9911796707
TMI Blog2014 (12) TMI 894X X X X Extracts X X X X X X X X Extracts X X X X ..... Method (TNMM) as the most appropriate method with the Profit Level Indicator (PLI) of Operating Profit to Total cost (OP/TC). As against its PLI at 5.62%, the assessee showed weighted PLI of seven comparable companies at 9.18%. The Transfer Pricing Officer (TPO) did not treat two companies as comparable, namely, Mapro Industries Ltd. and Nucleus Netsoft and GIS India Ltd., for the reasons given in his order. He worked out OP/TC of the remaining five companies at 18.46%, which resulted into eventual addition on account of Transfer pricing adjustment amounting to Rs. 13,40,26,353/-. 3. The assessee challenged the said addition of Rs. 13.40 crore before the ld. CIT(A). After considering various objections raised by the assessee, the ld. CIT(A) held that the only current year's data was to be used; the two companies excluded by the TPO were liable to be included in the list of comparables; one company, namely, Giltedge Infotech Services Ltd., was not comparable; arithmetic mean of the operating profit margin, after adjustment of working capital differences, was to be computed and considered; and the assessee was entitled to + 5% adjustment in terms of the proviso to section 92C of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparables. The question of adjudicating such issue would arise only if there, in fact, exists some difference in the rates at which the assessee charged depreciation vis-a-vis its comparables. In this regard, it is noticed that the assessee charged depreciation in its Profit & Loss account to the tune of Rs. 19,49,90297/-. Schedule of Fixed assets is available on page 115 of the paper book, indicating Opening balance of the assets, Additions, Disposals/ adjustments and Closing balance. Similarly, the amount of Opening depreciation, Disposal/adjustments and Depreciation for the year under consideration have also been given. It can be seen from Note 2(a) of "Notes to the Financial statements", a copy of which is available on page 112 of the paper book, that: "Depreciation on fixed assets is provided pro-rata to the period of use, based on the straight-line method at the rates specified in Schedule XIV of the Companies Act, 1956, or based on the management's assessment of the economic useful life of the asset, whichever is higher', as follows : - Leasehold improvements 33.33% Plant and machinery (including computers) 33.33% Office Equipment 20.00% - 33.33% Furniture and fixtu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ok. On a perusal of the rates on which depreciation has been charged by this company under SLM, it can be seen that albeit some of the depreciation rates accord with those prescribed in Schedule XIV, but, there is difference in some cases e.g. Air Conditioner has been depreciated at 6.33% whereas the general rate of depreciation on plant & machinery under Schedule XIV is 4.75%. Similar is the position regarding EPABX and Fax on which the company charged depreciation under SLM at 6.33%, whereas the rate prescribed under Schedule XIV is 4.75%. There are some other items also on which the rates of depreciation charged by this company are at variance with the rates given under Schedule XIV of the Companies Act. 5.7. The next company is Ace Software Exports Ltd. Annual accounts of this company indicate through Notes to accounts that it provided depreciation on SLM in accordance with the rates specified in Schedule XIV of the Companies Act. The next company is Nucleus Netsoft and GIS India Ltd. Notes to account of this company show that it also provided depreciation on SLM at the rates prescribed under Schedule XIV of the Companies Act, except for Computers on which depreciation was pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction. 5.11. A perusal of the above rule divulges that sub-clause (i) of Rule 10B(1)(e) provides for determining the net operating profit margin realised by the assessee from its international transaction. Sub-clause (ii) talks of c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t carrying out any adjustment on account of difference in depreciation. 5.13. There can be no dispute on the principle that calculation of 'Operating profit' as envisaged under Rule 10B(1)(e) embraces cumulative effect of all the items of income and expenses which are of operating nature. Ordinarily, there can be no question of considering each item of such operating expenses or income in isolation de hors the other expenses to claim adjustment on the ground of such expenditure or income of the assessee on the higher side seen individually or as a percentage of other operating expense/incomes in comparison with its comparables. The reason is obvious that when we consider the operating profit margin, the effect of all the individual higher or lower items of expenses or incomes gets submerged in the overall operating profit margin, ruling out the need for any adjustment on one-to-one comparison. One company may have taken a building on rent for carrying on its business, in which case, it will pay rent which will find its place in the operating costs. For the purposes of making comparison, one cannot contend that the payment of rent by one enterprise in comparison with a non-payment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h higher percentage of depreciation to total expenses is marginalized by the lower percentage of repairs and other incidental costs of the assets and vice versa. 5.14. However, the position may be a little different when there is a difference in the rates of depreciation charged by two companies on similar category of assets. One company may adopt the policy of charging depreciation on its assets in conformity with the rates prescribed in Schedule XIV of the Companies Act and other company may adopt a policy of charging depreciation at the higher rates or lower than those prescribed under Schedule XIV. This can be demonstrated with the help of an example. Other things being equal, if the operating profit of company A, after claiming depreciation of Rs. 10 on the value of asset worth Rs. 50 with rate of depreciation 20%, is Rs. 100, the operating profit of company B with everything same including the value of assets at Rs. 50, but with rate of depreciation 30%, will be Rs. 95. It shows that the comparability is jeopardized due to higher rate of depreciation charged by company B at 30% in comparison with lower rate of depreciation charged by company A at 20%. In such a situation, al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e companies with depreciation higher or lower than a particular percentage of total costs.'. It is, thus, overt that these two cases relied by the ld. DR, in fact, support the case of the assessee rather than the Revenue. 5.17. Another case relied by the ld. DR in 24/7 Customer Com Pvt. Ltd. VS. DCIT 2012-TII-143-ITAT-BANG-TP, again does not take us any further. In that case, the assessee raised an additional ground for suitable adjustment towards higher rate of depreciation charged by the assesee vis-a-vis its comparbles. It is patent from the penultimate para of this order that the tribunal eventually remitted the issue of depreciation, as raised through the additional ground, to the file of the AO/TPO for a fresh consideration and decision. So, this order also does not support the case of the Revenue. The last case relied by the ld. DR is Lason India Pvt. Ltd. VS. ACIT 2012-TII-47-ITAT-MAD-TP. The assessee in that case provided depreciation on assets under SLM at the rates higher than those provided in Schedule XIV, whereas the comparables provided for depreciation as per Income-tax Rules on written down value method. The assessee claimed before the tribunal that if depreciatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng of adjustment to the net profit margin of the comparables determined under sub-clause (ii) to Rule 10B(1)(e). Even Rule 10B(3) also requires the making of adjustment in the hands of comparables to eliminate the material effects of differences. Thus, the adjustment can be made only in the hands of the comparables' operating profit margin and not to that of the assessee. 5.20. The ld. DR pleaded for not allowing any adjustment on this score by arguing that the difference in the rates of depreciation by the assessee and comparables does not affect the computation of the net operating profit margin on a long term basis. He stated that the higher rates of depreciation would no doubt lower the profit in the earlier years, but such reduction of profits would be set off with the higher amount of profit due to lower amount of depreciation in the later years, thereby, nullifying the effect of such higher rate of depreciation over the life time of an asset. Asserting on this argument, the ld. DR stated that no adjustment could be accordingly allowed. 5.21. This contention, in our considered opinion does not move forwards the case of Revenue for the reason that Chapter X of the Act requir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... continue to hold assets in 4th, 5th and 6th year as well and the amount of depreciation in these three years will also be at 16.21% despite the fact that this particular asset has exhausted its useful life after three years as has been done by the assessee. This proposition, in the opinion of the ld. DR, warranted reduction in the amount of depreciation of comparables companies to the extent of 16.21% of the value of such asset from 4th to 6th years. It was thus pleaded that if some adjustment is to be allowed in favour of the assessee in line with the above arguments of the ld. AR, then a simultaneous negative adjustment on account of the above factor should also be directed. 5.22.2. This contention advanced on behalf of the Revenue can be properly appreciated if one understands the striking dissimilarities between the scheme of charging depreciation under the Income-tax Act, 1961 and the Companies Act, 1956. The concept of block of assets exists under the Act by which all the assets of a particular species having the same rate of depreciation are considered together as one unit. This can be seen from sec. 2(11) of the Act, which defines "block of assets" to mean 'a group of ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the written down value of such block and not the w.d.v. of such individual assets. Even the event of their transfer also does not lead to automatic charging of capital gains, unless the case falls under either of two clauses of section 50. Assessee gets depreciation on the w.d.v. of such assets, which stand merged with the w.d.v. of the block, even after their transfer, of course subject to the provisions of section 50 and other relevant sections. 5.22.3. Now let us examine the position under the Indian Companies Act, 1956. Section 349 deals with the determination of net profits. Sub-section (1) provides that in computing the net profits of a company in any financial year, : '(a) credit shall be given for the sums specified in sub-section (2) and credit shall not be given for those specified in sub-section (3); and (b) the sums specified in sub-section (4) shall be deducted, and those specified in sub-section (5) shall not be deducted.'. Clause (k) of sub-section (4) states that deduction shall be allowed for 'depreciation to the extent specified in section 350'. The later section, in turn provides that: 'The amount of depreciation to be deducted in pursuance of clause (k) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l year in which the asset is sold or discarded. In the converse situation, where the amount for which any fixed asset is sold exceeds the written-down value thereof referred to in section 350, then credit shall be given for so much of the excess, to the extent provided, as is not higher than the difference between the original cost of that fixed asset and its w.d.v. in the year of its sale. These two situations can be demonstrated with the help of a simple example. If asset A with original cost of Rs. 100 having w.d.v. of Rs. 40 is sold for Rs. 50, then the profit of Rs. 10 is to be credited to the Profit and Loss account for the year of sale of such asset. If asset A with original cost of Rs. 100 having w.d.v. of Rs. 40 is sold for Rs. 30, then the loss of Rs. 10 is to be debited to the Profit and Loss account for the year of sale/scrapping of such asset. 5.22.5. On a comparative study of the scheme for charging depreciation and treatment of profit/loss on the sale of specific assets under both the statutes, we observe that whereas, the Act does not recognize individual assets for the purposes of allowing depreciation and grants depreciation on the block of assets, the Companies ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar(s). 5.23. Turning to the facts of the instant case, we find that the method of charging depreciation, both by the assessee and its comparables, is by and large the same that is SLM. The assessee is seeking adjustment only due to higher rates of depreciation charged by it under SLM with the lower rates of depreciation charged by four comparable companies, other than Mapro Industries Ltd. and Karvy Consultants Ltd. In view of above discussion, we hold that the operating profit margins of these four comparable companies should be recomputed by the TPO/AO in line with the rates of depreciation charged by the assessee under SLM. To put it simply, the amount of depreciation of the four comparable companies on their assets shall also be recomputed under the SLM alone as per the rates at which the assessee has provided depreciation. In doing so, if the comparable companies have charged depreciation at a lower rate in comparison with the assessee, then suitable increase should be made to their amount of depreciation and if the comparables have charged depreciation at a higher rate in comparison with the assessee on some of the assets, then suitable reduction should be made in the amount ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sed this contention. 6.2. After considering the rival submissions and perusing the relevant material on record, we note from page 14 of the assessee's TP study report that the foreign AE is to identify and pursue customers in the US; enter into contract with the clients; and undertake responsibility for the quality of services. At the same time, it is apparent from the same TP study report that though the assessee is not liable to end-customers, but it is required to adhere to the group standards. A very important factor is the 'Utilisation risk'. The assessee is responsible for effective utilization of its resources and its foreign AE did not assure the assessee of a minimum level of utilization. Thus, it is clear that the assessee bears excess capacity or utilization risk in respect of the provision of services. It means that the assessee is responsible for effective utilization of its resources and there is no assurance of the volume of business generating from its AE. If there is no/less business, the assessee will continue to incur costs for which there will be no compensation from the AE. Apart from that, the assessee also bears foreign exchange fluctuation risk because it i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s not substantiated with any worthwhile evidence. In such circumstances, we are unable to allow any risk adjustment in the operating profit margins of the comparables on this score. III. WHETHER NO T.P. ADJUSTMENT BECAUSE OF THE GROUP SUFFERING LOSS 7.1. The ld. AR took up still another legal issue contending that the transfer pricing adjustment should be restricted to the overall profit at the group level. He put forth that since the overall EXL Group suffered losses, no TP adjustment should be sustained. To buttress this contention, he highlighted the background leading to the introduction of Chapter-X in the Act by which shifting of profits from Indian jurisdiction to outside jurisdictions was proposed to be checked. Relying on some Tribunal orders, the ld. AR argued that the transfer pricing adjustment cannot be made when the overall group is in loss. It was frankly accepted that this issue was not taken up before the authorities below and it is for the first time that the assessee raised it before the Tribunal. Referring to certain additional evidence in the shape of copy of consolidated financial statements of EXL Services.com, Inc., and EXL Service Holdings, Inc., the ld. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ALP/TP adjustment. It is quite possible that some of the associated enterprises of the overall group may suffer loss due to their own inefficiencies and wrong business decisions and the consequences of such wrong decisions taken by them cannot be allowed to affect the ALP of the international transaction undertaken by the assessee in India. This can be illustrated with the help of an example in which there are three AEs, viz., AE-A in India (with profit of Rs. 100), AE-B in Pakistan (with loss of Rs. 150) and AE-C in UK (with profit of Rs. 25). If AE-B supplies goods worth Rs. 50/- to AE-A at Rs. 60, then, the otherwise TP adjustment of Rs. 10 (Rs60-Rs50) in the hands of AE-A cannot be aborted simply for the reason that the group as a whole incurred loss of Rs. 25/- (Rs100-Rs150+Rs25). The Chapter-X requires the computation of income of AE-A in India at Rs. 110/- with transfer pricing adjustment of Rs. 10/-. The simple fact that AE-B incurred loss can be no reason to stop the Indian authorities from making TP adjustment of Rs. 10/- in the hands of AE-A, which is otherwise well deserved and rightly called for in conformity with the relevant provisions. Thus, it is crystal clear tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e reasons given by the company in its Annual report for next year, a copy which is available on pages 178 onwards of the paper book. In his message to the shareholder, the Managing Director of the company stated that the year ending 31st March 2004 (i.e. succeeding year) was a year of consolidation in which it "sacrificed immediate profits for much larger gains by preparing ourselves for future growth". The Annual report of this company for the next year indicates that it developed its own intangibles in such next year. These factors indicate that financial year 2003-04 relevant to assessment year 2004-05 was abnormal for Fortune Infotech Ltd. But for that, its profit progressed from assessment year 2002-03 to assessment year 2003-04 in question. 8.4. Reference to the Tribunal order in the case of 24/7 Customer (supra), for seeking exclusion of Fortune Infotech Ltd., is again misplaced. The palpable reason for our this conclusion is that the Tribunal order in that case is for the assessment year 2004-05 and we have noticed from the Annual report of this company that it was an abnormal year of its operations in which it sacrificed immediate profits for larger gains in future by dev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 10.2. Briefly stated, the facts of these grounds are that the assessee created provision for expenses to the tune of Rs. 5,18,03,004/- and claimed deduction for the same. As the assessee failed to furnish specific bills for which the above provision was made, the AO made addition of equal sum. The ld. CIT(A) observed that the assessee was not provided adequate opportunity of adducing necessary evidence in support of its claim of provision for expenses. After considering the relevant material furnished by the assessee, the ld. CIT (A) deleted addition of Rs. 4.85 crore for which the invoices were available. As regards the remaining amount of Rs. 32.08 lac for which the invoices were not available, the ld. CIT (A) sustained the addition. The assessee is aggrieved against the sustenance of addition to this extent. 10.3. After considering the rival submissions and perusing the relevant material on record, it is observed that the assessee is constantly making provision for expenses on year-to-year basis on the estimate of reasonable expenses incurred but the bills not received up to the year-ending. When in the subsequent year, the bills are received, such provision is reversed. If ..... X X X X Extracts X X X X X X X X Extracts X X X X
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