2015 (10) TMI 484 - AT - Income Tax

Tribunal adjusts working capital, upholds forex gain, excludes comparables. Focus on Arm's Length Price

The Deputy Commissioner of Income Tax, Circle 12 (3), Bangalore Versus M/s. Software AG Bangalore Technologies Pvt. Ltd. and Vica-Versa

The Tribunal partly allowed both the assessee and Revenue's appeals. It directed the AO/TPO to re-examine the working capital adjustment and apply the ... Determination of arm’s length price (ALP) in respect of an international transaction entered into with its Associated Enterprise (AE) - accepting/rejecting certain comparables - Held that:- Bodhtree Consulting Ltd. and KALS Information Systems Ltd. should be excluded from the list of comparable companies for the purpose of determining the ALP. It is also relevant to point out that in the case of CISCO Systems India Pvt. Ltd. (2014 (11) TMI 849 - ITAT BANGALORE) the very same 11 companies had been chosen by the TPO as comparables, thereby making it clear that the assessee in the present case and CISCO Systems India Pvt. Ltd. have the same business profile. Working capital adjustment - Held that:- The assessee has taken a specific plea that the TPO has used incorrect value of receivables and payables for comparable companies. In Annexure-II to the submissions before the CIT(Appeals), the assessee has also given the details which are enclosed to this order. Perusal of the order of the CIT(Appeals) shows that none of these contentions have been considered by him. We are, therefore, of the view that the order of CIT(Appeals) on this issue should be set aside and the AO/TPO should be directed to examine the details and arrive at the correct working capital adjustment. We hold and direct accordingly. Treating foreign exchange gain or loss and provision for bad debts as non-operating in nature and fringe benefit tax as part of operating cost - Held that:- Exchange Fluctuation gains are required to be added to operating revenue. Following the same, the AO is directed to accept the claim of the Assessee in this regard. As far as provision for bad debts are concerned, the TPO has accepted that the same would be part of operating expenses provided the same is incurred every year for at least three years and the manner in which provision is made is consistent. The Assessee in reply to the query of the TPO on the above aspect has not furnished any details. We are of the view that the Assessee should be afforded opportunity to explain its position on the above and the AO is directed to consider the same in accordance with law. As far as Fringe Benefit Tax (FBT) is concerned, the same was not considered by the TPO as part of operating cost in the case of comparables and therefore the same should also not be considered as part of operating cost of the Assessee. We hold accordingly and direct the AO to compute the operating cost of the Assessee Working capital adjustment has to be allowed on the basis of requirements of working capital in the case of the assessee and the comparable companies. Just because if on a proper working of the working capital adjustment, it reflects a negative working capital adjustment, that cannot be the basis not to grant working capital adjustment. In other words, working capital adjustment has to be allowed based on the working capital requirements of the assessee and the comparable companies irrespective of the fact, whether such adjustment is negative or positive. To this extent, we are of the view that the observations of the CIT(Appeals) are incorrect. We have already directed the AO/TPO to work out the proper working capital adjustment. This ground of appeal is therefore treated as allowed for statistical purposes. Issues Involved:1. Determination of Arm's Length Price (ALP) in respect of international transactions.2. Acceptance/rejection of certain comparables based on comparability criteria.3. Computation of working capital adjustment.4. Inclusion of foreign exchange gain as part of operating revenue.5. Risk adjustment due to negative working capital adjustment.6. Treatment of expenses incurred in foreign currency towards telecommunication expenses and other expenses as part of total turnover and export turnover.Detailed Analysis:1. Determination of Arm's Length Price (ALP) in respect of international transactions:The assessee and the Revenue both challenged the determination of ALP by the CIT(A). The Tribunal considered the appeal of the assessee focusing on the application of the turnover filter for comparables. The Tribunal held that companies having turnover more than Rs. 200 crores should be excluded from the list of comparables as per the decision in the case of Trilogy e-business Software India Pvt. Ltd. Consequently, Tata Elxsi Ltd., Sasken Communication Technologies Ltd., Persistent Systems Ltd., Larsen & Toubro Infotech Ltd., and Infosys Ltd. were excluded from the list of comparables.2. Acceptance/rejection of certain comparables based on comparability criteria:The Tribunal considered the exclusion of Bodhtree Consulting Ltd. and KALS Information Systems Ltd. The Tribunal referred to the case of CISCO Systems India Pvt. Ltd., where it was held that these companies are not comparable to a pure software development service provider. Hence, Bodhtree Consulting Ltd. and KALS Information Systems Ltd. were excluded from the list of comparable companies.3. Computation of working capital adjustment:The assessee contended that the TPO used incorrect values for receivables and payables, resulting in a negative working capital adjustment. The Tribunal directed the AO/TPO to re-examine the details and arrive at the correct working capital adjustment, acknowledging the assessee's claim that it does not bear any working capital risk with regard to transactions with AEs.4. Inclusion of foreign exchange gain as part of operating revenue:The CIT(A) followed the decision in Trilogy e-business Software India Pvt. Ltd., holding that foreign exchange gain should be treated as part of operating revenue. The Tribunal upheld this view, stating that foreign exchange fluctuation gains are required to be added to operating revenue.5. Risk adjustment due to negative working capital adjustment:The CIT(A) ordered the TPO to work out and grant risk adjustment to the assessee, acknowledging that the working capital adjustment provided by the TPO had a negative impact on the adjusted margin. The Tribunal directed the AO/TPO to work out the proper working capital adjustment, irrespective of whether it is negative or positive.6. Treatment of expenses incurred in foreign currency towards telecommunication expenses and other expenses as part of total turnover and export turnover:The CIT(A) followed the decision of the Hon'ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd., holding that whatever is excluded from the export turnover should also be excluded from the total turnover. The Tribunal upheld this decision, dismissing the Revenue's appeal on this ground.Conclusion:Both the appeals by the assessee and the Revenue were partly allowed. The Tribunal directed the AO/TPO to re-examine the working capital adjustment and apply the turnover filter correctly. The Tribunal upheld the inclusion of foreign exchange gain as part of operating revenue and the exclusion of certain comparables based on the comparability criteria.