2022 (11) TMI 960 - AT - Income Tax

TP Adjustment - Comparable selection - determination of Arm s Length Price (ALP) in respect of an international transaction of rendering Software Development Services (SWD services) by the assessee to its Associated Enterprises ( AEs ) - HELD THAT - Selection of companies as functionally similar with that of assessee confirmed. Computation of interest on delayed receivables - non-charging or undercharging of interest on the excess period of credit allowed to the AE - HELD THAT - Adopting the rate of LIBOR at 6 months 400 basis points adopted by the TPO is without any basis. The rate should be adopted after a proper benchmarking analysis. Interest computation if at all should be based on the delay of individual invoices, which has not been done. Whether delayed realization of trade receivables from the AE constitutes an international transaction or not? - Having concluded that deferred trade receivables constitute international transaction, we come to the computation of the ALP of the international transaction of 'debt arising during the course of business.' This has two ingredients, viz., the amount on which interest should be charged and the arm's length rate at which the interest should be charged. On this aspect we can take useful guidance from the decision of the ITAT Delhi Bench in the case of Techbooks International (P.) Ltd 2015 (7) TMI 473 - ITAT DELHI wherein the Tribunal laid down guidelines on the manner of determination of ALP. The issue with regard to determination of ALP in respect of the international transaction of giving extended credit period for receivables should be directed to be examined afresh by the AO/TPO on the guidelines laid down after affording assessee opportunity of being heard. As held in the aforesaid decision the prime lending rate should not be considered and this reasoning will apply to adopting short term deposit interest rate offered by State Bank of India (SBI) also. The rate of interest would be on the basis of the currency in which the loan is to be repaid. We hold and direct accordingly. All issues on determination of ALP of the transaction are kept open. Nature of expenses - Disallowance of software expenditure by treating it as capital in nature - AO and the DRP held that the software expenses claimed by the assessee was capital expenditure and cannot be allowed as deduction - HELD THAT - The period of license cannot be the basis to decide whether the expenditure is capital or revenue expenditure. The test to be applied is as to whether the expenditure was incurred to facilitate conduct of business more efficiently in its operation and not in the capital field. The assessee renders software development services and therefore the use of these software was in its operations and not in the capital field and in that view of the matter, we are of the view that the expenditure in question deserves to be allowed in full. The addition sustained is therefore directed to be deleted and the expenditure in question should be allowed as deduction as the expenditure is revenue expenditure allowable as deduction. Appeal by the assessee is partly allowed.

Summary

Issues Involved:
1. Inclusion and exclusion of comparable companies for determining Arm's Length Price (ALP).
2. Determination of ALP for delayed receivables.
3. Treatment of software expenditure as capital or revenue in nature.

Issue-Wise Detailed Analysis:

1. Inclusion and Exclusion of Comparable Companies for Determining ALP:

The primary issue was the selection of comparable companies to determine the ALP for software development services rendered by the assessee to its Associated Enterprises (AEs). The assessee challenged the inclusion of certain companies and the exclusion of others by the Transfer Pricing Officer (TPO).

Ground No. 14: The assessee contested the inclusion of Infosys Ltd., Larsen & Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd., and Thirdware Solutions Ltd. The Tribunal referred to its earlier decision in the case of Salesforce.com Vs. DCIT, where these companies were held to be functionally dissimilar to a software development service provider like the assessee. The Tribunal directed the exclusion of these companies from the final list of comparables.

Ground No. 16: The assessee sought the inclusion of I2T2 India Ltd. as a comparable. The Tribunal, following its earlier decision in Salesforce.com, remanded the matter to the AO/TPO for verification of the functional comparability of I2T2 India Ltd., directing the AO/TPO to obtain requisite information and provide an opportunity to the assessee to present its case.

2. Determination of ALP for Delayed Receivables:

The TPO computed interest on delayed receivables, treating them as an international transaction under Section 92B of the Income Tax Act. The DRP upheld this view but modified the interest rate, leading to an enhancement of the addition.

Ground Nos. 19-24: The assessee argued that receivables should not be considered an international transaction and that no interest should be imputed without a proper benchmarking analysis. The Tribunal noted conflicting decisions on whether delayed receivables constitute an international transaction. It referred to the retrospective amendment to Section 92B, which includes deferred payment or receivables as an international transaction. The Tribunal directed the AO/TPO to re-examine the issue, emphasizing that the interest rate should be based on the currency in which the loan is to be repaid, not the prime lending rate or SBI's short-term deposit rate.

3. Treatment of Software Expenditure:

The assessee claimed software expenses as revenue expenditure, while the AO and DRP treated them as capital expenditure, allowing only depreciation.

Ground No. 25: The Tribunal examined whether the software expenses were for application software or renewal of licenses for periods less than one year. The Tribunal referred to the Karnataka High Court's decision in CIT vs. IBM India Ltd., which held that expenditure on application software is revenue in nature. The Tribunal found that the AO/TPO did not make a clear finding on whether the software was application software. It concluded that the expenditure should be allowed in full as revenue expenditure, as it facilitated the efficient conduct of the business and was not in the capital field.

Conclusion:

The Tribunal partly allowed the appeal, directing the exclusion of certain companies from the list of comparables, remanding the issue of I2T2 India Ltd. for fresh consideration, and instructing the AO/TPO to re-examine the ALP for delayed receivables. It also directed that the software expenditure be treated as revenue expenditure, allowing the deduction in full.