2020 (9) TMI 1324 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - We find that the assessee is into providing Software Development Services thus companies functionally dissimilar with that of assessee need to be deselected. Since the Ld.Counsel for the assessee has submitted that by exclusion of above 5 companies Tata Elxsi Ltd (Seg), Mindtree Ltd., R S Software (India) Ltd. Larsen Turbo Infotech Ltd. and CG-VAK Software Exports Ltd. the average margin of the remaining comparables would be within ( ) or (-) 3% of assessee s margin we do not see any reason to adjudicate this ground as it would only be an academic exercise at this stage. Grant of working capital adjustment - Assessee has placed reliance upon the decisions of Hyndai Motor India Engineering P Ltd. 2019 (8) TMI 1465 - ITAT HYDERABAD and BA Continuum India P Ltd. 2016 (12) TMI 1583 - ITAT HYDERABAD - However since we find that the average margin of the comparables without Working Capital Adjustment itself is within 3% of the margin of the assessee we do not see any reason to adjudicate this issue also as it would only result in an academic exercise at this stage.

Summary

The core legal questions considered in this appeal pertain to the determination of the arm's length price (ALP) for international transactions under the transfer pricing provisions of the Income Tax Act, 1961. Specifically, the Tribunal examined:

1. Whether the Transfer Pricing Officer (TPO) and Assessing Officer (AO) erred in rejecting the assessee's transfer pricing study and in selecting comparable companies for benchmarking the ALP.

2. The correctness of the comparability analysis, including the selection and exclusion of certain companies as comparables based on functional, asset, and risk profiles.

3. The validity of the adjustments made by the TPO and AO, including the rejection of working capital adjustments.

4. The applicability of precedents and the proper application of transfer pricing principles under sections 92CA and 144C of the Income Tax Act.

Issue-wise Detailed Analysis

1. Rejection of Assessee's Transfer Pricing Study and Selection of Comparables

The legal framework governing this issue is rooted in the transfer pricing provisions of the Income Tax Act, particularly sections 92CA and 144C, which empower the TPO to determine the ALP of international transactions and the Dispute Resolution Panel (DRP) to resolve transfer pricing disputes. The arm's length principle requires benchmarking the taxpayer's international transactions against comparable uncontrolled transactions.

The AO referred the ALP determination to the TPO, who rejected the assessee's transfer pricing study based on the reported operating profit (OP) margin of 18.67% vis-`a-vis the assessee's claimed 13.63%. The TPO conducted a fresh search, selecting 12 companies as comparables and arriving at an OP margin of 34.32%. The DRP later excluded three companies, finalizing a set of 10 comparables and an adjustment of Rs. 13.54 crores.

The assessee challenged the rejection of its study and the selection of comparables, contending that the TPO erred in substituting the assessee's study and applying single-year data not available at the time of the study. However, the assessee did not press grounds relating to the rejection of the study and use of multiple-year data during hearing.

The Tribunal observed that the TPO's role includes verifying the appropriateness of comparables and that the assessee's study was not sacrosanct. The rejection was based on material differences in margins and functional profiles. The Tribunal, however, examined the comparability of the selected companies in detail.

2. Comparability Analysis: Inclusion and Exclusion of Companies

The Tribunal undertook a detailed functional and risk profile analysis of the companies included and excluded by the TPO and DRP. The assessee sought exclusion of five companies-Infosys Ltd., Persistent Systems Ltd., E-Infochips Ltd., Infobeans Technologies Ltd., and Thirdware Solutions Ltd.-arguing that these were functionally dissimilar and relied on a coordinate bench decision involving a similarly situated company engaged in software development services.

The Tribunal agreed with the assessee, relying on the precedent to exclude these companies for the following reasons:

• E-Infochips Ltd. was engaged in product manufacturing and R&D activities, unlike the assessee, which provided captive software development services without product manufacturing or R&D expenditures.
• Thirdware Solutions Ltd. generated revenue primarily from product sales and licenses rather than software development services, and had intangible assets not comparable to the assessee's profile.
• Infobeans Technologies Ltd. was involved in sale of goods and had tax deposits indicating a different business model, making it functionally dissimilar.
• Infosys Ltd. underwent extraordinary acquisitions and mergers, had a turnover vastly exceeding that of the assessee, incurred significant R&D expenses, and held intellectual property rights, all factors rendering it non-comparable.
• Persistent Systems Ltd. operated in product development, platforms, and services with significant R&D and lacked segmental data, making it functionally different from the assessee.

The Tribunal thus excluded these companies from the comparable set.

Regarding inclusion, the assessee pressed only for the inclusion of Sagar Soft (India) Ltd., arguing that the TPO wrongly excluded it on the basis of loss-making status without considering subsequent profitable years. The Tribunal declined to adjudicate this point, noting that the exclusion or inclusion would not materially affect the margin analysis as the margin of remaining comparables was within +/-3% of the assessee's margin, rendering further adjudication academic.

3. Working Capital Adjustment

The assessee sought a working capital adjustment, citing precedents from coordinate benches. However, the Tribunal found that since the margin of the comparables without the working capital adjustment was already within the permissible range of the assessee's margin, adjudicating this issue would be an academic exercise and declined to grant the adjustment.

4. Application of Law to Facts and Treatment of Competing Arguments

The Tribunal applied the arm's length principle by critically examining the functional and risk profiles of the comparables vis-`a-vis the assessee. It emphasized the need for comparability in business activities, asset base, and risk exposure. The Tribunal gave due weight to the coordinate bench decisions, which had considered similar facts and companies for the same assessment year.

The assessee's arguments on rejection of its transfer pricing study and selection criteria were partially accepted insofar as the exclusion of functionally dissimilar companies was concerned. However, the Tribunal did not find merit in further grounds not pressed at hearing or those that would not affect the outcome materially.

Significant Holdings

"Since the relevant AY is also 2014-15, the facts and circumstances under which those companies have been held to be not comparable to M/s. Kony India Private Limited are also the same, the said decision is also applicable to the case before us."

"Considering the nature of activities carried out by M/s. E-infochips Limited discussed hereinabove and since the assessee company is primarily engaged in custom-built mobile platform, applications and software support and maintenance related services to M/s. Kony Group of Companies, we are of the view that M/s. E-infochips Limited cannot be considered as a comparable company because of the reasons stated hereinabove."

"Considering the above-mentioned factors, we are of the considered view that M/s. Infosys Limited is not a comparable company with respect to the assessee company for TP Adjustments."

"Thus, the final list of comparable companies after excluding functionally dissimilar companies would be as follows..." (listing the remaining comparable companies and their operating profit margins).

"Since, the assessee had declared profit margin on cost @ 21.45% which is above the Arm's Length price of 20.31% as per the second proviso to section 92C(2) of the Act, we are of the considered view that TP Adjustment is not required in the case of the assessee towards assessee's international transaction with respect to software development services."

The Tribunal established the principle that comparability for transfer pricing must be based on a detailed functional and risk analysis, and that companies engaged in materially different business activities or having significant differences in asset base and risk profile cannot be treated as comparables.

It further held that where the declared margin of the assessee falls within the arm's length range derived from appropriate comparables, no transfer pricing adjustment is warranted.

Finally, the Tribunal declined to entertain grounds not pressed or those that would not affect the outcome, emphasizing judicial economy.

In conclusion, the Tribunal partly allowed the appeal by excluding certain companies from the comparable set, resulting in the assessee's declared margin being within the permissible arm's length range, thereby negating the need for transfer pricing adjustment for the international transaction of software development services for the assessment year 2014-15.