TaxTMI 
TaxTMI 
2020 (2) TMI 1365
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.... wholly owned subsidiary of Yahoo (non resident). 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....
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....he AO, the assessee filed objections before the Dispute Resolution Panel (DRP). The DRP 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 compa....
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....ed Assets, Current Assets, Loans and Advances, Current Liabilities and provisions are classified based on specific geographical segment's business. The 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 a....
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....rofile of the Assessee and that of the Assessee in the case of Kony IT Services Pvt. Ltd. (supra) are identical. We find that the ITAT Hyderabad has clearly brought out in its order that the functional profile of the assessee in 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....
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....ule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions 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 dome....
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....price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment 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 ....
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....e in the balance sheet does not contain break up of trade and non-trade debtors and creditors and therefore working capital adjustment done without such break up would result in computation being skewed. (iv) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results. 20. The 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....
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....so add that the complete working capital adjustment working has been given by the Assessee and a copy of the same is at page 186 to 200 of the Assessee's paper book. No defect whatsoever has been pointed out in these working by the CIT(A). We may also further add that in terms of Rule 10B(1)(e) (iii) of the Rules, the net profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences, if any, 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:- "(....
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....z., CG Vak Software & Exports Ltd., E-Zest Solutions Ltd. and Tata Elxsi Ltd. as comparable companies. The TPO on his own selected 13 other comparable companies and arrived at a set of 16 comparable companies. The average arithmetic mean profit of the comparable companies was as follows:-SWD Segment 29. The TPO did not allow the working capital adjustment and finally determined the ALP and consequent addition made to the total income as follows:- 22.4. Computation of Arm's 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....
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....cause notice issued, the learned TPO has excluded companies for which the ratio of RPT to sales exceeds 25% during the current year i.e., during FY 2014-15. The relevant extract from the show-cause notice is reproduced below for case of reference: e) Companies who have more than 25% related parry transactions of the sales were excluded. Companies having related party transactions of more than 25% are proposed to be excluded. A threshold of 25% is being applied following the provisions of Section 92A(2)(a) which provides 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....
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....ed in a transaction. The argument that if pricing structure were to be considered as criteria, then it will have to be seen as to what is the pricing structure of all the comparable for various projects cannot be accepted because the TPO has not chosen any other onsite software service provider with a revenue composition of more than 75% from onsite software services as comparable. As rightly observed by the TPO, the pricing is different in onsite when compared to offshore operations. The further observations of the TPO that the reasons for the same lie in the fact that 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 a....
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.... in coming to the conclusion that the onsite revenue filter is not applicable has placed reliance on the decision of the ITAT Mumbai Bench in the case of Capegemini as quoted in para 16 in para 14 of the TPO's order, but that decision does not deal with a case of onsite revenue filter and the decision was rendered on the facts of its own case. 37. On the issue of RPT filter, we notice that the TPO in para 16 has accepted that the RPT filter should be @ 25%. In the case of Persistent Systems Ltd., the RPT is at 31.32% as extracted in the earlier part of this order and therefore this company should 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 Delh....
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.... Commands substantial brand value. 40. The DRP, however, has not thought it fit to exclude this company by observing that this company has substantial pre-dominant revenue from software services and the growth was not attributable to any brand value. Presence of onsite activity and the expenses on R&D have all been brushed aside. In our view, the difference pointed out by the ld. counsel for the assessee before us show that this company cannot be compared with that of the assessee basically because of its business model, presence of onsite revenue generation and other reasons cited before us. Besides, the reason that turnover of this company is huge and more than 10 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 manag....
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....dentical issue while dealing with similar objections raised by the assessee in AY 2014-15, the working capital adjustment should be allowed to the assessee after affording opportunity of being heard to the Assessee. We hold and direct accordingly. 44. The AO/TPO is directed to compute the ALP after affording opportunity of being heard to the assessee and as per directions contained in this order. 45. In the result, the appeal by the assessee is partly allowed. 46. Thus, both the appeals are partly allowed. Pronounced in the open court on this 28th day of February, 2020. ============= Document 1 Particulars Income from provision of services Add: Exchange gain (Net) Operating revenue Amount (Rs) 8671741441 TOTAL EXPENSES (as per P&L) Less: Provision for doubtful advances Less: Provision for loss on fixed assets held for sale Less: Donations Operating Expenses Operating Profit OP/OC 86765355 8758506796 7322770620 6751270 5244587 7271536 7303503227 1455003569 19.92% Document 2 Amounts in Rs. Lakh S OP/OC NO NAME OF TAX PAYER OR/ SALES (in %) Ð¾Ñ OP 1 Infosys Ltd. 46,9....
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....rs Lakhs Million Revenue from operations 4,850 Other income 120 Operating Revenue 4.730 Total expenses 3,976 Less: Donation Operating Cost Operating Profit OP/OC OP/OR 9 3,967 763 19.23% 16.13% Document 7 S.No. Company Name Kals Information Systems Ltd Financial Year wise OP/OC (%) 2014-15 2013-14 2012-13 Average 5.77 16.94 13.51 11.88 Fails Export 2 E-Zest Solutions Ltd 12.59 15.80 14.05 Filter 3 CG-V AK Software & Exports Ltd. 19.87 13.81 22.07 18.50 4 Tata Elxsi Ltd. (Seg) 23.33 22.02 11.24 19.34 No data in 5 Rheal Software Pvt. Ltd. 2.76 36.64 Public 19.88 Domain 67 6 Mindtree Ltd. 20.55 21.18 19.75 20.55 7 Larsen & Toubro Infotech Ltd. 24.22 23.54 25.10 24.21 Document 8 8 R S Software (India) Ltd. 32.66 24.14 17.44 24.82 9 Infobeans Technologies Ltd. 20.70 41.95 29.22 29.91 10 Persistent Systems Ltd. 31.11 35.44 28.20 31.69 No data in 11 Nihilent Technologies Ltd. 29.19 35.72 Public 32.21 Domain No data in 12 Aspire ....