TMI Blog2019 (11) TMI 1411X X X X Extracts X X X X X X X X Extracts X X X X ..... Appellant. M. Vijay Kumar, Addl. CIT (DR) for the Respondent. ORDER Pavan Kumar Gadale, The assessee has filed an appeal against the Assessment order passed under Section 143(3) r.w.s. 254 of the Income-tax Act, 1961, dt.28.12.2018, in pursuance to the directions of Dispute Resolution Panel (DRP) order dt.17.12.2018. 2. The assessee has raised the following grounds of appeal : Sl. No Grounds of Appeal Tax effect (in INR) 1. Assessment and reference to Transfer Pricing Officer are bad in law and on facts 1,377,379 (a) The learned Deputy Commissioner of [neome-tax - Circle 4(1)(2) ('ld. AO )/learned Additional Commissioner of Income-tax - Range 2(1) ('Ld. TPO') erred in law and on facts in making an addition to the total income of the Appellant on account of adjustment to the arm's length price with respect to computer aided design ('CAD/CAM') services rendered by the Appellant to its associated enterprises. (b) The ld. AO/ld. TPO/Hon'ble Dispute Resolution ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions Limited, ICRA Techno Analytics Limited, Infosys Ltd, Larsen Toubro Infotech Limited, Persistent Systems Limited, Persistent Systems Solutions Limited, Sasken Communication Technologies and Tata Elxsi Limited as comparable to the captive software development services function rendered by the Appellant (e) The ld. AO/ld. TPO erred on facts in wrongly computing the margins of a certain companies (Larsen Toubro, Tata Elxsi, Persistent Systems and Solutions Limited) identified as comparable by the TPO and the ld. Panel also erred in confirming the same. (f) The ld. AO/ld. TPO erred on facts in arbitrarily accepting companies without considering the turnover and size of the Appellant and comparables and the ld. Panel also erred in confirming the same. (g) The ld. AO/ld. TPO erred on facts in arbitrarily accepting companies without considering the significant onsite revenue earned by comparables. The ld. Panel also erred in confirming the same. 3. Erroneous data used by the ld. TPO (a) The l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is engaged in the business of manufacturing of and trading in air intake systems and filters for automotive and heavy engineering industry and rendered services to its Associated Enterprises (AEs) in the nature of services using CAD and computer aided manufacturing software tools and filed the Return of Income for Assessment Year 2011-12 on 28.09.2011, with a total loss of ₹ 16,57,89,697. Subsequently, the assessee company filed Revised Return of Income with a total loss of ₹ 15,43,98,328. The case was selected for scrutiny and Notice under Section 143(2) and 142(1) of the Act were issued. In compliance, the ld. AR appeared from time to time and furnished the details. The Assessing Officer on perusal of the Audit Report, Form 3CEB found that the assessee has entered into international transactions exceeding ₹ 15 crore. Hence the matter was referred with the prior approval of CIT for determination of Arm's Length Price (ALP) to TPO. Whereas the TPO observed that the assessee had international transactions referred at para 4 of TPO order and the financial results with the Operating Profit/Operating Cost and Operating Profit/Operating Revenue are read as under : ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Foreign Exchange loss 3719199 Finance charges 2089329 Operating Cost 871982199 Operating Profit -197804163 OP/OC -22,68% OP/OR -29.34% The assessee's margin computed on OP/OC, is - 22.68%. The assesses is into Software Development Services segment and the TPO found that the Transfer Pricing Document contains 9 comparables on software development activities with applied filters and TNMM is considered as MAM further assessee has selected the comparables engaged in the same industry verticals i.e. Aero Space, Rail and Defence industries. The TPO has rejected the TP Study and applied the filters on usage of current year data, the companies of software development with Revenue less than ₹ 1 crore are excluded, companies with Software Development Services and related services is less than 75% of operating revenue were excluded an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erusal of relevant annual reports and examination of additional comparables suggested by the taxpayer on the touchstones of filters and functionality, the final set of comparables are arrived as per the discussions in the following paragraphs. Sl. No. Name Sales Cost PLI 1 Acropetal Technologies Ltd.(seg) 814,016,893 616,754,876 31.98% 2 E-zest solutions (from Capitaline) 112866098 93255341 21.03% 3 E-Infochips Ltd 260384251 166447527 56.44% 4 Evoke (from Capitaline) 144869912 133996568 8.11% 5 I C R A Techno Analytics Ltd. (in 000) 158401000 126894000 24.83% 6 Infosys Ltd 253850000000 177,030.000,000 43.39% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng adjustment u/s. 92CA in respect of software development segment of the taxpayer's international transactions The TPO made Adjustments on the provision of Software Development Services to the extent of ₹ 59,35,129 and passed order under Section 92CA r.w.s. 143(3) r.w.s. 144C dt.30.01.2015. Aggrieved by the draft assessment order, the assessee filed objections with DRP in Form 35A whereas the DRP has passed the order considering the objections of the assessee, the TP adjustment and TPO findings vide order dt.17.12.2015. Subsequently, the Assessing Officer passed final assessment order, dt.19.01.2016 with TP adjustment to the extent of ₹ 55,22,394. Aggrieved by the TPO order, the assessee has filed an appeal with the Tribunal in IT(TP)A No.586/Bang/2016, whereas the Tribunal remanded the matter to the file of DRP for fresh consideration by way of speaking and reasoned order vide order, dt.8.9.2017. The DRP after considering the directions of the Tribunal and the submissions of the assessee has passed order dt.17.12.2018, partly allowing the assessee's objections. The TPO in pursuance to the directions of the DRP passed the final assessment order under Section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his issue of comparability of E-Just Solution Ltd. to the record of the Assessing Officer/TPO for deciding the same after verification of the relevant facts as well as considering the objections of the assessee. (ii) Icra Techno Analytics Limited : This company is functionally different and significant RPT of 24.81% with margin of 24.83% and predominantly into Software Development Services and which is engaged in diversified activities and no segmental details are available and further concentrated in niche area of business intelligence and analytics space and has revenue from licensing activities. The ld. AR demonstrated Annual Report where the comparable company has significant growth in business intelligence and analytics space which are different from activities of the functional profile of the assessee and engaged in licensing activity. We found the said comparable was excluded by the co-ordinate Bench of the Tribunal in the case of Applied Materials India Limited (supra) at pages 32 33 paras 17.1 17.2 as under : '17.1 We have heard the learned D.R. as well as learned A.R. and considered the relevant material on record. The DRP has rejected this company by reco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fore us to show that the facts recorded by the DRP as well as by the co-ordinate bench of this Tribunal are not correct. Accordingly, in view of the decision of the co-ordinate bench of this Tribunal in the case of Electronics for Imaging India Pvt. Ltd. (supra), we do not find any error or illegality in the order of the DRP on this issue. (iii) Infosys Limited : The comparable company is functionally dissimilar as it is engaged in development of software products and has inventories, ownership and marketing intangibles and Intellectual Property Rights (IPR), with High brand value and incurred huge expenditure towards R D to the extent of ₹ 527 crore and has high turnover and more than 50% of revenue are from on site services. We found that the co-ordinate Bench in the case of Applied Materials India Limited (supra) has dealt on this issue at page 34 para 18 as under and excluded the comparable : '18. We have heard the learned D.R. as well as learned A.R. and considered the relevant material on record. At the outset, we note that the co-ordinate bench of this Tribunal in the case of Electronics for Imaging India Pvt. Ltd. (supra) has considered this issue in para ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that the company is mainly engaged in the business of software development. The Assessing Officer has considered entire revenue from 3 segments from the software development services. Out of the software development expenses of ₹ 1,488.30 crore debited in profit and loss account, salary to overseas staff is ₹ 1200.28 crore which also indicates that the company is predominantly engaged in development of software onsite. In view of the above differences, in our view the above company cannot be retained as comparable, the Assessing Officer is accordingly directed to exclude the above company from comparable. We further find that the comparability of this company has been considered by the co-ordinate bench of this Tribunal in the case of Electronics Imaging India (P.) Ltd. v. Dy. CIT [2017] 85 taxmann.com 124 (Bang. - Trib.) paras 62 to 65 as under : 62. The assessee has raised objection against this company on the basis of high turnover in comparison to the assessee. It was also contended that Related Party Transaction (RPT) of this company is 18.66%. The DRP rejected objections of the assessee on the ground that TPO has applied 25% filter of RPT and annual repor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8.8% of its total revenues related to activities of IPs and also engaged in Information Technological services and no segmental information available. We support our view relying on the decision of the co-ordinate Bench of the Hon'ble Tribunal in the case of Applied Materials India Limited (supra) has dealt on the issue at pages 20 21 para 9.2.4 which read as under : 9.2. (4) Persistent and Solutions Systems Ltd. 24. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. The assessee raised objections against selection of this company on the ground that this company is functionally not comparable as engaged in the product development. The segmental information for services and product is not available. Further, the assessee has also pointed out that there was an acquisition and restructuring during the year under consideration. 25. The DRP has noted the fact that this company has reported the entire receipt from sales and software services and product. Therefore, no segmental information was found to be available for sale of software services and product. Further, the DRP has noted that as per Note 1 of Schedule 15, this company i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation is available. Accordingly, the DRP directed the AO to exclude this company from the comparables. 28. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. The DRP has reproduced the break-up of revenue in the impugned order as under:- Amount in Rs. lakh Year ended March 31, 2010 Year ended March 31, 2019 Software Services 37,736.22 40,531.20 Software products 2,041.00 6,146.43 Other services 372.77 1,297.05 Total revenues 40,150.89 47,974.68 29. Thus, there is no dispute that this company earns revenue from 3 segments. However, the segmental operating margins are not available. Therefore, in the absence of segmental relevant data and particularly operating margins, this composite data cannot be considered as comparable with the assessee for software development services segment. Accordingly, we do not find any error or illegality in the findings of the DRP. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsidered the software development and services segment of this company as comparable to that of assessee, however, the assessee contended that even within the software segment, this company is engaged in diverse activities. The assessee placed reliance on the information in the annual report under the Directors Report and submitted before the DRP that even under the software development services segment, this company is engaged in various diversified activities including product design service, innovation design, engineering service, visual computing labs, etc. The assessee also placed reliance on the decision of Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. v. ACIT, 137 ITD 1 (Mum.). 31. The DRP found that this company is not functionally comparable with assessee company as it is engaged in diversified activities even in the software development services. The DRP has followed the decision of the Mumbai Bench of the Tribunal in the case of Telcordia Technologies Pvt. Ltd. (supra). 32. We have heard the ld. DR as well as ld. AR and considered the relevant material on record. We find that this company even in the software development segment is en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the TPO at 4.23% but was restricted to 1.63% without any basis. We found that the TPO has dealt on the Working Capital Adjustment in order at pages 241 to 243 para 10 and finally at page 243, the TPO has restricted the Working Capital Adjustment at 1.63% which read as under : 10. WORKING CAPITAL ADJUSTMENT: The working capital adjustment is computed as per the formula given in Annexure to the OECD Guidelines, 2009. In this case, the average PLR adopted by SBI, the largest scheduled bank, for short term working capital loans for the relevant FY 2010-11 is considered. The average PLR of 12.45% p.a was adopted by the TPO while computing the working capital adjustment. The detail working is annexed to this order as Annexure C. The working capital adjustment is restricted to the average working capital component of the comparables which 1.63%. Working capital is equal to the sum total of current assets appearing in the balance sheet of the firm. It is an important accounting concept that informs as to how liquid the firm is. Current Assets are divided by Current Liabilities to find out as to how capable the firm is to meet its current liabilities when they fall due by enca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unt of cost of capital recovered. Therefore, when the arithmetical average of net profit margins computed in the case of uncontrolled comparables is considered as arm's length profit margin in Transfer Pricing that arise from operating business, then the average cost of capita! computed in the case of uncontrolled comparables should also be considered as arm's length price of the cost of capital in Transfer Pricing exercise. Accordingly, the average cost of capital computed in the case of the uncontrolled comparables should be an upper cap for the purpose of allowing working capital adjustment. It implies that the uncontrolled comparables have earned a profit margin on operating activities using a certain amount of working capital that has average cost of capital calculated in their case. To have further discussion in this regard, it is considered necessary to understand as to how the cost of working capital is computed. The working capital is computed as per definition by adding up all the Current Assets but in Transfer pricing, we take only the debtors and inventories as they are considered to be items of working capital relating to the operating business that have a c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (-)8% 2% Adjusted profit margin 2-{-8)=10% 8-2%=6% Thus, the profit margin which was nearly 2% of the tested party before working capital adjustment has increased to 10% as against profit margin of 8% in the case of the uncontrolled comparables reduced to 6% after the working capital adjustment Accordingly, it should be accepted because adjusted profit margin is better than that of the uncontrolled comparables. In this manner, because of finding out working capital adjustment even on negative working capital the operating profit of the taxpayer maybe accepted wrongly. Therefore, in a particular kind of business even the arm's length price of working capital can be found out by computing the same in the case of uncontrolled comparables by finding the average mean of the cost of net working capital. Therefore, in the case of Wholly Owned Subsidiaries (WOS) receiving huge advances the right approach would be to reduce the average mean of cost of capital of the comparables from their average profit margins and in the case of the tested party, reducing the cost of capital on the net working capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing capital adjustment is restricted to the average cost of capital computed at 1.71% in the case of the uncontrolled comparables selected by the TPO. Hence, the working capital adjustment in the case of the taxpayer is allowed as per the calculation in anncxure-C or the average cost of capital to the comparables whichever is the least. The detailed discussion on this is given in the Annexure-D to the order. The computation of the working capital adjustment is annexed to this order as Annexure C. TPO had restricted the cost of capital to 1.71%. Rationality for such an upper limit being placed on working capital adjustment was an issue which had come up before this Tribunal in the case of Rambus Chip Technologies (India) (P.) Ltd. v. Dy. CIT [IT (TP) A. 23/Ban/2015, dt. 22.07.2015. Coordinate bench had held as under at paras 13 and 14 of its order: 13. As regards ground No. 3(f). learned counsel for the assessee submitted that the AO/TPO while considering the working capital adjustment, has arrived at the working capital adjustment in the case of the assessee at 5.97%, but while giving effect to the working capital adjustment, has restricted the said adjustment to 1.71% in c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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