2021 (2) TMI 846 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - Exclusion of companies functionally not similar with that of assessee who provides software development services to its parent company and also if as they fail the turnover filter. Working capital adjustment on the average margin at 1.98% - HELD THAT - Rule 10B(3) of the Income-tax Rules, 1962, supports the said action of the TPO in granting a working capital adjustment M/S. NTT DATA GLOBAL DELIVERY SERVICES LTD. 2016 (4) TMI 1221 - ITAT BANGALORE ,M/S BEARING POINT BUSINESS CONSULTING PRIVATE LTD. 2014 (4) TMI 997 - ITAT BANGALORE AND APIGEE TECHNOLOGIES (INDIA) PVT. LTD. 2015 (9) TMI 1547 - ITAT BANGALORE it has been held that adjustment towards working capital differences between the assessee and the comparables should be considered and appropriate adjustment granted in arriving at the profit margins of comparable companies for the purpose of comparison.

Issues Involved:
1. Exclusion of comparable companies in the software development segment.
2. Adjustments to the transfer price.
3. Rejection of Transfer Pricing (TP) documentation.
4. Use of financial data in determining the Arm's Length Price (ALP).
5. Application of sales turnover filter in benchmarking analysis.
6. Working capital adjustment.
7. Deduction under section 10B of the Income-tax Act.
8. Disallowance of software expenses.
9. Calculation of 'Export Turnover' for section 10B benefits.

Detailed Analysis:

1. Exclusion of Comparable Companies:
The primary issue was whether the CIT(A) was right in removing four comparable companies—Infosys Ltd., Kals Information Systems Ltd., Persistent Systems Ltd., and Tata Elxsi Ltd.—on grounds of functional dissimilarity in the software development segment. The Tribunal upheld the exclusion of these comparables, noting that they were excluded in the assessee's own case for the assessment year 2008-09 based on functionality. Additionally, the Tribunal directed the AO/TPO to exclude Larsen and Toubro Infotech Ltd., Mindtree Ltd., and Sasken Communications Technologies Ltd. due to their high turnover, which was not comparable to the assessee's turnover.

2. Adjustments to the Transfer Price:
The Tribunal noted that the TPO made an adjustment of INR 4,067,365 to the transfer price. The TPO applied various filters and selected 11 comparables, which resulted in an average margin of 22.71%. The Tribunal directed the AO/TPO to exclude certain high-turnover companies from the list of comparables, which would affect the transfer price adjustment.

3. Rejection of TP Documentation:
The AO/TPO rejected the TP documentation maintained by the assessee and conducted a fresh comparability analysis. The Tribunal found that the AO/TPO's rejection of the assessee's comparables and the introduction of new filters were justified based on the functional dissimilarity and turnover criteria.

4. Use of Financial Data:
The Tribunal noted that the AO/TPO erred in not considering the previous two years' financial data of the comparable companies while determining the ALP. The Tribunal directed the AO/TPO to follow the directions of the CIT(A) and consider the financial data in accordance with the law.

5. Application of Sales Turnover Filter:
The Tribunal upheld the use of an upper turnover limit for excluding comparables with high turnover. The Tribunal cited various decisions supporting the application of turnover filters and directed the AO/TPO to exclude companies with turnovers exceeding INR 200 crores.

6. Working Capital Adjustment:
The Tribunal noted that the AO/TPO restricted the working capital adjustment to 1.98% but failed to grant this adjustment while computing the margin. The Tribunal directed the AO/TPO to grant the working capital adjustment in actuals, as supported by Rule 10B(3) of the Income-tax Rules, 1962, and various Tribunal decisions.

7. Deduction under Section 10B:
The CIT(A) directed the AO to consider the deduction under section 10B in accordance with the Karnataka High Court ruling in Tata Elxsi Ltd. The Tribunal upheld this direction and instructed the AO to follow the CIT(A)'s directions.

8. Disallowance of Software Expenses:
The CIT(A) directed the AO to verify the assessee's claim regarding the deduction of TDS on software expenses and allow the payment if TDS was found to be deposited. The Tribunal upheld this direction.

9. Calculation of 'Export Turnover':
The Tribunal noted that the AO erred in reducing the 'Export Turnover' by certain expenses and not considering the actual turnover received in 'convertible foreign exchange'. The Tribunal directed the AO to follow the CIT(A)'s directions and consider the correct 'Export Turnover' for section 10B benefits.

Conclusion:
The Tribunal allowed the assessee's appeal partly, directing the AO/TPO to exclude certain high-turnover companies from the list of comparables, grant working capital adjustments, and follow the CIT(A)'s directions on various issues. The revenue's appeal was dismissed, upholding the CIT(A)'s exclusion of certain comparables based on functional dissimilarity and high turnover.

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