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2020 (2) TMI 1365 - AT - Income TaxTP Adjustment - determination of ALP in respect of an international transaction of rendering software development services SWD services by the assessee to its Associated Enterprise (AE) under the provisions of section 92 of the Act - Comparable selection - AY 2014-15 - HELD THAT - Assessee is a company engaged in the business of software design development testing support and implementation of computer software. The assessee is a wholly owned subsidiary of Yahoo (non resident) thus companies functionally dissimilar with that of assessee need to be deselected. Thirdware Solutions Ltd. Infosys Ltd. Persistent Systems Ltd. need to be deselected accordingly. No adjustment made to he profit margins on account of working capital differences between the tested party and the comparable companies - HELD THAT - Revenue authorities were not justified in denying adjustment on account of working capital adjustment. We may also add that the complete working capital adjustment working has been given by the Assessee and a copy of the same is at page 186 to 200 of the Assessee s paper book. No defect whatsoever has been pointed out in these working by the CIT(A). We may also further add that in terms of Rule 10B(1)(e) (iii) of the Rules the net profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences if any between the international transaction and the comparable uncontrolled transactions which could materially affect the amount of net profit margin in the open market. It is not the case of the TPO/DRP that differences in working capital requirements of the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by the revenue authorities working capital adjustment cannot be allowed to the profit margins then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 10B(3) of the Rules. Keeping with the OECD guidelines endeavour should be made to bring in comparable companies for the purpose of broad comparison. Therefore the working capital adjustment as claimed should be allowed. We hold and direct accordingly. The assessee in the present case has given all the details required for working capital adjustment and the revenue authorities were not justified in denying the claim of assessee for deduction. The TPO/AO is directed to allow working capital adjustment in the light of the material already available on record after affording opportunity of being heard to the assessee. Comparable selection - RPT filter @ 25% - AY 2015-16 - presence of onsite revenue over and above the threshold limit of 25% of total revenue - HELD THAT - TPO accepted that the RPT filter should be @ 25%. In the case of Persistent Systems Ltd. the RPT is at 31.32% as extracted in the earlier part of this order and therefore this company should be excluded by application of RPT filter. In view of the above we do not wish to go into other grounds on which this company is sought to be excluded viz. that it is a product company and there is no segmental data between product and services segment presence of onsite activity and the impact of extra-ordinary event of acquisition during the relevant previous year. Therefore this company is directed to be excluded from the list of comparable company. L T Infotech Ltd. - This company as part of its operating profit in Schedule-O of profit loss account contains expenditure for cost of bought out items for resale and this is a significant part of the operating expenditure. When we see the revenue in Schedule M of the profit loss account there is no break-up of the revenue with regard to software services and software product. In our opinion this distinction is enough to exclude this company from the list of comparable companies. Infosys Ltd. company cannot be compared with that of the assessee basically because of its business model presence of onsite revenue generation and other reasons cited before us. Besides the reason that turnover of this company is huge and more than 10 times that of the assessee. Mindtree Ltd. - Presence of IPR revenue was insignificant and so also expenses of brand value R D intangibles. More importantly the DRP did not dispute the presence of 46% of revenue from onsite model but went on to hold that the presence of revenue is not sufficient to exclude a company when it is otherwise functionally comparable. On this aspect we have already referred to the decision of the ITAT Bangalore Bench in the case of Trilogy e-business Software India P. Ltd. 2013 (1) TMI 672 - ITAT BANGALORE and in the light of this decision and the admitted factual position regarding presence of onsite revenue over and above the threshold limit of 25% of total revenue we are of the view that this company should be excluded from the list of comparable companies.
Issues Involved:
1. Determination of Arm's Length Price (ALP) for software development services. 2. Selection and exclusion of comparable companies. 3. Granting of working capital adjustment. Detailed Analysis: 1. Determination of Arm's Length Price (ALP) for Software Development Services: The primary issue in this appeal concerns the determination of the ALP for an international transaction involving software development services rendered by the assessee to its Associated Enterprise (AE). The assessee used the Transactional Net Margin Method (TNMM) to justify the price received, comparing its Operating Profit to Operating Cost (OP/OC) with that of selected comparable companies. The Transfer Pricing Officer (TPO) rejected the comparables chosen by the assessee and selected a new set, resulting in a proposed transfer pricing adjustment. The Dispute Resolution Panel (DRP) retained some of the TPO's comparables and included others suggested by the assessee, but the final assessment still led to an addition to the total income of the assessee. 2. Selection and Exclusion of Comparable Companies: The Tribunal examined the exclusion of three specific companies: Thirdware Solutions Ltd., Infosys Ltd., and Persistent Systems Ltd. The Tribunal referred to a previous decision in the case of Kony IT Services P. Ltd., highlighting that these companies were not purely engaged in software development services but also involved in product development, owning significant intangibles, and intellectual property rights (IPRs). The Tribunal concluded that these companies should be excluded from the list of comparables due to their functional dissimilarities with the assessee. 3. Granting of Working Capital Adjustment: The Tribunal addressed the issue of working capital adjustment, which the TPO and DRP had denied. The Tribunal emphasized the importance of comparability adjustments as per Rule 10B(1)(e)(iii) of the Income-tax Rules and the OECD Transfer Pricing Guidelines. The Tribunal criticized the TPO's reasoning for denying the adjustment, stating that the lack of daily working capital levels and segmental details should not preclude the adjustment. The Tribunal directed the revenue authorities to allow the working capital adjustment based on the calculations provided by the assessee, which had not been disputed. Separate Judgments for Assessment Years 2014-15 and 2015-16: For Assessment Year 2014-15, the Tribunal directed the exclusion of the three companies and allowed the working capital adjustment, leading to a partial allowance of the assessee's appeal. Similarly, for Assessment Year 2015-16, the Tribunal excluded additional companies like L&T Infotech Ltd. and Mindtree Ltd. based on similar reasoning and directed the revenue authorities to allow the working capital adjustment after affording an opportunity for the assessee to be heard. Conclusion: The Tribunal's judgment in both appeals resulted in the partial allowance of the assessee's appeals, directing the revenue authorities to recompute the ALP after excluding certain comparables and allowing the working capital adjustment. The decisions emphasized the need for accurate comparability analysis and adjustments to ensure the determination of ALP aligns with the arm's length principle.
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