2018 (5) TMI 1808 - AT - Income Tax

TPA - addition made on account of adjustment to ALP survives - directions of the DRP results in reduction of the addition on account of adjustment to ALP as suggested by the TPO - Held that - Companies functionally dissimilar with that of ITES segment of the Assessee need to be deselected from final list. Working capital adjustment - Held that - The working capital adjustment ought to be allowed on actuals upon taking into consideration the correct value of receivables and payables. We are of the view that it would be appropriate to direct the TPO/AO to examine the grievance of the Assessee in this regard and re work the working capital adjustment in accordance with law. Foreign exchange fluctuation is operating in nature - the margin of the Assessee has to be computed upon including the gains from the said fluctuation - Held that - In the light of Rule 10B(3) of the Rules and the business cycle in the relevant business the comparability will not be materially affected if the foreign exchange gain is considered as reflected in the accounts of the comparable companies as available in public domain. Respectfully following the decision of the ITAT Bangalore in the case of SAP Labs (2010 (8) TMI 676 - ITAT BANGALORE) we hold that the DRP was justified in directing the AO to consider the foreign exchange gain or loss as operating in nature. Therefore in light of the above this ground of the Revenue is liable to be dismissed Regarding 1% risk adjustment it is settled position that assesses that are captive service providers assume less risk compared to companies in an uncontrolled situation and therefore an adjustment is to be provided to the margins of the comparables to mitigate the said difference. This Hon ble Tribunal has consistently upheld the above approach and has directed the grant of risk adjustment to the margins of the comparables. In this regard reference may be made to the decision of ITAT Bangalore Bench in the case of Bearing Point Business Consulting (PR) Ltd. v. DOlT (2014 (4) TMI 997 - ITAT BANGALORE) where this Hon ble Tribunal has directed the grant of risk adjustment in the case of an assessee placed similarly to that of the Assessee herein. No grounds to interfere with the order of the DRP in this regard and dismiss the relevant ground of appeal of the Revenue.

Issues Involved:
1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD).
2. Determination of ALP for Information Technology Enabled Services (ITES).
3. Determination of ALP for Management Support Services (MSS).
4. Inclusion and exclusion of comparable companies.
5. Treatment of foreign exchange gain.
6. Working capital adjustment.
7. Risk adjustment.

Issue-wise Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD):
The Assessee, a wholly-owned subsidiary of a UK-based company, provided SWD services to its holding company. The Transfer Pricing Officer (TPO) determined that the Assessee should have charged a higher price, resulting in an addition of ?21,64,56,087 to the total income. The Assessee's Transfer Pricing Study (TP Study) used the Transaction Net Margin Method (TNMM) with Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI). The TPO accepted TNMM but selected different comparable companies, leading to a higher ALP. The Dispute Resolution Panel (DRP) upheld the TPO's selection of comparables but directed the inclusion of foreign exchange gains and verification of margin computations. The Tribunal excluded certain companies from the comparables list and remanded others for fresh consideration.

2. Determination of ALP for Information Technology Enabled Services (ITES):
For ITES, the TPO added ?94,66,683 to the total income, again using TNMM with OP/TC as the PLI. The TPO accepted only four of the Assessee's comparables and added six new ones. The DRP's directions were similar to those for SWD services, including the inclusion of foreign exchange gains and verification of margin computations. The Tribunal excluded certain companies based on previous decisions and remanded others for fresh consideration.

3. Determination of ALP for Management Support Services (MSS):
The TPO determined a higher ALP for MSS, resulting in an addition of ?11,33,279. The Assessee's TP Study used TNMM with OP/TC as the PLI, selecting five comparables. The TPO rejected all and chose three new ones. The DRP upheld the TPO's selection but directed the inclusion of foreign exchange gains and verification of margin computations. The Tribunal excluded two of the TPO's comparables based on previous decisions.

4. Inclusion and Exclusion of Comparable Companies:
The Tribunal excluded several companies from the TPO's comparables list for SWD and ITES segments based on functional dissimilarities and previous decisions. It also remanded the inclusion of certain companies for fresh consideration. For MSS, the Tribunal directed the exclusion of two companies based on previous decisions.

5. Treatment of Foreign Exchange Gain:
The DRP directed the inclusion of foreign exchange gains in the margin computation, considering them as operating in nature. The Tribunal upheld this direction, following previous decisions that foreign exchange gains or losses related to business operations should be treated as operating revenue or loss.

6. Working Capital Adjustment:
The Assessee argued that the TPO arbitrarily restricted the working capital adjustment. The Tribunal directed the TPO/AO to allow the working capital adjustment in full without any arbitrary cap and to verify the correct values of receivables and payables.

7. Risk Adjustment:
The DRP granted a 1% risk adjustment, recognizing that captive service providers assume less risk compared to companies in uncontrolled situations. The Tribunal upheld this direction, following previous decisions that support granting risk adjustments to comparables' margins.

Conclusion:
The Tribunal partly allowed the Assessee's appeal, directing exclusions and remands for fresh consideration of certain comparables and adjustments. The Revenue's appeal was dismissed, upholding the DRP's directions on foreign exchange gains and risk adjustments. The order was pronounced on 2nd May 2018.

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