2018 (7) TMI 2294 - AT - Income Tax

TP Adjustment - comparable selection for Software services - HELD THAT - Persistent systems Ltd. Ld. - Assessee has developed software during the year, and has earned royalties from sale of products. Assessee has earned revenues from Licensing of products. It is also observed from the notes to the accounts of this company that the segment information has been provided on consolidated financial statements. It is also observed that assessee owns the software developed by it on which depreciation is claimed. Thus this company has been characterised itself as engaged in providing outsourced product development services to independent software vendors and enterprises. It has been characterised to having earned significant portion of its revenues from export of software services and products. This function, the assets owned by this company and the risk assumed are not comparable with that of the present assessee and hence has to be excluded from the final list of comparable. Wipro Technology Services Ltd disqualifies to become a comparable uncontrolled transaction for the purposes of inclusion in the final list of comparables under Rule 10B(1)(e)(ii). We, therefore, direct removal of this company from the list of comparables. TATA Elxsi Ltd. - Functions performed by this company under software development services are basically on the basis of research and development. It is also observed that there is no segmental information regarding the same. On perusal of the audited reports of this company, we are of the considered opinion that this company is not performing services on the basis of contract as per the requirements of the clients but is into innovative development of its own. Staffing services - Comparable selection - HCCA Business Services Pvt. Ltd company is into services providing human resource to companies. It is also observed that this company has only staffing services and therefore entire revenues earned by this company is from providing manpower as per the agreements with its customers. Under such circumstances we do not find any functional dissimilarity of this company with that of the assessee before us. Accordingly we uphold the inclusion of this company in final list of comparables. Ma Foi Management Consultants Ltd - This company was rejected by Ld.TPO due to different financial year ending. It is also observed that Ld.TPO has not verified whether quarterly financial details could be extrapolated to match the financial year ending of assessee. We also observe that functions performed by this company are identical to functions performed by assessee, and therefore could be considered as a comparable. Merely because it has a different financial year ending cannot be a sole reason to reject it as a comparable. We therefore set aside this comparable to Ld.TPO to verify having regard to extrapolating quarterly details of this comparable. Nirbhay Management Services Pvt. Ltd. - We accordingly set aside this issue to ld.TPO to verify the FAR analysis of this company. Assessee is directed to provide all necessary information/details regarding TP report, audited accounts for verification. Ld.TPO is directed to verify the same for considering it for the purposes of comparability.

Summary

Issues Involved:
1. Validity of the assessment order.
2. Transfer Pricing adjustments for contract software development and staffing services.
3. Selection and rejection of comparables for benchmarking.
4. Risk adjustment for the assessee.
5. Application of the +/- 5 percent range under Section 92C(2).
6. Initiation of penalty under Section 271(1)(c).

Detailed Analysis:

1. Validity of the Assessment Order:
The assessee challenged the assessment order passed by the Learned Assessing Officer (Ld. AO) pursuant to the directions of the Learned Dispute Resolution Panel (Ld. DRP) as being "bad in law and void ab-initio." However, this ground was considered general and did not require adjudication.

2. Transfer Pricing Adjustments:
The Ld. TPO/AO enhanced the income of the assessee by Rs 2,14,00,851, holding that the international transactions related to its contract software development and staffing services did not satisfy the arm's length principle. The assessee argued that it was entitled to a tax holiday under Section 10A of the Act and had no motive to derive a tax advantage by manipulating transfer prices.

3. Selection and Rejection of Comparables:
Contract Software Development Services:
The Ld. TPO/AO included and excluded various comparables in the analysis, leading to an enhancement of income by Rs 1,10,39,773. The assessee raised several issues, including:
- Factual errors in the computation of net operating profit margins.
- Rejection and modification of filters for screening software companies.
- Inclusion of companies not comparable in terms of functions, assets, and risks.
- Inclusion of high-profit companies and those with different turnover/size, ownership of intellectual property, and significant advertising and marketing expenses.
- Inclusion of companies with extraordinary events affecting profitability and those engaged in the sale of software products without segmental information.

Staffing Services:
The Ld. TPO/AO enhanced the income by Rs 1,03,61,078. The assessee contested:
- Incorrect benchmarking with a payroll processing company.
- Inclusion and exclusion of non-comparable companies.
- Application of different financial year-end and declining sales filters.
- Turnover filter of sales greater than Rs 5 crores, excluding functionally comparable companies.

Functional Analysis:
The Tribunal conducted a detailed functional analysis of the assessee, categorizing it as a routine service provider for software development and IT consulting services with minimal business risks and routine tangible assets.

Comparables Analysis:
Software Services:
- Infosys Ltd: Excluded due to functional differences, ownership of substantial intangible assets, and revenue from software products.
- Persistent Systems Ltd: Excluded due to lack of segmental accounting and revenue from software products.
- Wipro Technology Services Ltd: Excluded due to related party transactions and revenue from a master service agreement with Citigroup Inc.
- Tata Elxsi Ltd: Excluded due to functional differences, involvement in innovative development, and lack of segmental information.

Staffing Services:
- HCCA Business Services Pvt. Ltd: Included as it provides human resource services similar to the assessee.
- Ma Foi Management Consultants Ltd: Set aside for verification by the Ld. TPO due to different financial year ending.
- Nirbhay Management Services Pvt. Ltd: Set aside for verification by the Ld. TPO due to turnover filter issues.

4. Risk Adjustment:
The assessee argued for a risk adjustment due to its status as a low-risk captive service provider. The Tribunal acknowledged this but did not provide a specific ruling on the adjustment.

5. Application of the +/- 5 Percent Range:
The assessee sought the benefit of the +/- 5 percent range under the proviso to Section 92C(2) of the Act. This issue was partly allowed by the Tribunal.

6. Initiation of Penalty:
The Ld. AO's initiation of penalty under Section 271(1)(c) was deemed premature at this stage and thus not adjudicated.

Conclusion:
The appeal filed by the assessee was partly allowed, with specific directions for the Ld. TPO to verify and reassess certain comparables. The Tribunal emphasized the importance of a precise functional analysis and the need for comparables to be both functionally similar and free from related party transactions.