KPMG FLASH NEWS KPMG IN INDIA The Hyderabad Tribunal adjudicates on rejection of certain comparables from the standard ITES set selected by the TPO in three different rulings, consequentially dropping the average PLI as low as 10.78 per cent 7 August 2014 In a major relief to the taxpayers engaged in the provision of Information Technology Enabled Services (ITES), the Hyderabad Bench of the Income-tax Appellate Tribunal (the Tribunal) rejects companies selected as comparables by the Transfer Pricing Officer (TPO) on various grounds. The table below summarises the average Profit Level Indicator (PLI) computed by the TPO vis-à-vis the revised PLI on exclusion of companies, as adjudicated by the Tribunal: Taxpayers TPO's computation Post Tribunal's rulings No. of comparab les Margin* Working capital adjustment No. of compara bles Margin* Capital IQ Information Systems (India ) Private 12 27.42% 2.19% 7 10.78% 2 Limited (Capital IQ) 1 Excellence Data Research Private Limited 12 27.42% 2.05% 6 10.78% (Excellence Data) 3 1 Capital IQ Information Systems (India) Private Limited v. ACIT (ITA No.170/Hyd/2014) 2 The margin is subject to change post inclusion of Allsec Technologies Limited as comparable 3 Excellence Data Research Private Limited v. ITO (ITA No.159/Hyd/2014)
Hyundai Motors India Engineering Private Limited 12 27.42% 2.05% 7 12.82% (Hyundai Motors) 4 *Margin as computed before the working capital adjustment The Tribunal also directed the TPO/Assessing Officer (AO) to allow risk and working capital adjustment based on the facts of each comparable case. Facts of the case The facts cover three Tribunal rulings pertain to the Assessment Year (AY) 2009-2010 in the following companies (the taxpayers), all operating as captive service providers: Capital IQ Excellence Data Hyundai Motors Capital IQ is engaged in the provision of processing financials of companies to extract data. Capital IQ earned a net cost plus margin of 15.46 per cent during the year. Excellence Data is engaged in the provision of back office data creation, content development, and support services in relation to analysis, content search, and projections for various types of business information. Excellence Data earned a net cost plus margin of 12.41 per cent during the year. Hyundai Motors is engaged in the provision of support services in the nature of modelling and iterative simulation in relation to computer aided engineering and computer aided design. Hyundai Motors earned a net cost plus margin of 6.44 per cent during the year. During the assessment proceedings, the TPO rejected the documentation maintained by the taxpayers on the following reasons: Use of multiple year data Improper application of export filters Selection of functionally dissimilar companies. The TPO undertook fresh search of comparables arriving at a set of 12 companies with an average PLI of 27.42 per cent before working capital adjustment. The TPO computed and allowed working capital adjustments in all the three cases. On further appeal to the Dispute Resolution Panel (DRP) by the taxpayers, the DRP confirmed the order of the TPO. 4 Hyundai Motors India Engineering Private Limited v. DCIT (ITA No.255/Hyd/14)
Taxpayer s contentions and the Tribunal s ruling The taxpayers in their appeal to the Tribunal restricted their arguments to the comparables. The table below provides contentions of the taxpayers, common to all three rulings, on the companies selected as comparable by the TPO, and the Tribunal s finding on the same: Company Taxpayer s objections Tribunal s findings Infosys BPO Limited (Infosys) Genesys International Limited (Genesys) Eclerx Services Limited (Eclerx) Cosmic Global Limited (Cosmic) Acropetal Technologies Limited (Acropetal) Accentia Technologies Limited (Accentia) 1. Holds brand value of Infosys Technologies Limited, incurring large amounts of brand building and advertisement expenditure, and undertakes brand campaigning outside India 2. Huge asset base 3. Difference in the size and scale of operations i.e. turnover. 1. Earned super normal profits 2. Geospatial services provided by this company are highly technical, and therefore functionally dissimilar to the taxpayer. Diverse and high end services in the nature of knowledge process outsourcing, and therefore functionally dissimilar to the taxpayer. Cosmic s employee cost is less than 21.30 per cent and most of the cost is with reference to outsourcing charges or translation charges, and therefore is not a comparable company. 1. The engineering design segment selected by the TPO provides high end services, and is therefore not comparable to the taxpayer 2. Allocation of expenses between segments is not possible and depreciation was not allocated between the segments 3. Profits have been impacted by extraordinary events. 1. Earned super normal profits 2. Extraordinary events on account of acquisition impacting the profits. Infosys to be rejected on the basis of functional dissimilarity on account of its brand value and huge asset base. Genesys to be rejected on functional dissimilarity. Eclerx to be rejected on functional dissimilarity. Cosmic to be rejected on turnover filter, revenue of the comparable segment (i.e. accounts BPO segment) being INR2.78 million. Acropetal to be rejected on functional dissimilarity 5. Accentia to be rejected on account of extraordinary events during the year. 5 In the case of Hyundai Motors, since the taxpayer is also engaged in the provision of engineering design services, the Tribunal did not reject it on functional dissimilarity at segment level. However, due to lack of information on the segmental allocation of expenditure, Acropetal has been restored to the TPO/AO for fresh consideration on the PLI
Company Taxpayer s objections Tribunal s findings Crossdomain Solutions Private Limited (Crossdomain) 1. The TPO obtained information under Section 133(6) of the Income-tax Act, 1961 (the Act), which is not available in the public domain 2. Functionally not comparable. Due to variation between the information in the annual report and the figures adopted by the TPO, Crossdomain to be restored to the TPO/AO for fresh consideration on the PLI after considering the taxpayer s objections 6. Further, the taxpayer in the case of Capital IQ, in addition to its contention on comparables selected by the TPO, also made its contentions on rejection of the two comparables selected by it, excluded by the TPO. The table below summarises the contention of the TPO on those companies, and the Tribunal s findings on the same: Company TPO s objections Tribunal s finding Allsec Technologies Limited (Allsec) Cepha Imaging Private Limited (Cepha) Failed export sales filter determined at 74.45 per cent, as against 75 per cent considered for the application of the filter. Cepha is engaged in the business of e-publishing services, and therefore functionally is not comparable. Allsec to be included as comparable on the basis of the fact that Allsec is functionally comparable and cannot be rejected for a miniscule difference. Cepha to be rejected on functional dissimilarity. On the taxpayer s 7 contention of risk adjustment of 1 per cent based on the Hyderabad Tribunal s ruling in the case of Hellosoft India Private Limited 8, the Tribunal asserted that the risk profile of each of the assesses differs, and therefore a standard deduction of 1 per cent cannot be adopted as a norm. The Tribunal directed the TPO/AO to examine the risk profile of the taxpayer and allow necessary deduction based on the facts of each case. The Tribunal also directed the TPO/AO to allow the working capital adjustment as already provided in the computation by the TPO. Our comments The Tribunal s leeway on acceptance of Allsec, despite failing export filter by a miniscule difference, demonstrates the Tribunal s intention to deliver a fair judgment to the taxpayer. The rulings delivered by the Hyderabad Tribunal are bound to bring cheer to the companies engaged in the provision of IT enabled services. The revised PLI, along with the risk and working capital adjustment are likely to bring down the arm s length margin, and hence the transfer pricing adjustment. The rulings may go a long way in providing guidance to the pending litigation cases. 6 No objection has been raised to the Tribunal on selection of Crossdomain in the case of Capital IQ 7 In the case of Capital IQ, the risk adjustment has not been discussed in the ruling 8 DCIT v. Hellosoft India Private Limited (ITA No.645/Hyd/09)
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