R.K. Panda, Accountant Member

1. This appeal filed by the Revenue is directed against the order dated 27.09.2006 passed by the CIT(A)-VIII, Mumbai relating to assessment year 2003-04.

2. The only effective ground raised by the Revenue reads as under :-

1. On the facts and in the circumstances of the case and in law, the ld. CIT(A) has erred in deleting the addition of Rs. 1,41,06,903 made on account of adjustment to the arms length price of the assessees international transactions.

3. Facts of the case, in brief, are that the assessee company is engaged in the business of ship management and the actual nature of business is Recruitment and Manning services for its foreign principals viz. Mitsui O.S.K. Manning Services S.A., Panama and Mitsui O.S.K. Lines Ltd., Japan. The A.O referred the international transactions of the assessee to the Transfer Pricing Officer (T.P.O.) who made an adjustment of Rs. 1,41,06,903 to the arms length price of the international transactions made by the assessee relating to professional fee/training fee/service fee.

4. It is pertinent to mention that the assessee in its TP study report followed TNMM method for professional fees received as the most appropriate method and CUP method for reimbursement of expenses, the details of which are as under:-

Sr. No.

Description

Amount in Rs.

Method

1

Professional fees received

3.83 crores

TNMM

2

Fee for training of seafarers received

91.73 lakhs

TNMM

3

Service fee received

1.27 crores

TNMM

4

ECB introit paid at libor plus 75 basic points

4.73 lakhs

TNMM

5

Reimbursement of expenses

1.63 crores

CUP

6

Manning expenses recovery (receipt)

2.08 lakhs

CUP

7

Reimbursement of salaries (payment)

57.81 lakhs

CUP

5. The T.P.O. examined the set of comparables given by the assessee and held that the assessee had erred in including loss making entities in its comparables, specially in the case of Vans Information Ltd. and Star Estates Management Ltd. The TPO after rejecting the comparables given by the assessee took the following comparables and determined the adjustment at Rs. 1,41,06,903, the details of which are as under:-

The comparables taken by T.P.O.:

The comparables taken by T.P.O.:



Company name

Individual Company Mean

Ace Software Exports Ltd.

8.65%

International Travel House Ltd.

10.78%

M.C.S Ltd.

15.08%

Hinduja TMT. Ltd.

105.34%

Mean

34.96%

The Adjustment made by T.P.O.:



Description

Amount

Total cost as reported by the assessee

5,50.22,482

Add Arms length return on total cost at 34.96%

1,92.35.860

Operating income at arms length

7,42,58,342

Less. Operating income reported by the assessee

6,01,51,439

Adjustment on account of charging the AEs below the arms length price

1,41,06,903

6. During the course of assessment proceedings, the assessee justified the inclusion of the loss making companies in the set of comparables by stating that in any industry there would be a mix of profitable and non-profitable ventures. Although every company would try to maximize its profit it is always not possible that all companies would always earn profit. Further, the assessee should be able to assess the arms length nature of the transaction undertaken at the point of undertaking the same or at such further point when it is able to take commercial actions to align the transaction with the arms length standard. For this the maximum time limit would be up to the end of the financial year and beyond this point it will not be realistically possible to take any remedial steps.

7. However, the A.O. was not convinced with the explanations given by the assessee. After meeting the objections submitted by the assessee he concluded that a sum of Rs. 1,41,06,903 has to be added to the returned income of the assessee-company by way of adjustments to international transactions of the assessee. While doing so, he did not accept the plea of downward adjustment by holding that the assessee was engaged in captive business and is not exposed to the vagaries of the unpredictable market and, therefore, the assessee was not correct in including loss making companies in this set of comparables. He did not accept the plea that the assessee should be able to assess the arms length nature of the transaction within a suitable timeframe, wherein it could take such commercial steps to align the transactions with the arms length standard. According to the AO the transfer pricing study is dated 02.10.2003 and, thus, has been undertaken much after the end of the financial year. Rejecting the various explanations given by the assessee, the AO assessed the income of the assessee by making necessary adjustments to the ALP relating to the professional fees, training fees, service fees by a sum of Rs. 1,41,06,903.

8. Before the ld. CIT(A), it was submitted that during financial year 2002-03, the search for comparables based on the "Company Main Activity" as identified by Prowess and ERS, yielded no matches for "manning" within the databases. Generally, such companies in India are private companies or proprietary/ partnership firms and hence data was not readily available. Accordingly, the assessee felt it appropriate to search for Indian companies having similar operational model and therefore similar functional profile as MOLMI. Hence, companies providing administrative back office support services were considered for the purpose of the transfer pricing analysis.

8.1 It was submitted that the T.P.O. has erred in excluding the loss making companies from a set of comparable companies on the ground that the loss making company is an abnormal instance and hence, such companies should be excluded from the comparables set. It was submitted that it is arbitrary to exclude only loss making companies without excluding corresponding extreme profit making companies as well. Such an attempt would be akin to cherry picking, skew the results of the comparable sets and makes it unreliable. It was submitted that every industry has a mixture of profitable and non-profitable ventures. Further, the Indian Transfer pricing regulations do not provide for the elimination of a comparable based on its profitability. It was submitted that exclusion of loss making companies would lead to unrealistic outcome.

8.2 As regards the remark of the AO that the assessee has specifically opted against a downward adjustment for risk, the assessee submitted that it has not opted against a downward adjustment for risk, but has retained the option to make adjustments to reflect the same, if and when warranted. The AO should have recognized that the risks assumed by the uncontrolled comparable companies are significantly high vis-a-vis captive service providers, like the assessee. This would further prove that the margins earned by the comparables need to be driven down to adjust for comparability.

8.3 Para 5.9 and 5.10 of the OECD guidelines were brought to the notice of the ld. CIT(A). It was submitted that the approach of using multiple year data is consistent with the Indian Regulations and OECD Guidelines. Proviso to Rule 10B(4) allowed data relating to a period not being more than 2 years prior to the financial year in which international transactions were entered into, also to be considered. Accordingly, for determining the ALP of the international transactions, the assessee used the financial data of functionally comparable companies having financial years ending 31st March, 2001 & 31st March, 2002. It was also submitted that none of the conditions laid down in section 92C(3) apply to the assessee-company and, therefore, it is inappropriate to disregard the transfer pricing analysis carried out by the assessee and to arbitrarily exclude loss making companies to determine the arms length price.

8.4 It was submitted that the assessee has determined the ALP in accordance with the relevant provisions of the Act and the Rules and has adequately discharged the onus bestowed upon it to determine the arms length price. Therefore, it is inappropriate to disregard the transfer pricing analysis carried out by the assessee and to arbitrarily exclude loss making companies to determine the arms length price. The provisions of section 92C(1) of the Act was also brought to the notice of the ld. CIT(A) and it was submitted that keeping in mind the various factors, the assessee has determined the TNMM as the most appropriate method. The analysis performed by the assessee to determine the most appropriate method has been documented in detail in paragraph 5.07 to 5.26 of the T.P.O. study report dated 02.10.2003. It was submitted that the assessee has duly complied with the provisions of section 92C(1) of the Act in relation to the choice of the most appropriate method. The comparable data used for determining the arms length price of the Company has been arrived at after considering various factors, particularly a comparative analysis of the functions performed by the Company as against the functions performed by the host of companies for the benchmarking analysis. It was thus argued that the Company has followed the basis of law for its transfer pricing documentation.

8.5 It was submitted that information/documents have been kept and maintained in accordance with section 92D(1) and the Rules made in this behalf. The company has duly complied within the specified time, with all requests for information /documents made on the assessee u/s. 92D(3) of the Act in the course of the present transfer pricing assessment proceedings. It was accordingly submitted that none of the conditions indicated in section 92C(3) of the Act apply to the assessee and, therefore, it was wholly inappropriate to disregard the transfer pricing analysis carried out by the assessee and to arbitrarily exclude loss making companies to determine the ALP.

9. Based on the various arguments advanced by the assessee, the ld. CIT(A) directed the AO to delete the addition of Rs. 1,41,06,903 made on account of adjustments to the ALP of the assessees international transactions by holding as under :-

The written submissions made on behalf of the appellant, the order of the T.P.O. and the order of the A.O. have been carefully perused and I am of the view that the adjustments made by the T.P.O. which have been incorporated by the A.O. in determining the income of the appellant is erroneous. From the order of the T.P.O., it is seen that there may be fair amount of rationality in excluding the data pertaining to Star Estate Management Ltd. and that of Van Information Ltd. but, even if these two comparables are removed, the mean would then come to 4.15% as against the appellants OP/TC of 9.32%, and therefore, by excluding the aforesaid concerns, no case can be made out for upward adjustment of the arms length price.

Coming to the second issue, wherein the T.P.O. has excluded all the loss making concerns, I am in agreement with the arguments placed before me by the Ld. Counsel that such an action is against commercial principles and expectations and against the principles of commercial accounting and such exclusion would give a distorted picture of the results. Further, considering the fact that every industry will have a mix of profitable and non-profitable ventures and the Indian Transfer pricing regulations do not provide for the elimination of a comparable, based on its profitability, there was an error in removing the loss making companies from the list of comparables. The error got further compounded with a company with a OP/TC of 105.34% - Hinduja TNT Ltd. being included for determining the average mean. In fact, if the data of Hinduja T.M.T. Ltd. is removed from the T.P.O.s list of comparable cases, the OP/TC would then work out to 11.5%.

Thus, having considered each and every aspect of the case, and the grounds pertaining to use of multiple year data and the determination of arms length price as per section 92C(3), it is held that the T.P.O. committed an error adjusting the arms length price by a sum of Rs. 1,41,06,903 which resulted in the income being assessed by the A.O. at a sum of Rs. 2,05,03,000. The AO shall recompute the income accordingly.

10. Aggrieved with such order of the ld. CIT(A), the Revenue is in appeal before us.

11. The ld. D.R. while challenging the order of the ld. CIT(A) submitted that he should not have deleted the comparables on the basis of excessive profit or loss. He submitted that those comparables given by the A.O. are only an indicator. Even the assessee himself has included Hinduja TMT Ltd. as functionally comparable case. Therefore, the ld. CIT(A) should not have excluded the same. Referring to the decision of the Special Bench of the Tribunal in the case of Dy. CIT v. Quark Systems (P.) Ltd. [2010] 38 SOT 307 (Chd.)(SB), the ld. D.R. submitted that the comparables excluded from consideration by TPO was valid since the basic requirements of FAR analysis had not been met by the assessee. Referring to the said decision, the ld. D.R. in his alternate contention submitted that the matter should be restored back to the file of the A.O. for his examination in proper perspective.

12. The ld. Counsel for the assessee, on the other hand, while supporting the order of the ld. CIT(A) relied on the following decisions and submitted that not only extreme loss making company but company having abnormal profit should also be excluded from comparable sets since they skew the results and cannot be considered as representative of the industry:-

1. Quark Systems (P.) Ltd. (supra)

2. Adobe Systems India (P.) Ltd. v. Addl CIT [2011] 44 SOT 49 (Delhi) (URO)

3. Teva India Ltd v. Dy. CIT [2011] 44 SOT 105 (Mum.)(URO)

4. SAP Labs India (P.) Ltd. (IT Appeal No. 5263 (Delhi) of 2010 dated May 6, 2010

5. Sony India (P.) Ltd v. Dy. CIT [2008] 118 TTJ 865 : 114 ITD 448 (Del)

12.1 Referring to the decision of the Delhi Bench of the Tribunal in the case of Sony India (P.) Ltd. (supra) he submitted that companies having related party transactions in excess of 10 to 15% of total sales cannot be considered as uncontrolled comparable and hence required to be excluded. Referring to the decision of Delhi Bench of the Tribunal in the case of Mentor Graphics (Noida) (P.)Ltd v. Dy. CIT [2007] 18 SOT 76 : 109 ITD 101 (Del), he drew the attention of the bench to page 112 and submitted that the Tribunal has held that tax administration and parties can work different Arms Length price i.e. a range by the application of different methods. He, however, has no objection if the matter is set aside to the file of A.O. for fresh adjudication.

13. We have considered the rival arguments made by both the sides, perused the orders of the A.O. and ld. CIT(A) and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us. We find the assessee before the TPO has submitted that the data for financial year 2002-03 was not available at the time the T.P. report was compiled. We find the assessee in its transfer pricing study analysis has given a set of comparables relating to financial year 2000-01 and 2001-02 according to which the mean of their operating profit by total cost ratio was 5.35%. Since the profit disclosed by the assessee is more than the mean profit, it was argued by the assessee that transactions are at arms length. The details of comparable companies given by the assessee are as under:-

Comparable Companies

Adjusted OP/TC

Star estates Management Ltd.

-13.27%

International Travel House Ltd.

3.58%

Mercury Travels Ltd.

-3.87%

Vans Information Ltd.

-36.78%

A M I Computers (I) Ltd.

-7.69%

Ace Software Exports Ltd.

22.63%

Hinduja T M T Ltd.

76.43%

M C S Ltd.

7.52%

Nucleus Netsoft & Gis India Ltd.

0.37%

13.1 We find the assessee, on being further questioned by the TPO, has given the following companies as comparables:-

Company Name

Individual Company Mean

Ace Software Exports Ltd.

8.65%

International Travel House Ltd.

10.78%

M C S Ltd.

15.08%

Hinduja T M T Ltd.

105.34%

Mean

34.96%

We find the TPO rejected the contention of the assessee and adopted the fresh working given by the assessee dt. 24.02.2006 according to which the mean is 34.9696.

13.2 it has been held by the Special bench of the ITAT in the case of Quark Systems (P.) Ltd (supra) that a business organization with negative net worth cannot be treated at par with a normal business organization. We find the assessee in its TP study report had included M/s Vans Information Ltd. which is making continuous losses and more than 50% of its net worth has been wiped off, a fact brought on record by TPO and not objected to by the ld. Counsel. Further, the observation of the TPO that certain loss making companies have been included in to comparables as well as entities which are nowhere close to the assessees business was also could not be controverted by the ld. Counsel for the assessee. We find on being confronted by the TPO the assessee furnished fresh comparables according to which the mean profit comes to 34.96% as against 9.32% reported by the assessee. Even if the contention of the assessee that Hinduja TMT Ltd. which makes abnormal profit of 105.34% and whose turnover is 100.80 croresas against 6.01 crores in the case of the assessee cannot be included as a comparable is accepted still the OP/TC works out to 11.5% as found by the CIT(A) is against 9.32% disclosed by the assessee. Still he has deleted the entire adjustment made by the A.O./TPO which is, in our opinion, is not correct.

13.3 We find the assessee before the TPO had contended that had the data for financial year 2002-03 been available, it could have arranged its affairs accordingly. We find the Special Bench in the case of Quark Systems (P.) Ltd. (supra) at para 39 of the order has been held as under:-

We have, however, also noted that the very basis of selection of comparables and application of filters leaves lot to the desired. As we have noted earlier as well, the transfer pricing was in the initial stages in this year and we are inclined to take a rather liberal approach by giving assessee an opportunity to make out its case properly and place all the relevant facts before the tax authorities so that proper ALP can be determined in accordance with the law. The proceedings before the tax authorities are not adversarial proceedings and the assessee should not, therefore, be placed at under advantage because of his inadvertent and bona fide mistakes. With this objective in sight, and having noted inconsistencies in selection of comparables, while we uphold the exclusion of Imercius from comparables, we also deem it fit and proper to remit the matter to the file of the Assessing Officer for adjudication de novoin the light of the above observations and in accordance with law. We direct the assessee to place all the relevant material before the Assessing Officer and/or TPO and fully co-operate in expeditious disposal of the matter in accordance with law. The matter stands restored to the file of the Assessing Officer as such.

13.4 The decision of the Special Bench cited above relates to A.Y. 2004-05 whereas the assessment year in the impugned case is A.Y. 2003-04. Thus in the light of the decision of the Special Bench, the T.P. issue was in the initial stages in this year and therefore a liberal approach should be taken. Considering the totality of the facts of the case, we are of the opinion that the matter should go back to the file of the A.O. for fresh adjudication with a direction to give sufficient opportunity to the assessee to file fresh comparables of the financial year 2002-03 and make out its case properly and place all relevant facts before the tax authorities so that proper ALP can be determined in accordance with the law. We hold and direct accordingly. The ground raised by the Revenue is accordingly allowed for statistical purpose.

14. In the result, the appeal filed by the Revenue is allowed for statistical purposes.