2018 (12) TMI 1665 - AT - Income Tax

TP Adjustment - Comparable selection - HELD THAT - INFINITE DATA SYSTEMS PRIVATE LTD. (INFINITE) brought on record by the taxpayer that the profitability of Infinite is increased by 1496% as compared to the preceding year despite the fact that for computation of OP/OC foreign exchange loss has been excluded from OC. We are of the considered view that super-normal profit to the tune of 1496% certainly affects OP/OC but in this case even foreign exchange loss has been excluded from the OC by the TPO and as such it makes the Infinite not a valid comparable vis- -vis the taxpayer. So we are of the considered view that because of functional dissimilarity of Infinite vis- -vis the taxpayer and earning supernormal profit by 1496% as compared to preceding years makes Infinite as invalid comparable. So we direct the AO/ TPO to exclude Infinite from the final set of comparables. INFOSYS LIMTIED (INFOSYS) - functional dissimilarity between Infosys vis- -vis the taxpayer and the fact that Infosys is incurring huge expenditure to the tune of 2.1% of its total revenue on its R D activities leading to the creation of significant intangible property and the fact that Infosys is a brand in itself and the fact that it assumes entrepreneurial risk and it also deals in software product and following the decision rendered in CIT vs. Agnity India Technologies Pvt. Ltd. 2013 (7) TMI 696 - DELHI HIGH COURT it cannot be taken as a valid comparable. So we direct the AO/ TPO to exclude Infinite from the final set of comparables. PERSISTENT SYSTEMS LIMTIED (PERSISTENT) - we are of the considered view that Persistent is not a valid comparable vis- -vis taxpayer. So we direct the AO/ TPO to exclude Infinite from the final set of comparables. SONATA SOFTWARE LTD. (SONATA) - when we examine Related Party Transactions of Sonata available at page 726 of the paper book it goes to prove that its RPT as percentage of sales is 53.83% whereas TPO himself has applied the filters to exclude the companies with more than 25% of RPT from the final set of comparables. So keeping in view the functional dissimilarity as well as substantial Related Party Transactions Sonata cannot be a valid comparable vis- -vis taxpayer hence ordered to be excluded. TATA ELXSI - As relying on M/S. NEC TECHNOLOGIES INDIA LTD. 2017 (11) TMI 71 - ITAT DELHI Tata Elxsi is being functionally dissimilar vis- -vis tax payer is ordered to be excluded from the final list of comparable for benchmarking the international transactions. ZYLOG SYSTEMS LIMITED (ZYLOG) - Zylog has undergone into business restructuring due to acquisition which is an extraordinary event the same cannot be a valid comparable hence order to be excluded from the final set of comparable THIRDWARE SOLUTIONS LTD. (THIRDWARE) - following the decision rendered by Co-ordinate bench of Tribunal in Open Solutions Software Services Pvt. Ltd. Vs. DCIT 2017 (4) TMI 960 - ITAT DELHI . We are of the considered view that Thirdware is also into development and sale of software products whereas the tax payer is purely into providing software development services. Moreover complete segmental financials are also not available. So keeping in view the fact that the Thirdware is having a different business model cannot be a valid comparables vis- -vis tax payer who is a routine software development services provider hence ordered to be excluded from the final set of comparables.

Issues Involved:
1. Validity of the order passed under Section 143(3) read with Section 144C of the Income-tax Act.
2. Correctness of income assessment at ?92,06,510/- against the declared income of ?61,681/-.
3. Addition of ?91,44,831/- as difference in arm's length price.
4. Inclusion of certain comparables by the DRP.
5. Rejection of the taxpayer's contention regarding non-comparability of Infosys Limited and Sonata Software.
6. Application of arm's length price based on non-comparable data.
7. Exclusion of exceptional comparables while determining the arm's length price.
8. Exclusion of comparables selected by the taxpayer.
9. Rejection of comparables given by the taxpayer.
10. Non-uniform application of comparability criteria/filters.
11. Use of multiple years' data in the taxpayer's TP study.
12. Rejection of adjustments for varying risk profiles and working capital differences.
13. Rejection of the benefit of the arm's length range of +/- 5%.

Detailed Analysis:

1. Validity of the Order:
The taxpayer challenged the order passed under Section 143(3) read with Section 144C of the Income-tax Act, asserting that it was flawed both legally and factually.

2. Income Assessment:
The Assessing Officer (AO) assessed the income at ?92,06,510/- against the declared income of ?61,681/-, which the taxpayer contested as erroneous both in law and on facts.

3. Addition of ?91,44,831/-:
The AO made an addition of ?91,44,831/- as a difference in arm's length price, which the taxpayer argued was incorrect.

4. Inclusion of Certain Comparables:
The taxpayer contended that the DRP erred in including the following comparables: Infinite Data System Private Limited, Infosys Limited, Persistent Systems Limited, Sonata Software, Tata Elxsi, Zylog Systems Limited, and Thirdware Solutions Limited, as their business activities were significantly different from those of the taxpayer.

5. Non-Comparability of Infosys Limited and Sonata Software:
The DRP rejected the taxpayer's contention that Infosys Limited and Sonata Software were not comparable. The Tribunal examined the functional profile of Infosys and concluded that due to its diversified services, significant R&D expenditure, and brand value, Infosys was not a valid comparable. Similarly, Sonata Software was excluded due to its substantial related party transactions and functional dissimilarity.

6. Application of Arm's Length Price:
The taxpayer argued that the AO applied arm's length price based on data from non-comparable companies, which was not appropriate given the taxpayer’s level of operations.

7. Exclusion of Exceptional Comparables:
The taxpayer contended that the DRP erred in rejecting the exclusion of exceptional comparables. The Tribunal agreed and excluded Infinite Data System Private Limited, Infosys Limited, Persistent Systems Limited, Sonata Software, Tata Elxsi, Zylog Systems Limited, and Thirdware Solutions Limited from the final set of comparables due to functional dissimilarities and extraordinary events affecting profitability.

8. Exclusion of Comparables Selected by the Taxpayer:
The taxpayer argued that the TPO arbitrarily excluded comparables selected by them, which had the same line of activities. The Tribunal directed the AO/TPO to reconsider the taxpayer’s comparables.

9. Rejection of Comparables Given by the Taxpayer:
The Tribunal found that the AO/TPO had rejected the comparables provided by the taxpayer without proper justification and directed a fresh comparability analysis.

10. Non-Uniform Application of Comparability Criteria/Filters:
The taxpayer claimed that the TPO did not apply the comparability criteria uniformly. The Tribunal directed the AO/TPO to ensure uniform application of filters.

11. Use of Multiple Years' Data:
The taxpayer argued that the DRP erred in rejecting the use of multiple years' data in the TP study. The Tribunal upheld the taxpayer's approach of using multiple years' data, considering its impact on current year profits.

12. Adjustments for Risk Profiles and Working Capital Differences:
The DRP rejected the taxpayer’s calculation for adjustments based on varying risk profiles and working capital differences. The Tribunal directed the AO/TPO to consider appropriate adjustments.

13. Arm's Length Range of +/- 5%:
The taxpayer contended that the benefit of the arm's length range of +/- 5% should be given as per the proviso to Section 92C(2) of the Act. The Tribunal directed the AO/TPO to apply this benefit where applicable.

Conclusion:
The Tribunal allowed the taxpayer's appeal for statistical purposes, directing the AO/TPO to exclude certain comparables, reconsider the taxpayer's comparables, and apply the arm's length range benefit. The Tribunal emphasized the need for a fresh comparability analysis to benchmark the international transaction undertaken by the taxpayer.

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