Vildirect: IncomeTax-caselaws-2018-VIL-1671-ITAT-DEL

2018-VIL-1671-ITAT-DEL

Income Tax Appellate Tribunal DELHI

ITA No.7549/Del/2017

Date: 14.05.2018

LI AND FUNG (INDIA) PVT. LTD.

ACIT, CIRCLE-15 (2) , NEW DELHI

For The Assessee : Sh. Porus Kaka, Sr. Adv. Sh. Neeraj Jain, Adv. Sh. Manish Kaut, Adv. , Sh. Ramit Katyal, CA
For The Revenue : Sh. Kumar Pranai, Sr. DR

BENCH

SH. N.K.SAINI, ACCOUNTANT MEMBER AND SH. SUDHANSHU SRIVASTAVA, JUDICIAL MEMBER

JUDGMENT

PER SUDHANSHU SRIVASTAVA, JUDICIAL MEMBER :

This appeal is preferred by the assessee against the final assessment order dated 23.10.2017 passed subsequent to the directions of the Ld. Dispute Resolution Panel (DRP), New Delhi for assessment year 2013-14.

2. The brief facts of the case are that the assessee is engaged in the business of providing sourcing support services. The assessee is a subsidiary company of Li & Fung (South Asia) Ltd. The assessee provides services to the group companies for supply of high volume, time sensitive consumer goods. It is paid sourcing service charges at cost plus mark up of 8%.

2.1 During the year under consideration, the assessee had entered into the international transaction of providing support services for sourcing of garments, handicrafts, leather products, etc. amounting to Rs. 147,05,72,472/- with its associated enterprises (AE). For the purpose of benchmarking the said transaction of sourcing services, Transactional Net Margin Method (TNMM) was considered to be the most appropriate method with operating profit to cost (OP/OC) as the Profit Level Indicator (PLI). Six companies were selected by the assessee as comparables for the purpose of benchmarking the international transaction of the provision of sourcing support services. The PLI of the assessee company was computed by the assessee at 7.92% whereas the average PLI of the comparables was computed at 3.76% as per the analysis in the transfer pricing document. Reference was made to the Transfer Pricing Officer (TPO) and a new search process was conducted with the final list having seven comparables and the PLI was computed at 14.35%. After considering the submissions of the assessee, the TPO proposed an adjustment of Rs. 5,75,92,477/- as an adjustment u/s 92CA of the Income Tax Act, 1961 (hereinafter referred to as the ‘Act’).

2.2 Aggrieved, the assessee approached the Ld. DRP and challenged the action of the TPO. The assessee’s thrust before the Ld. DRP in its objection was that the TPO had selected three companies as comparables in the final list of comparables which were functionally dissimilar companies as compared to the assessee, they being Axis Integrated Systems Ltd., B.V.G. India Ltd. and HGS Business Services Pvt. Ltd. The assessee also objected to the action of the TPO in not making working capital adjustment in the operating margins of Axis Integrated Systems Ltd. It was also objected by the assessee before the Ld. DRP that the TPO had wrongly considered miscellaneous expenses to be in the nature of non-operating expenditure.

2.3 The Ld. DRP, in its directions directed that BVG India Ltd. should be excluded but Axis Integrated Systems Ltd. and HGS Business Services Pvt. Ltd. be retained. The Ld. DRP also directed that the adjusted margins should be applied after taking miscellaneous expenses as operating expenditure in the comparables and further miscellaneous income should be treated as operating income in the case of comparables.

2.4 Now the assessee has approached the ITAT and has challenged the final order of assessment passed subsequent to the directions of the Ld. DRP and has raised the following grounds of appeal :-

1. “ That the assessing officer('AO’) erred on facts and in law in completing assessment under section 144C/143(3) of the Income-tax Act, 1961 (‘the Act’) at an income of Rs. 19,77,53,940 as against the income of Rs. 13,33,48,420 returned by the appellant.

2. That the AO/TPO erred on facts and in law in making an adjustment of Rs. 6,44,05,518 to the arm’s length price of the ‘international transaction of Provision of sourcing support Services on the basis of the order passed under section 92CA(3) of the Act by the TPO.

2.1 That the AO/TPO/Dispute Resolution Panel (‘DRP’) erred on facts and in law in not appreciating that the international transaction of Provision of procurement support services was at arm’s length and no adjustment to the price thereof was called for being made.

2.2 That the AO/TPO erred on facts and in law in considering Axis Integrated Systems Ltd as comparable not appreciating that the said company is an accredited agency for issuing digital certification and therefore cannot be regarded as functionally comparable to the appellant in terms of Rule 10B(2) of the Income Tax Rules, 1962(‘Rules’).

2.3 That the DRP erred on facts and in law in excluding ICRA Management Consulting Services Ltd. as comparable observing that “the company has a totally different FAR from the Assessee” ignoring the fact that the said company is engaged in providing business support services of consultancy in the area of transportation and development as well as skill development.

2.4 That the DRP erred on facts and in law in excluding ICRA Management Consulting Services Ltd. as comparable ignoring the fact that the said company has been accepted by the TPO as comparable in the current as well as in the preceding year.

2.5 That the DRP erred on facts and in law in excluding ICRA Management Consulting Services Ltd on the basis that the said company is engaged in providing consultancy services and at the same time accepting HGS Business services Pvt Ltd, a company engaged in provision of consulting services, as comparable.

2.6 That the DRP erred on facts and in law in suo-motto excluding ICRA Management Consulting Services Ltd. as comparable without confronting the assessee by issuing a show cause notice in terms of section 92C(3) of the Act allowing an opportunity of being heard to the appellant.

2.7 That the Transfer Pricing Officer erred on facts and in law in considering ‘Excess Provision Written Back’ of Rs. 53,25,212 being the charge to the Profit & Loss in earlier years and now written back, as operating income in the relevant year for computing the operating margin of APITCO Ltd.

2.8 That the Transfer Pricing Officer erred on facts and in law in incorrectly computing the operating margins of the following companies :

*S. N0.*	*Company Name*	*Margins as per TPO*	*Correct Margins*
1	Axis Integrated Systems Ltd.	33.54%	32.81%
2	Cameo Corporate Services Ltd.	3.83%	1.65%
3	HGS Business ServicesPvt. Ltd.	12.76%	11.95%

3. Without prejudice that the assessing officer/TPO erred on facts and in law in rejecting the claim of risk adjustment holding that the appellant has not produced any details of the risk profile of the comparables without appreciating that the appellant being a risk immune captive service provider was eligible for such adjustment.”

3. The Ld. Authorised Representative submitted that although numerous grounds have been raised by the assessee, the assessee was essentially challenging the inclusion of one comprable M/s. Axis Integrated Systems Ltd. as a comparable. It was further submitted that if this comparable is excluded from the set of comparables, other grounds raised by the assessee will be come academic in nature in view of the fact that the assessee’s PLI will be within plus/minus 5% range

3.1 The Ld. Authorised Representative submitted that Axis Integrated Systems Ltd. was engaged in the business of issuing digital certification and, therefore, it was not functionally comparable with the assessee company. It was further reiterated that the assessee company, on the other hand, provided sourcing support services for supply of high volume, time sensitive consumer goods. It was submitted that even the TPO had observed in Para 7 of his order that the assessee was in the business of providing support services and, therefore, for benchmarking purposes, the comparables engaged in business of support services are to be considered. It was further submitted that the assessee was a captive service provider and did not operate as a stand alone business arm.

3.2 The Ld. Authorised Representative drew our attention to the FAR analysis of the assessee company and submitted that the activities and business profile of the assessee were completely different from that of Axis Integrated Systems Ltd. Our attention was also drawn to the annual report of Axis Integrated Systems Ltd. wherein in the Notes forming part of the financial statements it has been mentioned that Axis Integrated Systems Ltd. was engaged in the business of trading in digital certificates and providing liaisoning services such as verification of service tax, Excise, NCBD documents etc. The Ld. Authorised Representative, while drawing attention to the annual accounts of the assessee company as well as those of Axis Integrated Systems Ltd., also submitted that in the profit and loss account it was evident that there was huge increase in the expenses from the earlier year in the case of Axis Integrated Systems Ltd. which was not explainable. It was also submitted that no segmental information was available in the case of Axis Integrated Services Ltd. and a very huge amount had been shown under ‘other expenses’. It was also pointed out that the assessee’s employee cost was high whereas in the case of Axis Integrated Systems Ltd. it was low.

3.3 The Ld. Authorised Representative also placed reliance on the judgment of the Hon’ble Delhi High Court in the case of Rampgreen Solutions Pvt. Ltd. vs. CIT report in 377 ITR 533 (Delhi). It was submitted that as per the judgment of the Hon’ble Delhi High Court it was settled that while selecting comparable transactions or entities, the basis should be one of similarity with the controlled transaction/entity and mere broad similarity is not sufficient. The Ld. Authorised Representative submitted that even while adopting the TNMM method, the standard for selection of the comparable transactions/entities cannot be diluted. Reliance was also placed on another judgment of Hon’ble Delhi High Court in the case of Avenue Asia Advisors Pvt. Ltd. vs. DCIT in ITA no. 350/2016. The Ld. Authorised Representative prayed that this comparable should be excluded from the final set of comparables.

4. In response the Ld. Sr. DR placed extensive reliance on the observation and findings of the TPO as well as the directions of the Ld. DRP in respect of Axis Integrated Systems Ltd. and vehemently argued that under the TNMM method only a broad functional similarity is to be considered and that there can be no exact comparable in the case of any company. It was submitted by the Ld. Sr. DR that this company should be retained as a comparable.

5. We have heard the rival submissions and have also perused the material on record. A perusal to the FAR analysis of the assessee company shows that the assessee is a routine captive sourcing service provider for Li & Fung and its group companies and assumes limited risk. The services provided by the assessee are in the nature of business support services. Admittedly and undisputedly, there is no dispute regarding the functional profile of the assessee and nor has the department questioned the action of the assessee in applying the TNMM as the most appropriate method. On the other hand, Axis Integrated Systems Ltd., as per the company’s profile, is engaged in the business of issuing digital certification. It is also the matter of record that the financial statements of this company were not available in the public domain at the time when this company was selected as a comparable. The Ld. DRP in its directions has held that there was a broad similarity in the functionality as both the companies were providing business support services. However, the Ld. DRP has not elaborated as to how it has reached the conclusion that there was a broad functional similarity between the assessed company and Axis Integrated Systems Ltd. The TPO has mentioned that Integrated Axis Systems Ltd. is engaged in liaisoning services which is in the nature of business support services and exactly resembles the functional profile of the assessee. However, we find that the Ld. DRP as well as the TPO have overlooked the essential requirement that even under TNMM the standard for selection of the comparable transactions cannot be diluted. The Hon’ble Delhi High Court in the case of Rampgreen Solutions (supra), had specifically rejected the proposition that broad functionality was sufficient to find the comparable entity and that the TNMM method allows broad flexibility tolerance in the selection of comparables. The Hon’ble Delhi High Court in paragraph 43 and 44 held as under :-

“43. In our view, the aforesaid approach would not be apposite. In so far as identifying comparable transactions/entities is concerned, the same would not differ irrespective of the transfer pricing method adopted. In other words, the comparable transactions/entities must be selected on the basis of similarity with the controlled transaction entity. Comparability of controlled and uncontrolled transactions has to be judged, inter alia, with reference to comparability factors as indicated under rule 10B(2) of the Income Tax Rules, 1962. Comparability analysis by the transactional net margin method may be less sensitive to certain dissimilarities between the tested party and the comparables. However, that cannot be the consideration for diluting the standards of selecting comparable transactions/entities. A higher product and functional similarity would strengthen the efficacy of the method in ascertaining a reliable arm’s length price. Therefore, as far as possible, the comparables must be selected keeping in view the comparability factors as specified. Wide deviations in profit level indicator must trigger further investigations/analysis.

44. Consideration for a transaction would reflect the functions performed, the significant activities undertaken, the assets or resources used/consumed, the risks assumed. Thus, comparison of activities undertaken /functions performed is important for determining the comparability between controlled and uncontrolled transactions/entity. It would not be apposite to ignore functional dissimilarity only for the reasons that its impact may be reduced on account of using arithmetical mean of the profit level indicator.”

5.1 Further the Hon’ble Delhi High Court in the case of Avenue Asia Advisors Pvt. Ltd. vs. DCIT in ITA 350/2016, while considering and approving Rampgreen Solutions (supra) laid down the following steps that ought to be undertaken in identification of comparable transactions/entities.

• The principle governing the identification of comparable transactions would be the same, irrespective of whichever transfer pricing method is adopted.

• Comparable transactions must be selected on the basis of a similarity with the controlled transaction/entity.

• Rule 10B(2) of the Income Tax Rules, 1962 ought to be borne in mind while choosing the factors of comparability in respect of uncontrolled transactions.

• Even while adopting the TNMM method, the standard for selection of the comparable transactions/entities cannot be diluted.

• Wide deviation in the Profit Level Indicator (‘PLI’) would require further investigation/analysis.

• For comparison of transactions, factors such as the nature of capital, resources used, the risks assumed, etc. ought to be considered.”

5.2 We do not agree with the findings of the lower authorities that a captive sourcing service provider like the assessee can be considered functionally similar to a company providing liaisoning services like Axis Integrated Systems Ltd. Considering the functional dissimilarity between the assessee company and Axis Integrated Systems Services Ltd., we are unable to persuade ourselves to agree with the directions of the Ld. DRP in retaining this company as a comparable. In the backdrop of the principles laid down by the Hon’ble Delhi High Court in Rampgreen Solutions (supra) and respectfully following the same it is our considered opinion that Axis Integrated Systems Ltd. cannot be considered as functionally similar to the assessee company and, accordingly, the same needs to be excluded from the final set of comparables. We direct that Axis Integrated Systems Ltd. be excluded from the final set of comparables.

5.3 As it has been stated by the Ld. Authorised Representative that if Axis Integrated Systems is excluded from the final set of comparables, the other grounds raised by the assessee in the appeal will not be pressed, the remaining grounds of the appeal are dismissed as not pressed.

6. In the result, the appeal of the assessee stands partly allowed.

(Order pronounced in the open court on 14th May, 2018).

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