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TMI Blog2014 (8) TMI 863X X X X Extracts X X X X X X X X Extracts X X X X ..... ng cost of the CDR unit which consists of the cost not only in respect of the services rendered to the associated enterprises but also in respect of the services rendered to the Goa plant by the CDR unit - since the total cost of the CDR unit has been taken, the notional revenue in respect of Goa plant should also be considered while computing the net operating profit - no addition in respect of IT-enabled engineering services can be made – Decided against Assessee. Adjustment of 12.31% of marketing expenses – Held that:- CIT(A) rightly was of the view that total marketing expenses, including those incurred in the company's European and Indian offices adopted - the TPO had netted off the Dubai office expenditure against the Dubai office income, without considering the ratio of total marketing expenses to total non-AE export sales as directed by the CIT(A) - no interference is called for in the order of CIT(A) - CIT(A) has rightly directed the AO to allow adjustment of 12.31% of the marketing expenses after verifying the correctness of the data submitted by the Assessee for allowing relief- Decided against Revenue. Deletion of the addition – Held that:- The purchase of the com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssing a speaking order on the relief for business operational risk adjustment @ 5.25%, as was asked for by the appellant. 7. The Ld. CIT (A) erred in not considering the functional differences between the appellant's CDR unit and comparable companies selected by TPO. 3. In Revenue's appeal, the Revenue has taken the following effective grounds of appeal : 1. The ld CIT(A) has erred in holding that the size turnover of the company are deciding factors for treating a company as a comparable and accordingly erred in excluding M/s Wipro Ltd. and M/s Wipro BPO Solutions Ltd. in ITES segment as comparable companies. 2. The Ld. CIT(A) has erred in excluding M/s Maple-E-Solutions Ltd., as a comparable in the ITES segment of the assessee. 3. The ld. CIT (A) has erred in excluding M/s Nucleus Netsoft and GIS (India) Ltd on the ground of related party transactions. 4. In view of the introduction of Sec. 92C(2A) of the IT Act, 1961. With retrospective effect from 01.04.2002, the order of the CIT(A) that the assessee is entitled to 5% standard deduction is contrary to the provisions of law. In the appeal filed initially, the Revenue h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the TPO. While I consider that use of this filter is valid, I am of the opinion that if there is a limit at the lower end of turnover for identifying comparables, there is no reason why there should not be an upper limit also, as size matters in business. This principle was upheld by the hon'ble Bengaluru Bench of ITAT in the case of Genisys Integrating Systems (India) (P.) Ltd. v. CIT [2012] 53 SOT 159 (Bang), where it was observed that while a big company would be in a position to bargain the price, attract more customers and have a broad base of skilled employees who were able to give better output, a small company might not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, when companies which were loss making were excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover and of classification made by Dun Bradstreet, the turnover filter was very important and companies which had turnover of ₹ 1 to ₹ 200 crore should be taken into consideration for the purpose of making TP study. 29. The H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the company's profit and loss account that its operating income was ₹ 57,55,24,067, as against operating expenses of ₹ 45,35,00,314, resulting in an operating profit of ₹ 12,20,24,293. Thus the ratio of operating margin to operating cost works out to 26.91%. I therefore direct the AO to adopt the correct operating margin of 26.91% in respect of this company. M/s. Maple E Solutions Ltd. 34. It was argued that the TPO had considered M/s Maple E Solutions Ltd. as a comparable and computed its margin at 28.75%. However, the hon'ble Delhi bench of ITAT had held in the case of ACIT v. M/s. CRM Services India P. Ltd 14 Taxmann.com 96 that this company could not be selected as a comparable for ITES companies as the management of this company was tainted, as the directors of the company were involved in a fraud. The business reputation of the Restage group which owned M/s Maple E Solutions was under serious indictment and in view of a question mark on the reputation of its owner, albeit for earlier years, it would be unsafe to take their results for comparison of the profitability of the assessee. 35. I am of the opinion that the financia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... filter in the selection or rejection of comparables. I therefore reject the appellant's argument that the two companies ought to have been rejected on the ground that their employee costs were less relative to turnover. 39. As regards outsourcing as a business model, I do not agree with the appellant that companies ought to be held as incomparable merely because they outsourced some or most of their tasks and had not hired their own employees, if they passed the other filters including functionality. Reliance by the appellant on the decision in ACIT v. M/s. Maersk Global Service Center (India) P. Ltd. (supra) does not help, as the hon'ble ITAT had actually remanded the case and had only referred to the respondent's argument that companies that had outsourced a considerable portion of their business needed to be excluded from comparison. M/s Wipro Ltd. 40. The appellant has pointed out that M/s Wipro Ltd. was 460 times bigger than itself and Wipro was thus significantly dissimilar in size. 41. I have already held in the preceding paragraphs that M/s Wipro Ltd. cannot be considered as comparable to the appellant company in view of the fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lude companies with export turnover of less than 25% of turnover. Therefore, its suggestion to reject companies with exports of more than 75% of revenue is superfluous. As the export revenue of this company was 44% of revenue by the appellant's own admission, there is no doubt that the export turnover was satisfied in this case. 45. The appellant's contention with regard to the RPT filter is also questionable, as one cannot assume on the basis of a preceding year's RPT information emanating from the case law cited by the appellant that RPT was more than 25% in the current year as well. However, I am in agreement with the appellant that in the absence of specific and correct information, it would be safer to exclude the company from comparison. I therefore direct the AO to exclude this company from the final set of comparables. M/s Saffron Global Ltd. and M/s Transworks Information Services Ltd. 46. The appellant has sought the exclusion of these two companies on the ground that their turnover was more than 20 crore. 47. I do not accept the appellant's contention as it goes against the basis laid down in Genisys Integrating Systems ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n respect of the services rendered to the Assessee's Goa plant at the same rate at which services were rendered to the AE abroad, the operating profit would have come @ 26.06%. It was contended that on an average the revenue has been received from the AE abroad @ ₹ 452/- as the CDR unit has spent 29,685 hrs. while to the Goa unit, the services were rendered for 4,870 hrs. If the said 4,870 hrs. are taken into consideration, the revenue from the entire division would have been ₹ 22,01,240/-. Thus, it was contended that there cannot be any addition as the operating margin in the case of the Assessee would have come to more than 26% while the TPO has calculated the margin at 23.68% and made addition on that basis while the CIT(A) has reduced it to 20.96%. It was contended that the Assessee has selected a set of 4 comparable companies. The average operating profit to operating percentage on the basis of the selection of the comparative companies was 10.04%. The list of the comparative companies is as under : Sl. No. Company Name Turnover (INR in Crs) Operating Cost (INR in Crs) Operating Mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1. Allsec Technologies Limited 57.76 26.91% Objection of Appellant -There was a calculation mistake in the computation of Operating margin by TPO. TPO calculated margin percentage @ 29.85% while the correct calculation comes to 26.91%. It was pointed out by appellant to CIT(A) and he agreed to correct it. (para 32 33 of appeal order). Relief was granted by CIT(A). 2 Saffron Global Ltd 27.78 24.88% No issue 3 Vishal Information Technologies Ltd 20.82 45.62% Objection of Appellant - Company's business model is different from that of assessee and the selected company had super profit. But CIT (A) did not agree to the objection of the appellant. Company enjoying tax free platform income exempt u/s 10A. Relief was denied by CIT(A). 4 Cosmic Global Ltd 1.9 17.02% Objection of Appellant - Company's business model is different from that of a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Arithmetic Mean 21.96% 5.1.2 He further pleaded that the TPO has selected companies that are economically and functionally different from that of the Assessee. The comparison should be made with like size companies. Wipro is having turnover more than ₹ 617 crores while the Assessee is having turnover of ₹ 1.34 crore. The Assessee requested the CIT(A) to consider only the companies which have a turnover from ₹ 1 - 20 crores. CIT(A) agreed with the upper filter but without specifying the limit. Size as criteria for comparison is also recommended by OECD in its TP guidelines, 2010. For this, attention was drawn towards para 3.43 of chapter on guidelines dealing with selecting or rejecting potential comparables. The ld. AR also relied in this regard on the following decisions of the Tribunal in which criteria of size has been recognised as one of the selection criteria : (i) DCIT vs. Quark Systems Pvt. Ltd., 2010-TIOL-31-ITAT-CHD-SB (ii) Genisys Integrating Systems (India) (P.) Ltd. v. DCIT [2012] 20 taxmann.com 715 (Bang.) Super profit making companies to be excluded. (iii) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... action between independent enterprises. For the purpose of such comparison, economically relevant characteristics must be sufficiently comparable. Two parties are to be placed in similar situation to make the comparison of like with like possible. It was submitted that two companies should be rejected on account of practising of different business model namely, Vishal Information Technologies Ltd. and Tulsyan Technologies Ltd. (earlier Cosmic Global). Both these companies have adopted business model of outsourcing its jobs. Super high profit company, Vishal Information Technologies Ltd. should also be ignored. In this regard reliance was placed on the following cases : (i) ACIT v. Maersk Global Services Centre (ITA No. 3774/M/2011 CO 111/M/2011) 48. Insofar as the cases of Tulsyan Technologies Limited and Vishal Information Technologies Limited are concerned, it is noticed from their annual accounts that these companies outsourced a considerable portion of their business. As the assessee carried out entire operations by itself, in our considered opinion, these two cases were rightly excluded. (ii) Sapient Corporation Pvt. Ltd. vs. DCIT (ITAT Delhi) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5 Transworks Information Services Ltd 108.23 2.81% 2.81% 2.81% 6 Wipro BPO Solutions Ltd 617.71 18.59% 7 Ace Software Exports Ltd 5.9 14.50% 14.50% 14.50% 8 Nucleus Netsoft GIS Ltd 2.79 40.06% 9 Maple E Solutions Ltd 1.47 28.75% Arithmetic Mean 24.68% 21.96% 14.74% It was further submitted that the CDR unit of the Assessee company is a captive service providing unit. It bears less than normal risk which an independent enterprise bears. There is no market or technology risk in case of the Assessee's unit whereas they exist in the normal business and therefore normal business enterprises due to the risk have to cha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... other unit in Goa. We also noted that the TPO has considered the total operating costs of the CDR unit which has been incurred by the unit not only in respect of services rendered to the associated concerns outside India but also in respect of services rendered to the unit in India and on that basis the operating profit was worked out in the following manner : S.No. Particulars Amount in INR 1 Revenue from Export of services 1,34,20,939 2 Operating Cost 1,23,92,372 3 Operating Profit 10,28,567 4 Operating Margin (OP/OC) 8.30% It is not denied in this case that the CDR unit was rendering services not only to the associated enterprises outside India but also was rendering services to the other divisions of the Assessee company. No nominal value has been assigned in respect of the services rendered by the CDR unit to the Indian division. The CDR unit has rendered services to the AE units abroad for 29685 hrs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8.30% 26.06% Thus, if notional revenue is assigned to the services rendered by the CDR unit to the Goa plant and taken into account, the net operating profit will be 26.06% which is much more than the margin calculated by the TPO. The TPO, in this case, we noted, has calculated the margin at 23.68%. Therefore, even if we reject all the submissions of the Assessee so far as selection of the comparable is concerned, in our opinion, in this case no addition can be made or sustained. On this basis itself, in our opinion, no addition in respect of IT-enabled engineering services can be made. We have also gone through the other submissions of the Assessee which relate to the selection of comparables. We find the submissions made by the assessee are duly supported by the various case laws on which the Assessee has relied but since in this case even on the basis of the operating profit, in our opinion, no addition can be sustained, we, therefore, are not taking into consideration the other submissions of the Assessee. We, accordingly, allow the ground nos. 2 to 7 of the Assessee and dismiss ground nos. 1 to 4 of the Revenue taken in the grounds of appe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenses to revenue [(1)/(4)] % 17.64 The AO relied on the order of the CIT(A) for the preceding A.Y 2004-05 which was confirmed by the ITAT. Ultimately, on the basis of the A.Y 2004-05 an adjustment of 19.35% was claimed in the following manner : 1. Non-AE export sales (Rs.) 23,21,91,702 2. Non-AE domestic sales (Rs.) 21,27,38,585 3. Commission income from AEs (Rs.) 2,02,65,126 4. Expenses of marketing office in Dubai (Rs.) 2,52,83,510 5. Expenses of marketing representative in Europe (Rs.) 54,07,237 6. Expenses of international marketing from India office (Rs.) 1,81,57,262 7. Total expenses on international marketing [(4+5+6)] (Rs.) 4,88,48,009 8. Ratio of international marketing expenses to international sales (%) [(1+3)/7] 19.35 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncurred by the appellant only in Dubai office, while the CIT(A)'s direction was to adopt total marketing expenses, including those incurred in the company's European and Indian offices. Secondly, the TPO had netted off the Dubai office expenditure against the Dubai office income, without considering the ratio of total marketing expenses to total non-AE export sales as directed by the CIT(A). 17. That there is merit in the appellant's contention seeking a higher rate of adjustment was accepted by CIT(A) in AY 2004-05, following which an upward adjustment was made in that year from 4.39% to 14.80%. As the facts and circumstances of the case are identical in the current year, the same principle needs to be followed. Therefore, considering the merit of the appellant's contentions and the TPO's remand report, I direct the AO to allow an adjustment of 12.31% for marketing expenses consistent with the CIT(A)'s direction. However, the AO may thoroughly verify the correctness of the relevant data before allowing relied as directed above. 6.2 The ld. DR relied on the order of the TPO while the Assessee relied on the order of CIT(A). 6.3 We have heard th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts listed in Annexure-5 where prices paid to the AEs happened to be higher than those paid to local vendors, but has simply ignored 11 other products where prices paid to the AEs happened to be much lower than domestic prices. If the average of prices paid for all the 19 products were considered, it turns out that the average price paid for imports was much lower at ₹ 195.58 than the average price of ₹ 204.68 paid to local vendors. 25. Thus, I find that the TPO's analysis in this segment suffers from factual errors, inconsistency in considering only a part of the transactions, and a bias against the appellant, which render the analysis unreliable. Further, purchases of components and spares from AEs constituted an insignificant 3% of the total purchases and one cannot argue that the appellant had understated its purchases of the value of ₹ 3 crore by ₹ 1 lakh for the purpose of shifting of profits outside India. For these reasons, I delete the addition of ₹ 1,07,017 on account of TP adjustment on import of components and spares. 7.2 We have heard the rival submissions and carefully considered the same alongwith the order of the tax auth ..... X X X X Extracts X X X X X X X X Extracts X X X X
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