2020 (8) TMI 832 - AT - Income Tax

TP Adjustment - determination of Arm s Length Price ALP in respect of international transaction entered into by the assessee with its Associate Enterprise AE - comparable selection - HELD THAT - The assessee provides software development SWD services to its AE. Rendering of SWD services by the assessee to its AE is an international transaction and that the income arising from the said international transaction has to be determined keeping in view the ALP as is required u/s. 92 of the Act. Thus companies functionally dissimilar with that of assessee need to be deselected.

Issues Involved:
1. Correctness of the determination of Arm's Length Price (ALP) in respect of international transactions.
2. Inclusion and exclusion of comparable companies for ALP determination.
3. Verification of the risk differential adjustment for the assessee's limited risk nature of contractual services.

Detailed Analysis:

1. Correctness of the determination of Arm's Length Price (ALP) in respect of international transactions:
The primary issue in this appeal concerns the determination of the ALP for international transactions between the assessee, an Indian subsidiary of LG Electronics, South Korea, and its Associate Enterprise (AE). The assessee provides software development (SWD) services to its AE, and the income from this transaction must be determined based on the ALP as per Section 92 of the Income-tax Act, 1961. Both parties agreed that the Transaction Net Margin Method (TNMM) was the Most Appropriate Method (MAM) for determining the ALP, with Operating Profit/Total Cost (OP/TC) as the profit level indicator. The assessee's OP/TC was 14.20%, while the arithmetic mean of 13 comparable companies selected by the assessee was 13.71%. The Transfer Pricing Officer (TPO) accepted only 2 of these 13 comparable companies and selected 11 additional companies, resulting in an arithmetic mean profit margin of 24.82% before adjustments.

2. Inclusion and exclusion of comparable companies for ALP determination:
The Dispute Resolution Panel (DRP) excluded 10 out of 13 comparable companies selected by the TPO, retaining only Persistent Systems & Solutions Ltd., Sasken Communication Technologies Ltd., and Persistent Systems Ltd. The revenue appealed against this exclusion, while the assessee contested the inclusion of the three retained companies and the exclusion of R S Software India Ltd. and Evoke Technologies Ltd. The Tribunal allowed the inclusion of R S Software India Ltd., Evoke Technologies Ltd., and Mindtree Ltd. as comparables, as both parties had no objections. For the remaining 7 companies excluded by the DRP, the Tribunal upheld their exclusion based on precedents from similar cases, emphasizing functional dissimilarities and issues such as high related party transactions (RPT) and lack of segmental details.

3. Verification of the risk differential adjustment for the assessee's limited risk nature of contractual services:
The assessee raised an issue regarding the non-provision of an appropriate adjustment for the risk differential, given its limited risk nature of contractual services compared to full-fledged entrepreneurial companies. The Tribunal directed the Assessing Officer (AO) to verify the assessee's claim and provide the correct credit for advance taxes paid.

Conclusion:
The Tribunal's decision partially allowed both the revenue's and the assessee's appeals. It directed the inclusion of certain companies as comparables and upheld the exclusion of others based on functional dissimilarities and other relevant factors. Additionally, the Tribunal instructed the AO to verify the risk differential adjustment claimed by the assessee. The detailed analysis and adherence to legal precedents ensure a fair determination of the ALP for the international transactions in question.

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