2020 (4) TMI 319 - AT - Income Tax

TP Adjustment - comparable selection - filters applied by Ld.TPO - HELD THAT - TPO has considered entity level revenue as well as cost for computing margin of assessee which was compared with the segmental margin of comparables. This is in total contradiction to transfer pricing law laid down by legislature. DRP failed to adjudicate this objection raised by assessee having to transfer pricing rules envisaged in the Act/Rules. DRP in a cryptic manner upheld action of Ld.TPO to be justified. Comparables that were objected by assessee has not been dealt with independently. As regards the comparables though DRP excluded certain comparables as well as upheld inclusion of remaining comparables, has not given proper reasoning for its exclusion/inclusion. It is observed that certain comparables cannot be considered in case of a captive service provider like assessee From the Transfer Pricing document placed in the paper book at page 614, it is observed that assessee is not involved in any of the strategic functions and is only undertaking preliminary tactical managerial functions. Assessee also does not undertake any marketing/business development activity. Further it is observed that assessee do not undertake any key risks. Based upon the above in our view the comparables needs to be revisited. Working capital adjustment has been restricted by Ld.TPO and upheld by DRP at 1.63% which is contrary to provisions of transfer pricing rules. As held by various decisions of coordinate benches of this Tribunal, we direct Ld.TPO to recompute working capital adjustment in actual, and to consider the same for purposes of computing arm s length margin. Risk adjustment on ad hoc basis at 1%, it is observed that there is no scientific manner which has been applied by DRP. Assessee is a low risk bearing company and therefore while computing risk adjustment risks assumed by the comparables for earning revenue in the particular segment needs to be analysed. Assessee is directed to provide for necessary details in respect of all the comparables finally selected. Ld.AO/TPO shall then compute the risk as adjustment in accordance with law. Transfer pricing issues raised by assessee is set aside to Ld.AO/TPO. Ld.AO/TPO is directed to pass a detailed order by considering all the submissions advanced by assessee in respect of each objections raised therein. Ld.AO/TPO shall granted proper opportunity to assessee of being represented as per law.

Summary

Issues Involved:
1. Transfer Pricing Adjustments
2. Working Capital Adjustment
3. Risk Adjustment
4. Disallowance of Provision for Doubtful Advances

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustments:
The assessee, a software development company, had international transactions exceeding ?15 crores, prompting a reference to the Transfer Pricing Officer (TPO) for determining the correct arm's length price. The TPO rejected most of the comparables selected by the assessee and computed an adjustment of ?29,89,22,549/-. The assessee raised objections before the Dispute Resolution Panel (DRP) regarding the filters applied by the TPO, such as excluding companies with different accounting periods, employee cost less than 25%, and export sales less than 75% of operating revenue. The DRP upheld these filters but excluded certain comparables like E-Zest Solutions, Infosys Ltd., Persistent Systems, and Tata Elxsi Ltd. The DRP also directed a 1% risk adjustment. The final assessment order by the Assessing Officer (AO) determined an adjustment of ?27,56,53,609/-. The Tribunal found that the TPO considered entity-level revenue and cost instead of segmental data, which contradicted transfer pricing laws. The Tribunal directed the AO/TPO to reconsider the comparables and recompute the margins.

2. Working Capital Adjustment:
The TPO restricted the working capital adjustment to 1.63%, which was upheld by the DRP. The assessee argued that this restriction was against the Tribunal's decisions, which mandate adjustments based on actual data without upper limits. The Tribunal directed the TPO to recompute the working capital adjustment accurately and consider it for computing the arm's length margin.

3. Risk Adjustment:
The DRP provided a 1% risk adjustment on an ad hoc basis without a scientific approach. The Tribunal observed that the assessee, being a low-risk bearing company, required a detailed analysis of the risks assumed by the comparables. The Tribunal directed the AO/TPO to compute the risk adjustment in accordance with the law, considering the necessary details provided by the assessee.

4. Disallowance of Provision for Doubtful Advances:
The DRP disallowed the provision for doubtful advances amounting to ?4,93,66,601/- and ?15,77,76,840/- (provision for service tax refund receivable) as not in accordance with accounting principles and not qualifying as expenditure under Section 37 of the Act. The Tribunal set aside this issue to the AO/TPO for verification and to consider the claim in accordance with the law.

Conclusion:
The Tribunal set aside the transfer pricing issues to the AO/TPO for a detailed order considering all objections raised by the assessee. The working capital and risk adjustments were directed to be recomputed accurately. The disallowance of provisions for doubtful advances was also set aside for verification. Both the assessee's and the revenue's appeals were allowed for statistical purposes.