IT Companies Excluded from Transfer Pricing Comparables Due to Functional Differences and Related Party Transactions

ITAT Bangalore held that multiple companies including Nihilent Limited, Tata Elxsi Limited, Larsen Toubro Infotech Ltd., Persistent Systems Limited, Wipro Limited, and Infosys Limited were not functionally comparable to the assessee for transfer pricing purposes and directed their exclusion from the comparable list. The companies were excluded due to functional differences, diversified activities, significant related party transactions exceeding 25% threshold, engagement in cognitive computing and software products, and turnover considerations. The matter regarding interest adjustment on outstanding receivables was remitted back to AO/TPO with direction to limit credit period to 30 days only.

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Issues Involved:
1. Validity of the final assessment order.
2. Transfer pricing adjustments.
3. Adjustment on account of interest on outstanding receivables.
4. Levy of interest under Sections 234B and 234C of the Income Tax Act.
5. Initiation of penalty proceedings under Section 270A of the Income Tax Act.

Detailed Analysis:

1. Validity of the Final Assessment Order:
The appellant argued that the final assessment order and the notice of demand dated 30 July 2022 were without jurisdiction, invalid, and bad in law as they were passed without following the procedure laid down in law. This issue was not pressed during the hearing and thus dismissed.

2. Transfer Pricing Adjustments:
The appellant raised multiple grounds related to the transfer pricing adjustments made by the AO/TPO/DRP, particularly concerning the software development services (SWD) segment and the interest on receivables.

a. Exclusion of Comparables:
The appellant sought the exclusion of certain companies from the list of comparables used for determining the Arm's Length Price (ALP). The Tribunal considered the functional dissimilarity and other factors for each company:

- Nihilent Limited: Excluded due to functional dissimilarity, as it provides high-end KPO services, business consulting, and other services not comparable to the appellant's routine SWD services.
- Tata Elxsi Limited: Excluded as it is engaged in diversified activities including product design services, innovation design engineering, and visual computing labs, which are not comparable to the appellant's services.
- Larsen & Toubro Infotech Limited: Excluded due to functional dissimilarity, as it offers a range of IT services across diverse industries, which are not comparable to the appellant's software development services.
- Persistent Systems Limited: Excluded due to significant related party transactions and involvement in product engineering services and IP products, making it functionally dissimilar.
- Wipro Limited: Excluded as it is engaged in cognitive computing, hyper-automation, robotics, cloud, analytics, and emerging technologies, which are not comparable to the appellant's services.
- Infosys Limited: Excluded due to its extensive range of services, significant turnover, and involvement in various high-end technology services, making it functionally dissimilar.

b. Adjustment on Account of Interest on Outstanding Receivables:
The appellant argued that the adjustment on account of interest on outstanding receivables amounting to INR 3,25,19,952 was unwarranted. The Tribunal considered the following points:

- Set-off of Excess Income: The appellant claimed that the excess income earned in the SWD and MSS segments already covered the alleged shortfall on account of delayed receivables. The Tribunal did not find this argument sufficient to negate the adjustment.
- Benchmarking Using EUR-LIBOR: The appellant argued that since the receivables were invoiced in Euro, the notional interest should be benchmarked using EUR-LIBOR instead of the SBI short-term deposit interest rate. The Tribunal remitted the issue to the AO/TPO for verification.
- Average Credit Period of Comparable Companies: The appellant suggested using the average credit period of comparable companies for imputation of interest. The Tribunal directed the AO/TPO to verify the details and consider the average credit period of comparable companies.

3. Levy of Interest Under Sections 234B and 234C:
The appellant contested the levy of interest under Sections 234B and 234C of the Income Tax Act. The Tribunal did not specifically address these grounds as they were not pressed during the hearing.

4. Initiation of Penalty Proceedings Under Section 270A:
The appellant argued against the initiation of penalty proceedings under Section 270A of the Income Tax Act. This issue was not pressed during the hearing and thus dismissed.

Order:
The Tribunal partly allowed the appeal for statistical purposes, remitting certain issues back to the AO/TPO for further verification and adjudication. The decision was pronounced in the open court on 10th Jan, 2024.

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