2020 (8) TMI 808 - AT - Income Tax

TP Adjustment - correctness of determination of ALP in respect of an international transaction between the assessee and its AE of rendering software development services SWD services u/s. 92 - Comparable selection - HELD THAT - The assessee rendered Software Development Services (SWD services) and marketing support services. During the previous year relevant to AY 2010-11, the assessee rendered SWD services to its Associated Enterprise AE thus companies functionally dissimilar with that of assessee need to be deselected from final list. Working capital adjustment - not considering the advances received from AEs while computing the average trade payables - TPO is directed to consider the advance received from AE as trade payable and considered for working capital adjustment. It was held in the said decision that advances received from AE par take the character of trade payables which is to be adjusted against future invoice. The advance received from the AE dispenses with the necessity to borrow for working capital and has direct bearing on the profitability of the concerned. The grievance of the assessee is accordingly allowed. AO is directed to compute the working capital adjustment by considering the advances received from AE as part of the average trade payable. Computation of OP/OC of the assessee - plea of the assessee is that OP/OC should be computed as done by the assessee by considering the retirement provision written back as part of operating expenditure - HELD THAT - The assessee s claim that for earlier AY its operating profit was considered after treating the provision for retirement benefit no longer required as part of operating expenses. This aspect was not verified either by the DRP/AO/TPO. Hence we deem it fit and appropriate to set aside the issue to TPO/AO for consideration of the claim of assessee with regard to past treatment of similar write back for computing its operating profit. The AO/TPO will afford opportunity of being heard to the assessee, before deciding the issue of determination of ALP in accordance with the directions contained in this order. TDS u/s 195 - Disallowance of Project Specific Costs u/s 40(a)(i) - AO held that the assessee is liable to deduct tax at source as there are plethora of judicial precedents supporting the fact that TDS compliance is mandatory even if the expenditure is incurred by the way of reimbursements and that the payment made for right to use computer software was in the nature of royalty and hence chargeable to tax in India in the hands of the recipient non-resident - HELD THAT - There cannot be a retrospective obligation to deduct tax at source and therefore as on the date when the assessee made payments to the non-resident for acquiring off-the-shelf software cannot be regarded as in the nature of royalty and therefore there was no obligation on the part of assessee to deduct tax at source. The payment would be in the nature of business profits in the hands of non-resident and since admittedly the non-resident does not have a Permanent Establishment in India, the sum in question is not chargeable to tax in the hands of non-resident. Consequently, the disallowance made u/s. 40(a)(ia) of the Act has to be deleted.

Issues Involved:
1. Correctness of determination of Arm's Length Price (ALP) in respect of an international transaction of rendering software development services (SWD services).
2. Inclusion/exclusion of specific comparable companies in the Transfer Pricing (TP) analysis.
3. Computation of working capital adjustment.
4. Treatment of retirement provision written back in the computation of Operating Profit/Operating Cost (OP/OC).
5. Disallowance of project-specific costs under section 40(a)(i) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Correctness of determination of ALP:
The primary issue revolves around the correctness of the ALP determination for the international transaction of rendering SWD services between the assessee and its Associated Enterprise (AE) under section 92 of the Income-tax Act, 1961. The assessee used the Transactional Net Margin Method (TNMM) with Operating Profit to Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The Transfer Pricing Officer (TPO) and the assessee had discrepancies in the computation of OP/OC, primarily due to the treatment of a retirement provision written back.

2. Inclusion/Exclusion of Comparable Companies:
The Tribunal had to decide on the inclusion and exclusion of certain comparable companies for the TP analysis:
- Infosys Ltd., Persistent Systems Ltd., Sasken Communication Technologies Ltd., and Kals Information Systems Ltd.: The Tribunal excluded these companies based on previous decisions, noting that they were either engaged in diversified activities, had significant brand value and intangibles, or lacked segmental reporting for SWD services.
- Tata Elxsi Ltd.: Excluded due to its engagement in diverse activities and lack of segmental details.
- R S Software India Ltd.: Included as the Tribunal had previously directed its inclusion in similar cases.
- Larsen & Toubro Infotech Ltd.: Excluded due to lack of segmental information.
- Akshay Software Technologies Ltd.: Remanded to the TPO/AO for fresh consideration due to discrepancies in the interpretation of its income sources.
- R Systems Ltd.: Remanded to the TPO/AO for fresh consideration, allowing the assessee to provide necessary details to align its financial year with that of the assessee.

3. Computation of Working Capital Adjustment:
The Tribunal directed the TPO to compute the working capital adjustment by considering advances received from AE as part of the average trade payable. This was based on the decision that advances received from AE par take the character of trade payables and have a direct bearing on profitability.

4. Treatment of Retirement Provision Written Back:
The Tribunal remanded the issue of whether the retirement provision written back should be treated as part of operating expenditure to the TPO/AO for fresh consideration. The assessee claimed that in previous assessment years, such provisions were considered part of operating expenses, which needed verification.

5. Disallowance of Project-Specific Costs under Section 40(a)(i):
The Tribunal addressed the disallowance of project-specific costs amounting to INR 76,139,459 under section 40(a)(i) for non-deduction of tax at source. The assessee argued that the payments were reimbursements for the usage of EDA software tools and not subject to tax deduction. The Tribunal relied on the principle that retrospective amendments or subsequent judicial rulings cannot impose a TDS obligation retrospectively. Consequently, the disallowance was deleted, and the assessee's appeal on this ground was allowed.

Conclusion:
Both the appeals by the assessee and the revenue were partly allowed. The Tribunal provided specific directions for the TPO/AO to reconsider certain aspects and compute adjustments accordingly. The judgment emphasized adherence to established legal principles and prior Tribunal decisions in determining the comparability and treatment of specific financial adjustments.

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