Assistant Commissioner of Income‐tax vs. 

Frost & Sullivan (I) (P.) Ltd. (ITAT Mumbai IT Appeal No. 2073 (Mum.) of 2010

The whole exercise of selecting comparables by TPO was done in ahaphazard manner by only excluding loss making companies and not highprofit making companies, therefore, upward adjustment made by TPOwhile determining ALP was to be deleted.

• The Frost & Sullivan (I) Private Limited (“the assessee” or “the company”),was engaged in the business of market research and consultancy services.

• During the AY 2004‐05, assessee operated through two divisions i.e. (a)Consulting Division (CD); (b) Global Innovation Centre (GIC). The CDprovided consulting services and GIC division provided low and back officesupport services to global offices of assessee's group, through the parentcompany in USA and for this the assessee charged on cost plus 10 per centmark up.

• The assessee has used Transactional net margin method (“TNMM”) asMost appropriate method (“MAM”) and its OP/TC PLI for GIC comes to1.8%.

Facts

• In show cause notice issued to assessee, TPO claimed that the mark up of 10per cent on cost charged by the assesee is unreasonable as according to himthe industry was earning a markup of 30 per cent. For this purpose, the TPOhad given the list of 149 companies as samples and the average GP/TC cameto 28.23 per cent. The TPO after excluding 47 more companies as lossmaking companies and holding the same as functionally different fromassessee determined the OP/TC at 20.42%. Based on this comparablemargin, TPO proposed an addition of Rs. 19,348,372 to the income of theassessee.

• AO in its order made addition of Rs.1, 93, 48,372/‐ as proposed by the TPO.

• Being aggrieved assessee filed appeal to CIT (A).

Assessee’s contention• Reasonable and sufficient opportunity of being heard was not granted

and since the order of the TPO was in blatant violation of principle ofnatural justice, it was submitted that the same should be treated as void‐ab ‐ initio.

• The TPO proposed 149 companies to be adopted as comparablecompanies, however, the annexure to the notice did not contain anydetails as regards the business activity of these companies, the detailedcomputation of their respective operating profit margins and how theoperations/business activities of these companies were comparable tothe back office support services provided by GIC division of the assessee.

CIT(A)’s Observation• The appellant’s GIC division is engaged in carrying out back office

processing work for its Parent Company with risk mitigated manner,whereas the TPO has compared its margin with that of companiesengaged in high end software development and therefore earningsubstantially high margins.

• There is a serious violation of the principle of natural justice on the partof the TPO as adequate, proper notice and hearing was not provided tothe appellant.

• The whole exercise of selecting comparables by the TPO was haphazardillogical and random without any FAR. Moreover, there areinconsistencies in standards adopted by the TPO while carrying out thedetermination of the ALP.

• While computing the arms length profit margin of 20.42%, TPO hadexcluded high (50% or more) loss making companies but he did notmake corresponding exclusion of companies earning more than 50% ofprofits. Absence of any turnover filter/criteria in selecting comparablesis also a sore point in the TPO's order. What applies to loss makingcompanies that they do not operate under Standard Economicscircumstances prevailing in the industry should apply to companiesearning super profits.

• TPO was not fair or reasonable in taking companies as comparable,which are 100 times bigger than the appellant in terms of turnover.

Contention of Department before ITAT

• The TPO has failed to expose any chinks in the Transfer Pricing studycarried out by the appellant and the alternative exercise it hasundertaken has gaping holes which cannot be accepted.

• The appellant’s AE at USA has suffered continuous losses but stillcompensated to the assessee at cost plus 10% markup on a low end backoffice support services. Thus even without allowing for any adjustmentssought on functions risk profile and taking all the above facts andcircumstances with its AE is held to be at arm’s length. The upwardadjustment of Rs. 1, 93, 48,372/‐ is therefore deleted.

Aggrieved with the order of the Ld. CIT (A), the Revenue is in appeal before ITAT.

Ld. CIT (A) was not justified in merely accepting the written submissionof the assessee without application of mind. Since the order of the Ld.CIT (A) suffers from so many infirmities, the same should be set asideand the order of the AO should be restored.

• The parent company is incurring losses worldwide; therefore, there isno question of the assessee transferring the profit to the UScompanies.

• Assessee submitted that if at all any addition has to be made onaccount of adjustment of ALP; it has to be done only in relation withthe transactions with AE's and not with entire transactions.

• Further, the order of the Ld. CIT (A) should be upheld and the groundrose by the Revenue to be dismissed.

ITAT Decision• The TPO has excluded the loss making companies but he has not excluded 

the high profit making companies from the comparable. There is merit in the submission of the assessee that the annexure given by the TPO during the assessment proceedings is incomplete and some fresh sets were given according to which the average ALP margin comes to 6.02 per cent as against 10 per cent on cost shown by the assessee. It is only after this incomplete list showing lesser profit than the profit declared by the assessee was brought to the notice of the TPO that he excluded the 47 loss making companies to determine the mean average profit at 20.42 per cent. Therefore, there was merit in the submission of the assessee that there is no basis for only excluding the loss making companies and not excluding the high profit making companies or companies which are not at all comparable considering their size, volume of turnover and other factors. 

• The whole exercise of selecting the comparables by the TPO is not proper and is in a haphazard manner. In this view of the matter and in view of the detailed discussion by the Commissioner (Appeals) on this issue, there is infirmity in his order and, accordingly, same is upheld. The ground raised by the Revenue is accordingly dismissed.

Delhi OfficeA‐380, Defence Colony, New Delhi –24Tel: +91‐11‐4980 0000Telefax: 91‐11‐4980 0029Email: spn@spnagrath.com

Bangalore Office616, Oxford Towers, BangaloreTel: +91‐80‐25705494Telefax: +91‐80‐32908917Email: spnblr@spnagrath.comwww.spnagrath.com

Made By‐ Rashi Pilaniwala,Nandita Naruka & 'MeenakshiGupta