TMI Blog2021 (1) TMI 775X X X X Extracts X X X X X X X X Extracts X X X X ..... Technologies India Pvt. Ltd. v. JCIT [ 2018 (10) TMI 1796 - ITAT BANGALORE] wherein Tribunal held that working capital adjustment has to be given. Deduction u/s 10A - Computation of deduction - HELD THAT:- Taking into consideration the decision rendered by the Hon'ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd. [ 2011 (8) TMI 782 - KARNATAKA HIGH COURT] we are of the view that communication charges should be excluded both from export turnover and total turnover. We are of the view that as of today, law declared by the Hon'ble High Court of Karnataka which is the jurisdictional High Court is binding on us. - ITA No. 2029/Bang/2017 and IT (TP) A No.2142/Bang/2017 - - - Dated:- 4-1-2021 - N.V. Vasudevan, Vice President And Chandra Poojari, Member (A) For the Appellant : K.R. Vasudevan, Advocate For the Respondents : Priyadarshi Mishra, JCIT (DR)(ITAT) ORDER N.V. Vasudevan, Vice President ITA No. 2029/Bang/2017 is an appeal by the assessee, while ITA No. 2142/Bang/2017 is an appeal by the revenue. Both these appeals are directed against the order dated 18.8.2017 of the CIT (Appeals)-IV, Bangalore relating to assessment ye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Less: Operating Expenses 24,45,93,369 Operating Profit 2,57,92,510 Return on Operating Cost 10.54% 7. The assessee had chosen certain comparable companies whose average arithmetic profit margin was comparable with that of the assessee and hence the assessee claimed that the price received in the international transaction was at arm's length. 8. The Transfer Pricing Officer (TPO) to whom the question of determination of ALP was referred by the AO, did not accept the claim of assessee and he on his own identified 26 comparable companies and adopting the average arithmetic mean of those companies determined the ALP as follows:- S.No. Company Name Unadjusted Margins FY 2006-07 1 Accel Transmatics Ltd 21.11% 2 Avani Cimcon Technologies Ltd 52.59% 3 Celestial Labs Ltd 58.35% 4 E ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Less: Working Capital Adjustment 0.50% Adjusted Arithmetic mean PLI 24.64% Arm's Length Price Particulars Amount INR Operating cost 24,45,93,369 Arm's Length Margin 24.64% of t the operating cost Arm's Length Price (ALP) @ 124.64% of operating cost 30,48,61,175 Price Received vis-a-vis the Arm's Length Price Particulars Amount INR Arm's Length Price @ 124.64% of operating cost 30,48,61,175 Price received 27 03 85 879 Shortfall being adjustment u/s 92CA 3,44,75,296 9. The addition suggested by the TPO was incorporated in the draft assessment order of the AO. The assessee did not file any objections before the Dispute Resolution Panel (DRP) against the draft assessment order and therefore the final assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eptance of this company as a comparable for the reason that it is into pure software development activities and is not engaged in R D activities is bad in law. Further reference was also made to the decision of the Mumbai Bench of the Tribunal in the case of Teva Pharma Private Ltd. v. Addl. CIT-ITA No. 6623/Mum/2011 (for AY 2007-08) in which the comparability of this company for clinical trial research segment was considered. It was therefore submitted that this company is not a pure software service provider such as the Assessee. The Tribunal accepted the plea of the Assessee and held that this company ought not to have been considered as comparable to a SWD service provider such as the Assessee. (iii) E-Zest Solutions Ltd. The Tribunal held in the decision cited that the TPO has included this company in the list of comparbales only on the basis of the statement made by the company in its reply to the notice under section 133(6) of the Act without examining whether the services rendered by the company to give a finding whether the services performed by this company are similar to the software development services performed by the assessee. From the details on record, the tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le. (vii) Persistent Systems Ltd. The assessee objected to the inclusion of this company as a comparable for the reasons that this company being engaged in software product designing and analytic services, it is functionally different and further that segmental results are not available. The Tribunal found that from the details on record that this company i.e. Persistent Systems Ltd., is engaged in product development and product design services while the assessee is a software development services provider and that the segmental details are not given separately. Therefore, following the principle enunciated in the decision of the Mumbai Tribunal in the case of Telecordia Technologies India Pvt. Ltd. (supra) that in the absence of segmental details/information a company cannot be taken into account for comparability analysis, the Tribunal held that this company i.e. Persistent Systems Ltd. ought to be omitted from the set of comparables for the year under consideration. (viii) Wipro Limited As far as this company is concerned, the Tribunal held that this company is engaged both in software development and product development services. There is no information on the segm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 007-08 and thereafter compare the segmental profit margin of this company from SWD services segment. 15. The TPO is directed to compute the ALP as per the directions contained in this order regarding exclusion of comparable companies. 16. As far as grounds 4 5 raised by the revenue is concerned, the grievance is that the CIT(A) ought not to have directed computation of margins of this company on a segmental basis. As far as this objection is concerned, we find that the CIT(A) while giving the aforesaid direction has taken note of the fact that the financials in public domain did not reflect the segmental details. The AO obtained segmental details by issue of notice u/s. 133(6) of the Act. The CIT(A) directed that only segmental profit margins relatable to software development services segment should be taken for the purpose of comparison. The plea of revenue is that the profit margin at the entity level should be taken, which in our view, cannot be accepted. In the TNMM, what is to be compared is only the transaction and margin from the transaction. The transaction for which the ALP is sought to be determined is rendering of software development services and therefore the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an international transaction [or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm's length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that: None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called comparability adjustments. 13. In Paragraphs 13 to 16 of the aforesaid OECD guidelines, need for working capital adjustment has been explained as follows: 13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ceivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these figures, (ii) the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The guidelines conclude by observing that the purpose of working capital adjustments is to improve the reliability of the comparables. 15. In the present case the TPO allowed working capital adjustment accepting the calculation given by the Assessee. The CIT (A) in exercise of his powers of enhancement held that no adjustment should be made to the profit margins on account of working capital differences between the tested party and the comparable companies for the following reasons: (i) The daily working capital levels of the tested party and the comparables was the only reliable basis of determining adjustment to be made on account of working capital because that would be on the basis of wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l requirements to compute working capital adjustment is not proper as it will be impossible to carry out such exercise and that working capital adjustment has to be based on the opening and closing working capital deployed. The Bench has also observed that that in Transfer Pricing Analysis there is always an element of estimation because it is not an exact science. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. Therefore there is little merit in CIT (A)'s objection on working adjustment based on unavailable daily working capital requirements data. There is also no merit in the objection of the CIT (A) regarding absence of segmental details available of working capital requirements of comparable companies chosen and absence of details of trade and non-trade debtors of comparable companies as these details are beyond the power of the Assessee to obtain, unless these details are available in public domain. Regarding absence of cost of working capital funds, the OECD guidelines clearly advocates adopting rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing capital adjustment as claimed by the Assessee should be allowed. We hold and direct accordingly. 19. The aforesaid decision clearly lays down the proposition that working capital adjustment is to be given effect to while determining ALP while adopting TNMM method. Respectfully following the said decision, we allow Ground No. 11 of the assessee. 20. The other issue that remains for consideration in the revenue's appeal is grounds 2 3 of the revenue's appeal which reads as follows:- 2. The ld. CIT(A) erred in holding the ratio laid down by the Hon'ble High Court in the case of M/s. Tata Elxsi Ltd. (ITA No. 70/2009). 3. The ld. CIT(A) erred in holding that the expenses reduced from the Export Turnover must also be reduced from the Total Turnover since there is no provision under Sec. 10A for exclusion of such expenses from Total Turnover. 21. We have considered the rival submissions. Taking into consideration the decision rendered by the Hon'ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd. [2012] 349 ITR 98 (Karn), we are of the view that communication charges should be excluded both from export turnover and total turnover. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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