2021 (4) TMI 297 - AT - Income Tax

Appeal allowed with directions on comparables exclusion & working capital adjustment for transfer pricing case

The appeal was allowed with directions for the exclusion of certain comparables and remand for verification of others. The working capital adjustment ... Comparability of international transactions - application of TNMM and selection of comparables - working capital adjustment in transfer pricing - reliability of comparable financials where fraud alleged - related party transactions filter and functional comparabilityComparability of international transactions - application of TNMM and selection of comparables - functional comparability - Exclusion of Bodhtree Consulting Ltd. (segment) from the final set of comparables - HELD THAT: - The Tribunal examined the annual report and records and found that Bodhtree generated its revenue from software development and had no segmental details indicating ITES activities; it incurred trademark expenses showing intangibles and therefore was functionally a software development company dissimilar to the assessee's ITeS/BPO functions. On that basis the Tribunal directed exclusion of Bodhtree from the final list of comparables as not functionally comparable for TNMM application. [Paras 21]Bodhtree Consulting Ltd. (Seg.) excluded from the final list of comparables.Reliability of comparable financials where fraud alleged - comparability of international transactions - Exclusion of Maple eSolutions Ltd. and Triton Corp Ltd. from the final list of comparables - HELD THAT: - Assessee relied on precedents where these companies' promoters were found involved in fraudulent activities, leading coordinate benches to hold that their financial results were distorted and unreliable. Revenue did not controvert those findings. Respectfully following the coordinate bench decisions, the Tribunal concluded that the financials of Maple eSolutions Ltd. and Triton Corp Ltd. for the relevant year could not be relied upon and directed their exclusion from the comparables. [Paras 22]Maple eSolutions Ltd. and Triton Corp Ltd. excluded from the final list of comparables.Related party transactions filter and functional comparability - comparability of international transactions - Exclusion of Vishal Information Technologies Ltd. from the final list of comparables - HELD THAT: - On examination of the annual report, the Tribunal noted that Vishal Information Technologies Ltd. had an abnormally high proportion of related party transactions (RPT ~82.92%) and had been characterised in earlier authority as a KPO rather than a BPO provider. Given the functional dissimilarity to the assessee and failure of the RPT filter applied by the TPO, the Tribunal directed exclusion of Vishal from the final comparable set. [Paras 26, 27]Vishal Information Technologies Ltd. excluded from the final list of comparables.Related party transactions filter and functional comparability - comparability of international transactions - remand for verification - Remand of Asit C Mehta Financial Services Ltd. for verification by AO/TPO - HELD THAT: - The Tribunal observed that Asit C Mehta Financial Services Ltd. operated in multiple segments (ITES, software, portfolio management) and that segmental details exist but the extent of related party transactions required verification. Because employee cost and outsourcing patterns affect functional comparability and the record showed RPT during the year, the Tribunal remanded this comparable to the AO/TPO to verify the RPT percentage and to decide inclusion or exclusion in accordance with law. [Paras 31]Asit C Mehta Financial Services Ltd. remitted to AO/TPO for verification; exclude if RPT > 25% or otherwise decide as per verification.Comparability of international transactions - employee cost and segmental revenue filters - remand for verification - Remand of Spanco Telesystems and Solutions Ltd. (segment) to AO/TPO for verification - HELD THAT: - Assessee challenged Spanco on grounds that ITES revenue constituted only about 8.21% and employee cost was low (7.16%), and that there had been a demerger. Following coordinate bench precedents that required verification of these facts, the Tribunal directed the AO/TPO to verify the employee cost and ITES revenue and, if verified, to exclude the company from the comparable set; accordingly the matter was remitted for factual verification. [Paras 32, 35]Spanco Ltd. (segment) remanded to AO/TPO for verification of employee cost and ITES revenue and considered for exclusion if verified.Employee cost and functional comparability - remand for verification - Remand of Accurate Data Converters Pvt. Ltd. to AO/TPO for verification of functions and financial data - HELD THAT: - Assessee contended Accurate Data Converters had very low employee cost (1.61%) and outsourced work, indicating a different business model; the Tribunal noted the TPO had not verified functions and directed that the AO/TPO must verify functional dissimilarities/similarities and available financial data before deciding on its inclusion as a comparable. [Paras 36, 39]Accurate Data Converters Pvt. Ltd. remanded to AO/TPO for verification of functions and financials and to decide comparability accordingly.Working capital adjustment in transfer pricing - remand for verification - Remand of the working capital adjustment computation to AO/TPO to consider advances/receipts from customers - HELD THAT: - Assessee claimed advances/receivables from its AE existed and were not considered by the TPO in computing the working capital adjustment; the Tribunal observed that the claim required verification of supporting evidence and therefore remitted the matter to the AO/TPO to reconsider the computation in light of assessee's submissions and evidence, to be decided in accordance with law. [Paras 40, 42]Working capital adjustment computation remanded to AO/TPO for reconsideration and verification of advances/receivables; assessee to produce relevant evidence.Final Conclusion: Appeal allowed in part: specific comparables (Bodhtree, Maple eSolutions, Triton Corp, Vishal) excluded from the TPO/DRP final list; other challenged comparables (Asit C Mehta, Spanco (seg.), Accurate Data Converters) and the working-capital adjustment issue remanded to the AO/TPO for verification and fresh consideration in accordance with law; directions given as indicated. Issues Involved:1. Assessment of total income2. Addition to total income based on arm's length price (ALP) for IT enabled services3. Economic analysis for determining ALP4. Use of FY 2006-07 data for determining ALP5. Use of information obtained under section 133(6) for comparability analysis6. Rejection of comparables by applying different filters7. Non-application of employee cost filters8. Selection of companies with financial irregularities as comparables9. Selection of functionally dissimilar companies as comparables10. Computation of working capital adjustment11. Adjustments for differences in risk profile12. Computation of ALP without +1-5 percent benefit13. Levy of interest under section 234B14. Initiation of penalty proceedings under section 271(1)(c)Issue-wise Detailed Analysis:1. Assessment of Total Income:The learned AO, following the directions of the Hon'ble DRP, assessed the total income at INR 2,27,63,060 against the returned income of INR 2,12,644.2. Addition to Total Income Based on ALP:The AO/DRP/TPO made an addition of INR 2,25,50,416 to the total income of the appellant, asserting that the price charged was lower than the arm's length price determined for IT enabled services transactions rendered by the appellant to its associated enterprises (AEs).3. Economic Analysis for Determining ALP:The AO/DRP/TPO did not accept the economic analysis undertaken by the appellant and conducted a fresh economic analysis for determining the ALP, holding that the appellant's international transaction was not at arm's length.4. Use of FY 2006-07 Data for Determining ALP:The AO/DRP/TPO used only FY 2006-07 data to determine the ALP, which was not available to the appellant at the time of complying with transfer pricing documentation requirements.5. Use of Information Obtained Under Section 133(6) for Comparability Analysis:The AO/DRP/TPO obtained information under section 133(6) that was not publicly available and relied on it for comparability purposes, selecting companies such as Bodhtree Consulting Ltd. and Accurate Data Converters Pvt. Ltd. as comparables.6. Rejection of Comparables by Applying Different Filters:The AO/DRP/TPO rejected certain comparables considered by the appellant by applying different quantitative and qualitative filters, including:- Companies with economic performance contrary to industry behavior (e.g., diminishing revenue trend)- Companies with turnover less than INR 1 crore- Not applying an upper turnover filter of INR 200 crores7. Non-application of Employee Cost Filters:The AO/DRP/TPO did not apply employee cost filters to reject companies with employee costs less than 25% of operating revenues, such as Vishal Information Technologies Ltd., Asit C Mehta Financial Services Ltd., and Spanco Ltd.8. Selection of Companies with Financial Irregularities as Comparables:The AO/DRP/TPO selected companies with financial irregularities, such as Maple eSolutions Ltd. and Triton Corp Ltd., which were under indictment for fraud during FY 2006-07.9. Selection of Functionally Dissimilar Companies as Comparables:The AO/DRP/TPO selected functionally dissimilar companies using unreasonable comparability criteria, including Bodhtree Consulting Ltd., Maple eSolutions Ltd., Triton Corp Ltd., Vishal Information Technologies Ltd., Asit C Mehta Financial Services Ltd., Spanco Ltd., Accurate Data Converters Pvt. Ltd., and Iservices India Pvt. Ltd.10. Computation of Working Capital Adjustment:The AO/DRP/TPO erred in computing the working capital adjustment by not considering advances received from customers.11. Adjustments for Differences in Risk Profile:The AO/DRP/TPO did not make suitable adjustments for differences in the risk profile of the appellant vis-à-vis the comparables during the comparability analysis.12. Computation of ALP Without +1-5 Percent Benefit:The AO/DRP/TPO computed the ALP without giving the benefit of the +1-5 percent range under the proviso to section 92C of the Act.13. Levy of Interest Under Section 234B:The AO levied interest of INR 107,45,187 under section 234B of the Act.14. Initiation of Penalty Proceedings Under Section 271(1)(c):The AO initiated penalty proceedings under section 271(1)(c) of the Act.Judgment Analysis:Exclusion of Comparables:- Bodhtree Consulting Ltd. (Seg.): Excluded as it provides software development services and lacks segmental details for ITES services.- Maple eSolutions Ltd. & Triton Corp Ltd.: Excluded due to involvement in fraudulent financial activities.- Vishal Information Technologies Ltd.: Excluded due to high RPT filter of 82.92% and being categorized as a KPO service provider.- Asit C Mehta Financial Services Ltd.: Remanded to AO/TPO to verify RPT percentage and consider comparability based on segmental details.- Spanco Ltd. (Seg.): Remanded to AO/TPO to verify employee cost and revenue earned under ITES segment.- Accurate Data Converters Pvt. Ltd.: Remanded to AO/TPO to verify functions and decide comparability based on functional dissimilarities/similarities.Working Capital Adjustment:The issue of working capital adjustment was remanded to the AO/TPO for reconsideration in light of the appellant's submissions regarding advances received from customers.Conclusion:The appeal was allowed, with directions for the exclusion of certain comparables and remand for verification of others. The working capital adjustment issue was also remanded for reconsideration. The judgment emphasized the need for accurate comparability analysis and proper application of filters in transfer pricing cases.