International Speciality Products ... vs Assessee

International Specialty Products vs. Income-tax Officer, Ward - (I) Pvt. Ltd., Hyderabad 2(1), Hyderabad.

PAN - AABCI 8200Q (Appellant) (Respondent)

Assessee by : Shri P.V.S.S. Prasad Revenue by : Shri Rajeev Benjwal

Date of hearing 12-11-2014 Date of pronouncement 07-01-2015

O RDE R

PER SAKTIJIT DEY, J.M.:

This appeal by the assessee is directed against assessment order dated 31/12/2013 passed u/s 143(3) read with section 92CA(3) and 144C(5) of the IT Act in pursuance to direction of the Dispute Resolution Panel (DRP), Hyderabad pertaining to the assessment year 2009-10.

2. Briefly the facts emanating from the materials on record are, assessee, an Indian company incorporated on 20/08/2007, is a wholly owned subsidiary of ISP Group having its headquarters in Wayne, New Jersey, USA. The ISP Group is engaged in developing, manufacturing and supplying innovative specialty ingredients that enhance product performance. Assessee on its part provides application support, analytical support, R&D services to its AEs. The business activity of the assessee is basically in three segments. The research and development services division is engaged in providing 2 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

research and development services to its group companies. For this purpose, assessee has set up a R&D centre at Somajiguda, Hyderabad. The corporate support services division is engaged in providing corporate support services (BPO services) to its group companies. Though, apart from these two divisions assessee also has a trading division, since no sales has been effected during the year, it has no relevance for the year under consideration. For the AY under consideration, assessee filed its Return of Income on 30/09/2009 declaring loss of Rs. 32,79,605. Subsequently, a revised return was filed declaring loss of Rs. 45,14,288. During the scrutiny assessment proceeding, AO noticed that assessee has entered into international transactions with its Associated Enterprises (AEs) as under:

(Rs.)

i) Provision of corporate support services 4,09,76,856

ii) Provision of R&D services to AE 6,91,62,304

iii) Payment of Management fee to AE 41,92,324

iv) Purchase of business undertaking from 13,18,91,892 AE

v) Purchase of business finished goods 1,42,234 from AE

vi) Reimbursement of expenses by AE 2,95,67,179

3. As the revenue earned by assessee from the international transactions with the AEs was more than Rs. 15 crores, AO made a reference u/s 92CA(1) to the Transfer Pricing Officer (TPO) for determining the Arm's Length Price (ALP). In course of proceeding before TPO, assessee submitted a TP study report carried out through an external agency. In the TP analysis, both for corporate support services segment as well as R&D segment, assessee was chosen as the tested party and Transaction Net Margin Method (TNMM) was adopted as the most appropriate method with operating profit to operating cost (OP/OC) as profit level indicator (PLI). In corporate support services segment seven companies with arithmetic mean (OP/OC) of 14.50% were selected as comparables. Assessee's 3 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

OP/OC being 10%, the price charged to AE was considered to be within arm's length. Similarly, for R&D services segment assessee selected two companies with average OP/OC of 10.08% as comparables. Assessee's OP/OC being 10%, price changed to AE was considered to be within arm's length.

4. The TPO though accepted TNMM as the most appropriate method with OP/OC as the PLI for both the segments i.e. corporate support services and R&D, but, after analyzing the TP study report as well as reply given by assessee to the queries made by him, was of the opinion that out of the seven comparables selected by assessee in corporate support services segment two companies, namely, CG Vak Software and Export Ltd. and CEPHA Imaging Pvt. Ltd. are not comparable to assessee. Accordingly, TPO out of the seven comparables selected by assessee retained five while rejecting the aforesaid two companies. The arithmetic mean of the five companies retained by TPO being 28.58% as against OP/OC of 10% shown by assessee, the ALP was determined at Rs. 4,78,98,219. ALP shown by assessee being 4,09,76,856, the short fall of Rs. 69,21,363 was treated as transfer pricing adjustment to be made to the ALP. As far as Research & Development support services segment is concerned, TPO, though, accepted the two companies selected by assessee as comparables, but, he nevertheless selected two more companies as comparables in addition to the two companies selected by assessee. The two companies selected by TPO are Celestial Biolabs Ltd., and TCG Lifescience Ltd. The arithmetic mean of the four comparables selected by TPO being 32.4%, the ALP was determined at Rs. 8,32,46,264 as against Rs. 6,91,62,304 shown by assessee. The resultant shortfall of Rs. 1,40,83,960 was recommended for addition towards TP adjustment to the ALP. Thus, the total addition recommended by the TPO under both the segments was to the tune of Rs. 2,10,05,323. TPO also did not allow any deduction on account of risk/working capital adjustment. In pursuance to the order passed by 4 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

TPO, AO proposed a draft assessment by incorporating the additions recommended by TPO on account of TP adjustment. Assessee objected to the draft assessment order before the DRP.

5. In course of proceeding before DRP, assessee apart from challenging the decision of the TPO in rejecting two of the companies selected as comparable in the corporate support services segment also sought exclusion of three companies out of five companies retained by TPO which were also selected by assessee itself in the TP study. In respect of one company i.e. R Systems International Ltd., assessee raised objections with regard to margin computation. In so far as Research & Development Support Services is concerned, assessee challenged the selection of two additional comparables by TPO. The DRP after considering the submissions of assessee and the remand report submitted by TPO did not find merit in any of the contentions raised by assessee and accordingly directed AO to finalise the draft assessment order. In pursuance to the directions of DRP, AO passed the impugned assessment order incorporating the additions proposed in the draft assessment order towards TP adjustment.

6. Being aggrieved, assessee is before us raising in total ten grounds. However, at the time of hearing, learned AR confined his argument to selection/rejection of comparables in both the segments as raised in ground Nos. 2, 3 & 4, not allowing economic adjustment as raised in ground no. 7 and levy of interest u/s 234B in ground no.

9. In view of the aforesaid, we will confine our finding to the aforesaid grounds canvassed by ld. AR before us.

Corporate Support Services Segment

7. As we have already discussed earlier, in the TP study report assessee selected seven companies as comparables, out of which, TPO retained five companies while rejecting two. Even, out of the five 5 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

companies retained by TPO, assessee has raised objections in respect of three companies before us, which are as under:

1. Caliberpoint Business Solutions Ltd.

2. Cosmic Global Ltd.

3. Infosys BPO Ltd.

7.1. Hereinafter we will deal with the companies objected by assessee.

8. The ld. AR objecting to the selection of the Caliber Point Business Solutions Ltd., submitted that it cannot be treated as comparable as it does not satisfy more than 25% RPT filter applied by TPO himself. Ld. AR referring to the annual report of the said company for the year ended 31/12/2008, submitted that RPT as a percentage of sales is 34.20%, hence, it cannot be considered to be a comparable to assessee.

8.1 In so far as Cosmic Global Ltd. is concerned, ld. AR submitted that the company is functionally different, hence, cannot be comparable to assessee. It was submitted that Cosmic Global Ltd., outsourced its activities which is evident from the low employee cost which is less than 21% of the sales. Ld. AR submitted that the low employee cost is a definite indication that the company is not a service company or into further outsourcing of work or a distributor company. In support of such contention, ld. AR relied on the following decision of the ITAT:

1. Cosmic Global Ltd. vs. ACIT, ITA No. 744/MDS/2014, dt.

30/07/14

2. Deloitte Consulting India Pvt. Ltd. ITA No. 1082/Hyd/10,

3. Symphony Marketing Solutions Pvt. Ltd. (2013) 38 Taxman.com 55

8.2 As regards Infosys BPO Ltd., the ld. AR submitted that considering the significant brand value, intangibles owned, economies 6 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

of scale due to size and premium pricing, it cannot at all be considered to be a comparable with a start up captive service provide like assessee. In support of such contention, he relied on the decision of the Hon'ble Delhi High Court in case of CIT Vs. Agnity India Technologies Pvt. Ltd., judgment dated 10/07/2013 in ITA 1204/2011 and a number of decisions of ITAT.

8.3 The ld. DR strongly contesting the claim of assessee submitted before us that all these companies having been selected by assessee itself in the TP study, TPO has merely gone in to the functional profiles of these companies and did not apply any filter to accept/reject the comparables proposed by assessee. Therefore, TPO's decision in retaining these companies as comparable should be upheld. Further, ld. DR submitted that the issue whether Caliberpoint Business Solutions Ltd. has failed more than 25% RPT filter was never raised by assessee before TPO. As far as Cosmic Global Ltd. is concerned, ld. DR argued that the fact whether this company does not satisfy the employees cost filter was never brought to the notice of TPO, hence, there was no occasion for the TPO to apply employee cost filter while selecting this company. With regard to Infosys BPO Ltd., ld DR submitted that brand value in a service industry may drive its revenues but may not affect the profitability of a company. It was submitted, the brand value of an ITES company does not determine its profit margin. He further submitted that there is no relevance between the size of the company and economies of scales in the ITES sector. Ld. DR submitted that scale has no influence on the profitability of a company in the ITES industry.

8.4 In the rejoinder, ld. AR submitted that even if the assessee might have initially selected some of the companies as comparables, but, that cannot preclude assessee from seeking exclusion of those companies wrongly selected. In support of such contention, he relied on the decision of the ITAT Special Bench in case of DCIT Vs. Quark Systems P. Ltd. 38 SOT 307 (Chd.) and the decision of the ITAT Delhi 7 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

Bench in case of Alcatel Lucent Technologies India P. Ltd. Vs. DCIT [2014] 45 Taxman.com 244.

8.5 Having considered the submissions of the parties and perused the materials on record, we record our finding as under:

8.6 The preliminary objection of the department is, assessee itself having selecting these companies and TPO having accepted them without applying any filter to accept/reject, assessee cannot seek exclusion of the companies selected by it. However, we are not convinced with the arguments of ld. DR. In case of DCIT Vs. Quark Systems P. Ltd. (supra), ITAT special Bench has held that if the assessee has wrongly included some comparables, which is not disturbed by TPO, then, assessee cannot be precluded from seeking exclusion of those companies subsequently. Following the aforesaid dictum of the Special Bench of ITAT, ITAT Delhi Bench in case of Alcatel lucent Technologies India P. Ltd. (supra) held as under:

"4. We have heard the rival submissions and perused the relevant material on record. At the outset it is relevant to note that the area of dispute in the present appeal is confined to inclusion or exclusion of these two cases. The assessee is satisfied on all other issues. It is relevant to note that the assessee suo motu included these two cases in its transfer pricing study. However, it was argued before the authorities below that these cases were not comparables. The special bench of the Tribunal in Dy. CIT Vs. Quark Systems (P.) Ltd., [2010] 38 SOT 307 (Chd.)(SB) has held that if the assessee has wrongly included some cases in the list of comparables, which position has not been disturbed by the TPO, then there can be no embargo on pleading by the assessee for the exclusion of such a case. In the light of the above special bench decision, we hold that the assessee can contend for the exclusion of these cases before the Tribunal notwithstanding the fact that it included such cases in the list of comparables."

8.7 Moreover, when the TPO has rejected two companies selected by assessee by going into their functionality by applying certain filters, in all fairness he should have done similar exercise in respect of other comparables also.

8 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

8.8 Having held that assessee is entitled to object to certain comparables selected by TPO which were also initially selected as comparables by assessee itself, we will now consider the merits of the arguments of the parties with regard to selection of the three companies as comparables by TPO.

9. Caliberpoint Business Solutions Ltd.

9.1. Assessee has sought exclusion of the aforesaid company on the ground that it fails more than 25% RPT filter applied by TPO. On a perusal of the financials of this company as shown in the annual report, a copy of which is placed at page 133 of assessee's paper book and working furnished by assessee, it is to be seen that the RPT as a percentage of sales is 34.20%. Further, it is seen from the order of TPO that he himself considers companies having more than 25% RPT not to be treated as comparables. That being the case, if actually the RPT of Caliberpoint Business Solutions Ltd. is more than 25%, it cannot be treated as a comparable to assessee. Accordingly, we direct AO/TPO to verify this aspect and if it is found that RPT as a percentage of sales is more than 25%, then, this company cannot be treated as comparable to assessee.

10. Cosmic Global Ltd.

10.1 The ground on which assessee seeks exclusion of the aforesaid company is, it outsources its activities. On a perusal of the profit & loss account of Cosmic Global Ltd. for the year ended 31 st March, 2009, a copy of which is enclosed in assessee's paper book, it is seen that against operational income of 7,37,02,584, the expenditure incurred towards salaries and wages was Rs. 1,57,11,463. Whereas the company has paid translation charges of Rs. 3,00,25,326. These figures to certain extent do indicate that the said company is 9 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

outsourcing its activities. This fact is also evident from the order of the ITAT in a case relating to this company in ITA NO. 744/MDS/14 dated 30/07/14 wherein the ITAT has categorically recorded a finding of fact that the said company receives work order from its clients around the world and gets the work done from translators in India and Overseas. Since it is evident from record that Cosmic Global Ltd. outsources its work, it cannot be treated as comparable to assessee. For coming to such view, we rely upon the decision of the coordinate benches of the Tribunal in case of Delloitte Consulting India P. Ltd. (supra) and Symphony Marketing Solutions India P. Ltd. (supra). Therefore, we direct AO/TPO to exclude this company from the list of comparables.

11. Infosys BPO Ltd.

11.1 As far as this company is concerned, we are of the view that it cannot at all be considered as a comparable to assessee not only because of its size but also due its brand value, diversified activities, and other functional dissimilarities. Different benches of this Tribunal are consistent in their view that this company cannot be treated as a comparable to a captive service provider like assessee. Even the Hon'ble Delhi High Court has also affirmed such view in case of CIT Vs. Agnity India (supra). In the aforesaid view of the matter, we direct AO/TPO to exclude this company as comparable.

12. Assessee has also objected to rejection of the following two comparables:

1. CG Vak Software and Exports Ltd.

2. CEPHA Imaging P. Ltd.

13. As far as CG Vak Software and Exports Ltd. is concerned, the ld. AR submitted before us that TPO and DRP were not correct in 10 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

rejecting the aforesaid company as comparables on ground of functional dissimilarity. The ld. AR submitted that segmental details of both software development segment and BPO Services segment are available in the annual report of the company. Hence, the TPO was not justified in rejecting the said company on the ground of low turnover from BPO sector.

13.1 As far as CEPHA Imaging P. Ltd. is concerned, ld AR referring to the annual report of the company, submitted that it is engaged in rendering BPO services and related party transaction is only 16.59%, hence, this company should not have been rejected by TPO and DRP.

14. Ld. DR on the other hand, submitted that segmental details of CG Vak is not available in the annual report. Further, the BPO services constitutes only 12% of the total turnover. Therefore, as revenue from BPO services is less than 1 crore, it cannot be considered as a comparable. As far as CEPHA Imaging P. Ltd. is concerned, ld. DR supporting the order of DRP and TPO submitted that the company being into software development and RPT being more than 25% cannot be treated as a comparable.

15. Having considered the submissions of the parties and perused the material on record, we are of the view that CG Vak Software cannot be treated as comparable to assessee. As can be seen from the annual report of the company, a copy of which is at page 159 of assessee's paper book, it is predominantly a computer software development company. While revenue earned from software services is to the tune of Rs. 637.29 crores, that from BPO services is only 86.10 crore. Further, though assessee submitted that segmental details are available but on a perusal of the annual report, it is found that segmental details of expenditure are not available. In the aforesaid view of the matter, we do not find any reason to disturb the finding of the DRP and TPO with regard to the aforesaid company.

11 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

16. As far as CEPHA Imaging P. Ltd is concerned, on a perusal of the order passed by TPO, it is to be noted that he has excluded this company mainly for the reason that it is a software development company and secondly RPT is more than 25%. However, on a perusal of the annual report of the company, copy of which is placed at page 169 of assessee's paper book, it is seen that the activities carried on by this company can be categorized as BPO services. There is nothing in the annual report to suggest that it is into software development. Further from the annual report as well as working submitted by assessee it appears that the RPT as a percentage of sale is 16.59%. In the aforesaid view of the matter, we direct AO/TPO to verify this aspect and if it is found that RPT of this company is less than 25%, then, this company cannot be rejected as a comparable.

Research & Development Services Segment

17. The assessee has objected to the selection of the following companies as comparables in this segment:

1. Celestial Biolabs Ltd.

2. TCG Life Science Ltd.

17.1 Objecting to the selection of the aforesaid two companies, ld.

AR submitted before us that Celestial Biolabs Ltd. is a product company, hence, cannot be treated as comparable to a purely IT service provider like assessee. In support of such contention he relied on a decision of the ITAT Bangalore Bench in case of M/s Millipore (India) P. Ltd. Vs. DCIT, IT(TP)A No. 689/Bang/12, dated 04/07/2014. Ld. AR submitted for this reason also other benches of the Tribunal have also rejected this company from being treated as a comparable to a BPO service Provider. As far as TCG Life Science ltd. is concerned, ld. AR submitted before us that this company cannot be treated as comparable to assessee as it has substantial sales from manufacturing activity. Ld. AR referring to the annual report of the said company, submitted that a company which is selected as 12 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

comparable should be engaged in substantial similar activity as the tested party. It was submitted by ld. AR that as the manufacturing activity amounts to 25.16% of the total sales of the company it fails the filter of 75% revenue from R&D activity, therefore, it cannot be treated as a comparable.

17.2 The ld. DR on the other hand, justified selection of the aforesaid two companies as comparables to the assessee.

17.3 We have considered the submissions of the parties and perused the materials on record. As far as Celestial Biolabs Ltd. is concerned, we are of the view that this company cannot be treated as comparable to assessee as it is engaged in various activities. The coordinate bench of this Tribunal in case of M/s Millipore (India) P. Ltd. Vs. DCIT (supra) approved the order of CIT(A) in rejecting the aforesaid company as it is engaged in diversified activities. Therefore, following the aforesaid decision of coordinate bench, we direct AO/TPO to exclude this company as comparable. As far as TCG Life Science Ltd. is concerned, as can be seen the only objection of the assessee is revenue from manufacturing activity as a percentage of total sales is 25.16% which exceeds the 75% revenue to be earned from R&D activities filter adopted by TPO. In our view, the contention of assessee is not tenable. As can be seen from facts on record, substantial revenue earned by the company is from R&D activities. Therefore, only because revenue from manufacturing activities exceed the cut off mark by 0.16%, the company cannot be treated as un-comparable to assessee. Accordingly, we uphold the selection of the company as comparable to assessee.

17.4 It needs to be mentioned, in course of hearing ld. DR had submitted, restricting comparability analysis to two or three companies will result in unhealthy comparative analysis, hence, TPO may be directed to conduct a fresh search for selecting comparables. However, we do not find merit in such contention of ld. DR. On a 13 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

perusal of Rule 10B, it becomes clear, there is nothing in the said provision to indicate that certain minimum number of companies are required to be selected for the purpose of comparative analysis for determining ALP under TNMM.

18. In the result, we direct the AO/TPO to compute the ALP of the international transactions under both the segments keeping in view our directions herein above.

19. The next issue as raised in ground No. 7 is with regard to allowance of risk/working capital adjustment.

20. Ld. AR submitted before us that assessee is in its first year of operations and has used unutilized capacity. He submitted that assessee is remunerated at a cost plus mark up basis and it functions under a limited risk environment as most of the risk is being assumed by its AEs. Hence, necessary risk adjustment has to be allowed while determining the ALP. He also submitted that necessary adjustment towards risk and working capital need to be made to the margins of comparable to eliminate differences on account of different functions, assets, and risks in determination of ALP. In support of such contention, he relied upon some decisions as referred to in the written submissions.

21. The ld. DR on the other hand submitted that under TNMM the standards of comparability are relatively relaxed and only broad similarity of functions is required. TNMM can be used with data for companies that are broadly comparable to the tax payer as functional differences are likely to be reflected in the level of operating expenses incurred by each company. These expenses are deducted in the calculation of operating profit and are accordingly taken account of in the comparability analysis. He submitted, considering these aspects assessee having adopted net margin or operating profit as the most reliable or viable indicator of profit level, selective argument against unutilized capacity is uncalled for. He submitted, 14 ITA No. 218/Hyd/2014 International Specialty Products (I) Pvt. Ltd.

assessee is being remunerated on cost plus mark-up which includes the cost of unutilized capacity also. The comparables selected by the TPO broadly undertake expenses similar to that of the assessee and are part of the R&D service providers and hence such comparables cannot be rejected simply on the ground of differences in functions and profits.

22. We have considered the submissions of the parties and perused the materials on record. It is a fact that in the TP study assessee has not worked out any adjustment on account of risk or working capital. However, since we have directed the AO/TPO to compute ALP in accordance with directions given by us on comparables, while doing so, he shall also consider assessee's claim towards adjustments to be made on account of risk/working capital etc. after allowing opportunity of being heard to assessee. This ground is considered to be allowed for statistical purposes.

23. In ground No. 9 assessee has challenged the levy of interest u/s 234B. Since the chargeability of interest u/s 234B will ultimately depend upon the income to be determined in accordance with our directions contained hereinabove, at this stage it is premature to dwell upon this issue. It is open for assessee to raise the issue at the appropriate stage.

24. In the result, assessee's appeal is partly allowed.

Pronounced in the open court on 07/01/2015.

Sd/- Sd/- (B. RAMAKOTAIAH) (SAKTIJIT DEY) ACCOUNTANT MEMBER JUDICIAL MEMBER

Hyderabad, Dated: 7 th January, 2015 kv 15 ITA No. 218/Hyd/2014

International Specialty Products (I) Pvt. Ltd.

Copy to:-

1) M/s International Specialty Products (India) Pvt. Ltd. Level 3, RVR Towers, Raj Bhavan Road, Somajiguda, Hyderabad

2) ITO, Ward - 2(1), Room No. 837, C-Block, 8 t h Floor, IT Towers, AC Guards, Hyderabad - 500 004

3)DRP, Hyderabad

4) DIT (International Taxation), Hyderabad

5) The Departmental Representative, I.T.A.T., Hyderabad.