M/S.SPERIDIAN TECHNOLOGIES P. LTD,TRIVANDRUM vs. THE ACIT,CIRCLE-1(1), TRIVANDRUM, TRIVANDRUM

PER CHANDRA POOJARI: AM

This appeal filed by the assessee is directed against the directions passed

u/s. 144C(5) of the Income Tax Act, 1961 by Dispute Resolution Panel-2,

Bangalore dated 21/03/2017 for the assessment year 2013-14.

A. The appellant would submit that the impugned consequential assessment order and the DRP directions to the extent challenged hereunder, is contrary to the law, facts and circumstances of the case.

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The order, if allowed to continue, would occasion travesty of justice and cause irreparable loss and hardship to the appellant.

B. The appellant would submit that there is no justification on the part of the TPO in rejecting the comparables selected by the appellant. the comparable companies were predominantly in the same domain as the appellant. The comparable companies were selected by using capital line database and by relying on the available information such as the Annual Reports of the comparable companies, information available in the data base, and information available in the websites of the companies. The rejection of the comparable companies selected by the appellant will not stand the test.

C. The TPO unilaterally selected the comparable companies. Out of the several companies taken for study by the TPO, only 7 companies which suits the finding of the TPO were selected. The selection of 7 comparable companies is a unilateral exercise made by the TPO. Regarding the other companies which are filtered out by the TPO, there is no reason provided by the TPO, there is no reason provided by the TPO. Therefore, the entire exercise of selection of 7 comparable companies is according to the whims and fancies of the TPO. The TPO while selecting the 7 comparable companies has acted in a pre-mediated manner, more so when the TPO has selected companies to suit his TP adjustment. The entire exercise is an empty formality, when the TPO has finalized the 7 comparable companies, even before passing the TPO order. The entire proceedings which culminated in the order of assessment and DRP directions are not just and proper.

D. It is submitted that the basis for collecting information of companies under section 133(6) sways in favour of the TPO, as the appellant is not having any such privilege, while preparing the TP study. This makes the TP study of the TPO a one-sided arrangement, while the appellant is left only to accept the comparable companies selected by the TPO, in the manner best suited to the authority.

E. The TPO as well as the DRP failed to consider the fact that the risk element in the instant case is borne by the parent company in USA. Therefore, the appellant will be only having low margins, in contradistinction to the comparable companies, whose margins are high owing to the high risk coverage.

F. The appellant would submit that the lower authorities overlooked the aspect that there is no transfer of profit in the instant case, to outside India. The appellant is operating at lower profit margin due to the lower

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risk facto and therefore, at any rate, there cannot be an instance of shifting/transferring of profit outside India. There is absolutely no material to justify the transfer pricing adjustment made by the TPO, as confirmed by the DRP.

G It is submitted that to bring in rationality, the comparable companies should be with the same turnover quotient and functionally similar. It is an admitted case that the comparable companies are operating at a higher turnover marging, mainly due to the operation in diversified domain/fields and with many filters, not applicable in the case of the appellant.

H. The Working Capital Adjustment (WCA for short) made by the TPO was erroneously rejected by the DRP without considering the prime aspect as to the difference in working capital between the tested and the comparable companies. The other aspects such as functional dissimilarities, low/high risk coverage etc., also have an impact on the Working Capital Adjustment, which were overlooked by the DRP. The case law relied on by the appellant was not even considered and no reasons are given as to why the same is not accepted is also not evident from the order.

I The TPO and DRP erred in adding back the provisions of doubtful debts and finance cost, which are to be treated as part of the operational cost.

At the time of hearing, Ground Nos. C, D, E, F & I were not pressed and hence,

they are dismissed as not pressed.

grounds:

B.1 The Ld. TPO and the DRP erred in not considering the following comparable companies selected by the assessee in the Transfer Pricing study which were functionally comparable to the assessee and qualified all the filters adopted by the TPO:

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a) Infomile Technologies Ltd. b) E-Zest

The Ld. DRP erred in upholding the actions of the TPO/AO.

G.1 The TPO/AO erred on law and on facts in arbitrarily accepting the following companies without considering the turnover and size of the assessee and comparable companies which was upheld by the DRP:

) Larsen & Tubro Infotech Ltd. ii) Mindtree Ltd. iii) Persistent Systems Ltd. iv) R.S. Software (India) Pvt. Ltd. v) Tech Mahindra Ltd. vi) ICRA Techno Analytics Ltd.

The Ld. DRP erred in upholding the actions of the TPO/AO.

H.1 The Ld. DRP/Assessing Officer erred in disallowing the working capital adjustments under Rule 10B of the Income Tax Rules, 1962 which is in line with the OECD guidelines.

H.2 The Ld. DRP/Assessing Officer erred in relying on Mobis India Limited in ITA No.2112/Mds/2011 for A.Y. 200-08, reported in 38 taxmann.com 231; to reject the benefit of working capital adjustment to the assessee. The Ld. DRP has not provided any opportunity of being heard to the assessee to differentiate its own case (a services Company) from that of Mobis India Limited which is a manufacturing entity in the initial year of operations.

J.1 The Assessee wishes to include a new comparable, Akshay Technologies Limited which is functionally comparable to Appellant and qualifies all the filters adopted by the TPO.

admission of additional grounds stating that these grounds raised were in

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relation to the facts which are on record of the proceedings relating to the

assessment year 2013-14. It was also submitted that the assessee was raising

the additional grounds with bona fide intention and also in accordance with law.

It was submitted that the additional grounds are detailed/specific in form and

nature, and treated as part of the grounds in the appeal. It was submitted that

the additional grounds raised are only in relation to question of law vis-à-vis facts

already raised in the appeal filed. It was submitted that in the interest of justice,

it was only just and proper that the additional grounds raised be admitted on

record and accepted as part of grounds of appeal and adjudicated upon by the

Tribunal.

5.1 We find bona fide reasons in the act of the assessee in not raising the

additional grounds in B.1, G.1, H.1 & H.2 on an earlier occasion by placing

reliance on the judgment of the Supreme Court in the case of National Thermal

Power Corporation Ltd. vs. CIT (229 ITR 383) wherein it was held that Tribunal

has the discretion to allow or not to allow additional ground to be raised for the

first time before the Tribunal. However, we dismiss the additional ground in J.1

since the assessee has not brought on record the required facts for adjudicating

the same. Accordingly, we admit the other additional grounds for adjudication.

to rejection of following comparables:

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a) Informile Technologies Ltd. b) E-Zest

The Ld. AR submitted that in the case of Infomile Technologies, its turnover was

Rs.1.73 crores for the AY 2013-14, SWD income 75% of sales, RPT – 25%-0%,

Export income – 75% of sale-100% and Employees cost – 25% sales – 35%. In

the case of E-Zest, its turnover was Rs.21.31 crores for AY 2013-14 SWD income

– 75% of sales- 1000%, RPT filter – 25%-0.68%, Export Income – 75% of sales

– 100% and Employees cost-25% sales- 63.8%. Thus, the above companies

selected by the assessee in the Transfer Pricing Study are functionally

comparable and qualifies all the filters adopted by the TPO. Hence, these

companies are to be included in the comparables.

6.1 In our opinion, this issue was not raised before the DRP. Hence, only for

first time, this ground was raised before us. Accordingly, we remit this issue to

the file of the Assessing Officer with a direction to call for TPO order from the

TPO and decide accordingly. This ground of appeal of the assessee is partly

allowed for statistical purposes.

that the following companies are not functionally comparable on account of high

turnover:

i) Larsen & Tubro Infortech Ltd. – turnover –Rs. 3,613.42 margin-26.06%

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ii) Mindtree Ltd. turnover – Rs.2,361.8 – margin -18.19% iii) Persistent Systems Ltd.- turnover- Rs.996.75 – margin - 28.27% iv) R.S. Software (India) Pvt. Ltd. – turnover – Rs.293.22 margin 17.41% v) Tech Mahindra Ltd. – turnover- Rs.6,001.9 – margin-18.72% vi) ICRA Techno Analytics Ltd. – turnover – Rs.18,073.70 margin-17.10%

The TPO found that turnover of these companies have no impact on the margins.

In a cost plus business mode, revenue is not relevant since markup remains same

for all levels of revenue. The DRP held that these comparables cannot be rejected

on account of high turnover. According to the Ld. AR, the turnover of these

comparables are very high and assessee’s turnover is only Rs.15.61 crores and it

should be excluded.

7.1 In our opinion, if other filters are within the parameters and only on account

of turn over, the comparables cannot be excluded. We remit this issue to the file of

the Assessing Officer for making T.P. study by examining whether the other

parameters of the assessee are satisfied as per T.P. study and decide accordingly.

If the other parameters are satisfied, this is to be considered as comparable. This

ground of the assessee is partly allowed for statistical purposes.

submitted that Akshay Software Technologies Limited is functionally comparable and

passes all the filters adopted by the TPO whose turnover is 19.1 crores, SWD

income – 75% of sales – 94.4%, Export income – 75% of sales- 93.5% and

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Employees cost – 25% sales -84.4%. The assessee wanted to include Akshay

Software Technologies Limited which was functionally comparable to the assessee

and qualified all the filters adopted by the TPO.

8.1 We are of the opinion that there was no T.P. study on this issue. The assessee

has not brought on record the required facts for adjudicating this ground. Hence,

Ground J is dismissed.

erroneous rejection of working capital adjustment. The Ld. AR submitted that the

DRP disallowed the working capital adjustments under Rule 10B of the Income Tax

Rules, 1962 which is in line with the OECD guidelines by relying on the decision of

the ITAT, Madras in the case of Mobis India Limited in ITA No.2112/Mds/2011 for

A.Y. 200-08, reported in 38 taxmann.com 231. It was submitted that the DRP has

not provided any opportunity of being heard to the assessee to differentiate its

own case (a services Company) from that of Mobis India Limited which is a

manufacturing entity in the initial year of operations.

9.1 The facts of the case are that the DRP disallowed working capital

adjustment (WCA)in view of the decision of the Tribunal in ITA No

21l2/Mds/2011(AY: 2007-08) [2013] 38 taxmann.com 231. The assessee has

also tried to distinguish the decision in case of Mobis India(supra) by submitting

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that the same related to a manufacturing concern and the said company had

claimed the adjustment on an adhoc basis. The DRP observed that Rule 10B of

the Income Tax Rules, 1962 provides for making reasonably accurate

adjustments to the uncontrolled comparable transaction to eliminate the material

effects of such differences on the price, cost or profits. If the taxpayer is able to

demonstrate that difference in its working capital vis-a-vis that of the comparable

companies had affected its profit margin, adjustment is warranted provided that

such adjustment could be computed in a reasonably accurate manner. The

taxpayer has not been able to demonstrate that the working capital differences

had impacted its profits. No analysis of

a. Whether the comparable companies have financed their working capital by own funds or borrowed funds;

b. Whether any cost has been incurred on the working capital by the comparable companies and if so,

c. How the cost of such working capital has had an impact on the margins of the comparable companies has been made to demonstrate the impact of the difference in working capital. First of all, the difference in working capital levels itself cannot be accurately measured as data with regard to the working capital employed by the assessee and the comparable companies is not available on a daily basis. Even if it is available, its impact on the profit margins cannot be measured.

9.2 The DRP observed that the effort to measure impact of working capital

differences on the profit margins is fraught with difficulties:

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(i) Average working capital will not show the actual working capital employed during the year: The adjustment sought by the assessee is for the differences in the working capital levels between the tested party and the comparable companies. However, such difference in working capital levels cannot be measured with reasonable accuracy. What is disclosed in the Balance Sheet is only the opening and closing figures of Debtors and Creditors. These opening and closing figures are the balances, as they existed on the opening and closing day of the year respectively. They do not show the movements in their accounts during the year. Working capital requirements are not uniform during the entire period of the year. They differ with the changes in the working capital cycle and the regularity of sales and purchases. The working capital requirements during the year is heavily influenced by the nature of market in which the company is operating e.g. a company dealing in agricultural implements may require more working capital during sowing season while a company dealing in jewellery requires more working capital during festival or marriage season. It is commonly observed that the sales and purchases are not uniform throughout the year and consequently, the debtors and creditors tend to be uneven at various points in time during the year. From the opening and closing figures of Debtors and Creditors, the difference in working capital employed by the tested party and the comparables cannot be ascertained. The adjustment calculated with such figures would only show the difference in working capital as on a particular date. What is required is the difference in working capital levels employed throughout the year. It is possible that the difference in working capital levels calculated based on the opening and closing balances is positive, while the same difference calculated on the basis of daily balances is negative.

(ii) The segmental working capital is not disclosed in the Annual reports: In respect of companies which are engaged in multiple business segments, the results of that particular segment which is subject to the Arm's Length Price analysis alone is considered for comparative analysis. While the results of the segment in the form of profits are available in the annual reports, the segmental figures of working capital employed is not disclosed. The figures of Debtors and Creditors are disclosed in the Balance Sheet on a consolidated basis at the entity level and not for each of the segments. When such segmental working capital figures are not available, computing the working capital adjustment with the entity level figures would not be appropriate.

(iii) Disclosures in the Annual report does not contain a breakup of trade and non trade Debtors and Creditors: The disclosure of the figures of Debtors and Creditors which are important for computing the working capital adjustment does not provide the breaks trade and non-trade nature of such

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balances. Sundry creditors and debtors which are out of non-trade transactions are also clubbed with the balances outstanding out of trade transactions. It is possible that the balance out of non-trade transactions constitute a major portion in a particular case. In the absence of such breakup, the computation of working capital adjustment would be skewed. These details are normally not disclosed in the annual report.

(iv) Cost of capital is different for different companies: After working out the difference in the working capital employed between the tested party and the comparable companies, the cost of financing such working capital needs to be adjusted to eliminate the impact of such difference in working capital on the profit margins of the tested party and comparable companies. To work out the cost of working capital, the rate of return/interest is an important factor. The cost of working capital for the tested party and each of the comparable companies is different. The cost would depend on the source of funds and the credit standing of the borrower. The assumption of prime lending rate as the interest rate applicable for making the working capital adjustment suffers from risks of inaccuracy. The cost of capital for MNCs is determined more by the global interest rates rather than Indian prime lending rate. There is always difference between prime lending rate of India and that of international market rate of interest. Choosing one of these rates among multiple rates available in the market is as debatable as not allowing any working capital adjustment. Any change in the interest rate in the working capital adjustment will produce significantly different results making the results highly unscientific. Even though it is possible for the comparable companies to borrow in the world market the reality is entirely different. A company with global presence has a distinct advantage in terms of credit worthiness and ability to bargain based on its financial muscle. This is not true with most of the Indian comparable companies chosen. Therefore, to make a working capital adjustment based on such broad approximations, estimations and assumptions may not lead to reliable results.

9.3 According to the DRP, the assessee has not brought anything on record to

show that there was negative working capital and the same had impacted its

profit margins. The issue is covered by the decision of ITAT (Chennai) in the

case of M/s Mobis India Limited in ITA 2112/Mds/2011(AY: 2007-08) [2013] 38

iaxmann.com 231 (Chennai – Trib.), wherein the bench held as follows:

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"29. Coming to the aspect of adjustment pleaded by the assesses for negative working capital no doubt, in the case of Demag Cranes & Components (India) (P) Ltd. (supra), it was held that adjustment had to be granted for eliminating material effects, if any, arising out of difference in working capital between tested party and comparables. Nevertheless, we find from the said decision that the plea regarding adjustment for working capital was first raised before DRP and the DRP had decided the issue without realizing that this was never adjudicated by the TPO. As per the assessee, it was having negative working capital as against substantial positive working capital enjoyed by the comparables. If the assessee is able to demonstrate that negative working capital had effected its margins, adjustment should have been made. Assessee has indeed filed before the DRP, margins of comparables adjusted for difference in working capital, but at no point of time it had given any reason why such adjustments were required. Assessee had made adjustment on inventories, debtors and creditors, which in its opinion, reflected the difference in working capital, based on OECD guidelines. Just because assessee relied on OECD guidelines, would not mean that the adjustment made by it were required, unless the impact could be demonstrated. Such a demonstration was never done by the assessee. Here it will be relevant to have a look at the narration given by the assessee with regard to the adjustment carried out for working capital, as appearing in its transfer pricing documentation. This reads as follows:- "To elaborate, the adjustment is made by adding the debtor adjustment to sales and by adding creditor adjustment and subtracting inventory adjustment from Cost of Goods Sold for each comparable company. Here, the prime-lending rate was used as the appropriate cost of capital because it can be determined with reasonable accuracy and is the best available estimate of the cost of capital. For this purpose, the prime-lending rate of 12.50% for the year 2007, 10,80% for the year 2006 and 10.89% for the year 2005 published in CM1E and Reserve Bank of India publications were considered." What were the debtor adjustment and creditor adjustment and how these were relevant have not been demonstrated by the assessee. We are thus of the opinion that the assessee has not been able to justify the adjustments that were required to be made on account of negative working capital"

9.4 The assessee argued before the DRP that OECD guidelines allowed

adjustment as held by the Tribunal in the above case. However, it was observed

by the DRP that the same is not sufficient and the assessee is required to show

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the impact of such adjustment. Further, the issue is that of availability of

requisite data to determine the adjustment in an accurate manner so as to

measure the impact of working capital differences on the profit margins. Thus,

the DRP directed the TPO to disallow the WCA allowed to the assessee and re-

compute the ALP of the international transactions.

9.5 Against this, the assessee is in appeal before us. The Ld. AR reiterated the

submissions made before the DRP.

9.6 The Ld. DR relied on the order of the DRP.

9.7 We have heard the rival submissions and perused the record. In the present

case, the assessee was not given opportunity to differentiate its own case from that

of the order of the Tribunal in the case of Mobis India Limited (supra). Accordingly,

we remit this issue to the file of the Assessing Officer to give an opportunity to the

assessee of being heard and decide thereupon.

purposes. Order pronounced in the open court on 9th October, 2019.

sd/- sd/- (GEORGE GEORGE K.) (CHANDRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER

Place: Kochi Dated: 9th October, 2019

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GJ Copy to: 1. Speridian Technologies Private Limited, G-2, Thejaswini Technopark, Campus, Karyavattom P.O.,Trivandrum-695 581. 2. The Assistant Commissioner of Income-tax, Circle-1(1), Trivandrum. 3. The Dispute Resolution Panel-2, Bangalore, 7th Floor, BMTC Building, 80 feet Road, Koramangala, Bangalore. 4. D.R., I.T.A.T., Cochin Bench, Cochin. 5. Guard File. By Order

(ASSISTANT REGISTRAR) I.T.A.T., Cochin