2016 (2) TMI 604 - AT - Income Tax

Addition on account of transfer pricing adjustment - calculation of the assessee s PLI - Held that - In the present case, the assessee has taken a stand that capacity adjustment be allowed on the assumption of all the comparables operating at 100% capacity level, which is not evidenced from any material on record. On a pertinent query, the learned Authorized Representative candidly admitted that no such data was available to vouch such a claim. In the absence of any reliable data to support the difference between the capacity utilization levels of the assessee and the comparables, we are helpless in granting any such adjustment. Summing up, we hold that neither there is any warrant for adjusting the assessee s profit margin with capacity adjustment, nor such adjustment, in the facts and circumstances of the present case, can be allowed in the profit margin of comparables. We, therefore, dismiss this ground of appeal. Selection of comparable - Held that - E-Infochips Limited as the assessee is simply engaged in rendering software development services and there is no sale of any software products, this company, in our considered opinion, ceases to be comparable. It is obvious that from the common pool of income from both the streams of software products and software services, one cannot deduce the revenue from software services and no one knows the impact of revenue from Products on the overall kitty of profit, which may be significant. Since no segmental data of this company is available indicating operating profit from software development services, we order to exclude this company from the list of comparables. E-Zest Solutions this company is its functional dissimilarity. We have gone through the Annual report of this company which is available in the paper book. Its Profit and loss account specifies Income from operations . It is further borne out that it is providing end-to-end development, software project development services. As the assessee is also engaged in the customised software development, we find this company to be functionally similar. The same is, therefore, retained in the list of comparables. L&T Infotech Ltd. - find from the Annual report of this company, which is available in the third paper book that its Profit and loss account shows Revenue Revenue software development services and products . Profit and loss account of this company having a list of software development expenses contains an item Cost of bought-out items for re-sale with a value of ₹ 25.55 crore. Apart from that, the balance-sheet of this company shows certain Software in its Schedule of fixed assets under the head Intangible assets . The above facts conclusively prove that this company is also engaged in the sale of Products apart from rendering software development services. Adopting the same reasons as given for the exclusion of Einfochips Ltd., we order for the exclusion of this company as well. Persistent Systems and Solutions Ltd. - The Annual Report of this company has been placed in the second paper book, from which it is lucid that this company is engaged only in providing software development and consultancy services, which is similar to those rendered by the assessee. When confronted, the ld. AR did not raise any objection to the inclusion of this company in the final set of comparables. We, therefore, uphold the impugned order in treating this company as comparable. Persistent Systems Ltd. - The TPO has himself observed that this company does have some products, but, product revenue is only 7.2% and, hence, this company is predominantly a software service provider. This discussion is contained in para 21.67 of the TPO s order. Even Schedule-11 to the Profit & Loss Account also shows Sale of software services and Products. This shows that this company is engaged in both rendering software development services as well as sale of software products. Albeit the percentage of software products in the total revenue is less, as has been noted by the TPO, yet, we are inclined to take it as non-comparable because there is no precise information about the contribution made by such small sale of software products to the total profit of the company. As no segmental information is available in respect of this company and the figures have been adopted by the TPO at entity level, we, therefore, order for the exclusion of this company from the list of comparables. Sasken Communications Technologies Ltd. - as find from TPO s order that he has recognized sale of software products to the tune of ₹ 37 crore and odd. Though the break-up of revenue from software services and software products is available, but, the break-up of operating costs and net operating revenues from these two segments have not been given. It is further observed that the TPO has taken entity level figures for the purposes of making comparison. Since such entity level figures contain revenue from both software services and software products, as against the assessee only providing software services, we are disinclined to treat this company as comparable Wipro Technology Services Ltd.earned a revenue from Master services agreement with Citigroup Inc. for the delivery of technology infrastructure services. This agreement was, in fact, executed between the assessee s AE, Wipro Ltd., and Citigroup Inc., a third person. This unfolds that the transaction of earning revenue from software development support and maintenance services by Wipro Technology Services Ltd., is an international transaction because of the application of section 92B(2) i.e., there exists a prior agreement in relation to such transaction between Citigroup Inc. (third person) and Wipro Ltd. (associated enterprise). In the light of this structure of transaction, it ceases to be uncontrolled transaction and, hence, Wipro Technology Services Ltd., disqualifies to become a comparable uncontrolled transaction for the purposes of inclusion in the final list of comparables under Rule 10B(1)(e)(ii). Acropetal Technologies Ltd. (Seg.) as find from the Annual accounts of this company, a copy of which is available at page 892 of the paper book, that it has a separate segment of software development covering Enterprise solutions and IT infrastructure solutions . The nature of activity done by this company under these segments is broadly similar to that conducted by the assessee. Since the TPO has considered only the segmental figures of this company for the purposes of inclusion in the list of comparables, we find no reason to accept the assessee s contention for its expulsion from the set of comparables. Sankhya Infotech Ltd. (Seg.) - AR s contention that this company was doing huge research and development and, hence, the same should be excluded, does not merit acceptance because the research and development activity is restricted to the Product segment as is apparent from page 1198 of the paper book which states that the company has in-house research and development centre involved in developmental activities for new products in the fields of simulations and training. Once this contention of the assessee is rejected and revenue from software products is excluded to the only inclusion of revenue from software development services segment which is akin to that of assessee, we feel no difficulty in considering this company as comparable on segmental level. The impugned order is upheld. Zylog Systems Ltd. - AR invited our attention towards page 9 of the TPO s order containing list of 19 companies on which the assessee s objections were sought for the purposes of their inclusion in the list of comparables. Name of Zylog Systems Ltd. is absent from such list., thus ends of justice would meet adequately if the impugned order on this issue is set aside and the matter is restored to the file of AO/TPO for deciding the inclusion or otherwise of Zylog Systems Ltd. in the final set of comparables afresh after entertaining objections from the assessee.

Summary

Issues Involved:
1. Transfer Pricing Adjustment
2. Calculation of Assessee's Profit Level Indicator (PLI)
3. Inclusion of Comparables

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment:
The core issue in this appeal was the addition of Rs. 7,76,66,682 on account of transfer pricing adjustment. The assessee, engaged in software development and technical support services, reported four international transactions, with the "Provision of Software Development" being disputed. The assessee applied the Transactional Net Margin Method (TNMM) to demonstrate that the international transaction was at Arm's Length Price (ALP). The assessee's profit margin from this transaction was 22.63% against the mean margin of 17.91% from five comparables. However, the Transfer Pricing Officer (TPO) observed a discrepancy in the Profit Level Indicator (PLI), showing an overall OP/OC at (-)15.34% while the transaction's profit margin was shown at 22.63%. The TPO refused any comparability adjustment claimed by the assessee, leading to the contested addition.

2. Calculation of Assessee's Profit Level Indicator (PLI):
The assessee challenged the TPO's calculation of its PLI, specifically the non-granting of capacity utilization adjustment. The TPO calculated the PLI at (-)12.65%, which the assessee disputed. The tribunal clarified that adjustments due to differences between the assessee and comparables should be made in the profit margin of comparables, not in the assessee's profit margin. The tribunal found the assessee's calculation of capacity utilization adjustment unjustified, noting that the assessee had excluded significant operating expenses and used an inflated full bench capacity figure. The tribunal emphasized that for any adjustment, the burden of proof lies on the assessee to demonstrate the comparables' capacity utilization levels. In the absence of such data, the tribunal denied the capacity adjustment.

3. Inclusion of Comparables:
The assessee contested the inclusion of ten companies in the final list of comparables. The tribunal examined each company as follows:

- E-Infochips Limited: Excluded due to functional dissimilarity and lack of segmental data separating software services from product sales.
- E-Zest Solutions: Retained as comparable due to functional similarity in providing software development services.
- L&T Infotech Ltd.: Excluded due to involvement in both software services and product sales without segmental data.
- Persistent Systems and Solutions Ltd.: Retained as comparable due to similarity in software development services.
- Persistent Systems Ltd.: Excluded due to involvement in both software services and product sales without segmental data.
- Sasken Communications Technologies Ltd.: Excluded due to involvement in both software services and product sales without segmental data.
- Wipro Technology Services Ltd.: Excluded due to significant related party transactions and being part of a master service agreement with the parent company, making it an international transaction.
- Acropetal Technologies Ltd. (Seg.): Retained as comparable on segmental level, similar to the assessee's activities.
- Sankhya Infotech Ltd. (Seg.): Retained as comparable on segmental level, similar to the assessee's activities.
- Zylog Systems Ltd.: Remitted to the AO/TPO for fresh consideration after allowing the assessee to present objections.

Conclusion:
The tribunal set aside the impugned order and remitted the matter to the AO/TPO for fresh computation of ALP in conformity with the tribunal's discussion, ensuring the assessee is given a reasonable opportunity of hearing. The appeal was partly allowed for statistical purposes.