2022 (7) TMI 489 - AT - Income Tax

Transfer Pricing Appeal Outcome: ALP Determination, Exclusions, Methodology, & Depreciation Ruling

M/s Harman Connected Services Corporation India Private Limited Versus Deputy Commissioner of Income Tax, Circle-3 (1) (2) Bengaluru

The Tribunal partly allowed the appeal by the assessee in a transfer pricing case involving determination of Arm's Length Price (ALP) in the SWD services ... TPA - Comparable selection - Functional dissimilarity - HELD THAT:- Infosys Ltd.company earns income from both rendering software services and development of products. Despite rendering diverse services, there are no segmental details in respect of the services rendered. The company provides end-to-end business solutions like business consulting, technology, engineering and outsourcing services. In addition, the company offers software products and platforms for banking industry. The company also invests in products which helped the company establish itself as a credible IP Owner. The company owns seven Edge products/platforms and six other product based solutions - the services rendered by the company are not functionally comparable to the routine SWD services rendered by the assessee - we direct exclusion of this company from the final list of comparables. Larsen and Toubro Infotech Ltd. ('L&T') is a product company having significant intangibles and is thus not comparable to captive software development service providers such as the assessee who does not own any significant or non-routine intangibles. Further, L&T enjoys significant brand value. As a result of this high brand value, the company enjoys a high bargaining power in the market. - this company is consistently excluded from the final list of comparables in cases of assessees which are placed similar to the assessee.We therefore direct that this company should be excluded from the final list of comparables. Persistent Systems Ltd. is functionally dissimilar as it is engaged in rendering IT services and in the development of software products without there being separate segmental information disclosed in its Annual Report for such activities. In the absence of segmental data being made available as regards the IT services and products offered by it, it is not possible to determine whether the company passes the filters applied by the TPO. The operations of the company predominantly relate to providing software products, services and technology innovation covering full life cycle of product to its customers, which is completely different from the services rendered by the assessee. The company also made significant investment in intellectual property led solutions and also had a dedicated team for research and Intellectual Property ('IP') developments. The company also owns several IP solutions, and during the year under consideration, it acquired four products.Persistent Systems, Inc. which is a subsidiary of the company acquired CloudSquads, Inc during the year under consideration. There acquisitions constitute peculiar economic circumstances for which no adjustment can be made to Persistent's mark-up to eliminate the material effects thereof. Thus this company is not comparable to the assessee and ought to be excluded from the list of comparables for the above reasons. Thirdware Solutions Ltd. company is an IT consulting firm engaged in consulting, design, implementing and support of enterprise applications. The company has significant capabilities in the transaction, analytics and cloud layers of enterprise application. The company also renders industry-specific solutions spanning business applications consulting, design, implementation and support. This company is also engaged in development of software products and earns revenues from sale of user licenses for software applications. These diverse services are reported under one segment without any details being available as regards these services. We find that this company is consistently excluded from the final list of comparables in cases of assessees placed similar to that of the assessee. Akshay Software Technologies Ltd., Maveric Systems Ltd. - We find that this Tribunal in the cases of EMC Software and Services India Pvt. Ltd [2019 (12) TMI 1279 - ITAT BANGALORE] wherein in the case of an assessee which placed similar to the assessee, the comparability of this company was remanded to the TPO. We accordingly remand the comparability of this company with the assessee to the AO/TPO for a decision afresh. Non-granting of working capital adjustment - HELD THAT:- As in the light of the settled proposition of law that necessary adjustments are to be made to the margins of comparables to give effect to the differences in the working capital positions of the tested party and of the comparables, the TPO ought to have given the assessee the benefit of the same. We direct the TPO/AO to give working capital adjustment in accordance with law. Selection of MAM - determination of ALP in the trading segment - HELD THAT:- We hold that the assessee is a mere distributor and the method applied by it ought to be adopted. Pertinently, in the assessee's own case for assessment years 2015-16 and 2016-17, the TPO accepted the method applied by the assessee in the trading segment. Since the facts and circumstances involved in the year under consideration remain the same in the assessment years 2015-16 and 2016-17, the assessee's method ought to be accepted and is directed to be accepted. We remand the question of determination of ALP to the TPO/AO for fresh consideration and opting RPM as MAM. Restriction of depreciation claimed on computer software - HELD THAT:- As relying in the case of Computer Age Management Services [2019 (2) TMI 37 - ITAT CHENNAI] depreciation at 60% is directed to be granted. Disallowance of provision for warranty - AO disallowed the provision created in excess of the utilization, for the reason that the provision created by the assessee at a fixed percentage of sales does not conform to the tenets of a scientific, empirical and statistically consistent method as conceived by the Hon'ble Supreme Court in the case of Rotork Controls India (P.) Ltd. [2009 (5) TMI 16 - SUPREME COURT] - HELD THAT:- the utilization against the provision created for FY 2012-13 of Rs. 54,75,988 during the course of the warranty period is Rs. 10,70,053 in FY 2013-14, Rs. 22,09,813 during FY 2014-15 and Rs. 26,45,128 for FY 2015-16. The total utilization therefore amounts to Rs. 59,24,994 which is more than the provision created of Rs. 54,75,988. The conclusion of the DRP that the provision created and actual utilization was less is therefore incorrect. It is thus clear from the facts of the case that the warranty provision was provided by the assessee on a scientific basis based on past experience, historical trend and satisfies the tests laid down by the Hon'ble Supreme Court in the case of Rotork Controls India (P) Ltd. [Sura] and therefore the disallowance of warranty provision cannot be sustained and the same is directed to be deleted. Appeal by the assessee is partly allowed. Issues Involved:1. Determination of Arm's Length Price (ALP) in the Software Development (SWD) services segment.2. Determination of ALP in the Trading segment.3. Restriction of depreciation claimed on computer software.4. Disallowance of provision for warranty.Issue-wise Detailed Analysis:1. Determination of Arm's Length Price (ALP) in the SWD Services Segment:The assessee, engaged in rendering SWD services to its Associate Enterprises (AEs), reported a net cost-plus mark-up of 19.64%. The Transfer Pricing Officer (TPO) identified a TP adjustment of Rs. 8,34,81,655/-. The Dispute Resolution Panel (DRP) directed the exclusion of Cigniti Technologies Ltd. and SQS India Ltd. from the list of comparables. The Tribunal upheld the exclusion of Infosys Ltd., Larsen and Toubro Infotech Ltd., Persistent Systems Ltd., and Thirdware Solutions Ltd. from the final list of comparables, citing functional dissimilarity and lack of segmental data. The Tribunal also remanded the inclusion of Akshay Software Technologies Ltd. and Maveric Systems Ltd. to the TPO for fresh consideration. Additionally, the Tribunal directed the TPO/AO to grant a working capital adjustment as per law.2. Determination of ALP in the Trading Segment:The assessee, engaged in trading infotainment systems, chose the Resale Price Method (RPM) as the Most Appropriate Method (MAM), while the TPO chose the Transaction Net Margin Method (TNMM). The Tribunal found that the assessee performs routine distributor functions and that RPM is the MAM for a routine distributor without value addition. The Tribunal directed the TPO/AO to adopt RPM as the MAM and remanded the determination of ALP for fresh consideration.3. Restriction of Depreciation Claimed on Computer Software:The Revenue restricted the depreciation on computer software to 25% instead of 60%, holding that 'computer software' is a license eligible for 25% depreciation. The Tribunal found that the definition of 'computer software' in Appendix-1 to the Income-tax Rules, 1962, includes any computer program recorded on any disc, tape, perforated media, or other information storage device, and does not distinguish between embedded software or otherwise. The Tribunal directed the Revenue to grant depreciation at 60%.4. Disallowance of Provision for Warranty:The assessee created a provision for warranty based on historical trends and empirical evidence. The Revenue disallowed the provision created in excess of utilization, stating that it was not based on a scientific method as per the Supreme Court's decision in Rotork Controls India (P.) Ltd. The Tribunal found that the provision was created on a scientific basis and satisfied the tests laid down by the Supreme Court. The Tribunal directed the deletion of the disallowance of the warranty provision.Conclusion:The appeal by the assessee was partly allowed, with directions for fresh consideration on certain aspects and specific instructions for granting depreciation and deleting the disallowance of the warranty provision.