VEVEO (INDIA) PVT LTD,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-7(1)(2), BANGALORE

This is an appeal by the assessee against the final assessment order dated 07.06.2017 passed by the Assessing Officer u/s. 143(3)

The only issue that arises for consideration in this appeal is as to whether the Transfer pricing adjustment ("TP adjustment") of Rs. 56,84,277/- made by Transfer Pricing Officer ("TPO") towards the international transaction of provision of Software Development services("SWD") to the Assessee's Associate Enterprise ("AE") which was subsequently enhanced to Rs. 78,69,258/- by the AO on giving effect to the directions of the Dispute Resolution Panel ("DRP") is valid and sustainable.

The Assessee is a company incorporated under the provisions of the Companies Act, 1956 and is a wholly owned subsidiary of Veveo Inc., USA and provides software development services to Veveo Inc.

During the previous year relevant to the assessment year 2013- 14, the Assessee provided SWD services to Veveo Inc., its Associated Enterprise ("AE") for which it received a consideration of Rs. 14,61,26,880/-. Since the transaction between the Assessee and its AE was an international transaction, the income from the said international transaction has to be determined having regard to Arm’s Length Price (ALP) as laid down in Sec.92 of the Act.

In support of its claim that the price received in the international transaction was at Arm’s Length, the Assessee filed a Transfer Pricing analysis. The Details of the Assessee's international transaction were as follows:-

The Assessee in its TP study chose the following 11 comparable companies and the arithmetic mean profit margin of those companies was 12.45%. Since the profit margin of the Assessee was much more than the comparable companies, the Assessee claimed that the transaction was at Arm’s Length:- SI. Average Name of the company No. NPI (in %) 1 Akshay Software Technologies Ltd. 5.66 RS Software (India) Ltd. 2 16.45 Spry Resources India Pvt. Ltd. 21.01 3 4 Cigniti Technologies Ltd 8.35 Persistent Systems and Solutions Ltd 16.55 5 6 KALS Information Systems Limited 9.95 Helios & Matheson Information 15.16 7 Technology Ltd. 8 Evoke Technologies Pvt Ltd 10.45 Acropetal Technologies Ltd 11.03 9 10 Sasken Communications Technologies Ltd 5.56

Out of the 11 comparables selected by the Assessee, the Transfer Pricing Officer (TPO) to whom the AO made a reference for determination of ALP u/s.92CA of the Act, accepted 2 comparables viz., RS Software (India) Ltd. and Mindtree Ltd. The TPO chose 5 more comparable companies and arrived at average arithmetic mean margin of 25.15%. Comparables selected by the TPO and their arithmetic mean SI. Mark-up on Mark-up on No. Total Costs Total Costs (WC—adj) Name of the Company (WC— unadj) (in %) (in %) 1 CG-VAK Software Exports Ltd. 20.54 25.26 2 ICRA Techno Analytics Ltd. 17.10 18.20 26.06 30.85 3 Larsen and Toubro Infotech Ltd. 4 Mindtree Ltd. (seg.) 18.19 22.60 5 Persistent Systems Ltd. 28.27 32.20 6 RS Software (India) Pvt. Ltd. 17.41 23.61 7 Tech Mahindra Ltd. (seg.) 18.72 23.33 AVERAGE MARK-UP 20.90 25.15

The TPO accordingly computed arm's length price and adjustment/addition to be made to total income as follows:- Arm's Length Mean Mark-up 20.90% Less: Working Capital Adjustment - 4.25% Adjusted mean mark-up of the comparables 25.15% Operating Cost Rs. 12,50,30,954/- Rs. 15,64,79,300/- Arm's Length Price – 125.15% of Operating Cost Price Received Rs. 15,07,95,023/- Shortfall being adjustment u/s. 92CA Rs. 56,84,277/-

The addition suggested above was incorporated by the AO in the draft order of assessment. The Assessee preferred objections to the draft order of assessment before the Dispute Resolution Panel (DRP u/s.144C of the Act. Apart from challenging the correctness of comparable companies chosen by the TPO and correctness of the action of the TPO in rejecting comparable companies chosen by the Assessee in its TP Study, the Assessee also submitted that negative Working Capital Adjustment (WCA) ought not to have been made by the TPO and thereby the average arithmetic mean margin of comparable companies were increased by 4.25%. It was submitted that working capital adjustment is made for the time value of money lost when credit time is given to the customers. The Assessee however is not an entrepreneur but a captive service provider which is entirely funded by the AEs. This being so, the assessee does not stand to lose anything as it is compensated on a total cost plus basis. The assessee is running the business without any working capital risk as compared to the comparables. Therefore, requirement for adjustment of negative working capital does not arise. It was submitted that in the Assessee's own case for assessment year 2012-13, the CIT(A) has reversed the order of the TPO making negative working capital adjustments. Detailed submissions in this regard were made before DRP which are placed at pages 154- 155 and 333-337 of the paperbook.

The DRP issued the following directions:-

Pursuant to the DRP's directions, the Respondent passed the final assessment order wherein the TP adjustment stood enhanced.

Before the Tribunal, the Assessee has raised various grounds of appeal. The gist of the grounds of appeal is prayer for the following reliefs:-

We are of the view that if Ground No.2.6 is adjudicated then there would be no necessity to adjudicate other grounds because the average arithmetic profit margin of comparable chosen by the TPO without WCA will be within the 3% (+) or (-) range to the profit margin of the Assessee which is permitted under proviso to Sec.92CA(2) of the Act and therefore there would be no necessity to make any working capital adjustment.

As far as Gr.No.2.6 is concerned, the Assessee has contended that the TPO and the DRP erred in adding to the average arithmetic profit margin of the comparable companies chosen by the TPO, negative working capital adjustment. It was submitted that Working capital adjustment is made for the time value of money lost when credit time is given to the customers. The Assessee however is not an entrepreneur but a captive service provider which is entirely funded by the AEs. This being so, the assessee does not stand to lose anything as it is compensated on a total cost plus basis. The assessee is running the business without any working capital risk as compared to the comparables. Therefore, requirement for adjustment of negative working capital does not arise. It was submitted that in the Assessee's own case for assessment year 2012-13, the CIT(A) has reversed the order of the TPO making negative working capital adjustments. Detailed submissions in this regard are placed at pages 154-155 and 333-337 of the paperbook.

The Assessee also places reliance on Digital Juice Animation Private Limited v. ACIT (order dated 06.02.2020 in IT(TP) No. 215/Bang/2017), Lam Research India Pvt Ltd, & 1385/2014 (order dated 30.04.2015) and Software AG Bangalore

On the above ground, it is undisputed that the Hyderabad Bench of the ITAT in for Assessment Year 2009-2010 in the case of Adaptec (India) P. Ltd. Vs. The ACIT, Circle 1(1), order dated 25.3.2015 held that no such addition can be made for the following reasons:- “Ground No.8 pertains to the issue of negative working capital. As briefly stated above, after arriving at the arithmetic mean of all comparables at 22.03%, the A.O. worked out negative working capital adjustment of 3.22% thereby, making arms length price at 25.25%. Even though, DRP refused to interfere with the objections of the assessee in its order, we were informed that DRP has directed the TPO/A.O. not to make any negative working capital adjustment in some of the cases in the next assessment year, in the cases of Market Tools Research P. Ltd., and Mega Systems Worldwide India P. Ltd., assessee placed on record copies of orders of DRP. In that DRP considered the issue and directed the TPO as under : "14. Ground No.11 : Negative Working Capital adjustment - Making a negative working capital adjustment without appreciating the fact that the company does not bear any working capital risks. On this issue, the assessee submitted as under : "The learned TPO determined the ALP for the international transactions with A.Es by making a negative working capital adjustment for the IT(TP)A No.1619/Bang/2017 Page 9 of 11

In view of the above, we are of the opinion that assessee's case being similar, there is no need for making any negative working capital adjustment when assessee does not carry any working capital risk. In fact, TPO should have done necessary working capital adjustment to the profits of the selected comparables so as to make them comparable to the assessee. In view of this, we direct the TPO not to make negative working capital adjustment.

It is undisputed that the Assessee is also a captive service provider such as the Assessee in the case decided by the ITAT Hyderabad Bench and therefore making a negative working capital adjustment without appreciating the fact that the company does not bear any working capital risks, was not correct. No other contrary decision was brought to our notice. Following the aforesaid decisions, we allow Gr.No.2.6 raised by the Assessee.

The TPO is directed to compute the ALP in accordance with the decision on Gr.No.2.6 after affording Assessee opportunity of being heard. In view of the decision on Gr.No.2.6, we are of the view that the grievance of the Assessee in other grounds relating to exclusion and inclusion of comparable companies raised in Gr.No.2.2, 2.3 & 2.5 does not require any adjudication and those grounds are left open without any adjudication.

The other grounds raised in its appeal in relation to its international transaction of provision of SWD services were not pressed at this stage. However, if necessary, the Assessee is allowed liberty to urge the said grounds in any future proceeding, appellate or otherwise, and in these proceedings at a future point in time.

In the result, the appeal by the assessee is partly allowed.