2022 (8) TMI 892 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - As assessee is doing part of software development cycle and therefore has been categorised as a captive software development service provider as well as ITeS segment, catering to needs of the group. The assessee in TP study held to be comprise of Software Engineers, who develop project based on inputs received from AE. Engineers employed by assessee designs functional specifications for the project identification of interfaces components coding and bug fixing. Ultimate approval and owner of project developed is the AE. In our view, by involving itself in process of Software development for AE, assessee cannot be held to be fulfledged Software Development Company. One has to look into transaction in regards to services rendered and FAR, which catagorises it to be a captive service provider, working on business model of cost plus margin. It is observed that comparables sought to be excluded are 100 % Software Development Companies, having high turnover and therefore respectfully following aforestated view in case of Genesis Integrating Systems India Pvt. Ltd. 2011 (8) TMI 952 - ITAT BANGALORE these comparables are to be excluded on both the counts of functionally not being similar with that of assessee and also because they have a high turnover of more than 200 crore. Thus respectfully following above decisions, we uphold exclusion of Tata Elxsi Ltd., Sasken Communication Technologies Ldt, Persistent Systems Ltd., L T Infotech Ltd., and Infosys Ltd., by applying turnover filter under SWD Segment and for ITeS Segment, Infosys BPO Ltd., iGate Global Ltd., and Mindtree Ltd., by applying turnover filter, from final list. Foreign exchange loss or gain as part of operating expenditure and excluding depreciation cost - Whether DRP erred in directing the Ld.AO/TPO to consider the foreign exchange fluctuation to be operating in nature? - HELD THAT - As relying on Finastra Software Solutions (India)(P.)Ltd. 2018 (5) TMI 1808 - ITAT BANGALORE we uphold the treatment of foreign exchange loss/gain to be operating in nature. Depreciation cost treated as being non-operating in nature - AR submitted that for year under consideration also the assessee charged higher rate of depreciation as compared to companies selected by Ld.TPO - HELD THAT - Facts being the same with assessment year 2009-10, we do not find any infirmity in adopting the consistent view to in computing the margin in respect of the comparables after excluding the depreciation from the cost. In the result the appeal filed by revenue stands dismissed. Comparable selection - Companies being functionally dissimilar to the SWD services segment of Assessee need to be deselected. Working capital adjustment - We are of the view that it would be appropriate to direct the Ld.TPO/AO to examine the grievance of the Assessee in this regard and rework the working capital adjustment in accordance with law. Short-Grant of TDS Credit - We direct the Ld.AO to verify the claim based on the evidence filed by the assessee in accordance with law.

Summary

Issues Involved:
1. Exclusion of comparables based on size and turnover.
2. Treatment of foreign exchange loss/gain and depreciation.
3. Functional comparability of specific companies.
4. Application of Resale Price Method (RPM) versus Transactional Net Margin Method (TNMM).
5. Working capital adjustments.
6. Short grant of TDS credit.

Detailed Analysis:

1. Exclusion of Comparables Based on Size and Turnover:
The Tribunal upheld the exclusion of certain companies from the list of comparables based on their size and turnover, following the principle that "the size matters in business" and companies with significantly higher turnover have different bargaining power and operational efficiencies. The Tribunal referenced the case of Genesis Integrating Systems India Pvt. Ltd., which established that companies with a turnover of Rs. 1 crore to 200 crores should be considered in the same range for Transfer Pricing (TP) study. Thus, companies like Tata Elxsi Ltd., Sasken Communication Technologies Ltd., Persistent Systems Ltd., L&T Infotech Ltd., and Infosys Ltd. were excluded for the Software Development Services (SWD) segment, and Infosys BPO Ltd., iGate Global Ltd., and Mindtree Ltd. for the IT Enabled Services (ITES) segment.

2. Treatment of Foreign Exchange Loss/Gain and Depreciation:
The Tribunal confirmed that foreign exchange gains or losses should be treated as operating in nature, referencing the case of Finastra Software Solutions (India)(P.) Ltd. It was held that such gains or losses are connected to the business for which the Arm's Length Price (ALP) is determined. Additionally, the Tribunal upheld the exclusion of depreciation from the cost base for computing margins, consistent with the decision in the assessee’s own case for AY 2009-10, recognizing that the assessee charged higher depreciation rates compared to comparables.

3. Functional Comparability of Specific Companies:
- Acropetal Technologies Ltd.: Excluded due to failing the software development services revenue filter and being functionally different.
- e-Zest Solutions Ltd.: Remanded to the TPO for reconsideration due to diverse services including product development and IT-enabled services.
- E-Infochips Ltd.: Excluded due to lack of segmental information and significant inventory and intangibles.
- ICRA Techno Analytics Ltd.: Excluded due to engagement in high-end KPO services and failing the Related Party Transactions (RPT) filter.
- Persistent Systems & Solutions Ltd.: Excluded due to engagement in diverse activities without segmental details and abnormal turnover increase.

4. Application of Resale Price Method (RPM) versus Transactional Net Margin Method (TNMM):
The Tribunal remanded the issue to the TPO for de novo consideration, emphasizing that the RPM should be applied if the assessee is a routine distributor without value addition, consistent with the assessee’s own case in subsequent years. The Tribunal referenced the case of Bristol Myers Squibb India Pvt. Ltd., which stated that direct methods like RPM should be preferred over TNMM unless rendered inapplicable.

5. Working Capital Adjustments:
The Tribunal directed the TPO to rework the working capital adjustments without imposing arbitrary caps, referencing the case of Brocade Communications Systems (P) Ltd. It was held that working capital adjustments must be granted in full to adjust for differences between the working capital positions of the tested party and comparables.

6. Short Grant of TDS Credit:
The Tribunal directed the AO to verify the claim of TDS credit based on the evidence provided by the assessee and allow the correct amount in accordance with the law.

Conclusion:
The Tribunal's judgment extensively analyzed the comparability of various companies, treatment of foreign exchange and depreciation, and the appropriateness of different TP methods. The Tribunal upheld the exclusion of certain comparables based on functional dissimilarity and turnover, confirmed the treatment of foreign exchange and depreciation as operating in nature, and directed re-examination of working capital adjustments and TDS credit claims. The case was remanded for reconsideration of the appropriate TP method for the SDR segment, ensuring consistency with subsequent years.