2017 (1) TMI 1215 - AT - Income Tax

Transfer pricing adjustment - ALP determination - grant of working capital adjustment - Held that - Respectfully following the finding in the case of Mercer Consulting (India) Private Limited (2014 (7) TMI 715 - ITAT DELHI), we set aside the finding of the DRP on the issue in dispute and remit the matter to the file of the TPO/AO for examining the assessee s claim for grant of working capital adjustment on merits and, thereafter, allow the same, if it is available. The assessee shall be afforded adequate opportunity of hearing. Selection of comparables for software development segment - characterization of the software development segment - Held that - On the issue characterization of the software development segment we find that rendering software development services as a captive service provider and development and sale of software product are altogether different activities and cannot be treated as interchangeable. In the process of development of software product, the entity carry out research and development activity, which results into generation of intellectual property rights, which is absent in case of a captive service provider. Accordingly, the segment in consideration is characterized at software development services. The services rendered by the assessee are in respect of the support services for sale of software by the AE and the post sales support services are also in respect of the sale of software by the AE. The bug fixing is also part of the post sales support services, which may be treated partly as a function of technical nature but same cannot be compared with consultancy provided in the field of engineering or infrastructure field. Thus, the segmental function of the assessee is characterized as sale and post sales support services. We find that the assessee has compared the turnkey contract and service segment of the company with the sales and post sales support segment of the assessee company. However, we do not agree with the contention of the assessee that the company segment of turnkey contract & service was functionally similar to the segment of the assessee under comparison. The segment of the company compared is turnkey contract and services. No information is available in respect of the turnkey contract executed by the company and, therefore, the result of turnkey contract and service segment are not comparable with the sales and post sale support services in respect of software products. In view of our direction to exclude the comparables chosen the TPO and one comparable chosen by the assessee as well as exclusion of the remaining two comparables by the TPO not challenged by the assessee before us, has left with no comparable in the sales and post sale support segment for determination of arm s length price. In view of the above facts and circumstances, we restore the matter to the TPO for carrying out a fresh search and selection of comparables having functions similarity to the segment of sales and post sales support and compute the adjustment accordingly as per law. Needless to mention that the assessee shall be provided sufficient opportunity of hearing.

Issues Involved:
1. Addition due to Transfer Pricing (TP) adjustments.
2. Rejection of economic analysis by the assessee.
3. Use of single-year data instead of multiple-year data.
4. Rejection of certain comparable companies based on employee cost criterion.
5. Rejection of certain comparable companies based on onsite revenue criterion.
6. Use of information obtained under section 133(6) of the Act.
7. Selection of companies with supernormal profits as comparables.
8. Rejection of companies based on turnover criterion.
9. Ad-hoc rejection and addition of companies to the comparables.
10. Computational errors in the margin of certain comparable companies.
11. Non-allowance of working capital adjustment.
12. Non-adjustment for differences in risk profiles.
13. Non-provision of benefit of the arm's length range.
14. Confirmation of additions by the Dispute Resolution Panel (DRP).

Detailed Analysis:

1. Addition due to Transfer Pricing (TP) Adjustments:
The AO/TPO made an addition of INR 49,981,078 to the total income of the appellant by rejecting the TP analysis undertaken by the appellant and making an adjustment under section 92CA(3) of the Act without returning a finding about the existence of any of the circumstances specified in clauses (a) to (d) of sub-section (3) of section 92C of the Act.

2. Rejection of Economic Analysis by the Assessee:
The AO/TPO did not accept the economic analysis undertaken by the appellant in accordance with the provisions of the Act read with the Income-tax Rules, 1962, and modified the same for the determination of the Arm's Length Price (ALP) of the appellant's international transactions to hold that the same are not at arm's length.

3. Use of Single-Year Data Instead of Multiple-Year Data:
The AO/TPO used data for a single year instead of multiple-year data and determined the arm's length margins/prices using data pertaining only to the financial year 2007-08, which was not available to the appellant at the time of complying with the Indian TP documentation requirements.

4. Rejection of Comparable Companies Based on Employee Cost Criterion:
The AO/TPO rejected certain comparable companies identified by the appellant using 'Employee cost greater than 25 percent of total revenue' as a comparability criterion.

5. Rejection of Comparable Companies Based on Onsite Revenue Criterion:
The AO/TPO rejected certain comparable companies identified by the appellant using 'Onsite revenues greater than 75 percent of the export revenues' as a comparability criterion.

6. Use of Information Obtained Under Section 133(6) of the Act:
The AO/TPO exercised powers assigned under section 133(6) of the Act to obtain information which was not available in the public domain and relied upon the same for comparability purposes.

7. Selection of Companies with Supernormal Profits as Comparables:
The AO/TPO selected certain companies (which are earning supernormal profits) as comparable to the appellant.

8. Rejection of Companies Based on Turnover Criterion:
The AO/TPO rejected certain comparable companies identified by the appellant using 'Turnover less INR 1 crore' as a comparability criterion.

9. Ad-Hoc Rejection and Addition of Companies to the Comparables:
The AO/TPO wrongly rejected certain companies from and added certain companies to the final set of comparables on an ad-hoc basis, thereby resorting to cherry-picking of comparables.

10. Computational Errors in the Margin of Certain Comparable Companies:
The AO/TPO passed an order under section 92CA(3) of the Act which contains computational errors in the margin of certain comparable companies used in the determination of ALP.

11. Non-Allowance of Working Capital Adjustment:
The AO/TPO did not make appropriate adjustments to account for differences in working capital employed by the appellant vis-a-vis the comparables. The Tribunal held that working capital adjustment is as much relevant to service industry as to manufacturers and traders, and set aside the finding of the DRP on the issue, remitting the matter to the TPO/AO for examining the claim for working capital adjustment on merits.

12. Non-Adjustment for Differences in Risk Profiles:
The AO/TPO did not make suitable adjustments to account for differences in the risk profile of the appellant vis-a-vis the comparables.

13. Non-Provision of Benefit of the Arm's Length Range:
The AO/TPO did not provide the benefit of the arm's length range as provided under proviso to Section 92C of Act for the purposes of computing the ALP under section 92F of the Act.

14. Confirmation of Additions by the Dispute Resolution Panel (DRP):
The DRP confirmed the additions proposed by the learned AO and erred in rejecting the objection filed against the draft assessment order.

Conclusion:
The Tribunal allowed the appeal partly for statistical purposes, directing the AO/TPO to exclude certain comparables and to reconsider the working capital adjustment. The Tribunal emphasized the need for functional comparability and allowed the assessee's claim for working capital adjustment, remitting the matter back to the TPO/AO for fresh examination. The Tribunal also directed the AO/TPO to carry out a fresh search and selection of comparables having functional similarity to the segment of sales and post-sales support.

← Previous Next →