2021 (9) TMI 1448 - AT - Income Tax

TP Adjustment - Comparable selection - HELD THAT - Companies functionally dissimilar with that of assessee into business of software development technical services and other related services need to deselected as comparable. Working capital adjustment - 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. Chapters I and III of OECD Transfer Pricing Guidelines contain guidelines on comparability analyses for transfer pricing purposes. Guidelines on adjustments to be provided is found in paragraphs 3.47-3.54 and in the Annex to Chapter III. The guidelines must be followed for computing arm s length principle and for comparing comparable uncontrolled transactions. Reasonably accurate adjustments should be made to eliminate effect of any such differences. Accordingly we direct Ld. AO/TPO to grant working capital adjustment in accordance with law.

Summary

Issues Involved:
1. Transfer Pricing Adjustment
2. Rejection of TP Study
3. Erroneous Computation of Operating Profit Margins
4. Use of Multiple Year Data
5. Use of Different FY Ending
6. Employee Cost Filter
7. Export Sales Filter
8. Companies Sought for Exclusion
9. Companies Sought for Inclusion
10. Information Gathered Under Section 133(6)
11. Not Granting Working Capital Adjustment and Risk Adjustment
12. Not Providing Economic Adjustment for High Foreign Exchange Fluctuations
13. Other TP Related Grounds
14. Other Matters (Interest and Penalty)

Detailed Analysis:

1. Transfer Pricing Adjustment:
The appellant contested the transfer pricing adjustment of INR 1,65,84,24,000 made by the AO/TPO, arguing that the international transactions with its AEs were at arm's length. The Tribunal found that the AO/TPO had erred in rejecting the TP study and making adjustments without adequate justification.

2. Rejection of TP Study:
The Tribunal noted that the AO/TPO had rejected the TP study prepared by the appellant, stating that the data used was "not reliable or correct." The Tribunal found this rejection to be erroneous and emphasized the need for proper consideration of the TP documentation.

3. Erroneous Computation of Operating Profit Margins:
The appellant argued that the AO/TPO had incorrectly treated 'Miscellaneous income' and 'Provision written back' as non-operating without adequate reasons. The Tribunal directed the AO/TPO to reconsider these items as operating in nature.

4. Use of Multiple Year Data:
The Tribunal observed that the AO/TPO had erred in rejecting the use of previous two years of data, despite Rule 10B(4) allowing such data. The Tribunal directed the AO/TPO to consider the contemporaneous data available at the time of the TP study.

5. Use of Different FY Ending:
The Tribunal found that the AO/TPO had erred in rejecting companies with different FY endings, which limited the set of comparable companies. The Tribunal directed the AO/TPO to reconsider these companies.

6. Employee Cost Filter:
The Tribunal noted that the AO/TPO had erred in rejecting comparable companies with an employee cost to sales ratio of less than 25%. The Tribunal directed the AO/TPO to reconsider this filter.

7. Export Sales Filter:
The Tribunal found that the AO/TPO had erred in applying a threshold limit of 75% for export sales. The Tribunal directed the AO/TPO to reconsider this threshold.

8. Companies Sought for Exclusion:
The appellant sought the exclusion of Infosys Ltd., Larsen & Toubro Infotech Ltd., Persistent Systems Ltd., and Thirdware Solutions Ltd. The Tribunal directed the exclusion of Infosys Ltd. and Persistent Systems Ltd., remanded Larsen & Toubro Infotech Ltd. for further verification, and upheld the inclusion of Thirdware Solutions Ltd.

9. Companies Sought for Inclusion:
The appellant sought the inclusion of I2T2 India Ltd. The Tribunal remanded this comparable back to the AO/TPO for verification of its functional analysis and comparability.

10. Information Gathered Under Section 133(6):
The Tribunal found that the AO/TPO had erred in relying on information not available in the public domain and misinterpreting OECD guidelines. The Tribunal directed the AO/TPO to reconsider the use of such information.

11. Not Granting Working Capital Adjustment and Risk Adjustment:
The Tribunal directed the AO/TPO to grant working capital adjustment in accordance with law, emphasizing that adjustments should be made to account for differences that could affect profitability.

12. Not Providing Economic Adjustment for High Foreign Exchange Fluctuations:
The Tribunal found that the AO/TPO had erred in not carrying out economic adjustments for foreign currency fluctuations. The Tribunal directed the AO/TPO to reconsider this adjustment.

13. Other TP Related Grounds:
The Tribunal noted various errors in the AO/TPO's observations and findings, directing them to reconsider the determination of ALP as required under section 92C of the Act.

14. Other Matters (Interest and Penalty):
The Tribunal noted that the AO had erred in computing interest under section 234B and initiating penalty proceedings under section 271(1)(c). The Tribunal directed the AO to reconsider these matters.

Conclusion:
The Tribunal partly allowed the appeal, directing the AO/TPO to reconsider various aspects of the TP adjustment, inclusion/exclusion of comparables, and granting of appropriate adjustments in accordance with law. The Tribunal emphasized the need for proper consideration of the appellant's submissions and relevant guidelines.