TaxTMI 
TaxTMI 
2020 (2) TMI 1365
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..... During the previous year, the assessee provided SWD services to Yahoo for which it received a payment of Rs. 867,17,41,441. Since the aforesaid transaction was an international transaction, the income arising from such international transaction has to be determined in accordance with the provisions of section 92 of the Act. To justify the price received in the international transaction as one at arm's length, the assessee filed a Transfer Pricing (TP) analysis adopting the Transactional Net Margin Method (TNMM) as the most appropriate method for determining the arm's length price (ALP). The Profit Level Indicator (PLI) chosen for the purpose of comparing the assessee's profit margin with the comparable companies profit margin was Operating Profit to Operating Cost (OP/OC). The OP/OC of the assessee was arrived at in the TP analysis as follows:- 4. The assessee chose 7 comparable companies and the arithmetic average profit margin of those 7 companies was arrived at 11.41%. Since the profit margin of assessee was much higher than the profit margin of the comparable companies, the assessee claimed that the price received in the international transaction has to be regard....
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....P retained all the comparables chosen by the TPO and further directed 3 comparables chosen by the assessee to be included in the final list of comparable companies viz., CG Vak Software & Exports Ltd., E-Zest Solutions Ltd. & Daffodils Software Ltd. The DRP upheld the order of TPO regarding non-grant of working capital adjustment. Consequent to the order of DRP, the arithmetic average mean of the comparable companies stood at 24.46% and still the price was not at arm's length and the addition made in the draft assessment order stood reduced from 69,22,26,380 to Rs. 35,26,13,483 in the final assessment order against which the Assessee has filed the present appeal. The assessee is aggrieved by the aforesaid addition which was retained in the final order of assessment and hence has preferred the present appeal before the Tribunal. 9. We have heard the rival submissions. At the time of hearing, it is noticed that if 3 out of 11 comparable companies that remain after the order of DRP are adjudicated and excluded then that would mean that the profit margin of the Assessee with the remaining comparable companies would be at Arm's length and hence there would be no necessity to ad....
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....he company maintains separate books of account for the reported segments. Wherever the costs are directly identifiable with the reported segment, it has been booked to that segment. Wherever common expenses are incurred, those expenses have already been considered for allocation and relevant entries in the books of account have been passed. Hence there are no un-allocable expenses. Further, cash, investment (net of provision) and bank balances are reported at the enterprise level. Current assets and current liabilities relating to the specific business segments are identified and reported. Those, which are not identifiable, are reported as common assets/liabilities." (d) As disclosed in the annual account it is also apparent that the company has acquired intangibles during the year. Relevant portion of page 210 of PB-II is extracted hereinbelow for reference:- "d) Intangible Assets and Amortization Acquired intangible assets relating to software purchased for company's internal use are capitalised at the cost of acquisition and is amortised on the straight line method over its estimated useful life of three years, as perceived by the management or useful life of asset....
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....n this appeal and comparable companies viz., Thirdware Solutions Ltd., Infosys Ltd. & Persistent Systems Ltd. are different inasmuch as the common difference is being that these companies are not pure software development services, but are also engaged in product development and the segmental profits of the software development services segment is not available. Besides the above, company like Infosys Ltd. owns Intellectual Property Rights (IPRs), besides having big brand value and the company like Persistent Systems Ltd. also own significant intangibles, besides owning IPRs and deriving income from such IPRs. We are therefore of the view that the aforesaid 3 comparable companies should be excluded from the list of comparable companies. We hold and direct accordingly. 13. The only other issue which was argued before us was action of the revenue authorities in not providing working capital adjustment to the profit margin of the comparable companies and that of the assessee. In this regard, as we have already seen, the primary reason assigned by the TPO which was endorsed by the DRP is that the assessee has not demonstrated the impact of working capital adjustment on the profit marg....
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....ctions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can ....
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....ayment terms and compensate for the timing effect. 14. The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefiting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect. 15. A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: * A company will need fu....
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....e TPO also placed reliance on a decision of Chennai ITAT in the case of Mobis India ITA No. 2112/Mds/2011, (2013) 38 taxmann.com. That decision was based on the factual aspect that the Assessee was not able to demonstrate how working capital adjustment was arrived at by the Assessee. Therefore, nothing turns on the decision relied upon by the CIT(A) in the impugned order. In the matter of determination of Arm's Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm's Length Price. The data available with the Assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable compani....
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....between the international transaction and the comparable uncontrolled transactions which could materially affect the amount of net profit margin in the open market. It is not the case of the TPO/DRP that differences in working capital requirements of the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by the revenue authorities working capital adjustment cannot be allowed to the profit margins, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 10B(3) of the Rules, which provides as follows:- "(3) An uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged to paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such diff....
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....Length Price: 22.4.1 The median of the weighted average Profit Level indicators is taken as the arm's length margin. Please see Annexure A& B for details of computation of PLI of the comparable. Based on this, the arm's length price of the services rendered by the taxpayer to its AE(s) is computed as under: 22.4.2 The above shortfall of Rs. 322.77 Million is treated as transfer pricing adjustment u/s. 92CA in respect of software development segment of the taxpayer's international transactions." 30. The addition suggested by the TPO was incorporated by the AO in the draft order of assessment and against such draft order, the assessee preferred objections before the DRP. The DRP excluded Thirdware Solutions from the list of comparable companies and included Sasken Communication Technologies Ltd. and Cigniti Technologies Ltd. The DRP did not grant any working capital adjustment. Consequent to the relief allowed by the DRP as above, the TP adjustment and addition to be made to total income stood reduced from Rs. 32,74,23,000 to 19,86,00,800. 31. The assessee, aggrieved, by the determination of ALP as above has filed the present appeal before the Tribunal. 32. At the ti....
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....vides a limit of 26% of the equity capital carrying voting rights for treating an enterprise as Associated Enterprise. if the limit is reduced further it would only result in eliminating more and more companies, on the other hand if the limit is relaxed then companies with predominantly related party transactions would get included which would not represent uncontrolled transactions. Therefore, on a balancing note, 25% is a proper threshold limit for related party transactions. The companies having more than 25% related party transactions should therefore be rejected as comparables. The Hon'ble IT.AT has upheld the application of this filter by the TPO in its order in the case of M/s. Supporisoft India Pvt. Ltd. for AY 2005-06 in IT (TP)A 1372/B/11 & 20/2012 dated 28.03.2013 following its own decision in the case of M/s. Actis Advertisers Pvt. Ltd. vide ITA No. 5277/Del/2011 dated 12.10.2012. On perusal of the Annual Report of Persistent, we observe that the company has RPT in excess of 25% of the sales. The calculation of the same has been provided below for your case of reference: From the above computation, it is clear that the controlled transactions of Persistent con....
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....while in the case of OFFSHORE projects most of the costs are incurred in India; an ONSITE project has to be carried out abroad significantly increasing the employee cost and other costs. 65. The next objection of the Assessee is with regard to Assets employed. The companies, which predominantly generate revenues from onsite activity, do not have significant assets as most of the work is carried on the site of customer outside India. The argument that the TPO has himself observed that software service providers do not require much assets cannot be basis to accept the Assessee's plea. Those observations are made by the TPO in the context of application of turnover filter and have been quoted out of context by the Assessee. 66. The next argument of the Assessee is that TPO has held that margins are lower in onsite software services and that margin is not a criteria to select or reject a comparable under Rule 10B(2) of the I.T. Rules. We are of the view that this argument again ignores the fact that the approach of the TPO has been to highlight the fact that there can be no functional comparability, if the assets employed and risks assumed are taken into consideration. It is in....
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....d be excluded by application of RPT filter. In view of the above, we do not wish to go into other grounds on which this company is sought to be excluded viz., that it is a product company and there is no segmental data between product and services segment, presence of onsite activity and the impact of extra-ordinary event of acquisition during the relevant previous year. Therefore, this company is directed to be excluded from the list of comparable company. 38. As far as L&T Infotech Ltd. is concerned, the ld. counsel for the assessee brought to our notice the decision of ITAT Delhi Bench in the case of Saxo India Pvt. Ltd. v. ACIT, ITA No. 6148/Del/2015 for AY 2011-12, order dated 5.2.2016, wherein the Tribunal took note of the fact that this company was also trading in software and owned insignificant intangible assets. The company was excluded from the list of comparable companies with reference to SWD services provider such as the assessee. The ld. Counsel pointed out that though this decision was rendered with reference to AY 2011-12, the same reasoning would apply to AY 2015-16 also and in this regard, he drew our attention to page 696 of assessee's PB, which gives the d....
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.... times that of the assessee. 41. The next company sought to be excluded is Mindtree Ltd. The submissions made before us were as follows:- "Functionally dissimilar, diversified operation, significant R&D spend, ownership of intangibles. - Also engaged in business of rendering IP-Led revenue, infrastructure management, package implementation, consultancy services, etc. constituting 45% of overall revenue during FY 2014-15. - Diversified operation i.e. engaged in infrastructure management services, business process management, technology consulting, product engineering and SAP services. Also lacks segmental data. - Significant research & development activity. By incurring R&D expenses, it was able to deliver IP based video surveillance management, recording and analytic products and solutions. It has filed 4 patents in India and US so far in the area of Video analysis. - Ownership of intangibles in the form of intangible property. Significant onsite activity: - 46% of revenue earned under Onsite model. - Incurred overseas branch office expenses amounting to INR 1582 crores - Receives incentives from State of Florida in relation to the development center located overse....