Tribunal limits turnover for comparables, orders re-examination of working capital adjustment.

The Tribunal partially allowed the appeal, directing the exclusion of companies with turnovers exceeding Rs. 200 Crores from the list of comparables and ordering a re-examination of the working capital adjustment by the TPO/AO. The TPO/AO were instructed to compute the Arm's Length Price for the international transaction in accordance with the Tribunal's directions after affording the assessee an opportunity of being heard.

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Issues Involved:
1. Choice of comparable companies chosen by the Transfer Pricing Officer (TPO).
2. Non-grant of working capital adjustment.

Detailed Analysis:

1. Choice of Comparable Companies:

The core issue pertains to the determination of the Arm’s Length Price (ALP) for the provision of Software Development Services (SWD services) by the assessee to its Associated Enterprises (AE). The assessee used the Transaction Net Margin Method (TNMM) and selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The TPO, while accepting TNMM as the Most Appropriate Method (MAM), reworked the OP/OC and selected additional comparable companies, resulting in a higher PLI of 27.37% compared to the assessee’s 16.19%.

The assessee contested the inclusion of eight specific companies (Tata Elxsi Ltd., Mindtree Ltd., Infosys Ltd., Larsen & Toubro Infotech Ltd., Persistent Systems Ltd., R.S. Software Ltd., Cybage Software Pvt Ltd., and Nihilent Ltd.) chosen by the TPO, arguing that these companies had a turnover exceeding Rs. 200 Crores, whereas the assessee’s turnover was only Rs. 86.29 Crores. The DRP upheld the TPO's inclusion, relying on the Delhi High Court's decision in Chryscapital Investment Advisors India Pvt. Ltd Vs. DCIT, which held that high turnover does not automatically exclude a company if it is otherwise functionally comparable.

The Tribunal, however, took a different view, emphasizing the importance of the turnover filter. It referenced several ITAT Bangalore Bench decisions, including Dell International Services India (P) Ltd. Vs. DCIT and Autodesk India Pvt. Ltd. Vs. DCIT, which supported the exclusion of companies with significantly higher turnovers to ensure comparability. The Tribunal concluded that companies with turnovers exceeding Rs. 200 Crores should be excluded from the list of comparable companies.

2. Non-grant of Working Capital Adjustment:

The assessee also raised the issue of not being granted a working capital adjustment. The DRP had denied this adjustment, citing reasons such as the lack of demonstrated data on the impact of working capital on costs, price, or profit, and the variability of working capital requirements based on numerous factors.

The Tribunal referred to its earlier decision in Huawei Technologies India Pvt. Ltd. v. JCIT, which emphasized the necessity of working capital adjustments to account for differences in the time value of money between the tested party and comparables. The Tribunal highlighted the OECD Transfer Pricing Guidelines, which explain that working capital adjustments are essential to reflect the timing effects on profits due to differences in accounts receivable, payable, and inventory levels.

The Tribunal directed the TPO/AO to re-examine the issue of working capital adjustment, considering the guidelines and ensuring that both the tested party and comparables are on the same footing. The TPO/AO was instructed to provide the assessee with an opportunity to present their case.

Conclusion:

The Tribunal partially allowed the appeal, directing the exclusion of companies with turnovers exceeding Rs. 200 Crores from the list of comparables and ordering a re-examination of the working capital adjustment by the TPO/AO. The TPO/AO were instructed to compute the ALP for the international transaction in accordance with the Tribunal’s directions after affording the assessee an opportunity of being heard.

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