ITAT upholds deselection of functionally dissimilar comparables for contract service provider in transfer pricing analysis

The ITAT Bangalore upheld the deselection of comparables that were functionally dissimilar to the assessee, a contract service provider providing limited services exclusively to its associated enterprise. Companies with turnover exceeding Rs. 200 crores were also excluded. However, Aptus Software Labs Pvt. Ltd was retained as a comparable despite deriving revenue from both domestic and foreign sources, as its NIC code 6201 indicated information technology services similar to the assessee's activities. The tribunal allowed appropriate working capital adjustments in the transfer pricing analysis.

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Issues Involved:
1. Legality of the assessment order.
2. Transfer Pricing adjustment to the Software Development (SWD) segment.
3. Rejection of Transfer Pricing (TP) documentation.
4. Misunderstanding of the business model.
5. Incorrect characterization of services rendered.
6. Application of "IT and ITES Services" filter.
7. Rejection of comparability analysis.
8. Non-consideration of submissions by the TPO.
9. Re-computation of margins without a hearing.
10. Non-application of upper turnover limit.
11. Incorrect acceptance/rejection of comparable companies.
12. Working capital adjustment.
13. Levy of interest under sections 234B and 234C.
14. Admission of additional grounds of appeal.

Detailed Analysis:

1. Legality of the Assessment Order:
The assessee contested the assessment order dated 28.07.2022, arguing that it was contrary to law, facts, and circumstances.

2. Transfer Pricing Adjustment to the SWD Segment:
The assessee argued that the DRP, AO, and TPO erred in making a transfer pricing adjustment to the SWD segment, failing to understand that the services rendered were related to software development activities, not software development itself.

3. Rejection of Transfer Pricing Documentation:
The TPO rejected the TP documentation maintained by the assessee by invoking provisions of subsection (3) of section 92C of the Act, which the assessee claimed was erroneous.

4. Misunderstanding of the Business Model:
The assessee contended that the authorities misunderstood its business model, failing to appreciate that the services rendered were in relation to software development activities, not software development.

5. Incorrect Characterization of Services Rendered:
The authorities concluded that the assessee was in the business of providing 'Software Testing and Implementation Services,' which the assessee argued was incorrect as it was merely rendering job work on already developed software.

6. Application of "IT and ITES Services" Filter:
The assessee argued that the authorities erred in applying the "IT and ITES Services" filter, without appreciating that the services rendered were professional services related to modification, enhancement, or improvement of already developed software.

7. Rejection of Comparability Analysis:
The TPO rejected the comparability analysis undertaken in the TP documentation and conducted a fresh analysis, introducing various filters, which the assessee claimed was non-transparent.

8. Non-Consideration of Submissions by the TPO:
The assessee argued that the TPO passed the TP order without considering its submissions.

9. Re-Computing Margins Without a Hearing:
The TPO and AO re-computed the margins of comparable companies without providing an opportunity of hearing to the assessee, which the assessee claimed was erroneous.

10. Non-Application of Upper Turnover Limit:
The authorities failed to apply the upper turnover limit, which the assessee argued was necessary to account for the benefits of economies of scale enjoyed by companies with high turnover.

11. Incorrect Acceptance/Rejection of Comparable Companies:
The assessee argued that the authorities erred in not rejecting certain companies and in not accepting others as comparable. The Tribunal directed the exclusion of companies with a turnover exceeding Rs. 200 crores and those functionally different from the assessee, following the precedent set in the case of NTS Technology Services Pvt. Ltd.

12. Working Capital Adjustment:
The Tribunal directed the AO/TPO to allow the appropriate working capital adjustment, following the decisions in Huawei Technologies India (P) Ltd. and Altimetrix India Pvt Ltd.

13. Levy of Interest Under Sections 234B and 234C:
The assessee contested the levy of interest under sections 234B and 234C in the final assessment order.

14. Admission of Additional Grounds of Appeal:
The Tribunal admitted the additional grounds of appeal raised by the assessee, considering them legal and relevant for deciding the issues. The Tribunal also dismissed additional ground No. 17 as withdrawn and not pressed by the assessee.

Conclusion:
The Tribunal partly allowed the appeal for statistical purposes, directing the exclusion of certain companies from the list of comparables, allowing working capital adjustments, and remitting some issues to the TPO for fresh consideration. The Tribunal upheld the application of the upper turnover filter and directed the exclusion of companies with a turnover exceeding Rs. 200 crores and those functionally different from the assessee.

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