Assistant Commissioner of Income‐tax vs. Frost & Sullivan (I) (P.) Ltd. (ITAT Mumbai IT Appeal No. 2073 (Mum.) of 2010

1. 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 a
haphazard manner by only excluding loss making companies and not high
profit making companies, therefore, upward adjustment made by TPO
while determining ALP was to be deleted.

2. Facts
• 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 CD
provided consulting services and GIC division provided low and back office
support services to global offices of assessee's group, through the parent
company in USA and for this the assessee charged on cost plus 10 per cent
mark up.
• The assessee has used Transactional net margin method (“TNMM”) as
Most appropriate method (“MAM”) and its OP/TC PLI for GIC comes to
1.8%.

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

4. 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 of
natural justice, it was submitted that the same should be treated as void‐
ab ‐ initio.
• The TPO proposed 149 companies to be adopted as comparable
companies, however, the annexure to the notice did not contain any
details as regards the business activity of these companies, the detailed
computation of their respective operating profit margins and how the
operations/business activities of these companies were comparable to
the 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 companies
engaged in high end software development and therefore earning
substantially high margins.

5. • While computing the arms length profit margin of 20.42%, TPO had
excluded high (50% or more) loss making companies but he did not
make corresponding exclusion of companies earning more than 50% of
profits. Absence of any turnover filter/criteria in selecting comparables
is also a sore point in the TPO's order. What applies to loss making
companies that they do not operate under Standard Economics
circumstances prevailing in the industry should apply to companies
earning 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.
• There is a serious violation of the principle of natural justice on the part
of the TPO as adequate, proper notice and hearing was not provided to
the appellant.
• The whole exercise of selecting comparables by the TPO was haphazard
illogical and random without any FAR. Moreover, there are
inconsistencies in standards adopted by the TPO while carrying out the
determination of the ALP.

6. • The TPO has failed to expose any chinks in the Transfer Pricing study
carried out by the appellant and the alternative exercise it has
undertaken has gaping holes which cannot be accepted.
• The appellant’s AE at USA has suffered continuous losses but still
compensated to the assessee at cost plus 10% markup on a low end back
office support services. Thus even without allowing for any adjustments
sought on functions risk profile and taking all the above facts and
circumstances with its AE is held to be at arm’s length. The upward
adjustment 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.
Contention of Department before ITAT
Ld. CIT (A) was not justified in merely accepting the written submission
of the assessee without application of mind. Since the order of the Ld.
CIT (A) suffers from so many infirmities, the same should be set aside
and the order of the AO should be restored.

7. • The parent company is incurring losses worldwide; therefore, there is
no question of the assessee transferring the profit to the US
companies.
• Assessee submitted that if at all any addition has to be made on
account of adjustment of ALP; it has to be done only in relation with
the transactions with AE's and not with entire transactions.
• Further, the order of the Ld. CIT (A) should be upheld and the ground
rose by the Revenue to be dismissed.

8. 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.

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