2021 (4) TMI 297 - AT - Income Tax

TP Adjustment - Comparable selection - Functional dissimilarity - HELD THAT - Referring to functions performed by assessee under ITeS segment companies functionally dissimilar with that of assessee need to be deselected from final list. Companies whose RPT is more than 25% the same may be excluded from the finalist.

Issues Involved:

1. Assessment of total income
2. Addition to total income based on arm's length price (ALP) for IT enabled services
3. Economic analysis for determining ALP
4. Use of FY 2006-07 data for determining ALP
5. Use of information obtained under section 133(6) for comparability analysis
6. Rejection of comparables by applying different filters
7. Non-application of employee cost filters
8. Selection of companies with financial irregularities as comparables
9. Selection of functionally dissimilar companies as comparables
10. Computation of working capital adjustment
11. Adjustments for differences in risk profile
12. Computation of ALP without +1-5 percent benefit
13. Levy of interest under section 234B
14. Initiation of penalty proceedings under section 271(1)(c)

Issue-wise Detailed Analysis:

1. Assessment of Total Income:
The learned AO, following the directions of the Hon'ble DRP, assessed the total income at INR 2,27,63,060 against the returned income of INR 2,12,644.

2. Addition to Total Income Based on ALP:
The AO/DRP/TPO made an addition of INR 2,25,50,416 to the total income of the appellant, asserting that the price charged was lower than the arm's length price determined for IT enabled services transactions rendered by the appellant to its associated enterprises (AEs).

3. Economic Analysis for Determining ALP:
The AO/DRP/TPO did not accept the economic analysis undertaken by the appellant and conducted a fresh economic analysis for determining the ALP, holding that the appellant's international transaction was not at arm's length.

4. Use of FY 2006-07 Data for Determining ALP:
The AO/DRP/TPO used only FY 2006-07 data to determine the ALP, which was not available to the appellant at the time of complying with transfer pricing documentation requirements.

5. Use of Information Obtained Under Section 133(6) for Comparability Analysis:
The AO/DRP/TPO obtained information under section 133(6) that was not publicly available and relied on it for comparability purposes, selecting companies such as Bodhtree Consulting Ltd. and Accurate Data Converters Pvt. Ltd. as comparables.

6. Rejection of Comparables by Applying Different Filters:
The AO/DRP/TPO rejected certain comparables considered by the appellant by applying different quantitative and qualitative filters, including:
- Companies with economic performance contrary to industry behavior (e.g., diminishing revenue trend)
- Companies with turnover less than INR 1 crore
- Not applying an upper turnover filter of INR 200 crores

7. Non-application of Employee Cost Filters:
The AO/DRP/TPO did not apply employee cost filters to reject companies with employee costs less than 25% of operating revenues, such as Vishal Information Technologies Ltd., Asit C Mehta Financial Services Ltd., and Spanco Ltd.

8. Selection of Companies with Financial Irregularities as Comparables:
The AO/DRP/TPO selected companies with financial irregularities, such as Maple eSolutions Ltd. and Triton Corp Ltd., which were under indictment for fraud during FY 2006-07.

9. Selection of Functionally Dissimilar Companies as Comparables:
The AO/DRP/TPO selected functionally dissimilar companies using unreasonable comparability criteria, including Bodhtree Consulting Ltd., Maple eSolutions Ltd., Triton Corp Ltd., Vishal Information Technologies Ltd., Asit C Mehta Financial Services Ltd., Spanco Ltd., Accurate Data Converters Pvt. Ltd., and Iservices India Pvt. Ltd.

10. Computation of Working Capital Adjustment:
The AO/DRP/TPO erred in computing the working capital adjustment by not considering advances received from customers.

11. Adjustments for Differences in Risk Profile:
The AO/DRP/TPO did not make suitable adjustments for differences in the risk profile of the appellant vis-à-vis the comparables during the comparability analysis.

12. Computation of ALP Without +1-5 Percent Benefit:
The AO/DRP/TPO computed the ALP without giving the benefit of the +1-5 percent range under the proviso to section 92C of the Act.

13. Levy of Interest Under Section 234B:
The AO levied interest of INR 107,45,187 under section 234B of the Act.

14. Initiation of Penalty Proceedings Under Section 271(1)(c):
The AO initiated penalty proceedings under section 271(1)(c) of the Act.

Judgment Analysis:

Exclusion of Comparables:
- Bodhtree Consulting Ltd. (Seg.): Excluded as it provides software development services and lacks segmental details for ITES services.
- Maple eSolutions Ltd. & Triton Corp Ltd.: Excluded due to involvement in fraudulent financial activities.
- Vishal Information Technologies Ltd.: Excluded due to high RPT filter of 82.92% and being categorized as a KPO service provider.
- Asit C Mehta Financial Services Ltd.: Remanded to AO/TPO to verify RPT percentage and consider comparability based on segmental details.
- Spanco Ltd. (Seg.): Remanded to AO/TPO to verify employee cost and revenue earned under ITES segment.
- Accurate Data Converters Pvt. Ltd.: Remanded to AO/TPO to verify functions and decide comparability based on functional dissimilarities/similarities.

Working Capital Adjustment:
The issue of working capital adjustment was remanded to the AO/TPO for reconsideration in light of the appellant's submissions regarding advances received from customers.

Conclusion:
The appeal was allowed, with directions for the exclusion of certain comparables and remand for verification of others. The working capital adjustment issue was also remanded for reconsideration. The judgment emphasized the need for accurate comparability analysis and proper application of filters in transfer pricing cases.

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