2023 (7) TMI 1406 - AT - Income Tax

TP Adjustment - notional interest computed by applying the SBI short term deposit rate - amounts outstanding have been settled by the AE on an on-going basis in the normal course of business having regard to economic and commercial factors - HELD THAT - We referred to decision of Special Bench of this Tribunal in case Instrumentation Corpn. Ltd. 2016 (7) TMI 760 - ITAT KOLKATA as held that outstanding sum of invoices is akin to loan advanced by assessee to foreign AE. hence it is an international transaction as per explanation to section 92 B of the Act. As argued working capital adjustment subsumes sundry creditors - In such situation computing interest on outstanding receivables and lones and advances to international transaction would amount to double taxation. We deem it appropriate to set aside the impugned order on this issue and remit the matter to the file of the Ld.AO/TPO for deciding it in conformity with the above referred judgment. We also direct the Ld.TPO that in the event the WCA subsumes the outstanding receivables no separate characterisation is to be made. However for those receivables that fall out of the WCA pertaining to year under consideration then the rate of interest to be charged must be LIBOR 300 basis points which is in accordance with the principles laid down in case of Cotton Naturals (I) Pvt. Ltd. 2015 (3) TMI 1031 - DELHI HIGH COURT by considering a credit of 90 days. Needless to say the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings. Comparable selection - inclusion of Rheal Software Ltd. and Evoke Technologies Pvt. Ltd. - HELD THAT - As the authorities have not disputed these comparables are functionally not similar it is directed that the objections of the assessee may be verified having regards to their annual reports and then to consider the claim for inclusion of these comparables in accordance with law. In the event the contentions of the assessee are found to be true the two comparables are directed for inclusion. Assessee is directed to file all the relevant documents in support of the claim. Needless to say that proper opportunity of being heard must be granted to assessee. Exclusion of 11 comparables on application of upper turnover filter - We note that the Ld.TPO erred in not applying a cap on upper limit on the turnover while selecting the companies comparable. In this regard we note that application of turnover filter is a relevant criterion in choosing comparable companies. The difference in the scale of operations has a direct impact on the profitability. The concept of economies of scale wherein an increase in the size and scale of the operations leads to a decrease in the long run average cost of each unit or each service project delivered. Therefore the per unit fixed cost of a small-scale company would be much higher than that of a medium/large size organisation. As relying on the case of Autodesk India Pvt Ltd. 2018 (7) TMI 1862 - ITAT BANGALORE we hold that the listed 11 companies whose turnover in the current year is more than Rs. 200 crores should be excluded from the list of comparable companies. Threesixty Logica Testing Services Pvt. Ltd. be excluded from the final list for lack of segmental information and functional dissimilarities with assessee. Elveego Circuits Pvt. Ltd. company is in the business of Chip and semiconductor design services where as the assessee before us is into basic SWD services of coding an documentation Testing and quality assurance software patches and maintenance. There is no similarity between the functions performed by the assessee vis- -vis that of this company. We therefore at the threshold reject this company being functionally not similar with that of the assessee. Great Software Laboratory Pvt. Ltd. company works in a different horizontal and this company has been retained by the Ld.TPO only because it renders services under the category SWD. It is also noted by the Ld.TPO that the operations of this comparable is from SWD segment without there being any segmental details which according to the Ld.TPO is irrelevant. In our considered opinion this Tribunal has been consistently rejecting the comparables whether there are no segmental information available in order to compare an apple with an apple . Therefore the services rendered by the assessee under a contract with its AE cannot be compared with a company that renders various services under SWD segment. We do not find any reason to include this comparable in the final list. Acewin Agriteck Ltd. (formerly known as OFS Technologies) fails the functionality test and this company OFS Technologies Ltd. is not functionally similar and deserves to be excluded. Appeal filed by assessee stands partly allowed

Summary

Issues Involved:
1. Notional interest on outstanding receivables.
2. Inclusion/exclusion of comparables.

Summary:

Issue 1: Notional Interest on Outstanding Receivables
The assessee contested the notional interest computed by applying the SBI short-term deposit rate, arguing that the outstanding receivables were settled in the normal course of business and should not be subject to transfer pricing adjustment. The Tribunal referred to the decision in Instrumentation Corpn. Ltd. v. Asstt. DIT, which held that outstanding invoices are akin to loans to foreign AEs and thus constitute an international transaction under Section 92B. The Tribunal directed the Assessing Officer (AO)/Transfer Pricing Officer (TPO) to re-examine the issue, considering whether working capital adjustment subsumes the outstanding receivables. If not, interest should be charged at LIBOR + 300 basis points, following the principles laid down in CIT vs. Cotton Naturals (I) Pvt. Ltd. The assessee was allowed a reasonable opportunity to present their case.

Issue 2: Inclusion/Exclusion of Comparables
The Tribunal addressed the inclusion and exclusion of various comparables:

Inclusion of Rheal Software Ltd. and Evoke Technologies Pvt. Ltd.
The Tribunal noted that the TPO rejected Rheal Software Ltd. based on persistent loss filter, which requires losses in three consecutive years. The Tribunal directed the AO/TPO to verify the assessee's claims and include the comparables if the contentions are found true.

Exclusion of Comparables Based on Turnover Filter
The Tribunal excluded 11 comparables (e.g., Tech Mahindra Ltd., Wipro Ltd.) due to their turnover exceeding Rs. 200 crores, following the principle that the scale of operations impacts profitability.

Exclusion of Threesixty Logica Testing Services Pvt. Ltd.
The Tribunal excluded this comparable due to its high Related Party Transactions (RPT) and functional dissimilarities, such as owning brand names and earning revenue from third-party software products without segmental data.

Exclusion of Elveego Circuits Pvt. Ltd.
The Tribunal excluded this company as it is engaged in chip and semiconductor design services, which are not similar to the software development services provided by the assessee.

Exclusion of Great Software Laboratory Pvt. Ltd.
The Tribunal excluded this company due to its diverse activities and lack of segmental information, which makes it incomparable to the assessee's contract services.

Exclusion of Acewin Agriteck Ltd. (formerly OFS Technologies)
The Tribunal excluded this company as it is engaged in diversified activities like outsourced product development and independent testing, which are not functionally similar to the assessee's software development services.

Conclusion:
The appeal was partly allowed, with directions for the AO/TPO to re-examine certain issues and comparables based on the Tribunal's guidelines. The Tribunal emphasized the need for proper functional analysis and adherence to relevant filters in the comparability study.