Recently in Flagstone Underwriting Support Services India (P.) Ltd. vs. Deputy Commissioner of Income-tax, Circle 1 (3), Hyderabad, it was held that while computing arm’s length price, companies with functional dissimilarity could not be taken as comparable. If there were extraordinary events like merger and demerger during relevant financial year same could not be taken as comparable.  

Facts of the case:

The assessee is a wholly owned subsidiary of ‘F’ Group (AE). The assessee was established to provide back office support services in the field of investment and insurance management primarily to its associated enterprises. For the reason, international transaction with AE, the case was referred to the TPO. The TPO suggested an adjustment of Rs. l.84 crores under section 92CA. The Assessing Officer  added the amount determined by the TPO as ALP to the total income of assessee. He also made a disallowance of Rs.20.38 lakhs on account of communication expenses as per Explanation 2 to section 10A and recalculated the exemption under section 10A.

TPO had selected 20 comparables by giving reasons out of which assessee had no objection for inclusion of 11 comparables but with reference to 9 comparables he had objected in terms of functionality. Referring to this assessee went for an appeal.

Commissioner (Appeals) noted that assessee had objected to 9 comparables, the Commissioner (Appeals) further noted that assessee mainly contested against inclusion of two comparables, he accordingly, directed to exclude two comparables out of 9 objected and issued directions accordingly. In addition to the adjustments on T.P, Commissioner (Appeals) directed the Assessing Officer to exclude the communication charges from total turnover as well.

Revenue was aggrieved on the exclusion of two comparables and direction of Commissioner (Appeals) on exclusion of communication charges from both export turnover as well as total turnover for the purpose of computing deduction under section 10A.

Whereas assessee argued that Commissioner (Appeals) had wrongly considered exclusion of only two comparables when assessee had objected to 9 comparables.

It was held that:

Following the decision in Capital IQ Information Systems (India) (P.) Ltd. Versus Deputy Commissioner of Income-tax (International Taxation) [2014 (3) TMI 626 – ITAT HYDERABAD] – Coral Hub works as an agent by outsourcing its work to third party vendors and cannot be taken as a comparable to the ITES functions being involved by assessee. There was no reason to interfere with the order of the Commissioner (Appeals) as his decision was based on decisions already available on this comparables on various cases.

Merger and de-merger are extra ordinary events which will have an effect on the profitability of the company in the financial year in which such event takes place. Assessee contented that there is amalgamation which has impacted the financial result. On verification, it was found that the amalgamation has taken place. Hence, the aforesaid comparable has to be excluded. In the previous year there were extra ordinary events that took place in this company which warrants exclusion of this company as a comparable.

 

AO excluded the communication charges from export turnover holding that they are not to be included in the Export turnover. Assessee contended that data link charges cannot be considered as attributable to export service. However, alternate plea was made that if the same was excluded from the export turnover, the same was also to be excluded from the total turnover while computing deduction u/s 10A. Following the decision in ITO vs. Saksoft Ltd. CIT(A) gave direction to exclude communication charges from the total turnover as well. There was no need to interfere with the direction of CIT(A). Decision was against the revenue.

Exclusion of Seven Comparables

Accentia Technologies Ltd.

During the previous year there were extra ordinary events that took place in this company which warrants exclusion of this company as a comparable. Therefore, this company cannot be considered as a comparable.

 

Acropetal Technologies Ltd.

he major source of income for the company is from providing Engineering Design Service and Information Technology Services. The functions performed by the Engineering Design Services segment of the company cannot be considered as comparable to the ITES/BPO functions performed by the Assessee. Therefore, this company could not have been selected as a comparable, as it performs engineering design services which only a Knowledge Process Outsourcing [KPO] would do and not a Business Process Outsourcing [BPO].

Cosmic Global Ltd.

It is for the TPO to determine whether this company falls within the filters as adopted by the TPO himself. If the assessee fails the employee cost filter, then the same cannot be accepted as a comparable company. Selection of this comparable is to be restored to the file of the TPO for fresh examination, after giving due opportunity of hearing to the assessee – the matter is remitted back to the TPO.

Eclerix Services Ltd.

This company cannot be regarded as a comparable for the reason that it was functionally different as it was having extraordinary event and super normal profits.

Genesys International Corporation Ltd.

The business of this company requires skilled manpower and scientists, civil engineers,etc. The assessee is a routine ITES provider who does not require such highly skilled employees. Besides the above, this company also carries out R&D services and own intangibles. The aforesaid facts will take this company out of the list of comparables.

HCL Comnet Systems & Services Ltd. & Wipro Ltd.

The TPO has excluded the companies whose turnover is less than Rs. 1 crore on the ground that they may not be representing the industry trend. The assessee’s turnover is Rs. 15 crore. The same logic also applies to the companies having high turnover of over Rs. 200 crores.

Since the seven comparables are held not comparable in various decisions of co-ordinate benches, Assessing Officer/TPO was directed to exclude the above comparables and rework the ALP. Assessee should be given an opportunity to make submissions on the risk adjustments/working capital adjustment if so required before finalising the order. With these observations, assessee’s appeal is considered as allowed for statistical purposes.

Hence, Revenue appeal was dismissed and appeal of assessee was allowed for statistical purposes.

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