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TMI Blog2021 (12) TMI 1421X X X X Extracts X X X X X X X X Extracts X X X X ..... not allow proper adjustment towards Risk Adjustment, Capacity utilization adjustment and working capital adjustment - We find that identical reasons assigned by the TPO for not allowing working capital adjustment was a subject matter of consideration by this Tribunal in the case of Barracuda Networks India Private Limited [ 2022 (5) TMI 322 - ITAT BANGALORE ] and this Tribunal following the decision in case of Huawei Technologies India Pvt. Ltd. [ 2018 (10) TMI 1796 - ITAT BANGALORE ] held that working capital adjustment has to be allowed to the assessee and directed the TPO/AO to examine the claim of the assessee in the light of the details of working capital adjustment furnished by the assessee which is given as annexure to this order. Grant of risk adjustment - Though the assessee has given a general note with regard to assessee s right to claim risk adjustment while computing ALP, no specific details have been given with regard to allowing risk adjustment. In this scenario, we are of the view that it would be just and appropriate to remand the issue to AO/TPO with a direction to the assessee to furnish computation of risk adjustment and the basis of claim for deduction on acco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evant provisions of law and in accordance with the guidelines laid down above. Selecting foreign AE as a tested party was an appropriate method of determining ALP and the Revenue authorities were not justified in rejecting the plea of the assessee - The facts of the Assessee s case is similar to the case decided by the Hon ble Madras High Court Virtusa Consulting Services Pvt. Ltd [ 2021 (2) TMI 378 - MADRAS HIGH COURT ] in as much as the Assessee had in its Transfer Pricing Study chosen the foreign AE as a tested party and the TPO refused to examine the said claim. The decision of the Hon ble Madras High Court being the only decision available on the issue of a High Court, judicial discipline requires us to follow the same in preference to the decisions of Tribunal to the contrary. Following the aforesaid decision of the Hon ble Madras High Court, we remand the issue with regard to foreign AE being chosen as a tested party to the TPO for fresh consideration. The relevant ground of appeal of the assessee in this regard is treated as allowed for statistical purposes. X X X X Extracts X X X X X X X X Extracts X X X X ..... r Quartile 5 3.60% ATMECS US - Segmental data for the period April 2015 to March 2016 Particulars Off-shore business On-site business Others Total Remarks Consulting Income 54,95,070 - 93,86,612 Note 1 Rental Income 3,361 3,361 Other -9,104 -9,104 Difference is a due to credit memos % of segment revenue on total revenue 58.54% 41.46% Operating Income 54,95,070 38,91,542 -5.743 93,80,869 Cost of Sales 36,08,444.90 - - 36,08,445 Note 2 Onsite Expenses - Payroll for employees working onsite and vendor payments onsite 20,75,030 - 20,75,030 Note 3 Other Operating costs 16,94,298 13,53,551 - 30,47,849 Business Tax - - 1,071 1,071 Federal taxes Operating Expenses 53,02,743 34,28,581 1,071 87,32,395 Operating profit 1,92,327 4,62,961 -6,814 6,48,474 OP/OR 3.50% 11.90% 1. The sales break-up is taken from the sales summary provided. 2. Amount of sales invoiced by ATMECS India for the offshore work as confirmed by their Sales Report 3. Vendor payments - $638,672, Payroll towards employees working only onsite - $1238726.66 for April 2015 to Dec 2015, $197,631.15 for Jan to Mar 2016 The Off-Shore business segment of the Atme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 'a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase... of tangible.. property..... The, methodology for computation of arm's length price of an international transaction has been set out in section 92C(1) of the Act to be as per any of the prescribed methods, including the TNMM method. He referred to the provisions of Rule 10B of the Rules, dealing with the determination of arm's length price under section 92C which provides through sub-rule (1) that for the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method. The mechanism for determining ALP under the TNMM method has been enshrined in clause ( e) of rule 10B (1) which reads as under : (i) the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rofit A). which is then compared with the adjusted rate of profit of comparable cases (say, profit B) so as to ascertain if profit A' is at arm's length vis-à-vis profit B' If it is not, then, an addition on account of transfer pricing adjustment, subject to other provisions, is made in the hands of the assessee having regard to the difference between the rates of profit A and profit B. The rate of profit of comparable cases (profit 8) may be computed from internally or externally comparable cases, depending upon the FAR analysis and the facts and circumstances of each case. Thus, the calculation of profit B' may undergo change with the varying set of comparable cases. However, insofar as calculation of profit A' is concerned, the same has to necessarily result in the hands of the assessee-enterprise (Indian entity) only from the transaction between two or more associated enterprises, as it is the mandate of section 92 read with section 92B in juxtaposition to rule 10B. The natural corollary which, ergo, follows is that under no situation can the calculation of profit' A be submitted with anything other than the profit realized by the assessee-enterpr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... then all the above factors in relation to the comparables in uncontrolled transactions can be judged. However. in case the foreign AE is taken as tested party the above factors being entirely different cannot be judged into. Based on the above discussion, the taxpayer has been considered as tested party. The TPO accordingly rejected the selection of foreign AE as tested party and considered the taxpayer as a tested party for benchmarking the international transactions. The TPO also held that in view of section 92C(3)(c), it is relevant to hold that the data used in computation of the arm's length price is not reliable or correct. The TPO thereafter proceeded to determine arm's length price by conducting an independent search for comparables considering the functions of the taxpayer, the assets employed and the risks taken and the results of the search is given in the following paras. 7. The Transfer Pricing Officer (TPO) thereafter proceeded to determine the determine the ALP of the international transaction by adopting TNMM as the MAM and also used the same PLI for comparison i.e., OP/OC. He selected comparable companies from Indian database. The TPO identified as compara ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iculars Formula Amount (in Rs.Lacs) Taxpayers operating revenue OR 236484177 Taxpayers operating cost OC 230252330 Taxpayers operating profit OP 6338492 Taxpayers PLI PLI=OP/OC 2.75% 35th Percentile Margin of comparable set 20.87 Adjustment Required (if PLI< 35th Percentile) Median Margin of comparable set M 25.64 Arm's Length Price ALP=(1+M)x 0C 28,92,89,028 Price Received OR 23,64,84,177 Shortfall being adjustment ALP-OR 5,28,04,851 24.2 The above shortfall of Rs.5,28,04,8511- is treated as transfer pricing adjustment u/s 92CA in respect of software development segment of the taxpayer's international transactions." 10. Thus, a sum of Rs.5,28,04,851/- was added to the total income of the assessee on account of determination of ALP for provision of SWD services by the assessee to its AE. 11. The assessee filed objections before the Disputes Resolution Panel (DRP) against the draft assessment order passed by the AO wherein the addition suggested by the TPO as adjustment consequent to determination of ALP was added to the total income of the assessee by the AO. The DRP gave certain directions. Based on the directions of the DRP, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the above grounds, the Ld TPO, while including the Companies as comparables has erred in computations of the margins and has considered wrong margins of the companies in the final list of comparables. 12. The Ld AO erred in levying interest u/s 234B and 234C of the Act against legally untenable adjustments. 13. Any other ground that may be urged at the time of hearing with the prior approval of the Hon'ble Tribunal. 12. At the time of hearing, the learned Counsel for the assessee did not press for adjudication of Grd.No.2. Grd.No.1 is general and calls for no particular adjudication. Grd.No.12 is purely consequential and Grd.No.13 is general and does not call for any specific adjudication. 13. Grd.No. 10 is with regard to specific choice of comparable companies. The learned counsel restricted his arguments to adjudication of exclusion of only the following 8 companies, viz., (a) Infosys Ltd. (b) Larsen & Toubro Infotech Ltd (c) Persistent Systems Ltd (d) Aspire Systems (India) Pvt Ltd (e) Thirdware Solution Ltd. (f) Cybage Software Pvt Ltd. (g) Nihilent Ltd. (h) Tata Elxsi Ltd. (i) R.S. Software (India) Ltd. In Grds.6, 7, 9 and 11, the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction]; (f)...... (2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... companies is more than Rs.200 Crores and the assessee's turnover is only Rs.23,64,84,177/-. The TPO excluded from the list of comparable companies chosen by the assessee in its TP study companies whose turnover was less than Rs.1 Crore. The contention of the assessee before the DRP was that while the TPO excluded companies with low turnover, he failed to apply the same yardstick to exclude companies with high turnover compared to the assessee. The reason for excluding companies with low turnover was that such companies do not reflect the industry trend as their low cost to sales ratio made their results less reliable. The contention of the assessee was that there would be effect on profitability wherever there is high or low turnover and therefore companies with high turnover should also be excluded from the list of comparable companies. The DRP primarily relied on the decision rendered by the Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors India Pvt. Ltd Vs. DCIT 82 Taxmann.com 167(Del), wherein it was held that high turnover ipso facto does not lead to the conclusion that a company which is otherwise comparable on FAR analysis can be excluded and that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon'ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee. 17.8. In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 15%. Following the said decision, we direct exclusion of R.S.Software (India) Ltd. from the list of comparable companies. 22. We shall now deal with Grd.No.8 with regard to the grievance of the assessee that in determining the ALP, the TPO did not allow proper adjustment towards Risk Adjustment, Capacity utilization adjustment and working capital adjustment. the remaining issues. The reasons assigned by the DRP for not accepting the aforesaid adjustment pleaded by the assessee is that the data for working out the working capital requirements is not reliable. In this regard, we find that identical reasons assigned by the TPO for not allowing working capital adjustment was a subject matter of consideration by this Tribunal in the case of Barracuda Networks India Private Limited Vs. DCIT in IT(TP)A No.229/Bang/2021 and this Tribunal following the decision of the ITAT Bengaluru Bench in the case of Huawei Technologies India Pvt. Ltd., Vs. JCIT (2019) 101 taxmann.com 313 held that working capital adjustment has to be allowed to the assessee and directed the TPO/AO to examine the claim of the assessee in the light of the details of working capital adjustment furnished by the assessee w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n adjustment. Rule 10B(3) of the Rules specifically states that an uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if 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 transaction in the open market. He submitted that `Difference' between tested party and comparables are significant when tested party is a newly established entity and the differences are likely to materially affect the profit from such transactions in the open market. Thus, a transfer pricing analysis 'done without accounting for capacity utilization adjustment would not bring out the correct result. He therefore submitted that in determining the arm's length price for the international transaction entered into by the assessee, the difference for the risks borne, capacity utilized by the assessee vis-à-vis the comparable companies needs to be factored into. Reference was made by him to the following decisions in support of the contention that adjustme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oner, order dated 17.09.2018, laid down some principles with regard to grant of capacity utilization. The Tribunal held on the question whether adjustment can be made to the margins of the tested party on account of capacity under utilization, the Indian transfer pricing regulations, OECD Guidelines and the US transfer pricing regulations call for an adjustment to be made in case of material differences in the transactions or the enterprises being compared so as to arrive at a more reliable arm's length price/ margin. While the Indian transfer pricing regulations refer to the adjustments on uncontrolled transactions, however the same has to be read with Rule10B(3) of the Rules which clearly emphasizes the necessity and compulsion of undertaking adjustments. Hence in case appropriate adjustments cannot be made to the uncontrolled transaction, due to lack of data, then in order to read the provisions of transfer pricing regulations in harmony, the adjustments should be made on the tested party. On the question of the data and method of computation of under utilization capacity adjustment, the tribunal held that the claim depends on acceptability of such adjustments being concerte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion is required to be determined using any of the prescribed methods, being the most appropriate method, having regard to the nature of transaction or class of transaction. However, in order to determine the most appropriate method for determining the arm's length price, it is first necessary to select the 'tested party'. Although the Indian regulations do not lay down any specific procedure or guidelines for the choice of the tested party; however, the OECD Transfer Pricing Guidelines 2017, UN Practical Manual on Transfer Pricing for developing countries 2013 ("UN TP Manual") and the US regulations have provided some guidance for selecting the tested party. He drew our attention to the relevant extracts of OECD Guidelines, have been provided below for your Honour's reference and UN TP Manual: (i) Para 3.18 of the OECD Guidelines, which states the following: 3.18 When applying a cost plus, resale price or transactional net margin method as described in Chapter II, it is necessary to choose the party to the transaction for which a financial indicator (mark-up on costs, gross margin, or net profit indicator) is tested. The choice of the tested party shou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arty' i.e., the party to the international transaction whose functions are simpler to evaluate, which does not own valuable non routine intangible assets and does not undertake substantial business risks. • Reliable information about the 'tested party' must be easily and readily available and should be capable of being verified independently. • Reliable information about the 'comparable companies' must be easily and readily available and should be capable of being verified independently. • The available information on 'tested party' and 'comparable companies' shall be sufficient to carry out reliable adjustments for material differences, if any. 29. He submitted that the assessee in the present case satisfies all the parameters and was right in law to have chosen foreign AE ATMECS US as a tested party in its Transfer Pricing Analysis. • ATMECS US is engaged in provision of software development support and other services. The operations of ATMECS US are divided into two segments i.e., onsite and offshore. While onsite services are being handled by ATMECS US, ATMECS India is responsible for the management of the off-sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... S India establish its business in the US region. It merely acts as a distributor/ marketer for the offshore services delivered and does not have any valuable, unique contribution in relation to the transaction. • As evident from the functional profile, most of the functions in the entire supply chain of the services are rendered by ATMECS India with respect to the offshore business. Accordingly, ATMECS India also bears majority of the risks associated with the business such as market risk, underutilization of resource risk, rework risk, service liability risk, etc. • The contracts entered by ATMECS US with the thirdparty customers also provide that ATMECS India will perform all tasks and duties assigned by the Customer Stakeholder and shall be managed by the "Contractor Manager - Project Management" on a day-to-day basis. Hence, once a contract is signed, ATMECS US shall have no further role to play in delivery of the project. 30. The learned counsel for the Assessee submitted that the term 'Enterprise' and 'associated enterprise' under TNMM and all other methods, in absence of any specific legal provision, restrictive interpretation of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as held that where the functions and risks of the assessee are more complex in nature and numerous adjustments would have to be made, the foreign AEs should be considered as tested party as has been considered by the assessee in the TP study. Reference was made to the decision of the Hon'ble Madras High Court in the case of Virtusa Consulting Services (P.) Ltd. v. DCIT [2021] 124 taxmann.com 309 (Madras) where it was held that where assessee considered its AEs to be tested party to determine ALP of its international transactions and also submitted relevant evidences and documents to establish functional profile and risks assumed by its AEs and the TPO rejected same and undertook a fresh search for external comparables, the TPO himself had not attached any sanctity to TP documentation as submitted by assessee, he could not foreclose assessee from canvassing issue that subsidiaries were least complex entities which should be taken note of and matter was remanded back to TPO. 32. The learned DR while relying on the decision of the Hon'ble Pune Tribunal in the case of Eaton Industrial Systems Pvt. Ltd., Vs. DCIT (2020) 113 taxmann.com 267 (Pune Tribunal) submitted that the ratio l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssociated Enterprise as defined in section 92A of the Act, it is evidently clear that the statute does not indicate that 'Enterprise' shall mean the assessee and the 'Associated Enterprise' will mean the other party. As pointed out earlier, the words 'Enterprise' and 'Associated Enterprise' have been used interchangeably. Therefore, the conclusion of the Tribunal in this regard is not sustainable. 26. The Tribunal was largely guided by the decision in Aurionpro Solutions Ltd.. The learned senior counsel for the assessee has referred to various decisions of the Tribunal which were rendered subsequently, more particularly, the decision of the Ahemdabad Tribunal in the case of General Motors India (P.) Ltd., which had taken note of the decision of the Mumbai Tribunal in Aurionpro Solutions'. Ltd. and noted the facts of the said case and held that the said decision cannot be applied as the main issue in Aurionpro Solutions Limited was the percentage of interest to be calculated on the loan advanced by the assessee to its AE. Thus, on facts the decision in Aurionpro Solutions Ltd. could not have been applied to the facts of the assessee's case ..... X X X X Extracts X X X X X X X X Extracts X X X X
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