2016 (9) TMI 1363 - AT - Income Tax

TPA - comparable selection criteria - Held that - Assessee was engaged in the business of providing high end IT enabled services to its Associated Enterprise. The company was registered with Software technology Park of the Government of India. The assessee conducted research activities and provided knowledge management services to its associated enterprise thus companies functionally dissimilar with that of assessee need to be rejected from final list of comparable. Misc. income and misc. expenses treated as operating profits - Held that - CIT(A) has observed in regard to misc. income that the same pertained to income from other sources and the misc. income was included as part of operating profit in the case of comparable company. Therefore there could not be any prejudice to revenue on this count. As regards misc. expenses ld. CIT(A) has observed that the same included a multitude of expenses that were too small in value. But since they pertained to the operations of the company they were treated as operating expenses for both the tested party as well as the comparable companies. The TP analysis as we have earlier observed is not an exact science and we have to arrive at reasonable conclusions which would not materially affect the profit margins. Therefore we do not find any reason to interfere with the finding of ld. CIT(A) Considering finance charges for computation of operating profits - Held that - We find that ld. CIT(A) has observed that finance charges were in the nature of bank charges which pertained to the business operations of a company. He further referred to this observation in regard to working capital adjustment wherein he had held that the interest on loans taken by both the comparables as well as the assessee should be treated as part of operating expense. These findings have not at all been controverted. Therefore we do not find any reason to interfere with the finding of ld. CIT(A).

Summary

Issues Involved:
1. Selection of comparables for benchmarking international transactions.
2. Application of upper sales filter.
3. Working capital adjustment.
4. Computation of operating profit margins.
5. Classification of the assessee as a Knowledge Process Outsourcing (KPO) or Business Process Outsourcing (BPO).
6. Treatment of stock adjustments, miscellaneous income, and finance charges in operating profit calculations.
7. Admission of additional grounds by the department.

Detailed Analysis:

1. Selection of Comparables for Benchmarking International Transactions:
The assessee initially selected seven comparables for benchmarking its international transactions using the Transactional Net Margin Method (TNMM). The Transfer Pricing Officer (TPO) increased the upper sales filter to Rs. 150 crores, resulting in the selection of nine comparables. The TPO rejected two comparables due to different year endings and included two additional comparables. The CIT(A) upheld the upper sales filter but rejected four comparables selected by the TPO, leading to a final selection of five comparables.

2. Application of Upper Sales Filter:
The TPO applied an upper sales filter of Rs. 150 crores, which was upheld by the CIT(A). This application was crucial in determining the comparables for benchmarking the international transactions.

3. Working Capital Adjustment:
The TPO rejected the working capital adjustment claimed by the assessee, citing inadequate demonstration of the need for extra working capital. The CIT(A) allowed the working capital adjustment only for interest on loans taken by both the comparables and the assessee. The ITAT disagreed with the CIT(A)'s reasoning that working capital adjustment could not be computed based on year-end figures, emphasizing that opening and closing working capital data is sufficient for such adjustments.

4. Computation of Operating Profit Margins:
The CIT(A) recomputed the operating profit margins, treating stock adjustments as operating expenses and including miscellaneous income and expenses as part of operating profits. The ITAT upheld the CIT(A)'s approach, emphasizing the need for consistency in treating stock adjustments and the reasonable inclusion of miscellaneous items in operating profits.

5. Classification of the Assessee as KPO or BPO:
The TPO classified the assessee as a KPO, citing its high-end service activities. The CIT(A) and the ITAT considered the functional profile of the assessee, noting that it primarily provided IT-enabled services rather than software development. The ITAT upheld the CIT(A)'s rejection of Tech Mahindra (R&D) as a comparable, as it was engaged in software development services, which differed from the assessee's IT-enabled services.

6. Treatment of Stock Adjustments, Miscellaneous Income, and Finance Charges:
The CIT(A) treated stock adjustments as operating expenses and included miscellaneous income and expenses in operating profits. The ITAT agreed with this treatment, emphasizing the need for consistency and reasonable adjustments in the TP analysis. The CIT(A) also included finance charges as operating expenses, which the ITAT upheld.

7. Admission of Additional Grounds by the Department:
The department raised an additional ground regarding the working capital adjustment, which the ITAT admitted. The ITAT found that the issue had been considered by the TPO and the CIT(A), and all facts were on record, making the additional ground admissible for substantial justice.

Conclusion:
The ITAT upheld the CIT(A)'s order, dismissing the department's appeal and the assessee's cross-objection. The ITAT emphasized the need for consistency in the selection and treatment of comparables, reasonable adjustments in TP analysis, and proper classification of the assessee's services. The final decision maintained the arm's length nature of the assessee's international transactions.