Avenue Asia Advisors Pvt. Limited v. Deputy Commissioner Of Income Tax

$~18 *IN THE HIGH COURT OF DELHI AT NEW DELHI+ITA 350/2016 AVENUE ASIA ADVISORS PVT. LIMITED..... AppellantThrough :Mr. M.S. Syali, Senior Advocate withMr.Vishal Kalra and Mr. MayankNagi, Advocates. versus DEPUTY COMMISSIONER OF INCOME TAX ..... RespondentThrough :Mr.RahulChaudhary,SeniorStanding Counsel with Mr. SanjayKumar, Junior Standing Counsel. CORAM:JUSTICE S. MURALIDHARJUSTICE PRATHIBA M. SINGH O R D E R%18.09.2017 Prathiba M. Singh, J. 1. This appeal under Section 260A of the Income Tax Act, 1961 (‘the Act’)arises out of an order dated 22[nd]January, 2016 passed by the Income TaxAppellate Tribunal (‘ITAT’) in ITA No. 6638/Del/2013 for the AssessmentYear (‘AY’) 2009-10. 2. On 26[th]April, 2017, this court framed the following questions of law fordetermination: "(i) Was the Income Tax Appellate Tribunal (ITAT')justified in re-characterizing the function of theAssessee as a merchant banker and was this inconformity with the sub-advisory agreement dated 1[st] ITA 350/2016 Page 1 of 17 February 2006? (ii) Whether the ITAT was in error in upholding theinclusion of the comparable companies by the TPOconsidering the business profile of the Assessee asoutlined in the transfer pricing documentation? (iii) Whether the ITAT erred in upholding theaddition of notional interest on the ground of it beingan international transaction?” Case of the Assessee 3. The Appellant-Assessee (hereafter ‘Assessee’) is a company incorporatedin India, inter alia providing non-binding investment advisory services to itsAssociated Enterprise (‘AE’) viz., Avenue Asia Capital Management LP,(Avenue US’), an investment management firm based in New York, USunder the agreement dated 1[st]July, 2016 along with the addendum dated 5[th]December, 2008. According to the said agreement, the consideration/remuneration to the Assessee is cost plus 20% mark up of the servicesrendered by the Assessee which included providing research reports andother material to assist the AE in carrying out assessment of potentialinvestment opportunities in India. 4. The Assessee filed its return of income for AY 2009-10 on 30[th]September, 2009 declaring a total income of Rs.5,87,81,405/-. Pursuant to anotice dated 8[th]September, 2010, issued under Section 143 (2) of the Act, areference under Section 92 CA (1) of the Act was made to the TransferPricing Officer (‘TPO’) in order to determine the arm’s length price (‘ALP’)qua the international transactions between the Assessee and its AE. In view ITA 350/2016 Page 2 of 17 of this, the Assessee identified 8 (eight) comparable companies, having a netaverage margin of 17.48% as against the net margin of the Assessee being21.93% for the instant AY. The comparable companies chosen by theAssessee are as under: 5. In the show cause notice (‘SCN’) dated 18[th]December, 2012, issued bythe TPO, a new set of comparables were proposed. However, he rejected oneof them. The TPO finally chose 10 comparable companies having anaverage margin of 39.13%, as against the aforementioned margin earned bythe Assessee. 6. On 29[th]January, 2013, the TPO passed an order under Section 92 CA (3)of the Act recommending an upward adjustment of Rs.3,20,29,913/-. TheTPO also recommended an adjustment of Rs. 51,34,309/- being the notional ITA 350/2016Page 3 of 17 interest at 15.77% on the outstanding receivables from its AE on the basisthat the same constituted an international transaction. Pursuant to the TPO’sorder, the AO passed a draft assessment order on 28[th]February, 2013 andassessed the income of the Assessee at Rs. 9,59,45,630 as against the returnincome of INR 5,87,81,405/-. Objections were filed by the Assessee againstthe said draft order with the Dispute Resolution Panel (‘DRP’). 6. On 29[th]January, 2013, the TPO passed an order under Section 92 CA (3)of the Act recommending an upward adjustment of Rs.3,20,29,913/-. TheTPO also recommended an adjustment of Rs. 51,34,309/- being the notional ITA 350/2016Page 3 of 17 interest at 15.77% on the outstanding receivables from its AE on the basisthat the same constituted an international transaction. Pursuant to the TPO’sorder, the AO passed a draft assessment order on 28[th]February, 2013 andassessed the income of the Assessee at Rs. 9,59,45,630 as against the returnincome of INR 5,87,81,405/-. Objections were filed by the Assessee againstthe said draft order with the Dispute Resolution Panel (‘DRP’). 7. On 16[th]August, 2013, the DRP upheld the transfer pricing adjustmentsmade by the AO/TPO. Subsequently, on 10[th]October, 2013, the AO passedthe final assessment order under Section 143 (3) read with Section 144C ofthe Act, computing the total income as Rs. 9,59,45,630/- as per thedirections issued by the DRP. This assessment order was challenged by theAssessee before the ITAT. 8. The ITAT has, by a detailed order, analysed the various comparables andremanded the matter to the TPO in respect of a few comparables for furtheranalysis. The ITAT has also rejected some of the comparables suggested byTPO/AO but retained some of them. The ITAT, thus, partly allowed theappeal of the Assessee on the issue of comparables. Insofar as theadjustments for receivables were concerned, the ITAT upheld that theoutstanding receivables constitute an international transaction by relying onthe decision in Logics Micro System v. ACIT (2011) 8 ITR 159 (hereafter‘Logics Micro System’). The ITAT, thus, restored the matter of computationof the adjustment to outstanding receivables, to the TPO with a direction tocompute the interest for receivables on a day to day basis beyond the periodavailable as per the industry standard and apply LIBOR rate of interest. ITA 350/2016 Page 4 of 17 9. The Assessee is aggrieved by the impugned order to the extent it hasretained three of the comparables namely Sumedha Fiscal Services Limited(hereafter ‘Sumedha’), Brescon Advisors Limited (hereafter ‘Brescon’) andLadderup Corporation Limited (hereafter ‘Ladderup’) and on the issue ofoutstanding receivables being treated as international transactions andinterest being computed thereon. 10. Arguments have been heard on behalf of the Assessee’s counsel Mr.M.S. Syali, Senior Advocate and Mr. Rahul Chaudhary, Senior StandingCounsel for Revenue. Submissions of the Appellant-Assessee 11. Mr. M.S. Syali, learned Senior Advocate for the Assessee has submittedthat the ITAT has committed a grave error by characterizing the servicesrendered by the Assessee as investment/merchant banking services. Mr.Syali relies upon the order of the TPO wherein the services of the Assesseehave been squarely termed as being investment advisory services. Hesubmits that a perusal of the agreement dated 1[st]July, 2006 along with itsaddendum clearly reveals that the role of the Assessee is of a non-bindingadvisory nature which primarily involves advising the AE in preparingreports, making non-binding recommendations etc. Mr. Syali submits thatthe Assessee merely provides information to its AE and is not involved inthe decision making process of the AE. The active role is of the AE and notof the Assessee. Mr. Syali categorized the services provided by the Assesseeas contained in the TPO's report under the following heads: (i)Identification of investment opportunity and relevant research; (ii)Recommendation on the mode of financing; (iii)Engagement of third party service provider; (iv)Recommendation for exchange of investment; (v)Recommendation of exit strategies; (vi)Identifying the opportunities for investment; (vii)Recommendation for the provision of equity or date or similarfinancing for investment companies;financing for investment companies; (viii) Recommendation in relation to date or similar financing; (ix)Purchase of preferred securities; (i)Identification of investment opportunity and relevant research; (ii)Recommendation on the mode of financing; (iii)Engagement of third party service provider; (iv)Recommendation for exchange of investment; (v)Recommendation of exit strategies; (vi)Identifying the opportunities for investment; (vii)Recommendation for the provision of equity or date or similarfinancing for investment companies;financing for investment companies; (viii) Recommendation in relation to date or similar financing; (ix)Purchase of preferred securities; (x)Investment in asset-back securitisation of vehicles and issuance ofguarantees;guarantees; (xi)Giving advice and opinions in connection with reorganisation,recapitalization, splitting of shares, change of par value, conversionotherwise;recapitalization, splitting of shares, change of par value, conversionotherwise; (xii)Engage and remunerate third party service providers. 12. Thus, the Assessee company’s activities are that of a fee basedinvestment/financial advisory service provider. Unlike merchant bankerswho are involved in active financing transactions, the Assessee is onlyadvising on financial issues. Thus, according to Mr. Syali, the activities ofthe Assessee cannot be compared to that of the merchant bankers. Mr. Syalisubmits that since an exact comparable was not available, the cut basedmethod (‘CUP’) cannot be used for determining the ALP and the TNMMmethod is rightly used. However, while agreeing that the TNMM method isthe correct method, Mr. Syali relies upon the judgment of this court in ITA 350/2016 Page 6 of 17 Rampgreen Solutions Private Limited v. Commissioner of Income Tax(2015) 377 ITR 533 (Del) (hereafter ‘Rampgreen Solutions’) to submit thatwhile selecting the comparable transactions or entities, the basis should beone of similarity with the controlled transaction/ entity and a mere broadsimilarity is not sufficient. Mr. Syali has broadly summarised the findings ofthe DRP and the ITAT qua the 10 comparable companies chosen by theTPO, in the following table: 13. Thus, he submits that the selection of comparables must be done keepingin view the comparability factors as specified. Mr. Syali submits that the ITA 350/2016 Page 7 of 17 ITAT has erred in retaining Sumedha, Brescon and Ladderup as accordingto him that has led to an incorrect conclusion and marking up of the ALP toa higher percentage of margin. According to Mr. Syali, the said entities werenot functionally similar to the Assessee. 14. Mr. Syali submits that the ITAT has rightly held in para 6.2 of theimpugned order that the activity of the Assessee had to be characterised as afee based financial advisory service provider. However, according to him,having done so, the retention of these three comparables does not match thecriteria set down by the ITAT itself. He submits that though the TNMMmethod is sufficiently tolerant to a wide variety of functions, there shouldnot be broad comparability between the comparables and the functionaldifferences ought to be taken note of. Mr. Syali relies upon details of theaccounts of the comparable entities of Sumedha, Brescon and Ladderup filedbefore the ITAT to argue that these three had completely different functionalprofiles. He also submits that even if a part of their services overlap with theservices provided by the Assessee, the segmental data for the comparableservices was not available and hence they ought to have been excluded bythe ITAT. The Assessee further relies upon clause 12.1 of the sub-advisoryagreement that the nature of the services being merely advisory isestablished from this clause as the Assessee could not conduct anytransaction or conduct any negotiation or enter into any agreement qua anytransaction on behalf of its AE. This clause, according to him, establishedthat the Assessee merely conducted research and made recommendationsand did not have any role in the decision making or any right to takedecisions. ITA 350/2016 Page 8 of 17 ITA 350/2016 Page 8 of 17 15. Insofar as the issue of notional interest on receivables is concerned, Mr.Syali relies upon the submission made by the Assessee before the DRP toargue that if the working capital adjustment is given as per the margin of thefinal set of comparables proposed by the TPO, the outstanding receivableswould be automatically factored in and separate adjustment on account ofinterest on receivables would not be required. Mr. Syali, thus, submits thatthe approach of the ITAT on this issue is also erroneous. Submissions of the Revenue 16. Mr. Rahul Chaudhary, learned Senior Standing Counsel for the Revenue,submitted that the adoption of the TNMM method is not faulted by theRevenue. He submits that there is no flaw in the approach of the ITAT or theDRP, inasmuch as, the ITAT was quite conscious of the difference betweenthe merchant banking services and the financial advisory services renderedby the Assessee. In any case, he submits that the ITAT has noticed that amerchant banker performed two types of services namely - First,management and issuance of shares, under-writing, portfolio managementetc. and secondly, advisory or consultancy services. The ITAT has taken thelatter segment as being comparable to the services rendered by the Assesseeand thus has committed no error. 17. According to Mr. Chaudhary, the ITAT also noted that while privateequity funds have higher yield, merchant banking services do not have thesame level of yield and thus, comparing merchant bankers would notprejudice the interest of the Assessee. Mr. Chaudhary further submits that ITA 350/2016 though the activities of the Assessee are not that of a merchant banker, theterm consultancy, encompasses the larger gamut of services, which wouldbe included. The ITAT, has, in fact undertaken an in-depth analysis of eachof the comparables chosen by the TPO and while retaining three of them hasalso rejected four of the comparables. This shows that the ITAT hasexercised its powers in a judicious manner. Mr. Chaudhary draws theattention of this Court to what he considers an increasing trend of Assesseesto themselves suggest several comparables and when the TPO chooses toinclude the comparables which perform similar functions as those suggestedby the Assessees, the same are objected to if the percentage margin is high.Further, according to Mr. Chaudhary, Assessees tend to only challenge thecomparables which have high margins on the ground of dissimilarity offunctions, though they may in fact possess the same functions as thosecomparables chosen by the Assessee itself. In fact, this kind of trend oughtnot to be encouraged by this Court according to him. 18. The Revenue further relies upon specific findings of the ITAT in respectof Sumedha to submit that the ITAT has merely restored the matter to theTPO to examine if the income from management and issuance of shares ofSumedha is substantial and if so, then to exclude the said comparable.Insofar as Brescon is concerned, the ITAT has given a finding that theconsultancy or advisory services in respect of debt syndication is similar toadvisory services in investment in distressed debt. The question of merchantbanking does not arise in the case of Brescon. In the case of Ladderup, Mr.Chaudhary points out that the ITAT’s finding that there is not much of adifference in the extended support services offered by the Assessee and the ITA 350/2016 Page 10 of 17 comparables cannot be faulted with as the ITAT noted specifically that theAssessee is not engaged in merchant banking services. Analysis of the decision in Rampgreen Solutions ITA 350/2016 Page 10 of 17 comparables cannot be faulted with as the ITAT noted specifically that theAssessee is not engaged in merchant banking services. Analysis of the decision in Rampgreen Solutions 19. The first and the foremost issue that arises in this case is with respect tothe applicability of tests laid down in Rampgreen Solutions (supra), whichwas rendered on 10[th]August, 2015. This decision has clearly laid down thevarious principles on the basis of which determination of comparables needsto be undertaken while fixing the ALP and the margin that needs to beassigned. This Court had specifically rejected the proposition that broadfunctionality is sufficient to find the comparable entity though the TNMMmethod allows broad flexibility tolerance in the selection of comparables.This proposition having been rejected, the Court in Rampgreen Solutions(supra) held as under: “43. In our view, the aforesaid approach would not beapposite.Insofarasidentifyingcomparabletransactions/entities is concerned, the same would notdiffer irrespective of the transfer pricing method adopted.In other words, the comparable transactions/entities mustbe selected on the basis of similarity with the controlledtransaction entity. Comparability of controlled anduncontrolled transactions has to be judged, inter alia,with reference to comparability factors as indicatedunder rule 10B(2) of the Income Tax Rules, 1962.Comparability analysis by the transactional net marginmethod may be less sensitive to certain dissimilaritiesbetween the tested party and the comparables. However,thatcannotbetheconsiderationfordilutingthestandards of selecting comparable transactions/entities.Ahigherproductandfunctionalsimilaritywould strengthen the efficacy of the method in ascertaining areliable arm’s length price.Therefore, as far aspossible, the comparables must be selected keeping inview the comparability factors as specified.Widedeviations in profit level indicator must trigger furtherinvestigations/analysis. 44. Consideration for a transaction would reflect thefunctions performed, the significant activities undertaken,theassetsorresourcesused/consumed,therisksassumed. Thus, comparison of activities undertaken/functions performed is important for determining thecomparabilitybetweencontrolledanduncontrolledtransactions/entity. It would not be apposite to ignorefunctional dissimilarity only for the reasons that itsimpact may be reduced on account of using arithmeticalmean of the profit level indicator.” 20. A perusal of the above decision reveals that the following steps ought to be undertaken in identification of comparable transactions/entities. The principle governing the identification of comparable transactionswould be the same, irrespective of whichever transfer pricing methodis adopted.The principle governing the identification of comparable transactionswould be the same, irrespective of whichever transfer pricing methodis adopted. Comparable transactions must be selected on the basis of a similaritywith the controlled transaction/entity.Comparable transactions must be selected on the basis of a similaritywith the controlled transaction/entity. Rule 10B (2) of the Income Tax Rules, 1962 ought to be borne inmind while choosing the factors of comparability in respect ofuncontrolled transactions.Rule 10B (2) of the Income Tax Rules, 1962 ought to be borne inmind while choosing the factors of comparability in respect ofuncontrolled transactions. Even while adopting the TNMM method, the standard for selection ofthe comparable transactions/entitles cannot be diluted.Even while adopting the TNMM method, the standard for selection ofthe comparable transactions/entitles cannot be diluted. Wide deviation in the Profit Level Indicator (‘PLI’) would requirefurther investigation/analysis.Wide deviation in the Profit Level Indicator (‘PLI’) would requirefurther investigation/analysis. Rule 10B (2) of the Income Tax Rules, 1962 ought to be borne inmind while choosing the factors of comparability in respect ofuncontrolled transactions.Rule 10B (2) of the Income Tax Rules, 1962 ought to be borne inmind while choosing the factors of comparability in respect ofuncontrolled transactions. Even while adopting the TNMM method, the standard for selection ofthe comparable transactions/entitles cannot be diluted.Even while adopting the TNMM method, the standard for selection ofthe comparable transactions/entitles cannot be diluted. Wide deviation in the Profit Level Indicator (‘PLI’) would requirefurther investigation/analysis.Wide deviation in the Profit Level Indicator (‘PLI’) would requirefurther investigation/analysis. For comparison of transactions, factors such as the nature of capital,resources used, the risks assumed, etc. ought to be considered.For comparison of transactions, factors such as the nature of capital,resources used, the risks assumed, etc. ought to be considered. Broadly, therefore, the dictum by this Court was that though in the TNMMmethod there is sufficient tolerance, mere broad functionality is by itselfinsufficient. Question (i) 21. In the backdrop of the principles laid down in Rampgreen Solutions(supra) and the analysis of the ITAT’s order with respect to each of thecomparables disputed by the Assessee, is as follows: (i) Sumedha Fiscal Services Limited - In the case of Sumedha, the ITATclearly acknowledged that if it had handled management of rights issues andthe revenue from such service was substantial, then the services provided bySumedha would be dissimilar to that of the Assessee. However, having heldso, the ITAT restored the matter to the TPO to again examine whether therevenue of Sumedha was substantial from handling the said services ofrights issues and with a direction to exclude it if the TPO found it in theaffirmative. Such an approach of the ITAT is not in accordance with theprinciples laid down in Rampgreen Solutions (supra). The ITAT's findingsacknowledge that Sumedha may not be functionally similar to the Assessee,as admittedly, the Assessee does not render services relating to rights issues.Starting the entire exercise of comparability analysis from the stage of theTPO would result in an unending cycle of proceedings especially when therelevant material in the form of annual reports etc. was available on therecord. The ITAT ought to itself have determined whether Sumedha is to be ITA 350/2016Page 13 of 17 retained at all in view of its own findings. Remanding the issue to the TPOwas an incorrect approach. (ii) Brescon Advisors Limited – In the case of Brescon, the ITAT analysedthe annual reports and noticed that the income of Brescon is from fee basedfinancial services, from debt resolution and debt syndication. Brescon alsoearned revenue from sale of investments. The ITAT has equated `Advisoryservices related to debt financing' with `financial services from debtresolution and debt syndication'. These two are not identical services.Whereas the former is advisory in nature, the latter is executory in nature.While there could be some overlap between the former and latter, the matterrequires deeper analysis and examination. (iii) Ladderup Corporation Limited – The ITAT noticed that Ladderuphad shown operational income from financial and management consultancyservices as also fee based activities such as ‘Debt Syndication, IPOAdvisory, Private Equity Placement, Merger and Acquisitions, CorporateRestructuring and a host of other corporate advisory services.’ The ITAT,thereafter, simply held that Ladderup had similar functions as that of theAssessee and was a comparable that deserved to be retained. 22. Broadly, it appears that the ITAT has gone on the usage of several termssuchasdebtsyndication,debtfinancing,IPOadvisory,corporaterestructuring, mergers, acquisitions etc, appearing in the annual reports ofthe comparable to hold that the Assessee and the said comparables performsimilar functions. The analysis at such a broad level, based upon the 22. Broadly, it appears that the ITAT has gone on the usage of several termssuchasdebtsyndication,debtfinancing,IPOadvisory,corporaterestructuring, mergers, acquisitions etc, appearing in the annual reports ofthe comparable to hold that the Assessee and the said comparables performsimilar functions. The analysis at such a broad level, based upon the ITA 350/2016Page 14 of 17 appearance of such similar terminologies, does not by itself make thefunctions similar in nature. 23. The argument of the Assessee appears to be that while the Assessee wasmerely advising on these issues and providing advisory services to its AE,these three comparables appear to be actually involved in the providing ofservices relating to debt restructuring, debt financing, issuance of IPOs,mergers and de-mergers, etc. There is a difference between giving adviceon these matters and actually undertaking the said services. A similarillustration, in the context of litigation, would be the difference betweengiving advice on what to argue in Court and actually arguing the matter inthe Court. This difference needs to be borne in mind and the mereappearance of similar sounding words does not by itself constitute similarfunctions. Further, as laid down in Rampgreen Solutions (supra), all thesethree companies demonstrated a wide deviation in the percentage ofmargins. Thus, it requires a deeper analysis to determine as to whether theywere in fact comparables to be retained for the purpose of fixing the ALP. 24. Insofar as the argument of Mr. Chaudhary regarding the trend ofAssessees to challenge the inclusion of comparables which show a higherpercentage margin, is concerned, the same cannot be faulted with in as muchas every Assessee is entitled to make submissions as to the selection ofcomparables and choose what is advantageous to it. So long as the same canstand the test of legal scrutiny, it cannot be held that such challenges are notmaintainable. 25. In this backdrop, when sub-advisory agreement dated 1[st]July, 2006along with the addendum thereto, is examined, the services of the Assesseecannot be termed as that of merchant banking though there may be someoverlap in the advisory segment of the services provided by merchantbankers. In view of the services rendered by the Assessee, Question (i) isanswered in the negative i.e. in favour of the Assessee and against theRevenue. Question (ii) 26. In view of the above discussion on the various comparables, the findingsof the ITAT in respect of Sumedha, Brescon and Ladderup are set aside. Wehave been informed by the learned counsel for the parties that subsequent tothe order of the ITAT, the TPO passed an order which resulted in a finalassessment order being passed by the AO. The matter is currently pending inappeal, by the Assessee, before the CIT (A). All those consequential orderswould not survive in view of the present order. 27. In order to not brook any further delay, this matter may be placed beforethe CIT (A) to consider as to whether these three companies can be held tobe comparables in the light of observations made in Rampgreen Solutions(supra) and in this order. The CIT (A) would, thereafter, pass acomprehensiveorderanddeterminetheALPfortheinternationaltransactions. Question (ii) is answered in the affirmative i.e. in favour of theAssessee and against the Revenue. Question (iii) 27. In order to not brook any further delay, this matter may be placed beforethe CIT (A) to consider as to whether these three companies can be held tobe comparables in the light of observations made in Rampgreen Solutions(supra) and in this order. The CIT (A) would, thereafter, pass acomprehensiveorderanddeterminetheALPfortheinternationaltransactions. Question (ii) is answered in the affirmative i.e. in favour of theAssessee and against the Revenue. Question (iii) 28. On the question of notional interest, it was incorrect on the part of theITAT to hold that the entire outstanding receivables constitute aninternational transaction. The reliance by the Assessee on the decision ofthis Court dated 25[th]April, 2017 in ITA 765/2016 [Pr. Commissioner ofIncome Tax v. Kusum Health Care Pvt. Ltd.] (hereafter ‘Kusum HealthCare’) is apt. There are several factors which need to be considered beforeholding that every receivable is an international transaction and it requiresan assessment on the working capital of the Assessee. Applying the decisionin Kusum Health Care (supra), Question (iii) is answered in the affirmativei.e. favour of the Assessee and the CIT (A) is directed to study the impact ofthe receivables appearing in the accounts of the Assessee; looking into thevarious factors as to the reasons why the same are shown as receivables andalso as to whether the said transactions can be characterized as internationaltransactions. 29. The appeal is allowed in the above terms. There will be no order as tothe costs. PRATHIBA M. SINGH, J. S. MURALIDHAR, J. SEPTEMBER 18, 2017j/dk ITA 350/2016