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TMI Blog2019 (11) TMI 1411X X X X Extracts X X X X X X X X Extracts X X X X ..... ect to computer aided design ('CAD/CAM') services rendered by the Appellant to its associated enterprises. (b) The ld. AO/ld. TPO/Hon'ble Dispute Resolution Panel ('Hon'ble DRP' or 'the ld. Panel') erred in law and on facts in failing to establish that the Appellant shifted profits outside India. 2. Determination of arm's length price of international transactions (a) The ld. AO/ld. TPO grossly erred on facts and in law in rejecting the filters and search process adopted by the Appellant in the Transfer Pricing Study without considering the Appellants facts. Further, the ld. AO/ld. TPO also erred on facts and in law by conducting a fresh benchmarking analysis in respect of captive CAD/CAM services provided by the Appellant and wrongly comparing the Appellant's activities with companies operating as full-fledged entrepreneurs without considering the differences in functions performed, assets employed and risks assumed by the Appellant vis-a-vis comparable companies. (b) The ld. AO/ld. TPO erred in law in applying arbitrary filters as criterion for rejection of companies identified by the Appellant in the Transfer Pricing Study such as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting the transfer pricing study by the Appellant. (b) The ld. AO/ld. TPO erred in law erred in disregarding the application of multiple-year data while computing the margin of comparable companies. The ld. Panel erred in confirming the same. 4. Non-allowance of appropriate adjustment to the comparable companies by the ld. Panel and the ld. AO/ld. TPO (a) The ld. AO/ld. TPO/ld. Panel erred in law and on facts in not allowing appropriate adjustments under Rule 10B of the Rules to account for, inter alia, differences in (i) accounting practices, (ii) marketing expenditure adjustment, (iii) research and development expenditure between the Appellant and the comparable companies. (b) The ld. AO/ld. TPO erred in law and on facts in restricting the working capital adjustment to 1.63% as against 4.23% originally computed by the ld. TPO in the transfer pricing order. The ld. DRP erred in upholding the actions of the ld. AO/ld. TPO. 5. Variation of 5% from the arithmetic mean (a) The ld. AO/ld. TPO/ld. Panel erred in law in not granting the variation as per proviso to Section 92C(2) of the Income-tax Act, 1961 ('The Act') 6. Initiation of penalty proceedings The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AP charges 19,119,535 11 Recovery of expenses 939,372 12 Reimbursement of expenses 38,634,385 13 Issue of share capital 357,000,000 14 Share application money received 412,318,000 4.1 THE FINANCIAL RESULTS OF THE COMPANY FOR THE F.Y. 10-11 : Particulars Amount Amount Total Operating Income 741384445 Less: Other Income 67206409 Operating Income 674178036 Total Operating Cost 985025291 Less: Provision for doubtful debtors 9236319 Provision for obsolete inventory 123670 Provision for claims 89950000 Provision for warranties 7924575 Foreign Exchange loss 3719199 Finance charges 2089329 Operating Cost 871982199 Operating Profit -197804163 OP/OC -22,68% OP/OR -29.34% The assessee's margin computed on OP/OC, is - 22.68%. The assesses is into Software Development Services segment and the TPO found that the Transfer Pricing Document contains 9 comparables on software development activities with applied filters and TNMM is considered as MAM further assessee has selected the comparables engaged in the same industry verticals i.e. Aer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rrived as per the discussions in the following paragraphs. Sl. No. Name Sales Cost PLI 1 Acropetal Technologies Ltd.(seg) 814,016,893 616,754,876 31.98% 2 E-zest solutions (from Capitaline) 112866098 93255341 21.03% 3 E-Infochips Ltd 260384251 166447527 56.44% 4 Evoke (from Capitaline) 144869912 133996568 8.11% 5 I C R A Techno Analytics Ltd. (in 000) 158401000 126894000 24.83% 6 Infosys Ltd 253850000000 177,030.000,000 43.39% 7 Larsen & Toubro Infotech Ltd. 23318122096 19,764,861,289 19.83% 8 Mindtree Ltd.(seg) 8,783,000,000 7,937,143,242 10.68% 9 Persistent Systems & Solutions Ltd. 189,490,457 155,172,089 22.12% 10 Persistent Systems Ltd. 6,101,270,000 4.971,860,000 22.84% 11 RS Software (India) Ltd. 1,882,638,471 1,617,804,170 16.37% 12 Sasken Communication Technologies Ltd 3,941,962,000 3,175,616,000 24.13% 13 Tata Elxsi Ltd (seg) 3,581,985,000 2.962,533,352 20.91% AVERAGE MARGIN 24.82% Further the TPO worked out Working Capital Adjustment and risk adjustment and computed the ALP of Software Development Services at para 12.4 of the order as under : Computation of Arm's Length P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Contra, the ld. DR supported the orders of the TPO and DRP and filed written submissions. 5. We heard the rival contentions and perused the material on record. Prima facie, the learned Authorised Representative has made submissions on 8 comparables selected by the TPO for examination and Working Capital Adjustment. First we shall deal with the exclusion of comparables as under : (i) E-Zest Solutions Limited : This company is functionally different and has on-site services and significant presence of inventory and is functionally incomparable and is engaged in product development, web development and KPO services and segmental details are not available. We found that this comparable was excluded in the case of co-ordinate Bench decision Applied Materials India Ltd. v. ACIT [IT(TP) Appeal Nos.17 & 39/Bang/2016, dt.21.09.2016] for the Assessment Year 2011-12. The Tribunal has observed at page 17 para 9.1.3 as under : "9.1.3 We have considered the rival submissions as well as the relevant material on record. We find that the assessee has raised objections against this company before the DRP. However the DRP did not adjudicate the objections raised by the assessee. The deci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cer to exclude this company from comparables."' 17.2 We further note that the Tribunal in the case of DCIT v. Electronics for Imaging India Pvt. Ltd. (supra) has considered the comparability of this company in paras 14 to 16 as under : "(1) ICRA Techno Analytics Ltd. (seg) 14. At the outset, we note that apart from having the related party revenue at 20.94% of the total revenue, this company was also found to be functionally not comparable with software development services segment of the assessee. The DRP has given its finding at pages 13 to 14 as under:- "Having heard the contention, on perusal of the annual report, it is noticed by us that the segmental information is available for two segments i.e., services and sales. However, it is evident from the annual report that the service segment comprises of software development, software consultancy, engineering services, web development, web hosting, etc. for which no segmental information is available and therefore, the objection of the assessee is found acceptable. Accordingly, Assessing Officer is directed to exclude the above company from the comparables." 15. We find that the facts recorded by the DRP in respect o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssue.' (iv) M/s. L & T Infotech Limited : The said comparable company has site revenues more than 50% of total revenue with three different segments being financial services, manufacturing and telecom as per the Annual Report of the company and further no segmental results are available and cannot be functionally comparable. The comparable company is a market leader and on account of ownership marketing, intangibles IPRs for the proprietary software products developed in House and during the year the company has acquired Canadian Transfer Agency business which has impact on the profitability of the company and has to be excluded being dissimilar to the assessee's functional profile. We found that the co-ordinate Bench of the Hon'ble Tribunal in the case of Applied Materials India Limited (supra) has dealt on the issue at page 35 para 19 as under : '19. We have heard the learned D.R. as well as learned A.R. and considered the relevant material on record. The DRP rejected this company by recording the facts at page 15 as under : On perusal of schedule to the notes of the accounts, it is noticed by us that expenses incurred in foreign currency are 938.94 crore (4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pany is also in the software products and therefore cannot be considered as good comparable. He has further contended that in a series of decisions, the Tribunal has applied 15% RPT filter and since this company is having more than 15% RPT, the same cannot be considered as a good comparable. 64. On the other hand, the ld. DR has submitted that TPO has applied RPT filter of 25% and therefore only for this company, the RPT cannot be reduced to 15%. Further, the DRP has examined annual report of this company and found that this company earns revenue from software development services and accordingly is comparable. 65. We have considered the rival submissions and relevant material on record. We find that in the normal circumstances the tolerance range of RPT should not be more than 15%. In the case of the assessee, the availability of the comparable is not an issue and therefore we do agree with the view taken by the coordinate Benches of the Tribunal that the threshold limit of tolerance range should not exceed 15% as far as RPT revenue is concerned. Therefore, we direct the AO/TPO to apply 15% RPT filter in respect of all the comparables." In view of the facts recorded by the D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idered as functionally comparable with the assessee. Further, this company also earns income from outsource product development. In the absence of any segmental data of this company, we do not find any error or illegality in the findings of the DRP that this company cannot be compared with the assessee and the same is directed to be excluded from the set of comparables." We further find from the Annual Report that there is no change in the activity and functions of these companies during the year under consideration in comparison to the Assessment Year 2010-11. Accordingly, following the decisions of the co-ordinate benches of this Tribunal (supra), we direct the A.O./TPO to exclude these two companies from the set of comparables." (vi) Sasken Communication Technology Limited : The company is engaged in software products and present inventory and intangible assets, with High expenditure on R & D and no segmental details are available, income from sale of products amounting to 9.4% of total revenue of software services include network services. We support our view based on the decision of the co-ordinate Bench of the Hon'ble Tribunal in the case of Applied Materials India Li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenditure and incurred significant expenditure in foreign currency to the extent of 21.26% of total sales with High turnover. We support our view relying on decision of the co-ordinate Bench of the Hon'ble Tribunal in the case of Applied Materials India Limited (supra) which has dealt on the issue at pages 37 to 39 para 20 which read as under : '20. We have heard the learned Departmental Representative as well as learned Authorised Representative and considered the relevant material on record. The DRP has rejected this company by discussing the fact at page 16 as under : Directed to exclude as per paragraph 2.7 of the order, further, on perusal of annual report, it is noticed by us from page 14 that software development and services consist of embedded product design, industrial design and visual computing labs which are not comparable to the software development services provided by the assessee and therefore, we direct the Assessing Officer to exclude the above company from the comparables. We further note that the DRP has also recorded the fact that export revenue of this company is 73.30% which is less than 75% applied by the TPO. Therefore this company does not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company as fit for comparability analysis for determining the arm's length price for the assessee, hence, should be excluded from the list of comparable parties." 33. No contrary view has been brought to our notice regarding comparability of this company with that of a pure software development service provider. Accordingly, in view of the decision of the Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. (supra), we do not find any reason to interfere with the finding of the DRP." In view of the facts recorded by the DRP as well as the decision of the Tribunal in the case of Electronics for Imaging India Pvt. Ltd. (supra), we do not find any error or illegality in the directions of the DRP to exclude this company from the set of comparables.' We considering the dissimilarities of the comparable companies which are functionally different from assessee's profile and rely on the judicial decisions and direct the following comparables to be excluded by the TPO from the final list of comparables selec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Transfer Pricing, we take into consideration the 'Net Working Capital'. Net Working Capital is calculated as follows Debtors + Inventory - Creditors = Net Working Capital. In Transfer Pricing, no other Current Assets and Liabilities are considered. By using these three items of Current Assets and Current Liabilities it is found out as to how much net working capital is being utilized in operating business. This Working Capital is calculated to find out as to how much is the cost of capital that must be recovered from the customers by increasing the sales price. The logic behind this exercise is that the firm would factor in the cost of capital in the sales price. Therefore, to find out the operating profit, the cost of capital factored in the operating price is excluded. The Arm's length price of the operating profit when we use TNMM as the most appropriate method is found out in the case of tested party by comparing it with the average operating profit margin of the uncontrolled comparables. As in the case of uncontrolled comparables also, there is cost of working capital involved, the operating profit is computed by excluding the cost of capital factored in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and therefore, the working capital is zero. Even if they are receiving lot of advances from the Holding company, the cost of working capital is zero because there are neither debtors nor inventory in their case. In such circumstances the issue that arises is as to whether we should find out the cost of working capital when there are neither debtors nor inventory. In Transfer Pricing, we reduce creditors from the total sum of debtors and inventory to find out the net working capital and cost thereof to recover the same by factoring it in the safes price. Therefore, in the absence of debtors as well as inventory, the creditors should not be taken into consideration as even if the creditors are there in the balance sheet, they are not being used for the operating revenues. For the academic discussion in a case where the taxpayer Is receiving lot of advances but no debtors or inventory, if the cost of capital is computed for the advances received from the Holding company, then It is quite likely that it may result into abnormal adjustment in the sales price of the taxpayer on a stand-alone basis that even if no operating profit is earned, the adjusted profit margin may become comparabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rking capital adjustment as in any business there is an optimum working capital that can be found out only on the basis of comparison with third parties as third parties alone represent the optimum working capital requirement. Accordingly the working capital adjustment is restricted to 1.63% The contention of the learned Authorised Representative that there is no clarity and the basis of rationality computing the Working Capital Adjustment and restricting it to 1.63%. The learned Authorised Representative supported his argument relying on the judicial decisions. We found that the similar issue was dealt by the co-ordinate Bench of Tribunal in the case of ARM Embedded Technologies (P.) Ltd. v. Dy. CIT [2015] 64 taxmann.com 445 (Bang. - Trib.) observed at paras 24 & 25 as under : 24. Now coming to the issue of working capital adjustment, findings of the TPO in this regard as it appears at para 3.7. reads as under: "3.7 Working Capital Adjustment: The working capital adjustment is computed as per the formula given in Annexure to the OECD Guidelines. 2009. In this case, the average PLR adopted by SBI, the largest scheduled bank, for short term working capital loans for the relev ..... X X X X Extracts X X X X X X X X Extracts X X X X
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