2022 (7) TMI 1579 - AT - Income Tax

TPO directed to reallocate expenses between software development marketing support and data center segments under section 144C(13)

M/s. Blue Coat Network (India) Pvt. Ltd., Versus The Deputy Commissioner of Income Tax, Circle – 1 (1) (2), Bangalore.

ITAT Bangalore ruled on transfer pricing adjustments involving expense reallocation and comparable selection. The TPO was directed to follow DRP ... TP Adjustment - reallocating other expenses between software development service segment, marketing support service segment and Data center service segment on the basis of revenue by the Ld.TPO - HELD THAT:- We note that the Ld.AO/TPO rejected the segmental financial details provided by assessee and reallocated other expenses including restructuring cost between SWD segment, marketing support service segment and Data center service segment by using segmental turnover as the allocation key instead of “headcount” as was followed by the assessee in the TP study. We note that the directions of the DRP has not been followed by the Ld.TPO. TPO is directed to pass the order in consonance with the directions of the DRP as per the sub clause (13) to section 144C of the Act. We therefore direct the TPO/Assessing Officer to consider this issue in accordance with the directions of DRP. Comparable selection - exclusion of certain comparables on turnover filter as well as dissimilarity in functions - HELD THAT:-Exclude Tata Elxi Ltd (Seg.), Mindtree Ltd., Larsen and Toubro Infotech Ltd., RS Software (India) Ltd., Persistent Systems Ltd., Nihilent Technologies Ltd., Infosys Ltd., Cybage software Pvt.Ltd. for having high turnover as compared to a captive service provider like assessee. Infobeans Technologies Ltd. be excluded as having multiple segments and cannot be compared with a captive service provider like assessee. Inteq Software Pvt.Ltd as noted is involved in multifarious services such as application services, software testing, data warehousing, EDI, BPO, staffing etc. As noticed from the Ld.AO/TPO and the DRP's order, it is stated that Inteq Software Pvt.Ltd., is only involved in software development services and the entire turnover is from such service. It is not clear how DRP had arrived at such a conclusion. The profit and loss account of Inteq Software Pvt.Ltd., is not on record. We therefore, deem it appropriate to restore this issue to the file of Ld.AO/TPO. Aspire Systems (I.) Pvt.Ltd. company is an outsourced technology service company. It is also stated that, there is income from power generation. Since the profit and loss account of the assessee company is not enclosed, we are not in a position to examine the observation of the DRP that, this comparable is a pure software development service provider. Therefore, we deem it appropriate to restore the issue to the files of the AO/TPO. The AO/TPO is directed to afford a reasonable opportunity of hearing to the assessee and take a decision whether Aspire Systems (I.) Pvt.Ltd., can be a comparable. Non granting to WCA while computing the margines of the comparables - AO was not justified in denying adjustment on account of working capital adjustment. In the light of the decision referred to above, the assessee is entitled to working capital adjustment. The assessee is directed to provide the working capital adjustment for year under consideration The TPO is accordingly directed to allow the same as per law. 3 comparables sought for exclusion by the assessee under the MSS segment - Killick Agencies & Marketing Ltd is engaged in acting as agent for various foreign principals for sale of dredgers, dredging equipment, steerable rudder propellers, maritime and aviation lighting, acoustic communication equipment etc. and sales services, whereas, the assessee is involved in corporate services and market research & business development. The corporate service includes assisting the day-to-day management of the organization (e.g. finance, human resources, information systems etc.). With respect to human resources, financial management, routine administration etc. In our view this comparable cannot be held functionally similar with that of the assessee before us. Digital Radio Broadcasting Ltd. - Comparing the functions with that of assessee before us, is after sales support functions for customers in India causing an increasing awareness of the Bluecoat products. Further the services are rendered only to the clientele of the AE to whom the Bluecoat products are sold. The above functions of this comparable is therefore not akin to the functions performed. Justdial Ltd. has a turnover of more than 5,897.98 million. We note that this company works on pan India operation and is supported by sales and marketing team consisting of telesales executives, Feet-On-Street and Just dial ambassadors. The advertising activity carried by this company has led to increase in its brand value and is considered to be India’s leading local search related service provider. This company has its presence in the e-commerce sector with an unprecedented growth in the year 2014 with about 893 million wireless subscribers by placing India as the largest wireless largest market globally. With the above functions and the wide variety of services rendered by this company, assessee is not at all comparable that has carried on with the captive service provider only rendering services to the clients of its AE. ISSUES PRESENTED and CONSIDEREDThe primary issues considered in this judgment pertain to transfer pricing adjustments made by the Transfer Pricing Officer (TPO) and upheld by the Dispute Resolution Panel (DRP) regarding the international transactions of the assessee, specifically in the segments of software development services, marketing support services, and data center services. The issues include:Whether the TPO erred in making upward adjustments to the transfer price of the assessee's international transactions.Whether the TPO correctly applied the segmental financial information and allocation of expenses.Whether the TPO complied with the directions of the DRP regarding the exclusion of restructuring costs.Whether the comparability analysis conducted by the TPO was appropriate, including the rejection or acceptance of certain comparables based on functional dissimilarities and turnover filters.Whether the TPO erred in not providing adjustments for differences in working capital and risk profiles between the assessee and comparable companies.Whether the additional ground concerning the application of turnover filters was admissible.ISSUE-WISE DETAILED ANALYSISTransfer Pricing AdjustmentsThe TPO made significant upward adjustments to the transfer prices of the assessee's international transactions in software development services, marketing support services, and data center services. The DRP upheld these adjustments, leading to the assessee's appeal.Legal Framework and PrecedentsThe relevant legal framework includes the provisions of the Income Tax Act related to transfer pricing, specifically Section 92CA, which governs the determination of the arm's length price for international transactions. The Tribunal referred to various precedents, including decisions of coordinate benches and the Hon'ble Bombay High Court, regarding the application of turnover filters and comparability criteria.Court's Interpretation and ReasoningThe Tribunal found that the TPO and DRP did not adequately consider the functional dissimilarities and turnover differences between the assessee and the selected comparables. The Tribunal emphasized the importance of applying appropriate filters, including turnover filters, to ensure comparability.Key Evidence and FindingsThe Tribunal noted that the TPO failed to apply an upper turnover filter, which is critical in ensuring that companies with significantly higher turnovers are not compared with smaller entities like the assessee. The Tribunal also observed that the TPO did not follow the DRP's directions regarding the exclusion of restructuring costs from the operating cost base.Application of Law to FactsThe Tribunal applied the principles established in previous cases, such as the Zynga Game Network India Pvt. Ltd. case, to exclude companies with high turnovers from the list of comparables. The Tribunal also directed the TPO to follow the DRP's instructions regarding the exclusion of restructuring costs.Treatment of Competing ArgumentsThe Tribunal considered the arguments presented by both the assessee and the revenue. It found merit in the assessee's contention that the TPO's approach to comparability and expense allocation was flawed. The Tribunal also acknowledged the revenue's reliance on the TPO's findings but ultimately found them insufficient to justify the adjustments.ConclusionsThe Tribunal concluded that the TPO's adjustments were not justified due to the inappropriate selection of comparables and failure to apply the DRP's directions. The Tribunal directed the TPO to re-evaluate the comparables and expense allocations in line with the Tribunal's findings and the DRP's directions.Additional Ground on Turnover FilterThe assessee raised an additional ground regarding the application of a turnover filter, arguing that the TPO applied only a lower turnover limit without considering an upper limit.Legal Framework and PrecedentsThe Tribunal referred to precedents that established the relevance of applying both lower and upper turnover filters to ensure comparability, especially in cases involving entities with significantly different turnovers.Court's Interpretation and ReasoningThe Tribunal found that the TPO's failure to apply an upper turnover filter was inconsistent with established precedents and resulted in the inclusion of non-comparable entities in the analysis.Key Evidence and FindingsThe Tribunal cited decisions from other cases, such as the Radisys India Pvt. Ltd. and Yahoo Software Development India Pvt. Ltd. cases, where similar issues were addressed, and companies with high turnovers were excluded from comparability analysis.Application of Law to FactsThe Tribunal applied the principles from these precedents to the current case, directing the TPO to exclude companies with turnovers exceeding Rs. 200 crores from the list of comparables.Treatment of Competing ArgumentsThe Tribunal considered the revenue's arguments but found them unpersuasive in light of the established legal principles favoring the exclusion of high-turnover companies.ConclusionsThe Tribunal allowed the additional ground, directing the TPO to apply an upper turnover filter and exclude companies with turnovers exceeding Rs. 200 crores from the comparability analysis.Working Capital AdjustmentThe assessee argued that the TPO failed to provide a working capital adjustment, which is necessary to account for differences in working capital levels between the assessee and comparable companies.Legal Framework and PrecedentsThe Tribunal referred to the provisions of the Income Tax Act and precedents that recognize the need for working capital adjustments to ensure accurate comparability.Court's Interpretation and ReasoningThe Tribunal found that the TPO's refusal to provide a working capital adjustment was unjustified, as such adjustments are necessary to eliminate material differences affecting comparability.Key Evidence and FindingsThe Tribunal cited the Huawei Technologies India (P.) Ltd. case, where a working capital adjustment was deemed necessary to ensure a fair comparison.Application of Law to FactsThe Tribunal applied these principles to the current case, directing the TPO to provide a working capital adjustment based on the assessee's submissions.Treatment of Competing ArgumentsThe Tribunal considered the revenue's arguments against the adjustment but found them insufficient to justify the denial of a working capital adjustment.ConclusionsThe Tribunal allowed the assessee's request for a working capital adjustment, directing the TPO to implement the adjustment in accordance with the Tribunal's findings.SIGNIFICANT HOLDINGSThe Tribunal established several core principles in this judgment:Turnover filters must include both lower and upper limits to ensure comparability, especially in cases involving entities with significantly different turnovers.Working capital adjustments are necessary to account for differences in working capital levels between the assessee and comparable companies, ensuring accurate comparability.The TPO must adhere to the DRP's directions, including the exclusion of restructuring costs from the operating cost base.Functional dissimilarities and turnover differences are critical factors in determining comparability, and the TPO must carefully evaluate these aspects when selecting comparables.The Tribunal's final determinations on each issue resulted in the partial allowance of the assessee's appeal, with directions to the TPO to re-evaluate the comparability analysis and expense allocations in line with the Tribunal's findings and the DRP's directions.