2022 (11) TMI 1338 - AT - Income Tax

Tribunal Directs Reconsideration of Transfer Pricing Adjustments, Upholds ESOP Expenditure Deductibility.

The Tribunal partially allowed the appeal for statistical purposes, directing the AO/TPO to reconsider specific transfer pricing adjustments. It mandated ... Transfer Pricing - Arm's Length Price - comparability adjustment - working capital adjustment - operating income - service tax refund - selection of comparables - functional comparability - employees stock option (ESOP) expenditure - deduction under section 37 - remand for fresh considerationService tax refund - operating income - Transfer Pricing - Whether service tax refund credited to profit and loss should be treated as operating revenue for transfer pricing purposes - HELD THAT: - The Tribunal examined the accounts and submissions that service tax had been earlier included in operating costs and that refunds for earlier years were credited to profit and loss in FY 2016-17. It recognised competing contentions: the assessee's submission that refunds reverse earlier operating costs and thus should be treated as operating income for consistency in TP; the Revenue's submission that refunds relate to prior years and are shown as 'other income' and their inclusion for the tested party alone would result in a lopsided comparison with comparables. The Tribunal held that if the service tax payments or provisions related to the ITES segment and had been included in the cost base used for cost plus billing, then the corresponding refunds relating to that segment ought to be considered operating income for TP parity. Finding that this factual linkage and segmental nexus required verification, the Tribunal remitted the matter to the AO/TPO for fresh consideration consistent with that principle.Remitted to AO/TPO for fresh consideration to determine whether the service tax refund pertains to the ITES segment and, if so, to treat it as operating revenue for transfer pricing purposes.Working capital adjustment - comparability adjustment - Arm's Length Price - Whether working capital adjustment claimed by the assessee must be allowed in computing the TNMM margin - HELD THAT: - Applying Rule 10B and the OECD guidance, the Tribunal emphasised that differences in working capital that materially affect net profit margin must be adjusted where reasonably accurate adjustments can be made. Noting precedents including Huawei and other Tribunal rulings, the Tribunal rejected the DRP/CIT(A)'s categorical denial of working capital adjustment and accepted that a reasonable adjustment-as worked out by the TPO or as furnished by the assessee and not shown to be defective-should be allowed to bring the tested party and comparables on the same footing. Consequently the AO/TPO was directed to grant the working capital adjustment claimed.Directed AO/TPO to allow the working capital adjustment claimed by the assessee.Selection of comparables - functional comparability - ITeS segment - Exclusion of Microland Limited from the final set of comparables - HELD THAT: - On examination of Microland's segmental disclosures and nature of revenue, the Tribunal found that Microland's ITES revenue was about 60% and the TPO's inclusion of additional selling services revenue as ITES was incorrect. Because Microland did not satisfy the export/segment filter applied, the Tribunal held it was not an appropriate comparable and directed its exclusion.Microland Limited excluded from the list of comparables.Selection of comparables - functional comparability - ITeS segment - Exclusion of Manipal Digital Systems Private Limited from the final set of comparables - HELD THAT: - Having considered the annual report, website material, and authorities on the need to examine the character of ITeS services, the Tribunal found that the Department had not made the necessary functional analysis and that material differences in the services performed warranted exclusion. Following judicial guidance emphasizing scrutiny of service characteristics within the broad ITeS label, the Tribunal directed the AO/TPO to exclude Manipal Digital Systems Pvt. Ltd.Manipal Digital Systems Pvt. Ltd. directed to be excluded from the list of comparables.Selection of comparables - export revenue filter - remand for fresh consideration - Datamatics Business Solutions Limited - remand to AO/TPO for verification of filters and export revenue percentage - HELD THAT: - The assessee challenged the export revenue computation and functional comparability for Datamatics. The Tribunal considered the parties' factual contentions and found that these matters required verification of the correct export percentages and application of filters. Rather than decide on the record, the Tribunal remitted the comparable to the AO/TPO to reassess whether Datamatics satisfies the export revenue and other selection filters and to include it if it does.Remitted to AO/TPO to verify whether Datamatics satisfies the AO/TPO's filters and include it in comparables if satisfied.Selection of comparables - functional comparability - precedential consistency - Exclusion of Infosys BPO Limited from the final set of comparables - HELD THAT: - Relying on Tribunal orders in the assessee's group and co ordinate bench decisions that found Infosys BPO functionally dissimilar (brand, scale, different operating models and outsourcing/subcontracting patterns), the Tribunal concluded Infosys BPO is not a suitable comparable for the assessee's ITeS activities and directed its exclusion from the comparable set.Infosys BPO Limited directed to be excluded from the list of comparables.Selection of comparables - extraordinary events - functional comparability - Exclusion of SPI Technologies India Private Limited and Eclerx Services Limited from the final set of comparables - HELD THAT: - Having considered earlier Tribunal decisions where extraordinary events (amalgamation, acquisition) or KPO characteristics rendered these entities unsuitable as comparables, the Tribunal directed AO/TPO to exclude SPI Technologies India Pvt. Ltd. and Eclerx Services Ltd. from the comparable list for the assessment year under consideration.SPI Technologies India Pvt. Ltd. and Eclerx Services Ltd. excluded from the list of comparables.Selection of comparables - inclusion of comparables - ITeS segment - Inclusion of ISN Global Solutions Private Limited in the final set of comparables - HELD THAT: - The Tribunal reviewed the DRP's reasoning and the annual report information showing ISN's engagement in business process outsourcing and data processing consistent with ITeS activities. Finding the functional profile comparable for the year under consideration, the Tribunal directed the AO/TPO to include ISN Global Solutions Ltd. in the comparables list.ISN Global Solutions Private Limited to be included in the list of comparables.Selection of comparables - remand for fresh consideration - Bhilwara Infotechnology Limited and R Systems International Limited - remitted for AO/TPO verification - HELD THAT: - The assessee sought inclusion and asked that the AO/TPO verify whether these companies satisfy the selection filters. The Tribunal agreed that verification of the AO/TPO's search matrix and application of filters is required and therefore remitted both comparables to the AO/TPO for fresh consideration to confirm whether they meet the adopted filters.Remitted to AO/TPO for fresh consideration to verify whether Bhilwara Infotechnology Ltd. and R Systems International Ltd. satisfy the selection filters.Employees stock option (ESOP) expenditure - deduction under section 37 - remand for verification - Allowability of ESOP expenditure under section 37 and consequential verification of TDS compliance - HELD THAT: - Following Tribunal precedents in the assessee's group and the Karnataka High Court in Biocon, the Tribunal accepted in principle that ESOP discount/reimbursement constitutes a deductible business expenditure under section 37 where the liability has been incurred and the expense is for business purposes. However, recognising factual aspects remaining (notably whether appropriate TDS under sections 192/195 has been complied with), the Tribunal remitted the matter to the AO for verification of TDS compliance and related facts before finalising the allowance.Grounds on ESOP expenditure allowed in principle; matter remitted to AO to verify TDS compliance and to reconsider disallowance in light of that verification.Final Conclusion: The Tribunal partly allowed the appeal for statistical purposes: it directed allowance of the working capital adjustment; excluded certain comparables (Microland, Manipal Digital Systems, Infosys BPO, SPI Technologies, Eclerx) and ordered inclusion or fresh verification for others (ISN included; Datamatics, Bhilwara Infotechnology and R Systems remitted to AO/TPO); it remitted the service tax refund question and the ESOP disallowance (allowed in principle) to the AO/TPO for fresh consideration and factual verification. Issues Involved:1. Transfer Pricing Adjustments2. Incorrect Disallowance with respect to ESOP Expenditure3. Disallowance of Depreciation on Slump Sale4. Disallowance of Employees' Contribution to Welfare Fund5. Initiation of Penalty Proceedings and Levy of InterestDetailed Analysis:1. Transfer Pricing Adjustments:- Grounds 1.1 to 1.9: These grounds were deemed general and did not require adjudication.- Ground 1.10: The assessee argued that service tax refunds should be considered as part of 'Operating Revenue.' The Tribunal remitted the issue to the AO/TPO for fresh consideration, stating that if service tax payments were considered operating expenses, then refunds should be considered operating income.- Ground 1.11: This was deemed academic and did not require adjudication.- Ground 1.12: This ground was kept open pending the findings on grounds 1.15 to 1.16.- Ground 1.13: The Tribunal directed the AO/TPO to grant working capital adjustment, following the precedent set in previous Tribunal decisions.- Ground 1.14: This ground was dismissed as academic.- Ground 1.15: The Tribunal directed the exclusion of Microland Limited, Manipal Digital Systems Pvt. Ltd., and Infosys BPO Ltd. from the list of comparables. Datamatics Business Solutions Ltd. was remitted to the AO/TPO for reconsideration.- Ground 1.16: The Tribunal directed the inclusion of Bhilwara Infotechnology Ltd., R Systems International Ltd., ISN Global Solutions Ltd., and E-Zest Solutions Ltd. in the list of comparables, subject to verification by the AO/TPO.2. Incorrect Disallowance with respect to ESOP Expenditure:- Grounds 2.1 to 2.8: The Tribunal allowed these grounds, following the precedent set in the assessee's group case and the Karnataka High Court decision in Biocon Ltd. The Tribunal held that ESOP expenditure is deductible under Section 37 of the Act.- Grounds 2.9 to 2.15: These grounds were not adjudicated as the disallowance was made under Section 37, not under Section 40(a)(i).3. Disallowance of Depreciation on Slump Sale:- Grounds 3.1 to 3.5: These grounds were not pressed and were dismissed as not pressed.4. Disallowance of Employees' Contribution to Welfare Fund:- Grounds 4.1 to 4.4: These grounds were not pressed and were dismissed as not pressed.5. Initiation of Penalty Proceedings and Levy of Interest:- Ground 5.1: This ground was deemed preposterous and dismissed.- Ground 5.2: This ground was deemed consequential and mandatory, thus not requiring adjudication.Conclusion:The Tribunal partly allowed the appeal for statistical purposes, directing fresh consideration on specific grounds and adjustments to be made by the AO/TPO. The Tribunal upheld the principles set in previous decisions regarding the treatment of ESOP expenditure and transfer pricing adjustments.