2016 (6) TMI 1259 - AT - Income Tax

TPA - comparable selection criteria - Held that - Assessee is engaged in providing software development services (SDS), IT enabled services (ITES) and market support services (MSS) to its AEs. The company is primarily engaged in the business of software development for export, more specifically, the assessee is involved in development of switching integration and comer stone modules for Janus release, a next generation messaging products, thus companies functionally dissimilar with that of assessee need to be deselected from final list.

Issues Involved:
1. Transfer Pricing Adjustments for Software Development Services (SDS), IT Enabled Services (ITES), and Market Support Services (MSS).
2. Exclusion of certain comparables in the benchmarking analysis.
3. Application of filters and selection of comparables.
4. Use of multiple year/prior years' data.
5. Rejection of low-profit/loss-making companies.
6. Risk adjustment and working capital adjustment.
7. Penalty proceedings under Section 271(1)(c).

Detailed Analysis:

1. Transfer Pricing Adjustments for SDS, ITES, and MSS:
The assessee, a subsidiary of Avaya International LLC, reported international transactions in software development services (SDS), IT enabled services (ITES), and market support services (MSS). The Transfer Pricing Officer (TPO) selected the Transactional Net Margin Method (TNMM) as the most appropriate method and used the Operating Profit to Total Cost (OP/TC) ratio as the Profit Level Indicator (PLI). Adjustments were made by the TPO based on a fresh comparability analysis, leading to discrepancies between the prices charged by the assessee and the arm's length prices.

2. Exclusion of Certain Comparables:
The Dispute Resolution Panel (DRP) directed the exclusion of certain comparables such as Celestial Biolabs, Softsol India Ltd., Mold-tek Technologies Ltd., RITES, and Vapti Waste & Effluent Management Co. Ltd. The Tribunal upheld these exclusions based on functional dissimilarity and improper segmental reporting. For instance, Celestial Biolabs was excluded as it failed the employee cost filter and received loans from the Department of Science and Industrial Research, indicating different economic circumstances.

3. Application of Filters and Selection of Comparables:
The Tribunal noted that the TPO applied additional/revised filters to determine the arm's length price (ALP). The Tribunal emphasized the need for proper functional analysis and segmental reporting to ensure comparability. For example, the Tribunal excluded Infosys Technologies Ltd., KALS Information Systems Ltd., and Wipro Ltd. due to their significant differences in functions, scale, and risk profiles compared to the assessee.

4. Use of Multiple Year/Prior Years' Data:
The Tribunal addressed the assessee's contention regarding the use of multiple year/prior years' data. The Tribunal noted that the TPO relied on current year data, which was not necessarily available to the assessee at the time of preparing its transfer pricing documentation. The Tribunal highlighted the importance of considering data availability and the principles of natural justice.

5. Rejection of Low-Profit/Loss-Making Companies:
The Tribunal observed that the TPO arbitrarily rejected low-profit/loss-making companies without consistent reasons. The Tribunal stressed the need for a balanced approach in selecting comparables, ensuring that both high-profit and low-profit companies are considered to achieve a fair benchmarking analysis.

6. Risk Adjustment and Working Capital Adjustment:
The Tribunal acknowledged the assessee's claim for risk adjustment, noting that the assessee, being a low-risk captive unit, should be compensated for its minimal business risks. The Tribunal also addressed the issue of working capital adjustment, directing the TPO to consider the assessee's claims in this regard.

7. Penalty Proceedings under Section 271(1)(c):
The Tribunal noted that the Assessing Officer (AO) initiated penalty proceedings under Section 271(1)(c) of the Income-tax Act. The Tribunal did not delve into this issue in detail, as the primary focus was on the transfer pricing adjustments and the selection of comparables.

Conclusion:
The Tribunal directed the AO to compute the arm's length price (ALP) in accordance with the Tribunal's observations for inclusion/exclusion of comparables. The appeal was partly allowed, with the Tribunal emphasizing the importance of functional comparability, proper segmental reporting, and a balanced approach in the selection of comparables. The Tribunal's decision underscores the need for a meticulous and fair benchmarking analysis in transfer pricing cases.

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