Transfer pricing: exclude functionally dissimilar comparables (developers vs maintenance providers); allow working capital adjustment after verification and statistical appeal consideration

ITAT, Bangalore (AT) held that companies functionally dissimilar to the assessee-engaged in software development versus merely providing maintenance services to related foreign entities-must be deselected from the comparable list. The tribunal directed the TPO to allow a working capital adjustment after verification of the assessee's computations and to permit the assessee's statistical-ground appeal to be considered for that purpose.

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Issues Involved:

1. Inclusion of certain comparable companies.
2. Exclusion of certain comparable companies.
3. Adjustment for differences in working capital.

Detailed Analysis:

1. Inclusion of Certain Comparable Companies:

i) Akshay Software Technologies Ltd.:
The company is functionally comparable as it primarily derives revenue from software-related services. The TPO did not apply the on-site development filter, and foreign branch expenses are not the same as on-site development of software. There is no difference in the business model adopted by the company and the assessee. The Tribunal restored this issue to the TPO for examination and verification.

ii) Sasken Communication Technologies Ltd.:
The company is functionally comparable as it engages in rendering software development services and software product development. The income from software products constitutes a meager 0.88% of total revenue, which would not impact the profitability of the software development services segment. The Tribunal restored this issue to the TPO for fresh consideration.

iii) I2T2 India Limited:
The company is functionally comparable and passes all the filters. The DRP erred in upholding the exclusion of the company without first notifying the assessee. The Tribunal directed the TPO to include this comparable in the final list for determination of ALP.

iv) Kireeti Soft Technologies Ltd.:
The company is functionally comparable as it passes the export turnover filter and operates in one segment, which is software and information technology services. The Tribunal directed the TPO to include this comparable in the final list for determination of ALP.

v) Exilant Technologies Pvt. Ltd. and Celstream Technologies Ltd.:
These companies are functionally comparable and pass all filters. The Tribunal restored these issues to the TPO for verification of financial statements and inclusion in the final list for determination of ALP.

vi) Maveric Systems Ltd.:
The company is functionally comparable as it engages in software testing, which is an integral part of software development. The DRP erred in upholding the exclusion of the company based on R&D expenses without applying a filter for the same. The Tribunal restored this issue to the TPO for a logical conclusion and findings.

vii) Sankya Infotech Ltd.:
The company is functionally comparable as it passes the export turnover filter, and revenue from products is merely 0.005% of service income, which cannot impact the profit margin. The Tribunal directed the TPO to include this comparable in the final list for determination of ALP.

2. Exclusion of Certain Comparable Companies:

i) Infosys Ltd.:
The company is not functionally comparable due to its diversified operations, significant brand value, substantial R&D activities, and lack of segmental data. The Tribunal directed the TPO to exclude Infosys Ltd. from the final list of comparables.

ii) L & T Infotech Ltd.:
The company is not functionally comparable due to its high brand value, proprietary business, and extraordinary events during the year. The Tribunal directed the TPO to exclude L & T Infotech Ltd. from the final list of comparables.

iii) Persistent Systems Ltd.:
The company is not functionally comparable due to its diverse business operations, IP-led business, and significant R&D activities. The Tribunal directed the TPO to exclude Persistent Systems Ltd. from the final list of comparables.

iv) Thirdware Solutions Ltd.:
The company is not functionally comparable due to its diverse activities, income from software development, subscription contracts, and lack of segmental details. The Tribunal directed the TPO to exclude Thirdware Solutions Ltd. from the final list of comparables.

3. Adjustment for Differences in Working Capital:

The Tribunal recognized the need for a working capital adjustment to account for differences in the working capital positions of the tested party and comparables. It directed the TPO to allow the working capital adjustment after verifying the assessee's computation and providing an opportunity for representation. The Tribunal also considered the need for a risk adjustment, directing the TPO to examine the computation of risk adjustment and afford the assessee an opportunity to be heard.

Conclusion:

The appeal was partly allowed for statistical purposes, with directions to the TPO to include or exclude specific comparables and to grant working capital and risk adjustments after verification and examination.

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