2016 (3) TMI 1256 - AT - Income Tax

Tribunal directs Transfer Pricing Officer to reconsider comparables list, stresses accuracy in transfer pricing analysis.

The Tribunal allowed the assessee's grounds regarding the exclusion of certain comparables and directed the Transfer Pricing Officer to rework the list ... Comparability in transfer pricing - functional dissimilarity as a test for exclusion of comparables - application of filters for selection of comparables (employee cost, product sales, RPT, onsite/export criteria) - arm's length principle under TNMM and use of PLI (Operating Profit to Operating Cost) - related party transaction threshold (RPT) as a comparability filter - working capital adjustment to comparable margins - remand for verification and re-computation of comparable marginsComparability in transfer pricing - functional dissimilarity as a test for exclusion of comparables - application of filters for selection of comparables (employee cost, product sales, RPT, onsite/export criteria) - Exclusion of identified comparable companies from the TPO's final list for being functionally dissimilar or otherwise non-comparable to the assessee's software development services segment - HELD THAT: - The Tribunal examined the comparability objections raised by the assessee and applied precedent from coordinate and Special Bench decisions addressing software development services. For each contested comparable the Tribunal accepted the assessee's contention of functional dissimilarity or other disqualifying circumstances (such as presence of product sales, significant R&D/IP/intangible ownership, inappropriate segmentation, consolidated financials, or failure of employee-cost/product-sales filters). Having reviewed the materials and earlier Tribunal authorities, the Bench directed exclusion of Accel Transmatic Ltd. (seg), Avani Cimcon Technologies Ltd, Celestial Labs Ltd, E Zest Solutions Ltd, Flextronics Software Systems Ltd (seg), Helios & Matheson Information Technology Ltd, Infosys Technologies Ltd, Ishir Infotech Ltd, KALS Information Systems Ltd (seg), Lucid Software Ltd, Persistent Systems Ltd, Sasken Communication Technologies Ltd (seg), Tata Elxsi Ltd (seg), Thirdware Solutions Ltd (seg) and Wipro Ltd (seg) from the set of comparables for the purpose of determining the arm's length margin under TNMM. The Tribunal relied on consistency with earlier findings that companies with product revenues, substantial intangibles/IP, discrepant segmental profiles, or where the mandatory filters were not satisfied, are not appropriate comparables for a pure software development services provider. [Paras 30, 34]Direct the AO/TPO to exclude the specified companies from the final list of comparables.Related party transaction threshold (RPT) as a comparability filter - remand for verification and re-computation of comparables - Remand of the question of exclusion of Geometric Ltd (seg) to the AO/TPO for fresh consideration on RPT grounds - HELD THAT: - Although the assessee raised an additional ground that Geometric Ltd (seg) should be excluded because its related party transactions exceeded a threshold argued from Tribunal practice, the Bench noted that the assessee had not raised this point before the lower authorities. The Tribunal observed that coordinate benches vary in the RPT thresholds applied and that the appropriate threshold may depend on availability of comparables. Given these circumstances, the Tribunal declined to make a final exclusionary finding and remitted the issue to the AO/TPO for fresh consideration in accordance with law. [Paras 31]Remit the question of Geometric Ltd (seg)'s exclusion back to the AO/TPO for reconsideration.TNMM and PLI (Operating Profit to Operating Cost) - segmentation of comparables and entity level versus segmental margins - remand for computation of correct comparable margin - Direction to recompute Megasoft Ltd's margin on a segmented (software services) basis and to rework the comparable set and margins accordingly - HELD THAT: - The Tribunal found Megasoft Ltd's entity level margin to be distorted by combining product and services segments. Following precedent, the Tribunal held that where segmental results are available and segments are materially different, the margin for the relevant software services segment must be used for comparability. Consequently, Megasoft was accepted as a comparable only after segmentation and recalculation of its PLI for the software services segment. The Bench directed the TPO/AO to compute the correct margin for Megasoft and to rework the list of comparables applying the working capital adjustment to the final set. [Paras 32, 33]Remit computation of Megasoft Ltd's correct segmented margin to the TPO/AO and direct reworking of the comparable set and working capital adjustment.Working capital adjustment to comparable margins - arm's length principle under TNMM and use of PLI - Direction to rework the list of comparables and apply the working capital adjustment to the margins of the final set of comparables - HELD THAT: - After excluding the directed comparables and after segmentation/recomputation where required, the Tribunal mandated that the AO/TPO rework the comparable list and apply the appropriate working capital adjustment to the arm's length margin derived from the remaining comparables, in accordance with the methodology applied by the TPO subject to the Tribunal's exclusions and segmentation directions. [Paras 33]AO/TPO to rework the final comparable set and apply working capital adjustment to derive the arm's length margin.Final Conclusion: Appeal partly allowed: the Tribunal accepted the assessee's objections to a substantial number of TPO comparables and directed exclusion of specified companies, remitted the Geometric (seg) issue to the AO/TPO for fresh consideration, directed recomputation/segmentation of Megasoft Ltd's margin and ordered the AO/TPO to rework the comparable set and apply the working capital adjustment; consequently the TP related addition is to be reworked in accordance with these directions. Issues Involved:1. Selection of comparables.2. Application of filters by the AO.3. Application of 25% criteria for RPTs.4. Exclusion of certain companies from the list of comparables.5. Segmentation of results for Megasoft Ltd.6. Reworking the list of comparables with working capital adjustment.Detailed Analysis:1. Selection of Comparables:The assessee, a wholly owned subsidiary of Novell Inc., USA, provided software development and support services. The Transfer Pricing Officer (TPO) rejected most of the 55 comparables selected by the assessee, retaining only 10. The TPO applied various filters and arrived at a list of 26 comparables with an average PLI of 25.14%.2. Application of Filters by the AO:The TPO applied filters such as non-comparability of results, export revenues being less than 75% of total revenue, RPT in excess of 25%, onsite revenue of more than 75% of export revenue, functional dissimilarity, employee cost being less than 25% of revenue, consistent losses, and diminishing revenues.3. Application of 25% Criteria for RPTs:The assessee contested the 25% threshold for RPTs, advocating for a 15% threshold based on the decision in 24/7 Customer.com Pvt Ltd v. DCIT. The TPO, however, maintained the 25% threshold citing statutory mandates.4. Exclusion of Certain Companies from the List of Comparables:The Tribunal accepted the assessee's plea to exclude several companies based on functional dissimilarity and other grounds. These included:- Accel Transmatic Ltd.: Excluded due to functional differences and significant related party transactions.- Avani Cimcon Technologies Ltd.: Excluded due to revenue from software products and abnormal profit margins.- Celestial Labs Ltd.: Excluded as it was primarily a research and development company.- E-Zest Solutions Ltd.: Excluded for being a knowledge process outsourcing (KPO) service provider.- Flextronics Software Systems Ltd. (Seg.): Excluded due to discrepancies between annual report and information obtained u/s 133(6).- Helios & Matheson Information Technology Ltd.: Excluded for being engaged in development and sale of software products.- Infosys Technologies Ltd.: Excluded due to significant intangibles, revenue from software products, and substantial R&D expenditure.- Ishir Infotech Ltd.: Excluded for outsourcing work and failing the employee cost filter.- KALS Information Systems Ltd.: Excluded due to engagement in both software development and software products.- Lucid Software Ltd.: Excluded for being involved in software product development.- Persistent Systems Ltd.: Excluded for being engaged in product development and product design services.- Sasken Communication Technologies Ltd. (Seg.): Excluded due to significant R&D expenditure and ownership of IPR.- Tata Elxsi Ltd. (Seg.): Excluded for being engaged in product design services.- Thirdware Solutions Ltd. (Seg.): Excluded due to involvement in product development and sale of licenses.- Wipro Ltd. (Seg.): Excluded for owning significant intangibles and using consolidated financial statements for comparability.5. Segmentation of Results for Megasoft Ltd.:The Tribunal directed the TPO to compute the correct margin for Megasoft Ltd. by considering only the software services segment, as the company was involved in both software development and software product segments.6. Reworking the List of Comparables with Working Capital Adjustment:The Tribunal directed the TPO to rework the list of comparables applying the working capital adjustment relatable to the final set of comparables remaining in the list.Conclusion:The Tribunal allowed the grounds raised by the assessee regarding the exclusion of certain comparables and directed the TPO to rework the list of comparables with appropriate adjustments. The appeal of the assessee was treated as partly allowed.