitable comparable vis- -vis the taxpayer as it fails employee cost/net sales ratio filter applied by the TPO and segmental financials are not available, which is into new infrastructure activities, real estate, etc.. So, we order to exclude Excel from the final set of comparables. BNR UDYOG LTD. (BNR) - It is engaged in medical transcription and medical coding which is different from the taxpayer who is a routine ITES service provider working on cost plus mark-up business model. So, we are of the considered view that since BNR fails RPT filter of 25% applied by the TPO himself, having super normal growth, having functional dissimilarity vis- -vis taxpayer is not a suitable comparable, hence ordered to be excluded. Treating foreign exchange loss as a non-operating item - taxpayer invoices its AEs for its services in US Dollars and bears foreign exchange risk qua movement in the exchange rate between US Dollar and INR - HELD THAT - When foreign exchange loss is to form part of the total base of the taxpayer for the purpose of charging a mark up to its AEs as it drives income from its overseas AEs and it being a cost plus entity, the taxpayer earns foreign exchange loss incurred if any, foreign exchange fluctuation is operating in nature in order to compute margins, hence ld. DRP/TPO/AO has erred in treating foreign exchange loss as non-operating item. So, we direct to treat foreign exchange loss as operating in nature, hence ground no. 8 is determined in favour of the taxpayer.

Summary

Issues Involved:
1. Addition to returned income by re-computing arm's length price (ALP) of international transactions.
2. Jurisdictional error in reference made by the AO to the TPO.
3. Non-satisfaction of conditions under section 92C(3) of the Act.
4. Classification of the appellant as a Knowledge Process Outsourcing (KPO) company.
5. Re-computation of ALP by rejecting taxpayer’s quantitative filters.
6. Rejection of comparable companies selected by the taxpayer.
7. Disregarding multiple year data in comparability analysis.
8. Non-consideration of foreign exchange gains and bank charges as operating items.
9. Arithmetical errors in computing margins of comparable companies.
10. Ignoring business/commercial reality and not allowing risk adjustment.
11. Non-grant of MAT credit.
12. Initiation of penalty proceedings.

Detailed Analysis:
Ground No. 1: General Nature
Ground No. 1 is general in nature and does not require specific adjudication.

Grounds No. 1, 2, 3, 4, 5, 6, 7, 9 & 10: Benchmarking International Transactions
The taxpayer's main contention revolves around the inclusion and exclusion of certain comparables by the TPO/DRP for benchmarking international transactions using TNMM with OP/OC as the PLI.

1. Eclerx Services Limited (Eclerx):
- The taxpayer argued for exclusion due to functional dissimilarity, outsourcing substantial work, and unreliable data.
- Eclerx is a KPO providing data analytics and customized process solutions, which is functionally different from the taxpayer, a BPO/ITES service provider.
- Eclerx outsources significant work and has unreliable financial data in the public domain.
- The Tribunal concluded that Eclerx is not a suitable comparable and ordered its exclusion.

2. TCS E-Serve Limited (TCS E-Serve):
- The taxpayer sought exclusion on grounds of functional dissimilarity, high turnover, related party transactions, and abnormal profitability trends.
- TCS E-Serve provides services predominantly to Citi Group and has a high turnover, making it incomparable to the taxpayer.
- The Tribunal, referencing the Delhi High Court's decision in Avaya India Pvt. Ltd., excluded TCS E-Serve due to these factors.

3. Excel Infoways Ltd. (Excel):
- The taxpayer argued for exclusion due to failing the employee cost filter, facing extraordinary circumstances, and lack of segmental financials.
- Excel's employee cost/net sales ratio is 13.50%, failing the TPO's filter.
- Excel is engaged in infrastructure activities, making it functionally dissimilar to the taxpayer.
- The Tribunal ordered Excel's exclusion.

4. BNR Udyog Ltd. (BNR):
- The taxpayer sought exclusion due to high related party transactions, supernormal profits, and functional dissimilarity.
- BNR's related party transactions/net sales ratio is 49.60%, failing the TPO's filter.
- BNR is engaged in medical transcription and coding, different from the taxpayer's ITES services.
- The Tribunal ordered BNR's exclusion.

Ground No. 8: Foreign Exchange Loss
The Tribunal held that foreign exchange loss should be considered as an operating item since the taxpayer invoices its AEs in US Dollars and bears foreign exchange risk. The Safe Harbour Rule is not applicable for AY 2012-13. The Tribunal directed to treat foreign exchange loss as operating in nature.

Ground No. 11: MAT Credit
Ground No. 11 was dismissed as it was not pressed during the course of arguments.

Ground No. 12: Penalty Proceedings
Ground No. 12 being consequential in nature required no specific findings.

Conclusion:
The appeal filed by the taxpayer was partly allowed. The Tribunal ordered the exclusion of Eclerx, TCS E-Serve, Excel, and BNR from the list of comparables and directed that foreign exchange loss be treated as an operating item. Other grounds were either dismissed or not specifically adjudicated.