Transfer pricing comparables revised under Section 92C, partly allowing revenue appeal and assessee cross-objections in EDS, software

ITAT partly allowed the revenue's appeal and partly allowed the assessee's cross-objections in a transfer pricing dispute. For the EDS segment, inclusion of CADSYS (India) Pvt. Ltd. was allowed, but the assessee's related grounds were treated as academic as its margin remained within arm's length. For the software development services segment, the Tribunal directed exclusion of Infosys Ltd., Three Sixty Logica Testing Services Pvt. Ltd., Indianic Infotech Ltd., Nihilent Ltd. and Cybage Software Pvt. Ltd. from the set of comparables on functional/turnover and data grounds. The issue of Evoke Technologies Ltd. was remitted to the AO/TPO for fresh consideration. The AO/TPO was directed to recompute ALP accordingly, with remaining grounds held academic.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Transfer pricing - determination of arm's length price under TNMM for the Engineering Design Services (EDS) segment based on selection of comparables and application of filters.

1.2 Transfer pricing - computation of profit level indicator (OP/OC) and adjustment to operating profit based on percentile margins of selected comparables in the EDS segment.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Transfer pricing - determination of arm's length price under TNMM for the Engineering Design Services (EDS) segment based on selection of comparables and application of filters

(a) Legal framework (as discussed)

2.1 The Tribunal records that the assessee is a captive service provider rendering software R&D and Engineering Design Services to its associated enterprises, and that a reference was made under section 92CA for computation of arm's length price of international transactions with associated enterprises.

2.2 The assessee applied the Transactional Net Margin Method (TNMM) as the most appropriate method with Profit Level Indicator (PLI) being Operating Profit to Operating Cost (OP/OC) for the EDS segment. The Transfer Pricing Officer rejected the assessee's transfer pricing study and undertook an independent comparability analysis.

(b) Interpretation and reasoning

2.3 The Tribunal notes that the assessee functions as a 100% subsidiary, operating on an extended enterprise model, performing software development and engineering design services for group entities, and that the EDS activities cover multiple vehicle modules and stages of product design and development, including execution, project set-up and monitoring, budgetary control, quality control, procurement and certain strategic and administrative functions.

2.4 The Tribunal records that, for the EDS segment, the TPO applied revised filters, rejected the assessee's TP documentation, and identified a fresh set of comparables, comprising the following entities with their weighted OP/OC margins across three years:

- Taal Tech India Ltd - 8.47%
- Prothious Engineering Services Pvt. Ltd. - 13.17%
- Axiscades Engineering Technologies Ltd. - 14.08%
- X S Cad India Pvt. Ltd - 19.78%
- L & T Technology Services Ltd. - 20.44%
- Tata Elxsi Ltd - 24.54%
- Cadsys (India) Ltd - 30.22%

2.5 The Tribunal notes that the TPO computed percentile margins for this final set of comparables - 35th percentile, median and 65th percentile - and used these to benchmark the assessee's EDS segment margin.

(c) Conclusions

2.6 For the EDS segment, the Tribunal records that the assessee's EDS segment margin (OP/OC) was 13.92% and that the TPO, after selecting the above comparables and percentile margins, proceeded to compute an adjustment to align the assessee's margin with the comparables' 35th percentile margin. The detailed adjudication on inclusion/exclusion of individual comparables and filters is not set out in the extracted portion.

Issue 2: Transfer pricing - computation of profit level indicator (OP/OC) and adjustment to operating profit based on percentile margins of selected comparables in the EDS segment

(a) Legal framework (as discussed)

2.7 The Tribunal proceeds on the basis that under TNMM, the operating profitability of the tested party (assessee) is compared to that of independent comparables using OP/OC as the profit level indicator, and that adjustments are to be made where the assessee's margin falls outside the arm's length range derived from comparables.

(b) Interpretation and reasoning

2.8 The Tribunal records the TPO's computation for the EDS segment as follows:

- Taxpayer's operating revenue (OR): ? 9,91,92,43,276
- Taxpayer's operating cost (OC): ? 8,70,69,60,789
- Taxpayer's operating profit (OP): ? 1,21,22,82,487
- Taxpayer's PLI (OP/OC): 13.92%

2.9 The Tribunal notes that, against this, the TPO adopted the 35th percentile margin of the comparable set at 16.51%, and proceeded to determine the required adjustment to the assessee's profit for the EDS segment based on the difference between 13.92% and 16.51%.

(c) Conclusions

2.10 The Tribunal records that an upward transfer pricing adjustment was proposed in the EDS segment to bring the assessee's margin in line with the comparables' percentile margin. The precise quantum of adjustment and any modification thereof by the Tribunal is not discernible from the extracted text.

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