2025 (4) TMI 979 - AT - Income Tax

TP Adjustment - Comparability analysis of the companies sought for inclusion/exclusion by the assessee - HELD THAT - Cybage Software Pvt.Ltd Nihilent Ltd. and Techwava Infotech Pvt.Ltd be rejected as functionally dissimilar with that of assessee. Notional interest computed by the Ld.AO/TPO on outstanding receivables - TPO treated the outstanding receivables from AE as advancement of loan and computed the arm s length interest adopting 6-month LIBOR plus 400 basis points - as submitted TPO did not consider the outstanding payables which were less that 20 days in respect of some AE s - HELD THAT - No doubt there should be TP adjustment on this count after making proper TP study by the Ld.TPO by considering the period of credit enjoyed by the comparables and also applicable LIBOR rate in the place of AE s for benchmarking the rate of interest to arrive at the ALP. As per the RBI Master Circular no. 8/2010-11 dated 1-7-2010 for average maturity period upto 3 years the maximum cost ceiling is LIBOR plus 200 basis points. In view of the above 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 CIT v. Cotton Naturals (I) (P.) Ltd 2015 (3) TMI 1031 - DELHI HIGH COURT considering a credit of 90 days.

Summary

Issues Presented and Considered

The core legal questions addressed by the Tribunal in this appeal revolve around transfer pricing adjustments made by the Assessing Officer (AO) and Transfer Pricing Officer (TPO) relating to international transactions between the assessee and its associated enterprises (AEs). The principal issues are:

1. Whether the addition of INR 6,45,17,464 made on account of provision of software development support and related services and interest on overdue receivables is justified under transfer pricing provisions.

2. Whether the selection and rejection of comparable companies by the AO/TPO for benchmarking the arm's length price (ALP) of software development and related services transactions were appropriate and in accordance with the legal framework.

3. Whether the imputation of notional interest on outstanding receivables from AEs, treating such receivables as international transactions akin to loans, and charging interest at LIBOR plus 400 basis points is legally sustainable.

4. Whether procedural irregularities, including non-provision of copies of 'Giving Effect Order' and failure to adhere to directions of the Dispute Resolution Panel (DRP), render the assessment order void or liable to be quashed.

Issue-wise Detailed Analysis

Issue 1: Legality and correctness of transfer pricing adjustments on provision of software development and related services

Legal framework and precedents: The transfer pricing provisions under sections 92 to 92F of the Income Tax Act, 1961, read with Rule 10D of the Income-tax Rules, 1962, govern the determination of ALP in international transactions. The TNMM (Transactional Net Margin Method) is an accepted method for benchmarking. Precedents emphasize the need for functional comparability and appropriate selection of comparable companies.

Court's interpretation and reasoning: The Tribunal undertook a detailed functional analysis of the assessee's activities and risks assumed. It characterized the assessee as a limited risk service provider engaged in offshore software development and support services, bearing limited manpower and service liability risks, with no ownership of non-routine intangibles. The AEs, in contrast, assumed significant market, product liability, credit, technology, foreign exchange, and other risks.

The Tribunal examined the comparability of companies selected by the AO/TPO and the assessee. It found that certain companies (Cybage Software Pvt. Ltd. and Nihilent Ltd.) accepted by the AO/TPO were not functionally comparable, as they undertook significant R&D, had large turnovers, and provided diversified services including IT consulting and advanced analytics, unlike the limited risk profile of the assessee. The Tribunal relied on a prior coordinate bench decision excluding these companies on similar facts.

Regarding Techwave Infotech Pvt. Ltd., the Tribunal noted it was primarily engaged in business process outsourcing and management services, with significant related party transactions, rendering it functionally non-comparable.

Conversely, Maveric Systems Ltd., rejected by the AO/TPO on turnover filter grounds, was found by the Tribunal to satisfy the turnover criteria upon reassessment and was remitted for verification and potential inclusion as a comparable.

Key evidence and findings: The Tribunal relied on the functional and risk analysis, turnover data, and prior judicial precedents to assess comparability. It also considered the contemporaneous data maintained by the assessee and submissions on the functional profile of comparables.

Application of law to facts and treatment of competing arguments: The Tribunal upheld the principle that comparability must be grounded in functional similarity, risk profile, and asset ownership. It rejected the AO/TPO's arbitrary turnover filter and acceptance of functionally dissimilar companies. The Tribunal gave weight to the assessee's submissions and prior rulings, directing exclusion of certain comparables and remanding inclusion of Maveric Systems Ltd. for fresh consideration.

Conclusions: Grounds 2.1 to 2.6 were allowed in part, directing the AO/TPO to exclude non-comparable companies and reconsider inclusion of Maveric Systems Ltd., thereby reducing the transfer pricing adjustment on software development services.

Issue 2: Procedural compliance and validity of assessment order

Legal framework: Sections 144B and 144C of the Income Tax Act prescribe procedures for transfer pricing assessments, including the requirement to provide copies of 'Giving Effect Orders' and adherence to DRP directions.

Court's reasoning: The assessee contended that failure to provide the 'Giving Effect Order' and non-compliance with DRP directions rendered the assessment void. However, the Tribunal did not find sufficient grounds to quash the assessment on procedural lapses alone, given that the substantive issues were addressed and the assessee was given opportunities to raise objections before the DRP and the Tribunal.

Conclusion: Procedural objections were not upheld to the extent of invalidating the assessment order, but the Tribunal ensured the assessee's rights to be heard in remand proceedings.

Issue 3: Imputation of notional interest on outstanding receivables from associated enterprises

Legal framework and precedents: Section 92B defines international transactions, including loans and advances between associated enterprises. The Explanation to section 92B clarifies that outstanding invoices may be treated as loans for transfer pricing purposes. The Hon'ble Kolkata Special Bench decision in Instrumentation Corpn. Ltd. v. Asstt. DIT held that outstanding invoices constitute international transactions and that interest imputation using LIBOR plus a margin is appropriate.

Court's interpretation and reasoning: The Tribunal acknowledged that outstanding receivables from AEs may be treated as loans, attracting interest imputation. However, it emphasized the need for a proper transfer pricing study considering the actual credit period enjoyed, the working capital adjustment (WCA), and the applicable LIBOR rate relevant to the AE's country.

The Tribunal referred to RBI Master Circular No. 8/2010-11, which prescribes maximum cost ceilings over LIBOR depending on the average maturity period of loans, with a ceiling of LIBOR plus 200 basis points for loans up to three years.

The Tribunal also cited the Delhi Tribunal and Delhi High Court decisions which mandate a case-by-case inquiry into the nature and impact of receivables, including their effect on working capital, before imputing interest. It held that if the WCA subsumes the outstanding receivables, no separate interest adjustment is warranted. For receivables outside the WCA, interest should be benchmarked at LIBOR plus 300 basis points, considering a credit period of 90 days.

Key evidence and findings: The assessee's debt-free status and net payable position were noted, indicating no actual borrowing cost. The AO/TPO's imputation of interest without applying transfer pricing methods or considering working capital impact was found improper.

Application of law to facts and treatment of competing arguments: The Tribunal balanced the legal principle that outstanding receivables can be international transactions with the practical need to assess actual credit terms and financial impact. It remitted the issue for fresh determination in conformity with judicial precedents and regulatory guidelines, ensuring the assessee's right to be heard.

Conclusions: Grounds 3.1 to 3.6 were partly allowed; the interest adjustment was set aside and remanded for fresh consideration with appropriate benchmarking and working capital analysis.

Significant Holdings

"Varian India performs all the normal functions in relation to software development and related services; Varian India does not own any non-routine intangibles; and Varian AEs face market risk, credit risk, product, service liability and contract risk, technology risk and manpower risk for their business."

"Cybage Software Private Limited is not functionally comparable since it is a technology consulting company specializing in outsourced product engineering services."

"Nihilent Ltd. is not functionally comparable since it is engaged in rendering diversified services including software services, business consulting in the area of enterprise transformation, change and performance management and providing related IT services."

"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 92B of the Act."

"There has to be a proper inquiry by the TPO by analysing the statistics over a period of time to discern a pattern which would indicate that vis-`a-vis the receivables for the supplies made to an AE, the arrangement reflected an international transaction intended to benefit the AE in some way."

"If the working capital adjustment subsumes the outstanding receivables, no separate characterization is to be made. However, for those receivables that fall out of the WCA pertaining to the year under consideration, the rate of interest to be charged must be LIBOR + 300 basis points."

The Tribunal's final determination allowed the appeal partly by excluding non-comparable companies from the benchmarking set, remitting inclusion of Maveric Systems Ltd. for verification, and setting aside the interest adjustment on outstanding receivables for fresh consideration with proper benchmarking and working capital analysis. The appeal filed electronically was allowed in part, while the manually filed appeal was dismissed as infructuous.