2020 (1) TMI 1030 - AT - Income Tax

TP Adjustment - comparable selection - TPO rejected CG Vak as a comparable on the ground that it fails employee cost filter (6%). HELD THAT - When we examine the filters applied by the TPO to benchmark the international transactions detailed in para 2.1, there is no such filter such as employee cost filter applied by the TPO. Even otherwise, when we examine annual report of CG Vak for AY 2011-12 along with Notes annexed forming part of accounts employee cost is ₹ 4,73,01,685/- which is 70.50% of the total operating expenses of ₹ 6.7 crores. Functionality of CG Vak vis- -vis taxpayer has not been disputed by the ld. TPO. In view of the financials of CG Vak, we hereby direct TPO/AO to verify employee cost of CG Vak with reference to next year annual report so as to decide the suitability of CG Vak as a comparable. Kals rejected as a comparable chosen by the taxpayer on the ground that segmental information is not matching with entity level financials - As decided in M/S. MERCEDES-BENZ RESEARCH AND DEVELOPMENT INDIA PVT. LTD. 2016 (6) TMI 1322 - ITAT BANGALORE low turnover cap applied by the TPO in case of taxpayer is required to be restricted to ₹ 1 crore instead of ₹ 5 crores. Even by applying the rule of consistency, we are of the considered view that when there is no change in the business model of the taxpayer in AYs 2008-09, 2009-10 2012-13 as well as year under assessment for AY 2011-12, rule of consistency has to be followed and TPO is directed to apply the turnover cap of ₹ 1 crore as against cap of ₹ 5 crores applied by him. So far as, question of segmental information being not matching with entity level functions as has been held by ld. TPO is concerned, as per AS-17 on segment reporting, revenue derives from reportable segments should be at least 75% of the total external revenue as segmental results are not expected to match with entity-wise results. So, in these circumstances, Kals is ordered to be included in the final set of comparables. Melstar rejected as a comparable on the ground that it fails export filter - Detail of export sales was not available in public domain. So, when detail of export sales is not available Melstar cannot be rejected just like that. So, we direct the ld. TPO to rework the suitability of Melstar as a comparable vis- -vis taxpayer by supplying the copy of details of export sales of Melstar relied upon by him. Virnichi rejected which is taxpayer s comparable on the ground that it fails employee cost filter - When we examine filters applied by the ld. TPO to benchmark the international transaction, there is no such filter such as employee cost filter applied by the ld. TPO. In these circumstances, ld. TPO is directed to reexamine the Virnichi so as to find out the suitability as a comparable vis- -vis the taxpayer. Wipro is not a suitable comparable vis- -vis the taxpayer for benchmarking the international transaction qua software development services on ground of related party transactions on the basis of Master Service Agreement with Citi Group for delivery of Technical Infrastructure Services Ltd. and application of maintenance services for a period of 6 years. See CADENCE DESIGN SYSTEMS (I) (P.) LTD. VERSUS ASSISTANT COMMISSIONER OF INCOME TAX, CIRCLE- 5 (2) , NEW DELHI, 2018 (4) TMI 1574 - ITAT NEW DELHI Infosys - Coordinate Bench of the Tribunal in case of Clear 2 Pay India (P.) Ltd. vs.ITO 2018 (6) TMI 1628 - ITAT DELHI examined the comparability of Infosys vis- -vis the routine software development service provider in AYs 2011-12 2012-13 and ordered to exclude the same by relying upon the case of CIT vs. Agnity India Technologies (P.) Ltd. 2013 (7) TMI 696 - DELHI HIGH COURT I Gate exclusion on the ground that the ld. TPO has erroneously excluded the same from the final set of comparables despite the fact that findings have been returned against its inclusion - I Gate is not a suitable comparable vis- -vis taxpayer who is a captive software development service provider having meager turnover vis- -vis I Gate and having huge intangibles in the form of goodwill of ₹ 225.99 crores as against nil of taxpayer, hence ordered to be excluded. Persistent exclusion on the grounds inter alia that Persistent is having huge fixed assets in the form of software and other intangibles which is 7.90% of the turnover - objections raised by the taxpayer against inclusion of Persistent as a comparable by the ld. TPO are correct having not been controverted by the ld. DR for the Revenue. When Persistent is having huge software and other intangibles and having invested in IPR and has created several IPs and is having revenue from licencing of product and royalties and having huge turnover of ₹ 645.39 crores which is 32 times of the taxpayer, it cannot be a suitable comparable vis- -vis the taxpayer who is a captive software service provider, hence ordered to be excluded. Sasken is not a suitable comparable vis- -vis the taxpayer on ground of functional dissimilarity and being into trademark products/patents having no segmental financials, hence ordered to be excluded as a comparable. CG Vak is shown to have the profit of ₹ 1,39,70,696/- for FY ending 31.03.2012 and ₹ 9,64,864/- for the year ending 31.03.2011. So, it has come on record that ld. DRP has lost sight of the actual figure showing profit by CG Vak and proceeded to reject the same on the basis of incorrect facts. So, the AO/TPO is directed to verify the facts and include CG Vak as a valid comparable vis- -vis the taxpayer. Kals - Annual report show that all the filters applied by the ld. TPO stood satisfied. So, in these circumstances, the ld. TPO/AO is directed to include Kals as a valid comparable. Infomile functionally similar to the taxpayer and directed the TPO to include the same as a valid comparable if it meets the filter approved by the ld. DRP. So, we direct ld. TPO to reconsider Infomile as a comparable vis- -vis the taxpayer by providing an opportunity of being heard to the taxpayer. Bells functionally - DRP held Bells functionally similar to the taxpayer and directed the TPO to include the same as a valid comparable if it meets the filter approved by the ld. DRP. So, we direct ld. TPO to reconsider Bells as a comparable vis- -vis the taxpayer by providing an opportunity of being heard to the taxpayer. L T is a giant company having huge intangibles and having dissimilar functional profile being into wide range of services and also into products, cannot be a suitable comparable vis- -vis the taxpayer.

Summary

Issues Involved:
1. Determination of arm's length adjustment for international transactions.
2. Rejection and selection of comparables by the Transfer Pricing Officer (TPO).
3. Application of quantitative search filters in benchmarking analysis.
4. Consideration of operating margin and idle capacity adjustments.
5. Treatment of foreign exchange income/expenses and miscellaneous income.
6. Consideration of risk profile differences between the taxpayer and comparables.

Issue-Wise Detailed Analysis:

1. Determination of Arm's Length Adjustment:
The taxpayer, engaged in software development services, used the Transactional Net Margin Method (TNMM) with Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) to benchmark its international transactions. For AY 2011-12, the TPO proposed an adjustment of ?1,76,07,484/- and for AY 2012-13, an adjustment of ?1,57,82,426/- was proposed, later reduced to ?1,26,10,260/- by the DRP.

2. Rejection and Selection of Comparables by TPO:
For AY 2011-12, the taxpayer sought the inclusion of CG Vak Software & Exports Ltd., Kals Information Systems Ltd., Melstar Information Technologies Ltd., and Virnichi Technologies Ltd., and the exclusion of Wipro Technologies Services Ltd., Infosys Ltd., I gate Global Solutions Ltd., Persistent Systems Ltd., and Sasken Communication Technologies Ltd. The Tribunal directed the TPO to verify and include CG Vak and Kals, and reconsider Melstar and Virnichi. Wipro, Infosys, I gate, Persistent, and Sasken were ordered to be excluded due to functional dissimilarity, presence of intangibles, and high turnover.

For AY 2012-13, similar directions were given. The Tribunal directed the inclusion of CG Vak, Kals, Infomile Technologies, and Bells Software, and the exclusion of Infosys, Persistent, and Larsen & Toubro Infotech Ltd. (L&T) due to their dissimilar functional profiles, high turnover, and presence of intangibles.

3. Application of Quantitative Search Filters:
The TPO applied various filters such as employee cost filter, turnover filter, and export sales filter. The Tribunal found discrepancies in the application of these filters and directed the TPO to reapply them correctly. For instance, the turnover cap was directed to be restricted to ?1 crore instead of ?5 crores.

4. Consideration of Operating Margin and Idle Capacity Adjustments:
The taxpayer's operating margin was considered at 10.62% for AY 2011-12, which the TPO disregarded. The Tribunal directed the TPO to consider the correct margin and also account for idle capacity adjustments claimed by the taxpayer.

5. Treatment of Foreign Exchange Income/Expenses and Miscellaneous Income:
The TPO treated foreign exchange income/expenses and miscellaneous income as non-operating. The Tribunal directed a reconsideration of this treatment to ensure consistency with the treatment of similar items in comparable companies.

6. Consideration of Risk Profile Differences:
The taxpayer argued for adjustments based on differences in risk profiles between itself and the comparables. The Tribunal acknowledged these differences and directed the TPO to consider suitable adjustments for risk differences.

Conclusion:
The Tribunal allowed the taxpayer's appeals for statistical purposes, directing the TPO to re-evaluate the selection and rejection of comparables, reapply quantitative filters correctly, consider appropriate operating margins and idle capacity adjustments, and account for differences in risk profiles. The Tribunal emphasized the need for consistency and accuracy in benchmarking international transactions for transfer pricing purposes.