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TMI Blog2021 (1) TMI 775X X X X Extracts X X X X X X X X Extracts X X X X ..... ven by the CIT(A) for not allowing working capital adjustment are not the same reasons as was given in the case of Huawei Technologies India Pvt. Ltd. v. JCIT [ 2018 (10) TMI 1796 - ITAT BANGALORE] wherein Tribunal held that working capital adjustment has to be given. Deduction u/s 10A - Computation of deduction - HELD THAT:- Taking into consideration the decision rendered by the Hon ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd. [ 2011 (8) TMI 782 - KARNATAKA HIGH COURT] we are of the view that communication charges should be excluded both from export turnover and total turnover. We are of the view that as of today, law declared by the Hon ble High Court of Karnataka which is the jurisdictional High Court is binding on us. X X X X Extracts X X X X X X X X Extracts X X X X ..... ting Cost 10.54% 7. The assessee had chosen certain comparable companies whose average arithmetic profit margin was comparable with that of the assessee and hence the assessee claimed that the price received in the international transaction was at arm's length. 8. The Transfer Pricing Officer (TPO) to whom the question of determination of ALP was referred by the AO, did not accept the claim of assessee and he on his own identified 26 comparable companies and adopting the average arithmetic mean of those companies determined the ALP as follows:- S.No. Company Name Unadjusted Margins FY 2006-07 1 Accel Transmatics Ltd 21.11% 2 Avani Cimcon Technologies Ltd 52.59% 3 Celestial Labs Ltd 58.35% 4 E Zest Solutions Ltd 36.12% 5 Flextronics Software Systems Ltd 25.31% 6 Helios & Matheson Information Technology Ltd 36.63% 7 (gate Global Solutions Ltd 7.49% 8 Infosys Technologies Ltd 40.30% 9 Ishir Infotech Ltd 30.12% 10 KALS Information Systems Ltd 30.55% 11 Lucid Software Ltd 19.37% 12 Megasoft Ltd 60.23% 13 Mindtree Ltd 16.90% 14 Persistent Systems Ltd 24.52% 15 R Systems International Ltd 15.07% 16 Tat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .6.2019 for AY 2007-08. This was also a case of a company rendering software development services such as the assessee. The TPO in the aforesaid case had also selected the very same 26 comparable companies as was chosen by the TPO in the case of assessee in this appeal. The very same 13 comparable companies which the assessee seeks to exclude was considered by the Tribunal in the aforesaid decision and the Tribunal excluded 10 out of 13 comparable companies from the list of comparable companies with the following findings:- (i) Avani Cimcon Technologies Ltd. As far as this company is concerned, the Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. v. ACIT-ITA No. 7821/Mum/2011 accepted the assessee's contention that this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable to the assessee who was rendering software development services only. In view of the aforesaid decision, The Tribunal accepted the plea of the Assessee to reject this company as a comparable. (ii) Celestial Labs Ltd. As far as this company is concerned, the stand of the assessee is that i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wns significant intangible and has huge revenues from software products. It was also held that the break-up of revenue from software services and software products is not available. (vi) KALS Information Systems Ltd. As far as this company is concerned, the contention of the assessee is that the aforesaid company has revenues from both software development and software products. Besides the above, it was also pointed out that this company is engaged in providing training. It was also submitted that as per the annual report, the salary cost debited under the software development expenditure was ₹ 45,93,351. The same was less than 25% of the software services revenue and therefore the salary cost filter test fails in this case. Reference was made to the Pune Bench Tribunal's decision of the ITAT in the case of Bindview India Private Limited v. DCI, ITA No. ITA No 1386/PN/10 wherein KALS as comparable was rejected for AY 2006-07 on account of it being functionally different from software companies. Accepting the aforesaid contentions, the Tribunal held that this company was developing software products and not purely or mainly software development service provider and acce ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 86/Bang/2011 for A.Y. 07-08. 12. The aforesaid decision takes care of 10 comparable companies out of 13 comparable companies that are sought to be excluded in ground No. 9. The other companies which assessee seeks to exclude are Megasoft Ltd. which has been directed to be excluded by the Tribunal in Sonus Networks India Pvt. Ltd. (supra). Also the Tribunal directed segmental results of this company to be taken and hence the grievance of assessee in this regard is not accepted. 13. The next company the assessee seeks exclusion is Flextronics Systems Ltd. which has been directed to be excluded in the case of Sonus Networks India Pvt. Ltd. (supra) on the ground that there was a variation in the financial results as available in the public domain and as obtained by the TPO by issue of notice u/s. 133(6) of the Act. Hence we direct the exclusion of this company. 14. The other company which remains to be excluded is R Systems International Ltd. As far as this company is concerned, in the very same decision in the case of Sonus Networks India Pvt. Ltd. (supra), the comparability of this company was remanded to the TPO with a direction to cull out the financial results of this company i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not the same reasons as was given in the case of Huawei Technologies India Pvt. Ltd. v. JCIT [2019] 101 taxmann.com 313 (Bang. Trib.). In the aforesaid decision on an identical issue, the Tribunal held that working capital adjustment has to be given. The following are the relevant observations of the Tribunal:- "10. The next grievance projected by the Assessee in its appeal is with regard to the action of the CIT (A) in not allowing any adjustment towards working capital differences. On this issue we have heard the rival submissions. The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows: Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely;-- (a) to (b)** ** ** (e) transactional net margin method, by which,-- (i) the net profit margin realise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction]if-- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. 11. A reading of Rule 10B(1)(e)(iii) of the Rules read with Sec. 92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. 12. Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the "TPG") contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: • A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) • This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers-(less) the period granted to pay debts to suppliers." 14. Examples of how to work out adjustment on account of working capital adjustment is also given in the said guidelines. The guideline also expresses the difficulty in making working capital adjustment by concluding that the following factors have to be kept in mind (i) The point in time at which the Receivables, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ;s Length Price. The data available with the Assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing working capital adjustment, the Delhi Bench of ITAT in the case of ITO v. E Value Serve.com [2016] 75 taxmann.com 195 (Delhi-Trib.). has held that insisting on daily balances of working capital requirements to compute wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ally affect the amount of net profit margin in the open market. If for reasons given by CIT (A) working capital adjustment cannot be allowed to the profit margins, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 10B(3) of the Rules, which provides as follows: "(3) An uncontrolled transaction shall be comparable to an international transaction if-- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged to paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences." 18. In such a scenario there would remain no comparable uncontrolled transactions for the purpose of comparison. The transfer pricing exercise would therefore fail. Therefore in keeping with the OECD guidelines, endeavor should be made to bring in comparable companies for the purpose of broad comparison. Therefore the working capital adjustment as claimed ..... X X X X Extracts X X X X X X X X Extracts X X X X
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