2025 (4) TMI 642 - AT - Income Tax

TP Adjustment - compatibility of the companies sought for inclusion/exclusion by the assessee - HELD THAT - Innovana Thinklabs Ltd. and K7 Computing Pvt Ltd to be excluded from the final list as assessee is a limited risk reseller having no plant and equipments owning no intangible assets having no expenses on promotions and is not selling its product. Virtual Galaxy Infotech Private Limited comparable deals in software products solutions. From the disclosure of general information about the company and page B17 it is noted that this company belongs to commercial industry. This company is into automatic data processing machine weighing less than 10 KG in the product services relates to personal computer laptop other digital automatic data processing machine etc. Thus the company is functionally not similar with that of the assessee. Accordingly the Ld.AO/TPO is directed to exclude this comparable from the finalist. Sonata Information Technology Ltd comparable satisfies the turnover filter. Accordingly we direct the Ld.AO/TPO to include this comparable in the finalist. Unisys software and holding industries Ltd. JMD ventures Ltd., PS IT Infrastructure Services Ltd. Advance Technologies - TPO rejected these comparable at the threshold by holding it to be functionally not similar. On the face of it when we look into the annual reports of these comparables it is noted that these are into a trading segment of sale of hardware and software. However in respect of the other filters no verification has been carried out in order to determine the compatibility on qualitative basis. It is also not clear from the order of the TPO regarding filters adopted by him in order ascertain the compatibility.In the interest of justice we therefore remit all these comparable to the Ld.AR/TPO to verify these comparables based on the filters applied for determining the compatibility with assessee. Non granting working capital and proportionate adjustments claimed by the assessee in order to iron out the differences between the comparables and the assessee for computing the margin - We find that the Co-ordinate Bench of this Tribunal in assessee s own case for A.Y. 2016-17 in Red Hat India (P.) Ltd. 2022 (2) TMI 1283 - ITAT MUMBAI also granted working capital adjustment at well as proportional adjustment to the assessee in respect of difference in working capital levels between the comparable companies and the assessee. Based on the above discussions we direct Ld.AO/TPO to grant WCA and any other proportionate adjustment that would materially affect the margin computation for the purposes of comparability analysis. Seeking inclusion/exclusion of comparables under Payment of Royalty and Service fee (Service segment) - MT Education Services Pvt.Ltd is to be excluded as the turnover of this comparable is Rs.237.24 lakhs whereas the assessee has turnover under this segment at Rs.7, 55, 81, 437/- which is less that assessee s turnover. Merittrac Services Pvt.Ltd - We remit this comparable back to the Ld.AO/TPO with the direction to verify the segmental details of this comparable in respect of revenue earned by providing training coaching/tutorial classes. If such segmental details are available and the filters applied by the Ld.TPO stand satisfied then it is to be considered in the final list. Lakshya Educare Pvt. Ltd. Company is engaged in business of conducting commercial training coaching/tutorial classes and activities incidental thereto.As we have remitted Merritrac Services Pvt.Ltd. with certain directions to the Ld.AO/TPO this comparable is also remitted with the direction to verify the segmental details in respect of the revenue earned by providing training/tutorial classes. Sarala Holdings Pvt. Ltd. People Combine Educational Initiatives Pvt. Ltd. Career Mosaic Pvt. Ltd. G.D.Goenka Pvt.Ltd. - These companies are engaged in running schools which is not functionally similar with the training and coaching activities carried on by the assessee. It will not be out of place to note that these companies have different business model of rendering education which is not similar with training activities carried on by the assessee. Thus all to be excluded. Athena Endspark Ltd. comparable is accepted by the Ld.AO/TPO in the remand report for A.Y. 2016-17. We accordingly direct the Ld.AO/TPO to consider this comparable in the finalist. Aptech Ltd - We direct the Ld.AO/TPO to verify compatibility of Aptech Ltd. based on similar parameters for Merittrac Services Pvt.Ltd and Lakshya Educare Pvt. Ltd. Seeking correction of errors computation in margin of comparables that would remain to determine arms length margin of the transaction - We direct the Ld.AO/TPO to adopt the correct figures for computing the margins of the remaining comparables. Inclusion/exclusion of comparables under Provision of Software Development Service Segment - Inclusion of Aspire Systems (India) Pvt. Ltd. and Interglobe technology quotient Pvt. Ltd. And exclusion of Kiliton Tech Solutions Ltd. Dun Bradstreet Technologies Data Services Pvt.Ltd Nihilent Ltd. Nihilent Analytics Ltd. Infobeans Technologies Ltd.. Cybercom Datamatics Information Solutions Ltd - Admittedly segmental details are not available in respect of the diversified business activities undertaken by this company. This alone is sufficient to eliminate this company from the finalist. It is also noted that the DRP had directed exclusion of this comparable which was not been followed by the Ld.AO/TPO while giving effect to DRP directions. Akshay Software Technologies Ltd - DRP accepted this comparable to be valid in the earlier years and following the same principle of consistency the directions of the DRP for this year was to include it in the final list. Sagarsoft India Ltd.- We have perused relevant observations of the remand report and found that the Ld.AO/TPO accepted this comparable for assessment 2016-17. Accordingly we direct this comparable to be included in the finalist. Inclusion/exclusion of comparables under Provision of IT enabled Service Segment - MPS Ltd. (MPS) - Activities of MPS are akin to a IT service provider and not an ITES service provider. So we direct to exclude MPS from the final set of comparables. Tech Mahindra Business Services Ltd. company has scored huge brand value and also does not have segmental details. Further the functions of this comparable is not similar with that of the assessee who is a captive service provider. Under such circumstances we do not find it appropriate to include this company in the final list.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal issues considered in the judgment include:

• Whether the Transfer Pricing Officer (TPO) erred in determining the arm's length price (ALP) for international transactions related to payment of royalty and service fees in the subscription and service segments.
• Whether the TPO correctly applied quantitative filters and selected appropriate comparables for benchmarking the transactions.
• Whether the TPO's rejection of working capital adjustments and proportionate adjustments was justified.
• Whether the TPO's computation of net operating profit margin of comparables was accurate.
• Whether the TPO's adjustments extended to transactions with non-associated enterprises were appropriate.
• Whether there were errors in the computation of margins of comparables that needed correction.
• Whether the TPO's adjustments for the provision of software development services and IT-enabled services were justified.
• Whether the TPO's non-granting of working capital adjustments and other proportionate adjustments was appropriate.

2. ISSUE-WISE DETAILED ANALYSIS

Transfer Pricing Adjustments for Subscription and Service Segments

• Legal Framework and Precedents: The transactions were evaluated under the Income-tax Act, 1961, using the Transactional Net Margin Method (TNMM) as the most appropriate method. The OECD guidelines on transfer pricing were also considered, particularly concerning comparability and adjustments.
• Court's Interpretation and Reasoning: The Tribunal examined whether the TPO correctly applied the TNMM and selected appropriate comparables. The Tribunal noted that the TPO rejected comparables proposed by the assessee and introduced new ones without sufficient justification.
• Key Evidence and Findings: The Tribunal found that some of the comparables selected by the TPO were functionally dissimilar to the assessee's business operations. The Tribunal also noted that the TPO did not adequately consider the working capital differences between the comparables and the assessee.
• Application of Law to Facts: The Tribunal directed the TPO to exclude certain comparables that were not functionally similar and to include others that met the criteria. The Tribunal emphasized the need for accurate working capital adjustments to ensure comparability.
• Treatment of Competing Arguments: The Tribunal considered the assessee's arguments for including and excluding specific comparables and found merit in some of the claims. The Tribunal also recognized the need for consistency with previous years' assessments.
• Conclusions: The Tribunal directed the TPO to revise the list of comparables and to allow working capital adjustments where applicable. The Tribunal also instructed the TPO to correct computational errors in the margins of comparables.

Provision of Software Development and IT-enabled Services

• Legal Framework and Precedents: The transactions were evaluated under the same legal framework as the subscription and service segments, with a focus on functional, asset, and risk (FAR) analysis.
• Court's Interpretation and Reasoning: The Tribunal examined the functions performed, assets employed, and risks assumed by the assessee and compared them with those of the selected comparables.
• Key Evidence and Findings: The Tribunal found that some comparables were engaged in diversified business activities without segmental financials, making them unsuitable for comparison.
• Application of Law to Facts: The Tribunal directed the TPO to exclude comparables that did not provide segmental financials or were functionally dissimilar. The Tribunal also instructed the TPO to include comparables that were previously accepted in similar cases.
• Treatment of Competing Arguments: The Tribunal considered the assessee's arguments for excluding certain comparables based on functional dissimilarity and lack of segmental financials and found them persuasive.
• Conclusions: The Tribunal ordered the exclusion of certain comparables and directed the TPO to re-evaluate the inclusion of others based on functional similarity and segmental financials.

3. SIGNIFICANT HOLDINGS

The Tribunal made several significant holdings:

• "The TPO is directed to exclude comparables that are functionally dissimilar to the assessee and do not provide segmental financials."
• "Working capital adjustments should be allowed to neutralize the effects of different trade terms and inventory levels between the comparables and the assessee."
• "The TPO is instructed to correct computational errors in the margins of comparables to ensure accurate determination of the arm's length price."
• "The inclusion of comparables should be consistent with previous assessments, and any deviations must be justified with adequate reasoning."

The Tribunal's final determinations on each issue emphasized the importance of accurate comparability analysis and adjustments to ensure that the arm's length price reflects the true economic conditions of the transactions. The Tribunal's directions aimed to rectify errors in the TPO's approach and to ensure consistency with established transfer pricing principles.