TMI Blog2021 (11) TMI 1150X X X X Extracts X X X X X X X X Extracts X X X X ..... to the grant of working capital adjustment should be directed to be examined by the TPO/AO afresh in the light of the decision of the tribunal referred to above, after affording the Assessee opportunity of being heard. Incorrect computation of margins of 2 companies viz., Kals Information Systems Pvt. Ltd., and CG Vak Software and Exports Ltd - DRP in coming to the above conclusion has rightly followed the decision of Sap Labs India Pvt.Ltd. [ 2010 (8) TMI 676 - ITAT, BANGALORE] wherein it has been held that foreign exchange fluctuation to the extent it relates to the business of the Assessee which is subject matter of the TP adjustment should be regarded as operating in nature. We find no grounds to take a different view and refuse to interfere with the order of the DRP. Not granting risk adjustment - We find that the DRP has primarily rejected the plea of the Assessee in this regard on the ground that quantification of risk adjustment has not been given and in the absence of such quantification, the plea cannot be accepted. Besides the above, the DRP has also placed reliance on judicial pronouncements holding that risk adjustment cannot be allowed in the absence of pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The assessee selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) for the purpose of comparison of the assessee s profit margin with that of the comparable companies. The OP/OC of the assessee was arrived at 16.31 % by the assessee in its TP study. The operating income was Rs. 93,02,61,671/- and the Operating Cost was Rs.79,98,02,919/-. The Operating profit (Operating income Operating cost was Rs.13,04,58,752/-. Thus, the OP/TC was arrived at 16.31 %. The assessee chose companies who are engaged in providing similar services such as the assessee. The assessee identified 7 companies whose average arithmetic mean of profit margin was 12.52% and was comparable with the Operating margin of the assessee. The assessee therefore claimed that the price it charged in the international transaction should be considered as at Arm s Length. 4. The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO, accepted TNMM as the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... SWD SEGMENT Particulars Formula Amount (in Rs.) Taxpayers Operating Revenue OR 93,02,61,671 Taxpayers Operating Cost OC 79,98,02,919 Taxpayers Operating Profit OP 13,04,58,752 Taxpayers PLI PLI=OP/OC 16.31% 35th Percentile Margin of comparable set 24.83% Adjustment Required (if PLI 35 th Percentile) Yes Median Margin of comparable set M 28.20% Arm's Length Price ALP=(1+M)*OC 1,02,53,47,342 Price Received OR 93,62,61,671 Shortfall being adjustment ALP-OR 9,50,85,671 21.4.2 The above shortfall of Rs.9,50,85,671/- is treated as Transfer Pricing adjustment u/ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thods, being the most appropriate method, in the following manner, namely : (a) to (d)...... ( e)transactional net margin method, by which, (i) the net profit margin realised by the enterprise from 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 subclause (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 ref ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... II of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the TPG ) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability 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. 11. As far as comparability of companies listed as (a) to (g) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... No.18 of 2015 dated 16.9.2015 wherein it was held that high turnover is a ground to exclude a company from the list of comparable companies in determining ALP, held that there were contrary views on the issue and hence the view favourable to the Assessee laid down in the case of Pentair Water (supra) should be adopted. The following were the conclusions of the Tribunal in the case of Dell International (supra): 41. We have given a very careful consideration to the rival submissions. ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, relying on Dun and Bradstreet s analysis, held grouping of companies having turnover of Rs. 1 crore to Rs.200 crores as comparable with each other was held to be proper. The following relevant observations were brought to our notice:- 9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sion held as that high turnover is a ground for excluding companies as not comparable with a company that has low turnover. The following were the relevant observations: 17.7. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon'ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon'ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criterion for choosing compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra). 14. In view of the aforesaid decision, we hold that companies listed in Sl.No.(a) to (g) in paragraph 7 (i) above, which the assessee seeks exclusion and whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of comparable companies. 15. We shall now deal with the remaining two companies listed as Sl. No. (h) and (i) in paragraph-7(i) of this order, which the assessee seeks exclusion from the list of comparable companies,viz., (a) Inteq Software Private Limited and (b) Infobeans Technologies Ltd. 16. As far as exclusion of Inteq Software Private Limited is concern ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2014-15 62,88,994 1,13,92,014 55.20% 2013-14 1,01,76,689 1,70,81,419 59.58% Therefore, the total value of assets derives substantial value from intangible assets is which is peculiar and unusual. We are of the view that by merely pointing out that there is a substantial increase in value of intangible assets, the assessee cannot seek to exclude this company from the list of comparable companies, unless the assessee is able to show that the presence of intangibles is owing to factors which can affect the functional comparability of this company with the assessee. 18. As far as the plea of the assessee for exclusion of Infobeans Technologies Ltd., is concerned, the first plea of the learned counsel for the assessee is that this company is functionally dissimilar to a SWD service provider and there are no segmental details available for varied activities carried out by this company. As far as AY 2016-17 is concerned, the DRP has observed that this company was in the business of rendering SWD services in para 2.4.21.3 of its order, which re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r (India) Pvt.Ltd. Vs. DCIT ITA TP No.198/Hyd/2021 for AY 2016-17 order dated 6.10.2021 wherein in paragraph 4.7 of the aforesaid order, the Tribunal remanded the question of comparability of the aforesaid company for fresh consideration to verify the plea of the Assessee regarding existence of diversified activities of this company. As far as the present appeal is concerned, the activities of the said company have already been verified by the TPO in the form of replies to notices u/s.133(6) of the Act. Therefore the aforesaid decision is not of any assistance to the plea of the Assessee. 20. The next ground that needs adjudication is with regard to the grievance of the assessee that no adjustment towards working capital has been allowed to the assessee. In this regard though the ground of appeal makes a reference to risk adjustment also, the point that was pressed for adjudication was only with regard to grant of working capital adjustment. On the issue of non granting of working capital adjustment, the DRP gave its decision by observing that (i) The Assessee has not demonstrated with any data or information as to the impact of working capital on the costs, price or profit. (ii ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing effect. 14. The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect. 15. A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. Therefore working capital adjustment has to be allowed. 23. We are therefore of the view that the issue with regard to the grant of working capital adjustment should be directed to be examined by the TPO/AO afresh in the light of the decision of the tribunal referred to above, after affording the Assessee opportunity of being heard. 24. The next issue that requires adjudication is the grievances of the assessee with regard to non-inclusion of 4 companies in the list of comparable companies viz., Sasken Communication Technologies Ltd., Sagarsoft (India) Ltd., Akshay Software Technologies Ltd. and Evoke Technologies Ltd., 25. As far as Sasken Communic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vt.Ltd. (2011) 44 SOT 156 (Trib.-Bang.) wherein it has been held that foreign exchange fluctuation to the extent it relates to the business of the Assessee which is subject matter of the TP adjustment should be regarded as operating in nature. We find no grounds to take a different view and refuse to interfere with the order of the DRP. 28. The last issue which was argued before us is with regard to not granting risk adjustment. The submissions made in this regard were that Rule 10B(3) of the IT Rules provides that an adjustment ought to be provided for any differences in the economic factors between the tested party and the comparables. A risk adjustment is one such adjustment which is to be applied in order to adjust for the differences between the risk undertaken by the tested party vis-a-vis the comparable companies. Being a low risk service provider, the Assessee is devoid of any significant risks relating to its business operations whereas the comparable companies operate under uncontrolled conditions bearing risks, as a result of which the companies earn a risk premium which is not earned by a contract service provider like the assessee. Therefore, the profits of a contra ..... 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