2018 (5) TMI 1536 - AT - Income Tax

Determination of Arm s Length Price in respect of international transaction of rendering of Software Development Services - comparability selection criteria - Held that - Assessee is a company engaged in the business of providing contract Software Development Services (SWD Services) to its AE. The transaction of rendering software development services to its AE was an international transaction, thus companies functionally dissimilar with that of assessee need to be deselected from final list.

Issues Involved:
1. Correctness of determination of Arm’s Length Price (ALP) for international transactions of Software Development Services (SWD) by the Assessee to its Associated Enterprise (AE).
2. Selection and rejection of comparable companies for determining ALP.
3. Application of Transfer Pricing regulations and methods.

Detailed Analysis:

1. Correctness of determination of Arm’s Length Price (ALP):
The primary issue in this appeal concerns the determination of the ALP for the international transaction of providing SWD services by the Assessee to its AE. The Assessee used the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) and adopted Operating Profit/Total Cost (OP/TC) as the profit level indicator. The Assessee’s OP/TC was 13.09%, and it selected 11 comparable companies with an arithmetic mean OP/TC less than the Assessee’s. The Transfer Pricing Officer (TPO) accepted 2 out of the 11 comparables and added 5 more, resulting in a final set of 7 comparables with an average margin of 20.90%. The TPO adjusted this margin to 20.57% after working capital adjustments and computed the ALP, leading to an addition of ?1,09,25,580/- to the Assessee’s income.

2. Selection and rejection of comparable companies:
The Assessee challenged the inclusion of three companies (CG VAK Software Exports Ltd., Larsen & Toubro Infotech Ltd., Persistent Systems Ltd.) and the exclusion of two companies (Cigniti Tech Ltd., Helios & Matheson Information Technology Ltd.) from the list of comparables.

CG VAK Software Exports Ltd.:
The Assessee argued for exclusion based on the company’s ownership of intangibles, diverse service offerings, and lack of segmental details. However, the Tribunal upheld the inclusion, agreeing with the TPO that the intangibles were operational tools and that the company’s services were comparable to the Assessee’s SWD services.

Larsen & Toubro Infotech Ltd.:
The Assessee sought exclusion due to functional dissimilarity, absence of segmental information, and presence of intangibles. The Tribunal found that the company’s SWD services were comparable, and the objections regarding intangibles and segmental information were not material differences.

Persistent Systems Ltd.:
The Assessee objected based on the company’s involvement in software products and lack of segmental details. The Tribunal noted that the company’s revenue was from SWD services and upheld its inclusion.

Cigniti Technologies Ltd.:
The TPO excluded this company, stating it only performed software testing. The Tribunal agreed, noting that software testing is part of the software development cycle but not equivalent to SWD services.

Helios & Matheson Information Technology Ltd.:
The Tribunal remanded the case to the TPO for fresh consideration, as the financial results for the relevant accounting year were available and should be considered for comparability analysis.

3. Application of Transfer Pricing regulations and methods:
The Tribunal discussed the statutory provisions under Section 92 of the Income Tax Act, 1961, and Rule 10B of the Income Tax Rules, 1962, for determining the ALP. The TNMM was confirmed as the MAM, and the criteria for comparability were outlined. The Tribunal emphasized the need for accurate adjustments and comparability based on the same financial year.

Conclusion:
The Tribunal upheld the inclusion of CG VAK Software Exports Ltd., Larsen & Toubro Infotech Ltd., and Persistent Systems Ltd. in the list of comparables, rejected the inclusion of Cigniti Technologies Ltd., and remanded the case for Helios & Matheson Information Technology Ltd. to the TPO for fresh consideration. The appeal was partly allowed for statistical purposes.

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