2022 (1) TMI 1275 - AT - Income Tax

TP Adjustment - Comparable selection - functional dissimilarity - HELD THAT - Companies functionally dissimilar with that of Assessee ITES segment need to be deselected from final list. Also if a company is making profit in any one of the 3 immediate preceding years, then it should be considered as a comparable. Re-characterizing certain trade receivables as unsecured loans and computing notional interest on such trade receivables - main contention of the ld. AR is that deferred receivables would not constitute a separate international transaction and need not be benchmarked while determining the ALP of the international transaction - HELD THAT - We are of the opinion that deferred receivables would constitute an independent international transaction and the same is required to be benchmarked independently as held in PCIT v. AMD (India) Pl. Ltd. 2018 (8) TMI 2094 - KARNATAKA HIGH COURT Once we have held that the transaction between the assessee and AE was in foreign currency with regard to receivables and transaction was international transaction, then transaction would have to be looked upon by applying the commercial principles with regard to international transactions and accordingly proceeded to take into account interest rate in terms of London Inter Bank Offer Rate LIBOR and it would be appropriate to take the LIBOR rate 2%. For this purpose, we place reliance on the judgment of the Bombay High Court in the case of CIT v. Aurionpro Solutions Ltd. 2017 (6) TMI 1087 - BOMBAY HIGH COURT It is ordered accordingly.

Issues Involved:
1. Validity and timeliness of the final assessment order.
2. Addition to total income based on arm's length price (ALP) for IT enabled services (ITeS).
3. Acceptance and rejection of economic analysis for ALP determination.
4. Rejection of comparable companies with different accounting years.
5. Application of employee cost greater than 25% as a comparability criterion.
6. Application of export services income less than 75% of turnover as a comparability filter.
7. Application of lower turnover filter without a higher threshold.
8. Testing related party transactions separately for revenue and expense.
9. Application of persistent loss filter.
10. Use of information obtained under section 133(6) for comparability.
11. Acceptance/rejection of specific comparable companies.
12. Computation of operating margins of comparable companies.
13. Adjustment for differences in working capital position.
14. Adjustment for differences in risk profile.
15. Re-characterization of trade receivables as unsecured loans and computation of notional interest.
16. Consideration of working capital adjustment for credit period.
17. Computation of notional interest using SBI short-term fixed deposit rate.
18. Erroneous computation of adjustment pursuant to DRP directions.
19. Levy of interest under section 234B.
20. Initiation of penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Validity and Timeliness of Final Assessment Order:
The appellant contended that the final assessment order dated 29.06.2021 by NFAC was not in accordance with the express provisions of the Act and was time-barred. However, this issue was not specifically addressed in the judgment.

2. Addition to Total Income Based on ALP for ITeS:
The Assessing Officer (AO), Transfer Pricing Officer (TPO), and Dispute Resolution Panel (DRP) made an addition of INR 12,01,06,252 to the total income of the appellant on the grounds that the price charged was lower than the ALP determined for ITeS rendered to its Associated Enterprises (AEs). The Tribunal reviewed the financials and comparables selected by the TPO and DRP.

3. Acceptance and Rejection of Economic Analysis for ALP Determination:
The appellant's economic analysis was not accepted by the AO/TPO/DRP, who conducted a fresh economic analysis for ALP determination. The Tribunal upheld the fresh analysis conducted by the authorities.

4. Rejection of Comparable Companies with Different Accounting Years:
The AO/TPO/DRP rejected certain comparable companies following different accounting years. The Tribunal upheld this rejection, emphasizing the importance of consistency in accounting periods for comparability.

5. Application of Employee Cost Greater than 25% as a Comparability Criterion:
The authorities applied a filter of employee cost greater than 25% of the total operating cost. The Tribunal upheld this criterion, noting its relevance in ensuring comparability.

6. Application of Export Services Income Less than 75% of Turnover as a Comparability Filter:
The authorities applied a filter rejecting companies whose export services income was less than 75% of turnover. The Tribunal found this filter appropriate for ensuring comparability.

7. Application of Lower Turnover Filter Without a Higher Threshold:
The AO/TPO/DRP applied only the lower turnover filter of less than INR 1 crore without a higher threshold limit. The Tribunal upheld this approach.

8. Testing Related Party Transactions Separately for Revenue and Expense:
The authorities tested the proportion of revenue and expense transactions with related parties separately against total revenue and expenses. The Tribunal upheld this method.

9. Application of Persistent Loss Filter:
The authorities applied a persistent loss filter, rejecting companies with losses in any two out of three years. The Tribunal upheld this filter, citing various judicial precedents supporting the exclusion of loss-making companies for comparability.

10. Use of Information Obtained Under Section 133(6) for Comparability:
The AO/TPO/DRP used information obtained under section 133(6) for comparability purposes. The Tribunal upheld this approach.

11. Acceptance/Rejection of Specific Comparable Companies:
- Exclusion of Infosys BPM Ltd.: The Tribunal excluded Infosys BPM Ltd. from the list of comparables, noting its diversified activities, significant intangibles, and brand presence, which made it functionally different from the appellant.
- Exclusion of Eclerx Services Ltd.: The Tribunal excluded Eclerx Services Ltd., noting its involvement in high-end KPO services, which were not comparable to the appellant's routine IT enabled services.
- Inclusion of Sundaram Business Services Ltd. and ACE Software Exports Ltd.: The Tribunal remitted the issue to the AO/TPO to consider the financials and decide on the comparability of these companies.
- Inclusion of Hartron Communications Ltd.: The Tribunal directed the AO/TPO to follow the DRP's directions and consider this company as comparable if it passed all the filters.

12. Computation of Operating Margins of Comparable Companies:
The appellant contended errors in computing operating margins of some comparables. The Tribunal did not specifically address this issue in detail.

13. Adjustment for Differences in Working Capital Position:
The authorities did not make suitable adjustments for differences in working capital positions. The Tribunal upheld the authorities' approach, noting that working capital adjustments were already considered in the TP documentation.

14. Adjustment for Differences in Risk Profile:
The authorities did not make adjustments for differences in the risk profile. The Tribunal upheld this approach, noting that the appellant operated as a captive service provider with minimal risks.

15. Re-characterization of Trade Receivables as Unsecured Loans and Computation of Notional Interest:
The authorities re-characterized certain trade receivables as unsecured loans and computed notional interest. The Tribunal upheld this approach, citing judicial precedents and directing the application of LIBOR + 2% for computing notional interest.

16. Consideration of Working Capital Adjustment for Credit Period:
The Tribunal noted that working capital adjustments already accounted for the impact of credit periods extended to customers, and no separate analysis was required for trade receivables.

17. Computation of Notional Interest Using SBI Short-Term Fixed Deposit Rate:
The Tribunal upheld the DRP's direction to consider SBI short-term fixed deposit interest rate for computing notional interest on re-characterized trade receivables.

18. Erroneous Computation of Adjustment Pursuant to DRP Directions:
The appellant contended erroneous computation of adjustment pursuant to DRP directions. The Tribunal did not specifically address this issue in detail.

19. Levy of Interest Under Section 234B:
The AO levied interest under section 234B. The Tribunal did not specifically address this issue in detail.

20. Initiation of Penalty Proceedings Under Section 271(1)(c):
The AO initiated penalty proceedings under section 271(1)(c). The Tribunal did not specifically address this issue in detail.

Conclusion:
The appeal was partly allowed. The Tribunal directed the exclusion of Infosys BPM Ltd. and Eclerx Services Ltd. from the list of comparables, remitted the comparability of Sundaram Business Services Ltd. and ACE Software Exports Ltd. to the AO/TPO, and upheld the re-characterization of trade receivables as unsecured loans with notional interest computed using LIBOR + 2%. The other grounds were dismissed.

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