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DCIT Circle-11(1), Room No-312, C.R.Building, New Delhi Vs. Innodata Isogen India Pvt Ltd, 19 K G Marg, 708 Surya Kiran Building, New Delhi
May, 05th 2015
                    DELHI BENCH "I": NEW DELHI
                                  ITA No5390/Del/2010
                              (Assessment Year: 2003-04)

                     DCIT                      Innodata Isogen India Pvt Ltd, 19 K
                     Circle-11(1), Room        G Marg, 708 Surya Kiran Building,
                     No-312,               Vs. New Delhi
                     C.R.Building,             Pan No- AAACI2425G
                     New Delhi
                     (Appellant)                (Respondent)

                   Appellant by   :   Sh. Ajay Vohra Adv,
                                      M.L. Krishnamurty, CA
                                      Sh R Katyal CA, Mehar Gupta, Adv
                                      R. Balasubrmanium, CA
                 Respondent by    :   Sh Judy James, Standing Counsel,

                     Date of Hearing              10.04.2014
                     Date of pronouncement         30.04.2015


      This appeal filed by the Revenue arises out of the order passed by the
ld. CIT(A)-XX,    New Delhi dated 30.09.2010 pertaining to assessment year

2.    The effective sole grounds raised in the Revenue's appeal read as

      "The Ld. CIT(A) erred in deleting the addition of Rs.4,34,12,348/- made
      to the price to the international transaction."

3.    Apropos ground No.1 is of deletion of the addition of Rs.4,34,12,348/-
made of the price of the international transaction.

4.    Facts, in brief are that the assessee company is engaged in the
business of providing content related services such as data conversion,
composition editorial services and indexing etc. to its parent company
Innodata US. The Return of income has been filed by the assessee on
                                                                         Page 2 of 8

28.11.2003 declaring a loss of Rs.1,25,40,010/-. The return was processed u/s.
143(1) of the Income Tax Act, 1961 (herein after `the Act') on 19.03.2004. The
case was selected for scrutiny. A reference was made to TPO, New Delhi for
determining the arm's length price u/s. 92CA(3) of the Act in respect of
international transaction entered into by the assessee during the financial
year 2002-03.    The TPO vide his order dated 3.3.2006 has examined           and
determined the arm's length price of the international transactions of the
assessee with its Associated Enterprises using multiple year data as under:-

              "The operating margin of the comparables was 10.12%. By
              applying this margin, the arm's length operating profit on cost of
              Rs.22,42,93,560/- works out to Rs.2,26,98,508/- as compared to the
              loss posted of Rs.2,07,13,840/-. The difference works out to
              Rs.4,34,12,348/-. The primary international transaction of the
              assessee is in respect of IT Enabled services because the effect of
              any price different on purchase of computers or sale of
              computers will get reflected in the depreciation being part of
              total cost. It is therefore held that the price different as
              computed above is attributable to the main activity of provision
              of IT Enabled services to the group companies. The price of
              international transaction as per books of accounts is
              Rs.20,27,10,379/- and to bring it back this transaction to arm's
              sphere its value is enhanced to Rs.24,61,22,727 and thus an
              addition of Rs.4,34,12,348/- to the taxable income of the
              assessee. In view of provision of chapter X of the I.T. Act, the
              assessee will not be entitled to benefit of exemption u/s 10A of
              the Act."

5.      In view of above, the difference amounting to Rs.4,34,12,348/-
between arm's length operating profit and adjusted operating profit is added
to the income of the assessee company by the AO vide his order dated 20-3-

6.      Against the aforesaid order of the Assessing Officer, assessee appealed
before the Ld. CIT(A), who vide her Order dated 30.9.2010 has allowed the
appeal of the assessee by deleting the addition.

7.      Now the Revenue is in appeal before us.

8.      Ld. DR relied upon the order of the Assessing Officer and TPO.

9.      On the contrary, Ld. Counsel of the assessee relied upon the order of
the Ld. CIT(A) and does not want us to interfere in the same.
                                                                               Page 3 of 8

10.    We have heard both the parties and perused the records. We have
carefully considered the facts and the detailed submissions of Revenue and
the assessee in pursuance to the various observations of the TPO, as
contained in his order under section 92CA(3) of the Income Act dated 3rd
March 2006 and also the paper book filed before us. In this case, we take
note that the assessee and its Parent company Innodata US are independent
service providers. The parent company Innodata US, secures business from its
customers and is then sub-contracted to the assessee. So if the Parent
company does not secure business it cannot pass it on to the assessee.
Likewise if the parent company secures good work then it will pass it on to the
assessee and the assessee in turn will have good work/ business. Therefore,
like other service providers, the assessee and its Parent are exposed to risks of
business fluctuations.

11.    Table 1, below indicates the fixed personnel costs, variable personnel
cots sales and variable personnel costs over sales over a five year period
starting 2001:

                               TABLE 1: EMPLOYEE COSTS
                                  (figures in Rs. million)
                      March     March                        March      March
       Year                                March 2003
                      2001      2002                          2004      2005
 Total employee
                     118.54      148.46       104.00         117.55     157.64
                     102.10      122.87        77.29         92.68      134.47
 employee cost
 Fixed employee
                       16.44     25.59         26.71         24.88      23.17
 Revenue             331.50      282.80       202.70         249.40    290.10

 Variable emp cost
                       31%       43%            38%           37%        46%
 as % of revenue

 Fixed Employee
 Cost as a % of        5%        9%             13%           10%        8%

12.    As shown above, variable costs as a percentage of revenues have
fluctuated from as low as 37% to as high as 46%, ignoring             March         2001
because of abnormal profits. (The TPO excluded this year for comparative
purposes.) Fixed labour costs (in absolute terms) have remained more or less
constant. It is this fixed cost which creates idle capacity/manpower. Thus the
                                                                          Page 4 of 8

TPO's argument that the employee cost does not show much variation is not
based on facts.

13.    We find that Parent company has no content manufacturing capacity
in the United States. So the observations of the TPO that the assessee's lower
capacity utilization is because of lower/volume of work outsourced by Parent
Company is not based on facts and has been rightly stated by the ld CIT(A).
Since the Parent company outsources one hundred percent of its work it
secure from customers to its subsidiaries in India and Asia. The natural
outcome is that the volume of business outsourced by the Parent is directly
co-related to the volume of business obtained by its customers. From a
perusal of the chart below the assessee has been able to demonstrate
before the ld CIT(A) and before us that it was receiving consistently jobs from
Innodata US, as a percentage of the total revenue of the assessee.

14.    Table 6 indicates the revenue of the Group and the appellant for five
years, which is as under:-

                                 TABLE 6: REVENUES
                                (figures in Rs. million)
                   March       March                           March           March
      Year         2001        2002           March 2003       2004             2005

 (Group)          2,739.70   2,518.99       1,478.07         1,943.29        2,381.01

 Revenue (IIPL)   331.50     282.80         202.70           249.40         290.10

 % of IIPL
 over group
 revenue             12.1%        11.2%              13.7%        12.8%           12.2%

15.    Therefore the observation of the TPO that the Parent company has
outsourced lower volume of work to the assessee is incorrect.

16.    The explanation of the assessee that excess capacities were on
account of human resources, computers, infrastructural facilities, electricity
costs, etc. And variable labour costs had been controlled by the reduction in
workforce (550 people), fixed costs like portion of management salaries and
                                                                                 Page 5 of 8

general and administrative staff did not get reduced. The assessee has
attached a table/chart to demonstrate that the fixed employee cost (in
absolute numbers) is fairly constant (supra). However, as a percentage of
sales it fluctuates. This fluctuation according to assessee was on account of
fluctuation in revenues (chart supra). Neither the parent company nor the
assessee had any control over the global melt down which was happening
especially at US. The fluctuation in percentages went to show that in the year
when it is high, there is under absorption of the fixed costs, which results in
excess capacities and idle fixed costs including manpower. Further, despite
the revenues being low, the assessee had to retain skilled technical
manpower. Also there were fixed cost on rentals, electricity, depreciation on
computers and infrastructure, which had to be incurred. This resulted in idle
time costs. Under utilization had taken place because of scaling up the
operations in financial years 2000-01 and 2001-02 in which years there was an
increase in revenues: In financial year 2002-03, with the revenues of the
parent company declined and as a consequence thereof; the revenue of
the assessee also declined creating excess capacities and idle time costs.
The submissions made by the assessee in response to the observations of the
TPO as contained in para 4.1 of his order establish the fact that the fixed
assets were purchased in the quarter January to March 2003 on account of
new orders being received by the parent company and in turn the assessee
which continued in the financial year 2003-2004. A perusal of the table clearly
shows that in the financial years 2003-2004 and 2004-2005, there were
insignificant purchase of fixed assets on account of capacities built up as in
the quarter ending January to March 2003 and earlier years. A perusal of the
table will reveal this fact

                              TABLE 1.1: FIXED ASSETS
                                  (figures in Rs. million)
                              March      March        March          March     March
                              2001       2002         2003           2004      2005
       Computer I equipment     18.08       42.55            26.48      6.49      2.71
       software                  1.26       30.89            28.98      0.80           -
                                 5.95       26.71            10.26      1.42      6.22
       improvements / equip
       Total Fixed asset
                                25.10      100.15            65.72      8.71      8.93
       Revenue                 331.50      282.80       202.70        249.40    290.10
                                                                                Page 6 of 8

10.10           As shown above, the assessee made significant capital additions
in March 2002. But, the revenue in the same year declined as compared to
March 2001 of the prior year. Revenue of the Group further declined in March
2003 as compared to the prior year and so did the appellant's revenues. Due
to the reduction in revenues, the assessee curtailed fixed asset additions in
March 2003. Albeit, the revenue went up in 2004 and 2005, the assessee
further curtailed its fixed assets procurement due to its already existing

17.     The observations of the TPO as regards improper Transfer Pricing and
that the parent company had passed on part of its losses to the assessee is
not based on proper evaluation of facts. A perusal of the table represents the
Parent's revenue for seven years starting March 2000:

                                       TABLE 7: REVENUES
                                     (figures in Rs. million)
               March     March       March           March      March   March   March
                2000      2001        2002           2003        2004   2005     2006
  Revenue                                                                       1, 822
                1413      2,740        2,519         1,478      1,943   2,381
      %                                              -41%
                 -        94%          -8%                       31%    23%       -23%

18.     The ld CIT(A) has noted that in the financial year 2002-2003, Innodata
US, the parent company had transferred 98% of its gross revenues which it
had earned from its customers on the jobs done by the assessee for the same
financial year, which is as given below:-

                        REVENUE COMPUTATION - Assesse
                           (amount in Rs.)
                 Total Revenue    Customer Price (CP) % of the appellant's
  Financial Year Reported (by the as invoiced by Parent revenue as a % of
                 appellant)       Company               Customer Price

      2001-02          282,893,100             321,681,600              88%

      2002-03          202,706,500             207,743,700              98%

      2003-04          249,458,600             283,162,000              88%
                                                                         Page 7 of 8

19.   This table also corroborates the stand of the assessee that the
international transactions entered in to by the appellant with its associated
enterprises, were at arm's length.

20.   Moreover we take note that during the course of the appellate
proceedings before the ld CIT(A), the assessee had filed a copy of the,
transfer   pricing   audit   conducted   by   the   Internal   Revenue   Service,
Department of the Treasury US. The assessee was audited by Internal
Revenue Service - International Division US for the calendar years 2003, 2004
and 2005. The examination carried out by the international division of the
Internal Revenue Service, indicated a downward adjustment to income of
one its foreign subsidiaries in Sri Lanka, resulting in an increase of income in
the U.S. No adjustments were carried out to any transaction between the
assessee India Co. and the parent company.

21.   TPO is of the opinion that reason of loss are on other segments and not
the content segment which is not correct because in the calendar 2002 the
parent company had suffered a total loss of USD (5,165,000), which included
loss from content segment of USD (2,996,900)and loss from system and
training segment of USD (2,169,000). So, it is an incorrect observation of the
TPO that the reasons for the loss of the parent company are on account of
segments and not the content segment. In view of the precedents cited in
the impugned order, we find that the ld CIT(A) rightly observed that the
assessee was justified in reducing idle fixed expenses of Rs.3,87,30,000/- from
the total operating expenses and thereby arriving at net operating expenses
of Rs.18,55,63,560/-. Based on such net operating expenses, the net operating
profit margin works out to Rs.1,80,16,160/-, resulting in NCP margin
percentage of 9.71%. The arithmetical mean of the weighted averages of the
comparable companies as compiled by the assessee and as also referred to
and accepted by the TPO in para 5. 1 of his order is 10.12%. Since the
assessee's operating margins falls within (+1-) 5% of the arithmetical mean of
comparable prices, Ld. CIT(A) has rightly held that the assessee's
International Transactions with its associated enterprises during the year to be
at Arm's Length. Consequently the addition of Rs.4,34,12,348/- made to the
price of international transaction was directed to be deleted by the ld CIT(A).
                                                                            Page 8 of 8

For the reasons enumerated above by the ld CIT(A), she rightly deleted the
addition made by the Assessing Officer on account of difference in arm's
length price of Rs.4,34,12,348/-. In the background of the aforesaid
discussions, we find that Ld. CIT(A) has passed a well reasoned order which
does not need any interference on our part, hence, we uphold the same.
Therefore, the issue in dispute raised by the Revenue is rejected.

22.      In the result, the Appeal filed by the Revenue stands dismissed.

         Order pronounced in the open court on 30.04.2015.

            -Sd/-                                                 -Sd/-
         (S.V.MEHROTRA)                                       (A. T. VARKEY)
       ACCOUNTANT MEMBER                                     JUDICIAL MEMBER
 Dated: 30/04/2015
*A K Keot
Copy forwarded to
      1. Applicant
      2. Respondent
      3. CIT
      4. CIT (A)
      5. DR:ITAT
                                                          ASSISTANT REGISTRAR
                                                            ITAT, New Delhi
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