2019 (11) TMI 1411 - AT - Income Tax

TP Adjustment - comparable selection - functional similarity - HELD THAT - Assessee is engaged in the business of manufacturing of and trading in air intake systems and filters for automotive and heavy engineering industry and rendered services to its Associated Enterprises (AEs) in the nature of services using CAD and computer aided manufacturing software tools thus companies functionally dissimilar with that of assessee need to be deselected from final list. Working capital adjustment - HELD THAT - Authorised Representative are realistic as the TPO has not given proper basis/findings in restricting the Working Capital Adjustment to 1.63% and we support our view on judicial decisions and restored this disputed issue to the file of TPO for computing adjustment of working capital on actual facts and allow the grounds of appeal of the assessee for statistical purposes.

Summary

Issues Involved:
1. Legality of the assessment and reference to Transfer Pricing Officer (TPO).
2. Determination of arm's length price (ALP) of international transactions.
3. Use of erroneous data by the TPO.
4. Non-allowance of appropriate adjustments to comparable companies.
5. Variation of 5% from the arithmetic mean.
6. Initiation of penalty proceedings.
7. Relief sought by the assessee.

Detailed Analysis:

1. Legality of the Assessment and Reference to TPO:
The assessee challenged the assessment and the reference to the TPO as being "bad in law and on facts." The primary contention was the addition to the total income due to adjustments in the arm's length price (ALP) for CAD/CAM services provided to associated enterprises (AEs). The assessee argued that the authorities failed to establish that profits were shifted outside India.

2. Determination of Arm's Length Price (ALP):
a. Rejection of Filters and Search Process:
The TPO rejected the filters and search process adopted by the assessee in the Transfer Pricing Study. The TPO conducted a fresh benchmarking analysis and compared the assessee's activities with full-fledged entrepreneurs without considering differences in functions, assets, and risks.

b. Application of Arbitrary Filters:
The TPO applied several arbitrary filters, such as companies with related party transactions greater than 25% of sales, companies with export sales less than 75% of total sales, and others. The Dispute Resolution Panel (DRP) upheld these filters.

c. Rejection of Comparables:
The TPO rejected comparables identified by the assessee and selected others. The assessee contested the inclusion of companies like Infosys Ltd, Persistent Systems Ltd, and Tata Elxsi Ltd, arguing they were functionally different.

d. Incorrect Margin Computation:
The TPO incorrectly computed margins for certain companies. The assessee argued that the TPO did not consider turnover and size differences and significant onsite revenue earned by comparables.

Exclusion of Comparables:
The Tribunal directed the exclusion of the following comparables due to functional dissimilarities:
- E-Zest Solutions Ltd.
- ICRA Techno Analytics Ltd.
- Infosys Ltd.
- Larsen & Toubro Infotech Ltd.
- Persistent Systems & Solutions Ltd.
- Sasken Communication Technologies Ltd.
- Tata Elxsi Ltd.

3. Use of Erroneous Data by the TPO:
The TPO used non-contemporaneous data not available in the public domain at the time of the assessee's study. The TPO also disregarded the application of multiple-year data while computing margins.

4. Non-Allowance of Appropriate Adjustments:
The TPO and DRP did not allow appropriate adjustments under Rule 10B to account for differences in accounting practices, marketing expenditure, and research and development expenditure. The working capital adjustment was restricted to 1.63% without a clear basis.

Working Capital Adjustment:
The Tribunal found that the TPO did not provide a clear rationale for restricting the working capital adjustment to 1.63%. It directed the TPO to compute the adjustment on an actual basis, referencing the case of ARM Embedded Technologies (P.) Ltd. v. Dy. CIT.

5. Variation of 5% from the Arithmetic Mean:
The authorities failed to grant variation as per the proviso to Section 92C(2) of the Income-tax Act, 1961.

6. Initiation of Penalty Proceedings:
The Assessing Officer (AO) initiated penalty proceedings under Section 271(1)(c) of the Act, which the assessee contested.

7. Relief Sought by the Assessee:
The assessee sought relief from the preceding grounds and consequential relief.

Conclusion:
The Tribunal partly allowed the assessee's appeal for statistical purposes. It directed the exclusion of certain comparables and remanded the issue of working capital adjustment to the TPO for computation on an actual basis. The Tribunal emphasized the need for proper basis and findings in the TPO's adjustments and supported its decision with relevant judicial precedents.