ITAT remits transfer pricing adjustment on notional interest for outstanding receivables directing fresh consideration with specific guidelines

The ITAT Bangalore remitted the TP adjustment issue regarding notional interest on outstanding receivables to the AO/TPO for fresh consideration, directing that if working capital adjustment subsumes receivables, no separate characterization should be made. For receivables outside WCA, LIBOR + 300 basis points should apply with 90-day credit period. The tribunal directed verification of two comparables for potential inclusion and excluded 11 companies exceeding Rs. 200 crores turnover limit. Three additional comparables were rejected for functional dissimilarity and lack of segmental information. The assessee's appeal was partly allowed.

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Issues Involved:
1. Notional interest on outstanding receivables.
2. Inclusion/exclusion of comparables.

Summary:

Issue 1: Notional Interest on Outstanding Receivables
The assessee contested the notional interest computed by applying the SBI short-term deposit rate, arguing that the outstanding receivables were settled in the normal course of business and should not be subject to transfer pricing adjustment. The Tribunal referred to the decision in Instrumentation Corpn. Ltd. v. Asstt. DIT, which held that outstanding invoices are akin to loans to foreign AEs and thus constitute an international transaction under Section 92B. The Tribunal directed the Assessing Officer (AO)/Transfer Pricing Officer (TPO) to re-examine the issue, considering whether working capital adjustment subsumes the outstanding receivables. If not, interest should be charged at LIBOR + 300 basis points, following the principles laid down in CIT vs. Cotton Naturals (I) Pvt. Ltd. The assessee was allowed a reasonable opportunity to present their case.

Issue 2: Inclusion/Exclusion of Comparables
The Tribunal addressed the inclusion and exclusion of various comparables:

Inclusion of Rheal Software Ltd. and Evoke Technologies Pvt. Ltd.
The Tribunal noted that the TPO rejected Rheal Software Ltd. based on persistent loss filter, which requires losses in three consecutive years. The Tribunal directed the AO/TPO to verify the assessee's claims and include the comparables if the contentions are found true.

Exclusion of Comparables Based on Turnover Filter
The Tribunal excluded 11 comparables (e.g., Tech Mahindra Ltd., Wipro Ltd.) due to their turnover exceeding Rs. 200 crores, following the principle that the scale of operations impacts profitability.

Exclusion of Threesixty Logica Testing Services Pvt. Ltd.
The Tribunal excluded this comparable due to its high Related Party Transactions (RPT) and functional dissimilarities, such as owning brand names and earning revenue from third-party software products without segmental data.

Exclusion of Elveego Circuits Pvt. Ltd.
The Tribunal excluded this company as it is engaged in chip and semiconductor design services, which are not similar to the software development services provided by the assessee.

Exclusion of Great Software Laboratory Pvt. Ltd.
The Tribunal excluded this company due to its diverse activities and lack of segmental information, which makes it incomparable to the assessee's contract services.

Exclusion of Acewin Agriteck Ltd. (formerly OFS Technologies)
The Tribunal excluded this company as it is engaged in diversified activities like outsourced product development and independent testing, which are not functionally similar to the assessee's software development services.

Conclusion:
The appeal was partly allowed, with directions for the AO/TPO to re-examine certain issues and comparables based on the Tribunal's guidelines. The Tribunal emphasized the need for proper functional analysis and adherence to relevant filters in the comparability study.

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