2022 (9) TMI 449 - AT - Income Tax

TP Adjustment - comparable selection - Provision of software development services - application of upper turnover filter and thereby exclusion of 7 companies from the comparable list - HELD THAT - The Bangalore Bench of the Tribunal in the case of BORQS Software Solutions Pvt. Ltd. 2021 (10) TMI 1351 - ITAT BANGALORE has considered a host of rulings on this issue including that of Hon ble High Courts wherein divergent views were taken with respect to the application of different filters. It was held by the Tribunal that the application of the turnover filter is justified on the basis of the classification of companies as per the report of Dun and Bradstreet. Since the assessee, in the present case, has disclosed an operating income companies reporting turnover above a threshold are considered not comparable. Accordingly, by following the order of the Tribunal, we direct the AO / TPO to apply the appropriate upper turnover filter and exclude the following 7 companies having turnover in excess of Rs.200 crores, i.e. Larsen and Toubro Infotech Limited, Nihilent Technologies Limited, Persistent Systems Limited, Thirdware Solutions Limited, Infosys Limited, Aspire Systems (India) Private Limited and Cybage Software Private Limited. Sagarsoft (India) Limited and Evoke Technologies Limited - DRP has rejected the objection of the assessee for its inclusion by claiming that the same does not feature in the TPO s search matrix, thereby amounting to cherry-picking of companies with low margins - HELD THAT - Since the learned AR has demonstrated that the same is appearing in the TPO s list of comparable companies and are deriving 100% of its revenue from software development services, we direct the AO / TPO to re-examine the compatibility of these two companies. We accordingly allow the grounds of the assessee for statistical purposes. Computing operating margins of certain companies considered comparables which are arising out of arithmetical inaccuracies - In the view of principles of natural justice, we deem it appropriate to remand the matter back to the files of the AO / TPO to examine the claims of the assessee with regard to erroneous computation of operating margin. We direct the AO / TPO to specifically adjudicate each of the items of either expenses / income with respect to its inclusion or exclusion in calculating the operating margins. The ground of the assessee is accordingly allowed for statistical purposes. Working capital adjustment - assessee has submitted that TPO did not allow any adjustment on working capital - HELD THAT - We have heard rival submissions and perused the material on record. In the view of the ruling in the case of M/s.Huawei Technologies India (P) Ltd. 2018 (10) TMI 1796 - ITAT BANGALORE the basis of rejection of the relief by the DRP is no longer valid. We direct the AO/TPO to consider the workings in the light of the aforesaid ruling and allow appropriate adjustment in arriving at an arm s length price. Interest on outstanding receivables - HELD THAT - The details with respect to the terms of the Master Service Agreement, credit period allowed thereunder, invoicing details, the realization data, and such other particulars as may be relevant to adjudicate on this issue, are not emanating from the DRP s directions / TPO s order. We accordingly direct the AO / TPO to examine the factual aspect. The AO / TPO is also directed to examine computation of debtors holding period of comparable vis- -vis that of the assessee. If the debtors holding period of comparable is higher than that of the assessee, then prima facie, no TP adjustment is required on the amounts outstanding from the AEs. We, accordingly, allow the ground for statistical purposes. Operating margins of the Assessee considering foreign exchange gain as non-operating by taking the values as per TP study - assessee could not raise this ground before the DRP / AO /TPO on account of omission - HELD THAT - TPO in its initial orders under section 92CA dated 31.10.2019 has considered the foreign exchange gain/loss as operating in computing the operating margins of comparable companies. The Assessee has claimed an inconsistent approach in the computation of operating margins of the tested party vis-a-vis the comparable companies. It is well accepted that the benchmarking exercise should result in a comparison of Apple with Apple. Since there is inconsistency in computing the margins, we direct the AO / TPO to verify the issue afresh. It is ordered accordingly. In the result, the additional ground raised by the assessee is allowed for statistical purposes.

Summary

Issues Involved:
1. Transfer Pricing Adjustment for Software Development Services.
2. Transfer Pricing Adjustment for Interest on Delayed Receivables.
3. Application of Turnover Filters.
4. Inclusion and Exclusion of Comparable Companies.
5. Working Capital Adjustment.
6. Computation of Operating Margins.
7. Notional Interest on Outstanding Receivables.
8. Inconsistent Treatment of Foreign Exchange Gain/Loss.

Detailed Analysis:

1. Transfer Pricing Adjustment for Software Development Services:
The TPO proposed a TP adjustment of INR 4,27,00,084 for software development services. The DRP accepted the assessee's contention that adjustments should be made only on the SWD segment operating revenue, reducing the adjustment to INR 3,93,70,344.

2. Transfer Pricing Adjustment for Interest on Delayed Receivables:
The TPO re-characterized trade receivables as loans to AEs, imputing interest at 6-month LIBOR plus 450 bps, resulting in an adjustment of INR 31,98,111. The DRP directed the TPO to use the SBI short-term deposit interest rate, reducing the adjustment to INR 7,68,976.

3. Application of Turnover Filters:
The assessee sought the application of an upper turnover filter to exclude seven companies. The Tribunal directed the AO/TPO to apply an appropriate upper turnover filter and exclude companies with turnover above INR 200 crores, following the precedent set by BORQS Software Solutions Pvt. Ltd. v. ITO.

4. Inclusion and Exclusion of Comparable Companies:
The assessee requested the inclusion of Sagarsoft (India) Limited and Evoke Technologies Limited as comparables. The Tribunal directed the AO/TPO to re-examine the compatibility of these companies, allowing the grounds for statistical purposes.

5. Working Capital Adjustment:
The Tribunal referenced the decision in M/s.Huawei Technologies India (P) Ltd. v. JCIT, directing the AO/TPO to consider working capital adjustments as per actuals and allow appropriate adjustments in arriving at an arm's length price.

6. Computation of Operating Margins:
The assessee claimed errors in the computation of operating margins due to arithmetical inaccuracies. The Tribunal remanded the matter back to the AO/TPO to examine the claims and adjudicate each item of expenses/income for accurate computation.

7. Notional Interest on Outstanding Receivables:
The Tribunal noted the need to consider receivables as an international transaction under section 92B of the I.T. Act. The AO/TPO was directed to examine the factual aspects, including the debtors' holding period of comparables vis-à-vis the assessee. If the holding period of comparables is higher, no TP adjustment is required.

8. Inconsistent Treatment of Foreign Exchange Gain/Loss:
The assessee raised an additional ground regarding the inconsistent treatment of foreign exchange gains/losses. The Tribunal admitted the additional ground, directing the AO/TPO to verify the issue afresh to ensure consistency in computing operating margins.

Conclusion:
The appeal was partly allowed, with several grounds being remanded for re-examination and statistical purposes. The Tribunal emphasized the need for consistency and accurate adjustments in transfer pricing assessments.