2022 (5) TMI 322 - AT - Income Tax

TP Adjustment - comparable selection - application of RPT filter at 15% - HELD THAT - RPT filter has to be applied adopting the threshold limit of 15%. Comparables selected accordingly. Companies whose turnover in the current year is more than ₹ 200 Crores should be excluded from the list of comparable companies. Exclusion of Infobeans Software Ltd. - As far as the argument that RPT is to be calculated as a percent of total RPT income and expense/Total operating sales, there is no such proposition as contended by the learned counsel for the Assessee and the decisions cited in this regard have only applied the RPT filter adopting the threshold limit as 15% and above as the limit for exclusion of companies. The argument in this regard is therefore devoid of any merit. As far as the argument that RPT filter is to be considered at 15% of operating sales, the computation given by the Assessee in this regard is inclusive of managerial remunerations and if the same is excluded then the percentage of RPT would be less than 15%. In our view when Transaction Net Margin method is adopted as MAM, it is only the similar transaction that has to be compared and therefore the ratio of total sales to sales to related party alone has to be seen. Therefore the plea of the Assessee that RPT is in excess of 15% is devoid of any merit and the same is rejected. Therefore we find no ground to exclude this company from the list of comparable companies. Inteq Software Private Limited - Mere absence of response from this company to the notice u/s. 133(6) of the Act cannot be the basis to hold that this company is not comparable. - Regarding the argument that there are some unusual features observed from the financial statements of this company, these features do not affect the comparability. By merely pointing out that there is a substantial increase in value of intangible assets, the Assessee cannot seek to exclude this company from the list of comparable companies, unless the Assessee is able to show that the presence of intangibles is owing to factors which can affect the functional comparability of this company with the Assessee. With regard to exclusion of this company on the basis of inconsistencies in the financial statement, we find that this objection was not raised before the TPO as can be seen from the discussion of the TPO - There is no inference drawn with regard to how these disparities will influence comparability in the light of the functions performed, assets employed, risk assumed. Just by pointing out some inconsistencies, the Assessee cannot seek to exclude a company which otherwise is found to be comparable. We therefore find that none of the arguments advanced seeking exclusion of this company from the list of comparable companies are sustainable and hence we uphold inclusion of this company in the list of comparable companies. Adjustment on account of working capital adjustment - HELD THAT - As in Huawei Technologies India Pvt. Ltd. 2018 (10) TMI 1796 - ITAT BANGALORE on an identical issue, the Tribunal held that working capital adjustment has to be given. The tribunal reasoned in the aforesaid decision that a reading of Rule 10B(1)(e)(iii) of the Rules read with Sec. 92CA of the Act, would clearly show that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. The tribunal referred to Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the TPG ) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annexure to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. We are therefore of the view that the issue with regard to the grant of working capital adjustment should be directed to be examined by the TPO/AO afresh in the light of the decision of the tribunal referred to above, after affording opportunity of being heard to the Assessee. Delayed realization of trade receivables from the AE - International transaction or not? - determination of ALP by construing the delayed realization of receivable by the Assessee from its AE as a separate international transaction and determining ALP of such delayed receivables - non-charging or under- charging of interest on the excess period of credit allowed to the AE, for the realization of invoices amounts to an international transaction and the ALP of such an international transaction - HELD THAT - Non-charging or under- charging of interest on the excess period of credit allowed to the AE, for the realization of invoices amounts to an international transaction and the ALP of such an international transaction is required to be determined. In view of the above observations. the reliance placed by the ld. counsel for the assessee on earlier decisions cannot be accepted. Similarly, Considering the above discussion, it is held that deferred trade receivable constitutes international transaction.Having concluded that deferred trade receivables constitute international transaction, we come to the computation of the ALP of the international transaction of 'debt arising during the course of business.' This has two ingredients, viz., the amount on which interest should be charged and the arm's length rate at which the interest should be charged. On this aspect we can take useful guidance from the decision of the ITAT Delhi Bench in the case of Techbooks International (P.) Ltd. v. Deputy Commissioner of Income-tax, Circle-3, Noida 2015 (7) TMI 473 - ITAT DELHI wherein the Tribunal laid down guidelines on the manner of determination of ALP. We are of the view that the issue with regard to determination of ALP in respect of the international transaction of giving extended credit period for receivables should be directed to be examined afresh by the AO/TPO on the guidelines laid down in the decision referred to in the earlier paragraph, after affording Assessee opportunity of being heard. As held in the aforesaid decision the prime lending rate should not be considered and this reasoning will apply to adopting short term deposit interest rate offered by State Bank of India (SBI) also. The rate of interest would be on the basis of the currency in which the loan is to be repaid.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) for Software Development Services.
2. Choice of comparable companies.
3. Application of turnover filter.
4. Exclusion of certain companies based on functional dissimilarity and related party transactions.
5. Non-grant of working capital adjustment.
6. Determination of ALP for delayed realization of receivables.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for Software Development Services:
The Assessee, engaged in providing Software Development Services (SWD services) to its Associated Enterprises (AEs), filed a Transfer Pricing Study (TP Study) adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for determining ALP. The Assessee selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) and identified 7 comparable companies. The Transfer Pricing Officer (TPO) accepted TNMM as the MAM but identified 13 comparable companies, arriving at a PLI of 24.83% and added ?1,47,11,060/- to the Assessee’s income.

2. Choice of Comparable Companies:
The Assessee raised objections regarding the inclusion of certain companies by the TPO, arguing that they were not functionally comparable. The Tribunal upheld the inclusion of Inteq Software Pvt. Ltd. and Infobeans Technologies Ltd., rejecting the Assessee’s arguments about functional dissimilarity, inconsistencies in financial statements, and absence of response to notices under Section 133(6).

3. Application of Turnover Filter:
The Tribunal discussed the application of the turnover filter, noting that the Assessee’s turnover was ?17,77,11,711/-, while the TPO included companies with turnovers exceeding ?200 Crores. Citing various precedents, the Tribunal concluded that companies with high turnover should be excluded from the list of comparable companies. Consequently, companies like Infosys Ltd., Larsen & Toubro Infotech Ltd., Persistent Systems Ltd., Aspire Systems (India) Pvt. Ltd., Thirdware Solution Ltd., Cybage Software Pvt. Ltd., and Nihilent Ltd. were excluded.

4. Exclusion of Certain Companies Based on Functional Dissimilarity and Related Party Transactions:
The Tribunal addressed the exclusion of R.S. Software (India) Ltd. based on related party transactions exceeding 15%. The Tribunal upheld the Assessee’s contention, noting that the Related Party Transaction (RPT) filter should be applied with a threshold limit of 15%, as per the Karnataka High Court’s decision in the case of M/s. Yodlee Infotech Pvt. Ltd.

5. Non-Grant of Working Capital Adjustment:
The Tribunal directed the TPO/AO to re-examine the issue of working capital adjustment, referencing the decision in Huawei Technologies India Pvt. Ltd., which emphasized the need for adjustments to account for differences in working capital. The Tribunal noted that reasonable adjustments should be made to bring both the comparable and the tested party on the same footing.

6. Determination of ALP for Delayed Realization of Receivables:
The Tribunal addressed the issue of delayed realization of receivables, which the TPO treated as a separate international transaction, determining a TP adjustment of ?4,21,784/-. The Tribunal discussed conflicting decisions on whether delayed receivables constitute an international transaction. Citing the Delhi High Court’s decision in Kusum Healthcare Pvt. Ltd., the Tribunal concluded that delayed realization of receivables should not be treated as a separate international transaction if the working capital adjustment already accounts for the impact of receivables on profitability. The Tribunal directed the TPO/AO to re-examine the issue, emphasizing the need to consider the currency in which the loan is to be repaid for determining the interest rate.

Conclusion:
The Tribunal partially allowed the Assessee’s appeal, directing the TPO/AO to re-examine certain issues, including the exclusion of companies based on turnover, application of the RPT filter, and granting of working capital adjustment, while upholding the inclusion of certain companies in the list of comparables. The Tribunal also directed a fresh examination of the ALP for delayed realization of receivables, considering the guidelines laid down in relevant decisions.