2022 (5) TMI 355 - AT - Income Tax

TP adjustment - Comparability - determination of Arm s Length Price (ALP) in respect of an international transaction of rendering software development services by the assessee to its Associated Enterprises (AE) - HELD THAT - As referring to assessee as software development company and relying on M/S. APPLIED MATERIALS INDIA PVT. LTD. 2016 (9) TMI 1458 - ITAT BANGALORE we direct the AO to exclude Persistent Systems and Solutions Ltd., and Persistent Systems Ltd., from the list of the comparable companies and remand the question of comparability of Sasken Communication Technologies Ltd., to the TPO for fresh consideration. Companies functionally dissimilar with that of assessee need to be deselected from final list of comparability. Negative working capital adjustment - HELD THAT - As the assessee is a captive service provider entirely funded by its AE and has no working capital contingent, we accept the contention of the assessee and allow ground and hold that adjustment on account of negative working capital does not arise in the present case. Exclusion of operating expenses while computing the operating margin - Assessee filed application to file additional evidence before the Tribunaln - HELD THAT - We find that on this issue, the DRP has merely observed that no submissions were made on the above ground of appeal. Assessee has however pointed out that in Annexure 1.26 of the objections filed by the assessee before the DRP, the submissions have been made with regard to the computation of operating margin. Since this issue has not been adjudicated by the DRP, we are of the view that it would be just and appropriate to remand this issue to the TPO/AO for consideration afresh with liberty to the assessee to file additional evidence before AO/TPO. The issue was not raised before the TPO in the assessment proceedings. Therefore, it would be appropriate if the TPO/AO are directed to consider the claim of the assessee in this regard. The TPO/AO will decide the issue after affording assessee opportunity of being heard. Disallowance of provision towards rental expenses - HELD THAT - The deduction has been claimed by the assessee towards provision for rental expenses based on the possibility of increase in rental expenses. This is purely on the basis of the estimate and was rightly treated as contingent in nature and not allowed as a deduction by the Revenue authorities. In this regard, we are of the view that the assessee has not given any basis for its anticipated liability towards rental expenses nor has he quantified the basis of arriving at the anticipated liability. In such circumstances, we are of the view that the Revenue authorities were justified in rejected the claim of the assessee. Accordingly, this ground of appeal raised by the assessee is dismissed.

Issues Involved:
1. Dismissal of Revenue's appeal due to low tax effect.
2. Determination of Arm’s Length Price (ALP) for software development services.
3. Computation of working capital adjustment.
4. Exclusion and inclusion of certain comparable companies.
5. Consideration of extraordinary expenses in operating margin.
6. Deduction of ALP adjustment offered to tax twice.
7. Disallowance of provision for rental expenses.

Issue-wise Detailed Analysis:

1. Dismissal of Revenue's Appeal:
The appeal by the Revenue was dismissed as the tax effect was less than Rs. 50 lakhs, making it not maintainable under CBDT’s Circular No. 17/2019.

2. Determination of ALP for Software Development Services:
The main issue in the assessee's appeal was the determination of ALP for software development services rendered to its Associated Enterprises (AE). The TPO had initially determined a TP adjustment of Rs. 10,44,44,180/-, which was later reduced to Rs. 1,00,46,453/- by the DRP. The assessee contested this final adjustment.

3. Computation of Working Capital Adjustment:
The assessee argued against the negative working capital adjustment determined by the TPO, asserting that as a captive service provider funded by its AE, it had no working capital risk. The Tribunal accepted this contention, citing several judicial precedents, and held that negative working capital adjustment does not arise in this case.

4. Exclusion and Inclusion of Comparable Companies:
The Tribunal addressed the inclusion and exclusion of certain comparable companies:
- Exclusion of Companies: Persistent Systems & Solutions Ltd., Persistent Systems Ltd., and Sasken Communication Technologies Ltd. were considered. The Tribunal directed the exclusion of Persistent Systems & Solutions Ltd. and Persistent Systems Ltd. and remanded the comparability of Sasken Communication Technologies Ltd. to the TPO for fresh consideration.
- Inclusion of Companies: The Tribunal remanded the inclusion of LGS Global Ltd., Evoke Technologies Ltd., and R S Software India Ltd. to the TPO for fresh consideration. It also remanded the question of comparability of Thinksoft Global Ltd. and FCS Software Solutions Ltd. to the TPO.

5. Consideration of Extraordinary Expenses in Operating Margin:
The assessee claimed that certain one-time extraordinary expenses should be excluded from operating expenses while computing the operating margin. The DRP had not adjudicated this issue, and the Tribunal remanded it to the TPO/AO for fresh consideration, allowing the assessee to file additional evidence.

6. Deduction of ALP Adjustment Offered to Tax Twice:
The assessee raised the issue of an ALP adjustment amounting to INR 1,20,30,164 being offered to tax twice. The Tribunal directed the AO/TPO to consider this issue afresh after affording the assessee an opportunity of being heard.

7. Disallowance of Provision for Rental Expenses:
The assessee’s claim for deduction of provision for rental expenses was based on an estimate of future liability. The Tribunal upheld the Revenue authorities' decision to disallow this deduction, as the assessee did not provide a basis for the anticipated liability.

Conclusion:
The appeal by the Revenue was dismissed, and the appeal by the assessee was partly allowed for statistical purposes. The Tribunal provided detailed directions for fresh consideration on various issues, ensuring that the assessee is given an opportunity to present additional evidence and arguments.

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