2017 (2) TMI 1337 - AT - Income Tax

Determination of arm s length (ALT) of an International Transaction - comparable selection criteria - Held that - Assessee is engaged in the business of software development and it provides software development services to its various group companies, thus companies functionally dissimilar with that of assessee need to be deselected from final list. Adjustment towards working capital and risk adjustment - Held that - Similar adjustments should also be allowed in the present assessment year. We hold and direct accordingly. We also observe that the principle reasons assigned by the DRP in the present assessment year was lack of details furnished by the assessee. In this regard we find that all the details have been given by the assessee in its transfer pricing study and we find that the observations of the DRP in this regard cannot be sustained. We accordingly direct that adjustment of 2% towards working capital adjustment and risk adjustment should be allowed to the assessee as was done in A.Y.2004-05. We hold and direct accordingly.

Issues Involved:
1. Determination of arm's length price (ALP) for international transactions.
2. Inclusion/exclusion of comparable companies.
3. Claim of risk adjustment.
4. Claim of working capital adjustment.
5. Enhancement of income.
6. Granting of deduction under section 80G.
7. Levy of interest under sections 220(2) and 234B.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for International Transactions:
The primary issue was the determination of the ALP for the software development services provided by the assessee to its Associated Enterprises (AEs). The assessee used the Transaction Net Margin Method (TNMM) with an operating margin of 12% to justify its transactions as being at arm's length. The Transfer Pricing Officer (TPO) disagreed, arguing that loss-making companies and those with significantly different turnovers should be excluded from the comparables. The TPO selected nine comparables, resulting in an average operating margin of 18.41%, leading to an ALP adjustment of ?21.79 crores.

2. Inclusion/Exclusion of Comparable Companies:
The TPO included three additional companies (M/s. Mphasis BFL Ltd., M/s. Visual Soft Technologies Ltd., and M/s. Blue Star Infotech Ltd.) which were later excluded by the Dispute Resolution Panel (DRP). The DRP also applied a turnover filter, resulting in a sample of six companies with an average operating margin of 17.77%. The Tribunal directed the exclusion of these three companies from the comparables list, as their inclusion was erroneous and had already been settled by the DRP.

3. Claim of Risk Adjustment:
The assessee claimed a risk adjustment, arguing that as a captive service provider, it bore less risk compared to full-fledged entrepreneurs. The DRP rejected this claim, stating that the assessee did not provide adequate evidence showing how the risks materially affected the comparables' margins. The Tribunal, however, noted that the DRP had accepted the principle of risk adjustment and directed a 2% adjustment for risk and working capital, consistent with the previous assessment year.

4. Claim of Working Capital Adjustment:
The assessee argued for a working capital adjustment, citing differences in the working capital cycles between itself and the comparables. The DRP rejected this claim due to a lack of reliable data. The Tribunal found that the assessee had provided the necessary details in its transfer pricing study and directed a 2% adjustment for working capital, consistent with the previous assessment year.

5. Enhancement of Income:
The assessee contended that the enhancement of the transfer pricing adjustment to ?32.81 crores was erroneous, as the Tribunal had only remanded specific issues for fresh adjudication. The Tribunal agreed, noting that the enhancement was unjustified and directed the exclusion of certain comparables, leading to a recalculation of the adjustment.

6. Granting of Deduction under Section 80G:
The assessee claimed a deduction under section 80G, which was not granted in the final assessment order. The Tribunal directed the Assessing Officer (AO) to verify the claim and allow the appropriate relief if found correct.

7. Levy of Interest under Sections 220(2) and 234B:
The assessee contested the levy of interest under sections 220(2) and 234B. The Tribunal held that these issues were consequential and directed the AO to provide the necessary relief based on the revised assessment.

Conclusion:
The Tribunal partly allowed the appeal, directing the exclusion of certain comparables, granting a 2% adjustment for risk and working capital, and instructing the AO to verify and allow the deduction under section 80G. The levy of interest was held to be consequential. The final order emphasized the need for a thorough and accurate assessment in line with the Tribunal's directions.

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