2023 (4) TMI 21 - AT - Income Tax

Transfer Pricing Appeal Outcome: Exclusions, Interest Treatment, Disallowance, Operating Costs Ruling

M/s. Applied Materials India Pvt. Ltd., Versus The Deputy Commissioner of Income Tax, Circle – 1 (1) (1), Bangalore.

The Tribunal partly allowed the appeal, providing detailed directions on the exclusion of certain comparables in Transfer Pricing analysis, treatment of ... TP Adjustment - Determination of Net Cost Margin of Appellant - excluding the sub-contracting charges from the operating cost as they are a pass-through cost - HELD THAT:- As decided in own case [2022 (6) TMI 1357 - ITAT BANGALORE] cost on the software development activity is incurred by the assessee and charging the AE on the said services with a mark up of 10% on cost. The cost of subcontracting in software development services is also charged with 10% mark up to the AE. When the margin on the cost of sub- contracting charges is part of the operating revenue of the assessee then only the cost of sub-contracting activity cannot be excluded as pass through - pass through cost can be considered only when the activity of providing services to the AE does not involve value addition on the part of the AE. - the cost of software development services cannot be treated in this fashion as claimed by the assessee. Hence we do not find any merit in the contention raised by the assessee on this issue. Decided against assessee. Comparable selection - Functionally dissimilar companies cannot be held to be functionally comparable with that of assessee which is a captive service provider that caters only to its AE. Interest on receivables - We note that in assessee’s own case TPO has considered a credit period of 90 days. Accordingly, we direct the Ld.AO/TPO to compute the notional interest if any that falls out of this credit period for the year under consideration by considering LIBOR + 300 basis points. Disallowance u/s. 40(a)(i) towards the salary cost reimbursed by assessee to AE on cost to cost basis - HELD THAT:- We remand this issue to the Ld.AO to consider the claim in accordance with the decision of Hon’ble Karnataka High Court in case of M/s. Flipkart Internet Pvt. Ltd. [2022 (6) TMI 1251 - KARNATAKA HIGH COURT] and M/s. Toyota Boshoku Automotive India Pvt. Ltd. [2022 (4) TMI 1443 - ITAT BANGALORE], Goldman Sachs Services Pvt. Ltd. [2022 (4) TMI 1444 - ITAT BANGALORE] having regard to the evidences filed by the assessee. We also direct that in the event, TDS has been deducted u/s. 192 of the Act, no disallowance can be made u/s. 40(a)(i). Section 40(a)(i) can be invoked only when there has been non-deduction of tax at source. Assessee has relied on the decision of Coordinate Bench of this Tribunal in case of ACIT vs. AON Specialist Services Pvt. Ltd. [2020 (2) TMI 1632 - ITAT BANGALORE] We accordingly direct the Ld.AO to carry out necessary verification in accordance with the decisions referred to hereinabove. Issues Involved:1. Exclusion of sub-contracting charges from operating cost.2. Exclusion of certain comparables in Transfer Pricing analysis.3. Interest on receivables as an international transaction.4. Disallowance under Section 40(a)(i) for reimbursement of salary costs.Detailed Analysis:1. Exclusion of Sub-Contracting Charges from Operating Cost:The assessee contended that sub-contracting charges should be excluded from the operating cost as they are a pass-through cost. The Tribunal, however, upheld the view taken in the assessee's own case for AY 2014-15, stating that the assessee is not acting as an agent but is providing software development services with a mark-up. Therefore, the cost of sub-contracting cannot be excluded as a pass-through cost as it would artificially inflate the margins. The Tribunal found no merit in the contention and dismissed this ground.2. Exclusion of Certain Comparables in Transfer Pricing Analysis:The assessee sought the exclusion of ten comparables, arguing they were not functionally similar. The Tribunal analyzed the functional, asset, and risk (FAR) profile of the assessee, concluding that the assessee is a limited risk captive service provider. Following the decision in ARM Embedded Technologies Pvt. Ltd. vs. DCIT, the Tribunal excluded the following comparables for functional dissimilarities:- Inteq Software Pvt. Ltd.- L&T Infotech Ltd.- Infobeans Technologies Ltd.- Thirdware Solutions Ltd.- Persistent Systems Ltd.- Infosys Ltd.- Aspire Systems India Pvt. Ltd.- Cybage Software Pvt. Ltd.- RS Software (I) Pvt. Ltd.- Nihilent Technologies Ltd.3. Interest on Receivables as an International Transaction:The assessee argued that interest on receivables should not be considered a separate international transaction, citing decisions in Avnet India Pvt. Ltd. vs. DCIT and Kusum Healthcare Pvt. Ltd. vs. ACIT. The Tribunal noted that interest on receivables is indeed an international transaction as per the explanation to Section 92B of the IT Act. However, it directed the AO/TPO to recompute the notional interest considering a credit period of 90 days and using LIBOR + 300 basis points, following the assessee's own case for AY 2014-15 and 2018-19.4. Disallowance under Section 40(a)(i) for Reimbursement of Salary Costs:The assessee argued that Section 195 does not apply to the reimbursement of salary costs, relying on several judicial decisions, including DIT(IT) vs. Abbey Business Services India (P.) Ltd. and M/s. Flipkart Internet Pvt. Ltd. vs. DCIT (IT). The Tribunal remanded the issue to the AO for reconsideration in light of these decisions and directed that if TDS has been deducted under Section 192, no disallowance should be made under Section 40(a)(i). The AO was instructed to verify the claim in accordance with the relevant judicial precedents.Conclusion:The appeal was partly allowed, with the Tribunal providing detailed directions on the exclusion of comparables, interest on receivables, and the application of Section 40(a)(i) concerning salary cost reimbursements. The Tribunal dismissed the ground regarding the exclusion of sub-contracting charges from operating costs.